[Federal Register Volume 85, Number 227 (Tuesday, November 24, 2020)]
[Notices]
[Pages 75097-75103]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-25902]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-90454; File No. SR-FINRA-2020-040]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing and Immediate Effectiveness of a 
Proposed Rule Change To Adopt Temporary Supplementary Material .17 
(Temporary Relief To Allow Remote Inspections for Calendar Year 2020 
and Calendar Year 2021) Under FINRA Rule 3110 (Supervision)

November 18, 2020.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on November 6, 2020, the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been prepared by FINRA. FINRA has designated 
the proposed rule change as constituting a ``non-controversial'' rule 
change under paragraph (f)(6) of Rule 19b-4 under the Act,\3\ which 
renders the proposal effective upon receipt of this filing by the 
Commission. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 17 CFR 240.19b-4(f)(6).
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to adopt temporary Supplementary Material .17 
(Temporary Relief to Allow Remote Inspections for Calendar Year 2020 
and Calendar Year 2021) under FINRA Rule 3110 (Supervision) to provide 
member firms the option, subject to specified requirements under the 
proposed supplementary material, to complete remotely their calendar 
year 2020 and calendar year 2021 inspection obligations under FINRA 
Rule 3110(c) (Internal Inspections), without an on-site visit to the 
office or location.\4\ The temporary rule change is necessitated by the 
compelling health and safety concerns and the operational challenges 
member firms are facing due to the sustained COVID-19 pandemic.\5\
---------------------------------------------------------------------------

    \4\ SEC staff and FINRA have stated in guidance that inspections 
must include a physical, on-site review component. See SEC National 
Examination Risk Alert, Volume I, Issue 2 (November 30, 2011) and 
Regulatory Notice 11-54 (November 2011) (``Notice 11-54'') (joint 
SEC and FINRA guidance stating, a ``broker-dealer must conduct on-
site inspections of each of its office locations; Office of 
Supervisory Jurisdictions (``OSJs'') 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.'') (footnote defining an OSJ omitted). 
See also SEC Division of Market Regulation, Staff Legal Bulletin No. 
17: Remote Office Supervision (March 19, 2004) (``SLB 17'') 
(stating, in part, that broker-dealers that conduct business through 
geographically dispersed offices have not adequately discharged 
their supervisory obligations where there are no on-site routine or 
``for cause'' inspections of those offices).
    \5\ The proposed rule change will automatically sunset on 
December 31, 2021. If FINRA seeks to extend the duration of the 
temporary proposed rule beyond December 31, 2021, FINRA will submit 
a separate rule filing to further renew the temporary relief.
---------------------------------------------------------------------------

    Below is the text of the proposed rule change. Proposed new 
language is italicized; proposed deletions are bracketed.
* * * * *

3000. Supervision and Responsibilities Relating to Associated Persons

3100. Supervisory Responsibilities

3110. Supervision

(a) through (f) No Change

   Supplementary Material

.01 through .16 No Change

    .17 Temporary Relief To Allow Remote Inspections for Calendar Year 
2020 and Calendar Year 2021
    (a) Use of Remote Inspections. Each member obligated to conduct an 
inspection of an office of supervisory jurisdiction, branch office or 
non-branch location in calendar year 2020 and calendar year 2021 
pursuant to, as applicable, paragraphs (c)(1)(A), (B) and (C) under 
Rule 3110 may, subject to the requirements of this Rule 3110.17, 
satisfy such obligation by conducting the applicable inspection 
remotely, without an on-site visit to the office or location. In 
accordance with Rule 3110.16, inspections for calendar year 2020 must 
be completed on or before March 31, 2021 and inspections for

[[Page 75098]]

