On February 18, the Financial Industry Regulatory Authority (FINRA) released a Targeted Examination Letter (Targeted Letter) to member firms underscoring the critical importance of firms establishing, communicating and implementing strong cultural values.
It is not yet clear how FINRA will use the “cultural” information or how many firms, and what type, will receive the Targeted Letter. A small number of firms have received it with more likely to once the initial responses are evaluated by FINRA. It is likely in reviewing this information, however, that FINRA will form impressions of firm and industry cultural norms, and so firms that receive the Targeted Letter should carefully consider their response. Moreover, it is a warning that these fundamental concerns will be a core part of FINRA’s examinations and investigations and that deficiencies in these areas will likely justify increased sanctions for other violations.
As noted in Sidley’s Update “Financial Industry Regulatory Authority 2016 Exam Priorities” and also in FINRA’s 2016 Examination Priorities Letter, the Targeted Letter reemphasizes that firm culture has a profound effect on how a firm conducts its business and manages its conflicts of interest. Accordingly, FINRA is reviewing how firms establish, communicate and implement cultural values and whether cultural values are guiding business conduct. As part of this review, FINRA intends to meet with executive business, compliance, legal and risk management staff to discuss how firms communicate and reinforce their cultural values directly, implicitly and through their reward systems; how firms measure compliance with their cultural values; what metrics, if any, are used; and how firms monitor for implementation and consistent application of those values throughout their organizations.
According to FINRA, the goals of the Targeted Letter are to better understand industry practices in this area and the challenges firms face in order to develop potential guidance for the industry. However, FINRA will be assessing whether firms are taking reasonable steps to properly establish and implement their own cultural values within the firms. Notably, the Targeted Letter suggests that the conclusions FINRA reaches from the responses may affect how firms are treated in the future.
Specifically, in preparation for the meetings, the Targeted Letter requests information across a range of subjects. Firms are to submit the information (or indicate instances where the requested information is not available) to FINRA by March 21. The information requested includes a description of the firm’s supervisory procedures and policies related to cultural values, how the board is involved, the establishment of a “tone from the top,” how a firm identifies and responds to policy breaches, noncompliant subcultures and how cultural values are addressed in the firm’s compensation and promotion policies. FINRA also notes that firms may have their own definition of “firm culture” that they can use in preparing for the meeting and responding to the Targeted Letter.
While most firms maintain appropriate cultural values, not many have memorialized them in writing in the detail that FINRA has requested. Responding to this request is a serious exercise that requires the active involvement of executive management, legal, compliance and business staff. It requires firms to provide a detailed written description of a firm’s core cultural values, not a one-page mission statement and code of conduct. FINRA also expects firms to have programs to measure and assess firm culture and to tie firm culture to compensation. In addition, receipt of the Targeted Letter should not deter firms from assessing their firm culture based on the questions FINRA poses in the Targeted Letter. Indeed, firms should carefully assess any gaps noted in their policies and procedures that touch upon firm culture.
Firms should address these issues immediately and bear in mind that FINRA perceived cultural deficiencies could lead to increased regulatory interest and higher sanctions. Again, we would hope that the opposite is also true, that a firm that can demonstrate appropriate culture and ethics would not be subject to as harsh discipline, or perhaps any formal discipline, when a potential issue is detected and appropriately addressed.
If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or
Sidley Securities & Derivatives Enforcement and Regulatory Practice
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Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.
Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, 212.839.5300; One South Dearborn, Chicago, IL 60603, 312.853.7000; and 1501 K Street, N.W., Washington, D.C. 20005, 202.736.8000.
It is not yet clear how FINRA will use the “cultural” information or how many firms, and what type, will receive the Targeted Letter. A small number of firms have received it with more likely to once the initial responses are evaluated by FINRA. It is likely in reviewing this information, however, that FINRA will form impressions of firm and industry cultural norms, and so firms that receive the Targeted Letter should carefully consider their response. Moreover, it is a warning that these fundamental concerns will be a core part of FINRA’s examinations and investigations and that deficiencies in these areas will likely justify increased sanctions for other violations.
As noted in Sidley’s Update “Financial Industry Regulatory Authority 2016 Exam Priorities” and also in FINRA’s 2016 Examination Priorities Letter, the Targeted Letter reemphasizes that firm culture has a profound effect on how a firm conducts its business and manages its conflicts of interest. Accordingly, FINRA is reviewing how firms establish, communicate and implement cultural values and whether cultural values are guiding business conduct. As part of this review, FINRA intends to meet with executive business, compliance, legal and risk management staff to discuss how firms communicate and reinforce their cultural values directly, implicitly and through their reward systems; how firms measure compliance with their cultural values; what metrics, if any, are used; and how firms monitor for implementation and consistent application of those values throughout their organizations.
According to FINRA, the goals of the Targeted Letter are to better understand industry practices in this area and the challenges firms face in order to develop potential guidance for the industry. However, FINRA will be assessing whether firms are taking reasonable steps to properly establish and implement their own cultural values within the firms. Notably, the Targeted Letter suggests that the conclusions FINRA reaches from the responses may affect how firms are treated in the future.
Specifically, in preparation for the meetings, the Targeted Letter requests information across a range of subjects. Firms are to submit the information (or indicate instances where the requested information is not available) to FINRA by March 21. The information requested includes a description of the firm’s supervisory procedures and policies related to cultural values, how the board is involved, the establishment of a “tone from the top,” how a firm identifies and responds to policy breaches, noncompliant subcultures and how cultural values are addressed in the firm’s compensation and promotion policies. FINRA also notes that firms may have their own definition of “firm culture” that they can use in preparing for the meeting and responding to the Targeted Letter.
While most firms maintain appropriate cultural values, not many have memorialized them in writing in the detail that FINRA has requested. Responding to this request is a serious exercise that requires the active involvement of executive management, legal, compliance and business staff. It requires firms to provide a detailed written description of a firm’s core cultural values, not a one-page mission statement and code of conduct. FINRA also expects firms to have programs to measure and assess firm culture and to tie firm culture to compensation. In addition, receipt of the Targeted Letter should not deter firms from assessing their firm culture based on the questions FINRA poses in the Targeted Letter. Indeed, firms should carefully assess any gaps noted in their policies and procedures that touch upon firm culture.
Firms should address these issues immediately and bear in mind that FINRA perceived cultural deficiencies could lead to increased regulatory interest and higher sanctions. Again, we would hope that the opposite is also true, that a firm that can demonstrate appropriate culture and ethics would not be subject to as harsh discipline, or perhaps any formal discipline, when a potential issue is detected and appropriately addressed.
If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or
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W. Hardy Callcott
Partner
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Gerald J. Russello
Partner
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Paul M. Tyrrell
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Michael D. Wolk
Partner
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Sidley Securities & Derivatives Enforcement and Regulatory Practice
To receive Sidley Updates, please subscribe at www.sidley.com/subscribe.
Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.
Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, 212.839.5300; One South Dearborn, Chicago, IL 60603, 312.853.7000; and 1501 K Street, N.W., Washington, D.C. 20005, 202.736.8000.