Eyes on the Horizon: The FINRA Troubleshooter Tackling Emerging Risk

Published On January 28, 2019

Radar spent time with Kavita Jain, director in the Office of Emerging Regulatory Issues at FINRA, discussing risks, trends, new technology and the rise of “alternative data”.

Change and uncertainty is the new normal for the US securities industry, which has undergone a dramatic transformation following the financial crisis as all attempts to navigate even choppier political waters, while riding a growing wave of disruptive technologies.

Standing astride these risks with a confident attitude that it can withstand the turbulence and shepherd its constituents into a safer and healthier sector, is the Financial Industry Regulatory Authority (FINRA) Office of Emerging Regulatory Issues.

FINRA, the not-for-profit self-regulatory organization authorized by law to protect investors and keep a watchful eye on the broker-dealer industry, created the office in 2006 with a brief to identify and assess new developments and risks on the horizon. One key area of focus for the Office is the emergence and adoption of new technologies by the securities industry, in addition to new financial products and business models, macro market trends and policy development.

“The financial services industry has always been at the forefront of adopting technology; going back to the emergence of the internet, brokerage firms were quick to set up online brokerage services,” said Kavita Jain, director in the Office of Emerging Regulatory Issues (OERI). “What is different now, as compared to 10 years ago, is the confluence of multiple different emerging technologies, like artificial intelligence, blockchain, or robotics process automation.”

The OERI team is seven-strong, and is led by senior director, Haime Workie, who, alongside Jain, is a FINRA stalwart. Jain has held several influential positions across the agency, honing her ability to identify, analyze and react, if necessary, to emerging risks and trends.

“We recognize that this is a revolutionary time for the financial services industry,” Jain told Radar in an exclusive interview. “We are starting to see technology impact every aspect of a broker-dealer.”

One example is collaboration with FINRA’s membership application group to understand what new business models and products are being developed by the industry. FINRA does not actively regulate technology, but focuses on the activities of a firm; when big-ticket items like blockchain or artificial intelligence begin to take hold, the team has already mapped out the pain points.

“The success of our office depends on how closely we work with the rest of the organization,” said Jain. “We work with all of the operational and policy departments to gather information on what trends and issues the front-line staff may be seeing.”

The impact of technological disruption is being felt everywhere from wealth management to research functions, Jain said, where natural language processing is speeding up the reading of filings and the creation of research reports.

In recent years, the regulator has issued extensive briefings on blockchain technology, cryptocurrencies and cybersecurity, and has a dedicated examination team for the last of these.

When evaluating the appropriate approach it has several options, from simple monitoring of an issue to educating and training internal staff, to the extreme end, where there is a need for a regulatory response.

“It may also include a component of investor education and making investors aware of potential risks associated with a certain emerging product or trend,” said Jain. “In terms of providing related guidance, we are increasingly starting to publish white papers to share the intelligence we gather from our outreach to the industry, and our analysis of those findings.”

Back when it was formed in 2007 through a consolidation of the National Association of Securities Dealers (NASD) and the member regulation, enforcement and arbitration operations of the New York Stock Exchange, FINRA did not encounter an industry propelled by internet and cloud developments that turn software into product almost overnight, and the regulator itself has evolved in its response.

In 2017, president and CEO Robert Cook launched FINRA360, a multi-year organizational review designed to make the regulator a more effective and efficient regulator.

As a result, the authority has undertaken a range of new initiatives, highlighted in a progress report released in April detailing the significant operational and regulatory changes it has made.

Earlier this year, FINRA consolidated its two separate enforcement departments – one that handled disciplinary matters relating to violations found through market surveillance and trading examinations conducted by the Market Regulation team, and another that handled cases referred from other regulatory oversight divisions – to create a unified enforcement program.

FINRA360 also has sparked the creation of FINRA’s Innovation Outreach Initiative, an effort to foster an ongoing dialogue with the securities industry to help the regulator better understand financial technology (fintech) innovations and their impact on the industry. A cross-departmental team, led by OERI, is working closely with industry participants to gain real-time intelligence on fintech issues.

Given the quickening pace, the regulator also understands that innovation naturally carries risks to investors and firms, and its ongoing work covers areas such as cybersecurity, data monitoring and gathering, as well as data privacy.

“Data has become central to all this, and firms are gathering and centralizing so much more that it will create more vulnerabilities,” said Jain. The collection of data, its cleanliness and quality, its origins and how it is stored and secured, all aspects of data governance are nearing the top of the OREI agenda.

“How firms gather data comes up a lot when we talk to firms, it’s definitely something in the back of our minds.”

“I think a lot about the integrity of data. If firms are going to pool data from various sources and use algorithms to identify potential risks, then the integrity, quality and completeness of the data is of paramount importance.”

The concept of big data has been around for more than a decade, but only recently with advances in analytics, AI and machine learning, are firms starting to realise what they can do with it, and how it can help their business.

The emergence of “alternative data”, where firms scrape satellite images of retail units and shops, or assess activity on platforms such as Twitter, for their quants to mine, is now very much in FINRA’s sights.

Traditional market data, such as price and volume information, are making way for datasets of footfall inside shops, or social media activity around a particular stock or brand, and FINRA is watching closely as these tactics trickle into the retail space, already identifying some cause for concern.

“For a retail investor to look at a positive tweet and think they should buy a particular stock based on that one data point is not the same as a hedge fund using its massive amounts of data to make a determination,” said Jain.

“There are also concerns of market manipulation here too, with people potentially using false social media handles to move markets or facilitate pump and dump schemes.”

Data privacy is headline news following the Facebook political scandals, numerous hacks of credit agencies, and Europe’s onerous new environment for how business stores personal data, under the General Data Protection Regulation.

It is of equal concern for FINRA, says Jain.

“If you are using technology to bring data together before you mine it for insights, have you considered the privacy rules and requirements?”

“We are focused on ensuring that firms really understand the applicable privacy rules around data collection and data mining and work within those rules. Firms also must supervise related technology applications to ensure that they do what they are supposed to do.”

To that end, FINRA practices what it preaches when it comes to technology, and is proud of the boundaries it has pushed for a regulatory agency, leading by example.

“We were lead adopters of cloud,” said Jain. “We have been looking at AI for our own surveillance program. We have a big data team. It’s the early days for us too, in regard to some of these technologies, but we, like the industry, are learning about them.”.