Escalating Complaints and/or Potential Red Flags

Escalating Complaints and/or Potential Red Flags

When a customer complaint is received by a broker-dealer, the appropriate personnel at the member firm must promptly be notified. This is also the case when a red flag is spotted concerning a customer account. Personnel who may require notification include the account representative, the principal over that account, the branch manager, or member of the compliance team. The process of alerting the appropriate "higher ups" is referred to as escalation. Like an escalator, this process raises something to a higher level.

A complaint is a written statement by a customer-or a person acting on behalf of a customer-that alleges any grievance or dispute connected to a securities transaction or the handling of the account. Maybe a customer was recommended an investment that has suffered a large loss, an investment she now feels was unsuitable. Or, maybe the customer checks her monthly account statement and sees three purchases she doesn't recognize, with the agent claiming she told him to execute the trades.

If no resolution is reached, the firm must report the complaint to FINRAs director of arbitration. And, if the complaint involves an allegation of theft, forgery, or misappropriation of customer assets, it must be reported within 10 business days at the latest.

Broker-dealers must maintain files for customer complaints, with notes indicating what happened and how it was resolved, endorsed by a principal. Copies of customer complaints are maintained at the supervising OSJ. Within 15 days after the end of each calendar quarter member firms must electronically file information on all cus¬tomer complaints to FINRA.

Copies of customer complaints, and the quarterly filings, are required to be maintained for three years, as are many broker-dealer records.

Red flags include anything that looks suspicious to broker-dealer personnel. For example, excessive customer complaints against a registered representative often signal a pattern that should be brought to the attention of the firm's management. Any suspicious activity involving the movement of funds or securities should be taken as a red flag. And, if the account of a deceased individual shows any activity, that is an¬other example of a red flag.

Also, if the back office finds discrepancies between the address where customer account documents are delivered and the street address provided by the customer, they should treat this is a red flag. In such a case, a registered representative engaging in excessive or inappropriate transactions may be trying to mail all documents to a PO box he controls. Maybe he is engaging in expensive annuity switches he doesn't want his customer to know about. If he signs the customer's name to the paperwork and sends all the paperwork to his own PO box, he might get away with it.

For a while. The broker-dealer's procedures for handling red flags, including the proper steps for escalation to the appropriate supervisors, are designed to prevent and detect such fraudulent sales practices.
Political Contributions

Political Contributions

Political Contributions
Municipal securities are issued by states, cities, counties, school districts, etc. Therefore, many elected officials are in a position to influence which firms get to underwrite certain offerings. They could either rig the bidding process for a competitive, sealed bid, or they could manipulate the negotiated underwritings in a way that benefits those firms willing to donate to their campaign funds.

Fortunately, the securities regulators are interested in maintaining the integrity of the municipal bond underwriting process. The tax payers supporting all the school bond issues should not have to worry that some politically-connected broker-dealer is gouging them every time another bond is sold.

Therefore, if any firm makes a large political contribution, they are prohibited from doing securities business with the related issuer for a period of two years. So, if your broker-dealer is a municipal bond underwriter in New Orleans, and you make a $10,000 donation to the mayor's reelection campaign, not only must you disclose the contribution, but also you are not to do any municipal securities business with the City of New Orleans for two years.

The same would apply if a political action committee controlled by your firm funneled the money to the mayor's campaign, or if one of your "municipal finance professionals" made the contribution with her own money. For purposes of this rule, a "municipal finance professional" includes principals, registered representatives, and any paid solicitors who help firms land underwriting deals.

Firms must keep records on all contributions by the firm, their municipal finance professionals, and any associated PACs (political action committees). And, they must refrain from doing business with an issuer if large donations are made, or if donations are made to politicians that the firm and its personnel are not even in a position to vote for. To that end, if the municipal finance professional making the contribution is eligible to vote for the mayor, governor, etc. and the contribution does not exceed $250, then provided the firm keeps records of this there is no reason to refrain from doing business with the related issuer. In other words, if one of the principals lives in New Orleans and is eligible to vote for the mayor, he or she could contribute up to $250 and provided the firm disclosed this to regulators in their regular reports on such contributions, the firm could continue to underwrite securities for the City of New Orleans. So, we're not allowing the firm or one of their PACs to make such a contribution; only the individuals working for the firm who are eligible to vote for that official. And, only up to a small amount currently $250.

Quarterly, members who engage in municipal securities activities must file reports disclosing to FINRA the following information:
  •  the name and title (including any city/county/state or political subdivision) of each official of an issuer and political party receiving contributions or payments during such calendar quarter, listed by state.
  • the contribution or payment amount made and the contributor category of each person and entity making such contributions or payments during such calendar quarter.
  • a list of issuers with which the broker, dealer or municipal securities dealer has engaged in municipal securities business during such calendar quarter, listed by state, along with the type of municipal securities business.
  • records on contributions to any "bond ballot campaign" beyond the allowed $250 contribution by eligible municipal finance professionals.
Gifts and Gratuities & Non-cash Compensation

Gifts and Gratuities & Non-cash Compensation

FINRA does not allow member firms and their associated persons to buy influence at other firms with gifts of cash or gifts with resale value over a certain amount. Currently the amount is $100 but is expected to rise to $175 in the near future. Why would someone at your firm want to give someone at another firm a $1,000 set of titanium golf clubs? Maybe your firm would like to start getting invited to join certain municipal securities underwritings that they run as syndicate manager. Or, maybe your firm would just like the other firm to start throwing some of the smaller accounts they don't want your way? Maybe a case of expensive scotch would do the trick?

While gifts and business entertainment are not completely prohibited, we are now entering a gray area that can either be considered normal business expenses or a violation of FINRA rules on influencing or rewarding the employees of other member firms.

Here is how FINRA states the rule:
No member or person associated with a member shag directly or indirectly give or permit to be given anything of value, including gratuities, in excess of one hundred dollars per individual per year to any person, principal proprietor, employee, agent or representative of another person where such payment or gratuity, is in relation to the business of the employer of the recipient of the payment or gratuity. A gift  of any kind is considered a gratuity.

FINRA then makes it clear that what they are prohibiting here is more along the lines of a $1,000 set of golf clubs, as opposed to legitimate contracts of employment where one member employs another member's employee for legitimate purposes. As the rule then states:

This Rule shall not apply to contracts of employment with or to compensation for services rendered provided that there is in existence prior to the time of employment or before the services are rendered a written agreement between the member and the person who is to be employed to perform such services. Such agreement shall include the nature of the proposed employment, the amount of the proposed compensation, and the written consent of such person's employer or principal.

As with most sensitive issues, FINRA requires records surrounding these activities to be kept:
A separate record of all payments or gratuities in any amount known to the member, the employment agreement referred to in paragraph (b) and any employment compensation paid as a result thereof shall be retained by the member for the period specified by SEA Rule 17a-4.
Note that "SEA' means "Securities Exchange Act of 1934" and "SEA Rule 17a-4" would be that SEC Rule promulgated under the Securities Exchange Act of 1934.

