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Regulation and Compliance > State Regulation

When the Firm is the Teacher

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It all began during a routine examination of a small securities firm by the Securities & Exchange Commission in 1995. The examiner found some deficiencies, including a failure to have completed an “analysis of training needs as well as a written training plan.” Then, two years later, NASD Regulation filed charges against the firm and its registered general principal. The end result would be censure, fines, and a blot on the firm’s previously unblemished disciplinary record.

The firm maintained it had complied with NASD rules, including holding a meeting of its registered personnel, in conjunction with its annual compliance meeting to participate in the “firm element” requirement of its continuing education program. But that did not satisfy NASDR. Even small securities firms must stick very closely to the letter of the law–or regulation, actually–when firm element is involved. Not doing so can invite disciplinary action against firms by NASDR, or even lawsuits against registered representatives by investors attempting to claim they were put into financial instruments by an unqualified rep. In some investor litigation against registered representatives, reps themselves may even turn against their broker/dealers with suits of their own, claiming they were not provided with meaningful continuing education programs on the products they sold.

For all these reasons, firm element is an issue that should preoccupy both securities firms and the individuals associated with them. This is an especially large concern for smaller firms, which may not have the experience or personnel to deal adequately with the issue.

The National Association of Securities Dealers is a self-regulatory organization with rules that supervise continuing education. Rule 1120 outlines firm element by requiring individual securities firms to “maintain a continuing and current education program for its covered registered persons to enhance their securities knowledge, skills, and professionalism.” The first component of firm element is “needs analysis.” The second component is the written training plan. Needs analysis is an annual examination of your firm’s training needs in relation to your customer demographics and product lines, and the written training plan is the next step. The training plan is a well-thought-out design for continuing education that comes about when you identify your firm’s weaknesses, or “deficiencies,” in securities industry parlance. Those weaknesses could be that your registered representatives or registered investment advisers inadequately understand the product or services that the broker/dealer offers. Or, perhaps, they fail to understand their job functions at the firm, or are unfamiliar with the latest rules, regulations, or enforcement actions dealing with conduct that they might be tempted to engage in.

Got a Problem?

However uncomfortable, the needs analysis must not avoid addressing customer complaints or legal actions instituted against the firm. Complaints, arbitration, and litigation, along with internal disciplinary actions and terminations of reps and RIAs for cause, are likely to point to recurring problems or trends that need to be corrected. These are problems that firm element, when properly implemented, is designed to fix.

Adding products and services means that reps and RIAs will need to thoroughly understand how these lines work and which client investment needs will be filled. Marketing and sales strategies are a natural part of this process. As a general rule, seminars that deal with market and sales strategies do not qualify for continuing education credit toward insurance agents’ and attorneys’ licenses. But here is where NASD’s continuing education program parts company with its brethren. NASD Regulation requires product, service, market, and sales strategy seminars, as well as seminars on the effects of changes in market conditions on product and services, to be an integral part of the NASD continuing education program. A firm’s needs analysis would be incomplete if it fails to include relevant market and sales strategy seminars for the products and services it offers.

A written training plan will be spawned from the needs analysis. The analysis itself starts with demographics of the firm and its customers. An analysis must identify whether the firm is a corporation or other legal entity. Indicate the state of incorporation or home office. If there are other office locations, these should be identified in terms of number and location. The location of the office of supervisory supervision should be identified.

Each office should be addressed separately and broken down into number of registered reps, RIAs, and registered principals, identifying their resp

Firm Element Resources

on the Web

The Investment Advisor Worksheets

Exclusive worksheets you can download and use to perform needs analysis and structure firm element training

Report on the Status of Recommendations From the Large Firm Project Report

The SEC weighs in on the need for continuing education


Securities Industry Continuing Education Program 2000 Firm Element Advisory

The latest word on where securities firms need to provide training

Guidelines for Firm Element Training

NASD Regulation’s explanation of firm and regulatory element requirements

NASD Institute for Professional Development

Courses for industry professionals

Three Steps to Creating a Firm Element Training Plan

Forms from the Securities Education Institute Inc. to help design a program

ective NASD registrations. You can, and perhaps should, quantify the years of securities or financial service experience that each licensed person at that office has. Make sure to state whether any of the reps or RIAs have degrees or designations, such as JD, CPA, CLU, ChFC, CFS, or CFP, or other licenses. Break this information down into numbers of registered licensed personnel at each office. You might also want to indicate the total percentage of credentialed personnel who work at the firm. And identify the years of licensing for your firm’s general and financial operations principals, as well their locations. The collective years of sales experience of staff should also be stated. This leads to the need to evaluate the various levels of knowledge and skills that your reps and RIAs have in the areas of product, administrative procedures, and sales practices.

