Fri, Dec 8, 2023

The official Financial Regulation Journal of SAIFM

FINRA 2018 Annual Regulatory and Examination Priorities Letter Makes No Mention of a Fiduciary Duty for Brokers


Sandra D. Grannum, Fred Reish, James G. Lundy and Jamie L. Helman






FINRA released its 2018 Annual Regulatory and Examination Priorities Letter (Priorities Letter) on January 8, 2018. While FINRA advises that it can change its priorities in response to circumstances, the purpose of the Priorities Letter is to permit broker-dealers to plan their compliance, supervisory and risk management programs and to prepare for FINRA examinations. Therefore, this Priorities Letter is significant both in what it says and in what it has chosen not to say including failing to discuss FINRA’s views regarding a “fiduciary standard.”

For 2018, FINRA will focus on:

  • Fraud – including insider trading, microcap pump and dump schemes which target seniors, issuer fraud and, Ponzi schemes;
  • High-Risk Firms and Brokers – hiring and training practices, including the danger “firms and brokers pose to investors, including unsophisticated or senior investors” with a “focus on recommendations for speculative or complex products by high-risk brokers to investors who may not have the necessary sophistication, experience or investment objectives;”
  • Operational and Financial Risks – business continuity planning, customer protection and verification of assets and liabilities, technology governance, cybersecurity, anti-money laundering, liquidity risk and Short sales;
  • Sales Practice Risks – suitability, initial coin offerings and cryptocurrencies, use of margin and securities backed lines of credit;
  • Market Integrity – manipulation, best execution, regulation SHO, fixed income data integrity, options, market access, alternative trading system surveillance, and report cards; and,
  • New Rules
    • Financial Exploitation of Specified Adults: FINRA Rule 2165 (effective February 5, 2018).
    • Amendments to FINRA Rule 4512 requireing members to make reasonable efforts to obtain the name of and contact information for a trusted contact person for a non-institutional customer’s account. (effective February 5, 2018).
    • The Financial Crimes Enforcement Network (FinCEN)’s Customer Due Diligence Rule (CDD Rule): Firms have until May 11, 2018, to comply with FinCEN’s CDD Rule.9. FinCEN issued the CDD Rule to clarify and strengthen customer due diligence for covered financial institutions, including broker-dealers. In the CDD Rule, FinCEN identifies four components of customer due diligence: (1) customer identification and verification; (2) beneficial ownership identification and verification; (3) understanding the nature and purpose of customer relationships; and (4) ongoing monitoring for reporting suspicious transactions and, on a risk basis, maintaining and updating customer information.
    • Amendments to FINRA Rule 2232 (Customer Confirmations): requiring mark-up or mark-down; a reference, and/or a FINRA hyperlink containing publicly available trading data for the specific security that was traded and (2) the execution time of the transaction, expressed to the second. (effective May 14, 2018).
    • Amendments to FINRA Rule 4210 establishing margin requirements for covered agency transactions including to-be-announced (TBA) transactions, inclusive of (1) adjustable rate mortgage (ARM) transactions, (2) specified pool transactions, and (3) transactions in collateralized mortgage obligations (CMOs); issued in conformity with a program of an agency or government-sponsored enterprise (GSE) (effective June 25, 2018).
    • Consolidated FINRA Registration Rules: The consolidated FINRA registration rules (FINRA Rules 1210 through 1240) (effective October 1, 2018.)

It is clear that FINRA intends to spend a significant amount of time ensuring that senior investors are protected. In fact, FINRA indicates that an area of focus will be the “rollovers of qualified plans into non-qualified accounts [Individual Retirement Accounts (“IRA”)] for senior investors.”

The Department of Labor (DOL) Fiduciary Duty Rule has been a focus of industry discussion for the past two years and became applicable on June 9, 2017. That rule mandates that rollover recommendations to IRAs, which will be one of FINRA’s area of focus, are subject to a fiduciary standard. However, nowhere in FINRA’s Priorities Letter is there any discussion of a “fiduciary duty” or supervision of such a duty. Rather, FINRA reemphasizes that these rollover recommendations will be reviewed under the industry’s “suitability” standard:

Employer-sponsored retirement plans play a critical role in many individuals’ retirement planning and for this reason will be an important area of focus for FINRA. In this regard, FINRA will focus on the suitability of firms’ and registered representatives’ recommendations made to plan participants, including Individual Retirement Account rollover recommendations involving securities transactions. [Emphasis added].

Regulatory Notice 13-45 governs rollovers to IRAs and sets forth the items which FINRA mandates brokers consider in his/her suitability analysis regarding rollovers. Interestingly, those items are virtually identical to the DOL’s listed factors for the best interest standard of care relating to rollovers. Yet the DOL is not mentioned in the Priorities Letter.

Similarly, FINRA does not discuss “conflict of interest” with regard to recommendations relating to retirement funds. Instead, the only discussion of “conflict of interest” in FINRA’s Priorities Letter is one relating to best execution and the pricing of fixed income securities (retirement accounts are not distinguished, nor is broker compensation mentioned). FINRA advises that:

FINRA 2018 Regulatory and Examination Priorities Letter will review how broker-dealers manage the conflict of interest that exists between their duty of best execution and their own financial interests, including whether the broker dealers’ procedures provide for a regular and rigorous evaluation of the execution quality they are likely to obtain from the market centers trading a security. We will also expand our review of execution quality and fair pricing in fixed income securities. For example, we expect to implement surveillance patterns that focus on fair pricing and best execution in transactions in Treasury securities.

FINRA has emphasized that the standard of its review for 2018 will be its own standard of “suitability.” This may be FINRA reasserting its dominance over enforcement actions against broker-dealers or it may merely be FINRA’s deference to the SEC to lead the way in establishing a fiduciary standard. The SEC has not yet issued its priorities letter and FINRA may adjust its focus if the SEC indicates that a fiduciary duty standard will be enforced in 2018.

However, for now FINRA will review broker-dealers under a “suitability” standard.

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