FINRA 2017 Annual Regulatory And Examinations Priorities Letter

On January 4, 2017 FINRA issued its Annual Regulatory and Examination Priorities Letter (the “Priorities Letter”). In the opening paragraph of his Cover Letter, FINRA President and CEO Robert Cook said that in 2017 FINRA examiners would focus on “core ‘blocking and tackling’ issues” of compliance, supervision and risk management.

Cook further stated that, based on feedback he received while conducting “listening tours” in 2016, FINRA will undertake two initiatives in 2017.

First, FINRA will begin to publish a summary report outlining “key findings in selected areas” of on-going examinations. This will allow firms that have not yet been examined to address the issues FINRA examiners are discovering before their own examinations.

Secondly, according to Cook, numerous small firms asked FINRA to provide additional tools to assist those firms in fulfilling their compliance functions. Therefore, in 2017 FINRA will introduce a compliance calendar and a directory of compliance service providers to aid those firms.

Below we highlight and comment on some of the key findings in the Priorities Letter.

Introduction

FINRA indicated that in 2017 it would initiate electronic, off-site reviews to supplement traditional on-site examinations. FINRA will serve targeted information requests (often focused on areas discussed in the Priorities Letter) on selected firms and analyze the responses off-site.

High Risk and Recidivist Brokers

FINRA “will devote particular attention” to the hiring and supervision of high risk and recidivist brokers. The Priorities Letter indicates that FINRA has strengthened its oversight of brokers they feel fall into the above categories:

  • FINRA has created a dedicated examination unit to identify and examine brokers who, in their view, pose a high risk to investors;
  • FINRA will review firms’ supervisory procedures regarding hiring and retaining statutorily disqualified and recidivist brokers. Firms will be examined as to their due diligence in confirming the accuracy and completeness of information on a questionable broker’s CRD. Firms will be expected to independently verify, either themselves or through a third party, information on a CRD by conducting a national search of public records. Firms will be expected to implement a supervision plan to detect and prevent future misconduct of questionable brokers based on past misconduct. FINRA examiners will also focus on firms with a “concentration” of problem brokers (although the Priorities Letter does not quantify what a “concentration” constitutes); and
  • The third leg of this section of the Priorities Letter discusses FINRA’s intended review of the adequacy branch office inspection programs. Presumably by referencing branch inspection programs in this section, FINRA is stating that they will be concerned with the inspection of branches in which high risk brokers work.
Sales Practice

Senior Investors – In 2017, FINRA will review firm controls protecting senior investors from “fraud, abuse and improper advice.” FINRA will also focus on microcap fraud schemes targeting the elderly (microcap fraud in general was also on FINRA’s radar in 2016).

Product Suitability and Concentration - Concerned with instances of unsuitable recommendations, FINRA will assess how firms conduct suitability reviews. Brokers, their supervisors and compliance staff should understand the objectives, risk and pricing factors of products sold, especially new products being introduced by the firm.

FINRA will also review the controls firms use to insure that firm recommendations do not result in excessive concentration in a particular product, or even an industry sector.

Excessive Short-Term Trading of Long Term-Products – The Priorities Letter expressed concern regarding short term trading of products, such as mutual funds, variable annuities and unit investment trusts (UITs), which are designed to be held long term. Additionally, FINRA expects firms to evaluate whether their surveillance systems can detect attempts to evade automated surveillance programs designed to reveal excessive switching.

Outside Business Activities and Private Securities Transactions – FINRA will focus on firms’ procedures involving registered representatives’ written disclosures of outside business activities and private securities transactions. This is a repeat area of concern from FINRA’s 2016 Priorities Letter.

Social Media and Electronic Communications Record Retention and Supervision – Given the explosion in social media usage in society in general, and the securities industry in particular, it is not surprising that FINRA would highlight to its members that it intends to rigorously review firms’ efforts to comply with supervision and record retention requirements as to business related communications with clients. FINRA will test during its examinations to insure that all such communications are captured regardless of the device or network used.

Financial Risk

In 2017, FINRA will review firms’ funding and liquidity plans and whether firms adequately evaluate their liquidity needs. FINRA will assess how firms manage risk across their entire organization. Lastly, in 2016 amendments were passed to Rule 4210 regarding margin requirements. FINRA will review firms’ implementation of the obligations established in that rule amendment.

Operational Risks

Recognizing that “[c]ybersecurity threats remain one of the most significant risks many firms face” (see FINRA’s Topic Page on cybersecurity) FINRA continues to emphasize that firms must minimize such risks. FINRA will also look at this issue as it relates to vendors’ and other third parties’ access to customer information. This topic was also discussed in FINRA’s 2016 Priorities Letter.

There are two specific areas drawing FINRA’s attention regarding cybersecurity. One deals with firms’ deficiencies regarding cybersecurity controls at the branch level. The second is the failure of firms to keep electronic records in WORM (write once read many) format as required by SEA Rule 17a-4(f).

In 2017, FINRA will be testing firms’ supervisory controls. Rule 3120 requires firms to have supervisory controls in place to test the adequacy of their written supervisory procedures (WSPs). FINRA will be assessing the strength of those controls.

FINRA will continue to examine for deficiencies in firms’ anti–money laundering programs (a repeat topic from 2016). FINRA noted that it observed shortcomings during 2016 in firms’ automated trading and money movement surveillance systems.

The 2017 Priorities Letter also discussed customer protection/segregation of client assets, municipal advisor registration and compliance with Reg SHO.

Market Integrity

In the last section of its 2017 Priorities Letter, FINRA outlined its concerns on several topics, such as manipulation (a “critical priority for FINRA”), best execution, audit trail issues (a repeat from 2016), the Tick Size Pilot, the Market Access Rule (a 2016 repeat), trading exams and fixed income securities surveillance.


CEOs, CFOs, CCOs and their direct reports and senior and middle management in branch administration, operations, compliance and internal audit should review FINRA’s 2017 Priorities Letter. The Letter details FINRA’s concerns from 2016 and expectations for 2017. It serves as a roadmap for what firms can anticipate in the examinations to be conducted in the coming year.

The attorneys at Lubiner, Schmidt and Palumbo have combined decades of experience in dealing with the multiple and varied issues broker-dealers and their employees face on daily basis. Several Lubiner, Schmidt and Palumbo attorneys worked in-house at large brokerage firm and are intimately familiar with most, if not all, of the issues raised in the 2017 Priorities Letter. We stand ready to assist you in navigating the ever increasingly complex regulatory environment securities firms now face.