Supervising
Supervision is an important part of every principal’s duties at every firm. There are many rules, regulations, and norms that need to be followed.
Each member firm is required to create and maintain a supervision system designed to achieve compliance with all applicable laws, rules, and regulations, from any federal, state, or other regulatory authority with jurisdiction over the firms business lines. The final supervision of member’s employees, with however many laws they might create, never rests with a regulator. Final supervision of employees always rests with the member itself. We are part of a “self regulatory organization”, we, to a degree, regulate ourselves.
The bare minimum that would be required of the supervisory system, and there are more details, but these are the most likely testable topics.
- The supervisory system must establish and maintain a written procedure as required by Rule 3110. There must be an appropriately licensed and registered principal, designated by the member with authority to carry out the supervisory responsibilities of the member for each line of business they engage in.
- The member firm must also designate offices as an Office of Supervisory Jurisdiction OSJ, with these being the final supervisory authority in the geographic area. The specific geographic area and requirements are set by each member firm to follow the rules. These OSJs (it is an office, not a person), must be supervised a principal. Branch offices may be supervised by a principal or registered rep. These supervisors, be they of OSJs, or Branch Offices, are designated by the member firms as well.
Each registered representative is to be supervised by either another qualified registered representative, or a registered principal. These persons, will also be supervised, all the way up. The firms must use reasonable efforts to determine that the supervisory personnel are qualified. That qualification can be from training, experience, or both.
Part of the supervisory process, is making sure representatives are staying up to date on all regulation updates, and similar needed knowledge. Part of Rule 3110 is that each member firm must have each registered rep and principal participate, no less than annually, in a meeting of some sort, at which compliance matters relevant to the person are discussed. It may occur in conjunction with other matters, and is often part of the annual compliance, or other regular meetings with managers or trainers.
All incoming and outgoing mail to offices must also be checked. If you do not want your personal mail to be opened and read by someone else, don’t have personal mail sent to the office! They do not have a choice, it must be opened and checked. The procedures must require a review of incoming and outgoing written correspondence to make sure that any such messages subject to review, are reviewed. Those subjected to review specifically would be; procedures, complaints, instructions, funds, and retail communications.
Supervisory control system
Each member must designate to FINRA, or similar SRO, one or more principals that are charged with establishing, maintaining, and enforcing the supervisory control policies and procedures of the firm.
- They must have ways of testing and verifying procedures are designed with respect to the member firm and their associated persons to follow all laws, rules, and appropriate regulations.
- They must also create or amend supervisory procedures when needed, as identified by the originally mentioned testing the verification procedures finding a problem.
The designated principals must also submit to senior management, at least annually, a detailed report containing the system of supervisory controls explained, summary of test results and any identified problems in those tests, and any additional or amended procedures that were created in response to those identified problems.
For firms reporting in excess of $200m gross revenue for the previous calendar year, their systems must include;
Tabulation of reports pertaining to complaints and internal investigations related to those complaints, or any other investigations during the previous calendar year, and
Discussions of the year’s compliance efforts, in each of the following areas;
- Trading and market activities,
- Investment banking activities,
- Antifraud and sales practices,
- Finance and operations,
- Supervision, and
- Anti-money laundering
Office reviews
All offices must go through some type of review process. Depending on the type of office, is it an Office of Supervisory Jurisdiction, or is it an office that only occasionally is used for business, or is it something in between? Depending on who works there, what type of work and business is done in the office, and how often that work and business is done, all will determine how often the office must be audited.
These audits are internal audits of the offices, branches, and OSJs, done by the company. They are most often going to be done by an “arm’s length” supervisor, another principal or similar supervisor in the company, but not in direct chain as the office being reviewed. This helps prevent hurt feelings, potential friendships impacting the review, and things like that.
Discretion
Discretionary accounts require extra supervision from the principal due to the risks of overtrading. Discretionary accounts refer to accounts where the representative, usually an investment advisor representative, makes decisions as to what securities to buy or sell, whether to buy or sell, and how much to buy or sell, without needing to directly confirm with the client each time. It requires prior written authorization from the client, usually in the form of a limited financial power of attorney.
The easiest way to remember what would require a discretionary account, is if any of the 3 A’s are missing; Action, Asset, or Amount.
Action is the buy or sell, and likely is the hardest to hide, and will be stated each time.
Asset means a specific asset, usually given as a name of a company or a ticker symbol. As long as the company is described, down to a singular entity with no argument, it would count. If a client said “buy 100 shares of that company, oh gosh I can’t remember the name, they’ve got that amusement park in Florida and California, they have that mouse character, yeah, buy 100 shares of that”. Everyone knows the client is talking about Disney. If the client said “buy 100 shares of the best entertainment company stock” or “the best amusement park stock”, that would not work, as there could very easily be arguments as to which is actually “the best”.
Amount is the amount of stock to buy or sell. It could be expressed in number of shares, or dollar amounts. It also could be percentages, either specific “sell half of my holdings”, which is 50%, or a little more hidden “sell all of my position”, that is selling 100% of what is owned.
If the order contains all 3 of the A’s, whether to buy and sell, what specifically to buy and sell, and how much specifically to buy and sell, then it would be a non-discretionary order and could be placed in a normal non-discretionary account.
Additional supervision required over discretionary accounts
Although there is no specific time frame stated in law, each member firm likely has their own specific interpretations. Supervisors or principals must review discretionary accounts frequently at regular intervals. Again, what those are specifically, is left to each member firm.
All orders in the discretionary accounts must be marked as discretionary orders. If the client is missing one of the 3 A’s discussed earlier, if the registered rep calls the client and asks for clarification and gets it, than the order isn’t missing any of the A’s anymore, the client has provided all of them, and that would not be a discretionary order. Orders in discretionary accounts are approved promptly, but not necessarily before the trade. They are generally approved the same day, though.
The additional requirements on discretionary accounts are several, but primarily can be thought of as three primarily. The control the representative on the account has over the client’s assets, greatly increases the risks of mismanagement and mistakes. There are higher risks of abuse, with the potential easy way to churn accounts for extra commissions, and so the trust must be maintained. Finally, there can be complex products in these accounts, and supervision is important to make sure they are suitably handled.