FINRA issues its 2016 Regulatory and Examination Priorities Letter.
The Financial Industry Regulatory Authority (FINRA) rang in the New Year with the release on January 5 of its annual Regulatory and Examination Priorities Letter (2016 Letter). The 2016 Letter identifies supervision, liquidity, and firm culture as broad themes for 2016. As in previous years, FINRA focused on areas of risk affecting investor interests and market stability.
This LawFlash highlights potential new areas of concern for firms—as well as identifying topics that have fallen down (or off) the priority list since 2015—to help guide firms’ assessment of risk management policies in order to align with FINRA’s priorities in the new year.
Expanding on last year’s “tone from the top” message, the 2016 Letter announces that FINRA will formalize its assessment of a firm’s culture when reviewing how its executives, supervisors, and employees conduct business. We expect this to mean a top-to-bottom focus on how firms implement their policies and procedures. Indicators FINRA will consider when assessing a firm’s culture include management of conflicts of interest, adequacy of compliance functions, and responses to breaches of firm policies.
Conflicts of Interest
Underscoring FINRA’s focus on firm culture, ethics, and supervision, the 2016 Letter emphasizes specific areas that could create conflicts of interest, including compensation incentive structures, investment banking and research business conflicts, information leakage inside and outside a firm, and position valuation. FINRA will review whether research analysts are inappropriately involved in banking activities, whether information is being inappropriately leaked between different areas of a firm’s trading activities, and the many conflicts that can arise when traders provide valuations for the illiquid (level 3) positions they establish. The 2016 Letter also notes concern with potentially inadequate review by firms of employees’ outside business activities.
Supervision of Technology
FINRA will review firms’ approaches to cybersecurity risk management and consider the ability of firms to protect the confidentiality and integrity of sensitive customer information, as well as high-frequency trading firms’ ability to protect systems from unauthorized access. FINRA notes that firms retain the responsibility to supervise certain activities outsourced to third-party providers.
Anti-Money Laundering Controls
FINRA addresses anti-money laundering (AML) controls as a supervisory issue. The 2016 Letter states that FINRA expects firms to routinely test their AML compliance systems. FINRA will focus on high-risk accounts and activity and will review documentation of any decision to exclude certain customer transactions from surveillance.
The 2016 Letter also lists a host of perennial priorities that appear year-after-year. This year’s list includes the following:
Seniors and Vulnerable Investors
FINRA has again identified this class of investor as an increased priority. Of particular note, the 2016 Letter highlights instances of third-party fraud perpetrated upon seniors by bad actors in positions of trust who hold powers of attorney or other means of controlling assets. FINRA also previewed that it will look closely at the sale of high commission products to senior or vulnerable investors.
Suitability and Concentration
FINRA indicated that it would continue its focus on complex products, speculative or longer-duration interest-rate sensitive products, and alternative investments. FINRA’s 2016 Letter notes that while “many firms have established robust systems” to support recommendations of these products, “others have not.” Regardless, firms should expect continued scrutiny regarding the recommendation of these products.
Handling of fixed-income orders seem likely to remain a priority in 2016, given the attention in FINRA’s 2016 Letter, as well as guidance in its 2015 regulatory notice “Guidance on Best Execution Obligations in Equity, Options and Fixed Income Markets.” In the 2016 Letter, FINRA explains that it will augment its best execution surveillance using spread-based surveillance patterns. This focus coincides with the Municipal Securities Rulemaking Board’s (MSRB’s) focus on best execution in the fixed-income markets, outlined in its new rule scheduled to take effect on March 21, 2016.
FINRA also seems likely to continue its focus on market access, and will begin publishing monthly “report cards” focused on layering and spoofing. These reports may be useful for firms to assess their own surveillance systems and enhance their policies, practice, and protocols as appropriate.
Sales Charge Discounts and Waivers
Another recurring priority (and the subject of several 2015 settlements) is FINRA’s continued concern with firms that fail to provide appropriate volume discounts (breakpoints) or sales charge waivers for products such as mutual funds, Unit Investment Trusts (UITs), non-traded Real Estate Investment Trusts (REITs), and Business Development Companies (BDCs).
Of arguably equal use to firms may be areas that have “dropped off” the letter since last year. None of the following areas in FINRA’s 2015 Regulatory and Examination Priorities Letter (2015 Letter) were included in the 2016 Letter:
IRA Rollovers and Other Wealth Events
In 2015, FINRA focused on fair and balanced communication related to wealth events, such as IRA rollovers. The 2015 Letter emphasized concern with adequate communication of fees, as well as policies to ensure that no recommendation would occur if a broker-dealer did not intend for its registered representative to recommend securities transactions as a result of an IRA rollover.
Municipal Adviser Registration
The 2015 Letter expressed concern about failure to register as a municipal adviser, noting that the SEC’s municipal advisor registration rules became effective July 1, 2014.
Reporting of Disclosable Information
The 2015 Letter focused on adequate and timely disclosure of information, primarily information derived from U4 and U5 registration filings. FINRA indicated that this focus would include a review of all registered persons to determine whether there were any reporting failures.
FINRA’s 2016 Letter provides guidance regarding areas of new, continued, and decreased focus that should guide firms’ own risk management priorities.
If you have any questions or would like more information on the issues discussed in this LawFlash, you can also feel free to contact any of the following Morgan Lewis lawyers:
Peter K.M. Chan
Susan D. Resley