[Federal Register Volume 88, Number 225 (Friday, November 24, 2023)]
[Notices]
[Pages 82464-82482]
[FR Doc No: 2023-25886]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-98982; File No. SR-FINRA-2023-007]

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

November 17, 2023.

I. Introduction

    On April 14, 2023, the Financial Industry Regulatory Authority,
Inc. (``FINRA'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change SR-FINRA-2023-007 pursuant to
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Exchange
Act'') \1\ and Rule 19b-4 \2\ thereunder, to adopt a voluntary, three-
year remote inspections pilot program to allow eligible member firms to
elect to fulfill their obligation under paragraph (c) (Internal
Inspections) of FINRA Rule 3110 (Supervision) by conducting inspections
of eligible branch offices,\3\ offices of supervisory jurisdiction
(``OSJ''),\4\ and non-branch locations \5\ remotely without an on-site
visit to such locations,\6\ subject to specified safeguards and
limitations (the ``Pilot'').\7\ The proposed rule change was published
for public comment in the Federal Register on May 4, 2023.\8\ The
Commission received thirteen comment letters in response to the
Notice.\9\ On June 7, 2023, FINRA consented to an extension of the time
period in which the Commission must approve the proposed rule change,
disapprove the proposed rule change, or institute proceedings to
determine whether to approve or disapprove the proposed rule change to
August 2, 2023.\10\ On

August 1, 2023, FINRA filed an amendment to modify the proposed rule
change (``Amendment No. 1'').\11\ On August 2, 2023, the Commission
published a notice of filing of Amendment No. 1 and an order
instituting proceedings to determine whether to approve or disapprove
the proposed rule change, as modified by Amendment No. 1 (hereinafter,
the ``proposed rule change'' unless otherwise specified).\12\ The
Commission received ten comment letters in response to the notice of
Amendment No. 1 and order instituting proceedings.\13\ On August 29,
2023, FINRA responded to the comment letters received in response to
the Notice.\14\ On September 22, 2023, FINRA consented to an extension
of the time period in which the Commission must approve or disapprove
the proposed rule change to December 30, 2023.\15\ On October 25, 2023,
FINRA responded to comments received in response to the notice of
Amendment No. 1 and order instituting proceedings.\16\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ A ``branch office'' is defined as: (1) ``any location where
one or more associated persons of a member firm regularly conducts
the business of effecting any transactions in, or inducing or
attempting to induce the purchase or sale of, any security, or is
held out as such''; or (2) ``any location that is responsible for
supervising the activities of persons associated with the member at
one or more non-branch locations of the member.'' FINRA Rule
3110(f)(2)(A) and (B). A branch office is either ``supervisory''
(i.e., it supervises one or more non-branch locations) or ``non-
supervisory'' (i.e., it does not supervise one or more non-branch
locations). See FINRA Rule 3110(c)(1).
    \4\ An OSJ is any office of a member firm at which any one or
more of the following functions take place: (1) order execution or
market making; (2) structuring of public offerings or private
placements; (3) maintaining custody of customers' funds or
securities; (4) final acceptance (approval) of new accounts on
behalf of the member firm; (5) review and endorsement of customer
orders, pursuant to FINRA Rule 3110(b)(2); (6) final approval of
retail communications for use by persons associated with the member
firm, pursuant to FINRA Rule 2210(b)(1), except for an office that
solely conducts final approval of research reports; or (7) having
responsibility for supervising the activities of persons associated
with the member firm at one or more other branch offices of the
member firm. See FINRA Rule 3110(f)(1).
    \5\ Seven types of locations--often referred to as
``unregistered offices'' or ``non-branch locations''--are excluded
from the definition of ``branch office'': (1) any location that is
established solely for customer service or back office type
functions where no sales activities are conducted and that is not
held out to the public as a branch office; (2) any location that is
the associated person's primary residence, subject to certain
conditions; (3) any location, other than a primary residence, that
is used for securities business for less than 30 business days in
any one calendar year, subject to certain conditions; (4) any office
of convenience, where associated persons occasionally and
exclusively by appointment meet with customers, which is not held
out to the public as an office; (5) any location that is used
primarily to engage in non-securities activities and from which the
associated person(s) effects no more than 25 securities transactions
in any one calendar year (provided that any retail communication
identifying such location also sets forth the address and telephone
number of the location from which the associated person(s)
conducting business at the non-branch locations are directly
supervised); (6) the ``floor'' of a registered national securities
exchange where a member firm conducts a direct access business with
public customers; and (7) a temporary location established in
response to the implementation of a business continuity plan. See
FINRA Rule 3110(f)(2)(A)(i)-(vii).
    \6\ Unless otherwise specified, the Commission uses the term
``location'' in this Order to refer to any location where a member
firm does business, such as an OSJ, supervisory branch office, non-
supervisory branch office, or non-branch location, as applicable.
    \7\ See proposed Rule 3110.18.
    \8\ Exchange Act Release No. 97398 (Apr. 28, 2023), 88 FR 28620
(May 4, 2023) (File No. SR-FINRA-2023-007) (``Notice'').
    \9\ The comment letters are available at https://www.sec.gov/comments/sr-finra-2023-007/srfinra2023007.htm.
    \10\ See letter from Sarah Kwak, Associate General Counsel,
Office of General Counsel, FINRA, to Daniel Fisher, Branch Chief,
Division of Trading and Markets, Commission, dated June 7, 2023,
https://www.finra.org/sites/default/files/2023-06/sr-finra-2023-007-extension-no-1.pdf.
    \11\ See Amendment No. 1, https://www.finra.org/sites/default/files/2023-08/SR-FINRA-2023-007-Amendment-1.pdf.
    \12\ Exchange Act Release No. 98046 (Aug. 2, 2023), 88 FR 53569
(Aug. 8, 2023) (File No. SR-FINRA-2023-007).
    \13\ See supra note 9.
    \14\ See letter from Sarah Kwak, Associate General Counsel,
Office of General Counsel, FINRA, to Vanessa Countryman, Secretary,
Commission, dated August 29, 2023, https://www.sec.gov/comments/sr-finra-2023-007/srfinra2023007-252179-579662.pdf (``FINRA Response to
Comments I'').
    \15\ See letter from Sarah Kwak, Associate General Counsel,
Office of General Counsel, FINRA, to Daniel Fisher, Branch Chief,
Division of Trading and Markets, Commission, dated September 22,
2023, https://www.finra.org/sites/default/files/2023-09/sr-finra-2023-007-ext2.pdf.
    \16\ See letter from Kosha Dalal, Vice President and Associate
General Counsel, Office of General Counsel, FINRA, to Vanessa
Countryman, Secretary, Commission, dated October 25, 2023, https://www.sec.gov/comments/sr-finra-2023-007/srfinra2023007-281119-686483.pdf (``FINRA Response to Comments II'').
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    This Order approves the proposed rule change.

A. Description of the Proposed Rule Change

    FINRA stated that technological advancements and an emerging remote
workplace prompted FINRA to further study the effectiveness of remote
inspections as part of a reasonably designed supervisory system.\17\ As
a result of this evaluation, FINRA determined the Pilot would provide
it ``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.'' \18\ After describing the current regulatory framework and
FINRA's stated reasons for proposing the Pilot, the Commission
describes the proposed rule change.
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    \17\ See Notice at 28620.
    \18\ See Notice at 28620.
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B. Background

