FINRA proposes bosses treat home offices like the office but without all of the pesky supervision activities that come with the office!
- Currently under FINRA rules, a private residence at which certain supervisory functions occur would need to be registered and designated as a branch office or office of supervisory jurisdiction (“OSJ”) under Rule 3110(a)(3) and inspected at least annually under Rule 3110(c)(1)(A).
- However, as part of its response to the COVID-19 pandemic, FINRA temporarily suspended the requirement for member firms to submit branch office registration applications on Form BR (Uniform Branch Office Registration Form) for any newly opened temporary office locations or space-sharing arrangements established as a result of the pandemic (the “Form BR Temporary Suspension”).
- Under the proposed rule change, a new location designation, Residential Supervisory Location (“RSL”), would be treated as a nonbranch location, subject to inspections on a regular periodic schedule under Rule 3110(c)(1)(C), presumed to be every three years.
Proposed Rule Change, as Modified by Amendment No. 1:
- FINRA is proposing to adopt new Supplementary Material .19 under Rule 3110 to establish an RSL designation that would treat an eligible location as a non-branch location (i.e., exclude it from branch office registration and the corresponding annual inspection requirement), subject to specified limitations and conditions.
- Conditions for Designation as a Residential Supervisory Location Under proposed Rule 3110.19(a), an associated person’s private residence where supervisory activities are conducted (i.e., an RSL) shall be considered for those activities a nonbranch location (and thus excluded from branch-office registration and the corresponding annual inspection requirement), provided that:
- Only one associated person, or multiple associated persons who reside at that location and are members of the same immediate family, conduct business at the location
- The location is not held out to the public as an office
- The associated person does not meet with customers or prospective customers at the location
- Any sales activity that takes place at the location complies with the conditions set forth under Rule 3110(f)(2)(A)(ii) or (iii)
- Neither customer funds nor securities are handled at that location
- The associated person is assigned to a designated branch office, and such designated branch office is reflected on all business cards, stationery, retail communications, and other communications to the public by such associated person
- The associated person’s correspondence and communications with the public are subject to the firm’s supervision in accordance with Rule 3110
- The associated person’s electronic communications (e.g., email) are made through the member’s electronic system
(A) the member has a recordkeeping system to make and keep current, and preserved records required to be made and kept current, and preserved under applicable securities laws and regulations, FINRA rules, and the member’s own written supervisory procedures under Rule 3110
- (B) such records are not physically or electronically maintained and preserved at the office or location
- (C) the member has prompt access to such records
- The member has determined that its surveillance and technology tools are appropriate to supervise the types of risks presented by each RSL
these tools may include but are not limited to: (A) firm-wide tools such as, an electronic recordkeeping system; electronic surveillance of email and correspondence; electronic trade blotters; regular activity-based sampling reviews; and tools for visual inspections; (B) tools specific to the RSL based on the activities of the associated person assigned to the location, products offered, and restrictions on the activity of the RSL; and (C) system tools, such as secure network connections and effective cybersecurity protocols.
