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Jan 18, 2017

Exam Priorities January 2017

Featuring David Grumer

Regulatory exam priorities for 2017 -  What registered
broker-dealers and registered investment advisers should know.
 
On January 4, 2017, The Financial Industry Regulatory Authority (“FINRA”) issued its 2017 Regulatory and Examination Priorities Letter. FINRA is appointed by the SEC to oversee broker-dealers.
 
In addition, on January 13, 2017, the Securities and Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) announced its examination priorities for 2017.  The OCIE oversees the activities of more than 4,000 broker-dealers and 12,000 investment advisers. 
 
We have selected, some of the issues that registered broker-dealers and registered investment advisers should anticipate as areas of interest – some new, some continuing.
 
Operational Risks of Broker-Dealers
 
Cybersecurity is a growing concern for FINRA.  Controls over the protection of data will be looked at by FINRA.  FINRA states its observation of repeated shortcomings in controls at branch offices and the obligation of broker dealers to preserve certain records in non-rewriteable, nonerasable format.  Firms should consider themselves warned by FINRA’s reference to enforcement actions against 12 firms for failure to preserve broker-dealer and customer records in this format.
 
Customer Protection and Segregation of Client Assets:  FINRA has indicated that it will evaluate whether firms have implemented adequate controls and supervision to protected customer assets pursuant to SEC Rule 15c3-3.  Special Reserve Accounts will be checked for appropriate documentation and timeliness of cash movements.
 
High-Risk and Recidivist Brokers and Advisers
 
FINRA intends to devote particular attention to firms’ hiring and monitoring of high-risk and recidivist brokers, including whether firms establish appropriate supervisory and compliance controls for such persons.   Although this may appear to be a new topic, readers may view this exam priority as an outgrowth of the 2016 FINRA priority to examine culture, conflicts of interest, and ethics.  In 2017 FINRA will be looking at supervisory procedures for hiring and retaining high-risk brokers, how supervisory plans to detect and prevent future misconduct have evolved, and will also examine new and continuing membership applications, and lastly, evaluate branch office inspections.
 
The SEC intends to continue to use its capabilities to examine investment advisers that employ individuals with a track record of misconduct.
 
Sales Practices of Broker-Dealers
 
FINRA expresses its view that sales practices are a continuing concern.  Many of the sales practice exam priorities from 2016 will remain.  Whereas in 2016 particular investment products were identified for examination for suitability, it appears that suitability as an exam priority will have broader attention by FINRA.
 
The SEC indicates that it will continue reviewing conflicts of interest and other factors that may affect advisers’ and broker investment recommendations.  The SEC provides as an example, recommendations that may favor share classes that have higher loads or distribution fees.  The formulation of investment recommendations and the management of client portfolios will be reviewed. 
 
 
Electronic Trading Advice of Registered Investment Advisers and Broker-Dealers
 
The SEC intends to examine registered investment advisers and broker-dealers that offer electronic investment advice through interaction with clients online.  In addition the SEC will look at firms that utilize automation as a component of their services and, at the same time, offer clients access to financial professionals.
 
Wrap Fee Programs at Registered Investment Advisers and Broker-Dealers
 
The SEC will likely review investment advisers in areas of interest such as suitability, effectiveness of disclosures, conflicts of interest, and various brokerage practices.
 
Never Before Examined Investment Advisers
 
The SEC will expand this initiative to perform risk-based examinations of investment advisers that have yet to be examined.
 
Market Manipulation at Broker-Dealers
 
Pursuing market manipulation remains a very important priority for FINRA.  FINRA reports that it has enhanced its surveillance programs to detect layering and spoofing.  It has introduced its “Cross Market Equity Supervision Report Cards” for layering and spoofing activity as a compliance tool to complement firms’ supervisory systems and procedures; the objective being to proactively alert firms when it appears that a firm or its customers’ activities may be demonstrating manipulative conduct in the markets.
 
Anti-Money Laundering Programs and Suspicious Activity Monitoring at Broker-Dealers
 
This is a continuing area of attention for both the SEC and FINRA.  FINRA tells us that it is seeing shortcomings in firms’ automated trading and money movement surveillance systems caused by data integrity programs, poorly set parameters, or surveillance patterns that are failing to capture problematic behavior such as suspicious microcap activity.  Other weaknesses have been found in systems that monitor foreign currency transactions and transactions that flow through suspense accounts.  Lastly, FINRA mentions that it will continue to focus on firms’ controls around accounts held by nominee accounts.  The SEC indicates that it will also continue its examinations of broker-dealers to assess the effectiveness of their AML programs.

Please call Dave Grumer at Citrin Cooperman if you would like to discuss these initiatives further.