Statutory Disqualification Process

The following is an overview of the rules and procedures applicable to members seeking to hire or retain a person who becomes "subject to disqualification," and for members that themselves become subject to disqualification.

 

 

Eligibility Requirements

 

Article III, Section 3 of NASD By-Laws1 provides that no member shall be continued in membership if it becomes subject to disqualification; and that no person shall be associated with a member, continue to be associated with a member, or transfer association to another member if such person is or becomes subject to disqualification. FINRA's authority to deny the registration and/or membership of disqualified persons or members is set forth in Section 15A(g)(2) of the Securities Exchange Act of 1934.

 

 

Disqualification Defined

 

Article III, Section 4 of the By-Laws1 defines disqualification. Disqualifying events include, but are not limited to:

 

  • certain misdemeanor and all felony criminal convictions for a period of ten years from the date of conviction.
  • temporary and permanent injunctions (regardless of their age) issued by a court of competent jurisdiction involving a broad range of unlawful investment activities.
  • expulsions (and current suspensions) from membership or participation in a self-regulatory organization.
  • bars (and current suspensions) ordered by the Securities and Exchange Commission (SEC) or self-regulatory organizations.
  • denials or revocations of registration by the SEC or Commodity Futures Trading Commission (CFTC).
  • findings that a member or person has made certain false statements in applications or reports made to, or in proceedings before, self-regulatory organizations.

 

Special Permission to Continue in or Enter the Securities Industry Notwithstanding a Disqualification

 

Article III, Section 3(d) of NASD By-Laws1 permits a disqualified person or member to request permission to enter or remain in the securities industry. NASD Procedural Rules 9520-271 set forth procedures for a member to sponsor the proposed association of a person subject to disqualification or for a member to obtain approval to remain a member notwithstanding the existence of a disqualification. These actions are referred to as "Eligibility proceedings."

 

Generally speaking, a person who is subject to disqualification may not associate with a FINRA member in any capacity unless and until approved in an Eligibility proceeding. If a person is currently associated with a FINRA member at the time the disqualifying event occurs, however, the person is permitted to continue to work provided the employer member promptly files a written application seeking permission to continue the employment in an Eligibility proceeding. A member subject to disqualification also is allowed to remain a member pending the outcome of an Eligibility proceeding, provided the member promptly files an application requesting approval of its continued membership.

 

 

Filing an Application under the Eligibility Rules

 

Once it becomes aware of a statutory disqualifying event (related to the member or a disqualified person), the member is obligated to report the event to FINRA. In the case of a disqualified person, the Firm must either file a Form U-5, if it wishes to terminate the individual's association or, file a Form MC-400 application if a member wishes to sponsor the association of a disqualified person. The member should file any MC-400 application when it amends the Form U-4 and it must amend the Form U-4 within 10 days of learning of a statutory disqualifying event (see Art. 5, Sec. 2(c) of the FINRA By-Laws). The MC-400 application requests information about the terms and conditions of the proposed employment, with special emphasis on the proposed supervision to be accorded the disqualified person.

 

The member may request, in writing, an extension of time to file the application. However, a member must not assume that an extension request has been granted if it has not received written approval from the Department of Member Regulation (Member Regulation). Failure of the member to either terminate the individual or submit an MC-400 application may subject the member to a statutory disqualification (see Art. 3, Sec. 3(a) of the FINRA By-Laws).

 

One exception, to the requirements to file an MC-400 application, concerns persons or members that are subject to an injunction that is greater than 10 years old. In these situations, pursuant to Rule 9522(e)(1)(A), the member may provide to FINRA's Registration and Disclosure Department ("RAD") a written request for relief. If the member submits the written request, RAD will send it to FINRA's Member Regulation Department which will review the proposed employment or change in membership and in its discretion may either approve the proposed association/continued membership or require that the sponsoring or disqualified member file a Form MC-400 application.
 
Members subject to disqualification that wish to retain their membership are required to submit a Form MC-400A. A member that becomes subject to disqualification must immediately amend its Form BD, in accordance with FINRA By-Laws, to report the disqualifying event and should simultaneously file an MC-400A application with RAD, if it wishes to continue in membership.
 
If a person subject to disqualification is allowed to associate with a member and later wishes to become associated with another firm, the new firm is not required to undergo the full Eligibility proceedings process in all cases (see Rule 9522(e)(2)(A)). Instead, the proposed new employer should file a Form MC-400 application, which will be reviewed by Member Regulation. If Member Regulation finds: (1) that the terms and conditions of the proposed employment are the same in all material respects as those previously approved, and (2) that there is no intervening conduct or other circumstance that would cause the employment to be inconsistent with the public interest or protection of investors, then pursuant to SEC Rule 19h-1(a)(3)(ii), Member Regulation may approve the application and provide the SEC with notification of the new employment. If Member Regulation does not believe that the application meets that standard, it may exercise its discretion to require the firm to submit to the full Eligibility proceedings process.
 
