In October 2019, FINRA published its 2019 Report on FINRA Examination Findings and Observations. The full report may be found at the following link: https://www.finra.org/rulesguidance/guidance/reports/2019-report-examfindings-and-observations.
The report reflects FINRA’s key findings and observations identified in its recent examinations of broker-dealers. The report sets forth what FINRA believes to be effective practices that could help these firms improve their compliance and risk management programs. The report also summarizes findings and observations across a range of topics. In this article, we focus on a number of issues that are of particular interest to the structured products market.
Insufficient Written Supervisory Procedures (“WSPs”) for New or Amended Rules – FINRA reports that some broker-dealers did not adequately address recently adopted or amended rules to address the new requirements applicable to their business and update their WSPs accordingly. In particular, FINRA references its:
- fixed income mark-up disclosure requirements under FINRA Rule 2232 (Customer Confirmations)2 ; and
- trusted contact person information requirements under FINRA Rule 4512 (Customer Account Information), and temporary holds, supervision and record retention requirements under new Rule 2165 (Financial Exploitation of Specified Adults)3 .
Limited Supervision and Internal Inspections – FINRA indicated that some firms did not maintain reasonably designed branch supervision and inspection programs. In particular, some firms did not adequately understand the activities being conducted through their branch offices, including products and services that were offered only at certain branch locations; this factor could prevent such firms from effectively supervising and addressing the specific risks of each branch location. For example, some branch offices may offer products with a greater degree of complexity than other offices with the firm. FINRA noted that many firms:
- did not conduct periodic inspections of nonbranch locations as required by FINRA Rule 3110(c) (Internal Inspections);
- did not determine relevant areas of review at branch offices or non-branch locations, taking into consideration the nature and complexity of the products and services offered or any indicators of irregularities or relevant misconduct;
- failed to set forth the inspections and reviews to a written report; or
- did not follow through on corrective action determined to be necessary based upon their branch inspections.
Limited Supervision to Identify “Red Flags” for Suitability – FINRA indicated that some brokerdealers’ supervisory systems were not reasonably designed or used to detect “red flags” of possible unsuitable transactions. For example, some firms did not identify or question patterns of similar recommendations by representatives or branch offices across many customers with different risk profiles, time horizons, and investment objectives. In some cases, multiple customers of a representative or branch office appeared to have made “unsolicited” transactions in identical securities. These factors, according to FINRA, could raise questions around whether the transactions were actually “unsolicited.”
Unsuitable Options Strategy Recommendations – FINRA identified registered representatives who recommended complex options strategies to customers who did not have the sophistication to understand the features of an option or the associated strategy, or recommended such strategies without adequately considering the customers’ individual financial situations and needs, as well as other investment profile factors. Further, some firms did not implement trade limits and controls to identify and prevent options trading that exceeded customer pre-approved investment levels.