Each year, financial institutions and counsel pore over the annual priority letter and the annual priority letter issued by the Securities and Exchange Commission (SEC) for important insight into areas of focus for the upcoming year. For this article, we attended an ABA SRO Subcommittee roundtable with regulators and member firms and reviewed recent guidance and disciplinary actions to identify three main points of emphasis for 2020. This article also provides some practical tips and considerations resulting from FINRA’s recent organizational changes.
A Structural Shake-Up
At the end of 2019, FINRA announced its most recent structural change resulting from FINRA 360, the regulator’s multiyear operational review initiative. Starting in 2020, FINRA has implemented a new examination and risk monitoring structure that consolidated its three examination functions into one program that groups member firms into one of five main business model categories: Retail, Capital Markets, Carrying and Clearing, Trading and Execution, and Diversified. In addition, each member firm will now have a single point of contact with FINRA, ultimately responsible for oversight of the exam and risk monitoring activities conducted at the firm.
Based on insights from the industry participants on the panel, the new regime is likely to result in a more efficient examination practice and better communication between firms and the regulator. To increase those efficiencies, member firms should consider tailored steps to educate their new FINRA contacts on their specific business models and how they develop controls for the primary risks presented by their businesses.
Senior and Vulnerable Clients—More Enforcement Actions in the Hopper
Senior and vulnerable clients have been a perennial focus of priorities letters, and the intersection between the new and enhanced vulnerable client rules and guidance combined with the growing senior population makes the topic one of ever-increasing importance. As a result, firms are presented with real challenges regarding their abilities, as nonmedical professionals, to detect diminished capacity and protect these investors while, at the same time, facing potential liability resulting from freezing account activity. And even if the firm acted appropriately, miscalculation can irreparably damage client relationships.
Despite the years of vulnerable client focus, to date there have only been a handful of enforcement actions relating to those clients. However, Jessica Hopper, the head of FINRA’s Enforcement Department, noted that more vulnerable-client investigations are in the pipeline for 2020.
The disciplinary actions to date offer little practical guidance for firms due to the extreme sets of facts in those cases. For example, in December 2019, FINRA announced that it had barred the Forte Group, a Florida-based firm of two brokers who churned the accounts of a 79-year-old customer suffering from severe cognitive impairment to the tune of $9 million via 2,800 trades over a 10-month period. While the facts described in Forte Group would cause most supervisors to spring into action, it’s the large gray area between little to no activity in an advisory account to 2,800 trades in a brokerage account that cause well-intentioned supervisors to lose sleep at night.
Firms seeking practical tips should look to address their interactions with senior and vulnerable clients, marketing materials for events focused on such clients, and how fees, costs, and expenses apply to products or accounts used by those clients. In addition, firms should periodically review how they supervise senior and vulnerable client accounts differently than “regular” accounts and whether their monitoring systems are designed to generate reports and alerts for this client type.
Regulation Best Interest—June 2020 Is Not So Far Away
The “generational overhaul” of the standard of conduct that applies to broker-dealer interactions with retail clients is now only a few short months away from the June 30, 2020, implementation deadline. By that time, member firms must be able to demonstrate compliance with the four core obligations of Regulation Best Interest (Reg BI)—disclosure, care, conflicts of interest, and compliance—and brokers and advisors alike will need to complete the related Form CRS disclosure filing. These new and enhanced obligations have far-reaching implications that touch multiple firm functions. Client-facing representatives need training on the new rules, operations and technology stakeholders need to develop delivery solutions for new disclosures, product committees need to understand the implications of an enhanced conflicts review, and supervisors need training on monitoring activity and reviewing correspondence for compliance with these rules. To put a firm in the best position for success, Reg BI needs full buy-in from senior management and a dedicated team to allocate resources to meet the aggressive deadline. Firms should first focus on the development of compliant policies and procedures and the drafting of Form CRS, as the other work streams will largely be dependent on those materials. Initially, regulators are likely to focus on firm polices and controls before testing for full compliance in 2021.
In early 2020, FINRA completed 30 preparedness exams and expects to release guidance from those reviews in advance of the implementation deadline. From the SEC, the main points of guidance have been a Small Entity Compliance Guide and periodic updates to frequently asked questions pages on Reg BI and Form CRS, but member firms and advisors are encouraged to submit questions to the SEC’s Office of Inter-Divisional Standards of Conduct via a dedicated Reg BI email address.
Extraordinary Cooperation Credit Should Always Be the Goal
Last but certainly not least, in July 2019, FINRA issued its first official update on extraordinary cooperation credit since 2008. In addition, in cases in which firms have received extraordinary cooperation credit, both FINRA and the SEC have begun including helpful statements in settlement documents that describe the factors that went into awarding such cooperation credit. While the recent notice largely echoed themes from prior guidance, three factors emerged as those of primary importance for the regulator in assessing whether assistance was substantial, efforts were significant, and cooperation was extraordinary: speed, remediation, and independence.
Firms should act quickly to “stop the bleeding,” scope the problem, and report it to the regulator. If relevant, remediation should be comprehensive, swift, and voluntary, and when the need to report takes precedence over the ability to complete remediation, firms may still be eligible for credit. And while regulators will not foreclose the possibility of a firm achieving extraordinary cooperation credit without hiring an independent law firm or consultant (or both), the participation of independent experts increases the likelihood of the issuance of credit. A final point, often overlooked in the frenzy over extraordinary cooperation, is that although such credit will be afforded in only a small number of cases, as FINRA’s release makes clear, the “extraordinary cooperation” factors parallel mitigating factors in the sanctions guidelines. Accordingly, counsel should consider presenting such facts as mitigants, irrespective of whether FINRA believes the firm’s actions were “extraordinary.”
David G. Buffa is a principal in the Securities Practice Group of Bressler, Amery & Ross in New York City, New York.
Copyright © 2020, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).