By now you have probably read FINRA’s recent “Targeted Exam Letter” entitled “Establishing, Communicating and Implementing Cultural Values.” In case you haven’t, it is clear that FINRA is following up on the promise it made in January in the 2016 Regulatory & Examination Priorities Letter to “formalize [its] assessment of firm culture while continuing [its] focus on conflicts of interest and ethics.” With this new letter, FINRA has now moved, at least for the 12 firms that received it, beyond the conceptual and theoretical and on to the actual and practical. Unfortunately, attempting to measure objectively something as clearly subjective as “firm culture” is of limited utility, and the eight questions that FINRA has posed establish that fact.
I suppose that the problem starts with the effort even to define “firm culture.” Strangely, in the Targeted Exam Letter, FINRA identifies “one definition of ‘firm culture,’” but does not expressly adopt that definition as its own, even though the language comes almost directly from FINRA’s 2016 Examination Priorities letter. Moreover, FINRA acknowledges that each firm “may have its own definition of ‘firm culture.’” So, as its examiners work to gauge whether the broker-dealers who received the letter have a firm culture, or, if they do, whether it is good or bad, we don’t really know the standard to which FINRA will be holding these firms.
Second, even if we assume that the definition FINRA provides is, in fact, the one that FINRA has adopted, it is so general and vague that it is largely without meaning. According to FINRA, this “one definition” of firm culture is “the set of explicit and implicit norms, practices and expected behaviors that influence how employees make and carry out decisions in the course of conducting the firm’s business.” This is like trying to describe the color blue. You can likely conjure up some adjectives, but, really, the result may not be particularly useful. It’s like a Dilbert cartoon, or, even better, one of those “mission statement generators” you can find on the web that basically string a bunch of important-sounding words together, creating a grammatically correct but utterly nonsensical phrase.
So let’s look at the eight things that FINRA is asking these 12 firms to provide, and other than chuckle at them, see if there is any real guidance to be gleaned:
- “summary of the key policies and processes by which the firm establishes cultural values”
- “description of the processes employed by executive management, business unit leaders and control functions in establishing, communicating and implementing your firm’s cultural values”
- “description of how your firm assesses and measures the impact of cultural values (to the extent assessments and measures exist) and whether they have made a difference”
- “summary of the processes your firm uses to identify policy breaches”
- “description of how your firm addresses cultural value policy or process breaches once discovered”
- “description of your firm’s policies and processes, if any, to identify and address subcultures within the firm that may depart from or undermine the cultural values articulated by your board and senior management”
- “description of your firm’s compensation practices and how they reinforce your firm’s cultural values”
- “description of the cultural value criteria used to determine promotions, compensation or other rewards”The first thing that strikes me is, basically none of these has any application to a small broker-dealer, and, last time I checked, the vast majority of FINRA members is still comprised of small firms. FINRA has nearly always employed a one-size-fits-all approach to its rules, but I wonder here whether its concern about firm culture has any real application to most of its members. Second, as we try to understand what FINRA is really looking for, I think we can skip through a lot of this rhetoric and safely substitute “conflict of interest” for “cultural values.” While “culture” is difficult to define, identify or measure, the same is not true for conflicts of interest. Even small broker-dealers can reasonably be expected to be able to demonstrate their sensitivity to conflicts of interest in a manner that cannot be replicated for “firm culture.” FINRA has increasingly begun to signal its interest in testing how its members deal with conflicts of interest, and the questions posed in the Targeted Exam Letter reflect that same interest.
Last, pay particular attention to “compensation practices,” found in Item 7. Given FINRA’s keen interest in conflicts, and especially in light of the DOL’s anticipated rules regarding retirement accounts, firms simply cannot pay enough attention to their current compensation practices to make FINRA happy. The industry seems inexorably sliding towards a “best interest of the client” standard, and one of the easiest ways for a regulator to demonstrate an indifference to that standard is the use of pricey fee/pay structures. So, if even if you find FINRA’s questions to be wholly inapplicable to your business, at least this one should strike home.
Remember, FINRA has stated its goal with this Letter is merely “to better understand industry practices and determine whether firms are taking reasonable steps to properly establish and implement their own cultural values within the firm.” But, history teaches that it is a very short trip from merely “understanding” industry practices to examining them, and then to enforcing them. So ignore this Letter, even if it seems completely off-target, at your own peril.
 Interestingly, the one difference between the two iterations of the definition is that the first time it was used, in the 2016 Exam Priorities Letter, FINRA referred to “firm executives, supervisors and employees.” In the Targeted Exam Letter, however, FINRA simply used “employees,” suggesting, perhaps, that firm culture should be embraced at all levels, not just at management levels.