One of the many challenges that member-firms face is the performance of branch office inspections. FINRA and the SEC are paying particular attention to this area of oversight because poor inspections may lead to violation of the securities laws and customer harm. In an effort to highlight the importance of branch office inspections, in FINRA Notice to Members 11-54, FINRA and the SEC issued joint guidance on effective policies and procedures for broker-dealer branch inspections.
In providing this guidance, FINRA and the SEC highlighted significant deficiencies seen with the integrity of branch office inspections. These deficiencies included: using a generic examination process; using inexperienced branch office examiners; performing inspections in a “check the box” fashion without critically questioning the local control environment; failure to actually conduct branch inspections consistent with overall firm policy; announcing what are supposed to be unannounced inspections; failure to have adequate policies and procedures for firms that have the independent contractor business model; and lack of heightened supervision over branch representatives who should be subject to such supervision.
To address these issues, FINRA and the SEC recommended a risk-based approach to branch inspections. By applying this approach, member-firms will sharpen their intensity and focus on branch office inspections. A risk-based approach should also influence the decision to conduct unannounced inspections. The fundamental aspect of a risk-based approach is for a firm to assess the overall business, products, people and practices. Only individuals with adequate experience should be conducting these inspections, and those individuals should be overseen by senior members of the firm. Furthermore, a risk-based approach will endeavor to avoid conflicts of interest that would otherwise under serve the inspection process.
This guidance was also accompanied with a tacit warning. According to FINRA and the SEC, “[t]o test the quality of broker-dealers’ required inspections of branch offices, [their] examiners may seek to review and verify issues related to an effective branch examination program, particularly matters such as supervisory procedures regarding customer accounts and sales of retail products.”
In light of this message, now is as good a time as any for a member firm to reevaluate its branch office inspection policies and procedures. If you do not have a risk-based approach, I recommend that you adopt one as FINRA and the SEC are expecting it. If you opt to follow a program that excludes a risk-based approach, then be prepared for FINRA and the SEC to come down on you for having a deficient branch office inspection policies and procedures.