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.

This Legal Alert explores the possible implications for firms that self-report violations to FINRA under FINRA Rule 4530(b).

Tomorrow, we will discuss 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 the following four factors it would consider in assessing whether cooperation was “extraordinary”: (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, favorable 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 mandatory self-reporting requirements described in Rule 4350(b).

Rule 4530(b): There Are Violations Going On

Rick: How can you close me up? On what grounds? Captain Renault: I’m shocked! Shocked to find that gambling is going on in here. [a croupier hands Renault a pile of money] Croupier: Your winnings, sir. Captain Renault: [sotto voce] Oh, thank you very much. [aloud] Captain Renault: Everybody out at once.

When FINRA first introduced the concept of receiving credit for extraordinary cooperation in 2008, it stated that firms or individuals could receive credit if they self-reported violations. Specifically, FINRA stated:

FINRA will consider credit for self-reporting of violations before any regulatory inquiry into the conduct at issue has begun and before the violation otherwise comes to the regulator’s attention. The self-reporting must be prompt, detailed, complete and straightforward in order to warrant special consideration. The type of reporting that is contemplated here is beyond that which is otherwise required to be reported pursuant to regulatory reporting requirements.

When FINRA adopted Rule 4530 in 2011, that analysis changed because FINRA Rule 4530(b) specifically requires firms to report violations to FINRA within 30 days of when the firm “concluded or reasonably should have concluded” the existence of such events.3 In general, to trigger a Rule 4530(b) reporting obligation, the underlying event must have “widespread or potential widespread impact to the member, its customers or the markets, or [be] conduct that arises from a material failure of the member’s systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts.”

If firms are required to self-report, how can they receive credit for extraordinary cooperation? That is a question firms have been asking since 2011. Regulatory Notice 19-23 provides some answers to that question.

Extraordinary Cooperation: Receiving Credit for a Rule 4530(b) Report

Rick: Last night we said a great many things. You said I was to do the thinking for both of us. Well, I’ve done a lot of it since then, and it all adds up to one thing: you’re getting on that plane with Victor where you belong. . . . Inside of us, we both know you belong with Victor. You’re part of his work, the thing that keeps him going. If that plane leaves the ground and you’re not with him, you’ll regret it. Maybe not today. Maybe not tomorrow, but soon and for the rest of your life.

Simply complying with Rule 4530(b) does not constitute extraordinary cooperation. “[A]t a minimum,” firms must “go significantly beyond” their required regulatory obligations.4 Firms that desire to receive credit for extraordinary cooperation in connection with their Rule 4530(b) reporting may want to consider engaging in the following conduct:

  • adopt written supervisory procedures addressing Regulatory Notice 19-23.
  • have robust compliance, audits, or other surveillance to identify potential violations
    • Regulatory Notice 19-23 notes that, where appropriate, in the Rule 4530(b) filing, firms may want to note that the firm discovered the violation through those internal controls rather than through notification from customers, counterparties, or regulators;
  • provide a supplementary submission in addition to the Rule 4530(b) filing
    • the 4530 form allows only 255 characters to describe the issue, and firms may determine that they need additional space to describe the violation or their extraordinary cooperation; to accomplish that task, firms can file a supplementary letter or other submission;
    • Regulatory Notice 19-23 makes clear that the more information and detail a firm provides in its self-report, the more likely that FINRA may view the firm’s assistance as “extraordinary cooperation”;
  • voluntarily provide information that the firm believes would be helpful to FINRA, such as:
    • before or after filing the Rule 4530(b) report, voluntarily ask to meet with FINRA staff to discuss the misconduct;
    • provide summaries of key facts;
    • identify and explain key documents;
    • identify key witnesses;
    • keep FINRA apprised of any facts that the firm learns after the Rule 4530(b) filing;
    • provide relevant industry knowledge to help FINRA assimilate information, such as regarding a complex product/practice or industry-wide conduct;
    • conduct an audit or investigation and disclose the findings to FINRA;
  • continue to address the violation after making the Rule 4530(b) filing
    • if a firm remediates, that may need to take place after the 30-day self-reporting window;
    • Regulatory Notice 19-23 acknowledges the “tension between expecting firms to report misconduct promptly” and take appropriate corrective action. FINRA notes that it will “consider, in appropriate circumstances, giving credit for corrective measures taken promptly after a firm reports misconduct”; and
  • where applicable, report the misconduct to the public and other regulators.

The Future

Ugarte [Peter Lorre]: You know, Rick, I have many a friend in Casablanca, but somehow, just because you despise me, you are the only one I trust.

* * *

Rick: Louis, I think this is the beginning of a beautiful friendship.

Regulatory Notice 19-23 will likely provide some comfort for firms that self-report violations under Rule 4530(b). First, it clears up any confusion as to whether firms need to do more than self-report a violation to receive credit. Second, it provides some specific examples of steps that firms may want to consider taking to receive credit for extraordinary cooperation. Third, it confirms that FINRA may provide credit in a variety of forms, including a reduction of sanctions or a determination to forgo a formal disciplinary action. Unfortunately, Regulatory Notice 19-23 does not provide specific criteria for firms to assess what kind of credit they may receive.

Similarly, thus far, FINRA’s settlements have not provided details about the percentage reduction in fines that FINRA has applied for extraordinary cooperation. This practice stands in contrast to other regulators that have been more transparent. For example, in October 2018, when the Financial Conduct Authority (FCA) entered into a settlement with a bank related to a cyber-attack, the FCA specifically stated that the bank’s actions qualified it for a 30% reduction in penalties.5 Until FINRA provides additional transparency so that firms can weigh the advantages and costs of extraordinary cooperation, it is unclear whether this new policy will be the beginning of a beautiful friendship between FINRA and self-reporting firms.