CARDS proposal poses challenges, unintended consequences

Though well-intended, Finra's plan could come with new security concerns and costs

Many members of the industry are just beginning to understand the very serious potential implications that the Financial Industry Regulatory Authority Inc.’s Comprehensive Automated Risk Data System initiative could have for clients and their businesses.

By way of background, CARDS would gather financial firms’ data on client accounts and trading activity from clearing firms in the hope of helping Finra identify risks, spot patterns of business misconduct and target information requests to firms more efficiently.

CONSEQUENCES

Although the Financial Services Institute Inc. understands Finra’s aims as outlined in the concept release, it thinks that every participant in the industry — including financial services firms, financial advisers, investors and regulators — will best be served through a comprehensive and open discussion of the challenges that the CARDS proposal could create. These include increased operating costs, data security risks and other potential unintended consequences.

As the FSI stated in a recent comment letter to Finra regarding the CARDS proposal, the key concerns about this initiative include the following:

1. CARDS would raise significant issues regarding data security, data privacy and potential liability in the event of a security breach.

Without question, Finra did the right thing this month by limiting the sensitive personally identifiable information that it intends to collect through CARDS. Finra would specifically exclude client names, addresses and tax identification numbers from the data it gathered.

Unfortunately, other items that would be collected are still a cause for concern. These include information on account balances, customer investment profiles, suitability and purchase/sale dates, among many others.

In light of recent high-profile data breaches that have occurred involving major retailers and government agencies, there is simply no way for Finra to ensure that the extraordinarily sensitive information collected by CARDS could be kept completely safe from hackers and data thieves. Regardless, all the data originally sought by CARDS would be consolidated at the clearing firm, where the same data security concerns would arise.

2. Collection of direct-business data would involve significant challenges.

As proposed, CARDS would rely primarily on clearing firms to collect, aggregate and submit the data that Finra intends to monitor. A significant portion of the FSI’s members’ business, however, isn’t conducted through clearing platforms but with various product providers — such as mutual fund companies, variable annuity companies and alternative investment sponsors — on a direct basis.

This raises questions about whether Finra would be using only a subset of industry data for its analysis and subsequent regulatory action.

Clients would also have sensitive private information shared with clearing firms, whether or not they desired or authorized it. Also, should Finra require firms to collect their direct-business data and submit those to them in a specified format, this would create enormous burdens on firms that would likely have them rethinking whether to offer the direct business to clients.

The benefit of direct business is that it is affordable to middle-market investors.

3. CARDS would have significant problems with respect to data standardization, quality and translation.

In order for CARDS to work as envisioned, Finra would need to ensure that all data collected through the system conformed to uniform standards. Firms have expended significant resources over the past decade to standardize data among different products and have experienced significant challenges.

Finra itself has seen firsthand the difficulty of data standardization with respect to just one product, variable annuities, through its Variable Annuity Data Pilot Program.

Differences in data format, pipeline and translation methods between various firms would mean that this single component of the CARDS rollout could consume an immense amount of time and resources. Moreover, if Finra were to require new data fields in CARDS data to address this challenge, firms and advisers would be forced to change their systems, repaper their accounts and enter the new information themselves.

4. CARDS could cause advisers to move toward alternative business models.

Thanks to independent firms’ ability to control costs, the independent model is very well-suited to delivering financial products, services and advice to middle-market clientele. The FSI and its members are concerned that the costs of establishing CARDS would fall heavily on the independent channel, driving more business to less regulated business models and actually damaging Finra’s ability to provide effective oversight.

Another closely related concern is that Finra hasn’t yet performed a thorough cost-benefit analysis of each feature and element of the CARDS proposal. Although larger firms would be able to absorb the costs of CARDS, smaller firms would be severely affected.

Affiliated advisers running their own small businesses would also have to absorb enormous costs, and they might be unable to withstand the pressure.

In addition to the points above, the FSI has a wide range of other concerns with CARDS.

As just one example, many financial services firms use software tools that allow them to customize their suitability analyses to their particular business model and clientele, strengthening their service and helping them develop better recommendations to address clients’ needs. These capabilities could be seriously degraded if Finra were to require firms to standardize suitability data.

OTHER INITIATIVE

Other concerns include the fact that Finra is simultaneously working on another enormous technology initiative, the Consolidated Audit Trail program, which will establish a massive database of every order, cancellation, modification and trade execution for all exchange-listed equities and equity options across all U.S. markets. Finra has taken longer than expected in the development of the CAT, and the initiative may create areas of substantial overlap with CARDS.

The FSI enjoys a strong and constructive working relationship with Finra and looks forward to helping it progress toward its goal of becoming a more effective regulator for the industry. As the FSI’s comment letter on the CARDS proposal makes clear, however, the FSI and its members have serious concerns about Finra’s ambitious new technology initiative.

The FSI will continue to bring the voice of independent advisers and firms across the country to Finra as it moves forward with the CARDS initiative.

Dale E. Brown is president and chief executive of the Financial Services Institute Inc., a lobbying group that represents independent broker-dealers.