FINRA’s Remote Office Inspection Pilot Program

FINRA Rule 3110(c)(1) requires broker-dealers to conduct onsite inspections of their offices of supervisory jurisdiction (OSJs), branch offices and non-branch locations. In response to the COVID-19 pandemic, FINRA adopted Rule 3110.17, providing broker-dealers the option – subject to specific conditions – to complete inspections remotely. This temporary, remote-inspection option has been repeatedly extended and the most recent extension expires on June 30, 2024.

FINRA has developed amendments to FINRA Rule 3110, which were approved by the SEC, instituting a voluntary, three-year pilot program (“Pilot Program”) which would allow eligible member firms to fulfill their inspection obligations under FINRA Rule 3110(c) by conducting inspections of eligible OSJs, branch offices and non-branch locations remotely without an on-site visit to such locations, subject to specified safeguards and limitations. Participation requires submission of a self-assessment of compliance risks.

Members Excluded from Participating

Not all firms are eligible to participate. Member firms meeting any of the following criteria are ineligible to participate in the Pilot Program:

1. Restricted firms (designated as such under FINRA Rule 4111).
2. Taping firms (designated as such under Rule 3170).
3. Firms receiving notice from FINRA under Rule 9557 regarding compliance with various financial rules/requirements (e.g., FINRA Rule 4110, 4120 or 4130).
4. Firms suspended from FINRA membership.
5. Newly-registered firms whose memberships were effective within the prior 12 months.
6. Any firm found to have violated FINRA Rule 3110(c) by either FINRA or the SEC within the past three years.

Members’ Locations Excluded from Participating

Similarly, even eligible firms may be prohibited from inspecting all office locations remotely. A firm location will be ineligible to participate in the pilot program under any of the following circumstances:

1. An associated person at the branch is subject to mandatory heightened supervision under SEC, FINRA or state rules/requirements.
2. An associated person at the location is or becomes statutorily disqualified.
3. A member firm becomes subject to FINRA Rule 1017(a)(7) as a result of one or more associated persons at the location.
4. One or more associated persons at the location answered “yes” to any item in Questions 14A(1)(a) and (2)(a), 14B(1)(a) and (2)(a), 14C, 14D and 14E on Form U4 based on an event that occurred in the previous three years.
5. An associated person at the location is or becomes subject to a disciplinary action taken by the participating member firm that is or was reportable under FINRA Rule 4530(a)(2).
6. An associated person at the location is engaged in proprietary trading, including the incidental crossing of customer orders or the direct supervision of such activities.
7. The location handles customer funds or securities.

Conditions (Including Surveillance and Technology Tools)

If a firm and its locations qualify to participate in the Pilot Program, the following conditions will apply:

Member Firm Conditions:

1. Recordkeeping systems. Firms will be required to have a record-keeping system that makes, keeps current and preserves required records under applicable laws, rules and regulations, FINRA’s rules and the firm’s own written supervisory procedures (WSPs). These records cannot be physically or electronically maintained at the remote location and the member firm must have prompt access to the records.
2. Surveillance and technology tools. The firm must have surveillance and technology tools that are appropriate to supervise the risks associated with each remotely supervised location.

Location-level Conditions:

1. Electronic communications. Location-level electronic communications must be made through the participating member firm’s electronic system.
2. Correspondence and communications. Associated persons’ correspondence and communications with the public must be subject to the member firm’s supervision in accordance with FINRA Rule 3110.
3. Books and records. None of the members’ required original books and records can be physically or electronically maintained and preserved at the location.

Risk Assessment Requirement

Participating firms will be required to complete and submit to FINRA a risk assessment prior to selecting remote inspection locations. As part of the risk assessment, firms must include a written analysis of the factors set forth in FINRA Rule 3110.12 and consider any high-risk activities conducted at the location. FINRA includes a non-exclusive list of activities to be taken into consideration, including outside business activities conducted at the location. Locations identified as high risk or displaying red flags should be inspected in-person or the firm should use unannounced, on-site inspections.