calendar year 2021 must be completed on or before December 31, 2021. 
Notwithstanding Rule 3110.17, a member shall remain subject to the 
other requirements of Rule 3110(c).
    (b) Written Supervisory Procedures for Remote Inspections. 
Consistent with a member's obligation under Rule 3110(b)(1), a member 
that elects to conduct each of its calendar year 2020 or calendar year 
2021 inspections remotely must amend or supplement its written 
supervisory procedures to provide for remote inspections that are 
reasonably designed to assist in detecting and preventing violations of 
and achieving compliance with applicable securities laws and 
regulations, and with applicable FINRA rules. Reasonably designed 
procedures for conducting remote inspections of offices or locations 
should include, among other things: (1) A description of the 
methodology, including technologies permitted by the member, that may 
be used to conduct remote inspections; and (2) the use of other risk-
based systems employed generally by the member firm to identify and 
prioritize for review those areas that pose the greatest risk of 
potential violations of applicable securities laws and regulations, and 
of applicable FINRA rules.
    (c) Effective Supervisory System. The requirement to conduct 
inspections of offices and locations is one part of the member's 
overall obligation to have an effective supervisory system and 
therefore, the member must continue with its ongoing review of the 
activities and functions occurring at all offices and locations, 
whether or not the member conducts inspections remotely. A member's use 
of a remote inspection of an office or location will be held to the 
same standards for review as set forth under Rule 3110.12. Where a 
member's remote inspection of an office or location identifies any 
indicators of irregularities or misconduct (i.e., ``red flags''), the 
member may need to impose additional supervisory procedures for that 
office or location or may need to provide for more frequent monitoring 
of that office or location, including potentially a subsequent 
physical, on-site visit on an announced or unannounced basis when the 
member's operational difficulties associated with COVID-19 abate, 
nationally or locally as relevant, and the challenges a member is 
facing in light of the public health and safety concerns make such on-
site visits feasible using reasonable best efforts. The temporary 
relief provided by this Rule 3110.17 does not extend to a member's 
inspection requirements beyond calendar year 2021 and such inspections 
must be conducted in compliance with Rule 3110(c).
    (d) Documentation Requirement. A member must maintain and preserve 
a centralized record for each of calendar year 2020 and calendar year 
2021 that separately identifies: (1) All offices or locations that had 
inspections that were conducted remotely; and (2) any offices or 
locations for which the member determined to impose additional 
supervisory procedures or more frequent monitoring, as provided in Rule 
3110.17(c). A member's documentation of the results of a remote 
inspection for an office or location must identify any additional 
supervisory procedures or more frequent monitoring for that office or 
location that were imposed as a result of the remote inspection.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    On March 13, 2020 the United States declared a national emergency 
in response to the pandemic.\6\ Around this time, many states issued 
stay-at-home orders and imposed restrictions on businesses, social 
activities, and travel to slow the spread of COVID-19 and reduce the 
burden on the U.S. health care system in accordance with the 
recommendations of public health experts.\7\ In response, like many 
employers across the U.S., member firms closed their offices to the 
public, transitioned their employees to telework arrangements to comply 
with stay-at-home orders, and implemented other restrictive measures in 
an effort to slow the spread of COVID-19 such as curtailing or 
eliminating non-essential business travel, and significantly limiting 
or canceling in-person activities.\8\ These pandemic-related 
operational changes have made it impracticable for member firms to 
conduct the on-site inspection component of Rule 3110(c) at many or 
most locations for calendar year 2020 because this compliance function 
requires firm employees to travel to geographically dispersed OSJs, 
branch offices, and non-branch locations. Such travel not only has been 
restricted at times by government orders, but also puts the health and 
safety of employees at great risk of contracting and spreading COVID-
19.\9\ By mid-year, with many restrictive measures still in place, and 
in some instances additional quarantine requirements imposed on 
interstate travel, on-site inspections of offices or locations 
scheduled for calendar year 2020 continued to remain in abeyance.\10\ 
In recognition of the logistical challenges firms were facing at that 
time to satisfy the on-site regulatory component of Rule 3110(c), FINRA 
adopted Rule 3110.16 (Temporary Extension of Time to Complete Office 
Inspections), extending the time by which member firms must complete

[[Page 75099]]

their calendar year 2020 inspection obligations under Rule 3110(c) to 
March 31, 2021, but emphasizing that the extension of time did not 
relieve firms from conducting the on-site portion of the inspections of 
their OSJs, branch offices, and non-branch locations.\11\
---------------------------------------------------------------------------

    \6\ See Centers for Disease Control and Prevention (``CDC''), 
International Classification of Diseases, Tenth Revision, Clinical 
Modification, https://www.cdc.gov/nchs/data/icd/Announcement-New-ICD-code-for-coronavirus-3-18-2020.pdf. See also WHO Director-
General, Opening Remarks at the Media Briefing on COVID-19 (March 
11, 2020), https://www.who.int/dg/speeches/detail/who-director-general-s-opening-remarks-at-the-media-briefing-on-covid-19---11-march-2020.
    \7\ See S.J. Lange et al., Potential Indirect Effects of the 
COVID-19 Pandemic on Use of Emergency Departments for Acute Life-
Threatening Conditions--United States, January-May 2020, Morbidity 
and Mortality Weekly Report (June 26, 2020), https://www.cdc.gov/mmwr/volumes/69/wr/mm6925e2.htm.
    \8\ See generally Regulatory Notice 20-16 (May 2020) (``Notice 
20-16'') (describing practices implemented by firms to transition 
to, and supervise in, remote work environment during the COVID-19 
pandemic).
    \9\ See CDC, Travel During the COVID-19 Pandemic (stating in 
part, ``Travel increases your chance of getting and spreading COVID-
19. Staying home is the best way to protect yourself and others from 
COVID-19.''), https://www.cdc.gov/coronavirus/2019-ncov/travelers/travel-during-covid19.html (updated October 21, 2020).
    \10\ See, e.g., Government of the District of Columbia, Phase 
Two (June 22, 2020) (announcing certain businesses to reopen and 
activities to resume under specified conditions and stating that 
anyone coming into Washington, DC from states specified as high-risk 
is required to self-quarantine for 14 days), https://coronavirus.dc.gov/phasetwo (last visited November 6, 2020); New 
York Department of Health, Interim Guidance for Quarantine 
Restrictions on Travelers Arriving in New York State Following Out 
of State Travel (November 3, 2020), available at https://coronavirus.health.ny.gov/covid-19-travel-advisory (last visited 
November 6, 2020); and Chicago Department of Public Health, 
Emergency Travel Order (issued July 2, 2020) (directing travelers 
entering or returning to Chicago from specified states experiencing 
a surge in new COVID-19 cases to quarantine for a 14-day period from 
the time of last contact within the identified state), https://www.chicago.gov/city/en/sites/covid-19/home/emergency-travel-order.html (updated October 27, 2020).
    \11\ See Securities Exchange Act Release No. 89188 (June 30, 
2020), 85 FR 40713 (July 7, 2020) (Notice of Filing and Immediate 
Effectiveness of File No SR-FINRA-2020-019) (stating, among other 
things, that FINRA will consider whether additional relief may be 
warranted to address any backlog of 2020 inspections that may 
continue to exist in light of ongoing public health and safety 
concerns).
---------------------------------------------------------------------------

