• FINRA 2012 Regulatory and Examination Priorities: Current Issues Facing Securities Firms
  • February 24, 2012 | Authors: Benjamin J. Biard; Jessica F. Longobardi; Stephanie Myers Bersak
  • Law Firms: Wilson Elser Moskowitz Edelman & Dicker LLP - Miami Office ; Wilson Elser Moskowitz Edelman & Dicker LLP - White Plains Office
  • The Financial Industry Regulatory Authority (FINRA) recently issued a letter to the executive representatives and chief compliance officers of FINRA member firms delineating areas of compliance that FINRA will focus on in 2012.

    The letter outlined FINRA’s assessment of issues currently facing the securities industry to assist member firms in refining their compliance, supervisory and ethics programs. Specifically, the letter dealt with 41 areas that FINRA will focus on in 2012, and this Wilson Elser Alert will highlight some of those key areas.

    Regulatory Program Developments
    In an effort to collect data to enhance its regulatory programs, investigations and enforcement activities, FINRA is implementing a new data collection process. In the first quarter of 2012, FINRA will send a risk control assessment survey (RCA) to member firms. The RCA will seek information pertaining to the firms’ business activities, product mix, customer base and underlying controls. FINRA indicated that it will share the findings of the RCA in late 2012.

    Business Conduct and Sales Practices
    FINRA is concerned with business conduct and sales practices for retail customers related to (1) the disclosure of risks, mispricing and overcharging, and (2) the suitability of products. FINRA reminded its members that the new Suitability Rule, Rule 2111, and the Know Your Customer Rule, Rule 2090, take effect on July 9, 2012. Among other things, the new rules contain a comprehensive list of factors to be considered when making an investment recommendation. Additionally, FINRA reminded member firms to heighten their supervisory systems, given the forthcoming rule changes.

    FINRA also outlined the following areas, which are of particular concern and will likely be focus areas in regulatory investigations: (1) investors chasing high yields without adequately understanding, or without the broker adequately disclosing, the risks; (2) the lack of liquidity for certain investments; and (3) the correlation between the investors’ time horizon and the timing of the product’s cash flow and information concerning whether returns are being paid from the investors’ principal.

    FINRA specifically identified the following products:

    • Residential and Commercial Mortgage-Backed Securities
    • Non-Traded REITs
    • Municipal Securities
    • Complex Exchange-Traded Products
    • Variable Annuities
    • Structured Products
    • Securities Offered Through Private Placements
    • Unregistered Securities Acquired in Secondary Markets
    • Church Bonds
    • Promissory Notes
    • Life Settlements

    FINRA indicated that its examiners will review member firms’ supervision and internal controls. One area of interest is private securities transactions and outside business activities of the firms’ registered representatives (see NASD Rule 3040 and FINRA Rule 3270). FINRA is concerned that member firms are not adequately supervising these activities or maintaining adequate records. FINRA also reminded member firms that their supervisory systems and internal controls are to be tailored to their specific business models, products and services, and to types of clients. If a firm offers high-risk products or services, it should have a supervisory system that will ensure adequate due diligence and suitability analyses are completed before offering the product for sale.

    Where member firms employ associated persons who operate out of remote branch offices, FINRA requires that there be an adequate supervisory system in place to monitor the conduct of the branch. In connection with the SEC, FINRA has issued guidance for member firms to adequately supervise their branches by conducting inspections and instituting risk-management programs. FINRA and its examiners will continue to review member firms’ policies and programs for the branch office examinations, as well as conduct independent examinations of the members’ branch offices.

    Additionally, FINRA reminded member firms of several other ongoing supervisory obligations, including:

    • Members have an obligation to appropriately supervise business communications (see FINRA Regulatory Notice 10-06 and FINRA Regulatory Notice 11-37), including those made electronically and through social media.
    • Members have a duty to review internal controls and risk management systems to detect unauthorized trades and rogue brokers.
    • Members have an obligation to comply with GAAP when keeping their own records and a duty to protect customer assets by segregating them from use by broker-dealers for business activities.
    • Member firms must maintain information barriers sufficient to safeguard customer and material non-public information. FINRA examiners will review members’ systems to ensure that information on pending orders, executed orders and other business units is kept separate and safeguarded.

    FINRA is also making high-frequency trading (HFT) an upper-level priority to ensure that programs that engage in HFT do not have market-manipulative effects. Specifically, FINRA identified “momentum ignition strategies,” where a proprietary trading firm initiates a series of orders or trades to ignite a rapid price move either up or down. By establishing a position early, the proprietary trading firm attempts to profit by subsequently liquidating the position (if successful in igniting a price movement). Member firms are urged to maintain systems of supervision and control to detect these strategies and prevent abuses.

    In its letter, FINRA has identified other areas that it will make priorities in 2012.