OCIE 2020 Examination Priorities Released

OCIE has announced its 2020 exam priorities as part of its risk-based approach to protecting investors. As in the past, key risk areas that are prioritized impacting SROs, clearing firms, investment advisers and other market participants include:

  • Retail Investors, Including Seniors and Those Saving for Retirement
  • Market Infrastructure related to capital markets, including clearing agencies, national securities exchanges, alternative trading systems and transfer agents
  • Cyber and information security risks
  • Examining RIAs, including investment companies, ETFs, private funds that have never been examined, including new RIAs and RIAs never examined and oversight practices of their boards of directors
  • AML requirements
    Fintech and innovation, including digital assets and electronic advice
  • Oversight of FINRA and MSRB operations, programs and their examinations of broker-dealers and municipal advisors

OCIE makes clear that the above risk areas is not exhaustive and will be dependent on risk-based approaches employed by OCIE and its staff. A copy of the 2020 exam priorities can be found here.

Recent Regulatory Actions Against Broker-Dealers

Variable Annuity Exchanges:  $Six Million is the Costs for Failing to Consider and Accurately Describe their Costs and Benefits

Fifth Third Securities, Inc. Action

For the second time, the FINRA has sanctioned Fifth  Third related to its sale of variable annuities.  This time, Fifth Third failed to ensure that its reps obtained and assessed accurate information when recommending VA exchanges.  FINRA also found that the firm’s reps and principals were not adequately trained in how to conduct a comparative analysis of the material features of its VAs, causing the firm to misstate the costs and benefits of exchanges, thus making the exchange appear more beneficial to its customers.  To make matters worse, the firm’s principals approved approximately 92 percent of the exchange applications submitted for review. FINRA reviewed a sample of VA exchanges Fifth Third approved from 2013 through 2015, and found  that Fifth Third misstated or omitted at least one material fact relating to the costs or benefits of the VA exchange in approximately 77 percent of the sample.

FINRA fined Fifth Third Securities, Inc. $4 million and required restitution to customers of approximately $2 million.  So what went wrong?  FINRA found Fifth Third’s practices included

  •  overstating the total fees for existing VA or misstating fees associated with various additional optional benefits, known as riders;
  • failing to disclose that existing VAs had an accrued living benefit value, or understating that a customer would forfeit a living benefit value, upon executing an exchange; and
  • representing that a proposed VA had a living benefit rider when it did not.

Compared to FINRA’s fine against MetLife Securities, Inc., ($20 million and order to pay $5 million to eligible customers,  for similar behavior, around the same time two years ago) Fifth Third fared better.  Do these firms believe that such fines (which could have easily been avoided) are simply a cost of doing business? Or maybe Fifth Third believes for namesake that, next time, a “third” time violation may be just the charm.

Cyber-Security: FINRA’s Targeted Examination Letter

The IPR Blog: FINRA's Targeted Examination LetterAs we posted earlier in outlining  FINRA’s  2014 Regulatory and Examination Priorities Letter, one focus included FINRA’s concern for the integrity of member firms’ policies, procedures and controls that are supposed to protect sensitive customer data.  In the letter, FINRA states that it will examine and conduct targeted investigations and followed up by issuing  a separate notice concerning  Targeted Examination Letters that some firms may get seeking information about how the firm addresses the issue of cyber-security threats, vulnerabilities, and management of related risks.  The cyber-security topics FINRA will examine or assess include a firm’s

Continue reading “Cyber-Security: FINRA’s Targeted Examination Letter”

Compliance Risks With Leveraged and Inverse ETF Sales

FINRA has ordered Atlanta-based broker-dealer, J.P. Turner & Company, L.L.C. to pay $707,559 in restitution to 84 customers for sales of unsuitable leveraged and inverse exchange-traded funds (ETFs) and for excessive mutual fund switches.

FINRA’s action against J.P. Turner is another reminder of the need for broker-dealers to carefully scrutinize the suitability of such non-conventional investments products like inverse exchange-traded funds.

While FINRA mutual fund switch violation cases (a practice FINRA has addressed repeatedly) are more common, inverse ETFs sales practice violations case have not been as prominent, but should come as no less a surprise. Continue reading “Compliance Risks With Leveraged and Inverse ETF Sales”

Public Arbitrator Definition Excludes Mutual Funds and Hedge Funds

Effective July 1, 2013, add to the types of  individuals who are no longer eligible to serve as public arbitrators in FINRA arbitrations persons associated with, or registered through, a mutual fund or hedge fund.

