Behind the Process: How an Enforcement Action Becomes an Enforcement Action
Formal disciplinary action or informal action, settlement or complaint. Or, the one you never hear about: no action. There are a lot of possible outcomes for an Enforcement investigation. And a disciplinary action is far from guaranteed at the outset of the process.
On this episode, Executive Vice President and Head of FINRA Enforcement Jessica Hopper walks us through the Enforcement process from referral to final outcome for all these possibilities and details the many steps along the way.
Resources mentioned in this episode:
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00:00 – 00:49
Kaitlyn Kiernan: Formal action or informal action, settlement or complaint, or the one you never hear about: no action. There are a lot of possible outcomes for an Enforcement investigation, and a disciplinary action is far from guaranteed at the outset of the process. On this episode, FINRA Head of Enforcement Jessica Hopper walks us through the process from referral to final outcome for all of these possibilities and details of many, many steps along the way.
00:28 – 00:38
00:38 – 00:49
Kaitlyn Kiernan: Welcome to FINRA Unscripted, I'm your host, Kaitlyn Kiernan. Today, we are welcoming back to the show Jessica Hopper, FINRA's Executive Vice President and Head of Enforcement. Jessica, welcome back.
00:49 – 00:51
Jessica Hopper: Thank you, Kaitlyn. Glad to be here.
00:52 - 01:18
Kaitlyn Kiernan: So today I wanted to talk about the overall Enforcement process and what it takes for an Enforcement action to become an Enforcement action. We've heard that there's been some misunderstanding about what the process looks like, how long it takes and the steps involved. But before we dig into that process, I wanted to make sure that we're starting the conversation with a common vocabulary. So, to kick things off, what is a disciplinary action?
01:18 - 03:12
Jessica Hopper: I think it's important to have the right vocabulary, but I think we can back up and start with what we're doing, both as a regulator and in Enforcement.
First, FINRA is here to protect investors and to ensure market integrity. And those aren't just words. Everything we do in regulatory operations and Enforcement is really driven in making sure that the industry is safe, and investors are safe, too. So, along those lines, I think there's been some confusion about how a matter ends up in formal disciplinary action. And at the very outset, Member Supervision, Market Regulation and Enforcement work together to look at a broad range of information that we get and to find where there is misconduct, where we can protect the investors, where we can make sure the market is safe. And there is a very long, long journey from identification of potential misconduct through the long process of investigation and multiple reviews to get to a formal disciplinary action.
So why don't we start with, like you said, what is a disciplinary action? So, a disciplinary action is a type of regulatory response to address findings of a rule violation. A formal disciplinary action is typically resolved with a fine, sometimes with restitution, if that's appropriate, and some sort of requirement to fix what's wrong if it's not already fixed. Formal disciplinary actions are reserved for really the most egregious type of misconduct that we see. So, it could include financial harm or an impact to market integrity or a significant risk to investors or member firms or the market, and sometimes even involves repeat offenders. So, given all that, formal disciplinary action is definitely not our go to response for all exams or referrals.
03:12 - 03:18
Kaitlyn Kiernan: And so, on the flip side of that, what is not a disciplinary action?
03:18 - 03:43
Jessica Hopper: So, I just told you about formal disciplinary actions, but there's actually such a thing as an informal disciplinary action. And these responses, usually cautionary action letters, are what we use for the less egregious violations. It's basically a warning of what's not right or what's a violation and gives firms an opportunity to fix what's wrong. Unlike formal actions, these are not public.
03:44 - 03:55
Kaitlyn Kiernan: OK, so once a month, it's usually on the 15th of the month, we release a whole list of disciplinary actions. So that is only formal disciplinary actions in that document?
03:56 - 04:13
Jessica Hopper: That's right. We do issue the formal disciplinary actions and a summary of the month's worth of disciplinary actions in a report that I know that firms rely on and use for information, especially compliance departments. So, if you're not already familiar with that document, I suggest going to FINRA.Org and looking it up.
04:14 - 04:29
Kaitlyn Kiernan: You mentioned that formal disciplinary actions are reserved for the more egregious referrals and results of investigations. So, what is the difference between a FINRA regulatory examination and a FINRA Enforcement investigation?
04:30 - 06:10
Jessica Hopper: Good question. So, let's start with FINRA's exam program. FINRA's exam program is designed to check for firms’ compliance with FINRA rules and the federal securities laws. An examination is done by an examiner and the examiners trained to do these types of compliance reviews. So, when an examiner finds an area that's not in compliance, they let the firm know and they provide the firm with a report of the findings so that they can correct them. The vast majority of these findings don't rise to the level of a FINRA investigation. And so, for matters that have been identified in earlier exams or that haven't been corrected or significant violations that involve harm to customers or risk to the market, those are matters that may be escalated for investigation.
