2020 Examination Priorities

Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) Office of Compliance Inspections and Examinations (OCIE) have published their 2020 examination priorities, which highlights areas of focus for risk monitoring, surveillance and examination programs.1

Key Themes
  • FINRA Oversight FINRA has integrated its examination programs into a single framework designed to align examination resources to the risk profiles and business models of member firms. As part of the new program, all FINRA member firms are grouped into one of five firm business models: Capital Markets, Carrying and Clearing, Diversified, Trading and Executions, and Retail. Each firm will be assigned by FINRA a senior leader as the point of accountability , with the ultimate responsibility for the ongoing risk monitoring, risk assessment, planning and scoping of examinations.
  • Sales Practices Both FINRA and the OCIE will continue to prioritize examinations for investor protection. The OCIE will focus on investments designed for retail investors such as mutual funds, ETFs, municipal securities and other fixed income securities, and microcap securities. FINRA will continue to evaluate compliance with sales practice obligations and supervision in areas such as complex products, variable annuities, private placements, fixed income mark-up/mark-down disclosures and senior investors.
  • Regulation Best Interest (Reg BI) On June 5, 2019, the SEC adopted Reg BI, which establishes a “best interest” standard of conduct for broker-dealers and associated persons when recommending securities or investment strategies to a retail customer. As part of the rulemaking package, the SEC has also adopted new rules and forms, requiring broker-dealers to provide a brief relationship summary to retail investors, called Form CRS. Firms must comply with Reg BI and Form CRS by June 30, 2020.In the first part of the year, FINRA and the OCIE will review firms’ preparedness for Reg BI, to gain an understanding of implementation challenges faced. After the compliance date, they will examine firms’ compliance with Reg BI and Form CRS.
  • Communication Via Digital Channels FINRA will examine how registered representatives of member firms communicate with customers through digital communication formats (e.g., social media, text messaging, etc.). FINRA will review firms’ processes for electronic communication, supervisory review and retention of the communications.
  • Direct Market Access FINRA will assess firms’ compliance with Exchange Act Rule 15c3-5 (Market Access Rule), focusing on issues relevant to business activities and associated risks. FINRA will review procedures and trainings for credit limit thresholds, third-party vendor due diligence, and controls to detect unusual behavior.
  • Best Execution FINRA and the OCIE will examine whether firms use reasonable diligence to determine if their customer order flow is directed to the best market given the size and types of orders. Other items that will be considered include:
    • Routing Decisions: Potential conflicts of interest in order routing decisions, including the impact of the recent increase in zero-commission brokerage activity.
    • Odd-Lot Order Handing: Filling customer odd-lot orders at the National Best Bid and Offer (NBBO) disseminated by Security Information Processors and offsetting these trades with odd-lot executions at superior prices reflected in the exchanges’ proprietary data feeds.
    • U.S. Treasury Securities: Reasonableness of firms’ policies and procedures for best execution and fair pricing for U.S. Treasury securities.
    • Options: Situations where customers may not be receiving best execution for their options orders
  • Digital Assets Due to its increasing growth, FINRA and the OCIE will continue to evaluate firms that engage in activities related to digital assets (e.g., through private placements, secondary trading platforms and facilitating trades of indirect investment). Key areas of focus will be control effectiveness, policies and procedures, client suitability, safety of funds and marketing materials.
  • Electronic Advice The OCIE will continue its focus on services provided to clients through automated investment tools and platforms (i.e. robo-advisors). Areas of focus include SEC registration eligibility, cybersecurity policies and procedures, marketing practices, adherence to fiduciary responsibility and effectiveness of compliance programs.
  • LIBOR Transition FINRA and the OCIE will engage with and closely monitor how the firms are preparing for the transition away from London Interbank Offered Rate (LIBOR) in 2021. Both agencies will review how firms are measuring their exposure, preparing for the transition to alternative reference rates and planning to address its effect on investors.
  • Cybersecurity & Technology FINRA and the OCIE will prioritize their review on cybersecurity policies, procedures and controls. In addition, FINRA and OCIE will focus on reviewing firms’ technology governance programs, particularly business continuity plans, documentation on system changes, internal and customer data protection, data loss prevention, vendor management and incident response and remediation.
  • Sales of IPOs As the IPO market has grown over the past year, FINRA is focusing its attention on firms’ obligations under FINRA Rule 5130 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings) and Rule 5131 (New Issue Allocations and Distributions). FINRA may review firms’ procedures to detect flipping, spinning, reporting of aggregate retail demand and allocation methodologies.
  • Anti-Money Laundering FINRA and the OCIE will continue to ensure that broker-dealers and investment companies have adequate policies and procedures that are reasonably designed to identify suspicious activity, illegal money-laundering activities and meeting Suspicious Activity Report filing obligations.
  • Cash Management FINRA will evaluate firms’ compliance with FINRA and OCIE rules around Bank Sweep Programs. FINRA will review communications on terms and disclosures for customers, as well as procedures in place for reconciliations of customer balances.
  • Consolidated Audit Trail (CAT) FINRA will begin surveillance and investigations to review compliance with the CAT requirement once it goes into effect in April 2020.
  • Conclusion

    FINRA and SEC examination priorities focus on the risks, issues and policy matters identified through their examination program, tips, complaints, referrals and coordination with other regulators. These letters are not exhaustive and other areas may be reviewed during examinations. Firms should conduct an annual review of policies, procedures, trainings and business activities accordingly.

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    Sources

    1. SEC and OCIE 2020 Examination Priorities and FINRA 2020 Risk Monitoring and Examination Priorities Letter.