1. FINRA Rule 3110 (Supervision)
    FINRA Rule 3110(a) (Supervisory System) requires 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 applicable FINRA
rules (hereinafter, a ``reasonably designed supervisory system'').\19\
As part of a reasonably designed supervisory system, FINRA Rule 3110(c)
(Internal Inspections) requires a member firm to conduct a review, at
least annually, of the businesses in which it engages in a manner
reasonably designed to assist the member firm in detecting and
preventing violations of, and achieving compliance with, applicable
securities laws and regulations, and with applicable FINRA rules. FINRA
Rule 3110(c) also requires a review of the activities of each of the
member firm's locations, including a periodic examination of customer
accounts to detect and prevent irregularities or abuses, and each
member firm also must retain a written record of the date upon which
each review and inspection is conducted.\20\
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    \19\ See FINRA Rule 3110(a).
    \20\ See FINRA Rule 3110(c)(1).
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    FINRA Rule 3110(c) sets forth three main components for conducting
internal inspections. First, a member firm must conduct an inspection
of each location on a designated frequency. The designated frequency
varies depending on the classification of the location and the nature
of the securities activities for which each location is responsible:
OSJs and supervisory branch offices must be inspected at least
annually; \21\ non-supervisory branch offices must be inspected at
least every three years; \22\ and non-branch locations must be
inspected on a periodic schedule, presumed to be at least every three
years.\23\ FINRA has interpreted the rule to require that inspections
take place on-site, irrespective of the type of office.\24\
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    \21\ See FINRA Rule 3110(c)(1)(A).
    \22\ See FINRA Rule 3110(c)(1)(B).
    \23\ See FINRA Rules 3110(c)(1)(C) and 3110.13 (General
Presumption of Three-Year Limit for Periodic Inspection Schedules).
On November 17, 2023, the Commission issued an approval order for
File Number FINRA-2023-006, which adopted new Supplementary Material
.19 (Residential Supervisory Location) under FINRA Rule 3110
(Supervision). FINRA Rule 3110.19 treats a private residence at
which an associated person engages in certain supervisory activities
as a non-branch location, subjecting it to inspections on a regular
periodic schedule (presumed to be at least every three years)
instead of the annual schedule required for OSJs and supervisory
branch offices.
    \24\ See FINRA Regulatory Notice 17-38 (Nov. 2017), https://www.finra.org/rules-guidance/notices/17-38.
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    Second, a member firm must make and retain a written record of each
inspection. Specifically, a member firm must retain a written record of
the date upon which each review and inspection occurred; \25\ reduce
each location's inspection to a written report; \26\ 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, at least
until the next inspection report has been written.\27\ If applicable to
the location being inspected, the inspection report must include the
testing and verification of the member firm's policies and procedures,
including supervisory policies and procedures, in specified areas.\28\
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    \25\ See FINRA Rule 3110(c)(1).
    \26\ See FINRA Rule 3110(c)(2).
    \27\ Id.
    \28\ See FINRA Rule 3110(c)(2)(A) (providing that the inspection
report must include, without limitation, the testing and
verification of the member firm's policies and procedures, including
supervisory policies and procedures for: (1) safeguarding customer
funds and securities; (2) maintaining books and records; (3)
supervising supervisory personnel; (4) transmitting 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)
changing customer account information, including address and
investment objectives changes and validation of such changes).
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    Third, a member firm must address potential conflicts of interest
related to inspections of its locations. For example, a member firm
must: (1) have procedures reasonably designed to prevent the
effectiveness of the inspections from being compromised due to the
conflicts of interest that may be present with respect to the location;
\29\ and (2) 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.\30\
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    \29\ FINRA Rule 3110(c)(3)(A).
    \30\ FINRA Rule 3110(c)(3)(B). FINRA Rule 3110(c)(3)(C) provides
a limited exception from this requirement if a member firm
determines compliance is not possible either because of its size or
its business model. FINRA Rule 3110.14 (Exception to Persons
Prohibited from Conducting Inspections) reflects FINRA's expectation
that a member firm generally will rely on the exception in instances
where it has only one location or has a business model where small
or single-person locations report directly to an OSJ manager who is
also considered the location's branch office manager. However, these
situations are non-exclusive, and a member firm may still rely on
the exception in other instances where it cannot comply because of
its size or business model, provided it complies with the
documentation requirements under the rule. See Notice at 28622 n.22.
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    FINRA Rule 3110.12 describes the components of a reasonable review.
In particular, the rule requires a member firm to establish and
maintain supervisory procedures that take into consideration, among
other things, the member firm's size, organizational structure, scope
of business activities, number and location of the member firm's
offices, the nature and complexity of the products and services offered
by the member firm, 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'').\31\
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    \31\ Red flags that suggest the existence or occurrence of
violations, prompting an unannounced visit, 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); representatives with disciplinary records;
customer investments in one or a few securities or class of
securities that is inconsistent with member 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 Notice at 28622
n.23 (citing SEC Division of Market Regulation, Staff Legal Bulletin
No. 17: Remote Office Supervision (Mar. 19, 2004) (``SLB 17''),
https://www.sec.gov/interps/legal/mrslb17.htm); see also NASD Notice
to Members 98-38 (May 1998) (``Notice 98-38'') and NASD Notice to
Members 99-45 (Jun. 1999) (``Notice 99-45'').
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2. FINRA's Stated Reasons for the Proposed Rule Change
    FINRA has identified, among others, three factors supporting
consideration of this Pilot. First, in response to the COVID pandemic,
FINRA adopted Rule 3110.17 to provide member firms the option, subject
to specified conditions, to complete remotely their calendar year
inspection obligations without an on-site visit to their locations.\32\
Under FINRA Rule 3110.17, member firms generally have been performing
remote inspections to satisfy their inspection obligations since
2021.\33\ FINRA stated that during this period, the variance between
member firms' rates of inspection findings through an on-site process
and findings through a remote process were not material.\34\ This
relief was extended on several occasions, and is currently scheduled to
last until the earlier of June 30, 2024, or the effective date of the
Pilot.\35\
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    \32\ See Notice at 28625.
    \33\ Id.
    \34\ Id. FINRA stated that its overall examination findings in
recent years across all member 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. See id.
    \35\ See Exchange Act Release No. 98560 (Sept. 27, 2023), 88 FR
68258 (Oct. 3, 2023) (Notice of Filing and Immediate Effectiveness
of File No. SR-FINRA-2023-012) (``2024 Extension''); see also
Exchange Act Release No. 96241 (Nov. 4, 2022), 87 FR 67969 (Nov. 10,
2022) (Notice of Filing and Immediate Effectiveness of File No. SR-
FINRA-2022-030) (extending the relief through December 31, 2023);
Exchange Act Release No. 94018 (Jan. 20, 2022), 87 FR 4072 (Jan. 26,
2022) (Notice of Filing and Immediate Effectiveness of File No. SR-
FINRA-2022-001) (extending the relief through December 31, 2022);
Exchange Act Release No. 93002 (Sept. 15, 2021), 86 FR 52508 (Sept.
21, 2021) (Notice of Filing and Immediate Effectiveness of File No.
SR-FINRA-2021-023) (extending the relief through June 30, 2022).
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    Second, FINRA stated that ``developments in technology have
enhanced firms' overall and ongoing supervision and monitoring of the
activities occurring at branch offices and non-branch locations'' such
that an on-site visit may not be required as part of every
inspection.\36\ Specifically, recordkeeping, correspondence, opening
customer accounts, placing trades, and transmitting customer funds and
securities are increasingly done electronically.\37\ As such, a large
portion of inspection work can be conducted electronically, prior to
any on-site visit to the location, and electronic reviews of many
locations have become one component of a member firm's overall
supervisory system of associated persons and locations.\38\
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    \36\ See Notice at 28622.
    \37\ Id. at 28623.
    \38\ See id. FINRA stated that it observed member 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. Id. at
28625.
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    Third, FINRA stated that, in general, the U.S. workforce has
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.\39\ For example, FINRA
stated that member firms have conveyed that the flexibility of hybrid
work has made a positive impact in attracting more diverse talent and
retaining existing talent.\40\ However, retaining the hybrid workplace
model means that more locations are subject to inspections and, but for
this Pilot, those locations would have to be physically inspected.
According to FINRA, ``a system of risk-based on-site and remote
inspections will allow firms to more efficiently deploy compliance
resources and to use an on-site component only when appropriate.'' \41\
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    \39\ See id. at 28624.
    \40\ Id. FINRA stated that the proposed rule change may also
support the competitiveness of the broker-dealer industry for
individuals who seek professional positions in compliance, as
``[t]he expectation of workplace flexibility and remote work by such
individuals may lead them away from the broker-dealer industry if
other segments of financial services or professional occupations
offer more flexible workforce arrangements, with regulatory
frameworks that offer more discretion in how the supervision is
conducted.'' See id. at 28637.
    \41\ See id. at 28636-37.
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    With the confluence of advances in compliance technology and the
shift to a remote or hybrid work environment made more pronounced by
the pandemic, FINRA stated that the optimal use of on-site inspections
deserves further consideration.\42\
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    \42\ See id. at 28637.
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C. The Proposed Rule Change

    As stated above, FINRA Rule 3110(c)(1) currently provides that an
inspection of a location must occur on a designated frequency that
varies depending on the classification of the location as an OSJ,
branch office, or non-branch location.\43\ FINRA is proposing to amend
FINRA Rule 3110 to adopt a voluntary, three-year pilot program to allow
eligible member firms to elect to fulfill their inspection obligations
under FINRA Rule 3110(c) by conducting inspections of eligible OSJs,
branch offices, and non-branch locations remotely without an on-site
visit to such locations, subject to specified safeguards and
limitations (such member firms hereinafter referred to as
``participating member firms''). To help mitigate the potential risks
associated with not conducting an on-

site inspection of every location, the proposed rule change would
establish safeguards that limit eligibility to participate in the Pilot
to certain member firms and locations based on criteria designed to
minimize risk.\44\ These safeguards and limitations would: (1) exclude
certain member firms from participating in the Pilot; (2) exclude
certain locations of participating member firms from participating in
the Pilot; (3) impose certain conditions that a participating member
firm and its eligible locations would be required to meet prior to
participating in the Pilot; and (4) require any participating member
firm to provide specified data to FINRA on a regular basis.\45\ These
safeguards and limitations, as well as others, are discussed in more
detail below.
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    \43\ See id. at 28621.
    \44\ See id. (stating that ``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.'').
    \45\ See id. at 28620.
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1. Length of Pilot
    Proposed Rule 3110.18(a) would permit participating member firms to
perform required inspections of OSJs, branch offices, and non-branch
locations remotely under the applicable provisions of FINRA Rule
3110(c)(1), subject to specified safeguards and limitations. The
proposed Pilot would automatically sunset on a date that is three years
after its effective date.\46\
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    \46\ In addition, if FINRA Rule 3110.17 (the temporary remote
inspections relief currently in place) has not already expired by
its own terms, Rule 3110.17 will automatically sunset on the
effective date of the Pilot. See proposed Rule 3110.18(m); see also
Notice at 28634; 2024 Extension at 68258.
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2. Member Firm-Level Requirements
    Proposed Rule 3110.18(f) would establish: (1) a list of criteria
that would render a member firm ineligible to participate in the Pilot;
and (2) a list of conditions to which participating member firms would
be required to adhere to during the Pilot.\47\
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    \47\ See proposed Rule 3110.18(f).
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a. Member Firm-Level Ineligibility Criteria
    Under proposed Rule 3110.18(f)(1), a member firm would be
ineligible to conduct remote inspections of any of its locations if at
any time during the Pilot the member firm: (1) is or becomes designated
as a Restricted Firm under FINRA Rule 4111 (``Restricted Firm''); \48\
(2) is or becomes designated as a Taping Firm under FINRA Rule 3170
(``Taping Firm''); \49\ (3) receives a notice from FINRA pursuant to
FINRA Rule 9557 regarding compliance with FINRA 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); \50\
(4) is or becomes suspended from membership by FINRA; \51\ (5) had its
FINRA membership become effective within the prior 12 months based on
the date in the Central Registration Depository (``CRD''); \52\ or (6)
is or has been found within the past three years by the Commission or
FINRA to have violated FINRA Rule 3110(c).\53\
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    \48\ See proposed Rule 3110.18(f)(1)(A). In general, FINRA 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 Notice at 28629 n.74.
    \49\ See proposed Rule 3110.18(f)(1)(B). In general, FINRA Rule
3170 (Tape Recording of Registered Persons by Certain Firms)
requires a member firm to establish, enforce, and maintain special
written procedures for 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 Notice at 28629 n.75.
    \50\ See proposed Rule 3110.18(f)(1)(C).
    \51\ See proposed Rule 3110.18(f)(1)(D).
    \52\ See proposed Rule 3110.18(f)(1)(E). FINRA stated that CRD
is the central licensing and registration system that FINRA operates
for the benefit of the Commission, FINRA and other self-regulatory
organizations, state securities regulators, and broker-dealers. The
information maintained in the CRD system is reported by registered
broker-dealers, associated persons, and regulatory authorities in
response to questions on specified uniform registration forms. See
Notice at 28629 n.76; see generally FINRA Rule 8312 (FINRA
BrokerCheck Disclosure).
    \53\ See proposed Rule 3110.18(f)(1)(F). FINRA stated that the
term ``found'' as used in this proposed criterion would carry the
same meaning as in FINRA Rule 4530.03 (Meaning of ``Found''). See
Notice at 28630 n.77.
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b. Member Firm-Level Conditions
i. Recordkeeping System
    Proposed Rule 3110.18(f)(2)(A) would require each participating
member firm to have a recordkeeping system that: (1) makes, keeps
current, and preserves records required to be made, kept current, and
preserved under applicable securities laws and regulations, FINRA
rules, and the participating member firm's own written supervisory
procedures under FINRA Rule 3110; (2) ensures such records are not
physically or electronically maintained and preserved at the location
subject to remote inspection; and (3) gives the participating member
firm prompt access to such records.\54\
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    \54\ See proposed Rule 3110.18(f)(2)(A).
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ii. Surveillance and Technology Tools
    Proposed Rule 3110.18(f)(2)(B) would require each participating
member firm to determine that its surveillance and technology tools are
appropriate to supervise the types of risks presented by each remotely
supervised location. Proposed Rule 3110.18(f)(2)(B) would also set
forth a non-exclusive list of surveillance and technology tools a
participating member firm may use, including: (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 location based on the activities of
associated persons, products offered, restrictions on the activity of
the 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.
3. Location-Level Requirements
    Proposed Rule 3110.18(g) would establish: (1) a list of criteria
that would render a location of a participating member firm ineligible
for remote inspection; and (2) a list of conditions a location would be
required to satisfy to be eligible for remote inspection.
a. Location-Level Ineligibility Criteria
    Under proposed Rule 3110.18(g)(1), a participating member firm's
location would not be eligible for a remote inspection if at any time
during the Pilot: (1) one or more associated persons at such location
is or becomes subject to a mandatory heightened supervisory plan under
the rules of the Commission, FINRA, or a state regulatory agency; \55\
(2) one or more associated persons at such location is or becomes
statutorily disqualified, unless such disqualified person (A) has been
approved (or is otherwise permitted pursuant to FINRA rules and the
federal securities laws) to associate with a member firm and (B) is not
subject to a mandatory heightened supervisory plan described in
proposed Rule 3110.18(g)(1)(A) or otherwise as a condition to approval
or permission for such association; \56\ (3) the member firm

