Regulator blocks public scrutiny of firms with tainted brokers
Longstanding hire practices at certain firms are a threat to investors: FINRA officials
NEW YORK, June 13, (RTRS): In three years of managing investments for North Dakota farmer Richard Haus, Long Island stock broker Mike McMahon and his colleagues charged their client $267,567 in fees and interest — while losing him $261,441 on the trades, Haus said.
McMahon and others at National Securities Corporation, for instance, bought or sold between 200 and 900 shares of Apple stock for Haus nine times in about a year — racking up $27,000 in fees, according to a 2015 complaint Haus filed with the Financial Industry Regulatory Authority (FINRA).
Haus alerted the regulator to what he called improper “churning” of his account to harvest excessive fees. But the allegation could hardly have come as a surprise to FINRA, the industry’s self-regulating body, which is charged by Congress with protecting investors from unscrupulous brokers.
FINRA has fined National at least 25 times since 2000. As of earlier this year, 35 percent of National’s 714 brokers had a history of regulatory run-ins, legal disputes or personal financial difficulties that FINRA requires brokers to disclose to investors, according to a Reuters analysis of FINRA data.
McMahon did not respond to requests for comment. National declined to comment.
National is among 48 firms where at least 30 percent of brokers have such FINRA flags on their records, according to the Reuters analysis, which examined only the 12 most serious incidents among the 23 that FINRA requires brokers to disclose. That compares to 9 percent of brokers industrywide who have at least one of those 12 FINRA flags on their record.
In total, the 48 firms oversee about 4,600 brokers and billions of dollars in investor funds.
FINRA officials acknowledged in interviews with Reuters that the longstanding hiring practices at certain firms are a threat to investors. But they also argued that they can do little to stop firms from hiring high concentrations of potentially problematic brokers because doing so is not illegal.
That leaves investors like Haus vulnerable to a small group of brokerages that regularly hire advisors with blemishes on their backgrounds that would make them unemployable at most firms, former regulators and industry experts said.
The dozen FINRA flags examined by Reuters include regulatory sanctions for misconduct, employment terminations after allegations of misconduct and payments by firms to settle customer complaints. They also include brokers’ personal financial troubles, such as bankruptcies or liens for nonpayment of debts.
Last year, a FINRA official told Reuters, the regulator identified 90 firms as posing the highest risk to investors and flagged them internally for higher scrutiny. But FINRA declined to name the firms publicly or to release statistics showing the concentration of brokers with a history of FINRA flags within each firm.
In an interview with Reuters, FINRA’s executive vice president of regulatory operations, Susan Axelrod, declined to comment on any specific firm identified by Reuters. She would not directly address why the regulator will not publicly name the firms it identified as high-risk.
“Let’s just say those are not new names to us,” she said of the firms identified by Reuters.
FINRA Chief Executive Robert Cook, however, addressed its unwillingness to name names in a speech on Monday morning in Washington at Georgetown University, according to prepared remarks released by FINRA.
“We must consider fairness and due process,” Cook said. “FINRA does not possess a crystal ball — someone who we may identify as a high-risk broker for oversight purposes is not necessarily a bad actor.”
The regulator has created a dedicated unit focused on those high-risk firms, Axelrod told Reuters, but she declined to discuss its budget, staffing or specific duties. Cook on Monday said the unit included an unstated number of “examiners and managers” with experience dealing with high-risk brokers.
FINRA makes data on individual brokers’ backgrounds available through its Brokercheck website, which Axelrod said provides “unparalleled transparency” to investors. That site allows the public to search histories of complaints and sanctions against individual brokers — but only one at a time.
The regulator will not release the data in bulk form, such as a database, that would enable researchers to identify firms with high concentrations of brokers with a history of FINRA flags.
Reuters analyzed the FINRA data after receiving it from researchers at Columbia University Law School DataLab, who wrote computer code to extract it from the regulator’s website.
Reuters sought comment from officials at all 48 firms. Some responded that many of the FINRA-mandated disclosures do not necessarily equate to misconduct by brokers, such as when a firm pays a client to settle a complaint without admitting wrongdoing.
Cook, the FINRA chief, echoed that point in his speech Monday.
“A broker who has an unpaid lien because of a debt accrued due to a medical issue in her family must disclose that lien,” he said. “That event should not be treated the same as fraud or stealing money from customers.”
At least one executive from a firm identified in the Reuters analysis serves on FINRA’s 24-member Board of Governors — Brian Kovack, president of Fort Lauderdale-based Kovack Securities Inc.
Thirty-four percent of the firm’s 388 brokers have a history of FINRA flags, according to the Reuters analysis.
In a statement, Brian Kovack attributed those figures to the firm’s decision to take on a large number of new brokers from another brokerage in 2014, which prevented the firm from using its usual vetting process for new employees.
