FINRA’s guidance sheds further light on the new rule, which will permit firms to elect “non-branch” designation for a private residence where an associated person conducts specified supervisory activities.

By Marlon Q. Paz, Naim Culhaci, and Donald Thompson

The Financial Industry Regulatory Authority (FINRA) has issued much-needed guidance on residential supervisory locations (RSLs). The new guidance supplements its January 23, 2024, Regulatory Notice 24-02 (Reg. Notice 24-02) on new supplementary material .19 under FINRA Rule 3110 (See this Latham blog post for more on the Reg. Notice 24-02):

  1. RSL Overview and Key Dates
  2. Frequently Asked Questions about RSLs (RSL FAQs)
  3. RSL eligibility requirements and conditions checklist (RSL Checklist)
  4. Rule 3110 Office Classification Guidance (Classification Guidance)

As a reminder, new FINRA Rule 3110.19, which will become effective on June 1, 2024, will permit firms to treat a private residence where an associated person engages in specified supervisory activities (an RSL) as a non-branch location, subject to safeguards and limitations.

Background

As discussed in greater detail in our prior post on Reg. Notice 24-02, FINRA Rule 3110, FINRA’s Supervision Rule, imposes various supervisory obligations on member firms, including the obligation to classify each location where the business of the firm is conducted under the following four categories: (1) office of supervisory jurisdiction (or OSJ); (2) supervisory branch office; (3) non-supervisory branch office; and (4) non-branch location. Importantly, firms have an ongoing obligation to identify and classify each location, and update Form BR and Form U4 accordingly.

The classification of each location will determine the level of required supervision and inspection, including considerations such as whether the office or location must be: (1) registered with FINRA via Form BR; (2) reported as an Office of Employment Address (OEA) on an associated person’s Form U4; and (3) subjected to a mandatory annual inspection, mandatory three-year inspection, or presumptive three-year inspection cycle. While the Supervision Rule currently deems any location, including a private residence, from which a registered person engages in supervisory activity an OSJ, the RSL rule will permit registered persons to engage in supervisory activities from their private residences without causing their private residences to be deemed branch offices or OSJs, provided certain eligibility criteria are satisfied.

Summary of RSL Implementation

As set forth in Reg. Notice 24-02, certain COVID-19-related temporary relief measures under Regulatory Notice 20-08 (Reg. Notice 20-08) pertaining to updates of office information on Forms U4 and BR expire on May 31, 2024, and Rule 3110.19 becomes effective on June 1, 2024. As a result, firms have until July 1, 2024, to review and appropriately classify all offices and locations, followed by making any necessary Form U4 and BR updates.

Firms seeking to designate eligible locations as RSLs must develop a reasonable risk-based approach to designating a private residence as an RSL and document a risk assessment for the associated person prior to designating a location as an RSL. The assessment must document the factors considered, including certain enumerated factors, whether any higher risk activities take place at the location, and consideration of any red flags. Firms must then submit an initial list of RSL designations to FINRA by October 15, 2024, followed by quarterly updates.

Key Dates

May 31, 2024 End of COVID-19 relief provided under Regulatory Notice 20-08
June 1, 2024   The first day a firm may use the RSL designation (Rule 3110.19 effective date) Firms previously relying on the Notice 20-08 Relief must comply with the timeframes specified in Article V, Section 2 or Article IV, Section 8 of the FINRA By-Laws.
July 1, 2024    Firms previously relying on the Notice 20-08 Relief must file supplementary amendments to Form U4 and BR with FINRA in accordance with Article V, Section 2 or Article IV, Section 8 of the FINRA By-Laws.
October 15, 2024Date by which firms must submit the first RSL list to FINRA (reflecting all locations the firm designates as RSLs during the period June 1, 2024, to September 30, 2024.

