Finra to Probe Effect of Waning Commissions on Firm Practices
The Financial Industry Regulatory Authority put member firms on notice this week that it will be tracking whether brokerage firms’ shift away from commission revenue is affecting sales and order-execution practices for customers.
“As commission practices change, cash management services that sweep investor cash into firms’ affiliated or partner banks or money market funds (Bank Sweep Programs) have taken on a greater significance,” Finra said in its 2020 Risk Monitoring and Examination Priorities letter published on Thursday.
Examiners also will intensify their look at how firms that divert their retail order flow to outside trading firms and exchanges are meeting their best-execution responsibilities to customers, the letter said.
Discount brokerage firms such as Charles Schwab have historically directed some of their customer orders to large market-maker trading firms such as Citadel Securities, which pay for the per-share “flow” to, in part, get an edge on market sentiment. Full-service firms that internalize execution of their trade orders also receive rebates on some trade costs from many exchanges.
Reviews of potential conflicts in order-routing will include “the impact of the recent increase in zero-commission brokerage activity,” the Finra letter said, referring to the rapid succession of brokerage firms catering to self-directed investors that eliminated stock and option commissions at the end of 2019.
In addition to making more bank loans to investment customers, firms ranging from traditional discount brokers to wirehouses across the retail brokerage industry have bulked their net interest revenue and spreads by moving brokerage account cash into bank accounts rather than into higher-paying money-market accounts that were the traditional sweep destinations.
Concerns have risen about how the programs comply with a range of Finra and Securities and Exchange Commission rules, including net capital and customer protection rules, the Finra letter said.
The industry-financed regulator outlined nine factors it may review in considering whether money placed with affiliate or outside banks comply with its rules and standards.
“Does your firm clearly communicate the alternative for cash management available to customers, the terms provided by the Bank Sweep program and any alternatives,” one question asked.
“Has your firm omitted or misrepresented material information” about the amount of FDIC insurance coverage on deposits, the nature and structure of the accounts, the relations of the brokerage accounts to partner banks, the amount of time it takes for funds to reach bank accounts and the “risks of participating in such programs,” another question says.
In scrutinizing order-routing practices, Finra may review “whether changing to the zero-commission model resulted in changes to…routing practices, execution quality, regular and rigorous review policies, or the level” of fees and rebates received, according to the 2020 priority letter.
“FINRA may also assess disclosures and advertisements related to zero commissions,” it said.
Both Finra and the SEC, which issued its examination goals this week, also highlighted the priority they will be giving this year tocompliance with the new Regulation Best Interest and Client Relationship Summary rules that become effective on June 30.
Reg BI and the CRS form raise a wide range of compliance issues, including how firms can prove to regulators that they have created and are using procedures and training programs to determine if brokers are meeting new requirements when they make investment recommendations.
At a Finra conference on Reg BI this week, LPL Financial associate general counsel Michelle Kelley said firms should be well on their way to determining everything from technology changes needed for compliance with the new regulation to compensation changes, web updates and even changing titles on business cards that could mislead customers.