The list has been growing and already includes  (i) attorneys and accountants who derive a certain percentage or a certain amount of their income from the securities industry, (ii) investment advisers, (iii) persons or spouses employed by entities involved in the securities industry, and (iii) directors or officers or spouses or an immediate family member of a person who is a director or officer of, an entity that directly or indirectly controls, is controlled by, or is under common control with, any partnership, corporation or other organization that is engaged in the securities business.

Despite complaints from some in the securities industry that the change means more arbitrators with less experience and education about how the securitie industry works, the rationale approved by the SEC and adopted under Codes of Arbitration Rules (Customer and Industry Codes) 12100(u)(3) and 13100(u)(3) for including these categories is just the opposite.  The change arises from complaints that certain arbitrators on FINRA’s public arbitrator roster are not perceived as public and may be biased because of their industry background and experience.  The exclusion is not permanent.   If the individual ends the affiliation that was the basis for the exclusion, they are eligible to serve as a public arbitrator  two calendar years after ending the affiliation.

FINRA’s Broker-Dealer Conflicts of Interest Sweep

Seeking to ensure that broker-dealers identify conflicts and place their customers’ interests above there own, FINRA sent to its member firms, in July, another “Targeted Examination Letter”  announcing that it would be conducting targeted examinations (or sweeps) of  member practices to review how they identified and managed conflicts of interest.  The letter sent to  a number of firms seeks a response by September 14, 2012, followed by a potential three hour meeting to discuss information reported. 

What this exercise means for member firms in the near term and in the future is that any new rules FINRA enacts are likely to have a significant effect on broker-dealers with retail clients, particularly in the areas of best execution and customer order handling.  Firms will need to address whether conflicts exist for topics related to best execution as “internalization” (i.e. agency cross trades orders), “preferencing (directing to one market maker over another), affiliated brokerage (i.e. directing  fund brokerage commissions to brokers that sold large number of fund shares), and the priority of trade execution (i.e. trading ahead of customers, block trading, front running and proprietary trading issues) to name a few.     

FINRA makes explicit that it will not be using information gathered from the sweeps as a tool for potential enforcement actions, but instead is using  responses to better understand whether firms are taking reasonable steps to properly identify, manage and mitigate conflicts that may impact clients and the industry.  The letter also states that FINRA intends to develop potential guidance for the industry from the information it learns.  From a fiduciary perspective, and if  broker-dealers haven’t been doing so, they need to start thinking about creating formal risk assessment programs that address conflicts concerns.

FINRA: Advertising Rules Guidance For DOL Disclosure For Participant-Directed Plans


FINRA has now provided regulatory guidance  to member firms about how its advertising rules  (NASD Rules 2210 and 2211) would apply to information they provide to participant-directed individual account plan participants under a U.S. Department of Labor rule.  The DOL rule, Rule 404a-5, was designed to ensure that plan participants are provided with sufficient information about the plan and designated investment options alternatives under ERISA.  The DOL rule requires the disclosure of certain plan and investment-related information, including performance information, to participants.

The FINRA guidance follows the SEC’s issuance, in October 2011, of a letter to the DOL in which the SEC’s staff agreed to treat information provided by a plan administrator to plan participants that complies with the DOL rule requirements as if it were a communication that complies with the requirements of Rule 482 under the Securities Act.  The SEC does not require that such information be filed under Rule 497 of the Securities Act and Section 24(b) of the Investment Company Act with the SEC or FINRA.  The SEC letter mentioned that FINRA staff intended to interpret applicable FINRA rules consistent with the SEC letter.

FINRA now says that if a firm provides information to plan participants that complies with the DOL rule requirements, it will treat the information as if it were a communication satisfying the content and filing requirements of NASD Rules 2210 and 2211.  Thus, firms would not be required to file the information with FINRA under NASD Rule 2210(c), nor would the information be subject to the content requirements of NASD Rule 2210.

However, FINRA warns, to the extent a firm includes in an advertisement or item of sales literature content promoting a product or service of the firm, in addition to what is required by the DOL rule, the non-required content will be subject to NASD Rules 2210 and 2211.





Client Records, You Can’t Always Take Them with You When you Go

Despite the SEC’s adoption of Regulation S-P back in 2000, some reps still mistakenly believe that client accounts belong to them and that they are free to take them, including any information about the client, when they depart one firm for another.  And whether by bringing  improper recruiting practices or misuse of client information enforcement cases, FINRA and the SEC keep reminding reps and their firms that this is not the case.

