Remarks at the CCOutreach BD National Seminar

Richard G. Ketchum

Chairman and CEO

Washington, DC

February 8, 2011

As prepared for delivery.

Thank you, Carlo [di Florio], for that introduction. It's good to be here—to share with all of you what's on my mind and also to hear about some of the challenges you're facing.

I'd like to talk briefly about regulatory reform from FINRA's perspective and then address some changes to our regulatory programs. I'll also touch on a few high-level areas where we continue to have concerns.

Regulatory Reform

As Mary [Schapiro] just discussed, the SEC released two studies last month that are particularly relevant to this group—one on oversight of investment advisers and the other on the fiduciary standard.

On the first study, we have long advocated that more frequent examinations of IA firms will enhance investor protection. We look forward to working with the SEC and Congress as decisions are made on how to implement the options in the study.

On the standard of care issue, we fully support moving to a fiduciary duty for broker-dealers when providing investment advice. We believe a fiduciary standard should attempt to eliminate conflicts, but where conflicts can't be eliminated, they should be properly and clearly disclosed to customers. We will work closely with SEC staff on the implementation of a fiduciary duty for broker-dealers in a way that recognizes the value in being able to access a variety of models and products but doesn't restrict firms' activity.

On disclosure, we think the time is right to ensure that customers receive more plain English disclosure about products from broker-dealers, and disclosure about brokerage services—including the conflicts of interest that a broker-dealer faces when offering these services. Today, account agreements are enormous in size—and often discarded by customers.

We believe there is a need for more Web-based, brochure-like disclosure that provides—in plain-English—information about conflicts and fees, and range of products. It is a fundamental building block of a single standard of care.

To that end, we published a concept proposal requesting comment in October. The proposed rule would require firms, at or prior to commencing a business relationship with a retail customer, to provide a written statement that describes the types of accounts and services it provides. Firms would also be required to disclose the conflicts associated with such services. FINRA is proposing a document similar in purpose to Form ADV, which investment advisers must provide to each advisory customer. We received many comments on the proposal, and we will keep firms updated on any proposed rulemaking.

Changes at FINRA

Let me now turn to some of the ways FINRA is changing its exam program and other regulatory processes to become more effective. I firmly believe that we have an obligation, just like you do, to learn and continue to change.

Member Application Program (MAP) Process Changes
We have been aware for some time—and heard from firms, as well—that the member application process does not always work as well as it could. So, we've taken a look at it and recently announced some changes.

We have created a central Member Application Program Group to manage the review of all new and continuing membership applications. The centralized approach is designed to ensure a consistent review of applications and implementation of policies across the country. Beyond this structural change, we are evaluating the entire program and working to improve the application process while maintaining the core investor protection principles.

Our planned enhancements include technology-based initiatives such as electronic submission for all continuing applications as well as possible changes to the existing electronic form for new applications. We are also planning to provide more guidance about the application process and FINRA's expectations for submitted applications. These efforts should lead to improvement in the overall quality and timeliness of our membership application review.

Exam Resources
Another important area of change is the way we are deploying our resources to regulate and examine firms. Using a more risk-based approach, we are focused on understanding the composition of each firm's business as we walk in the door. And our exam teams are homing in on those areas that pose a real risk to investors.

Through our expanded coordinator program, we want to have more continuous, ongoing conversations with you about what's happening with your firm and where and how your firm is changing, both from the standpoint of your business model and elsewhere. To be efficient and effective, we need to understand how your firm is evolving and the challenges you see ahead.

Exam Priorities

Before closing, I want to discuss—at a high level—a few of FINRA's exam priorities for 2011. Later today, Susan Axelrod, our head of Sales Practice, will discuss more of our priorities in greater detail.

Fraud Detection
We are continuing to strengthen our efforts to detect fraud and other egregious misconduct in order to better protect investors. Our examiners are focused on finding red flags that may indicate fraudulent behavior, whether associated with offerings, stock manipulations, misrepresentations or other misconduct. Likewise, examiners are assessing affiliate activity, including how the affiliate interacts with the broker-dealer business and any conflicts of interest it may pose. We've also strengthened our ability to independently verify customer and proprietary assets that a firm maintains at non-member financial institutions.

Product Concerns
Over the last couple of years, FINRA has issued a number of Regulatory Notices related to products that have raised concerns for us from an investor protection standpoint. As I've said time and again, firms must make sure that all the products they offer—proprietary and non-proprietary—are appropriate for individual customers in light of their needs, goals and current financial situation. However, we continue to see some firms selling products that are not in the best interest of their customers.

Let me touch on three examples:

Private Placements & Private Self Offerings
First, we're looking at retail sales of private placement interests, including those issued by broker-dealers and control affiliates. Our examinations and investigations have identified significant failures in firms' compliance with suitability, supervision and advertising rules, as well as potential instances of fraud and participation in illegal distributions of unregistered securities. A number of these investigations have led to enforcement actions.

Last year, we reminded firms of their obligations to conduct reasonable investigations into "Reg D" offerings. And we highlighted a number of specific practices relating to these offerings that firms should consider. But the bottom line is that the responsibility and the commitment to know what you're selling—whether it is from a legal or reputational standpoint—is more important than ever. Recently, we have also proposed changes and are requesting comment on an expansion of the provisions of our private placements rule, to provide investors with additional protection from fraud and abuse.

Municipal Securities
Second, we want to ensure that firms meet their sales practice and due diligence obligations when selling municipal securities. Municipal securities dealers must understand what they're selling in order to meet their disclosure, suitability and pricing obligations—and their obligation to deal fairly with customers under MSRB rules and federal securities laws. Firms must also review their procedures for compliance with MSRB Rule G-32, which requires the delivery of an official statement, or a notice of its availability on the MSRB's EMMA system, to any customer purchasing a municipal security during the primary offering disclosure period.

In any transaction in a municipal security, a dealer must obtain, analyze and disclose to customers all known material facts about the transaction, as well as material facts that are reasonably accessible to the market through established industry sources.

Non-Conventional Investments
Third, we are looking at firms that sell structured products and certain riskier asset-backed securities to retail investors. Recent enforcement cases highlight the importance of training brokers on products sold and reasonable supervision to ensure suitable recommendations. Brokers must understand the risks and costs associated with the products recommended and disclose them to customers. For instance, collateralized mortgage obligations present a variety of risks, including credit and default risk, interest-rate risk, prepayment risk and extension risk. CMOs are structured into different tranches, each with their own set of rules by which interest and principal get distributed. So it is important for brokers to understand the features of the tranche they are selling and the rules governing its income stream as these affect the product's risk.


One of the defining features of the financial industry is innovation, as firms continually devise new instruments in search of an advantage relative to their competitors. For regulators, adapting to this evolution—and maintaining investor protections—is a constant challenge. We've learned that we can be most effective when we have a meaningful and ongoing dialogue with firms. These conversations contribute to understanding on both sides, and underscore that when firms and regulators are focused in the same direction—investors benefit.

Thank you again for having me.