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Federal Register / Vol. 86, No. 121 / Monday, June 28, 2021 / Notices
IEX Rule 5.110c1, may satisfy such obligation by conducting the applicable inspection remotely, without an on-site visit to the office or location subject to the other requirements set forth under the proposed supplementary material.
In addition, the proposed Supplementary Material would expressly provide that inspections for calendar year 2021 must be completed on or before December 31, 2021. IEX
believes that providing firms with the option to satisfy the inspection component of IEX Rule 5.110c remotely would enable firms to finish their calendar year 2021 inspections on or before December 31, 2021, particularly given the uncertainty surrounding planning inspections at this time. Further, proposed Supplementary Material .15a would affirm that a Member would remain subject to the other requirements of IEX
Rule 5.110c.23
B. Written Supervisory Procedures for Remote Inspections
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IEX Rule 5.110a requires that Members establish and maintain a supervisory system that is tailored specifically to the member firms business and addresses the activities of all its associated persons. The Rule requires that a Members supervisory system shall include a number of elements, including the establishment and maintenance of written procedures required by this IEX
Rule 5.110 . . . . Under IEX Rule 5.110b Written Procedures a Member must establish, maintain, and enforce written procedures to supervise the types of business in which it engages and the activities of its associated persons that are reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable IEX rules.
23 In addition to requiring firms to conduct inspections of their offices and locations on a designated frequency, IEX Rule 5.110c generally requires a member to retain a written record of the date upon which each review and inspection occurred, reduce a locations inspection to a written report and keep each inspection report on file either for a minimum of three years or, if the locations inspection schedule is longer than three years, until the next inspection report has been written. If applicable to the location being inspected, the inspection report must include, without limitation, the testing and verification of the members policies and procedures, including supervisory policies and procedures, in specified areas. See IEX Rule 5.110c2. In addition, to prevent compromising the effectiveness of inspections due to conflicts of interest, IEX Rule 5.110c3B requires a Member to ensure that the person conducting the inspection is not an associated person assigned to the location or is not directly or indirectly supervised by, or otherwise reporting to, an associated person assigned to that location.

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To underscore the importance of this existing requirement in the context of remote inspections, proposed Supplementary Material .15b would expressly provide that consistent with a Members obligation under Rule 5.110b1, a Member that elects to conduct its calendar year 2021
inspections remotely must amend or supplement its written supervisory procedures to provide for remote inspections that are reasonably designed to assist in detecting and preventing violations of and achieving compliance with applicable securities laws and regulations, and with applicable IEX
rules. As proposed by the Exchange, reasonably designed procedures for conducting remote inspection of offices or locations should include, among other things, a description of the methodology, including technologies permitted by the member, that may be used to conduct remote inspections. In addition, such procedures should include the use of other risk-based systems employed generally by the Member to identify and prioritize for review those areas that pose the greatest risk of potential violations of applicable securities laws and regulations, and of applicable IEX rules.24
C. An Effective Supervisory System Internal inspections are a critical component of a Members fundamental obligation under IEX Rule 5.110 to establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable IEX
rules. Proposed Supplementary Material .15c would expressly affirm this principle that: i The requirement to conduct inspections of offices and locations is one part of the Members overall ongoing obligation to have an effective supervisory system; and ii a Member must continue with its reviews of the activities and functions occurring at all offices and locations, whether or not such offices or locations are due for an inspection under IEX Rule 5.110c in a given year or the Members election to conduct such inspections remotely.
In addition, under the proposed Supplementary Material, a Members 24 Offices or locations that may present a higher risk profile would include, for example, those that have associated persons engaging in activities that involve handling customer funds or securities, maintaining books and records as described under applicable federal securities laws and IEX rules, order execution or other activities that may be more susceptible to higher risks of operational or sales practice wrongdoing, or have associated persons assigned to an office or location who may be subject to additional or heightened supervisory procedures.

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remote inspection of an office or location, like the traditional on-site inspection, would be held to the same standards for review as set forth under IEX Rule 5.110, Supplementary Material .12 Standards for Reasonable Review.25 Further, in accordance with this obligation, proposed Supplementary Material .15c would provide that where a Members remote inspection of an office or location identifies any indicators of irregularities or misconduct i.e., red flags,26 the Member may need to impose additional supervisory procedures for that office or location, or may need to provide for more frequent monitoring or oversight of that office or location, or both, including potentially a subsequent physical, on-site visit on an announced 25 IEX Rule 5.110, Supplementary Material .12
provides: In fulfilling its obligations under IEX
Rule 5.110c, each Member must conduct a review, at least annually, of the businesses in which it engages. The review must be reasonably designed to assist in detecting and preventing violations of and achieving compliance with applicable securities laws and regulations and with IEX rules.
Each Member shall establish and maintain supervisory procedures that must take into consideration, among other things, the firms size, organizational structure, scope of business activities, number and location of the firms offices, the nature and complexity of the products and services offered by the firm, the volume of business done, the number of associated persons assigned to a location, the disciplinary history of registered representatives or associated persons, and any indicators of irregularities or misconduct i.e., red flags, etc. The procedures established and reviews conducted must provide that the quality of supervision at remote locations is sufficient to ensure compliance with applicable securities laws and regulations and with IEX rules. A Member must be especially diligent in establishing procedures and conducting reasonable reviews with respect to a non-branch location where a registered representative engages in securities activities. Based on the factors outlined above, Members may need to impose reasonably designed supervisory procedures for certain locations or may need to provide for more frequent reviews of certain locations.
26 Red flags that suggest the increased risk or occurrence of violations may include, among other events: Customer complaints; an unexplained increase or change in the types of investments or trading concentration that a representative is recommending or trading; an unexpected improvement in a representatives production, lifestyle, or wealth; questionable or frequent transfers of cash or securities between customer or third party accounts, or to or from the representative; a representative that serves as a power of attorney, trustee or in a similar capacity for a customer or has discretionary control over a customers accounts; representative with disciplinary records; customer investments in one or a few securities or class of securities that is inconsistent with firm policies related to such investments; churning; trading that is inconsistent with customer objectives; numerous trade corrections, extensions, liquidations; or significant switching activity of mutual funds or variable products held for short time periods. See generally SEC Division of Market Regulation, Staff Legal Bulletin No. 17: Remote Office Supervision March 19, 2004; see also FINRA Regulatory Notices 98
38 and 9945.

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