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On July 8, FINRA released a targeted examination letter it sent to 10 firms to assess their compliance with requirements related to order routing and execution quality of customer orders in exchange listed stocks during the period of January 1, 2014 to present. The letters include numerous requests for information, including requests that each firm explain: (i) how it uses reasonable diligence to ascertain the best market for orders that the firm routes for execution to an exchange, or broker-dealer, so that the resultant price is as favorable as possible for its customer under prevailing market conditions; (ii) how the firm’s exchange order-routing decisions are made for customer non-marketable, customer market, and marketable limit orders; and (iii) how the firm reviews the execution quality of such orders. The letters also include requests related to each firm’s use of the “Smart Order Router.”
On February 21, the SEC released an administrative order against a foreign financial institution that provided cross-border securities services to thousands of U.S. clients. The SEC asserted that the institution’s employees traveled to the U.S. to solicit clients, provide investment advice, and induce securities transactions despite not being registered to provide brokerage or advisory services. The order states that over a period of at least seven years, the institution served as many as 8,500 U.S. client accounts that contained an average total of $5.6 billion in securities assets. The institution admitted it was aware of federal broker-dealer and investment adviser registration requirements related to the provision of certain cross-border broker-dealer and investment adviser services to U.S. clients. After another foreign institution became subject to a federal investigation for similar activities, the institution began to exit the business, though the SEC order states it took years to do so. The order requires the company to disgorge more than $82 million, pay more than $64 million in prejudgment interest, and pay a $50 million civil penalty. In addition, the institution must retain an independent consultant to, among other things, confirm the institution has completed the termination of the business, and evaluate policies and procedures that could detect and prevent similar activity in the future.
On January 9, the SEC National Examination Program (NEP) published its examination priorities for 2014. The NEP’s market-wide priorities include (i) fraud detection and prevention; (ii) corporate governance and enterprise risk management; (iii) technology controls; (iv) issues posed by the convergence of broker-dealer and investment adviser businesses and by new rules and regulations; and (v) retirement investments and rollovers. The NEP also identifies priorities for specific program areas, including (i) investment advisers and investment companies; (ii) broker-dealers; (iii) clearing and transfer agents; (iv) market oversight program areas; and (v) clearance and settlement. For example, for the investment advisers and investment companies program area, the NEP plans to focus on certain emerging risks including (i) advisers who have never been previously examined, including new private fund advisers, (ii) wrap fee programs, (iii) quantitative trading models, and (iv) payments by advisers and funds to entities that distribute mutual funds.
On January 2, FINRA outlined certain specific areas of concern the independent regulator intends to focus on in 2014. The topics are largely consistent with FINRA’s 2013 priorities and are grouped in several categories: (i) business conduct; (ii) fraud; (iii) financial and operational; and (iv) market regulation. Under business conduct, for example, FINRA explains that it remains concerned about the suitability of recommendations to retail investors for complex products whose risk-return profiles may be difficult for investors to understand. FINRA lists numerous specific products it intends to scrutinize with regard to suitability. FINRA also intends to focus on, among other things, conflicts of interest, cybersecurity, anti-money laundering, and senior investors.
On November 12, FINRA released an enhanced version of BrokerCheck, its online system that allows investors to research the professional background of investment professionals. The enhancements allow investors to search both the BrokerCheck and Investment Adviser Public Disclosure record of any securities professional or firm directly on the FINRA homepage. Additional changes were made to present data in a more user-friendly format.
On October 14, FINRA released a report on conflicts of interest in the broker-dealer industry, stating that the report is intended to identify potential problem areas and highlight effective conflicts management practices that may go beyond current regulatory requirements. The report identifies the components of an effective conflicts management framework, which include, for example (i) identifying and managing conflicts on an ongoing basis through an enterprise-level approach that is scaled to the size and complexity of a firm's business, (ii) establishing new product review processes that provide independent perspectives and identify potential conflicts raised by new products, (iii) minimizing conflicts in compensation structures between customer and broker or firm interests where possible, and (iv) including "best-interest-of-the-customer" standards in codes of conduct that apply to brokers' personalized recommendations to retail customers.
On July 31, the SEC approved a final rule that amends certain broker-dealer annual reporting, audit, and notification requirements. The amendments require, among other things, (i) that broker-dealers conduct audits in accordance with PCAOB standards, (ii) that broker-deals that clear transactions or carry customer accounts agree to allow the SEC or the broker-dealer’s designated examining authority (DEA) to review the documentation associated with certain reports of the broker-dealer’s independent public accountant and to allow the accountant to discuss the findings relating to the reports of the accountant with those representatives when requested in connection with a regulatory examination of the broker-dealer, and (iii) that broker-dealers file a new form with their DEA that elicits information about the broker-dealer’s practices with respect to the custody of securities and funds of customers and non-customers. Broker-dealers are required to begin filing new quarterly reports with the SEC and annual reports with the Securities Investor Protection Corporation by the end of 2013, and must begin filing annual reports with the SEC June 1, 2014. The SEC also approved amendments to the net capital, customer protection, books and records, and notification rules for broker-dealers. Those amendments take effect 60 days after publication in the Federal Register.
On June 21, the SEC approved a change to FINRA’s rules that will allow the self-regulatory organization to publish greater information about FINRA’s disciplinary actions. Under existing rules, FINRA only releases disciplinary actions upon request, unless the action meets specified criteria established for use in determining whether an action is worthy of publication. Once the new rules take effect – likely several months from now – those publication criteria will be removed, and most FINRA disciplinary actions will be released as a matter of course. FINRA will retain authority to redact information to protect privacy of individuals. The new rules also update and codify FINRA’s practices related to the publication of other FINRA actions, including temporary cease and desist orders, statutory disqualification decisions, expedited proceeding decisions, summary actions, and others.
On June 12, the DOJ and the SEC announced additional charges in a previously announced case against employees of a U.S. broker-dealer related to an alleged “massive international bribery scheme.” The DOJ unsealed criminal charges against a third employee of the broker-dealer who allegedly arranged bribe payments to a Venezuela state economic development bank official in exchange for financial trading business for the broker-dealer. The SEC, whose routine compliance examination detected the allegedly illegal conduct, announced parallel civil charges.