Series 24 – General Securities Principal Exam Key Study Note Set Two

RIAs and BDs are governed by different regulatory frameworks. RIAs are regulated under the Investment Advisers Act of 1940, focusing on providing advice, while BDs are regulated under the Securities Exchange Act of 1934, focusing on executing transactions. RIAs have a fiduciary duty to their clients, requiring them to act in the client’s best interest. BDs, under Regulation Best Interest (Rule 15l-1), must act in the client’s best interest without placing the firm’s interest ahead of the client. Registration requirements differ significantly. BDs must register with the SEC and FINRA, adhering to FINRA By-Laws Article IV and FINRA Rules 3110. RIAs register with the SEC or state securities authorities, depending on their assets under management, as defined in Section 202(a)(11) of the Investment Advisers Act of 1940. The choice depends on the firm’s activities; advisory services necessitate RIA registration, while brokerage services require BD registration. Some firms register as both, navigating the complexities of dual registration.

To terminate registration, a broker-dealer must file Form BDW through the CRD system. FINRA By-Laws Article IV, Section 5 governs resignation of members. The form requires detailed information about the reasons for termination and the firm’s plans for its remaining assets and liabilities. All outstanding customer complaints and regulatory issues must be addressed. FINRA may retain jurisdiction over a terminated firm or individual under FINRA By-Laws Article IV, Section 6. This typically occurs if FINRA has initiated an investigation or disciplinary proceeding before the termination becomes effective, or if there are unresolved customer complaints or potential violations of securities laws. Retention of jurisdiction allows FINRA to continue its investigation and pursue disciplinary actions, even after the firm is no longer registered. This ensures accountability for past misconduct.

FINRA Rule 3110(e) mandates that member firms investigate applicants for registration to ensure they meet qualification standards. A Series 24 principal is responsible for developing and implementing procedures to conduct thorough background checks. This includes verifying information on Form U4, reviewing employment history, and checking for disciplinary actions or customer complaints through FINRA BrokerCheck. Heightened scrutiny is required if an applicant has a history of regulatory violations, customer complaints, financial difficulties, or a criminal record. Firms must also comply with Securities Exchange Act of 1934 Section 17(f-2), requiring fingerprinting of security industry personnel. Failure to adequately investigate applicants can result in supervisory failures and potential liability for the firm.

Upon discovering a violation of FINRA Rule 3280, a Series 24 principal must immediately initiate an investigation. This includes interviewing the registered representative, reviewing relevant documents, and assessing the scope and nature of the private securities transactions. The principal must determine whether the transactions involved firm customers, whether the representative received compensation, and whether the transactions posed any conflicts of interest. Appropriate disciplinary actions may include written warnings, suspensions, fines, or termination of employment. The principal must also ensure compliance with FINRA Rule 4530, which requires reporting of certain events, including violations of securities laws and firm policies. The report must be filed promptly and accurately, providing all relevant details of the violation and the firm’s response. Failure to report can result in additional regulatory sanctions.

FINRA Rule 3270 requires registered representatives to provide written notice to their firm before engaging in any outside business activity (OBA). A broker-dealer’s WSPs must outline the procedures for reviewing and approving OBAs, assessing potential conflicts of interest, and monitoring the representative’s involvement in the OBA. The WSPs should include specific criteria for evaluating OBAs, such as the nature of the business, the time commitment required, and the potential for customer confusion or solicitation. The firm must also establish procedures for ongoing monitoring of approved OBAs, including periodic reviews of the representative’s activities and customer complaints. Potential conflicts of interest should be addressed by implementing restrictions on the representative’s ability to solicit firm customers for the OBA or to use firm resources for the OBA.

FINRA Rule 3130 requires the CEO (or equivalent officer) of a member firm to certify annually that the firm has processes in place to establish, maintain, and enforce compliance with applicable securities laws and regulations. This certification must be based on a comprehensive review of the firm’s supervisory system, control policies, and procedures. The CEO must certify that they have conducted a review of the firm’s compliance efforts, consulted with compliance personnel, and are satisfied that the firm’s supervisory system is reasonably designed to achieve compliance. If material weaknesses are identified during the review, the firm must take prompt corrective action, including revising its WSPs, enhancing training programs, and implementing additional monitoring procedures. The CEO must also document the steps taken to address the weaknesses and report them to the firm’s board of directors or equivalent governing body.

