Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment Nos. 1 and 2, To Adopt Supplementary Material .19 (Residential Supervisory Location) Under FINRA Rule 3110 (Supervision), 82447-82464 [2023-25880]

Download as PDF Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices Under the Exchange Act and relevant rules thereunder, SROs, including OCC, determine for themselves when to file a proposed rule change. The Exchange Act defines the process and time within which the Commission may act,65 and Section 19(b)(2)(C) of the Exchange Act requires the Commission to approve a proposed rule change of a SRO if it finds that such change is consistent with the Exchange Act and rules and regulations thereunder that are applicable to the SRO.66 Concerns regarding rules proposed by the Commission may be presented as comments to such rules so that the Commission may consider them in determining what, if any, final rule it will adopt. Based on the foregoing, the Commission finds that the proposed rule change is consistent with the requirements of Rule 17Ad–22(e)(17)(i) under the Exchange Act.67 IV. Conclusion On the basis of the foregoing, the Commission finds that the proposed rule change, as modified by Partial Amendment No. 1, is consistent with the requirements of the Exchange Act, and in particular, the requirements of Section 17A of the Exchange Act 68 and the rules and regulations thereunder. It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act,69 that the proposed rule change (SR– OCC–2023–003), as modified by Partial Amendment No. 1, be, and hereby is, approved. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.70 Sherry R. Haywood, Assistant Secretary. [FR Doc. 2023–25883 Filed 11–22–23; 8:45 am] ddrumheller on DSK120RN23PROD with NOTICES1 BILLING CODE 8011–01–P 65 See, e.g., 15 U.S.C. 78s(b)(2)(A)(ii) (allowing the Commission to extend the period for review by not more than 45 days if the Commission determines that a longer period is appropriate and publishes the reasons for such determination). 66 15 U.S.C. 78s(b)(2)(C). 67 17 CFR 240.17Ad–22(e)(17)(i). 68 In approving this proposed rule change, the Commission has considered the proposed rules’ impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 69 15 U.S.C. 78s(b)(2). 70 17 CFR 200.30–3(a)(12). VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 SECURITIES AND EXCHANGE COMMISSION [Release No. 34–98980; File No. SR–FINRA– 2023–006] Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment Nos. 1 and 2, To Adopt Supplementary Material .19 (Residential Supervisory Location) Under FINRA Rule 3110 (Supervision) November 17, 2023. I. Introduction On March 29, 2023, the Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’) 1 and Rule 19b–4 thereunder,2 a proposed rule change (SR–FINRA–2023–006) to adopt new Supplementary Material .19 (Residential Supervisory Location) under FINRA Rule 3110 (Supervision). The proposed rule change, as modified by Amendment Nos. 1 and 2 (hereinafter, the ‘‘proposed rule change’’ unless otherwise specified), would treat a private residence in which an associated person engages in specified supervisory activities, subject to certain safeguards and limitations, as a nonbranch location.3 Treated as non-branch locations, these newly defined Residential Supervisory Locations (‘‘RSLs’’) would be subject to inspections on a regular periodic schedule (presumed to be at least every three years) instead of the annual inspection currently required for ‘‘offices of supervisory jurisdiction’’ (‘‘OSJs’’) and ‘‘supervisory branch offices.’’ 4 The proposed rule change was published for public comment in the Federal Register on April 6, 2023.5 On May 16, 2023, FINRA consented to an extension of the time period in which the Commission must approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Exchange Act Release No. 97237 (Mar. 31, 2023), 88 FR 20568, 20568 (Apr. 6, 2023) (File No. SR–FINRA–2023–006 (‘‘Notice’’) (citing FINRA Rules 3110(c)(1)(C) and 3110.13), https:// www.govinfo.gov/content/pkg/FR-2023-04-06/pdf/ 2023-07145.pdf. 4 See id. 5 Id. 2 17 PO 00000 Frm 00135 Fmt 4703 Sfmt 4703 82447 approve or disapprove the proposed rule change to July 5, 2023.6 The Commission received thirteen comment letters in response to the Notice.7 On July 3, 2023, FINRA filed an amendment to the proposed rule change (‘‘Amendment No. 1’’).8 On July 5, 2023, the Commission published a notice of filing of Amendment No. 1 and an order instituting proceedings to determine whether to approve or disapprove the proposed rule change, as modified by Amendment No. 1.9 On July 25, 2023, FINRA responded to the comment letters received in response to the Notice.10 The Commission received twelve comment letters in response to the notice of Amendment No. 1 and order instituting proceedings. On September 14, 2023, FINRA responded to the comment letters received in response to the notice of Amendment No. 1 and order instituting proceedings, and it filed an amendment to the proposed rule change (‘‘Amendment No. 2’’).11 On September 22, 2023, FINRA consented to an extension of the time period in which the Commission must approve or disapprove the proposed rule change to December 2, 2023.12 The Commission is publishing this order to provide notice of the filing of, and to solicit comments on, Amendment No. 2 from interested persons and is approving the proposed 6 See letter from Sarah Kwak, Associate General Counsel, Office of General Counsel, FINRA, to Daniel Fisher, Branch Chief, Division of Trading and Markets, Commission, dated May 16, 2023, https://www.finra.org/sites/default/files/2023-05/srfinra-2023-006-extension-no-1.pdf. 7 The comment letters are available at https:// www.sec.gov/comments/sr-finra-2023-006/ srfinra2023006.htm. 8 See Amendment No. 1, https://www.finra.org/ sites/default/files/2023-07/sr-2023-006-amendmentNo1.pdf. 9 Exchange Act Release No. 97839 (July 5, 2023), 88 FR 44173 (July 11, 2023) (File No. SR–FINRA– 2023–006), https://www.govinfo.gov/content/pkg/ FR-2023-07-11/pdf/2023-14523.pdf. 10 See letter from Sarah Kwak, Associate General Counsel, Office of General Counsel, FINRA, to Vanessa Countryman, Secretary, Commission, dated July 25, 2023 (‘‘FINRA Response I’’), https:// www.sec.gov/comments/sr-finra-2023-006/ srfinra2023006-235699-491502.pdf. 11 See Amendment No. 2, https://www.finra.org/ sites/default/files/2023-09/SR-FINRA-2023-006Amendment-2.pdf; letter from Kosha Dalal, Vice President and Associate General Counsel, Office of General Counsel, FINRA, to Vanessa Countryman, Secretary, Commission, dated Sept. 14, 2023 (‘‘FINRA Response II’’), https://www.sec.gov/ comments/sr-finra-2023-006/srfinra2023006259039-608182.pdf. 12 See letter from Sarah Kwak, Associate General Counsel, Office of General Counsel, FINRA, to Daniel Fisher, Branch Chief, Division of Trading and Markets, Commission, dated Sept. 22, 2023, https://www.finra.org/sites/default/files/2023-09/srfinra-2023-006-ext2.pdf. E:\FR\FM\24NON1.SGM 24NON1 82448 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices rule change, as modified by Amendment Nos. 1 and 2, on an accelerated basis. II. Description of the Proposed Rule Change FINRA stated that technological advancements and an emerging remote workplace prompted it to reconsider the regulatory framework for the supervision and inspection of residential locations.13 As a result of this evaluation, FINRA determined to issue the proposed rule change ‘‘to create a regulatory framework in which member firms can capably continue to carry out their obligation to effectively inspect the supervisory activities taking place at an office or location . . . on a regular periodic schedule without diminishing investor protection.’’ 14 After describing the current regulatory framework, the Commission describes the proposed rule change. A. Background 1. FINRA Rule 3110 (Supervision) FINRA Rule 3110 requires a member firm to establish and maintain a supervisory system for the activities of its associated persons ‘‘that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules’’ (hereinafter, a ‘‘reasonably designed supervisory system’’).15 The rule identifies the minimum requirements of a member’s supervisory system, including: (1) the registration and designation as a branch office or an OSJ of each location,16 including the main office, that meets the definitions contained in FINRA Rule 3110(f); 17 and (2) inspecting all offices and locations in accordance with Rule 3110(c).18 The rule also establishes the frequency with which a member firm must inspect its locations.19 The frequency is based, in part, on whether the location is designated as a supervisory branch office, a nonsupervisory branch office, an OSJ, or a non-branch location.20 Each of these designations is described in turn. a. Supervisory and Non-Supervisory Branch Offices FINRA Rule 3110(f)(2) defines a ‘‘branch office’’ as: (1) any location where one or more associated persons of a member regularly conducts the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of, any security, or is held out as such; 21 or (2) any location that is responsible for supervising the activities of persons associated with the member at one or more non-branch locations of the member.22 A branch office is either ‘‘supervisory’’ (i.e., it ‘‘supervises one or more non-branch locations’’) or ‘‘non-supervisory’’ (i.e., it ‘‘does not supervise one or more nonbranch locations’’).23 The branch office’s type dictates the frequency of its inspection cycle: a supervisory branch office must be inspected at least annually,24 and a non-supervisory branch office must be inspected at least every three years.25 b. Office of Supervisory Jurisdiction A branch office may be further designated as an OSJ. An OSJ is any office of a member at which any one or more of the following functions take place: (1) order execution or market making; (2) structuring of public offerings or private placements; (3) maintaining custody of customers’ funds or securities; (4) final acceptance (approval) of new accounts on behalf of the member; (5) review and endorsement of customer orders pursuant to Rule 3110(b)(2); 26 (6) final approval of retail communications for 20 See id. 21 FINRA ddrumheller on DSK120RN23PROD with NOTICES1 13 Notice at 20569. 14 Id. at 20573. 15 FINRA Rule 3110(a). 16 Unless otherwise specified, the Commission uses the term ‘‘location’’ in this order to refer to any location where a firm does business, such as an OSJ, supervisory branch office, non-supervisory branch office, or non-branch location, as applicable. 17 See FINRA Rule 3110(a)(3). 18 See FINRA Rule 3110(c). On November 17, 2023, the Commission issued an approval order for File Number FINRA–2023–007, which adopted new Supplementary Material .18 (Remote Inspections Pilot Program) under FINRA Rule 3110 (Supervision). FINRA Rule 3110.18 establishes a voluntary, three-year pilot program to allow eligible member firms to elect to fulfill their inspection obligations under FINRA Rule 3110(c) by conducting inspections of eligible OSJs, branch offices, and non-branch locations remotely without an on-site visit to such locations, subject to specified safeguards and limitations. 19 See FINRA Rule 3110(c)(1). VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 Rule 3110(f)(2)(A). Rule 3110(f)(2)(B). 23 See Notice at 20573 (‘‘[A]ny location that is responsible for supervising the activities of persons associated with the member at one or more nonbranch locations of the member is a branch office (i.e., a supervisory branch office).’’); FINRA Rule 3110(c)(1)(B) (‘‘Each member shall inspect at least every three years every branch office that does not supervise one or more non-branch locations.’’). 24 FINRA Rule 3110(c)(1)(A) (‘‘Each member shall inspect at least annually . . . any branch office that supervises one or more non-branch locations.’’). 25 FINRA Rule 3110(c)(1)(B) (‘‘Each member shall inspect at least every three years every branch office that does not supervise one or more non-branch locations.’’). 26 FINRA Rule 3110(b)(2) provides that ‘‘[t]he supervisory procedures required by [Rule 3110(b) (Written Procedures)] shall include procedures for the review by a registered principal, evidenced in writing, of all transactions relating to the investment banking or securities business of the member.’’ 22 FINRA PO 00000 Frm 00136 Fmt 4703 Sfmt 4703 use by persons associated with the member pursuant to Rule 2210(b)(1), except for an office that solely conducts final approval of research reports; 27 or (7) having responsibility for supervising the activities of persons associated with the member at one or more other branch offices of the member.28 If a location satisfies any one of those criteria, it is an OSJ that must be inspected at least annually.29 c. Non-Branch Locations FINRA explained that seven types of locations—often referred to as ‘‘unregistered offices’’ or ‘‘non-branch locations’’—are excluded from the definition of ‘‘branch office.’’ 30 Member firms must inspect their non-branch locations on a regular periodic schedule, presumed to be at least every three years.31 Two of the seven exclusions address residential locations: the primary residence exclusion and the nonprimary residence exclusion. The primary residence exclusion 32 excludes from registration as a branch office any non-supervisory 33 location that is an associated person’s primary residence, provided that: (1) only one associated person, or multiple associated persons who reside at that location and are 27 ‘‘In general, with some exceptions, paragraph (b)(1) of Rule 2210 (Communications with the Public) requires that an appropriately qualified registered principal approve each retail communication prior to use or filing with FINRA.’’ Notice at 20574 n.57. 28 FINRA Rule 3110(f)(1). 29 See FINRA Rule 3110(c)(1)(A). In 1988, the National Association of Securities Dealers (‘‘NASD,’’ the predecessor to FINRA) stated that the amended OSJ definition, among other proposed amendments, focused on creating a ‘‘supervisory ‘chain of command,’ in which qualified supervisory personnel are appointed to carry out the firm’s supervisory obligations . . . .’’ See Notice at 20572 (quoting NASD Notice to Members 88–11 (Feb. 8, 1988), https://www.finra.org/rules-guidance/ notices/88-11). 30 See Notice at 20574; FINRA Rule 3110(f)(2)(A)(i)–(vii) (identifying seven exclusions from the definition of branch office). 31 See FINRA Rules 3110(c)(1)(C) (stating that ‘‘[i]n establishing such schedule, the member shall consider the nature and complexity of the securities activities for which the location is responsible and the nature and extent of contact with customers. The member’s written supervisory and inspection procedures shall set forth the schedule and an explanation regarding how the member determined the frequency of the examination.’’) and 3110.13 (stating that ‘‘[i]n establishing a non-branch location inspection schedule, there is a general presumption that a non-branch location will be inspected at least every three years, even in the absence of any indicators of irregularities or misconduct (i.e., ‘‘red flags’’). If a member establishes a longer periodic inspection schedule, the member must document in its written supervisory and inspection procedures the factors used in determining that a longer periodic inspection cycle is appropriate.’’). 32 FINRA Rule 3110(f)(2)(A)(ii). 33 See supra note 23 and corresponding text. E:\FR\FM\24NON1.SGM 24NON1 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 members of the same immediate family, conduct business at the location; (2) the location is not held out to the public as an office, and the associated person does not meet with customers at the location; (3) neither customer funds nor securities are handled at that location; (4) the associated person is assigned to a designated branch office, and such designated branch office is reflected on all business cards, stationery, retail communications, and other communications to the public by such associated person; (5) the associated person’s correspondence and communications with the public are subject to the member firm’s supervision in accordance with Rule 3110; (6) electronic communications (e.g., email) are made through the member’s electronic system; (7) all orders are entered through the designated branch office or an electronic system established by the member that is reviewable at the branch office; (8) written supervisory procedures pertaining to supervision of sales activities conducted at the residence are maintained by the member; and (9) a list of the residence locations is maintained by the member.34 The non-primary residence exclusion 35 excludes from registration as a branch office any non-supervisory location, ‘‘other than a primary residence, that is used for securities business for less than 30 business days in any one calendar year, provided [that] the member complies with’’ the conditions described in (1) through (8) of the primary residence exclusion (detailed above).36 FINRA explained that the non-primary residence exclusion typically applies to a vacation or second home.37 Notwithstanding these residential exclusions, a private residence is considered a branch office if it ‘‘is responsible for supervising the activities of persons associated with the member at one or more non-branch locations of the member,’’ 38 and it is an OSJ if it performs any of the seven functions associated with OSJs.39 Therefore, a primary or non-primary residence is subject to registration and annual inspection if the associated person’s activities at the residence cause it to be an OSJ or supervisory branch office.40 34 See FINRA Rule 3110(f)(2)(ii)(a) through (i). Rule 3110(f)(2)(A)(iii). 35 FINRA 36 Id. 37 See NASD Notice to Members 06–12 (Mar. 21, 2006), https://www.finra.org/rules-guidance/ notices/06-12; see also Notice at 20574. 38 FINRA Rule 3110(f)(2)(B). 39 FINRA Rule 3110(f)(1). 40 See FINRA Rules 3110(a)(3) and 3110(c)(1)(A). VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 2. FINRA’s Stated Reasons for the Proposed Rule Change FINRA stated that during the COVID– 19 pandemic, many member firms developed ‘‘hybrid workforce models’’ in which ‘‘some employees may work permanently in an alternative location[,] such as a private residence, other employees may spend some time in alternative locations and some time onsite in a conventional office setting, and some may work on-site full time.’’ 41 FINRA ‘‘believes this model will endure’’ notwithstanding the end of the COVID–19 Public Health Emergency in May 2023.42 Many of the supervisors who began working from home during the pandemic continue to do so, at least on a part-time basis.43 Under the current regulatory framework, those supervisors likely conduct activities that would require the registration and designation of their private residences as supervisory branch offices or OSJs under Rule 3110(a)(3) and thus would require inspections at least annually under Rule 3110(c)(1)(A).44 During the pandemic, FINRA temporarily suspended members’ requirements to comply with the registration and inspection obligations applicable to new locations. Specifically, in March 2020, FINRA temporarily suspended the requirement for member firms to submit branch office registration applications on Form BR (Uniform Branch Office Registration Form) for any newly opened temporary office locations or space-sharing arrangements established because of the pandemic (the ‘‘Form BR Temporary Suspension’’).45 The Form BR Temporary Suspension remains in effect. But when it ends, FINRA believes that current FINRA rules would require member firms to ‘‘either curtail 41 Notice at 20579. Notice at 20569; Centers for Disease Control and Prevention, COVID–19: End of Public Health Emergency (PHE) Declaration (Sept. 12, 2023), https://www.cdc.gov/coronavirus/2019-ncov/ your-health/end-of-phe.html. 43 See Notice at 20575 (‘‘Firms responded that they relied extensively on technology to support their effective transition to the remote work environment and enhance the supervision of geographically dispersed associated persons, many of whom have been working from home since early 2020 and may continue to do so in some manner in the current environment.’’); FINRA Regulatory Notice 21–44 (Dec. 2021), https://www.finra.org/ rules-guidance/notices/21-44 (‘‘To mitigate the impacts of the pandemic, member firms have relied heavily on remote offices and alternative work arrangements (e.g., working from home or a backup or recovery location) for a broad range of personnel.’’). 44 See FINRA Rules 3110(a)(3) and 3110(c)(1)(A). 45 See FINRA Regulatory Notice 20–08 (Mar. 2020) (‘‘Regulatory Notice 20–08’’), https:// www.finra.org/rules-guidance/notices/20-08; see also Notice at 20569 n.7. 42 See PO 00000 Frm 00137 Fmt 4703 Sfmt 4703 82449 activities at residential locations or register large numbers of residential locations as OSJs or supervisory branch offices.’’ 46 As set forth above, registering a private residence as an OSJ or supervisory branch office would trigger a corresponding annual inspection requirement.47 FINRA explained that the proposed rule change would alter the regulatory framework to accommodate hybrid workforce models and mitigate the costs associated with registering and inspecting so many private residences.48 FINRA stated that the proposed rule change ‘‘would allow firms to effectively and more efficiently carry out their supervisory responsibilities to review the activities of each office or location while preserving investor protections.’’ 49 B. The Proposed Rule Change The proposed rule change would adopt new Supplementary Material .19 (Residential Supervisory Location) under FINRA Rule 3110 (Supervision) and would treat a private residence at which an associated person engages in certain supervisory activities as a nonbranch location, subjecting it to inspections on a regular periodic schedule (presumed to be at least every three years) instead of the annual schedule required for OSJs and supervisory branch offices.50 To help mitigate the potential risks associated with a less frequent inspection cycle, the proposed rule change also would establish safeguards that limit RSL designation to certain firms and locations based on criteria designed to minimize risk.51 These safeguards would: (1) exclude certain member firms from designating any location as an RSL; 52 (2) exclude certain locations from designation as an RSL; 53 (3) impose certain conditions that a member firm and/or its candidate locations must meet prior to RSL 46 See Notice at 20579. Rule 3110(c)(1)(A). 48 Notice at 20575, 20579 (explaining that the proposed rule change would reduce, but not eliminate, the need to register and inspect residential locations as supervisory branch offices or OSJs). 49 Id. at 20569. 50 See id. at 20568. 51 See id. at 20568–69 (‘‘FINRA believes the proposal strikes an appropriate balance to preserve investor protection while developing a risk-based approach for designating residential supervisory locations that includes key safeguards with respect to, among other things, books and records of the member, while excluding locations where higher risk activities may take place or associated persons that may pose higher risk are assigned.’’). 52 See proposed Rule 3110.19(b). 53 See proposed Rule 3110.19(c). 47 FINRA E:\FR\FM\24NON1.SGM 24NON1 82450 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices designation; 54 (4) require any member firm that elects to designate an RSL to provide certain data to FINRA on a regular basis; 55 and (5) require any eligible member firm to develop a reasonable risk-based approach to designating a location as an RSL and conduct and document a risk assessment for the associated person assigned to that location prior to designating a location as an RSL.56 1. Member Firm Ineligibility Criteria Under proposed Rule 3110.19(b), a member firm would be ineligible to designate any of its locations as an RSL if the member: (1) is currently designated as a Restricted Firm under Rule 4111 (Restricted Firm Obligations) (hereinafter, a ‘‘Restricted Firm’’); 57 (2) is currently designated as a Taping Firm under Rule 3170 (Tape Recording of Registered Persons by Certain Firms) (hereinafter, a ‘‘Taping Firm’’); 58 (3) is currently undergoing, or is required to undergo, a review under Rule 1017(a)(7) as a result of one or more associated persons at such location (hereinafter, a ‘‘continuing membership review’’); 59 (4) receives a notice from FINRA pursuant to Rule 9557 (Procedures for Regulating Activities under Rule 4110 (Capital Compliance), Rule 4120 (Regulatory Notification and Business Curtailment), or Rule 4130 (Regulation of Activities of Section 15C Members Experiencing Financial and/or Operational Difficulties)), unless FINRA has otherwise permitted activities in writing pursuant to such rule; 60 (5) is or becomes suspended by FINRA (hereinafter, a ‘‘suspended firm’’); 61 (6) based on the date in the Central Registration Depository (‘‘CRD’’), had its FINRA membership become effective within the prior twelve months; 62 or (7) 54 See proposed Rule 3110.19(a). proposed Rule 3110.19(d). 56 See proposed Rule 3110.19(e). 57 See proposed Rule 3110.19(b)(1). 58 See proposed Rule 3110.19(b)(2). 59 See proposed Rule 3110.19(b)(3). FINRA Rule 1017(a)(7) ‘‘requires a member firm to file an application for continuing membership 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.’’ Notice at 20577 n.94 (citing FINRA Regulatory Notice 21–09 (Mar. 2021) (announcing FINRA’s adoption of rules to address brokers with a significant history of misconduct)). 60 See proposed Rule 3110.19(b)(4). 61 See proposed Rule 3110.19(b)(5). 62 See proposed Rule 3110.19(b)(6). ddrumheller on DSK120RN23PROD with NOTICES1 55 See VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 is or has been found within the past three years by the SEC or FINRA to have violated Rule 3110(c).63 FINRA stated that these exclusions address ‘‘attributes of a member firm that FINRA believes are more likely to raise investor protection concerns . . . .’’ 64 For example, FINRA explained that ‘‘a member firm that is experiencing issues complying with its capital requirements or that has been suspended by FINRA is more likely to face significant operational challenges that may negatively impact the firm’s overall supervision of its associated persons.’’ 65 Similarly, FINRA stated that ‘‘a firm that has been a FINRA member for less than 12 months is often still implementing its business plan and developing a supervisory system appropriate[ly] tailored to the firm’s specific attributes and structure.’’ 66 FINRA also stated that firms with recent Rule 3110(c) violations have ‘‘demonstrated challenges in developing or maintaining a robust inspection program.’’ 67 2. Location Ineligibility Criteria A location of an otherwise eligible member firm 68 would be ineligible for RSL designation if one or more associated persons at the location: (1) is a designated supervisor who has less than one year of direct supervisory experience with the member, or an affiliate or subsidiary of the member that is registered as a broker-dealer or investment adviser; 69 (2) is functioning as a principal for a limited period in accordance with Rule 1210.04 (Registration Requirements); 70 (3) is subject to a mandatory heightened supervisory plan under the rules of the SEC, FINRA, or a state regulatory agency; 71 (4) is statutorily disqualified, unless such disqualified person (A) has been approved (or is otherwise permitted pursuant to FINRA rules and the federal securities laws) to associate with a member and (B) is not subject to a mandatory heightened supervisory plan under proposed Rule 3110.19(c)(3) or otherwise as a condition to approval or permission for such association; 72 (5) 63 See proposed Rule 3110.19(b)(7). at 20576. 65 Id. at 20577. 66 Id. 67 Id. 68 Id. at 20578 (‘‘Proposed Rule 3110.19 would not be available to a member firm or private residence that meets any of the ineligibility criteria in proposed paragraphs (b) or (c), respectively, under Rule 3110.19 even with the safeguards and limitations listed in proposed Rule 3110.19(a).’’). 69 See proposed Rule 3110.19(c)(1). 70 See proposed Rule 3110.19(c)(2). 71 See proposed Rule 3110.19(c)(3). 72 See proposed Rule 3110.19(c)(4). 64 Notice PO 00000 Frm 00138 Fmt 4703 Sfmt 4703 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 (Uniform Application for Securities Industry Registration or Transfer Registration) (‘‘Form U4’’); 73 or (6) has been notified in writing that such associated person is now subject to any Investigation 74 or Proceeding,75 as such terms are defined for Form U4, by the SEC, a self-regulatory organization, including FINRA, or state securities commission (or agency or office performing like functions) (each, a ‘‘Regulator’’) expressly alleging they have failed reasonably to supervise another person subject to their supervision with a view to preventing the violation of any provision of the Securities Act of 1933 (‘‘Securities Act’’), the Exchange Act, the Investment Advisers Act of 1940 (‘‘Investment Advisers Act’’), the Investment Company Act of 1940 (‘‘Investment Company Act’’), the Commodity Exchange Act, any state law pertaining to the regulation of securities, or any rule or regulation under any of such acts or laws, or any of the rules of the Municipal Securities Rulemaking Board (‘‘MSRB’’) or other self-regulatory organization, including FINRA.76 73 See proposed Rule 3110.19(c)(5). Form U4’s Questions 14A(1)(a), 14A2(a), 14B(1)(a), and 14B2(a) elicit reporting of criminal convictions, and Questions 14C, 14D, and 14E pertain to regulatory action disclosures. See Notice 20577 n.97. 74 As defined for purposes of Form U4, an Investigation ‘‘[i]ncludes: (a) grand jury investigations; (b) U.S. Securities and Exchange Commission investigations after the ‘Wells’ notice has been given; (c) FINRA investigations after the ‘Wells’ notice has been given or after a person associated with a member, as defined by The FINRA By-Laws, has been advised by the staff that it intends to recommend formal disciplinary action; (d) NYSE Regulation investigations after the ‘Wells’ notice has been given or after a person over whom NYSE Regulation has jurisdiction, as defined in the applicable rules, has been advised by NYSE Regulation that it intends to recommend formal disciplinary action; (e) formal investigations by other SROs; or (f) actions or procedures designated as investigations by jurisdictions. The term investigation does not include subpoenas, preliminary or routine regulatory inquiries or requests for information, deficiency letters, ‘blue sheet’ requests or other trading questionnaires, or examinations.’’ FINRA, Form U4 Explanation of Terms at 2 (Apr.—Version 2014.1), https:// www.finra.org/sites/default/files/AppSupportDoc/ p468051.pdf. 75 As defined for purposes of Form U4, a Proceeding is ‘‘[a] formal administrative or civil action initiated by a governmental agency, selfregulatory organization or a foreign financial regulatory authority; a felony criminal indictment or information (or equivalent formal charge), or a misdemeanor criminal information (or equivalent formal charge), but does not include an arrest or similar charge effected in the absence of a formal criminal indictment or information (or equivalent formal charge).’’ Id. at 3. 76 See proposed Rule 3110.19(c)(6); Amendment No. 1. E:\FR\FM\24NON1.SGM 24NON1 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices Nonetheless, this sixth exclusion would permit an affected location to be designated or redesignated as an RSL upon the earlier of: (1) the member’s receipt of written notification from the applicable Regulator that such Investigation has concluded without further action; or (2) one year from the date of the last communication from such Regulator relating to such Investigation.77 This relief would not apply to an associated person subject to a covered Proceeding.78 FINRA stated that these exclusions ‘‘reflect the appropriate limitations on the private residences that can be designated’’ as an RSL.79 For example, FINRA stated that ‘‘specified disclosures on Form U4 pertaining to criminal convictions[,] . . . final regulatory action[,] and the imposition of a mandatory heightened supervisory plan are indicia of increased risk to investors at some firms and locations . . . .’’ 80 FINRA further explained that requiring one-year of direct supervisory experience recognizes that ‘‘a new supervisor at the current member firm may need time to become knowledgeable about that firm’s systems, people, products, and overall compliance culture,’’ even if that new supervisor comes to the member firm with prior supervisory experience from another firm.81 But FINRA also stated that affiliates and subsidiaries of FINRA members ‘‘may share systems and have similar compliance cultures to meet their obligations under federal securities laws.’’ 82 For that reason, FINRA stated that the proposed rule change would ‘‘permit the one-year supervisory experience minimum to be satisfied by also counting supervisory experience accrued at an affiliate or subsidiary of the member firm that is registered as a broker-dealer or investment adviser.’’ 83 3. Conditions for Designation as a Residential Supervisory Location The proposed rule change includes ten conditions that an eligible member firm and its eligible location must meet prior to designating the location as an RSL. Under proposed Rule 3110.19(a), a location that is the associated person’s private residence where supervisory activities 84 are conducted would be ddrumheller on DSK120RN23PROD with NOTICES1 77 See id. id. 79 Notice at 20578. 80 Id. 81 Id. 82 Amendment No. 1 at 5. 83 Id. at 4. 84 Proposed Rule 3110.19(a) indicates that the ‘‘supervisory activities’’ include ‘‘those described in Rule 3110(f)(1)(D) through (G) or in Rule 3110(f)(2)(B).’’ The supervisory activities identified 78 See VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 considered a non-branch location, provided that: (1) only one associated person, or multiple associated persons who reside at that location and are members of the same immediate family, conduct business at the location; 85 (2) the location is not held out to the public as an office; 86 (3) the associated person does not meet with customers or prospective customers at the location; 87 (4) any sales activity that takes place at the location complies with the conditions set forth under Rule 3110(f)(2)(A)(ii) or (iii); 88 (5) neither customer funds nor securities are handled at that location; 89 (6) the associated person is assigned to a designated branch office, and such designated branch office is reflected on all business cards, stationery, retail communications, and other communications to the public by such associated person; 90 (7) the associated person’s correspondence and communications with the public are subject to the member firm’s supervision in accordance with Rule 3110; 91 (8) the associated person’s electronic communications (e.g., email) are made through the member’s electronic system; 92 (9)(A) the member has a recordkeeping system to make, keep current, and preserve records required to be made, kept current, and preserved under applicable securities laws and regulations, FINRA rules, and the member’s own written supervisory procedures under Rule 3110, (B) such records are not physically or electronically maintained and preserved at the office or location, and (C) the member has prompt access to such records; 93 and (10) the member has determined that its surveillance and in FINRA Rule 3110(f)(1)(D) through (G) include: final acceptance (approval) of new accounts on behalf of the member; review and endorsement of customer orders, pursuant to FINRA Rule 3110(b)(2); final approval of retail communications for use by persons associated with the member, pursuant to Rule 2210(b)(1), except for an office that solely conducts final approval of research reports; and, responsibility for supervising the activities of persons associated with the member at one or more other branch offices of the member. FINRA Rule 3110(f)(2)(B) addresses ‘‘any location that is responsible for supervising the activities of persons associated with the member at one or more nonbranch locations of the member . . . .’’ 85 See proposed Rule 3110.19(a)(1). 86 See proposed Rule 3110.19(a)(2). 87 See proposed Rule 3110.19(a)(3). 88 See proposed Rule 3110.19(a)(4). Rule 3110(f)(2)(A)(ii) and (iii) identify the conditions for the primary and non-primary residence exclusions. For a discussion of those exclusions, see Section II(A)(1)(c) above. 89 See proposed Rule 3110.19(a)(5). 90 See proposed Rule 3110.19(a)(6). 91 See proposed Rule 3110.19(a)(7). 92 See proposed Rule 3110.19(a)(8). 93 See proposed Rule 3110.19(a)(9). PO 00000 Frm 00139 Fmt 4703 Sfmt 4703 82451 technology tools are appropriate to supervise the types of risks presented by each RSL, and that these tools may include but are not limited to: (A) firmwide tools, such as an electronic recordkeeping system, electronic surveillance of email and correspondence, electronic trade blotters, regular activity-based sampling reviews, and tools for visual inspections, (B) tools specific to the RSL based on the activities of the associated person assigned to the location, products offered, and restrictions on the activity of the RSL, and (C) system tools, such as secure network connections and effective cybersecurity protocols.94 FINRA stated that these conditions ‘‘would strengthen a firm’s ability to monitor the supervisory activities occurring at [an RSL] and act to lower the overall risks associated with such location . . . .’’ 95 FINRA explained that the first eight conditions are derived from those for the primary and non-primary residence exclusions, ‘‘which align with the SEC’s Books and Records Rules [and] were developed in coordination with other [self-regulatory organizations] and state securities regulators.’’ 96 For that reason, FINRA stated that member firms have ‘‘experience with monitoring and supervising these conditions.’’ 97 FINRA coupled those eight conditions with a new books and records requirement and a condition addressing technology and surveillance tools.98 4. Obligation To Provide List of RSLs to FINRA Under proposed Rule 3110.19(d), any member that elects to designate any location of the member as an RSL would be required to ‘‘provide FINRA with a current list of all locations designated as RSLs by the 15th day of the month following each calendar quarter in the manner and format (e.g., through an electronic process or such other process) as FINRA may prescribe.’’ 99 FINRA acknowledged that the CRD system 100 94 See proposed Rule 3110.19(a)(10). at 20576. 96 Id.; see FINRA Rule 3110(f)(2)(A)(ii) and (iii). 97 Notice at 20576. 98 Id. 99 Proposed Rule 3110.19(d). FINRA stated that it is ‘‘exploring ways to provide this information to state regulators in a practical format.’’ Notice at 20578 n.108. 100 The CRD system is the central licensing and registration system used by the U.S. securities industry and its regulators. In general, information in the CRD system is obtained through the uniform registration forms that firms and regulatory authorities complete as part of the securities industry registration and licensing process. The uniform registration forms are Form BD (Uniform Application for Broker-Dealer Registration), Form 95 Notice E:\FR\FM\24NON1.SGM Continued 24NON1 82452 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices currently provides access to ‘‘information regarding the offices and locations (registered and unregistered) to which associated persons required to be registered are assigned,’’ but it explained that ‘‘requiring member firms to affirmatively provide this information to FINRA through a scheduled process would make this information more readily accessible to regulators.’’ 101 5. Risk Assessment ddrumheller on DSK120RN23PROD with NOTICES1 Under proposed Rule 3110.19(e), a member would be required to ‘‘develop a reasonable risk-based approach to designating an office or location as an RSL[] and conduct and document a risk assessment for the associated person assigned to that office or location’’ prior to designating that location as an RSL (hereinafter, a ‘‘person-specific risk assessment’’).102 The proposed rule change would require documentation of the factors considered, including, among others, whether the associated person at such office or location is now subject to: (1) customer complaints, taking into account the volume and nature of the complaints; (2) heightened supervision other than where such office or location is ineligible for RSL designation under proposed Rule 3110.19(c)(3); (3) any failure to comply with the member’s written supervisory procedures; (4) any recordkeeping violation; and (5) any regulatory communications from a Regulator indicating that the associated person at such office or location failed reasonably to supervise another person subject to their supervision, including but not limited to, subpoenas, preliminary or routine regulatory inquiries or requests for information, deficiency letters, ‘‘blue sheet’’ requests or other trading questionnaires, or examinations.103 Furthermore, the proposed rule change would require the member to account for ‘‘any higher risk activities that take place [at] or a higher risk associated BDW (Uniform Request for Broker-Dealer Withdrawal), Form BR (Uniform Branch Office Registration Form), Form U4, Form U5 (Uniform Termination Notice for Securities Industry Registration), and Form U6 (Uniform Disciplinary Action Reporting Form). These forms, particularly Forms U4 and U5, collect administrative, regulatory, criminal history, customer complaint, and other information about brokers, while Form BD collects similar information about broker-dealer firms. FINRA, state, and other regulatory authorities use this information in connection with their licensing and regulatory activities, and member firms use this information to help them make informed employment decisions. See Exchange Act Release No. 88760 (Apr. 28, 2020), 85 FR 26502, 26503 (May 4, 2020) (File No. SR–FINRA–2020– 012). 101 Notice at 20578. 102 Proposed Rule 3110.19(e). 103 Id. VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 person that is assigned to that office or location.’’ 104 ‘‘Consistent with [a firm’s] obligation under Rule 3110(a),’’ the proposed rule change also would provide that ‘‘the member’s supervisory system must take into consideration any indicators of irregularities or misconduct (i.e., ‘red flags’) when designating an office or location as an RSL.’’ 105 Further, the proposed rule change would provide that ‘‘[r]ed flags should . . . be reviewed in determining whether it is reasonable to maintain the RSL designation of such office or location in accordance with the requirements of [proposed Rule 3110.19] and [that] the member should consider evidencing steps taken to address those red flags where appropriate.’’ 106 III. Discussion and Commission Findings After careful review of the proposed rule change, the comment letters, and FINRA’s responses to the comments, the Commission finds that the proposed rule change, as modified by Amendment Nos. 1 and 2, is consistent with the requirements of the Exchange Act and the rules and regulations thereunder that are applicable to a national securities association.107 Specifically, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Exchange Act, which requires, among other things, that FINRA rules 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.108 Pursuant to FINRA Rule 3110, member firms must ‘‘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.’’ 109 Rule 3110 provides that ‘‘[e]ach member shall establish and maintain supervisory procedures that must take into consideration, among other things, the firm’s size, organizational structure, scope of business activities, number and location of the firm’s offices, the nature and complexity of the products and services offered by the firm, the volume 104 Id. 105 Id. 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’), etc.’’ 110 Rule 3110(c) further requires member firms to conduct internal inspections of each location, and it identifies the presumed frequency of inspection for various types of locations.111 Importantly, Rule 3110 provides that ‘‘[f]inal responsibility for proper supervision . . . rest[s] with the member.’’ 112 The proposed rule change is consistent with these obligations. It permits certain eligible firms to inspect certain eligible locations on a regular periodic schedule (presumed to be at least every three years) instead of an annual schedule. If an eligible member firm and its eligible location comply with various conditions and safeguards—including a person-specific risk assessment—designed to minimize risks, the proposed rule change would provide this additional flexibility for the member firm in structuring its reasonably designed supervisory system. But it does not automatically transform residences into RSLs subject to less frequent inspection. Nor does it require firms to treat all residences where certain supervisory activities are performed as RSLs. It only permits a member firm to consider whether an RSL designation for a specific location would be appropriate in light of the rule’s requirements and the member firm’s broader obligation to establish and maintain a reasonably designed supervisory system. Accordingly, and as explained in more detail below, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Exchange Act. A. Residential Supervisory Location Terms and Conditions The proposed rule change has various terms and conditions that limit the RSL designation to certain firms and locations. The Commission addresses the terms and conditions, and any related comments, in turn. 1. Member Firm Ineligibility Criteria As stated above, under proposed Rule 3110.19(b), a member firm would be ineligible to designate any of its locations as an RSL if the member is subject to any of seven firm-level 106 Id. 107 In approving this rule change, the Commission has considered the rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 108 15 U.S.C. 78o–3(b)(6). 109 FINRA Rule 3110(a). PO 00000 Frm 00140 Fmt 4703 Sfmt 4703 110 FINRA Rule 3110.12. Rule 3110(c)(1). 112 See id. Rule 3110(a)(1) through (7) identify certain minimum requirements for the reasonably designed supervisory system. See generally FINRA Rule 3110. 111 FINRA E:\FR\FM\24NON1.SGM 24NON1 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 eligibility exclusions. The seven exclusions address members that are designated as Restricted Firms under FINRA Rule 4111; members designated as Taping Firms under FINRA Rule 3170; members undergoing, or required to undergo, a continuing membership review under FINRA Rule 1017(a)(7) as a result of one or more associated persons at such location; firms that have received a notice from FINRA pursuant to FINRA Rule 9557, unless FINRA has otherwise permitted activities in writing pursuant to such rule; firms suspended by FINRA; firms that have been FINRA members for less than one year; and firms that have been found within the past three years by the SEC or FINRA to have violated Rule 3110(c).113 One commenter specifically supported the inclusion of the firm-level exclusions covering suspended firms and firms that have been FINRA members for less than one year.114 No commenter opposed any of the proposed seven firm-level eligibility exclusions. FINRA reasonably determined to exclude a member firm from participation in the Pilot if the member firm is subject to any of the six proposed firm-level ineligibility criteria. Each of these criteria identifies—and excludes— member firms with characteristics that may indicate increased risk of noncompliance. Specifically, Restricted Firms have a history of misconduct or a high concentration of registered persons with a significant history of misconduct that gave rise to the designation,115 while Taping Firms are subject to heightened regulatory oversight because they employ a ‘‘significant number of registered persons [who] previously worked for firms that have been expelled from the industry or have had their registrations revoked for inappropriate sales practices.’’ 