[Federal Register Volume 87, Number 156 (Monday, August 15, 2022)]
[Notices]
[Pages 50144-50155]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-17428]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-95452; File No. SR-FINRA-2022-021)


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt 
Supplementary Material .18 (Remote Inspections Pilot Program) Under 
FINRA Rule 3110 (Supervision)

August 9, 2022.
    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 July 28, 2022, 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, 
II, and III below, which Items have been prepared by FINRA. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing 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.
    The text of the proposed rule change is available on FINRA's 
website at http://www.finra.org, at the principal office of FINRA and 
at the Commission's Public Reference Room.

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

[[Page 50145]]

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
    Beginning many years ago, SEC staff and FINRA have interpreted 
FINRA rules to require member firms to conduct on-site inspections of 
branch offices and unregistered offices (i.e., non-branch locations) in 
accordance with the periodic schedule described under Rule 
3110(c)(1).\3\ Over the years, widespread advancements in technology 
and communications in the financial industry have significantly changed 
the way in which members and their associated persons conduct their 
business and communicate, including the practices that formed the 
original bases for an on-site inspection requirement. For example, 
making and preserving records electronically have increasingly become 
the norm and the preferred recordkeeping medium rather than paper 
(e.g., cloud based storage); communications between and among members, 
their associated persons and customers commonly take place through 
email, video or some other electronic means (e.g., WebEx, Zoom) that 
can be monitored electronically by firms; processes for opening 
customer accounts and placing trades are moving to online platforms; 
and customer funds and securities are frequently and increasingly 
transmitted electronically rather than in physical form (e.g., Venmo, 
Zelle). Relatedly, the challenges in supervising associated persons who 
work in outlying offices or locations have been mitigated over the 
years with the prevalent and effective use of technology. For example, 
supervisory reviews for outside business activities of associated 
persons are often conducted through general internet searches, 
including social media and online public records, and by reviewing 
electronic communications and customer fund transfers. Similarly, 
reviews of correspondence, customer funds and securities, and order 
flows are accomplished primarily through the use of electronic tracking 
programs or applications.
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    \3\ See SEC National Examination Risk Alert, Volume I, Issue 2 
(November 30, 2011), https://www.sec.gov/about/offices/ocie/riskalert-bdbranchinspections.pdf 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 Jurisdiction 
(``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.''). 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), https://www.sec.gov/interps/legal/mrslb17.htm.
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    FINRA notes that firms are turning to new and innovative regulatory 
tools such as artificial intelligence, natural language processing, and 
robotics process automation, among others, to strengthen their 
compliance programs.\4\ More recently, firms have questioned the 
benefits of the on-site inspection requirement for all offices, 
particularly in light of these significant technological advances that 
have enhanced the effectiveness of a firm's overall and ongoing 
supervision and monitoring of the activities occurring at their offices 
(registered and unregistered).\5\
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    \4\ See generally FINRA White Paper, Technology Based 
Innovations for Regulatory Compliance (``RegTech'') on the 
Securities Industry (September 2018), https://www.finra.org/sites/default/files/2018_RegTech_Report.pdf.
    \5\ Some firms have indicated, for example, that technology has 
enhanced real time monitoring of their associated persons by 
providing the ability for firm compliance personnel to join, on an 
ad hoc basis, digital or virtual meetings occurring between the 
firm's associated persons and customers. Firms have also indicated 
that technology has allowed them to impose various restrictions or 
limitations on associated persons, such as the ability to print firm 
records from remote locations using a firm-issued laptop, and only 
accepting electronic payments from customers.
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    The COVID-19 pandemic has accelerated the use of a wide variety of 
compliance and workplace technology as many government and private 
employers, including member firms, were driven to adopt a broad remote 
work environment by quickly moving their employees out of their usual 
office setting to an alternative worksite such as a private residence. 
Insights obtained from member firms and other industry representatives 
through various pandemic-related initiatives and other industry 
outreach have led FINRA to carefully consider whether some processes 
and rules, including the manner in which a firm may satisfy its Rule 
3110(c) obligations, should be modernized.\6\ Technological 
improvements and developments in regulatory compliance have provided 
more tools than before to create more effective and efficient 
compliance programs. To that end, FINRA believes that regulatory models 
should evolve to benefit from the availability and use of effective 
technology tools. With the confluence of advances in compliance 
technology and the permanent shift to a remote or hybrid work 
environment, made more pronounced by the pandemic, FINRA believes that 
the optimal use of on-site inspections deserves further consideration.
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    \6\ See generally FINRA's Key Topic: COVID-19/Coronavirus 
(referencing, among other things, Frequency Asked Questions, 
temporary amendments to FINRA rules, and Regulatory Notices such as 
Regulatory Notices 20-08 (March 2020) (``Notice 20-08''), regarding 
pandemic-related business continuity planning, guidance and 
regulatory relief to member firms from some requirements, including 
the temporary suspension of the requirement to maintain updated 
information on Form U4 (Uniform Application for Securities Industry 
Registration or Transfer) and submit Form BR (Uniform Branch Office 
Registration Form) for temporary locations; 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; 20-42 (December 2020) (``Notice 20-42''), seeking 
comment on lessons from the pandemic; and 21-44 (December 2021) 
(``Notice 21-44''), regarding business continuity planning and 
lessons from the pandemic, https://www.finra.org/rules-guidance/key-topics/covid-19. See also SEC Press Release 2022-112 (June 22, 2022) 
for the Spring 2022 Regulatory Agenda (quoting SEC Chair Gary 
Gensler: ``When I think about the SEC's agenda, I'm driven by two 
public policy goals: continuing to drive efficiency in our capital 
markets and modernizing our rules for today's economy and 
technologies.''), https://www.sec.gov/news/press-release/2022-112?utm_medium=email&utm_source=govdelivery.
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    To address the operational challenges in conducting on-site 
inspections during the pandemic, FINRA adopted temporary Rule 3110.17, 
effective since November 2020, to provide member firms the option to 
conduct inspections of their branch offices and non-branch locations 
remotely, subject to specified terms therein.\7\ Although uncertainty 
about the pandemic remains, firms are beginning to look ahead at the 
post-pandemic changes to their workplaces, including more flexible work 
hours and hybrid work models--working sometimes on-site in a 
conventional office setting and other times remotely in a private 
residence or other alternative worksite. As such, FINRA believes now is 
the time to assess possible longer-term rule changes and is, therefore, 
proposing a voluntary, three-year remote inspections pilot program. 
This program would provide FINRA with specific, structured data from 
member firm pilot participants to evaluate their experiences--positive 
and negative--and inspection findings. This data would enable FINRA to

