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  • 2015

    • 15-52 SEC Staff Provides Insight Into Firms' Obligations When Providing Stock Quote Information to Customers

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      Providing Stock Quotations to Customers

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rules 5130
      Rule 603 of Regulation NMS
      Suggested Routing

      Compliance
      Institutional
      Legal
      Registered Representatives
      Senior Management
      Trading
      Key Topics

      Vendor Display Rule

      Executive Summary

      FINRA is issuing this Notice to remind firms and registered representatives of their obligations under Rule 603(c) of Regulation NMS (Vendor Display Rule) when providing quotation information to customers. The SEC staff recently made clear its view that if a registered representative provides a quotation to a customer that can be used to assess the current market or the quality of trade execution, reliance on non-consolidated market information as the source of that quotation would not be consistent with the Vendor Display Rule. In light of the SEC staff's statements, firms should review whether they are in compliance with the requirement in the Vendor Display Rule that broker-dealers provide a consolidated display of market data when they are providing quotation information to customers.

      Questions concerning this Notice should be directed to:

      •   Brant K. Brown, Associate General Counsel, Office of General Counsel, at (202) 728-6927; or
      •   Christine Sakach, Special Counsel, Market Regulation, at (240) 386-5404.

      Background & Discussion

      FINRA is issuing this Notice to remind firms and registered representatives of their obligations under the Vendor Display Rule when providing quotation information to customers. In particular, firms should review whether they are in compliance with the requirement in the Vendor Display Rule that broker-dealers provide a consolidated display of market data in a context in which a trading or order routing decision can be implemented. Given the proliferation of various types of market data feeds and the SEC staff's recent statements regarding compliance with the Vendor Display Rule, which are discussed below, firms should undertake this review with a particular focus on the specific data feeds or other products registered representatives use when providing quotation information to customers.

      With the adoption of Regulation NMS, the SEC updated requirements for consolidating, distributing and displaying market information. In particular, the SEC revised the requirement in former Rule 11Ac1-3 (renumbered as Rule 603 in Regulation NMS) that if vendors and broker-dealers provided market information for an NMS stock, they also were required to provide a consolidated display with information from all the market centers that traded the stock. The revised requirements reduced the information that firms must include in a consolidated display and narrowed the circumstances in which the consolidated display requirement would be triggered to those "in which a trading or order-routing decision can be implemented."1 More specifically, the revised Vendor Display Rule requires a consolidated display that includes (1) the prices, sizes and market center identifications of the national best bid or offer and (2) the most recent last sale information.2 In the adopting release, the SEC stated that vendors and broker-dealers will have the ability to decide what, if any, additional data from other market centers to display.3

      Since the adoption of Regulation NMS, the number of market data products offered has increased significantly. Many of these products provide data specific to a particular market or markets, and although they may provide valuable information to subscribers, many do not provide a "consolidated display," as that term is defined in Regulation NMS. On July 22, 2015, the SEC staff denied a no-action request regarding registered representatives' use of a data feed containing only a subset of consolidated market data when providing securities quotations to customers.4 The letter requested assurance from the SEC staff that it would be permissible under the Vendor Display Rule for an individual registered representative of a broker-dealer to use the feed to identify a reference price for a security and use that price to provide a quotation to a customer. The letter noted that, if the customer submitted an order, the customer order would be executed or routed by a system using consolidated market-wide data, and the order would remain subject to the firm's duty of best execution.5

      In a response letter denying the request for no-action relief, the SEC staff made clear its view that "a quotation provided by a registered representative to a customer, which the customer can use to assess the current market or the quality of trade execution, is provided 'in a context in which a trading or order-routing decision can be implemented' for purposes of the Vendor Display Rule," and, therefore, reliance only on a feed that is limited to a subset of consolidated market data as the source of the quotation would not be consistent with the Vendor Display Rule. The SEC staff noted that, in adopting Regulation NMS, the SEC stated that, "[p]articularly for retail investors, the [national best bid and national best offer, or NBBO] continues to retain a great deal of value in assessing the current market for small trades and the quality of execution of such trades."6 Consequently, relying solely on a market data product that is limited to a particular market or markets to provide quotation information to customers will not suffice for a firm in meeting its obligations under the Vendor Display Rule. Based on these statements by the SEC staff, firms should undertake a review of the market data they use in the operation of their businesses, including the data they make available to customers and internally within the firm to verify that they are complying with the requirements of the Vendor Display Rule when providing quotations to customers.


      1. See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, 37569 (June 29, 2005) (Reg NMS Adopting Release).

      2. "Consolidated display" is defined to mean "(i) The prices, sizes and market identifications of the national best bid and national best offer for a security; and (ii) Consolidated last sale information for a security." 17 CFR 242.600(b) (13). "Consolidated last sale information" means the price, volume and market identification of the most recent transaction report for a security that is disseminated pursuant to an effective national market system plan. See 17 CFR 242.600(b)(14).

      3. See Reg NMS Adopting Release, supra note 1, at 37569 ("Beyond disclosure of this basic information, market forces, rather than regulatory requirements, will... determine what, if any, additional data from other market centers is displayed.").

      4. The letter was submitted by BATS Global Markets, Inc. (BATS) and concerned the BATS One Feed, which is "a data feed that disseminates, on a real-time basis, last sale information and the aggregate best bid and offer of all displayed orders for securities traded on the [four] BATS Exchanges and for which the BATS Exchanges report quotes under the Consolidated Tape Association Plan or the Nasdaq/UTP Plan." See Letter from Eric Swanson, EVP, General Counsel & Secretary, BATS, to Stephen Luparello, Director, Division of Trading and Markets, SEC, dated February 25, 2015. Both the BATS request letter and the response letter from the staff of the SEC's Division of Trading and Markets are available on the SEC's website.

      5. See FINRA Rule 5130.

      6. See Reg NMS Adopting Release, supra note 1, at 37567. "National best bid and national best offer" is defined in Rule 600(b)(42) under SEC Regulation NMS. See 17 CFR 242.600(b)(42).

    • 15-51 Submission of “Clearing-Only, Non-Regulatory Reports” to the FINRA Equity Trade Reporting Facilities; Effective Date: February 1, 2016

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      Equity Trade Reporting

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rules 6160
      FINRA Rule 6170
      FINRA Rule 6480
      FINRA Rule 7130
      FINRA Rule 7230A
      FINRA Rule 7230B
      FINRA Rule 7330
      Regulatory Notice 07-38
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Key Topics

      Alternative Display Facility (ADF)
      Alternative Trading Systems (ATS)
      Clearing
      OTC Reporting Facility (ORF)
      Trade Reporting
      Trade Reporting Facilities (TRF)

      Executive Summary

      Pursuant to rule amendments that will be effective February 1, 2016, FINRA is introducing a new category of trade submissions—clearing-only, non-regulatory reports—that firms can use to submit to clearing those OTC transactions in equity securities that have been previously reported through a FINRA facility.1 Clearing-only, non-regulatory reports cannot be used for regulatory reporting purposes. As such, firms can only use these reports where their regulatory reporting obligations to FINRA have been satisfied through other submissions (tape reports, i.e., submitted for public dissemination purposes, or non-tape reports).

      The amended rule text is available in the online FINRA Manual.

      Questions regarding this Notice may be directed to:

      •   Dave Chapman, Director, Market Regulation, at (240) 386-4995 or dave.chapman@finra.org;
      •   FINRA Market Operations at (866) 776-08;
      •   FINRA Product Management at (866) 899-2107; or
      •   Lisa Horrigan, Associate General Counsel, Office of General Counsel, at (202) 728-8190 or lisa.horrigan@finra.org.

      Background and Discussion

      Current FINRA rules require a firm operating an alternative trading system (ATS) to obtain for each ATS a single, unique market participant identifier (MPID) that is designated for exclusive use for reporting the ATS's transactions (the ATS MPID requirement).2 The firm must use such separate MPID to report all transactions executed within the ATS to FINRA, and a firm that operates multiple ATSs or engages in other lines of business requiring the use of MPIDs must obtain and use multiple MPIDs.

      Some firms that operate an ATS and use a FINRA facility to submit trades to the National Securities Clearing Corporation (NSCC) for clearance and settlement prefer to use their main broker-dealer MPID on their clearing submissions. To accommodate these firms, FINRA has amended its rules to introduce "clearing-only, non-regulatory" reports.3 With this new type of report, the transaction is submitted solely to facilitate clearing and not for purposes of dissemination or satisfying a firm's non-tape, regulatory reporting obligations, e.g., to identify FINRA member firms that are parties to the trade and not otherwise identified in the tape report.4 Pursuant to the amendments, ATSs are relieved of the requirement to use their unique ATS MPID—and are permitted to use another MPID—on this subset of reports. In addition, FINRA notes that while the amendments were prompted by issues involving ATS trade reporting, any firm (e.g., a firm that does not operate an ATS but nonetheless uses multiple MPIDs) could submit clearing-only, non-regulatory reports, in accordance with the amendments, if all other regulatory reporting requirements have been met.

      As set forth in the amendments, a firm may submit a clearing-only, non-regulatory report to a FINRA facility only for a previously executed trade for which a tape report has been submitted to the facility, or for the offsetting portion of a riskless principal or agency transaction for which a non-tape, non-clearing report already has been submitted to the facility satisfying FINRA reporting requirements.5 In other words, the information contained in a clearing-only, non-regulatory report must be reported to the FINRA facility in other submissions. When submitting clearing-only, non-regulatory reports, firms must use a unique indicator to denote that the report is submitted solely for purposes of clearing the transaction and not for purposes of satisfying any regulatory reporting requirements.6

      A clearing-only, non-regulatory report cannot be used to satisfy any regulatory reporting requirement under FINRA rules that may apply to the transaction. Thus, firms should submit such reports only where the firm's regulatory reporting obligations have been satisfied through other reports (tape or non-tape, as applicable) submitted to the FINRA facility. Submission of a clearing-only, non-regulatory report constitutes certification by the firm that it has satisfied all regulatory reporting requirements that may apply to the transaction through its other submissions.7

      FINRA notes that clearing-only, non-regulatory reports may only be submitted if the transaction was previously reported to a FINRA facility for regulatory purposes. Consequently, a step-out/step-in or offsetting riskless principal leg of a trade executed on an exchange should not be submitted as a clearing-only, non-regulatory report. While not required by FINRA rules, such entries do not duplicate entries previously submitted to FINRA. FINRA further notes that where a firm must cancel or reverse a trade for which a clearing-only, non-regulatory report has previously been submitted, the firm should also use the clearing-only, non-regulatory report indicator on the clearing report reflecting the cancellation or reversal.

      Although clearing-only, non-regulatory reports cannot be used by firms to satisfy their regulatory reporting obligations, the information contained in such reports must nonetheless be consistent with previously submitted information for the same transaction, unless otherwise expressly provided under FINRA rules. Pursuant to the amendments, firms that operate an ATS are expressly allowed to use an MPID other than their ATS MPID on clearing-only, non-regulatory reports.8 This relief relates solely to the ATS MPID requirement, and the firm with the trade reporting obligation under FINRA rules ("executing party") must continue to be identified as such in all clearing-only, non-regulatory reports.

      In addition, firms are not required to use the short sale (or short sale exempt) indicator, if applicable, on clearing-only, non-regulatory reports.9 In accordance with current guidance, the short sale indictor must be included on the tape report and, if submitted, on the non-tape, non-clearing report that identifies the FINRA member firm that is selling short (or short exempt).10 This guidance is not changing, and pursuant to the amendments, the firm is not required to duplicate this information on the clearing-only, non-regulatory report.

      As of February 1, 2016, pursuant to the amendments, a firm that operates an ATS and elects to use an MPID other than its unique ATS MPID on its clearing submissions to FINRA is required to submit clearing-only, non-regulatory reports, in addition to the regulatory reports submitted under the firm's ATS MPID.

      Application of the Amendments

      To further illustrate the application of the amendments, FINRA is providing the following detailed example: FINRA member Firm 1 operates an ATS that uses the MPID "MATS," and Firm 1's main broker-dealer MPID is "MAIN." Firm 1 executes an agency cross transaction in its ATS between FINRA member Firm 2, as the buyer, and FINRA member Firm 3, as the seller. In this example, the ATS knows the identity of the two FINRA member firms whose orders are being crossed in the ATS. Under FINRA rules, using its ATS MPID "MATS," Firm 1 must report the transaction to FINRA for public dissemination (for purposes of this example, "MATS" reports a cross transaction) and must submit non-tape report(s) to identify Firms 2 and 3 as parties to the trade, because they are FINRA member firms ("MATS" sells to Firm 2 and "MATS" buys from Firm 3).

      Firm 1 has the option, but is not required, to report the transaction to FINRA for submission to NSCC for clearance and settlement. Firm 1 may elect to use its ATS MPID on its clearing submissions, i.e., Firm 1 would designate the non-tape reports showing "MATS" sells to Firm 2 and "MATS" buys from Firm 3 for clearing. In that instance, Firm 1 would not use the clearing-only, non-regulatory report, because the clearing reports are also satisfying Firm 1's reporting obligation under FINRA rules to identify Firms 2 and 3 as parties to the trade.

      Alternatively, Firm 1 may use an MPID other than its ATS MPID, e.g., its main broker-dealer MPID, on its clearing submissions. In that instance, pursuant to the amendments, Firm 1 must submit two additional reports—i.e., two clearing-only, non-regulatory reports with the firm's main broker-dealer MPID ("MAIN" sells to Firm 2 and "MAIN" buys from Firm 3). In making such submissions, Firm 1 is certifying that it has satisfied all regulatory reporting requirements through the submission of the tape ("MATS" reports a cross) and non-tape, non-clearing ("MATS" sells to Firm 2 and "MATS" buys from Firm 3) reports.11 The same would be true if the firm used an MPID other than its main broker-dealer MPID or its unique MPID used for the ATS.

      Current Trade Reporting Guidance Is Not Changing

      FINRA notes that use of the clearing-only, non-regulatory report is not mandatory, and firms may continue to use their clearing submissions to satisfy their regulatory reporting obligations. In that instance, a firm that operates an ATS is required to use its ATS MPID on all tape and non-tape reports, including clearing reports, submitted to FINRA, except where otherwise expressly permitted under current guidance. Specifically, on required non-tape reports, a firm that operates an ATS is permitted to use the MPID of the firm's desk or department that originally received and routed the order to the ATS in the limited instance where the ATS does not know the identity of the other FINRA member firms that are parties to the trade.12

      For example, a firm receives two FINRA member firm client orders at another department and routes the orders to the firm's ATS. The orders are crossed against each other in the ATS. The identities of the FINRA member firm clients are not known by the ATS. The ATS uses the MPID "MATS" and the other department uses the MPID "MOTH." The firm must use the ATS MPID on the tape report. However, because the ATS does not know the identity of the two FINRA member firms, current guidance permits the firm to use the non-ATS MPID "MOTH" on the non-tape report(s) required to satisfy the firm's regulatory reporting obligation to identify the other FINRA member firms involved in the trade.

      FINRA is not changing this guidance as a result of the amendments, and firms are not required to use their ATS MPID in this limited instance. If, in the example above, the firm submits a clearing report using the MPID "MOTH" that is also intended to satisfy its regulatory reporting obligations, then it should not use the new clearing-only, non-regulatory report.


      1. For purposes of this Notice, the FINRA facilities are the Alternative Display Facility (ADF) and the Trade Reporting Facilities (TRF), to which firms report OTC transactions in NMS stocks, and the OTC Reporting Facility (ORF), to which firms report transactions in OTC equity securities, as defined in Rule 6420 (i.e., non-NMS stocks such as OTC Bulletin Board and OTC Market securities), as well as transactions in restricted equity securities, as defined in Rule 6420, effected pursuant to Securities Act Rule 144A.

      2. See Rules 6160, 6170 and 6480.

      3. See Securities Exchange Act Release No. 76061 (September 30, 2015), 80 FR 60421 (October 6, 2015) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2015-035).

      4. See Rules 6282(d)(4), 6380A(d)(4), 6380B(d)(4) and 6622(d)(4).

      5. See, e.g., current Rules 7130(g)(1), 7230A(i)(1), 7230B(h)(1) and 7330(h)(1), which prohibit firms from submitting to a FINRA facility any non-tape report associated with a previously executed trade that was not reported to that FINRA facility, except where submitting the offsetting portion of a riskless principal or agency transaction. See also Regulatory Notice 07-38 (August 27).

      6. Firms should review and report in accordance with the applicable system technical specifications.

      7. FINRA notes that firms will not be required to provide information (e.g., the system-assigned control number) to identify the associated trade report(s) in the clearing-only, non-regulatory report.

      8. See Rules 6160, 6170 and 6480.

      9. See Rules 7130(d), 7230A(d), 7230B(d) and 7330(d).

      10. See, e.g., Trade Reporting Frequently Asked Questions, FAQ # 407.5 [http://www.finra.org/industry/trade-reporting-faq#407] .

      11. If Firm 1 were to subsequently cancel (or reverse) the trade in this example, Firm 1 would be required to submit a cancellation (or reversal) for each leg previously reported with the MATS MPID (i.e., cancellation (or reversal) of the tape report reflecting a "MATS" cross and the two non-tape reports reflecting MATS sells to Firm 2 and MATS buys from Firm 3). These entries would not be marked as clearing-only, non-regulatory reports since they are cancelling original entries required by FINRA rules. Firm 1 would also have to submit clearing-only, non-regulatory reports to reflect the cancellation (or reversal) of the previously submitted clearing-only, non-regulatory entries reflecting MAIN sells to Firm 2 and MAIN buys from Firm 3. With respect to the cancellation (reversal) of the MAIN entries, because the original entries were submitted as clearing-only, non-regulatory reports, the cancellations (or reversals) should also be submitted as clearing-only, non-regulatory reports.

      12. See guidance on reporting ATS transactions to FINRA's Order Audit Trail System (OATS) and FINRA trade reporting facilities. Firms are reminded that in all instances, the ATS MPID must be used on the tape report.

    • 15-50 SEC Approves Rule Requiring Members' Websites to Include a Readily Apparent Reference and Hyperlink to BrokerCheck; Effective Date: June 6, 2016

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      BrokerCheck

      Regulatory Notice
        Referenced Rules & Notices

      FINRA Rule 2210
      Suggested Routing

      Advertising
      Compliance
      Legal
      Registered Representatives
      Registration
      Senior Management
      Systems
      Technology
      Key Topics

      BrokerCheck®
      Member Firm Websites

      Executive Summary

      The SEC approved amendments to FINRA Rule 2210 (Communications with the Public) to require each of a member firm's websites to include a readily apparent reference and hyperlink to BrokerCheck on (1) the initial Web page that the firm intends to be viewed by retail investors, and (2) any other Web page that includes a professional profile of one or more registered persons who conduct business with retail investors.1 The rule amendments become effective June 6, 2016.

      The rule text is available in Attachment A.

      Questions regarding this Notice should be directed to:

      •   Joseph Savage, Vice President, Regulatory Policy, at (240) 386-4534 or Joe.Savage@finra.org;
      •   Richard E. Pullano, Vice President and Chief Counsel, Registration and Disclosure, at (240) 386-4821 or Richard.Pullano@finra.org (regarding BrokerCheck); or
      •   Jeanette Wingler, Assistant General Counsel, Office of the General Counsel, at (202) 728-8013 or Jeanette.Wingler@finra.org.

      Background and Discussion

      BrokerCheck

      BrokerCheck provides the public with information on the professional background, business practices, and conduct of FINRA member firms and their associated persons, as well as on firms and their associated persons registered with national securities exchanges that use the Central Registration Depository (CRD®). These firms, their associated persons and regulators report information to the CRD system, the securities industry online registration and licensing database, via the uniform registration forms. FINRA releases to the public through BrokerCheck information derived from the CRD system to, among other things, help investors make informed choices about the individuals and firms with which they conduct business.

      FINRA believes that greater investor awareness of and access to BrokerCheck continues to be important to protect investors. The rule change will help increase investor awareness and make it easier for investors to find BrokerCheck by requiring references and hyperlinks to BrokerCheck on member firms' websites.

      Scope of New Rule

      The SEC approved amendments to FINRA Rule 2210 to require a readily apparent reference and hyperlink to BrokerCheck on member firms' websites. Specifically, Rule 2210(d)(8)(A) requires each of a member firm's websites to include a readily apparent reference and hyperlink to BrokerCheck on:

      •   the initial Web page that the member firm intends to be viewed by retail investors;2 and
      •   any other Web page that includes a professional profile of one or more registered persons who conduct business with retail investors.

      A hyperlink to the BrokerCheck home page satisfies the rule's linking requirements. Alternatively, firms may elect to satisfy the requirements of the rule by using a "deep-link" to the firm or associated person's individual BrokerCheck pages. FINRA notes that it is making BrokerCheck-related icons and similar resources available to member firms as one option for complying with the proposed rule. Member firms use of any such icons or similar resources would be subject to terms and conditions established by FINRA.3

      Rule 2210(d)(8)(B) excepts from the rule's requirements:

      •   a member firm that does not provide products or services to retail investors; and
      •   a directory or list of registered persons limited to names and contact information.

      At this time, the rule does not require a member firm to include a readily apparent reference and hyperlink to BrokerCheck from communications appearing on a third-party website. Accordingly, the rule does not require a readily apparent reference and hyperlink to BrokerCheck from communications appearing on a social media site (e.g., Twitter or LinkedIn). Moreover, the rule does not require a readily apparent reference and hyperlink to BrokerCheck on each email or text message sent by a member firm or registered person to a retail investor.

      FINRA views websites operated by registered representatives that promote the member's business to be websites of the member firm for purposes of Rule 2210. FINRA, therefore, expects member firms to supervise such websites for compliance with Rule 2210. For example, if a registered representative includes a professional profile on a website that he or she operates and that promotes the member firm's business, FINRA expects that the member firm will monitor any such Web page for compliance with the rule.

      Appearance and Location of Readily Apparent Reference and Hyperlink to BrokerCheck

      With respect to what constitutes a readily apparent reference and hyperlink, member firms should adopt the perspective of a reasonable retail investor when making this determination. Some of the factors that firms should consider include: (1) placement (i.e., whether the reference and hyperlink are visible as soon as a person lands on the website or only after significant scrolling; if scrolling is required, whether it is clear that further information is available below the screen that is being viewed; the type of information that is in close proximity to the description and hyperlink; and whether the BrokerCheck reference and hyperlink are set out separately or buried in a long paragraph); (2) font size (i.e., whether the font size of the description and hyperlink are similar to the font size of other information on the page); and (3) font color (i.e., whether the font color of the description and hyperlink contrasts or blends in with the website's background). Although not an exhaustive list, these factors should help member firms and individuals determine whether the reference and hyperlink to BrokerCheck is readily apparent. Furthermore, FINRA generally does not believe that including the required reference and hyperlink to BrokerCheck in a footer would satisfy the "readily apparent" standard.


      1. See Securities Exchange Act Release No. 76105 (October 8, 2015) (Order Approving File No. SR-FINRA-2015-022).

      2. Rule 2210(a)(6) defines "retail investor" as any person other than an institutional investor (as defined in Rule 2210(a)(4)), regardless of whether the person has an account with a member firm.

      3. See Complying With the BrokerCheck Link Requirements in Rule 2210 for additional information regarding these resources and FINRA's terms and conditions for use.


      Attachment A

      New language is underlined; deletions are in brackets.

      * * * * *

      Text of Changes to FINRA Rule 2210

      * * * * *

      2200. COMMUNICATIONS AND DISCLOSURES

      * * * * *

      2210. Communications with the Public
      (a) through (c) No Change.
      (d) Content Standards
      (1) through (7) No Change.
      (8) BrokerCheck
      (A) Each of a member's websites must include a readily apparent reference and hyperlink to BrokerCheck on:
      (i) the initial webpage that the member intends to be viewed by retail investors; and
      (ii) any other webpage that includes a professional profile of one or more registered persons who conduct business with retail investors.
      (B) The requirements of subparagraph (A) shall not apply to:
      (i) a member that does not provide products or services to retail investors; and
      (ii) a directory or list of registered persons limited to names and contact information.
      ([8]9) Prospectuses Filed with the SEC

      Prospectuses, preliminary prospectuses, fund profiles and similar documents that have been filed with the SEC and free writing prospectuses that are exempt from filing with the SEC are not subject to the standards of this paragraph (d); provided, however, that the standards of this paragraph (d) shall apply to an investment company prospectus published pursuant to Securities Act Rule 482 and a free writing prospectus that is required to be filed with the SEC pursuant to Securities Act Rule 433(d)(1)(ii).
      (e) through (g) No Change.

      * * * * *

    • 15-49 SEC Approves Changes to Reduce the Waiting Period for the Release of Information Reported on Form U5 Through BrokerCheck; Effective Date: December 12, 2015

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      BrokerCheck

      Regulatory Notice
      Notice Type
      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 8312
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Registration
      Senior Management
      Key Topics

      BrokerCheck®
      Central Registration Depository
      Uniform Registration Forms

      Executive Summary

      The SEC approved a change to FINRA Rule 8312 (FINRA BrokerCheck Disclosure) to reduce the waiting period from 15 days to three business days for the release of certain information reported on the Form U5 (Uniform Termination Notice for Securities Industry Registration) through BrokerCheck.1 The effective date is December 12, 2015.

      The text of the rule amendment is set forth in Attachment A.

      Questions concerning this Notice should be directed to FINRA's Gateway Call Center at (301) 590-6500.

      Background & Discussion

      FINRA Rule 8312 governs the information FINRA releases to the public via BrokerCheck. BrokerCheck provides the public with information on the professional background, business practices, and conduct of FINRA member firms and their associated persons, as well as on firms and their associated persons registered with national securities exchanges that use the Central Registration Depository (CRD®). These firms, their associated persons and regulators report information to the CRD system—the securities industry online registration and licensing database—via the uniform registration forms.2 FINRA releases to the public through BrokerCheck information derived from the CRD system to, among other things, help investors make informed choices about the individuals and firms with which they conduct business.

      Reduction of the Waiting Period for the Release of Information Reported on Form U5

      Most of the information that FINRA releases through BrokerCheck generally is made available the day after it is filed with the CRD system.3 Rule 8312, however, provides for a 15-day delay in the release of disclosure information filed on Form U5, which firms use to terminate registrations with self-regulatory organizations (SROs) and the states.4 The 15-day waiting period was established to give brokers on whose behalf the Form U5 was submitted an opportunity to comment on the disclosure event either through a Form U4, which firms use to register brokers with SROs and the states, or by submitting a broker comment directly to FINRA.5

      Beginning on December 12, 2015, the 15-day delay in the release of disclosure information filed on Form U5 will be reduced to three business days.6 FINRA believes that a three-business-day waiting period is more reasonable than a 15-day period because it allows investors to more quickly access disclosure information reported on Form U5 while at the same time still providing brokers the opportunity to comment on the reported disclosure event.


      1. See Securities Exchange Act Release No. 76359 (November 5, 2015), 80 FR 70016 (November 12, 2015) (Order Approving SR-FINRA-2015-032).

      2. FINRA discloses through BrokerCheck information that is reported on the following uniform registration forms: Form U4 (Uniform Application for Securities Industry Registration or Transfer), Form U5, Form U6 (Uniform Disciplinary Action Reporting Form), Form BD (Uniform Application for Broker-Dealer Registration), and Form BDW (Uniform Request for Broker-Dealer Withdrawal).

      3. BrokerCheck is periodically "refreshed" based on information filed with the CRD system on the uniform registration forms. Information filed with the CRD system on Monday through Thursday generally is released through BrokerCheck the following day. Information filed with the CRD system on Friday or Saturday generally is released through BrokerCheck on Sunday. The CRD system is not available for filings on Sunday. Information filed with the CRD system that contains details about a disclosure event may require additional processing time.

      4. Only disclosure information is subject to the 15-day waiting period. Other Form U5 information, such as the date of termination of a broker's registrations, is published in BrokerCheck in accordance with the protocols described earlier (see supra note 3).

      5. See Securities Exchange Act Release No. 55127 (January 18, 2007), 72 FR 3455 (January 25, 2007) (Order Approving File No. SR-NASD-2003-168).

      6. The three-business-day waiting period may be curtailed if a broker reports on Form U4 the disclosure event that the broker's prior firm reported on Form U5 prior to the expiration of the waiting period. For example, if FINRA processes a disclosure event reported on Form U5 on Monday, and on Tuesday processes a Form U4 filed by a broker reporting that event, the Form U5 information would be made publicly available in BrokerCheck on Wednesday, which is the same day that the Form U4 information would be released. In such circumstances, the broker has had a chance to comment on the disclosure event that has been reported by the firm on the Form U5, so continuing to exclude the Form U5 version of the event from BrokerCheck does not serve any purpose.


      ATTACHMENT A

      Below is the text of the proposed rule change. Proposed new language is underlined; proposed deletions are in brackets.

      * * * * *

      8000. INVESTIGATIONS AND SANCTIONS

      * * * * *

      8300. SANCTIONS

      * * * * *

      8310. Sanctions for Violation of the Rules

      * * * * *

      8312. FINRA BrokerCheck Disclosure
      (a) through (c) No Change.
      (d) FINRA shall not release:
      (1) through (4) No Change.
      (5) [Form U5 information] events reported on Section 7 of the Form U5 (other than an "Internal Review Disclosure" event) for three business [fifteen (15)] days [following the filing of such information] after FINRA's processing of the filing. However, if an event is reported on Form U5 and the same event is thereafter reported on Form U4 prior to the expiration of the three-business-day period, FINRA will release the Forms U4 and U5 information simultaneously upon processing. Under such circumstances, the three-business-day period may be curtailed;
      (6) through (7) No Change.
      (e) through (f) No Change.

      . . . Supplementary Material:---------------

      .01 through .03 No Change.

      * * * * *

    • 15-48 SEC Approves Amendments to Publish OTC Equity Volume Executed Outside Alternative Trading Systems; Effective Date: April 2, 2016

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      Equity Trading Initiatives: OTC Equity Trading Volume

      Regulatory Notice
      Notice Type
      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 4552
      FINRA Rule 6110
      FINRA Rule 6610
      Regulatory Notice 14-48
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Key Topics

      Alternative Display Facility
      NMS Securities
      OTC Equity Securities
      OTC Reporting Facility
      Trade Reporting
      Trade Reporting Facilities

      Executive Summary

      Pursuant to rule amendments that will become effective on April 2, 2016, FINRA will expand its alternative trading system (ATS) transparency initiative to publish the remaining equity volume executed over-the-counter (OTC) by FINRA member firms, including the trading activity of non-ATS electronic trading systems and internalized trades. Beginning on Monday, April 18, 2016, data as of April 4, 2016, will be available in accordance with the amendments—free of charge to all users—on FINRA's website.

      The amended rule text is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •  Dave Chapman, Director, Market Regulation, at (240) 386-4995 or dave.chapman@finra.org;
      •  Brendan Loonam, Director, Business Services, at (212) 858-4203 or brendan.loonam@finra.org; or
      •  Lisa Horrigan, Associate General Counsel, Office of General Counsel, at (202) 728-8190 or lisa.horrigan@finra.org.

      Background & Discussion

      FINRA currently makes the volume and trade count information for equity securities executed in an ATS publicly available on the FINRA website.1 The Securities and Exchange Commission has approved amendments to Rules 6110 and 6610 to expand this transparency initiative by publishing the remaining OTC equity volume (non-ATS volume) by member firm and security.2

      A firm's non-ATS volume information will be derived directly from OTC trades reported to FINRA's equity trade reporting facilities.3 As such, firms do not have any additional reporting requirements as a result of the amendments. FINRA will base a firm's non-ATS volume on trades reported for dissemination purposes (or "tape reports") where the firm is identified as the firm with the trade reporting obligation.4 A firm's published trading volume information will not include trades for which the firm is the reported contra party, nor will it include trades that are reported solely for clearing or regulatory purposes (or "non-tape reports").

      FINRA will publish non-ATS volume information at the firm level and not at the Market Participant Identifier (MPID) level if a firm uses more than one MPID. For firms that use more than one MPID for their non-ATS trading,5 FINRA will aggregate and publish the non-ATS trading volume for all non-ATS MPIDs belonging to the firm under a single "parent" identifier or firm name.6

      FINRA will publish on its website weekly volume information (number of trades and shares) by firm and security, with limited de minimis exceptions described below, on a two-week or four-week delayed basis in accordance with the time frames specified for ATS volume publication. Specifically, volume information will be published on a two-week delayed basis for NMS stocks in Tier 1 under the NMS Plan to Address Extraordinary Market Volatility (also referred to as the "Limit Up/Limit Down Plan")7 and a four-week delayed basis for all other NMS stocks and OTC equity securities.8

      FINRA also will publish aggregate volume totals across all NMS stocks and aggregate volume totals across all OTC equity securities for each calendar month. Monthly aggregate totals will be published on a one-month delayed basis, e.g., totals for the month of June will be published on or about August 1.9

      Aggregated De Minimis Volume

      For firms executing fewer than on average 200 non-ATS transactions per day during the reporting period (i.e., during the week for weekly volume data or during the month for monthly volume data), FINRA will combine and publish such de minimis volume on an aggregated non-attributed basis. For a firm with more than one non-ATS MPID, the total volume across all of its non-ATS MPIDs will be combined for purposes of determining whether the de minimis threshold has been met.

      Thus, if a firm averages fewer than 200 non-ATS transactions per day across all securities during the reporting period, FINRA will aggregate the firm's volume with that of similarly situated firms. Additionally, because the published volume data will be broken down by security, if a firm averages fewer than 200 non-ATS transactions per day in a given security during the reporting period, FINRA will aggregate the firm's volume in that security with that of similarly situated firms, even if the firm averages more than 200 non-ATS transactions per day across all securities during the reporting period.

      FINRA notes that for the weekly non-ATS data, the de minimis threshold will be calculated separately for Tier 1 NMS stocks, other NMS stocks and OTC equity securities, and for the monthly non-ATS data, the de minimis threshold will be calculated separately for NMS stocks (not broken down by tier) and OTC equity securities.

      The following example may assist firms in understanding how the de minimis threshold will be applied. Suppose that Firm 1 has non-ATS volume in three Tier 1 NMS stocks for the week:

        Security A Security B Security C Firm 1 Total Tier 1 Stocks
      # Trades 800 20,000 4,200 25,000
      # Shares 800,000 1,000,000 10,000 1,810,000
      Attributed to Firm 1 in published data? No Yes Yes Yes

      At the firm aggregate level, FINRA will attribute to Firm 1 the total non-ATS volume in all three securities—25,000 trades and 1,810,000 shares. At the security level, however, FINRA only will attribute to Firm 1 the volume in Securities B and C. Because Firm 1 averaged fewer than 200 trades a day in Security A, Firm 1's volume in that security will be aggregated and published on a non-attributed basis with the other de minimis firms. If the other de minimis firms had a total of 10,000 trades and 200,000 shares in Security A, the published data for Security A will reflect a de minimis volume of 10,800 trades and 1,000,000 shares; users of the data will not know that Firm 1 contributed to that volume. By comparing Firm 1's aggregate total for Tier 1 stocks and Firm 1's attributed volume in Securities B and C, users of the data could deduce that Firm 1 had de minimis volume, but would not know in which security (or securities).

      Firms can find ATS volume data and non-ATS volume data on the same page of FINRA's website. Specifically, the ATS Transparency page will be rebranded to "OTC Transparency," and on the existing ATS Transparency Data page, the tabs will be updated to reflect both ATS and non-ATS data.


      1. See Rule 4552. FINRA currently does not publish ATS volume information regarding fixed income securities.

      2. See Securities Exchange Act Release No. 76078 (October 5, 2015), 80 FR 61246 (October 9, 2015) (Order Approving File No. SR-FINRA-2015-020). Prior to filing, FINRA solicited comment on the proposal in Regulatory Notice 14-48 (November 2014).

      3. FINRA's equity trade reporting facilities (collectively referred to herein as the "FINRA Facilities") are the Alternative Display Facility (ADF) and the Trade Reporting Facilities (TRFs), to which members report OTC transactions in NMS stocks; and the OTC Reporting Facility (ORF), to which members report transactions in OTC equity securities (i.e., non-NMS stocks such as OTC Bulletin Board and OTC Market securities).

      4. Under FINRA rules, in a trade between a member and non-member or customer, the member has the obligation to report the trade, and in a trade between two members, the "executing party," defined as the member that receives an order for handling or execution or is presented an order against its quote, does not subsequently re-route the order, and executes the transaction, has the obligation to report the trade. See Rules 6282(b), 6380A(b), 6380B(b) and 6622(b).

      5. For example, a firm may use separate MPIDs for its proprietary and agency desks.

      6. Under FINRA rules, each firm that operates an ATS is required to use a unique MPID for reporting order and trade information to FINRA for that ATS. A firm's ATS volume will continue to be published separately under the unique MPID(s) for each ATS operated by the firm.

      7. Tier 1 NMS stocks include those NMS stocks in the S&P 500 Index or the Russell 1000 Index and certain ETPs. See NMS Plan to Address Extraordinary Market Volatility. FINRA will make changes to the Tier 1 NMS stocks in accordance with the indices. Changes to the S&P 500 are made on an as needed basis and are not subject to an annual or semi-annual reconstitution. S&P typically does not add new issues until they have been seasoned for six to twelve months. Russell 1000 rebalancing typically takes place in June.

      8. FINRA notes that non-ATS volume data will be displayed in the same format in which ATS volume data is displayed today, i.e., aggregate volume for each firm across all NMS stocks (Tier 1 and all other NMS stocks) and OTC equity securities; aggregate volume for each security across all firms; and volume for each security by each firm (except with respect to de minimis volume).

      9. FINRA notes that the monthly volume information will cover a single calendar month, whereas the weekly information may span multiple months. For example, monthly volume information for June 2016 will cover trading between June 1 and June 30, whereas weekly volume information will cover trading during the weeks of May 30 through June 3 and June 27 through July 1.


      ATTACHMENT A

      Below is the text of the amendments. New language is underlined.

      * * * * *

      6000. QUOTATION AND TRANSACTION REPORTING FACILITIES
      6100. QUOTING AND TRADING IN NMS STOCKS
      6110. Trading Otherwise than on an Exchange
      (a) Members are required to report transactions in NMS stocks, as defined in Rule 600(b)(47) of SEC Regulation NMS, effected otherwise than on or through a national securities exchange to FINRA. For purposes of the Rule 6100 Series, "otherwise than on an exchange" means a trade effected by a FINRA member otherwise than on or through a national securities exchange. The determination of what constitutes a trade "on or through" a particular national securities exchange shall be determined by that exchange in accordance with all applicable statutes, rules and regulations, and with any necessary SEC approval.
      (b) Trading Information for OTC Transactions in NMS Stocks Executed Outside of Alternative Trading Systems
      (1) FINRA will publish on its public web site the Trading Information for each member with the trade reporting obligation under Rules 6282(b), 6380A(b) and 6380B(b) on the following timeframes:
      (A) no earlier than two weeks following the end of the Trading Information week, Trading Information regarding NMS stocks in Tier 1 of the NMS Plan to Address Extraordinary Market Volatility;
      (B) no earlier than four weeks following the end of the Trading Information week, Trading Information regarding NMS stocks that are subject to FINRA trade reporting requirements and are not in Tier 1 of the NMS Plan to Address Extraordinary Market Volatility; and
      (C) no earlier than one month following the end of the Trading Information month, aggregate volume totals across all NMS stocks.
      (2) Published Trading Information will be presented on FINRA's web site as follows:
      (A) Trading Information will be aggregated for all Market Participant Identifiers (MPIDs) used by a single member (excluding, if applicable, any MPIDs used by the member for reporting trades executed in its alternative trading system).
      (B) Trading Information will be aggregated for members that have executed on average fewer than 200 transactions per day across all NMS stocks during the applicable Trading Information period.
      (C) Trading Information will be aggregated for members that have executed on average fewer than 200 transactions per day in an NMS stock during the applicable Trading Information period.
      (3) "Trading Information" includes:
      (A) the number of shares of an NMS stock executed by the member with the trade reporting obligation under Rules 6282(b), 6380A(b) and 6380B(b) and reported to FINRA; and
      (B) the number of trades in an NMS stock executed by the member with the trade reporting obligation under Rules 6282(b), 6380A(b) and 6380B(b) and reported to FINRA.

      "Trading Information" for purposes of this Rule shall not include any transactions executed within an alternative trading system, which information is published under Rule 4552.

      * * * * *

      6600. OTC REPORTING FACILITY
      6610. General
      (a) Members are required to report transactions (other than transactions executed on or through an exchange) in OTC Equity Securities, including secondary market transactions in non-exchange-listed Direct Participation Program securities, and Restricted Equity Securities to the OTC Reporting Facility in compliance with the Rule 6600 and 7300 Series, as well as all other applicable rules and regulations.
      (b) Trading Information for OTC Transactions in OTC Equity Securities Executed Outside of Alternative Trading Systems
      (1) FINRA will publish on its public web site the Trading Information for each member with the trade reporting obligation under Rule 6622(b) on the following timeframes:
      (A) no earlier than four weeks following the end of the Trading Information week, Trading Information for OTC Equity Securities; and
      (B) no earlier than one month following the end of the Trading Information month, aggregate volume totals across all OTC Equity Securities.
      (2) Published Trading Information will be presented on FINRA's web site as follows:
      (A) Trading Information will be aggregated for all Market Participant Identifiers (MPIDs) used by a single member (excluding, if applicable, any MPIDs used by the member for reporting trades executed in its alternative trading system).
      (B) Trading Information will be aggregated for members that have executed on average fewer than 200 transactions per day across all OTC Equity Securities during the applicable Trading Information period.
      (C) Trading Information will be aggregated for members that have executed on average fewer than 200 transactions per day in an OTC Equity Security during the applicable Trading Information period.
      (3) "Trading Information" includes:
      (A) the number of shares of an OTC Equity Security executed by the member with the trade reporting obligation under Rule 6622(b) and reported to FINRA;
      (B) the number of trades in an OTC Equity Security executed by the member with the trade reporting obligation under Rule 6622(b) and reported to FINRA.

      "Trading Information" for purposes of this Rule shall not include any transactions executed within an alternative trading system, which information is published under Rule 4552.

      * * * * *

    • 15-47 SEC Approves Amendments to Require Firms to Add a No-Remuneration Indicator in TRACE Trade Report; Implementation Date: May 23, 2016

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      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6730
      Suggested Routing

      Compliance
      Fixed Income
      Legal
      Operations
      Systems
      Trading
      Key Topics

      Fixed Income Securities
      Mark-ups, Mark-downs and Commissions
      TRACE
      Transaction Reporting

      Executive Summary

      The SEC approved amendments to the Trade Reporting and Compliance Engine (TRACE) rules to require an indicator when the TRACE report does not reflect a commission or mark-up/mark-down. The implementation date for these amendments is May 23, 2016.

      The amended rule text is available in the online FINRA Manual.

      Questions regarding this Notice should be directed to:

      •  Ola Persson, Vice President, Transparency Services, at (212) 858-4796 or by email at Ola.Persson@finra.org;
      •  Patrick Geraghty, Vice President, Market Regulation, at (240) 386-4973 or by email at Patrick.Geraghty@finra.org; or
      •  Andrew Madar, Associate General Counsel, Office of General Counsel, at (202) 728-8056 or by email at Andrew.Madar@finra.org.

      Background and Discussion

      FINRA Rule 6730 (Transaction Reporting) sets forth the requirements that apply to firms when reporting transactions in TRACE-eligible securities,1 and provides the specific items of information that must be included in a TRACE trade report. Among other things, Rules 6730(c) and (d) require that firms report the commission (total dollar amount) separately on the TRACE trade report for agency transactions. FINRA then combines the dollar amount that is reported as the commission with the amount that is reported in the price field, and disseminates to the market this aggregate amount as the transaction's price. For principal transactions, Rule 6730(d)(1) provides that firms must report a price that includes the mark-up/mark-down, and FINRA disseminates this price to the market. The goal of these reporting requirements is to enable FINRA to provide investors and market participants with pricing information that better reflects comparable prices for principal and agency trades in a TRACE-eligible security.

      The SEC approved amendments to Rule 6730 that require that firms use a No-Remuneration indicator to identify those transactions for which a commission or mark-up/mark-down is not reflected in a TRACE trade report.2 A firm may select the No-Remuneration indicator either because the firm does not charge or does not know the amount of the commission or mark-up/mark-down at the time of TRACE reporting. For example, some firms may assess a charge that is not transaction-based, such as in the case of a "fee-based account" where remuneration is based upon assets under management (and individual commissions or mark-ups/mark-downs are not charged). As is the case now, the disseminated TRACE feed will not explicitly distinguish between agency and principal transactions, and the No-Remuneration flag will apply to both principal and agency transactions. FINRA believes that the No-Remuneration flag will provide more meaningful pricing transparency through TRACE by identifying those transactions where no commission or mark-up/mark-down was charged or known at the time of TRACE reporting, while not inhibiting possible firm remuneration arrangements.

      Rule 6730 also sets forth three exceptions regarding the use of the No-Remuneration indicator: (1) the transaction is a "List or Fixed Offering Price Transaction," as defined in Rule 6710(q); (2) the transaction is a "Takedown Transaction," as defined in Rule 6710(r); and (3) the transaction is an inter-dealer transaction.

      The implementation date of these amendments is May 23, 2016.


      1. Rule 6710 generally defines a "TRACE-eligible security" as: (1) a debt security that is U.S. dollar-denominated and issued by a U.S. or foreign private issuer (and, if a "restricted security" as defined in Securities Act Rule 144(a)(3), sold pursuant to Securities Act Rule 144A); or (2) a debt security that is U.S. dollar denominated and issued or guaranteed by an "Agency" as defined in Rule 6710(k) or a "Government-Sponsored Enterprise" as defined in Rule 6710(n).

      2. See Securities Exchange Act Release No. 76176 (October 16, 2015), 80 FR 64039 (October 22, 2015) (SR-FINRA-2015-026).

    • 15-46 Guidance on Best Execution Obligations in Equity, Options and Fixed Income Markets

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      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 3110
      FINRA Rule 5310
      MSRB Regulatory Notice 2014-02
      Notice to Members 06-58
      Notice to Members 01-22
      Notice to Members 99-12
      Notice to Members 97-57
      Rule 605 of SEC Regulation NMS
      Rule 606 of SEC Regulation NMS
      Rule 611 of SEC Regulation NMS
      SEA Rule 10b-10
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Trading
      Key Topics

      Best Execution
      Directed Orders
      Equity Securities
      Fixed Income Securities
      Payment for Order Flow
      Regular and Rigorous Review
      Standardized Options

      Executive Summary

      In light of the increasingly automated market for equity securities and standardized options, and recent advances in trading technology and communications in the fixed income markets, FINRA is issuing this Notice to reiterate the best execution obligations that apply when firms receive, handle, route or execute customer orders in equities, options and fixed income securities. FINRA is also issuing this Notice to remind firms of their obligations, as previously articulated by the Securities and Exchange Commission (SEC) and FINRA, to regularly and rigorously examine execution quality likely to be obtained from the different markets trading a security. FINRA also welcomes comments on whether there are other topics related to best execution for which additional guidance would be helpful. Any such comments can be emailed to pubcom@finra.org.1

      Questions concerning this Notice or FINRA Rule 5310 should be directed to:

      •  Brant Brown, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6927 or Brant.Brown@finra.org; or
      •  Andrew Madar, Associate General Counsel, OGC, at (202) 728-8056 or Andrew.Madar@finra.org.

      Background and Discussion

      Best execution of customer orders is a key investor protection requirement. In light of the increasingly automated nature of the equities, options and fixed income markets, firms need to regularly review their systems and procedures relating to obtaining best execution for their customers' orders. The purpose of this Notice is to remind firms of their obligations to provide best execution, reiterate best execution principles particularly relevant in automated markets and provide guidance on conducting regular and rigorous reviews. This Notice provides both general guidance on best execution obligations for firms when handling customer orders and more specific guidance on issues that have recently arisen in the fixed income market. Firms should review their systems and procedures to ensure they are designed to incorporate and reflect the best execution principles and the guidance provided herein.

      1. The Duty of Best Execution

      As previously stated,2 a broker-dealer's obligation to obtain best execution of a customer's order in any security is based, in part, on the common law agency duty of loyalty, which obligates an agent to act exclusively in the principal's best interest, and also has been incorporated explicitly in FINRA rules.3 As such, any broker-dealer, when acting as agent on behalf of a customer in a transaction, is under a duty to exercise reasonable care to obtain the most advantageous terms for the customer.4 In addition, best execution duties also arise when a broker-dealer is trading in a principal capacity with a customer.5 Broker-dealers that are FINRA members also have best execution obligations pursuant to FINRA Rule 5310.

      The SEC has recognized that the scope of the duty of best execution must evolve as changes occur in the market that give rise to improved executions for customer orders. The SEC has articulated a non-exhaustive list of factors that firms should consider as part of their best execution analysis as markets evolve: (1) the size of the order; (2) the trading characteristics of the security involved; (3) the availability of accurate information affecting choices as to the most favorable market center for execution and the availability of technological aids to process such information; and (4) the cost and difficulty associated with achieving an execution in a particular market center.6

      When a firm is routing order flow for automated execution, or internally executing such order flow on an automated basis, the SEC has indicated that simply obtaining the best bid or best offer (BBO) may not satisfy a firm's best execution obligation, particularly with respect to small orders.7 Conversely, while a firm is required to seek the most favorable terms reasonably available under the circumstances of the transaction, such terms may not necessarily in every case be the best price available.8 The SEC also has stated that the best execution analysis may evolve due to changes in the market that give rise to improved executions, including the opportunity to trade at more advantageous prices.9 If different markets may be more suitable for different types of orders or particular securities, the broker-dealer will also need to consider such factors.10 For example, the routing decisions for non-marketable orders may require a different analysis (e.g., including fill rates in the analysis) than would be appropriate for marketable orders.

      The broker-dealer duty of best execution has been codified in FINRA's best execution rule, Rule 5310. This rule provides that, "[i]n any transaction for or with a customer or a customer of another broker-dealer, a member and persons associated with a member shall use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions." The rule governs both transactions where the firm acts as agent for the account of its customer, and also where transactions are executed as principal.11 Among the factors that will be considered in determining whether a firm has used "reasonable diligence" are:
      a. the character of the market for the security (e.g., price, volatility, relative liquidity and pressure on available communications);
      b. the size and type of transaction;
      c. the number of markets checked;
      d. accessibility of the quotation; and
      e. the terms and conditions of the order which result in the transaction, as communicated to the member and persons associated with the member.12
      As demonstrated by the language of Rule 5310, the determination as to whether a firm exercised reasonable diligence to ascertain the best market for the security and bought or sold in that market so that the resultant price to the customer is as favorable as possible under prevailing market conditions necessarily involves a "facts and circumstances" analysis.13 In addition, a firm must make every effort to execute a marketable customer order that it receives fully and promptly.14 For non-marketable orders, firms should regularly review their routing decisions as well as the policies and procedures in place regarding the monitoring of non-marketable orders to ensure their best execution obligations are met. Depending upon the particular set of facts and circumstances surrounding an execution, actions that in one instance may meet a firm's best execution obligation may not satisfy that obligation under another set of circumstances.

      FINRA also reminds firms that they cannot transfer to another person their obligations to provide best execution to their customers' orders, although other firms may also acquire that best execution obligation.15 Accordingly, when a firm receives customer orders from a routing firm for purposes of order handling and execution, both the routing firm and the executing firm have best execution obligations, although the routing firm and the executing firm may have different best execution obligations.16 As such, a broker-dealer that routes all of its order flow to another broker-dealer without conducting an independent review of execution quality would violate the duty of best execution.17
      2. Regular and Rigorous Review for Best Execution

      An important focus of FINRA's examination program is the review of a firm's procedures to regularly and rigorously examine execution quality likely to be obtained from the different markets or market makers trading a security. The requirement that a broker-dealer must "regularly and rigorously" examine the execution quality that is likely to be obtained from different venues has been articulated by the SEC in a variety of contexts.18 FINRA has also incorporated the "regular and rigorous review" requirement into Rule 5310.19 However, when routing or internally executing larger-sized orders in any security, regular and rigorous review alone (as opposed to an order-by-order review) may not satisfy best execution requirements, given that the execution of larger-size orders "often requires more judgment in terms of market timing and capital commitment."20

      FINRA believes that, given developments in order routing technology, order-by-order review of execution quality is increasingly possible for a range of orders in all equity securities and standardized options. A firm that chooses not to conduct an order-by-order review for some orders must have procedures in place to ensure that it periodically conducts a regular and rigorous review of execution quality for those orders. Such periodic reviews of execution quality must be conducted on a security-by-security, type-of-order basis (e.g., for equity securities, limit order, market order, and market on open order). Firms choosing to conduct a regular and rigorous review must conduct the reviews, at a minimum, on a quarterly basis; however, Supplementary Material .09 to Rule 5310 notes that firms should consider, based on the firm's business, whether more frequent reviews are needed.21 FINRA has found that some firms, in reviewing their business, have determined that it is necessary to conduct their reviews more frequently than quarterly, with most of those firms conducting monthly reviews.22

      Although FINRA has noted that a regular and rigorous review can satisfy a firm's best execution obligation for firms that route orders and for firms that internalize orders,23 a firm's ability to rely on a regular and rigorous review applies only to the firm's initial determination whether to route an order and those orders ultimately routed outside of the firm. Any orders a firm determines to execute by internalizing would be subject to an order-by-order analysis of execution quality. Thus, while Supplementary Material .09 to Rule 5310 allows a firm to use a regular and rigorous review of execution quality, this standard only applies to a firm's initial determination whether to route an order and to its review of orders routed outside of the firm. Orders that a firm determines to execute internally are subject to an order-by-order best execution analysis.

      When conducting its review of execution quality in any security, a firm should consider: (1) the price obtained, including the extent to which an execution results in price disimprovement (i.e., instances where orders are executed at inferior prices);24 (2) the extent to which an order may obtain price improvement at other venues;25 (3) the likelihood that an order will be partially or fully executed; (4) the speed of execution; (5) the size of execution; (6) transaction costs; and (7) customer needs and expectations.26 In addition, a firm should consider the factors listed below, as applicable, when considering its best execution obligations in equities, options or fixed income securities.27 In the context of equity securities, FINRA notes that these requirements apply to customer non-marketable limit orders as well as market and marketable limit orders.
      •  In conducting its regular and rigorous review, a firm must determine whether any material differences in execution quality exist among the markets trading the security.28 If so, a firm should take these differences into account in its customer routing arrangements or justify why it is not modifying its routing arrangements.29
      •  In formulating policies and procedures to review execution quality for customer transactions, firms should consider what procedures they use or would use for executing the same or similar transactions for their own firm accounts, even if such procedures are not required to be the same.
      •  A firm that routinely routes a customer order to multiple trading centers (internal or external) should regularly review the execution quality that results from this practice. For example, the firm should evaluate the latency attendant in routing a customer order (or portion of a customer order) to multiple ATSs, a practice of routing to a particular trading center (e.g., an internal ATS) before other routing decisions are made, or repeated routing to the same ATS, and whether such practices may result in latency that impacts fill rates or the overall quality of execution. The firm should also examine whether any of these practices may result in information leakage, and the impact of any information leakage on execution quality. Firms should consider the risk of information leakage by routing orders to a particular venue in light of the fill rates achieved at that venue and carefully assess whether the risks outweigh the potential for an execution.
      •  A firm that limits its review of execution quality only to those markets to which it currently routes customer order flow without considering competing markets would not satisfy the duty of best execution.30 Accordingly, the firm must compare the quality of the executions it is obtaining via current order routing and execution arrangements (including the internalization of order flow) to the quality of the executions that it could obtain from competing markets.31 This obligation would include reviewing new markets and trading centers that become available as potential markets to which the firm may route orders; thus, a firm should regularly consider execution quality at venues to which it is not connected and assess whether it should connect to such venues.
      •  Some firms may employ "filters," which generally refers to automated tools that allow the firm to limit its trading, with, for example, specific parties or parties with specified attributes with which it does not want to interact. If a firm uses filters on counterparties or filters on specific securities intended to limit accessing bids or offers in those securities, they may be used only for a legitimate purpose consistent with obtaining the most favorable executions for customers, and should be reviewed on a periodic basis and adjusted as needed. The firm, accordingly, should have policies and procedures in place that govern when and how to reasonably use filters without negatively impacting the quality of execution; periodically reevaluate their use; and determine whether to lift them upon request.32
      •  A firm must take into account market and technology changes that might alter its best execution analysis.33
      •  With respect to customer limit orders for equity securities, a firm must consider any material differences in execution quality (e.g., the likelihood of execution) among the various markets to which orders may be routed.34
      An introducing firm may rely on the executing firm's regular and rigorous review of execution quality for any security, so long as the executing firm fully discloses the statistical results and rationale of its review to the introducing firm, and the introducing firm reviews both the methodology and the results of that review.35
      3. Best Execution and Payment for Order Flow

      The SEC has also addressed the concept of best execution and its relationship to the practice of payment for order flow in connection with equity securities and options. For example, while the SEC has previously stated that bulk order routing "based, in part, on the receipt of payment for order flow is not, in and of itself, a violation of" a broker-dealer's duty of best execution,36 the SEC also has emphasized that payment for order flow may "raise concerns about whether a firm is meeting its obligation of best execution to its customer."37 The SEC has stated that an order routing inducement, such as receipt of payment for order flow, cannot be allowed to interfere with a broker-dealer's duty of best execution.38 Similarly, firms should not allow access fees charged by particular venues to inappropriately affect their routing decisions, and, in general, a firm's routing decisions should not be unduly influenced by a particular venue's fee or rebate structure. Rule 5310 also addresses the practice of payment for order flow as it relates to best execution. Specifically, Supplementary Material .09 states that a firm should consider the existence of internalization or payment for order flow arrangements when conducting its regular and rigorous review of execution quality.39

      The SEC has stated that the possibility of obtaining price improvement on an order is a heightened consideration when the broker-dealer is receiving payment for order flow.40 Payment for order flow may encompass a broad variety of rebate and payment structures and practices. Specifically, SEA Rule 10b-10 defines payment for order flow to include "discounts, rebates, or any other reductions of or credits against any fee to, or expense or other financial obligation of, the broker or dealer routing a customer order that exceeds that fee, expense or financial obligation."41 Given the potential conflict between the receipt of payment for order flow, which is broadly defined under Rule 10b-10, and the duty of best execution, a firm should carefully evaluate its receipt of payment for order flow and the impact of such practices on execution quality.
      4. Directed Orders

      Firms may receive unsolicited orders for equity securities from customers that instruct the firm to route the orders to a particular market, often referred to as "directed orders." A firm's best execution obligations are somewhat different with respect to the execution of directed orders because the customer has provided the firm with a specific instruction as to where to route the order for execution.42 Under Supplementary Material .08 to Rule 5310, a firm that is handling an unsolicited directed order is not required to undertake a best execution determination regarding the market of execution beyond the customer's specific instruction.43 However, the firm is still required to process that customer's order promptly and in accordance with the terms of the order. Furthermore, if a customer has directed that an order be routed to another specific broker-dealer that is also a FINRA member, the receiving broker-dealer to which the order was directed would be required to meet the requirements of Rule 5310 with respect to its handling of the order.

      FINRA notes that, as a general matter, a firm is not obligated to accept directed orders. If a firm accepts a directed order from a customer, however, and has access to a trading center to which the customer requests that its order be directed, then the firm is obligated to act in accordance with the customer's instructions. If the firm is unable to route the order to the specific market in accordance with the customer's instructions, the customer must be informed of that fact and have been provided the opportunity to revise or cancel the order. Just as with a firm's regular and rigorous review, a firm has an obligation to periodically assess whether it should establish connectivity to trading centers, or terminate connectivity, when handling customer orders.
      5. Additional Considerations for Best Execution for Fixed Income Securities

      The market for fixed income securities has evolved significantly in recent years. Some firms have reduced their inventory positions in response to market and regulatory influences and the use of electronic trading systems, including dark and lit ATSs, continues to grow. In addition, transaction prices for most fixed income securities are now widely available to market participants and investors. Although the amount of pre-trade pricing information (e.g., bids and offers) available also has increased, it is still relatively limited as compared to equities and generally not readily accessible by the investing public. While new technology and communications in the fixed income market have advanced, the market remains decentralized, with much trading still occurring primarily through individual dealers.

      As the availability of electronic systems that facilitate trading in fixed income securities increases, firms need to determine whether these systems may provide benefits to their customer order flow, particularly retail order flow, and help ensure they are meeting their obligations under the rule with respect to ascertaining the best market for their customer transactions. Similarly, pre-trade transparency, such as through electronic trading platforms, is also increasing in the fixed income markets, although predominantly for smaller orders, and firms need to routinely analyze and determine whether incorporating pricing information available from these systems should be incorporated into their best execution policies and procedures.

      FINRA recognizes that different systems provide different levels of price information and execution functionality, and that a firm's analysis of the available pricing information offered by different systems may take these differences into account. Some systems, including auto-execution systems, both display prices and provide execution functionality, while other systems display prices but provide no execution functionality. Still other systems, such as RFQ systems, may provide indications of interest but not display prices or provide execution functionality. As such, a firm that uses, for example, an auto-execution system should routinely analyze pricing information from other systems that offer bona fide, executable prices and determine whether those systems should be incorporated into the firm's best execution policies and procedures.

      FINRA also notes that prices of a fixed income security displayed on an electronic trading platform may not be the presumptive best price of that security for best execution purposes, especially for securities that are illiquid or trade infrequently. Thus, although a firm should consider using this information as part of its reasonable diligence in determining the best market for the security, executing a customer order at the displayed price may not fulfill the firm's obligations, particularly if other sources of information indicate the displayed price may not be the best price available. For example, if , as disussed in more detail below, a firm regularly uses a reliable similar security analysis to establish prices, that firm may need to use particular care before executing a trade at a price that is displayed by a trading system if its similar security analysis suggests that the displayed price is not reflective of the market.

      FINRA also recognizes that the market for fixed income securities differs from the market for equity securities and options and also can vary significantly depending on the specific fixed income product. For example, some fixed income securities may trade frequently, be highly liquid and have transparent, accessible and firm quotations available. Other fixed income securities do not have public quotations or frequent pricing information available, and may trade infrequently; however, some fixed income securities that are less liquid also are highly fungible, meaning that they trade like other, similar securities, and the pricing in these similar securities can be used as a basis for determining prices in the original security.44 Given this significant variation in trading characteristics across fixed income securities, the best execution rule uses a "facts and circumstances" analysis by requiring that a firm use reasonable diligence to ascertain the best market for the security and to buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. A key determinant in assessing whether a firm has met this reasonable diligence standard is the character of the market for the security itself, which includes an analysis of price, volatility and relative liquidity. FINRA also recognizes that orders may be handled and executed differently in the fixed income market than in the market for equity securities and options. Given such differences firms may determine that their review of execution quality for fixed income securities may be less frequent than that of equity securities or options.

      In addition, Supplementary Material .03 to Rule 5310 specifically addresses the application of the best execution rule to the fixed income market when assessing the accessibility of a quotation. Supplementary Material .03 states that, when quotations are available, FINRA will consider the accessibility of such quotations when determining whether a firm has used reasonable diligence. However, Supplementary Material .03 also notes that the accessibility of the quotation is only one of the non-exhaustive reasonable diligence factors set out in Rule 5310, and that, in the absence of accessibility, firms are not relieved from taking reasonable steps and employing their market expertise in achieving the best execution of customer orders.

      The duty of best execution does not necessarily require a firm to access every available platform that trades fixed income securities, especially given the differences in pricing information and execution functionality offered by different systems. For example, a firm may not need to post a bid-wanted on each RFQ platform for a sell order, or become a subscriber to every fixed income ATS to meet its best execution obligations. However, firms are required to evaluate the execution quality of the venues that they have access to and, to the extent information is reasonably available, regularly assess whether other venues to which a firm is not connected may provide the opportunity for best execution.45 A firm should also have policies and procedures in place for determining when it will access platforms or engage in further conduct in seeking to execute a customer order (e.g., when it will post a bid-wanted on a platform or reach out to other dealers). Firms must compare the quality of the executions they are obtaining for customers via current order routing and execution arrangements (including executing against orders as principal) to the quality of the executions that they could obtain from competing markets, including, for example, alternative trading systems or other electronic trading platforms, particularly for smaller size orders that may trade more frequently on these platforms.46 This obligation may include, for example, reviewing TRACE data for previous executions in the security or similar securities and assessing existing, as well as new, markets and trading centers that become available as potential markets from which the firm can receive pricing information or to which it may route orders.

      Supplementary Material .06 to Rule 5310 addresses instances where orders involve securities where there is limited quotation or pricing information available, which is not uncommon for many fixed income securities. In such instances, the firm must have written policies and procedures in place that address how the firm will determine the best inter-dealer market for such a security in the absence of pricing information or multiple quotations and must document its compliance with those policies and procedures.47 For example, a firm should analyze pricing information based on other data, such as previous trades in the security, to determine whether the resultant price to the customer is as favorable as possible under prevailing market conditions.48 Although a firm should generally seek out other sources of pricing information or potential liquidity when little or none is otherwise available, which may include obtaining quotations from other sources (e.g., other firms with which the firm previously has traded in the security), FINRA recognizes that, in other instances, obtaining quotations from multiple sources could adversely affect execution quality due to delays in execution or other factors.49 Consequently, a firm's procedures should include relevant factors in assessing when obtaining quotations or other pricing information from outside sources may and may not be appropriate. If pricing information related to that security, such as a firm's previous trades in the security, or other pricing information, such as a quotation from another source or the use of an evaluated pricing service, is unavailable, a firm may also consider previous trades in a similar security, if that security and those previous trades constitute a reliable basis for comparison.

      The following examples illustrate the application of best execution principles to fixed income transactions:50

      Example 1

      A firm uses Platform A to obtain pricing information and to execute transactions, although Platform B, which offers similar pricing information and execution functionality, consistently offers better prices for transactions in the same securities. The firm is not linked to Platform B. Is the firm obligated to link to Platform B, or should it otherwise modify its routing practices?

      In exercising reasonable diligence to ascertain the best market for the security, a firm may consider a variety of factors, including the price that may be obtained at different venues, the accessibility of quotations at different venues, and the size and type of the transaction, among other things. In addition, firms should regularly evaluate the execution quality of venues to which they are connected, and of the venues to which they are not connected. While price may not always be the determinative factor when evaluating execution quality, given that Platform B consistently offers superior prices, it is likely that the firm's analysis would result in connecting to Platform B. In determining whether Platform B represents the best market for the security, however, the firm should also examine other factors set forth in Rule 5310.

      Example 2

      A firm uses Platform A to execute retail transactions and Platform B to execute institutional transactions. There is no size limitation that would prevent retail transactions from being executed on Platform B. Is it permissible for a firm to use different platforms to execute different customer transactions?

      In exercising reasonable diligence to ascertain the best market for the security, a firm may consider a variety of factors, including the size and type of the transaction and the accessibility of the quotation. Given that there is no limitation on executing retail transactions on Platform B, however, and the fact that the firm already routes institutional orders to Platform B for execution, the firm should thoroughly evaluate whether retail customer orders would obtain superior executions if routed to Platform B for execution.

      Example 3

      After receiving a customer sell order for a particular bond, a firm checks Platform A for bids and, finding no bids on Platform A, calls several other firms to solicit a bid. Following this outreach, the firm conducts a bid-wanted process; however, no bids are received. Is the firm obligated to seek out prices or solicit bids on other platforms, even if this would require the firm to subscribe to such platforms?

      In exercising reasonable diligence to ascertain the best market for the security, a firm may consider a variety of factors, including the number of markets checked. If a firm generally receives bids on Platform A in response to a bid-wanted process, then the firm may not be obligated to connect to other platforms, unless other factors set forth in Rule 5310 indicate that other platforms represent the best market for the security. If, however, the firm regularly receives no bids on Platform A in response to a bid-wanted process, then the firm should evaluate the liquidity and accessibility of other platforms in determining whether to connect to such platforms. If the firm ultimately intends to buy the bonds from the customer as principal, best execution continues to apply, and the firm would need to have a reasonable basis for establishing the price to the customer, which, under the circumstances described above, may include reviewing previous trades in the same bond, similar securities, or both pursuant to the process established in the firm's policies and procedures.

      Extreme Market Conditions

      In the potential event of extreme market conditions impacting the trading of fixed income securities (e.g., a shortage of liquidity and divergent prices during periods of significant ratings changes or interest rate movements), a firm should consider establishing and implementing procedures that are designed to preserve the continued execution of customers' orders in a manner that is consistent with the firm's best execution obligations while also recognizing and limiting the exposure of the firm to extraordinary market risk. A firm should consider the following guidelines when evaluating its best execution procedures during extreme market conditions:
      •  The treatment of customer orders must remain fair, consistent, and reasonable.
      •  To the extent that a firm's order handling procedures are different during extreme market conditions, the firm should disclose to its customers the differences in the procedures from normal market conditions and the circumstances in which the firm may generally activate these procedures.51
      •  Activation of procedures designed to respond to extreme market conditions may be implemented only when warranted by market conditions. Excessive activation of modified procedures on the grounds of extreme market conditions could raise best execution concerns. Accordingly, firms should document the basis for activation of their modified procedures.
      Ultimately, a facts and circumstances analysis is neccessary to determine whether actions taken by a firm during extreme market conditions are consistent with the duty of best execution, but FINRA recognizes that market conditions are an important factor in the firm's best execution determination.

      * * * * *

      The structure of the fixed income, equity and options markets continues to evolve. As the SEC stated in the Order Execution Obligations Release, "[t]he scope of this duty of best execution must evolve as changes occur in the market that give rise to improved executions for customer orders.... As these changes occur, broker-dealers' procedures for seeking to obtain best execution for customer orders also must be modified to consider price opportunities that become "reasonably available.""52 Firms are reminded to routinely review and assess their systems and procedures relating to obtaining best execution for their customers' orders, particularly in light of advances in trading technology and communications, and consider how these changes may afford new opportunities for more favorable executions for customer orders.


      1. FINRA believes the guidance in this Notice is consistent in all material respects with guidance on best execution obligations on transactions in municipal securities published by the MSRB on November 20, 2015, except where the rule or context otherwise specifically requires. The two instances where material differences exist with the MSRB's guidance are with respect to (1) the regular and rigorous review of execution quality required by members, and (2) the timeliness of executions consistent with reasonable diligence. See Section 2 (Regular and Rigorous Review for Best Execution); MSRB Implementation Guidance on MSRB Rule G-18, On Best Execution, note 12 and accompanying text; Section 1 (The Duty of Best Execution); MSRB Implementation Guidance on MSRB Rule G-18, On Best Execution, Section VI.1. FINRA and the MSRB will continue to work together with the goal of ensuring that their guidance on best execution obligations remains consistent in all material respects, unless differentiation is necessary due to differences in the markets for municipal or corporate fixed income securities or their respective rules.

      2. See, e.g., Notice to Members 06-58 (October 2006); Notice to Members 01-22 (April 2001); Notice to Members 99-12 (February 1999); and Notice to Members 97-57 (September 1997).

      3. See Securities Exchange Act Release No. 34902 (October 27, 1994), 59 FR 55006, 55007 at n.15 (November 2, 1994) ("Payment for Order Flow release") (citing Restatement 2d Agency Sections 387; 424 (1958)); see also Newton v. Merrill, Lynch, Pierce, Fenner & Smith, 135 F.3d 266, 270 (3d Cir. 1998).

      4. See Payment for Order Flow release, 59 FR at 55007 n.15.

      5. See Rule 5310(e); see also SEC Market 2000 Report, Study V (January 1994).

      6. See Securities Exchange Act Release No. 43590 (November 17, 2000), 65 FR 75414, 75418 (December 1, 2000) ("Disclosure of Order Execution and Routing Practices release"); see also Payment for Order Flow release, 59 FR at 55008 n.25.

      7. See Securities Exchange Act Release No. 37619A (September 6, 1996), 61 FR 48290, 48323 (September 12, 1996) ("Order Execution Obligations release"). See also In the Matter of Scottrade, Inc., Securities Exchange Act Release No. 58012 (June 24, 2008). In that case, the SEC found that the firm willfully violated Section 15(c)(1)(A) of the Act, which prohibits the making of material misrepresentations in connection with the execution of customer orders, where the firm represented to customers that it would provide customers with the opportunity to receive executions that were superior to the NBBO, but, for pre-open orders in Nasdaq securities, routed such orders to previously selected market centers using pre-programmed routing, and did not evaluate whether other venues offered prices superior to the NBBO for such orders.

      8. See Disclosure of Order Execution and Routing Practices release, 65 FR at 75420. Although Rule 611's general prohibition on trading through a protected quotation can help ensure that customer orders are not executed at prices that are inferior to the best protected bid or offer, the SEC emphasized that Rule 611 "in no way lessens a broker-dealer's duty of best execution." See Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, at 37537 (June 29, 2005); see also 17 CFR 242.611. Rather, Rule 611 "undergirds" a firm's best execution obligation and serves as a minimum requirement, and compliance with Rule 611 does not necessarily equate with satisfaction of best execution. See id. at 37538.

