Armstrong compliance solutions llc

Here are a few areas that the regulators are focused on, and so should you.

First, FINRA has reminded members to start their engines and begin the process of the Regulatory Continued Education (Reg CE) plan. Reg CE Rule 1240 was amended recently to require all registered representatives to complete the regulatory requirements on an ANNUAL basis- not every three years as was previously required. The program must be completed by December 31 of each year.

Firms should note that Reg CE is now provided by FINRA through the FINPRO system, and all registered representatives will have to create a FINPRO account in order to complete their Reg CE requirements. Firms would be wise to get started NOW on the process of ensuring that all their reps have a FINPRO account so as not to be running around in the last few days of the year, trying to herd the cats.

The SEC made it clear on August 8 that they still have “off channel” communications high on their priority their list of “things to examine”, with the release of a press statement related to 11 firms that have been fined for not properly supervising or documenting texts.

Firms must write policies and procedures that address these texts and come to grips with how to capture them.

The MSRB has gotten on board with a recent change related to fixed income reporting and how quickly firms must report trades to the MSRB’s Real Time Transaction Reporting System (RTRS). Municipal trades currently must be reported to RTRS within 15 minutes of the time of the trade’s execution; that reporting time will be slashed to 1 minute due to the SEC’s belief that it will help provide transparency in the market. Details are still being worked out ( there may be carve-outs for firms that trade small numbers of municipal trades, or for firms that process their trades manually) but the handwriting is on the wall. Or perhaps we should say the Rule is in the queue.

Back to the SEC, where new rules have been proposed that would require broker dealers and investment advisers to take steps that address conflicts of interest associated with their use of “predictive data analytics and similar technologies” and to prevent firms from placing their own interests over those of their investors. That release is here. There’s a link to the proposed Rule, which is more than 200 pages long. The good news is that you really only need to read the first 141 or so pages in order to get the gist of the Rule. I will leave you to deal with terms like “chatbot”, “robo-advisory”, and “algorithm” on your own, as I can barely do a Google search. 

That’s all for now- have a compliant day!

FINRA’s Report has been changed this year to incorporate information from two reports that had previously been issued separately, these being the report that had summarized findings, and the report highlighting areas expected to be examined in the coming year. The 2021 Report therefore is a longer and more inclusive release; each topic section contains, if applicable, a brief description of Regulatory Obligations, Related Considerations (questions that FINRA might ask when examining a firm), Exam Findings, Effective Practices, and Additional Resources. The Report lists newer findings from recent examinations, older findings from past years, and emerging topics

FINRA recommends that firms use the Report to aid in the consideration of compliance obligations, in the identification of various risks, and in considering relevant practices to incorporate into their own compliance programs.

Highlighted Areas specifically mentioned by FINRA in its Report:

RegBI and Form CRS: FINRA will continue to focus on this Rule, and expand the scope of reviews now that firms have had a chance to implement its requirements. FINRA states that it is still in the early stages of examination, and therefore does not include exam findings or effective practices for this topic. The Report does include an extensive list of Related Considerations that firms should review, as well as a list of Additional Resources that firms can access.

Consolidated Audit Trail (CAT): This recently enacted Rule is still in the early stages of FINRA firm reviews, and findings and effective practices are not available at this time. However, the Report includes a list of recommended steps, considerations, and resources available to firms when assessing their CAT programs.

Cybersecurity: FINRA points out that the remote work environments caused by the pandemic, and the likely continued use of that business model has posed additional risks. FINRA notes various  considerations, observations, and effective practices in the Report.

Communication with the Public: FINRA is focused on ongoing developments in communication technology such as app-based platforms or “game-like” features that may improperly influence customers. FINRA will examine how firms are communicating with accounts regarding new products. Supervision of these communications, and related record keeping, are a focus.

Best Execution: FINRA will be examining firms’ practices regarding reviews of execution quality. Firms will be asked whether these reviews are done “order by order” or by a “regular and rigorous” method, and to show documentation and rationale for such methods. Order routing, in general, will be a focus, and FINRA has highlighted that they will be performing a TARGETED REVIEW of firms that do not charge commissions for customer transactions to in order to evaluate the effects of that policy on order routing and other firm business.

Variable Annuities: Exchanges under Rule 2330 will continue to be evaluated. FINRA engaged in an informal review of how firms handle “buyouts”, prompted by a change in a large insurer’s practices impacted a sizable number of customers. Firms are encouraged to consider the effective practices that were identified as part of that review.

