2017 Small Firm Position Paper (Form U4, the Central Registration Depository, and BrokerCheck: Yesterday, Today and Tomorrow)
September 25, 2017
Robert W. Cook, FINRA CEO
William H. Heyman, Chair FINRA Board of Governors
Robert L. D. Colby, Chief Legal Officer
Members of the FINRA Board of Governors
FINRA Small Firm Advisory Board Position Paper
Form U4, the Central Registration Depository, and BrokerCheck: Yesterday, Today, and Tomorrow (Request for Customer-Facing and Customer Harm-Related Disclosure Identifiers)
PURPOSE OF THIS PAPER
In its role of representing over 3400 small firms in the brokerage industry, the Small Firm Advisory Board (SFAB) has examined the need to differentiate customer harm-related events and individuals associated with those events with non-customer-harm-related events, considered it in the context of what information is currently being disseminated to the public and academia via BrokerCheck, and our conclusion is that prompt system enhancement, to the CRD and BrokerCheck systems, is necessary.
The database containing the FINRA registered person dataset derived in part from Form U4 and providing the foundation of BrokerCheck system is the CRD (aka Web CRD) system. The design limitations of the CRD system, as well as the far-reaching and serious negative consequences stemming from these system limitations, are a focal point of our letter. We intend to illustrate the need for immediate action by FINRA, in concert with the SFAB, to enhance the CRD system with customer harm-related specific fields.
The Small Firm Advisory Board acknowledges the increasing pressure levied on FINRA by PIABA, NASAA, the SEC, and members of Congress to increase the amount of information displayed and advertised on BrokerCheck. In this letter, we do not take up the matter of the request for making additional Form U4 information public which we are, for the record, against unless our Small Firm voice is included in discussions relating to expansion. The matter of our members’ right to privacy has been ignored or dismissed as unimportant, by both FINRA staff and investor advocates such as PIABA; we strenuously disagree and (re)assert that registered persons in the industry are entitled to privacy considerations. Instead, our focus today is on protecting both our Small Firm members and the investing public by requesting FINRA immediately enhance the design of the CRD system. By providing easily discernable critical information on bad actors to the industry and public FINRA will fulfill its mission to protect both the investing public and, of equal importance, its SRO members.
Finally, in a related matter, we are also concerned about the matter of data-driven research, the issue of imbedded bias, and our belief that without the “right” data the data scientists, journalists, et al, are handicapped to such an extent that their findings will unavoidably be defective. The benefits that extend from maintaining a more complete database are many: the compilations provided for data-driven research relating to customer harm-related events/individuals will include precise and complete data, the regulators will be in possession of data supportive of their mission, and the clear majority of upstanding FINRA-registered individuals will finally be portrayed accurately via BrokerCheck (and in the compilations).
CENTRAL REGISTRATION DEPOSITORY (CRD) & FORM U4 AT A GLANCE
Developed by NASAA and NASD (now FINRA) and implemented in 1981, the CRD consolidated a multiple paper-based state licensing and regulatory process into a single, nationwide computer system.
In 1999, FINRA introduced “Web CRD,” which allowed electronic filing of registration forms through its website. Information in CRD is obtained through the Uniform Forms that brokers, brokerage firms and regulators complete as part of the securities industry registration and licensing process. The system contains the registration records of more than 3,700 registered broker-dealers, and the qualification, employment and disclosure histories of more than 634,000 active registered individuals.
The CRD was set up as a system for regulators to access when determining whether to register a broker or firm and is a collection of information that states and FINRA require per Form U4. The Form U4 is the Uniform Application for Securities Industry Registration or Transfer. Representatives of broker-dealers, investment advisors, and issuers of securities must use this form to become registered in the appropriate jurisdictions and/or SROs.
The CRD includes information on all registered representatives, including public-facing brokers as well other brokers that generally do not deal with public investors. Currently, CRD forms do not collect information about the role a broker plays within a firm that could be used to distinguish public-facing brokers from other brokers.