      9. See Order Execution Obligations release, 61 FR at 48323.

      10. See id.

      11. See Rule 5310(e).

      12. Rule 5310(a)(1). The exercise of reasonable diligence to ascertain the best market under prevailing market conditions can be affected by the market data, including specific data feeds, used by a firm. For example, a firm that regularly accesses proprietary data feeds, in addition to the consolidated SIP feed, for its proprietary trading, would be expected to also be using these data feeds to determine the best market under prevailing market conditions when handling customer orders to meet its best execution obligations.

      13. Because a determination regarding whether a firm has used reasonable diligence is a "facts and circumstances" analysis, firms should consider documenting their compliance with the rule with respect to trading in equities, options and fixed income securities. More generally, FINRA also notes that Rule 3110 requires members to have written policies and procedures in place that are reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. See Rule 3110(b)(1). Although some firms may choose to document their compliance on a transaction-by-transaction basis, FINRA recognizes that there may be reasonable alternative approaches that would satisfy the requirements of FINRA rules and be sufficient to demonstrate compliance. As discussed below, Supplementary Material .06 to Rule 5310 addresses instances where orders involve securities where there is limited quotation or pricing information available. In those instances, the firm must have written policies and procedures in place that address how the firm will determine the best inter-dealer market for such a security in the absence of pricing information or multiple quotations and must document its compliance with those policies and procedures.

      14. See Supplementary Material .01 to Rule 5310. See also In the Matter of Morgan Stanley & Co., Securities Exchange Act Release No. 55726 (May 9, 2007) (firm failed to seek best execution where a new trading mechanism improperly delayed the execution of certain held market orders, which the firm "had an obligation to execute without hesitation as required").

      15. FINRA also notes that firms must maintain adequate resources to fulfill their best execution obligations and a firm's "[f]ailure to maintain or adequately staff an over-the-counter order room or other department assigned to execute customers' orders cannot be considered justification for executing away from the best available market." See Rule 5310(c).

      16. See Supplementary Material .09 to Rule 5310. In contrast, a firm's duty to provide best execution in any transaction "for or with a customer of another broker-dealer" does not apply in instances when another broker-dealer is simply executing a customer order against the firm's quote.

      17. See Office of Compliance Inspections and Examinations: Examinations of Broker-Dealers Offering Online Trading: Summary of Findings and Recommendations (January 25, 2001); see also Notice to Members 01-22 at 204 ("[A]n introducing firm has an obligation to conduct an independent review for execution quality.").

      18. See, e.g., Disclosure of Order Execution and Routing Practices release, 65 FR at 75418; see also Securities Exchange Act Release No. 37619A (September 6, 1996), 61 FR 48290, 48323 (September 12, 1996) ("Order Execution Obligations release") (articulating this requirement in the context of the routing and execution of small customer orders); Notice to Members 01-22 at 203 (April 2001).

      The SEC has clearly stated that the duty of best execution does not necessarily require broker-dealers with a large volume of orders to determine individually whereto route each order, particularly with respect to small customer orders. See Disclosure of Order Execution and Routing Practices release, 65 FR at 75420; Order Execution Obligations release, 61 FR at 48323. Similarly, FINRA Rule 5310 and its Supplementary Material allow for a regular and rigorous review, as opposed to an order-by-order review, for firms that route customer orders to other broker-dealers for execution on an automated, non-discretionary basis, as well as for firms that internalize customer order flow. See Supplementary Material .09 to Rule 5310.

      In the Order Execution Obligations release, which adopted the Display Rule and amendments to the Quote Rule, the SEC noted that the amendments were designed, in part, to "narrow quotes, enhance market liquidity, and improve an investor's ability to monitor the quality of its executions." 61 FR at 48296. The SEC found that the Display Rule "will increase the likelihood that limit orders will be executed," which is a result that "is consistent with the duty of best execution." Id.

      19. See Supplementary Material .09 to Rule 5310.

      20. See Notice to Members 01-22 at n.13.

      21. Supplementary Material .09(a) to Rule 5310; see also Notice to Members 01-22 at 205. FINRA notes that reports on order execution pursuant to Rule 605 of Regulation NMS are required to be made available on a monthly basis. See 17 CFR 242.605(a).

      22. FINRA understands that some firms may enter into contracts pursuant to which they agree in advance to send a portion (or all) of their customer order flow to another firm for handling and execution. FINRA notes that the existence of such a contract in no way alters a firm's best execution obligation to analyze and review the execution quality of the orders routed to that firm. Firms should ensure that such contracts do not inappropriately influence or constrain the firm in making its routing decisions based on the results of its regular and rigorous reviews for best execution.

      23. See Securities Exchange Act Release No. 65579 (October 17, 2011), 76 FR 65549 (October 21, 2011).

      24. See Order Execution Obligations release, 61 FR at 48323, Supplementary Material .09 to Rule 5310. FINRA believes that, given the requirements of Regulation NMS, trades at prices outside the best bid and offer for smaller orders should be rare. Firms should avoid and address such trades.

      25. See Order Execution Obligations release, 61 FR at 48323; see also Payment for Order Flow release, 59 FR at 55009; Supplementary Material .09 to Rule 5310. For example, if a firm obtains price improvement at one venue of $0.0005 per share, and it could obtain mid-point price improvement at another venue of $0.025 per share, the firm should consider the opportunity of such midpoint price improvement on that other venue as part of its best execution analysis.

      26. See Supplementary Material .09 to Rule 5310; see also Notice to Members 01-22 at 205.

      27. Although the price obtained in a transaction is a key element of the best execution analysis, the SEC has noted that execution price and speed "are not the sole relevant factors in obtaining best execution of investor orders," and rejected commenters' concerns that Rule 11Ac1-5 (now Rule 605) would over-emphasize the quantitative factors of execution price and speed in the best execution analysis. See Disclosure of Order Execution and Routing Practices release, 65 FR at 75418.

      28. See Disclosure of Order Execution and Routing Practices release, 65 FR at 75420 n.33 (citing Order Execution Obligations release, 61 FR at 48323); see also Supplementary Material .09 to Rule 5310.

      29. See Supplementary Material .09 to Rule 5310; see also Notice to Members 01-22 at 204.

      30. See Office of Compliance Inspections and Examinations: Examinations of Broker-Dealers Offering Online Trading: Summary of Findings and Recommendations (January 25, 2001).

      31. See Supplementary Material .09 to Rule 5310; see also Notice to Members 01-22 at 204.

      32. The scope of a firm's policies and procedures on the use of filters, as well as the periodic review and adjustment of their use, should be appropriate to the nature of the firm's business and, therefore, may be different than the policies and procedures used by other firms.

      33. See Order Execution Obligations release, 61 FR at 48323 (noting that, because technology is rapidly making ECNs more accessible, "broker-dealers must regularly evaluate whether prices or benefits offered by these systems are reasonably available for purposes of seeking best execution").

      34. Id.; see also Supplementary Material .09 to Rule 5310.

      35. See Supplementary Material .09 to Rule 5310; see also Notice to Members 01-22 at 204.

      36. See Payment for Order Flow release, 59 FR at 55009 n.28. See also Disclosure of Order Execution and Routing Practices release, 65 FR at 75420 (a broker-dealer does not violate its best execution obligation solely because it receives payment for order flow).

      37. See Payment for Order Flow release, 59 FR at 55007.

      38. Id. at 55009.

      39. Supplementary Material .09 to Rule 5310.

      40. See Payment for Order Flow release, 59 FR at 55009.

      41. 17 CFR 240.10b-10. In the 1994 Payment for Order Flow release, which adopted the current language for Rule 10b-10, some commenters (including most of the then-exchanges) argued that rebates and fee reductions are structurally different from other cash payments and should be excluded from the monetary definition of payment for order flow. See Payment for Order Flow release, 59 FR at 55008 n.20. One commenter suggested that exchange rebates and fees could constitute the economic equivalent of payment for order flow, provided that the arrangement exceeded the fee charged for executing the order. Id. at 55008. The SEC found that payment for order flow would "include a fee arrangement in which an exchange charges 50 cents per order but offers a $2.00 per order credit for agency orders, which can be used to offset other fees incurred on that exchange." Id. at 55008 n.23. However, payment for order flow would "not include fee arrangements in which the market's net charge for executing the order, after any discount, rebate, or credit, is greater than zero." Id.

      42. Of note, directed orders are excluded from the order routing statistics required to be produced under Rule 606 of SEC Regulation NMS. See 17 CFR 242.606.

      43. See Supplementary Material .08 to Rule 5310.

      44. Given the wide variety of fixed income securities, it is impracticable to provide an exhaustive list of characteristics that qualify a bond as a "similar security" for these purposes. By way of example, however, issuer, credit rating, coupon, maturity, redemption features, sector and tax status are some factors a firm could use to identify similar bonds. Although the use of a similar security analysis may be less common in the corporate debt market than other debt securities such as municipal securities, to the extent that a firm uses a similar security analysis, its written policies and procedures should establish how it identifies similar securities, as well as how and when to consider the market for them for the purposes of complying with the best execution rule.

      45. See Office of Compliance Inspections and Examinations: Examinations of Broker-Dealers Offering Online Trading: Summary of Findings and Recommendations (January 25, 2001). Unlike in the equity market, where a firm may use a market center's report under Rule 605 of SEC Regulation NMS to evaluate execution quality, FINRA recognizes that a corollary does not exist for the fixed income markets.

      46. See Supplementary Material .09 to Rule 5310; see also Notice to Members 01-22 at 204.

      47. See Supplementary Material .06 to Rule 5310. The documentation required in this area will necessarily depend on the content of the policies and procedures that the firm determines to adopt. Only by way of example, recognizing this dependence on the content of the policies and procedures, a firm could use records providing information displayed on an alternative trading system and reviewed by a trader prior to execution, records of periodic observation of traders, notations by traders or records of pre- or post-trade reviews. These are, however, only examples of documentation methods, and the rule provides sufficient flexibility to accommodate the diverse population of firms, which can adopt policies and procedures that are reasonably related to the nature of their business, including the level of sales and trading activity and the type of customer transactions at issue, and to allow firms to demonstrate that they had been sufficiently diligent in a manner that is different than that used by other firms.

      48. Id.

      49. FINRA notes that a dealer providing a price in response to a bid request or bid list presented to the dealer or other competitive bidding process would not be subject to a best execution obligation since the dealer has not accepted a customer order for the purpose of facilitating the handling and execution of such order. This situation is analogous to Supplementary Material .04 to Rule 5310 which draws a distinction between those situations in which a firm acts solely as the buyer or seller in connection with an order presented against the firm's quote as opposed to accepting an order for handling and execution.

      50. These examples are relevant to firms' duty to connect to newtrading venues and how firms execute against orders.

      51. However, the disclosure of alternative order handling procedures that are unfair or otherwise inconsistent with the firm's best execution obligations would neither correct the deficiencies with such procedures nor absolve the firm of potential best execution violations.

      52. See Order Execution Obligations release, 61 FR at 48322–23.

    • 15-45 FINRA Announces Approval of and Implementation Date for Securities Trader and Securities Trader Principal Registration Categories and Related Qualification Examination, Fee and Continuing Education Requirements; Implementation Date: January 4, 2016

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      Securities Trader Registration and Qualification Examination

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      NASD Rule 1021
      NASD Rule 1021(a)
      NASD Rule 1022(a)
      NASD Rule 1031
      NASD Rule 1031(c)
      NASD Rule 1032(f)
      NASD Rule 1070(e)
      Regulatory Notice 15-28
      Suggested Routing

      Compliance
      Continuing Education
      Legal
      Operations
      Registration
      Senior Management
      Key Topics

      Continuing Education
      Equity Trader
      Proprietary Trader
      Qualification Examinations
      Registration Categories
      Securities Trader Principals
      Securities Traders
      Series 55
      Series 56
      Series 57

      Executive Summary

      The SEC recently approved FINRA's proposal to establish a registration category and qualification examination requirement for Securities Traders and Securities Trader Principals.1 This Notice provides firms with information regarding the Securities Trader registration category and qualification examination (Series 57), Securities Trader Principal registration category, Series 57 examination fee and implementation of the new registration categories. In addition, the Notice provides firms with information regarding the Regulatory Element Continuing Education (CE) Program for Securities Traders.

      Candidates for the Series 57 examination will be able to schedule and take the examination beginning on January 4, 2016. The content outline for the examination is available on FINRA's website.

      The amended rule text is attached as Appendix A. The rules will be implemented on January 4, 2016.

      Questions regarding this Notice should be directed to:

      •  Deborah Kase, Senior Qualifications Analyst, Testing and Continuing Education, at (212) 858-4069;
      •  Alexandra Toton, Manager, Testing and Continuing Education, at (240) 386-4677;
      •  Victoria Crane, Associate General Counsel, Office of General Counsel, at (202) 728-8104; or
      •  Afshin Atabaki, Associate General Counsel, Office of General Counsel, at (202) 728-8902.

      Background and Discussion

      The SEC approved a proposed rule change to replace the current Equity Trader registration category and qualification examination (Series 55) with a Securities Trader registration category and Series 57 examination.2 In addition, the SEC approved a Securities Trader Principal registration category for a principal with supervisory responsibility over securities trading activities.3

      A. Securities Trader Registration Category

      Amended NASD Rule 1032(f) (Limited Representative—Equity Trader) replaces the Equity Trader registration category and Series 55 examination with the Securities Trader registration category and Series 57 examination. The amended rule provides that each associated person of a firm who is included within the definition of "representative" in NASD Rule 1031 (Registration Requirements) is required to register with FINRA as a Securities Trader if, with respect to transactions in equity (including equity options), preferred or convertible debt securities effected otherwise than on a securities exchange, such person is engaged in proprietary trading, the execution of transactions on an agency basis or the direct supervision of such activities. There is an exception from the Securities Trader registration requirement for any associated person of a firm whose trading activities are conducted principally on behalf of an investment company that is registered with the SEC pursuant to the Investment Company Act of 1940 and that controls, is controlled by or is under common control with the firm. In addition, amended NASD Rule 1032(f) provides that before registration as a Securities Trader may become effective, an applicant must pass the Series 57 examination. The Series 57 examination will qualify an associated person to function as a Securities Trader. There is no prerequisite registration requirement for Securities Trader registration.

      An associated person registered as a Securities Trader will not be qualified to function in any other registered capacity unless he or she is qualified and registered in that other registration category.4 For instance, a person registered as a Securities Trader will not be able to engage in any retail or institutional sales activities unless he or she is qualified and registered in the appropriate registration category, such as a General Securities Representative.
      B. Securities Trader Principal Registration Category

      Amended NASD Rule 1022(a) (General Securities Principal) establishes a Securities Trader Principal registration category and requires each associated person of a firm who is included within the definition of "principal" in NASD Rule 1021 (Registration Requirements) with supervisory responsibility over the securities trading activities described in NASD Rule 1032(f), to qualify and register as a Securities Trader Principal.

      To qualify for registration as a Securities Trader Principal, an associated person must be registered as a Securities Trader and pass the General Securities Principal qualification examination (Series 24). An associated person registered as a Securities Trader Principal will not be eligible to register as a General Securities Principal unless the person passes the appropriate prerequisite examination for General Securities Principal registration, such as the Series 7 examination. In this regard, NASD Rule 1022(a) provides that a person qualified and registered as a Securities Trader Principal may only have supervisory responsibility over the activities specified in NASD Rule 1032(f), unless the person is separately qualified and registered in another appropriate principal registration category, such as the General Securities Principal registration category.
      C. Series 57 Examination Content and Fee

      The Series 57 examination will consist of 125 scored multiple-choice questions.5 Candidates will be allowed 3 hours and 45 minutes to complete the examination. On the day of the examination, candidates will receive a report of their results both on screen and in paper format at the end of their examination session. The score report will indicate pass/ fail status and a score profile indicating performance based on each major content area covered on the examination.

      FINRA has published a content outline for the Series 57 examination. The content outline provides a comprehensive guide to the areas covered on the examination and is intended to familiarize candidates with the range of subjects covered by the examination. Firms may wish to use the content outline to structure or prepare training materials, develop lecture notes and seminar programs, and as a training aide for candidates. The content outline is divided into four major job functions that are performed by a Securities Trader: (1) Market Overview and Products; (2) Engaging in Professional Conduct and Adhering to Regulatory Requirements; (3) Trading Activities; and (4) Maintaining Books and Records and Trade Reporting. The number of questions assigned to each major job function reflects the key tasks performed by a Securities Trader and is listed in the table below.

      Job Functions and Number of Questions by Job Function

        Job Functions Number of Questions
      Function 1 Market Overview and Products 22
      Function 2 Engaging in Professional Conduct and Adhering to Regulatory Requirements 12
      Function 3 Trading Activities 79
      Function 4 Maintaining Books and Records and Trade Reporting 12
      Total 125


      FINRA will update, as needed, the content outline and questions used in the examination to reflect amendments to, or the introduction of, government and self-regulatory organization rules and regulations, changes in industry practice and the introduction of new products. Questions on new rules and regulations will be added to the pool of questions for this examination within a reasonable period of time of the effective dates of these rules and regulations. Questions on rescinded rules and regulations will be deleted promptly from the pool of questions. Candidates will be asked rules- and regulations-based questions pertaining only to rules and regulations that are effective at the time they take the examination.

      The Series 57 examination is administered as a closed-book examination. The test administrator will provide white boards/dry erase markers and basic electronic calculators to candidates, who must return these materials to the test center administrator at the end of the testing session. Some examination questions may involve calculations. Only calculators provided by the test center administrators will be allowed to be used during the examination.

      The Series 57 examination will be administered at test centers operated by Pearson VUE and Prometric professional testing center networks. Appointments to take the examination may be scheduled through either network.

      The fee for the Series 57 examination will be $120.
      D. Implementation of the Securities Trader and Securities Trader Principal Registration Categories

      The Securities Trader registration category and the Series 57 examination will become available in the Central Registration Depository (CRD®) system on January 4, 2016. Candidates will not be able to request the Securities Trader registration category or schedule an appointment to take the Series 57 examination until January 4, 2016.
      1. Current Representative Registrants

      A person registered as an Equity Trader in the CRD system on January 4, 2016, will be grandfathered as a Securities Trader without having to take any additional examinations and without having to take any other actions. Individuals who were registered as Equity Traders in the CRD system prior to January 4, 2016, will be eligible to register as Securities Traders without having to take any additional examinations, provided that no more than two years have passed between the date they were last registered as a representative and the date they register as a Securities Trader.6
      2. New Representative Registrants

      The Equity Trader registration category and the Series 55 examination will continue to be available in the CRD system until December 29, 2015, when the CRD system will become unavailable due to annual registration renewal processing. A person for whom an Equity Trader registration request has been made in the CRD system prior to December 29, 2015, but who has not yet taken the Series 55 examination, will take the Series 55 examination even if the examination is scheduled to be taken on or after December 29, 2015. If the person passes the Series 55 examination and meets the other registration requirements prior to January 4, 2016, he or she will be registered as an Equity Trader and then automatically converted to the Securities Trader registration category on January 4, 2016.

      If the person for whom the Equity Trader registration request has been made in the CRD system prior to December 29, 2015, passes the Series 55 examination and meets the other registration requirements on or after January 4, 2016, he or she will be registered as a Securities Trader. If the person fails the Series 55 examination on or after January 4, 2016, and wishes to become registered as a Securities Trader, he or she must request the Securities Trader registration category in the CRD system and take the Series 57 examination.7
      3. Principal Level Registrants

      On or after January 4, 2016, any individual who supervises Securities Traders must maintain a Securities Trader Principal registration with FINRA. This includes associated persons who are currently registered as General Securities Principals and supervise Equity Traders. As such, firms will be required to file amended Forms U4 in the CRD system no later than 180 calendar days after January 4, 2016, to request the Securities Trader Principal registration category for applicable individuals. There will be no systematic conversion of the Securities Trader Principal registration category onto CRD. The passing of an additional securities examination (e.g., Series 24) will not be required if no more than two years have passed between the date an individual was last registered as a principal and the date the individual registers as a Securities Trader Principal.
      E. Regulatory Element CE Program for Securities Traders

      The personalized S101 CE Program will be the required CE program for Securities Traders. On January 4, 2016, the Regulatory Element CE Program for the S101 will be available via CE Online.8 In addition, the S101 CE Program will include a fourth, personalized module that will allow the participant to select one of five job functions (Institutional Sales, Trading, Operations, Retail Sales or Investment Banking/Research) specific to his or her responsibilities as a registered person. As a result of this change, starting on January 4, 2016, the S101 CE Program will incorporate the S501 CE Program for Proprietary Traders. All individuals registered as Securities Traders on or after January 4, 2016, including Proprietary Traders currently subject to the S501 CE Program, will be subject to the personalized S101 CE Program. For more information regarding this transition, please visit: http://www.finra. org/industry/ce-online-proprietary-traders.

      1. See Securities Exchange Act Release No. 75783 (August 28, 2015), 80 FR 53369 (September 3, 2015) (Order Approving File No. SR-FINRA-2015-017) (Approval Order).

      2. See id.

      3. The national securities exchanges have also filed or will file proposed rule changes to replace the Proprietary Trader qualification examination (Series 56) with the Series 57 examination in their respective registration rules relating to securities trading activities. Further, the Series 57 examination will replace the Series 56 examination for those exchange registration categories, such as the Proprietary Trader Principal registration category, where the Series 56 examination was an acceptable prerequisite.

      As part of the proposed rule change, and in anticipation of the national securities exchanges filing similar proposed rule changes to replace the Series 56 examination with the Series 57 examination in the respective registration rules, FINRA also amended the Form U4 to replace: (1) the Equity Trader registration category with the Securities Trader registration category as well as references to the Series 55 examination with the Series 57 examination; (2) the Proprietary Trader registration category with the Securities Trader registration category as well as references to the Series 56 examination with the Series 57 examination; and (3) the Proprietary Trader Principal registration category with the Securities Trader Principal registration category.

      4. See NASD Rule 1032(f).

      5. Consistent with FINRA's practice of including "pre-test" questions on certain qualification examinations, which is designed to ensure that new examination questions meet acceptable testing standards prior to use for scoring purposes, the Series 57 examination will include ten additional, unidentified pre-test questions that will not contribute towards the candidate's score. Thus, the examination will consist of 135 questions, 125 of which will be scored. The ten pre-test questions will be randomly distributed throughout the examination.

      6. See NASD Rule 1031(c) (Requirements for Examination on Lapse of Registration).

      7. See NASD Rule 1070(e). See also www.finra.org/industry/series 57 for more information on administrative tasks associated with the implementation of the Securities Trader registration category and changes to the Propriety Trader examination and registration category.

      8. See Regulatory Notice 15-28 (August 2015).


      APPENDIX A

      Appendix A shows the text of the proposed rule change. Proposed new language is underlined; proposed deletions are in brackets.

      *****

      1000. MEMBERSHIP, REGISTRATION AND QUALIFICATION REQUIREMENTS

      *****

      1020. Registration of Principals

      *****

      1022. Categories of Principal Registration
      (a) General Securities Principal
      (1) Each person associated with a member who is included within the definition of principal in Rule 1021, and each person designated as a Chief Compliance Officer on Schedule A of Form BD, shall be required to register with the Association as a General Securities Principal and shall pass an appropriate Qualification Examination before such registration may become effective unless such person's activities are so limited as to qualify such person for one or more of the limited categories of principal registration specified hereafter. A person whose activities in the investment banking or securities business are so limited is not, however, precluded from attempting to become qualified for registration as a General Securities Principal, and if qualified, may become so registered.
      (A) Subject to paragraphs (a)(1)(B), (a)(2), [and] (a)(5) and (a)(6), each person seeking to register and qualify as a General Securities Principal must, prior to or concurrent with such registration, become registered, pursuant to the Rule 1030 Series, either as a General Securities Representative or a Limited Representative-Corporate Securities.
      (B) through (C) No Change.
      (2) through (5) No Change.
      (6)
      (A) Each person associated with a member who is included within the definition of principal in Rule 1021 and who will have supervisory responsibility over the securities trading activities described in Rule 1032(f)(1) shall become qualified and registered as a Securities Trader Principal. To qualify for registration as a Securities Trader Principal, such person shall become qualified and registered as a Securities Trader under Rule 1032(f) and pass the General Securities Principal qualification examination. A person who is qualified and registered as a Securities Trader Principal under this subparagraph (A) may only have supervisory responsibility over the activities specified in Rule 1032(f)(1), unless such person is separately qualified and registered in another appropriate principal registration category, such as the General Securities Principal registration category.
      (B) A person who is registered as a General Securities Principal shall not be qualified to supervise the trading activities described in Rule 1032(f)(1), unless such person has also become qualified and registered as a Securities Trader under Rule 1032(f) by passing the Securities Trader qualification examination and become registered as a Securities Trader Principal.
      (b) through (h) No Change.
      1030. Registration of Representatives

      *****

      1032. Categories of Representative Registration
      (a) through (e) No Change.
      (f) [Limited Representative—Equity] Securities Trader
      (1) Each person associated with a member who is included within the definition of a representative as defined in Rule 1031 must register with the Association as a [Limited Representative—Equity] Securities Trader if, with respect to transactions in equity, preferred or convertible debt securities effected otherwise than on a securities exchange, such person is engaged in proprietary trading, the execution of transactions on an agency basis, or the direct supervision of such activities, other than any person associated with a member whose trading activities are conducted principally on behalf of an investment company that is registered with the Commission pursuant to the Investment Company Act of 1940 and that controls, is controlled by or is under common control, with the member.
      (2) Before registration as a [Limited Representative—Equity] Securities Trader as defined in subparagraph (1) hereof may become effective, an applicant must[:]
      [(A) be registered pursuant to Rule 1032, either as a General Securities Representative or a Limited Representative—Corporate Securities; and]
      [(B)] pass [an appropriate] the Securities Trader [Q]qualification [E] examination [for Limited Representative—Equity Trader].
      (3) A person registered as a Securities Trader shall not be qualified to function in any other registration category, unless he or she is also qualified and registered in such other registration category.
      (g) through (i) No Change.

      *****

    • 15-44 FINRA and ISG Extend Effective Date for Certain Electronic Blue Sheet Data Elements; Effective Date: November 1, 2017

      View PDF

      Electronic Blue Sheet Submissions

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 8211
      FINRA Rule 8213
      Notice to Members 05-58
      Notice to Members 06-33
      Regulatory Notice 11-56
      Regulatory Notice 12-36
      Regulatory Notice 12-47
      Regulatory Notice 13-16
      Regulatory Notice 13-38
      SEA Rule 13h-1
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Blue Sheets

      Executive Summary

      FINRA and the other U.S. members of the Intermarket Surveillance Group (ISG members)1 have extended the effective date for compliance with certain data elements for Electronic Blue Sheets (EBS) identified in Regulatory Notice 13-38 to November 1, 2017. FINRA and the other ISG members are extending the effective date for these data elements to be consistent with the exemptive relief recently granted by the SEC, which extended the compliance date for certain broker-dealer recordkeeping and reporting requirements of SEA Rule 13h-1 (Large Trader Rule) from November 1, 2015 to November 1, 2017.

      Attachment A to this Notice sets forth the EBS record layout, which, except for minor modifications noted below, remains unchanged from the version previously published in Regulatory Notice 13-38.

      Questions concerning the EBS enhancements should be directed to ebsfaq@finra.org.

      Discussion

      FINRA and the other ISG members have extended the effective date for compliance with certain data elements to be consistent with the exemptive relief provided by the SEC, which recently extended the compliance date for certain broker-dealer recordkeeping and reporting requirements of the Large Trader Rule from November 1, 2015 to November 1, 2017.2 Accordingly, FINRA and the other ISG members are extending the effective date for compliance with certain data elements to November 1, 2017.

      The SEC has grouped the Large Trader Rule into three phases for purposes of implementation.

      •  Phase One required clearing broker-dealers for large traders to keep records of and report, upon SEC request, specified data concerning (1) proprietary trades by large traders that are U.S.-registered broker-dealers; and (2) transactions effected by large traders through a sponsored access arrangement.3 Transaction data includes both the large trader identification number (LTID) and execution time. The compliance date for Phase One was November 30, 2012.
      •  Phase Two extended the recordkeeping and reporting requirements for clearing broker-dealers to transactions effected pursuant to a direct market access arrangement.4 As with Phase One, this requires clearing broker-dealers to report transaction data that includes both LTID and execution time. With respect to all other types of transactions, the prime broker or other carrying broker broker-dealer that carries an account for a Large Trader will have to report transaction data other than execution time, e.g., the applicable LTID. The compliance date for Phase Two was November 1, 2013.
      •  The remaining types of large traders and the transactions not covered by Phases One and Two are covered by Phase Three. Phase Three will therefore apply to all other broker-dealers subject to the recordkeeping and reporting requirements of the rule (i.e., broker-dealers that are large traders but do not self-clear, and broker-dealers effecting transactions directly or indirectly for a large trader where a non-broker-dealer carries the account for the large trader). Phase Three will therefore require all remaining broker-dealers subject to the recordkeeping and reporting requirements of Rule 13h-1 to come into full compliance with those provisions. The compliance date for Phase Three was November 1, 2015, and as noted above is being extended to November 1, 2017.

      Given the SEC's extension of the Phase Three reporting requirements and the corresponding extension of the EBS data elements, broker-dealers must now be in EBS reporting compliance by November 1, 2017, for the Order Execution Time, Large Trader Identification Number 1-3 and Large Trader Identification Qualifier fields as outlined in Phase Three of the recordkeeping, reporting and monitoring requirements of SEA Rule 13h-1.

      The EBS fields that are subject to this extension are set forth below and are unchanged from Regulatory Notice 13-38. Attachment A contains additional detail on these fields.

      Order Execution Time, Record Sequence Number Five, Field Position 72 to 77

      Firms should use this record to submit the order execution time in 24-hour format and in Eastern Time formatted as HHMMSS. This information is not limited to the blue sheet transactions relating to the SEC Large Trader Reporting Rule (SEA Rule 13h-1). Please note that all firms must synchronize their time clocks to the atomic clock to maintain an accurate audit trail in connection to the reported execution time.

      Large Trader Identification Number 1, Record Sequence Number Seven, Field Position 2 to 14

      Firms should use this record to submit the Large Trader Identification Number. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.

      Large Trader Identification Number 2, Record Sequence Number Seven, Field Position 15 to 27

      Firms should use this record to submit the Large Trader Identification Number. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.

      Large Trader Identification Number 3, Record Sequence Number Seven, Field Position 28 to 40

      Firms should use this record to submit the Large Trader Identification Number. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.

      Large Trader Identification Qualifier, Record Sequence Number Seven, Field Position 41

      Firms should use this record to submit the Large Trader Identification Qualifier. If more than three LTIDs exist for a transaction, then firms should mark the field "Y" for Yes. Otherwise it should be marked "N" for No. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.

      Broker-dealers are reminded that failure to properly fill out the EBS fields is a violation of FINRA Rule 8211 or 8213.

      The following Exchange Code modifications were made to Attachment A of this Notice:

      •  NYSE MKT, LLC (Equity and Options) = 'B'
      •  NYSE Arca (Equity and Options) = 'E'
      •  BATS Exchange, Inc. (Equity and Options) = 'H'
      •  International Securities Exchange (Options Only) = 'I'
      •  EDGA Exchange = 'P'
      •  EDGX Exchange (Equity and Options) = 'V'
      •  ISE Mercury = '2'

      In addition, the following Requestor Code modifications were made to Attachment A of this Notice:

      •  BATS Exchange, Inc. (Equity and Options) = 'H'
      •  International Securities Exchange, ISE Gemini and ISE Mercury = 'I'
      •  EDGA Exchange and EDGX Exchange (Equity and Options) = 'J'

      Separately, clearing firms are also reminded of their obligation that if the firm has a Clearing Member Trade Assignment (CMTA) agreement with another brokerage firm(s), and option trades executed during the requested date range are received from the other brokerage firm(s), then those CMTA trades should be included in the EBS submission. Refer to FAQ #72 in Notice to Members 06-33.

      Blue Sheet Testing

      FINRA's customer test website is available for firms to test whether the field format of their enhanced blue sheets data file is consistent with the EBS record layout before submitting it to production. The test website will not test whether the inputted values are complete or accurate. Firms that already have entitlement to FINRA's Regulation Filing Application can proceed with testing their EBS modifications by submitting their test data to https://regfilingtest.finra.org. To access the customer test website, firms should enter the same user ID and password that they use to access the production website. Firms that do not have entitlement to FINRA's Regulation Filing Application should contact (800) 321-6273.

      The Securities Industry Automation Corporation (SIAC) is also available to receive blue sheet test files. Questions concerning testing with SIAC should be directed to efp-support@nyse.com.

      Frequently Asked Questions

      FINRA provides answers to frequently asked questions (FAQ) on its website. The FAQs will be updated from time to time. Please see FINRA's website for the most recent version. Questions concerning the EBS enhancements should be directed to ebsfaq@finra.org.


      1. The U.S. members of the ISG include the following exchanges and self-regulatory organizations (SROs): BATS Exchange, Inc., BATS Y-Exchange, Inc., Chicago Board Options Exchange, Inc., C2 Options Exchange, Inc., CBOE Stock Exchange, LLC, Chicago Stock Exchange, Inc., EDGA Exchange, Inc., EDGX Exchange, Inc., FINRA, International Securities Exchange, LLC, The NASDAQ Stock Market LLC, NASDAQ OMX BX, Inc., NASDAQ OMX PHLX LLC, National Stock Exchange, Inc., New York Stock Exchange, LLC, NYSE MKT, LLC, NYSE Area, Inc., BOX Options Exchange, LLC, Miami International Securities Exchange, ISE Gemini and ISE Mercury.

      2. See Securities Exchange Act Release No. 76322 (October 30, 2015). The SEC previously extended the compliance date for Phase Three from November 1, 2013, to November 1, 2015. See Securities Exchange Act Release No. 70150 (August 8, 2013), 78 FR 49556 (August 14, 2013) ("SEC Extension Order I").

      In connection with the extension of Phase Three from November 1, 2013, to November 1, 2015, FINRA and the other ISG members granted a corresponding extension of certain EBS data elements to May 1, 2014. See Regulatory Notice 13-38 (November 2013).

      3. A sponsored access arrangement is defined as one "where a broker-dealer permits a customer to enter orders into a trading center without using the broker-dealer's trading system (i.e., using the customer's own technology or that of a third party provider)." See Extension Order I, supra note 2 at 49557.

      4. A direct market access arrangement is defined as "an arrangement whereby a broker-dealer permits customers to enter orders into a trading center but such orders flow through the broker-dealer's trading systems prior to reaching the trading center." See Extension Order I, supra note 2 at 49560. In that order, the SEC noted that direct market access arrangements subject to recordkeeping and reporting in Phase Two, would include, for example, those where the large trader customer enters individual orders manually or through an algorithm under its control, but those orders flow through the broker-dealer's systems prior to reaching the trading center. Phase Two would not include, however, large trader customers that delegate to the broker-dealer the discretion to determine the price, size, timing, or routing of individual orders. Id.


      Attachment A—Record Layout for Submission of Trading Information

      Field Position Field Length Field Name/Description/Remarks Field Format Justify Picture Clause Default Value
      From To
        ***This record must be the first record of the file***  
      1 3 3 FILLER A LJ X(3) HDR
      4 5 2 FILLER A LJ X(2) .S
      6 10 5 DTRK-SYSID N LJ 9(5) 12343
      11 12 2 FILLER A LJ X(2) .E
      13 14 2 FILLER N LJ 9(2) 00
      15 16 2 FILLER A LJ X(2) .C
      17 20 4 DTRK-ORIGINATOR
      Please contact SIAC for assignment at efp-support@nyse.com
      A LJ X(4)
      21 22 2 FILLER A LJ X(2) .S
      23 26 4 DTRK-SUB-ORIGINATOR
      Please contact SIAC for assignment at efp-support@nyse.com
      A LJ X(4)
      27 27 1 FILLER A LJ X(1) B
      28 33 6 DTRK-DATE
      Contains submission date.
      N LJ 9(6) MMDDYY
      34 34 1 FILLER A LJ X(1) B
      35 59 25 DTRK-DESCRIPTION
      Required to identify this file.
      A LJ X(25) FIRM TRADING INFORMATION
      60 80 21 FILLER A LJ X(21) B
      1 1 1 HEADER RECORD CODE
      Value: Low Values OR ZERO
      A X
      2 5 4 SUBMITTING BROKER NUMBER
      If NSCC member use NSCC clearing number.
      If not a NSCC member, use clearing number assigned to you by your clearing agency.
      A–R LJ X(4) B
      6 40 35 FIRM'S REQUEST NUMBER
      Tracking number used by the firm to record requests from an organization.
      A X(35) B
      41 46 6 FILE CREATION DATE
      Format is YYMMDD
      A X(6)
      47 54 8 FILE CREATION TIME
      Format is HH:MM:SS
      A X(8)
      55 55 1 REQUESTOR CODE
      Requesting Organization Identification Values:
      A X
        A = New York Stock Exchange  
      B = NYSE MKT, LLC
      C = Chicago Stock Exchange
      D = NASDAQ OMX
      E = NYSE Arca
      F = NASDAQ OMX BX, Inc.
      G = National Stock Exchange
      H = BATS Exchange, Inc. (Equity and Options)
      I = International Securities Exchange, ISE Gemini and ISE Mercury
      J = EDGA Exchange and EDGX Exchange (Equity and Options)
      K = Chicago Board Options Exchange,C2 Options Exchange and CBSX (CBOE Stock Exchange)
      R = FINRA
      U = BOX Options Exchange, LLC
      X = U.S. Securities and Exchange Commission
      Y = BATS Y-Exchange, Inc.
      7 = Miami International Securities Exchange
      56 70 15 REQUESTING ORGANIZATION NUMBER
      Number assigned by requesting organization
      A LJ X(15) B
      71 80 10 FILLER A X(10) B
      1 1 1 RECORD SEQUENCE NUMBER ONE
      The first record of the transaction. Value: 1
      A X
      2 5 4 SUBMITTING BROKER NUMBER
      Identical to Submitting Broker Number in Header Record
      A–R LJ X(4)
      6 9 4 OPPOSING BROKER NUMBER
      The NSCC clearing house number of the broker on the other side of the trade.
      A–R LJ X(4) B
      10 21 12 CUSIP NUMBER
      The cusip number assigned to the security.
      Left justified since the number is nine characters at present (8+ check digit) but will expand in the future.
      A LJ X(12) B
      22 29 8 TICKER SYMBOL
      The symbol assigned to this security. For options (pre-OSI), the OPRA option symbol (space), OPRA expiration month symbol and OPRA strike price symbol should be used. (Ex. Maytag May 20 call option series would be reported as MYG ED. This example uses six spaces in the field with a space between the OPRA symbol and the OPRA expiration month.)

      Post OSI this field must contain OPTIONXX and a Record Sequence Number Six must be completed
      A–R LJ X(8) B
      30 35 6 TRADE DATE
      The date this trade executed.
      Format is YYMMDD.
      A–R X(6) B
      36 41 6 SETTLEMENT DATE
      The date this trade will settle.
      Format is YYMMDD
      A X(6) B
      42 53 12 QUANTITY
      The number of shares or quantity of bonds or option contracts.
      N-R RJ 9(12) Z
      54 67 14 NET AMOUNT
      The proceeds of sales or cost of purchases after commissions and other charges.
      N RJ S9(12) V99 Z
      68 68 1 BUY/SELL CODE
      Values: 0 = Buy, 1 = Sale, 2 = Short Sale, 3 = Buy Open, 4 = Sell Open, 5 = Sell Close, 6 = Buy Close. A = Buy Cancel, B = Sell Cancel, C = Short Sale Cancel, D = Buy Open Cancel, E = Sell Open Cancel, F = Sell Close Cancel, G = Buy Close Cancel. Values 3 to 6 and D to G are for options only
      A–R X B
      69 78 10 PRICE
      The transaction price. Format: $$$$ CCCCCC.
      N-R RJ 9(4)V(6) Z
      79 79 1 EXCHANGE CODE
      Exchange where trade was executed. Values:
      A–R X B
        A = New York Stock Exchange  
      B = NYSE MKT, LLC (Equity and Options)
      C = Chicago Stock Exchange
      D = NASDAQ OMX PHLX
      E = NYSE Arca (Equity and Options)
      F = NASDAQ OMX BX, Inc.
      G = National Stock Exchange
      H = BATS Exchange, Inc. (Equity and Options)
      I = International Securities Exchange (Options Only)
      J = C2 Options Exchange
      K = Chicago Board Options Exchange
      L = London Stock Exchange
      M =Toronto Stock Exchange
      N = Montreal Stock Exchange
      O =TSX Venture Exchange
      P = EDGA Exchange
      Q=FINRA ADF
      R = NASDAQ OMX/NASDAQ OMX Options Market
      S = Over-the-Counter
      T = Tokyo Stock Exchange
      U = BOX Options Exchange, LLC
      V = EDGX Exchange (Equity and Options)
      W = CBSX (CBOE Stock Exchange)
      X = NASDAQ OMX PSX
      Y = BATS Y-Exchange, Inc.
      Z = Other
      1 = ISE Gemini
      2 = ISE Mercury
      7 = Miami International Securities Exchange
      80 80 1 BROKER/DEALER CODE
      Indicate if trade was done for another Broker/Dealer. Values: 0 = No; 1 = Yes
      A–R X B
      1 1 1 RECORD SEQUENCE NUMBER TWO
      Value: 2
      A X
      2 2 1 SOLICITED CODE
      Values: 0 = No; 1 = Yes
      A–R X B
      3 4 2 STATE CODE
      Standard Postal two character identification.
      A–R X(2) B
      5 14 10 ZIP CODE/COUNTRY CODE
      Zip Code—five or nine character (zip plus four)
      Country code—for future use.
      A–R LJ X(10) B
      15 22 8 BRANCH OFFICE/REGISTERED REPRESENTATIVE NUMBER
      Each treated as a four-character field.
      Both are left justified.
      A–R LJ X(8) B
      23 28 6 DATE ACCOUNT OPENED
      Format is YYMMDD
      A–R X(6) B
      29 48 20 SHORT NAME FIELD
      Contains last name followed by comma (or space) then as much of first name as will fit.
      A LJ X(20) B
      49 78 30 EMPLOYER NAME A LJ X(30) B
      79 79 1 TIN 1 INDICATOR
      Values: 1 = SS#; 2 = TIN
      A–R X B
      80 80 1 TIN 2 INDICATOR
      Values: 1 = SS#; 2 = TIN—for future use.
      A X B
      1 1 1 RECORD SEQUENCE NUMBER THREE
      Value: 3
      A X
      2 10 9 TIN ONE
      Taxpayer Identification Number
      Social Security or Tax ID Number.
      A–R LJ X(9) B
      11 19 9 TIN TWO
      Taxpayer Identification Number #2
      Reserved for future use.
      A LJ X(9) B
      20 20 1 NUMBER OF N&A LINES A X B
      21 50 30 NAME AND ADDRESS LINE ONE A–R LJ X(30) B
      51 80 30 NAME AND ADDRESS LINE TWO A–R LJ X(30) B
      1 1 1 RECORD SEQUENCE NUMBER FOUR
      Value: 4
      A X
      2 31 30 NAME AND ADDRESS LINE THREE A–R LJ X(30) B
      32 61 30 NAME AND ADDRESS LINE FOUR A–R LJ X(30) B
      62 62 1 TRANSACTION TYPE IDENTIFIERS
      See Attachment B for current codes.
      A–R X B
      63 80 18 ACCOUNT NUMBER
      Account number
      A–R LJ X(18) B
      1 1 1 RECORD SEQUENCE NUMBER FIVE
      Value: 5
      A X(1)
      2 31 30 NAME AND ADDRESS LINE FIVE A–R LJ X(30) B
      32 61 30 NAME AND ADDRESS LINE SIX A–R LJ X(30) B
      62 65 4 PRIME BROKER
      Clearing number of the account's prime broker.
      A–R LJ X(4) B
      66 66 1 AVERAGE PRICE ACCOUNT
      1= recipient of average price transaction.
      2= average price account itself.
      N-R 9(1) Z
      67 71 5 DEPOSITORY INSTITUTION IDENTIFIER
      Identifying number assigned to the account by the depository institution.
      A–R LJ X(5) B
      72 77 6 Order Execution Time

      HHMMSS—Time format will be in Eastern Time and 24 hour format.
      A–R LJ
      78 80 3 FILLER A X B
      1 1 1 RECORD SEQUENCE NUMBER SIX
      Value: 6
      A  
      2 9 8 DERIVATIVE SYMBOL
      The symbol assigned to the derivative
      A–R LJ B
      10 15 6 EXPIRATION DATE
      The date the option expires. Format is YYMMDD
      A–R B
      16 16 1 CALL/PUT INDICATOR
      C = Call, P = Put
      A–R B
      17 24 8 STRIKE DOLLAR
      The dollar amount of the strike price
      N-R RJ Z
      25 30 6 STRIKE DECIMAL
      The decimal amount of the strike price
      N-R LJ Z
      31 80 50 FILLER A LJ B
      1 1 1 RECORD SEQUENCE NUMBER SEVEN
      Value: 7
      A  
      2 14 13 Large Trader Identification 1 A–R LJ Z
      15 27 13 Large Trader Identification 2 A–R LJ Z
      28 40 13 Large Trader Identification 3 A–R LJ Z
      41 41 1 Large Trader Identification Qualifier A–R LJ Z
      42 49 8 Primary Party Identifier

      Identity of the party to the trade that is represented by the Submitting Broker of an EBS. Acceptable values include MPID, CRD or OCC Clearing Number.
      A–R LJ B
      50 57 8 Contra Party Identifier

      Identity of the contra party to the trade that is represented by the Opposing Broker of an EBS. Acceptable values include MPID, CRD or OCC Clearing Number.
      A–R LJ B
      58 80 23 FILLER A LJ B
      1 1 1 TRAILER RECORD DATE
      One record per submission. Must be the last record on the file. Value: High Values or "9"
      A X
      2 17 16 TOTAL TRANSACTIONS
      The total number of transactions.
      This total excludes Header and Trailer Records.
      N RJ 9(16) B
      18 33 16 TOTAL RECORDS ON FILE
      The total number of 80 byte records.
      This total includes Header and Trailer Records, but not the Datatrak Header Record (i.e., it does not include the first record on the file).
      N RJ 9(16) Z
      34 80 47 FILLER A X(47) B
                     
            Field Format
      A = Alphanumeric (all caps)
      N = Numeric
      P = Packed
      B = Binary
      R = Validation Required
      Default Values
      B = Blanks
      Z= Zero
      Justify
      RJ = Right Justification of Data
      LJ = Left Justification of Data
         

      Attachment B—Record Layout for Submission of Trading Information

      Transaction Type Security Type
      Equity* Options
      Non-Program Trading, Agency A C
      Non-Index Arbitrage, Program Trading, Proprietary C  
      Index Arbitrage, Program Trading, Proprietary D  
      Index Arbitrage, Program Trading, Individual Investor J  
      Non-Index Arbitrage, Program Trading, Individual Investor K  
      Non-Program Trading, Proprietary P F
      Non-Program Trading, Individual Investor I  
      Non-Index Arbitrage, Program Trading, Agency Y  
      Index Arbitrage, Program Trading, Agency U  
      Designated Market Makers S S
      Market-Maker   M
      Non-Member Market-Maker/Specialist Account   N
      Stock Specialist—Assignment   Y
      Customer Range Account of a Broker/Dealer   B
      Error Trade Q  
      Registered Trader Market Maker Transaction Regardless of the Clearing Number   P
      Voluntary Professional   W
      Joint Back Office   J

      * Equity securities include those securities that trade like equities (e.g., ETFs and structured products).

    • 15-43 FINRA Files Rule with SEC for Authority to Designate Firms for Mandatory Participation in FINRA's Business Continuity/Disaster Recovery Testing, As Required by Regulation SCI; Effective Date: November 3, 2015

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      BC/DR Testing Under Regulation SCI

      Regulatory Notice
      Notice Type

      New Rule
      Referenced Rules & Notices

      FINRA Rule 4380
      Rule 1000 of SEC Regulation SCI
      Rule 1001 of SEC Regulation SCI
      Rule 1004 of SEC Regulation SCI
      Suggested Routing

      Compliance
      Legal
      Operations
      Systems
      Trading
      Training
      Risk Management Committee
      Key Topics

      Business Continuity
      Disaster Recovery Planning
      Regulation SCI

      Executive Summary

      As required by Regulation Systems Compliance and Integrity (Regulation SCI), FINRA has adopted new Rule 4380 related to mandatory member firm participation in business continuity and disaster recovery (BC/DR) testing.1 The new rule authorizes FINRA to designate firms that must participate in FINRA's BC/DR testing under Regulation SCI, which will be conducted once per year. Under Rule 4380, FINRA will designate member firms for mandatory BC/DR testing participation based on established standards, which this Notice describes in detail.

      Questions regarding this Notice should be directed to:

      •  Chris Stone, Vice President, Transparency Services (TS), at (202) 728-8457 or chris.stone@finra.org;
      •  Ola Persson, Vice President, TS, at (212) 858-4796 or ola.persson@finra.org;
      •  Jon Kroeper, Senior Vice President, Quality of Markets, at (240) 386-5952 or jon.kroeper@finra.org; or
      •  Alex Ellenberg, Assistant General Counsel, Office of General Counsel, at (202) 728-8152 or alexander.ellenberg@finra.org.

      Background and Discussion

      Regulation SCI was adopted by the SEC on November 19, 2014, and the general compliance date is November 3, 2015.2

      Regulation SCI requires that FINRA, as an SCI entity, establish, maintain, and enforce written policies and procedures that address, among other things, "[b]usiness continuity and disaster recovery plans that include maintaining backup and recovery capabilities sufficiently resilient and geographically diverse...."3 In addition, Regulation SCI contains a separate, corresponding requirement that each SCI entity, including FINRA, designate firms that must participate in the testing of the entity's BC/DR plans.4

      The SEC noted when it adopted Regulation SCI that these mandatory backup plan testing requirements are meant to reduce the risks associated with backup plan activation and to ensure that such plans operate as intended, if activated.5 The SEC pointed specifically to situations like Superstorm Sandy, which caused the securities markets to close for two days in part based on the belief of some exchanges that some market participants could or would not be able to operate adequately from the backup facilities of all market centers.6

      As a result, Regulation SCI requires SCI entities, including FINRA, to do three things in conjunction with testing their BC/DR plans:

      1. establish standards to designate the firms it reasonably determines are, taken as a whole, the minimum necessary for the maintenance of fair and orderly markets in the event of the activation of its BC/DR plans;
      2. designate member firms pursuant to those established standards and require them to participate in scheduled functional and performance testing7 of the operation of FINRA's backup plans, at least once every 12 months; and
      3. coordinate the testing of FINRA's backup plans on an industry- or sector-wide basis with other SCI entities.8

      FINRA believes, based on preliminary discussions among SCI entities, that the yearly BC/DR testing contemplated by Regulation SCI would likely take the place of the current industry test facilitated by the Securities Industry and Financial Markets Association (SIFMA) each October. This would be consistent with guidance the SEC provided in Regulation SCI, when it noted that the existing SIFMA test could provide a foundation for the regulation's mandatory testing requirements.

      Established Standards to Designate Members for Mandatory BC/DR Testing

      Under FINRA Rule 4380, FINRA will designate member firms according to established criteria that are designed to ensure participation by those firms that FINRA reasonably determines are, taken as a whole, the minimum necessary for the maintenance of fair and orderly markets in the event of the activation of its BC/DR plan. FINRA noted when it filed Rule 4380 that its designation criteria will consider volume of activity on a FINRA market system over a specified period of time.

      Based on a study of the member-facing systems that FINRA believes would be subject to Rule 4380—the equity trade reporting facilities (the FINRA/NYSE TRF, the FINRA/Nasdaq TRF and ORF), equity order audit trail system (OATS), equity quotation display and trade reporting facility (ADF), unlisted equity quotation display facility (OTCBB), and fixed income trade reporting system (TRACE)—FINRA has established the following criteria for member firm designation, which reflect the different types or levels of activity generally found on each system.

      •  For the FINRA/NYSE TRF and the FINRA/Nasdaq TRF, FINRA will designate those TRF participants9 that account for 5 percent or more of the total number of trades reported to the TRF over the six-month period immediately preceding designation, provided that the cumulative trade volume represented by designated firms amounts to at least 50 percent of all trade volume reported to the TRF during the applicable six-month period.
      •  For ORF, FINRA will designate participants that account for at least 5 percent or more of the total number of trades reported to ORF over the six-month period immediately preceding designation, provided that the cumulative trade volume represented by designated firms amounts to at least 50 percent of all trade volume reported to ORF during the applicable six-month period.
      •  For TRACE, FINRA will designate participants that account for at least 5 percent or more of the average dollar volume in either: (1) corporate and agency debt securities, or (2) Securitized Products,10 over the six-month period immediately preceding designation, provided that the cumulative dollar volume represented by designated firms amounts to at least 50 percent of all dollar volume reported to TRACE during the applicable six-month period.
      •  For OATS, FINRA will designate firms that account for at least 5 percent or more of OATS Reportable Order Event records (ROEs) over the six-month period immediately preceding the designation, provided that the cumulative activity represented by designated firms amounts to at least 50 percent of all ROEs reported to OATS during the applicable six-month period.
      •  For the ADF, there currently are not any active participants. If the ADF becomes active, FINRA will then study the system's activity to establish appropriate criteria for member designation.
      •  For the OTCBB, FINRA will designate participants that account for at least 20 positions in OTCBB symbols per day on the OTCBB during the applicable six-month period, provided that the cumulative quoting represented by designated firms amounts to at least 50 percent of all quoting on the OTCBB during the applicable six-month period.

      In general, if the 5 percent threshold were to be applied today, it would result in roughly five to nine firms designated per system, generally representing at least 50 percent of the activity on each system. FINRA notes, however, that if designation according to the 5 percent threshold would not result in a representation of at least 50 percent of the activity on a given system for a future testing cycle, then the top most active participants that together represent the minimum cumulative activity level would be designated despite the fact that their individual activity levels may be below the 5 percent threshold.

      Designation would occur according to these established criteria at least 90 days prior to the scheduled testing date. To safeguard potentially sensitive information concerning member firms' trading activity, FINRA will notify firms that meet the designation criteria on an individual basis, rather than through public notice. FINRA will continue to study the characteristics of each system on an ongoing basis, both between now and the first designation, and in future designation/testing cycles. Should FINRA determine at any time that adjustments to these established criteria are necessary to improve its BC/DR testing process, it will publish a Regulatory Notice prior to the change.

      Results of Designation and Voluntary Test Participation

      Rule 4380(c) states the obligations of member firms that are designated for mandatory participation in FINRA's BC/DR testing according to the standards specified above. Specifically, designated firms would be required to fulfill, within the time frames established by FINRA, certain testing requirements that FINRA determines are necessary and appropriate. These requirements could include, for example, bringing up their systems on the designated testing day and processing test scripts to simulate trading activity. Designated firms may also be required to satisfy related reporting requirements, for example, reporting the firm's testing results, so that FINRA may evaluate the efficacy of the test and, correspondingly, its BC/DR plan.11

      FINRA recognizes that there may be additional market participants that wish to participate on a voluntary basis in FINRA's annual BC/DR test beyond those that are designated under Rule 4380. For example, certain system participants may wish to test their backup capabilities even if they do not exceed the system's threshold cutoff. Additionally, third-party service providers, like service bureaus that transmit information to FINRA systems on behalf of FINRA member firms, may also wish to ensure their ability to function in FINRA's backup environment, even though the service providers may not be subject to Rule 4380. FINRA encourages any such market participant to contact FINRA Product Management at (866) 899-2107 or Market Operations at (866) 776-0800 to consider arrangements to take part in FINRA's testing.


      1. See File No. SR-FINRA-2015-046 (filed with the SEC on October 30, 2015).

      2. See Securities Exchange Act Release No. 73639 (November 19, 2014), 79 FR 72252 (December 5, 2014) ("SCI Adopting Release").

      3. Rule 1001(a)(2)(v) of SEC Regulation SCI.

      4. Rule 1004 of SEC Regulation SCI.

      5. See SCI Adopting Release, 79 FR at 72348.

      6. See id., 79 FR at 72348.

      7. The SEC explained that "functional and performance testing" requires more than simple connectivity or validation testing. According to the SEC, it also requires testing of an SC entity's systems, such as order entry, execution, clearance and settlement, order routing, and the transmission and/or receipt of market data, as applicable, to determine if they can operate as contemplated by business continuity and disaster recovery plans. But, it does not require comprehensive simulation of the same levels of liquidity, depth, volatility, and other characteristics of trading on a normal trading day. See SCI Adopting Release, 79 FR at 72353.

      8. Rule 1004 of SEC Regulation SCI.

      9. Based on FINRA's analysis of recent activity on each of the specified systems, FINRA intends to calculate participant activity at the Member Participant Identifier (MPID) level and designate the parent firm of any MPID that meets or exceeds a stated threshold. If FINRA encounters a situation where a parent firm represents significant volume on a system through multiple MPIDs—none of which individually meet or exceed the system's stated threshold—FINRA may in its discretion designate the member based on its overall activity on the system.

      10. The terms agency debt security and securitized product are defined in Rule 6710.

      11. As it noted when it filed Rule 4380, FINRA anticipates that compliance with the rule would be enforced consistent with existing FINRA rules and practice, and that a designated firm's failure to participate in mandatory testing could result in possible sanctions, including fines, under FINRA Rule 8310.

    • 15-42 FINRA to Require Electronic Submission of Subordination Approval Requests; Effective Date: November 30, 2015

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      Subordination Agreements

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4110
      Regulatory Notice 10-15
      SEA Rule 15c3-1 Appendix D
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Subordination Agreements

      Executive Summary

      FINRA is launching, effective November 30, 2015, a new electronic platform on Firm Gateway for firms to submit all new requests for approval of proposed subordinated loan agreements and secured demand note agreements (referred to as subordinations), including renewals of existing agreements. This Notice discusses the electronic submission process, which will replace the current submission of subordination requests in hard copy form to FINRA. As of November 30, 2015, all new requests must be submitted in electronic form through Firm Gateway, and FINRA will no longer accept new requests filed in hard copy form.

      Questions concerning this Notice should be directed to:

      •  Sheryl Martinez, Examination Manager, Membership Application Program (MAP), at (212) 858-4135; or
      •  Diana Hernandez, Regulatory Specialist, MAP, at (646) 315-8476.

      Background and Discussion

      Under FINRA Rule 4110(e)(1), subordinations must meet such standards as FINRA may require to ensure the continued financial stability and operational capability of the member firm, in addition to those specified in Appendix D of SEA Rule 15c3-1. Any subordination entered into by a firm that wishes to receive beneficial regulatory capital treatment must be acceptable to FINRA prior to becoming effective.1

      To make the approval process for subordination requests more efficient, FINRA is launching, effective November 30, 2015, a new electronic platform on Firm Gateway for firms to submit requests for approval of proposed subordinations and renewals of existing subordinations. The new platform will replace the current submission of subordination requests in hard copy form to FINRA. Pursuant to FINRA Rule 4517(a),2 effective November 30, 2015, all new requests for approval of proposed subordinations and renewals of existing subordinations must be submitted in electronic form through the Firm Gateway. FINRA is making no changes to the subordination documentation and related requirements at this time.

      Each firm's Super Account Administrator (SAA) will be provided with more details on entitlements prior to the effective date of the new platform. Firms must use their current FINRA entitlement user ID and password to access the Firm Gateway and access the platform for subordination requests. Firm personnel should contact their firm's SAA with any questions regarding how to access Firm Gateway. For Firm Gateway technical questions, contact FINRA's Technical Support Group at (301) 869-6699. In addition, FINRA will announce a training schedule in the FINRA Weekly Update email.


      1. See Regulatory Notice 10-15 (March 2010).

      2. FINRA Rule 4517(a) gives FINRA authority to require member firms to file or otherwise submit electronically any regulatory notice or other document that a member firm is required to file with or otherwise submit to FINRA.

    • 15-41 SEC Approves Amendments to Require Firms to Report Transactions in TRACE-Eligible Securities As Soon As Practicable; Effective Date: November 30, 2015

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      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6710
      FINRA Rule 6730
      FINRA Rule 6750
      Suggested Routing

      Compliance
      Fixed Income
      Legal
      Operations
      Systems
      Trading
      Key Topics

      Fixed-Income Securities
      TRACE
      Transaction Reporting

      Executive Summary

      The SEC approved amendments to the Trade Reporting and Compliance Engine (TRACE) rules to codify that firms are required to report transactions in TRACE-eligible securities that are subject to dissemination as soon as practicable following the time of execution of the transaction. The amendment will become effective on November 30, 2015.

      The amended rule text is available in the online FINRA Manual.

      Questions regarding this Notice should be directed to:

      •  Patrick Geraghty, Vice President, Market Regulation, at (240) 386-4973 or by email at Patrick.Geraghty@finra.org; or
      •  Racquel Russell, Associate General Counsel, Office of General Counsel, at (202) 728-8363 or by email at Racquel.Russell@finra.org.

      Background and Discussion

      FINRA Rule 6730 (Transaction Reporting) sets forth the requirements that apply to firms when reporting transactions in TRACE-eligible securities.1 A firm that is a "party to a transaction"2 in a TRACE-eligible security generally is required to report the transaction within 15 minutes of the "time of execution,"3 unless a different time period for the security is specified in the rule, or the transaction report will be deemed "late." Paragraph (a)(4) of the rule further provides that firms have an ongoing obligation to report transaction information promptly, accurately and completely.4

      The SEC approved amendments to Rule 6730 clarifying that firms must report transactions in TRACE-eligible securities that are subject to dissemination5 "as soon as practicable" following the time of execution. New Supplementary Material .03 provides additional guidance around the requirement that trades be reported as soon as practicable, specifically that firms must adopt policies and procedures reasonably designed to comply with the "as soon as practicable" requirement by implementing systems that commence the trade reporting process at the time of execution without delay. In addition, if a firm has such reasonably designed policies, procedures and systems in place, the firm generally will not be viewed as violating the "as soon as practicable" requirement because of delays in trade reporting that are due to extrinsic factors that are not reasonably predictable and where the firm does not purposely intend to delay the reporting of the trade. The new Supplementary Material .03 further states that in no event may a firm purposely withhold trade reports, e.g., by programming its systems to delay reporting until the end of the reporting time period.

      In the case of manual trade reporting for TRACE-eligible securities, Supplementary Material .03 acknowledges that the trade reporting process may not be completed as quickly as an automated trade reporting system and that, in these cases, FINRA will take into consideration the manual nature of the firm's trade reporting process in determining whether the firm's policies and procedures are reasonably designed to report the trade "as soon as practicable" after execution.

      The effective date of these amendments is November 30, 2015.


      1. Rule 6710 generally defines a "TRACE-eligible security" as: (1) a debt security that is U.S. dollar-denominated and issued by a U.S. or foreign private issuer (and, if a "restricted security" as defined in Securities Act Rule 144(a)(3), sold pursuant to Securities Act Rule 144A); or (2) a debt security that is U.S. dollar denominated and issued or guaranteed by an "Agency" as defined in Rule 6710(k) or a "Government-Sponsored Enterprise" as defined in Rule 6710(n).

      2. Rule 6710(e) provides that a "party to a transaction" is an introducing broker-dealer, if any, an executing broker-dealer, or a customer. "Customer" includes a broker-dealer that is not a FINRA member.

      3. Among other things, Rule 6710(d) provides that the "time of execution" for a transaction in a TRACE-eligible security means the time when the parties to a transaction agree to all of the terms of the transaction that are sufficient to calculate the dollar price of the trade.

      4. Firms may employ an agent for the purpose of submitting transaction information. However, the primary responsibility for the timely, accurate and complete reporting of transaction information remains the non-delegable duty of the firm obligated to report the transaction.

      5. FINRA Rule 6750 (Dissemination of Transaction Information) provides that FINRA will disseminate information on all transactions in TRACE-eligible securities, including transactions effected pursuant to Securities Act Rule 144A, immediately upon receipt of the transaction report, except as specified in Rule 6750(b).

    • 15-40 Broker-Dealer, Investment Adviser Firm, Agent and Investment Adviser Representative, and Branch Renewals for 2016; Payment Deadline: December 18, 2015

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      BD and IA Renewals for 2016

      Regulatory Notice
      Notice Type

      Renewals
      Referenced Rules & Notices

      NTM 02-48
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Senior Management
      Key Topics

      IARDTM
      Registration
      Renewals
      Web CRD®

      Executive Summary

      The 2016 Renewal Program begins on November 16, 2015, when FINRA makes the online Preliminary Statements available to all firms on Web CRD/IARD.

      Firms should note the following key dates in the renewal process:

      October 26, 2015 Firms may begin submitting post-dated Form U5 and BR Closing/Withdrawal filings via Web CRD/IARD.
      November 2, 2015 Firms may begin submitting post-dated Form BDW and ADV-W filings via Web CRD/IARD.

      Please Note: Post-dated filings submitted by 11 p.m., Eastern Time (ET), November 13, 2015, do not appear on the firm's Preliminary Statement. The only allowed date for post-dated filings is December 31, 2015.
      November 16, 2015 Preliminary Statements are available on Web CRD/IARD.
      December 18, 2015 Full payment of Preliminary Statements is due.
      January 4, 2016 Final Statements are available on Web CRD/IARD.
      January 15, 2016 Full payment of Final Statements is due.

      FINRA advises FINRA-registered firms that failure to remit full payment of their Preliminary Statements to FINRA by December 18, 2015, may cause the firm to become ineligible to do business in the jurisdictions where it is registered, effective January 1, 2016. FINRA-registered firms will also be subject to a late fee if payment is not received by December 18, 2015.

      In addition to this Notice, firms should review the renewal instructions, the IARD Renewal Program Bulletin (if applicable) on the Investment Adviser Registration Depository (IARD) website, and any information mailed to ensure continued eligibility to do business in 2016.

      Please direct questions concerning this Notice to the FINRA Gateway Call Center at (301) 869-6699.

      Background & Discussion

      Preliminary Statements

      Beginning November 16, 2015, Preliminary Statements are available for viewing and printing on Web CRD/IARD. The statements include the following fees.

      FINRA assesses a fee of $45 for each individual who renews his/her BD registration with any regulator through Web CRD. Firms can access a list of agents (AGs) assessed this fee by requesting the Renewals—Firm Renewal Roster. FINRA also assesses the annual statutory disqualification fees for registered individuals.

      In addition, any IARD system fees as determined by the SEC and/or the North American Securities Administrators Association (NASAA) for investment adviser (IA) firms and investment adviser representatives (RAs) who renew through IARD will also be included on the Preliminary Statement.

      Based on the number of active FINRA branches, FINRA assesses each firm a branch office annual registration renewal fee per branch. FINRA waives one branch office annual registration renewal fee per firm. Additionally, FINRA assesses each firm a FINRA branch system processing renewal fee of $20 per branch. FINRA waives one branch system processing renewal fee per firm.

      Please Note: FINRA does not assess the personnel assessment fees through the Renewal Program. All FINRA-registered firms will receive a separate invoice for these fees. Firms can obtain a list of AGs for whom the firms will be assessed the personnel assessment fee by requesting the Renewals—Firm Renewal Roster.

      Web CRD/IARD assesses renewal fees for participating state regulators and self-regulatory organizations (SROs)/exchanges including: BATS Y-Exchange, Inc. (BATS-YX), BATS Z-Exchange, Inc. (BATS-ZX), BOX Options Exchange, LLC (BOX), NASDAQ OMX BX, Inc. (BX), C2 Options Exchange, Incorporated (C2), Chicago Board Options Exchange (CBOE), Chicago Stock Exchange (CHX), EDGA Exchange, Inc. (EDGA), EDGX Exchange, Inc.(EDGX), International Securities Exchange (ISE), ISE GEMINI (ISE GEMINI), Miami International Stock Exchange, LLC (MIAX), NASDAQ Stock Exchange (NQX), National Stock Exchange (NSX), New York Stock Exchange (NYSE), NYSE Arca, Inc. (ARCA), NYSE MKT LLC (NYSE-MKT), and NASDAQ OMX PHLX, Inc. (PHLX) maintenance fees, if applicable. The system displays any applicable renewal fees for broker-dealer/investment adviser firm, branch, agent and RA registered with each SRO and/or jurisdiction.

      Some participating jurisdictions may require steps beyond the payment to FINRA of renewal fees to complete their renewal process. Firms should contact each jurisdiction directly for further information on state renewal requirements. A Regulator Directory is located on the NASAA website.

      For detailed information regarding IA renewals, you may also visit the IARD website. For information on states' participation in the IARD Renewal Program, review the Fees and Accounting page on the IARD website.

      FINRA must receive full payment of the Preliminary Statement fees by December 18, 2015.

      If payment is not received by December 18, 2015, FINRA-registered firms will be assessed a Renewal Late Fee. FINRA includes this late fee as part of the Final Statement and calculates the fee as follows: 10 percent of a firm's cumulative final renewal assessment or $100, whichever is greater, with a cap of $5,000. Please see Notice to Members (NTM) 02-48 for details. In addition, if FINRA fails to receive payment by the deadline, firms also risk becoming ineligible to do business in the jurisdictions where their registrations are not renewed.

      Renewal Payment

      Firms may pay electronically through FINRA's E-Bill system, send a wire transfer or mail a check; however, it is highly recommended that funds be remitted via E-Bill. Firms are encouraged to check their Renewal Statements to confirm FINRA has received payment and that the firm's Renewal Statement balance is paid in full.

      Electronic Payment via E-Bill

      Firms may submit electronic payments to fund their renewal accounts through FINRA's E-Bill system. FINRA does not charge for using E-Bill; however, firms should verify if their banks charge additional fees. Firms must enroll to use E-Bill. For your convenience, a hyperlink to E-Bill is on your firm's renewal statement.

      Please Note: Firm users with the proper entitlement may transfer funds from their Flex-Funding Account to their Renewal Account or transfer funds between affiliated firms at any time by using E-Bill.

      ACH/Wire Transfer

      Wire transfer and check payments are initially deposited into a firm's Flex-Funding Account. Beginning December 11, 2015, if sufficient funds are available, FINRA will systematically transfer funds from Flex-Funding Accounts to Renewal Accounts. Firms do not have to wait for FINRA to systematically transfer funds on December 11 as firms have the ability to transfer funds to their Renewal Accounts using E-Bill. Funds will only be systematically transferred if the entire renewal amount owed is available in the firm's Flex-Funding Account. This automatic Flex-Funding Account-to-Renewal Account transfer process will also be applied daily beginning January 11, 2016, for firms that still owe fees on their Final Statements.

      To initiate a wire or ACH transfer, instruct your firm's bank to contact Bank of America and provide your bank with the following information:

      Wire ABA Number: 026009593
      ACH ABA Number: 054001204
      Beneficiary: FINRA
      FINRA Account: 226005684771
      Reference Number: Firm CRD number

      Inform your bank to credit funds to the FINRA bank account and to only use your firm's CRD number as a reference. Record the confirmation number of the wire transfer provided by your bank.

      If you send your wire transfer by 2 p.m., ET, you may confirm receipt the next business day by reviewing your Flex-Funding Account.

      Checks

      Checks should be made payable to FINRA and your firm's CRD Number should be written on the check memo line. Processing of check payments may take up to two business days. Please account for mail delivery and payment processing time when sending payment. Send payment in the blue, pre-addressed renewal payment envelope mailed to your firm in early November or write the address on an envelope exactly as noted in this Notice:

      U.S. Mail Express/Overnight Delivery
      FINRA
      P.O. Box 418911
      Boston, MA 02241-8911

      Note: This P.O. Box will not accept courier or overnight deliveries.
      Bank of America Lockbox Services
      FINRA 418911
      MA5-527-02-07

      2 Morrissey Blvd. Dorchester, MA 02125

      Provide the following phone number, if required: (800) 376-2703

      Renewal Reports

      When Preliminary Statements are made available, firms should request, print and/or download renewal reports via Web CRD/IARD. The three renewal reports available for reconciliation with the Preliminary Statement:

      •  Firm Renewal Report—lists individuals included in the Renewal Program and includes billing codes (if the firm has provided them).
      •  Branches Renewal Report—lists each branch registered with FINRA and/or with any other regulator that renews branches through Web CRD/IARD and for which the firm is being assessed a fee.
      •  Approved AG Reg Without FINRA Approval Report—contains all individuals who are not registered with FINRA, but are registered with one or more jurisdictions. Firms should request this report as soon as possible to determine if it needs to request any FINRA registrations or terminate jurisdiction registrations.

      Post-Dated Form Filings

      Firms can begin filing post-dated Form U5 and BR Closing/Withdrawal termination filings on October 26, 2015, and Form BDW and ADV-W filings on November 2, 2015. Post-dated filings are filings that have a termination date of December 31, 2015. If a post-dated Form U5, BDW, BR Closing/Withdrawal or ADV-W filing is submitted, the affected individual, firm, and/or branch may continue doing business in that jurisdiction until the end of the calendar year without being assessed renewal fees. December 31, 2015, is the only date allowed for a post-dated form filing.

