FINRA and SEC Investigations

Regulators may investigate a broker for potential broker misconduct including insider trading, market manipulation, misappropriation of customer funds, and/or fraudulent misrepresentations, amongst other things.

The SEC is a governmental agency empowered to act by Congress, and FINRA is a not-for-profit self-regulatory authority (SRO) that is empowered by the SEC. The SEC has broad power over the financial markets, including focusing on individual investors. Meanwhile, FINRA has a narrower power, specifically with a focus on broker-dealers (known as member firms).

The United States Securities and Exchange Commission (SEC) is created by Congress and empowered to act as a U.S. governmental agency. The SEC is the principal federal agency that oversees and regulates the financial markets. The SEC has the power to bring its own civil actions and can work with the Department of Justice (DOJ) in criminal actions. Further, the SEC can work with self-regulatory organizations (SROs), like FINRA, on investigations.

The SEC Divisions are as follows: Corporation Finance, Economic and Risk Analysis, Enforcement, Examinations, Investment Management, and Trading and Markets.

The Financial Industry Regulatory Authority (FINRA) is a not-for-profit SRO, which oversees and enforces its own rules against member firms and registered persons. It is important to note that FINRA is not a governmental agency, however, it is authorized by the government to oversee the financial markets. FINRA’s stated mission is investor protection and market integrity.

A broker-dealer must register with FINRA as a member firm. Registered persons are people associated with a member firm who engage in its securities business, like stockbrokers or branch managers. To be considered registered, the employees must pass certain securities qualification exams, such as the SIE and Series 7 exams.

FINRA’s Enforcement Department is made up of the following offices: Investigations, Main Enforcement, Market Regulation, Sales Practice, and Counsel to the Head of Enforcement.

Although FINRA is a privately owned self-regulatory organization (SRO), it has the power to create and enforce regulations in the financial industry. Through FINRA’s Enforcement Department, the SRO is able to investigate potential violations of securities laws. Investigations may include on-the-record testimony, informal interviews, and 8210 requests.

Section 8000 of the FINRA Rules outlines the procedures surrounding FINRA Investigations and Sanctions. FINRA Rule 8210 specifically handles the information-gathering stage of the arbitration process. It provides clarity on FINRA’s authority in these matters. According to FINRA Rule 8210(a), FINRA has both the authority to compel a witness to testify at a hearing and to examine relevant documents that are in a member person’s possession. Furthermore, FINRA Rule 8210(b) states that FINRA may enter into agreements with other federal regulators to share information in FINRA’s possession. If FINRA shares information with other governmental agencies, those agencies must keep such information confidential and private from third parties. For example, if the SEC is investigating a broker and the SEC believes FINRA could have relevant information on the broker, then FINRA can turn over this evidence to the SEC. The SEC generally cannot provide this information to other governmental agencies, the communication remains between the SEC and FINRA.

A FINRA Regulatory Hearing is similar to a court proceeding, but there are notable distinctions. Under Section 15A(b)(8) of the Securities Exchange Act of 1934, FINRA must provide a fair and impartial procedure for the disciplining of members and enforcement of the rules. FINRA employs an Office of Hearing Officers (OHO). These hearing officers preside over the disciplinary and expedited proceedings that FINRA’s enforcement action initially commenced.

Once FINRA decides to pursue a formal complaint, it files the claim with the OHO. The OHO serves the complaint on the respondent and then the respondent must file an answer. Once the respondent files the answer, the OHO gathers a three-person panel to hear the case. To avoid any bias, an independent hearing officer, who is a member of the OHO, is brought on as the independent adjudicator. The Chief Hearing Officer then selects two additional panelists from a large pool of industry members. These two other panelists could come from FINRA’s regional or district committees, market regulation committees, former members of FINRA’s National Adjudicatory Council (NAC), former FINRA governors, and current or former FINRA board advisory committees.

The Hearing Officer conducts the pre-hearing conferences, rules of motions, rules on the admissibility of evidence, and issues decisions. The hearing panels issue decisions at the end of each hearing and the “losing” party may appeal a decision in which FINRA will perform a de novo review.

The Enforcement Division of the SEC recommends the commencement of investigations of securities law violations. The Division gathers information on potential violations from market surveillance activities, investor tips and complaints, other Divisions and Offices of the SEC, self-regulatory organizations (SROs), and media reports.

All investigations that the SEC conducts are private and will either be formal or informal. An informal investigation involves interviewing witnesses, examining brokerage records, reviewing trading data, and other methods. The focus of an informal investigation is broader, meaning that the SEC will rely on information provided by the company or individual being investigated. On the other hand, if a formal investigation is conducted, the Division's staff may compel witnesses by subpoena to testify and produce books, records, and other relevant documents. Moreover, the SEC will generally have information that clearly suggests certain securities law(s) have been violated and usually involves alleged violations involving large sums of money.

When under investigation, the SEC will not notify you, but rather, the Division will send a letter with a subpoena for documents and for you to give testimony. You must respond to the SEC in a timely manner or else it could lead to civil and criminal penalties. From there, you may request to review the Formal Order of Investigation. After the investigation is completed, the Division will present its findings to the Commission for review. Then, the Commission may authorize the staff to file a case in federal court or bring an administrative action. However, the violation can also be settled out of court.

The SEC may also issue the alleged bad actor a “Wells Notice.”

A Wells Notice is a letter spelling out what the SEC thinks you did wrong and gives you an opportunity to correct them if you believe they are wrong. People and companies hesitate to respond because it can be used against you at trial, however, it can sometimes be a useful tool in the defense’s toolbox.