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Regulation and Compliance > Federal Regulation > FINRA

FINRA to Examine BDs for Conflicts of Interest

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The Financial Industry Regulatory Authority said Thursday that it will begin targeted exams of broker-dealers’ “culture of compliance” and that BDs must tell the self-regulator how their compliance culture mitigates conflicts of interest by March 21.

FINRA plans to meet with BD executives in firms’ business, compliance, legal and risk areas to discuss their cultural values and how the BD “communicates and reinforces” those values “directly, implicitly and through its reward system” in eight specific areas.

“Firm culture has a profound influence on how a broker-dealer conducts its business, including how it manages conflicts of interest,” FINRA stated in the targeted examination letter posted on its website.

“A culture that consistently places ethical considerations and client interests at the center of business decisions helps protect investors and the integrity of the markets,” FINRA said, whereas failures “in these areas can impose significant harm on investors and the markets as well as firms themselves.”

FINRA cited an estimate that found fines and litigation costs to firms, or their parent companies, related to cultural failures had reached more than $300 billion since 2010.

Richard Ketchum, FINRA’s chairman and CEO, told ThinkAdvisor in an interview in January that reining in brokers’ conflicts is a top exam priority for FINRA this year.

Ketchum said that “firms have failed in managing their conflicts on too many occasions,” in discussing the release of the self-regulator’s 2016 regulatory and exam priorities.

In announcing the targeted exams on Thursday, FINRA said that the review will zero in on “how firms establish, communicate and implement cultural values, and whether cultural values are guiding business conduct.”

FINRA’s targeted exams show that the self-regulator “wants firms to have the clients’ best interests at heart rather than best profits as the driving force,” said Jon Henschen of the recruiting firm Henschen & Associates.

“Stock brokers that do active trading of stocks on a transactional basis have been a good example of a culture that had [put] the reps’ profits ahead of clients’ interests, with the large volume of litigation associated with such models evidence of that conflict,” Henschen explained in an interview.

The exam letter states that “knowing firms’ practices in this area, and the challenges they face” will help FINRA “develop potential guidance for the industry and determine other steps that could be taken.”

FINRA told BDs to detail the following eight areas of their compliance culture:

1. Summarize key policies and processes by which the firm establishes cultural values. Include whether this is a board-level function at your broker-dealer or at the corporate parent of the firm. If it is a board-level function, describe the board’s involvement. Also, provide a description of any steps you have initiated or completed in the past 24 months to promote, strengthen or change your firm’s culture.

2. Describe the processes employed by executive management, business unit leaders and control functions in establishing, communicating and implementing your firm’s cultural values. Describe how executive management communicates, promotes and establishes a “tone from the top” as it relates to cultural values (to the extent not covered by the previous question). Include a description of the firm’s approach to ensure that its cultural values are adopted and applied by middle management.

3. Describe how your firm assesses and measures the impact of cultural values (to the extent assessments and measures exist) and whether they have made a difference at your firm in achieving desired behaviors. Summarize policy statements, procedures, mission statements or other related documents that reflect your firm’s assessments and measures.

4. Summarize the processes your firm uses to identify policy breaches, including the types of reports or other documents your firm relies on, in determining whether a breach of its cultural values has occurred. Please focus your summary on those activities your firm considers to be directly related to reinforcing its culture.

5. Describe how your firm addresses cultural value policy or process breaches once discovered. What efforts are used to promptly address these policy or process breaches? What is the escalation process to surface and resolve such breaches?

6. Describe your firm’s policies and processes, if any, to identify and address subcultures within the firm that may depart from or undermine the cultural values articulated by your board and senior management?.

7. Describe your firm’s compensation practices and how they reinforce your firm’s cultural values.

8. Describe the cultural value criteria used to determine promotions, compensation or other rewards, including opportunities for promotion to the managing director or equivalent level available to personnel of your compliance, legal, risk and internal audit functions.

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