[Federal Register Volume 88, Number 86 (Thursday, May 4, 2023)]
[Notices]
[Pages 28620-28638]
[FR Doc No: 2023-09444]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-97398; File No. SR-FINRA-2023-007]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt
Supplementary Material .18 (Remote Inspections Pilot Program) Under
FINRA Rule 3110 (Supervision)

April 28, 2023.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on April 14, 2023, the Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission'') the proposed rule change as described in Items I,
II, and III below, which Items have been prepared by FINRA. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    FINRA is proposing to amend FINRA Rule 3110 (Supervision) to adopt
a voluntary, three-year remote inspections pilot program to allow
member firms to elect to fulfill their obligation under paragraph (1)
to Rule 3110(c) (Internal Inspections) by conducting inspections of
some or all branch offices and locations remotely without an on-site
visit to such office or location, subject to specified terms. As
detailed below, the key terms would include, among others: (1) a
requirement for a firm to conduct and document a risk assessment for
inspecting an office or location remotely and providing a non-
exhaustive list of factors to consider for this risk assessment; (2)
criteria that would make a member firm ineligible to participate in the
program; (3) conditions a member firm must satisfy before becoming a
pilot program participant relating to the firm's recordkeeping system,
and surveillance and technology tools; (4) criteria that would make
ineligible for remote inspection certain member firm offices or
locations; (5) conditions a member firm's office or location must
satisfy to be able to undergo a remote inspection relating to
electronic communications, correspondence, and books and records; (6) a
requirement that a participating firm provide FINRA specified data and
information on a quarterly basis; and (7) authorization for FINRA to
determine in the public interest that a firm is no longer eligible to
participate in the proposed program.
    The proposed Remote Inspections Pilot Program would not change the
current requirements under Rule 3110(c). Instead, the proposed program
would provide firms the flexibility to satisfy their Rule 3110(c)(1)
inspection obligation with or without an on-site visit to the office or
location, subject to the proposed terms described herein. FINRA
believes that proposed Rule 3110.18, on balance, preserves investor
protection objectives through the proposed safeguards while also
providing FINRA the opportunity to gauge the effectiveness of remote
inspections as part of a modernized, reasonably designed supervisory
system that reflects the current work environment and availability of
technologies that did not exist when the on-site inspection originally
was conceived.
    Subject to further clarifications to proposed Rule 3110.18 as
described below, the terms of the proposed rule change herein are
largely similar to File No. SR-FINRA-2022-021 filed in July 2022,\3\
then amended in December 2022 \4\ (together, the ``2022 Remote
Inspections Pilot Program Rule Filing''). FINRA withdrew File No. SR-
FINRA-2022-021 on April 11, 2023 to consider whether more safeguards
and clarifications to the filing would be appropriate in response to
concerns raised by commenters.\5\ This proposed rule change is
organized in five sections: (1) the background, which provides a
historical overview of Rule 3110(c), and discusses the environmental
changes that have occurred over the years relating to technology and
the workplace; (2) FINRA's observations of evolving inspection
practices; (3) the emergence of remote inspections as a new approach to
evaluation under Rule 3110(c)(1); (4) a description of the terms of the
proposed rule change; and (5) an overview of FINRA's monitoring and
compliance with proposed Rule 3110.18.
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    \3\ See Securities Exchange Act Release No. 95452 (August 9,
2022), 87 FR 50144 (August 15, 2022) (Notice of Filing of File No.
SR-FINRA-2022-021) (``Initial Rule Filing''); see also Exhibit 2a.
    \4\ See Securities Exchange Act Release No. 96520 (December 16,
2022), 87 FR 78737 (December 22, 2022) (Notice of Partial Amendment
No. 1 to File No. SR-FINRA-2022-021) (``Amended Rule Filing''); see
also Exhibit 2b.
    \5\ See Exhibit 2d.
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    The text of the proposed rule change is available on FINRA's
website at http://www.finra.org, at the principal

office of FINRA and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

1. Purpose
(I) Background
A. Overview
    The responsibility of firms to supervise their associated persons
is a critical component of broker-dealer regulation.\6\ Member firms
must supervise all of their associated persons, regardless of their
location, compensation or employment arrangement, or registration
status.\7\ Rule 3110 requires a member, regardless of size or type, to
have a supervisory system for the activities of its associated persons
that is reasonably designed to achieve compliance with the applicable
securities laws and regulations and FINRA rules, and sets forth the
minimum requirements for such supervisory system.\8\ The internal
inspection obligation under Rule 3110(c) is one component of such
system.
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    \6\ See generally SEC Division of Market Regulation, Staff Legal
Bulletin No. 17: Remote Office Supervision (March 19, 2004) (``SLB
17'') (SEC guidance on remote office supervision), https://www.sec.gov/interps/legal/mrslb17.htm; and Regulatory Notice 11-54
(November 2011) (``Notice 11-54'') (joint SEC and FINRA guidance on
effective policies and procedures for broker-dealer branch
inspections).
    \7\ This obligation is consonant with Sections 15(b)(4)(E) and
15(b)(6)(A) of the Exchange Act. Section 15(b)(4)(E) provides that
the: ``Commission, by order, shall censure, place limitations on the
activities, functions, or operations of, suspend for a period not
exceeding twelve months, or revoke the registration of any broker or
dealer if it finds . . . that such broker or dealer . . . or any
person associated with such broker or dealer . . . has willfully
aided, abetted, counseled, commanded, induced, or procured the
violation by any person of any provision of the Securities Act of
1933, the Investment Advisers Act of 1940, the Investment Company
Act of 1940, the Commodity Exchange Act, [the Securities Exchange
Act of 1934], the rules or regulations under any of such statutes,
or the rules of the Municipal Securities Rulemaking Board, or has
failed reasonably to supervise, with a view to preventing violations
of the provisions of such statutes, rules, and regulations, another
person who commits such a violation, if such other person is subject
to his supervision.'' 15 U.S.C. 78o(b)(4)(E). Section 15(b)(6)(A)(i)
parallels Section 15(b)(4)(E) and provides for the imposition of
sanctions against persons associated with a broker or dealer that
violates those statutes, rules and regulations enumerated in Section
15(b)(4)(E) and other specified subparagraphs under Section
15(b)(4). 15 U.S.C. 78o(b)(6)(A).
    \8\ See Rule 3110(a).
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    Before the adoption of Rule 3110(c) in its current form as
described below, FINRA's (then NASD's) Rules of Fair Practice \9\
required a member firm to review the activities of each office
including the periodic examination of customer accounts to detect and
prevent irregularities and abuses and at least an annual inspection of
each OSJ.\10\ Subsequently, FINRA expanded the review requirement to
include not only the activities of each office, but also the businesses
in which a member firm engages.\11\
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    \9\ Then NASD adopted its Rules of Fair Practice when it was
founded in 1939 under provisions of the 1938 Maloney Act amendments
to the Exchange Act.
    \10\ See Notice to Members 87-41 (June 1987) (``Notice 87-41'')
(setting forth the proposed rule text changes to Article III,
Section 27 of the NASD Rules of Fair Practice for the review and
annual inspection requirement, among other provisions).
    \11\ See Notice to Members 88-84 (November 1988) (``Notice 88-
84'').
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    The expanded review requirement included, among other things, an
inspection of branch offices in accordance with a schedule as set forth
in the member's supervisory procedures.\12\ This expansion was intended
to address concerns about the adequacy of ongoing supervision and
regular examination of associated persons engaged in the offer and sale
of securities to the public at locations away from a member firm's
office.\13\ FINRA guidance during this period of supervisory change
focused on the need for the effective supervision of the securities-
related activities of ``off-site representatives,'' and advised firms
of the importance of not only reviewing their supervisory systems and
procedures to ensure that they were current and adequate, but also
conducting inspections to determine whether these systems and
procedures were being followed.\14\ Further, the guidance advised firms
that an inspection should include, among other things, a ``review of
any on-site customer account documentation and other books and records,
meetings with individual registered representatives to discuss the
products they are selling and their sales methods, and an examination
of correspondence and sales literature.'' \15\
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    \12\ See Notice 88-84. By 2004, the requirement to inspect a
branch office in accordance with a regular schedule as set forth in
the member's supervisory procedures was replaced by mandatory
inspection cycles as set forth under Rule 3110(c)(1). See Notice to
Members 04-71 (October 2004).
    \13\ See Notice 88-84.
    \14\ See Notice to Members 99-45 (June 1999) (``Notice 99-45'').
    \15\ See Notice to Members 98-38 (May 1998) (``Notice 98-38'')
and Notice 99-45; see also Notice to Members 86-65 (September 1986)
(``Notice 86-65'').
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    The guidance about the effective supervision of ``off-site
representatives'' and what an inspection entailed was pragmatic at a
time when business activities were conducted primarily using paper
documents \16\ that were created and stored locally at an office or
location; registered persons were interacting with their customers
largely through in-person meetings, paper-based correspondence
transmitted through the postal service, and landline telephone calls;
and supervisory personnel were conducting supervision through manual
reviews of paper files (e.g., exception reports bearing a supervisor's
handwritten comments and initials or signature). In that environment,
the best practice to determine whether the firm's supervisory system
and procedures were being followed was through having firm compliance
personnel visit the office or location. This practice has remained the
prevailing means to satisfy the inspection obligation under Rule
3110(c)(1).
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    \16\ Paper-based documents included, for example, customer
account opening documents; correspondence with customers; marketing
materials; communications from registered persons to the firm; order
tickets; checks received and forwarded; and fund transmittal
records.
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    Currently, Rule 3110(c) sets forth three main requirements for
inspections. First, an inspection of an office or location must occur
on a designated frequency. The periodicity of the required inspection
varies depending on the classification of the location or the nature of
the activities that take place: OSJs and supervisory branch offices
must be inspected at least annually; \17\ non-supervisory branch
offices, at least every three years; \18\ and non-branch locations, on
a periodic schedule, presumed to be at least every three years.\19\
Second, a member must retain a written record of the date upon which
each review and inspection occurred, reduce a location's inspection to
a written report and keep each inspection report on file either for a
minimum of

