FINRA 5 Percent Policy – What Firms Actually Need to Know

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mitch atkins finraA practitioner’s guide to FINRA Rule 2121 — covering the rule text, the governing case law, how the 5% and 10% thresholds actually work, what FINRA is finding in current exams, and what your firm needs to do to stay compliant.

The Core Obligation

FINRA Rule 2121 — titled “Fair Prices and Commissions” — governs how broker-dealers price transactions with their customers. The rule’s language is deceptively simple: when a firm buys or sells a security for its own account (acting as principal), it must do so at a price that is fair, taking into account all relevant circumstances, including market conditions, expense, and the firm’s entitlement to a profit. When a firm acts as agent, it must not charge more than a fair commission or service charge. Importantly, the obligation runs in both directions. The rule applies equally to markups — when a firm sells to a customer above the prevailing market price — and to markdowns, when a firm buys from a customer below the prevailing market price. Both must meet the same standard of fairness.

“It shall be deemed a violation of Rule 2010 and Rule 2121 for a member to enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security or to charge a commission which is not reasonable.” FINRA Rule 2121, Supplementary Material .01 

Every markup and markdown analysis is anchored to the prevailing market price (PMP) — the price that reflects current market conditions at the time of the transaction. The markup or markdown is the difference between what the customer pays or receives and that PMP. Getting the PMP right is not a technicality; it is the foundation of the entire analysis, and it is where FINRA examiners focus first.

The 5 Percent Policy: What It Is and What It Isn’t

Alongside the rule text, FINRA maintains what is known as the “5 Percent Policy” — an interpretive guideline adopted by the NASD Board in 1943, based on studies showing that the large majority of customer transactions were executed at markups of 5% or less. The Policy has been reviewed and reaffirmed by the FINRA Board of Governors multiple times since then.

Understanding what the 5% figure actually means in practice requires reading it carefully:

What the rule actually says about 5 Percent

The 5 Percent Policy is explicitly a guide, not a rule. Critically, the rule states that a markup pattern of 5% or even less may be considered unfair or unreasonable — and that the percentage of markup is only one of several factors that determine fairness. There is no “safe harbor” at 5%. There never has been.

In today’s markets — far more liquid and transparent than 1943 — FINRA applies considerably more pressure well below the 5% threshold, particularly for listed equities where inter-dealer spreads are tight and execution costs are minimal. A 5% markup on a listed equity transaction will attract significant examiner attention.

The 10% Threshold: Per Se Fraud

While FINRA guidance frames the 5% figure as a guideline, the SEC has established a considerably harder legal line at 10%. This is not a soft regulatory expectation — it is stated explicitly by the SEC in Release No. 34-24368 (April 21, 1987), transmitted to the industry via NASD Notice to Members 87-31:

The Commission consistently has held that, at the least, undisclosed mark-ups of more than 10% above the prevailing market price are fraudulent in the sale of equity securities.”

SEC Release No. 34-24368 (April 21, 1987) — citing In re Alstead, Dempsey & Co.; In re Peter J. Kisch (Release No. 19005, 1982); In re Powell & Associates (Release No. 18577, 1982); James E. Ryan; In re Sherman Cleason (1944); Duker & Duker

This line of administrative decisions — running from Duker & Duker in 1939 through multiple SEC releases — establishes that an undisclosed markup exceeding 10% on an equity security is fraudulent under Section 10(b) of the Exchange Act and Rule 10b-5, as well as Section 17(a) of the Securities Act of 1933.

The standard is stricter for debt securities

For debt securities — corporate bonds, municipals, and government securities — the standard is stricter. The SEC has consistently held that markups on debt are expected to be lower than on equities. A markup that might be defensible on an equity may be clearly excessive on a bond of equivalent dollar value.

Disclosure does not cure an excessive markup under FINRA rules

Disclosing the amount of a markup to the customer before the transaction is a relevant factor under Rule 2121 — but it does not render an otherwise excessive or unfair markup permissible. The rule is explicit: disclosure itself does not justify a commission or markup that is unfair in light of all other circumstances. The disclosure defense is available only in the narrower federal fraud analysis — it may defeat the “undisclosed” element of a 10b-5 claim — but it carries no weight under the SRO fair pricing rules, where excessive markups are prohibited whether or not disclosed.