An investigation is typically handled by an attorney and an investigator. And if you think about it, while the starting point of an exam is a compliance check up with no evidence of rule violations, an investigation's starting point, by contrast, is much after that. It is after a likely and significant rule violation has been identified. So, the investigation asks the question whether that rule violation rises to the level of a formal disciplinary action. And if you think about all the data and information that FINRA receives and reviews, we may identify red flags that are serious enough to turn into investigations for more than just exams. It could be out of a U4 or U5 filing or amendment or customer complaints or trade surveillance or tips or referrals from other regulators or even from other FINRA departments. So, exams really aren't the only possible referral source for investigations.
06:11 - 06:25
Kaitlyn Kiernan: And so how would a firm know whether they are receiving an inquiry as part of that standard Member Supervision exam process or as part of an Enforcement investigation?
06:26 - 08:11
Jessica Hopper: They would know based on who's reaching out to contact them. And let me go a little deeper, too, and say that there is definitely a difference between the exam and the investigation because the investigation has a few more consequences. An investigation has a more serious potential outcome than an exam. Few exam findings actually lead to investigations. An investigation, though, could lead to a formal disciplinary action, and that means a potential fine or requirement to pay customers back in order to fix the problem if it's not already fixed, and other possible sanctions. And formal actions, whether it's a settlement or a complaint, are public and they describe the misconduct and the sanctions. And those are all serious consequences.
You'll know if you're part of an Enforcement investigation when a matter is referred to Enforcement, the assigned Enforcement attorneys will send you a letter either to the person or to the firm being investigated to let them know that the matter is in Enforcement for investigation and to provide contact information. So if you receive one of these letters, you should call the assigned attorney if you have any questions. But that letter will mark the beginning of the life of that matter in Enforcement.
And as we're talking about the distinctions between the exam process and the investigation process, I think it's important to make clear what isn't always well understood. I think when people hear Enforcement, I think that's often confused as meaning disciplinary actions. And Enforcement does two things actually. We do both investigations, and depending on the outcome of those investigations, we bring disciplinary actions. And those are two separate things, two separate steps along the process. So just as not all exams become investigations, not all investigations become disciplinary actions.
08:11 - 08:40
Kaitlyn Kiernan: Now that we're working from a common vocabulary with formal and informal disciplinary actions and exams versus investigations, I want to dig into the process to learn how an investigation might become a formal or informal action or might not lead to anything at all. We have a diagram that lays this process out that we will also link to for those that are more visually inclined. But, Jessica, what's the first step after receiving a referral for a potential matter?
08:41 - 09:11
Jessica Hopper: The first step when a referral comes in is to review the evidence we receive from the referral source. So typically, there's some level of preliminary review before a matter heads to investigation. As part of that review, the reviewer collects evidence to satisfy them that an issue should be investigated, so will typically receive documents or trade data reports. And our first job is to familiarize ourselves with what we have and then we determine what other steps we need to take to complete the picture.
09:12 - 09:15
Kaitlyn Kiernan: So, what additional steps might be needed?
09:16 - 10:32
Jessica Hopper: Investigations vary in scope and complexity, so it's not surprising that investigation plans and the amount of work needed vary just as much. Investigative steps, like I said, could include document and information requests and typically do. They involve on the record testimony or occasionally even informal interviews. Our goal is always to move quickly and efficiently to try to get the information that we need to help us determine if there really was a violation and if so, what the proper remedy is or regulatory response up to a formal disciplinary action.
So, yes, Enforcement is made up of both attorneys and investigators who work together to do our investigations. Our investigators come from lots of different backgrounds. We have former FBI agents, we have securities firm compliance professionals and traders and accountants and forensic experts and really just a very talented team that work with our attorneys. When we assign cases, we try to pair investigators with cases that overlap with their backgrounds and expertise. They also work with our training program to keep up to date on the latest investigative techniques. And lately, that includes data analytics and how we can use that to help streamline our investigations.
10:33 - 10:38
Kaitlyn Kiernan: So, are they collaborating with others and within FINRA, such as FINRA examiners?