[[Page 50146]]

systematically assess the overall impact on firms' supervisory systems, 
which has not been feasible with information drawn from the pandemic-
related office shutdowns. Moreover, the proposed pilot program would 
maintain effective supervision by firms through firms' ongoing 
supervisory obligations under Rule 3110, and the proposed limitations 
on the firms and locations that would be eligible to participate in the 
proposed pilot program.
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    \7\ See Securities Exchange Act Release No. 90454 (November 18, 
2020), 85 FR 75097 (November 24, 2020) (Notice of Filing and 
Immediate Effectiveness of File No. SR-FINRA-2020-040).
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The Inspection Requirement Under Rule 3110
    The responsibility of firms to supervise their associated persons 
is a critical component of broker-dealer regulation.\8\ Member firms 
must supervise all of their associated persons, regardless of their 
location, compensation or employment arrangement, or registration 
status.\9\ Rule 3110 requires a member, regardless of size or type, to 
have a supervisory system for the activities of its associated persons 
that is reasonably designed to achieve compliance with the applicable 
securities laws and regulations and FINRA rules, and sets forth the 
minimum requirements for such supervisory system.\10\
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    \8\ See SLB 17, supra note 3; see also Notice 11-54 and Notice 
to Members 98-38 (May 1998) (``Notice 98-38'').
    \9\ This obligation is derived from Sections 15(b)(4)(E) and 
15(b)(6)(A) of the Exchange Act. Section 15(b)(4)(E) provides that 
the ``Commission, by order, shall censure, place limitations on the 
activities, functions, or operations of, suspend for a period not 
exceeding twelve months, or revoke the registration of any broker or 
dealer if it finds . . . that such broker or dealer . . . or any 
person associated with such broker or dealer . . . has willfully 
aided, abetted, counseled, commanded, induced, or procured the 
violation by any person of any provision of the Securities Act of 
1933, the Investment Advisers Act of 1940, the Investment Company 
Act of 1940, the Commodity Exchange Act, [the Securities Exchange 
Act of 1934], the rules or regulations under any of such statutes, 
or the rules of the Municipal Securities Rulemaking Board, or has 
failed reasonably to supervise, with a view to preventing violations 
of the provisions of such statutes, rules, and regulations, another 
person who commits such a violation, if such other person is subject 
to his supervision.'' 15 U.S.C. 78o(b)(4)(E). Section 15(b)(6)(A)(i) 
parallels Section 15(b)(4)(E) and provides for the imposition of 
sanctions against persons associated with a broker or dealer that 
violates those statutes, rules and regulations enumerated in Section 
15(b)(4)(E) and other specified subparagraphs under Section 
15(b)(4). 15 U.S.C. 78o(b)(6)(A).
    \10\ See Rule 3110(a).
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    As part of that supervisory system, Rule 3110(c) requires a member 
to review, at least annually, the businesses in which it engages for 
purposes of detecting and preventing violations of, and achieving 
compliance with, applicable securities laws and regulations. The review 
must include periodic inspections of each office and examination of 
customer accounts to detect and prevent irregularities and abuses. The 
inspection requirement is a longstanding supervisory obligation that in 
its early form had addressed the inspection requirement for an OSJ 
only.\11\ FINRA expanded the inspection requirement to cover branch 
offices out of concern for the potential regulatory problems that could 
emerge when a registered person, situated in an office other than an 
OSJ, was engaging in securities-related activities without the direct 
oversight of qualified supervisory personnel and without an annual 
inspection.\12\
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    \11\ Article III, Section 27(d) of the NASD Rules of Fair 
Practice had provided: ``Each member shall review the activities of 
each office, which shall include the periodic examination of 
customer accounts to detect and prevent irregularities or abuses and 
at least an annual inspection of each office of supervisory 
jurisdiction.'' See Notice to Members 87-41 (June 1987) (setting 
forth the then existing rule text for specified parts of Article 
III, Section 27 (Supervision) of the NASD Rules of Fair Practice as 
part of a proposal to amend the OSJ and branch office definitions).
    \12\ See Securities Exchange Act Release No. 26177 (October 13, 
1988), 53 FR 41008 (October 19, 1988) (Order Approving File No. SR-
NASD-88-31). See also Notice to Members 88-84 (November 1988) and 
Notice to Members 89-34 (April 1989).
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    Currently, Rule 3110(c) sets forth three main requirements for 
conducting internal inspections. First, an inspection of an office or 
location must occur on a designated frequency. 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; \13\ 
non-supervisory branch offices, at least every three years; \14\ and 
non-branch locations, on a periodic schedule, presumed to be at least 
every three years.\15\ Second, a member must 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.\16\ If applicable to the 
location being inspected, the inspection report must include the 
testing and verification of the member's policies and procedures, 
including supervisory policies and procedures, in specified areas.\17\ 
Third, 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.\18\ All branch offices and non-branch location are subject to 
Rule 3110(c).
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    \13\ See Rule 3110(c)(1)(A).
    \14\ See Rule 3110(c)(1)(B).
    \15\ See Rules 3110(c)(1)(C) and 3110.13 (General Presumption of 
Three-Year Limit for Periodic Inspection Schedules).
    \16\ See Rule 3110(c)(2).
    \17\ See Rule 3110(c)(2)(A) (providing 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).
    \18\ Rule 3110(c)(3) provides a limited exception from this 
requirement if a firm determines compliance is not possible either 
because of the firm's size or its business model. Rule 3110.14 
(Exception to Persons Prohibited from Conducting Inspections) 
reflects FINRA's expectation that a firm generally will rely on the 
exception in instances where the firm has only one office or has a 
business model where small or single-person offices report directly 
to an OSJ manager who is also considered the offices' branch office 
manager. However, these situations are non-exclusive, and a firm may 
still rely on the exception in other instances where it cannot 
comply because of its size or business model, provided the firm 
complies with the documentation requirements under the rule.
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    Further, Rule 3110.12 (Standards for Reasonable Review) sets out 
factors that constitute a reasonable review. This provision emphasizes 
establishing reasonable supervisory procedures and conducting reviews 
of locations, taking into consideration, among other things, the 
member's size, organizational structure, scope of business activities, 
number and location of the member's offices, the nature and complexity 
of the products and services offered by the member, 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'').\19\ The provision further states

