Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt Supplementary Material .18 (Remote Inspections Pilot Program) Under FINRA Rule 3110 (Supervision), 50144-50155 [2022-17428]
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2. Statutory Basis
FINRA believes that the proposed rule
change is consistent with the provisions
of Section 15A(b)(6) of the Exchange
Act,9 which requires, among other
things, that FINRA rules must be
designed to prevent fraudulent and
manipulative acts and practices, to
promote just and equitable principles of
trade, and, in general, to protect
investors and the public interest. FINRA
believes that the proposed rule change
will provide greater clarity to members
and the public regarding FINRA rules by
conforming paragraph (d) of FINRA
Rule 13802 with the rest of the
provisions in current FINRA Rule 13802
and by making technical updates to
FINRA Rule 5122 and provisions of the
Industry and Customer Codes.
FINRA does not believe that the
proposed rule change will result in any
burden on competition that is not
necessary or appropriate in furtherance
of the purposes of the Exchange Act.
The proposed rule change brings clarity
and consistency to FINRA rules without
adding any burden on firms.
C. Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received From
Members, Participants, or Others
Written comments were neither
solicited nor received.
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III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
Because the foregoing proposed rule
change does not: (i) significantly affect
the protection of investors or the public
interest; (ii) impose any significant
burden on competition; and (iii) become
operative for 30 days from the date on
which it was filed, or such shorter time
as the Commission may designate, it has
become effective pursuant to Section
19(b)(3)(A) of the Exchange Act 10 and
Rule 19b–4(f)(6) thereunder.11
At any time within 60 days of the
filing of the proposed rule change, the
Commission summarily may
temporarily suspend such rule change if
it appears to the Commission that such
action is necessary or appropriate in the
public interest, for the protection of
investors, or otherwise in furtherance of
the purposes of the Exchange Act. If the
Commission takes such action, the
Commission shall institute proceedings
U.S.C. 78o–3(b)(6).
U.S.C. 78s(b)(3)(A).
11 17 CFR 240.19b–4(f)(6).
10 15
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IV. Solicitation of Comments
Interested persons are invited to
submit written data, views and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Exchange
Act. Comments may be submitted by
any of the following methods:
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number SR–
FINRA–2022–022 on the subject line.
• Send paper comments in triplicate
to Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–1090.
All submissions should refer to File
Number SR–FINRA–2022–022. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
internet website (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rule
change that are filed with the
Commission, and all written
communications relating to the
proposed rule change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549, on official
business days between the hours of 10
a.m. and 3 p.m. Copies of such filing
also will be available for inspection and
copying at the principal office of
FINRA. All comments received will be
posted without change. Persons
submitting comments are cautioned that
we do not redact or edit personal
identifying information from comment
submissions. You should submit only
information that you wish to make
available publicly.
All submissions should refer to File
Number SR–FINRA–2022–022 and
should be submitted on or before
September 6, 2022.
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For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.12
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022–17429 Filed 8–12–22; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–95452; File No. SR–FINRA–
2022–021)
Electronic Comments
Paper Comments
B. Self-Regulatory Organization’s
Statement on Burden on Competition
9 15
to determine whether the proposed rule
should be approved or disapproved.
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Self-Regulatory Organizations;
Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a
Proposed Rule Change To Adopt
Supplementary Material .18 (Remote
Inspections Pilot Program) Under
FINRA Rule 3110 (Supervision)
August 9, 2022.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’) 1 and Rule 19b–4 thereunder,2
notice is hereby given that on July 28,
2022, the Financial Industry Regulatory
Authority, Inc. (‘‘FINRA’’) filed with the
Securities and Exchange Commission
(‘‘SEC’’ or ‘‘Commission’’) the proposed
rule change as described in Items I, II,
and III below, which Items have been
prepared by FINRA. The Commission is
publishing this notice to solicit
comments on the proposed rule change
from interested persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
FINRA is proposing to amend FINRA
Rule 3110 (Supervision) to adopt a
voluntary, three-year remote inspection
pilot program to allow member firms to
elect to fulfill their obligation under
Rule 3110(c) (Internal Inspections) by
conducting inspections of some or all
branch offices and locations remotely
without an on-site visit to such office or
location, subject to specified terms.
The text of the proposed rule change
is available on FINRA’s website at
https://www.finra.org, at the principal
office of FINRA and at the
Commission’s Public Reference Room.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission,
FINRA included statements concerning
the purpose of and basis for the
proposed rule change and discussed any
12 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
1 15
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comments it received on the proposed
rule change. The text of these statements
may be examined at the places specified
in Item IV below. FINRA has prepared
summaries, set forth in sections A, B,
and C below, of the most significant
aspects of such statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
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1. Purpose
Beginning many years ago, SEC staff
and FINRA have interpreted FINRA
rules to require member firms to
conduct on-site inspections of branch
offices and unregistered offices (i.e.,
non-branch locations) in accordance
with the periodic schedule described
under Rule 3110(c)(1).3 Over the years,
widespread advancements in
technology and communications in the
financial industry have significantly
changed the way in which members and
their associated persons conduct their
business and communicate, including
the practices that formed the original
bases for an on-site inspection
requirement. For example, making and
preserving records electronically have
increasingly become the norm and the
preferred recordkeeping medium rather
than paper (e.g., cloud based storage);
communications between and among
members, their associated persons and
customers commonly take place through
email, video or some other electronic
means (e.g., WebEx, Zoom) that can be
monitored electronically by firms;
processes for opening customer
accounts and placing trades are moving
to online platforms; and customer funds
and securities are frequently and
increasingly transmitted electronically
rather than in physical form (e.g.,
Venmo, Zelle). Relatedly, the challenges
in supervising associated persons who
work in outlying offices or locations
have been mitigated over the years with
3 See SEC National Examination Risk Alert,
Volume I, Issue 2 (November 30, 2011), https://
www.sec.gov/about/offices/ocie/riskalert-bdbranch
inspections.pdf and Regulatory Notice 11–54
(November 2011) (‘‘Notice 11–54’’) (joint SEC and
FINRA guidance stating, a ‘‘broker-dealer must
conduct on-site inspections of each of its office
locations; [Office of Supervisory Jurisdiction
(‘‘OSJs’’)] and non-OSJ branches that supervise nonbranch locations at least annually, all nonsupervising branch offices at least every three years;
and non-branch offices periodically.’’). See also
SEC Division of Market Regulation, Staff Legal
Bulletin No. 17: Remote Office Supervision (March
19, 2004) (‘‘SLB 17’’) (stating, in part, that brokerdealers that conduct business through
geographically dispersed offices have not
adequately discharged their supervisory obligations
where there are no on-site routine or ‘‘for cause’’
inspections of those offices), https://www.sec.gov/
interps/legal/mrslb17.htm.
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the prevalent and effective use of
technology. For example, supervisory
reviews for outside business activities of
associated persons are often conducted
through general internet searches,
including social media and online
public records, and by reviewing
electronic communications and
customer fund transfers. Similarly,
reviews of correspondence, customer
funds and securities, and order flows
are accomplished primarily through the
use of electronic tracking programs or
applications.
FINRA notes that firms are turning to
new and innovative regulatory tools
such as artificial intelligence, natural
language processing, and robotics
process automation, among others, to
strengthen their compliance programs.4
More recently, firms have questioned
the benefits of the on-site inspection
requirement for all offices, particularly
in light of these significant
technological advances that have
enhanced the effectiveness of a firm’s
overall and ongoing supervision and
monitoring of the activities occurring at
their offices (registered and
unregistered).5
The COVID–19 pandemic has
accelerated the use of a wide variety of
compliance and workplace technology
as many government and private
employers, including member firms,
were driven to adopt a broad remote
work environment by quickly moving
their employees out of their usual office
setting to an alternative worksite such as
a private residence. Insights obtained
from member firms and other industry
representatives through various
pandemic-related initiatives and other
industry outreach have led FINRA to
carefully consider whether some
processes and rules, including the
manner in which a firm may satisfy its
Rule 3110(c) obligations, should be
modernized.6 Technological
4 See generally FINRA White Paper, Technology
Based Innovations for Regulatory Compliance
(‘‘RegTech’’) on the Securities Industry (September
2018), https://www.finra.org/sites/default/files/
2018_RegTech_Report.pdf.
5 Some firms have indicated, for example, that
technology has enhanced real time monitoring of
their associated persons by providing the ability for
firm compliance personnel to join, on an ad hoc
basis, digital or virtual meetings occurring between
the firm’s associated persons and customers. Firms
have also indicated that technology has allowed
them to impose various restrictions or limitations
on associated persons, such as the ability to print
firm records from remote locations using a firmissued laptop, and only accepting electronic
payments from customers.
6 See generally FINRA’s Key Topic: COVID–19/
Coronavirus (referencing, among other things,
Frequency Asked Questions, temporary
amendments to FINRA rules, and Regulatory
Notices such as Regulatory Notices 20–08 (March
2020) (‘‘Notice 20–08’’), regarding pandemic-related
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improvements and developments in
regulatory compliance have provided
more tools than before to create more
effective and efficient compliance
programs. To that end, FINRA believes
that regulatory models should evolve to
benefit from the availability and use of
effective technology tools. With the
confluence of advances in compliance
technology and the permanent shift to a
remote or hybrid work environment,
made more pronounced by the
pandemic, FINRA believes that the
optimal use of on-site inspections
deserves further consideration.
To address the operational challenges
in conducting on-site inspections during
the pandemic, FINRA adopted
temporary Rule 3110.17, effective since
November 2020, to provide member
firms the option to conduct inspections
of their branch offices and non-branch
locations remotely, subject to specified
terms therein.7 Although uncertainty
about the pandemic remains, firms are
beginning to look ahead at the postpandemic changes to their workplaces,
including more flexible work hours and
hybrid work models—working
sometimes on-site in a conventional
office setting and other times remotely
in a private residence or other
alternative worksite. As such, FINRA
believes now is the time to assess
possible longer-term rule changes and
is, therefore, proposing a voluntary,
three-year remote inspections pilot
program. This program would provide
FINRA with specific, structured data
from member firm pilot participants to
evaluate their experiences—positive and
negative—and inspection findings. This
data would enable FINRA to
business continuity planning, guidance and
regulatory relief to member firms from some
requirements, including the temporary suspension
of the requirement to maintain updated information
on Form U4 (Uniform Application for Securities
Industry Registration or Transfer) and submit Form
BR (Uniform Branch Office Registration Form) for
temporary locations; 20–16 (May 2020) (‘‘Notice
20–16’’), describing practices implemented by firms
to transition to, and supervise in, remote work
environment during the COVID–19 pandemic; 20–
42 (December 2020) (‘‘Notice 20–42’’), seeking
comment on lessons from the pandemic; and 21–
44 (December 2021) (‘‘Notice 21–44’’), regarding
business continuity planning and lessons from the
pandemic, https://www.finra.org/rules-guidance/
key-topics/covid-19. See also SEC Press Release
2022–112 (June 22, 2022) for the Spring 2022
Regulatory Agenda (quoting SEC Chair Gary
Gensler: ‘‘When I think about the SEC’s agenda, I’m
driven by two public policy goals: continuing to
drive efficiency in our capital markets and
modernizing our rules for today’s economy and
technologies.’’), https://www.sec.gov/news/pressrelease/2022-112?utm_medium=email&utm_
source=govdelivery.
7 See Securities Exchange Act Release No. 90454
(November 18, 2020), 85 FR 75097 (November 24,
2020) (Notice of Filing and Immediate Effectiveness
of File No. SR–FINRA–2020–040).
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systematically assess the overall impact
on firms’ supervisory systems, which
has not been feasible with information
drawn from the pandemic-related office
shutdowns. Moreover, the proposed
pilot program would maintain effective
supervision by firms through firms’
ongoing supervisory obligations under
Rule 3110, and the proposed limitations
on the firms and locations that would be
eligible to participate in the proposed
pilot program.
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The Inspection Requirement Under Rule
3110
The responsibility of firms to
supervise their associated persons is a
critical component of broker-dealer
regulation.8 Member firms must
supervise all of their associated persons,
regardless of their location,
compensation or employment
arrangement, or registration status.9
Rule 3110 requires a member, regardless
of size or type, to have a supervisory
system for the activities of its associated
persons that is reasonably designed to
achieve compliance with the applicable
securities laws and regulations and
FINRA rules, and sets forth the
minimum requirements for such
supervisory system.10
As part of that supervisory system,
Rule 3110(c) requires a member to
review, at least annually, the businesses
in which it engages for purposes of
detecting and preventing violations of,
and achieving compliance with,
applicable securities laws and
regulations. The review must include
periodic inspections of each office and
8 See SLB 17, supra note 3; see also Notice 11–
54 and Notice to Members 98–38 (May 1998)
(‘‘Notice 98–38’’).
9 This obligation is derived from Sections
15(b)(4)(E) and 15(b)(6)(A) of the Exchange Act.
Section 15(b)(4)(E) provides that the ‘‘Commission,
by order, shall censure, place limitations on the
activities, functions, or operations of, suspend for
a period not exceeding twelve months, or revoke
the registration of any broker or dealer if it finds
. . . that such broker or dealer . . . or any person
associated with such broker or dealer . . . has
willfully aided, abetted, counseled, commanded,
induced, or procured the violation by any person
of any provision of the Securities Act of 1933, the
Investment Advisers Act of 1940, the Investment
Company Act of 1940, the Commodity Exchange
Act, [the Securities Exchange Act of 1934], the rules
or regulations under any of such statutes, or the
rules of the Municipal Securities Rulemaking
Board, or has failed reasonably to supervise, with
a view to preventing violations of the provisions of
such statutes, rules, and regulations, another person
who commits such a violation, if such other person
is subject to his supervision.’’ 15 U.S.C.
78o(b)(4)(E). Section 15(b)(6)(A)(i) parallels Section
15(b)(4)(E) and provides for the imposition of
sanctions against persons associated with a broker
or dealer that violates those statutes, rules and
regulations enumerated in Section 15(b)(4)(E) and
other specified subparagraphs under Section
15(b)(4). 15 U.S.C. 78o(b)(6)(A).
10 See Rule 3110(a).
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examination of customer accounts to
detect and prevent irregularities and
abuses. The inspection requirement is a
longstanding supervisory obligation that
in its early form had addressed the
inspection requirement for an OSJ
only.11 FINRA expanded the inspection
requirement to cover branch offices out
of concern for the potential regulatory
problems that could emerge when a
registered person, situated in an office
other than an OSJ, was engaging in
securities-related activities without the
direct oversight of qualified supervisory
personnel and without an annual
inspection.12
Currently, Rule 3110(c) sets forth
three main requirements for conducting
internal inspections. First, an inspection
of an office or location must occur on
a designated frequency. The periodicity
of the required inspection varies
depending on the classification of the
location or the nature of the activities
that take place: OSJs and supervisory
branch offices must be inspected at least
annually; 13 non-supervisory branch
offices, at least every three years; 14 and
non-branch locations, on a periodic
schedule, presumed to be at least every
three years.15 Second, a member must
retain a written record of the date upon
which each review and inspection
occurred, reduce a location’s inspection
to a written report and keep each
inspection report on file either for a
minimum of three years or, if the
location’s inspection schedule is longer
than three years, until the next
inspection report has been written.16 If
applicable to the location being
inspected, the inspection report must
include the testing and verification of
the member’s policies and procedures,
including supervisory policies and
procedures, in specified areas.17 Third,
11 Article III, Section 27(d) of the NASD Rules of
Fair Practice had provided: ‘‘Each member shall
review the activities of each office, which shall
include the periodic examination of customer
accounts to detect and prevent irregularities or
abuses and at least an annual inspection of each
office of supervisory jurisdiction.’’ See Notice to
Members 87–41 (June 1987) (setting forth the then
existing rule text for specified parts of Article III,
Section 27 (Supervision) of the NASD Rules of Fair
Practice as part of a proposal to amend the OSJ and
branch office definitions).
12 See Securities Exchange Act Release No. 26177
(October 13, 1988), 53 FR 41008 (October 19, 1988)
(Order Approving File No. SR–NASD–88–31). See
also Notice to Members 88–84 (November 1988) and
Notice to Members 89–34 (April 1989).
13 See Rule 3110(c)(1)(A).
14 See Rule 3110(c)(1)(B).
15 See Rules 3110(c)(1)(C) and 3110.13 (General
Presumption of Three-Year Limit for Periodic
Inspection Schedules).
16 See Rule 3110(c)(2).
17 See Rule 3110(c)(2)(A) (providing that the
inspection report must include, without limitation,
the testing and verification of the member’s policies
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to prevent compromising the
effectiveness of inspections due to
conflicts of interest, the rule requires a
member to ensure that the person
conducting the inspection is not an
associated person assigned to the
location or is not directly or indirectly
supervised by, or otherwise reporting to,
an associated person assigned to that
location.18 All branch offices and nonbranch location are subject to Rule
3110(c).
Further, Rule 3110.12 (Standards for
Reasonable Review) sets out factors that
constitute a reasonable review. This
provision emphasizes establishing
reasonable supervisory procedures and
conducting reviews of locations, taking
into consideration, among other things,
the member’s size, organizational
structure, scope of business activities,
number and location of the member’s
offices, the nature and complexity of the
products and services offered by the
member, the volume of business done,
the number of associated persons
assigned to a location, the disciplinary
history of registered representatives or
associated persons, and any indicators
of irregularities or misconduct (i.e., ‘‘red
flags’’).19 The provision further states
and procedures, including supervisory policies and
procedures for: (1) safeguarding of customer funds
and securities; (2) maintaining books and records;
(3) supervision of supervisory personnel; (4)
transmittals of funds from customers to third party
accounts, from customer accounts to outside
entities, from customer accounts to locations other
than a customer’s primary residence, and between
customers and registered representatives, including
the hand delivery of checks; and (5) changes of
customer account information, including address
and investment objectives changes, and validation
of such changes).