three years or, if the location's inspection schedule is longer than
three years, until the next inspection report has been written.\20\ If
applicable to the location being inspected, the inspection report must
include the testing and verification of the member's policies and
procedures, including supervisory policies and procedures, in specified
areas.\21\ Third, to prevent compromising the effectiveness of
inspections due to conflicts of interest, the rule requires a member to
ensure that the person conducting the inspection is not an associated
person assigned to the location or is not directly or indirectly
supervised by, or otherwise reporting to, an associated person assigned
to that location.\22\ All branch offices and non-branch locations are
subject to Rule 3110(c).
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    \17\ See Rule 3110(c)(1)(A).
    \18\ See Rule 3110(c)(1)(B).
    \19\ See Rules 3110(c)(1)(C) and 3110.13 (General Presumption of
Three-Year Limit for Periodic Inspection Schedules).
    \20\ See Rule 3110(c)(2).
    \21\ See Rule 3110(c)(2)(A) (providing that the inspection
report must include, without limitation, the testing and
verification of the member's policies and procedures, including
supervisory policies and procedures for: (1) safeguarding of
customer funds and securities; (2) maintaining books and records;
(3) supervision of supervisory personnel; (4) transmittals of funds
from customers to third party accounts, from customer accounts to
outside entities, from customer accounts to locations other than a
customer's primary residence, and between customers and registered
representatives, including the hand delivery of checks; and (5)
changes of customer account information, including address and
investment objectives changes, and validation of such changes).
    \22\ Rule 3110(c)(3) provides a limited exception from this
requirement if a firm determines compliance is not possible either
because of the firm's size or its business model. Rule 3110.14
(Exception to Persons Prohibited from Conducting Inspections)
reflects FINRA's expectation that a firm generally will rely on the
exception in instances where the firm has only one office or has a
business model where small or single-person offices report directly
to an OSJ manager who is also considered the offices' branch office
manager. However, these situations are non-exclusive, and a firm may
still rely on the exception in other instances where it cannot
comply because of its size or business model, provided the firm
complies with the documentation requirements under the rule.
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    Further, Rule 3110.12 (Standards for Reasonable Review) sets out
factors that constitute a reasonable review. This provision emphasizes
establishing reasonable supervisory procedures and conducting reviews
of locations, taking into consideration, among other things, the
member's size, organizational structure, scope of business activities,
number and location of the member's offices, the nature and complexity
of the products and services offered by the member, the volume of
business done, the number of associated persons assigned to a location,
the disciplinary history of registered representatives or associated
persons, and any indicators of irregularities or misconduct (i.e.,
``red flags'').\23\ The provision further states that the procedures
established and reviews conducted must provide that the quality of
supervision at remote (i.e., geographically dispersed) locations is
sufficient to ensure compliance with applicable securities laws and
regulations and with FINRA rules, and that members must be especially
diligent with respect to a non-branch location where a registered
representative engages in securities activities. This provision
incorporates guidance FINRA has previously issued about supervising
associated persons working in geographically dispersed offices.\24\
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    \23\ Such red flags may include: customer complaints; a large
number of elderly customers; a concentration in highly illiquid or
risky investments; an unexplained increase or change in the types of
investments or trading concentration that a representative is
recommending or trading; an unexpected improvement in a
representative's production, lifestyle, or wealth; questionable or
frequent transfers of cash or securities between customer or third
party accounts, or to or from the representative; a representative
that serves as a power of attorney, trustee or in a similar capacity
for a customer or has discretionary control over a customer's
account(s); a representative with disciplinary records; customer
investments in one or a few securities or class of securities that
is inconsistent with firm policies related to such investments;
churning; trading that is inconsistent with customer objectives;
numerous trade corrections, extensions, liquidations; or significant
switching activity of mutual funds or variable products held for
short time periods. See SLB 17, supra note 6; see also Notices 98-38
and 99-45.
    \24\ See, e.g., Notices 98-38 and 99-45.
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    In 2004, the SEC staff similarly provided guidance to broker-
dealers on supervision principles.\25\ At that time, the SEC staff
noted that small, geographically scattered offices presented
supervisory challenges when they were not subject to on-site
supervision. The SEC staff observed that an office's geographic
distance from supervisory personnel could make it easier for registered
persons and other employees to carry out and conceal violative conduct.
This general observation was derived from SEC enforcement cases finding
that firms had inadequately supervised their associated persons working
in small, geographically distant offices due to the failure of their
supervisory mechanisms to detect and prevent misconduct. Citing
technology available at the time, the guidance emphasized that an
effective supervisory system for geographically dispersed offices uses
a combination of on-site and off-site monitoring; it specifically said
that ``[c]entralized technology to monitor the trading and handling of
funds in remote office accounts, as well as the use of personal
computers, helps detect misappropriation of customer funds, selling
away, and unauthorized trading, among other things[.]'' \26\ The
guidance supported both routine or ``for cause'' on-site inspections,
and encouraged unannounced inspections either on a random basis or
where there are red flags about unusual activity at those offices.
Further, SEC staff and FINRA issued joint guidance that included a
FINRA interpretation of Rule 3110(c)(1) requiring member firms to
conduct on-site inspections of branch offices and unregistered offices
(i.e., non-branch locations) and stating that the inspection process is
an element of a firm's compliance and reasonable supervision of its
offices and locations, and personnel, and a component of a firm's risk
management program.\27\ In the joint guidance, the SEC and FINRA also
articulated that the ``inspection provides the firm with the
opportunity to validate its surveillance results from branch offices
and to gather on-site intelligence that supplements the ongoing
management and surveillance of the branch from a business and risk
management standpoint.'' \28\ Since the time these in-person guidelines
were expressed, workplace models have changed significantly and
developments in technology have enhanced firms' overall and ongoing
supervision and monitoring of the activities occurring at branch
offices and non-branch locations. In response to these developments,
member firms have questioned the historical expectation that firms
satisfy the inspection component of Rule 3110(c) in a physical, on-site
manner.
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    \25\ See SLB 17, supra note 6.
    \26\ See SLB 17, supra note 6.
    \27\ See Notice 11-54 (stating, in part, a ``broker-dealer must
conduct on-site inspections of each of its office locations; [OSJs]
and non-OSJ branches that supervise non-branch locations at least
annually, all non-supervising branch offices at least every three
years; and non-branch offices periodically.''). See also SLB 17
(stating, in part, that broker-dealers that conduct business through
geographically dispersed offices have not adequately discharged
their supervisory obligations where there are no on-site routine or
``for cause'' inspections of those offices), https://www.sec.gov/interps/legal/mrslb17.htm.
    \28\ See Notice 11-54.
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B. Environmental Changes Support Revision of In-Person Supervisory
Conventions Relating to Rule 3110(c)(1)
    Over the years, widespread advancements in technology and
communications in the financial industry have significantly changed the
way in which members and their associated persons conduct their
business and communicate, including the practices that formed the
original bases for the on-site inspection. For

example, making and preserving records electronically have increasingly
become the norm and the preferred recordkeeping medium rather than
paper (e.g., cloud based storage); communications between and among
members, their associated persons and customers commonly take place
through email, video or online meeting programs (e.g., WebEx, Zoom)
that can be monitored electronically by firms; \29\ processes for
opening customer accounts and placing trades are moving to online
platforms; and customer funds and securities are frequently and
increasingly transmitted electronically rather than in physical form
(e.g., Venmo, Zelle). Relatedly, the challenges in supervising
associated persons who work in outlying offices or locations (i.e.,
``off-site representative'') have been mitigated over the years with
the prevalent and effective use of technology. For example, supervisory
reviews for outside business activities of registered persons are often
conducted through general internet searches, including social media and
online public records, and by reviewing electronic communications and
customer fund transfers. Similarly, reviews of correspondence, customer
funds and securities, and order flows are accomplished primarily
through the use of electronic tracking programs or applications.
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    \29\ Many customers now expect their primary mode of interaction
with their firm to be digital. In a study to learn about investors
who, during year 2020, entered into the markets using taxable, non-
retirement investment accounts, FINRA found that nearly half (48%)
of ``new investors,'' investors who opened a non-retirement
investment account during 2020, indicated that they accessed their
account primarily through a mobile app, and three-quarters (75%) of
``holdover account owners,'' investors who maintained a taxable
investment account opened before year 2020, indicated they accessed
their account primarily through a website. See generally FINRA
Investor Education Foundation & NORC, Consumer Insights: Money &
Investing, Investing 2020: New Accounts and the People Who Opened
Them at 11 (February 2021), https://www.finrafoundation.org/sites/finrafoundation/files/investing-2020-new-accounts-and-the-people-who-opened-them_1_0.pdf.
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    In addition, the progressive digitization of firm data and the
centralization of control functions have converged, with significant
advantages for a firm's supervision of its business, including
monitoring of an associated person's activities and conducting
inspections. Today, many firms capture the lifecycle of an associated
person's activities with a firm, as well as a customer's interactions
with the firm, in digital audit trails. Such activities include, for
example, information about associated persons and customers obtained at
the account opening process; communications between associated persons
and customers or among associated persons; order and trade activity;
and money and security movements in customer accounts. As a result, a
firm can monitor the activities of its associated persons and customers
continuously, on a real-time or near-real time basis, and react
promptly to actual or potential exceptions to routine behaviors, rather
than depend on a ``point-in-time'' office inspection visit on a
prescribed schedule.
    Further, increased digitization has centralized elements of firm
compliance and supervisory functions, and these centralized functions
have become the front line in supervision and surveillance. Rather than
having a firm's compliance personnel walk around an office or location
during an inspection to identify potential problems or to gather on-
site intelligence--an approach that relies on chance encounters such as
overhearing an associated person making a sales pitch to a customer for
a product a firm is not approved to sell or observing an associated
person cutting and pasting a customer signature onto a form--
digitization now allows a firm to readily ``walk around the data,''
reducing the member's dependence on on-site intelligence because most
of activities occurring at an office or location are electronically
captured. The technology-driven environment has provided firms the
opportunity to develop a more holistic view of a firm's risk management
programs, fostering a more efficient and timely response to areas of
concern. For example, centralized control functions strengthen
supervision by enabling a firm to implement more frequent or ongoing,
repeatable, consistent, and highly scalable approaches to analyzing the
activities of associated persons across dispersed offices and
locations, creating a level of process discipline not previously
achievable in the past. These centralized control functions allow a
firm to identify potential areas of concern, and implement targeted
solutions or preventative measures in a more timely manner. For
example, a fraud specialist team may identify a new fraud scenario and
then promptly implement a new surveillance pattern to identify red
flags for this behavior throughout the firm. A firm may also use in-
house or vendor-created technologies to regularly adjust and ``right
size'' its surveillance alerts and patterns. For example, a firm may
quickly adjust its email review lexicons to surveil communications
relating to any topic or term.
    FINRA notes that firms are turning to new and innovative regulatory
tools such as artificial intelligence, natural language processing, and
robotics process automation, among others, to strengthen their
compliance programs.\30\ Over the last few years, firms have questioned
the benefits and practicalities of the need to conduct an inspection in
an on-site manner for each office and location, particularly in light
of these significant technological advances that have not only changed
the way in which firms conduct business and communicate, but also
enhanced the effectiveness and efficiencies of a firm's overall and
ongoing supervision and monitoring of the activities occurring at their
offices and locations.\31\
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    \30\ See generally FINRA White Paper, Technology Based
Innovations for Regulatory Compliance (``RegTech'') in the
Securities Industry (September 2018), https://www.finra.org/sites/default/files/2018_RegTech_Report.pdf.
    \31\ Some firms have indicated, for example, that technology has
enhanced real time monitoring of their associated persons by
providing the ability for firm compliance personnel to join, on an
ad hoc basis, digital or virtual meetings occurring between the
firm's associated persons and customers. Firms have also indicated
that technology has allowed them to impose various restrictions or
limitations on associated persons, such as the ability to print firm
records from remote locations using a firm-issued laptop, and only
accepting electronic payments from customers.
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C. Impact of the Pandemic on Workplace Arrangements, and Diversity,
Equity and Inclusion
    The COVID-19 pandemic, identified in early 2020,\32\ has had a
profound and lasting impact on workplace arrangements, and brought
focus to the integrity of firms' supervisory systems in a more
dispersed work environment. The pandemic accelerated the use of a wide
variety of compliance and workplace technology as many government and
private employers, including member firms, were driven to adopt a broad
remote work environment by quickly moving their employees out of their
usual office setting to an alternative worksite such as a private
residence. Insights obtained from member firms and other industry
representatives through various pandemic-related initiatives and other
industry outreach have led FINRA to carefully consider whether some
processes and rules, including the manner in which a firm may satisfy
its Rule 3110(c)(1) obligations, should be