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that the procedures established and reviews conducted must provide that 
the quality of supervision at remote (i.e., geographically dispersed) 
locations is sufficient to ensure compliance with applicable securities 
laws and regulations and with FINRA rules, and that members must be 
especially diligent with respect to a non-branch location where a 
registered representative engages in securities activities. This 
provision incorporates guidance FINRA has previously issued about 
supervising associated persons working in geographically dispersed 
offices.\20\
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    \19\ Red flags that suggest the existence or occurrence of 
violations, prompting an unannounced visit, may include: customer 
complaints; a large number of elderly customers; a concentration in 
highly illiquid or risky investments; 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 SLB 17, supra note 3; see also 
Notice 98-38 and Notice to Members 99-45 (June 1999) (``Notice 99-
45'').
    \20\ See, e.g., Notices 98-38 and 99-45.
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    In 2004, the SEC staff similarly provided guidance on supervision 
principles.\21\ At that time, the SEC staff noted that small, 
geographically scattered offices presented supervisory challenges when 
they were not subject to on-site supervision. The SEC staff observed 
that an office's geographic distance from supervisory personnel could 
make it easier for registered persons and other employees to carry out 
and conceal violative conduct. This general observation was derived 
from SEC enforcement cases finding that firms had inadequately 
supervised their associated persons working in small, geographically 
distant offices due to the failure of their supervisory mechanisms to 
detect and prevent misconduct. Citing technology available at the time, 
the guidance emphasized that an effective supervisory system for 
geographically dispersed offices uses a combination of on-site and off-
site monitoring; it specifically said that ``[c]entralized technology 
to monitor the trading and handling of funds in remote office accounts, 
as well as the use of personal computers, helps detect misappropriation 
of customer funds, selling away, and unauthorized trading, among other 
things[.]'' \22\ The guidance supported both routine or ``for cause'' 
on-site inspections, and encouraged unannounced inspections either on a 
random basis or where there are red flags about unusual activity at 
those offices. Further, as noted above, in the past both the SEC staff 
and FINRA have expressed the view that inspections must have an on-site 
component, reflecting how office inspections have been historically 
conducted.\23\
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    \21\ See SLB 17, supra note 3.
    \22\ See SLB 17, supra note 3.
    \23\ See note 3, supra.
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    Since the time these in-person guidelines were expressed, 
developments in technology have enhanced firms' overall and ongoing 
supervision and monitoring of the activities occurring at branch 
offices and non-branch locations. In response to these developments, 
member firms have questioned the historical expectation that firms 
satisfy the inspection component of Rule 3110(c) solely in a physical, 
on-site manner.
The 2017 Proposal To Allow Remote Inspections and the Impact From the 
Pandemic
    Even prior to the pandemic, in 2017, FINRA considered a proposal to 
give firms the option of satisfying the inspection requirement remotely 
for ``qualifying offices'' that met specified criteria.\24\ However, 
the COVID-19 pandemic, declared in early 2020,\25\ significantly 
changed the industry's standard business operations, forcing member 
firms to adapt to a full remote work environment and implement remote 
supervisory practices.\26\ FINRA deferred the 2017 Proposal in light of 
the pressing need to address significant operational disruptions to the 
securities industry, regulators, impacted member firms, investors and 
other stakeholders. During this exigent period, FINRA responded to 
numerous issues and questions that urgently arose.\27\ Following up on 
these actions, FINRA published Notice 20-42 to gain a broader 
understanding of member firm experiences during the pandemic. This 
notice sought feedback from firms about their experiences in a range of 
areas, including how member firms' operations and business models 
changed during the public health crisis and how they might further 
evolve as the pandemic persisted. Other initiatives included sharing 
general practices of firms in transitioning and supervising in the 
remote work environment, and providing temporary relief to member firms 
from specified FINRA rules and requirements.\28\ In particular, to give 
firms an opportunity to better manage their operational challenges and 
redirect resources attendant to fulfilling their inspection 
obligations, FINRA provided temporary relief to member firms pertaining 
to the in-person inspection aspect of Rule 3110(c).\29\
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    \24\ See Regulatory Notice 17-38 (November 2017) (``2017 
Proposal''). FINRA had requested comment on a proposed amendment to 
Rule 3110 to allow remote inspections of ``qualifying offices'' that 
met specified criteria, in lieu of on-site inspections of such 
offices and locations. In general, many of the comment letters FINRA 
had received expressed support for the underlying concept of remote 
inspections and offered recommendations on specific criteria to 
broaden the potential population of qualifying offices.
    \25\ See Centers for Disease Control and Prevention (``CDC''), 
International Classification of Diseases, Tenth Revision, Clinical 
Modification (ICD-10-CM) (Effective March 18, 2020), 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/director-general/speeches/detail/who-director-general-s-opening-remarks-at-the-media-briefing-on-covid-19-11-march-2020.
    \26\ See generally Regulatory Notice 20-16 (May 2020).
    \27\ See note 6, supra.
    \28\ Some temporary amendments to other FINRA rules still remain 
in effect. See Securities Exchange Act Release No. 95281 (July 14, 
2022), 87 FR 43335 (July 20, 2022) (Notice of Filing and Immediate 
Effectiveness of File No. SR-FINRA-2022-018) (extending the 
expiration date of temporary amendments set forth in SR-FINRA-2020-
015 and SR-FINRA-2020-027).
    \29\ See Rules 3110.16 and 3110.17.
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Temporary Amendments to the Inspection Requirement Under Rule 3110(c)
    At the outset of the pandemic in the United States, many states 
issued stay-at-home orders and imposed restrictions on businesses, 
social activities, and travel in hopes of slowing the spread of COVID-
19.\30\ In response, many government and private employers, including 
member firms, closed their offices and moved their employees to 
alternative worksites (e.g., an employee's residence). These 
operational changes made it impracticable for member firms to conduct 
the on-site inspection component of Rule 3110(c) at most locations for 
that year because of limitations on travel to geographically dispersed 
OSJs, branch offices, and non-branch locations. In response to the 
logistical challenges, FINRA extended the time by which member firms 
were required to complete their calendar year 2020 inspection 
obligations under Rule 3110(c) to March 31, 2021 with the expectation 
that the extension did not relieve firms from the on-site portion of 
the inspections of their offices and locations.\31\ However, health and 
safety concerns remained unabated and with many restrictive measures 
still in place as calendar year 2020 was ending, FINRA adopted Rule 
3110.17 to provide member firms the option, subject to specified 
requirements under the supplementary material, to complete

[[Page 50148]]

remotely their calendar year inspection obligations without an on-site 
visit to the office or location.\32\ This relief was repeatedly 
extended until the end of 2022.\33\ Rule 3110.17 will automatically 
sunset on December 31, 2022.\34\
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    \30\ See note 7, supra, 85 FR 75097, 75098 n.10.
    \31\ 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).
    \32\ See note 7, supra.
    \33\ See Securities Exchange Act Release No. 93002 (September 
15, 2021), 86 FR 52508 (September 21, 2021) (Notice of Filing and 
Immediate Effectiveness of File No. SR-FINRA-2021-023); and 
Securities Exchange Act Release No. 94018 (January 20, 2022), 87 FR 
4072 (January 26, 2022) (Notice of Filing and Immediate 
Effectiveness of File No. SR-FINRA-2022-001).
    \34\ See note 33, supra.
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    Through comments to the 2017 Proposal, Notice 20-42, the various 
temporary amendments to Rule 3110, and other engagement with industry 
representatives, firms have highlighted that Rule 3110(c) was adopted 
well before the prevalence of modern technology, including laptops, 
mobile devices, video conferencing capabilities, electronic storage and 
electronic surveillance, at a time when on-site inspections were the 
only conceivable way firms could inspect and review activities 
occurring in outlying offices and locations. The advent of new and 
developing technologies has enhanced the effectiveness of a firm's 
ongoing supervision and monitoring of associated persons working from 
dispersed branch offices and non-branch locations. In addition, firms 
have noted that in practice, those technological advances allow a large 
portion of inspection work to be conducted electronically, prior to any 
on-site visit to the office and location, and that in general, on-site 
inspections of many offices and locations are one component of a firm's 
overall supervisory system of associated persons and offices, and as 
such are no longer an efficient and effective use of limited firm 
resources.\35\
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    \35\ In response to FINRA's proposed rule changes associated 
with Rule 3110.17, one commenter made similar points about the 
physical, on-site piece of the inspection process. This commenter 
stated that pre-pandemic, an on-site inspection of a branch office 
typically consisted of reviewing the lobby area of the office, the 
back office (to review safe contents, sales literature, daily 
operations logs containing account applications), signage, and the 
physical security of the office. See Letter from Carrie L. Chelko, 
Chief Compliance Officer, Fidelity Brokerage Services LLC 
(``Fidelity Brokerage'') & Norman L. Ashkenas, Chief Compliance 
Officer, National Financial Services LLC (``NFS'') and Fidelity 
Distributors Company LLC (``Fidelity Distributors''), to Vanessa 
Countryman, Secretary, SEC, dated July 28, 2020, in response to 
Securities Exchange Act Release No. 89188 (June 30, 2020), 86 FR 
40713 (July 7, 2022) (Notice of Filing and Immediate Effectiveness 
of File No. SR-FINRA-2020-019) and Letter from Gail Merken, Chief 
Compliance Officer, Fidelity Brokerage, Janet Dyer, Chief Compliance 
Officer, NFS & John McGinty, Chief Compliance Officer, Fidelity 
Distributors, to Vanessa Countryman, Secretary, SEC, dated February 
16, 2022, in response to Securities Exchange Act Release No. 94018 
(January 20, 2022), 87 FR 4072 (January 26, 2022) (Notice of Filing 
and Immediate Effectiveness of File No. SR-FINRA-2022-001).
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    However, Rule 3110.17 was adopted in the midst of the pandemic, 
when many offices and locations were closed, and employees carried out 
their responsibilities from alternative worksites. FINRA recognizes 
that the pandemic has changed the conventional thinking on where work 
is conducted and this shift in the workforce landscape will unlikely 
revert to the model that existed pre-pandemic. As noted above, FINRA 
believes that adopting a voluntary, three-year remote inspection pilot 
program, under terms based largely on Rule 3110.17, but with 
significant safeguards, would allow FINRA the time to collect specified 
data from member firm pilot participants to evaluate their experiences 
and inspection findings in a uniform, comparable manner in the context 
of the emerging hybrid work model. FINRA anticipates that the proposed 
pilot program will provide broader systemized information to supplement 
the information obtained through the FINRA examination process in an 
environment where offices and locations were closed. The information 
firms will be required to produce as a pilot program participant will 
help FINRA more accurately assess the overall impacts on firms' 
supervisory systems to inform FINRA's application of supervisory 
requirements to the new work environment, including potentially broader 
reliance on remote inspections.
Proposed Voluntary, Three-Year Pilot Program for Remote Inspections
    With Rule 3110.17 operational since November 2020, and the 
widespread availability and use of technology described above, 
regulators are being challenged to consider whether on-site inspections 
by firms should be a necessity and if they continue to be an efficient 
and effective method for supervising and monitoring associated persons 
and offices as part of a firm's overall supervisory system.
    As FINRA emphasized in the proposed rule change to adopt Rule 
3110.17, the responsibility of firms to supervise their associated 
persons on a day-to-day basis is a critical component of broker-dealer 
regulation.\36\ The inspection requirement in Rule 3110(c) is just one 
element of a reasonably designed supervisory system. FINRA believes 
that a pilot period of risk-based on-site supervision is consistent 
with firms' core responsibility, as set forth 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 proposed pilot program would build largely on the 
terms of Rule 3110.17, but would be enhanced in several ways, including 
notably targeted exclusions from participation in the program for 
higher risk member firms, and offices or locations. In addition, the 
proposed pilot program would require a firm conduct a risk assessment 
for each office or location that is selected to be inspected remotely, 
documented with the factors considered. Finally, the proposed pilot 
program would require a firm to establish and maintain written 
supervisory procedures to account for the risk assessment and sets 
forth the scope of the program.
---------------------------------------------------------------------------