18 Rule 3110(c)(3) provides a limited exception
from this requirement if a firm determines
compliance is not possible either because of the
firm’s size or its business model. Rule 3110.14
(Exception to Persons Prohibited from Conducting
Inspections) reflects FINRA’s expectation that a
firm generally will rely on the exception in
instances where the firm has only one office or has
a business model where small or single-person
offices report directly to an OSJ manager who is
also considered the offices’ branch office manager.
However, these situations are non-exclusive, and a
firm may still rely on the exception in other
instances where it cannot comply because of its size
or business model, provided the firm complies with
the documentation requirements under the rule.
19 Red flags that suggest the existence or
occurrence of violations, prompting an
unannounced visit, may include: customer
complaints; a large number of elderly customers; a
concentration in highly illiquid or risky
investments; an unexplained increase or change in
the types of investments or trading concentration
that a representative is recommending or trading; an
unexpected improvement in a representative’s
production, lifestyle, or wealth; questionable or
frequent transfers of cash or securities between
customer or third party accounts, or to or from the
representative; a representative that serves as a
power of attorney, trustee or in a similar capacity
for a customer or has discretionary control over a
customer’s account(s); representative with
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that the procedures established and
reviews conducted must provide that
the quality of supervision at remote (i.e.,
geographically dispersed) locations is
sufficient to ensure compliance with
applicable securities laws and
regulations and with FINRA rules, and
that members must be especially
diligent with respect to a non-branch
location where a registered
representative engages in securities
activities. This provision incorporates
guidance FINRA has previously issued
about supervising associated persons
working in geographically dispersed
offices.20
In 2004, the SEC staff similarly
provided guidance on supervision
principles.21 At that time, the SEC staff
noted that small, geographically
scattered offices presented supervisory
challenges when they were not subject
to on-site supervision. The SEC staff
observed that an office’s geographic
distance from supervisory personnel
could make it easier for registered
persons and other employees to carry
out and conceal violative conduct. This
general observation was derived from
SEC enforcement cases finding that
firms had inadequately supervised their
associated persons working in small,
geographically distant offices due to the
failure of their supervisory mechanisms
to detect and prevent misconduct.
Citing technology available at the time,
the guidance emphasized that an
effective supervisory system for
geographically dispersed offices uses a
combination of on-site and off-site
monitoring; it specifically said that
‘‘[c]entralized technology to monitor the
trading and handling of funds in remote
office accounts, as well as the use of
personal computers, helps detect
misappropriation of customer funds,
selling away, and unauthorized trading,
among other things[.]’’ 22 The guidance
supported both routine or ‘‘for cause’’
on-site inspections, and encouraged
unannounced inspections either on a
random basis or where there are red
flags about unusual activity at those
offices. Further, as noted above, in the
past both the SEC staff and FINRA have
expressed the view that inspections
must have an on-site component,
disciplinary records; customer investments in one
or a few securities or class of securities that is
inconsistent with firm policies related to such
investments; churning; trading that is inconsistent
with customer objectives; numerous trade
corrections, extensions, liquidations; or significant
switching activity of mutual funds or variable
products held for short time periods. See SLB 17,
supra note 3; see also Notice 98–38 and Notice to
Members 99–45 (June 1999) (‘‘Notice 99–45’’).
20 See, e.g., Notices 98–38 and 99–45.
21 See SLB 17, supra note 3.
22 See SLB 17, supra note 3.
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reflecting how office inspections have
been historically conducted.23
Since the time these in-person
guidelines were expressed,
developments in technology have
enhanced firms’ overall and ongoing
supervision and monitoring of the
activities occurring at branch offices and
non-branch locations. In response to
these developments, member firms have
questioned the historical expectation
that firms satisfy the inspection
component of Rule 3110(c) solely in a
physical, on-site manner.
The 2017 Proposal To Allow Remote
Inspections and the Impact From the
Pandemic
Even prior to the pandemic, in 2017,
FINRA considered a proposal to give
firms the option of satisfying the
inspection requirement remotely for
‘‘qualifying offices’’ that met specified
criteria.24 However, the COVID–19
pandemic, declared in early 2020,25
significantly changed the industry’s
standard business operations, forcing
member firms to adapt to a full remote
work environment and implement
remote supervisory practices.26 FINRA
deferred the 2017 Proposal in light of
the pressing need to address significant
operational disruptions to the securities
industry, regulators, impacted member
firms, investors and other stakeholders.
During this exigent period, FINRA
responded to numerous issues and
questions that urgently arose.27
Following up on these actions, FINRA
published Notice 20–42 to gain a
broader understanding of member firm
experiences during the pandemic. This
notice sought feedback from firms about
their experiences in a range of areas,
including how member firms’
operations and business models
23 See
note 3, supra.
Regulatory Notice 17–38 (November 2017)
(‘‘2017 Proposal’’). FINRA had requested comment
on a proposed amendment to Rule 3110 to allow
remote inspections of ‘‘qualifying offices’’ that met
specified criteria, in lieu of on-site inspections of
such offices and locations. In general, many of the
comment letters FINRA had received expressed
support for the underlying concept of remote
inspections and offered recommendations on
specific criteria to broaden the potential population
of qualifying offices.
25 See Centers for Disease Control and Prevention
(‘‘CDC’’), International Classification of Diseases,
Tenth Revision, Clinical Modification (ICD–10–CM)
(Effective March 18, 2020), https://www.cdc.gov/
nchs/data/icd/Announcement-New-ICD-code-forcoronavirus-3-18-2020.pdf. See also WHO DirectorGeneral, Opening Remarks at the Media Briefing on
COVID–19 (March 11, 2020), https://www.who.int/
director-general/speeches/detail/who-directorgeneral-s-opening-remarks-at-the-media-briefingon-covid-19-11-march-2020.
26 See generally Regulatory Notice 20–16 (May
2020).
27 See note 6, supra.
24 See
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50147
changed during the public health crisis
and how they might further evolve as
the pandemic persisted. Other
initiatives included sharing general
practices of firms in transitioning and
supervising in the remote work
environment, and providing temporary
relief to member firms from specified
FINRA rules and requirements.28 In
particular, to give firms an opportunity
to better manage their operational
challenges and redirect resources
attendant to fulfilling their inspection
obligations, FINRA provided temporary
relief to member firms pertaining to the
in-person inspection aspect of Rule
3110(c).29
Temporary Amendments to the
Inspection Requirement Under Rule
3110(c)
At the outset of the pandemic in the
United States, many states issued stayat-home orders and imposed restrictions
on businesses, social activities, and
travel in hopes of slowing the spread of
COVID–19.30 In response, many
government and private employers,
including member firms, closed their
offices and moved their employees to
alternative worksites (e.g., an
employee’s residence). These
operational changes made it
impracticable for member firms to
conduct the on-site inspection
component of Rule 3110(c) at most
locations for that year because of
limitations on travel to geographically
dispersed OSJs, branch offices, and nonbranch locations. In response to the
logistical challenges, FINRA extended
the time by which member firms were
required to complete their calendar year
2020 inspection obligations under Rule
3110(c) to March 31, 2021 with the
expectation that the extension did not
relieve firms from the on-site portion of
the inspections of their offices and
locations.31 However, health and safety
concerns remained unabated and with
many restrictive measures still in place
as calendar year 2020 was ending,
FINRA adopted Rule 3110.17 to provide
member firms the option, subject to
specified requirements under the
supplementary material, to complete
28 Some temporary amendments to other FINRA
rules still remain in effect. See Securities Exchange
Act Release No. 95281 (July 14, 2022), 87 FR 43335
(July 20, 2022) (Notice of Filing and Immediate
Effectiveness of File No. SR–FINRA–2022–018)
(extending the expiration date of temporary
amendments set forth in SR–FINRA–2020–015 and
SR–FINRA–2020–027).
29 See Rules 3110.16 and 3110.17.
30 See note 7, supra, 85 FR 75097, 75098 n.10.
31 See Securities Exchange Act Release No. 89188
(June 30, 2020), 85 FR 40713 (July 7, 2020) (Notice
of Filing and Immediate Effectiveness of File No.
SR–FINRA–2020–019).
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remotely their calendar year inspection
obligations without an on-site visit to
the office or location.32 This relief was
repeatedly extended until the end of
2022.33 Rule 3110.17 will automatically
sunset on December 31, 2022.34
Through comments to the 2017
Proposal, Notice 20–42, the various
temporary amendments to Rule 3110,
and other engagement with industry
representatives, firms have highlighted
that Rule 3110(c) was adopted well
before the prevalence of modern
technology, including laptops, mobile
devices, video conferencing capabilities,
electronic storage and electronic
surveillance, at a time when on-site
inspections were the only conceivable
way firms could inspect and review
activities occurring in outlying offices
and locations. The advent of new and
developing technologies has enhanced
the effectiveness of a firm’s ongoing
supervision and monitoring of
associated persons working from
dispersed branch offices and nonbranch locations. In addition, firms have
noted that in practice, those
technological advances allow a large
portion of inspection work to be
conducted electronically, prior to any
on-site visit to the office and location,
and that in general, on-site inspections
of many offices and locations are one
component of a firm’s overall
supervisory system of associated
persons and offices, and as such are no
longer an efficient and effective use of
limited firm resources.35
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32 See
note 7, supra.
33 See Securities Exchange Act Release No. 93002
(September 15, 2021), 86 FR 52508 (September 21,
2021) (Notice of Filing and Immediate Effectiveness
of File No. SR–FINRA–2021–023); and Securities
Exchange Act Release No. 94018 (January 20, 2022),
87 FR 4072 (January 26, 2022) (Notice of Filing and
Immediate Effectiveness of File No. SR–FINRA–
2022–001).
34 See note 33, supra.
35 In response to FINRA’s proposed rule changes
associated with Rule 3110.17, one commenter made
similar points about the physical, on-site piece of
the inspection process. This commenter stated that
pre-pandemic, an on-site inspection of a branch
office typically consisted of reviewing the lobby
area of the office, the back office (to review safe
contents, sales literature, daily operations logs
containing account applications), signage, and the
physical security of the office. See Letter from
Carrie L. Chelko, Chief Compliance Officer, Fidelity
Brokerage Services LLC (‘‘Fidelity Brokerage’’) &
Norman L. Ashkenas, Chief Compliance Officer,
National Financial Services LLC (‘‘NFS’’) and
Fidelity Distributors Company LLC (‘‘Fidelity
Distributors’’), to Vanessa Countryman, Secretary,
SEC, dated July 28, 2020, in response to Securities
Exchange Act Release No. 89188 (June 30, 2020), 86
FR 40713 (July 7, 2022) (Notice of Filing and
Immediate Effectiveness of File No. SR–FINRA–
2020–019) and Letter from Gail Merken, Chief
Compliance Officer, Fidelity Brokerage, Janet Dyer,
Chief Compliance Officer, NFS & John McGinty,
Chief Compliance Officer, Fidelity Distributors, to
Vanessa Countryman, Secretary, SEC, dated
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However, Rule 3110.17 was adopted
in the midst of the pandemic, when
many offices and locations were closed,
and employees carried out their
responsibilities from alternative
worksites. FINRA recognizes that the
pandemic has changed the conventional
thinking on where work is conducted
and this shift in the workforce
landscape will unlikely revert to the
model that existed pre-pandemic. As
noted above, FINRA believes that
adopting a voluntary, three-year remote
inspection pilot program, under terms
based largely on Rule 3110.17, but with
significant safeguards, would allow
FINRA the time to collect specified data
from member firm pilot participants to
evaluate their experiences and
inspection findings in a uniform,
comparable manner in the context of the
emerging hybrid work model. FINRA
anticipates that the proposed pilot
program will provide broader
systemized information to supplement
the information obtained through the
FINRA examination process in an
environment where offices and
locations were closed. The information
firms will be required to produce as a
pilot program participant will help
FINRA more accurately assess the
overall impacts on firms’ supervisory
systems to inform FINRA’s application
of supervisory requirements to the new
work environment, including
potentially broader reliance on remote
inspections.
Proposed Voluntary, Three-Year Pilot
Program for Remote Inspections
With Rule 3110.17 operational since
November 2020, and the widespread
availability and use of technology
described above, regulators are being
challenged to consider whether on-site
inspections by firms should be a
necessity and if they continue to be an
efficient and effective method for
supervising and monitoring associated
persons and offices as part of a firm’s
overall supervisory system.
As FINRA emphasized in the
proposed rule change to adopt Rule
3110.17, the responsibility of firms to
supervise their associated persons on a
day-to-day basis is a critical component
of broker-dealer regulation.36 The
inspection requirement in Rule 3110(c)
is just one element of a reasonably
designed supervisory system. FINRA
believes that a pilot period of risk-based
on-site supervision is consistent with
February 16, 2022, in response to Securities
Exchange Act Release No. 94018 (January 20, 2022),
87 FR 4072 (January 26, 2022) (Notice of Filing and
Immediate Effectiveness of File No. SR–FINRA–
2022–001).
36 See note 7, supra.
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firms’ core responsibility, as set forth in
Rule 3110, 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. The proposed
pilot program would build largely on
the terms of Rule 3110.17, but would be
enhanced in several ways, including
notably targeted exclusions from
participation in the program for higher
risk member firms, and offices or
locations. In addition, the proposed
pilot program would require a firm
conduct a risk assessment for each office
or location that is selected to be
inspected remotely, documented with
the factors considered. Finally, the
proposed pilot program would require a
firm to establish and maintain written
supervisory procedures to account for
the risk assessment and sets forth the
scope of the program.
A. Scope of Pilot (Proposed Rule
3110.18(a))
Under proposed Rule 3110.18(a), the
proposed pilot program would apply to
the required inspections of OSJs, branch
offices, and non-branch locations under
the applicable provisions under Rule
3110(c)(1) for a pilot period of three
years starting on the effective date, and
expiring on a date that is three years
after the effective date. If the proposed
pilot program is not extended or Rule
3110.18, as may be amended, is not
approved as permanent by the SEC, the
proposed supplementary material will
automatically sunset on a date that is
three years after the effective date. In
addition, proposed Rule 3110.18(a)
would expressly state that members
would not be able to avail themselves of
the proposed pilot program after it
expires.
B. Use of Remote Inspections (Proposed
Rule 3110.18(b))
1. Risk-Based Approach; Risk
Assessment (Proposed Rule
3110.18(b)(1))
As described above, Rule 3110(c)(1)
provides that an inspection of an office
or location must occur on a designated
frequency, and the periodicity of the
required inspection varies depending on
the classification of the location as an
OSJ, branch office or non-branch
location. Subject to proposed Rule
3110.18(b)(2) as described below,
proposed Rule 3110.18(b)(1) would
provide that a member firm may elect to
conduct the applicable inspection of an
office or location during the pilot period
remotely, without necessarily an on-site
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visit for the office or location, when the
member reasonably determines that the
purposes of the rule can be
accomplished by conducting such
required inspection remotely.37
Proposed Rule 3110.18(b)(1) would also
provide that prior to electing a remote
inspection for an office or location,
rather than an on-site inspection, the
firm must develop a reasonable riskbased approach to using remote
inspections and conduct and document
a risk assessment for that office or
location. The assessment must
document the factors considered,
including the factors set forth in Rule
3110.12, and must take into account any
higher risk activities that take place or
higher risk associated persons that are
assigned to that location. FINRA expects
that higher risk factors at a particular
location would cause a firm to conduct
on-site inspections of such location.
Further, under the proposed
supplementary material, a member that
is not eligible to conduct remote
inspections under proposed Rule
3110.18(b)(2) must conduct an on-site
inspection of that office or location on
the required cycle. Finally,
notwithstanding the pilot program, a
member would remain subject to the
other requirements and limitations of
Rule 3110(c).38
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2. Ineligible Member Firms, and Offices
or Locations (Proposed Rule
3110.18(b)(2))
FINRA is proposing to exclude some
member firms or their offices or
locations from participating in the
proposed pilot program. The proposed
categories of ineligibility are events or
activities of a member firm or its
associated persons that FINRA believes
are more likely to raise investor
37 As described further below, a member firm that
elects to participate in the proposed pilot program
would be subject to the requirements of proposed
Rule 3110.18 for a Pilot Year. See proposed Rule
3110.18(g).
38 For example, as currently required with any
physical, on-site inspection, a member would be
required to reduce the remote inspection to a
written report and satisfy the content and record
retention requirements of such report as described
in Rule 3110(c)(2). Similarly, a member would
remain subject to Rule 3110(c)(3)’s general
prohibition against an associated person from
conducting a location’s inspection if the person
either is assigned to that location or is directly or
indirectly supervised by, or otherwise reports to,
someone assigned to that location. Rule 3110(c)(3)
provides a limited exception from this general
prohibition for specified circumstances (e.g., the
member has a business model where a small or
single-person offices report directly to an OSJ
manager who is also considered the offices’ branch
office manager) by requiring a member to document
in the inspection report both the factors the member
used to make the determination that it could not
comply with the general prohibition and how the
inspection otherwise complies with Rule 3110(c)(1).
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protection concerns based on the firm’s
or an associated person’s record of
specified regulatory or disciplinary
events.
