Study guide
Functions 1 and 2 of the official FINRA outline together supply 54 of the exam's 150 scored questions, more than any other pairing: 9 questions on registration and personnel management and 45 on general broker-dealer activities. This chapter covers how firms and individuals become and stay registered, how supervisory systems are built and tested, and the operational backbone of compliance, from anti-money laundering programs to books and records to financial responsibility.
Registering the Firm and Its People: Forms BD, U4, and U5
A broker-dealer comes into regulatory existence by filing Form BD through the Central Registration Depository (CRD), registering with the SEC, joining FINRA through the new member application process, and registering in most states where it intends to do business. Form BD must be kept accurate, with material changes filed promptly as amendments. Individuals register by filing Form U4, which discloses employment and residential history plus disclosure events such as criminal charges, regulatory actions, customer complaints, bankruptcies, and unsatisfied liens. New registrants must be fingerprinted, and the U4 must stay current: amendments are generally due within 30 days of learning of a change, and events involving statutory disqualification must be reported even faster. When a registered person leaves for any reason, the firm files Form U5 within 30 days of termination and gives the departing person a copy. The stated reason for termination must be accurate. If Priya is discharged from Meridian Securities for unauthorized trading, the firm cannot soften the U5 to say she resigned voluntarily; a misleading U5 is itself a violation and a source of liability. Registration categories matter to supervisors as well. A General Securities Principal (Series 24) may supervise investment banking, trading, and sales activities, but certain functions require specialized principals, such as a Registered Options Principal for options business or a Financial and Operations Principal for net capital and financial reporting. FINRA generally expects each member to maintain at least two registered principals, although a small firm can request a waiver of that standard.
Statutory Disqualification and Continuing Education
Statutory disqualification, defined in Section 3(a)(39) of the Securities Exchange Act, prevents a person from associating with a member firm. Triggers include any felony conviction within the past ten years, misdemeanor convictions within ten years involving securities, money, or false statements, bars or expulsions imposed by a securities or banking regulator, willful violations of the securities laws, and material false statements on registration applications. A disqualified person may associate with a firm only if the firm files a Form MC-400 application and FINRA, subject to SEC oversight, approves the association, almost always under a heightened supervision plan that names a specific principal responsible for day-to-day oversight. Continuing education has two components. The Regulatory Element is FINRA-administered content that every registered person must complete by December 31 each year; someone who misses the deadline becomes CE inactive, may not act in or be paid for any registered capacity, and must requalify by examination if inactive for two years. The Firm Element is annual training the firm designs itself, based on a needs analysis of its products, services, and regulatory developments. Finally, know the lapse rules. A terminated registration ordinarily remains valid for two years, so a rep who returns within that window does not retest. The Maintaining Qualifications Program (MQP) stretches that window to five years for people who elect it when they leave and complete annual continuing education while away. Example: Devon leaves the industry to care for a parent, enrolls in the MQP, and rejoins a firm four years later without retaking his qualification exams.
Building the Supervisory System: Rules 3110, 3120, and 3130
FINRA Rule 3110 requires every member to establish a supervisory system, including written supervisory procedures (WSPs), reasonably designed to achieve compliance with the securities laws and FINRA rules. The firm must designate an appropriately registered principal for each type of business, assign every registered person to a supervisor, hold at least one compliance meeting per year for each representative, and conduct risk-based review of correspondence, internal communications, and transactions. An Office of Supervisory Jurisdiction (OSJ) is any office where key functions occur: order execution or market making, structuring of public offerings or private placements, custody of customer funds or securities, final approval of new accounts or retail communications, or supervision of other offices. Each OSJ needs at least one on-site registered principal. Inspection cycles are heavily tested: OSJs and branch offices that supervise other locations must be inspected at least annually, other branch offices at least every three years, and non-branch locations on a regular periodic schedule. FINRA has recently allowed qualifying home offices to be treated as residential supervisory locations inspected on the non-branch cycle, and a voluntary pilot program permits many inspections to be conducted remotely; because these programs continue to evolve, confirm their current status before exam day. Rule 3120 requires supervisory control procedures that independently test and verify the WSPs, with a report to senior management at least annually; firms with more than 200 million dollars in gross revenue must include additional detail. Rule 3130 requires the chief executive officer to certify annually that the firm has processes to establish, maintain, review, test, and modify its compliance policies, after meeting with the chief compliance officer within the prior twelve months.
