The Exchange Act and FINRA rules require broker-dealers to establish and maintain supervisory systems that are reasonably designed to promote compliance with the federal securities laws and FINRA rules. With certain exceptions, broker-dealers are generally provided with flexibility to design and implement a supervisory system appropriately tailored to its particular business and the environment in which it operates. During a pandemic, the securities regulators understand that brokerage firms may implement large-scale teleworking by associated persons. The Securities and Exchange Commission (SEC) and FINRA recognize that firms are structured differently and the need for flexibility to adopt procedures to suit their individual structure and business needs, but firms are still expected to establish and maintain a reasonably designed supervisory system for alternative work arrangements during a pandemic.
FINRA recently published guidance that addressed, among other things, the supervisory obligations of member firms that are using “remote offices or telework arrangements” in response to the spread of COVID-19. See FINRA Notice 20-08, Pandemic-Related Business Continuity Planning, Guidance and Regulatory Relief (Mar. 9, 2020).1 These arrangements may result in registered representatives working in a different environment (e.g., at their homes instead of in the member’s office), and supervising many remote locations can present significant challenges or unique considerations that do not exist when supervising non-remote locations. See SEC Division of Market Regulation, Staff Legal Bulletin No. 17: Remote Office Supervision (Mar. 19, 2004). As a result, and as FINRA recently reminded, “the use of remote offices or telework arrangements during a pandemic may necessitate a member firm to implement other ways to supervise its associated persons who change their work locations or arrangements for the duration of the pandemic.” This recent notice echoes guidance that FINRA issued in 2009 following the H1N1 (swine flu) pandemic, where FINRA observed that “it is important that firm’s supervisory systems are adequately designed to provide reasonable supervision of employees’ activities (regardless of their functions) while working from remote locations.” FINRA Notice 09-59, Business Continuity Planning: FINRA Provides Guidance on Pandemic Preparedness (Oct. 12, 2009). Notably, FINRA’s recent guidance also advised that FINRA was “temporarily suspending the requirement to maintain updated Form U4 information regarding office of employment address for registered persons who temporarily relocate due to COVID 19.” Similarly, FINRA indicated that “member firms are not required to submit branch office applications on Form BR for any newly opened temporary office locations or space-sharing arrangements established as a result of recent events.”2
In light of FINRA’s guidance, broker-dealers should review their supervisory policies to confirm that they are reasonably designed to promote compliance by employees working remotely with the federal securities laws and FINRA rules, and that the appropriate personnel are performing supervisory functions.3 Depending on the broker-dealer’s particular lines of business, supervisory systems that were reasonably designed to supervise the activities of registered representatives in non-remote locations may need to be modified while employees are working from home or other remote locations. Determining whether a supervisory structure is reasonably designed will depend largely on the broker-dealer’s particular business, and firms should consider whether their supervisory policies appropriately take into account the different functions of different employees. For example, it may be appropriate to use policies and procedures to remotely supervise traders that differ from the policies and procedures used to remotely supervise research analysts. For traders who are accustomed to working in highly customized work environments, separating operations may pose issues for desk communication and liquidity in the market. Therefore, firms should review their supervisory procedures regarding, among other things, capital and risk limits and desk communications and determine whether alternative supervisory systems are needed for oversight of trading operations. Firms may also consider the frequency of supervisory reviews in light of market events and changing conditions.
Firms should also assess whether their remote supervision procedures appropriately address concerns that may be more acute when employees are working remotely, such as those involving cybersecurity or the capture of communications or other records. For instance, firms that permit remote access to their systems should consider whether additional safeguards may be warranted given the circumstances to guard against cyber threats or to otherwise protect customer records and information. Likewise, employees working remotely may be more likely to use online collaborative or communication tools, including some tools that would not typically be used if the employees were not working remotely. Firms should accordingly consider whether during this period they are appropriately capturing and reviewing electronic communications and other records relating to their investment banking or securities business.
Similarly, firms should consider whether their supervisory systems appropriately account for areas that may present more regulatory or operational risk during this time. For example, the current environment could present a heightened risk that misconduct by associated persons may occur and remain unidentified for a period of time without a physical supervisor at the office or location. Customers may also be more likely to transfer funds between accounts or institutions, either as the result of decreasing market exposure or to meet liquidity needs. As such, firms should consider whether additional reviews or safeguards are needed regarding, among other things, unusual trading activity and frequent or questionable transfers of funds or securities between customer accounts or employee accounts. In addition, during this time, customer complaints may be high, and firms should review their supervisory process for reviewing the issues and nature of customer complaints received and how such complaints are being addressed.
1 FINRA’s notice advises that a member “should use its best efforts to provide written notification to its FINRA Risk Monitoring Analyst as soon as possible after establishing a new temporary office or space-sharing arrangement, to include at a minimum the office address, the names of each member firm involved, the names of registered personnel, a contact telephone number and, if possible, the expected duration. The notification should also indicate whether the member firm’s personnel will be sharing space with another entity, and if so, the type of business in which it is engaged (e.g., an affiliated investment adviser or an organization in the securities business).” Although not the focus of this notice, FINRA’s recent guidance also recognizes that branch office exams may need to be temporarily postponed during the pandemic, and compliance with FINRA Rule 3110(c) in connection with conducting on-site inspections of branch offices this year may need to be reevaluated.
2 As the industry largely shifts to teleworking, the North American Securities Administrators Association (NASAA) has adopted model guidance that allows a registered representative to work from a remote location during the pandemic without having to register in that state. State regulators are in the process of considering whether, or how to, implement this guidance.
3 Under FINRA Rule 1210.04, individuals generally may not function in a principal capacity for more than 120 days without having passed the appropriate examination(s). Because examination centers have been closed in response to COVID-19, FINRA recently extended the relevant period of time so that “individuals who were designated to function as principals under Rule 1210.04 prior to February 2, 2020 will be given until May 31, 2020 to pass the appropriate examination(s).” FINRA, Frequently Asked Questions Related to Regulatory Relief Due to the Coronavirus Pandemic, https://www.finra.org/rules-guidance/guidance/faqs/coronavirus.