FINRA Publishes 2021 Enforcement Priorities and Exam Findings Report | Bressler, Amery & Ross, P.C.

Earlier this week, FINRA revealed its 2021 Report on FINRA’s Examination and Danger Monitoring Program (the “Report”). The Report, which mixes FINRA’s prior publications on regulatory priorities and examination findings, identifies particular areas of regulatory focus together with relevant guidelines and concerns, noteworthy examination findings, and greatest practices and rising dangers for corporations to contemplate when evaluating their compliance packages and controls. Beneath, we summarize key takeaways for every of the matters recognized within the Report.

Agency Operations

Anti-Cash Laundering (“AML”) – Anti-money laundering continues to be a perennial matter for regulators’ precedence letters, and 2021 will likely be no completely different. Within the Report, FINRA stresses the significance of creating AML packages tailor-made to a agency’s distinctive enterprise dangers and which can be subjected to common, unbiased testing. FINRA cautions towards counting on knowledge feeds for monitoring and surveillance capabilities with out periodically verifying the accuracy of these feeds, and equally advises towards counting on clearing corporations to report suspicious exercise that needs to be reported by the member agency. FINRA recommends that corporations use automated methods to detect tendencies round account openings, make use of each documentary and non-documentary strategies for buyer identification, and prepare each AML and non-AML employees on the necessities to report a variety of doubtless suspicious exercise. As well as, the Report famous three areas of focus for rising AML dangers within the coming 12 months: (i) microcap / penny inventory exercise in omnibus accounts of international establishments; (ii) account exercise in restricted markets, reminiscent of China; and (iii) fraud danger attendant to public choices of particular objective acquisition firms (SPACs).

Cybersecurity and Know-how Governance – Newfound reliance on distant, work-from-home expertise mixed with rising buyer demand for handy and on-demand account providers presents member corporations with an ever-changing panorama of cybersecurity dangers reminiscent of system-wide outages, electronic mail and account takeovers, fraudulent wire transfers, ransomware, and “imposter” web sites. FINRA means that corporations take into account whether or not their cybersecurity governance packages adequately deal with these rising dangers, together with whether or not corporations’ testing capabilities embody opinions of (i) distributors’ controls; (ii) pre-production environments for brand spanking new expertise rollouts; and (iii) buying and selling algorithm performance in durations of market dislocation. Companies ought to affirm that Knowledge Loss Prevention packages have encryption controls in place for confidential knowledge, and that cybersecurity insurance policies aren’t “one dimension matches all” when branches and distant areas have various ranges and varieties of exercise and expertise sophistication. As cybersecurity continues to develop in each scope and significance, corporations ought to improve coaching modules and require that each one employees – not simply registered representatives – full annual assessments.

Outdoors Enterprise Actions (OBAs) and Personal Securities Transactions (PSTs) – Representatives that have interaction in enterprise away from member corporations current a number of dangers starting from gross sales practices points to cybersecurity issues to buyer fraud. FINRA means that corporations require that reps and related individuals full – each upon rent and periodically thereafter – detailed questionnaires and attestations concerning their involvement in OBAs and PSTs. Companies must also retain documentation supporting each their evaluation of the questionnaires/attestations and monitoring of any limitations for permitted OBA/PST exercise. As sure representatives might have obtained cost from the Paycheck Safety Program (PPP) throughout the pandemic, FINRA means that corporations evaluation publically obtainable knowledge on such loans to find out if a registered consultant obtained one for an undisclosed OBA.

Books and Information – Member corporations ought to evaluation vendor contracts to verify that their agreements present for compliance with recordkeeping necessities, Digital Storage Media (ESM) formatting requirements and notification necessities. FINRA recommends that corporations use simulations to check vendor packages, together with “Cloud Vendor” packages, for compliance with the Books and Information rule and different ESM necessities.