      Firms that submit post-dated termination filings by 11 p.m., ET, on November 13, 2015, will not be assessed renewal fees for the select registrations on their Preliminary Statements. Firms that submit post-dated termination filings on, or after, November 13, 2015, will not be assessed renewal fees for the select registrations on their Final Statements. Those firms should see a credit balance on their Final Statements if the firm has not requested additional registrations during that time period to offset the credit balance.

      After submitting a termination filing, firms should query individual, branch and/or firm registrations to ensure that Form U5, BR Closing/Withdrawal, BDW and ADV-W filings process by the renewal filing deadline date of 6 p.m., ET, on December 28, 2015.

      Firms should exercise care when submitting all post-dated filings. Web CRD/IARD processes these forms when they are submitted and FINRA cannot withdraw a post-dated termination filing. A firm that submits a post-dated termination filing in error will have to file a new Form U4, BD, Form BR or Form ADV when Web CRD/IARD resumes normal processing on January 4, 2016, and Web CRD/IARD will assess new registration fees.

      Filing Form BDW

      The deadline for electronic filing of a Form BDW for any firm that wants to terminate a registration before year-end is 6 p.m., ET, December 28, 2015.

      Filing Forms ADV to Cancel Notice Filings or Forms ADV-W to Terminate Registrations

      Firms that file either a Form ADV Amendment, unmarking a state (generating the status of "Removal Requested at End of Year") or a Form ADV-W by 11 p.m., ET, November 13, 2015, avoid the assessment of applicable renewal fees on their Preliminary Statements. The deadline to file Form ADV Amendments or Form ADV-W for firms that want to cancel a notice filing or terminate a state registration before year-end is 6 p.m., ET, December 28, 2015.

      Removing Open Registrations

      The "Approved AG Reg Without FINRA Approval Report" report identifies AGs with an approved jurisdiction registration but who do not have an approved FINRA registration. Firms should use this report to terminate obsolete jurisdiction registrations through the submission of a Form U5 or reinstate the FINRA positions through the filing of a Form U4 Amendment.

      Renewals Mass Transfer Moratorium

      A mass transfer is used to programmatically transfer individuals and branch offices from one firm to another firm as a result of a merger, acquisition, succession or consolidation. December 2, 2015, is the last day firms will be able to request that a mass transfer occur in 2015. There will be a moratorium on mass transfers from December 23, 2015, through January 15, 2016.

      Final Statements

      On January 4, 2016, FINRA makes available all Final Statements on Web CRD/IARD. These statements reflect the status of broker-dealer, AG, investment adviser firm and RA registrations, exempt reporting, or notice filings as of December 31, 2015. Any adjustments in fees owed resulting from registration terminations, approvals, notice filings or transitions after the Preliminary Statement appear on the Final Statement.

      •  Web CRD/IARD reflects an amount owed if a firm has more individuals, branch offices or jurisdictions registered and/or notice filed at year-end than it did when the Preliminary Statement was generated.
      •  A refund is issued if a firm has fewer individuals, branch offices or jurisdictions registered or notice filed at year-end than it did on the Preliminary Statement. FINRA transfers overpayments to firms' Flex-Funding Accounts on January 4, 2016. Firms that have a credit balance in their Flex-Funding Account may submit a refund request.

      When Final Statements are made available, firms should access the Web CRD reports functionality for the Firm Renewal Report, which will list all individuals renewed with SROs/exchanges and each jurisdiction. AGs and RAs whose registrations are "approved" in any of these jurisdictions during November and December will be included in this roster. "Pending" and "deficient" registrations at year's end are not included in the Renewal Program. Firms will also be able to request the Branches Renewal Report that lists all branches for which they have been assessed renewal fees. Versions of these reports will also be available for download.

      Firms have until January 15, 2016, to report any discrepancies on the renewal reports. This is also the deadline for receipt of final payment. Specific information and instructions concerning the Final Statement and renewal reports will be available in a January 2016 Regulatory Notice.

    • 15-39 FINRA Revises the Series 27 and Series 28 Examination Programs; Implementation Date: December 14, 2015

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      Qualification Examinations

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NASD Rule 1021
      NASD Rule 1022
      SEA Section 15A(g)(3)
      SEA Rule 15c3-1
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Training
      Key Topics

      Financial and Operations Principal
      Introducing Broker-Dealer Financial and Operations Principal
      Qualification Examinations
      Series 27
      Series 28

      Executive Summary

      FINRA periodically reviews the content of qualification examinations to determine whether revisions are necessary or appropriate in view of changes-including changes to the laws, rules and regulations-pertaining to the subject matter the examinations cover. Based on this review process, FINRA has revised the Financial and Operations Principal (Series 27) and Introducing Broker-Dealer Financial and Operations Principal (Series 28) examination programs.1

      Questions concerning this Notice should be directed to:

      •  Deborah Kase, Senior Qualifications Analyst, Testing and Continuing Education Department, at (212) 858-4069; or
      •  Alexandra Toton, Manager, Testing and Continuing Education Department, at (240) 386-4677.

      Background and Discussion

      Section 15A(g)(3) of the Securities Exchange Act authorizes FINRA to prescribe standards of training, experience and competence for persons associated with FINRA-regulated firms. In accordance with that provision, FINRA has developed examinations that are designed to establish that persons associated with FINRA-regulated firms have attained specified levels of competence and knowledge, consistent with applicable registration requirements under FINRA rules. FINRA periodically reviews the content of the examinations to determine whether revisions are necessary or appropriate in view of changes pertaining to the subject matter covered by the examinations.

      Financial and Operations Principal

      NASD Rule 1022(b)(1) requires that each firm that operates pursuant to the provisions of SEA Rule 15c3-1(a)(1)(ii),2 SEA Rule 15c3-1(a)(2)(i)3 or SEA Rule 15c3-1(a)(8)4 must designate as Financial and Operations Principal5 those persons associated with it, at least one of whom must be its chief financial officer, who perform the duties described in paragraph (b)(2) of the rule. The rule provides that each person associated with a firm who performs such duties must register as a Financial and Operations Principal with FINRA and must pass an appropriate qualification examination before the registration may become effective. Paragraph (b)(2) of the rule provides that the term Financial and Operations Principal means a person associated with a firm whose duties include:

      •  final approval and responsibility for the accuracy of financial reports submitted to any duly established securities industry regulatory body;
      •  final preparation of such reports;
      •  supervision of individuals who assist in the preparation of such reports;
      •  supervision of and responsibility for individuals who are involved in the actual maintenance of the member's books and records from which such reports are derived;
      •  supervision and/or performance of the member's responsibilities under all financial responsibility rules promulgated pursuant to the provisions of the Exchange Act;
      •  overall supervision of and responsibility for the individuals who are involved in the administration and maintenance of the member's back office operations; or
      •  any other matter involving the financial and operational management of the member.

      NASD Rule 1022(b)(3) provides that a person registered solely as a Financial and Operations Principal shall not be qualified to function in a principal capacity with responsibility over any area of business activity not described in paragraph (b)(2) of the rule.

      Introducing Broker-Dealer Financial and Operations Principal

      NASD Rule 1022(c)(1) requires that every firm that is subject to the requirements of SEA Rule 15c3-1, other than a firm operating pursuant to SEA Rule 15c3-1(a)(1)(ii),6 SEA Rule 15c3-1(a)(2)(i)7 or SEA Rule 15c3-1(a)(8),8 must designate as Introducing Broker-Dealer Financial and Operations Principal9 those persons associated with it, at least one of whom must be its chief financial officer, who perform the duties described in paragraph (c)(2) of the rule. The specified duties under the rule are identical to those for Financial and Operations Principals as discussed above. The rule provides that each person associated with a firm who performs such duties is required to register as an Introducing Broker-Dealer Financial and Operations Principal with FINRA and must pass an appropriate qualification examination before such registration may become effective.

      NASD Rule 1022(c)(3) provides that, except as set forth in NASD Rule 1021(c),10 a person designated pursuant to the provisions of NASD Rule 1022(c)(1) is not be required to take the Introducing Broker-Dealer Financial and Operations Principal examination and shall be qualified for registration as such if the person is qualified to be registered or is registered as a Financial and Operations Principal.

      NASD Rule 1022(c)(4) provides that a person registered solely as an Introducing Broker-Dealer Financial and Operations Principal shall not be qualified to function in a principal capacity with responsibility over any area of business activity not described in paragraph (c)(2) of the rule. The rule provides that such person shall not be qualified to function in a principal capacity at a member unless the member operates under paragraph (c)(1) of the rule.

      Revisions to the Series 27 and Series 28 Examination Programs

      In consultation with a committee of industry representatives, FINRA recently undertook a review of the Series 27 and Series 28 examination programs. As a result of this review, FINRA has revised the content outlines for the examinations to reflect changes to the laws, rules and regulations covered by the examinations and to incorporate the functions and associated tasks currently performed by a Financial and Operations Principal, with respect to the Series 27 examination, and an Introducing Broker-Dealer Financial and Operations Principal, with respect to the Series 28 examination. FINRA has also made changes to the format of the content outlines.

      To develop the revised outlines, FINRA conducted a job analysis study of Financial and Operations Principals and Introducing Broker-Dealer Financial and Operations Principals, which included the use of a survey. The study provided detailed information regarding the day-to-day roles, responsibilities and job functions of these principals. As a result, FINRA has revised the structure of the content outlines as described below to include functions and associated tasks that reflect the day-to-day activities of a Financial and Operations Principal and an Introducing Broker-Dealer Financial and Operations Principal.

      Series 27

      FINRA has divided the Series 27 content outline into five major job functions that are performed by a Financial and Operations Principal. The following are the five major job functions, denoted Function 1 through Function 5, with the associated number of questions:

      •  Function 1: Financial Reporting, 25 questions;
      •  Function 2: Operations, General Securities Industry Regulations, and Preservation of Books and Records, 42 questions;
      •  Function 3: Customer Protection, 24 questions;
      •  Function 4: Net Capital, 41 questions; and
      •  Function 5: Funding and Cash Management, 13 questions.

      Series 28

      Similarly, FINRA has divided the Series 28 content outline into four major job functions that are performed by an Introducing Broker-Dealer Financial and Operations Principal. The following are the four major job functions, denoted Function 1 through Function 4, with the associated number of questions:

      •  Function 1: Financial Reporting, 16 questions;
      •  Function 2: Operations, General Securities Industry Regulations, and Preservation of Books and Records, 30 questions;
      •  Function 3: Net Capital, 31 questions; and
      •  Function 4: Customer Protection, Funding and Cash Management, 18 questions.

      Job Functions and Specific Tasks

      As noted above, each major job function includes an assigned number of questions. FINRA determined the number of questions for each function based on the results of the job analysis study. Thus, the allocation of questions in the revised Series 27 and Series 28 outlines more closely reflects the current day-to-day activities of a Financial and Operations Principal or an Introducing Broker-Dealer Financial and Operations Principal.

      Each function also includes specific tasks describing activities associated with performing that function. In the Series 27 content outline, there are five tasks (1.1–1.5) associated with Function 1; three tasks (2.1–2.3) associated with Function 2; five tasks (3.1–3.5) associated with Function 3; seven tasks (4.1–4.7) associated with Function 4; and two tasks (5.1–5.2) associated with Function 5.11 Similarly, in the Series 28 content outline, there are five tasks (1.1–1.5) associated with Function 1; three tasks (2.1–2.3) associated with Function 2; seven tasks (3.1–3.7) associated with Function 3; and three tasks (4.1–4.3) associated with Function 4.12

      For example, one such task (Task 2.2 in both the Series 27 and the Series 28 content outline) is to prepare and preserve financial records to ensure accuracy and completeness of internal financial documents.13 Further, the outline lists the knowledge required to perform each function and associated tasks (e.g., general ledger and sub-ledgers).14 In addition, where applicable, the outline lists the laws, rules and regulations a candidate is expected to know to perform each function and associated tasks. These include the applicable FINRA Rules (e.g., FINRA Rule 4160), NASD Rules (e.g., NASD Rule 2340) and SEC rules (e.g., SEA Rule 17a-4).15

      Other Revisions

      As noted above, FINRA has revised the Series 27 and Series 28 content outlines to reflect changes to the laws, rules and regulations covered by the respective examination. Among other revisions, FINRA has revised the content outlines to reflect the adoption of rules in the consolidated FINRA rulebook (e.g., NASD Rule 2430 (Charges for Services Performed) and NASD Rule 3110 (Books and Records) were adopted as FINRA Rule 2122 (Charges for Services Performed) and FINRA Rule 4510 Series (Books and Records Requirements), respectively).16 Further, based on the MSRB's elimination of the Financial and Operations Principal requirements in MSRB Rule G-3(d), the revised Series 27 outline does not include any MSRB rules.17

      The number of questions on the Series 27 examination will remain at 145 scored multiple-choice questions,18 and candidates will continue to have 225 minutes to complete the examination. The number of questions on the Series 28 examination will remain at 95 multiple-choice questions, and candidates will continue to have 120 minutes to complete the examination. Currently, a score of 70 percent is required to pass the Series 27 and Series 28 examinations. The passing score for the revised Series 27 and Series 28 examinations will be 69 percent.

      Finally, FINRA has made changes to the format of the content outlines, including the preface, sample questions and reference materials.

      Availability of Content Outlines

      The current Series 27 and Series 28 content outlines are available on FINRA's website, at http://www.finra.org/industry/qualification-exams. The revised Series 27 and Series 28 content outlines will replace the current content outlines on FINRA's website.


      1. See Securities Exchange Act Release No. 76189 (October 19, 2015), 80 FR 64465 (October 23, 2015) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to the Series 27 Examination Program; File No. SR-FINRA-2015-038); Securities Exchange Act Release No. 76190 (October 19, 2015), 80 FR 64458 (October 23, 2015) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to the Series 28 Examination Program; File No. SR-FINRA-2015-039).

      2. SEA Rule 15c3-1 is the SEC's net capital rule. SEA Rule 15c3-1(a)(1)(ii) addresses net capital requirements for brokers or dealers that elect not to be subject to the Aggregate Indebtedness Standard of paragraph (a)(1)(i) under Rule 15c3-1.

      3. SEA Rule 15c3-1(a)(2)(i) addresses net capital requirements for brokers or dealers that carry customer accounts.

      4. SEA Rule 15c3-1(a)(8) addresses net capital requirements for municipal securities brokers' brokers, as defined under the rule.

      5. The term "Limited Principal-Financial and Operations" as set forth in NASD Rule 1022(b) is referred to as "Financial and Operations Principal" for purposes of the Series 27 examination. The term "principal" is defined in NASD Rule 1021(b) (Definition of Principal).

      6. See note 2.

      7. See note 3.

      8. See note 4.

      9. The term "Limited Principal-Introducing Broker/ Dealer Financial and Operations" as set forth in NASD Rule 1022(c) is referred to as "Introducing Broker-Dealer Financial and Operations Principal" for purposes of the Series 28 examination.

      10. NASD Rule 1021(c) addresses requirements for examination on lapse of registration.

      11. See Series 27 Outline Pages 6–20.

      12. See Series 28 Outline Pages 6–17.

      13. See Series 27 Outline Page 10 and Series 28 Outline Page 10.

      14. See Series 27 Outline Page 10 and Series 28 Outline Page 10.

      15. See Series 27 Outline Page 10 and Series 28 Outline Page 10.

      16. See Rule Conversion Chart.

      17. See Securities Exchange Act Release No. 72743 (August 1, 2014), 79 FR 46290 (August 7, 2014) (Order Approving File No. SR-MSRB-2014-04).

      18. Consistent with FINRA's practice of including "pre-test" questions on certain qualification examinations, which is designed to ensure that new examination questions meet acceptable testing standards prior to use for scoring purposes, the Series 27 examination includes ten additional, unidentified pre-test questions that do not contribute towards the candidate's score. Therefore, the examination actually consists of 155 questions, 145 of which are scored. The ten pre-test questions are randomly distributed throughout the examination.

    • 15-38 Securities Industry/Regulatory Council on Continuing Education Issues Firm Element Advisory Update

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      Continuing Education

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

      Compliance
      Continuing Education
      Legal
      Registration
      Senior Management
      Key Topics

      Continuing Education
      Firm Element

      The Securities Industry/Regulatory Council on Continuing Education (Council) has released its Fall 2015 Firm Element Advisory (FEA). The Council produces the FEA to identify regulatory and sales practice topics that firms should consider in their Firm Element training plans. Topics updated or added since the prior FEA are indicated in the document as such.

      The updated FEA is available at: http://cecouncil.com/media/248954/2015-fall-fea.pdf.

      The FEA topics are not exhaustive and are intended as a guide to firms when they determine what to include in their training plans. Firms should consider the specific nature of their business, clients, products and services when creating their training plans.

      Previous editions of the FEA, as well as a matrix indicating the topics covered in those editions, are available at the Council's website at www.cecouncil.com.

      Questions concerning this Notice should be directed to:

      •  Roni Meikle, Director, Continuing Education, FINRA, at (212) 858-4084.

    • 15-37 FINRA Requests Comment on Rules Relating to Financial Exploitation of Seniors and Other Vulnerable Adults; Comment Period Expires: November 30, 2015

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      Financial Exploitation of Seniors and Other Vulnerable Adults

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 4512
      Proposed FINRA Rule 2165
      SEA Rule 17a-3
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      Customer Accounts
      Financial Exploitation
      Senior and Vulnerable Adult Investors
      Temporary Holds on Disbursements
      Trusted Contact Persons

      Executive Summary

      FINRA seeks comment on proposed rules addressing the financial exploitation of seniors and other vulnerable adults. FINRA is proposing: (1) amendments to FINRA Rule 4512 (Customer Account Information) to require firms to make reasonable efforts to obtain the name of and contact information for a trusted contact person for a customer's account; and (2) the adoption of new FINRA Rule 2165 (Financial Exploitation of Specified Adults) to permit qualified persons of firms to place temporary holds on disbursements of funds or securities from the accounts of specified customers where there is a reasonable belief of financial exploitation of these customers.

      The proposed rule text is available in Attachment A.

      Questions regarding this Notice should be directed to:

      •  James S. Wrona, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8270;
      •  Ann-Marie Mason, Director and Counsel, Shared Services, at (202) 728-8231; or
      •  Jeanette Wingler, Assistant General Counsel, OGC, at (202) 728-8013.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by November 30, 2015.

      Comments must be submitted through one of the following methods:

      •  Emailing comments to pubcom@finra.org; or
      •  Mailing comments in hard copy to:

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      To help FINRA process comments more efficiently, persons should use only one method to comment on the proposal.

      Important Notes: All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.1

      Before becoming effective, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board of Governors, and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2

      Background & Discussion

      FINRA's experience with its Securities Helpline for Seniors™ has highlighted issues relating to financial exploitation of this group of investors.3 Among these issues is a firm's ability to quickly and effectively address suspected financial exploitation of seniors and other vulnerable adults consistent with FINRA rules. Currently, FINRA rules do not explicitly permit firms to contact a non-account holder or to place a temporary hold on disbursements of funds or securities where there is a reasonable belief of financial exploitation of a senior or other vulnerable adult.

      To address these issues, FINRA is proposing rules to provide firms with a way to respond to situations in which they have a reasonable basis to believe that financial exploitation of vulnerable adults has occurred, is occurring, has been attempted or will be attempted.4 FINRA believes that a firm can better protect its customers from financial exploitation if the firm can: (1) place a temporary hold on a disbursement of funds or securities from a customer's account; and (2) notify a customer's trusted contact (or, if unavailable, immediate family member) of the firm's decision to place the temporary hold on a disbursement from the customer's account.

      Proposed Rules

      Trusted Contact Person—Proposed Amendments to Rule 4512

      FINRA is proposing to amend Rule 4512 to require firms to make reasonable efforts to obtain the name of and contact information for a trusted contact person upon the opening of a non-institutional customer's account.5 The proposal does not prohibit firms from opening and maintaining an account if a customer fails to identify a trusted contact as long as the firm made reasonable efforts to obtain it. FINRA believes that asking a customer to provide the name and contact information for a trusted contact person ordinarily would constitute reasonable efforts to obtain the information and would satisfy the proposed rule's requirements.

      Consistent with the current requirements of Rule 4512, a firm would not need to attempt to obtain the name of and contact information for a trusted contact person for currently existing accounts until such time as the firm updates the information for the account either in the course of the firm's routine and customary business or as otherwise required by applicable laws or rules. With regard to updating the contact information once provided, FINRA believes that firms should consider asking the customer to review and update the name of and contact information for a trusted contact person periodically, such as when updating account information pursuant to SEA Rule 17a-3, or when there is a reason to believe that there has been a change in the customer's situation.6

      FINRA intends the trusted contact person to be a resource for the firm in administering the customer's account and in responding to possible financial exploitation. The proposed rule would require that the trusted contact person be age 18 or older and not be authorized to transact business on behalf of the account. A firm may elect to notify an individual that he or she was named as a trusted contact person; however, the proposed rule would not require notification.

      The proposed rule would also require that, at the time of account opening, a firm shall disclose in writing (which may be electronic) to the customer that the firm or an associated person is authorized to contact the trusted contact person and disclose information about the customer's account to confirm the specifics of the customer's current contact information, health status, and the identity of any legal guardian, executor, trustee or holder of a power of attorney, and as otherwise permitted by proposed Rule 2165. In addition, a firm would be required to provide this disclosure when it attempts to obtain the name of and contact information for a trusted contact person when updating information for currently existing accounts either in the course of the firm's routine and customary business or as otherwise required by applicable laws or rules. Firms would be required to provide this disclosure at account opening or when updating information for currently existing accounts, even if a customer fails to identify a trusted contact. As noted below, pursuant to proposed Rule 2165, when information about a trusted contact person is available, a firm must attempt to notify the trusted contact person that the firm has placed a temporary hold on a disbursement of funds or securities from a customer's account, unless the firm reasonably believes that the trusted contact person is engaged in the financial exploitation.7

      Temporary Hold on Disbursement of Funds or Securities—Proposed New Rule 2165

      FINRA is also proposing to permit "qualified persons" who reasonably believe that financial exploitation is occurring to place temporary holds on disbursements of funds or securities from the accounts of "specified adult" customers. Proposed Rule 2165 creates no obligation to withhold disbursement of funds or securities where financial exploitation may be occurring. Accordingly, Supplementary Material to proposed Rule 2165 would expressly state that the rule provides firms with a safe harbor when they exercise discretion in placing temporary holds on disbursements of funds or securities from the account of a specified adult under the circumstances denoted in the rule. It would further state that the rule does not require firms to place temporary holds on disbursements of funds or securities from the account of a specified adult.8

      FINRA believes that "specified adults" may be particularly susceptible to financial exploitation.9 Proposed Rule 2165 would define "specified adult" as: (A) a natural person age 65 and older;10 or (B) a natural person age 18 and older who the firm reasonably believes has a mental or physical impairment that renders the individual unable to protect his or her own interests. Supplementary Material to proposed Rule 2165 would provide that a firm's reasonable belief that a natural person age 18 and older has a mental or physical impairment that renders the individual unable to protect his or her own interests may be based on the facts and circumstances observed in the firm's business relationship with the person.11

      The proposed rule would denote the persons who can place a temporary hold on a disbursement as "qualified persons," which would mean associated persons of a firm who serve in supervisory, compliance or legal capacities that are reasonably related to the account of the specified adult. The proposed rule would define the term "account" to include any account of a firm for which a specified adult has the authority to transact business.

      FINRA has proposed a broad definition of "financial exploitation." Specifically, financial exploitation would include: (A) the wrongful or unauthorized taking, withholding, appropriation, or use of a specified adult's funds or securities; or (B) any act or omission taken by a person, including through the use of a power of attorney, guardianship, or any other authority, regarding a specified adult, to: (i) obtain control, through deception, intimidation or undue influence, over the specified adult's money, assets or property; or (ii) convert the specified adult's money, assets or property.

      Proposed Rule 2165 would permit a qualified person to place a temporary hold on a disbursement of funds or securities from the account of a specified adult if the qualified person reasonably believes that financial exploitation of the specified adult has occurred, is occurring, has been attempted or will be attempted.12 If a firm places such a hold, the proposed rule would require the firm to immediately initiate an internal review of the facts and circumstances that caused the qualified person to reasonably believe that financial exploitation of the specified adult has occurred, is occurring, has been attempted or will be attempted. In addition, the proposed rule would require the firm to provide notification of the hold and the reason for the hold to all parties authorized to transact business on the account and, if available, the trusted contact person, no later than two business days after placing the hold. While oral or written (including electronic) notification would be permitted under the proposed rule, a firm would be required to retain records evidencing the notification.

      If the trusted contact person is not available or the firm reasonably believes that the trusted contact person has engaged, is engaged or will engage in the financial exploitation of the specified adult, the proposal states that the firm shall attempt to contact an immediate family member,13 unless the firm reasonably believes that the immediate family member has engaged, is engaged or will engage in the financial exploitation of the specified adult. For purposes of proposed Rule 2165, FINRA would consider the lack of an identified trusted contact person, the inability to contact the trusted contact person or a person's refusal to act as a trusted contact person to mean that the trusted contact person was not available. The same is true of an immediate family member. A firm may use the temporary-hold provision under proposed Rule 2165 when a trusted contact or an immediate family member is not available.

      While the proposed rule does not require notifying the customer's registered representative of suspected financial exploitation, a customer's registered representative may be the first person to detect potential financial exploitation. If the detection occurs in another way, a firm may choose to notify and discuss the suspected financial exploitation with the customer's registered representative, unless the firm suspects that the registered representative is involved in the financial exploitation.

      The temporary hold authorized by proposed Rule 2165 would expire not later than 15 business days after the date that the qualified person first placed the temporary hold on the disbursement of funds or securities, unless sooner terminated or extended by an order of a court of competent jurisdiction. In addition, provided that the firm's internal review of the facts and circumstances supports its reasonable belief that the financial exploitation of the specified adult has occurred, is occurring, has been attempted or will be attempted, the proposed rule permits the temporary hold to be extended by a qualified person for an additional 15 business days, unless sooner terminated by an order of a court of competent jurisdiction.

      Proposed Rule 2165 would require firms to retain records related to compliance with the rule, which shall be readily available to FINRA, upon request. The retained records shall include records of: (1) requests for disbursement that may constitute financial exploitation of a specified adult and the resulting temporary hold; (2) the finding of a reasonable belief that financial exploitation has occurred, is occurring, has been attempted or will be attempted underlying the decision to place a temporary hold on a disbursement; (3) notification(s) to the relevant parties pursuant to the rule; and (4) the internal review of the facts and circumstances supporting the qualified person's reasonable belief that the financial exploitation of the specified adult has occurred, is occurring, has been attempted or will be attempted.

      The proposed rule would require a firm that anticipates using a temporary hold in appropriate circumstances to establish and maintain specific written supervisory procedures reasonably designed to achieve compliance with the rule, including, but not limited to, procedures on the identification, escalation and reporting of matters related to financial exploitation of specified adults. The proposed rule would also require firms to develop and document specific training policies or programs reasonably designed to ensure that registered persons comply with the requirements of the rule.

      Economic Impact Assessment

      FINRA's experience with its Securities Helpline for Seniors has reaffirmed its understanding of the risks to customers of financial exploitation. The proposed rules are intended to further the protection of potentially at-risk customers by relieving firms from those FINRA rules that might otherwise discourage firms from exercising discretion to protect customers through placing a temporary hold on disbursements of funds or securities. Such a hold, combined with contact with a trusted person, also may permit these customers to stop unwanted disbursements and better protect themselves from financial exploitation.

      The proposed rules not only better safeguard customers, to the extent that firms today do not provide protections for specified adults, but also better protect those firms that are already doing so.

      The proposed amendments to Rule 4512 would require firms to attempt to collect information about a trusted person at the time of account opening or in the course of updating information for the account. Firms also would incur additional responsibilities to provide disclosure about the firm's right to share certain private information with the customer's trusted contact.

      In addition, there may be significant impacts with respect to legal risks and attendant costs to firms that choose to rely on the proposed rule in placing temporary holds on disbursements; although the direction of the impact is ambiguous. The proposed rules may provide some legal protection to firms if they are sued for withholding disbursements where there is a reasonable belief of financial exploitation. At the same time, while proposed Rule 2165 creates no obligation to withhold disbursement where financial exploitation may be occurring or to refrain from opening or maintaining an account where no trusted contact is identified, this proposed rule might serve as a rationale for a private action against firms that do not withhold disbursements when there is a reasonable belief of financial exploitation. To reduce the latter risk, proposed Rule 2165 would explicitly state that it provides firms with a safe harbor when they exercise discretion in placing temporary holds on disbursements of funds or securities, but would not require firms to place such holds.

      To the extent that firms today have reasons to suspect financial exploitation of their customers, they may make judgments with regard to making or withholding disbursements of funds or securities. As such, these firms may already face litigation risk with regard to their actions, whether or not they choose to disburse funds or securities.

      Request for Comment

      In addition to generally requesting comments, FINRA specifically requests comment on the following questions:

      1. Should the scope of the proposed rules be expanded to encompass other requirements?
      2. Are there approaches other than the proposed rulemaking that FINRA should consider?
      3. Should Rule 4512 require customer consent to contact the trusted contact or is customer notice sufficient? Should the types of information that may be disclosed to the trusted contact under Rule 4512 be modified?
      4. What are firms' current practices when they suspect financial exploitation has occurred, is occurring, has been attempted or will be attempted? Would the proposed rules change firms' current practices?
      5. What are firms' views on any potential legal risks associated with placing or not placing temporary holds on disbursements of funds or securities at present and under the proposal?
      6. Should the ages used in the definition of "specified adult" in proposed Rule 2165 be modified or eliminated?
      7. Should the definition of "account" be expanded to include accounts for which a specified adult is a named beneficiary?
      8. Should the scope of the persons included in the definition of "qualified person" in proposed Rule 2165 be modified?
      9. Is the two business day period for notifying the appropriate parties under proposed Rule 2165 appropriate? If not, what circumstances may warrant a shorter or longer period?
      10. Should the permissible time periods for placing and extending a temporary hold pursuant to proposed Rule 2165 be modified?
      11. Should FINRA mandate specific procedures for escalating matters related to financial exploitation?

      FINRA also specifically requests comments on the economic impact and expected beneficial results of the proposed rules.

      12. What direct costs for the firm will result from the proposed rules?
      13. What indirect costs will arise for the firm from the proposed rules?
      14. Will the proposed rules impose different costs on firms of different sizes or with different business models?
      15. What benefits will result for customers from the proposed rules? How extensive are these benefits?
      16. What costs for customers will result from the proposed rules?
      17. Are the costs imposed by the rules warranted by the potential benefit to customers arising from the proposed rules?
      18. How will the proposed rules change business practices and competition among firms? Will these impacts differently affect small or specialized broker-dealers?
      19. Are there other means or mechanisms to efficiently and effectively provide customers with suitable protections as contemplated by the SEA?

      We request quantified comments where possible.


      1 FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.

      2 See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

      3 See FINRA Launches Toil-Free FINRA Securities Helpline for Seniors (Apr. 20, 2015).

      4 FINRA notes that Delaware, Missouri and Washington have enacted statutes that permit financial institutions, including broker-dealers, to place temporary holds on "disbursements" or "transactions" if financial exploitation of covered persons is suspected. See Del. Code Ann. tit. 31, § 3910 (2015); Mo. Rev. Stat. §§ 409.600–.630 (2015); and Wash. Rev. Code §§ 74.34.215, 220 (2015). Due to the small number of state statutes currently in effect and the lack of a uniform state or federal standard in this area, FINRA believes that the proposed rules would aid in the creation of a uniform national standard for the benefit of firms and their customers.

      5 While the proposed amendments do not specify what contact information should be obtained, FINRA believes that a mailing address, phone number and email address for the trusted contact person may be the most useful to firms.

      6 FINRA also notes that a customer's request to change his or her trusted contact person may be a possible red flag of financial exploitation (e.g., a senior customer changing his trusted contact person from an immediate family member to a previously unknown third party).

      7 With respect to disclosing information to the trusted contact person, FINRA notes that Regulation S-P excepts from the Regulation's notice and opt-out requirements disclosures made: (A) to comply with federal, state, or local laws, rules and other applicable legal requirements; or (B) made with client consent, provided such consent has not been revoked. See 17 C.F.R §§ 248.15(a)(1) and (a)(7)(i). FINRA believes that disclosures to a trusted contact person pursuant to proposed Rules 2165 or 4512 or with unrevoked customer consent would be consistent with Regulation S-P.

      8 FINRA understands that some firms, pursuant to state law or their own policies, may already place temporary holds on disbursements from customers' accounts where financial exploitation is suspected.

      9 See National Senior Investor Initiative: A Coordinated Series of Examinations, SEC's Office of Compliance Inspections and Examinations and FINRA (Apr. 15, 2015) (noting the increase in persons aged 65 and older living in the United States and the concentration of wealth in those persons during a time of downward yield pressure on conservative income-producing investments) (hereinafter Senior Investor Initiative). See also The MetLife Study of Elder Financial Abuse: Crimes of Occasion, Desperation, and Predation Against America's Elders (June 2011) (noting the many forms of vulnerability that "make elders more susceptible to [financial]abuse," including, among others, poor physical or mental health, lack of mobility, and isolation); Protecting Elderly Investors from Financial Exploitation: Questions to Consider (Feb. 11, 2015) (noting that one of the greatest risk factors for diminished capacity is age).

      10 See, e.g., Aging Statistics, U.S. Department of Health and Human Services Administration on Aging (referring to the "older population" as persons "65 years or older"); Senior Investor Initiative (noting the examinations underlying the report "focused on investors aged 65 years old or older").

      11 FINRA notes that a firm may not ignore contrary evidence in making a determination based on the facts and circumstances observed in the firm's business relationship with the natural person (e.g., a court order finding a customer to be legally incompetent).

      12 Proposed Rule 2165 would apply only to disbursements of funds or securities from the account of a specified adult and would not apply to transactions in securities.

      13 For purposes of proposed Rule 2165, the term "immediate family member" shall include a spouse, child, grandchild, parent, brother or sister, mother-in-law or father-in-law, brother-in-law or sister-in-law, and son-in-law or daughter-in-law, each of whom must be age 18 or older.


      ATTACHMENT A

      Below is the text of the proposed rule change. Proposed new language is underlined; proposed deletions are in brackets.

      * * * * *

      Text of Proposed Changes to FINRA Rule 4512

      * * * * *

      4000. FINANCIAL AND OPERATIONAL RULES

      * * * * *

      4500. BOOKS, RECORDS AND REPORTS

      * * * * *

      4512. Customer Account Information
      (a) Each member shall maintain the following information:
      (1) for each account:
      (A) customer's name and residence;
      (B) whether customer is of legal age;
      (C) name(s) of the associated person(s), if any, responsible for the account, and if multiple individuals are assigned responsibility for the account, a record indicating the scope of their responsibilities with respect to the account, provided, however, that this requirement shall not apply to an institutional account;
      (D) signature of the partner, officer or manager denoting that the account has been accepted in accordance with the member's policies and procedures for acceptance of accounts; [and]
      (E) if the customer is a corporation, partnership or other legal entity, the names of any persons authorized to transact business on behalf of the entity; and
      (F) subject to Supplementary Material .06, name of and contact information for a trusted contact person who may be contacted about the customer's account, is age 18 or older and not authorized to transact business on behalf of the account; provided, however, that this requirement shall not apply to an institutional account.
      (2) through (3) No Change.
      (b) A member need not meet the requirements of this Rule with respect to any account that was opened pursuant to a prior FINRA rule until such time as the member updates the information for the account either in the course of the member's routine and customary business or as otherwise required by applicable laws or rules.
      (c) No Change.

      • • • Supplementary Material: --------------

      .01 through .05 No Change.
      .06 Trusted Contact Person
      (a) With respect to paragraph (a)(1)(F) of this Rule, at the time of account opening, a member shall disclose in writing, which may be electronic, to the customer that the member or an associated person of the member is authorized to contact the trusted contact person and disclose information about the customer's account to confirm the specifics of the customer's current contact information, health status, and the identity of any legal guardian, executor, trustee or holder of a power of attorney, and as otherwise permitted by Rule 2165.
      (b) The absence of the name of or contact information for a trusted contact person shall not prevent a member from opening or maintaining an account for a customer, provided that the member makes reasonable efforts to obtain the name of and contact information for a trusted contact person.

      Text of Proposed New FINRA Rule

      * * * * *

      2000. DUTIES AND CONFLICTS

      * * * * *

      2100. TRANSACTIONS WITH CUSTOMERS

      * * * * *

      2165. Financial Exploitation of Specified Adults
      (a) Definitions
      (1) For purposes of this Rule, the term "Specified Adult" shall mean: (A) a natural person age 65 and older; or (B) a natural person age 18 and older who the member reasonably believes has a mental or physical impairment that renders the individual unable to protect his or her own interests.
      (2) For purposes of this Rule, the term "Account" shall include any account of a member for which a Specified Adult has the authority to transact business.
      (3) For purposes of this Rule, the term "Qualified Person" shall mean an associated person of a member who serves in a supervisory, compliance or legal capacity that is reasonably related to the Account of the Specified Adult.
      (4) For purposes of this Rule, the term "Trusted Contact Person" shall mean the person who may be contacted about the Specified Adult's Account in accordance with Rule 4512.
      (5) For purposes of this Rule, the term "immediate family member" shall include a spouse, child, grandchild, parent, brother or sister, mother-in-law or father-in-law, brother-in-law or sister-in-law, and son-in-law or daughter-in-law, each of whom must be age 18 or older.
      (6) For purposes of this Rule, the term "financial exploitation" shall include:
      (A) the wrongful or unauthorized taking, withholding, appropriation, or use of a Specified Adult's funds or securities; or
      (B) any act or omission taken by a person, including through the use of a power of attorney, guardianship, or any other authority regarding a Specified Adult, to:
      (i) obtain control, through deception, intimidation or undue influence, over the Specified Adult's money, assets or property; or
      (ii) convert the Specified Adult's money, assets or property.
      (b) Temporary Hold on Disbursements
      (1) A Qualified Person may place a temporary hold on a disbursement of funds or securities from the Account of a Specified Adult if:
      (A) The Qualified Person reasonably believes that financial exploitation of the Specified Adult has occurred, is occurring, has been attempted, or will be attempted; and
      (B) The member not later than two business days provides notification of the temporary hold and the reason for the temporary hold to:
      (i) all parties authorized to transact business on the Account; and
      (ii) the Trusted Contact Person, unless the Trusted Contact Person is unavailable or the member reasonably believes that the Trusted Contact Person has engaged, is engaged, or will engage in the financial exploitation of the Specified Adult, in which case the member shall attempt to contact an immediate family member of the Specified Adult, if available, unless the member reasonably believes that the immediate family member has engaged, is engaged, or will engage in the financial exploitation of the Specified Adult; and
      (C) The member immediately initiates an internal review of the facts and circumstances that caused the Qualified Person to reasonably believe that the financial exploitation of the Specified Adult has occurred, is occurring, has been attempted, or will be attempted.
      (2) The temporary hold authorized by this Rule will expire not later than 15 business days after the date that the Qualified Person first placed the temporary hold on the disbursement of funds or securities, unless sooner terminated by an order of a court of competent jurisdiction or extended either by an order of a court of competent jurisdiction or pursuant to paragraph (b)(3) of this Rule.
      (3) Provided that the member's internal review of the facts and circumstances under paragraph (b)(1)(C) of this Rule supports the Qualified Person's reasonable belief that the financial exploitation of the Specified Adult has occurred, is occurring, has been attempted, or will be attempted, the temporary hold authorized by this Rule may be extended by a Qualified Person for no longer than 15 business days following the date authorized by paragraph (b)(2) of this Rule, unless sooner terminated by an order of a court of competent jurisdiction.
      (c) Record Retention

      Members shall retain records related to compliance with this Rule, which shall be readily available to FINRA, upon request. The retained records shall include, but shall not be limited to, records of: (1) request(s) for disbursement that may constitute financial exploitation of a Specified Adult and the resulting temporary hold; (2) the finding of a reasonable belief that financial exploitation has occurred, is occurring, has been attempted, or will be attempted underlying the decision to place a temporary hold on a disbursement; (3) notification(s) to the relevant parties pursuant to paragraph (b)(1)(B) of this Rule; and (4) the internal review of the facts and circumstances pursuant to paragraph (b)(1)(C) of this Rule.

      • • • Supplementary Material: --------------

      .01 Applicability of Rule. This Rule provides members with a safe harbor when they exercise discretion in placing temporary holds on disbursements of funds or securities from the Account of a Specified Adult under the specified circumstances denoted in the Rule. This Rule does not require members to place temporary holds on disbursements of funds or securities from the Account of a Specified Adult.
      .02 Supervision. In addition to the general supervisory and recordkeeping requirements of Rules 3110, 3120, 3130, 3150, and Rule 4510 Series, a member relying on this Rule must establish and maintain specific written supervisory procedures reasonably designed to achieve compliance with this Rule, including, but not limited to, procedures related to the identification, escalation and reporting of matters related to financial exploitation of Specified Adults.
      .03 Training. A member relying on this Rule must develop and document specific training policies or programs reasonably designed to ensure that registered persons comply with the requirements of this Rule.
      .04 Reasonable Belief of Mental or Physical Impairment. A member's reasonable belief that a natural person age 18 and older has a mental or physical impairment that renders the individual unable to protect his or her own interests may be based on the facts and circumstances observed in the member's business relationship with the natural person.

    • 15-36 FINRA Requests Comment on a Revised Proposal Requiring Confirmation Disclosure of Pricing Information in Corporate and Agency Debt Securities Transactions; Comment Period Expires: December 11, 2015

      View PDF

      Pricing Disclosure in the Fixed Income Markets

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 2232
      MSRB Regulatory Notice 2014-20
      MSRB Regulatory Notice 2015-16
      Regulatory Notice 14-52
      SEA Rule 10b-10
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Trading
      Key Topics

      Fixed Income Securities
      Pricing Information
      Transaction Confirmations

      Executive Summary

      FINRA is requesting comment on a proposed rule that would require member firms to disclose additional information on customer confirmations for transactions in corporate and agency debt securities. FINRA initially sought comment on the proposed rule in Regulatory Notice 14-52. In response to the comments received, FINRA is proposing several changes to the proposed rule. These changes include replacing the size-based disclosure threshold with a retail customer standard; permitting firms to use alternate methodologies for calculating the reference price for more complex trade scenarios; requiring firms to add a link to TRACE on the confirmation; and proposing additional exceptions from the requirements.

      FINRA and the Municipal Securities Rulemaking Board (MSRB) have discussed a coordinated approach to potential rulemaking in this area. The MSRB has published Regulatory Notice 2015-16 soliciting comment on a revised proposal that differs from FINRA's proposal described herein. This Notice also invites comment on the MSRB's revised approach.

      The text of the proposed rules can be found in Attachment A.

      Questions concerning this Notice should be directed to:

      •  Patrick Geraghty, Vice President, Market Regulation, at (240) 386-4973;
      •  Cynthia Friedlander, Director, Fixed Income Regulation, Regulatory Operations, at (202) 728-8133; or
      •  Andrew Madar, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8056.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by December 11, 2015.

      Comments must be submitted through one of the following methods:

      •  Emailing comments to pubcom@finra.org; or
      •  Mailing comments in hard copy to:

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      To help FINRA process comments more efficiently, persons should use only one method to comment on the proposal.

      Important Notes: All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.1

      Before becoming effective, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board of Governors, and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA or Exchange Act).2

      Background and Discussion

      Initial Proposal

      In Regulatory Notice 14-52, FINRA sought comment on a proposal to require firms to disclose additional pricing information for retail-size customer trades in corporate and agency debt securities.3 Specifically, the proposal would require that, if a firm sells to a customer as principal and on the same day buys the same security as principal from another party, the firm would have to disclose on the customer confirmation (i) the price to the customer; (ii) the price to the firm of the same-day trade (reference price); and (iii) the difference between those two prices.4 Under the initial proposal, the disclosure requirement would apply where the transaction with the customer was of a "qualifying size" of 100 bonds or less or bonds with a face value of $100,000 or less, which was designed to capture those trades that are retail in nature.

      Revised Proposal in Response to Comments

      FINRA received 30 comment letters in response to its initial proposal.5 FINRA now seeks comments on a revised proposal. The significant differences between the initial proposal and the revised proposal include:

      •  replacing the "qualifying size" threshold with a retail customer account standard;
      •  permitting firms to use alternative methodologies for calculating the reference price for more complex trade scenarios;
      •  permitting firms, in the event of a material change in the price of the security between the time of the firm principal trade and the customer trade, to omit the reference price;
      •  requiring a link to TRACE data on confirmations that are subject to the disclosure requirement;
      •  providing an exemption to the proposed disclosure requirements for transactions that are part of a fixed price new issue and are sold at the fixed price offering price;
      •  excluding firm principal trades that are executed on a trading desk functionally separate from the retail trading desk for purposes of calculating a reference price; and
      •  excluding firm principal trades with affiliates for positions that were acquired by the affiliate on a previous trading day.
      A. Criteria For Triggering Disclosure

      In the initial proposal, FINRA proposed that the disclosure requirement would apply where the transaction with the customer was of a "qualifying size" of 100 bonds or less or bonds with a face value of $100,000 or less. This qualifying size standard was designed to capture those trades that are retail in nature. Commenters indicated that the 100-bond standard may be difficult to implement, whereas a retail/institutional account identification is already used in firms' business processing and therefore would be simpler to apply. Accordingly, FINRA proposes to replace the qualifying size requirement with an exclusion for transactions that involve an institutional account, as defined in FINRA Rule 4512(c).6 This would ensure that all eligible transactions involving non-institutional customer accounts, regardless of size or face amount, would be subject to the proposed disclosure.
      B. Alternative Methodologies for More Complex Trades

      The initial proposal set forth several methodologies that firms should apply when there are multiple firm trades equaling or exceeding a customer trade, which could potentially contribute to the determination of the reference price for purposes of the proposed disclosure. These methodologies consisted of average weighted price, last in, first out, and closest in time. Commenters raised concerns about the operational burdens associated with determining the reference price for these "complex" trade scenarios and said that determining the reference price would be difficult and costly.7 Commenters also indicated that differing methodologies would result in inconsistent disclosures for similar customer trades on the same trading day. In response to these comments, FINRA is proposing to provide flexibility to establish alternative methodologies in certain instances.

      In non-complex scenarios, where there is a non-institutional customer transaction and a firm principal transaction of the same or greater size without intervening principal trades within the same trading day, determining the reference price to include on the confirmation is straightforward. FINRA therefore is proposing that the price of the principal trade should be used as the reference price for these scenarios.8

      However, where there is not a same (or greater) size principal and customer trade scenario or there are one or more intervening principal trades of a different size, the proposal would allow firms flexibility in calculating the reference price.9 In such scenarios, firms may employ a reasonable alternative methodology, such as the average weighted price of the firm trades that equal or exceed the size of the customer trade, or the price of the last same-day trade executed as principal by the firm prior to the customer trade (or closest in time if executed after), irrespective of the size of that principal trade.10 The firm must adequately document and consistently apply its chosen methodology.11

      Attached as Attachment B is a more detailed description of the guidelines firms must follow when establishing a reference price with specific examples.
      C. Material Changes to the Price of the Security

      Some commenters also raised concerns about scenarios where there is a material change in the market price, due to, for example, a credit downgrade or breaking news regarding the obligor. These commenters indicated that customers may be confused by reference price information provided on trading days where there are large price swings between the time of the trade with the customer and the firm's own trade. These scenarios do not necessarily involve operational difficulties in calculating the reference price; rather, firms are concerned the reference price may be confusing or misleading.12

      In response to these comments, the proposal would permit firms to either not disclose the reference price, or disclose with the reference price clarifying information, where the firm can demonstrate that there was an unusual and material change in the price of the bond between the time of the firm principal and the customer transactions. This provision is not intended to be used when the price of the security has changed due to normal price fluctuations or general market volatility. Firms may use this provision when the material change in the price of the security has occurred due to a material event such as a credit downgrade or breaking news. A firm that elected not to disclose the reference price under this provision would be required to demonstrate that there was a material change in the price of the security between the time of the firm and the customer transactions.
      D . Link to TRACE Data

      Several commenters advocated replacing this proposal with a variety of methods of providing TRACE data to customers. However, FINRA believes that access to TRACE data alone is insufficient because an investor may not be able to use TRACE to identify precisely the principal trade that was made by that investor's broker-dealer, and thus would not be able to ascertain the exact amount of the price differential between the firm and customer trade. FINRA agrees that TRACE data can help customers understand the market at the time of the customer's transaction, and that investors should be encouraged to access this information. FINRA is therefore proposing that firms also be required to provide a link to TRACE on the customer confirmation. FINRA also invites comment on other ways, in addition to the proposed requirement that firms include a link to TRACE on the confirmation, in which it could make TRACE data more accessible to investors.
      E. Fixed Price New Issues

      Some commenters indicated that new issues should be exempted from the proposal, as primary offerings already provide significant disclosure through offering memoranda. In response, FINRA proposes to exclude transactions that are part of fixed price offerings and are sold at the fixed price offering price on their first trading day from the proposed disclosure. However, in contrast, variable price offerings are reported as secondary trades, may involve investors paying different prices, and may be difficult for firms to distinguish from other kinds of secondary trades. Therefore, the revised proposal would continue to apply the proposed disclosure requirements to transactions that are part of variable price offerings.
      F. Trades That Occur on Functionally Separate Desks

      The initial proposal required disclosure if a firm principal trade occurred on the same day as a customer trade of Qualifying Size and did not distinguish between where the firm principal trade originated within the firm for purposes of triggering the disclosure requirements. Some commenters noted that having the disclosure requirements triggered by trades that were made by separate trading departments or desks would undermine the legal and operational separation of those desks, and may not be relevant in determining the reference price. In response to comments, FINRA proposes to exclude firm-side transactions from the proposed disclosure that are conducted by a department or desk that is functionally separate from the retail-side desk, e.g., where the firm can demonstrate through policies and procedures that the firm-side transaction was made by an institutional desk for an institutional customer that is separate from the retail desk and the retail customer. This exception would not apply, however, where the transaction of the separate department or desk is related to the other desk, e.g., if the transactions and positions of a separate department or desk are regularly used to source the retail transactions at the other desk.
      G. Positions Acquired by an Affiliate on a Previous Trading Day

      As discussed above, the initial proposal did not distinguish between the types of firm principal trades that would trigger disclosure. Some commenters indicated that a broker-dealer affiliate may hold securities in inventory with any subsequent trades between affiliates being more akin to a back-office transfer. In those situations, commenters indicated that the original acquisition time period of the securities should be used to determine whether the disclosure requirements are triggered. In response to this comment, FINRA proposes to exclude trades where the member's principal trade was executed with an affiliate of the member and the affiliate's position that satisfied this trade was not acquired on the same trading day.

      MSRB Proposal

      As noted above, the MSRB also published a notice soliciting comment on a revised proposal.13 As described in detail in the MSRB's notice, the MSRB's approach differs from FINRA's proposed approach described above and would require disclosure of the amount of the firm's mark-up (or mark-down) for certain retail customer transactions, rather than the reference price paid by the firm and the differential between the reference price and the price paid by the customer. Under the MSRB's proposal, the firm would be required to disclose its mark-up or mark-down from the prevailing market price of a security if the firm traded as principal with a non-institutional customer within a discrete time window (e.g., the firm purchased the security in the two hours preceding the sale to the customer, or sold the security in the two hours following the purchase from the customer). 14 While FINRA and the MSRB's revised proposals currently differ, both entities favor a coordinated approach. Accordingly, FINRA is inviting comments on the MSRB's proposal in comparison to FINRA's revised proposal, and whether the MSRB's proposal, or elements of the proposal, may be an appropriate alternative to FINRA's revised proposal.

      Economic Impact Analysis

      Need for the Rule

      FINRA is concerned that investors in fixed income securities currently are limited in their ability to understand and compare transaction costs associated with their purchases and sales. FINRA's analysis of TRACE data for the first quarter of 2015 finds a material difference between the median mark-up/mark-down and the tail of the distribution, indicating that some customers paid considerably more than others in similar trades.

      Economic Baseline

      The revised proposal would impact broker-dealers in the retail market of corporate and agency debt securities by imposing confirmation disclosure requirements on certain customer transactions. FINRA has analyzed TRACE data for the first quarter of 2015 to better understand the transactions and firms affected by the proposal. Since TRACE data cannot differentiate between retail and institutional transactions, the staff focused on customer trades of 100 bonds or less, which is intended to capture those trades that are retail in nature.15

      In the first quarter of 2015, the average daily number of retail-sized customer trades (100 or fewer bonds) was 20,510 in corporate debt securities and 768 in agency debt securities. More than half of the corporate bond transactions were in investment grade securities. For both corporate and agency debt securities, approximately 75 percent of the retail-sized customer trades in the first quarter of 2015 were less than 40 bonds. The transactions of interest were also concentrated among large firms. For example, the top 20 broker-dealers with the highest volumes accounted for roughly 70 percent of the transactions for both corporate and agency debt securities.16

      FINRA also estimated mark-ups and mark-downs on customer trades in corporate and agency debt securities during the first quarter of 2015.17 This analysis shows that there was a material difference between the median mark-ups and mark-downs and the tail of the distribution. For example, for retail-sized investment grade corporate debt transactions the median estimated mark-up on customer buy orders was 0.51 percent whereas the 95th percentile was more than four times higher (2.22 percent), suggesting that while the mark-up was half a percent or less on 50 percent of these orders, 5 percent of the orders had mark-ups of more than two percent.18 These results indicate that some customers paid considerably more than others in similar trades.19 These differences were also significant for high-yield and unrated securities. For example, the median retail-sized corporate debt transactions in high-yield and unrated securities was 0.71 percent and the 95th percentile was 2.68 percent.20

      FINRA also examined the time period separating the customer trades and the corresponding principal trades during the first quarter of 2015. This analysis reveals that approximately 93 percent of retail-sized customer trades in corporate debt securities with same-sized corresponding principal trades occurred within 10 minutes. Similarly, customer and principal trades occurred within 30 minutes of each other for approximately 96 percent and within 2 hours for more than 98 percent of the trades.21 For trades involving two or more different sized offsetting transactions, the maximum time interval separating the trades was within 10 minutes for approximately 58 percent, and within 2 hours for 82 percent of the trades.

      Economic Impact

      As discussed above, the proposal would impact broker-dealers in the retail segment of the corporate and agency debt securities market. To assess the economic impacts associated with the proposed rule change, FINRA reviewed retail-sized customer trades (100 bonds or less) during the first quarter of 2015 to analyze trades that would trigger the disclosure requirement.22 During this period, there were a total of 826,965 customer trades in corporate debt securities. FINRA estimates that 481,726 (or 58.25 percent) of these trades would be subject to the disclosure requirement. These disclosure-eligible trades were reported by over 800 dealers but were concentrated among large dealers. For example, consistent with the estimates based on all retail-sized customer trades discussed above, the top 20 broker-dealers with the highest number of disclosure eligible retail-sized customer trades accounted for more than 66 percent of these transactions in corporate debt securities.23 The top 5 dealers alone accounted for more than 36 percent of the corporate debt transactions.

      FINRA also examined the trades that would fall under the complex and non-complex trading scenarios discussed in this proposal. As discussed above, non-complex scenarios comprised a customer transaction and a firm principal transaction of the same or greater size without intervening trades within the same trading day. FINRA estimates that at least 76 percent of the disclosure-eligible customer trades in corporate and agency debt securities had corresponding principal trades without intervening trades. In such non-complex scenarios, dealers would be required to disclose the price of the corresponding principal trade as the reference price on the confirmation disclosures. FINRA also estimated the differential between the prices on the customer trades and the corresponding reference prices on principal trades for these non-complex trades. The average price differential in corporate debt securities was 0.73 percent and in agency debt securities was 0.43 percent.24 Consistent with the mark-up and mark-down analysis discussed above, there was a material difference between the median price differential and the tail of the distribution, which suggests that some customers paid considerably more than others in similar trades. For example, for retail-sized corporate debt transactions the median estimated price differential was 0.48 percent whereas the 95th percentile was much higher at 2.19 percent.25 These non-complex corporate debt trades were reported by 806 dealers but were concentrated among a few large dealers. For example, the top 20 dealers based on number of disclosure eligible trades accounted for approximately 67 percent of the transactions in corporate debt securities.

      FINRA estimates that for approximately 24 percent of the customer transactions in corporate debt securities that would be subject to the disclosure requirement, there were one or more intervening trades of different size. As discussed above, in these complex trading scenarios firms would have flexibility in calculating the reference price. Firms may use a reasonable methodology, such as the average weighted price of the firm trades that equal or exceed the size of the customer trade or the price of the last same-day trade executed as principal by the firm prior to the customer trade (or closest in time if executed after). FINRA estimates that the average price differential between the prices on the customer trades and the corresponding reference prices for these complex trades was 1.06 percent in corporate debt securities and 0.34 percent in agency debt securities.26 As with non-complex trading scenarios, there was a material difference between the median price differential and the tail of the distribution for these complex trades as well.27 Similarly, while the complex trades in corporate debt securities were reported by 443 dealers, they were concentrated among large dealers, with the top 20 broker-dealers (based on number of disclosure eligible trades) accounting for approximately 64 percent of the eligible corporate debt transactions.28

      Benefits

      As with the initial proposal, FINRA believes this additional pricing information will better enable customers to evaluate the cost and quality of the services firms provide by assisting customers in monitoring current same-day prices a firm and a customer pays or receives in connection with a transaction. The proposal will provide customers with pricing information that customers cannot currently obtain through TRACE data. FINRA further believes this type of information will promote transparency into firms' pricing practices and encourage communications between firms and their customers about pricing of their fixed income transactions. This proposal also may provide customers with additional information that may assist them in detecting practices that are possibly improper, which would supplement FINRA's own surveillance and enforcement program.29 By providing additional pricing information to customers, this proposal may encourage customers to seek out other dealers that might offer more competitive prices. Accordingly, dealers may be incentivized to offer more competitive prices to their retail customers. Any resulting reduction in the differential between the reference price and the price paid by the customer would reduce transaction costs paid by investors and enhance investor confidence. Increase in investor confidence may also encourage wider participation by investors in the retail segments of the corporate and agency debt market.

      Costs

      As with the initial proposal, FINRA recognizes that the proposal would impose burdens and costs on firms. Specifically, FINRA expects that the proposal would require firms to modify their systems to identify instances where firm and customer trades in the same security occur on the same trading day and to adopt a methodology to satisfy the disclosure requirement. Firms may need to record and monitor the decisions on the disclosure methodology. Firms would have to adopt compliance policies and procedures to ensure consistent and appropriate application of the methodology. Firms would also be required to calculate the price difference between the customer and firm trade, and to convey the firm price and differential to the customer price on the customer confirmation. FINRA understands some firms may use legacy systems for confirmations which may be costly to reprogram. Accordingly, firms would likely incur costs associated with updating operational systems and procedures to identify customer transactions that would be subject to disclosure, costs associated with conveying the disclosure on the customer confirmation, cost of including a link to TRACE on the customer confirmation, and costs associated with adopting policies and procedures to ensure continued compliance with this proposal. FINRA specifically requests comments on the sources and quantified estimates of these costs and will estimate these costs based on the information obtained through the public comment process.

      FINRA understands that some firms generate confirmation statements directly following trade execution while others generate confirmations in batches at the end of the day. The costs associated with this proposal may be different depending on the processes that firms rely upon to generate confirmations. FINRA specifically seeks comment on the types of processes firms use to generate confirmations and how the proposal might have differential impacts based on these processes. FINRA requests data and quantified comments where possible.

      However, FINRA believes that changing the scope of the proposal to require disclosure for non-institutional accounts may lessen some of the costs and complexity associated with this proposal by allowing firms to use an existing distinction that already is integrated into their operations. Similarly, FINRA believes that providing flexibility to use an alternative methodology for more complex trading scenarios also will lessen the costs and burdens on firms. FINRA does not believe that requiring firms to add a link to TRACE on the customer confirmation will create a significant business or operational impact for firms, but requests comment on the potential impact.

      While permitting firms to use alternative methodologies for more complex trading scenarios will lessen the costs and burdens on firms, FINRA notes that it will also make it more difficult for potential consumers of this information to evaluate transactions within and across firms, reducing comparability to customers. In addition, the flexibility may increase FINRA's market surveillance and rule enforcement costs.

      FINRA is requesting comment on the potential costs that the revised proposal may impose on firms. FINRA is also requesting comment as to whether the revised proposal may have an unintended negative impact on dealer behavior. FINRA requests data and quantified comments where possible.

      Regulatory Alternatives

      FINRA recognizes that there are alternatives to the proposed approach of requiring disclosure of pricing information for trades in the same security where the firm principal and the customer trades occur on the same trading day. As discussed above, the MSRB is proposing to require disclosure of the amount of the firm's mark-up (or mark-down) for certain retail customer transactions, rather than the reference price paid by the firm and the differential between the reference price and the price paid by the customer. Under the MSRB's proposal, the firm would be required to disclose its mark-up or mark-down from the prevailing market price of a security if the firm traded as principal with a non-institutional account within a discrete time window (e.g., the firm purchased the security in the two hours preceding the sale to the customer, or sold the security in the two hours following the purchase from the customer).

      While FINRA believes its revised approach is likely to result in more consistent disclosures for a greater number of retail customers,30 FINRA notes that, in many circumstances, the revised FINRA approach and the MSRB's mark-up disclosure approach would produce similar outcomes. For example, where there is a 1:1 match in a short duration of time with no intervening trades or material price movement, the mark-up/differential disclosed would be the same under the mark-up disclosure approach and the revised proposals. Similarly, if a firm was using a last-in-time methodology for calculating its reference price in a more complex trading scenario, and the price for that bond did not change significantly between the time of the firm's last purchase and the time of the trade with the customer, the differential between the price to the firm and the price to the customer would likely be comparable to the firm's mark-up calculation.

      Some commenters also suggested a shorter timeframe for purpose of triggering the disclosure requirement, such as 15 or 30 minutes. While the TRACE data indicated that a majority of firm and customer trades occur within 30 minutes of each other, FINRA continues to believe that requiring disclosure for a broader time span of within the same trading day will capture additional customer trades that would benefit from the proposed disclosure and should not be excluded. FINRA also believes that a same-trading day standard will help reduce the concern that a firm might delay trading activity to avoid triggering the disclosure requirements, as it would be less likely that a firm would hold a position overnight solely to avoid the proposed disclosure requirement.

      Some commenters also suggested that the proposed disclosure only be triggered where the customer trade is part of a riskless principal firm trade. FINRA believes using the riskless principal standard is too narrow31 and often may be difficult to objectively define and implement for fixed income securities. As noted above, TRACE data indicates that there is a variance in the price differential in both riskless principal trades and trades that would not be considered riskless principal, therefore again supporting the notion that disclosure in all cases will be valuable.

      FINRA recognizes that there are alternative forms and data points of pricing information that may be disclosed to retail customers, and specifically requests comment on the mark-up disclosure alternatives. Of the options that were considered, however, FINRA believes that, in trades in the same security where the firm and the customer trades occur on the same trading day, requiring firms to disclose the price to the firm, the price to the customer, and the corresponding differential will provide customers with comprehensive and beneficial information, while balancing the costs and burdens to firms of providing the disclosure.

      Request for Comments

      FINRA seeks comments on all aspects of the revised proposal as outlined above. In addition to general comments, FINRA specifically requests comments on the following questions. FINRA requests data and quantified comments where possible.

      1. In comparison to the initial proposal, does the revised proposal alter the anticipated benefits to investors?
      •  Does the revised proposal alter the ability of investors to evaluate the cost and quality of the services that firms provide, and help ensure that customers receive fair and reasonable prices?
      •  Does the revised proposal alter investors' ability to obtain greater transparency into the compensation of their broker-dealers or the costs associated with the execution of their fixed income trades?
      2. What kinds of costs would the revised proposal impose on firms?
      •  What are the anticipated costs to firms in developing and implementing systems to comply with the revised proposal? What are the anticipated on-going costs associated with this revised proposal?
      •  What are the estimates of these costs, including costs associated with updating operational systems and procedures to identify customer transactions that would be subject to disclosure, costs associated with conveying the disclosure on the customer confirmation, cost of including a link to TRACE on the customer confirmation, and costs associated with adopting policies and procedures to ensure continued compliance with the revised proposal? What are the assumptions that underlie these estimates? To what extent do these estimates differ across firms of different sizes and different business models?
      3. In addition to systems modifications, are there other potential changes to firms' infrastructure that would be necessary to comply with the revised proposal? What are those modifications?
      4. What factors might explain differences in mark-ups and mark-downs realized by retail transactions within the same security in the corporate and agency debt market? FINRA requests data and quantified comments.
      5. Do dealers have adequate guidance to distinguish between "complex" and "non-complex" trading scenarios discussed in this proposal? If not, specifically what additional guidance would be helpful?
      •  What methodologies are the dealers anticipated to employ for calculating reference prices in the complex trading scenarios?
      6. Does providing flexibility to the dealers in calculating reference prices for complex trades diminish the value of these disclosures to the investors?
      7. In eliminating the Qualifying Size requirement in favor of a retail customer standard, does the revised proposal better address the universe of transactions that should require confirmation disclosure?
      •  Is the definition of an institutional account as set forth in Rule 4512(c) appropriate for purposes of the revised proposal?
      •  Should the proposal use the term institutional investor as set forth in Rule 2110(a)(4)32 either instead of, or in addition to, the institutional account standard that is currently proposed?
      •  Should the proposal apply to investment advisory accounts or participant-directed plans that would otherwise be excluded?
      8. Are the proposed exceptions for fixed price new issues, trades involving functionally separate desks or departments, and transactions between affiliates for positions that were acquired on a previous trading day appropriate?
      9. Is it appropriate to allow firms to not disclose the reference price in the event of a material change in the market price for the security?
      10. Real time TRACE data is available free of charge on the FINRA site for personal, non-commercial use. In addition, FINRA policy, as per Rule 7730, allow for redistribution of real time TRACE data for personal, non-commercial use free of charge.
      •  In addition to, or instead of requiring firms to provide a link to TRACE on the confirmation, are there are other ways to increase investors' awareness of, and ability to access, TRACE data? For example, should FINRA allow firms the option of making TRACE data available to their customers via their own customer portal (website)?
      11. In its revised proposal, the MSRB is proposing that firms disclose the mark-up both as a total dollar amount and as a percentage of the principal amount of the customer transaction. Should FINRA also consider requiring firms to disclose additional information about the reference price, such the percentage of the price differential or a total dollar amount differential?
      12. In its revised proposal, the MSRB is proposing to require firms to "look through" a transaction with an affiliated broker-dealer and use that affiliated broker-dealer's transaction with a third party in determining whether disclosure is required, and the mark-up to be disclosed. For purposes of determining whether disclosure is required, and the reference price to be used, should FINRA also consider adopting a similar affirmative requirement that would look through a firm's same-day transaction with an affiliated broker-dealer to the price of that affiliate's trade with a third party?
      13. In its revised proposal, the MSRB is proposing to require firms to provide a link to EMMA on all trades with non-institutional accounts, not just those trades that are subject to the proposed disclosure requirement. Should FINRA also consider adopting this requirement?
      14. In its revised proposal, the MSRB is proposing, on all trades with non-institutional accounts, to require firms to disclose the time of execution, accurate to the nearest minute, of the customer's trade. Should FINRA also consider adopting this requirement? What are the potential benefits and drawbacks of this requirement?
      15. If a firm elects to use an alternative methodology for purposes of calculating the reference price, should the firm be required to describe the methodology that was used? If so, would it be appropriate for a firm to make this disclosure on its website, or through some other means?
      16. The revised proposal would require firms, for purposes of establishing the reference price, to consider trades where the firm principal trade was with another customer. Would an alternative methodology be appropriate for calculating the reference price in these cases?
      17. Are there alternative forms of disclosure or methods to achieve the objectives of the revised proposal and are they better suited than the revised proposal?
      •  As discussed above, the MSRB is proposing to require a firm to disclose its mark-up (or mark-down) from the prevailing market price of a security if the firm traded as principal with a non-institutional account within a discrete time window (e.g., the firm purchased the security in the two hours preceding the sale to the customer, or sold the security in the two hours following the purchase from the customer).
      •  Are there benefits to this alternative that are not present in the revised proposal?
      •  Are there limitations to this alternative that are no present in the revised proposal?
      •  What would be the costs to firms to implement such an alternative disclosure? What are the assumptions that underlie those cost estimates?
      •  Should FINRA require similar disclosure instead of the revised proposal?
      •  Instead of requiring firms to calculate a reference price for every eligible trade, should firms be permitted to state that the firm's mark-up/mark-down will not exceed a certain specified figure unless otherwise disclosed, e.g., 0.50 percent, and require firms to disclose mark-ups/mark-downs in excess of that figure?
      18. In comparison to the initial proposal, would the revised proposal differently impact markets and market participants?
      •  Would the revised proposal alter the incentives and dynamics of the broker-customer relationship, result in decreased liquidity in the fixed income market, cause firms to reduce service in retail-sized trades, or encourage firms to trade with customers as principal from inventory?
      •  How should FINRA measure and assess these potential effects against the benefits the proposal might create?
      •  In comparison to the initial proposal, would the revised proposal differently impact markets and market participants?
      •  Are there other potential economic impacts to market participants of the revised proposal? Would the proposal alter the incentives and dynamics of the broker-customer-relationship? FINRA requests data and quantified comments.

      1. FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (NASD Announces Online Availability of Comments) for more information.

      2. See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes, however, take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

      3. The MSRB issued a companion notice soliciting comment on a substantially similar proposal applicable to municipal securities. See MSRB Regulatory Notice 14-20 (November 2014).

      4. In the case of a sale to a customer, the proposal would apply to instances where the firm bought bonds as principal both prior to, and after, it sold bonds to the customer. The proposal would also apply to instances where the firm buys bonds from a customer and sells the same bonds as principal to another party on the same trading day. In that scenario, the proposal would apply to instances where the firm sold bonds as principal both prior to, and after, it bought bonds from the customer.

      5. The comments received in response to Regulatory Notice 14-52 are available on FINRA's website at www.finra.org/notices/14-52.

      6. Rule 4512(c) defines an institutional account as an account of (1) a bank, savings and loan association, insurance company or registered investment company; (2) an investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act or with a state securities commission (or any agency or office performing like functions); or (3) any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.

      7. The scenario was also raised where a firm trade used to calculate the reference price is later cancelled on a subsequent trade date. In such a scenario, FINRA would not require the firm to recalculate the reference price or re-issue a confirmation, but the firm would be permitted to do so at its discretion.

      8. Using data from the first quarter of 2015 for corporate bonds, FINRA observed that approximately 42 percent of retail-size customer trades (100 bonds or fewer) had same-size corresponding principal trades on the same trading day. In addition, for these trades, the customer and principal trades occurred within 30 minutes of each other in approximately 96 percent of those trades.

      9. Using data from the first quarter of 2015 for corporate bonds, the percentage of retail-sized trades that have off-setting firm trades (both same-size or that otherwise satisfy the customer trades) increases to 58.25 percent. For this universe of retail trades, the principal and the customer trades occurred within thirty minutes of each other in over 88 percent of those trades.

      10. For the disclosure requirements to apply, there still must be an offsetting principal trade on the same day that meets or exceeds the size of the retail customer trade.

      11. While FINRA believes that firms should be provided flexibility in calculating the reference price in more complex scenarios, FINRA notes that greater flexibility reduces the comparability of such disclosure across firms.

      12. FINRA's data indicated that, where retail-size trades had a same-size match with a firm trade on the same trading day, over 96 percent of those matched trades occurred within 30 minutes of each other, meaning that concerns about intervening volatility or news between the firm and customer trade, while possible, are not typical and that the close time proximity of the trades further supports that the pricing information would be valuable to investors.

      13. See MSRB Regulatory Notice 2015-16.

      14. As described in the MSRB's notice, the prevailing market price for the customer's security would presumptively be established by referring to the dealer's contemporaneous cost as incurred, or contemporaneous proceeds as obtained, consistent with applicable MSRB rules. See MSRB Regulatory Notice 2015-16.

      15. This analysis is both under-inclusive relative to the proposal, as it does not include retail transactions of larger size, as well as over-inclusive, as it includes non-retail trades of smaller size. Nonetheless, FINRA believes that the analysis provides useful initial evidence around an economic baseline.

      16. The top 5 dealers alone accounted for more than 37 percent of the corporate bond transactions and over 34 percent of the agency debt transactions.

      17. The mark-up and mark-down calculations involved matching customer trades to offsetting same-day principal trades by the same dealer in the same CUSIP. This included matching same-sized trades as well as trades of different sizes where there was no same-sized match (e.g., a customer buy of 100 corporate bonds matched to two principal sells of 50 corporate bonds each). The markups (mark-downs) on customer buys (sells) correspond to the percentage difference in price in customer trades and the offsetting principal trade. In cases when the offsetting principal trade was also a customer trade, the combined mark-up and mark-down ("spread") on these roundtrip transactions was calculated as the percentage difference in price between the customer buy and the customer sell.