    \36\ See note 7, supra.
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A. Scope of Pilot (Proposed Rule 3110.18(a))
    Under proposed Rule 3110.18(a), the proposed pilot program would 
apply to the required inspections of OSJs, branch offices, and non-
branch locations under the applicable provisions under Rule 3110(c)(1) 
for a pilot period of three years starting on the effective date, and 
expiring on a date that is three years after the effective date. If the 
proposed pilot program is not extended or Rule 3110.18, as may be 
amended, is not approved as permanent by the SEC, the proposed 
supplementary material will automatically sunset on a date that is 
three years after the effective date. In addition, proposed Rule 
3110.18(a) would expressly state that members would not be able to 
avail themselves of the proposed pilot program after it expires.
B. Use of Remote Inspections (Proposed Rule 3110.18(b))
1. Risk-Based Approach; Risk Assessment (Proposed Rule 3110.18(b)(1))
    As described above, 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 as an OSJ, branch office or non-branch 
location. Subject to proposed Rule 3110.18(b)(2) as described below, 
proposed Rule 3110.18(b)(1) would provide that a member firm may elect 
to conduct the applicable inspection of an office or location during 
the pilot period remotely, without necessarily an on-site

[[Page 50149]]

visit for the office or location, when the member reasonably determines 
that the purposes of the rule can be accomplished by conducting such 
required inspection remotely.\37\ Proposed Rule 3110.18(b)(1) would 
also provide that prior to electing a remote inspection for an office 
or location, rather than an on-site inspection, the firm must develop a 
reasonable risk-based approach to using remote inspections and conduct 
and document a risk assessment for that office or location. The 
assessment must document the factors considered, including the factors 
set forth in Rule 3110.12, and must take into account any higher risk 
activities that take place or higher risk associated persons that are 
assigned to that location. FINRA expects that higher risk factors at a 
particular location would cause a firm to conduct on-site inspections 
of such location. Further, under the proposed supplementary material, a 
member that is not eligible to conduct remote inspections under 
proposed Rule 3110.18(b)(2) must conduct an on-site inspection of that 
office or location on the required cycle. Finally, notwithstanding the 
pilot program, a member would remain subject to the other requirements 
and limitations of Rule 3110(c).\38\
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    \37\ As described further below, a member firm that elects to 
participate in the proposed pilot program would be subject to the 
requirements of proposed Rule 3110.18 for a Pilot Year. See proposed 
Rule 3110.18(g).
    \38\ For example, as currently required with any physical, on-
site inspection, a member would be required to reduce the remote 
inspection to a written report and satisfy the content and record 
retention requirements of such report as described in Rule 
3110(c)(2). Similarly, a member would remain subject to Rule 
3110(c)(3)'s general prohibition against an associated person from 
conducting a location's inspection if the person either is assigned 
to that location or is directly or indirectly supervised by, or 
otherwise reports to, someone assigned to that location. Rule 
3110(c)(3) provides a limited exception from this general 
prohibition for specified circumstances (e.g., the member has a 
business model where a small or single-person offices report 
directly to an OSJ manager who is also considered the offices' 
branch office manager) by requiring a member to document in the 
inspection report both the factors the member used to make the 
determination that it could not comply with the general prohibition 
and how the inspection otherwise complies with Rule 3110(c)(1).
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2. Ineligible Member Firms, and Offices or Locations (Proposed Rule 
3110.18(b)(2))
    FINRA is proposing to exclude some member firms or their offices or 
locations from participating in the proposed pilot program. The 
proposed categories of ineligibility are events or activities of a 
member firm or its associated persons that FINRA believes are more 
likely to raise investor protection concerns based on the firm's or an 
associated person's record of specified regulatory or disciplinary 
events.
    Under proposed Rule 3110.18(b)(2)(A), a member firm would be 
ineligible to conduct remote inspections of any of its offices if any 
time during the period of the proposed pilot program, the member is or 
becomes: (1) designated as a Restricted Firm under Rule 4111 \39\ 
(proposed Rule 3110.18(b)(2)(A)(i)); or (2) designated as a Taping Firm 
under Rule 3170 \40\ (proposed Rule 3110.18(b)(2)(A)(ii). These rules 
expressly address firms that pose higher risks, and for that reason, 
would be ineligible to participate in the proposed pilot program.
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    \39\ In general, Rule 4111 (Restricted Firm Obligations) 
requires member firms that are identified as ``Restricted Firms'' to 
deposit cash or qualified securities in a segregated, restricted 
account; adhere to specified conditions or restrictions; or comply 
with a combination of such obligations. See generally Regulatory 
Notice 21-34 (September 2021) (announcing FINRA's adoption of rules 
to address firms with a significant history of misconduct).
    \40\ In general, Rule 3170 (Tape Recording of Registered Persons 
by Certain Firms) requires a member firm to establish, enforce and 
maintain special written procedures supervising the telemarketing 
activities of all of its registered persons, including the tape 
recording of conversations, if the firm has hired more than a 
specified percentage of registered persons from firms that meet 
FINRA Rule 3170's definition of ``disciplined firm.'' See generally 
Regulatory Notice 14-10 (March 2014) (announcing FINRA's adoption of 
consolidated rules governing supervision).
---------------------------------------------------------------------------

