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California Securities Lawyer Update: FINRA Releases 2018 Regulatory and Examination Priorities Letter

By George C. Miller, Esq. of Shustak Reynolds & Partners, P.C. posted on Monday, February 12, 2018.

George C. Miller

George C. Miller


Location: San Diego, California
Phone: (619) 696-9500 (Ext. 105)
Direct: (619) 501-8270
Email[email protected]

George C. Miller, Esq.
619.696.9500 ext. 105
[email protected]

Each year, the Financial Industry Regulatory Authority (FINRA) outlines its core areas of focus through its annual Regulatory and Examination Priorities Letter.  This year’s letter highlights a number of longstanding areas of focus, including fraud, suitability, anti-money laundering and private placement investments, as well as several new categories.

Here are FINRA’s top priorities for 2018:

1. Fraud.  Fraud is always a major focus area for FINRA.  It comes as no surprise, then, that in 2018 the regulator will focus on insider trading, microcap pump-and-dump schemes, issuer fraud and Ponzi or “Ponzi-like” schemes.  In addition, FINRA will increase its focus on fraudulent schemes targeting senior investors.  FINRA’s 2017 Examination Priorities Letter described some of the enhanced controls member firms should use to protect elderly investors.  With the addition of FINRA’s new Rule 2165 (allowing firms to place holds on elderly investors’ accounts to prevent financial exploitation) and amendments to Rule 4512 (requiring firms to obtain the contact information of a “trusted person” in connection with those accounts), member firms have more tools to protect senior investors, and we assume FINRA will be watching closely to determine whether firms are using those tools.

2. High Risk Firms and Brokers.  Building on 2017’s initiative, FINRA will continue making high-risk firms and brokers–e.g., those with extensive compliance and disciplinary backgrounds–a top area of focus.  FINRA will focus on firms’ hiring and supervisory processes, remote supervision arrangements and branch audit and inspection protocols to ensure firms are appropriately supervising high-risk financial advisors to minimize the risk of customer harm. 

3. Business Continuity Planning.  Recent natural disasters have underscored the importance of firms maintaining appropriate business continuity plans (BCPs).  Those plans should, at a minimum, contain operating protocols in the event a firm or financial advisor loses physical access to their branch location, potentially for a lengthy period of time.  FINRA Rule 4370 requires member firms to maintain BCPs that are reasonably designed to allow them to meet their existing obligations to investors in the event of an emergency. 

4. Verification of Firm Assets and Liabilities.  Securities Exchange Act Rules 15c3-1 and 15c3-3 require member firms to maintain accurate net capital and reserve computations.  In 2018, FINRA will review firms’ processes for verifying customer assets and proprietary assets and liabilities as maintained in those records. 

5. Technology Governance.  Noting that some firms have experienced significant customer service and regulatory problems following the implementation of new technology (e.g., inaccurate account statements and reporting and the permanent loss of emails and other electronic account information), FINRA will continue to review firms’ information and technology change management processes to ensure firms are minimizing the risk of downtime in a technology conversion or update.  Along these lines, Cybersecurity will remain an area of focus to ensure firms maintain a robust system to detect and prevent unauthorized access to sensitive client information. 

6. Anti-Money Laundering.    FINRA will continue to assess the adequacy of its member firms’ anti-money laundering (AML) policies and procedures.  In 2017, FINRA identified concerns regarding firms’ ability to detect and report suspicious transactions, the resources (or lack thereof) firms were committing to ensuring AML compliance and failures to conduct independent testing under Rule 3310(c).  In the coming year, FINRA will expand its focus on the activities of foreign affiliates of FINRA member firms, as FINRA has observed situations where domestic firms either do not monitor or inadequately monitor the activities of their affiliated foreign firms.

7. Suitability.  With the historically low interest rate environment over the past five-plus years, issuers and firms have developed increasingly complicated investment products to increase returns.  As the type and complexity of these products increases, FINRA will continue to assess the adequacy of firms’ controls to ensure the suitability of their recommendations.  FINRA also will review scenarios in which firms steer clients away from brokerage accounts into investment advisory or managed money accounts.  While fee-based accounts often make sense for consumers, there instances in which they may not.  Of particular note is the scenario where an investor purchases a high commission product just before their account is converted to advisory, or where the investors’ overall fees will increase as a result of the conversion. 

8. Initial Coin Offerings and Cryptocurrencies.  2017 was the year Cryptocurrency investing and Initial Coin Offerings went mainstream, and signs suggest crypto is here to stay.  With that, FINRA and the SEC will closely monitor activity in the space and the role that firms and their registered representatives may play in crypto and ICO transactions.  We expect the regulators to step up their monitoring and oversight of cryptocurrency in the coming year. 

9. Margin.  Having previously discovered situations in which firm representatives solicited customers to purchase securities on margin without ensuring those investors were aware of the risks and costs of margin, FINRA will reassess firms’ disclosure and supervisory practices governing margin loans.  FINRA also will review firms’ policies and procedures governing securities-backed lines of credit (SBLOCs), which have increased substantially over the past several years. 

10. Market Integrity.  Protecting market integrity maintains a top priority for FINRA.  As such, FINRA will continue to monitor member firms’ policies and procedures governing market manipulation, best execution practices, compliance with Regulation SHO (governing short sale execution prices), fixed income data integrity, options, market access and alternative trading system surveillance.

11. New Rules.  The upcoming year also brings a handful of new rules member firms must be aware of and comply with, including Rule 2165 (Financial Exploitation of Specified Adults); amendments to Rule 4512  (Customer Account Information); FinCEN Due Diligence Rule (requiring broker-dealers to conduct enhanced customer due diligence to confirm client and account beneficial owner’s identity etc.); and Rule 2232 (Customer Confirmations). 

Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. For more information, or if you or your company require counsel in these areas, contact us today for a confidential, complimentary consultation.

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