Quick Answer
Every broker-dealer must run a supervisory system reasonably designed to catch violations, documented in written supervisory procedures. Offices split into three tiers with different inspection cycles. Failure to reasonably supervise is a standalone ground, and the federal safe harbor needs procedures that could reasonably prevent and detect violations, reasonably applied.
The whole unit on one sheet: how a firm supervises its own people, how often it inspects, and what happens when supervision fails.
What Must the Supervisory System Include?
- A system reasonably designed to catch violations, with written supervisory procedures (WSPs). FINRA guidance says WSPs should describe who supervises, the steps and reviews, how often they occur, and how they are documented.
- Final responsibility for supervision rests with the firm, not with any one supervisor.
- Designated principals must test and verify that the WSPs are reasonably designed for the firm's activities and associated persons, and report results to senior management at least annually.
- The CEO certifies annually, after at least one meeting with the Chief Compliance Officer in the prior 12 months, that the firm has processes to establish, maintain, review, test, and modify its procedures. Each one is due no later than the anniversary date of the previous certification.
How Do the Three Office Tiers Differ?
| Tier | What makes it one |
|---|---|
| Office of Supervisory Jurisdiction (OSJ) | Order execution or market making, structuring offerings or private placements, custody of funds or securities, final new-account approval, order review or endorsement, final retail-communications approval, or supervising other branch offices |
| Branch office | Regularly conducts broker-dealer business |
| Non-branch location | Everything else |
How Often Must Each Be Inspected?
- OSJs: annually.
- A branch office that itself supervises a non-branch location: annually, taking on the OSJ cycle even though it is not an OSJ.
- Other branch offices: at least every 3 years.
What Is Failure to Supervise?
- The Administrator may deny, suspend, or revoke for failure to reasonably supervise agents or employees, all of them, not only the wrongdoers, alongside the required public-interest finding.
- The order may also bar or censure the firm's officers, directors, partners, or persons performing similar functions. Under the Securities Exchange Act, the SEC may sanction an individual who failed reasonably to supervise a person subject to his supervision.
Which Gotchas Are Tested Most?
- A branch office is not automatically on a 3-year cycle. If it supervises a non-branch location, it moves to annual.
- The federal safe harbor has two limbs: procedures and a system for applying them that would reasonably be expected to prevent and detect the violation, and reasonable discharge of those duties without reasonable cause to believe they were not being followed. Having the procedures on paper is not enough.
One-Breath Recap
Every broker-dealer must run a supervisory system reasonably designed to catch violations, written down as procedures that guidance says should describe who supervises and how often, tested by principals and certified annually by the CEO. Offices split into supervisory jurisdictions inspected annually, and branch offices inspected at least every three years unless they supervise a non-branch location. Failure to reasonably supervise stands on its own, and the federal safe harbor needs procedures and a system for applying them that could reasonably prevent and detect the violation, reasonably discharged.
Need more than the recap? Read the full Broker-Dealer Agent Supervision unit.