FINRA Issues Exam Priorities for 2013

On January 11, 2013, the Financial Industry Regulatory Authority (FINRA) released its exam priorities list that it will focus on during its routine examinations this year. As investors continue to seek attractive returns, FINRA highlighted its intent to focus on potential sales practice abuses, yield-chasing behaviors, and external stress events. The list includes a total of 27  risk areas, some of  which are included below:

  1. Suitability and Complex Products – In light of FINRA Rule 2111 (the revised suitability rule) FINRA examinations will focus on brokerage firms’ and registered representatives’ understanding of complex or high yield products and their ability to explain the risk versus return of certain products.
  2. Leveraged Loan Products – These adjustable-rate loans provided to companies of low credit quality are inherently illiquid and difficult to value.  FINRA will be reviewing advertisements that claim these products are less susceptible to interest rate fluctuations and disclosures of risks to investors.
  3. Commercial Mortgage-Backed Securities (MBS) – MBS products offered to retail customers are often represented as a fixed-income instrument but fail to disclose the inherent risks of the product. FINRA examinations will be reviewing whether broker-dealers are accurately portraying performance and fully disclosing the risks associated with MBS, particularly given today’s low-interest-rate, low-yield environment.
  4. Exchanged Traded Funds (ETFs) and Exchange Traded Notes (ETNs) – Given the popularity of newly created index products, FINRA is concerned with the lack of an established track record for these products.  During examinations, FINRA will be looking at how performance is portrayed, and specifically focus on valuation, performance tied to volatility, emerging markets, and foreign currencies.
  5. Non-traded REITs – REITs continue to be an area of focus.  FINRA is concerned with customers not fully understanding the sales costs that are deducted from the offering and the use of principal as dividend payments early in the REIT program. Consequently, FINRA will be carefully reviewing sales practices and those materials provided to investors prior to purchase.
  6. Variable Annuities – While variable annuities may provide certain consumers with predictable income streams, tax deferral, and flexible investment choices, the products also have long holding periods and surrender charges, which could make the investment an unsuitable choice for clients who have liquidity needs.
  7. Private Placement Securities – FINRA continues to be concerned about the sales and marketing of private placement securities.  During upcoming examinations, FINRA will be evaluating broker-dealers’ due diligence written supervisory procedures, paying special attention to the evaluation of valuation processes, third-party valuation services, and timely disclosure of material risks. FINRA plans on achieving this goal through the review of the private placement the member firm, selling the private placement, is required to provide FINRA under the newly implemented Rule 5123.

Based upon the guidance provided, broker-dealers should review their supervisory and compliance programs to ensure all applicable focus areas are adequately addressed. For additional information regarding this topic and guidance on enhancing supervisory controls and compliance programs, please contact us at (619) 278-0020 to schedule a consultation.

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