FINRA Shows Regulatory Hand: Brokers, Pay Heed or Watch Out!

One of the benefits of working in financial services is that regulatory agencies are usually transparent about their concerns. They communicate well in advance when they’re about to crack down on something, giving agents, advisors, and brokers more than enough time to respond. FINRA is an excellent case in point.

In early January 2018, the securities self-regulatory organization released its annual Regulatory and Examination Priorities Letter, which tells member firms and registered representatives what it intends to focus on during the year. The letter, in effect, is a great resource for resolving compliance issues before FINRA gets involved.  It also helps firm executives prepare for their FINRA examinations.

The regulator’s 2018 letter was wide-ranging. FINRA announced it will focus its efforts on fraud, high-risk firms and brokers, and operational and financial risks, including technology governance, cybersecurity, and market regulations. Other priorities will include:

  • Sales practice risks, especially recommendations of complex products to unsophisticated, vulnerable investors;
  • Protection of customer assets and the accuracy of firm’s financial data; and
  • Market integrity, including best execution, manipulation across markets and products, and fixed-income data integrity.

In the body of the letter, FINRA provided further details on each regulatory concern. Several that bear a strong relationship to broker sales activities follow.

Fraud: FINRA announced that once again, fraud will be a high enforcement priority. These include activities such as insider trading, microcap pump-and-dump schemes, issuer fraud, and Ponzi-type schemes. Also, a focus will be continuing to identify cases of potential insider trading, which FINRA refers to the U.S. Securities and Exchange Commissions (SEC). Reining in scams targeting senior investors will receive a strong emphasis, as well.

High-Risk Firms and Brokers: FINRA will focus on protecting investors from firms and brokers that take advantage of their customers. Specifically, it will look at practices such as hiring, supervision of high-risk brokers, supervision of point-of-sale activities, and branch inspection programs. Also a focus will be sales of advanced securities products to unsophisticated investors.

Sales Practice Risks: This is an especially wide-ranging area. In 2018, FINRA says it will pay serious attention to suitability violations, especially to the business practices and processes that produce suitable sales. Suitability in the context of employer-sponsored retirement plans and IRA rollovers will be hot-button issues too, as will be sales of initial coin offerings, cryptocurrencies, the use of margin loans in the sales process, and proper use of securities-backed lines of credit.

Cybersecurity: 2018 will continue to see high FINRA involvement in protecting customer assets and information against hacking and other cyber-crimes. As in prior years, FINRA will continue to evaluate the effectiveness of firms’ cybersecurity protocols—specifically their preparedness, technical defenses, and resiliency measures.

To further help member firms and their brokers, FINRA released a Report on FINRA Examination Findings. Based on what it finds when it visits firms at least once every four years, this document can also be a helpful resource in assuring firm compliance with FINRA rules in 2018 and beyond.

For further information about FINRA’s 2018 priorities, please visit its website here.

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Technology has reshaped almost every aspect of insurance and financial sales. From the advent of the personal computer and spreadsheet software to the rise of the Web and mobile technology, it has become easier and more efficient to run a financial-services business today than at any time in the past.

However, sometimes the development of new technology raises more questions than it answers. That’s the case with facial expression software, which financial firms are using to uncover people’s emotions about money. Does this new application make traditional fact-finding more revealing and productive? Or does it undermine the financial advisor/client relationship . . . perhaps jeopardizing advisors’ standing in the industry of tomorrow?

One cause for concern: facial recognition software is entering a finance domain that until now has been old school—needs assessments. Until recently, this process has been human-directed. Flesh-and-blood advisors typically sit down in actual rooms and ask real customers questions to identify their financial needs and concerns. The best advisors are skilled at detecting client worries, both through their words and body language. They’re also adept at asking probing questions to clarify when words and and posture conflict.