The Seven Factors: How Fairness Is Determined

Rule 2121’s Supplementary Material .01(b) sets out seven factors that firms and regulators must weigh in assessing whether a markup, markdown, or commission is fair. No single factor is determinative — the analysis is always holistic. All seven must be considered:

1. Type of security – Higher markups are more defensible on lower-grade, less liquid, or more complex instruments. Listed common stocks face the tightest standards. Bonds carry tighter standards than equities. Units of direct participation programs and condominium securities have historically carried higher acceptable markups than common stock.
2. Availability in the market – For inactive or thinly traded securities, the effort and cost of sourcing the security may justify a wider spread. The firm should document specifically what effort was required — dealer inquiries made, time spent, risk taken in positioning inventory.
3. Price of the security – Lower-priced securities generally support higher percentage markups. The rule acknowledges that low-price transactions may require more handling and expense. The key is whether the economics of the specific transaction actually bear this out.
4. Amount of money involved – Small-dollar transactions may justify a higher percentage to cover handling expenses. Larger transactions — particularly block trades — are expected to be more efficient. Sliding-scale grids tied to transaction size are common and appropriate when kept current.
5. Disclosure – Prior disclosure of the markup amount is one factor among seven — not a trump card. The rule is explicit that disclosure does not justify a charge that is otherwise unfair. It is relevant but limited in its protective effect under SRO rules.
6. Pattern of markups – Each transaction must individually meet the fairness standard. FINRA pays particular attention to patterns — a consistent pattern of elevated markups across a class of transactions or for a specific customer draws far more scrutiny than an isolated outlier that was promptly documented and addressed.
7. Nature of the firm’s business – Firms providing substantive, continuing services — research, market access, advisory capabilities — may have a stronger basis for higher charges than execution-only operations. Note: inventory losses or unrealized market losses the firm sustained are the firm’s risk and may not be passed through to the customer as a justification for a higher markup.

Determining the Prevailing Market Price

Every markup and markdown analysis begins with the prevailing market price. Rule 2121 and its Supplementary Material .02 (for debt securities) establish a clear hierarchy for determining PMP. Firms must follow this waterfall in order — they cannot skip levels or use a lower-tier source when a higher-tier source is available:

1. Contemporaneous cost (primary presumption) — For a firm selling to a customer, its own contemporaneous cost of acquiring the security is presumptively the best evidence of PMP. For markdowns, contemporaneous proceeds from the firm’s own sales control. This presumption is strong: a firm must produce actual evidence to overcome it — not just assert that market conditions changed.
2. Inter-dealer transaction prices — If no contemporaneous cost exists, or if the presumption is legitimately overcome (for example, due to a material interest rate change, a significant credit quality shift, or market-moving news after the firm’s acquisition), the next source is contemporaneous inter-dealer transactions in the same security.
3. Institutional transaction prices — Contemporaneous dealer purchases or sales to institutional accounts with which the dealer regularly transacts in the same security.
4. Inter-dealer bid/offer quotations — For actively traded securities only, validated contemporaneous inter-dealer quotations through a mechanism where transactions generally occur at displayed prices. Quotations for inactively traded securities are frequently subject to negotiation and may not reflect actual PMP.
5. Similar securities and economic models — Only when none of the above yield relevant pricing information. Economic models (such as discounted cash flow or credit spread analysis) may be used, but only at the bottom of this hierarchy — not as a shortcut past the earlier steps. Isolated transactions or a limited number of non-representative transactions have little or no weight.
Firms cannot skip levels in this hierarchy

Using quotations from a limited number of market participants when inter-dealer transaction prices are available, or relying on economic models when contemporaneous transactions exist, is itself a Rule 2121 violation — regardless of whether the markup ultimately charged would have been found fair under a correct PMP analysis.

Transactions Covered — and One Key Exemption

The 5% Policy and Rule 2121’s fair pricing obligation apply broadly across transaction types. Firms should not assume the rule is limited to straightforward principal sales from inventory.

Transactions the rule covers

  • Principal sales from inventory to customers
  • Principal purchases from customers (markdowns)
  • Riskless and simultaneous principal transactions
  • Agency transactions (commissions)
  • Proceeds transactions (see below)
  • All security types: equities, bonds, direct participation programs, oil royalties, and others

One key exemption

  • New issue / prospectus sales: the 5% Markup Policy does not apply where a prospectus or offering circular is required to be delivered and the securities are sold at the specific public offering price.

