Section 2 Regulated Persons and Their Activities

Broker-dealer supervision and conduct

14 min read · Lesson 3 of 16

About This Lesson

The BD arc closes with what registered firms actually look like from the inside. Three business models — introducing, clearing, and market making — each mapped to the net capital floor you learned last chapter. Then the supervisory scaffolding FINRA Rule 3110 requires around all of them, the principal licenses that staff it, and the recordkeeping and reporting rhythm that keeps regulators satisfied. The Series 63 tests this chapter as matching problems: business model to floor, activity to principal license, record to retention clock.

What you'll cover

the three BD business types and why the capital floors track custody of customer assets
FINRA 3110's supervisory system: WSPs, designated principals, OSJs, the annual compliance meeting, and the CEO's Rule 3130 certification
the inspection cadence — OSJs annually, non-OSJ branches every 3 years
the principal license roster: Series 24, 26, 53, and the 27/28 FINOP pair
FOCUS reports and the annual audited Form X-17A-5, plus the retention clocks in cross-reference

After this, the module changes track: from the firm to the humans who work for it — the agents.

BD business types — introducing, clearing, market making

"Broker-dealer" is one registration covering three very different businesses, and the Series 63 expects familiarity with all three — especially the way each one's risk profile sets its capital and operational requirements.

Introducing broker-dealer:

Solicits and accepts customer orders; "introduces" them to a clearing firm for execution and settlement
Does not hold customer funds or securities; assets flow to the clearing firm directly
Net capital minimum: $50,000 (substantially lower because of reduced risk profile)
Most retail-facing BDs that lack their own clearing infrastructure operate this way; the relationship is governed by a clearing agreement between the introducing and clearing firms

Clearing (carrying) broker-dealer:

Holds customer funds and securities; clears and settles trades; sends confirmations and statements to customers of introducing firms
Bears the heaviest regulatory burden: full Customer Protection Rule (15c3-3), Customer Reserve Bank Account, possession-or-control segregation
Net capital minimum: $250,000
Examples include large firms such as Pershing, National Financial Services, and other custodial platforms used by introducing BDs and IAs

Market maker:

Stands ready to buy and sell specified securities for its own account on a continuous basis, providing liquidity to the market
Earns the spread between bid and ask; subject to firm-quote rules under SEA Rule 11Ac1-1
Net capital minimum: $100,000 (with additional formula based on number of securities in which the firm makes markets)
Many market makers also act as dealers in their own account and may participate in trading desks within larger BD organizations

Customer-facing

Introducing

No customer assets held

RoleSolicit, route orders

Net cap$50,000 min

15c3-3Limited applicability

Typical examples

Retail-facing BDs without clearing
Small/regional brokerages
Online front-ends

Custodial

Clearing / Carrying

Holds customer funds & securities

RoleClear, settle, custody

Net cap$250,000 min

15c3-3Full applicability

Typical examples

Pershing, NFS
Large wirehouses with own clearing
Custodial platforms

Liquidity provider

Market Maker

Principal trades for own account

RoleQuote two-sided, provide liquidity

Net cap$100,000 min + formula

EarningsBid-ask spread

Typical examples

Equity wholesalers
OTC market makers
HFT firms registered as BDs

FINRA Rule 3110 — firm-level supervision

FINRA Rule 3110 (Supervision) is the central rule governing how a broker-dealer must supervise its own operations and its agents. The agent chapters approach supervision from the agent's side; this is the firm's side of the same rule — the scaffolding every registered firm must build and staff.