RIAs are governed primarily by the Investment Advisers Act of 1940, focusing on providing advice for compensation and adhering to a fiduciary duty to clients. Registration is typically with the SEC or state securities authorities, depending on assets under management (AUM). Broker-Dealers, on the other hand, are regulated under the Securities Exchange Act of 1934 and are primarily involved in the business of effecting securities transactions for the accounts of others or for their own account. They must register with the SEC and become members of FINRA. Key differences lie in the nature of services, compensation structures, and regulatory oversight. RIAs charge fees for advice, while BDs earn commissions on transactions. A firm operating in both capacities must establish robust policies and procedures to manage conflicts of interest, ensure appropriate disclosures, and maintain separate books and records as required by both the Investment Advisers Act of 1940 Section 202(a)(11) and Securities Exchange Act of 1934 Section 17 and related rules. This includes implementing information barriers and clearly delineating advisory and brokerage activities.

Heightened supervision involves implementing specific procedures to closely monitor the registered representative’s activities. This may include increased review of transactions, closer scrutiny of customer communications, and more frequent meetings to discuss sales practices. The supervisory plan should be documented in writing and tailored to the specific concerns raised by the customer complaints. FINRA Rule 3110 requires firms to establish and maintain a system to supervise the activities of its associated persons. While the complaints did not result in disciplinary action, they still indicate potential issues that warrant attention. The principal must balance the need to protect customers with the need to treat the representative fairly. This includes providing the representative with clear expectations, training, and opportunities to improve their performance. The firm should also document all supervisory actions taken and the rationale behind them. If the heightened supervision reveals further misconduct, appropriate disciplinary action should be taken in accordance with firm policies and FINRA guidelines.

Developing WSPs involves a comprehensive review of all applicable rules and regulations, including FINRA Rule 3110 and Securities Exchange Act Rule 15b2-2. The WSPs should clearly outline the firm’s policies and procedures for supervising associated persons, detecting and preventing violations, and responding to customer complaints. Specific elements that must be addressed include procedures for reviewing transactions, monitoring communications, conducting branch office inspections, and ensuring compliance with anti-money laundering (AML) regulations. Implementation involves training all associated persons on the WSPs and ensuring that they understand their responsibilities. Regular testing is crucial to identify weaknesses in the supervisory system and ensure that the WSPs are effective. This may include conducting mock audits, reviewing exception reports, and soliciting feedback from associated persons. The testing should be documented, and any identified deficiencies should be promptly addressed. The WSPs should be updated regularly to reflect changes in rules and regulations and to address any identified weaknesses.

FINRA Rules 3270 and 3280 address outside business activities (OBAs) and private securities transactions (PSTs) of registered representatives. A Series 24 principal must establish and maintain procedures to identify, review, and approve or disapprove these activities. Registered representatives must provide written notice to their firm before participating in any OBA or PST. The principal must then evaluate whether the activity presents a conflict of interest, raises regulatory concerns, or could potentially harm customers. For OBAs, the principal must assess whether the activity interferes with the representative’s duties to the firm or its customers, or whether it is being conducted on firm premises. For PSTs, the principal must determine whether the representative is selling securities away from the firm and whether the firm is supervising the transaction. If the firm approves a PST, it must record the transaction on its books and supervise it as if it were executed by the firm. The principal must also ensure that customers are fully informed about the nature of the OBA or PST and any associated risks. Failure to properly supervise OBAs and PSTs can result in disciplinary action by FINRA.

