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  • 2018

    • 18-31 SEC Staff Issues Guidance on Third-Party Recordkeeping Services

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      Third-Party Recordkeeping

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      •   SEA Section 17(a)
      •   SEA Rule 17a-3
      •   SEA Rule 17a-4
      Suggested Routing

      Compliance
      Finance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      Recordkeeping
      Third-Party Services

      Summary

      This Notice provides firms with information regarding recent guidance (the guidance) issued by staff of the SEC's Division of Trading and Markets (the SEC staff) regarding the use of recordkeeping services provided by third parties to preserve records pursuant to SEA Section 17(a) and SEA Rule 17a-4.1

      Questions concerning this Notice may be directed to:

      •   Kris Dailey, Vice President, Risk Oversight & Operational Regulation (ROOR), at (646) 315-8434 or Kris.Dailey@finra.org;
      •   Yui Chan, Senior Director, ROOR, at (646) 315-8426 or Yui.Chan@finra.org; or
      •   Ann Duguid, Senior Director, ROOR, at (646) 315-7260 or Ann.Duguid@finra.org.

      Background & Discussion

      The SEC staff recently issued guidance regarding contractual arrangements between broker-dealers and third-party recordkeeping service providers that include provisions permitting the third-party recordkeeping service providers to delete or discard the broker-dealer's records required to be preserved pursuant to SEA Rules 17a-3 and 17a-4, typically in response to non-payment by the broker-dealer of fees due under the contract.

      In the guidance, the SEC staff stated that SEA Rule 17a-4(i) provides that, if the records a broker-dealer is required to preserve pursuant to SEA Rules 17a-3 and 17a-4 are prepared or maintained by an outside service bureau, depository, bank which does not operate pursuant to paragraph (b)(2) of Rule 17a-3, or other recordkeeping service (each referred to in the guidance as a "service provider"), the service provider shall file with the Commission a written undertaking in form acceptable to the Commission, signed by a duly authorized person, to the effect that such records are the property of the broker-dealer required to preserve such records and will be surrendered promptly on request of the broker-dealer. The SEC staff stated that the service provider also must undertake that with respect to any books and records preserved on behalf of the broker-dealer, the service provider will permit examination of such books and records at any time or from time to time during business hours by representatives or designees of the Commission, and to promptly furnish to the Commission or its designee true, correct, complete and current hard copy of any or all or any part of such books and records.2

      In addition, the SEC staff stated that the Commission adopted paragraph (i) of Rule 17a-4 to assure the accessibility of broker-dealer records in situations where, for example, a service bureau refuses to surrender the records due to nonpayment of fees.3 The SEC staff stated that, in adopting paragraph (i), the Commission emphasized that the records of a brokerdealer must be available at all times for examination in order to assure the protection of customers. Prior to adopting paragraph (i), the Commission had found that, in situations where a broker-dealer or its service providers were experiencing financial difficulty, the records of the broker-dealer had not always been available to the broker-dealer or to the Commission.4 The SEC staff stated that, accordingly, contractual provisions that would permit, among other things, a service provider to delete or discard records in the event of non-payment by the broker-dealer are inconsistent with the retention requirements of SEA Rule 17a-4 and the undertaking requirements of paragraph (i) of Rule 17a-4. Moreover, the SEC staff stated that if a service provider deletes or discards broker-dealer records in a manner that is not consistent with the retention requirements of Rule 17a-4, such action would constitute a primary violation of the rule by the broker-dealer and may subject the service provider to secondary liability for causing or aiding and abetting the violation.

      FINRA advises members that use third-party recordkeeping service providers to review their contracts for compliance with the SEC staff's guidance.


      1. See letter from Michael A. Macchiaroli, Associate Director, Division of Trading and Markets, Securities and Exchange Commission, to Kris Dailey, Vice President, Risk Oversight & Operational Regulation, FINRA (April 12, 2018), available on the SEC's website [https://www.sec.gov/divisions/marketreg/mr-noaction.shtml#chron]. SEA Section 17(a) and SEA Rules 17a-3 and 17a-4 address among other things requirements as to records to be made and preserved by broker-dealers.

