FINRA Exec Lays Out FINRA’s Enforcement Agenda


On October 24, 2012, Susan Axelrod (FINRA’s executive vice president, member regulation sales practice) spoke at PLI’s seminar for broker-dealer regulation and enforcement. Broker-dealers and registered representatives should take note because FINRA’s enforcement agenda was made clear. Issues of concern for FINRA include:

Cyber Security

FINRA has seen an uptick in instances where a customer’s email account has been hacked and the perpetrator sends a phony email to a brokerage firm requesting an outbound wire transfer. Given that NASD Rule 3012 requires diligent supervision concerning the outbound transmittal of funds, FINRA requested that “broker-dealers reassess their policies and procedures for accepting instructions to withdraw or transfer funds via electronic means to ensure that they are adequately designed to protect customer accounts from the risk that customers’ email accounts may be compromised and used to send fraudulent transmittal or withdrawal instructions.” (FINRA Regulatory Notice 12-05). In that Notice, FINRA recommended that firms verify that the email was sent by the customer and adopt policies to identify “red flags” such as transfer requests that are out of the ordinary or to an unfamiliar third-party account.

Complex Products

FINRA examiners are focused on principal-protected notes, non-traded REITs, reverse-convertible notes, structured notes, and leveraged and inverse ETFs. Over the years, FINRA has issued various regulatory notices concerning these products and others, including Notice to Members 05-50 (equity-indexed annuities), Notice to Members 05-59 (structured products), Regulatory Notice 09-31 (leveraged and inverse ETFs), Regulatory Notice 09-73 (principal protected notes), Regulatory Notice 10-09 (reverse convertibles), and Regulatory Notice 10-51 (commodities futures linked securities).

According to Axelrod, these products require “more scrutiny and supervision” by a broker-dealer including enhanced due diligence prior to approving the product for sale to customers. Due diligence guidance for new products is found within Notice to Members 05-26, which recommends documenting a “new product” review by considering to whom the product can be sold, what kind of training must be required of the sales force, and what kind of market conditions must exist for the approval to remain effective. FINRA also recommends documenting a “post-approval review” to reassess the suitability of the product and enforce any conditions which may have been placed on the sale of the product.

New Suitability Rule and Know Your Customer Rule

FINRAs new suitability rule (Rule 2111) went into effect in July 2012 and we blogged about the rule in advance of the effective date. The new rule requires reasonable basis suitability (the broker must understand the product), customer-specific suitability (the security or strategy must comport with the customer’s risk profile), and quantitative suitability (no churning or excessive fees). Further, the rule covers any recommendation to “hold” a security, not just “buy” or “sell.”

Axelrod noted that “although not a specific requirement of the rule”, some broker-dealers have implemented a “hold” ticket to memorialize an explicit hold recommendation. Further, FINRA examiners are looking for updated policies and procedures to account for Rule 2111 as well as Rule 2090 (know your customer). Robert L. Herskovits, Esq. 1065 Avenue of the Americas 27th Floor New York, NY 10018 Tel: (212) 897-5410 Fax: (646) 558-0239

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