Comprehensive List of Topics Included in the Report

The Report is broken down into four sections, each section having several subsections. They are as follows:

Firm Operations, which includes AML, Cybersecurity, Outside Business Activities, Private Transactions, Books and Records, Regulatory Event Reporting, and Fixed Income Mark-up Disclosure.

Communications and Sales, which includes RegBI and Form CRS, Communications with the Public, Private Placements, and Variable Annuities.

Market Integrity, covering CAT, Best Execution, Large Trader Reporting, Market Access, and the Vendor Display Rule.

Financial Management, which includes Net Capital, Liquidity Management, Credit Risk Management, and Segregation of Assets and Customer Protection.

As mentioned above, for each topic and where applicable, the Report includes Regulatory Obligations, Related Considerations, Exam Findings, Effective Practices, and Additional Resources. The Report also includes an appendix designed to help firms use the Report in developing and improving their own compliance programs.

A link to the Report can be found here.

The Bond Dealers Association recently held a series of webinars as part of their virtual 12^th Annual Fixed Income Conference. These are my takeaways on a very thoughtful panel discussion that focused on the quantification of climate risk in the municipal bond market.

Panel members included Matt Boles of RBC, Lynn Martin of ICE, Tim Coffin of Breckinridge Capital Advisors, Tom Doe of MMA, and Bernard Bailey of Assured Guaranty. I won’t be quoting any of them directly, as the topic matter below is taken from my own notes and may or may not represent the opinions of the panelists.

Climate change, while still a controversial subject, is being increasingly recognized as a factor that could be the “next big thing” to strike the municipal bond industry. While the process of climate change will occur over the long term, taking decades to play out, the bonds issued by municipalities to fund their infrastructure projects are also often long term, with thirty or forty year maturities. As panelists pointed out, it’s likely that within the capital markets, the first tremors having to do with climate risk will be felt in the municipal market, as underwriters, issuers, and investors increasingly turn their attention to the risks associated with the long term viability of infrastructures underwritten by municipal bonds. Investors in longer term issues will begin (if it has not already started) to demand interest premiums as risks are identified. Issuers having exposure to hurricanes, flooding, and other climate risks may suffer widespread downgrades in the market, and the anticipation of future events, not the actual eventual occurrence of events, will cause the market to build in these premiums as more data on risk becomes available.

The “non-climate related” Covid 19 Pandemic has already demonstrated that an unanticipated widespread event can make re-examination of credit risk essential even before actual harm to debt service is realized. Markets are already beginning to examine and anticipate likely downgrades (and credit risk) that will result from the pandemic’s disruption.

Quantification of Risk

As climate change emerges as a risk factor within the industry, evaluation of that risk evaluation is becoming a highly sought commodity and an emerging business model.

A growing number of firms are already collecting data associated with known climate risks,  and new areas of risk, such as forest fire risk and heat stress risk are being added to current models. The data regarding these risks is increasingly being used by investors to quantify and identify issuer risk in their commitment of capital. This data will also be useful in helping  urban and infrastructure planners to attract that capital.  

While there are currently some standards by which risk can be ascertained, (for example, using a measure of meters above sea level to measure the risk of certain coastal cities), risk data companies are investigating methods by which newly identified risks can be measured.

Difficulties in developing these risk models, including the vast variation of issuers and their individual risks present complexities of deal structure that may initially cause periods of information discrepancies.

Eventually, however, the industry may arrive at a uniform taxonomy, enabling issuers and investors to develop standards by which issuers can be compared, and to ascertain how risk exposure should be priced into the market. Valuations will be made, for example, on water systems that score higher than others, utilizing a uniform scale. Municipalities will then attempt to improve their “scores” in order to reduce borrowing costs.

Risk Magnification

Some risks pose problems not only for the issuer itself, but also for those affected downstream from the issuer. For example, heat stress, now being realized as a strain on electrical grids and other infrastructures, can have downstream effects on utility companies and those individuals and businesses dependent on them. Likewise, issuers facing risk of drought have downstream risk magnifiers- drought affects the not only the farmer and the tax base of a municipality but also the food chain and the economic benefits of employment and downstream business models.

These downstream risks, as more fully identified, will be incorporated into the risk models of issuers.

Effects of Climate Change on Municipalities

“Climigration”  is a term already being used to describe how climate change may cause mass migrations over the next thirty to forty years. Populations may migrate from currently large urban areas to other smaller cities. While businesses and people may pack up their bags and leave, the city, and the infrastructure that composes it, is set in place. These possible population migrations will be taken into consideration by urban planners, and their static projects, meant to be used over many years, will be risk evaluated for long term viability. Population migration will also cause “tax migration”, as issuers subject to climate risk face  reductions in their tax base.

