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FINRA Examination Program Improvements

Background

Examinations are central to FINRA's regulatory operations, and they are one of the principal means by which the organization protects investors and promotes market integrity. FINRA's examinations also aim to provide valuable feedback to firms on areas for improvement and best practices based on insights we have gathered from examining others in the industry.

FINRA has continuously sought to improve the effectiveness and efficiency of its examination programs, an effort that has accelerated under FINRA360.  These efforts have focused on a number of objectives, ranging from moving  away from a "one-size-fits-all" examination program to a more risk-based program, to identifying certain elements of the examination process that cause unnecessary friction in the day-to-day professional interactions between firms and examiners. After careful analysis and review of input from our member firms, staff, and other stakeholders, FINRA adopted, and continues to evaluate, new measures to enhance its examination programs with the goal of making FINRA a more effective, agile and risk-focused regulator. 

Enhancing the Risk-based Examination Framework

FINRA is continuing to implement a risk-based framework designed to better direct and align examination resources to the risk profile and complexity of its member firms. In October 2018, we announced that we will consolidate our Examination and Risk Monitoring Programs (“Exam and Risk Monitoring Transformation Program”), integrating the separate financial, business conduct, and trading examination programs into a single, unified program to drive more effective oversight and greater consistency, eliminate duplication and create a single point of accountability for examinations and risk monitoring for each firm.

After careful consideration, we are moving toward a program structure that is based on the business models of the firms FINRA oversees. Firms will be grouped according to the business(es) in which they are engaged, while FINRA simultaneously groups its resources to engage in targeted examination and risk monitoring efforts. By directing our expertise and resources in a more tailored way, we will drive greater staff expertise and become more effective at examining for compliance. We have begun to implement a "roadmap" that thoughtfully and methodically builds toward this future structure, which is expected to be rolled out in phases beginning in 2020.  

In each routine examination cycle, and as part of the Transformation Program, FINRA is evaluating how resources are deployed and ensuring that we direct our attention particularly to firms, branch offices, and registered representatives that pose greater risk. The changes already made and still planned to the examination and risk monitoring program are designed to result in more effective oversight of firms and greater overall integrity in the broader marketplace. They include:

  • The depth and scope of examinations will more closely match the business model, activities and risks of the firm being examined, avoiding a "one-size-fits-all" approach, and aligning FINRA resources to account for a firm’s complexity and risk profile.
  • Firms that pose a greater risk because of their size, examination and disciplinary history, or approach to, among other things, business practices, hiring practices, due diligence, suitability, supervision, and financial and operational risks, will be examined more frequently.
  • FINRA will continue to strengthen its risk-monitoring program, which informs FINRA’s overall view of a firm, and drives the frequency and approach to examinations, by tailoring the risk assessment methodology and scoring to more closely align with the business models of firms.
  • FINRA also will continue to leverage technology in its examinations to facilitate more work off-site and conduct more efficient, focused examinations while on-site. In particular, FINRA will continue its efforts to analyze specific data from a firm relative to its potential risks before arriving on-site, enabling the on-site portion of an examination to be completed with greater efficiency.

FINRA also will continue to leverage technology in its examinations, with a focus on facilitating more work off-site and conducting more efficient, focused examinations while on-site. In particular, FINRA will continue its efforts to analyze specific data from a firm about its potential risks before arriving on-site, enabling the on-site portion of an examination to be completed with greater speed and efficiency. In 2017, we conducted a pilot electronic off-site examination program to leverage our ability to use our technology and expertise to do more oversight from our offices. We conducted 263 examinations pursuant to this program and will use the lessons learned as our program evolves.

In addition to the above overarching changes and plans, FINRA made the following specific modifications to its examination program in 2019:

  • Timing of exams has been updated to allow, where appropriate, for a reasonable period of time (3-6 months, depending on a firm’s risk) between a firm’s receipt of the prior year’s examination report and the announcement of their next examination. This allows firms more time to evaluate FINRA’s examination report and execute changes to address any findings.
  • Examination Recommendations will no longer be included in Examination Reports. Examiners will convey Observations verbally with member firms. Observations, like findings and effective firm controls, represent information shared with Risk Monitoring for purpose of having a more holistic understanding of a firm.
  • The risk assessment process for evaluating registered representatives has been enhanced to determine who will be monitored or examined in the coming year. As a result of this assessment, double the number of registered representatives were put in scope for 2019.
  • The existing three examination programs are being consolidated to eliminate duplication in examinations.

Improving Information Sharing With Member Firms

FINRA recognizes that the information developed during the course of risk monitoring and examinations can be useful for member firms looking to improve their compliance efforts and proactively remediate potential risks. Accordingly, FINRA endeavors to provide information-sharing channels and develop new means for member firms to benefit from our broader regulatory insights that transcend individual examination interaction. These efforts include:

  • Publishing an annual Examination Priorities Letter to provide member firms and other stakeholders with insight into FINRA’s upcoming areas of focus.
  • Publishing an annual Examination Findings Report that identifies common findings across recent examinations and provides general observations on effective controls and practices FINRA has observed at member firms.
  • Maintaining a Small Firm Helpline to augment the relationships of small firms with their regulatory coordinators, and to provide clear answers to firms on FINRA rule interpretations.
  • Making the examination management team available to a member firm throughout its examination, clearly identifying the key individual managers prior to the beginning of the examination, and encouraging firms with questions or concerns to reach out to these managers.3
  • Facilitating a dialogue between the examination team and the firm regarding examination findings. Absent ongoing investor harm, this includes providing the firm with transparency about the nature of any preliminary findings and offering the firm a reasonable opportunity to respond before FINRA makes any final decisions on exceptions and disposition of the matter.
  • Holding forums to maintain ongoing communication regarding the examination and risk-monitoring program.

