More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
The Financial Industry Regulatory Authority (FINRA) on Tuesday released its 2012 regulatory and examination “watch list,” which provides a laundry list of products the regulator will be zeroing in on and warns broker-dealers not to promote products and practices that are meant to beat the market instead of promoting what’s most suitable for investors.
Among the products that top FINRA’s watch list for suitability issues include: residential mortgage-backed securities and commercial mortgage-backed securities; non-traded REITs; municipal securities; complex exchange-traded products; variable annuities; structured products, private placements and life settlements.
FINRA also warned that it would be zeroing in on broker fees and had a heightened focus on branch office inspections.
In a 16-page letter, FINRA said the “challenging economic environment can lead individual retail investors to be susceptible to recommendations to chase yields without necessarily understanding the risk-versus-reward tradeoffs, particularly as more esoteric or complex products find their way into retail portfolios.
FINRA went on to say that the “current environment can exacerbate underlying business-conduct issues that have a detrimental impact on retail investors. Some of our concerns include the full disclosure of material risks, mispricing and overcharging issues, and the suitability of products based on those underlying risks.”
The regulator said that since 2008, the economic environment that investors had faced had steadily contributed to conditions that fostered “an increased risk of aggressive yield chasing, inappropriate sales practices, unsuitable product offerings, and misappropriation and fraud.”
Chief among FINRA’s concerns include the full disclosure of material risks, mispricing and overcharging issues, and the suitability of products based on those underlying risks.
Against this back drop, FINRA said that it is specifically concerned with:
- Yield Chasing – Given the low yields on Treasuries, we are concerned that investors may be inadvertently taking risks that they do not understand or that are inadequately disclosed as they chase yields.
- Liquidity – The lack of a deep secondary trading market for certain investments make them unsuitable for many retail investors who have strong liquidity needs.
- Cash Flow Characteristics – The timing of anticipated cash flows should be in line with investor time horizons.
FINRA also noted that suitability reviews will continue to be important this year, as the new Suitability Rule (FINRA Rule 2111) and Know Your Customer Rule (FINRA Rule 2090) become effective on July 9.
In 2011, FINRA said it also brought cases against several broker-dealers for charging excessive fees in the form of postage and handling charges that were unrelated to actual
As for social media, FINRA says it remains a “top concern” for the regulator as “we continue to receive many questions from firms.”
FINRA noted its Regulatory Notices that have been issued on social media guidance, and pointed to the recordkeeping requirements of Rule 17a-4(b)(4) under the Securities Exchange Act of 1934 (SEA) which remain in effect even when an associated person is using a device for “business as such” communications.
Further, FINRA said, firms must be able to appropriately supervise business communications made using personal devices.