Non-cash Compensation
Associated persons may not accept compensation from anyone other than the member firm. The only exception here is if there is an arrangement between you and the other party that your member firm agrees to, and your firm deals with a bunch of other requirements. Associated persons (you) may not accept securities from some-body else in exchange for selling variable contracts. The only non-cash compensation that can be offered or accepted is:
  • gifts that do not exceed an annual amount per person fixed periodically by the Association, and that are not preconditioned on achievement of a sales target. The gift limit is still $100, by the way.
  • an occasional meal, a ticket to a sporting event or the theater, or comparable entertainment that is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a sales target.
  • payment or reimbursement by offerors in connection with meetings held by an offeror or by a member for the purpose of training or education of associated persons of a member.
For that last bullet, the associated person must get the firm's permission to attend and his attendance and reimbursement of expenses cannot be preconditioned on meeting a sales target. Only he -not a guest- can have expenses reimbursed. The location of the meeting must be appropriate, too, meaning if the offeror's office is in Minneapolis, it looks suspicious when the meeting is held in Maui.
And, the rule states that the "member firm shall maintain records of all compensation received by the member or its associated persons from offerors. The records shall include the names of the offerors, the names of the associated persons, the amount of cash, the nature and, if known, the value of non-cash compensation received."

A firm can give their registered representatives non-cash compensation for selling variable contracts, but they can't compensate them more for selling one variable contract than for another. This rule states that the non-cash compensation arrangement requires that the credit received for each variable contract security is equally weighted.
Specific Communications Rules

Specific Communications Rules

Investment Company ProductsNew FINRA members must pre-file their retail communications at least 10 business days before first use with the Advertising Regulation Department of FINRA. That applies during their first year of association and applies to all retail communications other than free-writing prospectuses filed with the SEC—those can be filed with FINRA within 10 days but after-the-fact. Also, if a member firm has problems getting their advertising up to regulatory standards, FINRA can require that firm to pre-file all their retail communications or just the types that are causing the problems.

After their first year of registration member firms file most of their retail communications with FINRA, but within 10 days after they have already been used. On the other hand, retail communications concerning certain investments still must be pre-filed. Not only must some of these communications be pre-filed, but also members must wait to see if any changes are demanded by FINRA and must withhold using the communications until they have been approved by the regulators. As the rule states:

At least 10 business days prior to first use or publication (or such shorter period as the Department may allow), a member must file the following retail communications with the Department an withhold them from publication or circulation until any changes specified by the Department have been made.

The communications subject to this heightened requirement are:

Retail communications concerning registered investment companies that include or incorporate performance rankings or performance comparisons of the investment company with other investment companies when the ranking or comparison category is not generally published or is the creation, either directly or indirectly of the investment company, its underwriter or an affiliate. Such filings must include a copy of the data on which the ranking or comparison is based.

The rule defines "registered investment companies" as "including mutual funds, exchange-traded funds, variable insurance products, closed-end funds and unit investment trusts." So, if there is a ranking that did not come from, say, Lipper or Morning star, but, rather, by the fund or its underwriter—FINRA wants to look at that sort of publication, before it goes out.

Specific Retail Communications
Retail communications for investment company securities that contain a ranking or performance comparison used to require members to file a copy of the ranking or comparison used when filing the retail communication with FINRA. The rule was created back when FINRA staff did not have ready access to such rankings or comparisons. Now that such information is readily available online, members simply need to maintain back-up materials supporting what was cited in their retail communications.

FINRA also used to require any retail communication involving bond mutual fund volatility to be filed 10 days prior to first use. Also, any such communication had to be preceded or accompanied by a prospectus when delivered to an investor. Now, FINRA allows these retail communications to be filed within (after) 10 days of first use and has eliminated the prospectus-delivery requirement for these communications.

Members offering and providing investment analysis tools allowing customers to make their own investment decisions used to be required to provide access to the tools to FINRA staff. Now, members simply must provide such access upon FINRA's request. Members also no longer must file report templates and the retail communications themselves with FINRA.

Communications Regarding Variable Contracts
Communications about variable contracts are subject to the FINRA standards for communications generally, as well as a few that are specific to these products. First, a statement to a customer or, say, a full-page advertisement in Forbes magazine must be clear that what is being offered or advertised is a variable annuity or variable life insurance (VLI) policy and not a traditional insurance product.

Liquidity is not available on deferred variable contracts, so if a customer is sold an annuity or variable life policy thinking it makes a good short-term investment that can be liquidated for a good price, that's a problem if it turns out to be a lie. Remember that cashing in or "surrendering" a deferred variable annuity can subject the investor to a 10% penalty tax plus surrender charges/contingent deferred sales charges to the annuity company. If the customer didn't realize that, we're looking at securities fraud.

There are "guarantees" offered in variable contracts, but these guarantees are subject to the insurance company's ability to pay claims. That needs to be made clear to investors, and it needs to be made clear that "backed up by the insurance company" and "you can't lose money" are not the same thing.

Even though variable life insurance ties cash value and death benefit values to the ups and downs of the investment markets, it must be presented primarily as a life insurance product as opposed to a security. If the regulators feel that you're selling VLI as a way to invest in the stock and bond market while barely considering the more important insurance protections, you could have problems. To that end, don't compare VLI to mutual funds, stocks or bonds; compare it to other types of insurance, including term, whole life, or variable universal life (VUL) insurance.

Unlike with a mutual fund —where you never even imply what future results might be—when selling insurance, illustrations are routinely used. Chances are an agent will show illustrations of a whole life insurance policy compared to a VLI and perhaps a VUL policy. The illustrations are not guarantees, and the insurance company must be careful how they present this information. They can show a hypothetical illustration as high as a "gross rate" of 12%, provided they also show how things would work out with a "gross rate" of 0%. Whatever the maximum rate used, it must be reasonable given recent market conditions and the available investment options. Since mortality and expense charges reduce returns, illustrations must be figured using the maximum charges. Current charges may also be included.

Websites and Broker Check
FINRA requires member firms to include a prominent reference to FINRAs Broker-Check and a hyperlink to it on the initial web page intended to be viewed by retail investors, as well as on any page containing a professional profile of any registered person conducting business with retail investors. Clearly, FINRA wants to encourage investors to check out their registered representatives both before and after they start investing through them. A few minutes with Broker Check will confirm—or not—whether the individual is licensed and with which firm, as well as any disciplinary reports or arbitration awards of $15,000 or more paid out to disgruntled customers.

Public Appearances
Registered representatives frequently attract customers by holding seminars, or speaking to a local chamber of commerce, for example. This activity is called a public appearance. Member firms must establish written supervisory procedures to appropriately handle public appearances through education and training, documentation, and surveillance. Evidence that the firm has implemented such procedures must be maintained and made available to FINRA staff upon request.

If the agent uses PowerPoint slides or gives attendees a handout or DVD, these communications are subject to principal review and approval according to the rules on retail communications and correspondence.

