FINRA Rule 3110 Explained

FINRA Rule 3110 Explained

Known as the “Supervision Rule,” FINRA Rule 3110 requires brokerage firms to establish, maintain, and enforce a system to supervise the activities of their associated persons.

The rule stipulates that the system of supervision should be reasonably designed to achieve compliance with all applicable regulations established by the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC).

Compliance with FINRA Rule 3110 is critical for brokerage firms to effectively manage risk and avoid costly liability. Establishing a robust supervisory system, however, is not only a key regulatory obligation but also helps broker-dealers build trust with investors and strengthen their business practices.

In this article, we explain the key elements of Rule 3110, as well as upcoming amendments to the rule that firms should have on their radar.

FINRA Rule 3110 sets forth the requirements for effective risk management practices within brokerage firms.  As referenced above, the Rule requires brokerage firms to have reasonably designed written supervisory procedures (WSPs) in place to identify, monitor, and mitigate risks associated with their business.  Among other requirements, a firm’s WSPs must address the supervision of supervisory personnel and provide for the review of a firm’s investment banking and securities business, correspondence and internal communications, and customer complaints. WSPs must also detail the specific individual(s) responsible for each review; the supervisory activities such persons will perform; the frequency of the review; and the manner of documentation.

Below is a summary of five key requirements of FINRA Rule 3110:

• Designation of Registered Principals: Firms must designate appropriately registered principal(s) with authority to carry out the supervisory responsibilities of the firm for each type of business that it conducts. To ensure adequate supervision at all locations, firms must also designate and register branch offices and Offices of Supervisory Jurisdiction (OSJs).

• Review of Correspondence and Internal Communications: Firms must have supervisory procedures in place for the review of incoming and outgoing written (including electronic) correspondence and internal communications relating to the firm’s investment banking or securities business. The supervisory procedures must be appropriate for the firm’s business, size, structure, and customers

• Review of Customer Complaints: Firms must implement procedures to promptly capture, acknowledge, and respond to all written (including electronic) customer complaints.

• Transaction Reviews: Firms must establish supervisory systems to identify fraudulent trades, insider trading, and securities transactions that otherwise violate the Securities and Exchange Act, SEC regulations, or FINRA rules.

• Internal Inspections: Firms must conduct a review, at least annually (on a calendar-year basis), of the businesses in which they engage. The review must be reasonably designed to assist the firm in detecting and preventing violations of, and achieving compliance with, applicable securities laws and regulations, and with applicable FINRA rules. As part of their internal inspection, firms must review the activities of each office, which must include the periodic examination of customer accounts to detect and prevent irregularities or abuses.

Changes to FINRA Rule 3110 are on the horizon. As set forth in FINRA’s Regulatory Notice 24-02, a new rule will take effect on July 1, 2024, which will establish a voluntary, three-year remote inspections pilot program.  Specifically, new Rule 3110.18 will allow eligible member firms to fulfill their inspection obligation of qualified branch offices (under Rule 3110(c)(1)) without an on-site visit to such offices or locations.

Another rule change becomes effective on June 1, 2024. Under new Rule 3110.19, FINRA will treat a private residence at which an associated person engages in specified supervisory activities, as a non-branch location, subject to certain safeguards and limitations. As a non-branch location, the newly defined residential supervisory location (or RSL) will be subject to inspections on a regular periodic schedule (presumed to be at least every three years) rather than the annual inspections currently required for an office of supervisory jurisdiction (OSJ) and “supervisory branch office.”

The recent decade-plus of relative calm in the market has allowed regulators to spend more time and resources on aggressive investigation and enforcement. As such, it is more important than ever that firms stay informed and ahead of the curve by adopting a supervisory framework in full compliance with all relevant rules and regulations. Effectively developing, implementing, and enforcing such a supervisory framework can be daunting, especially in such a challenging regulatory environment. As such, brokerage firms are strongly advised to work with experienced counsel. Scarinci Hollenbeck’s Regulatory Compliance Group is dedicated to helping firms achieve FINRA compliance in this challenging regulatory environment. We assist clients in building supervisory systems, navigating changes in supervisory obligations, and monitoring the effectiveness of their supervisory procedures to avoid enforcement efforts being directed at them.