Member Firm Ineligibility Criteria:
- Under proposed Rule 3110.19(b), a member firm would be ineligible to designate any of its offices or locations as an RSL if the member:
- is currently designated as a Restricted Firm under Rule 4111 (Restricted Firm Obligations)
- is currently designated as a Taping Firm under Rule 3170 (Tape Recording of Registered Persons by Certain Firms)
- is currently undergoing, or is required to undergo, a review under Rule 1017(a)(7) as a result of one or more associated persons at such location
- receives a notice from FINRA pursuant to Rule 9557 (Procedures for Regulating Activities under Rule 4110 (Capital Compliance), Rule 4120 (Regulatory Notification and Business Curtailment) or Rule 4130 (Regulation of Activities of Section 15C Members Experiencing Financial and/or Operational Difficulties)), unless FINRA has otherwise permitted activities in writing pursuant to such rule
- is or becomes suspended by FINRA
- (6) based on the date in the Central Registration Depository, had its FINRA membership become effective within the prior twelve months
- is or has been found within the past three years by the SEC or FINRA to have violated Rule 3110(c)
As originally proposed, under proposed Rule 3110.19(c), a specific location of an otherwise eligible member would be ineligible for designation as an RSL if one or more associated persons at the location: (1) is a designated supervisor who has less than one year of direct supervisory experience with the member;30 (2) is functioning as a principal for a limited period in accordance with Rule 1210.04 (Registration Requirements); 31 (3) is subject to a mandatory heightened supervisory plan under the rules of the SEC, FINRA, or a state regulatory agency;32 (4) is statutorily disqualified, unless such disqualified person has been approved (or is otherwise permitted pursuant to FINRA rules and the federal securities laws) to associate with a member and is not subject to a mandatory heightened supervisory plan under proposed Rule 3110.19(c)(3) or otherwise as a condition to approval or permission for such association;33 (5) has an event in the prior three years that required a “yes” response to any item in Questions 14A(1)(a) and 2(a), 14B(1)(a) and 2(a), 14C, 14D, and 14E on Form U4 (Uniform Application for Securities Industry Registration or Transfer Registration); 34 or (6) is currently subject to, or has been notified in writing that it will be subject to, any investigation, proceeding, complaint or other action by the member, the SEC, a self-regulatory organization, including FINRA, or state securities commission (or agency or office performing like functions) alleging they have failed reasonably to supervise another person subject to their supervision, with a view to preventing the violation of any provision of the Securities Act, the Exchange Act, the Investment Advisers Act, the Investment Company Act, the Commodity Exchange Act, any state law pertaining to the regulation of securities or any rule or regulation under any of such Acts or laws, or any of the rules of the Municipal Securities Rulemaking Board (“MSRB”) or FINRA. Amendment No. 1 would modify two of these six originally proposed criteria. Specifically, Amendment No. 1 would modify proposed Rule 3110.19(c)(1) to provide that an office or location would be ineligible for RSL designation if one or more associated persons at such office or location is a designated supervisor who has less than one year of direct supervisory experience with the member, or an affiliate or subsidiary of the member that is registered as a broker-dealer or investment adviser. Amendment No. 1 also would modify proposed Rule 3110.19(c)(6). As amended, proposed Rule 3110.19(c)(6) would provide that an office or location would be ineligible for RSL designation if one or more associated persons at such office or location has been notified in writing that such associated person is now subject to any Investigation or Proceeding, as such terms are defined in the Explanation of Terms for the Form U4, by the SEC, a self-regulatory organization, including FINRA, or state securities commission (or agency or office performing like functions) (each, a “Regulator”) expressly alleging they have failed reasonably to supervise another person subject to their supervision, with a view to preventing the violation of any provision of the Securities Act of 1933, the Exchange Act, the Investment Advisers Act of 1940, the Investment Company Act of 1940, the Commodity Exchange Act, any state law pertaining to the regulation of securities or any rule or regulation under any of such acts or laws, or any of the rules of the MSRB or other self-regulatory organization, including FINRA. Further, Amendment No. 1 would permit such office or location to be designated or redesignated as an RSL subject to the requirements of proposed Rule 3110.19 upon the earlier of: (1) the member’s receipt of written notification from the applicable Regulator that such Investigation has concluded without further action; or (2) one year from the date of the last communication from such Regulator relating to such Investigation.
Obligation to Provide List of RSLs to FINRA Under proposed Rule 3110.19(d), any member that elects to designate any office or location of the member as an RSL pursuant to proposed Rule 3110.19 shall provide FINRA with a current list of all locations designated as RSLs by the 15th day of the month following each calendar quarter in the manner and format (e.g., through an electronic process or such other process) as FINRA may prescribe.