Agents who make securities recommendations through public appearances must have a reasonable basis to believe the recommendation is suitable. And, if the agent has a conflict of interest such as receiving compensation from sales of the security, these must be clearly disclosed.

Independently Prepared Reprint
Broker-dealers and agents are not allowed to write or commission a favorable publication about the firm and then pass it off as positive press. They are also not allowed to hire English majors to churn out favorable press through fake magazines and web-sites like a propaganda machine.

On the other hand, if the firm or an agent wants to use a reprint of an article published by an unaffiliated third party, such activity is allowed subject to FINRA rules. For example, if Forbes or Bloomberg publish a favorable article about the broker-dealer, the firm can distribute this independently prepared reprint. They may not alter the article other than to correct facts or to make it confirm to FINRA rules. And, the publisher must be an independent third party.

Recordkeeping and Filing Requirements
Member firms must maintain a separate file containing retail communications and independently prepared reprints. The file must include the names of the persons who prepared and approved the communication's first use and must be maintained for 3 years from the date of its last use.

Members must also maintain records of its registered representatives' correspondence. A file showing the persons who prepared and approved the correspondence must be maintained for 3 years. Firms typically have all emails route to a central mailbox, where they can be reviewed and archived.

During its first year of operation, a FINRA member pre-files retail communications 10 business days before first use. After that, assuming the firm does not have problems getting their communications in compliance, the firm files such communications within 10 business days after first use. We explored some communications that are always subject to pre-filing, as well. And, a firm with a history of misleading communications may be required to pre-file with FINRA for a stated time or indefinitely.

FINRA may send a written request for records concerning retail communications over a stated time. Members must comply with such spot checks within the required time frame.

Research Reports

Research Reports

If you're a big Wall Street broker-dealer the research reports your analysts put out encouraging customers to buy or sell a security can have an impact on the price of the stock. So, if your research department is about to issue a "strong buy" recommendation and a glowing report on Google tomorrow morning, why not buy a boatload of Google shares today, and then release the report tomorrow? Won't that be fun? Your customers will want to buy the stock tomorrow at higher and higher prices and, heck, you'll be right here to sell it to them, at higher and higher prices. FINRA defines a research report as:

any written (including electronic) communication that includes an analysis of equity securities of individual companies or industries, and that provides information reasonably sufficient upon which to base an investment decision.

FINRA states:

Trading Ahead of Research Reports
The Board of Governors, under its statutory obligation to protect investors and enhance market quality, is issuing an interpretation to the Rules regarding a member firm's trading activities that occur in anticipation of a firm's issuance of a research report regarding a security. The Board of Governors is concerned with activities of member firms that purposefully establish or adjust the firm's inventory position in NASDAQ-,listed securities, an exchange-listed security traded in the OTC market, or a derivative security based primarily on a specific NASDAQ or exchange-listed security in anticipation of the issuance of a research report in that same security For example, a firm's research department may prepare a research report recommending the purchase of a NASDAQ: listed security. Prior to the publication and dissemination of the report, however; the trading department of the member firm might purposefully accumulate a position in that security to meet anticipated customer demand for that security. After the firm had established its position, the firm would issue the report, and thereafter fill customer orders from the member firm's inventory positions.

The Association believes that such activity is conduct which is inconsistent with just and equitable principles of trade, and not in the best interests of the investors. Thus, this interpretation prohibits a member from purposefully establishing, creating or charging the firm's inventory position in a NASDAQ-listed security, an exchange-listed security traded in the third market or a derivative security related to the underlying equity seen? in anticipation of the issuance of a research report regarding such setting by the member firm.

In the old days research analysts often functioned as cheerleaders for a company's stock to drum up investment banking business for the firm. Basically, the firms were just drawing in suckers willing to prop up the stock of a company whose CEO would become so giddy he would then do mergers and acquisitions, as well as stock and bond offerings through the firm's investment banking department. To put an end to those days, FINRA now stipulates:

 No research analyst may be subject to the supervision or control of any employee of the member's investment banking department, and no personnel engaged in investment banking activities may have any influence or control over the compensatory evaluation of  a research analyst.

Research analysts cannot participate in efforts to solicit investment banking business. Accordingly:

No research analyst may, among other things, participate in any 'pitches' for investment banking business to prospective investment banking customers, or have other communications with companies for the purpose of soliciting investment banking business.


No member may pay any bonus, salary or other form of  compensation to a research analyst that is based upon a specific investment banking services transaction.

So, the research analysts can't put out positive reports just to help the investment banking or trading departments. Surely, they can buy a few shares of the stock for themselves, their family, and friends, right?


Restrictions on Personal Trading by Research Analysts
(1) No research analyst account may purchase or receive any securities before the issuer's initial public offering if the issuer is principally engaged in the same types of business as companies that the research analyst follows.

(2) No research analyst account may purchase or sell any security issued by a company that the research analyst follows, or any option on or derivative of such security, for a period beginning 30 calendar days before and ending five calendar days after the publication of a research report concerning the company or a change in a rating or price target of the company's securities; provided that:

(A) a member may permit a research analyst account to sell securities held by the account that are issued by a company that the research analyst follows, within 30 calendar days after the research analyst began following the company for the member

So, the research analyst who's working on a "strong buy" research report on XYZ can't receive bonuses if XYZ then does investment banking through the firm, and can't go on the "road shows" for IPOs designed to drum up interest in the new issue. Also, the firm can't establish a large inventory position in XYZ to then sell it to their customers all excited by the glowing research report. And, the analyst can't buy any XYZ ahead of releasing his research report. But, surely, as the guy's golfing buddy, with an office right next door, you can look at it before the firm releases it, right?

FINRA saw that problem coming a mile away and, therefore, now stipulates that:

Non-research personnel may review a research report before its publication as necessary only to verify the factual accuracy of information in the research report or identity any potential conflict of interest, provided that (A) any written communication between non-research personnel and research department personnel concerning the content of a research report must be made either through authorized legal or compliance personnel of the member or in a transmission copied to such personnel and (B) any oral communication between non-research personnel and research department personnel concerning the content of a research report must be documented and made either through authorized legal or compliance personnel acting as intermediary or in a conversation conducted in the presence of such personnel.

But, other than that: employee of the investment banking department or any other employee of the member who is not directly responsible for investment research ("non-research personnel"), other than legal or compliance personnel, may review or approve a research report of the member before its publication.

The research report can also not be sent to the subject company except according to this:

A member may submit sections of such a research report to the subject company before its publication for review as necessary only to verify the factual accuracy of information in those sections, provided that:

(A) the sections of the research report submitted to the subject company do not contain the research summary, the research rating or the price target,

(B) a complete draft of the research report is provided to legal or compliance personnel before sections of the report are submitted to the subject company; and

(C) if after submitting the sections of the research report to the subject company the research department intends to change the proposed rating or price target, it must first provide written justification to, and receive written authorization from, legal or compliance personnel for the change. The member must retain copies of any draft and the final version of such a research report for three years following its publication.

