Broker-Dealer Compliance Tips for an Ambiguous Enforcement Climate

Many regulatory policies set by the SEC and FINRA are broadly construed, posing problems for broker-dealers trying their best to follow the rules. Compliance itself is often defined as having “reasonable” safeguards, leaving broker-dealer’s open to qualitative interpretation by regulators.

“Reasonable” is a particular sticking point. Many regulations are qualified by this term. But what is the definition of “reasonable”?

Because broker dealers are subject to such open-ended, unpredictable regulatory actions, broker-dealers may be unaware that their compliance procedures are inadequate until regulators take action against them. Businesses with outdated, inefficient oversight processes that lack “reasonable safeguards” risk severe consequences from financial authorities, underscoring the importance of compliance best practices.

The Ambiguous Enforcement Climate

The intricate structure and vague wording of many compliance rules makes it difficult for broker-dealers to decipher what regulators expect of them. In particular, there are three FINRA regulations that are challenging to understand:

  • Know Your Customer. This rule states that broker-dealers must use reasonable diligence to know and retain the essential facts about every customer and person acting on that customer’s behalf. “Facts” include information required to effectively service the customer’s account and must comply with applicable laws, regulations, and rules. It’s unclear how regulators will interpret what these ‘facts’ are.
  • Reasonable Investigation of Private Placements. According to this regulatory item, broker-dealers have an obligation to conduct a reasonable investigation of securities that they recommend, including those sold as private placements. This notice is unclear as to whether broker-dealers must conduct such investigations themselves or rely on advisors for help. It is also unclear what rules restrict the advisor from carrying out the investigation.

  • Reasonable Oversight Policies. Firms must have “reasonable” operational oversight policies, according to this FINRA rule (which is, unsurprisingly, one of the rules firms are more frequently accused of violating). Additionally, the policy states that compliance officers must maintain and review compliance procedures, and periodically test the effectiveness of such procedures. The rule doesn’t tangibly define “reasonable,” leaving actions open to interpretation.

Violation of any of these rules can be incur sever penalties – last month, FINRA fined broker-dealer Securities America $100,000 for making inaccurate and misleading statements to their clients in emails. Though Securities America had an email monitoring system in place, FINRA deemed that it wasn’t sufficiently in compliance with federal laws and rules regarding customer communications.

To prevent severe punishment, companies must exercise extreme vigilance when adhering to compliance standards by thoroughly evaluating their own procedures.

Tips for Improving Compliance Practices

Broker-dealers can implement proactive, preventive solutions to reduce vulnerability to discretionary, ambiguous enforcement by financial regulators. Automated compliance solutions provide broker-dealers with numerous benefits, including:

  • Transparent client interaction. When broker-dealers choose to automate their compliance procedures, their client communication becomes more transparent. This is especially important given the recent push by the SEC to establish a uniform fiduciary standard for broker-dealers. The fiduciary standard will require broker-dealers to disclose facts and conflicts of interests to their clients, acting as stronger customer advocates.
  • Robust data collection. Automation allows broker-dealers to collect and structure large amounts of data, which helps them meet the confusing criteria set by regulators, such as “reasonable oversight.”

In an unpredictable climate with regulators penalizing broker-dealers for actions they mistakenly overlook, firms should consider employing an automated compliance solution to ease the burden of adhering to such vaguely drawn standards. These solutions help brokers reduce the possibility of severe punishment and promote compliance best practices, despite the often-muddled policies in place.