Broker-Dealer Supervision
With registration and enforcement rules covered, the final piece is ongoing supervision. A registered broker-dealer (BD) does not just file forms and forget about compliance; it must actively supervise every person and activity within the firm. Failure to supervise is itself a standalone violation.
FINRA Rule 3110: Supervision
Every broker-dealer must establish and maintain a supervisory system reasonably designed to achieve compliance with applicable securities laws, regulations, and FINRA rules.
The supervisory system must include written supervisory procedures (WSPs) covering:
- Supervision of all associated persons
- Review of investment banking and securities business activities
- Review of incoming and outgoing correspondence (including electronic)
- Review of internal communications
- Procedures to promptly capture, acknowledge, and respond to all customer complaints
BDs must designate appropriately registered principals with authority to supervise each type of business conducted.
The standard is "reasonably designed," not perfection. A BD is not required to catch every violation, but it must have a system that a reasonable firm would implement.
Exam Tip: Gotchas
- The supervision standard is "reasonably designed," not absolute perfection. A BD that has a reasonable system in place is not liable just because a violation slipped through.
- Customer complaints must be promptly captured, acknowledged, and responded to. The WSPs must include specific procedures for handling complaints.
Supervisory Structure
BDs must designate and properly register two types of locations:
| Location Type | Purpose |
|---|---|
| Offices of Supervisory Jurisdiction (OSJs) | Locations from which supervisory activities are conducted |
| Branch offices | Locations where BD business is conducted |
- Each OSJ and branch office must have a designated supervisor
- Supervisory activities flow from OSJs down to branch offices
Exam Tip: Gotchas
- Each OSJ and branch office must have a designated supervisor. Exam questions may test whether a location without a supervisor is compliant (it is not).
Annual Compliance Review
- BDs must conduct a review at least annually (on a calendar-year basis) of their business
- The annual review must be reasonably designed to detect and prevent violations and achieve compliance with securities laws and FINRA rules
- FINRA Rule 3120 requires firms to maintain supervisory control procedures (SCPs) to test and verify that WSPs are reasonably designed
The distinction between Rules 3110 and 3120:
| Rule | What It Requires |
|---|---|
| FINRA Rule 3110 | Written Supervisory Procedures (WSPs): the actual procedures for supervising |
| FINRA Rule 3120 | Supervisory Control Procedures (SCPs): procedures to test whether the WSPs work |
Think of it this way: Rule 3110 says "have a supervision plan." Rule 3120 says "test whether your supervision plan actually works."
Exam Tip: Gotchas
- Rule 3110 = WSPs (the actual procedures); Rule 3120 = SCPs (testing the procedures). Do not confuse these two rules. The exam tests whether you know which rule covers which function.
- Annual compliance reviews are required at least once per calendar year. Missing the annual review is itself a violation.
Supervisory Liability
- The state Administrator may deny, suspend, or revoke a BD's registration for failure to reasonably supervise agents or employees
- Supervision failures are a standalone ground for action, separate from the underlying violation committed by the unsupervised person
- Both the agent AND the BD face regulatory consequences when supervision fails
Exam Tip: Gotchas
- A BD can be held liable for supervisory failures even if the BD itself did not commit the underlying violation. If an agent engages in misconduct and the BD failed to supervise, the Administrator can take action against both the agent (for the violation) and the BD (for failing to supervise).