Investment Fund Law Blog
Written by: Jessica M. Brown
The Securities and Exchange Commission (the “SEC”) approved two new Financial Industry Regulatory Authority (“FINRA”) rules as part of FINRA’s ongoing rulebook consolidation process. The two new rules approved by the SEC on December 23, 2013 consolidate a number of existing NASD and NYSE rules and interpretations regarding supervision into the new FINRA Rules 3110 and 3120. The new rules will require broker-dealer firms to bring their current supervisory system and written policies and procedures into compliance with a handful of new requirements. Firms should be aware of the impact the new rules have on: (i) which personnel may act in a supervisory role; (ii) who may conduct office inspections; (iii) how certain internal communication must be reviewed; and (iv) additional requirements in regards to monitoring and reporting insider trading.
Supervisory Personnel
FINRA Rule 3110 requires a broker-dealer to have a supervisory system that designates at least one principal on-site to supervise the activities in each of the broker-dealer’s offices of supervisory jurisdiction (“OSJs”). The designated on-site principal for each OSJ must have a “regular and routine” physical presence and, absent certain circumstances, should not be responsible for the supervision of more than one OSJ.
Inspections of Offices
FINRA Rule 3110 requires broker-dealers to, at minimum, inspect (i) supervisory branch offices and OSJs annually, (ii) non-supervisory branch offices every three years, and (iii) non-branch locations (including “home offices”) on a “regular periodic schedule” which period should not be longer than three years.
Conflicts of Interest with Inspections
The new FINRA Rule 3110(c)(3) requires broker-dealers to establish policies and procedures that are reasonably designed to prevent conflicts of interest from compromising office inspections. Broker-dealers may not permit, except under certain special circumstances, an associated person to perform the inspection of a location where that person is assigned to or is directly/indirectly supervised by, or reports to, a person assigned to that location.
Investment Banking/Securities Transactions
New Rule 3110(b)(2) requires a principal to perform a written review of transactions related to the broker-dealer’s securities or investment banking business. The review does not need to be detailed for each transaction if the broker-dealer’s review system meets certain criteria.
Written and Electronic Communication Review
The new FINRA Rule 3110(b)(4) requires supervisory procedures be in place to review written and electronic communications which relate to the broker-dealer’s securities or investment banking. Further, broker-dealers must put procedures in place to review internal communications which may contain subject matter needing to be reviewed for compliance with securities laws and FINRA rules. While the supervisor is ultimately responsible, Rule 3110(b)(4) permits the delegation of certain communication review duties to unregistered personnel.
Insider Trading
In order to identify potential insider trading or other types of manipulative or deceptive devices, new FINRA Rule 3110(d) requires broker-dealers to have procedures in place to supervise the broker-dealer’s transactions and well as those of its associated persons or family members of the associated persons. In the event of a questionable trade, the broker-dealer must promptly perform an internal investigation. If the broker-dealer is engaged in investment banking services, it must supply FINRA with a quarterly report concerning insider trading investigations in the prior quarter, as well as a report within five days of the completion of an internal investigation where violations of insider trading policies were found.
Annual Report
New FINRA Rule 3120 requires broker-dealers to test and verify supervisory procedures and provide senior management with an annual report. Further, the annual report to senior management of a broker-dealer with more that $200 million in gross annual revenue must detail the reports made to FINRA concerning customer complaints and internal investigations, as well as information on the previous year’s compliance procedures.