Regulatory Occasions Reporting – Rule 4530 requires that member corporations promptly report sure violations of securities legal guidelines and FINRA guidelines and statistics on buyer complaints. FINRA emphasised the significance of not solely making certain that insurance policies and procedures explicitly require such reporting (each from the agency to FINRA and representatives to the agency) but in addition present for monitoring public databases and inside information (reminiscent of e-mails) for indicators that representatives have undisclosed reportable occasions. FINRA recommends corporations evaluation coaching to verify that it correctly educates representatives on the kind of monetary occasions that must be disclosed, and ensure that personnel use the correct Rule 4530 codes when reporting data to FINRA.

Mounted Earnings Mark-up Disclosure – FINRA and the Municipal Safety Rulemaking Board require that corporations present prospects with confirmations that comprise particular, transaction-related data when these prospects commerce company, company and municipal debt securities. Primarily based on observations from prior exams, FINRA famous that sure corporations didn’t precisely disclose the entire required transaction data, and failed to understand that sure types of debt (reminiscent of structured notes) are additionally throughout the scope of the disclosure guidelines. To keep away from inadvertent errors, corporations ought to conduct common opinions of a pattern of commerce confirmations to verify that each one required transaction-related knowledge (reminiscent of prevailing market worth and time of execution) and mandatory buyer disclosures move to confirmations. Specifically, corporations utilizing a number of distributors for several types of mounted earnings transactions ought to develop insurance policies that present for accuracy and consistency of disclosures throughout completely different platforms and buying and selling desks.

Communications and Gross sales

Reg BI and Kind CRS – When the deadline for implementing the SEC’s “generational” change to the usual of care laws coincided with an unprecedented pandemic, regulators assured corporations that preliminary exams for Reg BI and Kind CRS compliance can be carried out underneath a superb religion normal. Now, FINRA notes that it intends to “increase the scope” of Reg BI / CRS exams in 2021. As FINRA continues to be within the early levels of its Reg BI and CRS exams, the Report doesn’t comprise any findings or efficient follow strategies, and the concerns largely echo prior FINRA and SEC steering on CRS and Reg BI. Of be aware, nevertheless, FINRA reminded corporations that suitability necessities are nonetheless in impact for non-retail (i.e., institutional) shoppers, and insurance policies ought to proceed to account for Rule 2111 necessities.

Communications with the Public – FINRA guidelines require that corporations’ communications with the general public have to be truthful and balanced and never deceptive. Within the Report, FINRA highlighted the significance of those guidelines within the context of recent merchandise (reminiscent of digital property) and digital communication channels. FINRA particularly famous the dangers round app-based buying and selling platforms with “game-like options” that doubtlessly understate the dangers attendant to investing, significantly within the context of choices buying and selling. Within the context of digital property, corporations ought to affirm that disclosures “prominently” determine the distinctive dangers and speculative nature of such investments. As well as, the Report highlights the significance of money administration account disclosures, together with correct disclosures concerning a agency’s function (financial institution vs. broker-dealer) and potential conflicts of curiosity. Companies that allow texting, social media and different types of digital communication by related individuals ought to affirm that their insurance policies and procedures account for the particular recordkeeping and supervisory challenges introduced by these types of communication. Greatest practices embody clearly defining permissible and prohibited types of communication in insurance policies and procedures, administering up-to-date coaching that accounts for current expertise developments, and issuing acceptable self-discipline for infractions of digital communication insurance policies.

Personal Placements – FINRA guidelines and steering require that corporations providing non-public placement investments underneath Reg D carry out an inexpensive investigation into particular features of personal placement issuer and the issuer’s claims concerning the potential return and use of proceeds for the non-public funding. To fulfill these obligations, FINRA means that corporations develop a personal placement committee, use checklists to doc opinions, and depend on unbiased sources for verification of fabric info (i.e., don’t merely depend on the issuer). Companies should deal with crimson flags (reminiscent of conflicts of curiosity and issuer administration disciplinary historical past) throughout each preliminary due diligence and on an ongoing foundation. With a view to meet varied submitting necessities for Reg D choices, FINRA recommends using an automatic alert system to maintain deadlines and filings present.