Written Supervisory Procedures

Participating firms are required to establish, maintain and enforce reasonably designed procedures for conducting remote inspections that address, among other things:

• Methodologies, including technology, that may be used to conduct remote inspections.
• Factors considered in the risk assessment made for each applicable location.
• Procedures specified in proposed Rules 3110.18(h)(1)(G) and (h)(4) of the data and information collection section of the proposed rule.
• The use of other risk-based systems employed generally by the participating member firm to identify and prioritize for review those areas that pose the greatest risk of potential violations of applicable securities laws, related regulations and FINRA rules.
• Procedures for escalating “significant findings.”
• Procedures for new hires.
• Procedures for supervising brokers with a significant history of misconduct.
• Procedures related to outside business activities and “doing business as” designations.

Supervisory Oversight

Office inspections are only one aspect of a comprehensive supervisory system. Participating firms will be required to maintain ongoing reviews of all activities and functions occurring at all locations, whether subject to remote inspections or not. Participating firms are reminded that remote inspections are held to the same standard as in-person inspections, meaning that the remote inspection must be designed to detect and prevent violations of, and achieve compliance with, applicable securities laws and regulations.

Additionally, should a participating firm identify any “red flags,” additional oversight procedures – including on-site examinations – may be required. FINRA’s non-exclusive red flag examples include:

• Customer complaints.
• Many elderly customers.
• A concentration in highly illiquid or risky investments.
• An unexplained increase or change in the types of investments or trading concentration that a representative is recommending or trading.An unexpected improvement in a representative’s production, lifestyle or wealth.
• Questionable or frequent transfers of cash or securities between customer or third-party accounts, or to or from the representative.
• A representative that serves as a power of attorney, trustee or in a similar capacity for a customer or has discretionary control over a customer’s account(s).Representatives with disciplinary records.
• Customer investments in one or a few securities or class of securities that is inconsistent with member firm policies related to such investments.Churning and trading that is inconsistent with customer objectives.
• Numerous trade corrections, extensions and liquidations.
• Significant switching activity of mutual funds or variable products held for short time periods.

Reporting Data to FINRA

Participating firms will be required to collect the following data (collectively, “Inspection Data”) regarding their remote inspection programs and provide the information to FINRA on a quarterly basis:

1. The total number of locations with an inspection completed during each calendar quarter.
2. The number of locations from the total quarterly number that were inspected remotely.
3. The number of locations from the total quarterly number that were inspected on-site.
4. The number of these locations in each calendar quarter that were subject to an on-site inspection because of a finding.
5. The number of locations for which a remote inspection was conducted in the calendar quarter that identified a finding, the number of those findings and a list of the most significant findings.
6. The number of locations for which an on-site inspection was conducted in the calendar quarter that identified a finding, the number of those findings and a list of the most significant findings.

Additionally, participating firms must provide FINRA with data from inspections conducted during calendar year 2019 (FINRA’s benchmark year) including the number of inspections completed during calendar year 2019 and of those 2019 inspections, the number of locations where findings were identified, the number of those findings and a list of the most significant findings.

Firms should carefully consider their initial and ongoing ability to comply with FINRA’s requirements and the compliance expectations associated with the Pilot Program before electing to participate. Opting into the Pilot Program requires continued participation until the Pilot Program expires or the firm gives FINRA an opt-out notice at least five calendar days before the end of the then current Pilot Program year. Bear in mind the Pilot Program requires new compliance-related records that will be discoverable in customer arbitration proceedings.

Warner’s Compliance Consulting Support Industry Group specializes in providing compliance support to broker-dealers, including assistance in evaluating whether the broker-dealer and its locations are eligible to participate in the Pilot Program, preparing risk assessments and analyzing and drafting written supervisory procedures. For assistance with these or any other compliance needs, please contact Andrea McGrew or a member of Warner’s Compliance Consulting Support team.