In a 2017 Regulatory and Examination Priorities Letter (“Priorities Letter”), FINRA identified compliance, supervision and risk management as primary areas for review.
FINRA stated that it will be focusing on the following issues, among others:
- High-Risk and Recidivist Brokers. FINRA will enhance its approach to high-risk and recidivist brokers by reviewing firms’ (i) supervisory procedures for hiring or retaining statutorily disqualified and recidivist brokers, (ii) supervisory plans to prevent future misconduct, and (iii) branch office inspection programs and supervisory systems for branch and non-branch office locations.
- Sales Practices. FINRA will evaluate firms’ (i) compliance and supervisory controls that are intended to protect senior investors, especially against microcap fraud schemes, (ii) reviews of product suitability and concentration in customer accounts, (iii) capacity to monitor the short-term trading of long-term products, (iv) procedures regarding registered and associated persons, and (v) compliance with social media supervisory and record-retention obligations.
- Financial Risks. FINRA will examine firms’ (i) funding and liquidity plans, (ii) financial risk management practices, and (iii) implementation of the first phase of the new FINRA Rule 4210 margin requirements for covered agency transactions, which became effective on December 15, 2016.
- Operational Risks. FINRA will assess firms’ (i) cybersecurity programs, (ii) internal supervisory controls testing, (iii) controls and supervision intended to protect customers’ assets, (iv) compliance with SEC Regulation SHO, (v) anti-money laundering programs, and (vi) application of exemptions and exclusions to municipal advisor registration requirements.
- Market Integrity. FINRA will (i) monitor firms’ compliance with amended Order Audit Trail System rules, (ii) expand surveillance for cross-product manipulation to include trading in exchange-traded products, and (iii) supplement firms’ supervisory systems and procedures with “Cross-Market Equity Supervision Report Cards.” In addition, FINRA will (i) expand its Audit Trail Reporting Early Remediation Initiative to include Regulation NMS trade-throughs and locked and crossed markets, (ii) review firms’ compliance with Tick Size Pilot data collection obligations, and (iii) ensure that firms improve their Market Access Rule compliance by incorporating recommended best practices. FINRA also intends to review alternative trading systems’ customer disclosures and develop a pilot trading examination program in order to help “determine the value of conducting targeted examinations of some smaller firms that have historically not been subject to trading examinations due to their relatively low trading volume.” Lastly, FINRA will continue to expand its “fixed income surveillance program to include additional manipulation-based surveillance patterns, such as wash sales and interpositioning.”
Lofchie Comment: The new Priorities Letter offers a lot to talk about, since FINRA has managed to cover virtually every aspect of a firm’s business. It is incumbent on each firm to go through the letter carefully and scrutinize every relevant priority. The following areas might be of particular interest: (i) custody, (ii) seniors, (iii) improving the automation of “suitability” reviews (e.g., the ability to search for concentrated positions, or positions with excessive turnover), and (iv) cybersecurity training. Anti-money laundering enforcement actions have proved to be a treasure trove for financial regulators, so firms should continue to devote their attention to this area. Liquidity seems to be the odd item on FINRA’s list, since there are no real rules governing it, but rulemaking advances in that area should be expected in the near future, so regulators will be exploring ways to refine their understanding of best practices.