U.S. securities regulators have issued a risk alert and a regulatory notice on broker-dealer branch inspections, which offers guidance to securities firms on how to carry out these inspections to protect both clients, and their own interests.
The U.S. Securities and Exchange Commission’s Office of Compliance Inspections and Examinations and the Financial Industry Regulatory Authority Wednesday issued the notices providing guidance on branch inspections, which they note is a critical component of a comprehensive risk management program that can help protect investors and brokerage firms.
The notice indicates that the regulators’ examination staff have observed that firms that execute this process well typically: tailor the focus of branch exams to the business conducted in that branch and assess the risks specific to that business; schedule the frequency and intensity of exams based on underlying risk, rather than on an arbitrary cycle, but examine branch offices at least annually; engage in a significant percentage of unannounced exams, selected through a combination of risk based analysis and random selection; deploy sufficiently senior branch office examiners who understand the business and have the gravitas to challenge assumptions; and, design procedures to avoid conflicts of interest by examiners that may serve to undermine complete and effective inspection.
Firms that don’t do a good job and display significant deficiencies in the integrity of their overall branch inspection process, typically: utilize generic examination procedures for all branch offices; utilize unexperienced branch office examiners; perform inspections in a ‘check the box’ fashion; devote minimal time to each exam; fail to follow their firm’s own policies by not inspecting branch offices as required, announcing exams that were supposed to be unannounced, or failing to generate a written inspection report; failing to have adequate policies; and, lacking heightened supervision of individuals with disciplinary histories.
“An effective risk based branch office inspection program is an important component of a broker-dealer’s supervisory system and, when constructed and implemented reasonably, it can better protect investors and the firm’s own interests,” said Stephen Luparello, vice chairman of FINRA. “FINRA encourages broker-dealers to review this guidance and consider enhancements to their own branch office inspection programs.”
The SEC indicates that this is the second in a continuing series of risk alerts that its national examination staff expects to issue, alerting senior management, risk management, and compliance managers in the securities industry to significant risks they uncover, so that industry members can more effectively address those risks.