Note: municipal securities are subject to MSRB Rule G-30 for debt-specific pricing requirements. The general fair pricing obligation under Rule 2121 continues to apply.

Proceeds transactions require particular attention. When a customer liquidates a position and uses those proceeds to purchase another security at or about the same time, both legs are treated as a single transaction for markup purposes. Any profit the firm realized on the liquidation side must be included in calculating the total markup on the purchase. Firms that treat each leg as a separate, independent transaction — and calculate markups independently on each — are incorrectly applying the rule and likely charging the customer an aggregate amount that would not pass the fairness test if properly measured.

What FINRA Is Finding in Current Examinations

FINRA’s current examination priorities in this area focus heavily on fixed income and principal transactions. The following deficiencies are the most frequently cited:

  • Incorrect PMP determination. Firms not following the contemporaneous cost presumption, or bypassing the required waterfall by jumping to quotations or economic models when inter-dealer transaction prices are available. This is the most frequently cited deficiency in markup-related exam findings.
  • Inadequate oversight of third-party pricing software. Firms using vendor systems to determine PMP but lacking oversight of how the software establishes prices, not verifying that the firm’s own trade data feeds are complete and accurate, or allowing manual overrides without documented supervision and rationale for each override.
  • Stale markup and markdown grids. Relying on fixed pricing grids established years earlier and never updated to reflect changed market conditions, instrument characteristics, or current transaction economics.
  • No facts-and-circumstances analysis. Relying solely on grids or fixed thresholds to assess fair pricing — without conducting the actual multi-factor analysis required by the rule — is a supervisory deficiency even if no individual transaction is found to be priced excessively.
  • Yield impact not considered for short-term debt. Charging markups on short-maturity fixed income securities that materially reduce the investor’s yield to maturity — sometimes eliminating a significant fraction of available return — without accounting for that impact in the fairness analysis.
  • No PMP documentation. Firms are required to document the basis for PMP in each transaction, particularly when departing from the contemporaneous cost presumption. Without this documentation, the firm cannot meet its evidentiary burden if a transaction is challenged in an examination or enforcement proceeding.

Building a Compliant Markup and Commission Program

A sound compliance program in this area rests on three pillars: a written policy that accurately reflects the firm’s actual business and pricing practices; supervisory systems capable of detecting and investigating deviations; and documentation sufficient to support the firm’s positions under examination. Here is what each requires:

Written Policy

  • Standard markup and markdown ranges by security type — equities, investment-grade debt, high-yield, municipals, direct participation programs
  • An explicit PMP determination methodology that follows the Rule 2121 waterfall in the correct order
  • A documentation standard for transactions where contemporaneous cost is not used as PMP, including the specific basis for departing from the presumption
  • A proceeds transaction identification and calculation procedure
  • A grid review schedule — pricing grids must be reviewed and updated periodically to reflect current market conditions
  • Disclosure protocols for markups above standard policy thresholds

Supervisory Systems

  • Automated exception reports flagging transactions above defined markup and markdown thresholds by security type
  • Periodic recalibration of exception parameters — static exception reports become ineffective as market conditions shift and stop identifying genuine outliers
  • Oversight of any third-party PMP software, including verification that firm trading data feeds are complete, accurate, and current
  • Supervision of all manual PMP overrides, with documented rationale required for each
  • Account-level monitoring: cost-to-equity ratios and turnover ratios for active accounts, with a defined protocol for investigating outliers

Documentation

  • PMP determination record for each principal transaction, particularly where the contemporaneous cost presumption is departed from
  • Written rationale for exception transactions identifying which of the seven factors apply and what specific work was performed to justify the charge
  • Investigation records for all exceptions flagged by supervisory systems, including disposition and any follow-up action taken
  • Records of periodic grid and procedure reviews, including what was reviewed, who conducted the review, and what changes were made
The practical test

If a FINRA examiner asks two questions — “how did you determine the prevailing market price for this transaction?” and “what specific factors justify this particular charge?” — can every person who prices transactions at your firm answer both clearly and consistently, with supporting documentation? If not, the compliance program has gaps worth addressing before the next examination cycle.

