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Regulation and Compliance > Federal Regulation > FINRA

FINRA Points Out Common Mistakes for Firms to Avoid

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The Financial Industry Regulatory Authority and other industry experts, executives and policymakers shared their knowledge Wednesday about compliance, regulatory and a wide range of other topics affecting institutional firms at the FINRA Institutional Conference in New York.

During a session on common examination findings, FINRA staff discussed some of the most common deficiencies they’ve seen during their cycle examinations of institutional firms.

FINRA typically checks to see if personnel have been properly registered, “not only with FINRA, but across all exchanges” broker-dealers at a firm do business with, Rajesh Mirchandani, senior director of FINRA Market Regulation, noted. What FINRA often finds is that while individuals have passed the required qualification exams, they’re “not properly registered at the various exchanges that the firm is a member of,” he said, noting that’s an issue he’s seen with many exams in the past year and a half.

FINRA, however, put functionality in place that allows firms to automatically add each individual to all the exchanges that person is a member of, he told attendees. He urged everybody to take advantage of that new capability that was implemented in October 2018.

Firms, meanwhile, need to also make sure that all their clocks used to record certain events in securities or over-the-counter (OTC) equity securities are accurately synchronized within the new standard of 50 milliseconds that was put in place by the Securities and Exchange Commission, he said.

“While we haven’t seen synchronization issues per se, what we’ve seen is firms do not have procedures or they’re not maintaining logs where the synchronization is not taking place,” he said. One common problem: Many of the firms are using vendors to handle that functionality for them, he noted, adding it’s important for firms to request logs from the vendors to make sure those vendors are synchronizing their clocks.

Another area where “we’ve been seeing issues across the board” is with the Order Audit Trail System (OATS), he said. There aren’t many exams in which FINRA doesn’t find at least some violation of OATS, he noted, adding “we typically find issues” that include times are not reported or certain events are not reported, or special handling instructions customers have provided are not being reported correctly.

FINRA established OATS as an integrated audit trail of order, quote and trade information for all NMS stocks and OTC equity securities. FINRA uses this audit trail system to recreate events in the life cycle of orders and more completely monitor the trading practices of member firms. Under FINRA Rules 7410 – 7470, FINRA member firms are required to develop a means for electronically capturing and reporting to OATS specific data elements related to the handling or execution of orders, including recording all times of these events in hours, minutes, and seconds and to synchronize their business clocks. These rules were approved by the SEC March 6, 1998.

In the area of vendor management, vendors are often omitting certain disclosures, Mirchandani also said. In fact, one big takeaway from the session was that firms need to do their due diligence before hiring vendors.

If any violation has been identified early in the exam process, it behooves a firm to try to fix it as soon as possible, Gary Distell, chief compliance officer at Guggenheim Securities, said during the same session. “The quicker the better,” he said, adding: The best case scenario is “if you can do it before” FINRA comes to your firm, “second best is if you can do it before they leave your firm and the third best is before they issue the letter,” because all those things lead to better outcomes.

Eric Field, director of capital markets compliance at Robert W. Baird & Co., cautioned firms that if they make specific pledges in writing to FINRA about making fixes to gain compliance, they have to deliver. So if you don’t think you can achieve a fix by a certain date don’t make a promise to do it by that date, he stressed.

During another session, in which attendees got to ask FINRA senior staff questions, Gene DeMaio, executive vice president at FINRA, noted “we are doing quite a bit” with machine learning (ML) now, including “prototyping a number of surveillance reviews.” So far, FINRA has been seeing positive results from the use of supervised learning that can spot deceptive practices at firms, he said. FINRA is also looking at how it can “incorporate unsupervised learning to look at trading anomalies on the option side” — situations where there’s a trade that wouldn’t yield an exception report about a potential issue, he told attendees.

Also discussed was the transition away from Libor. While large member firms have largely been working to reduce their exposure, Ornella Bergeron, senior vice president at FINRA, said it’s important to make sure that midsize and smaller members firms are prepared also, so FINRA started reaching out to them to assist.

Meanwhile, there’s a lot of “transformation work going on” at FINRA, she also said. For example, FINRA is consolidating its three exam programs, a move that the BD self-regulator started last October. 2020 is going to be the year of implementation of a new exam program where there will be one integrated program based on the business model of each firm and each firm will be tracked through its business model, she noted. Examiners will be organized around that business model, and there will be a single point of accountability for risk management and exam oversight.

Sit-down meetings will also become optional starting in 2020, Bergeron said. “We have made some changes already,” including in the timing of exams based on feedback, she said, noting FINRA is now giving more time in between exams, with a six-month window between exams and a three-month window for those firms with more risk.

Earlier, in a fireside chat with FINRA CEO Robert Cook, discussing the SEC’s Regulation Best Interest (Reg BI), he said: “We will be looking at our rulebook to determine whether there are aspects of our rules that might need to be modified. We’ll probably do that in phases.” In the first phase, FINRA will determine if there are rule amendments and modifications that need to be made because they may be creating conflicts or inconsistencies in relation to Reg BI. “I don’t think there are a lot of those, but there are some cleanup” actions that need to be taken, he said.


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