(3) The member may notify a subject company that the member intends to change its rating of the subject company's securities, provided that the notification occurs on the business day before the member announces the rating change, after the close of trading in the principal market of the subject company's securities.

Research reports are subject to a "quiet period," meaning firms cannot publish a research report on a newly public company until 10 days after the IPO. Some smaller firms don't have their own research analysts, so they use third parties to provide reports on various securities and then deliver them to their customers. If that is the case, the member firm needs to disclose that the research was/is provided by someone else and is third-party research. Finally, research analysts are regulated by Regulation AC, which requires them to certify that their research accurately reflects their own objective, non-cash-influenced views. To that end, they also need to disclose if they or any of their immediate family members received any type of compensation (cash, options, warrants, what-have-you) for making this recommendation. This regulation applies to both research reports and public appearances by research analysts.
Communications with the Public

Communications with the Public

Communications with the Public
Before we distinguish the types of communications, let's understand the main points:
  •  A principal (compliance officer) must approve the firm's communications and file them. 
  • The communications cannot be misleading in any way.
(1) Standards Applicable to All Communications with the Public 

(A) All member communications with the public shall be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any security or type of security, industry, or service. No member may omit any material fact or qualification if the omission, in the light of the context of the M4-terial presented, would cause the communications to be misleading. 

(B) No member may make any false, exaggerated, unwarranted or misleading statement or claim in any communication with the public. No member may publish, circulate or distribute any public communication that the member knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading 

(C) Information may be placed in a legend or footnote only in the event that such placement would not inhibit an investor's understanding of the communication. 

(D) Communications with the public may not predict or project performance, imply that past performance will recur or make any exaggerated or unwarranted claim, opinion or forecast. A hypothetical illustration of mathematical principles is permitted, provided that it does not predict or project the performance of an investment or investment strategy 

(E) If any testimonial in a communication with the public concerns a technical aspect of investing, the person making the testimonial must have the knowledge and experience to form a valid opinion.

Okay. Seems fair enough - don't mislead investors through any of your communications regardless of the format. for any types of communication. Understand that all communications must be at least monitored by the firm, but that your correspondence with retail investors would not be approved before it went out. It would just be monitored, with filters and red-flag words built into the automatic monitoring system. If you send out, say 50 letters to existing retail investors, this is now considered retail communications, while in the past it would have been correspondence. The difference between correspondence—which does not have to be per-approved - and retail communications - which do - has to do with the number 25. Up to 25 retail investors = correspondence. Over 25 retail investors = retail communications.

If the communications are for only institutional investors, they are considered institutional communications. For institutional communications, each member firm simply must, "establish written procedures that are appropriate to its business, size, structure, and customers for the review by an appropriately qualified registered principal of institutional communications used by the member and its associated persons. Such procedures must be reasonably designed to ensure that institutional communications comply with applicable standards. When such procedures do not require review of all institutional communications prior to first use or distribution, they must include provision education and training of associated persons as to the firm's procedures governing institutional communications, documentation of such education and training, and surveillance and follow-up to ensure that such procedures are implemented and adhered to."

So, correspondence is not per-approved but is monitored. Institutional communications may be per-approved or not, depending on how the firm sets up its supervisory and training system. Retail communications are subject to per-approval before being first used or filed with FINRA.

Regardless of what we call it, the communication had better not be misleading. Any statement of the benefits of an investment or strategy, for example, needs to be balanced out with the associated risks involved.

Any materials that are subject to review, approval and filing are subject to this:

(1) Date of First Use and Approval Information
 The member must provide with each filing under this paragraph the actual or anticipated date of first use, the name and title of the registered principal who approved the advertisement or sales literature,and the date that the approval was given.

This is also self-explanatory:

(7) Spot-Check Procedures
In addition to the foregoing requirements, each member's written and electronic communications with the public may be subject to a spot-check procedure. Upon written request from the Department, each member must submit the material requested in a spot-check procedure within the time frame specified by the Department.

FINRA recently changed some definitions and procedures involving communications with the public. First, they added some new definitions:

"Retail communication" means any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.

"Retail investor" means any person other than an institutional investor, regardless of whether the person has an account with a member.

Then, to protect "retail investors," FINRA requires that any "retail communication" that has not already been filed with FINRA must be approved by a principal either before its first use or before filing it with FINRAs Advertising Regulation Department. And, for new member firms retail communications must be filed with FINRA at least 10 days prior to first use. This includes the content of the firm's website, and any other communication with retail investors (radio, newspaper, magazine, etc.). A retail communication could come in the form of a group email, a form letter, a chat room, or a webinar provided it involves more than 25 retail investors, it is probably a form of retail communications subject to prior principal approval.

A recent change says that firms who are intermediaries in selling investment company products (e.g., mutual funds, annuities) are not required to approve or file sales material that was already filed by someone else, usually the distributor of the fund. The intermediary selling the products could not alter the material significantly; otherwise, they would have changed it enough to require re-approval and re-filing, which is what they're trying to avoid in the first place. So, the many broker-dealers selling the American Funds TM are acting as intermediaries. Provided they don't alter the materials, they can just use the materials that have already been created and filed by the distributor of the funds, American Funds Distributors.

Members use television and other video formats to communicate with investors. Therefore, FINRA stipulates that, "If a member has filed a draft version or 'story board' of a television or video retail communication pursuant to a filing requirement, then the member also must file the final filmed version within 10 business days of first use or broadcast."

Code of Arbitration

Code of Arbitration

Code of Arbitration
When broker-dealers are arguing over money, they must take it to arbitration. Under the Code of Arbitration members of FINRA must resolve disputes with an arbi¬trator or arbitration panel, which cuts to the chase and makes their decision quickly. There are no appeals to arbitration. If they say your firm owes the other side one mil¬lion dollars, your firm must cut a check for one million dollars. End of story.
A customer is free to sue a firm or registered rep in civil court unless the customer signs the arbitration agreement. Once that's signed, the customer is also bound by the Code of Arbitration, which means they can't sue their agent of broker-dealer in civil court. Which is why most firms get their customers to sign arbitration agreements when the new account is opened. Civil court is too costly and time-consuming. Arbi¬tration can be very painful, but at least it's quick.
If the arbitration claim is for a small amount of money, Simplified Industry Arbitra¬tion is used. Here there is just one "chair-qualified" arbitrator and no hearing. The claims are submitted in writing, and the arbitrator reaches a decision.
Larger amounts of money are handled by three or five arbitrators, some from the industry and some from outside the industry. Evidence and testimony is examined, and the arbitration panel makes a final determination. Maybe they say the lead underwriter owes your firm $1 million. Maybe they say they owe nothing. Either way, all decisions are final and binding in arbitration, unlike civil court where the appeal process can go on and on.
So, if the arbitration panel says a firm owes somebody $250,000, they must pay them, promptly. Failure to comply with the arbitration decision could lead to disciplinary proceedings under Code of Procedure, which is always bad.
The bylaw doesn't specifically mention the word "money" The precise wording is:
•    • • • • • • • • • • • • •
•    any dispute, claim, or controversy arising out of or in connection •

