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3.1 The Supervisory System, Written Supervisory Procedures, and Standards of Conduct

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Investment Company and Variable Contracts Products Principal Series 26

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1 Chapter 1: Registration of the Broker-Dealer and Its Associated Persons

1.1 Broker-Dealer Registration, FINRA Membership, and Firm Filings 1.2 Individual Registration: Forms U4 and U5, Registration Categories, and Exempt Persons 1.3 Pre-Hire Screening, Fingerprinting, and Statutory Disqualification 1.4 Heightened Supervision, Interim Plans, and the Taping Rule 1.5 Broker-Dealers, Investment Advisers, Dual Registrants, and Unregistered Entities

2 Chapter 2: Training, Continuing Education, and Product Knowledge

2.1 Continuing Education (Rule 1240), the Maintaining Qualifications Program, and the Annual Compliance Meeting 2.2 The Investment Company Act of 1940: Classifications, Registration, and Fund Governance 2.3 Mutual Fund Pricing, Redemption, Exchanges, Sales Charges, and Share Classes 2.4 Variable Annuities and Variable Life Insurance: Structure, Charges, and Rule 2320 2.5 Closed-End and Interval Funds, UITs, Money Market Funds, 529 Plans, and Investment Risks

3 Chapter 3: Supervisory System, Conduct Standards, Insider Trading, and Discipline

3.1 The Supervisory System, Written Supervisory Procedures, and Standards of Conduct 3.2 Insider Trading, Information Barriers, and Personal Trading Supervision 3.3 FINRA Investigations, Disciplinary Proceedings, Sanctions, and Exemptions

4 Chapter 4: Communications with the Public

4.1 Communications Categories, Principal Approval, Filing, and Recordkeeping (Rule 2210) 4.2 Content Standards, Investment Company Advertising, and Professional Designations 4.3 Variable Contract Communications, Fund Rankings, Bond Fund Volatility Ratings, and Investment Analysis Tools 4.4 Correspondence and Internal Communications, Social Media, Public Appearances, and Telemarketing

5 Chapter 5: Recommendations, Customer Accounts, and Product Sales Supervision

5.1 Regulation Best Interest, Conflicts, and Form CRS 5.2 Know Your Customer, FINRA Suitability, and Institutional Accounts 5.3 New Accounts, Customer Authority, Discretion, and Order Handling 5.4 Mutual Fund Breakpoints, Share Classes, and Switching Supervision 5.5 Deferred Variable Annuities and the Seven-Business-Day Principal Review 5.6 Prospectuses, Summary Prospectuses, SAIs, and Ongoing Disclosures

6 Chapter 6: Compensation, Outside Activities, and Personal Conduct

6.1 Cash Compensation, Distribution Arrangements, and Conflicts 6.2 Gifts, Gratuities, and Business Entertainment (Rule 3220) 6.3 Training Meetings, Sales Contests, and Non-Cash Compensation 6.4 Referral Payments, Bank Networking, and Unregistered Persons 6.5 Outside Business Activities, Private Securities Transactions, and Rule 3290 Transition 6.6 Outside Accounts, Borrowing and Lending, Account Sharing, and Guarantees

7 Chapter 7: Customer Account Operations, Transfers, and Privacy

7.1 Account Records, Trusted Contacts, Confirmations, and Statements 7.2 Cash Accounts, T+1 Settlement, Regulation T, Extensions, and Freeriding 7.3 ACATS Transfers, Transfer-on-Death Accounts, and Account Changes 7.4 Regulation S-P, Incident Response, Service Providers, and Identity Theft

8 Chapter 8: Anti-Money Laundering, Customer Identification, and Sanctions

8.1 AML Program, Independent Testing, Training, and Governance 8.2 Customer Identification, Due Diligence, and Beneficial Ownership 8.3 SARs, CTRs, OFAC, Information Sharing, and AML Red Flags

9 Chapter 9: Supervisory Controls, Business Continuity, and Regulatory Reporting

9.1 Supervisory Controls, Annual Testing, and CEO Certification 9.2 Business Continuity, Systems Resilience, Cybersecurity, and Vendors 9.3 Rule 4530, FOCUS and Annual Reports, and Customer-Asset Events

10 Chapter 10: Office Classifications, Inspections, and Records

10.1 OSJs, Branches, RSLs, and Inspection Cycles 10.2 Inspection Reports, Independent Review, Signage, and Office Files 10.3 Broker-Dealer Books and Records, Electronic Storage, and Correspondence