modernized.\33\ Technological improvements and developments in
regulatory compliance have provided more tools than before to create
more effective and efficient compliance programs. To that end, FINRA
believes that regulatory models should evolve to benefit from the
availability and use of effective technology tools. The SEC's recent
Strategic Plan similarly recognized that ``[t]echnology and business
models are always changing, and it is important for [the SEC] to evolve
in kind[,]'' and expressed the overall need to ``[u]pdate existing SEC
rules and approaches to reflect evolving technologies, business models,
and capital markets.'' \34\ With the confluence of advances in
compliance technology and the shift to hybrid work environments, FINRA
believes that the optimal use of on-site inspections deserves further
consideration as part of the overall effort to modernize FINRA rules to
reflect evolving technologies and business models.\35\ As such, FINRA
believes it is appropriate now to assess possible longer-term rule
changes and is, therefore, proposing a voluntary, three-year remote
inspections pilot program. This program would provide FINRA with
specific, structured data from pilot program participants to evaluate
impacts--positive and negative--on inspection findings and to
systematically assess the overall impact on firms' supervisory systems,
which has not been feasible with information drawn from the pandemic-
related office shutdowns. Moreover, the proposed pilot program would
maintain effective supervision by firms through the ongoing supervisory
obligations under Rule 3110, and the proposed limitations on the firms
and locations that would be eligible to participate in the proposed
pilot program. FINRA emphasizes that the proposed pilot program is not
intended to signal the abandonment of on-site inspections, but to
assess the effectiveness and efficiency of additional approaches,
subject to specified controls, for firms to meet their inspection
obligations under Rule 3110(c)(1) while still preserving the investor
protection objectives of the rule.
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    \32\ See Centers for Disease Control and Prevention (``CDC''),
International Classification of Diseases, Tenth Revision, Clinical
Modification (ICD-10-CM) (Effective March 18, 2020), https://www.cdc.gov/nchs/data/icd/Announcement-New-ICD-code-for-coronavirus-3-18-2020.pdf. See also WHO Director-General's Opening Remarks at
the Media Briefing on COVID-19 (March 11, 2020), https://www.who.int/director-general/speeches/detail/who-director-general-s-opening-remarks-at-the-media-briefing-on-covid-19---11-march-2020.
    \33\ See generally FINRA's Key Topic: COVID-19/Coronavirus
(referencing, among other things, Frequency Asked Questions,
temporary amendments to FINRA rules, and Regulatory Notices such as
Regulatory Notices 20-08 (March 2020) (``Notice 20-08''), regarding
pandemic-related business continuity planning, guidance and
regulatory relief to member firms from some requirements, including
the temporary suspension of the requirement to maintain updated
information on Form U4 (Uniform Application for Securities Industry
Registration or Transfer) and submit Form BR (Uniform Branch Office
Registration Form) for temporary locations; 20-16 (May 2020)
(``Notice 20-16''), describing practices implemented by firms to
transition to, and supervise in, remote work environment during the
COVID-19 pandemic; 20-42 (December 2020) (``Notice 20-42''), seeking
comment on lessons from the pandemic; and 21-44 (December 2021),
regarding business continuity planning and lessons from the
pandemic, https://www.finra.org/rules-guidance/key-topics/covid-19).
See also SEC Press Release 2022-112 (June 22, 2022) for the Spring
2022 Regulatory Agenda (quoting SEC Chair Gary Gensler: ``When I
think about the SEC's agenda, I'm driven by two public policy goals:
continuing to drive efficiency in our capital markets and
modernizing our rules for today's economy and technologies.''),
https://www.sec.gov/news/press-release/2022-112?utm_medium=email&utm_source=govdelivery.
    \34\ See SEC, Strategic Plan for fiscal years 2022 to 2026
(November 23, 2022), https://www.sec.gov/files/sec_strategic_plan_fy22-fy26.pdf.
    \35\ FINRA notes one state regulator has issued a policy
statement, acknowledging that ``more businesses have adapted
practices, hired employees, and instituted other changes to their
compliance initiatives which have allowed then to adapt to working
from a remote setting.'' As a result, the state securities
commissioner concluded that a ``full and thorough Branch Inspection
conducted remotely may allow broker-dealers similar opportunity to
monitor practices and ensure regulatory compliance when compared
with in-person Branch Inspections.'' Through this policy statement,
a broker-dealer registered in the state may satisfy that state's
branch office examination requirements through remote inspections by
using mediums such as video conference and digital file sharing. See
Indiana Secretary of State Securities Division, Statement of Policy
Regarding Broker-Dealer Branch Office Examinations in 2023 (January
13, 2023), https://securities.sos.in.gov/sop-bd-branch-exams-2023.
---------------------------------------------------------------------------

    Firms have also conveyed that the flexibility of hybrid work has
made a positive impact in attracting more diverse talent and retaining
existing talent. These views are consistent with those expressed by
several commenters in response to the Initial Rule Filing.\36\ For
example, several commenters to the Initial Rule Filing noted the
positive impact that proposal was expected to have on workplace
flexibility and hiring efforts that would enhance talent recruitment
and retention in the financial industry, particularly with respect to
diversity and inclusion initiatives.\37\ In general, the U.S. workforce
has increasingly demanded greater workplace flexibility and the
securities industry is subject to the same national pressures as it
aims to recruit and retain diverse, talented and qualified employees,
especially supervisors essential to a reasonably designed supervisory
program.\38\ Notably, the SEC has also indicated that it needed to
``harness the benefits of telework as highlighted during the
pandemic[.]'' \39\
---------------------------------------------------------------------------

    \36\ See Exhibit 2c.
    \37\ See Exhibit 2c.
    \38\ See, e.g., McKinsey & Company, Americans are embracing
flexible work--and they want more of it (June 23, 2022)
(highlighting survey results that 58 percent of U.S. workers, an
estimated 92 million people, shared that they can work remotely at
least part of the time, and that when employees are given the option
to work remotely, 87 percent of employees chose to do so), https://www.mckinsey.com/industries/real-estate/our-insights/americans-are-embracing-flexible-work-and-they-want-more-of-it#/.
    \39\ See note 34, supra.
---------------------------------------------------------------------------

(II) FINRA's Observations of Evolving Inspection Practices
    Over the last decade, FINRA has observed that the widespread
advances in technology in the financial industry, including the
progressive digitization of data and the centralization of control
functions, have given firms the greater ability to continuously monitor
for, identify and investigate atypical behaviors or patterns. With this
evolution, the importance of on-site inspections as a primary means to
identify non-compliant conduct at all offices and locations has
seemingly diminished. Inspection practices that previously depended on
an on-site presence at an office or location included, for example,
reviewing paper-based books and records (e.g., logs or blotters
reflecting transmittals of funds and securities, and paperwork related
to new customer accounts); testing the implementation of controls at
the office or location relating to the security of checks and stock
certificates, the security of an office or location itself (e.g.,
secured file cabinets containing paper-based books and records);
reviewing how supervisors perform their functions such as ensuring that
an associated person's uniform form filings were current and accurate;
and looking for physical signs of an associated person's outside
business activities that were unreported to the firm or a lifestyle
that did not align with the associated person's compensation or
production levels.
    As firms are working in a progressively more digitized environment
and operating under a system of controls that has become more
centralized, FINRA has observed that in general, much of the work
traditionally associated with an on-site inspection takes place before
the on-site visit. For example, efforts to investigate potential
undisclosed outside business activities or evidence of a registered
person's lifestyle that may not be commensurate with the person's
revenue production at the firm are accomplished through general
internet searches of social media and public records; and irregular
customer account activity, trading activity, and written communications
are reviewed through the firm's electronic systems. The pandemic has
revealed the pragmatism of satisfying

Rule 3110(c)(1) through an on-site process in a technological
environment that is vastly different from the environment in which the
office review requirement was expanded in the 1980s. In engagement with
industry representatives, particularly in recent years, some firms have
shared with FINRA that the variance between their rates of inspection
findings through an on-site process and findings through a remote
process were not material. These firm observations align with the
observations some commenters conveyed in response to the Initial Rule
Filing.\40\ Moreover, FINRA's experience examining firms' remote
inspection programs also aligns with these observations.
---------------------------------------------------------------------------

    \40\ See Exhibit 2c.
---------------------------------------------------------------------------

    In 2022, FINRA examined several firms, including those that operate
under an independent contractor business model and others with branch
office networks, to test their compliance with Rule 3110.17, the
temporary provision that provides firms the option, subject to the
specified requirements under that supplementary material, to complete
their calendar year inspection obligations remotely without an on-site
visit to the office or location.\41\ The targeted examinations assessed
firms' implementation of their remote inspection processes and the
effectiveness of their supervisory systems. FINRA found that, in
general, these systems were effective in supporting remote branch
office inspections. Of the examinations completed for Rule 3110.17
compliance, approximately 43% resulted in no findings and 21%
identified findings that were operational in nature and did not raise
concerns of customer harm, while 36% of the examinations remain
ongoing. In addition to engaging in ongoing surveillance of activities,
FINRA observed that firms were using, among other inspection tools,
``pre-audit'' questionnaires to assess the risk level of a branch
office and determine the frequency of inspections (remote or on-site)
on an announced or unannounced basis. In addition, FINRA observed firms
making broad use of technology to supervise the activities of their
associated persons remotely to: identify undisclosed private securities
transactions and outside business activities; identify problematic
electronic communications; surveil trades and movements of customer
assets; conduct interviews with supervisors and other associated
persons assigned to the office or location; take and record online
office tours; and review associated persons' computers in real-time
using tools such as remote desktop software. FINRA's overall
examination findings in recent years across all firm examinations
conducted during the period in which firms were conducting fully remote
inspections or operating in a fully remote or hybrid work environment,
have remained within the bounds of general norms.\42\
---------------------------------------------------------------------------

    \41\ See Securities Exchange Act Release No. 96241 (November 4,
2022), 87 FR 67969 (November 10, 2022) (Notice of Filing and
Immediate Effectiveness of File No. SR-FINRA-2022-030). See also
Item II.A.1.(III)B. for further discussion.
    \42\ FINRA notes that examination findings that were
attributable to complying with a new regulation adopted by the SEC,
for example, are separate from this general view.
---------------------------------------------------------------------------

(III) The Emergence of Remote Inspections as a New Approach To Evaluate
Under Rule 3110(c)(1)
A. The 2017 Proposal To Allow Remote Inspections and the Impact From
the Pandemic
    Even prior to the pandemic, in 2017, FINRA considered a proposal to
give firms the option of satisfying the inspection requirement remotely
for ``qualifying offices'' that met specified criteria.\43\ However,
the pandemic significantly changed the industry's standard business
operations, forcing member firms to adapt to a full remote work
environment and implement remote supervisory practices.\44\
Consequently, FINRA deferred the 2017 Proposal in light of the pressing
need to address significant operational disruptions to the securities
industry, regulators, impacted member firms, investors and other
stakeholders. During this exigent period, FINRA responded to numerous
issues and questions that urgently arose.\45\ Following up on these
actions, FINRA published Notice 20-42 to gain a broader understanding
of member firm experiences during the pandemic. This notice sought
feedback from firms about their experiences in a range of areas,
including how member firms' operations and business models changed
during the public health crisis and how they might further evolve as
the pandemic persisted. Other initiatives included sharing general
practices of firms in transitioning and supervising in the remote work
environment, and providing temporary relief to member firms from
specified FINRA rules and requirements. In particular, to give firms an
opportunity to better manage their operational challenges and redirect
resources attendant to fulfilling their inspection obligations, FINRA
provided temporary relief to member firms pertaining to Rule
3110(c).\46\
---------------------------------------------------------------------------

    \43\ See Regulatory Notice 17-38 (November 2017) (``2017
Proposal''). FINRA requested comment on a proposed amendment to Rule
3110 to allow remote inspections of ``qualifying offices'' that met
specified criteria, in lieu of on-site inspections of such offices
and locations. In general, many of the comment letters FINRA
received expressed support for the underlying concept of remote
inspections and offered recommendations on specific criteria to
broaden the potential population of qualifying offices.
    \44\ See generally Notice 20-16.
    \45\ See note 33, supra.
    \46\ See Rules 3110.16 and 3110.17.
---------------------------------------------------------------------------

B. Temporary Amendments to the Inspection Requirement Under Rule
3110(c)
    The ensuring pandemic-related operational changes made it
impracticable for member firms to conduct the on-site inspection
component of Rule 3110(c) at most offices and locations because of
limitations on travel to geographically dispersed OSJs, branch offices,
and non-branch locations. In response to the logistical challenges,
FINRA extended the time by which member firms were required to complete
their calendar year 2020 inspection obligations under Rule 3110(c) to
March 31, 2021 with the expectation that the extension did not relieve
firms from the on-site portion of the inspections of their offices and
locations.\47\ However, health and safety concerns remained unabated
and with many restrictive measures still in place as calendar year 2020
was ending, FINRA adopted Rule 3110.17 to provide member firms the
option, subject to specified requirements under the supplementary
material, to complete remotely their calendar year inspection
obligations without an on-site visit to the office or location.\48\
This relief was repeatedly extended and currently, Rule 3110.17 will
automatically sunset on December 31, 2023.\49\
---------------------------------------------------------------------------

    \47\ See Securities Exchange Act Release No. 89188 (June 30,
2020), 85 FR 40713 (July 7, 2020) (Notice of Filing and Immediate
Effectiveness of File No. SR-FINRA-2020-019).
    \48\ See Securities Exchange Act Release No. 90454 (November 18,
2020), 85 FR 75097 (November 24, 2020) (Notice of Filing and
Immediate Effectiveness of File No. SR-FINRA-2020-040).
    \49\ See Securities Exchange Act Release No. 93002 (September
15, 2021), 86 FR 52508 (September 21, 2021) (Notice of Filing and
Immediate Effectiveness of File No. SR-FINRA-2021-023); Securities
Exchange Act Release No. 94018 (January 20, 2022), 87 FR 4072
(January 26, 2022) (Notice of Filing and Immediate Effectiveness of
File No. SR-FINRA-2022-001); and Securities Exchange Act Release No.
96241 (November 4, 2022), 87 FR 67969 (November 10, 2022) (Notice of
Filing and Immediate Effectiveness of File No. SR-FINRA-2022-030).
---------------------------------------------------------------------------

