On April 10, 2017, the Financial Industry Regulatory Authority’s (FINRA) National Adjudicatory Council (NAC) introduced new Sanction Guidelines (Guidelines) which allow the NAC and FINRA staff to take into consideration the vulnerability of customers in determining appropriate sanction levels.1 The last update to the Guidelines occurred approximately two years ago, and included changes related to unsuitable recommendations and misrepresentations.2 Last month’s changes to the Guidelines provide for the first time a “principal consideration that analyzes whether a respondent has exercised undue influence over a customer.”3 Now listed as a specific factor for adjudicators and FINRA staff4 to consider in determining appropriate sanctions is “[w]hether the respondent exercised undue influence over the customer.”5
I. New Guidelines Codify Past Practices and Apply Immediately
Prior to the new “principal consideration,” FINRA has historically acknowledged the vulnerability of customers in certain decisions.6 However, including customer vulnerability and a respondent’s undue influence over a vulnerable customer when analyzing sanctions has never been specified.
This new “principal consideration” applies to all FINRA cases immediately, unlike the recent senior investor-related rulemakings (new FINRA Rule 2165 (Financial Exploitation of Specified Adults) and amended FINRA Rule 4512 (Customer Account Information)), which are not effective until February 2018. The NAC and applicable FINRA staff can immediately take the new “undue influence” factor into consideration when adjudicating, prosecuting or negotiating disciplinary actions.
II. New FINRA Rule 2165 and “Undue Influence”
Neither FINRA Rules nor By-Laws define the term “undue influence.”7 Definitions in new FINRA Rule 2165 may help the industry to understand what it means for a respondent to “exercise undue influence” over a customer. The concept of undue influence arises in Rule 2165’s “financial exploitation” definition as “an act or omission . . . to . . . obtain control, through deception, intimidation or undue influence, over the Specified Adult’s8 money, assets or property.”9
It is possible that the NAC or FINRA staff may look to whether a senior investor was deceived or intimidated by the respondent, or whether the respondent exercised an inappropriate level of “control” over an investor given that investor’s mental capacity or the availability of a designated family member or friend. Presumably any influence over a customer’s decisions would only be considered “undue” if there was some level of deceit, self-dealing or other bad intent. However, this conclusion is not clear from the Guidelines.
III. Expect Continued Scrutiny of Firm Interaction with Senior and Vulnerable Investors
The senior-centric update to the Sanction Guidelines should come as no surprise. Over the past two years, FINRA has significantly increased its focus on senior investors, first with a joint report with the U.S. Securities and Exchange Commission in early 2015,10 followed closely by the launch of its Securities Helpline for Seniors,11 the topic’s rising prominence in the latest examination priorities letters,12 and most recently with the adoption of new FINRA Rule 2165.13 This scrutiny is expected to increase, with a focus on related sales practice examinations and subsequent enforcement actions.
1 See FINRA Sanction Guidelines (Apr. 2017), available at https://www.finra.org/sites/default/files/Sanctions &under;Guidelines.pdf.
2 See FINRA Regulatory Notice 15-15 (May 2015), available at http://www.finra.org/sites/default/files/Regulatory Notice &under;15-15.pdf.
3 FINRA Regulatory Notice 17-3 (Apr. 2017), available at https://www.finra.org/sites/default/files/Regulatory-Notice-17-13.pdf.
4 See Sanction Guidelines FAQs (Mar. 2006), available at http://www.finra.org/industry/march-2006-revisions-nasd-sanction-guidelines-faq. The Sanction Guidelines are very important because they apply to all FINRA disciplinary actions, whether settled or litigated.
5 Supra note 1. The Regulatory Notice accompanying the Guidelines implies that customer age or vulnerability is a prerequisite for undue influence. The language in the Guidelines provides no reference to age or customer vulnerability; rather, the focus is on the action of a respondent vis-à-vis a customer. See FINRA Regulatory Notice 17-13 at p. 2 (April 2017), available at http://www.finra.org/sites/default/ files/Regulatory-Notice-17-13.pdf (explaining that “the new consideration reaffirms that financial exploitation of senior and other vulnerable customers should result in strong sanctions”).
6 Supra note 1. See, e.g., Dep’t. of Enforcement v. Dima, FINRA OHO Order No. 2015046440701 (Feb. 28, 2017) (barring a registered representative for making unauthorized and unsuitable trades worth approximately $15 million in a 73-year-old retiree’s account); In re Prudential Annuities Distributors, Inc., FINRA AWC No. 2012034423502 (July 19, 2016) (fining firm $950,000 for supervisory violations related to its failure to “detect and prevent the misappropriation of nearly $1.3 million from an elderly customer’s variable annuity account”).
7 The term “undue influence” has infrequently occurred in FINRA disciplinary decisions and regulatory releases. See, e.g., Dep’t. of Enforcement v. Butler, OHO Decision No. 2012032950101 (July 8, 2014) at p. 28 (Elderly widow’s change of annuity beneficiary from her grandchildren to her registered representative considered “a red flag of possible undue influence and fraud”); Order Approving a Proposed Rule Change [t]o Adopt FINRA Rule 2272 To Govern Sales or Offers of Sales of Securities on the Premises of Any Military Installation to Members of the U.S. Armed Forces or Their Dependents, 80 Fed. Reg. 48,376, 48,377 (Aug. 12 2015) (One industry commenter suggested to FINRA that persons associated with a broker-dealer be required to disclose: (i) whether that individual served in the United States military, (ii) the status of the individual’s discharge, and (iii) “that a service member should not feel compelled to invest because of that associated person’s former military service.” In rejecting the commenter’s proposal, FINRA raised the concern of potential undue influence of more seasoned or decorated military service members over those with lesser rank. Due to the nature of the military culture in society, “some veterans with prestigious careers or assignments may hold undue influence over current members of the Armed Forces,” and that “requiring disclosure of military service for persons associated with a member firm could have the unintentional effect of unduly influencing or pressuring current service members’ investment decisions”).
8 Defined in Rule 2165 as “(A) a natural person age 65 and older; or (B) a natural person age 18 and older who the member reasonably believes has a mental or physical impairment that renders the individual unable to protect his or her own interests.” FINRA Rule 2165(a)(1).
9 FINRA Rule 2165(a)(4)(b)(ii).
10 See National Senior Investor Initiative: A Coordinated Series of Examinations, The SEC’s Office of Compliance Inspections and Examinations and FINRA (Apr. 15, 2015), available at https://www.finra.org/sites/default/files /SEC%20 National%20Senior%20Investor%20Initiative.pdf.
11 See Press Release, FINRA Senior Helpline Marks Second Anniversary With $4.3 Million in Voluntary Reimbursements to Callers (Apr. 20, 2017), available at http://www.finra.org/newsroom/2017/finra-senior-helpline-marks-second-anniversary-43-million-voluntary-reimbursements.
12 See, e.g., 2017 FINRA Annual Regulatory and Examination Priorities Letter (Jan. 2017) at p. 3, available at http://www.finra.org/sites/default/files/2017-regulatory-and-examination-priorities-letter.pdf.
13 See, e.g., FINRA Regulatory Notice 17-11 (Mar. 2017), available at http://www.finra.org/sites/default /files/Regulatory-Notice-17-11.pdf.