10:38 - 12:08
Jessica Hopper: They definitely collaborate. And our investigators happen to be fantastic collaborators. And it's not just the investigators and it's not just Enforcement, all of regulatory operations really collaborate closely together. And the goal, again, is to protect investors and make sure that there is market integrity. And we do that by considering every possible regulatory response. At no point in this process that we're talking about do we assume that something is going to go to disciplinary action, for instance, or that something won't go to disciplinary action. At every point in the life of a matter, we're in collaboration with each other.
So, for instance, if a matter is in an exam, it is not unlikely that an examiner will contact Enforcement, whether it's an investigator or an attorney, to talk about something they've seen. And the purpose of that collaboration is to resolve questions instead of going down rabbit holes that would just waste time. So often we avoid referrals for investigation that way, but sometimes we'll actually fast forward it so that if they see an issue that should be resolved through investigation, then we can get it there more quickly. But all this is the result of some strong collaboration to make sure that we're all on the same page, that we're all working towards the best regulatory response for what we see the most quickly to give the information back to the firm so that they can correct issues and again, to protect investors where there might be potential harm out there.
12:08 - 12:15
Kaitlyn Kiernan: What happens next after the additional investigative steps are determined and executed and completed?
12:16 - 12:46
Jessica Hopper: At the point where we feel like we have all the relevant facts to understand what happened, then the attorney will recommend a disposition. The recommendation can be to go formal, to bring a formal disciplinary action that is, or to go informal or no further action. And when I say that we gather all relevant facts, I'm not just talking about facts that help bolster our case. I'm including mitigating and even exculpatory facts. And by that, I mean facts that would push us towards informal or no formal action.
12:46 - 12:56
Kaitlyn Kiernan: When the attorney makes this recommendation, is that it then? it's going towards a formal or an informal action, or is there another step in that process?
12:56 - 13:14
Jessica Hopper: Oh, no. The attorney's recommendation is just the start. The attorney's recommendation is reviewed first by at least two senior managers who do their own assessment of the legal and factual reasons behind the recommendation. And often there are robust discussions to test the lawyer's conclusions.
13:15 - 13:24
Kaitlyn Kiernan: So, if an attorney recommends no action and then those two senior managers also agree, is that it? Is a matter closed?
13:24 - 13:43
Jessica Hopper: If the recommendation is for no formal action or a cautionary action letter or closing, then basically, yes, the attorney proceeds with the informal action in case closing after the approval by the two senior managers. We let the referral source know what the conclusion is so we can close the loop and that's the end of that.
13:43 - 13:46
Kaitlyn Kiernan: Then will the firm also be notified that the case is closed?
13:46 - 13:47
Jessica Hopper: Yes.
13:47 - 13:55
Kaitlyn Kiernan: What about if the attorney recommends informal action and these two senior managers agree informal action is the course to go?
13:56 - 14:20
Jessica Hopper: If the attorney recommends an informal action or a cautionary action and the two senior managers agree, then it's a similar process. We let the respondent, or the firm or individual know by sending the cautionary action letter, it gives them some understanding of the fact there is an issue to be corrected. And we also close the loop with the referral source, but then that's the end of the matter.
14:21 - 14:24
Kaitlyn Kiernan: And because it's informal, there's no appeal process involved?
14:24 - 14:34
Jessica Hopper: There is not. The benefit of the informal, like I said, is really that it's a warning, a request that the firm or the individual fix the issue. And then the benefit is that it's not public.
14:35 - 14:42
Kaitlyn Kiernan: Worst case, a formal action is recommended, and the two senior managers agree. What happens then?
14:42 - 15:26
Jessica Hopper: So, there are a few more stops on the road here. It really depends on the case. But for some of the categories where it's a more complex or novel issue, those have a stop at our Office of the Counsel to the Head of Enforcement or because that is really a mouthful, we call it OCHE. And they do their review.
15:01 - 15:04
Kaitlyn Kiernan: That always makes me think of ESPN, 8, the "ocho", I don't know why. That's what I think of when OCHE comes up.
15:08 - 15:12
Jessica Hopper: It's just a tick different. Yes. And definitely more serious.
15:12 - 15:16
Kaitlyn Kiernan: So, what is OCHE responsible for?
15:16 - 15:50
Jessica Hopper: So OCHE is responsible for looking at every matter that's done in Enforcement, and because of that, they have a really good view of the types of matters we do and of how we describe the misconduct. So as part of their consultation process, they're very focused on the clarity of our documents, our settlement documents, so that when you read a settlement document, you should really understand how we came to our decisions on both the charging and the sanctions. We really want them to be transparent and predictable. And so that's the core of their function.
