Nobody wants to get caught in the crosshairs of a securities regulator, but by exercising forethought and due diligence, a brokerage or advisory firm should be able to maintain a clean track record — or at least increase their odds of staying on the right side of the law.
Every January, the
Financial Industry Regulatory Authority Inc. and the Securities and Exchange Commission issue letters to their advisory constituents telling them what their examination priorities are going to be in the upcoming year.
Advisers should pay attention. That's because those letters can serve as a road map for the types of infractions the regulators are going to be focusing on.
In the past year, a review of fines and orders of restitution imposed by Finra, for example, showed that some of the biggest enforcement actions were for violations in areas that the agency had highlighted at the beginning of 2015 or in previous years.
SUITABILITY, SUPERVISION
For example, two areas Finra had identified as priorities in past years were sales suitability and supervisory practices. Yet
LPL Financial, the country's largest independent broker-dealer, was fined $10 million in May for supervisory failures, while another well-known firm,
Barclays Capital, had to pay more than $10 million in restitution and another $3.75 million in fines for suitability violations.
So what's on the regulators' radar going into 2016?
In addition to specific investment products and practices, Finra said this year in its letter that it will be looking at the compliance culture at individual brokerage firms and how that culture affects compliance and risk management.
It remains to be seen how Finra is going to judge a firm's culture, admittedly a fuzzy subject. In the letter, Finra defines culture as the “set of explicit and implicit norms, practices and expected behaviors that influence how firm executives, supervisors and employees make and implement decisions in the course of conducting a firm's business.”
But is Finra simply going to ask for companies to describe their culture and how it fosters a climate of compliance? Probably not. Firms will likely have to demonstrate specific actions they have taken to create a culture that encourages compliance. For example, have they held seminars or other educational programs for their advisers on the subject of compliance? How often? How big is the compliance budget at the firm, and is it comparable to other firms of the same size?
Another key area of inquiry is a firm's disciplinary process. How are advisers who violate Finra rules treated? Do they get a slap on the wrist or do they face real penalties? Last year, Oppenheimer & Co. was fined $2.5 million and ordered to pay $1.25 million in restitution for not properly supervising a rogue broker who Finra said stole nearly $3 million from his customers.
Why is culture so important? Because a firm's attitude can be a flag for Finra, indicating whether it should look for other problems. “Culture speaks volumes when we do risk assessments,” Susan Axelrod, Finra's executive vice president for regulatory operations, told reporter Mark Schoeff Jr.
One area the SEC identified as a priority this year is variable annuities. VAs are popular for baby boomers seeking a steady stream of retirement income. However, they can be hard to comprehend and are a high-commission product.
OLDER CLIENTS
“It's pretty clear that the SEC is concerned with the aging population of the country,” lawyer Jay Gould, a partner at Winston & Strawn, told Mr. Schoeff.
Broker-dealers and advisory firms would be foolish not to take these priority letters seriously. In short, the regulators' priorities should become their priorities. It's as simple as that.
