How To Understand Supervision
Guidelines for the practices that a brokerage firm uses to conduct the operation of its daily business are regulated by industry, state, and federal regulators. These guidelines are the foundation for the way that the firm handles all business, from hiring a new agent to executing a customer’s order. All candidates must have a full understanding of a brokerage firm’s operations and procedures to successfully complete the exam.
Hiring New Employees
A registered principal of a firm will be the individual who interviews and screens potential new employees. They will be required to make a thorough investigation into the candidate’s professional and personal backgrounds. With few exceptions other than clerical personnel, all new employees will be required to become registered as an associated person with the firm. The new employee will begin their registration process by filling out and submitting a Uniform Application for Securities Industry Registration, also known as Form U4. The Form U4 is used to collect the applicant’s personal and professional history including:
- 10-year employment history
- Five-year resident history
- Legal name and any aliases used
- Any legal or regulatory actions
The principal of the firm is required to verify the employment information for the last three years and must attest to the character of the applicant by signing Form U4 prior to its submission to FINRA. All U4 forms will be sent to the Central Registration Depository (CRD) for processing and recording. Any applicant who has answered yes to any of the questions on the form regarding their background must give a detailed explanation in the DRP pages attached to the form. The applicant is not required to provide information regarding:
- Marital status
- Educational background
- Income or net worth
The only information regarding the employee’s finances that is disclosed on the U4 form is if the associated person has ever declared bankruptcy. Any development that would cause an answer on the associated person’s U4 to change requires that the member update the U4 within 30 days of when the member becomes informed of the event. In the case of an event that could cause the individual to become statutorily disqualified, such as a felony conviction or a misdemeanor involving cash or securities, the member must update the associated person’s U4 within 10 business days of learning of the event.
Resignation of a Registered Representative
If a registered representative voluntarily resigns or has their association with a member firm terminated for any reason, the member must fill out and submit a Uniform Termination Notice for Securities Industry Registration, known as Form U5. The member must submit the U5 to FINRA within 30 days of the termination. The member firm is also required to give a copy of the U5 to the representative upon termination. The member must also state the reason for the termination, either voluntary or for cause. An associated person’s registration is non-transferable. A representative may not simply move their registration from one firm to another. The employing firm that the representative is leaving must fill out and submit a U5 to FINRA, which terminates the representative’s registration. The new employing firm must fill out and submit a new U4 to begin a new registration for the associated person with the new employer. The new employer is required to obtain a copy of the U5 form filed by the old employing member either from the employee or directly from FINRA. The previous employer is not required to provide a copy to the new member firm. If the new employing member asks the associated person for a copy of the U5, they have two business days to provide it. A representative who leaves the industry for more than 24 months is required to re-qualify by exam. During a period of absence from the industry of two years or less FINRA retains jurisdiction over the representative in cases involving customer complaints and violations.
The following individuals are exempt from registration:
- Non-supervising officers and managers not dealing with customers
- Non-U.S. citizens working abroad
- Floor personnel
Persons Ineligible to Register
Individuals applying for registration must meet the association’s requirements in the following areas:
Anyone who fails to meet the association’s requirements in any of the above listed areas may not become registered. An individual may also be disqualified by statute or through rules for any of the following:
- Expulsion, suspension, or disciplinary actions by the Securities Exchange Commission (SEC) or any foreign or domestic self-regulatory organization (SRO)
- The individual caused the expulsion or suspension of a broker dealer or principal
- The individual made false or misleading statements on the application for registration on Form U4 or Form B-D
- Felony conviction or misdemeanor involving securities within the last 10 years
- Court injunction or order barring the individual
Disciplinary Actions Against a Registered Representative
If another industry regulator takes disciplinary action against a representative, the employing member firm must notify FINRA. Actions by any of the following should be immediately disclosed to the association:
- An exchange or association
- State regulator
- Clearing firm
- Commodity regulatory body
All disclosures must include the type of action brought as well as the name of the party bringing the actions and the name of the representative involved. FINRA members are required to regulate the activities of its associated people and must disclose to the association any action that the member takes against a registered representative.
Termination for Cause
A member may terminate a registered representative for cause if the representative has:
- Violated firm policy
- Violated the rules of the New York Stock Exchange (NYSE), FINRA, SEC, or any other industry regulator
- Violated state or federal securities laws
A firm may not terminate a representative who is the subject of investigation by any securities industry regulator until the investigation is completed.
If a registered representative wants to obtain employment outside of their position with a member firm, the registered representative must first provide written notification to the employing member firm. The member firm may reject or limit the representative’s outside employment. Exceptions to this rule are if the registered representative is a passive investor in a business or if the representative owns rental property. All other outside business activities must be disclosed to the member firm. If the member is a NYSE member, they must provide the representative with prior written approval before the representative engages in any outside activity.
Private Securities Transactions
A registered representative may not engage in any private securities transactions without first obtaining the broker dealer’s prior written approval. The registered representative must provide the employing firm with all documentation regarding the investment and the proposed transaction. An example of a private securities transaction would be if a representative helped a start-up business raise money through a private placement. If the representative is going to receive compensation, the employing member firm must supervise the transaction as if the firm itself executed the transaction. If a representative sells investment products that the employing member does not conduct business in without the member’s knowledge, then the representative has committed a violation known as selling away. An exception to this is if the representative is helping an immediate family member raise money and the representative receives no compensation for their role in the private transaction. In this case, the notification and permission of the member is not required.
Broker dealers may not pay compensation to employees of other broker dealers. If a broker dealer wants to give a gift to an employee of another broker dealer, it must:
- Be valued at less than $100 per person per year
- Be given directly to the employing member firm for distribution to the employee
- Have the employing member’s prior approval for the gift
The employing member must obtain a record of the gift, including the name of the giver, the name of the recipient, and the nature of the gift. These rules have been established to ensure that broker dealers do not try to influence the employees of other broker dealers. An exception to this rule would be in cases where an employee of one broker dealer performs services for another broker dealer under an employment contract. The following are also excluded from the $100 limit:
- Occasional meals
- Occasional tickets to sporting events
- Business-related travel
Records of gifts and employment contracts must be retained for three years. Prior FINRA approval is not required for employment contracts between members. The gift rule also applies to gifts given to or received from customers of the firm or agent.