The Impact of FINRA Disciplinary Proceedings on SEC and State Registered Investment Advisers
The number of “dually registered” financial advisers–those who offer both transactional
brokerage services through a broker-dealer and investment adviser services through an RIA–are
on the rise. These advisers are subject to oversight by both FINRA and the Securities and
Exchange Commission (SEC) or state securities regulators.
While there is significant overlap, FINRA maintains its own rules, regulations and
enforcement mechanisms separate and apart from the SEC and state regulators. FINRA has
stepped up its regulatory and enforcement efforts significantly in the wake of the financial crisis.
While there is no question serious misconduct warrants serious discipline, it is increasingly
common for FINRA to conduct an investigation or start an enforcement proceeding for conduct
that, while fairly innocuous, constitutes a technical rule violation. It is not unusual, therefore, for
a dually registered adviser to be named in a FINRA inquiry or investigation for a relatively
minor transgression, or sometimes more questionable conduct that still would not trigger an
investigation or discipline by the SEC or a state regulator.
When facing a FINRA regulatory proceeding, dually registered advisers often
contemplate “giving up” their FINRA registration, as they may continue serving their clients as
an SEC or state registered investment adviser even after dissociating from a FINRA brokerdealer.
The issue of whether an adviser may simply leave FINRA to avoid the headache of a
regulatory proceeding is, however, not so black and white. This article discusses the impact a
FINRA regulatory proceeding may have on an adviser’s ability to continue offering advisory
services even if he or she decides to leave FINRA.
Impact of FINRA Discipline on SEC-Registered Advisers
An investment advisor is defined as “any person who, for compensation, engages in the
business of advising others, either directly or through publications or writings, as to the value of
securities or as to the advisability of investing in, purchasing or selling securities, or who, for
compensation and as a part of a regular business, publishes analyses or reports concerning
securities.” Investment Adviser’s Act of 1940, codified, as amended, at 15 U.S.C. §§ 80b-1, et
seq., at §80b-2(a)(11). In short, absent an exemption, anyone who gives investment advice for
compensation will be considered an investment adviser and subject to strict licensing and
registration requirements.
Investment Advisers must be registered either through the SEC or a state regulatory
agency, depending on the amount of assets they have under management. The Investment
Advisers Act of 1940 (“IAA”), 15 U.S.C. § 80b-1, et seq., which is administered by the SEC,
regulates investment advisers. The IAA dictates whether an adviser must register with the
state(s) in which they conduct business or with the SEC. An adviser must register with the SEC
if it has assets under management of at least $100 million or provides investment advice to an
investment company registered under the Investment Company Act of 1940. 17 CFR §
275.203A-1. Advisers with between $25 million and $100 million under management (so called
“mid-range” advisers) generally are required to register with the state (though there are
exceptions allowing for SEC registration). Those with less than $25 million under management
generally must register with the states in which they do business.
Both the SEC and state regulators have strict rules governing investment adviser
discipline with rules and policies that generally mirror those of FINRA. The IAA prescribes
when the SEC may censure, deny, or suspend an investment adviser’s SEC registration. 15
U.S.C. § 80b-3(e). Although disciplinary measures are discretionary at both the state and federal
level, an examination of the relevant disciplinary history shows that, in practice, the SEC is much
less likely to discipline an investment adviser for a FINRA rule violation or disciplinary finding
than are state securities regulators.
The relevant sections of the IAA provide that the SEC “shall censure, place limitations on the
activities, functions, or operations of, suspend for a period not exceeding twelve months, or
revoke the registration of any investment adviser if it finds . . . that such censure, placing of
limitations, suspension, or revocation is in the public interest and that such investment adviser, or
any person associated with such investment adviser, whether prior to or subsequent to becoming
so associated” has engaged in any of the following conduct:
- 1. Willfully made a false or misleading statement with respect to a material fact, or
omitted a material fact, in an application for registration, report filed with the
SEC, or in any proceeding before the SEC with respect to registration; - 2. Has been convicted within ten prior years of a felony or misdemeanor for certain
crimes; - 3. Has been convicted of a crime in the prior 10 years that is punishable by
imprisonment for one or more years that is not described in the above section; - 4. Is permanently or temporarily enjoined by order, judgment, or decree of any court
of competent jurisdiction, including any foreign court of competent jurisdiction,
from acting as an investment adviser, underwriter, broker, dealer, municipal
securities dealer, government securities broker, government securities dealer,
transfer agent, credit rating agency, foreign person performing a function
substantially equivalent to any of the above, or entity or person required to be
registered under the Commodity Exchange Act or any substantially equivalent
statute or regulation, or as an affiliated person or employee of any investment
company, bank, insurance company, foreign entity substantially equivalent to any
of the above, or entity or person required to be registered under the Commodity
Exchange Act or any substantially equivalent statute or regulation, or from
engaging in or continuing any conduct or practice in connection with any such
activity, or in connection with the purchase or sale of any security; - 5. Has willfully violated any provision of the Securities Act of 1933, the Securities
Exchange Act of 1934, the Investment Company Act of 1940, the IAA, the
Commodity Exchange Act, or the rules or regulations under any such statutes or
any rule of the Municipal Securities Rulemaking Board, or is unable to comply
with any such provision; - 6. Has willfully aided, abetted, counseled, commanded, induced, or procured the
violation by any other person any provision of the laws listed above, or has failed
to reasonably supervised; - 7. Is subject to any order of the SEC barring or suspending the right of the person to
be associated with an investment adviser; - 8. Has been found by a foreign financial regulatory authority to have violated certain
laws; - 9. Is subject to a final order of a State securities commission, other State authority
that supervises financial institutions, State insurance commission, an appropriate
Federal banking agency, or the National Credit Union Administration, that: (A)
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
(B) constitutes a final order based on violations of any laws or regulations that
prohibit fraudulent, manipulative, or deceptive conduct.