116 Moreover, a member firm that is required to undergo a continuing membership review pursuant to FINRA Rule 1017(a)(7) has a person at the proposed RSL who is seeking to become an owner, control person, principal, or 113 See supra notes 57 through 63 and accompanying text. 114 Theresa J. Manderski, SVP, Chief Compliance Officer—BD, Davenport & Company LLC, to the Commission, dated Apr. 27, 2023, at 2 (‘‘Davenport’’). 115 Proposed Rule 3110.19(b)(1); see FINRA, Rule 4111 Frequently Asked Questions, https:// www.finra.org/rules-guidance/key-topics/ protecting-investors-from-misconduct/faq# :∼:text=A%20Restricted% 20Firm%20is20a,such%20in%20a%20Department %20decision. 116 Proposed Rule 3110.19(b)(2); FINRA, FINRA Taping Rule (FINRA Rule 3170), https:// www.finra.org/rules-guidance/guidance/taping-rule. VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 82453 registered person of the member firm who has, in the previous five years, one or more ‘‘final criminal matters’’ or two or more ‘‘specified risk events.’’ 117 Finally, if the Commission or FINRA has found that a member firm has violated Rule 3110(c) within the past three years, the member firm has demonstrated a recent difficultly implementing a compliant inspection program.118 Member firms covered by these exclusions therefore have a history of non-compliance or have registered representatives who have a history of (or come from a member firm with a history of) non-compliance. It is therefore reasonable for FINRA to determine that member firms that fall into these categories are not eligible to designate RSLs and exercise the flexibility that the proposed rule change provides in designing a member firm’s supervisory system. Furthermore, Rule 9557 notices are sent to member firms that are experiencing financial or operational difficulties.119 Additionally, suspension of a member firm by FINRA would be based on FINRA’s determination that the member firm has failed to comply with its regulatory requirements or suspension is needed for the safety of investors, creditors, or other members because of the member firm’s financial or operational difficulties.120 Such member firms raise concerns about their ability to comply with their obligations and may present risk to others. As such, it is reasonable to conclude that these member firms should not be eligible for the proposed rule change that is designed to afford member firms greater flexibility in designing their supervisory systems. Moreover, member firms that have been FINRA members for less than 12 months may need additional time to develop their supervisory and compliance systems to effectively comply with applicable securities laws and rules.121 This time period also provides FINRA and other regulators with time to conduct inspections of new member firms to determine their compliance with their regulatory obligations before they may be eligible for the flexibility provided in the proposed rule.122 It is therefore reasonable for FINRA to determine that firms must be operating for a certain amount of time before they can be eligible to designate RSLs. One year provides a reasonable balance between providing member firms with the flexibility for supervision allowed in the proposed rule and concerns that member firms need to develop experience operating before they are given such flexibility. In sum, these proposed exclusions limit RSL designation to certain member firms without indicia that their business operations, supervisory system, or inspection programs may lack the maturity or safeguards to fully address the potential risks associated with RSLs.123 117 Proposed Rule 3110.19(b)(3) (exclusion applicable where the person responsible for triggering a continuing membership review is located at the proposed RSL); FINRA Rule 1017(a)(7). ‘‘The term ‘final criminal matter’ means a criminal matter that resulted in a conviction of, or plea of guilty or nolo contendere (‘no contest’) by, a person that is disclosed, or is or was required to be disclosed, on the applicable Uniform Registration Forms.’’ FINRA Rule 1011(h). ‘‘Specified risk events’’ include certain investmentrelated, consumer-initiated (1) customer arbitration awards, (2) civil judgments, (3) customer arbitration settlements, or (4) civil litigation settlements. FINRA Rule 1011(p)(1), (2). ‘‘Specified risk events’’ also include certain investment-related civil actions or regulatory actions that result in (1) monetary sanctions for a dollar amount at or above $15,000 or (2) a bar, expulsion, revocation, recission, or suspension. See FINRA Rule 1011(p)(3), (4). 118 Proposed Rule 3110.19(b)(7). 119 Proposed Rule 3110.19(b)(4); see FINRA Rule 9557 (Procedures for Regulating Activities Under Rules 4110, 4120 and 4130 Regarding a Member Experiencing Financial or Operational Difficulties); see also FINRA Regulatory Notice 09–71 (Dec. 2009) (announcing SEC approval of consolidated FINRA rules governing financial responsibility), https://www.finra.org/rules-guidance/notices/09-71. 120 Proposed Rule 3110.19(b)(5); A suspended firm may have been suspended because of a violation of ‘‘federal securities laws, rules or regulations thereunder, the rules of the Municipal Securities Rulemaking Board, or FINRA rules.’’ FINRA Rule 8310(a)(3), (5); see FINRA Rule 9550 Series. 2. Location Ineligibility Criteria As stated above, proposed Rule 3110.19(c) would prohibit RSL designation for any location if one or more associated persons at the location is subject to any of six location-level eligibility exclusions.124 These six exclusions address associated persons with less than one year of direct supervisory experience with the member or its affiliate or subsidiary, who are functioning as a principal for a PO 00000 Frm 00141 Fmt 4703 Sfmt 4703 121 Proposed Rule 3110.19(b)(6). Exchange Act Rule 15b2–2, 17 CFR 240.15b2–2 (generally requiring inspection of a newly registered broker dealer within six months for compliance with applicable financial responsibility rules and within 12 months for all other applicable regulatory requirements). 123 Cf. Exchange Act Release No. 90635 (Dec. 10, 2020), 85 FR 81540 (Dec. 16, 2020) (Order Approving File No. SR–FINRA–2020–011 to Address Brokers With a Significant History of Misconduct); Exchange Act Release No. 92525 (July 30, 2021), 86 FR 42925 (Aug. 5, 2021) and 86 FR 49589 (Sept. 3, 2021) (Corrected Order Approving File No. SR–FINRA–2020–041 to Adopt FINRA Rules 4111 (Restricted Firm Obligations) and 9561 (Procedures for Regulating Activities Under Rule 4111)). 124 Proposed Rule 3110.19(c). 122 See E:\FR\FM\24NON1.SGM 24NON1 82454 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices another broker-dealer.’’ 130 Although one commenter acknowledged that a member firm could still permit a new supervisor to work from a residence registered as an OSJ or supervisory branch office in the first year, that commenter emphasized that this proposed exclusion would ‘‘create[] an additional burden that could have a disparate impact on people with years of experience who are reentering the workforce after time off to care for a. Less Than One Year of Supervisory children or other family members.’’ 131 Experience In the event that FINRA declined to delete the proposed exclusion, some As originally proposed in the Notice, commenters requested modifications to proposed Rule 3110.19(c)(1) would have the provision instead.132 For example, prohibited an RSL designation for any some commenters asked FINRA to location with a designated supervisor modify the proposed exclusion to with less than one year of direct permit RSL designation for locations supervisory experience with the with supervisors who have as little as member firm.126 Several commenters three months of direct supervisory urged FINRA to eliminate this experience with the member firm.133 127 exclusion. One commenter stated that Alternatively, some commenters urged requiring one year of supervisory FINRA to permit RSL designation for experience is ‘‘not supported by any supervisors with less than one year of objective evidence and can only be supervisory experience with the 128 characterized as arbitrary.’’ These member firm so long as the member firm commenters indicated that this conducts an inspection of the RSL proposed exclusion would negatively within the first year of designation.134 impact the employment opportunities In response, FINRA amended for ‘‘experienced supervisory personnel proposed Rule 3110.19(c)(1) to address who may switch firms or those ‘‘the comments about the potential associated persons who are stand-outs at adverse impacts [this condition] could a firm [and secure a] promotion to a have on hiring efforts.’’ 135 As modified supervisory role.’’ 129 Another by Amendment No. 1, the proposed rule commenter emphasized that ‘‘there is change would prohibit RSL designation not a sufficient investor protection for any location with a designated justification for this language to offset supervisor who has less than one year the substantial chilling effect on the of direct supervisory experience with transfer of experienced supervisory the member or an affiliate or subsidiary personnel from one broker-dealer to limited period in accordance with Rule 1210.04 (Registration Requirements), who are subject to a mandatory heightened supervisory plan, who are statutorily disqualified, who are required to make disclosures about certain criminal and regulatory actions, or who are subject to a covered regulatory investigation or proceeding.125 These six exclusions are discussed in more detail below. ddrumheller on DSK120RN23PROD with NOTICES1 125 See supra notes 69 through 78 and accompanying text. 126 Notice at 20577. 127 Letters from Eversheds Sutherland LLP on behalf of the Committee of Annuity Insurers, to Secretary, Commission, dated Apr. 27, 2023, at 2 (‘‘CAI’’); David T. Bellaire, Esq., Executive Vice President & General Counsel, Financial Services Institute, to Secretary, Commission, dated Apr. 27, 2023, at 4–5 (‘‘FSI’’); Mark Quinn, Director of Regulatory Affairs, Cetera Financial Group, to Sherry Haywood, Assistant Secretary, Commission, dated Apr. 27, 2023, at 2–3 (‘‘Cetera I’’); Bernard V. Canepa, Managing Director & Associate General Counsel, Securities Industry and Financial Markets Association, to Vanessa Countryman, Secretary, Commission, dated Apr. 27, 2023, at 2 n.6 (‘‘SIFMA I’’). 128 Cetera I at 2. 129 FSI at 4; see Cetera I at 2 (‘‘Branches would be ineligible for classification as an RSL simply because individual supervisors who may have been employed by the member firm for many years but who have previously either performed functions not directly related to supervision were not formally designated as supervisors. In addition, branches that house supervisors who have a lot of experience in supervisory roles with other member firms but have been employed by the current member firm for less than one year would be ineligible for RSL status.’’). VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 130 CAI at 2; see FSI at 4 (‘‘this proposed criterion would place an unnecessary impediment on firms to hire and retain talent in a competitive job market.’’); Cetera I at 3 (‘‘If a member firm wishes to hire a supervisor in a remote location, the arbitrary one-year requirement will prevent them from classifying their residence as an RSL for at least one year, which may prevent the firm from hiring the individual. [. . .] The benefits of this are minimal and do not outweigh the burdens.’’). 131 FSI at 4. 132 See FSI at 5; letter from Mark Seffinger, Chief Compliance Officer, LPL Financial, to Vanessa Countryman, Secretary, Commission, dated May 25, 2023, at 2 (‘‘LPL I’’); ASA 3. 133 FSI at 5 (suggesting a ‘‘three or six-month requirement’’ if such a requirement remains in the proposed rule change); cf. Cetera I at 2 (suggesting that the time period ‘‘could as easily be three months or three years.’’). 134 LPL I at 2 (‘‘[W]e support a requirement for such [a] branch to be inspected within the first year of designation versus registering that location as an OSJ.’’); letter from Christopher A. Iacovella, President & Chief Executive Officer, American Securities Association, to Vanessa Countryman, Secretary, Commission, dated May 25, 2023, at 3 (‘‘ASA’’) (‘‘Rather than prohibiting new supervisors from taking advantage of the definition, we believe firms should be able to perform an onsite branch exam during the supervisor[’]s first year.’’). 135 FINRA Response I at 5. PO 00000 Frm 00142 Fmt 4703 Sfmt 4703 of the member that is registered as a broker-dealer or investment adviser.136 FINRA explained that this modification would permit RSL designation for a location with a designated supervisor who has, for example, six months of supervisory experience with the member firm and six months of supervisory experience at the member’s affiliate or subsidiary that is registered as a broker-dealer or investment adviser.137 FINRA stated that this modification ‘‘recogniz[es] that such entities may share systems and have similar compliance cultures to meet their obligations under the federal securities laws.’’ 138 As such, FINRA indicated that such supervisors should have sufficient experience with the member firm’s compliance systems.139 Five commenters supported the amended exclusion,140 and one of them ‘‘agree[d] that this amendment strikes an appropriate balance between regulators’ interest in high supervisory standards and industry concerns about the impact on hiring efforts.’’ 141 Three other commenters, on the other hand, opposed this proposed exclusion.142 One of these three 136 See proposed Rule 3110.19(c)(1); Amendment No. 1 at 4. 137 FINRA Response I at 5. 138 Id. 139 See id. at 4–5. 140 Letters from Bernard V. Canepa, Managing Director & Associate General Counsel, Securities Industry and Financial Markets Association, to Vanessa Countryman, Secretary, Commission, dated Aug. 1, 2023, at 2 (‘‘SIFMA II’’) (indicating that the modified language addresses ‘‘concerns raised by the industry’’); Gail Merken, Chief Compliance Officer, Janet Dyer, Chief Compliance Officer, John McGinty, Chief Compliance Officer, Fidelity Investments, to Vanessa Countryman, Secretary, Commission, dated Aug. 1, 2023, at 1 (‘‘Fidelity II’’); Jim McHale, Executive Vice President, Head of WIM Compliance and Peter Macchio, Executive Vice President, Head of CIB Compliance, Wells Fargo, to Vanessa Countryman, Secretary, Commission, dated Aug. 1, 2023, at 2 (‘‘Wells Fargo’’) (expressing appreciation for the amended proposal but encouraging a future reassessment ‘‘for experienced supervisors [who] are switching to a new supervisory role at an unaffiliated brokerdealer’’); Jennifer Szaro, CRCP, Chief Compliance Officer, XML Securities, LLC, et al., to Vanessa Countryman, Secretary, Commission, dated July 29, 2023, at 1 (‘‘XML’’) (the amended proposal ‘‘applies a commonsense approach, in that if an associated person has been working in either capacity the member will have a basis to evaluate the associated person’s working relationship and conduct a reasonable risk assessment.’’); Andrew Hartnett, NASAA President and Deputy Commissioner, Iowa Insurance Division, North American Securities Administrators Association, Inc., to Sherry Haywood, Assistant Secretary, Commission, dated July 26, 2023, at 4 (‘‘NASAA II’’). 141 NASAA II at 4. 142 Letters from Michael Friedman, Head of Broker Dealer, Albert Securities, LLC, to Vanessa Countryman, Secretary, Commission, dated July 24, 2023, at 1–2 (‘‘Albert’’); Mark Quinn, Director of Regulatory Affairs, Cetera Financial Group, to Vanessa Countryman, Secretary, Commission, dated E:\FR\FM\24NON1.SGM 24NON1 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 commenters repeated its request to remove this proposed exclusion, stating that it ‘‘is arbitrary and not reasonably related to the objectives it seeks to accomplish.’’ 143 Another of these commenters preferred the exclusion as originally proposed in the Notice, explaining that FINRA erroneously assumes that the compliance and supervisory cultures are the same at all of a member’s affiliates and subsidiaries.144 The third commenter asked for a modification that would permit RSL designation so long as the associated person at the location has at least one year of any experience—either supervisory or non-supervisory—with the member, its affiliates, or its subsidiaries.145 In response, FINRA declined to further amend the proposed rule change.146 FINRA stated that the amended language ‘‘appropriately addresses’’ the concern that this proposed exclusion is intended to address: that an associated person at an RSL might otherwise ‘‘not have the requisite tenure at the member firm to develop experience with the firm’s systems, people, products, and overall compliance culture.’’ 147 The proposed rule change, as modified by Amendment No. 1 (requiring a level of supervisory experience to permit a member firm to consider an RSL designation), is reasonable. For new supervisors or supervisors hired from outside of a member firm’s broader organization, the proposed rule change requires that they operate from a location that is an OSJ or supervisory branch office (where they would be inspected at least annually) for at least a year to gain supervisory July 31, 2023, at 2 (‘‘Cetera II’’); Hugh Berkson, President, Public Investors Advocate Bar Association, to Vanessa Countryman, Secretary, Commission, dated July 31, 2023, at 3 (‘‘PIABA II’’). 143 Cetera II at 2 (stating that ‘‘[o]nce an individual passes the necessary qualifications examinations, they [should be able to] begin their duties immediately.’’). 144 PIABA II at 3 (‘‘While some firms may share systems and have similar compliance cultures with affiliates and subsidiaries, many others [do not], especially given the size and complexity of numerous financial firms. Yet, FINRA’s adjustment permits disparate entities to combine supervisory experience for meeting the one year minimum and contains no minimum time requirement at all for the member itself.’’). 145 Albert at 1–2 (‘‘[U]nlike FINRA, we believe a newly-hired registered principal should be allowed to start the clock on their one year at their new employer by working remotely in a non-supervisory capacity prior to becoming a designated supervisor and qualifying their home as a residential supervisory location.’’ . . . Doing so ‘‘would still require new employees to learn the details of their new firm before being eligible to supervise remotely . . . .’’). 146 FINRA Response II at 4–5. 147 Id. VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 experience with the member firm’s systems and overall compliance culture.148 Because of the unique nature of each member firm’s business, FINRA reasonably determined that supervisors wishing to exercise the flexibility of this proposed rule change must first have experience with the member firm’s systems and products, and fully integrate into a member firm’s compliance program and culture. Therefore, just as it is reasonable for FINRA to exclude supervisors without any direct supervisory experience, it is also reasonable for FINRA to exclude supervisors with substantial direct supervisory experience at different member firm(s). This proposed rule change does not, however, require these categories of excluded supervisors to work from a non-residential location. A member firm may permit such a supervisor to work from a residential location under the current regulatory framework by designating the new supervisor’s residence as an OSJ or supervisory branch office and subjecting it to an annual inspection. The one-year time period—whether in a nonresidential location or residential location designated as an OSJ or supervisory branch office—allows supervisors to develop experience with the member firm’s systems, people, products, and overall compliance culture. This should help to ensure that new supervisors at a member firm develop the experience necessary to reasonably carry out their assigned supervisory responsibilities for a member firm’s supervisory system before their residences become eligible for RSL designation and less frequent inspection. It is reasonable for FINRA to determine that supervisors must have a certain amount of direct supervisory experience with the member firm, or an affiliate or subsidiary of the member that is registered as a broker-dealer or investment adviser, before their residence can be eligible for RSL designation. The one-year requirement will help ensure that new supervisors have an opportunity to gain experience with a member firm’s systems and products, and fully integrate into a member firm’s compliance program and culture. This time period also provides the member firm with time to evaluate the performance of the new supervisor to determine their compliance with their regulatory obligations before they may be eligible for the flexibility provided in the proposed rule. Moreover, one year provides a reasonable balance between providing member firms with the flexibility for supervision allowed in the proposed rule and concerns that supervisors need to spend time directly supervising before they are given such flexibility. Regarding the commenter’s request to permit RSL designation so long as the associated person at the proposed RSL has at least one year of any experience with the member firm, its affiliates, or its subsidiaries,149 it is reasonable for FINRA to conclude that supervisors without direct supervisory experience at the member firm, its affiliates, or its subsidiaries may lack the skills and experience to effectively supervise other people, locations, and business activities from a residence treated as a non-branch location. For that reason, it is reasonable that FINRA limited qualifying experience to direct supervisory experience with the member firm, its affiliates, or its subsidiaries. Commenters expressed concern that this proposed exclusion would negatively impact hiring and retention without providing an investorprotection benefit.150 However, member firms retain the flexibility to permit supervisors to work from a residential location registered as an OSJ or supervisory branch office. Firms may choose to exercise that flexibility to attract and retain talent, and the proposed rule change would provide member firms even more flexibility after the supervisor has gained at least one year of supervisory experience with the member firm. In light of these factors, it is reasonable to require new supervisors or supervisors new to the member firm to work from a location registered as an OSJ or supervisory branch office that would be subject to an annual inspection cycle for a set period of time. A commenter opposed the provision providing that the one-year experience requirement may be satisfied by experience with a member firm’s affiliate or subsidiary that is registered as a broker-dealer or investment adviser.151 This commenter explained that member firms, affiliates, and subsidiaries do not necessarily share the same compliance systems and cultures.152 However, where a member firm relies on a supervisor’s experience from an affiliate or subsidiary to satisfy the experience requirement, the supervisor’s private residence would not be automatically designated as an RSL. Rather, as discussed further below, 149 Albert at 1–2. FSI at 4, CAI at 2, Cetera I at 2–3. 151 PIABA II at 3. 152 See id. 150 See 148 See proposed Rule 3110.19(c)(1); supra notes 81 through 83 and accompanying text. PO 00000 Frm 00143 Fmt 4703 Sfmt 4703 82455 E:\FR\FM\24NON1.SGM 24NON1 82456 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices proposed Rule 3110.19(e) would require the member firm to conduct and document a person-specific risk assessment prior to designating the location as an RSL. If a supervisor lacks comparable supervisory experience with the member, its affiliates, or its subsidiaries, or if the member, its affiliates, or its subsidiaries do not have similar compliance systems and cultures, the member firm may choose to consider those circumstances to assess whether such an RSL designation is appropriate. b. Heightened Supervisory Plans As stated above, proposed Rule 3110.19(c)(3) would prohibit RSL designation for any location with a designated supervisor who ‘‘is subject to a mandatory heightened supervisory plan under the rules of the SEC, FINRA, or a state regulatory agency.’’ 153 One commenter urged FINRA to modify this proposed exclusion to also cover ‘‘heightened supervision under a plan established by the member in connection with or in response to any such regulator’s recommendation or finding,’’ stating that the rule should not distinguish between heightened supervisory plans imposed by regulators and those imposed by member firms.154 The commenter explained that a member firm’s decision to impose its own heightened supervisory plan ‘‘in lieu of a formal regulatory action or order[ ] or in response to a regulatory examination’’ raises ‘‘the same concerns as regulator-mandated plans and should be addressed accordingly.’’ 155 In response, FINRA declined to extend the proposed exclusion to cover any heightened supervisory plans imposed by a member.156 FINRA expects that a member may, from time to time, impose voluntary heightened supervisory plans as part of its supervision program.157 FINRA stated that what constitutes a firm-imposed heightened supervisory plan is ‘‘subjective,’’ and it expressed concern that extending this proposed exclusion to them ‘‘could act to disincentivize ddrumheller on DSK120RN23PROD with NOTICES1 153 See proposed Rule 3110.19(c)(3). 154 See letter from Andrew Hartnett, NASAA President and Deputy Commissioner, Iowa Insurance Division, North American Securities Administrators Association, Inc., to Sherry Haywood, Assistant Secretary, Commission, dated April 27, 2023, at 4–5 (‘‘NASAA I’’). 155 Id. at 5. 156 FINRA Response I at 6. 157 Id. (‘‘[A] firm should routinely evaluate its supervisory system to ensure it is appropriately tailored to the firm’s business. Such an evaluation may prompt a firm, out of an abundance of caution and independent of specific regulatory requirements or mandates, to undertake additional supervisory measures, including voluntarily imposing a heightened supervisory plan.’’). VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 firms from imposing tailored or more specific supervisory controls if the result [would be] RSL ineligibility.’’ 158 However, FINRA ‘‘agree[d] that there is value in considering heightened supervision as a risk factor.’’ 159 To balance the commenter’s concern with FINRA’s concern about discouraging the use of heightened supervision, FINRA modified the proposed rule change to require consideration of non-mandatory heightened supervisory plans in the risk assessment described in proposed Rule 3110.19(e).160 The same commenter characterized FINRA’s modification as ‘‘an acceptable balance between [its previous] concerns and FINRA’s desire not to disincentivize firms from taking such steps to proactively improve their supervisory systems.’’ 161 No commenter opposed the amended language. Prohibiting locations with an associated person subject to a regulatorimposed heightened supervisory plan from being designated as an RSL is reasonable as it is designed to limit compliance risks. If a regulator has imposed a heightened supervisory plan on a specific associated person, the regulator has determined that they require additional supervision to help ensure their compliance with securities laws, regulations, and rules. It is reasonable for FINRA to determine that under those circumstances a member firm should not be permitted to designate that person’s residence as an RSL and permit a reduced inspection cycle. Firm-imposed heightened supervisory plans may, in some circumstances, indicate similar risks. At the same time, expanding this exclusion to firm-imposed supervisory plans could disincentivize firms from using heightened supervision when circumstances would otherwise counsel such a plan. Under these circumstances, it is reasonable to require member firms to consider any firm-imposed heightened supervisory plans as part of the mandatory, person-specific risk assessment. c. Investigations and Proceedings Alleging a Failure To Supervise As originally proposed in the Notice, proposed Rule 3110.19(c)(6) would have prohibited RSL designation for any location with an associated person who is ‘‘currently subject to, or has been notified in writing that [they] will be subject to, any investigation, proceeding, complaint or other action 158 Id. 159 Id. 160 Id.; see proposed Rule 3110.19(e). II at 4. 161 NASAA PO 00000 Frm 00144 Fmt 4703 Sfmt 4703 by the member, the SEC, a selfregulatory organization, including FINRA, or state securities commission (or agency or office performing like functions) alleging they have failed reasonably to supervise another person subject to their supervision, with a view to preventing the violation of any provision of the Securities Act, the Exchange Act, the Investment Advisers Act, the Investment Company Act, the Commodity Exchange Act, any state law pertaining to the regulation of securities or any rule or regulation under any of such Acts or laws, or any of the rules of the MSRB or FINRA.’’ 162 Three commenters supported this proposed exclusion.163 One commenter emphasized the importance of equal treatment for all regulatory actions alleging a failure to supervise, regardless of whether federal or state securities laws are at issue.164 Another commenter coupled its support with a recommendation that the proposed exclusion also extend to associated persons who have been subject to multiple customer complaints, arbitrations, and civil cases.165 Four commenters opposed the proposed exclusion, citing practical challenges associated with the tracking, duration, and resolution of state-level securities investigations.166 In particular, three of the opposing commenters stated that the inclusion of state-law violations in this proposed exclusion is fundamentally unfair, and one of these commenters stated that supervisors would ‘‘lose[ ] the privilege 162 Notice at 20577; proposed Rule 3110.19(c)(6). I at 2; letter from Hugh Berkson, President, Public Investors Advocate Bar Association, to Vanessa Countryman, Secretary, Commission, dated Apr. 26, 2023, at 3 (‘‘PIABA I’’); Davenport at 2 (supporting ‘‘[m]aking an office or location ineligible when an associate[d] person is [the] subject of an investigation or action relating to a failure to supervise.’’). 164 NASAA I at 2 (‘‘State securities laws are an important part of the regulatory framework and should not be treated differently with respect to assessments of regulatory and supervisory risks that the proposed ineligibility criteria are designed to address.’’). 165 PIABA I at 3. 166 ASA at 2; Cetera I at 3–4; letter from Scott C. Kursman, Managing Director & Chief Compliance Officer, Citigroup Global Markets, Inc., to Vanessa Countryman, Secretary, Commission, dated Apr. 28, 2023, at 1–2 (‘‘Citigroup’’); SIFMA I at 1–3. Taken together, the alleged practical challenges include: state investigations are difficult to track; state investigations may take years to commence or conclude; it is difficult to discern when state investigations commence or conclude; state regulators open investigations based on varying standards for the evidence required to open such an investigation; and the phrase ‘‘subject of’’ is too vague to equip firms to effectively comply with the proposed exclusion. See SIFMA I at 1–3; Citigroup at 1 (noting that it shares SIFMA’s concern); ASA at 2 (taking this position in comments related to the ‘‘Pilot Program’’); Cetera at 3–4. 163 NASAA E:\FR\FM\24NON1.SGM 24NON1 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 of workplace flexibility for an uncertain and inordinate amount of time[, disrupting their lives] without any adjudication that they failed in their supervisory duties.’’ 167 For these reasons, three opposing commenters urged FINRA to remove state-level securities investigations from the proposed rule change.168 The fourth opposing commenter similarly recommended that FINRA narrow the proposed exclusion such that it take effect upon receipt of something akin to a Wells notice.169 In response, FINRA amended the proposed exclusion in two ways.170 First, FINRA limited its scope to Investigations and Proceedings, as those terms are defined in Form U4, by a Regulator ‘‘expressly’’ alleging a failure to supervise.171 FINRA stated that 167 SIFMA I at 3; see Citigroup at 1 (‘‘[T]he fact that the mere initiation of an investigation, as opposed to some adjudicated finding, can be the basis for ineligibility seems problematic from an individual fairness and notice standpoint.’’); Cetera at 4 (‘‘It unfairly shifts the presumption from innocence to guilt without any form of substantive finding, much less adjudication.’’). 168 SIFMA at 3; Citigroup at 1 (‘‘We support the suggestion made by SIFMA that, rather than lose RSL eligibility, a state investigation for failure to supervise should be considered by a firm’s preexisting obligations under Rule 3110 to maintain a reasonably designed supervisory system and to conduct an appropriate risk assessment.’’); ASA at 2 (‘‘We implore federal regulators not to allow unsubstantiated claims by state regulators trying to protect their regulatory turf to dictate how the regulation of the modern broker-dealer business should evolve.’’). 169 Cetera I at 4 (‘‘RSL eligibility would only be precluded if the associated person has been notified by a regulatory agency, in writing, that the agency intends to take or recommend enforcement action against the individual for failure to perform supervisory responsibilities.’’). A Wells notice is a communication from SEC Staff to a person involved in an investigation that: (1) informs the person the staff has made a preliminary determination to recommend that the Commission file an action or institute a proceeding against them; (2) identifies the securities law violations that the staff has preliminarily determined to include in the recommendation; and (3) provides notice that the person may make a submission to the Division and the Commission concerning the proposed recommendation. See Enforcement Manual, Securities and Exchange Commission, Division of Enforcement, at 19–20, https://www.sec.gov/ divisions/enforce/enforcementmanual.pdf. 170 See FINRA Response I at 6–9; proposed Rule 3110.19(c)(6); Amendment No. 1. 171 FINRA Response I at 7–8; see Amendment No. 1; proposed Rule 3110.19(c)(6). As modified by Amendment No. 1, the proposed rule change would prohibit RSL designation for any location with an associated person who ‘‘has been notified in writing that [he or she] is now subject to[ ] any Investigation or Proceeding, as such terms are defined [for Form U4], by [a Regulator] expressly alleging they have failed reasonably to supervise another person subject to their supervision with a view to preventing the violation of any provision of the Securities Act, the Exchange Act, the Investment Advisers Act, the Investment Company Act, the Commodity Exchange Act, any state law pertaining to the regulation of securities[,] or any rule or regulation under any of such [a]cts or laws, or any VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 ‘‘using the definitions from Form U4 provides consistency and clarity not only with respect to the scope of applicable events subject to the ineligibility criteria, but also regarding when some events ‘‘begin’’ (e.g., after the ‘Wells’ notice has been given).’’ 172 Second, FINRA included a temporal element to provide that such locations may be designated or redesignated as an RSL subject to the requirements of the proposed rule change, as modified by Amendment No. 1, upon the earlier of: (1) the member’s receipt of written notification from the applicable Regulator that such Investigation has concluded without further action; or (2) one year from the date of the last communication from such Regulator relating to such Investigation.173 FINRA explained that the proposed amendment addresses ‘‘commenters’ concerns that unadjudicated allegations would form the basis of a location’s permanent exclusion as an RSL.’’ 174 Three commenters supported the modified exclusion, stressing that the revisions provide regulatory clarity and address industry concerns about the uncertain length of some regulatory investigations.175 A fourth commenter ‘‘generally support[ed]’’ the modified provision because it ‘‘reduces the likelihood that a location remains ineligible for longer than reasonably of the rules of the MSRB or other self-regulatory organization, including FINRA.’’ Proposed Rule 3110.19(c)(6). The proposed amendment also broadens the scope of the applicable rules. As originally proposed in the Notice, the proposed rule change would have reached the rules of the MSRB and FINRA, but not—as now proposed—‘‘any’’ selfregulatory organization. See Notice at 20577. 172 FINRA Response I at 8–9. FINRA emphasized that this proposed exclusion would apply ‘‘where a Regulator’s written notification to an associated person describes circumstances and other allegations that could be reasonably construed to relate to a failure to reasonably supervise another individual under the associated person’s supervision.’’ Id. at 8. 173 See FINRA Response I at 6–9; Proposed Rule 3110.19(c)(6); Amendment No. 1. As stated above, this proposed modification would not apply to an associated person who is subject to an ongoing Proceeding. 174 FINRA Response I at 9. 175 SIFMA II at 2 (‘‘[T]he Proposed Rule Change, as amended, addresses in part concerns raised by the industry. For example, proposed Rule . . . 3110(c)(6) now allows a firm to designate or redesignate an RSL location after a specified period of time following an investigation.’’); XML at 1 (the use of the Form U4 definitions for Investigation and Proceeding ‘‘will maintain consistency within the industry,’’ and the revised exclusion ‘‘will enable members to determine an effective date for designation or redesignation of an RSL’’); Fidelity II at 2 (‘‘Fidelity also appreciates the clarification provided concerning an associated person who is the subject of an investigation or proceeding by a regulator, particularly the ability to resume designating a location as an RSL either at the closure of the proceeding or after the matter has been idle for a year.’’). PO 00000 Frm 00145 Fmt 4703 Sfmt 4703 82457 necessary for a regulator to investigate potential misconduct[ ] while allowing regulators sufficient flexibility to conduct a thorough investigation.’’ 176 But this commenter asked for further modifications to broaden the scope of the proposed rule change, including to codify FINRA’s statement that the exclusion would apply where circumstances can be reasonably construed to evidence a covered Investigation, to clarify that a Wells notice or its equivalent ‘‘is not a prerequisite for ineligibility under this criterion,’’ and to clarify that some regulatory communications, including subpoenas, may provide notice of a covered investigation ‘‘depending on the information’’ they contain.177 In response, FINRA declined to further amend the proposed rule change.178 FINRA stated that ‘‘the wellestablished definitions from Form U4 provide a clear picture of the scope of applicable events subject to the proposed eligibility criterion.’’ 179 FINRA also emphasized that although subpoenas and other regulatory communications do not necessarily establish the existence of an ‘‘Investigation’’ as defined in Form U4, the proposed rule change separately requires firms to consider ‘‘any regulatory communications,’’ including subpoenas, in the mandatory risk assessment.180 The proposed rule change, as modified by Amendment No. 1, reasonably addresses the potential risks indicated by written communications from a Regulator alleging a failure to supervise. It is reasonable for FINRA to conclude that, where an associated person’s conduct has resulted in a Regulator notifying the associated person that they are subject to an Investigation or a Proceeding expressly alleging that they have failed reasonably to supervise another person subject to their supervision, the potential risk warrants the associated person having their residence inspected on a more frequent basis, and therefore the residence should not be designated as an RSL.181 176 NASAA II at 2–3. at 3–4 and n.8. 178 FINRA Response II at 6. 179 Id. 180 See id. 181 NASAA requested that FINRA clarify that a Wells notice or its equivalent ‘‘is not a prerequisite for ineligibility under this criterion.’’ NASAA II at 3. The proposed rule change, as modified by Amendment No. 1, makes clear that ‘‘Investigation’’ has the same meaning as it does for Form U4. See supra note 74 and accompanying text. For purposes of Form U4, some of the circumstances constituting 177 Id. E:\FR\FM\24NON1.SGM Continued 24NON1 82458 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 The proposed exclusion, as modified by Amendment No. 1, also reasonably addresses commenter concerns with its scope and equips member firms to comply with its terms. By limiting its scope to certain Investigations and Proceedings, as those terms are defined for purposes of Form U4, that ‘‘expressly’’ allege a failure to reasonably supervise, the proposed exclusion clarifies that FINRA does not expect firms to discern—based on vague or ambiguous information—whether the exclusion applies. Separately, the proposed rule change addresses commenter concerns that unadjudicated allegations might permanently prohibit a location from RSL designation by including a temporal element that permits the designation or redesignation of affected RSLs under limited circumstances. Specifically, this provision would permit RSL designation or redesignation upon (1) the member’s receipt of written notification from the applicable Regulator that such Investigation has concluded without formal action or (2) one year from the date of the last communication from such Regulator relating to such Investigation.182 Finally, while the proposed exclusion would not capture circumstances short of a formal Investigation or Proceeding that could counsel against an RSL designation, the proposed rule change separately requires firms to consider—as part of the mandatory, person-specific risk assessment—any regulatory communications from a Regulator indicating that the associated person at the proposed RSL failed reasonably to supervise another person subject to their supervision.183 d. Customer Complaints, Arbitration Claims, and Civil Actions As originally proposed in the Notice, proposed Rule 3110.19(c) did not include a location-level exclusion addressing any associated person who is or has been subject to multiple customer complaints or customer-initiated, investment-related arbitration claims or civil actions.184 One commenter recommended that FINRA include a location-level exclusion covering such associated persons, as these customerinitiated actions are often the ‘‘canary in the coal mine’’ indicating threats to investor protection.185 In response, FINRA modified the proposed rule change (as described in more detail below) to require a member to consider the volume and nature of customer complaints as part of the mandatory, person-specific risk assessment prior to RSL designation.186 Although the proposed risk assessment does not expressly require the consideration of customer-initiated, investment-related arbitration or civil litigation, FINRA emphasized that the risk assessment’s list of factors is ‘‘non-exhaustive’’ and it ‘‘agree[d] that the presence of such arbitration[s] or civil litigation[s] would be a factor for a firm to consider as part of the risk assessment.’’ 187 In response to the Amendment No. 1, the commenter repeated its request that the location-level exclusions also cover locations of associated persons who have been subject to multiple customer complaints or customer-initiated, investment-related arbitrations or civil actions.188 This commenter emphasized that such an associated person should be disqualified from working from an RSL ‘‘[r]ather than trusting member firms to conduct and document a risk assessment[ ] that includes examining the ‘volume and nature of customer complaints.’ ’’ 189 In response, FINRA declined to modify the proposed rule change to include an automatic exclusion for locations with associated persons who have been the subject of multiple customer complaints.190 FINRA emphasized that customer complaints ‘‘may lack merit,’’ and the proposed rule change’s mandatory risk assessment requires the consideration of the volume and nature of customer complaints prior to any RSL designation.191 The proposed rule change takes a reasonable approach to the issue of customer complaints and customerinitiated, investment-related arbitration claims and civil actions by requiring firms to consider the ‘‘volume and nature of customer complaints’’ in the mandatory risk assessment prior to RSL designation.192 Although the proposed risk assessment does not explicitly mandate the consideration of customerinitiated, investment-related arbitration claims and civil actions, the risk assessment’s factors are non-exhaustive. Moreover, FINRA has stated that such arbitration claims and civil actions would be relevant factors for 186 Proposed Rule 3110.19(e); Amendment No. 1 at 6. an ‘‘Investigation’’ would not require a Wells notice. See id. 182 Proposed Rule 3110.19(c)(6). 183 Proposed Rule 3110.19(e)(5). 184 See Notice at 20577–78; proposed Rule 3110.19(c). 185 PIABA I at 3. VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 187 FINRA 188 PIABA 189 Id. Response I at 7. II at 3–4. at 4. FINRA Response II at 6. 190 See 191 Id. 192 The Commission addresses the proposed risk assessment in Section III(A)(5). PO 00000 Frm 00146 Fmt 4703 Sfmt 4703 consideration during the mandatory risk assessment.193 Such complaints, claims, and actions may, in certain circumstances, indicate heightened levels of risk. However, they are not formal investigations or proceedings initiated by a regulator charged with enforcing securities laws, regulations, and rules. For example, they may be overly broad in scope or lack the factual development of a comparable regulatory action. Because assessing the risk associated with complaints, claims, and actions may require investigation and a consideration of the totality of the circumstances, it is reasonable that—in lieu of creating a blanket exclusion for such associated persons—the volume and nature of customer complaints should be considered in the mandatory risk assessment. e. Other Three Location-Level Exclusions As stated above, the proposed rule change’s location-level eligibility exclusions also prohibit RSL designation for any location with an associated person who: (1) is functioning as a principal for a limited period in accordance with Rule 1210.04 (Registration Requirements); (2) is statutorily disqualified, unless such disqualified person (A) has been approved (or is otherwise permitted pursuant to FINRA rules and the federal securities laws) to associate with a member and (B) is not subject to a mandatory heightened supervisory plan under proposed Rule 3110.19(c)(3) or otherwise as a condition to approval or permission for such association; or (3) 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 U4.194 No commenter offered specific support for, or opposition to, any of these three exclusions. Each of these three location-level exclusions is reasonable in light of the increased risk each category of person might pose. First, a supervisor acting as a principal for a limited period prior to passing a qualification examination has not yet acquired the credentials allowing them to act as a principal on a permanent basis.195 Second, an 193 FINRA Response I at 7. proposed Rule 3110.19(c)(2), (4), and (5). 