2019 Risk Monitoring and Examination Priorities Letter Released by FINRA

The Financial Industry Regulatory Authority (FINRA) has released its 2019 Risk Monitoring and Examination Priorities Letter, which highlights new priorities as well as identifies areas of ongoing concern that FINRA will continue to review in the coming year.  This year’s Priorities Letter to FINRA member firms takes a new approach by focusing primarily on those topics that will be materially new areas of emphasis for risk monitoring and examination programs in the ongoing process through which FINRA monitors developments at firms and across the securities industry to identify risks and assess their prevalence and impact.  FINRA intends to use this analysis to evaluate whether a regulatory response is appropriate, determine what that response should be and then allocate the required resources to implement the response.

Notwithstanding that, FINRA intends to continue to review and examine firms’ compliance with longstanding priorities previously discussed, including sales practice risks; hiring and supervision of associated persons with a problematic regulatory history; cybersecurity; and fraud, insider trading and manipulation across markets and products.

To this end, FINRA CEO Robert Cook stated in the release of the Priorities Letter that  “While we will continue to review and examine for longstanding priorities discussed in greater detail in past letters, we agree with the suggestion from many of our member firms that a sharper focus on emerging issues will help them better determine whether those issues are relevant to their businesses and how they should be addressed.”

Emerging Issues

Among the emerging issues identified in the Priorities Letter as areas of focus in 2019, includes online distribution platforms; firms’ compliance with FinCEN’s Customer Due Diligence (CDD) rule; and firms’ compliance with their mark-up or mark-down disclosure obligations on fixed income transactions with customers.

Online Distribution Platforms

Member firms increasingly are involved in the distribution of securities through online platforms in reliance on Rule 506(c) of Regulation D and Regulation A under the Securities Act of 1933 (Securities Act). While some online distribution platforms are owned and operated by broker-dealers, others are operated by unregistered entities, which may use member firms as selling agents or brokers of record, or to perform activities such as custodial, escrow, back-office and financial technology (FinTech) related functions.

FINRA also expressed concern that some member firms assert they are not selling or recommending securities when involved with online distribution platforms despite evidence to the contrary, including handling customer accounts and funds, or receiving transaction-based compensation.  To address these concerns, FINRA intends to evaluate how firms conduct their reasonable basis and customer-specific suitability analyses, supervise communications with the public and meet AML requirements.

Additionally, FINRA intends to evaluate how firms are addressing the risk of offering documents or communications with the public that omit material information or may contain false or misleading statements, or promissory claims of high targeted returns. Finally, for offerings subject to Regulation D, FINRA will also evaluate how firms address the risk of sales to non-accredited investors and non-compliant escrow arrangements.

Fixed Income Mark-Up Disclosure

FINRA also intends to review member firms’ compliance with their mark-up or mark-down disclosure obligations on fixed income transactions with customers pursuant to amendments to FINRA Rule 2232 (Customer Confirmations) and MSRB Rule G-15, which became effective on May 14, 2018.

To help firms evaluate their compliance with mark-up requirements, FINRA developed a Mark-up/Mark-down Analysis Report that is available to individual firms. Also made publicly available is the Bond Facts Tool, which provides security-specific product data to help retail investors understand the quality of their fixed income securities transactions (e.g., the time, price and size of other transactions in the same bond).  It should also be noted that FINRA will also review for any changes in member firms’ behavior that might be undertaken to avoid their mark-up and mark-down disclosure obligations.

Customer Due Diligence and Suspicious Activity Reviews

FINRA will assess member firms’ compliance with FinCEN’s Customer Due Diligence (CDD) rule, which became effective on May 11, 2018. The CDD rule requires that firms identify beneficial owners of legal entity customers, understand the nature and purpose of customer accounts, conduct ongoing monitoring of customer accounts to identify and report suspicious transactions and, on a risk basis, update customer information. FINRA will focus on the data integrity of those suspicious activity monitoring systems, as well as the decisions associated with changes to those systems.

Additional Significant Risk Issues

In addition to the emerging compliance and risk issues listed above, FINRA also noted in the Priorities Letter that the following areas of focus will be of continued importance in its 2019 examination program:

  • Regulatory Technology
    • Sales Practice Risks
    • Suitability
    • Senior Investors
  • Outside Business Activities and Private Securities Transactions
  • Supervision of Digital Assets Business
  • Market Risks
    • Best Execution
    • Market Manipulation
    • Short Sales
    • Short Tenders
  • Financial Risks
    • Credit Risk
    • Funding and Liquidity

Important Takeaway for Member Firms

FINRA may update its view on risks throughout the year, as well as provide observations on both concerns and effective practices relevant to the examination matters that are noted in this year’s Priorities Letter.  However, member firms can expect to see the emerging areas of FINRA’s concern appearing prominently in its risk monitoring and examination programs in 2019.

To that end, member firms need to review the priorities set forth by FINRA, and determine whether those issues are relevant to their businesses.  If they are relevant, action should be taken now to address them so as to stay ahead of the regulatory curve.