I wish I was able to report some fireworks, or something semi-controversial, but FINRA and its hand-picked panelists managed to avoid saying anything particularly remarkable in any way. If you have never attended one of these conferences, and think that people come to learn cutting edge strategies, forget it. It is all very basic, very vanilla. The panelists, who are generally from member firms, can be counted on to offer views on how their particular firms handle issues, which I suppose some people find instructive. As for me, I come to hear what FINRA has to say, since, chances are, I already know the strategies that the firms are employing. But, you have to pay really, really close attention to hear anything from FINRA that can be characterized as even slightly newsworthy…apart, arguably, from Rick’s opening statement yesterday endorsing a fiduciary standard.
With that sobering preface, here is what I heard today:
I started with a session on “suitability.” Remember: the “new” suitability rule became effective in July 2012 – nearly three years ago. By now, therefore, one would think that everyone already “gets” it. Given the tone of this session, however, it seems FINRA doesn’t think so, which is why I suppose we started with a long description of the differences between Rule 2111 and “old” rule 2310. Yawn.
There were, however, a couple of interesting things. The first concerned explicit recommendations to hold. As you know, such recommendations are now subject to the suitability requirement under 2111, just like a recommendation to buy or sell a security. But, unlike the latter, which have always been captured on order tickets, which are then reviewed and approved by a principal in a demonstration of supervision, recommendations to hold generate no paper record. Accordingly, firms have had to come up with some mechanism to memorialize these recommendations.
This has been done in different ways. Some BDs created an order ticket. Some required their RRs to record the recommendation in their electronic broker notes. Some have required that an email be sent, outlining the recommendation. When my clients ask me, I consistently advise them that I don’t care about the particular method they choose, provided that the recommendation gets reviewed right away by a principal…just like a recommendation to buy or sell. Anyway, today, to my surprise, FINRA seemed to say that it was ok if the hold recommendation is not immediately reviewed and approved by a principal. Imagine my surprise!
Here’s how that played out. One of the panelists stated that at her firm, the RR creates a note, a memo, I guess, of a hold recommendation and then sticks it in a file, a file that then gets reviewed during the next branch audit. Really?? Who knows how much time will transpire between the day the recommendation is made and the day someone comes in to do the branch audit and reviews that file? It could be months, or even years (if the RR is not in an OSJ, which are subject to annual reviews). And what if the recommendation is deemed to be problematic? How does the firm address something that took place months ago? I figured FINRA would immediately jump in and say, no, you cannot do that. But, that didn’t happen. Just crickets. Weird, if you ask me.
Here is my wish: if FINRA is really ok with that approach to capturing and reviewing hold recommendations – and I don’t see why this wouldn’t also apply to strategy recommendations, which also don’t show up on “regular” order tickets – can’t they put that guidance out in a Regulatory Notice, so everyone can see it in print and, therefore, rely on it? Somehow, I don’t see that happening.
There was also a lot of talk about concentration issues. Possibly in reaction to the huge number of customer arbitrations filed in Puerto Rico over the past year, which, generally speaking, involve claims that the customers were the victims of unsuitable recommendations because they ended up with portfolios concentrated in Puerto Rican securities, FINRA is now examining to see how firms review concentration as part of their supervisory processes. That’s not so bad, in and of itself. But, what is potentially bad is that the FINRA representative on the panel stated that when firms review recommendations for concentration, they need to do so in light of all of a customer’s accounts and holdings. Including, presumably, accounts and holdings elsewhere. Does any BD capture that information? Apart from net worth information, which is collected on new account forms, a BD does not necessarily know, or need to know, the nature (or extent) of the assets its customers own away from the BD. If FINRA is serious, however, that a firm needs to know that information in order to be able to gauge whether a particular recommendation will result in an undue concentration, then there needs to be a rule passed that requires BDs to capture this information, because neither Rule 2090 nor Rule 2111 addresses this. Until then, this is just rhetoric.
After that, I went to a panel on Outside Business Activities. Again, it was all pretty basic information. The most encouraging thing I heard was that FINRA seems to understand perfectly well that (1) outside business activities do not need to be supervised, which means that (2) BDs are not responsible for what RRs do as part of their OBAs. Unfortunately, the panel also recognized that arbitration panels do not necessarily share that understanding, so the challenge remains to devise a system pursuant to which a customer who deals with RRs away from the BD somehow acknowledge, in writing, his awareness that he is not working with the BD, creating a document the BD can use when the customer sues the BD when, inevitably, the deal transacted away from the BD goes south.
FINRA did say that the most common exam finding relating to OBAs is a failure by firms to abide by their own WSPs. That seems straightforward enough: if you say you are going to do something, then you should expect to be held accountable if you don’t do it.
Last, but not in terms of humor, was a statement by the FINRA representative that they are not there “to second-guess” firms’ supervisory procedures and policies. Based on the fact that I have personally defended any number of Enforcement cases involving allegations of inadequate supervisory procedures, I, for one, found this remark to be rather silly.
I next attended a panel on Compliance and Legal Trends. It was largely repetitive of other sessions, however, as the speakers, essentially, identified issues discussed in detail elsewhere, e.g., the growing challenge of dealing with senior investors; addressing conflicts of interest; overlapping regulatory schemes causing increased work and expensesfor BDs; and the increased need for, and reliance on, technology solutions for compliance issues.
The last session I attended before bolting to the airport – only to sit on the tarmac, in bright sunshine, waiting for some supposed nearby lightning strikes to abate – dealt with “lessons learned” from examinations for medium and large firms. The take-aways:
- When you get the call from FINRA 60 days before the on-site exam starts to schedule another call to discuss the firm’s business, feel free to inquire what topics FINRA is interested in;
- When FINRA tells you that it wants to examine some of your branches, feel free to inquire why it has chosen those particular branches (and you can expect to get the answer “9 1/2 out of ten times!”); and
- If you don’t like the answers you get from the examiner, feel free to escalate the matter to supervisors in the District Office, they don’t mind at all.
Did you detect the pattern? Easy-going, that’s the first word that comes to mind when you think of FINRA examiners, right?
Sadly, I could not stay through the conclusion of the conference tomorrow, especially since the last panel is the best: “Ask FINRA Senior Staff.” I feel like I could fill the entire hour-and-15-minute session all by myself!
 I don’t want to call out anyone in particular, but I found it odd, and a bit disappointing, that some of the firms that FINRA picked to sit on its panels have less-than-stellar regulatory histories. Why would anyone want to take advice from the CCO of a firm that just signed an AWC for supervisory issues? Moreover, FINRA likes to use speakers from very big BDs, with thousands of RRs. Most BDs are much smaller, with a fraction of the number of RRs and branch offices (and, of course, a fraction of the big firms’ compliance budgets). Hearing tips from big firms is often pointless as they cannot be duplicated, even partially, by small BDs, which lack the resources, in terms of staffing, software, systems, etc., that the big BDs take for granted.