FINRA Proposes to Require Registration of Back Office and Operations Personnel

June 03, 2010

On May 26, 2010, FINRA published Regulatory Notice 10-25 (the “Notice”) that would add an addendum to proposed Rule 1230. Rule 1230 was proposed by FINRA in Regulatory Notice 09-70 (See FINRA Proposes Significant Changes To Its Registration Requirements and Categories, Bingham Legal Alert, December 14, 2009). The additions in the Notice would add a new registration category, qualification examination, and continuing education requirements for back office and operations professionals. The breadth of the proposed rule will likely require firms to register significant numbers of back office and operations personnel who currently, under existing rules, are not required to be registered. FINRA notes that these new amendments will be included in proposed Rule 1230 and, presumably, a single combined rule will ultimately be submitted to the SEC for approval.

I. Background

The new proposal would require certain back office and operations personnel to become registered in a new category called “Operations Professional.” In proposing this new registration category FINRA expressed its view that the current lack of registration creates the “potential for regulatory gaps in the area of licensing and education requirements for individuals performing operations functions.”1 As FINRA explains in the Notice, it “believes that licensing and education requirements for certain operations personnel are needed to help ensure that investor protection mechanisms are in place in all areas of a member firm’s business that could harm a customer, a firm, the integrity of the marketplace or the public.”2 To that end, the proposal requires certain “covered persons” who are responsible for the supervision and/or management of particular “covered functions” to become registered. The definitions of covered persons and the scope of covered functions is discussed below.

II. Who Are “Covered Persons” Who Must Register as an Operations Professional?

The new registration category is aimed at “those persons who are directly responsible for overseeing that tasks within the covered functions are performed correctly in accordance with industry rules, firm protocols, policies and procedures, and who are charged with protecting the functional and control integrity of the covered functions for the firm.”3

The proposal identifies three specific categories of persons that it would require to register as Operations Professionals:

(1) Senior management with responsibility over the covered functions;

(2) Supervisors, managers or other persons responsible for approving or authorizing work in direct furtherance of the covered functions, including work of other persons in the covered functions;

(3) Persons with the authority or discretion to commit the firm’s capital in direct furtherance of the covered functions or to commit the firm to any contract or agreement (written or oral) in direct furtherance of the covered functions (including, e.g., a person who has the discretion to commit the firm to any contract or agreement involving securities lending or borrowing activities).4

In the Notice FINRA expressly states that it expects member firms to register persons who are vested with these responsibilities “irrespective of their employing entity,” making them “subject to all FINRA rules applicable to associated persons and/or registered persons.”5 This would included persons employed by affiliates if they have the necessary responsibilities over covered functions. FINRA notes, however, that those in “a role that can be viewed as supportive or advisory,”6 such as audit, legal or compliance, would not be considered covered persons.

The broad functional definitions in the proposal will ultimately place the burden on member firms to identify those individuals who posses the relevant authority. The number of covered persons will vary significantly from one firm to the next depending on the firm’s structure and whether these management and supervisory responsibilities are concentrated and centralized or decentralized and distributed.

III. What Are the “Covered Functions?”

In the proposal FINRA lists 15 specific back office or operational functions which the rule would designate as covered functions. These covered functions can be broadly grouped into three categories:

Brokerage Operations, including:

  • Development and approval of pricing models used for valuations;
  • Trade confirmation, account statements, settlement, margin;
  • Stock loan/securities lending;7
  • Prime brokerage (services to other broker-dealers and financial institutions);
  • Client on-boarding (customer account data and document maintenance);

Information Technology and Information Security, including:

  • Capturing of business requirements for sales and trading systems and any other systems related to the covered functions, and validation that these systems meet such business requirements;
  • With respect to the covered functions, defining and approving business security requirements and policies for information technology (including, but not limited to, systems and data);
  • Defining information entitlement policy in connection with the covered functions;

Custody, Cashiering, Settlement, Finance and Reporting, including:

  • Financial controller (including general ledger);
  • Collection, maintenance, re-investment (i.e., sweeps) and disbursement of funds;
  • Bank, custody, depository, and firm account management and reconciliation;
  • Segregation, possession and control, fail control, buy ins;
  • Receipt and delivery of securities and funds, account transfers;
  • Financial regulatory reporting;
  • Posting entries to the books and records of a firm in connection with the covered functions.8

In short, almost all operational functions of the broker-dealers will, under the proposal, be considered covered functions. Moreover, certain functions (e.g., certain aspects of technology and systems development) that broker-dealers have, in some cases, relied on subsidiaries to perform would be required to be overseen by registered persons who are associated persons of the broker-dealer and directly subject to FINRA’s jurisdiction.

