Finra's goal is to win back investors' trust: Ketchum

May 25, 2014 @ 12:01 am

The following is an edited transcript of a speech given by Richard G. Ketchum, chairman and chief cxecutive of the Financial Industry Regulatory Authority Inc., at Finra's annual conference last Monday in Washington, D.C.

My remarks today are centered on trust. I want to talk about the role Finra is determined to play in restoring investor confidence and trust in the securities industry. I want to talk about the challenges we are facing, how we plan to address those issues and how we're planning to move to a new age of regulation.

Starting with the credit crisis in 2007 and the market plunge of 2008, to the devastating frauds of Madoff and Stanford, to the flash crash and other market disruptions — investors have witnessed a string of events over the better part of a decade that have left them with the perception that our capital markets have fundamentally changed. And not for the better.

To many investors, the markets have become complex to the point of seeming inaccessible. So it should come as no surprise that there's been a loss of confidence. It should come as no surprise that investors are feeling de-emphasized and vulnerable. The current debate on high-frequency trading and market structure only adds to the confusion.

Finra is determined to be a key engine in restoring trust in the securities markets. Can we solve all of this country's consumer and market issues? No. But we can tackle many of them.


Before I jump into where we are going, I think it's constructive to briefly review where we are today. We have already done a significant amount of work over the last few years to improve our ability to protect investors and maintain market integrity. Our risk-based exam program — which you've heard me talk about frequently — is one of the most meaningful results of that work.

So, let's talk a bit about the current state. One of the changes you may have noticed about our risk-based exam program is that it's now more data-driven. We are collecting more information electronically weeks before a scheduled exam and using available technology to better manage and analyze that data.

This data-driven approach has already resulted in a sharper focus and narrower scope of many of our exams. We're spending more time reviewing information from you before we show up, which means more efficient exams.

In addition to the data we're collecting as part of the exam requests, we are now also leveraging transactional data — such as the data we gather via TRACE — to inform our exams. By taking a look at this information, we can identify riskier transactions and narrow the field of customer accounts and information that our examiners review.

Understanding individual transactions is only one facet, though. We also use risk analytics at the account level to identify customer or house accounts with outsized risk positions to narrow the field for our coordinators and examiners. Using this kind of analysis, our coordinators can better plan our exams and our examiners can focus their time and resources on, for example, suitability reviews and other serious business conduct concerns where there is a higher likelihood of harm to investors.

Another way we are using data to help us quickly home in on risk is through our oversight of individual, high-risk brokers. Early last year, we launched an initiative to identify for targeted, expedited review those individual reps who pose a significant risk to investors or the industry — and where they have harmed investors and violated our rules, to bar them from the industry as quickly as possible. This “High Risk Broker Program” uses incoming regulatory intelligence such as broker terminations, complaints, tips, arbitrations and field reports from ongoing exams to pinpoint brokers we want to investigate quickly. Since we introduced the program last year, we have expanded it, and this year created a dedicated enforcement team to pursue high-risk broker disciplinary cases.


If that's all that we needed to do to boost investor confidence, I'd step off the stage right now. But clearly, there's still more work to do. We need to take our vigilance to the next level and leverage the advanced technology now at our disposal. We need investors to understand that there is ongoing, aggressive monitoring of how firms and reps are investing their money. We need investors to understand that we are watching the markets like hawks — and monitoring to see that orders are handled fairly. We need investors to understand that when we see potential or existing harm, we can respond quickly. We need investors to trust in the markets again.

In short, Finra's role in responding to these needs — and our role in promoting investor confidence — should be focused on a single, strong set of organizing principles. Those are:

€ To be data informed.

€ To be technology empowered.

€ To be responsive to change.

€ To be capable of more quickly and effectively identifying and disciplining bad actors.

These overarching principles will guide us in our rule making, our firm examination programs and enhancements to our market surveillance going forward.

An important cornerstone of fulfilling these principles is CARDS — the Comprehensive Automated Risk Data System. CARDS is the next step — and big leap forward — in the evolution of our risk-based regulatory program. CARDS will allow us to collect and manage data from firms in such a way that we can quickly identify trends and product concentrations that are harmful to investors and take swift, responsive action.

