Wealth Management (November 30, 2022) – The regulatory agency released an update Wednesday on its targeted sweep of firms’ supervision of options recommendations, launched in August 2021, offering more pointed questions for registrants.
Firms recommending options trading for customers need to be on the lookout for “red flags” on customer applications, according to the Financial Industry Regulatory Authority (FINRA).
The brokerage industry regulator released an update Wednesday on its targeted exam and sweep of registered firms’ supervision of options trading and strategies, which was first announced in August 2021.
Based on information thus far, FINRA designed questions for firms to consider when assessing customers for options trading, as well as their disclosures and supervision of approved options accounts.
In assessing how they approve customers for options trading, FINRA asked firms to consider whether they’d established “minimum criteria” for account applications, including whether their stated investment objectives align with their desired levels of options trading, and whether more requirements should be necessary for complex strategies.
When it comes to looking for red flags, firms should compare information on an account application with information already available at the firm and look for inconsistencies on the applications themselves; FINRA cites hypotheticals, including a 21-year-old applicant claiming to have a decade of experience in trading options, an applicant selecting all investment objectives or a 20-year-old student applicant claiming to make $300,000 per year in income.
FINRA also urged firms to review automated systems to ensure they’ll catch such red flags, and make sure that any options trading recommendations adhere to compliance requirements in the Securities and Exchange Commission’s Regulation Best Interest.
If a rejected customer resubmits an application, FINRA wants to know how firms compare the two applications to determine what has been changed and if firms require a waiting period before customers reapply. (This concern arose in a case brought by Massachusetts Commonwealth Secretary William Galvin earlier this year, where customers outsmarted Fidelity’s automated approval system for options trading by submitting multiple applications, leading to situations where customers “gained” years of experience in just a few days.)
Regarding disclosures, FINRA wanted firms to review the types of options account promotions they use and whether they tailor those communications when marketing to customers with different backgrounds. It also asked whether firms offer guidance or educational opportunities to customers informing them about options trading, and whether their disclosures met Reg BI mandates.
When supervising accounts, firms should “conduct periodic, ongoing” reviews of trading activity to ensure customers are still eligible for trading options and not moving out of their approved space, and firms should be surveilling customer account information to determine if a customer’s account should be downgraded, denied for further trading or ruled ineligible.
“Does your firm review customers’ trading eligibility as market conditions change?” FINRA asked. “If so, does your firm downgrade customers’ trading levels if their account profiles do not continue to meet certain criteria (e.g., decrease in total net worth)?”
FINRA’s sweep came shortly after a settlement with the brokerage app Robinhood, in which the agency ordered it to pay $70 million for “systemic supervisory failures” that harmed clients, including accusations that the app didn’t alert clients to the risks in certain options trades and failed to properly supervise its automated approval of customers for certain options trading.
Earlier this year, the Public Investors Advocate Bar Association called on FINRA to strengthen its rules on complex products and options, including the alleged tendency for small firms to use strategies that their own advisors might not understand.