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National Examination Risk Alert

By the Office of Compliance Inspections and Examinations

in cooperation with the Financial Industry Regulatory Authority 1

Information for Managers and Chief Compliance Officers

Volume I, Issue 2 November 30, 2011 

Broker-Dealer Branch Inspections

The branch inspection process is a critical component of a 

comprehensive risk management program and can help protect 

investors and the interests of the firm. OCIE and FINRA examination 

staff have observed that firms that execute this process well 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.

 1 The Securities and Exchange Commission (“SEC”), as a matter of policy, disclaims responsibility for any 

private publication or statement by any of its employees. The views expressed herein are those of the staff 

of the Office of Compliance Inspections and Examinations (“OCIE”) in coordination with other SEC staff, 

including in the Division of Trading and Markets, and do not necessarily reflect the views of the 

Commission or the other staff members of the SEC. This document was prepared by OCIE staff in 

consultation with the staff of the Financial Industry Regulatory Authority (“FINRA”) and is not legal 

advice.

In this Alert: 

Topic: Broker-dealer 

branch inspections

Objectives: Encourage 

firms to create effective 

policies and procedures for 

their branch inspections.

Key Takeaways: 

A broker-dealer’s branch 

inspection program is a key 

part of its supervisory 

system.

Exam staff have found a 

number of deficiencies in 

branch inspections 

conducted by firms.

This Risk Alert presents a 

joint report by OCIE staff 

and FINRA staff, 

highlighting a number of 

practices that examiners 

have observed that are 

found in effective branch 

office supervisory systems.
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Conversely, firms with significant deficiencies in the integrity of their overall branch inspection 

process, 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 firm’s 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 firm’s 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.

A well-designed branch inspection program is both: (1) a necessary element (but not the only 

element) of a firm’s compliance and reasonable supervision of its branch offices and branch 

office personnel under Section 15(b)(4)(E) of the Securities Exchange Act as well as FINRA

rules; and (2) an integral component of the firm’s risk management program. The branch 

inspection provides the firm with the opportunity to validate its surveillance results from branch 

offices and to gather on-site intelligence that supplements the ongoing management and 

surveillance of the branch from a business and risk management standpoint.

Risk-Based Inspections

An effective risk assessment process will help drive the frequency, intensity and focus of branch 

office inspections; it should also serve as an important consideration in the decision to conduct 

the exam on an announced or unannounced basis. Therefore, branch offices should be 

continuously monitored with respect to changes in the overall business, products, people and 

practices. Branch inspections should be conducted by persons that have sufficient knowledge

and experience to evaluate the activities of the branch, and should be overseen by senior 

personnel such as the CCO or other knowledgeable principal. Further, procedures should be 

designed to avoid conflicts of interest that may serve to undermine complete and effective 

inspections because of the economic, commercial or financial interests that an examiner holds in 

the associated person or branch being inspected. 

Branch office inspections provide an opportunity for oversight that should enhance the firm’s 

routine surveillance and supervisory activities. For instance, branch office inspections may allow 

a firm to better identify the nature and extent of outside business activities of registered branch 

office personnel. Outside business activities conducted by registered persons may carry added 

risk because these activities may be perceived by customers as part of the member’s business. 
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Confirming that the scope of outside business activities of registered branch office personnel

conform to those activities authorized by the firm is an important component of the branch office 

inspection, and addresses a risk that may be more difficult to monitor. For much the same 

reasons, unannounced inspections (which do not provide an opportunity to hide, alter or destroy 

documentation or other information reflecting such activities) are a critical element of any well 

designed branch office inspection program and should constitute a significant percentage of all 

exams conducted.

This ongoing risk analysis should be a key element of the firm’s exam planning process and lead 

to more frequent examinations of offices posing higher levels of risk than dictated by the firm’s 

non-risk based cycle, and lead firms to engage in more unannounced exams of such offices. 

Some areas of high risk to consider are: sales of structured products; sales of complex products, 

including variable annuities; sales of private or otherwise unregistered offerings of any type; or 

offices that associate with individuals with a disciplinary history or that previously worked at a 

firm with a disciplinary history. NASD IM-3010-1 also lists additional factors to consider in 

making this determination.

Pursuant to NASD Rule 3010(c)(2), each branch office inspection must include a written report 

that includes, at a minimum, testing and verification of the firm’s policies and procedures in 

specified areas. As discussed further below, it is a good practice for this report to note any 

deficiencies and areas of improvement, as well as outline agreed-upon actions, including 

timelines, to correct the identified deficiencies.