Who Will Cause the Change to Green Bonds?

Investopedia defines a “green bond” as “a fixed income instrument designed specifically

to support specific climate related or environmental projects”.

While the issuance of bonds that would decrease risk are increasingly recognized as being important, they are not currently at the top of the list when issuers set out to fund projects. Economic realities limit the viability of these considerations; essential service budgets of issuers are already under stress.

However, economic realities may eventually be a catalyst in causing climate risk to be addressed when issuers discover that the costs of risk become higher than the alternative. Issuers may find that adaptation for climate change, such as transitioning to low carbon alternatives, could help lower, rather than raise, borrowing costs.

And, while economic factors may drive more issuers to consider lowering their climate risk, investors will also have a say.  Investors are increasingly becoming “socially aware”, and changing their investment priorities. As a panelist noted, while it is currently hard to move these issues up the “essentiality ladder”, the movement is growing.

Bottom Lines:

• Municipalities are on the front line of this evolving issue, and integrating climate risk into underwriting and investing will grow in importance.
• The collection of risk data will increase and improve, becoming a commoditized item.
• To facilitate this new method of evaluation, improved disclosure and transparency will be required of issuers.
• Issuers will need help from underwriters in understanding how to communicate to investors the steps they are taking to mitigate climate risk.
• Investors will increasingly play a role of causing change, by “voting with their money”.
• New ideas and information will continue to emerge in this growing field.

I was recently contracted to help a small firm develop additional wording for its Written Supervisory Procedures (WSPs). The firm had recently received a FINRA cautionary letter due to a failure to include wording in its WSPs regarding “bonds of limited quotation”. The MSRB, in its Rule G-18, Supplementary Material .06, states “Each dealer must have written policies and procedures in place that address how the dealer will make its best-execution determinations with respect to such a security in the absence of pricing information or multiple quotations and must document its compliance with those policies and procedures.”

When I reached out to other firms that I’ve worked with, to ask what sort of policies they have in place to show compliance with the Rule, I was surprised (perhaps I shouldn’t have been) to find that examiners had also asked them about this topic during recent exams. Perhaps it’s on FINRA’s radar and being used as a common exam focus.

Discussion about limited quotation bonds becomes even more timely as the MSRB re-implements its practice of sending “off market” alerts to firms. While the MSRB had discontinued the alerts during the early stage of the pandemic shutdown, as prices of bonds moved wildly and firms invoked their business continuity “extreme market condition” policies, the resumption of these alerts (September 1, 2020) may bring renewed scrutiny of prices at which dealers transact trades. Dealers should be ready to defend the methods by which they reviewed and approved trade prices. Notice that I said, defend their methods. It’s important to remember during this process the Rule requires that a firm engages in “reasonable diligence”, not necessarily that a firm discovers the perfect price for a bond.

Determining the fair price of a bond with limited quotations depends upon, as one of my compliance acquaintances describes it, a sort of “mosaic” approach to that determination. A description of the ingredients of this mosaic should be included in a firm’s WSPs, listing the  multitude of factors used in order to show that a reasonable attempt has been made to ensure fair execution. Wording in the WSPs should describe the firm’s attempt to gain a total picture for the value of the bonds, employing various checklists to compare the price of the bond with other available data. Items on the checklist would obviously include matching dealer,  institutional, or retail trades, but for bonds with limited quotations, these may be difficult to produce. Still, the lack of such trade information can be used to show that these sources were considered and sought. Other items on the checklist could be:

• Recent bid and asked levels (by contacting broker’s brokers and asking if they have a history on the bond),
  • The historic spread to a curve at which the bond has traded in the past, and using that same spread. (Curves are published on the MSRB’s EMMA site.)
  • BVAL, other Pricing Services, and Third Party Vendors
  • Trade levels of similar bonds.
  • Trade levels of bonds from the same (or other) series of the same issuer.
  • Economic models.

One might note that this is all similar to the “waterfall” method of determining the prevailing market price (PMP) of a bond for mark-up purposes. However, unlike determining most PMPs,  which usually have a starting point and go down the waterfall, there may be no “starting point” in the case of a limited quotation bond. The starting point is anywhere and everywhere, using all possible items on the list.

Always glad to chat about compliance and hear others’ thoughts- especially any other methods by which firms are ensuring compliance with G-18.

I wear two hats- working as CEO of Armstrong Compliance Solutions LLC and also as the CCO of Regional Brokers, Inc. (RBI).

