Securities Litigation

Every year the Financial Institution Regulatory Authority (FINRA) issues its “Report on FINRA’s Examination and Risk Monitoring Program.” The Report covers issues noted during the prior year’s exams and topics that examiners will look for going forward. It also foreshadows where Enforcement is likely to follow.

FINRA continues to improve the format, making it more user-friendly. This year’s Report highlights new material, includes expanded questions to ask about your firm’s activities, describes best practices, and provides resource links.

NEW FOR 2023

Financial Crimes is a new section, covering some recurrent topics, but with greater emphasis on crime risks and more coordination with regulatory guidance from Treasury’s FinCEN and OFAC units.

Manipulative Trading is a new topic, covering market manipulation noted in small cap IPOs, including pump-and-dump schemes and “pig butchering” scams involving social media, in addition to more traditional concerns such as wash trading and momentum-ignition trades through layering and spoofing.

Cybersecurity and Device Management, continues as an area of escalating concern, this year emphasizing Reg S-ID, which requires firms to have written policies to detect, prevent and mitigate identity theft. The Report also highlights related account security measures and incident disclosure and response.

AML and Sanctions is expanded, noting the 2021 National Defense Authorization Act AML provisions including the Corporate Transparency Act (and FinCEN’s new implementing regulations); OFAC sanctions related to the conflict in Ukraine and FinCEN warnings regarding their evasion; ACATs fraud in connection with account-transfers; and FinCEN warnings on terrorist and proliferation financing.

Fixed Income Pricing is a new topic, addressing adequate determination of prevailing market price, determinations of mark-up/-down, and supervision of fixed-income pricing.

Fractional Shares – Reporting and Order Handling is new, reminding firms of their obligations to report and supervise trading in fractional shares.

Locates for Intraday Covering Trades is new, addressing the inappropriate use (and supervision) of the narrow exception under Reg. SHO allowing true market makers to re-use a “good locate” to cover a second short sale order in the same trading day.

PERENNIAL FAVORITES

The Report always includes some perennial examination favorites, some having remained on the list since its earliest days as the “Errico Letter” to member firms. They include:

OBA, Private Securities Transactions: Outside business activities always make the list. This year highlights firms’ lack of monitoring and documentation, and failure to review digital-asset activities.

Books and Records: The Report always includes recordkeeping. This year notes new undertakings for digital recordkeeping under revised SEC Exchange Act Rule 17a-4, and lack of policies covering all digital channels (e.g. third-party channels, texts, chat), as evidenced by recent enforcement actions.

Trusted Contact Persons: Failure to attempt to obtain as required by FINRA Rule 4512(a)(1)(F) require firms to attempt to obtain a trust contact person for each account. Many do not lack written disclosures and have inadequate training on the issue. FINRA also calls out continuing risks to senior investors and firm obligations regarding elder abuse.

Reg BI and Form CRS: Regulation Best Interest and its accompanying Form CRS are still relatively new (effective June 30, 2020), and FINRA continues to emphasize them. This year, it notes shortcomings on “reasonable basis” obligation to understand products, required disclosures, and inadequate procedures around conflicts of interest.

Communications with the Public: FINRA notes a number of issues with public communications. Mobile apps are in the spotlight, including “gamification” and inappropriate interfaces (e.g. options trading availability without suitability screening) (both continuing from the Robinhood/GameStop episode) and texting/social media enforcement. Crypto is a big concern, with firms falling short in disclosing risks, conflicts of interest, accuracy of representations, and failing to note the lack of SIPA coverage. FINRA notes its 2022 Targeted Exam letter on crypto concerns. Another hangover from the Robinhood/Gamestop episode is inadequate disclosures regarding revenue sharing arrangements. FINRA also is concerned about the adequacy and truthfulness of product ESG claims.

Best Execution: Best execution remains in the spotlight, with conflicts of interest, disclosures of routing information–especially regarding payment-for-order-flow, lack of evaluation of alternative markets and supervision of concern.

Variable Annuities: Perhaps the longest-standing item in the Report, highlights lack of training, suitability of additional deposits, and the usual concerns about product complexity, suitability, and high commissions.

The Report is here.