Demographic Details

How do you determine your firm’s customer demographics? One way is to ask your reps and RIAs to rank, in the order of importance, products, services, and skills. To clarify importance, you will need to give some explanation, such as importance in terms of gross dollar commissions or gross sales. Answers to these questions, in conjunction with other personal information in customer files, should enable you to assign blocks of customers into areas of practice; such as, for example education, retirement, estate, financial, and charitable planning. This analysis should point you in the general direction where the firm might have actual or potential weaknesses. Ultimately, it should provide you with the data you need for writing a training plan.

Analyzing customer demographics will lead you to scrutinize the firm’s product mix and risk. Here is where NASD Regulation will want to see revenue and sales volume numbers. For example, your firm might offer mutual funds, insurance, variable annuities, general securities, and fee-based products or programs. Break these down into percentages of contribution to this year’s–or at least the most recent reporting year’s–revenues, making a comparison with the previous year’s percentage of contribution to revenues. If, for example, in this reporting period you’ve experienced a significant percentage increase in fee-based service revenues, you know that, at a minimum, your firm will need to include a registered investment advisor education module in this year’s firm element, especially if there was none in the past.

NASD Regulation encourages the use of charts. The information you gather should lend itself to producing computer-generated charts that can show gross sales by product lines, sales by account type (such as general securities trading, margin trading, pension/401(k), or RIA), and sales volume by representatives. Lists showing revenue and sales volume information according to product line help you to identify the sources of the firm’s revenue. It also suggests areas where important training needs might arise. Specifically, it helps determine areas of risk to different types of customers and the firm, thereby encouraging discussion of suitability in these areas. This same information also helps the firm make an intelligent allocation of training resources for training topics. Better still, it forces you to undertake the process of doing a bona fide needs analysis. And this helps to avoid making the dangerous mistake of concluding that other sources of continuing education remove your firm’s need for firm element.

Not Good Enough

In one case, Office of Hearing Officers, Department of Enforcement v. Respondents, NASD Disciplinary Proceeding No. C9A980041 (August 1999,, the firm claimed all its registered reps completed 12 or more hours of continuing education annually to comply with state insurance department requirements. The firm said the reps were trained by “wholesalers and other outside vendors [who] train . . . in the proper use of various products,” and added that courses taken by employees include ones offered by the Pennsylvania Bar Association and the Certified Financial Planner Board of Standards. “Because of our small size, if and when a training situation arises with a new product, we take care of that immediately, without undue formalities,” the firm maintained. But the firm admitted it did not maintain records to reflect its training. And that raised red flags at NASDR.

If the needs analysis or training plan is contracted to an outside vendor, which is allowed, NASD Regulation still requires the firm to maintain close supervision and final accountability for the plan. So if the CE program you choose is excellent in terms of educational quality, but not relevant to your firm’s business, registered licensed personnel will not get credit for this year’s firm element requirement. The firm and its general securities principal or other supervisor in charge of CE will be liable.

NASD Regulation does not approve or pre-approve any educational programs or any materials from outside vendors. If NASD Regulation examines your firm for firm element issues, the pivotal question will not be whether you secured a CE program from a reputable provider. The focus will be, “Is this CE program directly related to a deficiency or problem that a needs analysis would have uncovered and then corrected by appropriate education programs in the firm’s written training plan?

A written training plan must identify the person or persons responsible for ensuring the plan is implemented; identify the general objective and the specific knowledge and skills that the plan is intended to teach; state the specific training needs to be addressed; correlate CE programs in the plan to deficiencies and problems discovered in the needs analysis process; link CE programs to specific persons or specific positions or specific business units; describe the format in which training will be conducted; establish a time frame for training; provide a means for evaluating the quality of the program, including capturing participant feedback; and be reviewed and updated at

least annually.

The materials the firm employs to implement the plan must address the products, services, and strategies offered to customers. Plan materials must be appropriate to your firm’s size, scope of business, and methods of operation. At a minimum, the materials must include discussion and explanation of the general investment features of the products and services being offered to customers; market and sales strategies supporting the products and services; fees and charges for these products and services; basic factors that determine the value of the investment products and services; any risks (business, interest rate, inflation, market, political, and others) associated with the products and services; usual and unusual features that could, for certain classes of customers, affect the liquidity, taxability, callability, convertibility, and legality of the product or service; suitability for the various investors; and any applicable regulatory requirements, including communications with the public.

Firm Element Advisory

It is very important for your firm to be mindful that on an annual basis, the Firm Element Advisory lists topics that the Council of Continuing Education considers to be relevant to the industry at this time–and, therefore, significant for firm element purposes. Use the Firm Element Advisory to identify training topics relevant to the business. You can find the latest Advisory online at .

