FINRA 2018 Annual Regulatory and Examination Priorities Letter

On January 8, 2018, FINRA President and CEO Robert Cook issued FINRA’s 2018 Regulatory and Examination Priorities Letter.

We will highlight below several of the concerns and observations expressed by FINRA in the Priorities Letter.

The first of FINRA’s concerns identified in the Letter is fraud. Fraudulent activities such insider trading, microcap pump and dump and Ponzi schemes remain major targets of FINRA enforcement actions. The Letter indicates FINRA will specifically focus on fraudulent microcap activity involving senior citizens. Microcap fraud was also referenced in both the 2017 and 2016 Priorities Letters.

Microcap pump and dump schemes occur when unscrupulous investors and/or stock promoters falsely recommend the stock of a microcap (a small capitalized company traded over the counter or on the pink sheets) as a “hot tip” or “can’t miss,” thereby increasing the demand and volume of trading in the company. This will usually cause the price of the stock to jump. When the per share price of the company reaches a certain point, they then “dump” their shares on the market at a profit. However, this causes a sharp decrease in the price. The investors who were unaware of the scheme then typically incur losses.

The Letter points to new FINRA Rule 2165, Financial Exploitation of Specified Adults, effective February 5, 2018. This rule will allow firms to place temporary holds on the disbursement of funds or securities from certain customer accounts where financial exploitation is suspected. Amendments to Rule 4512 (Customer Account Information), also effective February 5, 2018, requires firms to make a reasonable effort to identify a trusted contact person for a non-institutional “specified adult” customer’s account. A specified adult is a customer age 65 or older, or any person age 18 or up, who may have a mental or physical impairment, which would lead a reasonable member to believe that the customer could be financially exploited.

These new rules/amendments will hopefully assist firms in preventing the financial abuse of senior and impaired/handicapped investors.

One of FINRA’s major targets identified in the 2017 Priorities Letter was recidivist or “high risk” brokers-and the firms that employ them. FINRA will pay strict attention to the hiring and supervision of such brokers. Moreover, FINRA will expect firms to implement heightened supervision of such brokers as warranted.

Sales practice risks are highlighted in the Letter. It notes that as the number and complexity of new products continue to increase, the responsibility of firms to insure that sales of these products to their clients meet firm and industry suitability standards remains constant.

The Letter specifically mentions unit investment trusts (UITs) as an example of a complex product about which firms may have not adequately trained sales personnel as to the risks of the product. Insufficient training can lead to brokers who do not completely understand the risk characteristics of these complex investments. That, in turn, can result in brokers making unsuitable recommendations to their clients.

The Letter also states that digital assets, such as cryptocurrencies and initial coin offerings (ICOs) have received significant media, public and regulatory attention. Therefore, FINRA will more closely monitor those activities in 2018.

Margin loans and securities backed lines of credit (SBLOCs) will also receive scrutiny from FINRA in the coming year. FINRA will want to ensure that clients are fully aware of the potential downsides of borrowing against a their portfolio of securities.

The Letter also discusses operational and financial risks, such as business continuity planning, cyber security and anti-money laundering, and market integrity (best execution, market manipulation and Reg SHO).

Lubiner, Schmidt & Palumbo are experienced securities arbitration, regulatory and employment attorneys. We represent large, medium and small broker dealers and their employees. Contact us if you have questions or concerns about issues raised in FINRA’s 2018 Priorities Letter.