Broker-dealers answering to new and upcoming regulations must adapt to changes ranging from new exams for certain individuals to closer monitoring of internal activity, a panel of industry experts including the Financial Industry Regulatory Authority said this week.
But exactly how changes will play out for the industry is still indefinite as both firms and regulators like FINRA, the Securities and Exchange Commission and Commodities Future Trading Commission each grapple with the watershed regulatory overhaul.
“There is this uncertainty about the rulemaking process and the funding of the regulators and what the impact is going to be,” said Steven Goldberg, an advisory principal in the national broker-dealer industry team at Grant Thornton LLP. “A lot of pressure is going to be on the compliance role, overseeing supervision programs, as well as internal audit.”
Members of the New York panel, which also included law firm Cadwalader, Wickersham & Taft LLP and consulting firm Promontory Financial Group, said they are working closely with broker-dealer clients to prepare for the changes.
One pending change that has already created some buzz in the industry is a proposal in regulation notice 10-25 that would create new examination and continuing education requirement for certain members of the industry, said Grace Vogel, executive vice president of member regulation at FINRA.
The rule, which resulted directly from the Bernard L. Madoff scandal, would target certain members of senior management to make sure they understand margin accounts and daily operations. The proposed rule is aimed at making sure those professionals can raise a red flag when they need to, Vogel said.
Professionals targeted for the new requirement will include back office operations members that support sales and trading and handle customer assets. Under the current proposal, the exam for those professionals will include 100 multiple choice questions on ethics, products, markets and operations, Vogel said.
But the rule has resulted in many comment letters, many of them voicing concerns about new qualifications for professionals who in some cases have been in the same position for 30 or 40 years. FINRA plans to work with the industry to define who is subject to the new requirements and how they can work toward them, Vogel said.
“We are in discussion with the registration groups to determine how often and how frequently someone can take the test until they finally pass it,” Vogel said.
As the regulatory landscape changes, broker-dealers must also pay attention to making sure their technologies and internal processes can withstand regulatory scrutiny, panel members said.
The SEC, for instance, turned out a new regulatory action related to charges of AXA Rosenberg earlier this year for not having specific compliance staff or reviews. That regulatory action, while “absurd,” said Steven Lofchie, partner at Cadwalader, Wickersham & Taft, resulted from real events where the firm’s models went awry and caused significant investor losses. By paying attention to their models, broker-dealers can prevent the same mishap, according to Lofchie.
“You do need to have procedures around technology and around models to make sure you are testing that they in fact work,” Lofchie said. Firms also need to define how they change processes, how they test and document tests of those processes and how they check to make sure the models work.
Broker-dealers should also be prepared for SEC examinations that address risk management processes, said Promontory Financial Group Managing Director Kathleen Hamm. Those inquiries will likely look into how internal audit functions reflect the firm’s risk management, compliance and control functions.
“The good news for brokers dealers that have a thought-out, well-documented enterprise-wide risk management program, all you need to do is be prepared to describe that to the SEC examination staff, and that will help focus your inquiry,” Hamm said.
For broker-dealers that do not have a enterprise wide risk management program in place, they will need more time to prepare for an examination, Hamm said.
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