Under proposed Rule
3110.18(b)(2)(A), a member firm would
be ineligible to conduct remote
inspections of any of its offices if any
time during the period of the proposed
pilot program, the member is or
becomes: (1) designated as a Restricted
Firm under Rule 4111 39 (proposed Rule
3110.18(b)(2)(A)(i)); or (2) designated as
a Taping Firm under Rule 3170 40
(proposed Rule 3110.18(b)(2)(A)(ii).
These rules expressly address firms that
pose higher risks, and for that reason,
would be ineligible to participate in the
proposed pilot program.
In addition, under proposed Rule
3110.18(b)(2)(B), a member firm’s office
or location would be ineligible for a
remote inspection if at any time during
the period of the proposed pilot
program, an associated person at such
office or location is or becomes: (1)
subject to a mandatory heightened
supervisory plan under the rules of the
SEC, FINRA or state regulatory agency
(proposed Rule 3110.18(b)(2)(B)(i)); (2)
statutorily disqualified, unless such
disqualified person has been approved
(or is otherwise permitted pursuant to
FINRA rules and the federal securities
laws) to associate with a member and is
not subject to a mandatory heightened
supervisory plan under proposed Rule
3110.18(b)(2)(B)(i) or otherwise as a
condition to approval or permission for
such association (proposed Rule
3110.18(b)(2)(B)(ii)); (3) subject to Rule
1017(a)(7) 41 as a result of one or more
39 In general, Rule 4111 (Restricted Firm
Obligations) requires member firms that are
identified as ‘‘Restricted Firms’’ to deposit cash or
qualified securities in a segregated, restricted
account; adhere to specified conditions or
restrictions; or comply with a combination of such
obligations. See generally Regulatory Notice 21–34
(September 2021) (announcing FINRA’s adoption of
rules to address firms with a significant history of
misconduct).
40 In general, Rule 3170 (Tape Recording of
Registered Persons by Certain Firms) requires a
member firm to establish, enforce and maintain
special written procedures supervising the
telemarketing activities of all of its registered
persons, including the tape recording of
conversations, if the firm has hired more than a
specified percentage of registered persons from
firms that meet FINRA Rule 3170’s definition of
‘‘disciplined firm.’’ See generally Regulatory Notice
14–10 (March 2014) (announcing FINRA’s adoption
of consolidated rules governing supervision).
41 In general, Rule 1017(a)(7) require a member
firm to file a CMA when a natural person seeking
to become an owner, control person, principal or
registered person of the member firm has, in the
prior five years, one or more defined ‘‘final criminal
matters’’ or two or more ‘‘specified risk events’’
unless the member firm has submitted a written
request to FINRA seeking a materiality consultation
for the contemplated activity. Rule 1017(a)(7)
applies whether the person is seeking to become an
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50149
associated persons at such location
(proposed Rule 3110.18(b)(2)(B)(iii)); or
(4) one or more associated persons at
such location has an event in the prior
three years that required a ‘‘yes’’
response to any item in Questions
14A(1)(a) and 2(a), 14B(1)(a) and 2(a),
14C, 14D and 14E on Form U4 42
(proposed Rule 3110.18(b)(2)(B)(iv)).
FINRA believes that the imposition of a
mandatory heightened supervisory plan,
a statutorily disqualification, a Rule
1017(a)(7) review due to significant
misconduct, or the existence of
specified disclosures on Form U4
pertaining to criminal convictions and
final regulatory action are indicia of
increased risk to investors at some office
or locations, such that they should not
be eligible for remote inspections in
accordance with the proposed pilot
program.
A member firm or an office or location
subject to one of the categorical
restrictions would not be eligible for
remote inspections, even if the firm’s
risk assessment concludes that a remote
inspection would be appropriate. A
member firm would be required to
conduct an on-site inspection of that
office or location on the required cycle.
FINRA believes the proposed list of
ineligibility categories is appropriately
derived from existing rule-based criteria
that are part of processes to identify
firms that may pose greater concern
(e.g., Rules 4111 and 3170) or associated
persons that may pose greater concerns
due to the nature of disclosures of
regulatory or disciplinary events on the
uniform registration forms. FINRA
believes that these objective categorical
restrictions will provide safeguards that
will help ensure that firms maintain
effective supervisory procedures during
the pilot period.
C. Written Supervisory Procedures for
Remote Inspections (Proposed Rule
3110.18(c))
As part of an effective supervisory
system tailored specifically to the
member firm’s business and the
activities of all its associated persons, a
member must establish and maintain
written procedures.43 Paragraph (1)
(General Requirements) under Rule
3110(b) (Written Procedures) provides
owner, control person, principal or registered
person at the person’s current member firm or at a
new member firm. See generally Regulatory Notice
21–09 (March 2021) (announcing FINRA’s adoption
of rules to address brokers with a significant history
of misconduct).
42 Form U4’s Questions 14A(1)(a) and 2(a),
14B(1)(a) and 2(a) elicit reporting of criminal
convictions, and Questions 14C, 14D, and 14E
pertain to regulatory action disclosures.
43 See Rule 3110(a)(1); see generally Notice 99–45
and Regulatory Notice 18–15 (April 2018).
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that a member must establish, maintain,
and enforce written procedures to
supervise the types of business in which
it engages and the activities of its
associated persons that are reasonably
designed to achieve compliance with
applicable securities laws and
regulations, and with applicable FINRA
rules.
Currently, Rule 3110.17(b) expressly
provides that consistent with a
member’s obligation under Rule
3110(b)(1), a member that elects to
conduct each of its inspections in the
specified calendar years remotely must
amend or supplement its written
supervisory procedures to provide for
remote inspections that are reasonably
designed to assist in detecting and
preventing violations of and achieving
compliance with applicable securities
laws and regulations, and with
applicable FINRA rules. In addition,
under Rule 3110.17(b), reasonably
designed procedures for conducting
remote inspection of offices or locations
should include, among other things, a
description of the methodology,
including technologies permitted by the
member, that may be used to conduct
remote inspections. Further, such
procedures should include the use of
other risk-based systems employed
generally by the member firm to identify
and prioritize for review those areas that
pose the greatest risk of potential
violations of applicable securities laws
and regulations, and of applicable
FINRA rules.44 To underscore the
importance of Rule 3110(b)(1) in the
context of the proposed pilot program,
FINRA is proposing to add to the
elements currently described under
Rule 3110.17(b) an express provision
that the firm must adopt written
supervisory procedures regarding
remote inspections that are reasonably
designed to detect and prevent
violations of and achieve compliance
with applicable securities laws and
regulations, and with application
FINRA rules. In addition, a firm’s
written supervisory procedures should
also include the factors considered in
the risk assessment made for each
applicable office or location pursuant to
proposed Rule 3110.18(b).
44 Offices or locations that may present a higher
risk profile would include, for example, those that
have associated persons engaging in activities that
involve handling customer funds or securities,
maintaining books and records as described under
applicable federal securities laws and FINRA rules,
order execution or other activities that may be more
susceptible to higher risks of operational or sales
practice wrongdoing, or have associated persons
assigned to an office or location who may be subject
to additional or heightened supervisory procedures.
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D. Effective Supervisory System
(Proposed Rule 3110.18(d))
FINRA is proposing to retain the
terms of Rule 3110.17(c), without
substantive change, in proposed Rule
3110.18(d). Similar to Rule 3110.17(c),
proposed Rule 3110.18(d) would
expressly reiterate the principle that the
requirement to conduct inspections of
offices and locations is one part of the
member’s overall ongoing obligation to
have an effective supervisory system,
and therefore a member must continue
with its reviews of the activities and
functions occurring at all offices and
locations whether or not the member
conducts inspections remotely. In
addition, proposed Rule 3110.18(d)
would provide that a member’s remote
inspection of an office or location would
be held to the same standards for review
applicable to on-site inspections as set
forth under Rule 3110.12.45 Further,
proposed Rule 3110.18(d) would
provide that where a member’s remote
inspection of an office or location
identifies any indicators of irregularities
or misconduct (i.e., ‘‘red flags’’), the
member may need to impose additional
supervisory procedures for that office or
location, or may need to provide for
more frequent monitoring or oversight
of that office or location, or both,
including potentially a subsequent
physical, on-site visit on an announced
or unannounced basis.
E. Documentation Requirement
(Proposed Rule 3110.18(e))
In general, Rule 3110(c)(2) imposes
various documentation requirements for
inspections, including maintaining a
written record of the date upon which
each inspection is conducted. Currently,
Rule 3110.17(d) requires supplemental
documentation by a member that avails
itself of the remote inspection option.
The member must maintain and
preserve a centralized record for each of
calendar years specified in the
supplementary material that separately
identifies: (1) all offices or locations that
had inspections that were conducted
remotely; and (2) any offices or
locations that the member determined to
impose additional supervisory
procedures or more frequent
monitoring, as provided in Rule
3110.17(c). A member’s documentation
of the results of a remote inspection for
an office or location must identify any
additional supervisory procedures or
more frequent monitoring for that office
or location that were imposed as a result
of the remote inspection. FINRA is
proposing to incorporate, without
45 See
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substantive change, the terms of Rule
3110.17(d) in proposed Rule 3110.18(e),
but make two clarifying changes. One
change would be to reference that the
centralize record must be for each of the
‘‘pilot years’’ (as defined in proposed
Rule 3110.18(h)), and the other change
would be to clarify that a member’s
documentation of the results of a remote
inspection for an office or location must
identify any additional supervisory
procedures or more frequent monitoring
for that office or location that were
imposed as a result of the remote
inspection, including whether an on-site
inspection was conducted at such office.
F. Data and Information Collection
Requirement (Proposed Rule 3110.18(f))
1. Data and Information (Proposed Rule
3118.18(f)(1))
As noted above, Rule 3110.17 was
adopted in the midst of the pandemic
and operationalized in an environment
in which many offices and locations
were closed to the public. FINRA
believes that the formalized, uniform
collection of data is critical to allow
FINRA to meaningfully assess the
effectiveness of remote inspections to
help shape potential permanent
amendments to Rule 3110(c) that would
optimize an inspection program in the
evolving workplace environment.
FINRA believes having a pilot program
for remote inspections with appropriate
conditions, limitations and
documentation requirements in an
environment that is resettling into a
hybrid workplace model would provide
a clearer picture of the strengths and
weaknesses of remote inspections,
without compromising investor
protection. Proposed Rule 3110.18(f)
would impose upon firms a data and
information collection requirement as a
condition for participating in the pilot
program. On a frequency not to exceed
quarterly, participating firms would be
required to collect and produce to
FINRA, in a manner and format
determined by FINRA, data consisting
of separate counts for OSJs, supervisory
branch offices, non-supervisory branch
offices, and non-branch locations,
consistent with paragraphs (c)(1)(A), (B)
and (C) under Rule 3110, for several
categories, including: (1) the total
number of inspections—on-site and
remote—completed during each
calendar quarter; 46 (2) the number of
those office or locations in each
calendar quarter that were subject to an
on-site inspection because of a
‘‘finding’’ (defined under proposed Rule
3110.18(f) as an item that led to any
46 See
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remedial action or was listed on the
member’s inspection report); 47 (3) the
number of locations for which a remote
inspection was conducted in the
calendar quarter that identified a
finding, the number of findings, and a
list of the most significant findings; 48
and (4) the number of locations for
which a on-site inspection was
conducted in the calendar quarter that
identified a finding, the number of
findings, a list of the most significant
findings.49 In addition, firms would be
required to provide FINRA their written
supervisory procedures for remote
inspections that account for: (1)
escalating significant findings; new
hires; supervising brokers with a
significant history of misconduct; and
outside business activities and ‘‘doing
business as’’ (or DBA) designations.50
Firms would be required to provide
FINRA with a copy of these written
supervisory procedures alongside the
first delivery of the data points
described above, and any subsequent
amendments to such procedures for
remote inspections.51
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2. Additional Data and Information for
Pilot Year 1 (Proposed Rule
3110.18(f)(2))
Proposed Rule 3110.18(f)(2) would
address the additional data and
information requirements for Pilot Year
1 (as defined under proposed Rule
3110.18(h)), if such year covers a period
that is less that a full calendar year. In
such case, a member that elects to
participate in the proposed pilot
program would be required to collect
the following data and information and
provide such data and information to
FINRA (in a manner and format FINRA
determines) no later than December 31
of such first Pilot Year. For items (1)
through (3) below, a member would be
required to provide separate counts for
OSJs, supervisory branch offices, nonsupervisory branch offices, and nonbranch locations consistent with
paragraphs (c)(1)(A), (B) and (C) under
Rule 3110: (1) the number of locations
with an inspection completed during
the full calendar year of the first Pilot
Year; (2) the number of locations in item
(1) that were inspected remotely during
the full calendar year of the first Pilot
Year; and (3) the number of locations in
item (1) that were inspected on-site
during the full calendar year of the first
Pilot Year. This additional data and
47 See
proposed Rule 3110.18(f)(1)(D).
proposed Rule 3110.18(f)(1)(E).
49 See proposed Rule 3110.18(f)(1)(F).
50 See proposed Rule 3110.18(f)(1)(G)(i) through
(iv).
51 See proposed Rule 3110.18(f)(1)(G).
48 See
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information would provide FINRA the
ability to capture, in the aggregate,
complete inspection counts—total
number of Rule 3110(c)(1) inspections
(remote and on-site)—for the entire
calendar year in addition to the more
detailed data and information
requirements under proposed Rule
3110.18(f)(1).
3. Written Policies and Procedures
(Proposed Rule 3110.18(f)(3))
Proposed Rule 3110.18(f)(3) would
also remind firms of the general
requirement to establish, maintain and
enforce written policies and procedures
that are reasonably designed to comply
with the data and information
collection, and transmission
requirements of the proposed pilot
program.
4. Remote Inspections Pilot Program
Participation (Proposed Rule 3110.18(g))
Proposed Rule 3110.18(g) would set
forth the manner in which a firm would
notify FINRA of the firm’s election to
participate in the proposed pilot
program and to withdraw from it. The
proposed rule would provide that
FINRA may, in exceptional cases and
where good cause is shown, waive the
applicable timeframes described below
for the required opt-in or opt-out
notices.
Proposed Rule 3110.18(g) would
require a firm, at least five calendar days
before the beginning of such Pilot Year,
to provide FINRA an ‘‘opt-in notice’’ in
the manner and format determined by
FINRA. By providing such opt-in notice
to FINRA, the firm agrees to participate
in the proposed pilot program for the
duration of such Pilot Year and to
comply with the requirements of Rule
3110.18.52 A firm that provides the optin notice for a Pilot Year would be
automatically deemed to have elected
and agreed to participate in the Remote
Inspections Pilot Program for
subsequent Pilot Years (i.e., Pilot Year 2,
Pilot Year 3, and Pilot Year 4, if
applicable) until the pilot program
expires. Further, proposed Rule
3110.18(g) would describe the notice
requirement for a firm to withdraw from
the proposed pilot program. A firm
would be required to provide FINRA
with an ‘‘opt-out notice’’ at least five
calendar days before the end of the then
current Pilot Year.
By way of example, a firm that
provides FINRA an opt-in notice on
June 26 to join Pilot Year 1 that begins
on July 1 would be automatically
52 A firm that participates in a Pilot Year would
be committed to complying with the terms of
proposed Rule 3110.18 for that Pilot Year.
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deemed to continue participating in
Pilot Year 2 unless the firm provides
FINRA the required opt-out notice no
later than December 26 of Pilot Year 1.
To continue with this example, a firm
that was automatically deemed to
participate in Pilot Year 2 and
determines in mid-Pilot Year 2 that it
does not want to automatically continue
into Pilot Year 3 could elect to
withdraw from Pilot Year 3 if it
provides FINRA an opt-out notice at
least five calendar days before the end
of Pilot Year 2. However, because Pilot
Year 2 is already underway, the firm
would be required to complete Pilot
Year 2 in accordance with proposed
Rule 3110.18.
FINRA believes that this proposed
operational aspect of the program would
not only establish a cohesive process in
which firms and FINRA may manage
program participation but also lend
some continuity in data and information
collection that would support FINRA’s
assessment and evaluation of the
experiences of pilot participants.
5. Definitions (Proposed Rule
3110.18(h))
Proposed Rule 3110.18(h) would set
forth the meanings underlying ‘‘Pilot
Year’’ to explain the duration of the
proposed pilot program. Under
proposed Rule 3110.18(h), a ‘‘Pilot
Year’’ would mean the following: (1)
Pilot Year 1 would be the period
beginning on the effective date of the
proposed pilot program and ending on
December 31 of the same year; (2) Pilot
Year 2 would mean the calendar year
period following Pilot Year 1, beginning
on January 1 and ending on December
31; and (3) Pilot Year 3 would mean the
calendar year period following Pilot
Year 2, beginning on January 1 and
ending on December 31. Finally, if
applicable, where Pilot Year 1 covers a
period that is less than a full calendar
year, then Pilot Year 4 would mean the
period following Pilot Year 3, beginning
on January 1 and ending on a date that
is three years after the effective date.
6. Failure To Satisfy Conditions
(Proposed Rule 3110.18(i))
Proposed Rule 3110.18(i) would
address a situation in which a firm fails
to satisfy terms of the proposed pilot
program. The proposed paragraph
would provide that a firm that fails to
satisfy the conditions of Rule 3110.18,
including the requirement to timely
collect and submit the data and
information to FINRA as set forth in
proposed Rule 3110.18(f), would be
ineligible to participate in the pilot
program and must conduct on-site
inspections of each office and location
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7. Sunset of Rule 3110.17 (Proposed
Rule 3110.18(j))
Proposed Rule 3110.18 would
expressly account for the possibility that
the proposed pilot program becomes
effective while Rule 3110.17 is in effect
to avoid overlapping provisions.