In fact, the entire industry depends on thousands of financial advisors sitting across from prospects and clients, asking questions and encouraging clients to reveal their concerns. Problem is, the field of behavioral economics has poked holes in this methodology. In repeated studies, it has shown that clients have trouble making rational money decisions. More often, emotional and cognitive errors cloud their thoughts, leading them to make sub-optimal decisions. And the traditional fact-finding interview may not help advisors much, since emotional and cognitive errors may not be visible to the naked eye.

Making matters worse, sometimes clients hide their emotions when meeting with their advisors, either deliberately or unconsciously. This leads advisors to make off-the-mark recommendations that end up poorly serving their clients.

What if there were a way to better assess client emotions prior to making recommendations? If software could deliver that, would you use it? The financial professionals at independent advisory firm Cetera Financial Group are answering that question now. Their firm has introduced a new software program designed to analyze a client’s facial expressions during fact-finding meetings. The goal: to shine a light on people’s money emotions in order to build a deeper relationship between them and their advisors.

How does it work? Cetera’s Decipher application runs on any device that has a web camera. The financial advisor simply asks clients to watch a series of videos about financial scenarios. The software then maps minute changes in their facial expressions to reveal their underlying emotions toward money.

“Decipher is transformative for the advice industry,” says Robert Moore, CEO, Cetera Financial Group. “It takes the relationship with the advisor to the next level. A lot of information is conveyed non-verbally. This is a tool for relationship building that will help the advisor really know what is in the best interests of the client.” A side benefit is that it will make the entire investment recommendation process more transparent and compliant with the Department of Labor’s Fiduciary Rule.

Moore adds that the program will be available to any advisor and client who’d like to use it. Plus, it will not be used to create financial plans. Instead, its function will be to increase an advisor’s understanding of a client’s perceived problems. And he says the company may eventually integrate Decipher into its online risk profiling application, giving a future automated investment platform greater ability to retain client assets during times of market volatility.

Although Moore says Decipher will not replace advisors, it’s not hard to envision a scenario in which the software might decrease the advisor’s role during fact-finding. It’s possible Decipher may prove to be more efficient than a human advisor at detecting emotions. And how will advisors react to partnering with a computer? Will they assume the software is smarter than they and defer to it? Or will they stubbornly rely on their own instincts even when the computer says otherwise?

Another implication: how will clients react to interacting with a computer instead of a human advisor? Will they be comfortable with a machine “reading” their deepest emotions? Will they buy it when the computer says they’re feeling something they don’t believe they’re feeling? Or will they make an issue out of it, thereby derailing the sales process?

Finally, how will all concerned react to automating what used to be the living, beating heart of financial planning—the advisor/client needs discussion? Will people view the transference of part of this process to a computer as a good or bad thing? And ultimately, if the technology catches on at other firms, will it actually help clients and advisors build stronger relationships or will it undermine them? Only time will

To read on ethical business practices, visit the Ethics Center at the National Ethics Association, sponsor of EOforLess. 

It’s a rare day when consumers don’t read about another cybersecurity breach afflicting a U.S. business. For example, last year Anthem, a large health insurer, announced that hackers stole sensitive personal information from 80 million of its customers. Not surprisingly, consumers are on edge about future attacks, as are financial-services regulators. In fact, the North American Securities Administrators Association (NASAA), went so far as to publish an alert encouraging consumers to discuss cybersecurity with their investment advisors.

 “The increasing reliance on technology in our daily lives could leave our sensitive financial information more vulnerable to unwanted viewing or theft without proper safeguards in place,” said William Beatty, NASAA President and Washington Securities Director.

In September 2014, NASAA reported that 62 percent of state-registered investment adviser firms participating in a NASAA pilot survey had undergone a cybersecurity risk assessment, and 77 percent had established policies and procedures related to technology or cybersecurity. “Investors should think about the safety of their financial information, and talk with their investment professionals about what steps firms are taking to safeguard client information,” Beatty said.