 

Atkins Discusses FinCEN CDD Rule on FINRA AML Panel

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Don’t miss the the AML Challenges panel at the 2018 FINRA Annual Conference on May 23, 2018 in Washington DC. FirstMark’s founder, Mitch Atkins, will present as a panelist. One of the key topics to be discussed is the FinCEN CDD Rule. The rule became fully effective May 11, 2018. If you’re ready, or even if you’re not, implementation questions still abound. As recently as April 2018. FinCEN issued additional guidance in the form of FAQs. This was the second round of FAQs issued on the FinCEN CDD Rule. The first round can be found here. Many firms have experienced challenges in understanding the nuances involved with the beneficial ownership requirements, including the ownership and control prong. There are numerous exceptions and interpretations to both. Also, perhaps more challenging has been the so-called “fifth pillar” requirements that involving ongoing monitoring to detect potential suspicious activity. The FinCEN CDD Rule codifies, for the first time, the requirement to conduct ongoing monitoring and to update customer information if there are red flags noted. Some AMLCOs have struggled with the concept of the fifth pillar, particularly with regard to the ongoing monitoring requirements. Questions have arisen as to whether the FinCEN CDD Rule requires that small firms implement an automated surveillance system. Guidance issued by Treasury on the FinCEN CDD Rule provides that this is not true – there is no new requirement to install a trade surveillance system. Instead, the FAQs explain that the monitoring can be done on a risk basis. However, during the course of the normal risk monitoring, if a red flag of potentially suspicious activity is noted, the customer profile that was developed based on the FinCEN CDD Rule “nature and purpose” provision should be revisited and if necessary updated. All of these issues will be addressed on the AML Challenges panel at the 2018 FINRA Annual Conference in Washington DC. If you haven’t signed up and were considering doing so, you can at this link. Also, you can view the conference video

Click on the image below to view the conference brochure:

FinCEN CDD Rule Atkins

 

Click on the image below to view FirstMark’s presentation materials (a practical quick reference guide to the FinCEN CDD Rule).

FinCEN CDD Rule Atkins

FirstMark Regulatory Solutions, Inc. is a compliance consulting organization based in Boca Raton, Florida. Mitch Atkins is FirstMark’s founder and principal. He focuses on broker-dealer compliance matters, including anti-money laundering independent testing, FINRA new member applications, FINRA CMAs, FINRA Enforcement litigation support, and supervisory controls testing.

 

 

 

AML Surveillance – Major FINRA AML Case

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Yesterday FINRA settled yet another major case involving AML surveillance system deficiencies. This is one more in a series of cases in which FINRA has found that a broker-dealer’s electronic surveillance systems were insufficient to detect potentially suspicious transactions. In this case, FINRA fined the firm $13 million (which was duplicated by the SEC bringing the total sanction to $26 million) for failures related to an automated system the firm used for monitoring transactions for potentially suspicious activity. In 2010, firm connected the system to a larger, enterprise-wide system that risk-scored the results in such a way that limited the reviews of alerts from the original system. This means that, according to the settlement document, for a four-month period, the firm did not investigate suspicious activity detected by the original system. It appears from the settlement language that the firm believed its system was generating too many “false positives” and during a transition period simply determined not to investigate those items. All in all, it seems that the firm failed to investigate 1,015 instances of potentially suspicious activity.  The firm designed the system parameters such that it also excluded multiple occurrences of potentially suspicious money movements that involved high-risk counterparties and entities only once. Thus, because there was no linkage between related accounts, it did not consistently identify or monitor these customers, which apparently included some in high-risk jurisdictions and who were senior foreign political figures (PEPs). Also, quite interestingly, the settlement states that millions of accounts were excluded from the firm’s automated monitoring system.

This case is an obvious demonstration of FINRA’s increasing ability to conduct highly sophisticated AML investigations. FINRA’s last several major AML actions have sought progressively higher fine amounts for failures to adequately implement AML surveillance technology. No doubt, the investment in staffing and technology to address this issue proactively would have cost less than $26 million. But of course, hindsight is always 20/20. That said, the message is abundantly clear. It is time to invest in top-notch AML surveillance systems. And, such an investment is not simply the installation, but the ongoing periodic maintenance, which in the industry is often called tuning. It is also important that firms utilizing AML surveillance systems employ experts in FINRA AML requirements to ensure that the systems are tested and tuned in a manner similar to that which is performed by FINRA.