with the business of any member of the Association, or arising out

of the employment or termination of employment of associated
•    person(s) with any member    •
•    • • • • • • • • • • • • •
While arbitrators generally don't explain their decision, FINRA requires arbitrators to explain their decision if both parties make a joint request. The parties to the arbitration are required to submit any joint request for an explained decision at least 20 days before the first scheduled hearing date. The chairperson of the arbitration panel writes the explained decision and receives an additional honorarium of $400 for doing so.
An alternative method for resolving disputes is called mediation. Let's see how FINRA describes the difference between the two processes at ArbitrationMediation/Parties/Overview/Overview0fDisputeResolutionProcess/:
•    • • • • • • • • • • • • •
•    Dispute resolution methods, including mediation and arbitration, •
•    are non judicial processes for settling disputes between two or more •
•    parties. In mediation, an impartial person, called a mediator,
assists the parties in reaching their own solution by helping to
•    diffuse emotions and keeping the parties focused on the issues. In •
•    arbitration, an impartial judge, called an arbitrator, hears all sides •
of the issue, studies the evidence, and then decides how the matter
•    •
should be resolved. The arbitrator's decision is final.
•    •
•    The mediator's role is to guide you and the other party toward    •

your own solution by helping you to define the issues clearly and

understand each other's position. Unlike an arbitrator or a judge,
•    •the mediator has no authority to decide the settlement or even    •
•    compel you to settle. The mediator's "key to success" is to focus    •
•    everyone involved on the real issues of settling--or the consequences •
•    of not settling. While the mediator may referee the negotiations--
defining the terms and rules of where, when, and how negotiations
•    •will occur--he or she never determines the outcome of the settle-

•    ment itself    •
•    • • • • • • • • • • • • •
Okay, so what if the parties try to mediate the issue but can't come to a resolution?
• • • • • • • • • • • • • •
•    When it seems that other efforts to resolve your dispute are not    •
•    working, it is then time to decide whether you will file a claim to •
arbitrate. Even if you choose, or are required to use, arbitration
•    rather than a lawsuit as a means of resolvingyour dispute, you    •
•    should consider hiring an attorney who will provide valuable in- •

struction and advice.

•    Arbitrators are people from all walks of life and all parts of    •
the country. After being trained and approved, they serve as
•    •
arbitrators when selected to hear a case. Some arbitrators work

in the securities industry; others may be teachers, homemakers,    11111
•    investors, business people, medical professionals, or lawyers. What •
•    is most important is that arbitrators are impartial to the case and • sufficiently knowledgeable in the area of controversy. Potential

arbitrators submit personal profiles to FINRA; the profiles detail •
•    their knowledge of the securities industry and investment concerns. •
•    If accepted, their names and backgrounds go into a pool from    •
which arbitrators are selected for any given case. Arbitrators do    •

not work for FINRA, though they receive an honorarium from
•    FINRA in recognition of their service.    •
•    • • • • • • • • • • • • •
FINRA also warns investors:
•    • • • • • • • • • • • • •
•    Caution. When deciding whether to arbitrate, bear in mind    •
•    that if your broker or brokerage firm goes out of business or    •

declares bankruptcy, you might not be able to recover your money-

(Tot if the arbitrator or a court rules in your favor. Over 80
•    percent of all unpaid awards involve a firm or •
•    individual that is no longer in business.    •
•    •(That is one of the reasons why it is so important to investigate    •
•    the disciplinary history of your broker or brokerage firm before you •
•    invest. For tips on how to do this please read the SEC publication • entitled Check Out Your Broker located on the SEC Investor
•    •
Education Web site. Through FINRA's BrokerCheck Program,
•    •investors, and others, can find out background information about •
•    brokers and brokerage firms.)    •
•    • • • • • • • • • • • • •
If a registered representative violates sales practice rules, and a customer makes an arbitration claim after losing money, the firm must report it on the registered (or formerly registered) representative's U4/U5 forms. As mentioned, if the amount of the award is $15,000 or more, the public will be able to find out about it, even if the plaintiff (customer) names the firm and not the registered rep specifically.
The exam could also mention that broker-dealer customers are not prevented from joining a class of plaintiffs in a class-action lawsuit. Meaning, if a large broker-dealer with offices all over the nation is found to be gouging customers on mutual fund sales through hidden charges, there could be a class-action lawsuit filed that all customers could join. Also, if an agent has a sexual harassment or civil rights case to file, that is also outside the scope of arbitration.
Code of Procedure (COP)

Code of Procedure (COP)

Code of Procedure (COP)
FINRA investigates violations of the conduct rules through Code of Procedure. When we mentioned words such as "suspend, expel, bar, and censure," those are all part of the Code of Procedure. Maybe a staff member of FINRA found out some disturbing information during a recent routine examination of a firm, or maybe a customer is upset about losing 90% this year and then found out her agent was break¬ing rules along the way.
Either way, the respondent is notified and asked to respond to the charges in writing. All requests for information must be met within 25 days. All registered persons must cooperate with the investigation, producing documents or testimony as required. And if it's decided that the respondent broke a rule, he could be censured, fined, sus¬pended, expelled, or barred.
Respondents receive an offer from FINRA to use what they call "summary complaint procedure," and if they want to avoid a hearing, they must accept it within 10 busi¬ness days. Acceptance, waiver, and consent is the term used when the respondent ac¬cepts this outcome.
On the other hand, if the respondent rejects their offer, there will be a hearing. Although not held in a court of law, the respondent typically is represented by an at-torney in these proceedings.
A third method of handling disciplinary charges is for the respondent to make an offer of settlement, in which he or they propose their own penalties.

Whether acceptance, waiver and consent (AWC), an offer of settlement, or a con¬tested hearing is used, FINRA can hand down any of the following penalties:
•    Censure
•    Fine
•    Suspension (up to 1 year) from the member firm or all member firms
•    Expelled (up to 10 years, for firms only)
•    Barred
What is the maximum fine FINRA can impose? Trick question—for a major violation, they've never set a cap. If it's a minor rule violation, there is a maximum fine (which changes from time to time), but no maximum will ever be set for the big violations.
Under COP, if the respondent is unhappy with the outcome of his hearing, he may appeal the decision, first, to FINRAs National Adjudicatory Council (NAC), then, to the SEC, and, finally, to the appropriate Federal appellate court.
That would also involve significant legal fees, and we would not find a lot of overturned disciplinary decisions through this process. But, unlike under Code of Ar-bitration—up next—there is an appeal process under Code of Procedure.
FENRA Exam Confidentiality

FENRA Exam Confidentiality

Exam Confidentiality
How serious is FINRA about protecting the surprise element in their exams?
•    • • • • • • • • • • • • •
•    FINRA considers all of its Qualification Examinations to be    •

highly confidential. The removal from an examination center, re-

production, disclosure, receipt from or passing to any person, or use
•    •for study purposes of any portion of such Qualification Examin-

