By Anne Sherry, J.D.
SEC Commissioner Hester Peirce dissented from the Commission’s approval of a FINRA rule filing allowing it to take steps to address the hiring of brokers with a history of misconduct. Among other things, the rule allows a hearing officer to restrict or condition a firm’s activities when a disciplinary matter or statutory disqualification is under review. Firms must also seek a materiality consultation with FINRA before hiring an associated person with a criminal history. Peirce said that while she supports FINRA’s goals and feels its investor-protection concerns are justified, the rule filing did not appropriately weight the concerns of due process and the right to earn a livelihood (Order Approving a Proposed Rule Change, as Modified by Amendment No. 1, to Address Brokers with a Significant History of Misconduct, Release No. 34-90635, December 10, 2020).
Rule changes. FINRA proposed the rule amendments to address investor protection concerns of misconduct by associated persons. Under the rules as amended, when a disciplinary matter is appealed to the National Adjudicatory Council or called for NAC review, a hearing officer may place conditions or restrictions on the activities of the respondent broker-dealer or associated person, and may require the member broker-dealer to adopt heightened supervisory procedures. FINRA will also require broker-dealers to adopt heightened supervision for statutorily disqualified associated persons when their eligibility request is under review and require disclosure of a broker-dealer’s status as a "taping firm." Finally, broker-dealers must seek a materiality consultation from FINRA if an individual seeking to become an owner, control person, principal, or registered person of the broker-dealer has one or more "final criminal matters" or two or more specified risk events within the last five years.
Due process. Peirce credited FINRA’s rule filing with remaining sensitive to due process concerns despite its focus on investor protection. For example, she noted that the rule that allows a hearing officer to impose restrictions or conditions pending appeal also allows the respondent to oppose the motion and appeal any such restriction or condition. On the other hand, the rule gives the hearing officer the discretion to determine what is "reasonably necessary for the purpose of preventing customer harm." While intended as a limiting principle, this standard could actually maximize the discretion available to the hearing officer: "The hearing officer need not establish that such measures are necessary; she need only show that one might reasonably conclude that they are necessary." This standard is inadequate when the viability of the firm or the livelihood of the individual are at stake, Peirce said.
Effects on livelihood. The commissioner also objected to the requirement that a firm seek a materiality consultation when an individual with a criminal conviction, or guilty or no contest plea, seeks to become an owner, control person, principal, or registered person of the firm. The SEC found that this requirement would enhance investor protection by incentivizing good hiring practices and disincentivizing higher-risk activity on the part of broker-dealers. Peirce counters that the rule is overly broad because it triggers a costly and invasive consultation process regardless of whether the firm or individual is capable of observing high standards of commercial honor and just and equitable principles of trade.
"Knowing someone is a felon tells us little about who she is as a person," Peirce continued, noting that some offenses involve unknowing violations and the prosecutor need not prove mens rea. In some cases, such as a conviction for misappropriating client assets, there is a relationship between the underlying offense and the lost employment opportunity. But where the consequences bear no relationship to the offense, "the loss of employment opportunities may be a harsher punishment than the criminal sanction." Peirce acknowledged that the rule does not bar individuals with a felony conviction from the industry but said that in practice it is likely that firms will pass on such candidates given the costs imposed by the rule.
The release is No. 34-90635.