FINRA 2019 Risk Monitoring and Examination Priorities and OCIE 2019 Examination Priorities

February 5, 2019

FINRA Risk Monitoring and Examination Priorities Letter

On January 22, 2019, FINRA released its newly titled Risk Monitoring and Examination Priorities Letter for 2019. While noting that the letter’s format has changed to concentrate more on new risk areas, FINRA stated that it will continue to examine the areas of concern on which it has repeatedly focused in previous years.

In his cover letter to the release, FINRA president and CEO Robert Cooke highlighted the various ways in which FINRA works to meet its mission of maintaining “Investor Protection and Market Integrity.” These efforts include but are not limited to producing the following publications:

In addition, as noted in the 2019 letter, FINRA will review the following risk areas during its examinations.

Online Distribution Platforms

FINRA has concerns regarding broker-dealers that act as selling agents or brokers of record on offerings pursuant to Regulation D Rule 506(c) and Regulation A. Firms often act in this capacity for unregistered offerings, handling customer funds and accounts and receiving transaction-based compensation for these activities. FINRA will focus on how these firms meet their suitability requirements, as well as how they monitor communications and documents for false or misleading statements. Other FINRA concerns in this area include the handling of escrow accounts, sales to non-accredited investors, and undisclosed compensation arrangements.

Fixed Income Mark-Up Disclosure

As of May 14, 2018, amendments to FINRA Rule 2232 and MSRB Rule G-15 added new mark-up/mark-down disclosure requirements for firms. FINRA will review firms’ adherence to these requirements. To encourage and facilitate compliance with the new mandates, FINRA has added a “Mark-up/Mark-down Analysis Report” to the Report Center’s available documents.

Regulatory Technology

FINRA will examine how firms use RegTech tools and how they address the risks associated with these tools. The reviews will cover supervision, governance, cybersecurity, privacy, and vendor management.

Suitability

As in prior years, suitability remains a FINRA priority. Along with the suitability issues outlined in previous letters, FINRA will also focus on:

  • quantitative suitability
  • recommendations of, and over-concentration in, illiquid and/or complex securities
  • share-class recommendations in line with customer time horizons
  • recommendations in packaged collateralized loan obligations securities to certain investors

Senior Investors

This year, FINRA has again outlined concerns regarding senior investors. Along with the usual concerns regarding supervision and monitoring of senior investor account activities, FINRA will review the controls related to instances when representatives act in a fiduciary or similar capacity for accounts of seniors. FINRA will also review firms’ compliance with the new “trusted contact” requirements (FINRA Rule 4512), as well as how firms supervise activity and recommend temporary holds on senior accounts (FINRA Rule 2165).

Outside Business Activities (“OBAs”) and Private Securities Transactions (“PSTs”)

FINRA will continue to review firms’ supervision of their registered representatives’ OBAs and PSTs. Of particular concern are the fundraising activities representatives conduct for entities not associated with their broker-dealer.

Supervision of Digital Assets Business

In Regulatory Notice 18-20, FINRA encouraged firms to provide notification of any activities they conduct in digital assets. In 2019, FINRA will take the following actions to assess digital asset activity:

  • Determine whether a digital asset is considered a security
  • Identify how firms comply with applicable securities laws
  • Evaluate what firms do to supervise activity in digital assets regarding, among other things, sales, operations, and anti-money laundering (“AML”) risks 

Customer Due Diligence and Suspicious Activity Reviews

FINRA will review firms’ compliance with FinCEN’s new Customer Due Diligence (“CDD”) requirements. In addition to their identification of beneficial owners, FINRA will examine how firms monitor these accounts for suspicious activity based on the on the risk profile of customers. FINRA will also check the data integrity of the firms’ monitoring systems.

Best Execution

FINRA will continue to review how firms route orders for best execution. In 2019, FINRA will look at the firms’ systems for supervising, monitoring, and reporting order routing, as well as examine how the firms manage conflicts regarding any payments or other inducements for order routing.

Market Manipulation

Using its surveillance systems, FINRA will continue to monitor for market manipulation. One area of focus will be on Exchange Traded Products (“ETPs”), particularly those correlated to broad-based indexes. In addition, FINRA will continue to offer Cross-Market Supervision Report Cards to aid firms in their management of compliance risks associated with market manipulation.

Market Access

FINRA will review the controls that firms have established to address the Market Access Rule (Exchange Act Rule 15c3-5). In addition, FINRA will review how firms monitor customer trading activity for potentially manipulative practices.

Short Sales

FINRA will review firms’ compliance with Exchange Act Rule 200(f) regarding the structuring of aggregation units and how the firms can demonstrate the independence of these units.

Short Tenders

As noted in last year’s letter, FINRA will review how firms calculate their net long positions when tendering shares pursuant to an offer.

Credit Risk

FINRA will review firms’ policies and procedures for identifying and managing credit risk. This will include how the firm monitors collateral in margin accounts which may be illiquid, volatile or concentrated.

Funding and Liquidity

FINRA will evaluate firms’ assessment of and planning for liquidity needs. 2018 saw several market events in which market volatility increased. As part of its examinations, FINRA will review how firms adjust their stress tests to account for such market events.

Office of Compliance Inspections and Examinations (“OCIE”) Examinations Priorities Letter

In December 2018, the Securities Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) released its 2019 Examination Priorities Letter. The letter outlines its examination priorities for broker-dealers and registered investment advisers (“RIAs”), among other types of registrants.

In its letter, the OCIE identified the following areas related to broker-dealers that are similar to FINRA priorities:

  • Senior Investors
  • Cybersecurity

Other priorities noted by OCIE pertaining to broker-dealers include the following:

  • Municipal Advisors – The focus will be on areas such as registration, professional qualifications, continuing education, and conflict-of-interest disclosures
  • Customer Protection – OCIE intends to focus on compliance with Exchange Act Rule 15c3-3 requirements
  • Microcap Securities – OCIE will focus on how broker-dealers monitor for market manipulation, compliance with Regulation SHO, and compliance with Exchange Act Rule 15c2-11
  • Clearing Agencies – OCIE will also focus on large and small clearing agencies
  • AML Programs – OCIE will examine how broker-dealers implement all aspects of their AML programs, with an emphasis on obligations for filing Suspicious Activity Reports (“SARs”).

ACA Guidance

As in previous years, FINRA and the SEC have given the industry guidance on some key concerns for 2019. However, it is important for firms to remember that these are not exhaustive lists of the areas regulators review. As part of their planning for 2019, it is important for firms to identify areas of risk pertinent to their business and review them for compliance with the applicable rules and regulations. These priority lists should provide at least a baseline for firms to confirm that their controls address these key regulatory requirements.

For More Information

For more information on the FINRA 2019 Risk Monitoring and Examination Priorities and OCIE 2019 Examination Priorities, please contact your ACA consultant or Dee Stafford at (561) 628-5288 dstafford@acacompliancegroup.com.