Regardless of administration, the SEC Enforcement Division continues to set new enforcement records. Nothing suggests any changes for the current fiscal year. If you haven’t received the memo, it’s time to get your compliance house in order.
FINRA has released its 2019 Report on Examination Findings and Observations, offering insight on enforcement cases and risk management concerns. FINRA provides a long list of examination and enforcement findings including negligent practices related to (i) supervision (failure to amend WSPs for new or amended rules, weak branch office inspections); (ii) suitability (product exchanges, churning); (iii) digital communications (failure to stop individual texting, electronic sales seminars); (iv) anti-money laundering (inadequate transaction monitoring, overreliance on clearing firms); (v) UTMA/UGMA (know your customer); (vi) cybersecurity; (vii) business continuity plans; (viii) fixed income mark-ups; (ix) best execution; (x) market access; (xi) short sales; (xii) liquidity risk management; (xiii) segregation of client assets; and (xiv) net capital. A senior FINRA official explained the purpose of the Report: “We hope firms find the Exam Findings and Observations Report useful in strengthening their own control environments and addressing potential deficiencies before their next exam.”
The Exam Report is more useful than the annual Exam Priorities letter because it reflects actual cases and findings rather than a regulatory wish list. We recommend that all compli-pros establish an internal working group to address the issues raised in the Report.
released its 2019 Examination Priorities Letter, spotlighting new areas
including online distribution platforms and fintech, regulatory technology, digital
assets, and fundraising for outside business activities. FINRA will closely scrutinize member firms’
participation with online securities distribution platforms and whether firms
are aiding the unlawful distribution of unregistered securities by handling
customer accounts and/or receiving transaction-based compensation. When using regulatory technology tools, firms
will be asked how they supervise third party vendors and how they protect customer
information. FINRA will work with the
SEC to ensure that member firms implement adequate controls and supervision when
engaging with digital asset offerings through marketing, clearing, and
recordkeeping activities. FINRA continues
its focus on outside business activities with a special emphasis on fundraising
for personal benefit. FINRA also makes
clear that it will continue to review firms for compliance with longstanding
priorities including suitability, fund share classes, private placements,
communications, AML, cybersecurity, senior investors, best execution, and
Compli-pros should read this Examination Priorities Letter together with the recently released Examinations Findings to create an inventory of compliance risks that the firm should immediately address through gap analysis and enhanced procedures. Our experience is that the FINRA examiners hew closely to the announced priorities.
Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues. Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.
Christmas came early this year as the SEC’s Office of Compliance Inspections and Examinations (OCIE) released its 2019 priorities, which in prior years came out in January or February. OCIE has expanded its activities under the new Administration, boasting that it completed over 3,150 exams during the past year. OCIE increased investment company exams by 45% and reviewed 17% of investment advisers, making good on its prior commitment to double adviser exams. The Exam Priorities letter is long (12 single space pages) and covers many topics. To help synthesize the data, we offer the Top 10 OCIE Priorities for 2019:
Top 10 OCIE Priorities for 2019
Fees and Expenses: OCIE will review disclosure and calculation of fees charged to clients.
Portfolio Management: The staff will scrutinize how firms allocate investment opportunities and whether assets are managed according to stated investment objectives.
New Advisers: OCIE continues to focus on never-before examined advisers and advisers that have not been examined in many years.
Mutual Fund Share Classes: The SEC will focus on which mutual fund share classes are recommended and whether reps have a financial incentive.
Wrap Fee Programs: Firms must monitor wrap programs to make certain that the bundled fee is the best deal for clients.
Affiliated Products/Services: OCIE will examine the use of affiliated services or products for undisclosed conflicts of interest.
Senior Investors: The regulators are concerned about unsuitable recommendations to senior investors and supervision of reps.
ETFs: The staff has prioritized ETFs with custom indexes, limited secondary market trading, and risky assets.
Digital Assets: Concerned about the volatile cryptocurrency markets, the SEC remains vigilant about the sale, trading, and management of digital assets.
