Bates Research - 01-10-18
FINRA 2018 Regulatory and Examination Priorities Comparison and Commentary
This week, FINRA released its Regulatory and Exam Priorities for 2018. The Priorities Letter is intended to be a reference point for firms to prepare their compliance, supervisory and risk management programs, as well as to prepare for FINRA examinations. While most of the priorities from previous years remain in force, here we look at a handful of new topics and new emphases stemming from regulatory developments during 2017. See the Bates comparison chart below to examine how these priorities have changed over time. Further, please note that FINRA’s accompanying cover letter describes important new organizational initiatives and new resources for member firms. These organizational developments will impact the implementation of the priorities contained in this year’s priorities letter. Here are some of the takeaways:
Regulatory and Exam Priorities for 2018
This year’s letter is informed by observations contained in the Report on FINRA Examination Findings published in December 2017. FINRA’s 2018 priorities reflect a continuing emphasis on fraud, high risk firms (and brokers), operational and financial risk and market regulation, including AML and sales practice risks. Of note is this year’s emphasis on insider trading, microcap pump-and-dump schemes, issuer fraud and Ponzi-type schemes targeting vulnerable investors. Attention should be paid to these ongoing priorities given FINRA’s new Rules to protect seniors. (See Bates blog here). Likewise, FINRA asserted that it will pay particular attention to suitability determinations in situations where registered representatives have recommended complex products to less sophisticated and/or potentially vulnerable investors.
Based on our comparison below, FINRA has upgraded certain priorities, particularly in the areas of market manipulation, lending and cyber/fintech. To combat market manipulation, FINRA has “enhanced and expanded” its surveillance programs, adding “machine learning techniques” to identify aggressive and dominant trading surrounding the market open and close. For 2018, FINRA prioritized alternative trading system surveillance and announced an intention to review firm supervisory systems to ensure that they are designed to catch disruptive or manipulative quoting and trading activity. FINRA also identified enhanced surveillance of options with an emphasis on their potential use in cross-market and cross-product manipulation schemes. Consistent with the organizational changes described by FINRA CEO Robert Cook in his cover letter, FINRA will launch several new report cards to assist firms with their compliance efforts in combatting market manipulation.
FINRA will prioritize review of certain kinds of lending including margin loans and securities backed lines of credit (“SBLOCs”). FINRA stated that it will assess whether “firms maintain controls reasonably designed to prevent excessive margin trading” and whether firms provide customers with adequate disclosure regarding the potential risks associated with SBLOCs.
Digital and ICOs
The broadest new priority concerns the treatment of digital assets and initial coin offerings. FINRA asserted it will monitor “the role firms and registered representatives may play in effecting transactions” in these assets and “may review the mechanisms—for example, supervisory, compliance and operational infrastructure— firms have put in place to ensure compliance with relevant federal securities laws and regulations and FINRA rules.”
BATES GROUP'S YEAR-TO-YEAR COMPARISON OF FINRA REGULATORY & EXAMINATION PRIORITIES
Source: 2018 FINRA Regulatory and Examination Priorities Letter (Compiled by Alex Russell, Bates Group LLC)
CEO Highlights Significant Organizational Change
This year’s priorities letter was framed by a comprehensive cover letter discussing broad changes in the organizational activities of the self-regulatory organization. In his introduction to this year’s priorities, FINRA CEO Cook recounted several important steps taken to date, and many upcoming plans, to transform FINRA into “a more effective and efficient” entity.
From enforcement to compliance, information sharing to market outreach, Mr. Cook sent a clear message that the FINRA organizational change will affect every aspect of its relationship with member firms. Through FINRA360, a comprehensive self-evaluation initiative, FINRA has already consolidated enforcement functions into a single unit and has begun retrospective reviews of rules. Through its Innovation Outreach Initiative, FINRA has begun a dialogue around fintech (see updates) that have important implications for future regulatory policy. Mr. Cook described efforts to improve the examination program in order to “implement a risk-based framework designed to better align examination resources to the risk profile of our member firms.” As a practical matter, Mr. Cook promised an increase in information sharing with firms during examinations, improved processes for making examination information requests, and enhanced training of examiners.
Mr. Cook also listed a host of new FINRA tools that are intended to enable and improve compliance by member firms: the Examination Findings Report, a new Compliance Calendar, a Compliance Vendor Directory and most notably, supervision report cards. As to the latter, he emphasized the importance of cross-market surveillance report cards which “have helped firms identify potential market manipulation through trading activity across multiple firms, markets and products.” He said that these supervision cards are already having a desired effect, insofar as firms have upgraded their internal controls and addressed specific problematic activity. For example, he touted the “significant decline in exceptions for ‘layering’—a manipulative trading strategy—since the launch of our report cards in 2016.” New supervision report cards, a Report Center which provides online access to reports containing a range of compliance data, and the expansion of a “rapid remediation program” intended to assist firms in correcting systems problems are some of the organizational initiatives on tap for 2018.
Perspective on 2018 FINRA Priorities
This year, member firms should consider how FINRA’s organizational initiatives and the announced regulatory priorities will affect their compliance, supervisory and risk management programs in 2018. CEO Robert Cook is clearly communicating that FINRA is raising the bar for compliance while providing firms with substantial new resources to get things right. Prudent preparation requires consideration of both messages from FINRA. Bates will continue to keep you apprised of new developments.
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