Cooperation, Only More So
In October 2005, we wrote an article titled “Cooperation, Only More So: What it Takes to Receive Credit for Cooperating with NASD.”1 The title came from a line in the movie Casablanca. In it, Rick (Humphrey Bogart) is asked what kind of man Captain Renault (Claude Rains) is. Rick responds, “Oh, he’s just like any other man, only more so.”2 The article chided NASD for not adopting a comprehensive approach to giving credit for cooperation, unlike the Securities and Exchange Commission and the New York Stock Exchange, both of which had specific policies encouraging cooperation and offering firms the potential of receiving credit in return for cooperation. We stated that NASD “expects (and demands) full cooperation and has rarely awarded credit for good behavior. When clients ask us what it takes to receive credit following an NASD investigation, we say, ‘cooperation, only more so.’”
In November 2008, FINRA (the successor of NASD) heeded our advice and released Regulatory Notice 08-70, which stated that “extraordinary cooperation” in FINRA investigations would be considered in determining the level of sanctions imposed or disciplinary action taken for violations. For the past ten years, the industry has been clamoring for additional guidance, so that industry members could understand more concretely what conduct would “move the needle,” leading to reduced sanctions or no enforcement action if a firm or individual cooperated extraordinarily. Last week, on July 11, 2019, FINRA released new guidance on the subject through Regulatory Notice 19-23.
Yesterday, we discussed the implications for firms that self-report violations to FINRA under FINRA Rule 4530(b).3
This Legal Alert explores what this guidance may mean for a firm or an individual who enters into a settlement order (a Letter of Acceptance, Waiver and Consent, or AWC) with FINRA.
The Lay of the Land
Captain Renault: What in heaven’s name brought you to Casablanca? Rick: My health. I came to Casablanca for the waters. Captain Renault: The waters? What waters? We’re in the desert. Rick: I was misinformed.
In Regulatory Notice 08-70, FINRA highlighted four factors it would consider in assessing whether cooperation was “extraordinary.” Those factors were: (1) self-reporting of the violations before regulators were aware of the issue; (2) taking extraordinary steps to correct deficient procedures and systems; (3) making extraordinary remedial measures; and (4) providing substantial assistance in FINRA’s investigations. In return, firms could possibly be rewarded with a reduction of sanctions, complementary language in AWCs, or in rare cases, complete abandonment of enforcement actions. Regulatory Notice 19-23 “incorporates FINRA’s prior guidance and provides clarification and additional information about how FINRA assesses whether a potential respondent’s cooperation is ‘extraordinary’ and distinct from the level of cooperation expected of all member firms and their associated persons.” Regulatory Notice 19-23 also includes examples of how “extraordinary cooperation” goes beyond the cooperation required under Rule 8210 and the mandatory self-reporting requirements described in Rule 4350.
Extraordinary Cooperation In Prior AWCs
Captain Renault: Rick, there are many exit visas sold in this cafe, but we know that you’ve never sold one. That is the reason we permit you to remain open. Rick: Oh? I thought it was because I let you win at roulette. Captain Renault: That is another reason.
Prior to Regulatory Notice 19-23, when FINRA entered into AWCs with firms or individuals and when FINRA decided to acknowledge publically that it was rewarding credit for extraordinary cooperation, the AWCs often included descriptions of extraordinary cooperation in a section titled “Other Factors.” For example, recent AWCs included descriptions of the following extraordinary cooperation:
- Initiating an investigation prior to deduction or intervention by a regulator;
- Reviewing the effect of any violative conduct before the initiation of a regulatory investigation;
- Providing prompt restitution and/or remediation to affected customers; and
- Taking prompt action and remedial steps to correct the violative conduct.
These descriptions offer little in the way of tangible guidance for firms looking to earn extraordinary cooperation credit. To enhance transparency and provide firms substantive guidance for earning extraordinary cooperation credit, FINRA is rolling out a new section of AWCs called “Credit for Extraordinary Cooperation.” The Notice states that the purpose of this new section is to describe what specific steps a firm took to provide extraordinary cooperation and what credit the firm earned for its cooperation (e.g., reduction in fine, no undertaking, etc.). The next section discusses what specific steps FINRA anticipates those may be.
Extraordinary Cooperation in Future AWCs
Captain Renault: Realizing the importance of the case, my men are rounding up twice the usual number of suspects.
We expect that future AWCs involving extraordinary cooperation will look different from those in prior years. While Regulatory Notice 19-23 does not offer any factors different from the ones cited in its 2008 Notice, the 2019 Notice does provide enhanced guidance of what types of steps firms can take to receive such credit. AWCs will likely flesh out those steps, specifically highlighting the following factors:
1. Self-reporting the violation before FINRA discovers it
FINRA will continue to provide credit for extraordinary cooperation when firms self-report violations or misconduct discovered through their own internal investigations before FINRA or another regulator uncovers it. In Notice 19-23, FINRA identified specific areas where such credit may be due, such as where the firm:
- Identified the violation or misconduct through its own investigation rather than a customer complaint;
- Provided FINRA with information on the violation or misconduct beyond what is required by Rule 4530; and
- Identified and informed FINRA of all relevant facts as soon as it discovered the violation or misconduct and kept FINRA updated as its internal investigation progressed.
