Financial advisers support beefing up background checks on hires as a way to better protect investors, while acknowledging that new Finra requirements could raise costs for small firms.
On Monday, the Securities and Exchange Commission
approved a Finra rule that mandates firms adopt written procedures to verify the accuracy and completeness of a broker's registration information on Form U4. The document is the foundation of the broker profile contained on the Financial Industry Regulatory Authority Inc.'s BrokerCheck database investors can review before hiring a financial adviser.
“I like [the rule] because there should be barriers to entry in helping people with their money,” said Julia Carlson, chief executive of Financial Freedom Wealth Management Group.
Gary Ruchin, principal of Ruchin & Associates, echoed Ms. Carlson, saying financial advisers play a sensitive role in clients' lives that merits heightened scrutiny of their background.
“You're handling someone's money; you damn well ought to be checked out thoroughly,” Mr. Ruchin said.
Usually new rules provoke grousing among industry participants. But when talking about background checks, advisers first mention the positive aspects first.
“It's a good thing for furthering investor protection,” said Dean Harman, founder of Harman Wealth Management. “It helps firms hire quality advisers. The last thing I want is some rogue person at the broker-dealer to shed bad light on the 99% [of advisers] who are good.”
Under the
new rule, brokerage firms must conduct a search of “reasonably available public records,” such as those pertaining to criminal history, bankruptcy, civil litigation, liens and business records, both for new registrants and those newly hired. The background check must be completed within 30 days of a U4 being filed with Finra.
“The proposal will provide firms with an incentive to determine if additional disclosures on Form U4 are required for their registered personnel, ultimately resulting in more complete and accurate information in WebCRD, and as a consequence in BrokerCheck,” the staff of the SEC Division of Trading and Markets wrote in a Dec. 30 regulatory order.
The new rule will be implemented on July 1.
But it's not all rosy: The additional requirements are likely to increase compliance time and costs for financial firms.
“The deeper [the background check] the better,” Mr. Ruchin said. “I have no problem with that. The question is: Who is going to pay for it? If Finra is concerned, they have the information, they should do it.”
A typical background check can cost $2,500 to $5,000 per individual, said Kenneth E. Springer, president of Corporate Resolutions Inc., a firm that conducts such research for investors.
Sifting through public litigation records, for instance, is more than a check-the-box undertaking.
“Even if a lawsuit is closed, it can still be toxic,” Mr. Springer said. “If someone has been sued 10 times, it's important to look at the underlying facts.”
Many public records are not available online, said Mr. Springer, a former FBI agent. Assessing an individual's background and character may require additional research.
“It's going to take more time than [firms] expect,” Mr. Springer said. “You can't just do an Internet search.”
Mr. Ruchin and Ms. Carlson rely on the big broker-dealers with whom they're associated, Commonwealth Financial Network and LPL Financial, respectively, to delve into the background of their new hires.
Commonwealth is taking the new Finra requirements in stride. For years, it has been compiling profiles of new hires separate from the U4 that include personal references and credit checks. The firm reviews the public records Finra has outlined in its new mandate.
“For the most part, our procedures and processes already include the background requirements of the rule proposal,” said Paul Tolley, senior vice president and chief compliance officer at Commonwealth. “I'm confident that we are exceeding some of them.”
Modest-size firms are unlikely to say the same thing.
“If you're a small broker-dealer and don't have the systems in place, and have to invest in the systems, I could see that being onerous,” Mr. Harman said.
In a comment letter on the original proposal, the Securities Industry and Financial Markets Association expressed concerned that Finra had not clearly defined the mandate to verify the accuracy of U4 forms.
“As currently proposed, the language appears to require member firms to verify all of the information contained within the Form U4,” wrote Kevin Zambrowicz, SIFMA general counsel and managing director, in an Oct. 24 comment letter. “Such a requirement would, for some responses in the Form U4, necessitate a member firm to review voluminous additional records not typically maintained in a centralized public database.”
Finra, the industry-funded broker-dealer regulator, made only minor changes to the original proposal, so some uncertainty likely remains.
But essentially, the regulator is trying to help its member firms avoid “headline risk,” Mr. Springer said. The new background check rules may force them to think twice about hiring a hotshot broker with a big book of business but a sketchy regulatory history.
“You have to look at the long-term effect,” Mr. Springer said. “Are they going to hurt the firm's reputation? It's well worth the due diligence upfront to lessen the reputational risk.”
Ms. Carlson credited LPL's background checks for nixing some potentially dicey new hires. It helped her in her role as an office of supervisory jurisdiction.
“There was a reason [they were turned down],” Ms. Carlson said. “They weren't ethical, which would have caused me more headaches and hardships in supervising them as an OSJ.”
