In the post-Madoff era, broker-dealers and other financial services providers find themselves facing an enhanced and rapidly changing regulatory environment. Some of this new landscape stems from the series of recently implemented regulations called for in the sweeping Dodd-Frank Act of 2010, but it is also driven by regulators’ determination to never again have a Madoff-like scandal under their watch.
The Current Situation
Beyond the new regulations, however, another set of challenges has come to light for broker-dealers: the need to effectively register individuals performing certain back office functions. Traditionally, FINRA has not required that strictly back office personnel be registered (by way of passing a qualification exam), due to the fact that these individuals have no direct contact with the public. Nevertheless, FINRA recently stated that it
“… believes registration and education requirements for certain operations personnel are needed to help ensure that investor protection mechanisms are in place in all areas of a member’s business that could harm the member, a customer, the integrity of the marketplace, or the public.”
As a result, FINRA has adopted Rule 1230(b)(6), creating the new registration category and qualifying exam for “Operations Professional.” This new rule means certain back office operations personnel of FINRA members, along with senior management with direct responsibility for back office functions, must register with FINRA and pass a qualification examination.
There has been much commentary in the industry about the merits of this rule and its basis. Regardless of whether or not industry observers believe that it will result in significant new protections, the change has come into effect and the burden of compliance falls on each and every member firm to comply. While some broker-dealers—but by no means the majority—have had their own internal policies in place to register affected individuals, many broker-dealers now face the challenging task of understanding what is required, developing an implementation strategy and meeting the upcoming deadlines and requirements in an effective and cost-efficient manner without disrupting their primary focus.
The three categories of individuals defined as Operations Professionals
- Senior Management with direct responsibility over the covered operations functions
- Any person designated by senior management specified in FINRA Rule 1230(b)(6)(A)(i) as a supervisor, manager or other person responsible for approving or authorizing work, including work of other persons, in direct furtherance of each of the covered functions, as applicable, provided that there is sufficient designation of such persons by senior management to address each of the applicable covered functions
- Persons with authority or discretion materially to commit a member firm to any material contract or agreement (written or oral) in direct furtherance of the covered functions
The New Classification
The reality is that, with this new requirement, an even greater number of individuals with no sales practice issues to face will be accountable to regulators able to impose fines or other disciplinary measures. In addition, this change will require not only additional expenses, such as exam fees, FINRA registration costs1 and fingerprint processing fees, but also increased internal costs to train and oversee a new and, potentially, large number of new “affiliated” personnel requiring additional work, oversight and planning.
To gain a better view of the new classification, it may help to separate specifics regarding the new category designation from the requirements of the qualifying exam, both of which require a thorough understanding of FINRA’s intent. There are sixteen (16) different “functions” and three (3) categories of individuals defined under the Rule. Any individual falling into any one of the categories, engaged in any one or more of the functions, must become registered as an Operations Professional.
The amended rule requirement that registration (but not exams) of all “Day One” Operations Professionals2 be accomplished by October 17, 2011, does not leave firms a lot of time to undertake all that will be required to ensure the Rule is incorporated into their business processes and supervisory structure as effectively as possible.
However, “Day One” individuals will have until October 17, 2012, to take the Operations Professional (or another qualification exam3) during which time they may continue to fulfill the responsibilities requiring the Operations Professional registration.
Very small and extremely limited broker-dealers may have an easier time with this new requirement. FINRA has stated that all broker-dealers must have at least one (1) registered Operations Professional. For the smaller firms this individual will, in all likelihood, be the FINOP. In addition, depending on the “functions” of the CEO, President, CCO, etc. the latter may also be required to register in this new category4.
However, for the majority of broker-dealers this will not be an easy project to organize. The firm will need to create a process that works in the best possible manner for the firm while at the same time complying with the requirements. And for large and complex firms, implementing this new requirement will be a major undertaking—especially for those who wait.
