1.3 Pre-Hire Screening, Fingerprinting, and Statutory Disqualification
Key Takeaways
Rule 3110(e) requires a member to investigate an applicant's good character, business reputation, qualifications and experience before applying to register the person.
If the applicant was previously registered, the firm must review the most recent Form U5 within 60 days of filing the application, and must verify the Form U4 through a public-records search within 30 calendar days of filing it.
SEC Rule 17f-2 requires fingerprinting of partners, directors, officers and employees unless an exemption applies, and fingerprint records are kept until at least three years after the person's employment ends.
Under Exchange Act Section 3(a)(39)(F), any felony conviction within 10 years, and certain financial misdemeanors within 10 years, create a statutory disqualification.
A member that wants to associate with a statutorily disqualified person files a Form MC-400 eligibility application under the FINRA Rule 9520 Series, and FINRA notifies the SEC under SEC Rule 19h-1 of any approval.
A Series 26 principal is often the person who signs off on new hires for a branch. Hiring a person with an undisclosed past is one of the most common supervisory failures FINRA sanctions, so the outline's "pre-hire requirements based on background, disciplinary, complaint or financial history" deserve close study.
The Rule 3110(e) Background Investigation
FINRA Rule 3110(e) requires each member to ascertain by investigation the applicant's good character, business reputation, qualifications and experience before applying to register the person and before certifying that it has done so on Form U4. The rule adds three specific steps:
- Prior Form U5 review. If the applicant was previously registered with FINRA or another SRO, the firm must review the most recent Form U5, including amendments, within 60 days of filing the application, or show FINRA it made reasonable efforts to do so. It must then take appropriate action based on what it finds.
- CFTC Form 8-T. If the applicant was recently employed by a futures commission merchant or introducing broker that is notice-registered with the SEC, the firm must review the most recent Form 8-T within the same 60 days.
- Public-records verification. The firm must have written procedures to verify the accuracy and completeness of an initial or transfer Form U4 no later than 30 calendar days after the form is filed. At a minimum, this means a search of reasonably available public records, performed by the firm or a vendor. FINRA's guidance (Regulatory Notice 15-05) highlights bankruptcies, judgments and liens because they are frequently under-reported.
If verification turns up an unreported item, the firm must file a U4 amendment within 30 days after learning of it. The firm should also consider whether the omission was willful, because a willful material omission on a registration form can itself be a statutory disqualification.
Fingerprinting Under SEC Rule 17f-2
Exchange Act Section 17(f)(2) and Rule 17f-2 require every broker-dealer to fingerprint its partners, directors, officers and employees and submit the prints to the U.S. Attorney General's designee (in practice, through FINRA to the FBI). The rule allows permissive exemptions:
- General exemption (Rule 17f-2(a)(1)(i)). A person is exempt if the person does not sell securities, does not regularly have access to securities, money or the original books and records, and does not directly supervise people who do.
- Packaged-product firm exemption (Rule 17f-2(a)(1)(iii)). Personnel of a firm engaged exclusively in selling uncertificated open-end fund shares, variable contracts, unit investment trusts, limited partnership interests or REITs may be exempt if they lack regular access to securities, money and original records. The firm must also keep Item 10 of Form BD current for statutory disqualifications, carry insurance or bonding against employee fraud for those persons, and be subject to a state insurance department for its variable contract sales.
A clerk who opens the mail and handles customer checks is not exempt under either provision. Fingerprint records and processing results must be kept until at least three years after the person's employment ends (Rule 17f-2(d)).
