FINRA Reveals Examination Priorities for 2018

Earlier this month, FINRA released its annual regulatory and examination priorities letter, which drew on some reoccurring issues firms should pay close attention to in 2018, including high-risk brokers, fraud and cybersecurity. Additionally, the regulator flagged several uncharted areas of focus, including cryptocurrencies, securities-backed lines of credit and business continuity planning.

The six major enforcement categories include:

Fraud

Fraudulent activities such as insider trading, microcap pump-and-dump schemes, issuer fraud and Ponzi-type schemes remain a top priority in 2018. In the past year, FINRA has made hundreds of referrals to the SEC for potential insider trading and other fraudulent activities involving individuals or entities outside FINRA’s jurisdiction, and audit staff will continue to pursue investigations in these areas aggressively. In addition, FINRA will focus on microcap fraud schemes, including schemes that target senior investors.

 

High Risk Firms and Brokers

No surprise here – a top priority for FINRA in 2018 will continue to be identifying high-risk firms and individual brokers and mitigating the potential risks that they can pose to investors. FINRA will focus on firms’ hiring and supervisory practices for high-risk brokers, including, for example, firms’ remote supervision arrangements; supervision of point-of-sale activities, including individual broker accountability when using joint rep codes; and branch inspection programs. It’s important that firms adopt and implement tailored heighted supervisory procedures under FINRA Rule 3110 for high-risk individuals.

Operational and Financial Risks

Recent events such as Hurricanes Harvey and Maria underscore the need for firms to maintain written Business Continuity Plans (BCPs) that address continued access to critical systems. Not only that, but cybersecurity threats remain a significant risk and continue to be a priority in 2018. Other operational and financial risks include: technology governance, customer protection and verification of assets and liabilities, anti-money laundering liquidity risk and short sales.

Sales Practice Risks

Making its FINRA exam priorities debut, initial coin offerings and cryptocurrencies topped FINRA’s list, after receiving significant media, public and regulatory attention this past year. FINRA will continue to assess the adequacy of firms’ controls to meet their suitability obligations. This includes reviewing how firms identify products that are subject to new product vetting, the vetting process itself, and the supervisory systems and controls firms put in place to ensure personnel are appropriately educated and trained on the sale and supervision of the product and that recommendations are suitable.

Market Integrity

In typical fashion, FINRA is placing major emphasis on protecting the integrity of our markets. Specifically, manipulation, best execution, Regulation SHO, fixed income data integrity, options, market access, and alternative trading system surveillance were identified as areas firms should review. FINRA will also launch several new report cards in 2018 to assist firms with their compliance efforts, such as “The Auto Execution Manipulation” Report Card, “The Alternative Trading System Cross Manipulation” Report Card and “The Fixed Income Mark-up” Report Card.

New Rules

Finally, a nice addition to this year’s priorities list is a list of rules that have already been approved and are taking effect this year. These rules include: FINRA Rule 2165 (Financial Exploitation of Specified Adults), FinCEN’s CDD Rule, Consolidated FINRA Registration Rules, and amendments to FINRA Rule 2232 (Customer Confirmations), FINRA Rule 4210 (Margin Requirements for Covered Agency Transactions) and FINRA Rule 4512 (Customer Account Information).

Below is a graph that identifies FINRA’s examination priorities for the past three years.

Exam Priority 

2016

2017

2018

529 College Savings Plans (529 Plans) X
Alternative Trading System Surveillance X
Anti-Money Laundering X X  X
Audit Trail Reporting Early Remediation Initiative and Expansion X X
Best Execution X X
Business Continuity Planning X
Client Onboarding X
Credit Risk Policies, Procedures and Risk Limit Determinations X
Cross Market and Cross-Product Manipulation X X X
Culture, Conflicts of Interest and Ethics X
Customer Protection/Segregation of Client Assets X X
Cybersecurity X X X
Data Quality and Governance X
Excessive and Short-term Trading of Long-Term Products X X
Excessive Charges to Customers in New Bond Sales X
Exchange Traded Funds (FTFs) X X
Fixed Income Prime Brokerage X
Fixed Income Securities – Surveillance Program X X X
High-risk and Recidivist Brokers X  X
Incentive Structures X
Information leakage X
Initial Coin Offerings and Cryptocurrencies X
Internal Audit X
Investment Banking and Research Business Lines X
Liquidity Risk X X X
Margin Loans X
Market Access Rule X X X
Market-Maker Net Capital Exemptions X
Microcap Securities Monitoring X X X
Municipal Advisor Registration X
Non-Traded REITs and Direct Participation Programs (DPPs) X X
Options X
Outside Business Activities and Private Securities Transactions X X X
Outsourcing X
Position Valuation X
Private Placements X
Product Suitability and Concentration X X X
Public Offerings X
Regulation SHO X X X
Report Cards X
Sales Charge Discounts and Waivers X
Securities-Baked Lines of Credit X
Senior Suitability/Suitability X X
Social Media & Electronic Communications Retention/Supervision X
Supervision, Risk Management and Controls X X  X
Technology Management X
Tick Size Pilot X
Trading Examinations X
Transmittal Of Customer Funds X