FINRA and SEC’s OCIE release examination priorities

Bank sweeps, payment for order flow: What regulators are looking at in 2020

January 16, 2020 11:31 AM

SEC OCIE completed examinations in 2019 exams 1/15/20

Bank sweeps, payment for order flow, digital assets — they’re all under scrutiny this year by the SEC and FINRA, according to 2020 examination priority reports the regulators released this month.

With Regulation Best Interest taking force at the end of June, regulators will evaluate how firms are adjusting their procedures. Also in the spotlight are recent industry changes, such as the host of brokerages that dropped trading commissions, and whether it will impact order-routing practices.

At the same time, regulators remain focused on issues they have highlighted in former years: advice to elderly clients, cybersecurity and private investments.

Yet despite regulators’ augmented to-do list, oversight at the SEC was down last year. OCIE completed 3,089 examinations in 2019 — a 2.7% annual decrease from 2018. The regulator said this was a minor decrease in light of the government shutdown, which suspended “virtually all examination activity.”

Going forward, the SEC stated concern that it lacks “sufficient resources” to adequately monitor the ever-growing number of RIAs. According to the SEC, within the last five years the number of RIAs has grown to 13,475 with $84 trillion in assets, from 11,500 with $62 trillion in assets.

“OCIE’s coverage rates will likely not keep pace with the continued growth in the population and complexity, without corresponding staffing increases,” the report reads.

The SEC examined approximately 2,180 RIAs in 2019, about 15% of the channel.

Scroll through to see what the SEC and FINRA will focus on in this year’s exams:

Preparation for Reg BI

FINRA and the SEC will evaluate how firms are readying themselves for Regulation Best Interest, according to the regulatory reports. During examinations, OCIE will “engage with” BDs and answer questions about implementing the new rules, according to the SEC. After June, OCIE and FINRA will work to assess policies, procedures and training, according to the regulators.

FINRA may concentrate on issues including how reps are guarding against excessive trading and policies around updating and delivering Form CRS.

Digital assets and robo advice

On watch from the regulators this year are digital assets, which FINRA says raise “novel and complex regulatory issues” under federal securities laws and regulation. The regulators are working together to understand firms’ business plans and how laws apply to them.

FINRA may evaluate firms considering using digital assets and the presentation of marketing materials regarding them. SEC examiners will spotlight factors including investment suitability and pricing.

In addition, the SEC says it will focus on RIAs that utilize robo advice with clients, paying heed to factors like SEC registration eligibility, cybersecurity policies and procedures and adherence to fiduciary duty.

Bank sweep programs

Bank sweep programs are under watch this year, according to FINRA. While the sweeps may be useful to customers, and may offer competitive interest rates, the regulator says it may evaluate whether firms are clearly communicating the nature of these arrangements and what alternatives are available.

FINRA says it may evaluate whether firms imply that brokerage accounts are similar — or the same as — checking and savings accounts, or whether they have misrepresented the amount of FDIC insurance coverage.

Best execution

FINRA will focus on whether firms are using “reasonable diligence” when determining the best market to direct client orders. The regulator will be looking at conflicts of interest in order-routing decisions, including whether there is an impact as a result of zero-commission brokerage activity, according to the regulatory report.

FINRA may review changes in processes to handle customer orders, especially as they relate to payment for order flow. The SEC also said it would be looking at these rebate arrangements, according to its report.

Financial incentives

The SEC says it will evaluate financial incentives provided to financial services firms and advisors that may influence how they select mutual fund share classes. OCIE will also be reviewing the fee discounts on mutual funds that firms should be providing to clients, based on their policies.

Also on OCIE’s radar: revenue sharing arrangements between registered firms and service providers, issuers or others. The SEC will also look at direct or indirect compensation tied to executing client transactions.

“These potential breaches of fiduciary duty may adversely impact portfolio management costs, reduce investor returns and inappropriately influence investment decision making,” the SEC report states.

Client communication

FINRA will keep an eye on how firms are supervising and distributing communication with retail clients via traditional platforms and digital tools like text messaging, social media or collaborative apps.

FINRA may consider whether a firm has omitted material information that makes communication misleading and whether firms explain the high degree of risk of private placements, illiquidity and potential losses, according to the regulator.