Document ID: SEC-2022-1644-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2022-12-22T05:00Z

[Federal Register Volume 87, Number 245 (Thursday, December 22, 2022)]
[Notices]
[Pages 78737-78740]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-27787]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-96520; File No. SR-FINRA-2022-021]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Partial Amendment No. 1 to Proposed Rule 
Change To Adopt Supplementary Material .18 (Remote Inspections Pilot 
Program) Under FINRA Rule 3110 (Supervision)

December 16, 2022.

I. Introduction

    On July 28, 2022, the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change (SR-FINRA-2022-021) to amend 
FINRA Rule 3110 (Supervision) to adopt a voluntary, three-year remote 
inspection pilot program to allow member firms to elect to fulfill 
their obligation under Rule 3110(c) (Internal Inspections) by 
conducting inspections of some or all branch offices and locations 
remotely without an on-site visit to such office or location, subject 
to specified terms.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for public comment in the 
Federal Register on August 15, 2022.\3\ On September 23, 2022, FINRA 
consented to an extension of the time period in which the Commission 
must approve the proposed rule change, disapprove the proposed rule 
change, or institute proceedings to determine whether to approve or 
disapprove the proposed rule change to November 11, 2022.\4\ On 
November 9, 2022, FINRA filed a letter stating that it was considering 
comments received in response to the Notice, and anticipated submitting 
a response and amendments to the proposed rule change in the near 
future.\5\ On November 10, 2022, the Commission filed an order 
instituting proceedings to determine whether to approve or disapprove 
the proposed rule change.\6\ The Commission received several comments 
on the proposed rule change.\7\
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    \3\ Exchange Act Release No. 95452 (August 9, 2022), 87 FR 50144 
(August 15, 2022) (File No. SR-FINRA-2022-021) (``Notice'').
    \4\ See letter from Sarah Kwak, Associate General Counsel, 
Office of General Counsel, FINRA, to Daniel Fisher, Branch Chief, 
Division of Trading and Markets, Commission, dated September 23, 
2022.
    \5\ See letter from Sarah Kwak, Associate General Counsel, 
Office of General Counsel, FINRA, to Vanessa Countryman, Secretary, 
SEC, dated November 9, 2022.
    \6\ See Exchange Act Release No. 96297 (November 10, 2022), 87 
FR 68774 (November 16, 2022) (File No. SR-FINRA-2022-021) (``OIP'').
    \7\ Comments received on the Notice and OIP are available on the 
Commission's website at https://www.sec.gov/comments/sr-finra-2022-021/srfinra2022021.htm.
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    On December 15, 2022, FINRA responded to the comment letters 
received on the Notice and OIP \8\ and filed a partial amendment to the 
proposed rule change in response to certain comments on the proposed 
rule change (``Partial Amendment No. 1''). Partial Amendment No. 1 is 
described in Item II below, which has been substantially prepared by 
FINRA.\9\ The Commission is publishing this notice to solicit comments 
on Partial Amendment No. 1 from interested persons.\10\
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    \8\ See letter from Kosha Dalal, Vice President and Associate 
General Counsel, Office of General Counsel, FINRA, to Vanessa 
Countryman, Secretary, Commission, dated December 15, 2022, 
available at https://www.sec.gov/comments/sr-finra-2022-021/srfinra2022021-20152889-320539.pdf.
    \9\ The Commission has reformatted FINRA's presentation of its 
proposed modifications to, and descriptions of, the proposed rule 
change.
    \10\ Partial Amendment No. 1 is also available on FINRA's 
website at https://www.finra.org/sites/default/files/2022-12/sr-finra-2022-021-amendment-no-1-proposed-rule-change.pdf.
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II. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Partial Amendment

    FINRA is proposing the following amendments to the filing:

1. FINRA Proposes To Amend Proposed Rule 3110.18(b) by Adding Subpart 
(2)

    In light of concerns raised by commenters that a firm might not 
appropriately consider certain higher risk criteria in conducting its 
risk assessment, FINRA is proposing to add new paragraph (b)(2) to 
proposed Rule 3110.18 that would provide a non-exhaustive list of 
factors that a firm must consider and document. In addition, proposed 
new paragraph (b)(2) would further provide that consistent with Rule 
3110.12, members should conduct on-site inspections or make more 
frequent use of unannounced, on-site inspections for high-risk 
locations or where there are ``red flags.'' Following are the changes 
proposed in this Partial Amendment No. 1, with the proposed changes in 
the original filing shown as if adopted. Proposed new language in this 
Partial Amendment No. 1 is italicized; proposed deletions in this 
Partial Amendment No. 1 are in brackets:

