“The coming year will bring both continuity and change in FINRA’s programs.”

On January 8, 2018, the Financial Industry Regulatory Authority (FINRA) released its 2018 Regulatory and Examination Priorities Letter. Similar to 2017, their efforts in 2018 will be focused on addressing fraudulent activities, high risk firms and brokers, and operational and financial risks.1 “The coming year will bring both continuity and change in FINRA’s programs,” FINRA CEO Robert Cook wrote in a cover letter.2 “The continuity comes, first and foremost, in our unwavering commitment to our mission: protecting investors and promoting market integrity in a manner that facilitates vibrant capital markets.”3

What this means

The 2018 Regulatory and Examination Priorities Letter identifies topics FINRA will focus on in the coming year and member firms should keep these FINRA priorities at the top of their checklist when reviewing their compliance, supervisory and risk management programs, and internal training and communications. These priorities include some new topics, as well as others that remain ongoing areas of focus, and include Fraud, High-Risk Firms and Brokers, Operational and Financial Risks, Sales Practice Risks and Market Integrity.4

  1. Fraud

Fraudulent activities such as insider trading, microcap schemes targeting senior investors and Ponzi schemes are always a major area of focus for FINRA. Firms should be attentive to their brokers’ activity and evaluate internal policies and training regarding permissible communications and interactions with microcap stock promoters to make sure brokers do not participate in any fraudulent schemes.

  1. High-Risk Firms and Brokers

Building on the work done in 2017, FINRA expects to continue identifying high-risk firms and individual brokers, and mitigate the potential risk they pose to investors, especially unsophisticated and senior investors. FINRA to also continue to review firms’ controls regarding registered representatives and their outside business activities, including whether the adequate disclosures are made about their interest in, control of, or association with securities offerings and issuers.

  1. Operational and Financial Risks

Business Continuity Planning

For financial firms, events such as Hurricanes Maria and Irma highlight the need to maintain written Business Continuity Plans (BCPs) that address continued access to critical systems. FINRA is to review firms’ BCPs, paying attention to how they are activated, how they accomplish data backup, how they coordinate with customers, affiliates and vendors, and how systems, procedures and records would be restored once firms are prepared to return to normal business.

Customer Protection and Verification of Assets and Liabilities

FINRA has stated that they will review the accuracy of firms’ net capital and reserve computations under Securities Exchange Act (SEA) Rules 15c3-1 and 15c3-3, and evaluate whether adequate controls and supervision are implemented to protect customer assets. Firms’ foreign depositories, clearing agencies and custodial banks are to be reviewed to confirm that they are in good control locations, and that the correct applications have been filed with the SEC for such foreign custodial arrangements.

Technology Governance

FINRA to examine firms’ information and technology change management policies and procedures, to mitigate any operational breakdowns caused by the implementation of new systems, or the enhancement and modification of existing proprietary or vendor systems. Firms’ are to maintain strong controls to avoid system defects or outages, data inaccuracies or unintended consequences that may negatively affect customers, the firm or the market.

Cybersecurity

Cybersecurity continues to be a significant threat and FINRA is to evaluate the effectiveness of firms’ cybersecurity programs to protect sensitive information, including personally identifiable information, from both internal and external threats. This is to include a review of preparedness, technical defenses and resiliency measures, as well as policies and procedures in place to assess whether to file a Suspicious Activity Report (SAR) when a cybersecurity event has been identified.

Anti-Money Laundering (AML)

The adequacy of firms’ AML programs, including policies and procedures to detect and report suspicious transactions, resources for AML monitoring, and independent testing required under FINRA Rule 3310(c) to be assessed by the regulator. Firms are to be attentive to the potential use of their foreign affiliates to conduct high-risk transactions.

Liquidity Risk

FINRA to evaluate whether a firm’s liquidity planning is appropriate for its businesses and customers, in addition to focusing on the adequacy of stress testing assumptions, and how assets and cash are categorized and identified in liquidity stress tests.

