Put clients’ interests first: FINRA

Firms could help mitigate many of these risks, FINRA suggests, by doing a better job of putting clients’ interests first. In a letter outlining its priorities, the regulator says that it continues to observe shortcomings with firms aligning their interests with their customers; industry ethical standards; their management of conflicts of interest; and, the development of strong supervisory and risk management systems. The SRO says that addressing these weaknesses “will enable firms to get ahead of many of the concerns” that are highlighted in the letter.

In particular, FINRA says that a “central failing” that it has observed is firms not putting customers’ interests first. “The harm caused by this may be compounded when it involves vulnerable investors (e.g., senior investors) or a major liquidity or wealth event in an investor’s life,” it says. “Poor advice and investments in these situations can have especially devastating and lasting consequences for the investor.”

FINRA says that regardless of whether firms must meet a suitability standard, or a fiduciary standard, it believes that “firms best serve their customers—and reduce their regulatory risk—by putting customers’ interests first.”

The regulator also says that many of the problems it sees in the industry are rooted in the culture of brokerage firms. “A poor culture may arise, for example, if firm management places undue emphasis on short-term profits or pursues rapid growth without a concomitant concern for controls,” it says, stressing that senior management must “articulate and practice high standards of ethical behavior that are expected and visible throughout the organization and are embedded in the firm’s incentives.”

FINRA maintains that high ethical standards should come from the top of firms, and should not simply be viewed as a compliance chore. “The absence of stated standards can contribute to failures at the individual broker level,” it says; adding that this can, in turn, lead to problems with potentially market-wide implications. “Firms must protect their culture against individual bad actors, as well as firm wide behaviors that can gradually erode that culture,” it says.

To that end, FINRA calls on firms to avoid high-risk, or recidivist, brokers. The regulator says that it is “expanding its use of data mining, analytics, specially targeted examinations, and expedited investigations and enforcement actions to remove from the securities industry unscrupulous registered representatives who prey on investors.” At the same time, it says that firms that hire these brokers “can expect rigorous regulatory attention”.

On the other hand, the regulator also calls on firms to pay closer attention to particularly vulnerable clients, such as senior investors. FINRA says that it recently completed an examination initiative on seniors issues. “Preliminary findings show that many firms are increasingly proactive in dealing with senior investors by developing specific internal guidelines to strengthen suitability decisions and providing training on the needs of these investors, including, in some cases handling individuals experiencing diminished capacity or elder abuse,” it says; adding that firms should review their procedures to find ways to improve their treatment of senior investors.

In the letter, FINRA also identifies specific areas of concern, including the sale and supervision of interest-rate-sensitive and complex products, such as alternative mutual funds; the management of cybersecurity risks; and a range of market regulation issues, including abusive trading algorithms, high-frequency trading, order routing practices, best execution, disclosure, and market access controls.

“In the decade since publishing the first exam priorities letter, there has been tremendous change in broker-dealer operations, the markets and the regulatory landscape. While we have seen some firms make great progress in keeping up with these changes, more attention needs to be paid to addressing specific challenges we’ve pinpointed,” says Richard Ketchum, chairman and CEO of FINRA. “Doing so will provide the building blocks for a stronger culture of compliance, while indifference to or inaction on these issues will only serve as stumbling blocks toward robust compliance and supervision programs.”

FINRA urges firms to review their business amid the concerns set out in the letter. “While this letter is designed to provide guidance for firms to adapt and review their business in light of the issues raised each year, those programs that strive to go beyond business as usual will be better positioned to protect investors and preserve the integrity of the market,” Ketchum says.