Regulatory Exams: Pave the Way For Positive Regulator Relations

The Importance of Building Positive Regulator Relationships

Building and maintaining strong relationships with regulators is not just beneficial, but essential. Join us for Part 2 as former regulators share their experience and insights into how to establish open, candid communication, and engage regulators on both professional and personal levels. Get tips on setting the right tone from leadership and fostering a culture of compliance.  Stay on the right side of compliance while cultivating positive interactions with financial regulatory bodies.

In this episode we’ll build on Part 1 and cover:

• Dealing with Regulatory Violations: Identifying violations and deciding on the next steps.
• The Exam Process and Levels of Review: From deficiency letters to enforcement referrals, learn how regulators evaluate violations through multiple levels of review and how firms can proactively manage these stages.
• The Role of Cooperation – Discover why setting a tone of cooperation matters, and where to draw the line when the process turns adversarial.
• Educating Examiners: Learn why it is important to ensure they understand your operations in context and reduce the risk of misinterpretation.
• Culture of Compliance: Learn how tone at the top and a strong compliance culture influence examinations and relationships with regulators.
• Building Positive Relationships with Regulators: Get practical tips on engaging with regulators and industry working groups to foster mutual trust and gain valuable insights into regulatory priorities.

Enhance your compliance efforts by understanding the importance of communication, and by developing relationships with regulators. Our panel of former regulators will provide you with actionable insights and practical strategies to navigate these challenges confidently.

Additional Resources for Navigating Regulatory Exams:

Managing Regulatory Exams: 8 Steps To Minimize Risk Of An Enforcement Action

Dispute Resolution: Managing Customer Complaints and Regulatory Inquiries

How to Successfully Manage Regulatory Remediation

Regulatory Exam and Compliance Support

Oyster Consulting specializes in helping firms navigate the complexities of regulatory examinations by providing expert guidance and practical solutions. Our team of former regulators and industry professionals offers tailored support, from preparing for exams and responding to inquiries to addressing potential violations and building a strong compliance program. With a focus on collaboration and proactive strategies, we help firms maintain regulatory compliance and foster productive relationships with their regulators.

Transcript

Transcript provided by TEMI

Libby Hall: Welcome to the Oyster Stew Podcast. I’m Libby Hall Director of Communications for Oyster Consulting. This week we present Part 2 of 2 podcasts featuring former regulators Patrick Dennis, Evan Rosser, Ed Wegener, and Bill Reilly.  Join us as they share strategies for navigating regulatory interactions and fostering a culture of compliance. Let’s join our experts as they continue their discussion.

Patrick Dennis:  Ed, your thoughts on dealing with the violations?

Ed Wegener:  Yeah, I think that’s spot on because I think there’s really two determinations that have to be made by the regulators. The first is whether there is a violation, and the second is, if there is a violation, what are we going to do about it? Those are two really separate discussions.

To your point, there are several points during the examination where you can provide information to help to make that determination of whether there is or isn’t a violation. It starts, to Jeffrey’s point, when the examiners first start talking about it, before there’s an exit conference, before there’s an examination report that’s issued, they’re going to let you know throughout the exam whether there’s something that they see and start gathering information about it. So, at that point, you want to provide them with as much information as you can to help show them that we don’t think that there’s a violation. Or, again, to Jeffrey’s point, there is a violation and we’re starting to take care of it.

Then there’s a lot of levels of review that happen. So that’s one thing that I’m not sure people appreciate, is just the number of levels of review that go on throughout the course of the examination before there’s a final determination. Examiners will turn it into their managers who review it. If it’s something where there’s a violation that looks like it might be referred to Enforcement, senior management will usually take a look at it as well. So, there’s a lot of points of review, and those are also opportunities to get in front of the regulator and plead your case. But once it’s been determined that there’s a violation and that there’s evidence that supports the violation, the question becomes, so what are you going to do about it?

At FINRA, and this is similar, I think, to what the other regulators do, we had different things that we could do; some formal action, some informal. An exam could result in no action being taken. It can result in a letter of caution where we identify these are the issues that are found, show us how you’re going to fix them. There were some cases where FINRA would hold what we called corrective action meetings, where it was something that was probably more egregious than a letter of caution would resolve, but didn’t feel like it was something that should be referred to Enforcement. So, they might call the firm in to have a discussion about it and discuss how the firm’s going to resolve the issue. If none of those things work or don’t appear to be appropriate, then the determination is made to refer it to Enforcement.

