Principal Approval for Securities Communications

7.3.1 Principal Approval

In the realm of securities, ensuring that communications are compliant with regulatory standards is crucial. This section delves into the concept of principal approval, a fundamental aspect of the compliance process in the securities industry, particularly for those preparing for the Series 6 Exam. We will explore the types of communications that require principal approval, the responsibilities of a registered principal, and the relevant FINRA rules.

Understanding Principal Approval

Principal approval is a regulatory requirement that mandates certain communications to be reviewed and approved by a registered principal before they are used or filed with FINRA. This process is designed to ensure that all communications adhere to regulatory standards and do not mislead or deceive investors.

Types of Communications Requiring Approval

According to FINRA Rule 2210, communications in the securities industry are categorized into three main types: retail communications, correspondence, and institutional communications. Among these, retail communications often require principal approval due to their potential impact on a wide audience.

• Retail Communications: These are any written (including electronic) communications distributed or made available to more than 25 retail investors within any 30-calendar-day period. This category includes advertisements, sales literature, and promotional material. Retail communications must be approved by a registered principal before the earlier of their use or filing with FINRA.

• Advertisements: These are public communications that promote a product or service. Advertisements must be clear, fair, and not misleading, and they require principal approval to ensure compliance with these standards.

• Sales Literature: This includes brochures, flyers, and other materials distributed to a broader audience, often used to promote specific products or services. Like advertisements, sales literature requires principal approval.

• Social Media Posts: Increasingly, firms use social media to communicate with clients. Posts that qualify as retail communications must be pre-approved by a principal.

• New Product Announcements: Any communication introducing a new product to the market typically requires principal approval to ensure all claims are substantiated and compliant.

Responsibilities of the Registered Principal

A registered principal is an individual who supervises the activities of registered representatives and ensures that all communications comply with regulatory standards. The responsibilities of a principal in the approval process are multifaceted:

• Compliance Oversight: The principal must ensure that all communications adhere to FINRA’s content standards, which require that communications be fair, balanced, and not misleading.

• Review and Approval: The principal must review and approve communications before they are used or filed with FINRA. This involves checking for accuracy, completeness, and compliance with regulatory requirements.

• Recordkeeping: Principals are responsible for maintaining records of all approved communications, including the date of approval and the name of the approving principal. These records must be kept for at least three years, with the first two years in an easily accessible place.

• Training and Education: Principals must ensure that registered representatives are adequately trained in compliance standards and the importance of principal approval.

• Monitoring and Auditing: Ongoing monitoring of communications is essential to ensure continued compliance. Principals may conduct audits to assess adherence to regulatory standards.

Key FINRA Rules and Regulations

The principal approval process is governed by several key FINRA rules, notably Rule 3110 and Rule 2210. Understanding these rules is essential for anyone preparing for the Series 6 Exam.

• FINRA Rule 3110 (Supervision): This rule outlines the supervisory responsibilities of firms, including the requirement for principal approval of communications. It mandates that firms establish and maintain a system to supervise the activities of each registered representative and associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations.

• FINRA Rule 2210 (Communications with the Public): This rule categorizes communications and sets forth the content standards for each category. It requires that retail communications be approved by a registered principal before use or filing with FINRA. Rule 2210 also specifies the recordkeeping requirements for communications.

Practical Examples and Scenarios

To illustrate the importance of principal approval, consider the following scenarios:

• Scenario 1: A New Mutual Fund Advertisement

  • A firm plans to launch a new mutual fund and has developed an advertisement highlighting its features and benefits. Before the advertisement can be published, it must be reviewed and approved by a registered principal to ensure that all claims are accurate and that the advertisement is not misleading.

• Scenario 2: Social Media Campaign

  • A registered representative wants to use social media to promote a new investment product. The proposed posts must be reviewed and approved by a principal to ensure compliance with FINRA’s content standards and to verify that they are not misleading.

• Scenario 3: Sales Literature for a Variable Annuity

  • A firm creates a brochure to promote a variable annuity product. The brochure must be approved by a principal to ensure that all information is accurate and that the risks associated with the product are adequately disclosed.

Best Practices for Principal Approval

To ensure effective compliance with principal approval requirements, firms should adopt the following best practices:

• Develop Comprehensive Policies and Procedures: Establish clear policies and procedures for the review and approval of communications. These should outline the types of communications that require approval and the process for obtaining it.

• Implement Training Programs: Regularly train registered representatives and principals on the importance of compliance and the specifics of principal approval. This training should include updates on any changes to FINRA rules or regulations.

• Utilize Technology: Leverage technology to streamline the approval process. Automated systems can help track communications, facilitate reviews, and maintain records.

• Conduct Regular Audits: Periodically audit communications to ensure ongoing compliance with regulatory standards. This can help identify any areas for improvement and ensure that all communications are reviewed and approved as required.

• Foster a Culture of Compliance: Encourage a firm-wide culture that prioritizes compliance and ethical behavior. This can help ensure that all employees understand the importance of principal approval and adhere to the firm’s policies and procedures.

Common Pitfalls and Challenges

Despite the importance of principal approval, firms may encounter several challenges in the process:

• Volume of Communications: The sheer volume of communications requiring approval can be overwhelming, particularly for large firms. Implementing efficient processes and utilizing technology can help manage this challenge.

• Evolving Regulations: Keeping up with changes in FINRA rules and regulations can be challenging. Regular training and updates are essential to ensure compliance.

• Inadequate Recordkeeping: Failing to maintain adequate records of approved communications can lead to compliance issues. Firms must ensure that all records are complete, accurate, and easily accessible.

• Misinterpretation of Rules: Misunderstanding or misinterpreting FINRA rules can result in non-compliance. Ongoing education and consultation with compliance experts can help mitigate this risk.

Summary

Principal approval is a critical component of the compliance process in the securities industry. By understanding the types of communications that require approval, the responsibilities of registered principals, and the relevant FINRA rules, individuals preparing for the Series 6 Exam can ensure they are well-equipped to navigate this important aspect of the industry. By adopting best practices and addressing common challenges, firms can maintain compliance and protect investors from misleading or deceptive communications.

Series 6 Exam Practice Questions: Principal Approval