Suitability and Sales Practice Issues Top FINRA Report
The Financial Industry Regulatory Authority (FINRA) published its 2019 Report on Examination Findings and Observations on October 16, 2019. This marks the third published annual report of FINRA finding which in an unprecedented departure from the prior reports, distinguishes “findings” (determinations that a firm or registered person has violated SEC, FINRA or other relevant rules) from “observations” (suggestions as to how a firm might improve control of its environment).
Sales Practice and Supervision
A major focus of the 2019 Report were supervisory issues, in respect of suitability; digital communication; Anti-money laundering (AML); and Uniform Transfers to Minors Act (UTMA) and Uniform Grants to Minors Act (UGMA) accounts.
Supervision: Generally, FINRA found that some firms lack sufficient written supervisory procedures (WSPs) to adequately address newly adopted or amended rules applicable to their business. While some firms had limited branch supervision, inadequate record-keeping, and insufficient supervision for specific types of accounts (i.e., restricted and insider accounts; margin accounts; option accounts). FINRA also found a lack of understanding of particular products and services offered at certain locations; inspections not tailored to the products and services offered; and instances of inadequate scrutiny of red flags.
Suitability: FINRA found that some firms did not have adequate supervisory systems to determine recommendations satisfactory to the firm’s customer-specific suitability obligation in light of the particular customer’s investment profile (e.g., financial situation and needs, investment experience, risk tolerance, time horizon, investment objectives, liquidity needs). Other findings related to supervisory systems are failures in detecting suspicious trading patterns due to inadequate structures to reasonably determine the suitability of recommendations in the exchange of certain securities (particularly, mutual funds, variable annuities and unit investment trusts) and long-term products (e.g., reviews of trade blotters). Alterations of customers’ account information were also noted.
Digital Communication: Some firms have encountered issues of compliance with supervisory and recordkeeping requirements in respect to the use of digital communications tools, technologies and services. Several have prohibited the use of certain communication channels such as texting, messaging, social media or collaboration applications for business-related communications with customers, but FINRA maintained that they failed to maintain a process to reasonably apprehend registered representatives if they were using prohibited communication channels for firm business. Firms were advised to conduct reviews of customer complaints, registered representatives’ emails, external business activities and advertisements in order to detect the use of prohibited communications channels.
Examples of effective practices cited are the establishment of comprehensive governance processes; defining and controlling permissible digital channels; implementing WSPs to manage video content; implementing mandatory training programs; and disciplining the misuse of digital communications.
AML: The deficiencies in the implementation of systems and processes detecting and reporting suspicious activity violates the provisions under the Bank Secrecy Act and other regulations. FINRA advised careful review and revision of firms AML programs intermittently and scrutiny of securities trade for suspicious activity. FINRA also reiterated the need to monitor third-party wire transactions, and for brokers not to rely excessively on their clearing firms.
UTMA and UGMA Accounts: FINRA indicated that some firms did not satisfy “Know Your Customer” (KYC) obligations under FINRA Rule 2090 with respect to UTMA and UGMA accounts. Several firms did not transfer authority for an account to its beneficiary once they attained the age of majority. FINRA advised implementation of verification procedures for the authority of custodians of UTMA and UGMA accounts and automated tools to track when beneficiaries of those account attain the age of majority; and notify custodians and registered representatives.
