A Summary of FINRA’s 2018 Report on Examination Findings

Last week, FINRA issued its 2018 “Report on FINRA Examination Findings.”  This report tracks FINRA’s 2018 Priorities letter, which this blog has previously covered.  Putting its member firms on notice, FINRA advised that it issued the report as another resource for firms to “strengthen their compliance programs and supervisory controls.”  Not surprisingly, the first highlighted observation is “Suitability for Retail Customers.” Specifically, FINRA reported that:

FINRA observed situations where registered representatives did not adequately consider the customer’s financial situation and needs, investment experience, risk tolerance, time horizon, investment objectives, liquidity needs and other investment profile factors when making recommendations; in others, they failed to take into account the cumulative fees, sales charges or commissions. In some cases, unsuitable recommendations involved complex products (such as leveraged and inverse exchange-traded products (ETPs), including exchange-traded funds (ETFs) and notes (ETNs)). In other cases, they involved overconcentration in illiquid securities, variable annuities, switches between share classes, and sophisticated or risky investment strategies. FINRA also remains concerned about recommendations of unsuitable mutual fund share classes and Unit Investment Trusts (UITs), as discussed in the 2017 Report on Examination Findings. Inadequate product due diligence across product classes, including failure to understand the specific features and terms of products recommended to customers, was a common contributor to the challenges  FINRA observed.

FINRA elaborated on three selected areas of suitability and corresponding supervisory findings from recent FINRA examinations: overconcentration; excessive trading; and unsuitable variable annuity recommendations.

  • Overconcentration— FINRA reported that some firms maintained customer accounts that were concentrated in complex structured products and illiquid securities, when the customers lacked sophistication and the products lacked price transparency.
  • Excessive trading­­‑‑ FINRA observed that some firms failed to establish and enforce adequate supervisory systems. Specifically, FINRA reported that some firms failed to: review alerts from their clearing firm; use available compliance tools to detect excessive trading; take into account combined activity at a customer level; establish threshold values or parameters; and/or identify potential quantitative suitability concerns. FINRA also identified weaknesses in the “active account” letter processes across firms.
  • Unsuitable Variable Annuity Recommendations— FINRA observed supervisory failures and suitability concerns with variable annuity exchanges that resulted in increased fees and the loss of paid-for accrued benefits. Also, some representatives concealed the source of funds used to purchase new variable annuities that created the appearance of un-invested cash being used to purchase a new variable annuity that may have resulted in unfavorable tax consequences. Finally, FINRA remains concerned about the accuracy and completeness of certain firms’ data for annuity products, including general product information, share class, riders, and exchange-based activities.

FINRA’s “Highlighted Observations” also covered: findings from the targeted examination of volatility linked products; fixed income mark-up disclosure; reasonable diligence for private placements; and abuse of authority. These observations were followed by a “Summary of Additional Observations.” These included: anti-money laundering; accuracy of net capital computations; liquidity; segregation of client assets; operations of professional registration; customer confirmations; DBAs and communications with the public; best execution; TRACE reporting; and market access controls.

This report is a must read for FINRA member firms. While the scope of the issues covered is broad, the report itself is only 15 pages and provides direct and clear information regarding FINRA’s varying observations across an array of industry issues. Using the report, firms can and should utilize the findings and observations to assess, contrast, and compare a firm’s policies, procedures, and practices and use the guidance to develop, implement, and execute on remediation plans where necessary.

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About the Author: Sandra D. Grannum

Sandra Dawn Grannum concentrates her practice on securities, broker/dealer arbitration, litigation, mediation and regulatory defense. She is co-chair of the Commercial Litigation Team.

Sandy has tried complex multimillion-dollar arbitrations before FINRA, AAA and JAMS across the country. She has represented brokerage firms, banks, clearing firms, and associated persons in over 60 arbitrations before the NASD and FINRA which have been tried through award. In addition, she has successfully pursued cases in state and federal courts and in adversarial proceedings before bankruptcy courts.

About the Author: Jamie L. Helman

Jamie L. Helman concentrates her practice on securities, broker-dealer arbitration, litigation, mediation, employment matters, and regulatory defense. She has experience first-chairing FINRA arbitrations, defended on-the-record testimony of broker-dealer employees before FINRA, and is presently involved in the representation of broker-dealers in several pending FINRA cases as well as regulatory matters.

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