FINRA’s CARDS: Time to Get Ready

The US Financial Industry Regulatory Authority’s proposal to collect megatons of customer account information is far from being implemented, but behind the scenes, operations, technology and data management specialists are rushing to make the necessary preparations for the first phase expected in 2015.

The reason: despite all the lobbying against the initiative coined CARDS, short for Comprehensive Automated Risk Data System, the introducing brokers, their clearing brokers and the technology providers say they must be ready. That means ready to track down, aggregate and format the necessary information. Regardless of the exact set of data FINRA will require and its formatting, based on recent public statements by the regulatory agency’s Chief Executive Richard Ketchum, it seems to be a given that CARDS will be implemented. So, no one can afford to be caught flat-footed.

Granted, FINRA has made some concessions making compliance a bit easier for introducing broker-dealers, non-clearing brokers and clearing brokers. There is still plenty of operational work to be done and little time left. Ketchum indicated that CARDS would be implemented in stages beginning next year and FINRA will not entertain the industry’s request to leverage another pending data collection program — the Consolidated Audit Trail (CAT) — to serve the purpose envisioned for CARDS. The reason: CAT will be a real-time system and processing data for CARDS in such a mode “would be light years more costly,” said Ketchum.

Where’s the Client Data?

Introducing brokers are just that. They sit at the front end of the transaction cycle, dealing directly with investors. They are responsible for ensuring the correct securities are bought and sold to meet their customer’s risk profiles and requirements. Clearing brokers, which actually execute the transactions, have no direct contact with the underlying investors, but hold the introducing broker’s books and records. Some of the US largest brokers also self-clear — aka handle clearing on their own. Yet other broker-dealers — typically smaller independent shops — don’t maintain any clearing relationship at all. Such is particularly the case when the broker-dealer’s business is in alternative investment funds, mutual funds and some variable insurance products. These accounts are often called “submit app and check,” referring to the process of submitting the customer account application and physical payment check to the sponsoring firm.

“Operations, IT and data management specialists are meeting with back-office brokerage operations systems vendors to understand what data FINRA might ask for in the CARDS program, where the data is located, and what potential data fields we might need to add,” one operations director at an introducing brokerage firm tells FinOps. The same type of activity is happening at five other firms contacted by FinOps.

FINRA says that the CARDS program is part of its goal to protect investors from unscrupulous brokers. Therefore, the regulatory agency will require information on customer accounts, namely transactional activity as well as their risk profiles. Using data analytics on the information provided to CARDS, FINRA will supposedly be able to spot potential “sales practice misconduct” and home in more closely during exams, which took place for more than 1,800 brokerages in 2012 alone.

Fear of False Positives

Introducing brokers, clearing firms and and technology providers are worried about potential data overload and errors — false positives which would generate unnecessary additional questions and intensified exams. Bottom line: lots of extra time and cost spent in pointless fishing expeditions during the exams, with no results for FINRA.

In March FINRA acquiesced to industry concerns over investor privacy and data security by eliminating the requirement to identify specific customers in CARDS reporting. At FINRA’s annual meeting last week, Ketchum also said that that the agency, which oversees almost 4,300 brokers, is revising its CARDS plan to allow introducing broker dealers the option to send client information either directly to FINRA or through a service bureau, rather than only through clearing brokers, as was initially envisioned. More relief came from the announcement that, in the first phase of CARDS, accounts in non-cleared products would not fall under the investor account reporting requirements.

“It will be a whole lot easier with FINRA allowing introducing brokers to forward the necessary information on their own, once FINRA provides the necessary data content requirements and formats,” asserts Rod Lueck, president of Techmate, a Denver firm offering a back-office recordkeeping system called C5. Now that introducing brokers can bypass clearing firms in reporting, the brokers no longer have to worry about dealing with data formats of multiple clearing brokers. Firms like Techmate can handle translating the customer account data to FINRA’s reporting formats without the extra step — and risk — of clearing brokers acting as middlemen.

That doesn’t mean everything is rosy for the broker-dealers. The full range of data required by CARDS is likely to be stored in multiple systems. While most will be found in transaction recordkeeping systems, customer risk profiles may be harder to pin down, say operations experts. Risk profiles may be stored in a separate customer relationship management platform, a paper-based file cabinet, or the files of another firm altogether. From a data gathering and integration prespective, this starts to look like herding cats.

Defining Risk Profiles

“This isn’t like transactional information that is simply based on a ticker symbol, number of shares and dollar value. Customer suitability information, investment risk, liquidity requirements and client profile are reflected differently, using different value ranges and codes depending on the introducing broker,” says Scott Gillespie, senior consultant at Denver’s Quadron Data Solutions, a data aggregation platform operator. Despite FINRA recently promising more flexibility in reporting this information, he warns, it will “be difficult to ensure the suitability information will be interpreted in the same fashion across all introducing brokers.”

Case in point: the definition of “moderate” risk tolerance will vary from brokerage to brokerage. Without industry-standard definitions, it may be impossible to use machine analytics with any fairness. “FINRA could always decide not to require the suitability information, but that would defeat its purpose as it needs the data for its analysis,” notes Gillespie.

As for account information on non-cleared trades exempt in the initial phase of CARDS, Gillespie recommends thinking ahead toward the likelihood that reporting will be required. If that transaction data happens to be kept by non-clearing brokers or introducing brokers in scanned documents, they should strongly consider changing their workflow to get transactions records into electronic formats. “We don’t expect brokers to go back into history and convert scanned forms into data, but moving forward they should capture new business as data in a database,” he says.

Of course, once these transactions become subject to CARDS reporting, it opens another can of worms for these smaller firms, which are more likely than larger firms to face challenges associated with hard-copy files of all sorts. If their customer notes on these accounts have to be digitized into reporting data from hard copies, there is no question that CARDS is going to be creating plenty of business for integration firms or new jobs in firms that were previously operating without an in-house data specialist.

As the broker-dealer industry waits for definitive word from FINRA about the data and technical requirements for CARDS, there is clearly a lot of activity already by firms that are getting ready. Given the fact that there is nothing simple about the data requirements, the integration tasks or even the data definitions, it looks like any headstart is going to save big headaches later.