November 2014 – Mitch Atkins FINRA Rules Consulting

FINRA recently held its South Region Compliance Seminar in Fort Lauderdale, Florida. One of the panels at the conference was titled, Branch Office Supervision. There were no surprises from this panel – branch supervision is a critical aspect of any supervisory system. And with the updates to FINRA’s Supervision Rule taking effect December 1, 2014, now is a good time to be discussing branch office supervision. What was clear from this discussion is that FINRA is moving more and more to a risk-based approach to supervising branch offices.

FINRA staff during the panel suggested that broker-dealers conduct a percentage of their branch office examinations on an unannounced basis. This is long supported by case law. FINRA staff also pointed out several characteristics of broker-dealers with effective branch office supervision programs, specifically:

1) inspections are tailored to the business conducted in that branch

2) these firms conduct a significant number of their branch office inspections on an unannounced basis

3) that branches are selected through a combination of random selection and risk-based analysis

4) that the frequency and intensity of the branch inspections is based on the risk posed by that branch

5) use senior branch examiners who understand the business and will challenge assumptions.

Clearly, the move in branch office examinations to a risk-ranking approach is what FINRA is expecting. So to the extent your branch inspection program uses solely a calendar-based approach to determining when inspections are conducted, it may be time to consider implementing a risk-raking approach to your branch offices. Mitch Atkins, Principal of FirstMark Regulatory Solutions, has worked with clients to re-design their branch office inspection programs in the past. Using internal data, firms can consider which data points indicate the greatest risk, and thus develop a ranking process for each branch office. This ranking process can drive the frequency and intensity of the branch office inspection program for the firm, resulting in more effective deployment of branch examination resources. FINRA and the SEC have stated that firms should also avoid using generic exam procedures for the branch office inspection and instead should develop procedures that are specific to risks noted in the particular office.

FINRA also discussed branch examination preparatory techniques. These included some enhanced diligence approaches such as searches for outside business activities through the appropriate state’s division of corporations website, Google searches and social media searches. FINRA reminded attendees that they should not simple rely on information that has been disclosed by associated persons in the branch office, but should instead seek independent verification through available public records searches, economic reality testing and other reliable methods.

Mitch Atkins, FINRA’s former Senior Vice President and Regional Director, has extensive experience with branch office inspection programs. As Principal of FirstMark Regulatory Solutions he can provide assistance in developing compliant branch office inspection programs. Contact Mitch Atkins at 561-948-6511.

NASD Rule 3012 and FINRA Rule 3130

NASD Rule 3012(a)(1)(A) requires FINRA members to perform an annual test to verify that procedures are reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA/NASD rules. The review must take into account the activities in which the FINRA member and its associated persons and registered representatives engage. And, if the test indicates a need, FINRA requires that its members create additional supervisory procedures (or make amendments to existing procedures) as required based on the review. Following the test, FINRA requires that each member prepare a report that is provided to senior management detailing that member’s supervisory controls, the summary of the test results, any significant identified exceptions, and any additional or amended supervisory procedures created as a result of the test.

FINRA Regulatory Notice 14-10 outlined changes to FINRA’s Supervision Rule, and specifically, the requirements of new FINRA Rule 3110 which replaces NASD Rule 3010 effective December 1, 2014. Key changes include: paragraph (b)(6) of Rule 3110 which eliminates “heightened supervision” requirements and imposes a requirement to review conflicts, paragraph (d)(3)(B) of Rule 3110 which requires a review of transactions with a view toward detecting insider trading, requirements to investigate and document reviews thereof, and specific requirements for the annual report including the firm’s system of supervisory controls, summaries of test results, and details of any additional or amended procedures required. Also, in response to FINRA’s report on conflicts (October 2013), Rule 3110 requires firms to have procedures in place to identify and mitigate conflicts, particularly in the instance of branch office inspections and supervision of personnel also responsible for supervising others. New Supplementary Material 3110.03 impacts OSJ supervision and requires an “on-site” principal at each OSJ. Rule 3110(e) requires firms to justify, in writing, why a supervisor can or must supervise more than one OSJ (if applicable).

FINRA Rule 3130 requires, among other things, that the CEO certify annually that the FINRA member has procedures in place to maintain, review, test and modify written compliance policies and procedures reasonably designed to achieve compliance with applicable rules and regulations.
Many FINRA members utilize outside consultants to conduct the NASD Rule 3012 review so that the executives of the broker-dealer can rely on the report of the consultant in order to make the required certification under FINRA Rule 3130. These assessments are required by Rule 3012 to be conducted every 12 months, unlike the AML Independent Test which is required to be conducted on a calendar year basis.
Mitch Atkins, FINRA’s former South Region Director, has over 21 years of experience in working with broker-dealer supervisory systems, assessing compliance, and preparing reports. Contact Mitch Atkins by calling FirstMark Regulatory Solutions at 561-948-6511.