•    ation, whether of a present or past series, or any other use which •
would compromise the effectiveness of the Examinations and the
•    •
use in any manner and at any time of the questions or answers to
•    •the Examinations are prohibited and are deemed to be a violation •
•    of Rule 2110.    •
•    • • • • • • • • • • • • •
FINRA also explains that:
•    • • • • • • • • • • • • •
•    An applicant cannot receive assistance while taking the examin-    •
ation. Each applicant shall certify to the Board that no assistance
•    •was given to or received by him during the examination.    •
•    • • • • • • • • • • • • •
Gifts and Gratuities

Gifts and Gratuities

Gifts and Gratuities
FINRA does not allow member firms and their associated persons to buy influence at other firms with gifts of cash or gifts with resale value over a certain amount. Currently the amount is $100 but is expected to rise to $175 in the near future. Why would someone at your firm want to give someone at another firm a $1,000 set
of titanium golf clubs? Maybe your firm would like to start getting invited to join certain municipal securities underwritings that they run as syndicate manager. Or, maybe your firm would just like the other firm to start throwing some of the smaller accounts they don't want your way? Maybe a case of expensive scotch would do the trick?
While gifts and business entertainment are not completely prohibited, we are now entering a gray area that can either be considered normal business expenses or a violation of FINRA rules on influencing or rewarding the employees of other mem¬ber firms.
Here is how FINRA states the rule:
•    • • • • • • • • • • • • •
•    No member or person associated with a member shall, directly or •
•    indirectly; give or permit to be given anything of value, including • gratuities, in excess of one hundred dollars per individual per
•    year to any person, principal, proprietor, employey agent or repre- •
•    sentative of another person where such payment or gratui0 is in    •
relation to the business of the employer of the recipient of the pay-
•    meat or gratuity. Agift of any kind is considered a gratuiy.    •
•    • • • • • • • • • • • • •
FINRA then makes it clear that what they are prohibiting here is more along the lines of a $1,000 set of golf clubs, as opposed to legitimate contracts of employment where one member employs another member's employee for legitimate purposes. As the rule then states:
•    • • • • • • • • • • • • •
•    This Rule shall not apply to contracts of employment with or    •
•    to compensation for services rendered provided that there is in    •
existence prior to the time of employment or before the services are
•    rendered a written agreement between the member and the person •
•    who is to be employed to perform such services. Such agreement    •
•    shall include the nature of the proposed employment, the amount •
of the proposed compensation, and the written consent of such
•    person's employer or principal.    •
•    • • • • • • • • • • • • •
As with most sensitive issues, FINRA requires records surrounding these activities to be kept:
• • • • • • • • • • • • • •
•    A separate record of all payments or gratuities in any amount    •
•    known to the member, the employment agreement referred to in    •
paragraph (b) and any employment compensation paid as a result
•    •thereof shall be retained by the member for the period specified by •
•    SEA Rule 17a-4.    •
•    • • • • • • • • • • • • •
Note that "SEA' means "Securities Exchange Act of 1934" and "SEA Rule 17a-4" would be that SEC Rule promulgated under the Securities Exchange Act of 1934.


FINRA requires principals to supervise registered representatives. The member firm must establish and maintain written procedures to supervise the types of business it's engaged in and must supervise the activities of registered representatives. They must also designate a principal responsible for supervising each type of business in which the firm engages, and they must designate an "OSJ" (Office of Supervisory Jurisdiction).
The firm must perform internal inspections:
•    • • • • • • • • • • • • •
•    Each member shall conduct a review at least annually, of the    •
•    businesses in which it engage; which review shall be reasonably •
•    designed to assist in detecting and preventing violations of and    •
achieving compliance with applicable securities laws and regula-
•    don; and with the Rules of this Association. Each member shall •
•    review the activities of each office, which shall include the periodic •
•    examination of customer accounts to detect and prevent irregular- •
•    ities or abuses and at least an annual inspection of each office of •
supervisogjurisdiction. Each branch office of the member shall
•    be inspected according to a cycle which shall be set forth in the    •
•    firm's written supervisory and inspection procedures.    •
•    • • • • • • • • • • • • •
This is how FINRA defines office of supervisory jurisdiction (OSJ) and branch office:
•    • • • • • • • • • • • • •
•    Branch office: any location identified by any means to the public or •
•    customers as a location at which the member conducts an invest-
ment banking or securities business
•    •
•    OSj• "Office of Supervisory jurisdiction" means any office of a •
member at which any one or more of the followingfunctions take

place:    •
•    •
(A) order execution and/or market making;
•    •
(B) structuring of public offerings or private placements;
•    •
•    (C) maintaining custody of customers' funds and/or securities;    •

(D) final acceptance (approval) of new accounts on behalf of the •
•    member;    •
•    •(E) review and endorsement of customer orders    •
•    •
(F) final approval of advertising or sales literature for use by
•    •persons associated with the member    •
•    •
(G) responsibilih,for supervising the activities of persons
•    •
associated with the member at one or more other branch offices of •
•    the member    •
•    • • • • • • • • • • • • •
More on Registration & Exemptions

More on Registration & Exemptions

More on Registration Requirements
Many people in the industry ask, "If I stop selling for a while, can I just park my license at the firm until I'm ready to use it again?"
Here is how FINRA answers that:
•    • • • • • • • • • • • • •
•    A member shall not maintain a representative registration with    •
•    FINRA for any person (1) who is no longer active in the member's •
investment banking or securities business, (2) who is no longer

 functioning as a representative, or (3) where the sole purpose is to •
•    avoid the examination requirement prescribed in paragraph (c).    •
•    • • • • • • • • • • • • •
So, if the registered representative is out for two years or more, he must take his Series 6 or Series 7 exam again. Item (3) is saying that a member firm had better not pretend the agent is associated just so he can skip the requirement to requalify by exam.
A broker-dealer also could not sponsor someone for the Series 7 exam just so the person could sit for the test and maybe tell the rest of the candidates what to expect. As the rules say:
•    • • • • • • • • • • • • •
•    A member shall not make application for the registration of any •
•    person as representative where there is no intent to employ such
person in the member's investment banking or securities business.
•    • • • • • • • • • • • • •

Exemptions from Registration
Not every employee of a broker-dealer must register. The following have been granted exemptions from the painful process you're undergoing right now:
•    • • • • • • • • • • • • •
•    Persons Exempt from Registration    •
•    (a) The following persons associated with a member are not    •
•    required to be registered with the Association:    •
•    •(1) persons associated with a member whose functions are solely •
•    and exclusively clerical or ministerial•    •
(2) persons associated with a member who are not actively engaged
•    in the investment banking or securities business;    •
•    •(3) persons associated with a member whose functions are related •
•    solely and exclusively to the member's need for nominal corporate • officers or for capital participation; and
•    •
•    (4) persons associated with a member whose functions are related • solely and exclusively to:
•    •
•    (A) effecting transactions on the floor of a national securities    •
exchange and who are registered as floor members with such
•    •
•    •
•    (B) transactions in municipal securities;    •
•    (C) transactions in commodities; or    •
•    •(D) transactions in securityfutures, provided that any such person •
•    is registered with a registeredfutures association.    •
•    • • • • • • • • • • • • •
So, if he is just doing filing/temp work, not involved with underwriting or trading securities, just sitting on the board or investing in the firm, or is a member of a futures or stock exchange filling orders for the firm, that individual is not required to register as a registered representative.


