Financial Planning (February 8, 2022) - As FINRA prepares to implement a new rule that takes aim at firms with a “significant history of misconduct,” lawyers, investor groups and others within the industry are only cautiously optimistic about its potential for success.

Investor groups say they would like to see Rule 4111 force compliance rather than set up incentives for brokers to stop behaving badly. Lawyers applaud its provision that calls for setting aside capital to pay out awards and other claims. And industry leaders say there are concerns over allowing pending matters to determine if a firm should be slapped with a “restricted” label.

Under the rule, FINRA will evaluate its 3,400 broker-dealers starting June 1 each year, to decide which should be categorized as restricted. The annual process will be based on the number of risk-related disclosures a firm has compared to other firms of similar size. FINRA said the restriction of a firm will be based in large part on publicly available information on BrokerCheck.

Then on July 1, FINRA will begin determining which broker-dealers meet the criteria for being categorized as restricted.

If a firm is restricted, it will have to deposit money in a restricted deposit account, the size of which will be partly based on the amount of unpaid arbitration awards and other claims it faces. The money will be used to pay those claims.

A firm is labeled restricted has the right to appeal to FINRA and may also move to correct the situation through a "one-time staff reduction," the rule states, meaning dismissal of the brokers found to have engaged in misconduct. FINRA said the rule is designed to serve as an incentive for firms to rid themselves of or not hire brokers with histories of misconduct who jump from firm to firm.

The restricted designation will be made public on BrokerCheck.

Firms will be evaluated annually, allowing restricted firms to make modifications to the practices and seek to remove the label and other obligations FINRA imposes. 

Lawyers, investor groups and the industry are encouraged by the rule but see some potential pitfalls.

Kevin Galbraith, owner of The Galbraith Law Firm in Manhattan, called it “a good start. I am encouraged after many years of watching firms get away with murder, hiring people who shouldn’t be working in the industry. Firms who have been slapped on the wrist — a $10,000 fine here and there — are going to have to account for what they have done and the culture they have allowed to flourish or even promote, a culture of non-compliance.”

The issue of when the information actually will be available to the investing public, however, causes some concern for Michael Edmiston, president of the Public Investor Advocate Bar Association and an attorney in the Law Offices of Jonathan W. Evans & Associates in Studio City, California.

“The initial finding isn’t being made public until some time later. During that window, a customer could be vulnerable,” he said, referring to the fact that evaluations take place only once each year.

Edmiston stressed PIABA’s support for the rule, however.

“It is an effort systemwide to stop the behavior of troubled brokers jumping from firm to firm when the heat gets too hot or a firm is shut down, so they scurry to the next firm,” Edmiston said.

He said this behavior often leads to arbitration awards that are never paid by firms that wind up going out of business.