Statutory Disqualification Process for Broker-Dealers
The following is an overview of the rules and procedures applicable to broker-dealer members seeking to hire or retain a person who is or becomes subject to disqualification, and for broker-dealer members that themselves are or become subject to disqualification.
Special Information for Member Firms Participating in the MCDC Initiative
For FINRA member firms that become statutorily disqualified based on an SEC order issued under the SEC’s Municipalities Continuing Disclosure Cooperation (MCDC) Initiative, FINRA has compiled a set of Frequently Asked Questions on FINRA’s Eligibility Proceedings for Firms Participating in the MCDC Initiative. Updated as of February 26, 2016.
Within those Frequently Asked Questions, Question number 3 references a notification letter (the “SD Notification Letter”) that FINRA will send to any firm participating in the MCDC Initiative once the SEC has issued an Order accepting that firm’s offer of settlement. The SD notification letter will notify the firm of its statutory disqualification and will outline the firm’s next steps with respect to continued FINRA membership. A sample of the SD Notification Letter may be viewed here: Sample MCDC Notification Letter
As noted in the SD Notification Letter, a firm will not be required to complete Section 2, Questions 1-2 and 4-8 of the MC-400A Application. The remainder of the Application must be submitted to FINRA along with a plan of supervision, detailed immediately below, and the findings and results of all examinations conducted during the past two years by FINRA and any other self-regulatory organization to which the firm belongs. FINRA is unable to provide a firm with exact language that must be contained in its plan of supervision until the SEC issues an Order accepting that firm’s offer of settlement; however, based on publicly available information regarding the likely sanctions and undertakings for firms participating in the SEC’s MCDC Initiative, FINRA expects that at a minimum an acceptable plan will contain the following conditions:
- The Firm must comply with the undertakings specified in the Order;
- Establish protocols to ensure that the undertakings outlined in the Orders are completed in the time period established in the Order or by the time period granted by Commission staff in any extension;
- Provide FINRA with copies of correspondence between the Firm and Commission staff regarding requests to extend the procedural dates relating to the undertakings; and
- The Firm must provide FINRA with a copy of the certification and all supporting documentation that will be provided to the Commission upon completion of the undertakings as specified in the Order.
General Information on FINRA’s Eligibility Requirements
Article III, Section 3 of FINRA's By-Laws 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 (“Exchange Act”).
Article III, Section 4 of the By-Laws states that a person is subject to a "disqualification" with respect to membership, or association with a member, if such person is subject to any "statutory disqualification" as such term is defined in Section 3(a)(39) of the Exchange Act.
The list of disqualifying events according to Section 3(a)(39) of the Exchange Act are as follows:
- certain misdemeanor and all felony criminal convictions for a period of ten years from the date of conviction.
- temporary and permanent injunctions (regardless of their age) issued by a court of competent jurisdiction involving a broad range of unlawful investment activities.
- expulsions or bars (and current suspensions) from membership or participation in a self-regulatory organization (SRO). Includes bars with a right to re-apply.
- bars (and current suspensions) ordered by the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC) or other appropriate regulatory agency or authority. Includes bars with a right to re-apply.
- denials or revocations of registration by the SEC, CFTC or other appropriate regulatory agency or authority.
- findings that a member or person has made certain false statements in applications or reports made to, or in proceedings before, SROs, the SEC on other appropriate regulatory agency or authority.
- any final order of a State securities commission (or any agency or officer performing like functions), State authority that supervises or examines banks, savings associations, or credit unions, State insurance commission (or any agency or office performing like functions), an appropriate Federal banking agency (as defined in Section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813(q)), or the National Credit Union Administration, that
- 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
- constitutes a final order based on violations of any laws or regulations that prohibit fraudulent, manipulative, or deceptive conduct.
- findings by the SEC, CFTC or an SRO that a person: 1) "willfully" violated the federal securities or commodities laws, or the Municipal Securities Rulemaking Board (MSRB) rules; 2) "willfully" aided, abetted, counseled, commanded, induced or procured such violations; or 3) failed to supervise another who commits violations of such laws or rules.
- Certain associations with disqualified persons. In determining "association" for purposes of Exchange Act Section 3(a)(39)(E), FINRA uses the definition of "associated person" set forth in Exchange Act Section 3(a)(21).
Special Permission to Continue in or Enter the Securities Industry Notwithstanding a Disqualification
Article III, Section 3(d) of FINRA's By-Laws permits a disqualified person or member to request permission to enter or remain in the securities industry. FINRA Rules 9520 through 9527 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, the person may be permitted to continue to work in certain circumstances, provided the employer member promptly files a written application with FINRA seeking permission to continue that person’s employment with the member firm. Likewise, a member subject to disqualification also may be allowed to remain a member, provided the member promptly files an application requesting approval of its continued membership, and the disqualifying event does not involve a licensing sanction, such as a bar, revocation or expulsion.
Filing an Application under the Eligibility Rules
Once a member becomes aware that it or one of its associated persons is subject to a disqualification, 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 Article 5, Section 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 a Non-Registered Fingerprint (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 renders the member ineligible to continue in FINRA membership (see Article 3, Section 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 a firm fails to respond to FINRA’s 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 Member Regulation, 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 file an MC-400A application with RAD if it wishes to continue in membership.
If a person subject to disqualification is approved 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 a 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. There is no fee for a Form MC-400A.
Registration and Disclosure's Role
When a member files a Form MC-400 or Form MC-400A, 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 (to be known as the "Record"), 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. CRD composite screens for both member firms and representatives contain a statutory disqualification (SD) status. For member firms, the SD status shows a null value, a "yes," or a "no."
SD status codes for representatives contain additional detail. A full list of SD status codes is available on this site.
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:
- the nature and gravity of the disqualifying event;
- the length of time that has elapsed since the disqualifying event;
- whether any intervening misconduct has occurred;
- any other mitigating or aggravating circumstances that may exist;
- the precise nature of the securities-related activities proposed in the application; and
- the disciplinary history and industry experience of both the member firm and the person proposed by the firm to serve as the responsible supervisor of the disqualified person.
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, Member Regulation 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 FINRA Rule 9523(b); Regulatory Notice 09-19).
The Important Role of Supervision
Pursuant to FINRA Rule 3110, 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 held in Washington DC, are conducted pursuant to 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-Laws, the hearing fee is $2,500. Applicants must pay this fee to RAD prior to the hearing.
The Statutory Disqualification Committee (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, it must then file a notice with the SEC pursuant to SEC Rule 19h-1 notifying the Commission of its decision. The SEC must review and approve that decision before it takes effect. The SEC will notify FINRA of its decision by written communication.
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 must be filed within 30 days of FINRA’s decision. 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 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 in relation to the next scheduled hearing days, 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||This process may take 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-Laws, 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.