Proposed paragraph (j) would provide
that if Rule 3110.17 has not already
expired by its own terms, it would
automatically sunset on the effective
date of proposed Rule 3110.18.
Consistent with the principles set
forth in prior guidance, FINRA expects
members to establish reasonably
designed inspection programs. The
proposed pilot program for remote
inspections does not alter the core
obligation of a member firm 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.53 As part of the
inspection planning process, FINRA
expects members to continue with their
ongoing supervision, including risk
analysis of the activities and functions
occurring at all offices or locations.
While the option to conduct remote
inspections provides greater choice in
how to effectively supervise some
offices or locations, a member must
continue to consider the factors
described in Rule 3110.12, along with
the activities taking place there. This
analysis may require the member to
conduct a physical, on-site inspection of
an office or location. Where there are
indications of problems or red flags at
any office or location, FINRA expects
members to investigate them as they
would for any other office or location
subject to Rule 3110(c), which may
include an unannounced, on-site
inspection of the office or location.
FINRA is committed to diligently
monitoring the impacts of remote
inspections on a firms’ overall
supervisory systems and reviewing the
data over the life of the proposed pilot
program to assess how firms apply the
flexibility provided by the pilot program
while maintaining an effective
supervisory program.
If the Commission approves the
proposed rule change, FINRA will
announce the effective date of the
proposed rule change in a Regulatory
Notice.
53 See
Rule 3110(a).
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2. Statutory Basis
FINRA believes that the proposed rule
change is consistent with the provisions
of Section 15A(b)(6) of the Act,54 which
requires, among other things, that
FINRA rules must be designed to
prevent fraudulent and manipulative
acts and practices, to promote just and
equitable principles of trade, and, in
general, to protect investors and the
public interest.
The terms of the proposed voluntary,
three-year remote inspection pilot
program, while based largely on the
terms of Rule 3110.17, which has been
operational since the latter part of 2020
and is set to automatically sunset on
December 31, 2022, would include
important safeguards that would require
individual risk assessments of each
office, supplemental written supervisory
procedures related to remote
inspections, documentation
requirements and obligations to share
data with FINRA to allow for
assessment of the pilot program. The
proposed rule change is intended to
provide firms that are transitioning to a
hybrid work environment the option to
conduct remote inspections of their
offices and locations, subject to
specified conditions, while maintaining
effective supervision. FINRA believes
that the proposed pilot program would
provide FINRA the appropriate amount
of time and population sample to better
evaluate the use of remote inspections
in the unfolding office work
environment. FINRA believes the
proposed pilot program, with the
proposed safeguards and controls, will
provide firms more flexibility to adapt
to changing work conditions. The
proposed pilot program would aid in
FINRA’s assessment of the effectiveness
of a flexible remote inspection option
and its utility in an environment that is
increasingly moving to hybrid
workplace models, without
compromising investor protection.
B. Self-Regulatory Organization’s
Statement on Burden on Competition
FINRA does not believe that the
proposed rule change will result in any
burden on competition that is not
necessary or appropriate in furtherance
of the purposes of the Act.
Economic Impact Assessment
FINRA has undertaken an economic
impact assessment, as set forth below, to
analyze the regulatory need for the
proposed rule change, its potential
economic impacts, including
anticipated costs, benefits, and
distributional and competitive effects,
54 15
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relative to the current baseline, and the
alternatives FINRA considered in
assessing how best to meet FINRA’s
regulatory objectives.
1. Regulatory Need
The proposed pilot program would
serve two purposes. First, it would
mitigate potential disruptions to the
hybrid work arrangements that have
developed during the pandemic. In
particular, for participating members,
the proposed pilot program would limit
the increase in aggregate inspection
costs, and the resulting incentive to
reduce the number and type of work
locations, that would occur when
temporary relief provided during the
pandemic expires.55 The proposed pilot
program would not eliminate the need
for such adjustments, but it would allow
member firms to focus their on-site
inspections on riskier locations.
The proposed pilot program would
also allow FINRA to assess the benefits
and costs of allowing some element of
remote inspection of branch offices and
non-branch locations, under specified
conditions, in the post-pandemic world.
FINRA would obtain information from
participating members on certain
elements of the risk-based approach that
they implement, the type and frequency
of inspections, and certain outcomes
conditional on the type and frequency
of inspections, as well as the type of
office or location inspected.
2. Economic Baseline
The economic baseline for the
proposed rule change includes both
current and foreseeable workforce
arrangements and business practices,
including those that were first
developed during the pandemic and
have been modified since. In particular,
the economic baseline includes the
innovations, and investments in
communication and surveillance
technology, that have supported and
continue to support supervision in the
remote work environment.56 These
55 According to the April Survey of Working
Arrangements and Attitudes (SWAA), post-COVID,
many employers are planning to allow employees
to work from home between two and three days per
week. See Jose Maria Barrero, Nicholas Bloom &
Steven J. Davis, SWAA April 2022 (April 11, 2022),
https://wfhresearch.com/wp-content/uploads/2022/
04/WFHResearch_updates-April-2022.pdf. The
number of expected work-from-home days postpandemic has been increasing steadily since the
January 2021 survey. The SWAA is monthly survey
with respondents that are working-age persons in
the United States that had earnings of at least
$20,000 in 2019. Further details about this survey
can be found in https://wfhresearch.com.
56 The pandemic propelled increased reliance on
technology solutions in the remote work
environment. A Thompson Reuters survey of
compliance and risk practitioners shows a 70%
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innovations and investments were
developed during the temporary relief
allowing remote inspections in Rule
3110.17, and the temporary suspension
of the requirement to submit branch
office applications on Form BR for new
office locations provided in Notice 20–
08. The baseline includes the scheduled
expiration of Rule 3110.17 on the
effective date of the proposed Rule
3110.18; and, in order to provide a full
accounting of the likely effects of the
proposed rule change, the analysis also
assumes that, going forward, the
temporary suspension of the above
requirement is no longer in effect.
FINRA expects that numerous
additional office locations would then
need to be registered, greatly expanding
the number of inspections, and all
inspections would then need to be
conducted on-site.
As of April 30, 2022, FINRA’s
membership included 3,365 firms with
151,463 registered branch offices.57 Of
these branch offices, 18,290 (12%) are
OSJs subject to an annual inspection
requirement. The remaining 133,173
branch locations are non-OSJ branch
offices subject to an inspection
requirement at least annually or every
three years. In addition, according to
FINRA estimates, there are more than
66,054 non-branch locations, of which
37,290 are private residences.58 A nonbranch location must be inspected on a
periodic schedule, presumed to be at
least every three years. These data may
be affected by the temporary relief from
certain requirements to update Form U4
and to submit Form BR provided in
Notice 20–08. FINRA estimates that
member firms conduct approximately
84,700 inspections per year.
FINRA adopted temporary Rule
3110.17 in late 2020 and the temporary
rule has been extended twice since.59
Hence, as of June 2022, member firms
have been able to conduct remote
inspections for 18 months. FINRA staff
considered findings from FINRA’s
increase in the reliance on technological solutions
and 30% of respondents expected increases in the
budget for RegTech solutions, specifically. See
Thompson Reuters, FinTech, RegTech and the Role
of Compliance 2021, https://
legal.thomsonreuters.com/content/dam/ewp-m/
documents/legal/en/pdf/reports/fintech-regtechand-the-role-of-compliance-in-2021.pdf.
57 This count excludes firms with membership
pending approval, and withdrawn or terminated
from membership.
58 Non-branch locations do not have to be
registered with FINRA. The estimates for nonbranch locations, including those that are also
private residences, are obtained by reviewing Form
U4. There may be some double counting of nonbranch locations if members record the address
differently on more than one Form U4 (e.g., use
‘‘St.’’ on one and ‘‘Street’’ on another).
59 See notes 7 and 33, supra.
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examination of member firms and their
branch locations that took place in
between 2018 and 2021. This
preliminary review found no significant
departures relative to pre-pandemic
examination results.60
3. Economic Impacts
As discussed above, absent the
proposed rule change, FINRA expects
that numerous additional office
locations will need to be registered,
greatly expanding the number of
inspections, and all inspections would
then need to be conducted on site. The
economic impacts of these changes
would be mitigated by the proposed rule
change for firms that choose to
participate in the pilot program.61
Participants in the pilot program
would be expected to take a risk-based
approach to conducting remote
inspections. A firm that does not
conduct a remote inspection for an
office or location must conduct an onsite inspection of that office or location
on the required cycle and remains
subject to the other requirements of Rule
3110(c). A firm that chooses to
participate in the pilot program
(assuming that it is not otherwise
ineligible from participating) would also
be required to provide FINRA with
certain data and other information about
60 FINRA examinations generally review member
activities for the year preceding the examination,
and the vast majority of examinations takes place
during the first 10 months of the calendar year.
Examinations check for compliance with federal
laws, rules and regulations; the specific areas
examined in a firm are based on the risk profile of
the firm. FINRA publishes an annual summary of
key observations and best practices across all
examinations. See the published reports at https://
www.finra.org/rules-guidance/key-topics/finraexamination-risk-monitoring-programs#guidance.
Due to this time lag in FINRA examinations,
findings may reflect decisions about remote
inspections made by members preceding
examinations up to 12 months. Hence, most FINRA
examinations in 2020 will reflect member planning
undertaken prior to the adoption of Rule 3110.17.
Conversely, 66% of FINRA examinations for
calendar 2021 have not been finalized. In addition,
FINRA examinations of member firms and their
activities are risk-based. Given the focus on higher
risk firms and some variations in the areas of focus
in examinations, year-on-year comparisons should
be treated with caution.
61 Separately, FINRA has filed a proposed rule
change to establish a Residential Supervisory
Location (‘‘RSL’’), a new non-branch location, that
would, relative to the baseline, reduce the number
of inspections that members with RSLs would need
to conduct in a year. See Securities Exchange Act
Release No. 95379 (July 27, 2022) (Notice of Filing
of File No. SR–FINRA–2022–019). For member
firms with locations that would meet the proposed
definition of an RSL, the aggregate cost savings from
choosing to participate in the proposed pilot
program would be lower if the RSL proposal were
in place because the cost savings from remote
inspections would accrue over fewer inspections.
The qualitative impacts of the proposed pilot
program, however, are similar whether the
proposed definition of an RSL is adopted or not.
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50153
the risk-based approach that they
implement, the type and frequency of
inspections, and certain outcomes
conditional on the type and frequency
of inspections.
Anticipated Benefits
The benefit to firms of choosing to
participate in the pilot program, in an
improved health environment, would
result from limiting the increase in
travel costs and lost productivity due to
time spent during travel and in the onsite inspection. On-site visits have
material costs from travel expenses and
additional staff time. A system of riskbased on-site and remote inspections
will allow firms to more efficiently
deploy compliance resources and to use
an on-site component only when
appropriate.
Firms as well as investors may benefit
if remote inspections provide new
flexibility in the design of inspection
teams. For example, remote inspections
may facilitate the development of
specialized inspection staff that are
deployed over more inspections, for
shorter periods of time, in a targeted
way. This option may especially benefit
diversified member firms with a variety
of product offerings. Remote inspections
can also facilitate the use of inspections
that target a particular area of focus in
a member firm’s business across all
branches of the member firm.
The proposed rule change may also
support the competitiveness of the
broker-dealer industry for individuals
who seek professional positions in
compliance.62 The expectation of
workplace flexibility and remote work
by such individuals may lead them
away from the broker-dealer industry if
other segments of financial services or
professional occupations offer more
flexible workforce arrangements, with
regulatory frameworks that offer more
discretion in how the supervision is
conducted.63 Even prior to the
pandemic, the scope of on-site
inspections had been much reduced due
62 See note 56, supra. See also Jose Maria Barrero,
Nicholas Bloom & Steven J. Davis, Why Working
from Home Will Stick (NBER Working Paper 28731,
April 2021), https://wfhresearch.com/wp-content/
uploads/2021/04/w28731-3-May-2021.pdf, who
point to a lasting effect of the pandemic on work
arrangements, in particular for those with higher
education and earnings; and Alexander Bick, Adam
Blandin & Karel Mertens, Work from Home Before
and After the COVID–19 Outbreak, (Working Paper,
February 2022), https://karelmertenscom.
files.wordpress.com/2022/02/wfh_feb17_2022_
paper.pdf, who find consistent results, with a
higher adoption rate of work from home jobs in
Finance and Insurance, relative to other industries,
reflected in Figure 10.
63 For example, Advisers Act Rule 206(4)–7 does
not require Registered Investment Advisers to
conduct in-person inspections or reviews of its
offices or personnel.
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to technological surveillance solutions
and centralization of books and records.
The proposed pilot would support
continued adoption and innovation in
technological solutions and reductions
in the cost of these solutions.
Participants in the proposed pilot
program would provide FINRA with
periodic (not to exceed quarterly) data
on the frequency and type of
inspections (on-site or remote), counts
of findings from inspections subdivided
by category of office or location,
qualitative information about these
findings, and certain information about
the written supervisory procedures for
remote inspections they are required to
have.64 Depending on the number and
types of firms that participate in the
proposed pilot program, this data may
allow FINRA to identify differences in
risks between remote versus on-site
inspection, both conditional on the
observable characteristics and policies
of firms and overall, the extent of
variation in these risks across firms and
firm characteristics, and factors
associated with very high or low risks.
The proposed pilot program has the
potential to yield a more thorough
collection of sensitive information in a
structured manner than voluntary
submissions or a survey of FINRA
members could provide. This data will
be useful both for monitoring for risks
as the pilot proceeds and, with
sufficient participation, for developing a
balanced assessment of the potential
impact of permitting further remote
inspection.
Anticipated Costs
Participation in the proposed pilot
program is voluntary, and the proposed
rule change provides firms with an
additional method for complying with
certain supervisory requirements
without removing other methods of
compliance. Eligible pilot participants
will therefore participate in the pilot
program only if doing so is beneficial to
their operations relative to complying
with current Rule 3110. The cost of
complying with the requirements of the
proposed pilot program is a factor in
this decision. These costs include
conducting risk-based analyses for
inspections and providing aggregated
data on findings to FINRA. The data
request in particular may require more
standardization and aggregation of
inspection findings than some member
firms typically conduct. The data
64 In addition, if the effective date of the rule is
such that the first year of the pilot program covers
a period less than a full calendar year, participating
firms would be required to provide, the data and
information specified in proposed Rule
3110.18(f)(2).
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request may also not use the same terms
or formats used by compliance officers
for reporting and tracking inspection
findings. Firms may need to develop
new written supervisory procedures and
new trainings for compliance staff to
ensure that all required data is accurate
and compiled and submitted to FINRA
in a timely manner. Firms will incur
new ongoing costs both for compliance
and monitoring for compliance.
Supervision and inspections are
intended to identify not only the
activities that violate member
procedures or FINRA rules but also poor
practices that might ultimately allow for
such violations. FINRA recognizes that
remote inspections may be less likely to
identify such practices or activities as
on-site inspections. FINRA believes that
risks to member firms and investors
from remote inspections are mitigated
by the proposed requirements to have
written supervisory procedures for
remote inspections, the proposed
requirement to conduct and document
risk assessments, the proposed
limitations on the firms and locations
that would be eligible to participate in
the proposed pilot program, and the
technology already employed for day-today supervision. In addition, FINRA
will continue to closely monitor the
outcomes of examinations during the
pilot program period.
4. Alternatives Considered
The proposed pilot program would
continue for three years. FINRA staff
considered alternative durations for the
program. FINRA members firms vary by
business model and organizational
structure, so a shorter program is less
likely to yield enough data on
inspection findings to allow for
meaningful comparisons between onsite and remote inspection regimes
across members. In addition,
inspections are typically planned by
members well ahead of time, so some
members may not implement the
requirements of the program until well
into the duration of the pilot program.
It may also help firms and the policy
development process if FINRA had
enough data to meaningfully evaluate
well ahead of the expiration of the pilot
program.
FINRA staff also considered a
proposed pilot program that would not
exclude certain firms, like restricted
firms, from participating in the program.
These additional restrictions will limit
the availability of the pilot program as
well as the potential learnings from the
program. As a result, the same
restrictions may ultimately need to be
carried over into any ongoing program
of risk-based examinations. The
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exclusion of such firms, however,
should reduce any risk of customer
harm from not having on-site
inspections.65
C. Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received From
Members, Participants, or Others
Written comments were neither
solicited nor received.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of
publication of this notice in the Federal
Register or within such longer period (i)
as the Commission may designate up to
90 days of such date if it finds such
longer period to be appropriate and
publishes its reasons for so finding or
(ii) as to which the self-regulatory
organization consents, the Commission
will:
(A) by order approve or disapprove
such proposed rule change, or
(B) institute proceedings to determine
whether the proposed rule change
should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
Electronic Comments
• Use the Commission’s internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an email to rule-comments@
sec.gov. Please include File Number SR–
FINRA–2022–021 on the subject line.
Paper Comments
• Send paper comments in triplicate
to Secretary, Securities and Exchange
Commission, 100 F Street NE,
Washington, DC 20549–1090.
All submissions should refer to File
Number SR–FINRA–2022–021. This file
number should be included on the
subject line if email is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
65 See Zachary T. Kowaleski, Andrew G.
Sutherland & Felix W. Vetter, Supervisor Influence
on Employee Financial Misconduct (Working
Paper, July 2022), https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=3646617. This paper
presents evidence that could be interpreted as
supportive of the exclusions based on misconduct
and lack of experience.