To help investors with that discussion, Beatty suggests asking the following questions:

  • Has the firm addressed which cybersecurity threats and vulnerabilities may impact its business?
  • Does the firm have written policies, procedures, or training programs in place regarding safeguarding client information?
  • Does the firm maintain insurance coverage for cybersecurity?
  • Has the firm engaged an outside consultant to provide cybersecurity services?
  • Does the firm have confidentiality agreements with any third-party service providers with access to the firm’s information technology systems?
  • Has the firm ever experienced a cybersecurity incident where, directly or indirectly, theft, loss, unauthorized exposure, use of, or access to customer information occurred? If so, has the firm taken steps to close any gaps in its cybersecurity infrastructure?
  • Does the firm use safeguards such as encryption, antivirus, and anti-malware programs?
  • Does the firm contact clients via email or other electronic messaging, and if so, does the firm use secure email and/or any procedures to authenticate client instructions received via email or electronic messaging, to work against the possibility of a client being impersonated?

Guidance from the National Ethics Association: Make sure you have completed a cybersecurity assessment and that you have comprehensive policies and procedures in place to prevent a cyber attack. This is important not only to protect customer information, but also to prevent data thefts that could spawn client complaints and E&O insurance claims. If you haven’t done this yet, tap into resources or referrals available from your FMO, RIA, or Broker-Dealer. Most importantly, do not assume that a cyber attack will never happen to you. It can, and if it does, your response plan must be ready to go.

For information on affordable E&O insurance for low-risk insurance agents, investment advisors, and real estate broker/owners, please visit For information on ethical sales practices, please visit the National Ethics Association’s Ethics Center.

This article continues with the third and fourth most common real estate E&O insurance claims: breach of contract and negligence. The first and second most common types are here.

Breach of Contract

We regularly encounter lawsuits wherein one party, usually the plaintiff, asserts a breach of contract claim against the insured real estate agent. Breach of contract is a cause of action based upon an allegation that one or more parties failed to perform under the terms of a contract. If a Court finds a breach occurred, it will award damages in such an event. Note that plaintiffs will sometimes claim breach of the real estate contract; however, a breach of contract claim should not exist against the real estate agent in this circumstance, unless the agent was party to the real estate contract itself. This is distinguishable from allegations that the real estate agent breached his/her legal duties which arose out of the buying or listing agreement. It is for this reason that we typically see breach of contract claims in conjunction with other causes of action, such as breach of duty, negligence, fraud, etc.


Generally speaking, negligence is a cause of action alleging the failure to exercise due care toward others, which a reasonable or prudent person would do in the circumstances. The plaintiff must show the defendant had a duty to the plaintiff; the defendant’s act or inaction breached that duty; the defendant’s act or inaction was the cause of the plaintiff’s harm; and the plaintiff must have suffered a discernible injury. Acts of negligence are set apart from intentional torts such as fraud, since negligence claims lack an element of intent. For example, a plaintiff does not have to prove the defendant purposefully concealed a property defect, but rather that the defendant knew or should have known about the complained of defect and failed to disclose it. Typically most plaintiffs will plead fraud and negligence in the alternative, which means that in the event the plaintiffs fail to prove fraud, the defendant can still be found to have acted negligently.

Some examples of negligence claims include:

  • “Our agent failed to transmit written notice to the listing agent before the deadline that we were opting out of the purchase and sale agreement per the inspection contingency in the contract.”
  • “Our real estate agent should have known that even though the property was advertised as a 4-bedroom house, the septic system was only approved for a 2-bedroom house.”
  • “The real estate agent should have known there was termite damage to the house and disclosed it to us, the buyers.”

Normally, plaintiffs are not entitled to punitive damages in a negligence claim, but rather are limited to the actual damages suffered, which may or may not include the costs of the litigation.

(Editor’s note: We’ll cover the remaining real estate E&O insurance claim types in Parts Three through Five of this series.)

Reprinted with permission of Rice Insurance Services Company, LLC

For more information on affordable errors and omissions insurance for low-risk real estate agents and brokers, visit E& For information on ethical sales practices, please visit the National Ethics Association’s Ethics Center.