    Through comments to the 2017 Proposal, Notice 20-42, the various
temporary amendments to Rule 3110, and other engagement with industry
representatives, firms have highlighted

that technological advances, as described above, have allowed a large
portion of the inspection work to be conducted electronically, prior to
any on-site visit to the office and location, and that in general,
inspecting offices and locations in accordance with Rule 3110(c)(1)
through a compulsory on-site process is not an efficient and effective
use of limited firm resources.\50\
---------------------------------------------------------------------------

    \50\ In response to FINRA's proposed rule changes associated
with Rule 3110.17, one commenter made similar points about the
physical, on-site piece of the inspection process. This commenter
stated that pre-pandemic, an on-site inspection of a branch office
typically consisted of reviewing the lobby area of the office, the
back office (to review safe contents, sales literature, daily
operations logs containing account applications), signage, and the
physical security of the office. See Letter from Carrie L. Chelko,
Chief Compliance Officer, Fidelity Brokerage Services LLC
(``Fidelity Brokerage'') & Norman L. Ashkenas, Chief Compliance
Officer, National Financial Services LLC (``NFS'') and Fidelity
Distributors Company LLC (``Fidelity Distributors''), to Vanessa
Countryman, Secretary, SEC, dated July 28, 2020, in response to File
No. SR-FINRA-2020-019, https://www.sec.gov/comments/sr-finra-2020-019/srfinra2020019-7488701-221389.pdf, and Letter from Gail Merken,
Chief Compliance Officer, Fidelity Brokerage, Janet Dyer, Chief
Compliance Officer, NFS & John McGinty, Chief Compliance Officer,
Fidelity Distributors, to Vanessa Countryman, Secretary, SEC, dated
February 16, 2022, in response to File No. SR-FINRA-2022-001,
https://www.sec.gov/comments/sr-finra-2022-001/srfinra2022001-20116307-267950.pdf.
---------------------------------------------------------------------------

    Rule 3110.17 was adopted in the midst of the pandemic, when many
offices and locations were forced to close to allow employees to carry
on with their responsibilities from alternative worksites. This relief
has been extended as pandemic concerns continued.\51\ FINRA recognizes
that the pandemic has changed the conventional thinking on where work
is conducted and this shift in the workforce landscape will unlikely
revert to the model that existed pre-pandemic.
---------------------------------------------------------------------------

    \51\ See note 49, supra.
---------------------------------------------------------------------------

C. The 2022 Remote Inspections Pilot Program Rule Filing (File No. SR-
FINRA-2022-021)
    Based on the foregoing, in July 2022, FINRA filed the Initial Rule
Filing to amend Rule 3110 to adopt proposed Rule 3110.18 to establish a
voluntary, three-year remote inspection pilot program, under terms
based largely on Rule 3110.17, but with significant safeguards that
would have allowed FINRA the opportunity to collect specified data from
pilot program participants to evaluate their experiences and inspection
findings in a uniform, comparable manner in the context of then
emerging hybrid work model. The SEC twice published the Initial Rule
Filing for public comment, which elicited responses from many
individuals, broker-dealers, law schools, and trade organizations and
other associations, including the Securities Industry and Financial
Markets Association, the North American Securities Administrators
Association, Inc. (``NASAA'') and the Public Investors Advocate Bar
Association (``PIABA'').\52\ The SEC received over 30 comment letters
during the course of the two comment periods.\53\ Most of the comment
letters expressed support for the overall objectives of the proposal,
and many commenters viewed the proposal as a step towards FINRA rule
modernization, and having a positive impact on diversity and inclusion
initiatives.\54\ However, four commenters, which included NASAA and
PIABA, raised concerns with the Initial Rule Filing.\55\ NASAA and
PIABA each submitted two comment letters expressing opposition to the
Initial Rule Filing.\56\ NASAA and PIABA asserted generally that the
proposal would adversely impact investor protection due to, among other
concerns: the adequacy and scope of the proposed pilot program's
controls--the exclusions and conditions--to address higher-risk
conduct; the identification of technologies firms would use to conduct
their inspections remotely; the fundamental change to the approach of
supervision; monitoring for pilot program compliance; and the lack of
data to fully support the effectiveness of remote inspections.\57\
---------------------------------------------------------------------------

    \52\ See Submitted Comments to File No. SR-FINRA-2022-021,
https://www.sec.gov/comments/sr-finra-2022-021/srfinra2022021.htm.
    \53\ See note 52, supra.
    \54\ See Exhibit 2c.
    \55\ See Exhibit 2c.
    \56\ See note 52, supra.
    \57\ See Exhibit 2c.
---------------------------------------------------------------------------

    FINRA submitted a letter responding to comments \58\ and filed the
Amended Rule Filing in December 2022.\59\ The Amended Rule Filing
proposed to: (1) add specific risk criteria that a member must consider
in making its risk-based evaluation of an office or location; (2)
expand the list of exclusions that would make a member ineligible to
participate in the proposed pilot program; (3) expand the list of
exclusions that would make a specific office or location of a member
ineligible for a remote inspection; (4) add express conditions that a
member must satisfy to be eligible to conduct remote inspections of any
of its offices or locations; (5) add express conditions that a specific
office or location of a member must satisfy to be eligible for a remote
inspection; and (6) add a new provision to allow FINRA to make a
determination in the public interest and for the protection of
investors that a member is no longer eligible to participate in the
proposed pilot program for failing to comply with the requirements of
proposed Rule 3110.18. The SEC subsequently published the Amended Rule
Filing for public comment,\60\ and during the third comment period, the
SEC received four more comment letters, including a third letter from
NASAA, stating that in general, while the Amended Rule Filing was an
improvement to the proposed pilot program, it still needed more
guardrails with respect to the risk assessment; written supervisory
procedures; the firm level condition relating to surveillance and
technology tools; the data and information collection requirement; and
FINRA's determination of ineligibility for pilot participation.\61\ On
April 11, 2023, FINRA withdrew File No. SR-FINRA-2022-021 from the SEC
to consider whether more guardrails and clarifications to the filing
would be appropriate in response to concerns raised by commenters.\62\
---------------------------------------------------------------------------

    \58\ See Exhibit 2c.
    \59\ See Exhibit 2b.
    \60\ See Securities Exchange Act Release No. 96520 (December 16,
2022), 87 FR 78737 (December 22, 2022) (Notice of Filing of Partial
Amendment No. 1 to File No. SR-FINRA-2022-021).
    \61\ See Letter from Andrew Hartnett, President, NASAA, to
Sherry R. Haywood, Assistant Secretary, SEC, dated January 12, 2023
(``NASAA III''), https://www.sec.gov/comments/sr-finra-2022-021/srfinra2022021-20154758-323090.pdf.
    \62\ See Exhibit 2d.
---------------------------------------------------------------------------

(IV) Proposed Voluntary, Three-Year Pilot Program for Remote
Inspections
    Proposed Rule 3110.18, which sets forth the terms of the proposed
pilot program, would build largely on the terms of Rule 3110.17 and
retain the key changes as proposed in the 2022 Remote Inspections Pilot
Program Rule Filing, including the areas pertaining to the risk
assessment, written supervisory procedures, the firm level condition
relating to surveillance and technology tools, and FINRA's
determination of ineligibility for pilot participation.\63\ As detailed
below, the proposed rule change would clarify proposed Rule 3110.18 in
the areas pertaining to: (1) the frequency of FINRA's data and
information collection from pilot program participants, and the type of
``findings'' that would be part of the collection; and (2) the location
level ineligibility criterion for market making and trading activities.
---------------------------------------------------------------------------

    \63\ FINRA is also proposing technical changes that would
include, among others, reorganizing the presentation of the proposed
rule.
---------------------------------------------------------------------------

    FINRA anticipates that the proposed pilot program will provide
broader systemized information to supplement

the information obtained through the FINRA examination process in an
environment where offices and locations were closed. The information
firms would be required to produce as a pilot program participant will
help FINRA more accurately assess the overall impact and effectiveness
of remote inspections.
    FINRA is wholly dedicated to ensuring effective firm supervision as
a bulwark against misconduct or misadventure that could harm investors.
To this end, FINRA has been in the forefront of developing strong
supervision standards for member firms. As FINRA emphasized in the
proposed rule change to adopt Rule 3110.17, the responsibility of firms
to supervise their associated persons on a day-to-day basis is a
critical component of broker-dealer regulation.\64\ FINRA remains
committed to ensuring that firms maintain a strong, effective
supervisory system, of which the inspection requirement in Rule 3110(c)
is a component. Moreover, this inspection requirement is just one facet
of a reasonably designed supervisory system; the inspection process is
one of several critical components of the broad supervisory process
required of member firms to effectively oversee all of their associated
persons, regardless of location, compensation or employment
arrangement, or registration status. FINRA believes at this time that
the proposed pilot program is consistent with a firm's core
responsibility, as set forth in Rule 3110, to 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. Thus, FINRA
believes that the remote inspections pilot program's proposed controls
and safeguards achieve a responsible balance preserving the investor
protection objectives of the rule, while allowing FINRA and the
industry to gather data to further evaluate the appropriate contours of
the remote inspection construct. FINRA of course welcomes the insights
of commenters as FINRA strives to further articulate an effective firm
supervisory process.
---------------------------------------------------------------------------

    \64\ See note 48, supra.
---------------------------------------------------------------------------

A. Scope (Proposed Rule 3110.18(a))
    Consistent with the 2022 Remote Inspections Pilot Program Rule
Filing, proposed Rule 3110.18(a) would apply to the required
inspections of OSJs, branch offices, and non-branch locations under the
applicable provisions under Rule 3110(c)(1) for a pilot period of three
years starting on the effective date, and expiring on a date that is
three years after the effective date. If the proposed pilot program is
not extended or Rule 3110.18, as may be amended, is not approved as
permanent by the SEC, the proposed supplementary material would
automatically sunset on a date that is three years after the effective
date. In addition, proposed Rule 3110.18(a) would expressly state that
members would not be able to participate in the proposed pilot program
after it expires.
B. Risk Assessment (Proposed Rule 3110.18(b))
    As described above, Rule 3110(c)(1) provides that an inspection of
an office or location must occur on a designated frequency, and the
periodicity of the required inspection varies depending on the
classification of the location as an OSJ, branch office or non-branch
location. Subject to the proposed provisions relating to written
supervisory procedures, and the firm and location level requirements as
described below, proposed Rule 3110.18(b)(1) would provide that a
member firm may elect to conduct the applicable inspection of an office
or location during the pilot period remotely, without necessarily an
on-site visit for the office or location, when the member reasonably
determines that the purposes of the rule can be accomplished by
conducting such required inspection remotely.\65\ To address the
concerns raised by commenters to the Initial Rule Filing that a firm
might not appropriately consider certain higher risk criteria in
conducting its risk assessment, the Amended Rule Filing added a non-
exhaustive list of factors that a firm must consider and document.
FINRA is proposing to retain, without substantive change, those terms
under proposed Rule 3110.18(b).
---------------------------------------------------------------------------

    \65\ As described further below, a member firm that elects to
participate in the proposed pilot program would be subject to the
requirements of proposed Rule 3110.18 for a Pilot Year. See proposed
Rule 3110.18(i).
---------------------------------------------------------------------------

1. Standards for Reasonable Review (Proposed Rule 3110.18(b)(1))
    Consistent with the 2022 Remote Inspections Pilot Program Rule
Filing, proposed Rule 3110.18(b)(1) would provide that prior to
electing a remote inspection for an office or location, rather than an
on-site inspection, the firm must develop a reasonable risk-based
approach to using remote inspections and conduct and document a risk
assessment for that office or location. The assessment must document
the factors considered, including the factors set forth in Rule
3110.12, and must take into account any higher risk activities that
take place or higher risk associated persons that are assigned to that
location. FINRA expects that higher risk factors at a particular
location would cause a firm to conduct on-site inspections of such
location. Further, under the proposed supplementary material, a member
that is not eligible to conduct remote inspections under paragraphs (f)
or (g) under proposed Rule 3110.18, pertaining to firm level and
location level requirements, respectively, must conduct an on-site
inspection of that office or location on the required cycle. Finally,
notwithstanding the pilot program, a member would remain subject to the
other requirements and limitations of Rule 3110(c).\66\
---------------------------------------------------------------------------

