Each year, we anticipate the release of the report on FINRA’s Examination and Risk Monitoring Program; and more often than not, we see some overlap from year-to-year. FINRA’s keeping an eye on anti-money laundering. FINRA will be reviewing cybersecurity policies and procedures – and so on. Another area that seems to regularly show up on FINRA’s list is outside business activities (OBAs) and private securities transactions (PSTs).
Rather than broadly mentioning that examiners will be focusing on OBAs and PSTs, FINRA’s exam priorities letter details ways for firm’s to meet these, and other compliance obligations. Specifically, FINRA’s letter offers considerations for firms, lists specific findings examiners have come across in recent inspections, and shares some best practices on how to properly handle compliance obligations. We’re summarizing the information from FINRA’s letter regarding OBAs and PSTs to help your firm better comply with this ongoing focus area.
To start, let’s focus on what firms should consider when addressing OBAs and PSTs:
- Choose a method(s) to easily identify individuals involved in undisclosed OBAs and PSTs.
- Check your WSPs – Do they specifically state when notification or pre-approval is required to engage in an OBA or PST?
- Require firm members to complete and update questionnaires and attestations, as needed, to record their involvement, or potential involvement in OBAs and PSTs.
- The responsibility lands on you to determine whether a disclosed OBA will interfere with or compromise the firm member’s responsibilities to the firm and/or its customers.
- Familiarize yourself with FINRA Rules 3270 and 3280 – should the disclosed OBA actually be treated as a PST?
- Create a process that allows you to easily update a registered representative’s Form U4.
- Consider the unique regulatory factors and characteristics of digital assets when reviewing these types of OBAs and PSTs.
- Have a plan in place for supervising and documenting PST-related activities.
FINRA’s annual report is also upfront about the issues they’ve come across in recent examinations regarding OBAs and PSTs. Some of the biggest issues found include:
- Incorrect Interpretation of Compensation – Interpreting “compensation” too narrowly; and as a result, erroneously determining that certain activities were not PSTs.
- Inadequate Consideration of Need to Supervise – Approving participation in proposed transactions without adequately considering whether firms need to supervise the transaction as if it were executed on their own behalf.
- No Documentation – Not retaining documentation necessary to demonstrate compliance with the supervisory obligations for PSTs and not recording the transactions on the firm’s books and records.
- No Insufficient Notice and Notice Review – Registered personal failing to notify their firms in writing of OBAs or PSTs; and WSPs not requiring the review of such notices, or the documentation that such reviews had taken place.
- Inadequate Controls – Inadequate controls to confirm adherence to limitations placed on OBAs or PSTs, such as prohibiting registered representatives from soliciting firm clients to participate in an OBA or PST.
- No Review and Recordkeeping of Digital Asset Activities – Failing to conduct the required assessment of OBAs that involve digital assets to incorrectly assuming all digital assets are not securities and therefore, not evaluating digital asset activities to determine whether they are more appropriately treated as PSTs.
As a way to help firms and their members avoid the exam findings above, FINRA’s letter offers best practices for dealing with OBAs and PSTs. These include:
- Questionnaires – Requiring firm’s members to participate in ongoing questionnaires that prompt individuals to disclose their involvement, or potential involvement in OBAs and PSTS.
- Due Diligence – Conducting due diligence to learn about all OBAs and PSTs at the time of a registered representative’s initial disclosure to the firm and periodically thereafter.
- Monitoring – Monitoring significant changes in, or other red flags relating to, firm member’s performance, production levels or lifestyle that may indicate involvement in undisclosed or prohibited OBAs and PSTs. This includes conducting regular, periodic background checks.
- Affiliate Activities – Considering whether registered representatives’ and other associated persons’ activities with affiliates, especially self-offerings, may implicate FINRA Rules 3270 and 3280.
- WSPs – Clearly identify types of activities or investments that would constitute an OBA or PST subject to disclosure’ approval or not, as well as defining selling compensation.
- Training – Conducting training on OBAs and PSTs during onboarding and periodically thereafter, including regular reminders of written notice requirements and for registered persons to update their disclosures.
- Disciplinary Action – Imposing significant consequences—including heightened supervision, fines or termination—for persons who fail to notify firms in writing of their OBAs and PSTs, or fail to receive approval of their PSTs for compensation.
- Digital Asset Checklists – Creating checklists with a list of considerations to confirm whether digital asset activities would be considered OBAs or PSTs.
While these considerations and best practices may seem easy to implement, OBAs and PSTs continue to land on FINRA’s radar year-after-year. Do yourself (and FINRA) a favor by studying these tips and working these practices into your firm’s day-to-day operations. To review FINRA’s guidance on OBAs and PSTs, click here.