Statutory Disqualification Process
The following is an overview of the rules and procedures applicable to members seeking to hire or retain a person who becomes "subject to disqualification," and for members that themselves become subject to disqualification.
Article III, Section 3 of FINRA's By-Laws1 provides that no member shall be continued in membership if it becomes subject to disqualification; and that no person shall be associated with a member, continue to be associated with a member, or transfer association to another member if such person is or becomes subject to disqualification. FINRA's authority to deny the registration and/or membership of disqualified persons or members is set forth in Section 15A(g)(2) of the Securities Exchange Act of 1934.
FINRA amended its By-Laws on July 30, 2007 to incorporate the definition of "disqualification" as set forth in Section 3(a)(39) of the Exchange Act. The amended eligibility rules are effective June 15, 2009. Members should review Regulatory Notice 09-19, Amendments to FINRA Rule 9520 Series to Establish Procedures Applicable to Firms and Associated Persons Subject to Certain Statutory Disqualifications, for detailed information related to the amended eligibility rules.
Based upon the expanded definition of "disqualification," the list of disqualifying events are as follows:
(i) bars such person from association with an entity regulated by such commission, authority, agency, or officer, or from engaging in the business of securities, insurance, banking, savings association activities, or credit union activities; or
(ii) constitutes a final order based on violations of any laws or regulations that prohibit fraudulent, manipulative, or deceptive conduct.
Special Permission to Continue in or Enter the Securities Industry Notwithstanding a Disqualification
Article III, Section 3(d) of FINRA's By-Laws1 permits a disqualified person or member to request permission to enter or remain in the securities industry. Procedural Rules 9520-27 set forth procedures for a member to sponsor the proposed association of a person subject to disqualification or for a member to obtain approval to remain a member notwithstanding the existence of a disqualification. These actions are referred to as "Eligibility Proceedings."
Generally speaking, a person who is subject to disqualification may not associate with a FINRA member in any capacity unless and until approved in an Eligibility Proceeding. If a person is currently associated with a FINRA member at the time the disqualifying event occurs, however, the person may be permitted to continue to work in certain circumstances, provided the employer member promptly files a written application seeking permission to continue the employment in an Eligibility Proceeding. A member subject to disqualification also may be allowed to remain a member, in certain circumstances, pending the outcome of an Eligibility Proceeding, provided the member promptly files an application requesting approval of its continued membership.
Filing an Application under the Eligibility Rules
Once it becomes aware of a statutory disqualifying event (related to the member or a disqualified person), the member is obligated to report the event to FINRA. In the case of a disqualified person, the Firm must either file a Form U5 if it wishes to terminate the individual's association or file a Form MC-400 application if a member wishes to sponsor the association of a disqualified person. The member should file any MC-400 application when it amends the Form U4 and it must amend the Form U4 within 10 days of learning of a statutory disqualifying event (see Art. 5, Sec. 2(c) of the FINRA By-Laws). The MC-400 application requests information about the terms and conditions of the proposed employment, with special emphasis on the proposed supervision to be accorded the disqualified person. Firms are reminded that the Eligibility Proceedings process extends to all associated persons, including those individuals for whom firms would file an NRF.
The member may request, in writing, an extension of time to file the application. However, a member must not assume that an extension request has been granted if it has not received written approval from the Department of Member Regulation (Member Regulation). Failure of the member to either terminate the individual or submit an MC-400 application may subject the member to a statutory disqualification (see Art. 3, Sec. 3(a) of the FINRA By-Laws). Further, pursuant to Rule 9522(a)(2) & (3), FINRA may cancel the membership of a firm or revoke the registration of a disqualified person where there is no response to the notice of disqualification.
One exception, to the requirements to file an MC-400 application, concerns persons or members that are subject to an injunction that is greater than 10 years old. In these situations, pursuant to Rule 9522(e)(1)(A), the member may provide to FINRA's Registration and Disclosure Department ("RAD") a written request for relief. If the member submits the written request, RAD will send it to FINRA's Member Regulation Department which will review the proposed employment or change in membership and in its discretion may either approve the proposed association/continued membership or require that the sponsoring or disqualified member file a Form MC-400 application.
