AdvisorHub (December 19, 2022) - The Financial Industry Regulatory Authority, in an attempt to address criticisms from state regulators and investor advocates, among others, has amended its proposal to allow brokerages to complete their internal inspection obligations remotely beyond year-end 2023.

The industry’s self regulatory organization filed late last week tweaks to its proposal for extending those remote inspections on a three-year “pilot” basis.

Finra’s tweaks would call for brokerages to consider more risk factors when determining if locations are eligible for remote inspections. Finra specifically wants firms to evaluate a location based on its trade volume, the complexity of the products it sells, the vulnerabilities of its clients, and the risk-levels of its brokers, including if any are under heightened supervision.

If one of the location’s brokers, for instance, is under mandatory heightened supervision, under Finra’s amended proposal, it would no longer be eligible for remote inspection. 

The amendment also would require brokerages to “make more frequent use of unannounced, on-site inspections” for locations where “red flags” exist, according to a December 15 letter to the Securities and Exchange Commission signed by Kosha Dalal, a Finra vice president and associate general counsel.

Finra also proposed expanding the reasons that firms, not just their specific locations, should be excluded from eligibility. The tweaks specifically propose barring from remote-inspection eligibility brokerages that have only registered with Finra in the past 12 months, as well as ones that the regulators previously designated as required to follow more stringent compliance measures than the rest of the industry. 

Barred, for instance, are so-called “taping firms,” which, based on their prior violations, Finra has ruled must tape record all telephone conversations between brokers and customers. Also barred are “restricted” firms, which because of past violations, Finra has required to establish segregated accounts with funds earmarked to pay customers’ pending arbitration claims or unpaid arbitration awards.

Finra also added a clause to its proposed remote inspection rules that would allow it to determine “in the public interest and for the protection of investors” that a brokerage couldn’t conduct remote inspections of locations.

In the meantime, while it awaits SEC approval of its proposal to extend, Finra had in place a temporary, pandemic-based rule allowing, at least until December 31, 2023, brokerages to conduct remote inspections. 

But Finra is seeking approval from the SEC for a three-year “pilot” to extend the remote inspections. The SEC has posted the amended proposal and is seeking comments for the next three weeks.

Finra initially in July had sought SEC approval for the “pilot” program but it was delayed amid pushback from National American Securities Administrators Association, representing state regulators, the Public Investors Advocate Bar Association, and others.

Hugh Berkson, the president of PIABA, was not moved by Finra’s most recent fixes to change his objections to its proposal for remote inspections. “It does not appear that these responses make a material difference and it doesn’t fix an otherwise flawed concept,” Berkson, who is also a lawyer with McCarthy, Lebit, Crystal & Liffman in Cleveland, said. 

Finra is mischaracterizing its proposal for remote inspections as a “pilot” program, Andrew Hartnett, the president of NASAA, told AdvisorHub in a recent interview but prior to the most recent filing of the amended proposal. Under the initial proposal, the number of participants eligible to participate were too broad a swath of the industry for it to be regarded as a “pilot” or trial run, Hartnett said.