FINRA will assess firms' controls to protect senior investors from fraud, abuse, and improper advice. After seeing numerous cases where registered representatives have recommended that senior investors purchase speculative or complex products, FINRA will assess whether these recommendations were suitable given an investor's profile and risk tolerance, and whether firms have appropriate supervisory mechanisms in place to detect and prevent problematic sales practices.

FINRA will also focus on microcap, or penny stock, fraud schemes, especially those targeting the elderly. The letter states that in 2015 and 2016, FINRA saw an increase in the use of aggressive tactics by unregistered persons in pump-and-dump schemes targeting elderly investors. The letter sets out the following controls that firms can implement to enhance protection for elderly clients:

After observing instances where firms recommend products that are unsuitable for customers, FINRA will assess how firms conduct reasonable-basis and customer-specific suitability reviews. This may include examining firms':

Firms should pay attention to the adequacy of their supervision and training when:

Firms that hire registered representatives who sell products with which the firm is not familiar should educate themselves on the products and carefully evaluate their ability to supervise recommendations. Training should ensure that registered representatives, compliance, and supervisory staff understand the objectives, risks, and pricing factors of the products sold, including any changes in the features of those products.

In 2017, FINRA will also increase its focus on the controls firms use to monitor recommendations that could result in excess concentration in customers' accounts. Firms should be attentive to shifts in the interest rate environment and should be prepared to assess and discuss the possible impact of these changes on recommendations to clients. They should also monitor for excessive concentration in securities exposed to an industry sector.

Another area of concentration will be firms' ability to monitor for short-term trading of long-term products. FINRA has observed instances of registered representative recommending that their clients trade long-term products (such as open and closed-end mutual funds, variable annuities, and unit investment trusts (UITs)) on a short-term basis, which is detrimental to clients who may experience diminished investment returns because of increased costs or missed dividend payments. In September 2016, FINRA launched a targeted exam that focuses on UIT rollovers at select firms, and FINRA will also review other firms' UIT sales and surveillance practices.

Further, the letter urges firms to evaluate whether their supervisory systems can detect activity intended to evade automated surveillance for excessive switching activity. FINRA has observed instances where registered representatives switch customers:

FINRA will also focus on firms' obligations with respect to their registered representatives' outside business activities and private securities transactions. It will continue evaluating firms' procedures to review registered persons' written notifications of proposed outside business activities, including firms' consideration of whether the proposed outside business activities may compromise a registered person's responsibilities to the firms' clients or be viewed as part of the firm's business. In addition, FINRA will focus on firms' procedures for handling associated persons' notifications of proposed private securities transactions and firms' ongoing supervision over associated persons' approved private securities transactions for compensation.

In 2017, FINRA will review firms' compliance with their supervisory and record-retention obligations with respect to social media. The letter notes that under SEC and FINRA record-retention requirements, firms must ensure they capture all business-related communications regardless of the devices or networks used, and in such a way that the firm can review them for inappropriate business conduct.

In 2016, FINRA identified firms that lacked liquidity risk management plans, did not conduct stress tests, applied insufficiently rigorous assumptions in their stress tests, or maintained insufficient sources of funding. FINRA also found that many firms' funding contingency plans relied on committed secured and unsecured loan facilities. As a result, in 2017, FINRA will review firms' funding and liquidity plans, and assess whether firms':

FINRA will also review how correspondent clearing firms incorporate funding needs for large introducing firms and market participants in their contingency plans, where these entities rely on their clearing brokers for funding during a stress event, including coverage for intraday risk. The letter encourages firms to consider the effective practices discussed in Regulatory Notice 15-33 as they evaluate their liquidity management plans (for more information on the Regulatory Notice, see Legal Update, FINRA Issues Regulatory Notice on Liquidity Risk Management Practices).

This year, FINRA will ask a select group of firms to explain how they would react to a specific stress scenario that affects a firm's market, credit, and liquidity risks. FINRA will assess the firms' risk management practices, considering areas such as readiness, communication plans, risk metrics and triggers, and contingencies. The purpose of the assessment will be to understand whether the approach appears reasonable in light of the risks to the firm's business.

In December 2016, the first phase of the new amendments to FINRA Rule 4210 became effective. As a result, in 2017, FINRA will review firms' implementation of the obligations established in the first phase of the rule amendment. FINRA will assess firms' written risk policies, procedures, risk limit setting processes, and the way firms establish and supervise for compliance with the rule's requirements. Firms should review Rule 4210 to ensure they have appropriately tailored their risk policies and limits to their counterparties and covered agency transactions.

FINRA will continue to assess firms' programs to mitigate cybersecurity risks and will tailor its assessment to each firm based on a variety of factors, including its business model, size, and risk profile. In its assessment, FINRA may:

The letter also notes two areas where FINRA has observed repeated shortcomings in controls:

FINRA will also assess firms' testing of their internal supervisory controls. The letter states that regular testing is critical to enabling firms to identify and mitigate gaps or inadequate controls that, if left undetected, may lead to significant, systemic control breakdowns. FINRA has observed that these problems can be more prevalent when firms increase the scale or scope of their business or change from legacy to new compliance systems. FINRA has also observed situations where data is inaccurate, such as with respect to product or order types. The letter reminds firms of their obligations with respect to supervisory controls testing and chief executive officer certifications under FINRA Rules 3120 and 3130.