Form U4 and the CRD were not originally intended for public dissemination of the information contained within the form; they were tools for regulatory review of potential and existing securities industry registered individuals. The state regulatory agencies subsequently determined that Form U4 was a public record and initiated efforts to make form contents public. Congress and the SEC, too, have pressed on making the information public.
Upon design, neither the questions contained in Form U4 nor the CRD system were designed with the investing public in mind; according to an individual who participated in the Form U4 question creation process, there are many questions on Form U4 that were never supposed to be made public. Likewise, a reasonable consideration of an industry person’s right to privacy was not deliberated because the U4 and CRD were tools designed by regulators and originally intended for use solely by regulators.
Consequently, retail-oriented representatives cannot currently be differentiated from other non-customer facing registered individuals in the CRD system. Additionally, disclosure events are currently advertised as implicitly analogous to customer harm-related events. Both form-related and system design-related deficiencies result in presenting a wholly inaccurate and severely discriminatory portrayal of the industry and its brokers and, further, impair the ability of researchers, journalists, industry members, and the investing public to discern customer-harm data from non-customer-harm data.
BROKERCHECK AT A GLANCE
To help investors make informed choices about the brokers with whom they conduct business, the Financial Industry Regulatory Authority (FINRA) provides an online tool, BrokerCheck, to investors. BrokerCheck provides information on the professional background, including disciplinary history and customer complaints, of more than 1.2 million current and former brokers. The information FINRA makes available through BrokerCheck is derived from the CRD. The type and amount of CRD information FINRA releases to the public, is governed by its BrokerCheck Disclosure Rule and instructions from the SEC.
In the FINRA OCE Working Paper by Qureshi and Sokobin dated August 2015, FINRA sought to assess whether BrokerCheck currently provided useful information to investors allowing them to evaluate a broker’s propensity for investor harm. The Qureshi/Sokobin tested, in part, the predictability of investor harm based on BrokerCheck information and concluded that the information currently available through BrokerCheck has significant power to inform users of the platform so they can differentiate between brokers associated with investor harm events and other brokers.
The Small Firm Advisory Board holds a dissenting opinion to the OCE’s conclusions. Currently, FINRA members (individuals and firms) are meaningfully disadvantaged due to the limitations of the architecture of the CRD system housing the data that feeds the BrokerCheck system. As mentioned above, data fields do not exist in the CRD system to properly identify and categorize differing families of the disclosure set or distinguish customer-facing representatives from non-customer-facing representatives. These limitations have the potential to result in improper weighting in algorithms focused on customer-harm indicators, potentially skew research and predictive analytic conclusions, and contribute to the inaccurate portrayal of industry members as dishonest and untrustworthy. We reasonably argue that because of the lack of necessary granularity relating to, specifically, these two areas that the research results are unavoidably imprecise and unreliable. Further, right now, BrokerCheck publishes accusations, convenient settlements and decades-old misdemeanors side by side with true malfeasance which obfuscates what matters most when making the decision of who to trust with your investing needs. We seek to address and resolve part of this problem through our request.
It bears mentioning, too, that in the current regulatory paradigm, where FINRA member firms and associated persons are examined far more often than their investment advisor counterpart, Form U4 disclosures and how they are categorized and held in the CRD dataset and displayed on BrokerCheck are matters of paramount importance and concern to our Small Firm constituency, as well as all SRO registered persons and members. In 2016, FINRA performed more than 4100 examinations on approximately 3700-member firms while, during the same period, the SEC performed 1365 audits on 11,986 registered investment advisor firms. These two datasets are fundamentally dissimilar and not fairly compared due to the differing rulesets and uneven regulatory exam and enforcement schedules between the two regulatory agencies. Having said that, people will continue to compare these two groups which further illustrates the need for system enhancement in the areas we have identified.
