FINRA Requests Comments on Proposal for Remote Inspections of Branch Offices

FINRA’s responded to industry feedback on the inspection process for branch offices.  Based on Rule 3110 (the Supervision Rule),  each firm to currently required to establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. Rule 3110(c) requires each firm to review, at least annually (on a calendar-year basis), the businesses in which it engages. The review must be reasonably designed to assist the firm in detecting and preventing violations of, and achieving compliance with, applicable securities laws and regulations, and with applicable FINRA rules. The rule requires that a firm review the activities of all branch offices and inspect each branch office on a specified cycle depending on the office classification.   FINRA has interpreted the rule to require that inspections take place on-site, irrespective of the type of office.

Over the last few years, firms have raised questions about the manner in which they must conduct the internal inspections, particularly for those branch offices or locations with a limited number of associated persons or where only operational or limited supervisory functions take place. These locations often include personal residences of an associated person, an office of convenience where an associated person may meet a customer occasionally and exclusively by appointment, an office used by “circuit riders,” or other public places.  Firms have noted that advances in communications technology and increased acceptance of flexible work arrangements have made remote locations more commonplace. They have further noted that most such locations do not hold themselves out to the public as a place where securities business takes place and engage in low-risk activity, with no books or records or funds or securities kept on the premises.

In light of these factors, and in recognition of the fact that technology already plays a prominent role in how firms conduct branch office inspections, firms have questioned the practicality and efficiency of conducting on-site inspections of such locations in fulfilling their obligations under Rule 3110(c). Among other things, they note the travel and related expenses incurred in connection with on-site inspections of these low-risk locations and have suggested that those resources could be better allocated to higher risk activities.

FINRA is proposing to adopt new  Supplementary Material .15 (Remote Inspections), which would give firms the option to fulfill their obligations under Rule 3110(c) by conducting a remote inspection of a “qualifying office,” in lieu of a physical, on-site inspection of such office. Specifically, proposed Rule 3110.15(a) would require a firm that conducts remote inspections to have policies and procedures reasonably designed to determine whether a location is eligible for remote inspection as a “qualifying office” and to assess whether a remote inspection of any such office is reasonable.

FINRA considered a range of suggestions in developing the proposal (Regulatory Notice 17-38). The alternatives to the proposed amendments included an alternative definition of the number of associated persons for the definition of a qualifying office, and alternative criteria and conditions regarding associated person misconduct as a prerequisite for eligibility for remote inspections. The  proposal reflects the changes that FINRA believes strike the appropriate balance to address the concerns of firms while preserving the investor protection purposes of an inspection requirement.