    The acute health and safety concerns related to COVID-19 persist, 
with the number of confirmed cases of COVID-19 in the U.S. continuing 
to rise since March 13, 2020.\12\ While firms have continued to 
supervise OSJs, branch offices, and non-branch locations by, among 
other things, implementing remote supervisory practices through novel 
uses of technology as well as existing methods of supervision (e.g., 
supervisory checklists, surveillance tools, incident trackers, email 
review, and trade exception reports),\13\ firms are still experiencing 
logistical challenges related to conducting the on-site portion of 
their inspections due to continuing business and governmental 
restrictions and public health concerns.\14\
---------------------------------------------------------------------------

    \12\ See Johns Hopkins, Coronavirus Resource Center, COVID-19 
Dashboard by the Center for Systems Science and Engineering at Johns 
Hopkins University, https://coronavirus.jhu.edu/map.html (last 
visited November 6, 2020).
    \13\ See Notice 20-16.
    \14\ See supra note 10.
---------------------------------------------------------------------------

    Based on feedback described in Notice 20-16, in comment letters 
submitted in response to File No. SR-FINRA-2020-019,\15\ and through 
recent discussions with FINRA's advisory committees and other industry 
representatives, FINRA understands that since approximately March 2020, 
many firms have suspended the on-site component of their inspections 
scheduled for calendar year 2020. With no certainty as to when 
pandemic-related health concerns and restrictions will subside, firms 
will have a considerable backlog of 2020 inspections that may be 
difficult, if not impossible, to overcome on or before March 31, 2021, 
even if restrictions are lifted sometime between now and then. 
Moreover, FINRA recognizes that planning on-site inspections for 
calendar year 2021 for OSJs, branch offices, and non-branch locations 
in the current environment may now be impacted as well. In light of 
pandemic-related developments, including those since the adoption of 
Rule 3110.16, and the approaching end of year 2020, FINRA believes 
further sensible and tailored temporary relief is warranted for member 
firms to meet their inspection obligations under Rule 3110(c) for 
calendar years 2020 and 2021.
---------------------------------------------------------------------------

    \15\ See Submitted Comments to Securities Exchange Act Release 
No. 89188 (June 30, 2020), 85 FR 40713 (July 7, 2020) (Notice of 
Filing and Immediate Effectiveness of File No SR-FINRA-2020-019), 
https://www.sec.gov/comments/sr-finra-2020-019/srfinra2020019.htm.
---------------------------------------------------------------------------

Proposed Supplementary Material .17 to Rule 3110
    In order to proactively address these concerns, FINRA is proposing 
to adopt temporary Supplementary Material .17. Temporary proposed 
Supplementary Material .17 would provide member firms, subject to 
specified requirements therein, the option to conduct remotely the 
inspections of their OSJs, branch offices, and non-branch locations for 
calendar year 2020 and calendar year 2021, without the requirement to 
conduct an on-site visit to such office or location. As described 
further below, proposed Rule 3110.17 would set forth the dates by which 
inspections for calendar years 2020 and 2021 are due, the requirement 
to amend or supplement written supervisory procedures for remote 
inspections, the use of remote inspections as part of an effective 
supervisory system, and documentation requirements. FINRA believes this 
temporary remote inspection option is a reasonable alternative to 
provide to firms to fulfill their Rule 3110(c) obligations during these 
pressing times, and is designed to achieve the investor protection 
objectives of the inspection requirements under these unique 
circumstances.
    The responsibility of firms to supervise their associated persons 
is a critical component of broker-dealer regulation.\16\ The temporary 
proposed supplementary material is not intended to alter this core 
responsibility, embodied in Rule 3110, to establish and maintain a 
system to supervise the activities of each associated person that is 
reasonably designed to achieve compliance with applicable securities 
laws and regulations, and with applicable FINRA rules. The advent of 
technology and automation in the financial industry has significantly 
changed the way in which members and their associated persons conduct 
their business, communicate, and meet their regulatory obligations. 
FINRA recognizes that firms generally use an array of technological 
tools to facilitate their supervisory practices (e.g., surveillance 
systems; electronic tracking programs or applications; electronic 
communications, including video conferencing tools), which many firms 
have leveraged to create and implement remote inspection plans, on a 
temporary basis, in response to pandemic-related operational 
challenges.\17\ FINRA believes that proposed Rule 3110.17 would provide 
a sensibly tailored regulatory alternative for firms to fulfill their 
obligations under Rule 3110(c) that would not materially diminish, and 
is reasonably designed to achieve, the investor protection objectives 
of the inspection requirements under these unique circumstances. FINRA 
further notes that the proposed relief would be limited in duration to 
align with the extended dates set forth under Rule 3110.16 of March 31, 
2021 for calendar year 2020 inspections and December 31, 2021 for 
calendar year 2021 inspections.\18\
---------------------------------------------------------------------------