    \66\ See notes 21 and 22, supra, and accompanying text.
---------------------------------------------------------------------------

2. Other Factors To Consider for the Risk Assessment (Proposed Rule
3110.18(b)(2))
    Consistent with the Amended Rule Filing, FINRA is proposing to set
forth a non-exhaustive list of factors that a firm must consider and
document as part of the risk assessment. Proposed Rule 3110.18(b)(2)
would provide that in addition to the requirements under proposed Rule
3110.18(b)(1), a member would be required to consider other factors in
making its risk assessment for remotely inspecting an office or
location. These factors would include, among others: (1) the volume and
nature of customer complaints; (2) the volume and nature of outside
business activities, particularly investment-related; (3) the volume
and complexity of products offered; (4) the nature of the customer
base, including vulnerable adult investors; (5) whether associated
persons are subject to heightened supervision; (6) failures by
associated persons to comply with the member's written supervisory
procedures; and (7) any recordkeeping violations. In addition, proposed
Rule 3110.18(b)(2) would provide that, consistent with Rule 3110.12,
members should conduct on-site inspections or make more frequent use of
unannounced, on-site inspections for high-risk offices or locations or
where there are indicators of irregularities or misconduct (i.e., ``red
flags.'').
    In response to the Amended Rule Filing, NASAA recommended that in
the absence of an affirmative on-site inspection requirement, a firm
should be required to document its reasons for not conducting an on-
site inspection of an office or location, particularly if high

risk factors or red flags are identified, or the office or location is
a private residence.\67\ FINRA believes that Rule 3110.18(b), as
proposed herein, reflects NASAA's insight. As noted previously, FINRA
emphasizes that the inspection requirement is but one part of a firm's
overall supervisory system, and that the inspection, whether done
remotely or on-site under the proposed pilot program, would be held to
the existing standards of review under Rule 3110.12. Those standards
provide, in part, that based on the factors set forth under that
supplementary material, members ``may need to provide for more frequent
review of certain locations.'' FINRA notes that proposed Rule
3110.18(b) would continue to account for the existing standards for
reasonable review under Rule 3110.12 and retain the requirement for a
firm, before electing a remote inspection for an office or location, to
develop a reasonable risk-based approach to using remote inspections
for its offices or locations, and conduct and document a risk
assessment. In conducting the assessment, a firm must document the
factors considered, including the factors set forth in Rule 3110.12,
and must take into account any higher risk activities that take place
or higher risk associated persons that are assigned to that office or
location, irrespective of whether such office or location is a private
residence. FINRA expects a firm to carefully consider the proposed
factors listed above and Rule 3110.12 for the risk assessment. The
outcome of such assessment may raise red flags that should prompt a
firm to consider, among other things, more frequent inspections of an
office or location--be they remote or on-site--than the schedule set
forth under Rule 3110(c)(1) (on an announced or unannounced basis).
Further, FINRA notes that Rule 3130 (Annual Certification of Compliance
and Supervisory Processes) requires member firms to have processes to
establish, maintain, review, test, and modify written compliance
policies and written supervisory procedures reasonably designed to
achieve compliance with applicable FINRA rules, Municipal Securities
Rulemaking Board rules, and federal securities laws and regulations.
FINRA expects firms to consider proposed Rule 3110.18 as part of their
annual certification process under Rule 3130.
---------------------------------------------------------------------------

    \67\ See NASAA III.
---------------------------------------------------------------------------

C. Written Supervisory Procedures for Remote Inspections (Proposed Rule
3110.18(c))
    As part of an effective supervisory system tailored specifically to
the member firm's business and the activities of all its associated
persons, a member must establish and maintain written procedures.\68\
Paragraph (1) (General Requirements) under Rule 3110(b) (Written
Procedures) provides that a member must establish, maintain, and
enforce written procedures to supervise the types of business in which
it engages and the activities of its associated persons that are
reasonably designed to achieve compliance with applicable securities
laws and regulations, and with applicable FINRA rules.
---------------------------------------------------------------------------

    \68\ See Rule 3110(a)(1); see generally Notice 99-45 and
Regulatory Notice 18-15 (April 2018).
---------------------------------------------------------------------------

    Currently, Rule 3110.17(b) expressly provides that consistent with
a member's obligation under Rule 3110(b)(1), a member that elects to
conduct each of its inspections in the specified calendar years
remotely must amend or supplement its written supervisory procedures to
provide for remote inspections that are reasonably designed to assist
in detecting and preventing violations of and achieving compliance with
applicable securities laws and regulations, and with applicable FINRA
rules. In addition, under Rule 3110.17(b), reasonably designed
procedures for conducting remote inspection of offices or locations
should include, among other things, a description of the methodology,
including technologies permitted by the member, that may be used to
conduct remote inspections. Further, such procedures should include the
use of other risk-based systems employed generally by the member firm
to identify and prioritize for review those areas that pose the
greatest risk of potential violations of applicable securities laws and
regulations, and of applicable FINRA rules.\69\ To underscore the
importance of Rule 3110(b)(1) in the context of the proposed pilot
program, FINRA proposed in the 2022 Remote Inspection Pilot Program
Rule Filing to add to the elements currently described under Rule
3110.17(b) an express provision that the firm must adopt written
supervisory procedures regarding remote inspections that are reasonably
designed to detect and prevent violations of and achieve compliance
with applicable securities laws and regulations, and with applicable
FINRA rules. In addition, a firm's written supervisory procedures
should also include the factors considered in the risk assessment made
for each applicable office or location pursuant to proposed Rule
3110.18(b).
---------------------------------------------------------------------------

    \69\ Offices or locations that may present a higher risk profile
would include, for example, those that have associated persons
engaging in activities that involve handling customer funds or
securities, maintaining books and records as described under
applicable federal securities laws and FINRA rules, order execution
as principal or other activities that may be more susceptible to
higher risks of operational or sales practice wrongdoing, or have
associated persons assigned to an office or location who may be
subject to additional or heightened supervisory procedures.
---------------------------------------------------------------------------

    In response to this proposed provision, NASAA stated that a firm's
written supervisory procedures should require more prescriptive details
such as specifying the technologies a firm would be using ``for what
purposes[,]'' and providing evidence of firm personnel's accessibility
to and proficiency with those technologies; describing the
circumstances under which a firm would conduct an on-site inspection in
the ``ordinary course'' and as a result of risk indicators and red
flags; indicating ``whether the firm [intended] to conduct unannounced
inspections, how the firm intend[ed] to do so remotely, and whether
certain factors might influence the firm's decision to do so in
particular [circumstances];'' and describing ``how [a] firm will use
its remote inspection procedures to control for the possibility of
active deception.'' \70\
---------------------------------------------------------------------------

    \70\ See NASAA III.
---------------------------------------------------------------------------

    After considering the specific details recommended by NASAA, FINRA
is proposing to largely retain the terms as proposed in the 2022 Remote
Inspections Pilot Program Rule Filing as consistent with the tenor of
other provisions of Rule 3110. Proposed Rule 3110.18(c) would provide
that consistent with a member's Rule 3110(b) obligations, a member that
elects to participate in the proposed remote inspection pilot program
must adopt written supervisory procedures regarding remote inspections
that are reasonably designed to detect and prevent violations of and
achieve compliance with applicable securities laws and regulations, and
with applicable FINRA rules. Further, under the proposed provision,
reasonably designed procedures for conducting remote inspections of
offices or locations must address, among other things: (1) the
methodology, including technology, that may be used to conduct remote
inspections; (2) the factors considered in the risk assessment made for
each applicable office or location pursuant to proposed Rule
3110.18(b); (3) the procedures specified in paragraphs (h)(1)(G) and
(h)(4) under

proposed Rule 3110.18.\71\ and (4) the use of other risk-based systems
employed generally by the member firm to identify and prioritize for
review those areas that pose the greatest risk of potential violations
of applicable securities laws and regulations, and of applicable FINRA
rules.
---------------------------------------------------------------------------

    \71\ The areas specified in proposed Rule 3110.18(h)(1)(G)
include the procedures for escalating significant findings, new
hires, supervising brokers with a significant history of misconduct,
outside business activities and doing business as designations, and
the areas specified in proposed Rule 3110.18(h)(4) include data and
information collection, and transmission.
---------------------------------------------------------------------------

    While the details identified by NASAA may be useful elements for
firms to consider in devising reasonably designed procedures, FINRA
believes that proposed Rule 3110.18(c), read in conjunction with
proposed Rule 3110.18(d), as described below, would provide the
appropriate level of direction for firms with respect to technology,
the areas that written policies and procedures must address, and the
use of other risk-based systems while also staying aligned with the
principles underlying Rule 3110. FINRA expects firms to take into
account the factors affecting their systems and businesses in crafting
reasonably designed policies and procedures to achieve the purposes of
the rule.
D. Effective Supervisory System (Proposed Rule 3110.18(d))
    Consistent with the 2022 Remote Inspections Pilot Program Rule
Filing, FINRA is proposing to retain the terms of Rule 3110.17(c),
without substantive change, in proposed Rule 3110.18(d). Similar to
Rule 3110.17(c), proposed Rule 3110.18(d) would expressly reiterate the
principle that the requirement to conduct inspections of offices and
locations is one part of the member's overall ongoing obligation to
have an effective supervisory system, and therefore a member must
maintain its ongoing review of the activities and functions occurring
at all offices and locations whether or not the member conducts
inspections remotely. In addition, proposed Rule 3110.18(d) would
provide that a member's remote inspection of an office or location
would be held to the same standards for review applicable to on-site
inspections as set forth under Rule 3110.12.\72\ Further, proposed Rule
3110.18(d) would provide that where a member's remote inspection of an
office or location identifies any indicators of irregularities or
misconduct (i.e., ``red flags''), the member may need to impose
additional supervisory procedures for that office or location, or may
need to provide for more frequent monitoring or oversight of that
office or location, or both, including potentially a subsequent
physical, on-site visit on an announced or unannounced basis.
---------------------------------------------------------------------------

    \72\ See note 23, supra, and accompanying text.
---------------------------------------------------------------------------

E. Documentation Requirement (Proposed Rule 3110.18(e))
    In general, Rule 3110(c)(2) imposes various documentation
requirements for inspections, including maintaining a written record of
the date upon which each inspection is conducted. Currently, Rule
3110.17(d) requires supplemental documentation by a member that avails
itself of the remote inspection option. The member must maintain and
preserve a centralized record for each of calendar years specified in
the supplementary material that separately identifies: (1) all offices
or locations that had inspections that were conducted remotely; and (2)
any offices or locations that the member determined to impose
additional supervisory procedures or more frequent monitoring, as
provided in Rule 3110.17(c). A member's documentation of the results of
a remote inspection for an office or location must identify any
additional supervisory procedures or more frequent monitoring for that
office or location that were imposed as a result of the remote
inspection.
    Consistent with the 2022 Remote Inspections Pilot Program Rule
Filing, FINRA is proposing to incorporate, without substantive change,
the terms of Rule 3110.17(d) in proposed Rule 3110.18(e), while making
two clarifying changes. One change would be to reference that the
centralized record must be for each of the ``pilot years'' (as defined
in proposed Rule 3110.18(l)), and the other change would be to clarify
that a member's documentation of the results of a remote inspection for
an office or location must identify any additional supervisory
procedures or more frequent monitoring for that office or location that
were imposed as a result of the remote inspection, including whether an
on-site inspection was conducted at such office.
F. Firm Level Requirements (Proposed Rule 3110.18(f))
    In the Initial Rule Filing, FINRA proposed to exclude some member
firms from participating in the proposed pilot program. The categories
of ineligibility were events or activities of a member firm that FINRA
explained were more likely to raise investor protection concerns based
on the firm's record of specified regulatory or disciplinary events.
Some commenters to the Initial Rule Filing expressed general concerns
relating to the adequacy and scope of those proposed controls--the
exclusions and conditions--to address higher risk conduct.\73\ In
response to those concerns, the Amended Rule Filing proposed expanding
the list of controls. The proposed rule change would retain, without
substantive change, the criteria as set forth in the Amended Rule
Filing.
---------------------------------------------------------------------------