Conspicuously absent from this list is any provision allowing the SEC to automatically
suspend a dually registered adviser following a FINRA disciplinary order, bar or suspension.
The SEC interprets Section 5, above, to include discipline by the SEC for having “violated a
securities-related statute or rule, or have been the subject of a securities-related injunction, or
similar legal action.” STAFF OF THE INV. ADVISER REGULATION OFFICE, DIV. OF INV. MGMT.,
S.E.C., REGULATION OF INV. ADVISERS BY THE U.S. SEC. AND EXCHANGE COMM’N (Mar. 2013).
Section 9, meanwhile, expressly authorizes the SEC to discipline an adviser who is subject to a
final order of a state securities commission. Section 8 specifically includes foreign financial
regulatory authority findings as grounds for “automatic” SEC discipline, but there is no mention
of FINRA.
Notwithstanding the foregoing, the SEC obviously has the power to discipline an adviser
for the same misconduct that could also give rise to a FINRA disciplinary proceeding. The SEC
expressly may censure, deny or suspend an investment adviser even if FINRA has already
punished the adviser for the same conduct. Jones v. SEC, 115 F.3d 1173, 1174 (4th Cir. 1997).
An exhaustive search of SEC disciplinary proceedings did not, however, show any instances
where the SEC barred or suspended an investment adviser solely because that adviser had been
disciplined by FINRA. Assuming the adviser’s conduct did not also violate SEC rules and
regulations, therefore, it is much less likely that an SEC registered adviser would face SEC
discipline solely because of a FINRA regulatory proceeding or disciplinary finding.
Impact of FINRA Discipline on California Investment Advisers
Investment advisers who are not eligible to register with the SEC are required to register
with the states in which they do business. Cal. Corp. Code § 25230, et seq. Virtually identical
to the SEC, California defines investment advisers as persons who, for compensation, engage in
the business of advising others, either directly or indirectly through publications or writings, as to
the value of securities or as the advisability of investing in, purchasing or selling securities, or
who, for compensation and as part of a regular business, publish analyses or reports concerning
securities. Cal. Corp. Code § 25009.
California’s rules governing adviser discipline also mimic those of the SEC. The
statutory framework, however, specifically refers to suspensions or expulsions from membership
in any national securities association (i.e., FINRA) as grounds for suspension or discipline. Like
the SEC, California may invoke these penalties for conduct that occurred even prior to the
individual registering as an investment adviser. Also like the SEC, these penalties are
permissive, and not mandatory, and require notice and opportunity to be heard.
