U.S. securities regulators say that they will be focusing on suitability, high-risk brokers, and conflicts of interest, among their priorities in the year ahead.
The Financial Industry Regulatory Authority (FINRA) released a letter today setting out its regulatory priorities for the year ahead, which highlights some of the issues that regulators are worried could adversely affect investors and market integrity, including conduct issues, operational risks, and market regulation.
Heading the list of conduct issues is concerns about suitability, particularly where complex products are involved. FINRA says that it “remains concerned about the suitability of recommendations to retail investors for complex products whose risk-return profiles, including their sensitivity to interest rate changes, underlying product or index volatility, fee structures or complexity may be challenging for investors to understand.”
“These concerns are magnified when there is a strong incentive for the firm or registered representative to recommend the product because of its fee or compensation structure,” it adds.
FINRA says that it intends to focus its examinations on the disclosure of material risks to investors, and the policies and procedures surrounding those disclosures. In particular, it will focus on concentrations in longer duration instruments, and in speculative equities positions in retail accounts. It will also feature a review of the training for retail brokers to determine whether they understand the products they recommend.
Additionally, FINRA says that it plans to focus on the “small number of brokers [that] have a pattern of complaints or disclosures for sales practice abuses and could harm investors as well as the reputation of the securities industry and financial markets.”
It launched a so-called “high risk broker” initiative last year in order to sniff out these sorts of brokers and expedite investigations into them. In 2014, FINRA says it will expand this program and create a dedicated enforcement team to prosecute these sorts of cases.
It will also review certain aspects of the firms that hire these kinds of brokers, such as the due diligence conducted in the hiring process, the adequacy of supervision for higher risk brokers, and it will focus on the brokers’ client accounts in conducting reviews of sales practices.
Additionally, FINRA says that it is concerned about the potential risks posed by brokers who formerly worked at firms that have been severely disciplined, “who may bring unethical or illegal practices to a firm.”
Other conduct issues include: conflicts of interest and firms’ conflicts management practices; cybersecurity; abuses in the sale and marketing of private placements, particularly in the wake of changes designed to bolster the U.S. exempt market; crowdfunding; and issues involving senior investors, including firms’ procedures to prevent the financial abuse of seniors and to identify clients with diminished mental capacity.
In terms of fraud, FINRA says that its priorities will include focusing on microcap and low-priced over-the-counter (OTC) securities; and, insider trading. Market regulation priorities include algorithmic trading and the risk of malfunctions; firms’ controls related to high-frequency trading (HFT) and other algorithmic trading strategies; and, abusive HFT strategies.
Its financial and operational priorities include worries about funding and liquidity risk. And, FINRA says that it will require larger firms to undertake a liquidity stress test; among other things.
“FINRA’s examination priorities for 2014 provide the industry with a road map of issues that may be of risk to the investing public,” said Richard Ketchum, FINRA’s chairman and CEO. “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.”