Running a Broker-Dealer Firm: What’s Culture Got To Do With It?

FINRA has placed a renewed focus on “firm culture” and its “profound influence on how a broker-dealer conducts its business,” as stated in its February targeted exam letter, titled “Establishing, Communicating and Implementing Cultural Values.” The letter aligns with FINRA’s 2016 Regulatory Examinations and Priority Letter, which states that “firm culture, ethics and conflicts of interest” remain a top priority, which is closely related to supervision. Among the firms being subject to compliance failures and sanctions, FINRA is seeing a common theme—weak culture values. This evaluation comes from $300 billion in fines and litigation costs borne by firms since 2010. For example, in October 2015, FINRA expelled a New York-based member firm and barred its CEO and CCO for fraud, sales practice abuses, and widespread supervisory and anti-money laundering failures, which FINRA noted were consistent with the culture of non-compliance fostered by the firm and its principals and manifested itself in widespread sales practice abuses. These types of cases have lead FINRA to the logical inference that culture does indeed have something to do with a firm’s success (or at least its compliance prowess). Prompted by this connection the exam letter, issued by FINRA to more than a dozen firms this month, is FINRA’s probe into learning information about how firms establish, communicate and implement culture values.

Despite the subjective nature of the term “culture,” FINRA is determined to turn it from a qualitative to quantitative factor in assessing firms’ compliance structures. FINRA concedes that the definition of firm culture is amorphous and, pulling from its 2016 Priorities Letter, provides that “one definition of ‘firm culture’ is the set of explicit and implicit norms, practices and expected behaviors that influence how employees make and carry out decisions in the course of conducting the firm’s business.” Logistically, we may have all been under the assumption that firm policies and procedures set forth such norms, practices, and expected behaviors but FINRA is obviously concerned with what is going on off the paper and in actuality. After all, if all the firm policies and procedures were being enforced and adhered to, then no firm would wind up with sanctions.

In its quest to gain a better understanding of the industry standard in firms, FINRA has asked firms to supply information about their practices and the challenges that they face so that FINRA may develop potential guidance for the industry. As a part of its examination, FINRA intends to meet with firms’ executive business, compliance, legal and risk management staff to discuss their impressions of cultural values. In anticipation of those meetings, FINRA has asked firms to submit summaries and descriptions about:

  1. Key policies and processes by which the firm establishes cultural values, including board-level functions
  1. Processes employed by executive management, business unit leaders and control functions in establishing, communicating and implementing the cultural values
  1. How the firm assesses and measures the impact of cultural value and whether they have made a difference at the firm in achieving desired behaviors
  1. Processes used by the firm to identify policy breaches, including the types of reports or other documents the firm relies on
  1. How the firm addresses cultural value policy or process breaches once discovered
  1. A firm’s policies and processes used to identify and address subcultures within the firm that may differ or undermine the culture embodied by the firm’s board and senior management
  1. How the firm’s compensation practices reinforce cultural values
  1. Cultural value criteria used to determine promotions, compensation, or other awards

While FINRA is using this as an exercise to learn from firms, at the heart of its quest, FINRA is looking for a supervisory system that employs visible action to help mitigate conflicts of interest and promotes the fair and ethical treatment of customers. FINRA provides, for example, in its 2016 Priorities Letter that “material breaches of firm policies and procedures should not be tolerated, and compliance functions should be equipped with necessary resources to help firms navigate a complex and changing regulatory and market environment.” Based on these expectations, firms should ensure that their memorialized and daily policies and practices incorporate a strong “tone at the top,” wherein senior personal are reminding employees of the firm’s dedication to managing conflicts of interest and treating customers ethically; employees should be encouraged to report conduct that stems away from this culture with a clear escalation procedure; changes in firms’ policies and practices, as well as, rules and regulations should be effectively communicated through regular updates, ideally through senior personnel; and firms should design tests for evaluating firm culture based on employees’ experiences (e.g. through an annual survey with firm culture-related questions).

Culture, as subjective as it may be, does exist and FINRA is determined to make it a material part of member firms’ operations. As attorneys, we know very well that “firm culture” differs from one private practice to another. Just the same, broker-dealers may embody different cultures and this stems from the simple notion of how senior personnel speak and more importantly how they act.  Because “actions speak louder than words,” FINRA is striving to understand how firm philosophies and senior personnel influence the work place, especially compliance. Because a number of firms have been subject to sanctions due in part because of unclear or destructive firm culture, there may indeed be something that culture has to do with a firm and its compliance success. This may therefore, following FINRA’s exams, mandate changes in how firms employ and assess their individual cultures.

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