Chapter 4: Customer Accounts - D. Compliance and the Patriot Act

The foundation of a firm’s supervisory system is its written supervisory manual, also known as the firm’s policy and procedures manual. All members are required to have a policy and procedures manual that outlines the supervisory structure of the firm and that designates a principal to be responsible for each business area of supervision. The policy and procedures manual must include the title, location, and registration status of all supervisors and a copy of the manual must be kept in each office of the firm where supervised activities are conducted. The purpose of the written policy and procedures manual is to ensure compliance with the firm’s rules, as well as the rules of the industry. The manual must be updated to reflect the adoption of new policies, a change in personnel, or new industry regulations. The manual must also clearly outline the way the periodic compliance examinations are conducted and documented. Both the SEC and FINRA can take action against a firm or principal for failing to supervise its operations and agents.

The Role of the Principal

Prior to any firm being admitted as a member of FINRA, they must have a least two principals to supervise the activities of the firm. At a minimum, one must be a principal to supervise employees and the other must be a financial operations principal, or FINOP, to supervise the financial and operational activities of the firm. It is the principal’s responsibility to ensure that all rules in the policy and procedures manual are followed by the firm’s employees. It is also the responsibility of the principal to review and approve all of the following:

  • New accounts
  • Advertising
  • Sales literature
  • Transactions
  • Correspondence

The principal reviews and approves the above listed items in writing by signing or initialing the item. In the case of transactions, a principal may initial each ticket or initial a daily trade run. This supervisor’s initials will evidence the fact that the trades have been reviewed and approved. There is no requirement that a principal approve a trade prior to its execution, but the trade must be reviewed and approved promptly. Each registered representative must be assigned to a specific supervisor. A principal of a member firm who fails to supervise the actions of the agents under their control may be subject to action by both FINRA and the SEC. A principal will not be subject to action if there are written procedures in place that are designed to detect and prevent violations. These procedures must have been enacted and the supervisor must not have reason to believe the system is not operating properly. Additionally, the principal will not be found to have failed to supervise if an agent has employed extreme measures to conceal their actions. Each member firm must designate a principal to review the firm’s supervisory system. This person is responsible for recommending changes in the system to the firm’s senior management and this person must be identified to FINRA as the principal in charge of reviewing the firm’s compliance systems.

Supervisor Qualifications and Prerequisites

People who supervise or train agents generally must register as a principal with FINRA and qualify by training or experience. Prior to taking a principal exam, the individual must have successfully completed the appropriate registered representative examination. A principal of an FINRA member firm will usually take the General Securities Principal exam known as the series 24. Series 24 general securities principals may manage or supervise the firm’s corporate securities business, including investment banking, direct participation programs, investment company products, and variable contracts. A Series 24 does not qualify an individual as a:

  • Registered Options Principal
  • General Securities Sales Supervisor for Options or Municipal Securities
  • Municipal Securities Principal
  • Financial and Operations Principal
  • Introducing Broker/Dealer Financial and Operations Principal

All portions of FINRA administered exams are proprietary and to be held in the strictest of confidence. FINRA considers it a violation of its rules for any individual to:

  • Disclose exam questions or content to anyone
  • Reproduce exam questions
  • Receive exam questions or content from anyone
  • Compromise the content of any exam
  • Remove any portion of an exam from the exam location

Annual Compliance Review

At least once per year the member must conduct a compliance review of each OSJ and each registered representative. Branch offices are not required to be directly reviewed. When the member reviews the OSJ, the member is automatically inspecting the activities of the branch offices under the jurisdiction of the OSJ.

Business Continuity Plan

One of the regulations developed as a result of the attack on 9/11 is the requirement for FINRA member firms to develop and maintain plans and back up facilities to ensure that the firm can meet its obligations to its customers and counterparties in the event that its main facilities are damaged, destroyed or are inaccessible. The plan must provide for alternative means of communication as well as a data backup. The plan must be approved by a senior member of the firm’s management team and must provide plans to ensure customers have access to their funds. The plan must be provided to FINRA upon request and must identify two members of senior management as emergency contacts, one of which must be a registered principal with the firm.

Currency Transactions

All member firms must guard against money laundering. Every member must report any currency receipt of $10,000 or more from any one customer on a single day. The firm must fill out and submit a currency transaction report also known as Form 4789 to the Internal Revenue Service (IRS) within 15 days of the receipt of the currency. Multiple deposits that total $10,000 or more will also require the firm to file a currency transaction report (CTR). Additionally, the firm is required to maintain a record of all international wire transfers of $3,000 or greater.

The Patriot Act

The Patriot Act requires broker dealers to have written policies and procedures designed to detect suspicious activity. The firm must designate a principal to ensure compliance with the firm’s policies and to train firm personnel. The firm is required to file a Suspicious Activity Report for any transaction of more than $5,000 that appears question­able. Anti-money-laundering rules require that all firms implement a customer identification program to ensure that the firm knows the true identity of their customers. All customers who open an account with the firm, as well as individuals with trading authority, are subject to this rule. The firm must ensure that its customers do not appear on any list of known or suspected terrorists. A firm’s anti-money-laundering program must be approved by senior management.

The money laundering process begins with the placement of the funds. This is when the money is deposited in an account with the broker dealer. The second step of the laundering process is known as layering. The layering process will consist of multiple deposits in amounts less than $10,000. The funds will often be drawn from different financial institutions; this is also known as structuring. The launderers will then purchase and sell securities in the account. The integration of the proceeds back into the banking system completes the process. At this point, the launderers may use the money to purchase goods and services and they appear to have come from legitimate sources. Firms must also identify the customers who open the account and must make sure that they are not conducting business with anyone on the OFAC list. This list is maintained by the Treasury Department Office of Foreign Assets Control. It consists of known and suspected terrorists, criminals, and members of pariah nations. Conducting business with anyone on this list is strictly prohibited. Registered representatives who aid the laundering of money are subject to prosecution and face up to 20 years in prison and a $500,000 fine per transaction. The representative does not even have to be involved in the scheme or even know about it to be prosecuted.

U.S. Accounts

Every member must obtain from U.S. customers:

  • A social security number/documentation number
  • Date of birth
  • Address
  • Place of business

Foreign Accounts

All non-U.S. customers must provide at least one of the following:

  • A passport number and country of issuance
  • An alien ID number
  • A U.S. tax ID number
  • A number from another from of government-issued ID and the name of the issuing country
A. Introduction: Investment Companies


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