    In addition, under proposed Rule 3110.18(b)(2)(B), a member firm's 
office or location would be ineligible for a remote inspection if at 
any time during the period of the proposed pilot program, an associated 
person at such office or location is or becomes: (1) subject to a 
mandatory heightened supervisory plan under the rules of the SEC, FINRA 
or state regulatory agency (proposed Rule 3110.18(b)(2)(B)(i)); (2) 
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 proposed Rule 
3110.18(b)(2)(B)(i) or otherwise as a condition to approval or 
permission for such association (proposed Rule 3110.18(b)(2)(B)(ii)); 
(3) subject to Rule 1017(a)(7) \41\ as a result of one or more 
associated persons at such location (proposed Rule 
3110.18(b)(2)(B)(iii)); or (4) one or more associated persons at such 
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 \42\ (proposed Rule 
3110.18(b)(2)(B)(iv)). FINRA believes that the imposition of a 
mandatory heightened supervisory plan, a statutorily disqualification, 
a Rule 1017(a)(7) review due to significant misconduct, or the 
existence of specified disclosures on Form U4 pertaining to criminal 
convictions and final regulatory action are indicia of increased risk 
to investors at some office or locations, such that they should not be 
eligible for remote inspections in accordance with the proposed pilot 
program.
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    \41\ In general, Rule 1017(a)(7) require a member firm to file a 
CMA when a natural person seeking to become an owner, control 
person, principal or registered person of the member firm has, in 
the prior five years, one or more defined ``final criminal matters'' 
or two or more ``specified risk events'' unless the member firm has 
submitted a written request to FINRA seeking a materiality 
consultation for the contemplated activity. Rule 1017(a)(7) applies 
whether the person is seeking to become an owner, control person, 
principal or registered person at the person's current member firm 
or at a new member firm. See generally Regulatory Notice 21-09 
(March 2021) (announcing FINRA's adoption of rules to address 
brokers with a significant history of misconduct).
    \42\ Form U4's Questions 14A(1)(a) and 2(a), 14B(1)(a) and 2(a) 
elicit reporting of criminal convictions, and Questions 14C, 14D, 
and 14E pertain to regulatory action disclosures.
---------------------------------------------------------------------------

    A member firm or an office or location subject to one of the 
categorical restrictions would not be eligible for remote inspections, 
even if the firm's risk assessment concludes that a remote inspection 
would be appropriate. A member firm would be required to conduct an on-
site inspection of that office or location on the required cycle. FINRA 
believes the proposed list of ineligibility categories is appropriately 
derived from existing rule-based criteria that are part of processes to 
identify firms that may pose greater concern (e.g., Rules 4111 and 
3170) or associated persons that may pose greater concerns due to the 
nature of disclosures of regulatory or disciplinary events on the 
uniform registration forms. FINRA believes that these objective 
categorical restrictions will provide safeguards that will help ensure 
that firms maintain effective supervisory procedures during the pilot 
period.
C. Written Supervisory Procedures for Remote Inspections (Proposed Rule 
3110.18(c))
    As part of an effective supervisory system tailored specifically to 
the member firm's business and the activities of all its associated 
persons, a member must establish and maintain written procedures.\43\ 
Paragraph (1) (General Requirements) under Rule 3110(b) (Written 
Procedures) provides

[[Page 50150]]

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.
---------------------------------------------------------------------------

    \43\ See Rule 3110(a)(1); see generally Notice 99-45 and 
Regulatory Notice 18-15 (April 2018).
---------------------------------------------------------------------------

    Currently, Rule 3110.17(b) expressly provides that consistent with 
a member's obligation under Rule 3110(b)(1), a member that elects to 
conduct each of its inspections in the specified calendar years 
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. In addition, under 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. Further, 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.\44\ To underscore the 
importance of Rule 3110(b)(1) in the context of the proposed pilot 
program, FINRA is proposing to add to the elements currently described 
under Rule 3110.17(b) an express provision that the firm must adopt 
written supervisory procedures regarding remote inspections that are 
reasonably designed to detect and prevent violations of and achieve 
compliance with applicable securities laws and regulations, and with 
application FINRA rules. In addition, a firm's written supervisory 
procedures should also include the factors considered in the risk 
assessment made for each applicable office or location pursuant to 
proposed Rule 3110.18(b).
---------------------------------------------------------------------------

    \44\ 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.
---------------------------------------------------------------------------

D. Effective Supervisory System (Proposed Rule 3110.18(d))
    FINRA is proposing to retain the terms of Rule 3110.17(c), without 
substantive change, in proposed Rule 3110.18(d). Similar to Rule 
3110.17(c), proposed Rule 3110.18(d) would expressly reiterate the 
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 the member conducts 
inspections remotely. In addition, proposed Rule 3110.18(d) would 
provide that a member's remote inspection of an office or location 
would be held to the same standards for review applicable to on-site 
inspections as set forth under Rule 3110.12.\45\ Further, proposed Rule 
3110.18(d) 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''), the member may need to impose 
additional supervisory 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.
---------------------------------------------------------------------------

    \45\ See note 19, supra and accompanying text.
---------------------------------------------------------------------------

E. Documentation Requirement (Proposed Rule 3110.18(e))
    In general, Rule 3110(c)(2) imposes various documentation 
requirements for inspections, including maintaining a written record of 
the date upon which each inspection is conducted. Currently, Rule 
3110.17(d) requires 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 years specified in 
the supplementary material 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 is proposing to incorporate, without substantive 
change, the terms of Rule 3110.17(d) in proposed Rule 3110.18(e), but 
make two clarifying changes. One change would be to reference that the 
centralize record must be for each of the ``pilot years'' (as defined 
in proposed Rule 3110.18(h)), and the other change would be to clarify 
that 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, including whether an 
on-site inspection was conducted at such office.
F. Data and Information Collection Requirement (Proposed Rule 
3110.18(f))
1. Data and Information (Proposed Rule 3118.18(f)(1))
    As noted above, Rule 3110.17 was adopted in the midst of the 
pandemic and operationalized in an environment in which many offices 
and locations were closed to the public. FINRA believes that the 
formalized, uniform collection of data is critical to allow FINRA to 
meaningfully assess the effectiveness of remote inspections to help 
shape potential permanent amendments to Rule 3110(c) that would 
optimize an inspection program in the evolving workplace environment. 
FINRA believes having a pilot program for remote inspections with 
appropriate conditions, limitations and documentation requirements in 
an environment that is resettling into a hybrid workplace model would 
provide a clearer picture of the strengths and weaknesses of remote 
inspections, without compromising investor protection. Proposed Rule 
3110.18(f) would impose upon firms a data and information collection 
requirement as a condition for participating in the pilot program. On a 
frequency not to exceed quarterly, participating firms would be 
required to collect and produce to FINRA, in a manner and format 
determined by FINRA, data consisting of separate counts for OSJs, 
supervisory branch offices, non-supervisory branch offices, and non-
branch locations, consistent with paragraphs (c)(1)(A), (B) and (C) 
under Rule 3110, for several categories, including: (1) the total 
number of inspections--on-site and remote--completed during each 
calendar quarter; \46\ (2) the number of those office or locations in 
each calendar quarter that were subject to an on-site inspection 
because of a ``finding'' (defined under proposed Rule 3110.18(f) as an 
item that led to any