    \16\ See SLB 17. See also Notice 11-54 and Notice to Members 98-
38 (May 1998) (``Notice 98-38'').
    \17\ See Notice 20-16. See generally FINRA White Paper, 
``Technology Based Innovations for Regulatory Compliance 
(``RegTech'') in the Securities Industry'' (September 2018) 
(reporting, among other things, that as financial services firms 
seek to keep pace with regulatory compliance requirements, they are 
turning to new and innovative regulatory tools to assist them in 
meeting their obligations in an effective and efficient manner), 
https://www.finra.org/sites/default/files/2018_RegTech_Report.pdf.
    \18\ See supra note 5.
---------------------------------------------------------------------------

A. Deadlines To Complete Calendar Year 2020 Inspections and Calendar 
Year 2021 Inspections (Proposed Rule 3110.17(a))
    Currently, Rule 3110(c)(1) provides that an inspection of an office 
or location must occur on a designated frequency, and the periodicity 
of the required inspection varies depending on the classification of 
the location or the nature of the activities that take place. OSJs and 
supervisory branch offices must be inspected at least annually (on a 
calendar-year basis); non-supervisory branch offices, at least every 
three years; and non-branch locations, on a periodic schedule, presumed 
to be at least every three years.\19\ Under Rule 3110.16, firms have 
until March 31, 2021 to complete their calendar year 2020 inspections 
in accordance with the current requirements of Rule 3110(c) that 
include physical, on-site inspections.\20\
---------------------------------------------------------------------------

    \19\ See generally Rule 3110(c)(1) and Rule 3110.13 (General 
Presumption of Three-Year Limit for Periodic Inspection Schedules).
    \20\ See supra note 4.
---------------------------------------------------------------------------

    Proposed Rule 3110.17(a) would provide that a member firm that is 
obligated to conduct an inspection of an OSJ, branch office or non-
branch location in calendar year 2020 and calendar year 2021 pursuant 
to the applicable periodicity set forth under

[[Page 75100]]

Rule 3110(c)(1) may satisfy such obligation by conducting the 
applicable inspection remotely, without an on-site visit to the office 
or location subject to the other requirements set forth under the 
proposed supplementary material. In addition, the proposed 
supplementary material would expressly provide that in accordance with 
Rule 3110.16, inspections for calendar year 2020 must be completed on 
or before March 31, 2021 and inspections for calendar year 2021 must be 
completed on or before December 31, 2021. FINRA believes that providing 
firms with the option to satisfy the inspection component of Rule 
3110(c) remotely would enable firms to finish their 2020 inspections on 
or before March 31, 2021, and their upcoming 2021 inspections on or 
before December 31, 2021, particularly given the uncertainty 
surrounding planning inspections at this time. Further, proposed Rule 
3110.17(a) would affirm that notwithstanding Rule 3110.17, a member 
would remain subject to the other requirements of Rule 3110(c).\21\
---------------------------------------------------------------------------

    \21\ In addition to requiring firms to conduct inspections of 
their offices and locations on a designated frequency, Rule 3110(c) 
generally requires a member to retain a written record of the date 
upon which each review and inspection occurred, reduce a location's 
inspection to a written report and keep each inspection report on 
file either for a minimum of three years or, if the location's 
inspection schedule is longer than three years, until the next 
inspection report has been written. If applicable to the location 
being inspected, the inspection report must include, without 
limitation, the testing and verification of the member's policies 
and procedures, including supervisory policies and procedures, in 
specified areas. See Rule 3110(c)(2). In addition, to prevent 
compromising the effectiveness of inspections due to conflicts of 
interest, the rule requires a member to ensure that the person 
conducting the inspection is not an associated person assigned to 
the location or is not directly or indirectly supervised by, or 
otherwise reporting to, an associated person assigned to that 
location. See Rule 3110(c)(3).
---------------------------------------------------------------------------

