Here's What Makes a Rep High Risk: FINRA

What You Need to Know

FINRA has a number of ways to spot risky brokers, including machine learning models.
Warning signs could include client complaints, outside business activities or association with high-risk firms.
Only a fraction of one percent of brokers are high risk, a FINRA official says.

The Financial Industry Regulatory Authority’s process to identify high-risk brokers is evolving with market activities, according to officials with FINRA’s High Risk Representative Program.

What makes a rep high risk? What is FINRA looking at when it’s making this determination?

Brooks Brown, senior director, and Eric Hebert and John Salerno, investigative directors in the high-risk program, set out the parameters in a recent FINRA Unscripted podcast episode, ”Keeping an Eye on Individuals Posing a Heightened Risk of Misconduct.”

A FINRA spokesperson told ThinkAdvisor in separate comments that there’s an “overlap between the types of registered representatives that the HRR team focuses on and the registered representatives who have the types of U4 disclosures that trigger Restricted Firm designation under Rule 4111.”

FINRA has “a number of different ways” to spot such individuals, Brown said, including “a machine learning model” to gauge reps’ “predicted likelihood to engage in future misconduct.”

The model also ”ranks those individuals using a number of different factors and attributes that are part of each representative’s risk profile, such as complaint disclosures, termination disclosures, financial disclosures, could be associations with risky firms, and it could be their associations with other risky representatives,” Brown said.

The machine learning aspect “views more recent events and associations, and weighs those more heavily than events that occurred many years ago,” Brown explained.

FINRA has made improvements to the model “over the years to improve its accuracy, whether by adding additional data elements to it or tweaking the machine learning approach.”

However, FINRA also relies on “internal intelligence and interactions with various parts of FINRA to identify other individuals who may be high risk and may warrant a detailed review based on what FINRA is observing,” Brown continued.

FINRA is “very mindful of the notion that birds of a feather flock together, and association risk is certainly a significant factor that we look for to identify problematic individuals,” Brown said.

Always Evolving

At the end of the day, “this whole identification process is continuous,” Brown said. ”It’s always ongoing and it’s always evolving with market activities.”

FINRA has about 620,000 registered reps, but the number of representatives FINRA has identified as high risk “is a small portion of the industry, as one might expect,” Brown relayed. ”We’re talking about a fraction of a percent.”

The model that FINRA uses to identify potentially risky reps “reviews the full population of 620,000,” Brown said. ”We don’t target it at particular firms or particular parts of the market. It really is a tool that canvasses the entire population of representatives without bias.”

High-Risk Activities

While high-risk activities can include areas such as off-channel communications, investigations have historically covered a broad range of activities and misconduct, Salerno explained.

“Common findings are excessive trading or an undisclosed business activity, or what is known as selling away, which is basically selling securities without the knowledge or approval of your broker-dealer,” Salerno said.

“Depending on the time frame, suitability is a common finding, which is now replaced with Regulation Best Interest and the care obligation,” Salerno added.

Other areas include anti-money laundering or know-your-customer issues and a “very common finding” is a violation of Rule 8210, which “essentially requires representatives to cooperate with FINRA’s investigation.”

Often, “if we’ve touched on something very significant, perhaps something with underlying misconduct that could be criminal, the representatives just won’t cooperate with the investigation,” Salerno said. “If you don’t cooperate with an investigation, then you could be sanctioned on the Rule 8210 and typically would be barred for failure to cooperate.”