[[Page 50151]]

remedial action or was listed on the member's inspection report); \47\ 
(3) the number of locations for which a remote inspection was conducted 
in the calendar quarter that identified a finding, the number of 
findings, and a list of the most significant findings; \48\ and (4) the 
number of locations for which a on-site inspection was conducted in the 
calendar quarter that identified a finding, the number of findings, a 
list of the most significant findings.\49\ In addition, firms would be 
required to provide FINRA their written supervisory procedures for 
remote inspections that account for: (1) escalating significant 
findings; new hires; supervising brokers with a significant history of 
misconduct; and outside business activities and ``doing business as'' 
(or DBA) designations.\50\ Firms would be required to provide FINRA 
with a copy of these written supervisory procedures alongside the first 
delivery of the data points described above, and any subsequent 
amendments to such procedures for remote inspections.\51\
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    \46\ See proposed Rule 3110.18(f)(1)(A), (B) and (C).
    \47\ See proposed Rule 3110.18(f)(1)(D).
    \48\ See proposed Rule 3110.18(f)(1)(E).
    \49\ See proposed Rule 3110.18(f)(1)(F).
    \50\ See proposed Rule 3110.18(f)(1)(G)(i) through (iv).
    \51\ See proposed Rule 3110.18(f)(1)(G).
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2. Additional Data and Information for Pilot Year 1 (Proposed Rule 
3110.18(f)(2))
    Proposed Rule 3110.18(f)(2) would address the additional data and 
information requirements for Pilot Year 1 (as defined under proposed 
Rule 3110.18(h)), if such year covers a period that is less that a full 
calendar year. In such case, a member that elects to participate in the 
proposed pilot program would be required to collect the following data 
and information and provide such data and information to FINRA (in a 
manner and format FINRA determines) no later than December 31 of such 
first Pilot Year. For items (1) through (3) below, a member would be 
required to provide separate counts for OSJs, supervisory branch 
offices, non-supervisory branch offices, and non-branch locations 
consistent with paragraphs (c)(1)(A), (B) and (C) under Rule 3110: (1) 
the number of locations with an inspection completed during the full 
calendar year of the first Pilot Year; (2) the number of locations in 
item (1) that were inspected remotely during the full calendar year of 
the first Pilot Year; and (3) the number of locations in item (1) that 
were inspected on-site during the full calendar year of the first Pilot 
Year. This additional data and information would provide FINRA the 
ability to capture, in the aggregate, complete inspection counts--total 
number of Rule 3110(c)(1) inspections (remote and on-site)--for the 
entire calendar year in addition to the more detailed data and 
information requirements under proposed Rule 3110.18(f)(1).
3. Written Policies and Procedures (Proposed Rule 3110.18(f)(3))
    Proposed Rule 3110.18(f)(3) would also remind firms of the general 
requirement to establish, maintain and enforce written policies and 
procedures that are reasonably designed to comply with the data and 
information collection, and transmission requirements of the proposed 
pilot program.
4. Remote Inspections Pilot Program Participation (Proposed Rule 
3110.18(g))
    Proposed Rule 3110.18(g) would set forth the manner in which a firm 
would notify FINRA of the firm's election to participate in the 
proposed pilot program and to withdraw from it. The proposed rule would 
provide that FINRA may, in exceptional cases and where good cause is 
shown, waive the applicable timeframes described below for the required 
opt-in or opt-out notices.
    Proposed Rule 3110.18(g) would require a firm, at least five 
calendar days before the beginning of such Pilot Year, to provide FINRA 
an ``opt-in notice'' in the manner and format determined by FINRA. By 
providing such opt-in notice to FINRA, the firm agrees to participate 
in the proposed pilot program for the duration of such Pilot Year and 
to comply with the requirements of Rule 3110.18.\52\ A firm that 
provides the opt-in notice for a Pilot Year would be automatically 
deemed to have elected and agreed to participate in the Remote 
Inspections Pilot Program for subsequent Pilot Years (i.e., Pilot Year 
2, Pilot Year 3, and Pilot Year 4, if applicable) until the pilot 
program expires. Further, proposed Rule 3110.18(g) would describe the 
notice requirement for a firm to withdraw from the proposed pilot 
program. A firm would be required to provide FINRA with an ``opt-out 
notice'' at least five calendar days before the end of the then current 
Pilot Year.
---------------------------------------------------------------------------

    \52\ A firm that participates in a Pilot Year would be committed 
to complying with the terms of proposed Rule 3110.18 for that Pilot 
Year.
---------------------------------------------------------------------------

    By way of example, a firm that provides FINRA an opt-in notice on 
June 26 to join Pilot Year 1 that begins on July 1 would be 
automatically deemed to continue participating in Pilot Year 2 unless 
the firm provides FINRA the required opt-out notice no later than 
December 26 of Pilot Year 1. To continue with this example, a firm that 
was automatically deemed to participate in Pilot Year 2 and determines 
in mid-Pilot Year 2 that it does not want to automatically continue 
into Pilot Year 3 could elect to withdraw from Pilot Year 3 if it 
provides FINRA an opt-out notice at least five calendar days before the 
end of Pilot Year 2. However, because Pilot Year 2 is already underway, 
the firm would be required to complete Pilot Year 2 in accordance with 
proposed Rule 3110.18.
    FINRA believes that this proposed operational aspect of the program 
would not only establish a cohesive process in which firms and FINRA 
may manage program participation but also lend some continuity in data 
and information collection that would support FINRA's assessment and 
evaluation of the experiences of pilot participants.
5. Definitions (Proposed Rule 3110.18(h))
    Proposed Rule 3110.18(h) would set forth the meanings underlying 
``Pilot Year'' to explain the duration of the proposed pilot program. 
Under proposed Rule 3110.18(h), a ``Pilot Year'' would mean the 
following: (1) Pilot Year 1 would be the period beginning on the 
effective date of the proposed pilot program and ending on December 31 
of the same year; (2) Pilot Year 2 would mean the calendar year period 
following Pilot Year 1, beginning on January 1 and ending on December 
31; and (3) Pilot Year 3 would mean the calendar year period following 
Pilot Year 2, beginning on January 1 and ending on December 31. 
Finally, if applicable, where Pilot Year 1 covers a period that is less 
than a full calendar year, then Pilot Year 4 would mean the period 
following Pilot Year 3, beginning on January 1 and ending on a date 
that is three years after the effective date.
6. Failure To Satisfy Conditions (Proposed Rule 3110.18(i))
    Proposed Rule 3110.18(i) would address a situation in which a firm 
fails to satisfy terms of the proposed pilot program. The proposed 
paragraph would provide that a firm that fails to satisfy the 
conditions of Rule 3110.18, including the requirement to timely collect 
and submit the data and information to FINRA as set forth in proposed 
Rule 3110.18(f), would be ineligible to participate in the pilot 
program and must conduct on-site inspections of each office and 
location

[[Page 50152]]

on the required cycle in accordance with Rule 3110(c).
7. Sunset of Rule 3110.17 (Proposed Rule 3110.18(j))
    Proposed Rule 3110.18 would expressly account for the possibility 
that the proposed pilot program becomes effective while Rule 3110.17 is 
in effect to avoid overlapping provisions. Proposed paragraph (j) would 
provide that if Rule 3110.17 has not already expired by its own terms, 
it would automatically sunset on the effective date of proposed Rule 
3110.18.
    Consistent with the principles set forth in prior guidance, FINRA 
expects members to establish reasonably designed inspection programs. 
The proposed pilot program for remote inspections does not alter the 
core obligation of a member firm 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.\53\ As part of the 
inspection planning process, FINRA expects members to continue with 
their ongoing supervision, including risk analysis of the activities 
and functions occurring at all offices or locations. While the option 
to conduct remote inspections provides greater choice in how to 
effectively supervise some offices or locations, a member must continue 
to consider the factors described in Rule 3110.12, along with the 
activities taking place there. This analysis may require the member to 
conduct a physical, on-site inspection of an office or location. Where 
there are indications of problems or red flags at any office or 
location, FINRA expects members to investigate them as they would for 
any other office or location subject to Rule 3110(c), which may include 
an unannounced, on-site inspection of the office or location. FINRA is 
committed to diligently monitoring the impacts of remote inspections on 
a firms' overall supervisory systems and reviewing the data over the 
life of the proposed pilot program to assess how firms apply the 
flexibility provided by the pilot program while maintaining an 
effective supervisory program.
---------------------------------------------------------------------------

    \53\ See Rule 3110(a).
---------------------------------------------------------------------------

    If the Commission approves the proposed rule change, FINRA will 
announce the effective date of the proposed rule change in a Regulatory 
Notice.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\54\ 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.
---------------------------------------------------------------------------

    \54\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The terms of the proposed voluntary, three-year remote inspection 
pilot program, while based largely on the terms of Rule 3110.17, which 
has been operational since the latter part of 2020 and is set to 
automatically sunset on December 31, 2022, would include important 
safeguards that would require individual risk assessments of each 
office, supplemental written supervisory procedures related to remote 
inspections, documentation requirements and obligations to share data 
with FINRA to allow for assessment of the pilot program. The proposed 
rule change is intended to provide firms that are transitioning to a 
hybrid work environment the option to conduct remote inspections of 
their offices and locations, subject to specified conditions, while 
maintaining effective supervision. FINRA believes that the proposed 
pilot program would provide FINRA the appropriate amount of time and 
population sample to better evaluate the use of remote inspections in 
the unfolding office work environment. FINRA believes the proposed 
pilot program, with the proposed safeguards and controls, will provide 
firms more flexibility to adapt to changing work conditions. The 
proposed pilot program would aid in FINRA's assessment of the 
effectiveness of a flexible remote inspection option and its utility in 
an environment that is increasingly moving to hybrid workplace models, 
without compromising investor protection.