Cybersecurity: OCIE wants firms to identify and manage cybersecurity risks including devices, governance, and policies and procedures.
FINRA has released its 2018 Examinations Findings as a “resource for firms to strengthen their compliance programs and supervisory controls.” FINRA says the report selected certain observations because of “their potential significance, frequency, and impact on investors and the markets.” The report highlights widespread deficiencies in suitability policies and procedures including “quantitative suitability” (i.e. series of transactions), overconcentrations, excessive trading, and variable annuities. FINRA also cites widespread failures to ensure fulsome disclosure of fixed income mark-ups, reasonable private placement due diligence, and abuse of discretionary authority. The broker-dealer regulator summarizes other concerns including anti-money laundering, net capital and customer protection calculations, best execution and outside business activities.
This extensive list (15 pages) covers many of FINRA’s greatest regulatory hits. It’s a great document for new compliance officers because it covers a wide range of broker-dealer compliance requirements. Rather than helping compli-pros focus resources, it works better as a checklist to verify that the firm has addressed the most serious regulatory requirements.
The SEC’s Office of Compliance Inspections and Examinations has announced a sweep of certain mutual funds and ETFs. The OCIE staff will target smaller ETFs and funds/ETFs that use custom indexes, allocate to securitized assets, exhibit aberrational underperformance, or employ inexperienced managers or private fund sponsors that manage a similar mutual fund. The SEC will assess compliance policies and procedures and fund oversight of risks and conflicts, disclosures to shareholders and the Board, and oversight processes. Among some of the issues of concern to the OCIE staff include bid/ask spreads for secondary market trading of smaller ETFs, portfolio management for underperforming funds, the effect of unexpected market stresses on securitized assets, and side-by-side allocations for private and public funds. OCIE is encouraging fund sponsors and boards “to consider improvements in their supervisory, oversight, and compliance programs.”
Compli-pros and fund lawyers should mobilize to review policies and procedures for affected advisers and boards, consult about changes, and implement enhanced oversight and processes. We recommend taking action before the OCIE staff arrives for its examination.
OUR TAKE: OCIE is fairly transparent. Now that the staff has identified these issues, compli-pros should expect a heavy focus during examinations. Compliance departments should review policies and procedures and testing to get ready.
FINRA released its annual Regulatory and Examination Priorities Letter identifying areas of FINRA focus for 2018. FINRA announced a focus on fraud including insider trading, microcap pump-and-dump, Ponzi schemes and the resulting referrals to the SEC, even if the wrongdoing is outside of FINRA’s jurisdiction. FINRA will also target supervision practices including the hiring and review of high-risk brokers, branch offices, and outside business activities. New this year is a focus on cryptocurrency offerings and the role registered reps play in effecting transactions. FINRA also highlights best execution, cybersecurity, anti-money laundering, and business continuity. Consistent with prior years, FINRA will devote resources to customer protection and net capital, suitability, and liquidity risk.
OUR TAKE: Compli-pros should use the Priorities Letter as a checklist to review the Written Supervisory Procedures. FINRA generally means what it says and addresses these topics during exams.
FINRA has issued a report summarizing its observations on the compliance and supervision issues arising from recent examinations. Highlighted concerns include cybersecurity, outside business activities, anti-money laundering, product suitability, best execution, and alternatives in IRA accounts. FINRA found weaknesses in cybersecurity programs including failure to control access to data, insufficient risk assessments, and inadequate vendor supervision. FINRA expressed concerns about failures to report OBAs and failures to execute adequate reviews or retain documentation. AML programs fell behind as firms changed and grew but failed to properly resource growing AML volume. FINRA raised suitability concerns over recommendations of UITs, fund share classes, and complex products. FINRA hopes that firms will use the report as a “resource in tailoring their compliance and supervisory programs to their business.”
OUR TAKE: It’s always good to get more transparency into the examination program. What’s less clear is how firms should react to this information especially since FINRA generally issues its examination priorities letter in January. Regardless, expect FINRA to focus on these issues during cycle exams.