The factors that are considered are, they’ll take a look at the violation and look to see and weigh aggravating factors and mitigating factors. Things like, was there customer harm? Was their intent to harm the customers? Were the firm’s procedures and supervision good, or were they poor when this was raised to the firm? What did they do about it? Did they take action? Did they dig their heels in and argue about it? All of those factors are weighed into making determination of whether to refer a matter to Enforcement. And there are a couple of documents from FINRA’s perspective that I would look to. One, FINRA issued an enforcement guiding principles document, which outlines some of the factors that they look to when making those determinations. But then also something that was amended are FINRA sanction guidelines. In those sanction guidelines, they outline aggravating and mitigating factors based on by violation. So, you can see what are the specific things that regulators look at when determining both sanctions, but also whether to make a referral to enforcement.

Patrick Dennis:  One of the things that we’ve all talked about in preparing for this, some number of firms that think everything, every violation is going to turn into enforcement referral. And frankly, we know that’s not the case. The number of exams that turn into enforcement or enforcement referrals or enforcement actions is really pretty small, at least from my experience. And I think everybody else agrees. The other challenge is there’s a lot of steps to take before we get to an enforcement referral. I mean, correct me if I’m wrong, but there are deficiency letters that require corrective action or a corrective action statement that’s required.

Bill Reilly:  Patrick, if I can add a couple things from a state perspective.  One of the things, and I’m not sure a lot of people in the industry are aware of this, is that unlike the SEC is able to enforce, of course, SEC FINRA rules, you know, FINRA has certain regulations, but one of the things that a lot of states do is they adopt FINRA, SEC, MSRB and NASAA model rules and guidelines, as well as state statutory references for each individual state. So, one of the things that needs to be clear is that a state can bring an action based upon a state law, a FINRA rule, the SEC regulation, or MSRB regulation. So that’s something there to make sure you understand the jurisdiction of the regulator that you’re dealing with.

You kind of mentioned the situation of maybe people reaching out – they’re from the regulatory side or from the industry side – to the regulator. I can tell you many times when examiners were conducting exams or investigations, they would bring attorneys in, they would bring consultants in very much like us here on the panel today. The one thing that people would say, before you get to that point of resolving that case, is “we want to have the opportunity to come in and talk to you. We want to meet with you. We want to make sure that we’re all the same understanding, want to make sure that if someone did not provide a record to you, and we can correct that, we want to do that.” I think it’s imperative to know the rules or regulations, but it’s also important if you can, to know who the players are. Because, as Ed said, many times most cases will end up in a cautionary or deficiency letter, a large percentage of cases will end up in a formal, but a negotiated settlement, and very few cases actually go to an administrative proceeding.

Evan Rosser:  Examiners in the field conducting the examination are rarely going to give you any certainty as to any findings at that stage. As everyone here has pointed out, an exam deficiency goes through a process by which it’s reviewed, and nevertheless, that examiner in the field is the person giving the information to the people up the line. When you get an indication that that examiner might have found a problem, and you can tell by the questions, by the documents, by the follow up, whether that might be the case, I think it’s then you need to say, look, maybe there’s something else here I can explain to you, because maybe your best defense, your best explanation is not in those written documents that you’ve produced and they’ve requested. Now, it’d be great if it is. I mean, that’s the goal. But, sometimes your best explanation is outside those documents, and you need to make the examiner aware of it.

That story goes along up the line, and ideally, maybe that possible deficiency doesn’t go up the line if you can shut it down during the exam process. The one question, or the one issue that I’ve heard for years from firms about examinations, is they say the examiner doesn’t understand my business. I have to take my time to explain my business to the examiner. Well, that’s not such a bad idea to explain your business to the examiner. In fact, it’s a pretty good idea. Sometimes the examiner will ask questions just to hear you explain it. It’s not that they may not know it or understand it, but they want you to explain it to them. So, if they want you to explain your business, I would, rather than have a deep sigh and roll your eyes, take the opportunity to explain it and to provide that explanation that puts your business and your program in the best light.

