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Say, What?!? Brokerage Firms Pushing Regulators to End On-Site Inspections

If brokerage firms have their way, temporary measures adopted in response to COVID may become permanent, putting customers at risk.

Routine onsite inspections of brokerage firm branch offices have been part-and-parcel of securities industry rules and best practices for decades. Such inspections play a critical role in combatting broker fraud, particularly in remote branch offices that lack day-to-day oversight and where Ponzi schemes and other unauthorized securities sales may flourish.

But while regulators relaxed certain on-site inspection requirements during the past year because of COVID-19, brokerage firms are now pushing to make these changes permanent. If adopted, these changes will make it easier for bad brokers to hide their misconduct from supervisors, putting customers’ life savings at substantial risk.

In response to the pandemic, and in specific recognition of health and safety concerns as well as state and local orders that limited the ability to conduct in-person meetings, FINRA adopted temporary relief to brokerage firms allowing them to complete their calendar year 2020-21 office inspection obligations without conducting on-site visits to branch offices.

In December 2020, FINRA issued Regulatory Notice 20-42 seeking comments from stakeholders, including brokerage firms and customers, regarding lessons learned during the pandemic. In response, many brokerage firms have urged FINRA to end on-site inspections altogether.

Firms contend that improved technology allows remote inspections to be just as effective as on-site inspections. In addition, firms claim that costs associated with conducting on-site inspections are too onerous and that compliance resources can be better shifted toward virtual inspections and exams.

The investing public should be alarmed at the prospect of on-site inspections being scrapped. This is particularly so with regard to remote branch offices where a single broker may work alone, far away from the watchful eye of a branch manager or compliance personnel. The SEC has long recognized these sort of remote office arrangements as a “recipe for trouble.” In re Royal Alliance Associates, Exchange Act Rel. No. 38,174 (Jan. 15, 1997).

In our law firm’s experience, brokers working in remote offices are much more likely to engage in serious misconduct involving the sale of unlicensed securities and Ponzi scheme “investments.” Frequent, unannounced audits of these remote offices have proven to be the most effective way to detect and prevent unlawful activity. Moving to a system of strictly virtual oversight would create a tremendous gap in firms’ compliance programs, allowing bad brokers to conceal misconduct in physical files and offline systems that are not connected to a firm’s authorized network, and thus never reviewed as part of any supervisory process.

FINRA must ignore the securities industry’s pleas for loosening on-site inspection requirements. Experience has shown a robust system of routine, unannounced audits plays a crucial role in ensuring compliance with industry rules and protecting customers from serious misconduct.

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