San Diego, Calif. (PRWEB) May 22, 2012
Of particular concern are branch offices operated by independent contractors because the independent contractor relationship does not tie these branch offices as closely to the broker-dealer as ones operated by firm employees.
By way of illustration, the SEC recently settled a case involving 1st Discount Brokerage* which focused on the activities of an independent registered representative who was found to be operating a Ponzi scheme out of a branch office where he defrauded over 50 investors of nearly $9 million. The accused was operating under a separate business name and put up temporary signage indicating his relationship with the broker-dealer only when staff arrived to conduct internal audits. Once an audit was over, he took down the signs in order to hide his relationship with the broker-dealer so as to forestall potential client complaints to 1st Discount and avert discovery.
First Discount failed to conduct unannounced examinations (in accordance with its established policies and procedures) and did not provide examiners with prior audit reports which cited signage issues. In addition, the firm failed to conduct periodic reviews of registered representative activity (as required by its policies and procedures), so failed to discover “red flags” such as sharply declining commissions and a customer complaint of unauthorized trading. Had the firm done these things, they would most likely have investigated further and discovered the scheme. As part of its opinion, the SEC stated that independent contractors require greater supervision than that provided for ordinary firm employees.
FINRA and the SEC recently issued a joint alert concerning best practices for branch office supervision. The bulletin discussed the following best practices that should be included in any branch office supervisory program:
- The inclusion of more unannounced internal branch office audits (the SEC has sanctioned broker-dealers in the past that have not conducted unannounced examinations)
- Conducting more frequent examinations of branch office that exhibit more risk factors based on previous internal audits (and selecting some branches randomly) rather than relying solely on arbitrary examination schedules
- Utilizing more knowledgeable senior examiners who have a greater understanding of the securities business of the firm (and the underlying regulations) to conduct internal audits
- Avoiding the use of “check the box” internal audit report forms instead of more in-depth checklists that allow for a sufficiently thorough examination of business practices and activities
- Including procedures for heightened supervision of remote branch offices that have associated persons with disciplinary histories
- Providing detailed internal examination reports and a timeline for following up with senior management and correcting any deficiencies discovered during examinations
- Conducting more frequent unannounced “re-audits” of branch offices where routine examinations uncovered a larger than normal number of deficiencies, repeat deficiencies or serious deficiencies
- Including conflict of interest guidelines that prevent examiners from conducting internal audits of branch offices from which they may receive commissions or revenue
- Increasing the frequency and/or scope of inspections where registered personnel are allowed to conduct business activities other than in their capacities as associated persons of a broker-dealer
Broker-Dealers must also ensure that they are in compliance with the reporting requirements for outside business activities by their registered representatives. Under recently enacted FINRA Rule 3270, registered representatives must provide prior written notice to the firm before engaging in an outside activity.
These recommendations should help broker-dealers establish a good program for branch office supervision and enable compliance with the more stringent regulatory guidelines. Doing so will also make them more prepared for the increased regulatory scrutiny.
*In the Matter of 1st Discount Brokerage, Inc. and Michael R. Fisher, Securities Exchange Act of 1934 Release No. 66212A /January 23, 2012, Investment Advisers Act of 1940 Release No. 3360A /January 23, 2012 (SEC) – Order Instituting Administrative Proceedings Pursuant to Section 15(b) of the Securities Exchange Act of 1934 and Sections 203(e) and 203(f) of the Investment Advisers Act of 1940 Making Findings, Imposing Remedial Sanctions and a Censure Order as to 1st Discount Brokerage, Inc., and Making Findings and Imposing Remedial Sanctions as to Michael R. Fisher.