Short Sales

FINRA has also indicated that they will examine policies and procedures for establishing and monitoring rates charged to customers for short sales.

 

  1. Sales Practice Risks

Suitability

FINRA expects to continue to assess the adequacy of a firm’s controls to meet customer suitability obligations. Systems and controls should be in place to vet new products, and to identify the risks associated with a product. These risks should be included in their product training, to allow registered representatives to appropriately evaluate the suitability of products for specific customers. FINRA to also review situations in which registered representatives recommend a switch from a brokerage account to an investment advisor accountꟷwhere that switch may clearly disadvantage the customer.

Initial Coin Offerings (ICOs) and Cryptocurrencies

Cryptocurrencies and ICOs have received significant media attention recently and FINRA is to closely monitor developments, including the supervisory, compliance and operational infrastructure firms have put in place to comply with relevant federal securities laws and regulations.

Use of Margin

FINRA is to assess firms’ disclosure and supervisory practices related to margin loans, and examine whether registered representatives adequately disclose the risk of margin loans. Firms’ to maintain controls designed to prevent excessive margin trading.

Securities Backed Lines of Credit (SBLOCs)

SBLOCs usage has increased significantly, and FINRA to assess the adequacy of disclosures firms provide customers regarding the potential risks of SBLOCs, including the impact of a market downturn, and potential tax implications if pledged securities are liquidated.

 

  1. Market Integrity

Manipulation

In August of 2017, FINRA launched the Cross Market Auction Ramping surveillance pattern. This pattern uses machine learning techniques to identify aggressive trading surrounding the market open or close. FINRA also updated their Cross Market Marking the Open and Close surveillance pattern to reduce false positives and more accurately identify potential marking of the open or close, and enhanced the Cross Market Layering surveillance pattern in July 2017, to detect collusion among multiple market participants. FINRA also indicated they will look to review the effectiveness of firms’ surveillance programs in these same areas.

Best Execution

FINRA is expanding their best execution surveillance program through machine learning to assess the degree to which firms provide price improvement when routing customer orders for execution. FINRA to also examine broker-dealers’ best execution obligations when they receive order routing inducements such as payment for flow. The regulator has indicated that these reviews of execution quality and fair pricing are to be expanded in 2018 to surveillance of fixed income securities.

Regulation SHO

FINRA to increase their focus on evaluating firms’ compliance with Rule 201 of Regulation SHO, which requires firms to develop policies and procedures to prevent the execution of a short sell order at a price below the best bid when a Short Sale Circuit Breaker (SSCB) is in effect for a National Market System (NMS) security.

Fixed Income Data Integrity

Data integrity is a priority for FINRA’s fixed income surveillance and trading examination programs. FINRA plans to expand surveillance of electronic communications with customers trading in Treasury securities to monitor potential discrepancies with firms’ transaction reporting to the Trade Reporting and Compliance Engine (TRACE).

Options

In 2017, FINRA developed a surveillance pattern to detect the front-running in options products. They have also indicated that they will continue to conduct reviews of potential options related violations of SEA Rule 14e-4 which governs partial tender offers.

Market Access

FINRA to continue to review broker-dealers compliance with SEA Rule 15c3-5 requiring that reasonable pre-trade financial controls are in place.

Alternative Trading System Surveillance

For their alternative trading systems, registered broker-dealers are required to maintain supervisory systems that are designed to comply with applicable securities regulations, including rules on disruptive or manipulative quoting and trading activity. FINRA to evaluate these supervisory systems through monitoring of surveillance alerts.

This year, FINRA also plans to introduce a number of new report cards to assist member firms with their compliance efforts, and draw members attention to new rules that are scheduled to become applicable in 2018. These new rules include, The Financial Crimes Enforcement Network’s (FinCEN) Customer Due Diligence Rule, Financial Exploitation of Specified Adults, and Amendments to FINRA Rule 4512 (Customer Account Information), among others.

