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FINRA shifts an unwelcome spotlight away from itself -- by training it on the brokers it oversees

The embattled SRO is spending $3.5 million to advertise BrokerCheck and is requiring its front-and-center placement on firms' websites as public demand for heightened fiduciary care grows

Wednesday, August 17, 2016 – 8:05 PM by Irwin Stein
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Alan Wolper: The biggest challenge [for FINRA] is finding a way to strike a reasonable balance between being the tough cop on the beat it yearns to convey and an industry association that actually helps its members.

Brooke’s Note: In my 16 years covering RIAs, I have perceived only one existential threat to the budding industry, if you will — namely that a registered investment advisor no longer register with the SEC but instead be compelled to register with FINRA. What galvanizes RIAs so fervently against that happening is the knowledge of how the big SRO operates and what it ultimately cares for most — itself. After all, it needs to pay for itself, justify itself and — in the absence of the latter — create the illusion that its continued existence is justified. But as its industry shrinks and a DOL ethos takes hold more broadly in the advice business, FINRA is having to exert itself harder to make the public perceive that its existence is warranted. Our reporter, Natalie Carpenter, is working on a bigger article on this topic and the Wolper quote is borrowed from here article. But some of those CYA dynamics are apparent here as FINRA shows a willingness to err on the side of throwing brokers under the bus to keep its larger chassis intact.. To be sure, some of these brokers had it coming so there are good consequences here perhaps as well as bad for investors, and ethical brokers. But it also shows the atmosphere is changing from Wall Street united to one where it’s every advisor, broker-dealer and SRO for itself. What does FINRA have to say about all of this? Absolutely nothing.

As the financial services industry scrambles to attain the level of fiduciary rigor that RIAs have always practiced, a caveat emptor component still obtains when it comes to investors using stockbrokers to “advise” under FINRA oversight.

But the efforts of the Financial Industry Regulatory Authority Inc. to up its full-disclosure quotient regarding tainted broker-dealers has some of those practitioners and observers crying foul.

Historically, registered reps have put their employers’ interests first with a we’ll-take-care-of-you wink and a nod to their customers called the suitability standard. See: Tick, tick, tick … FINRA rewrites 'culture,’ 'conflicts of interest’ and 'ethics’ into a farcical 'best interests’ code after DOL drops a bomb on its suitability ethos.

Crucial to the perceived legitimacy of that system is BrokerCheck, FINRA’s online directory of commission-based advisors that includes a Yelp-like mechanism by which investors can complain about brokers, which becomes a black mark unto itself. See: RIA advocates cry foul after international media pick up on U. of Chicago study labeling shady stock brokers as 'investment advisers’.

But amid urgent calls for Wall Street reform and questions about FINRA’s validity, the self regulatory and lobbying group has been cracking down on firms to make certain that negative information about a broker — such as felonies, litigation, bankruptcies and tax liens — are reported on the broker’s Form U-4.

As for BrokerCheck, a new rule requires firms to verify the accuracy and completeness of disclosures made by new employees within 30 days and to monitor all employees on a continuing basis. See: Can advisors keep their dirty compliance laundry in the closet thanks to lack of NASAA, SEC and FINRA coordination?.

And as of July, FINRA requires all member firms and registered representatives to include a link to BrokerCheck on the homepage of their website. This follows a June 2015 initiative in which FINRA launched a $3.5 million national advertising campaign for BrokerCheck.

Scarlett letters

But Steve Kolinsky, a managing member and founder of Kolinsky Wealth Management in Ramsey, N.J., and registered representative with American Portfolios Financial Services in Holbrook, N.Y., says that putting BrokerCheck front and center impedes the cause of full and fair disclosure because the system does not verify complaints, much less put them in context for the lay investor.

For Kolinsky and brokers like him, BrokerCheck, which is meant to shed purifying sunlight on brokers, is about as beloved as unsterilized 19th century surgical knife for two reasons: because consumer complaints appear on BrokerCheck regardless of merit and, at the other end of the spectrum, because transgressions — often serious ones — are regularly expunged.

Kolinsky, whose BrokerCheck report from FINRA shows a single customer complaint against him, says that this whipsaw effect has firms erring on the side of hiring brokers who manage to keep their BrokerChecks free of ugly marks. See: In exclusive RIABiz interview, Dawn Bennett tells how she’s striking back at SEC after a $4-million legal drubbing has left her 30-year career in shambles.

“You cannot be a top producer for 35 years and not have a client issue.” says Kolinsky.

FINRA collects information about a broker’s terminations, the reasons for the terminations and whether the broker was under investigation for investment-related issues at the time of their termination — but does not report this information on BrokerCheck.

FINRA did not respond to requests for comments on this story.

Too-tough cop?

Such imperfect disclosure illustrates lamentable mission-drift on the part of FINRA, says Alan Wolper, a partner in the Chicago office of Ulmer & Berne LLP who represents brokers, broker-dealers and investment advisors.

“I fear that FINRA has lost its identity as an SRO,” he writes in an email. “Rather than the entity that was created decades ago, which was strictly the securities industry quietly policing itself, with no publicity, no fanfare, no worries about how it would be perceived by others, FINRA today is extremely enforcement oriented, loudly extolling the number of cases it brings, the fines, the individual’s it’s barred. The one group whose approval it either takes for granted or ignores is its member firms. So, the biggest challenge that these gentleman face is finding a way to strike a reasonable balance between being the tough cop-on-the-beat it yearns to convey and an industry association that actually helps its members.”

