Slideshow 11 Ways Brokers Need to Protect Themselves from FINRA

Published
  • February 10 2011, 12:00am EST
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11 Ways Brokers Need to Protect Themselves from FINRA

11. Know Exactly What’s In That Account


As brokerages increase their use of consolidated reports which combine all of a customer’s financial holdings into a single statement, they must also have procedures in place to conduct due diligence on all of the customer’s assets. That includes assets held outside the firm. “When consolidated financial reports contain assets not in the broker-dealer’s possession they must have procedures in place to conduct due diligence on the valuation of such assets prior to including them on financial account reports to customers,” writes FINRA.


11 Ways Brokers Need to Protect Themselves from FINRA

10. Get Social, But Keep Copies


FINRA reminds firms that they are still required to establish adequate systems to monitor and retain all electronic communications. That includes any communications sent by a registered representative to a customer or prospective customer. “When considering social media, while prior approval by a registered principal is required for static content on such sites, interactive real-time communications can be supervised using reasonable methods of post-trade review,” says FINRA.

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11 Ways Brokers Need to Protect Themselves from FINRA

9. Watch Your Words


FINRA says it is conducting targeted exams to gather information on the advertising and sales literature involved in selling exchange-traded products such as funds and notes that are not registered investment companies.


“We have identified marketing materials that appear to omit the material risk disclosures necessary to provide a sound basis for evaluating a product as required by FINRA’s advertising rules,” the agency says.


11 Ways Brokers Need to Protect Themselves from FINRA

8. Don’t Push Complex Securities Too Hard


FINRA says broker-dealers must be certain to disclose the risks involved with collateralized mortgage obligations and non-traded REITS. For instance, CMOs present credit and default risk, interest rate risk, prepayment risk; and extension risk. “It is important for brokers to understand the features of the tranche they are selling and the rules governing its income stream as these affect the products’ risk,” says FINRA. “Firms also should pay careful attention to recommendations that may lead to unsuitable concentration levels of non-conventional instruments.”


11 Ways Brokers Need to Protect Themselves from FINRA

7. Disclose the Risks of Municipal Securities


Municipal bond dealers must obtain, analyze and disclose to customers all the material facts about the transaction at or before the time of the trade. Recent amendments to Securities and Exchange Commission Rule 15c2-12 also requires them to ensure that the price they sell the bonds is fair.


Bottom line: The muni bond dealer can’t just rely on the credit rating of the bond to determine if its suitable for a customer; it has to do lots of extra work on its own.

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11 Ways Brokers Need to Protect Themselves from FINRA

6. Make It Clear That You Know Your Customer


FINRA says that firms recommending low-rated or non-rated securities, particularly to retail and elderly customers, must take extra care to ensure that they understand the risk tolerance of the customer. And the firms must inform the customer that their principal is not guaranteed.


11 Ways Brokers Need to Protect Themselves from FINRA

5. Make Private Placements Bulletproof


FINRA warns firms that it has identified significant failures in how broker-dealers comply with the suitability, supervision and advertising rules, as well as the potential instance of fraud and participation in illegal distributions of unregistered securities.


11 Ways Brokers Need to Protect Themselves from FINRA

4. Prevent Leaks of Non-Public Information


FINRA says it is worried about the lack of controls broker-dealers have in distributing material and non-public information within a firm and its affiliates, clients and others.


The goal: to prevent insider trading and front running activities. Firms should also be aware, according to FINRA, that information that the regulator receives from outside research firms or so-called expert networks could in some cases be considered material and non-public. These expert networks, or independent research networks that pay experts for information on public companies, have become the focus of recent SEC investigations.

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11 Ways Brokers Need to Protect Themselves from FINRA

3. Document High-Frequency Trading, Algorithmic Trading and Sponsored Access Activities


Sponsored Access: FINRA is telling broker-dealers that they must provide customers with sponsored access to ensure their chief executive officer or another official certify their risk management controls and supervisory procedures are solid. Brokerages have until July 14 to comply with the requirement adopted by SEC’s passage of Rule 15c3-5 in November 2010.


High-frequency trading: FINRA also says it expects firms generating orders using high-frequency trading models or trading algorithms to have written policies and procedures in place to ensure