RBI is a Municipal Securities Broker’s Broker (MSBB)- it facilitates liquidity in the municipal market by widely distributing bid-wanted requests received from dealers and SMMPs. It’s RBI’s opinion that the wide net cast by its auction platforms helps the retail accounts of dealers by getting as many eyes on the bonds as possible. And, wide distribution is what the MSRB wants!

Despite the ability of an MSBB to cast that wide net, there’s a type of municipal bond that’s currently limited in its liquidity- that is, any bond whose face value is below the minimum denomination (BMD) stipulated for that bond. For example, a piece of $3000 from an issue where the minimum denomination was $5000.

I won’t get into a long discussion here about “why” there are minimum denominations specified on bond issues- much of it had to do with operational costs, like printing and settlement procedures. In the days of electronic settlement and book entry form, these costs have been minimized. Nevertheless, bonds that are below their minimum denomination have historically had limited liquidity, due to the way registered reps at dealers were paid. If a rep wanted to make a $100 commission on a 5m trade, the rep would work for $20 per bond. To make that same $100 on a 2m bond trade, the rep would have to work for $50 per bond, which could be considered an excessive markup by the regulatory agencies. The limited ability to re-sell these bonds led to a lack of liquidity- no firm wanted to bring into its inventory a bond that none of its reps could re-sell. However, in a world where I get advertisements from firms willing to do a trade for $1 a bond, this seems like less of a hurdle for firms- I’d certainly buy pieces like that if I could pay that low a commission.

This lack of liquidity caused the MSRB to enact MSRB Rule G-15(f), which placed compliance requirements on the trading of these bonds. A firm that purchases a BMD from a customer must ensure that it is “taking out” the entire position of that customer, and a firm selling a BMD to an account must warn that account, in writing, that the bond may be difficult to re-sell in the future.

While adhering to these parts of the Rule are certainly manageable, there is another part of the Rule that has affected liquidity in a more stringent way- the requirement of G-15(f)(iii), that requires a dealer purchasing this type of bond from another dealer to receive a letter from the seller stipulating that it was a takeout. The Rule states, ” In determining whether this is the case, a broker, dealer or municipal securities dealer may rely upon customer account records in its possession or upon a written statement provided by the party from which the securities are purchased.“

RBI, as an MSBB, provides confidentiality to its counter-parties. It can therefore not provide a letter from the seller to the buyer without breaking that confidentiality. And, while RBI is willing to receive a letter from a seller, and write its own letter to the buyer, the selling firms are often unwilling to make the letter available . RBI believes that the biggest reason they don’t want to make the letter available is an age old reluctance to put anything in writing, outside their own firm, that could come back and bite them if it ever turned out to be incorrect. The requirement of the letter means that firms are reluctant to use an MSBB, and therefore may not be getting the breadth and scope (from Rule G-18) that the MSRB would like.

RBI’s opinion is that that the requirement of such a letter is not only an imposition, but also a meaningless imposition. If Dealer A buys bonds from Dealer B, and gets a letter from B that it was a takeout, Dealer A has no way of affirming that it really was a takeout. RBI believes that if the regulatory authorities are concerned about whether compliance with the Rule is being fulfilled, that they need to examine Firm A’s procedures and Firm B’s procedures independently. It makes no sense to make Firm A dependent on the compliance of Firm B.

RBI has written a letter to the MSRB regarding this problem of liquidity. While RBI has not suggested specific changes to the Rule, it would seem that, at least, guidance should be given that a letter is not required as long as each firm can show that it has properly performed and memorialized their internal compliance requirements of the Rule.

RBI has also written a letter to FINRA, in that RBI has anecdotally heard that FINRA is actively examining firms for their compliance with receiving a letter from the selling firm, and has been (at least) issuing cautionary letters, warning firms that they cannot proceed with trades such as this without the letter. These actions by FINRA have further caused a freeze in the market for these bonds.

And, who is hurt by all this? The retail investor, who through no fault of their own ended up with a small piece of a bond, either due to a divorce, or death, or some other life event.

I’d be happy to discuss this with anyone interested in trying to solve the liquidity problem.

FINRA recently made available a video conference in which representatives of FINRA, the SEC, and two individuals from broker dealers gave an update on what they believed to be the current status of RegBI.

These are very rough notes. Contact me for further discussion.

Status:

Compliance Date is still June 30

Helpful Guides to Members:

RegBI spotlight page on SEC

Small firm compliance guide

FAQs- SEC continues to issue and update these on their site

4/7/20 – two risk alerts, one notably from OCIE, outlining what SEC will be looking for in early exams     

REG BI topic page on FINRA

Primary Interest of Regulators:

That firms have entered into a Good faith attempt to implement the Rule.

