Regulators Target 'High Risk' Brokers


NEW YORK (MainStreet) — The regulatory focus for 2014 will be on brokers with a "high-risk" profile and complex investments – particularly those with interest-rate sensitivity, according to FINRA, the securities industry self-regulatory authority.

"A small number of brokers have a pattern of complaints or disclosures for sales practice abuses and could harm investors as well as the reputation of the securities industry and financial markets," FINRA states in a just-issued statement of enforcement priorities for the coming year. "Early last year, FINRA launched the High Risk Broker initiative to identify such individuals and expedite investigations. In 2014, FINRA will expand the High Risk Broker program and create a dedicated Enforcement team to prosecute such cases."

FINRA intends to examine the hiring practices and supervision of these targeted brokers based on patterns of past conduct, as well as brokers who have switched firms after being "severely disciplined." The regulator is concerned that such brokers may "bring unethical or illegal practices" to a firm.

The oversight agency is also taking a hard look at the sale of "complex" investment products. FINRA is particularly wary of firms that offer registered reps incentives for the sale of such products.

These sophisticated investments often have layers of fees that are difficult for investors to understand, and may carry increased risk and volatility. Structured products, private real estate investment trusts (REITs) and "frontier funds" that invest in emerging markets are included on the investment watch list.

Transitioning interest rates can also impact a wide range of investment products, and FINRA examiners will focus this year on client accounts holding concentrations of interest rate sensitive securities. These investments can include mortgage-backed securities, as well as long-duration bond funds, ETFs and corporate bonds -- particularly zero coupon or bullet bonds. Emerging market bond sales may also warrant enhanced examination by the regulatory authority.

The financial uncertainty impacting municipal bond markets will also be a focus for FINRA regulators in 2014.

"Well-known examples of municipalities in significant financial distress including Detroit, Puerto Rico and others highlight instances where investors may face real harm from both a credit and market risk perspective," FINRA states. "While many municipal bonds remain strong investments, the additional funding costs associated with a potentially rising interest rate environment pose a broader risk to the market."

A new area of concern that the regulatory authority will also be keeping a close eye on this year is the growing market for business development companies (BDCs). FINRA is worried that retail investors may not understand the liquidity risks they assume when gaining exposure to business development companies (BDCs) through baby bonds.

"The secondary market for these instruments is thin and investors forced to sell prior to maturity may be harmed," FINRA says.

The regulatory authority will also be continuing to highlight the risks of broker conflicts of interest, as well as cyber security concerns.

—Written by Hal M. Bundrick for MainStreet

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