Statutory Disqualification
Exchange Act Section 3(a)(39) defines when a person is subject to a statutory disqualification (SD). FINRA's By-Laws then bar the person from becoming or remaining associated with a member unless FINRA approves through an eligibility proceeding. The main triggers are:
| Trigger | Statutory reference | Look-back |
|---|---|---|
| Expulsion or suspension from an SRO, or a bar from association with members | 3(a)(39)(A) | While in effect |
| An SEC, CFTC or other regulatory order denying, suspending or revoking registration or barring association | 3(a)(39)(B) | While in effect |
| Being found to be a cause of another person's expulsion, suspension or bar | 3(a)(39)(C) | While in effect |
| Conviction of any felony | 3(a)(39)(F) | 10 years |
| Conviction of a misdemeanor involving securities, false oaths or reports, bribery, perjury, burglary, larceny, theft, robbery, extortion, forgery, counterfeiting, fraudulent concealment, embezzlement, fraudulent conversion or misappropriation | 3(a)(39)(F), by reference to Section 15(b)(4)(B) | 10 years |
| A court injunction relating to securities, banking or insurance activity | 3(a)(39)(F), by reference to Section 15(b)(4)(C) | While in effect |
| Willfully making a materially false or misleading statement, or omitting a material fact, in a registration application or report | 3(a)(39)(F) | No fixed look-back |
A drunk-driving misdemeanor with no financial element is not an SD, though it may still need to be disclosed on Form U4. A personal bankruptcy is a disclosure event, not an SD. A felony theft conviction eight years ago is an SD.
Sponsoring a Disqualified Person
A disqualified person cannot apply on their own behalf. The sponsoring member files Form MC-400 under the FINRA Rule 9520 Series (eligibility proceedings). The application typically includes a proposed written plan of heightened supervision naming a qualified supervisor, and FINRA's rules require an interim plan of heightened supervision while the application is pending (Section 1.4). FINRA staff in Member Supervision review the application, and a contested matter can go to a hearing before a panel of the National Adjudicatory Council (NAC). FINRA considers the nature and gravity of the disqualifying event, how much time has passed, the proposed duties, the sponsoring firm's disciplinary history, and the quality of the supervisory plan.
If FINRA approves, it must notify the SEC under SEC Rule 19h-1. Depending on the circumstances, the SEC may act on the notice or let the approval stand. A member whose own SD event arises must also report it under Rule 4530(a)(1)(H) and amend Forms BD or U4 as required.
Supervisory Checklist for a New Hire
- Run the Rule 3110(e) investigation before filing the U4: employment and reference checks, prior U5 and any Form 8-T, BrokerCheck, and an interview about every disclosure answer.
- Complete public-records verification within 30 calendar days of filing and amend the U4 within 30 days if anything new appears.
- Fingerprint the person unless a documented Rule 17f-2 exemption applies.
- Escalate any possible SD to compliance before the person performs any function, including clerical work, because SD bars association in any capacity.
- Decide whether the person's history calls for heightened supervision even without an SD (Section 1.4).
A member files a Form U4 for an experienced representative transferring from another firm. Under Rule 3110(e), by when must the member complete its verification of the Form U4 information through a search of reasonably available public records?
Within one year, at the representative's first annual compliance meeting
Before the representative's first customer transaction, with no other deadline
Within 60 days, the same period allowed for reviewing the prior Form U5
No later than 30 calendar days after the Form U4 is filed
Which of the following would make an applicant subject to a statutory disqualification under Exchange Act Section 3(a)(39)?
A misdemeanor drunk-driving conviction entered two years ago
A personal bankruptcy discharged four years ago
A customer complaint alleging unsuitability that settled for $20,000
A felony conviction for grand larceny entered eight years ago
A firm sells only uncertificated mutual fund shares and variable annuities and is subject to its state insurance department. Its mailroom clerk opens customer envelopes and logs incoming premium checks. Is the clerk exempt from fingerprinting under SEC Rule 17f-2?
Yes, because employees of packaged-product firms are always exempt
No, because the clerk regularly has access to customer money, which defeats both the general and the packaged-product exemptions
No, because every employee of every broker-dealer must be fingerprinted with no exemptions
Yes, because the clerk does not sell securities
Sections you finish are checked off in the contents.