Regulatory Inspections, Examinations, Reviews and Compliance Practices Wednesday, December 2 2:00 p.m. 3:00 p.m.

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1 Regulatory Inspections, Examinations, Reviews and Compliance Practices Wednesday, December 2 2:00 p.m. 3:00 p.m. FINRA staff discuss common deficiencies noted during FINRA cycle examinations, and identify controls, procedures and leading compliance practices that member firms are incorporating into their respective supervisory systems to address these deficiencies. Moderator: Panelists: Daniel J. Stefek Associate Vice President and District Director FINRA Atlanta District Office Casey Harper Examination Manager FINRA Dallas District Office Emilio R. Mahia Examination Manager FINRA New Orleans District Office Elizabeth Mauro Examination Manager FINRA Boca Raton District Office 2015 Financial Industry Regulatory Authority, Inc. All rights reserved. 1

2 Regulatory Inspections, Examinations, Reviews and Compliance Practices Panelist Bios: Moderator: Daniel J. Stefek, Associate Vice President, is District Director of FINRA s Atlanta District Office. The Atlanta office is responsible for the examination and regulation of the FINRA member firms located in Georgia, North Carolina and South Carolina (approximately 180 main offices and 10,500 branches). Mr. Stefek has extensive regulatory experience, starting his career in FINRA s Los Angeles District Office in While in Los Angeles, he worked in a variety of positions for NASD (FINRA s predecessor), first conducting financial and sales practice examinations, then managing the district s examination programs as Exam Manager and then as Associate Director. Mr. Stefek moved to Georgia in 2004, where he became Director of the Atlanta Office. He received his business degree in finance from the University of Southern California. Panelists: Casey Harper has been an Examination Manager in FINRA s Dallas District Office since In this role, Mr. Harper leads a team of Examiners in the planning and execution of risk-based cycle examinations involving many different types of broker dealers. He also managed the on-going surveillance of approximately 100 broker dealers during his first two years as an Examination Manager. Mr. Harper started his career with FINRA in 2005 as an Examiner conducting cycle and cause examinations and worked on numerous high profile examinations involving allegations of fraud. Mr. Harper holds a B.B.A. in Finance from Texas A&M University-College Station. Emilio R. Mahia is an examination manager in the FINRA New Orleans District Office. Mr. Mahia joined NASD/FINRA in 1999 as an examiner. Prior to his current position, Mr. Mahia served as an examiner for 14 years. Mr. Mahia has participated in numerous high profile cycle, cause and special initiative examinations, involving a broad scope of sales practice issues. Mr. Mahia received a bachelor s degree in economics from the University of Southern Mississippi. Mr. Mahia is designated as a Certified Regulatory and Compliance Professional (CRCP ) through the FINRA Institute at Wharton. Elizabeth Mauro is an Examination Manager in the Florida District office and is responsible for managing a team of examiners that conduct Sales Practice cycle examinations. Prior to becoming an Examination Manager, she served as a Staff Examiner and as a Regulatory Coordinator assigned to the District s member firms as their primary point of contact at FINRA, and responsible for monitoring their overall regulatory compliance through ongoing financial and sales practice surveillance. Ms. Mauro s knowledge of the securities industry has evolved from approximately 19 years of regulatory experience, including serving as an Examiner and Finance Coordinator with the New York Stock Exchange specializing in the Financial and back-office Operations of a broker-dealer, and compliance with the Net Capital and Customer Protection rules. She has also served as a Securities Compliance Examiner with U.S. Securities and Exchange Commission in their Miami Regional office. Ms. Mauro received her Bachelor in Business Administration degree with a major in Finance and Banking from Hofstra University Financial Industry Regulatory Authority, Inc. All rights reserved. 2

3 South Region Compliance Seminar December 2-3, 2015 New Orleans, LA Regulatory Inspections, Examinations, Reviews and Compliance Practices

4 Panelists Moderator: Daniel J. Stefek, Associate Vice President and District Director, FINRA Atlanta District Office Panelists: Casey Harper, Examination Manager, FINRA Dallas District Office Emilio R. Mahia, Examination Manager, FINRA New Orleans District Office Elizabeth Mauro, Examination Manager, FINRA Boca Raton District Office 1

5 Overview of Cycle Examination Process Examination begins on announcement date Onsite visit will typically occur 60 days after announcement date Prior to onsite visit, the exam team is conducting risk reviews and interviews of firm personnel This is contingent upon timely and accurate production via Firm Gateway 2