is or becomes subject to FINRA Rule 1017(a)(7) as a result of one or
more associated persons at such location (hereinafter, a ``continuing
membership review''); \57\ (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 (Uniform Application for Securities
Industry Registration or Transfer Registration) (``Form U4''); \58\ (5)
one or more associated persons at such location is or becomes subject
to a disciplinary action taken by the participating member firm that is
or was reportable under FINRA Rule 4530(a)(2); \59\ (6) one or more
associated persons at such location is engaged in proprietary trading,
including the incidental crossing of customer orders, or the direct
supervision of such activities; \60\ or (7) the location handles
customer funds or securities.\61\
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    \55\ See proposed Rule 3110.18(g)(1)(A).
    \56\ Section 3(a)(39) of the Exchange Act identifies a list of
events that disqualify someone from membership in, participation in,
or association with a member of a self-regulatory organization. 15
U.S.C. 78c(a)(39).
    \57\ See proposed Rule 3110.18(g)(1)(C); see also Notice at
28631 n.83. In general, a member firm must file a Continuing
Membership Application 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. FINRA Rule
1017(a)(7); see generally FINRA Regulatory Notice 21-09 (Mar. 2021)
(announcing FINRA's adoption of rules to address brokers with a
significant history of misconduct), https://www.finra.org/rules-guidance/notices/21-09.
    \58\ See proposed Rule 3110.18(g)(1)(D); see also Notice at
28631 n.84. Form U4's Questions 14A(1)(a), 14(2)(a), 14B(1)(a), and
14B(2)(a) elicit reporting of criminal convictions, and Questions
14C, 14D, and 14E pertain to regulatory action disclosures. See Form
U4, https://www.finra.org/sites/default/files/form-u4.pdf.
    \59\ See proposed Rule 3110.18(g)(1)(E); see also Notice at
28631 n.85. A member firm must report to FINRA if an associated
person of the member firm is the subject of any disciplinary action
taken by the member firm 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. See FINRA Rule 4530.
    \60\ See proposed Rule 3110.18(g)(1)(F).
    \61\ See proposed Rule 3110.18(g)(1)(G). 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. See Notice at 28631 n.86
(citing NASD Notice to Members 06-12 (Mar. 2006)).
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b. Location-Level Conditions
    Proposed Rule 3110.18(g)(2) would require a specific location of a
participating member firm to satisfy certain conditions to be eligible
for a remote inspection. These conditions are: (1) electronic
communications would be required to be made through the participating
member firm's electronic system; (2) the associated person's
correspondence and communications with the public would be required to
be subject to the participating member firm's supervision in accordance
with FINRA Rule 3110; and (3) no books or records of the participating
member firm required to be made and kept current, and preserved under
applicable securities laws and regulations, FINRA rules, and the
participating member firm's own written supervisory procedures under
FINRA Rule 3110, can be physically or electronically maintained and
preserved at such location.\62\
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    \62\ See proposed Rule 3110.18(g)(2).
---------------------------------------------------------------------------

4. Risk Assessment
    Proposed Rule 3110.18(b)(1) (Standards for Reasonable Review) would
require that prior to electing a remote inspection for a location, a
participating member firm would be required to develop a reasonable
risk-based approach to using remote inspections and conduct and
document a risk assessment for that location. The risk assessment would
require the participating member firm to document the factors
considered, including the factors set forth in FINRA Rule 3110.12 and
would require the participating member firm take into account any
higher-risk activities that take place at, or higher-risk associated
persons that are assigned to, that location.\63\ Proposed Rule
3110.18(b)(2) (Other Factors to Consider for Risk Assessment) sets
forth a non-exhaustive list of factors that a participating member firm
would be required to consider and document as part of the risk
assessment for each location, including: (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 participating member firm's written
supervisory procedures; and (7) any recordkeeping violations.\64\ In
addition, proposed Rule 3110.18(b)(2) states that participating member
firms should conduct on-site inspections or make more frequent use of
unannounced, on-site inspections for high-risk locations or locations
where there are red flags.\65\ Amendment No. 1 modified proposed Rule
3110.18(b)(2) to add that, consistent with FINRA Rule 3110(a), a
participating member firm's supervisory system would be required to
take into consideration any red flags when determining whether to
conduct a remote inspection of a location.\66\
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    \63\ See proposed Rule 3110.18(b)(1).
    \64\ See proposed Rule 3110.18(b)(2).
    \65\ Id.; see also supra note 31 and accompanying text.
    \66\ See Amendment No. 1. In addition to the substantive
modifications made by Amendment No. 1 discussed here and below,
FINRA stated that Amendment No. 1 contains non-substantive updates
to the proposed rule text to improve readability. See id.
---------------------------------------------------------------------------

5. Written Supervisory Procedures for Remote Inspections
    As originally proposed, Rule 3110.18(c) would have required a
participating member firm to 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. Under
the proposed provision, reasonably designed procedures for conducting
remote inspections of locations would be required to 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 location; (3) the procedures
specified in proposed Rules 3110.18(h)(1)(G) \67\ and (h)(4) \68\ of
the data and information collection section of the proposed rule; and
(4) the use of other risk-based systems employed generally by the
participating 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\
Amendment No. 1 modified proposed Rule 3110.18(c) to state that a
participating member firm would be required to ``establish, maintain,
and enforce''

written supervisory procedures regarding remote inspections rather than
solely ``adopt'' such procedures.\70\
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    \67\ Proposed Rule 3110.18(h)(1)(G) requires written supervisory
procedures in the following four areas: (1) procedures for
escalating significant findings; (2) procedures for new hires; (3)
procedures for supervising brokers with a significant history of
misconduct; and (4) procedures related to outside business
activities (``OBAs'') and doing business as (``DBA'') designations.
    \68\ Proposed Rule 3110.18(h)(4) states that a participating
member firm shall 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
Pilot.
    \69\ See proposed Rule 3110.18(c).
    \70\ See Amendment No. 1.
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6. Effective Supervisory System
    Proposed Rule 3110.18(d) (Effective Supervisory System) states that
the requirement to conduct inspections of locations is one part of the
member firm's overall obligation to have an effective supervisory
system, and therefore a member firm would be required to maintain its
ongoing review of the activities and functions occurring at all
locations, whether or not the member firm conducts inspections
remotely. Proposed Rule 3110.18(d) additionally states that a
participating member firm's use of a remote inspection of a location
would be held to the same standards for review applicable to on-site
inspections as set forth in FINRA Rule 3110.12 (Standards for
Reasonable Review), which requires that the review must be reasonably
designed to assist in detecting and preventing violations of, and
achieving compliance with, applicable securities laws and regulations
and with FINRA rules, and that the member firm shall establish and
maintain supervisory procedures that must take into consideration,
among other things, any red flags.\71\ Finally, proposed Rule
3110.18(d) would provide that where a participating member firm's
remote inspection of a location identifies any red flags, the
participating member firm may need to impose additional supervisory
procedures for that location or may need to provide for more frequent
monitoring or oversight of that location, including potentially a
subsequent physical, on-site visit on an announced or unannounced
basis.\72\
---------------------------------------------------------------------------

    \71\ See also supra note 31 (discussing red flags).
    \72\ See proposed Rule 3110.18(d).
---------------------------------------------------------------------------

7. Documentation Requirement
    Proposed Rule 3110.18(e) would require a participating member firm
to maintain and preserve a centralized record for each Pilot Year \73\
in which it participates that separately identifies: (1) all locations
that were inspected remotely; and (2) any locations for which the
participating member firm determined to impose additional supervisory
procedures or more frequent monitoring, as provided in proposed Rule
3110.18(d). Further, proposed Rule 3110.18(e) would require a
participating member firm's documentation of the results of a remote
inspection for a location to identify any additional supervisory
procedures or more frequent monitoring for that location imposed as a
result of the remote inspection, including whether an on-site
inspection was conducted at such location.\74\
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    \73\ Proposed Rule 3110.18(l) would set forth the meanings
underlying ``Pilot Year'' as follows: (1) Pilot Year 1 would be the
period beginning on the effective date of the Pilot 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; (3) Pilot Year 3 would mean the calendar
year period following Pilot Year 2, beginning on January 1 and
ending on December 31; and (4) 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 of the Pilot. See proposed Rule 3110.18(l).
    \74\ See proposed Rule 3110.18(e).
---------------------------------------------------------------------------

8. Data and Information Collection Requirement
a. Data and Information During Pilot
    As originally proposed, proposed Rule 3110.18(h)(1) would have
required a participating member firm to collect and provide to FINRA on
a quarterly basis and in the manner and format determined by FINRA the
following data and information:\75\ (1) the total number of locations
with an inspection completed during each calendar quarter; \76\ (2) the
number of locations from that total quarterly number that were
inspected remotely; \77\ (3) the number of those locations from that
total quarterly number that were inspected on-site; \78\ (4) the number
of those locations in each calendar quarter that were subject to an on-
site inspection because of a finding; \79\ (5) the number of locations
for which a remote inspection was conducted in the calendar quarter
that identified a finding, the number of those findings, and a list of
the most significant findings; \80\ and (6) the number of locations for
which an on-site inspection was conducted in the calendar quarter that
identified a finding, the number of those findings, and a list of the
most significant findings.\81\ Amendment No. 1 modified proposed Rule
3110.18(h)(1) to change the requirement to provide a list of
``significant findings'' by deleting the word ``most'' from the phrase
``most significant findings.'' \82\
---------------------------------------------------------------------------

    \75\ The participating member firm would be required to provide
separate counts for OSJs, supervisory branch offices, non-
supervisory branch offices, and non-branch locations consistent with
FINRA Rule 3110(c)(1)(A)-(C). See proposed Rule 3110.18(h)(1).
    \76\ See proposed Rule 3110.18(h)(1)(A).
    \77\ See proposed Rule 3110.18(h)(1)(B).
    \78\ See proposed Rule 3110.18(h)(1)(C).
    \79\ See proposed Rule 3110.18(h)(1)(D). For purposes of this
paragraph, the term ``finding'' means a discovery made during an
inspection that led to a remedial action or was listed on the
participating member firm's inspection report. See proposed Rule
3110.18(h)(1).
    \80\ See proposed Rule 3110.18(h)(1)(E).
    \81\ See proposed Rule 3110.18(h)(1)(F).
    \82\ See Amendment No. 1. According to FINRA, a ``significant
finding'' would be one that should prompt the member 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 location, or other
targeted reviews of the root cause of the finding. FINRA stated that
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. See Amendment No. 1 (citing Notice at 28632
n.92).
---------------------------------------------------------------------------

    In addition, at the time a participating member firm first delivers
the quarterly data described above, it would also be required to
provide to FINRA the following written supervisory procedures for
conducting remote inspections: (1) procedures for escalating
significant findings; (2) procedures for new hires; (3) procedures for
supervising brokers with a significant history of misconduct; and (4)
procedures related to outside business activities and ``doing business
as'' designations.\83\
---------------------------------------------------------------------------

