Regulatory Certainty... Really? A Look at Compliance with FINRA Rules

A look at compliance with FINRA Rules 2090 and 2111

Spotlight Issue 3 - 2012

As the leading provider of sales and regulatory automation solutions to the insurance and financial services industries, we know all about deadlines. Deadlines bring focus and a sense of urgency. We work closely with all our clients to assure that the requirements and specifications are clear and that there is certainty in the process. Once that certainty is established, delivery is much easier. As new FINRA rules are introduced, Broker-Dealers are forced to deal with a regulatory environment of guidelines and broad interpretations of the facts and circumstances of each case. They don't have the benefit of a detailed "specification" for compliance.

We won't revisit the details of the regulations in this article. What follows are observations of how some Broker-Dealers are approaching the new rules and creatively meeting the challenges of compliance when certainty may be in short supply.

Certainty – And, Not So Much

Make no mistake; there is certainty in the wealth management community regarding FINRA rules 2090 and 2111:

  • Regulations are final
  • Implementation date is July 9, 2012
  • Scrutiny of Broker-Dealers, Compliance Officers, and Advisors will increase
  • Cost of compliance (and non-compliance) will increase

In addition to the points above, another area of certainty is the interest among the Broker-Dealers in the actual implementation of the rules. This interest was obvious in the standing-room-only session at the FINRA Annual Conference session titled "Suitability and Know Your Customer". As the presentation progressed through a summary of the regulations, documentation considerations and some of the practical challenges of implementation, the body language of the attendees was telling. Whether it was a shake of the head, shared looks and shrugs or hand to the forehead rubbing temples, I didn't observe any indication of certainty from the attendees that they knew precisely what they needed to do and how they were going to comply.

Timeline – Preparation

Everyone knows that the implementation date for the regulations is July 9, 2012. However, there has been a wide disparity in preparation for the regulations. In some cases, even before the regulations were final, Broker-Dealers were working to define the changes to their processes and systems to meet the requirements of the regulations entailing over a year of preparation. Conversely, as recently as June 1st, I've encountered some Broker-Dealers that were just beginning the process.

Why, with the impending implementation, are we seeing such variability in response to the regulations? While there actually may be as many reasons as there are Broker-Dealers, there are a couple themes that emerge: 1. Confusion about what compliance looks like 2. Reliance on clarity to come through enforcement

What Compliance Looks Like

"Investment Strategy" is one of the key elements of FINRA 2111. Supplemental materials accompanying the regulation indicate that investment strategies involving a security or securities should be "interpreted broadly." The introduction of this language, in part, takes suitability from the traditional transaction-based suitability model to a broader interpretation that some believe is the first step toward a fiduciary standard, which is a much different level of suitability.

Another new action covered under the considerations of an investment strategy is the explicit hold order. What once was a simple conversation with a client about market conditions could become an explicit hold order, a recommendation. If it does become a recommendation, it will require all of the same documentation and review as the sale of a new product. In a very real sense, this will be creating action from inaction.

Several concerns about the explicit hold recommendations go beyond implementation concerns. If a hold recommendation triggers all of the same documentation and review obligations of a new sale without any corresponding revenue: 1) Will it inhibit client/advisor communication in an attempt to avoid the additional responsibilities and corresponding operational costs? 2) Will it encourage transactions that would not otherwise take place because the effort required for a recommended sale and a recommended hold are identical? 3) Will this serve any real benefit for the average investor? 4) Will it serve only as fodder for increased litigation? 5) Or, could it be all of the above?

Clarity Through Enforcement

This is likely one of the riskier justifications for procrastination, regardless of its truth. To a certain extent, everyone I talked with agreed that the practical requirements will be defined through the FINRA examination and audit process. Obviously, the risk for a firm and/or its advisors is the potential that they become the object lesson of the industry, which could be a costly approach.

A variation of this view is one that large firms will drive the expectations of examiners based on processes defined by an "army of attorneys" and resulting in expectations, systems, and processes that are completely impractical for small to mid-sized regional firms. This is likely to further exacerbate conflict in the examination process over the expectations and what the regulation actually says. Speculation also exists that this could drive the merger or acquisition of smaller firms in order to generate the economies necessary to implement more complex compliance processes.

Response – Implementation

Though varying widely in urgency and content, the response of almost all Broker-Dealers has been enhanced collection of data to demonstrate reasonable diligence associated with both rules. We won't go into the specifics of the data being collected. Suffice it to say that I have seen plans that range from firms requiring two or fewer pages of data points on a single form, to other firms requiring as many as twelve pages of data included on as many as seven forms. It's worth noting again that the new definition of a "hold recommendation" will require similar documentation and review in the absence of a transaction.

Implementation of enhanced data collection on most automated platforms requires significant IT budgets. Another shortcoming of those platforms is a lack of agility to evolve as requirements become clearer. Finally, most systems attempt to force Broker-Dealers into a one-size-fits-all solution, which is difficult for a group known for their independence and widely varying interpretations of the rules.

The most common approach being taken is a redesign of forms specific to each Broker-Dealer. Why? Generally, we believe it to be familiarity for the population served and their ability to customize their forms to their specific interpretation of the rules. We believe it also gives them the assurance that they can easily change these forms as the implementation of the rules evolves with their changing interpretation.

This approach comes at a price:

  • Loss of automation opportunities
  • NIGO (Not In Good Order) rework
  • Manual/paper processes
  • Duplication of effort—no reuse of information from other platforms

The benefits of automation increase with the complexity of the data being collected. Experience has shown me that, regardless of where Broker-Dealers are in the implementation process, they have been receptive to looking at solutions that can offer flexibility while also minimizing operational costs associated with rework and tech-heavy solutions.

Enforcement – Change

All firms are taking the new rules seriously. The potential of non-compliance resulting in damaged reputations and fines for the advisor and firm are real. The consensus is that there will be more clarity a year from now.

Enforcement will be the catalyst that drives the "compliance specification." Even then, implementation will be unique to each firm just as compliance will be determined by the facts and circumstances of each case. In an environment where margins are always being pressured, firms that position themselves to respond to the changes efficiently will be served well.

 

Del Lang
SVP, Strategic Relationship Management
Insurance Technologies

 

Are you ready to simplify your complete sales process?