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Many Broker-Dealers’ Branch Exams on Hold, And Problems May Emerge

By Peter Rawlings November 20, 2020

Many broker-dealer firms have not conducted on-site branch exams amid Covid-19 concerns, and there’s a pending Finra proposal that would allow for remote inspections until the end of 2021.

However, broker-dealers could face challenges when conducting remote inspections, a compliance executive and lawyers say. And when pandemic-related restrictions ease, catching up with on-site branch exams could lead to other struggles, such as a faster pace of inspections, they say.

Finra requires broker-dealers to inspect branches that don’t supervise other locations at least once every three years. Offices of supervisory jurisdiction and branches that supervise other locations must be examined annually.

On November 6, Finra proposed a rule change that would allow, though not require, remote inspections until the end of next year.

Remote exams bring relief, but …

“The industry took a big sigh of relief” when Finra put forward the proposal, says Sander Ressler, managing director at Essential Edge Compliance Outsourcing Services.

“But there are still a lot of potential glitches” in remote inspections and broker-dealers will likely need to speed up their on-site exams when they become possible again, he adds.

Susan Schroeder, former head of Finra’s Department of Enforcement, says remote exams could overlook some activities.

“Probably the most difficult conduct to detect in a remote exams is malfeasance by individual brokers, such as the broker who has gone rogue and has forged documentation or is creating client presentations and using them without getting approval,” says Schroeder.

“Under those circumstances, there’s a value to in-person exams because you can actually look through someone’s office and files,” she says.

Outside business activities could also be especially hard to spot from a remote inspection, says James Burns, former deputy director of the SEC’s Division of Trading and Markets.

Essential Edge’s Ressler adds other potential problems to the list, such as the use of pre-signed forms or selling away by registered representatives, which are considerably harder to detect in remote exams.

Broker-dealers with higher-risk activities

Schroeder, who is now a partner at law firm WilmerHale, believes Finra will expect broker-dealers that have “higher-risk activities” to conduct on-site exams ahead of schedule and “actually think about their overall supervisory structure with those risks in mind.” The higher-risk activities could be having a broker on heightened supervision or a type of business that presents a higher level of risk, she says.

Because of the three-year exam cycle for branches that don’t supervise other locations, some branches may end up with as much as a six-year gap between on-site inspections. Branches that were last visited in 2018 and are likely to undergo remote review in 2021, for example, may not have an on-site inspection again until 2024.

That scenario could prove especially worrisome for higher-risk branches or for representatives on heightened supervision plans, says Essential Edge’s Ressler.

“Bad apples could potentially be emboldened to commit bad acts knowing they won’t have any visitors from the home office,” he says.

Burns, who is now a partner at law firm Willkie Farr & Gallagher, says broker-dealers must “carefully” evaluate “how they’re handling ongoing supervisory responsibilities while in this remote environment to make sure they’re really being thorough.”

“If you’re in the independent model, it will be especially important to have really good, robust records,” on account of the sheer number of offices independent broker-dealers have, he adds.

In its proposal, Finra says broker-dealers must include in their procedures for conducting remote inspections the use of risk-based systems to “identify and prioritize” riskier areas, which would include, for instance, locations that have associated persons subject to heightened supervisory procedures.

A Finra spokesperson declined to comment on the pending proposal for remote branch exams. The spokesperson also declined to comment on the type and percentage of branch exams that had been conducted so far in 2020, noting that Finra publishes data only on its own exams.

Ameriprise Financial welcomes Finra’s proposal.

“We support the flexibility afforded by the proposal and we don’t anticipate any issues in complying due to investments we’ve made to digitize our branch books and records,” says a spokesperson for Ameriprise.

Willkie Farr & Gallagher’s Burns says a transition to remote exams may even prove to be beneficial for broker-dealers.

“This could present the opportunity for a kind of great leap forward in terms of supervision, which could ultimately reduce costs for firms,” he says. “If there’re were ever an opportunity to rethink what supervision ought to look like, we’ve got the test case right now.”

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