FINRA is still watching (and refining) its monitoring processes
Speaking at Georgetown University’s McDonough School of Business earlier this summer, Robert Cook, the Financial Industry Regulatory Authority (FINRA) president and CEO talked about how the agency has updated and continues to refine and improve its monitoring of member firms. He noted that the Authority has developed a unified risk hierarchy against which all firms are assessed, taking into account both the likelihood and potential impact of the risk. Ultimately, he said, these assessments form the basis for determining the frequency with which a firm should be routinely examined and provide the foundation for each exam strategy.
FINRA examines every new member firm within its first year of operation and thereafter each member is subject to an on-site routine examination based on its risk assessment, or at least once every four years. Examinations cover the core area of broker-dealers’ businesses, including dealings with customers, financial integrity and operations, and books and records.
Cook also noted that, in an industry with more than 165,000 branch offices, FINRA also conducts examinations based on a risk assessment of the brokers operating in each branch. The Authority also allocates dedicated resources responsible for conducting “cause” examinations, non-routine exams triggered by customer complaints or other red flag events that often arise from the actions of individual brokers, and may occur even in firms not previously considered higher risk.
FINRA’s Office of Fraud Detection and Market Intelligence (OFDMI), operates a whistleblower office and expedites the review of high-risk tips and fraud-related matters by senior staff and coordinates closely with federal and state law enforcement. In 2016, the OFDMI referred 785 matters to the SEC and other law enforcement agencies for a wide range of misconduct, including potential insider trading and fraud, which may not always involve brokers within FINRA’s jurisdiction. Where a broker is believed to be engaged in misconduct or to pose imminent harm to investors, a team of investigators and enforcement attorneys conduct expedited investigations and disciplinary actions regarding the broker, which has resulted in the barring of nearly 300 individuals from the industry.
Focus on bad actors
According to Cook, while FINRA’s program of regulation permits it to identify and address a range of compliance issues—many of which pose no direct harm to investors—it has also successfully identified and provided the basis for action against many bad actors, including firms and brokers. To find “bad” needles in a good haystack, Cook said FINRA is initiating more targeted efforts to better identify and supervise “high-risk” firms and brokers. Key red flags in FINRA’s “sights” include sales practices, fraud and deception, and the protection of client assets. It is also targeting individual brokers based on an analysis of information is derived from a variety of sources, including regulatory reports by firms and brokers, our examination program, employment histories, past associations with problematic firms, customer complaints, and any history of informal actions levied by FINRA.
High-risk firms typically face examinations annually by specialized examiners. This heightened scrutiny, Cook noted, has had an impact. Of the firms assessed as higher risk in the last five years, more than 40 percent are no longer FINRA members, in many cases because of regulatory action. In other cases, FINRA scrutiny has caused firms to take steps to address the Authority’s concerns and to make changes or improvements in personnel, operations, and the quality of their supervisory controls, resulting in a downgrade in their risk level. Key, Cook said, is to focus FINRA’s branch office exam program on those branches that present the greatest risk, either as a stand-alone branch exam or in conjunction with a broader exam of the firm as a whole.
Confidentiality and consideration
According to Cook, FINRA does not publish the names of the high-risk firms and brokers it identifies for its own risk-assessment purposes in consideration of fairness to those firms and individuals who pass through the process with clean slates, and in consideration of due process. He also noted that FINRA does not, and should not, have unfettered discretion — something with which most of its members would agree. Formal action, he said, to bar or suspend a broker requires satisfying procedural safeguards established by federal law and FINRA rules to prevent enforcement overreach by regulators (including FINRA) and to protect the rights of brokers to engage in business unless proven guilty of serious misconduct. Those safeguards include the right to defend oneself before a hearing panel and the right to appeal to FINRA’s National Adjudicatory Council, the SEC, and ultimately the federal courts.
In addition, federal law and regulations define the types of misconduct that presumptively disqualify a broker from associating with a firm, and also govern the standards and procedures FINRA must follow when a broker who was found to have engaged in such misconduct applies to re-enter the industry. These requirements, Cook added, are complex and impose significant constraints on FINRA.
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