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.
Economic Impact Assessment
    FINRA has undertaken an economic impact assessment, as set forth 
below, to analyze the regulatory need for the proposed rule change, its 
potential economic impacts, including anticipated costs, benefits, and 
distributional and competitive effects, relative to the current 
baseline, and the alternatives FINRA considered in assessing how best 
to meet FINRA's regulatory objectives.
1. Regulatory Need
    The proposed pilot program would serve two purposes. First, it 
would mitigate potential disruptions to the hybrid work arrangements 
that have developed during the pandemic. In particular, for 
participating members, the proposed pilot program would limit the 
increase in aggregate inspection costs, and the resulting incentive to 
reduce the number and type of work locations, that would occur when 
temporary relief provided during the pandemic expires.\55\ The proposed 
pilot program would not eliminate the need for such adjustments, but it 
would allow member firms to focus their on-site inspections on riskier 
locations.
---------------------------------------------------------------------------

    \55\ According to the April Survey of Working Arrangements and 
Attitudes (SWAA), post-COVID, many employers are planning to allow 
employees to work from home between two and three days per week. See 
Jose Maria Barrero, Nicholas Bloom & Steven J. Davis, SWAA April 
2022 (April 11, 2022), https://wfhresearch.com/wp-content/uploads/2022/04/WFHResearch_updates-April-2022.pdf. The number of expected 
work-from-home days post-pandemic has been increasing steadily since 
the January 2021 survey. The SWAA is monthly survey with respondents 
that are working-age persons in the United States that had earnings 
of at least $20,000 in 2019. Further details about this survey can 
be found in https://wfhresearch.com.
---------------------------------------------------------------------------

    The proposed pilot program would also allow FINRA to assess the 
benefits and costs of allowing some element of remote inspection of 
branch offices and non-branch locations, under specified conditions, in 
the post-pandemic world. FINRA would obtain information from 
participating members on certain elements of the risk-based approach 
that they implement, the type and frequency of inspections, and certain 
outcomes conditional on the type and frequency of inspections, as well 
as the type of office or location inspected.
2. Economic Baseline
    The economic baseline for the proposed rule change includes both 
current and foreseeable workforce arrangements and business practices, 
including those that were first developed during the pandemic and have 
been modified since. In particular, the economic baseline includes the 
innovations, and investments in communication and surveillance 
technology, that have supported and continue to support supervision in 
the remote work environment.\56\ These

[[Page 50153]]

innovations and investments were developed during the temporary relief 
allowing remote inspections in Rule 3110.17, and the temporary 
suspension of the requirement to submit branch office applications on 
Form BR for new office locations provided in Notice 20-08. The baseline 
includes the scheduled expiration of Rule 3110.17 on the effective date 
of the proposed Rule 3110.18; and, in order to provide a full 
accounting of the likely effects of the proposed rule change, the 
analysis also assumes that, going forward, the temporary suspension of 
the above requirement is no longer in effect. FINRA expects that 
numerous additional office locations would then need to be registered, 
greatly expanding the number of inspections, and all inspections would 
then need to be conducted on-site.
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    \56\ The pandemic propelled increased reliance on technology 
solutions in the remote work environment. A Thompson Reuters survey 
of compliance and risk practitioners shows a 70% increase in the 
reliance on technological solutions and 30% of respondents expected 
increases in the budget for RegTech solutions, specifically. See 
Thompson Reuters, FinTech, RegTech and the Role of Compliance 2021, 
https://legal.thomsonreuters.com/content/dam/ewp-m/documents/legal/en/pdf/reports/fintech-regtech-and-the-role-of-compliance-in-2021.pdf.
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    As of April 30, 2022, FINRA's membership included 3,365 firms with 
151,463 registered branch offices.\57\ Of these branch offices, 18,290 
(12%) are OSJs subject to an annual inspection requirement. The 
remaining 133,173 branch locations are non-OSJ branch offices subject 
to an inspection requirement at least annually or every three years. In 
addition, according to FINRA estimates, there are more than 66,054 non-
branch locations, of which 37,290 are private residences.\58\ A non-
branch location must be inspected on a periodic schedule, presumed to 
be at least every three years. These data may be affected by the 
temporary relief from certain requirements to update Form U4 and to 
submit Form BR provided in Notice 20-08. FINRA estimates that member 
firms conduct approximately 84,700 inspections per year.
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    \57\ This count excludes firms with membership pending approval, 
and withdrawn or terminated from membership.
    \58\ Non-branch locations do not have to be registered with 
FINRA. The estimates for non-branch locations, including those that 
are also private residences, are obtained by reviewing Form U4. 
There may be some double counting of non-branch locations if members 
record the address differently on more than one Form U4 (e.g., use 
``St.'' on one and ``Street'' on another).
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    FINRA adopted temporary Rule 3110.17 in late 2020 and the temporary 
rule has been extended twice since.\59\ Hence, as of June 2022, member 
firms have been able to conduct remote inspections for 18 months. FINRA 
staff considered findings from FINRA's examination of member firms and 
their branch locations that took place in between 2018 and 2021. This 
preliminary review found no significant departures relative to pre-
pandemic examination results.\60\
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    \59\ See notes 7 and 33, supra.
    \60\ FINRA examinations generally review member activities for 
the year preceding the examination, and the vast majority of 
examinations takes place during the first 10 months of the calendar 
year. Examinations check for compliance with federal laws, rules and 
regulations; the specific areas examined in a firm are based on the 
risk profile of the firm. FINRA publishes an annual summary of key 
observations and best practices across all examinations. See the 
published reports at https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs#guidance. Due to 
this time lag in FINRA examinations, findings may reflect decisions 
about remote inspections made by members preceding examinations up 
to 12 months. Hence, most FINRA examinations in 2020 will reflect 
member planning undertaken prior to the adoption of Rule 3110.17. 
Conversely, 66% of FINRA examinations for calendar 2021 have not 
been finalized. In addition, FINRA examinations of member firms and 
their activities are risk-based. Given the focus on higher risk 
firms and some variations in the areas of focus in examinations, 
year-on-year comparisons should be treated with caution.
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3. Economic Impacts
    As discussed above, absent the proposed rule change, FINRA expects 
that numerous additional office locations will need to be registered, 
greatly expanding the number of inspections, and all inspections would 
then need to be conducted on site. The economic impacts of these 
changes would be mitigated by the proposed rule change for firms that 
choose to participate in the pilot program.\61\
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    \61\ Separately, FINRA has filed a proposed rule change to 
establish a Residential Supervisory Location (``RSL''), a new non-
branch location, that would, relative to the baseline, reduce the 
number of inspections that members with RSLs would need to conduct 
in a year. See Securities Exchange Act Release No. 95379 (July 27, 
2022) (Notice of Filing of File No. SR-FINRA-2022-019). For member 
firms with locations that would meet the proposed definition of an 
RSL, the aggregate cost savings from choosing to participate in the 
proposed pilot program would be lower if the RSL proposal were in 
place because the cost savings from remote inspections would accrue 
over fewer inspections. The qualitative impacts of the proposed 
pilot program, however, are similar whether the proposed definition 
of an RSL is adopted or not.
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    Participants in the pilot program would be expected to take a risk-
based approach to conducting remote inspections. A firm that does not 
conduct a remote inspection for an office or location must conduct an 
on-site inspection of that office or location on the required cycle and 
remains subject to the other requirements of Rule 3110(c). A firm that 
chooses to participate in the pilot program (assuming that it is not 
otherwise ineligible from participating) would also be required to 
provide FINRA with certain data and other information about the risk-
based approach that they implement, the type and frequency of 
inspections, and certain outcomes conditional on the type and frequency 
of inspections.
Anticipated Benefits
    The benefit to firms of choosing to participate in the pilot 
program, in an improved health environment, would result from limiting 
the increase in travel costs and lost productivity due to time spent 
during travel and in the on-site inspection. On-site visits have 
material costs from travel expenses and additional staff time. A system 
of risk-based on-site and remote inspections will allow firms to more 
efficiently deploy compliance resources and to use an on-site component 
only when appropriate.
    Firms as well as investors may benefit if remote inspections 
provide new flexibility in the design of inspection teams. For example, 
remote inspections may facilitate the development of specialized 
inspection staff that are deployed over more inspections, for shorter 
periods of time, in a targeted way. This option may especially benefit 
diversified member firms with a variety of product offerings. Remote 
inspections can also facilitate the use of inspections that target a 
particular area of focus in a member firm's business across all 
branches of the member firm.
    The proposed rule change may also support the competitiveness of 
the broker-dealer industry for individuals who seek professional 
positions in compliance.\62\ The expectation of workplace flexibility 
and remote work by such individuals may lead them away from the broker-
dealer industry if other segments of financial services or professional 
occupations offer more flexible workforce arrangements, with regulatory 
frameworks that offer more discretion in how the supervision is 
conducted.\63\ Even prior to the pandemic, the scope of on-site 
inspections had been much reduced due