Risk Assessment Amendment No. 1 would further modify the proposed rule change by adding proposed Rule 3110.19(e). This proposed rule change would require a member – prior to designating an office or location as an RSL – to develop a reasonable risk-based approach to designating the office or location as an RSL, and conduct and document a risk assessment for the associated person assigned to that office or location. This proposed rule change would require documentation of the factors considered, including, among others, whether the associated person at such office or location is now subject to: (1) customer complaints, taking into account the volume and nature of the complaints; (2) heightened supervision other than where such office or location is ineligible for RSL designation under proposed Rule 3110.19(c)(3); (3) any failure to comply with the member’s written supervisory procedures; (4) any recordkeeping violation; and (5) any regulatory communications from a Regulator, including but not limited to, subpoenas, preliminary or routine regulatory inquiries or requests for information, deficiency letters, “blue sheet” requests or other trading questionnaires, or examinations indicating that the associated person at such office or location failed reasonably to supervise another person subject to their supervision. Furthermore, this proposed rule change would require the member to account for any higher risk activities that take place or a higher risk associated person that is assigned to that office or location. Amendment No. 1 also would provide – as part of proposed Rule 3110.19(e) – that (consistent with its obligation under Rule 3110(a)) the member’s supervisory system must take into consideration any indicators of irregularities or misconduct (i.e., “red flags”) when designating an office or location as an RSL.43 Further, this proposed rule change would provide that red flags should be reviewed in determining whether it is reasonable to maintain the RSL designation of an office or location in accordance with the requirements of proposed Rule 3110.19, and that the member should consider evidencing steps taken to address those red flags where appropriate
Request for Comment:
How to comment:
- Use the Commission’s internet comment form (https://www.sec.gov/rules/sro.shtml);
- Send an email to
[email protected]. Please include file number SRFINRA-2023-006 on the subject line.
As a retail investor concerned about loopholes and conflicts of interest, a few potential issues around Residential Supervisory Locations (RSLs) might concern you in a comment:
- Reduced Oversight: Even though there are measures to ensure oversight, the nature of remote working might potentially reduce the effectiveness of such supervision. The change from annual to a presumed three-year inspection schedule might reduce the frequency of oversight, potentially allowing misconduct to go unnoticed for longer periods.
- Information Security: With work-from-home setups, there's always the risk of information being less secure than it would be in a traditional office environment. Even with cybersecurity protocols in place, there's an increased risk of data breaches or mishandling of sensitive information that could impact investors.
- Increased Opportunities for Misconduct: The decreased visibility of activities in an RSL may create increased opportunities for fraudulent activities or misconduct. While there are clear guidelines about activities conducted in RSLs, enforcement of these could be more challenging.
- Record Keeping: There may be concerns over how effectively records are maintained in a residential setup. While the proposal mentions requirements for keeping records according to regulations, the practical enforcement of this requirement could pose challenges.
- Conflicts of Interest: Working from a home environment may blur professional boundaries, and potentially increase the chances for conflicts of interest to arise and go unchecked.
- Ineligibility Criteria Loopholes: The rules exclude certain firms from designating RSLs, mostly based on past violations or ongoing issues. However, there could be potential for firms to circumvent this by, for example, having associated persons with clean records establish RSLs on behalf of the firm.
All of these could potentially create loopholes that allow for misconduct, poor handling of sensitive data, or inadequate supervision of activities, which ultimately could be detrimental to the interests of retail investors.
- FINRA is proposing a rule change, which allows certain supervisory functions to occur at private residences without the need for registering them as branch offices. They've dubbed this the Residential Supervisory Location (RSL).
- The RSL designation would exempt these residences from the current rule that requires annual inspections, instead, inspections would occur on a regular periodic schedule, likely every three years.
There are a bunch of conditions for an RSL:
- Limited to family members residing at the location.
- Can't be advertised as an office.
- No meetings with customers or potential customers.
- Sales activity must comply with certain rules.
- No handling of customer funds or securities.
- Business cards, stationery, etc. must reflect their assigned branch office.
- All communications must be supervised according to FINRA rules.
- Electronic communication must be through the member's electronic system.
- Must maintain recordkeeping systems compliant with applicable laws and regulations.
- Surveillance and technology tools are appropriate for supervising the RSL.
However, some firms are not eligible to designate an RSL:
- Those designated as Restricted or Taping Firms.
- Those undergoing specific reviews due to associated persons.
- Those receiving certain notices from FINRA.
- Those suspended by FINRA.
- New firms (less than a year old).
- Those found to have violated certain rules within the past three years.
- There are also criteria about which specific locations or individuals are ineligible. Basically, they're trying to prevent RSL designations for people or places associated with a history of issues, rule violations, or those currently under investigation.
- Any firm that uses the RSL designation will need to provide FINRA with a list of all their RSLs every quarter.
- The proposal also introduces a risk assessment component, likely designed to ensure ongoing compliance and risk management with the RSL arrangement.
- All of these could potentially create loopholes that allow for misconduct, poor handling of sensitive data, or inadequate supervision of activities, which ultimately could be detrimental to the interests of retail investors.