      18. The median mark-down on these retail-sized investment grade corporate debt transactions was 0.44 percent and the 95th percentile was 1.57 percent. The corresponding two-way median spread (combined mark-up and mark-down on these roundtrip transactions) and the 95th percentile were 0.07 percent and 2.81 percent, respectively. These estimates are consistent with the academic literature on the impact of transparency and transaction costs in the corporate bond market. For example, Goldstein, Hotchkiss & Sirri (2007) estimated average two-way spreads on BBB corporate bond trades within the same day. The authors' estimates of transaction costs for retail sized trades measured in groupings from less than 10 bonds through 51–100 bonds range from 0.85 percent to 2.35 percent for a period pre- and post- introduction of public TRACE reporting. Consistent with FINRA's analysis, the authors report a material difference between the median transaction costs and the tail of the distribution. For example, the authors find that the median two-way spreads range from 0.38 percent to 2.25 percent whereas the corresponding 99th percentiles were significantly higher, ranging from 4.88 percent to 6.26 percent. Overall, the authors show that the introduction of transparency in the corporate bond market led to a decline in transaction costs. This finding is consistent with other studies, such as Edwards, Harris, and Piwowar (2007) and Bessembinder, Maxwell, and Venkataram (2006), who also find that transparency reduced transaction costs in the corporate bond market.

      19. Similarly, the median mark-up and the 95th percentile for agency debt transactions of 100 bonds or less were 0.11 percent and 1.78 percent, respectively. These differences between the median mark-up/mark-down and the tail of the distribution also remain material across transactions of varying sizes within retail-sized corporate and agency debt transactions. For example, the median mark-ups for corporate debt transactions of less than 10 bonds, between 10 and 40 bonds, between 40 and 70 bonds, and between 70 and 100 bonds were 0.32 percent, 0.75 percent, 0.73 percent and 0.61 percent, respectively whereas the corresponding 95th percentiles were significantly higher (2.11 percent, 2.40 percent, 2.54 percent and 2.54 percent).

      20. The difference between the median mark-up or mark-down and the tail of the distribution also remains material after accounting for differences in security characteristics. For example, the staff calculated the difference between the median and the 95th percentile mark-up and mark-down by CUSIP for all securities that had 50 or more customer trades and corresponding principal trades during the first quarter of 2015. This analysis shows that the difference between median markups and mark-downs and the tail of the distribution continues to remain material across a range of securities. For example, the difference in mark-ups and mark-downs exceeds 1.04 percent for half of the individual corporate debt securities and exceeds 1.47 percent for a quarter of the corporate debt securities. These findings suggest that the material difference between median markups and mark-downs and the tail of the distribution is not driven solely by differences in characteristics of the underlying securities.

      21. These statistics were similar for trades in agency debt securities. For example, customer trades with same-sized corresponding principal trades occurred within 10 minutes of each other for approximately 91 percent and within 2 hours for more than 98 percent of the trades.

      22. As discussed above, since the underlying data cannot differentiate between retail and institutional transactions, FINRA focused on customer trades of 100 bonds or less, which is intended to capture trades that are retail in nature.

      23. For these calculations, dealers are identified based on unique Market Participant Identifiers (MPIDs).

      24. These calculations include all customer trades where the offsetting principal trade was not a customer. For customer trades where the offsetting principal trade was also a customer, the two-way price differentials were higher. For example, the average two-way price differential was 0.85 percent for corporate debt securities and 0.65 percent for agency debt securities.

      25. These results suggest that while the price differential was less than half a percent on 50 percent of these corporate debt transactions, 5 percent of the transactions had price differential of more than two percent. Similarly, for retail-sized agency debt transactions the median estimated price differential was 0.43 percent whereas the 95th percentile was 1.78 percent.

      26. Consistent with the calculations for the non-complex trading scenarios, these calculations include all customer trades where the offsetting principal trades were not a customer.

      27. For example, the median estimated price difference in retail-sized corporate debt transactions was 0.82 percent whereas the 95th percentile was 2.72 percent.

      28. Similarly agency debt trades identified as complex scenarios were reported by 124 dealers but were concentrated among large dealers. For example, the top 20 dealers based on number of disclosure eligible trades accounted for more than 70 percent of the transactions in agency debt securities.

      29. See Securities Exchange Act Release No. 33743 (March 9, 1994), 59 FR 12767 (March 17, 1994) (noting the functions of the transaction confirmation).

      30. For example, under the mark-up disclosure approach, a non-riskless principal transaction effectuated greater than two hours apart would not be eligible to receive pricing disclosure. Similarly, firms may not use uniform approaches in calculating their mark-ups, which would reduce the comparability of this information across firms.

      31. TRACE data from the first quarter of 2015 indicates that by not limiting the proposal to riskless principal trades, 38 percent more retail-size trades would have received the proposed reference price information.

      32. Rule 2110(a)(4) defines an institutional investor as any "(A) person described in Rule 4512(c), regardless of whether the person has an account with a member; (B) governmental entity or subdivision thereof; (C) employee benefit plan, or multiple employee benefit plans offered to employees of the same employer, that meet the requirements of Section 403(b) or Section 457 of the Internal Revenue Code and in the aggregate have at least 100 participants, but does not include any participant of such plans; (D) qualified plan, as defined in Section 3(a)(12)(C) of the Exchange Act, or multiple qualified plans offered to employees of the same employer, that in the aggregate have at least 100 participants, but does not include any participant of such plans; (E) member or registered person of such a member; and (F) person acting solely on behalf of any such institutional investor."


      Attachment A

      Below is the text of the proposed rule change. Proposed new language is underlined; proposed deletions are in brackets.

      FINRA Rules

      2230. Customer Account Statements and Confirmations
      2232. Customer Confirmations
      (a) A member shall, at or before the completion of any transaction in any security effected for or with an account of a customer, give or send to such customer written notification ("confirmation") in conformity with the requirements of SEA Rule 10b-10.
      (b) A confirmation given or sent pursuant to this Rule shall further disclose:
      (1) with respect to any transaction in any NMS stock, as defined in Rule 600 of SEC Regulation NMS, or any security subject to the reporting requirements of the FINRA Rule 6600 Series, other than direct participation programs as defined in FINRA Rule 6420, the settlement date of the transaction; [and]
      (2) with respect to any transaction in a callable equity security, that:
      (A) the security is a callable equity security; and
      (B) a customer may contact the member for more information concerning the security[.];
      (3) with respect to a sale to (purchase from) a non-institutional customer in a corporate or agency debt security, if the member also executes a buy (sell) transaction(s) as principal with one or multiple parties in the same security within the same trading day that equals or exceeds the size of the customer transaction:
      (A) the price to the customer;
      (B) the member's Reference Price;
      (C) the differential between the price to the customer and the member's Reference Price; and
      (D) a reference, and hyperlink if the confirmation is electronic, to the Trade Reporting And Compliance Engine (TRACE) publicly available trading data.
      (c) Definitions

      For purposes of this Rule, the term:
      (1) "corporate debt security" shall mean a debt security that is United States ("U.S.") dollar-denominated and issued by a U.S. or foreign private issuer and, if a "restricted security" as defined in Securities Act Rule 144(a)(3), sold pursuant to Securities Act Rule 144A, but does not include a Money Market Instrument as defined in Rule 6710(o) or an Asset-Backed Security as defined in Rule 6710(m);
      (2) "agency debt security" shall have the same meaning as in Rule 6710(l); and
      (3) "non-institutional customer" shall mean a customer account that is not an institutional account, as defined in Rule 4512(c).
      (4) "Reference Price" shall mean the price of a same-day principal trade by the member in the same security. For purposes of establishing the Reference Price:
      (A) A member is not required to consider a principal trade where:
      (i) The member's principal buy (sell) transaction was executed by a trading desk that was functionally separate from the trading desk that executed the non-institutional customer order, including that the transactions and positions of the separate desk are not regularly used to source the retail transactions at the other desk;
      (ii) The member's principal trade was executed with an affiliate of the member, where the affiliate's position that satisfied this trade was not acquired on the same trading day; or
      (iii) The member acquired the security in a fixed-price offering and sold the security to non-institutional customers at the fixed price offering price on the day the securities were acquired.
      (B) Where the member executes a principal trade that is the same size or greater than a customer trade within the same trading day in the same security, the Reference Price shall be the price of the principal trade.
      (C) Where a single principal trade is not the same size or greater than the customer trade or where there are one or more intervening principal trades between the same or greater size trades within the same trading day, the member may use an alternative methodology to determine the Reference Price. Such methodology must be;
      (i) an average weighted price of the member's same-day principal trades that either equal or exceed the size of the customer trade, or is derived from the price(s) of the member's same-day principal trades and communicates comparable pricing information to the customer;
      (ii) consistently applied across the member's non-institutional customer base; and
      (iii) clearly documented in the member's written policies and procedures.
      (D) Where the member has documented and can demonstrate that there was a material change in the price of the security between the time of the transaction(s) that is (are) being used as the basis of the Reference Price and the time of the customer transaction, the member may elect not to disclose the Reference Price for that customer transaction, or may disclose the Reference Price together with a statement explaining such price change.

      * * * * *


      Attachment B

      Guidelines For Permissible Methodologies in Establishing a Reference Price

      1. Where there is a principal transaction and a customer transaction of the same size within the same trading day, or the principal transaction exceeds the size of the customer transaction and there are no intervening principal transactions, the price of the principal trade must be used.

      Example:

      10:00:00 AM: Firm A purchases 60 XYZ bonds from a dealer at a price of 100 for $60,000.

      10:30:00 AM: Firm A sells 60 XYZ bonds to Customer 1 at a price of 101 for $60,600.

      The firm must use the firm trade (100) as the reference price on the customer confirmation.

      If there is an intervening principal trade, irrespective of size, the firm may use an alternative methodology for calculating the reference price.

      Example: 1:1 Match with Intervening Trade

      10:00:00 AM: Firm A purchases 100 XYZ bonds from a dealer at a price of 100 for $100,000.

      10:30:00 AM: Firm A purchases 30 XYZ bonds from a dealer at a price of 100.50 for $30,150.

      15:00:00 PM: Firm A sells 100 XYZ bonds to Customer 1 at a price of 101.50 for $101,500.

      The firm is permitted to use an alternative methodology as described below.
      2. Where there is not a 1:1 scenario, allow firms to calculate the reference price by a reasonable alternative methodology. We believe that a reasonable methodology could include either using the last same-day trade reported by the firm (or closest in time if reported after), or by using an average weighted price. The firm must adequately document, and consistently apply, its chosen methodology.

      Example:

      10:00:00 AM: Firm A purchases 200 XYZ bonds from a dealer at a price of 102.50 for $205,000.

      10:30:00 AM: Firm A purchases 100 XYZ bonds from a dealer at a price of 104 for $104,000.

      13:30:00 PM: Firm A purchases 500 XYZ bonds from a dealer at a price of 104.50 for $522,500.

      15:00:00 PM: Firm A sells 90 XYZ bonds to Customer 1 at a price of 105.50 for $94,950.

      No trades occur after the trade at 15:00:00.

      The firm is permitted to use either the last firm trade (104.50), or the average weighted price (103.94).

      Example:

      10:00:00 AM: Firm A purchases 200 XYZ bonds from a dealer at a price of 102.50 for $205,000.

      10:30:00 AM: Firm A purchases 100 XYZ bonds from a dealer at a price of 104 for $104,000.

      13:30:00 PM: Firm A purchases 500 XYZ bonds from a dealer at a price of 104.50 for $522,500.

      15:00:00 PM: Firm A sells 90 XYZ bonds to Customer 1 at a price of 105.50 for $94,950.

      15:45:00 PM: Firm A purchases 150 XYZ bonds from a dealer a price of 105 for $157,500.

      The firm is permitted to use either the last firm trade (105), which occurred after the last customer trade in this example, or the average weighted price (104.11).
      3. Allow firms to either not disclose, or disclose with a disclaimer, pricing information for transactions where the firm has documented and can demonstrate that there was a material change in the price of the bond between the time of the firm and the customer transactions.

      Example:

      10:00:00 AM: Firm A purchases 200 XYZ bonds from a dealer at a price of 85 for $170,000.

      10:30:00 AM: Due to news of an impending positive rating change, the prevailing market price for XYZ rises to 90.

      13:30:00 PM: Firm A sells 100 XYZ bonds to Customer 1 at a price of 91 for $91,000.

      Firms could either use the last firm trade (85) and provide explanatory language for the ensuing price change, or could decline to make pricing disclosure in this instance.

    • 15-35 SEC Approves Amendments to FINRA Rules Regarding Temporary and Permanent Cease and Desist Orders; Effective Date: November 2, 2015

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      Cease and Desist Orders

      Regulatory Notice
      Notice Type

      Rule Amendment
      New Rule
      Referenced Rules and Notices

      FINRA Rule 9200 Series
      FINRA Rule 9300 Series
      FINRA Rule 9550 Series
      FINRA Rule 9556
      FINRA Rule 9800 Series
      FINRA Rule 9820(a)
      FINRA Rule 9840
      Suggested Routing

      Compliance
      Legal
      Key Topics

      Disciplinary Proceedings
      Expedited Proceedings
      Permanent Cease and Desist Orders
      Temporary Cease and Desist Orders
      Temporary Cease and Desist
      Proceedings

      Executive Summary

      The SEC recently approved amendments to FINRA rules that lower the evidentiary standard to impose a temporary cease and desist order (TCDO); create a new expedited proceeding for repeated failures to comply with a TCDO or a permanent cease and desist order (PCDO); harmonize the provisions governing how documents are served in temporary cease and desist and expedited proceedings; clarify FINRA's authority to impose a PCDO; and ease FINRA's administrative burden in temporary cease and desist proceedings.1 The amendments become effective on November 2, 2015.

      The amended rule text is available at www.finra.org/notices/15-35.

      Questions concerning this Notice should be directed to:

      •    James S. Wrona, Vice President & Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8270 or Jim.Wrona@finra.org; or
      •    Michael Garawski, Associate General Counsel, OGC, at (202) 728-8835 or Michael.Garawski@finra.org.

      Background & Discussion

      Pursuant to the FINRA Rule 9800 Series, FINRA is authorized to seek and impose a TCDO in connection with the violation of specified rules. A TCDO can be imposed by a FINRA hearing panel where the potential harm resulting from violations to investors is likely and significant. It is designed to stop serious violative conduct and maintain the status quo while an underlying disciplinary proceeding is being litigated. FINRA's TCDO authority is a critical investor-protection tool. Relatedly, FINRA Rule 9556 permits FINRA to bring an expedited proceeding against a firm, associated person or person subject to FINRA's jurisdiction who fails to comply with a TCDO or a PCDO.

      The SEC recently approved amendments to FINRA rules that will strengthen FINRA's ability to use its TCDO and expedited-proceedings authority to better protect investors. In particular, the approved rule changes lower the evidentiary standard to obtain a TCDO; equip FINRA with stronger authority to sanction a firm, associated person or person subject to FINRA's jurisdiction who repeatedly violates a TCDO or PCDO; reduce FINRA's administrative burdens in processing temporary cease and desist proceedings, including expanding the pool of persons who are eligible to serve on hearing panels; and clarify FINRA's authority to impose PCDOs. The rule amendments also harmonize the provisions governing service of documents and permit email service in temporary cease and desist and expedited proceedings.

      TCDO Evidentiary Standard

      Prior to the approved rule change, FINRA Rule 9840(a)(1) provided that a TCDO will be imposed if the hearing panel finds "by a preponderance of the evidence that the alleged violation… has occurred." To increase the effectiveness of FINRA's temporary cease and desist authority and improve its capacity to protect investors facing the likelihood of significant dissipation or conversion of assets, FINRA amended FINRA Rule 9840(a)(1) by lowering the evidentiary standard for obtaining a TCDO to "a showing of a likelihood of success on the merits." This change will enable FINRA to initiate and resolve temporary cease and desist proceedings sooner and more efficiently, which will better protect investors' assets and prevent other significant harm until the concurrent disciplinary proceeding is held.2

      Expedited Proceeding for Repeated Failures to Comply With a TCDO or a PCDO

      Pursuant to FINRA Rule 9556, if a firm, associated person or person subject to FINRA's jurisdiction fails to comply with a TCDO or a PCDO, FINRA staff (with prior written authorization from FINRA's chief executive officer or such other senior officer as the chief executive officer may designate) may issue a notice to the firm or person stating that the failure to comply within seven days will result in a suspension or cancellation of membership or a suspension or bar from associating with any firm, and also stating what the firm or person must do to avoid such action. Prior to the approved rule change, a respondent could potentially abuse this procedure by repeatedly violating a TCDO or a PCDO and then curing that violation before the effective date of the Rule 9556 notice, without being subject to immediate sanctions.

      To address FINRA's concerns with such "violate and cure" situations, FINRA has created a new expedited proceeding. Under new FINRA Rule 9556(h), if a firm, associated person or person subject to FINRA's jurisdiction fails to comply with a TCDO or a PCDO and has previously been served under FINRA Rule 9556(a) with a notice for a failure to comply with any provision of the same TCDO or PCDO, FINRA staff (with prior written authorization from FINRA's chief executive officer or such other senior officer as the chief executive officer may designate) may file a petition with the Office of Hearing Officers seeking a hearing and the imposition of any fitting sanctions. In contrast with FINRA Rule 9556(a) proceedings, full compliance with the TCDO or PCDO is not a ground for dismissing a FINRA Rule 9556(h) proceeding.

      Administrative Changes to Temporary Cease and Desist Proceedings

      The SEC approved amendments to the FINRA Rule 9800 Series that ease FINRA's administrative burdens in temporary cease and desist proceedings. Most significantly, amended FINRA Rule 9820(a) expands the pool of persons who are eligible to serve on hearing panels in temporary cease and desist proceedings. Prior to the rule change, this pool was narrowly circumscribed, which carried the potential to impede the recruitment and appointment of panelists. Amended FINRA Rule 9820(a) alleviates this burden by authorizing the chief hearing officer to appoint panelists from the same, larger group of persons who are eligible to serve on hearing panels in disciplinary proceedings.3

      PCDO Authority

      FINRA amended the FINRA Rule 9200 and 9300 Series to clarify the process for imposing a PCDO in disciplinary proceedings. These rule amendments are procedural in nature and do not reflect any change to FINRA's prior representations concerning the context in which it will seek to impose a PCDO.4

      Harmonized Service Provisions in Temporary Cease and Desist and Expedited Proceedings

      The approved rule change amends provisions in the FINRA Rule 9550 and 9800 Series that govern service of documents in temporary cease and desist and expedited proceedings. The amended rules will allow service by facsimile and by email, and service on counsel, across all temporary cease and desist and expedited proceedings.


      1 See Securities Exchange Act Release No. 75629 (August 6, 2015), 80 FR 48379 (August 12, 2015) (Order Approving File No. SR-FINRA-2015-019).

      2 The SEC also approved a corresponding amendment to FINRA Rule 9840(a)(2). Prior to the amendment, FINRA Rule 9840(a)(2) provided that a TCDO shall be imposed if the hearing panel finds "that the violative conduct or continuation thereof is likely to result in significant dissipation or conversion of assets or other significant harm to investors prior to the completion of the underlying disciplinary proceeding." Amended FINRA Rule 9840(a)(2) will require that a TCDO be imposed if the hearing panel makes this finding with respect to the "alleged" violative conduct.

      3 FINRA also amended FINRA Rule 9840 to require a firm that is the subject of a TCDO to deliver a copy of the TCDO to its associated persons, within one business day of receiving it. As the SEC stated in its approval order, this provision should help prevent fraudulent and manipulative acts and practices by ensuring that the persons who may act on behalf of the firm are made aware of the contents of a TCDO imposed against the firm.

      4 See Securities Exchange Act Release No. 47925 (May 23, 2003), 68 FR 33548, 33550 & n.18 (June 4, 2003) (Order Approving File No. SR-NASD-98-80).

    • 15-34 SEC Approves Rule Governing Sales of Securities on Military Installations to Members of the U.S. Armed Forces or Their Dependents; Effective Date: March 30, 2016

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      Sales on Military Installations

      Regulatory Notice
      Registered Representatives

      Senior Management
      Referenced Rules and Notices

      FINRA Rule 2111
      FINRA Rule 2272
      Regulatory Notice 12-25
      Suggested Routing

      Compliance
      Legal
      Key Topics

      Sales Practices
      Suitability
      Supervision

      Executive Summary

      The SEC approved the adoption of FINRA Rule 2272 (Sales and Offers of Sales of Securities on Military Installations) to govern sales and offers of sales of securities by firms on the premises of any military installation to members of the U.S. Armed Forces or their dependents.1 The rule becomes effective March 30, 2016.

      The rule text is available in Attachment A.

      Questions regarding this Notice should be directed to Jeanette Wingler, Assistant General Counsel, Office of the General Counsel, at (202) 728-8013 or Jeanette.Wingler@FINRA.org.

      Background and Discussion

      The Military Personnel Financial Services Protection Act ("Military Act") was enacted to protect members of the U.S. Armed Forces from unscrupulous practices regarding sales of insurance, financial and investment products.2 Congress amended Section 15A(b) of the Securities Exchange Act of 1934 with the enactment of the Military Act to require FINRA, as a registered securities association, to adopt rules governing the sales or offers of sales of securities on the premises of any military installation to members of the U.S. Armed Forces or their dependents.3 The rules must require: (1) the broker-dealer performing brokerage services to clearly and conspicuously disclose to potential investors (a) that the securities offered are not being offered or provided by the broker-dealer on behalf of the federal government, and that its offer is not sanctioned, recommended, or encouraged by the federal government and (b) the identity of the registered broker-dealer offering the securities; (2) the broker-dealer to perform an appropriate suitability determination, including consideration of costs and knowledge about securities, prior to making a recommendation of a security to a member of the U.S. Armed Forces or a dependent thereof; and (3) that no person receive any referral fee or incentive compensation in connection with a sale or offer of sale of securities, unless the person is an associated person of a registered broker-dealer and is qualified pursuant to the rules of a self-regulatory organization.4 Rule 2272 is intended to comply with the statutory requirements.

      Scope

      The rule applies to offers and sales of securities on the premises of a military installation to members of the U.S. Armed Forces or their dependents. Rule 2272(a) defines "military installation" to include any federally owned, leased or operated base, reservation, post, camp, building or other facility to which members of the U.S. Armed Forces are assigned for duty, including barracks, transient housing and family quarters.

      FINRA reminds firms that any such sales or offers of sales of securities off the premises of a military installation must comply with applicable FINRA rules, including suitability requirements, and that any misleading representation made to a member of the U.S. Armed Forces or a dependent thereof off the premises of a military installation that the securities are being offered or provided on behalf of, or sanctioned, recommended, or encouraged by the federal government would be otherwise prohibited by FINRA rules.

      Disclosure

      Rule 2272(b) requires that any firm engaging in sales or offers of sales of securities on the premises of a military installation to any member of the U.S. Armed Forces or a dependent thereof clearly and conspicuously disclose in writing, which may be electronic, to a potential investor prior to engaging in sales or offers of sales of securities to the investor: (1) the identity of the member offering the securities; and (2) that the securities offered are not being offered or provided by the member on behalf of the federal government, and that the offer of such securities is not sanctioned, recommended or encouraged by the federal government.

      FINRA reminds members that electronic delivery of the disclosures required by proposed Rule 2272 must be consistent with SEC guidance on the use of electronic media to satisfy delivery obligations which, among other things, requires affirmative consent of the customer for delivery of certain documents.5

      Suitability

      Rule 2272(c) provides that a firm must satisfy the suitability obligations imposed by FINRA Rule 2111 (Suitability) when making a recommendation on the premises of a military installation to any member of the U.S. Armed Forces or a dependent thereof. The suitability obligations imposed by Rule 2111 satisfy the statutory requirement that FINRA adopt rules requiring its members to perform an appropriate suitability determination, including consideration of costs and knowledge about securities, prior to making a recommendation to a member of the U.S. Armed Forces or a dependent thereof.6

      Referrals Fees and Incentive Compensation

      Rule 2272(d) prohibits a member from causing a person to receive a referral fee or incentive compensation in connection with sales or offers of sales of securities on the premises of a military installation with any member of the U.S. Armed Forces or a dependent thereof, unless such person is an associated person of a registered broker-dealer who is appropriately qualified consistent with FINRA rules, and the payment complies with applicable federal securities laws and FINRA rules.


      1 See Securities Exchange Act Release No. 75633 (August 6, 2015) (Order Approving File No. SR-FINRA-2015-009).

      2 Public Law 109-290, 120 Stat. 1317.

      3 15 U.S.C. 78 o-3(b).

      4 15 U.S.C. 78 o-3(b)(14).

      5 See Securities Exchange Act Release No. 37182 (May 6, 1996); 61 FR 24644 (May 15, 1996). See also Securities Exchange Act Release No. 42728 (April 28, 2000); 65 FR 25843 (May 4, 2000).

      6 FINRA has previously stated that the cost associated with a recommendation is one factor for a member or an associated person to consider when determining whether a security or investment strategy is suitable for a customer pursuant to Rule 2111. See Regulatory Notice 12-25 (May 2012) (stating that the cost associated with a recommendation is one of many important factors to consider when determining whether the subject security or investment strategy involving a security or securities is suitable). Further, Rule 2111 requires a member or associated person to use reasonable diligence to obtain and consider, among other things, the customer's investment experience. See Rule 2111(a) (requiring that a member or associated person use reasonable diligence to obtain and consider a customer's investment profile, which includes the customer's investment experience). See also Regulatory Notice 12-25.


      Attachment A

      New language is underlined.

      * * * * *

      Text of New FINRA Rule

      * * * * *

      2200. COMMUNICATIONS AND DISCLOSURES

      * * * * *

      2272. Sales and Offers of Sales of Securities on Military Installations

      (a) Military Installations

      For purposes of this Rule, a "Military Installation" shall mean any federally owned, leased or operated base, reservation, post, camp, building or other facility to which members of the U.S. Armed Forces are assigned for duty, including barracks, transient housing and family quarters.
      (b) Disclosures

      A member engaging in sales or offers of sales of securities on the premises of a Military Installation to any member in the U.S. Armed Forces or a dependent thereof shall clearly and conspicuously disclose in writing, which may be electronic, to such potential investor prior to engaging in sales or offers of sales of securities to such potential investor:
      (1) The identity of the member offering the securities; and
      (2) That the securities offered are not being offered or provided by the member on behalf of the Federal Government, and that the offer of such securities is not sanctioned, recommended or encouraged by the Federal Government.
      (c) Suitability

      A member shall satisfy the suitability obligations imposed by FINRA Rule 2111 when making a recommendation on the premises of a Military Installation to any member of the U.S. Armed Forces or a dependent thereof.
      (d) Fees and Compensation

      No member shall cause a person to receive a referral fee or incentive compensation in connection with sales or offers of sales of securities on the premises of a Military Installation with any member of the U.S. Armed Forces or a dependent thereof, unless such person is an associated person of a registered broker-dealer who is appropriately qualified consistent with FINRA rules, and the payment complies with applicable federal securities laws and FINRA rules.

      * * * * *

    • 15-33 Guidance on Liquidity Risk Management Practices

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      Liquidity Risk

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules and Notices

      NTM 99-92
      Regulatory Notice 10-44
      Regulatory Notice 10-57
      Suggested Routing

      Compliance
      Internal Audit
      Legal
      Risk Management Committee
      Treasury and Finance Operations
      Key Topics

      Financial Stress Tests
      Liquidity Risk Management Practices

      Executive Summary

      Effective liquidity management is a critical control function at broker-dealers and across firms in the financial sector. Failure to manage liquidity has contributed to both individual firm failures and, when widespread, systemic crises. From an investor protection perspective, sound liquidity risk management practices enhance investor protection because they make it more likely that a firm's customers continue to have prompt access to their assets, even in times of stress.

      FINRA is providing guidance on effective practices that senior management and risk managers at firms should consider and implement. This Notice is directed to firms that hold inventory positions or clear and carry customer transactions. Other types of broker-dealers may also find this Notice is of value to them when assessing their own liquidity risks.

      Questions concerning this Notice should be directed to:

      •  Mark Frankenberg, Director, Risk Oversight and Operational Regulation, (646) 315-8816;
      •  Robert Mendelson, Senior Advisor, Risk Oversight and Operational Regulation, (646) 315-8660; or
      •  Anthony Sacco, Examination Director, Risk Oversight and Operational Regulation, (646) 315-8441.

      Background

      The primary role of liquidity-risk management is ensuring the availability of cash or highly liquid assets to support a financial institution's funding needs under both normal and stressed conditions. To do so, a financial institution needs a rigorous prospective assessment of its sources of funds to meet obligations, the amounts it will need when a stress occurs, the behavior characteristics of funding sources, and the limitations that funding sources may have or to which they may become subject.

      Beginning in March 2014 and continuing into the first quarter of 2015, FINRA conducted a review of the policies and practices at 43 firms related to managing liquidity needs in a stressed environment. The review had two broad purposes: to understand better firms' liquidity risk-management practices and to raise awareness of the need for liquidity stress planning. The review included assessing firm management's knowledge and understanding of the liquidity risks that their firm faced, the firm's ability to measure liquidity needs in stress situations, management's preparedness and plans for addressing such a scenario should it arise, and the specific steps the firm would take to address its needs.

      The firms reviewed comprised a wide range of clearing firms and large introducing firms with varying levels of capitalization. The business mix at these firms also varied, from firms that focused on one or two market sectors to firms that provide a full range of products and services. A number of the firms were affiliated with banks, including firms affiliated with non-U.S. banks. In some instances, the banking business was an adjunct to the broker-dealer business and in other instances the banking business was the primary business of the holding company group. Of the 43 participating firms, 28 were part of a bank holding company group1 (11 U.S. bank holding company (BHC) or financial holding company groups, and 17 non-U.S. groups). Of the U.S. firms, nine were associated with BHCs that had greater than $50 billion of total consolidated assets, and two were affiliated with BHCs that had from $10 billion to $50 billion in total consolidated assets.

      The review consisted of two phases. The first phase required firms to calculate the impact on liquidity when five stresses were applied concurrently to the broker-dealer's business. The second phase allowed a firm to challenge the severity of the assumptions used in the test, describe mitigating action the firm would take and demonstrate the resources available to offset the stressed outflows of cash.

      The results of our review of the 43 firms for effective and ineffective practices in meeting stressed outflows of funds are described in the Results section below. Planning for adverse liquidity conditions based upon stress tests is one way to protect against failure when extreme events occur. The practices described in this Notice are intended to inform senior management and risk managers at firms of steps that they should consider and implement.

      In general, each broker-dealer should review its liquidity condition under possible stress events and determine which liquidity management practices are best suited to its particular business. Similar to Regulatory Notice 10-57, this Notice is directed to firms that hold inventory positions or clear and carry customer transactions. Other types of broker-dealers may also find this Notice is of value to them when assessing their own liquidity risks.

      Financial Responsibility Rules

      A fundamental purpose of the SEC's financial responsibility rules is to assure that broker-dealers have sufficient liquidity to conduct their business or to liquidate it without losses to customers. As part of a firm's obligation to supervise the businesses in which it engages, FINRA expects each firm to regularly assess its funding and liquidity risk management practices so that it can continue to operate under adverse circumstances, whether these result from an idiosyncratic or a systemic event. Sound liquidity risk management practices enhance investor protection because a firm's customers are more likely to continue to have prompt access to their assets.

      Twice in the past, FINRA has issued Notices addressing liquidity practices. Notice to Members 99-92 reported on the results of a multi-year effort by examination staffs of the NASD, NYSE and SEC assessing broker-dealer risk management practices. This report set forth general risk management practices that were found to be sound, as well as describing shortcomings at certain firms.

      Regulatory Notice 10-57 outlined a number of steps that firms should consider in managing liquidity and funding risks. In addition to criteria for immediate escalation to senior management, the Notice noted 10 areas where appropriate broker-dealer staff (e.g., treasury) should consider reviewing with senior management on a regular basis formal risk reports — both quantitative and qualitative — that summarize key measures of funding and liquidity.

      Overview of the Stress Test and FINRA's Stress Criteria

      FINRA's current review had two phases. First, each participating firm computed a stress test for a 30-calendar-day period using specific stress criteria. These criteria were selected based, in part, upon our review and analysis of a number of broker-dealers whose businesses had failed during the past 30 years.

      The Phase 1 baseline stress test assumed limited or no mitigating action could be taken, so that the result in extreme stress could be observed. The test also assumed that the firm would fulfill all of its contractual obligations as would its counterparties. We believe that these assumptions reflect what may occur in a real idiosyncratic stress situation.

      During Phase 2 of the stress test FINRA met with each participating firm to discuss baseline stress results. If any liquidity shortfall resulted during the 30-day period tested during Phase 1, the firm was given the opportunity to identify any mitigating action that it expected to take to ameliorate the shortfall. Phase 2 also involved a discussion of contingent funding sources that a firm expected to be available to offset any stressed outflows, including commitments and contingencies from affiliates and other lenders. A firm that is part of a holding company group, as many of the firms are, was expected to conduct this analysis and have contingency funding plans at the broker-dealer level.2 Planning at the broker-dealer level supplements the corporate group's planning at the holding-company level. Assessing funding and liquidity risks at the broker-dealer level enables the governing boards and senior management of broker-dealers to measure, monitor and control risks that relate specifically to the broker-dealer.3 Further, this level of analysis can help broker-dealers plan for the challenges they would face should access to funding from affiliated entities become limited or unavailable.

      The five specific concurrent stresses in the Phase 1 review are described below. In performing the required computations, the firm was asked to include a daily analysis for the first 10 consecutive business days, and a weekly analysis for the remainder of the 30-day stress period.

      1. Funding Inventory Positions. The firm was to assume a 100 percent loss of all money market funds as counterparties for funding and a 100 percent loss of funding for collateral other than Treasury securities, agency pass-through securities and agency debentures (immediately for open or demand transactions, at maturity for term financing). In addition, the firm was to assume 10 percent loss of available funding from all counterparties with Treasury, agency pass-through and agency debentures collateral. Further, for all inventory positions consisting of Treasury, Agency Pass-Through and Agency Debentures the firm was to assume haircuts of 3 percent, 7 percent and 9 percent, respectively, as each funding transaction rolled over.
      2. Stressing of Financing for Mismatched Financing Transactions. For other financing transactions, generally those that involved a matched book in repo/reverse repo or stock borrow/loan, the firm was to make the same assumptions with respect to the collateral securing the side in which it was receiving funding as it was to make with respect to funding inventory positions. Just as in the first stress criteria, the firm was to assume fulfillment of the contractual terms of each transaction and apply the stress as funding transactions matured.
      3. Operational Drains. To address daily operational items that can cause liquidity drains, the firm was to stress clearing deposits with clearing banks, central counterparties (CCPs) and clearing organizations. Specifically, the firm was to assume a doubling of all clearing deposits, whether client or firm related, on Day 1. In addition, it was to assume no release of net settlement amounts from clearing banks, CCPs or clearing organizations for the first 10 business days.
      4. Funding Customer Withdrawals. The firm was to assume customers would withdraw free credit balances at the rate of 5 percent each day for the first 10 business days.
      5. Losses from Forced Deleveraging and Reserves Against Trading Losses. Firms were to reasonably assess loss estimations against potential trading losses for each day of the stress analysis. (For example, sales of inventory at a discount.)

      Evaluation Methodology

      At the conclusion of both phases of the stress test, FINRA evaluated the liquidity risk management practices of each of the participating firms based on four different criteria. The criteria and basis for evaluation and effective and ineffective practices for managing liquidity stress are described below.

      The areas of evaluation and factors we considered under each phase were:

      1. Management and line staff understanding of the issues that can reasonably be expected to arise in such events. We evaluated whether the firm's management considered the issues that would go into planning, whether they had analyzed the differences between operating in normal times and in times of stress, and understood how different these situations can be. We also evaluated management's familiarity with risk mitigating strategies based on the firm's business mix.
      2. Measuring risk. We reviewed a firm's capability to make the necessary computations required in Phase 1 and, to the extent a firm proposed mitigating techniques, to accurately compute the effects and incorporate them into the results of the stress test.
      3. Plan for responding to an idiosyncratic stress events. We reviewed whether a firm had a written liquidity plan, a governance process for determining when to implement the plan, the operational processes needed to carry out its plan, and the firm's testing of those processes. We also evaluated the comprehensiveness of the plan in relation to its business lines and resources.
      4. Effectiveness of a firm's contingent funding plan. We reviewed a firm's plans for funding its inventory, particularly fixed income inventory, including its ability to absorb increases in haircut requirements for repurchase transactions. We also compared FINRA's suggested stress haircuts on collateral to those firms used in their liquidity stress planning. We reviewed whether firms had loan facilities and liquidity pools that could be drawn on to meet funding needs as they arose during the test, which included whether the terms under which the loan facilities and liquidity pools could be accessed were properly understood by the firm and whether the amount of such liquidity sources were commensurate with the firm's business and the attendant risks. If applicable to a particular firm, we evaluated the firm's plans and capacity to obtain liquidity to meet customer withdrawals by accessing the funds in its Special Reserve Account for the Exclusive Benefit of Customers. We also reviewed the firm's plans to reduce inventory through outright sale.

      Observations Regarding Effective and Ineffective Practices

      1. Management's and line staff's understanding of the issues that can reasonably be expected to arise in such events.
      a. We observed a number of firms that had a sound planning process in place and others that had not planned for erosion of funding or counterparties not conducting business as usual. Understanding that counterparties would not continue to conduct business as usual during a stress period is a critical attribute of a firm's plans and mitigating actions. Counterparties in times of stress could discontinue funding or require greater collateral haircuts. It is not acceptable planning for a stress environment to assume counterparties will conduct business as usual.
      b. Designating a group to ensure that systems and reports are available for use by responsible personnel to understand and manage the firm's funding and liquidity process is part of a well-developed plan.
      c. A firm's new product approval process that included an assessment of liquidity risk introduced by each new product under normal and stress scenarios is an effective practice. Including liquidity risk in this process is critical for any firm that provides to its customers or to the market new products, be they exchange-traded or otherwise.
      2. Measuring Risk.
      a. An important baseline practice for a firm's planning for stress scenarios is for it to be able to anticipate and measure cash outflows under particular stress scenarios. Doing so, and having reports that enable management to consider the impact of stresses, are essential tools to developing an appropriate contingent funding plan.
      b. We observed that many of the firms participating in this stress test were able to do so and had staff and systems that could perform the necessary computations. Other firms required some guidance before they could perform the computations, but with that guidance were able to do so. A few firms were simply unable to perform the necessary computations. Generally, these firms did not have a formal plan for addressing liquidity stress.
      3. Plans for responding to an idiosyncratic stress event.
      a. A realistic assessment of the effects of potential shocks is essential to effective liquidity risk management. Conducting regular stress tests that are appropriate considering the business, services and products in which a firm operates contributes to achieving this realistic assessment of liquidity risks.
      b. The stress scenarios used by a firm should be based on severe stresses that the firm could face or that have arisen in the past for firms in similar businesses. Firms also should conduct ongoing reviews of the stress scenarios that are part of the firm's own risk management process. Doing so increases the likelihood that a firm's current business mix and observed market events, both recent and historical, are properly contemplated in those stress scenarios (e.g., growth of a product line, taking on a new correspondent, or contemplating other events, such as the October 2014 fixed income Flash Crash, the events of 2008, currency devaluations or governmental defaults).
      c. Having a governance process around stress test results and use of contingency funding plans is part of a well-developed plan. We observed plans that had clear criteria for when results should be escalated and discussed with senior management and with appropriate management committees or board committees, or indeed the full board of the firm. We also observed a number of firms that did not have a clear process for escalation.
      d. Establishing clear criteria for when a firm should shift from "business as usual" to contingent funding mode is critical to successfully executing the plan.
      4. Committed loan facilities and access to a committed liquidity pool.
      a. A well-developed contingent funding plan should include a committed facility dedicated exclusively to the firm. We observed firms that relied on committed unsecured loan facilities. A majority of these loan facilities were from an affiliate or parent. Often loan facilities with parents or affiliates were not dedicated to a specific entity in a corporate group. Firms should ensure that a committed facility is not committed to multiple affiliates to ensure that funding is available when and if needed.
      b. Third-party lending facilities that have terms and conditions that make the availability of funding unlikely should be appropriately discounted or excluded. Most third-party lending facilities we observed had extensive restrictions on borrowing in adverse conditions. Restrictive covenants and material adverse changes clauses make these facilities significantly less likely to be available in an idiosyncratic stress event and firms should be careful not to place undue reliance on such facilities. We also found instances where firms were relying on uncommitted facilities, which have little value in a stress environment.
      c. Some firms had multiple committed funding sources both for repo/secured financing and for unsecured financing. We also observed instances where a firm was reliant on a single material funding source.
      d. A well-prepared treasurer's office or financial office will have its loan documents readily available so that necessary forms and certifications can be quickly provided to meet preconditions for advances of funds.
      5. Responding to customer withdrawals of funds.
      a. Many firms indicated they expected to and could perform a daily computation of their customer reserve fund requirement.4 Among the participants in the test, several indicated that in a stress environment they would do a daily computation and had trained staff and tested their systems so that they are prepared to perform daily reserve computations. We also observed firms that included performing daily computations in their mitigation plans, but had not done the preparation necessary to assure that the process would work. For example, these firms had not identified which employees would be involved in the process, had not tested the ability to run the reports necessary for the computation, and had not identified which manual computations it ordinarily performs weekly that it would have to perform on a daily basis.
      6. Funding firm inventory.
      a. Having reasonable assumptions regarding the haircuts that counterparties are likely to require in stress scenarios, especially on less liquid collateral, is necessary to ensure the effectiveness of a firm's contingent funding plan. When firms evaluated the availability of secured financing based on securities collateral, there was a wide range of haircuts used. This was particularly the case with respect to DTCC eligible equity securities. Reliance on secured funding without adjusting for increased haircut levels has proven to be unreliable at times of stress. The range of haircuts on high-quality-liquid assets appeared reasonable at most firms. However, many of the firms' assumptions around less liquid collateral were too optimistic to be used for a stressed situation's collateral haircut. Examples from the table below demonstrate this optimism, such as 5 percent or 10 percent haircuts on municipal bonds; 25 percent haircuts on high yield corporate bonds; and 2-13 percent for equities. The table below shows data regarding the haircuts we set for the test and those firms used in their own testing.

      Haircuts by Asset Class
        U. S. Treasury Bills, Notes and Bonds Agency and GSE asset backed pass-through securities Agency and GSE Debentures Investment grade corporate bonds rated A & Above Corporate bonds rated BBB Listed Equities Municipal Bonds High Yield Corporate Bonds
      FINRA 3% 7% 9% 100% 100% 100% 100% 100%
      AVG 3% 6% 6% 12% 21% 15% 12% 95.7%
      Median 3% 6% 6% 12% 19% 13% 10% 100%
      High 5% 10% 10% 100% 100% 100% 100% 100%
      Low 1% 2% 2% 5% 5% 2% 5% 25%
      b. Comprehending the potential effects of the FICC's GCF facility's capacity limit on a firm's liquidity funding plans is important to the effectiveness of that plan. Many firms indicated that they would rely to a much greater extent on FICC's GCF repo facility for "general collateral." While under normal conditions the GCF facility is a useful tool for funding inventory that meets the GCF standard, under the terms of FICC's rules and agreements with participants a firm's GCF capacity is limited to 140 percent of the firm's trailing one month average outstanding usage. Comprehending the effect of this limit in the firm's liquidity funding plans is important to the effectiveness of the plan. Otherwise, over-reliance on the GCF or any other facility with limits to access undrawn funding capacity will fail to produce the anticipated liquidity.
      c. Diverse sources of funding in the repo market can be a significant risk mitigation method.
      7. Plans for liquidating firm inventory.
      a. The vast majority of firms stated that they intended to promptly and significantly reduce inventory in liquidity stress positions. A majority of the firms participating in the test indicated they would liquidate government securities positions first. Otherwise, many firms indicated that, they would choose to liquidate positions where a bid was available rather than by the collateral type.
      b. Many firms stratified their inventory into specific groupings based upon the anticipated market for securities in the grouping, e.g., highly rated corporate debt or highly rated municipal debt and listed equities with market depth.
      c. While reducing inventory is helpful in raising liquidity, it does not resolve the problem that less liquid securities may need to be marked down substantially in order to sell quickly.
      d. A few firms developed a cushion for losses as part of their liquidity risk management. FINRA strongly believes that firms should incorporate this step in their stress planning and calculations. Without appropriate haircuts, firms may cling to positions that are draining liquidity in order to avoid losses when in fact consideration should be given to selling less liquid securities as well as more marketable positions.

      Results

      We evaluated each of the participating firms' capacity and readiness in the areas described under evaluation methodology. We also reviewed and evaluated firms upon the numerical outcomes of the stress test before and after applying the firm's proposed mitigants. With respect to the Understanding, Measurement, Planning and Contingent Funding evaluation criteria, we rated the firms as either well prepared, adequately prepared or insufficiently prepared. With respect to four specific mitigants that many firms indicated they would use, we rated the firms as either sufficiently prepared or insufficiently prepared (or N/A, if the mitigant was not applicable).

      Of the 43 participants, staff considered the large majority, 37, of the firms participating as having sufficient resources, staff and liquidity plans to be likely to surmount the stress scenario posed. A firm was considered to be sufficiently prepared for significant liquidity stress if it was also able to demonstrate sufficient liquidity throughout the 30 days covered during the test.

      A small number of smaller firms did not demonstrate convincingly their preparedness to surmount the stress scenario for 30 days. These six firms could not demonstrate sufficient knowledge and understanding of the impact of the stressors on its business, or could not survive 30 days without running out of liquidity. It is FINRA's belief that of these six firms,5 three have subsequently improved their liquidity plans such that they now appear likely to withstand the stress scenario. We continue to work with the remaining firms as they develop their plans and mitigating strategies. While each of these three firms generally remains in compliance with the net capital and other financial responsibility rules, they continue to be subject to financial and operational surveillance in accordance with criteria described in Regulatory Notice 10-44.

      Our evaluation of these areas is summarized in the tables below.

      Characteristic Evaluated
        Well
      Prepared
      Adequately
      Prepared
      Insufficiently
      Prepared
      Understanding 22 15 6
      Measuring 17 16 10
      Planning 16 21 6
      Contingent Funding Plan 10 27 6


      Mitigant
        Number of Firms Sufficiently
      Prepared
      Number of Firms Insufficiently
      Prepared
      Factor Not Applicable
      Committed loan facilities and access to a liquidity pool 37 4 2
      Responding to customer withdrawal of funds 15 9 19
      Funding firm inventory 23 10 10
      Plans for Liquidating Inventory 43 - -

      Conclusion

      The test was intended to serve as a tool to understand the preparedness at firms to employ effective practices so that they could withstand significant idiosyncratic stresses. As part of the review we expected to observe practices that we considered effective for addressing stresses and to assist firms in understanding areas in their own preparation and planning that had weaknesses so their management could address those areas. Firms that implement liquidity risk metrics should ensure that conservative and appropriately difficult assumptions are used in designing the risk measurement and management systems. Failure to do so could well cause the risk management framework to fail in a real liquidity crisis.

      Based on this review, FINRA expects that each firm would:

      •  rigorously evaluate its liquidity needs related to both market wide stress and idiosyncratic stresses;
      •  devote sufficient resources to measuring risks applicable to its business and report the results of measurement to senior management,
      •  This would include a review for what those risks might be based on historical events that have affected the firm or other firms, and
      •  Thinking about stresses that could occur but have not yet been observed,
      •  develop contingency plans for addressing those risks so that the firm will have sufficient liquidity to operate after the stress occurs while continuing to protect all customer assets;
      •  conduct stress tests and other reviews to evaluate the effectiveness of the contingency plans; and
      •  have a training plan for its staff and have tested processes on which it intends to rely if such stresses occur.

      As a result of the many benefits that accrued to the firms participating in this review, FINRA intends to review firm liquidity risk planning and will use stress tests with various designs from time to time in the future, either with a group of firms or as part of the examination of individual firms where appropriate. We strongly encourage all firms to conduct a self-assessment of their businesses and incorporate firm wide liquidity stress testing into their risk and business planning.


      1 Fifteen firms were not affiliated with BHCs although several were part of groups that had non-deposit taking trust companies and one was affiliated with a bank but not via a BHC.

      2 Bank supervisory agencies routinely conduct stress tests of banks and their holding companies. In the United States these are mandated by the regulations adopted pursuant to the Dodd-Frank Act, 12 CFR part 252, subparts E and F. Recently, the Board of Governors of the Federal Reserve System released "Dodd-Frank Act Stress Test 2015: Supervisory Stress Test Methodology and Results March 2015." The European Banking Authority also conducts stress tests. See, e.g., EBA publishes 2014 EU-wide stress test results. Similarly, the Bank of Japan evaluates funding liquidity risk as part of its semi-annual Financial System Report.

      3 The Securities and Exchange Commission has proposed that ANC broker-dealers and nonbank securities based swap dealers approved to use internal models be subject to liquidity risk management requirements. Exchange Act Release No. 34-68071. An ANC broker-dealer is one that is permitted to use the alternative internal model-based method for computing net capital.

      4 None of the firms in the review currently do the reserve computation on a daily basis.

      5 The six that were insufficiently prepared are not among our 50 largest firms as measured by net capital and none are part of a bank holding company group.

    • 15-32 FINRA Filing Requirements and Review of Regulation A Offerings

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      Regulation A Offerings

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules

      FINRA Rule 2111
      FINRA Rule 2210
      FINRA Rule 2310
      FINRA Rule 3110
      FINRA Rule 5110
      FINRA Rule 5121
      SEA Rule 144
      SEC Regulation A
      Suggested Routing

      Advertising
      Corporate Finance
      Compliance
      Legal
      Registered Representatives
      Senior Management
      Syndicate
      Underwriting
      Key Topics

      Communications with the Public
      Compensation Limitations
      Confidential Treatment
      EDGAR
      Investment Banking
      Public Offerings
      Suitability
      Supervision
      Underwriting

      Executive Summary

      FINRA is publishing this Notice to provide guidance regarding the FINRA filing requirements and review procedures that apply to firms that participate in Regulation A+ offerings. Specifically, FINRA's Corporate Financing Rules require firms that participate in Regulation A+ offerings to file with FINRA information specified in the rules. FINRA's Communications with the Public Rule and its Suitability Rule also apply to a firm's participation in these offerings. FINRA also reminds firms that communications with the public concerning a Regulation A+ offering of direct participation program (DPP) securities must be filed with FINRA.

      Questions regarding this Notice may be directed to:

      •   Joseph E. Price, Senior Vice President, Corporate Financing/Advertising Regulation, at (240) 386-4642;
      •   Amy C. Sochard, Senior Director, Advertising Regulation, at (240)386-4508; or
      •   Kathryn M. Moore, Associate General Counsel, Office of General Counsel, at (202) 728-8200.

      Background and Discussion

      Regulation A+

      Regulation A under the Securities Act of 1933 has been a longstanding exemption from the registration requirement for offerings of up to $5 million of securities in any 12-month period.1 Pursuant to Title IV of the Jumpstart Our Business Startups (JOBS) Act,2 the SEC recently updated and expanded Regulation A with amendments that became effective on June 19, 2015. The new amendments, popularly known as Regulation A+, allow offerings of up to $50 million of securities in a 12-month period. Below, FINRA highlights a few of the amendments to Regulation A.

      While Regulation A continues to require that an offering statement must be prepared on Form 1-A, the amendments provide that the offering statement must be filed electronically with the SEC on EDGAR. Offering statements continue to be subject to review and comment by the SEC and must be qualified by the SEC in a "notice of qualification" prior to any sales of securities. Under the Regulation A+ amendments, certain issuers3 also have an option to submit a draft offering statement to the SEC for non-public review, which must be filed electronically on EDGAR, and all non-public submissions must be filed publicly no less than 21 calendar days before qualification of the offering statement.

      Amendments to an offering statement must be filed with the SEC in the same manner as the initial filing. A post-qualification amendment must be filed to reflect any facts or events arising after the qualification date that represent a fundamental change in the information in the offering statement.

      In addition, Regulation A+ provides that eligible issuers and intermediaries in Regulation A+ offerings may conduct a solicitation of interest in an offering (testing the waters), including solicitation of non-accredited investors, both before or after the filing of the offering statement.4 Solicitation materials must be filed with the SEC as exhibits to the offering statement.

      Corporate Financing Rules

      FINRA's Corporate Financing Rules—Rules 5110, 2310 and 5121—generally: (1) require the filing of specified information in connection with public offerings in which FINRA member firms will participate; (2) prohibit unfair terms and arrangements in connection with public offerings of securities; and (3) impose requirements on offerings in which there is a specified conflict of interest.5 The Corporate Financing Rules require firms that participate in the distribution of securities in a Regulation A+ offering to file documents and other information with the Corporate Financing Department.6 These documents include an offering statement and its exhibits and amendments.7 The documents are required to be submitted no later than one business day after they are filed or submitted to the SEC.8 FINRA accords confidential treatment to all filed documents and information.9 No sales of securities subject to the rules, including Regulation A+ offerings, may commence until FINRA has provided a "no objections" opinion.10

      When FINRA issues a "no objections" opinion to proposed underwriting terms and arrangements, the opinion relates solely to the Corporate Financing Rules and does not purport to express any determination regarding compliance with FINRA's suitability or supervision rules, or any other statutory or regulatory requirements, including that the offering is a qualified Regulation A offering.11

      Communications with the Public Rule

      FINRA Rule 2210 governs firms' communications with the public. The rule requires that communications be fair, balanced and not misleading.12 The rule also requires that an appropriately qualified registered principal approve retail communications distributed to investors prior to use.13 A "retail communication" is defined as any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.14 Firm communications made available to 25 or fewer retail investors within any 30 calendar-day period are defined as correspondence and are also subject to the content standards of Rule 2210.15

      Regulation A+ solicitation materials also may need to be filed with FINRA, depending upon the product being offered.16 Rule 2210 requires that retail communications concerning public direct participation programs (as defined in Rule 2310) be filed with the Advertising Regulation Department within 10 business days of first use or publication.17 If a firm uses Regulation A+ solicitation materials concerning a direct participation program security with more than 25 retail investors, the materials would be subject to the rule's filing requirement and must be approved by an appropriately qualified registered principal of the firm.


      1. The SEC has stated that securities purchased by investors in a Regulation A offering are not "restricted" securities for purposes of the federal securities laws. See 80 FR 21806, at 21866.

      2. See Pub. L. No. 112-106, 126 Stat. 306 (2012).

      3. Regulation A only permits issuers whose securities have not been previously sold pursuant to a qualified offering statement under Regulation A or an effective registration statement under the Securities Act to submit to the SEC a draft offering statement for non-public review.

      4. See Securities Act Rule 255 for the timing and requirements for the use of solicitation materials.

      5. Rule 5110 governs offerings of debt and equity securities. Rule 2310 governs offerings of direct participation plans. Rule 5121 governs offerings in which firms participating in a distribution have a conflict of interest with the issuer.

      6. See, e.g., Rule 5110(b)(9)(G), which specifically lists securities offered pursuant to SEC Regulation A as among the types of offerings for which documents and information must be filed with FINRA.

      7. Rule 5110(b)(5). See also Rule 5110(b)(5)(B) that provides that documents that are filed with the SEC through EDGAR that are referenced in FINRA's electronic filing system shall be treated as filed with FINRA.

      8. Rule 5110(b)(4).

      9. Rule 5110(b)(3).

      10. Rule 5110(b)(4)(B).

      11. FINRA Rule 2111 (Suitability) requires that a member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile. FINRA Rule 3110 (Supervision) requires each member to establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules.

      12. See Rule 2210(d) for additional content standards, including that the member must consider the nature of the audience to which the communication will be directed and must provide details and explanations appropriate to the audience.

      13. See Rule 2210(b)(1)(A). The rule also requires principal approval prior to filing with FINRA's Advertising Regulation Department.

      14. Rule 2210(a)(5).

      15. Rule 2210(a)(2). Correspondence must be supervised in accordance with the firm's procedures adopted pursuant to Rule 3110(b)(4).

      16. See Rule 2210(c) for the types of retail communications that require filing, including those concerning public direct participation programs, registered investment companies, registered derivatives and collateralized mortgage obligations.

      17. Rule 2210(c)(3)(B).

    • 15-31 SEC Approves Rule to Address Conflicts of Interest Relating to the Publication and Distribution of Debt Research Reports; Effective Date: February 22, 2016

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      Debt Research

      Regulatory Notice
        Referenced Rules & Notices

      FINRA Rule 0140
      FINRA Rule 2111
      FINRA Rule 2210
      FINRA Rule 2241
      FINRA Rule 2242
      FINRA Rule 4512
      FINRA Rule 6710
      FINRA Rule 9600 Series
      Suggested Routing

      Compliance
      Fixed Income
      Investment Banking
      Legal
      Research
      Senior Management
      Trading
      Key Topics

      Conflicts of Interest
      Fixed Income
      Principal Trading
      Research Analysts
      Research Reports

      Executive Summary

      The SEC approved the adoption of FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) to address conflicts of interest relating to the publication and distribution of debt research reports.1 Rule 2242 becomes effective on February 22, 2016.

      The rule text is available at www.finra.org/notices/15-31.

      Questions regarding this Notice should be directed to:

      •  Philip Shaikun, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8451 or philip.shaikun@finra.org; or
      •  Jeanette Wingler, Assistant General Counsel, OGC, at (202) 728-8013 or jeanette.wingler@finra.org.

      Background and Discussion

      Rule 2242 is intended to foster objectivity and transparency in debt research and to provide investors with more reliable and useful information to make investment decisions. The rule adopts a tiered approach that, in general, provides retail debt research recipients with extensive protections similar to those provided to recipients of equity research under FINRA rules, with modifications to reflect differences in the trading of debt securities.2 At the same time, the rule provides broad exemptions for debt research distributed solely to eligible institutional investors.

      The rule differs from the equity research rule in three key respects. First, it sets out prohibited and permissible communications between debt research analysts and principal trading and sales and trading personnel, taking into account the need to ration a debt research analyst's resources among the multitude of debt securities, the limitations on price discovery in the debt markets, and the need for trading personnel to perform credit risk analyses with respect to current and prospective inventory. Second, as noted above, the rule exempts debt research provided solely to institutional investors from many of the structural protections and prescriptive disclosure requirements that apply to research reports distributed to retail investors, but adds a "health warning" requirement. Third, in addition to the exemption for limited investment banking activity found in the equity research rule, the rule also contains an exemption for limited principal trading activity from the review, supervision, budget and compensation provisions in the rule related to principal trading activity.

      Definitions

      Most of the defined terms in the rule closely follow the defined terms in the equity research rule, with minor changes to reflect their application to debt research. The following are the rule's key debt-related definitions:

      Rule 2242(a)(1) defines "debt research analyst" as an associated person who is primarily responsible for, and any associated person who reports directly or indirectly to a debt research analyst in connection with, the preparation of the substance of a debt research report, whether or not any such person has the job title of "research analyst."

      Rule 2242(a)(3) defines "debt research report" to include any written, including electronic, communication that includes an analysis of a debt security or an issuer of a debt security and that provides information reasonably sufficient upon which to base an investment decision, excluding communications that solely constitute an equity research report under Rule 2241. A "debt research report" would not include communications that:

      •  constitute statutory prospectuses that are filed as part of the registration statement;
      •  constitute private placement memoranda and comparable offering-related documents, other than those that purport to be research;
      •  are limited to the following, if they do not include an analysis of, or recommend or rate, individual debt securities or issuers:
      •  discussions of broad-based indices;
      •  commentaries on economic, political or market conditions;
      •  commentaries on or analyses of particular types of debt securities or characteristics of debt securities;
      •  technical analyses concerning the demand and supply for a sector, index or industry based on trading volume and price;
      •  recommendations regarding increasing or decreasing holdings in particular industries or sectors or types of debt securities; or
      •  notices of ratings or price target changes, provided that the member simultaneously directs the readers of the notice to the most recent debt research report on the subject company that includes all current applicable disclosures required by the rule and that such debt research report does not contain materially misleading disclosure, including disclosures that are outdated or no longer applicable; and
      •  are limited to the following, even if they include an analysis of an individual debt security or issuer and information reasonably sufficient upon which to base an investment decision:
      •  statistical summaries of multiple companies' financial data, including listings of current ratings that do not include an analysis of individual companies' data;
      •  an analysis prepared for a specific person or a limited group of fewer than 15 persons;
      •  periodic reports or other communications prepared for investment company shareholders or discretionary investment account clients that discuss individual debt securities in the context of a fund's or account's past performance or the basis for previously made discretionary investment decisions; or
      •  internal communications that are not given to current or prospective customers.

      Rule 2242(a)(4) defines the term "debt security" as any "security" as defined in Section 3(a)(10) of the Securities Exchange Act of 1934 (SEA), except for any "equity security" as defined in Section 3(a)(11) of the SEA, any "municipal security" as defined in Section 3(a)(29) of the SEA, any "security-based swap" as defined in Section 3(a)(68) of the SEA, and any "U.S. Treasury Security" as defined in paragraph (p) of FINRA Rule 6710.

      Rule 2242(a)(5) defines the term "debt trader" to include a person, with respect to transactions in debt securities, who is engaged in proprietary trading or the execution of transactions on an agency basis.

      Identifying and Managing Conflicts of Interest

      Rule 2242(b)(1) contains an overarching provision that requires members to establish, maintain and enforce written policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to the preparation, content and distribution of debt research reports, public appearances by debt research analysts, and the interaction between debt research analysts and persons outside of the research department, including investment banking, sales and trading and principal trading personnel, subject companies and customers. The rule draws a distinction between sales and trading personnel3 and persons engaged in principal trading activities, imposing greater restrictions on the latter group due to the greater magnitude of the conflict between those persons and debt research analysts. Under Rule 2242(b)(2), the required written policies and procedures must be reasonably designed to promote objective and reliable debt research that reflects the truly held opinions of debt research analysts and to prevent the use of debt research reports or debt research analysts to manipulate or condition the market or favor the interests of the firm or current or prospective customers or class of customers. These provisions, therefore, set out the fundamental obligation for a member to establish and maintain a system to identify and mitigate conflicts to foster integrity and fairness in its research products and services. The required policies and procedures also must prohibit or restrict specified conduct, as set forth in more detail below.

      Prepublication Review

      Pursuant to Rule 2242(b)(2)(A) and (B), the required policies and procedures must prohibit prepublication review, clearance or approval of debt research by persons involved in investment banking, sales and trading or principal trading, and either restrict or prohibit such review, clearance and approval by other non-research personnel other than legal and compliance. A member must specify in its policies and procedures the circumstances, if any, where prepublication review by other non-research personnel would be permitted as necessary and appropriate; for example, where non-research personnel are best situated to verify select facts or where administrative personnel review a research report for formatting. The policies and procedures also must prohibit prepublication review of a debt research report by a subject company, other than for verification of facts.

      Sections of a draft debt research report may be provided to non-investment banking personnel, non-principal trading personnel, non-sales and trading personnel or to the subject company for factual review, so long as:

      1. the sections of the draft debt research report submitted do not contain the research summary, recommendation or rating;
      2. a complete draft of the debt research report is provided to legal or compliance personnel before sections of the report are submitted to non-investment banking personnel, non-principal trading personnel, non-sales and trading personnel or the subject company; and
      3. if, after submitting sections of the draft debt research report to non-investment banking personnel, non-principal trading personnel, non-sales and trading personnel or the subject company, the research department intends to change the proposed rating or recommendation, it must first provide written justification to, and receive written authorization from, legal or compliance personnel for the change.4

      The member must retain copies of any draft and the final version of such debt research report for three years after publication.

      Coverage Decisions

      Rule 2242(b)(2)(C) requires that a member's written policies and procedures restrict or limit input by investment banking, sales and trading and principal trading personnel to ensure that research management independently makes all final decisions regarding the research coverage plan. However, Rule 2242(b)(2)(C) does not preclude personnel from these departments or any other department from conveying customer interests and coverage needs, so long as final decisions regarding the coverage plan are made by research management.

      Supervision and Control of Debt Research Analysts

      Under Rule 2242(b)(2)(D), a member's written policies and procedures must limit the supervision and control of debt research analysts to persons not engaged in investment banking, sales and trading or principal trading activities. In addition, the policies and procedures further must establish information barriers or other institutional safeguards reasonably designed to ensure that debt research analysts are insulated from the review, pressure or oversight by persons engaged in investment banking services, principal trading or sales and trading activities or others who might be biased in their judgment or supervision.5

      Budget and Compensation

      Under Rule 2242(b)(2)(E), a member's written policies and procedures also must limit the determination of a firm's debt research department budget to senior management, excluding senior management engaged in investment banking or principal trading activities, and without regard to specific revenues or results derived from investment banking. However, the rule permits all persons to provide input to senior management regarding the demand for and quality of debt research, including product trends and customer interests and allows consideration by senior management of a firm's overall revenues and results in determining the debt research budget and allocation of expenses.

      With respect to compensation determinations, a member's written policies and procedures must prohibit compensation based on specific investment banking services or trading transactions or contributions to a firm's investment banking or principal trading activities and prohibit investment banking and principal trading personnel from input into the compensation of debt research analysts.6 Further, the firm's written policies and procedures must require that the compensation of a debt research analyst who is primarily responsible for the substance of a research report be reviewed and approved at least annually by a committee that reports to a member's board of directors or, if the member has no board of directors, a senior executive officer of the member.7

      Neither investment banking personnel nor persons engaged in principal trading activities may give input with respect to the compensation determination for debt research analysts. However, sales and trading personnel may give input to debt research management as part of the evaluation process in order to convey customer feedback, provided that final compensation determinations are made by research management, subject to review and approval by the compensation committee.8

      Retaliation

      Under Rule 2242(b)(2)(I), a member's written policies and procedures must prohibit direct or indirect retaliation or threat of retaliation against debt research analysts by any employee of the firm for publishing research or making a public appearance that may adversely affect the member's current or prospective business interests.

      Personal Trading Restrictions

      Under Rule 2242(b)(2)(J), a member's written policies and procedures must restrict or limit trading by a "debt research analyst account" in securities, derivatives and funds whose performance is materially dependent upon the performance of securities covered by the debt research analyst.9 The procedures must ensure that those accounts, supervisors of debt research analysts and associated persons with the ability to influence the content of debt research reports do not benefit in their trading from knowledge of the content or timing of debt research reports before the intended recipients of such research have had a reasonable opportunity to act on the information in the report. Furthermore, the procedures must prohibit a debt research analyst account from purchasing or selling any security or any option or derivative of such security in a manner inconsistent with the debt research analyst's most recently published recommendation, except that they may define circumstances of financial hardship in which the firm will permit trading contrary to that recommendation. In determining whether a particular trade is contrary to an existing recommendation, firms may take into account the context of a given trade, including the extent of coverage of the subject security.

      FINRA will not consider a research analyst account to have traded in a manner inconsistent with a research analyst's recommendation where a member has instituted a policy that prohibits any research analyst from holding securities, or options on or derivatives of such securities, of the companies in the research analyst's coverage universe, provided that the member establishes a reasonable plan to liquidate such holdings consistent with the principles in Rule 2242(b)(2)(J)(i) and such plan is approved by the member's legal or compliance department.10

      Promises of Favorable Research

      Rule 2242(b)(2)(K) requires that the policies and procedures prohibit explicit or implicit promises of favorable debt research, specific research content or a specific rating or recommendation as inducement for the receipt of business or compensation.

      Solicitation and Marketing of Investment Banking Transactions

      A member's written policies and procedures must restrict or limit activities by debt research analysts that can reasonably be expected to compromise their objectivity, including prohibiting participation in pitches and other solicitations of investment banking services transactions and road shows and other marketing on behalf of issuers related to such transactions.11 As in the equity rule, Supplementary Material .01 interprets the solicitation provision to prohibit members from including in pitch materials any information about a member's research capacity in a manner that suggests, directly or indirectly, that the member might provide favorable research.

      Furthermore, Supplementary Material .01 provides that the solicitation provision prohibits members from including in pitch materials any information about a member's research capacity in a manner that suggests, directly or indirectly, that the member might provide favorable research coverage.

      Joint Due Diligence With Investment Banking Personnel

      The rule establishes a proscription with respect to joint due diligence activities (i.e., due diligence by the debt research analyst in the presence of investment banking department personnel) prior to the selection of underwriters for the investment banking services transaction.12 Supplementary Material .09 states that FINRA interprets the overarching principle requiring members to, among other things, establish, maintain and enforce written policies and procedures that address the interaction between research analysts and those outside of the research department, including investment banking and sales and trading personnel, subject companies and customers, to prohibit the performance of joint due diligence prior to the selection of underwriters for the investment banking services transaction.

      Under Rule 2242(b)(2)(M), investment banking personnel are prohibited from directing debt research analysts to engage in sales or marketing efforts related to an investment banking services transaction or any communication with a current or prospective customer about an investment banking services transaction. Supplementary Material .02 clarifies that three-way meetings between debt research analysts and a current or prospective customer in the presence of investment banking department personnel or company management about an investment banking services transaction are prohibited by this provision. Supplementary Material .02 also requires that any written or oral communication by a debt research analyst with a current or prospective customer or internal personnel related to an investment banking services transaction must be fair, balanced and not misleading, taking into consideration the overall context in which the communication is made.

      Communications Between Debt Research Analysts and Trading Personnel

      Supplementary Material .03 delineates the prohibited and permissible interactions between debt research analysts and sales and trading and principal trading personnel. Members are required to establish, maintain and enforce written policies and procedures reasonably designed to prohibit sales and trading and principal trading personnel from attempting to influence a debt research analyst's opinions or views for the purpose of benefiting the trading position of the firm, a customer or a class of customers.

      Debt research analysts are prohibited from identifying or recommending specific potential trading transactions to sales and trading or principal trading personnel that are inconsistent with such debt research analyst's currently published debt research reports or from disclosing the timing of, or material investment conclusions in, a pending debt research report.

      Sales and trading and principal trading personnel may communicate customers' interests to a debt research analyst, so long as the debt research analyst does not respond by publishing debt research for the purpose of benefiting the trading position of the firm, a customer or a class of customers. In addition, debt research analysts may provide customized analysis, recommendations or trade ideas to sales and trading and principal trading personnel and customers, provided that any such communications are not inconsistent with the analyst's currently published or pending debt research, and that any subsequently published debt research is not for the purpose of benefiting the trading position of the firm, a customer or a class of customers.

      Sales and trading and principal trading personnel are also permitted to seek the views of debt research analysts regarding the creditworthiness of the issuer of a debt security and other information regarding an issuer of a debt security that is reasonably related to the price or performance of the debt security, so long as, with respect to any covered issuer, such information is consistent with the debt research analyst's published debt research report and consistent in nature with the types of communications that a debt research analyst might have with customers. Finally, debt research analysts may seek information from sales and trading and principal trading personnel regarding a particular debt instrument, current prices, spreads, liquidity and similar market information relevant to the debt research analyst's valuation of a particular debt security.13

      Unless otherwise prohibited, communications between debt research analysts and sales and trading or principal trading personnel that are not related to sales and trading, principal trading or debt research activities may take place without restriction.

      In determining what is consistent with a debt research analyst's published research, a member may consider the context, including that the investment objectives or time horizons being discussed differ from those underlying the debt research analyst's published views.

      Restrictions on Communications With Customers and Internal Sales Personnel

      A debt research analyst may not engage in any communication with a current or prospective customer in the presence of investment banking department personnel or company management about an investment banking services transaction. Any written or oral communication by a debt research analyst with a current or prospective customer or internal personnel related to an investment banking services transaction must be fair, balanced and not misleading, taking into consideration the overall context in which the communication is made.14

      Content and Disclosure in Debt Research Reports

      The rule adopts the required disclosures in the equity research rule for debt research, with modifications to reflect the different characteristics of the debt market. Members are required to establish, maintain and enforce written policies and procedures reasonably designed to ensure that: (i) purported facts in their debt research reports are based on reliable information; and (ii) any recommendation or rating has a reasonable basis and is accompanied by a clear explanation of any valuation method used and a fair presentation of the risks that may impede achievement of the recommendation or rating.15 While there is no obligation to employ a rating system, members that choose to employ a rating system must clearly define in each debt research report the meaning of each rating in the system, including the time horizon and any benchmarks on which a rating is based. In addition, the definition of each rating must be consistent with its plain meaning.

      Irrespective of the rating system a member employs, a member must include in each debt research report limited to the analysis of an issuer of a debt security (i.e., a credit analysis) that includes a rating of the subject company, the percentage of all subject companies rated by the member to which the member would assign a "buy," "hold" or "sell" rating. In addition, a member must disclose in each debt research report the percentage of subject companies within each of the "buy," "hold" and "sell" categories for which the member has provided investment banking services within the previous 12 months. All such information must be current as of the end of the most recent calendar quarter or the second most recent calendar quarter if the publication date of the debt research report is less than 15 calendar days after the most recent calendar quarter.

