Part 1: Broker-Dealers – What’s Your Priority for 2014?

With 2013 behind us, now is as good a time as any for broker-dealers to prioritize the higher risk areas of their compliance programs.  As FINRA and the SEC have already begun their announcement calls for their 2014 examination program, there truly is no rest for the regulatory weary.  FINRA and the SEC recently issued 2014 Examination Priorities Letters to help you focus and allocate your resources to the higher-risk areas of your business and the areas that may be assessed in your upcoming examination.

Suitability and complex products, leveraged loan products, structured products, leveraged exchange-traded funds and notes, variable annuities, cyber-security and data integrity, private placements, anti-money laundering, insider trading, margin lending practices, leverage and liquidity, algorithmic trading, high frequency trading, and alternative trading systems – where do you start?

Here’s an overview of some of the areas that FINRA or SEC examinations may focus on at your firm in the coming year.

Disclosure, Interest Rates, and the New Frontier

FINRA remains concerned about the suitability of recommendations to retail investors for complex products. Complex products disclosures, overconcentration in interest-rate-sensitive products and frontier fund risks are three areas where FINRA has placed an increased focus for 2014.

When in doubt, disclose – Given the growth of complex products, FINRA examination staff will continue to focus on the way in which firms disclose product risks to customers and the policies and procedures around those disclosures. Firms should evaluate their training efforts in this area to ensure that registered representatives are providing a balanced discussion of the product risks and potential scenarios that may result in customer losses.

Interest rates, nowhere to go but up – As today’s record low interest rates will not last forever, FINRA has encouraged firms to consider the downside risks to interest-rate-sensitive products and the equities markets that could result from a sudden shift in the interest rate environment. Firms should evaluate customers that have near-term liquidity needs that are highly concentrated in higher duration, fixed-income products. Brokers should be proactive about discussing interest-rate risk with their clients and document client conversations accordingly.

Frontier funds, the new emerging markets – Coming off a disappointing year for emerging market funds due to “taper talk” in the U.S. and slowing growth for emerging market countries, investors may look to frontier markets such as Vietnam, Kuwait and Nigeria for above market returns. FINRA warns of the heightened risks associated with these markets given political instability, liquidity risk and lower regulatory standards.

Wolf in Sheep’s Clothing

Think twice before hiring brokers with a history of complaints or disclosures for sales practice issues. FINRA will expand its High Risk Broker Initiative in 2014 and create a dedicated enforcement team to expedite the prosecution of recidivist brokers. FINRA examinations will evaluate firms’ hiring efforts, heightened supervision, and trading practices of such brokers. In our next blog post, we will look at Conflict Management and the recent expansion of FINRA’s anti-money laundering team.