Oversight of Branch Office Inspections

A broker-dealer’s internal branch inspection program is a necessary part of its supervisory 

system and a strong indicator of a firm’s culture of compliance. To test the quality of brokerdealers’ required inspections of branch offices, SEC and FINRA examiners may seek to review 

and verify items related to an effective branch examination program, particularly matters such as 

supervisory procedures regarding customer accounts and sales of retail products. For example, 

examiners may review the following:

• policies and procedures, including supervisory procedures as they pertain to the 

supervision of customer accounts, including those serviced by income producing

managers;

• policies and procedures relating to the handling of money and securities physically 

received at the branch;

• validation of changes in customer addresses and other account information in accounts 

serviced by the branch;

• procedures related to transmittals of funds between customers and third parties, and 

between customers and registered representatives (“RRs”); 

• firm testing of policies and procedures related to specific retail products, including:

o sales of structured products;

o private and other unregistered offerings;

o municipal securities;

o mutual funds; and

o variable annuity sales and exchanges;
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• firm testing in retail sales practice areas, including: 

o verification of customer account information;

o supervision of customer accounts;

o written supervisory procedures (“WSPs”);

o new account review, suitability of investments;

o unauthorized trading;

o churning;

o allocations of new issues;

o licensing; and

o training;

• advertising and other communications with the public or with customers (such as email 

and other written correspondence) and compliance with approval procedures; 

• evidence of unreported outside or other unauthorized business activities by review of: 

customer files, written materials on the premises and at any satellite locations, branch 

office accounting records, appointment books and calendars, phone records, bank 

records;

• procedures for handling of customer complaints;

• risk-based reviews of bank accounts of the branch and affiliated entities, third-party wire 

transfers, and branch signature guarantee log; and

• procedures to uncover use of unauthorized computers or other electronic devices and/or 

social media.

Requirements and Guidance Pertaining to Broker-Dealer Branch Inspections

The responsibility of broker-dealers to supervise their associated persons is a critical component 

of the federal regulatory scheme. Sections 15(b)(4)(E) and 15(b)(6)(A) of the Exchange Act 

authorize the Commission to impose sanctions on a firm or any person that fails to reasonably 

supervise someone that is subject to the supervision of such firm or person who violates the 

federal securities laws. In order to defend such a charge, a broker-dealer could show that it has 

established procedures that would reasonably be expected to prevent and detect a violation by 

such other person, and has a system for applying such procedures that has been effectively 

implemented. Such a system must be designed in such a way that it could reasonably be expected 

to prevent and detect, insofar as practicable, securities law violations. 

The staff of the SEC’s Division of Trading and Markets (formerly known as the Division of 

Market Regulation) has noted that an effective branch office inspection program is a vital 

component of a supervisory system reasonably designed to oversee activities at remote branch 

offices.2 A number of Commission decisions in the area, both settled and litigated, set forth 

principles that can guide firms in constructing an effective branch office inspection program.

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 2 Staff Legal Bulletin No. 17, Remote Office Supervision (March 19, 2004) (“SLB 17”). 3 See, e.g., Consolidated Investment Services, Inc., Rel. No. 34-36687(Jan. 5, 1996) (where the Commission 

notes that: “We also agree with the law judge that surprise inspections of [the branch office] would have 

been a prudent course of action”); Signal Securities, Inc.,, Rel. No. 34-43350 (Sep. 26, 2000) (citing 

Consolidated Investment Services); and Quest Capital Strategies, Rel. No. 34-44935 (Oct. 15, 2001) 

()(where the Commission stated that : “A surprise inspection is a compliance tool that is necessarily 

available to every securities firm in carrying out its supervisory responsibilities.”); Royal Alliance 

Associates, Inc., Rel. No. 34-38174 (Jan. 15, 1997) (settled matter); see also SLB 17.
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Those cases suggest that regular branch office inspections over reasonably short intervals, 

including unannounced inspections, are the cornerstone of a well designed branch office 

inspection program.4

 The Commission has sanctioned firms that have not conducted 

unannounced examinations of their branch offices. 5 Where a firm only conducts pre-announced 

examinations, that could create opportunities for branch office personnel to alter or destroy,

documents, or commit other securities law violations, resulting in major fines for the firm.6

Beyond the timing and nature of the inspections, OCIE and FINRA staff also believe that past 

guidance suggests that a well-constructed branch office supervisory program should include:

procedures for heightened supervision of remote branch offices that have associated persons with 

disciplinary histories; independent verification of the nature and extent of outside business 

activities; senior management’s involvement in assuring that adequate procedures are in place 

and that sufficient resources are devoted to implementing those procedures; periodic 

reassessment of supervisory responsibilities; adequate delineation of supervisory responsibilities;

periodic reassessment of supervisory responsibilities; thorough investigation and documentation 

of customer complaints; and a system of follow up and review of those and other red flags.