Member firms need principals who review correspondence, approve every account, initial order tickets, handle written customer complaints, and make sure there's a procedural manual for the office to use. In other words, somebody at the firm is ulti¬mately responsible for the business of the firm—that person is the principal.
FINRA says:
•    • • • • • • • • • • • • •
•    All Principals Must Be Registered    •
•    All persons engaged or to be engaged in the investment banking or •
•    securities business of a member who are to function as principals •
shall be registered as such with F1NRA in the category of regis-
•    •tration appropriate to the function to be performed as specified in •
•    Rule 1022. Before their registration can become of ffective, they    •
•    shall pass a Qualification Examination for Principals appiv-
priate to the category of registration as specified by the Board of
•    Governors.    •
•    • • • • • • • • • • • • •
Here is how FINRA defines a principal:
•    • • • • • • • • • • •
•    Definition of Principal    •
•    Persons associated with a member who are actively engaged in    •
•    the management of the member's investment banking or securities •
•    business, including supervision, solicitation, conduct of business or
the training of persons associated with a member for any of these
•    functions are designated as principals.    •
•    • • • • • • • • • • • • •
Also, note that, in general, each member must have at least two principals taking care of:

•    New accounts
•    Trades (transactions)
•    Communications
•    Written Customer Complaints
•    Updating the Written Supervisory Procedures (WSPs)
Research Analysts
A research analyst prepares the research reports put together by a member firm. To become a research analyst, one generally must earn the Series 7 and then pass an¬other license exam specifically for research analysts (Series 86 and 87).
A supervisory analyst must approve all research reports.
•    • • • • • • • • • • • • •
•    Registration of Research Analysts    •
•    •(a) All persons associated with a member who are to function as •
•    research analysts shall be registered with FINRA.    •
•    • • • • • • • • • • • • •

FINRA Membership

FINRA Membership

FINRA Membership
If your firm wants to join FINRA, it must:
•    meet net capital requirements
•    have at least two principals to supervise the firm
•    have an acceptable business plan detailing its proposed activities
•    attend a pre-membership interview
If your firm becomes a member of FINRA, they must agree to:
•    abide by the rules of the "Association"
•    abide by all federal and state laws
•    pay dues, fees, and membership assessments
What are these fees the firm must pay?
•    Basic membership fee
•    Fee for each rep and principal
•    Fee based on gross income of the firm
•    Fee for all branch offices
Membership, Registration and Qualification Requirements
FINRiVs Central Registration Depository (CRD) is the electronic registration system for member firms, principals, and registered representatives. FINRA reminds their member firms not to file misleading information. As the FINRA Manual says:
•    • • • • • • • • • • • • •
•    Filing of Misleading Information as to Membership or    •
•    •
•    The filing with the Association of information with respect to    •
membership or registration as a Registered Representative which
•    is incomplete or inaccurate so as to be misleading or which could •
•    in any way tend to mislead, or the failure to correct such filing    •
•    after notice thereof may be deemed to be conduct inconsistent with
just and equitable principles of trade and when discovered may be
•    sufficient cause for appropriate disciplinary action.    •
•    • • • • • • • • • • • • •
Filing misleading information with FINRA is a major violation. Firms also must not use their association with FINRA in a way that is misleading, as we see with this rule:
Use of the FINRA Logo
Member firms may not use the FINRA logo in any manner; however, a firm may refer to itself as a "FINRA Member Firm" or "Member of FINRA." Also, if a firm refers to its FINRA membership on its website, it must provide a hyperlink to FINRA's website, which is
•    • • • • • • • • • • • • •
•    Failure to Register Personnel    •
•    The failure of any member to register an employee, who should    •
•    be so registered, as a Registered Representative may be deemed to •
•    be conduct inconsistent with just and equitable principles of trade
and when discovered may be sufficient cause for appropriate dis-
•    ciplinary action.    •
•    • • • • • • • • • • • • •
As we can see above, it is a violation to use an individual in a position that requires registration unless and until the individual is registered. Who "should be so regis-tered"?
• • • • • • • • • • • • • •
•    Definition of Representative    •
•    •Persons associated with a member, including assistant officers    •
•    other than principals, who are engaged in the investment banking •
or securities business for the member including the functions of
•    •
supervision, solicitation or conduct of business in securities or who
•    •
are engaged in the training of persons associated with a member •
•    for any of thesefinctions are designated as representatives.    •
•    • • • • • • • • • • • • •
There are different categories of "registered representative," too. A General Secur¬ities Representative has a Series 7 and can sell individual stocks, bonds, municipal securities, options...generally just about anything. A person with a Series 6 is called a Limited Representative—Investment Company and Variable Contracts Products. This allows the individual to sell only mutual funds and variable contracts.
So, if you fit the definition of "representative," you must be registered:
•    • • • • • •    • • • • • •
•    All Representatives Must Be Registered    •
•    All persons engaged or to be engaged in the investment banking or •
•    securities business of a member who are to function as represen- •
tatives shall be registered as such with FINRA in the category of
•    •registration appropriate to the function to be performed as specified •
•    in Rule 1032. Before their registration can become effectivy    •
•    they shall pass a Qualification Examination for Representatives
appropriate to the category of registration as specified by the Board
•    of Governors.    •
•    • • • • • • • • • • • • •
As basic as that rule seems, you might be surprised how often member firms try to use an unlicensed employee to function as a registered representative. Bad idea. Unless and until the individual is licensed by FINRA and the state securities regulators, he must not perform any of the functions of a registered representative.
As we said, firms, principals, and registered representatives submit their registration information to FINRNs Central Registration Depository (CRD). An individual trying to become a registered representative submits information to the CRD through
a Form U4, which asks questions about residential history and professional back¬ground, etc. A principal must sign the U4 application and certify that he or she has reviewed the information, which is why it's not a good idea to use a fictional work his¬tory—they check that stuff
The CRD system is used for many different purposes. FINRA uses the information to determine whether the applicant is subject to statutory disqualification or presents a risk for the firm and its customers. Member firms use the information to determine if a candidate is subject to statutory disqualification or special heightened supervision. Firms also use the information reported to check the backgrounds of candidates. Maybe most important, the information released to the public through BrokerCheck protects investors from serial offenders in the securities industry.
Candidates for registered representative and principal positions often try to conceal their criminal or regulatory problems when completing Form U4. When FINRA finds out, they usually bar the representative permanently from association with any member firm, because if the individual can't be trusted when applying, why let him meet with customers?
In a notice to members FINRA explains that firms have the responsibility to review the information their candidates submit on Form U4 and conduct thorough back¬ground checks. Member firms are not supposed to just run candidates through the CRD system and see which ones get past the regulators. FINRA requires that "each member firm ascertain by investigation the good character, business reputation, qualifications and experience of an applicant before the firm applies to register that applicant with FINRA and before making a representation to that effect on the appli¬cation for registration."
If the applicant has already been registered, member firms are required to review his most recent U5 information—the form filed when an associated person ends employ¬ment with a member firm—within 60 days of filing the candidate's U4.
When a principal or registered representative leaves a member firm or ceases to function as a principal or registered representative at the firm, a U5 must be submit¬ted to FINRA within 30 days. The firm the associated person is leaving completes
a U5, and the firm that is hiring him completes a U4. If the exam uses the phrase "termination for cause," that means the registered rep gave the firm a good reason to fire him, including:
•    Violating the firm's policies
•    Violating the rules of the NYSE, FINRA, SEC, or any other industry regulator
•    Violating state or federal securities laws
If the registered representative is the subject of an investigation by any securities industry regulator, the firm cannot terminate the rep until the investigation is completed.
FINRA requires firms to adopt written procedures on how they verify the informa¬tion on a candidate's U4, and to complete that verification process within 30 calendar days of filing the U4. If the member finds information that doesn't match what the candidate disclosed, the firm must file an amended U4 within 30 calendar days. While FINRA encourages firms to complete this process before filing the U4, the firm can also just pay the Late Disclosure Fee involved with filing the amended U4.
Not surprisingly, the filing of an amended U4 often leads to FINRA deciding they might need to deny this one. For example, an amended U4 is often where a "no" answer to felony convictions and charges becomes two very embarrassing "yes" answers, with detailed explanations and court records detailing the unfortunate incident.
It used to be that if a customer wanted to win an arbitration claim, it was sort of understood that they needed to name the firm—not the individual representative—in the claim. This way, when the customer got paid, the registered representative had nothing to report on a U4 or U5 form.
Now, the firm must add the arbitration or civil litigation (lawsuit) award to the regis¬tered representative's U4/U5 form even if he or she isn't specifically named in the arbitration award. But, the threshold is $15,000 for the firm to report the settlement. FINRA and the SEC are also especially concerned about "willful violations" of secur¬ities law, and the new questions under the disclosure section are specifically designed to find out about those.
As you might expect, if your U4 contains information about "willful violations" of securities law—maybe executing transactions that your customers don't even know about, or misleading people about the mutual funds you sold them—it can be very tough to stay in the business. FINRA uses "statutory disqualification," which means that by statute you are disqualified.
After becoming a registered representative, you will also need to put in some time earning continuing education requirements. Let's see what FINRA must say about that:
•    • • • • • • • • • • • • •
•    Continuing Education Requirements    •
•    This Rule prescribes requirements regarding the continuing    •
•    education of certain registered persons subsequent to their initial    •
•    qualification and registration with FINRA. The requirements
shall consist of a Regulatory Element and a Firm Element as set
•    forth below.    •
•    • • • • • • • • • • • • •
The Regulatory Element is described like so:
•    • • • • • • • • • • • • •
•    Each registered person shall complete the Regulatory Element on •
the occurrence of their second registration anniversary date and
•    •
every three years thereafter, or as otherwise prescribed by FINRA.
•    •On each occasion, the Regulatory Element must be completed    •
•    within 120 days after the person's registration anniversary date.    •
•    • • • • • • • • • • • • •
What if you don't complete the Regulatory Element in that time frame?