DATA-DRIVEN ANALYTICS AND UNINTENTIONAL BIAS
The new millennia ushered in the time of big data, development of algorithmic-based analytics tailored to big data sets, and the regulatory and public push toward full transparency.
Data-driven analytics used to aid decision-making can have serious consequences on people’s lives. Companies, regulators, researchers, and data scientists in all sectors need reliable methods for eliminating unintentional bias from data-driven decision-making. The only way to audit automated systems and mitigate these risks is to constantly examine the quality, integrity, and thoroughness of the dataset underlying the analysis (the SFAB’s argument on the BrokerCheck data set) and the human judgments underpinning the analysis.
Behind every data-driven decision lies a series of human judgments. Decisions about what variables to use, how to define categories or thresholds for sorting information, and which datasets to use to build the algorithm can all introduce bias. Left unexamined, value-laden software can have unintended discriminatory effects that perpetuate structural inequality. This is particularly true when algorithms are tasked with making critical decisions about people’s lives. In conjunction with the focus of this paper, the SFAB’s intention is to clearly articulate that a true and accurate appropriately detailed dataset relating to customer-harm-related events and associated individuals does not currently exist.
Data-driven decision-making systems may seem to rely entirely on objective data, but most still involve value judgments about how that data should be analyzed. How should a specified event or role be defined, for example. What characteristics in the data should be included in the analysis? Into what categories should events be sorted? The answers to these questions may vary based on who is designing the algorithm, their motivations, and their worldview. The SFAB seeks to reduce the variable introduced through value judgments by working with FINRA to escalate this project to highest priority; value judgments diminish in the face of well-articulated data in the set which may result in more exact conclusions.
When algorithmic designers ignore nuance or inequality, they risk designing systems that create disparate impacts and perpetuating inequality – and faulty conclusions. Data scientists have a responsibility to be aware of possible biases involved in the design, implementation, and use of analytic systems and we encourage attention to this area of concern.
FINRA-registered persons and firms have the right to be fairly and accurately portrayed to industry members, regulatory agencies, academia, legislators, journalists, and the investing public. The decision to publicly disseminate Form U4 disclosure events was decided many years ago by state regulatory agencies, with the SEC and FINRA subsequently following suit with BrokerCheck and IARD. However, the questions on the U4 were never intended to be made public so the CRD system design was custom-made for the needs of regulators, not for the age of big data, data-driven analytics, and public consumption.
The consequence of the underlying database not currently allowing for necessary designations relating to customer-facing individuals and customer harm-related events is that faulty conclusions are drawn from an incomplete dataset, and good and decent industry members are unfairly portrayed as hoodlums and criminals by journalists, academics, members of Congress, the public and FINRA staff. In our modern age, this differentiation is critical and the lack of it has created a pervasive view of our industry that is misaligned with the reality.
THE SMALL FIRM ADVISORY BOARD’S DESIRE IS:
For FINRA, and all parties exposed to the registration and disclosure data of registered individuals, to have the ability to discern customer harm-related data from non-customer harm-related data and customer-facing registered individuals in the industry from non-customer-facing representatives in order to properly identify the perpetrators of retail customer harm-related events for the investing public, FINRA members, and regulators.
Working with the SFAB, we request that FINRA enhance the Web CRD system to include differentiating fields related to:
• Role: customer-facing reps (retail/institutional)
• Role: non-customer-facing reps (retail/institutional)
• Disclosure: customer harm-related disclosure events
• Disclosure: pending/unadjudicated disclosure events
• Disclosure: non-customer harm-related disclosure events
The Small Firm Advisory Board would like to take this opportunity to thank Messrs. Cook, Heyman, Colby, and the esteemed members of the FINRA Board of Governors, for your time and consideration of our Position Paper and associated systems enhancement request. We look forward to working with you on this important matter and if I can be of assistance, please do not hesitate to contact me.
Paige W. Pierce
Chair, FINRA Small Firm Advisory Board