Finally, I have previously explained that while tuning is an important aspect of the maintenance of AML surveillance systems, it is important to take a measured approach to managing false positives generated by these systems. On one hand, false positives are a fact of life with AML surveillance systems. However, changes to rules and thresholds that are not validated or tested by experts against prior results can end up causing costly mistakes. I’m a firm believer in eliminating as many false positives as possible, because by their nature a good percentage of them are just noise and interfere with proper AML surveillance and detecting potentially suspicious activity. I’ve written about this before.  However, I worry that FINRA actions such as this will have a chilling effect on those firms wishing to fine tune these systems. I fully support modification of thresholds and rules to result in the maximum efficiency of the AML surveillance system overall. Also, it often makes sense to implement enterprise-wide surveillance. As with many things, however, this case illustrates that the devil is in the details.

Mitch Atkins, CRCP is the founder and principal of FirstMark Regulatory Solutions, a compliance consulting organization based in Boca Raton, Florida that specializes in AML compliance.

 

Mitch Atkins Presenting at FINRA South Region Conference

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Mitch Atkins, founder and principal of FirstMark Regulatory Solutions, will present at the FINRA South Region Compliance Seminar in Fort Lauderdale, Florida on December 6, 2017.  Mitch Atkins will present as a panelist on FINRA’s panel entitled Writing and Maintaining Written Supervisory Procedures. The panel will discuss the FINRA’s Supervision Rule (Rule 3110), and in particular, best practices for developing effective supervisory and compliance procedures. As a panelist, Atkins will discuss the regulatory requirements for procedures, and will provide take-away resource materials to attendees that will serve as a guide for developing procedures, including procedures for FINRA’s new Rule 2165 on financial exploitation of seniors/specified adults.

One of the most commonly cited violations on FINRA examinations is the failure to develop and implement adequate written supervisory procedures (“WSPs”). Beyond simply satisfying regulatory requirements, effective WSPs are a compliance tool that broker-dealers utilize to delegate responsibilities for compliance with FINRA and SEC rules. Additionally, effective WSPs do more than simply state the requirements of a particular rule, rather, they serve as a blueprint of the firm’s supervisory system. A supervisory system collectively includes the processes, technology, personnel and related documentation. Before engaging in the development of WSPs a firm should first carefully consider all aspects of an overall supervisory system. Lastly, an effective supervisory system includes clear lines of authority. There have been numerous regulatory enforcement actions which cited firms for failure to designate authority, or worse, in which a problem arose, but the lines of authority were blurred such that nothing was done to correct the problem. In some of these cases, the identification of the problem was not the issue so much as who was responsible for the resolution of the issue. These issues will be covered by the panel, which includes industry and regulator participation. The FINRA South Region Conference is a cost-effective way to gain additional knowledge in this and many other areas.

To register, please visit http://www.finra.org/industry/2017-south-region-compliance-seminar 

FirstMark offers a broad range of compliance consulting services, including AML independent testing, Rule 3120 supervisory controls testing, SRO relationship management, FINRA membership applications, training, and more. Mitch Atkins founded FirstMark in 2013.

For more information and to view the seminar brochure and agenda, simply click the image below.

mitch atkins finra

Update: To view the session materials, click the image below:

Epic BD AML Compliance Failure Yields Another Record Fine

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On Monday, December 5, 2016, FINRA announced yet another record fine against a broker-dealer for AML compliance failure. This action follows another just seven months ago in which FINRA fined a broker-dealer complex $17 million for AML compliance failure. There are numerous messages here which you can read about in my LinkedIn article that analyzes the new case. The bottom line here is to remember that the days of a slap on the wrist for a firm with a serious AML compliance failure are over. FINRA has demonstrated that it will not hesitate to slap a broker-dealer with a significant sanction, and even to name individual AML compliance officers if violations are serious. There are parallels between this case and FINRA’s May 2016 action against a Florida BD complex. Read my summary of that case here.

The case involved several significant areas of compliance breakdowns. The firm utilized and automated surveillance system, but according to the FINRA settlement document, the data feeding into the system was inaccurate and/or missing information critical to its proper functioning. FINRA also found that the system did not utilize scenarios to detect specific types of activity that it believed the firm systems should have covered.

