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Microcap schemes, high-risk brokers in FINRA's crosshairs

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FINRA has alerted brokers that it will be using its examinations in 2018 to crack down on a growing wave of investment schemes involving microcap stocks.

The regulator issued its customary January priorities letter, detailing the issues that will guide its examination activity and pledging ongoing reforms in the regulator's operations.

Fraud is a perennial issue for FINRA, but officials lately are focusing on a wave of microcap schemes, in particular those that target senior investors using high-pressure sales tactics.

"Firms should be attentive to their brokers' activity in microcap stocks, particularly when brokers show a new or sudden interest in buying microcap stocks for their own accounts or those of their customers," FINRA cautions in the letter.

FINRA is also reminding firms that they are expected to file suspicious activity reports when they suspect that a senior investor is the victim of a scam. In February, a new rule will take effect authorizing firms to place temporary holds on clients' funds when they believe that a senior or other vulnerable adult is the victim of financial exploitation.

Advisors should expect more regulatory requirements, enforcement actions and uncertainty in 2018, experts say.
December 11

The focus on high-risk brokers mirrors the initiatives at both FINRA and the SEC to concentrate the limited resources of the examination teams on the firms and individuals that engage in the riskiest activity. FINRA is planning to scrutinize how firms handle the hiring and supervision of high-risk brokers, especially individuals who work outside of the main office.

FINRA says it is alarmed about the sale of complex products to unsophisticated investors, and is also looking at arrangements in which a registered rep has control of a client's finances as a trustee or through a power-of-attorney agreement. FINRA requires firms to maintain a customized supervision protocol regarding high-risk individuals.

In a letter accompanying the statement of priorities, FINRA President and CEO Robert Cook pledged that 2018 would be a year of "continuity and change in FINRA's programs."

FINRA's mission of protecting investors and promoting market integrity will hold steady, Cook says. "Change will come in how we accomplish that mission," he says. Cook is looking ahead to continued organizational reforms in FINRA's operations and exam regime that seek to make the outfit a more efficient regulator, an effort formalized last year under the FINRA360 program.

Under that program, FINRA moved to consolidate its enforcement operations into a single unit, and is looking to further change the functions of its advisory committees.

FINRA is also pursuing reforms to its exam program in a bid to "better align examination resources to the risk profile of our member firms," Cook says. Cook is also calling for FINRA examiners to improve how they share information with the firms they are scrutinizing, and he is looking to enhance examiner training.

In addition to the warnings about fraud and high-risk brokers, FINRA's letter runs through a litany of other issues that examiners will be looking into, including the policies firms have in place around their technology systems, anti-money laundering programs and cybersecurity.

Among the risks associated with firms' sales practices that FINRA is scrutinizing, the suitability of investment recommendations tops the list.

"As the number and complexity of products available to investors continue to increase," FINRA says, examiners "will continue to assess the adequacy of firms' controls to meet their suitability obligations."

In particular, examiners want to see how firms are vetting new and complex products and identifying risks before making a recommendation to clients, FINRA says.

Regulators are also focused on the investor harm that arises with reverse churning, where an advisor moves a client from the brokerage wing of the firm to the advisory side in a bid to collect fees on accounts that aren't bound for active trading.

"FINRA will review situations in which registered representatives recommend a switch from a brokerage account to an investment advisor account where that switch clearly disadvantages the customer," FINRA says, "such as where the registered representative recommended that the customer purchase a securities product subject to a front-end sales charge in a brokerage account and then shortly thereafter recommended that account be transferred to a fee-based account."

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