IV. New Qualification Examination

To become registered as an Operations Professional, covered persons (who are not already registered — as discussed below) would be required to take and pass a new qualifications examination. In the Notice FINRA acknowledges that, given the breadth of functions that are preformed by covered persons, its goal for the exam is to “provide reasonable assurance that such individuals understand their professional responsibilities, including key regulatory and control themes, as well as the importance of identifying and escalating red flags that may harm a firm, its customers, the integrity of the marketplace or the public.”9 FINRA therefore expects the examination will “test for a broad understanding of a broker-dealer’s business at a basic level; a basic understanding of the operations functions that support a broker-dealer’s business; and the regulations designed to achieve investor protection and market integrity that drive the operations processes and procedures conducted at a broker-dealer.”10

Specifically, FINRA identifies three themes that would comprise the new examination:

Professional Conduct and Ethical Considerations:

The focus here will be on “knowledge of what are considered serious violations of securities industry rules” and “ethics-based questions that address issues such as data integrity, escalation of regulatory red flags and separation of duties.”11 

Essential Product and Market Knowledge for an Operations Professional

This section will “assess a candidate’s basic product and market knowledge, including definitions and characteristics of major product categories (i.e., equities, debt, packaged securities, options and markets).”12

Knowledge Associated With Operations Activities:

In this section candidates will be tested on their “broad-based knowledge regarding the covered functions. . .that support a broker-dealer’s business, and the underlying rules that drive the processes associated with these activities.”13

V. Exceptions to the New Examination

Under the proposal most existing registered representatives and principals who will fit the definition of Operations Professionals will not have to take the qualification examination. The proposal allows all persons holding a Series 6 or 7 registration as well as persons holding Series 4, 9/10, 14, 16, 23, 24, 26, 27, 28, 51, and 53 principal registrations to register as an Operations Professional without passing the new exam. Those individuals, however, will not be automatically “waived” in, but instead will be required to opt in by requesting Operations Professional registration on their Form U4. If there are no deficiciencies, the Operations Professional registration will automatically be approved at the time the request is made, and FINRA will not assess a separate registration fee.

VI. Continuing Education Requirements for Operations Professionals

Under the proposal Operations Professionals will be subject to both the Firm and Regulatory Elements of continuing education. The Regulatory Element will be geared toward expanding, reinforcing and updating Operations Professionals’ knowledge in those areas covered by the qualification exam. FINRA notes that Operations Professionals who are or become registered in another category (e.g., Series 6, 7, 24, 26) and are, therefore, exempt from taking the Operations Professional exam will be able to satisfy their Operations Professional Regulatory Element by taking the Regulatory Element appropriate to the other registration(s).

Although in the Notice FINRA gives no indication of particular topics it expects will be covered in the Firm Element, firms will no doubt be expected to customize their training based on their particular product offerings and organizational structure.

VII. Timing

The proposal allows for a transition period. Individuals who are on the proposed rule’s effective date employed in a position that requires registration as an Operations Professional will have a six- to nine-month period in which to become registered. Persons who, after the proposed rule’s effective date, first begin work in a job that requires registration, will not be eligible for any transition period and will be required to register before they begin work in those capacities.

VII. Conclusion

FINRA notes in the Notice that the SEC has previously indicated its support “for the establishment of a qualifications examination for covered persons”14 and for their registration, making the inclusion of some version of proposal rule in the final registration rule submission likely.15 The comment period for the proposed rule runs until July 12, 2010.

For additional information concerning this alert, please contact the following lawyers:

Amy Natterson Kroll, Partner, Broker-Dealer Group, 202.373.6118

David C. Boch, Partner, Broker-Dealer Group, 617.951.8485

Michael R. Weissmann, Partner, Broker-Dealer, 617.951.8705   

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area, 617.951.8615

Timothy P. Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area, 617.951.8620

1Notice at 2.
2Id. at 3.
5Id. at 4.
6Id. at 3.
7In Regulatory Notice 09-70, FINRA had proposed to include a new registration category for stock loan and securities lending. In the notice they state that these individuals will instead be required to register as Operations Professionals and proposed Rule 1230 will be updated to remove the requirement for separate registration.
8Notice at 4.
9Id. at 5.
12Id. at 6.
14Id. at 5.
15Comments on the proposal FINRA published to overhaul existing registrations, after having been extended, closed on March 1, 2010. The comments FINRA received generally supported many of the changes in the proposal including the elimination of the prohibition on “parking” registrations in favor of a more flexible approach. Many of the comments, however, took issue with the complex system of active, inactive and retained associate statuses. It is unclear when FINRA is likely to submit the registration rules to the SEC or whether it will amend the rule and seek further comments before sending it to the SEC for approval.

This article was originally published by Bingham McCutchen LLP.