Supervisory System

Many firms have a misconception that once a perfectly written compliance manual is put in place then everything will be under control. They ignore the fact that a good supervisory system should at least include ALL of the following:

• Written compliance procedures which are properly communicated to all relevant staff
• Effective and consistent enforcement of compliance procedures by regular monitoring and disciplinary action for non-compliance
• Keeping of adequate records to demonstrate compliance

NASD recently fined CCO Investment Services Corp. US$850,000 for failing to establish, maintain and enforce a reasonably designed supervisory system and written procedures relating to a series of issues. Some violations are highlighted below:

• CCO failed to maintain business-related email and records of compensation given to its brokers by issuers of variable contracts or mutual funds.
• CCO's suitability reviews of variable annuity contract sales were not reasonably designed to prevent and detect sales practice violations. For example, although the firm utilized surveillance reports and its operations personnel reviewed variable annuity applications before the transactions were completed, it inconsistently provided for reasonable follow-up and review to ensure that noted exceptions were adequately addressed.
• Although the firm had some policies related to variable annuity sales to elderly clients, it failed to provide for reasonable follow-up and review to ensure that those policies were implemented for these clients. To the extent that the firm had customer suitability review procedures, such as mandating the use of customer financial profile forms, it did not consistently enforce those procedures. As a result, customer information that could have assisted registered persons and the firm in assessing suitability was not always available.
• CCO made telephone calls to prospective customers during "call nights". The firm required affiliated bank employees, who were not registered representatives, to use pre-approved scripts and not to discuss specific financial products with customers. But the firm had no supervisory system or written procedures for monitoring compliance with its supervisory procedures in this area. The firm had no reasonable way of even tracking the occurrence of call nights or otherwise monitoring compliance with its procedures.

Compared with dealing operations, sales operations is more difficult to monitor. The audit trails are usually maintained by human efforts (instead of automatic capture by computer systems), thus the probability of misuse and abuse is higher.