195 FINRA Rule 1210.04 permits a member to ‘‘designate any person currently registered, or who becomes registered, with the member as a representative to function as a principal for a period of 120 calendar days prior to passing an appropriate principal qualification examination as specified under Rule 1220(a), provided that such person has at least 18 months of experience functioning as a 194 See E:\FR\FM\24NON1.SGM 24NON1 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices individual subject to a statutory disqualification has engaged in violative conduct that may indicate an increased risk of non-compliance.196 Third, an individual with certain regulatory or criminal-action disclosures on Form U4 has a history of criminal conviction(s) or regulatory finding(s) that may indicate an increased risk of non-compliance.197 Because of the heightened risks associated with these three categories of supervisors, it is reasonable for the proposed rule change to require such supervisors to operate from an OSJ or supervisory branch office (where they will be inspected at least annually) rather than from a location designated as an RSL (where they would be inspected on a regular periodic schedule, presumed to be at least every three years).198 Therefore, it is reasonable to exclude such supervisors’ residences from RSL designation. 3. Conditions for Designation as a Residential Supervisory Location ddrumheller on DSK120RN23PROD with NOTICES1 As stated above, proposed Rule 3110.19(a) would provide that an associated person’s private residence where supervisory activities are conducted may be eligible for RSL designation provided that the member firm and/or location complies with ten conditions.199 FINRA stated that it adapted the first eight conditions from the primary and non-primary residence exclusions.200 It added a ninth condition on recordkeeping and a tenth condition addressing technology and registered representative within the five-year period immediately preceding the designation and has fulfilled all applicable prerequisite registration, fee and examination requirements prior to designation as a principal. However, in no event may such person function as a principal beyond the initial 120 calendar day period without having successfully passed an appropriate principal qualification examination as specified under Rule 1220(a).’’ 196 Section 3(a)(39) of the Exchange Act identifies a list of events that disqualify someone from membership in, participation in, or association with a member of a self-regulatory organization. 15 U.S.C. 78c(a)(39). 197 See supra note 73. 198 See FINRA Rule 3110(c)(1); proposed Rule 3110.19(a). 199 See proposed Rule 3110.19(a). SEB Securities stated that the proposed rule change ‘‘does not fully explain how often a home office would need to be used to be considered a non-branch location or RSL’’ and questioned whether the RSL designation is ‘‘only for associated persons whose primary place of business is their home.’’ Letter from Anonymous, Compliance Officer, SEB Securities, Inc. (‘‘SEB’’), to the Commission, dated July 13, 2023. FINRA responded that SEB’s comment relates to a ‘‘broader question about the branch office definition’’ and that the proposed rule change ‘‘is not intended to change’’ the longstanding definition of ‘‘branch office,’’ which has been in effect since 2006. FINRA Response II at 8. 200 Notice at 20576. VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 surveillance tools.201 These ten conditions are discussed in more detail below. a. Conditions Adapted From the Primary and Non-Primary Residence Exclusions As stated above, FINRA adapted the first eight conditions of the proposed rule change from the primary and nonprimary residence exclusions: (1) only one associated person, or multiple associated persons who reside at that location and are members of the same immediate family, conduct business at the location; 202 (2) the location is not held out to the public as an office; 203 (3) the associated person does not meet with customers or prospective customers at the location; 204 (4) any sales activity that takes place at the location complies with the conditions set forth under Rule 3110(f)(2)(A)(ii) or (iii); 205 (5) neither customer funds nor securities are handled at that location; 206 (6) the associated person is assigned to a designated branch office, and such designated branch office is reflected on all business cards, stationery, retail communications, and other communications to the public by such associated person; 207 (7) the associated person’s correspondence and communications with the public are subject to the member firm’s supervision in accordance with Rule 3110; 208 and (8) the associated person’s electronic communications (e.g., email) are made through the member’s electronic system.209 One commenter opposed the requirement, set forth in proposed Rule 3110.19(a)(1), that only one associated person, or multiple associated persons who reside at that location and are members of the same immediate family, conduct business at the location.210 This commenter stated that this proposed condition would not provide any meaningful investor protection safeguards because associated persons who reside together ‘‘to afford the rising cost of housing’’ do not necessarily pose a higher risk to investor protection.211 This commenter further stated that this 201 Id. 202 See proposed Rule 3110.19(a)(1). proposed Rule 3110.19(a)(2). 204 See proposed Rule 3110.19(a)(3). 205 See proposed Rule 3110.19(a)(4). Rule 3110(f)(2)(A)(ii) and (iii) identify the conditions for the primary and non-primary residence exclusions. For a discussion of those exclusions, see Section II(A)(1)(c) above. 206 See proposed Rule 3110.19(a)(5). 207 See proposed Rule 3110.19(a)(6). 208 See proposed Rule 3110.19(a)(7). 209 See proposed Rule 3110.19(a)(8). 210 CAI at 1–2. 211 See CAI at 1–2, Exhibit A at 2. 203 See PO 00000 Frm 00147 Fmt 4703 Sfmt 4703 82459 proposed condition is ‘‘unnecessarily narrow and restrictive.’’ 212 In response, FINRA declined to modify proposed Rule 3110.19(a)(1).213 FINRA emphasized that the proposed rule change ‘‘is intended to align with one of several conditions to the current’’ primary and non-primary residence exclusions.214 FINRA also noted that the proposed rule change aligns with SEC Books and Records rules, which provide (among other things) that ‘‘a broker dealer is not required to maintain records at an office that is a private residence ‘where only one associated person (or multiple associated persons who reside at that location and are members of the same immediate family) regularly conducts business.’ ’’ 215 Although FINRA declined to modify this proposed condition, it stated that it would consider relevant comments ‘‘in connection with future initiatives to consider the OSJ and branch office definitions more broadly.’’ 216 A second commenter requested that FINRA modify proposed Rule 3110.19(a)(7), which would require that the associated person’s correspondence and communications with the public be subject to the member firm’s supervision in accordance with Rule 3110.217 The commenter stated that this language improperly focuses on the recipient (as opposed to the subject) of the communications, and its reference to ‘‘the public’’ is unclear.218 The commenter recommended that the condition instead require that ‘‘all correspondence and communications by the associated person related in any way to existing or potential business activities [be] subject to the firm’s supervision in accordance with [Rule 3110].’’ 219 212 See CAI, Exhibit A at 2 (‘‘The Committee believes that this language is unnecessarily narrow and restrictive and would limit the ability of a location, in several common scenarios, to claim [RSL] status, without providing any meaningful investor protection safeguards.’’). 213 FINRA Response I at 3–4. 214 Id. at 3. 215 Id. at 3–4 (quoting 17 CFR 240.17a–4(l)). 216 Id. at 4. FINRA acknowledged that Rule 3110(f)(2) does not define ‘‘immediate family,’’ but it noted that this term is defined in Rule 3241. Id. at 4 n.12. 217 See proposed Rule 3110.19(a)(7); NASAA I at 1 (‘‘We reiterate and incorporate our previous comments on [File Number FINRA–SR–2022– 019]’’); see also NASAA (8/23/2022) at 12 (addressing the same provision), https:// www.sec.gov/comments/sr-finra-2022-019/ srfinra2022019-20137298-307861.pdf. 218 See NASAA I at 1; see also NASAA (8/23/ 2022) at 12. 219 Id. E:\FR\FM\24NON1.SGM 24NON1 82460 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 In response, FINRA declined to modify proposed Rule 3110.19(a)(7).220 FINRA explained that the proposed language ‘‘aligns with existing rule text used in the primary residence exclusion in Rule 3110(f)(2)(A)(ii)[(e)] and aligns with the terminology in FINRA Rule 2210 (Communications with the Public).’’ 221 Adopting the commenter’s proposed alternative would, FINRA stated, ‘‘create an incongruity within Rule 3110 and raise questions about the difference in meanings.’’ 222 A commenter requested to expand proposed Rule 3110.19(a)(7) to require that ‘‘all correspondence and communications by the associated person related in any way to existing or potential business activities [be] subject to the firm’s supervision in accordance with [Rule 3110].’’ 223 However, Rule 3110 already imposes broad supervision requirements to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules, and those obligations would apply to RSLs.224 Moreover, the proposed condition’s use of the term ‘‘communications with the public’’ aligns with language in FINRA Rule 2210, the SEC Books and Records Rule,225 and the preexisting residential exclusions,226 and so should be familiar to both firms and to regulators. For these reasons, it is reasonable for FINRA to retain the same condition as that for the primary and non-primary residence exclusions. No other commenter offered specific support for or opposition to any of the remaining six conditions adapted from the primary and non-primary residence exclusions.227 Each of these eight conditions imposes a reasonable limitation on the designation of an RSL. Limiting an RSL designation to a location with only one associated person, or multiple associated persons who reside at that location and are members of the same immediate family, is a reasonable limitation in light of FINRA’s stated 220 Letter from Kosha Dalal, Vice President and Associate General Counsel, Office of General Counsel, FINRA, to Vanessa Countryman, Secretary, Commission, dated Oct. 31, 2022, at 8, available as Exhibit 2b to File Number FINRA–SR–2023–006 (addressing the same provision). 221 Id. 222 Id. 223 See NASAA I at 1; NASAA (8/23/2022) at 12. 224 FINRA Rules 3110(a); see FINRA Rules 3110(b)(4), 3110.06, and 3110.09. 225 17 CFR 240.17a–4(b)(4) (requiring preservation of ‘‘[o]riginals of all communications . . . which are subject to the rules of a self-regulatory organization of which the member, broker[,] or dealer is a member regarding communications with the public.’’). 226 FINRA Rule 3110(f)(2)(A)(ii)(e). 227 Proposed Rule 3110(a)(2) through (6), (8). VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 intention to align the condition with the SEC Books and Records rules.228 Restrictions on activities that occur at the RSL, such as prohibitions involving interactions with customers (e.g., not holding the office out to the public, not meeting customers or prospective customers in-person, and limitations on sales activities) and the handling of customer funds and securities,229 will limit higher risk activities occurring at an RSL that may benefit from more frequent inspection of the location. Furthermore, requiring an associated person to be assigned to a designated branch office and to name that branch office on all of their communications with the public 230 provides investors with information about the person with whom they are conducting business. In addition, the affirmative obligations in the conditions, such as explicitly subjecting the associated person’s correspondence and communication with the public to the member firm’s supervision and requiring the associated person’s electronic communications to be made through the member firm’s electronic system,231 will help provide the member firm with enhanced supervisory oversight of certain activities directly involving investors, and thereby lower risk associated with an RSL. Moreover, incorporating the conditions from the preexisting residential exclusions, a rule that FINRA has experience in administering and that the industry is familiar with, will promote regulatory consistency and minimize regulatory confusion, thereby enhancing investor protection. b. Books and Records As its ninth condition for designation as an RSL, the proposed rule change would impose the following recordkeeping requirements: (1) the member must have a recordkeeping system that makes, keeps current, and preserves records required to be made, kept current, and preserved under applicable securities laws and regulations, FINRA rules, and the member’s own written supervisory procedures under Rule 3110; (2) such records must not be physically or electronically maintained and preserved at the office or location; and (3) the member must have prompt access to such records.232 Because books and records required to be made and preserved would not be maintained onsite at the RSL, FINRA believes that this condition ‘‘strengthen[s] a firm’s ability to monitor the supervisory activities occurring’’ at an RSL and lowers overall risk.233 Two commenters supported this recordkeeping condition.234 One stated that requiring members to have ‘‘prompt access’’ to their records ‘‘would better enable firms to supervise their associated persons centrally’’ and ‘‘protect against misappropriation and misuse of sensitive customer information.’’ 235 The second commenter agreed with prohibiting the preservation and maintenance of books and records at the RSL.236 No commenter opposed this proposed condition. The proposed rule change’s recordkeeping conditions are reasonable. Prompt access to an RSL’s records from an alternative location decreases the need for more frequent inspection of the RSL. Specifically, the proposed rule change couples the prompt-access requirement with a prohibition on the physical or electronic storage of records at the RSL location. Because records would not be located at the RSL, the member firm should have the ability to supervise the RSL remotely so long as it can promptly access such records, thus decreasing the need for a more frequent inspection cycle. Consequently, the recordkeeping condition would help facilitate the timely and effective supervision of an RSL’s business activities. c. Surveillance and Technology Tools The tenth condition for designation as an RSL would require a member firm to ‘‘determine that its surveillance and technology tools are appropriate to supervise the types of risk[] presented by each [RSL].’’ 237 The proposed rule change explains that these tools may include but are not limited to: (1) firmwide tools, such as an electronic recordkeeping system, electronic surveillance of email and correspondence, electronic trade blotters, regular activity-based sampling reviews, and tools for visual inspections; (2) tools specific to the RSL based on the activities of the associated person assigned to the location, products offered, and restrictions on the activity of the RSL; and (3) system tools, such as secure network connections and effective cybersecurity protocols.238 No commenter offered specific support for 233 See 228 See supra note 215 and accompanying text. 229 Proposed Rule 3110.19(a)(2) through (5). 230 Proposed Rule 3110.19(a)(6). 231 Proposed Rule 3110.19(a)(7) and (8). 232 See proposed Rule 3110.19(a)(9). PO 00000 Frm 00148 Fmt 4703 Sfmt 4703 Notice at 20576. NASAA I at 2–3; Davenport at 2. 235 NASAA I at 2–3. 236 Davenport at 2. 237 Proposed Rule 3110.19(a)(10). 238 See proposed Rule 3110.19(a)(10). 234 See E:\FR\FM\24NON1.SGM 24NON1 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices or opposition to this proposed condition. FINRA justified the proposed rule change, in part, on technological advancements that equip firms to supervise employees working from remote locations.239 Therefore, it is reasonable to require any member firm taking advantage of the proposed rule change—and its less-frequent inspection cycle—to first determine that its surveillance and technology tools are appropriate to supervise the types of risks presented by each RSL. To aid member firms in this assessment, the non-exhaustive list of tools outlined in the proposed rule change, including firm-wide tools and tools particular to the RSL based on the activities of the person assigned to that RSL, help illustrate FINRA’s expectations and will assist firms in implementing robust surveillance systems. ddrumheller on DSK120RN23PROD with NOTICES1 4. Obligation To Provide List of RSLs to FINRA As stated above, proposed Rule 3110.19(d) would require any member firm that has designated any RSL locations to provide a current list of all of its RSL locations to FINRA on a quarterly basis.240 Two commenters supported the proposed rule change, and one of them labeled this quarterly-reporting requirement as ‘‘critical’’ to the ability of regulators ‘‘to effectively oversee firms’ important supervisory functions.’’ 241 Two other commenters opposed the proposed rule change because of the inefficiency that would result.242 Instead of a quarterly filing 239 Notice at 20575 (‘‘FINRA believes that the structural and lifestyle changes for member firms and their workforce catalyzed by the pandemic— along with advances in technology—merit reevaluation of some aspects of the branch office registration and inspection requirements.’’), 20575 (firms indicated that they responded to the COVID– 19 pandemic by relying ‘‘extensively on technology to support their effective transition to the remote work environment and enhance the supervision of geographically dispersed associated persons, many of whom have been working from home since early 2020 and may continue to do so in some manner in the current environment. These technological tools facilitating their supervisory practices include surveillance systems, electronic tracking programs or applications, and electronic communications, including video conferencing tools.’’). 240 Proposed Rule 3110.19(d) (‘‘A member that elects to designate any office or location of the member as an RSL pursuant to [proposed Rule 3110.19] shall provide FINRA with a current list of all locations designated as RSLs by the 15th day of the month following each calendar quarter in the manner and format (e.g., through an electronic process or such other process) as FINRA may prescribe.’’). 241 NASAA I at 2; see Davenport at 2. 242 See letter from James Rabenstine, Vice President, NISC and NSLLC Chief Compliance Officer, Nationwide Office of the Chief Legal Officer, Nationwide Financial Services, Inc. and VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 that provides intermittent snapshots of RSL designations, the opposing commenters recommended that FINRA leverage CRD and the existing branch office registration process to continuously collect timely information on RSL designations.243 For example, one opposing commenter emphasized that using the existing branch-office registration process would provide FINRA ‘‘with more current information . . . because of existing requirements to amend and update information within 30 days.’’ 244 In response, FINRA declined to modify the proposed rule change.245 FINRA indicated, however, that it appreciates the commenters’ recommendations and ‘‘is exploring ways for firms to provide this information to FINRA and other state regulators in a more efficient manner.’’ 246 No commenter offered a specific response to FINRA’s decision not to modify the proposed rule change, although one commenter encouraged FINRA to seek input from its members to avoid creating an ‘‘overly burdensome reporting process.’’ 247 Prompt access to information about a member firm’s RSL designations should improve the ability of FINRA to readily identify which of a member firm’s locations have been designated as an RSL and more efficiently assess the reasonableness of a member firm’s RSL designations and corresponding supervision. Therefore, the proposed rule change’s quarterly-reporting requirement is reasonable and would provide FINRA with the information it needs to carry out its regulatory obligations.248 5. Risk Assessment As stated above, proposed Rule 3110.19(e) would require a member Holly Butson, Chief Compliance Officer, Nationwide Fund Distributors, LLC, Nationwide Financial Services, Inc. to Sherry Haywood, Assistant Secretary, Commission, dated Apr. 24, 2023, at 2 (‘‘Nationwide’’); FSI at 3–4. 243 See Nationwide at 2; FSI at 3–4. 244 FSI at 3–4; see Nationwide at 2 (recommended ‘‘a separate filing for [an RSL] like a Form BR 2, similar to the U4 page 2 process, so that members have a way to track and link Registered Representatives who are supervised from the [RSL] not an OSJ’’). 245 See FINRA Response I at 9. 246 Id.; FINRA Response II at 7 (FINRA ‘‘is exploring ways for firms to provide this information to FINRA and state regulators in a more efficient and timely manner, including through the use of existing uniform registration forms or FINRA Gateway.’’). 247 XML at 2. 248 FINRA indicated that it is exploring ways to structure this data-collection requirement, and it expressed appreciation for the commenters’ suggestions. FINRA Response I at 9; FINRA Response II at 7. PO 00000 Frm 00149 Fmt 4703 Sfmt 4703 82461 firm—prior to designating any location as an RSL—to ‘‘develop a reasonable risk-based approach to designating such office or location as an RSL, and [to] conduct and document a risk assessment’’ that considers five mandatory factors.249 These factors would require consideration of, among other things, customer complaints, firmimposed heightened supervisory plans, and regulatory communications indicating a failure to reasonably supervise.250 The proposed rule change also would require the member to account for any higher risk activities occurring at the location, any higher risk associated persons assigned to the location, and any indicators of irregularities or misconduct (i.e., red flags) prior to designating a location as an RSL.251 Further, the proposed rule change would provide that member firms should review red flags—and consider evidencing their review—in determining whether it is reasonable to maintain an RSL designation for a particular location.252 FINRA explained that this risk assessment—and the nonexhaustive list of factors to consider— would strengthen supervisory controls and further investor protection ‘‘by requiring firms to consider higher risk criteria in determining whether to designate an office or location as an RSL.’’ 253 One commenter offered unqualified support for the proposed rule change.254 Two other supportive commenters asked that FINRA clarify and modify one aspect of proposed Rule 249 Proposed Rule 3110.19(e); Amendment No. 1 at 8; Amendment No. 2 at 4–5. The five mandatory factors are: ‘‘(1) customer complaints, taking into account the volume and nature of the complaints; (2) heightened supervision other than where such office or location is ineligible for RSL designation under [proposed Rule 3110.19(c)(3)]; (3) any failure to comply with the member’s written supervisory procedures; (4) any recordkeeping violation; and (5) any regulatory communications from a Regulator, indicating that the associated person at such office or location failed reasonably to supervise another person subject to their supervision, including but not limited to, subpoenas, preliminary or routine regulatory inquiries or requests for information, deficiency letters, ‘blue sheet’ requests or other trading questionnaires, or examinations.’’ See proposed Rule 3110.19(e). 250 See supra note 103 and accompanying text. 251 Proposed Rule 3110.19(e). 252 Id. 253 FINRA Response I at 9–10; Amendment No. 1 at 8. 254 Cetera II at 1 (‘‘We endorse the requirement for member firms to develop and document a riskbased assessment before designating a location[] as an RSL. This approach is both logical and proportional.’’); see XML at 2 (‘‘In addition to the time needed to address other requirements in Rule 3110.19, members will need adequate time to develop policies and procedures to comply with the location assessments and documentation requirements of Rule 3110.19(e) and time to implement and perform such activities.’’). E:\FR\FM\24NON1.SGM 24NON1 82462 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 3110.19(e)(5).255 As originally proposed in Amendment No. 1, the risk assessment would have required members to consider, among other things, ‘‘any regulatory communications from a Regulator, including but not limited to, subpoenas, preliminary or routine regulatory inquiries or requests for information, deficiency letters, ‘blue sheet’ requests or other trading questionnaires, or examinations indicating that the associated person at such office or location failed reasonably to supervise another person subject to their supervision.’’ 256 The commenters that asked for modifications both questioned whether the italicized language modified the preceding illustrative list or only ‘‘examinations.’’ 257 In response to the commenters’ concern about ambiguity in the scope of proposed Rule 3110.19(e)(5), FINRA reorganized the proposed rule text to improve its readability.258 As modified by Amendment No. 2, proposed Rule 3110.19(e)(5) reads as follows: ‘‘any regulatory communications from a Regulator, indicating that the associated person at such office or location failed to reasonably supervise another person subject to their supervision, including but not limited to, subpoenas, preliminary or routine regulatory inquiries or requests for information, deficiency letters, ‘blue sheet’ requests or other trading questionnaires, or examinations.’’ 259 One opposing commenter stated that the risk assessment’s requirement ‘‘to ‘consider’ higher risk criteria’’ is insufficient.260 For example, this commenter stated that red flags and many of the risk assessment’s factors should constitute eligibility exclusions, not just factors for a member to consider.261 In addition, the commenter 255 SIFMA II at 1–2 (offering general support for the proposed rule change); Fidelity II at 2 (‘‘We conceptually support the addition of a risk assessment and appreciate there may be instances where use of the RSL is not appropriate.’’). 256 Proposed Rule 3110.19(e)(5) (emphasis added); Amendment No. 1 at 8. 257 SIFMA II at 2–3 (‘‘It is not clear whether the emphasized phrase is meant to modify all the listed types of communications or only examinations. It may be difficult to determine how these noninvestigatory communications indicate a risk presented by an RSL absent an indication of supervisory concern.’’); Fidelity II at 2 (‘‘It is not clear whether the phrase ‘indicating that the associated person at such office or location failed reasonably to supervise another person subject to their supervision’ is meant to modify all the listed types of communications or only examinations.’’) 258 FINRA Response II at 8; Amendment No. 2 at 4. 259 Proposed Rule 3110.19(e)(5); Amendment No. 2. 260 PIABA II at 4. 261 Id. VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 criticized FINRA’s ‘‘complete lack of guidance as to how to weigh and assess the various risk criteria,’’ including the volume and nature of customer complaints.262 In response, FINRA stated that it ‘‘expects that a firm will consider customer complaints and weigh their volume and nature based on the firm’s business, products, and customer base among other factors generally considered by the firm when making risk-based assessments in other contexts, such as in how a firm may establish and maintain a supervisory system that is appropriately tailored to the firm’s business and structure, whether unannounced visits to an office or location may be appropriate, or whether heightened supervisory procedures may need to be imposed.’’ 263 As stated above, the proposed rule change’s member- and location-level exclusions prohibit the designation of RSLs in certain circumstances that may indicate a higher potential risk of noncompliance. But other factors not explicitly identified among the exclusions can, in certain circumstances, indicate heightened levels of risk either before or after RSL designation. Proposed Rule 3110.19(e) will help to mitigate residual risk not explicitly addressed in the conditions, firm-level exclusions, and location-level exclusions. Specifically, the proposed rule change would require a member firm to assess and document for each associated person at a candidate RSL certain indicia of risk, including the volume and nature of customer complaints, any firm-imposed heightened supervisory plans, and any regulatory communications indicating that the associated person failed reasonably to supervise another person subject to their supervision, prior to RSL designation. In addition, the proposed rule change would require a member to account for any higher risk activities occurring at the location, any higher risk associated persons assigned to the location, and any red flags when designating a location as an RSL. Furthermore, the proposed rule change emphasizes consideration of red flags as part of a member firm’s ongoing determination of whether it is 262 Id. 263 FINRA Response II at 7; see FINRA Response I at 7 (‘‘FINRA emphasizes that the enumerated list of factors is non-exhaustive. While consumerinitiated, investment-related arbitration or civil litigation is not listed as one of the enumerated factors under proposed Rule 3110.19(e), FINRA agrees that the presence of such arbitration or civil litigation would be a factor for a firm to consider as part of the risk assessment.’’). PO 00000 Frm 00150 Fmt 4703 Sfmt 4703 reasonable to maintain an RSL designation. In this way, the proposed rule change helps to ensure that a member firm designating RSLs appropriately accounts for the full range of risks associated with each proposed RSL. For these reasons, the proposed rule change is reasonable. A commenter asserted that the five factors in the risk assessment should instead be eligibility exclusions and noted the absence of guidance as to how to weigh and assess the various risk factors.264 As an assessment of the risk associated with each factor will depend on the facts and circumstances of each case, no single factor lends itself to an automatic exclusion. For example, customer complaints may, in certain cases, indicate an unacceptable level of risk, but in other cases, complaints may be overly broad or lack factual development to indicate the level of risk. Moreover, as discussed below, this is an ongoing risk assessment, and its outcome could change with new circumstances or as the member firm obtains additional information. Therefore, it is reasonable for FINRA to instead require that firms consider each factor as part of a person-specific risk assessment prior to RSL designation. Similarly, it is reasonable that the proposed rule change provides member firms flexibility as to how to weigh and assess the various risk factors. 6. Frequency of Inspections RSL designation would permit firms to inspect the location on a regular periodic schedule (presumed to be at least every three years) instead of the annual schedule otherwise required for OSJs and supervisory branch offices.265 264 PIABA II at 4. Rule 3110.19(a); FINRA Rules 3110(c)(1)(C) and 3110.13. Virtu Financial, Inc., and Nationwide submitted out-of-scope comments regarding the frequency and method of inspections. Virtu asked FINRA to modify the proposed rule change ‘‘to codify that all personal residences where only electronic activities are carried out, whether those be supervisory or other securitiesrelated activities, are non-branch locations and reconsider the need to conduct any physical inspections of an associated person’s residence and instead rely on technological monitoring tools and electronic recordkeeping.’’ Letter from Thomas M. Merritt, Deputy General Counsel, Virtu Financial, Inc., to Vanessa Countryman, Secretary, Commission, dated Aug. 1, 2023, at 2 (‘‘Virtu’’). Nationwide asked FINRA to permit certain limitedpurpose OSJs, supervisory branch offices, and RSLs to be inspected remotely and/or on a five-year inspection cycle. Nationwide at 1–2. Because the proposed rule change is designed to establish a new location designation (RSL) for certain personal residences at which supervisory activities occur, the recommendations regarding the method of inspection are outside the scope of the proposed rule change. Because Nationwide appears to request an amended inspection schedule for any limitedpurpose OSJ, supervisory branch office, or RSL— 265 Proposed E:\FR\FM\24NON1.SGM 24NON1 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 Two commenters opposed this lessfrequent inspection cycle and contended that RSLs should be inspected annually.266 Emphasizing the importance of effective supervision, one commenter stated that ‘‘[l]ax or otherwise ineffective supervision can result in the failure to stop preventable harms before they occur, or even exacerbate harms that have already begun.’’ 267 Although the commenter did not dispute the emergence of the hybrid work environment and supervision technologies, it contended that those developments have no ‘‘bearing on the appropriate frequency or depth of scrutiny of supervisory activities.’’ 268 It also contended that ‘‘FINRA has not shown that supervisory functions present sufficiently ‘lower risk’ to warrant loosening oversight of individuals performing those functions.’’ 269 In response, FINRA declined to require annual inspections for RSLs, explaining that ‘‘impos[ing] an annual inspection cycle on an RSL would adversely impact the utility’’ of the proposed rule change.270 FINRA stressed that ‘‘the inspection requirement is only one part’’ of a member firm’s ‘‘ongoing obligation’’ to supervise under Rule 3110, and ‘‘a firm’s inspection of an office or location is not the only occasion during which a firm supervises its associated persons.’’ 271 Indeed, FINRA stated that Rule 3110 ‘‘does not preclude a firm from conducting inspections of its offices or locations more frequently or conducting unannounced visits.’’ 272 FINRA also stated that the proposed rule change includes ‘‘a rigorous set of safeguards and conditions that . . . align with the regulatory purposes of Rule 3110.’’ 273 The proposed rule change permits— but does not require—member firms to inspect their RSLs on a less frequent inspection cycle. This proposed rule change is reasonable for two reasons. regardless of its status as a personal residence—the request to for a five-year inspection cycle is likewise outside the scope of the proposed rule change. FINRA stated, however, that it would consider these recommendation ‘‘more generally as part of any future initiatives to consider the OSJ and branch office definitions more broadly.’’ FINRA Response I at 13; FINRA Response II at 9. 266 NASAA I at 3; NASAA II at 5; PIABA I at 3 (‘‘[R]esidential supervisory locations should at minimum be subject to annual in person audits, if not more frequent unannounced visits, rather than periodic inspections every three years.’’). 267 NASAA I at 3. 268 Id. at 4. 269 Id. at 3; see NASAA II at 5. 270 FINRA Response I at 10–12. 271 Id. at 12. 272 Id. 273 Id. at 11. VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 First, the proposed rule change is reasonable in light of Rule 3110’s general obligation to establish and maintain a reasonably designed supervisory system that is tailored to its unique business operations and associated risks. Although an RSL designation would permit a member firm to inspect a location on a less frequent schedule, the proposed rule change would not limit inspections to this less frequent schedule. Instead, Rule 3110 contemplates that a member firm may, in certain circumstances, choose to conduct more frequent or unannounced visits to an RSL in furtherance of its obligation to supervise effectively. In this way, the proposed rule change is consistent with that obligation. Relatedly, the Rule 3110 requirement to maintain a reasonably designed supervisory system is an ongoing obligation. A firm may need to reconsider a residence’s RSL designation, and the corresponding relief from annual inspection, if circumstances suggest that the designation may no longer be appropriate. Importantly, proposed Rule 3110.19(e) indicates that firms should review red flags when determining whether it is reasonable to maintain an RSL designation. The various terms and conditions associated with initial RSL designation therefore are only the beginning of an ongoing assessment of a location’s qualification for RSL designation and less frequent inspections. Second, the proposed rule change is reasonable in light of its terms and conditions. The member- and locationlevel eligibility exclusions would identify—and exclude—certain firms and locations with characteristics that may indicate a higher potential risk of non-compliance.274 Additionally, an eligible member firm may designate its eligible location as an RSL only if it complies with ten conditions, such as limitations on customer interactions, a recordkeeping requirement, and a mandatory technology assessment.275 Even if an eligible member firm is prepared to comply with those ten conditions, it must still ‘‘develop a reasonable risk-based approach to designating [the eligible location] as an RSL, and conduct and document a risk assessment for the associated person assigned to’’ the proposed RSL.276 These layers of protection are designed to limit RSL designation (and its less-frequent inspection cycle) to locations without 274 Proposed Rule 3110.19(b), (c). Rule 3110.19(a). 276 Proposed Rule 3110.19(e). 275 Proposed PO 00000 Frm 00151 Fmt 4703 Sfmt 4703 82463 indicia of increased potential risk of non-compliance. With those safeguards, a regular periodic inspection schedule is reasonable for those locations that can comply with the proposed rule change’s various terms and conditions. IV. Solicitation of Comments on Amendment No. 2 Interested persons are invited to submit written data, views, and arguments concerning whether Amendment No. 2 is consistent with the Exchange 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–2023–006 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–2023–006. 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. Do not include personal identifiable information in submissions; you should submit only information that you wish to make available publicly. We may redact in part or withhold entirely from publication submitted material that is obscene or subject to copyright protection. All submissions should refer to File Number SR–FINRA–2023–006 and E:\FR\FM\24NON1.SGM 24NON1 82464 Federal Register / Vol. 88, No. 225 / Friday, November 24, 2023 / Notices should be submitted on or before December 15, 2023. ddrumheller on DSK120RN23PROD with NOTICES1 V. Accelerated Approval of Proposed Rule Change, as Modified by Amendment Nos. 1 and 2 The Commission finds good cause to approve the proposed rule change, as modified by Amendment Nos. 1 and 2, prior to the thirtieth day after the date of publication of notice of the filing of Amendment No. 2 in the Federal Register.277 In Amendment No. 2, FINRA modified the proposed rule change—in direct response to comments received—to clarify the substantive intent of proposed Rule 3110.19(e)(5). FINRA did not propose to change any substantive obligation of the proposed rule change. To reduce ambiguity regarding its scope, FINRA instead proposed to reorganize a single sentence describing a single factor in the mandatory risk assessment.278 The basis for this amendment is the same as the basis for the original proposed rule change, as modified by Amendment No. 1, which the Commission previously noticed for public comment. After consideration of the comments FINRA received on the proposed rule change, the Commission concludes that Amendment No. 2 represents a reasonable extension of, and is substantially similar to, the language originally proposed for proposed Rule 3110.19(e). The Commission also concludes that Amendment No. 2 responds to comments received, adds clarity to the proposed rule change, and does not raise any novel regulatory concerns. Accordingly, the Commission finds good cause, pursuant to Section 19(b)(2) of the Act,279 to approve the proposed rule change, as modified by Amendment Nos. 1 and 2, on an accelerated basis. VI. Conclusion For the reasons set forth above, the Commission finds that the proposed rule change, as modified by Amendment Nos. 1 and 2, is consistent with Section 15A(b)(6) of the Exchange Act, which requires, among other things, that FINRA rules be designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, and, in general, protect investors and the public interest.280 It is therefore ordered pursuant to Section 19(b)(2) of the Exchange Act 281 277 See 15 U.S.C. 78s(b)(2)(C)(iii). supra notes 258 through 259 and accompanying text. 279 15 U.S.C. 78s(b)(2). 280 15 U.S.C. 78o–3(b)(6). 281 15 U.S.C. 78s(b)(2). 278 See VerDate Sep<11>2014 21:46 Nov 22, 2023 Jkt 262001 that the proposed rule change (SR– FINRA–2023–006), as amended by Amendment Nos. 1 and 2, be, and hereby is, approved. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.282 Sherry R. Haywood, Assistant Secretary. [FR Doc. 2023–25880 Filed 11–22–23; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–98982; File No. SR–FINRA– 2023–007] Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change To Adopt Supplementary Material .18 (Remote Inspections Pilot Program) Under FINRA Rule 3110 (Supervision) November 17, 2023. I. Introduction On April 14, 2023, the Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change SR–FINRA– 2023–007 pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’) 1 and Rule 19b–4 2 thereunder, to adopt a voluntary, threeyear remote inspections pilot program to allow eligible member firms to elect to fulfill their obligation under paragraph (c) (Internal Inspections) of FINRA Rule 3110 (Supervision) by conducting inspections of eligible branch offices,3 offices of supervisory jurisdiction 282 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 A ‘‘branch office’’ is defined as: (1) ‘‘any location where one or more associated persons of a member firm regularly conducts the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of, any security, or is held out as such’’; or (2) ‘‘any location that is responsible for supervising the activities of persons associated with the member at one or more non-branch locations of the member.’’ FINRA Rule 3110(f)(2)(A) and (B). A branch office is either ‘‘supervisory’’ (i.e., it supervises one or more non-branch locations) or ‘‘non-supervisory’’ (i.e., it does not supervise one or more non-branch locations). See FINRA Rule 3110(c)(1). 1 15 PO 00000 Frm 00152 Fmt 4703 Sfmt 4703 (‘‘OSJ’’),4 and non-branch locations 5 remotely without an on-site visit to such locations,6 subject to specified safeguards and limitations (the ‘‘Pilot’’).7 The proposed rule change was published for public comment in the Federal Register on May 4, 2023.8 The Commission received thirteen comment letters in response to the Notice.9 On June 7, 2023, FINRA consented to an extension of the time period in which the Commission must approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change to August 2, 2023.10 On 4 An OSJ is any office of a member firm at which any one or more of the following functions take place: (1) order execution or market making; (2) structuring of public offerings or private placements; (3) maintaining custody of customers’ funds or securities; (4) final acceptance (approval) of new accounts on behalf of the member firm; (5) review and endorsement of customer orders, pursuant to FINRA Rule 3110(b)(2); (6) final approval of retail communications for use by persons associated with the member firm, pursuant to FINRA Rule 2210(b)(1), except for an office that solely conducts final approval of research reports; or (7) having responsibility for supervising the activities of persons associated with the member firm at one or more other branch offices of the member firm. See FINRA Rule 3110(f)(1). 5 Seven types of locations—often referred to as ‘‘unregistered offices’’ or ‘‘non-branch locations’’— are excluded from the definition of ‘‘branch office’’: (1) any location that is established solely for customer service or back office type functions where no sales activities are conducted and that is not held out to the public as a branch office; (2) any location that is the associated person’s primary residence, subject to certain conditions; (3) any location, other than a primary residence, that is used for securities business for less than 30 business days in any one calendar year, subject to certain conditions; (4) any office of convenience, where associated persons occasionally and exclusively by appointment meet with customers, which is not held out to the public as an office; (5) any location that is used primarily to engage in nonsecurities activities and from which the associated person(s) effects no more than 25 securities transactions in any one calendar year (provided that any retail communication identifying such location also sets forth the address and telephone number of the location from which the associated person(s) conducting business at the non-branch locations are directly supervised); (6) the ‘‘floor’’ of a registered national securities exchange where a member firm conducts a direct access business with public customers; and (7) a temporary location established in response to the implementation of a business continuity plan. See FINRA Rule 3110(f)(2)(A)(i)– (vii). 6 Unless otherwise specified, the Commission uses the term ‘‘location’’ in this Order to refer to any location where a member firm does business, such as an OSJ, supervisory branch office, nonsupervisory branch office, or non-branch location, as applicable. 7 See proposed Rule 3110.18. 8 Exchange Act Release No. 97398 (Apr. 28, 2023), 88 FR 28620 (May 4, 2023) (File No. SR–FINRA– 2023–007) (‘‘Notice’’). 9 The comment letters are available at https:// www.sec.gov/comments/sr-finra-2023-007/ srfinra2023007.htm. 10 See letter from Sarah Kwak, Associate General Counsel, Office of General Counsel, FINRA, to E:\FR\FM\24NON1.SGM 24NON1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 88, Number 225 (Friday, November 24, 2023)]
[Notices]
[Pages 82447-82464]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-25880]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98980; File No. SR-FINRA-2023-006]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Amendment No. 2 and Order Granting 
Accelerated Approval of a Proposed Rule Change, as Modified by 
Amendment Nos. 1 and 2, To Adopt Supplementary Material .19 
(Residential Supervisory Location) Under FINRA Rule 3110 (Supervision)

