Finra Bearing Down on Securities-Backed Loans and Rollovers
Financial Industry Regulatory Authority examiners are likely to ask more questions this year about sales to retail investors of securities-backed loans and the timing of recommendations to roll over retirement accounts and to switch from brokerage to advisory accounts.
The areas are new additions to the annual Regulatory and Examination Priorities Letter, whose 2018 edition was released on Monday as an aide to help firms focus their growing compliance, supervisory and risk management responsibilities, and perhaps as a warning to brokers about where whips may be cracked.
The letter also highlighted ongoing regulation and examination priority areas from previous years, including questions about procedures for monitoring penny-stock red flags, for hiring and supervising high-risk brokers, and for identifying cybersecurity issues.
On the hot-button issue of sales of cyrptocurrency transactions and initial coin offerings, the regulator was more equivocal.
“Finra may review the mechanisms—for example, supervisory, compliance and operational infrastructure—firms have put in place,” the letter said, noting it will “closely monitor developments in this area.”
The letter’s “sales practice risks” section zeroed in on Securities Backed Lines of Credit as a new priority area.
General-purpose loans collateralized by customers’ investment portfolios have “increased significantly in the past years,” and Finra is concerned about whether firms are adequately disclosing such risks as “the potential impact of a market downturn, the potential tax implications if pledged securities are liquidated and the potential impact of an increase in interest rates.”
Morgan Stanley paid $1 million last April to settle charges that it used sales contests to drum up securities-backed loan sales in several branches in New England.
Following a year in which the Labor Department’s vacillating messages on raising retirement account standards riled firms and brokers, Finra’s new priorities letter also put the industry on high alert about ensuring the suitability of recommendations to move accounts to firms from company plans.
“Employer-sponsored retirement plans play a critical role in many individuals’ retirement planning and for this reason will be an important area of focus for Finra,” the regulator said. “Finra will also review the supervisory mechanisms firms establish for these recommendations.”
The regulator also said it is closely watching the timing of recommendations to move customers from traditional commission-based brokerage accounts to fee-based advisory accounts, a twist on the issue of reverse churning that other regulators have identified as an issue for buy-and-hold clients.
“Finra will review situations in which registered representatives recommend a switch from a brokerage account to an investment advisor account where that switch clearly disadvantages the customer, such as where the registered representative recommended that the customer purchase a securities product subject to a front-end sales charge in a brokerage account and then shortly thereafter recommended that account be transferred to a fee-based account,” the exam priorities letter said.
The notice should raise eyebrows at firms that have been promoting fee-based accounts as a way to better comply with the DOL’s fiduciary rule, said Amy Lynch, president of Frontline Compliance in Bethesda, Md.
“If there’s a policy mandate to make an account a fee-based account, they need to do extra surveillance around the timing of transactions,” she said.
The annual letter reminded firms and brokers to revisit its new “Examination Findings Report” issued last month to show other areas where it has been focusing, and to comment on whether such notices help them prioritize their increasingly complex compliance responsibilities. The exam findings notice highlighted, among other issues, sales practice violations involving short-term trading and exchanges of Unit Investment Trusts, and failure to supervise and have mechanisms for tracking brokers’ outside business activities that could create conflicts of interest.