15:50 - 15:55
Kaitlyn Kiernan: What are they looking at when it comes to determining consistency between cases?
15:56 - 16:29
Jessica Hopper: Well, because they're trying to produce formal actions where the sanctions and charging decisions are clear and understandable, they start and focus on the four corners of the document. When they review that document, if they have any questions about what we're trying to communicate or how the charges line up with the sanctions and how those decisions line up with the facts that are described, then they work closely with the team to talk it through, to provide feedback, to get more information. And they're there to identify the areas of risk that they've identified and to propose solutions with the team.
16:30 - 16:39
Kaitlyn Kiernan: Is this document that they're looking at, one that has already been negotiated, or does a review happen before the documents negotiated?
16:40 - 17:08
Jessica Hopper: Typically the review happens before the settlement negotiation. We really want to be sure that we have all the benefit of our good counsel before we head out with any sort of document, rather than going out and then having to revise it. Sometimes those reviews even happen at the very earliest point of the investigation, especially where there's a hint of a novel rule interpretation or something that could be perceived as a novel rule interpretation. So, it's really a wide time span when you're going to see the OCHE intervention.
17:09 - 17:14
Kaitlyn Kiernan: What happened after OCHE has completed their review of a matter?
17:14 - 17:25
Jessica Hopper: Once that happens, all settlements and all complaints head to our Office of Disciplinary Affairs and every matter that goes there requires approval by ODA.
17:26 - 17:29
Kaitlyn Kiernan: So how is ODA different then OCHE?
17:30 - 18:10
Jessica Hopper: Yeah, OCHE and ODA are quite different. The biggest difference is that ODA is a group that's independent from Enforcement. They have no part in our investigations, they have no part in litigation. They're just designed to be independent of Enforcement because they conduct an independent review of our legal and evidentiary sufficiency. So, they're there to make sure that we've done what we're supposed to do, that we do have enough evidence to support the charges that we propose to bring. ODA must approve all settlements and all complaints before they can become effective and for good reason. I think that independence really keeps us honest.
18:11 - 18:13
Kaitlyn Kiernan: So who are the people making up ODA?
18:14: - 18:32
Jessica Hopper: ODA is a group of lawyers. They review every Enforcement settlement and every complaint, and sometimes they assign the cases that we send to the specialists there who maybe are more familiar with registration or AML issues and other matters just are assigned as they come.
18:32 - 18:36
Kaitlyn Kiernan: And how do these lawyers and ODA remain independent?
18:37 - 18:52
Jessica Hopper: Primarily, our communications protocol limits our conversations and opportunities for interaction with ODA, and we are held to those distances for good reason. We have different reporting lines and they're really just as separate from Enforcement as they could be.
18:53 - 18:55
Kaitlyn Kiernan: So they don't report to you?
18:55 - 19:29
Jessica Hopper: They do not report to me. Again, I think there is some confusion about whether the Enforcement process also includes all these review and approval processes. And while we do have a lot of processes in Enforcement that are designed to make sure that our cases are done right, that we are really thinking through the types of evidence we have and the charging and sanctions decisions, it's also important to understand that the final review process at ODA is absolutely separate, doesn't have a window into what we're doing ahead of that point at the end, where they're reviewing for approval of our formal actions.
19:29 - 19:34
Kaitlyn Kiernan: And how long does that ODA review typically take?
19:34 - 19:48
Jessica Hopper: It really varies. Typically, it's around a week, but sometimes it's less and sometimes it's more. And it really depends on the complexity of the case, the evidence, the legal issues. It's a very case-specific determination.
19:49 - 19:55
Kaitlyn Kiernan: It seems like there are quite a number of steps here. What happens next after the ODA review?
19:56 - 20:36
Jessica Hopper: The case is ready to be approved for release after ODA's approval. So, for settlements, what I mean is we issue them and they become final and public. And like we were talking about earlier, final settlements are available in two forms. First, you can find them on FINRA.org's Disciplinary Actions Database online, which happens to be my favorite thing. It's got really good key search terms and it's incredibly user friendly. And for those of us who have predated that Disciplinary Actions Online database, it is just magical and wonderful. But you can also find our settlements and our monthly disciplinary actions publications. And that's a very handy tool for the folks in compliance in particular.
20:36 - 20:41
Kaitlyn Kiernan: And we'll link to that in our show notes as well. And what about complaints?
