On December 1, 2014, the Financial Industry Regulatory Authority’s (FINRA) Consolidated Supervision Rules will take effect. The Consolidated Supervision Rules, which were approved by the U.S. Securities and Exchange Commission (SEC) on December 23, 2013, will replace existing NASD1 Rules 3010 and 3012 (the NASD Supervision Rules) in the FINRA Consolidated Rulebook with FINRA Rule 3110 (Supervision) and FINRA Rule 3120 (Supervisory Control System).2
The Consolidated Supervision Rules provide a comprehensive supervision framework for FINRA member firms. As your firm and your compliance department work towards the December 1st effective date, here are the 10 changes in supervisory requirements that you may want to consider.
- Supervision of Multiple OSJs by a Single Principal – The Consolidated Supervision Rules require member firms to maintain at least one on-site principal with supervisory responsibilities, and a regular and routine physical presence, at each office of supervisory jurisdiction (“OSJ”).3 As a result, the rules contain a general presumption that a principal will not be designated and assigned to be an on-site principal to supervise more than one OSJ. However, this presumption may be overcome if a member considers (and documents its consideration of) certain factors identified in FINRA Rule 3110.03, including the experience of the principal and the geographic proximity of each OSJ the principal will be supervising.
- Internal Office Inspections – The Consolidated Supervision Rules continue to require inspections of non-branch offices, but establish the presumption that a non-branch office will be inspected at least every three years.4 Additionally, these same rules generally prohibit an associated person from inspecting his or her own office, but exempt compliance personnel from this prohibition, provided that the compliance personnel are assigned to a compliance department that is separate from business operations and they are supervised solely by the compliance department.5
- Restrictions on Supervisory Personnel – The NASD Supervision Rules provided for heightened supervision and other restrictions on the activities of producing managers. The Consolidated Supervision Rules eliminate these restrictions on producing managers, and instead impose restrictions on all supervisory personnel.6 Under the new restrictions on all supervisory personnel, firms must have procedures to prohibit supervisory personnel from supervising their own activities, and reporting to (or having compensation or employment determined by) the person whom the supervisor is supervising.
- Risk-Based Review of Transactions – The Consolidated Supervision Rules carry over the requirement, codified in FINRA Rule 3110(b)(2), that firms review transactions in their investment banking and securities business. However, firms may now utilize a “risk-based” review of transactions. Under this “risk-based” review, firms are not required to conduct a detailed review of each transaction and may prioritize for review certain transactions that pose a greater risk of potential violations of securities laws and rules.7
- Risk-Based Review of Correspondence and Communication – Similarly, with regard to the requirement to review all written (including electronic) correspondence and internal communication relating to a firm’s investment banking and securities business, the Consolidated Supervision Rules codify existing guidance permitting a firm to use risk-based principles for its review of these communications.8
- Internal Supervisory Reports –FINRA Rule 3120 retains the requirement in NASD Rule 3012 that a member firm must submit an annual report to senior management summarizing the testing and verification of its supervisory procedures. However, new FINRA Rule 3120(b) adds a requirement that a member with $200 million or more in gross revenue must include additional content in the annual report submitted to senior management, including information related to customer complaints, internal investigations, and the firm’s compliance efforts.
- Customer Complaints – Under the Consolidated Supervision Rules, a member firm’s supervisory procedures must include procedures to capture, acknowledge, and respond to all written (including electronic) customer complaints.9 Although the rules do not require procedures related to oral customer complaints, FINRA encouraged firms to provide customers with a standardized form so that they could easily communicate their complaints in writing. Additionally, FINRA reminded firms that the failure to address any customer complaint, whether written or oral, may constitute a violation of FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade).10
- Review of Securities Transactions for Insider Trading – FINRA Rule 3110(d)(1) requires member firms to have supervisory procedures to review securities transactions effected for a member’s or its associated persons’ accounts, as well as any other covered account11, to identify trades that may violate SEC or FINRA rules prohibiting insider trading and manipulative and deceptive devices. This rule means that member firms must now implement processes designed to identify insider trading and manipulative practices for certain securities transactions, which is a new requirement that many firms may be unprepared to handle.
- Internal Investigations of Securities Transactions for Insider Trading – In addition to reviewing certain securities transactions for insider trading and manipulative devices, member firms must also conduct a prompt internal investigation into any such trade to determine whether a violation of the laws prohibiting insider trading and manipulative devices has occurred.12
- Written Reports for Firms Engaging in Investment Banking Services – Under the Consolidated Supervision Rules, member firms engaging in “investment banking services”13 must file written reports with FINRA in connection with the internal investigations discussed in item 9 above. The written reports must be signed by a senior officer of the member firm, and must provide certain details about the results of the internal investigation and any disciplinary action taken to correct the prohibited insider trading or manipulative conduct.14
The Consolidated Supervision Rules make other changes to the supervisory framework that will take effect on December 1, 2014. The changes listed above are intended to assist firms with a final check of the supervisory systems, given the upcoming effective date.