Show that the firm is moving towards compliance.

Participants suggested:

That firms should “live and breathe the Rule”.

That work could be broken up into four work streams, mimicking four parts of Rule

Make sure that products are good investments for at least some clients.

Communicate constantly with Reps and make sure that they are prepared.

Train the front line (Reps)

Write sample CRS and modify up until the send date.

Training: reps will be on front line.

                        Here is how it will impact you.

Dialogue and interaction. One company’s training program included quiz so that reps had to pay attention.

                        Teach What, when, how.

Here’s the info and here’s how you will be impacted-

Many very good panel discussions are still on line on the regulator web sites. Make use of them. Also make use of the OCIE Risk Alert- it’s a guide to what they will be looking for.

Basics:

            When does RegBi apply?

                        When there is a recommendation.

                                    Use the fact and circumstances test

                                    Action/applies to HOLD recommendations

                        Is it a retail customer?

Applies any recommendation to natural person or a representative of that person. Yes, it applies to limited purpose broker dealers if they are making a recommendation.

                        High net worth, accredited investor still applies.     

Caution Area: “we only do institutional business”- this may not be a good way to think about your accounts- they may be eligible even though they were previously thought of as “accredited” institutional accounts.

What if you have issues in implementing??

If you have issues with the pandemic, staff encourages firms to contact and work with regulator. Don’t be afraid to contact a regulator- if not comfortable coming in direct, use an industry association or counsel.

Regarding FORM CRS:

            Form CRS- are you preparing a combined or two page?

            Participants on the webinar both at first chose to do separate BD and IA , and then combined them. Most likely going to go with the combined version- SEC points in that direction. Also this will make sure that no information is left out or falls through the cracks.

 Does an insert or post card suffice?

            NO! Pretty clear that access=delivery is not sufficient.

            When a BD has reps that are un-affiliated?

            Each firm has its own delivery obligations. Perhaps both would be delivering.

Per one participant, the firm’s clearing firm will deliver the CRS in the July statement- and fulfill the 30 day requirement. They have consent email addresses in some case, but not all- so they will be doing a large mailing

            Another participant says they will be doing a mailing, large, to existing clients, and expect to time it so that it is around the June 30 timing.

            Every customer will get on or before June 30

            Ongoing deliver: Repeat delivery- watch for certain events that trigger another CRS- (rollover, other examples). How do you determine when to re-deliver?

            The SEC is working on information release on what might trigger another CRS.

REGBI has its own disclosures

             The CRS may be the simple part of this, compared to other requirements of Reg BI

Use Layering- similar to IA part 2A – where is the money coming from, this is what you would want to know if you were an investor, direct the client towards that

One participant created a broker dealer brochure- 14-16 pages, layered disclosures, conflicts,

            Layered disclosure

Use of the term advisor or adviser- capacity has to be disclosed- you can’t use the word unless very limited exceptions. An ap supervised by an IA would be ok, (maybe).

If a firm addresses this by having the rep sit for the 65, what is the SEC response to whether there is relief from the rule given that reps cannot currently sit for the exam.

            SEC working on a response to this.

CARE OBLIGATION: looks like suitability with enhancements. What are the practical ways to shift from suitability to higher care standard?

                                     Care- identify when events occurred:

                                    Establishment of account

                                    Funding of account

                                    Transactions within account

                                    Withdrawals from account

            Step b would be looking at those items and adds costs, alternatives, transaction within accounts, complex products, variable annuity. Enhancing existing pre-approval. Look at post-transaction reviews and if an alert goes off, make sure that documents done and

One participant recommended slowing down the investment process and make sure that the client has a chance to ask questions and understand. Agent should come up with a reason for making the recommendation and it will be documented.

            WSPs will be adjusted for ensuring that consideration of cost.

 WSPs will be revisited in late May, June to look for additional needed revisions.

Overdeliver- have a CRS in hand every time. Don’t just stop at the rule.

Continued opportunity for improvement. Ever evolving. Use the enforcement actions of FINRA to learn.

One participant hopes to be able to share documents with other firms as a method of improvement.

FINRA has hosted a teleconference for small firms, answering questions sent to them by industry members. Among the panelists were Chip Jones, Bob Colby, and Robert Cook, Below is a list of the questions and answers as I understood them to be. A recording of the call will be available on the FINRA website

Q. Will the SEC grant extension of RegBI due to the outbreak?

A. FINRA has made the SEC aware of requests by dealers to delay, and has been told that the SEC is “considering” the option.