Required supervisory system components:

Written Supervisory Procedures (WSPs) — a written document covering each line of business and each rule the firm must comply with; updated for new rules, products, and processes
Designation of registered principals — for each line of business, with specific responsibility allocated and recorded in the WSPs
Office of Supervisory Jurisdiction (OSJ) designations for offices conducting customer order handling, market making, or supervisory activities
Annual compliance meeting with each registered person discussing the firm's compliance and supervisory program (FINRA Rule 3110(a)(7))
CEO annual certification — FINRA Rule 3130 requires the chief executive to certify that the firm has procedures reasonably designed to achieve compliance

Office inspections — two clocks:

OSJs and supervisory branch offices must be inspected at least annually
Non-OSJ branch offices must be inspected at least every three years
Non-branch locations on a periodic basis defined by the firm based on risk

Principal qualifications — match the license to the activity:

Series 24 — General Securities Principal, the most common principal license, required for supervisors of most retail and institutional securities activity
Series 26 — Investment Company/Variable Contracts Principal, for firms whose products are limited to mutual funds and variable annuities
Series 53 — Municipal Securities Principal, for firms with municipal securities activity
Series 27 / 28 — Financial and Operations Principal (FINOP) for clearing firms and introducing firms respectively, responsible for net capital and recordkeeping

Books and records — cross-reference

You've met the recordkeeping regime already: the detailed mechanics are governed by SEC Rules 17a-3 (records to be made) and 17a-4 (records to be preserved), covered in depth in the Communications chapter (Section 3). Here's the BD-side summary, plus the financial-reporting layer that belongs to this chapter.

Key recordkeeping timelines a BD must meet:

Customer account records (Rule 4512 information) — 6 years, with the first 2 years easily accessible
Order tickets, trade confirmations, and 2210 communications — 3 years, with the first 2 years easily accessible
Organizational documents — lifetime of the firm plus 2 years
Customer complaints — 4 years (under FINRA Rule 4513) plus the SEC's 3-year requirement

FOCUS reports (Financial and Operational Combined Uniform Single) — the firm's financial pulse:

BDs must file periodic FOCUS reports with FINRA and the SEC, summarizing financial condition, net capital, and operational metrics
Most BDs file Part II or Part IIA monthly or quarterly depending on size and business type
An annual audit by an independent PCAOB-registered accounting firm must be filed as Form X-17A-5 Part III, due within 60 days of fiscal year end

BD-type and supervision answer framework

The Series 63 writes this chapter as matching problems. Three filters resolve nearly every fact pattern:

What is the BD's business model? Holds customer assets → clearing/carrying ($250K). Routes orders but doesn't custody → introducing ($50K). Quotes two-sided markets in OTC equities → market maker ($100K + formula).
What supervisory structure does the rule require? WSPs, designated principals, OSJ designations, annual compliance meeting, CEO certification under Rule 3130. OSJ inspections at least annual; non-OSJ branches every 3 years.
Which principal license fits? Series 24 (General), 26 (Investment Company), 53 (Municipal), 27 (FINOP-carrying) or 28 (FINOP-introducing).

FOCUS reports are the periodic financial filings every BD makes; the annual audited Form X-17A-5 Part III is the year-end capstone. Books-and-records retention follows the 6/3/lifetime pattern from the Communications chapter — same clocks, firm-side view.

Concept Check

A broker-dealer that solicits customer orders and routes them to a clearing firm for execution and settlement — but never holds customer funds or securities itself — is best classified as which BD type?

An introducing BD solicits customer orders and routes them to a clearing firm; it does not hold customer funds or securities. The clearing/carrying BD is the firm that holds customer assets, computes the Customer Reserve formula, and bears the full SEC Rule 15c3-3 burden. A market maker stands ready to buy and sell specified securities for its own account on a continuous basis. A specialist (now usually called a designated market maker) is a specialized exchange role for maintaining orderly markets in particular securities.

Concept Check

A broker-dealer that continuously quotes both bid and ask prices in specified OTC equity securities and stands ready to buy or sell at its quoted prices is functioning as:

A market maker stands ready on a continuous basis to buy and sell specified securities at its quoted prices, providing liquidity to the market. Market makers are subject to firm-quote rules under SEA Rule 11Ac1-1 (the quote must be honored at the price and size quoted, subject to certain exceptions), and the SEC Rule 15c3-1 net capital minimum is $100,000 plus an additional formula based on the number of securities in which markets are made. Introducing brokers route orders without making markets. Clearing firms hold customer assets. Transfer agents maintain shareholder records.

