FINRA Rule 4111 to address financial firm misconduct

Oct 20th '21

On September 28, Financial Industry Regulatory Authority (FINRA) adopted new rules to address firms with a significant history of misconduct. As explained in Regulatory Notice 21-34, New Rule 4111, (Restricted Firm Obligations) requires member firms that are identified as “Restricted Firms” to deposit cash or qualified securities in a segregated, restricted account, adhere to specified conditions or restrictions, or comply with a combination of such obligations.


New Rule 9561 (Procedures for Regulating Activities Under Rule 4111) and amendments to Rule 9559 (Hearing Procedures for Expedited Proceedings Under the Rule 9550 Series) establish a new expedited proceeding to implement Rule 4111.


The new rules and rule amendments become effective on January 1, 2022.


New Rule 4111 (Restricted Firm Obligations)

The new rule allows the self-regulator to impose new obligations on broker-dealers with significantly higher levels of risk-related disclosures than other similarly sized peers, based on numeric, threshold-based criteria.


FINRA Rule 4111 establishes a multi-step, annual process through which the self-regulator will determine whether a member firm raises investor protection concerns substantial enough to require that it be designated (or re-designated) as a “Restricted Firm” and subject to additional obligations, including a “Restricted Deposit Requirement.” The multi-step process includes numerous features designed to narrowly focus the new obligations on the firms of most concern.


Each year’s process will begin with a calculation of which firms meet numeric thresholds based on firm-level and individual-level disclosure events to identify member firms with a significantly higher level of risk-related disclosures as compared to similarly-sized peers. The process also gives each member firm that is preliminarily identified by these numeric criteria several ways to affect outcomes during subsequent steps in the process. These include:


  • A one-time opportunity to avoid the imposition of obligations by voluntarily reducing its workforce
  • An opportunity to explain to the Department of Member Supervision (Department) why the firm should not be designated as a Restricted Firm or be subject to a Restricted Deposit Requirement or to propose alternatives that would still accomplish FINRA’s goal of protecting investors
  • The opportunity to request a hearing before a FINRA Hearing Officer in an expedited proceeding to challenge a Department determination


New Rule 9561 and Amendments to Rule 9559

Also adopted is new Rule 9561 (Procedures for Regulating Activities Under Rule 4111), and amendments to Rule 9559 (Hearing Procedures for Expedited Proceedings Under the Rule 9550 Series), which establishes a new expedited proceeding to implement Rule 4111.


Rule 9561 establishes a new expedited proceeding that will:


  • Allow member firms to request a prompt review of the Department’s determinations under Rule 4111 and challenge any of the “Rule 4111 Requirements” imposed, including any Restricted Deposit Requirements
  • Address a member firm’s failure to comply with any requirements imposed under Rule 4111


If a member firm requests a hearing under Rule 9561, the hearing will be subject to Rule 9559. Several amendments to Rule 9559 have been approved that are specific to hearings requested pursuant to Rule 9561. These include, among others:


  • Amendments to Rule 9559(d) and (n) to establish the authority of the Hearing Officer
  • Amendments to Rule 9559(f) to set out timing requirements for hearings conducted under Rule 9561(a) and (b)
  • Amendments to Rule 9559(p)(6) to account for the obligations that may be imposed under Rule 4111 within the content requirements of any decision issued by a Hearing Officer under the Rule 9550 Series


Rule 4111 follows the same pre-emptive regulatory approach as FINRA’s Taping Rule (FINRA Rule 3170) and requires firms that employ a large number of high-risk brokers from expelled firms to record all phone conversations — including mobile phone calls — between brokers and customers. The Taping Rule also requires that the recordings are monitored and reviewed to ensure compliance with FINRA rules. Like with taping firms, the public will be able to view which firms are restricted firms on the FINRA website.


Firms that need to comply with the new rule should invest in a FINRA-compliance provider that is equipped to record, retain and play back relevant phone conversations, comprehensively, natively and efficiently.


This new FINRA rule is positive for the public as it will help protect investors and safeguard market integrity. However, this could be seen as a negative for brokers as there will be extreme FINRA supervision and examination focused on this “bad boy” list.


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Author: Marianna Shafir Esq. Regulatory Advisor at Smarsh


Marianna Shafir, Regulatory Advisor at Smarsh, is responsible for regulatory affairs worldwide. With her expertise in financial services industry, compliance and e-discovery, Marianna counsels Smarsh clients on meeting regulatory obligations, leveraging technology and guidance on best practices related to electronic communications supervision. Prior to joining Smarsh, Marianna worked for BNY Mellon and Invesco where she was an instrumental member on compliance teams.Marianna has also served as an adjunct professor at New York Career Institute where she taught Law Office Management and Real Estate Law. She earned her Juris Doctorate from Nova Southeastern University. She is a frequent speaker at industry conferences and a contributor to various online publications.


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