      If a debt research report limited to the analysis of an issuer of a debt security contains a rating for the subject company and the member has assigned a rating to such subject company for at least one year, the debt research report must show each date on which a member has assigned a rating to the debt security and the rating assigned on such date. This information is required for the period that the member has assigned any rating to the debt security or for a three-year period, whichever is shorter. Unlike the equity research rule, the debt research rule does not require those ratings to be plotted on a price chart because of limits on price transparency, including daily closing price information, with respect to many debt securities.

      These provisions do not apply to debt research on individual debt securities, only to an analysis of the issuer of a debt security.

      A member is required to disclose in any debt research report at the time of publication or distribution of the report:

      •  if the debt research analyst or a member of the debt research analyst's household has a financial interest in the debt or equity securities of the subject company (including, without limitation, any option, right, warrant, future, long or short position), and the nature of such interest;
      •  if the debt research analyst has received compensation based upon (among other factors) the member's investment banking, sales and trading or principal trading revenues;
      •  if the member or any of its affiliates managed or co-managed a public offering of securities for the subject company in the past 12 months; received compensation for investment banking services from the subject company in the past 12 months; or expects to receive or intends to seek compensation for investment banking services from the subject company in the next three months;
      •  if, as of the end of the month immediately preceding the date of publication or distribution of a debt research report (or the end of the second most recent month if the publication date is less than 30 calendar days after the end of the most recent month), the member or its affiliates have received from the subject company any compensation for products or services other than investment banking services in the previous 12 months;
      •  if the subject company is, or over the 12-month period preceding the date of publication or distribution of the debt research report has been, a client of the member, and if so, the types of services provided to the issuer. Such services, if applicable, shall be identified as either investment banking services, non-investment banking securities-related services or non-securities services;
      •  if the member trades or may trade as principal in the debt securities (or in related derivatives) that are the subject of the debt research report;
      •  if the debt research analyst received any compensation from the subject company in the previous 12 months; and
      •  any other material conflict of interest of the debt research analyst or member that the debt research analyst or an associated person of the member with the ability to influence the content of a debt research report knows or has reason to know at the time of the publication or distribution of a debt research report.16

      Disclosure of firm ownership of debt securities is required in research reports or a public appearance to the extent those holdings constitute a material conflict of interest.17 Further, Rule 2242(c)(5) provides an exception for disclosure that would reveal material non-public information regarding specific potential future investment banking transactions.

      Disclosures must be presented on the front page of debt research reports or the front page must refer to the page on which the disclosures are found. Electronic debt research reports, however, may provide a hyperlink directly to the required disclosures. All disclosures and references to disclosures required by the rule must be clear, comprehensive and prominent.18

      Disclosure of Compensation Received by Affiliates

      The rule permits a member to satisfy the disclosure requirement with respect to receipt of non-investment banking services compensation by an affiliate by implementing written policies and procedures reasonably designed to prevent the debt research analyst and associated persons of the member with the ability to influence the content of debt research reports from directly or indirectly receiving information from the affiliate as to whether the affiliate received such compensation.19 In addition, the rule permits a member to satisfy the disclosure requirement with respect to the receipt of investment banking compensation from a foreign sovereign by a non-U.S. affiliate of the member by implementing written policies and procedures reasonably designed to prevent the debt research analyst and associated persons of the member with the ability to influence the content of debt research reports from directly or indirectly receiving information from the non-U.S. affiliate as to whether such non-U.S. affiliate received or expects to receive such compensation from the foreign sovereign. However, a member must disclose receipt of compensation by its affiliates from the subject company (including any foreign sovereign) in the past 12 months when the debt research analyst or an associated person with the ability to influence the content of a debt research report has actual knowledge that an affiliate received such compensation during that time period.

      Disclosure in Public Appearances

      Rule 2242(d)(1) requires a debt research analyst to disclose in public appearances:

      •  if the debt research analyst or a member of the debt research analyst's household has a financial interest in the debt or equity securities of the subject company (including, without limitation, whether it consists of any option, right, warrant, future, long or short position), and the nature of such interest;
      •  if, to the extent the debt research analyst knows or has reason to know, the member or any affiliate received any compensation from the subject company in the previous 12 months;
      •  if the debt research analyst received any compensation from the subject company in the previous 12 months;
      •  if, to the extent the debt research analyst knows or has reason to know, the subject company currently is, or during the 12-month period preceding the date of publication or distribution of the debt research report, was, a client of the member. In such cases, the debt research analyst also must disclose the types of services provided to the subject company, if known by the debt research analyst; or
      •  any other material conflict of interest of the debt research analyst or member that the debt research analyst knows or has reason to know at the time of the public appearance.20

      Rule 2242(d)(3) requires members to maintain records of public appearances by debt research analysts sufficient to demonstrate compliance by those debt research analysts with the applicable disclosure requirements for public appearances. Such records must be maintained for at least three years from the date of the public appearance.

      Disclosure Required by Other Provisions

      With respect to both research reports and public appearances, Rule 2242(e) requires that, in addition to the disclosures required under the rule, members and debt research analysts must comply with all applicable disclosure provisions of FINRA Rule 2210 (Communications with the Public) and the federal securities laws.

      Distribution of Member Research Reports

      Rule 2242(f) requires firms to establish, maintain and enforce written policies and procedures reasonably designed to ensure that a debt research report is not distributed selectively to internal trading personnel or a particular customer or class of customers in advance of other customers that the member has previously determined are entitled to receive the debt research report.

      Firms may provide different debt research products and services to different classes of customers, provided the products are not differentiated based on the timing of receipt of potentially market moving information and the firm discloses its research dissemination practices to all customers that receive a research product. A member that provides different debt research products and services for certain customers must inform its other customers that its alternative debt research products and services may reach different conclusions or recommendations that could impact the price of the debt security.21 The notification need not be included in every research report; however, a customer must be notified of the alternative research products, services and dissemination practices prior to receiving or accessing a research report for the first time and promptly after any material changes to a firm's research products, services or dissemination practices.

      Distribution of Third-party Debt Research Reports

      Rule 2242(g)(1) prohibits a member from distributing third-party debt research if it knows or has reason to know that such research is not objective or reliable. A member satisfies the standard based on its actual knowledge and reasonable diligence; however, there is no duty of inquiry to definitively establish that the third-party research is, in fact, objective and reliable.

      In addition, Rule 2242(g)(2) requires a member to establish, maintain and enforce written policies and procedures reasonably designed to ensure that any third-party debt research report it distributes contains no untrue statement of material fact and is otherwise not false or misleading. For the purpose of this requirement, a member's obligation to review a third-party debt research report extends to any untrue statement of material fact or any false or misleading information that should be known from reading the debt research report or is known based on information otherwise possessed by the member.

      Rule 2242(g)(3) requires a member to accompany any third-party debt research report it distributes with, or provide a Web address that directs a recipient to, disclosure of any material conflict of interest that can reasonably be expected to have influenced the choice of a third-party debt research report provider or the subject company of a third-party debt research report, including:

      •  if the member or any of its affiliates managed or co-managed a public offering of securities for the subject company in the past 12 months; received compensation for investment banking services from the subject company in the past 12 months; or expects to receive or intends to seek compensation for investment banking services from the subject company in the next three months;
      •  if the member trades or may trade as principal in the debt securities (or in related derivatives) that are the subject of the debt research report; and
      •  any other material conflict of interest of the debt research analyst or member that the debt research analyst or an associated person of the member with the ability to influence the content of a debt research report knows or has reason to know at the time of the publication or distribution of a debt research report.

      Rule 2242(g)(4) provides that members are not required to review a third-party debt research report prior to distribution if such debt research report is an independent third-party debt research report. For the purposes of the disclosure requirements for third-party research reports, a member shall not be considered to have distributed a third-party debt research report where the research is an independent third-party debt research report and made available by a member upon request, through a member-maintained website, or to a customer in connection with a solicited order in which the registered representative has informed the customer, during the solicitation, of the availability of independent debt research on the solicited debt security and the customer requests such independent debt research.22

      Under Rule 2242(g)(6) members must ensure that third-party debt research reports are clearly labeled as such and that there is no confusion on the part of the recipient as to the person or entity that prepared the debt research reports. Absent such clarity, the research report will be treated as the member's own research report.

      Obligations of Persons Associated With a Member

      Consistent with FINRA Rule 0140, persons associated with a member must comply with such member's written policies and procedures as established pursuant to the rule. In addition, consistent with Rule 0140, Supplementary Material .08 provides that it shall be a violation of Rule 2242 for an associated person to engage in the restricted or prohibited conduct to be addressed through the establishment, maintenance and enforcement of written policies and procedures required by provisions of the rule, including applicable Supplementary Material.

      Exemption for Members With Limited Investment Banking Activity

      Rule 2242(h) exempts from certain provisions regarding supervision and compensation of debt research analysts those members that over the previous three years, on average per year, have participated in 10 or fewer investment banking services transactions as manager or co-manager and generated $5 million or less in gross investment banking revenues from those transactions.23 However, members with limited investment banking activity must establish information barriers or other institutional safeguards reasonably designed to ensure debt research analysts are insulated from pressure by persons engaged in investment banking services activities or other persons, including persons engaged in principal trading or principal sales and trading activities, who might be biased in their judgment or supervision.

      The rule still prohibits these firms from compensating a debt research analyst based upon specific investment banking services transactions or contributions to a member's investment banking services activities. Members that qualify for this exemption must maintain records sufficient to establish eligibility for the exemption and also maintain for at least three years any communication that, but for this exemption, would be subject to all of the requirements of Rule 2242(b).

      Exemption for Limited Principal Trading Activity

      Rule 2242(i) includes an exemption from certain provisions regarding supervision and compensation of debt research analysts for members that engage in limited principal trading activity where: (1) in absolute value on an annual basis, the member's trading gains or losses on principal trades in debt securities are $15 million or less over the previous three years, on average per year; and (2) the member employs fewer than 10 debt traders; provided, however, such members must establish information barriers or other institutional safeguards reasonably designed to ensure debt research analysts are insulated from pressure by persons engaged in principal trading or sales and trading activities or other persons who might be biased in their judgment or supervision.24

      As with the limited investment banking activity exemption, members are still required to establish information barriers or other institutional safeguards reasonably designed to ensure debt research analysts are insulated from pressure by persons engaged in principal trading or sales and trading activities or other persons who might be biased in their judgment or supervision. Members that qualify for this exemption must maintain records sufficient to establish eligibility for the exemption and also maintain for at least three years any communication that, but for this exemption, would be subject to all of the requirements of Rule 2242(b).

      Exemption for Debt Research Reports Provided to Institutional Investors

      Rule 2242(j) exempts debt research distributed solely to eligible institutional investors (institutional debt research) from most of the provisions regarding supervision, coverage determinations, budget and compensation determinations and all of the disclosure requirements applicable to debt research reports distributed to retail investors ("retail debt research").25

      Rule 2242(j) requires either negative or affirmative written consent for eligible institutional investors to receive the less protected institutional debt research. Specifically, Rule 2242(j) allows firms to distribute institutional debt research by negative consent to a person who meets the definition of a qualified institutional buyer (QIB) and where, pursuant to FINRA Rule 2111(b): (1) the member or associated person has a reasonable basis to believe that the QIB is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies involving a debt security or debt securities; and (2) the QIB has affirmatively indicated that it is exercising independent judgment in evaluating the member's recommendations pursuant to Rule 2111 and such affirmation is broad enough to encompass transactions in debt securities. The rule requires written disclosure to the QIB that the member may provide debt research reports that are intended for institutional investors and are not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. If the QIB does not contact the member and request to receive only retail debt research reports, the member may reasonably conclude that the QIB has consented to receiving institutional debt research reports.26 FINRA interprets this standard to allow an order placer, e.g., an investment adviser, for a QIB that satisfies the Rule 2111 suitability requirements with respect to debt transactions to agree to receive institutional debt research on behalf of the QIB by negative consent.

      Institutional accounts that meet the definition of FINRA Rule 4512(c) but do not satisfy the higher tier requirements described above may still affirmatively elect in writing to receive institutional debt research. Specifically, a person that meets the definition of "institutional account" in Rule 4512(c) may receive institutional debt research provided that such person, prior to receipt of a debt research report, has affirmatively notified the member in writing that it wishes to receive institutional debt research and forego treatment as a retail investor for the purposes of the rule. Retail investors may not choose to receive institutional debt research.27

      To avoid a disruption in the receipt of institutional debt research, the rule allows firms to send institutional debt research to any Rule 4512(c) account, except a natural person, without affirmative or negative consent for a period of up to one year after SEC approval while they obtain the necessary consents. Natural persons that qualify as an institutional account under Rule 4512(c) must provide affirmative consent to receive institutional debt research during this transition period and thereafter.28

      The exemption relieves members that distribute institutional debt research to institutional investors from the requirements to have written policies and procedures for this research with respect to:

      1. restricting or prohibiting prepublication review of institutional debt research by principal trading and sales and trading personnel or others outside the research department, other than investment banking personnel;
      2. input by investment banking, principal trading and sales and trading into coverage decisions;
      3. limiting supervision of debt research analysts to persons not engaged in investment banking, principal trading or sales and trading activities;
      4. limiting determination of the debt research department's budget to senior management not engaged in investment banking or principal trading activities and without regard to specific revenues derived from investment banking;
      5. determination of debt research analyst compensation;
      6. restricting or limiting debt research analyst account trading; and
      7. information barriers or other institutional safeguards reasonably designed to ensure debt research analysts are insulated from review or oversight by investment banking, sales and trading or principal trading personnel, among others (but members still must have written policies and procedures to guard again those persons pressuring analysts).

      The exemption further applies to all disclosure requirements, including content and disclosure requirements for third-party research.

      Notwithstanding the exemption, some provisions of the rule still apply to institutional debt research, including the prohibition on prepublication review of debt research reports by investment banking personnel and the restrictions on such review by subject companies. While prepublication review by principal trading and sales and trading personnel is permitted pursuant to the exemption, other provisions of the rule continue to require management of those conflicts, including the requirement to establish information barriers reasonably designed to insulate debt research analysts from pressure by those persons. Furthermore, the requirements in Supplementary Material .05 related to submission of sections of a draft debt research report for factual review applies to any permitted prepublication review by persons not directly responsible for the preparation, content or distribution of debt research reports. In addition, members must prohibit debt research analysts from participating in the solicitation of investment banking services transactions, road shows and other marketing on behalf of issuers and further prohibit investment banking personnel from directly or indirectly directing a debt research analyst to engage in sales and marketing efforts related to an investment banking deal or to communicate with a current or prospective customer with respect to such transactions. The provisions regarding retaliation against debt research analysts and promises of favorable debt research also still apply with respect to research distributed to eligible institutional investors.29

      While the rule does not require institutional debt research to carry the specific disclosures applicable to retail debt research, it does require that such research carry general disclosures prominently on the first page warning that:

      1. the report is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports;
      2. if applicable, that the views in the report may differ from the views offered in retail debt research reports; and
      3. if applicable, that the report may not be independent of the firm's proprietary interests and that the firm trades the securities covered in the report for its own account and on a discretionary basis on behalf of certain customers, and such trading interests may be contrary to the recommendation in the report.30

      Rule 2242(j)(4) requires members to establish, maintain and enforce written policies and procedures reasonably designed to ensure that institutional debt research is made available only to eligible institutional investors. A member may not rely on the exemption with respect to a debt research report that the member has reason to believe will be redistributed to a retail investor. However, absent a red flag, this provision does not create a duty to inquire or conduct due diligence to determine whether institutional debt research will be redistributed to a retail investor. The exemption does not relieve a member of its obligations to comply with the antifraud provisions of the federal securities laws and FINRA rules.

      General Exemptive Authority

      Rule 2242(k) provides FINRA, pursuant to the FINRA Rule 9600 Series, with authority to conditionally or unconditionally grant, in exceptional and unusual circumstances, an exemption from any requirement of the rule for good cause shown, after taking into account all relevant factors and provided that such exemption is consistent with the purposes of the rule, the protection of investors, and the public interest.

      Implementation Date

      The rule will become effective on February 22, 2016.


      1. See Securities Exchange Act Rel. No. 75472 (July 16, 2015), 80 FR 43528 (July 22, 2015) (Order Approving File No. SR-FINRA-2014-048).

      2. The SEC separately approved FINRA's proposal to amend and adopt NASD Rule 2711 (Research Analysts and Research Reports) as consolidated FINRA Rule 2241. See Securities Exchange Act Rel. No. 75471 (July 16, 2015), 80 FR 43482 (July 22, 2015) (Order Approving File No. SR-FINRA-2014-047) (the "equity research rule"). See also Regulatory Notice 15-30. That proposal also amended NASD Rule 1050 (Registration of Research Analysts) and Incorporated NYSE Rule 344 (Research Analysts and Supervisory Analysts) to create a limited exemption from the research analyst registration and qualification requirements. Those requirements only apply to equity research analysts. FINRA is considering whether debt research analysts also should be subject to the same or a similar qualification requirement.

      3. The rule defines "sales and trading personnel" to include persons in any department or division, whether or not identified as such, who perform any sales and trading service on behalf of a member. FINRA intends for the term "sales and trading" to exclude principal and proprietary trading activities. See Rule 2242(a)(15).

      4. See Rule 2242.05 (Submission of Sections of a Draft Research Report for Factual Review).

      5. See Rule 2242(b)(2)(H).

      6. See Rule 2242(b)(2)(D) and (F).

      7. See Rule 2242(b)(2)(G). This committee may not have representation from investment banking personnel or persons engaged in principal trading activities and must consider the following factors when reviewing a debt research analyst's compensation, if applicable: the debt research analyst's individual performance, including the analyst's productivity and the quality of the debt research analyst's research; and the overall ratings received from customers and peers (independent of the member's investment banking department and persons engaged in principal trading activities) and other independent ratings services.

      8. See Rule 2242(b)(2)(D) and (G). The committee, which may not have representation from investment banking or persons engaged in principal trading activities, must document the basis for each debt research analyst's compensation, including any input from sales and trading personnel.

      9. Rule 2242(a)(2) defines "debt research analyst account" to mean any account in which a debt research analyst or member of the debt research analyst's household has a financial interest, or over which such analyst has discretion or control; provided, however, it does not include an investment company registered under the Investment Company Act of 1940 over which the debt research analyst or a member of the debt research analyst's household has discretion or control, provided that the debt research analyst or member of a debt research analyst's household has no financial interest in such investment company, other than a performance or management fee. The term also does not include a "blind trust" account that is controlled by a person other than the debt research analyst or member of the debt research analyst's household where neither the debt research analyst nor a member of the debt research analyst's household knows of the account's investments or investment transactions.

      10. See Rule 2242.10.

      11. See Rule 2242(b)(2)(L).

      12. See Rule 2242(b)(1)(C) and Rule 2242.09 (Joint Due Diligence).

      13. See Rule 2242.03 (Information Barriers between Research Analysts and Trading Desk Personnel).

      14. See Rule 2242.02(b) (Restrictions on Communications with Customers and Internal Personnel).

      15. See Rule 2242(c)(1)(A), (c)(1)(B), and (c)(2).

      16. See Rule 2242(c)(4). The "catch all" disclosure requires disclosure of material conflicts known not only by the research analyst, but also by any "associated person of the member with the ability to influence the content of a research report." A person with the "ability to influence the content of a research report" is an associated person who is required to review the content of the debt research report or has exercised authority to review or change the debt research report prior to publication or distribution. This term does not include legal or compliance personnel who may review a debt research report for compliance purposes but are not authorized to dictate a particular recommendation or rating. See Rule 2242.07 (Ability to Influence the Content of a Debt Research Report). The "reason to know" standard in the provision covers disclosure of those conflicts that should reasonably be discovered by those persons in the ordinary course of discharging their functions.

      17. See Rules 2242(c)(4)(H) and (d)(1)(E).

      18. See Rule 2242(c)(6). A member that distributes a debt research report covering six or more companies (compendium report) may direct the reader in a clear manner to the applicable disclosures. Electronic compendium reports must include a hyperlink to the required disclosures. Paper-based compendium reports must provide either a toll-free number or a postal address to request the required disclosures and also may include a Web address of the member where the disclosures can be found. See Rule 2242(c)(7).

      19. See Rule 2242.04 (Disclosure of Compensation Received by Affiliates).

      20. A member or debt research analyst is not required to make any such disclosure to the extent it reveals material non-public information regarding specific potential future investment banking transactions. The "catch-all" disclosure requirement in public appearances applies only to a conflict of interest of the debt research analyst or member that the analyst knows or has reason to know at the time of the public appearance.

      21. See Rule 2242.06 (Distribution of Member Research Products).

      22. See Rule 2242(g)(5).

      23. Specifically, members that meet those thresholds are exempt from the requirement to establish, maintain and enforce policies and procedures that: prohibit prepublication review of debt research reports by investment banking personnel or other persons not directly responsible for the preparation, content or distribution of debt research reports (but not principal trading or sales and trading personnel, unless the member also qualifies for the limited principal trading activity exemption); restrict or limit investment banking personnel from input into coverage decisions; limit supervision of debt research analysts to persons not engaged in investment banking; limit determination of the research department budget to senior management, excluding senior management engaged in investment banking activities; require that compensation of a debt research analyst be approved by a compensation committee that may not have representation from investment banking personnel; and establish information barriers to insulate debt research analysts from the review or oversight by persons engaged in investment banking services or other persons who might be biased in their judgment or supervision.

      24. Specifically, members that meet those thresholds are exempt from the requirement to establish, maintain and enforce policies and procedures that: prohibit prepublication review of debt research reports by principal trading or sales and trading personnel or other persons not directly responsible for the preparation, content or distribution of debt research reports (but not investment banking personnel, unless the firm also qualifies for the limited investment banking activity exemption); restrict or limit principal trading or sales and trading personnel from input into coverage decisions; limit supervision of debt research analysts to persons not engaged in sales and trading or principal trading activities, including input into the compensation of debt research analysts; limit determination of the research department budget to senior management, excluding senior management engaged in principal trading activities; require that compensation of a debt research analyst be approved by a compensation committee that may not have representation from principal trading personnel; and establish information barriers to insulate debt research analysts from the review or oversight by persons engaged in principal trading or sales and trading activities or other persons who might be biased in their judgment or supervision.

      25. A "retail investor" includes any person other than an institutional investor. See Rule 2242(a)(13).

      26. See Rule 2242(j)(1)(A)(i) and (ii).

      27. See Rule 2242(j)(1)(B).

      28. See Rule 2242.11 (Distribution of Institutional Debt Research During Transition Period).

      29. See Rule 2242(j)(2).

      30. See Rule 2242(j)(3).

    • 15-30 SEC Approves Consolidated Rule to Address Conflicts of Interest Relating to the Publication and Distribution of Equity Research Reports; Effective Date: September 25, 2015, or December 24, 2015

      View PDF

      Equity Research

      Regulatory Notice
        Referenced Rules & Notices

      FINRA Rule 0140
      FINRA Rule 2210
      FINRA Rule 2241
      FINRA Rule 3110
      FINRA Rule 9600 Series
      Incorporated NYSE Rule 344
      Incorporated NYSE Rule 472
      NASD Rule 1050
      NASD Rule 2711
      Suggested Routing

      Compliance
      Investment Banking
      Legal
      Research
      Senior Management
      Trading
      Key Topics

      Conflicts of Interest
      Investment Banking
      Research Analysts
      Research Reports

      Executive Summary

      The SEC approved the adoption of FINRA Rule 2241 (Research Analysts and Research Reports), a consolidated rule to address conflicts of interest relating to the publication and distribution of equity research reports.1 Provisions of Rule 2241 become effective either on September 25, 2015, or December 24, 2015, as set forth below.

      The rule text is available at www.finra.org/notices/15-30.

      Questions regarding this Notice should be directed to:

      •  Philip Shaikun, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8451 or philip.shaikun@finra.org; or
      •  Jeanette Wingler, Assistant General Counsel, OGC, at (202) 728-8013 or Jeanette.wingler@finra.org.

      Background and Discussion

      NASD Rule 2711 and Incorporated NYSE Rule 472 (Communications with the Public) set forth requirements to foster objectivity and transparency in equity research and provide investors with more reliable and useful information to make investment decisions. The rules require disclosure of conflicts of interest in research reports and public appearances by research analysts and further prohibit conflicted conduct—investment banking personnel involvement in the content of research reports and determination of analyst compensation, for example—where the conflicts are too pronounced to be cured by disclosure. Several of the rules' provisions implement provisions of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), which mandates separation between research and investment banking, proscribes conduct that could compromise a research analyst's objectivity, and requires specific disclosures in research reports and public appearances.2

      NASD Rule 1050 (Registration of Research Analysts) and Incorporated NYSE Rule 344 (Research Analysts and Supervisory Analysts) require any person associated with a member and who functions as a research analyst to be registered as such and pass the Series 86 and 87 exams, unless an exemption applies. Those rules define "research analyst" for registration purposes as an associated person who is primarily responsible for the preparation of the substance of a research report or whose name appears on a research report.

      The SEC has approved a new consolidated FINRA Rule 2241.3 In general, the rule retains the core provisions of the current rules, broadens the obligations on members to identify and manage research-related conflicts of interest, restructures the rules to provide some flexibility in compliance without diminishing investor protection, extends protections where gaps have been identified, expands an exemption for firms with limited investment banking activity, and provides clarity to the applicability of existing rules. The SEC also approved an accompanying amendment to NASD Rule 1050 and Incorporated NYSE Rule 344 that creates a limited exception from the research analyst registration and qualification requirements for "research reports" produced by individuals whose primary job function is something other than producing investment research.

      Definitions

      The rule mostly maintains the definitions in current NASD Rule 2711, with the following modifications:

      •  Rule 2241(a)(5) clarifies that "investment banking services" includes all acts in furtherance of a public or private offering on behalf of an issuer.4
      •  Rule 2241(a)(9) clarifies that "research analyst account" does not apply to a registered investment company over which a research analyst or member of the research analyst's household has discretion or control, provided that the research analyst or member of the research analyst's household has no financial interest in the investment company, other than a performance or management fee.
      •  Rule 2241(a)(11) excludes from the definition of "research report" communications concerning open-end registered investment companies that are not listed or traded on an exchange.
      •  Rule 2241(a)(11)(D) excludes from the definition of "research report" communications that constitute private placement memoranda and comparable offering-related documents prepared in connection with investment banking services transactions, other than those that purport to be research.
      •  Rules 2241(a)(3) and (14) move into the definitional section the definitions of "independent third-party research report" and "third-party research report," respectively, that are now in a separate provision of the rule.
      •  Rule 2241(a)(12) adopts a definition of "sales and trading personnel" to include persons in any department or division, whether or not identified as such, who perform any sales or trading service on behalf of a member.

      Identifying and Managing Conflicts of Interest

      The rule includes a new section entitled "Identifying and Managing Conflicts of Interest." Rule 2241(b)(1) contains an overarching requirement to establish, maintain and enforce written policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to the preparation, content and distribution of research reports and public appearances by research analysts and the interaction between research analysts and persons outside of the research department, including investment banking and sales and trading personnel, the subject companies and customers. Rule 2241(b)(2) requires the written policies and procedures to be reasonably designed to promote objective and reliable research that reflects the truly held opinions of research analysts and to prevent the use of research or research analysts to manipulate or condition the market or favor the interests of the member or a current or prospective customer or class of customers. These provisions, therefore, set out the fundamental obligation for a member to establish and maintain a system to identify and mitigate conflicts to foster integrity and fairness in its research products and services. The required policies and procedures also must prohibit or restrict specified conduct, as set forth in more detail below.

      Prepublication Review

      The rule modifies the current restrictions on prepublication review of research reports. Rule 2241(b)(2)(A) requires the written policies and procedures to prohibit prepublication review, clearance or approval of research reports by persons engaged in investment banking services activities and restrict or prohibit such review, clearance or approval by other persons not directly responsible for the preparation, content and distribution of research reports, other than legal and compliance personnel. This provision effectively eliminates an exception in NASD Rule 2711 that allows investment bankers to review a research report prior to publication for factual accuracy or to assist in a conflicts review. A firm must specify in its policies and procedures the circumstances, if any, where prepublication review by other non-research personnel would be permitted as necessary and appropriate; for example, where non-research personnel are best situated to verify select facts or where administrative personnel review a research report for formatting.

      Rule 2241(b)(2)(N) requires the written policies and procedures also to prohibit prepublication review of a research report by a subject company for purposes other than verification of facts. Supplementary Material .05 maintains the current guidance applicable to the prepublication submission of a research report to a subject company. Specifically, sections of a draft research report may be provided to non-investment banking personnel or the subject company for factual review, provided that:

      1. the draft sections do not contain the research summary, research rating or price target;
      2. a complete draft of the report is provided to legal or compliance personnel before sections are submitted to non-investment banking personnel or the subject company; and
      3. any subsequent proposed changes to the rating or price target are accompanied by a written justification to legal or compliance and receive written authorization for the change.

      The member also must retain copies of any draft and the final version of the report for three years.

      Coverage Decisions

      The rule includes a new provision that codifies an interpretation regarding investment banking input into research coverage decisions. Rule 2241(b)(2)(B) requires that the written policies and procedures restrict or limit input by the investment banking department into research coverage decisions to ensure that research management independently makes all final decisions regarding the research coverage plan. However, the provision does not preclude personnel from investment banking or any other department from conveying customer interests or providing input into coverage considerations, so long as final decisions regarding the coverage plan are made by research management. This provision makes express FINRA's interpretation that the separation requirements in NASD Rule 2711(b)(1) prohibit investment banking from making any final coverage decisions.

      Supervision and Control of Research Analysts

      The rule effectively retains the prohibitions regarding supervision and control of research analysts by investment banking personnel. Rule 2241(b)(2)(C) requires that the written policies and procedures prohibit persons engaged in investment banking activities from supervision or control of research analysts, including influence or control over research analyst compensation evaluation and determination. This provision is substantively the same as NASD Rule 2711(b).

      Research Budget

      The rule includes a new provision that codifies an interpretation with respect to research budget determination. Rule 2241(b)(2)(D) requires that the written policies and procedures limit determination of the research department budget to senior management, excluding senior management engaged in investment banking services activities. This provision makes express FINRA's interpretation that the separation requirements in current Rule 2711(b)(1) prohibit investment banking personnel from making any determination of research budget decisions.

      Compensation

      The rule effectively maintains the compensation determination requirements in NASD Rule 2711(d). Rule 2241(b)(2)(E) requires that the written policies and procedures prohibit compensation based upon specific investment banking services transactions or contributions to a member's investment banking services activities. Rule 2241(b)(2)(F) further provides that the written policies and procedures must require a committee that reports to the member's board of directors—or if none exists, a senior executive officer—to review and approve at least annually the compensation of any research analyst who is primarily responsible for preparation of the substance of a research report. The committee may not have representation from a member's investment banking department. The committee must consider, among other things, the productivity of the research analyst and the quality of his or her research and must document the basis for each research analyst's compensation.

      Information Barriers

      The rule includes a new information barrier requirement drawn from Sarbanes-Oxley. Rule 2241(b)(2)(G) requires that the written policies and procedures establish information barriers or other institutional safeguards reasonably designed to ensure that research analysts are insulated from the review, pressure or oversight by persons engaged in investment banking services activities or other persons, including sales and trading personnel, who might be biased in their judgment or supervision. FINRA believes the other policies and procedures required by the proposed rule change to identify and manage research-related conflicts of interest should effectively result in compliance with this provision. The provision is included to emphasize that the conflicts management must extend to persons other than investment banking personnel, including sales and trading personnel, who a firm may place in a position to supervise or influence the content of research reports or public appearances.

      Retaliation

      The rule modifies the current retaliation prohibition. Rule 2241(b)(2)(H) requires that the written policies and procedures prohibit direct or indirect retaliation or threat of retaliation against research analysts employed by the member or its affiliates by persons engaged in investment banking services activities or other employees as the result of an adverse, negative, or otherwise unfavorable research report or public appearance written or made by the research analyst that may adversely affect the member's present or prospective business interests. This provision is consistent with NASD Rule 2711(j), except that it extends the retaliation prohibition to employees other than investment banking personnel.

      Quiet Periods

      The rule modifies the quiet periods after an initial public offering (IPO) or secondary offering and before and after the expiration, waiver or termination of a lock-up agreement. Rule 2241(b)(2)(I) requires that the written policies and procedures define quiet periods of a minimum of 10 days following the date of an IPO, and a minimum of three days following the date of a secondary offering, during which the member must not publish or otherwise distribute research reports, and research analysts must not make public appearances, relating to the issuer if the member has participated as an underwriter or dealer in the IPO or, with respect to the quiet periods after a secondary offering, acted as a manager or co-manager of that offering.5 FINRA interprets the date of the offering to be the later of the effective date of the registration statement or the first date on which the securities were bona fide offered to the public.

      The rule therefore reduces the current 40-day and 25-day IPO quiet periods to a minimum of 10 days after the date of the offering for any member that participated as an underwriter or dealer, and reduces the 10-day secondary offering quiet period to a minimum of three days after the completion of the offering for any member that has acted as a manager or co-manager in the secondary offering. The rule maintains exceptions to the quiet periods for research reports or public appearances concerning the effects of significant news or a significant event on the subject company and, for secondary offerings, research reports or public appearances pursuant to Securities Act Rule 139 regarding a subject company with "actively-traded securities."

      The rule also eliminates the current quiet periods 15 days before and after the expiration, waiver or termination of a lock-up agreement.

      Personal Trading Restrictions

      The rule establishes a new standard with respect to personal trading by research analysts, supervisors of research analysts, and persons with the ability to influence the content of a research report. Rule 2241(b)(2)(J) requires firms to establish written policies and procedures that restrict or limit research analyst account trading in securities, any derivatives of such securities and funds whose performance is materially dependent upon the performance of securities covered by the research analyst. Rule 2241(b)(2)(J)(i) requires the policies and procedures to ensure that research analyst accounts, supervisors of research analysts and associated persons with the ability to influence the content of research reports do not benefit in their trading from knowledge of the content or timing of a research report before the intended recipients of such research have had a reasonable opportunity to act on the information in the research report. Rule 2241(b)(2)(J)(ii) maintains the current prohibition on research analysts trading against their most recent recommendations, but allows firms to define financial hardship circumstances, if any, in which a research analyst would be permitted to trade against his or her most recent recommendation. Rule 2241(b)(2)(J)(iii) maintains the current prohibition on research analysts receiving pre-IPO shares in the sector they cover.

      Supplementary Material .10 provides that FINRA would not consider a research analyst account to have traded in a manner inconsistent with a research analyst's recommendation where a member has instituted a policy that prohibits any research analyst from holding securities, or options on or derivatives of such securities, of the companies in the research analyst's coverage universe, provided that the member establishes a reasonable plan to liquidate such holdings consistent with the principles in paragraph (b)(2)(J)(i) and such plan is approved by the member's legal or compliance department.

      Promises of Favorable Research

      The rule effectively maintains the current prohibition on promises of favorable research. Rule 2241(b)(2)(K) requires that the written policies and procedures prohibit explicit or implicit promises of favorable research, a particular research rating or recommendation or specific research content as inducement for the receipt of business or compensation. This provision is substantively the same as NASD Rule 2711(e).6

      Solicitation and Marketing of Investment Banking Transactions

      The rule effectively carries over the prohibitions on solicitation and marketing of investment banking transactions. Rule 2241(b)(2)(L) adds a requirement that the written policies and procedures restrict or limit activities by research analysts that can reasonably be expected to compromise their objectivity. These must include the existing prohibitions on participation in pitches and other solicitations of investment banking services transactions and road shows and other marketing on behalf of issuers related to such transactions. Consistent with existing guidance, analysts may listen to or view a live webcast of a transaction-related road show or other widely attended presentation by investment banking to investors or the sales force from a remote location, or another room if they are in the same location.7

      Supplementary Material .01 codifies the existing interpretation that the solicitation provision prohibits members from including in pitch materials any information about a member's research capacity in a manner that suggests, directly or indirectly, that the member might provide favorable research coverage.8

      Joint Due Diligence and Other Interactions With Investment Banking

      The rule establishes a new proscription with respect to joint due diligence activities—i.e., due diligence by the research analyst in the presence of investment banking department personnel. Supplementary Material .02 states that FINRA interprets the overarching principle requiring members to, among other things, establish, maintain and enforce written policies and procedures that address the interaction between research analysts and those outside of the research department, including investment banking and sales and trading personnel, subject companies and customers, to prohibit the performance of joint due diligence prior to the selection of underwriters for the investment banking services transaction.

      FINRA will interpret this provision to apply only to the extent it is not contrary to the JOBS Act. Among other things, the JOBS Act prohibits FINRA from restricting an analyst from participating in any communications with the management of an emerging growth company (EGC) that is also attended by another associated person of a broker-dealer whose functional role is other than as a research analyst. Thus, for example, FINRA does not interpret the joint due diligence prohibition to apply where the joint due diligence activities involve a communication with the management of an EGC that is attended by both the research analyst and an investment banker.

      Rule 2241(b)(2)(M) continues to prohibit investment banking department personnel from directly or indirectly directing a research analyst to engage in sales or marketing efforts related to an investment banking services transaction, and directing a research analyst to engage in any communication with a current or prospective customer about an investment banking services transaction. Supplementary Material .03 clarifies that three-way meetings between research analysts and a current or prospective customer in the presence of investment banking department personnel or company management about an investment banking services transaction are prohibited by this provision. Supplementary Material .03 also retains the current requirement that any written or oral communication by a research analyst with a current or prospective customer or internal personnel related to an investment banking services transaction must be fair, balanced and not misleading, taking into consideration the overall context in which the communication is made.

      Content and Disclosure in Research Reports

      With a couple of modifications, the rule maintains the current disclosure requirements. Rule 2241(c)(1)(A) adds a requirement that a firm must establish, maintain and enforce written policies and procedures reasonably designed to ensure that purported facts in its research reports are based on reliable information. Rule 2241(c)(1)(B) requires that the policies and procedures also must be reasonably designed to ensure that any recommendation, rating or price target has a reasonable basis and be accompanied by a clear explanation of any valuation method used and a fair presentation of the risks that may impede achievement of the recommendation, rating or price target. That provision is consistent with NASD Rule 2711(h)(7).

      Rule 2241(c)(2) maintains the requirement that a firm that employs a ratings system must clearly define the meaning of each rating, including the time horizon and any benchmarks on which a ratings is based. The ratings definitions must be consistent with their plain meanings. In addition, Rules 2241(c)(2)(A) and (B) require that, irrespective of the ratings system a firm employs, it must disclose in each research report the percentage of all securities rated to which the firm would assign a "buy," "hold," or "sell" rating, as well as the percentage of subject companies within each category for which the firm has provided investment banking services in the previous 12 months. Rule 2241(c)(2)(C) requires this information to be current as of the end of the most recent calendar quarter or the second most recent calendar quarter if the publication date of the research report is less than 15 days after the most recent calendar quarter. These provisions are consistent with NASD Rules 2711(h)(4) and (5).

      Rule 2241(c)(3) further retains the price chart provision in NASD Rule 2711(h)(6), which requires for any research report that contains a rating or price target, a line graph of the security's daily closing prices for the period that the member has assigned any rating or price target or for a three-year period, whichever is shorter. The chart must indicate the dates on which the firm assigned or change each rating or price target. The provision applies where a firm has assigned a rating or price target for at least one year and must be current as of the end of the most recent calendar quarter or the second most recent calendar quarter if the publication date of the research report is less than 15 days after the most recent calendar quarter.

      In addition, the rule carries over in substance9 from NASD Rule 2711 the following disclosure requirements that must be made in any research report at the time of publication or distribution of the report:

      •  if the research analyst or a member of the research analyst's household has a financial interest in the debt or equity securities of the subject company (including, without limitation, whether it consists of any option, right, warrant, future, long or short position), and the nature of such interest (Rule 2241(c)(4)(A));
      •  if the research analyst has received compensation based upon (among other factors) the member's investment banking revenues (Rule 2241(c)(4)(B));
      •  if the member or any of its affiliates: (i) managed or co-managed a public offering of securities for the subject company in the past 12 months; (ii) received compensation for investment banking services from the subject company in the past 12 months; or (iii) expects to receive or intends to seek compensation for investment banking services from the subject company in the next three months (Rule 2241(c)(4)(C));
      •  if, as of the end of the month immediately preceding the date of publication or distribution of a research report (or the end of the second most recent month if the publication or distribution date is less than 30 calendar days after the end of the most recent month), the member or its affiliates have received from the subject company any compensation for products or services other than investment banking services in the previous 12 months (Rule 2241(c)(4)(D));
      •  if the subject company is, or over the 12-month period preceding the date of publication or distribution of the research report has been, a client of the member, and if so, the types of services provided to the issuer. Such services, if applicable, must be identified as either investment banking services, non-investment banking services, non-investment banking securities-related services or non-securities services (Rule 2241(c)(4)(E));
      •  if the member or its affiliates beneficially own 1 percent or more of any class of common equity securities of the subject company (Rule 2241(c)(4)(F);10
      •  if the member was making a market in the securities of the subject company at the time of publication or distribution of the research report (Rule 2241(c)(4)(G)); and
      •  if the research analyst received any compensation from the subject company in the previous 12 months (Rule 2241(c)(4)(H)).

      The rule expands upon the current "catch-all" disclosure in NASD Rule 2711(h)(1)(C), which mandates disclosure of any other material conflict of interest of the research analyst or member that the research analyst knows or has reason to know of at the time of the publication or distribution of a research report. Rule 2241(c)(4)(I) requires disclosure of material conflicts known not only by the research analyst, but also by any "associated person of the member with the ability to influence the content of a research report."

      Supplementary Material .08 defines a person with the "ability to influence the content of a research report" as an associated person who is required to review the content of the research report or has exercised authority to review or change the research report prior to publication or distribution. This term does not include legal or compliance personnel who may review a research report for compliance purposes but are not authorized to dictate a particular recommendation, rating or price target. The "reason to know" standard in this provision does not impose a duty of inquiry on the research analyst or others who can influence the content of a research report. Rather, it covers disclosure of those conflicts that should reasonably be discovered by those persons in the ordinary course of discharging their functions.

      Rule 2241(c)(5) modifies the current exception in Rule 2711(h)(2)(C) for disclosure that would reveal material non-public information regarding specific potential future investment banking transactions of the subject company to include specific potential future investment banking transactions of other companies, such as a competitor of the subject company.

      As with the current rules, Rule 2241(c)(6) provides that all disclosures must be presented on the front page of a research report or the front page must refer to the page on which the disclosures are found. Electronic research reports may provide a hyperlink directly to the required disclosures. All disclosures and references to disclosures must be clear, comprehensive and prominent. Rule 2241(c)(7) also continues to permit a member that distributes a research report covering six or more companies (compendium report) to direct the reader in a clear manner as to where the applicable disclosures can be found. An electronic compendium research report may hyperlink to those disclosures. A paper compendium report must include a toll-free number or a postal address where the reader may request the disclosures. In addition, paper compendium reports may include a Web address where the disclosures can be found.

      Disclosures in Public Appearances

      Rule 2241(d) groups in a separate provision the disclosures required when a research analyst makes a public appearance, but the required disclosures remain substantively the same as under the current rules.11 The disclosures include if the member or its affiliates beneficially own 1 percent or more of any class of common equity securities of the subject company, as computed in accordance with Section 13(d) of the Exchange Act. Unlike in research reports, the "catch all" disclosure requirement in public appearances applies only to a conflict of interest of the research analyst or member that the research analyst knows or has reason to know at the time of the public appearance and does not extend to persons with the ability to influence the content of a research report. Rule 2241(d)(2) provides that a research analyst need not make an otherwise required disclosure during a public appearance if it would reveal material non-public information regarding specific future investment banking transactions of the subject company. Rule 2241(d)(3) also retains the current requirement in NASD Rule 2711(h)(12) to maintain records of public appearances sufficient to demonstrate compliance by research analysts with the applicable disclosure requirements.

      Disclosure Required by Other Provisions

      With respect to both research reports and public appearances, Rule 2241(e) continues to require members and research analysts to comply with applicable disclosure provisions of FINRA Rule 2210 and the federal securities laws.

      Termination of Coverage

      Rule 2241(f) retains with non-substantive modifications the provision in the current rule that requires a member to notify its customers if it intends to terminate coverage of a subject company. Such notification must be made promptly12 using the member's ordinary means to disseminate research reports on the subject company to its various customers. Unless impracticable, the notice must be accompanied by a final research report, comparable in scope and detail to prior research reports, and include a final recommendation or rating. If impracticable to provide a final research report, recommendation or rating, a firm must disclose to its customers the reason for terminating coverage.

      Distribution of Member Research Reports

      The rule includes a new provision with respect to selective dissemination of research reports. Rule 2241(g) requires firms to establish, maintain and enforce written policies and procedures reasonably designed to ensure that a research report is not distributed selectively to internal trading personnel or a particular customer or class of customers in advance of other customers that the firm has previously determined are entitled to receive the research report. The rule includes further guidance in Supplementary Material .07 to explain that firms may provide different research products and services to different classes of customers, provided the products are not differentiated based on the timing of receipt of potentially market moving information and the firm informs its other customers that its alternative research products and services may reach different conclusions or recommendations that could impact the price of the equity security. The notification need not be included in every research report; however, a customer must be notified of the alternative research products, services and dissemination practices prior to receiving or accessing a research report for the first time and promptly after any material changes to the firm's research products, services or dissemination practices.

      Distribution of Third-party Research Reports

      Rule 2241(h) maintains the existing third-party disclosure requirements,13 incorporating the change to the "catch-all" provision to include material conflicts of interest that an associated person of the member with the ability to influence the content of a research report knows or has reason to know at the time of the distribution of the third-party research report. Rule 2241(h)(4) also requires members to disclose any other material conflict of interest that can reasonably be expected to have influenced the member's choice of a third-party research provider or the subject company of a third-party research report.

      In addition, the rule continues to address qualitative aspects of third-party research reports. For example, the rule maintains, but in the form of policies and procedures, the existing requirement that a registered principal or supervisory analyst review and approve third-party research reports distributed by a member. To that end, the Rules 2241(h)(1) and (3) require a member to establish, maintain and enforce written policies and procedures reasonably designed to ensure that any third-party research it distributes contains no untrue statement of material fact and is otherwise not false or misleading. For the purpose of this requirement, a member's obligation to review a third-party research report extends to any untrue statement of material fact or any false or misleading information that should be known from reading the research report or is known based on information otherwise possessed by the member. Rule 2241(h)(2) further prohibits a member from distributing third-party research if it knows or has reason to know that such research is not objective or reliable.

      The rule maintains the existing exceptions for "independent third-party research reports." Specifically, Rules 2241(h)(5) and (6) provide that those research reports do not require principal pre-approval or, where the third-party research is not "pushed out," the third-party disclosures. As to the latter, a member will not be considered to have distributed independent third-party research where the research is made available by the member: (a) upon request; (b) through a member-maintained website; or (c) to a customer in connection with a solicited order in which the registered representative has informed the customer, during the solicitation, of the availability of independent research on the solicited equity security and the customer requests such independent research.

      Finally, Rule 2241(h)(7) also includes a new requirement that members ensure that a third-party research report is clearly labeled as such and that there is no confusion on the part of the recipient as to the person or entity that prepared the research report.

      Obligations of Persons Associated With a Member

      The rule includes new supplementary material to address the obligations of associated persons with respect to policies-based provisions. Consistent with Rule 0140, Supplementary Material .09 provides that persons associated with a member must comply with the member's policies and procedures as established pursuant to the Rule 2241.14 In addition, consistent with Rule 0140, Supplementary Material .09 states that it shall be a violation of the rule for an associated person to engage in the restricted or prohibited conduct to be addressed through the establishment, maintenance and enforcement of policies and procedures required by Rule 2241, including applicable Supplementary Material.

      Exemption for Firms With Limited Investment Banking Activity

      The rule expands the current exemption for firms with limited investment banking activity. The current rule exempts firms with limited investment banking activity—those that over the previous three years, on average per year, have managed or co-managed 10 or fewer investment banking transactions and generated $5 million or less in gross revenues from those transactions—from the provisions that prohibit a research analyst from being subject to the supervision or control of an investment banking department employee.15 However, those firms currently remain subject to the provision that requires the compensation of a research analyst to be reviewed and approved annually by a committee that reports to a member's board of directors, or a senior executive officer if the member has no board of directors.16 That provision further prohibits representation on the committee by investment banking department personnel and requires the committee to consider the following factors when reviewing a research analyst's compensation: (1) the research analyst's individual performance, including the research analyst's productivity and the quality of research; (2) the correlation between the research analyst's recommendations and the performance of the recommended securities; and (3) the overall ratings received from clients, the sales force and peers independent of investment banking, and other independent ratings services.17

      Rule 2241(i) maintains the same parameters for the exemption for firms with limited investment banking activity and extends the exemption to include the compensation committee provision in Rule 2241(b)(2)(E). However, the rule still prohibits these firms from compensating a research analyst based upon specific investment banking services transactions or contributions to a member's investment banking services activities.

      Rule 2241(i) further exempts firms with limited investment banking activity from the provisions restricting or limiting research coverage decisions and budget determination. In addition, the provision exempts eligible firms from the requirement to establish information barriers or other institutional safeguards to insulate research analysts from the review or oversight by investment banking personnel or other persons, including sales and trading personnel, who may be biased in their judgment or supervision. However, those firms still are required to establish information barriers or other institutional safeguards reasonably designed to ensure that research analysts are insulated from pressure by investment banking and other non-research personnel who might be biased in their judgment or supervision.

      Exemption From Registration Requirements for Certain "Research Analysts"

      The rule change also creates a new limited exemption from the research registration and qualification requirements. It amends the definition of "research analyst" in NASD Rule 1050(b) and Incorporated NYSE Rule 344.10 to limit the scope of the registration and qualification requirements to persons who produce "research reports" and whose primary job function is to provide investment research. FINRA cautions that the revised definition is not intended to carve out anyone for whom the preparation of research is a significant component of their job; rather, it is intended to provide relief for those who produce research reports on an occasional basis. FINRA notes that, in accordance with the mandates of the Sarbanes-Oxley, both NASD Rule 2711 and FINRA Rule 2241 are constructed such that the person who is primarily responsible for the preparation of the substance of a communication that meets the definition of a "research report" is a "research analyst," irrespective of his or her title or primary job (e.g., it could include a registered representative or a trader).

      Attestation Requirement

      The rule no longer contains a requirement to attest annually that the firm has in place written supervisory policies and procedures reasonably designed to achieve compliance with the applicable provisions of the rules. However, FINRA notes that the underlying supervisory obligations continue to attach pursuant to FINRA Rule 3110.

      General Exemptive Authority

      The rule includes new general exemptive authority for FINRA. Rule 2241(j) provides FINRA, pursuant to the Rule 9600 Series, with authority to conditionally or unconditionally grant, in exceptional and unusual circumstances, an exemption from any requirement of the proposed rule for good cause shown, after taking into account all relevant factors and provided that such exemption is consistent with the purposes of the rule, the protection of investors, and the public interest.

      Implementation Schedule

      The rule changes will be implemented in two stages:

      Effective on September 25, 2015

      •  Amendments to NASD Rule 1050 and Incorporated NYSE Rule 344.10 (registration of research analysts)
      •  Rule 2241(b)(2)(I) and deletion of NASD Rules 2711(f)(1) through (5) and Incorporated NYSE Rules 472(f)(1) through (6) (quiet periods)
      •  Rule 2241(j) (exemption for good cause)
      •  Rule 2241.10 (divesting research analyst holdings)
      •  Deletion of NASD Rule 2711(i) and Incorporated NYSE Rule 351 (annual attestation requirement)

      Effective on December 24, 2015

      •  All other provisions

      1. See Securities Exchange Act Rel. No. 75471 (July 16, 2015), 80 FR 43482 (July 22, 2015) (Order Approving File No. SR-FINRA-2014-047).

      2. 15 U.S.C. 78o-6.

      3. The SEC separately approved FINRA's proposal to adopt FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) to address conflicts of interest relating to the publication and distribution of debt research reports. See Securities Exchange Act Rel. No. 75472 (July 16, 2015), 80 FR 43528 (July 22, 2015) (Order Approving File No. SR-FINRA-2014-048). See also Regulatory Notice 15-31.

      4. The current definition in NASD Rule 2711(a) (3) includes, without limitation, many common types of investment banking services. The rule adds the language "or otherwise acting in furtherance of" either a public or private offering to further emphasize that the term "investment banking services" is meant to be construed broadly.

      5. Consistent with the Jumpstart Our Business Startups Act (JOBS Act), those quiet periods do not apply following the IPO or secondary offering of an Emerging Growth Company (EGC), as that term is defined in Section 3(a)(80) of the Exchange Act.

      6. For additional guidance, see generally Regulatory Notice 11-41 (September 2011) and Research Rules Frequently Asked Questions.

      7. See Notice to Members 07-04 (January 2007) and NYSE Information Memo 07-11 (January 2007).

      8. See FINRA Rule 2241.01 and Notice to Members 07-04 (January 2007). For additional guidance on the solicitation prohibition, see generally Research Rules Frequently Asked Questions.

      9. In some instances, Rule 2241 makes minor word or grammatical changes, uses streamlined language or moves some text to Supplementary Material, but has not changed the substantive disclosure requirements of these provisions.

      10. The determination of beneficial ownership continues to be based upon the standards used to compute ownership for the purposes of the reporting requirements under Section 13(d) of the Exchange Act.

      11. See NASD Rules 2711(h)(1), (h)(2)(B) and (C), (h) (3)and (h)(9).

      12. While NASD Rule 2711(f)(6) does not contain the word "promptly," FINRA has interpreted the provision to require prompt notification of termination of coverage of a subject company.

      13. NASD Rule 2711(h)(13)(A) currently requires the distributing member firm to disclose the following, if applicable: (1) if the member owns 1 percent or more of any class of equity securities of the subject company; (2) if the member or any affiliate has managed or co-managed a public offering of securities of the subject company or received compensation for investment banking services from the subject company in the past 12 months, or expects to receive or intends to seek compensation for such services in the next three months; (3) if the member makes a market in the subject company's securities; and (4)any other actual, material conflict of interest of the research analyst or member of which the research analyst knows or has reason to know at the time the research report is distributed or made available.

      14. Rule 0140(a), among other things, provides that persons associated with a member shall have the same duties and obligations as a member under the Rules.

      15. See NASD Rule 2711(k).

      16. See NASD Rule 2711(d)(2).

      17. See NASD Rule 2711(d) and (k).

    • 15-29 FINRA Revises the Series 4 Examination Program; Implementation Date: September 28, 2015

      View PDF

      Qualifications Examinations

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules and Notices

      FINRA Rule 2111
      FINRA Rule 2220
      FINRA Rule 2711
      FINRA Rule 3110
      FINRA Rule 3230
      FINRA Rule 4510
      NASD Rule 1022(f)
      NASD Rule 1030 Series
      NASD Rule 2212
      NASD Rule 2310
      NASD Rule 3110
      Rule 135 under the Securities Act of 1933
      SEA Section 15A(g)(3)
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Training
      Key Topics

      Qualification Examinations
      Registered Options Principal
      Series 4

      Executive Summary

      FINRA periodically reviews the content of qualification examinations to determine whether revisions are necessary or appropriate in view of changes—including changes to the laws, rules and regulations—pertaining to the subject matter the examinations cover. Based on this review process, FINRA has revised the Registered Options Principal (Series 4) examination program.1

      The changes are reflected in the Series 4 content outline on FINRA's website and will appear in Series 4 examinations administered on or after September 28, 2015.

      Questions regarding this Notice should be directed to:

      •    Bridget Fox, Qualifications Analyst, Testing and Continuing Education Department, at (240) 386-6472; or
      •    Gemma Sartori, Qualifications Analyst, Testing and Continuing Education Department, at (212) 858-4146.

      Background

      Section 15A(g)(3) of the Securities Exchange Act of 1934 (SEA) authorizes FINRA to prescribe standards of training, experience and competence for persons associated with FINRA-regulated firms. In accordance with that provision, FINRA has developed examinations that are designed to establish that persons associated with FINRA-regulated firms have attained specified levels of competence and knowledge, consistent with applicable registration requirements under FINRA rules.

      NASD Rule 1022(f) requires firms that engage in, or that intend to engage in transactions in options with the public to have at least one Registered Options Principal. Further, every person engaged in the supervision of options sales practices with the public, including a person designated pursuant to FINRA Rule 3110(a)(2) must be registered as a Registered Options Principal.2 A person registered solely as a Registered Options Principal is not qualified to function in a principal3 capacity with responsibility over any area of business activity that is not stated above.

      A Registered Options Principal must, prior to or concurrent with such registration, be or become qualified pursuant to the NASD Rule 1030 Series, as either a General Securities Representative (Series 7)4 or a Corporate Securities Representative (Series 62) and an Options Representative (Series 42).

      In consultation with a committee of industry representatives, FINRA recently undertook a review of the Series 4 examination program. As a result of this review, FINRA has revised the content outline to reflect changes to the laws, rules and regulations covered by the examination and to incorporate the functions and associated tasks currently performed by a Registered Options Principal. FINRA also has revised the format of the content outline.

      Revisions

      FINRA has divided the content outline into the following six major job functions that are performed by a Registered Options Principal and included specific tasks for each function:

      •    Function 1: Supervise the Opening of New Options Accounts;
      •    Function 2: Supervise Options Account Activities;
      •    Function 3: Supervise General Options Trading;
      •    Function 4: Supervise Options Communications;
      •    Function 5: Implement Practices and Adhere to Regulatory Requirements; and
      •    Function 6: Supervise Associated Persons and Personnel Management Activities.

      FINRA also adjusted the number of questions assigned to each major job function to ensure that the overall examination better reflects the key tasks performed by a Registered Options Principal. The questions on the revised Series 4 examination will place greater emphasis on key tasks such as supervision of registered persons, sales practices and compliance. The following are the number of questions assigned to each of the functions on the Series 4.

      •    Function 1: 21 questions;
      •    Function 2: 25 questions;
      •    Function 3: 30 questions;
      •    Function 4: 9 questions;
      •    Function 5: 12 questions; and
      •    Function 6: 28 questions.

      Each function also includes specific tasks describing activities associated with performing that function. There are four tasks (1.1–1.4) associated with Function 1; four tasks (2.1–2.4) associated with Function 2; four tasks (3.1–3.4) associated with Function 3; four tasks (4.1–4.4) associated with Function 4; two tasks (5.1–5.2) associated with Function 5; and four tasks (6.1–6.4) associated with Function 6.5 For example, one such task (Task 4.2) is to review options retail communications and determine appropriate approval.6 Further, the content outline lists the knowledge required to perform each function and associated tasks (e.g., types of retail communications, required approvals).7 In addition, where applicable, the content outline lists the laws, rules and regulations a candidate is expected to know to perform each function and associated tasks. These include the applicable FINRA Rules (e.g., FINRA Rule 2220), NASD Rules (e.g., NASD Rule 2711(i)) and SEC rules (e.g., Rule 135a under the Securities Act of 1933).8

      FINRA conducted a job analysis study of Registered Options Principals, which included the use of a survey, in developing each function and associated tasks and updating the required knowledge set forth in the revised content outline. The functions and associated tasks, which appear in the revised content outline for the first time, reflect the day-to-day activities of a Registered Options Principal. FINRA also has revised the content outline to reflect changes to the laws, rules and regulations covered by the examination. Among other revisions, FINRA has revised the content outline to reflect the adoption of rules in the consolidated FINRA rulebook (e.g., NASD Rule 2310 (Recommendations to Customers (Suitability)), NASD Rule 2212 (Telemarketing) and NASD Rule 3110 (Books and Records) were adopted as FINRA Rule 2111 (Suitability), FINRA Rule 3230 (Telemarketing) and FINRA Rule 4510 Series (Books and Records Requirements), respectively).9

      In conjunction with the changes to the content outline, FINRA has made changes to the weighting of questions on the topics on the content outline and to the question bank for the Series 4 examination.

      Finally, FINRA has revised the format of the content outline, including the preface, sample questions and reference materials.

      The number of questions on the Series 4 examination will remain at 125 multiple-choice questions,10 and candidates have 195 minutes to complete the examination. The passing score will change to 72 percent with the revised Series 4 examination program (the current passing score is 70 percent).

      Availability of Content Outline

      The revised Series 4 content outline is available on FINRA's website.


      1 See Securities Exchange Act Release No. 75246 (June 18, 2015), 80 FR 36388 (June 24, 2015) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2015-018).

      2 NASD Rule 1022(f) also includes additional requirements applicable to Registered Options Principals engaged in securities futures activities. The rule generally provides that prior to the introduction of an appropriate qualification examination that addresses security futures products, a Registered Options Principal is required to complete a firm-element continuing education program that addresses security futures products and a principal's responsibilities for security futures before such person can supervise security futures activities.

      3 The term principal is defined in NASD Rule 1021(b) (Definition of a Principal).

      4 Registration as a United Kingdom Securities Representative or Canada Securities Representative is an acceptable alternative prerequisite to the General Securities Representative prerequisite.

      5 See Series 4 Outline Pages 6–22.

      6 See Series 4 Outline Page 15.

      7 See Series 4 Outline Page 15.

      8 See Series 4 Outline Page 15.

      9 See Rule Conversion Chart, available at http://www.finra.org/industry/finra-rule-consolidation.

      10 Consistent with FINRA's practice of including "pretest" items on certain qualification examinations, which is designed to ensure that new examination items meet acceptable testing standards prior to use for scoring purposes, the examination includes 10 additional, unidentified pretest items that do not contribute towards the candidate's score. Therefore, the examination actually consists of 135 items, 125 of which are scored. The 10 pretest items are randomly distributed throughout the examination.

    • 15-28 SEC Approves Amendments Relating to Web-based Delivery of the Regulatory Element of Continuing Education; Effective Date: October 1, 2015

      View PDF

      Continuing Education

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules and Notices

      FINRA Rule 1250
      FINRA Rule 2010
      FINRA Rule 4530
      NASD Rule 1043
      NTM 95-35
      Section 4(f) of Schedule A to the FINRA By-Laws
      SEA Section 3(a)(39)
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Senior Management
      Training
      Key Topics

      CE Online
      Continuing Education
      Fees
      FINRA CE Online System™
      In-firm Delivery
      Proctors
      Regulatory Element
      Rules of Conduct
      Test-center Delivery
      Web-based Delivery

      Executive Summary

      The SEC approved amendments to FINRA rules to provide a Web-based delivery method for completing the Regulatory Element of the Continuing Education (CE) requirements, and to establish the fee for it.1 The amendments become effective on October 1, 2015.

      The amended rule text is attached as Appendix A.

      Questions regarding this Notice should be directed to:

      •    Roni Meikle, Senior Director, Testing and Continuing Education, at (212) 858-4084 or roni.meikle@finra.org; or
      •    Afshin Atabaki, Associate General Counsel, Office of General Counsel, at (202) 728-8071 or afshin.atabaki@finra.org.

      Background and Discussion

      The CE requirements under FINRA Rule 1250 (Continuing Education Requirements) include a Regulatory Element2 and a Firm Element.3 The Regulatory Element applies to registered persons4 and consists of periodic computer-based training on regulatory, compliance, ethical and supervisory subjects, and sales practice standards, which must be completed within prescribed time frames.5 Currently, the Regulatory Element may be administered in a test center or in-firm subject to specified procedures,6 but most registered persons complete the Regulatory Element in a test center.

      Web-based Delivery (CE Online)

      Because of the costs and other concerns regarding the test center delivery method, FINRA has amended Rule 1250(a)(6) to provide that the Regulatory Element program will be administered through Web-based delivery or such other technological manner and format as specified by FINRA.

      The new Web-based delivery method, which will be called CE Online and administered through the FINRA CE Online System, will provide registered persons with the flexibility to complete the Regulatory Element at a location of their choosing, including their private residence, at any time during their 120-day window for completion of the Regulatory Element.7

      Authentication Process and Rules of Conduct

      CE Online will include safeguards to authenticate the identity of the CE participant. For instance, prior to commencing a CE Online session, the participant will be asked to provide a portion of his or her Social Security number (either first five or last four digits) and date of birth.8

      In addition, before commencing a CE Online session, FINRA will require that each participant agree to the Rules of Conduct for CE Online. Among other things, the rules of conduct require each participant to attest that he or she is in fact the person who is taking the CE session. The rules of conduct further require that each participant agree that the Regulatory Element content is the intellectual property of FINRA and that the content cannot be copied or redistributed by any means.

      If FINRA discovers that a participant has violated the rules of conduct, the participant will forfeit the results of the CE Online session and may be subject to disciplinary action by FINRA.9 Violation of the rules of conduct will be considered conduct inconsistent with high standards of commercial honor and just and equitable principles of trade, in violation of FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade).10

      Phased Implementation

      FINRA is rolling out the CE Online program in two phases. FINRA will launch the first phase of CE Online, which will include the S106, S201 and S901 Regulatory Element programs, on October 1, 2015; FINRA will launch the second phase of CE Online, which will include the S101 Regulatory Element program in a more personalized format, on January 4, 2016.11

      In addition, FINRA is phasing out test-center delivery by no later than six months after January 4, 2016. Registered persons will continue to have the option of completing the Regulatory Element in a test center until the phase-out of the test center delivery method, but they will be required to use the FINRA CE Online System after that date.

      FINRA is also phasing out in-firm delivery of the Regulatory Element now offered through Pearson VUE. FINRA will phase out in-firm delivery on a rolling basis as each Regulatory Element program becomes available for CE Online. Firms will not be able to establish new in-firm delivery programs after October 1, 2015. Moreover, firms that currently offer in-firm delivery programs will not be able to use that delivery method for the S106, S201 and S901 Regulatory Element programs after October 1, 2015. However, such firms may continue to use their in-firm delivery system for the S101 Regulatory Element program until January 4, 2016.

      Fees

      The current fee for test-center and in-firm deliveries is typically $100 per session.12 In conjunction with the amendment to Rule 1250(a)(6), FINRA has amended Section 4(f) of Schedule A to the FINRA By-Laws to establish a fee of $55 for each participant who completes the Regulatory Element via CE Online.13

      Proctors

      FINRA has eliminated NASD Rule 1043 relating to the registration of proctors for in-firm delivery. FINRA will automatically terminate the proctor registration category in the CRD system on January 4, 2016, which, as noted above, is the launch date of the second phase of CE Online.

      Additional Resources

      For additional information regarding the transition to CE Online, including the phase-out dates for test-center and in-firm deliveries, please visit the CE Online Web page, which provides details and information that firms and participants need to know. FINRA will regularly update the Web page with any new information.


      1 See Securities Exchange Act Release No. 75581 (July 31, 2015) (Order Approving File No. SR-FINRA-2015-015).

      2 See FINRA Rule 1250(a) (Regulatory Element).

      3 See FINRA Rule 1250(b) (Firm Element). FINRA is not making any changes to the Firm Element requirements under FINRA Rule 1250(b).

      4 For purposes of the Regulatory Element, a "registered person" is defined as any person registered with FINRA as a representative, principal, assistant representative or research analyst. See FINRA Rule 1250(a)(5) (Definition of Registered Person).

      5 Pursuant to FINRA Rule 1250(a), each registered person is required to complete the Regulatory Element initially within 120 days after the person's second registration anniversary date and, thereafter, within 120 days after every third registration anniversary date. Any registered person who has not completed the Regulatory Element program within the prescribed time frames will have his or her FINRA registrations deemed inactive and designated as "CE inactive" on the Central Registration Depository (CRD®) system until such time as the requirements of the program have been satisfied. A CE inactive person is prohibited from performing, or being compensated for, any activities requiring registration, including supervision. See also Notice to Members 95-35 (Continuing Education Program Update: Regulatory Element Questions and Answers) (May 1995). Moreover, if a registered person is CE inactive for a two-year period, FINRA will administratively terminate the person's registration status with FINRA. The twoyear period would be calculated from the date the person becomes CE inactive. If a registered person becomes CE inactive but is not registered with a member when the two-year period ends, FINRA will nevertheless update the CRD system to reflect that the person did not satisfy the Regulatory Element program. In either case, such person must reapply for registration and requalify (or obtain a waiver of the applicable qualification examination(s)) to be eligible to register again.

      In addition, a registered person is required to retake the Regulatory Element in the event such person is: (1) subject to a statutory disqualification as defined by Section 3(a)(39) of the Securities Exchange Act of 1934; (2) subject to a suspension or imposition of a fine of $5,000 or more by a self-regulatory organization (SRO) or securities governmental agency; or (3) ordered to do so as a sanction in a disciplinary action by an SRO or a securities governmental agency.

      6 The in-firm delivery procedures require, among other things, that the in-firm sessions be administered by a proctor who will be responsible for ensuring compliance with the required procedures and for monitoring the participants. See FINRA Rule 1250(a)(6) (In-Firm Delivery of the Regulatory Element). NASD Rule 1043 (Proctors of In-Firm Delivery of Regulatory Element) addresses the registration requirements for proctors. The rule requires that an associated person designated as a proctor by a firm for the purposes of the in-firm delivery of the Regulatory Element be registered as a proctor with FINRA through the filing of a Form U4 (Uniform Application for Securities Industry Registration or Transfer); provided that an associated person who is already registered with FINRA in another registration category, such as a General Securities Representative, may be designated as a proctor by a firm without having to register as a proctor with FINRA.

      7 While the amendment provides such flexibility, firms may choose to impose their own conditions based on their supervisory and compliance needs. For instance, a firm that wishes to have registered persons complete CE on the firm's premises can do so by having the registered person access CE Online from a firm device and location. Moreover, firms would have to update their written policies and procedures regarding the Regulatory Element to reflect the transition to CE Online and communicate the update to registered persons.

      8 Individuals who do not have a Social Security number will be required to provide their date of birth and another unique identifier, such as their CRD number or Form U10 (the Uniform Examination Request for Non-FINRA Candidates) identification number, to validate their identity.

      9 For instance, for cheating on the Regulatory Element, FINRA's Sanction Guidelines recommend a bar. See FINRA Sanction Guidelines at 40 (2013).

      10 Further, an associated person who assists another associated person in violating the rules of conduct will also be considered to have violated FINRA Rule 2010. Firms must also consider whether they have an obligation to report violations of the rules of conduct to FINRA. For instance, FINRA Rule 4530.01 (Reporting of Firms' Conclusions of Violations) requires a firm to report, among other things, if it concludes that an associated person has engaged in multiple instances of any violative conduct.

      11 The S106 is for Investment Company and Variable Contracts Representatives, the S201 is for registered principals and supervisors, the S901 is for Operations Professionals and the S101 is for all other registration categories.

      12 In-firm deliveries receive a three dollar rebate per session. There are also additional fees for taking the session outside the United States, failing to appear on time for an appointment or cancelling or rescheduling an appointment. See Section 4 of Schedule A to the FINRA By-Laws.

      13 The total reduction in fees is estimated to be approximately $1 million in 2015, $9 million in 2016, and $11 million in 2017 compared to the fee structure of the test-center delivery.


      APPENDIX A

      Amended Rule Text

      New language is underlined; deletions are in brackets.

      * * * * *

      By-Laws of the Corporation

      * * * * *

      Schedule A to the By-Laws of the Corporation

      Assessments and fees pursuant to the provisions of Article VI of the By-Laws of the Corporation shall be determined on the following basis.

      Section 1 through Section 3 No Change.

      Section 4—Fees

      (a) through (e) No Change.
      (f) There shall be a session fee of $100 assessed as to each individual [who is required] for each scheduled session to complete the Regulatory Element of the Continuing Education [R]requirements pursuant to FINRA rules via a test center or in-firm method. There shall be a session fee of $55 assessed as to each individual who completes the Regulatory Element of the Continuing Education requirements pursuant to FINRA rules via a Web-based method prescribed by FINRA.
      (g) through (i) No Change.

      IM-Section 4(b)(1) and (e) Exemption from Certain Registration and Membership Application Fees for Certain NYSE and NYSE Alternext US LLC Member Organizations

      No Change.

      Section 5 through Section 14 No Change.

      * * * * *

      FINRA Rule

      * * * * *

      1200. REGISTRATION AND QUALIFICATION

      * * * * *

      1250. Continuing Education Requirements

      This Rule prescribes requirements regarding the continuing education of certain registered persons subsequent to their initial qualification and registration with FINRA. The requirements shall consist of a Regulatory Element and a Firm Element as set forth below.

      (a) Regulatory Element
      (1) through (5) No Change.
      (6) [In-Firm] Delivery of the Regulatory Element

      [Members]The continuing education Regulatory Element program will be [permitted to] administered [the continuing education Regulatory Element program to their registered persons by instituting an in-firm program acceptable to] through Web-based delivery or such other technological manner and format as specified by FINRA.