[[Page 78738]]

    (2) In conducting the risk assessment of each office or location 
in accordance with Rule 3110.18(b)(1), a member shall consider, 
among other things, the following in making their risk-based 
evaluation of each office or location: (A) the volume and nature of 
customer complaints; (B) the volume and nature of outside business 
activities, particularly investment-related; (C) the volume and 
complexity of products offered; (D) the nature of the customer base, 
including vulnerable adult investors; (E) whether associated persons 
are subject to heightened supervision; (F) failures by associated 
persons to comply with the member's written supervisory procedures; 
and (G) any recordkeeping violations. In addition, consistent with 
Rule 3110.12, members should conduct on-site inspections or make 
more frequent use of unannounced, on-site inspections for high-risk 
locations or where there are ``red flags.''

    FINRA expects a firm to carefully consider the proposed factors 
listed above and Rule 3110.12 for the risk assessment. The outcome of 
such assessment may raise red flags that should prompt a firm to 
consider, among other things, inspecting, remotely or on-site, its 
offices or locations more frequently than the schedule set forth under 
Rule 3110(c)(1) (on an announced or unannounced basis). Moreover, FINRA 
notes that Rule 3130 (Annual Certification of Compliance and 
Supervisory Processes) requires member firms to have processes to 
establish, maintain, review, test, and modify written compliance 
policies and written supervisory procedures reasonably designed to 
achieve compliance with applicable FINRA rules, Municipal Securities 
Rulemaking Board rules, and federal securities laws and regulations. 
FINRA expects firms to consider Rule 3110.18 as part of their Rule 3130 
annual certification process.

2. FINRA Proposes To Amend Proposed Rule 3110.18(c) by Adding Subparts 
(1)(A)(iii)-(vi)

    As proposed, the proposed rule change would exclude some member 
firms and their offices or locations from participating in the proposed 
pilot program based on events or activities of a member firm or its 
associated persons that FINRA believed were more likely to raise 
investor protection concerns based on the firm's or an associated 
person's record of specified regulatory or disciplinary events. In 
light of concerns raised by the commenters, FINRA is proposing to 
expand the list of events that would deem a member firm ineligible to 
participate in the pilot program. Following are the changes proposed in 
this Partial Amendment No. 1, with the proposed changes in the original 
filing shown as if adopted. Proposed new language in this Partial 
Amendment No. 1 is italicized; proposed deletions in this Partial 
Amendment No. 1 are in brackets:

(c) Eligibility Exclusions and Conditions

(1) Firm Level

    [2](A) A member shall not be eligible to conduct remote 
inspections of any of its offices or locations in accordance with 
this Supplementary Material if any time during the period of this 
Remote Inspections Pilot Program, the member[ is or becomes]:
    (i) is or becomes designated as Restricted Firm under Rule 4111; 
[or]
    (ii) is or becomes designated as a Taping Firm under Rule 
3170[.];
    (iii) receives a notice from FINRA under Rule 9557 under Rule 
4110 (Capital Compliance), Rule 4120 (Regulatory Notification and 
Business Curtailment) or Rule 4130 (Regulation of Activities of 
Section 15C Members Experiencing Financial and/or Operational 
Difficulties), unless FINRA has otherwise permitted activities in 
writing pursuant to such rule;
    (iv) is or becomes suspended by FINRA;
    (v) based on the date in the Central Registration Depository 
(CRD), had its FINRA membership become effective within the prior 12 
months; or
    (vi) is or has been found within the past three years by the SEC 
or FINRA to have violated Rule 3110(c) (Internal Inspections).

    FINRA believes that a member firm that is experiencing issues 
complying with its capital requirements or has been suspended by FINRA 
is more likely to face significant operational challenges that may 
negatively impact the firm's inspection program. FINRA further believes 
that a firm that has been a FINRA member for less than 12 months is 
often still implementing its business plan and may not have sufficient 
experience to develop a sufficiently robust inspection program. With 
respect to a firm that is or has been found within the past three years 
by the SEC or FINRA to have violated Rule 3110(c), FINRA believes such 
firms have demonstrated challenges in developing or maintaining robust 
inspection programs. As such, FINRA believes that these proposed 
additional ineligibility criteria would appropriately limit the 
potential population of member firm pilot program participants to those 
firms that may be better positioned to conduct remote inspections. 
Moreover, FINRA believes these amendments more appropriately tailor the 
proposal to maintain investor protection.

