FINRA exam priorities for 2014 incorporate enterprise wide, risk-based approach

January 7, 2014

By Nick Paraskeva, for Compliance Complete

NEW YORK, Jan.7 (Thomson Reuters Accelus) – Broker dealers have been put on notice of regulatory priority areas where they will be examined in 2014. The topics seen as posing greatest risk to investors and markets were issued in a letter by the Financial Industry Regulatory Authority (FINRA) on the first day of the year. They include new areas such as seeing patterns of suspicious activity by representatives, including questioning firms why they hired the persons.

“We encourage firms to use this guidance along with their own analysis to enhance their programs as we will be examining for strong controls and robust compliance efforts in these areas” stated Susan Axelrod, FINRA Executive Vice President, Regulatory Operations, on release of the letter to member firms.

FINRA has moved away from its prior approach of describing treatment of individual products, in a move to a more enterprise wide, risk-based approach. New compliance areas include systems and algorithms, retirement, liquidity and hiring. All areas are under four broad topics of business conduct, fraud, financial and operational, and market regulation. The regulator stated it will update its view on risk during the year.

“By providing clear and detailed guidance to firms, we hope to not only support firms’ compliance efforts but also to alert firms to the issues we have identified as the most salient risks to investors and the integrity of our markets,” said Richard Ketchum, FINRA’s CEO.

Business-conduct topics are broadly consistent with those from 2013. Revisions were driven by economic changes, including a long period of very low interest rates, which incentivized investors to take more risks in a search for yield. Other exam areas are driven by rule changes in the last year, including Dodd-Frank and the JOBS act, as well as new product and compensation practices that may cause conflict of interest.

The growth in initial public offerings (IPOs) is causing review of accuracy in firms’ underwriting filings with FINRA’s Corporate Finance Department and compliance with rules on IPO securities sales and allocation.

Cybersecurity has a higher prominence after several publicized data losses by large companies. FINRA’s primary focus is the integrity of firms’ policies, and controls to protect sensitive customer data.

Recidivist brokers

FINRA will expand their high risk broker program and create a dedicated Enforcement team to prosecute violations. When examining a firm that hires such brokers, staff will review what due diligence the firm did in the hiring process. This will also assess the adequacy of firm supervision of high risk brokers, including whether employees were placed under heightened supervision based on their pattern of past misconduct.

Activity in client accounts managed by high risk brokers’ will be a focus of sales practice exams. FINRA is concerned about the potential risks from brokers who formerly worked at one or more firms they severely disciplined. Such brokers have been able to be re-hired by other firms and may repeat the violations. This comes alongside an expansion of public information on prior violations in FINRAs BrokerCheck system.


Anti-money laundering (AML) reviews will focus on institutional business. An emerging trend is utilization of executing broker-dealers that settle by Delivery versus Payment/Receipt versus Payment (DVP/RVP). Such customers have been seen to liquidate large volumes of low-priced securities using such accounts.

FINRA identified a “misconception among some executing brokers” that Customer Identification Program (CIP) requirements do not apply to DVP/RVP customers. DVP/RVP customers meet the definition of an “account” for CIP purposes. Thus, the executing broker is responsible for implementing CIP for customers unless they are exempt or an agreement with a prime broker stipulates the latter are responsible for CIP.

Financial and operational

In the Financial and Operational (FinOps) area, larger firms will be required for the first time to perform a liquidity stress test. This will incorporate the factors FINRA believes are important to understanding the resiliency of a firm’s liquidity position. Factors include the impact of a loss of funding for their proprietary positions, their repo book, settlement and depository payments, and funding of customer balances.

Documentation of risk management is also required for the first time under SEC rules for firms with over $1 million in aggregate customer credits or $20 million in regulatory capital. The documentations should describe controls for managing credit, market and liquidity risks. In their 2014 exams, FINRA will assess whether the controls documented are in place and functioning, as well as their adequacy to monitor risk.

Accuracy of financial statements and capital calculations will also be reviewed, with FINRA requiring firms to be able to prepare these throughout the year, not just at year-end. They found failures to apply charges on open contractual commitments, positions, and concentrations. Accruals should be provided throughout the year, and the netting of transactions should only be made if the accounting guidance clearly allows it.

Market regulation priorities

Given market disruption, FINRA seeks firms to demonstrate pre-implementation testing of algorithms and trading systems. This includes Legal and Compliance review of the design and development of systems to ensure they comply with legal requirements, including detection of trading abuses, such as wash sales. Firms should explain their approach to ‘kill switches’, and controls to comply with the market access rule.

Surveillance of high frequency and algorithmic trading abuse should cover sponsored participants outside the United States. This requires conducting due diligence when taking new sponsored access customers, especially if they had accessed the market through firms who faced regulatory discipline. Concerns were expressed over misreporting of large options positions, including which capacity the firm acted for option orders.

New surveillance processes will review if firms’ provide best execution for equity orders, and the variation in fixed income prices from recent trades. This includes when a firm ignores a better price on one options market that disadvantages customers. Firms are reminded to conduct reviews of differences in execution quality to ensure their order flow is directed to markets providing the most beneficial terms for customers.

List of Issues

Business Conduct Priorities

  • Suitability
  • Recidivist Brokers
  • Conflicts of Interest
  • Cybersecurity
  • Qualified Plan Rollovers
  • Initial Public Offering Market
  • General Solicitation and Advertising of Private Placements
  • Due Diligence and Suitability of Private Placements
  • Offerings of Securities through Private Placements
  • Anti-Money Laundering (AML)
  • Municipal Advisors
  • Crowdfunding Portals
  • Senior Investors

Fraud Priorities

  • Microcap Fraud
  • Insider Trading

Financial and Operational Priorities

  • Funding and Liquidity Risk
  • Risk Control Documentation and Assessment
  • Accuracy of Firm’s Financial Statements and Net Capital
  • Auditor Independence

Market Regulation Priorities

  • Algorithmic Trading and Trading Systems
  • Audit Trail Integrity
  • Best Execution of Equities, Options and Fixed Income Securities

(Nick Paraskeva is principal of Reg-Room LLC (, which provides regulatory information and consultancy. He covers various facets of the banking and securities industry and delivers exclusive analysis through Thomson Reuters. He can be contacted at (212) 217-0403 and Follow Nick on Twitter@regroom. )

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see