Q. Should firms be afraid to contact their Risk Analyst to ask questions, in light of possibly throwing up a red flag?

A. Firms should have no fear of contacting FINRA, there will be no penalties. FINRA needs to know what’s going on.

Q. Cities and states are locking down. Can FINRA advocate that Dealers are essential businesses?

A. FINRA believes Dealers are essential and will make that point to authorities.

Q. How should Dealers handle offices that might become quarantined due to the virus, and issues such as checks, mail, etc. ?

A. No real answer to this other than that firms should devise supervisory procedures to handle these items in a best efforts way. Firms will be on a case-by-case basis.

Q. Are firms required to contact FINRA in the event of an office closure?

A. No, but best practice should be that firms contact their FINRA contact person know of such events.

Q. Are persons working remotely required to be registered at a new “branch office”?

A. No, refer to Notice 20-08, and this question will be answered as part of an FAQ that will be placed on FINRA’s web site in order to make the requirements clearer.

Q. Will extensions be made for persons currently needing to be fingerprinted?

A. FINRA hopes that the SEC will allow for extensions.

Q. Will there be extensions for form filing, such as Focus reports?

A. Approach the firm’s FINRA coordinator and discuss. FINRA expects to have a blanket extension for certain classes of firms, dependent upon size and risk.

Q. Will there be an extension of routine firm exams?

A. Routine exams most likely will be delayed until after the outbreak is controlled; however, firms exhibiting risk/obvious potential harm will be examined.

Q. Will there be relief from late fees?

A. Late fees will most likely be waived if properly documented and explained. Fees may be reversed if paid; there will be no time limit on the ability to reverse fees.

Q. What about pending tests and qualification tests?

A. With Prometric closed, enrollments will be open longer.

Q. Will original signatures on U-4 forms be allowed electronically?

A. Signatures will eventually need to be made but may be electronic during the outbreak.

Q. CAT Reporting- will this be extended?

A. Currently extended to 5.20.20, and hoping to have equity trades extended to 6.22.20 and options to 7.20.20, with changes possible. Letters regarding these changes are on FINRA web site.

Q. Will FINRA grant extensions regarding Rule 8210 (information provided during investigations)?

A. FINRA will be reasonable in the expectation of such information. Reach out to FINRA, there will be no repercussions.

Q. Will new arbitration claims be served?

A. Yes, but hearings are pushed out to later dates.

Q. What is the status of Member Application Program (MAP)?

A. Open for business, by telephone or teleconference; extensions will be granted.

Q. How should Dealers handle the inspection of their branch offices?

A. Firms should keep notes of what procedures are put in place to reasonably handle supervision during these times, the factors involved and actions taken.

Q. Will the 2020 National Conference be held?

A. Decision will be made next week.

FINRA is reminding firms to review their Business Continuity Plans (BCPs) to consider whether those BCPs are sufficiently flexible enough to address the wide-ranging effects of a pandemic. The Notice does not create new rules or obligations but is instead intended to provide (within current FINRA rules) pandemic-related guidance and regulatory relief from some requirements

Notice 20-08 centers on FINRA Rule 4370 (Business Continuity Plans and Emergency Contact Information), which requires member firms to create, maintain, review, and update at least annually a BCP to be used in an emergency or significant business disruption. A firm’s BCP is to be designed based on the firm’s business model, taking into consideration such factors as the firm’s size and business needs.

FINRA is encouraging firms to examine their BCPs in light of the recent COVID-19 outbreak, and to consider whether their plans will be sufficient to handle issues that might arise, such as staff absenteeism, the use of remote offices or telework arrangements, travel or transportation limitations, and technology interruptions.

The following is a partial list of the areas of business that should be considered, and FINRA’s granting of relief from requirements. Readers should refer to the Notice for a more complete description (a link to the Notice is found below).

            Remote Offices or Telework Arrangements: Because firms may need to employ methods such as social distancing, travel restrictions, extended sick leave, revised sick leave policies, and alleviation of dense employee seating, firms may require the use of additional temporary office space or teleworking arrangements.

            FINRA understands the possible necessity of such arrangements. While it expects that firms will develop procedures to supervise the persons working in such arrangements, it also understands that some oversight obligations (such as on-site branch inspections) may be temporarily postponed.

            Cybersecurity: Due to the possibility that bad actors will attempt to take advantage of the situation of those employees who are working remotely, FINRA makes the following four recommendations; 1) Ensure that virtual private networks are properly patched with current security updates; 2) Ensure that system entitlements are current; 3) Use multi-factor authentication; 4) Continue to educate  employees in the subject of cyber-risk.

