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FINRA Sets Ethics and Conduct as 2016 Examination Priorities

Alexander Moshinsky, CPA, Director 03.22.2016 | Client Alert

Compliance officers and management teams are advised to prepare for sharper attention to ethics and conduct in light of the Financial Industry Regulatory Authority's (FINRA) 2016 Regulatory and Examination Priorities Letter. FINRA has made it clear that it will be looking into messages from management, compensation programs, and an overall culture that encourages employees across the firm to "do the right thing" for their clients and the institution itself. 

While "culture" and "ethics" are broad terms that may be difficult to examine, it is important that firms can demonstrate appropriate "tone from the top" and support for various control and compliance programs.  In addition, firms should assess incentive programs to confirm that they encourage ethical behavior.  This document can serve as a guideline for management in setting the right tone and for compliance officers in reviewing governance, compensation, and training programs to better meet regulatory expectations in these areas. 

Ethics and Conduct Framework

FINRA defines ethics and conduct as the set of explicit and implicit norms, practices, and expected behaviors that influence how firm executives, supervisors, and employees make and implement decisions in the course of conducting the firm's business. The areas of scrutiny are frameworks firms use to develop, communicate, and evaluate conformance with their culture.

Five key indicators are:

  • How internal control, compliance, and internal audit functions are valued within the organization;
  • How policy or control breaches are tolerated;
  • Whether the organization proactively seeks to identify risk and compliance events;
  • Whether supervisors are effective role models of firm culture; and
  • Whether sub-cultures (e.g., a branch office, a trading desk, or an investment banking department) conform to overall corporate culture.

Ethics and Conduct Risk

Firms should be aware of key areas of risk associated with ethics and conduct - performing a risk assessment in these areas can reduce overall risk and better prepare the institution for regulatory examination.  Some areas of risk include:

  • Poor corporate governance, sales, or market share goals leading to irresponsible actions by traders; brokers, sales personnel, or other employees acting in self-interest; 
  • Conflict of interest issues, such as the combined roles for the design, approval, and implementation in model development.
  • Research rules issues. Firms have been fined significantly for inappropriately using the promise of favorable research to win investment banking business;
  • Information sharing between different areas of firm's trading activities, between firm's trading activities and other parts of a firm, and through the front-running of a pending rating change;
  • Certain business functions and job categories that present a higher level of risk in terms of ethical behavior. These functions include sales, vendor management, and trading; and
  • Certain incentives in performance goals that further increase or are associated with unethical behavior (i.e., market share goals, project completion deadlines and aggressive mark-to-market practices etc.

Increased Regulatory Implications 

Firms may pay a high price for ethics violations.  In May 2015, FINRA's National Adjunctory Council (NAC) released updated Sanctions Guidelines for use in disciplinary proceedings involving FINRA member firms and associated brokers. The Guidelines follow the NAC's decision to review existing disciplinary guidelines and generally provide for tougher sanctions for violations of FINRA rules. FINRA explained that the Guidelines "harmonize the Sanction Guidelines with the current state of the cases in this area," but are not meant to prescribe fixed sanctions for particular violations.1

Actions to Consider

Firms can consider taking specific steps to demonstrate that they have made ethics and culture a high priority for the institution.  Among these steps are:

  • Set tone at the top: set company culture policies and make them accessible to all associates by storing them on the company intranet and any mobile devices accessible to all employees as a point of reference; 
  • Ensure channels exist for employees to easily and securely report ethics or conduct violations (e.g., whistleblower hotline, online submission form, creation of an ethics and conducts chair);
  • Reinforce companies' values via town halls and company-wide and departmental events;
  • Provide continuing professional education programs focusing on ethics and the company's values;
  • Dedicate certain aspects of the human resources department to identify ethics violations by monitoring trader activity for market abuse and information leakage;
  • Monitor employee incentive structures to ensure they do not contradict or counteract ethics standards; and
  • Reward employees for ethically-driven behavior.

Firms may consider an ethics and culture risk assessment process, including an incentive risk heat mapping program in order to review the current environment and benchmark against best practices and reporting recommendations. This process will enable the institution to demonstrate a systematic approach to ethics and culture across business units, geographies, and overtime. The goal is to maintain efficient regulatory compliance and stave off unwanted FINRA sanctions.

Conclusion

FINRA has placed a high priority on examining firms' behavior regarding ethics, conduct, and overall culture.  The issues described in this Alert should be considered priorities by management and specifically by compliance functions within your organization.

Questions? Contact your Berdon advisor or Alexander Moshinsky 

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1 http://www.reedsmith.com/FINRA-Publishes-New-Sanction-Guidelines-Urging-Tougher-Penalties-for-Rule-Violations-05-21-2015/
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