The following story appeared in the Wall Street Journal on April 18, 2011:
A fiduciary standard for brokers could be a long way off, but the Financial Industry Regulatory Authority is already turning up the heat with rules that require brokerages to analyze a mountain of client data. Implementing Finra’s new know-your-customer and suitability rules is proving so cumbersome that regulators recently extended the compliance deadline by nine months, to July 9, 2012.
Brokerage firms will have to collect more details from potentially millions of customers, and then routinely monitor them to ensure that the securities and investment strategies brokers recommend are consistently suitable. The rules expand on long-standing industry rules from the two self-regulatory organizations that merged in 2007 to become Finra. The newer, beefed-up rules are a step toward extending to brokers the fiduciary standard that now applies to registered investment advisers, says James Heinzman, managing director of securities solutions at NICE Actimize, a unit of NICE Systems (NICE). “Finra is slowly turning the temperature up,” he says.
Under the fiduciary standard, an adviser must always act in the client’s best interest. The suitability rule is less stringent, requiring brokers to make sure securities they recommend are suitable for retail clients. A recent Securities and Exchange Commission staff study recommends holding brokers who give advice to a fiduciary standard, and SEC Chairman Mary Schapiro has said the agency intends to develop rules for that.
Firms, in the meantime, are trying to adapt to mammoth responsibilities imposed by Finra’s new rules, which the SEC approved in August 2010. “They’re challenged,” says Heinzman. “They’re asking themselves, ‘How do I develop a system that will capture information, and how do I go to millions of customers and get that information?”
Brokers typically gather financial details about customers at the onset of a relationship in order to recommend suitable securities. The new suitability rule more clearly spells out the types of information to collect, such as age, investment experience and liquidity needs. While many brokers already ask for that information, it often doesn’t reach a firm’s back office technology systems, where it can be routinely analyzed and monitored, says Heinzman.
Revisiting that information often will be necessary to satisfy Finra’s new requirements. Brokerages will need to monitor, in real time, whether individual transactions are appropriate and client profiles are up to date, says Amy Lynch, founder and president of FrontLine Compliance LLC in Leesburg, Va.
“For every transaction you need to show that it was suitable at that time for that customer. That’s how it’s perceived by the industry,” she says. Holding securities for the long term may also invite scrutiny, since firms must be able to demonstrate, at any given moment, that recommended strategies are suitable, she says.
Firms are implementing technology to collect and monitor the data, and alert compliance departments of unsuitable circumstances. They’re also considering new policies and procedures, such as rules for updating client information. That could mean asking clients to confirm personal data at the time of a transaction, or reviewing it at least annually.
“If it’s a really good customer that you speak to once or twice a week, you’ll have a good idea what’s going on,” says David Sobel, chief compliance officer of Abel/Noser Corp., a New York-based brokerage. But problems may crop up under the rule in situations where there’s limited client contact, he says.
Compliance departments will also be busy, he says. They’ll need to develop a list of internal documents for establishing new accounts. There may need to be a log book or form, for example, where brokers can record when they speak to clients. The compliance officer then has to set up a routine for how to review recommendations and strategies for suitability, says Sobel. Employee training will be part of the transition.
“Somewhere, somehow, every little step has to be evidenced,” says Sobel. “It’s going to make it pretty hard on the pump-and-dump guys.”