      [The following procedures are required:]
      [(A) Principal/Officer In-Charge. The firm has designated a principal to be responsible for the in-firm delivery of the Regulatory Element.]
      [(B) Site Requirements.]
      [(i) The location of all delivery sites will be under the control of the firm.]
      [(ii) Delivery of Regulatory Element continuing education will take place in an environment conducive to training. (Examples: a training facility, conference room or other area dedicated to this purpose would be appropriate. Inappropriate locations would include a personal office or any location that is not or cannot be secured from traffic and interruptions.)]
      [(iii) Where multiple delivery terminals are placed in a room, adequate separation between terminals will be maintained.]
      [(C) Technology Requirements. The communication links and firm delivery computer hardware must comply with standards defined by FINRA or its designated vendor.]
      [(D) Supervision.]
      [(i) The firm's Written Supervisory Procedures must contain the procedures implemented to comply with the requirements of in-firm delivery of the Regulatory Element continuing education.]
      [(ii) The firm's Written Supervisory Procedures must identify the principal designated pursuant to Rule 1250(a)(6)(A) and contain a list of individuals authorized by the firm to serve as proctors.]
      [(iii) Firm locations for delivery of the Regulatory Element continuing education will be specifically listed in the firm's Written Supervisory Procedures.]
      [(E) Proctors.]
      [(i) All sessions will be proctored by an authorized person during the entire Regulatory Element session. Proctors must be present in the session room or must be able to view the person(s) sitting for Regulatory Element continuing education through a window or by video monitor.]
      [(ii) The individual responsible for proctoring at each administration will sign a certification that required procedures have been followed, that no material from Regulatory Element continuing education has been reproduced, and that no candidate received any assistance to complete the session. Such certification may be part of the sign-in log required under Rule 1250(a)(6)(F).]
      [(iii) Individuals serving as proctors must be persons registered with an SRO and supervised by the designated principal for purposes of in-firm delivery of the Regulatory Element continuing education.]
      [(iv) Proctors will check and verify the identification of all individuals taking Regulatory Element continuing education.]
      [(F) Administration.]
      [(i) All appointments will be scheduled in advance using the procedures and software specified by FINRA to communicate with FINRA's system and designated vendor.]
      [(ii) The firm/proctor will conduct each session in accordance with the administrative appointment scheduling procedures established by FINRA or its designated vendor.]
      [(iii) A sign-in log will be maintained at the delivery facility. Logs will contain the date of each session, the name and social security number of the individual taking the session, that required identification was checked, the sign-in time, the sign-out time, and the name of the individual proctoring the session. Such logs are required to be retained pursuant to SEA Rules 17a-3 and 17a-4.]
      [(iv) No material will be permitted to be used for the session nor may any session-related material be removed.]
      [(v) Delivery sites will be made available for inspection by FINRA.]
      [(vi) Before commencing in-firm delivery of the Regulatory Element continuing education, members are required to file with their Designated Examining Authority ("DEA"), a letter of attestation (as specified below) signed by a principal executive officer or executive representative, attesting to the establishment of required procedures addressing principal in-charge, supervision, site, technology, proctors, and administrative requirements. Letters filed with FINRA should be sent to Registration and Disclosure, Continuing Education Department, 9509 Key West Avenue, Rockville, MD 20850.]
      [Letter of Attestation for In-Firm Delivery of Regulatory Element Continuing Education]

      [[Name of member] has established procedures for delivering Regulatory Element continuing education on its premises. I have determined that these procedures are reasonably designed to comply with SRO requirements pertaining to in-firm delivery of Regulatory Element continuing education, including that such procedures have been implemented to comply with principal/officer in-charge, supervision, site, technology, proctors, and administrative requirements.]

      [Signature]
      [__________________________________________]

      [Printed name]
      [__________________________________________]

      [Title [Must be signed by a Principal Executive Officer (or Executive Representative) of the firm]]
      [__________________________________________]

      [Date]
      (7) No Change.
      (b) No Change.
      * * * * *

    • 15-27 Guidance Relating to Firm Short Positions and Fails-to-Receive in Municipal Securities

      View PDF

      Municipal Securities Trading

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules and Notices

      FINRA Rule 4530
      MSRB Rule G-8
      MSRB Rule G-9
      MSRB Rule G-12
      MSRB Rule G-15
      MSRB Rule G-17
      MSRB Rule G-27
      SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Trading
      Key Topics

      Branch Error Account Supervision
      Fails-to-Receive
      Firm Short Positions
      Municipal Securities

      Executive Summary

      FINRA is issuing this Notice to remind firms engaging in municipal securities transactions that their written supervisory procedures should identify the process for detecting, resolving and preventing the consequences of firm short positions and fails-to-receive in municipal securities, as well as the controls for ensuring that communications with customers regarding municipal securities transactions, including the tax status of interest payments, are not false or misleading. FINRA examinations have found that, as a result of trading errors and inadequate firm controls, some customers who purchased tax-exempt municipal securities have been paid substitute interest, which is not tax-exempt under the Internal Revenue Code.

      Questions concerning this Notice should be directed to:

      •  Mark Frankenberg, Director, Risk Oversight and Operational Regulation, at (646) 315-8816;
      •  Cynthia Friedlander, Director, Fixed Income Regulation, Regulatory Operations, at (202) 728-8133; or
      •  Andrew Madar, Associate General Counsel, Office of General Counsel, at (202) 728-8056.

      Background and Discussion

      As the SEC has previously recognized, "short positioning municipal securities is rare because the Internal Revenue Service will not allow both a borrower and lender of a municipal security to claim a tax exemption" and "[i]n effect, the lender of a municipal security would be trading tax exempt interest for taxable interest."1 Recent FINRA examinations, however, have identified a number of instances where firms have effected sales of municipal securities to customers where either the firm's trading activity inadvertently resulted in the firm creating a firm short position, or the firm failed to receive the securities it purchased to fill a customer's municipal securities order, collectively referred to as municipal short positions. Although municipal short positions may be infrequent, FINRA is concerned that firms may lack supervisory controls and procedures reasonably designed to detect and resolve them and to prevent the consequences described below.

      Firms need to be mindful of the additional concerns that arise when customer long positions in tax-exempt municipal securities allocate to short positions. Consequently, a customer seeking tax-exempt interest may be receiving substitute interest from the firm, which could in fact be taxable.2 Communications provided to the customer, including confirmations, account statements and tax forms, must not contain false or misleading information regarding the tax status of paid or accrued3 interest payments in connection with municipal securities.

      For example, a firm buys 100 tax-exempt Issuer A municipal bonds from the market and subsequently sells 100 tax-exempt Issuer A bonds to Retail Customer 1. The firm then inadvertently sells the same 100 tax-exempt Issuer A bonds to Retail Customer 2, thus creating a firm short position. Although the firm over-sold 100 tax-exempt Issuer A bonds to Retail Customer 2, both customers receive a confirmation indicating a long position of 100 tax-exempt Issuer A bonds and both receive monthly statements and Forms 1099 indicating the receipt of tax-exempt interest. However, Issuer A will only pay tax-exempt interest on 100 bonds. The firm will need to pay substitute interest on 100 bonds. As a result, the IRS has indicated that in such a scenario, the substitute interest allocated to customers would be taxable, causing any disclosures to the contrary to be inaccurate.4 Where a municipal security accrues interest from settlement date, resolving the firm short position prior to settlement date can avoid a potential misrepresentation to a customer regarding the tax status of the security's interest accrual and payment.

      In another example, a firm buys 100 tax-exempt Issuer B municipal bonds from Counterparty 1, and subsequently sells 100 Issuer B bonds to a retail customer. Counterparty 1 does not deliver the bonds to the firm on settlement date, thus setting up a fail-to-receive at the firm and the potential payment of substitute interest to the customer.5 Although the firm has not yet taken possession of the security, the customer may receive communications from the firm, such as a confirmation or account statement, indicating that interest on Issuer B bonds is tax-exempt.

      Guidance on Specific Controls and Remedial Action

      FINRA is providing the following guidance for consideration to assist firms in developing policies and procedures relating to municipal short positions.6

      Firms should review Municipal Securities Rulemaking Board (MSRB) rules to ensure compliance with applicable securities laws and regulations and with MSRB rules, both through a supervisory system, including for the processing and clearance of municipal securities transactions, and written supervisory procedures. Relevant MSRB rules include:

      •  MSRB Rule G-8, including G-8(a)(iv),7 which sets forth the recordkeeping standards for municipal securities;
      •  MSRB Rule G-9, which sets forth the record retention requirements for municipal securities;
      •  MSRB Rule G-12, which sets forth the requirements for the inter-dealer delivery of securities and close-out procedures;
      •  MSRB Rule G-15, which sets forth the confirmation requirements with respect to transactions with customers;
      •  MSRB Rule G-17, which requires that municipal securities firms deal fairly with all persons and not engage in any deceptive, dishonest, or unfair practice; and
      •  MSRB Rule G-27, which imposes an obligation on municipal securities firms to supervise their municipal securities activities.

      Firms should also review SEA Rule 15c3-3, which requires, among other things, that a member firm obtain and maintain possession and control of customer fully paid and excess margin securities.8

      Further, a firm should have procedures to correct any communications provided to customers that are, as a result of the short position in municipal securities, inaccurate or misleading.9

      Since short positions in municipal securities can be caused by both introducing and clearing firms, such firms should review their existing policies and procedures to address any gaps between those procedures and the appropriate policies and procedures described herein.10 Based on the particular circumstances of a clearing firm and its correspondent, both may have regulatory obligations arising from a single municipal securities transaction.

      Identifying and Resolving Firm Short Positions

      FINRA has observed that most municipal short positions are inadvertent and may result from branch or trading errors, duplicate transactions, the sale of a security in the process of a partial redemption or a partial call, or a delay in delivery of the securities from a counterparty. In addition to the scenarios explained above, two common situations that may cause short positions are described below.

      •  A firm may sell an incorrect CUSIP from a customer's account and subsequently cancel the trade after settlement date. However, the firm has already delivered the security to the counterparty and it is no longer available in the market to effect a buy-in, leaving the customer with a long position that identifies to a firm short position.
      •  A firm may sell a security after the record date for a partial redemption or partial call, causing the firm to be short when completing the redemption process with the issuer.

      Firms can reduce the impact of short positions by detecting municipal securities trading activity that inadvertently creates firm short positions as early as trade date, and at a minimum by T+1. Remedial actions to resolve a municipal securities firm short position and avoid the risk of paying substitute interest to a customer include, for example:

      •  cancelling the trade, consistent with instructions from a customer;
      •  cancelling the trade and, consistent with instructions from a customer, purchasing a comparable bond;
      •  purchasing the bond from the market or another customer on a shortened settlement basis; or
      •  an introducing firm requesting the assistance of its clearing firm to identify other correspondents' customers who are long the security and may be willing to sell it to the introducing firm.

      Identifying and Resolving Fails-to-Receive

      One of the first steps a firm should take after identifying a fail-to-receive in municipal securities is to determine if there is a customer long position in the bonds. Procedures designed to address fails-to-receive in municipal securities need to be consistent with the procedures for closing out a municipal securities transaction in accordance with MSRB Rule G-12(h).11 If a firm's counterparty fails to deliver the securities after five business days, the firm may initiate a close-out of the transaction. If the counterparty is not able to deliver the securities as of the original settlement date, the counterparty will be responsible for paying accrued, substitute interest to the buying firm (which will, in turn, pay its customer) from settlement date until the close-out is executed. Substitute interest paid by the counterparty may not be tax-exempt.

      FINRA recognizes that the majority of fails-to-receive are resolved within days of the original settlement date. Consequently, a firm's procedures for correcting a communication that could be misleading because of an inadvertent municipal short position could reasonably afford more time to correct the communication when the municipal short position is caused by a fail-to-receive.

      Other Considerations

      Municipal short positions remain an area of focus for FINRA examiners. If the firm, through a self-review process, becomes aware that the activity described in this Notice has taken place, it is important to evaluate the conduct to determine if a filing pursuant to FINRA Rule 4530 is required. In addition, the firm should consider consulting legal counsel and the appropriate taxing authorities, such as the IRS or appropriate regulatory bodies of the states in which affected customers reside, to resolve tax reporting or underpayment issues, if any.


      1. Securities Exchange Act Release No. 33743 (March 9,1994), 59 FR 12767, 12769 n.24 (March 17,1994) citing Internal Revenue Code, Sec. 6045(d). The SEC also noted that, to the extent any short positioning occurs with respect to municipal securities, the IRS imposes additional reporting requirements on the participating parties.

      2. For example, the Internal Revenue Service previously addressed the tax implications of a short sale transaction where title passes from the ender of a municipal security to the purchaser, and the lender receives a substitute payment instead of receiving interest on the municipal security. In this instance, the IRS has found that, because title passed to the purchaser as a result of the short sale, the lender is no longer the owner of the bond, and so any subsequent payment received by the lender is not interest on an obligation of a state or political subdivision for purposes of determining the lender's gross income under the Internal Revenue Code. See IRS Rev. Rul. 80-135 (1980-1 C.B. 18).

      3. If by transaction settlement date the firm is not in possession of the securities for which the customer is long, the firm assumes the accrued interest liability until the firm covers its short position. Even if the firm covers the short before the next coupon date, the interest accrued between settlement date and the date the firm covers the short will be taxable to the customer (i.e., substitute interest). This is because when the firm purchases the security from a dealer or another customer to cover the short, the firm will pay the accrued interest to the seller. The seller, not the customer, is entitled to tax exempt interest during the accrual period. One exception would be a fail-to-receive that cleans up as of the original settlement date with the original counterparty. This would not result in a substitute interest payment.

      4. See supra note 3.

      5. See supra note 3.

      6. Firms should not consider this guidance to include all rules and interpretations applicable to municipal short positions. Firms are reminded that, in designing written supervisory procedures, firms are to consider, among other things, the nature of the business the firm conducts, the manner in which procedures are implemented and followed, and the extent to which the firm updates and revises its procedures to reflect operating experience and regulatory and operational changes.

      7. See also SEA Rule 17a-3(a)(B) and MSRB Rule G-8(a)(iii).

      8. When a member firm has a deficit in the quantity of a particular security that it is required to have in its possession and control, SEA Rule 15c3-3(d) (4) requires the firm to take timely curative action to obtain physical possession or control of a customer's fully paid and excess margin securities of the same issue and same class as those allocated to a short position for more than 30 calendar days. The rule states, in relevant part, that "[securities included on the broker's or dealer's books or records that allocate to a short position of the broker or dealer or a short position for another person, excluding positions covered by paragraph (m) of this section, for more than 30 calendar days, then the broker or dealer must, not later than the business day following the day on which the determination is made, take prompt steps to obtain physical possession or control of such securities." While the 30-calendar-day period begins upon allocating the security in deficit to a short position, firms should not view this 30-calendar-day period as a "safe harbor" for resolving firm short positions in municipal securities.

      9. See, e.g., MSRB Rules G-1B and G-17.

      10. For example, MSRB Rules G-17 and G-27 apply to both introducing and clearing firms.

      11. See MSRB Rule G-12(h) regarding the process to close out a transaction between any broker, dealer or municipal securities dealer and any other broker, dealer or municipal securities dealer which has been confirmed or otherwise agreed upon by both parties but which has not been completed and the MSRB's Manual on Close-Out Procedures.

    • 15-26 FINRA Requests Comment on a New Academic TRACE Data Product; Comment Period Expires: September 14, 2015

      View PDF File

      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules and Notices

      FINRA Rule 7730
      Regulatory Notice 10-14
      Regulatory Notice 15-24
      Securities Act Rule 144A
      Suggested Routing

      Fixed Income
      Research
      Trading
      Key Topics

      Fees
      Historic TRACE Data
      TRACE Transaction Data

      Executive Summary

      FINRA is soliciting comment on a proposal to create a new Academic TRACE Data product that would be available to institutions of higher education. FINRA and the Municipal Securities Rulemaking Board (MSRB) have been engaged in ongoing dialogue to support a coordinated approach to potential rulemaking in this area. The MSRB also is publishing a notice soliciting comment on a similar proposal that would establish a historical data product of post-trade municipal securities transaction data collected though the MSRB's Real-time Reporting System (RTRS) for institutions of higher education.1

      The proposed rule text is attached as Appendix A. Selected key terms from the User Agreement for the proposed new Academic TRACE Data product is attached as Appendix B.

      Questions regarding this Notice should be directed to:

      •  Ola Persson, Vice President, Transparency Services, at (212) 858-4796; or
      •  Racquel Russell, Associate General Counsel, Office of General Counsel, at (202) 728-8363.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by September 14, 2015.

      Member firms and other interested parties can submit their comments using the following methods:

      •  Emailing comments to pubcom@finra.org; or
      •  Mailing comments in hard copy to:

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      To help FINRA process and review comments more efficiently, persons should use only one method to comment on the proposal.2

      Before becoming effective, the proposed rule change must be filed with the Securities and Exchange Commission (SEC) pursuant to Section 19(b) of the Securities and Exchange Act.3

      Important Notes: The only comments that FINRA will consider are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.

      Background and Discussion

      FINRA Rule 7730 sets forth the TRACE data products offered by FINRA. FINRA's data offerings include both real-time as well as aged historical data for most TRACE-eligible securities.4 FINRA is soliciting comment on proposed changes to create a new Academic TRACE Data product, which would be made available solely to institutions of higher education and would include masked dealer identities.

      Academic TRACE Data

      FINRA periodically receives requests from academics for enhanced historical TRACE data. FINRA's existing Historic TRACE Data product provides transaction-level data on an 18-month delayed basis for all transactions that have been reported to TRACE in the classes of TRACE-eligible securities that currently are disseminated.5 While Historic TRACE Data is used by academic researchers today, it does not include any identifying information regarding the dealer reporting each transaction. Thus, where a researcher wishes to track the behavior of an individual dealer—even anonymously—the existing Historic TRACE Data product would not allow for this type of observation. As a result, academics have requested that FINRA make available an enhanced version of Historic TRACE Data that would include dealer identification.

      In response to these requests from academics, FINRA is proposing to create a new Academic TRACE Data product that would include masked market participant identifiers (MPIDs). As noted previously, masked MPID information may be useful to academics in a variety of ways—for example, to enable researchers to track activity by individual dealers or group of dealers and observe their behaviors in studying the impact of various events on measures such as intermediation costs, dealer participation and liquidity. Academic TRACE Data would be made available only to academics (i.e., requests originating from an institution of higher education) for a fee of $500 per data set per calendar year (with a one-time initial set-up fee of $500), and would include the same security classes as included in Historic TRACE Data.6

      While FINRA understands that masked dealer identifications may be very useful to academics in connection with their research activities, we also appreciate that firms may be concerned regarding the potential for reverse engineering of dealer identities (even though masked). To address this issue, in addition to masking dealer MPIDs, FINRA proposes to take further measures to allay such concerns, including to: (1) explicitly require subscribers to agree that they will not attempt to reverse engineer the identity of any market participant; (2) prohibit the redistribution of data in the Academic TRACE Data product; (3) require users to disclose each intended use of the data (including a description of each study being performed and the names of each individual who will have access to the data for the study); and (4) require that the data be returned or destroyed if the agreement is terminated. Select key terms intended to be included in the User Agreement to safeguard the data are attached in Appendix B. In addition, the transactions included in the Academic TRACE Data product will be aged no less than 24 months.

      Economic Impact Analysis

      Need for the Rule

      As discussed above, FINRA has received requests from academics for access to historical TRACE data that provides sufficient information to allow them to track the behaviors of individual dealers, even on an anonymous basis.

      Regulatory Objective

      The proposed new Academic TRACE Data product with masked MPIDs is expected to enable academics to conduct research on a variety of topics related to dealer activities, which could enhance understanding of the fixed-income market and its participants.

      Economic Impacts

      The proposal will not have any direct operational impact on firms, as it does not require firms to provide FINRA with any additional data. The purchase of TRACE data products will continue to be optional.

      The proposed Academic TRACE Data product with masked MPIDs may promote academic research on dealer behaviors; it also may raise concerns regarding the potential for reverse engineering of dealer identities. FINRA will explore this issue further using available data and information obtained through the comment process.

      Request for Comment

      FINRA requests comment on all aspects of the proposal. FINRA requests that commenters provide empirical data or other factual support for their comments wherever possible. FINRA specifically requests comment concerning the following issues.

      •  What public and investor protection benefits might arise from the addition of masked MPIDs to TRACE data available to academics?
      •  FINRA proposes that the Academic TRACE Data product be issued on a 24-month delayed basis. Is this delay an appropriate period of time to allay concerns regarding potential reverse engineering of dealer identities? If not, what other delay period would be appropriate to address these concerns, while still providing data that is timely enough to be useful for market research purposes?
      •  Would a shorter delay period, such as 12 months, be appropriate to enhance the timeliness of the data for research purposes while still minimizing the risk and potential impact of reverse engineering of dealer identities?
      •  Are there alternative ways that dealers may be identified in the Academic TRACE Data? Are there groupings of dealers based on dealer characteristics (e.g., size of firm) that could be used to identify the type of dealer that executed each transaction? Are there behavioral groupings that may be used (e.g., average daily trading volume across TRACE-eligible security asset classes)? How would this approach be preferable to a masked MPID approach in retaining the usefulness of the data to academics while presenting fewer concerns regarding reverse engineering of dealer identifiers?
      •  FINRA intends to limit the availability of Academic TRACE Data to academics currently associated with an institution of higher education in connection with their research activities. Is this an appropriate limitation? If not, please provide alternatives and explain how the alternatives would address concerns regarding reverse engineering of dealer identities. For example, should a data product containing masked MPIDs be made available more broadly to researchers, even if not part of an institution of higher education (e.g., industry groups, non-profit organizations or research-oriented for-profit companies)? Would a broader subscriber base increase the likelihood that dealers or other market participants may obtain the data for competitive reasons?
      •  Are the key terms of the User Agreement in Appendix B sufficient in striking the appropriate balance between protecting member dealer transaction confidentiality interests and facilitating academic research? Should FINRA include any additional restrictions on the use of the data? Are any of the key terms in the User Agreement unduly restrictive such that they may potentially hinder research? Would academics be opposed to a requirement that a copy of all derivative works that rely on the Academic TRACE Data be provided to FINRA upon publication?
      •  How would dealers or other market participants be impacted if dealer identities were reverse engineered? Is there data or other evidence, including studies or research, that supports estimates of these impacts?

      1. See MSRB Notice 2015-10 (July 16, 2015), on www.rnsrb.org.

      2. FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.

      3. See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Some proposed rule changes take effect immediately upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

      4. FINRA adopted the Historic TRACE Data rule and related fees in 2010. See Securities Exchange Act Release No. 61012 (November 16, 2009), 74 FR 61189 (November 23, 2009) (Order Approving File No. SR-FINRA-2007-006). See also Regulatory Notice 10-14 (March 2010).

      5. FINRA recently published a Regulatory Notice seeking comment on a proposal to shorten the delay period for the Historic TRACE Data product from 18 months to six months. See Regulatory Notice 15-24 (June 2015). That proposal would not impact the proposed 24-month delay for the Academic TRACE Data product.

      6. Historic TRACE Data is transaction-level data and includes the following data sets: the Historic Corporate Bond Data Set, the Historic Agency Data Set, the Historic Securitized Product Data Set, and the Historic Rule 144A Data Set. Historic TRACE Data originally included only the Corporate Bond and Agency Data Sets; the Securitized Product and Rule 144A Data Sets were added to Historic TRACE Data later as information about transactions in those securities became subject to dissemination. Additional securities may be included in the data sets as they become subject to dissemination.


      APPENDIX A

      Below is the text of the proposed rule change. Proposed new language is underlined; proposed deletions are in brackets.

      * * * * *

      7000. CLEARING, TRANSACTION AND ORDER DATA REQUIREMENTS, AND FACILITY CHARGES

      * * * * *

      7700. CHARGES FOR OTC REPORTING FACILITY, OTC BULLETIN BOARD AND TRADE REPORTING AND COMPLIANCE ENGINE SERVICES

      * * * * *

      7730. Trade Reporting and Compliance Engine (TRACE)

      The following charges shall be paid by participants for the use of the Trade Reporting and Compliance Engine ("TRACE"):

      (a) through (e) No Change.

      System Fees Transaction Reporting Fees Data Fees
      * * * * * * * * * * * * * * *
          Academic TRACE Data: Set-Up Fee—a single fee of $500 for development and set-up to receive Academic TRACE Data.
          Academic TRACE Data: Fee—$500/calendar year per Data Set for receipt of Academic TRACE Data. Redistribution of data is not permitted.
      (f) Definitions
      (1) through (4) No Change.
      (5) "Academic TRACE Data" as used in Rule 7730 means historic transaction-level data with elements to be determined from time to time by FINRA in its discretion and as stated in a Regulatory Notice or other equivalent publication. Academic TRACE Data will be delayed a minimum of 24 months and will not include MPIDs, but will substitute an identifier for each MPID included in the Data Set. Academic TRACE Data is available only to institutions of higher education. Academic TRACE Data includes the following Data Sets:
      (A) Academic Corporate Bond Data Set—includes all transactions in corporate bonds reported to TRACE, except Rule 144A transactions in corporate bonds;
      (B) Academic Agency Data Set—includes all transactions in Agency Debt Securities as defined in Rule 6710(l) reported to TRACE;
      (C) Academic SP Data Set—includes all transactions in Securitized Products as defined in Rule 6710(m) reported to TRACE, if transactions in the type of Securitized Products are subject to real-time dissemination under Rule 6750, but excludes historic Rule 144A transactions in Securitized Products; and
      (D) Academic Rule 144A Data Set—includes all Rule 144A transactions reported to TRACE, except transactions involving a type of TRACE-Eligible Security that is not subject to real-time dissemination under Rule 6750.
      (g) No Change.

      * * * * *


      APPENDIX B

      Selected key terms of proposed data agreement. Some of these terms may be modified in the final version of the agreement.

      Authorized Use

      •  Except as otherwise provided in the agreement, Licensee is granted a world-wide, non-transferable, non-exclusive, non-assignable, limited right and license to use the Academic Data Set in accordance with the agreement and its attachments, and to create and publish derivative works.
      •  Authorized use is limited to accessing, receiving, using, processing, manipulating and storing the Academic Data Set and creating and publishing derivative works in accordance with the agreement and attachments. Licensee is prohibited from disseminating the Academic Data Set or any Data contained therein to third parties.
      •  Licensee must submit to FINRA a new attachment to the agreement for each new intended use of the Academic Data Set by Licensee. Any use of the Data, by a Licensee or its Internal Users, unless expressly described in an Attachment B received by FINRA, is prohibited.
      •  Internal Users of Licensee listed on a separate attachment to the agreement are authorized to use the specifically identified Academic Data Set in accordance with the terms and conditions of the agreement and its attachments. Licensee warrants that those individuals listed in the attachment fall within the definition of Internal Users set out in the agreement.
      •  Licensee remains liable to FINRA for any breach of the agreement resulting from the action/inaction of Licensee's Internal Users or any other individual or entity that accesses the Academic Data Set via Licensee or to whom Licensee provides any derivative works.
      •  If Licensee learns of any Unauthorized Use of the Data, it shall immediately provide FINRA with written notice of the Unauthorized Use, and shall assist FINRA in investigating, halting and prosecuting, if necessary, any such Unauthorized Use. If FINRA so elects, Licensee shall assign and shall ensure that its, agents assign, all right, title and interest in and to any suit, including its subject matter, of or concerning the Data or which otherwise arises out of or is related to the agreement, to FINRA.
      •  FINRA reserves the right to monitor and review the activities of Licensee to ensure that no Unauthorized Use of the Data occurs. Licensee agrees to cooperate with FINRA, and use reasonable efforts to obtain the cooperation of its Internal Users with FINRA, at Licensee's cost, in any such review. In the event that FINRA identifies any Unauthorized Use, Licensee shall, upon notice from FINRA, immediately cease all such use and confirm to FINRA that such use has been terminated. At such time when the Unauthorized Use, in the sole, reasonable judgment of FINRA, has been cured, FINRA may grant Licensee permission to resume using Academic Data Set and disseminating the Derivative Data. This remedy is in addition to and not in place of any other remedy FINRA may have as a matter of law or equity.

      Restrictions and Redistribution

      •  As the Data includes masked identification of the FINRA Member executing the trade, Licensee will not attempt to reverse engineer or take any other measures, nor will it assist any other person or entity, in taking any measures, to discover the true identity of any FINRA Member at any time.
      •  Licensee shall not redistribute the Academic Data Set or any Data comprising the Academic Data Set to any other individual or entity with the exception of the Internal Users listed in the attachment to the agreement and shall use commercially reasonable measures to cause Licensee's Service to be configured and operated in such a manner as to protect the Data. Such measures may include, but not be limited to, the use of user IDs and passwords and other forms of entitlements to gain access to the Data. Additionally, Licensee shall administer reasonable security procedures in the place(s) where Licensee's Service and the Data are used, accessed, processed, stored or transmitted in order to ensure that the Academic Data Set remains, at all times, secure from unauthorized access or interference and to prevent the Academic Data Set from being accessed or taken from or in any way communicated, divulged or published except through authorized channels of transmission or reception.
      •  If Licensee is a Public University, terms to protect the Data from FOIA laws of Licensee's state shall be applicable.

      Publication of Derivative Works

      All Data results included in any draft or final version provided to or made available in any way whatsoever, to any third party, shall be sufficiently aggregated to ensure that no third party can identify any specific FINRA Member, or reverse engineer any specific transaction. Licensee shall inform all of its Internal Users and Authorized Users to act accordingly and shall take reasonable measures to ensure their compliance. Any disclosure of the identity of any FINRA Member, whether willful or accidental, is considered a material breach of the agreement and will result in immediate Termination of the agreement for Cause.

      Termination

      Immediately upon conclusion or termination of the agreement for any reason, Licensee shall, without additional cost to or demand from FINRA, return to FINRA in an orderly and expeditious manner or destroy all information, records, documentation, data, and other property supplied to Licensee by and for FINRA, and shall certify in writing that it has done so.

    • 15-25 FINRA Announces Updates of the Interpretations of Financial and Operational Rules

      View PDF

      SEC Financial Responsibility Rules

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Regulatory Notice 08-56
      Regulatory Notice 13-44
      Regulatory Notice 14-06
      Regulatory Notice 14-12
      Regulatory Notice 14-25
      Regulatory Notice 14-38
      SEA Rule 15c3-1
      SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Finance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      Customer Protection
      Net Capital

      Executive Summary

      FINRA is making available updates to interpretations in the Interpretations of Financial and Operational Rules that have been communicated to FINRA by the staff of the SEC's Division of Trading and Markets (SEC staff). The updated interpretations relate to the effectiveness of amendments that the SEC adopted to Securities Exchange Act (SEA) Rules 15c3-1 and 15c3-3.1

      Questions concerning this Notice should be directed to:

      •    Yui Chan, Managing Director, Risk Oversight and Operational Regulation (ROOR), at (646) 315-8426; or
      •    Susan DeMando Scott, Associate Vice President, ROOR, at (240) 386-4620.

      Background & Discussion

      In July 2013, the SEC adopted rule amendments that became effective on March 3, 2014, pursuant to a temporary exemption granted by the SEC.2 As previously announced in Regulatory Notice 14-12, FINRA is updating interpretations in the Interpretations of Financial and Operational Rules related to the SEC's amendments to SEA Rules 15c3-1 and 15c3-3, as set forth below. Page references are to the hardcopy version. These interpretations are being updated with specific additions, revisions and rescissions.

      The following interpretations have been added:

      •    SEA Rule 15c3-3(a)(1)/022 (Non-Conforming Subordination Agreements for PAB Account Exclusion) on page 2007.
      •    SEA Rule 15c3-3(a)(16)/01 (Non-Conforming Subordination Agreements for PAB Account Exclusion) on page 2043.
      •    SEA Rule 15c3-3(a)(16)/02 (Piggyback Carrying Arrangements) on page 2044.
      •    SEA Rule 15c3-3(d)(4)/01 (Extensions of Time) on page 2341.
      •    SEA Rule 15c3-3(e)(5)/01 (Cash Deposits in Reserve Bank Accounts—Aggregation of Deposits for Concentration Calculation) on page 2434.
      •    SEA Rule 15c3-3(Exhibit A—Item 5)/03 (Possession or Control Requirement vs. Non-Customer Short) on page 2695.

      The following interpretations have been revised:

      •    SEA Rule 15c3-1(a)(2)(vi)/04 (Sole Proprietor Joint Securities Account With Spouse) on page 43.
      •    SEA Rule 15c3-1(a)(2)(vi)/05 (Sole Proprietor IRA, Keogh or ERISA Accounts) on page 44.
      •    SEA Rule 15c3-1(c)(2)(iv)(B)/111 (Customers' Unsecured/Partly Secured Deficits Offset by Correspondent's Deposits) on page 281.
      •    SEA Rule 15c3-1(c)(2)(iv)(E)/021 (Clearing Deposits of Introducing Brokers) on page 320.
      •    SEA Rule 15c3-1(c)(2)(iv)(E)/025 (U.S. Broker-Dealer's Deposit at Foreign Entity) on page 323.
      •    SEA Rule 15c3-1(c)(2)(iv)(E)/027 (Piggyback Carrying Arrangements) on page 324.
      •    SEA Rule 15c3-1(c)(2)(iv)(E)/028 (Aged Commissions Receivables) on page 325.
      •    SEA Rule 15c3-3(a)(1)/01 (Customer/Non-Customer Classification) on page 2002-2004.
      •    SEA Rule 15c3-3(a)(1)/021 (Non-Conforming Subordination Agreements for Customer Account Exclusion) on page 2006.
      •    SEA Rule 15c3-3(a)(1)/032 (Foreign Banks—Customer and Non-Customer Classification) on page 2008.
      •    SEA Rule 15c3-3(a)(1)/033 (Foreign Broker-Dealers—Customer and Non-Customer Classification) on page 2009.
      •    SEA Rule 15c3-3(a)(6)/012 (Certificates of Deposit in Reserve Bank Accounts) on page 2023.
      •    SEA Rule 15c3-3(a)(6)/0121 (Certificates of Deposit in Reserve Bank Accounts—Aggregation of Deposits for Concentration Calculation) on page 2024.
      •    SEA Rule 15c3-3(b)(1)/011 (Borrowing Required) on page 2101.
      •    SEA Rule 15c3-3(b)(2)/033 (Segregation Management Allocation System) on page 2104.
      •    SEA Rule 15c3-3(d)(1)/06 (Customer Long vs. Customer, Non-Customer or Proprietary Short) on page 2305.
      •    SEA Rule 15c3-3(e)(1)/01 (Money Market Deposits in Reserve Bank Accounts) on page 2401.
      •    SEA Rule 15c3-3(e)(1)/010 (Money Market Deposits in Reserve Bank Accounts—Aggregation of Deposits for Concentration Calculation) on page 2402.
      •    SEA Rule 15c3-3(e)(1)/011 (Time Deposits in Reserve Bank Accounts) on page 2403.
      •    SEA Rule 15c3-3(e)(1)/012 (Time Deposits in Reserve Bank Accounts—Aggregation of Deposits for Concentration Calculation) on page 2404.
      •    SEA Rule 15c3-3(f)/02 (Amendment to Reserve Account Notification Letter) on page 2452.
      •     SEA Rule 15c3-3(Exhibit A—Note E(4))/01 (Determination of the Includible Amount of an Affiliated Account's Debit Balance in the Reserve Formula) on page 2604.
      •    SEA Rule 15c3-3(Exhibit A—Note E(5))/01 (Determination of the Includible Amount of a Customer's Concentrated Margin Debit Balance in the Reserve Formula) on page 2605.
      •    SEA Rule 15c3-3(Exhibit A—Note E(6))/02 (Determination of the Includible Amount of a Non-Customer's Debit Balance Portion in a Joint Account with a Customer in the Reserve Formula) on page 2607.
      •    SEA Rule 15c3-3(Exhibit A—General)/08 (Customer Reserve Formula Allocation Chart) on page 2625.
      •    SEA Rule 15c3-3(Exhibit A—General)/09 (PAB Reserve Formula Allocation Chart) on page 2637.
      •    SEA Rule 15c3-3(Exhibit A—Item 10)/0120 (Customers' Unsecured/Partly Secured Deficit Offset by Correspondent's Deposits) on page 2722.

      The following interpretations have been rescinded:

      •    SEA Rule 15c3-1(c)(2)(iv)(E)/022 (Introducing Firms with No Proprietary Trading Accounts) on page 323.
      •    SEA Rule 15c3-1(c)(2)(iv)(E)/023 (Introducing Firm's Net Equity) on page 323.
      •    SEA Rule 15c3-1(c)(2)(iv)(E)/024 (Proprietary Accounts of Other Broker-Dealers) on page 323.
      •    SEA Rule 15c3-1(c)(2)(iv)(E)/026 (DVP/RVP Accounts) on page 323.
      •    SEA Rule 15c3-3(a)(1)/012 (Proprietary Accounts of Foreign Broker-Dealer) on page 2005.
      •    SEA Rule 15c3-3(e)(3)/051 (Reserve Bank Account Cash Deposits with Parent and/or Affiliated Bank) on page 2433.
      •    SEA Rule 15c3-3(Exhibit A—Item 4)/03 (Possession or Control Requirement vs. Non-Customer Short Treated as Fail to Receive) on page 2691.

      These interpretation updates are available in portable digital format (pdf) on FINRA's Interpretations of Financial and Operational Rules page.

      Further, SEC staff continues to communicate and issue written and oral interpretations of the financial responsibility and reporting rules. FINRA has previously updated the Interpretations of Financial and Operational Rules on its website in Regulatory Notices 08-56, 13-44, 14-06, 14-12, 14-25 and 14-38.

      FINRA member firms and others that maintain the hardcopy version of the Interpretations of Financial and Operational Rules may refer to the accompanying updated pages, containing the aforementioned interpretation updates, which are being made available to enable the replacement of existing pages in the hardcopy version of the Interpretations of Financial and Operational Rules. The filing instructions for the new pages are as follows:

      SEA Rule Remove Old Pages Add New Pages
      15c3-1 43–44 43–44
      15c3-1 281 281
      15c3-1 320–321 320–321
      15c3-1 323 323
      15c3-1 324 324
      15c3-1 325 325
      15c3-3 2002–2010 2002–2011
      15c3-3 2023–2024 2023–2024
      15c3-3 2042 2042–2044
      15c3-3 2101 2101
      15c3-3 2104 2104
      15c3-3 2305 2305
      15c3-3 2341–2342 2341
      15c3-3 2401–2408 2401–2410
      15c3-3 2433–2434 2433–2434
      15c3-3 2452 2452
      15c3-3 2604–2605 2604–2605
      15c3-3 2607 2607
      15c3-3 2625–2634 2625–2634
      15c3-3 NA 2637–2648
      15c3-3 2691 2691
      15c3-3 2695 2695
      15c3-3 2722 2722
      15c3-3 2774 2774
      15c3-3 2801–2812 NA

      1 See Securities Exchange Act Release No. 70072 (July 30, 2013), 78 FR 51824 (August 21, 2013) (Financial Responsibility Rules for Broker-Dealers). The SEC subsequently modified the effective date of specified amendments to these rules pursuant to an Exemptive Order. See Securities Exchange Act Release No. 70701 (October 17, 2013), 78 FR 62930 (October 22, 2013) (Order Providing Broker-Dealers a Temporary Exemption from the Requirements of Certain New Amendments to the Financial Responsibility Rules for Broker-Dealers under the Securities Exchange Act of 1934) (granting temporary exemption, until March 3, 2014, from the amendments to: SEA Rule 15c3-3, except paragraph (j)(1); SEA Rule 15c3-3a; SEA Rule 17a-3; SEA Rule 17a-4; and paragraph (c)(2)(iv)(E) (2) of SEA Rule 15c3-1).

      2 See note 1.

    • 15-24 FINRA Requests Comment on the Reduction of the Delay Period for Historic TRACE Data; Comment Period Expires: August 24, 2015

      View PDF

      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 7730
      Regulatory Notice 10-14
      Securities Act Rule 144A
      Suggested Routing

      Fixed Income
      Research
      Trading
      Key Topics

      Fees
      Historic TRACE Data
      TRACE Transaction Data

      Executive Summary

      FINRA is soliciting comment on a proposal to reduce the delay period for the Historic TRACE Data Sets from 18 months to six months.

      The proposed rule text is attached as Appendix A.

      Questions regarding this Notice should be directed to:

      •    Ola Persson, Vice President, Transparency Services, at (212) 858-4796; or
      •    Racquel Russell, Associate General Counsel, Office of General Counsel, at (202) 728-8363.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by August 24, 2015.

      Member firms and other interested parties can submit their comments using the following methods:

      •    Emailing comments to pubcom@finra.org; or
      •    Mailing comments in hard copy to:

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      To help FINRA process and review comments more efficiently, persons should use only one method to comment on the proposal.1

      Before becoming effective, the proposed rule change must be filed with the Securities and Exchange Commission (SEC) pursuant to Section 19(b) of the Securities and Exchange Act.2

      Important Notes: The only comments that FINRA will consider are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.

      Background and Discussion

      FINRA Rule 7730 sets forth the TRACE data products offered by FINRA. FINRA's data offerings include both real-time as well as aged historical data for most TRACE-eligible securities.3 FINRA is soliciting comment on proposed changes to reduce the delay period applicable to the Historic TRACE Data Sets from 18 months to six months.

      Historic TRACE Data

      FINRA adopted the Historic TRACE Data rule and related fees in 2010.4 Historic TRACE Data provides transaction-level data for all transactions that have been reported to TRACE in those classes of TRACE-eligible securities that currently are disseminated. Historic TRACE Data includes, among other things, the price, date, time of execution, yield and uncapped volume for each transaction, provided the transaction is at least 18 months old.5 Initially, Historic TRACE Data was available only for corporate bonds and agency debt, but was expanded to include other classes of TRACE-eligible securities as they became subject to public dissemination.

      While Historic TRACE Data has been used by researchers and other non-dealers, firms rarely use it due to the 18-month minimum period that transactions must age prior to being included in the data sets. FINRA has received feedback from firms that 18 months is too long to make Historic TRACE Data useful, and that six months would greatly improve its utility. When FINRA initially adopted the Historic TRACE Data rule, an 18-month delay was put in place as a conservative measure intended to respond to concerns that the data might be used to identify current trading, positions or the strategies of market participants.6 However, FINRA believes that a shorter delay period can be sufficient to continue to address information leakage concerns, while improving the usefulness of the data.7 Thus, FINRA proposes to amend Rule 7730 to shorten the delay period from 18 months to six months. FINRA believes that a six-month delay will increase the utility of historic data to market participants, thereby promoting the goal of increased transparency for TRACE-eligible securities.8

      Economic Impact Analysis

      Need for the Rule

      As discussed above, FINRA has received feedback from firms that the current 18-month delay period may be too long to make Historic TRACE Data useful. Most subscribers to the Historic TRACE Data Sets have been vendors and research firms. There have been very few broker-dealer subscribers due to the length of the delay.

      Regulatory Objective

      The proposed shorter delay period for Historic TRACE Data aims to increase the utility of historical data to market participants, thereby promoting the goal of increased transparency for TRACE-eligible securities.

      Economic Impacts

      The proposal will not have any direct operational impact on firms, as it does not require firms to provide FINRA with any additional data. The purchase of TRACE data products will continue to be optional for firms and others. The proposal will require changes by FINRA to adjust the permissible delay for Historic TRACE Data product generation to six months.

      While the shortened delay period for Historic TRACE Data is likely to increase transparency for TRACE-eligible securities, FINRA is aware of the potential concern that the dissemination of more recent transaction information may interfere with certain trading strategies and liquidity provision. FINRA requests comment regarding this potential concern, and intends to investigate the issue more closely during the rulemaking process.

      Request for Comment

      FINRA requests comment on all aspects of the proposal. FINRA requests that commenters provide empirical data or other factual support for their comments wherever possible. FINRA specifically requests comment concerning the following issues.

      •    FINRA proposes to reduce the delay period for Historic TRACE Data from 18 months to six months. Historic TRACE Data does not include masked MPID information. In light of this fact, is a six-month delay sufficient to address concerns regarding the current trading, positions or strategies of particular market participants? Please provide information to support your analysis.
      •    Are there other possible harms associated with reducing the delay period from 18 months to six (in addition to potential information leakage regarding current trading, positions or strategies)?
      •    Would the six-month delay be more detrimental for certain types of TRACE-eligible securities compared to others. Should FINRA consider setting different delay periods for different types of TRACE-eligible securities?

      1 FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.

      2 See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Some proposed rule changes take effect immediately upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

      3 Historic TRACE Data is transaction-level data and includes the following data sets: the Historic Corporate Bond Data Set, the Historic Agency Data Set, the Historic Securitized Product Data Set, and the Historic Rule 144A Data Set. Historic TRACE Data originally included only the Corporate Bond and Agency Data Sets; the Securitized Product and Rule 144A Data Sets were added to Historic TRACE Data later as information about transactions in those securities became subject to dissemination. Additional securities may be included in Historic TRACE Data as they become subject to dissemination.

      4 See Securities Exchange Act Release No. 61012 (November 16, 2009), 74 FR 61189 (November 23, 2009) (Order Approving File No. SR-FINRA-2007-006). See also Regulatory Notice 10-14 (March 2010).

      5 Historic TRACE Data also may include transactions or items of information that were not disseminated previously. For example, Historic TRACE Data includes exact trade volumes, rather than the capped amounts that are disseminated in real-time. The applicable real-time dissemination cap differs depending upon the type of TRACE-eligible security being reported. The caps are $5 million for agency debentures and corporate bonds that are rated investment grade; $1 million for corporate bonds that are rated non-investment grade; $25 million for agency pass-through mortgage-backed securities traded TBA for good delivery; and $10 million for agency pass-through mortgage-backed securities traded TBA not for good delivery, agency pass-through mortgage-backed securities traded in specified pool transactions, and SBA-backed asset-backed securities traded TBA and in specified pool transactions.

      Historic TRACE Data also is available for trade reports dating back to 2002, even for transactions that were not subject to public dissemination at the time. Similarly, while real-time information for specified pool transactions is disseminated based on security characteristics, Historic TRACE Data identifies securities by CUSIP. Historic TRACE Data also includes reports on both the buy- and sell-side of inter-dealer transactions, whereas only sell-side trade reports are subject to real-time dissemination.

      6 See Securities Exchange Act Release No. 56327 (August 28, 2007), 72 FR 51689 (September 10, 2007) (Notice of Filing of File No. SR-FINRA-2007-006).

      7 FINRA notes that the Municipal Securities Rulemaking Board (MSRB) disseminates in real-time the exact par value on all transactions with a par value of $5 million or less, and includes an indicator ("MM+") in place of the exact par value on transactions where the par value is greater than $5 million until the fifth business day. MSRB disseminates the exact par value on all transactions on the fifth day after the trade.

      8 FINRA is not proposing any changes to the fields made available in the Historic TRACE Data Sets at this time, and notes that the data will continue to omit any identifying dealer information. Additional information regarding included fields is available in "Historic TRACE Data: Enhanced Historical Time and Sales—Trade Record File Layout" in the technical specifications.


      APPENDIX A

      Below is the text of the proposed rule change. Proposed new language is underlined; proposed deletions are in brackets.

      *   *   *   *   *

      7000. CLEARING, TRANSACTION AND ORDER DATA REQUIREMENTS, AND FACILITY CHARGES

      *   *   *   *   *

      7700. CHARGES FOR OTC REPORTING FACILITY, OTC BULLETIN BOARD AND TRADE REPORTING AND COMPLIANCE ENGINE SERVICES

      *   *   *   *   *

      7730. Trade Reporting and Compliance Engine (TRACE)

      The following charges shall be paid by participants for the use of the Trade Reporting and Compliance Engine ("TRACE"):

      (a) through (e) No Change.
      (f) Definitions
      (1) through (3) No Change.
      (4) "Historic TRACE Data" as used in Rule 7730 means historic transaction-level data with elements to be determined from time to time by FINRA in its discretion and as stated in a Regulatory Notice or other equivalent publication. Historic TRACE Data will be delayed a minimum of [18] six months and will not include MPIDs [information]. Historic TRACE Data includes the following Data Sets:
      (A) through (D) No Change.
      (g) No Change.
      *   *   *   *   *

    • 15-23 FINRA Provides Limited Relief Regarding Requirement to Promptly Transmit Funds in Connection With Sales of Securities on a Subscription-Way Basis for the Purpose of Completing Suitability Reviews Under Identified Conditions

      View PDF

      Subscription-Way Transactions

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 2111
      FINRA Rule 2150
      FINRA Rule 3110
      NASD Rule 2830
      SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topics

      Investment Company Securities
      Principal Review
      Sales Practices
      Suitability
      Supervision

      Executive Summary

      FINRA is providing limited relief regarding the requirement to promptly transmit customer funds received in connection with sales of securities on a subscription-way basis for the purpose of completing suitability reviews. Pursuant to the limited relief, a firm may hold a customer check payable to an issuer or an appropriate third-party payee acting on behalf of the issuer (e.g., a transfer agent or custodian) (hereinafter collectively referred to as "issuer") for up to seven business days from the date that an office of supervisory jurisdiction (OSJ) receives a complete and correct application package for the purchase of securities on a subscription-way basis provided that all conditions set forth herein are present.

      Questions regarding this Notice should be directed to:

      •    Joseph P. Savage, Vice President and Counsel, Regulatory Policy, at (240) 386-4534;
      •    James S. Wrona, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8270;
      •    Jeanette Wingler, Assistant General Counsel, OGC, at (202) 728-8013; and
      •    Susan DeMando Scott, Associate Vice President, Risk Oversight and Operational Regulation, at (240) 386-4620.

      Background and Discussion

      SEC No-Action Letter

      Recently, the staff of the Securities and Exchange Commission's (SEC) Division of Trading and Markets (SEC staff) issued a no-action letter1 providing relief from the requirement to promptly transmit customer funds received in connection with sales of securities on a subscription-way basis.2 If the no-action letter's conditions are met, a firm is permitted to hold a customer check payable to an issuer for up to seven business days from the date that the firm's OSJ receives a complete and correct application package in order for a principal to complete a suitability review of each sale of a recommended subscription-way security.

      Prior to the issuance of the no-action letter, a firm was required to send a check a registered representative received in connection with the sale of securities on a subscription-way basis to the issuer of such securities by noon local time on the business day following receipt regardless of the location at which the check was received.3 In providing no-action relief, SEC staff considered that a firm's obligation to supervise customer subscriptionway transactions under FINRA Rules 2111 and 3110 to ensure, among other things, that the recommended transactions were suitable may conflict with the firm's obligation to promptly transmit funds to issuers under SEA Rule 15c3-3.4

      FINRA Relief

      To alleviate any potential conflict between the relief provided by SEC staff in the no-action letter and FINRA rules, FINRA is providing limited relief, as described below, to firms from the requirements of FINRA Rule 2150(a) and NASD Rule 2830(m) regarding the obligation to promptly transmit customer funds to an issuer in connection with sales of securities on a subscription-way basis.5 FINRA Rule 2150(a) generally prohibits firms from making improper use of customer funds. NASD Rule 2830(m) requires firms that engage in direct retail transactions for investment company shares to transmit payments received from customers for such shares to the appropriate third-party payee (e.g., the investment company or its agent) by: (i) the end of the third business day following a receipt of a customer's order to purchase such shares; or (ii) the end of one business day following receipt of a customer's payment for such shares, whichever is the later date.

      Without violating either FINRA Rule 2150(a) or NASD Rule 2830(m), a firm may hold a customer check payable to an issuer for up to seven business days from the date that an OSJ receives a complete and correct application package for the sale of securities on a subscription-way basis provided that all seven conditions delineated below are present.6

      1. The reason that the firm is holding the application for the securities and a customer's non-negotiated check payable to a third party is to allow completion of principal review of the transaction pursuant to FINRA Rules 2111 and 3110.
      2. The associated person who recommended the purchase of the securities makes reasonable efforts to safeguard the check and, after receiving information necessary to prepare a complete and correct application package, promptly prepares and forwards the complete and correct copy of the application package to an OSJ.
      3. The firm has policies and procedures in place that are reasonably designed to ensure compliance with condition number 2 above.
      4. A principal reviews and makes a determination of whether to approve or reject the purchase of the securities in accordance with the provisions of FINRA Rules 2111 and 3110.
      5. The firm holds the application and check no longer than seven business days from the date an OSJ receives a complete and correct copy of the application package.
      6. The firm maintains a copy of each such check and creates a record of the date the check was received from the customer and the date the check was transmitted to the issuer or returned to the customer.
      7. The firm creates a record of the date when the OSJ receives a complete and correct copy of the application package.
      8. If any of these seven conditions are not present, FINRA's limited relief will not apply and it will enforce FINRA Rule 2150(a) and NASD Rule 2830(m), as appropriate.

      1 See letter from Mark M. Attar, Senior Special Counsel, Division of Trading and Markets, SEC, to Christopher M. Salter, Allen & Overy LLP, counsel to NYLIFE Securities LLC (March 12, 2015) (no-action letter). The conditions for relief set forth in the no-action letter are comparable to the conditions set forth in the SEC's exemptive relief for sales of deferred variable annuities. See Securities Exchange Act of 1934 (SEA) Release No. 56376, 72 FR 52400 (Sept. 13, 2007). See also SEA Release No. 59772 (April 15, 2009), 74 FR 18419, at 18422 n.37 (April 22, 2009) (Order Approving File No. SR-FINRA-2008-019) (stating in SEC order approving rule amendments that the exemptive order continues to apply, notwithstanding the new starting point for the principal review period under FINRA Rule 2330).

      2 As described in the no-action letter, sales of securities on a subscription-way basis commonly involve a registered representative meeting with a current or potential customer, discussing a security or securities, which may or may not be recommended by the registered representative, assisting the customer in completing an application for the purchase of securities, and obtaining a check payable to the issuer or an appropriate third-party payee acting on behalf of the issuer (e.g., a transfer agent or custodian) from the customer. As noted above, for purposes of brevity in this limited relief, both the issuer of the relevant securities and any third-party payee acting on behalf of the issuer are referred to herein as the "issuer." Following these interactions, the registered representative typically forwards the application package to an OSJ where it is reviewed by a supervisor before being sent to the issuer.

      3 The SEC has interpreted the term "promptly transmit" for purposes of SEA Rules 15c3-1 and 15c3-3 to mean that "such transmission or delivery is made no later than noon of the next business day after receipt of such funds or securities." See SEA Release No. 31511 (Nov. 24, 1992), 57 FR 56973 at n.11 (Dec. 2, 1992), and 17 CFR 240.15c3-1(c)(9). Further, the SEC staff has stated that a firm "receives" customer funds when a registered representative receives a check from a customer. See Interpretation of Financial Responsibility Rules, Rule 15c3-3 (Exhibit A-Item 1)/18.

      4 The SEC has previously noted that "many broker-dealers are subject to lower net capital requirements under SEA Rule 15c3-1 and are exempt from the requirement to establish and fund a customer reserve account under SEA Rule 15c3-3 because they do not carry customer funds or securities." See SEA Release No. 56376 (Sept. 7, 2007), 72 FR 52400 (Sept. 13, 2007) (Order Granting Exemption to Broker-Dealers from Requirements in SEA Rules 15c3-1 and 15c3-3 to Promptly Transmit Customer Checks). Although some of these firms receive checks from customers made payable to third parties, the SEC also has stated that "a broker-dealer is not deemed to be carrying customer funds if it 'promptly transmits' the checks to the third parties." Id.

      5 FINRA emphasizes that firms are not required to collect and hold checks or funds prior to principal review and approval. A firm may elect to wait until after a principal approves the transaction to collect the check or funds for the purchase of a security. FINRA also notes the no-action letter's observation regarding the requirements of Rule 22c-1(a) under the Investment Company Act of 1940 for broker-dealers subject to the rule. Rule 22c1(a) prohibits any registered investment company (RIC) issuing any redeemable security, any person designated in the RIC's prospectus as authorized to consummate transactions in the security, and any principal underwriter of or dealer in the security from selling and redeeming the security except at a price based on the security's current net asset value next computed after receipt of an order to purchase or redeem. The no-action letter comments that "[a] broker-dealer subject to the requirements of Rule 22c-1(a) that relies on the time periods set forth in this letter to transmit an order to purchase redeemable shares issued by a RIC would have to ensure that the price of the shares is based on the net asset value next computed after receipt of the order (i.e., the completed and correct application and check) in accordance with the rule." No-action letter at n.13.

      6 To promote operational efficiency, FINRA notes that the conditions required for the relief for sales of securities on a subscription-way basis are consistent with the conditions required for the relief FINRA has previously provided for transmissions of payments for deferred variable annuities. Regulatory Notice 10-05 (Jan. 2010).

    • 15-22 FINRA Requests Comment on a Revised Proposal to Adopt a Consolidated FINRA Rule Regarding Discretionary Accounts and Transactions; Comment Period Expires: August 17, 2015

      View PDF

      Discretionary Accounts and Transactions

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      Request for Comment
      Referenced Rules & Notices

      FINRA Rules 2090, 3160 and 4512
      NASD Rules 1011, 1017 and 2510
      NTMs 83-70 and 02-57
      NYSE Info Memo 05-11
      NYSE Rule 408 and Rule Interpretation 408
      Proposed FINRA Rule 3260
      SEA Rules 15c3-3, 17a-3 and 17a-4
      SEC Regulation S-P
      Suggested Routing

      Compliance
      Legal
      Operations
      Risk
      Senior Management
      Key Topics

      Account Approval and Review
      Bulk Transfer of Customer Accounts
      Change of Broker-Dealer of Record
      Customer Authorization
      Discretionary Accounts and Transactions
      Free Credit Balances
      Negative Response Letters
      Sweep Programs
      Unauthorized and Excessive Trading

      Executive Summary

      FINRA is requesting comment on a revised proposal to adopt the NASD and Incorporated NYSE rules regarding discretionary accounts and transactions as FINRA Rule 3260 (Discretionary Accounts and Transactions by Persons Other Than the Customer) in the consolidated FINRA rulebook.1 In addition, the revised proposal addresses the treatment of customers' free credit balances, sweep programs, bulk transfers of customers' accounts and change of broker-dealer of record. The revised proposal also reflects the comments received on the initial proposal.

      The proposed rule text is attached as Appendix A.

      Questions regarding this Notice should be directed to Afshin Atabaki, Associate General Counsel, Office of General Counsel, at (202) 728-8071.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by August 17, 2015.

      Comments must be submitted through one of the following methods:

      •    Emailing comments to pubcom@finra.org; or
      •    Mailing comments in hard copy to:

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      To help FINRA process comments more efficiently, persons should use only one method to comment on the proposal.

      Important Notes: All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.2

      Before becoming effective, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board of Governors, and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA or Exchange Act).3

      Background and Discussion

      NASD Rule 2510 (Discretionary Accounts), Incorporated NYSE Rule 408 (Discretionary Power in Customers' Accounts)4 and NYSE Rule Interpretation 408 (Discretionary Power in Customers' Accounts) currently set forth the obligations of a firm and its associated persons regarding the exercise of any discretionary power over a customer's account, including the obligation of the firm to detect and prevent unauthorized and excessive trading in such an account. NYSE Rule 408 also addresses the obligations of a firm when accepting an order for a customer's account from someone other than the customer. In Regulatory Notice 09-63 (Discretionary Accounts and Transactions) (November 2009), FINRA proposed to revise and consolidate these NASD and NYSE rules as FINRA Rule 3260 in the consolidated FINRA rulebook. FINRA received eight comment letters in response to the Notice. Several commenters requested that FINRA clarify the proposal, including its scope. In addition, since the publication of the initial proposal, the SEC amended Rule 15c3-3 (Customer Protection—Reserves and Custody of Securities) under the Exchange Act in ways that impact FINRA rules relating to sweep programs and the use of negative response letters for a bulk transfer of customers' accounts.5 In response to comments on the initial proposal and the SEC rule amendments, FINRA is seeking comment on a revised proposal to create a consolidated FINRA rule regarding discretionary accounts and transactions.

      Proposal

      A. Discretionary Transactions by Member Firms and Their Associated Persons (Proposed FINRA Rule 3260(a))

      NASD Rules 2510(a) (Excessive Transactions), (b) (Authorization and Acceptance of Account) and (c) (Approval and Review of Transactions) address the obligations of firms and their associated persons that have discretionary power over a customer's account and prohibit unauthorized and excessive trading in such accounts.

      NASD Rule 2510(a) prohibits a firm from effecting for a customer's account over which the firm, or an agent or employee of the firm, has any discretionary power any transactions that are excessive in size or frequency in view of the financial resources and character of the account. NASD Rule 2510(b) prohibits firms and their registered representatives from exercising any discretionary power in a customer's account unless the customer has given prior written authorization to a stated individual or individuals, and the account has been accepted by the firm as evidenced in writing by the firm or a designated partner, officer or manager of the firm. NASD Rule 2510(c) requires that the firm or designated partner, officer or manager approve promptly in writing each discretionary order entered and review all discretionary accounts at frequent intervals to detect and prevent transactions that are excessive in size or frequency in view of the financial resources and character of the account. NYSE Rules 408(a), (b) and (c) include corresponding requirements.

      The initial proposal grouped together and reorganized under proposed FINRA Rule 3260(a) the requirements currently under NASD Rules 2510(a), (b) and (c). The initial proposal required that firms and their associated persons obtain the customer's "dated" prior written authorization to identify the date that discretionary authority was granted.6 Further, the initial proposal required that a customer's written authorization be provided to a named natural person or persons, instead of a stated individual or individuals as currently required. The initial proposal also required that the account be accepted in writing by a designated partner, officer or manager of a firm denoting that the account has been accepted in accordance with the firm's policies and procedures for acceptance of discretionary accounts. In addition, the initial proposal clarified that the requirements apply to all associated persons of a firm, not just agents, employees and registered representatives. Moreover, consistent with NYSE Rule 408(b), the initial proposal clarified that the designated partner, officer or manager responsible for denoting acceptance of discretionary accounts, approving discretionary orders and reviewing such accounts has to be someone other than the associated person vested with discretionary power.

      The revised proposal maintains the requirements of the initial proposal subject to a few clarifications and changes. The revised proposal clarifies that the customer must sign the written authorization.7 Further, the revised proposal clarifies that a customer's written authorization be provided to a named associated person or associated persons, rather than a named natural person or persons as required under the initial proposal, and that the account documentation be "signed" by a partner, officer or manager8 designated by the firm.9 The revised proposal also requires that the associated person and the firm exercise discretionary power in such account only in the manner, and under the terms and conditions, specified in the customer's prior written authorization.10

      For purposes of proposed FINRA Rule 3260(a), firms may approve discretionary trades post trade and in bulk, provided that the designated partner, officer or manager approves the trades promptly.

      The signature and approval requirements of proposed FINRA Rule 3260(a) may be satisfied through the use of "electronic" means. FINRA will consider a valid electronic signature to be any electronic mark that clearly identifies the signatory and is otherwise in compliance with the Electronic Signatures in Global and National Commerce Act (E-Sign Act), the guidance issued by the SEC relating to the E-Sign Act,11 and the guidance provided by FINRA through its interpretive letters,12 which address electronic approval processes generally.

      The requirements of proposed FINRA Rule 3260(a) apply to an associated person of a firm who is engaged in investment adviser discretionary activities in a customer's account at the firm13 or who is granted non-broker-dealer and non-investment adviser discretionary authority by a customer of the firm, such as a family member who has given a power of attorney to the associated person. FINRA believes that such discretionary activities involve the placing of brokerage orders by an associated person of a firm for a customer's account at the firm, and such activities should be subject to a higher standard of review and approval.14 FINRA also understands that some firms already conduct the review and approval required under the proposed rule based on existing practices and requirements. However, the revised proposal would exclude fee-based only accounts, including accounts that are charged only a flat fee or a fee based on assets under management, from the requirements of proposed FINRA Rule 3260(a). FINRA does not believe that the concerns relating to excessive trading apply to fee-based only accounts, and thus approval of individual trades and excessive trading restrictions are unnecessary. FINRA notes that fee-based accounts would only be excluded from the scope of proposed FINRA Rule 3260(a). Fee-based accounts would remain subject to other applicable FINRA rules, including, as discussed below, proposed FINRA Rule 3260(b) (Transactions by Agents of Customers).

      Proposed FINRA Rule 3260(a) incorporates some of the requirements that are currently in NASD and NYSE rules, and it harmonizes the requirements with substantially similar requirements currently in other rules. Thus, the proposed rule should create minimal additional obligations upon firms. Further, the benefits of the proposed requirements include the protection of customers from the misuse of discretionary power by firms and associated persons. As discussed in greater detail below, proposed FINRA Rules 3260(c)(1) (A) through (F) also provide several exceptions to the requirements of proposed FINRA Rule 3260(a) based on existing NASD, NYSE and SEC requirements.
      B. Transactions by Agents of Customers (Proposed FINRA Rule 3260(b))

      NYSE Rule 408(a) states, in part, that no firm or employee may accept an order for a customer's account from a person other than the customer without first obtaining: (1) the customer's written authorization; (2) the signature of the person(s) authorized to exercise discretion in the account; and (3) the date such discretionary authority was granted.

      The initial proposal transferred into proposed FINRA Rule 3260(b) the requirements of NYSE Rule 408(a) regarding accepting orders for a customer's account from someone other than the customer, with the exception of the requirement that the firm obtain the authorized person's signature. The initial proposal required that, before accepting an order for a customer's account from any person other than the customer, firms and associated persons obtain the customer's dated prior written authorization granting discretionary power to such person.

      The revised proposal maintains the requirements of the initial proposal subject to the following changes. The revised proposal clarifies that the customer must sign the written authorization,15 and it requires that an order placed by a person other than the customer be within the scope of that person's authority as specified in the customer's authorization.16 A customer may provide an electronic signature for purposes of this requirement.

      Further, the revised proposal applies to any person who is authorized to place orders in the customer's account, not just a person who has discretionary power over a customer's account. The revised proposal also applies to the fee-based accounts exempted from proposed FINRA Rule 3260(a). Therefore, under the revised proposal, the requirements of proposed FINRA Rule 3260(b) would apply to: (1) an investment adviser, other than an associated person, engaged in investment adviser discretionary activities in a customer's account at the firm; (2) any person, other than an associated person, granted non-investment adviser discretionary authority by a customer of the firm, such as a family member; (3) any person, including an associated person, engaged in non-discretionary trading in a customer's account;17 or (4) transactions by firms or associated persons in fee-based accounts exempted from proposed FINRA Rule 3260(a).

      In addition, the revised proposal requires that where a customer gives written authorization to a natural person, firms and associated persons obtain the prior dated manual signature of the named natural person,18 and where a customer gives written authorization to an entity, firms and associated persons obtain the prior dated manual signature of a natural person authorized to act on behalf of the entity. For purposes of compliance with this requirement, firms must obtain a wet signature or a copy of a wet signature, such as a scanned or faxed copy of a wet signature.

      The requirements of proposed FINRA Rule 3260(b) do not extend to a customer that is itself a legal entity and that has authorized its personnel to trade on behalf of the entity. Rather, the obligation of firms with respect to such customers is set forth in FINRA Rule 4512(a)(1)(E), which requires firms to maintain a record with the names of such authorized persons. Also, proposed FINRA Rule 3260(b) is not intended to apply to online brokerage activities where a customer has provided account access to another person and the firm or associated person does not know or have reason to know that a particular order is being placed by someone other than the customer. Rather, such activities are subject to other requirements governing the protection of customer information and records, and the prevention of identity theft.19

      Moreover, proposed FINRA Rule 3260(b) only applies to those circumstances where the order is from a person other than the customer (i.e., the accountholder), and it does not require a firm or an associated person to look through an intermediary (e.g., an investment adviser) to the underlying beneficial owners where the intermediary, and not the underlying beneficial owners, is identified as the firm's customer. For instance, where an investment adviser opens a master account, and associated subaccounts, at a firm for trade execution purposes only and transactions are settled on a delivery-versus-payment (DVP) basis to its clients' individual accounts at the client's custodian financial institution, the investment adviser (rather than the investment adviser's clients) ordinarily would be considered the firm's customer.

      Where current NASD and NYSE rules differ, proposed FINRA Rule 3260(b) incorporates the more stringent requirements of NYSE Rule 408(a) relating to accepting orders from someone other than the customer, which provides a heightened standard of investor protection as described above. Thus, the proposed rule may impose some additional obligations on firms not subject to NYSE rules, but the additional obligations may be limited as FINRA understands that most firms currently do not accept an order from someone other than the customer without some form of authorization from the customer, such as a trading authorization.
      C. Temporary Time or Price Discretion (Proposed FINRA Rule 3260(c)(1)(A))

      NASD Rule 2510(d)(1) provides an exception to the requirements of NASD Rules 2510(a), (b) and (c) for the exercise of discretion by a firm or an associated person as to the price at which or the time to execute an order given by a customer for the purchase or sale of a definite amount of a specified security. Currently, the authority to exercise such discretion will be in effect only until the end of the business day on which the customer granted such discretion, unless the customer provides a specific written contrary indication signed and dated. The rule also provides an exception for the exercise of time or price discretion for an institutional account based on a valid good-'til-canceled instruction issued on a "not-held" basis, without any time limits. NASD Rule 2510(d)(1) requires that any exercise of time or price discretion be reflected on the order ticket. NYSE Rule 408(d) includes corresponding exceptions.20

      The initial proposal transferred the existing exceptions in NASD Rule 2510(d)(1) into proposed FINRA Rule 3260(c)(1)(A). Specifically, the initial proposal provided an exception to the requirements of proposed FINRA Rule 3260(a) for a customer's limited authorization for time or price discretion for the purchase or sale of a definite dollar amount or quantity of a specified security.21 In response to inquiries from firms regarding the duration and scope of such authorization, the initial proposal clarified that a firm may exercise: (1) time or price discretion given by a customer during a normal trading session, provided that such discretion is only valid during that session; or (2) time or price discretion given by a customer after the close of a normal trading session, provided that such discretion is only valid during the next normal trading session. For institutional accounts, the initial proposal also provided an exception to the requirements of proposed FINRA Rule 3260(a) for a firm that exercises time or price discretion for such accounts pursuant to valid good-'til-canceled instructions issued on a "not-held" basis, without time limits.22 The revised proposal retains the exceptions set forth in the initial proposal without any changes.

      For purposes of proposed FINRA Rule 3260(c)(1)(A)(i), a normal trading session is between 9:30 a.m. and 4:00 p.m., Eastern Standard Time, Monday through Friday, with the exception of market holidays. Further, firms and associated persons may continue to exercise time or price discretion that lasts longer than a normal trading session so long as such exercise of discretion is consistent with the requirements of proposed FINRA Rule 3260(a). In addition, FINRA does not believe that the exception in proposed FINRA Rule 3260(c)(1)(A)(ii) for not-held good-'til-canceled orders for institutional accounts, which is of unlimited duration, should be extended to retail accounts. FINRA believes that retail customer orders that are to last beyond a normal trading session as specified in proposed FINRA Rule 3260(c)(1)(A)(i) require the protections set forth in proposed FINRA Rule 3260(a).

      FINRA understands that the terms of these exceptions, including the clarification regarding the duration of the limited authorization for time or price discretion, are consistent with current industry practices, and, thus, should not create any new significant burdens for firms.
      D. Mergers and Acquisitions of Money Market Mutual Funds (Proposed FINRA Rule 3260(c)(1)(B))

      NASD Rule 2510(d)(2) provides an exception to the requirements of NASD Rules 2510(a), (b) and (c) for bulk exchanges at net asset value of money market mutual funds using negative response letters in situations involving mergers or acquisitions of the mutual funds, changes of clearing firms and exchanges of money market mutual funds used in sweep accounts. Such negative response letters must include a tabular comparison of the nature and amount of the fees charged by each money market mutual fund, a comparative description of the investment objectives of each money market mutual fund and a prospectus of the money market mutual fund to be purchased. Further, the bulk exchange can be no sooner than 30 days after the date on which the negative response letter was mailed to the customer.

      The initial proposal would have transferred into proposed FINRA Rule 3260(c)(1)(B) the current exceptions in NASD Rule 2510(d)(2). However, as noted earlier, following the publication of the initial proposal, the SEC amended SEA Rule 15c3-3 relating to the treatment of free credit balances outside and in sweep programs and published guidance regarding the application of the amendments to bulk transfers under FINRA rules, including bulk transfers resulting from a change in clearing firms. As a result, bulk exchanges of money market mutual funds using negative response letters in situations involving changes of clearing firms or changes in sweep accounts are now subject to different conditions and addressed separately under the proposed rule.23

      The revised proposal continues to provide an exception to the requirements of proposed FINRA Rule 3260(a) for firms using negative response letters to effect a bulk exchange at net asset value of money market mutual funds in situations involving a merger or acquisition of the mutual funds. The revised proposal clarifies that the bulk exchange can be no sooner than 30 calendar days after the date on which the negative response letter was sent to the customer. The revised proposal also requires that where such bulk exchange involves money market mutual funds in a sweep program, the negative response letter used to effect the bulk exchange must describe the new terms and conditions of the new product, and the options available to the customer if the customer does not accept the new terms and conditions or the new product consistent with SEA Rule 15c3-3(j)(2)(ii) (B)(3)(ii).24

      FINRA does not believe that the proposed rule would create any additional burden on firms because firms are currently subject to these requirements.
      E. Bulk Transfer of Customer Accounts and Change of Broker-Dealer of Record (Proposed FINRA Rule 3260(c)(1)(C))

      Notice to Members (NTM) 02-57 (Bulk Transfer of Customer Accounts) (September 2002) identified specific situations in which the use of negative response letters by firms could be appropriate for the bulk transfer of customers' accounts. FINRA also has provided interpretive guidance on other situations where it could be appropriate for firms to use negative response letters to effect a bulk transfer25 or change the broker-dealer of record.26 Further, FINRA has encountered additional situations, which do not fall under NTM 02-57 or the existing interpretive guidance, where the use of negative response letters could be appropriate to effect a bulk transfer.27 A bulk transfer of customers' accounts may involve a transfer of free credit balances in the securities accounts of customers at one firm to another firm, including the transfer of free credit balances that result from the liquidation of products in a sweep program. Accordingly, bulk transfers of customers' accounts must also comply with SEC requirements relating to the treatment of free credit balances.

