NASAA & FINRA Reports Point to Regulatory Expectations for Heightened Supervision

Due DiligenceFINRA’s 2019 Risk Monitoring and Examination Priorities Letter was released last week. While the letter’s second paragraph lists areas of focus which are detailed throughout the report, the third paragraph includes a brief statement about how FINRA will focus on risk related to associated persons with a “problematic regulatory history”.  Where there was not a lot of elaboration in the letter, we at Oyster were reminded of the NASAA report on Heightened Supervision and thought it would be beneficial to remind you of the risks that can accompany hiring someone with such a history.

According to a September 2018 North American Securities Administrators Association Inc. (“NASAA”) report, there is a view that Registered Representative (“RRs”) misconduct is a recurring threat for investors, and that RRs with prior records of misconduct are three times more likely to be repeat offenders than their peers.  Heightened supervision of risk-prone RRs is an important supervisory obligation of broker-dealers.

The NASSA report discussed how firms of varying types and size addressed the issue of heightened supervision, highlighting these practices to provide guidance on state regulatory expectations for broker-dealers. The report findings were based upon the results of 30 NASAA member jurisdictions that participated in a coordinated series of examinations of broker-dealers to survey heightened supervision policies and procedures for RRs.

During the course of the NASAA examinations, FINRA issued Notice to Members 18-15 providing additional guidance to its member firms concerning supervisory obligations for RRs with a history of misconduct.

The examinations focused on three areas:

  • Supervisory procedures for identifying persons to place on heightened supervision; terms of the supervision; the need for an individual to be responsible for compliance with the heightened supervision; removal from heightened supervision after all the requirements were completed
  • Procedures for designing individual plans for RRs, determining the conduct leading to the heightened supervision and, if necessary, restricting the RR from engaging in that activity;
  • Procedures for establishing a person designated to ensure compliance with the agreement

The report identified nine reasons for being placed on heightened supervision, with the top four being:

  • Customer complaints (45.2%)
  • State regulator action/required heightened supervision (33.3%)
  • Financial concerns (28.6%)
  • Sales practice violations (21.4%)

The conclusions of the report indicated that 90% of those individuals for the examined firms did not have any client complaints while on heightened supervision. However, the report provides recommendations that policies and procedures should ensure that written plans include:

  • Designated individuals(s) with the necessary experience and authority to enforce the plan;
  • Appropriate and meaningful written documentation evidencing the RRs awareness of the conditions of the plan and the supervisor’s awareness of his responsibilities;
  • Periodic review(s) to determine the plan’s effectiveness; and
  • Procedures for removing RRs from plans once all the necessary requirements are met

Although not contained in the report, those responsible for supervising the RR on heightened supervision, and the firm itself, should be aware they may be subject to disciplinary action for failing to enforce compliance with the requirements of the written plan.

About the Author: Bill Reilly Bill leverages his examination expertise and relationships with state and federal regulators and self-regulatory organizations to guide broker-dealers and investment advisers through both proactive and reactive regulatory processes and compliance issues. Among others Bill conducts FINRA Rule 3120, Supervisory Control Reviews, Annual Compliance Reviews for federally and state-covered investment advisers, creates and/or updates policies and procedures for opening and monitoring senior and vulnerable adult client accounts, has been retained as an expert witness by law firms representing industry participants in arbitrations and regulatory matters, updates policies and procedures for both broker dealer and investment advisers, and acts as an independent third party in reviewing firm activity prior to and as a result of regulatory actions and settlements.

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