In a speech at the SIFMA AML Conference last week, FINRA Head of Enforcement Susan Schroeder openly explained the “straightforward framework” that Enforcement uses when making decisions about enforcement actions. The context for Schroeder’s speech was FINRA’s merger of two separate enforcement departments, resulting from FINRA head Robert Cook’s “listening tour” and FINRA’s recent self-evaluation, but Schroeder’s explanation appeared to be more of a response to broader industry complaints about FINRA Enforcement’s lack of consistency and transparency in its charging and sanctions decisions.
If that was Schroeder’s mission, she was successful. She identified the goals of enforcement actions, and justified FINRA’s use of its enforcement tool based upon harms to investors and perceived market risks. Overarching Schroeder’s speech was the principle that firms should know “what to expect from their regulator” so they know “how to shape their behavior in order to comply with the rules.” In this spirit of transparency, Schroeder identified the various principles or factors that FINRA Enforcement considers when evaluating enforcement actions and sanctions. Those principles should provide a vocabulary for firms and their counsel to assess and question FINRA’s enforcement activities.
Here are the principles in Schroeder’s own words:
Is this enforcement action appropriate? According to Schroeder, enforcement actions should be brought to “fix something that is broken or to prevent future misconduct, either by the same respondent or by another individual or firm.” Enforcement is not the only means FINRA has to fix something, and it is not always the “right tool” to use. To determine whether enforcement action is the appropriate regulatory response, FINRA will ask:
- Is there demonstrated financial harm resulting from the misconduct? If this is the case, FINRA expects the “firm or the individual who caused that harm” to “make the customers whole.
- Has there been a significant impact to market integrity? If so, FINRA will ensure that the “issue is fixed” and that steps are taken “to prevent something harmful from recurring.”
- Did the misconduct create significant risk? Schroeder recognized that this is where “most  cases land.” In these instances, FINRA analyzes “whether the misconduct created significant risk, such that the misconduct requires an enforcement response in order to prevent and deter future harm.” In particular, FINRA focuses on cases where there is (1) “high likelihood of harm,” (2) “potential for widespread harm,” or (3) “intentional or reckless misconduct.” According to Schroeder, the following activities constitute “red flags”: “repeated misconduct after disciplinary action,” “broad patterns of disregarding regulatory requirements,” and “failure to implement reasonable supervision.”
What does a fair and effective sanction look like? FINRA has a host of sanctions options available to it – “fines, restitution, disgorgement, expulsions, bars, plenary and principle suspensions, undertakings, rescission, requirements to requalify, business restrictions, supervision requirements, and pre-approval requirements” – but when is it appropriate to use which ones? FINRA’s “highest priority” is to “obtain restitution for harmed investors.” But Schroeder recognizes that “there are many cases in which that is not practical because there has been no calculable financial harm.” In those instances, FINRA seeks to “tailor sanctions to most effectively address the root of the problem.” When determining sanctions, FINRA asks:
- Have wronged investors been made whole? If investors have been harmed, this is “the most important outcome” of sanctions.
- Do sanctions effectively address the root of the problem? Schroeder admits that this is “one of the hardest parts of [FINRA’s] job.” According to Schroeder, sanctions should: (1) be “proportionate to the harm or risk of harm posed,” (2) “encourage remediation” (but “not be excessive to the point of being vindictive”), and (3) “reflect credit for cooperation and discipline by other regulators.”
For its part, FINRA’s merged Enforcement Department will approach cases consistently and “reach foreseeable conclusions,” according to Schroeder. Schroeder promised “thoughtful, balanced, and timely [FINRA] investigations.” In particular, Schroeder said that settlement documents – she cited the AML context as an example – should identify the “legal framework supporting [FINRA’s] conclusions,” so that anyone looking at a case can “immediately understand the basis for the charge.”
Schroeder’s speech offers helpful guidance to firms seeking to focus their compliance priorities or understand why FINRA has brought enforcement action or sanctions against them. Schroeder also appears to accept, on behalf of FINRA, responsibility for ensuring that firms understand exactly what FINRA expects and why FINRA believes certain enforcement actions and sanctions are deserved. Firms and counsel who deal with FINRA in enforcement matters should hold the regulator to these principles. In short, firms now have a template for engaging more constructively with FINRA Enforcement.