Quote from FINRA Regulatory Notice 11-33
“FINRA Rule 1230(b)(6) is intended, among other things, to increase covered persons’ awareness and knowledge that they are operating in a regulated environment designed to protect investors’ interests and the integrity of the operations of a broker-dealer.”
The Operations Professional Exam
While the full extent of the exam and the areas it will cover are not yet known, there is industry concern that it might be too all-encompassing for those back-office personnel deemed to be Operations Professionals as their responsibilities are often extremely limited. FINRA’s expressed opinion of that view is as follows:
“In general, given the diversity of functions performed by covered persons, the proposed Operations Professional qualification examination would be a principles-based qualification examination with a regulatory focus to test for a broad understanding of a broker-dealer’s business at a basic level, a basic understanding of the operations functions that support a broker-dealer’s business and the regulations designed to achieve investor protection and market integrity that drive the operations processes and procedures conducted at a broker-dealer.”
Training individuals to ensure their successful completion of an exam that may contain areas of expertise never required to be understood in the past, and having little to nothing to do with someone’s limited job responsibilities, will be yet another challenge presented by this new requirement.
While FINRA has stated that an Operations Professional “would not be expected to know the same level of detail” about the products and markets as a product specialist or a representative selling products to customers, there is reasonable skepticism as to how this will be accomplished. What’s critical is for firms to develop a plan to become and remain compliant and ensure that, in doing so, they remain true to their primary mission and minimize any drain on the bottom line.
A Plan for Implementation
Given the regulatory timeline, broker-dealers must begin to act now or risk missing the first critical deadline in October of this year. To deal with this new requirement, NRS recommends that broker-dealers consider forming a committee or, minimally, assigning specifically qualified individuals to address the most critical implementation issues.
- Identify all Day One personnel
- Review the functions and categories of each identified individual to determine what structural changes might be beneficial both in terms of the function and the individual
- Determine for which individuals the Operations Professional exam is appropriate (and sufficient) and which would better serve the firm by qualifying with another more general exam (i.e. the #26 or #7)
- Amend the firm’s WSPs to ensure appropriate policies and procedures are in effect to ensure compliance with Operations Professional registration requirements in an ongoing manner
- Undertake a new Needs Analysis to develop a Firm Element training plan that addresses the needs of all the new “affiliated” persons
- Determine who already has fingerprints on file and who will need to be newly fingerprinted
- File all the paperwork on WebCRD (no later than December 16, 2011)
- Develop a training plan that will prepare all individuals required to take the Operations Principal or another qualifying exam.
A Path to Success
When this implementation has been completed, firms can begin forming another committee to address requirements, rewrite policies and procedures, create new account documents, modify automated systems and train personnel for new FINRA Rules 2090 (“Know Your Customer”) and 2111 (“Suitability”), effective July 9, 2012.
For some broker-dealers, these registration and compliance issues can seem overwhelming right out of the gate. In today’s shifting compliance landscape for financial and investment providers, broker-dealers are increasingly seeking the best route to compliance. Some choose to go it alone but, unless they’ve done it before, it is often more efficient and cost-effective to work with an expert.
Further, attacking compliance challenges now allows firms to focus on doing the job right the first time instead of rushing to meet deadlines. For those facing a resource or expertise deficit, recognizing the need to engage a trusted partner is important. There are many firms ready, willing and able to partner with a firm, but only those with specific industry focus and expertise in compliance and regulatory services can offer solutions tailored to a firm’s specific business and compliance needs. Choosing such a partner early can mean the difference between success and failure in the long run.
Developing an effective compliance infrastructure to meet the requirements of the Operations Professional designation can take a significant amount of time and should be driven by the need to minimize risk and maximize compliance. Tapping into outside expertise can help you learn how to think like a regulatory examiner and develop firm-wide best practices well in advance of a potential SEC examination. In the end, the most successful firms make compliance work for them by making it part of their total business plan.