B. Written Supervisory Procedures for Remote Inspections (Proposed Rule 
3110.17(b))
    FINRA has long emphasized that member firms have a fundamental 
obligation to implement a supervisory system that is tailored 
specifically to the member firm's business and addresses the activities 
of all its associated persons.\22\ As part of an effective supervisory 
system, a member must establish and maintain written procedures.\23\ 
Paragraph (1) (General Requirements) under Rule 3110(b) (Written 
Procedures) provides that a member must establish, maintain, and 
enforce written procedures to supervise the types of business in which 
it engages and the activities of its associated persons that are 
reasonably designed to achieve compliance with applicable securities 
laws and regulations, and with applicable FINRA rules.
---------------------------------------------------------------------------

    \22\ See Notice to Members 99-45 (June 1999) (``Notice 99-45''); 
see generally Regulatory Notice 18-15 (April 2018).
    \23\ See Rule 3110(a)(1).
---------------------------------------------------------------------------

    To underscore the importance of this existing requirement in the 
context of remote inspections, proposed Rule 3110.17(b) would expressly 
provide that consistent with a member's obligation under Rule 
3110(b)(1), a member that elects to conduct each of its calendar year 
2020 or calendar year 2021 inspections remotely must amend or 
supplement its written supervisory procedures to provide for remote 
inspections that are reasonably designed to assist in detecting and 
preventing violations of and achieving compliance with applicable 
securities laws and regulations, and with applicable FINRA rules. Under 
proposed Rule 3110.17(b), reasonably designed procedures for conducting 
remote inspection of offices or locations should include, among other 
things, a description of the methodology, including technologies 
permitted by the member, that may be used to conduct remote 
inspections. In addition, such procedures should include the use of 
other risk-based systems employed generally by the member firm to 
identify and prioritize for review those areas that pose the greatest 
risk of potential violations of applicable securities laws and 
regulations, and of applicable FINRA rules.\24\
---------------------------------------------------------------------------

    \24\ Offices or locations that may present a higher risk profile 
would include, for example, those that have associated persons 
engaging in activities that involve handling customer funds or 
securities, maintaining books and records as described under 
applicable federal securities laws and FINRA rules, order execution 
or other activities that may be more susceptible to higher risks of 
operational or sales practice wrongdoing, or have associated persons 
assigned to an office or location who may be subject to additional 
or heightened supervisory procedures.
---------------------------------------------------------------------------

C. An Effective Supervisory System (Proposed Rule 3110.17(c))
    Internal inspections are a critical component of a member's 
fundamental obligation under Rule 3110 to establish and maintain a 
system to supervise the activities of each associated person that is 
reasonably designed to achieve compliance with applicable securities 
laws and regulations, and with applicable FINRA rules.\25\ Proposed 
Rule 3110.17(c) would expressly affirm this principle that the 
requirement to conduct inspections of offices and locations is one part 
of the member's overall ongoing obligation to have an effective 
supervisory system and therefore, a member must continue with its 
reviews of the activities and functions occurring at all offices and 
locations whether or not such offices or locations are due for an 
inspection under Rule 3110(c) in a given year, and the member's 
election to conduct such inspections remotely. In addition, under the 
proposed supplementary material, a member's remote inspection of an 
office or location, like the traditional on-site inspection, would be 
held to the same standards for review as set forth under Rule 3110.12 
(Standards for Reasonable Review).\26\ Further, in accordance with this 
obligation, proposed Rule 3110.17(c) would provide that where a 
member's remote inspection of an office or location identifies any 
indicators of irregularities or misconduct (i.e., ``red flags''),\27\ 
the member may need to impose additional supervisory

[[Page 75101]]

procedures for that office or location, or may need to provide for more 
frequent monitoring or oversight of that office or location, or both, 
including potentially a subsequent physical, on-site visit on an 
announced or unannounced basis when the member's operational 
difficulties associated with COVID-19 meetings abate, nationally or 
locally as relevant, and the challenges the member is facing in light 
of the public health and safety concerns make such physical, on-site 
visits feasible, using reasonable best efforts.
---------------------------------------------------------------------------

    \25\ See SLB 17 (stating, in part, ``Inspections are a vital 
component of a supervisory system.'').
    \26\ Rule 3110.12 provides: ``In fulfilling its obligations 
under Rule 3110(c), each member must conduct a review, at least 
annually, of the businesses in which it engages. The review must be 
reasonably designed to assist in detecting and preventing violations 
of and achieving compliance with applicable securities laws and 
regulations and with FINRA rules. Each member shall establish and 
maintain supervisory procedures that must take into consideration, 
among other things, the firm's size, organizational structure, scope 
of business activities, number and location of the firm's offices, 
the nature and complexity of the products and services offered by 
the firm, the volume of business done, the number of associated 
persons assigned to a location, the disciplinary history of 
registered representatives or associated persons, and any indicators 
of irregularities or misconduct (i.e., ``red flags''), etc. The 
procedures established and reviews conducted must provide that the 
quality of supervision at remote locations is sufficient to ensure 
compliance with applicable securities laws and regulations and with 
FINRA rules. A member must be especially diligent in establishing 
procedures and conducting reasonable reviews with respect to a non-
branch location where a registered representative engages in 
securities activities. Based on the factors outlined above, members 
may need to impose reasonably designed supervisory procedures for 
certain locations or may need to provide for more frequent reviews 
of certain locations.''
    \27\ Red flags that suggest the increased risk or occurrence of 
violations may include, among other events: Customer complaints; an 
unexplained increase or change in the types of investments or 
trading concentration that a representative is recommending or 
trading; an unexpected improvement in a representative's production, 
lifestyle, or wealth; questionable or frequent transfers of cash or 
securities between customer or third party accounts, or to or from 
the representative; a representative that serves as a power of 
attorney, trustee or in a similar capacity for a customer or has 
discretionary control over a customer's account(s); representative 
with disciplinary records; customer investments in one or a few 
securities or class of securities that is inconsistent with firm 
policies related to such investments; churning; trading that is 
inconsistent with customer objectives; numerous trade corrections, 
extensions, liquidations; or significant switching activity of 
mutual funds or variable products held for short time periods. See 
generally SLB 17. See also Notice 98-38 and Notice 99-45.
---------------------------------------------------------------------------

