Last week FINRA published its 2016 Regulatory and Examination Priorities Letter – the 11th year it has published what its focus will be for the new year. Going back to 2005 and reviewing the first letter illustrates that some things just stay the same in this industry. In 2005, FINRA focused on Anti-Money Laundering, Mutual Fund Breakpoints, Supervision and Control, New Products and Reg SHO.
In 2016, FINRA announced it will again focus on all those risk areas and of course, new areas of concern such as Firm Culture, Conflicts of Interest, Risk Management and Liquidity.
Culture first appeared in a FINRA Regulatory and Examinations priorities letter in 2015 aligned with putting customer’s interest first. This year, a firm’s culture is aligned with compliance and risk management firm practices. FINRA will perform an assessment of a firm’s culture to gain understanding of the methods used to cultivate their firm culture. FINRA will use five indicators to make its assessment:
Are control functions valued within the firm?
Are policy or control breaches tolerated or handled properly?
Does the firm proactively seek to identify areas of risk or compliance problems?
Are those persons performing activities of Supervision effective role models?
Are “sub-cultures” that do not conform to the overall culture of the firm identified and addressed?
FINRA anticipates completing its review, started in 2015, of incentives and conflicts of interest within a member firm as it relates to retail customer handling. By focusing on a firm’s culture and conflicts of interest, FINRA is expressing its expectation that firms be proactive and take immediate action related to any conflicts, risk or compliance issues. By doing so, firms demonstrate their commitment to putting the customer’s interest ahead of their own.
As in 2015, FINRA is aligning supervision, risk management and controls together as areas of concern. Within this broad topic, it will focus on four areas where it has found repeated concern:
Management of Conflicts of Interest – what are the firm’s actions related to compensation plans for their sales force, third-party compensation arrangements and sales of proprietary or affiliated products? Does it take action related to conflicts of interest that arise in their research and investment banking functions? How does the firm address information leakage both inside and outside the firm? Does the firm allow traders to value or price their proprietary positions or is pricing independent?
Supervision of Risk Management Related to Technology – Does the member have strong governance, controls response, management and preventative practices to address Cybersecurity? Does it maintain effective management over technical assets including vendor systems by having strong practices surrounding change management in general and change management specifically related to trading algorithms, user acceptance testing and quality assurance? What are the practices around data quality controls that insure accurate and complete data is captured in the member’s books and records systems as well as surveillance, compliance and risk monitoring systems?
Outsourcing – Are the firm’s due diligence and risk assessments of outsourced services strong and supervised appropriately?
Anti-Money Laundering – Do firms test and verify the accuracy of their AML programs and systems to insure that all types of customer accounts and activities are identified, monitored and reviewed for potential suspicious activities? Are the firm’s practices of due diligence related to micro-cap securities deposited into a customer’s account designed to insure compliance with the SEC registration regulations or exemptions?
Liquidity as it relates to a firm’s ability to fund its business makes it first appearance as a stand-alone area of concern in 2016. In light of the practices FINRA discussed in its Regulatory Notice 15-33, it will review for a member’s contingency funding plans as dictated by their business models, evaluations of liquidity needs, stress tests and planning related to firm funding.
FINRA will review suitability systems and practices that include new product review and training as it relates to the recommendations of complex investment products. This review will include focusing on concentration of risk products within areas or branches of the firm.
FINRA is making the treatment of senior and other vulnerable investors a high priority in 2016. It recently published its Report on the FINRA Securities Helpline for Seniors where, in conjunction with its examination programs and other sources, has observed repeated situations in which seniors are victims of fraud and abuseby both inside and outside the securities industry. FINRA will focus on suitability and concentration as well as recommendations of investment products that come with a higher cost.
Sales Charge Discounts and Waivers
As in the 2005 letter and the 2016 letter, the application of breakpoints and discounts to eligible customer transactions continues to be a concern for FINRA. Firms must have strong policies, procedures and systems to insure that these discounts are applied appropriately.
Excessive Charges to Customers New Bond Sales
The SEC took significant disciplinary action against a municipal bond underwriter in 2015 for abuse of customers in the municipal new bond sales arena. Specifically, the underwriter took the issue into inventory and conducted sales to retail clients at a price above the original offering price. FINRA will be looking at member’s processes and procedures to insure that the member is adhering to its fair pricing and obligations and conduct during public offerings.
FINRA announces in the letter that it will deliver, starting in 2016, a compliance report card to firms with information derived from its cross-market equity manipulation surveillance program. Its initial report card focus will be on layering and spoofing and will provide information to firms where FINRA seeks potentially manipulative activity occurring through the firm – either all the activity or a portion of the suspicious activity. As part of its examination activities in 2016, FINRA will review how firms use this new information to identify and take measures against this type of conduct.
Reg SHO issues continue to be an area of concern. FINRA will review for Reg SHO supervisory and operational procedures that insure compliance with the fail close out requirements and the net-flat or net-long position requirements under Rule 204.
The above discussion is not all inclusive of what FINRA indicated as areas of concern. Members should review the Letter for specifics as it relates to their business practices and be prepared to address each issue as applicable.