    \73\ See Exhibit 2c.
---------------------------------------------------------------------------

1. Firm Level Ineligibility Criteria (Proposed Rule 3110.18(f)(1)
    Under proposed Rule 3110.18(f)(1), a member firm would be
ineligible to conduct remote inspections of any of its offices if any
time during the pilot period, the member: (1) is or becomes designated
as a Restricted Firm under Rule 4111 \74\ (proposed Rule
3110.18(f)(1)(A)); (2) is or becomes designated as a Taping Firm under
Rule 3170 \75\ (proposed Rule 3110.18(f)(1)(B)); (3) receives a notice
from FINRA pursuant to Rule 9557 regarding compliance with Rule 4110
(Capital Compliance), Rule 4120 (Regulatory Notification and Business
Curtailment) or Rule 4130 (Regulation of Activities of Section 15C
Members Experiencing Financial and/or Operational Difficulties)
(proposed Rule 3110.18(f)(1)(C)); (4) is or becomes suspended from
membership by FINRA (proposed Rule 3110.18(f)(1)(D)); (5) based on the
date in the Central Registration Depository (``CRD[supreg]'') \76\ had
its FINRA membership become effective within the prior 12 months
(proposed Rule 3110.18(f)(1)(E)); or (6) is or has been found within
the past three years by the SEC or FINRA to have violated

Rule 3110(c) (proposed Rule 3110.18(f)(1)(F)).\77\
---------------------------------------------------------------------------

    \74\ In general, Rule 4111 (Restricted Firm Obligations)
requires member firms that are identified as ``Restricted Firms'' to
deposit cash or qualified securities in a segregated, restricted
account; adhere to specified conditions or restrictions; or comply
with a combination of such obligations. See generally Regulatory
Notice 21-34 (September 2021) (announcing FINRA's adoption of rules
to address firms with a significant history of misconduct).
    \75\ In general, Rule 3170 (Tape Recording of Registered Persons
by Certain Firms) requires a member firm to establish, enforce and
maintain special written procedures supervising the telemarketing
activities of all of its registered persons, including the tape
recording of conversations, if the firm has hired more than a
specified percentage of registered persons from firms that meet
FINRA Rule 3170's definition of ``disciplined firm.'' See generally
Regulatory Notice 14-10 (March 2014) (announcing FINRA's adoption of
consolidated rules governing supervision).
    \76\ CRD is the central licensing and registration system that
FINRA operates for the benefit of FINRA, the SEC, other SROs, state
securities regulators and broker-dealer firms. The information
maintained in the CRD system is reported by registered broker-dealer
firms, associated persons and regulatory authorities in response to
questions on specified uniform registration forms. See generally
Rule 8312 (FINRA BrokerCheck Disclosure).
    \77\ FINRA notes that the term ``found'' as used in this
proposed criterion would carry the same meaning as Rule 4530.03
(Meaning of ``Found'').
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    Rules 4111 and 3170 expressly address firms that pose higher risks,
and for that reason, those firms would be ineligible to participate in
the proposed pilot program. Further, FINRA believes that a member firm
that is experiencing issues complying with its capital requirements or
has been suspended from membership by FINRA is more likely to face
significant operational challenges that may negatively impact the
firm's inspection program. FINRA further believes that a firm that has
been a FINRA member for less than 12 months is often still implementing
its business plan and may not have sufficient experience to develop a
sufficiently robust inspection program. With respect to a firm that is
or has been found within the past three years by the SEC or FINRA to
have violated Rule 3110(c), FINRA believes such firms have demonstrated
challenges in developing or maintaining robust inspection programs.
Collectively, FINRA believes that these proposed ineligibility criteria
would appropriately limit the potential population of pilot program
participants to those firms that may be better positioned to conduct
remote inspections.
2. Firm Level Conditions (Proposed Rule 3110.18(f)(2))
    To further address commenters' concerns pertaining to the adequacy
and scope of the proposed controls of the pilot program, the Amended
Rule Filing proposed enhancing the controls with respect to books and
records, and surveillance and technology tools. In that filing, FINRA
explained that those conditions were appropriate to establish
reasonable baseline requirements for remote inspections. FINRA
reaffirms this view through this proposed rule change by retaining,
without substantive change, the conditions set forth in the Amended
Rule Filing.
a. Recordkeeping System (Proposed Rule 3110.18(f)(2)(A))
    As part of the requirements in proposed Rule 3110.18(b) to develop
a reasonable risk-based approach to using remote inspections, and to
conduct and document a risk assessment for each office or location, the
member must, under proposed Rule 3110.18(f)(2)(A), have a recordkeeping
system to make and keep current, and preserve records required to be
made and kept current, and preserved under applicable securities rules
and regulations, FINRA rules, and the member's own written supervisory
procedures under Rule 3110. In addition, such records may not be
physically or electronically maintained and preserved at the office or
location subject to the remote inspection, and the member has prompt
access to such records.
b. Surveillance and Technology Tools (Proposed Rule 3110.18(f)(2)(B))
    In response to the Initial Rule Filing, NASAA expressed general
concern about the lack of detail on the technology firms use to conduct
effective remote surveillance.\78\ Many commenters, however, had
countered with the view that advances in technology have facilitated
remote surveillance, including inspections, with some commenters
describing the technology that they leverage to effectively surveil and
inspect offices and locations remotely.\79\ Examples included the use
of laptops connected to the firm's network; smart phones for live video
calls; video conferencing technology; electronic notifications of
shipments to and from an office or location; and internet searches of
social media and public records.\80\ To address NASAA's general
concerns about surveillance and technology, the Amended Rule Filing
provided that as part of the requirement to develop a reasonable risk-
based approach to using remote inspections, and the requirement to
conduct and document a risk assessment for each office or location, the
member must determine that its surveillance and technology tools are
appropriate to supervise the types of risks presented by each such
office or location, and set forth a description of the types of tools
(e.g., electronic surveillance of email, electronic trade blotters,
secure network connections). However, in response to the Amended Rule
Filing, NASAA, while acknowledging that supervisory requirements are
principles-based, suggested that FINRA should revise the proposed
provision to establish a mandatory technology floor for participants in
the proposed pilot program comprising the tools commenters listed as
examples of effective technologies.\81\
---------------------------------------------------------------------------

    \78\ See Exhibit 2c.
    \79\ See Exhibit 2c.
    \80\ See Exhibit 2c.
    \81\ See NASAA III.
---------------------------------------------------------------------------

    As noted above, FINRA is proposing to retain, without substantive
change, the condition pertaining to surveillance and technology tools
as set forth in the Amended Rule Filing, as consonant with the
principle-based tenor of the rule. Under proposed Rule
3110.18(f)(2)(B), as part of the requirement to develop a reasonable
risk-based approach to using remote inspections, and the requirement to
conduct and document a risk assessment for each office or location, the
member must determine that its surveillance and technology tools are
appropriate to supervise the types of risks presented by each such
remotely supervised office or location. The proposed provision would
provide that these tools may include but are not limited to: (1) firm-
wide tools such as electronic recordkeeping systems, electronic
surveillance of email and correspondence, electronic trade blotters,
regular activity-based sampling reviews, and tools for visual
inspections; (2) tools specifically applied to such office or location
based on the activities of associated persons, products offered,
restrictions on the activity of the office or location (including
holding out to customers and handling of customer funds or securities);
and (3) system security tools such as secure network connections and
effective cybersecurity protocols. FINRA believes that proposed Rule
3110.18(f)(2)(B) appropriately conveys a reasonable baseline
requirement for remote inspections. FINRA maintains that it would not
be appropriate to identify specific technology-based tools because of
the evolving development and ongoing advances in technologies.
Moreover, FINRA notes that proposed Rule 3110.18(c) would require a
firm to adopt reasonably designed written supervisory procedures that
must include, among other things, a description of the methodology,
including the technology, that a firm may use to conduct remote
inspections.
G. Location Level Requirements (Proposed Rule 3110.18(g))
    In the Initial Rule Filing, FINRA had proposed several criteria
that if met would render a member's office or location ineligible for
remote inspection. The categories of ineligibility were events or
activities of an associated person of the member firm that FINRA had
explained were more likely to raise investor protection concerns based
on the individual's record of specified regulatory or disciplinary
events. Some commenters to the Initial Rule Filing expressed general
concerns relating to the discretion provided to firms to make risk
assessments as to whether an office or location could undergo a remote

inspection.\82\ In response to those concerns, FINRA had expanded the
list of events or activities that would deem a specific office or
location of a member ineligible from participating in the pilot
program. The proposed rule change would retain the criteria set forth
in the Amended Rule Filing, but with one clarifying adjustment
pertaining to an associated person who is a part of a member's trading
desk.
---------------------------------------------------------------------------

    \82\ See Exhibits 2b and 2c.
---------------------------------------------------------------------------

1. Location Level Ineligibility Criteria (Proposed Rule 3110.18(g)(1))
    Under proposed Rule 3110.18(g)(1), a member firm's office or
location would be ineligible for a remote inspection if at any time
during the period of the proposed pilot program, an associated person
at such office or location is or becomes: (1) subject to a mandatory
heightened supervisory plan under the rules of the SEC, FINRA or state
regulatory agency (proposed Rule 3110.18(g)(1)(A)); (2) statutorily
disqualified, unless such disqualified person has been approved (or is
otherwise permitted pursuant to FINRA rules and the federal securities
laws) to associate with a member and is not subject to a mandatory
heightened supervisory plan under proposed Rule 3110.18(g)(1)(A) or
otherwise as a condition to approval or permission for such association
(proposed Rule 3110.18(g)(1)(B)); (3) subject to Rule 1017(a)(7) \83\
as a result of one or more associated persons at such location
(proposed Rule 3110.18(g)(1)(C)); (4) one or more associated persons at
such location has an event in the prior three years that required a
``yes'' response to any item in Questions 14A(1)(a) and 2(a), 14B(1)(a)
and 2(a), 14C, 14D and 14E on Form U4 \84\ (proposed Rule
3110.18(g)(1)(D)); (5) one or more associated persons at such office or
location is or becomes subject to a disciplinary action taken by the
member that is or was reportable under Rule 4530(a)(2) (proposed Rule
3110.18(g)(1)(E)); \85\ or (6) the office or location handles customer
funds or securities (proposed Rule 3110.18(g)(1)(G)).\86\ These
proposed criteria remain substantively unchanged from the Amended Rule
Filing.
---------------------------------------------------------------------------

    \83\ In general, Rule 1017(a)(7) requires a member firm to file
a CMA when a natural person seeking to become an owner, control
person, principal or registered person of the member firm has, in
the prior five years, one or more defined ``final criminal matters''
or two or more ``specified risk events'' unless the member firm has
submitted a written request to FINRA seeking a materiality
consultation for the contemplated activity. Rule 1017(a)(7) applies
whether the person is seeking to become an owner, control person,
principal or registered person at the person's current member firm
or at a new member firm. See generally Regulatory Notice 21-09
(March 2021) (announcing FINRA's adoption of rules to address
brokers with a significant history of misconduct).
    \84\ Form U4's Questions 14A(1)(a) and 2(a), 14B(1)(a) and 2(a)
elicit reporting of criminal convictions, and Questions 14C, 14D,
and 14E pertain to regulatory action disclosures.
    \85\ Paragraph (a)(2) under Rule 4530 (Reporting Requirements)
requires a member firm to report when an associated person of the
member is the subject of any disciplinary action taken by the member
involving suspension, termination, the withholding of compensation
or of any other remuneration in excess of $2,500, the imposition of
fines in excess of $2,500 or is otherwise disciplined in any manner
that would have a significant limitation on the individual's
activities on a temporary or permanent basis.
    \86\ In accordance with existing guidance, the meaning and
interpretation of the term ``handled'' that currently appears in
Rule 3110(f)(2)(A)(ii) would remain consistent in the proposed pilot
program. See also Notice to Members 06-12 (March 2006).
---------------------------------------------------------------------------

