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FINRA Rule 3110 : Supervisions & Compliances to Follow FINRA Rules & Regulations

Aug 8, 2022 Articles

Financial Industry Regulatory Authority (FINRA) Rule 3110, also known as the Supervision Rule, requires brokerage firms to diligently supervise the activities of their representatives (e.g., financial advisors and stockbrokers) to ensure that their representatives comply with FINRA and SEC rules and regulations, as well as federal and state laws. To comply with Rule 3110, each firm is required to draft a set of written supervisory procedures and appoint designated supervisors to enforce them. These supervisors, known as “supervisory principals”, are required to obtain a special supervisory license.   

FINRA Rule 3110 is designed to protect investors from intentional exploitation by brokers. Brokers may negligently recommend risky and unsuitable investment products, and without diligent firm supervision, investors are susceptible to various types of securities fraud and misconduct. Because fraud is so common in the securities industry, it is critical that firms fulfill their Rule 3110 obligations and maintain vigilant supervision to prevent their customers from becoming victims.

The Written Supervisory System

FINRA Rule 3110 states that each member firm “shall 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.”

Each firm must have written supervisory procedures (WSPs) designed to address every aspect of FINRA’s supervision rules. This includes ensuring that every broker has an assigned supervisor. The brokerage firm must also make sure that its supervisors are properly trained and have obtained all necessary licenses (e.g., FINRA Series 24 General Securities Principal license).    

How Does FINRA Rule 3110 Prevent Investor Losses?

A proper supervisory system should automatically flag suspicious activity. Suspicious activity comes in many forms, requiring that supervisors always be on the lookout for violations of FINRA rules and regulations, such as:

  • Selling Away: Brokerage firms approve the securities that their brokers recommend. Selling an investment outside of the firm’s approved securities could expose investors to inappropriate levels of risk.
  • Unsuitable Recommendations: FINRA Rule 2111 requires brokers to only recommend investments that suit their client’s risk profile.
  • Excessive Trading/ Churning: Excessive trading is a common type of broker fraud. Brokers sometimes execute an excessive number of trades solely for the purpose of earning more commissions since each transaction generates a commission payment for the broker.
  • Unsuitable Use of Margin: The use of margin is of special concern for supervisors. Margin accounts use borrowed money in an effort to maximize returns and risks.

FINRA Supervision Rules

Each firm should be able to demonstrate compliance with FINRA rules and regulations in the following areas:

1.     Designation of Registered Principals

The designation of any registered principals with the authority to supervise each specific type of business at the firm. For example, a firm might have a supervisor who exclusively oversees options trading.

2.     Customer Complaints

Firm supervisors are required to review and address any customer complaints. Once the supervisor reviews the dispute, they may deny the investor’s claims. Firms frequently deny customer complaints hoping that the customer will simply drop the dispute and not hire an attorney. However, customers should know that a denial does not mean that there is no case. Customers can still sue the firm and recover money even after their initial complaint to the firm was denied.

3.     Written Communication

Designated supervisors must also review correspondence with customers and internal communications. These reviews must be documented. For this reason, brokers are required to only communicate with investors using firm-approved channels. Brokers should never email their customers from a private email address or text their customers from a personal cell phone.

Firms must also have supervisory procedures concerning marketing material.

4.     Securities Transactions

Firms are required to have supervisory systems in place that can identify fraudulent trades or any transaction that violates the Securities and Exchange Act.  

5.     Anti-Money Laundering Programs

Under the Bank Secrecy Act, each brokerage firm is required to have an anti-money laundering program (AML). These programs are designed to catch the common signs of money laundering, including large deposits broken up into smaller deposits, wire transfers from suspicious companies, and transfers from countries known as money-laundering hotspots.

FINRA Rule 3100

FINRA Rule 3110 falls under the broader FINRA Rule 3100.  FINRA Rule 3100 also requires firms to comply with the following:

Every firm must test and verify that its supervisory procedures are reasonably designed to achieve compliance with FINRA rules and regulations.

Every year, a brokerage firm must identify its chief compliance officer to FINRA.

Firms may only hold mail for customers who will not be receiving mail at their usual address, so long as the firm receives written instructions from the investor.

This rule establishes the standards of conduct for a brokerage firm that is a party to a networking arrangement. Financial institutions like Wells Fargo often offer regular banking services in addition to their brokerage services. Rule 3160 establishes that these institutions must distinguish between broker-dealer services and financial institution services.

Firms with disciplinary histories, or firms that have an especially high number of brokers who have worked for firms with disciplinary histories, may be required under FINRA supervision rules to tape record conversations between their brokers and existing or potential customers to ensure compliance with securities laws. Rule 3170 establishes supervisory requirements for the tape-recording process.

The Office of Supervisory Jurisdiction (FINRA OSJ)

Each brokerage firm location reports to an office of supervisory jurisdiction that in turn reports to FINRA. OSJs are subject to an annual inspection, and each OSJ must have a registered principal who carries out the supervisory responsibilities for that office.

Failure to Supervise Examples

The following regulatory actions offer examples of the failure to supervise.

  • FINRA ordered First Allied to pay $2.6 million following allegations that the firm had failed to supervise their brokers when they made unsuitable recommendations in non-traded Real Estate Investment Trusts (“REITs”), which are risky investment products.
  • According to a Letter of Acceptance, Waiver, and Consent (AWC), a designated supervisor named Tim Vorpahl failed to supervise another broker who executed excessive trades and recommended unsuitable investments. Vorpahl served as the Chief Compliance Officer and General Securities Representative for his firm, Vorpahl Wing.
  • Pasquale Rappa was fined by FINRA following allegations that he failed to notice excessive short-term trading in one of his brokers’ accounts. FINRA ordered him to complete an additional 20 hours of continuing education regarding supervisory responsibilities. The AWC alleges that he reviewed a daily trade record that showed a broker had purchased and sold the same security on one of his customer’s accounts 41 times.

What Should I Do If My Firm Failed to Follow FINRA Supervision Rules?

Investors who lost money due to a lack of firm supervision over their financial advisor are entitled to recover their losses. Firms that fail to properly supervise the activities of their representatives are responsible for the investment losses caused by those representatives.  An experienced securities attorney can assess whether your financial advisor was properly supervised or not.    

Get a free case evaluation with a securities attorney can help you determine if you were possibly the victim of investment fraud. Contact us at (877) 600-0098 or info@kurtalawfirm.com.