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From Securities Regulation Daily, May 1, 2015

FINRA Chair Ketchum testifies about FINRA’s operations and regulatory programs

By R. Jason Howard, J.D.

Richard G. Ketchum, Chairman and CEO of FINRA, offered testimony before the U.S. House of Representatives Subcommittee on Capital Markets and Government Sponsored Enterprises Committee on Financial Services at a hearing entitled “Oversight of the Financial Industry Regulatory Authority” and covered a broad range of topics on FINRA’s operations and the regulatory programs that support its mission of protecting investors and safeguarding market integrity.

Examinations. On the topic of examinations, Ketchum said that FINRA issued its tenth annual examination priorities letter in January 2105 and it addressed “specific areas of concern that will be a focus of examinations this year, including the sale and supervision of interest-rate-sensitive and complex products, such as alternative mutual funds, as well as controls around the handling of wealth events in investors' lives, management of cybersecurity risks and treatment of senior investors.”

Fraud detection. FINRA's Office of Fraud Detection and Market Intelligence (OFDMI) provides rapid response to allegations of fraud and conducts “robust cross-market surveillance for potential insider trading and fraud, generating hundreds of referrals each year.” To date, Ketchum explained, over 140 registered persons designated as high-risk brokers have been barred from association with a broker-dealer. The investigation and prosecution cycle for these cases averaged approximately 120 days from the time the individuals were designated as high-risk brokers, Ketchum said.

Enforcement. On the subject of enforcement, Ketchum pointed out that in 2014, FINRA brought 1,397 disciplinary actions and ordered $32.3 million in restitution to customers. In addition to the monetary sanctions, there were 403 bars and 705 suspensions of individuals and, of those actions, the High-Risk Broker program accounted for 85 bars against individuals posing a particularly high risk of harm to investors.

Market regulation. Ketchum also referenced FINRA’s 2015 regulatory priorities letter and noted that the areas of focus for the coming year include potentially abusive trading algorithms, high-frequency trading (HFT), cross-market and cross-product manipulation, order routing practices, best execution and disclosure and market access controls.

CARDS proposal. The Comprehensive Automated Risk Data System (CARDS) proposal was one of the more heavily addressed topics and on this, Ketchum explained that “the concept motivating the CARDS proposal is that by enhancing our access to data and analytics, we can evolve our risk-based surveillance and examination programs regarding sales activities.” He said that CARDS would operate as an early warning system to identify potential fraudulent activity and customer sales practice abuse to guide examinations.

Ketchum also recognized that the process is ongoing as FINRA continues to meet with industry and investor groups, as well as individual firms, to address comments about concerns over the proposal. Those concerns include questions about the feasibility of meeting the important goal of enhancing the early warning capabilities regarding fraud and investor abuse using existing data sources and the data that will become available when the Consolidated Audit Trail (CAT) is implemented, and the potential ability of bad actors to access information that could possibly be reengineered to identify individuals. Ketchum reiterated that FINRA would not move forward with the proposal until it concludes that the concerns raised in the comments have been addressed.

The Securities Industry and Financial Markets Association (SIFMA) released a statement on CARDS in response to Ketchum's prepared testimony before the House Financial Services Committee. “We commend FINRA for recognizing the industry's concerns with respect to the sensitivities involving client information, the burden of building yet another reporting system, and the abundance of data already received.  We look forward to continuing to work with FINRA to ensure efficient supervision and investor protection,” SIFMA stated.

Consolidated Audit Trail. CAT will be the world’s largest repository of securities data, processing approximately 58 billion records on a daily basis, Ketchum explained. CAT will collect information on virtually every order and trade in equity securities and options in the United States. Ketchum said that “FINRA strongly supports the SEC’s action to require the development of the CAT, an important initiative that will enhance regulators' ability to conduct surveillance of trading activity across multiple markets and perform market reconstruction and analysis.”

During the testimony, Ketchum also touched on several other topics including rulemaking, economic analysis and retrospective rule review, transparency, dispute resolution, registration and disclosure, and investor education prior to the conclusion of his testimony.

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