On January 10, 2023, the Financial Industry Regulatory Authority, Inc. (“FINRA”) released its 2023 Report on FINRA’s Examination and Risk Monitoring Program (the “Report), available at: 2023 Report on FINRA’s Examination and Risk Monitoring Program. The Report details findings from FINRA’s recent oversight activities of the FINRA Member Supervision, Market Regulation and Enforcement programs. This year’s report has several new sections, including Financial Crimes and Fixed Income – Fair Pricing. The new Financial Crimes section consists of three topics – Cybersecurity and Technology Governance, AML, Fraud and Sanctions and Manipulative Trading.
FINRA notes in the Report, they will continue to review member firms’ communications and disclosures made to customers in relation to complex products, and that it will also review customer account activity to assess whether member firms’ recommendations regarding these products are in the best interest of the retail customer.
Focusing on Regulation Best Interest (“Reg BI”), which requires broker-dealers to establish a “best interest” standard of conduct when making recommendations to retail customers of any securities transaction or investment strategy, the Report details a number of considerations and recommendations. The following summary relates to the Report’s observations and effective practices relating to complex products, such as structured notes:
- Reg BI Care Obligation: Has your firm considered applying heightened scrutiny as to whether recommended investments that are high-risk, high-cost, complex or represent a high conflict of interest are in a retail customer’s best interest?
- Effective practices: discussing limitations on complex or higher-risk products, such as firm concentration guidelines or minimum liquid net worth requirements; mitigating the risk of making recommendations that might not be in a retail customer’s best interest by establishing product review processes to identify and categorize risk and complexity levels for existing and new products and applying heightened supervision to recommendations of products, or investment strategies involving securities, that are high-risk, high-cost, complex or represent a high conflict of interest, or limiting such recommendations to specific customer types.
- Reg BI Compliance Obligation: Has your firm considered how it will demonstrate (via documentation or otherwise) it has met its obligations with respect to the basis for recommendations of complex, risky or illiquid securities?
- Effective practices: Monitoring associated persons’ compliance with Reg BI by conducting at least monthly reviews to confirm that their recommendations meet care obligation requirements, including system-driven alerts or trend criteria to identify products that are high-risk, high-cost, complex or represent a high conflict of interest.
The Report summarizes considerations in examinations relating to Rule 2210 (Communications with the Public). On general content standards, firms were asked whether their communications balance specific claims of benefits from a product or service (especially complex products) with the key risks specific to that product or service. Regarding mobile apps, firms were asked if these apps consider detailed customer information—including the customer’s knowledge, investment experience, age, financial situation and investment objectives—when approving access to options or other complex products. Under the heading “Findings – False, Misleading and Inaccurate Information in Mobile Apps,” the Report noted, in the area of communications promoting ESG factors, an example was “including rankings, ratings, or awards that lack a sound basis or are unwarranted or misleading based on the criteria used or factors considered.”
The Report also discusses private placements and variable annuities. A detailed client alert will follow.
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