      Because the bulk transfer of customers' accounts using negative response letters involves a discretionary transaction to facilitate the transfer, FINRA is proposing to address bulk transfers under proposed FINRA Rule 3260. As such, the revised proposal codifies for the first time under proposed FINRA Rule 3260(c)(1)(C) FINRA's guidance regarding the use of negative response letters to effect a bulk transfer of customers' accounts. The proposed rule also expands FINRA's existing guidance relating to bulk transfers and incorporates published SEC guidance regarding the applicability of SEA Rule 15c3-3 to bulk transfers.28

      Specifically, proposed FINRA Rule 3260(c)(1)(C) provides an exception to the requirements of proposed FINRA Rule 3260(a) for the use of negative response letters to effect bulk transfers of customers' accounts in the following seven situations:
      •    an introducing firm that has entered into a clearing arrangement with a different clearing firm is seeking to transfer its customer accounts to the new clearing firm (based on NTM 02-57);
      •    an introducing firm or a clearing firm that is experiencing financial or operational difficulties is seeking to transfer all of its customer accounts, including in the case of a clearing firm all of the accounts carried by such clearing firm, to another introducing firm(s) or clearing firm(s) (based on NTM 02-57);29
      •    an introducing firm or a clearing firm that is going out of business, other than for financial or operational difficulties, is seeking to transfer all of its customer accounts to another introducing firm(s) or clearing firm(s);
      •    an introducing firm or a clearing firm that is divesting itself of a specific business line or area, such as its retail brokerage business or some of its branch offices, is seeking to transfer the affected customer accounts to another introducing firm or clearing firm;
      •    a clearing firm, for an introducing firm that has gone out of business, is seeking to transfer all of the introducing firm's customer accounts to another introducing firm at the same clearing firm (based on NTM 02-57);
      •    a firm that is acquired by or merged with another firm is seeking to transfer all of its customer accounts to the new firm (based on NTM 02-57); and
      •    upon the conclusion or termination of a networking arrangement between a firm and a financial institution pursuant to FINRA Rule 3160 (Networking Arrangements Between Members and Financial Institutions), the firm is seeking to transfer all customer accounts established under the arrangement to a new firm with which the financial institution has formed a networking arrangement pursuant to FINRA Rule 3160 (based on NTM 02-57).

      FINRA believes that the use of negative response letters to facilitate the bulk transfer of customer accounts in the specified situations is appropriate, given the potential risks to investors and costs to firms that could result if firms were required to solicit individual transfer instructions from each customer as required under proposed FINRA Rule 3260(a). The bulk transfer of accounts through the use of negative response letters in these situations also helps minimize interruptions to customers' access to their accounts and the trading markets.

      The situations specified above address bulk transfer of customer accounts and do not apply to directly held mutual fund and variable insurance product accounts. However, FINRA is also codifying under proposed FINRA Rule 3260(c)(1)(C) its existing guidance regarding the use of negative response letters to change the broker-dealer of record on such directly held accounts.

      FINRA notes that while it may be appropriate for firms to use negative response letters to transfer customer accounts or change the broker-dealer of record in the situations identified above, registered individuals may not under any circumstance use negative response letters to transfer customer accounts or change the broker-dealer of record.

      The revised proposal requires that the firm send the negative response letters to the customers, absent exigent circumstances, at least 30 calendar days before the firm effects the transfer. The negative response letter must contain: (1) a brief description of the circumstances necessitating the transfer; (2) a statement that the customer has the right to object to the transfer and the date by which the customer must respond if objecting to the transfer (such date can be no sooner than 30 calendar days after the date on which the negative response letter was sent to the customer); (3) information on how the customer can effectuate a transfer to another firm; (4) disclosure of any costs to the customer if the customer initiates a transfer of the account after the account is moved pursuant to the negative response letter; and (5) a statement regarding the firm's compliance with SEC Regulation S-P in connection with the transfer. The requirements above are consistent with the current conditions in NTM 02-57. FINRA is proposing similar timing and disclosure requirements for negative response letters to change the broker-dealer of record.

      The revised proposal imposes additional conditions on the bulk transfer of customer accounts using negative response letters.30 For instance, notwithstanding the situation resulting in a bulk transfer of accounts, the firms involved in the transfer, if required to do so based on the requirements set forth in NASD Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations),31 must file an application with FINRA with respect to the proposed transfer, and such application must be approved prior to sending the negative response letters to the customers. Further, no personal confidential customer information (e.g., Social Security numbers) may be provided to the receiving firm unless the sharing of such information is in compliance with SEC Regulation S-P. In addition, a firm that effects the transfer of a customer's account via a negative response letter may not charge a fee to that customer, and a firm may not charge a fee to a customer who in response to a negative response letter decides to move his or her account to another firm during the opt-out period provided in the letter.

      The revised proposal codifies and expands FINRA's guidance regarding the use of negative response letters to effect a bulk transfer of customers' accounts or change the broker-dealer of record in specific situations that could result in potential risks to investors and costs to firms if those firms were required to solicit individual instructions from each customer. However, the proposed rule also imposes conditions with respect to a bulk transfer of customers' accounts or change in broker-dealer of record to protect the interests of customers. FINRA believes that the proposed rule will reduce the burden on firms while providing customers with time and information to decide whether to object to the transfer of their accounts or change in broker-dealer of record.
      F. Treatment of Free Credit Balances

      All transactions involving free credit balances32 are subject to SEC requirements. Paragraph (j) (Treatment of Free Credit Balances) of SEA Rule 15c3-3 sets forth specific requirements regarding the treatment of free credit balances carried for the account of a customer. As such, as described in greater detail below, the revised proposal incorporates the SEC requirements as exceptions to the requirements of proposed FINRA Rule 3260(a).
      1. Treatment of Free Credit Balances Outside of a Sweep Program (Proposed FINRA Rule 3260(c)(1)(D))

      The revised proposal incorporates under proposed FINRA Rule 3260(c)(1)(D) the requirements of SEA Rule 15c3-3(j)(2)(i) with respect to transactions outside of a sweep program involving customers' free credit balances as an exception to the requirements of proposed FINRA Rule 3260(a). Consistent with SEA Rule 15c3-3(j)(2)(i), proposed FINRA Rule 3260(c)(1)(D) provides that a firm may invest, or transfer to another account or institution, free credit balances in a customer's account outside of a sweep program only upon a specific order, authorization or draft from the customer, and only in the manner, and under the terms and conditions, specified in the order, authorization or draft. Further, consistent with the SEC's published guidance,33 proposed FINRA Rule 3260(c)(1)(D) states that a firm is not subject to the requirements above if the firm effects a bulk exchange of money market mutual funds using negative response letters consistent with proposed FINRA Rule 3260(c) (1)(B) or effects a bulk transfer of customers' accounts using negative response letters consistent with proposed FINRA Rule 3260(c)(1)(C).

      FINRA does not believe that the proposed rule would create any additional burden on firms because firms are currently subject to these requirements.
      2. Treatment of Free Credit Balances in a Sweep Program (Proposed FINRA Rule 3260(c)(1)(E))

      The revised proposal incorporates under proposed FINRA Rule 3260(c)(1)(E) the requirements of SEA Rule 15c3-3(j)(2)(ii) relating to the treatment of free credit balances in a sweep program as an exception to the requirements of proposed FINRA Rule 3260(a). The revised proposal also incorporates NASD and NYSE requirements relating to sweep programs.

      The revised proposal permits a firm to transfer free credit balances held in a customer's securities account to a product in the firm's sweep program or transfer a customer's interest in one product in a sweep program to another product in a sweep program, subject to the following conditions:
      •    the firm sends the customer a negative response letter consistent with the requirements of SEA Rule 15c3-3(j)(2)(ii)(B)(3);
      •    if the firm is transferring a customer's interest in one money market mutual fund in the member firm's sweep program to another money market mutual fund in the sweep program, the negative response letter must also include a tabular comparison of the nature and amount of the fees charged by each money market mutual fund, a comparative description of the investment objectives of each money market mutual fund and a prospectus of the money market mutual fund to be purchased;34
      •    the firm provides notice to the customer, as part of the customer's quarterly account statement, that the balance in the bank deposit account or shares of the money market mutual fund in which the customer has a beneficial interest can be liquidated on the customer's order and the proceeds returned to the securities account or remitted to the customer consistent with SEA Rule 15c3-3(j)(2)(ii)(B)(2);
      •    the firm includes additional disclosures in an attachment to the negative response letter addressing any conflicts of interest relating to the sweep program, current interest rates applicable to the sweep program, the manner by which future interest rates will be determined, the nature and extent of SIPC or FDIC insurance available; and the entity that the customer should contact should the customer wish to gain access to his or her funds;35
      •    the firm posts on its website applicable bank and money market mutual fund updated interest rates and information regarding any conflicts of interest relating to its sweep program;36 and
      •    the firm complies with specified recordkeeping and customer account statement requirements.37

      The conditions above apply to existing customer accounts and accounts opened on or after the effective date of the revised proposal.

      Consistent with SEA Rule 15c3-3(j)(2)(ii)(A), for accounts opened on or after the effective date of the revised proposal, proposed FINRA Rule 3260(c)(1)(E) also requires that the firm obtain the customer's prior written affirmative consent38 to having free credit balances in the customer's securities account included in the firm's sweep program after the customer has been notified of the general terms and conditions of the products available through the sweep program and notified that the firm may change the products available under the sweep program.39

      In addition, consistent with the SEC's published guidance,40 the revised proposal provides that a firm is not subject to the requirements above if the firm effects a bulk exchange of money market mutual funds using negative response letters consistent with proposed FINRA Rule 3260(c)(1)(B), provided that the negative response letter used to effect the bulk exchange also complies with the disclosure requirements of SEA Rule 15c3-3(j)(2)(ii)(B)(3)(ii).

      FINRA does not believe that incorporating the requirements of SEA Rule 15c3-3 and NASD Rule 2510(d)(2) relating to sweep programs would create any additional burden on firms because firms are currently subject to these requirements. The disclosure and notice requirements in NYSE Information Memorandum 05-11 provide the benefits of a heightened standard of investor protection and will be new requirements for firms that are not NYSE member firms.
      G. Money Market Mutual Fund Redemption Programs and Transactions to Satisfy Indebtedness (Proposed FINRA Rule 3260(c)(1)(F))

      NYSE Rule Interpretation 408/01 (Automatic Money Market Fund Redemptions) addresses the obligation of firms that offer their customers automatic money market fund redemption programs whereby debit balances created by the purchase of securities in a customer's account are automatically satisfied by the redemption of shares of a money market fund in the account.41 Such programs are subject to specific conditions, including the requirement to notify customers in writing regarding the programs. In addition, FINRA believes that firms and their customers should be provided the flexibility to enter into written agreements that allow transactions by firms to satisfy an indebtedness to them (such as to meet a margin call).

      Therefore, the initial proposal included an exception to the requirements of proposed FINRA Rule 3260(a) for automatic money market mutual fund redemptions based on the requirements of NYSE Rule Interpretation 408/01, and an exception to address situations where a firm effects a transaction to satisfy an indebtedness to the firm.

      Specifically, the initial proposal provided an exception to the requirements of proposed FINRA Rule 3260(a) for a firm that: (1) redeems money market mutual funds for the payment of securities purchases; or (2) effects transactions to satisfy an indebtedness to the firm (such as to meet a margin call), provided that such redemptions or transactions are permitted by a prior signed, written agreement between the firm and customer that prominently discloses the terms and conditions of such arrangements. The initial proposal also noted that any provisions in such agreement allowing the use of negative response letters remain subject to applicable FINRA rules and federal securities laws governing the use of such letters. The revised proposal maintains these exceptions under proposed FINRA Rule 3260(c)(1)(F), but it removes the reference to the use of negative response letters because it is superfluous.

      FINRA believes that firms and their customers should be provided the flexibility to enter into such written agreements and that the proposed rule is anticipated to reduce the burden on firms.
      H. Additional Supplementary Material

      As originally proposed, FINRA Rule 3260.01 (Compliance With Federal Securities Laws Governing Discretionary Accounts and Transactions) stated that the requirements of proposed FINRA Rules 3260(a) and (c) applied only to the extent firms could maintain broker-dealer discretionary accounts or otherwise exercise broker-dealer discretion in an account as permitted under the federal securities laws. FINRA included this language to address the ability of broker-dealers to maintain discretionary accounts or otherwise exercise broker-dealer discretion in light of a pending SEC rulemaking proposal.42 The revised proposal continues to require firms to comply with applicable federal securities laws in this regard, but it modifies the language to state that firms may maintain discretionary accounts or otherwise exercise discretion in an account only as permitted under the federal securities laws.

      The revised proposal also would add the following supplementary material:
      •    Proposed FINRA Rule 3260.05 (Definition of Free Credit Balances and Sweep Program), which provides that the terms "free credit balances" and "Sweep Program" as used in proposed FINRA Rule 3260 have the meaning assigned to such terms in SEA Rule 15c3-3.

      The revised proposal includes recordkeeping requirements similar to the initial proposal. Specifically, proposed FINRA Rule 3260.06 (Record Retention) requires firms to preserve customers' prior written authorizations, signature records, records denoting acceptance of accounts and written agreements between firms and customers for at least six years after the date that such records are updated, and to preserve the last update to such records, or the original records if there are no updates, for at least six years after the date the account is closed. Further, proposed FINRA Rule 3260.06 requires that firms preserve records relating to the approval of discretionary orders under proposed FINRA Rule 3260(a) for the period of time and accessibility specified in SEA Rule 17a-4(b), which is for at least three years. In addition, for purposes of compliance with proposed FINRA Rule 3260(c)(1)(E)(vi), the revised proposal requires firms to maintain records of individual customer balances on their books and records and preserve such records for at least six years after the date the account is closed.

      The proposed six-year retention period is consistent with the record retention period for similar customer account records under FINRA Rule 4512.01 (Customer Account Information Retention Periods) and under the Exchange Act.43 The proposed three-year retention period is consistent with the record retention period for order tickets under the Exchange Act.44 Therefore, FINRA does not believe that the proposed retention periods would create any undue burden on firms.

      In general, firms would be required to update accounts established prior to the effective date of proposed FINRA Rule 3260 whenever they update the account information in the course of their routine and customary business. With respect to accounts subject to the requirements of SEA Rule 15c3-3, firms would be required to comply with the timing requirements under that rule.

      The revised proposal also makes various technical, non-substantive changes, including updating cross references to FINRA rules.
      I. Eliminated Rules

      Similar to the initial proposal, the revised proposal deletes NYSE Rule 408 and NYSE Rule Interpretation 408 as they are substantially similar to proposed FINRA Rule 3260, otherwise incorporated as described above, rendered obsolete by the approach reflected in proposed FINRA Rule 3260, or addressed by other rules.

      Economic Impact Assessment

      Need for the Rule

      As discussed above, the FINRA rulebook contains several provisions regarding discretionary accounts and transactions, including NASD Rule 2510 and NYSE Rule 408 (and its Interpretation). While the NASD rule generally applies to all FINRA member firms, the NYSE rule applies only to those members of FINRA that are also members of NYSE. FINRA believes that it can provide greater clarity and regulatory efficiency to firms by consolidating the NASD and NYSE rules into one rule set that applies to all FINRA member firms.

      Regulatory Objective

      FINRA recognizes that discretionary power over customer accounts can create value for customers by providing flexibility and convenience, but may also create opportunities for firms to compromise the interest of customers by engaging in activities such as unauthorized and excessive trading. The proposal seeks to harmonize current NASD and NYSE rules regarding discretionary accounts and transactions to eliminate duplicative rules, streamline regulation, and establish appropriate requirements for exercising discretionary power over customer accounts. It aims to bring clarity and consistency to FINRA rules without imposing any significant additional burden on member firms or undermining investor protection.

      Economic Baseline

      The current industry practices under existing NASD, NYSE and SEC requirements serve as an economic baseline for the proposed rule. FINRA member firms may face different requirements for the same activities depending on the rules to which they are subject. The proposed rule in the consolidated FINRA rulebook will bring to all customers the same benefits from the flexibility and investor protection provided by the rule.

      The economic impact of the proposed requirements depends on how they compare to existing rules and current industry practices. Specifically, the proposed requirements that are substantially similar to existing rules or otherwise consistent with current industry practices are not expected to create any additional burden on firms. The proposed requirements that are more stringent than existing rules may impose some additional obligations on firms, but will also enhance investor protection. The proposed requirements that provide more flexibility to firms than existing rules may reduce the burden on firms. Some customers may benefit from the additional flexibility in firms' exercise of discretionary power, but such flexibility should not compromise the interest of customers.

      Economic Impacts

      Some of the proposed requirements are substantially similar to existing rules, while others are either more stringent or more flexible than existing rules. The economic impacts of these three types of proposed requirements are as follows.

      Proposed FINRA Rule 3260(a), proposed FINRA Rule 3260(c)(1)(A), proposed FINRA Rule 3260(c)(1)(B) and proposed FINRA Rule 3260(c)(1)(D) are substantially similar to existing rules and consistent with current industry practices, and, thus, should not create any new significant burdens on firms nor alter the protections to customers.

      Proposed FINRA Rule 3260(b) incorporates the requirements of NYSE Rule 408(a) regarding accepting orders for a customer's account from someone other than the customer. It incorporates the more stringent requirements of the NYSE rule where current NASD and NYSE rules differ. Under the proposed rule, firms must obtain the customer's signed and dated written authorization as well as the authorized person's manual dated signature and any orders from the authorized person must be consistent with such person's authority as specified in the customer's authorization. Thus, the proposed rule may impose additional obligations on member firms not subject to NYSE rules, but the additional obligations may be limited as FINRA understands that most firms currently do not accept an order from someone other than the customer without some form of authorization from the customer, such as a trading authorization. In addition, as noted, FINRA Rule 2090 requires firms to use reasonable diligence to understand the authority of each person acting on behalf of the customer. Similarly, proposed FINRA Rule 3260(c)(1)(E) codifies the disclosure and notice requirements in NYSE Information Memorandum 05-11, which will impose new requirements on firms that are not NYSE members. FINRA seeks specific comments on the potential costs to these member firms associated with the new requirements. The new requirements are expected to provide the benefits of a heightened standard of investor protection.

      Proposed FINRA Rule 3260(c)(1)(C) codifies and expands FINRA's guidance regarding the use of negative response letters to effect a bulk transfer of customers' accounts or change the broker-dealer of record in specific situations. However, the proposed rule also imposes conditions with respect to a bulk transfer of customers' accounts or change in broker-dealer of record to protect the interests of customers. FINRA believes that the proposed rule will reduce the burden on firms while providing customers with time and information to decide whether to object to the transfer of their accounts or change in broker-dealer of record. Similarly, proposed FINRA Rule 3260(c)(1)(F) provides exceptions to proposed FINRA Rule 3260(a) to offer firms and their customers the flexibility to enter into written agreements that allow specified redemptions and transactions by firms. It is anticipated to reduce the burden on firms while protecting customers by requiring prior written agreements that prominently disclose the terms and conditions of such arrangements.

      Request for Comments

      FINRA seeks comments on the revised proposal. In addition to generally requesting comments, FINRA specifically requests comments on the questions below. FINRA requests data and quantified comments where possible.

      1. As described above, many of the requirements of proposed FINRA Rule 3260 are based on existing NASD, NYSE and SEC requirements. Therefore, FINRA does not believe that the proposed rule would impose a significant burden on firms. However, FINRA is seeking specific comments on any potential costs associated with the proposed rule, including the factors or firm characteristics that contribute to any potential costs and the magnitude of any potential costs associated with developing, implementing and maintaining the systems and procedures to comply with the proposed rule.
      2. What are the anticipated costs and benefits of the proposed rule to customers?
      3. A customer may give discretion to a firm to purchase or sell a security or type of security limited by specific parameters established by the customer, and the firm may charge the customer per transaction in such arrangements. What is the impact of proposed FINRA Rule 3260(a) on such discretionary transactions? Do firms that exercise such discretion believe that they can satisfy the purposes of the proposed rule, such as identifying excessive trading, through the use of automated supervisory systems, or a mix of automated and manual supervisory systems?
      4. What is the impact of proposed FINRA Rules 3260(a) and (b), including the requirement to obtain the signature of the authorized agent under proposed FINRA Rule 3260(b), on centrally managed accounts.
      5. FINRA is proposing to exclude fee-based only accounts from the requirements of proposed FINRA Rule 3260(a) because such accounts generally do not raise concerns relating to excessive trading. Is the proposed exclusion appropriate?
      6. Should the exception under proposed FINRA Rule 3260(c)(1)(A)(ii) for not-held good-'til-canceled orders for institutional accounts, which is of unlimited duration, be extended to retail accounts?
      7. Proposed FINRA Rule 3260(c)(1)(C) addresses the use of negative response letters to transfer customer accounts or change the broker-dealer of record in potential situations where a firm is going out of business and is not able to service its customers' accounts (which may result in what is commonly referred to as "orphaned accounts" or "abandoned accounts"). In addition to the situations identified in proposed FINRA Rule 3260(c)(1)(C), a clearing firm that has non-transferrable assets in accounts of customers of an introducing firm for which the clearing firm no longer clears may also seek to transfer or assign such "orphaned accounts" to another introducing firm at the same clearing firm. Clearing firms have requested that they also be permitted to use negative response letters to transfer or assign such accounts. What level of due diligence do such clearing firms conduct on the prospective introducing firm and how do they address issues relating to the privacy of consumer financial information in connection with transferring or assigning the accounts? What other situations, including situations involving directly held mutual fund and variable insurance product accounts, cause accounts to be "orphaned" or "abandoned"?
      8. Proposed FINRA Rules 3260(a) and (b) apply to defined benefit plans and defined contribution plans, including in situations where an individual plan participant gives an associated person of a firm or a third-party investment adviser discretion over his or her account. Are there any unique issues relating to such plans that may impact the application of the proposed rules?
      9. Proposed FINRA Rule 3260(c)(1)(E) codifies the disclosure and notice requirements in NYSE Information Memorandum 05-11, which will impose new requirements on firms that are not NYSE members. What are the potential costs to such member firms associated with the proposed requirements?

      1 The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA members, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA members, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice 03-12-08 (Rulebook Consolidation Process).

      2 FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.

      3 See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

      4 For convenience, Incorporated NYSE Rules are referred to as NYSE Rules.

      5 See Securities Exchange Act Release No. 70072 (July 30, 2013), 78 FR 51824 (August 21, 2013) (File No. S7-08-07) (hereinafter, Financial Responsibility Rules for Broker-Dealers); Frequently Asked Questions Concerning the Amendments to Certain Broker-Dealer Financial Responsibility Rules, Bulk Transfer Questions, Division of Trading and Markets (March 6, 2014).

      6 See also NYSE Rule 408(a) and SEA Rule 17a-3(a)(17)(ii).

      7 This signature requirement is generally consistent with SEA Rule 17a-3(a)(17)(ii), which requires that, for each discretionary account with a natural person, firms maintain a record containing the dated signature of the customer granting authorization.

      8 The term "manager" as used in the proposed rule includes a principal with managerial responsibilities, but such principal does not necessarily have to be a senior executive of the firm.

      9 See also FINRA Rule 4512(a)(1)(C) (which requires that for each account firms maintain the name(s) of the associated person(s), if any, responsible for the account) and FINRA Rule 4512(a)(1)(D) (which requires that for each account firms maintain the signature of the partner, officer or manager denoting that the account has been accepted in accordance with the firm's policies and procedures for acceptance of accounts).

      10 This requirement is generally consistent with FINRA Rule 2090 (Know Your Customer), which requires firms to use reasonable diligence to understand the authority of each person acting on behalf of the customer.

      11 See Securities Exchange Act Release No. 44238 (May 1, 2001), 66 FR 22916 (May 7, 2001) (Commission Guidance to Broker-Dealers on the Use of Electronic Storage Media Under the Electronic Signatures in Global and National Commerce Act of 2000 with Respect to Rule 17a-4(f)).

      12 See, e.g., letter to Jeffrey W. Kilduff, O'Melveny & Myers, LLP, from Nancy Libin, NASD, dated July 5, 2001.

      13 See, e.g., Regulatory and Compliance Alert (June 1998) (stating that when a registered investment adviser is a registered representative who establishes a customer account at the employing broker-dealer, NASD Rule 2510 applies).

      14 See also SEA Rule 17a-3(a)(6)(i) (which requires that an order entered pursuant to the exercise of discretionary authority by an associated person of a firm be designated as such).

      15 See supra note 7.

      16 See supra note 10.

      17 Where a customer grants a person nondiscretionary trading authority over the customer's account, the person is authorized to place an order in the customer's account, but the person must obtain the customer's approval prior to placing the order.

      18 See also FINRA Rule 4512(a)(3) (which requires that, for discretionary accounts, firms maintain a record of the dated, manual signature of each named, natural person authorized to exercise discretion in the account) and SEA Rule 17a-3(a) (17)(ii) (which requires that, for discretionary accounts with a natural person, firms maintain a record containing the dated signature of each natural person to whom discretionary authority was granted).

      19 See, e.g., Regulation S-P (Privacy of Consumer Financial Information and Safeguarding Personal Information) under the Exchange Act. 17 CFR Part 248.

      20 However, the FINRA and NYSE rules define the term "institutional account" differently. FINRA Rule 4512(c) defines the term "institutional account" to mean the account of: (1) a bank; (2) a savings and loan association; (3) an insurance company; (4) a registered investment company; (5) an SEC-registered investment adviser or a state-registered investment adviser; or (6) a person with total assets of at least $50 million. NYSE Rule 408.11 defines the term "institutional account" to mean the account of: (1) a bank; (2) a savings association; (3) an insurance company; (4) a registered investment company; (5) a state or a political subdivision; (6) a pension or profit sharing plan, subject to ERISA, with more than $25 million in total assets under management, or of a federal agency or political subdivision; (7) any person that has a net worth of at least $45 million and financial assets of at least $40 million; or (8) an SEC-registered investment adviser. Proposed FINRA Rule 3260(c) (1)(A) incorporates the definition in FINRA Rule 4512(c).

      21 See proposed FINRA Rule 3260(c)(1)(A)(i).

      22 See proposed FINRA Rule 3260(c)(1)(A)(ii).

      23 See proposed FINRA Rules 3260(c)(1)(C), (D) and (E).

      24 This requirement is based on the SEC's published guidance regarding the application of its rules relating to the treatment of free credit balances to a bulk exchange at net asset value of money market mutual funds in situations involving a merger or acquisition of the mutual funds under FINRA rules. See supra note 5.

      25 See, e.g., letter to Michael R. Trocchio, Bingham McCutchen LLP, from Patricia Albrecht, NASD, dated November 10, 2004 (where a firm was divesting itself of its retail brokerage business and seeking to effect a bulk transfer of its retail customer accounts to another firm using negative response letters).

      26 The broker-dealer of record refers to the broker-dealer identified on a customer's account application for accounts held directly at a mutual fund or variable insurance product issuer. Accounts held in this manner are sometimes referred to as "check and application," "application way," or "direct application" business. The broker-dealer of record generally receives fees or commissions resulting from the customer's transactions in the account. See memorandum from NASD Office of General Counsel, Regulatory Policy and Oversight, dated November 8, 2004 (permitting a member firm named as broker-dealer of record on directly held mutual fund and variable insurance product accounts to use negative response letters to change the broker-dealer of record on the accounts to another firm in the following situations: (1) the firm is going out of business; (2) a registered representative is leaving the firm and the firm will not be providing the services the registered representative was performing for the directly held account; or (3) a networking arrangement between the firm and a financial institution has concluded or terminated); letter to Barry Harris, Chief Counsel, Banc of America Investment Services, Inc., from Patricia Albrecht, Assistant General Counsel, NASD, dated October 20, 2004 (stating that a member firm named as broker-dealer of record on directly held mutual fund and variable insurance product accounts that is acquired by or merged with another member firm that will be the legal successor-in-interest may use negative response letters to change the broker-dealer of record on the accounts to the member firm that will become the successor-in-interest).

      27 For instance, where a clearing firm is seeking to transfer all of its customer accounts to another clearing firm.

      28 See proposed FINRA Rules 3260(c)(1)(D) (Treatment of Free Credit Balances Outside of a Sweep Program) and 3260.04 (Compliance with Rule 3260(c)(1)(E)(iii) In Connection With a Bulk Transfer of Customers' Accounts) (which provide exceptions from the requirements of SEA Rule 15c3-3 for bulk transfers of customers' accounts consistent with published SEC guidance).

      29 NTM 02-57, however, did not expressly address transfers by a clearing firm that is experiencing financial or operational difficulties.

      30 See proposed FINRA Rule 3260.02 (Additional Conditions for Bulk Transfers Under Rule 3260(c) (1)(C)).

      31 Pursuant to NASD Rule 1017(a) (Events Requiring Application), a firm is required to file a Continuing Membership Application with FINRA if it plans to: (1) merge with another member firm (unless both are NYSE member firms or the surviving entity will continue to be an NYSE member firm); (2) directly or indirectly acquire another member firm (unless the acquiring member firm is an NYSE member firm); (3) directly or indirectly acquire or transfer 25% or more in the aggregate of its assets or any asset, business or line of operation that generates revenues comprising 25% or more in the aggregate of its earnings measured on a rolling 36-month basis (unless both the seller and acquirer are NYSE member firms); (4) change its equity ownership or partnership capital so that one person or entity directly or indirectly owns or controls 25 percent or more of the equity or partnership capital; or (5) undergo a "material change in business operations" as defined in NASD Rule 1011(k) (Material Change in Business Operations).

      32 According to the SEC, "[f]ree credit balances are funds payable by a broker-dealer to its customers on demand", and "[t]hey may result from cash deposited by the customer to purchase securities, proceeds from the sale of securities or other assets held in the customer's account, or earnings from dividends and interest on securities and other assets held in the customer's account." See Financial Responsibility Rules for Broker-Dealers, page 49; 17 CFR 240.15c3-3(a)(8).

      33 See supra note 5.

      34 This requirement is based on the current disclosures and notices required under NASD Rule 2510(d)(2).

      35 This requirement is based on the guidance in NYSE Information Memorandum 05-11 (February 15, 2005) relating to sweep programs, which FINRA is proposing to codify. Proposed FINRA Rule 3260.03 (Format of Disclosures Required Under Rule 3260(c)(1)(E)(iv)) provides that the required disclosures must be summarized in a one- or two-page document written in plain English and refer customers to places where additional and more detailed disclosure is available.

      36 See supra note 35.

      37 See supra note 35.

      38 The SEC has provided no-action relief to broker-dealers from the prior written affirmative consent requirement of SEA Rule 15c3-3(j)(2)(ii)(A), subject to specified conditions, including, among other requirements, a requirement that the broker-dealer obtain the customer's affirmative consent after giving the customer notice of the general terms and conditions of the products available through the sweep program and that the broker-dealer may change the products available under the sweep program. See Letter from Randall W. Roy, Assistant Director, Division of Trading and Markets, U.S. Securities and Exchange Commission, to Thomas F. Price, Operations, Technology & BCP, Securities Industry and Financial Markets Association (February 26, 2014); Letter from Michael A. Macchiaroli, Associate Director, Division of Trading and Markets, U.S. Securities and Exchange Commission, to Kevin M. Carroll, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association (February 5, 2015). The no-action relief extends until September 30, 2015.

      39 A member firm receiving customers' accounts following a bulk transfer of accounts using negative response letters consistent with proposed FINRA Rule 3260(c)(1)(C) would not be subject to this requirement, provided that: (1) the customers' free credit balances were previously invested in a substantially similar product in the sweep program of the member firm delivering the accounts; (2) the negative response letters contain the general terms and conditions of the products available through the sweep program and notify customers that the member firm receiving the accounts may change the products available under the sweep program; (3) the negative response letters contain specified disclosures; and (4) if customers' free credit balances are invested in a different money market mutual fund at the member firm receiving the accounts than the one available through the sweep program of the member firm delivering the accounts, the negative response letters also contain a tabular comparison of the nature and amount of the fees charged by each money market mutual fund, a comparative description of the investment objectives of each money market mutual fund and a prospectus of the money market mutual fund to be purchased. See proposed FINRA Rule 3260.04. This exception is consistent with the SEC's published guidance. See supra note 5.

      40 See supra note 5.

      41 See also NTM 83-70 (Automatic Money Market Fund Redemptions) (December 1983).

      42 In 2005, the SEC adopted Rule 202(a)(11)-1 under the Advisers Act, a principal purpose of which was to deem broker-dealers offering "fee-based brokerage accounts" not subject to the Advisers Act. Rule 202(a)(11)-1 also included several interpretive positions regarding Advisers Act Section 202(a)(11)(C), including a provision that any account over which a broker-dealer exercises investment discretion (other than on a temporary or limited basis) is subject to the Advisers Act. In March 2007, Rule 202(a)(11)-1 was vacated. See Financial Planning Association v. SEC, 482 F.3d 481 (D.C. Cir. 2007). In September 2007, the SEC re-proposed its interpretive positions for comment, including the provision regarding the application of the Advisers Act to discretionary accounts. See Investment Advisers Act Release No. 2652 (September 24, 2007), 72 FR 55126 (September 28, 2007) (Interpretive Rule Under the Advisers Act Affecting Broker-Dealers).

      43 However, FINRA notes that currently member firms are required to preserve records relating to powers of attorney and other evidence of the granting of discretionary authority with respect to accounts of non-natural persons for only three years. Compare SEA Rule 17a-4(b)(6) with SEA Rule 17a-3(a)(17)(ii) and SEA Rule 17a-4(e) (5) (which requires a six-year retention period with respect to similar records for a discretionary account with a natural person).

      44 See SEA Rules 17a-3(a)(6) and 17a-4(b).


      Appendix A

      Below is the text of the proposed rule change. Proposed new language is underlined; proposed deletions are in brackets.

      *   *   *   *   *

      Text of Proposed New FINRA Rule 3260

      (Marked to Show Changes from NASD Rule 2510; NASD Rule 2510 and NYSE Rule 408 (and Its Interpretation) to Be Deleted in Their Entirety from the Transitional Rulebook)

      *   *   *   *   *

      [2500. SPECIAL ACCOUNTS]

      [2510]3260. Discretionary Accounts and Transactions by Persons Other Than the Customer

      (a) [Excessive] Discretionary Transactions by Members and Their Associated Persons

      No member or associated person of the member shall exercise any discretionary power in a customer's account unless such customer has given a signed, dated prior written authorization to exercise discretionary power to a named associated person or associated persons and the account documentation has been signed by a partner, officer or manager designated by the member, other than the associated person vested with discretionary power, denoting that the account has been accepted in accordance with the member's policies and procedures for acceptance of such discretionary accounts. The associated person and the member shall exercise discretionary power in such account only in the manner, and under the terms and conditions, specified in the customer's prior written authorization. [No member] The associated person and the member shall not effect with or for [any] such [customer's] account [in respect to which such member or his agent or employee is vested with any discretionary power] any transactions of purchase or sale [which] that are excessive in size or frequency in view of the financial resources and character of such account. A partner, officer or manager designated by the member, other than the associated person vested with discretionary power, shall approve promptly in writing each discretionary order entered in such discretionary account and shall review such discretionary account at frequent intervals to detect and prevent transactions that are excessive in size or frequency in view of the financial resources and character of the account. The requirements of this paragraph (a) shall not apply to accounts that are only fee-based.
      (b) [Authorization and Acceptance of Account] Transactions by Agents of Customers

      No member or [registered representative] associated person of the member shall [exercise any discretionary power in a customer's account] accept an order for a customer's account from a person other than the customer unless [such] the customer has given a signed, dated prior written authorization to such person and the order is consistent with such person's authority as specified in the customer's prior written authorization. Where a customer provides written authorization to a natural person, a member or associated person must obtain the prior manual dated signature of the named natural person, and where a customer provides written authorization to an entity, a member or associated person must obtain the prior manual dated signature of a natural person authorized to act on behalf of the entity [a stated individual or individuals and the account has been accepted by the member, as evidenced in writing by the member or the partner, officer or manager, duly designated by the member, in accordance with Rule 3010].
      [(c) Approval and Review of Transactions]

      [The member or the person duly designated shall approve promptly in writing each discretionary order entered and shall review all discretionary accounts at frequent intervals in order to detect and prevent transactions which are excessive in size or frequency in view of the financial resources and character of the account.]
      ([d]c) [Exceptions] Specific Discretionary Activities; Extent Permissible

      [This Rule shall not apply to:](1) Notwithstanding the requirements of paragraph (a) of this Rule, a member may engage in the activities set forth in subparagraphs (A) through (F) below.
      [(1)](A) Temporary Time or Price Discretion
      (i) A member or an associated person may exercise discretion as to [the price at which or] the time or price [when] of execution of an order [given by a customer] for the purchase or sale of a definite dollar amount or quantity of a specified security [shall be executed] given by a customer:
      a. during a normal trading session, provided that such time or price discretion shall be in effect only until the end of that normal trading session [, except that the authority to exercise time and price discretion will be considered to be in effect only until the end of the business day on which the customer granted such discretion, absent a specific, written contrary indication signed and dated by the customer.]; or
      b. after a normal trading session, provided that such time or price discretion shall be in effect only during the next normal trading session; and
      (ii) A member or an associated person may exercise discretion as [This limitation shall not apply] to the time [and] or price [discretion exercised in] for an institutional account, as defined in FINRA Rule 4512(c) [3110(c)(4)], pursuant to valid [G]good-[T]til[l]-[C]cance[l]led instructions issued on a "not-held" basis.
      Any exercise of time [and] or price discretion must be reflected on the order ticket[;].
      [(2)](B) Mergers and Acquisitions of Money Market Mutual Funds

      A member may effect bulk exchanges at net asset value of money market mutual funds [("funds") utilizing] using negative response letters, provided[:]

      [(A)][T]the bulk exchange is limited to situations involving mergers and acquisitions of money market mutual funds[,changes of clearing members and exchanges of funds used in sweep accounts;].

      [(B)] Such [The] negative response letter must:
      (i) contain[s] a tabular comparison of the nature and amount of the fees charged by each fund;
      (ii)[(C)] [The negative response letter] contain[s] a comparative description of the investment objectives of each fund and a prospectus of the fund to be purchased; and
      (iii)[(D)] [The negative response feature will] not be activated until at least 30 calendar days after the date on which the letter was [mailed] sent.
      Where such bulk exchange involves money market mutual funds in a Sweep Program, the negative response letter used to effect the bulk exchange, in addition to satisfying the requirements above, also describes the new terms and conditions of the new product, and the options available to the customer if the customer does not accept the new terms and conditions or the new product consistent with SEA Rule 15c3-3(j)(2)(ii)(B)(3)(ii).
      (C) Bulk Transfer of Customer Accounts and Change of Broker-Dealer of Record
      (i) A member may effect a bulk transfer of customers' accounts using negative response letters, provided that the bulk transfer is limited to the following circumstances:
      a. an introducing firm that has entered into a clearing arrangement with a different clearing firm is seeking to transfer its customer accounts to the new clearing firm;
      b. an introducing firm or a clearing firm that is experiencing financial or operational difficulties is seeking to transfer all of its customer accounts, including in the case of a clearing firm all of the accounts carried by such clearing firm, to another introducing firm(s) or clearing firm(s);
      c. an introducing firm or a clearing firm that is going out of business, other than for financial or operational difficulties, is seeking to transfer all of its customer accounts to another introducing firm(s) or clearing firm(s);
      d. an introducing firm or a clearing firm that is divesting itself of a specific business line or area, such as its retail brokerage business or some of its branch offices, is seeking to transfer the affected customer accounts to another introducing firm or clearing firm;
      e. a clearing firm, for an introducing firm that has gone out of business, is seeking to transfer all of the introducing firm's customer accounts to another introducing firm at the same clearing firm;
      f. a member that is acquired by or merged with another member is seeking to transfer all of its customer accounts to the new firm; and
      g. upon the conclusion or termination of a networking arrangement between a member and a financial institution pursuant to FINRA Rule 3160, the member is seeking to transfer all customer accounts established under the arrangement to a new firm with which the financial institution has formed a networking arrangement pursuant to FINRA Rule 3160.
      (ii) A member named as broker-dealer of record on directly held mutual fund and variable insurance product accounts may use negative response letters to change the broker-dealer of record on the accounts to another member, provided that the change in broker-dealer of record is limited to the following circumstances:
      a. a member that is going out of business is seeking to change the broker-dealer of record on the directly held accounts to another member willing to service the accounts;
      b. where a registered representative of a member who is servicing the directly held accounts is leaving the firm and the firm will not be providing the services the registered representative was performing for the accounts, the firm is seeking to change the broker-dealer of record on the directly held accounts to another member willing to service the accounts;
      c. upon the conclusion or termination of a networking arrangement between a member and a financial institution pursuant to FINRA Rule 3160, the member is seeking to change the broker-dealer of record on directly held customer accounts established under the arrangement to a new firm with which the financial institution has formed a networking arrangement pursuant to FINRA Rule 3160; and
      d. a member that is acquired by or merged with another member is seeking to change the broker-dealer of record on the directly held accounts to the member that will become the successor-in-interest.
      (iii) For purposes of subparagraphs (i) and (ii) above, the member shall send the negative response letters to the customers, absent exigent circumstances, at least 30 calendar days before the member effects the transfer or change in broker-dealer of record, and the negative response letters shall contain:
      a. a brief description of the circumstances necessitating the transfer or change in broker-dealer of record;
      b. a statement that the customer has the right to object to the transfer or change in broker-dealer of record and the date by which the customer must respond if objecting to the transfer or change in broker-dealer of record (such date can be no sooner than 30 calendar days after the date on which the negative response letter was sent to the customer);
      c. information on how the customer can effectuate a transfer or change in broker-dealer of record to another firm;
      d. disclosure of any costs to the customer if the customer initiates a transfer of the account or change in broker-dealer of record after the account is moved or the broker-dealer of record has been changed pursuant to the negative response letter; and
      e. a statement regarding the firm's compliance with SEC Regulation S-P (Privacy of Consumer Financial Information) in connection with the transfer or change in broker-dealer of record.
      (D) Treatment of Free Credit Balances Outside of a Sweep Program

      A member may invest, or transfer to another account or institution, free credit balances in a customer's account outside of a Sweep Program only upon a specific order, authorization or draft from the customer, and only in the manner, and under the terms and conditions, specified in the order, authorization or draft consistent with SEA Rule 15c3-3(j)(2)(i),provided, however, that a member may effect a (i) bulk exchange of money market mutual funds using negative response letters consistent with subparagraph (B) above, and (ii) bulk transfer of customers' accounts using negative response letters consistent with subparagraph (C) above.
      (E) Treatment of Free Credit Balances in a Sweep Program

      A member may transfer free credit balances held in a customer's securities account to a product in the member's Sweep Program or transfer a customer's interest in one product in a Sweep Program to another product in a Sweep Program, provided that:
      (i) the member sends the customer a negative response letter consistent with SEA Rule 15c3-3(j)(2)(ii)(B)(3)(i) at least 30 calendar days before:
      a. making changes to the terms and conditions of the Sweep Program;
      b. making changes to the terms and conditions of a product currently available through the Sweep Program;
      c. changing, adding or deleting products available through the Sweep Program; or
      d. changing the customer's investment through the Sweep Program from one product to another.
      The negative response letter must describe the new terms and conditions of the Sweep Program or product or the new product, and the options available to the customer if the customer does not accept the new terms and conditions or product consistent with SEA Rule 15c3-3(j)(2)(ii)(B)(3)(ii).

      If the member is transferring a customer's interest in one money market mutual fund in the member's Sweep Program to another money market mutual fund in the Sweep Program, the negative response letter provided to the customer must also include a tabular comparison of the nature and amount of the fees charged by each money market mutual fund, a comparative description of the investment objectives of each money market mutual fund and a prospectus of the money market mutual fund to be purchased;
      (ii) the member provides notice to the customer, as part of the customer's quarterly account statement, that the balance in the bank deposit account or shares of the money market mutual fund in which the customer has a beneficial interest can be liquidated on the customer's order and the proceeds returned to the securities account or remitted to the customer consistent with SEA Rule 15c3-3(j)(2)(ii)(B)(2);
      (iii) for accounts opened on or after [insert effective date of the proposed rule change], the member must also obtain the customer's prior written affirmative consent to having free credit balances in the customer's securities account included in the member's Sweep Program after the customer has been notified of the general terms and conditions of the products available through the Sweep Program and notified that the member may change the products available under the Sweep Program consistent with SEA Rule 15c3-3(j)(2)(ii)(A);
      (iv) the member includes the following disclosures in an attachment to the negative response letter:
      a. any conflicts of interest relating to the Sweep Program, including whether the member receives compensation or other benefits for customer balances maintained at a money market mutual fund or bank;
      b. current interest rates applicable to the Sweep Program;
      c. the manner by which future interest rates will be determined;
      d. the nature and extent of SIPC or FDIC insurance available; and
      e. the entity that the customer should contact should the customer wish to gain access to his or her funds;
      (v) the member posts on its website applicable bank and money market mutual fund interest rates and information regarding any conflicts of interest relating to its Sweep Program with prominent notice of the availability of such information, and regularly updates applicable interest rates posted on its website;
      (vi) where the member maintains customer bank sweep balances on an omnibus basis with an affiliated bank, the member maintains detailed individual customer balances on its books and records on behalf of the bank and the member's customers; and
      (vii) where customer free credit balances swept to a bank are not under the control of the member, the member may reflect such balances on customer account statements, subject to the following conditions:
      a. the member must indicate that the balance statement is informational, and is provided as a courtesy and includes assets held at different entities;
      b. the member must identify each other entity, their relationship (if any) to each other and their respective functions; and
      c. relative to services provided for assets included on the summary, the member must: clearly distinguish between assets held at each entity; identify the customer's account numbers at each entity; and provide a customer service telephone number at each entity (if the account number and customer service numbers are not included on the underlying statements).
      Notwithstanding the requirements of this subparagraph (E), a member may effect a bulk exchange of money market mutual funds using negative response letters consistent with subparagraph (B) above, provided that the negative response letter used to effect the bulk exchange also describes the new terms and conditions of the new product, and the options available to the customer if the customer does not accept the new terms and conditions or the new product consistent with SEA Rule 15c3-3(j)(2)(ii)(B)(3)(ii).
      (F) Money Market Mutual Fund Redemption Programs and Transactions to Satisfy Indebtedness

      A member may:
      (i) redeem money market mutual funds for payment of securities purchases; or
      (ii) effect transactions to satisfy an indebtedness to the member (e.g., margin requirements),provided that such redemptions or transactions are permitted by a prior signed, written agreement between the member and customer that prominently discloses the terms and conditions of any such arrangement.

      • • • Supplementary Material: ---------

      .01 Compliance With Federal Securities Laws Governing Discretionary Accounts and Transactions. Members may maintain discretionary accounts or otherwise exercise discretion in an account only as permitted under the federal securities laws.
      .02 Additional Conditions for Bulk Transfers Under Rule 3260(c)(1)(C). A bulk transfer pursuant to Rules 3260(c)(1)(C)(i)a. through g. is subject to the following additional conditions:
      (a) For purposes of a transfer pursuant to Rules 3260(c)(1)(C)(i)a. through g., (1) the firms involved in the transfer, if required to do so, must file an application under NASD Rule 1017 with FINRA with respect to the proposed transfer, and such application must be approved prior to sending the negative response letters to the customers; and (2) no personal confidential customer information (e.g., social security numbers) may be provided to the receiving introducing or clearing firm, as applicable, unless the sharing of such information is in compliance with SEC Regulation S-P (Privacy of Consumer Financial Information);
      (b) For purposes of a transfer or assignment pursuant to Rules 3260(c)(1)(C)(i)b., d. and e., the firm making the transfer or assignment must provide a letter to FINRA, along with any related legal agreement entered into with the receiving firm detailing the financial and other terms of the transfer or assignment of the accounts to the receiving firm at least 30 calendar days prior to the negative response letter being sent to the customers;
      (c) For purposes of a transfer pursuant to Rule 3260(c)(1)(C)(i)c., (1) the negative response letters may not be sent to the customers until there is a written executed agreement between the parties; and (2) the introducing firm or clearing firm that is going out of business must make a written representation to FINRA, to the attention of the firm's regulatory coordinator, that it will submit a Form BDW within 30 calendar days of the initial bulk transfer of the accounts; and
      (d) For purposes of a transfer pursuant to Rule 3260(c)(1)(C)(i)d., (1) the accounts will be transferred to only one introducing firm or clearing firm; (2) the accounts subject to transfer are currently held at a clearing firm that is a FINRA member, whether or not the transfer of the accounts will result in a change in clearing firm; (3) the transfer does not occur until there is a fully-executed agreement between the divesting member and the receiving member; and (4) the transfer of the accounts can only be to entities that are permitted, due to the nature of their registration with the appropriate regulatory authorities, to service the accounts transferred. For instance, if a firm is selling one or more branch offices, it must sell them to an introducing firm or a clearing firm that is registered as a broker-dealer with the SEC and is a member of FINRA.

      In addition, a member that effects the transfer of a customer's account via a negative response letter shall not charge a fee to that customer, and a member shall not charge a fee to a customer who in response to a negative response letter decides to move his or her account to another member during the opt-out period provided in the letter.
      .03 Format of Disclosures Required Under Rule 3260(c)(1)(E)(iv). The disclosures required under paragraph (c)(1)(E)(iv) of this Rule must be summarized in a one- or two-page document written in plain English and refer customers to places where additional and more detailed disclosure is available.
      .04 Compliance with Rule 3260(c)(1)(E)(iii) In Connection With a Bulk Transfer of Customers' Accounts. Notwithstanding the requirements of paragraph (c)(1)(E)(iii) of this Rule, following the bulk transfer of customers' accounts to a member using negative response letters consistent with paragraph (c)(1)(C) of this Rule, the member receiving the accounts may invest customers' free credit balances in products available through its Sweep Program in reliance on the negative response letters that were used to effect the bulk transfer of customers' accounts, provided that:
      (a) the customers' free credit balances were previously invested in a substantially similar product in the Sweep Program of the member delivering the accounts;
      (b) the negative response letters contained the general terms and conditions of the products available through the Sweep Program and notified customers that the member receiving the accounts may change the products available under the Sweep Program;
      (c) the negative response letters contained the disclosures set forth in paragraph (c)(1) (E)(iv) of this Rule; and
      (d) if customers' free credit balances were previously invested in a money market mutual fund in the Sweep Program of the member delivering the accounts different than the one available through the Sweep Program of the member receiving the accounts, the negative response letters also contained a tabular comparison of the nature and amount of the fees charged by each money market mutual fund, a comparative description of the investment objectives of each money market mutual fund and a prospectus of the money market mutual fund to be purchased.
      .05 Definition of Free Credit Balances and Sweep Program. The terms "free credit balances" and "Sweep Program" as used in this Rule shall have the meaning assigned to such terms in SEA Rule 15c3-3.
      .06 Record Retention. For purposes of this Rule, members shall preserve customers' prior written authorizations, signature records, records denoting acceptance of accounts and written agreements between members and customers that subsequently are updated for at least six years after the date that they are updated. Members shall preserve the last update to such records, or the original records if there are no updates, for at least six years after the date the account is closed. For purposes of paragraph (a) of this Rule, members shall preserve records relating to the approval of discretionary orders for the period of time and accessibility specified in SEA Rule 17a-4(b). For purposes of paragraph (c)(1)(E)(vi) of this Rule, members shall maintain records of individual customer balances on their books and records and preserve such records for at least six years after the date the account is closed.
      *   *   *   *   *

    • 15-21 SEC Approves Amendments to the Codes of Arbitration Procedure to Increase the Fees Assessed for Late Cancellation or Postponement of a Hearing; Effective Date: July 6, 2015

      View PDF

      Late Cancellation Fees

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 12214
      FINRA Rule 12601
      FINRA Rule 13214
      FINRA Rule 13601
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      Arbitration
      Arbitrators
      Fees
      Honoraria

      Executive Summary

      The Code of Arbitration Procedure for Customer Disputes (Customer Code) and the Code of Arbitration Procedure for Industry Disputes (Industry Code) (together, codes) govern the payments that FINRA makes to its arbitrators for the services they provide to FINRA's dispute resolution forum, as well as the fees assessed to the parties for arbitration proceedings. FINRA has amended Rules 12214(a), 12601(b)(2), 13214(a) and 13601(b)(2) to require that if one or more parties request a postponement or cancellation within 10 days before a scheduled hearing session and the arbitrators grant the request, the party or parties making the request would pay a late cancellation fee of $600 per-arbitrator.1

      The amendments are effective for arbitration cases filed on or after July 6, 2015. The extended cancellation period and the increased late cancellation fee would not apply to parties whose cases were filed prior to the effective date.

      The text of the amendments is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •  Kenneth L. Andrichik, Senior Vice President, Chief Counsel, and Director of Mediation & Strategy, FINRA Dispute Resolution, at (212) 858-3915 or ken.andrichik@finra.org; or
      •  Mignon McLemore, Assistant Chief Counsel, FINRA Dispute Resolution, at (202) 728-8151 or mignon.mclemore@finra.org.

      Background & Discussion

      In FINRA arbitration, after the parties select arbitrators, the arbitrators hold an initial pre-hearing conference (IPHC)2 with the parties, usually by telephone, to discuss procedural issues, the mediation alternative, discovery and scheduling of hearings.3 In many cases, the hearing dates are selected months in advance, thus requiring arbitrators to reserve these dates and forego other opportunities that would result in a conflict with the scheduled dates. An arbitrator receives an honorarium payment only for participation in the hearing sessions that take place. A typical day in an arbitration case has two hearing sessions for which an arbitrator would receive $600 or $300 for each session.4

      Prior to the amendments, if a party or parties cancelled or postponed a hearing more than three business days before the start of a scheduled hearing, arbitrators did not receive an honorarium. Further, if the hearing was postponed or cancelled within three business days of the hearing, the arbitrators received a per-arbitrator honorarium of $100. Many arbitrators complained that the three-day cancellation period did not provide enough time to schedule other opportunities, and the $100 per-arbitrator fee did not adequately compensate them for their preparation time or anticipated income, now lost due to cancellation of the hearings. In light of the inconvenience and lost income to arbitrators that late cancellations cause, FINRA has amended the codes to increase the cancellation period and late cancellation fee to encourage parties to begin case preparation earlier and, when appropriate, to begin settlement discussions as soon as reasonably possible.

      Late Cancellations or Postponements

      Rules 12601 and 136015 permit parties and arbitrators to postpone6 hearings under certain circumstances, and establish fees, which the parties could incur, depending on the timing of the postponement request. Rules 12601(b)(2) and 13601(b)(2), which address late postponements, have been amended to require that parties give more advance notice before postponing or cancelling a hearing, or be assessed a higher late cancellation fee if such notice is not provided. Specifically, the amendments require that if a postponement or cancellation request is made by one or more parties within 10 calendar days7 before a scheduled hearing session and granted, the party or parties making the request must pay a late cancellation fee of $600 per arbitrator.

      Under the amendments, if a party or parties request a postponement more than 10 days before the start of a scheduled hearing session, the party or parties would not be assessed a late cancellation fee, regardless of when the arbitrators grant the request.8 Further, if the party or parties request a postponement of a group of consecutively scheduled hearing sessions within the 10-day cancellation period and the arbitrators grant the request, the party or parties making the request would be assessed the $600 per-arbitrator late cancellation fee for the first of the scheduled hearing sessions, not for each of the remaining scheduled hearing sessions that are cancelled.

      The following example illustrates how the rule will work. An arbitrator schedules the first of five consecutive hearing sessions to begin on Monday, March 15. If the party or parties' request postponement no later than Thursday, March 4, the party or parties would not be assessed the per-arbitrator fee because the request was made more than 10 days before the start of the first scheduled hearing session.9 If, however, the party or parties' request postponement on Monday, March 8, then the party or parties would be assessed the $600 per-arbitrator late cancellation fee because the request was made seven days prior to the first day of scheduled hearing sessions. The party or parties would not be assessed the per-arbitrator late cancellation fee for each of the four remaining scheduled hearing sessions that also have been postponed or cancelled.

      FINRA notes that arbitrators will notify the parties during the IPHC of the deadline by which the party or parties must request a postponement or cancellation to avoid the late cancellation fee, so that the parties can prepare their cases accordingly.

      Finally, as is current practice, arbitrators should assess the per-arbitrator fee, regardless of the reason for the request. The only exception will be in cases where extraordinary circumstances exist. FINRA recognizes that there are some extraordinary circumstances that could prevent a party from making a cancellation or postponement request in time to avoid the additional fee assessment (e.g., a serious accident or a sudden severe illness). In these cases, arbitrators will continue to have the discretion to waive the fee, provided they receive verification of such circumstances.10

      Effective Date

      The amendments are effective for arbitration cases filed on or after July 6, 2015. The extended cancellation period and the increased late cancellation fee would not apply to parties whose cases were filed prior to the effective date.


      Endnotes

      1. See Securities Exchange Act Release No. 34-75036 (May 22, 2015), 79 FR 30740 (May 29, 2015) (Order Approving File No. SR-FINRA-2015-003).

      2. After the panel is appointed, the Director of Dispute Resolution will schedule an initial prehearing conference for the parties and pane to meet to schedule the hearing dates, seta discovery schedule and provide a list of possible motions, for example. See Rules 12500 and 13500.

      3. A hearing is a meeting between the parties and the arbitrators of four hours or less to determine the merits of the arbitration. See Rules 12100(m) and 13100(m); see also 12100(n) and 13100(n).

      4. See Rules 12214(a) and 13214(a).

      5. Rules 12214 and 13214 govern payment of arbitrators and have also been amended, as they require FINRA to pay an honorarium to arbitrators in the event of a postponement under Rules 12601(b)(2) and 13601(b)(2).

      6. If the parties settle an arbitration case, hearings that were scheduled to occur after settlement are cancelled, and depending on the timing of the cancellation, could result in the assessment of a cancellation fee. See Rules 12902(d) and 13902(d).

      7. Under the codes, "day" is defined as a calendar day, not a business day. If a deadline specified in the code falls on a Saturday, Sunday or any FINRA holiday, the deadline is extended until the next business day. See Rules 12100(j) and 13100(j).

      8. For each postponement agreed to by the parties, or granted upon request of one or more parties, FINRA assesses a postponement fee to the parties, equal to the applicable hearing session fee. See Rules 12601(b)(1) and 13601(b)(1).

      9. If Thursday, March 4 falls on a FINRA holiday, the deadline would be extended to the next business day or March 5.

      10. See Rules 12601(b)(2) and 13601(b)(2). A waiver of the fee will not affect payment of the honorarium.


      Attachment A

      Customer Code

      12214. Payment of Arbitrators
      (a) Except as provided in paragraph (b) and in Rule 12800, FINRA will pay the panel an honorarium, as follows:
      •  no change;
      •  no change;
      •  no change; and
      •  $[100] 600 for each arbitrator if a hearing session other than a prehearing conference is postponed within [three business] 10 days before a scheduled hearing session pursuant to Rules 12601(a)(2) and (b)(2).
      (b)–(e) No change.
      12601. Postponement of Hearings
      (a) No change.
      (b) Postponement Fees
      (1) No change.
      (2) If a postponement request is made by one or more parties [and granted] within [three business] 10 days before a scheduled hearing session and granted, the party or parties making the request shall pay an additional fee of $[100] 600 per arbitrator. If more than one party requests the postponement, the arbitrators shall allocate the $[100] 600 per arbitrator fee among the requesting parties. The arbitrators may allocate all or a portion of the $[100] 600 per arbitrator fee to the non-requesting party or parties, if the arbitrators determine that the non-requesting party or parties caused or contributed to the need for the postponement. In the event that a request results in the postponement of consecutively scheduled hearing sessions, the additional fee will be assessed only for the first of the consecutively scheduled hearing sessions. In the event that an extraordinary circumstance prevents a party or parties from making a timely postponement request, arbitrators may use their discretion to waive the fee, provided verification of such circumstance is received.
      (3) No change.
      (c) No change.

      * * * * *

      Industry Code

      13214. Payment of Arbitrators
      (a) Except as provided in paragraph (b), Rule 13800, and Rule 13806(f), FINRA will pay the panel an honorarium, as follows:
      •  no change;
      •  no change;
      •  no change; and
      •  $[100] 600 for each arbitrator if a hearing session other than a prehearing conference is postponed within [three business] 10 days before a scheduled hearing session pursuant to Rules 13601(a)(2) and (b)(2).
      (b)–(e) No change.
      13601. Postponement of Hearings
      (a) No change.
      (b) Postponement Fees
      (1) No change.
      (2) If a postponement request is made by one or more parties [and granted] within [three business] 10 days before a scheduled hearing session and granted, the party or parties making the request shall pay an additional fee of $[100] 600 per arbitrator. If more than one party requests the postponement, the arbitrators shall allocate the $[100] 600 per arbitrator fee among the requesting parties. The arbitrators may allocate all or a portion of the $[100] 600 per arbitrator fee to the non-requesting party or parties, if the arbitrators determine that the non-requesting party or parties caused or contributed to the need for the postponement. In the event that a request results in the postponement of consecutively scheduled hearing sessions, the additional fee will be assessed only for the first of the consecutively scheduled hearing sessions. In the event that an extraordinary circumstance prevents a party or parties from making a timely postponement request, arbitrators may use their discretion to waive the fee, provided verification of such circumstance is received.
      (3) No change.
      (c) No change.

      * * * * *

    • 15-20 FINRA Requests Comment on a Concept Proposal to Restructure the Representative-Level Qualification Examination Program; Comment Period Expires: July 27, 2015

      View PDF

      Qualification Examinations Restructuring

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 8310
      NASD Rule 1031
      NASD Rule 1032
      NASD Rule 1070
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Senior Management
      Training
      Key Topics

      Central Registration Depository (CRD®)
      Content Outline
      Examination Restructuring
      General Knowledge Examination
      Qualification Examinations
      Registered Representatives
      Registration Rules
      Securities Industry Essentials Examination™ (SIE™)
      Series 6, 7, 11, 17, 22, 37, 38, 42, 55, 62, 72, 79, 82, 86, 87 and 99
      Specialized Knowledge Examinations

      Executive Summary

      FINRA is requesting comment on a concept proposal to restructure the current representative-level qualification examination program into a format whereby all potential representative-level registrants would take a general knowledge examination and an appropriate specialized knowledge examination to reflect their particular registered role. For purposes of this proposal, the general knowledge examination will be called the Securities Industry Essentials Examination (SIE). SIE content would include knowledge fundamental to working in the securities industry, such as basic product knowledge; structure and functioning of the securities industry markets, regulatory agencies and their functions; and regulated and prohibited practices. Individuals taking the SIE would not need to be associated with a FINRA member firm and a passing result on the SIE would be valid for four years. Each specialized knowledge examination would correlate to a current representative examination and registration position (e.g., Series 7 and General Securities Representative) and would test content specific to that registration category or job function. In addition, several of the current registration categories would be retired. This Notice seeks comment on the proposal from the industry and other interested persons.

      The draft SIE Content Outline is attached as Appendix A.

      Questions concerning this Notice should be directed to:

      •  Afshin Atabaki, Associate General Counsel, Office of General Counsel, at (202) 728-8902;
      •  Joe McDonald, Senior Director, Testing and Continuing Education Department, at (240) 386-5065; or
      •  Alexandra Toton, Qualifications Manager, Testing and Continuing Education Department, at (240) 386-4677.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by July 27, 2015.

      Comments must be submitted through one of the following methods:

      •  Emailing comments to pubcom@finra.org; or
      •  Mailing comments in hard copy to:

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      To help FINRA process comments more efficiently, persons should use only one method to comment on the proposal.

      Important Notes: All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.1

      Before becoming effective, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board of Governors, and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA or Exchange Act).2

      Background and Discussion

      FINRA administers qualification examinations that are designed to establish that persons associated with FINRA-regulated firms have attained specified levels of competence and knowledge pertinent to their function.

      The first of these examinations was the NASD Registered Representative Examination (Series 1) established in 1956.3 Over time, the examination program has increased in complexity to address the introduction of new products and functions, and related regulatory concerns and requirements.

      As a result, today, there are a large number of examinations, considerable content overlap across the representative-level examinations and requirements for individuals in various segments of the industry to pass multiple examinations.

      To address these issues, FINRA is seeking comment on a concept proposal to restructure the current representative-level qualification examination program into a more efficient format whereby all potential representative-level registrants would take a general knowledge examination and a tailored, specialized knowledge examination for their particular registered role. The proposed format would eliminate duplicative testing of general securities knowledge on examinations. As discussed below, FINRA is also evaluating the structure of the principal-level examinations and may propose to streamline this examination structure at a later time.

      A. Current Structure

      The current FINRA representative-level examination program consists of 16 examinations, including 10 that have been introduced during the past 20 years. There are 11 FINRA representative-level examinations that qualify individuals to engage in sales activities with investors. These are the:
      •  Investment Company and Variable Contracts Products Representative Examination (Series 6);
      •  General Securities Representative Examination (Series 7);
      •  Order Processing Assistant Representative Examination (Series 11);
      •  United Kingdom (U.K.) Securities Representative Examination (Series 17);
      •  Direct Participation Programs Representative Examination (Series 22);
      •  Canadian Securities Representative Examinations (Series 37 and Series 38);
      •  Options Representative Examination (Series 42);
      •  Corporate Securities Representative Examination (Series 62);
      •  Government Securities Representative Examination (Series 72); and
      •  Private Securities Offerings Representative Examination (Series 82).
      Each of these examinations focuses on testing a different set of products and was created in response to a federal law requirement, an identified regulatory need or an industry request.

      Six of these examinations—the Series 6, Series 22, Series 42, Series 62, Series 72 and Series 82—are associated with limited representative registrations. The Series 17, Series 37 and Series 38 are limited versions of the Series 7 for individuals who are in good standing as a representative of either the Financial Conduct Authority in the U.K., or with a Canadian stock exchange or securities regulator. Passing these examinations satisfies the examination requirements to obtain the U.K. Securities Representative or Canadian Securities Representative registration. If a representative does not engage in municipal securities activities, registration and qualification as a U.K. Securities Representative or Canadian Securities Representative is equivalent to registration and qualification as a General Securities Representative.

      The Order Processing Assistant Representative registration and associated Series 11 examination were created in 1990 for individuals whose sole function is to accept unsolicited orders (other than orders for municipal securities and direct participation programs) from existing customers. These individuals are not permitted to engage in any other activities requiring registration or to receive commissions. In addition, this is a standalone registration category in that an individual registered as an Order Processing Assistant Representative cannot be registered in any other registration category. Therefore, if an individual who is registered as an Order Processing Assistant Representative wants to move into another registered category, he or she must terminate his or her Order Processing Assistant Representative registration to obtain that new registration.

      The remaining five representative-level examinations are not related to sales activities. These are the:
      •  Equity Trader Examination (Series 55);
      •  Investment Banking Representative Examination (Series 79);
      •  Research Analyst Examinations (Series 86 and Series 87); and
      •  Operations Professional Examination (Series 99).
      B. Proposed Examination Structure

      Over the past year, FINRA conducted a review of the representative-level qualification examination program to identify alternative approaches to assessing the knowledge and competence of applicants for the various registration positions. In conducting the review, FINRA considered the following objectives:
      •  Reducing redundancy of subject matter content across examinations
      •  Identifying opportunities to simplify the qualification examination requirements
      •  Limiting the impact of any alternative structure on the registration rules
      •  Identifying and eliminating outdated registrations or registrations that now have limited utility and the qualifying examinations associated with these registrations
      In addition, the staff consulted with a number of outside groups, FINRA advisory committees and other self-regulatory organizations (SROs) to gather feedback on an alternative examination structure that would achieve the objectives noted above.

      As a result of this review and consultation process, FINRA is proposing to change its representative-level qualification examination program by creating a new structure consisting of a general knowledge examination called the Securities Industry Essentials Examination, or SIE, and a set of specialized knowledge examinations. Under this new structure, all individuals interested in pursuing employment as representative-level registrants would take the SIE. Individuals would not have to be associated with a FINRA member firm to be eligible to take the SIE. However, passing the SIE alone would not qualify an individual for registration with FINRA. An individual who has passed the SIE would also need to pass the appropriate specialized knowledge examination associated with the registration category pertaining to his or her job function to be eligible for registration with FINRA. If following an individual's registration with a firm, the job functions for which the individual is registered change at that firm and he or she needs to become registered in an additional or alternative representative-level position, he or she would not need to pass the SIE again. Rather, the registered individual would need to pass only the appropriate specialized knowledge examination for the additional or alternative representative-level position.

      Securities Industry Essentials Examination (SIE)

      The securities industry has become increasingly complex and sophisticated over the past 30 years. It is increasingly important for industry professionals to have a broad knowledge of the fundamental concepts and rules of the securities industry. The proposed SIE would bring together this subject matter into a single examination.

      The SIE would assess basic product knowledge; the structure and function of the securities industry markets, regulatory agencies and their functions; and regulated and prohibited practices. FINRA has prepared a draft SIE content outline for the purpose of gathering comment. The draft outline contains four proposed major topic areas. The first, "Knowledge of Capital Markets," focuses on topics such as types of markets and offerings, broker-dealers and depositories, and economic cycles. The second, "Understanding Products and Their Risks," covers securities products at a high level as well as associated investment risks. The third, "Understanding Trading, Customer Accounts and Prohibited Activities," focuses on accounts, orders, settlement and prohibited activities. The final section, "Overview of the Regulatory Framework," encompasses topics such as SROs, registration requirements and specified conduct rules. The draft SIE Content Outline is attached as Appendix A.

      FINRA anticipates that the SIE would include between 75 and 100 questions. FINRA intends for the questions to cover a broad range of industry content areas reflecting the diversity of regulatory agencies, securities products and regulated practices. The SIE content, examination length and passing score would be determined through the use of testing industry standards used to develop examinations and would include advice from a committee of individuals active in the securities industry.

      Eligibility to Take the SIE

      FINRA is proposing to permit individuals who are not associated with firms, including members of the general public, to take the SIE. Currently, only individuals associated with FINRA member firms are eligible to take FINRA qualification examinations. FINRA has received feedback that employment with a member firm would be more accessible if individuals were able to pass an introductory knowledge examination prior to becoming an associated person. FINRA believes that expanding who is eligible to take an examination will enable prospective securities industry professionals to demonstrate to prospective employers a basic level of knowledge prior to a job application. In addition, FINRA believes this approach would allow for more flexibility and career mobility within the securities industry.

      As is the case today, associated persons taking the SIE and any specialized knowledge examination would be subject to the Rules of Conduct4 and the current waiting periods for retaking a failed exam.5 Further, individuals taking the SIE who are not associated persons would have to agree to be subject to the same Rules of Conduct and waiting periods for retaking a failed exam.

      Expiration of SIE Results

      FINRA believes the knowledge covered by the SIE would be less likely to change than the content covered by the specialized knowledge examinations. For example, the definition of a stock or the purpose of an SRO is content that is not likely to change in the short term. Consequently, FINRA is proposing that a passing result on the SIE would be valid for four years.

      The following examples illustrate the application of the four-year period to different individuals:
      •  An individual who passes the SIE and is not associated with a FINRA member firm at the time would have up to four years to become associated with a member firm and pass a specialized knowledge examination to register with FINRA without having to retake the SIE.
      •  An individual who passes the SIE and is associated with a FINRA member firm at the time would have up to four years to pass a specialized knowledge examination to register with FINRA without having to retake the SIE.
      •  An individual holding a representative-level registration who leaves the industry would have up to four years to re-associate with a member firm without having to retake the SIE. However, if more than two years passes between the date an individual was last registered with FINRA as a representative and the date he or she reregisters as a representative, the individual would be required to take and pass an appropriate specialized knowledge examination to reregister with FINRA.
      The following examples further illustrate the interplay between the SIE and the specialized knowledge examinations with respect to a registered representative who leaves the securities industry:
      •  If a registered individual leaves the securities industry and then returns three years later, he or she would not have to retake the SIE, but he or she would need to pass an appropriate specialized knowledge examination to regain registration.
      •  If a registered individual leaves the securities industry and then returns five years later, he or she would have to pass the SIE and an appropriate specialized knowledge examination to regain registration.
      Specialized Knowledge Examinations

      To register as a new representative with FINRA, an associated person of a member firm would need to take and pass the SIE and a specialized knowledge examination appropriate to the desired registration. As noted above, an individual does not have to be associated with a member firm to take the SIE, but the individual must have passed the SIE within four years prior to passing the specialized knowledge examination. Individuals must be associated with a member firm to be eligible to take a specialized knowledge examination. Subject to the exceptions described below, each specialized knowledge examination would correspond to an existing representative-level examination, such as the current Series 7 examination, and would test knowledge of concepts and rules specific to the associated registration category. FINRA would consult with committees of subject matter experts from the industry to update the content outlines and develop specialized knowledge examinations excluding the content covered on the SIE.

