In what has become an annual, but hardly exciting – I mean, it’s not like anxiously awaiting the day that pitchers and catchers report to Spring Training – tradition, with the turning of the calendar to the new year, FINRA has once again released a letter announcing what it deems to be its priorities for the upcoming examination season. FINRA claims to have tried something new this year, “by focusing primarily on those topics that will be materially new areas of emphasis for our risk monitoring and examination programs in the coming year,” rather than rehashing the same old, tired topics. I say “claims to have tried” because even though FINRA says it does “not repeat topics that have been mainstays of FINRA’s attention over the years,” in fact, a good part of the letter is devoted to those mainstays. Indeed, FINRA was very clear to state at the very outset of the letter that member firms “should expect that FINRA will review for compliance regarding these ongoing areas of focus”:
- obligations related to suitability determinations, including with respect to recommendations relating to:
- complex products
- mutual fund and variable annuities share classes
- the use of margin or the execution of trades in a margin account
- outside business activities and private securities transactions
- private placements
- communications with the public
- best execution
- fraud (including microcap fraud), insider trading and market manipulation
- net capital and customer protection
- trade and order reporting
- data quality and governance
- risk management
- supervision related to these and other areas
In other words, in large part, BDs can, by and large, expect the same-old, same-old when it comes to their 2019 exams. But, there are a couple of interesting new wrinkles worth our attention.
The first would be the three “Highlighted Items” FINRA identified, i.e., the three things that FINRA characterizes as “materially new” areas of emphasis:
- Online distribution platforms. Specifically, FINRA is focusing on such platforms that “are operated by unregistered entities, which may use member firms as selling agents or brokers of record, or to perform activities such as custodial, escrow, back-office and financial technology (FinTech)-related functions.” The reason for the focus is that some firms which use such third-party platforms are, apparently, taking the position that “they are not selling or recommending securities,” a position with which FINRA takes some issue. As a result, even when using a third-party platform, FINRA will still be evaluating whether ordinary BD obligations have been triggered, including the obligation to conduct both reasonable basis and customer specific suitability analyses, to supervise communications with the public, and to conduct AML reviews. You can clearly see that again, even here, in this “materially new” area, it still devolves to an examination of the same-old, same-old – sales practice issues.
- Fixed income mark-up disclosure. You can’t argue with this one, since the rule that FINRA is enforcing only became effective in May 2018, so, by definition, it is new.
- Regulatory technology. I found this item to be particularly interesting, and it’s because of the language that FINRA employed. There was no expression of any particular concern on FINRA’s part, no overt threat of enforcement actions; rather, it was phrased more in terms of FINRA getting its head around the subject: “FINRA will engage with firms to understand” how they are using regulatory technology. I am unsure what it means for FINRA to “engage with firms,” but, regardless, history teaches that is never good for firms. It is a short walk from FINRA simply educating itself about what firms are doing to FINRA deciding that it doesn’t like what firms are doing.
The second observation I would make is that for the first time, FINRA doesn’t just call the letter the Examination Priorities letter, but the “Risk Monitoring and Examination Priorities” letter. Maybe this is what FINRA meant when it said it would “engage with firms to understand” their use of regulatory technology. Here is how FINRA described what “Risk Monitoring” means:
[T]he ongoing process through which FINRA monitors developments at firms and across the securities industry to identify risks and assess their prevalence and impact. We use this analysis to evaluate whether a regulatory response is appropriate, determine what that response should be and then allocate the required resources to implement the response. The risk monitoring process involves numerous inputs, including firms’ reporting to FINRA, data from our market and member surveillance programs, findings from our examinations, FINRA surveys and questionnaires, and ongoing dialogue between FINRA and the industry as well as other stakeholders.
Look, I would certainly prefer that before FINRA launches a new Enforcement initiative that it first take the necessary time to figure out that there is, in fact, a real problem that needs to be addressed. I guess, to some degree, however, I remain troubled by how even this seemingly righteous endeavor is phrased, i.e., FINRA’s decision to characterize it as a “risk” assessment. Not everything is about risk. By calling something a risk, however, or even a potential risk, suggests to me that FINRA may have already reached the conclusion, even if only preliminarily, that whatever FINRA is looking at does, indeed, present a risk. That is not proper auditing. No good auditor, regardless of subject, should presuppose the outcome of the audit. By labeling the subject of its inquiry a “risk,” it seems that FINRA may have done just that.
Finally, FINRA has made clear, once again, that it is interested in doing something about a perceived mess, one of FINRA’s own creation, namely, “associated persons with a problematic regulatory history.” Yes, the old rogue rep thing. As I have written about repeatedly, FINRA has once again succumb to its historic inclination to bend to media attention that it considers to be unfavorable, and so it wants to do something, apparently, about BDs that hire RRs who have done nothing bad enough for FINRA to have barred them. What FINRA is doing here is passing the buck to the member firms, by focusing on their “hiring practices and supervision programs,” instead of taking responsibility for its own failures to have kept out of the industry those truly bad RRs who ought to have been barred. Again, I am certainly not advocating that FINRA start barring everyone; as things stand, FINRA already seeks to bar more respondents than actually deserve that draconian sanction – and let’s make it very clear, a permanent bar is a punitive sanction in the purest sense, with nothing “remedial” about it. Rather, I just want FINRA to acknowledge its complicity in the alleged problem, and to stand up to the media for a change. That will be high on my personal list of 2019 FINRA priorities.