Securities Law & Corporate Counsel Blog

The SEC and FINRA have issued a Risk Alert and a Regulatory Notice on broker-dealer branch inspections, and offered suggestions to help securities industry firms better perform this key supervisory function. The Risk Alert noted that the branch inspection process is a critical component of a comprehensive risk management program and can help protect investors and the interests of a firm. The SEC and FINRA offered the following tips to help perform robust branch inspections:

• 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) and 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 inspections.

To provide further guidance, the Risk Alert also identified certain shortcomings in firms’ branch office examination processes.  The following were noted as significant deficiencies which impact the integrity of the overall branch inspection process.  In these instances, firms:

• Utilized generic examination procedures for all branch offices, regardless of business mix and underlying risk;
• Attempted to leverage novice or unseasoned branch office examiners who do not have significant depth of experience or understanding of the business to challenge assumptions;
• Performed the inspection in a “check the box” fashion without questioning critically the integrity of underlying control environments and their effect on risk exposure;
• Devoted minimal time to each exam and little, if any, resources to reviewing the effectiveness of the branch office exam program;
• Failed to follow the broker-dealer’s own policies and procedures by not inspecting branch offices as required, announcing exams that were supposed to be unannounced, or failing to generate a written inspection report that included the testing and verification of the firm’s policies and procedures, including supervisory policies and procedures;
• Failed to have adequate written supervisory procedures, particularly in firms that used an independent contractor model and allowed registered personnel to conduct business away from the firm; and
• Lacked heightened supervision for individuals with disciplinary histories (both past and present).

While the Risk Alert pertains to broker-dealer branch office inspections, many of its tips and suggestions are equally applicable to the risk assessments and tests that should be conducted by investment advisers and private fund advisers.For additional information on broker-dealer branch inspections, please contact us  at (619) 298-2880.