Conclusion

FINRA CEO Robert Cook emphasized in his cover letter statement that 2018 would bring both “continuity and change” to FINRA’s programs. That continuity comes in the form of a commitment to protect investors and promote market integrity while facilitating vibrant capital markets, and the change comes in how that is accomplished.  FINRA is planning changes to improve the examination program and implement a risk-based framework to better align examination resources to the risk profiles of member firms. As well, the development of compliance tools using artificial intelligence and robotics is expected to help member firms with their compliance efforts.5

The regulator has also indicated that there will be an ongoing effort to work with member firms to better understand new technologies and how they are being deployed in the market, continuing the Innovation Outreach Initiative to keep abreast of FinTech developments, and assess their potential benefits and risk for both investors and markets.6 Robert Cook concluded, “We have much work to do in the coming year. But with the strong support and engagement of so many of our member firms, I am optimistic about what we can achieve in 2018.”7

 

References

  1. FINRA’s 2018 Exam Priorities – Continue Focus on Fraud, High-Risk Activities,” National Association of Plan Advisors, January 10, 2018. Access at: http://www.napa-net.org/news/managing-a-practice/regulatory-compliance/finras-2018-exam-priorities-continue-focus-on-fraud-high-risk-activities.
  2. Ibid
  3. Ibid
  4. “2018 Regulatory and Examination Priorities Letter,” Cover letter from Robert Cook, Financial Industry Regulatory Authority, January 8, 2018. Access at: http://www.finra.org/industry/2018-regulatory-and-examination-priorities-letter.
  5. FINRA’s 2018 Exam Priorities – Continue Focus on Fraud, High-Risk Activities,” National Association of Plan Advisors, January 10, 2018. Access at: http://www.napa-net.org/news/managing-a-practice/regulatory-compliance/finras-2018-exam-priorities-continue-focus-on-fraud-high-risk-activities. “FINRA Releases Exam Priorities for 2018 – Risky firms, rogue brokers top the list as FINRA plans exam changes,” ThinkAdvisor, January 8, 2018. Access at: http://www.thinkadvisor.com/2018/01/08/finra-releases-exam-priorities-for-2018?&slreturn=1516659277.
  6. “2018 Regulatory and Examination Priorities Letter,” Cover letter from Robert Cook, Financial Industry Regulatory Authority, January 8, 2018. Access at: http://www.finra.org/industry/2018-regulatory-and-examination-priorities-letter.
  7. Ibid

 

Newsletter Author: Venetia Woo, Mairi Bryan

Newsletter Contact Person: Venetia Woo

Visit www.accenture.com/RegulatoryCompliance for latest insights on regulatory remediation and compliance transformation.

 

Disclaimer

This blog is intended for general informational purposes only, does not take into account the reader’s specific circumstances, may not reflect the most current developments, and is not intended to provide advice on specific circumstances. Accenture disclaims, to the fullest extent permitted by applicable law, all liability for the accuracy and completeness of the information in this blog and for any acts or omissions made based on such information. Accenture does not provide legal, regulatory, audit or tax advice. Readers are responsible for obtaining such advice from their own legal counsel or other licensed professional.

 

About Accenture:

Accenture is a leading global professional services company, providing a broad range of services and solutions in strategy, consulting, digital, technology and operations. Combining unmatched experience and specialized skills across more than 40 industries and all business functions—underpinned by the world’s largest delivery network—Accenture works at the intersection of business and technology to help clients improve their performance and create sustainable value for their stakeholders. With more than 373,000 people serving clients in more than 120 countries, Accenture drives innovation to improve the way the world works and lives. Its home page is www.accenture.com.

 

Copyright © 2017 Accenture. All rights reserved.

Accenture, its logo, and High Performance Delivered are trademarks of Accenture. This document is produced by Accenture as general information on the subject. It is not intended to provide advice on your specific circumstances.

Submit a Comment

Your email address will not be published. Required fields are marked *