In a market defined by low interest rates, investors are searching for higher returns. But brokers better be careful how they try to deliver those results, according to their primary regulator.
In a 16-page letter posted on its website late Tuesday, the
Financial Industry Regulatory Authority Inc. outlined its regulatory and examination priorities for 2012. At the top of the list: conduct and products meant to beat the market that instead are unsuitable for investors.
“Finra is informing its examination priorities against the economic environment that investors have faced since 2008, as these circumstances have steadily contributed to conditions that foster an increased risk of aggressive yield chasing, inappropriate sales practices, unsuitable product offerings, and misappropriation and fraud,” the letter states.
“Given the low yields on Treasuries, we are concerned that investors may be inadvertently taking risks that they do not understand or that are inadequately disclosed as they chase yields,” the letter continues. Lack of liquidity and inadequate cash flow in investments also are red flags Finra is monitoring.
Among the products that are on Finra's watch list for suitability problems: residential- and commercial-mortgage-backed securities, nontraded real estate investment trusts, municipal securities, exchange-traded funds using synthetic derivatives and significant leverage, variable annuities, structured products, private placements and life settlements.
The agency said that it is undertaking a “broader data collection effort” and targeting its enforcement efforts on high-risk firms.
The regulator warned brokers not to enhance their balance sheets by taking on excessive debt or manipulating their assets and liabilities.
“Finra is concerned about the additional risks that are being taken as a result of increased leverage, including market, credit and liquidity risk,” the letter states. “We will continue to monitor firms that employ a high degree of leverage, both on-balance-sheet and off-balance-sheet during the upcoming year.”
Finra also is zeroing in on fees.
“We remain concerned about firms' charging retail investors hidden, mislabeled or excessive fees,” the letter states. “In 2011, Finra brought cases against several broker-dealers that charged such excessive fees in the form of postage and handling charges that were unrelated to actual costs, and we will continue to investigate firms that appear to be taking advantage of investors through fee schemes.”
The regulator's guidance on social media is less explicit. It said that it “is a topic on which we continue to receive many questions from firms.” Finra reiterated that “core regulatory requirements apply to all communications with the public, irrespective of the medium or device used to communicate. Firms must be able to appropriately supervise business communications made using personal devices.”
High-frequency trading, and oversight of the creation and redemption of exchange-traded funds, also are listed among the agency's many priorities.
Finra oversees about 4,460 broker-dealers and enforces the suitability standard, which requires brokers to sell products that fit their clients' investment needs, timelines and risk appetites.
Linda Riefberg, special counsel at Fried Frank Harris Shriver & Jacobson LLP, said that the Finra guidance is welcome.
“It gives the industry a chance to prepare for what's on the exam and to do an introspective review to make sure they're up to snuff in these areas,” said Ms. Riefberg, a former Finra chief counsel.
Other regulators also are paying attention to Finra's priorities.
“States look at these very highly,” said Steve Thomas, director of Lexington Compliance, a division of RIA in a Box LLC, and former South Dakota chief compliance examiner. “They make individual decisions on whether these items should be added to their state's examinations.”
