FinanciallyRegulated

He totally almost nailed it.

Failing tests can be embarrassing. But failing the Series 7 Exam can be particularly embarrassing. Why? Because an individual must be sponsored by a broker-dealer firm just to sit for the exam.

This involves credit and criminal background checks, fingerprints, and the filing of Finra’s infamous Form U4, with its probing questions about criminal charges, lawsuits, regulatory actions, bankruptcies, liens, employment terminations and other categories.

Broker-dealers don’t slog through this regulatory process out of a charitable desire to further the education of others. Rather, they typically plan to employ the individual as a new financial advisor (a new “producer,” as they are affectionately called). Many broker-dealers even pay a small salary to individuals while they study. Firms such as Merrill Lynch, Morgan Stanley and Wells Fargo, for example, have well-attended training programs, in which the firms pay the “trainees” to attend internal training and provide Series 7 study materials at no cost.

In other words, the broker-dealers put their faith, their time and their funds into their trainees. It’s like sponsoring a prize fighter and then betting he will win. As such, it can be rather humiliating to have to report to your sponsoring broker-dealer that the exam knocked you out. In addition, a failing score often marks the end of the sponsorship. So what’s a trainee who failed the Series 7 to do?

The “Almost Nailed it” Approach

According to a recent Finra settlement,* a former Merrill Lynch trainee has allegedly devised a new method of breaking the bad news to a sponsoring broker-dealer (allegedly, because in the settlement, the trainee did not admit the truth of Finra’s allegations). As a condition of employment, the trainee was required to pass the Series 7 Exam by February 19, 2013. Nearing his deadline, he sat for the Series 7 Exam on January 31, 2013.

The Series 7 Exam, or “General Securities Representative Qualification Examination,” qualifies an individual (who is registered with a broker-dealer) to solicit and to execute purchases and sales of securities on behalf of customers. The exam is held at formal testing centers around the country. It has 250 multiple choice questions, administered in two three-hour sessions of 125 questions each.

The exam is either very hard, or very easy, depending on who you ask. Josh Brown, of Reformed Broker fame, was not impressed:

The Series 7 exam requires you to memorize enough useless information to get through a 6-hour, 250-question test. Most of the useful calculations one learns for the test are done by computers in the real world, and most of the ethics questions are obvious, making this the most pointless barrier-to-entry exam being given in the United States today. You should meet some of the cavemen I know who’ve managed to pass it.

Brown, Joshua M., Backstage Wall Street: An Insider’s Guide to Knowing Who to Trust, Who to Run From, and How to Maximize Your Investments. McGraw-Hill. Kindle Edition (2012-03-06).

Whether or not the exam is substantively useless, there does appear to be a useful correlation: the more times a qualifying exam was retaken, the higher the average total of black marks on a stockbroker’s record. Stockbrokers Who Fail Test Have Checkered Records, Wall Street Journal, April 13, 2014.

In any event, the test proved hard for the Merrill Lynch trainee mentioned above. After six hours of clicking answers into a computer, he scored a 58%. This was unfortunate because 72% is the minimum score required to pass. If a 72% is viewed as the lowest possible D minus, then a 58% is a rather solid F.

After many weeks of paychecks, training and support, one supposes that our trainee was in no mood to report a solid F to Merrill Lynch. Plus, a solid F would likely guarantee that Merrill Lynch would not sponsor him for a second try. It would be much better, he reasoned, if he could report a less solid F. And so a plan was hatched.

Close only counts in. . .

According to the Finra settlement, after the exam, the trainee received a printed score report from the exam proctor showing his score, including the scores he received on each of the five sections of the exam. This was no doubt an unpleasant experience: not as bad as being handed a draft notice, but worse than being handed divorce papers.

According to Finra, he then “falsified” a version of the official score report to show that he had scored — not a solid F, but rather, a far more respectable 68%, an F+. He also allegedly emailed a supervisor at Merrill Lynch explaining that, although from a strictly technical perspective he did not pass, all was good because he had scored a gentleman’s 68%. In other words, he totally almost nailed it.

Drinks were definitely in order. That is, until Merrill Lynch and Finra discovered that the trainee had not totally almost nailed it.

Finra Enforcement Steps In

This little fib, made to his broker-dealer, and not to Finra, was deemed worthy of substantial punishment by Finra. In the settlement, the trainee consented to a $5,000 fine and a two-month suspension from associating with a broker-dealer in any capacity.

So what Finra rule did he violate? Finra found that he violated Finra Rule 2010, which provides:

A registered representative candidate shall not claim to have totally almost nailed the Series 7 Exam when in fact a solid F was earned.

As you can see, this is a very clear, specific rule. There’s no question that our trainee flagrantly violated it. He really ought to be ashamed of himself. Just kidding, here’s Finra Rule 2010:

A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.

This is sometimes called Finra’s “catch all” rule because it captures a wide variety of unethical conduct that is not specifically prohibited by another rule. Nobody really knows what the rule means. But that’s the idea. It forces advisors to think twice about a course of action, lest it later be deemed by Finra to be below “high standards of commercial honor.”

So what do you think? Did our (allegedly) fibbing trainee fall below the standard? While it’s not made explicit in the settlement, one suspects that the trainee reported an inflated score in the hopes that Merrill Lynch would sponsor a second attempt. If Merrill Lynch would have sponsored a second attempt with a 68% but not a 58%, then the fib would have induced Merrill Lynch to expend further time and resources that it would not have, had it known the truth. Duping Merrill Lynch in this way, while perhaps amusing, would seem to fall below “high standards of commercial honor.”

The case would be harder if the trainee knew there was no possibility that Merrill Lynch would sponsor a second attempt, regardless of the first score, as may be suggested by the deadline for passing mentioned in the Finra settlement. That is, if the trainee fibbed solely to try to save face (well, some face; we are still talking about boosting an F to an F+). Would lying to Merrill Lynch simply to save face (again, a very small piece of face, like say half an eyebrow) be sufficient to find a violation? Does no harm no foul apply?

The case would be harder still if the trainee was merely caught bragging to strangers in a night club that he rocked a 68% on the Series 7 Exam, perhaps adding that he did so on his first try. This is considered a downright impressive achievement in some quarters such as night clubs, greyhound tracks, WrestleMania events and around the water coolers at several broker-dealers headquartered in Florida. People could be misled by this conduct, perhaps even potential dating companions (those with very low, but very precise, dating standards). Would a lie about the true depth of his exam failure, uttered outside of the context of the broker-dealer’s business, be sufficient?

At any rate, there is a bright side here for our battered Merrill Lynch trainee: this is almost certainly the last brush he will ever have with Finra. That’s got to be a somewhat pleasant thought.

*As is typical, the trainee settled with Finra without admitting the truth of Finra’s findings and there was no adjudication. See Finra Letter of Acceptance, Waiver and Consent, No. 2013036670002, July 15, 2014.

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Bonus Material

One Weird Trick For Avoiding Finra Trouble

For those advisors worried about the seemingly endless scope of Rule 2010, just follow this one weird trick to avoid Finra trouble: before each of your daily decisions, pause for one minute and ask yourself this: What would Finra think about me doing this? Some find it helpful to visualize a Finra Enforcement Lawyer leaning over their shoulder.

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Published by Jeremy L. Bartell

Financially Regulated is published by Jeremy L. Bartell, a long-time admirer of Wall Street and its interesting cast of regulators. Jeremy is an attorney with Bartell Law in Washington D.C. He represents financial professionals nationwide in Finra inquiries and investigations, Finra arbitration, securities employment disputes and registration and disclosure matters.