Financial Advisor IQ (June 16, 2023) - There is “no substitute” for on-site examinations, according to Sander Ressler, a compliance consultant who works with broker-dealer and registered investment advisor firms.
Many industry firms are supportive of the Financial Industry Regulatory Authority’s proposal to extend remote inspections of branch offices, but others in the industry are raising alarm bells about the limitations of conducting examinations without an on-site visit.
In April, Finra resubmitted its proposal to the Securities and Exchange Commission for a three-year pilot program that allows remote inspections of branch offices. Finra has been allowing firms to remotely conduct inspections of offices and non-branch locations since November 2020 in a concession to the coronavirus pandemic. The industry self-regulator submitted a similar proposal in July 2022 and amended it in December 2022.
Critics of the proposal in its various forms, including state securities regulators and plaintiffs’ lawyers, have argued that extending remote inspections would allow advisors working remotely to more easily dodge the scrutiny of outside business activities and other conflicts by their employers and regulators.
However, firms including Cetera Financial, LPL Financial and Raymond James have written comments supporting Finra’s latest proposal, arguing, in part, that technology has helped bridge the gap.
“The pandemic forced the industry into a largely remote, alternative work environment. With the advances in technology over the past decades, that transition was largely seamless. Firms have long been able to conduct comprehensive supervision of associated persons electronically, allowing for real-time virtual oversight of associated persons, regardless of where they are physically located,” Dee O’Neill, senior vice president and head of branch exams at Raymond James, wrote in a letter dated May 23.
O’Neill pointed to the labor market as a key factor in the benefit of expanding remote inspections. She added that the sunsetting of temporary relief under Finra Rule 3110.17 will force firms to risk losing “key talent” by ordering employees back into offices or “greatly increase” the number of locations requiring on-site examinations.
“The difficult labor market will make it challenging for firms to return to full-time travel for onsite inspections and nearly impossible for firms to add enough staff to reasonably undertake a substantial jump in the volume of required inspections. The increased burden on existing staff puts firms at further risk of losing critical talent and being unable to meet regulatory inspection requirements,” she wrote in the letter.
Yet continuing to allow remote inspections could increase risk for investors, according to the Public Investors Advocate Bar Association. The proposal is “a fundamentally flawed idea and runs counter to Finra’s stated objective of investor protection,” Piaba President Hugh Berkson wrote in a letter dated May 24. Berkson is also a principal at Cleveland-based law firm McCarthy, Lebit, Crystal and Liffman.
“While it is understood that Finra is attempting to leverage the increased use of virtual technology, the rule proposal leaves considerable opportunity for advisors to skirt the rules,” Berkson wrote in the letter.
An in-person inspection “will uncover things a remote inspection simply won’t,” such as a person who is known to have a salary of $50,000 driving a Bentley, Berkson said in an interview with FA-IQ.
In-person exams are especially important for overseeing remote workers, according to Berkson.
“When folks are working remotely, it really makes it more important to supervise and make sure that they are abiding by the appropriate rules and regulations,” he said.
There is “no substitute” for on-site examinations, according to Sander Ressler, co-owner and managing director at Essential Edge Compliance Outsourcing Services, a Lamy, New Mexico–based provider of compliance services for broker-dealer and registered investment advisor firms.
“There’s no substitute for seeing what the rep is doing. You can’t get that remotely,” he said.
Ressler said that it’s just “a very small percentage of representatives that are doing something wrong” and that firms are weighing the potential financial impact of an employee’s wrongdoing with the cost of conducting in-person examinations.
Larger firms, for example, might prefer to run the risk of a lawsuit to the cost of inspecting numerous branches, according to Ressler.
“They’re the ones that have to go out and do 1,000 or 1,500 or 2,000 branch exams a year. At $1,000 an exam or $1,200 an exam for internal costs, which is about what they run, you’re talking about a two-million-dollar or three-million-dollar expense commitment. They want to save that money,” he said.
As an alternative to remote inspections, Finra could change the frequency of office supervisory jurisdiction inspections, according to Ressler. Noting that an OSJ has to be inspected annually while a non-OSJ office has to be inspected every three years, he suggests that firms could perform a risk assessment.
“For those OSJs that are high risk, do them every year; medium risk, every two years; low risk, every three years, and do the same thing for the non-OSJs: If it’s high risk, do it every year; if it’s medium risk, do it every three years; if it’s low risk, do it every five years,” he said.
“You lessen the amount of money that’s being spent, and you address the high-risk offices more frequently than the low-risk offices,” he added.
Finra’s membership included 3,381 firms with 150,495 registered branch offices as of the end of 2022, according to the self-regulator’s April proposal. Of those branch offices, just 12% are OSJs subject to an annual inspection while the remaining 131,931 branch locations are non-OSJ branch offices subject to inspection at least annually or every three years. There are also about 59,830 non-branch locations, of which 41,078 are private residences, Finra estimates. A non-branch location must be inspected on a periodic schedule, presumed to be at least every three years.