Branch Office Inspection Update

NASD Notice to Members 05-67 announced changes in the definition of branch offices. The changes were originally scheduled to become effective on May 1, 2006. However, as announced in Notice to Members 06-12, the effective date of the amendment was delayed until July 3, 2006. While the changes are codified in Rule 3010(g) and interpretative material is provided in the previously mentioned notices to members, the materials do not clearly address the inspection cycle of non-branch locations.

Ultimately the changes in branch office definitions could affect the inspection cycle of a broker/dealer’s various office locations. NASD Rule 3010(c) mandates that office inspections occur no less frequently than: (i) yearly for OSJ’s (i.e. Offices of Supervisory Jurisdiction) and for branch offices that supervise one or more non-branch locations; (ii) every three years for branch offices that do not supervise any non-branch locations; and (iii) pursuant to a regular and periodic schedule for non-branch locations.

The regular and periodic schedule was not conclusive as to what would be considered appropriate, and it appears that the sufficiency of the reviews will be determined in hindsight. Thus to the extent supervisory issues arise, the cycle will be judged as inadequate, especially if the cycle exceeds three years. With that in mind, firms should consider inspecting non-supervisory branch offices more frequently if conditions merit. Items to consider when establishing an inspection cycle include but are not limited to the nature and complexity of the securities activities for which the location is responsible; the volume of business done; and the number of associated people that are assigned to the office. Firms are still required to document in their written supervisory and inspection procedures the factors that the firm used in determining the frequency of its examination cycle.

In addition to the actual inspection cycle chosen by a firm, firms are reminded that Rule 3010(c) also has other requirements such as keeping a record of the inspection dates, maintaining a report of the inspection, the testing and verification of the office’s adherence to certain supervisory practices in certain areas, who can conduct the inspections, and when heightened office inspections must be implemented.