FINRA: SUITABILITY AND SALES PRACTICES ISSUES LINGER
Financial Industry Regulatory Authority Inc (FINRA) released its “2019 Report on Examination Findings and Observations”, in October 2019. The report reflected key finding/observations identified in FINRA’s recent examinations of broker-dealers and practices FINRA deems to be effective in helping firms improve their compliance and risk management programs. In this article, we summarize aspects of FINRA’s report, relevant to the structured products industry. The full report is available here.
INSUFFICIENT WRITTEN SUPERVISORY PROCEDURES FOR NEW OR AMENDED RULES
FINRA reported that some broker-dealers did not adequately address newly adopted or amended rules by developing controls to address recently enacted regulatory requirements and updating their written supervisory procedures (WSPs). These rules include:
Fixed income mark-up disclosure requirements under FINRA Rule 2232 (Customer Confirmations);
Trusted contact person information requirements under FINRA Rule 4512 (Customer Account Information);
Rules relating to temporary holds, supervision and record retention requirements under new FINRA Rule 2165 (Financial Exploitation of Specified Adults)
The report is a reminder to broker-dealers of FINRA’s expectations, for them to evaluate new and amended laws and regulations applicable to their businesses and review their supervisory systems, WSPs and training programs, whether they need to be amended or updated to comply.
LIMITED SUPERVISION AND INTERNAL INSPECTIONS
FINRA noted that some broker-dealers did not have reasonably designed branch supervision and inspection programs. According to the report, some firms did not adequately understand the activities being conducted through their branch offices, products and services offered at certain branch locations. Therefore, hindering effective supervision, investigation and addressing the unique risks of each branch location.
INADEQUATE SUPERVISION OF PRODUCT EXCHANGES
The report also noted that some firms did not maintain a supervisory system to monitor the suitability of recommendations that customers exchange certain products, such as Mutual funds, Variable annuities or Unit Investment Trusts (UITs). In particular, some firms lacked processes to identify patterns of unsuitable recommendations of exchanges involving long-term products. In addition, some firms did not reasonably supervise exchanges because they could not verify the information provided by registered representatives in order to justify a recommended exchange, such as inaccurate descriptions of product fees, costs and existing product values. In other cases, a firm’s supervision team failed to detect that the source of funds for a purchase was misrepresented (i.e., it was misrepresented as “new” money and not as funds coming from sales of other products).
LIMITED SUPERVISION TO IDENTIFY “RED FLAGS” FOR SUITABILITY
FINRA explained that some firms’ supervisory systems were not reasonably designed to detect possible unsuitable transactions. Some firms did not identify or question patterns of similar recommendations by representatives or branch offices across many customers with different risk profiles, time horizons and investment objectives. In some instances, several customers of a representative or branch office appeared to have made ‘unsolicited’ transactions in identical securities, which could raise questions around whether the transactions were actually ‘unsolicited.
INADEQUATE SUPERVISION OF CHANGES TO CUSTOMER ACCOUNT INFORMATION
FINRA noted instances where registered representatives unilaterally altered account information, such as customers’ income, net worth or account objectives. In some cases, these changes preceded or were made at the same time as one or more transactions that, if the account change had not been made, would have been subject to heightened supervisory scrutiny, suitability concerns or end up unapproved.
UNSUITABLE OPTIONS STRATEGY RECOMMENDATIONS
FINRA reported situations in which registered representatives recommended complex options strategies to customers who lacked the understanding of the features of an option or the associated strategy, or without adequately considering the customers’ peculiar financial situations and needs. In addition, some firms did not properly implement trade limits and control to curtail options trading that exceeded customer pre-approved investment levels.
