Compliance

FINRA Standards for Admission

FINRA will consider, as a whole, the Applicant’s business plan, information and documents submitted by the Applicant under NASD rule requirements, information provided during the Membership Interview, as well as information obtained by the staff, taking into account the following standards set forth in NASD Rule 1014:

I. Complete and Accurate Application

All aspects of the membership application must be complete and accurate, including all forms and agreements signed and executed by authorized personnel of the Applicant.

II. Licenses and Registrations Required by State and Federal Authorities and Self-Regulatory Organizations

Applicants must successfully complete all registrations required by FINRA, the SEC, and state regulatory authorities. Registrations are required for both the firm and the individuals associated with the firm.

FINRA Registration Requirements
The requirements for FINRA registration are set out under the Rule 1010 Series, which can be found in the NASD Manual.One prerequisite for registration is successful completion of each required qualification examination. Required examinations will be determined based upon the position in an Applicant’s business that the individual will occupy. Those individuals who wish to take a qualification examination can do so if "sponsored" by a current member firm or an Applicant for FINRA membership.

Where a person has previously passed a qualifications exam and has been registered with a member firm within the previous two years, additional qualification examinations would not be required in order to continue functioning in the same capacity. Where new or additional examinations are required in order for an individual to function as proposed at a new member firm, a new member application will need to have been filed so that there is a member firm through which the individual may become registered.

Applicants need to take into account the strict time frames governing new member applications under the NASD Rule 1010 Series when contemplating the registration requirements necessary for the individuals who will operate/work at the firm and the need for additional qualification examinations. In this regard, an individual who will be associated with a new member Applicant may require a series of examinations that could exceed the timeframe within which an Applicant must submit information (see NASD Rule 1012(b)(1)(A) and, thereby need to request in writing an extension of time from the FINRA District Office staff in order to avoid a lapse of the application and meet the qualification requirements.
1. Minimum FINRA Registration Requirements
  The NASD Rule 1010 Series outlines a requirement for each new Applicant for membership, except sole proprietorships, to have at least two registered principals, and one Financial and Operations Principal. The Applicant may, however, request, in writing, a waiver or exemption from the two principal requirement based on its proposed business in accordance with NASD Rule 9610. The decision for granting such a waiver will be made by FINRA District Office staff.
2. FINRA Registrations Based on Type of Business
  An Applicant’s proposed business activities usually dictate the applicable registration requirements. For example, if the Applicant intends to conduct business in options or municipal securities, it will be required to have the appropriate individuals maintain the necessary options or municipal registrations.
3. FINRA Principal Registrations
  Principal registration is required for persons associated with a member who are actively involved in the management of the member's investment banking securities business. Principal registration may also be required where indications of control exist. Indications of control include participation in the management of the broker/dealer and assertion of authority over daily operations. Persons in managerial positions normally require principal registration. However, a registered representative may not automatically need principal registration, nor would an individual who is an officer of the corporation solely for ministerial purposes (e.g., a corporate secretary). Also, an individual contributing capital but not involved in the operations or management of the broker/dealer does not necessarily need to be registered as a principal.
4. Simultaneous or Multiple Securities Registrations with Separate FINRA Member Firms
  FINRA does not preclude an individual from being simultaneously registered with more than one member firm. This most often occurs in situations where the member firms are separate but otherwise related. Where simultaneous securities registrations exist, the FINRA District Office staff will consider the ability of the individual to adequately meet the various responsibilities assigned for each of the firms at which the individual is registered. Applicants should be aware, however, that some states do not allow simultaneous or multiple securities registrations.
5. FINRA Executive Representative
  The FINRA By-Laws, Article IV, Section 3, require that each Applicant designate a "FINRA executive representative" who will represent, vote, and act for the member in all affiars of FINRA. The executive representative is required to be a registered principal in the Applicant's senior management. Since all important membership communications, including votes, are directed to these individuals, it is critical that the designated representative is the appropriate person to ensure that important information is disseminated properly at the firm.
  