November 17, 2023.

I. Introduction

    On March 29, 2023, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change (SR-FINRA-2023-006) to adopt new 
Supplementary Material .19 (Residential Supervisory Location) under 
FINRA Rule 3110 (Supervision). The proposed rule change, as modified by 
Amendment Nos. 1 and 2 (hereinafter, the ``proposed rule change'' 
unless otherwise specified), would treat a private residence in which 
an associated person engages in specified supervisory activities, 
subject to certain safeguards and limitations, as a non-branch 
location.\3\ Treated as non-branch locations, these newly defined 
Residential Supervisory Locations (``RSLs'') would be subject to 
inspections on a regular periodic schedule (presumed to be at least 
every three years) instead of the annual inspection currently required 
for ``offices of supervisory jurisdiction'' (``OSJs'') and 
``supervisory branch offices.'' \4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Exchange Act Release No. 97237 (Mar. 31, 2023), 88 FR 
20568, 20568 (Apr. 6, 2023) (File No. SR-FINRA-2023-006 (``Notice'') 
(citing FINRA Rules 3110(c)(1)(C) and 3110.13), https://www.govinfo.gov/content/pkg/FR-2023-04-06/pdf/2023-07145.pdf.
    \4\ See id.
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    The proposed rule change was published for public comment in the 
Federal Register on April 6, 2023.\5\ On May 16, 2023, FINRA consented 
to an extension of the time period in which the Commission must approve 
the proposed rule change, disapprove the proposed rule change, or 
institute proceedings to determine whether to approve or disapprove the 
proposed rule change to July 5, 2023.\6\ The Commission received 
thirteen comment letters in response to the Notice.\7\
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    \5\ Id.
    \6\ See letter from Sarah Kwak, Associate General Counsel, 
Office of General Counsel, FINRA, to Daniel Fisher, Branch Chief, 
Division of Trading and Markets, Commission, dated May 16, 2023, 
https://www.finra.org/sites/default/files/2023-05/sr-finra-2023-006-extension-no-1.pdf.
    \7\ The comment letters are available at https://www.sec.gov/comments/sr-finra-2023-006/srfinra2023006.htm.
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    On July 3, 2023, FINRA filed an amendment to the proposed rule 
change (``Amendment No. 1'').\8\ On July 5, 2023, the Commission 
published a notice of filing of Amendment No. 1 and an order 
instituting proceedings to determine whether to approve or disapprove 
the proposed rule change, as modified by Amendment No. 1.\9\ On July 
25, 2023, FINRA responded to the comment letters received in response 
to the Notice.\10\ The Commission received twelve comment letters in 
response to the notice of Amendment No. 1 and order instituting 
proceedings.
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    \8\ See Amendment No. 1, https://www.finra.org/sites/default/files/2023-07/sr-2023-006-amendment-No1.pdf.
    \9\ Exchange Act Release No. 97839 (July 5, 2023), 88 FR 44173 
(July 11, 2023) (File No. SR-FINRA-2023-006), https://www.govinfo.gov/content/pkg/FR-2023-07-11/pdf/2023-14523.pdf.
    \10\ See letter from Sarah Kwak, Associate General Counsel, 
Office of General Counsel, FINRA, to Vanessa Countryman, Secretary, 
Commission, dated July 25, 2023 (``FINRA Response I''), https://www.sec.gov/comments/sr-finra-2023-006/srfinra2023006-235699-491502.pdf.
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    On September 14, 2023, FINRA responded to the comment letters 
received in response to the notice of Amendment No. 1 and order 
instituting proceedings, and it filed an amendment to the proposed rule 
change (``Amendment No. 2'').\11\ On September 22, 2023, FINRA 
consented to an extension of the time period in which the Commission 
must approve or disapprove the proposed rule change to December 2, 
2023.\12\ The Commission is publishing this order to provide notice of 
the filing of, and to solicit comments on, Amendment No. 2 from 
interested persons and is approving the proposed