Variable Annuities (VAs) – Gross sales follow issues across the buy of VAs are an evergreen matter in FINRA precedence letters. On this Report, FINRA focuses totally on VA exchanges and buyout gives. FINRA notes the significance of utilizing automated surveillance instruments and exception studies to each evaluation proposed exchanges and to create historic studies with standardized thresholds to detect tendencies throughout representatives, prospects and merchandise. As with different matters within the Report, corporations must also be cognizant of the necessity to check the accuracy of knowledge feeds and different inputs used for these automation instruments. As well as, FINRA recommends that representatives recommending exchanges present detailed, written rationales for the alternate and require that supervisors confirm the data supplied for each the prevailing and proposed VA. Agency insurance policies must also deal with VA buyouts and prepare representatives on the doubtless increased charges and lack of advantages when such occasions happen.

Market Integrity

Consolidated Audit Path (CAT) – Underneath the brand new CAT laws, all member corporations that obtain or originate orders in Nationwide Market System (NMS) shares, over-the-counter (OTC) fairness securities or listed choices should report sure knowledge to CAT. As well as, all agency proprietary buying and selling exercise is topic to CAT reporting whatever the dimension or sort of agency or sort of buying and selling exercise. Companies should develop insurance policies to adjust to CAT, and such insurance policies ought to (i) determine the accountable events for well timed reporting; and (ii) element the agency’s processes for confirming accuracy of knowledge posted to the CAT Reporter Portal. Like Reg BI, FINRA continues to be within the early levels of exams on the brand new CAT necessities, so the Report doesn’t comprise particular examination findings and efficient practices, however FINRA particularly highlighted CAT as an space of focus throughout many corporations within the coming 12 months.

Greatest Execution – FINRA greatest execution guidelines require that corporations acquire ample execution high quality for his or her prospects; if a agency doesn’t evaluation each commerce for execution high quality, opinions have to be “common and rigorous.” A frequent matter of priorities letters, greatest execution presents distinctive challenges for corporations providing prospects an array of safety varieties throughout completely different buying and selling methods. Within the Report, FINRA highlights the significance of addressing potential conflicts of curiosity in order-routing choices and the necessity to tailor the character of the most effective execution opinions to the agency’s enterprise (i.e. completely different opinions for various safety varieties). In 2021, FINRA will focus regulatory efforts on corporations that supply “zero fee” trades, and consider whether or not these corporations use completely different order-routing practices for these merchandise or depend on modifications to different enterprise traces (e.g. Money Administration Accounts) to offset misplaced fee earnings. FINRA means that corporations use exception and surveillance studies to help in assembly greatest execution obligations and conduct opinions on a frequency that, whereas a minimum of a quarterly, adequately accounts for the character and scope of a agency’s enterprise.

Massive Dealer Reporting – The “Massive Dealer Rule” (Change Act Rule 13h-1) requires that sure merchants determine themselves to the SEC as giant merchants and additional requires that member corporations acquire and report giant dealer data to the CAT for accounts with CAT-reportable occasions. FINRA recommends that corporations evaluation their WSPs to verify the adequacy of each giant dealer data reporting controls and enormous commerce ID disclosure necessities. Primarily based on current exams, FINRA famous that some corporations didn’t correctly determine or monitor for “giant merchants,” and recommends that corporations add a “giant dealer” examine to their Digital Blue Sheet (“EBS”) insurance policies and require that institutional shoppers determine giant dealer data in new account varieties.