    In the Amended Rule Filing, FINRA had also proposed a criterion
that would make a member firm's office or location ineligible for a
remote inspection if one or more associated persons at such office or
location was ``a part of the member's trading desk (e.g., engaging in
market making activities or having authority to enter proprietary
trades on behalf of the member or as agent for other parties)[.]'' \87\
In response to the Amended Rule Filing, one commenter conveyed that the
proposed criterion was overly broad, and overstated the risks presented
by trade desk personnel.\88\ FINRA is proposing to adjust this
criterion. As adjusted, under proposed Rule 3110.18(g)(1)(F), a member
firm's office or location would be ineligible for a remote inspection
if at any time during the period of the proposed pilot program, an
associated person at such office or location is engaged in proprietary
trading, including the incidental crossing of customer orders, or the
direct supervision of such activities.\89\
---------------------------------------------------------------------------

    \87\ See Exhibit 2b.
    \88\ See Letter from Sandip Khosla, General Counsel, Two Sigma
Securities, LLC, to Vanessa A. Countryman, Secretary, SEC, dated
January 12, 2023, https://www.sec.gov/comments/sr-finra-2022-021/srfinra2022021-20154757-323056.pdf.
    \89\ FINRA notes that this proposed criterion would encompass
trading activity in any security, whether traded on a national
securities exchange or over-the-counter.
---------------------------------------------------------------------------

2. Location Level Conditions (Proposed Rule 3110.18(g)(2)
    To further address the concerns about the adequacy and scope of the
proposed pilot program's controls, the Amended Rule Filing had proposed
enhancing the controls with respect to electronic communications,
correspondence and books and records. FINRA is proposing to retain,
without substantive change, the conditions set forth in the Amended
Rule Filing. Under proposed Rule 3110.18(g)(2), as part of the
requirement to develop a reasonable risk-based approach to using remote
inspections, and the requirement to conduct and document a risk
assessment for each office or location, the member must satisfy the
following conditions: (1) electronic communications (e.g., email) are
made through the member's electronic system; (2) the associated
person's correspondence and communications with the public are subject
to the firm's supervision in accordance with Rule 3110; and (3) no
books or records of the member required to be made and kept current,
and preserved under applicable securities laws and regulations, FINRA
rules, and the member's own written supervisory procedures under Rule
3110 are physically or electronically maintained and preserved at such
office or location. FINRA believes that proposed Rule 3110.18(g)(2)
appropriately conveys a reasonable set of conditions related to
communications of associated persons and the creation and preservation
of books and records at a specific office or location.
    FINRA believes that the proposed location level ineligibility
criteria are indicia of increased risk to investors at some office or
locations, such that they should not be eligible for remote inspections
in accordance with the proposed pilot program.
    A member firm, or an office or location subject to one of the
categorical restrictions would not be eligible for remote inspections,
even if the firm's risk assessment concludes that a remote inspection
would be appropriate. A member firm that meets one of these
ineligibility criteria would not be able to participate in the proposed
pilot program. If a member firm is eligible to participate in the
proposed pilot program, but one of its offices or locations meets one
of the location level ineligibility criteria, the member would be
required to conduct an on-site inspection of that office or location on
the required cycle. FINRA believes the proposed list of ineligibility
categories is appropriately derived from existing rule-based criteria
that are part of processes to identify firms that may pose greater
concern (e.g., Rules 4111 and 3170) or associated persons that may pose
greater concerns due to the specified activities and nature of
disclosures of regulatory or disciplinary events on the uniform
registration forms. FINRA believes that these objective categorical
restrictions will provide safeguards that will help ensure that firms
maintain effective supervisory procedures during the pilot period.

H. Data and Information Collection Requirement (Proposed Rule
3110.18(h))
1. Data and Information (Proposed Rule 3118.18(h)(1))
    As noted above, Rule 3110.17 was adopted in the midst of the
pandemic and operationalized in an environment in which many offices
and locations were closed to the public. FINRA believes that the
formalized, uniform collection of data is critical to allow FINRA to
meaningfully assess the effectiveness of remote inspections to help
shape potential permanent amendments to Rule 3110(c) that would
optimize an inspection program in the evolving workplace environment.
FINRA believes having a pilot program for remote inspections with
appropriate conditions, limitations and documentation requirements in
an environment that is settling into a hybrid workplace model would
provide a clearer picture of the strengths and weaknesses of remote
inspections, without compromising investor protection. Proposed Rule
3110.18(h), the terms of which are similar to those set forth in the
2022 Remote Inspections Pilot Program Rule Filing, would impose upon
firms a data and information collection requirement as a condition for
participating in the pilot program. On a quarterly frequency,
participating firms would be required to collect and produce to FINRA,
in a manner and format determined by FINRA, data consisting of separate
counts for OSJs, supervisory branch offices, non-supervisory branch
offices, and non-branch locations, consistent with paragraphs
(c)(1)(A), (B) and (C) under Rule 3110, for several categories. These
categories include: (1) the total number of inspections--on-site and
remote--completed during each calendar quarter; \90\ (2) the number of
those office or locations in each calendar quarter that were subject to
an on-site inspection because of a ``finding,'' (as described under
proposed Rule 3110.18(h)(1) as a discovery made during an inspection
that led to a remedial action or was listed on the member's inspection
report); \91\ (3) the number of locations for which a remote inspection
was conducted in the calendar quarter that identified a finding, the
number of findings, and a list of the most significant findings; \92\
and (4) the number of locations for which a on-site inspection was
conducted in the calendar quarter that identified a finding, the number
of findings, a list of the most significant findings.\93\ In addition,
firms would be required to provide FINRA their written supervisory
procedures for remote inspections that account for: (1) escalating
significant findings; new hires; supervising brokers with a significant
history of misconduct; and outside business activities and ``doing
business as'' (or DBA) designations.\94\ Firms would be required to
provide FINRA with a copy of these written supervisory procedures
alongside the first delivery of the data points described above, and
any subsequent amendments to such procedures for remote
inspections.\95\
---------------------------------------------------------------------------

    \90\ See proposed Rule 3110.18(h)(1)(A), (B) and (C).
    \91\ See proposed Rule 3110.18(h)(1)(D).
    \92\ See proposed Rule 3110.18(h)(1)(E). A ``significant
finding'' would be one that should prompt the firm to take further
action that could include escalation to the appropriate channels at
the firm for further review, the result of which may be enhanced
monitoring or surveillance of a particular event or activity through
more frequent inspections (remotely or on-site), on an announced or
unannounced basis, of the office or location, or other targeted
reviews of the root cause of the finding. Examples of some findings
that may prompt escalation or further internal review by the
appropriate firm personnel include, among other things, the use of
unapproved communication mediums, customer complaints, or
undisclosed outside business activities or private securities
transactions.
    \93\ See proposed Rule 3110.18(h)(1)(F).
    \94\ See proposed Rule 3110.18(h)(1)(G)(i) through (iv).
    \95\ See proposed Rule 3110.18(h)(1)(G).
---------------------------------------------------------------------------

    In response to the Amended Rule Filing, NASAA suggested that firms
should be required to provide FINRA with `` `all findings' made during
remote inspections, not only the ones the firm subjectively deems `most
significant'[,]'' contending that the discretion given to firms to make
this determination would undermine the data and hinder FINRA's ability
to assess trends and developments.\96\ FINRA believes that to require
firms to provide ``all findings'' rather than the ``significant
findings'' would yield an overly broad data set where it would be
challenging to discern key trends in a meaningful way. Moreover, while
Rule 3110(c)(2) specifies the areas that a firm must address in an
inspection report, if applicable to the office or location being
inspected, the rule does not impose any other content requirements of
an inspection report. FINRA believes that pilot program participants,
which FINRA would expect to reflect a variety of attributes (e.g.,
size, business model, organizational structure), should have the agency
to assess their significant findings and report them to FINRA in the
manner specified under the proposed rule. FINRA maintains that this
approach would enhance FINRA's ability to review a discrete set of data
that would focus on key areas of concern to firms, which in turn, would
help FINRA assess the effectiveness of remote inspections.
---------------------------------------------------------------------------

    \96\ See NASAA III.
---------------------------------------------------------------------------

2. Additional Data and Information for Pilot Year 1, if Less Than Full
Calendar Year (Proposed Rule 3110.18(h)(2)) and for Calendar Year 2019
(Proposed Rule 3110.18(h)(3))
    Consistent with the 2022 Remote Inspections Pilot Program Rule
Filing, proposed Rule 3110.18(h)(2) would address the additional data
and information requirements for Pilot Year 1 (as defined under
proposed Rule 3110.18(l)), if such year covers a period that is less
that a full calendar year. In such case, a member that elects to
participate in the proposed pilot program would be required to collect
the following data and information and provide such data and
information to FINRA (in a manner and format FINRA determines) no later
than December 31 of such first Pilot Year. For items (1) through (3)
below, a member would be required to provide separate counts for OSJs,
supervisory branch offices, non-supervisory branch offices, and non-
branch locations consistent with paragraphs (c)(1)(A), (B) and (C)
under Rule 3110: (1) the number of locations with an inspection
completed during the full calendar year of the first Pilot Year; (2)
the number of locations in item (1) that were inspected remotely during
the full calendar year of the first Pilot Year; and (3) the number of
locations in item (1) that were inspected on-site during the full
calendar year of the first Pilot Year. This additional data and
information would provide FINRA the ability to capture, in the
aggregate, complete inspection counts--total number of Rule 3110(c)(1)
inspections (remote and on-site)--for the entire calendar year in
addition to the more detailed data and information requirements under
proposed Rule 3110.18(h)(1).
    In response to the Amended Rule Filing, NASAA recommended that
firms be required to provide FINRA with the information specified in
the proposed provision relating to data and information collection to
cover the most recent 12-month period during which the firm conducted
in-person inspections under Rule 3110(c). FINRA agrees with this
approach. Thus, in addition to the data and information requirement
under paragraphs (h)(1) and (h)(2) to proposed Rule 3110.18, proposed
Rule 3110.18(h)(3) would require a pilot program participant to collect
and provide to FINRA calendar year 2019 data and information no later
than December 31 of Pilot Year 1 (as