  Each executive representative must have an e-mail account so as to facilitate timely member firm-related communications. For insurance company members, FINRA recognizes that the person designated as the executive representative may be a middle manager in the insurance company but act as senior management of the company’s securities activities. To accommodate these unique circumstances, the FINRA District Office staff may, on review, permit an insurance company to appoint as executive representative a registered principal serving in an equivalent position to senior management in charge of the insurance company’s securities operations.
State Securities Regulatory Agency Registration Requirements
For purposes of FINRA membership admission, the broker/dealer and its principals must be registered in the state in which the firm’s home office is located. However, under state law the broker/dealer, principals, and each registered representative must be registered in each and every state in which a securities business will be conducted. This is accomplished by checking off the appropriate states on the Form BD and the Form U-4. Some states require that the Series 63 qualification examination be completed for registration in the state.
SEC Registration Requirements
When an Applicant submits Part One of the application for membership with FINRA, registration with the SEC is initiated by the submission of the Form BD. There are no further documentation requirements for registration with the SEC.
Problematic Issues Impacting Registration
Where a firm’s application, or that of any individual to be associated with the Applicant, reflects information of any kind of a disciplinary or enforcement action taken by FINRA or other regulatory authority, arbitrations, civil actions, or criminal matters, such information will be considered by the FINRA District Office staff in its review of the application. The nature of the information reported, the time, nature and extent of any wrongdoing, and the remedial actions taken will be included in the FINRA District Office staff’s consideration. Also, consideration will be given to the adequacy of the methods to be employed to preclude reoccurrence of any previous deficiencies.

III. Applicant’s Capability to Comply with Industry Rules, Regulations, and Laws

The Applicant’s capability to comply with industry rules, regulations, and laws includes observing high standards of commercial honor and just and equitable principles of trade. The FINRA District Office staff will also take into consideration whether any persons associated with the Applicant have any disciplinary actions taken against them by other industry authorities, customer complaints, adverse arbitrations, pending or unadjudicated matters, civil actions, remedial actions imposed, or other industry-related matters that could pose a threat to public investors.

IV. Contractual or Other Arrangements and Business Relationships

At the time the application is submitted or shortly thereafter, the Applicant should be in a position to describe the contractual or other arrangements and other business relationships that will allow the Applicant to operate in accordance with the business plan as submitted. The Applicant is also required to submit copies of all draft or final agreements for the proposed business, including those with banks, clearing entities, or service bureaus.

V. Business Facilities

The FINRA District Office staff’s consideration of the adequacy of the Applicant’s facilities or planned facilities will include not only the obvious ones, such as office space, computer equipment, etc., but will also take into account the location of such facilities to determine whether the Applicant’s business plan can be effected with adequate supervision for the public’s protection.

FINRA District Office staff will consider whether the Applicant’s facilities or planned facilities, taken as a whole, will be sufficient to effectively carry out the business plan and to allow for the operation of the Applicant’s proposed business activities in compliance with all relevant securities rules and regulations.

VI. Adequacy of Communications and Operational Systems

The communications and operational systems that the Applicant intends to employ for the purpose of conducting business with customers and other members must be adequate and provide reasonably for business continuity with respect to: system capacity to handle the anticipated level of usage; contingency plans in the event of systems or other technological or communications problems or failures that may impede customer usage or firm order entry or execution; system redundancies; disaster recovery plans; system security; disclosures to be made to potential and existing customers who may use such systems; and supervisory or customer protection measures that may apply to customer use of, or access to, such systems.

That Applicant will be required to review its communications and operational systems and certify to the FINRA District Office that these systems are adequate for the proposed business. The Applicant may, but is not required to, utilize the services of a third party to arrive at the determination of systems adequacy.

VII. Determining the Adequacy of an Applicant’s Capital

If determined to be necessary, FINRA has the right to impose higher net capital requirements beyond the minimum requirements.

To be approved for FINRA membership, Applicants must meet the provisions of SEC Rules 15c3-1 and 17a-11, the SEC’s net capital rule and early warning rule, respectively, which are reprinted in the NASD Manual. These are two of the key financial responsibility rules of the SEC, and FINRA members must strictly comply with these provisions at all times.

Compliance with Net Capital Rule
The SEC’s net capital rule requires a minimum amount of net capital dictated by the type or method of business to be conducted, the securities products involved, and considerations of customer exposure. The statutory minimum amounts of net capital range from as low as $5,000 to over $1,000,000. Applicants should carefully review the SEC’s net capital rule, which can be found in the NASD Manual under SEC Rule 15c3-1.
Early Reporting Requirements
SEC Rule 17a-11 requires broker/dealers to make accelerated financial reporting anytime net capital falls below 120 percent of its minimum capital level. In instances where the Applicant’s capital falls below the minimum capital required, the broker/dealer is required to immediately notify both FINRA and the SEC. Failure to make reports timely and accurately will normally result in formal disciplinary action. Filing requirements will continue at least until the Applicant’s capital is restored to an amount in excess of 120 percent of the minimum required.
Adequate Funds to Meet Expenses
A key document reviewed by the FINRA District Office staff in connection with the application for membership is the Applicant’s business plan. Among other things, this plan must include a detailed description of projected revenues that will be generated by the business operation and the costs expended in pursuit of those revenues, as well as any forms of capital contributed including a basis for the projections.