Another AML compliance failure was that there were deficiencies in the manner in which the firm determined ownership and saleability of microcap securities. FINRA noted that the firm was involved in the liquidation of over 3.7 billion shares of microcap issuers during its review period and earned $10.4 million in commissions from same. Because the system for determining whether the shares could be properly liquidated was inadequate, FINRA found that the firm violated NASD Rule 3010, FINRA Rule 3110, and FINRA Rule 2010.

The AML compliance failure also involved inadequate procedures covering suspicious activity reporting, and failure to conduct adequate due diligence on foreign financial institutions that were also firm affiliates.

FINRA Tolerance for AML Compliance Failures Fading

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AML compliance failures are starting to get the “zero tolerance” message from FINRA. It recently announced its largest fine ever against two firms for AML compliance failures, including the suspension of the AML compliance officer. Mitch Atkins, a former FINRA official breaks down this action in a LinkedIn article. In reality, these sanctions are not too different in scope than that which was levied on Brown Brothers Harriman in 2014. The difference is there are two firms involved in this sanction. Also, the failures in the Brown Brothers case appear to be more limited to the area of low-priced securities and while that is an element of the recent action, it seems broader in scope as to the nature of the compliance failures.

At the recent FINRA Annual Conference in Washington, D.C., FINRA’s head of Enforcement, Brad Bennett, indicated in his comments during a panel discussion that there were more enforcement cases to come in the AML compliance space. Bennett stated that FINRA noted a signficant number of red flags in the recent case, but he suggested that future cases may involve actual money laundering rather than just compliance failures. I suspect these cases will be as significant or more significant given the apparent escalation of sanctions of late.

AML Compliance Failures Don’t Necessarily Mean AMLCOs will be Named

The good news is that Bennett reassured the attendees that the action against the AMLCO in this case was an exception and that FINRA is not out to get compliance officers. He insisted that FINRA carefully considers naming compliance officers and would rather not do it at all. FINRA has long stated that compliance officers who are doing their jobs and who take reasonable steps to address compliance issues will not be named in disciplinary actions. Bennett warned, however, that should senior executives ignore the calls of compliance officers for additional resources and compliance failures were the result of such decisions, FINRA would not hesitate to name them in an action.

Mitch Atkins is a consultant to broker-dealers, investment advisers and financial firms. He has over 23 years experience in the securities industry and is the founder and principal of FirstMark Regulatory Solutions based in Boca Raton, Florida.

Atkins in Forbes: Email and Social Media Compliance

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Last month in New York, I was invited to speak with a group of broker-dealer compliance staff at an event about email and social media compliance. More specifically, and to be technically correct, we call this “supervision of electronic communications” and you can read all about it in FINRA Rule 3110(b)(4). There, I had the opportunity to speak with Forbes contributor, Joanna Belbey. Before the event, we had a good discussion on the FINRA 2016 examination priorities and more specifically, how they relate to email and social media compliance. You can read the interview by clicking here: Mitch Atkins Forbes. See the follow-up piece to this (Don’t ‘Set it and Forget it’) by clicking here: Mitch Atkins Forbes Part II.

Email and Social Media Compliance Decrypted

After having worked in regulation for nearly 20 years, working as a consultant to broker-dealers and investment advisers has been truly enlightening, particularly in understanding the perspective of the chief compliance officer. I have had the opportunity to help design, audit and improve systems of supervision for electronic communications. What has become evident in my recent work with consulting clients is that FINRA has been very active in its email and social media compliance reviews. Today, more than ever, the term electronic communications includes far more than email. In the past, firms could be relatively confident if they had a decent email compliance system and banned the use of social media. But today, if talented advisors are not permitted to use popular communication channels, they may work elsewhere – read: competitors.

For these reasons more employers are ensuring that they have top-notch supervisory controls in place to allow the use of communication channels advisors want. To that end, firms wanting to beef up compliance might consider the following:

  1. procedures – development of clear policies and procedures covering communications;
  2. technology – implementation of a cutting edge email and social media compliance platform (but be careful and remember that simply buying the system isn’t enough – FINRA recently published an AWC in which a Chief Compliance Officer was suspended for failing to implement such a system – see FINRA Case 2014039194102 – Feb. 23, 2016);
  3. personnel – ensuring that persons tasked with conducting email and social media compliance reviews are adequately trained and that adequate resources are devoted to conducting reviews;
  4. controls – requiring annual compliance questionnaires in which advisors certify their compliance with policy and disclose all communication channels they use;
  5. testing – some firms are hiring summer interns to search advisor names against social media sites (and who is better at social media?).

