FINRA has released its 2020 Risk Monitoring and Examination Priorities Letter highlighting new areas of focus and identifying areas of ongoing concern (including sales practice risks, senior investors, cybersecurity, AML, order routing, and market manipulation). Among the primary newer areas of concern are:
(1) Regulation Best Interest (Reg BI) and Form CRS;
(2) LIBOR transition;
(3) cash management and bank sweep programs;
(4) communications via digital channels and concerning private placements; and
(5) regulating digital assets.
FINRA also reminded that, in April, firms will be required to begin reporting transactional data to the Consolidated Audit Trail (CAT). Once reporting begins, FINRA will begin surveillance and investigations to review compliance with CAT requirements. Below are summaries of FINRA’s new areas of emphasis:
Reg BI and Form CRS
Firms are required to comply with Reg BI by June 30, 2020. During the first part of 2020, FINRA will review firms’ preparedness to implement Reg BI, including its requirement to provide clients with new Form CRS (Client Review Summary). During this process, firms should communicate any challenges they have encountered with Reg BI preparations. FINRA exams post-June 30, 2020 will focus on firms’ policies and procedures, training, and supervision, as well as examining how the best interest standard is being applied to recommendations – including recommendations as to the type of account a client maintains. (For further guidance, see: https://news.bloomberglaw.com/us-law-week/insight-lawsuits-or-not-secs-reg-bi-rule-is-coming-and-firms-must-prepare)
LIBOR Retirement and Alternative Rate Transition
FINRA will be contacting member firms in an effort to understand how the industry is preparing to transition from LIBOR, which will be retired by 2022. FINRA will focus on customer and firm exposure to LIBOR-linked products, including corporate and municipal bonds, asset-backed securities, interest rate swaps and other derivatives, as well as how firms are planning to transition to alternative rates such as the Secured Overnight Financing Rate (SOFR). Firms should also expect FINRA to review identified risks and planned mitigation efforts related to LIBOR-affected contracts that extend beyond 2021.
Cash Management and Bank Sweep Programs
FINRA believes cash management services that sweep customers’ cash into firm-affiliated banks or money market funds raise concerns over compliance with several FINRA and SEC rules. While acknowledging that these programs offer useful features to customers (higher interest rates, check writing, debit cards), FINRA will be reviewing firms’ documentation and disclosures, including whether firms clearly communicate other available cash management alternatives, the nature of the sweep arrangement, and the risks of the sweep program. FINRA will also be looking for any misleading or incorrect implication that bank sweeps are similar to or the same as bank checking or savings accounts, or that they are insured by the FDIC.
Communications with the Public
i. Private Placement Retail Communications - FINRA is focused on how firms supervise, approve and distribute communications regarding private placement securities. Exams will focus on the nature and accuracy of the material information which is disclosed to retail clients, whether they contain false or predictive language and whether risks are adequately disclosed.
ii. Communications via Digital Channels - Due to an increasing array of digital communication formats, FINRA will examine how firms supervise certain types of means by which registered representative communicate with customers, e.g., social media, text messaging and collaborative applications. Exams will focus on firms’ processes for evaluating new communication channels as well as their supervisory procedures. Specifically addressing supervision, FINRA advises that it will be examining whether firms’ routine communications reviews are identifying “red flags” that may indicate use of unapproved communications channels. Also under review will be the manner in which firms evaluate, review and store communications data and whether firms are complying with their books and records obligations.
Regulating Digital Assets and Cryptocurrency-related Securities
FINRA continues to focus on cryptocurrencies and the complex regulatory issues they raise. FINRA has received an increasing number of New Member Applications and Continuing Member Applications (CMAs) from firms wanting to engage in activities related to digital assets, including private offerings, secondary platform operations and clearance/settlement of transactions related to digital assets. FINRA’s exams will focus on whether existing firms have filed a CMA to engage in digital asset activities, the truth and accuracy of risk disclosures in materials marketing digital assets to retail customers, and whether firms are accurately disclosing when offerings of digital asset services are made through an affiliated entity and are not being supervised, cleared or in the custody of a registered broker-dealer.
To put FINRA’s priorities in context, it is useful to consider whether FINRA focused on similar issues during the past few years. Below is a chart comparing FINRA’s 2018, 2019 and 2020 Priorities Lists.
FINRA expects that firms will incorporate the guidance from the 2020 letter and prior letters into their compliance, supervisory and risk programs.