3. FINRA Proposes To Amend Proposed Rule 3110.18(c) by Adding Subpart 
(1)(B)

    To further address commenters' concerns pertaining to the proposed 
controls of the pilot program, FINRA is proposing to enhance those 
controls with respect to books and records and surveillance and 
technology tools. Following are the changes proposed in this Partial 
Amendment No. 1, with the proposed changes in the original filing shown 
as if adopted. Proposed new language in this Partial Amendment No. 1 is 
italicized; proposed deletions in this Partial Amendment No. 1 are in 
brackets:

(c) Eligibility Exclusions and Conditions

(1) Firm Level

* * * * *
    (B) In addition to the requirements of this Supplementary 
Material, during the period that a member is participating in this 
Remote Inspections Pilot Program the member must satisfy the 
following conditions to be eligible to conduct remote inspections of 
any of its offices or locations in accordance with this 
Supplementary Material:
    (i)(a) the member must have a recordkeeping system to make and 
keep current, and preserve records required to be made and kept 
current, and preserved under applicable securities laws and 
regulations, FINRA rules, and the member's own written supervisory 
procedures under Rule 3110; (b) such records are not physically or 
electronically maintained and preserved at the office or location 
subject to the remote inspection; and (c) the member has prompt 
access to such records; and
    (ii) as part of the requirement to develop a reasonable risk-
based approach to using remote inspections, and the further 
requirement to conduct and document a risk assessment for each 
office or location, the member must determine that its surveillance 
and technology tools are appropriate to supervise the types of risks 
presented by each such office or location. These tools may include 
but are not limited to: (a) firm-wide tools such as, electronic 
recordkeeping system; electronic surveillance of email and 
correspondence; electronic trade blotters; regular activity-based 
sampling reviews; and tools for visual inspections; (b) tools 
specific to that office or location based on the activities of 
associated persons, products offered, restrictions on the activity 
of the office or location (including holding out to customers and 
handling of customer funds or securities); and (c) system tools such 
as secure network connections and effective cybersecurity protocols.

    FINRA believes these proposed new eligibility conditions are 
appropriate to establish reasonable baseline requirements for remote 
inspections.

4. FINRA Proposes To Amend Proposed Rule 3110.18(c) by Adding Subparts 
(2)(A)(v)-(vii)

    In light of the comment letters expressing concern about the 
discretion provided to firms to make risk assessments of the criteria 
specified earlier of their offices or locations, FINRA is proposing to 
expand the list of events or activities that would make specific 
offices or locations of a member firm ineligible for remote 
inspections.

[[Page 78739]]

Following are the changes proposed in this Partial Amendment No. 1, 
with the proposed changes in the original filing shown as if adopted. 
Proposed new language in this Partial Amendment No. 1 is italicized; 
proposed deletions in this Partial Amendment No. 1 are in brackets:

(c) Eligibility Exclusions and Conditions

(1) Firm Level

* * * * *

[(B)](2) Location Level

    (A) A specific office or location of a member shall not be 
eligible for a remote inspection in accordance with this 
Supplementary Material if any time during the period of this Remote 
Inspections Pilot Program[, an associated person at such office or 
location is or becomes]:
    (i) one or more associated persons at such office or location is 
or becomes subject to a mandatory heightened supervisory plan under 
the rules of the SEC, FINRA or a state regulatory agency;
    (ii) one or more associated persons at such office or location 
is or becomes statutorily disqualified, unless such disqualified 
person has been approved (or is otherwise permitted pursuant to 
FINRA rules and the federal securities laws) to associate with a 
member and is not subject to a mandatory heightened supervisory plan 
under paragraph [(b)(2)(B)(i)](c)(2)(A)(i) of this Supplementary 
Material or otherwise as a condition to approval or permission for 
such association;
    (iii) the firm is or becomes subject to Rule 1017(a)(7) as a 
result of one or more associated persons at such office or location; 
or
    (iv) one or more associated persons at such office or location 
has an event in the prior three years that required a ``yes'' 
response to any item in Questions 14A(1)(a) and 2(a), 14B(1)(a) and 
2(a), 14C, 14D and 14E on Form U4[.];
    (v) one or more associated persons at such office or location is 
or becomes subject to a disciplinary action taken by the member that 
is or was reportable under Rule 4530(a)(2);
    (vi) one or more associated persons at such office or location 
is a part of the member's trading desk (e.g., engaging in market 
making activities or having authority to enter proprietary trades on 
behalf of the member or as agent for other parties; or
    (vii) the office or location handles customers' funds or 
securities.

    FINRA believes the expanded list of exclusions for specific offices 
or locations of a member further strengthens the terms of the proposed 
pilot program by identifying additional offices or locations that may 
particularly benefit from in-person inspections and expressly excluding 
them, regardless of any individual firm's risk assessment.