[[Page 82448]]

rule change, as modified by Amendment Nos. 1 and 2, on an accelerated 
basis.
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    \11\ See Amendment No. 2, https://www.finra.org/sites/default/files/2023-09/SR-FINRA-2023-006-Amendment-2.pdf; letter from Kosha 
Dalal, Vice President and Associate General Counsel, Office of 
General Counsel, FINRA, to Vanessa Countryman, Secretary, 
Commission, dated Sept. 14, 2023 (``FINRA Response II''), https://www.sec.gov/comments/sr-finra-2023-006/srfinra2023006-259039-608182.pdf.
    \12\ See letter from Sarah Kwak, Associate General Counsel, 
Office of General Counsel, FINRA, to Daniel Fisher, Branch Chief, 
Division of Trading and Markets, Commission, dated Sept. 22, 2023, 
https://www.finra.org/sites/default/files/2023-09/sr-finra-2023-006-ext2.pdf.
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II. Description of the Proposed Rule Change

    FINRA stated that technological advancements and an emerging remote 
workplace prompted it to reconsider the regulatory framework for the 
supervision and inspection of residential locations.\13\ As a result of 
this evaluation, FINRA determined to issue the proposed rule change 
``to create a regulatory framework in which member firms can capably 
continue to carry out their obligation to effectively inspect the 
supervisory activities taking place at an office or location . . . on a 
regular periodic schedule without diminishing investor protection.'' 
\14\ After describing the current regulatory framework, the Commission 
describes the proposed rule change.
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    \13\ Notice at 20569.
    \14\ Id. at 20573.
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A. Background

1. FINRA Rule 3110 (Supervision)
    FINRA Rule 3110 requires a member firm to establish and maintain a 
supervisory system for the activities of its associated persons ``that 
is reasonably designed to achieve compliance with applicable securities 
laws and regulations, and with applicable FINRA rules'' (hereinafter, a 
``reasonably designed supervisory system'').\15\ The rule identifies 
the minimum requirements of a member's supervisory system, including: 
(1) the registration and designation as a branch office or an OSJ of 
each location,\16\ including the main office, that meets the 
definitions contained in FINRA Rule 3110(f); \17\ and (2) inspecting 
all offices and locations in accordance with Rule 3110(c).\18\ The rule 
also establishes the frequency with which a member firm must inspect 
its locations.\19\ The frequency is based, in part, on whether the 
location is designated as a supervisory branch office, a non-
supervisory branch office, an OSJ, or a non-branch location.\20\ Each 
of these designations is described in turn.
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    \15\ FINRA Rule 3110(a).
    \16\ Unless otherwise specified, the Commission uses the term 
``location'' in this order to refer to any location where a firm 
does business, such as an OSJ, supervisory branch office, non-
supervisory branch office, or non-branch location, as applicable.
    \17\ See FINRA Rule 3110(a)(3).
    \18\ See FINRA Rule 3110(c). On November 17, 2023, the 
Commission issued an approval order for File Number FINRA-2023-007, 
which adopted new Supplementary Material .18 (Remote Inspections 
Pilot Program) under FINRA Rule 3110 (Supervision). FINRA Rule 
3110.18 establishes a voluntary, three-year pilot program to allow 
eligible member firms to elect to fulfill their inspection 
obligations under FINRA Rule 3110(c) by conducting inspections of 
eligible OSJs, branch offices, and non-branch locations remotely 
without an on-site visit to such locations, subject to specified 
safeguards and limitations.
    \19\ See FINRA Rule 3110(c)(1).
    \20\ See id.
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a. Supervisory and Non-Supervisory Branch Offices
    FINRA Rule 3110(f)(2) defines a ``branch office'' as: (1) any 
location where one or more associated persons of a member regularly 
conducts the business of effecting any transactions in, or inducing or 
attempting to induce the purchase or sale of, any security, or is held 
out as such; \21\ or (2) any location that is responsible for 
supervising the activities of persons associated with the member at one 
or more non-branch locations of the member.\22\ A branch office is 
either ``supervisory'' (i.e., it ``supervises one or more non-branch 
locations'') or ``non-supervisory'' (i.e., it ``does not supervise one 
or more non-branch locations'').\23\ The branch office's type dictates 
the frequency of its inspection cycle: a supervisory branch office must 
be inspected at least annually,\24\ and a non-supervisory branch office 
must be inspected at least every three years.\25\
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    \21\ FINRA Rule 3110(f)(2)(A).
    \22\ FINRA Rule 3110(f)(2)(B).
    \23\ See Notice at 20573 (``[A]ny location that is responsible 
for supervising the activities of persons associated with the member 
at one or more non-branch locations of the member is a branch office 
(i.e., a supervisory branch office).''); FINRA Rule 3110(c)(1)(B) 
(``Each member shall inspect at least every three years every branch 
office that does not supervise one or more non-branch locations.'').
    \24\ FINRA Rule 3110(c)(1)(A) (``Each member shall inspect at 
least annually . . . any branch office that supervises one or more 
non-branch locations.'').
    \25\ FINRA Rule 3110(c)(1)(B) (``Each member shall inspect at 
least every three years every branch office that does not supervise 
one or more non-branch locations.'').
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b. Office of Supervisory Jurisdiction
    A branch office may be further designated as an OSJ. An OSJ is any 
office of a member at which any one or more of the following functions 
take place: (1) order execution or market making; (2) structuring of 
public offerings or private placements; (3) maintaining custody of 
customers' funds or securities; (4) final acceptance (approval) of new 
accounts on behalf of the member; (5) review and endorsement of 
customer orders pursuant to Rule 3110(b)(2); \26\ (6) final approval of 
retail communications for use by persons associated with the member 
pursuant to Rule 2210(b)(1), except for an office that solely conducts 
final approval of research reports; \27\ or (7) having responsibility 
for supervising the activities of persons associated with the member at 
one or more other branch offices of the member.\28\ If a location 
satisfies any one of those criteria, it is an OSJ that must be 
inspected at least annually.\29\
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    \26\ FINRA Rule 3110(b)(2) provides that ``[t]he supervisory 
procedures required by [Rule 3110(b) (Written Procedures)] shall 
include procedures for the review by a registered principal, 
evidenced in writing, of all transactions relating to the investment 
banking or securities business of the member.''
    \27\ ``In general, with some exceptions, paragraph (b)(1) of 
Rule 2210 (Communications with the Public) requires that an 
appropriately qualified registered principal approve each retail 
communication prior to use or filing with FINRA.'' Notice at 20574 
n.57.
    \28\ FINRA Rule 3110(f)(1).
    \29\ See FINRA Rule 3110(c)(1)(A). In 1988, the National 
Association of Securities Dealers (``NASD,'' the predecessor to 
FINRA) stated that the amended OSJ definition, among other proposed 
amendments, focused on creating a ``supervisory `chain of command,' 
in which qualified supervisory personnel are appointed to carry out 
the firm's supervisory obligations . . . .'' See Notice at 20572 
(quoting NASD Notice to Members 88-11 (Feb. 8, 1988), https://www.finra.org/rules-guidance/notices/88-11).
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c. Non-Branch Locations
    FINRA explained that seven types of locations--often referred to as 
``unregistered offices'' or ``non-branch locations''--are excluded from 
the definition of ``branch office.'' \30\ Member firms must inspect 
their non-branch locations on a regular periodic schedule, presumed to 
be at least every three years.\31\
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    \30\ See Notice at 20574; FINRA Rule 3110(f)(2)(A)(i)-(vii) 
(identifying seven exclusions from the definition of branch office).
    \31\ See FINRA Rules 3110(c)(1)(C) (stating that ``[i]n 
establishing such schedule, the member shall consider the nature and 
complexity of the securities activities for which the location is 
responsible and the nature and extent of contact with customers. The 
member's written supervisory and inspection procedures shall set 
forth the schedule and an explanation regarding how the member 
determined the frequency of the examination.'') and 3110.13 (stating 
that ``[i]n establishing a non-branch location inspection schedule, 
there is a general presumption that a non-branch location will be 
inspected at least every three years, even in the absence of any 
indicators of irregularities or misconduct (i.e., ``red flags''). If 
a member establishes a longer periodic inspection schedule, the 
member must document in its written supervisory and inspection 
procedures the factors used in determining that a longer periodic 
inspection cycle is appropriate.'').
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    Two of the seven exclusions address residential locations: the 
primary residence exclusion and the non-primary residence exclusion. 
The primary residence exclusion \32\ excludes from registration as a 
branch office any non-supervisory \33\ location that is an associated 
person's primary residence, provided that: (1) only one associated 
person, or multiple associated persons who reside at that location and 
are

[[Page 82449]]

members of the same immediate family, conduct business at the location; 
(2) the location is not held out to the public as an office, and the 
associated person does not meet with customers at the location; (3) 
neither customer funds nor securities are handled at that location; (4) 
the associated person is assigned to a designated branch office, and 
such designated branch office is reflected on all business cards, 
stationery, retail communications, and other communications to the 
public by such associated person; (5) the associated person's 
correspondence and communications with the public are subject to the 
member firm's supervision in accordance with Rule 3110; (6) electronic 
communications (e.g., email) are made through the member's electronic 
system; (7) all orders are entered through the designated branch office 
or an electronic system established by the member that is reviewable at 
the branch office; (8) written supervisory procedures pertaining to 
supervision of sales activities conducted at the residence are 
maintained by the member; and (9) a list of the residence locations is 
maintained by the member.\34\
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    \32\ FINRA Rule 3110(f)(2)(A)(ii).
    \33\ See supra note 23 and corresponding text.
    \34\ See FINRA Rule 3110(f)(2)(ii)(a) through (i).
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    The non-primary residence exclusion \35\ excludes from registration 
as a branch office any non-supervisory location, ``other than a primary 
residence, that is used for securities business for less than 30 
business days in any one calendar year, provided [that] the member 
complies with'' the conditions described in (1) through (8) of the 
primary residence exclusion (detailed above).\36\ FINRA explained that 
the non-primary residence exclusion typically applies to a vacation or 
second home.\37\
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    \35\ FINRA Rule 3110(f)(2)(A)(iii).
    \36\ Id.
    \37\ See NASD Notice to Members 06-12 (Mar. 21, 2006), https://www.finra.org/rules-guidance/notices/06-12; see also Notice at 
20574.
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    Notwithstanding these residential exclusions, a private residence 
is considered a branch office if it ``is responsible for supervising 
the activities of persons associated with the member at one or more 
non-branch locations of the member,'' \38\ and it is an OSJ if it 
performs any of the seven functions associated with OSJs.\39\ 
Therefore, a primary or non-primary residence is subject to 
registration and annual inspection if the associated person's 
activities at the residence cause it to be an OSJ or supervisory branch 
office.\40\
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    \38\ FINRA Rule 3110(f)(2)(B).
    \39\ FINRA Rule 3110(f)(1).
    \40\ See FINRA Rules 3110(a)(3) and 3110(c)(1)(A).
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2. FINRA's Stated Reasons for the Proposed Rule Change
    FINRA stated that during the COVID-19 pandemic, many member firms 
developed ``hybrid workforce models'' in which ``some employees may 
work permanently in an alternative location[,] such as a private 
residence, other employees may spend some time in alternative locations 
and some time on-site in a conventional office setting, and some may 
work on-site full time.'' \41\ FINRA ``believes this model will 
endure'' notwithstanding the end of the COVID-19 Public Health 
Emergency in May 2023.\42\ Many of the supervisors who began working 
from home during the pandemic continue to do so, at least on a part-
time basis.\43\ Under the current regulatory framework, those 
supervisors likely conduct activities that would require the 
registration and designation of their private residences as supervisory 
branch offices or OSJs under Rule 3110(a)(3) and thus would require 
inspections at least annually under Rule 3110(c)(1)(A).\44\
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    \41\ Notice at 20579.
    \42\ See Notice at 20569; Centers for Disease Control and 
Prevention, COVID-19: End of Public Health Emergency (PHE) 
Declaration (Sept. 12, 2023), https://www.cdc.gov/coronavirus/2019-ncov/your-health/end-of-phe.html.
    \43\ See Notice at 20575 (``Firms responded that they relied 
extensively on technology to support their effective transition to 
the remote work environment and enhance the supervision of 
geographically dispersed associated persons, many of whom have been 
working from home since early 2020 and may continue to do so in some 
manner in the current environment.''); FINRA Regulatory Notice 21-44 
(Dec. 2021), https://www.finra.org/rules-guidance/notices/21-44 
(``To mitigate the impacts of the pandemic, member firms have relied 
heavily on remote offices and alternative work arrangements (e.g., 
working from home or a backup or recovery location) for a broad 
range of personnel.'').
    \44\ See FINRA Rules 3110(a)(3) and 3110(c)(1)(A).
---------------------------------------------------------------------------

    During the pandemic, FINRA temporarily suspended members' 
requirements to comply with the registration and inspection obligations 
applicable to new locations. Specifically, in March 2020, FINRA 
temporarily suspended the requirement for member firms to submit branch 
office registration applications on Form BR (Uniform Branch Office 
Registration Form) for any newly opened temporary office locations or 
space-sharing arrangements established because of the pandemic (the 
``Form BR Temporary Suspension'').\45\ The Form BR Temporary Suspension 
remains in effect. But when it ends, FINRA believes that current FINRA 
rules would require member firms to ``either curtail activities at 
residential locations or register large numbers of residential 
locations as OSJs or supervisory branch offices.'' \46\
---------------------------------------------------------------------------

    \45\ See FINRA Regulatory Notice 20-08 (Mar. 2020) (``Regulatory 
Notice 20-08''), https://www.finra.org/rules-guidance/notices/20-08; 
see also Notice at 20569 n.7.
    \46\ See Notice at 20579.
---------------------------------------------------------------------------

    As set forth above, registering a private residence as an OSJ or 
supervisory branch office would trigger a corresponding annual 
inspection requirement.\47\ FINRA explained that the proposed rule 
change would alter the regulatory framework to accommodate hybrid 
workforce models and mitigate the costs associated with registering and 
inspecting so many private residences.\48\ FINRA stated that the 
proposed rule change ``would allow firms to effectively and more 
efficiently carry out their supervisory responsibilities to review the 
activities of each office or location while preserving investor 
protections.'' \49\
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    \47\ FINRA Rule 3110(c)(1)(A).
    \48\ Notice at 20575, 20579 (explaining that the proposed rule 
change would reduce, but not eliminate, the need to register and 
inspect residential locations as supervisory branch offices or 
OSJs).
    \49\ Id. at 20569.
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B. The Proposed Rule Change

    The proposed rule change would adopt new Supplementary Material .19 
(Residential Supervisory Location) under FINRA Rule 3110 (Supervision) 
and would treat a private residence at which an associated person 
engages in certain supervisory activities as a non-branch location, 
subjecting it to inspections on a regular periodic schedule (presumed 
to be at least every three years) instead of the annual schedule 
required for OSJs and supervisory branch offices.\50\ To help mitigate 
the potential risks associated with a less frequent inspection cycle, 
the proposed rule change also would establish safeguards that limit RSL 
designation to certain firms and locations based on criteria designed 
to minimize risk.\51\ These safeguards would: (1) exclude certain 
member firms from designating any location as an RSL; \52\ (2) exclude 
certain locations from designation as an RSL; \53\ (3) impose certain 
conditions that a member firm and/or its candidate locations must meet 
prior to RSL

[[Page 82450]]

designation; \54\ (4) require any member firm that elects to designate 
an RSL to provide certain data to FINRA on a regular basis; \55\ and 
(5) require any eligible member firm to develop a reasonable risk-based 
approach to designating a location as an RSL and conduct and document a 
risk assessment for the associated person assigned to that location 
prior to designating a location as an RSL.\56\
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    \50\ See id. at 20568.
    \51\ See id. at 20568-69 (``FINRA believes the proposal strikes 
an appropriate balance to preserve investor protection while 
developing a risk-based approach for designating residential 
supervisory locations that includes key safeguards with respect to, 
among other things, books and records of the member, while excluding 
locations where higher risk activities may take place or associated 
persons that may pose higher risk are assigned.'').
    \52\ See proposed Rule 3110.19(b).
    \53\ See proposed Rule 3110.19(c).
    \54\ See proposed Rule 3110.19(a).
    \55\ See proposed Rule 3110.19(d).
    \56\ See proposed Rule 3110.19(e).
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1. Member Firm Ineligibility Criteria
    Under proposed Rule 3110.19(b), a member firm would be ineligible 
to designate any of its locations as an RSL if the member: (1) is 
currently designated as a Restricted Firm under Rule 4111 (Restricted 
Firm Obligations) (hereinafter, a ``Restricted Firm''); \57\ (2) is 
currently designated as a Taping Firm under Rule 3170 (Tape Recording 
of Registered Persons by Certain Firms) (hereinafter, a ``Taping 
Firm''); \58\ (3) is currently undergoing, or is required to undergo, a 
review under Rule 1017(a)(7) as a result of one or more associated 
persons at such location (hereinafter, a ``continuing membership 
review''); \59\ (4) receives a notice from FINRA pursuant to Rule 9557 
(Procedures for Regulating Activities under Rule 4110 (Capital 
Compliance), Rule 4120 (Regulatory Notification and Business 
Curtailment), or Rule 4130 (Regulation of Activities of Section 15C 
Members Experiencing Financial and/or Operational Difficulties)), 
unless FINRA has otherwise permitted activities in writing pursuant to 
such rule; \60\ (5) is or becomes suspended by FINRA (hereinafter, a 
``suspended firm''); \61\ (6) based on the date in the Central 
Registration Depository (``CRD''), had its FINRA membership become 
effective within the prior twelve months; \62\ or (7) is or has been 
found within the past three years by the SEC or FINRA to have violated 
Rule 3110(c).\63\
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    \57\ See proposed Rule 3110.19(b)(1).
    \58\ See proposed Rule 3110.19(b)(2).
    \59\ See proposed Rule 3110.19(b)(3). FINRA Rule 1017(a)(7) 
``requires a member firm to file an application for continuing 
membership 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.'' Notice at 20577 n.94 (citing FINRA 
Regulatory Notice 21-09 (Mar. 2021) (announcing FINRA's adoption of 
rules to address brokers with a significant history of misconduct)).
    \60\ See proposed Rule 3110.19(b)(4).
    \61\ See proposed Rule 3110.19(b)(5).
    \62\ See proposed Rule 3110.19(b)(6).
    \63\ See proposed Rule 3110.19(b)(7).
---------------------------------------------------------------------------

    FINRA stated that these exclusions address ``attributes of a member 
firm that FINRA believes are more likely to raise investor protection 
concerns . . . .'' \64\ For example, FINRA explained that ``a member 
firm that is experiencing issues complying with its capital 
requirements or that has been suspended by FINRA is more likely to face 
significant operational challenges that may negatively impact the 
firm's overall supervision of its associated persons.'' \65\ Similarly, 
FINRA stated that ``a firm that has been a FINRA member for less than 
12 months is often still implementing its business plan and developing 
a supervisory system appropriate[ly] tailored to the firm's specific 
attributes and structure.'' \66\ FINRA also stated that firms with 
recent Rule 3110(c) violations have ``demonstrated challenges in 
developing or maintaining a robust inspection program.'' \67\
---------------------------------------------------------------------------

    \64\ Notice at 20576.
    \65\ Id. at 20577.
    \66\ Id.
    \67\ Id.
---------------------------------------------------------------------------

2. Location Ineligibility Criteria
    A location of an otherwise eligible member firm \68\ would be 
ineligible for RSL designation if one or more associated persons at the 
location: (1) is a designated supervisor who has less than one year of 
direct supervisory experience with the member, or an affiliate or 
subsidiary of the member that is registered as a broker-dealer or 
investment adviser; \69\ (2) is functioning as a principal for a 
limited period in accordance with Rule 1210.04 (Registration 
Requirements); \70\ (3) is subject to a mandatory heightened 
supervisory plan under the rules of the SEC, FINRA, or a state 
regulatory agency; \71\ (4) is statutorily disqualified, unless such 
disqualified person (A) has been approved (or is otherwise permitted 
pursuant to FINRA rules and the federal securities laws) to associate 
with a member and (B) is not subject to a mandatory heightened 
supervisory plan under proposed Rule 3110.19(c)(3) or otherwise as a 
condition to approval or permission for such association; \72\ (5) 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 (Uniform Application for Securities Industry 
Registration or Transfer Registration) (``Form U4''); \73\ or (6) has 
been notified in writing that such associated person is now subject to 
any Investigation \74\ or Proceeding,\75\ as such terms are defined for 
Form U4, by the SEC, a self-regulatory organization, including FINRA, 
or state securities commission (or agency or office performing like 
functions) (each, a ``Regulator'') expressly alleging they have failed 
reasonably to supervise another person subject to their supervision 
with a view to preventing the violation of any provision of the 
Securities Act of 1933 (``Securities Act''), the Exchange Act, the 
Investment Advisers Act of 1940 (``Investment Advisers Act''), the 
Investment Company Act of 1940 (``Investment Company Act''), the 
Commodity Exchange Act, any state law pertaining to the regulation of 
securities, or any rule or regulation under any of such acts or laws, 
or any of the rules of the Municipal Securities Rulemaking Board 
(``MSRB'') or other self-regulatory organization, including FINRA.\76\

[[Page 82451]]

Nonetheless, this sixth exclusion would permit an affected location to 
be designated or redesignated as an RSL upon the earlier of: (1) the 
member's receipt of written notification from the applicable Regulator 
that such Investigation has concluded without further action; or (2) 
one year from the date of the last communication from such Regulator 
relating to such Investigation.\77\ This relief would not apply to an 
associated person subject to a covered Proceeding.\78\
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    \68\ Id. at 20578 (``Proposed Rule 3110.19 would not be 
available to a member firm or private residence that meets any of 
the ineligibility criteria in proposed paragraphs (b) or (c), 
respectively, under Rule 3110.19 even with the safeguards and 
limitations listed in proposed Rule 3110.19(a).'').
    \69\ See proposed Rule 3110.19(c)(1).
    \70\ See proposed Rule 3110.19(c)(2).
    \71\ See proposed Rule 3110.19(c)(3).
    \72\ See proposed Rule 3110.19(c)(4).
    \73\ See proposed Rule 3110.19(c)(5). Form U4's Questions 
14A(1)(a), 14A2(a), 14B(1)(a), and 14B2(a) elicit reporting of 
criminal convictions, and Questions 14C, 14D, and 14E pertain to 
regulatory action disclosures. See Notice 20577 n.97.
    \74\ As defined for purposes of Form U4, an Investigation 
``[i]ncludes: (a) grand jury investigations; (b) U.S. Securities and 
Exchange Commission investigations after the `Wells' notice has been 
given; (c) FINRA investigations after the `Wells' notice has been 
given or after a person associated with a member, as defined by The 
FINRA By-Laws, has been advised by the staff that it intends to 
recommend formal disciplinary action; (d) NYSE Regulation 
investigations after the `Wells' notice has been given or after a 
person over whom NYSE Regulation has jurisdiction, as defined in the 
applicable rules, has been advised by NYSE Regulation that it 
intends to recommend formal disciplinary action; (e) formal 
investigations by other SROs; or (f) actions or procedures 
designated as investigations by jurisdictions. The term 
investigation does not include subpoenas, preliminary or routine 
regulatory inquiries or requests for information, deficiency 
letters, `blue sheet' requests or other trading questionnaires, or 
examinations.'' FINRA, Form U4 Explanation of Terms at 2 (Apr.--
Version 2014.1), https://www.finra.org/sites/default/files/AppSupportDoc/p468051.pdf.
    \75\ As defined for purposes of Form U4, a Proceeding is ``[a] 
formal administrative or civil action initiated by a governmental 
agency, self-regulatory organization or a foreign financial 
regulatory authority; a felony criminal indictment or information 
(or equivalent formal charge), or a misdemeanor criminal information 
(or equivalent formal charge), but does not include an arrest or 
similar charge effected in the absence of a formal criminal 
indictment or information (or equivalent formal charge).'' Id. at 3.
    \76\ See proposed Rule 3110.19(c)(6); Amendment No. 1.
    \77\ See id.
    \78\ See id.
---------------------------------------------------------------------------

    FINRA stated that these exclusions ``reflect the appropriate 
limitations on the private residences that can be designated'' as an 
RSL.\79\ For example, FINRA stated that ``specified disclosures on Form 
U4 pertaining to criminal convictions[,] . . . final regulatory 
action[,] and the imposition of a mandatory heightened supervisory plan 
are indicia of increased risk to investors at some firms and locations 
. . . .'' \80\ FINRA further explained that requiring one-year of 
direct supervisory experience recognizes that ``a new supervisor at the 
current member firm may need time to become knowledgeable about that 
firm's systems, people, products, and overall compliance culture,'' 
even if that new supervisor comes to the member firm with prior 
supervisory experience from another firm.\81\ But FINRA also stated 
that affiliates and subsidiaries of FINRA members ``may share systems 
and have similar compliance cultures to meet their obligations under 
federal securities laws.'' \82\ For that reason, FINRA stated that the 
proposed rule change would ``permit the one-year supervisory experience 
minimum to be satisfied by also counting supervisory experience accrued 
at an affiliate or subsidiary of the member firm that is registered as 
a broker-dealer or investment adviser.'' \83\
---------------------------------------------------------------------------

    \79\ Notice at 20578.
    \80\ Id.
    \81\ Id.
    \82\ Amendment No. 1 at 5.
    \83\ Id. at 4.
---------------------------------------------------------------------------

3. Conditions for Designation as a Residential Supervisory Location
    The proposed rule change includes ten conditions that an eligible 
member firm and its eligible location must meet prior to designating 
the location as an RSL. Under proposed Rule 3110.19(a), a location that 
is the associated person's private residence where supervisory 
activities \84\ are conducted would be considered a non-branch 
location, provided that: (1) only one associated person, or multiple 
associated persons who reside at that location and are members of the 
same immediate family, conduct business at the location; \85\ (2) the 
location is not held out to the public as an office; \86\ (3) the 
associated person does not meet with customers or prospective customers 
at the location; \87\ (4) any sales activity that takes place at the 
location complies with the conditions set forth under Rule 
3110(f)(2)(A)(ii) or (iii); \88\ (5) neither customer funds nor 
securities are handled at that location; \89\ (6) the associated person 
is assigned to a designated branch office, and such designated branch 
office is reflected on all business cards, stationery, retail 
communications, and other communications to the public by such 
associated person; \90\ (7) the associated person's correspondence and 
communications with the public are subject to the member firm's 
supervision in accordance with Rule 3110; \91\ (8) the associated 
person's electronic communications (e.g., email) are made through the 
member's electronic system; \92\ (9)(A) the member has a recordkeeping 
system to make, keep current, and preserve records required to be made, 
kept current, and preserved under applicable securities laws and 
regulations, FINRA rules, and the member's own written supervisory 
procedures under Rule 3110, (B) such records are not physically or 
electronically maintained and preserved at the office or location, and 
(C) the member has prompt access to such records; \93\ and (10) the 
member has determined that its surveillance and technology tools are 
appropriate to supervise the types of risks presented by each RSL, and 
that these tools may include but are not limited to: (A) firm-wide 
tools, such as an electronic recordkeeping system, electronic 
surveillance of email and correspondence, electronic trade blotters, 
regular activity-based sampling reviews, and tools for visual 
inspections, (B) tools specific to the RSL based on the activities of 
the associated person assigned to the location, products offered, and 
restrictions on the activity of the RSL, and (C) system tools, such as 
secure network connections and effective cybersecurity protocols.\94\
---------------------------------------------------------------------------

    \84\ Proposed Rule 3110.19(a) indicates that the ``supervisory 
activities'' include ``those described in Rule 3110(f)(1)(D) through 
(G) or in Rule 3110(f)(2)(B).'' The supervisory activities 
identified in FINRA Rule 3110(f)(1)(D) through (G) include: final 
acceptance (approval) of new accounts on behalf of the member; 
review and endorsement of customer orders, pursuant to FINRA Rule 
3110(b)(2); final approval of retail communications for use by 
persons associated with the member, pursuant to Rule 2210(b)(1), 
except for an office that solely conducts final approval of research 
reports; and, responsibility for supervising the activities of 
persons associated with the member at one or more other branch 
offices of the member. FINRA Rule 3110(f)(2)(B) addresses ``any 
location that is responsible for supervising the activities of 
persons associated with the member at one or more non-branch 
locations of the member . . . .''
    \85\ See proposed Rule 3110.19(a)(1).
    \86\ See proposed Rule 3110.19(a)(2).
    \87\ See proposed Rule 3110.19(a)(3).
    \88\ See proposed Rule 3110.19(a)(4). Rule 3110(f)(2)(A)(ii) and 
(iii) identify the conditions for the primary and non-primary 
residence exclusions. For a discussion of those exclusions, see 
Section II(A)(1)(c) above.
    \89\ See proposed Rule 3110.19(a)(5).
    \90\ See proposed Rule 3110.19(a)(6).
    \91\ See proposed Rule 3110.19(a)(7).
    \92\ See proposed Rule 3110.19(a)(8).
    \93\ See proposed Rule 3110.19(a)(9).
    \94\ See proposed Rule 3110.19(a)(10).
---------------------------------------------------------------------------

