Inside FINRA Enforcement: What Firms Need to Know

FINRA Investigations & Enforcement: Strategies from the Experts

Unlock the secrets of navigating the complex FINRA enforcement landscape with former enforcement officials Lisa Colone and Chris Kelly, who now provide defense counsel to broker-dealers. Drawing on their rich experience at FINRA and current roles at CSG Law, Lisa and Chris share their perspectives on the current state of FINRA enforcement in the securities industry. We discuss the statistics of previous enforcement actions, the importance of strategic cooperation, and the reality of FINRA credit for cooperation. 

Key Topics

• 2024 enforcement action analysis
• Importance of proactive strategies in handling investigations
• Distinction between mandatory self-reporting and extraordinary cooperation
• Navigating the centralized process for FINRA enforcement referrals
• Key factors that influence enforcement outcomes and credit for cooperation
• Recommendations for improving compliance and engaging with regulators

How FINRA Evaluates Enforcement Referrals

The transition from a FINRA examination to an enforcement referral is not a straightforward path; enforcement is a centralized process where various departments evaluate potential referral cases. Lisa and Chris share invaluable strategies for proactively addressing potential issues to prevent unwanted referrals to enforcement. Learn how contextual information, even if not explicitly requested, can crucially influence examination outcomes and decision-making processes.

The Reality of Credit for Cooperation

Finally, we delve into the nuances of receiving credit for extraordinary cooperation with FINRA. You’ll understand the distinction between self-reporting and extraordinary cooperation and get practical advice on how broker dealers can leverage available reports and tools to enhance their compliance programs.

Additional Resources

Managing Regulatory Exams – 8 Steps to Minimize Risk Of An Enforcement Action

Regulatory Exams: Pave the Way For Positive Regulator Relations

Managing the Regulatory Exam Process

Regulatory Exam and Compliance Support

Oyster Consulting specializes in helping firms navigate the complexities of regulatory examinations by providing expert guidance and practical solutions. Our team of former regulators and industry professionals offers tailored support, from preparing for exams and responding to inquiries to addressing potential violations and building a strong compliance program. With a focus on collaboration and proactive strategies, we help firms maintain regulatory compliance and foster productive relationships with their regulators.

Transcript

Transcript provided by TEMI

Libby Hall: Hi, and welcome to today’s episode of the Oyster Stew Podcast. I’m Libby Hall, Director of Communications for Oyster Consulting. In this episode, Oyster’s Ed Wegner, along with special guests, Lisa Colone and Chris Kelly of the CSG Law firm, share their perspectives on the current state of FINRA enforcement. They’ll discuss how FINRA evaluates enforcement referrals, the importance of strategic cooperation and the reality of FINRA credit for cooperation. Listen in to discover strategies to proactively address issues so you can prevent unwanted referrals to enforcement, and learn how contextual information, even if not explicitly requested, can influence examination outcomes and decision-making processes. Let’s get started, Ed.

Ed Wegener: Thank you very much, and hello, everyone. I’m Ed Wegener and I am the head of the Governance, Risk, and Compliance Practice at Oyster Consulting. I want to welcome you to our podcast today where we’re going to be providing an update and analysis on FINRA’s enforcement efforts. Given that that’s our topic, I’m really fortunate today to have with me Lisa Colone and Chris Kelly from the CSG Law firm. Both Lisa and Chris are former colleagues of mine from when we all worked at FINRA together. So thanks to you both for joining and I’m really looking forward to your insights today. I wonder if you could share a little bit about yourselves, your backgrounds, as well as your practice at CSG and the types of areas you concentrate on and the types of clients that you serve.

Lisa Colone: Thank you, Ed. Thank you for having us. My name is Lisa Colone, and as you said, Ed, I am a partner at CSG Law where I specialize in securities enforcement work. A bit about my background -after law school and a clerkship with a federal judge, I worked at a big New York City law firm doing litigation for a number of years and then went to the US Attorney’s Office where I met my friend and colleague, Chris Kelly. I spent about nine years at the US Attorney’s Office as a federal prosecutor, handling all sorts of federal criminal cases and trials. And then, I went to FINRA to the Department of Enforcement where I spent about eight years. At FINRA I was a line attorney to start. So, I worked on FINRA enforcement cases, and then I was lucky enough to supervise different teams at FINRA.