As set forth in Section 12(a) of Schedule A to NASD By-Laws1, the application fee for Form MC-400 is $1,500. This fee should be submitted along with the Form MC-400. Payment can be made either with a check from the member, or by means of a member's written request to have the amount deducted from its CRD account.

 

 

RAD/Regulatory Review & Disclosure's Role

 

When a member files a Form MC-400 or Form MC-400A, RAD/Regulatory Review & Disclosure first examines the applicable Form U4 or Form BD to determine whether there are any deficiencies. For example, all persons must be qualified (by examination or waiver) in the capacity for which they seek to associate before RAD/Regulatory Review & Disclosure will process an application.

 

RAD/Regulatory Review & Disclosure then compiles a package of relevant information, including, but not limited to: documentation regarding the disqualifying event; CRD Records for the disqualified person, the sponsoring or disqualified member firm, and the proposed supervisor of the disqualified person; and documentation in the form of orders, decisions, and the like related to the disciplinary events concerning the disqualified person, member firm, and proposed supervisor. RAD/Regulatory Review & Disclosure prepares an index of this information, together with the application form and the Form U4 or Form BD, and sends the index and documents to Member Regulation, FINRA's Office of General Counsel (OGC), and the applicant member firm.

 

 

Member Regulation's Role

 

Under the Eligibility rules, Member Regulation acts as a party in all Eligibility proceedings. Member Regulation is responsible for evaluating MC-400 and MC-400A applications and making recommendations either to approve or deny the application to the National Adjudicatory Council (NAC). Member Regulation conducts a thorough review of each file. Part of this function includes obtaining additional information, as required, from the applicant member firm, the proposed associated person, and/or various other sources.

 

To ensure a uniform and consistent approach, Member Regulation staff conducts a prescribed analysis of each application. This analysis takes into account:

 

  • the nature and gravity of the disqualifying event;
  • the length of time that has elapsed since the disqualifying event;
  • whether any intervening misconduct has occurred;
  • any other mitigating or aggravating circumstances that may exist;
  • the precise nature of the securities-related activities proposed in the application; and
  • the disciplinary history and industry experience of both the member firm and the person proposed by the firm to serve as the responsible supervisor of the disqualified person.

 

Effective March 7, 2005, Member Regulation will have the discretion to approve the applications of member firms seeking to associate disqualified persons in a purely clerical and/or ministerial capacity without requiring applicants to undergo the hearing process before the NAC prescribed by Rule 9524. See NASD Rule 9522(e)(2).  The sponsoring firm will still be required to file a Form MC-400.  In the event Member Regulation does not approve an application to associate a person in a clerical and/or ministerial capacity, the sponsoring member will have the right to proceed under Rule 9524 (i.e., to have the matter decided by the NAC after a hearing and consideration by the SD Committee). For more information see NASD Notice to Members 05-12.

 


The Important Role of Supervision

 

Pursuant to NASD Conduct Rule 30101, each member must establish, maintain, and enforce written procedures to supervise the activities of its registered representatives and associated persons that are reasonably designed to achieve compliance with applicable securities laws and regulations and with applicable FINRA rules. It is particularly important for members to be prepared to implement appropriate supervisory controls when it sponsors the association of a person who is subject to disqualification or when it seeks to retain its membership after becoming subject to disqualification. This is the case because in virtually every application that the NAC approves, it will do so subject to the applicant member's agreement to implement a special supervisory plan.

 

There is no one prescription for an appropriate supervisory plan. FINRA considers the following four factors to determine whether the supervision proposed for a disqualified person is adequate: 1) the nature of the underlying disqualification, 2) the disciplinary history of the sponsoring member and proposed supervisor of the disqualified person, 3) the nature of the proposed business activities for the disqualified person, and 4) the overall supervisory plan that the firm agrees to impose. For firms with rigorous written supervisory procedures, it may be sufficient to simply apply those procedures to the disqualified individual. Depending on the nature of the disqualification, the firm may need to propose additional controls and/or business restrictions.

 

As a general matter, FINRA and the SEC prefer that disqualified individuals seeking to act as registered representatives in retail sales capacities be supervised on-site by a qualified and experienced general securities principal to ensure active, immediate, and comprehensive supervision. In cases where on-site supervision is not feasible, an alternative supervisory system should be proposed that will assure the protection of investors.

 

For more information on the important role supervision plays in governing the employment of persons who are subject to disqualification as well as other persons with regulatory history, please see the Winter 1999 Regulatory & Compliance Alert article re: Special Supervisory Plans and NASD Notice to Members 97-19 re: Guidance on Heightened Supervision Recommendations.