6 Overview of Cycle Examination Process Exit meeting will typically occur on the last day of the field work Examination report will typically be issued within 60 days of the exit interview Examination is complete after the firm has responded to the examination report and final disposition letter has been issued, typically within 30 days after examination report date. This is contingent upon timely and adequate responses. 3

7 Preparing for a FINRA Exam Conduct a risk assessment of your business activities, products, sales force, compliance and supervisory structure Identify gaps in your controls or supervision Encourage staff to escalate gaps they identify Encourage Preventive Compliance Maintain ongoing dialogue with your FINRA Regulatory Coordinator Monitor regulatory actions and consider whether your firm has potential exposure 4

8 Preparing for a FINRA Exam Resources FINRA s Annual Priorities Letters Correlate to your firm s business FINRA On-Demand Video Webinars Your Regulatory Coordinator 5

9 Common Deficiencies: Transaction Supervision Failure to review for or evidence reviews of high risk activity Suspicious activity Variable Annuity exchanges, share classes and riders Open and closed-end mutual fund switching Active accounts (e.g. high volume trading, turnover, commissions) Higher risk alternative products (e.g. illiquid products, inverse and/or leveraged products, speculative products) 6

10 Common Deficiencies: Supervision of Transactions FINRA Rules 3110(b)(2) and Principal review of all securities transactions: Retains requirement that a principal review all transactions; but allows firms to use a risk-based approach. A reasonably designed risk-based review system will provide the firm with sufficient information to enable the firm to focus on the areas that pose the greatest risks of violation. Principal must review parameters and is responsible for any deficiency in the system s criteria. 7

11 Common Deficiencies: Supervision of Transactions Direct Business Transaction blotters Commission reconciliation Suitability considerations (e.g., source of funds) Patterns of red flag transactions (e.g., switches, exchanges, withdrawals) Cleared Business Use of exception reports Reliance on clearing firms (e.g. AML, wires) 8

12 Common Deficiencies: Supervision of Transactions Resources Regulatory Notice Complex Products Regulatory Notice Consolidated Supervision Rules Regulatory Notice Deferred Variable Annuities 9

13 Common Deficiencies: Issues Involving Registered Representatives Books and Records FINRA By-Laws, Article V, Sections 2 & 3: Late complaint disclosures (RN 13-08) Undisclosed OBAs/PSTs Undisclosed Disclosures (e.g., criminal and bankruptcy records, civil litigations, judgments and liens) Effective July 1, 2015 FINRA Rule 3110(e) Background Checks on Registration Applicants 10

14 Common Deficiencies: Issues Involving Registered Representatives Books and Records Effective Practices Use of outside vendors for background checks of new hires Conduct independent internet searches (e.g., GOOGLE, Secretary of State Websites) Employ the use of FREQUENT attestations Conduct independent reviews on an ONGOING basis (e.g., annually, branch office inspections) not just at the time of hire Indications of financial pressure (e.g., requests for commission advances, loans) Educate RRs of consequences for disclosure failures 11

15 Common Deficiencies: Issues Involving Registered Representatives Conflicts of Interests Potential Fiduciary Relationships Power of Attorney Beneficiary Trustee Executor 12

16 Common Deficiencies: Issues Involving Registered Representatives Conflicts of Interests Common Fact Patterns RR befriends elderly customer with no close relatives RR runs errands for customer, involves customer with own family, keeps other away from customer RR is named as beneficiary in will RR does not tell firm until after inheritance Firm and RR become involved in dispute with relatives Disciplinary action by FINRA based upon firm s procedures 13

17 Common Deficiencies: Issues Involving Registered Representatives Conflicts of Interests Effective Practices Require annual disclosure of acting as power-of-attorney, trustee, executor Require annual disclosure of being named as beneficiary, successor beneficiary, successor trustee, executor Require annual disclosure of immediate family being named or acting in these roles If there is approval of any of these roles, require transfer of account to a different representative Educate RRs that receipt of funds as a trustee or executor is an outside business activity 14

18 Common Deficiencies: Issues Involving Registered Representatives Use of Discretion Use of Discretion w/o Written Authorization (NASD Rule 2510). Most Commonly Associated With: Actively traded accounts Variable Annuity subaccount reallocations Preventive Measures: Use of in-house and/or clearing firm exception/surveillance reports Use of outside vendor activity reports Customer contact by an independent party as is deemed necessary (by letter and/or phone) 15