FINRA updates examination priorities for 2018
Once the Financial Industry Regulatory Authority (FINRA) updates examination priorities, you have to address changes proactively before you incur costly penalties. FINRA’s 2017 Examination Findings Report reveal new concerns, such as cybersecurity and cryptocurrency.
Subsequently, FINRA published its 2018 Annual Regulatory and Examination Priorities Letter in January, which can help your firm strengthen compliance programs and improve risk management. Here is a breakdown of key takeaways from this year’s list of FINRA priorities and actions taken by FINRA following the letter.
As you might expect, fraud continues to top FINRA’s list of priorities. Financial crime takes many forms, and new mechanisms to perpetrate fraud come to light each year. In 2018, FINRA has concentrated on the dual threats of insider trading and microcap “pump-and-dump” fraud, which exploits an investor’s lack of sophistication.
Recently FINRA issued an alert to investors following Hurricane Florence, warning them about potential stock fraud.
High-risk firms and brokers
FINRA continues to highlight the problem of high-risk firms and brokers manipulating new investors. To strengthen compliance, be wary of offering complex, speculative products as these transactions draw more scrutiny than in previous years. Regulatory Notice 18-15 reaffirms FINRA’s supervisory role.
Operational and financial risks
If your firm struggles with operational and financial risks, FINRA’s 2018 new priorities will help you address the problem. The following updates are most critical to supporting more consistent compliance to FINRA’s rules.
Business continuity planning
In 2017, major natural disasters, such as Hurricane Harvey, influenced how FINRA views business continuity planning. FINRA requires your firm to create a written business continuity plan. This rule minimizes the impact of catastrophic events on firms’ operations in disaster areas.
In a recent Regulatory Notice, FINRA requires distinguishing between mission-critical systems and non-critical systems.
Protection of customer assets
As another long-standing pain point, protection of customer assets made another appearance on FINRA’s list. FINRA requires that your firm implement necessary mechanisms to fulfill fiduciary responsibilities.
Apart from previous years, FINRA has started scrutinizing the arrangements of underlying customer assets arranged by foreign entities.
Technology governance and cybersecurity
It’s clear that FINRA takes technology governance and cybersecurity risk very seriously. They are two sides of the same coin since weak control of IT resources coincides with increased security threats. Hackers will always view the financial industry as a prime target for identity fraud and intellectual property theft, so FINRA expects your firm to keep pace with cybersecurity best practices.
Along with fraud and protecting customer assets, FINRA has always focused on anti-money laundering surveillance. Note that anti-money laundering prevention goes hand-in-hand with technology governance and cybersecurity.
For example, there has been a greater emphasis on monitoring accounts opened by foreign affiliates in 2018.
Risks of liquidity and short sales
Liquidity risk and short sales are undergoing further examination as FINRA reviews the strengths and weakness of firms’ liquidity policies. In short, you have to ensure that your liquidity planning squares with financial industry best practices of stress testing and identifying unencumbered and encumbered cash.
Sales practice risks
FINRA’s review of sales practice risks merits a closer look, too. As new financial products, such as initial coin offerings (ICOs), become more popular and more profitable, you must review sales practices to maintain FINRA registrations.
Suitability refers to the rising number of securities available to investors. You’ll have to contend with FINRA’s renewed attention on how your firm acts on a client’s behalf. The increasing practice of recommending complex products to new investors has been an area of particular concern in 2018.
Cryptocurrencies and ICOs
Transactions involving the sale of assets in digital currencies are subject to further FINRA examination. Since cryptocurrencies and ICOs keep evolving quickly, it’s incumbent upon you to tread softly when the sale of securities involves digital assets or risk an audit.
Margin loan practices
Concerning the use of margin, your firm has to disclose how it enforces supervisory loan policies. Recently, FINRA has uncovered questionable share purchases on margin made on behalf of investors who didn’t understand the risks.
Securities-backed lines of credit
Since securities-back lines of credit (SBLOC) have become more popular, FINRA is taking a closer look at how you comply with regulations. There is stronger enforcement of rules governing SBLOC lenders, their affiliates and how they inform investors of the inherent risks of margin arrangements.
FINRA’s last emphasis is on market integrity, which aligns with FINRA’s primary mission to guard against volatility. As the U.S. economy maintains healthy GDP growth, market integrity will be a crucial priority to continue expanding the economy.
Manipulation and best execution for investor protection
FINRA continues to use automated technology, such as Cross Market Auction Ramping, to watch for sophisticated attempts to manipulate markets. Similarly, FINRA has improved its detection of false positives and collusion between markets.
You need to show FINRA regulators that your firm adheres to best execution standards, such as lawful order routing inducements.
Improper short selling and naked short selling has always been on FINRA’s radar, but in 2018, you can expect a renewed emphasis on regulation SHO. If you rely too heavily on third-parties to supervise compliance, FINRA intends to examine whether or not your firm’s verification policies are still adequate. FINRA recently fined Interactive Brokers $5.5 million for regulation SHO improprieties.
Fixed-income data integrity
Related to cybersecurity threats, data integrity of fixed-income transactions keep drawing FINRA’s attention. You must adjust to changes to FINRA surveillance of trade reporting for U.S. Treasury securities.
Be aware of the danger of late reporting and under-reporting inter-dealer trades, which may look suspicious.
If your firm can maintain the proper level of pre-trade financial controls, FINRA is less likely to find you out of compliance with the Market Access Rule. The key is to build strong document controls lest FINRA conclude that you haven’t performed due diligence to the Market Access Rule. FINRA fined several firms in April for violating market access rules.
Alternative trading surveillance
The final priority set by FINRA for 2018 is the surveillance of alternative trading systems. There is a requirement to maintain an adequate supervisory system that follows all FINRA rules and securities laws. Some areas of concern include manipulative quoting practices or malicious trade activity.
FINRA’s priorities for 2018 align with previous years. While not exhaustive, this breakdown of critical takeaways represents the bulk of FINRA’s updated recommendations.