            Form U-4/Form BR: FINRA will temporarily suspend the requirement to maintain updated U-4 information for persons who are relocated due to COVID-19, and firms will not be required to submit branch office applications on Form BR for any newly opened temporary office locations.

            In the event that a firm relocates personnel to a temporary location, the firm should use its best efforts to provide written notification to its FINRA Risk Monitoring Analyst as soon as possible. Information provided should include, at a minimum, the office address, the name of the member firm, the names of associated persons at that location, and telephone numbers or other contact information.

            Communication with Customers: FINRA understands that firms may encounter higher than normal phone and online traffic during an emergency. FINRA recommends that firms ensure that customer identity validation remains robust, and that firms use websites and other means of communication to advise customers how they might best contact the firm or engage in trading.

            Communication with FINRA: FINRA reminds firms that they should already have designated, and provided to FINRA, two associated members of the firm who will act as emergency contacts. The Notice provides a phone number to be used in the event that a firm is unable to contact FINRA through normal methods: 301-590-6500.

            Regulatory Filings and Regulatory Responses: FINRA recommends that any firm that will be delayed in providing a regulatory filing or response due to the COVID-19 outbreak should contact the firm’s Risk Monitoring Analyst in order to seek extensions. FINRA notes that late fees associated with such filings may be waived.

            Qualification Exams and Regulatory Continuing Education: FINRA recommends that firms contact the Call Center at 301-590-6500 with questions about extensions.

            Military Personnel and National Guard: FINRA reminds firms that Rule 1210 (Registration Requirements) provides specific relief to those persons called to active duty.

Held once again at the Marriot Marquise in Washington DC, the 2019 FINRA National Convention offered member firms an opportunity to hear from (and rub shoulders with) the top brass of FINRA, SEC and MSRB. There was also a large contingent of SRO employees in attendance, helping with panel discussions and manning booths where members could view exhibits from FINRA and the MSRB.

Topics brought up at the conference ranged from the basic (how will FINRA examine my branch) to the latest (what can I do to protect my firm from cyber issues). Below, in no particular order, are a few of the topics that seemed to permeate the conference.

Regulation Best Interest (Reg BI): During one of the plenaries where members forwarded questions to the panel, Robert Colby, Executive Vice President of FINRA, joked that the number of questions centered around Reg BI could take up the entire session. However, because no time had been announced for the implementation of the Rule, answers from the panel were generalized. Panelists recommended that dealers identify conflicts, disclose those conflicts, and mitigate those conflicts. They also recommended that a firm’s corporate board should, if possible, be “nose in, fingers out”, while setting a compliant tone from the top.
Reg BI has been since been finalized and was announced in the SEC’s recent release, 2019-89.

Mark-up and Mark-down: On the one year anniversary of the release of the MSRB’s changes to Rules G-15 and G-30 requiring certain mark-ups and mark-downs to be disclosed on account confirms, FINRA and the MSRB seemed in agreement (along with many member firm panelists) that initial anxiety over the rule was overblown, and, as one panelist said, “a non-event”.
Common findings by FINRA when examining some 200 firms data showed exceptions that included:
Traders improperly entering information into trading systems;
Dealers assuming that their clearing firms were handling all aspects of the requirements;
Retail accounts improperly marked as institutional accounts;
Mark-up being calculated as only the amount of commission paid, as opposed to the difference between a firm’s cost and the customer’s cost; and
Failure to include the required URL on the confirm pointing the account to information about the bond on the EMMA web site.

Focus on the “Bad Apples”: FINRA stated several times during the conference that a focus of the authority will be to go after that very small percentage of the industry that causes the most problems. The Chair of the SEC is proposing changes to capital requirements based on the risk posed by certain firms that show a preponderance to hire risky reps. Firms would do well to pay attention to their “heightened supervision” policies.

Social Media and the Changes that are coming with it: This topic was widely discussed at the conference, with sessions devoted not only to emerging fintech trends, but also specifically to social media and digital communications. Too large to cover here in detail, sessions included “the rapidly changing world of digital communications, compliance” and “supervision of text and instant messages, social media and email”. Suggested sources to learn more about this area and the SROs’ guidance should refer to MSRB Notice 2019-07, SEC National Exam Program Risk Alert (December 2018), and FINRA Regulatory Notice 17-18: Social Media and Digital Communications.