    Finally, to underscore the limited duration of proposed Rule 
3110.17, the proposed supplementary material expressly states that the 
temporary relief would not extend to a member's inspection requirements 
beyond calendar year 2021 and that such inspections must be conducted 
in compliance with Rule 3110(c).
D. Documentation Requirement (Proposed Rule 3110.17(d))
    In general, Rule 3110(c)(2) describes the documentation 
requirements associated with conducting internal inspections. The rule 
requires a member to reduce the inspection and review conducted under 
Rule 3110(c)(1) to a written report and specifies how long the member 
must keep the report on file.\28\ If applicable to the location being 
inspected, Rule 3110(c)(2)(A) specifies that the inspection report must 
include, without limitation, the testing and verification of the 
member's policies and procedures, including supervisory policies and 
procedures for: (1) Safeguarding of customer funds and securities; (2) 
maintaining books and records; (3) supervision of supervisory 
personnel; (4) transmittals of funds from customers to third party 
accounts, from customer accounts to outside entities, from customer 
accounts to locations other than a customer's primary residence, and 
between customers and registered representatives, including the hand-
delivery of checks; and (5) changes of customer account information, 
including address and investment objectives changes, and validation of 
such changes.\29\
---------------------------------------------------------------------------

    \28\ See supra note 21.
    \29\ See Rule 3110(c)(2)(A)(i)-(v).
---------------------------------------------------------------------------

    In addition to the requirements under Rule 3110(c)(2), proposed 
Rule 3110.17(d) would require supplemental documentation by a member 
that avails itself of the remote inspection option. The member must 
maintain and preserve a centralized record for each of calendar year 
2020 and calendar year 2021 that separately identifies: (1) All offices 
or locations that had inspections that were conducted remotely; and (2) 
any offices or locations that the member determined to impose 
additional supervisory procedures or more frequent monitoring, as 
provided in Rule 3110.17(c). A member's documentation of the results of 
a remote inspection for an office or location must identify any 
additional supervisory procedures or more frequent monitoring for that 
office or location that were imposed as a result of the remote 
inspection. FINRA believes that this documentation requirement would 
help readily distinguish the offices and locations that underwent 
remote inspections and their attendant supervisory procedures, and 
their more frequent monitoring, as applicable.
    FINRA notes that even in the current environment, member firms have 
an ongoing obligation to establish and maintain a system to supervise 
the activities of their associated persons that is reasonably designed 
to achieve compliance with applicable securities laws and regulations, 
and with applicable FINRA rules. FINRA emphasizes that proposed Rule 
3110.17 is not intended to lessen the core obligations prescribed under 
Rule 3110. FINRA believes that proposed Rule 3110.17, which would 
permit firms to remotely inspect, subject to specified requirements 
described above, their offices and locations for calendar years 2020 
and 2021 instead of an on-site visit to the office or location would 
provide firms a way to comply with Rule 3110(c) that would not 
materially diminish, and is reasonably designed to achieve, the 
investor protection objectives of the inspection requirements under 
these unique circumstances. FINRA notes that potential risks that may 
arise from providing firms the option to conduct their inspections 
remotely are mitigated by firms' use of technology to meet their 
supervisory obligations on an ongoing basis, the unique circumstances 
under which they are operating, and the temporary nature of proposed 
Rule 3110.17, which would be in place through December 31, 2021.\30\ 
FINRA will continue to monitor the situation and engage with member 
firms, other financial regulators, and governmental authorities to 
determine whether further regulatory relief or guidance related to Rule 
3110(c) may be appropriate. In addition, during the time that proposed 
Rule 3110.17 remains in effect, FINRA will closely monitor the 
effectiveness of remote inspections and their impacts--positive or 
negative--on firms' overall supervisory systems to assess whether FINRA 
should propose to make permanent a remote inspection option for some or 
all locations that would not materially diminish, and is reasonably 
designed to achieve, the investor protection objectives of the 
requirement to inspect offices or locations in accordance with Rule 
3110(c).\31\
---------------------------------------------------------------------------

