FINRA’s 2022 Risk Monitoring Report Highlights Reg BI and Customer Communications Issues
On February 9, 2022, the Financial Industry Regulatory Authority (FINRA) released its 2022 Report on FINRA’s Examination and Risk Monitoring Program (the Report), intended to assist member firms in their compliance efforts. FINRA, an industry self-regulator overseeing approximately 3,400 brokerage firms and 617,000 registered representatives, identifies 21 topics of interest in the Report, divided among four categories: firm operations, communications and sales, market integrity, and financial management. While some of the newly listed enforcement priorities relate to the ever-increasing role of technology—from cybersecurity threats to the use of trading through mobile apps—the Report also stresses compliance with Regulation Best Interest (Reg BI), a standard of conduct for brokerage firms and their affiliated registered representatives issued by the Securities and Exchange Commission (SEC) in 2020.
Pursuant to FINRA Rule 2111 (Suitability), broker-dealers and their registered representatives are required to ensure that a recommended investment or investment strategy is suitable. Reg BI enhances that standard of conduct in certain circumstances, with Reg BI’s new requirements applying to retail investor clients, while Rule 2111 remains the default standard for institutional clients. Reg BI requires brokerage firms 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”). In addition to Reg BI, the SEC 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 whether or not a recommendation is made to the customer. Reg BI and Form CRS became effective on June 30, 2020.
Reg BI and Form CRS saw their first full year of implementation in 2021. According to the Report, FINRA expanded the scope of its reviews of brokerages to determine the types of processes, practices, and conduct put in place by those firms to comply with the new rules. Among other things, FINRA looked at the degree to which brokerage firms established and enforced adequate written supervisory procedures, made recommendations that adhere to Reg BI’s Care Obligation, and delivered Form CRS to customers. FINRA found widespread deficiencies, including firms having inadequate Reg BI compliance procedures and training programs, making recommendations that were not in the best interest of a particular retail customer, providing retail customers with insufficient or inaccurate Form CRS information, and not complying with Form CRS formatting and posting requirements.
In addition to a firm’s general compliance with Reg BI, the Report discusses certain perennial risk areas that are now affected by the new requirements. For example, with respect to private placements, FINRA has previously noted that Rule 2111 (Suitability) and Rule 3110 (Supervision) require broker-dealers to conduct reasonable due diligence of the investment product. The requirement to conduct diligence to determine the suitability of a private placement is now met pursuant to Reg BI’s Care Obligation. Likewise, when a broker-dealer recommends the purchase or exchange of a variable annuity to a retail customer, Reg BI’s obligations apply in addition to the sales practice standards of FINRA Rule 2330 (Members’ Responsibilities Regarding Deferred Variable Annuities).
FINRA intends to continue conducting reviews of brokerage firms in 2022. As such, the Report will be supplemented as new information is obtained. FINRA recommends that each member firm “review the Report and consider incorporating relevant practices into its compliance program in a manner tailored to its activities.”
The attorneys at Giarrusso Law Group LLC have considerable experience with issues unique to the financial services industry, including federal and state legislative and regulatory 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.