Recently, FINRA issued the 11th Regulatory and Examination Priorities Letter that addresses issues in the financial industry, if left unaddressed could adversely effect market integrity and investors. In 2016 their key points of emphasis have been identified as (1) culture, conflicts of interest and ethics; (2) supervision, risk management and controls; and (3) liquidity. The Letter also highlights specific policies and procedures the FINRA will use to ensure that member firms are compliant with the priorities identified.
According to Richard G. Ketchum, CEO and Chairman, FINRA, “ Firm culture, ethics and conflicts of interest remain a top priority for FINRA. A firm’s culture contributes to, and is also a product of, a firm’s supervision and its approaches to identifying and managing conflicts of interest and the ethical treatment of customers. Given the significant role culture plays in how a firm conducts its business, this year the letter addresses how we will formalize our assessment of firm culture to better understand how culture affects a firm’s compliance and risk management practices.”
- Culture, Conflicts of interest and Ethics
Although firm culture can be interpreted subjectively, FINRA expressed its intent this year to craft its own definition of “firm culture” and formalize its assessment based on how executives, supervisors and employees make and implement decisions in the course of conducting a firm’s business. FINRA has express that firm culture is an important indicator of how a firm manages conflicts of interests and ethics. FINRA does not intend to dictate firm culture but rather understand with a view to how it affects compliance and risk management practices internally in a firm.
As per FINRA 2016 the five indicators that will be assessed for a firm’s culture include
(1) whether control functions are valued within the organization
(2) whether policy or control breaches are tolerated
(3) whether the organization proactively seeks to identify risk and compliance events
(4) whether supervisors are effective role models of firm culture
(5) whether sub-cultures (e.g., at a branch office, a trading desk or an investment banking department) that may not conform to overall corporate culture are identified and addressed.
Since a firm’s culture is both and input to and product of its supervisory system, it is critical to identify that to assess fair and compliant treatment of customers. They will seek to understand how far these firms tolerate ethical breaches, take visible steps to mitigate conflicts of interest, and have compliance functions in keeping with the changing regulatory landscape.
- Supervision Risk Management and Controls
Closely related to culture, FINRA’s rules require firms to maintain systems to supervise activities of their associated persons to help the firm adhere to securities laws and FINRA rules. In 2016, FINRA has identified four focus areas which have continued to pose concerns. First being management of conflicts of interest, in particular a firm’s incentive structures. The review they will undertake will encompass conflict mitigations specially arising from compensation plans for representatives and how firms approach conflicts of interests arising from sale of proprietary and affiliated products, or products that result in revenue sharing and other third-party payments. FINRA’s review will draw on suitability and overconcentration issues. FINRA will remind firms that we they have filed the proposed Rule 2273 with the SEC, which relate to recruitment practices and whether transfer of assets to the recruiting firm and financial incentives received by a registered representative may create a conflict of interest.
In keeping with FINRA’s research rules, firms may not use research analysts or the promise of offering favorable research to win investment banking business. FINRA will assess whether firms’ research analysts are inappropriately involved in their investment banking activities and whether investment banking personnel exercise undue influence on analysts.
Some of the other priorities identified include mitigating information leakage within or outside a firm, outsourcing (reminding firms that they remain responsible for supervision of third parties), and anti-money laundering (particularly, where certain customer transactions are automatically excluded from portions of AML surveillance, the reasoning for the decision should be documented for FINRA to check).
Since the failure to monitor liquidity led to financial failure and systemic crisis, FINRA will rigorously continue to monitor firm’s liquidity requirements, contingency funding practices and the effectiveness of these contingency practices to weather market wide and internal stresses. FINRA will focus on high-frequency trading (HFT) firms’ liquidity planning and controls and whether sudden changes in a firm’s execution rate, triggered by a market event or other factors, could create liquidity challenges for a firm. FINRA will continue to focus on firms’ liquidity risk management practices, guided by the framework established by the agency in its Regulatory Notice 15-33