Improving Processes for Information Requests

FINRA also recognizes that the process of collecting and submitting information required for an examination can require a significant investment of time and resources by member firms. Making information requests more focused improves FINRA’s communications with firms and results in the production of information more on point for what FINRA is seeking in its examinations and risk monitoring programs. In addition, FINRA is committed to being flexible where it can be with the manner in which information is requested from, and produced by, member firms. It does this by:

  • Reviewing its protocols for setting the scope of information requests and taking steps to appropriately match the time provided for a response to the scope of the request.
  • Using Request Manager4 for all information requests made in connection with examinations. FINRA has extended its use of Request Manager to requests from regulatory coordinators with respect to their monitoring responsibilities wherever possible. While FINRA may make information requests of a firm outside of an examination using means other than Request Manager, FINRA will continue to seek to minimize such instances.
  • Enabling firms (as many have requested) to designate a single point of contact for all communications about examinations.
  • Providing firms flexibility as to the data format they use to submit data in response to targeted information requests, and seek wherever practical to accept data in the format (e.g., Excel) in which a firm retains it. FINRA is committed to working with firms to address any practical challenges arising from differences between the data format used by a firm or its vendor and the format requested by examiners.
  • Making information requests that clearly identify the FINRA department or exchange client making the request.5

Improving Examiner Expertise in Member Firm Operations and Risks

Effective examinations depend on an examination staff that is conversant in the operations and risks of the firms that are being examined. As firms and markets continuously evolve, so too must the skill set of FINRA examiners. Accordingly, FINRA is expanding its efforts to ensure that the training and support it provides its examiners and other FINRA staff are sufficient for the work demanded in this ever-changing environment. These efforts include:

  • Designing a uniform training program for new examiners, and enhancing examiner training broadly to improve understanding of different business models and risks.
  • Providing opportunities for its staff to take the licensing tests it administers for industry participants, including the Securities Industry Essentials Exam that was implemented on October 1, 2018.
  • Exploring new ways to leverage the expertise of firms, fellow regulators and other market participants to help better train staff.
  • Developing additional examiner “specialization” to ensure staff are able to effectively assess risks inherent to certain business models and activities.

Summary of Our Key Actions and Plans

Tailoring of Examination and Risk Monitoring Programs to the Business Models of Member Firms

  • Designed and began implementing a "roadmap" that thoughtfully and methodically builds toward an integrated examination program for 2020 and beyond.
  • Strengthened, and will continue to enhance, FINRA's risk-monitoring program to support the enhanced examination framework.
  • Align FINRA Examination and Risk Monitoring staff to new firm groupings to further develop expertise in the business models of those firms.

2019 Examination Program Changes

  • Established longer window between end of prior, and start of new, examinations to allow time for remediation and improvement in a firm’s controls.
  • Eliminated written Recommendations in examination reports. Verbal Observations will be provided, giving firms information about effective practices to improve controls.
  • Improved coordination across three existing examination programs to eliminate duplication.

More Focus and Flexibility in Examination Information Requests

  • Enhance Request Manager by (1) using it for all information requests in connection with examinations, (2) including requests from regulatory coordinators with respect to their monitoring responsibilities, wherever possible, and (3) enabling firms to designate a single point of contact for all communications about examinations.
  • Review protocols for setting the scope of information requests.
  • Provide firms flexibility as to the data format they use to submit data in response to targeted information requests, and seek wherever practical to accept data in the format (e.g., Excel) in which a firm retains it.

Staff Development to Foster more in-depth Knowledge and Subject Matter Expertise

  • Build a uniform training program for new examiners and enhance examiner training broadly to improve understanding of different business models and risks.
  • Provide opportunities for examiners to take the licensing tests FINRA administers for industry participants, including the Securities Industry Essentials Exam.
  • Explore new ways to leverage the expertise of firms, fellow regulators and other market participants to help better train staff.

Improved Communications with Member Firms

 


2. FINRA provided more information about the risks it considers in this monitoring program in a video for member firms, available at: www.finra.org/industry/few-minutes-finra-nine-risks-inform-finras-examination-and-surveillance-program.

3. Firms may also continue to raise any concerns with the Office of the Ombudsman, which reports to the Audit Committee of the FINRA Board of Governors. Information is available at www.finra.org/about/office-ombudsman.

4. Request Manager is a FINRA-built software tool that facilitates the electronic exchange of information between firms and FINRA. With Request Manager, which is available via Firm Gateway, firms are able to securely submit, manage and track information requests.

5. FINRA provides services to certain equities and options exchanges, including market surveillance, examinations, investigations and disciplinary actions. For more information, see www.finra.org/industry/few-minutes-finra-nine-risks-inform-finras-examination-and-surveillance-program.