Broker-dealers with checkered pasts and a history of hiring brokers from expelled firms have less than four months to clean up their operations or face being publicly labeled as "high-risk," the Financial Industry Regulatory Authority (Finra) announced in February.

The deadline is part of the restricted firm rule (Rule 4111), which went into effect January 1 to address firms that have “a significant history of misconduct,” according to Finra. The self-regulatory organization said it will begin evaluating which broker-dealers will be designated as restricted on June 1.  

Finra also expects to send firms an “early indicator calculation” by early June to alert them if they meet preliminary criteria for identification as restricted, Finra said.

Calculations will be based on criteria including firms’ hiring of high-risk brokers from expelled firms, disciplinary and compliance events and unpaid arbitrations, Finra said.

The rule requires broker-dealers identified as “restricted” to publicly disclose their high-risk status publicly, deposit cash or qualified securities in a designated account to cover potential investor losses and adhere to specified restrictions, such as prohibitions on the sale of complex or esoteric products.

The regulator said it believes “that the direct financial impact of a restricted deposit is likely to change such member firms’ behavior—and therefore protect investors.”

Attorneys who represent investors gave the new rule mixed reviews. “Finra is clearly trying, and at the end of day I think it is a step in the right direction and may press some of these bad actors to add to their regulatory budget or change their practices or lastly, set aside more cash,” said Joe Wojciechowski, managing partner of Chicago-based Stoltmann Law Offices.

Wojciechowski and plaintiff attorneys, however, have a number of concerns about what they say are gaps in the new rule. Chief among them is the discretion Finra can use to decide which firms are restricted and how large a financial deposit they must set aside.

“Will a $50,000 deposit change the behavior of a five-rep New York-based firm with 90% commission payouts and unpaid arbitrations? I don’t think so,” said Wojciechowski, who has won arbitration claims for investors, only to see firms close up shop and principals declare bankruptcy.

The fact that Finra relies so heavily on adjudicated events to calculate “restricted” status is also concerning, since firms and reps both go to arbitration to expunge many “relevant” records, the attorney added.

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