As regulators unveil new approaches to examinations, firms should make sure they have proper compliance systems in place and be ready to take the initiative in their communications with examiners, experts say.
In his keynote address at the FINRA annual conference in May, the self-regulatory organization's chief executive, Richard G. Ketchum, outlined the changes firms should expect as the examination process evolves to better identify risk.
The modifications include new ways of delving deeper into firms' transactional and financial data, including verifying the existence of assets through paper and electronic records. FINRA also plans to better educate its examination staff on business profiles and risk analysis. Ketchum also adds that examinations will include more time at branch offices — the point of sale where "troubling conduct" occurs most often.
Changes in the examination approach come as regulators, including the Securities and Exchange Commission's Office of Compliance Inspections and Examinations, are gearing their in-depth screenings to a more risk-based approach to better uncover fraud. Ultimately, those changes will require more cooperation, Ketchum says.
"At a time of great market complexity, I think finding the right balance depends — even more than ever — on firms and regulators working together and sharing information on risk and exposure," Ketchum says.
For broker-dealers, the changes should not throw out the traditional approach to receiving examinations — that is to readily provide information and communicate, experts say. The announced changes could also arm firms with information to better prepare for examinations before they happen.
"It gives a firm an opportunity to be more proactive in preparing for potential areas of scrutiny by the securities regulators because both the SEC and FINRA have said that they're going to take a more risk-based approach to examinations and have announced their likely areas of focus," says Kathleen Hamm, managing director at Washington, D.C.-based financial services consulting firm Promontory Financial Group.
The firm can prepare by doing a self-evaluation, Hamm says, and carefully looking at its business model, areas of risk and the effectiveness of related controls, which can be enhanced in anticipation of an examination.
Once an examination is underway, it is important for the firm to set up a clear communication system, Hamm says. For branches, that means establishing a central point of contact, either with compliance or legal staff, and making sure that the branch manager is ready to explain the business and compliance and control infrastructure.
"For time and efficiency, we recommend that you be very proactive," Hamm says. "Hopefully that will get the regulators comfortable with the control infrastructure around your branch offices and it will limit the number of branch offices that they go to."
Examinations can run more smoothly if firms are more mindful of how they communicate from the start, John Sakhleh, a partner at law firm Sidley Austin LLP, wrote in a February report, "The Survival Guide to Regulatory Examinations." Sakhleh's tips include not approaching examiners in a combative or defensive manner and also letting the facts speak for themselves. That communication becomes increasingly important before any findings are documented.
"My advice is generally to try and have a meeting with the regulators before the findings are issued," says Kevin J. Campion, co-head of Sidley Austin's broker-dealer regulatory group. "Such a meeting can be used as an opportunity to discuss the regulators' concerns, and hopefully address to their satisfaction, before the exam report is issued. Once a finding is in an exam report, it can be difficult to get it removed."
As the examination landscape changes, firms' best defense should be accuracy, says Paul F. McCurdy, chair of the broker-dealer practice group at law firm Kelley Drye & Warren LLP.
"The regulators and the industry are kind of feeling their way through some of these things together and are trying to figure out where the problem areas are and then how to best address them and resolve them," McCurdy says. "That's why it's important for the firm, in response to any inquiries it gets, to make sure it's right and gets the facts right."
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