Earlier this year, FINRA published its Annual Regulatory and Examination Priorities Letter to provide the industry with insights into the areas FINRA plans to review in its 2017 exams and to assist financial firms with reviewing and strengthening their own supervisory and compliance systems. The letter states five priority areas the authority will focus on in its 2017 exams with a common theme of the industry’s need to focus on what FINRA President Robert Cook terms “core ‘blocking and tackling’ issues of compliance, supervision and risk management.”
FINRA’s first priority area is monitoring firms hiring high-risk and recidivist brokers to ensure that these firms establish appropriate supervisory and compliance controls for recidivist brokers. Recently, FINRA formed a specific examination group dedicated to identifying and examining brokers with a history of bad behavior to protect investors. This group will “rigorously review” these brokers’ customer interactions to examine if the brokers have complied with rules regarding suitability, outside business activities, and commission and fees, amongst others. FINRA will also assess firms’ due diligence in hiring recidivist brokers and whether firms “develop and implement a supervisory plan reasonably tailored to detect and prevent future misconduct” by brokers with problematic regulatory histories.
Second, FINRA will carefully examine firms’ sales practices. The letter highlights FINRA’s continual observance of firms’ recommending unsuitable products to customers and the over-recommendation of certain securities that can result in excess concentration in customers’ accounts. The authority will particularly focus on problematic sales practices targeted at the elderly, including recommendations to purchase speculative or complex products and microcap fraud schemes. Thus, the authority will assess how firms conduct reasonable-basis and customer-specific suitability reviews and whether firms assess a customer’s account for excessive concentration in a particular product or in securities exposed to a certain sector. This includes registered representatives recommending short-term trading of long-term products, such as open- and closed-end mutual funds, variable annuities, and unit investment trusts (UIT). FINRA believes this activity can hurt customers because of missed UIT dividend payments or increased costs from commissions and fees. Lastly, FINRA will focus on whether a registered representative’s outside business activities and private securities transactions compromise the representative’s ability to make unbiased recommendations to clients.
FINRA’s third priority is to assess firms’ financial risks, including the effectiveness of financial risk management practices at some larger firms and the sufficiency of liquidity management plans. In 2016, FINRA discovered that some firms lacked the appropriate liquidity, failed to perform stress tests, and applied insufficiently rigorous assumptions in their stress tests. To correct this inadequacy, FINRA will continue to review and assess whether firms adequately evaluate their liquidity needs and if their contingency plans effectively address market-wide and idiosyncratic stresses. FINRA recommends that firms consider the effective practices discussed in Regulatory Notice 15-33 when they review their liquidity management plans. Also, FINRA will review firms’ implementation of the amended FINRA Rule 4210 margin requirements to ensure that firms have established risk policies and limits appropriate for their counterparties and covered agency transactions.
Fourth, FINRA will prioritize assessing firms’ operational risks. This is a broad priority stating the authority’s commitment to analyze the following: cybersecurity threat mitigation; supervisory controls testing; customer protection regarding the segregation of client assets; compliance with SEC Regulation SHO; anti-money laundering and suspicious activity monitoring; and correct municipal advisor registration. FINRA will review firms’ internal controls and monitoring systems to determine whether they detect and address the issues previously listed and, where applicable, ensure that firms are either registering with the appropriate authority or implementing each new rule.
Lastly, FINRA will prioritize detecting and deterring behavior that compromises market integrity. FINRA plans to continue expanding and enhancing its systems to identify market manipulation practices. This includes reviewing firms’ Cross Market Equity Supervision Report Cards for layering and spoofing activity to assess each firm’s compliance with trading rules and regulations. Furthermore, FINRA plans to expand its Audit Trail Reporting Early Remediation Initiative that identifies and alerts firms to potential equity audit trail issues to include areas such as Regulation NMS trade-throughs and locked and crossed markets. FINRA believes this allows it to more effectively police the market as it will only open formal investigations when the problem is widespread and long-standing or the firm does not adequately address the problem in a timely manner. Also, FINRA will review whether firms continue to comply with rules such as the Market Access Rule and the data requirements of the Tick Size Pilot.
While this letter highlights FINRA’s priorities, it is not a complete list of the areas FINRA may review during an examination. Yet, regulatory compliance dominates FINRA’s priorities for 2017. In order to address the many regulatory burdens that many small firms face, FINRA will introduce a “compliance calendar” as well as a directory of compliance service providers this year. FINRA hopes that this, along with this letter and its plan to publish a summary report outlining key examination findings from a national perspective, will aid firms’ efforts to strengthen their own internal compliance policies.
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