Outside Business Activities (OBAs): The subject of OBAs came up frequently in the plenaries as well as having an individual session devoted to it (Outside Business Activities and Private Securities Transactions). FINRA believes that OBAs and private securities transactions continue to be regulatory and examination priorities due to their contribution to conflicts of interest at firms. Mention was also made of proposed changes to the rules regarding OBAs, in which FINRA will attempt to focus in on risks posed by certain OBAs and not by others (e.g. driving for Uber).

Consolidated Audit Trail (CAT): CAT is coming- FINRA recently issued Notice 19-19, with the following wording “FINRA is issuing this Notice to remind firms they must register with FINRA CAT, LLC (FINRA CAT) for reporting to the Consolidated Audit Trail (CAT). CAT registration commenced on March 18, 2019, and will run through June 27, 2019. All Industry Members, as defined under the CAT NMS Plan, that will have a CAT reporting obligation must register during this window”.

In response to a question from the floor, a FINRA panelist stated that CAT will eventually replace the current OATS system.

For questions about these and other topics discussed at the 2019 FINRA National Conference, contact H. Deane Armstrong, CEO Armstrong Compliance Solutions
610-996-8904

When I write an article, I’m never sure if some readers will say, “Who didn’t know that??” But, for folks like myself, who are willing to admit what they don’t know, the following is both a lesson learned about a rule, and an example of how different districts of FINRA may enforce regulations differently. And, you may learn something that you didn’t know- one or more of your branch offices should be listed as an OMSJ- an Office of Municipal Supervisory Jurisdiction.

During a recent cycle exam by FINRA, the firm where I work as CCO (which had recently re-located to District 9-New Jersey) was informed by the examiner that a “finding” that would need correction was the improper designation of our one and only branch office. We’d designated the office as a “non-branch” since the inception of the firm (originally located in District 9-Philadelphia), in 1992.

In our response to the examiner, we cited past history; the Philadelphia District had agreed with us since 1992 that the location did not rise to the level of the definition of a branch. The office had no retail clients, did not hold itself out as a branch, and performed all execution through the systems of the firm.

FINRA’s counter-response was a surprise, but hard to argue with. They pointed not to their own definition of a branch, but to that of the Municipal Securities Rulemaking Board.

The MSRB, under their Rule G-27 “Supervision”, defines what branches should be listed as Offices of Municipal Supervisory Jurisdiction (OMSJ). The section of the rule that related to our business model, was G-27 (b)(iii), which “requires the designation as an office of municipal supervisory jurisdiction of each location that meets the definition contained in section (g) of this rule”. 

The definition in section (g) reads as follows:

(g) Definitions.  For purposes of this rule, the following terms have the following meanings:

(i) “Office of municipal supervisory jurisdiction” means any office of a dealer at which any one or more of the following functions take place with respect to municipal securities:

(A) order execution and/or market making;

In other words, because the person working in this “branch” was executing orders on municipal bonds with other dealers, the branch did, in fact, fall under the requirement.

Despite having been made aware of the requirement, we still were puzzled. While doing research on the topic, we’d found the following statement published by FINRA regarding the designation of OMSJs on Form BR:

 “FINRA CRD – FAQ Branch Office Registration”, Question #8: “Must a firm designate a branch office as an Office of Municipal Supervisory Jurisdiction (OMSJ) for the MSRB in Section 2 (Registration/Notice Filing/ Type of Office/Activities)?”

The answer is “NO”- the question is optional.” (footnote 1)

Why, we wondered, is the designation of a branch as an OMSJ not required on a firm’s Form BR? 

The reason for the “No” answer to FINRA’s FAQ, as explained by a person that we contacted at the MSRB, is that MSRB items are not included on Form BR, which is a form associated with the SEC and FINRA. So, while a cursory examination of FINRA’s FAQ might lead a firm to believe that it’s optional to designate a branch as an OMSJ, that would be an incorrect answer. The correct answer is that the filing of the designation on Form BR is optional; the designation itself is not. A firm must still make those designations either in their WSPs or other appropriate books and records.

Firms should review their WSPs, using G-27 (b)(iii) and (g) to determine the designations that they must make for their offices. Designations, once made, should be identified on at least an annual basis.

One piece of good news is that, while OMSJs are not required to be shown on Form BR, they can be listed there.  As FINRA says, “a firm may elect to answer this question in Section 2 (Registration/Notice Filing/Type of Office/Activities) to help track their OMSJs”.

I hope that this article taught you something that you didn’t know, or perhaps reminded you of something that you’d known and forgotten. In either case, feel free to contact me with questions about this or other municipal topics.