What's in FINRA's 2021 Examination and Risk Monitoring Program Report That Could Impact Your Firm's Private Placement Offerings?

by Lynn Lawson

Lynn Lawson, Esq. is the founder of Advertising Regulatory Consulting, LLC, which provides advertising and marketing guidance to broker-dealers, registered investment advisors, product sponsors, and financial services industry associations. Prior to starting Advertising Regulatory Consulting, Ms. Lawson served as a manager in FINRA’s Advertising Regulation Department for 22 years. Ms. Lawson has advised product sponsors that FactRight has covered, and given her experience at FINRA, we believe she can be a valuable regulatory resource for product sponsors and wealth managers who are distributing alternative investments.

Are you fully up to speed on your firm’s regulatory obligations and does your firm’s compliance program implement effective practices in connection with private placement offerings? If the answer is no or not quite, you should consider spending some time reading FINRA’s 2021 Report on FINRA’s Examination and Risk Monitoring Program (the Report).[1]

The Report is a 45-page publication that provides broker-dealers with, among other things, a summary of key findings from recent FINRA risk-based examinations[2]; an overview of areas that FINRA plans to review in 2021 and a list of effective practices FINRA observed member firms implement in their compliance programs. It also serves as a primer for firms as it provides insight into what firms can expect during their next exam.

What notable priorities specific to private placement offerings are identified in the Report?

If your firm engages in the sale of private placement offerings, pay particular attention to subject matter areas the Report identifies as regulatory obligations. Noteworthy highlights include a reminder of broker-dealers’ obligations to conduct reasonable investigations in Regulation D offerings as part of their responsibility under FINRA’s suitability and supervision rules.[3] In addition, the Report notes that (i) the SEC’s Reg BI[4] applies to recommendations of private placement offerings to retail investors (ii) timely filings for specific private placement offerings must be made as required by FINRA Rule 5122 and (iii) required disclosures must be made as specified in FINRA Rule 5123.[5]

What risk-based exam questions should you consider?

In connection with a firm’s private placement offerings, the Report raises several questions to consider. These considerations include:

  • How does your firm use and evaluate consultants or third-party due diligence reports, such as those provided by FactRight?
  • Do your firm’s policies and procedures address timeliness and filing requirements to satisfy the standards of FINRA Rules 5122 and 5123?
  • How are “reasonable investigations” of private placement offerings conducted?
  • If your firm engaged in new business, are the written supervisory procedures (WSPS) updated and if applicable, did your firm submit a Continuing Membership Application to FINRA?

What other noteworthy findings regarding deficiencies were included in the Report?

As part of FINRA’s ongoing risk-based exam program, the Report also identifies a variety of deficiencies found during recent examinations. These findings include:

  • Failure to have or implement policies and procedures to satisfy the filing requirements under FINRA Rules 5122 and 5123.
  • Failure to perform reasonable investigations of private placement offerings that include failure to conduct additional research about new offering(s), relying on the prior experience with issuers in previous offerings and not conducting sufficient third-party due diligence.
  • Failure to file private placement filings and lack of policies and procedures to ensure compliance with submitting filings in a timely manner as specified in FINRA Rule 5122 and FINRA Rule 5123.

How can broker-dealers actively navigate the regulatory maze?

Broker-dealers face constant challenges to satisfy their ongoing compliance responsibilities that often resemble a maze with many twists and turns. To find your way to the other side and clearly navigate the ever-changing regulatory landscape, use the Report as one tool to determine where additional attention or enhancements may be needed.

Also, review the Report’s list of effective practices observed by FINRA in recent exams to evaluate whether some of these practices can improve your compliance programs. Examples include: [6]

  • Creating private placement checklists that include steps such as filing dates, related documentation requirements, and proof of supervisory principal approval.
  • Establishing an automated alert system that alerts responsible individuals of missed deadlines or due filings.
  • Conducting independent research and documenting key aspects of the offering.
  • Implementing reasonable investigation processes to limit conflicts of interest.

The Report also encourages firms to remain informed about evolving trends in the private placement market and stay aware of any amendments to FINRA rules and/or federal securities laws. Designating key personnel to be the “gatekeeper” of regulators’ updates is also essential. In addition, circulate important information to compliance, marketing and legal teams and provide in-depth training on a regular basis.

How can you make the most of the available resources?

Many factors can influence the success of your firm’s compliance program. Read the Report’s “Appendix” section as it serves as a helpful resource to review how member firms use FINRA publications as a “guide” to improve their compliance programs. Also, make sure to actively communicate with regulators if you need assistance or further clarification about any regulatory matter. And remember, if your firm’s active area of business involves private placement offerings, the Report helps take some of the mystery out of FINRA’s examination process. Use this treasure trove of information to your advantage.

[1] On February 1, 2021, FINRA published the 2021 Report on FINRA’s Examination and Risk Monitoring Program (the “Report”). The report consolidates FINRA’s Risk Monitoring and Examination Program Priorities Letter, a letter that identified areas of regulatory concern for the upcoming year and the Report on Examination Findings and Observations, a publication that provided analysis of prior FINRA examination findings program. For the complete report please refer to the original document link. https://www.finra.org/sites/default/files/2021-02/2021-report-finras-examination-risk-monitoring-program

[2] According to FINRA’s “Preparing for A Cycle Examination,” FINRA’s exam process is risk-based. FINRA’s exam process is risk-based, which means that the approach for identifying firms for examination is based less on the calendar and more upon risk, scale and scope of firm operations. Based on an assessment of these factors, cycle examinations are performed periodically—on a one-, two- or four-year cycle. The risk assessment is performed annually, so it’s possible that your firm’s cycle may change from one year to the next.

[3] FINRA Rule 2211 (Suitability) and FINRA Rule 3310 (Supervision).

[4] The SEC's Regulation Best Interest (Reg BI) under the Securities Exchange Act of 1934 establishes a "best interest" standard of conduct for broker-dealers and associated persons when they make a recommendation to a retail customer of any securities transaction or investment strategy involving securities, including recommendations of types of accounts. As part of the rulemaking package, the SEC also adopted new rules and forms to require broker-dealers and investment advisers to provide a brief relationship summary, Form CRS, to retail investors. In addition, the SEC published interpretations concerning investment advisers’ standard of conduct under the Investment Advisers Act of 1940, and the "solely incidental" prong of the broker-dealer exclusion from the Advisers Act.

[5] FINRA Rule 5123 is part of a multi-pronged approach to enhance oversight and investor protection in private placements. In Rule 5122, FINRA established standards on disclosure, use of proceeds and a filing requirement for private placements issued by a member firm or a control entity. FINRA also has previously provided guidance on the scope of a firm's responsibility to conduct a reasonable investigation of private placement issuers in Regulatory Notice 10-22.

[6] See pages 25 and 26 of the Report for the full list of “Effective Practices.”

Contact Information:

Lynn Lawson

Founder/CEO of Advertising Regulatory Consulting, LLC


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