As a 

result, OCIE and FINRA staff believe that a well-constructed branch office inspection program 

should include unannounced inspections, based on a combination of random selection, risk-based 

selection and for cause exams.

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FINRA rules and rule interpretations provide additional requirements and guidance in the area. 

NASD Rule 3010(b) requires every member broker-dealer to establish, maintain and enforce 

written procedures to supervise the types of business in which it engages and to supervise the 

activities of RRs, registered principals, and other associated persons that are reasonably designed 

to achieve compliance with applicable securities laws and regulations, and with the applicable 

FINRA rules. 

 

Notice to Members 99-45 instructs broker-dealers to adopt and implement a supervisory system 

that is “tailored specifically to the member’s business and must address the activities of all its 

registered representatives and associated persons.”8 Procedures that merely recite the applicable 

rules or fail to describe the steps the firm will take to determine compliance with applicable 

securities laws and regulations are not reasonable.

9 A broker-dealer’s procedures should instruct 

the supervisor on the requirements needed to be in compliance with the regulations.

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 4 See, e.g., Consolidated Investment Services, Inc., Rel. No. 34-36687(Jan.5, 1996); Signal Securities, Inc.,

Rel. No. 34-43350 (Sep. 26, 2000); Quest Capital Strategies, Rel. No. 34-44935 (Oct. 15, 2001).

The 

5 See, e.g., Quest Capital Strategies, Inc., Rel. No. 34-44935 (Oct. 15, 2001) and NYLIFE Securities Inc.,

Rel. No. 34-40459 (September 23, 1998) (settled matter). 6 See, e.g., Fidelity Brokerage Services, LLC, Rel. No. 34-50138 (Aug. 3, 2004) (pre-announced inspections

resulted in, among other things, employees altering and destroying documents; sanctions included a 

$1,000,000 fine payable to the SEC, plus a $1,000,000 fine payable to the NYSE) (settled matter). 7 See, e.g., Prospera Financial Services, Admin. Pro. File No. 3-10306, Rel. No. 34-43352 (September 26, 

2000) (settled matter) for a discussion of the above elements of a branch office supervisory program; see 

also SLB 17 for further discussion of these and other elements of an effective branch office supervisory 

system. See also NASD IM-3010-1 (Standards for Reasonable Review). 8 NASD Notice to Members 99-45 (June 1999) at 294. 9 Id. at 295. See also NASD Notice to Members 98-96 (Dec. 1998). 10 NASD Notice to Members 99-45 (June 1999) at 293-94 (giving examples of situations in which “written 

supervisory procedures would instruct the supervisor” in how to document compliance).
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procedures should describe the activities the supervisor will conduct along with the frequency as 

to when the reviews will be conducted.

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NASD Rule 3010(c)(1) requires each member to conduct a review, at least annually, of the 

businesses in which it engages. A broker-dealer must conduct on-site inspections of each of its 

office locations; Office of Supervisory Jurisdictions (“OSJs”)12 and non-OSJ branches that 

supervise non-branch locations at least annually, all non-supervising branch offices at least every 

three years; and non-branch offices periodically. For these other branch offices, firms should 

consider whether a cycle of less than three years would be more appropriate, using factors such 

as the nature and complexity of the branch’s securities business, the volume of business done, 

and the number of associated persons assigned to each branch.13 Pursuant to NASD Rule 

3010(c)(1), broker-dealers must document the examination schedules for each non-supervisory 

branch and non-branch office in their WSPs, including a description of the factors used to 

determine the examination cycle for such locations. The rule also requires broker-dealers to 

record the dates each inspection was conducted.14

Pursuant to NASD Rule 3010(c)(2) the reports reflecting these reviews and inspections must be 

kept on file by the broker-dealer for a minimum of three years. NASD Rule 3010(c)(3) generally 

prohibits a branch office manager or any other person within the office with supervisory duties 

(or any person supervised by such person) from conducting an inspection of the office.15

 11 Id. 12 An OSJ is defined under NASD Rule 3010(g) as any office of a member at which any one or more of the 

following functions take place: (a) order execution and/or market making; (b) structuring of public 

offerings or private placements; (c) maintaining custody of customers' funds and/or securities; (d) final 

acceptance (approval) of new accounts; (e) review and endorsement of customer orders; (f) final approval 

of advertising or sales literature, except for an office that solely conducts final approval of research reports; 

or, (g) responsibility for supervising the activities of associated persons at one or more other branch offices. 13 NASD Rule 3010(c)(1)(B). 14 NASD Rule 3010(c), which governs “Internal Inspections,” requires that each broker-dealer review the 

activities of each of its offices including the periodic examination of customer accounts to detect and 

prevent irregularities or abuses. The rule also requires that the written inspection report include, without 

limitation, the testing and verification of the member's policies and procedures, including supervisory 

policies and procedures in the following areas: 

• Safeguarding of customer funds and securities; 

• Maintaining books and records; 

• Supervision of customer accounts serviced by branch office managers; 

• Transmittal of funds between customers and RRs and between customers and third parties; 

• Validation of customer address changes; and 

• Validation of changes in customer account information. 