When I left FINRA, I was a vice president of enforcement, and that means that I supervised about half of the enforcement attorneys, so about a hundred attorneys at FINRA. I left FINRA in late 2023 and came to CSG with Chris in 2024. I’ll save some of the thunder for Chris, but here we have a practice where we represent primarily broker dealers and associated persons in all sorts of things. We certainly specialize in FINRA enforcement defense, and also, responding to FINRA regulatory requests and FINRA exams. But we also do SEC enforcement defense work. We have cases where we’re defending against state securities actions. We handle litigations and arbitrations on behalf of broker dealers and individuals, and we also do a nice amount of counseling work. So thank you again for having us, and I’ll turn it over to Chris.

Chris Kelly: This will be easy because my resume is very similar to Lisa’s. After clerking on the federal court, I went to a big law firm where I was an associate for about seven or eight years. I then went to the US Attorney’s Office where I tried a bunch of white-collar cases, ultimately became the head of Economic Crimes at the US Attorney’s Office in New Jersey. Then I left to go to FINRA, where I started as the Chief Counsel in the North region of enforcement. I stayed at FINRA for about 10 years, all that time in enforcement, and got promoted several times. At the end, I was deputy head of enforcement and spent about 10 months as acting head of enforcement. Lisa and I left a little over a year ago to start this practice group here at CSG Law, and what Lisa said is exactly right, mostly defending broker dealers.

But I would say the one thing that surprised me is we do a lot of counseling and advice work. I think, not surprisingly, it probably shouldn’t have surprised me, but there are a lot of FINRA rules that were legacy NASD rules or rules that are 10, 20 years old. And I think firms could use guidance and counseling and trying to figure out how those firms fit into the modern business practices of a broker dealer. And so, we try to give them practical advice as to, this is what the rule says, this is how FINRA reviews it, and this is likely to be the result if you try to comply with it in this manner. So, a lot more advice and counseling than I expected, but it’s been a fascinating learning experience for sure.

Ed Wegener: Clearly, we have the right folks to talk about FINRA enforcement given your backgrounds. So again, we’re really excited to have you here. You know, I feel the same way on the consulting side. Having worked both as a regulator and now working with the industry, I do find that a lot of it is just sharing experiences about FINRA, how they operate, what to expect. And I’m really excited that as we talk through these things, I think that what we’re really trying to do here is to provide the insights based on your background about the enforcement department and what firms can expect in dealing with FINRA enforcement. And I think that our timing is really good because, not only did you both put out a recap of FINRA’s enforcement statistics in 2024, but FINRA just released a regulatory oversight report.

I think there’s a lot of overlap there to some extent and just understanding what’s behind all that can be really helpful for the industry and for our clients, and really appreciate you being here. So that being the case, Lisa, why don’t we start with you and, thinking back when you were putting the recap together about FINRA enforcement, were there any things that that caught your eye in terms of the number of enforcement actions, how they broke out in terms of the different firm types?

Lisa Colone: First, I want to give credit to Chris Kelly and our colleague Joanne Young, who’s not on the podcast today, but together we read every single AWC (Acceptance, Waiver and Consent) that FINRA issued in 2024 and then broke them out by firm size and tried to produce some statistics that would be useful to folks in the industry. And there were a number of things that caught my eye. I do think it’s important to note that while we really focused on enforcement actions against firms, the vast majority of enforcement actions, like nearly 70% were brought against individuals. So that 70/30 split is consistent with years past. In terms of how the violations against firms broke out, I think it’s notable that 60 of the 158 settlements were brought against large firms. Large firms make up only a small portion of the overall firm population, less than 5%, and yet they accounted for almost 40% of the settlements. And maybe not surprisingly, the median fine for large firms, $375,000, was substantially higher than the median fines for small and midsize firms. I know that there’s often a feeling in the industry that small firms bear a disproportionate share of the regulatory burden. And I’m not saying that that’s not true, but these numbers certainly suggest that large firms are not getting a free pass either.

Ed Wegener: Excellent. What about you, Chris?

Chris Kelly: I agree with that. And just to pick up on that, I think one of the things that surprised me was the median fine for firms in 2024, which was $125,000. Perhaps that shouldn’t have been a surprise, but I think we’ve gotten so used to seeing these giant fines come out from the SEC in recent years, particularly in the off-channel communication cases where you have tens of millions of dollars in fines that the $125,000 fine number, well, it’s not nothing, and it’s not small, it’s a meaningful amount, I think, contrasted to the SEC fine numbers. It really shows you the difference between the penalties in FINRA and the penalties of the SEC. And I think practically what this may mean for a lot of firms is that the cost of defending the investigation in terms of, time, resources, maybe attorney’s fees, that can actually add up to be more burdensome than the fine itself particularly, if you want to litigate, and you’re now talking about two to three years down the road. And so strategically, one of the things that Lisa and I discuss is not always for some firms, it may make sense to be more proactive. If you’re going to spend more money on responding to the investigative requests and defending it, maybe it makes sense to get ahead of it as much as you can. Reach out proactively to FINRA and give them more information than you are obligated to, to try to get to the issue quicker and save yourselves from an additional six months or a year of getting and responding to document requests to try to get to the meat of the issues more quickly, knowing that that could be the costliest part of the case.

