Potential Red Flags

Beyond handling complaints after they arise, firms have a duty to proactively watch for warning signs that misconduct may be occurring. These are the red flags that should trigger heightened scrutiny.

Red Flags That Signal Potential Misconduct

The following situations should raise concern and prompt further investigation:

• High complaint volume: An unusually high number of customer complaints against a single representative
• Excessive trading (churning): Patterns of frequent buying and selling that generate commissions without benefiting the customer
• Concentration risk: Customer assets heavily concentrated in a single security or product type
• Lifestyle inconsistencies: Unexplained wealth or lifestyle that doesn't match the representative's compensation
• Reluctance to take vacations: A representative who never takes time off may be concealing unauthorized activity
• Personal device usage: Requests to use personal email or devices for business communications (to avoid firm oversight)
• Vulnerable customers in complex products: Elderly customers or those lacking financial sophistication being placed in high-risk or complex investments
• Suspicious account activity: Large wire transfers or significant account changes shortly after account opening

Exam Tip: Gotchas

• A registered person who never takes vacation is a red flag, not a sign of dedication. Mandatory vacation policies exist so another person can review the representative's accounts and uncover potential misconduct.
• Churning means excessive trading for commissions, not legitimate active trading.
• Firms are liable if they should have known about misconduct. Actual knowledge is not required.
• Using personal email for business is a red flag because it avoids the firm's recordkeeping and supervision systems. The same rule applies equally to a personal cell phone (calls or texts) used for business: it is not a lesser violation, it is the same red flag on a different channel.

Why Firms Must Monitor

• FINRA expects firms to have supervisory systems that detect red flags
• Ignoring red flags can result in the firm being held liable for the representative's misconduct
• Supervisory failures are among the most common findings in FINRA examinations
• The principle is simple: if a firm knew or should have known about misconduct and failed to act, the firm shares responsibility

What Should You Check on Exam Day?

• Can you list the red flags that should prompt a firm to investigate a representative more closely?
• Do you know why a representative who never takes vacation is considered a red flag, not dedication?
• Can you explain why using personal email or a personal phone for business communication is a compliance concern?
• Do you know what churning means and why it differs from legitimate active trading?
• Can you state the standard that makes a firm liable for misconduct it should have known about?