By Bernard Canepa, Managing Director and Associate General Counsel at SIFMA
During the COVID-19 pandemic, broker-dealers successfully demonstrated their ability to maintain regulatory compliance remotely in many ways. Data from a new survey – conducted by SIFMA and Protiviti on behalf of the securities industry – offers qualitative and quantitative data related to their branch inspection activities during the pandemic, along with prior data to demonstrate that they met their inspection obligations seamlessly.
This new survey data from firms representing a large swath of the industry reveals:
- Firms of all sizes conducted their inspections remotely with technology that was easily and affordably available;
- Survey participants identified and rectified inspection findings as appropriate; and
- There was no reported increase in significant findings from branch inspections during the pandemic.
Why does this matter?
Recently, the Financial Industry Regulatory Authority (FINRA) proposed a three-year pilot program to assess a potential change to FINRA Rule 3110 that would permanently allow firms to conduct remote inspections of eligible branch locations on a risk basis. As the leading voice of America’s securities industry, SIFMA supports a pilot that provides stakeholders with information to assess the viability of remote inspections on a permanent basis.
In the early days of the pandemic, FINRA and the U.S. Securities and Exchange Commission (SEC) – along with several states – suspended on-site branch inspections for broker-dealers as the world transitioned to a work-from-home environment, allowing firms to utilize technology to fulfill their inspection obligations remotely. For nearly three years now, broker-dealers have successfully conducted remote inspections in an effective manner.
There are many reasons to support remote inspections, including but not limited to:
- They are an effective means of inspection for lower-risk locations in an industry that has evolved dramatically since Rule 3110 was implemented;
- They allow firms to focus limited resources on higher-risk locations;
- The technological tools to conduct remote inspections are widely available and cost-effective for firms of all sizes and resources; and
- Firms can recruit and retain qualified inspection and supervisory staff only if they offer workplace flexibility.
Over the past few decades, the industry has evolved from brick, mortar, and paper to online and electronic. Branches are now less relevant for managing risks. More brokers and financial advisors than ever work in a hybrid or remote capacity, and in-person client interactions at branches are no longer the norm. This dynamic has created a divergence between the original purpose of the rule, which was to identify risks at physical locations, and what its current purpose should be, to identify where the salient risks now lie.
The supervisory and compliance concerns now rest in the ability to monitor a broker’s electronic activity instead of paper-based activities. Electronic communications, money movement, trading, and signatures are all now industry standards, and all can be administered and monitored remotely, leaving little to inspect physically. Participating firms expressed that the pre-inspection work they perform prior to an on-site examination captures 85 to 90 percent of the inspection process and material findings, leaving the on-site visit to be a relationship-building activity, which firms still value outside of the inspection process. The types of risks that are mitigated by today’s on-site inspections, such as signage, are not critical risks in the current environment. This means that on-site visits to locations that pose little risk are a perfunctory exercise to comply with an outdated rule and draw resources away from inspections of higher-risk locations.
As we found out through the pandemic and the continuing tight labor market, the human resources to conduct on-site inspections can be unavailable or scarce, particularly as the number of locations to be inspected exponentially expands with more people working from their homes. Being able to conduct remote inspections has a direct impact on firms’ ability to recruit and retain qualified inspectors and other compliance and supervisory staff. Outdated rules that require people to be onsite, even though their job functions can be performed remotely, prevent firms from hiring qualified, diverse staff who want to balance their work and personal life or live in a more affordable community. Without the ability to provide flexibility, firms are concerned that they may lose the very staff essential to a well-functioning supervisory program, particularly to other industries where remote work is the norm. If we want to make our industry as diverse, equitable, and inclusive as possible, regulators need to modernize outdated rules that impact this goal.
One way to do this is to allow firms to take a risk-based approach to their branch inspections. Based on their size, distribution of branches, business model, remote inspection capability, and the inherent risk of a branch or advisor, they will make a risk-based decision to conduct an inspection on-site or remotely. To get there, we understand that regulators need to make an informed decision with additional data, which the FINRA pilot program is designed exactly to do.