RSL FAQ Guidance

The new RSL FAQs address topics relating to RSL designation; reporting; Form U4 address updates; frequency considerations; hybrid work arrangement classifications; location conditions, ineligibility criteria, and recordkeeping requirements; and threshold considerations pertaining to Material Change in Business Operations determinations. In addition to clarifying certain operational mechanics, the RSL FAQs provide the following select notable guidance:

  • Reminding firms that if an associated person engages in supervisory activities from a residential location and said person/location is ineligible for RSL designation or otherwise has yet to be designated, the residence must be registered as a branch office and identified as an OSJ, as applicable (FAQs 2, 27)
  • Clarifying that firms may designate associated persons to more than one RSL (FAQ 4)
  • Highlighting that Form U4s must be updated to list all OEAs, registered and unregistered, including through reporting multiple OEAs, as applicable (FAQs 7, 8, 10-12, 20)
  • Reiterating that the “regularly conducts” frequency threshold in the branch office definition remains undefined, though the RSL FAQs note that if the associated person is working three days a week at a branch office and two days a week “on a regular schedule” at a private residence, the residence must be registered or exempt, as applicable (FAQs 12, 18)
  • Confirming that the RSL should only be utilized with respect to associated persons conducting supervisory activities. As such, the private residences of non-supervisory personnel should continue to rely on existing relief, as applicable, such as the “primary residence,” “non-primary residence,” and back office/non-sales location exclusions (FAQs 19-22)
  • Noting that if, following assessment and classification, the firm’s total number of offices and locations (registered and unregistered, including residential locations) exceed the office count specified in the firm’s membership agreement and further thresholds set forth in the IM-1011-1 Safe Harbor for Business Expansions, the firm would not necessarily be required to file with FINRA a materiality consultation or Continuing Membership Application pursuant to FINRA Rule 1017. Instead, firms may conduct and document a reasonable review of the relevant facts and circumstances, including assessment of the considerations highlighted in Notice to Members 00-73, and determine that there has been no Material Change in Business Operations, particularly when the only change is providing a “second seat” to associated persons at eligible locations (FAQs 31-36)

RSL Checklist

FINRA also issued a five-step checklist addressing RSL eligibility requirements and conditions to further assist in interpreting and implementing the new Rule 3110.19 determinations. Step one is designed to identify whether the firm is ineligible to utilize the new RSL designations. If eligible, step two then aids in determining whether the associated person is ineligble. If both the firm and associated person are eligible, step three contains the criteria to determine whether the private residence satisfies the requisite conditions. Step four then reminds firms that, prior to designating eligible locations, firms must develop a reasonable risk-based approach to designation and conduct and document a risk assessment on a case-by-case basis. Lastly, step five reminds firms of the ongoing obligation to report quarterly lists of RSL designations to FINRA.

Rule 3110 Office Classification Guidance

The Classification Guidance notes that, “[i]n general, a member firm’s office or location is either registered as a branch office, if it meets the definitions contained in Rule 3110(f), or exempt from branch office registration (i.e., an unregistered office or non-branch location), if it fits within an express exclusion from the branch office definition.” The Classification Guidance then summarizes the three types of registered branch offices and the eight branch office exclusions, along with a discussion of the related filing and inspection frequency requirements for each type of office/location.

Open Questions

While the guidance provides a number of helpful clarifications and aids to operational implementation, certain key questions remain open, including:  (1) guidance on the scope of certain terms used in the location definitions, such as definition of an OSJ, including “order execution,” “structuring,” and “market making;” and (2) what impact, if any, arise with respect to the eligibility of associated persons engaged in such functions to utilize the RSL and other branch office exclusions.

With respect to the former, FINRA has repeatedly indicated that it intends to continue its modernization of Rule 3110 to address these and other concerns. Our conversations with FINRA staff have been ongoing, and we hope guidance will be forthcoming.  As for the latter, some firms have indicated they interpret the exclusions to be applicable to all branch offices, including OSJs, subject to satisfaction of the eligibility criteria, whereas others take a different view that the OSJ functions trump the exclusions. In either event, firms should ensure that their procedures adequately address the factors considered in reasonably classifying offices and locations into the four categories noted in the Classification Guidance.  

Key Takeaways

All firms should continue carefully considering the potential impacts from the cessation on May 31, 2024, of the Reg. Notice 20-08 temporary relief with regard to Form U4 and Form BR filing requirements, as well as potential Form CMA triggers as a result of increased office counts. Such considerations should include assessments of supervisory processes and controls, as well as making any necessary enhancements to written supervisory procedures.

Member firms seeking to mitigate such impacts by taking advantage of the new RSL rule will need to quickly address the various implementation requirements under FINRA Rule 3110.19 and as further detailed through Reg. Notice 24-02 and the RSL FAQs.