      2. See paragraph (i) of SEA Rule 17a-4.

      3. See footnote 4 of the guidance, citing in part to Exchange Act Release No. 13962 (September 15, 1977), 42 FR 47551 (September 21, 1977) (Rule Amendment: Recordkeeping by Brokers and Dealers) (amending SEA Rule 17a-4 to add paragraph (i) to the rule).

      4. See note 3.

    • 18-30 Enhancements to the REX System and Updates to Data and Other Requirements Applicable to Requests for Extensions of Time Under Regulation T and SEA Rule 15c3-3

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      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      •   FINRA Rule 4230
      •   Regulation T
      •   Regulatory Notice 18-07
      •   Regulatory Notice 17-12
      •   SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Legal
      Margin
      Operations
      Registered Representatives
      Risk
      Senior Management
      Systems
      Key Topics

      Extension of Time Requests

      Effective Date:

      December 3, 2018 (enhancements to the REX System to provide firms the ability to submit Securities Exchange Act (SEA) Rule 15c3-3(d)(4) extension of time requests via a batch file process and other updates to the extension of time request forms)

      February 25, 2019 (updates to data and validation requirements for extension of time requests under Regulation T and SEA Rule 15c3-3)

      Summary

      Effective on December 3, 2018, FINRA will update the Regulatory Extension (REX) system1 to improve the process for requesting extensions of time required under SEA Rule 15c3-3 and FINRA Rule 4210. Specifically, the changes will provide firms the ability to submit SEA Rule 15c3-3(d)(4) extension of time requests via a batch file process and add functionality to enhance the process by which firms request extensions of time under FINRA Rule 4230(a), SEA Rule 15c3-3(d), (m) and (h), and file the reports required under FINRA Rule 4230(b). Further, effective on February 25, 2019, firms will no longer be required to submit a customer's complete Social Security or tax identification number, and shall instead submit the last four digits of such numbers when requesting extensions of time under Rule 4230(a). In addition, FINRA is updating certain validation identifiers and validation criteria that will affect the extension timeframes available to meet Regulation T calls. These updates are further detailed in Appendix A of this Notice.

      Questions concerning this Notice may be directed to:

      •   Adam Rodriguez, Director, Credit Regulation, at (646) 315-8572 or adam.rodriguez@finra.org;
      •   Peter Grassi, Principal Specialist, Credit Regulation, at (212) 416-1786 or peter.grassi@finra.org; or
      •   Theresa Reynolds, Senior Credit Specialist, Credit Regulation, at (646) 315-8567 or theresa.reynolds@finra.org.

      Background & Discussion

      REX System Update

      FINRA is updating the REX system to provide firms the ability to submit SEA Rule 15c3-3(d) (4) extension of time requests via a batch file process. Currently, SEA Rule 15c3-3(d)(4) extension of time requests are submitted via the online request form in the REX system. Beginning December 3, 2018, firms will have the option to submit SEA Rule 15c3-3(d)(4) requests via a batch file process using the same REX batch XML file format that is used for Regulation T and SEA Rule 15c3-3(d), (m), and (h) related extension of time requests. To file SEA Rule 15c3-3 (d)(4) extension of time requests via the batch file process, firms must update the data fields in their batch XML file layout. Information about the batch filing process and the required changes is available at FINRA's REX technical page.

      Also effective on December 3, 2018, FINRA will modify the online forms used to submit extension of time requests and the reports required under FINRA Rule 4230. Certain data fields within the REX system have been modified, affecting how firms must submit requests for extensions of time related to Regulation T calls and SEA Rule 15c3-3 (d), (m) and (h) requirements. See the FINRA's REX technical page for further details regarding these changes.