11 Chapter 11: Complaints, Arbitration, Mediation, and Expungement

11.1 Customer Complaints, Investigation, Retention, and Reporting 11.2 Predispute Agreements, Arbitration Codes, Eligibility, Panels, and Awards 11.3 Mediation and Customer-Dispute Expungement

12 Chapter 12: Financial Responsibility, Membership Changes, and Investor Protection

12.1 Net Capital, Minimum Tiers, Haircuts, and Early Warning 12.2 Customer Protection, Possession or Control, Reserve Formula, and Exemptions 12.3 New-Product Review and Continuing Membership Applications 12.4 SIPC, Fidelity Bonds, Proxy Materials, and Financial Reports

3.1 The Supervisory System, Written Supervisory Procedures, and Standards of Conduct

Key Takeaways Explain This Topic AI

Rule 3110(a) requires a supervisory system reasonably designed to achieve compliance, including designated principals, registered OSJs and branches, assignment of every registered person to a supervisor, and an annual compliance meeting.

An OSJ is any office where order execution or market making, structuring of offerings, custody of customer funds or securities, final approval of new accounts, review and endorsement of customer orders, final approval of retail communications, or supervision of other branch offices takes place (Rule 3110(f)(1)).

Written supervisory procedures must list the titles, registration status and locations of supervisory personnel, must be kept at each OSJ and supervisory location, and must be amended promptly when rules or the supervisory system change.

Rule 3110.05 permits risk-based review of transactions, but a principal must still review transactions and evidence that review in writing.

Rule 5270 prohibits trading a security or a related instrument while in possession of material, nonpublic information about an imminent block transaction; FINRA generally treats 10,000 shares or more of an equity security as a block.

Last updated: September 2026

Function 2 is the largest part of the Series 26, with 49 of 110 scored questions, and Task 2.1 asks the principal to monitor, supervise and document associated persons' sales activities. The foundation is FINRA Rule 3110 . The legal standard is reasonable design : no system catches every violation, but final responsibility for proper supervision rests with the member , and a supervisor who ignores red flags is personally exposed to discipline.

Elements of the Supervisory System (Rule 3110(a))

At a minimum, the system must provide for:

written supervisory procedures (WSPs);

appropriately registered principals with authority over each type of business that requires broker-dealer registration;

registration and designation of each location, including the main office, as a branch office or office of supervisory jurisdiction (OSJ) when it meets the definitions in Rule 3110(f);

one or more registered principals in each OSJ , and one or more registered representatives or principals in each non-OSJ branch, with authority to carry out that office's supervisory duties;

  • assignment of every registered person to an appropriately registered supervisor;
  • reasonable efforts to confirm that supervisory personnel are qualified by experience or training; and

an annual compliance meeting or interview for each registered representative and principal (Section 2.1).

Offices of Supervisory Jurisdiction (Rule 3110(f)(1))

An OSJ is any office where one or more of these functions takes place:

  • OSJ function Packaged-product example
  • (A) Order execution or market making Rare at fund distributors
  • (B) Structuring public offerings or private placements Rare at fund distributors
  • (C) Maintaining custody of customers' funds or securities A cash cage holding customer checks
  • (D) Final acceptance (approval) of new accounts A principal signing new account forms
  • (E) Review and endorsement of customer orders Daily principal review of mutual fund and VA trades

(F) Final approval of retail communications Approving a seminar flyer, other than offices that only approve research

(G) Supervising associated persons at one or more other branch offices A regional office overseeing several branches

Supplementary material adds detail. .01 : the main office must be registered as a branch or OSJ if it meets the definitions. .02 : firms should designate additional OSJs where needed, considering factors such as retail customer contact, number of registered persons, geographic distance and the complexity of the business. .03 : there is a presumption against one principal serving as the on-site principal for more than one OSJ . Because an on-site principal must have a regular physical presence, assigning one principal to several OSJs requires documented justification. Section 10.1 covers branch and non-branch locations and the residential supervisory location.

Written Supervisory Procedures (Rule 3110(b))

The WSPs must be tailored to the firm's actual business and must include:

(b)(2) procedures for review, by a registered principal and evidenced in writing , of all transactions relating to the investment banking or securities business;

  • (b)(4) review of incoming and outgoing correspondence and internal communications (Section 4.4);
  • (b)(5) procedures to capture, acknowledge and respond to all written customer complaints (Section 11.1);

(b)(6) the titles, registration status and locations of supervisory personnel and each person's responsibilities, with a record of all designated supervisory personnel and their effective dates kept for three years , and procedures addressing conflicts in the supervision of supervisory personnel (Section 9.1); and

(b)(7) a copy of the WSPs, or the relevant portions, kept at each OSJ and each location where supervisory activities occur . The firm must promptly amend the WSPs when laws or rules change or its supervisory system changes, and promptly communicate them to the associated persons they apply to.

