Former Lead FINRA Enforcer Dissects Regulator’s 2019 Priorities Letter

The Financial Industry Regulatory Authority (FINRA) this week released its member priorities for the coming year, pledging to focus on emerging issues such as online distribution platforms and fixed-income markup disclosure obligations, as well as ongoing member risks such as fraud and cybersecurity.

This year, in addition to online distribution platforms, FINRA said it will concentrate on firms’ compliance with the Financial Crimes Enforcement Network’s Customer Due Diligence rule and with disclosure obligations related to fixed-income transactions. Unlike previous priorities letters, this year’s edition does not explicitly repeat topics that have been mainstays of FINRA’s attention in the past.

“Nonetheless, firms should expect that FINRA will review for compliance regarding these ongoing areas of focus,” the letter states.

Speaking with PLANADVISER about the 2019 FINRA priorities list, Mirella deRose, partner in King & Spalding’s securities enforcement and regulation practice and former principal counsel for FINRA’s Department of Enforcement, said there are several key takeaways.

PLANADVISER: Before we discuss the new member priorities letter, can you tell us about your background working on enforcement at FINRA?

deRose: I was at FINRA from 2014 to 2016, and prior to that I was a prosecutor and an assistant district attorney in Manhattan. While I was at FINRA, my main focus was on the high risk broker unit, which focuses on instances of ongoing rule violations and securities fraud among the brokers that FINRA considers to be high risk.

A number of factors go into the determination of who is a high risk broker, as your readers will know. I was the primary case attorney in that unit for the majority of my time at FINRA. I can say that FINRA is, among other things, remaining focused on how firms, if they have what FINRA deems to be high risk brokers, are supervising the brokers’ activities to make sure there is not a risk of harm to investors.

PA: You have reviewed the 2019 FINRA priorities letter that was just recently published. Given that you work with clients on this topic every day, was there anything unexpected in this year’s letter? FINRA says the new focus elements are online distribution platforms, fixed-income markup disclosures and regulatory technology.

deRose: I think the most important takeaway at this point is FINRA’s heightening focus on online distribution platforms. This is a new area for FINRA and for other regulators. The letter makes clear that FINRA is concerned about and is going to closely monitor firms’ associations with online distribution platforms, in order to make sure the securities being offered on those platforms comply with all the relevant rules and regulations.

This is an increasingly active space, and FINRA is very aware of the risks this poses to investors. 

PA: Are there particular concerns FINRA has in this area? Or is it a general concern about these platforms being more popular? 

deRose: There is a definite connection between these online distribution platforms and cryptocurrencies, which has caught the attention of FINRA. Oftentimes these cryptocurrencies are tied to some type of online distribution system, and there are unanswered questions as to whether curtain cryptocurrencies fall under securities laws. If a brokerage firm is tied to a given online distribution platform and is deemed by FINRA to be selling or recommending securities in connection with that online distributor, FINRA is going to be closely monitoring those firms.

I don’t have to tell your readers that this is a very quickly evolving space, and so FINRA is working closely with the Securities and Exchange Commission (SEC) to just go about defining what is a security or not in this context. That answer has not been fully developed yet, so FINRA is very aware that this needs to be looked at. There is a clear need to monitor this area for potential fraud or abuse.  

PA: FINRA is also calling out the topic of regulatory technology. When advisers and brokers are managing their own compliance efforts, technology solutions are increasingly an important part of this. FINRA wants to make sure this is being done with investors’ best interest in mind, right?

deRose: Regulatory technology has offered many firms, large broker/dealers especially, some real benefits in terms of their supervision programs. Digital technology can make these programs far more efficient to monitor and manage. But by the same token, broker/dealers must be very wary of putting blind faith in these regulatory technologies. FINRA is sending the message to broker/dealers that it is their responsibility to make sure the technology is working properly. It’s not hard to imagine that if a firm puts all its trust in a system that is producing bad results, the compliance structure can be jeopardized. That’s not something any firm wants to experience.

PA: In your opinion, is the fixed-income market disclosure item significant for brokers or advisers working with institutional clients? Or is this something more of interest to wealth managers for individual clients? Perhaps readers working with individual retirement account (IRA) clients will want to think about this?

deRose: This is more important for individual retail investor or IRA business, I would think. Your readers may recall that FINRA’s rules on this topic were amended back in May 2018—aiming to ensure that customers are better made aware of any markups they pay on a fixed-income security when they are purchasing it. If a firm is able to acquire a security for a given price and then turns around and sells it to a retail investor for a higher price, there are certain disclosure requirements that go along with this. The customer is free to buy that security of course, but the firm has disclosures it has to make in this situation. FINRA wants to make sure this system is functioning smoothly. 

PA: It seems that, for PLANADVISER readers, the sales practice risk section is most important? This section talks about suitability requirements, and we know that separately the SEC is working on suitability and point of sales issues among advisers and brokers. Does that make sense to you? There is also the senior investor section that could be important for retirement plan advisers.

deRose: Yes, suitability is a leading concern of both FINRA and the SEC. With the offering of increasingly complex investment products to all types of investors, FINRA wants to ensure that the proper analyses are being conducted at the broker/dealer with regard to suitability issues.

The broker must understand the product being offered, and that those products are suitable for specific investors. It is obvious, but important, to point out that the more complex a product is, the more potential there is for insufficient information being provided to the investor regarding the product—and insufficient attention being paid by the broker before offering the product in that situation.

On the topic of senior investors, this has been an area of FINRA focus for a number of years now, and it will remain so. There are issues here we all are familiar with. Seniors can be vulnerable targets for brokers looking to defraud investors. With increasingly complex products coming into the market this is even more important, so FINRA is closely focused on this issue.

PA: Any other parts of the letter you would highlight?

deRose: I would just say generally that it seems clear that FINRA is going to keep up with the continually evolving cryptocurrency space and the continually evolving online distribution platform space. They will be hard at work in 2019 ensuring that brokers who move into this area are meeting all of their duties and obligations.