2019 EXAMINATION FINDINGS REPORT

October 16, 2019

Supervision

Regulatory Obligations

FINRA Rule 3110 (Supervision) requires firms to establish, maintain and enforce a system to supervise their activities and the activities of their associated persons that is reasonably designed to achieve compliance with federal securities laws and regulations, as well as FINRA rules. This includes updating supervisory processes and written supervisory procedures (WSPs) to address new or amended rules, as well as products and services.

Customer account and trading supervision includes complying with other obligations, such as FINRA Rule 4512 (Customer Account Information), which specifies the categories of customer account information firms must maintain. Further, FINRA Rule 2231 (Customer Account Statements) generally requires firms to send customers account statements containing their securities positions, money balances and account activity at least once each calendar quarter. Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 (Exchange Act), as well as the FINRA Rule Series 4510 (Books and Records Requirements) prescribe recordkeeping obligations relating to customer account records, trading records and related documentation.

Noteworthy Examination Findings

FINRA noted the following issues relating to supervision and documentation requirements.

  • Insufficient WSPs for New or Amended Rules – Some firms did not adequately address newly adopted or amended rules by developing controls to address the new requirements applicable to their business and updating their WSPs accordingly, for example: new fixed income mark-up disclosure requirements under FINRA Rule 2232 (Customer Confirmations); new trusted contact person information requirements pursuant to Rule 4512 (Customer Account Information); temporary holds, supervision and record retention requirements under new Rule 2165 (Financial Exploitation of Specified Adults) (if they intended to use the rule); and compliance with amended Rule 3310 (Anti-Money Laundering Compliance Program), which incorporates FinCen’s new Customer Due Diligence (CDD) rule obligations. Firms are expected to evaluate which new and amended laws and regulations apply to their business, and review whether their supervisory systems, WSPs and training programs need to be amended to comply with any new or amended requirement(s).
  • Limited Supervision and Internal Inspections – Some firms did not have reasonably designed branch supervision and inspection programs. In particular, some firms did not adequately understand the activities being conducted through their branch offices, including products and services that were offered only at certain branch locations, which could prevent such firms from effectively supervising and addressing the unique risks of each branch location. Many firms also did not conduct periodic inspections of non-branch locations as required by FINRA Rule 3110(c) (Internal Inspections); did not determine relevant areas of review at branch offices or non-branch locations, taking into consideration the nature and complexity of the products and services offered or any indicators of irregularities or misconduct; failed to reduce the inspections and reviews to a written report; or did not follow through on corrective action determined to be necessary through their branch inspections.
  • Inadequate Supervision of Account Statements, Consolidated Account Reports and Other Forms – FINRA found that some firms did not consistently maintain accurate information in account documents, which impacted their ability to reasonably supervise account activity.
    • Consolidated Account Reports (CARs)1 – In certain instances, firms did not have supervisory systems to evaluate whether and when registered representatives used CARs, did not know when CARs included manual entries by representatives or customers, and did not require review of relevant customer documents to confirm that CARs accurately represented customers’ assets and values that were held outside the broker-dealer. FINRA notes that firms with stronger supervisory systems maintained comprehensive WSPs and training addressing the use and supervision of CARs; had strict limits on the use of CARs, including around manual entries; and determined whether they accurately reflected customer holdings outside of the broker-dealer.
    • Falsifying Documents – Some firms did not have reasonable processes to detect or prevent various forms of forgeries, including “accommodation forgery,” where registered representatives and associated persons asked customers to sign blank, partial or incomplete documents. Some firms expanded risk-based reviews of associated persons’ communications to cover requests for customer signatures or enhanced firm reviews of customer complaints for issues relating to forgery or falsification of documents. In addition, some firms did not follow their protocols relating to notarization and medallion stamp guarantees, or did not have any supervisory procedures for supervising the use of such stamps.
  • Insufficient Supervision for Specific Types of Accounts – FINRA noted the following supervisory issues.
    • Restricted and Insider Accounts – Some firms failed to update timely their watch and restricted lists, or reasonably identify and restrict account activity susceptible to insider trading. Other firms did not have surveillance systems or procedures to review and approve restricted trading because they relied on clearing firms to conduct the review. Both introducing and correspondent firms are required to have supervisory systems reasonably designed to detect and prevent insider trading.
    • Margin Accounts – Some firms allowed customers to open margin accounts even though the customers did not meet the firms’ standards for such accounts. FINRA also identified that some firms’ systems of supervision were not reasonably designed to detect recommended margin account activity that appeared to be unsuitable and inconsistent with the cost and expense of margin use. Many firms’ supervisory systems could not identify situations where the firm failed to accurately disclose their own—as well as their clearing firms’—fees, costs and charges relating to customers’ use of margin.
    • Options Accounts – FINRA noted instances where some firms did not identify or prevent registered representatives from creating and canceling fictitious orders to circumvent sales limits; mismarking opening options transactions as “closing”; listing inaccurate receipt time, execution time and origin codes on tickets; failing to record purchases and time of order transmission for routed options orders in the firms’ order management systems; and failing to show the terms or conditions of the order on tickets.

Additional Resources

 

1 See Regulatory Notice 10-19 (FINRA Reminds Firms of Responsibilities When Providing Customers with Consolidated Financial Account Reports).

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