There has been quite a bit of recent news about FINRA’s revisions to its Supervision Rule. The details are spelled out in FINRA Regulatory Notice 14-10. Updates to the rule became effective on December 1, 2014. Since there are numerous articles already written on the FINRA Notice, the key focus of this discussion is the requirement to inspect branch offices. This requirement remains largely unchanged, other than the elimination of the producing branch manager requirements (replaced with identifying and managing conflicts). Taking a look back over the last several years, it is clear that the direction FINRA is moving on its expectations of its members’ branch inspection programs is similar to what it is doing with its own examination program – going risk-based.
If your firm is still conducting branch office examinations based simply on the time since the last review and whether or not the location is an OSJ, it may be time to revisit the design of the program. Simply put, a risk-based program employs
the use of data to essentially risk-rank the branch offices (and representatives working in them). This may involve assigning a risk score to the representative and/or the branch office. To develop this risk score, firms consider all available data on the branch and its representatives including: complaints, disclosures, regulatory inquiries, production, outside business, and product mix to name just a few. Once a firm has identified its risk factors and compiled risk scores for each office/representative it may then tailor its branch program to those risks.
An effective risk-based branch inspection program will use the risk scores to drive both the frequency and intensity of the inspection. For example, a higher risk score may result in a more frequent (or even unannounced) visit to the branch. A risk score heavily weighted by outside business activities may drive in-depth reviews from the home office or by outside due diligence providers. And clearly, there are some risks that do not lend themselves to scoring – many have seen events that the information the firm maintains did not predict. For those, an element of randomness in the reviews is warranted as well.
A risk-based approach can yield benefits in terms of maximizing the yield of the branch inspection program. Broker-dealers will want to direct their limited resources to the places where they are most needed. Effective use of data can accomplish this. And both FINRA and the SEC have stated that they expect firms to conduct risk assessments to drive the frequency, intensity and focus of branch examinations. For more information on their views, see Joint SEC/FINRA National Examination Risk Alert – November 30, 2011 and FINRA Regulatory Notice 11-54
If you have questions about developing a risk-based branch inspection program, Mitch Atkins, FINRA’s former South Region Director has extensive experience in this area. Mitch Atkins, Principal at FirstMark Regulatory Solutions, can be reached by calling 561-948-6511.