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News December 5, 2011 Issue

SEC and FINRA Issue Guidance for Monitoring Satellite Operations

Compliance isnít just for the mother ship; itís for the satellites, too.

The SEC issued a risk alert jointly with FINRA on November 30 that highlights the practices of effective branch inspection programs and similarly observes the deficiencies found in poor programs.

"A robust process for self-inspection of branch offices is a critical element of a firmís compliance and supervision process, and a vital part of a comprehensive risk management program," said OCIE director Carlo di Florio in the release accompanying the alert.

Although tailored for broker-dealers, the alert offers food for thought to advisers as well.

The alert observes that effective programs typically:

  • Tailor the focus of branch exams to the business conducted in that branch and assess the risks specific to that business;
  • Schedule the frequency and intensity of exams based on underlying risk, rather than on an arbitrary cycle, but examine branch offices at least annually;
  • Engage in a significant percentage of unannounced exams, selected through a combination of risk based analysis and random selection;
  • Deploy sufficiently senior branch office examiners who understand the business and have the gravitas to challenge assumptions; and
  • Design procedures to avoid conflicts of interest by examiners that may serve to undermine complete and effective inspection.

Conversely, deficient programs typically:

  • Utilize generic examination procedures for all branch offices, regardless of business mix and underlying risk;
  • Try to leverage novice or unseasoned branch office examiners who do not have significant depth of experience or understanding of the business to challenge assumptions;
  • Perform the inspection in a "check the box" fashion without questioning critically the integrity of underlying control environments and their effect on risk exposure;
  • Devote minimal time to each exam and little, if any, resources to reviewing the effectiveness of the branch office exam program;
  • Fail to follow the firmís own policies and procedures by not inspecting branch offices as required, announcing exams that were supposed to be unannounced, or failing to generate a written inspection report that included the testing and verification of the firmís policies and procedures, including supervisory policies and procedures;
  • Fail to have adequate policies and procedures, particularly in firms that use an independent contractor model and that allow registered personnel to also conduct business away from the firm; and
  • Lack heightened supervision of individuals with disciplinary histories or individuals previously associated with a firm with a disciplinary history.