      Beginning February 25, 2019, the following additional changes to the REX system will take effect:

      1. Firms will no longer be required to submit the customer's complete Social Security or tax ID number for Regulation T and SEA Rule 15c3-3 extension of time requests. In lieu, firms shall instead submit the last four digits of the customer's Social Security or tax ID number.
      2. Certain validation identifier numbers and validation criteria that affect the extension timeframes available to meet Regulation T calls have been modified. Specific details about these changes are included in Appendix A of this Notice.

      Firms may consult the REX technical page for further information about these changes.

      Testing: REX Customer Test Environment (CTE) — October 15, 2018

      To assist firms in preparing for the changes specified in this Notice, FINRA has created a REX CTE that firms may use to test their submission of extension of time requests and the reports required by FINRA Rule 4230(b). Firms may submit extension of time requests required by Regulation T and SEA Rule 15c3-3 via both the FINRA CTE Gateway online request form and the batch file process.

      FINRA will begin accepting test files through the REX batch file CTE on October 15, 2018. During the testing period, firms will have the ability to request reports of all extension requests submitted. The reports will be available the business day after the request is submitted. FINRA encourages firms to begin testing as soon as possible to ensure their readiness to file extension of time requests when the changes to the REX system are implemented on December 3, 2018, and February 25, 2019. Connectivity testing to the CTE for submissions of extension of time requests via the REX batch process will be available at https://filetransfer.ct.finra.org/ beginning October 8, 2018.

      To log into the FINRA CTE, firms must use their current FINRA Gateway user ID and password. Firms that encounter technical problems, or require a FINRA user ID and password, may contact the FINRA Help Desk at (800) 321-6273. Additional information about the test phase is included in Appendix B of this Notice. Firms may also consult the REX technical page.


      1. FINRA introduced the REX system in August 2010 and has implemented periodic updates as appropriate. These enhancements will not affect FINRA Rule 4210 extension of time requests noted in Regulatory Notice 18-07. See, e.g., Regulatory Notice 10-28 (June 2010) (Extension of Time Requests), Regulatory Notice 14-13 (March 2014) (REX System Update), Regulatory Notice 17-12 (Regulatory Extension (REX) System Update), and Regulatory Notice 18-07 (Extensions of Time Requests Relating to FINRA Rule 4210).

      Appendix A

      Extension
      Type
      Current
      Validation
      Identifier
      Current REX Message
      New
      Validation
      Identifier
      Beginning
      February
      25, 2019
      Updated REX Denial Message –
      Beginning February 25, 2019
      Reg T BR3530 For Reg T extension requests on New
      Issue Securities filed under code 008,
      the request shall be made between S+6
      business days and S+34 calendar days
      BR3530 For Reg T extension requests under
      code 008,
      1. If the settlement date is less than
      or equal to T+3 business days,
      the request shall be made on T+4
      business day, or
      2. If the settlement date is greater
      than or equal to T+4 business days,
      the request shall be made on the
      earlier of one business day after
      the date on which settlement is
      required to occur by the rules of the
      foreign securities market or T+35
      calendar days.
      Reg T BR3630 For Reg T requests other than New
      Issue Securities filed under code 008,
      the request shall be made between T+6
      business days and T+34 calendar days
      BR3630
      Reg T BR3520 For Reg T extensions requests on New
      Issue Securities filed under code 015,
      the request shall be made between S+4
      business days and S+35 calendar days
      BR3520 For Reg T extension requests on New
      Issue Securities under codes 012, 014,
      or 015, the request shall be made
      promptly after the securities have been
      made available and no later than T+35
      calendar days.
      Reg T BR3540 For Reg T extensions requests on New
      Issue Securities filed under code 015,
      the request shall be made between S+4
      business days and S+35 calendar days
      Reg T BR3620 For Reg T requests other than New
      Issue Securities filed under codes 012
      or 014, the request shall be made
      between T+4 business days and T+34
      calendar days
      BR3620 For Reg T extension requests other than
      New Issue Securities under codes 012,
      014, or 015, the request shall be made
      no later than T+35 calendar days.
      Reg T BR3615 For Reg T extension requests other
      than New Issue Securities filed under
      code 015, the request shall be made
      between T+4 business days and T+35
      calendar days

