Form U5 a Top Trigger of FINRA Investigations

Most of the enforcement actions taken by the Financial Industry Regulatory Authority are focused on brokers who are "bad actors" and made "clear-cut violations" of FINRA member rules and securities laws, and they are "not close calls," according to Steven Price, senior vice president, National Cause Program for FINRA Member Supervision.

Part of the National Cause and Financial Crimes (NCFC) Detection Programs launched in 2020, the National Cause Program usually starts looking into a firm based on some "triggering" event or information it receives that raises concern, he explained during a virtual conference panel on the "Lifecycle of a FINRA Investigation" posted on FINRA's website last week.

"We see around 25,000 matters that are coming in" through the National Cause Program that it investigates, he said.

But issues in U5 Termination forms filed by FINRA-associated broker-dealer firms that fire brokers and U4 Application forms that all brokers fill out to become registered represent the No. 1 source of FINRA inquiries into firms and brokers, Price said.

Other top sources are tips from a variety of places including FINRA, the public, a firm's employees or the Securities and Exchange Commission; customer complaints; and arbitration, he said.

Meanwhile, the most frequent subjects of the matters FINRA investigates are investment strategy suitability, misrepresentations, excessive trading and fraud, he said, adding that FINRA has seen a lot of customer service issues recently.

U4 and U5 Issues

Price himself "lost sleep over how we word Form U5s" in his previous industry role as an executive at the asset services company ALPS before joining FINRA in April 2020, according to his LinkedIn profile.

"Firms often are concerned about their legal exposure when they terminate an employee, but they also have to battle with FINRA's guidance," he said, as first reported by Financial Advisor IQ on Monday.

FINRA Regulatory Notice 10-39 governs a firm's obligations to provide timely, complete and accurate information on Form U5.

Enough information must be included in the U5 by the firm so that FINRA or some future firm will "be able to reasonably determine what happened," Price explained.

However, "what oftentimes we'll see is firms sort of trying to walk that line," he pointed out. "They may provide not enough information on [it], you may see a violation of firm procedures or something a little more opaque, and I think if a firm were to put something like that on a Form U5 they are almost always going to expect a call from us."

When FINRA reviews the Form U5, it wants to know if there was any "true harm" to clients or rule violations, Price said.

On the other hand, when firms describe broker terminations for performance reasons or because brokers didn't hit sales targets, "those are generally not areas we're going to be following up on," he noted.

Two-thirds of the time, an investigation ends after FINRA staff members look at the Form U5 because they learn there was "nothing nefarious going on, according to the FINRA executive. Also, of the 25,000 matters brought to FINRA's attention each year, he said, about 8,000 move forward to the next stage of the investigation.

About three-fourths of the 8,000 or so matters are investigated through the National Cause Program, where FINRA will take a "deeper dive" into them, sometimes letting a FINRA expert in a certain matter help, he explained.

Some of the cases move on to a full investigation in which FINRA looks through records and seeks to interview people including brokers and clients, Price said, noting that generally is a "multi-month process" that is "going to be a bigger lift for us and for the firm" involved.

Ten percent or less of the matters are referred to FINRA Enforcement because of how serious they are, he added. Issues that are studied before FINRA moves on to that stage include whether a firm has made a one-time error or keeps making the same one, he said.

"Our goal, of course, is to protect investors," he explained. "Our goal is not to sit in the weeds and wait to play gotcha on firms," so it prefers to act quickly to solve a problem early than to "wait until they work their way through the enforcement process." That is why FINRA recently created an early issue identification team, he said.

"We really do give things a lot of thought" and generally there is a consensus as a team after discussing a matter, the FINRA executive went on to say, adding: "We're not looking to crush a firm with requests." FINRA just wants to reach a point where it understands what happened and can "make an intelligent decision."

Most of the industry is doing the right thing, he said.

FINRA, meanwhile, is developing tools and using technology more, and Price predicted that artificial intelligence will help it to become "a lot more efficient" in identifying violations two years from now.

Disciplinary Actions

FINRA Enforcement "brings about 700 to 800 disciplinary actions a year," according to Christopher Kelly, senior vice president and deputy head of enforcement. That may sound like a lot, but FINRA's examination program takes in more than 25,000 matters a year, he noted.

FINRA is "no longer handcuffed" to keep investigations within regions based on geography because everything can be done virtually now and the best people to handle each case can be picked for any investigation across the U.S., Kelly said, noting that "makes us a lot more efficient" now.

FINRA relies on its ability to take testimony because it does not have subpoena power like a government agency, he pointed out.

In 2020, FINRA took more than 700 on-the-record testimonies, down from the usual 800 to 900 because of the pandemic, Kelly said.

An enforcement action is also "only one tool in FINRA's toolbox, and sometimes it's not the right tool," he explained. FINRA can provide guidance to the industry in other ways besides enforcement, including public announcements, he noted.

About 95% or more of FINRA enforcement cases are settled via a letter of acceptance, waiver and consent agreement with no hearing, and there are typically less than 20 hearings a year, Kelly pointed out.