Ed Wegener:  You know, I’ve seen firms that have done this really well, where the examiners would come in on the first day and they would sit down with them with a PowerPoint presentation and explain the firm, the activities they were involved in, the products they sell, how the firm was organized, who did what. It took a little time, but to the earlier point, you want the examiners to understand your business because if they have violations, you want them to be able to put that into the context of what you do. The other thing too is, it starts the examination off on a positive note that you’re there and you’re going to help them. You also then really own the message because you’re explaining to them what the firm does, as opposed to them trying to figure it out on their own. So, to the extent that you can do that and educate the examiners at the beginning of the exam, I think it is definitely a benefit, and I think it’ll really go a long way.

Patrick Dennis:  One thing that we should probably talk about is cooperation. I know, the SEC for years talked about the value of cooperation and how important it was to cooperate, particularly once they’ve gotten to the enforcement side of things. My theory is, and my approach has always been, to cooperate.  You want to certainly let the regulators know and tell them that you were intending to cooperate fully, and appreciate their time and all of those things. There are times that you may not want to cooperate quite as much as they would like or quite as much as you would say you are. But you always want to give the impression that you are trying to cooperate and give them what they want until you get to a point where you reach a serious impasse. Then you’re making a decision to fight rather than to cooperate. But up until that time, I think cooperating and giving that impression is clearly important. Evan, your thoughts?

Evan Rosser:  I think you cooperate up until the time it becomes adversarial. You don’t ever want it to become adversarial, but at some point, if they find violations, it might be where that line is.  That’s for you and your counsel to determine. But I think during the examination phase, I think cooperation is extraordinarily important. It just sets the tone because the examiners are human. You don’t want to look like you’re fighting them, or you’re hiding something. It makes an impression. It really makes an impression. So, get them as much as you can, as quickly as you can. In my experience, I’ve never had a regulator turn down a request for more time to produce documents the first time around. If you tell them ahead of time, hey, look, can I have an extra week? I’m having trouble pulling this together. I’ve never heard of a regulator saying, no.

Evan Rosser:  So, I think you need to work that way. I will say this, if you ever have a regulator show up unannounced, I would call your counsel immediately because every examination you have should be announced. You should get a letter. If they ever show up at your doorstep, I would certainly call my counsel. Have them wait a few minutes until you get straightened out exactly why they’re there.

One thing that FINRA did when I was there, and I assume they continue to do it, they will occasionally ask to copy your hard drive on your computers. There is a process for that, and they are entitled to do it under certain rules and procedures. So, if they do ask that, if they want to mirror your hard drive and take an exact copy, there is a procedure by which they need to let you know what they’ve taken, ensure you that they’ve taken it accurately, and have a process for any privilege documents that might be swept up in that mirror. So, if they do ask that, you’re entitled to find out exactly what process they’re going to use to do that, but they will ask that in some instances, and they are entitled to get it.

Patrick Dennis:  When they do ask for that, it is certainly the time to call your counsel unquestionably, because if they are asking to copy your hard drive off your computer, they believe there’s something on there that they’re not getting elsewhere. Things are fairly serious at that point.  

How do you show that there’s a culture of compliance and tone at the top to the examiners when they come in.

Evan Rosser:  I don’t think I’ve ever seen a firm where a firm that had compliance problems that didn’t start really at the top. I rarely see firms that, where the person at the top really wants to do the right thing, but he’s thwarted by all the people below him. I just really haven’t seen that. Certainly, at smaller firms, that’s the case. And I agree with Jeffrey, if it’s a smaller or mid-size firm, if you can get the CEO to meet with him (the regulator) the first day, because he or she feels it’s important and says, “Look, I think it’s important that I meet with you. I want you to know that we’re trying to do the right thing. I empower the Compliance staff.” I think that’s really important, and it does send a message to regulators because they know it. They know that, especially again, with smaller and mid-size firms, that firm’s compliance culture really is a reflection of the people at the top.

Patrick Dennis: Ed, your thoughts please?

Ed Wegener:  I think tone at the top is part of the broader category of the culture of compliance at the firm. And to all these points, I think that there are clues to that, and examiners are always looking for those clues. It really goes to decisions like, should something be referred to enforcement or should it be an informal action, and things like that – what the tone of the exam is going to be. Some of the things that I would say are clues are whether the firm is organized.  Does it seem like they have their act together? Whether the firm appears to be cooperative or obstructive, whether the firm appears to be well-meaning. Are they trying to do what’s right? Do they fix issues when they come up? Do they argue every point, or do they seek to understand what the examiners are trying to get at? As we talked about earlier, do they try to educate the examiners on their business? I think when you take all of those as a whole, you get a sense of what the culture is at the firm. I think that that really sets the tone, not only of the exam, but the full relationship between the firm and the regulators.