      Appendix B

      REX System Testing and Implementation Timeline
      Week Action
      October 8, 2018 Batch connectivity testing will be available at https://filetransfer.ct.finra.org/
      October 15 –
      November 23, 2018
      Testing cycle begins for the reporting requirement under FINRA Rule 4230 and
      for both online and batch filers for Regulation T and SEA Rule 15c3-3 extension
      of time requests. During this testing cycle, firms must submit the complete
      Social Security number or tax ID for Reg T and SEA Rule 15c3-3 extension
      of time requests. During this testing timeframe, the “current validation
      identifiers” listed in Appendix A will be in effect.
      November 29 – 30, 2018 Blackout period, extensions of time under Reg T and SEA Rule 15c3-3 will not
      be accepted.
      December 3, 2018 Implementation date of online form enhancements and the ability to file SEA
      Rule 15c3-3(d)(4) extension of time requests via the batch process. Firms must
      submit the complete Social Security number or tax ID for Reg T and SEA Rule 15c3-3
      extension of time requests until February 25, 2019.
      December 3, 2018 –
      February 18, 2019
      Testing Cycle continues for both online and batch filers for Regulation T and
      SEA Rule 15c3-3extension of time requests. During this testing cycle, firms
      must submit the last four digits of a customer's Social Security number or
      tax ID for Reg T and SEA Rule 15c3-3 extension of time requests. During this
      testing timeframe, the new validation identifiers listed in Appendix A will be in
      effect.
      February 18, 2019 End of testing cycle for Regulation T and SEA Rule 15c3-3 extension of time
      requests.
      February 18, 2019 Implementation date. Firms must submit the last four digits of a customer's
      Social Security or tax ID number for Regulation T and SEA Rule 15c3-3
      extension requests.

    • 18-29 FINRA Reminds Firms of Their Obligations When Effecting OTC Trades in Equity Securities on a Net Basis

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      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rules 2010 and 2020
      FINRA Rules 2121 and 2124
      FINRA Rules 5210, 5310 and 5320
      FINRA Rules 6282, 6380A, 6380B and 6622
      FINRA Rules 7130, 7230A, 7230B and 7330
      Securities Exchange Act Rule 10b-10
      Securities Exchange Act Rule 611
      Regulatory Notices 12-13 and 09-58
      Notices to Members 06-47, 99-65 and 95-67
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Key Topics

      Alternative Display Facility (ADF)
      Best Execution
      Interpositioning
      Net Transactions
      NMS Stocks
      OTC Reporting Facility (ORF)
      OTC Equity Securities
      Riskless Principal Transactions
      Trade Reporting
      Trade Reporting Facilities (TRFs)

      Summary

      FINRA is issuing this Notice to remind firms of their obligations under the FINRA trade reporting rules and other applicable FINRA and Securities and Exchange Commission (SEC) rules when effecting over-the-counter (OTC) trades in equity securities1 on a "net" basis.

      Questions regarding this Notice should be directed to:

      •   Patrick Geraghty, Vice President, Market Regulation, at (240) 386-4973 or patrick.geraghty@finra.org;
      •   Dave Chapman, Senior Director, Market Regulation, at (240) 386-4995 or dave.chapman@finra.org; or
      •   Lisa Horrigan, Associate General Counsel, Office of General Counsel, at (202) 728-8190 or lisa.horrigan@finra.org.

      Background & Discussion

      The term "net" trading generally refers to contemporaneous principal transactions where the initial and offsetting transactions are at different prices.2 For example, a firm trades on a "net" basis when it accumulates a position at one price and executes the offsetting trade with its customer or broker-dealer client at another price.3 These trades may otherwise be considered riskless principal transactions, except the initial and offsetting transactions are effected at different prices. As such, they do not constitute riskless principal transactions within the specific definition of that term under FINRA equity trade reporting rules.

