Loyola University Chicago School of Law, JD 2023
COVID-19 has ushered in a new era for the brokerage industry as financial advisors and professionals across the world have been exiled from regional offices in favor of remote work. Numerous financial advisors may continue working remotely whether due to a novel sense of autonomy, elimination of a commute, or perceived increase in productivity. However, the remote-work era has introduced a plethora of compliance-related issues throughout the brokerage industry. Brokers working remotely possess additional independence to determine when to work and how to communicate with clients, which heightens compliance risks because firms are not able to monitor employees as stringently as they were before COVID-19. Federal regulators, including the Financial Industry Regulatory Authority (FINRA), are responding to newfound compliance risks by issuing updated guidance and investigating potential violations throughout the brokerage industry.
How are federal regulators responding to compliance risks in the brokerage industry?
At FINRA’s annual conference in May 2021, a panel of regulators and compliance experts discussed the challenges of monitoring and overseeing brokers who are working remotely. The main regulatory issues examined by the panel focus on the printing of confidential client information as well as communication with clients from personal cellphones. Furthermore, the panel spent considerable time discussing the widespread misuse of Economic Injury Disaster Loans (EIDL) issued by the Small Business Association (SBA).
The SBA’s EIDL Program enables small businesses and nonprofits to apply for a low-interest loan of up to $2 million to provide economic support in the midst of COVID-19. Federal regulators are concerned that numerous brokers who applied to the EIDL Program may have used the proceeds to fund undisclosed outside business activities (OBAs), which are barred by FINRA Rule 3270. Brokers are required to disclose their involvement in OBAs pursuant to FINRA Rule 3270, which includes conducting fixed insurance sales, providing tax preparation, accounting support or legal advice. Additionally, non-compensated leadership positions such as serving as president, treasurer or trustee on an unaffiliated board constitutes an OBA.
For instance, FINRA recently suspended three brokers from the industry for improperly applying to the EIDL Program through the SBA. Two of the brokers, formerly of Wells Fargo and J.P. Morgan Securities, were found to have lacked “a valid and appropriate reason” for securing a small business loan from the SBA. The third broker, who worked at Merrill Lynch, misrepresented her ownership in a property management business after failing to disclose her OBA. FINRA expects to investigate several similar cases across the industry whose brokers’ EIDL Program applications hint at involvement in an undisclosed OBA. Determining whether a broker operated an undisclosed OBA or violated a FINRA rule was more straightforward prior to COVID-19; however, federal regulators will face an uphill battle in the coming months with enforcing compliance standards on brokers who work remotely.
How will the brokerage industry adapt to regulatory pressure?
Individual firms are facing heightened regulatory pressure to adopt a risk management approach to compliance and increase oversight of financial advisors as well as employees who work remotely. For example, J.P. Morgan Chase & Co. recently instructed bankers, financial advisors and some branch employees to review years of communications on personal devices and isolate all work-related messages. Some financial advisors were ordered to set aside work-related messages from alternative platforms such as WeChat and WhatsApp. Nevertheless, federal regulators are questioning whether J.P. Morgan sufficiently preserved records. Specifically, federal regulators are seeking information “concerning its compliance with records preservation requirements in connection with business communications sent over electronic messaging channels that have not been approved by the firm.”
Client communications and personal devices are another area of increased regulatory scrutiny amidst the remote work era. Prior to COVID-19, compliance departments were able to closely monitor client communications because financial advisors were mostly limited to using in-house technology. Regulators fear that financial advisors working remotely are more likely to communicate with clients on personal devices or unapproved platforms. Hence, federal regulators are pressuring brokerage firms to strengthen oversight of communications between brokers and clients.
An increasingly-popular risk management strategy for compliance in the industry involves requiring the use of company-issued devices, which was adopted by Merrill Lynch. At the outset of the pandemic, Merrill Lynch began mandating the use of company-issued bright red cellphones for work-related communications. The compliance strategy has proven to be effective as Merrill Lynch has recently terminated at least four brokers over alleged misuse of the company-issued cellphones. Merrill adopted the device policy in an effort to effectively examine and archive all client-broker communications for compliance purposes. Requiring the use of company-issued cellphones enables compliance departments to closely monitor brokers who may possess a perceived sense of freedom from working remotely. Merrill’s risk management approach successfully flagged inappropriate conduct, which bodes well for other FINRA member firms who implement similar compliance policies. While satisfying client communication regulatory obligations will be as challenging as ever amidst the remote-work era, brokerage firms must continue to adapt in order to avoid facing discipline from regulators.