Crypto, Reg BI Among Compliance Concerns From Brokerage Industry Regulator Finra

The latest compliance report card from brokerage industry self-regulator Finra has a few new tracks and several greatest hits.

The report, which summarizes the compliance challenges Finra examiners and other staffers have found in their reviews of brokerage firms’ practices, for the first time includes a detailed discussion of cryptocurrencies.

Other compliance issues, including record-keeping, especially regarding employee communications, and Regulation Best Interest, are making repeat appearances in Finra’s report.

“As our industry evolves, so do the compliance challenges faced by firms, which is why the report is so critical,” says Greg Ruppert, Finra’s executive vice president of market supervision. “Some of the topics covered will be familiar from past reports, updated for 2024, while others are new and represent emerging risks and evolving trends that are of growing importance as we look ahead.”

In the crypto sector, Finra notes that “bad actors” are exploiting investor interest in those investments with pump-and-dump and other manipulative schemes similar to those that have long been associated with low-price securities.

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Finra identifies several areas where member firms could improve their compliance policies and procedures around crypto assets, including more effective communications with clients about potential risks, better disclosures, and avoiding misleading statements.

Firna further suggests that firms revisit their supervision procedures to ensure they are conducting appropriate due diligence on private crypto placements, and to ensure that their anti-money-laundering programs are calibrated to catch suspicious crypto activity.

The crypto warnings take on a new urgency given that the Securities and Exchange Commission just this week approved a handful of Bitcoin exchange-traded funds. The commission did so after a long period of deliberation and with a warning for investors to be careful of investing in digital assets, which SEC Chairman Gary Gensler has characterized as rife with fraud and abuse.

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Another major compliance issue, albeit not a new one, concerns the communications channels employees are using to conduct business, including interactions with clients, outside vendors, and other company personnel. Finra says the risk of off-channel communications that aren’t recorded in a firms’ books and records protocols “has become a particular area of focus for regulators,” and notes that the SEC has issued hefty fines for violators in each of the past three years.

Finra is reminding firms of their regulatory obligations to preserve employee communications along with other firm documents, and suggesting that member firms undertake a review of their communications protocols and ensure that they and their vendors are monitoring and preserving all relevant correspondence.

Examiners reported multiple instances of firms failing to supervise vendors tasked with supporting their books-and-records obligations, as well as email archiving failures within the firm.

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Finra recommends firms review their third-party contracts with vendors and conduct their own testing of those contractors’ efforts “by, for example, simulating a regulator’s examinations by requesting records and engaging regulatory or compliance consultants to confirm compliance with the record-keeping requirements.”

Finra also reports that compliance with the SEC’s Regulation Best Interest and the associated Form CRS document remains a major challenge, 3 1/2 years after the rule went into effect.

That regulatory package included several new duties for brokers, but Finra found that firms are struggling to make “full and fair” disclosures about their fees, potential conflicts of interest, and other information that clients should be aware of, as well as making investment recommendations without determining that those products are in a client’s best interest.

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Some firms were cited for not maintaining detailed information about clients’ investor profiles and recommending complex, illiquid, or otherwise unsuitable products.

Conflicts of interest remain a perennial challenge, as Finra found brokers still struggle with “identifying conflicts and disclosing, mitigating or eliminating, as appropriate, conflicts of interest associated with recommendations of securities transactions or investment strategies.”

With Form CRS, intended to be a plain-language summary of how a firm works, Finra says it observed member firms’ filings “significantly departing” from SEC guidance by omitting material facts, inaccurately representing individuals’ disciplinary histories, and “incorrectly stating that the firm does not provide recommendations.”

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