Supervising Brokers: 4 Common Pitfalls to Avoid

Supervisory System. You have heard the term, but do really know what it means? Based upon previously long-held NASD requirements, FINRA Rule 3110 was established in 2014 so that financial firms start supervising brokers.

It requires that all member firms set up a formal supervisory system to internally review the operations and activities of local personnel for compliance with applicable securities laws and regulations. More specifically, firms must do the following:

1. Establish Written Supervisory Procedures

(WSPs) that are reasonably designed to review and supervise:

  • Customer account activity;
  • Branch office managers;
  • Sales managers;
  • Regional and district sales managers; and
  • Any other person performing a similar supervisory function.

2. Designate One or More Qualified Principals

  • Establish, maintain and enforce a system of WSPs and procedures;
  • Continually work to improve them as required after regular inspections or in response to internal or external changes that affect business operations.

Supervisors are prohibited to supervise their own activities or those who may determine their employment status or compensation, unless exceptions are granted.

Common Compliance Pitfalls

Even if you have the 3 previous points under control, you may be facing some compliance issues. This year, FINRA Examiners observed several noteworthy findings during examinations of member firms throughout the country.

There are a number of items related to supervision and documentation requirements (i.e., compliance with FINRA Rule 3110) described in full in FINRA’s 2021 Report on FINRA Examination Findings and Observations.

These issues are listed in the FINRA report to discuss common weaknesses and/or significant compliance vulnerabilities found within supervision programs throughout the year.

Take a look at the examples provided and compare with your firm’s supervisory systems. Could your company be exposed to any of these pitfalls?

Pitfall #1 – Not Keeping Up with the Times

One of the major components of any great policy or procedure, is having the ability and means to modify and update it frequently. A strong WSP is only as good as it is relevant to a firm’s current business operations. Firms need to have procedures in place to continually review WSPs to account for any recent regulatory changes.

In 2018 and 2019 alone, FINRA Rules 2232, 2165 and 3310 were adopted or amended. Firms need to evaluate whether changes in compliance requirements are applicable to business operations and what revisions should be made to WSPs, training personnel, and supervisory systems, overall.

Pitfall #2 – Can I Speak to Your Supervisor?

Part (c) of Rule 3110 mandates comprehensive supervision and inspection programs at each member firm. There were several flaws noted when looking and supervision programs such as:

  • Know Your Branches: Supervisors should know what products and services are offered in branches, and what activities are being conducted at each location.
  • Non-branches Need Inspection: Non-branches should be reviewed at least every 3 years.
  • Plan a Scope: Inspection scopes should be based on the size, complexity of operations and products/services offered at each location, with a focus on any red flags or areas of higher risk.
  • Acknowledge and Respond: Ensure that management responds to any exceptions noted in-branch inspections with corrective action as needed.

Pitfall #3 – Broken Records

Firms need to always maintain accurate information in account documents, allowing supervisors to appropriately monitor account activity for compliance. For example, companies should have strong procedures and training around the use and supervision of Consolidated Account Reports (CARs).

CARs are often offered to customers to show a broad view of investments, including account balances, valuations and performance data. While CARs are growing in popularity, they should not replace traditional brokerage statements. Additionally, supervision and inspections programs should monitor communications with customers to detect forgery or falsification of documents.

Protocols should be in place for notarization and medallion stamp guarantees to supervise use. The prevention and detection of falsified documents should be a top priority at every firm.

Pitfall #4 – Make It Account

Some higher-risk or more complex accounts may need more focus from supervisors to ensure compliance is observed.

  • Restricted and Insiders – update watch and restricted lists or set limits on account activity that is susceptible to insider trading. Maintain surveillance systems or procedures to review and approve restricted trading.
  • Margin Accounts – maintain adherence to WSPs when opening margin accounts, and ensure appropriate disclosures are given to customers- and document when done.
  • Options Accounts – Ensure accuracy in transactions, ordering, tickets; have systems in place to prevent errors (whether intentional or not).

Constantly Monitor

It’s important for a firm to consider its own unique risk profile when establishing its plan for supervising brokers and a supervisory system. It has to recognize the main characteristics of a compliant system, including strong WSPs and competent supervisors.

What’s more, management should constantly monitor for any weaknesses in their programs and respond quickly and efficiently to correct any potential compliance violations. By avoiding some of the mistakes other companies have made, your company will not only have a better supervisory system overall, but maybe even a leg up on the competition.