Regulators Call For Increased Scrutiny of Brokers with Disclosures
WHETHER JUSTIFIED OR NOT, the hiring and continued employment of brokers with disclosable events on their Central Registration Depositary (CRD) reports is an increasing concern. Just last year, a report issued by regulators recommended stringent hiring procedures and heightened supervision for brokers with CRD event histories.
In response to the report, the National Association of Securities Dealers (NASD) issued a Notice to Members. The NASD joined the New York Stock Exchange (NYSE) in recommending practices for member firms hiring or supervising brokers with sales practice violations.
Member firms have always been responsible for investigating the character, qualifications and experience of their brokers under self-regulatory organization (SRO) and Securities and Exchange Commission (SEC) rules. However, the new recommendations up the ante on the responsibilities and are likely to become the standard.
In addition to reviewing an applicant’s Form U-4, Form U-5 and CRD report and contacting the applicant’s previous employers, the Notice to Members recommends that firms: talk with the applicant regarding former customers and the types of securities previously sold; obtain explanations for any customer complaints or regulatory actions to determine whether they are justified; ask about any pending proceedings, customer complaints, regulatory investigations or arbitrations not listed in the CRD; and involve compliance and legal staff in hirings — designating an individual (above the branch office manager level) or a committee to review customer complaints, disciplinary actions or arbitrations before hiring a broker with such a history.
While most firms already perform such inquiries, these items are likely to become part of the standard lateral hire procedures for all firms. Brokers should be prepared to respond to extensive inquiries during interviews. Brokers with disclosable CRD items should maintain copies of all pleadings and decisions regarding these events and should provide such documentation early in the interview process so that a complete review and hiring decision can be made.
When hiring a broker with a CRD history, the NASD suggests that the firm examine the violation to determine whether its standard supervisory and educational programs are adequate to address the issues raised by the broker’s record. Firms may institute additional supervisory procedures to help ensure that similar complaints are not raised against that broker in the future. If the broker engages in further sales practice violations, securities regulators will consider whether the firm itself should be subject to disciplinary action for a failure to supervise the broker, beginning with the decision-making process that led to the individual’s hire.
Firms and supervisors should not view these new recommendations, or heightened concerns regarding complaint and disciplinary problems, as a prohibition on hiring financial advisers with CRD histories. Given the general litigation explosion in this country, and the increase in customer complaints and arbitrations, firms should view a CRD report in context while keeping in mind the industry’s increasing disclosure requirements.
In fact, the NASD itself states that the Notice to Members does not apply to brokers whose CRD report simply discloses isolated customer complaints, minor disciplinary actions or arbitrations; it is intended only to apply to brokers with histories of sales practice problems.
Identifying a broker who requires heightened supervision is left to a firm’s discretion, although the Notice to Members suggests that a broker with three customer arbitrations in a one-year period would be a strong candidate for such oversight.
Having identified such a broker, it will not be enough simply to institute heightened supervisory procedures. Undoubtedly, the SROs will require written verification that the procedures have been put into place and are being followed. Therefore, enhanced supervisory procedures should be put into to writing and signed by both the broker and the supervisor. This will protect the broker, the supervisor and the firm. Some states already require written confirmation of the supervision, and such a procedure should become the industry standard. Supervisory reviews should be documented in the broker’s file, and the supervisor should initial and date the broker’s holding pages, monthly activity summaries or any other documents reviewed.
Branch managers and supervisors will naturally be reluctant to commit the additional resources to such overview, but as the regulatory environment heats up, so must supervisory oversight. Brokers with CRD disclosures are becoming more common, and branch managers who refuse to hire brokers simply because of a CRD disclosure will find themselves with an ever-decreasing pool of potential hirees.
The NASD recognizes the additional burden its recommendations put on the supervisors, and it has recommended tying or increasing an existing component of compensation to effective supervision. Under such a scenario, managers would be compensated, in part, for effective supervision and compliance efforts that avoid sales practice abuses. How a firm is going to measure such performance remains to be seen, but firms must recognize the heightened responsibility of its supervisors and devise compensation methods to address these increased responsibilities.
The release, contained in Notice to Members number 97-19, is available on the World Wide Web at http://www.nasdr.com/9719ntm.txt.
Mark J. Astarita, Esq. represents investors, financial professionals and firms in litigation, arbitration and regulatory matters across the country. He is a partner in the national securities law firm of Sallah Astarita & Cox, LLC and can be reached by email at firstname.lastname@example.org or by phone at 212-509-6544.
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