Will FINRA Rule 4111 Finally Identify Firms with Troubling Misconduct Records?

The Financial Industry Regulatory Authority (FINRA) is preparing to implement a new rule that will flag brokerage firms that have significant records of misconduct. On January 1, 2022, FINRA Rule 4111 will take effect and FINRA will evaluate thousands of broker-dealers to determine which should be labeled as “restricted.” The first evaluations will begin on June 1, 2022. This review will take place on an annual basis. Restricted broker-dealers will have to adhere to a special set of rules designed to protect investors from losses.

FINRA will use publicly available information to conduct its evaluations of firms. Investors can also check the misconduct records of both their stockbrokers and their brokerage firms using FINRA’s BrokerCheck platform. These disclosures include regulatory actions and customer complaints. Even if your brokerage firm is not on FINRA’s restricted list, you should review your firm’s record before you entrust them with your investment portfolio.

According to regulatory requirements, investors should be provided with information about their brokerage firm’s disciplinary history from the outset of their professional relationship. Under Regulation Best Interest (Regulation BI), brokerage firms are supposed to disclose fees, conflicts of interest, and whether the firm and its financial professionals have a legal or disciplinary history. This information should be disclosed in their client relationship summary (Form CRS). Firms must deliver Form CRS to their clients and post it to the firm’s website if they have one.

SEC Announces Firms that Failed to Supply Necessary Information to Investors

Certain firms have failed to comply with the requirements of Regulation BI. On February 15, 2022, the SEC announced they six advisory firms and six broker-dealers had agreed to settle charges that they failed to file their Form CRS or failed to include all the information required under Regulation BI. These most recent firms bring the total to 42 firms charged with failing to meet their Form CRS obligations.

Here are the 12 most recent firms and broker-dealers along with their settlement fines:

• Arthur Zaske & Associates, LLC, — $15,000 civil penalty.
• Banyan Securities, LLC, — $10,000 civil penalty.
• Church, Gregory, Adams Securities Corporation, — $10,000 civil penalty.
• Gutt Financial Management, LLC, — $25,000 civil penalty.
• Hinsdale Associates, Inc., — $25,000 civil penalty.
• K. Financial Services, Inc., — $10,000 civil penalty.
• V.N.G. Investments, Inc., — $15,000 civil penalty.
• Personal Financial Planning, Inc. — $25,000 civil penalty.
• Stone Run Capital, LLC — $25,000 civil penalty.
• The Winning Edge Financial Group, Inc. — $10,000 civil penalty.
• Wall Street Access — $97,523 civil penalty.
• Watermark Securities, Inc.— 25,000 civil penalty.

Investor Protection Advocates Criticize FINRA Rule 4111

FINRA Rule 4111 comes with a provision that states firms must put aside capital to pay out for investor dispute awards. In a letter, the Public Investors Advocate Bar Association points out that the new rule does not incentivize brokers to pay their outstanding awards. Even if a firm puts money in a restricted deposit account, there is nothing to suggest that this money will go toward paying previously defrauded investors.

PIABA also states that they still have concerns about the expungement process that allows many stockbrokers to delete instances of misconduct from their public records. It is a good idea to compel firms to share their record of misconduct, but that rule has limited usefulness if that record of misconduct is incomplete.

How Do Investors See Firm Records of Misconduct?

Despite the disclosure obligations, Form CRS does not necessarily make it easy to find a brokerage firm’s record of misconduct.

The Form CRS itself does not list the disciplinary history. Frustratingly, it only provides a link to investor.gov.

• Once there, it is up to the investor to enter the firm’s name or CRD number.
• That link takes investors to the firm’s FINRA BrokerCheck record, which does not show the disciplinary history.
• Investors must then click on the “Detailed Report” button to see the full record.

It can be difficult to find for those unfamiliar with the BrokerCheck system.  FINRA should do more to make these records more easily accessible to everyday investors. 

Brokerage Firms with Disciplinary Records

Certain prominent advisory firms and broker-dealers have long disciplinary records. This is a short list of firms with relevant disciplinary histories that their investors should note. The following list highlights the fact that even prominent financial institutions may have poor regulatory track records.

The list below only includes the most recent disclosures.

1. Merrill Lynch, Pierce, Fenner, and Smith (CRD #: 7691): 1,465 Disclosures

Read their full disciplinary history here.

On December 20, 2021, FINRA alleged that Merrill Lynch had not provided information about three stockbrokers during an investigation into misconduct. Merrill Lynch agreed to pay a fine of $1.2 million.

In a disclosure also dated December 20, 2021, Merrill Lynch consented to the findings that they failed to reasonably supervise the transmittal of customer funds, and as a result, failed to detect that two of its representatives had misappropriated funds from certain customers. Merrill Lynch consented to a fine of $950,000.

2. UBS Financial Services (CRD #: 8174): 892 Disclosures

Read their full disciplinary history here.

UBS Financial consented to the findings that they did not adequately supervise their stockbrokers’ 529 Plan investments. As a result, many investors were overcharged for sales fees.

FINRA ordered UBS Financial Services to return $4,059,652.95 to their customers who overpaid.

3. JP Morgan Securities (CRD #: 79): 503 Disclosures

Read their full disciplinary history here.

The Commodity Futures Trading Commission (CFTC) alleged that JP Morgan representatives had been using personal text messages and Whatsapp to communicate with customers. The CFTC alleged that JP Morgan did not collect or maintain those communications, and therefore did not fulfill their supervisory requirements.

The CFTC fined JP Morgan $75,000,000.

4. Oppenheimer (CRD #: 249): 273 Disclosures

Read their full disciplinary history here.

In 2021, FINRA and the New York Stock Exchange fined Oppenheimer $1.4 million. The allegations included failing to adhere to good business practices when executing options trading orders and misreporting realized and unrealized gain or loss information.

5. LPL Financial (CRD #: 6413): 242 disclosures

Read their full disciplinary history here. 

On December 20, 2021, LPL Financial consented to the findings that they failed to supervise their representatives and as a result, LPL stockbrokers failed to ensure that customers received sales discounts for which they were eligible. This pertained to 529 Plans.

FINRA ordered LPL Financial to repay $982,354 to investors.