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internet website (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rule
change that are filed with the
Commission, and all written
communications relating to the
proposed rule change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for website viewing and
printing in the Commission’s Public
Reference Room, 100 F Street NE,
Washington, DC 20549, on official
business days between the hours of 10
a.m. and 3 p.m. Copies of such filing
also will be available for inspection and
copying at the principal office of
FINRA. All comments received will be
posted without change. Persons
submitting comments are cautioned that
we do not redact or edit personal
identifying information from comment
submissions. You should submit only
information that you wish to make
available publicly. All submissions
should refer to File Number SR–FINRA–
2022–021 and should be submitted on
or before September 6, 2022.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.66
J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022–17428 Filed 8–12–22; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–95450; File No. SR–
NASDAQ–2022–046]
Self-Regulatory Organizations; The
Nasdaq Stock Market LLC; Notice of
Filing and Immediate Effectiveness of
Proposed Rule Change To Amend Its
Schedule of Credits, at Equity 7,
Section 118
khammond on DSKJM1Z7X2PROD with NOTICES
August 9, 2022.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’),1 and Rule 19b–4 thereunder,2
notice is hereby given that on August 1,
2022, The Nasdaq Stock Market LLC
(‘‘Nasdaq’’ or ‘‘Exchange’’) filed with the
Securities and Exchange Commission
(‘‘SEC’’ or ‘‘Commission’’) the proposed
rule change as described in Items I, II,
and III, below, which Items have been
prepared by the Exchange. The
66 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
1 15
VerDate Sep<11>2014
17:24 Aug 12, 2022
Jkt 256001
Commission is publishing this notice to
solicit comments on the proposed rule
change from interested persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange proposes to amend the
Exchange’s transaction credits at Equity
7, Section 118(a), as described further
below. The text of the proposed rule
change is available on the Exchange’s
website at https://listingcenter.
nasdaq.com/rulebook/nasdaq/rules, at
the principal office of the Exchange, and
at the Commission’s Public Reference
Room.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission, the
Exchange included statements
concerning the purpose of and basis for
the proposed rule change and discussed
any comments it received on the
proposed rule change. The text of these
statements may be examined at the
places specified in Item IV below. The
Exchange has prepared summaries, set
forth in sections A, B, and C below, of
the most significant aspects of such
statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
The purpose of the proposed rule
change is to amend the Exchange’s
schedule of credits, at Equity 7, Section
118. Specifically, the Exchange
proposes to add (1) a new credit in
Tapes A, B and C for displayed quotes/
orders (other than Supplemental Orders
or Designated Retail Orders) and (2) a
new credit in Tapes A, B and C for nondisplayed midpoint orders (other than
Supplemental Orders).
Credit for Displayed Quotes/Orders
The Exchange currently provides
credits to members for displayed
quotes/orders (other than Supplemental
Orders or Designated Retail Orders). The
Exchange is proposing to add a credit of
$0.0020 per share executed to Tapes A,
B and C. The credit will be available to
a member that, through one or more of
its Nasdaq Market Center MPIDs, (i)
increases its shares of liquidity provided
in all securities by at least 20% as a
percentage of Consolidated Volume
during the month relative to the month
of July 2022 and (ii) has shares of
liquidity provided of least 5 million
average daily volume during the month.
PO 00000
Frm 00088
Fmt 4703
Sfmt 4703
50155
The Exchange hopes that by proposing
the new credit it will incentivize
members to increase their liquidity
providing activity on the Exchange,
which will improve market quality.
Credit for Non-Displayed Midpoint
Orders
The Exchange proposes to provide a
new supplemental credit for midpoint
orders (excluding buy (sell) orders with
midpoint pegging that receive an
execution price that is lower (higher)
than the midpoint of the NBBO) that
provide liquidity to the Exchange. This
credit will be in addition to other
credits otherwise available to members
for adding non-displayed liquidity to
the Exchange, but a member’s activity
will qualify it to receive only one of the
supplemental credits at a time, meaning
that they are not cumulative.
Additionally, members that receive a
supplemental credit will be entitled to
a combined credit (regular and
supplemental) up to a maximum of
$0.0027 per share executed.
Specifically, the Exchange proposes to
provide a supplemental credit of
$0.0001 per share executed for midpoint
orders (excluding buy (sell) orders with
midpoint pegging that receive an
execution price that is lower (higher)
than the midpoint of the NBBO) if the
member, during the month (i) provides
at least 10 million shares of midpoint
liquidity per day during the month; and
(ii) increases providing liquidity
through midpoint orders by 50% or
more relative to the member’s July 2022
consolidated volume provided through
midpoint orders.
The purpose of the new credit is to
provide extra incentive to members that
provide non-displayed liquidity to the
Exchange to do so through midpoint
orders, as well as to grow substantially
the extent to which they provide
midpoint orders to the Exchange
relative to a recent benchmark month.
The Exchange believes that if such
incentives are effective, then any
ensuing increase in midpoint liquidity
to the Exchange will improve market
quality, to the benefit of all participants.
2. Statutory Basis
The Exchange believes that its
proposal is consistent with Section 6(b)
of the Act,3 in general, and furthers the
objectives of Sections 6(b)(4) and 6(b)(5)
of the Act,4 in particular, in that it
provides for the equitable allocation of
reasonable dues, fees and other charges
among members and issuers and other
persons using any facility, and is not
3 15
4 15
E:\FR\FM\15AUN1.SGM
U.S.C. 78f(b).
U.S.C. 78f(b)(4) and (5).
15AUN1
]]>Agencies
[Federal Register Volume 87, Number 156 (Monday, August 15, 2022)]
[Notices]
[Pages 50144-50155]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-17428]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-95452; File No. SR-FINRA-2022-021)
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt
Supplementary Material .18 (Remote Inspections Pilot Program) Under
FINRA Rule 3110 (Supervision)
August 9, 2022.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on July 28, 2022, the Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission'') the proposed rule change as described in Items I,
II, and III below, which Items have been prepared by FINRA. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
FINRA is proposing to amend FINRA Rule 3110 (Supervision) to adopt
a voluntary, three-year remote inspection pilot program to allow member
firms to elect to fulfill their obligation under Rule 3110(c) (Internal
Inspections) by conducting inspections of some or all branch offices
and locations remotely without an on-site visit to such office or
location, subject to specified terms.
The text of the proposed rule change is available on FINRA's
website at https://www.finra.org, at the principal office of FINRA and
at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any
[[Page 50145]]
comments it received on the proposed rule change. The text of these
statements may be examined at the places specified in Item IV below.
FINRA has prepared summaries, set forth in sections A, B, and C below,
of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
Beginning many years ago, SEC staff and FINRA have interpreted
FINRA rules to require member firms to conduct on-site inspections of
branch offices and unregistered offices (i.e., non-branch locations) in
accordance with the periodic schedule described under Rule
3110(c)(1).\3\ Over the years, widespread advancements in technology
and communications in the financial industry have significantly changed
the way in which members and their associated persons conduct their
business and communicate, including the practices that formed the
original bases for an on-site inspection requirement. For example,
making and preserving records electronically have increasingly become
the norm and the preferred recordkeeping medium rather than paper
(e.g., cloud based storage); communications between and among members,
their associated persons and customers commonly take place through
email, video or some other electronic means (e.g., WebEx, Zoom) that
can be monitored electronically by firms; processes for opening
customer accounts and placing trades are moving to online platforms;
and customer funds and securities are frequently and increasingly
transmitted electronically rather than in physical form (e.g., Venmo,
Zelle). Relatedly, the challenges in supervising associated persons who
work in outlying offices or locations have been mitigated over the
years with the prevalent and effective use of technology. For example,
supervisory reviews for outside business activities of associated
persons are often conducted through general internet searches,
including social media and online public records, and by reviewing
electronic communications and customer fund transfers. Similarly,
reviews of correspondence, customer funds and securities, and order
flows are accomplished primarily through the use of electronic tracking
programs or applications.
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\3\ See SEC National Examination Risk Alert, Volume I, Issue 2
(November 30, 2011), https://www.sec.gov/about/offices/ocie/riskalert-bdbranchinspections.pdf and Regulatory Notice 11-54
(November 2011) (``Notice 11-54'') (joint SEC and FINRA guidance
stating, a ``broker-dealer must conduct on-site inspections of each
of its office locations; [Office of Supervisory Jurisdiction
(``OSJs'')] and non-OSJ branches that supervise non-branch locations
at least annually, all non-supervising branch offices at least every
three years; and non-branch offices periodically.''). See also SEC
Division of Market Regulation, Staff Legal Bulletin No. 17: Remote
Office Supervision (March 19, 2004) (``SLB 17'') (stating, in part,
that broker-dealers that conduct business through geographically
dispersed offices have not adequately discharged their supervisory
obligations where there are no on-site routine or ``for cause''
inspections of those offices), https://www.sec.gov/interps/legal/mrslb17.htm.
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FINRA notes that firms are turning to new and innovative regulatory
tools such as artificial intelligence, natural language processing, and
robotics process automation, among others, to strengthen their
compliance programs.\4\ More recently, firms have questioned the
benefits of the on-site inspection requirement for all offices,
particularly in light of these significant technological advances that
have enhanced the effectiveness of a firm's overall and ongoing
supervision and monitoring of the activities occurring at their offices
(registered and unregistered).\5\
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\4\ See generally FINRA White Paper, Technology Based
Innovations for Regulatory Compliance (``RegTech'') on the
Securities Industry (September 2018), https://www.finra.org/sites/default/files/2018_RegTech_Report.pdf.
\5\ Some firms have indicated, for example, that technology has
enhanced real time monitoring of their associated persons by
providing the ability for firm compliance personnel to join, on an
ad hoc basis, digital or virtual meetings occurring between the
firm's associated persons and customers. Firms have also indicated
that technology has allowed them to impose various restrictions or
limitations on associated persons, such as the ability to print firm
records from remote locations using a firm-issued laptop, and only
accepting electronic payments from customers.
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The COVID-19 pandemic has accelerated the use of a wide variety of
compliance and workplace technology as many government and private
employers, including member firms, were driven to adopt a broad remote
work environment by quickly moving their employees out of their usual
office setting to an alternative worksite such as a private residence.
Insights obtained from member firms and other industry representatives
through various pandemic-related initiatives and other industry
outreach have led FINRA to carefully consider whether some processes
and rules, including the manner in which a firm may satisfy its Rule
3110(c) obligations, should be modernized.\6\ Technological
improvements and developments in regulatory compliance have provided
more tools than before to create more effective and efficient
compliance programs. To that end, FINRA believes that regulatory models
should evolve to benefit from the availability and use of effective
technology tools. With the confluence of advances in compliance
technology and the permanent shift to a remote or hybrid work
environment, made more pronounced by the pandemic, FINRA believes that
the optimal use of on-site inspections deserves further consideration.
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\6\ See generally FINRA's Key Topic: COVID-19/Coronavirus
(referencing, among other things, Frequency Asked Questions,
temporary amendments to FINRA rules, and Regulatory Notices such as
Regulatory Notices 20-08 (March 2020) (``Notice 20-08''), regarding
pandemic-related business continuity planning, guidance and
regulatory relief to member firms from some requirements, including
the temporary suspension of the requirement to maintain updated
information on Form U4 (Uniform Application for Securities Industry
Registration or Transfer) and submit Form BR (Uniform Branch Office
Registration Form) for temporary locations; 20-16 (May 2020)
(``Notice 20-16''), describing practices implemented by firms to
transition to, and supervise in, remote work environment during the
COVID-19 pandemic; 20-42 (December 2020) (``Notice 20-42''), seeking
comment on lessons from the pandemic; and 21-44 (December 2021)
(``Notice 21-44''), regarding business continuity planning and
lessons from the pandemic, https://www.finra.org/rules-guidance/key-topics/covid-19. See also SEC Press Release 2022-112 (June 22, 2022)
for the Spring 2022 Regulatory Agenda (quoting SEC Chair Gary
Gensler: ``When I think about the SEC's agenda, I'm driven by two
public policy goals: continuing to drive efficiency in our capital
markets and modernizing our rules for today's economy and
technologies.''), https://www.sec.gov/news/press-release/2022-112?utm_medium=email&utm_source=govdelivery.
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To address the operational challenges in conducting on-site
inspections during the pandemic, FINRA adopted temporary Rule 3110.17,
effective since November 2020, to provide member firms the option to
conduct inspections of their branch offices and non-branch locations
remotely, subject to specified terms therein.\7\ Although uncertainty
about the pandemic remains, firms are beginning to look ahead at the
post-pandemic changes to their workplaces, including more flexible work
hours and hybrid work models--working sometimes on-site in a
conventional office setting and other times remotely in a private
residence or other alternative worksite. As such, FINRA believes now is
the time to assess possible longer-term rule changes and is, therefore,
proposing a voluntary, three-year remote inspections pilot program.
This program would provide FINRA with specific, structured data from
member firm pilot participants to evaluate their experiences--positive
and negative--and inspection findings. This data would enable FINRA to
[[Page 50146]]
systematically assess the overall impact on firms' supervisory systems,
which has not been feasible with information drawn from the pandemic-
related office shutdowns. Moreover, the proposed pilot program would
maintain effective supervision by firms through firms' ongoing
supervisory obligations under Rule 3110, and the proposed limitations
on the firms and locations that would be eligible to participate in the
proposed pilot program.
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\7\ See Securities Exchange Act Release No. 90454 (November 18,
2020), 85 FR 75097 (November 24, 2020) (Notice of Filing and
Immediate Effectiveness of File No. SR-FINRA-2020-040).
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The Inspection Requirement Under Rule 3110
The responsibility of firms to supervise their associated persons
is a critical component of broker-dealer regulation.\8\ Member firms
must supervise all of their associated persons, regardless of their
location, compensation or employment arrangement, or registration
status.\9\ Rule 3110 requires a member, regardless of size or type, to
have a supervisory system for the activities of its associated persons
that is reasonably designed to achieve compliance with the applicable
securities laws and regulations and FINRA rules, and sets forth the
minimum requirements for such supervisory system.\10\
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\8\ See SLB 17, supra note 3; see also Notice 11-54 and Notice
to Members 98-38 (May 1998) (``Notice 98-38'').
\9\ This obligation is derived from Sections 15(b)(4)(E) and
15(b)(6)(A) of the Exchange Act. Section 15(b)(4)(E) provides that
the ``Commission, by order, shall censure, place limitations on the
activities, functions, or operations of, suspend for a period not
exceeding twelve months, or revoke the registration of any broker or
dealer if it finds . . . that such broker or dealer . . . or any
person associated with such broker or dealer . . . has willfully
aided, abetted, counseled, commanded, induced, or procured the
violation by any person of any provision of the Securities Act of
1933, the Investment Advisers Act of 1940, the Investment Company
Act of 1940, the Commodity Exchange Act, [the Securities Exchange
Act of 1934], the rules or regulations under any of such statutes,
or the rules of the Municipal Securities Rulemaking Board, or has
failed reasonably to supervise, with a view to preventing violations
of the provisions of such statutes, rules, and regulations, another
person who commits such a violation, if such other person is subject
to his supervision.'' 15 U.S.C. 78o(b)(4)(E). Section 15(b)(6)(A)(i)
parallels Section 15(b)(4)(E) and provides for the imposition of
sanctions against persons associated with a broker or dealer that
violates those statutes, rules and regulations enumerated in Section
15(b)(4)(E) and other specified subparagraphs under Section
15(b)(4). 15 U.S.C. 78o(b)(6)(A).
\10\ See Rule 3110(a).
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As part of that supervisory system, Rule 3110(c) requires a member
to review, at least annually, the businesses in which it engages for
purposes of detecting and preventing violations of, and achieving
compliance with, applicable securities laws and regulations. The review
must include periodic inspections of each office and examination of
customer accounts to detect and prevent irregularities and abuses. The
inspection requirement is a longstanding supervisory obligation that in
its early form had addressed the inspection requirement for an OSJ
only.\11\ FINRA expanded the inspection requirement to cover branch
offices out of concern for the potential regulatory problems that could
emerge when a registered person, situated in an office other than an
OSJ, was engaging in securities-related activities without the direct
oversight of qualified supervisory personnel and without an annual
inspection.\12\
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\11\ Article III, Section 27(d) of the NASD Rules of Fair
Practice had provided: ``Each member shall review the activities of
each office, which shall include the periodic examination of
customer accounts to detect and prevent irregularities or abuses and
at least an annual inspection of each office of supervisory
jurisdiction.'' See Notice to Members 87-41 (June 1987) (setting
forth the then existing rule text for specified parts of Article
III, Section 27 (Supervision) of the NASD Rules of Fair Practice as
part of a proposal to amend the OSJ and branch office definitions).
\12\ See Securities Exchange Act Release No. 26177 (October 13,
1988), 53 FR 41008 (October 19, 1988) (Order Approving File No. SR-
NASD-88-31). See also Notice to Members 88-84 (November 1988) and
Notice to Members 89-34 (April 1989).
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Currently, Rule 3110(c) sets forth three main requirements for
conducting internal inspections. First, an inspection of an office or
location must occur on a designated frequency. The periodicity of the
required inspection varies depending on the classification of the
location or the nature of the activities that take place: OSJs and
supervisory branch offices must be inspected at least annually; \13\
non-supervisory branch offices, at least every three years; \14\ and
non-branch locations, on a periodic schedule, presumed to be at least
every three years.\15\ Second, a member must retain a written record of
the date upon which each review and inspection occurred, reduce a
location's inspection to a written report and keep each inspection
report on file either for a minimum of three years or, if the
location's inspection schedule is longer than three years, until the
next inspection report has been written.\16\ If applicable to the
location being inspected, the inspection report must include the
testing and verification of the member's policies and procedures,
including supervisory policies and procedures, in specified areas.\17\
Third, to prevent compromising the effectiveness of inspections due to
conflicts of interest, the rule requires a member to ensure that the
person conducting the inspection is not an associated person assigned
to the location or is not directly or indirectly supervised by, or
otherwise reporting to, an associated person assigned to that
location.\18\ All branch offices and non-branch location are subject to
Rule 3110(c).