Rule 3110.11 allows WSPs to be communicated electronically. The procedures must be readily accessible, amendments promptly posted, affected persons notified of changes, the posted material secured against unauthorized alteration, and current and prior versions retained under SEC Rule 17a-4(e)(7).

Risk-Based Review (Rule 3110.05)

A principal must review every transaction, but Rule 3110.05 lets the firm use a risk-based review system . Detailed review of each transaction is not required if the system gives the firm enough information to focus on the areas that pose the greatest number and risk of violations. Typical packaged-product exception reports include:

  • Class A purchases just below a breakpoint and C-share purchases in large amounts (Section 5.3);
  • mutual fund switches and variable annuity exchanges, including the 36-month exchange look-back (Section 5.4);
  • concentrations of complex or illiquid products and transactions involving customers 65 or older; and

address changes followed closely by disbursements (Section 9.1).

The reviewer must understand the report's parameters, follow up on red flags, and document the resolution. Merely clearing alerts without inquiry is not a reasonable review.

Transaction review for insider trading (Rule 3110(d)) requires procedures to review trades in firm accounts, accounts in which associated persons have a beneficial interest or trading authority, outside accounts disclosed under Rule 3210, and covered accounts of associated persons' spouses, dependent children and similar relatives, and to investigate promptly any trade that may violate insider trading or manipulation prohibitions (Section 3.2).

Conduct and Antifraud Standards

Provision What it prohibits or requires

FINRA Rule 2010 Members and associated persons must observe high standards of commercial honor and just and equitable principles of trade. It reaches unethical conduct, such as forging a customer's signature even with the customer's permission, without a more specific rule. FINRA routinely treats any rule violation as a Rule 2010 violation as well.

FINRA Rule 2020 Effecting or inducing transactions by means of any manipulative, deceptive or fraudulent device

Exchange Act Section 10(b) and Rule 10b-5 Fraud and material misstatements or omissions in connection with the purchase or sale of any security

Exchange Act Section 15(c)(1)-(2), Rules 10b-3, 15c1-2 Manipulative, deceptive or fraudulent devices and fictitious quotations by brokers and dealers

Rule 15c1-3 Representing that SEC registration of a broker-dealer means the SEC approved its financial standing, business or conduct

Securities Act Section 17(a) Fraud in the offer or sale of securities

Securities Act Section 12 Civil liability: rescission for sales that violate Section 5, or by prospectus or oral communication containing a material misstatement

Securities Act Section 23 Representing that an effective registration statement means the SEC found it accurate or passed on the merits

  • 1940 Act Section 37 Larceny or embezzlement of an investment company's assets is a federal crime
  • Front Running (Rule 5270)

Rule 5270 prohibits a member or associated person from causing an order to be executed in a security, a related financial instrument (such as an option or other derivative overlying it), or a security underlying a related instrument, while possessing material, nonpublic market information about an imminent block transaction , until the block information is public or stale. The prohibition covers accounts in which the member or person has an interest or exercises discretion, and customer or affiliate accounts that received the information from the member.

Rule 5270.03 : a transaction of 10,000 shares or more of an equity security is generally treated as a block, though smaller trades can qualify.

Rule 5270.04 : permitted transactions include those the member can show were unrelated to the information, such as trades behind effective information barriers , trades for prior customer orders, bona fide error corrections, and trades that facilitate the customer's block order with the customer's consent.

Rule 5270.05 : front running non-block orders may still violate Rule 2010, Rule 5320 or the federal securities laws.

Conflicts of Interest

The outline asks for knowledge of "regulatory requirements to manage conflicts of interest." In the packaged-product business, the main tools are:

Reg BI's conflict of interest obligation , which requires identifying, disclosing or eliminating conflicts and eliminating sales contests based on specific securities (Section 5.1);

  • Rule 2341(k) , which forbids favoring a fund family because of brokerage commissions directed to the firm;
  • the cash and non-cash compensation rules (Sections 6.1 and 6.2); and

Rule 3110(b)(6)(D)'s requirement that supervision not be compromised by a supervisor's financial interest in the person supervised.