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Regulation and Compliance > Federal Regulation > FINRA

FINRA’s Top Exam Priorities for 2015

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Among the long list of regulatory and exam issues that will be top priorities for the Financial Industry Regulatory Authority this year includes what FINRA says has been a “central failing” of broker-dealers: not putting customers’ interests first, specifically when it comes to dealing with senior investors and IRA rollovers.

FINRA’s regulatory and examination priorities list, released Tuesday, is long, and includes “everything but the kitchen sink,” said Brian Rubin, a partner at Sutherland Asbill & Brennan who heads the Securities Litigation and Enforcement Group. Such a lengthy priorities list may make it “hard for firms to figure out what to specifically focus on.”

Despite its length, Cipperman Compliance Services urges compliance officers to”closely review” FINRA’s priorities letter as well as the SEC’s priorities list, which should be out soon, as both regulators “generally follow through” with their exam priorities. Failure to comply with certain areas could lead to enforcement actions.

New to the list are alternative mutual funds as well as exchange-traded products tracking alternatively weighted indexes.

FINRA citing as a “recurring challenge” BDs’ failure to put clients’ interest first “sounds like the fiduciary standard,” which could be FINRA’s “attempt to draw a line in the sand that [the SRO] is moving in that direction,” Rubin said in an interview Tuesday.

Another recurring challenge FINRA says it will address is BDs’ failure to timely report “disclosable information,” which includes regulatory actions, customer complaints, bankruptcy filings, liens, judgments and criminal charges.

FINRA will be able to track such information more closely via its recently approved broker background check rule. The Securities and Exchange Commission approved on Dec. 30 FINRA’s new rule requiring member firms to conduct a public records search to verify the accuracy and completeness of information on a rep’s Form U4. 

The public records search must be satisfied “no later than 30 calendar days after the initial or transfer U4 is filed.” The new requirement becomes effective in July.

FINRA examiners will also review firms’ approaches to cybersecurity risk management, including their governance structures and processes for conducting risk assessments and addressing the output of those assessments.

In January 2014, FINRA initiated a sweep to understand better the type of threats member firms face, as well as their responses to those threats. FINRA expects to publish the results of that sweep in early 2015.

FINRA CEO Richard Ketchum noted that while “there has been tremendous change in broker-dealer operations, the markets and the regulatory landscape,” and that FINRA has seen “some firms make great progress in keeping up with these changes, more attention needs to be paid to addressing specific challenges” pinpointed in the self-regulator’s just-released list.

Top issues on FINRA’s radar include reps’ variable annuities sales practices, including new purchases and replacing one annuity with another without tax consequences, known as 1035 exchanges. FINRA also says it will focus on the sale and marketing of “L share” annuities as these shares typically have shorter surrender periods, but higher costs.

FINRA examiners will also focus on implementation of the revised supervision rules, including reviews of branch offices and OSJs and compliance testing.

Sales of alternative mutual funds (or liquid alts), which FINRA says “have increased rapidly over the past several years,” will also be scrutinized. FINRA notes that hundreds of new funds have launched, with assets under management in alternative funds being estimated at more than $300 billion as of November 2014, up from less than $50 billion at year-end 2008. Net inflows for 2014 through November reportedly exceeded $40 billion.

While there is no standard definition of alternative mutual funds, FINRA warns that if a fund’s strategy involves nontraditional asset classes, nontraditional strategies or illiquid assets, “the fund could be considered an alt fund.” FINRA recommends firms refer to such funds based on their specific strategies, as opposed to bundling them under one umbrella category. In this regard, firms must ensure that their communications about alternative funds accurately and fairly describe how the products work, ensuring that the descriptions of the funds are consistent with the representations in the funds’ prospectuses.

For example, a retail communication that includes a discussion of an alternative fund’s objectives that is inconsistent with the objectives included in the fund’s prospectus, or that does not clearly indicate there is no assurance that the objectives will be met, would not meet regulatory requirements.

IRA Rollovers and Other ‘Wealth Events’

Invididual retirement account rollovers and other “wealth events” when a client gains a large amount of money, such as an inheritance, life insurance payout, business sale or divorce settlement, also made FINRA’s priorities list.

“A broker’s recommendations made in connection with a wealth event can have long-lasting consequences for the customer,” FINRA says.

FINRA says that examiners will focus this year on the controls firms have in place related to wealth events, with an emphasis on firms’ compliance with their supervisory, suitability and disclosure obligations.

ETPs Tracking Alternatively Weighted Indexes

As the universe of exchange-traded funds and products explodes, the ETP market, in particular, has seen significant growth in the use of alternatively weighted indexes in terms of products and investor assets, FINRA says.

For individual investors, “products tracking these indexes may be complex or unfamiliar,” FINRA notes. Moreover, “ETPs tracking these indexes may be thinly traded and have wide bid-ask spreads, making these funds more costly to trade, in addition to their generally higher expenses.”

Structured Retail Products (SRPs)

FINRA continues to see trouble spots in complex retail products, with “firms creating and distributing SRPs, including structured notes, with complex payout structures and using proprietary indexes as reference assets.”

Complex features, long maturities, and linkages to less-traditional or less well-understood reference assets in some structured retail products may present investors with unique or unfamiliar risks, FINRA warns.

FINRA says it is concerned that some brokers and retail investors may not be familiar with the complexities of SRPs, compounded by the uncertain impact of a changing interest rate environment.

Check out FINRA’s full 2015 priority list.


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