Patrick Dennis:  What’s the best way you can think of to manage your relationship with the regulators and or improve the relationship with the regulators? Probably everybody needs to do that at one time or another, or certainly always wants to have a better relationship with the regulators than they currently have.

Ed Wegener:  Well, I’ll speak from a FINRA perspective. If I had one thing that I would recommend to a firm in terms of managing the relationships with FINRA, it would be to build a good working relationship with your risk analyst that’s assigned to your firm. They’re the person that is monitoring everything that the firm does, and their assessments are what drive a lot of key decisions in terms of how frequently the firm’s going to be reviewed, what’s going to be reviewed during an examination, whether the firm’s going to be considered low risk or high risk. Those are the people that are going to make those determinations. So, the better relationship that you have with them, if you can build a relationship of mutual trust, if you can meet with them regularly to explain what the firm does, but also the controls that the firm has in place to mitigate any risks that they’re concerned about, the better that relationship’s going to go, the better your exams are going to go. So that would be the one thing I would say from FINRA’s perspective that I would do.

Patrick Dennis:  Evan, your thoughts?

Evan Rosser:  FINRA presents some opportunities because as a private organization, they don’t like to admit it, but it’s a membership organization and they do have working groups and committees. You can get a little insight into the workings. Anyone I’ve known who has served on any, whether it’s a district business conduct committee or a working group, they really leave there and say, wow, FINRA really thinks this is important, or FINRA really wants to do this. They really do get an insight. I don’t know how much that insight is available to government organizations. They don’t have that kind of integration with the industry the way FINRA does. Certainly, working with FINRA committees or working groups is not going to inoculate you from compliance problems. You can’t schmooze your way out of it, but it does give you a sense of their priorities, how they operate. That can be very valuable. But as Ed said, getting to know the people who regulate you, now that FINRA has switched its model from a kind of geographic district exam program to a firm type program, I think it would be important to get to know, because a lot of firms now have new people they’re going to be working with. So, I think it’s important that they reach out, learn who they’re working with, and kind of see how much communication they can have with them.

Ed Wegener:  Evan, to that point, you know, I used to be one of FINRA’s representatives on the district and regional committees for the Midwest, and we would have meetings twice a year.  The meetings were great. It was a great opportunity for us to talk about issues and get to know what the challenges of the firms were. But the thing that I found the most informative was the dinner the night before, because you sat with people, regulators and industry people, in a social setting, and you got to talk to the people as just real people, and you got to know them. And quite frankly, I built a lot of great relationships that way. So, I would encourage, to your point, if you have the opportunity to run for a district committee, to run for small firm advisory board or a governor’s spot, or even being on one of the specific advisory committees, to do it, because I think you’ll learn a lot. You’ll get a preview of things that are coming, but you’ll also be able to build relationships with the people that regulate you.

Patrick Dennis:  I think you can try to make your presence known. Let the regulators know that you’re interested, that you’re showing up at these conferences to hear what they have to say. That helps, I think. Final thoughts by anybody?

Bill Reilly:  Just to discuss getting to know people. I think it’s important for people in the industry to understand who their players are. I couldn’t agree more. In conferences association, when I was a regulator and I would go to a conference, there were some times that I would seek out people in the industry and vice versa. We’d say, hey, we’re going to be at a conference. I’d like to meet you. I want to make sure that we’re getting everything right. Evan, as far as your comment, whether or not there are other working groups and so forth, I can’t tell you the number of working groups that I worked on when I was a state regulator. The other thing I’ll mention is that NASAA, North American Securities Administrators Association, has about 25 or 30 working groups. It’s very important to keep those relationships up and ongoing.

Libby Hall:  Thanks everyone for listening. If you’d like to learn more about our experts and how Oyster can help your firm, visit our website at oysterllc.com. If you like what you heard today, follow us on whatever platform you listen to and give us a review. Reviews make it easier for people to find us. Have a great day.