FINRA punishments in 2021 tell two tales

March 8, 2022 8:37 PM

Is FINRA showing its teeth? Look closely.

Last year, the Financial Industry Regulatory Authority, the self regulator of the brokerage industry, levied significantly more fines on wayward brokerages that misled or cheated investors. The watchdog also nearly doubled the amount of money it ordered sketchy broker-dealers and advisors to repay cheated customers.

Still, the two sets of figures for 2021 tell different stories, according to fresh data compiled by law firm Evershed Sutherlands.

Michael Edmiston, a lawyer and president of the Public Investors Advocate Bar Association, whose lawyers represent investors in claims and lawsuits against financial firms, said that he was “heartened by the increase in fines and regulatory activity” detailed in the analysis. But he added that he was “still disappointed that it’s still at a low level compared to what FINRA was doing in 2016.”

Wall Street’s self-regulator has long drawn criticism for not doing more to root out and discipline recidivist brokers who pile up securities-law violations and complaints from investors. Cheated customers often struggle to collect their awards. The watchdog oversaw more than 3,400 securities firms employing roughly 617,500 advisors in 2020, according to ts most recent public data.

Last year, FINRA launched a new initiative to weed out “high-risk firms” that cheat investors. But data and industry experts say the push will focus on small and mid-sized brokerages, giving larger ones a pass. Edmiston said he “would like to see the size of fines increase such that it dissuades actors from profiting from their bad behavior.”

FINRA hasn’t yet released its annual report or updated its public statistics website for 2021. For its yearly analysis of disciplinary actions by the watchdog, Eversheds compiled data from the self regulator’s monthly disciplinary reports, disciplinary actions online database and press releases.

For more on FINRA’s scrutiny of “high risk firms,” read our coverage here and here.

A fine situation

The watchdog reported levying $91 million in fines on member firms in 2021, a 60% increase on the prior year’s level. That represents the highest total in fines since 2016, when FINRA ordered $174 million in fines.

Sounds like a lot — but the boost came from a single, record-setting fine against Robinhood Financial, the online brokerage that regulators accused of misleading millions of investors. Minus that $57 million fine, levied for inappropriately letting thousands of Robinhood clients trade sophisticated options and “negligently” giving customers false information as far back as 2016, among other things, FINRA’s fines last year totaled $34 million, a plunge of more than 40% compared with 2020.

Either way, FINRA’s fines appeared to get bigger. Or is it smaller? The watchdog assessed eight fines of at least $1 million each, totaling $71 million. That’s fewer than in 2020, when it assessed 10 such “supersized” fines totaling $39 million. Likewise, FINRA assessed one “mega” fine of $5 million or more last year — on Robinhood. By contrast, 2020 saw two cases with “mega” fines totaling $22 million.

Compensating duped investors

When it came to getting brokerages to repay the customers they swindled, the story is different. Last year, FINRA ordered restitution of roughly $49 million, nearly double the $25 million it commanded in 2020. Like the fines it levied last year, the increased restitution total was driven in large part by a single, $12.6 million case — with Robinhood. But unlike fines, customer-payback totals were still up significantly, not counting the big Robinhood one — more than 45%.

What Eversheds called “supersized” restitution orders of at least $1 million helped propel this growth. There were 10 such orders totaling nearly $42 million last year.

Less discipline

FINRA reported 569 disciplinary actions in 2021, a 6% decrease from 602 in 2020 and a 4% drop from 591 in 2019. Cases against only brokerages (as opposed to cases against financial professionals or jointly against both firms and individuals) accounted for one in five of the actions, down slightly from 23% in 2020.

For more on brokers who call themselves advisors, read our coverage

here

and

here

Paging Reg BI and Form CRS

FINRA brought no cases related to Regulation Best Interest, the lower professional standard that says brokers only have to recommend “suitable” investments and merely disclose conflicts of interest, not avoid them. The higher fiduciary standard hewed to by independent advisors requires putting a customer’s best financial interests first and avoiding conflicts of interests when suggesting investment advice or products.