Market Entry – The Market Entry Rule requires that corporations develop controls round market entry dangers in order to not jeopardize the monetary situation of their very own agency and different market members. FINRA recommends that extremely automated corporations take into account how they may handle expertise modifications and whether or not their controls (reminiscent of “kill switches”) account for market-wide occasions and doubtlessly aberrant algorithmic exercise. Primarily based on current exams, FINRA discovered that sure corporations lacked ample pre-trade order limits, pre-set capital thresholds and controls for accessing various buying and selling methods. FINRA additionally discovered that some corporations’ monetary danger administration controls the place insufficient and improperly relied on third-party distributors for controls with out sustaining “direct and unique” management over them. FINRA beneficial that corporations (i) periodically check their controls; (ii) undertake practices for systemic pre-trade “exhausting” blocks to forestall mounted earnings trades from breaching ATS thresholds; (iii) tailor faulty or duplicative order controls to the agency’s enterprise; (iv) develop ample post-trade controls; and (v) implement processes for reviewing advert hoc changes (together with the flexibility to return to authentic values as wanted).

Vendor Show Rule – Companies that present citation data for sure shares are liable for offering a consolidated show of sure market knowledge for these shares to prospects. From current exams, FINRA famous that sure corporations supplied some, however not all, of the data required in consolidated shows, and failed to take care of insurance policies that deal with all elements of the Vendor Show Rule and ample testing. Companies ought to textual content the accuracy of their knowledge feeds on the entrance finish to verify that they’re receiving all mandatory market knowledge to offer full and correct consolidated quote data to prospects, and validate the adequacy of shows on the again finish, significantly after expertise enhancements.

Monetary Administration

Internet Capital – The Internet Capital Rule requires that corporations keep particular ranges of working capital to guard prospects and collectors from losses because of an impaired monetary situation. Within the Report, FINRA notes that corporations ought to periodically evaluation how they deal with sure asset varieties for internet capital functions and ensure that their procedures use the correct allocation methodology throughout asset lessons and expense sharing agreements. With a view to correctly report internet capital, corporations should (i) make sure the accuracy of their classification of receivables, liabilities and income; (ii) precisely file income and bills; (iii) doc expense sharing agreements; (iv) have a course of to appropriately determine “didn’t ship” and “didn’t obtain” contracts; and (v) assess capital fees for underwriting commitments. FINRA additionally highlighted the significance for corporations to collaborate with their clearing corporations to verify the correct move of required asset data and to doc tasks (on the agency and clearing agency) within the occasion of fails and different internet capital points.

Liquidity Administration – FINRA reminded corporations to evaluation liquidity administration plans and stress check frameworks to make sure consistency with their particular enterprise mannequin. Companies ought to have procedures that allow modifications to their “stress check interval” from a single time horizon to a number of time horizons, and ensure that their insurance policies have a course of for modifying enterprise fashions in response to emphasize check outcomes. As with different matters mentioned within the Report, corporations ought to affirm that their stress check and liquidity administration packages are adaptable, periodically reviewed for updates to account for modifications to the agency’s enterprise mannequin, and tailor-made to the particular features of a agency’s enterprise.

Credit score Danger Administration – In keeping with the monetary duty guidelines, corporations should keep a complete credit score danger administration management framework to precisely seize the agency’s publicity to credit score danger. Primarily based on current exams, FINRA means that corporations develop complete in-house management frameworks that determine credit score exposures in real-time environments and keep a governance course of for approving new, materials margin loans. Within the context of credit score danger restrict modifications, FINRA famous that some corporations adopted approval and documentation processes that supplied for ongoing evaluation of adherence to these limits.

Segregation of Shopper Belongings and Buyer Safety – The Buyer Safety Rule requires that corporations defend buyer funds by segregating property from their proprietary enterprise and promptly ship property to an proprietor upon request. Primarily based on current exams, FINRA discovered that some corporations didn’t reveal constant examine forwarding processes, correct reserve system calculations and correct upkeep of blotter data. FINRA recommends that corporations encourage collaboration amongst authorized and compliance departments to verify that agreements supporting management areas are in place earlier than new accounts are established and coded on the agency’s books, and ensure that employees with system entry to ascertain new management areas are unbiased from the enterprise space.

The whole model of the Report is accessible here.

— to www.jdsupra.com

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