    \83\ See proposed Rule 3110.18(h)(1)(G)(i)-(iv). If a
participating member firm amends its written supervisory procedures
for remote inspections, it is required to provide such amendments to
FINRA with its next delivery of quarterly data. See proposed Rule
3110.18(h)(1)(G).
---------------------------------------------------------------------------

b. Additional Data and Information for Pilot Year 1, if Less Than Full
Calendar Year
    As originally proposed, if the first year of the Pilot (``Pilot
Year 1'') \84\ would cover a period of time that is less than a full
calendar year, the proposed rule change would have required a
participating member firm to collect and provide to FINRA the following
data and information no later than December 31 of Pilot Year 1:\85\ (1)
the number of locations with an inspection completed during the full
calendar year of Pilot Year 1; \86\ (2) the number of locations
referenced in item (1) that were inspected remotely during the full
calendar year of Pilot Year 1; \87\ and (3) the number of locations
referenced in item (1) that were inspected on-site

during the full calendar year of Pilot Year 1.\88\
---------------------------------------------------------------------------

    \84\ ``Pilot Year 1'' is defined in proposed Rule 3110.18(l).
See also supra note 73.
    \85\ The participating member firm would be required to provide
separate counts for OSJs, supervisory branch offices, non-
supervisory branch offices, and non-branch locations consistent with
FINRA Rule 3110(c)(1)(A)-(C).
    \86\ See proposed Rule 3110.18(h)(2)(A) as originally proposed.
    \87\ See proposed Rule 3110.18(h)(2)(B) as originally proposed.
    \88\ See proposed Rule 3110.18(h)(2)(C) as originally proposed.
---------------------------------------------------------------------------

    Rule 3110.18(h)(2) as originally proposed did not divide data and
information collection and reporting into inspections that occurred
prior to, and after, the effective date of the Pilot, but rather would
have required reporting for the full calendar year of Pilot Year 1.
Amendment No. 1 amended proposed Rule 3110.18(h)(2) so that
participating member firms would be required to collect and provide
information under this provision for the time period between January 1
of Pilot Year 1 and the day before the effective date of the Pilot, in
addition to the other data requirements set forth in the Pilot.\89\
More specifically, if Pilot Year 1 covers a period of time that is less
than a full calendar year, the proposed rule change, as modified by
Amendment No. 1, would require a participating member firm to collect
and provide to FINRA the following data and information no later than
December 31 of Pilot Year 1:\90\ (1) the number of locations with an
inspection completed between January 1 of Pilot Year 1 and the day
before the effective date of the Pilot; \91\ (2) the number of
locations referenced in item (1) that were inspected remotely between
January 1 of Pilot Year 1 and the day before the effective date of the
Pilot; \92\ and (3) the number of locations referenced in item (1) that
were inspected on-site between January 1 of Pilot Year 1 and the day
before the effective date of the Pilot.\93\
---------------------------------------------------------------------------

    \89\ See proposed Rule 3110.18(h)(2)(A)-(C); see also Amendment
No. 1.
    \90\ The participating member firm would be required to provide
separate counts for OSJs, supervisory branch offices, non-
supervisory branch offices, and non-branch locations consistent with
FINRA Rule 3110(c)(1)(A)-(C).
    \91\ See proposed Rule 3110.18(h)(2)(A); see also Amendment No.
1.
    \92\ See proposed Rule 3110.18(h)(2)(B); see also Amendment No.
1.
    \93\ See proposed Rule 3110.18(h)(2)(C); see also Amendment No.
1.
---------------------------------------------------------------------------

    In addition, Amendment No. 1 modified proposed Rule 3110.18(h)(2)
to impose two new obligations for participating member firms to collect
and provide to FINRA certain data and information. Specifically, if
Pilot Year 1 covers a period of time that is less than a full calendar
year, the proposed rule change would require a participating member
firm to collect and provide to FINRA the following additional data and
information no later than December 31 of Pilot Year 1: (1) the number
of locations referenced in item (2) above where findings were
identified, the number of those findings, and a list of the significant
findings; \94\ and (2) the number of locations referenced in item (3)
above where findings were identified, the number of those findings, and
a list of the significant findings.\95\
---------------------------------------------------------------------------

    \94\ See proposed Rule 3110.18(h)(2)(D); see also Amendment No.
1.
    \95\ See proposed Rule 3110.18(h)(2)(E); see also Amendment No.
1.
---------------------------------------------------------------------------

c. Additional Data and Information for Calendar Year 2019
    As originally proposed, Rule 3110.18(h)(3) would have required a
participating member firm to collect and provide to FINRA the following
calendar year 2019 data and information (``2019 data'') no later than
December 31 of Pilot Year 1: \96\ (1) the number of locations with an
inspection completed during calendar year 2019; \97\ and (2) the number
of locations referenced in item (1) where findings were identified, the
number of those findings, and a list of the most significant
findings.\98\ Amendment No. 1 modified the proposed rule change to
require a participating member firm to ``act in good faith using best
efforts'' to collect and provide to FINRA such data, as FINRA rules in
general only require that member firms preserve these records for a
period of three years.\99\ Amendment No. 1 also clarified the data and
information requirement to require that participating member firms
provide a list of ``significant findings'' by deleting the word
``most'' from the phrase ``most significant findings.'' \100\
---------------------------------------------------------------------------

    \96\ The participating member firm would be required to provide
separate counts for OSJs, supervisory branch offices, non-
supervisory branch offices, and non-branch locations consistent with
FINRA Rule 3110(c)(1)(A)-(C).
    \97\ See proposed Rule 3110.18(h)(3)(A) as originally proposed.
    \98\ See proposed Rule 3110.18(h)(3)(B) as originally proposed.
    \99\ See proposed Rule 3110.18(h)(3); see also FINRA Rule
3110(c)(2), stating that an inspection report must be kept on file
by the member firm for a minimum of three years, unless the regular
periodic schedule is longer than a three-year cycle, in which case
the report must be kept on file at least until the next inspection
report has been written.
    \100\ See proposed Rule 3110.18(h)(3)(B); see also Amendment No.
1; supra note 82 and accompanying text.
---------------------------------------------------------------------------

d. Written Policies and Procedures
    Proposed Rule 3110.18(h)(4) would require a participating member
firm 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 proposed Rule
3110.18(h).\101\
---------------------------------------------------------------------------

    \101\ See proposed Rule 3110.18(h)(4).
---------------------------------------------------------------------------

9. Election To Participate in Pilot
    In general, proposed Rule 3110.18(i) would require a participating
member firm, at least five calendar days before the beginning of a
Pilot Year,\102\ to provide FINRA an opt-in notice in the manner and
format determined by FINRA. The proposed rule states that by providing
such opt-in notice to FINRA, the member firm agrees to participate in
the Pilot for the duration of such Pilot Year and to comply with the
requirements of Rule 3110.18.\103\ A member firm that provides an opt-
in notice for a Pilot Year would be automatically deemed to have
elected and agreed to participate in the Pilot for subsequent Pilot
Years until the Pilot expires.\104\ To opt out, proposed Rule
3110.18(i) would require a participating member firm to provide FINRA
with an opt-out notice in the manner and format determined by FINRA at
least five calendar days before the end of the then current Pilot
Year.\105\ The proposed rule change also states that FINRA may, in
exceptional cases and where good cause is shown, waive the applicable
timeframes for the required opt-in or opt-out notices.\106\
---------------------------------------------------------------------------

    \102\ See supra note 73.
    \103\ As stated in the Notice, a member firm that participates
in a Pilot Year would be committed to complying with the terms of
proposed Rule 3110.18 for that entire Pilot Year. See Notice at
28633 n.97.
    \104\ See proposed Rule 3110.18(i).
    \105\ See id.
    \106\ See id.
---------------------------------------------------------------------------

10. Failure To Satisfy Conditions
    Proposed Rule 3110.18(j) states that a member 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 and would be required to conduct on-site inspections of
each location on the required cycle in accordance with FINRA Rule
3110(c).\107\
---------------------------------------------------------------------------

    \107\ See proposed Rule 3110.18(j).
---------------------------------------------------------------------------

11. Determination of Ineligibility
    Proposed Rule 3110.18(k) would authorize FINRA to make a
determination in the public interest and for the protection of
investors that a participating member firm is no longer eligible to
participate in the Pilot if the participating member firm fails to
comply with the requirements of Rule 3110.18.\108\ In such instances,
FINRA would provide written notice to the participating member firm of
such determination and the participating member firm would no longer be
eligible to participate in the Pilot and

would be required to conduct on-site inspections of required locations
in accordance with FINRA Rule 3110(c).\109\
---------------------------------------------------------------------------

    \108\ See proposed Rule 3110.18(k).
    \109\ See id.
---------------------------------------------------------------------------

II. Discussion and Commission Findings

    After careful review of the proposed rule change, the comment
letters, and FINRA's responses to the comments, the Commission finds
that the proposed rule change, as modified by Amendment No. 1, is
consistent with the requirements of the Exchange Act and the rules and
regulations thereunder that are applicable to a national securities
association.\110\ Specifically, the Commission finds that the proposed
rule change is consistent with Section 15A(b)(6) of the Exchange Act,
which requires, among other things, that FINRA rules 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.\111\
---------------------------------------------------------------------------

    \110\ In approving this rule change, the Commission has
considered the rule's impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
    \111\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    Pursuant to FINRA Rule 3110, member firms must ``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.''
\112\ Rule 3110 provides that ``[e]ach member shall establish and
maintain supervisory procedures that must take into consideration,
among other things, the firm's size, organizational structure, scope of
business activities, number and location of the firm's offices, the
nature and complexity of the products and services offered by the firm,
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'), etc.'' \113\ Importantly, Rule 3110
provides that ``[f]inal responsibility for proper supervision . . .
rest[s] with the member.'' \114\ A reasonably designed supervisory
system must include an inspection of each location subject to
supervision.
---------------------------------------------------------------------------

    \112\ FINRA Rule 3110(a).
    \113\ FINRA Rule 3110.12.
    \114\ FINRA Rule 3110(a)(1)-(7) identify certain minimum
requirements for the reasonably designed supervisory system. See
generally FINRA Rule 3110.
---------------------------------------------------------------------------

    The Pilot is consistent with these obligations, permitting a
participating member firm the flexibility to consider whether remote
inspections of its eligible locations would be consistent with the
member firm's broader obligation to establish and maintain a reasonably
designed supervisory system. At the same time, to help mitigate the
potential risks associated with not conducting an on-site inspection of
certain locations, the proposed rule change would establish safeguards
that limit eligibility to participate in the Pilot to certain member
firms and locations and that impose on member firms electing to
participate in the Pilot affirmative obligations tailored to the risks.
Similarly, the Pilot would mandate the collection of data and
information that should help FINRA make well-informed decisions about
improvements to, and the prudence of, any permanent rule changes.
Accordingly, as explained in more detail below, the Commission finds
that the Pilot is consistent with Section 15A(b)(6) of the Exchange
Act.

