The following story appeared in The Wall Street Journal on Jan. 2, 2014:
Wall Street’s self-regulator, under heightened pressure from Washington, is vowing to crack down on “cockroaching” among financial brokers.
The Financial Industry Regulatory Authority is forming a six-member team to examine the activities of stockbrokers with long track records of violations and investor complaints, including those who move from one troubled firm to another, a practice known as cockroaching in the industry.
The watchdog announced the move on Thursday in a letter to about 4,180 Finra-registered broker-dealer firms outlining its 2014 enforcement priorities.
The annual letter also includes a pledge to look at mutual funds that invest in risky “frontier markets” and to clamp down on certain computer-driven trading strategies
A Wall Street Journal analysis of state securities records last year found that more than 5,000 brokers licensed to sell securities had worked at a firm that had been expelled by Finra from 2005 to 2012.
“Finra is concerned about the potential risks posed by brokers who formerly worked at one or more firms that have been severely disciplined,” the regulator said in the letter. Finra has the authority to expel firms and bar brokers, making it illegal for them to sell securities.
The Journal’s analysis revealed some of the nationwide migratory patterns of brokers associated with firms with checkered pasts. Some brokers remained in the industry even after having accumulated numerous arbitration claims against them or declaring multiple bankruptcies.
In one case reported by the Journal, a broker jumped from an expelled firm to another firm 10 times, after landing his first brokerage job in 1998.
Sen. Edward Markey (D., Mass.) in October pressed Finra for more information, telling the regulator’s chief executive, Richard Ketchum, that the Journal’s articles raised “serious concerns” about investor protections from rogue brokers. Mr. Ketchum in a Nov. 13 letter to Mr. Markey said the regulator was stepping up its scrutiny of high-risk brokers and repeat offenders.
Finra also said it plans to use a computerized analytic system called the Broker Migration Model to track brokers who move from an expelled firm to other firms. The system can “conduct focused or accelerated examinations and enforcement efforts,” the regulator said in its letter.
Finra’s latest moves are an expansion of a program to police brokerage firms that hire rogue brokers.
Finra says it has barred 22 brokers for a variety of rule violations in the effort, or about half of those it had identified as high-risk through regulatory-disclosure forms and from investors’ tips, complaints and formal arbitration claims.
“Where we see clusters of brokers who we are concerned about, we are pretty quickly focusing on that firm,” said Susan Axelrod, Finra’s head of regulatory operations, in an interview. “We’ll be all over them with exams and enforcement.”
New on Finra’s priority list this year: mutual funds that invest in so-called frontier markets, which were among the best-performing assets in 2013. Such highflying funds “are the ones that worry us the most,” Mr. Ketchum said in an interview. Frontier markets, such as Nigeria and Vietnam, are considered a step below emerging markets in terms of development.
Retail investors often follow trends that are better suited for institutional investors, Mr. Ketchum said. “Heightened risks associated with investing in foreign or emerging markets generally are magnified in frontier markets,” Finra said in its letter.
“In many cases, these markets have relatively few companies and investment opportunities, and the local securities market may not be fully developed. This could mean less liquidity and lower investor protection standards.”
Market structure issues will be another major area of attention for Finra, executives said. The regulator plans to publish a set of best practices for alternative trading systems, including so-called dark pools, said Tom Gira, executive vice president of the association’s market regulation unit, in an interview.
The recommendations are the result of Finra’s yearlong study of off-exchange trading venues.
“We found that the operations of some ATSs were not always aligned with how they were being described and instances where trading from a proprietary basis was different than what has been disclosed,” Mr. Gira said. “Investors should know how the systems are operating.”
Finra said in its letter that it expects to continue to clamp down on certain algorithmic strategies, including so-called “momentum ignition” techniques, in which a trader artificially inflates the price of a stock in order to profit from the move, Mr. Gira said.
Finra also reiterated its concerns about interest-rate sensitive securities, including municipal securities, and structured products. Cybersecurity, anti-money-laundering and fraud around microcap securities remain on the regulator’s list of issues to watch in 2014.