      FINRA is proposing to develop specialized knowledge examinations for the following representative categories:
      •  Investment Company and Variable Contracts Products Representative
      •  General Securities Representative
      •  Direct Participation Programs Representative
      •  Equity Trader
      •  Investment Banking Representative
      •  Private Securities Offerings Representative
      •  Research Analyst
      •  Operations Professional
      FINRA anticipates that each specialized knowledge examination would be shorter than the current qualification examination that it would replace. For example, the specialized Series 7 examination for General Securities Representatives would likely include 100 to 150 questions instead of the 250 questions on the current Series 7 examination and the specialized Series 6 examination for Investment Company and Variable Contracts Products Representatives would likely include 50-75 questions instead of the 100 questions on the current Series 6 examination.6 However, the total number of questions on the SIE plus the applicable specialized knowledge examination could be greater than the current examinations.

      In addition, under the new structure, individuals seeking registration as an Equity Trader or Research Analyst would no longer be required to first register and qualify as a General Securities Representative or Corporate Securities Representative as currently applicable. Instead, such individuals would need to pass the SIE and corresponding specialized knowledge examination for Equity Trader or Research Analyst. Also, individuals seeking registration in two or more representative-level registrations would experience a net decrease in the total number of questions because the SIE content would be tested only once. For example, an individual who seeks registration as a General Securities Representative and an Investment Banking Representative today would take two examinations, the Series 7 and Series 79, totaling 425 questions. Under the proposed structure, an individual who seeks registration in the same categories would take the SIE, the specialized Series 7 examination and the specialized Series 79 examination, totaling between 300–350 questions.

      Examination Retirement

      As part of the restructuring, FINRA is proposing to retire the current registration categories of Options Representative, Corporate Securities Representative and Government Securities Representative as well as the associated examinations, the Series 42, Series 62 and Series 72, respectively. Each of these registrations currently allow an individual to sell a subset of the products (e.g., options, common stocks and corporate bonds, government securities) permitted to be sold by a General Securities Representative. In recent years, however, the utility of these registrations has diminished as a result of technological, regulatory and business practice changes. This is evidenced by the low annual volume for each of these examinations and the relatively low number of individuals who currently hold these registrations. Under the proposal, an individual who wants to engage in activities represented by these registration categories would register as a General Securities Representative.

      However, an individual registered in any of these categories at the time of the effective date of the proposal would be able to maintain his or her registration, provided that if the individual then terminates that registration and the registration remains terminated for more than two years, he or she would not be able to reregister in that category.

      Foreign Examinations

      FINRA is considering retiring the U.K. Securities Representative registration and associated Series 17 examination and the Canadian Securities Representative registrations and associated Series 37 and Series 38 examinations. However, FINRA is conducting an analysis of the relevant U.K. and Canadian registration and qualification requirements to determine whether there is sufficient overlap between the SIE and these registration and qualification requirements, so as to permit them to act as exemptions to the SIE. If FINRA determines that such exemptions are appropriate based on its review, individuals with the applicable U.K. or Canadian registrations and qualifications would need to pass only an appropriate specialized knowledge examination to register with FINRA for the function in which they intend to engage. FINRA believes that this approach would provide individuals who are associated with member firms and hold foreign registrations with more flexibility to obtain any FINRA representative-level registration.

      If FINRA were to adopt this approach, an individual registered as a U.K. Securities Representative or Canadian Securities Representative at the time of the effective date of the proposal would be able to maintain his or her registration. However, if the individual then terminates that registration for more than two years, he or she would not be able to reregister in that category. If such individual wishes to reregister with FINRA, the individual would be required to register as a General Securities Representative and pass the SIE and the specialized Series 7 examination. As described above, FINRA may determine that an individual's U.K. or Canadian registrations and qualifications qualify as an alternative to the SIE, in which case the individual in the example above would only have to pass the specialized Series 7 examination.

      Order Processing Assistant Representative Examination

      The Series 11 examination qualifies an individual to function as an Order Processing Assistant Representative. In recent years, the utility of this registration category has diminished as technological advances and changes in industry practice have reduced the need for Order Processing Assistant Representatives. As a result, the volume of candidates taking the Series 11 has diminished and today less than 200 member firms employ one or more Order Processing Assistant Representatives. Therefore, FINRA is proposing to retire the Order Processing Assistant Representative registration category and associated Series 11 examination.

      If FINRA were to retire the Order Processing Assistant Representative registration category and Series 11 examination, an individual registered in this category at the time of the effective date of the proposal would be able to maintain his or her registration. However, if the individual then terminates that registration and the registration remains terminated for more than two years, the individual would not be able to reregister in that category.

      Proposed Examination Structure at a Glance

      The following table illustrates the proposed changes to the representative-level examinations for those representative categories that FINRA is proposing to retain.

      Current Registration Category (and CRD Designation) Scope of Activities Current Examination(s) Proposed Examination(s)
      Investment Company and Variable Contracts Products Representative (IR) No change Series 6 SIE +Specialized
      Series 6
      General Securities Representative (GS) No change Series 7 SIE + Specialized
      Series 7
      Direct Participation Programs Representative (DR) No change Series 22 SIE + Specialized
      Series 22
      Equity Trader (ET) No change Series 7 or Series 62 + Series 55 SIE + Specialized
      Series 55
      Investment Banking Representative (IB) No change Series 79 SIE + Specialized
      Series 79
      Private Securities Offerings Representative (PR) No change Series 82 SIE + Specialized
      Series 82
      Research Analyst (RS) No change Series 7 + Series 86
      (Part I: Analysis) +
      Series 87
      (Part II: Regulatory Administration and Best Practices)
      SIE + Specialized
      Series 86
      (Part I: Analysis) +
      Specialized Series 87
      (Part II: Regulatory Administration and Best Practices)
      Operations Professional (OS) No change Series 99 SIE + Specialized
      Series 99


      The chart above does not include those registration categories that FINRA is considering retiring.

      Current Representative Registrants

      Under the proposal, representative-level registrants who are registered, or had been registered within the past two years, prior to the effective date of the proposal would be eligible to maintain those registrations without being subject to any additional requirements.7 Further, such individuals, with the exception of an Order Processing Assistant Representative, would be considered to have passed the SIE in the CRD system, and thus if they wish to register in any additional representative category after the effective date of the proposal, they could do so by taking only the appropriate specialized knowledge examination.8 However, with respect to an individual who is not registered on the effective date of the proposal but was registered within the past two years prior to the effective date of the proposal, FINRA will administratively terminate the individual's SIE status in the CRD system if such individual does not register with FINRA within four years from the date of the individual's last registration.

      In addition, an individual who had been registered as a representative within the past four years prior to the effective date of the proposal but whose registration lapsed for more than two years,9 with the exception of an Order Processing Assistant Representative, would also be considered to have passed the SIE and designated as such in the CRD system. Therefore, if such individual reregisters with a firm after the effective date of the proposal and within four years of having been previously registered, the individual would only need to pass the specialized knowledge examination associated with that registration position. Similarly, if such individual does not register with FINRA within four years from the date of the individual's last registration, FINRA will administratively terminate the individual's SIE status in the CRD system.

      Individuals currently registered as principals would not be impacted by this proposal and would have no additional requirements to maintain their principal registrations.

      The table below provides examples for the individuals described above who are registered as representatives at the time of the effective date of the proposal or who were previously registered as representatives prior to the effective date of the proposal.

      Examples Required Examination(s) Conditions
      An individual who is registered as an Investment Company and Variable Contracts Products Representative at the time the proposal becomes effective and who wishes to maintain that registration. None None
      An individual who is registered as an Investment Company and Variable Contracts Products Representative at the time the proposal becomes effective subsequently terminates that registration and one year after that termination date reregisters with another member firm in that same registration category. None The individual must reregister with a member firm within two years of his or her last registration to avoid having to take any examinations.
      An individual who is registered as an Investment Company and Variable Contracts Products Representative at the time the proposal becomes effective subsequently terminates that registration and three years after that termination date reregisters with another member firm in that same registration category. Specialized
      Series 6
      The individual must reregister with a member firm within four years of his or her last registration to avoid having to take the SIE.
      An individual who is registered as an Investment Company and Variable Contracts Products Representative at the time the proposal becomes effective subsequently terminates that registration and three years after that termination date reregisters with another member firm as a Direct Participation Programs Representative. Specialized
      Series 22
      The individual must reregister with a member firm within four years of his or her last registration to avoid having to take the SIE.
      An individual who is registered as an Investment Company and Variable Contracts Products Representative at the time the proposal becomes effective subsequently terminates that registration and five years after that termination date reregisters with another member firm in that same registration category. SIE and Specialized
      Series 6
      None
      An individual who is registered as an Investment Company and Variable Contracts Products Representative at the time the proposal becomes effective remains registered in that category, but also wishes to register as a General Securities Representative. Specialized
      Series 7
      None
      An individual who was last registered as an Investment Company and Variable Contracts Products Representative a year prior to the effective date of the proposal wishes to register in that same category after the effective date of the proposal. None The individual must reregister with a member firm within one year of the effective date of the proposal to avoid having to take any examinations.
      An individual who was last registered as an Investment Company and Variable Contracts Products Representative three years prior to the effective date of the proposal wishes to register in that same category after the effective date of the proposal. Specialized
      Series 6
      The individual must reregister with a member firm within one year of the effective date of the proposal to avoid having to take the SIE.
      An individual who was last registered as an Investment Company and Variable Contracts Products Representative three years prior to the effective date of the proposal wishes to register as a General Securities Representative after the effective date of the proposal. Specialized
      Series 7
      The individual must reregister with a member firm within one year of the effective date of the proposal to avoid having to take the SIE.
      An individual who was last registered as an Investment Company and Variable Contracts Products Representative five years prior to the effective date of the proposal wishes to register in that same registration category after the effective date of the proposal. SIE and Specialized
      Series 6
      None


      Examination Enrollment and Administration

      Under the proposal, member firms would continue to use the CRD system to request registrations for associated persons. Individuals would be able to schedule both the SIE and specialized knowledge examinations for the same day, provided the individual is able to reserve space at one of FINRA's designated testing centers.

      To enable individuals who are not associated with a member firm to take the SIE, FINRA is proposing to create an enrollment system that would allow such individuals to enroll and pay the SIE examination fee. This system would also be available to associated persons of member firms who are not required to be registered as representatives, but are asked by their firms to take the SIE.

      The enrollment system would provide individuals who are not associated persons with documentation (either in paper or electronic format) of a passing or failing result. In addition, firms would be able to view in the CRD system the passing status of individuals prior to their hiring an individual using the pre-registration functionality in the CRD system. Further, the CRD system would automatically obtain an individual's SIE passing result once a firm submits a Form U4 (Uniform Application for Securities Industry Registration or Transfer) and requests a registration for that individual.

      Examination Fees

      FINRA will conduct a pricing analysis to determine a fair and reasonable cost for the SIE. Examination fees for the specialized knowledge examinations would be based on a number of factors, including the length of each specialized knowledge examination. FINRA believes that the fee for the specialized knowledge examinations will be lower than that of their current corresponding examinations because the specialized knowledge examinations will be shorter in length. For example, FINRA anticipates that the fee for the specialized Series 7 examination will be less than the fee for the current Series 7 examination.
      C. Phased Implementation Approach

      FINRA is proposing to roll out the revised structure in two phases. The first phase would include the SIE and the specialized knowledge examinations for the Investment Company and Variable Contracts Products Representative, the General Securities Representative and the Investment Banking Representative registration categories, which represent the highest volume representative-level examinations. Assuming all necessary approvals, FINRA would like to roll out the first phase in the fourth quarter of 2016. FINRA would then roll out the second phase, which would include the remaining specialized knowledge examinations, during the first half of 2017.
      D . Principal-Level Registration Structure

      FINRA is currently evaluating the structure of the principal-level examinations and may propose to streamline this examination structure at a later time. The current proposal would not impact the principal-level registration categories. However, if the proposal is approved and once implemented, an unregistered individual who intends to register as a principal in a registration category that has a prerequisite representative-level examination requirement would have to take and pass the SIE, the appropriate specialized knowledge examination and the appropriate principal examination.
      E. Continuing Education

      The proposed examination structure does not affect the current continuing education requirements. Individuals who have passed the SIE but not a specialized knowledge examination and do not hold a registered position would not be subject to the continuing education requirements.
      F. Qualification Examination Waivers

      NASD Rule 1070 permits FINRA, in exceptional cases and where good cause is shown, to waive the applicable qualification examination and accept other standards as evidence of an applicant's qualifications for registration. Under the proposed examination structure, FINRA would consider examination waivers by a member firm for individuals associated with the firm who are seeking registration in a representative-level registration category. In this regard, FINRA would consider waivers of the SIE or both the SIE and specialized knowledge examination(s) for these individuals.
      G. Economic Impact Assessment

      As discussed above, the current qualification examination program structure has become overly complex, and the industry has raised concerns over what it sees as a proliferation of qualification examination requirements. FINRA believes that it has an opportunity to introduce some efficiency to the program. The proposal aims to reduce redundancy of subject matter content across examinations, simplify the qualification examination requirements, limit the impact of the alternative structure on the registration rules, and eliminate outdated registrations or registrations that now have limited utility and the qualifying examinations associated with these registrations. The proposal is also likely to expand the pool of potential employee candidates for FINRA member firms. Currently, only individuals associated with member firms are eligible to take FINRA qualification examinations. The new examination structure would permit the general public to take the SIE, enabling prospective securities industry professionals to demonstrate to prospective employers a basic level of knowledge prior to a job application.

      FINRA understands that the costs associated with this proposal would primarily fall upon FINRA itself to develop and implement the new examination structure. Further, FINRA has historically sought to establish its examination fees at a level that aligns with FINRA's financial objectives. Should FINRA adopt the examination structure proposed here, FINRA will conduct a pricing analysis to determine the examination fees for the SIE and specialized knowledge examinations and assess the potential impacts on member firms and individuals. The pricing analysis would be included in a rule filing with the SEC to set the examination fees for the SIE and the specialized knowledge examinations.

      Request for Comments

      FINRA seeks comments on the concept proposal. In addition to generally requesting comments, FINRA specifically requests comments on the questions below. FINRA requests data and quantified comments where possible.

      1. FINRA is proposing to move to a general knowledge examination and specialized knowledge examinations for the representative-level qualification examinations. Does moving to this type of structure make sense? Would it help member firms better manage and develop individuals?
      2. FINRA is proposing to create the SIE covering fundamental securities industry knowledge. Do you consider the content listed in the sample content outline to be common knowledge? Is there other knowledge not listed that you believe should be included on the SIE? What is an appropriate level of depth?
      3. FINRA is proposing to allow any individual, including an individual who is not associated with a member firm, to take the SIE. Further, a passing result on the SIE would be valid for four years. Does this approach make sense? Is four years a reasonable length of time for a passing result on the SIE examination to be valid?
      4. FINRA is proposing retiring the Options Representative, the Corporate Securities Representative and the Government Securities Representative registration categories and the associated Series 42, Series 62 and Series 72 examinations. Do you believe that FINRA should retain any of these examinations? If so, why? Should FINRA consider retiring any other representative-level registration categories that it is considering retaining under the proposal?
      5. FINRA is considering retiring the U.K. Securities Representative and the Canadian Securities Representative registration categories and the associated Series 17, Series 37 and Series 38 examinations and instead determine foreign qualifications that would exempt an individual from taking the SIE. Do you believe that this approach makes sense or should FINRA create specialized knowledge examinations for the Series 17, Series 37 and Series 38 similar to the other specialized knowledge examinations described in the proposal?
      6. FINRA is considering retiring the Order Processing Assistant Representative registration category and the associated Series 11 examination. Do you believe that there is utility in continuing to maintain this registration category and examination?
      7. Are there any other potential economic impacts of the proposal that need to be identified?
      8. Are there more effective ways to achieve the proposal's goals?
      9. How much of the fees for representative-level examinations are currently paid by member firms versus individuals? Would the proposal change the payment responsibilities? If so, how?

      1. FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.

      2. See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes, however, take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

      3. The Series 1 examination is now the General Securities Representative Examination (Series 7).

      4. Before taking an examination, FINRA requires each candidate to agree to the Rules of Conduct for taking a qualification examination. Among other things, the Rules of Conduct require each candidate to attest that he or she is in fact the person who is taking the examination. The Rules of Conduct also requires that each candidate agree that the examination content is the intellectual property of FINRA and that the content cannot be copied or redistributed by any means. If FINRA discovers that a candidate has violated the Rules of Conduct, the candidate will forfeit the results of the examination and may be subject to disciplinary action by FINRA.

      5. Pursuant to NASD Rule 1070 (Qualification Examinations and Waiver of Requirements), an individual who fails to pass an examination must wait 30 calendar days before retesting. Further, a 180-day waiting period is triggered upon three successive examination failures within a two-year period.

      6. The length of each specialized knowledge examination would be determined through the use of testing industry standards used to develop examinations and, in part, by the length of the SIE.

      7. Pursuant to NASD Rule 1031(c) (Requirement for Examination on Lapse of Registration), any person whose registration has been revoked pursuant to FINRA Rule 8310 (Sanctions for Violation of the Rules) or whose most recent registration as a representative or principal has been terminated for a period of two or more years immediately preceding the date of receipt by FINRA of a new application is required to pass a qualification examination for representatives appropriate to the category of registration as specified in NASD Rule 1032 (Categories of Representative Registration).

      8. Because the principal-level registration structure is still being reviewed, only individuals who have passed an appropriate representative-level examination would be considered to have passed the SIE. Registered principals who do not hold an appropriate representative-level registration would not be considered to have passed the SIE. For example, an individual who is registered solely as a FINOP (Series 27) today would have to take the Series 7 to become registered as a General Securities Representative. Under this proposal, in the futureth individual would have to pass the SIE and the specialized General Securities Representative examination to obtain registration as a General Securities Representative.

      9. See supra note 7.


      Appendix A

      Draft

      Securities Industry Essentials Examination (SIE)

      Content Outline

      Section 1: Knowledge of Capital Markets

      Market Structure

      •  Types of markets (e.g., securities, currency, electronic, secondary)
      •  Offerings:
      •  Public securities offering
      •  Private securities offering
      •  Initial public offering
      •  Secondary offering
      •  Types of tombstones
      •  Shelf registration
      •  Prospectus delivery requirements
      •  Types of broker-dealers
      •  Depositories and clearing facilities

      Factors That Affect the Securities Market

      •  Business and economic cycles (e.g., depression, recession, inflation)
      •  Bankruptcy
      •  The Federal Reserve Board's impact on business activity and market stability
      •  Monetary vs. fiscal policy
      •  Open market activities and impact on economy
      •  Different rates: interest rate, discount rate, federal funds rate
      •  International and economic factors

      Associated Rules

      •  FINRA Rule 4311—Carrying Agreements
      •  Securities Exchange Act of 1934 (SEA) Rule 15c3-1—Net Capital Requirements for Brokers or Dealers
      •  Securities Act of 1933, Section 7—Information Required in a Registration Statement
      •  Securities Act of 1933, Section 8—Taking Effect of Registration Statements and Amendments Thereto
      •  Securities Act of 1933, Section 10—Information Required in Prospectus
      •  Securities Act of 1933, Schedule A—Schedule of Information Required in Registration Statement
      •  Securities Act of 1933, Schedule B—Schedule of Information Required in Registration Statement
      •  Securities Act of 1933, Regulation D—Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933
      •  Securities Act of 1933, Rule 144—Persons Deemed Not to Be Engaged in a Distribution and Therefore Not Underwriters
      •  Securities Act of 1933, Rule 144A—Private Resales of Securities to Institutions
      •  Securities Act of 1933, Rule 145—Reclassification of Securities, Mergers, Consolidations and Acquisitions of Assets
      •  Securities Act of 1933, Rule 147—"Part of an Issue," "Person Resident," and "Doing Business Within" for Purposes of Section 3(a)(11)
      •  Securities Act of 1933, Rule 164—Post-Filing Free Writing Prospectuses in Connection with Certain Registered Offerings

      Section 2: Understanding Products and Their Risks

      Products

      •  Equities
      •  Common stock
      •  Preferred stock
      •  Control and restricted securities (SEC Rule 144)
      •  IPOs
      •  Penny Stocks
      •  Debt Securities
      •  Corporate bonds
      •  Treasuries
      •  Municipal bonds
      •  Characteristics (e.g., maturities, coupons, yields, callable features)
      •  Options
      •  Basic strategies (e.g., calls, puts)
      •  In-the-money, out-of-the-money
      •  Characteristics (e.g., expiration date, strike price, premium)
      •  Basic calculations (e.g., premiums, breakeven)
      •  Risks, approvals and disclosures
      •  Money Market Instruments
      •  Characteristics (e.g., maturity, net asset value (NAV), liquidity)
      •  Hedge Funds
      •  Basic structure and characteristics
      •  Direct Participation Programs (DPPs)
      •  Limited Partnerships
      •  Real Estate Investment Trusts (REITs)
      •  Exchange Traded Funds (ETFs)
      •  Investment Companies
      •  Types (e.g., closed-end, mutual funds, unit investment trusts (UITs), variable annuities)
      •  Characteristics (no load)
      •  Share classes
      •  Market timing
      •  Net asset value (NAV)
      •  Disclosures
      •  Costs and fees
      •  Non-U.S. Market Securities
      •  529 College Savings Plans

      Investment Risks

      •  Definition and identification of risk types (e.g., call, capital, currency, inflation, liquidity, political, reinvestment)

      Associated Rules

      •  FINRA Rule 2213—Requirements for the Use of Bond Mutual Fund Volatility Ratings
      •  FINRA Rule 2260—Disclosures
      •  FINRA Rule 2330—Members' Responsibilities Regarding Deferred Variable Annuities
      •  FINRA Rule 2342—"Breakpoint" Sales
      •  FINRA Rule 2360—Options
      •  MSRB Constitution and Rules, Rules G-1 through G-41 and Rules D-8 through D-12
      •  Investment Company Act of 1940 Rule 12b-1—Distribution of Shares by Registered Open-End Management Investment Company
      •  Investment Company Act of 1940, Section 3(a)—Definitions: "Investment Company"
      •  Investment Company Act of 1940, Section 4—Classification of Investment Companies
      •  Investment Company Act of 1940, Section 5—Subclassification of Management Companies
      •  SEA Rule 3a11-1—Definition of the Term "Equity Security"
      •  SEA Rule 10b-18—Purchases of Certain Equity Securities by the Issuer and Others
      •  SEC, Regulation M
      •  SEC, Regulation NMS

      Section 3: Understanding Trading, Customer Accounts and Prohibited Activities

      Trading, Settlement and Corporate Actions

      •  Trading orders and strategies: bid-ask, long and short, buy and sell, naked and covered, bearish and bullish
      •  Investment returns (e.g., dividends, interest, ordinary income, return of capital)
      •  Same day versus regular way settlement
      •  Standard settlement time frames for various products
      •  Dividends
      •  Stock splits and reverse stock splits
      •  Making adjustments for securities subject to corporate actions
      •  Processing customer instructions and special situations related to corporate actions
      •  Delivery of notices
      •  Corporate action deadlines
      •  Proxies and proxy voting

      Customer Accounts and Compliance Considerations

      •  Account Types (e.g., cash, margin)
      •  Margin:
      •  Margin, hypothecation and re-hypothecation
      •  Types of accounts that are permitted to trade on margin
      •  Account approvals
      •  Eligible/ineligible securities
      •  Required disclosures
      •  Federal and FINRA margin requirements, margin calls
      •  Types of customer account registrations
      •  Individual
      •  Joint
      •  Corporate
      •  Trust
      •  Custodial
      •  Individual retirement accounts (IRAs), 403b and other qualified plans
      •  "Know Your Customer" (KYC)
      •  Customer Identification Program (CIP) requirements
      •  Securities Investor Protection Corporation (SIPC)
      •  Federal Deposit Insurance Corporation (FDIC)
      •  Anti-Money Laundering (AML) compliance
      •  Structuring, layering and other money laundering activities
      •  Office of Foreign Asset Control (OFAC) and the Specially Designated Nationals and Blocked Persons (SDNs) list
      •  Financial Crimes Enforcement Network (FinCEN)
      •  Suspicious activity reports (SARs)

      Account Statements, Confirmations and Settlement

      •  Types of information that appear on an account statement
      •  Updating customer account records
      •  Time frame for providing statements
      •  Types of information that appear on a confirmation
      •  Confirmation delivery requirements, including electronic confirmations
      •  Non-trade confirmations/third party activity notices

      Prohibited Activities

      •  Market manipulation (e.g., marking the close, wash sales, matched orders)
      •  Insider trading
      •  Prohibited breakpoint sales
      •  Restrictions for associated persons purchasing IPOs
      •  Use of manipulative, deceptive or other fraudulent devices
      •  Improper use of customers' securities or funds and prohibitions against guarantees and sharing in customer accounts
      •  Prohibition against paying commissions to unregistered persons
      •  Falsifying or withholding documents
      •  Prohibited activities related to maintenance of books and records (e.g., falsifying records and improper maintenance/retention of records)

      Associated Rules

      •  FINRA Rule 2010—Standards of Commercial Honor and Principles of Trade
      •  FINRA Rule 2020—Use of Manipulative, Deceptive or Other Fraudulent Devices
      •  FINRA Rule 2040—Payments to Unregistered Persons
      •  FINRA Rule 2090—Know Your Customer
      •  FINRA Rule 2150—Improper Use of Customers' Securities or Funds; Prohibition Against Guarantees and Sharing in Accounts
      •  FINRA Rule 2210—Communications with the Public
      •  FINRA Rule 3220—Influencing or Rewarding the Employees of Others
      •  FINRA Rule 3240—Borrowing From or Lending To Customers
      •  FINRA Rule 3310—Anti-Money Laundering Compliance Program
      •  FINRA Rule 4200 Series—Margin
      •  FINRA Rule 4512—Customer Account Information
      •  FINRA Rule 5130—Restrictions on the Purchase and Sale of Initial Equity Public Offerings
      •  FINRA Rule 5210—Publication of Transactions and Quotations
      •  FINRA Rule 5220—Offers at Stated Prices
      •  FINRA Rule 5230—Payments Involving Publications that Influence the Market Price of a Security
      •  FINRA Rule 5250—Payments for Market Making
      •  FINRA Rule 5270—Front Running of Block Transactions
      •  FINRA Rule 5280—Trading Ahead of Research Reports
      •  FINRA Rule 5290—Order Entry and Execution Practices
      •  FINRA Rule 5310—Best Execution and Interpositioning
      •  FINRA Rule 5320—Prohibition Against Trading Ahead of Customer Orders
      •  FINRA Rule 6438—Displaying Priced Quotations in Multiple Quotation Mediums
      •  NASD Rule 2510—Discretionary Accounts
      •  NASD Rule 3040—Private Securities Transactions of an Associated Person
      •  NASD Rule 3050—Transactions for or by Associated Persons
      •  NYSE Rule 407—Transactions: Employees of Members, Member Organizations and the Exchange
      •  USA PATRIOT Act, Section 326—Verification of Identification
      •  Federal Reserve Board Regulation T
      •  SEA Rule 8c-1—Hypothecation of Customers' Securities
      •  SEA Section 11(d)—Trading by Exchange Members, Brokers and Dealers: "Prohibition on Extension of Credit by Broker-Dealer"
      •  SEA Rule 10b-5—Employment of Manipulative and Deceptive Devices
      •  SEA Rule 10b5-1—Trading on Material Nonpublic Information in Insider Trading Cases

      Section 4: Overview of the Regulatory Framework

      Regulatory Entities

      •  The Securities and Exchange Commission (SEC)
      •  Self-Regulatory Organizations (SROs)

      SRO Regulatory Requirements for Associated Persons

      •  Registration and Continuing Education
      •  SRO and state registration requirements (e.g., Blue Sky)
      •  FINRA registration requirements
      •  Failing to register an associated person
      •  Continuing education requirement (e.g., firm element, regulatory element)
      •  Employee Conduct and Reportable Events
      •  Reporting of certain events on the Form U4 and Form U5
      •  Outside business activities
      •  Private securities transactions
      •  Reporting of political contributions and consequences for exceeding dollar contribution thresholds
      •  Dollar/value limits for gifts and gratuities and noncash compensation
      •  Business entertainment in relation to other FINRA members firms
      •  Consequences of filing misleading information or omitting information
      •  Customer complaints
      •  Potential red flag

      Associated Rules

      •  FINRA By-Laws Article IV Section 6—Retention of Jurisdiction
      •  FINRA Rule 1000 Series—Member Application and Associated Person Registration
      •  FINRA Rule 1122—Filing of Misleading Information as to Membership or Registration
      •  FINRA Rule 2060—Use of Information Obtained in Fiduciary Capacity
      •  FINRA 2150—Improper Use of Customers' Securities or Funds; Prohibition Against Guarantees and Sharing in Accounts
      •  FINRA 2266—SIPC Information
      •  FINRA Rule 3270—Outside Business Activities of Registered Persons
      •  FINRA Rule 4513—Written Customer Complaints
      •  FINRA Rule 4330—Customer Protection: Permissible Use of Customers' Securities
      •  FINRA Rule 4530—Reporting Requirements
      •  FINRA Rule 5240—Anti-Intimidation/Coordination
      •  NASD Rule 1000 Series—Membership, Registration and Qualification Requirements
      •  NYSE Rule 401A—Customer Complaints
      •  MSRB Rule G-37—Political Contributions and Prohibitions on Municipal Securities

      Business

      •  SEC Regulation S-P—Privacy of Consumer Financial Information and Safeguarding Personal Information
      •  Securities Investor Protection Act of 1970

    • 15-19 FINRA Requests Comment on a Proposed Rule to Require Delivery of an Educational Communication to Customers of a Transferring Representative; Comment Period Expires: July 13, 2015

      View PDF

      Recruitment Practices

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 4512
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      Conflicts of Interest
      Customer Account Transfers
      Disclosure

      Executive Summary

      FINRA seeks comment on a proposed rule that would require a member firm that hires or associates with a registered representative (recruiting firm) to provide an educational communication to former retail customers who the member, directly or through the transferring representative, attempts to induce to transfer assets to the recruiting firm or who choose to transfer assets to the recruiting firm. The educational communication would highlight the potential implications of transferring assets to the recruiting firm and suggest questions a customer may want to ask to make an informed decision. The recruiting firm would be required to provide the educational communication at or shortly after the time of first contact with a former retail customer regarding the transfer of assets to the recruiting firm.

      The proposed rule text is available as Attachment A. The proposed educational communication is available as Attachment B.

      Questions regarding this Notice should be directed to:

      •  Philip Shaikun, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8451; or
      •  Jeanette Wingler, Assistant General Counsel, OGC, at (202) 728-8013.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by July 13, 2015.

      Comments must be submitted through one of the following methods:

      •  Emailing comments to pubcom@finra.org; or
      •  Mailing comments in hard copy to:

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      To help FINRA process comments more efficiently, persons should use only one method to comment on the proposal.

      Important Notes: All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.1

      Before becoming effective, the proposed rule change must be authorized for filing with Securities and Exchange Commission (SEC) by the FINRA Board of Governors and must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2

      Background & Discussion

      FINRA remains concerned that retail customers may not be aware of important factors to consider in making an informed decision whether to transfer assets to their transferring registered representative's new firm. Therefore, to provide former customers3 with a more complete picture of the potential implications of a decision to transfer assets to a new firm, FINRA is requesting comment on a proposed rule to require delivery of an educational communication that highlights key considerations in transferring assets to the recruiting firm, and the direct and indirect impacts of such a transfer on those assets.

      Prior Proposal

      In developing the proposed rule, FINRA considered the comments received in response to the initial proposal filed with the SEC in March 2014.4 The initial proposal included two components: (1) a disclosure obligation to former retail customers who the recruiting firm attempts to induce to follow a transferring registered representative; and (2) a reporting obligation to FINRA where a transferring representative receives a significant increase in compensation. The disclosure obligation would have required a member recruiting firm to disclose to former customers ranges of recruitment compensation that the representative has received or will receive in connection with moving firms and the basis for that compensation (e.g., asset-based or production-based). In addition, the initial proposal would have required disclosure if a former customer would incur costs to transfer assets to the member firm that would not be reimbursed by the member firm and if any of the former customer's assets were not transferrable to the recruiting firm. The initial proposal would have required disclosure for one year following the date the registered representative began employment or associated with the recruiting firm.

      Commenters to the initial proposal conveyed concerns about the proposal's competitive implications and operational aspects, as well as the effectiveness of the proposed compensation disclosures.5 In June 2014, FINRA withdrew the initial proposal to further consider the comments.6

      Revised Proposal

      FINRA requests comment on a proposed rule that would require delivery of a FINRA-created educational communication focused on key considerations for a customer who is contemplating transferring assets to the recruiting firm.7

      Content of Communication

      The educational communication would highlight the potential implications of transferring assets to the recruiting firm and suggest questions the customer may want to ask to make an informed decision regarding: (1) whether financial incentives received by the representative may create a conflict of interest; (2) assets that may not be directly transferrable to the recruiting firm and as a result the customer may incur costs to liquidate and move those assets or inactivity fees to leave them with his or her current firm; (3) potential costs related to transferring assets to the recruiting firm, including differences in the pricing structure and fees imposed between the customer's current firm and the recruiting firm; and (4) differences in products and services between the customer's current firm and the recruiting firm.8 The educational communication is intended to prompt a former customer to make further inquiries of the transferring representative (and, if necessary, the customer's current firm), to the extent that the customer considers the information important to his or her decision making.

      Delivery of Communication

      The proposed rule would require the educational communication to be provided at or shortly after the time of first contact with a customer regarding the transfer of assets to the recruiting firm. If the contact is in writing, the educational communication must accompany the written communication. If the contact is by electronic communication, the recruiting firm may hyperlink directly to the educational communication. If the first contact is oral, the educational communication must be sent to the customer within three business days or with any other communication sent by the recruiting firm to the former customer in connection with a potential transfer of assets, whichever is earlier. In addition, if the first contact is oral, the recruiting firm or representative must inform the former customer that he or she will be receiving a document that contains important considerations in determining whether to transfer assets to the recruiting firm.

      The proposed rule further would require the educational communication to be provided to a former customer who seeks to transfer assets to an account assigned, or to be assigned, to the representative at the recruiting firm absent contact (e.g., where a customer decides to transfer assets after learning from a general announcement or other sources that his or her registered representative has changed firms). In those circumstances, the communication must be included with the account transfer approval documentation. Although the proposal does not specify supervisory procedures, FINRA expects that firms can implement a system reasonably designed to achieve compliance with the delivery requirements through training, spot checks, certifications or other measures.

      The requirement to provide the communication would continue to apply for six months following the date that the registered representative begins employment or associates with the recruiting firm.

      The requirement to provide the communication would not apply when the former customer who the member or registered representative attempts to induce to transfer assets expressly states that he or she is not interested in transferring assets to the recruiting firm. If the former customer subsequently decides to transfer assets to the recruiting firm without further individualized contact within the period of six months following the date the registered representative begins employment or associates with the member, then delivery of the communication with the account transfer approval documentation is required.

      Reporting to FINRA

      The proposed rule does not include the reporting obligation to FINRA that was in the initial proposal. FINRA will instead consider potential customer harm resulting from recruitment compensation as part of its broader conflicts management review.

      FINRA believes the proposal is an effective and efficient alternative to the initial proposal that would achieve the regulatory objective of informing decisions by retail customers whether to transfer assets to the recruiting firm, while reducing the direct costs on firms to provide the educational communication and the operational challenges of the initial proposal. In place of mandating disclosure of the magnitude of recruitment compensation paid, the proposal would highlight in the educational communication that firms may pay financial incentives to recruit or retain representatives and encourage retail investors to consider whether the incentives may impact the advice they receive. FINRA also considered, as some commenters suggested, a general disclosure requirement of the fact of additional compensation received by a transferring representative. However, FINRA believes the revised proposal is a more effective approach; the educational communication allows for more context and explanation about financial incentives and is more likely to prompt a discussion with the transferring representative or current firm.

      Investor Testing

      FINRA tested the educational communication with a diverse group of retail investors. In general, the investors indicated that the educational communication effectively conveyed important and useful information. Investors also indicated that the communication identified issues to consider that they had previously been unaware of and that would be meaningful in making a decision whether to transfer assets to the representative's new firm.

      Economic Impacts

      The proposed rule is intended to provide investors with relevant information to make an informed decision whether to transfer assets to their representative's new firm. FINRA believes the proposed rule would enhance investor protection by alerting retail customers to important considerations that may impact their costs and investment objectives and performance. FINRA seeks comment on the usefulness of such a disclosure to a representative's former retail customers.

      FINRA recognizes that a member firm that hires or associates with a registered person would incur costs to comply with the proposed rules on an initial and ongoing basis. Member firms would need to establish and maintain written policies and procedures reasonably designed to ensure compliance with the proposed rule, including monitoring communications by the transferring representative and other associated persons of the recruiting firm with former retail clients of the representative. The compliance costs would likely vary across member firms based on a number of factors such as the size of a firm, the extent a firm hires registered representatives from other firms, and the effectiveness and application of existing procedures to the types of communications that must be monitored under the proposal. FINRA seeks comment about the specific sources of these costs, their magnitude and how the costs might differ with a firm's size, business model and other relevant factors.

      Request for Comment

      In addition to generally requesting comments, FINRA specifically requests comment regarding whether the proposed rule should:

      1. require any additional or alternative information be included in the educational communication;
      2. include a requirement that a customer affirm receipt of the educational communication at or before account opening at the recruiting firm;
      3. apply beyond former retail customers to all customers recruited by or assigned to the transferring representative during the six months after transfer to the recruiting firm; or
      4. apply to a time period different from the proposed six months following the date the registered representative associates with the recruiting firm.

      FINRA also specifically requests comments on the economic impact and expected beneficial results of the proposed rule.

      5. What direct costs for the recruiting firm will result from the proposed rule? How do these costs relate to a firm's size, business model or other relevant characteristics?
      6. What indirect costs will arise for the member recruiting firm or its transferring representatives? How do these costs relate to a firm's size, business model or other relevant characteristics?
      7. What benefits would result for individual investors and their agents? How extensive are these benefits?
      8. Are the costs imposed by the rule warranted by the potential benefit of the education communication to investors?
      9. Is the proposed rule well designed to inform investors regarding the potential conflicts of interest and the direct and indirect impacts of transferring assets to a new firm?
      10. How will the rule change business practices and competition among firms? Will these impacts differently affect small or specialized broker-dealers?

      We request quantified comments where possible.


      1. FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.

      2. See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes, however, take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

      3. The proposed rule would define the term "former customer" to mean any customer that had a securities account assigned to a registered person at the registered person's previous firm. The term shall not include an account of a non-natural person that meets the definition of an institutional account pursuant to FINRA Rule 4512(c). FINRA Rule 4512(c) defines institutional account to mean the account of: (1) a bank, savings and loan association, insurance company, or registered investment company; (2) an investment adviser registered either with the SEC under Section 203 of the nvestment Advisers Act of 1940 or with a state securities commission (or any agency or office performing like functions); or (3) any other person (whether a natural person, corporation, partnership, trust, or otherwise) with total assets of at least $50 million.

      4. See Securities Exchange Act Rel. No. 71786 (Mar. 24, 2014), 79 FR 17592 (Mar. 28, 2014) (SR-FINRA-2014-010).

      5. See the SEC's website for a list of commenters to the initial proposal.

      6. See Securities Exchange Act Rel. No. 72459 (June 30, 2014), 79 FR 36855 (June 30, 2014) (SR-FINRA-2014-010).

      7. The text of the proposed rule is set forth in Attachment A.

      8. See Attachment B.


      Attachment A

      Text of Proposed New FINRA Rule

      * * * * *

      2200. COMMUNICATIONS AND DISCLOSURES

      * * * * *

      2272. Educational Communication Related to Recruitment Practices and Account Transfers

      (a) Educational Communication Delivery Requirement

      A member that hires or associates with a registered person shall provide to a former customer of the registered person, individually, in paper or electronic form, an educational communication prepared by FINRA when (1) the member, directly or through that registered person, attempts to induce the former customer of that registered person to transfer assets or (2) the former customer of that registered person, absent inducement, transfers assets to an account assigned, or to be assigned, to the registered person at the member.
      (b) Means and Timing of Delivery
      (1) A member shall deliver the communication in paragraph (a) at the time of first individualized contact with a former customer by the registered person or the member that attempts to induce the former customer to transfer assets to the member.
      (A) If the contact is in writing, the written communication required in paragraph (a) must accompany the written communication. If the contact is by electronic communication, the member may hyperlink directly to the educational communication.
      (B) If the contact is oral, the member or registered person must notify the former customer orally that an educational communication that includes important considerations in deciding whether to transfer assets to the member will be provided not later than three business days after the contact. The educational communication must be sent within three business days from such oral contact or with any other documentation sent to the former customer related to transferring assets to the member, whichever is earlier.
      (2) If a former customer attempts to transfer assets to an account assigned, or to be assigned, to the registered person at the member, but no individualized contact with the former customer or inducement by the registered person or member occurs before the former customer seeks to transfer assets, the member shall deliver the educational communication in paragraph (a) to the former customer with the account transfer approval documentation.
      (3) The delivery of the communication required by paragraph (a) shall apply for a period of six months following the date the registered person begins employment or associates with the member.

      • • • Supplementary Material: ---------------

      .01 Definition. For the purpose of this Rule, the term "former customer" shall mean any customer that had a securities account assigned to a registered person at the registered person's previous firm. This term shall not include an account of a non-natural person that meets the definition of an institutional account pursuant to Rule 4512(c).
      .02 Express Rejection by Former Customer. The requirement in paragraph (a) shall not apply when the former customer who the member, directly or through that registered person, attempts to induce to transfer assets expressly states that he or she is not interested in transferring assets to the member. If the former customer subsequently decides to transfer assets to the member without further individualized contact within the period of six months following the date the registered person begins employment or associates with the member, then the requirements of paragraph (b)(2) shall apply.

      * * * * *


      Attachment B



    • 15-18 SEC Approves Amendments to Arbitration Codes to Revise the Definitions of Non-Public and Public Arbitrator; Effective Date: June 26, 2015

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      Definitions of Non-Public and Public Arbitrator

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 12100
      FINRA Rule 13100
      Suggested Routing

      Compliance
      Legal
      Registered Representatives
      Key Topics

      Arbitration
      Codes of Arbitration Procedure
      Definitions of Non-Public and Public Arbitrator

      Executive Summary

      The SEC approved amendments to the definitions of non-public arbitrator and public arbitrator in the Customer and Industry Codes of Arbitration Procedure.1 The amended definitions provide, among other matters, that persons who worked in the financial industry for any duration during their careers will always be classified as non-public arbitrators, and persons who represent investors or the financial industry as a significant part of their business will also be classified as non-public, but may become public arbitrators after a cooling-off period. The amendments also reorganize the definitions to make them easier for arbitrator applicants and parties, among others, to determine the correct arbitrator classification.

      The amendments are effective on June 26, 2015.

      The text of the amendments is available at www.finra.org/notices/15-18.

      Questions concerning this Notice should be directed to:

      •  Todd Saltzman, Deputy Director of Case Administration, Dispute Resolution, at (212) 858-4273 or todd.saltzman@finra.org; or
      •  Margo A. Hassan, Associate Chief Counsel, Dispute Resolution, at (212) 858-4481 or margo.hassan@finra.org.

      Background & Discussion

      FINRA classifies arbitrators under the Customer and Industry Codes of Arbitration Procedure (codes) as either "non-public" or "public." FINRA Rules 12100 and 13100 define these terms. The non-public arbitrator definition lists affiliations that might qualify a person to serve as a non-public arbitrator at the forum and includes, among other matters, persons who work in the financial industry. Conversely, the public arbitrator definition itemizes affiliations that disqualify a person from serving as a public arbitrator at the forum. FINRA classifies persons who do not have any significant affiliation with the financial industry, and who do not have immediate family members who have a significant affiliation with the financial industry, as public arbitrators.

      FINRA amended the codes to provide, among other matters, that persons who worked in the financial industry for any duration during their careers will always be classified as non-public arbitrators, and persons who represent investors or the financial industry as a significant part of their business will also be classified as non-public, but may become public arbitrators if their business mix changes, after a cooling-off period. The amendments also reorganize the definitions to make them easier for arbitrator applicants and parties, among others, to determine the correct arbitrator classification. The key changes to the arbitrator definitions are highlighted below.

      Revisions to the Non-Public Arbitrator Definition

      FINRA amended the non-public arbitrator definition to:

      •  eliminate the five-year cooling-off period for financial industry employees to transition from the non-public arbitrator roster to the public arbitrator roster, thereby providing that FINRA will classify persons who worked in the financial industry, at any point in their careers, for any duration, as non-public;
      •  add two new categories of financial industry employees who may qualify as non-public, persons associated with a mutual fund or a hedge fund, and persons associated with an investment adviser;
      •  expand it beyond financial industry affiliates to also include professionals who regularly represent or provide services to investor parties in disputes concerning investment accounts or transactions;2 and
      •  adopt a standard cooling-off period of five years before specified persons may transition to the public arbitrator roster.

      Revisions to the Public Arbitrator Definition

      FINRA amended the public arbitrator definition to:

      •  add to the list of persons who are disqualified from serving as public arbitrators, attorneys, accountants, expert witnesses, or other professionals who earned significant revenue from representing or providing services to parties in disputes concerning investment accounts or transactions, or employment relationships within the financial industry;
      •  add to the list of persons who are disqualified from serving as public arbitrators, attorneys, accountants, or other professionals whose firms earned significant revenue from representing individual and/or institutional investors relating to securities matters;
      •  revise the cooling-off periods in the public arbitrator definition so that disqualified persons must wait five years after ending an affiliation based on their own activities, and two years after ending an affiliation based on someone else's activities, before they may be permitted to serve as public arbitrators (provided that another disqualification does not apply);
      •  decrease applicable permanent disqualification periods from 20 years to 15 years; and
      •  revise the definition of immediate family member to include more of the current societal relationships.

      Organizational Changes

      FINRA reorganized the arbitrator definitions to:

      •  remove confusing cross-references in the definitions to make it easier for staff, arbitrators and potential arbitrators, and parties to figure out the correct arbitrator classification; and
      •  separate the disqualifications in the public arbitrator definition into categories of those that are permanent versus those that are temporary, and those based on a person's own activities versus those based on the activities of others (e.g., others at a person's firm).

      Effective Date

      The amendments are effective on June 26, 2015. The new definitions will apply to all lists of arbitrators for arbitrator selection that FINRA sends to parties on or after June 26, 2015. However, for cases in which FINRA sent lists prior to June 26, 2015, FINRA will not change the classification status of non-public and public arbitrators based on the new definitions, and will not grant challenges for cause based solely on an arbitrator's reclassification.


      1. See Securities Exchange Act Rel. No. 74383 (February 26, 2015), 80 Federal Register 11695 (March 4, 2015) (File No. SR-FINRA-2014-028).

      2. Under the amendments, FINRA will reclassify these individuals as public arbitrators five years after their business mix changes. However, if their professional business mix keeps them on the non-public roster because of this rule for a total of 15 years, the non-public designation becomes permanent.

    • 15-17 Guidance on Rules Governing Communications With the Public

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      Communications With the Public

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      Guidance
      Suggested Routing

      Advertising
      Compliance
      Investment Companies
      Legal
      Registered Representatives
      Senior Management
      Key Topic(s)

      Advertising
      Communications with the Public
      Referenced Rules & Notices

      FINRA Rule 2210
      FINRA Rule 2310
      Investment Company Act Rule 34b-1
      NTM 06-48
      Regulatory Notice 12-02
      Regulatory Notice 13-03
      Securities Act Rule 482
      Securities Act Rule 497

      Background and Discussion

      In April 2014, FINRA launched a retrospective review of its communications with the public rules to assess their effectiveness and efficiency. In December 2014, FINRA published a report on the assessment phase of the review.1 The report concluded that, while the rules have met their intended investor protection objectives, they could benefit from some updating to better align the investor protection benefits and the economic impacts. To this end, FINRA staff recommended a combination of rule proposals, guidance and administrative measures.

      Pursuant to these recommendations, FINRA has published additional questions and answers on the Advertising Regulation page on the FINRA website. These questions and answers supplement previously published guidance.2

      Questions concerning this Notice should be directed to:

      •   Thomas A. Pappas, Vice President, Advertising Regulation, at (240) 386-4553;
      •   Joseph P. Savage, Vice President and Counsel, Regulatory Policy, at (240) 386-4534; or
      •   Amy C. Sochard, Senior Director, Advertising Regulation, at (240) 386-4508.

      1 See Retrospective Rule Review Report: Communications with the Public (December 2014).

      2 See Regulatory Notice 13-03 (January 2013).

    • 15-16 FINRA Requests Comment on Proposed Amendments to Rules Governing Communications With the Public; Comment Period Expires: July 2, 2015

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      Communications With the Public

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 2210
      FINRA Rule 2213
      FINRA Rule 2214
      Suggested Routing

      Advertising
      Compliance
      Investment Companies
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topic(s)

      Advertising
      Communications with the Public
      Supervision

      Executive Summary

      FINRA is soliciting comment on proposed amendments to the FINRA rules governing communications with the public. The proposed amendments would revise the filing requirements in FINRA Rule 2210 (Communications with the Public) and FINRA Rule 2214 (Requirements for the Use of Investment Analysis Tools) and the content and disclosure requirements in FINRA Rule 2213 (Requirements for the Use of Bond Mutual Fund Volatility Ratings).

      The proposed rule text is attached as Attachment A.

      Questions concerning this Notice should be directed to:

      •  Joseph E. Price, Senior Vice President, Corporate Financing/Advertising Regulation, at (240) 386-4623;
      •  Thomas A. Pappas, Vice President, Advertising Regulation, at (240) 386-4553; or
      •  Joseph P. Savage, Vice President and Counsel, Regulatory Policy, at (240) 386-4534.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by July 2, 2015.

      Comments must be submitted through one of the following methods:

      •  Emailing comments to pubcom@finra.org; or
      •  Mailing comments in hard copy to:

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      To help FINRA process comments more efficiently, persons should use only one method to comment on the proposal.

      Important Notes: All comments received in response to this Notice will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.1

      Before becoming effective, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board of Governors, and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2

      Background and Discussion

      In April 2014, FINRA launched a retrospective review of its communications with the public rules to assess their effectiveness and efficiency. In December 2014, FINRA published a report on the assessment phase of the review.3 The report concluded that, while the rules have met their intended investor protection objectives, they could benefit from some updating to better align the investor protection benefits and the economic impacts. To this end, FINRA recommended a combination of rule proposals, guidance and administrative measures.

      Pursuant to these recommendations, FINRA initially is proposing amendments to the filing requirements in FINRA Rule 2210 and FINRA Rule 2214 and the content and disclosure requirements in FINRA Rule 2213.4

      Proposed Amendments

      New Firm Communications

      New FINRA member firms currently are required to file with FINRA retail communications used in any electronic or other public media at least 10 business days prior to use. This requirement extends for one year from the effective date of the firm's membership. This new firm filing requirement only applies to broadly disseminated retail communications, such as generally accessible websites, print media communications, and television and radio commercials.

      The new firm filing requirement predates the Internet, and today new firms primarily reach customers and potential customers through websites. Accordingly, the review of these websites has become the most important objective of this filing requirement. FINRA's comments on new firm filings typically focus on their websites, particularly the websites of new firms with novel or unusual business models. FINRA also believes that the requirement for new firms to file their retail communications at least 10 business days prior to use unnecessarily delays firms' abilities to communicate with the public without a corresponding investor protection benefit beyond what post-use review would provide.

      Accordingly, FINRA proposes to narrow the new firm filing requirement by requiring new firms to file only their websites and material changes to their websites within 10 business days of first use for a one-year period. FINRA intends to continue to review new firms' communications for adherence with applicable standards by focusing on new firms' websites after they are filed with FINRA, and reviewing applicants' websites as part of the new firm application process.

      Investment Company Shareholder Reports

      FINRA has required firms to file the manager's discussion of fund performance (MDFP) portion of a registered investment company shareholder report if the report is distributed or made available to prospective investors. FINRA has required the MDFP to be filed because firms sometimes distribute or make shareholder reports available to prospective investors to provide more information about the funds they offer, and thus FINRA has considered the MDFP to be subject to the filing requirement for investment company retail communications. Registered investment companies are also required to file their annual and semi-annual shareholder reports with the SEC.5

      Because investment companies already must file shareholder reports with the SEC, and because the MDFP typically presents less investor risk than other types of promotional communications concerning investment companies, FINRA proposes to exclude shareholder reports that have been filed with the SEC from the filing requirements. The rule already excludes prospectuses, fund profiles, offering circulars and similar documents that have been filed with the SEC. As such, FINRA believes it would be consistent to add shareholder reports that have been filed with the SEC to that list.

      Backup Material for Investment Company Performance Rankings and Comparisons

      Firms that file a retail communication for a registered investment company that contains a fund performance ranking or performance comparison must include a copy of the ranking or comparison used in the retail communication. When FINRA adopted this requirement, prior to the Internet, FINRA staff did not have ready access to the sources of rankings or comparisons. Today, this information typically is available online. FINRA therefore proposes to eliminate the requirement to file ranking and comparison backup material and instead expressly to require firms to maintain back-up materials as part of their records.

      Generic Investment Company Communications

      Firms must file within 10 business days of first use retail communications "concerning" registered investment companies. FINRA proposes to exclude from the filing requirements generic investment company retail communications that do not promote a particular fund or fund family. An example might include a communication that describes different mutual fund types and features but does not discuss the benefits of a specific fund or fund family.

      This type of material typically is intended to educate the public about investment companies in general or the types of products that a firm offers, and thus does not present the same risks of including potentially misleading information as promotional communications about specific funds or fund families. FINRA is proposing to require instead the filing of retail communications that "promote or recommend a specific registered investment company or family of registered investment companies."

      Investment Analysis Tools

      "Investment analysis tools" are interactive technological tools that produce simulations and statistical analyses that present the likelihood of various investment outcomes if certain investments are made or certain investment strategies or styles are undertaken. Firms that intend to offer an investment analysis tool must file templates for written reports produced by, or retail communications concerning, the tool, within 10 business days of first use. They also must provide FINRA with access to the tool itself, and provide customers with specific disclosures when they communicate about the tool, use the tool or provide written reports generated by the tool. In light of the investor protection afforded by other content standards and the requirement that firms provide access to the tools and their output upon request of FINRA staff, FINRA proposes to eliminate the filing requirements for investment analysis tool report templates and retail communications concerning such tools.

      Filing Exclusion for Templates

      Firms are not required to file retail communications that are based on templates that were previously filed with FINRA but changed only to update recent statistical or other non-narrative information. FINRA proposes to expand the template filing exclusion also to allow firms to include updated non-predictive narrative descriptions of market events during the period covered by the communication and factual descriptions of portfolio changes without having to refile the template.

      Bond Mutual Fund Volatility Ratings

      Firms may use retail communications that include ratings provided by independent third parties that address the sensitivity of the net asset value of an open-end management investment company's bond portfolio to changes in market conditions and the general economy, subject to a number of requirements. For example, these communications must be accompanied or preceded by the bond fund's prospectus and contain specific disclosures.

      Firms currently must file retail communications that include bond mutual fund volatility ratings at least 10 business days prior to first use, and withhold them from publication or circulation until any changes specified by FINRA have been made.

      Accordingly, FINRA proposes to modify some of the rule's requirements. Consistent with the filing requirements for other retail communications about specific registered investment companies, the proposal would permit firms to file these communications within 10 business days of first use rather than prior to use. The proposal also would streamline the content and disclosure requirements and eliminate the requirement that the rating could only be included in a retail communication that accompanies or is preceded by the bond fund's prospectus.

      Economic Impact Assessment

      The assessment phase of FINRA's retrospective review of the communications with the public rules concluded that these rules have been largely effective in meeting their investor protection goals but there are several areas where the investor protection benefits may not align with the associated economic costs. For example, the views expressed by the stakeholders during the assessment suggested that certain filing requirements (e.g., prior to use filing requirements for new members, filings of investment company shareholder reports or generic investment company communications, and filing requirements for investment analysis tools) may be too broad and the direct and indirect costs associated with such filings may be unnecessarily large.

      The amendments in this rule proposal are intended to address opportunities to better align the protections to investors with the associated risks of the activities and the costs of compliance.

      The proposed amendments would impact firms that are subject to the filing, content and disclosure requirements in this proposal. Approximately 770 firms filed communications material with FINRA in 2014. FINRA estimates that about 80 to 90 percent of these firms filed communications specific to the requirements in this proposal. These firms would be directly impacted by the proposed amendments.

      Anticipated Benefits

      The amendments will benefit firms by reducing their costs associated with the specific requirements in this proposal. These cost savings would include savings on filing fees from the proposed elimination or reduction in the scope of certain filing requirements.

      FINRA reviewed the communications filing history and related comments on the material filed in 2014. Based on this review, FINRA preliminarily estimates that, as a result of the proposed amendments, there would be a reduction in filings of new member communications of approximately 300 filings per year, a decrease in the filings of investment company shareholder reports of 5,000 filings per year, and a potential decline in the filings of generic investment company communications of approximately 3,000 filings per year. FINRA further estimates that the anticipated decline in filings related to investment analysis tools and filings of templates would be approximately 500 and 13,000 filings per year, respectively. Overall, FINRA estimates that as a result of the proposed amendments, the total communications material filed would decline by 21,800 filings per year. Accordingly, based on an average filing fee of $185 in 2014, FINRA estimates that the proposed amendments would reduce the filing fees for firms by approximately $4 million per year.

      In addition to this reduction in filing fees, firms would likely also benefit from a decrease in other direct costs associated with filings, such as staff, systems and infrastructure costs, or third-party consulting fees associated with the requirements applicable to this proposal.

      The proposed amendments may also enable firms to communicate additional valuable information to investors (e.g., educational information about mutual funds in general or bond mutual fund volatility ratings), reduce disruption in the firms' marketing activities associated with filings of low-risk communications, and reduce barriers to entry for new firms by streamlining the filing requirement associated with new firm communications.

      The ability to provide additional educational material that permits investors to better understand the relative risks, costs, strategies and historical performance of mutual funds may generate a benefit to the public.

      Anticipated Costs

      Firms that are subject to the filing, content and disclosure requirements in this proposal would likely incur costs associated with updating their policies and procedures. These costs would include training their advertising review and other staff. Firms may also need to update their systems to reflect changes in the filing requirements. FINRA, however, anticipates that these costs would likely be minimal relative to the cost savings from the proposed amendments.

      FINRA would also incur costs associated with updating its internal systems as well as training the relevant staff on the amendments in the proposal.

      Other Economic Impacts

      The proposed exclusions and streamlining of filing requirements would not diminish investor protection because the applicable communications are either already subject to other regulatory reviews or pose little risk to investors, or FINRA believes that investors can still be protected through a post-use rather than a pre-use filing requirement. For example, investment company shareholder reports are already filed with the SEC and subject to regulatory review, and generic investment company retail communications or non-predictive narrative descriptions about market events in report templates are low-risk communications. Accordingly, excluding such communications from the filing requirements would not compromise investor protection.

      FINRA notes that some firms choose to file some mutual fund communications on a voluntary basis. Firms that choose to do so base their decision on business needs and not FINRA requirements. This proposal would not limit the ability of firms to continue to make voluntary filings if they should deem them to be valuable.

      Request for Comment

      FINRA requests comment on all aspects of the proposed amendments to the rules governing communications with the public, including the appropriate scope of these amendments and potential impacts on member firms, associated persons and the public. FINRA requests that commenters provide empirical data or other factual support for their comments whenever possible. FINRA specifically requests comments concerning the following issues:

      •  In addition to the economic impacts identified in this proposal, are there other significant sources of impacts, including direct or indirect costs and benefits, of the proposed amendments? What are these economic impacts and what factors contribute to them? Please provide data or other supporting evidence.
      •  Do firms anticipate altering the delivery method or content of their communications material as a result of the proposed amendments? If so, how would the firms alter their communications with the public?
      •  Are there other alternative approaches FINRA should consider to accomplish the goals described in this proposal? If so, what are those alternatives and why are they better suited?
      •  Will firms continue to file communications voluntarily? What is an estimate of the amount of materials that might continue to be filed voluntarily? Why might firms continue to file materials that would be exempt from filing under this proposal?

      1. FINRA will not edit personal identifying information, such as names or email addresses, from submissions. Person should submit only information that they wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.

      2. See SEA Section 19 and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes, however, take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

      3. See Retrospective Rule Report, Communications with the Public, December 2014.

      4. Stakeholders commenting on the retrospective rule review also recommended that FINRA revise Rule 2210's content standards to address other issues, such as the amount of disclosure required in communications with the public, the standards applicable to the presentation of performance, and the standards governing online, mobile and social media communications. FINRA is considering whether to propose additional changes to Rule 2210 in response to these comments.

      5. See Section 30 of the Investment Company Act of 1940 and Rules, 30b1-1 and 30b2-1 thereunder.


      ATTACHMENT A

      Below is the text of the proposed rule change. Proposed new language is underlined; proposed deletions are in brackets.

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      2000. DUTIES AND CONFLICTS

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      2200. COMMUNICATIONS AND DISCLOSURES

      2210. Communications with the Public

      (a) No Change.
      (b) Approval, Review and Recordkeeping
      (1) through (3) No Change.
      (4) Recordkeeping
      (A) Members must maintain all retail communications and institutional communications for the retention period required by SEA Rule 17a-4(b) and in a format and media that comply with SEA Rule 17a-4. The records must include:
      (i) a copy of the communication and the dates of first and (if applicable) last use of such communication;
      (ii) the name of any registered principal who approved the communication and the date that approval was given;
      (iii) in the case of a retail communication or an institutional communication that is not approved prior to first use by a registered principal, the name of the person who prepared or distributed the communication;
      (iv) information concerning the source of any statistical table, chart, graph or other illustration used in the communication; [and]
      (v) for any retail communication for which principal approval is not required pursuant to paragraph (b)(1)(C), the name of the member that filed the retail communication with the Department, and a copy of the corresponding review letter from the Department and;
      (vi) for any retail communication that includes or incorporates a performance ranking or performance comparison of a registered investment company, a copy of the ranking or performance used in the retail communication.
      (B) Members must maintain all correspondence in accordance with the record-keeping requirements of Rules 3110.09 and 4511.
      (c) Filing Requirements and Review Procedures
      (1) Requirement for Certain Members to File Retail Communications
      (A) For a period of one year beginning on the date reflected in the Central Registration Depository (CRD®) system as the date that FINRA membership became effective, the member must file with the Department [at least] within 10 business days [prior to] of first use [any retail communication that is published or used in any electronic or other public media, including] any generally accessible website[, newspaper, magazine or other periodical, radio, television, telephone or audio recording, video display, signs or billboards, motion pictures, or telephone directories (other than routine listings). To the extent any retail communication that is subject to this filing requirement is a free writing prospectus that has been filed with the SEC pursuant to Securities Act Rule 433(d)(1)(ii), the member may file such retail communication within 10 business days of first use rather than at least 10 business days prior to first use].
      (B) Notwithstanding the foregoing provisions, if the Department determines that a member has departed from the standards of this Rule, it may require that such member file all communications, or the portion of such member's communications that is related to any specific types or classes of securities or services, with the Department at least 10 business days prior to first use. The Department will notify the member in writing of the types of communications to be filed and the length of time such requirement is to be in effect. Any filing requirement imposed under this subparagraph will take effect 21 calendar days after service of the written notice, during which time the member may request a hearing under Rules 9551 and 9559.
      (2) Requirement to File Certain Retail Communications Prior to First Use

      At least 10 business days prior to first use or publication (or such shorter period as the Department may allow), a member must file the following retail communications with the Department and withhold them from publication or circulation until any changes specified by the Department have been made:
      (A) Retail communications concerning registered investment companies (including mutual funds, exchange-traded funds, variable insurance products, closed-end funds and unit investment trusts) that include or incorporate performance rankings or performance comparisons of the investment company with other investment companies when the ranking or comparison category is not generally published or is the creation, either directly or indirectly, of the investment company, its underwriter or an affiliate. Such filings must include a copy of the data on which the ranking or comparison is based.
      (B) Retail communications concerning security futures. The requirements of this paragraph (c)(2)(B) shall not be applicable to:
      (i) retail communications concerning security futures that are submitted to another self-regulatory organization having comparable standards pertaining to such retail communications; and
      (ii) retail communications in which the only reference to security futures is contained in a listing of the services of a member.
      [(C) Retail communications concerning bond mutual funds that include or incorporate bond mutual fund volatility ratings, as defined in Rule 2213.]
      (3) Requirement to File Certain Retail Communications

      Within 10 business days of first use or publication, a member must file the following communications with the Department:
      (A) Retail communications [concerning] that promote or recommend a specific registered investment company or family of registered investment companies (including mutual funds, exchange-traded funds, variable insurance products, closed-end funds, and unit investment trusts) not included within the requirements of paragraphs (c)(1) or (c)(2). [The filing of any retail communication that includes or incorporates a performance ranking or performance comparison of the investment company with other investment companies must include a copy of the ranking or comparison used in the retail communication.]
      (B) Retail communications concerning public direct participation programs (as defined in Rule 2310).
      [(C) Any template for written reports produced by, or retail communications concerning, an investment analysis tool, as such term is defined in Rule 2214.]
      ([D]C) Retail communications concerning collateralized mortgage obligations registered under the Securities Act.
      ([E]D) Retail communications concerning any security that is registered under the Securities Act and that is derived from or based on a single security, a basket of securities, an index, a commodity, a debt issuance or a foreign currency, not included within the requirements of paragraphs (c)(1), (c)(2) or subparagraphs (A) through ([D]C) of paragraph (c)(3).
      (4) Filing of Television or Video Retail

      If a member has filed a draft version or "story board" of a television or video retail communication pursuant to a filing requirement, then the member also must file the final filmed version within 10 business days of first use or broadcast.
      (5) Date of First Use and Approval Information

      A member must provide with each filing the actual or anticipated date of first use, the name, title and Central Registration Depository (CRD®) number of the registered principal who approved the retail communication, and the date that the approval was given.
      (6) Spot-Check Procedures

      In addition to the foregoing requirements, each member's written (including electronic) communications may be subject to a spot-check procedure. Upon written request from the Department, each member must submit the material requested in a spot-check procedure within the time frame specified by the Department.
      (7) Exclusions from Filing Requirements

      The following communications are excluded from the filing requirements of paragraphs (c)(1) through (c)(4):
      (A) Retail communications that previously have been filed with the Department and that are to be used without material change.
      (B) Retail communications that are based on templates that were previously filed with the Department the changes to which are limited to updates of more recent statistical or other non-narrative information and non-predictive narrative information that describes market events during the period covered by the communication or factual changes in portfolio composition.
      (C) Retail communications that do not make any financial or investment recommendation or otherwise promote a product or service of the member.
      (D) Retail communications that do no more than identify a national securities exchange symbol of the member or identify a security for which the member is a registered market maker.
      (E) Retail communications that do no more than identify the member or offer a specific security at a stated price.
      (F) Prospectuses, preliminary prospectuses, fund profiles, offering circulars, annual or semi-annual reports and similar documents that have been filed with the SEC or any state, or that is exempt from such registration, and free writing prospectuses that are exempt from filing with the SEC, except that an investment company prospectus published pursuant to Securities Act Rule 482 and a free writing prospectus that is required to be filed with the SEC pursuant to Securities Act Rule 433(d)(1)(ii) will not be considered a prospectus for purposes of this exclusion.
      (G) Retail communications prepared in accordance with Section 2(a)(10)(b) of the Securities Act, as amended, or any rule thereunder, such as Rule 134, and announcements as a matter of record that a member has participated in a private placement, unless the retail communications are related to publicly offered direct participation programs or securities issued by registered investment companies.
      (H) Press releases that are made available only to members of the media.
      (I) Any reprint or excerpt of any article or report issued by a publisher ("reprint"), provided that:
      (i) the publisher is not an affiliate of the member using the reprint or any underwriter or issuer of a security mentioned in the reprint that the member is promoting;
      (ii) neither the member using the reprint nor any underwriter or issuer of a security mentioned in the reprint has commissioned the reprinted article or report; and
      (iii) the member using the reprint has not materially altered its contents except as necessary to make the reprint consistent with applicable regulatory standards or to correct factual errors.
      (J) Correspondence.
      (K) Institutional communications.
      (L) Communications that refer to types of investments solely as part of a listing of products or services offered by the member.
      (M) Retail communications that are posted on an online interactive electronic forum.
      (N) Press releases issued by closed-end investment companies that are listed on the New York Stock Exchange (NYSE) pursuant to section 202.06 of the NYSE Listed Company Manual (or any successor provision).
      (O) Research reports as defined in NASD Rule 2711 that concern securities that are listed on a national securities exchange, other than research reports required to be filed with the Commission pursuant to Section 24(b) of the Investment Company Act.
      (8) Communications Deemed Filed with FINRA

      Although the communications described in paragraphs (c)(7)(H) through (K) are excluded from the foregoing filing requirements, investment company communications described in those paragraphs shall be deemed filed with FINRA for purposes of Section 24(b) of the Investment Company Act and Rule 24b-3 thereunder.
      (9) Filing Exemptions
      (A) Pursuant to the Rule 9600 Series, FINRA may exempt a member from the pre-use filing requirements of paragraph (c)(1)(A) for good cause shown.
      (B) Pursuant to the Rule 9600 Series, FINRA may conditionally or unconditionally grant an exemption from paragraph (c)(3) for good cause shown after taking into consideration all relevant factors, to the extent such exemption is consistent with the purposes of the Rule, the protection of investors, and the public interest.
      (d) through (g) No Change.

      * * * * *

      2213. Requirements for the Use of Bond Mutual Fund Volatility Ratings

      (a) Definition of Bond Mutual Fund Volatility Ratings

      For purposes of this Rule and any interpretation thereof, the term "bond mutual fund volatility rating" is a description issued by an independent third party relating to the sensitivity of the net asset value of a portfolio of an open-end management investment company that invests in debt securities to changes in market conditions and the general economy, and is based on an evaluation of objective factors, including the credit quality of the fund's individual portfolio holdings, the market price volatility of the portfolio, the fund's performance, and specific risks, such as interest rate risk, prepayment risk, and currency risk.
      (b) Prohibitions on Use

      Members and persons associated with a member may distribute a retail communication that includes [use]a bond mutual fund volatility rating [only in a communication that is accompanied or preceded by a prospectus for the bond mutual fund ("supplemental sales literature") and]only when the following requirements are satisfied:
      (1) The rating does not identify or describe volatility as a "risk" rating.
      (2) The retail communication[supplemental sales literature] incorporates the most recently available rating and reflects information that, at a minimum, is current to the most recently completed calendar quarter ended prior to use.
      (3) The criteria and methodology used to determine the rating must be based exclusively on objective, quantifiable factors. The rating and the Disclosure Statement that accompanies the rating must be clear, concise, and understandable.
      (4) The retail communication[supplemental sales literature] conforms to the disclosure requirements described in paragraph (c).
      (5) The entity that issued the rating provides detailed disclosure on its rating methodology to investors through a toll-free telephone number, a website, or both.
      (c) Disclosure Requirements
      [(1) Supplemental sales literature containing a bond mutual fund volatility rating shall include a Disclosure Statement containing all the information required by this Rule. The Disclosure Statement may also contain any additional information that is relevant to an investor's understanding of the rating.]
      [(2) Supplemental sales literature containing a bond mutual fund volatility rating shall contain all current bond mutual fund volatility ratings that have been issued with respect to the fund. Information concerning multiple ratings may be combined in the Disclosure Statement, provided that the applicability of the information to each rating is clear.]
      ([3]1) [All bond mutual fund volatility ratings shall be contained within the text of the Disclosure Statement.] The following disclosures shall be provided with respect to each [such] bond mutual fund volatility rating:
      (A) the name of the entity that issued the rating;
      (B) the most current rating and date of the current rating[, with an explanation of the reason for any change in the current rating from the most recent prior rating];
      (C) a link to, or website address for, a website that includes the criteria and methodologies used to determine the rating;
      ([C]D) a description of the rating in narrative form, containing the following disclosures:
      (i) a statement that there is no standard method for assigning ratings;
      [(ii) a description of the criteria and methodologies used to dete