Under Regulation S-P, any information given by consumers or customers to broker-dealers to obtain a product or service is generally considered to be nonpublic financial information.  The regulation mandates that financial firms safeguard customer confidential information and prevent its release to unaffiliated third parties without the customer’s authorization.

In a recent case, the SEC announced that it sustained FINRA’s sanctioning of a former Banc of America Investment Services, Inc. (“BAIS”) rep fining him $10,000 and suspended him from FINRA membership for ten business days for having downloaded confidential nonpublic information about  approximately 36,000 customers and providing that information to a competing firm that he joined.  In rejecting the rep’s claim that the FINRA sanctions for his violations were excessive or oppressive, the SEC found that FINRA’s fine and sanction were not excessive or oppressive, and that the rep’s conduct was unethical, and violated NASD Conduct Rule 2110.  (Rel. 34-66113; File No. 3-14195).

The essential facts leading to the SEC’s decision were that FINRA found that the rep breached his duty of confidentiality when he “surreptitiously” downloaded BAIS’s customers’ confidential nonpublic information, including account numbers and net worth figures, and transmitted that information to his future branch manager at a competitor firm.

Quoting Regulation S-P, the SEC found that the rep’s conduct prevented BAIS from giving its customers proper notice and an opportunity to opt out of the disclosures, as required by Regulation S-P.  The SEC held that the rep’s violation caused his new employer to improperly receive BAIS’s customers’ “nonpublic personal information.”


What FINRA’s Investor Protection Efforts Will Mean for Broker-Dealers and Reps in 2012

On December 16, Financial Industry Regulatory Authority (FINRA)  issued a Press Release highlighting its regulatory accomplishments during 2011.  FINRA makes clear its goal is two-fold:  protecting investors and bringing transparency to financial markets.  The release demonstrates for senior management, risk management and compliance managers the additional arsenal FINRA is employing to beef up its oversight of broker-dealers and their registered reps.  So far, for reps and their firms, this has meant a significant increase in the number of disciplinary actions this year.  The release identifies  some of the newer tools and sources FINRA has used and will continue to employ to protect investors.

What’s been different about 2011 and what will firms and reps experience more of in 2012?  The press release sheds light on some measures FINRA will be employing, including:

  • Using its Office of Fraud Detection and Market Intelligence (OFDMI) to refer matters involving potential fraudulent conduct to federal and state regulators and law enforcement agencies.  FINRA referred more than 600 matters this year.
  • Reconfiguring its exam program to be more risk-based and ensuring exam teams are more focused on those areas critical to investor safety; including identifying high-risk firms, branch offices, brokers, activities and products through broader data collection.
  • Developing, through its Market Regulation Department, cross-market surveillance patterns that monitors all FINRA, NYSE and NASDAQ markets (80 percent of equity markets) with plans to launch these patterns in 2012.  Earlier, FINRA expanded the Order Audit Trail System (OATS) to include all NMS securities to create a uniform order audit trail to serve as a foundation for the cross-market surveillance program.
  • Expanding the Trade Reporting and Compliance Engine (TRACE) to include securitized products.  The effect was to add more than 1.2 million asset- and mortgaged-backed securities to the current 70,000 TRACE-eligible securities; and introduced securitized products benchmark pricing and aggregated data reports on FINRA’s website.
  • Continuing to push rule proposals that include Back Office Registration, Suitability and Debt Research Conflicts of Interest.
  • Enhancing its examination program by taking a more risk-based approach to focus on areas posing greatest risk to investors.  With this, FINRA has increased the number of its staff in district offices responsible for having a deeper understanding of specific firms, including increased real-time monitoring of business and financial changes.
  • Placing greater emphasis on branch-level activity by increasing the number of branch exams that focus exams at the point-of-sale.
  • For 2012, developing comprehensive cross-market surveillance patterns that will examine trading activity across all markets, including FINRA, NYSE and NASDAQ equity markets, at one time (which account for 80 percent of equity volumee time), rather than having multiple patterns survey each market separately.  This is suppose to help FINRA identify problematic trading more quickly.
  • Finally, FINRA implemented a rule for firms and reps involved in FINRA arbitrations allowing investors to choose all-public panels in customer cases involving three arbitrators.