• • • • • • • • • • • • • •
•    Failure to Complete    •
•    Unless otherwise determined by the Association, any registered    •
•    persons who have not completed the Regulatory Element within the •
prescribed time frames will have their registrations deemed inactive
•    •until such time as the requirements of the program have been    •
•    satisfied. Any person whose registration has been deemed inactive •
•    under this Rule shall cease all activities as a registered person and •
is prohibited from performing any duties andfinctioning in any
•    capacity requiring registration.    •
•    • • • • • • • • • • • • •
The Firm Element is described like this by the FINRA Manual:
•    • • • • • • • • • • • • •
•    Standards for the Firm Element
•    (A) Each member must maintain a continuing and current edu- •
•    cation program for its covered registered persons to enhance their    •
•    securities knowledge, skill and professionalism. At a minimum,
each member shall at least annually evaluate and prioritize its
•    training needs and develop a written training plan.    •
•    • • • • • • • • • • • • •

Active Military Duty
What happens when a registered representative volunteers or is called into active military duty? FINRA and the SEC are accommodating when a registered represen¬tative or principal is called away from the firm to serve in the armed forces. Here are the basic facts:
•    license is placed on "inactive status"
•    continuing education requirements waived
•    dues, assessments waived
•    two-year expiration period does not apply—exam might refer to this as "tolling"
•    can earn commissions, usually by splitting them with another rep who will service the book of business
•    the "inactive" rep cannot perform any of the duties of a registered rep while on inactive status
For a "sole proprietor" called into active military duty the same bullet points above apply.
Investment Advisers
When you complete your Series 7 requirements, you will become licensed to sell securities. You will not, however, be automatically registered to provide investment advice for compensation. To open a financial planning business or manage portfolios for a percentage of assets, you must pass your Series 65 or 66 exam and register your firm as an investment adviser or associate with an investment adviser as an investment adviser representative. If an agent opened either type of sideline without informing her employer and/or getting registered, disciplinary action could be taken by FINRA and his or her state securities regulator.
As a securities agent/registered representative, some of your customers will be invest¬ment advisers entering trades on behalf of their customers. But you yourself can only work the advisory side of the financial services business if you are properly licensed.


The Securities and Exchange Commission has authority over broad aspects of the securities industry. They are granted this authority under the Securities Exchange Act of 1934. Under this landmark securities legislation the SEC requires securities exchanges such as NYSE and CBOE to register. These self-regulatory organizations in turn register and regulate their own member firms and the associated persons of those firms.
Securities have long traded both on the New York Stock Exchange and the Over¬The-Counter (OTC) market. In 1938 Congress passed the Maloney Act, a law providing for the regulation of the OTC securities markets through national associations registered with the SEC. The National Association of Securities Dealers (NASD) then registered under the act. In 2007 the NASD and the regulatory arm of the NYSE formed FINRA, which stands for the Financial Industry Regulatory Authority. FINRA, along with NYSE and CBOE, is a self-regulatory organization (SRO) registered with the SEC under the Securities Exchange Act of 1934.
FINRA is organized along four major bylaws:
•    rules of fair practice
•    uniform practice code
•    code of procedure
•    code of arbitration
The rules of fair practice describe how to deal with customers. Commissions, mark¬ups, recommendations, advertising, sales literature, etc., are covered here. These are often referred to as "member conduct rules." The uniform practice code is the code that keeps the practice uniform. Settlement dates, delivery of securities, the establish¬ment of the ex-date, ACAT transfers, etc. are covered here. The exam might refer to the uniform practice code as "promoting cooperative effort" among member firms.