Brokerage firms want FINRA’s suspension of regular, in-person inspections due to COVID-19 to continue after the pandemic ends.
Last December, FINRA asked industry participants what rules and regulations should be amended in light of the changes the pandemic has wrought. Specifically, the agency wanted opinions on whether the suspension of in-person visits should be extended, how firms were handling “virtual” inspections and exams, and whether the agency should change the definitions for branch offices and offices of supervisory jurisdiction, due to the “expected greater use of remote offices and alternative work arrangements” that may possibly continue even after the pandemic has subsided.
Responses from firms like Wells Fargo, Charles Schwab, LPL Financial and others were generally in favor of keeping inspectors out of the office, and in remote sessions, permanently. Lincoln Financial Group’s Senior EVP Will Fuller wrote that most broker/dealer functions can be performed remotely without the need for on-site supervision, and they expected many employees will not return full time to a physical office.
“Our experience during the pandemic is that remote inspections are just as effective as on-site inspections,” the letter read. “Compared to the on-site inspections we conducted before the pandemic, the remote inspections we have conducted during the pandemic have resulted in comparable findings. We have also found that remote inspections allow us to be more agile and effective with respect to how we deploy our inspectors and supervisors to address risks.”
Mark Quinn, the director of regulatory affairs for Cetera Financial Group, wrote that FINRA should consider conducting all its regular exams remotely unless an on-site visit is essential, arguing that the downsides of in-person meetings often outweighed the benefits. In an interview with WealthManagement.com, Quinn said the agency had already made strides in digitizing its exam process even before the pandemic. Five years ago, he said, FINRA inspectors may have been on-site at a firm of Cetera’s size for several weeks but now it was closer to one. Moving inspections online in full would be more cost-effective for both advisory firms and the agency.
“Anything they can do to save money on travel expenses or related costs is something they should consider looking into,” he said. “And I would guess the amount of money they spend on a branch office examiner’s travel expenses is pretty considerable if you aggregate it across all the FINRA membership.”
Firms also asked the agency to reconsider how they define a “branch office” and OSJ, a change that could impact when, how and even if those offices are inspected. Cambridge Investment Research explained it saw no need for annual exams for each “back-office employee” working from home or outside the office, and wanted the agency to carve out some functions from the annual exam requirement for OSJs.
The North American Securities Administrators Association—representing state securities regulators—cautioned FINRA against amending definitions hastily without questioning how it could impact investors. Changing those definitions, especially without consulting state regulators, could bring confusion.
“The definitions serve to determine where and how supervision should occur and where inspections should be required, regardless of whether those events occur in office or home settings, and regardless of whether they occur in disparate jurisdictions,” the group wrote.
“Whether conducted centrally or remotely, regulators need to have confidence that firms and their employees are following the law,” NASAA's statement read. “It is the experience of regulators that certain failures— such as recordkeeping, cybersecurity, and outside business activities—can escape notice in remote inspections.”
Jim Eccleston, a securities attorney at Eccleston Law in Chicago, expected FINRA could consider changes that would let a rep work out of their home without it being designated as a branch office, but it was less likely FINRA would redefine an OSJ.
Regulators might be wary of forgoing on-site inspections altogether, he said.
“It’s important for regulators to see the person you’re examining,” he said. “If someone breaks out in a profuse sweat when you ask what you did with a customer’s money, you want to see that.”
But the definitions for work locations were based on how business was conducted in past decades and warranted a fresh look, Quinn said. He noted the definition for a branch office was when business was being conducted in person or over the phone. Now, Quinn said, reps could conduct transactions for clients from a backyard with a laptop.
“Virtually all transaction review is electronic; it’s done through surveillance systems, or routing through a supervisory hierarchy. Nobody is sitting in an office reviewing order tickets anymore, that just isn’t the way it works,” he said. “To assume that physical presence helps you create a better supervisory environment, I think is a false premise because of the way business is conducted and the way supervisory oversight is conducted now.”
But the view that in-person branch exams had outlived its usefulness could hurt firms in the long run, according to Sander Ressler, a managing director of Essential Edge Compliance Outsourcing Services. The idea that technology could detect all disciplinary issues as well as on-site inspections was a “fallacy,” he said, arguing that when a representative is deliberately trying to circumvent a firm’s supervision, technology supervision may not suffice. He also stressed that FINRA’s compliance mandates urged firms to prevent misconduct, not just to find it after the fact.
“How do you prevent something? You have to be proactive, and there’s nothing about a remote inspection that is proactive. An unannounced exam is proactive,” he said. “By its own nature, a remote exam can only look at what’s already occurred.”
Like many, Ressler believed prioritizing on-site inspections based on a risk assessment could benefit firms, while keeping vital supervision in place. He suggested a situation where firms would have the latitude to inspect locations they deemed safe every five years, while continuing to assess riskier ones every year.
“I don’t have a problem with expanding the scope (of the definition),” he said. “I have a problem with limiting the presence.”
