Investigations by the Financial Industry Regulatory Authority (FINRA) pose significant risks to broker-dealers. Not only can FINRA take enforcement actions—including imposing sanctions and banning broker-dealers from the securities industry—but enforcement actions also often result in claims by individual investors. These claims may result in substantial liability in FINRA arbitration; and in many cases, once one investor’s claim is successful, more investors will feel encouraged to file claims as well.
With this in mind, when facing FINRA investigations, broker-dealers should know what to expect. They also need to know what to do – and what not to do – to maintain the full battery of protections at their disposal.
“FINRA uses the full weight of its enforcement powers to protect retail investors and investigate broker-dealers suspected of fraud. A FINRA investigation is a serious matter with potentially serious consequences, and broker-dealers subject to these investigations should defend themselves by all available means. ” – Dr. Nick Oberheiden, founding attorney at Oberheiden PC
What to Expect During a FINRA Investigation
In most cases, investigations by the Financial Industry Regulatory Authority (FINRA) follow a well-defined process. By understanding this process, broker-dealers targeted for violations of FINRA rules and federal securities laws can make informed and strategic decisions focused on resolving the FINRA inquiry as efficiently, favorably and confidentially as possible. In general, the steps involved in a FINRA investigation include:
1. Request for Documents Pursuant to FINRA Rule 8210(a)(2).
FINRA Rule 8210 serves as the primary source of quasi-governmental entity investigative authorities. Pursuant to FINRA Rule 8210(a)(2), FINRA has the authority to “inspect and copy the books, records, and accounts of [a broker-dealer] on any matter included in [an] investigation, complaint, inspection or proceeding which is in the possession, custody or control of such member or person.’
To perform this verification, a FINRA examiner will typically issue a written request to the target broker-dealer to produce relevant documents. Broadly speaking, this is similar to a request for discovery proceedings or an SEC subpoena, although there are various practical and procedural differences.
In many cases, upon receipt of a request for documents pursuant to FINRA Rule 8210(a)(2), a broker-dealer must immediately engage counsel. An experienced FINRA investigation attorney will be able to review the request and immediately begin the process of preparing a response—whether that involves communicating with FINRA enforcement personnel, drafting and editing compliant documents, or (as is often the case) adopting hybrid approach.
2. Interview on Record (OTR).
After reviewing the documents submitted in response to its request under FINRA Rule 8210(a)(2), FINRA enforcement officers or FINRA staff often seek to schedule an interview on the record (OTR) under Rule 8210(a) of FINRA (1). This is an interview conducted under oath at FINRA offices.
FINRA rules permit OTR interview subjects to have a FINRA investigative attorney present; However, the rules prohibit objections during the interview process. This makes it vital that target broker-dealers work closely with their attorneys to anticipate questions and develop an interview strategy in advance. Because OTR interviews are conducted under oath, FINRA enforcement officers or FINRA staff may use broker-dealer statements in subsequent enforcement proceedings.
During OTR interviews, FINRA enforcement officers or FINRA staff will typically ask questions about the documents submitted, but their questions will go beyond clarifying or verifying the content of the records. They will ask about broker-dealers’ personal conduct and relationships, communications with clients, personal knowledge of FINRA rules and federal securities laws, and any other matters they consider relevant to the FINRA investigation.
3. Meeting with FINRA’s enforcement team
After this initial fact-finding process, it will often make sense to schedule a meeting with FINRA enforcement staff or FINRA staff to discuss the status of the investigation and begin to guide the investigation toward a favorable outcome. This process requires the in-depth knowledge and insight of an experienced FINRA investigation attorney. At this stage, broker-dealers should have performed a privileged internal evaluation of attorney-client compliance and should have a clear understanding of both (i) their exposure to investigative risk and (ii) the defenses available to them.
4. Schedule a call with Wells
If discussions with FINRA Enforcement officials do not directly lead to a favorable resolution, FINRA Enforcement officials may decide to schedule an interview with Wells. As FINRA explains:
“During the conversation with Wells, staff informed the potential respondent of the proposed charges and the underlying evidence to support the charges. The purpose of the Wells call is to give the potential respondent an opportunity to submit a written statement, called a Wells submission, that discusses the facts and applicable law and explains why formal charges are not appropriate.”
