Brokerage Firms Have a Regulatory Obligation to Supervise Financial Advisors

  • February 28, 2021

As a regulatory organization with oversight of member firms, the Financial Industry Regulatory Authority (FINRA) has established Rule 3110 to govern the supervision of member firms over their employees. It’s just one way that regulatory safeguards help ensure that customers are protected from potential misconduct by investment advisors and financial advisors, also called members. No one wants to think that their advisor is working in anything other than a client’s best interests, and the supervisory rule helps enforce that.

What is Rule 3110?
Broadly speaking, Rule 3110 outlines how member firms are to watch over their employees’ work, what activities need to be supervised, how to proceed if irregularities are discovered, and how member firms are expected to ensure that only qualified applicants have their registration applications forwarded to FINRA. With a more thorough understanding of how member firms supervise their financial advisors, customers may be better prepared to recognize possible irregularities and take action.

Supervisory Systems: a High-Level View

According to Rule 3110, a supervisory system for oversight of all advisors in keeping with regulatory rules and securities law is required. FINRA doesn’t mandate what that system looks like, understanding that each member firm has unique needs; however, it does specify key components that must be included. For example, Rule 3110 specifies how often reviews need to be done, what kind of documentation is required, and how long these files must be maintained.

Most importantly, the supervisory system must be outlined in writing. The system must be revised and updated as FINRA regulations and securities laws change. Changes must be clearly and promptly communicated to advisors.

What Supervision Looks Like in Practice
Member firms are required to identify and register an office of supervisory jurisdiction with FINRA to carry out these oversight tasks. Member principals who serve in this role for each employee must be designated as such and qualified to supervise others’ work. No one is permitted to supervise their own investment activities.

Members are required to undergo an annual review of all investment activities with a supervising member of the firm. In addition, all communications subject to securities laws–incoming and outgoing–are reviewed. Aside from that, customer complaints against members must be documented, investigated, and responded to within strict time limits. During the review, the supervisor is alert to areas of possible violation and strives to ensure the advisor’s and the member firm’s compliance with regulations and laws. These steps are intended to help discover and correct wrong-doing as early as possible.

Supervision includes a review of customer accounts, too. The supervisor looks for red flags that suggest violations of legal and ethical practices. Also, the supervisor reviews the firm’s books and records, how funds are sent to and received from customers, and even customers’ contact information and documented investment objectives to ensure everything has been handled ethically.

It’s important to note that Rule 3110 strictly states that the performance of the employee being supervised cannot positively or negatively impact the employment or compensation of the supervisor. Also, reasonable steps are to be taken that eliminate or minimize potential or actual conflict of interest. So it doesn’t matter how much money an investment advisor brings into the firm; if their conduct is illegal or unethical, the member firm is required to take action. And because the supervising member cannot be punished or rewarded for taking action or not, there’s no justification for not following through on the assigned role.

What Happens When Irregularities are Flagged
When problematic trades are suspected, such as selling away or unsuitability, the firm is required to investigate as part of its supervisory role. Investigative reports must be completed within set time frames and signed off on by a senior officer of the member firm before being shared with FINRA.

Investigators go over all transactions carried out by an investment advisor on member accounts. A review is also made of covered accounts and any accounts where the customer is either associated with the member or can make investment decisions for another. Covered accounts include those held by spouses of members, minor children or others who depend on the advisor for support.

Advisors and those associated with them (their spouses and children, for example) are also prohibited from opening accounts at other broker-dealer firms aside from the one they’re employed with without first obtaining written consent. When a member has an account at their own firm, the transactions are reviewed as part of the supervisory system. To open an account someplace else would permit a member to carry out transactions outside the authority and supervision of their employing firm.

Investors may have the opportunity to increase their returns or incur serious losses through buying and selling securities. Rule 3110 ensures that investment advisors and financial advisors don’t intentionally or unintentionally tip the scales in their own favor, to the detriment of their clients.

Added Protections Allow Confident Investing
Fortunately, these instances of misconduct are not common. One reason why is because Rule 3110 also requires member firms to complete full background checks on prospective advisors before submitting their application for registration to FINRA.

Understanding more about the supervisory role that member firms have over the investors working for them should instill confidence in investors. In every transaction, member firms and their employees are required to put the customer’s needs first. And if an investor feels that may not be the case, there are strict protocols in place that guarantee a member firm will quickly and thoroughly investigate any complaint.

Attorney Matthew Wolper

Attorney Matthew WolperMatt Wolper is a trial lawyer who focuses exclusively on securities litigation and arbitration. Mr. Wolper has handled hundreds of securities matters nationwide before the Financial Industry Regulatory Authority (FINRA), American Arbitration Association (“AAA”), JAMS, and in state and federal court. Mr. Wolper has handled and tried cases involving complex financial products and strategies ranging from traditional stocks and bonds to options, margin and other securities-based lending products, closed/open-end mutual funds, structured products, hedge funds, and penny stocks. [Attorney Bio]