Asked why, three years later, the firm still has a high concentration of brokers with FINRA flags, Kovack said it took “considerable” time to ensure the review of new brokers’ backgrounds was “fair and transparent.”
After the review, the firm asked some advisors to leave, Kovack said, without specifying how many or the reasons they were dismissed.
FINRA is not a government agency, but rather an industry-financed “selfregulatory organization” — as FINRA puts it — that is not subject to public records laws and receives no taxpayer support.
Its annual operating budget of about $1 billion — supporting about 3,500 staffers in 16 offices — comes primarily from dues paid by member firms and individual brokers. FINRA has the power to fine, suspend and ban firms and brokers, and it can refer potentially criminal cases to the Securities and Exchange Commission (SEC).
Last year, in an unlikely collaboration, Senators Elizabeth Warren, a Democrat from Massachusetts, and Tom Cotton, a Republican from Arkansas, sent FINRA a letter demanding the regulator do more to stop broker misconduct and to prevent those with troubled histories from concentrating in the same firms.
“FINRA is not doing nearly enough to fulfill its investor protection mission,” the letter read.
The regulator responded with a letter on June 15 of last year saying that it closely oversees firms “to determine whether they present a heightened risk to investors.”
From 2013 to mid-2016, the regulator told the senators, it identified 279 “high-risk” brokers. After identifying them, the regulator permanently banned 238 brokers from the industry for subsequent violations.
FINRA oversees about 3,800 brokerages and 630,000 brokers.
In interviews with Reuters, Axelrod pointed to firms that FINRA expelled. The regulator shut down about 130 firms in the six years ending in January 2017, with many cited for securities fraud, misuse of funds or falsifying records.
But the Reuters analysis of FINRA data found that the regulator did not expel the firm’s chief executive in 58 percent of those cases, leaving him or her free to join other brokerages. The brokers at those banned firms typically were also able to continue working in the industry.
Axelrod said that FINRA gives extra scrutiny to former executives of expelled firms after they show up with new jobs at other firms.
Regulators in at least one state think more can be done to crack down on brokers and brokerages with track records of violations.
Massachusetts securities regulators are considering changing their licensing practices after completing a review last year of brokerages with a high proportion of brokers with troubled histories.
“The evidence is pretty overwhelming that there is a practice here — a history here — of people moving from one firm to another and re-offending,” Massachusetts Secretary of the Commonwealth William Galvin told Reuters. “We can’t simply stand by and say, ‘The companies will do a better job.’ They won’t do a better job unless they feel some incentive.”
Some former regulators contacted by Reuters agreed with FINRA’s policy of withholding its internal risk ratings of firms from the public.
Susan Merrill — former head of enforcement at FINRA and now a partner with the law firm Sidley Austin LLP — said that releasing such ratings would be unfair to firms who have not necessarily broken laws or regulations.
“If there is a finding by the regulator,” Merrill said, “then that’s fair game.”
FINRA’s former CEO, Richard Ketchum, told Reuters last June that the regulator was considering publicly disclosing more information about firms with high concentrations of problematic brokers.
“We are looking hard at questions about how we can appropriately and fairly provide that broader disclosure ... when firms have concentrations of persons that have similar problems,” Ketchum said in an interview.
Cook said Monday that FINRA was considering additional measures to rein in high-risk brokers, but he didn’t go into specifics.
Many of the 48 firms identified by Reuters regularly cold-call customers on the phone with high-pressure sales pitches, according to regulatory complaints and sanctions against the firms and their brokers.
Long Island, New York, has historically been a haven for boiler-room brokerages, which inspired the movie, “The Wolf of Wall Street,” based on the true story of broker Jordan Belfort and his firm, Stratton Oakmont. Belfort pleaded guilty to securities fraud and money laundering in 1999.
FINRA warned in a news release last year that boiler-room tactics were on the rise, particularly those targeting the elderly and other vulnerable investors.
Brokers generally know which firms will hire them despite past sanctions, said Dean Jeske, a lawyer at Foley & Lardner and FINRA’s former deputy regional chief counsel for enforcement in the Midwest.
“When you get a mark on your (record), it’s hard to get a job at Morgan Stanley or Merrill Lynch,” Jeske said.
Mike McMahon has had little trouble landing jobs at brokerages despite a trail of allegations and settlements.
McMahon left National in 2014 and later joined a smaller firm, Long Islandbased Worden Capital Management — where 43 percent of 79 brokers had a history of FINRA flags as of earlier this year.
Forty-one percent of the firm’s brokers had at some point in their careers worked at firms that were later expelled by FINRA, according to the Reuters analysis.
Jamie Worden, head of Worden Capital, said in a statement that his firm’s compliance team vets all prospective brokers and that FINRA-mandated disclosures do not necessarily indicate wrongdoing.
“The public disclosures only represent a sliver of the information surrounding any circumstance,” Worden said.