Chapter 1 - Registration of Broker Dealers and the Supervisory System

when are broker dealers exempt from FINRA registration requirements?

• if they only deal in exempt securities

• offer services outside the United States

what does the membership application for FINRA include and what is it called?

called form BD and includes

• copy of registration submission to the SEC

• trial balance and net capital computation

• the members written supervisory procedures

• list of officers, partners, and associated persons

• any other info requested by FINRA District Office

how many days until FINRA district office notifies if their application has been granted?

within 30 days

when would statutory disqualification occur for a broker dealer or person associated with it

• if they’ve been suspended or expelled from any other self regulatory organization, domestic or foreign

• is the subject of an SEC order suspending or revoking registration

• if they are the associated person who caused the suspension or expulsion of a different firm

• willfully filed a false or misleading application or omitted state material facts on the application

• violated federal securities or commodities laws

• failed to supervise or provided aid to someone who violated securities or commodities laws

• has been convicted of any securities or “money” related misdemeanor or felony within the last 10 years

• has been temporarily or permanently enjoined from engaging in the securities business

what is needed for FINRA to permit a disqualified person to request permission to enter or remain in the securities industry and what do they consider? who has to approve this?

an eligibility proceeding is needed and they consider

• nature and gravity of event that led to disqualification

• length of time since event occurred

• any mitigating circumstances

• the disciplinary history of the member firm and associated person

needs to be approved by FINRA and SEC. if denied by FINRA an appeal may be filed with the SEC

what is the SIPC?

Securities Investor Protection Corporation. an insurance program created to protect customers in the event of a BD insolvency. protects each customer of the firm for up to $500K of cash and securities (no more $250K cash)

when do customers get SIPC info?

when acct is opened, BD must advise new customers in writing that they may obtain info about SIPC including the brochure by contacting SIPC. must provide website address and phone number. all customers get same written info once a year

what is SIPC does not cover a BD?

must be disclosed on customers trade confirmations and customers must be told if asked

what is the taping rule?

if a member firm has too many individuals previously associated with firms that were expelled or had their membership revoked they must tape their phone conversations with current and potential customers. this is applied based on firm size, 20% for large firms and 40% for small firms. the rules state that the firm must

• establish procedures for reviewing tape recordings to ensure regulatory compliance

• implement procedures within 60 days within learning its subject to the rule

• submit a report to FINRA on the supervision of telemarketing activities within 30 days of the end of each calendar quarter

• retain all tape recordings for 3 years

when can you call someone on the federal do not call list?

if the individual has:

• made a financial transaction or has an account balance or account activity at that member firm during the prior 18 months

• inquired about the BDs services in the prior 3 months

• given express written (signed) consent to be solicited

• a personal relationship with the maker of the call

what makes an office an office of supervisory jurisdiction OSJ?

if any of these activities take place there

• order execution or market making

• structuring of public offerings or private placements

• maintaining custody of customer funds or securities

• final approve of new customer accts

• review and endorsement of customer orders

• final approval of retail communications before first use

• supervision of actives of associated persons at one or more of member firms branch offices

what is a General Securities Principal?

each OSJ must have at least one. series 24. they are

• responsible for supervision of registered representatives and other principals int hat office and any branch under its jurisdiction

• enforce written supervisory procedures

• periodically review customer accounts

• maintain customer records, including complaints

• periodically inspect its branch offices

what is a branch office

any location where one or more representatives solicit (but do not execute) the purchase or sale of any security. also any office that supervises actives or representatives at one or more non-branch locations is a branch office

• need at least one general representative or principal with supervisory authority and responsibility for that office and any non-branch office in its jurisdiction

• a limit principal (9/10) must be assigned supervisory authority for each type of BD business

• each registered person must be assigned a supervisor

to summarize, a supervisory system designates a person responsible for each office, each registered activity, and each registered employee of the firm

inspections

• conducted by registered principals

• annually inspect every OSJ and every branch office supervising a non-branch office

• other branch offices inspected every 3 years

• review customer acct records to detect irregularities or abuses, test and verify policies and procedures related to books and records requirements, and handling of customer funds

• each inspection includes written report which must be retained for 3 years

what is a non-branch location

• any office location established solely for customer service or back-office type functions, no sales activities and no more than 25 transactions per year are conducted

• locations used fewer than 30 business days per year for securities business

• office of convenience (coffee shop etc) where occasional meetings with customers are held on appt only basis

• floor of registered exchange

• employees private residence but only if

  • only resident employees who are immediate family members operate there

  • no customer meetings there

  • neither customer funds or securities handled there

  • assigned to branch office and subject to firms supervision

  • all orders made through designated branch office

  • all public communications must list supervising branch office not residence

when can an employees private residence be a non branch office?

• only resident employees who are immediate family members operate there

• no customer meetings there

• neither customer funds or securities handled there

• assigned to branch office and subject to firms supervision

• all orders made through designated branch office

• all public communications must list supervising branch office not residence

what do written supervisory procedures need?