A. Member Firm-Level Requirements

    The proposed rule change would impose various safeguards and
limitations that preclude certain member firms from participating in
the Pilot. The Commission addresses the safeguards and limitations, and
any related comments, in turn.
1. Member Firm Ineligibility Criteria
    As stated above, under proposed Rule 3110.18(f)(1), a member firm
would be ineligible to participate in the Pilot if at any time during
the pilot period the member firm is subject to any of six firm-level
ineligibility criteria.\115\ FINRA stated 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.'' \116\ For example,
FINRA stated 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.'' \117\
Additionally, FINRA stated that new member firms are often still
implementing business plans and ``may not have sufficient experience to
develop a sufficiently robust inspection program.'' \118\ Moreover,
firms with recent FINRA Rule 3110(c) (Internal Inspections) violations
have demonstrated challenges in developing or maintaining robust
inspection programs and should not be able to participate, according to
FINRA.\119\
---------------------------------------------------------------------------

    \115\ Member firms would be generally ineligible to participate
in the Pilot if at any time during the Pilot the member firm: (1) is
or becomes designated as a Restricted Firm; (2) is or becomes
designated as a Taping Firm; (3) receives a notice from FINRA
pursuant to FINRA Rule 9557 regarding compliance with FINRA 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); (4) is or becomes suspended from membership by FINRA;
(5) had its FINRA membership become effective within the prior 12
months based on the date in the CRD; or (6) is or has been found
within the past three years by the Commission or FINRA to have
violated FINRA Rule 3110(c) (Internal Inspections). See proposed
Rule 3110.18(f)(1).
    \116\ See Notice at 28630.
    \117\ Id. FINRA also stated that rules related to Restricted
Firms and Taping Firms expressly address member firms that pose
higher risks, and for that reason, they would be ineligible to
participate in the Pilot. Id.
    \118\ Id.
    \119\ Id.
---------------------------------------------------------------------------

    Three commenters offered general support for the firm-level
ineligibility criteria, each expressing the idea that these
ineligibility criteria ``would help to ensure that firms and locations
that present higher risks to investors would remain subject to in-
person inspection requirements, thereby helping to protect investors
from unnecessary risks under the pilot program.'' \120\ No commenter
opposed these firm-level ineligibility criteria.
---------------------------------------------------------------------------

    \120\ Letter from Andrew Hartnett, NASAA President and Deputy
Commissioner, Iowa Insurance Division, North American Securities
Administrators Association, Inc., to Sherry R. Haywood, Assistant
Secretary, Commission, dated May 25, 2023 (``NASAA I'') at 6; see
also letter from Bernard V. Canepa, Managing Director & Associate
General Counsel, Securities Industry and Financial Markets
Association, to Vanessa A. Countryman, Secretary, Commission, dated
May 25, 2023 (``SIFMA'') at 2 (describing the Pilot as including
``numerous safeguards to ensure onsite inspections are conducted
when appropriate'' and as ``well designed,'' noting that it scopes
out ``certain, higher-risk . . . firms''); letter from Eversheds
Sutherland LLP on behalf of the Committee of Annuity Insurers, to
Secretary, Commission, dated May 25, 2023 (``CAI'') at 2-3 (stating
that by ``disallowing certain firms . . . from participating in
remote inspections if they present a higher risk of possible
investor harm,'' FINRA is appropriately balancing investor
protection and permitting the regulatory regime to evolve). See also
generally letter from David T. Bellaire, Esq., Executive Vice
President & General Counsel, Financial Services Institute, to
Secretary, Commission, dated May 25, 2023 (``FSI'') at 3-4; Letter
from Mark Quinn, Director of Regulatory Affairs, Cetera Financial
Group, to Sherry R. Haywood, Assistant Secretary, Commission, dated
May 25, 2023 (``Cetera I'') at 1.
---------------------------------------------------------------------------

    FINRA reasonably determined to exclude a member firm from
participation in the Pilot if the member firm is subject to any of the
six proposed firm-level ineligibility criteria. Each of these criteria
identifies--and excludes--member firms with characteristics that may
indicate increased risk of non-compliance. Specifically, Restricted

Firms have a history of misconduct or a high concentration of
registered persons with a significant history of misconduct that gave
rise to the designation,\121\ while Taping Firms are subject to
heightened regulatory oversight because they employ a ``significant
number of registered persons [who] previously worked for firms that
have been expelled from the industry or have had their registrations
revoked for inappropriate sales practices.'' \122\ Moreover, if the
Commission or FINRA has found that a member firm has violated FINRA
Rule 3110(c) within the past three years, the member firm has
demonstrated a recent difficulty implementing a compliant inspection
program.\123\ Member firms covered by these exclusions therefore have a
history of non-compliance or have registered representatives who have a
history of (or come from a member firm with a history of) non-
compliance. It is therefore reasonable for FINRA to determine that
member firms that fall into these categories are not eligible for
participation in the Pilot and the flexibility that it provides in
designing their supervisor systems.
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    \121\ Proposed Rule 3110.18(f)(1)(A); see FINRA, Rule 4111
Frequently Asked Questions, https://www.finra.org/rules-guidance/key-topics/protecting-investors-from-misconduct/faq.
    \122\ Proposed Rule 3110.18(f)(1)(B); see FINRA, FINRA Taping
Rule (FINRA Rule 3170), https://www.finra.org/rules-guidance/guidance/taping-rule.
    \123\ Proposed Rule 3110.18(f)(1)(F).
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    Furthermore, Rule 9557 notices are sent to member firms that are
experiencing financial or operational difficulties.\124\ Additionally,
suspension of a member firm by FINRA would be based on FINRA's
determination that the member firm has failed to comply with its
regulatory requirements or suspension is needed for the safety of
investors, creditors, or other members because of the member firm's
financial or operational difficulties.\125\ Such member firms raise
concerns about their ability to comply with their obligations and may
present risk to others. As such, it is reasonable to conclude that
these member firms should not be eligible for the proposed rule change
that is designed to afford member firms greater flexibility in
designing their supervisory systems.
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    \124\ Proposed Rule 3110.18(f)(1)(C); see FINRA Rule 9557
(Procedures for Regulating Activities Under Rules 4110, 4120 and
4130 Regarding a Member Experiencing Financial or Operational
Difficulties); see also FINRA Regulatory Notice 09-71 (Dec. 2009)
(announcing SEC approval of consolidated FINRA rules governing
financial responsibility), https://www.finra.org/rules-guidance/notices/09-71.
    \125\ Proposed Rule 3110.18(f)(1)(D). A suspended firm may have
been suspended because of a violation of ``federal securities laws,
rules or regulations thereunder, the rules of the Municipal
Securities Rulemaking Board, or FINRA rules.'' FINRA Rule
8310(a)(3), (5); see FINRA Rule 9550 Series.
---------------------------------------------------------------------------

    Moreover, member firms that have been FINRA members for less than
12 months may need additional time to develop their supervisory and
compliance systems to effectively comply with applicable securities
laws and rules.\126\ This time period also provides FINRA and other
regulators with time to conduct inspections of new member firms to
determine their compliance with their regulatory obligations before
they may be eligible for the flexibility provided in the proposed
rule.\127\ It is therefore reasonable for FINRA to determine that firms
must be operating for a certain amount of time before they can be
eligible for participation in the Pilot. One year provides a reasonable
balance between providing member firms with the flexibility for
supervision allowed in the proposed rule and concerns that member firms
need to develop experience operating before they are given such
flexibility. In sum, these proposed ineligibility criteria limit Pilot
participation to certain member firms without indicia that their
business operations, supervisory system, or inspection programs may
lack the maturity or safeguards to fully address the potential risks
associated with remote inspections are reasonable.\128\
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    \126\ Proposed Rule 3110.18(f)(1)(E).
    \127\ See Exchange Act Rule 15b2-2, 17 CFR 240.15b2-2 (generally
requiring inspection of a newly registered broker dealer within six
months for compliance with applicable financial responsibility rules
and within 12 months for all other applicable regulatory
requirements).
    \128\ Cf. Exchange Act Release No. 90635 (Dec. 10, 2020), 85 FR
81540 (Dec. 16, 2020) (Order Approving File No. SR-FINRA-2020-011 to
Address Brokers With a Significant History of Misconduct); Exchange
Act Release No. 92525 (July 30, 2021), 86 FR 42925 (Aug. 5, 2021)
and 86 FR 49589 (Sept. 3, 2021) (Corrected Order Approving File No.
SR-FINRA-2020-041 to Adopt FINRA Rules 4111 (Restricted Firm
Obligations) and 9561 (Procedures for Regulating Activities Under
Rule 4111)).
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2. Member Firm Conditions for Eligibility To Participate in the Pilot
a. Firm Recordkeeping System
    As stated above, proposed Rule 3110.18(f)(2)(A) would require a
participating member firm to meet certain requirements regarding its
recordkeeping system, including that it have a recordkeeping system and
that the participating member firm have prompt access to the records
required by that system and that those records are not physically or
electronically maintained at remotely inspected locations.\129\ One
commenter expressed support for this provision, stating that it is
responsive to concerns about a participating member firm's access to
and control over records and ``will better enable firms to supervise
their associated persons.'' \130\ No commenter objected to this
provision of the proposed rule change.
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    \129\ Each participating member firm would be required to have a
recordkeeping system that: (1) makes, keeps current, and preserves
records required to be made, kept current, and preserved under
applicable securities laws and regulations, FINRA rules, and the
participating member firm's own written supervisory procedures under
FINRA Rule 3110; (2) ensures such records are not physically or
electronically maintained and preserved at the location subject to
remote inspection; and (3) gives the participating member firm
prompt access to such records. See proposed Rule 3110.18(f)(2)(A).
    \130\ NASAA I at 6-7. In a comment letter related to FINRA-2022-
021 (the original Pilot proposal), NASAA requested that FINRA
require participating member firms to maintain written supervisory
procedures for ``technology used to ensure that records are
maintained within the firm's access and control.'' See letter from
Andrew Hartnett, President, NASAA, to Sherry R. Haywood, Assistant
Secretary, Commission, dated December 7, 2022 (``NASAA Dec. 2022'')
at 5, https://www.sec.gov/comments/sr-finra-2022-021/srfinra2022021-20152479-320342.pdf.
---------------------------------------------------------------------------

    The proposed rule change's recordkeeping conditions are reasonable.
A key component of remote--as opposed to on-site--inspection is prompt
access to the records of the remotely inspected location from an
alternative location. Because the proposed rule change couples this
prompt-access requirement with a prohibition of the storage of a
remotely inspected location's records at the location itself, the
member firm need not conduct an on-site visit to gather and review
records during an inspection. The proposed rule change therefore should
facilitate timely and effective remote inspection of locations
participating in the Pilot and decrease, though not always eliminate,
the need for on-site inspections. For these reasons, the proposed
condition is reasonable.
b. Surveillance and Technology Tools
    As noted above, proposed Rule 3110.18(f)(2)(B) would require that
each participating member firm determine that its surveillance and
technology tools are appropriate to supervise the types of risks
presented by each remotely inspected location. These tools may include,
but are not limited to, firm-wide electronic tools, tools specifically
applied to a location, and system security tools.\131\ FINRA stated

that it believes that the absence of ``adequate surveillance and
technology tools would raise questions about the reasonableness of
remote inspections'' and therefore proposed the non-exhaustive list to
help set regulatory expectations for remote inspections.\132\
---------------------------------------------------------------------------

    \131\ The participating member firm would be required to
determine that its surveillance and technology tools are appropriate
to supervise the types of risks presented by each such remotely
supervised location. 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
location based on the activities of associated persons, products
offered, restrictions on the activity of the 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. See proposed Rule
3110.18(f)(2)(B).
    \132\ See FINRA Response to Comments I at 11.
---------------------------------------------------------------------------

    One commenter opposed the principle-based nature of the proposed
condition by stating that the listed technology and surveillance tools
should be ``mandatory, rather than permissive.'' \133\ This commenter
stated that the listed technologies are ``critical,'' should be
``standard features of all risk assessments and remote inspections,''
and are the ``bare minimum necessary for a firm to participate
safely.'' \134\ In particular, this commenter pointed to
videoconferencing and related technology as ``crucial to a rigorous
inspection.'' \135\ Similarly, another commenter who opposed the Pilot
expressed skepticism in particular about FINRA's reliance on the
increased use of technology to support approval of the proposed rule
change, stating that remote inspections would leave ``considerable
opportunity for advisors to skirt the rules.'' \136\
---------------------------------------------------------------------------

