FINRA recently proposed amendments to FINRA Rule 3110 (Supervision) to adopt a voluntary, three-year pilot program (Pilot Program) to allow member firms to conduct remote branch office inspections. In a nod to where things have headed since the onset of the Covid-19 pandemic (WFH and such), providing firms with the option to forego on-site exams comes as no surprise (although it is refreshing to see a regulator take pragmatic steps like this). After all, FINRA itself has been in a remote examination posture since the beginning of the pandemic, and firms have been similarly conducting remote branch inspections via temporary relief granted via FINRA Rule 3110.17.
Here are the key points we've extracted from the proposal:
Before electing a remote inspection for an office or location, a firm must develop a reasonable risk-based approach to using remote inspections and conduct and document a risk assessment for that location. The assessment must document the factors the firm considered, including the standard for reasonable review set forth in FINRA Rule 3110.12. The assessment must also take into account any higher risk associated persons or activities or that take place at or are assigned to that location.
Participating firms must adopt written supervisory procedures reasonably designed to detect and prevent violations of, and achieve compliance with, applicable securities laws and regulations and applicable FINRA rules in relation to the Pilot Program, including:
- A description of the methodology, including technology, the firm may use to conduct remote inspections;
- The factors considered in the risk assessment made for each applicable location;
- The use of other risk-based systems employed generally by the firm to identify and prioritize for review those areas that pose the greatest risk of potential violations of applicable securities laws and regulations and FINRA rules; and
- Policies and procedures reasonably designed to comply with the firm's recordkeeping and data collection and provision requirements.
Remote inspections will be subject to the same standards for review as on-site inspections (set forth in FINRA Rule 3110.12). To effectively supervise a location pursuant to the Pilot Program, if a identifies any red flags, the firm may need to (and likely should) impose additional supervisory procedures or conduct more frequent monitoring, including potentially a subsequent on-site visit on an announced or unannounced basis. If a firm chooses not to impose these additional measures, it should document the basis for not doing so.
Participating firms must “maintain and preserve a centralized record for each of the ‘Pilot Years' that separately identifies: (1) all offices or locations that were inspected remotely; and (2) any offices or locations for which the firm determined to impose additional supervisory procedures or more frequent monitoring. If a firm determines that additional supervisory procedures or more frequent monitoring is necessary, the firm's documentation be specific in this regard, including whether an on-site inspection was conducted.
Data Collection and Provision
At least quarterly, participating firms must collect and provide various data to FINRA related to the number of locations examined remotely, on-site, whether on-site because of a “finding,” and information about those findings. FINRA considers “findings” to be “items that led to any remedial action or were listed on an inspection report by the member.” FINRA also wants to see what a firm's WSPs require in areas where firms identified findings (presumably to see if they should have uncovered or prevented any underlying matters identified in the findings).
Opt-In (and Out)
Any firm that elects to participate in the Pilot Program is required to, at least five calendar days before the beginning of such “Pilot Year,” provide FINRA an “opt-in notice” (in a manner and format FINRA will determine in the future). By opting in, the firm must agree to participate in the Pilot Program for the duration of that Pilot Year. A firm would need to proactively opt out of the Pilot Program for subsequent years if it so chooses.
Restricted firms and taping firms would not be eligible to participate in the Pilot Program. A specific office or location is similarly ineligible for remote inspection if an associated person of the office becomes (i) subject to heightened supervision; (ii) statutorily disqualified; (iii) subject to one or more final criminal matters or two or more specified risk events; or (iv) answers in the affirmative to certain disclosures in question 14A-14E on Form U4. Firms can also become ineligible to participate if they fail to meet the requirements of the Pilot Program.
The proposal is pending for now and subject to review and public comment (and ultimately approval or disapproval by the SEC). We'll continue to monitor and provide related updates (including any interesting feedback in the public comment file).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.