      FINRA rules do not prohibit net trading or mandate the prices at which firms must execute the initial and offsetting transactions.4 However, if a firm chooses to trade on a net basis, it must comply with all applicable rules, including, but not limited to, the FINRA trade reporting rules, FINRA Rules 2124 (Net Transactions with Customers), 2121 (Fair Prices and Commissions), 5310 (Best Execution and Interpositioning) and 5320 (Prohibition Against Trading Ahead of Customer Orders), and SEC Rule 611 under Regulation NMS (Order Protection Rule). As discussed below, firms must apply all such rules based on the net price of the transaction.5

      Trade Reporting Requirements Applicable to Riskless Principal and Net Transactions

      As an initial matter, FINRA trade reporting rules require that when reporting OTC trades in equity securities to a FINRA facility,6 firms must report the price of the trade exclusive of commissions, mark-ups and mark-downs.7 The following example is set forth in the rules: Firm 1 sells as principal 100 shares to a customer at $40.10, which includes a $0.10 mark-up from the prevailing market at $40. Firm 1 must report 100 shares at $40.8

      In addition, FINRA trade reporting rules govern the reporting of riskless principal transactions, where the initial transaction and the offsetting transaction are effected at the same price.9 Firms can report OTC riskless principal transactions by submitting a single report to a FINRA facility for public dissemination purposes (or "tape" report) in the same manner as an agency transaction, marked with a "riskless principal" capacity indicator, excluding any commission or mark-up/mark-down.10 Alternatively, members can report an OTC riskless principal transaction by submitting two (or more, as necessary) reports: (1) a tape report to reflect the initial leg of the transaction with a capacity of principal; and (2) a non-tape (non-tape/non-clearing or non-tape/clearing-only) report to reflect the offsetting "riskless" leg of the transaction with a capacity of riskless principal.11 Where the tape report for an OTC riskless principal trade reflects a capacity of "principal," the non-tape report is required under FINRA trade reporting rules. Irrespective of the chosen reporting method, only one leg of a riskless principal transaction is reported for public dissemination purposes.

      As noted above, a net trade may otherwise be considered a riskless principal transaction, except that the initial and offsetting transactions are effected at different prices. As such, both transactions must be reported to a FINRA facility for public dissemination purposes.
      Net transaction example:

      Firm 1 receives a buy order and purchases the security from Firm 2 at $40. In the above example of a riskless principal transaction, the firm sells the security at $40 and charges a separate mark-up. In a net transaction, however, to satisfy the original buy order, Firm 1 sells the shares for $40.10 per share. In this example, both trades must be reported for public dissemination purposes: the trade at $40 between Firms 1 and 2, and the sale from Firm 1 to satisfy the original buy order at the net price of $40.10.

      Firms are reminded that they should not submit a second tape report if the offsetting transaction is at the same price as the initial transaction. Firms must report the trade price as reflected on their books and records, and customer or execution confirmations, etc., and are prohibited from reporting the offsetting leg of a riskless principal trade inclusive of commission or mark-up/mark-down to a FINRA facility for purposes of facilitating clearance and settlement of the trade at the all-inclusive price.

      Other FINRA and SEC Rules Applicable to Net Transactions

      In addition to the FINRA trade reporting rules, firms that execute OTC transactions on a net basis must comply with all other applicable FINRA and SEC rules, including, but not limited to, the rules discussed below. Firms are reminded that they must apply applicable FINRA and SEC rules based on the net, i.e., reported, price. In the net transaction example above, the net price of $40.10 is the execution price for purposes of determining compliance with applicable rules.

