Broker-Dealer Suitability Surveillance – wrestling the “KYC octopus”
Written By: Martin Orbach, Director of Product
The biggest challenge for Compliance Officers today is managing and monitoring the quality of the KYC reviews being done by branch managers and the firm’s representatives. Determining whether the reviews are being done consistently and in line with firm policies is almost impossible to monitor.

Representatives or compliance officers can usually perform these tasks quite successfully with a manageable amount of accounts. But with hundreds or maybe thousands of accounts to review for suitability, the task goes from somewhat manageable to outright impossible.

In round-table discussions with Compliance Officers and Branch Managers, a consistent theme kept emerging; as much as these supervisors knew exactly what to look for (customer’s age, risk and objectives, net worth, investment experience and most importantly, the existing holdings of the client) and they knew where and how to access this important information, few had any idea, in a practical way how to incorporate these multiple reference points into the surveillance process? It was, as one Compliance Officer noted, “Like trying to wrestle an octopus. Just too much to do and too hard to keep track of, in order to perform a consistent and quality job”.

Adding to this was the human element of fatigue and burn-out that lead to omissions and errors. Reviewing multiple account holdings along with an analysis of the customer’s risks and objectives (along with the age, total commission paid, fees, charges) and then escalating the identified accounts into track-able “cases” that can be moved up the supervisory chain proves how onerous the process really is. The current procedures understandably just don’t scale very well.

By the end of July 2010, FINRA will have already heard over 990 separate cases related to unsuitable investments, with over 1480 related to miss-representation and failure to supervise. Litigation, regulatory sanction, arbitration and dealing with customer advocacy groups are time consuming and expensive, draining value and time away from the job and firm.

This labor intensive task demands some sort of automation tool or process to ensure accuracy, compliance with firm policies and most importantly, compliance with FINRA and the SEC KYC rules.

The Helping Hand of Automation
With the availability of basic desk-top based tools, compliance must embrace technology to help them enhance this multi-reference KYC checking process.

Whether using spreadsheets or asking a clearing firm to create a report in Excel will help at least to identify accounts with missing risk and objectives. Ultimately, identifying accounts where the holdings of an account are not in sync with the customer’s investment desires is the goal.

Going Beyond the Spread Sheet
Clearing firms can generate exception reports in ‘machine readable’ formats. This set of reference data will further assist compliance officers to be able to leverage existing technology like Excel or Access but challenges still remain in leveraging multiple points of reference in creating a total KYC picture of the client. An enhanced surveillance process requires sophisticated tools or services as well as a deft understanding of the actual rules.

Conclusion
Compliance professionals need to quickly embrace data and surveillance technology to improve their current capabilities. A combination of technology based surveillance tools, exception reports and data generated by Correspondent Clearing firms can put a firm on a pathway to comprehensive and thorough KYC surveillance monitoring and case management.

ABOUT SUBSERVEO
Subserveo provides automated compliance solutions broker-dealer firms in the US and Canada.

Our solution includes:
• An extensive pre-configured compliance test library
• Unique user views and dashboards with comprehensive case management features, powerful search and archiving and user driven, customizable reporting tools
• Convenient subscription based pricing and offered as a Software as a Service (Saas) eliminating the burden of management and maintenance

Learn More About Subserveo . . .

Variable annuities and sales practices — lessons for compliance

Aug 12 2010 Martin Orbach

A recent study by the US Health and Human Services Administration found that over 12.4 percent of the population in the United States is 65. By 2030 that number should grow to over 19 percent. With an aging investor population, the demand for retirement-related investment products that provide some sort of guaranteed income is growing. Richard Ketchum, FINRA’s chairman and chief executive officer, recently remarked at the FINRA annual conference in May that there is a growing urgency when it comes to regulating the annuity industry and the sellers of variable annuities. Ketchum said the inappropriate sale of variable annuities continues to be a “major concern.”

Sales practices and compliance vigilance

As more seniors invest in annuity products, member firms need to be more vigilant as to how these products are being sold by its representatives. FINRA continues to see an upward trend in the number of violations and disciplinary actions, particularly around unsuitable recommendations, the exchange of annuities and the failure to document product suitability analysis. Recent FINRA examinations of member firms selling variable contracts found that the inappropriate sales of variable contracts, including unsuitable variable contract exchanges or replacements persisted. Compliance officers should be aware of accounts where numerous switches of annuities by the same broker occur.

Sales practices by registered representatives with high numbers of accounts held by seniors always require a heightened level of supervision. Examination of the sales pitches might uncover tactics or methods used to scare or confuse an investor, such as claiming that a variable annuity will protect them from lawsuits or the seizure of assets.

FINRA is explicit in its rules regarding annuity products. FINRA rule 2330 governs variable annuity sales practices and IM-2210-2 (Communications with the Public About Variable Life Insurance Products) states that “it is inappropriate to compare a variable life insurance policy with another product based on hypothetical performance.” Compliance officers should implement correct sales practice standards, such as:

* correct and accurate suitability assessments and the disclosure of all aspects of the annuity;

* a review and approval of the sale by the principal;

* the establishment and maintenance of written supervisory procedures; and

* the ongoing training and education of representatives.

The 1035 churn

A recommendation to an investor that he or she should exchange of an existing annuity contract for a new annuity contract could be churning by the representative. Being aware of exchanges where the new variable annuity contract has a lower contract value and a smaller death benefit than the annuity product being sold is evidence of an inappropriate exchange. Compliance officers should be aware of all section 1035 exchanges and ensure that the correct sales practices, approvals, reporting and supervision were employed.

Scrutinizing the transaction and knowing the client

Knowing the details of the product is as important as knowing the risk tolerance and investment objectives of the client. It’s a challenge to enforce rules like FINRA 2330 (Sales Practices Relating to Annuity and Variable Annuity Products) and rule 2310. The effort required to identify transactions in these specific products and then align that information with specific “know your customer” (KYC) details (such as age, status, risks and objectives and current employment) over an entire customer base of thousands of accounts and portfolios is a daunting task.

These labor-intensive tasks demand an automation tool or process to ensure accuracy, compliance with firm policies, and most importantly, compliance with KYC rules. With the availability of basic desktop-based tools, compliance professionals should consider the ways in which technology can help them meet their KYC obligations. By using spreadsheets or asking your clearing firm to create a report in CSV format that you can then sort or even run macros on will help at least identify accounts with missing risk and objectives.

Identifying an account in which the holdings are not in sync with the customer’s investment desires is the goal. Clearing firms can generate data using existing technology like Excel or Access, but challenges still remain in leveraging multiple points of reference and creating a total KYC picture of the client. An enhanced surveillance process requires sophisticated tools, as well as a deft understanding of the actual rules.

The fiduciary standard is here

The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law on July 21, 2010, affects a broad spectrum of financial activity. The law gives the SEC a mandate to examine and (where appropriate) to promulgate rules prohibiting or restricting certain sales practices, conflicts of interest and compensation schemes as well as imposing the same fiduciary duty on broker-dealers and insurance agents that it does for investment advisers. Compliance officers must be ready for additional supervision requirements and duties, especially concerning transactions in products like annuities.
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Martin Orbach is the Director of Product at Subserveo, a provider of compliance surveillance technology. Orbach has worked on the sell-side for over 19 years in compliance, sales trading, market-making and back-office operations.