WASHINGTON — The Financial Industry Regulatory Authority highlighted “key risk areas” for muni broker-dealers this week, warning that its exams will focus on whether incomplete disclosures and financial information from an issuer prevent retail customers from making informed investment decisions, as well as whether underwriters engage in bid-rigging and pay-to-play practices to secure muni business.
The areas of focus for exams were detailed in a 16-page annual letter sent to FINRA members’ chief compliance officers and posted on its website one month after the self-regulator adopted a risk-based compliance program for muni dealers.
Previously, FINRA was required to conduct an exam of every muni broker-dealer at least once every two years. But under recent changes to the Municipal Securities Rulemaking Board’s Rule G-16, which were approved by the Securities and Exchange Commission in December, FINRA will examine firms that pose high risks more frequently — possibly as often as once a year. FINRA will examine lower-risk firms, those with low volumes of muni business, less frequently, but at least once every four years.
FINRA’s letter sets forth certain key risk areas and encourages broker-dealers to use the information to enhance their supervisory and compliance programs, mitigate risk, and better protect investors.
“Our examination program is risk-based, in that the scope, content, frequency and nature of an individual examination will depend on the operational and risk characteristics associated with that firm,” said the letter, signed by Bradley Bennett, executive vice president for enforcement, and Cameron Funkhouser, executive VP in the office of fraud detection and market intelligence, as well as three other key FINRA officials. “These characteristics include the scope and scale of a firm’s operations, the products and services it sells, and the types of clients or counterparties with which it does business.”
As for municipal securities, FINRA warned that lack of timely disclosures and complete financial statements often prevent retail investors from making informed investment decisions and may preclude broker-dealers from “having a reasonable basis to recommend such a security.”
Broker-dealers should make suitable recommendations to secondary market investors, FINRA said, which includes “obtaining sufficient information about the issuer to provide a reasonable basis that the recommendation is suitable.”
Under MSRB Rule G-17 on fair dealing, firms must also disclose all material facts about the muni that are reasonably accessible to the market, including the MSRB’s online EMMA system “and other sources,” the officials said.
Separately, they said it is critical that firms adopt and enforce adequate supervisory systems and internal controls to ensure compliance with MSRB rules and fair-dealing obligations for customers trading in munis, including 529 college savings plans and Build America Bonds.
Broker-dealers that facilitate direct purchases of munis by banks or bank loans to municipalities as an alternative to public offerings should bear in mind that “these financings may be municipal securities and thus subject to all MSRB rules,” the officials said.
Finally, FINRA said muni underwriters must ensure that employees “do not engage in unethical and illegal activities such as pay-to-play, bid-rigging, or providing excessive gifts or business entertainment to issuer officials designed to secure municipal business.” Such conduct would be of concern when it “ultimately harms the issuer,” FINRA said.
Besides Bennett and Funkhouser, the letter was signed by Susan Axelrod, executive vice president for member regulation and sales practice; Grace Vogel, executive VP for member regulation, risk oversight and operational regulation; and Thomas Gira, executive VP in market regulation.
