Top Regulatory Areas of Focus for 2009

Presented By: Nathan Jodat

At SIFMA’s annual Compliance and Legal Conference in Phoenix, Arizona, March 22-25, 2009, senior officials from FINRA and the SEC presented the top areas of focus for this year. These areas were determined from a variety of factors, including customer complaints, investment products deemed to be of higher risk, and systemic examination findings.

One of the themes consistently communicated during the conference was the importance of making compliance part of every firm’s culture. A strong compliance program must be constantly monitored and improved as market and regulatory conditions change. Doing periodic risk assessments is necessary to determine where the firm’s biggest risks reside. Evaluating your firm’s compliance program regularly will assist in reducing the compliance and regulatory risks faced by your firm.

Questions for Evaluating Your Compliance Program
Regulators recommend you ask the following questions when reviewing your compliance program:

• How has the regulatory environment changed?
• Has the firm engaged in distributing any new investment products?
• Do the clients and representatives/advisors totally understand the risks in these products, and are representatives properly disclosing these risks to clients or potential investors?
• What are the supervisory controls in place?
• Who reviews our policies and procedures and is that person qualified?

It’s important to also understand the relationships between the regulators. The SEC not only approves FINRA rules, but its members also supervise FINRA and follow up on examinations conducted by FINRA. Therefore, you may have both FINRA and the SEC reviewing similar areas of your business. This makes it even more important to understand what the regulatory “hot topics” are, and to ensure you have properly addressed them in your compliance program.

Top 10 Areas of SEC Focus
Lori Richards, director of the Office of Inspections and Examinations at the SEC, offers the following list of her top 10 areas of focus for 2009:

1. Custody and Control of Assets: The safekeeping of customer assets is one of the SEC’s top areas of focus. They are particularly interested in small firms who maintain custody.
2. Controls Over Valuation: They are reviewing procedures used by firms to price investments. The main products focused on are structured products and illiquid securities. The three main areas reviewed are the firm’s procedures, any conflicts of interest, and the level of independence.
3. Retail Sales Practices: The disclosure of principal and liquidity risks is a main focus. The top products being reviewed for this topic are bond funds, principal protected notes, money market funds, municipal bonds, and hedge funds. Additionally, hedge fund performance claims are being reviewed.
4. Supervision and Compliance: The Commission wants to ensure firms are properly supervising their advisors and representatives, and the supervision is following Written Supervisory Procedures. They also want to make sure compliance will not suffer because of firms going through budget cuts.
5. Net Capital/Financial Controls: Reviews are being done on firms’ procedures and controls around valuations, reserve calculations, and disclosed financial conditions.
6. Trading Issues: The Commission is concerned with the spread of rumors and naked short selling. Naked short selling wrongfully manipulates the market because stock is sold that is not available for borrowing, so the transaction should not have occurred in the first place.
7. Rating Agencies: Rating agencies will be examined starting this year to ensure they comply with their policies and procedures. Other areas reviewed will include possible conflicts of interest, disclosures, and a proper ongoing surveillance program.
8. Revenue Sharing: The SEC is reviewing revenue sharing arrangements and disclosures. One of their concerns is undisclosed, under-the-table payments—paid by firms who are now trying to compete for a smaller number of deals.
9. Hedge Funds: Hedge fund compliance is receiving much attention and legislation is currently pending with Congress. The areas of concern are preferential treatment, lack of due diligence, undisclosed side deals, side pocket arrangements, insider trading, and engaging in activities outside of disclosures to clients.
10. Mergers/Changes/Consolidations: When firms merge, reorganize, or are bought out they must go through a process of integrating the compliance and operational functions. The SEC wants to make sure this integration doesn’t affect the firm’s compliance program in a negative way. Another area of focus is when third-party providers go through changes, ensuring the quality of services doesn’t decrease.

Top 10 Areas of FINRA Focus
Michael Rufino, a senior vice president in Member Regulation at FINRA, shared the following list of FINRA's top 10 areas of focus for 2009:

1. FACT Act: A firm’s Written Identity Theft Program will be reviewed to see how the  firm identifies, detects, and responds to red flags.  
2. Safeguarding Customer Information: To protect customer information, written and electronic, firms need to address the use of records destruction, securing electronic information, and the sharing of information with third-party service providers.
3. Structured Products: The focus is on disclosures, suitability, marketing material, and training relative to principal protected notes and reverse convertibles.
4. Alternative Investments: The concern is disclosing the risk to customers, specifically liquidity risk, of investments such as hedge funds and managed futures.
5. Cash Equivalents: FINRA has a concern with representatives marketing products as “similar to cash” or “cash alternatives.” Auction rate securities were one product consistently sold that way, which led to a high number of customer complaints when the auction rate market became illiquid. FINRA recommends reviewing Regulatory Notice 08-82 for more information: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p117559.pdf
6. Anti-Money Laundering: Firms must have a strong program in place to prevent, detect, and report money laundering activity. Additionally, independent testing must be completed by a qualified examiner.
7. Supervision/Controls: Firms must conduct risk assessments and supervisory controls testing annually, prior to their anniversary date. Evidence of testing and CEO attestations must be complete and on file.
8. Variable Annuities/Insurance: FINRA is focusing on a review of suitability around exchanges and how customers are notified of downgraded insurance companies.
9. Marketing to Seniors: The misuse of professional designations and techniques used when marketing to seniors will be evaluated.
10. Unregistered Sales of Restricted Securities: Firms should be aware of red flags and have procedures in place to avoid unregistered resales of restricted securities. A recent notice issued by FINRA can be used for more guidance: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p117716.pdf

Regulatory Compliance, LLC is dedicated to partnering with our clients and providing the most up-to-date information on the current regulatory environment. Additionally, we are constantly updating and refining our examination programs to ensure they meet all regulatory rules and guidelines. 

If you would like more information on our various examination programs, please contact Rich Horgan or Karen Hagan at 888-734-2667.

If you would like more information on the conference, please contact Nathan Jodat at the same toll-free number or by e-mail at njodat@regulatorycompliance.com.

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