U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

Speech by SEC Staff:
Keynote Address at NASD Branch Office Supervision Conference


Mary Ann Gadziala

Associate Director, Office of Compliance Inspections and Examinations
U.S. Securities and Exchange Commission

Boston, MA
July 13, 2004

Effective Branch Office Supervision Fosters Investor Protection

The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.

I very much appreciate this opportunity to share my views on branch office supervision. Branch office supervision is a function the SEC has long regarded as a critical component of investor protection. Our NASD colleagues can attest to the importance we, in the SEC exam program, ascribe to branch office supervision. They have heard me and other members of OCIE continually urge more vigilance in the area. Perhaps we can even take some of the credit for NASD's decision to hold this important and timely conference on branch office supervision.

Why is effective branch office supervision so critical and why has it become even more challenging? It is at your firm's branch offices that much of the contact with the investing public on retail securities sales is done. While policies and procedures are typically set at the main office, where the legal and compliance groups are headquartered, it is at your branch offices that these policies and procedures must be implemented on an individual basis. Compliance with the law depends on the actions of each individual employee of the firm. Each one must be properly trained and must follow all relevant rule requirements. The firm should have an effective branch office supervisory system, and a culture of compliance that encourages employees to always put compliance first.

As I mentioned, the challenges of compliance continue to grow. That can be attributed to several key factors. First, the number of branch offices of broker-dealers has been steadily escalating and firms are becoming more geographically diverse. The distance from the home office and the large number of offices can offer challenges to maintaining consistent and comprehensive compliance coverage. Second, products offered by firms are becoming more diverse and more complex. For example, variable insurance products have unique securities, insurance and tax attributes, which may impact their suitability for an investor. Mutual funds and a number of other products have "breakpoints" or similar incentives to attract investors to the particular product. These may require complex computations and comparisons for the suitability analysis. If a firm sells these products, then its registered reps must fully understand all the complexities and be able to convey them in an understandable way to the firm's customers. A third challenge is complying with the myriad of laws, rules and regulations that apply to securities sales. As financial markets and products become more complex, and as conflicts arise and violations occur, lawmakers and regulators respond with laws and rules to address them. Employees should not only be trained on the technical requirements, but should also have an understanding of the reasoning behind the laws to promote compliance. These compliance challenges may be additionally exacerbated by the lack of focus on the culture of compliance in the past years at some firms. Unless the culture promoted at the firm is compliance first and everything else behind it, including profit-making, it may be difficult to keep all the individual components of a firm in full compliance with the law.

Firms must recognize the increased challenges to compliance and implement a supervisory structure reasonably designed to achieve compliance with the securities laws in the current environment. Compliance should not be viewed as the responsibility of any one person or group at the firm. All firm personnel -including top management, compliance staff, supervisors, and individual registered representatives - play a role in maintaining comprehensive compliance.

The overall task is quite daunting. U.S. broker-dealers currently have approximately 100,000 registered branch offices - almost double the number less than a decade earlier. Despite efforts of the regulators to increase their examination presence at branch offices, they are not able to visit all 100,000 branches with the cyclical regularity of main office examinations. SEC and SRO staff generally select branch offices for onsite examinations based upon an assessment of risks. Some of the risk factors considered in deciding which branches to examine include: registered reps or a branch with a prior disciplinary history; a large number of customer complaints, arbitrations, or litigations; aberrations from the norm in profit or loss; marketing of new products; concentration of sales of illiquid or risky investments; questionable or frequent transfers of cash or securities in accounts; significant switching activities; and remoteness from the main office.

The SEC and SRO examination programs are continuing to increase the staff and resources dedicated to branch office exams at broker-dealers. In addition, we are working together to develop programs to share information and focus on branches with the greatest compliance risks. We are also working with the state securities regulators in this effort. However, regulators cannot conduct onsite examinations of every one of the 100,000 branch offices of broker-dealers on a regular basis. It is the firm's responsibility to do this for all of its offices. Unless each firm, through supervision, compliance, internal audit and others, conducts effective supervision and routine oversight at all offices of the firm, small problems could go undetected and escalate into big problems for the firm. That is why your roles in compliance and supervision are so important.

How is this challenging task of creating, implementing, and maintaining an effective branch office supervisory system accomplished? The basic legal requirement for branch office supervision arises from Section 15(b)(4)(E) of the Securities Exchange Act of 1934. That provision authorizes the SEC to censure, place limitations on activities, or suspend or revoke the registration of any broker-dealer, or any associated person, for failure to reasonably supervise another person who commits a violation if the person is subject to his supervision. NASD Rule 3010(a) requires broker-dealers to establish and maintain written procedures reasonably designed to achieve compliance with applicable securities laws, rules and regulations. NASD has stated that the supervision must be designed to monitor all securities-related activities and to detect and prevent compliance problems, whether at a registered branch, an offsite location, an unregistered office, or by an independent contractor.