20:42 - 21:14
Jessica Hopper: Yeah, complaints are a whole different thing. So, there are two different resolutions that can be formal disciplinary actions. Right? There's our settlements and then our complaints. So, while a settlement is an agreement between FINRA and the respondent on the findings of violations and the sanctions and the undertakings, sometimes a respondent doesn't want to settle. And you know what? They don't have to settle. If we come to a point where we're not agreeing on settlement, Enforcement will file a complaint, that's going to be filed with FINRA's Office of the Hearing Officers. And then we litigate and we determine if there was really a violation.
21:15 - 21:24
Kaitlyn Kiernan: If a firm doesn't settle, it does go to more of a litigation process. So, what is the Office of Hearing Officers and how is that different from ODA?
21:25 - 21:58
Jessica Hopper: The Office of Hearing Officers, or OHO, is like ODA in that they are independent of Enforcement, but they are very different functions. Their job is to administer our hearings and the hearings are heard by one hearing officer from the Office of Hearing Officers and two industry panelists. So it's a bit like a trial. They hear the evidence and then they enter the findings of fact. And whether those facts add up to a violation, they decide that too. And if they do amount to a violation, they also decide what the sanctions are. So it really is a bit like a trial.
21:59 - 22:03
Kaitlyn Kiernan: So is an OHO decision final or can that be appealed?
22:03 - 22:44
Jessica Hopper: The decision is final, but it can be appealed. So first stop if the respondent wants to appeal is to FINRA's National Adjudicatory Council, also known as the NAC. And from there, they can appeal to the SEC. After that, they can appeal up through the federal court system all the way up to the U.S. Supreme Court.
So, you see the journey of a matter through formal discipline is one with many roadblocks and hurdles to get to the finish line. And that's as it should be. We do recognize the seriousness of a formal disciplinary action and make sure that we take care to get to formal action only where it's appropriate.
22:44 - 23:08
Kaitlyn Kiernan: So just to wrap up, I wanted to go through some lightning round questions that we've heard frequently from firms. So, I'm hoping we can clarify some of these things with a quick true/false. So true or false? FINRA does rulemaking by enforcement, meaning we pursue enforcement action for violations without first updating our rules or educating firms.
23:08 - 24:16
Jessica Hopper: Very much false, very much something that seems to come up every now and then. As I've described, we do go through many layers of review and supervision to make sure that our regulatory response in charging decisions are clear and grounded and based in a common understanding of what those rules are.
I think a lot of confusion has historically been when our settlement documents aren't really as clear in describing the misconduct that supports the charges. And so that leaves room for interpretation that we're redefining the rules and we are not. So, we've worked really hard towards greater clarity. Our OCHE group is really there to help make sure that what we're putting out there isn't signaling some sort of a new interpretation of a rule.
And when we do find areas that aren't clear to the industry, we work really closely with the rest of regulatory operations to find ways to see how we can make clear to the industry what the expectations are or how that rule is viewed from our end. So that could be additional guidance through regulatory notices or lots of different ways, compliance meetings. And the answer isn't always an enforcement action, that's for sure.
24:17 - 24:25
Kaitlyn Kiernan: So next up, true or false? If a firm receives a letter from Enforcement staff, the matter will definitely result in a formal action.
24:25 - 24:46
Jessica Hopper: So false, false. Not every investigation turns into a disciplinary action. I hope what we've just talked about today helps dispel that. We are simply trying to understand what's happening when you receive a letter. Also read the letter. Sometimes we simply reach out to witnesses for information. So, their touch point to the investigation really could just be limited to being a fact witness for us.
24:47 - 24:53
Kaitlyn Kiernan: And true or false? An on the record interview, or OTR, implies a formal disciplinary action.
24:54 - 25:20
Jessica Hopper: False and on the record interview is an interview with a court reporter who takes down the questions and answers. And the OTR is scheduled under Rule 8210. And so for those of you who don't know Rule 8210, that's the rule that requires you to answer questions and provide us information. So, it's a way for gathering evidence and it's definitely a part of the investigative process and definitely does not imply that a formal action is about to happen.
25:20 - 25:49
Kaitlyn Kiernan: Well, Jessica, thanks so much for joining us. I think today we definitely helped demystify the enforcement process quite a bit. But listeners, if you have additional questions, you can let us know and we can maybe do a follow up podcast. And if you don't already, you can subscribe to FINRA Unscripted on Apple podcast, Overcast, Pandora or wherever you listen to podcasts. If you have ideas for future episodes you can email us at [email protected] Until next time.
25:49 – 25:55
25:55 - 26:21
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26:21 – 26:28
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