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FINRA Issues 2019 Examination Findings and Observations

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By Brian Nally

Securities Litigation Newsletter
October 24, 2019

One of my favorite quotes, from Maya Angelou, is “when people show you who they are, believe them.” This is particularly true when regulators, such as FINRA, shows the industry and the public who it is and what it is concerned about. To this end, on October 16, 2019, FINRA issued its 2019 Report on Examination Findings and Observations, which makes public a summary of the key findings from FINRA’s 2019 examination of member firms. Attached is a complete copy of the report. This report provides great insight into what areas of concern FINRA has identified, what they will likely continue to focus on in 2020, and how firms can improve their procedures to avoid any negative regulatory findings. The following is a summary of the material findings contained in the report:

1. Supervision, of course, continues to be a major focus. FINRA noted that firms failed to amend their policies to address new rules and failed to reasonably design branch supervision and inspection. To the latter point, firms should pay close attention to FINRA discussion about firms inadequately tailoring their branch examination programs and supervisory efforts to the specific products and services provided at certain branches, taking into consideration the nature and complexity of the products or services or indicators of irregularities or misconduct. In other words, it is not good enough to carry out a firm-wide approach—even a good one—across all branch offices; rather, firms should perform a more specific analysis of what unique characteristics may exist in particular branches or with registered representatives in the context of carrying out supervision and branch examination programs.

2. FINRA also discussed concerns about how firms inadequately supervised the use of Consolidated Account Reports (CARs) by, specifically, failing to have policies to evaluate whether and when registered representatives used CARs and failing to ensure that information contained in CARs was an accurate reflection of the customer’s assets. This concern stems from FINRA’s concern that firms increasingly provide customers with a single document summarizing the customer’s holdings, regardless of where those assets are held. The use of CARs can also become an issue in customer arbitrations or lawsuits, especially if the CARs were unapproved—which could be used to support a claim for negligent training and supervision—or when they contain inaccurate information that led a customer to believe—which could be used to argue that the customer believed his or her investments had a higher value than what should have been reported. These considerations should be revisited by firms to ensure appropriate policies are in place, appropriate training exists for how the policies should be carried out, and that supervisors are appropriately monitoring the use of CARs.

3. FINRA also noted that firms did not have appropriate procedures in place to detect and prevent various forms of forgery, including signing blank, incomplete, or partial documents or improper use of medallion stamp guarantees or notaries. Signature issues often times can go undetected even under the best supervisory structure, but FINRA’s focus on this issue should remind firms of what they can do. For example, firms can emphasis the policies surrounding signatures through branch examinations, annual compliance questionnaires and attestations, continuing education, and/or other training mechanisms. This is particularly important for firms for policies surrounding the specific use of medallion stamp guarantees or notaries. Documentation surrounding these efforts to educate and train registered representatives on these issues signature issues can sometimes be a firm’s best defense if a registered representative decides to go rogue.

4. FINRA also discussed suitability. FINRA noted concerns about firms failing to maintain procedures to properly monitor product exchanges, including failures to identify patterns of unsuitable exchanges. This can take the form of permitting unsuitable exchanges or failing to detect patterns of exchanges across multiple customers. In a similar regard, FINRA noted that firms were not adequately identifying “red flags” of possible unsuitable transactions, patterns of recommending similar unsuitable recommendations across multiple customers, or patterns surrounding mismarking trade tickets—that is, marking confirms “unsolicited” in identical securities across multiple customers. FINRA also noted that firms often failed to properly monitor changes in customer net worth/income/account objections, sometimes made immediately before an investment recommendation, to avoid supervisory scrutiny. These concerns all related to the fundamental question—what procedures do firms have in place to ensure transactions are suitable for customers under FINRA Rule 2111. Firms should continue to explore how to best monitor their sales practices and patterns, especially as software and data/analytics continue to offer potential solutions to these challenges.

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