RIA Compliance Blog
On January 4, 2017, the Financial Industry Regulatory Authority (“FINRA”) published its Annual Regulatory and Examination Priorities Letter (“Priorities Letter”). The Priorities Letter notifies firms about issues that FINRA intends to examine in 2017. It is also intended to let firms know which of these issues are relevant to their businesses so that the firms can improve their compliance with FINRA rules and their risk management programs.
According to the Priorities Letter, FINRA draws its examination priorities from both observations made in the course of regulation and suggestions from a variety of outside sources. Evidence has shown that many FINRA-registered firms have found past Priorities Letters helpful in making sure their business is in compliance with FINRA rules. Finally, FINRA assures readers of the Priorities Letter that in formulating an examination, FINRA looks to factors such a firm’s “business model, size and complexity of operations, and the nature and extent of a firm’s activities against the priorities outlined in this letter.”
FINRA intends to prioritize the following issues in 2017.
High-Risk and Recidivist Brokers
FINRA plans to prioritize the hiring and supervision of high-risk and recidivist brokers. To carry out this plan, FINRA has formed an examination unit to help single out brokers who potentially create a high risk to investors. This unit will also be dedicated to monitoring high-risk and recidivist brokers once they are discovered.
FINRA also intends to examine member firms’ supervisory procedures for employing high-risk and recidivist brokers. For example, FINRA will want to determine whether “a firm or third-party service provider conducts a national search of reasonably available public records to verify the accuracy and completeness of the information contained in an applicant’s Form U4.” If a firm does employ a broker that it knows to be high-risk or recidivist, FINRA has resolved to determine whether the firm establishes and puts into practice a supervisory plan that is designed to expose and to stop any future misconduct the broker may commit. FINRA intends, through its Membership Application Program, to signal out new and continuing member applicants that have hired, or wish to hire, registered representatives who have questionable disciplinary histories.
Finally, FINRA plans o continue examining “firms’ branch office inspection programs as well as their supervisory systems for branch and non-branch office locations.” The focus of these surveys will include such matters as a firm’s monitoring of account activities, advertising and communications, and outside business activities.
Sales Practices
One area of sales practices that FINRA intends to emphasize is the protection of senior investors. To achieve this goal, FINRA intends to examine recommendations made by registered representatives to senior investors in order to determine whether the recommendations were well suited to the particular customers. FINRA also notes in its Priorities Letter that senior investors are particularly vulnerable to fraud committed in relation to microcap stocks. To prevent such fraud from being committed, FINRA will recommend that member firms establish certain controls to help prevent financial exploitation of senior investors.
Another area of sales practice that will be prioritized is product suitability and concentration. FINRA has found instances where registered representatives who did not have a thorough understanding of various products’ characteristics recommended those products to customers, and the products were not suited to the customers. To counteract this, FINRA will recommend that firms ensure that their representatives are trained to comprehend the exact nature of the products sold to ensure suitability. FINRA also plans to prioritize the controls firms implement to oversee recommendations that could cause a customer’s account to suffer from excess concentration. For example, it will recommend that firms keep an eye out for excessive concentration in securities related to a particular industry sector.
FINRA also intends to place an emphasis on the problem of short-term trading of long-term products. It notes in the Priorities Letter that such trading is undesirable because of the potential for clients to incur increased costs or to lose dividend payments. To address this problem, FINRA implemented a targeted exam centered around short-term trading of unit investment trusts, a long-term product. It will also encourage firms to examine their supervisory systems to find out whether the systems can weed out potential short-term trading of long-term products.
Another area of sales practices that FINRA has prioritized is firms’ responsibilities in regards to their representatives’ outside business activities and private securities transactions. FINRA notes that supervision of outside business activities is needed because such activities have the potential to cause a registered representative’s interests to conflict with a client’s or to be regarded as a component of the firm’s work. Because of this, FINRA plans to examine member firms’ procedures to evaluate registered persons’ notifications of proposed outside business activities. FINRA also intends to examine member firms’ procedures for approving and supervising private securities transactions.
Finally, FINRA has prioritized issues relating to social media and electronic communications retention and supervision. It plans to examine “firms’ compliance with their supervisory and record-retention obligations with respect to social media and other electronic communications in light of the increasingly important role they play in the securities business.” FINRA notes that both it and the Securities and Exchange Commission (“SEC”) require that firms retain communications that are relevant to their business, no matter what device or network is used. These requirements exist so that the firm can monitor the communications for prohibited conduct.
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