• must record names, titles, registration status, responsibilities, and locations of all supervisory personnel

• document procedures for reviewing and endorsing all transactions as well as incoming and outgoing written and electronic correspondence

copy of relevant portions of WSP must be kept in each OSJ at each location where supervisory activities are conducted and retained for at least three years from date of last use

annual compliance meeting rules

• can be held in groups, individually, remotely, or as prerecorded webcast

• attendees must be able to ask questions and get timely answers

• firm must keep record documenting topics covered and who attended

who writes and tests supervisory controls?

• one or more principals develops, maintains, and implements

• this principal or compliance offer is also responsible for testing and verifying and amending or creating additional procedures as needed

supervisory controls report

the designated principal must annually submit a report to firms senior management

• detailing supervisory control system

• results of compliance testing

• significant violations or exceptions

• amended procedures.

any firm that reported $200 mil or more in gross revenue in prior calendar year must also include in the report

• tabulation of all reports made to FINRA of customer complaints and internal investigations

• review of proceedings year compliance efforts (including policies and procedures and educational programs related to trading, marketing, and investment banking activities, anti-fraud and sales practices, finance and operations, supervision, and anti money laundering)

FINRA requires CEO to certify each year that member firm has written and implemented a set of compliance policies and supervisory procedures that adhere to FINRA and SEC rules

when a firm has a branch office in a bank setting, what to they need to provide regarding any products purchased at the location

need to provide both verbally and in writing (and also on any communications issued from this location) that any products purchased at the location

• are not insured by the federal deposit insurance corporation FDIC

• not obligations nor guaranteed by bank

• subject to investment risks

what is the customer protection rule?

BDs must maintain full control over customer securities positions. every firm must have all fully paid customer securities and all excess margin securities unde its possession or control. must check that they are meeting this requriement daily

• fully paid: segregated and placed in safekeeping

• excess margin securities: value is more than 140% of a customers debit balance. firm must always have them in its physical possession or control

BDs are NOT allowed to obtain loans using fully paid or excess margin securities

when is a firm considered to have securities in their position or control?

• custody of firm or clearing corporation

• custody of a bank

• transfer (max 40 days)

• transit (max 5 days)

what is the required buy in rule?

• any fail to receive that is 30 days old or more must be bought in on next business day

• any fail to deliver for a customer acct must be brought in 10th business day after settlement. S+10

• any short securities differences (firm missing securities that are recorded on books) must be bought in after 45 days of discovery

fail to receive: customer at firm purchased security from another party but other party has not delivered security

fail to deliver: firms customer sells security but has yet to deliver it to purchaser

how is a customer complaint handled?

• a principal must acknowledge and respond to all customer complaints as part of firms supervisory procedures

• firms must report to FINRA within 30 days when they learn that the firm or associated person is subject to either of following

  • complaint involving allegation of theft, forgery, misappropriation of funds

  • claims for damages over $15K when filed against associated person or $25K filed against member firm

• firms must report statistical and summary info regarding all written customer complains by 15th day of month following calendar quarter in which complaint was received

• record keeping: kept in separate file, include any action taken by firm in response. separate file if related to options, index warrants, currency warrants, or currency index warrants. kept and maintained at OSJ for minimum 4 years

what does FINRA settle series customer grievances vs member firms or associated persons?

code of procedure

1. filing complaint w FINRA department of enforcement DOE

2. if DOE thinks complaint has merit, forwarded to FINRA office of hearing officers OHO where it is sent to member firm for response. has 25 calendar days to respond. if dont, second notice gives 14 more days.

3. once response is filed OHO determines if violation occurred and what penalties are imposed

4. may request hearing before FINRA hearing panel at mutually agreed upon location. after hearing written decision based on majority vote of 3 person panel usually within 60 days of hearing

5. if appealed, the order is National Adjudicatory Council (NAC) → SEC → Federal Court

6. if not appealed, NAC has 45 days to decide whether to review hearing panels decision (so earliest non-appealed hearing panel decision becomes effective is 45 days after issued)

7. once decision is final, FINRA determines penalty. if criminal, forwarded to SEC and handled by dept of justice DOJ (if suspended or expelled, no payment while penalty is in effect, sometimes modified tho if they still do others parts of job)

what kinds of arbitrators are there?

public: no association with industry, not employed in it within last 20 years

non-public: is or has been employed in securities industry within past 5 years

panel composition based on dispute type

• member firm vs member firm or clearing agency → 3 non-public

• member firm or associated person vs associated person → 1 non-public, 2 public

• member firm vs customer → 1 non-public, 2 public (upon customer request, can be 3 public instead)

smaller claims

• if $100K or less

  • member vs member → 1 non-public

  • involves customer or associated person → 1 public

• $50K or less → single arbitrator, decision solely based on written statements provided by each party unless either party requests in person hearing

arbitration awards

paid within 30 days of decision date, if not, FINRA gives 15 days notice to firm, if still not paid, may result in suspension or revocation of registration

minor complaint

if DOE considers minor, prepare and request respondent sign a minor rule violation MRV, accepting finding of violation, admits minor offense and subject to max $2500 fine (fines must be paid within 7 days of receiving written notice)

acceptance, waiver, and consent

applies to major or minor violation. respondent accepts findings, waives right to appeal, consents to any penalty, but does not admit guilt