defined under proposed Rule 3110.18(l)). For items (1) and (2) below, a
member would be required to provide separate counts for OSJs,
supervisory branch offices, non-supervisory branch offices, and non-
branch locations consistent with paragraphs (c)(1)(A), (B) and (C)
under Rule 3110: (1) the number of locations with an inspection
completed during calendar year 2019; and (2) the number of locations in
item (1) where findings were identified, the number of those findings
and a list of the most significant findings. This additional data and
information covering calendar year 2019, when firms conducted their
inspections solely on-site, would provide FINRA with some baseline data
and information about on-site inspections immediately preceding the
pandemic.
3. Written Policies and Procedures (Proposed Rule 3110.18(h)(4))
    Consistent with the 2022 Remote Inspections Pilot Program Rule
Filing, proposed Rule 3110.18(h)(4) would remind firms of the general
requirement to establish, maintain and enforce written policies and
procedures that are reasonably designed to comply with the data and
information collection, and transmission requirements of the proposed
pilot program.
I. Election To Participate in Remote Inspections Pilot Program
(Proposed Rule 3110.18(i))
    Consistent with the 2022 Remote Inspections Pilot Program Rule
Filing, proposed Rule 3110.18(i) would set forth the manner in which a
firm would notify FINRA of the firm's election to participate in the
proposed pilot program and to withdraw from it. The proposed rule would
provide that FINRA may, in exceptional cases and where good cause is
shown, waive the applicable timeframes described below for the required
opt-in or opt-out notices.
    Proposed Rule 3110.18(i) would require a firm, at least five
calendar days before the beginning of such Pilot Year, to provide FINRA
an ``opt-in notice'' in the manner and format determined by FINRA. By
providing such opt-in notice to FINRA, the firm agrees to participate
in the proposed pilot program for the duration of such Pilot Year and
to comply with the requirements of Rule 3110.18.\97\ A firm that
provides the opt-in notice for a Pilot Year would be automatically
deemed to have elected and agreed to participate in the Remote
Inspections Pilot Program for subsequent Pilot Years (i.e., Pilot Year
2, Pilot Year 3, and Pilot Year 4, if applicable) until the pilot
program expires. Further, proposed Rule 3110.18(i) would describe the
notice requirement for a firm to withdraw from the proposed pilot
program. A firm would be required to provide FINRA with an ``opt-out
notice'' at least five calendar days before the end of the then current
Pilot Year.
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    \97\ A firm that participates in a Pilot Year would be committed
to complying with the terms of proposed Rule 3110.18 for that Pilot
Year.
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    By way of example, a firm that provides FINRA an opt-in notice on
June 26 to join Pilot Year 1 that begins on July 1 would be
automatically deemed to continue participating in Pilot Year 2 unless
the firm provides FINRA the required opt-out notice no later than
December 26 of Pilot Year 1. To continue with this example, a firm that
was automatically deemed to participate in Pilot Year 2 and determines
in mid-Pilot Year 2 that it does not want to automatically continue
into Pilot Year 3 could elect to withdraw from Pilot Year 3 if it
provides FINRA an opt-out notice at least five calendar days before the
end of Pilot Year 2. However, because Pilot Year 2 is already underway,
the firm would be required to complete Pilot Year 2 in accordance with
proposed Rule 3110.18.
    FINRA believes that this proposed operational aspect of the program
would not only establish a cohesive process in which firms and FINRA
may manage program participation but also lend some continuity in data
and information collection that would support FINRA's assessment and
evaluation of the experiences of pilot program participants.
J. Failure To Satisfy Conditions (Proposed Rule 3110.18(j))
    Consistent with 2022 Remote Inspections Pilot Program Rule Filing,
proposed Rule 3110.18(j) would address a situation in which a firm
fails to satisfy terms of the proposed pilot program. The proposed
paragraph would provide that a firm that fails to satisfy the
conditions of Rule 3110.18, including the requirement to timely collect
and submit the data and information to FINRA as set forth in proposed
Rule 3110.18(h), would be ineligible to participate in the pilot
program and must conduct on-site inspections of each office and
location on the required cycle in accordance with Rule 3110(c).
K. Determination of Ineligibility (Proposed Rule 3110.18(k))
    To address commenters' concerns pertaining to monitoring for
compliance with the proposed pilot program, the Amended Rule Filing had
proposed a provision to allow FINRA to make a determination in the
public interest and for the protection of investors that a member is no
longer eligible to participate in the proposed pilot program if the
member fails to comply with the requirements of the proposed pilot
program. The proposal further provided that FINRA would provide written
notice to the member of such determination and such member would no
longer be eligible to participate in the proposed pilot program and
would be required to conduct on-site inspections of required offices
and locations in accordance with Rule 3110(c). In the Amended Rule
Filing, FINRA had explained that this authority would both align with
FINRA's examination and risk monitoring programs for member firms and
registered persons and allow FINRA to more effectively assess higher
risk. In response to the Amended Rule Filing, NASAA stated that the
proposed provision should be expanded broadly to provide FINRA the
ability to make such a determination if it finds that a firm ``fail[ed]
to comply with the requirements of applicable laws, rules, and
regulations related to supervision of associated persons[,]'' stating
that this broad scope would provide the appropriate level of
flexibility ``to protect investors from misconduct and lax supervisory
practices.'' \98\
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    \98\ See NASAA III.
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    FINRA believes that the proposed provision is sufficiently broad in
scope for purposes of the proposed pilot program. FINRA reiterates that
the purpose of the proposed three-year pilot program, which is
voluntary, is to study the effectiveness of remote inspections in
accordance with Rule 3110(c)(1) as part of a reasonably designed
supervisory system. Consistent with the Amended Rule Filing, FINRA is
proposing to retain, without substantive change, proposed Rule
3110.18(k) under the described terms.
L. Definitions (Proposed Rule 3110.18(l))
    Consistent with 2022 Remote Inspections Pilot Program Rule Filing,
proposed Rule 3110.18(l) would set forth the meanings underlying
``Pilot Year'' to explain the duration of the proposed pilot program.
Under proposed Rule 3110.18(l), a ``Pilot Year'' would mean the
following: (1) Pilot Year 1 would be the period beginning on the
effective date of the proposed pilot program and ending on December 31
of the same year; (2) Pilot Year 2 would mean the calendar year period

following Pilot Year 1, beginning on January 1 and ending on December
31; and (3) Pilot Year 3 would mean the calendar year period following
Pilot Year 2, beginning on January 1 and ending on December 31.
Finally, if applicable, where Pilot Year 1 covers a period that is less
than a full calendar year, then Pilot Year 4 would mean the period
following Pilot Year 3, beginning on January 1 and ending on a date
that is three years after the effective date.
M. Sunset of Rule 3110.17 (Proposed Rule 3110.18(m))
    As noted above, Rule 3110.17 is set to expire on December 31,
2023.\99\ FINRA will submit a separate rule filing if, during the
pendency of the SEC's determination of whether to approve or disapprove
this proposed rule change, FINRA seeks to extend the duration of Rule
3110.17 beyond the current term. Proposed Rule 3110.18 would expressly
account for the possibility of overlapping provisions if the proposed
pilot program becomes effective while Rule 3110.17 is also in effect.
Proposed paragraph (m), which is nearly identical to the provision set
forth in the 2022 Remote Inspections Pilot Program Rule Filing, would
provide that if Rule 3110.17 has not already expired by its own terms
(on December 31, 2023 or as the case may be, on an extended date), it
would automatically sunset on the effective date of proposed Rule
3110.18.
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    \99\ See note 49, supra.
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    Consistent with the principles set forth in prior guidance, FINRA
expects members to establish reasonably designed inspection programs.
The proposed pilot program for remote inspections does not alter the
core obligation of a member firm to 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.\100\ As part of the
inspection planning process, FINRA expects members to continue with
their ongoing supervision, including risk analysis of the activities
and functions occurring at all offices or locations. While the option
to conduct remote inspections in accordance with proposed Rule 3110.18
provides greater choice in how to effectively supervise some offices or
locations, a member must continue to consider the factors described in
Rule 3110.12, along with the activities taking place there. This
analysis may require the member to conduct a physical, on-site
inspection of an office or location. Where there are indications of
problems or red flags at any office or location, FINRA expects members
to investigate them as they would for any other office or location
subject to Rule 3110(c), which may include an unannounced, on-site
inspection of the office or location. FINRA is committed to diligently
monitoring the impacts of remote inspections on a firms' overall
supervisory systems and reviewing the data over the life of the
proposed pilot program to assess how firms apply the flexibility
provided by the pilot program while maintaining an effective
supervisory program.
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    \100\ See Rule 3110(a).
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(V) FINRA's Monitoring and Compliance With Proposed Rule 3110.18

A. Overview of FINRA's Data-Driven, Risk-Based Regulatory Framework

    FINRA's data-driven regulatory programs are integrated among
various FINRA departments, and the data and information FINRA currently
collects from its member firms helps provide FINRA with a holistic view
of firm risk management. FINRA's Examinations and Risk Monitoring
Program, which is a part of FINRA's Member Supervision Department, is a
critical component of FINRA's regulatory operations, and one of the
many ways in which FINRA oversees the activities of member firms and
its associated persons with the goal of detecting, deterring, and
addressing activities that may cause investor harm or adversely impact
market integrity.\101\
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    \101\ See generally FINRA Examination and Risk Monitoring
Programs, https://www.finra.org/rules-guidance/key-topics/finra-examination-risk-monitoring-programs.
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    FINRA's Risk Monitoring is organized by the primary business model
of member firms \102\ and serves as a point of contact for FINRA member
firms on a range of topics that may include, among others, financial
and business conduct requirements and firm submissions (e.g., FOCUS
filings, Rule 4530 filings, other reporting requirements), published
guidance, and new FINRA rules. This relationship allows Risk Monitoring
to cultivate a thorough understanding of the business activities and
operations of each firm they monitor. This knowledge, along with the
data FINRA collects serves FINRA by providing ongoing awareness and
analysis of member firm activities, including business lines,
operations, products, and controls. This proactive monitoring, with
Risk Monitoring as the point of contact for member firms, enables FINRA
to implement a risk-based regulatory program that focuses resources and
regulator responses on concerning risks. This assessment methodology
plays a role in many aspects of FINRA's regulatory programs, including
FINRA's Examinations in the preparation of firm examinations. The type
of examination may depend upon the firm profile that is created by a
number of attributes, including among others, business model, size, the
products offered, and disciplinary history of the firm and its
registered persons. The areas of review in an examination may also be
influenced by the adoption of a new FINRA rule and any accompanying
guidance or interpretation.
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    \102\ The five business models are Capital Markets, Carrying and
Clearing, Retail, Trading and Execution, and Diversified.
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    As described above, the terms of proposed Rule 3110.18 include
several rule-based or reportable criteria, or information that is
electronically captured that FINRA can readily monitor through Risk
Monitoring and Examinations. These criteria relate to Rules 1017(a)(7),
3170, 4111, and 9557, the suspension of FINRA membership, or a FINRA
membership that has been effective for less than 12 months, among other
criteria set forth in the proposed supplementary material. Activity-
based criteria such as market-making and trading activities, and the
handling of customer funds or securities can also be surveilled through
firm submissions, and other data sources and internal systems.
    FINRA recognizes that firms are using increasingly sophisticated
technology and analytic techniques to synthesize data in ways not
previously possible to identify indicators of possible rule violations
and associated person misbehavior. To keep pace with the technological
environment, FINRA's regulatory programs are also data driven, and
FINRA uses its data and information (e.g., Forms U4 and U5, regulatory
tips, transaction reporting, and other internal and externally-acquired
data), gathered, in part, through advanced analytics, to better
identify and address risks that can be marked not only to a member
firm, but also to a registered person. The picture that the data and
information reveal may initiate an examination separate from the firm's
routine examination or, through Risk Monitoring, further inquiry with
the firm.
    In the context of the proposed remote inspections pilot program,
FINRA would use the risk markers identified using its analytic
techniques to inform FINRA's Risk Monitoring and Examinations'
assessment of whether FINRA should examine an office or location, and
in turn, examine a firm's

reasonableness determination to conducting remote inspections rather
than an on-site inspection for that office or location. Some risk
markers may include, among others, CRD disclosures, the number and
types of OBAs of registered persons at a specific office or location,
the existence and type of investor harm events that have occurred for
individuals at an office or location, the historical results and
frequency of FINRA's examination of an office or location, and the
percentage of senior investors in the county in which the office or
location reside, among others. Relatedly, FINRA is able to leverage
this data and information when assessing the reasonableness of a firm's
supervision, including their determination to inspect an office or
location through a remote process, rather than an on-site process. For
example, if the data and information identify an office or location
with a concentration of OBAs or investor harm events and review of the
firm's remote inspection program does not appear to account for OBAs or
sales risks, there may be an overall weakness in the firm's inspection
program, irrespective of whether the inspection is done remotely or on-
site. As with any new process or rule, FINRA anticipates undertaking a
careful review of firm compliance with proposed Rule 3110.18. FINRA is
engaged in ongoing efforts to enhance its regulatory programs, with a
sustained focus on effectively identifying and addressing areas of risk
by firm and registered person. Several of FINRA's key functions provide
early warning indicators of potential problems, which FINRA leverages
in its regulatory oversight of firms. In the context of reviewing a
firm's remote inspections program, one indicator in this evaluation may
be whether the firm is identifying risk indicators that are similar to
those that FINRA is detecting.
B. FINRA's Use of the Data and Information Collected in Accordance With
Proposed Rule 3110.18(h)
    In general, proposed Rule 3110.18(h) would require a pilot program
participant to provide FINRA with specified data and information (in an
aggregated form), including written supervisory procedures for remote
inspections, that FINRA believes would complement FINRA's existing
regulatory intelligence as part of the larger effort to gauge the
effectiveness of remote inspections as part of a reasonably designed
supervisory system. For purposes of its regulatory programs and if
appropriate, FINRA may, after some experience with the data and
information collected, extrapolate trends and practices in this area
that could result in future rulemaking or updated guidance about
inspections generally.
    If the Commission approves the proposed rule change, FINRA will
announce the effective date of the proposed rule change in a Regulatory
Notice.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\103\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest.
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    \103\ 15 U.S.C. 78o-3(b)(6).
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    The terms of the proposed voluntary, three-year remote inspection
pilot program, while based largely on the terms of Rule 3110.17, which
has been operational since the latter part of 2020 and is set to
automatically sunset on December 31, 2023,\104\ would include important
safeguards that would require individual risk assessments of each
office, supplemental written supervisory procedures related to remote
inspections, documentation requirements and obligations to share data
with FINRA to allow for assessment of the pilot program. The proposed
rule change is intended to provide firms that are operating in a hybrid
work environment the option to conduct remote inspections of their
offices and locations, subject to specified conditions, while