FINRA Rule 2310 governs the sale of direct participation programs (DPPs). A Series 24 principal has significant supervisory responsibilities to ensure compliance with this rule. First, the principal must conduct thorough due diligence on any DPPs offered by the firm. This includes reviewing the program’s offering documents, financial statements, and management team to assess its risks and potential returns. Second, the principal must ensure that registered representatives make suitable recommendations to investors. This requires gathering detailed information about the investor’s financial situation, investment objectives, and risk tolerance. The principal must also establish procedures to review and approve each DPP transaction to ensure that it is suitable for the investor. Finally, the principal must ensure that investors receive all required disclosures about the DPP, including its risks, fees, and potential conflicts of interest. This includes providing investors with a copy of the prospectus and any other relevant materials. The principal must also establish procedures to monitor customer complaints and address any concerns about the DPP. Failure to adequately supervise DPP sales can result in significant regulatory penalties.

When a registered representative is suspected of violating securities laws or firm policies, a Series 24 principal must take immediate action to investigate the matter. This includes conducting an internal investigation to gather all relevant facts and evidence. The principal should interview the registered representative, review relevant documents, and consult with legal counsel as needed. If the investigation reveals evidence of a violation, the principal must take appropriate disciplinary action, which may include suspension, termination, or other sanctions. FINRA Rule 4530 requires firms to report certain events to FINRA, including violations of securities laws, rules, or regulations; customer complaints involving allegations of fraud or theft; and disciplinary actions taken against registered representatives. The principal must ensure that all required reports are filed with FINRA in a timely and accurate manner. The principal must also cooperate fully with any regulatory investigations and provide all requested information. Failure to properly investigate and report violations can result in significant penalties for the firm and the principal.

SEC Rule 17a-4(b)(4) and FINRA Rule 3170 mandate that broker-dealers establish and maintain a system for the creation, retention, and supervision of electronic communications. A Series 24 principal is responsible for ensuring that the firm’s system complies with these requirements. This includes establishing policies and procedures for archiving electronic communications, including emails, instant messages, and social media posts. The system must be able to retrieve these communications in a timely manner for regulatory review or internal investigations. The principal must also establish procedures for reviewing electronic communications to detect potential violations of securities laws or firm policies. This may involve using automated tools to scan communications for red flags, such as unauthorized recommendations or insider trading. The principal must also provide training to registered representatives on the firm’s electronic communications policies and procedures. FINRA Rule 3170 requires certain firms to tape record conversations between registered persons and customers. The principal must ensure that the firm complies with these requirements, including obtaining customer consent and providing required disclosures.

As a supervisor, upon discovering that a registered representative is engaging in OBAs without prior written notice, several steps must be taken to address the situation, ensuring compliance with FINRA rules and mitigating potential conflicts of interest. First, immediately direct the registered representative to cease all OBAs until the firm has reviewed and approved them. This is crucial to prevent further violations of FINRA Rule 3270, which requires registered persons to provide written notice to their firm before participating in any outside business activity, particularly if compensation is involved. Next, conduct a thorough investigation into the nature and scope of the OBAs. This investigation should include gathering detailed information about the activities, the time commitment involved, the source and amount of any compensation received, and whether the OBAs create any potential conflicts of interest with the firm’s business or its customers. Document all findings meticulously. Assess whether the OBAs present any conflicts of interest. Consider whether the OBAs compete with the firm’s business, create a potential for misuse of confidential information, or impair the registered representative’s ability to fulfill their duties to the firm and its customers. If conflicts exist, determine whether they can be adequately managed or if the registered representative must discontinue the OBA. Based on the investigation and conflict of interest assessment, determine the appropriate disciplinary action, if any. This could range from a written warning to suspension or termination, depending on the severity of the violation and the potential harm to customers or the firm. Document the disciplinary action taken and the reasons for it. Finally, implement enhanced supervision of the registered representative’s activities, including closer monitoring of their customer interactions, transactions, and communications. This heightened supervision should continue until the firm is confident that the registered representative understands and is complying with all applicable rules and regulations. Ensure the firm’s Written Supervisory Procedures (WSPs) are updated to reflect this specific instance and to prevent future occurrences. This aligns with FINRA Rule 3110, which mandates that firms establish and maintain a system to supervise the activities of its associated persons to achieve compliance with applicable securities laws and regulations.