FINRA’s annual examination priorities letter focuses on a host of topics including Reg BI, the consolidated audit trail, IPOs, and cybersecurity.
The June 2020 compliance date for Regulation Best Interest and Form CRS puts the matter at the top of FINRA’s examination priorities for the year. FINRA will also begin reviewing compliance with reporting under the Consolidated Audit Trail, which begins in April. In addition to these and other emerging topics, FINRA’s 2020 risk monitoring and examination priorities letter also addresses ongoing priorities such as market manipulation, TRACE reporting, short sales, and short tenders.
Sales practice and Reg BI. FINRA said that it will continue to focus on firms’ sales practice obligations and the supervision of those practices in areas including complex products, variable annuities, private placements, fixed-income mark-up/-down disclosures, positions of trust or authority, and senior investors. Additionally, FINRA will begin its Reg BI review even before the compliance date of June 30. Before then, FINRA will review firms’ preparedness to gain an understanding of the challenges in implementation. FINRA expects that its staff will work with that of the SEC to ensure consistency in examining broker-dealers and associated persons for compliance with Reg BI and Form CRS.
FINRA will also focus on two areas related to public communications, in addition to its ongoing reviews for compliance with core obligations. First, FINRA will review how firms deal with retail communications regarding private placement securities via traditional channels as well as online distribution platforms. Second, noting that the use of an array of digital communication channels may pose challenges to firms’ ability to review and retain communications as required, FINRA said it will review firms’ use and supervision of digital channels.
The 2020 letter observed that bank sweep programs have taken on more significance as commission practices change. The programs may be beneficial to customers, but they also raise concerns about firms’ compliance with FINRA and SEC rules. FINRA will look at whether firms clearly and fairly communicate the nature of the sweep arrangement and the available alternatives.
FINRA is also focusing attention on firms’ obligations under FINRA rules restricting the purchase and sale of initial equity public offerings and addressing new issue allocations and distributions. Examiners will look for procedures to detect and address instances of flipping and will question whether firms acting as book-running lead manager provide reports of aggregate retail demand to issuers’ pricing committees. Other factors in examinations will include IPO allocation methodologies, controls to prevent allocations to restricted person and detect spinning, and verification of customer information for those receiving IPO allocations.
FINRA will assess whether firms maintain reasonably designed supervisory systems relating to trading authorization, discretionary accounts, and key transaction descriptors, such as solicitation indicators. Examiners will review for systems designed to detect and address the exercise of discretion without written client authorization. In particular, FINRA is looking at whether firms look for and recognize red flags and how they follow up when red flags are identified.
Market integrity. FINRA’s letter notes that automated and high-speed trading increases risks to systemic financial stability as well as the financial condition of firms and the integrity of trading. Examiners’ assessment of compliance with the Market Access Rule will focus on issues relevant to firms’ business activities and associated risks.
Staff will also look at best execution and whether firms use reasonable diligence to direct customer order flow to the best market. This will include a particular focus on order routing decisions, odd-lot handling, U.S. Treasury securities, and options. FINRA will also examine whether broker-dealers are providing new customer-specific reports for not held orders in NMS stocks as required by amended NMS Rule 606. Finally, FINRA will evaluate the adequacy of firms’ controls and supervisory systems to provide customers with the current consolidated NBBO as required by the Vendor Display Rule.
Financial management. Digital assets are at the top of FINRA’s list of issues related to financial management. These assets raise novel regulatory questions, and FINRA is receiving an increasing number of applications from firms seeking to engage in activities related to digital assets. The group said that it is working closely with the SEC to understand firms’ business plans and determine how securities laws apply to those plans. In reviewing digital asset activities, FINRA will check if a firm has filed a Continuing Member Application with FINRA. It will also look for fair and balanced marketing, an absence of misleading statements about services offered through unaffiliated entities, and controls and procedures to facilitate digital asset transactions.
FINRA also sees liquidity management as a critical control function that should be documented in a firm’s books and records. Another financial-management topic is firms’ obligations when they engage in underwriting. And while it will not be part of the examination program, FINRA will engage with firms to understand how the industry is preparing for the retirement of LIBOR at the end of 2021.
Firm operations. Lastly, FINRA will review operational topics including cybersecurity and technology governance. Although it recognizes that there is no one-size-fits-all approach to cybersecurity, it expects to see controls, policies and procedures that are appropriate to a firm’s business model and scale of operations. With respect to technology governance, FINRA staff may ask how material changes to a firm’s business have been reflected in its business continuity plan, how the firm will maintain customer access and manage operations during a BCP event, and what controls, documentation systems, and testing are in place.
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