 


Hearings

 

Eligibility proceedings hearings, which are scheduled at approximately two-month intervals during the year (and are held in Washington DC), are conducted pursuant to NASD Procedural Rule 9524. Hearing panels are comprised of two individuals who can be industry or non-industry representatives. The applicant member firm and the disqualified person are afforded the opportunity to be heard in person, to be represented by an attorney, and to submit any relevant evidence. Member Regulation is represented by a staff attorney at the hearings. The applicant member firm ordinarily presents both the disqualified person and his/her supervisor at the hearing, together with counsel and any other witnesses or individuals who may have relevant information. A disqualified member is similarly entitled to have appropriate representatives attend the hearing. A FINRA OGC staff attorney attends each hearing and serves as the custodian of the record and as advisor to the NAC.

 

As set forth in Section 12(a) of Schedule A to NASD By-Laws1, the hearing fee is $2,500. Applicants must pay this fee to RAD/Regulatory Review & Disclosure prior to the hearing.

 

 

Decisions

 

The Statutory Disqualification (SD) Committee, consisting of 10 individuals comprised of eight securities industry members, and two non-industry representatives, meets after the hearing to consider the application. The SD Committee presents a recommended decision to the NAC for approval. The NAC decision is the final decision on behalf of FINRA, unless FINRA Board of Governors calls the matter for review. The critical inquiry in every case is the same: whether the admission of the disqualified person or member would be inconsistent with the public interest and the overriding regulatory goal to ensure the protection of investors.

 

Statutory Disqualification Decisions

 


Expedited Review

 

The Eligibility proceedings process may be accelerated in certain, appropriate cases when Member Regulation and the applicant member firm agree to the terms and conditions that would govern a disqualified person's or member's association. In these cases, a hearing would not be conducted and the period of the NAC's review could be significantly reduced (see Rule 9523).

 

 

SEC Review

 

If FINRA approves an application, the SEC must review and approve that decision before it takes effect, pursuant to the provisions of SEC Rule 19h-1. In most cases, the SEC's review and approval is routine and typically takes approximately 30 days. In some cases, however, the SEC scrutinizes a particular application by requesting more information or by requiring other restrictions or undertakings on behalf of the firm. When an individual is subject to a qualified or unqualified SEC bar, the SEC must issue an order approving the association, which usually takes 60 days or longer.

 

If FINRA denies an application (pursuant to SEC Rule 19d-1), the member firm and the aggrieved individual have rights of appeal to the SEC. The appeal process usually takes at least several months.

 

 

Length of Time for the Eligibility Proceedings Process

 

(The following ranges of periods of time are approximate and can deviate depending on individual facts and circumstances.)

 

Stage of Application

Length of Time

RAD/Regulatory Review & Disclosure's processing of an application

1 - 3 weeks, provided that members supply RAD/Regulatory Review & Disclosure with the required documentation in a timely manner.

Member Regulation's review

3 weeks to several months, depending on when Member Regulation receives the application and accompanying documentation from RAD/Regulatory Review & Disclosure in relation to the next scheduled hearing day/s, the complexity of the application, and whether the member provides Member Regulation with requested information in a timely manner.

NAC review and decision

3 - 4 months, provided that the SD Committee and NAC do not remand the proceeding, and provided FINRA Board does not call it for review.

SEC review

20 days to several months.


 

Examinations

 

FINRA examiners conduct periodic special SD examinations to ensure compliance with supervisory conditions and to monitor for other problems. FINRA classifies individuals and members subject to disqualification into three tiers with corresponding examination requirements.

 

Tier I generally consists of individuals and members subject to disqualification because of securities or commodities-related misconduct including crimes described in Section 15(b)(4) of the Exchange Act.

 

Tier II generally consists of individuals and members subject to disqualification whose disqualifying misconduct does not relate to activities enumerated in Tier I or Tier III (below). The disqualifying event for Tier II firms and individuals in most circumstances will be based on (1) felonies that are not securities or commodities related or (2) findings by certain foreign entities.

 

Disqualified members and persons in Tiers I and II are subject to periodic examination. District Office staff has discretion to conduct more frequent or additional SD examinations if it believes that more frequent examinations are appropriate, for example because of past violations of the approved terms and conditions.

 

Tier III consists of those individuals and members subject to disqualification that were permitted to associate or remain as a member without any special supervision. There are no special examination requirements associated with this class of disqualified persons and members.


Pursuant to Section 12(b) of Schedule A to the NASD By-Laws1, members employing Tier I disqualified persons are required to pay an annual fee in the amount of $1,500. Members that employ Tier II disqualified persons are required to pay an annual assessment in the amount of $1,000.

 

 

Any questions related to RAD/Regulatory Review & Disclosure's functions should be directed to Rhonda James at (240) 386-4820. All other questions related to this process should be directed to Lorraine Lee, Statutory Disqualification Administrator in Member Regulation at (240) 386-4783.

 

 

1 Accessing the online NASD Manual.