Concept Check

Under FINRA Rule 3110, a broker-dealer must establish written supervisory procedures (WSPs) that:

FINRA Rule 3110 requires WSPs to be tailored to each line of business, with designated principals having specific supervisory responsibility, and updated as the firm adopts new rules, products, processes, or business lines. WSPs are not filed with FINRA before business begins (though they must be maintained and produced on examination). They are not limited to retail activity — proprietary trading, market making, and investment banking are also covered by their own WSP sections. The CEO's role is to certify annually under Rule 3130 that procedures are reasonably designed to achieve compliance, not to personally select topics.

Concept Check

A broker-dealer registered as a clearing firm needs to designate a principal responsible for net capital, recordkeeping, and financial reporting. The appropriate principal qualification is the:

The Series 27 qualifies a Financial and Operations Principal (FINOP) for a clearing/carrying broker-dealer, with responsibility for net capital, customer reserve, books and records, and FOCUS reporting. The Series 28 is the analogous license for introducing firms that do not hold customer funds. The Series 24 (General Securities Principal) supervises retail and institutional securities activity but not the specific financial-and-operations function. Series 26 covers mutual fund and variable contracts supervision; Series 53 covers municipal securities supervision.

Concept Check

Under SEC Rule 17a-4, a broker-dealer must retain customer order tickets and trade confirmations for:

Under SEC Rule 17a-4, order tickets, trade confirmations, communications with the public (FINRA Rule 2210 records), trial balances, and similar transactional records must be retained for 3 years, with the first 2 years easily accessible. The 6-year retention applies to customer account records (Rule 4512 information), blotters, ledgers, and securities records. The lifetime-plus-2-years standard applies to organizational documents like the partnership articles or corporate charter. Order ticket retention is a frequently tested point.

Concept Check

A broker-dealer operates as a clearing firm that carries customer cash and securities accounts. Under SEC Rule 15c3-1, the minimum net capital required is:

Under SEC Rule 15c3-1, the minimum net capital requirement for a CLEARING firm that carries customer accounts is $250,000. This tier reflects the increased risk a clearing firm assumes by holding customer cash and securities. The $50,000 minimum applies only to INTRODUCING firms that do not hold customer assets and route all transactions to a separate clearing firm. The $1 million figure does not appear in 15c3-1; carrying firms with prime brokerage activities may face higher requirements under specific rule provisions, but $250,000 is the base for standard customer-account carrying. The $100,000 plus 4% structure is not a 15c3-1 formula.

Concept Check

An agent of a broker-dealer wishes to begin part-time work as a real estate agent on weekends. Under FINRA Rule 3270, the broker-dealer agent must:

Under FINRA Rule 3270, a registered person must provide PRIOR WRITTEN NOTICE of outside business activities (OBA) to their employing broker-dealer. The notice allows the firm to evaluate whether the OBA could interfere with the agent's duties, create conflicts of interest, or appear to be related to the firm's business. The firm may impose conditions, restrict, or prohibit the OBA but cannot delegate approval to the state Administrator. State Administrator notification is not required for OBAs that are unrelated to securities. There is no automatic hour limit; the analysis is fact-specific.

Concept Check

Under SEC Rule 17a-4(b), the minimum retention period for customer correspondence, including emails relating to the firm's business, is:

Under SEC Rule 17a-4(b), customer correspondence (including emails related to the broker-dealer's business) must be retained for not less than 3 YEARS, with the first 2 years in an easily accessible location. The retention regime distinguishes between document types: customer ACCOUNT records and corporate documentation are retained for 6 years; trade tickets and customer complaints are 3 years; correspondence is 3 years; certain Form BD and Form U4 records are kept for the life of the firm plus 3 years. The 7-year period does not appear in Rule 17a-4. State-level retention periods may be longer but are typically aligned with federal rules.

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