The Financial Industry Regulatory Authority (FINRA) has recently issued its 2024 Annual Regulatory Oversight Report (the Report). This comprehensive 90-page document underscores evolving regulatory concerns and introduces several new areas of focus. Notably, the Report includes a dedicated section on cryptoasset developments and a detailed examination of market integrity topics, including the Securities and Exchange Commission (SEC) Market Access Rule.
Key Takeaways
1. Cryptoassets-Related Activities
The Report emphasizes the significance of monitoring associated persons' involvement in cryptoasset-related outside business activities (OBA) and private securities transactions (PST), even if broker-dealers themselves are not directly engaged in cryptoasset activities. Given the heightened regulatory focus on cryptoassets, broker-dealers must ensure that financial advisers accurately report their OBAs and seek necessary approvals for PSTs.
FINRA highlights the importance of fair and balanced retail communications concerning cryptoassets. Firms should ensure their messaging accurately reflects the risks associated with these assets, including their speculative nature and the limited legal or regulatory protections available. FINRA's recent examination initiative on cryptoasset communications revealed substantial violations in about 70% of reviewed cases, emphasizing the need for robust practices.¹
The creation of a specialized crypto team within FINRA's Member Supervision's exam program aligns with its increased scrutiny. FINRA has approved certain firms to act as placement agents in private placements of cryptoasset securities, operate alternative trading systems (ATS) for these securities, and provide custodial services under SEC guidelines. Broker-dealers involved in cryptoasset activities are encouraged to inform FINRA about their engagement and review their supervisory programs and compliance policies, particularly in areas like cybersecurity, anti-money laundering (AML), and due diligence.
2. Reg BI and Form CRS
Firms should adhere to best practices regarding the duty of care, conflicts of interest, compliance, and disclosure obligations, including:
- Providing guidance on evaluating costs and alternative options when making securities recommendations and documenting these considerations as per firm policies.
- Establishing written policies and procedures tailored to the firm's business model.
- Assessing compensation practices to ensure they do not create conflicts of interest or incentivize recommendations that are not in customers' best interests.
- Identifying and mitigating conflicts of interest associated with private placements in accordance with Reg BI's standards.
3. Market Integrity
Over-the-Counter Quotations in Fixed-Income Securities
FINRA expects firms to maintain robust supervisory controls and procedures to comply with SEC Rule 15c2-11 concerning the publication of quotations for fixed-income securities in over-the-counter markets. This involves implementing front-end surveillance, conducting self-assessments, and using third-party vendors to manage controls effectively.
Advertised Market Volume
Firms must ensure that trade volume information disseminated by themselves or third parties is complete, accurate, and not misleading. This includes maintaining written supervisory procedures to verify and assess the accuracy of published trading volumes.
Market Access Rule
FINRA has outlined several considerations for compliance with the Market Access Rule to maintain financial stability, market integrity, and overall system stability:
- Implementing risk-management controls and written procedures.
- Assessing due diligence when employing third-party services.
- Documenting reviews of risk management frameworks and market access controls.
- Setting pretrade order limits, capital thresholds, and maintaining control over financial thresholds for orders.
- Conducting post-trade and supervisory reviews for potentially manipulative trading patterns.
4. Cybersecurity and Technology Management
Firms should be aware that cybersecurity incidents may trigger disclosure requirements under broker-dealer-specific rules such as FINRA Rule 4530(b). Staying updated on the SEC's proposed cybersecurity risk management rule is crucial. Additionally, firms should consider the implications of AI usage on accuracy, privacy, bias, and intellectual property.
5. AML, Fraud, and Sanctions
Firms should develop tailored surveillance programs to detect manipulative schemes and be vigilant about New Account Fraud (NAF), which exploits stolen or synthetic identities. Enhancing monitoring and review processes is essential to detect and address NAF effectively.
6. Financial Management
Liquidity Risk Management
Effective liquidity controls are vital. Firms should prepare contingency funding plans for market or idiosyncratic stress conditions and ensure accurate liquidity information. FINRA may request additional liquidity risk-related information under Rule 4524.
Communications With the Public — Mobile Apps
Firms should ensure their mobile apps include appropriate risk disclosures and clearly explain risks associated with options trading, margin use, and cryptoassets.
Conclusion
The FINRA 2024 Annual Regulatory Oversight Report highlights critical areas for broker-dealers, including emerging risks related to cryptoassets, regulatory compliance, and market integrity. A thorough review of the Report provides invaluable insights for managing these evolving regulatory challenges. Firms are encouraged to adopt effective practices and remain vigilant in addressing the regulatory expectations outlined by FINRA.
Footnotes
¹ FINRA, 2024 Annual Regulatory Oversight Report, available at https://www.finra.org/rules-guidance/guidance/reports/2024-finra-annual-regulatory-oversight-report.
² FINRA, Crypto Asset Communications Sweep Update (January 23, 2024), available at https://www.finra.org/rules-guidance/guidance/targeted-examination-letters/sweep-update-jan2024.
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