Brokers continue to make numerous mistakes when it comes to devising suitable investment strategies for retail clients and making appropriate product recommendations, FINRA warns.
The regulator has published a report highlighting the myriad deficiencies staffers observed over the course of their examinations of firms and branch offices in 2018. FINRA identified frequent citations in areas such as firms' supervision programs, abuses by registered reps with discretionary trading authority and how firms handled products tied to market volatility.
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Taken together, the report's findings offer a roadmap for firms to reassess their own compliance operations, fully knowing that the issues described will be on the radar of FINRA's examination staff.
"One of our core priorities is to provide firms with information that will help them more easily comply with rules and regulations, and this report aims to do just that," FINRA CEO Robert Cook said in a statement. "We hope the observations within the exam findings report enable firms to strengthen their own control environments and address potential deficiencies before their next exam."
FINRA's suitability standard rests at the core of brokers' relationships with retail clients, and the regulator reports that it "continues to observe unsuitable recommendations by associated persons to retail investors, as well as deficiencies in some firms' supervisory systems for registered representatives' activities."
In particular, FINRA reported that many firms and individuals failed to adequately assess their clients' investment profiles, overlooking factors such as experience, risk tolerance and time horizon.
In other cases, brokers did not adequately factor in fees, commissions or other expenses in their suitability determination. FINRA also cited the practice of selling complex products such as ETFs or ETNs to unsophisticated investors. This was an area the regulator highlighted at the beginning of the year, when it issued its examination priorities letter.
For FINRA, strong supervision programs are a crucial element to ensuring firm-wide compliance with the suitability rule.
"FINRA observed that firms with sound supervisory practices for suitability generally identified risks, developed policies and implemented controls tailored to the specific features of the products they offered and their customer base," the regulator writes in its report.
Some firms, for instance, have controls that prohibit or restrict registered reps from recommending a given product to certain investors. Other supervisory controls FINRA cited included training programs that registered reps are required to complete before they can recommend certain high-risk or complex products.
FINRA also identified suitability issues in cases where clients' assets were too heavily concentrated in one product segment, or were subject to excessive trading. FINRA found that many firms have lax supervisory programs in place to ensure that recommendations of variable annuities — a known red flag for regulators — are suitable.
FINRA also reported a variety of outright abuses of clients' trust in cases where registered reps engaged in discretionary trading. In some instances, the reps failed to secure written permission, or made trades after an authorization had expired. In other cases, the reps actually lied on their firms' compliance questionnaires, or cajoled elderly clients into setting up a trust and naming them as trustee or a co-trustee to seize control of the funds.
As the year winds to a close amid a spike in market turbulence, brokers might also take note of FINRA's scrutiny of how firms are handling volatility-linked products. Following a market tumble in early February, FINRA launched an exam initiative focusing on products with high volatility exposure, some of which plummeted 80% or more on Feb. 5 and Feb. 6.
FINRA credited some firms for having protocols in place that barred or restricted the recommendation of volatility-linked products, or for requiring extensive training to ensure such recommendations would be suitable.
FINRA has addressed the issue of complex and risky products in past regulatory notices, and is again calling on firms to improve their due diligence in vetting volatility-linked products and ensuring they have the controls in place to prevent unsuitable recommendations.
"Despite prospectuses and other materials that included risk disclosures," FINRA says, "some firms nevertheless marketed volatility-linked products to retail customers who did not understand those products' unique risks, and made recommendations that were inconsistent with the investors' investment profile."
