So, after all the hubbub about how Reg BI was going to turn the brokerage industry on its head, given the new standard of conduct – more like that of a fiduciary – that it was imposing on BDs and registered reps, I’m sure everyone was as super excited as I was the week before last to learn that FINRA had brought its first Enforcement action finding a violation of Reg BI! It came in the form of this AWC against the new answer to a (really boring) trivia question, a guy named Charles Malico, a former RR with Network 1.
And, what did we learn? Alas, not much. Mr. Malico was found to have excessively traded the account of a single customer. According to the AWC, this sort of trading “was excessive in light of the customer’s investment profile and therefore was not in that customer’s best interest.”
Well, duh. This is the exact same case that FINRA has been bringing for decades. Except that up until Mr. Malico came along, they called it “churning,” and charged it as a violation of the suitability rule. Under the Supplementary Material to FINRA Rule 2111, the suitability rule – which still exists, by the way, notwithstanding the promulgation of Reg BI, and which applies, I suppose to any trade not covered by Reg BI – FINRA defines “quantitative suitability” to require that
a member or associated person . . . have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile.
Do me a favor and compare that specific language with this, from Mr. Malico’s AWC, where it recites that Reg BI
requires broker-dealers and their associated persons to . . . have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest in light of the retail customer’s investment profile.
Notice anything? Yup, FINRA simply lifted its old suitability analysis, almost verbatim, except for the fact that it changed “unsuitable for the customer” to “not in the customer’s best interest.”
So this is what Reg BI is all about? A simple exercise in changing the vocabulary that FINRA is going to use when it brings the same old cases it’s always brought? Maybe it’s too early, maybe waaaay too early, to reach any sort of overarching conclusions about the impact that Reg BI will have on FINRA’s Enforcement program. But, based on this sample size of exactly one case, it is difficult to figure out what the fuss is all about. At least when it comes to churning cases.
To be fair, however, after doing my digging around FINRA’s website, this is exactly the result we should have been expecting. In a podcast from back in September 2020 called “Excessive Trading: When A Lot Becomes Too Much,” the Enforcement guy was asked whether “FINRA Enforcement’s expectations around excessive trading changed at all since the implementation of Reg BI in June of this year?” In response, Chris Kelly stated,
[t]he short answer is no. I don’t think you’ll see much of a difference in the excessive trading cases we traditionally brought under FINRA suitability rules and the cases that we are likely to bring under Reg BI with one important difference. Reg BI eliminated one of the key legal elements of an excessive trading case that we are required to prove and that is the element of control. So traditionally, in order to bring excessive trading case against the broker the enforcement action would have to establish that the broker controlled either in fact or had de facto control over the trading in the customer’s account. Reg BI explicitly eliminates that requirement of control and so we no longer need to prove that to bring an excessive trading case under Reg BI. Other than that, I think the cases are very much going to look the same.
Well, point to you, Mr. Kelly, you nailed it.
We will have to watch what other tricks FINRA may have up its sleeve if/when it starts using Reg BI to enforce things other than churning. For now, however, apart from using slightly different vocabulary, the Malico AWC demonstrates that it’s “same as it ever was” when it comes to churning, Reg BI notwithstanding.
P.S. After I posted this, I got a call from someone much smarter than me (which, of course, I acknowledge describes most humans). He pointed out that while there may not be any impact on the nature of the case that FINRA brings, calling the misconduct a violation of Reg BI vs. a violation of the suitability rule can have a huge impact on the respondent…IF THE CONDUCT IS FOUND TO BE WILLFUL! If someone is found to have violated Reg BI “willfully,” that results in the respondent being deemed to be STATUTORILY DISQUALIFIED. That would NOT be true for any violation of the suitability rule, even a willful violation. Indeed, as you can see from Mr. Malico’s AWC, he was, in fact, SD’d because his violation of Reg Bi was deemed to be willful. This is not a happy development.