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From Securities Regulation Daily, January 5, 2016

Supervision, risk management top FINRA’s 2016 exam priorities

By John M. Jascob, J.D., LL.M.

Supervision, risk management, and liquidity will top FINRA's list of regulatory and examination priorities for 2016, the organization has announced. FINRA will also focus on the firm culture of broker-dealers in order to better understand how that culture impacts compliance and risk management.

“Nearly a decade after the financial crisis, some firms continue to experience systemic breakdowns manifested through significant violations due to poor cultures of compliance," said FINRA CEO Richard Ketchum in a news release. "In 2016, FINRA will be looking for firms to focus on their culture and whether it is putting customers first and promoting risk management adaptable to a changing business environment.”

Supervision, risk management, and controls. In its 2016 Regulatory and Examination Priorities letter, FINRA said that it will focus on four areas of concern affecting firms’ business conduct and the integrity of the markets: management of conflicts of interest, technology, outsourcing, and anti-money laundering.

Conflicts of interest. With regard to conflicts of interest, FINRA will complete the targeted examination that it launched in late 2015 regarding incentive structures and conflicts of interest in connection with firms’ retail brokerage business. In the area of investment banking, FINRA will assess whether research analysts are inappropriately involved in their firms’ investment banking activities and whether investment banking personnel exercise undue influence on analysts. FINRA will also examine firms’ controls to identify, minimize and mitigate information leakage within or outside a firm.

Technology. In the area of technology, FINRA remains focused on firms’ cybersecurity preparedness and the continued need for firms to improve their cybersecurity defenses. Examinations will focus on one or more of the following topics: governance, risk assessment, technical controls, incident response, vendor management, data loss prevention and staff training. FINRA will also consider examining firms’ abilities to protect the confidentiality, integrity and availability of sensitive customer and other information, including compliance with SEC Regulation S-P and Exchange Act Rule 17a-4(f), which requires electronically stored records to be preserved in a non-rewriteable, non-erasable format.

Outsourcing. Even as broker-dealers continue to look to reduce costs by outsourcing key operational functions, FINRA reminded firms that the compliance responsibility to supervise these activities remains with the broker-dealer. FINRA will review firms’ due diligence and risk assessment of providers of outsourced services and their supervision of those services. Broker-dealers must also supervise and conduct adequate due diligence on employees of affiliates conducting certain functions on behalf of the broker-dealer.

Anti-money laundering. FINRA will continue to assess the adequacy of firms’ monitoring for suspicious activity, including surveillance of both money movements and trading activity. In particular, FINRA will make it a priority to assess the adequacy of firms’ monitoring of high-risk customer accounts and transactions, such as transactions in microcap securities. FINRA reminded firms of the need to assess whether their processes for conducting due diligence on deposits of large blocks of microcap securities are appropriate to ensure compliance with the registration provisions of the Securities Act.

Liquidity. With regard to liquidity, FINRA will review the adequacy of firms’ contingency funding plans in light of their business models, taking into consideration many of the practices contained in Regulatory Notice 15-33. For example, FINRA will review whether firms have rigorously evaluated their liquidity needs related to both market-wide and idiosyncratic stresses, developed contingency plans so that they have sufficient liquidity to weather those stresses, and conducted stress tests and other reviews to evaluate the effectiveness of their contingency plans. In addition, FINRA will focus on the adequacy of high-frequency trading (HFT) firms’ liquidity planning and controls, given that sudden changes in a firm’s execution rate—whether triggered by a market event or other factors—could create liquidity challenges for a firm.

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