    FINRA stated that these conditions ``would strengthen a firm's 
ability to monitor the supervisory activities occurring at [an RSL] and 
act to lower the overall risks associated with such location . . . .'' 
\95\ FINRA explained that the first eight conditions are derived from 
those for the primary and non-primary residence exclusions, ``which 
align with the SEC's Books and Records Rules [and] were developed in 
coordination with other [self-regulatory organizations] and state 
securities regulators.'' \96\ For that reason, FINRA stated that member 
firms have ``experience with monitoring and supervising these 
conditions.'' \97\ FINRA coupled those eight conditions with a new 
books and records requirement and a condition addressing technology and 
surveillance tools.\98\
---------------------------------------------------------------------------

    \95\ Notice at 20576.
    \96\ Id.; see FINRA Rule 3110(f)(2)(A)(ii) and (iii).
    \97\ Notice at 20576.
    \98\ Id.
---------------------------------------------------------------------------

4. Obligation To Provide List of RSLs to FINRA
    Under proposed Rule 3110.19(d), any member that elects to designate 
any location of the member as an RSL would be required to ``provide 
FINRA with a current list of all locations designated as RSLs by the 
15th day of the month following each calendar quarter in the manner and 
format (e.g., through an electronic process or such other process) as 
FINRA may prescribe.'' \99\ FINRA acknowledged that the CRD system 
\100\

[[Page 82452]]

currently provides access to ``information regarding the offices and 
locations (registered and unregistered) to which associated persons 
required to be registered are assigned,'' but it explained that 
``requiring member firms to affirmatively provide this information to 
FINRA through a scheduled process would make this information more 
readily accessible to regulators.'' \101\
---------------------------------------------------------------------------

    \99\ Proposed Rule 3110.19(d). FINRA stated that it is 
``exploring ways to provide this information to state regulators in 
a practical format.'' Notice at 20578 n.108.
    \100\ The CRD system is the central licensing and registration 
system used by the U.S. securities industry and its regulators. In 
general, information in the CRD system is obtained through the 
uniform registration forms that firms and regulatory authorities 
complete as part of the securities industry registration and 
licensing process. The uniform registration forms are Form BD 
(Uniform Application for Broker-Dealer Registration), Form BDW 
(Uniform Request for Broker-Dealer Withdrawal), Form BR (Uniform 
Branch Office Registration Form), Form U4, Form U5 (Uniform 
Termination Notice for Securities Industry Registration), and Form 
U6 (Uniform Disciplinary Action Reporting Form). These forms, 
particularly Forms U4 and U5, collect administrative, regulatory, 
criminal history, customer complaint, and other information about 
brokers, while Form BD collects similar information about broker-
dealer firms. FINRA, state, and other regulatory authorities use 
this information in connection with their licensing and regulatory 
activities, and member firms use this information to help them make 
informed employment decisions. See Exchange Act Release No. 88760 
(Apr. 28, 2020), 85 FR 26502, 26503 (May 4, 2020) (File No. SR-
FINRA-2020-012).
    \101\ Notice at 20578.
---------------------------------------------------------------------------

5. Risk Assessment
    Under proposed Rule 3110.19(e), a member would be required to 
``develop a reasonable risk-based approach to designating an office or 
location as an RSL[] and conduct and document a risk assessment for the 
associated person assigned to that office or location'' prior to 
designating that location as an RSL (hereinafter, a ``person-specific 
risk assessment'').\102\ The proposed rule change would require 
documentation of the factors considered, including, among others, 
whether the associated person at such office or location is now subject 
to: (1) customer complaints, taking into account the volume and nature 
of the complaints; (2) heightened supervision other than where such 
office or location is ineligible for RSL designation under proposed 
Rule 3110.19(c)(3); (3) any failure to comply with the member's written 
supervisory procedures; (4) any recordkeeping violation; and (5) any 
regulatory communications from a Regulator indicating that the 
associated person at such office or location failed reasonably to 
supervise another person subject to their supervision, including but 
not limited to, subpoenas, preliminary or routine regulatory inquiries 
or requests for information, deficiency letters, ``blue sheet'' 
requests or other trading questionnaires, or examinations.\103\ 
Furthermore, the proposed rule change would require the member to 
account for ``any higher risk activities that take place [at] or a 
higher risk associated person that is assigned to that office or 
location.'' \104\
---------------------------------------------------------------------------

    \102\ Proposed Rule 3110.19(e).
    \103\ Id.
    \104\ Id.
---------------------------------------------------------------------------

    ``Consistent with [a firm's] obligation under Rule 3110(a),'' the 
proposed rule change also would provide that ``the member's supervisory 
system must take into consideration any indicators of irregularities or 
misconduct (i.e., `red flags') when designating an office or location 
as an RSL.'' \105\ Further, the proposed rule change would provide that 
``[r]ed flags should . . . be reviewed in determining whether it is 
reasonable to maintain the RSL designation of such office or location 
in accordance with the requirements of [proposed Rule 3110.19] and 
[that] the member should consider evidencing steps taken to address 
those red flags where appropriate.'' \106\
---------------------------------------------------------------------------

    \105\ Id.
    \106\ Id.
---------------------------------------------------------------------------

III. Discussion and Commission Findings

    After careful review of the proposed rule change, the comment 
letters, and FINRA's responses to the comments, the Commission finds 
that the proposed rule change, as modified by Amendment Nos. 1 and 2, 
is consistent with the requirements of the Exchange Act and the rules 
and regulations thereunder that are applicable to a national securities 
association.\107\ Specifically, the Commission finds that the proposed 
rule change is consistent with Section 15A(b)(6) of the Exchange Act, 
which requires, among other things, that FINRA rules 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.\108\
---------------------------------------------------------------------------

    \107\ In approving this rule change, the Commission has 
considered the rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \108\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    Pursuant to FINRA Rule 3110, member firms must ``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.'' 
\109\ Rule 3110 provides that ``[e]ach member shall establish and 
maintain supervisory procedures that must take into consideration, 
among other things, the firm's size, organizational structure, scope of 
business activities, number and location of the firm's offices, the 
nature and complexity of the products and services offered by the firm, 
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'), etc.'' \110\ Rule 3110(c) further 
requires member firms to conduct internal inspections of each location, 
and it identifies the presumed frequency of inspection for various 
types of locations.\111\ Importantly, Rule 3110 provides that ``[f]inal 
responsibility for proper supervision . . . rest[s] with the member.'' 
\112\
---------------------------------------------------------------------------

    \109\ FINRA Rule 3110(a).
    \110\ FINRA Rule 3110.12.
    \111\ FINRA Rule 3110(c)(1).
    \112\ See id. Rule 3110(a)(1) through (7) identify certain 
minimum requirements for the reasonably designed supervisory system. 
See generally FINRA Rule 3110.
---------------------------------------------------------------------------

    The proposed rule change is consistent with these obligations. It 
permits certain eligible firms to inspect certain eligible locations on 
a regular periodic schedule (presumed to be at least every three years) 
instead of an annual schedule. If an eligible member firm and its 
eligible location comply with various conditions and safeguards--
including a person-specific risk assessment--designed to minimize 
risks, the proposed rule change would provide this additional 
flexibility for the member firm in structuring its reasonably designed 
supervisory system. But it does not automatically transform residences 
into RSLs subject to less frequent inspection. Nor does it require 
firms to treat all residences where certain supervisory activities are 
performed as RSLs. It only permits a member firm to consider whether an 
RSL designation for a specific location would be appropriate in light 
of the rule's requirements and the member firm's broader obligation to 
establish and maintain a reasonably designed supervisory system. 
Accordingly, and as explained in more detail below, the Commission 
finds that the proposed rule change is consistent with Section 
15A(b)(6) of the Exchange Act.

A. Residential Supervisory Location Terms and Conditions

    The proposed rule change has various terms and conditions that 
limit the RSL designation to certain firms and locations. The 
Commission addresses the terms and conditions, and any related 
comments, in turn.
1. Member Firm Ineligibility Criteria
    As stated above, under proposed Rule 3110.19(b), a member firm 
would be ineligible to designate any of its locations as an RSL if the 
member is subject to any of seven firm-level

[[Page 82453]]

eligibility exclusions. The seven exclusions address members that are 
designated as Restricted Firms under FINRA Rule 4111; members 
designated as Taping Firms under FINRA Rule 3170; members undergoing, 
or required to undergo, a continuing membership review under FINRA Rule 
1017(a)(7) as a result of one or more associated persons at such 
location; firms that have received a notice from FINRA pursuant to 
FINRA Rule 9557, unless FINRA has otherwise permitted activities in 
writing pursuant to such rule; firms suspended by FINRA; firms that 
have been FINRA members for less than one year; and firms that have 
been found within the past three years by the SEC or FINRA to have 
violated Rule 3110(c).\113\
---------------------------------------------------------------------------

    \113\ See supra notes 57 through 63 and accompanying text.
---------------------------------------------------------------------------

    One commenter specifically supported the inclusion of the firm-
level exclusions covering suspended firms and firms that have been 
FINRA members for less than one year.\114\ No commenter opposed any of 
the proposed seven firm-level eligibility exclusions.
---------------------------------------------------------------------------

    \114\ Theresa J. Manderski, SVP, Chief Compliance Officer--BD, 
Davenport & Company LLC, to the Commission, dated Apr. 27, 2023, at 
2 (``Davenport'').
---------------------------------------------------------------------------

    FINRA reasonably determined to exclude a member firm from 
participation in the Pilot if the member firm is subject to any of the 
six proposed firm-level ineligibility criteria. Each of these criteria 
identifies--and excludes--member firms with characteristics that may 
indicate increased risk of non-compliance. Specifically, Restricted 
Firms have a history of misconduct or a high concentration of 
registered persons with a significant history of misconduct that gave 
rise to the designation,\115\ while Taping Firms are subject to 
heightened regulatory oversight because they employ a ``significant 
number of registered persons [who] previously worked for firms that 
have been expelled from the industry or have had their registrations 
revoked for inappropriate sales practices.'' \116\ Moreover, a member 
firm that is required to undergo a continuing membership review 
pursuant to FINRA Rule 1017(a)(7) has a person at the proposed RSL who 
is seeking to become an owner, control person, principal, or registered 
person of the member firm who has, in the previous five years, one or 
more ``final criminal matters'' or two or more ``specified risk 
events.'' \117\ Finally, if the Commission or FINRA has found that a 
member firm has violated Rule 3110(c) within the past three years, the 
member firm has demonstrated a recent difficultly implementing a 
compliant inspection program.\118\ Member firms covered by these 
exclusions therefore have a history of non-compliance or have 
registered representatives who have a history of (or come from a member 
firm with a history of) non-compliance. It is therefore reasonable for 
FINRA to determine that member firms that fall into these categories 
are not eligible to designate RSLs and exercise the flexibility that 
the proposed rule change provides in designing a member firm's 
supervisory system.
---------------------------------------------------------------------------

    \115\ Proposed Rule 3110.19(b)(1); see FINRA, Rule 4111 
Frequently Asked Questions, https://www.finra.org/rules-guidance/
key-topics/protecting-investors-from-misconduct/
faq#:~:text=A%20Restricted%20Firm%20is20a,such%20in%20a%20Department%
20decision.
    \116\ Proposed Rule 3110.19(b)(2); FINRA, FINRA Taping Rule 
(FINRA Rule 3170), https://www.finra.org/rules-guidance/guidance/taping-rule.
    \117\ Proposed Rule 3110.19(b)(3) (exclusion applicable where 
the person responsible for triggering a continuing membership review 
is located at the proposed RSL); FINRA Rule 1017(a)(7). ``The term 
`final criminal matter' means a criminal matter that resulted in a 
conviction of, or plea of guilty or nolo contendere (`no contest') 
by, a person that is disclosed, or is or was required to be 
disclosed, on the applicable Uniform Registration Forms.'' FINRA 
Rule 1011(h). ``Specified risk events'' include certain investment-
related, consumer-initiated (1) customer arbitration awards, (2) 
civil judgments, (3) customer arbitration settlements, or (4) civil 
litigation settlements. FINRA Rule 1011(p)(1), (2). ``Specified risk 
events'' also include certain investment-related civil actions or 
regulatory actions that result in (1) monetary sanctions for a 
dollar amount at or above $15,000 or (2) a bar, expulsion, 
revocation, recission, or suspension. See FINRA Rule 1011(p)(3), 
(4).
    \118\ Proposed Rule 3110.19(b)(7).
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    Furthermore, Rule 9557 notices are sent to member firms that are 
experiencing financial or operational difficulties.\119\ Additionally, 
suspension of a member firm by FINRA would be based on FINRA's 
determination that the member firm has failed to comply with its 
regulatory requirements or suspension is needed for the safety of 
investors, creditors, or other members because of the member firm's 
financial or operational difficulties.\120\ Such member firms raise 
concerns about their ability to comply with their obligations and may 
present risk to others. As such, it is reasonable to conclude that 
these member firms should not be eligible for the proposed rule change 
that is designed to afford member firms greater flexibility in 
designing their supervisory systems.
---------------------------------------------------------------------------

    \119\ Proposed Rule 3110.19(b)(4); see FINRA Rule 9557 
(Procedures for Regulating Activities Under Rules 4110, 4120 and 
4130 Regarding a Member Experiencing Financial or Operational 
Difficulties); see also FINRA Regulatory Notice 09-71 (Dec. 2009) 
(announcing SEC approval of consolidated FINRA rules governing 
financial responsibility), https://www.finra.org/rules-guidance/notices/09-71.
    \120\ Proposed Rule 3110.19(b)(5); A suspended firm may have 
been suspended because of a violation of ``federal securities laws, 
rules or regulations thereunder, the rules of the Municipal 
Securities Rulemaking Board, or FINRA rules.'' FINRA Rule 
8310(a)(3), (5); see FINRA Rule 9550 Series.
---------------------------------------------------------------------------

    Moreover, member firms that have been FINRA members for less than 
12 months may need additional time to develop their supervisory and 
compliance systems to effectively comply with applicable securities 
laws and rules.\121\ This time period also provides FINRA and other 
regulators with time to conduct inspections of new member firms to 
determine their compliance with their regulatory obligations before 
they may be eligible for the flexibility provided in the proposed 
rule.\122\ It is therefore reasonable for FINRA to determine that firms 
must be operating for a certain amount of time before they can be 
eligible to designate RSLs. One year provides a reasonable balance 
between providing member firms with the flexibility for supervision 
allowed in the proposed rule and concerns that member firms need to 
develop experience operating before they are given such flexibility. In 
sum, these proposed exclusions limit RSL designation to certain member 
firms without indicia that their business operations, supervisory 
system, or inspection programs may lack the maturity or safeguards to 
fully address the potential risks associated with RSLs.\123\
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    \121\ Proposed Rule 3110.19(b)(6).
    \122\ See Exchange Act Rule 15b2-2, 17 CFR 240.15b2-2 (generally 
requiring inspection of a newly registered broker dealer within six 
months for compliance with applicable financial responsibility rules 
and within 12 months for all other applicable regulatory 
requirements).
    \123\ Cf. Exchange Act Release No. 90635 (Dec. 10, 2020), 85 FR 
81540 (Dec. 16, 2020) (Order Approving File No. SR-FINRA-2020-011 to 
Address Brokers With a Significant History of Misconduct); Exchange 
Act Release No. 92525 (July 30, 2021), 86 FR 42925 (Aug. 5, 2021) 
and 86 FR 49589 (Sept. 3, 2021) (Corrected Order Approving File No. 
SR-FINRA-2020-041 to Adopt FINRA Rules 4111 (Restricted Firm 
Obligations) and 9561 (Procedures for Regulating Activities Under 
Rule 4111)).
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2. Location Ineligibility Criteria
    As stated above, proposed Rule 3110.19(c) would prohibit RSL 
designation for any location if one or more associated persons at the 
location is subject to any of six location-level eligibility 
exclusions.\124\ These six exclusions address associated persons with 
less than one year of direct supervisory experience with the member or 
its affiliate or subsidiary, who are functioning as a principal for a

[[Page 82454]]

limited period in accordance with Rule 1210.04 (Registration 
Requirements), who are subject to a mandatory heightened supervisory 
plan, who are statutorily disqualified, who are required to make 
disclosures about certain criminal and regulatory actions, or who are 
subject to a covered regulatory investigation or proceeding.\125\ These 
six exclusions are discussed in more detail below.
---------------------------------------------------------------------------

    \124\ Proposed Rule 3110.19(c).
    \125\ See supra notes 69 through 78 and accompanying text.
---------------------------------------------------------------------------

a. Less Than One Year of Supervisory Experience
    As originally proposed in the Notice, proposed Rule 3110.19(c)(1) 
would have prohibited an RSL designation for any location with a 
designated supervisor with less than one year of direct supervisory 
experience with the member firm.\126\ Several commenters urged FINRA to 
eliminate this exclusion.\127\ One commenter stated that requiring one 
year of supervisory experience is ``not supported by any objective 
evidence and can only be characterized as arbitrary.'' \128\ These 
commenters indicated that this proposed exclusion would negatively 
impact the employment opportunities for ``experienced supervisory 
personnel who may switch firms or those associated persons who are 
stand-outs at a firm [and secure a] promotion to a supervisory role.'' 
\129\ Another commenter emphasized that ``there is not a sufficient 
investor protection justification for this language to offset the 
substantial chilling effect on the transfer of experienced supervisory 
personnel from one broker-dealer to another broker-dealer.'' \130\ 
Although one commenter acknowledged that a member firm could still 
permit a new supervisor to work from a residence registered as an OSJ 
or supervisory branch office in the first year, that commenter 
emphasized that this proposed exclusion would ``create[] an additional 
burden that could have a disparate impact on people with years of 
experience who are reentering the workforce after time off to care for 
children or other family members.'' \131\
---------------------------------------------------------------------------

    \126\ Notice at 20577.
    \127\ Letters from Eversheds Sutherland LLP on behalf of the 
Committee of Annuity Insurers, to Secretary, Commission, dated Apr. 
27, 2023, at 2 (``CAI''); David T. Bellaire, Esq., Executive Vice 
President & General Counsel, Financial Services Institute, to 
Secretary, Commission, dated Apr. 27, 2023, at 4-5 (``FSI''); Mark 
Quinn, Director of Regulatory Affairs, Cetera Financial Group, to 
Sherry Haywood, Assistant Secretary, Commission, dated Apr. 27, 
2023, at 2-3 (``Cetera I''); Bernard V. Canepa, Managing Director & 
Associate General Counsel, Securities Industry and Financial Markets 
Association, to Vanessa Countryman, Secretary, Commission, dated 
Apr. 27, 2023, at 2 n.6 (``SIFMA I'').
    \128\ Cetera I at 2.
    \129\ FSI at 4; see Cetera I at 2 (``Branches would be 
ineligible for classification as an RSL simply because individual 
supervisors who may have been employed by the member firm for many 
years but who have previously either performed functions not 
directly related to supervision were not formally designated as 
supervisors. In addition, branches that house supervisors who have a 
lot of experience in supervisory roles with other member firms but 
have been employed by the current member firm for less than one year 
would be ineligible for RSL status.'').
    \130\ CAI at 2; see FSI at 4 (``this proposed criterion would 
place an unnecessary impediment on firms to hire and retain talent 
in a competitive job market.''); Cetera I at 3 (``If a member firm 
wishes to hire a supervisor in a remote location, the arbitrary one-
year requirement will prevent them from classifying their residence 
as an RSL for at least one year, which may prevent the firm from 
hiring the individual. [. . .] The benefits of this are minimal and 
do not outweigh the burdens.'').
    \131\ FSI at 4.
---------------------------------------------------------------------------

    In the event that FINRA declined to delete the proposed exclusion, 
some commenters requested modifications to the provision instead.\132\ 
For example, some commenters asked FINRA to modify the proposed 
exclusion to permit RSL designation for locations with supervisors who 
have as little as three months of direct supervisory experience with 
the member firm.\133\ Alternatively, some commenters urged FINRA to 
permit RSL designation for supervisors with less than one year of 
supervisory experience with the member firm so long as the member firm 
conducts an inspection of the RSL within the first year of 
designation.\134\
---------------------------------------------------------------------------

    \132\ See FSI at 5; letter from Mark Seffinger, Chief Compliance 
Officer, LPL Financial, to Vanessa Countryman, Secretary, 
Commission, dated May 25, 2023, at 2 (``LPL I''); ASA 3.
    \133\ FSI at 5 (suggesting a ``three or six-month requirement'' 
if such a requirement remains in the proposed rule change); cf. 
Cetera I at 2 (suggesting that the time period ``could as easily be 
three months or three years.'').
    \134\ LPL I at 2 (``[W]e support a requirement for such [a] 
branch to be inspected within the first year of designation versus 
registering that location as an OSJ.''); letter from Christopher A. 
Iacovella, President & Chief Executive Officer, American Securities 
Association, to Vanessa Countryman, Secretary, Commission, dated May 
25, 2023, at 3 (``ASA'') (``Rather than prohibiting new supervisors 
from taking advantage of the definition, we believe firms should be 
able to perform an onsite branch exam during the supervisor[']s 
first year.'').
---------------------------------------------------------------------------

    In response, FINRA amended proposed Rule 3110.19(c)(1) to address 
``the comments about the potential adverse impacts [this condition] 
could have on hiring efforts.'' \135\ As modified by Amendment No. 1, 
the proposed rule change would prohibit RSL designation for any 
location with a designated supervisor who has less than one year of 
direct supervisory experience with the member or an affiliate or 
subsidiary of the member that is registered as a broker-dealer or 
investment adviser.\136\ FINRA explained that this modification would 
permit RSL designation for a location with a designated supervisor who 
has, for example, six months of supervisory experience with the member 
firm and six months of supervisory experience at the member's affiliate 
or subsidiary that is registered as a broker-dealer or investment 
adviser.\137\ FINRA stated that this modification ``recogniz[es] that 
such entities may share systems and have similar compliance cultures to 
meet their obligations under the federal securities laws.'' \138\ As 
such, FINRA indicated that such supervisors should have sufficient 
experience with the member firm's compliance systems.\139\
---------------------------------------------------------------------------

    \135\ FINRA Response I at 5.
    \136\ See proposed Rule 3110.19(c)(1); Amendment No. 1 at 4.
    \137\ FINRA Response I at 5.
    \138\ Id.
    \139\ See id. at 4-5.
---------------------------------------------------------------------------

    Five commenters supported the amended exclusion,\140\ and one of 
them ``agree[d] that this amendment strikes an appropriate balance 
between regulators' interest in high supervisory standards and industry 
concerns about the impact on hiring efforts.'' \141\
---------------------------------------------------------------------------

    \140\ Letters from Bernard V. Canepa, Managing Director & 
Associate General Counsel, Securities Industry and Financial Markets 
Association, to Vanessa Countryman, Secretary, Commission, dated 
Aug. 1, 2023, at 2 (``SIFMA II'') (indicating that the modified 
language addresses ``concerns raised by the industry''); Gail 
Merken, Chief Compliance Officer, Janet Dyer, Chief Compliance 
Officer, John McGinty, Chief Compliance Officer, Fidelity 
Investments, to Vanessa Countryman, Secretary, Commission, dated 
Aug. 1, 2023, at 1 (``Fidelity II''); Jim McHale, Executive Vice 
President, Head of WIM Compliance and Peter Macchio, Executive Vice 
President, Head of CIB Compliance, Wells Fargo, to Vanessa 
Countryman, Secretary, Commission, dated Aug. 1, 2023, at 2 (``Wells 
Fargo'') (expressing appreciation for the amended proposal but 
encouraging a future reassessment ``for experienced supervisors 
[who] are switching to a new supervisory role at an unaffiliated 
broker-dealer''); Jennifer Szaro, CRCP, Chief Compliance Officer, 
XML Securities, LLC, et al., to Vanessa Countryman, Secretary, 
Commission, dated July 29, 2023, at 1 (``XML'') (the amended 
proposal ``applies a commonsense approach, in that if an associated 
person has been working in either capacity the member will have a 
basis to evaluate the associated person's working relationship and 
conduct a reasonable risk assessment.''); Andrew Hartnett, NASAA 
President and Deputy Commissioner, Iowa Insurance Division, North 
American Securities Administrators Association, Inc., to Sherry 
Haywood, Assistant Secretary, Commission, dated July 26, 2023, at 4 
(``NASAA II'').
    \141\ NASAA II at 4.
---------------------------------------------------------------------------

    Three other commenters, on the other hand, opposed this proposed 
exclusion.\142\ One of these three

[[Page 82455]]

commenters repeated its request to remove this proposed exclusion, 
stating that it ``is arbitrary and not reasonably related to the 
objectives it seeks to accomplish.'' \143\ Another of these commenters 
preferred the exclusion as originally proposed in the Notice, 
explaining that FINRA erroneously assumes that the compliance and 
supervisory cultures are the same at all of a member's affiliates and 
subsidiaries.\144\ The third commenter asked for a modification that 
would permit RSL designation so long as the associated person at the 
location has at least one year of any experience--either supervisory or 
non-supervisory--with the member, its affiliates, or its 
subsidiaries.\145\
---------------------------------------------------------------------------

    \142\ Letters from Michael Friedman, Head of Broker Dealer, 
Albert Securities, LLC, to Vanessa Countryman, Secretary, 
Commission, dated July 24, 2023, at 1-2 (``Albert''); Mark Quinn, 
Director of Regulatory Affairs, Cetera Financial Group, to Vanessa 
Countryman, Secretary, Commission, dated July 31, 2023, at 2 
(``Cetera II''); Hugh Berkson, President, Public Investors Advocate 
Bar Association, to Vanessa Countryman, Secretary, Commission, dated 
July 31, 2023, at 3 (``PIABA II'').
    \143\ Cetera II at 2 (stating that ``[o]nce an individual passes 
the necessary qualifications examinations, they [should be able to] 
begin their duties immediately.'').
    \144\ PIABA II at 3 (``While some firms may share systems and 
have similar compliance cultures with affiliates and subsidiaries, 
many others [do not], especially given the size and complexity of 
numerous financial firms. Yet, FINRA's adjustment permits disparate 
entities to combine supervisory experience for meeting the one year 
minimum and contains no minimum time requirement at all for the 
member itself.'').
    \145\ Albert at 1-2 (``[U]nlike FINRA, we believe a newly-hired 
registered principal should be allowed to start the clock on their 
one year at their new employer by working remotely in a non-
supervisory capacity prior to becoming a designated supervisor and 
qualifying their home as a residential supervisory location.'' . . . 
Doing so ``would still require new employees to learn the details of 
their new firm before being eligible to supervise remotely . . . 
.'').
---------------------------------------------------------------------------

    In response, FINRA declined to further amend the proposed rule 
change.\146\ FINRA stated that the amended language ``appropriately 
addresses'' the concern that this proposed exclusion is intended to 
address: that an associated person at an RSL might otherwise ``not have 
the requisite tenure at the member firm to develop experience with the 
firm's systems, people, products, and overall compliance culture.'' 
\147\
---------------------------------------------------------------------------

    \146\ FINRA Response II at 4-5.
    \147\ Id.
---------------------------------------------------------------------------

    The proposed rule change, as modified by Amendment No. 1 (requiring 
a level of supervisory experience to permit a member firm to consider 
an RSL designation), is reasonable. For new supervisors or supervisors 
hired from outside of a member firm's broader organization, the 
proposed rule change requires that they operate from a location that is 
an OSJ or supervisory branch office (where they would be inspected at 
least annually) for at least a year to gain supervisory experience with 
the member firm's systems and overall compliance culture.\148\ Because 
of the unique nature of each member firm's business, FINRA reasonably 
determined that supervisors wishing to exercise the flexibility of this 
proposed rule change must first have experience with the member firm's 
systems and products, and fully integrate into a member firm's 
compliance program and culture. Therefore, just as it is reasonable for 
FINRA to exclude supervisors without any direct supervisory experience, 
it is also reasonable for FINRA to exclude supervisors with substantial 
direct supervisory experience at different member firm(s). This 
proposed rule change does not, however, require these categories of 
excluded supervisors to work from a non-residential location. A member 
firm may permit such a supervisor to work from a residential location 
under the current regulatory framework by designating the new 
supervisor's residence as an OSJ or supervisory branch office and 
subjecting it to an annual inspection. The one-year time period--
whether in a non-residential location or residential location 
designated as an OSJ or supervisory branch office--allows supervisors 
to develop experience with the member firm's systems, people, products, 
and overall compliance culture. This should help to ensure that new 
supervisors at a member firm develop the experience necessary to 
reasonably carry out their assigned supervisory responsibilities for a 
member firm's supervisory system before their residences become 
eligible for RSL designation and less frequent inspection.
---------------------------------------------------------------------------

    \148\ See proposed Rule 3110.19(c)(1); supra notes 81 through 83 
and accompanying text.
---------------------------------------------------------------------------

    It is reasonable for FINRA to determine that supervisors must have 
a certain amount of direct supervisory experience with the member firm, 
or an affiliate or subsidiary of the member that is registered as a 
broker-dealer or investment adviser, before their residence can be 
eligible for RSL designation. The one-year requirement will help ensure 
that new supervisors have an opportunity to gain experience with a 
member firm's systems and products, and fully integrate into a member 
firm's compliance program and culture. This time period also provides 
the member firm with time to evaluate the performance of the new 
supervisor to determine their compliance with their regulatory 
obligations before they may be eligible for the flexibility provided in 
the proposed rule. Moreover, one year provides a reasonable balance 
between providing member firms with the flexibility for supervision 
allowed in the proposed rule and concerns that supervisors need to 
spend time directly supervising before they are given such flexibility.
    Regarding the commenter's request to permit RSL designation so long 
as the associated person at the proposed RSL has at least one year of 
any experience with the member firm, its affiliates, or its 
subsidiaries,\149\ it is reasonable for FINRA to conclude that 
supervisors without direct supervisory experience at the member firm, 
its affiliates, or its subsidiaries may lack the skills and experience 
to effectively supervise other people, locations, and business 
activities from a residence treated as a non-branch location. For that 
reason, it is reasonable that FINRA limited qualifying experience to 
direct supervisory experience with the member firm, its affiliates, or 
its subsidiaries.
---------------------------------------------------------------------------

    \149\ Albert at 1-2.
---------------------------------------------------------------------------

    Commenters expressed concern that this proposed exclusion would 
negatively impact hiring and retention without providing an investor-
protection benefit.\150\ However, member firms retain the flexibility 
to permit supervisors to work from a residential location registered as 
an OSJ or supervisory branch office. Firms may choose to exercise that 
flexibility to attract and retain talent, and the proposed rule change 
would provide member firms even more flexibility after the supervisor 
has gained at least one year of supervisory experience with the member 
firm. In light of these factors, it is reasonable to require new 
supervisors or supervisors new to the member firm to work from a 
location registered as an OSJ or supervisory branch office that would 
be subject to an annual inspection cycle for a set period of time.
---------------------------------------------------------------------------

