RegTech Stakes Rise as FINRA Intensifies Options Trading Scrutiny

Q&A: Robert Cruz of RegTech Provider Smarsh on How Wealth Management Firms Can Best Address Heightened FINRA Expectations


In June, Gary Gensler, Chairman of the Securities & Exchange Commission (SEC), discussed his heightened interest in oversight of options trading, an activity that has continued to increase across the financial markets over the past 16 months in particular.

Consistent with the SEC’s perspectives, the Financial Regulatory Authority (FINRA), which serves as the Self-Regulatory Organization (SRO) for the broker-dealer community, recently announced that it will be conducting targeted exams focused on supervisory practices for options trading.

With so much happening on the regulatory front on this topic, Digital Wealth News recently connected with Robert Cruz, Vice President, Information Governance, at Smarsh, the global provider of digital communications content compliance solutions, to make sense of it all.

DWN:  Is there anything that stands out with FINRA’s recently announced plans for conducting targeted exams focused on supervisory practices for options trading, especially in terms of unusual obligations or extra burdens for wealth management firms and financial institutions?

Cruz:  Nobody should be surprised that FINRA will be looking closely at practices and controls when supervising options accounts.

But what is unusual here is the heavy emphasis on written communications and existing supervisory processes, which is not something we see every day. What this signifies is a focus not only on the financial vehicle, but also the communications platforms used to communicate with investors.

From producing Written Supervisory Procedures (WSPs), compliance manuals, and any other written guidance pertaining to opening options accounts and due diligence activities, to providing compliance manuals and any other written guidance pertaining to the firm’s process for supervision of options trading in customer accounts, and much, much more – Make no mistake, there will be high expectations on FINRA’s part.

DWN:  What’s motivating FINRA’s scrutiny of options trading?  And what does the role of market volatility driven by so-called “meme stocks” play within the current industry landscape?

Cruz:  What FINRA is doing is completely consistent with recent SEC commentary on firms attempting to connect with retail investors over the past 18 months.

As we saw with the case of Roaring Kitty, options are a preferred vehicle. The activity from retail investors largely explains why the volume of options is significantly higher than it has been historically.

But one of the biggest problems here is that newer retail investors may not be aware of the risks of options trading. This has resulted in the volatility called out by the SEC and other regulatory watchers surrounding meme stocks, with FINRA also having weighed in, most notably by imposing its largest-ever fine of $70M against a leading brokerage app.

The app company was sanctioned for systemic supervisory failures and significant harm to millions of customers for failing to alert clients to the loss risk they faced in certain options transactions.

DWN:  Do you believe an increasingly hybrid workforce, where a much larger number of home office staff and financial advisors are working from home, increases the compliance risks for wealth management firms and financial institutions?  If so, why?

Cruz:  There’s no question that there is increased compliance and regulatory risk with hybrid workforces likely to become the default work model.

This is due in large part to the confluence of the following key factors:  Reduced visibility of remote staff, an attractive financial market, and a virtually unlimited number of ways to connect with others via digital platforms.  All of this contributes to greater risks of compliance mishaps.

Also let’s not forget about the ongoing surge in cybersecurity risks, and the higher likelihood of harm to a newer, less sophisticated category of investors.

DWN:  How can regtech help the wealth management industry with these new regulatory challenges?

Cruz:  Let’s start with the fact that there continues to be a significant growth opportunity for wealth management firms and financial institutions that build the capabilities to engage with retail investors digitally, while doing so in a compliant way.

The majority of RIA firms, for example, view retail investors as the largest customer opportunity going into 2022.  These firms acknowledge the shifting demographics of their business and recognize the need to engage with new, retail investors through their preferred financial vehicles and digital communications tools.

So if we accept where the regulatory environment is heading and that some of the biggest growth opportunities can be found with digital engagement directly with retail investors, then the course is clear.

Firms must adapt their policies and procedures, employee training, and technology and automated controls to stay compliant while capitalizing on this moment.

Yes, the regulators are watching, but there are multiple regtech solutions that exist today that enable wealth management businesses to deliver on regulators’ expectations in a scalable way.  Without adopting regtech tools, wealth management businesses will only be able to grow as quickly as very manual and paper-heavy processes allow.