Ed Wegener: And having been in FINRA enforcement for so many years, that’s the kind of thing that FINRA would be receptive to in terms of that type of reach out and trying to get in front of those things.

Chris Kelly: I think that the instinct, and I don’t disagree with this, but the instinct for a lot of firms is to only respond to exactly what you’re asked and don’t give them anything you’re not asked for. And I understand that instinct and that makes sense in a lot of cases, but I do think it is worth a more nuanced, more thoughtful, strategic conversation in some cases where you say, yes, they didn’t ask for exactly this, but we know what they’re getting at. Or, you know what, let’s call the investigator or the examiner and say, we see what you’re asking here, but what are you really trying to get at? Because you’re asking for things not in the way we keep them. You’re asking for documents that we don’t have. If you tell us what you’re really looking for, that may save us from having to respond to three or four 8210 requests, which is the FINRA document request, until we get to the issue.

Ed Wegener: What about the types of cases that you noted that FINRA was bringing? What are the types of subject matter, or what’s the type of subject matter that FINRA’s bringing these cases in 2024, and do you see that they tend to correlate with what FINRA is identifying in their priorities?

Chris Kelly: It’s a great question, and I think I’m a big fan of the priorities, the annual regulatory operations report that they just issued. I think it’s very helpful, but I do think there’s a timing issue, because it takes a long time for matters to work their way from an examination to investigation to enforcement. So, the enforcement matters you’re seeing today are really a lagging indicator of FINRA’s priorities. They’re more likely to show up in the priority letter from three years ago than the priority letter today. Having said that, there’s still evergreen issues. So, for example, some of the areas highlighted in the 2025 report, Reg BI, anti-money laundering supervision of OBAs and PSTs, are things that have been in the reports for the last couple years. And we certainly see a lot of enforcement actions in those areas currently.

Ed Wegener: And so, thinking that these enforcement actions just don’t come out of nowhere, they come to enforcement from somewhere. So, where do the FINRA enforcement actions come from?

Lisa Colone: Well, the short answer is that most enforcement actions come from referrals from FINRA’s other departments, and particularly members supervision and market regulation. It can be a little hard to break it down further than that because FINRA doesn’t always disclose the source of an investigation. But having worked at FINRA for many years, I can tell you anecdotally that the most prolific source of enforcement matters traditionally has been the cause program within member supervision. And beyond that too, it’s important to note that that cause program within member supervision gets its matters from a wide variety of places. It can be from customer complaint form U-4 and form U-5 filings, whistleblower tips, senior helpline calls, and so on.

Chris Kelly:  Just following up on that, one of the things that did surprise me, FINRA doesn’t always tell you the source of the investigation. Lisa’s a hundred percent right on that, but occasionally they do, usually in the very beginning of the fact section in their settlement documents. And when we took a look back at 2024 and sort of tried to parse out the ones that they did indicate a source, what were the most prevalent sources. I was really surprised at how many enforcement actions had originated with cycle exams. Again, anecdotally, my sense had been that the cycle program was referring fewer and fewer matters to enforcement over the last five or six years. But the 2024 numbers would suggest to us that the trend may be reversing.

Ed Wegener: So, knowing that most of the cases come from member supervision, either through the cause or cycle programs and market regulation, I wonder if you can talk about the process practically. How do matters make their way from those programs to enforcement?

Chris Kelly: This is one of those areas that has changed a lot over the years. As you know, Ed, there’s been a reorganization in almost every FINRA department over the last three or four years. And one of the things that has changed is the way that matters work their way through the system. When you and I were there years ago, it was very much based on geography.  So, examiners in Chicago would meet with enforcement attorneys in Chicago, and they talk about the cases they thought were worthy of a formal disciplinary action. And it would happen on an office-by-office basis in all of the offices around the country. That’s now centralized. There is one centralized process where any examiner or investigator in any department around the country, who thinks they have a matter that may be worthy of a referral to enforcement, submit it through a centralized process.