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\13\ See Rule 3110(c)(1)(A).
\14\ See Rule 3110(c)(1)(B).
\15\ See Rules 3110(c)(1)(C) and 3110.13 (General Presumption of
Three-Year Limit for Periodic Inspection Schedules).
\16\ See Rule 3110(c)(2).
\17\ See Rule 3110(c)(2)(A) (providing that the inspection
report must include, without limitation, the testing and
verification of the member's policies and procedures, including
supervisory policies and procedures for: (1) safeguarding of
customer funds and securities; (2) maintaining books and records;
(3) supervision of supervisory personnel; (4) transmittals of funds
from customers to third party accounts, from customer accounts to
outside entities, from customer accounts to locations other than a
customer's primary residence, and between customers and registered
representatives, including the hand delivery of checks; and (5)
changes of customer account information, including address and
investment objectives changes, and validation of such changes).
\18\ Rule 3110(c)(3) provides a limited exception from this
requirement if a firm determines compliance is not possible either
because of the firm's size or its business model. Rule 3110.14
(Exception to Persons Prohibited from Conducting Inspections)
reflects FINRA's expectation that a firm generally will rely on the
exception in instances where the firm has only one office or has a
business model where small or single-person offices report directly
to an OSJ manager who is also considered the offices' branch office
manager. However, these situations are non-exclusive, and a firm may
still rely on the exception in other instances where it cannot
comply because of its size or business model, provided the firm
complies with the documentation requirements under the rule.
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Further, Rule 3110.12 (Standards for Reasonable Review) sets out
factors that constitute a reasonable review. This provision emphasizes
establishing reasonable supervisory procedures and conducting reviews
of locations, taking into consideration, among other things, the
member's size, organizational structure, scope of business activities,
number and location of the member's offices, the nature and complexity
of the products and services offered by the member, the volume of
business done, the number of associated persons assigned to a location,
the disciplinary history of registered representatives or associated
persons, and any indicators of irregularities or misconduct (i.e.,
``red flags'').\19\ The provision further states
[[Page 50147]]
that the procedures established and reviews conducted must provide that
the quality of supervision at remote (i.e., geographically dispersed)
locations is sufficient to ensure compliance with applicable securities
laws and regulations and with FINRA rules, and that members must be
especially diligent with respect to a non-branch location where a
registered representative engages in securities activities. This
provision incorporates guidance FINRA has previously issued about
supervising associated persons working in geographically dispersed
offices.\20\
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\19\ Red flags that suggest the existence or occurrence of
violations, prompting an unannounced visit, may include: customer
complaints; a large number of elderly customers; a concentration in
highly illiquid or risky investments; an unexplained increase or
change in the types of investments or trading concentration that a
representative is recommending or trading; an unexpected improvement
in a representative's production, lifestyle, or wealth; questionable
or frequent transfers of cash or securities between customer or
third party accounts, or to or from the representative; a
representative that serves as a power of attorney, trustee or in a
similar capacity for a customer or has discretionary control over a
customer's account(s); representative with disciplinary records;
customer investments in one or a few securities or class of
securities that is inconsistent with firm policies related to such
investments; churning; trading that is inconsistent with customer
objectives; numerous trade corrections, extensions, liquidations; or
significant switching activity of mutual funds or variable products
held for short time periods. See SLB 17, supra note 3; see also
Notice 98-38 and Notice to Members 99-45 (June 1999) (``Notice 99-
45'').
\20\ See, e.g., Notices 98-38 and 99-45.
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In 2004, the SEC staff similarly provided guidance on supervision
principles.\21\ At that time, the SEC staff noted that small,
geographically scattered offices presented supervisory challenges when
they were not subject to on-site supervision. The SEC staff observed
that an office's geographic distance from supervisory personnel could
make it easier for registered persons and other employees to carry out
and conceal violative conduct. This general observation was derived
from SEC enforcement cases finding that firms had inadequately
supervised their associated persons working in small, geographically
distant offices due to the failure of their supervisory mechanisms to
detect and prevent misconduct. Citing technology available at the time,
the guidance emphasized that an effective supervisory system for
geographically dispersed offices uses a combination of on-site and off-
site monitoring; it specifically said that ``[c]entralized technology
to monitor the trading and handling of funds in remote office accounts,
as well as the use of personal computers, helps detect misappropriation
of customer funds, selling away, and unauthorized trading, among other
things[.]'' \22\ The guidance supported both routine or ``for cause''
on-site inspections, and encouraged unannounced inspections either on a
random basis or where there are red flags about unusual activity at
those offices. Further, as noted above, in the past both the SEC staff
and FINRA have expressed the view that inspections must have an on-site
component, reflecting how office inspections have been historically
conducted.\23\
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\21\ See SLB 17, supra note 3.
\22\ See SLB 17, supra note 3.
\23\ See note 3, supra.
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Since the time these in-person guidelines were expressed,
developments in technology have enhanced firms' overall and ongoing
supervision and monitoring of the activities occurring at branch
offices and non-branch locations. In response to these developments,
member firms have questioned the historical expectation that firms
satisfy the inspection component of Rule 3110(c) solely in a physical,
on-site manner.
The 2017 Proposal To Allow Remote Inspections and the Impact From the
Pandemic
Even prior to the pandemic, in 2017, FINRA considered a proposal to
give firms the option of satisfying the inspection requirement remotely
for ``qualifying offices'' that met specified criteria.\24\ However,
the COVID-19 pandemic, declared in early 2020,\25\ significantly
changed the industry's standard business operations, forcing member
firms to adapt to a full remote work environment and implement remote
supervisory practices.\26\ FINRA deferred the 2017 Proposal in light of
the pressing need to address significant operational disruptions to the
securities industry, regulators, impacted member firms, investors and
other stakeholders. During this exigent period, FINRA responded to
numerous issues and questions that urgently arose.\27\ Following up on
these actions, FINRA published Notice 20-42 to gain a broader
understanding of member firm experiences during the pandemic. This
notice sought feedback from firms about their experiences in a range of
areas, including how member firms' operations and business models
changed during the public health crisis and how they might further
evolve as the pandemic persisted. Other initiatives included sharing
general practices of firms in transitioning and supervising in the
remote work environment, and providing temporary relief to member firms
from specified FINRA rules and requirements.\28\ In particular, to give
firms an opportunity to better manage their operational challenges and
redirect resources attendant to fulfilling their inspection
obligations, FINRA provided temporary relief to member firms pertaining
to the in-person inspection aspect of Rule 3110(c).\29\
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\24\ See Regulatory Notice 17-38 (November 2017) (``2017
Proposal''). FINRA had requested comment on a proposed amendment to
Rule 3110 to allow remote inspections of ``qualifying offices'' that
met specified criteria, in lieu of on-site inspections of such
offices and locations. In general, many of the comment letters FINRA
had received expressed support for the underlying concept of remote
inspections and offered recommendations on specific criteria to
broaden the potential population of qualifying offices.
\25\ See Centers for Disease Control and Prevention (``CDC''),
International Classification of Diseases, Tenth Revision, Clinical
Modification (ICD-10-CM) (Effective March 18, 2020), https://www.cdc.gov/nchs/data/icd/Announcement-New-ICD-code-for-coronavirus-3-18-2020.pdf. See also WHO Director-General, Opening Remarks at the
Media Briefing on COVID-19 (March 11, 2020), https://www.who.int/director-general/speeches/detail/who-director-general-s-opening-remarks-at-the-media-briefing-on-covid-19-11-march-2020.
\26\ See generally Regulatory Notice 20-16 (May 2020).
\27\ See note 6, supra.
\28\ Some temporary amendments to other FINRA rules still remain
in effect. See Securities Exchange Act Release No. 95281 (July 14,
2022), 87 FR 43335 (July 20, 2022) (Notice of Filing and Immediate
Effectiveness of File No. SR-FINRA-2022-018) (extending the
expiration date of temporary amendments set forth in SR-FINRA-2020-
015 and SR-FINRA-2020-027).
\29\ See Rules 3110.16 and 3110.17.
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Temporary Amendments to the Inspection Requirement Under Rule 3110(c)
At the outset of the pandemic in the United States, many states
issued stay-at-home orders and imposed restrictions on businesses,
social activities, and travel in hopes of slowing the spread of COVID-
19.\30\ In response, many government and private employers, including
member firms, closed their offices and moved their employees to
alternative worksites (e.g., an employee's residence). These
operational changes made it impracticable for member firms to conduct
the on-site inspection component of Rule 3110(c) at most locations for
that year because of limitations on travel to geographically dispersed
OSJs, branch offices, and non-branch locations. In response to the
logistical challenges, FINRA extended the time by which member firms
were required to complete their calendar year 2020 inspection
obligations under Rule 3110(c) to March 31, 2021 with the expectation
that the extension did not relieve firms from the on-site portion of
the inspections of their offices and locations.\31\ However, health and
safety concerns remained unabated and with many restrictive measures
still in place as calendar year 2020 was ending, FINRA adopted Rule
3110.17 to provide member firms the option, subject to specified
requirements under the supplementary material, to complete
[[Page 50148]]
remotely their calendar year inspection obligations without an on-site
visit to the office or location.\32\ This relief was repeatedly
extended until the end of 2022.\33\ Rule 3110.17 will automatically
sunset on December 31, 2022.\34\
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\30\ See note 7, supra, 85 FR 75097, 75098 n.10.
\31\ See Securities Exchange Act Release No. 89188 (June 30,
2020), 85 FR 40713 (July 7, 2020) (Notice of Filing and Immediate
Effectiveness of File No. SR-FINRA-2020-019).
\32\ See note 7, supra.
\33\ See Securities Exchange Act Release No. 93002 (September
15, 2021), 86 FR 52508 (September 21, 2021) (Notice of Filing and
Immediate Effectiveness of File No. SR-FINRA-2021-023); and
Securities Exchange Act Release No. 94018 (January 20, 2022), 87 FR
4072 (January 26, 2022) (Notice of Filing and Immediate
Effectiveness of File No. SR-FINRA-2022-001).
\34\ See note 33, supra.
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Through comments to the 2017 Proposal, Notice 20-42, the various
temporary amendments to Rule 3110, and other engagement with industry
representatives, firms have highlighted that Rule 3110(c) was adopted
well before the prevalence of modern technology, including laptops,
mobile devices, video conferencing capabilities, electronic storage and
electronic surveillance, at a time when on-site inspections were the
only conceivable way firms could inspect and review activities
occurring in outlying offices and locations. The advent of new and
developing technologies has enhanced the effectiveness of a firm's
ongoing supervision and monitoring of associated persons working from
dispersed branch offices and non-branch locations. In addition, firms
have noted that in practice, those technological advances allow a large
portion of inspection work to be conducted electronically, prior to any
on-site visit to the office and location, and that in general, on-site
inspections of many offices and locations are one component of a firm's
overall supervisory system of associated persons and offices, and as
such are no longer an efficient and effective use of limited firm
resources.\35\
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\35\ In response to FINRA's proposed rule changes associated
with Rule 3110.17, one commenter made similar points about the
physical, on-site piece of the inspection process. This commenter
stated that pre-pandemic, an on-site inspection of a branch office
typically consisted of reviewing the lobby area of the office, the
back office (to review safe contents, sales literature, daily
operations logs containing account applications), signage, and the
physical security of the office. See Letter from Carrie L. Chelko,
Chief Compliance Officer, Fidelity Brokerage Services LLC
(``Fidelity Brokerage'') & Norman L. Ashkenas, Chief Compliance
Officer, National Financial Services LLC (``NFS'') and Fidelity
Distributors Company LLC (``Fidelity Distributors''), to Vanessa
Countryman, Secretary, SEC, dated July 28, 2020, in response to
Securities Exchange Act Release No. 89188 (June 30, 2020), 86 FR
40713 (July 7, 2022) (Notice of Filing and Immediate Effectiveness
of File No. SR-FINRA-2020-019) and Letter from Gail Merken, Chief
Compliance Officer, Fidelity Brokerage, Janet Dyer, Chief Compliance
Officer, NFS & John McGinty, Chief Compliance Officer, Fidelity
Distributors, to Vanessa Countryman, Secretary, SEC, dated February
16, 2022, in response to Securities Exchange Act Release No. 94018
(January 20, 2022), 87 FR 4072 (January 26, 2022) (Notice of Filing
and Immediate Effectiveness of File No. SR-FINRA-2022-001).
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However, Rule 3110.17 was adopted in the midst of the pandemic,
when many offices and locations were closed, and employees carried out
their responsibilities from alternative worksites. FINRA recognizes
that the pandemic has changed the conventional thinking on where work
is conducted and this shift in the workforce landscape will unlikely
revert to the model that existed pre-pandemic. As noted above, FINRA
believes that adopting a voluntary, three-year remote inspection pilot
program, under terms based largely on Rule 3110.17, but with
significant safeguards, would allow FINRA the time to collect specified
data from member firm pilot participants to evaluate their experiences
and inspection findings in a uniform, comparable manner in the context
of the emerging hybrid work model. FINRA anticipates that the proposed
pilot program will provide broader systemized information to supplement
the information obtained through the FINRA examination process in an
environment where offices and locations were closed. The information
firms will be required to produce as a pilot program participant will
help FINRA more accurately assess the overall impacts on firms'
supervisory systems to inform FINRA's application of supervisory
requirements to the new work environment, including potentially broader
reliance on remote inspections.
Proposed Voluntary, Three-Year Pilot Program for Remote Inspections
With Rule 3110.17 operational since November 2020, and the
widespread availability and use of technology described above,
regulators are being challenged to consider whether on-site inspections
by firms should be a necessity and if they continue to be an efficient
and effective method for supervising and monitoring associated persons
and offices as part of a firm's overall supervisory system.
As FINRA emphasized in the proposed rule change to adopt Rule
3110.17, the responsibility of firms to supervise their associated
persons on a day-to-day basis is a critical component of broker-dealer
regulation.\36\ The inspection requirement in Rule 3110(c) is just one
element of a reasonably designed supervisory system. FINRA believes
that a pilot period of risk-based on-site supervision is consistent
with firms' core responsibility, as set forth in Rule 3110, 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. The proposed pilot program would build largely on the
terms of Rule 3110.17, but would be enhanced in several ways, including
notably targeted exclusions from participation in the program for
higher risk member firms, and offices or locations. In addition, the
proposed pilot program would require a firm conduct a risk assessment
for each office or location that is selected to be inspected remotely,
documented with the factors considered. Finally, the proposed pilot
program would require a firm to establish and maintain written
supervisory procedures to account for the risk assessment and sets
forth the scope of the program.
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\36\ See note 7, supra.
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A. Scope of Pilot (Proposed Rule 3110.18(a))
Under proposed Rule 3110.18(a), the proposed pilot program would
apply to the required inspections of OSJs, branch offices, and non-
branch locations under the applicable provisions under Rule 3110(c)(1)
for a pilot period of three years starting on the effective date, and
expiring on a date that is three years after the effective date. If the
proposed pilot program is not extended or Rule 3110.18, as may be
amended, is not approved as permanent by the SEC, the proposed
supplementary material will automatically sunset on a date that is
three years after the effective date. In addition, proposed Rule
3110.18(a) would expressly state that members would not be able to
avail themselves of the proposed pilot program after it expires.
B. Use of Remote Inspections (Proposed Rule 3110.18(b))
1. Risk-Based Approach; Risk Assessment (Proposed Rule 3110.18(b)(1))
As described above, Rule 3110(c)(1) provides that an inspection of
an office or location must occur on a designated frequency, and the
periodicity of the required inspection varies depending on the
classification of the location as an OSJ, branch office or non-branch
location. Subject to proposed Rule 3110.18(b)(2) as described below,
proposed Rule 3110.18(b)(1) would provide that a member firm may elect
to conduct the applicable inspection of an office or location during
the pilot period remotely, without necessarily an on-site
[[Page 50149]]
visit for the office or location, when the member reasonably determines
that the purposes of the rule can be accomplished by conducting such
required inspection remotely.\37\ Proposed Rule 3110.18(b)(1) would
also provide that prior to electing a remote inspection for an office
or location, rather than an on-site inspection, the firm must develop a
reasonable risk-based approach to using remote inspections and conduct
and document a risk assessment for that office or location. The
assessment must document the factors considered, including the factors
set forth in Rule 3110.12, and must take into account any higher risk
activities that take place or higher risk associated persons that are
assigned to that location. FINRA expects that higher risk factors at a
particular location would cause a firm to conduct on-site inspections
of such location. Further, under the proposed supplementary material, a
member that is not eligible to conduct remote inspections under
proposed Rule 3110.18(b)(2) must conduct an on-site inspection of that
office or location on the required cycle. Finally, notwithstanding the
pilot program, a member would remain subject to the other requirements
and limitations of Rule 3110(c).\38\
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\37\ As described further below, a member firm that elects to
participate in the proposed pilot program would be subject to the
requirements of proposed Rule 3110.18 for a Pilot Year. See proposed
Rule 3110.18(g).
