In an April 15, 2016 speech to the Brookings Institution, FINRA CEO Richard G. Ketchum addressed the fundamental question of whether the equity markets are sufficiently fair, flexible, and efficient to encourage the participation of retail investors. Ketchum described the substantial concerns of some investors regarding these issues and outlined recent action by FINRA to alleviate these concerns, including the steps FINRA will take to assess a firm’s culture of compliance.
As we reported here, in its 2016 Regulatory and Examination Priorities Letter, FINRA recently announced a new initiative to formalize FINRA’s assessments of firm culture. The need to review broker-dealers’ cultural values with respect to compliance arose in the wake of repeated compliance breakdowns that have harmed investors. Ketchum’s speech to the Brookings Institution provides additional insight into these examinations.
Ketchum explained that FINRA expects firms to “embrace a culture that puts investors first” and to inculcate an understanding that “‘good people’ do not take actions that harm their clients and expose their firms.” This year, FINRA has begun looking at a number of factors, including how a firm communicates and reinforces values directly, indirectly, and through its reward system; how a firm measures compliance with its cultural values; what metrics, if any, it uses; and how it monitors for implementation and consistent application of those values throughout its organization.
In its examinations, FINRA will assess the following five indicators of a firm’s culture:
- Whether the control functions FINRA values are within the organization;
- Whether policy or control breaches are tolerated;
- Whether the organization proactively seeks to identify risk and compliance events;
- Whether supervisors are effective role models of firm culture; and
- Whether sub-cultures (such as a branch, trading desk, or department) that may not conform to overall firm culture are identified and addressed.
FINRA understands that “rules alone” are not sufficient to protect investors and that firms must create and enforce a culture where the rules are followed. Broker-dealers may wish to consider how to best document their cultures of compliance, so they can present persuasive evidence of this culture when the regulator comes calling.
Elsewhere in his remarks, Ketchum outlined other steps that FINRA has taken to address other perceived concerns about the equity market, including a possible lack of transparency, periods of high volatility, and whether the market is hospitable for small and mid-sized companies. FINRA has addressed these issues in many ways, including by providing additional information to the public on trading via dark pools, requiring additional controls on algorithmic trading, implementing trading pauses in periods of potential volatility, and creating a pilot program to require wider trading and quoting increments for small and mid-cap companies.