To remain operational, a member’s capital will need to be sufficient to meet the projected expenses net of reliable revenues. If the member’s capital declines to amounts below minimum requirements, the member will have to cease operations. Such an event could jeopardize the member’s customers.

The amount of capital necessary to meet the net expenses will depend on the forecast contained in the Applicant’s business plan.
Adequate Funds to Meet Contractual Obligations, Including Market Making
In instances where a firm makes markets, it makes a commitment to buy or sell securities at stated prices. The Applicant’s capital must be adequate to meet such commitments. Thus, the required amount of capital will depend upon the number of markets to be made, the relative price range of such securities, and consideration for the historical volatility of these securities.

While not directly related to these risk factors, a broker/dealer will also be required to have capital of an amount of $1,000 to $2,500 based on each market made taking into consideration the price of each such security as referenced in the SEC’s net capital rule (SEC Rule 15c3-1(a)(4)).

Likewise, where a firm engages with some frequency in firm commitment underwritings, capital requirements will often exceed the SEC net capital rule’s minimum amounts in order to meet such contractual obligations. The amount of capital that will be considered adequate to meet these obligations will depend upon the size and frequency of the underwriting.
Risks to Capital
If the Applicant will be engaged in underwritings or proprietary trading, the District Office staff may consider relative risk, volatility, degree of liquidity, and the speculative nature of the securities where applicable.
Self-Clearing Firms
New firms may pose heightened financial risks to customer positions. All self-clearing firms are required to set aside moneys in a separate bank reserve account which is meant to protect customers who have positions at the firm in the event the firm were to fail.

VIII. Adequacy of Financial Controls

There are extensive federal, state, and self-regulatory securities laws and regulations under which members must operate that place great emphasis on financial and operational responsibility. Well-defined supervisory procedures, internal accounting, and financial controls, as well as a clearly articulated chain of command in this area are necessary for firms to ensure compliance with such laws and regulations. Securities regulators also look at these factors to establish liability if these responsibilities are not carried out. It is, therefore, in the Applicant’s best interest to make certain that the financial and operational portions of the business are operated as efficiently as possible and in compliance with applicable rules.

The Applicant must demonstrate that it can prepare, in a thorough and accurate manner, all reports pertaining to the financial condition of the firm and meet the requisite deadlines and times for their submission.

The adequacy of the financial controls includes the ability of those employees of the Applicant who will perform such functions to meet these requirements.

IX. Control Mechanisms Consistent with Industry Practices

The Applicant must demonstrate that its compliance, supervisory, operational, and internal control practices and standards are consistent with practices and standards regularly employed in the investment banking or securities business in light of the Applicant's proposed business.

For example, the supervisory control practices and standards of a securities business should include, but not be limited to, the delegation to qualified principals or other registered employees responsibility and authority for supervision and control of each office, department or business activity, and the establishment of appropriate procedures for supervision and control; and implementation of a separate system of follow–up and review to verify that the delegated authority and responsibility is being properly exercised.

Similarly, an Applicant which proposes to engage in investment banking activities would be required to demonstrate that consistent with the practices and standards regularly employed by the industry, it has developed and implemented policies and procedures to establish effective internal control systems and procedures to prevent the trading department from utilizing advance knowledge of the issuance of a research report. Firms that choose not to develop "Chinese Wall" procedures bear the burden of demonstrating that substantially equivalent internal control procedures have been implemented.

NASD Notices to Members that provide guidance for members’ compliance with supervisory controls include 98-96, 98-52, 98-38, and 98-18.

X. Adequate Supervisory System

NASD Rule 3010 requires all members to establish, maintain, and enforce written supervisory procedures (WSPs). The establishment of appropriate and effective written supervisory procedures is left to each member firm in the context of its business mix and method of operation, among other factors. Every FINRA member firm has an obligation to establish procedures designed to reasonably detect and prevent rule violations. As such, no one set of procedures may be considered as the only correct approach; what works well for one firm may not necessarily be appropriate for another. A firm’s procedures must be tailored to its business and cover all aspects of its operations. Generally, each supervisory procedure should identify and describe the procedure required to be conducted, who the responsible supervisor is, how often the required supervisory procedure is conducted, and how the responsible supervisor is to evidence compliance. (General guidance on the composition of Written Supervisory Procedures may be obtained from the Written Supervisory Checklist (DOC 1485 KB).)