    \150\ See FSI at 4, CAI at 2, Cetera I at 2-3.
---------------------------------------------------------------------------

    A commenter opposed the provision providing that the one-year 
experience requirement may be satisfied by experience with a member 
firm's affiliate or subsidiary that is registered as a broker-dealer or 
investment adviser.\151\ This commenter explained that member firms, 
affiliates, and subsidiaries do not necessarily share the same 
compliance systems and cultures.\152\ However, where a member firm 
relies on a supervisor's experience from an affiliate or subsidiary to 
satisfy the experience requirement, the supervisor's private residence 
would not be automatically designated as an RSL. Rather, as discussed 
further below,

[[Page 82456]]

proposed Rule 3110.19(e) would require the member firm to conduct and 
document a person-specific risk assessment prior to designating the 
location as an RSL. If a supervisor lacks comparable supervisory 
experience with the member, its affiliates, or its subsidiaries, or if 
the member, its affiliates, or its subsidiaries do not have similar 
compliance systems and cultures, the member firm may choose to consider 
those circumstances to assess whether such an RSL designation is 
appropriate.
---------------------------------------------------------------------------

    \151\ PIABA II at 3.
    \152\ See id.
---------------------------------------------------------------------------

b. Heightened Supervisory Plans
    As stated above, proposed Rule 3110.19(c)(3) would prohibit RSL 
designation for any location with a designated supervisor who ``is 
subject to a mandatory heightened supervisory plan under the rules of 
the SEC, FINRA, or a state regulatory agency.'' \153\ One commenter 
urged FINRA to modify this proposed exclusion to also cover 
``heightened supervision under a plan established by the member in 
connection with or in response to any such regulator's recommendation 
or finding,'' stating that the rule should not distinguish between 
heightened supervisory plans imposed by regulators and those imposed by 
member firms.\154\ The commenter explained that a member firm's 
decision to impose its own heightened supervisory plan ``in lieu of a 
formal regulatory action or order[ ] or in response to a regulatory 
examination'' raises ``the same concerns as regulator-mandated plans 
and should be addressed accordingly.'' \155\
---------------------------------------------------------------------------

    \153\ See proposed Rule 3110.19(c)(3).
    \154\ See letter from Andrew Hartnett, NASAA President and 
Deputy Commissioner, Iowa Insurance Division, North American 
Securities Administrators Association, Inc., to Sherry Haywood, 
Assistant Secretary, Commission, dated April 27, 2023, at 4-5 
(``NASAA I'').
    \155\ Id. at 5.
---------------------------------------------------------------------------

    In response, FINRA declined to extend the proposed exclusion to 
cover any heightened supervisory plans imposed by a member.\156\ FINRA 
expects that a member may, from time to time, impose voluntary 
heightened supervisory plans as part of its supervision program.\157\ 
FINRA stated that what constitutes a firm-imposed heightened 
supervisory plan is ``subjective,'' and it expressed concern that 
extending this proposed exclusion to them ``could act to disincentivize 
firms from imposing tailored or more specific supervisory controls if 
the result [would be] RSL ineligibility.'' \158\ However, FINRA 
``agree[d] that there is value in considering heightened supervision as 
a risk factor.'' \159\ To balance the commenter's concern with FINRA's 
concern about discouraging the use of heightened supervision, FINRA 
modified the proposed rule change to require consideration of non-
mandatory heightened supervisory plans in the risk assessment described 
in proposed Rule 3110.19(e).\160\
---------------------------------------------------------------------------

    \156\ FINRA Response I at 6.
    \157\ Id. (``[A] firm should routinely evaluate its supervisory 
system to ensure it is appropriately tailored to the firm's 
business. Such an evaluation may prompt a firm, out of an abundance 
of caution and independent of specific regulatory requirements or 
mandates, to undertake additional supervisory measures, including 
voluntarily imposing a heightened supervisory plan.'').
    \158\ Id.
    \159\ Id.
    \160\ Id.; see proposed Rule 3110.19(e).
---------------------------------------------------------------------------

    The same commenter characterized FINRA's modification as ``an 
acceptable balance between [its previous] concerns and FINRA's desire 
not to disincentivize firms from taking such steps to proactively 
improve their supervisory systems.'' \161\ No commenter opposed the 
amended language.
---------------------------------------------------------------------------

    \161\ NASAA II at 4.
---------------------------------------------------------------------------

    Prohibiting locations with an associated person subject to a 
regulator-imposed heightened supervisory plan from being designated as 
an RSL is reasonable as it is designed to limit compliance risks. If a 
regulator has imposed a heightened supervisory plan on a specific 
associated person, the regulator has determined that they require 
additional supervision to help ensure their compliance with securities 
laws, regulations, and rules. It is reasonable for FINRA to determine 
that under those circumstances a member firm should not be permitted to 
designate that person's residence as an RSL and permit a reduced 
inspection cycle. Firm-imposed heightened supervisory plans may, in 
some circumstances, indicate similar risks. At the same time, expanding 
this exclusion to firm-imposed supervisory plans could disincentivize 
firms from using heightened supervision when circumstances would 
otherwise counsel such a plan. Under these circumstances, it is 
reasonable to require member firms to consider any firm-imposed 
heightened supervisory plans as part of the mandatory, person-specific 
risk assessment.
c. Investigations and Proceedings Alleging a Failure To Supervise
    As originally proposed in the Notice, proposed Rule 3110.19(c)(6) 
would have prohibited RSL designation for any location with an 
associated person who is ``currently subject to, or has been notified 
in writing that [they] will be subject to, any investigation, 
proceeding, complaint or other action by the member, the SEC, a self-
regulatory organization, including FINRA, or state securities 
commission (or agency or office performing like functions) alleging 
they have failed reasonably to supervise another person subject to 
their supervision, with a view to preventing the violation of any 
provision of the Securities Act, the Exchange Act, the Investment 
Advisers Act, the Investment Company Act, the Commodity Exchange Act, 
any state law pertaining to the regulation of securities or any rule or 
regulation under any of such Acts or laws, or any of the rules of the 
MSRB or FINRA.'' \162\
---------------------------------------------------------------------------

    \162\ Notice at 20577; proposed Rule 3110.19(c)(6).
---------------------------------------------------------------------------

    Three commenters supported this proposed exclusion.\163\ One 
commenter emphasized the importance of equal treatment for all 
regulatory actions alleging a failure to supervise, regardless of 
whether federal or state securities laws are at issue.\164\ Another 
commenter coupled its support with a recommendation that the proposed 
exclusion also extend to associated persons who have been subject to 
multiple customer complaints, arbitrations, and civil cases.\165\
---------------------------------------------------------------------------

    \163\ NASAA I at 2; letter from Hugh Berkson, President, Public 
Investors Advocate Bar Association, to Vanessa Countryman, 
Secretary, Commission, dated Apr. 26, 2023, at 3 (``PIABA I''); 
Davenport at 2 (supporting ``[m]aking an office or location 
ineligible when an associate[d] person is [the] subject of an 
investigation or action relating to a failure to supervise.'').
    \164\ NASAA I at 2 (``State securities laws are an important 
part of the regulatory framework and should not be treated 
differently with respect to assessments of regulatory and 
supervisory risks that the proposed ineligibility criteria are 
designed to address.'').
    \165\ PIABA I at 3.
---------------------------------------------------------------------------

    Four commenters opposed the proposed exclusion, citing practical 
challenges associated with the tracking, duration, and resolution of 
state-level securities investigations.\166\ In particular, three of the 
opposing commenters stated that the inclusion of state-law violations 
in this proposed exclusion is fundamentally unfair, and one of these 
commenters stated that supervisors would ``lose[ ] the privilege

[[Page 82457]]

of workplace flexibility for an uncertain and inordinate amount of 
time[, disrupting their lives] without any adjudication that they 
failed in their supervisory duties.'' \167\ For these reasons, three 
opposing commenters urged FINRA to remove state-level securities 
investigations from the proposed rule change.\168\ The fourth opposing 
commenter similarly recommended that FINRA narrow the proposed 
exclusion such that it take effect upon receipt of something akin to a 
Wells notice.\169\
---------------------------------------------------------------------------

    \166\ ASA at 2; Cetera I at 3-4; letter from Scott C. Kursman, 
Managing Director & Chief Compliance Officer, Citigroup Global 
Markets, Inc., to Vanessa Countryman, Secretary, Commission, dated 
Apr. 28, 2023, at 1-2 (``Citigroup''); SIFMA I at 1-3. Taken 
together, the alleged practical challenges include: state 
investigations are difficult to track; state investigations may take 
years to commence or conclude; it is difficult to discern when state 
investigations commence or conclude; state regulators open 
investigations based on varying standards for the evidence required 
to open such an investigation; and the phrase ``subject of'' is too 
vague to equip firms to effectively comply with the proposed 
exclusion. See SIFMA I at 1-3; Citigroup at 1 (noting that it shares 
SIFMA's concern); ASA at 2 (taking this position in comments related 
to the ``Pilot Program''); Cetera at 3-4.
    \167\ SIFMA I at 3; see Citigroup at 1 (``[T]he fact that the 
mere initiation of an investigation, as opposed to some adjudicated 
finding, can be the basis for ineligibility seems problematic from 
an individual fairness and notice standpoint.''); Cetera at 4 (``It 
unfairly shifts the presumption from innocence to guilt without any 
form of substantive finding, much less adjudication.'').
    \168\ SIFMA at 3; Citigroup at 1 (``We support the suggestion 
made by SIFMA that, rather than lose RSL eligibility, a state 
investigation for failure to supervise should be considered by a 
firm's preexisting obligations under Rule 3110 to maintain a 
reasonably designed supervisory system and to conduct an appropriate 
risk assessment.''); ASA at 2 (``We implore federal regulators not 
to allow unsubstantiated claims by state regulators trying to 
protect their regulatory turf to dictate how the regulation of the 
modern broker-dealer business should evolve.'').
    \169\ Cetera I at 4 (``RSL eligibility would only be precluded 
if the associated person has been notified by a regulatory agency, 
in writing, that the agency intends to take or recommend enforcement 
action against the individual for failure to perform supervisory 
responsibilities.''). A Wells notice is a communication from SEC 
Staff to a person involved in an investigation that: (1) informs the 
person the staff has made a preliminary determination to recommend 
that the Commission file an action or institute a proceeding against 
them; (2) identifies the securities law violations that the staff 
has preliminarily determined to include in the recommendation; and 
(3) provides notice that the person may make a submission to the 
Division and the Commission concerning the proposed recommendation. 
See Enforcement Manual, Securities and Exchange Commission, Division 
of Enforcement, at 19-20, https://www.sec.gov/divisions/enforce/enforcementmanual.pdf.
---------------------------------------------------------------------------

    In response, FINRA amended the proposed exclusion in two ways.\170\ 
First, FINRA limited its scope to Investigations and Proceedings, as 
those terms are defined in Form U4, by a Regulator ``expressly'' 
alleging a failure to supervise.\171\ FINRA stated that ``using the 
definitions from Form U4 provides consistency and clarity not only with 
respect to the scope of applicable events subject to the ineligibility 
criteria, but also regarding when some events ``begin'' (e.g., after 
the `Wells' notice has been given).'' \172\ Second, FINRA included a 
temporal element to provide that such locations may be designated or 
redesignated as an RSL subject to the requirements of the proposed rule 
change, as modified by Amendment No. 1, upon the earlier of: (1) the 
member's receipt of written notification from the applicable Regulator 
that such Investigation has concluded without further action; or (2) 
one year from the date of the last communication from such Regulator 
relating to such Investigation.\173\ FINRA explained that the proposed 
amendment addresses ``commenters' concerns that unadjudicated 
allegations would form the basis of a location's permanent exclusion as 
an RSL.'' \174\
---------------------------------------------------------------------------

    \170\ See FINRA Response I at 6-9; proposed Rule 3110.19(c)(6); 
Amendment No. 1.
    \171\ FINRA Response I at 7-8; see Amendment No. 1; proposed 
Rule 3110.19(c)(6). As modified by Amendment No. 1, the proposed 
rule change would prohibit RSL designation for any location with an 
associated person who ``has been notified in writing that [he or 
she] is now subject to[ ] any Investigation or Proceeding, as such 
terms are defined [for Form U4], by [a Regulator] expressly alleging 
they have failed reasonably to supervise another person subject to 
their supervision with a view to preventing the violation of any 
provision of the Securities Act, the Exchange Act, the Investment 
Advisers Act, the Investment Company Act, the Commodity Exchange 
Act, any state law pertaining to the regulation of securities[,] or 
any rule or regulation under any of such [a]cts or laws, or any of 
the rules of the MSRB or other self-regulatory organization, 
including FINRA.'' Proposed Rule 3110.19(c)(6). The proposed 
amendment also broadens the scope of the applicable rules. As 
originally proposed in the Notice, the proposed rule change would 
have reached the rules of the MSRB and FINRA, but not--as now 
proposed--``any'' self-regulatory organization. See Notice at 20577.
    \172\ FINRA Response I at 8-9. FINRA emphasized that this 
proposed exclusion would apply ``where a Regulator's written 
notification to an associated person describes circumstances and 
other allegations that could be reasonably construed to relate to a 
failure to reasonably supervise another individual under the 
associated person's supervision.'' Id. at 8.
    \173\ See FINRA Response I at 6-9; Proposed Rule 3110.19(c)(6); 
Amendment No. 1. As stated above, this proposed modification would 
not apply to an associated person who is subject to an ongoing 
Proceeding.
    \174\ FINRA Response I at 9.
---------------------------------------------------------------------------

    Three commenters supported the modified exclusion, stressing that 
the revisions provide regulatory clarity and address industry concerns 
about the uncertain length of some regulatory investigations.\175\ A 
fourth commenter ``generally support[ed]'' the modified provision 
because it ``reduces the likelihood that a location remains ineligible 
for longer than reasonably necessary for a regulator to investigate 
potential misconduct[ ] while allowing regulators sufficient 
flexibility to conduct a thorough investigation.'' \176\ But this 
commenter asked for further modifications to broaden the scope of the 
proposed rule change, including to codify FINRA's statement that the 
exclusion would apply where circumstances can be reasonably construed 
to evidence a covered Investigation, to clarify that a Wells notice or 
its equivalent ``is not a prerequisite for ineligibility under this 
criterion,'' and to clarify that some regulatory communications, 
including subpoenas, may provide notice of a covered investigation 
``depending on the information'' they contain.\177\
---------------------------------------------------------------------------

    \175\ SIFMA II at 2 (``[T]he Proposed Rule Change, as amended, 
addresses in part concerns raised by the industry. For example, 
proposed Rule . . . 3110(c)(6) now allows a firm to designate or 
redesignate an RSL location after a specified period of time 
following an investigation.''); XML at 1 (the use of the Form U4 
definitions for Investigation and Proceeding ``will maintain 
consistency within the industry,'' and the revised exclusion ``will 
enable members to determine an effective date for designation or 
redesignation of an RSL''); Fidelity II at 2 (``Fidelity also 
appreciates the clarification provided concerning an associated 
person who is the subject of an investigation or proceeding by a 
regulator, particularly the ability to resume designating a location 
as an RSL either at the closure of the proceeding or after the 
matter has been idle for a year.'').
    \176\ NASAA II at 2-3.
    \177\ Id. at 3-4 and n.8.
---------------------------------------------------------------------------

    In response, FINRA declined to further amend the proposed rule 
change.\178\ FINRA stated that ``the well-established definitions from 
Form U4 provide a clear picture of the scope of applicable events 
subject to the proposed eligibility criterion.'' \179\ FINRA also 
emphasized that although subpoenas and other regulatory communications 
do not necessarily establish the existence of an ``Investigation'' as 
defined in Form U4, the proposed rule change separately requires firms 
to consider ``any regulatory communications,'' including subpoenas, in 
the mandatory risk assessment.\180\
---------------------------------------------------------------------------

    \178\ FINRA Response II at 6.
    \179\ Id.
    \180\ See id.
---------------------------------------------------------------------------

    The proposed rule change, as modified by Amendment No. 1, 
reasonably addresses the potential risks indicated by written 
communications from a Regulator alleging a failure to supervise. It is 
reasonable for FINRA to conclude that, where an associated person's 
conduct has resulted in a Regulator notifying the associated person 
that they are subject to an Investigation or a Proceeding expressly 
alleging that they have failed reasonably to supervise another person 
subject to their supervision, the potential risk warrants the 
associated person having their residence inspected on a more frequent 
basis, and therefore the residence should not be designated as an 
RSL.\181\
---------------------------------------------------------------------------

    \181\ NASAA requested that FINRA clarify that a Wells notice or 
its equivalent ``is not a prerequisite for ineligibility under this 
criterion.'' NASAA II at 3. The proposed rule change, as modified by 
Amendment No. 1, makes clear that ``Investigation'' has the same 
meaning as it does for Form U4. See supra note 74 and accompanying 
text. For purposes of Form U4, some of the circumstances 
constituting an ``Investigation'' would not require a Wells notice. 
See id.

---------------------------------------------------------------------------

[[Page 82458]]

    The proposed exclusion, as modified by Amendment No. 1, also 
reasonably addresses commenter concerns with its scope and equips 
member firms to comply with its terms. By limiting its scope to certain 
Investigations and Proceedings, as those terms are defined for purposes 
of Form U4, that ``expressly'' allege a failure to reasonably 
supervise, the proposed exclusion clarifies that FINRA does not expect 
firms to discern--based on vague or ambiguous information--whether the 
exclusion applies. Separately, the proposed rule change addresses 
commenter concerns that unadjudicated allegations might permanently 
prohibit a location from RSL designation by including a temporal 
element that permits the designation or redesignation of affected RSLs 
under limited circumstances. Specifically, this provision would permit 
RSL designation or redesignation upon (1) the member's receipt of 
written notification from the applicable Regulator that such 
Investigation has concluded without formal action or (2) one year from 
the date of the last communication from such Regulator relating to such 
Investigation.\182\ Finally, while the proposed exclusion would not 
capture circumstances short of a formal Investigation or Proceeding 
that could counsel against an RSL designation, the proposed rule change 
separately requires firms to consider--as part of the mandatory, 
person-specific risk assessment--any regulatory communications from a 
Regulator indicating that the associated person at the proposed RSL 
failed reasonably to supervise another person subject to their 
supervision.\183\
---------------------------------------------------------------------------

    \182\ Proposed Rule 3110.19(c)(6).
    \183\ Proposed Rule 3110.19(e)(5).
---------------------------------------------------------------------------

d. Customer Complaints, Arbitration Claims, and Civil Actions
    As originally proposed in the Notice, proposed Rule 3110.19(c) did 
not include a location-level exclusion addressing any associated person 
who is or has been subject to multiple customer complaints or customer-
initiated, investment-related arbitration claims or civil actions.\184\ 
One commenter recommended that FINRA include a location-level exclusion 
covering such associated persons, as these customer-initiated actions 
are often the ``canary in the coal mine'' indicating threats to 
investor protection.\185\ In response, FINRA modified the proposed rule 
change (as described in more detail below) to require a member to 
consider the volume and nature of customer complaints as part of the 
mandatory, person-specific risk assessment prior to RSL 
designation.\186\ Although the proposed risk assessment does not 
expressly require the consideration of customer-initiated, investment-
related arbitration or civil litigation, FINRA emphasized that the risk 
assessment's list of factors is ``non-exhaustive'' and it ``agree[d] 
that the presence of such arbitration[s] or civil litigation[s] would 
be a factor for a firm to consider as part of the risk assessment.'' 
\187\
---------------------------------------------------------------------------

    \184\ See Notice at 20577-78; proposed Rule 3110.19(c).
    \185\ PIABA I at 3.
    \186\ Proposed Rule 3110.19(e); Amendment No. 1 at 6.
    \187\ FINRA Response I at 7.
---------------------------------------------------------------------------

    In response to the Amendment No. 1, the commenter repeated its 
request that the location-level exclusions also cover locations of 
associated persons who have been subject to multiple customer 
complaints or customer-initiated, investment-related arbitrations or 
civil actions.\188\ This commenter emphasized that such an associated 
person should be disqualified from working from an RSL ``[r]ather than 
trusting member firms to conduct and document a risk assessment[ ] that 
includes examining the `volume and nature of customer complaints.' '' 
\189\
---------------------------------------------------------------------------

    \188\ PIABA II at 3-4.
    \189\ Id. at 4.
---------------------------------------------------------------------------

    In response, FINRA declined to modify the proposed rule change to 
include an automatic exclusion for locations with associated persons 
who have been the subject of multiple customer complaints.\190\ FINRA 
emphasized that customer complaints ``may lack merit,'' and the 
proposed rule change's mandatory risk assessment requires the 
consideration of the volume and nature of customer complaints prior to 
any RSL designation.\191\
---------------------------------------------------------------------------

    \190\ See FINRA Response II at 6.
    \191\ Id.
---------------------------------------------------------------------------

    The proposed rule change takes a reasonable approach to the issue 
of customer complaints and customer-initiated, investment-related 
arbitration claims and civil actions by requiring firms to consider the 
``volume and nature of customer complaints'' in the mandatory risk 
assessment prior to RSL designation.\192\ Although the proposed risk 
assessment does not explicitly mandate the consideration of customer-
initiated, investment-related arbitration claims and civil actions, the 
risk assessment's factors are non-exhaustive. Moreover, FINRA has 
stated that such arbitration claims and civil actions would be relevant 
factors for consideration during the mandatory risk assessment.\193\
---------------------------------------------------------------------------

    \192\ The Commission addresses the proposed risk assessment in 
Section III(A)(5).
    \193\ FINRA Response I at 7.
---------------------------------------------------------------------------

    Such complaints, claims, and actions may, in certain circumstances, 
indicate heightened levels of risk. However, they are not formal 
investigations or proceedings initiated by a regulator charged with 
enforcing securities laws, regulations, and rules. For example, they 
may be overly broad in scope or lack the factual development of a 
comparable regulatory action. Because assessing the risk associated 
with complaints, claims, and actions may require investigation and a 
consideration of the totality of the circumstances, it is reasonable 
that--in lieu of creating a blanket exclusion for such associated 
persons--the volume and nature of customer complaints should be 
considered in the mandatory risk assessment.
e. Other Three Location-Level Exclusions
    As stated above, the proposed rule change's location-level 
eligibility exclusions also prohibit RSL designation for any location 
with an associated person who: (1) is functioning as a principal for a 
limited period in accordance with Rule 1210.04 (Registration 
Requirements); (2) is statutorily disqualified, unless such 
disqualified person (A) has been approved (or is otherwise permitted 
pursuant to FINRA rules and the federal securities laws) to associate 
with a member and (B) is not subject to a mandatory heightened 
supervisory plan under proposed Rule 3110.19(c)(3) or otherwise as a 
condition to approval or permission for such association; or (3) 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.\194\ No commenter offered specific support for, or 
opposition to, any of these three exclusions.
---------------------------------------------------------------------------

    \194\ See proposed Rule 3110.19(c)(2), (4), and (5).
---------------------------------------------------------------------------

    Each of these three location-level exclusions is reasonable in 
light of the increased risk each category of person might pose. First, 
a supervisor acting as a principal for a limited period prior to 
passing a qualification examination has not yet acquired the 
credentials allowing them to act as a principal on a permanent 
basis.\195\ Second, an

[[Page 82459]]

individual subject to a statutory disqualification has engaged in 
violative conduct that may indicate an increased risk of non-
compliance.\196\ Third, an individual with certain regulatory or 
criminal-action disclosures on Form U4 has a history of criminal 
conviction(s) or regulatory finding(s) that may indicate an increased 
risk of non-compliance.\197\ Because of the heightened risks associated 
with these three categories of supervisors, it is reasonable for the 
proposed rule change to require such supervisors to operate from an OSJ 
or supervisory branch office (where they will be inspected at least 
annually) rather than from a location designated as an RSL (where they 
would be inspected on a regular periodic schedule, presumed to be at 
least every three years).\198\ Therefore, it is reasonable to exclude 
such supervisors' residences from RSL designation.
---------------------------------------------------------------------------

    \195\ FINRA Rule 1210.04 permits a member to ``designate any 
person currently registered, or who becomes registered, with the 
member as a representative to function as a principal for a period 
of 120 calendar days prior to passing an appropriate principal 
qualification examination as specified under Rule 1220(a), provided 
that such person has at least 18 months of experience functioning as 
a registered representative within the five-year period immediately 
preceding the designation and has fulfilled all applicable 
prerequisite registration, fee and examination requirements prior to 
designation as a principal. However, in no event may such person 
function as a principal beyond the initial 120 calendar day period 
without having successfully passed an appropriate principal 
qualification examination as specified under Rule 1220(a).''
    \196\ Section 3(a)(39) of the Exchange Act identifies a list of 
events that disqualify someone from membership in, participation in, 
or association with a member of a self-regulatory organization. 15 
U.S.C. 78c(a)(39).
    \197\ See supra note 73.
    \198\ See FINRA Rule 3110(c)(1); proposed Rule 3110.19(a).
---------------------------------------------------------------------------

3. Conditions for Designation as a Residential Supervisory Location
    As stated above, proposed Rule 3110.19(a) would provide that an 
associated person's private residence where supervisory activities are 
conducted may be eligible for RSL designation provided that the member 
firm and/or location complies with ten conditions.\199\ FINRA stated 
that it adapted the first eight conditions from the primary and non-
primary residence exclusions.\200\ It added a ninth condition on 
recordkeeping and a tenth condition addressing technology and 
surveillance tools.\201\ These ten conditions are discussed in more 
detail below.
---------------------------------------------------------------------------

    \199\ See proposed Rule 3110.19(a). SEB Securities stated that 
the proposed rule change ``does not fully explain how often a home 
office would need to be used to be considered a non-branch location 
or RSL'' and questioned whether the RSL designation is ``only for 
associated persons whose primary place of business is their home.'' 
Letter from Anonymous, Compliance Officer, SEB Securities, Inc. 
(``SEB''), to the Commission, dated July 13, 2023. FINRA responded 
that SEB's comment relates to a ``broader question about the branch 
office definition'' and that the proposed rule change ``is not 
intended to change'' the longstanding definition of ``branch 
office,'' which has been in effect since 2006. FINRA Response II at 
8.
    \200\ Notice at 20576.
    \201\ Id.
---------------------------------------------------------------------------

a. Conditions Adapted From the Primary and Non-Primary Residence 
Exclusions
    As stated above, FINRA adapted the first eight conditions of the 
proposed rule change from the primary and non-primary residence 
exclusions: (1) only one associated person, or multiple associated 
persons who reside at that location and are members of the same 
immediate family, conduct business at the location; \202\ (2) the 
location is not held out to the public as an office; \203\ (3) the 
associated person does not meet with customers or prospective customers 
at the location; \204\ (4) any sales activity that takes place at the 
location complies with the conditions set forth under Rule 
3110(f)(2)(A)(ii) or (iii); \205\ (5) neither customer funds nor 
securities are handled at that location; \206\ (6) the associated 
person is assigned to a designated branch office, and such designated 
branch office is reflected on all business cards, stationery, retail 
communications, and other communications to the public by such 
associated person; \207\ (7) the associated person's correspondence and 
communications with the public are subject to the member firm's 
supervision in accordance with Rule 3110; \208\ and (8) the associated 
person's electronic communications (e.g., email) are made through the 
member's electronic system.\209\
---------------------------------------------------------------------------

    \202\ See proposed Rule 3110.19(a)(1).
    \203\ See proposed Rule 3110.19(a)(2).
    \204\ See proposed Rule 3110.19(a)(3).
    \205\ See proposed Rule 3110.19(a)(4). Rule 3110(f)(2)(A)(ii) 
and (iii) identify the conditions for the primary and non-primary 
residence exclusions. For a discussion of those exclusions, see 
Section II(A)(1)(c) above.
    \206\ See proposed Rule 3110.19(a)(5).
    \207\ See proposed Rule 3110.19(a)(6).
    \208\ See proposed Rule 3110.19(a)(7).
    \209\ See proposed Rule 3110.19(a)(8).
---------------------------------------------------------------------------

    One commenter opposed the requirement, set forth in proposed Rule 
3110.19(a)(1), that only one associated person, or multiple associated 
persons who reside at that location and are members of the same 
immediate family, conduct business at the location.\210\ This commenter 
stated that this proposed condition would not provide any meaningful 
investor protection safeguards because associated persons who reside 
together ``to afford the rising cost of housing'' do not necessarily 
pose a higher risk to investor protection.\211\ This commenter further 
stated that this proposed condition is ``unnecessarily narrow and 
restrictive.'' \212\
---------------------------------------------------------------------------

    \210\ CAI at 1-2.
    \211\ See CAI at 1-2, Exhibit A at 2.
    \212\ See CAI, Exhibit A at 2 (``The Committee believes that 
this language is unnecessarily narrow and restrictive and would 
limit the ability of a location, in several common scenarios, to 
claim [RSL] status, without providing any meaningful investor 
protection safeguards.'').
---------------------------------------------------------------------------

    In response, FINRA declined to modify proposed Rule 
3110.19(a)(1).\213\ FINRA emphasized that the proposed rule change ``is 
intended to align with one of several conditions to the current'' 
primary and non-primary residence exclusions.\214\ FINRA also noted 
that the proposed rule change aligns with SEC Books and Records rules, 
which provide (among other things) that ``a broker dealer is not 
required to maintain records at an office that is a private residence 
`where only one associated person (or multiple associated persons who 
reside at that location and are members of the same immediate family) 
regularly conducts business.' '' \215\ Although FINRA declined to 
modify this proposed condition, it stated that it would consider 
relevant comments ``in connection with future initiatives to consider 
the OSJ and branch office definitions more broadly.'' \216\
---------------------------------------------------------------------------

    \213\ FINRA Response I at 3-4.
    \214\ Id. at 3.
    \215\ Id. at 3-4 (quoting 17 CFR 240.17a-4(l)).
    \216\ Id. at 4. FINRA acknowledged that Rule 3110(f)(2) does not 
define ``immediate family,'' but it noted that this term is defined 
in Rule 3241. Id. at 4 n.12.
---------------------------------------------------------------------------

    A second commenter requested that FINRA modify proposed Rule 
3110.19(a)(7), which would require that the associated person's 
correspondence and communications with the public be subject to the 
member firm's supervision in accordance with Rule 3110.\217\ The 
commenter stated that this language improperly focuses on the recipient 
(as opposed to the subject) of the communications, and its reference to 
``the public'' is unclear.\218\ The commenter recommended that the 
condition instead require that ``all correspondence and communications 
by the associated person related in any way to existing or potential 
business activities [be] subject to the firm's supervision in 
accordance with [Rule 3110].'' \219\
---------------------------------------------------------------------------

    \217\ See proposed Rule 3110.19(a)(7); NASAA I at 1 (``We 
reiterate and incorporate our previous comments on [File Number 
FINRA-SR-2022-019]''); see also NASAA (8/23/2022) at 12 (addressing 
the same provision), https://www.sec.gov/comments/sr-finra-2022-019/srfinra2022019-20137298-307861.pdf.
    \218\ See NASAA I at 1; see also NASAA (8/23/2022) at 12.
    \219\ Id.

