Finra plans to scrutinize brokerages' compliance culture

Regulator wants to know whether adhering to regs is part of firms' operational DNA

Jan 5, 2016 @ 1:45 pm

By Mark Schoeff Jr.

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Finra plans to assess whether adhering to regulations is part of brokerage firms' everyday habits – a gene in their operational DNA – during its examinations this year.

The Financial Industry Regulatory Authority Inc. announced on Tuesday that it will more formally scrutinize how firm culture affects compliance and risk management practices.

“A firm's culture is both an input to and product of its supervisory system, including its approaches to identifying and managing conflicts of interest and ensuring the ethical treatment of customers,” Finra said in its 13-page examination priorities letter. “This means that firms should take visible actions that help mitigate conflicts of interest and promote the fair and ethical treatment of customers.”

Other focus areas for Finra exams include the management of conflicts of interest in the sale of proprietary products and products the firm is paid to sell, technology, anti-money laundering and firm liquidity.

Among the cultural dimensions Finra will assess are whether compliance is valued at the firm and violations are not tolerated, whether the firm aggressively targets potential compliance problems, whether senior management serve as good role models and whether there are rogue “sub-cultures” that may not conform to the rules.

Finra is not trying to impose a specific culture, but the primary goal of any firm should be to elevate the needs of its clients above its own, said Richard Ketchum, Finra chairman and chief executive.

“There's not a single model,” Mr. Ketchum said in an interview. “But if that model starts with, 'Is everything we do in the customer's best interests,' that's a good start.”

Acting in the best interests of the client is actually the fiduciary standard that applies to investment advisers, who are overseen by the Securities and Exchange Commission. Finra, the industry-funded broker-dealer regulator, enforces the less stringent suitability standard.

In Mr. Ketchum's view, brokers shouldn't wait for the SEC to promulgate a fiduciary-duty rule that applies to all financial advisers. They should start meeting a fiduciary standard now.

“If brokers don't put their customers first, they violate other rules,” Mr. Ketchum said. “It's the best way to be compliant I can imagine, and it's the best way to grow their business and increase the loyalty of their clients.”

In last year's priorities letter, firm culture was among several “challenges” Finra listed. This year, it is the overarching theme of the letter.

“That's huge,” said Todd Cipperman, principal at Cipperman Compliance Services. “What that says to firms is that if you don't take compliance seriously, Finra is going to be looking hard at your compliance infrastructure.”

A firm's attitude toward compliance is the first thing that signals to Finra whether it should look for other problems.

“Culture speaks volumes when we do risk assessments,” Susan Axelrod, Finra executive vice president for regulatory operations, said in an interview. She added that brokers should be “proactive rather than reactive” when it comes to compliance.

The proliferation of alternative investment products designed to increase portfolio returns, and the ongoing consolidation of the industry, puts more pressure on the compliance function, said Amy Lynch, president of FrontLine Compliance.

“The more complex firms become, the more conflicts arise,” Ms. Lynch said. “They need to have a system in place to identify and mitigate conflicts and the threats they pose, both for the firm and the investors.”

Although Finra reduced the size of its priorities letter this year to 13 pages from the 17 pages it put out in 2015, the missive is still too long, said Brian Rubin, a partner at Sutherland Asbill & Brennan.

“There is a legitimate question as to whether Finra is highlighting too many priorities,” Mr. Rubin wrote in an email. “The more issues that Finra cites may mean that firms will have less time and fewer resources to focus on each issue.”


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