The written supervisory procedures should facilitate the Applicant’s ability to properly supervise its employees’ activities. The procedures should be designed to help Applicants comply with all applicable securities laws, rules, and regulations, including NASD rules. The procedures should set forth the designation of: appropriately registered principals for each type of business the firm is engaged in, any office meeting the definition of Office of Supervisory Jurisdiction (OSJ), at least one appropriately registered principal for each OSJ, and at least one registered representative or principal to be responsible for supervision in each non-OSJ branch office. Furthermore, each registered person must be assigned to a supervisor, and reasonable efforts must be made to ascertain that all supervisory personnel are properly qualified. (See NASD Rule 3010 for definitions of what type of office constitutes an OSJ office, as opposed to a branch office.)

The written supervisory procedures for Applicants that propose to engage in an options business must facilitate compliance with NASD Rule 2860 (Options Conduct Rule), and if the Applicant plans to conduct a municipal securities business, the procedures must cover steps to be followed by the firm to comply with MSRB rules.

The Number, Location, Experience, and Qualifications of Supervisory Personnel
An Applicant’s internal supervisory controls are the first line of defense for the protection of customers. The number of supervisory persons needed, as well as the level of their qualifications, depend upon a number of factors, including the number of individuals or departments that the supervisory structure will be required to oversee. Generally, the more individuals or departments to be supervised, the more supervisory personnel are needed to be in place. Also considered, however, are the experience and the qualifications of the supervisory personnel in carrying out this function, as well as whether the Applicant will employ methods, such as the use of technological techniques, to meet its supervisory responsibility. The experience level and disciplinary history of the employees being supervised also will be considered. NOTE: NASD Rule 1014(a)(10)(D) requires that each person identified in the Applicant’s business plan who will discharge a supervisory function should have at least one year of direct experience or two years of related experience in the subject area proposed to be supervised by such persons. Prior supervisory experience is helpful, but not required.

Experience Requirements:

Under Rule 1014(a)(10)(D), all supervisors must have at least one year of direct experience in the area to be supervised or two years of experience in a related area. FINRA will deny applications that fail to meet this requirement. For example, FINRA denied an application to permit an existing member to make markets where the proposed supervisors did not have any direct or related experience in market making. The applicant's proposed trader only had experience as an intern to a trading assistant. The firm proposed two supervisors who were General Securities Principals, but had no direct or related experience in market making. The first proposed supervisor, a retired military officer, had been associated with a broker-dealer applicant that was never approved for membership; he had studied with a trader for three days. The firm also proposed a business professor with ten years of supervisory experience, but offered no evidence that any of this experience involved trading or market making. The SEC upheld the NASD's decision to deny the firm's application to engage in market making. See In the Matter of Sierra Nevada Securities, Inc., Exchange Act Rel. 41330, Admin. Proc. File No. 3-9623 (Apr. 26, 1999).

XI. Recordkeeping System

The various federal and state securities rules pertaining to the recordkeeping systems of a broker/dealer rarely specify a particular format to maintain such information. Rather, the rules specify only that certain information must be created and maintained within the broker/dealer’s records. The methods employed by member firms vary widely depending on the size of the business, the specific products involved, and the volume of business conducted.

For example, a small retailer of mutual funds may employ the documents that are used in transmitting application-type mutual fund orders as the basis for the records themselves. Large firms with many customers and a substantial volume of transactions most often employ computers to record and maintain such information. Also, a large number of member firms contract with other broker/dealers to perform such services. The FINRA District Office staff’s determination of the adequacy of a particular Applicant’s recordkeeping system will be based upon the staff’s satisfaction that, whatever method is used, the required information is maintained and reasonably retrievable.

XII. Continuing Education

NASD Rule 1120 defines the obligation of member firms to comply with the Securities Industry Continuing Education Program. The Rule involves a two-part mandatory program that requires: periodic uniform training in regulatory matters (Regulatory Element), and ongoing programs by broker/dealers to keep employees up-to-date on job- and product-related subjects (Firm Element). For more information about the Securities Industry Continuing Education Program, please refer to the brochure, The Continuing Education Program For Securities Professionals, found in the FINRA Membership Kit.

XIII. Other Information Posessed by FINRA

This standard requires the District Office of FINRA to consider whether it possesses any information indicating that the applicant may circumvent, evade, or otherwise avoid compliance with the federal securities laws, the rules and regulations thereunder, or the Rules of the Association.¹

XIV. Consistency with Federal Securities Laws

This standard requires that the application and all supporting documents are consistent with federal securities laws, the rules and regulations thereunder, and the Rules of the Association.

1 Note: NASD Rules require that where the Department has obtained from a source other than the Applicant information or documentation on which the Department intends to base its decisions, copies of such information or document must be provided to the Applicant.