2. Correcting deficient procedures and systems
Identifying and correcting deficient procedures and systems continues to be a factor for which FINRA will provide credit for extraordinary cooperation. In the 2019 Notice, FINRA provided the following specific steps that firms can take to possibly earn this type of credit, including:
- Hiring an independent auditor or consultant to assist in revising any deficient procedures or systems;
- Making organizational changes within the firm, such as creating new supervisory positions;
- Conducting “a broader assessment” that goes beyond the immediate issue, including investigating and remediating “similar deficiencies in procedures that govern other aspects of [a firm’s] business.”
FINRA also provided guidance on the timing of correcting deficiencies. Historically, there has been tension between self-reporting and correcting deficiencies. Firms are obliged to self-report under Rule 4530(b) and may worry that if corrections are not made prior to self-reporting, they may not receive proper credit. FINRA attempted to allay those concerns, noting: “in order to encourage the timely self-reporting of misconduct, FINRA will consider, in appropriate circumstances, giving credit for corrective measures taken promptly after a firm reports the misconduct.” (Emphasis added.)
3. Restitution to harmed customers
While FINRA’s 2008 Notice encouraged firms to provide restitution to harmed customers, Regulatory Notice 19-23 focused on firms making “timely” remediation. FINRA is now acknowledging that in certain matters “identifying injured customers and calculating each individual’s losses can be complex and time consuming.” Therefore, firms may consider evaluating the following steps to accelerate the process of returning funds to harmed investors:
- Implementing a “statistical approach” to “efficiently identify customers for restitution”—rather than reviewing the recommendations in each customer’s accounts and calculating individual losses—as a means of accelerating remediation;
- Dedicating full-time staff or hiring temporary help to accelerate any necessary trade-by-trade analysis; and
- Engaging in dialogue with the Staff about structuring a methodology or process regarding how to best—and quickly—remediate harmed customers.
4. Providing substantial assistance to FINRA
Lastly, FINRA reiterated that it will consider giving cooperation credit to firms that provide substantial assistance in its investigation of the underlying misconduct. FINRA noted that what constitutes substantial assistance is relative and depends in part on the size of the firm and the misconduct at issue (i.e., “there is no one-size-fits-all approach”). Fortunately, for firms looking for more precise actions that may provide what FINRA considers to be substantial assistance, the 2019 Notice delineated much more than FINRA has previously, providing a useful checklist for firms seeking to take advantage of this credit. The ten examples identified in the Notice generally fall into the following categories:
- Going above and beyond: Providing information not required by Rule 4530 or requested by FINRA under Rule 8210, including access to firm offices or records before an 8210 request.
- Doing the heavy investigative lifting: Conducting a thorough and independent audit or investigation; providing relevant industry knowledge or common practice; and producing work product regarding its investigation, including analyses of relevant trading activities, demonstrations of trading or other systems, detailed summaries or chronologies, or relevant events.
- Identifying key individuals: Specifically identifying individuals who either may have committed violations—including any investigation the firm conducted into that individual’s misconduct—or may be witnesses who possess relevant information, including making witnesses available over whom FINRA may lack jurisdiction.
Possible Sanctions in Extraordinary Cooperation AWCs
Rick: Louie, I think this is the beginning of a beautiful friendship.
In Regulatory Notice 19-23, FINRA offered firms insight into what kind of credit they may earn, if they extraordinarily cooperate. One possibility is no enforcement action and no corresponding AWC. Where a firm has “fully remediated” a problem, FINRA “often concludes no enforcement action is warranted and closes an investigation with no further action or with a Cautionary Action Letter.” (Unfortunately, the Notice does not offer additional details on how a firm “fully remediates” a problem.)
Another possibility is reduced sanctions in AWCs. Even where a problem has not been “fully remediated,” FINRA noted two other kinds of credit firms can endeavor to receive by providing extraordinary cooperation. First, FINRA may reduce the sanctions in the AWC, including by substantially reducing any fine or, “in appropriate cases,” by imposing no fine at all. Second, FINRA may forgo requiring an undertaking, for example, by not requiring a firm to hire an independent consultant where the firm “is taking other extraordinary steps to address the problem.”
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Firms should heed FINRA’s long-awaited guidance on what constitutes extraordinary cooperation and consider FINRA’s suggestions on how to receive cooperation credit. While it’s unlikely that, as time goes by, future AWCs will say, “Here’s looking at you, Respondent,” it seems likely that we will see more AWCs highlighting the steps firms took to correct and remediate deficiencies and to provide substantial assistance to FINRA.