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FINRA's New Target: Broker Culture

Get ready for your close-up.

As FINRA examiners make their rounds this year, they will put firms’ culture under the microscope. Wall Street’s chief regulator is turning its attention to the tone set by senior leaders and supervisors, asking whether the culture they create supports compliance, risk management and ethical conduct throughout the organization.

The industry regulator on Tuesday published its annual letter outlining its examination priorities for the new year, putting the industry on notice that, along with firm culture, FINRA examiners will be looking broadly at issues around supervision and liquidity, as well as a host of other areas ranging from cybersecurity to how brokers work with elderly clients.

In a statement accompanying the exam-priorities letter, FINRA CEO Richard Ketchum explains that the focus on culture comes in response to the failure of too many firms to establish a compliance-driven ethos that rejects self-dealing and where brokers and advisors consistently place clients' interests ahead of their own.

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"Nearly a decade after the financial crisis, some firms continue to experience systemic breakdowns manifested through significant violations due to poor cultures of compliance," Ketchum says. "In 2016, FINRA will be looking for firms to focus on their culture and whether it is putting customers first and promoting risk management adaptable to a changing business environment."


While FINRA says that it plans to "formalize" its method for assessing a firm's culture in 2016, the industry regulator insists that it is not going to be overly prescriptive and hold brokers to a one-size-fits-all standard for what an appropriate culture should look like.

"Our goal is not to dictate a specific culture, but rather to understand how each firm's culture affects compliance and risk management practices," Ketchum says.

At the same time, FINRA is working toward a more objective set of criteria to evaluate the culture of a firm, and says that it will complete the review of incentives and conflicts of interest in the retail brokerage sector that it began late last year. Through those sweep exams, FINRA has been collecting information on how firms navigate conflicts of interest in areas like proprietary products and the compensation structure for registered reps. The mechanism for evaluating a firm's culture that FINRA expects to finalize in 2016 will draw on five criteria:

  • Whether control functions are valued within the organization
  • Whether policy or control breaches are tolerated
  • Whether the organization proactively seeks to identify risk and compliance events
  • Whether immediate managers are effective role models of firm culture
  • Whether sub-cultures (such as at a branch office or trading desk) that may not conform to overall corporate culture are identified and addressed

FINRA explains that it expects firms to take "visible actions" to mitigate conflicts of interest and promote the clients' interests, and to adopt a zero-tolerance policy for violations of the organization's protocols.
Additionally, FINRA intends to focus on the four areas where it has observed firms falling down in their supervisory procedures:

  • Conflicts of interest
  • Technology
  • Outsourcing
  • Anti-money laundering programs

Cybersecurity will be a chief focus as examiners review firms' technology operations. Officials at FINRA and the SEC have been warning the industry to sharpen its focus on protecting information systems and client data in the face of constantly evolving and widely varied cyber threats.
"While many firms have improved their cybersecurity defenses, others have not — or their enhancements have been inadequate," FINRA cautions in its letter.


FINRA is advising firms that examiners will be considering a host of cyber issues in their reviews, including governance, risk assessment, technical controls and staff training.

Those reviews will also consider how firms work with third-party vendors, part of a larger focus on the role of outsourcing in the brokerage sector that touches on conducting due diligence on outside service providers and ensuring that essential functions continue to be performed by "qualified registered persons."

FINRA says it will also continue to probe firms' liquidity policies, looking to ensure that brokerage houses have contingency plans to manage funding and liquidity risk that are appropriate to their business model.

Other areas of concern that FINRA has identified include the suitability of product recommendations, especially in the arena of new or complex investment vehicles such as alternative mutual funds or structured products. FINRA is also cautioning about excess concentration of clients' holdings in certain products that could create unwarranted risk.

FINRA notes that abuse of older investors is an area of persistent concern, recently highlighted by a report on the senior helpline the organization established last year. In fielding those calls, FINRA documented repeated instances of seniors falling victim to abuse or fraud at the hands of a trusted confidant, in some cases their financial advisor.

"We have seen products recommended that are not suitable for an elderly investor but provide high commissions and payouts to the salesperson," the regulator says. "FINRA urges firms to monitor investors' accounts for red flags of possible abuse, such as overly aggressive investments or unusual asset movements, including to recipients outside of the country."

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