FINRA Considers Substantial Changes to Enforcement Program

On June 30, the Financial Industry Regulatory Authority (FINRA) released a report (Report) prepared by two outside experts tasked with identifying “meaningful, common-sense improvements” to FINRA’s enforcement function.[1] As outlined below, the recommended changes would address many of the longstanding complaints by member firms about the enforcement program. FINRA President and CEO, Robert W. Cook, has committed to “drawing on these recommendations to strengthen [its] enforcement program, make necessary changes, and ensure it is operating in a fair, transparent, and effective manner.”[2] However, he acknowledged that, due to the “breadth and complexity of the recommendations, . . . it will take time to address them in a thoughtful and comprehensive manner.”[3] FINRA has committed to providing updates to the public on its website.[4]

The external report comes shortly after the Securities and Exchange Commission (SEC) announced meaningful changes to its Enforcement Manual[5] and while it reviews its enforcement priorities and procedures, according to Chairman Paul Atkins.[6]

The Report sets out 24 wide-ranging recommendations, including potentially narrower and more consultative Rule 8210 requests, a possible challenge mechanism to Rule 8210 requests, more robust Wells process disclosures and timing, limitations periods preventing FINRA from investigating some violations occurring over five years prior, clearer standards for cooperation credit, and less duplicative enforcement where other regulators are already acting. If implemented, the recommendations would materially change how member firms receive, negotiate, challenge, and resolve FINRA inquiries.

Below, we summarize the recommendations most consequential for member firms.

Investigation Recommendations

The recommendations most relevant to member firms concern the investigative process. The Report calls on FINRA to update policies governing both information requests generally and Rule 8210 requests in particular. Recommended enhancements include: 

• Centralized tracking to avoid duplicative requests; 

• Senior-level approval of information requests;[7]

• Pre-issuance consultation with member firms to discuss the objectives (and corresponding scope and timing) of the requests;

• Appropriate assessment of response deadlines, informed by the pre-issuance consultation mentioned above;

• Avoidance of inappropriate practices, such as contention interrogatories, seeking privileged information, or issuing post-Wells notification requests without a clear investigative purpose; and

• Evaluation of existing policies and procedures to ensure they clearly address the handling of inadvertently produced privileged materials.

The Report recommends adopting a procedural mechanism that would allow challenges to 8210 requests perceived as inappropriate in scope or burden, with those challenges being adjudicated by a neutral decision-maker. 

Regarding testimony, the Report recommends enhanced policies governing on-the-record (OTR) interviews, including: 

• Reservation of sworn testimony for matters warranting that level of formality;

• Limitation of attendance to a reasonable number of participants, with a goal of limiting to three enforcement staff members;

• Provision of access to exhibits during virtual OTRs; and

• Adherence to a pro-release presumption for OTR transcripts.

The Report also recommends that enforcement staff members avoid active attendance and participation in pre-referral exams and reviews, absent exigent circumstances. The reviewers recommend this as a way to prevent ordinary-course examinations from taking on an adversarial character.

Wells Process and Due Process Recommendations

The Report repeatedly emphasizes the need to improve procedural fairness during investigations. It recommends that member firms be given both (1) a reasonably detailed explanation of the enforcement staff’s concerns, and (2) a more meaningful opportunity to engage with enforcement staff to provide their views and engage on the merits of the basis for the referral.

With regard to the Wells process, the Report recommends updates for FINRA’s Wells procedures, including, among other recommendations, (1) encouraging “reverse proffers” and “open jacket” practices, so that potential respondents are apprised of the staff’s views on facts, law, and proposed sanctions;[8] (2) providing access to testimony transcripts immediately upon communication of a Wells notice; (3) setting Wells deadlines of no fewer than 30 days; and (4) welcoming post-Wells meetings with enforcement leadership.

Transparency and Timeliness Recommendations

A recurring theme throughout the Report is the importance of transparency. To that end, the Report recommends that FINRA revise and publish an enforcement manual that generally describes the enforcement process. Similarly, it recommends publication of enforcement workflows that show the internal lifecycle of a matter. 

The Report also recommends that FINRA improve the accessibility and searchability of disciplinary materials, ideally by making them available on third-party legal research platforms. 

The Report presents recommendations to address timeliness, aging and dormancy concerns by proposing the creation of a start-to-finish matter-tracking system that will keep respondents apprised of their status on a regular basis. Similarly, it recommends the adoption of limitation periods, suggesting that FINRA should “observe the corresponding federal statutes for all charges FINRA considers that are based on underlying violations of the federal securities laws or FINRA rules that incorporate the federal securities laws by reference.”[9] Where alleged violations do not correspond to federal law violations, the Report recommends a limitation period of five years, with some exceptions for scienter-based fraud or manipulative conduct involving customer loss. 

Settlements and Resolution Recommendations

The Report recommends several changes to how matters are resolved. It urges FINRA to revise and publish updated cooperation-credit guidance, dropping the requirement that cooperation be “extraordinary” and clarifying that credit is available on a sliding scale[10]. It recommends limiting “tag-along” Rule 2010 charges based solely on a violation of another rule that does not itself implicate unethical conduct[11], clarifying how the National Adjudicatory Council’s Sanction Guidelines apply to settled matters, providing more balanced context in letters of acceptance, waiver, and consent (AWCs), and expanding the Minor Rule Violation Plan. 

To avoid duplicative actions, the Report recommends that FINRA update its policies to avoid enforcement efforts that do not sufficiently add to what the SEC, Commodity Futures Trading Commission (CFTC), Financial Crimes Enforcement Network (FinCEN), the US Department of Justice (DOJ) or state regulators would accomplish, focusing on whether a FINRA action would be “additive.”[12]

Finally, the Report encourages continued expansion of pre-referral resolution tools, such as “Rapid Remediation,” and the streamlined post-referral resolution of technical matters where there is no investor harm, the underlying compliance issue has already been remediated, and there was a good-faith effort to comply.[13]

Takeaways

Implemented together, the recommendations would result in material improvements to FINRA’s enforcement program and benefit member firms. During investigations, member firms would be able to have more meaningful input on the scope and timing of 8210 requests and, critically, an opportunity to challenge certain inappropriate requests before a neutral decisionmaker. The adoption of “limitation periods” would prevent FINRA from punishing member firms for very old conduct and encourage it to conclude investigations more promptly. In addition, the recommendation to avoid “duplicative” actions with other regulators would address member firms’ concerns about double-dipping and unnecessarily increasing the cost, burden, and penalty for the same alleged misconduct. Finally, proposals to improve due process and transparency, and to revise cooperation credit, could result in quicker, fairer resolutions of settled matters. 

Katten has observed that FINRA has begun to adopt some of these practices by showing increased transparency about its concerns early in investigations, demonstrating flexibility with respect to information and testimony requests under Rule 8210, and closing a very significant investigation in light of a parallel SEC investigation into the same conduct. Katten will continue to monitor FINRA’s implementation efforts and provide further analysis as developments warrant. Should you have any questions, please contact your Katten attorney or one of the authors.