15 However, the rule provides an exception from this requirement for a firm so limited in size and resources 

that it cannot otherwise comply. Under NASD Rule 3010(c)(3) the basis for this exception must be 

documented in the report for each inspection conducted in reliance on the exception.
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Review of Effective Practices

As noted throughout this Risk Alert, SEC and FINRA examiners have identified some practices 

that are characteristic of many effective supervisory procedures and effective branch office 

supervisory systems.

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• Using risk analysis to identify whether individual non-supervising branches should be 

inspected more frequently than the FINRA-required minimum three-year cycle. Branches 

that meet certain risk criteria based on risk ratings are inspected more often. In addition, 

some firms conduct “re-audits” more frequently than required when routine inspections 

reveal a higher than normal number of deficiencies, repeat deficiencies or serious 

deficiencies. Typically, these re-audits and audits for cause are unannounced inspections.

Such practices are consolidated here: 

• Using surveillance reports, employing current technology and techniques as appropriate,

to help identify risk and develop a customized approach for the firm’s compliance 

program and branch office inspections that considers the type of business conducted at 

each branch.

• Employing comprehensive checklists that incorporate previous inspection findings and 

trends from internal reports such as audit reports.

• Conducting unannounced branch inspections. Firms elected to conduct unannounced 

examinations either randomly or based on certain risk factors. These “surprise” exams 

may yield a more realistic picture of a broker-dealer’s supervisory system, as it reduces 

the risk that individual RRs and principals might attempt to falsify, conceal or destroy 

records in anticipation for an internal inspection.

• Including in the written report of each branch inspection any noted deficiencies and areas 

of improvement. The report should also outline agreed upon actions, including timelines, 

to correct the identified deficiencies. 

• Using examiners with sufficient experience to understand the business being conducted at 

the particular branch being examined and the gravitas to challenge assumptions.

• Designing procedures to avoid conflicts of interest by examiners that may serve to 

undermine complete and effective inspection.

• Involving qualified senior personnel in several branch office examinations per year. 

• Incorporating findings on results of branch office inspections into appropriate 

management information or risk management systems; and using a compliance database 

that enables compliance personnel in various offices to have centralized access to 

comprehensive information about all of the firm’s RRs and their business activities. Such 

a system appears to be highly useful to the compliance personnel at the OSJ and 

elsewhere for quickly accessing information and for supervising independent contractor 

RRs dispersed across a broad geographic area.

• Providing branch office managers with the firm’s internal inspection findings and 

requiring them to take and document corrective action. 

 16 Firms are encouraged to consider the practices described herein in assessing their own procedures and 

implementing improvements that will best protect their clients. Firms are cautioned that these factors and 

suggestions are not exhaustive, and they constitute neither a safe harbor nor a “checklist” for SEC staff 

examiners. Other practices besides those highlighted here may be appropriate as alternatives or 

supplements to these practices. While some of the effective practices above are existing regulatory 

requirements, the adequacy of a supervisory program can be determined only with reference to the profile 

of the specific firm and the specific facts and circumstances.
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• Tracking corrective action taken by each branch office manager in response to branch 

audit findings.

• Elevating the frequency and/or scope of branch inspections where registered personnel 

are allowed to conduct business activities other than as associated persons of a brokerdealer, for example away from the firm.

Conclusion

This alert reminds broker-dealers that their branch office inspections must be conducted with 

vigilance. It describes certain supervisory tools that, based on OCIE and FINRA staff 

examinations and Commission enforcement cases, are characteristic of good supervisory 

procedures for branch office inspections, including the use of unannounced onsite inspections. 

While this alert summarizes recognized precedent and standards, and provides OCIE and FINRA 

staff views with regard to means to enhance branch inspections, it does not provide an exhaustive 

list of steps to effectively discharge responsibilities. A well-designed branch office inspection 

program is a necessary element – but not the only element – of reasonable supervision of a firm’s 

branch offices and branch office personnel.

We recognize that each firm is different and that firms need flexibility to adopt procedures to suit 

their individual structures and business needs. Our suggestions as to compliance methods are not 

meant to be exclusive or exhaustive and do not constitute a safe harbor. Rather, this report may 

assist firms in crafting more effective policies and procedures for branch office inspections to 

prevent and detect misconduct. We urge firms to review their policies and procedures in this 

regard to determine if they are reasonably designed to prevent and detect violations of applicable 

law and rules.