FINRA has made no secret of its interest in broker compensation, and the potential conflicts of interest that can be generated by some types of compensation practices.  FINRA discussed these issues in its 2015 annual priorities letter, as well as in its earlier 2013 report on conflicts of interest.  These conflicts are also relevant to FINRA’s ongoing discussions relating to the adoption of a fiduciary-standard for broker-dealers, as well as its recent efforts to adopt rules relating to the disclosure of compensation arrangements relating to registered representatives who transfer customer assets to a new firm.

In August 2015, FINRA sent to a significant number of its members a letter requesting information on their broker compensation practices and supervision.  In the letter, FINRA indicates that its intent is to “continue [its] assessment of the efforts employed by firms to identify, mitigate and manage conflicts of interest, specifically with respect to compensation practices.”

The text of the letter may be found at the following link on the FINRA website: http://www.finra.org/industry/conflicts-interest-review-compensation-and-oversight

The letter requests information as to the one year period commencing in August 2014 and ending July 2015.  The inquiry concerns solely retail accounts, and not institutional sales.

The detailed information sought by FINRA relates to a variety of areas impacting the compensation of registered representatives, including:

  • Who makes compensation decisions, and what departments are involved?
  • How are compensation-related conflicts of interest identified and managed?
  • What surveillance and supervisory tools and processes have been implemented to identify compensation-related conflicts of interest?  How frequently are they implemented?  Did these processes identify compensation-related conflicts of interest, and if so, how many were identified?
  • How is compensation determined for registered representatives, and what features are implemented to reduce any risk to clients’ long-term interests?
  • What types of standard and non-standard compensation arrangements are used to recruit or retain registered representatives?  To what extent is their compensation contingent upon their production from particular product types?  The letter includes a request for specific information as to production thresholds, and production penalties, that can increase or decrease a registered representative’s compensation.

The letter also requests information as to a number of items relating to retail sales process, including how approved products are communicated to registered representatives.  For example, are the products presented by product category, and are they ordered in any particular way?  Are there any methods used that promote specific products or product types?  The presentation may be able to indicate to some extent whether or not certain products are encouraged over others.

The letter requests fairly detailed information about how income is determined for each of several different product types (including no less than eight different types of structured notes), and how that income is shared with the relevant registered representative.  The letter also requests firms to indicate their top 10 proprietary products, and their top 10 independent products, by total revenue.

The letter also takes an interest in situations where third parties could influence a broker’s sales efforts.  For example, firms are asked whether third party product sponsors are permitted to meet with registered representatives, and whether those meetings are “chaperoned” by supervisors or managers.  Are registered representatives permitted to attend off-site sessions sponsored by product sponsors?  All of these situations have the potential to create conflicts of interest.

The responses to the sweep letter will provide FINRA with a considerable amount of information, and an opportunity to assess whether members have listed to, and addressed, FINRA’s concerns.  These responses may also impact any action that FINRA ultimately takes in considering the adoption of a fiduciary standard for broker-dealers.