FINRA issued a regulatory notice on new consolidated FINRA Rule 3110(e) concerning the requirement that broker-dealers perform reasonable background checks on associated persons that the firm intends to register with FINRA through FINRA Form U4.
On March 6, 2015, FINRA issued a regulatory notice on new consolidated FINRA Rule 3110(e) concerning the requirement that broker-dealers perform reasonable background checks on associated persons that the firm intends to register with FINRA through FINRA Form U4. The regulatory notice follows the SEC's approval of the rule on December 30, 2014. Rule 3110(e) becomes effective on July 1, 2015.
Broker-dealers are required to perform a reasonable background check on each person they intend to register with FINRA as to the person's good character, business reputation, qualifications and experience before making a representation on these characteristics in the person's application for registration. FINRA Rule 3110(e) is based in part on substantially similar provisions in current NASD Rule 3010(e) and Incorporated NYSE Rule 345.11 and includes several new requirements pertaining to verification of information on the applicant's Form U4 (Uniform Application for Securities Industry Registration or Transfer) by a broker-dealer. Rule 3110(e) is part of the new FINRA consolidated Supervision Rules that became effective on December 1, 2014 (see Practice Note, FINRA Supervision Rules).
Counsel to broker-dealers and firms' compliance personnel should review the firm's supervisory procedures prior to the effective date and revise them as necessary to comply with Rule 3110(e), particularly as to the new requirements that:
The process through which the firm performs background checks be included in the firm's written supervisory procedures.
That process include a search of reasonably available public records.
The current FINRA rulebook consists of the:
Rules incorporated from NYSE rules (incorporated NYSE rules).
While the NASD rules generally apply to all FINRA members, the incorporated NYSE rules apply only to member firms of the NYSE that are also FINRA member firms. The FINRA rules apply to all FINRA member firms.
FINRA Form U4
An applicant for registration with FINRA must complete and sign a Form U4 containing information on the applicant's background, employment experience, and criminal and regulatory disciplinary histories. A representative of the firm must make representations on the form as to the applicant's good character, business reputation, qualifications and experience. FINRA reviews the information disclosed on the Form U4 to determine whether an applicant is subject to a statutory disqualification or whether the applicant may present a regulatory risk for the firm and its customers.
Additionally, firms use the information reported on the Form U4 to determine whether an applicant is subject to a statutory disqualification or is a candidate for special supervision. Firms also use the information reported to FINRA's Central Registration Depository (CRD) system to check the backgrounds of applicants they are considering sponsoring for registration, and FINRA makes certain of the information publicly available to investors to assist them in choosing a broker. FINRA Form U5 (Uniform Termination Notice for Securities Industry Registration) is filed by the applicant's previous employer and contains information on the person's departure from the firm.
Duty to Investigate
Rule 3110(e) is similar to existing NASD Rule 3010(e) and Incorporated NYSE Rule 345.11 in that it requires a broker-dealer to:
Ascertain by investigation the good character, business reputation, qualifications and experience of an applicant before filing a Form U4 and making a representation to that effect on the form.
If the applicant previously has been registered with FINRA, review a copy of the applicant's most recent Form U5 within 60 days of the filing date of an application for registration, or demonstrate to FINRA that it has made reasonable efforts to do so.
If the applicant has been recently employed by a CFTC registered futures commission merchant or introducing broker that is notice-registered with the SEC, review a copy of the applicant's most recent National Futures Association Form 8-T (which contains similar information to Form U5) within 60 days of the filing date of an application for registration, or demonstrate to FINRA that it has made reasonable efforts to do so.
In conducting its review of either Form U5 or Form 8-T, take any action that may be deemed appropriate.
Rule 3110(e) is a principles based rule containing a new requirement that a firm establish and implement written procedures reasonably designed to verify the accuracy and completeness of the information contained in an applicant's initial (the applicant is currently unregistered) or transfer (the applicant has been registered within the prior two years) Form U4 no later than 30 calendar days after the form is filed with FINRA. Rule 3110(e) expressly requires that a firm's written procedures specify:
The firm's process for verifying the information in the Form U4.
That the firm must complete that verification process by no later than 30 calendar days after the Form U4 is filed.
While the requirement to have written procedures is a new requirement under Rule 3110(e), it is based on an implicit requirement of Form U4 that the person signing the form on behalf of the firm certify that he has taken appropriate steps to verify the accuracy and completeness of the information contained in the form.
The procedures also must provide for the new requirement under Rule 3110(e) that the firm conduct a search of reasonably available public records, or arrange that a third-party service provider conduct the search, to verify the accuracy and completeness of the information contained in the applicant's Form U4.
Scope of Investigation
A broker-dealer should obtain all information necessary to make an evaluation prior to the submission of either an initial or a transfer Form U4 on behalf of an applicant for registration with FINRA. In reviewing the information, the firm should consider all available information gathered prior to filing for this purpose, including, but not limited to information derived from:
Form U5 from the applicant's previous firm if he had been registered.
Firms also may consider private background checks, credit reports and reference letters for this purpose. Firms must ensure that these background investigations are conducted in accordance with all applicable laws, rules and regulations, including federal and state requirements, and that all necessary approvals, consents and authorizations have been obtained.
Firms must complete the verification process by no later than 30 calendar days after filing the Form U4 with FINRA, with the understanding that if they become aware of any discrepancies as a result of the verification process conducted after the filing of the form, they will be required to file an amended Form U4.
Search All Available Public Records
FINRA Rule 3110(e) contains a new requirement that a firm's verification process provide for a national search of reasonably available public records to be conducted by the firm or a third-party service provider to verify the accuracy and completeness of the information contained in an applicant's Form U4. The requirement to conduct a public records search must be satisfied by no later than 30 calendar days after an initial or a transfer Form U4 is filed with FINRA. Public records include, but are not limited to:
Records containing general information, including an applicant's name and address.
Civil litigations and judgements.
A firm may find it necessary to conduct a more in-depth search of public records depending on the applicant's job function, responsibilities or position at the firm. There is no specific method through which a firm may conduct a national search of reasonably available public records. A firm may satisfy the requirement, for example, by:
Reviewing a credit report from a major national credit reporting agency that contains public record information (including bankruptcies, judgments and liens) and reviewing the applicant’s fingerprint results.
Searching a reputable national public records database.
Reviewing a consolidated report from a specialized provider that includes criminal and financial public records.
No particular record is mandatory, and broker-dealers should base their search on the factors that apply to a particular applicant's background and prospective position.