    \133\ NASAA I at 7; see also, e.g., NASAA Dec. 2022 at 6.
    \134\ NASAA I at 7. NASAA also added that it would not be
inconsistent to establish a defined floor despite the principle-
based standard of reasonable supervision. Id.
    \135\ Id.
    \136\ See letter from Hugh Berkson, President, Public Investors
Advocate Bar Association, to Vanessa Countryman, Commission, dated
May 24, 2023 (``PIABA I'') at 3; letter from Hugh Berkson,
President, Public Investors Advocate Bar Association, to Vanessa
Countryman, Commission, dated August 28, 2023 (``PIABA II'') at 3.
---------------------------------------------------------------------------

    In response, FINRA stated that, while the proposed condition would
require that a member firm must determine that its surveillance and
technology tools are appropriate, it believes that flexibility among
the use of specific tools that may be used for remote inspections is
appropriate because these tools may vary among member firms depending
upon their business activities, size, and structure.\137\ FINRA also
stated that the proposed list of surveillance and technology tools is
non-exhaustive in order to account for ongoing advances in
technologies.\138\ For these reasons, FINRA declined to modify the
proposed rule change. However, while FINRA did not mandate video
conferencing technology or portable cameras, as suggested, it did
include ``visual inspection tools'' as a general description of this
technology in its non-exhaustive list of tools.\139\
---------------------------------------------------------------------------

    \137\ See FINRA Response to Comments I at 11.
    \138\ Id.
    \139\ Id. at 11 n.27.
---------------------------------------------------------------------------

    FINRA further noted that the proposed rule change would separately
require a participating member firm to adopt reasonably designed
written supervisory procedures that must include, among other things, a
description of the methodology, including the technology, that a
participating member firm may use to conduct remote inspections.\140\
---------------------------------------------------------------------------

    \140\ Id. at 12; see also proposed Rule 3110.18(c).
---------------------------------------------------------------------------

    Given variances in firm size, business models, and risk, and the
rapid development and use of technology among member firms, FINRA
reasonably determined to provide flexibility to each participating
member firm to determine that its surveillance and technology tools are
appropriate to supervise the types of risks presented by each remotely
inspected location. Requiring a member firm to determine that its
existing surveillance and technology tools are appropriate to supervise
the types of risks presented by each remotely inspected location before
participating in the Pilot is reasonable and should help ensure that
participating member firms employ appropriate tools to manage the
potential risks posed by the remote inspection of eligible locations.
The Commission acknowledges the commenter's request to require that
participating member firms use the technology tools identified by FINRA
to perform remote inspections. Indeed, a number of commenters indicated
that they already rely extensively on technology to supervise their
associated persons, and FINRA relied broadly on technological
developments in the securities industry in support of this
proposal.\141\
---------------------------------------------------------------------------

    \141\ See Notice at 28622; see also, e.g., letter from Raymond
James & Associates, Inc. and Raymond James Financial Services, Inc.
to Vanessa A. Countryman, Secretary, Commission, dated May 23, 2023
(collectively ``Raymond James I'') at 1.
---------------------------------------------------------------------------

    However, while the proposed rule change takes a principle-based
approach rather than mandating specific surveillance tools, it does set
expectations for the supervision of locations participating in the
Pilot. First, a participating member firm must determine that its
surveillance and technology tools are appropriate, starting by taking
stock of the methodology, including the technology, that the
participating member firm may use to conduct remote inspections and
incorporating it into its written supervisory procedures. Second, FINRA
identifies surveillance and technology tools that a participating
member firm may consider, including firm-wide electronic tools, tools
specifically applied to a location, and system security tools, which
will help clarify FINRA's expectations and assist participating member
firms with operationalizing the rules. These requirements, combined
with other safeguards and limitations, along with a participating
member firm's overarching obligation under FINRA Rule 3110(a) to
maintain an effective supervisory system, serve a crucial gatekeeping
role for member firms to participate in the Pilot. Furthermore, even a
participating member firm with state-of-the art tools may ultimately
determine that an unannounced on-site inspection, or more frequent
inspections, are appropriate to discharge its obligation to reasonably
supervise that location.\142\ For the reasons set forth above, the
proposed condition is reasonable.
---------------------------------------------------------------------------

    \142\ See proposed Rule 3110.18(b)(2) (``In addition, 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').''); see also
proposed Rule 3110.18(d) (``Where a member's remote inspection of an
office or location identifies any `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 of that
office or location including potentially a subsequent on-site visit
on an announced or unannounced basis.''); supra note 31 (discussing
red flags).
---------------------------------------------------------------------------

B. Location-Level Requirements

1. Location-Level Ineligibility Criteria
    As noted above, proposed Rule 3110.18(g)(1) would prohibit remote
inspections for any location subject to any of seven location-level
ineligibility criteria. Six of these seven location-level ineligibility
criteria address locations with associated persons who: (1) are subject
to a mandatory heightened supervisory plan; (2) are statutorily
disqualified; (3) have caused the participating member firm to undergo
a continuing membership review pursuant to FINRA Rule 1017(a)(7); (4)
are required to make disclosures about certain criminal and regulatory
actions; (5) are subject to certain disciplinary actions taken by the
participating member firm; or, (6) are engaged in proprietary trading.
The seventh criteria

would make locations that handle customer funds or securities
ineligible for the Pilot.\143\ FINRA stated that these seven location-
level ineligibility criteria are ``events or activities of an
associated person of the member firm that . . . [are] more likely to
raise investor protection concerns based on the individual's record of
specified regulatory or disciplinary events.'' \144\ FINRA stated that
it believes that ``these objective categorical restrictions will
provide safeguards that will help ensure that firms maintain effective
supervisory procedures during the pilot period.'' \145\
---------------------------------------------------------------------------

    \143\ See proposed Rule 3110.18(g)(1).
    \144\ See Notice at 28630; see also Notice at 28631 (``FINRA
believes the proposed list of ineligibility categories is
appropriately derived from existing rule-based criteria that are
part of processes to identify . . . 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 Response to Comments II at 10 (``FINRA
believes that these proposed criteria impose appropriate controls
and conditions regarding participation in the proposed Pilot Program
to further promote investor protection.'').
    \145\ Notice at 28631.
---------------------------------------------------------------------------

    Two commenters offered general support for these exclusions.\146\
As discussed in more detail below, one commenter recommended that FINRA
expand the exclusion for locations with associated persons that are
required to make disclosures about certain criminal and regulatory
actions set forth in proposed Rule 3110.18(g)(1)(D),\147\ and another
asked FINRA to clarify the exclusions for locations that engage in
proprietary trading or handle customer funds or securities as set forth
in proposed Rules 3110.18(g)(1)(F) and (G).\148\ No commenter offered
specific support for, or opposition to, any of the remaining
ineligibility criteria.
---------------------------------------------------------------------------

    \146\ See SIFMA at 2 (noting that the proposed rule change
scopes out ``certain, higher-risk locations [and] individuals'');
see also CAI at 3. See also generally NASAA I at 6 (stating that
``the ineligibility criteria would help to ensure that firms and
locations that present higher risks to investors would remain
subject to in-person inspection requirements, thereby helping to
protect investors from unnecessary risks under the pilot
program.'').
    \147\ See PIABA I at 4; PIABA II at 4.
    \148\ See letter from Jessica R. Giroux, General Counsel & Head
of Fixed Income Policy, American Securities Association, to Vanessa
Countryman, Secretary, Commission, dated August 29, 2023 (``ASA
II'') at 3.
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a. Criminal Convictions and Adjudicated Regulatory Actions
    Proposed Rule 3110.18(g)(1)(D) would exclude a location from the
Pilot where one or more associated persons at such location is required
to disclose certain criminal convictions or regulatory actions on Form
U4.\149\ One commenter recommended that FINRA expand this ineligibility
criterion to include locations with associated persons who: have a
``substantial number'' of customer complaints; are subject to pending
regulatory investigations; have been terminated for cause; or have
``significant'' judgments or liens.\150\ The commenter stated that such
associated persons are ``problematic'' and thus the locations at which
they work should be subject to on-site inspections, which offer greater
scrutiny.\151\
---------------------------------------------------------------------------

    \149\ See Form U4 Questions 14A(1)(a) and (2)(a), 14(B)(1)(a)
and (2)(a), and Questions 14C, 14D, and 14E.
    \150\ See PIABA I at 4; PIABA II at 4. PIABA stated that FINRA
should exclude individuals with ``a substantial number'' of customer
complaints but did not suggest a particular number or threshold. Id.
Similarly, PIABA suggested that FINRA exclude locations with
associated persons who have ``significant'' judgments or liens,
without commenting on a specific amount. Id.
    \151\ Id.
---------------------------------------------------------------------------

    In response, FINRA declined to expand the location-level
ineligibility criteria, stating that, as currently proposed, the
ineligibility criteria are based on clear, objective factors.\152\
Nonetheless, FINRA agreed with the commenter that the presence of such
disclosures would be factors a participating member firm should
consider as part of its required risk assessment.\153\ FINRA concluded
that the risk assessment, along with other provisions of the proposed
rule change, such as the requirement that a participating member firm
establish, maintain, and enforce written supervisory procedures for
remote inspections, would provide the appropriate safeguards related to
whether a particular location should be eligible to undergo a remote
inspection.\154\
---------------------------------------------------------------------------

    \152\ See FINRA Response to Comments I at 12.
    \153\ Id. at 13. The risk assessment would require a
participating member firm's consideration of higher-risk activities
occurring at a location, higher-risk associated persons that are
assigned to a location, and the presence of red flags. See proposed
Rule 3110.18(b).
    \154\ Id.
---------------------------------------------------------------------------

    An individual with certain regulatory or criminal-action
disclosures on Form U4 has a history of criminal conviction(s) or
regulatory finding(s) that may indicate an increased risk of non-
compliance. Because of the heightened risks associated with such
registered persons, it is reasonable for the proposed rule change to
exclude locations from the Pilot where one or more associated persons
at such location is required to disclose certain criminal convictions
or regulatory actions on Form U4. The Commission also recognizes,
however, that there may be other indicators of heightened risk.
    Customer complaints, investigations, terminations, and judgments or
liens may, in certain circumstances, indicate heightened levels of
risk. However, they are not formal investigations or proceedings
initiated by a regulator charged with enforcing securities laws,
regulations, and rules. For example, they may be overly broad in scope
or lack the factual development of a comparable regulatory action.
Because assessing the risk associated with customer complaints,
investigations, terminations, and judgments or liens may require
investigation and a consideration of the totality of the circumstances,
FINRA reasonably determined that--in lieu of creating a blanket
exclusion for such locations--these factors could be considered in the
mandatory risk assessment of each location to determine whether a
remote inspection is appropriate. Specifically, it is reasonable for
participating member firms to gauge the level of risk of a location by,
among other things, requiring participating member firms to: (1)
consider the ``volume and nature of customer complaints'' in the
mandatory risk assessment prior to inspecting a location remotely; and
(2) take into consideration any red flags when determining whether to
conduct a remote inspection of a location. For these reasons, the
proposed ineligibility criteria are reasonable.
b. Proprietary Trading and Handling Customer Funds or Securities
    As stated above, locations that engage in proprietary trading or
handle customer funds or securities would be excluded from the
Pilot.\155\ One supportive commenter requested that FINRA provide a
clearer definition of the types of trading activities that would
trigger these exclusions, fearing that certain common activities could
be interpreted in a way that would result in eliminating a significant
number of branches from eligibility for remote inspections.\156\
---------------------------------------------------------------------------