\38\ For example, as currently required with any physical, on-
site inspection, a member would be required to reduce the remote
inspection to a written report and satisfy the content and record
retention requirements of such report as described in Rule
3110(c)(2). Similarly, a member would remain subject to Rule
3110(c)(3)'s general prohibition against an associated person from
conducting a location's inspection if the person either is assigned
to that location or is directly or indirectly supervised by, or
otherwise reports to, someone assigned to that location. Rule
3110(c)(3) provides a limited exception from this general
prohibition for specified circumstances (e.g., the member has a
business model where a small or single-person offices report
directly to an OSJ manager who is also considered the offices'
branch office manager) by requiring a member to document in the
inspection report both the factors the member used to make the
determination that it could not comply with the general prohibition
and how the inspection otherwise complies with Rule 3110(c)(1).
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2. Ineligible Member Firms, and Offices or Locations (Proposed Rule
3110.18(b)(2))
FINRA is proposing to exclude some member firms or their offices or
locations from participating in the proposed pilot program. The
proposed categories of ineligibility are events or activities of a
member firm or its associated persons that FINRA believes are more
likely to raise investor protection concerns based on the firm's or an
associated person's record of specified regulatory or disciplinary
events.
Under proposed Rule 3110.18(b)(2)(A), a member firm would be
ineligible to conduct remote inspections of any of its offices if any
time during the period of the proposed pilot program, the member is or
becomes: (1) designated as a Restricted Firm under Rule 4111 \39\
(proposed Rule 3110.18(b)(2)(A)(i)); or (2) designated as a Taping Firm
under Rule 3170 \40\ (proposed Rule 3110.18(b)(2)(A)(ii). These rules
expressly address firms that pose higher risks, and for that reason,
would be ineligible to participate in the proposed pilot program.
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\39\ In general, Rule 4111 (Restricted Firm Obligations)
requires member firms that are identified as ``Restricted Firms'' to
deposit cash or qualified securities in a segregated, restricted
account; adhere to specified conditions or restrictions; or comply
with a combination of such obligations. See generally Regulatory
Notice 21-34 (September 2021) (announcing FINRA's adoption of rules
to address firms with a significant history of misconduct).
\40\ In general, Rule 3170 (Tape Recording of Registered Persons
by Certain Firms) requires a member firm to establish, enforce and
maintain special written procedures supervising the telemarketing
activities of all of its registered persons, including the tape
recording of conversations, if the firm has hired more than a
specified percentage of registered persons from firms that meet
FINRA Rule 3170's definition of ``disciplined firm.'' See generally
Regulatory Notice 14-10 (March 2014) (announcing FINRA's adoption of
consolidated rules governing supervision).
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In addition, under proposed Rule 3110.18(b)(2)(B), a member firm's
office or location would be ineligible for a remote inspection if at
any time during the period of the proposed pilot program, an associated
person at such office or location is or becomes: (1) subject to a
mandatory heightened supervisory plan under the rules of the SEC, FINRA
or state regulatory agency (proposed Rule 3110.18(b)(2)(B)(i)); (2)
statutorily disqualified, unless such disqualified person has been
approved (or is otherwise permitted pursuant to FINRA rules and the
federal securities laws) to associate with a member and is not subject
to a mandatory heightened supervisory plan under proposed Rule
3110.18(b)(2)(B)(i) or otherwise as a condition to approval or
permission for such association (proposed Rule 3110.18(b)(2)(B)(ii));
(3) subject to Rule 1017(a)(7) \41\ as a result of one or more
associated persons at such location (proposed Rule
3110.18(b)(2)(B)(iii)); or (4) one or more associated persons at such
location has an event in the prior three years that required a ``yes''
response to any item in Questions 14A(1)(a) and 2(a), 14B(1)(a) and
2(a), 14C, 14D and 14E on Form U4 \42\ (proposed Rule
3110.18(b)(2)(B)(iv)). FINRA believes that the imposition of a
mandatory heightened supervisory plan, a statutorily disqualification,
a Rule 1017(a)(7) review due to significant misconduct, or the
existence of specified disclosures on Form U4 pertaining to criminal
convictions and final regulatory action are indicia of increased risk
to investors at some office or locations, such that they should not be
eligible for remote inspections in accordance with the proposed pilot
program.
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\41\ In general, Rule 1017(a)(7) require a member firm to file a
CMA when a natural person seeking to become an owner, control
person, principal or registered person of the member firm has, in
the prior five years, one or more defined ``final criminal matters''
or two or more ``specified risk events'' unless the member firm has
submitted a written request to FINRA seeking a materiality
consultation for the contemplated activity. Rule 1017(a)(7) applies
whether the person is seeking to become an owner, control person,
principal or registered person at the person's current member firm
or at a new member firm. See generally Regulatory Notice 21-09
(March 2021) (announcing FINRA's adoption of rules to address
brokers with a significant history of misconduct).
\42\ Form U4's Questions 14A(1)(a) and 2(a), 14B(1)(a) and 2(a)
elicit reporting of criminal convictions, and Questions 14C, 14D,
and 14E pertain to regulatory action disclosures.
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A member firm or an office or location subject to one of the
categorical restrictions would not be eligible for remote inspections,
even if the firm's risk assessment concludes that a remote inspection
would be appropriate. A member firm would be required to conduct an on-
site inspection of that office or location on the required cycle. FINRA
believes the proposed list of ineligibility categories is appropriately
derived from existing rule-based criteria that are part of processes to
identify firms that may pose greater concern (e.g., Rules 4111 and
3170) or associated persons that may pose greater concerns due to the
nature of disclosures of regulatory or disciplinary events on the
uniform registration forms. FINRA believes that these objective
categorical restrictions will provide safeguards that will help ensure
that firms maintain effective supervisory procedures during the pilot
period.
C. Written Supervisory Procedures for Remote Inspections (Proposed Rule
3110.18(c))
As part of an effective supervisory system tailored specifically to
the member firm's business and the activities of all its associated
persons, a member must establish and maintain written procedures.\43\
Paragraph (1) (General Requirements) under Rule 3110(b) (Written
Procedures) provides
[[Page 50150]]
that a member must establish, maintain, and enforce written procedures
to supervise the types of business in which it engages and the
activities of its associated persons that are reasonably designed to
achieve compliance with applicable securities laws and regulations, and
with applicable FINRA rules.
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\43\ See Rule 3110(a)(1); see generally Notice 99-45 and
Regulatory Notice 18-15 (April 2018).
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Currently, Rule 3110.17(b) expressly provides that consistent with
a member's obligation under Rule 3110(b)(1), a member that elects to
conduct each of its inspections in the specified calendar years
remotely must amend or supplement its written supervisory procedures to
provide for remote inspections that are reasonably designed to assist
in detecting and preventing violations of and achieving compliance with
applicable securities laws and regulations, and with applicable FINRA
rules. In addition, under Rule 3110.17(b), reasonably designed
procedures for conducting remote inspection of offices or locations
should include, among other things, a description of the methodology,
including technologies permitted by the member, that may be used to
conduct remote inspections. Further, such procedures should include the
use of other risk-based systems employed generally by the member firm
to identify and prioritize for review those areas that pose the
greatest risk of potential violations of applicable securities laws and
regulations, and of applicable FINRA rules.\44\ To underscore the
importance of Rule 3110(b)(1) in the context of the proposed pilot
program, FINRA is proposing to add to the elements currently described
under Rule 3110.17(b) an express provision that the firm must adopt
written supervisory procedures regarding remote inspections that are
reasonably designed to detect and prevent violations of and achieve
compliance with applicable securities laws and regulations, and with
application FINRA rules. In addition, a firm's written supervisory
procedures should also include the factors considered in the risk
assessment made for each applicable office or location pursuant to
proposed Rule 3110.18(b).
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\44\ Offices or locations that may present a higher risk profile
would include, for example, those that have associated persons
engaging in activities that involve handling customer funds or
securities, maintaining books and records as described under
applicable federal securities laws and FINRA rules, order execution
or other activities that may be more susceptible to higher risks of
operational or sales practice wrongdoing, or have associated persons
assigned to an office or location who may be subject to additional
or heightened supervisory procedures.
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D. Effective Supervisory System (Proposed Rule 3110.18(d))
FINRA is proposing to retain the terms of Rule 3110.17(c), without
substantive change, in proposed Rule 3110.18(d). Similar to Rule
3110.17(c), proposed Rule 3110.18(d) would expressly reiterate the
principle that the requirement to conduct inspections of offices and
locations is one part of the member's overall ongoing obligation to
have an effective supervisory system, and therefore a member must
continue with its reviews of the activities and functions occurring at
all offices and locations whether or not the member conducts
inspections remotely. In addition, proposed Rule 3110.18(d) would
provide that a member's remote inspection of an office or location
would be held to the same standards for review applicable to on-site
inspections as set forth under Rule 3110.12.\45\ Further, proposed Rule
3110.18(d) would provide that where a member's remote inspection of an
office or location identifies any indicators of irregularities or
misconduct (i.e., ``red flags''), the member may need to impose
additional supervisory procedures for that office or location, or may
need to provide for more frequent monitoring or oversight of that
office or location, or both, including potentially a subsequent
physical, on-site visit on an announced or unannounced basis.
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\45\ See note 19, supra and accompanying text.
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E. Documentation Requirement (Proposed Rule 3110.18(e))
In general, Rule 3110(c)(2) imposes various documentation
requirements for inspections, including maintaining a written record of
the date upon which each inspection is conducted. Currently, Rule
3110.17(d) requires supplemental documentation by a member that avails
itself of the remote inspection option. The member must maintain and
preserve a centralized record for each of calendar years specified in
the supplementary material that separately identifies: (1) all offices
or locations that had inspections that were conducted remotely; and (2)
any offices or locations that the member determined to impose
additional supervisory procedures or more frequent monitoring, as
provided in Rule 3110.17(c). A member's documentation of the results of
a remote inspection for an office or location must identify any
additional supervisory procedures or more frequent monitoring for that
office or location that were imposed as a result of the remote
inspection. FINRA is proposing to incorporate, without substantive
change, the terms of Rule 3110.17(d) in proposed Rule 3110.18(e), but
make two clarifying changes. One change would be to reference that the
centralize record must be for each of the ``pilot years'' (as defined
in proposed Rule 3110.18(h)), and the other change would be to clarify
that a member's documentation of the results of a remote inspection for
an office or location must identify any additional supervisory
procedures or more frequent monitoring for that office or location that
were imposed as a result of the remote inspection, including whether an
on-site inspection was conducted at such office.
F. Data and Information Collection Requirement (Proposed Rule
3110.18(f))
1. Data and Information (Proposed Rule 3118.18(f)(1))
As noted above, Rule 3110.17 was adopted in the midst of the
pandemic and operationalized in an environment in which many offices
and locations were closed to the public. FINRA believes that the
formalized, uniform collection of data is critical to allow FINRA to
meaningfully assess the effectiveness of remote inspections to help
shape potential permanent amendments to Rule 3110(c) that would
optimize an inspection program in the evolving workplace environment.
FINRA believes having a pilot program for remote inspections with
appropriate conditions, limitations and documentation requirements in
an environment that is resettling into a hybrid workplace model would
provide a clearer picture of the strengths and weaknesses of remote
inspections, without compromising investor protection. Proposed Rule
3110.18(f) would impose upon firms a data and information collection
requirement as a condition for participating in the pilot program. On a
frequency not to exceed quarterly, participating firms would be
required to collect and produce to FINRA, in a manner and format
determined by FINRA, data consisting of separate counts for OSJs,
supervisory branch offices, non-supervisory branch offices, and non-
branch locations, consistent with paragraphs (c)(1)(A), (B) and (C)
under Rule 3110, for several categories, including: (1) the total
number of inspections--on-site and remote--completed during each
calendar quarter; \46\ (2) the number of those office or locations in
each calendar quarter that were subject to an on-site inspection
because of a ``finding'' (defined under proposed Rule 3110.18(f) as an
item that led to any
[[Page 50151]]
remedial action or was listed on the member's inspection report); \47\
(3) the number of locations for which a remote inspection was conducted
in the calendar quarter that identified a finding, the number of
findings, and a list of the most significant findings; \48\ and (4) the
number of locations for which a on-site inspection was conducted in the
calendar quarter that identified a finding, the number of findings, a
list of the most significant findings.\49\ In addition, firms would be
required to provide FINRA their written supervisory procedures for
remote inspections that account for: (1) escalating significant
findings; new hires; supervising brokers with a significant history of
misconduct; and outside business activities and ``doing business as''
(or DBA) designations.\50\ Firms would be required to provide FINRA
with a copy of these written supervisory procedures alongside the first
delivery of the data points described above, and any subsequent
amendments to such procedures for remote inspections.\51\
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\46\ See proposed Rule 3110.18(f)(1)(A), (B) and (C).
\47\ See proposed Rule 3110.18(f)(1)(D).
\48\ See proposed Rule 3110.18(f)(1)(E).
\49\ See proposed Rule 3110.18(f)(1)(F).
\50\ See proposed Rule 3110.18(f)(1)(G)(i) through (iv).
\51\ See proposed Rule 3110.18(f)(1)(G).
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2. Additional Data and Information for Pilot Year 1 (Proposed Rule
3110.18(f)(2))
Proposed Rule 3110.18(f)(2) would address the additional data and
information requirements for Pilot Year 1 (as defined under proposed
Rule 3110.18(h)), if such year covers a period that is less that a full
calendar year. In such case, a member that elects to participate in the
proposed pilot program would be required to collect the following data
and information and provide such data and information to FINRA (in a
manner and format FINRA determines) no later than December 31 of such
first Pilot Year. For items (1) through (3) below, a member would be
required to provide separate counts for OSJs, supervisory branch
offices, non-supervisory branch offices, and non-branch locations
consistent with paragraphs (c)(1)(A), (B) and (C) under Rule 3110: (1)
the number of locations with an inspection completed during the full
calendar year of the first Pilot Year; (2) the number of locations in
item (1) that were inspected remotely during the full calendar year of
the first Pilot Year; and (3) the number of locations in item (1) that
were inspected on-site during the full calendar year of the first Pilot
Year. This additional data and information would provide FINRA the
ability to capture, in the aggregate, complete inspection counts--total
number of Rule 3110(c)(1) inspections (remote and on-site)--for the
entire calendar year in addition to the more detailed data and
information requirements under proposed Rule 3110.18(f)(1).
3. Written Policies and Procedures (Proposed Rule 3110.18(f)(3))
Proposed Rule 3110.18(f)(3) would also remind firms of the general
requirement to establish, maintain and enforce written policies and
procedures that are reasonably designed to comply with the data and
information collection, and transmission requirements of the proposed
pilot program.
4. Remote Inspections Pilot Program Participation (Proposed Rule
3110.18(g))
Proposed Rule 3110.18(g) would set forth the manner in which a firm
would notify FINRA of the firm's election to participate in the
proposed pilot program and to withdraw from it. The proposed rule would
provide that FINRA may, in exceptional cases and where good cause is
shown, waive the applicable timeframes described below for the required
opt-in or opt-out notices.
Proposed Rule 3110.18(g) would require a firm, at least five
calendar days before the beginning of such Pilot Year, to provide FINRA
an ``opt-in notice'' in the manner and format determined by FINRA. By
providing such opt-in notice to FINRA, the firm agrees to participate
in the proposed pilot program for the duration of such Pilot Year and
to comply with the requirements of Rule 3110.18.\52\ A firm that
provides the opt-in notice for a Pilot Year would be automatically
deemed to have elected and agreed to participate in the Remote
Inspections Pilot Program for subsequent Pilot Years (i.e., Pilot Year
2, Pilot Year 3, and Pilot Year 4, if applicable) until the pilot
program expires. Further, proposed Rule 3110.18(g) would describe the
notice requirement for a firm to withdraw from the proposed pilot
program. A firm would be required to provide FINRA with an ``opt-out
notice'' at least five calendar days before the end of the then current
Pilot Year.
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\52\ A firm that participates in a Pilot Year would be committed
to complying with the terms of proposed Rule 3110.18 for that Pilot
Year.
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By way of example, a firm that provides FINRA an opt-in notice on
June 26 to join Pilot Year 1 that begins on July 1 would be
automatically deemed to continue participating in Pilot Year 2 unless
the firm provides FINRA the required opt-out notice no later than
December 26 of Pilot Year 1. To continue with this example, a firm that
was automatically deemed to participate in Pilot Year 2 and determines
in mid-Pilot Year 2 that it does not want to automatically continue
into Pilot Year 3 could elect to withdraw from Pilot Year 3 if it
provides FINRA an opt-out notice at least five calendar days before the
end of Pilot Year 2. However, because Pilot Year 2 is already underway,
the firm would be required to complete Pilot Year 2 in accordance with
proposed Rule 3110.18.
FINRA believes that this proposed operational aspect of the program
would not only establish a cohesive process in which firms and FINRA
may manage program participation but also lend some continuity in data
and information collection that would support FINRA's assessment and
evaluation of the experiences of pilot participants.
5. Definitions (Proposed Rule 3110.18(h))
Proposed Rule 3110.18(h) would set forth the meanings underlying
``Pilot Year'' to explain the duration of the proposed pilot program.
Under proposed Rule 3110.18(h), a ``Pilot Year'' would mean the
following: (1) Pilot Year 1 would be the period beginning on the
effective date of the proposed pilot program and ending on December 31
of the same year; (2) Pilot Year 2 would mean the calendar year period
following Pilot Year 1, beginning on January 1 and ending on December
31; and (3) Pilot Year 3 would mean the calendar year period following
Pilot Year 2, beginning on January 1 and ending on December 31.