It’s called the Collaborative Consultation Process, or the CCC process. All of those potential referrals get consolidated. And essentially, there’s a meeting every week where all of the potential matters for referral enforcement are brought to enforcement to a team of managers, not just in enforcement, but in member supervision and market regulation, where the managers discuss and decide whether or not, #one, it should go to enforcement. Number two – it should stay with the examiner investigative team for further investigation, or Number 3 – it should be closed out. And again, that happens every week. But with few exceptions, almost every matter that ends up in enforcement these days has to go through that process.

Ed Wegener: It sounds like there’s a lot of centralized oversight of that process and of that decision making.

Lisa Colone: That’s true. But one thing I would also add to what Chris said is that there are times where there’s not such a clear line or such a clear handoff between member supervision and market regulation on the one hand, and enforcement on the other hand. And it is common to see some enforcement attorneys working on matters that are being run by the other departments on what they call a pre docket basis, or that means before the matter is officially referred to enforcement. And I know that for firms, it can be off-putting when you see an enforcement attorney copied on your request for member supervision, for example. But I can tell you from experience that enforcement being involved in a matter on a pre docket basis does not mean that it’s a fatal plea that an enforcement action is coming. And sometimes it’s not a bad thing.  Sometimes, especially if you have a case where there’s a really novel legal issue or there’s a strong legal defense, it’s very helpful to have an enforcement attorney on the case early on who might be particularly well positioned to evaluate those defenses or those facts.

Ed Wegener: That’s a good lead in to my next question because working with clients, broker dealer clients, as they go through the examination process, or if they’re subject to a cause investigation, they’re very worried when there’s findings in any particular exam and very concerned that any findings that they have are going to be turned into enforcement actions. I’m curious, do most examinations and investigations by either member supervision or market reg, result in enforcement referrals?

Chris Kelly: No, really quite the contrary. FINRA conducts about a thousand cycle exams a year, give or take, and opens up something like 20,000 cause matters with the number supervision.  And yet every year FINRA enforcement gets about 1500 referrals and ends up bringing about 600 or 700 formal actions. And so, not every matter that gets opened up as an exam or investigation ends up in referral to enforcement. And quite the contrary, very few in terms of the overall statistics end up in an enforcement action.

Ed Wegener: So, going from that large number of examinations and investigations and the findings that result to that much smaller number of enforcement actions, what are the factors that enforcement uses to determine whether something does get accepted as a referral?

Lisa Colone: First of all, there has to be a violation, or at least member supervision or market regulation has to believe that they have some indication that a violation has occurred. And then usually staff will consider a bunch of other questions like, was there customer harm or risk of customer harm? Was there risk to market integrity? What’s the scope of the violation? Did it affect just one customer or hundreds of customers? Was this misconduct intentional or was it the result of negligence, for example? Did the firm have a history of problems in this space? Did the firm fix the problems? Things like this. There is no set formula, there’s no set matrix, but there tends to be an open discussion between the referring department and enforcement where the violation, the strength of the proofs of the violation, as well as these other issues are discussed to determine whether it merits a referral to enforcement.

Ed Wegener: So, thinking about this whole process and everything that we’ve been talking about, for firms that are going through an examination, or if it’s something that’s been referred to enforcement, what do you think they could take away from this?

Chris Kelly: I think one of the things that I’ve come to realize is sometimes the best way to defeat an enforcement action is to prevent it from getting referred to enforcement in the first place.  So again, it’s that difference between being reactive and proactive. I think sometimes early on when the matter is still with the examination or the investigation department, you may want to give a little bit more information than you’re obligated to, to explain to them why there isn’t a violation or maybe why they’re mitigating factors here that make it a violation, not worth moving on to enforcement. Just statistically, your chances of getting a matter closed before it gets referred to enforcement are exponentially better than getting it closed once it has already been referred to enforcement. So, in some cases, not in every case, I think it makes sense to strategically maybe provide more information. Maybe it’d be information about how you’ve improved your systems or your processes, information about remediation steps you’ve taken, even if it’s not asked for in the hope that you could sort of head off that potential referral enforcement down the line.

Ed Wegener: And, on that topic, what do you think, Lisa, some of the things people can take away?

Lisa Colone: I think I would just elaborate a bit on what Chris said. Because I agree with it wholeheartedly. I think the added perspective I would offer is that from my experience, the examiners and member supervision or market regulation are really typically focused on finding out whether a violation occurred. That makes sense, right? That’s what they’re looking at. And so, they may not always be asking about those contextual issues – that background information that I had mentioned earlier, things like, what was the scope of this violation? Was the misconduct intentional? Was the problem fixed? They may not be asking about those things because that’s naturally not their focus. But I think a lot of times it’s important to raise on your own these mitigating factors, especially when they exist, because that context is important to the determination of whether a matter should go to enforcement. So think it’s important, even if the question isn’t explicitly asked for, when they have that mitigating information to share it with the examiners.