[[Page 50154]]

to technological surveillance solutions and centralization of books and 
records. The proposed pilot would support continued adoption and 
innovation in technological solutions and reductions in the cost of 
these solutions.
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    \62\ See note 56, supra. See also Jose Maria Barrero, Nicholas 
Bloom & Steven J. Davis, Why Working from Home Will Stick (NBER 
Working Paper 28731, April 2021), https://wfhresearch.com/wp-content/uploads/2021/04/w28731-3-May-2021.pdf, who point to a 
lasting effect of the pandemic on work arrangements, in particular 
for those with higher education and earnings; and Alexander Bick, 
Adam Blandin & Karel Mertens, Work from Home Before and After the 
COVID-19 Outbreak, (Working Paper, February 2022), https://karelmertenscom.files.wordpress.com/2022/02/wfh_feb17_2022_paper.pdf, who find consistent results, with a higher 
adoption rate of work from home jobs in Finance and Insurance, 
relative to other industries, reflected in Figure 10.
    \63\ For example, Advisers Act Rule 206(4)-7 does not require 
Registered Investment Advisers to conduct in-person inspections or 
reviews of its offices or personnel.
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    Participants in the proposed pilot program would provide FINRA with 
periodic (not to exceed quarterly) data on the frequency and type of 
inspections (on-site or remote), counts of findings from inspections 
subdivided by category of office or location, qualitative information 
about these findings, and certain information about the written 
supervisory procedures for remote inspections they are required to 
have.\64\ Depending on the number and types of firms that participate 
in the proposed pilot program, this data may allow FINRA to identify 
differences in risks between remote versus on-site inspection, both 
conditional on the observable characteristics and policies of firms and 
overall, the extent of variation in these risks across firms and firm 
characteristics, and factors associated with very high or low risks. 
The proposed pilot program has the potential to yield a more thorough 
collection of sensitive information in a structured manner than 
voluntary submissions or a survey of FINRA members could provide. This 
data will be useful both for monitoring for risks as the pilot proceeds 
and, with sufficient participation, for developing a balanced 
assessment of the potential impact of permitting further remote 
inspection.
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    \64\ In addition, if the effective date of the rule is such that 
the first year of the pilot program covers a period less than a full 
calendar year, participating firms would be required to provide, the 
data and information specified in proposed Rule 3110.18(f)(2).
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Anticipated Costs
    Participation in the proposed pilot program is voluntary, and the 
proposed rule change provides firms with an additional method for 
complying with certain supervisory requirements without removing other 
methods of compliance. Eligible pilot participants will therefore 
participate in the pilot program only if doing so is beneficial to 
their operations relative to complying with current Rule 3110. The cost 
of complying with the requirements of the proposed pilot program is a 
factor in this decision. These costs include conducting risk-based 
analyses for inspections and providing aggregated data on findings to 
FINRA. The data request in particular may require more standardization 
and aggregation of inspection findings than some member firms typically 
conduct. The data request may also not use the same terms or formats 
used by compliance officers for reporting and tracking inspection 
findings. Firms may need to develop new written supervisory procedures 
and new trainings for compliance staff to ensure that all required data 
is accurate and compiled and submitted to FINRA in a timely manner. 
Firms will incur new ongoing costs both for compliance and monitoring 
for compliance.
    Supervision and inspections are intended to identify not only the 
activities that violate member procedures or FINRA rules but also poor 
practices that might ultimately allow for such violations. FINRA 
recognizes that remote inspections may be less likely to identify such 
practices or activities as on-site inspections. FINRA believes that 
risks to member firms and investors from remote inspections are 
mitigated by the proposed requirements to have written supervisory 
procedures for remote inspections, the proposed requirement to conduct 
and document risk assessments, the proposed limitations on the firms 
and locations that would be eligible to participate in the proposed 
pilot program, and the technology already employed for day-to-day 
supervision. In addition, FINRA will continue to closely monitor the 
outcomes of examinations during the pilot program period.
4. Alternatives Considered
    The proposed pilot program would continue for three years. FINRA 
staff considered alternative durations for the program. FINRA members 
firms vary by business model and organizational structure, so a shorter 
program is less likely to yield enough data on inspection findings to 
allow for meaningful comparisons between on-site and remote inspection 
regimes across members. In addition, inspections are typically planned 
by members well ahead of time, so some members may not implement the 
requirements of the program until well into the duration of the pilot 
program. It may also help firms and the policy development process if 
FINRA had enough data to meaningfully evaluate well ahead of the 
expiration of the pilot program.
    FINRA staff also considered a proposed pilot program that would not 
exclude certain firms, like restricted firms, from participating in the 
program. These additional restrictions will limit the availability of 
the pilot program as well as the potential learnings from the program. 
As a result, the same restrictions may ultimately need to be carried 
over into any ongoing program of risk-based examinations. The exclusion 
of such firms, however, should reduce any risk of customer harm from 
not having on-site inspections.\65\
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    \65\ See Zachary T. Kowaleski, Andrew G. Sutherland & Felix W. 
Vetter, Supervisor Influence on Employee Financial Misconduct 
(Working Paper, July 2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3646617. This paper presents evidence that 
could be interpreted as supportive of the exclusions based on 
misconduct and lack of experience.
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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

    Within 45 days of the date of publication of this 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:
    (A) by order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be 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 [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.

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

[[Page 50155]]

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 a.m. and 3 
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 September 6, 2022.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\66\
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    \66\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Deputy Secretary.
[FR Doc. 2022-17428 Filed 8-12-22; 8:45 am]
BILLING CODE 8011-01-P


