FINRA recently released its 2016 Regulatory and Examination Priorities Letter, an annual event which serves to highlight both emerging and existing risks in the financial services industry. The letter serves as a guide to FINRA’s priorities for the upcoming year, and highlights the issues which FINRA deems most important to its regulatory mission at the moment.
FINRA mentioned firm culture in its 2015 letter, but this year it has placed particular emphasis on the broad issue of “Culture, Conflicts of Interest and Ethics,” and it has announced that it will move to “formalize” its assessment of firm culture in the coming year. FINRA noted that while it will not seek to dictate firm culture, it will focus on the “frameworks that firms use to develop, communicate and evaluate conformance with their culture.” As part of the formalization process, the regulator will assess five indicators of a firm’s culture:
- Whether control functions are valued within the firm;
- Whether policy or control breaches are tolerated;
- Whether the firm proactively seeks to identify risk and compliance events;
- Whether supervisors are effective role models of firm culture; and
- Whether sub-cultures (e.g., at a branch office, a trading desk or an investment banking department) that may not conform to overall firm culture are identified and addressed.
FINRA did not set out any particular methodology or benchmarks for how it will make these assessments, or how it will judge a firm’s culture, but it did provide some guidance as to what it will be looking at in the coming year. According to FINRA, firms should “take visible actions” that help mitigate conflicts of interest and promote the fair and ethical treatment of customers. By way of example, “material breaches of firm policies and procedures should not be tolerated,” and compliance functions should be “equipped with necessary resources” to help firms navigate a complex and changing regulatory and market environment. In other words, FINRA expects firms’ efforts in promoting compliance and a culture of high ethics and fairness to be active and dynamic (i.e., “visible”), and not static. FINRA’s focus on firm culture dovetails with its ongoing examination priorities with regard to firms’ compliance, supervisory and risk management efforts.
FINRA also noted other key areas of priority for 2016:
- Incentive structures (including firms’ approaches to mitigating conflicts of interest that arise through the sale of proprietary or affiliated products);
- Information leakage (including inappropriate leakage between different areas of a firm’s trading activities, between a firm’s trading activities and other parts of a firm, and through front-running of pending rating changes);
- Outsourcing (including firms’ due diligence and risk assessment of providers of outsourced services and their supervision of those services);
- Firm liquidity (including the adequacy of firms’ contingency funding plans in light of their business model).
Given that the Examination Priorities Letter is an annual event, there were many holdovers in this year’s edition – areas that FINRA has focused on in the past and will continue to monitor for the foreseeable future. These include: protection of senior and other vulnerable investors, suitability and concentration issues, cybersecurity and the protection of confidential information, sales discounts and waivers (i.e., volume discounts and breakpoints) and outside business activities.
Lastly, FINRA addressed the recent regulatory changes approved by the SEC in 2015, including Regulation Crowdfunding and Regulation A+, and it noted that it will continue its focus on investor protection as it applies to these new rules. With regard to private placements, FINRA will focus on ensuring that firm communications concerning those products adequately reflect the significant risk of principal and lack of liquidity inherent in those products. With regard to public offerings, FINRA will consider “possible red flags that deserve a deeper inquiry,” including insiders of the issuer with a problematic regulatory history, conflicts of interest among parties, non-compliance with escrow requirements and disclosures that indicate inadequate due diligence by the underwriter. FINRA will also track the Regulation A+ filings to “gauge how the market is developing.”
The full text of the 2016 Examination Priorities Letter can be found here.