Ed Wegener: It’s interesting that you say that, and going back to when we were first starting out and talking about how each of us had made the transition from, you know, being on the regulatory side and working with FINRA for so many years and coming into the industry side, one of the things that I do hear a lot, and I understand where it comes from, and I think, Chris, you touched on this a little bit, is that fear and concern about reaching out proactively to a regulator, especially if you have an action like this going on, it just seems like why poke the bear? And just given everything that you guys had said about the additional information that you can provide that’s really going to be contextual and help make decisions like, do we refer this or not? But even if it’s referred, you want to have that information with enforcement so that they can consider it, without reaching out to the regulators and having that fear can really get in the way of that. You both worked at enforcement for a number of years and supervised between the two of you, thousands of enforcement matters. Now that you’re on the defense side, is there anything that surprised you?

Lisa Colone: Oh my gosh, so much has surprised me. Moving to the defense side has been really enlightening, and Chris and I joke all the time that we’ve learned more in the past year on the defense side than we had in a long time before this. I think one of the things that I’ve really noticed is that there unfortunately is often a disconnect between FINRA and the industry. And I don’t blame FINRA for that, by the way. I think FINRA does all kinds of things to try to increase communication and collaboration with the industry from their conferences, to publishing notices to members, their annual report, and their weekly emails. I also don’t blame the firms. I think that firms are very busy running their businesses and they can’t understand the inner workings of FINRA. But I have been surprised on the one side, how little FINRA understands about some of the practical realities of running a broker dealer in 2025.

And on the flip side, I’ve realized that firms don’t understand how FINRA really works or how they receive certain information. And just what you were saying, Ed, in your question, I’ve been surprised by how many times clients are so reticent to provide any additional information beyond that which has been asked. And I look to be clear sometimes that is the right strategy.  Is just answer the questions that are asked. But it has been surprising to me how much reluctance there is to do that when many times the information that they have to offer is so helpful to them. I just have found that oftentimes, the parties are sort of talking past each other, been run in the firms, and there’s often is communications that lead to all kinds of inefficiencies and sometimes unintended consequences, frankly.

Chris Kelly: And related to what Lisa said about the hesitancy to provide additional information or to information beyond what’s explicitly asked for, there’s also a hesitancy to escalate. And I get that. But I think, Lisa and I, our sense is that there is too much hesitancy to escalate. Too often firms suffer in silence for months or years before they finally say, okay, let’s talk to a director. Let’s talk to a Chief Counsel. Let’s talk to somebody up the chain. On the FINRA side, at least when we were there, our perspective was, that’s an ordinary course of business. You do not hold it against the firm because they escalated. You do not seek revenge because they escalated. It’s part of being a self-regulatory organization to gauge in these types of conversations. And so, I would encourage firms to think a little bit more about it. Hey, if you think there’s a disconnect between you and the line attorney or the line staff, do it in the right way. Do it respectfully, but don’t hesitate to escalate rather than to suffer in silence.

The other thing I was going to say more generally is, if I had one piece of advice to give in terms of how you deal with FINRA, it’s that there isn’t one piece of advice in how to deal with FINRA. I think what Lisa said is exactly right. Most people, and I understand this, don’t understand the inner workings of FINRA from the exam programs, the investigation programs, the difference between, cause and cycle and market regulation and member supervision. And that’s understandable. But if you do have some insight into those differences, it can really help in terms of the way you think about responding. Lisa and I do not have one set advice in terms of how to respond to a FINRA request.

Chris Kelly: For example, we try to tailor our response to, is this a cause exam or a cycle exam? Who are the examiners? How are they asking this question? In other words, there’s not a paint-by-numbers approach in our mind, or in our view, to responding to FINRA. Yes, you have to provide truthful information, yes, you have to respond to the requests, but that doesn’t mean they’re not important strategic decisions that can be made that can ultimately affect the outcome. If you understand who is making the request, what’s motivating that request, and how the process works

Ed Wegener: Well, that’s why it’s so critical to have really good counsel with you that can help you with that strategic decision making about how you want to navigate all of these tricky things.

Chris Kelly: Can I just add one thing to that? I think some people think when they make the decision to hire outside counsel, it tends to be an all-in or all-out decision. And one of the things I think you can do is in a lot of cases, Lisa and I will be hired to provide that sort of advice and counsel, but early on we’ll be behind the scenes.  Maybe you think that by hiring a law firm and doing that publicly with FINRA signals that you think you have a real problem. And I understand that. So that doesn’t mean that you can’t talk to a lawyer about, what is this request really asking? Where can we push back strategically? How should we respond to this and stay behind the scenes until it’s time not to be.

