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The U.S. Financial Industry Regulatory Authority (FINRA) gave priority to monitoring “high-risk” brokers in its 2017 Regulation and Examination Priorities letter issued in January. The industry self-regulator also reiterated prior warnings over senior investor abuse, outside business activities, and social media practices, but dropped a specific focus on culture of compliance.
A common thread in this year’s priorities is a focus on core “blocking and tackling” issues of compliance, supervision, and risk management, newly appointed FINRA president and CEO, Robert W. Cook, said in an introduction. He added that although some of the priorities have been seen in prior years, “specific areas of emphasis have been updated or modified based on recent observations and experience.”
“Attention to the core regulatory requirements identified in the letter — and how to address them in light of new business challenges and market developments — will serve investors and markets well.”
Below is an overview of the Priorities Letter and some of the more noteworthy initiatives that will affect broker-dealers and financial advisers in 2017.
The first and most prominent topic in this year’s letter is scrutinizing the activities of high-risk brokers. The regulator will “devote particular attention to firms’ hiring and monitoring of high-risk and recidivist brokers, including whether firms establish appropriate supervisory and compliance controls for such persons.” FINRA said it is strengthening its approach and established a dedicated exam unit to identify brokers who “may pose a high risk to investors.”
The issue has gained more prominence amid industry studies and criticisms over repeat offenders or “bad brokers” who remain in the industry.
Cook’s predecessor, Richard Ketchum, came under fire last year at a Senate Banking subcommittee hearing where Massachusetts Democratic Senator Elizabeth Warren, a leading Wall Street critic, asked what FINRA was doing to protect investors and cited research indicating that half of brokers with ethical lapses get fired, but 44 percent of them are rehired in the industry within one year.
A couple of months later, Arkansas Republican Senator Tom Cotton joined Senator Warren in sending a stern letter to Ketchum following up on the hearing, requesting answers about why widespread malfeasance by advisers appears to be going unpunished. The senators asked Ketchum what “specific steps” FINRA is taking to address advisor misconduct beyond more disclosures in BrokerCheck. They also asked how FINRA will “address the problem of high rates of recidivism among advisers with a history of disciplinary misconduct.”
Massachusetts Secretary of the Commonwealth, William Galvin, also launched an investigation in June seeking information from 241 brokerage firms in an effort to keep “rogue” brokers out of his state.
This year’s letter once again sends the message that the regulator will be keeping a watchful eye on brokers who prey on the elderly or vulnerable clientele. “Investor protection lies at the heart of FINRA’s mission, and protecting senior investors will remain a top priority in 2017,” FINRA said.
In its 2016 exam priorities, FINRA had voiced concern for senior and vulnerable investors. FINRA also set up a “Senior Helpline” in late 2015 to help senior investors with their concerns over brokerage accounts and brokers. This came on the heels of prior efforts to assist seniors.
FINRA stated it continues to see instances where firms recommend products that are unsuitable for customers as well as instances where customers and sometimes registered representatives do not understand the products. FINRA said it will review firms’ product vetting processes and supervisory systems and controls to review recommendations. FINRA warned that it “will also increase its focus on the controls firms use to monitor recommendations that could result in excess concentration in customer accounts.”
Conflicts of interest have always been an area of concern in the industry. Last year there were a number of instances where advisers and brokers ran afoul of the rules or were fired because of outside business activities or private securities transactions. In 2017, FINRA said, it “will continue to evaluate firms’ procedures to review registered persons’ written notifications of proposed outside business activities, including firms’ consideration of whether the proposed outside business activities may compromise a registered person’s responsibilities to the firm’s clients or be viewed as part of the firm’s business.”
Social media and electronic communications retention will once again be a priority with FINRA. The regulator reminded firms that they “must ensure the capture of business-related communications regardless of the devices or networks used. A firm must capture and maintain all business-related communications in such a way that the firm can review them for inappropriate business conduct.”
FINRA will attempt to provide more and different compliance tools and resources to assist small firms in complying with regulatory requirements, FINRA said. FINRA will introduce a “compliance calendar” and a directory of compliance service providers.
He also recognized “the vital role that small firms – as well as larger firms – play in facilitating capital formation by small and emerging growth companies, which are vital engines of our economy and of job creation. We will be looking for opportunities to support these activities, including by providing guidance where appropriate to encourage innovative business models and new technologies in the Fintech space, consistent with maintaining important investor protections.”
As other regulators, such as the New York Department of Financial Services, roll out new cybersecurity rules set to take effect in early 2017, FINRA also reminded firms of their responsibilities and said the issue remained a top concern of the regulator.
“We will tailor our assessment of cybersecurity programs to each firm based on a variety of factors, including its business model, size, and risk profile,” FINRA said. It will review “firms’ methods for preventing data loss, including understanding their data (e.g., its degree of sensitivity and the locations where it is stored) and its flow through the firm and possibly to vendors.”
Noticeably this year, FINRA did not include “culture” as an exam priority. FINRA also followed up with a round of exam sweeps focusing on what some saw as a difficult concept to measure.
Spokesperson Nancy Condon told Thomson Reuters that the regulator remains focused on culture issues as cited in a 2016 culture letter that was issued to select group of firms in 2016. “As a result, we are not repeating information that is readily available (that letter of course is posed on our website). Although some other topics in the 2017 priorities letter have appeared in prior letters, the most recent letter updates or modifies those areas,” she said.
The earlier FINRA emphasis on culture may have been too vague to sustain as a specific priority, said attorney Alan Wolper of Ulmer & Berne. “Culture of compliance is, in my view, the sum of a bunch of other parts, and those parts are generally capable of being objectively considered. The sum, on the other hand, is much less subject to definitions and yardsticks. Like the Justice Potter Stewart’s famous quote regarding obscene material – “I know it when I see it” – perhaps that is how FINRA will gauge culture of compliance going forward, as opposed to trying to articulate a standard, or even a definition.”
- 2017 Regulation and Exam Priorities Letter
- Cotton, Warren letter to FINRA
- 2016 Exam Priorities
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