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Exam priorities for financial services firms in 2020

SEC and FINRA annual examination priorities

The Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) recently released their annual examination priorities for 2020. Although the regulators independently develop their areas of focus, there are four overlapping priorities that securities firms and wealth managers may want to address in the near term.

January 27, 2020 | Financial services

SEC and FINRA priorities

The SEC’s priorities are organized around eight thematic areas:

  1. Retail investors, including seniors and individuals saving for retirement;
  2. Information security;
  3. Financial technology (fintech) and innovation, including digital assets and electronic investment advice;
  4. Additional focus areas involving registered investment advisors (RIAs) and investment companies;
  5. Additional focus areas involving broker-dealer and municipal advisors;
  6. AML programs;
  7. Market infrastructure; and
  8. Oversight of FINRA and the Municipal Securities Rulemaking Board (MSRB).

FINRA’s priorities fall into four main categories:

  1. Sales practice and supervision;
  2. Market integrity;
  3. Financial management; and
  4. Firm operations.

Four shared priorities

Our review reveals four priorities shared by the SEC and FINRA:

  1. Regulation Best Interest (Reg BI) and Form CRS: The SEC has adopted new regulations governing the conduct of broker-dealers and associated persons. Specifically, Reg BI imposes a new standard beyond existing suitability obligations. Broker-dealers and their associated persons that are natural persons will be required to act in the best interest of the retail customer when making a recommendation, without placing their financial or other interest ahead of the retail customers. Additionally, broker-dealers and registered investment advisors (RIAs) are required to deliver to retail clients1 a Customer Relationship Summary form (Form CRS). Both FINRA and the SEC indicate their intent to examine compliance with this regulation starting on June 30, 2020, but FINRA has indicated they will be reviewing firm preparation efforts ahead of the compliance date.

    For a detailed analysis of potential firm impacts and challenges related to Reg BI and changes to standards of care, refer to Deloitte’s Regulation Best Interest page.
  2. Cybersecurity: The Office of Compliance Inspections and Examinations (OCIE) is placing an emphasis on working with firms to "identify and address security risks, including cyber-related, and to encourage market participants to actively and effectively engage regulators and law enforcement in this effort."2 This will be a priority within the five examination programs (Investment Adviser/Investment Company, Broker-Dealer and Exchanges, Clearance and Settlement, FINRA and Securities Industry Oversight, and the Technology Controls Program). Both FINRA’s and OCIE’s efforts will be grounded in Regulation S-P reviews, which require firms to implement controls appropriate to their business model to protect customer information and records.

    Information security and technology governance are themes that are broadly mentioned throughout both the FINRA and SEC priorities for 2020.
  3. Best execution: FINRA will be examining member firms to ensure they are reasonably directing customer order flow to the best market given the size and order type and are adhering to FINRA Rule 5310 (Best Execution and Interpositioning). Four specific areas of examination for FINRA will be routing decisions, US Treasury securities, options, and odd-lot handling. Routing decisions will focus on potential conflicts of interest and will also look at the upsurge in zero-commission trading. For US Treasury securities, FINRA will be looking for adequate policies and procedures that establish fair pricing and best execution given the unique characteristics from other fixed-income products. Options will be examined for large orders being transacted at inferior prices; FINRA is currently conducting surveillance over these types of trades. Both FINRA and the SEC will be focusing on odd-lot handling by evaluating whether firms are filling customer orders at the National Best Bid or Offer (NBBO) and offsetting these trades with odd-lot executions at superior prices reflected in the exchanges’ proprietary data feeds.

    With the preliminary phases of the Consolidated Audit Trail (CAT) being implemented in 20203 along with continued progress toward Large Trader Phase 3 anticipated in early 2021, regulators will have more access to trade data across the industry than ever before. Firms may wish to closely consider the trading and market regulation priorities for 2020 as they continue to prioritize their implementation efforts around these new rules. For a detailed analysis of impacts, challenges, and considerations related to SEC Rule 613–The Consolidated Audit Trail, refer to Deloitte’s CAT NMS page.
  4. Digital assets: Given the rise in digital assets and the increase of firms’ participation in this arena, the SEC and FINRA will be working together to understand business activities related to these products and how securities laws apply. In July 2019, a joint statement was released that addressed certain noncustodial services, as well as challenges related to custody and critical Exchange Act Rule 15c3-3 obligations for digital assets. Additionally, examinations will focus on policies and procedures, fair and balanced communications with the public, investment suitability, portfolio management and trading practices, clearance and custody protection, and pricing and valuation. Additionally, the SEC will scrutinize the supervision of employees’ outside business activities.

That these four areas are being targeted by both the SEC and FINRA suggests they are especially important to regulators and should be top priorities for securities firms.

Additional areas of consideration

While not specifically an overlapping priority, it may be useful for certain dual registrants (broker-dealers, RIAs) to consider the crossover between the SEC’s Electronic Investment Advice priority and FINRA’s Digital Communication priority. With the proliferation of digital client interactions across the investment landscape, both regulators are devoting efforts to ramping up oversight and developing an examination approach that addresses the changing industry landscape.

Additionally, as communicated in the priorities letter, FINRA has implemented the revamp to its surveillance and examination programs first announced in October 2018. The new examination program has consolidated three previous examination programs and FINRA members have been grouped into five business models: retail, capital markets, carrying and clearing, trading and execution, and diversified. Each group will be assigned to a single point of contact responsible for the monitoring and risk scoping of examinations. Firms should consider the potential impacts of these changes as they plan for the year ahead.

The full 2020 examination priorities can be found on the SEC and FINRA websites.

For a broader perspective on regulatory trends in the securities and investment management industries, refer to the recently released Deloitte & Touche LLP 2020 Capital Market Regulatory Outlook and 2020 Investment Management Regulatory Outlook.

Endnotes

1 Retail client is used to standardize terminology between the use of the terms “retail customer”, “retail client”, and “retail investor” as the terms are defined and used differently between the Reg BI and Form CRS adopting releases given their applicability and scope. Firms should defer to the SEC guidance and rule language for clarity on definitions and usage in particular contexts.

2 https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2020.pdf

3 https://www.catnmsplan.com/

4 Deloitte Risk and Financial Advisory, Deloitte & Touche LLP

5 US Strategy & Analytics, Deloitte Consulting LLP

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser.

Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

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We would like to thank our senior consultants for their contributions to this blog: Jatin Ahuja,4 Samuel Mosser,4 Vili Paraskov,5 and Kyle Prast.4

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