Ed Wegener: And hopefully by having that, in some cases, you won’t have to come out from behind the scenes because using that strategy. You may be able to interject and hopefully not have a matter referred to enforcement if it doesn’t need to be.

Chris Kelly: Going back to what we were talking about earlier, sometimes your best defense is a good offense to try to be proactive and to get the matter closed before it gets referred to enforcement. I think some broker dealers think we’ll do what we can until it gets referred to enforcement, and then we’ll talk to counsel. Well, in reality, a lot of decisions have been made and there’s a lot of momentum behind that matter now that’s been referred to enforcement. And so, Lisa and I are having to undo a lot of things that have been done, and we’re sort of starting from behind the eight ball. Whereas even if we’re not overt, if we’re covert early on and can give some advice that would help avoid that in the first place, I think that can be very effective.

Ed Wegener: Pivoting a little, going back to the report on the FINRA statistics that you put out, one of the things that you had noted as a big driver of AWC or enforcement actions with firms is self-reporting. And it got me to thinking about FINRA’s communications and guidance that they put out about getting credit for extraordinary cooperation. They did a Regulatory Notice, 19-23, where they provided updated information about how they provide that credit. I wonder if, from your experience and from the reg notice, if you could describe the factors that FINRA considers when deciding whether they’re going to award credit for cooperation.

Lisa Colone: I can handle this one, and I think I’m going to pull that question apart into two pieces. And so, to answer the question directly, what are those factors in Notice 19-23. There are four primary factors that FINRA considers in determining whether to award credit for cooperation for extraordinary cooperation. And to paraphrase, they are:

1. If the firm self-reported the issue before the regulator became aware of the issue;
2. If the firm took extraordinary steps to correct deficient procedures and systems;
3. If the firm made extraordinary remediation to customers; and
4. If the firm offered substantial assistance to FINRA investigations.

But the second part that I wanted to separate a bit, Ed, was clarifying the distinction between self-reporting and extraordinary cooperation. When Chris and I put in our statistics roundup that self-reporting was a big driver of AWCs, and again, we pulled that right from the first sentence of the fact section of the settlement document, where it says this matter was the result of a self-report from a firm, that’s often referring to the fact that the AWC originated with the firm disclosing an issue to FINRA via Form 4530.

And FINRA has made very clear over the years that self-reporting on form 4530 is a regulatory obligation. It is not extraordinary cooperation. So just flagging that, a lot of cases that FINRA brings, do come from the self-report on 4530. But, I don’t want your audience to think that just because I report something on form 4530, that means extraordinary cooperation. FINRA views them very differently and for extraordinary cooperation, they’re looking at those four primary factors that I answered at the top.

Ed Wegener: I appreciate that. Thinking through what the guidance that FINRA has provided in the regulatory notice and those factors based on your experience working in enforcement and, being in the trenches when those decisions are made, practically, how does enforcement weigh these different factors when they’re deciding whether to award credit to a firm?

Lisa Colone: I wish I could tell the audience that there was a specific formula for each of those four factors, but there really is not. It’s much more amorphous than that. And from my experience when I was there, it just tended to be a discussion around those four factors that I mentioned earlier often among the enforcement attorney staff to the case with his or her director and Chief Counsel, often with input from personnel from the referring department. And in my opinion, in my experience, there was no specific formula, but the factor that tended to get the most weight in cases where there was customer harm was whether the firm provided extraordinary remediation to customers. This was especially true in cases where there were large populations of affected customers that required complicated restitution methodologies. In my experience, FINRA really appreciated both when firms undertook that analysis, that calculation on their own, and when firms did the right thing on their own volition and made customers whole. So again, and that doesn’t apply in every case. But if there was a case with customer harm, that was, in my experience, the single factor that got the most weight.

Ed Wegener: So, you wrote an article earlier this year entitled The Truth About Credit for Cooperation in FINRA Land.  It made me really curious – what is the truth about credit for cooperation in FINRA land?

Chris Kelly: The truth is that it’s rarely given. We were really stunned when we looked back and really did the analysis to see how often FINRA awards credit for cooperation in a settlement. And it’s not very often at all, the notice to members 1923 that announced their new approach and guidance regarding credit for cooperation was issued in July of 2019. Since July of 2019, FINRA has bought more than 3,500 disciplinary actions and has awarded credit for cooperation 25 times. And, in fact, that sort of overstates it a little bit itself because 10 of those 25 cases were part of FINRA’s 529 share class initiative, a sort of separate initiative that was its own sort of beast. If you take those out, you’re talking about just 15 cases since July, 2019, about 0.3% of all the cases that are brought resulted in some formal credit for cooperation.