AML, Books and Records, and Financial Responsibility
Under the Bank Secrecy Act and FINRA Rule 3310, every firm maintains a written anti-money laundering program approved in writing by senior management. Its pillars: internal policies and controls, a designated AML compliance officer whose identity is given to FINRA, ongoing training, independent testing (annually for most firms), and risk-based customer due diligence. The customer identification program (CIP) verifies each customer's identity, and the beneficial ownership rule requires identifying individuals who own 25 percent or more of a legal entity customer plus one control person. Suspicious activity reports (SARs) go to FinCEN within 30 days for transactions of 5,000 dollars or more that the firm suspects involve illicit funds or lack a lawful purpose, and the firm may not tell the subject a SAR was filed; currency transaction reports cover cash movements above 10,000 dollars. Recordkeeping under SEA Rules 17a-3 and 17a-4 is largely memorization: blotters, general ledgers, and stock records are kept six years, the first two easily accessible; most other records, including order tickets, confirmations, and communications, are kept three years; corporate organizational documents last the life of the firm. Following 2022 amendments, electronic records may be preserved in write-once format or under a compliant audit-trail alternative. Financial responsibility rests on the net capital rule, SEA 15c3-1, a liquidity standard: carrying firms that hold customer funds and securities generally need at least 250,000 dollars of net capital, while introducing firms have lower minimums, some as low as 5,000 dollars. The customer protection rule, 15c3-3, adds a reserve bank account computation and possession-or-control requirements for fully paid customer securities, all overseen by the firm's Financial and Operations Principal through FOCUS reporting.
Outside Activities, Gifts, and Rule 4530 Reporting
Rule 3270 requires a registered person to give prior written notice before engaging in any outside business activity for compensation, whether paid coaching, consulting, or serving on a corporate board. The firm evaluates whether the activity creates conflicts or could be confused with firm business, and it may restrict or prohibit the activity. Rule 3280 governs private securities transactions, commonly called selling away: participating in any securities transaction outside the regular scope of employment requires prior written notice describing the transaction and the person's role. If the person will receive selling compensation, the firm must approve the transaction in writing, supervise it as if it were the firm's own, and record it on the firm's books; if the firm disapproves, the person may not participate in any manner. Example: Marcus wants to raise money for his cousin's real estate limited partnership and collect a finder's fee. Because the partnership interests are securities and he is compensated, his firm must approve and supervise the sales, or Marcus must decline. FINRA Rule 3220 caps gifts connected to the business of the recipient's employer at 300 dollars per person per year, a limit raised from the long-standing 100 dollars effective March 2026. Ordinary business entertainment that the associated person attends is not a gift, provided it is neither preconditioned on sales targets nor excessive. Rule 4530 requires reporting specified events to FINRA within 30 calendar days, including regulatory actions, criminal charges, certain written customer complaints alleging theft or forgery, and internal conclusions that violations occurred, plus quarterly statistical complaint summaries filed by the 15th day of the month following each calendar quarter. The complaint records themselves are retained at least four years.
Key terms
- Form BD
- — The uniform application a broker-dealer files through CRD to register with the SEC, FINRA, and, in most states, state regulators; it must be amended when material information changes.
- Form U4
- — The uniform application for individual registration, containing employment history and disclosure events; amendments are generally due within 30 days of a reportable change.
- Form U5
- — The uniform termination notice a firm must file within 30 days after a registered person leaves, with a copy to the individual and an accurate reason for termination.
- Statutory disqualification
- — A status under Exchange Act Section 3(a)(39), triggered by events such as felony convictions within ten years or regulatory bars, that blocks association with a member absent FINRA approval via Form MC-400.
- Regulatory Element
- — FINRA-administered continuing education that every registered person must complete by December 31 each year; failure makes the person CE inactive.
- Maintaining Qualifications Program (MQP)
- — An elective program letting individuals who leave the industry keep their qualifications for up to five years by completing annual continuing education.
- Office of Supervisory Jurisdiction (OSJ)
- — An office where key functions such as order execution, custody, structuring offerings, or final account approval occur; each OSJ requires an on-site principal and an annual inspection.
- Written supervisory procedures (WSPs)
- — The written procedures required by Rule 3110 describing who supervises each activity, how, and how often, kept current as rules and business lines change.
- Suspicious activity report (SAR)
- — A confidential FinCEN filing due within 30 days for suspect transactions of 5,000 dollars or more; disclosing the filing to the subject is prohibited.
- Customer identification program (CIP)
- — The AML requirement to collect and verify identifying information for each customer at account opening and screen against government lists.
- Net capital rule (SEA 15c3-1)
- — The SEC liquidity standard for broker-dealers; carrying firms generally maintain at least 250,000 dollars, with lower minimums for introducing firms.
- Private securities transaction
- — A securities transaction outside the scope of employment (selling away) under Rule 3280; written notice is always required, and compensated transactions require firm approval, supervision, and recording.
Exam tips
- Memorize the inspection cycle: OSJs and supervisory branches at least annually, other branches every three years, non-branch locations on a regular periodic schedule.
- Keep Rules 3270 and 3280 straight: outside business activities need prior written notice only, while private securities transactions with compensation need written approval, supervision, and recording on the firm's books.
- The 30-day clock appears everywhere in Function 1 and 2 questions: U4 amendments, U5 filings, SARs, and Rule 4530 event reports all generally run on 30 days.
- Know that the gift limit under Rule 3220 is 300 dollars per person per year as of March 2026, and that legitimate business entertainment attended by the associated person is not a gift.
- Distinguish Rule 3120 from Rule 3130: 3120 is the annual supervisory controls report to senior management, while 3130 is the CEO's annual certification of compliance processes.