    \30\ See supra note 5.
    \31\ In Regulatory Notice 17-38 (November 2017) (``Notice 17-
38''), FINRA had requested comment on a proposed permanent amendment 
to Rule 3110 that had contemplated providing firms with the option 
to conduct remote inspections of ``qualifying offices'' that met 
specified criteria. At this time, FINRA intends to defer further 
consideration of the proposal described in Notice 17-38 and will 
reassess that proposal in light of the experience with and impacts 
of temporary proposed Rule 3110.17.
---------------------------------------------------------------------------

    FINRA has filed the proposed rule change for immediate 
effectiveness and has requested that the SEC waive the requirement that 
the proposed rule change not become operative for 30 days after the 
date of the filing, so FINRA can implement the proposed rule change 
immediately.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\32\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. In recognition of the impact of COVID-19 on performing 
the on-site inspection component of Rule 3110(c), the proposed rule 
change is intended to provide firms a temporary regulatory option to 
conduct inspections of offices and locations remotely for calendar year 
2020 in accordance with Rule 3110.16, and for calendar year 2021. This 
temporary proposed supplementary material does not relieve firms from 
meeting the core regulatory obligation to establish and maintain a 
system to supervise the activities of each associated person that is 
reasonably designed to achieve compliance with applicable securities 
laws and regulations, and with applicable FINRA rules that directly 
serve investor protection. In a time when faced with unique challenges 
resulting from the COVID-19 pandemic, FINRA believes that the proposed 
rule change provides sensibly tailored relief that will afford firms 
the ability to observe the recommendations of public health officials 
to provide for the health and safety of their personnel, while 
continuing to serve and promote the protection of investors and the 
public interest.
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 78o-3(b)(6).

---------------------------------------------------------------------------

[[Page 75102]]

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. The proposed rule change is 
intended solely to provide temporary relief given the impacts of the 
COVID-19 pandemic crisis.\33\ As a result of the temporary nature of 
the proposed relief, an abbreviated economic impact assessment is 
appropriate.
---------------------------------------------------------------------------

    \33\ See also Regulatory Notice 20-08 (March 2020).
---------------------------------------------------------------------------

Economic Impact Assessment
1. Regulatory Objective
    FINRA is proposing Rule 3110.17 to address an issue that has arisen 
due to the impacts of the coronavirus outbreak and restrictions related 
to health and safety concerns. As pandemic-related health and safety 
concerns persist across the U.S., firms are continuing to face 
operational challenges with respect to fulfilling the on-site review 
component of Rule 3110(c). These challenges persist even with the 
extended date set forth under Rule 3110.16 to complete calendar year 
2020 inspections. In addition, as the end of year 2020 is approaching, 
planning efforts for the on-site component of year 2021 inspections 
have also likely been impacted.
    Proposed Rule 3110.17 is intended to provide firms a sensibly 
tailored and temporary regulatory accomodation to fulfill their Rule 
3110(c) obligation remotely for calendar year 2020 in accordance with 
Rule 3110.16 and for calendar year 2021, that would not materially 
diminish, and is reasonably designed to achieve, the investor 
protection objectives of the requirement to inspect offices or 
locations in accordance with Rule 3110(c). Such accommodation is needed 
given the current pandemic-related limitations that still remain in 
place across the U.S. The temporary proposed rule change would permit 
firms to continue to comply with stay-at-home orders imposed in various 
states, and limit business travel and other in-person activities for 
the health and safety of their employees.
2. Economic Baseline
    The Economic Baseline of the proposed temporary relief is the 
obligation under Rule 3110(c), as described above, and the current 
number and types of FINRA member locations that require on-site 
internal inspections.
3. Economic Impact
    FINRA initially believes that economic impacts of the proposal 
would result in both benefits and costs to firms that would not 
materially diminish, and is reasonably designed to achieve, the 
investor protection objectives of the requirement to inspect offices or 
locations in accordance with Rule 3110(c). FINRA will undertake an 
evaluation of the efficacy of remote inspections within a reasonable 
period following the implementation date. The aim of such an evaluation 
is to ensure that the program is meeting its goals, without materially 
diminishing investor protections or unintentially increasing regulatory 
burdens on any relevant parties.
    The temporary proposed relief is expected to benefit firms by 
potentially reducing the costs and health-related risks and constraints 
associated with conducting on-site inspections of offices or locations. 
These benefits may also include reduced travel costs and lost 
productivity during travel, as well as avoiding the health and safety 
risks associated with on-site inspections in the current environment. 
Firms will be able to better manage any backlog of 2020 inspections 
that may continue to exist in light of ongoing public health and 
safety, and upcoming 2021 inspection planning efforts.
    In addition to the public safety-related aspects of the temporary 
proposed rule change, the ability to conduct remote inspections may 
free up firm resources that could potentially be allocated to other 
risk monitoring and mitigating programs. For example, firms might 
improve existing technologies and capabilities or invest in new ones. 
This could provide long-term benefits by further enhancing a firm's 
ability to fulfill its ongoing obligation to have an effective 
supervisory system that includes reviewing the activities and functions 
occurring at all offices and locations. The proposed rule change may 
also provide the opportunity for a firm to enhance its risk management 
programs, and assess the effectiveness of remote inspections and 
impacts on the firm's supervisory systems. Finally, FINRA preliminarily 
believes that the temporary proposed rule change would benefit the 
investor community. Such benefits would stem from the application of a 
remote monitoring and supervisory system on the firm's activities 
taking place at the offices and locations, despite the travel 
restrictions and resulting inability to conduct on-site inspections 
during the pandemic.
    FINRA believes that the temporary proposed rule change would not 
result in additional significant cost burdens on firms. FINRA 
recognizes that there may be some firms that have already incurred, or 
will incur short-term increased costs derived mainly from having to 
shift to the remote work environment (e.g., relying more on electronic 
formats and purchasing new hardware and software). FINRA anticipates 
firms would incur some costs stemming from the proposed documentation 
requirements. FINRA believes that costs stemming from the need to 
aggregate branch and office reports of additional supervisory 
procedures or more frequent monitoring into a centralized record should 
be minimal, relying on existing firm infrastructure and compliance 
systems. FINRA additionally believes that the proposed requirement to 
maintain a centralized record may require firms to incur technology 
costs to generate such record and could also result in firms being more 
focused on any additional supervisory procedures or more frequent 
monitoring that may be imposed on a location or office.
    Overall, FINRA believes that the proposal provides a balanced 
approach to the potential costs and benefits. As noted above, the 
proposed rule change would be limited in time, and cover the inspection 
cycles of calendar year 2020 and 2021, or until the conclusion of any 
extension thereof.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing proposed rule change does not: (i) 
Significantly affect the protection of investors or the public 
interest; (ii) impose any significant burden on competition; and (iii) 
become operative for 30 days from the date on which it was filed, or 
such shorter time as the Commission may designate, it has become 
effective pursuant to Section 19(b)(3)(A) of the Act \34\ and Rule 19b-
4(f)(6) thereunder.\35\
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78s(b)(3)(A).
    \35\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6)(iii) 
requires a self-regulatory organization to give the Commission 
written notice of its intent to file the proposed rule change, along 
with a brief description and text of the proposed rule change, at 
least five business days prior to the date of filing of the proposed 
rule change, or such shorter time as designated by the Commission. 
FINRA has satisfied this requirement.
---------------------------------------------------------------------------