And if you parse it even further, two large firms together receive credit for cooperation eight times, four times each. So that means two firms got credit for cooperation eight times the other 3,300 or so firms got credit for cooperation seven times since July of 2019. And even more extraordinarily, we went back and looked, and we couldn’t find a single case in over a decade when FINRA gave credit for cooperation to an individual. And that frankly shouldn’t be. The notice applies to individuals and to firms, as Lisa mentioned in the first response. About 70% of the formal actions every year are against individuals. It just doesn’t seem to make logical sense that there wouldn’t have been at least one case where an individual was worthy of receiving credit for cooperation.

Lisa Colone: I’ll just add one thing, not to contradict what Chris said, because I agree with it wholeheartedly, but I will say that I think it’s important to make a distinction here between formal credit for cooperation and informal credit for cooperation. When we were reporting out those really honestly grim numbers, those were based on formal credit for cooperation, which reflect in a separate subsection in the AWC in the settlement document, which spells out the firm’s extraordinary cooperation. And so, it is very hard, very rare to get formal credit for cooperation, but in my experience, there are times, and not infrequently, when FINRA enforcement will take the position that a firm’s cooperation doesn’t fit neatly within those four factors to merit that official credit for cooperation to merit that separate section in the AWC. But FINRA will recognize that a firm cooperated, I guess, lowercase cooperated with its investigation and acted responsibly. And so, in those cases, I think FINRA will give the firm a break on sanctions, or they may offer some other concession in the AWC negotiation process for those firms that, do cooperate, but don’t hit the threshold of formal cooperation.

Chris Kelly: Yeah, and I completely agree with that. Just because you’re not getting formal credit for cooperation doesn’t mean there aren’t good reasons to cooperate, as Lisa said, with a lowercase C in the investigation. And I would throw out one other, there may be things that you do that don’t result in any sort of discount to an ultimate sanction, but still in order the benefit of the firm. And I’m thinking, for example, of proactively calculating restitution in a case where there’s customer harm. One of the reasons why you want to calculate restitution and provide restitution is because you may get cooperation credit with FINRA. Another reason is calculating it yourself may save you months or, and sometimes frankly, years of going back and forth with FINRA on the methodology and the data. If you do it yourself, if you do it in a reasonable way, oftentimes FINRA will accept that calculation and methodology. They’ll check it, but they will accept it rather than having to do it themselves from scratch, which I think sometimes results in a lot of painful back and forth with FINRA.

Ed Wegener: So along with that, one thing that I’ve seen both working in the exam program at FINRA and working with clients here is that it’s best to start correcting deficiencies as soon as possible. I don’t think it signals that you’re agreeing necessarily that there’s a deficiency but getting a start on correcting any deficiencies is helpful. What can a firm do in this regard to better its chances of getting credit for that corrective action that they’ve taken.

Lisa Colone: It’s exactly what you just said, I think, and I’ve experienced this now on the defense side myself. Sometimes there is a real reluctance on a firm’s part to correct efficiencies because they’re worried that means they conceded that they did it wrong before, or that there was a violation before. And while I appreciate that worry, I think there are absolutely situations where firms can maintain legal defenses and simultaneously make improvements. And obviously, if you’re in the ballpark for credit for cooperation, big C or little C, the fact that the firm has actually taken corrective action will be a very helpful factor to raise on behalf of the firm. So, if a firm in doing its own analysis thinks that corrective action is appropriate, I think they should take it.

Ed Wegener: That’s one of the things that I’ve often seen in AWCs and enforcement actions taken by the SEC where they will include an independent consultant undertaking to correct the deficiencies and things. And that tends to be an after-the-fact thing. And where I’ve seen firms really be successful is they take a proactive approach by doing that before the enforcement action comes out, is they have a really good chance of not having that type of undertaking, which can be very costly. It’s very prescriptive. The timelines can be really tight. And so being able to do that can be really helpful.

Lisa Colone: And this is where I’m also going to give a nod to you and my friends at Oyster, Ed, because Chris and I have actually had cases where we’ve referred clients to you before there was even an exam. We’ve had clients that were anticipating an exam where we thought, oh, you know what? They might benefit from having the help of a consultant. And to your point, having a consultant come in before an exam, certainly before an investigation or an enforcement action can be money really well spent. The other thing I would just add, you jogged a thought too, was it’s important that firms think about corrective actions, and it’s not just independent consultants, that is obviously, certainly, a very important corrective action to take when there’s a real systemic issue, or there’s a situation where outside help is needed.

