FINRA Officials Provide Insight on Enforcement, Examination and Rulemaking Priorities Amid COVID-19 Pandemic

May 22, 2020
Firm Publication

A panel of senior Financial Industry Regulatory Authority (FINRA) officials participated in a webinar Tuesday, May 19, focusing on COVID-19’s impact on FINRA’s enforcement, examination and rulemaking priorities.

The SIFMA-sponsored event included the following FINRA panelists: Robert L.D. Colby, FINRA’s Chief Legal Officer; Thomas Gira, FINRA’s Executive Vice President of Market Regulation and Transparency Services; Bari M. Havlik, FINRA’s Executive Vice President, Member Supervision; and Jessica Hopper, FINRA’s Executive Vice President and Head of Enforcement. Michelle Bryan Oroschakoff, Managing Director and Chief Legal and Risk Officer of LPL Financial LLC, and Nader Salehi, Partner at Sidley Austin LLP, served as the webinar’s moderators.

The webinar covered a wide range of topics and we have summarized some of the key takeaways below.

Virtual Meetings

Colby said that consistent with FINRA’s rules requiring in-person hearings, it has conducted no remote hearings. He said there have been a handful of remotely conducted FINRA arbitrations, but those are the exceptions.

According to Hopper, as soon as the Enforcement Division realized they would be working remotely, FINRA set up an all-remote OTR (on-the-record) interview process. So far, FINRA has conducted 70 entirely remote OTRs and is very happy with the results.

In response to a question, Colby explained that a firm’s provision of food and/or drinks to clients in connection with virtual meetings most likely will be viewed as gifts—not business entertainment—by FINRA.

Increasing Frequency of Fraud Complaints

Hopper noted that FINRA’s COVID-19 fraud task force has seen a recent uptick in complaints of COVID-19-related fraud. These complaints frequently relate to false claims of vaccines and cures for COVID-19. Many of the complaints are outside of FINRA’s regulatory umbrella, however, and have been referred to the SEC.

Supervision of Remote Workers

Havlik explained that FINRA is drafting a regulatory notice relating to the supervision of employees working remotely. The notice will share practices that firms have employed to satisfy their obligations while employees are working remotely, such as tape-recording all calls. She expects the notice to be published in the next two to three weeks. Importantly, FINRA caveated that the purpose of the notice is to share firm practices and not to endorse them, as FINRA has not had the opportunity to evaluate them.

Colby explained that FINRA also is soliciting feedback from firms and committees to evaluate how its rules and practices may be impacted by the increase in remote work. For example, Colby explained that FINRA is examining its rules related to manual signatures and has discussed with the SEC the potential for eliminating the requirement.

Regulation BI

Colby said that Reg BI, the new rule establishing a “best interest” standard of conduct for broker-dealers and associated persons when making recommendations to retail customers, largely supplanted the basic FINRA Suitability Rule 2111. Colby explained that there are certain areas where Rule 2111 will continue to apply, for example, when an institutional customer is involved. Similarly, he noted that other FINRA rules remain applicable to specific securities such as deferred variable annuities (Rule 2330) or options (Rule 2360). In response to a question about the proliferation of state standards on fiduciary conduct, Colby said FINRA is tracking these standards and how they align with Reg BI, but explained that FINRA will not enforce these state standards.

Havlik noted that the first six months of evaluating compliance with Reg BI will focus on evaluating the policies, procedures and controls firms have put in place to comply with the standard, and will provide FINRA an opportunity to provide feedback to the industry. To that end, Hopper added that for now the Enforcement Division is not looking for “gotcha” type cases. Rather, they expect to pursue matters where they formerly would have brought cases under the suitability standard (e.g., excessive trading). It will not be until 2021 when FINRA will take a harder line on enforcing Reg BI. Havlik explained that it will not be enough to simply put new policies and procedures in place, rather FINRA will require that firms engage in supervision to ensure the policies and procedures are being implemented.

Ephemeral Messages

Havlik said that it is FINRA’s view that firms have to devise a way to retain ephemeral communications, just like any other communication. Hopper added that these messages should be treated like any other written communication. Hopper said FINRA has brought several claims in this area, including a recent claim against a registered representative related to that person’s use of “WhatsApp.” She explained that firms must communicate clearly to registered representatives the need to retain the communications and that representatives must understand the requirements.

Compliance Rates

Gira said that FINRA has been pleasantly surprised by the compliance rates across the industry during the pandemic, noting that late-trade reporting and OATS (order audit trail system) compliance remain at 99% or above. Nevertheless, market volatility has caused significant increases in the number of alerts in many areas, including market manipulation, wash sales transactions, spoofing, and layering. FINRA has also seen an increase in the number of account intrusions and encouraged firms to be on the lookout for them, particularly in the options realm. Gira also encouraged firms to review the FINRA report cards to see how their firm is doing.

Consolidation of Enforcement Functions

Hopper said the process of consolidating FINRA’s enforcement functions into a unified enforcement group has gone well and is helping FINRA meet its aim of creating more predictability and uniformity in its enforcement efforts. FINRA is continuing to emphasize clarity in settlement documents and in ensuring that charges described in settlement documents align with sanctions. Hopper encouraged firms that experience multiple ongoing FINRA matters or requests that overlap to inform the FINRA staff members involved, as they might be unaware of the overlap.

Enforcement Priorities

Hopper identified her priorities for enforcement as the same that she articulated in the recently published FINRA podcast, FINRA Enforcement: Protecting Investors and Markets in Good Times and Bad. FINRA aims to be tough but fair in its enforcement and has made it a priority to protect the most vulnerable customers. She emphasized that FINRA is interested in restitution whenever possible.

Cooperation Guidelines and Privilege Concerns

Hopper explained that Regulatory Notice 19-27 provides color on FINRA’s expectations with the hot topic of firm cooperation in investigations. The Notice did not change FINRA’s existing view of the necessary cooperation, which she said helps both a firm and FINRA to understand what went wrong and to move quickly to fix the issues. Hopper said that, in deciding whether to provide cooperation credit when FINRA pursues an enforcement action, FINRA will look at what a firm did in conducting its internal investigations and its provision of that information to FINRA. At the same time, she said that FINRA staff is mindful of concerns and the nuances regarding attorney-client privilege that surface during internal investigations and FINRA is not dismissive or lacking understanding regarding those concerns.

Rulemaking Priorities

Colby explained that the review of FINRA Rule 4530, which governs the reporting of specified events, is ongoing. The review was prompted by a large number of internal questions and his staff welcomed reexamining the rule. Similarly, FINRA continues to review the many comments sparked by proposed Rule 3290, which would streamline into a single rule FINRA’s current rules governing Outside Business Activities (Rule 3270) and Private Securities Transactions (Rule 3280). Colby also said they continue to focus on rules related to senior investors, given they represent a sizable portion of the wealth held at firms. According to Colby, it is too early for a rule governing digital assets, and while FINRA has handled many membership applications in that space, it has approved only a limited number given the stringent criteria.

Use of Data Analytics

Gira said that FINRA is increasingly using artificial intelligence and is using machine-learning techniques because the Consolidated Audit Trail (CAT) data is so high, surpassing 450 billion events a day at its peak. Both Hopper and Havlik said their departments are increasing the use of data analytics and expect to use it more in the future.

Regulation S-P

Both Hopper and Havlik said that Reg S-P – which requires firms to adopt written policies and procedures that address administrative, technical, and physical safeguards for protecting customer records and information – will continue to be a focus of FINRA’s rules, enforcement and exams.

If you have any questions about this latest FINRA guidance and how it might impact your business, please contact any of the authors.