    A proposed rule change filed under Rule 19b-4(f)(6) normally does 
not

[[Page 75103]]

become operative for 30 days after the date of filing. However, 
pursuant to Rule 19b-4(f)(6)(iii), the Commission may designate a 
shorter time if such action is consistent with the protection of 
investors and the public interest. In its filing with the Commission, 
FINRA has asked the Commission to waive the 30-day operative delay so 
that the proposed rule change may become operative immediately upon 
filing. As noted above, the ongoing extenuating circumstances of the 
COVID-19 pandemic make it impractical for FINRA member firms to conduct 
the on-site inspection component of Rule 3110(c) at many or most 
locations. Consequently, FINRA believes that firms will have a 
considerable backlog of 2020 inspections and that planning on-site 
inspections for 2021 may be impacted as well. FINRA stated that the 
temporary proposed rule change would help FINRA member firms meet their 
obligations under Rule 3110(c) using a regulatory alternative that 
would not materially diminish, and is reasonably designed to achieve, 
the investor protection objectives of the inspection requirements under 
these unique circumstances.
    The Commission believes that waiving the operative delay is 
consistent with the protection of investors and the public interest 
because it would allow the proposed change to become operative on the 
date of filing and to provide immediate temporary relief to firms 
during these extenuating circumstances. In reaching this conclusion, 
the Commission notes the proposed rule change would provide only 
temporary relief based on the compelling health and safety concerns and 
the operational challenges member firms are facing due to the sustained 
COVID-19 pandemic.\36\ Furthermore, the Commission notes that the 
proposed rule change would not relieve firms from meeting the core 
regulatory obligation to establish and maintain a system to supervise 
the activities of each associated person that is reasonably designed to 
achieve compliance with applicable securities laws and regulations, and 
with applicable FINRA rules that directly serve investor protection. 
Accordingly, the Commission waives the 30-day operative delay and 
designates the proposed rule change operative upon filing.\37\
---------------------------------------------------------------------------

    \36\ See supra note 5.
    \37\ For purposes only of waiving the operative delay, the 
Commission has considered the proposed rule's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act. If the Commission 
takes such action, the Commission shall institute proceedings to 
determine whether the proposed rule should be approved or disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 rule-comments@sec.gov. Please include 
File Number SR-FINRA-2020-040 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.

All submissions should refer to File Number SR-FINRA-2020-040. 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-2020-040 and 
should be submitted on or before December 15, 2020.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\38\
---------------------------------------------------------------------------

    \38\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-25902 Filed 11-23-20; 8:45 am]
BILLING CODE 8011-01-P