5. FINRA Proposes To Amend Proposed Rule 3110.18(c) by Adding Subparts 
(2)(B)(i)-(iii)

    To further address commenters' concerns regarding the proposed 
pilot program's controls, FINRA is proposing to add three new 
eligibility conditions to conduct a remote inspection during the pilot 
period. Following are the changes proposed in this Partial Amendment 
No. 1, with the proposed changes in the original filing shown as if 
adopted. Proposed new language in this Partial Amendment No. 1 is 
italicized; proposed deletions in this Partial Amendment No. 1 are in 
brackets:

(c) Eligibility Exclusions and Conditions

(1) Firm Level

[(B)](2) Location Level

* * * * *
    (B) In addition to the requirements of this Supplementary 
Material, during the period a member is participating in this Remote 
Inspections Pilot Program a specific office or location of the 
member must satisfy the following conditions to be eligible for a 
remote inspection in accordance with this Supplementary Material:
    (i) electronic communications (e.g., email) are made through the 
member's electronic system;
    (ii) the associated person's correspondence and communications 
with the public are subject to the firm's supervision in accordance 
with Rule 3110; and
    (iii) no books or records of the member required to be made and 
kept current, and preserved under applicable securities laws and 
regulations, FINRA rules, and the member's own written supervisory 
procedures under Rule 3110 are physically or electronically 
maintained and preserved at such office or location.

6. FINRA Proposes To Amend Proposed Rule 3110.18 by Adding Subparts (k)

    FINRA is also proposing to adopt new paragraph (k) to proposed Rule 
3110.18 to allow FINRA to make a determination in the public interest 
and for the protection of investors that a member is no longer eligible 
to participate in the proposed pilot program if the member fails to 
comply with the requirements of Rule 3110.18. If warranted, FINRA would 
provide written notice to the member of such determination and such 
member would no longer be eligible to participate in the proposed pilot 
program and would be required to conduct on-site inspections of 
required offices and locations in accordance with Rule 3110(c). 
Following are the changes proposed in this Partial Amendment No. 1, 
with the proposed changes in the original filing shown as if adopted. 
Proposed new language in this Partial Amendment No. 1 is italicized; 
proposed deletions in this Partial Amendment No. 1 are in brackets:
    (k) Determination of Ineligibility. FINRA may make a 
determination in the public interest and for the protection of 
investors that a member is no longer eligible to participate in the 
Pilot Program if the member fails to comply with the requirements of 
Rule 3110.18. In such instances, FINRA will provide written notice 
to the member of such determination and the member would no longer 
be eligible to participate in the Pilot Program and must conduct on-
site inspections of required offices and locations in accordance 
with Rule 3110(c).

    FINRA believes this added authority would both align with FINRA's 
examination and risk monitoring programs for member firms and 
registered persons and allow FINRA to more effectively assess higher 
risk.

7. FINRA Proposes To Amend Proposed Rule 3110.18 To Make Other Non-
Substantive, Technical Changes to the Proposed Rule Change

    FINRA is also proposing to make other non-substantive, technical 
changes to the proposed rule change, including conforming changes to 
the numbering of the proposed rules and updating cross-references.

III. Date of Effectiveness of the Proposed Rule Change As Modified By 
Partial Amendment No. 1 and Timing for Commission Action

    Within 45 days of the date of publication of the initial Notice in 
the Federal Register or within such longer period (i) as the Commission 
may designate up to 90 days of such date if it finds such longer period 
to be appropriate and publishes its reasons for so finding or (ii) as 
to which the self-regulatory organization consents, the Commission will 
by order approve or disapprove such proposed rule change, as amended by 
Partial Amendment No. 1.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended by Partial Amendment No. 1, is consistent with the 
Act. Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to [email protected]. Please include 
File Number SR-FINRA-2022-021 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

[[Page 78740]]

All submissions should refer to File Number SR-FINRA-2022-021. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's internet website (http://www.sec.gov/rules/sro.shtml). 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for website viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, on official business days between the hours of 10:00 a.m. and 
3:00 p.m. Copies of such filing also will be available for inspection 
and copying at the principal office of FINRA. All comments received 
will be posted without change. Persons submitting comments are 
cautioned that we do not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make available publicly.
    All submissions should refer to File Number SR-FINRA-2022-021 and 
should be submitted on or before January 12, 2023.
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    \11\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\11\
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2022-27787 Filed 12-21-22; 8:45 am]
BILLING CODE 8011-01-P