Breaking News Update SR-FINRA-2020-041 Approval

Breaking News Update SR-FINRA-2020-041 Approval

Amir Lahoud
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August 20, 2021

News Update: SEC Approves FINRA Rules Change

August 18, 2021

Overview & Summary

In an order[1] dated July 30, 2021, the SEC approved the adoption of new FINRA Rule 4111 and Rule 9561 and the amendment of Rule 9559. FINRA has extended the effective date for the proposed rule change to no later than 180 days after publication of a Regulatory Notice announcing this Commission approval. At time of this update, FINRA has not yet published such a Regulatory Notice.

From the SEC’s approval order:

The proposal to establish a process in new Rule 4111 to identify members firms that present a high degree of risk to the investing public, based on numeric thresholds of firm-level and individual-level disclosure events, and then impose a Restricted Deposit Requirement, conditions, or restrictions on the member firm’s operations, or both, will help protect investors and encourage such member firms to change their behavior. FINRA has designed the proposed rule change to establish an annual, multi-step process to determine whether a member firm raises investor protection concerns substantial enough to require the imposition of additional obligations, while allowing identified firms several means of challenging FINRA’s decisions and affecting the ultimate outcome.

The Department would begin each member firms’ annual Rule 4111 review process by calculating specified “Preliminary Identification Metrics” for each firm for each of six categories of events or conditions, collectively defined as the “Disclosure Event and Expelled Firm Association Categories.”

The six categories are: (1) Registered Person Adjudicated Events; (2) Registered Person Pending Events; (3) Registered Person Termination and Internal Review Events; (4) Member Firm Adjudicated Events; (5) Member Firm Pending Events; and (6) Registered Persons Associated with Previously Expelled Firms (also referred to as the Expelled Firm Association category).

There are numeric thresholds for seven different firm sizes, to provide that each member firm would be compared only to its similarly sized peers.

If the Department determines that a member firm warrants further review under Rule 4111, and such member firm would be meeting the Preliminary Criteria for Identification for the first time, the member firm would have a one-time opportunity to reduce its staffing level to avoid meeting the Preliminary Criteria for Identification, within 30 business days after being informed by the Department that it met the Preliminary Criteria for Identification. However, if the Department determines that the member firm still meets the Preliminary Criteria for Identification (or if the member firm did not opted to reduce staffing levels) the Department would determine the firm’s maximum Restricted Deposit Requirement, and the member firm would proceed to a “Consultation” with the Department.

During the Consultation, the Department would give the member firm an opportunity to demonstrate why it does not meet the Preliminary Criteria for Identification, why it should not be designated as a Restricted Firm, and why it should not be subject to the maximum Restricted Deposit Requirement. (42930) Pursuant to Proposed Rule 4111(e)(2), the Department would provide the member firm with written notice of its decision no later than 30 days from the date of FINRA’s letter scheduling the Consultation, stating any conditions or restrictions to be imposed, and the ability of the member firm to request a hearing with the Office of Hearing Officers in an expedited proceeding.

Under new Rule 9561(a)(1), the Department would serve to the member firm a notice of the Department’s decision following the Rule 4111 process. The proposed rule change would also provide that if a member firm does not request a hearing, the decision would constitute final FINRA action. In general, a request for a hearing would not stay any of the Rule 4111 Requirements imposed in the Department’s decision, which would be immediately effective with one exception being when member requests review of imposition of Restricted Deposit Requirement. In that case, the firm would be required to deposit the lesser of 25% of its Restricted Deposit Requirement or 25% of its average excess net capital over the prior year, while the proceeding is pending.

If a member firm fails to comply with any of the requirements imposed on it under Rule 4111, the Department would be authorized to serve a notice pursuant to proposed Rule 9561 stating that the member firm’s continued failure to comply within seven days of service of the notice would result in a suspension or cancellation of membership.

If a member firm requests a hearing under proposed Rule 9561, the hearing would be subject to Rule 9559 (Hearing Procedures for Expedited Proceedings Under the Rule 9550 Series).

Our Take

As always, CRC reminds firms that the best compliance program is a proactive one. As such, we suggest that firms review their programs to identify areas where updates relative to Rule 4111 are necessary, and implement such updates prior to the effective date, which will formally be determined as 180 days following the publication of a Regulatory Notice noting approval of this Rule. 

Some Key Takeaways:

  • This appears to be intended to be a fast-moving process once it starts (e.g., FINRA must issue a written decision within 30 days of the date of the letter scheduling the “Consultation,” and in the case of alleged non-compliance with obligations under Rule 4111, there is a seven-day window from service of notice under Rule 9561 that can result in a suspension or cancellation of membership).
  • FINRA may still determine that a firm has met its preliminary criteria for identification even after the firm engages in a “staffing reduction” as a part of the Rule 4111 process.
  • It is designed to provide an opportunity for the firm to affect the outcome through the “Consultation” process – e.g., by demonstrating to FINRA why the firm should not be a Restricted Firm or why it should not be subject to the maximum Restricted Deposit Requirement.

Opportunities for CRC to Assist Your Firm:

  • CRC can proactively conduct a review of your current compliance program to identify opportunities to potentially implement enhancements before the annual Rule 4111 reviews begin.
  • Between now and the effective date of this rule, CRC can help your firm to quickly scale up its compliance program with our resources to address concern areas.

Please contact Mitch Avnet for more information.

Mitch Avnet at mavnet@compliance-risk.com  or (646) 346.2468 


[1] SR-FINRA-2020-041 Approval Order, https://www.finra.org/sites/default/files/2021-08/sr-finra-2020-041-approval-order.pdf

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