---------------------------------------------------------------------------

[[Page 82460]]

    In response, FINRA declined to modify proposed Rule 
3110.19(a)(7).\220\ FINRA explained that the proposed language ``aligns 
with existing rule text used in the primary residence exclusion in Rule 
3110(f)(2)(A)(ii)[(e)] and aligns with the terminology in FINRA Rule 
2210 (Communications with the Public).'' \221\ Adopting the commenter's 
proposed alternative would, FINRA stated, ``create an incongruity 
within Rule 3110 and raise questions about the difference in 
meanings.'' \222\
---------------------------------------------------------------------------

    \220\ Letter from Kosha Dalal, Vice President and Associate 
General Counsel, Office of General Counsel, FINRA, to Vanessa 
Countryman, Secretary, Commission, dated Oct. 31, 2022, at 8, 
available as Exhibit 2b to File Number FINRA-SR-2023-006 (addressing 
the same provision).
    \221\ Id.
    \222\ Id.
---------------------------------------------------------------------------

    A commenter requested to expand proposed Rule 3110.19(a)(7) to 
require that ``all correspondence and communications by the associated 
person related in any way to existing or potential business activities 
[be] subject to the firm's supervision in accordance with [Rule 
3110].'' \223\ However, Rule 3110 already imposes broad supervision 
requirements to achieve compliance with applicable securities laws and 
regulations, and with applicable FINRA rules, and those obligations 
would apply to RSLs.\224\ Moreover, the proposed condition's use of the 
term ``communications with the public'' aligns with language in FINRA 
Rule 2210, the SEC Books and Records Rule,\225\ and the preexisting 
residential exclusions,\226\ and so should be familiar to both firms 
and to regulators. For these reasons, it is reasonable for FINRA to 
retain the same condition as that for the primary and non-primary 
residence exclusions.
---------------------------------------------------------------------------

    \223\ See NASAA I at 1; NASAA (8/23/2022) at 12.
    \224\ FINRA Rules 3110(a); see FINRA Rules 3110(b)(4), 3110.06, 
and 3110.09.
    \225\ 17 CFR 240.17a-4(b)(4) (requiring preservation of 
``[o]riginals of all communications . . . which are subject to the 
rules of a self-regulatory organization of which the member, 
broker[,] or dealer is a member regarding communications with the 
public.'').
    \226\ FINRA Rule 3110(f)(2)(A)(ii)(e).
---------------------------------------------------------------------------

    No other commenter offered specific support for or opposition to 
any of the remaining six conditions adapted from the primary and non-
primary residence exclusions.\227\
---------------------------------------------------------------------------

    \227\ Proposed Rule 3110(a)(2) through (6), (8).
---------------------------------------------------------------------------

    Each of these eight conditions imposes a reasonable limitation on 
the designation of an RSL. Limiting an RSL designation to a location 
with only one associated person, or multiple associated persons who 
reside at that location and are members of the same immediate family, 
is a reasonable limitation in light of FINRA's stated intention to 
align the condition with the SEC Books and Records rules.\228\ 
Restrictions on activities that occur at the RSL, such as prohibitions 
involving interactions with customers (e.g., not holding the office out 
to the public, not meeting customers or prospective customers in-
person, and limitations on sales activities) and the handling of 
customer funds and securities,\229\ will limit higher risk activities 
occurring at an RSL that may benefit from more frequent inspection of 
the location. Furthermore, requiring an associated person to be 
assigned to a designated branch office and to name that branch office 
on all of their communications with the public \230\ provides investors 
with information about the person with whom they are conducting 
business. In addition, the affirmative obligations in the conditions, 
such as explicitly subjecting the associated person's correspondence 
and communication with the public to the member firm's supervision and 
requiring the associated person's electronic communications to be made 
through the member firm's electronic system,\231\ will help provide the 
member firm with enhanced supervisory oversight of certain activities 
directly involving investors, and thereby lower risk associated with an 
RSL. Moreover, incorporating the conditions from the preexisting 
residential exclusions, a rule that FINRA has experience in 
administering and that the industry is familiar with, will promote 
regulatory consistency and minimize regulatory confusion, thereby 
enhancing investor protection.
---------------------------------------------------------------------------

    \228\ See supra note 215 and accompanying text.
    \229\ Proposed Rule 3110.19(a)(2) through (5).
    \230\ Proposed Rule 3110.19(a)(6).
    \231\ Proposed Rule 3110.19(a)(7) and (8).
---------------------------------------------------------------------------

b. Books and Records
    As its ninth condition for designation as an RSL, the proposed rule 
change would impose the following recordkeeping requirements: (1) the 
member must have a recordkeeping system that makes, keeps current, and 
preserves records required to be made, kept current, and preserved 
under applicable securities laws and regulations, FINRA rules, and the 
member's own written supervisory procedures under Rule 3110; (2) such 
records must not be physically or electronically maintained and 
preserved at the office or location; and (3) the member must have 
prompt access to such records.\232\ Because books and records required 
to be made and preserved would not be maintained on-site at the RSL, 
FINRA believes that this condition ``strengthen[s] a firm's ability to 
monitor the supervisory activities occurring'' at an RSL and lowers 
overall risk.\233\
---------------------------------------------------------------------------

    \232\ See proposed Rule 3110.19(a)(9).
    \233\ See Notice at 20576.
---------------------------------------------------------------------------

    Two commenters supported this recordkeeping condition.\234\ One 
stated that requiring members to have ``prompt access'' to their 
records ``would better enable firms to supervise their associated 
persons centrally'' and ``protect against misappropriation and misuse 
of sensitive customer information.'' \235\ The second commenter agreed 
with prohibiting the preservation and maintenance of books and records 
at the RSL.\236\ No commenter opposed this proposed condition.
---------------------------------------------------------------------------

    \234\ See NASAA I at 2-3; Davenport at 2.
    \235\ NASAA I at 2-3.
    \236\ Davenport at 2.
---------------------------------------------------------------------------

    The proposed rule change's recordkeeping conditions are reasonable. 
Prompt access to an RSL's records from an alternative location 
decreases the need for more frequent inspection of the RSL. 
Specifically, the proposed rule change couples the prompt-access 
requirement with a prohibition on the physical or electronic storage of 
records at the RSL location. Because records would not be located at 
the RSL, the member firm should have the ability to supervise the RSL 
remotely so long as it can promptly access such records, thus 
decreasing the need for a more frequent inspection cycle. Consequently, 
the recordkeeping condition would help facilitate the timely and 
effective supervision of an RSL's business activities.
c. Surveillance and Technology Tools
    The tenth condition for designation as an RSL would require a 
member firm to ``determine that its surveillance and technology tools 
are appropriate to supervise the types of risk[] presented by each 
[RSL].'' \237\ The proposed rule change explains that these tools may 
include but are not limited to: (1) firm-wide tools, such as an 
electronic recordkeeping system, electronic surveillance of email and 
correspondence, electronic trade blotters, regular activity-based 
sampling reviews, and tools for visual inspections; (2) tools specific 
to the RSL based on the activities of the associated person assigned to 
the location, products offered, and restrictions on the activity of the 
RSL; and (3) system tools, such as secure network connections and 
effective cybersecurity protocols.\238\ No commenter offered specific 
support for

[[Page 82461]]

or opposition to this proposed condition.
---------------------------------------------------------------------------

    \237\ Proposed Rule 3110.19(a)(10).
    \238\ See proposed Rule 3110.19(a)(10).
---------------------------------------------------------------------------

    FINRA justified the proposed rule change, in part, on technological 
advancements that equip firms to supervise employees working from 
remote locations.\239\ Therefore, it is reasonable to require any 
member firm taking advantage of the proposed rule change--and its less-
frequent inspection cycle--to first determine that its surveillance and 
technology tools are appropriate to supervise the types of risks 
presented by each RSL. To aid member firms in this assessment, the non-
exhaustive list of tools outlined in the proposed rule change, 
including firm-wide tools and tools particular to the RSL based on the 
activities of the person assigned to that RSL, help illustrate FINRA's 
expectations and will assist firms in implementing robust surveillance 
systems.
---------------------------------------------------------------------------

    \239\ Notice at 20575 (``FINRA believes that the structural and 
lifestyle changes for member firms and their workforce catalyzed by 
the pandemic--along with advances in technology--merit reevaluation 
of some aspects of the branch office registration and inspection 
requirements.''), 20575 (firms indicated that they responded to the 
COVID-19 pandemic by relying ``extensively on technology to support 
their effective transition to the remote work environment and 
enhance the supervision of geographically dispersed associated 
persons, many of whom have been working from home since early 2020 
and may continue to do so in some manner in the current environment. 
These technological tools facilitating their supervisory practices 
include surveillance systems, electronic tracking programs or 
applications, and electronic communications, including video 
conferencing tools.'').
---------------------------------------------------------------------------

4. Obligation To Provide List of RSLs to FINRA
    As stated above, proposed Rule 3110.19(d) would require any member 
firm that has designated any RSL locations to provide a current list of 
all of its RSL locations to FINRA on a quarterly basis.\240\
---------------------------------------------------------------------------

    \240\ Proposed Rule 3110.19(d) (``A member that elects to 
designate any office or location of the member as an RSL pursuant to 
[proposed Rule 3110.19] shall provide FINRA with a current list of 
all locations designated as RSLs by the 15th day of the month 
following each calendar quarter in the manner and format (e.g., 
through an electronic process or such other process) as FINRA may 
prescribe.'').
---------------------------------------------------------------------------

    Two commenters supported the proposed rule change, and one of them 
labeled this quarterly-reporting requirement as ``critical'' to the 
ability of regulators ``to effectively oversee firms' important 
supervisory functions.'' \241\ Two other commenters opposed the 
proposed rule change because of the inefficiency that would 
result.\242\ Instead of a quarterly filing that provides intermittent 
snapshots of RSL designations, the opposing commenters recommended that 
FINRA leverage CRD and the existing branch office registration process 
to continuously collect timely information on RSL designations.\243\ 
For example, one opposing commenter emphasized that using the existing 
branch-office registration process would provide FINRA ``with more 
current information . . . because of existing requirements to amend and 
update information within 30 days.'' \244\
---------------------------------------------------------------------------

    \241\ NASAA I at 2; see Davenport at 2.
    \242\ See letter from James Rabenstine, Vice President, NISC and 
NSLLC Chief Compliance Officer, Nationwide Office of the Chief Legal 
Officer, Nationwide Financial Services, Inc. and Holly Butson, Chief 
Compliance Officer, Nationwide Fund Distributors, LLC, Nationwide 
Financial Services, Inc. to Sherry Haywood, Assistant Secretary, 
Commission, dated Apr. 24, 2023, at 2 (``Nationwide''); FSI at 3-4.
    \243\ See Nationwide at 2; FSI at 3-4.
    \244\ FSI at 3-4; see Nationwide at 2 (recommended ``a separate 
filing for [an RSL] like a Form BR 2, similar to the U4 page 2 
process, so that members have a way to track and link Registered 
Representatives who are supervised from the [RSL] not an OSJ'').
---------------------------------------------------------------------------

    In response, FINRA declined to modify the proposed rule 
change.\245\ FINRA indicated, however, that it appreciates the 
commenters' recommendations and ``is exploring ways for firms to 
provide this information to FINRA and other state regulators in a more 
efficient manner.'' \246\ No commenter offered a specific response to 
FINRA's decision not to modify the proposed rule change, although one 
commenter encouraged FINRA to seek input from its members to avoid 
creating an ``overly burdensome reporting process.'' \247\
---------------------------------------------------------------------------

    \245\ See FINRA Response I at 9.
    \246\ Id.; FINRA Response II at 7 (FINRA ``is exploring ways for 
firms to provide this information to FINRA and state regulators in a 
more efficient and timely manner, including through the use of 
existing uniform registration forms or FINRA Gateway.'').
    \247\ XML at 2.
---------------------------------------------------------------------------

    Prompt access to information about a member firm's RSL designations 
should improve the ability of FINRA to readily identify which of a 
member firm's locations have been designated as an RSL and more 
efficiently assess the reasonableness of a member firm's RSL 
designations and corresponding supervision. Therefore, the proposed 
rule change's quarterly-reporting requirement is reasonable and would 
provide FINRA with the information it needs to carry out its regulatory 
obligations.\248\
---------------------------------------------------------------------------

    \248\ FINRA indicated that it is exploring ways to structure 
this data-collection requirement, and it expressed appreciation for 
the commenters' suggestions. FINRA Response I at 9; FINRA Response 
II at 7.
---------------------------------------------------------------------------

5. Risk Assessment
    As stated above, proposed Rule 3110.19(e) would require a member 
firm--prior to designating any location as an RSL--to ``develop a 
reasonable risk-based approach to designating such office or location 
as an RSL, and [to] conduct and document a risk assessment'' that 
considers five mandatory factors.\249\ These factors would require 
consideration of, among other things, customer complaints, firm-imposed 
heightened supervisory plans, and regulatory communications indicating 
a failure to reasonably supervise.\250\ The proposed rule change also 
would require the member to account for any higher risk activities 
occurring at the location, any higher risk associated persons assigned 
to the location, and any indicators of irregularities or misconduct 
(i.e., red flags) prior to designating a location as an RSL.\251\ 
Further, the proposed rule change would provide that member firms 
should review red flags--and consider evidencing their review--in 
determining whether it is reasonable to maintain an RSL designation for 
a particular location.\252\ FINRA explained that this risk assessment--
and the non-exhaustive list of factors to consider--would strengthen 
supervisory controls and further investor protection ``by requiring 
firms to consider higher risk criteria in determining whether to 
designate an office or location as an RSL.'' \253\
---------------------------------------------------------------------------

    \249\ Proposed Rule 3110.19(e); Amendment No. 1 at 8; Amendment 
No. 2 at 4-5. The five mandatory factors are: ``(1) customer 
complaints, taking into account the volume and nature of the 
complaints; (2) heightened supervision other than where such office 
or location is ineligible for RSL designation under [proposed Rule 
3110.19(c)(3)]; (3) any failure to comply with the member's written 
supervisory procedures; (4) any recordkeeping violation; and (5) any 
regulatory communications from a Regulator, indicating that the 
associated person at such office or location failed reasonably to 
supervise another person subject to their supervision, including but 
not limited to, subpoenas, preliminary or routine regulatory 
inquiries or requests for information, deficiency letters, `blue 
sheet' requests or other trading questionnaires, or examinations.'' 
See proposed Rule 3110.19(e).
    \250\ See supra note 103 and accompanying text.
    \251\ Proposed Rule 3110.19(e).
    \252\ Id.
    \253\ FINRA Response I at 9-10; Amendment No. 1 at 8.
---------------------------------------------------------------------------

    One commenter offered unqualified support for the proposed rule 
change.\254\ Two other supportive commenters asked that FINRA clarify 
and modify one aspect of proposed Rule

[[Page 82462]]

3110.19(e)(5).\255\ As originally proposed in Amendment No. 1, the risk 
assessment would have required members to consider, among other things, 
``any regulatory communications from a Regulator, including but not 
limited to, subpoenas, preliminary or routine regulatory inquiries or 
requests for information, deficiency letters, `blue sheet' requests or 
other trading questionnaires, or examinations indicating that the 
associated person at such office or location failed reasonably to 
supervise another person subject to their supervision.'' \256\ The 
commenters that asked for modifications both questioned whether the 
italicized language modified the preceding illustrative list or only 
``examinations.'' \257\
---------------------------------------------------------------------------

    \254\ Cetera II at 1 (``We endorse the requirement for member 
firms to develop and document a risk-based assessment before 
designating a location[] as an RSL. This approach is both logical 
and proportional.''); see XML at 2 (``In addition to the time needed 
to address other requirements in Rule 3110.19, members will need 
adequate time to develop policies and procedures to comply with the 
location assessments and documentation requirements of Rule 
3110.19(e) and time to implement and perform such activities.'').
    \255\ SIFMA II at 1-2 (offering general support for the proposed 
rule change); Fidelity II at 2 (``We conceptually support the 
addition of a risk assessment and appreciate there may be instances 
where use of the RSL is not appropriate.'').
    \256\ Proposed Rule 3110.19(e)(5) (emphasis added); Amendment 
No. 1 at 8.
    \257\ SIFMA II at 2-3 (``It is not clear whether the emphasized 
phrase is meant to modify all the listed types of communications or 
only examinations. It may be difficult to determine how these non-
investigatory communications indicate a risk presented by an RSL 
absent an indication of supervisory concern.''); Fidelity II at 2 
(``It is not clear whether the phrase `indicating that the 
associated person at such office or location failed reasonably to 
supervise another person subject to their supervision' is meant to 
modify all the listed types of communications or only 
examinations.'')
---------------------------------------------------------------------------

    In response to the commenters' concern about ambiguity in the scope 
of proposed Rule 3110.19(e)(5), FINRA reorganized the proposed rule 
text to improve its readability.\258\ As modified by Amendment No. 2, 
proposed Rule 3110.19(e)(5) reads as follows: ``any regulatory 
communications from a Regulator, indicating that the associated person 
at such office or location failed to reasonably supervise another 
person subject to their supervision, including but not limited to, 
subpoenas, preliminary or routine regulatory inquiries or requests for 
information, deficiency letters, `blue sheet' requests or other trading 
questionnaires, or examinations.'' \259\
---------------------------------------------------------------------------

    \258\ FINRA Response II at 8; Amendment No. 2 at 4.
    \259\ Proposed Rule 3110.19(e)(5); Amendment No. 2.
---------------------------------------------------------------------------

    One opposing commenter stated that the risk assessment's 
requirement ``to `consider' higher risk criteria'' is 
insufficient.\260\ For example, this commenter stated that red flags 
and many of the risk assessment's factors should constitute eligibility 
exclusions, not just factors for a member to consider.\261\ In 
addition, the commenter criticized FINRA's ``complete lack of guidance 
as to how to weigh and assess the various risk criteria,'' including 
the volume and nature of customer complaints.\262\
---------------------------------------------------------------------------

    \260\ PIABA II at 4.
    \261\ Id.
    \262\ Id.
---------------------------------------------------------------------------

    In response, FINRA stated that it ``expects that a firm will 
consider customer complaints and weigh their volume and nature based on 
the firm's business, products, and customer base among other factors 
generally considered by the firm when making risk-based assessments in 
other contexts, such as in how a firm may establish and maintain a 
supervisory system that is appropriately tailored to the firm's 
business and structure, whether unannounced visits to an office or 
location may be appropriate, or whether heightened supervisory 
procedures may need to be imposed.'' \263\
---------------------------------------------------------------------------

    \263\ FINRA Response II at 7; see FINRA Response I at 7 (``FINRA 
emphasizes that the enumerated list of factors is non-exhaustive. 
While consumer-initiated, investment-related arbitration or civil 
litigation is not listed as one of the enumerated factors under 
proposed Rule 3110.19(e), FINRA agrees that the presence of such 
arbitration or civil litigation would be a factor for a firm to 
consider as part of the risk assessment.'').
---------------------------------------------------------------------------

    As stated above, the proposed rule change's member- and location-
level exclusions prohibit the designation of RSLs in certain 
circumstances that may indicate a higher potential risk of non-
compliance. But other factors not explicitly identified among the 
exclusions can, in certain circumstances, indicate heightened levels of 
risk either before or after RSL designation. Proposed Rule 3110.19(e) 
will help to mitigate residual risk not explicitly addressed in the 
conditions, firm-level exclusions, and location-level exclusions. 
Specifically, the proposed rule change would require a member firm to 
assess and document for each associated person at a candidate RSL 
certain indicia of risk, including the volume and nature of customer 
complaints, any firm-imposed heightened supervisory plans, and any 
regulatory communications indicating that the associated person failed 
reasonably to supervise another person subject to their supervision, 
prior to RSL designation. In addition, the proposed rule change would 
require a member to account for any higher risk activities occurring at 
the location, any higher risk associated persons assigned to the 
location, and any red flags when designating a location as an RSL. 
Furthermore, the proposed rule change emphasizes consideration of red 
flags as part of a member firm's ongoing determination of whether it is 
reasonable to maintain an RSL designation. In this way, the proposed 
rule change helps to ensure that a member firm designating RSLs 
appropriately accounts for the full range of risks associated with each 
proposed RSL. For these reasons, the proposed rule change is 
reasonable.
    A commenter asserted that the five factors in the risk assessment 
should instead be eligibility exclusions and noted the absence of 
guidance as to how to weigh and assess the various risk factors.\264\ 
As an assessment of the risk associated with each factor will depend on 
the facts and circumstances of each case, no single factor lends itself 
to an automatic exclusion. For example, customer complaints may, in 
certain cases, indicate an unacceptable level of risk, but in other 
cases, complaints may be overly broad or lack factual development to 
indicate the level of risk. Moreover, as discussed below, this is an 
ongoing risk assessment, and its outcome could change with new 
circumstances or as the member firm obtains additional information. 
Therefore, it is reasonable for FINRA to instead require that firms 
consider each factor as part of a person-specific risk assessment prior 
to RSL designation. Similarly, it is reasonable that the proposed rule 
change provides member firms flexibility as to how to weigh and assess 
the various risk factors.
---------------------------------------------------------------------------

    \264\ PIABA II at 4.
---------------------------------------------------------------------------

6. Frequency of Inspections
    RSL designation would permit firms to inspect the location on a 
regular periodic schedule (presumed to be at least every three years) 
instead of the annual schedule otherwise required for OSJs and 
supervisory branch offices.\265\

[[Page 82463]]

Two commenters opposed this less-frequent inspection cycle and 
contended that RSLs should be inspected annually.\266\ Emphasizing the 
importance of effective supervision, one commenter stated that ``[l]ax 
or otherwise ineffective supervision can result in the failure to stop 
preventable harms before they occur, or even exacerbate harms that have 
already begun.'' \267\ Although the commenter did not dispute the 
emergence of the hybrid work environment and supervision technologies, 
it contended that those developments have no ``bearing on the 
appropriate frequency or depth of scrutiny of supervisory activities.'' 
\268\ It also contended that ``FINRA has not shown that supervisory 
functions present sufficiently `lower risk' to warrant loosening 
oversight of individuals performing those functions.'' \269\
---------------------------------------------------------------------------

    \265\ Proposed Rule 3110.19(a); FINRA Rules 3110(c)(1)(C) and 
3110.13. Virtu Financial, Inc., and Nationwide submitted out-of-
scope comments regarding the frequency and method of inspections. 
Virtu asked FINRA to modify the proposed rule change ``to codify 
that all personal residences where only electronic activities are 
carried out, whether those be supervisory or other securities-
related activities, are non-branch locations and reconsider the need 
to conduct any physical inspections of an associated person's 
residence and instead rely on technological monitoring tools and 
electronic recordkeeping.'' Letter from Thomas M. Merritt, Deputy 
General Counsel, Virtu Financial, Inc., to Vanessa Countryman, 
Secretary, Commission, dated Aug. 1, 2023, at 2 (``Virtu''). 
Nationwide asked FINRA to permit certain limited-purpose OSJs, 
supervisory branch offices, and RSLs to be inspected remotely and/or 
on a five-year inspection cycle. Nationwide at 1-2. Because the 
proposed rule change is designed to establish a new location 
designation (RSL) for certain personal residences at which 
supervisory activities occur, the recommendations regarding the 
method of inspection are outside the scope of the proposed rule 
change. Because Nationwide appears to request an amended inspection 
schedule for any limited-purpose OSJ, supervisory branch office, or 
RSL--regardless of its status as a personal residence--the request 
to for a five-year inspection cycle is likewise outside the scope of 
the proposed rule change. FINRA stated, however, that it would 
consider these recommendation ``more generally as part of any future 
initiatives to consider the OSJ and branch office definitions more 
broadly.'' FINRA Response I at 13; FINRA Response II at 9.
    \266\ NASAA I at 3; NASAA II at 5; PIABA I at 3 (``[R]esidential 
supervisory locations should at minimum be subject to annual in 
person audits, if not more frequent unannounced visits, rather than 
periodic inspections every three years.'').
    \267\ NASAA I at 3.
    \268\ Id. at 4.
    \269\ Id. at 3; see NASAA II at 5.
---------------------------------------------------------------------------

    In response, FINRA declined to require annual inspections for RSLs, 
explaining that ``impos[ing] an annual inspection cycle on an RSL would 
adversely impact the utility'' of the proposed rule change.\270\ FINRA 
stressed that ``the inspection requirement is only one part'' of a 
member firm's ``ongoing obligation'' to supervise under Rule 3110, and 
``a firm's inspection of an office or location is not the only occasion 
during which a firm supervises its associated persons.'' \271\ Indeed, 
FINRA stated that Rule 3110 ``does not preclude a firm from conducting 
inspections of its offices or locations more frequently or conducting 
unannounced visits.'' \272\ FINRA also stated that the proposed rule 
change includes ``a rigorous set of safeguards and conditions that . . 
. align with the regulatory purposes of Rule 3110.'' \273\
---------------------------------------------------------------------------

    \270\ FINRA Response I at 10-12.
    \271\ Id. at 12.
    \272\ Id.
    \273\ Id. at 11.
---------------------------------------------------------------------------

    The proposed rule change permits--but does not require--member 
firms to inspect their RSLs on a less frequent inspection cycle. This 
proposed rule change is reasonable for two reasons. First, the proposed 
rule change is reasonable in light of Rule 3110's general obligation to 
establish and maintain a reasonably designed supervisory system that is 
tailored to its unique business operations and associated risks. 
Although an RSL designation would permit a member firm to inspect a 
location on a less frequent schedule, the proposed rule change would 
not limit inspections to this less frequent schedule. Instead, Rule 
3110 contemplates that a member firm may, in certain circumstances, 
choose to conduct more frequent or unannounced visits to an RSL in 
furtherance of its obligation to supervise effectively. In this way, 
the proposed rule change is consistent with that obligation.
    Relatedly, the Rule 3110 requirement to maintain a reasonably 
designed supervisory system is an ongoing obligation. A firm may need 
to reconsider a residence's RSL designation, and the corresponding 
relief from annual inspection, if circumstances suggest that the 
designation may no longer be appropriate. Importantly, proposed Rule 
3110.19(e) indicates that firms should review red flags when 
determining whether it is reasonable to maintain an RSL designation. 
The various terms and conditions associated with initial RSL 
designation therefore are only the beginning of an ongoing assessment 
of a location's qualification for RSL designation and less frequent 
inspections.
    Second, the proposed rule change is reasonable in light of its 
terms and conditions. The member- and location-level eligibility 
exclusions would identify--and exclude--certain firms and locations 
with characteristics that may indicate a higher potential risk of non-
compliance.\274\ Additionally, an eligible member firm may designate 
its eligible location as an RSL only if it complies with ten 
conditions, such as limitations on customer interactions, a 
recordkeeping requirement, and a mandatory technology assessment.\275\ 
Even if an eligible member firm is prepared to comply with those ten 
conditions, it must still ``develop a reasonable risk-based approach to 
designating [the eligible location] as an RSL, and conduct and document 
a risk assessment for the associated person assigned to'' the proposed 
RSL.\276\ These layers of protection are designed to limit RSL 
designation (and its less-frequent inspection cycle) to locations 
without indicia of increased potential risk of non-compliance. With 
those safeguards, a regular periodic inspection schedule is reasonable 
for those locations that can comply with the proposed rule change's 
various terms and conditions.
---------------------------------------------------------------------------

    \274\ Proposed Rule 3110.19(b), (c).
    \275\ Proposed Rule 3110.19(a).
    \276\ Proposed Rule 3110.19(e).
---------------------------------------------------------------------------

IV. Solicitation of Comments on Amendment No. 2

    Interested persons are invited to submit written data, views, and 
arguments concerning whether Amendment No. 2 is consistent with the 
Exchange 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-2023-006 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-2023-006. 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. Do not include personal 
identifiable information in submissions; you should submit only 
information that you wish to make available publicly. We may redact in 
part or withhold entirely from publication submitted material that is 
obscene or subject to copyright protection. All submissions should 
refer to File Number SR-FINRA-2023-006 and

[[Page 82464]]

should be submitted on or before December 15, 2023.

V. Accelerated Approval of Proposed Rule Change, as Modified by 
Amendment Nos. 1 and 2

    The Commission finds good cause to approve the proposed rule 
change, as modified by Amendment Nos. 1 and 2, prior to the thirtieth 
day after the date of publication of notice of the filing of Amendment 
No. 2 in the Federal Register.\277\ In Amendment No. 2, FINRA modified 
the proposed rule change--in direct response to comments received--to 
clarify the substantive intent of proposed Rule 3110.19(e)(5). FINRA 
did not propose to change any substantive obligation of the proposed 
rule change. To reduce ambiguity regarding its scope, FINRA instead 
proposed to reorganize a single sentence describing a single factor in 
the mandatory risk assessment.\278\ The basis for this amendment is the 
same as the basis for the original proposed rule change, as modified by 
Amendment No. 1, which the Commission previously noticed for public 
comment.
---------------------------------------------------------------------------

    \277\ See 15 U.S.C. 78s(b)(2)(C)(iii).
    \278\ See supra notes 258 through 259 and accompanying text.
---------------------------------------------------------------------------

    After consideration of the comments FINRA received on the proposed 
rule change, the Commission concludes that Amendment No. 2 represents a 
reasonable extension of, and is substantially similar to, the language 
originally proposed for proposed Rule 3110.19(e). The Commission also 
concludes that Amendment No. 2 responds to comments received, adds 
clarity to the proposed rule change, and does not raise any novel 
regulatory concerns. Accordingly, the Commission finds good cause, 
pursuant to Section 19(b)(2) of the Act,\279\ to approve the proposed 
rule change, as modified by Amendment Nos. 1 and 2, on an accelerated 
basis.
---------------------------------------------------------------------------

    \279\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

VI. Conclusion

    For the reasons set forth above, the Commission finds that the 
proposed rule change, as modified by Amendment Nos. 1 and 2, is 
consistent with Section 15A(b)(6) of the Exchange Act, which requires, 
among other things, that FINRA rules be designed to prevent fraudulent 
and manipulative acts and practices, promote just and equitable 
principles of trade, and, in general, protect investors and the public 
interest.\280\
---------------------------------------------------------------------------

    \280\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    It is therefore ordered pursuant to Section 19(b)(2) of the 
Exchange Act \281\ that the proposed rule change (SR-FINRA-2023-006), 
as amended by Amendment Nos. 1 and 2, be, and hereby is, approved.
---------------------------------------------------------------------------

    \281\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\282\
---------------------------------------------------------------------------

    \282\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2023-25880 Filed 11-22-23; 8:45 am]
BILLING CODE 8011-01-P

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