In addition, FINRA will evaluate whether firms have implemented adequate controls and supervision to protect customer assets under Rule 15c3-3 of the Exchange Act. FINRA will assess firms' compliance with the specific requirements of the rule and will also emphasize that firms should maintain relevant documentary evidence to incorporate concentrated customer debit balances in the reserve formula. FINRA will also:

FINRA is also concerned that some firms may be engaging in transactions with little or no economic substance designed primarily, if not solely, to reduce their reserve or segregation requirements under the financial responsibility rules. FINRA will review for this behavior from two perspectives:

In 2017, FINRA will continue to assess firms' compliance with Regulation SHO. Following recent SEC enforcement actions, FINRA will focus on the locate process to ensure firms have reasonable grounds to believe securities are available for borrowing before accepting a short sale. FINRA will also assess firms' preparation and use of the easy-to-borrow list and will evaluate the adequacy of firms' automated locate models. FINRA has observed fails-to-deliver on settlement date, when locates are granted without the requisite reasonable grounds to believe that the security could be borrowed. The letter states that firms should continue to monitor their close-out processes and ensure that they appropriately close out fails-to-deliver by the designated close-out date under Rule 204 of Regulation SHO.

Another focus for 2017 will be on firms' anti-money laundering programs. FINRA has observed shortcomings in firms':

Firms may perform anti-money laundering suspicious activity monitoring using the same trading surveillance they use for supervisory purposes, but that surveillance must also include alerts tailored to the firm's anti-money laundering red flags. In addition, FINRA will continue to focus on firms' controls around accounts held by nominee companies. FINRA expects firms to determine whether they need to implement policies and procedures to identify accounts held by nominee companies and whether they should apply heightened scrutiny to those accounts.

FINRA has found that some firms are not registering correctly with both the SEC and Municipal Securities Rulemaking Board, or are not properly updating their registration information as it changes. In addition, firms may not be identifying all individuals who are engaged in municipal advisor activity as required for submission to EDGAR on Form MA-I.

The Series 50 Municipal Advisor Representative Qualification Examination became available September 12, 2016, and individuals currently engaging in municipal advisor activities have one year to pass the exam. The letter states that firms that do not wish to register as municipal advisors may still provide services to municipal customers under certain statutory exclusions and regulatory exemptions. FINRA will assess whether these firms properly apply the exemptions and exclusions to municipal advisor registration requirements under SEC rules.

Detecting and deterring manipulation will remain a critical priority for FINRA in 2017. In particular, FINRA:

In addition, in 2016, FINRA introduced the Cross Market Equity Supervision Report Cards for layering and spoofing activity as a compliance tool to complement firms' supervisory systems and procedures to detect and deter manipulative conduct by the firm or its customers. The letter states FINRA's expectation that firms that receive report cards will review them as a supplement to, and not a replacement for, their own reviews into potentially manipulative activity, and take appropriate steps in response to their findings.

In November 2015, FINRA issued Regulatory Notice 15-46 to remind firms of the best execution obligations they owe customers when they receive, handle, route, or execute customer orders in equities, options, and fixed income securities. The letter states that firms should:

The letter also reminds firms of the importance of providing accurate payment for order flow disclosures.

FINRA expects firms to use the alerts from its Audit Trail Reporting Early Remediation Initiative to correct systems issues and potentially avoid a formal investigation, if the issue is limited in scope and promptly addressed. FINRA will expand this initiative to other areas such as Regulation NMS trade-throughs and locked and crossed markets.

The letter also states that the Tick Size Pilot will continue in 2017 and that it is critical that firms submit accurate OATS and market maker data. FINRA will review the data for compliance with the data requirements of the Tick Size Pilot, as well as for compliance with its quoting and trading restrictions.

The letter states that firms need to better:

Some best practices firms should consider incorporating into their market access controls include:

Firms should also consider the effective practices FINRA describes in Regulatory Notice 15-09.

FINRA's trading examination priorities will include:

FINRA's priorities will include a pilot trading examination program to help FINRA determine the value of conducting targeted examinations of smaller firms that have historically not been subject to trading examinations due to their relatively low trading volume.

In recent years, FINRA has expanded its fixed income surveillance program to include additional manipulation-based surveillance patterns, such as wash sales and interpositioning. In 2017, FINRA will continue to enhance these patterns and conduct investigations into problematic activity that it detects through the surveillance program. FINRA has brought enforcement actions against individuals who engaged in non-bona fide trading to create an artificial price level in a bond, in order to hide an excessive mark-up to a customer trade or reset the aging of positions held by the firm. It continues to review firms' written supervisory procedures and systems to ensure they are reasonably designed to monitor for this conduct. In addition, FINRA will continue to review for and investigate potential misrepresentations and misleading conduct by position and sales traders in securitized products.

Further, due to new TRACE reporting requirements for transactions in US Treasury securities set to take effect in July 2017, the development of a data integrity program to monitor the accuracy of the submitted data is a priority for FINRA. FINRA will also develop customer protection surveillance patterns focusing on compliance with rules applicable to US Treasury securities, as well as patterns looking for abusive algorithms.