    \155\ See proposed Rules 3110.18(g)(1)(F) and (G).
    \156\ See ASA II at 3 (stating that the processing and
supervisory activities related to accepting funds or securities
happen at nearly every branch location).
---------------------------------------------------------------------------

    In response, FINRA stated that these two ineligibility criteria are
based on ``significant activities potentially impacting the operations
and financial stability of the firm and, as a result, may also
significantly impact customers and the markets generally.'' \157\ In
reference to the proprietary trading exclusion, FINRA stated that
providing an exhaustive list of the types of trading activities that
would trigger this exclusion ``is not practicable'' because the
analysis is fact-specific, but would consider providing additional
guidance,

as appropriate.\158\ With regard to the handling of customer funds and
securities, FINRA stated that in addition to having the potential for
significant impact on customers, this ineligibility criteria is derived
from one of several existing conditions that a member firm must satisfy
in order to deem a primary residence as a non-branch location.\159\
---------------------------------------------------------------------------

    \157\ FINRA Response to Comments II at 10.
    \158\ Id. at 11. Because of the fact-specific nature of the
definition of proprietary trading, FINRA stated that it believes
that this commenter's request would be better addressed through
FINRA's interpretative guidance process so that FINRA has the
opportunity to fully consider relevant facts and circumstances. Id.
    \159\ Id. at 10-11. FINRA also stated that it has previously
provided guidance on the meaning and interpretation of the term
``handled'' that currently appears in Rule 3110(f)(2)(A)(ii) and
such existing guidance would apply to the Pilot. Id. at 11.
---------------------------------------------------------------------------

    Proprietary trading activities can rapidly and adversely impact the
operational and financial stability of a member firm, and the resulting
instability can pose a significant risk of harm to the member firm's
customers. In light of this risk, FINRA reasonably determined that a
location conducting propriety trading should remain subject to on-site
inspection and not be permitted to participate in a temporary pilot
program designed to evaluate the prudence of a permanent remote-
inspection program. For this reason, the proposed exclusion is
reasonable.\160\
---------------------------------------------------------------------------

    \160\ Because additional guidance about the types of trading
activities that would trigger the proprietary trading ineligibility
criteria could assist participating member firms in complying with
the Pilot, the Commission notes that FINRA has offered to consider
issuing such guidance through its interpretive guidance process, as
appropriate. See FINRA Response to Comments II at 11.
---------------------------------------------------------------------------

    Similarly, a member firm handling its customers' funds or
securities increases, among other things, the risk of loss of those
customers' assets. In light of that risk, FINRA reasonably determined
that a location handling customer funds or securities should remain
subject to on-site inspection and not be permitted to participate in a
temporary pilot program designed to evaluate the prudence of a
permanent remote-inspection program. For this reason, the proposed
exclusion is reasonable.
c. Other Location-Level Ineligibility Criteria
    The proposed rule change would also prohibit remote inspections for
any location with an associated person who: (1) is subject to a
mandatory heightened supervisory plan under the rules of the
Commission, FINRA, or a state regulatory agency; (2) is statutorily
disqualified, unless such disqualified person (A) has been approved (or
is otherwise permitted pursuant to FINRA rules and the federal
securities laws) to associate with a member firm and (B) is not subject
to a mandatory heightened supervisory plan under item (1), above, or
otherwise as a condition to approval or permission for such
association; (3) causes the member firm to undergo a continuing
membership review pursuant to FINRA Rule 1017(a)(7); or, (4) is subject
to certain disciplinary actions by the participating member firm.\161\
FINRA stated that these location ineligibility criteria are necessary
to address the indicia of increased risk posed by some locations and
represent appropriate controls and conditions regarding participation
in the Pilot.\162\ No commenter offered specific support for, or
opposition to, any of these exclusions.
---------------------------------------------------------------------------

    \161\ See proposed Rules 3110.18(g)(1)(A)-(C) and (E); see also
supra note 59.
    \162\ See FINRA Response to Comments II at 10.
---------------------------------------------------------------------------

    FINRA reasonably determined to exclude each of these locations from
the Pilot given the increased risk each category of person could pose.
First, if a regulator has imposed a heightened supervisory plan on a
specific associated person, the regulator has determined that they
require additional supervision to help ensure their compliance with
securities laws, regulations, and rules. Second, an individual subject
to a statutory disqualification has engaged in violative conduct that
may indicate an increased risk of non-compliance.\163\ Third, an
individual who has triggered a continuing membership review pursuant to
FINRA Rule 1017(a)(7) is seeking to become an owner, control person,
principal, or registered person of the member firm and has, in the
previous five years, one or more ``final criminal matters'' or two or
more ``specified risk events.'' \164\ Fourth, an individual who is
subject to a reportable disciplinary action initiated by a member firm
has necessarily engaged in misconduct that warranted the member firm's
imposition of significant discipline.\165\ Because each of these
proposed exclusions identifies a category of person who has a history
of law violations, misconduct, or non-compliance with laws and rules
designed to protect investors, the proposed rule change reasonably
requires an on-site inspection for each location from which such
associated persons operate, rather than allowing those locations to be
inspected remotely. Therefore, FINRA reasonably determined to exclude
such locations from eligibility in the Pilot.
---------------------------------------------------------------------------

    \163\ Section 3(a)(39) of the Exchange Act identifies a list of
events that disqualify someone from membership in, participation in,
or association with a member of a self-regulatory organization. 15
U.S.C. 78c(a)(39).
    \164\ Proposed Rule 3110.18(g)(1)(C) (exclusion applicable where
the person responsible for triggering a continuing membership review
is located at the location subject to inspection); FINRA Rule
1017(a)(7). ``The term `final criminal matter' means a criminal
matter that resulted in a conviction of, or plea of guilty or nolo
contendere (`no contest') by, a person that is disclosed, or is or
was required to be disclosed, on the applicable Uniform Registration
Forms.'' FINRA Rule 1011(h). ``Specified risk events'' include
certain investment-related, consumer-initiated (1) customer
arbitration awards, (2) civil judgments, (3) customer arbitration
settlements, or (4) civil litigation settlements. FINRA Rule
1011(p)(1), (2). ``Specified risk events'' also include certain
investment-related civil actions or regulatory actions that result
in (1) monetary sanctions for a dollar amount at or above $15,000 or
(2) a bar, expulsion, revocation, recission, or suspension. See
FINRA Rule 1011(p)(3), (4).
    \165\ See proposed Rule 3110.18(g)(1)(E). A member firm must
report to FINRA if an associated person of the member firm is the
subject of any disciplinary action taken by the member firm
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. See FINRA Rule 4530.
---------------------------------------------------------------------------

2. Location-Level Conditions
a. Location-Level Recordkeeping System
    The proposed rule change would require a participating location to
make all electronic communications through the participating member
firm's electronic system, subject all communications with the public to
the firm's supervision, and preclude books and records from being
physically or electronically maintained and preserved at the
location.\166\ FINRA stated that it believes this provision
``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.'' \167\ No
commenter expressly supported or objected to these proposed changes.
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    \166\ As part of the requirement to develop a reasonably
designed risk-based approach to using remote inspections, and the
requirement to conduct and document a risk assessment for each
location in accordance with the risk assessment provision of the
Pilot, a specific location of the participating member firm would be
required to also satisfy the following conditions: (1) electronic
communications (e.g., email) are made through the participating
member firm's electronic system; (2) the associated person's
correspondence and communications with the public are subject to the
participating member firm's supervision in accordance with FINRA
Rule 3110; and (3) no books or records of the member firm required
to be made and kept current, and preserved under applicable
securities laws and regulations, FINRA rules and the participating
member firm's own written supervisory procedures under FINRA Rule
3110 are physically or electronically maintained and preserved at
such location. See proposed Rule 3110.18(g)(2).
    \167\ See Notice at 28631.
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    The proposed rule change's location-level recordkeeping conditions
are

reasonable. As discussed above, a key component of remote--as opposed
to on-site--inspection is prompt access to the records of the remotely
inspected location from an alternative location. The proposed location-
level recordkeeping conditions strengthen this component of the Pilot.
Prompt access should help provide the participating member firm with
the necessary insight into the location's operations, both at the
outset and on an ongoing basis. Mandating the use of the participating
member firm's electronic system for the location's electronic
communications and requiring the firm to supervise the location's
correspondence and communications help to ensure that the participating
location's activities lend themselves to remote inspection. Because the
proposed conditions prohibit the storage of a participating location's
records at the location itself, the participating member firm need not
conduct an on-site visit to gather and review records during an
inspection. The proposed rule change therefore should facilitate timely
and effective remote inspection of locations participating in the Pilot
and decrease, though not always eliminate, the need for on-site
inspections.

C. Risk Assessment

    The proposed rule change would require a participating member firm
to conduct and document a risk assessment for each location prior to
choosing to conduct a remote inspection for that location.\168\ The
risk assessment would require that a participating member firm take
into account any higher risk activities at, or higher risk associated
persons assigned to, that location, as well as mandate consideration of
a non-exhaustive list of factors, including: (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 participating member firm's written
supervisory procedures; and (7) any recordkeeping violations.\169\
According to FINRA, the inclusion of this non-exhaustive list would
help ensure that participating member firms consider certain high risk
criteria when determining whether to conduct a remote inspection.\170\
FINRA further stated that it ``expects that higher risk factors at a
particular location would cause a firm to conduct on-site inspections
of such location.'' \171\
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    \168\ See proposed Rule 3110.18(b)(1); see also supra note 63
and accompanying text.
    \169\ See proposed Rule 3110.18(b)(1) and (b)(2); see also supra
note 64 and accompanying text.
    \170\ See Notice at 28627.
    \171\ Id.
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    Five commenters generally supported the proposed risk
assessment.\172\ Three of these commenters stated that the requirement
to conduct risk assessments for each location would promote investor
protection.\173\ A fourth commenter stated that the use of a risk
assessment would enable a participating member firm to dedicate more
resources to specialized inspections targeting higher risk areas.\174\
The fifth commenter expressed general support for the provision.\175\
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    \172\ See SIFMA; Raymond James I; Cetera I; NASAA I; FSI.
    \173\ See Cetera I at 1 (stating that the Pilot ``includes
significant safeguards that are designed to maintain or enhance
investor protection'' including requiring participating member firms
to conduct and document risk-based assessments); SIFMA at 2 (``[The
Pilot] includes numerous safeguards to ensure onsite inspections are
conducted when appropriate, such as requiring firms to perform a
risk assessment that considers a non-exhaustive list of risk
factors, and scoping out certain, higher-risk locations,
individuals, and firms from the pilot.''); FSI at 3-4 (``The
required risk-based assessment, coupled with restrictions that limit
or restrict the ability of certain higher-risk firms and firm
offices from participating in remote inspections, will ensure that
investors are protected.'').
    \174\ Raymond James I at 2 (stating that risk assessments would
also allow participating member firms to tailor their inspection
programs to attract and retain a broader candidate pool who may not
be interested in, or be able to, travel).
    \175\ NASAA I at 4.
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    Two of the five supporting commenters also suggested modifications
to the proposed rule change.\176\ One commenter expressed concern that
FINRA would use the benefit of hindsight to evaluate a participating
member firm's determination to conduct a remote inspection where one of
the listed risk factors is present.\177\ In response, FINRA disagreed,
emphasizing that ``the `reasonably designed' standard requires that the
supervisory system, of which an inspection program is a part, `be a
product of sound thinking and within the bounds of common sense, taking
into consideration the factors that are unique to a member's
business[.]' '' \178\ FINRA also noted that the presence of one
particular enumerated factor or others may not be dispositive as to
whether an on-site or remote inspection of a location is appropriate,
and such factors should be reviewed in their totality under the facts
and circumstances.\179\
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    \176\ FSI; NASAA I.
    \177\ See FSI at 4.
    \178\ FINRA Response to Comments I at 8 (quoting Notice 99-45).
    \179\ See id.
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    The second commenter sought additional conditions to the risk
assessment. First, this commenter stated that a participating member
firm should be required to conduct and document a risk assessment after
identifying red flags and fully consider any significant change in
circumstances that may warrant higher scrutiny.\180\ In the
alternative, this commenter stated that FINRA should revise proposed
Rule 3110.18(b)(1) to require a risk assessment for each location
before ``each'' remote inspection of that location. The commenter
explained its concern that participating member firms may ignore red
flags and rely on a previous risk assessment to continue inspecting a
location remotely because the rule would require that a risk assessment
be conducted ``prior to electing a remote inspection.'' \181\
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    \180\ NASAA I at 4-5.
    \181\ Id. at 4-5.
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    Second, this commenter stated that a participating member firm
should be required to provide FINRA with documentation of all risk
assessments conducted after identifying red flags during the Pilot. The
commenter reasoned that it would ``maintain accountability'' to require
a participating member firm to articulate a sound basis for its
decisions upon identifying red flags.\182\ Moreover, this commenter
stated that the data would aid FINRA's and the Commission's
understanding of risk assessment practices and consider the merits of
any potential policy changes around remote inspections.\183\
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    \182\ Id. at 5.
    \183\ Id.
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    To address this concern, FINRA amended the proposed rule change to
expressly require that, consistent with FINRA Rule 3110(a), a
participating member firm ``take into consideration any red flags when
determining whether to conduct a remote inspection of an office or
location.'' \184\ FINRA stated, ``[w]here 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 FINRA Rule 3110(c), which may include an unannounced, on-
site inspection of the office or location.'' \185\ FINRA also noted
that red flags ``would be required to be considered not only when an
office or location is first determined to be