And finally, your keyword flagging database is the key (no pun intended) to the effectiveness of your supervisory system. Make sure that the database is reviewed frequently, that it is dynamic and evolves with both the business of the firm and the changing times. See my LinkedIn article about that for more details.

Mitch Atkins is Founder and Principal of FirstMark Regulatory Solutions, a broker-dealer and investment advisor compliance consulting practice in Boca Raton, Florida. Contact Mitch at 561-948-6511.

 

Electronic Communication “Let’s Talk Supervision”

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Compliance risks exist in your electronic communication. How will you effectively manage these risks? With the volume and velocity of information flowing through electronic communications channels, supervision has become a real challenge. Mitch Atkins presented at the Actiance Executive Briefing Series in New York on April 7, 2016 on how organizations can leverage their electronic communications applications to comply with regulatory requirements. Entitled, “Let’s Talk Supervision: Freedom with Responsibility” the talk took place at the Viceroy hotel in Midtown Manhattan. Among the topics discussed were:

  • FINRA 2016 examination priorities
  • Electronic communications requirements
  • Managing volume in supervisory reviews
  • Common challenges in managing reviews
  • Supervision of non-email content

Atkins discussed recent FINRA disciplinary actions that involved electronic communications rules violations, including two from the 1st quarter of 2016 in which FINRA named individuals, including a Chief Compliance Officer. CCOs are faced with many challenges from day to day and some of those include managing the review of electronic communications. During the presentation, Atkins stated that excessive volume, low value keywords, lack of training for reviewers and representatives, and insufficient internal controls contribute to failures in thia area. He emphasized that electronic communication channels are dynamic as is the language that is used through these channels. As such, supervisory systems related to electronic communications must also be dynamic. Keyword flagging databases must be updated frequently and should be developed with the input of the supervisors of the departments for which electronic communications are being monitored. Additionally, broker-dealers must develop and document that training has been conducted for associated persons who use electronic communications. He advised that systems of supervisory controls such as annual attestations by associated persons as to the electronic communications channels they use and that they understand the prohibition of using outside email or non-email channels for business communications. He recommended periodic testing of electronic communication channels to ensure that all are being captured in supervisory systems. He also queried the audience whether, in light of FINRA’s recent emphasis on culture of compliance, they know what culture is appearing in their electronic communications.

Electronic Communication Live Webinar

Additionally, Mitch Atkins was a featured presenter at the Actiance “From Supervision to Surveillance” webinar on April 12, 2016. This session also cover challenges in surveillance of electronic communication. View more information about the live webinar here. Another session will occur on May 5, 2016, and it is not too late to register.

Email Flagging Keywords Out of Date?

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Do you Update your Email Flagging Keywords?

It is important to remember to periodically update your email flagging keywords if you use a monitoring system for electronic communications. Those systems, while powerful, are only as good as the dictionary of email flagging keywords used to call out a communication for review. Broker-dealers are required to supervise all communications relating to their investment banking or securities business, so says FINRA Rule 3110. Systems provided by Global Relay and SMARSH have the ability to call out electronic communications for review based on the parameters set by the system administrator. And a key element of an adequate supervisory system for reviewing communications is a robust set of email flagging keywords. Knowing the fine line about how much is too much is also important. Because a list that is too long and doesn’t use carefully thought-out lists of email flagging keywords will call out too many “false positives” for review, thus making the process ineffective.

To develop an effective list, consider conducting a thorough analysis of: 1) business lines and relevant keywords, 2) languages spoken by clients and employees, and 3) latest industry intelligence on terminology being used. It is important to understand that the manner in which we communicate, even in business, is constantly changing. For this reason, we must ensure that the supervisory systems and processes we use are updated in such a way as to remain relevant tools. The email flagging keywords list should be dynamic and should be the product of careful scrutiny and analysis.

FirstMark Regulatory Solutions is a broker-dealer and investment adviser compliance consulting firm based in Fort Lauderdale, Florida. FirstMark founder, Mitch Atkins, has written an article on LinkedIn, about email flagging keywords and some of the terms prosecutors and defense attorneys are using according to a September 2, 2015 article in Bloomberg Business. For more information or for help preparing your email flagging keyword list, contact Mitch Atkins at (561) 948-6511.