Monahan & Roth, LLC
3511 Camino Del Rio South, San Diego, CA 92108
Margaret H. MacFarland, Deputy Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
Proposed Supervisory Controls
Dear Ms. MacFarland;
This letter is sent in comment to the above-named amendment which proposes new Rule 3012 and amendments to existing Rule 3010.
As you are aware, the proposal was initially made to require that internal inspections be conducted by "independent" persons, a suggestion which was met by significant industry resistance due to anticipated costs of such programs. In its second amendment, the proposal replaces the requirement for independence with other prohibitions and certain requirements regarding the individual(s) assigned to conduct office inspections. In addition, in the second amendment, the rule proposal codifies a cycle for inspection frequency that suggests that once every three years may be appropriate for certain non-registered and/or non-supervisory branch offices.
I wish to state in my commentary herein that a frequency of once in three years falls significantly short of the customary practices already in place in many non-traditional broker/dealers, is not reflective of prevailing SEC and NASD guidance, and that the opportunity to lessen frequency in examinations is likely have a detrimental affect on the overall supervisory systems for firms with remotely located offices.
Since 1997, many non-traditional firms employing registered persons in remotely located offices have taken heed to the SEC and NASD guidance regarding remote office inspections, both in regard to frequency and in other respects. It is in that time-frame that the SEC noted In re: Royal Alliance (SEC Release No. 34-38174 (January 15, 1997) that it harbors "grave doubts that a practice of conducting a pre-announced compliance examination only once a year would necessarily discharge the supervisory obligations of any firm that incorporates a structure in which smaller offices are operated by only one or two representatives." The NASD mirrored this guidance in subsequent Notices to Members 98-38 and 99-45, among other publications, including quotations and citations from the same SEC Release. We know of no further guidance regarding inspection frequency that has been published since that time, nor are we aware of any guidance then or now that suggest a three-year cycle might be appropriate for branch office inspections. Furthermore, it is our observation that many firms nationwide currently maintain a cycle of frequency that far exceeds the suggested three-year cycle. And, it is our impression that an NASD examiner in its routine inspection of a broker/dealer would expect to find the firm to have conducted its branch inspections far more frequently than once in three years.
In keeping with SEC Release No. 34-38174 , many non-traditional firms have implemented inspection cycles to ensure that examinations are conducted more often than annually where appropriate (such as for representatives under heightened supervision or when there is no qualified supervisor on the premises, among other instances), that unannounced inspections play a role in many inspection programs, and that independent examiners or regional personnel are used effectively to contribute to the programs where needed as a cross-check to the programs' efficacy. As compliance consultants to more than 200 firms nationwide, we have observed the constructive, practical and positive effect of these types of programs. We know of no credible inspection program that conducts its inspections less than annually. Our participation as independent consultants in many inspection programs appears to be beneficial to the firms and to their representatives. Especially in view of implementation of recent rulemaking including Anti-Money Laundering Customer ID Procedures and newly amended SEC Rule 17(a)3, we feel that more, rather than less, field guidance will be required in order to assist representatives and firms in meeting their compliance requirements.
I readily recognize that a business opportunity exists for us as compliance consultants if frequency is increased and independence is required, and I wish to state that this is NOT the context in which I am writing. Rather I hope to convey in this commentary that many of your constituents have invested heavily in their inspection programs in direct comprehensive response to SEC and NASD guidance, and they are finding their programs to have positive results. The proposed amendments to SR-2002-162 do not appear to recognize the extent to which firms have gone in responding to the regulatory guidance and past sanctions of non-traditional firms. It is my hope that this letter will draw the SEC's attention to the very positive results of its 1997 findings, and that as a result, it will at least credit the non-traditional industry for its broad and comprehensive commitment and investments, and, moreover that it will be discouraged from turning back the clock on such an important aspect of a supervisory system.
We feel that SR-NASD-2002-162 as proposed in the 2nd amended form presents the broker/dealer community with the opportunity of reducing inspection frequency three- or six-fold, an opportunity which may prove irresistible in a business context, and may place unfair pressure on the related business decision-making. Therefore, we discourage the SEC from approving the proposal in its current form, and suggest that the original parameters of Rule 3010, along with the guidance of NTM 99-38 and 99-45 remain intact.
Should you have any questions or comments regarding this letter, I trust you will feel free to contact me directly.
Lisa Roth, President