FINRA Rule 3110 (e) defines broker-dealer hiring practices and requires employee background checks. The Rule sets forth precise requirements about the steps that member institutions must follow to review applicant backgrounds, employment experience, and criminal and regulatory disciplinary histories before onboarding an employee.
Two recent Letters of Acceptance, Waiver, and Consent (known as AWC letters) discuss violations of two full-service broker-dealers relating to suitability issues. They highlight brokerages’ obligations to maintain and document relevant activities, supervise registered representatives’ activities, and investigate private placements.
In this article, we describe what steps firms must follow and provide eight takeaways for maintaining compliance. The rule applies to all FINRA-registered firms, including digital broker-dealers or other firms that carry out regulated activities.
What is Rule 3110 (e)
In 2015, FINRA approved Rule 3110 (e), which enhanced background screening requirements for member institutions and registered individuals. The revised Rule expanded member firms' obligations to investigate applicants' backgrounds for FINRA registration and to use public records to verify individuals' submitted information.
The original requirement's objective was to determine whether a FINRA-registered firm's employee might pose a risk to customers. The purpose of the added 2015 background checks was to "improve the accuracy and totality of details," according to Richard Ketchum, FINRA CEO.
Rule 3110 (e) Due Diligence Requirements
The Rule requires a firm to investigate an applicant's good character, business reputation, qualifications, and experience before it applies to register the applicant with the Financial Industry Regulatory Authority. It should also perform those checks before filing U4 Form (Uniform Application for Securities Industry Registration or Transfer), which contains information on the applicant's background, employment experience, and criminal and regulatory disciplinary histories.
Form U4 serves to reveal whether an applicant is subject to a statutory disqualification (such as previous securities violations). Firms also use FINRA's Central Registration Depository (CRD) system to check the backgrounds of applicants whom they are sponsoring for registration, released to the public through BrokerCheck, as an aid to help investors with choosing a broker.
The Scope of Background Investigations
Regulations place no limits on the scope of a background investigation. Firms should do whatever it takes to accomplish a complete evaluation. Potential sources of information include:
- CRD searches
- Credit reports
- Private background checks
- Reference letters
- Communication with previous employers
Most securities industry personnel are already required to be fingerprinted, with some exceptions for those not engaged in or supervising the sale or handling of securities.
Some applicants will have been previously registered with firms, in which case Form U5, which includes the reasons for termination, becomes the relevant document. The new employer must make reasonable efforts to review a copy of the U5 Form (Uniform Termination Notice for Securities Industry Registration) within 60 days of filing the U4 Form.
Verifying Background Investigation Findings
The verification process is a crucial element of Form U4 — it is complementary but not identical to the investigative process. Regulator takes a pragmatic approach, recognizing that the evidence may vary from firm to firm in different guises, whether as a state-issued driver's license, a government-issued passport, or an attestation that the firm has communicated with a previous employer over the past three years.
Whenever it is not feasible or practical to verify U4 Form information, firms must document the steps taken and the reasons for incomplete verification.
Firms have a 30-day window to verify after filing Form U4, but they should try to investigate and verify concurrently. Still, they might need the extra 30 days if, for example, an applicant has been hired for an urgent role or the time window is beyond control, such as illegible fingerprints that require resubmission.
It is mandatory to search all reasonably available public records for
- Names and addresses
- Criminal records
- Bankruptcy records
- Civil litigation
Those are the minimum base categories. An applicant's role and higher level of responsibilities may call for a deeper, more thorough search. While no specific search method is stipulated, credit reports and national public records databases may satisfy the requirements.
FINRA Rule 3110 (e) Takeaways for Compliance
- Ensure that personnel records comply with FINRA record retention requirements
- Initiate investigations of registered individuals promptly, allowing time to receive and review the information
- Record the reason for any information that cannot be verified
- Develop a policy that considers time-to-hire
- Consider third-party background check providers to speed up the process
- Perform due diligence on third-party providers who search public records
- Provide necessary disclosures to candidates before screening (e.g., if using BrokerCheck)
- Don't expect the 30-day verification window to protect from late disclosure fees for amended filings
If you are unsure of your responsibilities in identity theft protection or how to design the right compliance program to meet FINRA Rule 3110 (e) requirements for hiring, please be in touch.