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FINRA Violation Defense Strategies
Thursday, February 15, 2024

Violations of the Financial Industry Regulatory Authority (FINRA) Rules are more than just customer complaints. It can present substantial risks for brokerage firms and individual broker-dealers. Along with monetary fines, broker misconduct, and FINRA Rule violations can also lead to suspensions—and even bars from the securities industry in extreme cases. FINRA enforcement actions are set to prevent broker misconduct. It can lead to scrutiny from the U.S. Securities and Exchange Commission (SEC) as well, and investors may also use FINRA’s findings to pursue claims in arbitration.

As a result, when facing allegations of Rule violations from FINRA, brokerage firms and broker-dealers must assert vigorous and comprehensive defenses. Here are seven examples of defense strategies a registered firm, other firm representatives, and broker-dealers can use in these cases:

1. Identifying the Specific FINRA Rule (or FINRA Rules) at Issue

A key first step when facing a FINRA investigation is to identify the applicable securities laws at issue. FINRA enforces numerous Rules that address nearly all aspects of brokerage firms’ operations and customer relationships, private securities transactions, and different Rule violations (or alleged Rule violations) require different defenses.

There are a variety of ways to figure out what FINRA is investigating (and why). If FINRA issues a Rule 8210 letter, this letter should provide key insights into the focus of the investigation. Brokerage firms’ and broker-dealers’ counsel can also engage with FINRA’s investigators directly to gain insight into the specific private securities transaction allegations at hand.

As a corollary, when facing scrutiny from FINRA, it is important not to make any assumptions about the investigation’s focus or scope. Attempting to defend against Rule violations that aren’t at issue can lead to unnecessary disclosures and unnecessary scrutiny. Likewise, suppose a brokerage firm or broker-dealer makes assumptions and focuses on Rule violations that aren’t at issue.

In that case, this can prevent the firm or broker from defending against securities transaction allegations that are putting registered firms or brokers at risk.

2. Responding Strategically to the Rule 8210 Letter

The Rule 8210 letter is a powerful investigative tool that FINRA uses to obtain “on the record” information from targeted brokerage firms and broker-dealer firms. Firms and brokers have an affirmative duty to respond. Failure to respond can itself lead to enforcement action.

When responding to Rule 8210 letters, however, firms and brokers must do so strategically. Unnecessarily disclosing information from a customer's investment portfolio or a customer's funds or securities can be very dangerous, and even if a disclosure is inadvertent, in most cases, it cannot be undone.

Among other things, strategically responding to a Rule 8210 letter involves carefully evaluating the letter’s scope, negotiating the letter’s scope with FINRA as necessary, and ensuring that all privileged records are appropriately redacted or withheld.

3. Conducting an Independent (and Privileged) Compliance Assessment

Just as brokerage firms and broker-dealers should not assume that they know why FINRA is investigating, they also should not assume that FINRA’s allegations are valid. Instead, upon learning of an investigation, a targeted firm or broker should promptly engage counsel to conduct an independent (and privileged) compliance assessment, abiding by the just and equitable principles.

Once counsel has comprehensively identified the relevant facts and applied the relevant FINRA Rules, then counsel can formulate a targeted, cohesive, and comprehensive defense strategy based on legal and ethical guidelines.

4. Evaluating Options for Resolving the Securities Transaction Matter With No Action

When facing an investigation on commonly violated FINRA rules, the best-case scenario is to resolve the investigation with no action. Based on the defenses a targeted brokerage firm or broker-dealer has available, the firm’s or broker’s counsel should assess the feasibility of resolving the matter at the investigative stage.

If counsel can either (i) affirmatively demonstrate compliance or (ii) demonstrate that there is insufficient evidence for FINRA to move forward, both of these can potentially result in a “no action” letter that closes the investigation without further consequences.

5. Evaluating Options for Resolving the Matter Informally

If resolving a FINRA investigation without action is not feasible, then the next best option will usually be to seek to resolve the matter informally. As FINRA explains, “if [a] violation is of a minor nature and there is an absence of customer harm or detrimental market and financial situation impact, the matter may be resolved with an informal disciplinary action, such as the issuance of a Cautionary Action.”

As FINRA goes on to explain, “the staff considers while Cautionary Actions in any future disciplinary matter, these actions do not constitute formal discipline and are not reportable on FINRA's Central Registration Depository (CRD) system or Form BD.” Thus, although informal resolutions can have implications for future enforcement proceedings, they do not have any immediate adverse consequences.

6. Targeting Settlement Negotiations

If FINRA decides that formal disciplinary action is warranted—and if it appears that formal action is likely to lead to discipline—then the most strategic approach may be to target settlement negotiations. FINRA will be willing to settle in many cases, and when a settlement is on the table, mitigating the consequences of a FINRA Rule violation generally involves working to find a mutually agreeable resolution in light of the facts at hand.

7. Preparing for the Office of Hearing Officers (OHO) Hearing if Necessary

If a settlement is not on the table, or if settling is not in a brokerage firm’s or broker- dealer’s best interests, then the most effective strategy will likely be to challenge FINRA’s allegations through the formal disciplinary process. This starts with preparing to defend against FINRA’s allegations during an Office of Hearing Officers (OHO) hearing.

From affirmatively demonstrating compliance (despite FINRA’s allegations) to raising questions about the sufficiency of FINRA’s proof, there are various ways to defend against alleged Rule violations during an OHO hearing. Here, too, the key is to make a realistic assessment of the relevant facts and accurately apply all applicable substantive and procedural Rules in order to formulate a robust defense. Suppose the OHO determines that a violation has been committed.

In that case, firm representatives or registered brokers will need to work with their counsel to assess the viability of filing an appeal with the National Adjudicatory Council (NAC).

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