Culture Questions FINRA Will Ask in Exams

Established in 2007 during the calm before 2008’s stock market storm, the Financial Industry Regulatory Authority (FINRA) is just a baby when it comes to government institutions. Yet for a relatively young organization, it has accomplished a great deal in the fight against financial fraud, referring thousands of cases of potentially fraudulent conduct to the Securities and Exchange Commission (SEC).

In 2016, the agency launched an assessment tool to examine cultural values of brokerage firms. The examination targets “firm culture” with a series of eight questions that range from how firm culture is established, implemented and measured, as well as internal policies for dealing with compliance violations.

The ultimate goal of the examination? Through assessing firm values, FINRA intends to examine how these values shape brokerage behavior when it comes to compliance with regulatory rules. Their rationale lies in what happens when cultural values are violated or ignored. According to FINRA, fines and litigation due to “cultural failures” have cost brokerage firms over $300 billion since 2010.

While improving firm culture may sound like a noble or altruistic endeavor, it comes back to the financial bottom line: failure to comply with strong cultural values can be disastrously expensive - and prove a serious embarrassment to the financial industry.

While they find such groundbreaking efforts laudable, some experts in the field point out that defining culture is as ambitious and as ambiguous as it sounds. The ambiguity lies in the inherent subjectivity of trying to define culture, a concept that may vary widely among regulatory staff. Yet contrary to what some firms may fear, FINRA has made it clear that rather than attempting to define an ideal firm culture, they are simply assessing common industry practices. Ultimately, the goal is to gain understanding into the workplace culture that goes on behind closed doors of brokerage firms.

How is compliance with cultural values monitored and assessed, and what actions are taken to ensure implementation occurs? The emphasis here is on implementation. FINRA is interested in how metrics are used to measure successful application of firm values.

FINRA began their efforts slowly and deliberately, with an exploratory exercise to gather information rather than enforce compliance. According the agency’s website, FINRA staff met with brokerage staff - including representatives from the business, compliance, legal and risk management areas - to open up a dialogue on cultural values and their impact on business conduct. How do firms disseminate these values to their staff through both implicit and explicit messages? How do firm values determine how employees conduct business and make important decisions?

To prepare for the examination, brokerages should be prepared to address the following questions. First, what are the “key policies and processes” that the firm employs to establish cultural values, whether at the board level or corporate management level?

Next, FINRA wants to understand implementation, adoption and communication: how are these values actually implemented from the top down? Is there a process to ensure that middle management actively embraces these values? Measurement of impacts is another key issue: what tools, such as mission or policy statements, reflect attempts to measure and assess adoption of cultural values? If these policies are breached, is there a system of checks and balances in place to first identify the problem and address it?

And then there’s the sticky issue of money. FINRA endeavors to understand just how firms negotiate compensation, and how those practices ultimately shape internal culture. Among practices that regulatory officials look upon with increased scrutiny is the widespread practice of compensating brokers at a higher rate for selling high-fee stocks and funds. FINRA's stance on this practice is clear: the agency wants to know how carefully firms keep track of the recommendations that financial advisors make to their clients. How thoroughly do firms scrutinize the appropriateness of such recommendations on behalf of their customers?

Additionally, firms will be expected to describe the measures they have in place to identify potentially destructive subcultures within their organizations. Are there groups within the organization who undermine - or sabotage - the values set by board and management?

Finally, FINRA will also analyze promotion practices. How does firm culture determine who rises to power within an organization? Firms will be asked to describe the process of promotion to managing director level within the compliance, legal, risk and internal audit staff functions.

Ultimately, this measure signals that FINRA seeks to understand the realities of industry practices. For brokerage firms, this could be a win-win situation: firms will benefit by taking proactive measures to assess their internal cultural values and practices, rather than waiting until a violation triggers enforcement. Some might see it as arbitrary, as what constitutes a favorable or unfavorable 'culture' is difficult to quantify.