Finally, if applicable, where Pilot Year 1 covers a period that is less
than a full calendar year, then Pilot Year 4 would mean the period
following Pilot Year 3, beginning on January 1 and ending on a date
that is three years after the effective date.
6. Failure To Satisfy Conditions (Proposed Rule 3110.18(i))
Proposed Rule 3110.18(i) would address a situation in which a firm
fails to satisfy terms of the proposed pilot program. The proposed
paragraph would provide that a firm that fails to satisfy the
conditions of Rule 3110.18, including the requirement to timely collect
and submit the data and information to FINRA as set forth in proposed
Rule 3110.18(f), would be ineligible to participate in the pilot
program and must conduct on-site inspections of each office and
location
[[Page 50152]]
on the required cycle in accordance with Rule 3110(c).
7. Sunset of Rule 3110.17 (Proposed Rule 3110.18(j))
Proposed Rule 3110.18 would expressly account for the possibility
that the proposed pilot program becomes effective while Rule 3110.17 is
in effect to avoid overlapping provisions. Proposed paragraph (j) would
provide that if Rule 3110.17 has not already expired by its own terms,
it would automatically sunset on the effective date of proposed Rule
3110.18.
Consistent with the principles set forth in prior guidance, FINRA
expects members to establish reasonably designed inspection programs.
The proposed pilot program for remote inspections does not alter the
core obligation of a member firm 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.\53\ As part of the
inspection planning process, FINRA expects members to continue with
their ongoing supervision, including risk analysis of the activities
and functions occurring at all offices or locations. While the option
to conduct remote inspections provides greater choice in how to
effectively supervise some offices or locations, a member must continue
to consider the factors described in Rule 3110.12, along with the
activities taking place there. This analysis may require the member to
conduct a physical, on-site inspection of an office or location. Where
there are indications of problems or red flags at any office or
location, FINRA expects members to investigate them as they would for
any other office or location subject to Rule 3110(c), which may include
an unannounced, on-site inspection of the office or location. FINRA is
committed to diligently monitoring the impacts of remote inspections on
a firms' overall supervisory systems and reviewing the data over the
life of the proposed pilot program to assess how firms apply the
flexibility provided by the pilot program while maintaining an
effective supervisory program.
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\53\ See Rule 3110(a).
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If the Commission approves the proposed rule change, FINRA will
announce the effective date of the proposed rule change in a Regulatory
Notice.
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\54\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest.
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\54\ 15 U.S.C. 78o-3(b)(6).
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The terms of the proposed voluntary, three-year remote inspection
pilot program, while based largely on the terms of Rule 3110.17, which
has been operational since the latter part of 2020 and is set to
automatically sunset on December 31, 2022, would include important
safeguards that would require individual risk assessments of each
office, supplemental written supervisory procedures related to remote
inspections, documentation requirements and obligations to share data
with FINRA to allow for assessment of the pilot program. The proposed
rule change is intended to provide firms that are transitioning to a
hybrid work environment the option to conduct remote inspections of
their offices and locations, subject to specified conditions, while
maintaining effective supervision. FINRA believes that the proposed
pilot program would provide FINRA the appropriate amount of time and
population sample to better evaluate the use of remote inspections in
the unfolding office work environment. FINRA believes the proposed
pilot program, with the proposed safeguards and controls, will provide
firms more flexibility to adapt to changing work conditions. The
proposed pilot program would aid in FINRA's assessment of the
effectiveness of a flexible remote inspection option and its utility in
an environment that is increasingly moving to hybrid workplace models,
without compromising investor protection.
B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
Economic Impact Assessment
FINRA has undertaken an economic impact assessment, as set forth
below, to analyze the regulatory need for the proposed rule change, its
potential economic impacts, including anticipated costs, benefits, and
distributional and competitive effects, relative to the current
baseline, and the alternatives FINRA considered in assessing how best
to meet FINRA's regulatory objectives.
1. Regulatory Need
The proposed pilot program would serve two purposes. First, it
would mitigate potential disruptions to the hybrid work arrangements
that have developed during the pandemic. In particular, for
participating members, the proposed pilot program would limit the
increase in aggregate inspection costs, and the resulting incentive to
reduce the number and type of work locations, that would occur when
temporary relief provided during the pandemic expires.\55\ The proposed
pilot program would not eliminate the need for such adjustments, but it
would allow member firms to focus their on-site inspections on riskier
locations.
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\55\ According to the April Survey of Working Arrangements and
Attitudes (SWAA), post-COVID, many employers are planning to allow
employees to work from home between two and three days per week. See
Jose Maria Barrero, Nicholas Bloom & Steven J. Davis, SWAA April
2022 (April 11, 2022), https://wfhresearch.com/wp-content/uploads/2022/04/WFHResearch_updates-April-2022.pdf. The number of expected
work-from-home days post-pandemic has been increasing steadily since
the January 2021 survey. The SWAA is monthly survey with respondents
that are working-age persons in the United States that had earnings
of at least $20,000 in 2019. Further details about this survey can
be found in https://wfhresearch.com.
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The proposed pilot program would also allow FINRA to assess the
benefits and costs of allowing some element of remote inspection of
branch offices and non-branch locations, under specified conditions, in
the post-pandemic world. FINRA would obtain information from
participating members on certain elements of the risk-based approach
that they implement, the type and frequency of inspections, and certain
outcomes conditional on the type and frequency of inspections, as well
as the type of office or location inspected.
2. Economic Baseline
The economic baseline for the proposed rule change includes both
current and foreseeable workforce arrangements and business practices,
including those that were first developed during the pandemic and have
been modified since. In particular, the economic baseline includes the
innovations, and investments in communication and surveillance
technology, that have supported and continue to support supervision in
the remote work environment.\56\ These
[[Page 50153]]
innovations and investments were developed during the temporary relief
allowing remote inspections in Rule 3110.17, and the temporary
suspension of the requirement to submit branch office applications on
Form BR for new office locations provided in Notice 20-08. The baseline
includes the scheduled expiration of Rule 3110.17 on the effective date
of the proposed Rule 3110.18; and, in order to provide a full
accounting of the likely effects of the proposed rule change, the
analysis also assumes that, going forward, the temporary suspension of
the above requirement is no longer in effect. FINRA expects that
numerous additional office locations would then need to be registered,
greatly expanding the number of inspections, and all inspections would
then need to be conducted on-site.
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\56\ The pandemic propelled increased reliance on technology
solutions in the remote work environment. A Thompson Reuters survey
of compliance and risk practitioners shows a 70% increase in the
reliance on technological solutions and 30% of respondents expected
increases in the budget for RegTech solutions, specifically. See
Thompson Reuters, FinTech, RegTech and the Role of Compliance 2021,
https://legal.thomsonreuters.com/content/dam/ewp-m/documents/legal/en/pdf/reports/fintech-regtech-and-the-role-of-compliance-in-2021.pdf.
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As of April 30, 2022, FINRA's membership included 3,365 firms with
151,463 registered branch offices.\57\ Of these branch offices, 18,290
(12%) are OSJs subject to an annual inspection requirement. The
remaining 133,173 branch locations are non-OSJ branch offices subject
to an inspection requirement at least annually or every three years. In
addition, according to FINRA estimates, there are more than 66,054 non-
branch locations, of which 37,290 are private residences.\58\ A non-
branch location must be inspected on a periodic schedule, presumed to
be at least every three years. These data may be affected by the
temporary relief from certain requirements to update Form U4 and to
submit Form BR provided in Notice 20-08. FINRA estimates that member
firms conduct approximately 84,700 inspections per year.
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\57\ This count excludes firms with membership pending approval,
and withdrawn or terminated from membership.
\58\ Non-branch locations do not have to be registered with
FINRA. The estimates for non-branch locations, including those that
are also private residences, are obtained by reviewing Form U4.
There may be some double counting of non-branch locations if members
record the address differently on more than one Form U4 (e.g., use
``St.'' on one and ``Street'' on another).
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FINRA adopted temporary Rule 3110.17 in late 2020 and the temporary
rule has been extended twice since.\59\ Hence, as of June 2022, member
firms have been able to conduct remote inspections for 18 months. FINRA
staff considered findings from FINRA's examination of member firms and
their branch locations that took place in between 2018 and 2021. This
preliminary review found no significant departures relative to pre-
pandemic examination results.\60\
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\59\ See notes 7 and 33, supra.
\60\ FINRA examinations generally review member activities for
the year preceding the examination, and the vast majority of
examinations takes place during the first 10 months of the calendar
year. Examinations check for compliance with federal laws, rules and
regulations; the specific areas examined in a firm are based on the
risk profile of the firm. FINRA publishes an annual summary of key
observations and best practices across all examinations. See the
published reports at https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#guidance. Due to
this time lag in FINRA examinations, findings may reflect decisions
about remote inspections made by members preceding examinations up
to 12 months. Hence, most FINRA examinations in 2020 will reflect
member planning undertaken prior to the adoption of Rule 3110.17.
Conversely, 66% of FINRA examinations for calendar 2021 have not
been finalized. In addition, FINRA examinations of member firms and
their activities are risk-based. Given the focus on higher risk
firms and some variations in the areas of focus in examinations,
year-on-year comparisons should be treated with caution.
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3. Economic Impacts
As discussed above, absent the proposed rule change, FINRA expects
that numerous additional office locations will need to be registered,
greatly expanding the number of inspections, and all inspections would
then need to be conducted on site. The economic impacts of these
changes would be mitigated by the proposed rule change for firms that
choose to participate in the pilot program.\61\
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\61\ Separately, FINRA has filed a proposed rule change to
establish a Residential Supervisory Location (``RSL''), a new non-
branch location, that would, relative to the baseline, reduce the
number of inspections that members with RSLs would need to conduct
in a year. See Securities Exchange Act Release No. 95379 (July 27,
2022) (Notice of Filing of File No. SR-FINRA-2022-019). For member
firms with locations that would meet the proposed definition of an
RSL, the aggregate cost savings from choosing to participate in the
proposed pilot program would be lower if the RSL proposal were in
place because the cost savings from remote inspections would accrue
over fewer inspections. The qualitative impacts of the proposed
pilot program, however, are similar whether the proposed definition
of an RSL is adopted or not.
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Participants in the pilot program would be expected to take a risk-
based approach to conducting remote inspections. A firm that does not
conduct a remote inspection for an office or location must conduct an
on-site inspection of that office or location on the required cycle and
remains subject to the other requirements of Rule 3110(c). A firm that
chooses to participate in the pilot program (assuming that it is not
otherwise ineligible from participating) would also be required to
provide FINRA with certain data and other information about the risk-
based approach that they implement, the type and frequency of
inspections, and certain outcomes conditional on the type and frequency
of inspections.
Anticipated Benefits
The benefit to firms of choosing to participate in the pilot
program, in an improved health environment, would result from limiting
the increase in travel costs and lost productivity due to time spent
during travel and in the on-site inspection. On-site visits have
material costs from travel expenses and additional staff time. A system
of risk-based on-site and remote inspections will allow firms to more
efficiently deploy compliance resources and to use an on-site component
only when appropriate.
Firms as well as investors may benefit if remote inspections
provide new flexibility in the design of inspection teams. For example,
remote inspections may facilitate the development of specialized
inspection staff that are deployed over more inspections, for shorter
periods of time, in a targeted way. This option may especially benefit
diversified member firms with a variety of product offerings. Remote
inspections can also facilitate the use of inspections that target a
particular area of focus in a member firm's business across all
branches of the member firm.
The proposed rule change may also support the competitiveness of
the broker-dealer industry for individuals who seek professional
positions in compliance.\62\ The expectation of workplace flexibility
and remote work by such individuals may lead them away from the broker-
dealer industry if other segments of financial services or professional
occupations offer more flexible workforce arrangements, with regulatory
frameworks that offer more discretion in how the supervision is
conducted.\63\ Even prior to the pandemic, the scope of on-site
inspections had been much reduced due
[[Page 50154]]
to technological surveillance solutions and centralization of books and
records. The proposed pilot would support continued adoption and
innovation in technological solutions and reductions in the cost of
these solutions.
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\62\ See note 56, supra. See also Jose Maria Barrero, Nicholas
Bloom & Steven J. Davis, Why Working from Home Will Stick (NBER
Working Paper 28731, April 2021), https://wfhresearch.com/wp-content/uploads/2021/04/w28731-3-May-2021.pdf, who point to a
lasting effect of the pandemic on work arrangements, in particular
for those with higher education and earnings; and Alexander Bick,
Adam Blandin & Karel Mertens, Work from Home Before and After the
COVID-19 Outbreak, (Working Paper, February 2022), https://karelmertenscom.files.wordpress.com/2022/02/wfh_feb17_2022_paper.pdf, who find consistent results, with a higher
adoption rate of work from home jobs in Finance and Insurance,
relative to other industries, reflected in Figure 10.
\63\ For example, Advisers Act Rule 206(4)-7 does not require
Registered Investment Advisers to conduct in-person inspections or
reviews of its offices or personnel.
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Participants in the proposed pilot program would provide FINRA with
periodic (not to exceed quarterly) data on the frequency and type of
inspections (on-site or remote), counts of findings from inspections
subdivided by category of office or location, qualitative information
about these findings, and certain information about the written
supervisory procedures for remote inspections they are required to
have.\64\ Depending on the number and types of firms that participate
in the proposed pilot program, this data may allow FINRA to identify
differences in risks between remote versus on-site inspection, both
conditional on the observable characteristics and policies of firms and
overall, the extent of variation in these risks across firms and firm
characteristics, and factors associated with very high or low risks.
The proposed pilot program has the potential to yield a more thorough
collection of sensitive information in a structured manner than
voluntary submissions or a survey of FINRA members could provide. This
data will be useful both for monitoring for risks as the pilot proceeds
and, with sufficient participation, for developing a balanced
assessment of the potential impact of permitting further remote
inspection.
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\64\ In addition, if the effective date of the rule is such that
the first year of the pilot program covers a period less than a full
calendar year, participating firms would be required to provide, the
data and information specified in proposed Rule 3110.18(f)(2).
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Anticipated Costs
Participation in the proposed pilot program is voluntary, and the
proposed rule change provides firms with an additional method for
complying with certain supervisory requirements without removing other
methods of compliance. Eligible pilot participants will therefore
participate in the pilot program only if doing so is beneficial to
their operations relative to complying with current Rule 3110. The cost
of complying with the requirements of the proposed pilot program is a
factor in this decision. These costs include conducting risk-based
analyses for inspections and providing aggregated data on findings to
FINRA. The data request in particular may require more standardization
and aggregation of inspection findings than some member firms typically
conduct. The data request may also not use the same terms or formats
used by compliance officers for reporting and tracking inspection
findings. Firms may need to develop new written supervisory procedures
and new trainings for compliance staff to ensure that all required data
is accurate and compiled and submitted to FINRA in a timely manner.
Firms will incur new ongoing costs both for compliance and monitoring
for compliance.
Supervision and inspections are intended to identify not only the
activities that violate member procedures or FINRA rules but also poor
practices that might ultimately allow for such violations. FINRA
recognizes that remote inspections may be less likely to identify such
practices or activities as on-site inspections. FINRA believes that
risks to member firms and investors from remote inspections are
mitigated by the proposed requirements to have written supervisory
procedures for remote inspections, the proposed requirement to conduct
and document risk assessments, the proposed limitations on the firms
and locations that would be eligible to participate in the proposed
pilot program, and the technology already employed for day-to-day
supervision. In addition, FINRA will continue to closely monitor the
outcomes of examinations during the pilot program period.
4. Alternatives Considered
The proposed pilot program would continue for three years. FINRA
staff considered alternative durations for the program. FINRA members
firms vary by business model and organizational structure, so a shorter
program is less likely to yield enough data on inspection findings to
allow for meaningful comparisons between on-site and remote inspection
regimes across members. In addition, inspections are typically planned
by members well ahead of time, so some members may not implement the
requirements of the program until well into the duration of the pilot
program. It may also help firms and the policy development process if
FINRA had enough data to meaningfully evaluate well ahead of the
expiration of the pilot program.
FINRA staff also considered a proposed pilot program that would not
exclude certain firms, like restricted firms, from participating in the
program. These additional restrictions will limit the availability of
the pilot program as well as the potential learnings from the program.
As a result, the same restrictions may ultimately need to be carried
over into any ongoing program of risk-based examinations. The exclusion
of such firms, however, should reduce any risk of customer harm from
not having on-site inspections.\65\
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\65\ See Zachary T. Kowaleski, Andrew G. Sutherland & Felix W.
Vetter, Supervisor Influence on Employee Financial Misconduct
(Working Paper, July 2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3646617. This paper presents evidence that
could be interpreted as supportive of the exclusions based on
misconduct and lack of experience.
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C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) by order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-FINRA-2022-021 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2022-021. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's
[[Page 50155]]
internet website (https://www.sec.gov/rules/sro.shtml). Copies of the
submission, all subsequent amendments, all written statements with
respect to the proposed rule change that are filed with the Commission,
and all written communications relating to the proposed rule change
between the Commission and any person, other than those that may be
withheld from the public in accordance with the provisions of 5 U.S.C.
552, will be available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. Copies of such filing also will be available for inspection and
copying at the principal office of FINRA. All comments received will be
posted without change. Persons submitting comments are cautioned that
we do not redact or edit personal identifying information from comment
submissions. You should submit only information that you wish to make
available publicly. All submissions should refer to File Number SR-
FINRA-2022-021 and should be submitted on or before September 6, 2022.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\66\
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\66\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022-17428 Filed 8-12-22; 8:45 am]
BILLING CODE 8011-01-P