Members subject to disqualification that wish to retain their membership are required to submit a Form MC-400A. A member that becomes subject to disqualification must immediately amend its Form BD, in accordance with FINRA By-Laws, to report the disqualifying event and should simultaneously file an MC-400A application with RAD, if it wishes to continue in membership.
If a person subject to disqualification is allowed to associate with a member and later wishes to become associated with another firm, the new firm is not required to undergo the full Eligibility Proceedings process in all cases (see Rule 9522(e)(2)(A)). Instead, the proposed new employer should file a Form MC-400 application, which will be reviewed by Member Regulation. If Member Regulation finds: (1) that the terms and conditions of the proposed employment are the same in all material respects as those previously approved, and (2) that there is no intervening conduct or other circumstance that would cause the employment to be inconsistent with the public interest or protection of investors, then pursuant to SEC Rule 19h-1(a)(3)(ii), Member Regulation may approve the application and provide the SEC with notification of the new employment. If Member Regulation does not believe that the application meets that standard, it may exercise its discretion to require the firm to submit to the full Eligibility Proceedings process.
As set forth in Section 12(a) of Schedule A to FINRA By-Laws, the application fee for Form MC-400 is $1,500. This fee should be submitted along with the Form MC-400. Payment can be made either with a check from the member, or by means of a member's written request to have the amount deducted from its CRD account.
Registration and Disclosure's Role
When a member files a Form MC-400 or Form MC-400A, Registration and Disclosure (RAD) first examines the applicable NRF, Form U4, or Form BD to determine whether there are any deficiencies. For example, all persons must be qualified (by examination or waiver) in the capacity for which they seek to associate before RAD will process an application.
RAD then compiles a package of relevant information, including, but not limited to: documentation regarding the disqualifying event; CRD Records for the disqualified person, the sponsoring or disqualified member firm, and the proposed supervisor of the disqualified person; and documentation in the form of orders, decisions, and the like related to the disciplinary events concerning the disqualified person, member firm, and proposed supervisor. RAD prepares an index of this information, together with the application form and the Form U4 or Form BD, and sends the index and documents to Member Regulation, FINRA's Office of General Counsel (OGC), and the applicant member firm.
In addition to compiling the MC-400 package, RAD updates the individual's/member firm's statutory disqualification status "SD Status" in CRD. In 2008, RAD revised the codes it uses in Web CRD to describe the statutory disqualification status (SD status). CRD composite screens for both member firms and representatives now contain a statutory disqualification (SD) status (historically it was only available for representatives). For member firms, the SD status will simply show a null value, a "yes," or a "no."
SD status codes for representatives contain additional detail. Among the changes are the following:
What to Expect in Web CRD upon Implementation of the Amended Eligibility Rules (Effective Date - June 15th)
In preparation for the June 15, 2009 implementation of the revised eligibility rules, RAD queried information in Web CRD to identify persons who may be subject to a disqualification under the expanded definition of "statutory disqualification" that FINRA adopted on July 30, 2007. These queries were very broad and, in most cases, did not result in any definitive determination that a particular person is subject to disqualification.
Most of those identified as the result of the queries will have an SD Status of "Requires Review." This status does NOT necessarily mean that the person is subject to disqualification. It simply means that RAD will review the person's CRD record upon a "triggering" event, i.e., if the person changes employers, seeks a principal registration or seeks admission or readmission to the securities industry.
Once a "triggering" event occurs for those identified in the queries, just as when any new event occurs that could subject a person to disqualification for any reason, RAD staff will perform a review and:
As explained in Regulatory Notice 09-19, MC-400 applications will be required upon implementation of the new eligibility rules for a small number of persons who are subject to disqualification due to the expanded definition and are currently in the industry. This includes those who are currently subject to final orders that come under subsection (ii) of section 15(b)(4)(H) of the Exchange Act and involve licensing or registration suspensions or revocations or analogous sanctions, those who have become subject to disqualification on or after March 17, 2009 as a result of the expanded definition, and those subject to disqualification under the expanded definition who have experienced a triggering event on or after March 17, 2009.
