Exam Priorities for Securities Firms in 2016

The Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) recently released their annual examination priorities for 2016. Although the regulators independently develop their areas of focus, there are seven overlapping priorities that securities firms may want to address in the near term.

The SEC’s priorities are organized around the same three thematic areas as the 2015 priorities: (1) protecting retail investors, especially investors saving for retirement; (2) analyzing issues related to market-wide risks; and (3) using data analytics to identify registrants that may be engaged in illegal activities.

FINRA’s high-level focus will be on: (1) culture, conflicts of interest and ethics; (2) supervision, risk management and controls, including cybersecurity; (3) sales practice; (4) financial and operational controls; (5) liquidity; and (6) market integrity.

Digging into the details, our review reveals seven priorities shared by the SEC and FINRA:

  • Conflicts of Interest — The SEC will continue its 2015 initiative to examine SEC-registered investment advisers and broker-dealers that provide or sell investment products to retail investors, focusing on potential conflicts of interest, among other things. FINRA will focus on conflicts of interest in connection with a firm’s culture.
  • Cybersecurity — In 2014, the SEC launched an initiative to perform examinations of broker dealers’ and investment advisers’ compliance and controls. In 2016, the SEC will conduct reviews to advance these efforts and will include testing and assessments of firms’ implementation of procedures and controls. The focus of FINRA’s cybersecurity assessments will vary depending on a firm’s business and risk profile. The focus will include governance, technical controls, incident response, vendor management, data loss prevention, staff training, protection of confidential client information, electronic records retention, and protection of systems from unauthorized access.
  • Exchange-Traded Funds (ETFs) — For the first time, the SEC included ETFs on its list of examination priorities, and intends to examine them for compliance with exemptive relief granted under the Exchange Act and the Investment Company Act and review their unit creation and redemption process. FINRA will assess broker-dealers’ roles as Authorized Participants in the creation and redemption process of ETFs. The assessments will include broker-dealers’ processes for calculating and monitoring counterparty credit risk and to accurately reflect in net capital computations.
  • Liquidity Controls — In September 2015, the SEC issued a proposed rule that would establish new rules governing ETFs’ liquidity risk management. The SEC’s 2016 examinations of new or expanding liquidity providers will occur with an emphasis on evaluating controls over market risk management, valuation, liquidity management, trading activity, and regulatory capital. FINRA’s reviews of broker-dealers’ contingency funding plans will be conducted to determine if a sufficient plan has been put in place. Additionally, FINRA will conduct reviews related to high-frequency trading firms’ liquidity planning and controls.
  • AML — The SEC will continue to examine AML programs, with a focus on firms that have not filed suspicious activity reports (SARs) that would be consistent with their business models, or have filed incomplete or late SARs. The SEC will also assess AML programs for adequacy of testing, and the degree the firm has adapted programs to current money laundering and terrorist financing risks. FINRA will also focus on the adequacy of firms’ monitoring for red flags associated with suspicious trading activity, high risk customer accounts and transactions.
  • Microcap Fraud — The SEC will assess whether broker-dealers are complying with their obligations under the federal securities laws in regards to publishing quotes or trading securities in the over-the-counter markets. FINRA will assess the due diligence and acceptance processes of large blocks of microcap securities to ensure compliance with applicable registration provisions. FINRA will also examine processes that firms have in place to identify red flags associated with potentially manipulative trading activities.
  • Private Placements — The SEC will focus on whether firms have met their disclosure, due diligence, and suitability requirements. Additionally, the reviews will be performed to determine if the legal requirements of the Immigrant Investor Program are being met where applicable. FINRA will focus on inadequate due diligence, disclosures and suitability. Additionally, the reviews will evaluate compliance related to general solicitation advertisements and materials posted online.

The fact that these priority areas are being targeted by both the SEC and FINRA suggests they are especially important and should likely be a top priority for securities firms as well.

For more information regarding the SEC and FINRA 2016 Examination priorities, refer to our analysis here.

Official details of the 2016 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 2016 in Securities.

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