The Supervisory System, Written Procedures, and Control Testing

Three related duties sit on top of each other here: build a supervisory system, write it down as procedures, and then test whether the procedures actually work.

What Is a Supervisory System?

• Supervisory system: the system a member firm must establish and maintain to supervise the activities of each associated person, reasonably designed to achieve compliance with applicable securities laws, regulations, and FINRA rules.
• Final responsibility for proper supervision rests with the firm itself, not with any single principal it designates to carry the work out.
• Where applicable, the firm must designate an appropriately registered principal with authority to carry out its supervisory responsibilities for each type of business it engages in that requires broker-dealer registration.

Exam Tip: Gotchas

• Final responsibility for supervision belongs to the firm, not to the branch manager or principal who signs off on a given account. A designated principal carries out supervision; the firm still owns the result.

What Must Written Supervisory Procedures Cover?

• Written supervisory procedures (WSPs): the written procedures a firm must establish, maintain, and enforce to supervise the types of business it conducts and the activities of its associated persons.
• WSPs must be reasonably designed to achieve compliance with the securities laws, the regulations under them, and FINRA's rules. The separate standard that procedures be appropriate for the firm's business, size, structure, and customers belongs to its correspondence-review procedures, covered elsewhere in this unit.

What Does Supervisory Control Testing Require?

• Supervisory control system: the firm must designate one or more principals, and specifically identify them to FINRA. Those principals must establish, maintain, and enforce a system of supervisory control policies and procedures that tests and verifies the firm's WSPs are reasonably designed, and that creates or amends procedures where the testing identifies a need.
• The designated principal(s) must submit a report to the firm's senior management no less than annually. The rule states the contents in one sentence and numbers nothing, so learn the contents and not a count:
  • the firm's system of supervisory controls;
  • the summary of the test results and any significant identified exceptions; and
  • any procedures created or amended in response to the test results.

Exam Tip: Gotchas

• The rule says the firm must "specifically identify" its control principals to FINRA. Naming them is how a firm does that in practice, but the rule's own words are the safer answer.
• Writing WSPs is one duty. Testing whether they actually work, and reporting the results to senior management at least annually, is a separate duty on a designated principal. A question about the annual testing-and-reporting obligation is testing control testing, not the underlying supervisory system.

What Should You Check on Exam Day?

• Confirm the question is asking who owns final responsibility (the firm) versus who carries out day-to-day supervision (a designated principal).
• Do not match "appropriate for business, size, structure, and customers" to written procedures generally. It belongs to correspondence review.
• Confirm an annual control-testing report covers the control system, the summary of the test results and any significant identified exceptions, and any procedures created or amended in response. Do not count the items; the rule numbers none of them.