Member Regulation's Role
Under the Eligibility rules, Member Regulation acts as a party in all Eligibility Proceedings. Member Regulation is responsible for evaluating MC-400 and MC-400A applications and making recommendations either to approve or deny the application to the National Adjudicatory Council (NAC). Member Regulation conducts a thorough review of each file. Part of this function includes obtaining additional information, as required, from the applicant member firm, the proposed associated person, and/or various other sources.
To ensure a uniform and consistent approach, Member Regulation staff conducts a prescribed analysis of each application. This analysis takes into account:
Member Regulation has the discretion to approve the applications of member firms seeking to associate disqualified persons in a purely clerical and/or ministerial capacity without requiring applicants to undergo the hearing process before the NAC prescribed by Rule 9524. See Rule 9522(e)(2). The sponsoring firm is required to file a Form MC-400. In the event Member Regulation does not approve an application to associate a person in a clerical and/or ministerial capacity, the sponsoring member will have the right to proceed under Rule 9524 (i.e., to have the matter decided by the NAC after a hearing and consideration by the SD Committee). For more information see NASD Notice to Members 05-12.
In addition, based on the newly amended statutory disqualification rules, Member Regulation now has the authority to approve the applications of member firms with respect to disqualifications arising solely from findings or orders specified in Section 15(b)(4)(D), (E) or (H) of the Exchange Act or arising under Section 3(a)(39)(E) of the Exchange Act (see Regulatory Notice 09-19).
The Important Role of Supervision
Pursuant to Conduct Rule 30101, each member must establish, maintain, and enforce written procedures to supervise the activities of its registered representatives and associated persons that are reasonably designed to achieve compliance with applicable securities laws and regulations and with applicable FINRA rules. It is particularly important for members to be prepared to implement appropriate supervisory controls when it sponsors the association of a person who is subject to disqualification or when it seeks to retain its membership after becoming subject to disqualification. This is the case because in virtually every application that the NAC approves, it will do so subject to the applicant member's agreement to implement a special supervisory plan.
There is no one prescription for an appropriate supervisory plan. FINRA considers the following four factors to determine whether the supervision proposed for a disqualified person is adequate: 1) the nature of the underlying disqualification, 2) the disciplinary history of the sponsoring member and proposed supervisor of the disqualified person, 3) the nature of the proposed business activities for the disqualified person, and 4) the overall supervisory plan that the firm agrees to impose. For firms with rigorous written supervisory procedures, it may be sufficient to simply apply those procedures to the disqualified individual. Depending on the nature of the disqualification, the firm may need to propose additional controls and/or business restrictions.
As a general matter, FINRA and the SEC prefer that disqualified individuals seeking to act as registered representatives in retail sales capacities be supervised on-site by a qualified and experienced general securities principal to ensure active, immediate, and comprehensive supervision. In cases where on-site supervision is not feasible, an alternative supervisory system should be proposed that will assure the protection of investors.
For more information on the important role supervision plays in governing the employment of persons who are subject to disqualification as well as other persons with regulatory history, please see the Winter 1999 Regulatory & Compliance Alert article re: Special Supervisory Plans and Notice to Members 97-19 (Guidance on Heightened Supervision Recommendations).
Eligibility Proceedings hearings, which are scheduled at approximately two-month intervals during the year (and are held in Washington DC), are conducted pursuant to Procedural Rule 9524. Hearing panels are comprised of two individuals who can be industry or non-industry representatives. The applicant member firm and the disqualified person are afforded the opportunity to be heard in person, to be represented by an attorney, and to submit any relevant evidence. Member Regulation is represented by a staff attorney at the hearings. The applicant member firm ordinarily presents both the disqualified person and his/her supervisor at the hearing, together with counsel and any other witnesses or individuals who may have relevant information. A disqualified member is similarly entitled to have appropriate representatives attend the hearing. A FINRA OGC staff attorney attends each hearing and serves as the custodian of the record and as advisor to the NAC.
