Regulation and Compliance Federal Regulation FINRA

5 Hot Topics for FINRA Exams in 2022

by Melanie Waddell
News October 14, 2022 at 10:52 AM

The Financial Industry Regulatory Authority released Wednesday its 2022 exam report, which details the initial findings from its exams of broker-dealers' compliance with Regulation Best Interest and rules around the customer relationship summary, or Form CRS.

1. Firm Short Positions and Fails-to-Receive in Municipal Securities

Customers may receive taxable, substitute interest instead of the tax-exempt interest they were expecting when a firm effects sales to customers of municipal securities that are not under the firm's possession or control. This can occur when firm trading activity inadvertently results in a short position or a firm fails to receive municipal securities it purchases to fulfill a customer's order.

Firms must develop and implement adequate controls and procedures for detecting, resolving and preventing these adverse tax consequences to customers. Such procedures must include closing out fails-to-receive within the time frame prescribed within Municipal Securities Rulemaking Board (MSRB) Rule G-12(h) and confirming that their communications with customers regarding the tax status of paid or accrued interest for municipal securities are neither false nor misleading, in accordance with MSRB Rule G-17.

Deficiencies Found

  • Inadequate controls and procedures: Not maintaining adequate procedures and controls for preventing, identifying and resolving adverse consequences to customers when a firm does not maintain possession or control of municipal securities that a customer owns.
  • Inadequate lottery systems: Opting to use a random lottery system to allocate municipal short positions to certain customer accounts, but the system did not fairly or adequately account for or allocate substitute accrued interest payments.
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2. Trusted Contact Persons

For each of their non-institutional customer accounts, firms are required to make a reasonable effort to obtain the name and contact information for a trusted contact person (TCP) age 18 or older.

Deficiencies Found

  • No reasonable attempt to obtain TCP information and not providing a written disclosure explaining the circumstances under which the firm may contact a TCP when seeking to obtain TCP information.
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3. Funding Portals and Crowdfunding Offerings

The SEC's Regulation Crowdfunding and FINRA's corresponding set of funding portal rules set forth the principal requirements that apply to funding portal members.

Funding portals must register with the SEC and become a member of FINRA. Broker-dealers contemplating securities sales in reliance on the crowdfunding exemptions must notify FINRA.

Deficiencies Found

  • Failure to obtain attestation: Not obtaining the attestation required by Regulation Crowdfunding Rule 404 when using a third-party vendor to store the required records
  • Missing disclosures
  • Failure to report customer complaints
  • Untimely required filings.
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4. Disclosure of Routing Information

Rule 606 of Regulation NMS requires broker-dealers to disclose information regarding the handling of their customers' orders in NMS stocks and listed options. These disclosures are designed to help customers better understand how their firm routes and handles their orders, assess the quality of order handling services provided by their firm, and ascertain whether the firm is effectively managing potential conflicts of interest that may affect routing decisions.

Deficiencies Found

  • Inaccurate quarterly reports
  • Incomplete disclosures
  • Deficient communications
  • Insufficient written standard procedures.
(Image: Shutterstock)

5. Portfolio Margin and Intraday Trading

FINRA Rule 4210(g) (Margin Requirements) permits member firms to apply portfolio margin requirements — based on the composite risk of a portfolio's holdings — in margin accounts held by certain investors as an alternative to "strategy-based" margin requirements. Firms are required to monitor the risk of the positions held in these accounts during a specified range of possible market movements according to a comprehensive written risk methodology.

Deficiencies Found

  • Inadequate monitoring systems
  • Not promptly escalating incidents related to elevated risk exposure in portfolio margin accounts to senior management
  • Insufficient written standard procedures.
(Image: Adobe Stock)

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