California Corporations Code section 25232 outlines the conduct that may lead to
discipline by California’s Commissioner of Business Oversight and the potential loss or
suspension of an investment adviser’s certificate in California:
- The commissioner may, after appropriate notice and opportunity for hearing, by
order censure, deny a certificate to, or suspend for a period not exceeding 12
months or revoke the certificate of, an investment adviser, if the commissioner
finds that the censure, denial, suspension, or revocation is in the public interest
and that the investment adviser, whether prior or subsequent to becoming such, or
any partner, officer or director thereof or any person performing similar functions
or any person directly or indirectly controlling the investment adviser, whether
prior or subsequent to becoming such, or any employee of the investment adviser
while so employed has done any of the following: - (a) Willfully made a false or misleading statement with respect to a material fact,
or omitted a material fact, in an application for registration, report filed with the
Commissioner, or in any proceeding before the Commissioner; - (b) Has been convicted of a felony or misdemeanor, or held liable in a civil action
for conduct showing moral turpitude, and the actions involved the purchase or
sale of a security, arose out of conduct of the business of a broker-dealer or
investment adviser, involved theft, or involved “violation of Section 1341, 1342,
or 1343 of Title 18 of the United States Code.” - (c) Is permanently or temporarily enjoined by order, judgment, or decree of any
court of competent jurisdiction from acting as an investment adviser, underwriter
or broker-dealer or as an affiliated person or employee of any investment
company, bank, or insurance company, or from engaging in or continuing any
conduct or practice in connection with that activity, or in connection with the
purchase or sale of any security. - (d) Is or has been subject to (1) any order of the Securities and Exchange
Commission or the securities administrator of any other state denying or revoking
or suspending his or her registration as an investment adviser, or investment
adviser representative, or as a broker or dealer or agent, (2) any order of any
national securities association or national securities exchange (registered under
the Securities Exchange Act of 1934) suspending or expelling him or her from
membership in that association or exchange or from association with any
member thereof, or (3) any other order of the commission or any administrator,
association, or exchange referred to in this subdivision which is or has been
necessary for the protection of any investor. - (e) Has willfully violated any provision of the Securities Act of 1933, the
Securities Exchange Act of 1934, the Investment Advisers Act of 1940, the
Investment Company Act of 1940, the Commodity Exchange Act, or Title 4
(commencing with Section 25000), including the Franchise Investment Law,
Division 5 (commencing with Section 31000), or the California Commodity Law
of 1990, Division 4.5 (commencing with Section 29500), or of any rule or
regulation under any of those statutes, or any order of the commissioner which is
or has been necessary for the protection of any investor. - (f) Has been subject to an order denying, revoking or suspending registration by
the Commodity Futures Trading Commission, has been subject to an order of any
board of trade or commodity exchange suspending or expelling the person from
membership, or “any other order of the commission or any board or exchange
referred to in this subdivision which is or has been necessary for the protection of
any investor. - (g) Has aided, abetted, counseled, commanded, induced, or procured the violation
by any other person of any statute or rule or regulation referred to in subdivision
(e). - (h) Has violated any provision of this division or the rules thereunder or, in the
case of an applicant only, any similar regulatory scheme of the State of California
or a foreign jurisdiction.
Based on a review of case law, it is, in stark contrast to the SEC, quite common for the
California Department of Business Oversight to discipline investment advisers registered in
California based solely on FINRA disciplinary findings. The Commissioner has held that a
FINRA consent order barring or suspending association with any member of FINRA constitutes
grounds for discipline pursuant to section 25232(d). See In re David Scott Cacchione (OAH No.
2014100648); In re Rafeal Ramon Sanchez; In re Steven Paul Grager. Additionally, California
routinely suspends broker-dealers from “any position of employment, management or control of
any . . . investment adviser,” if they have been found to violate FINRA rules. See In re Paul
Mata (File No. 1791367); In re Wanda Pittman Spears (File No. 927-7646) (denying application
for investment adviser certificate).
The law in many other states is consistent with California. Numerous other states
routinely suspend investment advisers almost automatically following FINRA suspensions or
disciplinary findings. This is the case even when the FINRA suspension was solely for violating
FINRA rules. Some states have even held they only need to find that FINRA suspended the
investment adviser in order suspend them pursuant to state law, not that the underlying
allegations are true. See, e.g., In re Harry Shaw Hammond, 2014 Fla. Sec. LEXIS 261, *5
(Florida 2014) (holding that it is irrelevant that adviser’s conduct was as a general securities
representative and not as an associated person of an investment adviser); In re Thomas Rudolph
Fortino, 2013 Il. Sec. LEXIS 20, *8 (Illinois 2013); In re Azim Nakhooda, 2013 Mich. Sec.
LEXIS 4 (Ohio & Michigan 2013).
Now more than ever, it is important to hire experienced counsel when facing a FINRA
investigation or enforcement proceeding. While FINRA discipline will not result in an automatic
suspension by SEC or state securities regulators, it is far from uncommon. Dually registered
advisers should think twice about simply abandoning their FINRA registration to avoid the
hassle of an investigation or enforcement proceeding. The potential negative impacts of an
adverse FINRA regulatory finding, particularly to state registered advisers, are quite severe, and
may result in additional discipline by the SEC and state securities regulators.
Shustak Reynolds & Partners, P.C., with offices in San Diego, Irvine, Los Angeles, San Francisco and New York, focuses on financial services law and represents broker-dealers,
investment advisers, registered representatives and high net worth investors across the country.
Contact us today at 888.748.8748 for a confidential analysis of your situation.