Source: https://www.shufirm.com/the-impact-of-finra-disciplinary-proceedings-on-sec-and-state-registered-investment-advisers
Timestamp: 2019-04-25 04:52:30+00:00

Document:
By: George C. Miller, Esq. & Katherine S. DiDonato, Esq.
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.
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.
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.
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.
(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.
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.

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