Wells submission is optional. After the Wells call, the target broker-dealer will need to work with its advisor to determine the best path forward. Although a Wells Submission may be beneficial in some cases, voluntarily providing information to FINRA enforcement officers at this stage can be risky, and broker-dealers must make strategic decisions about how and when to submit the most your strong defenses.
5. Closing the investigation (and determining next steps)
As the final step in the investigative process, FINRA’s Office of Disciplinary Matters will decide whether to approve a settlement or authorize FINRA enforcement officers to move forward with issuing a formal complaint. If a formal complaint is issued, this begins an entirely separate process during which broker-dealers (now called “respondents”) must fight to defend themselves against disciplinary action.
What to do during a FINRA investigation
With this process in mind, there are several steps broker-dealers should take when facing a FINRA investigation. These steps include:
- Hire a FINRA Investigation Attorney – After being contacted by FINRA enforcement staff, broker-dealers must immediately hire a FINRA investigative attorney. This is true regardless of the means of contact (ie, whether in the form of an informal letter or a Rule 8210 request). In most cases, taking a proactive approach early in the process will provide the best opportunity to reach a favorable and confidential resolution.
- Identify all sources of relevant information – Regardless of whether FINRA has issued a records request pursuant to FINRA Rule 8210(a)(2), target broker-dealers should begin working with their counsel to identify all sources of relevant information. This is important for three reasons: (i) for the purposes of initiating a legal lien; (ii) to prepare for the issuance of a request for documents; and (iii) determine what protections are available to the broker-dealer.
- Creation of a lawful lien – Similar to federal investigations and private civil suits, when faced with a FINRA investigation, broker-dealers must initiate a legal lien. This ensures that all relevant documents remain accessible and that FINRA cannot bring charges of attempting to conceal, withhold or destroy evidence of wrongdoing.
- Perform an internal compliance assessment – To formulate effective defense strategies, broker-dealers subject to FINRA investigations must conduct internal compliance assessments under the protection of the attorney-client privilege. This includes reviewing all relevant records, communicating with internal staff (if appropriate), and then using the information obtained from these processes to determine what charges – if any – FINRA Enforcement staff may be able to justify.
- Develop a defensive strategy and map out next steps – After taking these preliminary steps, target broker-dealers can shift their efforts to developing a defensive strategy. Working with their counsel, targeted broker-dealers must chart a strategic path forward while maintaining the necessary flexibility to adapt as the investigation progresses.
What NOT to do during a FINRA investigation
In addition to taking these steps, broker-dealers subject to FINRA investigations should ensure they avoid several common pitfalls. Some examples of mistakes that broker-dealers should avoid when facing a FINRA investigation include:
- Continue to violate FINRA rules or federal securities laws – If a FINRA investigation is likely to reveal regulatory or statutory violations, the target broker-dealer must take appropriate steps to remedy any ongoing compliance issues. Continued violations of FINRA rules or federal securities laws can significantly increase the challenges of pursuing an effective defense.
- Voluntary Disclosure of Privileged Information – While it will often be beneficial to develop a working relationship with FINRA enforcement personnel, target broker-dealers should be careful to avoid voluntarily disclosing too much information. This is especially true with respect to information that is protected by the attorney-client privilege.
- Ignore requests for documents or OTR interviews – When facing a FINRA investigation, ignoring requests for documents or OTR interviews is not the right approach. FINRA has the authority to take disciplinary action against broker-dealers who do not participate in the investigative process.
- Attempt to eliminate concerns without documentation – Likewise, attempting to address FINRA’s concerns without supporting documentation will almost always result in additional scrutiny. Favorably resolving a FINRA investigation requires a strategic approach based on a clear understanding of the relevant facts, relevant legal authorities, and available evidence.
- Let the investigation continue unchecked – The longer a broker-dealer delays bringing counsel to intervene in a FINRA investigation, the more difficult it may become to catch up and ultimately escape the investigative process. Broker-dealers should not allow FINRA investigations to continue unchecked, but rather should do everything possible to take control of the process.