The Financial Industry Regulatory Authority’s annual regulatory and examination priorities letter, released on Monday, points to some old, perennial issues firms should pay close attention to, including high-risk brokers, fraud and cybersecurity. But the regulator also flagged some areas of focus for 2018, including cryptocurrencies, securities-backed lines of credit and business continuity planning.
Cryptocurrencies and initial coin offerings have gained significant media attention and popularity in recent months, and FINRA said it will also pay close attention to new developments in the space, including the role firms and brokers may play in transacting such assets.
“As with any new asset class, for lack of a better word, especially one that tends to rise in value without really any basis, it makes sense for FINRA just to shoot a warning shot across the bow of firms to say, ‘Look, to the extent you’re going to be involved in any of this sort of stuff, pay attention, make sure you understand what it is you’re involved in, make sure you understand what your customer’s objectives [are] when they’re getting involved in these things, and understand that we’ll be looking at it,’” said Mark Knoll, an attorney with Bressler, Amery & Ross’s securities law practice group.
When an initial coin offering involves the offer and sale of securities, FINRA said it may review the supervisory, compliance and operational infrastructure that the firms have in place.
Currently, none of the four wirehouses allow their advisors to purchase cryptocurrencies.
FINRA said it will also focus on firms’ compliance with sales practice and operational obligations that apply to securities-backed lines of credit, loans collateralized by the underlying assets in an investor’s nonretirement brokerage account. Many high-net-worth investors are demanding this service from advisors, and it’s becoming more widespread.
The regulator writes that firms need adequate disclosures of the risks of such loans, such as the impact of a market downturn, the tax implications if pledged securities are liquidated, and the effect of rising interest rates.
“Firms must also be alert to red flags indicating that proceeds of an SBLOC are possibly being used to purchase or carry margin stock and follow-up to ensure that they are not improperly arranging credit,” FINRA said.
In light of Hurricanes Harvey and Maria, the letter reminded firms of FINRA Rule 4370, which requires them to maintain business continuity plans. The regulator said it will review firms’ plans.
A lot of firms put such plans in place after 9/11, Knoll said.
“Now that we are going on 16, 17 years since then, a lot of firms who put in a plan back in 2004 or 2005, it’s probably worthwhile for them to go and take a look at it again,” he said.
Another big area of focus for FINRA—while not new—is high-risk firms and brokers. Knoll said this is still an area firms are struggling with.
“They still have not clearly identified who they are going to consider to be ‘high-risk individuals,’” he said. “Are these all individuals from firms that have had disciplinary records, even if their particular records are clean? Are they talking about somebody that comes over from any firm with one customer complaint or with one settled action?”
FINRA puts that burden on firms to identify them and then put in appropriate heightened supervision procedures.
