In an article for InvestmentNews.com, on February 1st, 2012, Mark Schoeff Jr. writes that in a market defined by low interest rates, investors are searching for higher returns. But brokers better be careful how they try to deliver those results, according to their primary regulator.

In a 16 page letter posted on its website, the Financial Industry Regulatory Authority Inc., (FINRA)  outlined its regulatory and examination priorities for 2012. At the top of the list: conduct and products meant to beat the market that instead are unsuitable for investors.

“FINRA is informing its examination priorities against the economic environment that investors have faced since 2008, as these circumstances have steadily contributed to conditions that foster an increased risk of aggressive yield chasing, inappropriate sales practices, unsuitable product offerings, and misappropriation and fraud,” the letter states.

“Given the low yields on Treasuries, we are concerned that investors may be inadvertently taking risks that they do not understand or that are inadequately disclosed as they chase yields,” the letter continues. Lack of liquidity and inadequate cash flow in investments also are red flags Finra is monitoring.

Shoeff writes that among the products that are on FINRA’s watch list for suitability problems: residential- and commercial-mortgage-backed securities, nontraded real estate investment trusts, municipal securities, exchange-traded funds using synthetic derivatives and significant leverage, variable annuities, structured products, private placements and life settlements.

FINRA said that it is undertaking a “broader data collection effort” and targeting its enforcement efforts on high-risk firms.  FINRA warned brokers not to enhance their balance sheets by taking on excessive debt or manipulating their assets and liabilities.

“FINRA is concerned about the additional risks that are being taken as a result of increased leverage, including market, credit and liquidity risk,” the letter states. “We will continue to monitor firms that employ a high degree of leverage, both on-balance-sheet and off-balance-sheet during the upcoming year.”

The InvestmentNews.com article goes on to say that FINRA also is zeroing in on fees.

“We remain concerned about firms’ charging retail investors hidden, mislabeled or excessive fees,” the letter states. “In 2011, FINRA brought cases against several broker-dealers that charged such excessive fees in the form of postage and handling charges that were unrelated to actual costs, and we will continue to investigate firms that appear to be taking advantage of investors through fee schemes.”

FINRA’s guidance on social media is less explicit. It said that it “is a topic on which we continue to receive many questions from firms.” FINRA reiterated that “core regulatory requirements apply to all communications with the public, irrespective of the medium or device used to communicate. Firms must be able to appropriately supervise business communications made using personal devices.”

Schoeff writes that high-frequency trading, and oversight of the creation and redemption of exchange-traded funds, also are listed among the agency’s many priorities. FINRA oversees about 4,460 broker-dealers and enforces the suitability standard, which requires brokers to sell products that fit their clients’ investment needs, timelines and risk appetites.

Other regulators are paying attention to FINRA’s priorities as   well.

“States look at these very highly,” said Steve Thomas, director of Lexington Compliance, a division of RIA in a Box LLC, and former South Dakota chief compliance examiner. “They make individual decisions on whether these items should be added to their state’s examinations.”

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Darla Mercado of InvestmentNews.com, recently wrote that Finra’s variable annuity (VA) suitability rule should be old news to broker-dealers, but firms that want to avoid an arbitration land mine ought to review their procedures.

Mercado writes this warning came directly from Andrew A. Favret, associate vice president and regional chief counsel at the Financial Industry Regulatory Authority Inc.

Along with Robert H. Watts, a Finra arbitrator and former compliance officer for John Hancock Financial Services Inc., Favret held a boot camp on annuities at the Insured Retirement Institute’s Government, Legal & Regulatory Conference in Washington. Both shared tales of broker-dealers’ missteps on following VA suitability rules and highlighted the red flags that likely would bring a firm under Finra’s suspicion.

“It’s funny how often firms have good procedures [for sales practices] and the reps will say they’ve never seen them,” Mr. Favret said. “Firms need to be able to show they have good procedures and that they’re getting the word out to their reps.”

In some cases, the person responsible for providing supervisory approval at a broker-dealer had left the firm years ago, Mr. Favret said.

“Whenever Finra finds something, they look at who’s the nearest principal,” said Mr. Watts. “What did they do? What should they have done?”

The InvestmentNews.com article goes on to say that some broker-dealers have been caught with outdated supervisory procedures and standards of conduct, and have been unable to give Finra an adequate explanation as to how the procedures were drafted or who exactly is responsible for ensuring that reps follow the rules.

Common pitfalls for firms include failure to have written supervisory procedures, failure to have appropriate policies and steps to assess suitability, and failure to document complete suitability information.

Mr. Favret also highlighted “the three C’s” that help determine whether Finra will pursue a case: concentration and how a firm justifies placing upward of 50% of a client’s net worth into a VA; costs and whether the rep took that into account when either selling or transferring a VA; and complexity — whether the customer knows what he or she is buying.

Finra began an initiative this year where it combed through data from five or six major VA issuers for data on concentration levels and the sales of VA riders, Mr. Favret said. It’s a way for Finra to highlight problem areas throughout the industry without having to rely solely on complaints, writes Mercado.

“We had relied on customer complaints, which isn’t a very efficient way to get at problems in the industry; you’re looking for a needle in the haystack,” Mr. Favret said. Instead, data mining “is a big deal in terms of how we look at this going forward.”

Securities Attorney, Lars Soreide, of Soreide Law, PLLC, has represented clients nationwide. If you or a family member feel you have become a victim of stock/securities loss, call a Securities Arbitration Lawyer for a free consultation on how to potentially recover your losses.  To speak with an attorney, call 888-760-6552, or visit www.securitieslawyer.com

Soreide Law Group, PLLC., representing investors nationwide before FINRA  the Financial Industry Regulatory Authority.

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