Kolinsky is convinced that FINRA’s too-tough stance has adversely affected his career, saying that over the years he has met with various broker-dealers, among them Merrill Lynch, TD Ameritrade, Morgan Stanley, who expressed interest in hiring him or acquiring his firm but, due to the disclosures on his U4, decided against it.

“I’ve been told by many broker-dealers that their compliance departments are petrified of FINRA” he says.

Future predictor

Outgoing FINRA chairman and CEO Richard G. Ketchum has a different take on BrokerCheck, calling it a key component to FINRA’s ongoing efforts to help investors make informed choices about brokers and brokerage firms in a 2015 press release.

Ketchum has gotten support on this contention from unlikely quarters. A study conducted by researchers at the Universities of Minnesota and Chicago found that roughly 7.8% of advisors have records of misconduct. That’s as opposed to a larger study by FINRA, which found that only 1.3% of broker’s registered since 2000 have customer complaints and arbitration claims against them regarding what the study termed matters of “investor harm.”

Steven Kolinsky: I just don't want to be remembered as a rule-breaker. Steven Kolinsky: I just don’t want
to be remembered as a rule-breaker.

The actual percentage of dinged brokers is probably falls somewhere in between those two figures. But the key takeaway from the FINRA study is the high recidivism rate of offenders. Brokers with a single problem are likely to have more. The more bad marks that a broker accumulates, the more bad marks a broker will likely accumulate in the future. The FINRA study concludes that “the 20% of brokers with the highest predicted probability of investor harm are associated with more than 55 % of the investor harm cases and the total dollar investor harm.”

Kolinsky says that the customer whose complaint shows up on his U-4 really had no real ax to grind against him, that he was not named as a party in the arbitration claim and did not participate in the settlement that the firm made with the customer.

“I sold an approved broker-dealer product that went bad. Why should my U-4 show a customer dispute settlement?” See: An in-depth analysis of FINRA’s attempted takeover of RIAs and why the group should be disbanded, Part 2.

Failure to expunge

Had Kolinsky participated in the arbitration claim, he might have had the matter expunged from his record. FINRA’s arbitration rules allow arbitrators to expunge a broker’s record where the claim is factually impossible, where the registered rep was not involved in the sale of the product or if the claim was false. See: Analysis: Beware of a FINRA bearing gifts for RIAs.

Kolinsky has a regulatory problem disclosed on his BrokerCheck report as well. He discovered that a registered representative he supervised was engaged in bad conduct.

Kolinsky said he did the right thing. “I turned him in as soon as I discovered what was happening.”

The New Jersey Bureau of Securities sees it differently. The bureau brought an action against Kolinsky for failing to adequately supervise the broker. Kolinsky settled with a fine and a suspension. Then, to make matters worse, Kolinsky failed to notify other regulators, including insurance regulators in New Jersey and California, of the settlement in a timely fashion. He paid small fines for his late filings and ended up with four regulatory actions on his record from the same incident.

Kolinsky has spent a considerable amount of time and effort trying to get New Jersey officials to remove this action from his record — even taking his case as far as the New Jersey Governor’s office without success.

Hive effect

Another study — this one just released in June 2016 by the Securities Litigation and Consulting Group of Fairfax, Va. — suggests that compromised brokers who’ve been fired from firms or who have other issues disclosed on their histories seem to congregate at a relatively small number of smaller brokerage firms.

According to Craig McCann, owner of SLCG and one of the authors, in a blog post, the 12 highest-risk firms identified by the study “employ only 3.9% of registered brokers but employ 14.1% of the brokers with investor harm and 13.2% of the brokers previously terminated after customer complaints.”

The study also found that 7.71% of the registered brokers in the six highest-risk firms have been fired at least once by a previous employer after allegations of misconduct. That was 10 times the average of the 0.78% of the remaining 204 brokerage firms that they studied. See: Weighed down by nonstop fines, LPL finally buys ounce of prevention by putting ex-FINRA veterans on its payroll.

How BrokerCheck works

BrokerCheck provides the public with access to a broker’s history of customer complainants, arbitrations and regulatory actions. RIAs that are not registered with FINRA and use the SEC’s Investment Advisor Public Disclosure (IAPD) system are not included. IAPD posts an RIA’s Form ADV Part 2, which has much of the same disclosure information as BrokerCheck.

The Public Investors Arbitration Bar Association (PIABA) and other groups representing the interests of investors have complained to the SEC that “investors considering whether to hire a new broker to manage their life savings have a legitimate interest in knowing whether that person has been fired from a previous firm and the circumstances surrounding that termination.”

PIABA reasoned that “existing customers commonly follow terminated brokers to their new firm(s) and they certainly have a legitimate need to know this information to be able to determine whether the broker is trustworthy.”

Kolinsky told RIABiz that his clients are not so much troubled by his BrokerCheck report as he is and that it has not adversely affected his business. For Kolinsky it’s more of a legacy issue.

“I just don’t want to be remembered as a rule-breaker,” he says.

Natale Carpenter contributed reporting to this article.

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