appropriate for a remote inspection but, consistent with Rule 3110(a)'s
overall obligation for a firm to establish and maintain a reasonably
designed supervisory system, as part of a firm's ongoing determination
to conduct subsequent inspections of the office or location remotely.''
\186\ One commenter expressed support for this amendment, stating that
it ``strengthen[ed] the Pilot's safeguards.'' \187\
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    \184\ Proposed Rule 3110.18(b)(2); see also Amendment No. 1.
    \185\ FINRA Response to Comments I at 7 (quoting Notice at
28634).
    \186\ FINRA Response to Comments II at 8.
    \187\ Letter from Jim McHale, Executive Vice President, Head of
WIM Compliance and Peter Macchio, Executive Vice President, Head of
CIB Compliance, Wells Fargo, to Vanessa Countryman, Secretary,
Commission, dated August 29, 2023 (``Wells Fargo'') at 1.
---------------------------------------------------------------------------

    FINRA declined to amend the proposed rule change to require
participating member firms provide FINRA the risk assessments conducted
after identifying red flags. FINRA stated that the Pilot already
requires submission of comprehensive data and information to FINRA that
is sufficient for FINRA to conduct its assessment.\188\ FINRA also
noted that it could obtain such assessments during a FINRA examination,
which should provide sufficient accountability.\189\
---------------------------------------------------------------------------

    \188\ See FINRA Response to Comments I at 7.
    \189\ Id.
---------------------------------------------------------------------------

    As stated above, the proposed rule change's ineligibility criteria,
safeguards, and limitations prohibit member firms and locations from
participating in the Pilot in certain higher-risk circumstances.
However, other factors not explicitly identified among the exclusions
can, in certain circumstances, indicate heightened levels of risk
either before or after determining whether a remote inspection is
appropriate. The risk assessment required by the proposed rule change
will help to mitigate residual risk not addressed by the ineligibility
criteria and the affirmative conditions imposed to participate in the
Pilot. Specifically, the proposed rule change would require a
participating member firm to consider certain indicia of risk for each
candidate location for remote inspection, including the volume and
nature of customer complaints; the volume and nature of outside
business activities, particularly investment-related; the volume and
complexity of products offered; the nature of the customer base,
including vulnerable adult investors; whether associated persons are
subject to heightened supervision; failures by associated persons to
comply with the member's written supervisory procedures; and any
recordkeeping violations. In addition, the proposed rule change would
mandate that a participating member firm consider higher-risk
activities, higher-risk persons, and red flags occurring at any
location when determining whether a remote inspection is or continues
to be appropriate. Furthermore, the proposed rule change emphasizes
consideration of red flags as part of a participating member firm's
ongoing determination of whether to remotely inspect a location. In
this way, the proposed rule change helps to ensure that a participating
member firm appropriately accounts for the full range of risks
associated with each location throughout the term of the Pilot. For
these reasons, the proposed rule change is reasonable.
    The commenter requested that participating member firms submit
documentation of risk assessments following the identification of red
flags, but FINRA reasonably determined not to require such
documentation, given that it would be required to be maintained by the
participating member firms and be made available to FINRA and the
Commission during an examination. In addition, the proposed rule change
already contains provisions requiring quarterly submission of data and
information to FINRA, including submission of ``significant findings,''
which should help FINRA to study trends and promptly identify any
regulatory oversight concerns, as well as provide FINRA with periodic
data to evaluate a participating member firm's continued participation
in the Pilot. For these reasons, the proposed risk assessment provision
is reasonable.

D. Written Supervisory Procedures

    The proposed rule change would require that a participating member
firm ``establish, maintain, and enforce'' certain written supervisory
procedures for conducting remote inspections.\190\ Reasonably designed
written supervisory procedures for conducting remote inspections would
be required to 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 location pursuant to the risk assessment provision of the
Pilot; (3) the procedures specified elsewhere in the Pilot regarding
escalating significant findings, new hires, supervising brokers with a
significant history of misconduct, OBA and DBA designations, and data
and information collection and transmission; and (4) the use of other
risk-based systems employed generally by the participating 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.\191\ FINRA stated that it
``expects firms to take into account the factors affecting their
systems and businesses in crafting reasonably designed policies and
procedures'' to comply with the Pilot.\192\
---------------------------------------------------------------------------

    \190\ See proposed Rule 3110.18(c); see also proposed Rule
3110.18(h)(1)(G), (h)(4).
    \191\ See id.
    \192\ See Notice at 28629.
---------------------------------------------------------------------------

    One commenter recommended that the proposed rule change also
require each participating member firm's written supervisory procedures
to include four additional factors: (1) the specific technologies that
the participating member firm would use for remote inspections and
evidence that the participating member firm and its supervisory
personnel have sufficient access to and proficiency with those
technologies; (2) the circumstances in which the participating member
firm will conduct physical inspections, both in the ordinary course and
as a result of red flags; (3) whether and how the participating member
firm intends to conduct unannounced inspections; and (4) how the
participating member firm will use its remote inspection procedures to
control for the possibility of active deception such as concealment,
removal, or destruction of evidence of misconduct.\193\
---------------------------------------------------------------------------

    \193\ NASAA I at 5-6 (stating that ``it is not inconsistent with
a principle-based approach to establish certain minimums or
otherwise set boundaries around the principle to ensure at least a
minimum level of efficacy and investor protection.'').
---------------------------------------------------------------------------

    In response, FINRA stated that the proposed written supervisory
procedures provision reflects a balanced approach between dictating the
content of a participating member firm's written supervisory procedures
for remote inspections and maintaining flexibility in alignment with
FINRA Rule 3110's principle-based view of what constitutes reasonably
designed written supervisory procedures.\194\ Nevertheless, FINRA also
stated that many of this commenter's recommendations are already
addressed by specific terms in its rules and in the proposed rule
change. For example, proposed Rule 3110.18(c) would require a
participating member firm's reasonably designed supervisory procedures
to address the technology tools that may be used to conduct

remote inspections. FINRA stated that it believes that the failure to
have adequate surveillance and technology tools, and the knowledge of
and access to them, would raise questions about the reasonableness of
remote inspection.\195\ Proposed Rule 3110.18(b)(2) also would require,
among other things, participating member firms to conduct on-site
inspections or more frequent unannounced, on-site inspections of a
location where there are indicators of irregularities or misconduct;
\196\ and proposed Rule 3110.18(c) would require participating member
firms to ``establish, maintain, and enforce written supervisory
procedures regarding remote inspections that are reasonably designed to
detect and prevent violations of and achieve compliance with applicable
securities and regulations, and with FINRA rules.'' \197\ In addition,
FINRA stated that, overall, FINRA Rule 3110 established a framework
that requires a firm to have a reasonably designed supervisory system,
including written supervisory procedures, to achieve compliance with
applicable securities laws and regulations, and with applicable FINRA
rules. As such, FINRA declined to amend the proposed rule change to
explicitly include the commenter's suggested prescriptive
elements.\198\
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    \194\ FINRA Response to Comments I at 9; see also id. at 9 n.21
(quoting Notice 99-45) (``[w]ritten supervisory procedures are not
static documents that can be used for an indefinite period of time
without modification. A firm's existing supervisory system may
become outdated or ineffective as a result of changes in the firm's
business lines, products, practices, or new or amended securities
laws.'').
    \195\ FINRA Response to Comments II at 6.
    \196\ Id.
    \197\ Id.
    \198\ FINRA Response to Comments I at 9.
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    Requiring participating member firms to establish, maintain, and
enforce written supervisory procedures for conducting remote
instructions is reasonable and should help such member firms detect and
prevent violations of and achieve compliance with applicable securities
laws and regulations, and with applicable FINRA rules. In particular,
requiring those procedures to address technology, risk assessment
factors, data and information collection and transmission, and other
risk-based systems to identify and prioritize for review areas that
pose the greatest risk should reasonably address aspects of remote
inspections that may raise a threat of heightened risk of compliance
failures. While the proposed rule change prescribes several items that
would be required to be addressed, participating member firms are not
limited to these items alone and have flexibility to tailor their
procedures to their business activities and other relevant factors to
meet the obligation under FINRA Rule 3110 that the procedures be
``reasonably designed to detect and prevent violations of and achieve
compliance with applicable securities laws and regulations, and with
applicable FINRA rules.'' \199\ In addition, the proposed rule change
makes clear that the requirement to conduct inspections of locations is
only one part of the member firms' overall obligation to have an
effective supervisory system.\200\ For these reasons, the proposed
written supervisory provisions are reasonable.
---------------------------------------------------------------------------

    \199\ See FINRA Rule 3110(a).
    \200\ See also FINRA Response to Comments I at 9 (``FINRA
believes that proposed Rule 3110.18(c), which must be read with
proposed Rule 3110.18(d) and Rule 3110, would provide the
appropriate guardrails that NASAA seeks while also remaining aligned
with the core tenet of Rule 3110--that is, a member firm must have a
`reasonably designed' supervisory system, including written
supervisory procedures, to achieve compliance with applicable
securities laws and regulations, and with applicable FINRA
rules.'').