FINRA’s 2023 Risk Monitoring Report Emphasizes Reg BI Compliance and Communications Issues
On January 10, 2023, the Financial Industry Regulatory Authority (FINRA) released its 2023 Report on FINRA’s Examination and Risk Monitoring Program (the Report), intended to provide member firms with findings from recent oversight activities covering a broad range of industry compliance issues. FINRA, an industry self-regulator of approximately 3,400 brokerage firms and more than 600,000 registered representatives, identifies 24 topics of interest in the Report, divided among five categories: financial crimes, firm operations, communications and sales, market integrity, and financial management. Of particular importance is FINRA’s continued emphasis on ensuring broker-dealer compliance with Regulation Best Interest (Reg BI) and communications issues as they relate to, among other things, mobile apps, cryptocurrency assets, private placements, and variable annuities.
Historically, broker-dealers were required to ensure that a recommended investment or investment strategy was suitable for an investor, pursuant to FINRA Rule 2111 (Suitability). Since June 30, 2020, Reg BI – as promulgated by the U.S. Securities and Exchange Commission – applies an enhanced standard of conduct for broker-dealers in their interactions with retail investors. (Rule 2111’s suitability standard remains the applicable standard of conduct for dealings with institutional investors.) Reg BI requires broker-dealers and their associated persons, when recommending a securities transaction or an investment strategy to a retail customer, to act in the customer’s best interest at the time of the recommendation. Among other things, reasonable due diligence, care, and skill must be exercised when making a recommendation (known as Reg BI’s “Care Obligation”). Reg BI also requires broker-dealers (and registered investment advisers) to provide a brief relationship summary to retail investors, disclosing in plain language certain information about the firm (Form CRS). Form CRS must be provided to a retail customer whether a recommendation is made or not.
Reg BI has now been effective for more than two years, and throughout 2022 FINRA increased its level of scrutiny and expectations of broker-dealers to comply with Reg BI’s obligations. The Report reflects this enhanced level of review by outlining certain deficiencies, especially with respect to Reg BI’s Care Obligation. Some relevant examples include:
Recommending a series of transactions that were excessive in light of retail customers’ investment profiles.
Only considering sales charges instead of the full range of costs and fees applicable to a given investment product.
Not maintaining profile information for retail customers, which undermines compliance with the Care Obligation.
Failing to reasonably investigate offerings prior to recommending them to retail customers, which suggests inadequate due diligence.
Furthermore, with respect to Form CRS, FINRA found instances of incomplete cost disclosures, inadequate explanations of a firm’s disciplinary history, and failure to properly deliver, post, and amend Form CRS. FINRA states in the Report that examinations of member firms will continue as to Reg BI and Form CRS compliance, suggesting that FINRA intends to fully enforce these requirements in 2023, three years after Reg BI and Form CRS became effective.
With respect to communications issues throughout 2022, the Report sets forth some notable findings of interest not only to member firms but also to retail investors. Broker-dealer communications are generally governed by FINRA Rule 2210 (Communications with the Public), which sets principles-based content standards for firm correspondence, retail communications, and institutional communications. The proper communication of correct information and material information to investors is a key component of these requirements.
The Report discusses member firms’ compliance with communications standards in various contexts. Notable examples, among many others, include:
Whether firms’ mobile apps clearly disclose applicable risks, consider detailed customer information including a customer’s investment experience, and distinguish products and services of the broker-dealer and those of affiliates or third parties.
Whether firms’ communications about cryptocurrency assets accurately describe the risks involved, misleadingly state or suggest the assets are approved by federal regulators, or discuss the extent to which federal securities laws or FINRA rules apply.
The extent to which firms apply the requirements of Reg BI, including performing adequate due diligence, to making recommendations of private placements to retail customers.
Failure to reasonably supervise recommendations of exchanges, conduct training for registered representatives and supervisors, or collect and retain key information with respect to variable annuity products and transactions.
The attorneys at Giarrusso Law Group LLC have considerable experience with issues unique to the financial services industry, including federal and state legislative developments affecting both investors and financial advisors. If you have a question about this recent announcement or any other industry matter, you may contact us at (201) 771-1115 or info@gialawgroup.com for a free and confidential consultation.