Exam priorities for securities firms in 2015

FINRA and SEC

The SEC and FINRA recently announced their examination priorities for 2015. Although each regulatory body has its own distinct focus areas, there are seven common priorities that securities firms may want to put at the top of their to-do lists.

Broadly speaking, the SEC will be focusing on three high level areas: protecting retail investors; assessing market-wide risks; and using data analytics. FINRA’s high level focus will be on addressing recurring challenges within its member firms, including: putting customer interests first, firm culture, supervision, risk management and controls, product and service complexity, and management of conflicts of interest.

Digging into the details, our analysis reveals seven specific priorities shared by both regulatory bodies:

    • Complex product sales practices and suitability — The SEC has indicated that retail investors continue to be offered a wide variety of products that were previously characterized as alternative investments including: private funds, illiquid investments, and structured products. As a result, the SEC has identified potential sales practice concerns and suitability issues related to recommendations to invest retirement assets in the aforementioned products. FINRA has continued to identify potential risk related both customer specific and reasonable basis requirements as a result of the complexity of various products being offered to the retail investing public. FINRA has specified that reviews will focus on the suitability of several different products including: interest rate-sensitive fixed income securities and variable annuities, alternative mutual funds, non-traded real estate investment trusts (REITs), exchange traded products (ETPs) tracking alternatively weighted indices, structured retail products (SRPs), floating-rate bank loan funds, and securities backed lines of credit (SBLOCs).
    • Cybersecurity — In 2014, the SEC launched an initiative to perform examinations of broker dealers’ and investment advisers’ cybersecurity systems. In 2015, the SEC intends to continue to perform assessments of broker dealers’ and investment advisers’ compliance and controls related to cybersecurity and will also be expanding their reviews to include transfer agents. FINRA will focus on broker dealers’ cybersecurity risk management programs, including but not limited to governance structures, the process for conducting risk assessments, in addition to addressing the results of firm risk assessments. Additionally, FINRA will conduct reviews pertaining to compliance with Rule 17a-4(f) related to the electronic storage and preservation of books and records in the event of a cyber-attack.
    • Excessive trading — The SEC will focus on excessive trading through the analysis of data from clearing brokers in an effort to key-in on both introducing brokers and registered representatives that appear to be engaging in excessive transactions. FINRA has indicated that their focus will be on both excessive trading in addition to concentration controls, including the supervisory systems that various broker dealers have in place to monitor for such issues. Additionally, FINRA will perform reviews that will determine if aggressive trading strategies and recommendations by representatives led to excessive trading and over-concentration concerns.
    • Order routing practices — The SEC has outlined concerns related to potential equity order routing conflicts, specifically related to broker dealers’ prioritization of trading venues as the result of compensation (e.g., payments, credits, and order flow) that represents risks of acting in contravention with best execution priorities. FINRA has outlined plans to focus on several potential concerns related to order routing practices in addition to best execution and disclosure. For instance, FINRA’s focus will include factors influencing broker dealers’ routing decisions, best execution in routing customers’ options orders, pricing practices related to fixed income securities, in addition to other fixed income-based examinations.
    • Retirement account rollovers — The SEC will conduct reviews geared toward registrants that are engaging in potentially misleading or inadequate recommendations in regards to the movement of retirement assets from employer-sponsored plans into higher risk investments and/or accounts with higher fees. FINRA has outlined a focus on both Individual Retirement Accounts in addition to other Wealth Events. FINRA has expressed plans to evaluate broker dealers’ controls in regards to suitability, supervisory systems, and disclosure obligations.
    • AML and Microcap fraud — The SEC has outlined plans to continue to focus on both broker dealers and transfer agents that appear to be participating in, and accommodating illicit schemes related microcap securities. FINRA plans to address microcap fraud in conjunction with assessments of broker dealers’ AML systems. Specifically, FINRA has highlighted broker dealers’ inadequate due diligence pertaining to microcap securities regarding AML and Section 5 compliance.
    • Recidivist and high risk brokers and representatives — Both the SEC and FINRA continue to express concerns related to representatives with historical track records of misconduct and the firms that employ these high risk individuals. The SEC has expressed plans to focus on registrants that employ representatives with a known history of misconduct. FINRA has outlined plans to gear reviews to high-risk registered representatives and intends to conduct assessments of the supervisory systems of the broker dealers that employ these individuals.

The fact that these priority areas are being independently targeted by both the SEC and FINRA suggests they are especially important and should likely be a top priority for securities firms as well. What’s more, by addressing these common areas first, securities firms can effectively kill two birds with one stone.

Official details of the 2015 examination priorities can be found on the websites for the SEC and FINRA.

For a broader perspective on key regulatory trends in the securities industry, refer to the recently released Deloitte report entitled “Forward Look: Top Regulatory Trends for 2015 in Securities”.

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