A Look Back and a Look Forward at FINRA Regulations

A Look Back (2016)

Regulators for the financial services industry initiate many enforcement actions throughout a calendar year.  FINRA is no exception.  In fact, FINRA pursued roughly 1500 enforcement actions in 2016.  A review of some of those actions provides a guide on how to avoid finding yourself on the wrong end of a regulatory enforcement action.

The larger FINRA enforcement actions in 2016 covered a variety of topics.  Among them are the following:

• Sale of Replacement Variable Annuities:  In the largest fine for 2016, FINRA fined a broker-dealer for, among other things, understating the value of existing VAs and also failing to disclose that existing guarantees were forfeited when replacing existing VAs with new VAs.

• Incentive Compensation:  FINRA heavily fined another broker-dealer for a compensation policy which incentivized registered representatives to favor VAs sponsored by the firm.

• UITs:   FINRA brought a large number of disciplinary actions against firms that failed to apply available sales charge discounts to UIT purchases.

• Procedural Matters:   Final also fined several firms in 2016 for failing to meet certain procedural formalities, such as sending letters to customers within 30 days of their changing their investment profiles, and retaining copies of customer letters changing their investment profiles.

From a broader perspective, it appears that the following types of behavior generally attract more enforcement attention than others (setting aside, of course, intentional wrongdoing):

• Sales practices relating to complex products (at least complex from the customer perspective);
• Inadequate due diligence relating to high risk customers and high risk activities; and
• Failure to correct past noted violations.

A Look Ahead (2017)

In what has become an annual tradition, both FINRA and the SEC recently disclosed their Exam Priorities for 2017.  Not surprisingly – and perhaps more of a Look Back than a Look Ahead, both regulatory bodies have indicated a continuing intent to focus on cybersecurity issues.

More specifically, the SEC has indicated an intent to focus on “compliance procedures and controls, including testing the implementation of those procedures.”  As I have indicated repeatedly over the past year, simply having cyber protection procedures in place is no longer sufficient.  Regulatory focus has turned as well to ensuring those procedures are being implemented and tested.  With the new incoming administration, however, the top spots at the SEC are changing.   Some commentators think we will see in the 2017 and beyond less focus on enforcement actions, but my personal belief is any such changes will not impact the focus on cybersecurity.

FINRA’s cybersecurity focus for 2017 will also on be on what and how firms are acting to mitigate the risk of cyberattacks.  FINRA, however, appears to be more focused on what firms are doing to protect and preserve records.  In particular, section 17(a) of the Exchange Act and Rules 17a-3 and 17a-4 require anti-alteration safeguards such as WORM formatting.  In what appears to be an attempt to highlight its intentions, FINRA recently fined 12 firms a total of $14.4 million for violations related to the record keeping rules and regulations.

Other areas of regulatory focus in the coming year also include the heightened supervision efforts of firms hiring brokers with disciplinary records; protecting senior investors; and how firms carry out suitability reviews and monitor recommendations.

Written by Daniel D. Hill