With the technologies that are now available to us, we can do things to transform our exam program in ways that haven't been available to us before. And frankly, it would be unconscionable not to embrace these technological advancements to better fulfill our investor protection and market integrity mission.

Using those technologies, CARDS will allow us to collect information — the same information we're already collecting on an ad hoc basis as part of our examination program — in a standard format across all firms on a regular basis.

CARDS will provide us with on-going “birds-eye-view surveillance” — similar to our current market regulation program — that complements our boots-on-the-ground exams. Let's face it: Regulators will need both to be effective in the future.

We are convinced that CARDS will revolutionize securities regulation and help us drive out activities that harm investors.


Just as one example, consider when we have a product concern. Today, we have to triage a range of sources to identify firms that are most likely active in the product. Then, we need to send out wide-ranging sweep letters to begin narrowing down whether any firms' activities are of concern.

In a CARDS world, we would already have the data to make that evaluation. We could begin instantly focusing on the few firms actively selling the product to retail investors and who have encouraged large, concentrated positions. Gone would be the burdensome reviews of many firms whose activity does not concern us. In short, CARDS enables a more focused, less arduous exam process and vastly improves the speed with which we can quickly intervene to protect investors.

We know you are concerned about the issue of personally identifiable information, or PII. We clarified that PII is not part of the proposal, so CARDS data will not include account names, addresses, tax IDs or Social Security numbers. Thus, customer accounts will not be linked across firms. We know that CARDS will be effective without collecting this information.

We've also heard your concerns about the security of such a large database. We believe the security risk is very low — and dispute that CARDS could create systemic risk.


We are also looking closely at the cost and operational concerns you've raised. While I understand where many commenters' concerns are coming from, they seem to me to be a tad one-sided. CARDS has the potential to be one of the most important investor protection tools to emerge in recent years. And if our goal is to protect investors and boost their confidence, if our goal is to restore investor trust in the markets, then I would strongly urge you to view this initiative through the broader lens of investor protection, rather than through the more narrow lens of how it affects your firm.

Having said that, we recognize that costs tied to CARDS are a real issue for firms. This is why we created a pilot and are talking to many of you about the real, bottom-line impact it may have on you from an implementation standpoint.

We are aggressively engaged in meeting with firms to understand the costs and benefits of CARDS. These meetings have already led to changes from our original concept that will help balance the impact on market participants while maintaining the benefits of CARDS.

We plan to launch CARDS in stages. In particular, we heard in many of your comment letters the concern over the need to send CARDS data through a clearing firm. The reasons varied — many of you voiced concerns about the cost implications of working with a clearing firm, especially since nearly 2,000 firms don't currently have clearing-firm relationships. So I'm pleased to announce that we are changing the CARDS proposal so you can choose how to send us the data. You can send it to us through a clearing firm, you can send it to us through a service bureau or you can send it to us directly. It's up to you. It's not exactly Burger King's “Have It Your Way,” but you will definitely have choices.

Before I move on, I want to quickly address a question that comes up frequently when we talk about CARDS: “Why not implement the consolidated audit trail — or CAT — first?”

Unlike CARDS, CAT will not contain the kind of critical information about customer risk appetites, investment objectives, cash movements, margin requirements and position data that we need for our sales practice reviews. Moreover, CAT needs to function on a near real-time basis. CARDS does not.

CAT will collect, identify and link orders, trades and quotes in equities and options from all market participants — and the activity of each participant will be flagged with a unique identifier. CAT will provide a level of granularity and precision that will dramatically reduce false positive alerts. And, by capturing equity and options data together, CAT will enable cross-market surveillance for options and cross-product surveillance across equities and options. Over time, fixed income, unlisted equities and derivatives will be included as well.


So, back to the issue of trust. What you've heard from me today is that Finra is firmly committed to restoring investor trust in the markets. We are backing up that commitment with the most advanced technology solutions available to us. We are investing our resources, our staff and our time.

I'll repeat what I said at the beginning: Finra is determined to be a key engine in restoring trust in the securities industry.


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