AdvisorHub (May 26, 2023) - A group of plaintiff lawyers are standing their ground against the Financial Industry Regulatory Authority’s proposal to launch a three-year “pilot” allowing most firms to conduct branch office inspections remotely without onsite visits.
The investor advocates have objected to the regulator’s third attempt filed in late April to tweak the rule and extract a requisite blessing from the Securities and Exchange Commission.
“Finra appears to believe that the third time is [the] charm as it proposes the misguided rule yet again,” Hugh Berkson, the president of Public Investors Advocate Bar Association, wrote in a comment letter filed Wednesday with the SEC.
But the proposal, along with Finra’s companion plan to reduce the inspection frequency of home offices, remains a “fundamentally flawed idea” despite the most recent amendments, Berkson said. Under Finra’s companion proposal to its pilot, some home offices would be defined as residential supervisory locations, rather than branches, and therefore subjected to inspections only every three years instead of annually.
“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. “The amendments made to this rule proposal do not address the significant harm done to investors by rogue brokers working without someone adequately supervising them.”
Finra submitted its initial version of the proposal in August 2022, submitted a second in late December and a third in April.
That most recent draft makes marginal changes. For example, it would require participating firms to provide more data to Finra, including the number of locations examined in 2019. The change was made in response to criticism from state securities regulators, according to the filing.
Finra also narrowed the criteria for which branches would be disqualified from remote inspections if they engaged in proprietary trading after a commenter had noted the prior proposal’s language was overly broad, according to the filing.
“Finra believes that the remote inspections pilot program’s proposed controls and safeguards achieve a responsible balance preserving the investor protection objectives of the rule,” the industry self-regulator wrote in the filing.
State securities regulators have yet to weigh in on the latest proposal, which the SEC has until late July to approve or deny.
Meanwhile, Finra’s end-of-year deadline for its temporary pandemic-era reprieve allowing for remote inspections is set to expire at the end of the year, and executives at the regulator said it is too early to tell whether it will extend those measures.
Firms are feeling the pressure as industry compliance officials have broadly endorsed the rule proposals. Raymond James Financial’s Private Client Group General Counsel David Spark said earlier this month that having to return to in-person exams would be “devastating” as they have expanded their supervisory team with remote roles since the pandemic.
“The past two years have shown that firms can successfully perform offsite inspections, which has been recognized by FINRA and have remained unchallenged by other regulators,” Dee O’Neill, head of branch examinations at Raymond James’ employee and independent brokers, wrote in a May 23 comment letter. “We believe our comments are in line with industry peers and we hope that the SEC will support the Proposal.”
Detractors of the proposals have wrongly conflated the concepts of inspection and supervision, Kosha Dalal, a Finra vice president and associate general counsel, told an audience at the regulator’s annual conference in Washington D.C. last week. Inspection is just “one component” over the overall supervisory system, she said.
Supervision involves a much broader scope, including record keeping, printing, data analysis.
“It’s really helpful to understand that the proposal around remote inspections is about remote inspections, not remote supervision,” she said.
While PIABA may have been a predictable opponent of the rule, even some pro-industry representatives are still nitpicking.
The American Securities Association submitted comments about Finra’s RSL proposal largely siding with its implementation and calling out its critics. “Too often, certain voices with no practical knowledge of how our businesses work send in hyperbolic letters about the alleged weakening of investor protection without citing any evidence that such protections have been eroded,” ASA President & CEO Chris Iacovella said.
But Iacovella also had a quibble with the RSL proposal, noting that it “does not consider differences between a true home office and someone who has been provided permission to work from home a few days a week from their secure laptop.”
“Unless inspections of home offices are limited to instances where there is cause, the number of homes that need to be audited will significantly increase resulting in a time-consuming and costly process for firms with little benefit to markets and investors,” he wrote.