The global economy has been thrown into crisis several times in the last two decades as a result of rather dubious practices in the financial sector, leaving public trust in the industry shaken. As the world still recovers from the mortgage foreclosure crisis of the late 2000s, the sector has become more rigorous in its attempts to clean up its act and self-regulate its activities.
The Financial Industry Regulatory Authority (FINRA) is one example of a self-regulatory body for the securities industry that acts to protect investors and maintain the integrity of the securities market in the US. It has the power to create rules and regulations that member firms are obliged to obey and it has the authority to take disciplinary action against violators. Sanctions can be serious – anything from hefty fines to suspensions, or even expulsion from the industry.
FINRA is a critical part of keeping the financial industry stable, and recordkeeping and supervision of all member firm activities is one of the most important ways they ensure regulations are being followed and standards are adhered to. These activities were seriously interrupted when the COVID-19 pandemic shut down offices and forced people to work from home. As once centralized workspaces became scattered into thousands of residential homes, maintaining recordkeeping and supervision regulations became increasingly difficult for firms to do.
To preserve the integrity of the industry during this crisis, FINRA was forced to make temporary changes to the rule governing supervision – Rule 3110. This blog will take a closer look at this rule, what changes were implemented, and what future amendments are being proposed.
Let’s Start at the Beginning: FINRA Rule 3110
FINRA Rule 3110, also known as the Supervision Rule, establishes requirements for member firms to supervise employee activities and ensure they are complying with securities laws and regulations. The rule establishes specific obligations regarding supervision and record retention:
- Supervision: Member firms must put in place a reasonable system to supervise the activities of anyone working for them. This includes implementing procedures for reviewing customer accounts, orders, transactions, and communications. If a firm has subsidiary or branch offices, the activities of these offices have to be supervised as well. This includes regular inspections of branch offices and the implementation of appropriate supervisory controls to address the unique risks associated with branch operations.
- Recordkeeping: FINRA requires member firms to retain all written and electronic correspondence sent or received by the firm and its employees. This includes order tickets, trade confirmations, account statements, customer complaints, and all communications, including mobile communications. The retention periods for these records vary based on the type of record and applicable regulations.
Establishing and maintaining appropriate systems and procedures to ensure compliance with these recordkeeping requirements were complex and onerous enough without the COVID-19 pandemic scattering employees and associated people to different corners of the country.
Enter Covid and Work From Home Regulations
The COVID-19 pandemic took an unprepared world by surprise. In an attempt to protect employees and follow federal mandates, workplaces across all industries were forced to close down and implement remote work arrangements instead. This posed particular challenges for the financial industry, which relied on employees being in a centralized office space in order to follow FINRA regulations and properly supervise and monitor their activities.
FINRA recognized that there was a need for flexibility during the pandemic, and they made temporary concessions in order to accommodate the need for people to work from home. These included:
- Remote inspections of branch offices and locations instead of requiring in-person inspections.
- Alternative supervisory measures such as virtual meetings, electronic communication reviews, and remote supervision tools.
- Relaxation of signature requirements by allowing the use of electronic signatures or alternative methods of authorization.
- Regulatory reporting extensions were provided to help alleviate some of the burdens during that period of transition and uncertainty.
- Virtual hearings and examinations were conducted using virtual platforms to accommodate remote work conditions.
Since then the COVID-19 pandemic has abated, but not the desire to work from home. People from across all sectors have found it more convenient and cost effective to work remotely, and have stuck to this arrangement even when restrictions were lifted. Given this new world order, and recognizing that patterns of work have now changed, FINRA has recognized the need to make some permanent changes to Rule 3110.
Proposed Amendments to FINRA Rule 3110
Under its initial proposal, FINRA expanded its definition of an Office Supervisory Jurisdiction (OSJ) to include a Residential Supervisory Location (RSL) which will allow firms to treat private residences as non-branch locations, even if specified supervisory activities are conducted there.
This marks a substantial departure from previous rules which only allowed those activities to take place in OSJs – the highest designation an office can have and therefore the most strictly regulated ones.
This proved to be a controversial decision, as under the FINRA proposal RSLs would not be as closely watched, requiring on-site inspections once every three years rather than every year as is required by OSJs. This means that RSLs could see less frequent, on-site supervisory scrutiny than in the current frameworks.
When the RSL proposal was initially filed in 2022, it received criticism and objections from a range of stakeholders in the industry who were concerned that the rules were too lenient. In response to this backlash, FINRA withdrew the proposals and subsequently presented a revised version for comment.
The new proposal takes into account these concerns and introduces a number of changes that tighten up the regulatory demands of these new residential offices. Among others, these amendments include:
- Records can no longer be physically or electronically kept at an RSL.
- Communications by a broker must go through the broker-dealer’s monitored electronic system.
- Creating stricter criteria for which firms will be allowed to register RSLs.
- RSL’s can be used to meet with clients or handle funds or securities.
The proposal is now open for a period of industry comment, after which the amendment will be finalized.
Implications for Brokers and Financial Firms
If (or, more likely, when) approved, the new rule could significantly add to the administrative and regulatory burden on FINRA members. This is particularly true where recordkeeping is concerned, as WFH offices provide a host of new challenges. These include:
- Ensuring that recordkeeping systems are able to scale up and accommodate all the new offices that are not allowed to store records physically or electronically at their location (the RSL) but will still require easy and efficient access to them.
- Ensuring that all business communications, regardless of whether they are conducted on work or personal devices, are stored and easily accessible.
- Ensuring that communications and recordkeeping practices of these offices can be effectively monitored and audited to check compliance with regulations
In order to do this effectively, brokers and financial firms will have to do a full audit of their current systems and tools, and most likely start using new platforms that can accommodate a complexity they have not previously experienced. This includes being able to track all communication, across all platforms and on a range of private and work devices, and store all of this in a safe place where it can be easily accessed when needed. While this might seem like an insurmountable task, there are platforms that can provide appropriate solutions.
There is Light at The End of The Tunnel
The world is changing far quicker than our systems and processes are, and there is no doubt we are in a lag period at the moment – where what is happening on the ground and in real life does not match the frameworks set up by businesses and regulatory bodies.
The proposed amendments to FINRA Rule 3110 represent a necessary attempt to align the new reality of remote work with supervisory expectations. While it will clearly benefit firms to embrace these changes and adapt their work practices to accommodate them, this will come at a cost.
Finding the right partners and solutions is critical in achieving the right solution for your firm. LeapXpert offers a platform that enables organizations to securely communicate with their clients wherever they are, across a range of platforms and devices, all while integrating with their business-critical systems and processes. As instant messaging and communication further intertwine with daily life, the challenge of maintaining a separate business persona for business conversations grows. LeapXpert gives businesses a comprehensive view and full visibility of employee-customer communication without capturing employees’ private and personal messages.
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