FINRA Details Enforcement Priorities, Tells Firms To Get Smarter

Published On September 17, 2021

At its annual conference in May, FINRA said it wanted to see AI and machine learning put to better use, and compliance enhancements across the board, as firms emerge from the pandemic.

Strong supervisory controls are the bedrock of orderly trading. As markets get choppier, brokers must broaden their use of artificial intelligence and machine learning across compliance operations, and utilize cutting-edge technologies to keep with the pace.

Officials at last month’s Financial Industry Regulatory Authority Enforcement (FINRA) Annual Conference have warned that harsher sanctions await firms if their compliance function is not up to scratch, and if they are not taking a hard line on identifying and addressing bad actors.

Broadcast virtually this year, the event gave officials a chance to expand on details laid out in the agency’s annual report, with themes of transparency, standardized data submissions through AI, and the ability of machine learning tools to reduce risk in increasingly frantic markets.

Market Abuse Isn’t Going Away, It’s Just Moving

“You’re still seeing lying, cheating, stealing. The only difference is the brokers engaging in that kind of behavior have found different ways to accomplish their goals,” said Terrence Bohan, Vice President of Investigations at FINRA Enforcement. 

For Bohan the more things change in trading, the more they stay the same.

Clients’ accounts are “being churned by a broker who just wants to gain those commissions,” as well as “pump and dumps,” he told those in attendance at the conference, adding that many of the scammers are not registered FINRA members or even U.S. residents. 

In years past a “pump-and-dump” may have involved one boiler room with everybody working together in downtown New York, “today you’re going to find the liquidator is in Dubai,” he explained. Compliance teams have to be smarter when tracking internal relationships with individuals outside the firm, as well as with those based in overseas jurisdictions. 

New Generation Of Investors

Also speaking at the event was Gary Gensler, Chairman at the Securities and Exchange Commission (SEC), who touched on the subject that has been red hot through 2021: retail investing.

With a flood of new entrants into the market, compliance departments inside brokerage houses will have their work cut out ensuring they are on top of revised accredited investor definitions, conflict of interest disclosures, and sales practices employed by their teams.

“We need to do whatever we can to ensure that bad actors aren’t playing with working families’ savings, and that the rules are enforced aggressively and consistently,” Gensler said.

SEC and FINRA executives repeatedly stressed the importance of protecting retail investors, be they seniors or the new generation of online investors, reiterating that registered representatives were squarely on a client’s side when recommending a transaction.

“Best interest means best interest. Best execution means best execution,” Gensler said. “So, if you’re asking a lawyer, accountant, or adviser if something is over the line, maybe it is time to step back from the line. Remember that going right up to the edge of a rule or searching for some ambiguity in the text or a footnote may not be consistent with the law and its purpose.”

Get Comfortable With AI

FINRA is increasingly leaning on data analytics to improve its operations, and it expects the firms it monitors to do so too. The regulator is particularly keen on machine learning as a way to “enhance surveillance and to be able to look more quickly at more complex patterns [in broker behavior]”, said Lara Thyagarajan, Senior Vice President and Head of Market Regulation Enforcement and Litigation at FINRA. “To be smarter and more efficient in our investigations is key,” she said.

Data analytics is speeding up investigations and, in the coming year, the regulator will use it “more proactively to try to identify misconduct” that might not have otherwise been picked up, said Christopher Kelly, Senior Vice President and Deputy Head at FINRA Enforcement. 

FINRA also wants to standardize how it requests and analyzes data so that there is a more consistent experience for firms and internally at the regulator.

“We’re working to standardize data analytics in a way that we may be able to upskill our staff and also bring in new people so that we can gain more insights into the large amounts of data that we’re seeing,” Bohan said. 

Transparency Drive

“One of the big changes we’ve made is to really try to make sure that when we are issuing a document — a settlement or a complaint — that we are being as clear and straightforward as we can,” said Thyagarajan. 

The end goal is to have any compliance officer be able to pick up one of FINRA’s letters of acceptance, waiver, and consent and know that if their firm engages in a certain type of misconduct “it will be the specific outcome when it comes to sanctions imposed by FINRA,” she said. 

Improvements to the transparency of charging documents are also likely to be a priority in the next 12 months.

In response to years of pressure from the industry, FINRA revealed in 2018 how it spent the proceeds from its fines, at least with regards to the fines issued in 2017. In 2020, the broker-dealer self-regulator announced it had collected $57 million in fines.

Pandemic-era Changes May Be Permanent

One rapid change FINRA Enforcement brought in after the pandemic started was remote on-the-record testimony to replace in-person testimony for its investigations. Although the regulator will conduct testimony in person again in some cases, FINRA “realized that we can be efficient and effective conducting virtual testimony and I think that’s going to be a large portion of the way we do that going forward,” Kelly said. 

Not having individuals travel to give testimony may also free up resources to conduct a greater number of interviews.

Remote exams are also likely to continue for the time being, as the nature of the tests evolves, like that of many workplaces, as firms transition from remote environments to back to the office, or to a hybrid arrangement that blends off-site and on-premises work.

FINRA and the SEC are considering the extension of remote inspections through 2022 to let firms and examiners adjust to the post-pandemic environment, said Bob Colby, Chief Legal Officer at FINRA.

“That has not been resolved yet, but I feel like the conversations are going well,” Colby said of discussions with SEC staff. “That is intended to buy a little time in order to figure out how to do this in the longer term.”

To enable a continuation of remote inspections, firms would need to track work remotely as if it were being done within a traditional office. “We’ll need to get information from the firms to make sure that if we go away from a location-based approach to a functional approach, that we’re going to get the same level of protection and supervision that we’ve had in the past,” Colby said.

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