Broker-dealers face disaster prep scrutiny

Jan 09, 2018
Finra looking into how firms intend to implement plans for dealing with hurricanes and other crises

Broker-dealers will this year face renewed scrutiny of how they prepare for disasters such as severe weather, cyber-attacks and pandemics – alongside a focus on whether they are getting clients the best deals in securities transactions.

These pointers for compliance teams about where they may need to devote attention during 2018 feature in the Financial Industry Regulatory Authority’s (Finra) annual regulatory and examination priorities letter, which it issued this week. Business continuity plans (BCPs) are not a new item on Finra’s agenda, but the issue of disaster preparedness has not been included in the self-regulatory organization’s (SRO) priorities letter since 2010, when attention was raised by an outbreak of influenza A (H1N1), or swine flu.

Weather-based crises have driven the SRO to renew its focus in the area. Recent events such as hurricanes Harvey and Maria underscore the need for firms to maintain written [BCPs] that address continued access to critical systems, including in situations where firms may not have physical access to locations, potentially for an extended period,’ officials write.

Finra Rule 4370 requires firms to have plans that are reasonably designed to enable them to meet their existing obligations to customers in an emergency or business disruption. Finra will this year examine firms’ BCPs with a focus on their implementation of the plan, according to officials. For example, it will look at:

  • How and under what circumstances brokerages activate their BCPs
  • How firms classify systems as mission-critical or secondary
  • How firms achieve data back-up and recovery
  • How firms co-ordinate with their affiliates and vendors during a business continuity situation.

The SRO will also review firms’ plans for restoring systems, procedures and records once they are ready to return to normal business, and how they make those decisions.

Finra in late 2012 conducted a targeted exam, in co-ordination with the SEC and the Commodity Futures Trading Commission, assessing the impact of Hurricane Sandy on firms’ operations and their ability to conduct business while BCPs were in operation. 

Another particular – if perennial – focus for Finra this year is best execution. The SRO recently identified concerns in a report on its exam findings, and officials say it is expanding its equity best execution surveillance program to assess the degree to which firms provide price improvement when routing customer orders for execution or when executing internalized customer orders.

‘Once the new surveillance pattern is in production, we will review systematically both the frequency of price improvement [and] the relative amount of price improvement obtained or provided when compared with other routing or execution venues,’ officials write. They add that Finra will also expand its review of execution quality and fair pricing in fixed income securities.

Finra in November launched a sweep exam into potential order-routing conflicts of interest in the industry (, 12/13). The concern is that broker-dealers may place trades at prices that are not the best available for the client because they will receive payment for doing so.

‘Recently there has been an increase in public discussion about the potential for conflicts of interest to affect order routing and execution quality,’ a Finra spokesperson told Corporate Secretary last month. ‘Best execution of customer orders is a cornerstone of investor protection and for years has been a priority-focus area for Finra.’

The spokesperson noted that the SRO in 2014 conducted a more general sweep regarding order routing and execution quality and issued related guidance in 2015: ‘We now want to take a deeper dive into the issue to ensure firms are conducting regular and rigorous reviews, and managing conflicts appropriately. We want to understand how firms are doing their execution-quality analysis and managing conflicts of interest.’

Among other things, Finra will this year launch ‘several new report cards to assist firms with their compliance efforts, and we will review whether and how firms make use of these report cards,’ officials say.

These cards are:

  • The auto execution manipulation report card, which officials say will highlight and assist firms with their supervision efforts to identify instances in which a market participant uses non-bona fide orders to move the national best bid and offer (NBBO)
  • The alternative trading system (ATS) cross-manipulation report card, which is designed to identify instances in which a market participant engages in potential manipulation of the NBBO that results in the modification of a security’s prevailing mid-point price on an ATS crossing venue
  • The fixed income mark-up report card, which will give firms and the industry information that firms will be able to display based on certain criteria such as investment rating, product and length of time to maturity.

In a notice accompanying the priorities letter, Finra president and CEO Robert Cook says there can be important benefits from compliance tools such as these and from the SRO’s sharing of information with firms.

‘For example, our cross-market surveillance report cards have helped firms identify potential market manipulation through trading activity across multiple firms, markets and products,’ he writes. ‘By providing this information for firms to review and act upon where appropriate, we have seen firms upgrade their internal controls and address problematic activity proactively.’

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