FINRA Approves Remote Branch Inspection Pilot Program

On January 23, 2024, FINRA announced the addition of new Supplementary Material .18 to FINRA Rule 3110 (Supervision) to adopt a voluntary, three-year remote inspections pilot program (Pilot Program) to allow eligible members to fulfill their location inspection obligations remotely instead of conducting on-site visits. FINRA adopted the new Pilot Program in tandem with the SRO’s approval of the new residential supervisory location or “RSL” category for private residences from which certain supervisory activity is conducted.

The Pilot Program is temporary in nature, at least for now, and FINRA will use the three-year pilot period to evaluate whether remote inspections have a permanent role in overall supervision. Absent the Pilot Program contributing to significant breakdowns in firms’ supervisory systems, we could easily foresee FINRA seeking SEC approval for permanent remote inspections, but time will tell. Participating firms will need to comply carefully with the new applicable requirements, but most will gladly do so given the added flexibility and decreased costs they will experience via the remote inspections compared to legacy on-site visits. Firms must also be mindful that FINRA’s Pilot Program does not preempt state law and there are a handful of states that require varying degrees of on-site inspections for broker-dealers with offices in those states. 

General Pilot Program Requirements

Each location designated for remote inspection must satisfy the following conditions, each of which is unsurprising and should be a given for most firms:

• Email and other electronic communications must be made through the member’s electronic system;
• Firm personnel correspondence and communications with the public must be subject to the firm's supervision in accordance with Rule 3110;
• The firm must have a recordkeeping system that makes, keeps current, and preserves records as required under applicable law, must have prompt access to such records, and cannot maintain or preserve its required books or records solely at the location subject to remote supervision; and
• A firm must determine that its surveillance and technology tools are appropriate to supervise the types of risks presented by each remotely supervised location, including electronic recordkeeping systems, electronic email surveillance, electronic trade blotters, regular activity-based sampling reviews, tools for visual inspections, and system security tools such as secure network connections and effective cybersecurity protocols.

Firm and Location Ineligibility

The Pilot Program is not available if any of the following apply:

• The firm became a FINRA member within the prior 12 months;
• The firm is or becomes designated as a “Restricted Firm” under Rule 4111 or a “Taping Firm” under Rule 3170;
• The firm receives a notice from FINRA pursuant to Rule 9557 regarding compliance with financial or operational rules relating to net capital compliance, business curtailment, or regulation of activities of firms experiencing financial difficulty;¹ or
• The SEC or FINRA has found within the past three years that the firm violated Rule 3110(c) (Internal Inspections).

A specific location is ineligible for inclusion in the Pilot Program if any of the following apply:

• Proprietary trading occurs at the location, including the incidental crossing of customer orders, or the direct supervision of such activities;
• The location handles customer funds or securities;
• One or more associated persons at the location is subject to a mandatory heightened supervisory plan under the rules of the SEC, FINRA, or a state regulatory agency or becomes statutorily disqualified (subject to certain limited permitted exceptions);
• An associated person at the location (A) has in the prior five years, one or more “final criminal matters” or two or more “specified risk events” as defined in FINRA Rule 1011; (B) has an event in the prior three years that required a “yes” response to certain disciplinary-related items on Form U4; or (C) is subject to a disciplinary action taken by the member that is or was reportable under FINRA Rule 4530(a)(2).

Reasonable Review and Risk Assessment

Prior to opting into the Pilot Program, a firm must develop a reasonable risk-based approach to using remote inspections and conduct and document a risk assessment for that office or location. The assessment must document the factors considered, such as the volume and nature of customer complaints, the complexity of products offered, the nature of the customer base (including vulnerable adult investors), and any higher risk activities that take place at, or higher risk associated persons that are assigned to, that office or location.

Written Supervisory Procedures and Documentation

A firm that elects to participate in the Pilot Program must establish, maintain, and enforce “reasonably designed” written supervisory procedures, including related to the technology the firm may use to conduct remote inspections, data and information collection, and the use of other risk-based systems to identify and prioritize for review areas that pose the greatest risk of potential rule violations. For example, if a firm's remote inspection identifies any “red flags,” the firm may need to impose additional supervisory procedures, more frequent monitoring for that location, or even a subsequent on-site visit on an announced or unannounced basis.

Data and Information Collection

A firm opting into the Pilot Program must maintain and preserve a centralized record for each of the pilot years that separately identifies all of the firm’s locations it inspected remotely and any locations for which the firm determined to impose additional supervisory procedures or more frequent monitoring.

Participating firms must also provide FINRA with quarterly counts and other information (broken down separately for OSJs, supervisory branch offices, non-supervisory branch offices, and non-branch locations) with respect to:

• The number of total, remote, and on-site inspections completed, and the number of on-site inspections completed due to a finding (including identification of the particular locations, how many findings the firm identified, and a list of any that were significant). “Finding,” for purposes of this requirement, means a discovery made during an inspection that led to a remedial action or was listed on the member's inspection report; and
• The firm’s written supervisory procedures for remote inspections in each of the four following areas: (i) procedures for escalating significant findings; (ii) procedures for new hires; (iii) procedures for supervising brokers with a significant history of misconduct; and (iv) procedures related to outside business activities (OBAs) and doing business as (DBA) designations. Supplementary Material .18 provides a schedule for delivery of the firm’s WSPs for remote inspections with the delivery of inspection data.

FINRA is also requiring that firms make a good faith effort to provide inspection data and information for calendar year 2019 (yes, 2019!) pursuant to Rule 3110.18(h)(3). The 2019 data is intended to help serve as a baseline for FINRA’s evaluation of the Pilot Program. The SEC’s order approving the Pilot Program notes that “[s]ince 2019 is the last full calendar year that member firms were required to include an on-site visit in their inspections, the 2019 data should represent a baseline of data about onsite inspections against which FINRA could measure changes due to using remote inspections.”

Election to Participate

An eligible firm will be able to elect to participate in the Pilot Program via FINRA Gateway during the election windows described below and, in doing so, will agree to participate for the entire duration of that pilot year. A participating firm will be deemed to have elected to participate in the Pilot Program for each subsequent pilot year unless the firm withdraws from the Pilot Program in a subsequent pilot year (by affirmatively notifying FINRA at least five calendar days before that subsequent year commences).

Pilot year 1 (a partial year) starts on July 1, 2024, and ends on December 31, 2024. An eligible firm may opt in between June 1, 2024, and June 26, 2024. After pilot year 1, an eligible firm may choose to join the Pilot Program by December 27th for the following pilot year.

 

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^[1] Under FINRA Rule 9557, FINRA staff may issue a notice directing a member to comply with the provisions of FINRA Rules 4110, 4120 or 4130 (the financial and operational rules) or restrict its business activities, by either limiting or ceasing to conduct those activities consistent with Rule 4110, 4120 or 4130, if FINRA staff has reason to believe that a condition specified in Rule 4110, 4120 or 4130 exists. A notice served under this Rule constitutes FINRA action.

 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.