Broker-Dealers Compliance


Does Your Leadership Structure Meet FINRA Requirements?

Aug 29, 2023




4 min read

As an executive or manager, you could easily cross the line and engage in activities that require FINRA securities licensing. The result: potentially steep penalties and fines. By outsourcing your compliance function, you get the appropriate licensed oversight you need, and reduce your exposure to the risks of costly supervision mistakes.

InnReg is a global regulatory compliance and operations consulting team serving financial services companies since 2013. If you need assistance with compliance or fintech regulations, click here.

Your Guide to Mitigating Compliance Risks

Securities professionals generally know that taking on the role of president or another senior executive within a broker dealer means registering as a principal. This, in turn, requires relevant FINRA securities licenses, often including the General Securities Principal license (Series 24). 

Per FINRA, anyone who supervises and/or manages activities related to trading, market making, underwriting, advertising, and other key functions must be properly licensed and registered to act in the capacities of a principal of a broker dealer.

How Firms Get Into Trouble

Despite the apparent clarity of this requirement, firms do occasionally get themselves into trouble by permitting individuals to act as principals without registering in that role with FINRA. 

Violations typically occur when an unregistered executive or senior manager acts in the capacity of a principal without being registered. Grey areas can crop up when internal management practices, supervisory activities, or governance create unintended consequences. These can emerge with the exercise of managerial decision-making authority even of an executive who is not directly carrying out relevant activities.

A Recent Real-World Example  

Merrill Lynch was recently censured and fined for allowing an executive to preside over its prime brokerage department without being registered with FINRA. Here’s what happened:

The executive directly supervised prime brokerage employees by writing annual performance reviews and by making hiring, promotion, and compensation decisions, among other conventional leadership roles. Even though those employees had appropriate FINRA licenses for sales and trading activity, managerial supervision by an unregistered principal resulted in a violation of FINRA’s rules of conduct. 

For fintech innovators, the risks of treading into such grey areas can be high. 

The typical scenario is as follows:

  1. A fintech firm will develop an innovative product that allows investors to buy and sell within a particular asset class. 

  2. To service those transactions, the fintech creates a broker dealer subsidiary. 

  3. While the core broker dealer activities are supervised and executed by appropriately licensed professionals, other functions end up blurring the lines.

  4. Result: The fintech violates FINRA rules of conduct.

Other Potential Scenarios for Risk

Many similar scenarios are possible for both large and small, well-funded and lean start-up firms. For example:

  • A Chief Human Resources Officer from the parent company may sit on the compensation committee or define performance management processes for the broker dealer subsidiary.

  • A CEO or product visionary from the parent company may directly or indirectly influence sales and marketing activities that originate from within the broker dealer.

  • Unregistered executives from the parent company may have voting rights on one or more of the broker dealer’s executive, management, or operations committees. 

  • The broker dealer may fail to have at least two required officer- or partner-level registered principals if some roles straddle the broker dealer and its parent company.

  • A principal’s function may require licensing or registration beyond the general securities principal license, such as in the case of options principals and supervisors of proprietary trading.

Good Governance Helps Mitigate the Risk

It is possible to mitigate these risks by taking steps during the setup of a subsidiary broker dealer as well as during its ongoing operations. Firms must clearly define how the broker dealer fits within their overall governance model and set out clear and unambiguous rules for keeping regulated activities directly and solely under the supervision of appropriately licensed and registered professionals.

In addition, firms must have registered principals overseeing these functions as well as licensed professionals carrying them out. However, these individuals do not necessarily need to be directly employed by the firm to carry out their functions. 

What Outsourcing Offers 

Outsourcing is a powerful tool to extend firms’ capabilities with additional resources. With compliance, for example, this could be a FINRA-registered Chief Compliance Officer to set strategy and oversee compliance operations, or a full team handling day-to-day compliance operations.

Digital broker dealers experience the benefits of outsourcing compliance on both a cost and complexity axis. As an end-to-end, full-stack compliance solution provider, InnReg takes care of the full range of compliance of activity more simply and more cost-effectively than a full in-house team with salaries, benefits, and bonuses: 

Meet FINRA Requirements with InnReg

Outsourcing Also Mitigates Risk

By offering registered professionals who can act in the capacity of a broker dealer’s Chief Compliance Officer (CCO), InnReg also helps mitigate the risk of enforcement actions, censures, and fines related to registered principal requirements. 

Firms must have two officers or partners who are registered in a principal capacity under FINRA Rule 1220(a) that corresponds to the scope of the member’s activities. Outsourcing the CCO role provides one such principal for meeting the requirement.

In addition, because InnReg specializes in the needs of innovative digital broker dealers, firms have access to unmatched experience with the unique compliance scenarios that being an innovator can present.

If you have questions about your firm’s executive functions and potential FINRA rule of conduct issues or would like to discuss the potential risks further, we’d be happy to discuss it with you. Please contact us to set up an introductory call.

How Can InnReg Help?

InnReg is a global regulatory compliance and operations consulting team serving financial services companies since 2013.

We are especially effective at launching and scaling fintechs with innovative compliance strategies and delivering cost-effective managed services, assisted by proprietary regtech solutions.

If you need help with broker-dealer compliance, reach out to our regulatory experts today:

Published on Jun 4, 2020


Last updated on Aug 29, 2023

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