As set forth in Section 12(a) of Schedule A to FINRA By-Laws1, the hearing fee is $2,500. Applicants must pay this fee to RAD/Regulatory Review & Disclosure prior to the hearing.
The Statutory Disqualification (SD) Committee, consisting of 10 individuals comprised of eight securities industry members, and two non-industry representatives, meets after the hearing to consider the application. The SD Committee presents a recommended decision to the NAC for approval. The NAC decision is the final decision on behalf of FINRA, unless FINRA Board of Governors calls the matter for review. The critical inquiry in every case is the same: whether the admission of the disqualified person or member would be inconsistent with the public interest and the overriding regulatory goal to ensure the protection of investors.
The Eligibility Proceedings process may be accelerated in certain, appropriate cases when Member Regulation and the applicant member firm agree to the terms and conditions that would govern a disqualified person's or member's association. In these cases, a hearing would not be conducted and the period of the NAC's review could be significantly reduced (see Rule 9523).
If FINRA approves an application, the SEC must review and approve that decision before it takes effect, pursuant to the provisions of SEC Rule 19h-1. In most cases, the SEC's review and approval is routine and typically takes approximately 30 days. In some cases, however, the SEC scrutinizes a particular application by requesting more information or by requiring other restrictions or undertakings on behalf of the firm. When an individual is subject to a qualified or unqualified SEC bar, the SEC must issue an order approving the association, which usually takes 60 days or longer.
If FINRA denies an application (pursuant to SEC Rule 19d-1), the member firm and the aggrieved individual have rights of appeal to the SEC. The appeal process usually takes at least several months.
Length of Time for the Eligibility Proceedings Process
(The following ranges of periods of time are approximate and can deviate depending on individual facts and circumstances.)
Stage of Application
Length of Time
|RAD/Regulatory Review & Disclosure's processing of an application||1 - 3 weeks, provided that members supply RAD/Regulatory Review & Disclosure with the required documentation in a timely manner.|
|Member Regulation's review||3 weeks to several months, depending on when Member Regulation receives the application and accompanying documentation from RAD/Regulatory Review & Disclosure in relation to the next scheduled hearing day/s, the complexity of the application, and whether the member provides Member Regulation with requested information in a timely manner.|
|NAC review and decision||3 - 4 months, provided that the SD Committee and NAC do not remand the proceeding, and provided FINRA Board does not call it for review.|
|SEC review||20 days to several months.|
FINRA examiners conduct periodic special SD examinations to ensure compliance with supervisory conditions and to monitor for other problems. FINRA classifies individuals and members subject to disqualification into three tiers with corresponding examination requirements.
Tier I generally consists of individuals and members subject to disqualification because of securities or commodities-related misconduct including crimes described in Section 15(b)(4) of the Exchange Act.
Tier II generally consists of individuals and members subject to disqualification whose disqualifying misconduct does not relate to activities enumerated in Tier I or Tier III (below). The disqualifying event for Tier II firms and individuals in most circumstances will be based on (1) felonies that are not securities or commodities related or (2) findings by certain foreign entities.
Disqualified members and persons in Tiers I and II are subject to periodic examination. District Office staff has discretion to conduct more frequent or additional SD examinations if it believes that more frequent examinations are appropriate, for example because of past violations of the approved terms and conditions.
Tier III consists of those individuals and members subject to disqualification that were permitted to associate or remain as a member without any special supervision. There are no special examination requirements associated with this class of disqualified persons and members.
Pursuant to Section 12(b) of Schedule A to the FINRA By-Laws1, members employing Tier I disqualified persons are required to pay an annual fee in the amount of $1,500. Members that employ Tier II disqualified persons are required to pay an annual assessment in the amount of $1,000.
Any questions related to RAD's functions should be directed to Patricia L. Delk-Mercer at (240) 386-5461 or Chris Dragos at (240) 386-5440. All other questions related to this process should be directed to Lorraine Lee-Stepney, Manager, Statutory Disqualification Program in Member Regulation at (202) 728-8442.
1 Accessing the online FINRA Manual.
2 See Exchange Act § 3(a)(39)(F) incorporating § 15(b)(4)(D) & (E).