Broker-Dealer Supervision
Recordkeeping ensures a paper trail exists. Supervision ensures someone is actually watching what happens. FINRA Rule 3110 sets out the comprehensive framework that every broker-dealer (BD) must follow to supervise its agents and business activities.
The Supervisory System Requirement
Every BD must establish and maintain a supervisory system reasonably designed to achieve compliance with applicable securities laws, regulations, and FINRA rules.
Key principles:
- The system must be reasonably designed; perfection is not required, but the firm must have meaningful procedures in place
- The supervisory obligation covers all associated persons (agents) and all types of business conducted by the firm
- The standard is reasonable supervision, not a guarantee that no violation will ever occur
Written Supervisory Procedures (WSPs)
The supervisory system must include written supervisory procedures (WSPs) that specify:
- The specific individual(s) responsible for each supervisory review
- The supervisory activities those individuals will perform
- The frequency of the review
- The manner of documentation for the review
Exam Tip: Gotchas
- WSPs must be updated as the business changes. Stale WSPs that do not reflect current business activities or regulations are a supervisory failure even if they existed at one time.
What WSPs Must Address
WSPs must cover supervision of:
- All associated persons' securities activities
- Investment banking and securities business activities
- Incoming and outgoing correspondence, including electronic communications
- Internal communications between associated persons
- Procedures to promptly capture, acknowledge, and respond to all customer complaints
WSPs must be updated as the firm's business changes or as new regulatory requirements arise.
Designation of Supervisory Personnel
- Broker-dealers (BDs) must designate appropriately registered principals with authority to supervise each type of business conducted
- A principal supervising a particular line of business must hold the appropriate registration or license for that business
- Each office must have a designated supervisor responsible for the activities conducted there
Office Classification and Supervision
FINRA Rule 3110 classifies broker-dealer (BD) locations into three types, each with different supervisory requirements.
| Office Type | Definition | Supervisory Requirements |
|---|---|---|
| Office of Supervisory Jurisdiction (OSJ) | A location from which supervisory activities are conducted: order execution or market making, structuring public offerings, maintaining custody of customer funds or securities, final approval of new accounts, review and endorsement of customer orders, final approval of advertising or sales literature | Must be supervised by a registered principal with regular on-site presence; subject to annual inspection |
| Branch office | Any location where one or more associated persons regularly conduct BD business (meeting customers, effecting transactions, handling customer funds) | Must have a designated supervisor; subject to periodic inspection (at least every 3 years based on the firm's risk assessment) |
| Non-branch location | A location that does not meet the branch office definition (e.g., an agent's home office where no customers are met) | Supervised through the firm's WSPs; may be subject to less frequent inspection |
Office Inspections
- Broker-dealers (BDs) must inspect each Office of Supervisory Jurisdiction (OSJ) on an annual (calendar-year) basis
- Non-OSJ branch offices must be inspected on a cycle determined by the firm, at minimum every 3 years
- Inspections must be reasonably designed to detect and prevent violations of applicable securities laws and FINRA rules
- Inspection results must be documented in writing and kept as part of the firm's records
Exam Tip: Gotchas
The inspection frequency distinction is a favorite exam question. OSJs require annual inspections; non-OSJ branch offices require inspections at least every 3 years. The exam may try to confuse the two.
Review of Correspondence and Communications
- Firms must establish procedures for review of incoming and outgoing written and electronic correspondence with the public relating to the firm's investment banking or securities business
- The review must be conducted by a registered principal or designee
- Firms must also review internal communications to detect potential compliance issues
- Electronic communications (email, text, social media) are subject to the same review requirements as traditional correspondence
FINRA Rule 3110 tells supervisors what to do. Next, let's look at how firms verify that those procedures actually work.