But I think also, it’s always helpful for firms to consider, especially when they’re in the throes of an investigation or an enforcement action. And if they think there has been a violation, think about the root cause and what you could do to fix it. So maybe you’ve just discovered, with the benefit of hindsight, the benefit of being in this exam, that supervisory procedures could be improved. So then, that is a corrective action you can take, closing a gap in supervisory procedures, or enhancing language in your WSPs. Another example, it can be helpful to consider whether certain organizational changes might be appropriate, whether it’s shifting reporting lines or maybe increasing training. That can be a useful corrective action that can be taken depending on the facts and circumstances of any given case.

Ed Wegener: Excellent. Well, it’s a lot of information that we shared, but I think your insights are really helpful. You talked about that disconnect between regulators and the industry. This kind of information really kind of helps shed a light for the industry in terms of how to deal with these issues, which can be  really complex, very challenging, anxiety inducing. And to have this kind of information going into that can be really helpful to start that process of creating a strategy to deal with this. So, I really appreciate the information that you both shared from your years of experience with FINRA. To wrap it all up, I wonder if you could just provide some advice based on what you’ve seen on both sides that you’d give firms beyond the things that FINRA’s officially communicated.

Lisa Colone: I think this is a theme you’ve probably heard from me and from Chris on this podcast today, but my one piece of advice would be to really consider firms being proactive with FINRA. And look, I recognize that this advice does not fit every case, but I do believe it makes sense in most cases. What I have found in the past year doing this practice with respect to firm cases is that problems have almost always been less egregious than FINRA immediately worried them to be. And firms were almost always doing much more good than FINRA immediately realized. And I think that it can be really powerful in the right cases for firms and their attorneys to not be so defensive and so passive in just responding to these information requests, but to take the bull by the horns in the right way and to present a broader picture for FINRA early and often, frankly. And I say that too with consideration that FINRA’s not always going to ask those questions. That’s not necessarily their concern. Like I said, they’re often charged with getting down to it and figuring out has there been a violation? Yes or no. But I think it’s incumbent upon firms and their attorneys, in the right cases and in the right way, to make FINRA aware of that additional context when it’s appropriate to do so.

Chris Kelly:   I 100% agree with that. I’m a big fan of trying to set the narrative yourself from early on in the case, rather than having somebody else set it for you, than having to back out of that narrative and convince them otherwise. The other thing I would mention is I know it is hard, firms have to worry not just about FINRA, but the SEC and the state regulators, and there’s a lot to worry about. And so, you can’t pay attention to everything, every guidance or every notice that comes out from every regulator. But I do think, particularly if you know that your time is coming up for a cycle exam, for example, FINRA puts out a lot of information. You can read all of the disciplinary actions that FINRA puts out on firms. One of the things I would recommend you do is take a look at firms that you know are your peer firms, firms of similar size and business model, and search FINRA’s disciplinary actions, see what other disciplinary actions have been brought against your peer firms. Look at the regulatory operations report and look at some of the recent guidance. I think if you do that, you could have a pretty good sense of the areas and the hot topics that FINRA’s going to be looking at and help prepare yourselves in advance. It’s always better to be prepared in advance than to be reacting once FINRA is onsite and in your building.

Ed Wegener: Well, I’m really glad you said that because it gives me an opportunity to make a shameless plug. One of the things that we had put together starting a few years back was taking the FINRA report and identifying each of the different areas, but then all of the considerations, common findings, best practices, or effective practices, and putting it into a tool where a firm can not only search and sort, but then also use that to identify, is this area applicable to my firm? Because if it’s not, don’t spend any time on it, but if it is applicable, taking a look and say, do we have the right procedures? Do we have the right controls? How are we doing in this space? So that you can always kind of be staying ahead of what the priorities are, because my sense is that was the intent FINRA had and being so open about providing the areas that they’re looking at.

And all of this information is that firms use that information to better their programs. And if you can do that and be proactive, identifying issues, it means that there may have been issues before, but at least you’re finding them proactively and fixing them. So, all terrific advice. And I really want to thank you both for being here. The information that you’ve provided is terrific and I’m really excited about the opportunity that we get to work together again. So thanks for joining. Thanks.

Libby Hall:  Thank you. If you found today’s discussion helpful, don’t forget to subscribe for more episodes where we dive into industry strategies and best practices. For more information about our experts and services, visit our website at oysterllc.com. Thanks for listening.