FINRA Resolutions: Financial and Operational Priorities

By Patricia Uceda, Spring 2015 Graduate Research Assistant

In 2015 FINRA has resolved to focus on several areas in order to better serve public investors, including key sales practice, financial and operational, and market integrity matters. We’ve already spoken to you about their key sales practice areas of focus, and today we will be focusing on the financial and operational issues that FINRA intends to highlight in 2015.

Funding and Liquidity: Valuing Non-High-Quality Liquid Assets

FINRA is concerned about the overall valuation process broker-dealers employ to assign prices to securities. They have observed instances where firms’ funding and liquidity plans rely on being able to enter into repurchase transactions at or very near the original prices at which the firms marked their inventory to market. Because of this, FINRA advises that broker-dealers develop funding and liquidity risk management programs in order to ensure that firms are accurately assigning prices to securities. FINRA will be closely examining these types of mark-to-market transactions this year, as well as the supervisory controls in place.

Sales Involving Tax-Exempt or Federal Deposit Insurance Corporation (FDIC)-Insured Products

Broker-dealers who sell tax-exempt securities or FDIC-insured products should have proper controls in place to ensure that firm actions do not cause customers to lose the tax-exempt status or FDIC protection they believe they have. These risks may arise if a firm sells more securities to customers than it has purchased, creating a shortage. In the case of tax-exempt securities, a shortage can result in a customer receiving taxable “substitute interest” from the firm. In the case of FDIC-insured products, a shortage can result in the customer’s product being denied status as an insured deposit from the FDIC if the issuing entity becomes insolvent. In 2015, FINRA plans to examine such short positions in firms and how they are resolved. In addition, they will ensure that adequate supervisory controls are in place to ensure that they do not arise.

Cybersecurity

In 2015 FINRA plans on reviewing firms’ approaches to cybersecurity risk management, an area that has been of growing concern for consumers in today’s technologically advanced society. They want to ensure that firms have proper government structures and processes in place for conducting risk assessments and responding to cybersecurity threats. In January 2014, FINRA initiated a sweep to understand the type of threats to which member firms are subject, as well as the typical responses to those threats. FINRA plans to publish the results of that sweep in early 2015. This report will include principles and effective practices firms should consider in developing and implementing their cybersecurity programs.

Outsourcing

FINRA intends on making outsourcing a key priority area of review in 2015. There has been a huge increase in firms outsourcing key operational functions as a way to reduce overhead expenses and focus on core business activities. FINRA reminds firms that outsourcing activities in no way diminish a broker-dealer’s responsibility for full compliance with all federal securities laws and regulations. FINRA will be examining this area to ensure that firms are performing due diligence and risk assessments on all potential providers, and that they are properly supervising these outsourced activities.

Timely Reporting of Disclosable Information

Timely reporting of disclosable information is a very important requirement for firms and associated persons. This information is published through FINRA’s BrokerCheck and Central Registration Depository (CRD) systems, and it is very important that the information is kept up-to-date for the many investors, regulators, and firms who rely on this information and count on it to be complete and accurate. FINRA regulations require that associated persons and firms promptly disclose to FINRA reportable events including regulatory actions, customer complaints, bankruptcy filings, liens, etc. However, FINRA has found that many firms either fail to report this information or fail to do so in a timely manner. Because of this, FINRA is making changes to its review process and will investigate whether required disclosures are complete, accurate, and made in a timely manner.