FINRA Reviews & Responses: SDDCO's Update on Small Firm Exams

Share Article

SDDCO Regulatory Services LLC shares their report on the 2012 FINRA exams of small broker-dealers. The assessment includes an accounting of FINRA exceptions and citations, an overview of the response process, and the unexpected challenges for small brokerage firms.

Small Firm examinations can be painful," said Evan Ignall, Partner, "but, if managed properly, should not result in a sanction or fine.

SDDCO Regulatory Services LLC (SDDCO-RS) provides outsourced regulatory compliance services to FINRA member broker-dealers. Their study of 2012 FINRA audits concerns a subset of broker-dealers: 20 firms with fewer than 20 representatives that do not handle customer funds or securities (“Small Firms”).

Exams in the Update -
The Financial Industry Regulatory Authority ("FINRA") conducts cycle examinations of member broker-dealers “to determine whether firms are in compliance with federal securities laws, rules and regulations.” Cycle exams explore business and operational areas that impact a firm. Of the 20 Small Firm exams reviewed, 16 were routine cycle exams, occurring every three to four years, and 4 were six-month exams for new FINRA members.

Final Disposition Letter -
SDDCO-RS assessed the Final Disposition Letter issued by FINRA at the completion of each Small Firm exam, relaying one of four outcomes:
1) No Further Action: 45% of the Small Firms received no deficiencies;
2) Cautionary Action: 55% received a letter indicating deficiencies requiring a reply by a given date;
3) Compliance Conference: no Small Firms were issued this notice. FINRA may request a formal meeting, however in three years of studying exam results, SDDCO-RS has not seen this outcome;
4) Enforcement Referral: no Small Firms received a referral to enforcement, which can ultimately result in a punitive sanction or fine.    

Exceptions and Citations -
The Final Disposition Letter with its examination report ("Report') can identify exceptions and citations identified during the review. An exception refers to a rule or law with which FINRA believes the firm did not comply. For each exception, FINRA lists one or more citation, each detailing a related non-compliant activity. In the 2012, examiners listed 52 exceptions across 55% of the Small Firm Reports. Within these exceptions, they cited 80 activities; the Reports with exceptions averaged 7 citations each.

Citation Topics -
Within 2012 Small Firm Reports containing exceptions, these topics were most cited by examiners: Written Supervisory Procedures (40%); Outside Business Activity (25%); Anti-Money Laundering; (25%); Financial Reporting (15%); FINRA Registration (15%); Customer Identification Program (10%); E-communication Review/Retention (10%); Supervision (10%); Fidelity Bond (10%); Annual Compliance Meeting (10%); and Branch Office Reviews (10%).

Responding to FINRA -
SDDCO-RS explains that FINRA often points out potential compliance issues during the on-site portion of an examination, enabling a firm to respond to or rectify issues immediately. Correcting an issue early could prevent its appearance in the FINRA Report.

Exceptions documented in the FINRA Report generally require a written response. Most Small Firms leverage their existing resources to evaluate exceptions and the supporting citations. To assess the merits and status of an exception, the CEO or CCO meets with key personnel—and, perhaps, in-house counsel or a retained compliance consultant—and review applicable documents, manuals and business practices. Firms with retained counsel or consultants typically utilize this expertise in drafting the written response.

To remediate deficiencies, SDDCO-RS recommends that broker-dealers respond to FINRA by outlining a Corrective Action Plan detailing their completed, in progress or planned action steps. A firm may dispute exceptions, though SDDCO-RS stresses careful consideration before taking this approach. A firm must be certain of its position and is advised to respond with specific documentation to evidence its compliance within a response letter.

Small Firm Challenges -
SDDCO-RS finds FINRA rules and the exam process to be more oriented towards conventional broker-dealers—firms handling customer accounts and dealing in traditional products such as stocks and bonds. “FINRA examiners are using a playbook designed for traditional firms,” said Evan Ignall, Partner. “Often the examiners themselves find it challenging to apply FINRA rules to firms with limited business models. Some don’t acknowledge the disconnect. But others do and work with such firms and their consultants to discern which rules apply and how.”

Some disconnect between the review process and nonconventional broker-dealers could be evidenced by a surprising finding. An in-house review of the annual analyses SDDCO-RS has conducted on varying small firms across 2012, 2011 and 2010 revealed that brokerage firms with limited business models (no customer accounts) received a similar or greater number of exceptions than brokerage firms with customer accounts.

Post-Exam Trend -
SDDCO-RS recounts that FINRA closed several 2012 cycle exams and then followed up months later with routine information requests (...“pursuant to exam #”...) as though the exam were still in process. SDDCO-RS observes that while this is consistent with FINRA's goal of moving toward real-time oversight, clients were confused by these post-exam requests but typically cooperated.

Enforcement Actions -
“Small Firm examinations can be painful," said Ignall, "but, if managed properly, should not result in a sanction or fine. The exceptions FINRA finds in these firms are typically procedural and don’t present investor protection concerns. We make sure our clients pay attention and correct deficiencies on time and then communicate these corrections to FINRA."

[The contents above are intended for general informational purposes only, not as a substitute for consulting with a professional.]

About SDDCO Regulatory Services LLC -
The SDDCO Regulatory Services LLC of The SDDCO Group provides full-service compliance consulting to FINRA member broker-dealers, onsite and off, on a project or retainer basis. Seasoned professionals facilitate FINRA membership and support ongoing compliance with the rules and regulations of the industry. Service inquiries can be sent via

Share article on social media or email:

View article via:

Pdf Print

Contact Author

Teri Daniels, Manager
Follow us on
Visit website