This year, the Advisory lists the following topics: decimalization; advertising recent performance in the sales of mutual funds; bond fund volatility ratings; sales charges for variable contracts and mutual funds; suitability and disclosure of risk in the sales of brokered certificates of deposit; supervisory responsibility in connection with risk management practices; and supervision of suitability in sales of variable contracts. Other concerns are at

Putting this all together, what might a needs assessment and written training plan profile look like for a small firm, say, one with 25 or fewer registered licensed personnel? First is a statement about the process. You are the compliance officer designated by the firm’s owner and general securities principal. Your compliance manual calls for you to handle firm element. You have circulated among the firm’s personnel a firm survey that combines inquires from both forms discussed earlier. (You can view examples of these forms at Your supervisory procedures should state when or how often each week or quarter you deal with the firm element process. It may be your habit to check the Web sites for the various state securities commissions, in addition to the SEC and NASD Regulation’s sites, for investor alerts. Certainly, you will want to review all Notices to Members that you receive from NASD Regulation as soon as they hit your computer screen. If you don’t have the time to do this kind of extensive independent research, you may want to subscribe to an electronic service that keeps you current with e-mail updates on changes on securities, insurance, and tax laws, as well as upcoming legislation. All of these devices can be part of your “process” for the needs analysis.

You will also need to review continuing education programs that you might recommend in the firm’s written training plan for this year. Your firm element program should begin with a fundamental discussion of suitability: Your CE program will certainly address the importance of having accurate, updated information about clients’ objectives, financial situations, and risk tolerance. Other suitability topics can include switching of mutual funds and VAs. This part of the program would be relevant to all members of the firm, and so all should be expected to attend.

However, a Part 2 to this program might be added to address something that you’ve been following on the regulator’s radar concerning fraudulent sales practices directed towards older clients. You checked the NASD Firm Element Advisory and learned that brokered CDs are being sold to older clients under unsuitable circumstances. You also noticed that some of the state securities commissions have dedicated “investor alert” Web sites to this topic. Some commissions have even instituted cease and desist actions against certain producers, some of whom are selling without Series 7 registrations. Therefore, you might want to consider building into your basic suitability program an element that pays special attention to the unsuitable sales of brokered CDs to older customers. This should cover how these CDs work, what the commission structure is for selling them, and under what circumstances these products are suitable or not. Part 2 of your suitability program could serve as a lead into a separate CE program for RIAs in your firm whose practices are heavily into retirement planning. Since the Internal Revenue Service recently announced new minimum distribution regulations for IRAs, for example, you probably would want to provide this new development as a separate continuing education program.

Let’s say three of your firm’s RIAs are recent graduates of the Series 65 exam and recent converts to fee-based planning. Since they have been commission-based in the past, here is a substantive issue that will need to be addressed in your CE program. Also, RIA regulations are really new to them. Your firm element program should have a separate program devoted to explaining the fundamentals of the Investment Adviser Act of 1940 and the relevant state statutes and regulations.

Or let’s say that it has recently come to your attention that a national CE organization recently hosted a financial planning forum. A three-hour program was devoted to asset allocation, modern portfolio theory, cost of capital, and other investment valuation analyses and financial planning strategies. Perhaps you should obtain a videotape of the program to investigate whether it can be incorporated into your CE firm element program for the RIAs who have recently come on board.

Answer These Questions

Remember that every firm is unique and that its needs analysis and firm element education is supposed to be tailored to that factor. But assuming that you have either done the CE programs yourself or contracted some of your programs to outside vendors, in order for your firm’s firm element to be in compliance with NASD rules, you will want to make sure you have answered “yes” to these key questions:

o Have you compiled detailed records reflecting how you developed, implemented, administered, and monitored your program?

o Does your firm’s needs analysis statement contain all the required components–data sources, names of participants in the fact-finding, analysis, and final decision making, methods used for evaluating your firm’s deficiencies and needs, the materials you relied on to do your fact-finding, analysis, and decision-making, and a statement of your results and conclusions?

Make sure you maintain in your firm’s library a copy of the resume for each presenter for each CE program, a copy of the presenter’s outline, and a copy of the audio or videotape, if any. Maintain attendance records of all participating “covered persons” (your firm’s reps, RIAs, and general securities principals). Finally, make sure that your firm element program has forms for your participating “covered persons” to complete for their feedback and evaluation. Remember that firm element books and records must be maintained as part of the firm’s books and records. Rules 17a-3 and Section 17a-4 of the 1934 Act say so.

The NASD is charged with the mission of propagating “high standards of commercial honor and just and equitable principles of trade.” NASD Regulation sees firm element as a major part of this mission. In the introduction to The Securities Industry Continuing Education Program, the Council on Continuing Education states that it “believes that a critical component of an effective firm element process … is the enthusiastic support and encouragement of a firm’s senior management.” Where a firm’s senior management is solidly committed to continuing education, there is little doubt that appropriate resources will be committed, covered persons will participate in the firm’s training programs, and the firm’s training programs will improve year after year.

Without this enthusiastic support and encouragement, training can become a joke or just a formality that is insignificant for the covered person. Or worse, it can become the portal for litigation.


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