To rein in the riskiest of broker-dealers, the Financial Industry Regulatory Authority (Finra) is moving ahead with a new rule that would require firms with histories that include a high level of misconduct to restricted deposit requirements
Finra sent the new rule (Restricted Firm Obligations) to the Securities and Exchange Commission for approval.
Such obligations include requiring a member firm to maintain a specific deposit amount, with cash or qualified securities, in a segregated account at a bank or clearing firm, from which the member firm could make withdrawals only with Finra's approval.
In the rule, Finra said it seeks “to impose a Restricted Deposit Requirement on member firms that present a high degree of risk to the investing public. Finra believes that the direct financial impact of a restricted deposit is most likely to change such member firms’ behavior—and therefore protect investors. An added benefit of this proposal would be to preserve member firm funds for payment of arbitration awards against them and their associated persons.”
The new rule would use numeric thresholds based on firm-level and individual-level disclosure events to impose obligations on broker-dealers that have “significantly higher levels of risk-related disclosures than similarly sized peers.”
If approved by the SEC, the new rule would allow Finra to use a multistep process to determine whether a member firm raises investor-protection concerns substantial enough to require that it be subject to additional obligations.
The regulator said that its studies find that some firms persistently employ brokers who engage in misconduct and that misconduct can be concentrated at these firms. The studies provide evidence that the past disciplinary and other regulatory events associated with a firm or individual can be predictive of similar future events, the regulator said.
“While these firms may eventually be forced out of the industry through Finra action or otherwise, these patterns indicate a persistent, if limited, population of firms with a history of misconduct that may not be acting appropriately as a first line of defense to prevent customer harm by their brokers. Such firms expose investors to real risk,” Finra said.
Finra said the new rule will help it regulate the firms that have been identified consistently hiring reps with misconduct histories and then failing to reasonably supervise their activities. “These firms generally have a retail business engaging in cold calling to make recommendations of securities, often to vulnerable customers. Finra has also identified groups of individual brokers who move from one firm of concern to another firm of concern,” the regulator said.
The new rule would also give Finra the authority to impose additional obligations on risky firms, including conditions or restrictions on the operations and activities of the member firm and its associated persons.
Finra is also seeking SEC approval to adopt procedures to create a new expedited proceeding to implement restricted deposits.