Michael G. Dana, Peter D. Fetzer and Terry D. Nelson/Foley & Lardner LLP
At the beginning of each year, the Financial Industry Regulatory Authority (FINRA) announces its regulatory and examination priorities for the year. The priorities are based on FINRA’s current assessment of both investor protection needs and market issues. The following represents the 2013 regulatory and examination priorities for business conduct and sale practices, as recently published by FINRA:
Suitability and Complex Products. FINRA Rule 2111 requires broker-dealers and their associated persons to make suitable recommendations to their customers. FINRA considers this a priority area due, in large part, to the complexity of some of the investment products currently being recommended to customers. FINRA is concerned that the associated persons may not fully understand the complexities of such products and would not be able to fully explain the products to customers, especially the full extent of the risks involved in such investments. Listed by FINRA as those product areas that are being recommended by broker-dealers and their associated persons that will be the subject of heightened review by FINRA examiners include investments in business development companies (BDCs), leveraged loan products, commercial mortgage-backed securities (MBS), high-yield debt instruments, structured products, exchange traded funds and notes, non-traded REITs, closed-end funds, municipal securities, and variable annuities. Investments recommended in these types of securities will be examined by FINRA to determine, among other things, if they were suitable investments and the associated person’s level of knowledge about the product.
Cyber Security and Data Integrity. FINRA is concerned about cyber-security issues within the financial services industry and whether its member firms have adequate controls to protect customer data during cyber attacks and data security breaches.
Microcap Fraud. Microcap and low-priced securities traded over-the-counter are often hyped by stock price manipulators. FINRA expects to examine its members to determine if they have adequate policies and controls to ensure that any activities by their associated persons in such securities are in full compliance with suitability and other FINRA provisions.
Private Placement Offerings. FINRA recently implemented Rule 5123, which is intended to keep FINRA more informed about member firms’ participation in private offerings. The Rule requires member firms to file a copy of the private placement offering memorandum with FINRA to the extent that such a memorandum was utilized in the offering and sales were conducted with retail investors. FINRA is concerned about the level of due diligence conducted by member firms prior to the placement and the suitability of such investments for retail investors.
Anti-Money Laundering. FINRA believes that member firms generally need to be more vigilant for suspicious activity with respect to money laundering activities. FINRA will examine the level of due diligence conducted and whether the member firm has an adequate review process for suspicious activity.
Branch Office Supervision. FINRA will especially review those branch offices of member firms that have, in the past, exhibited inadequate supervision over sales practices and where a significant number of associated persons who are located there have disciplinary history.
Insider Trading. Capturing most of the financial service industry headlines during the past year or so have been the enforcement actions by regulatory authorities against member firms, associated persons, and others in trading on material non-public information. FINRA will examine to determine if member firms have adequate policies and procedures in place to safeguard material non-public information that comes into their possession.
Financial and Operational Priorities. FINRA will examine in this area, among other things, whether member firms have sufficient net capital to fund operations and otherwise meet regulatory capital requirements, margin lending practices, leverage and liquidity, and for any guarantees and/or contingencies taken on by the member firm.
Market Regulation. Due to the increasing complexity of the financial services industry and its products, FINRA wants especially to review those areas where market integrity may be in question. Namely, FINRA will focus on algorithmic trading, high-frequency trading, the use of alternative trading systems (ATS), the proper use of order origin codes for options transactions, the misreporting or non-reporting of open positions in options, and best execution, inter-positioning, and fair pricing in the fixed-income market.
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