FINRA also brought no cases related to Form CRS. Brokers and advisors have been required since mid-2020 to provide their customers a client or customer relationship summary document detailing their fees, history of misconduct, legal troubles and conflicts of interest. Brokers and advisors self-report the information, and omissions are rife.

The Wall Street Journal found in August 2020 that forms submitted by advisors often contradicted longer disclosures filed with the SEC. It also found that roughly 20% of all brokerage and financial advisory firms falsely stated on Form CRS that neither they nor their professionals had any legal or disciplinary blemishes.

The SEC, which oversees advisors, has been more aggressive than FINRA, which oversees brokers, in cracking down on false or incomplete forms. But it appears that “the regulators are lacing up their gloves,” the Eversheds report said. So far, the SEC has brought 42 cases against firms for failing to provide customers with the form or failing to provide certain required information in a timely manner.

Nonetheless, FINRA “has signaled that it is ready to enter the ring," Eversheds said. For the past two years, the self-regulator has included Reg BI and Form CRS in its 2022 examination and risk monitoring priorities.

As such, Eversheds said that “Firms may want to carefully review FINRA’s findings, as well as those cited by the North American Securities Administrators Association (NASAA), or they may find themselves on the receiving end of a FINRA enforcement action.”

For more on Reg BI and Form CRS, read our coverage

here

and

here

Unusual SEC move

The SEC, which supervises FINRA and is the first line of appeal for brokerages and brokers who contest its decisions, overturned two FINRA rulings against two broker-dealers, an unusual move by the Wall Street regulator.
One of the rulings concerned Scottsdale Capital Advisors, a full-service brokerage in Scottsdale, Arizona, that specializes in penny stocks. In September 2021, the SEC overturned a $1.6 million fine with penalties levied by FINRA on the firm for failing to maintain internal controls and selling registered microcap securities to unnamed foreign financial institutions.

Scottsdale’s principals own Alpine Securities in Salt Lake City, another firm in hot water with FINRA over $5,000 monthly fees it charged clients.

After vacating the award by FINRA’s National Adjudicatory Council, or NAC, the SEC declined to send the case back to FINRA, leaving Scottsdale free of further disciplinary hearings on the matter. The NAC is a committee that reviews FINRA panel decisions about disciplinary actions that are disputed by either FINRA or a broker under censure or fine.

“The SEC’s setting aside one-half of the NAC’s cases in 2021 demonstrates the potential value in appealing NAC decisions,” said Eversheds partner Adam Pollet. “The SEC has made clear that it isn’t rubber-stamping FINRA’s findings, but rather giving them a hard look.”

For more on brokers who call themselves advisors, read our coverage

here

The Dirty Five

Anti-money laundering cases got more numerous, but with less financial pain for violators. FINRA reported 16 AML cases in 2021 with $4.6 million in fines, compared with 14 cases with $16.2 million in fines in 2020.
Unit investment trusts. FINRA reported five UIT cases in 2021, with $3.9 million in fines and $10.9 million in restitution. The number of cases decreased slightly from the six cases brought in 2020, while fines and restitution increased significantly from $325,000 and $1.3 million, respectively.

A UIT is an investment company that offers investors shares, or “units,” in a fixed portfolio of securities in a one-time public offering that typically terminates after 24 months. Unscrupulous brokers and advisors cheat investors by charging them fresh commissions to “roll over” the funds into new UITs.
Suitability. FINRA reported 54 cases in which brokers sold clients investments that were unsuitable for them, with $3.9 million in fines in 2021. The number of “suitability” cases increased 29% from 42 cases brought in 2020, while fines increased 109% from $1.9 million.

Trade reporting. FINRA disclosed nine trade reporting cases, with $3.4 million in fines, in 2021. The number of cases decreased 74% from the 34 cases brought in 2020, while fines decreased 51% from $7 million.

Municipal securities. FINRA reported seven municipal securities cases, with $3 million in fines in 2021. The number of cases remained flat compared with 2020, while fines increased significantly from $355,000.