Following up on Securities and Exchange Commission (SEC) Chairman Gary Gensler’s comments from June, Financial Industry Regulatory Authority (FINRA) announced that it will be conducting targeted exams focused on supervisory practices for options trading. In the announcement, FINRA outlined guidance for potential examinations. Firms must be ready to:
- Produce Written Supervisory Procedures (WSP), compliance manuals, and any other written guidance pertaining to opening options accounts and due diligence activities. This includes materials used in the review and approval or denial of customer applications
- Produce compliance manuals and any other written guidance pertaining to the firm’s process for supervision of options trading in customer accounts
- State whether they surveil their existing options customers, and if so, how frequently
- State whether they’ve reviewed their customer base to identify existing options customers for promotion, or if they’ve recommended more advanced options account levels
- Describe if they’ve advertised the availability of option account applications, and by which means the advertising was provided
- Produce sample options-related disclosure materials or other communications provided to customers that explain firm practices and policies
Emphasis on supervisory processes
That FINRA will be looking at practices and controls when supervising options accounts should not surprise anyone. But the emphasis on written communications and existing supervisory processes is not something we see every day.
FINRA’s scrutiny of options trading, however, is completely consistent with the Security & Exchange Commission’s (SEC) commentary on firms attempting to connect with retail investors over the past 18 months. As we saw with the case of Roaring Kitty, options are a preferred vehicle. The activity from retail investors largely explains why the volume of options is significantly higher than it has been historically.
Newer retail investors may not be aware of the risks of options trading. This has resulted in the volatility called out by the SEC and other regulatory watchers surrounding so-called “meme stocks.” FINRA has also weighed in, most notably by imposing its largest-ever fine of $70M against a leading brokerage app. The app company was sanctioned for systemic supervisory failures and significant harm to millions of customers for failing to alert clients to the loss risk they faced in certain options transactions.
New work model, new supervision needs
Smarsh has previously commented, the action also highlights the perfect conditions that have persisted and will continue now that hybrid workforces are likely to become the default work model. Reduced visibility of remote staff, an attractive financial market, and a virtually unlimited number of ways to connect with others via digital platforms all contribute to greater risks of compliance mishaps. Not to mention a spike in cybersecurity schemes, and the higher likelihood of harm to a newer, less sophisticated category of investors.
Despite all this concern, 63% of registered investment advisors see retail investors as the largest opportunity going into 2022. They acknowledge the shifting demographics of their business and recognize the need to engage with new, retail investors through their preferred financial vehicles and communications tools.
Firms must adapt their policies and procedures, employee training, and technology and automated controls to stay compliant while capitalizing on this moment. Because it is clear: the regulators are watching.
Source & author: Robert Cruz. Vice President, Information Governance at Smarsh.
Robert is Vice President, Information Governance for Smarsh. He has more than 20 years of experience in providing thought leadership on emerging topics including cloud computing, information governance, and discovery cost and risk reduction.
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