These provisions state the broad conceptual basis upon which your supervisory programs must be built. There are many other rules that may provide specific requirements regarding branch office supervision, but they do not cover everything that must be in your programs. You must, of course, comply with the rules. However, the rules should be viewed as a starting point. You should adopt and implement a supervisory program, considering best practices, that is tailored to your firm's business, structure, the products it sells, and its customers.

What are the basic steps you may consider in designing your branch office supervisory program? As I mentioned, you start with the law. This gives you a direction on supervisory requirements. You should create well-written and comprehensive policies and procedures, tailored to your business, with well-defined responsibilities and authorities. But having the perfect policies and procedures, is not enough. I have seen some very detailed and well-written policies and procedures that are kept on the bookshelf to provide to regulators when they conduct an exam. That is not effective supervision. Policies and procedures must be effectively implemented. It is critical that a clear message on the importance of compliance and supervision is conveyed from top management to all employees. Policies and procedures should be made available to all relevant employees and the employees should be trained to properly implement them. Firms should have qualified staff and adequate resources dedicated to compliance and supervision. There should be appropriate systems and controls to monitor compliance and confirm that any responsibility to supervise is being diligently exercised. Concerns and weaknesses should be detected and problems addressed promptly. Documentation is also a critical element. And the supervisory system should be viewed as dynamic - under constant review and updated and improved as appropriate.

Some of the key areas that should be covered by branch office supervision are:

  • safeguarding customer funds and securities;
  • maintaining books and records;
  • communications with customers;
  • supervision of customer accounts;
  • transmittal of customer funds; and
  • validation of customer account information.

The SEC's Division of Market Regulation recently issued Staff Legal Bulletin No. 17 on supervision. The bulletin discusses supervisory tools that, based on SEC examinations and enforcement actions, are characteristic of good supervisory procedures. I will highlight a few of those for you. While the focus was remote office supervision, the bulletin notes that these supervisory suggestions also may be relevant to non-remote offices and I think you would be well-served to consider them generally.

The bulletin states that "clearly articulated and vigorously enforced policies and procedures, with sufficient resources to implement them, are an essential part of a supervisory system". Among the policies and procedures suggested for an effective supervisory system are the following:

  • Firms are urged to conduct random, surprise inspections to enhance supervision. Inspections of firm offices are considered a vital component of a supervisory system in detecting misconduct early, deterring future wrongdoing, and preventing or mitigating customer harm.
  • Firms should consider centralized technology to monitor trading and funds transfers, as well as personal computers. This should assist in detecting misappropriation, selling away, unauthorized trading or other illegal activity.
  • The supervisory structure should include explicit delineation of the supervisory hierarchy with assignment of specific supervisory responsibilities and sufficient resources to implement those responsibilities. Independence of the supervisors is an important consideration.
  • Firms should be cautious about hiring registered reps with a disciplinary history, and should implement a system of heightened supervision as appropriate.
  • Firms should implement special monitoring procedures for outside business activities of its employees, to detect financial misconduct, to verify customer address changes, to deter misuse of the signature guarantee stamp, and to review incoming and outgoing correspondence.
  • Education for registered reps as well as education and awareness for customers are also important elements of an effective supervisory system.

Before concluding my remarks, I would like to mention some problem areas that are currently areas of focus for the SEC examination program. These include:

  • late trading and market timing
  • excessive markups in fixed income securities
  • "breakpoint" violations in the sales of mutual funds
  • inappropriate sales of hedge funds
  • unsuitable sales of Section 529 plans
  • unsuitable sales or switching of variable annuities
  • misappropriation of customer funds
  • excessive fees or commissions
  • incomplete or inaccurate disclosure.

Because there are significant compliance risks in these areas, you may wish to reexamine your own systems and procedures to protect against the occurrence of these problems at your firm.

I will end where I began, emphasizing the SEC's long-standing position that the responsibility of broker-dealers to supervise their employees through effective established procedures is a critical component of the federal investor protection scheme. Maintaining effective branch office supervision is a challenging job. Those of you with supervisory and compliance responsibilities have been designated by your firms to help fulfill that responsibility. You need to do your part in assisting every individual employee to be compliant with the securities laws. Each time one of the firm's employees deals with the investing public or any potential customer- whether disclosing information, recommending a security, making a sale, or performing some other service - compliance with the law is at stake and the reputation of the firm is on the line. Strong and effective supervision will help ensure that your firm's employees always do the right thing. Thank you.


Modified: 07/16/2004