      Customer Disclosure Obligations. Market makers that trade with customers on a net basis have disclosure and consent obligations under FINRA rules. Specifically, FINRA Rule 2124 requires a market maker to provide disclosure to, and obtain consent from, a customer prior to executing a transaction with a customer on a net basis. The disclosure and consent requirements under the rule apply only to market makers and differ depending on whether the market maker is trading with an institutional or non-institutional customer.12

      For non-market makers, SEC Rule 10b-10(a) requires that firms disclose to customers, among other things, the difference between the price to the customer and the contemporaneous purchase (sale) price, where the firm, after having received an order to buy (sell) from a customer, purchases (sells) the security from another person to offset a contemporaneous sale to (purchase from) such customer.13 Because this differential is separately disclosed on a customer confirmation under SEC Rule 10b-10(a), FINRA Rule 2124 does not impose disclosure and consent obligations on non-market makers.

      SEC Rule 611 (Order Protection Rule). Firms trading on a net basis must comply with the Order Protection Rule, which requires trading centers to establish, maintain and enforce written policies and procedures reasonably designed to prevent the execution of trades at prices inferior to protected quotations displayed by automated trading centers, subject to applicable exceptions and exemptions. Accordingly, the net or reported price (i.e., $40.10 in the above example) must not be inferior to a protected quotation, unless an exception or exemption applies.

      SEC staff has provided the following guidance:
      Q: A broker-dealer buys a block of an NMS stock as principal from a customer. Consistent with the broker-dealer's understanding with its customer, the trade price reported to the relevant SRO is lowered by two cents per share to compensate the block trading desk for committing its capital. Does this "net price" determine the price of the trade for all purposes under Rule 611?
      A: Yes, the net price reported to the SRO (and thereafter disseminated in the Network data stream) is the price of the block trade for all purposes under Rule 611, such as determining whether a trade-through occurred and routing the necessary orders to execute against protected quotations to comply with the ISO exception.14

      Fair Prices. Firms trading on a net basis with a customer must comply with Rule 2121 (Fair Prices and Commissions), which provides that if a firm buys (sells) for its own account from (to) its customer, the firm shall do so at a price that is fair, taking into consideration all relevant circumstances, including market conditions with respect to the security at the time of the transaction, the expense involved and the fact that the firm is entitled to a profit. The rule further states, in pertinent part, that it shall be deemed a violation of Rules 2010 (Standards of Commercial Honor and Principles of Trade) and 2121 for a firm to enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security.15

      Best Execution and Interpositioning. Firms trading on a net basis for or with a customer or a customer of another broker-dealer must comply with Rule 5310. As FINRA has previously stated, FINRA rules do not prohibit firms from reporting trades at two different prices of what essentially is a riskless principal trade, assuming the firm is complying with best execution obligations.16 The net or reported price (i.e., $40.10 in the above example) is used for purposes of assessing a firm's compliance with its best execution obligations.

      Rule 5310(a)(1) requires a firm, in any transaction for or with a customer or a customer of another firm, to use "reasonable diligence" to ascertain the best market for a security and to buy and sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. The rule identifies five factors that are among those to be considered in determining whether the firm has used reasonable diligence: (i) the character of the market for the security, including price, (ii) the size and type of the transaction, (iii) the number of markets checked, (iv) the accessibility of the quotation, and (v) the terms and conditions of the order as communicated to the firm.17 Thus, factors of particular relevance in evaluating the offsetting transaction at the net or reported price may include the prevailing market price at the time of execution, as well as the terms and conditions of the order (e.g., whether the customer consented to trade on a net basis).

      Rule 5310 expressly applies to the handling of all customer orders, including those involving interposed third parties. Specifically, Rule 5310(a)(2) provides that in any transaction for or with a customer or a customer of another broker-dealer, no member firm shall interject a third party between the member firm and the best market for the security in a manner inconsistent with paragraph (a)(1) of the rule. Rule 5310(b) provides that when a member firm cannot execute directly with a market but must employ a broker's broker or some other means in order to ensure an execution advantageous to the customer, the burden of showing the acceptable circumstances for doing so is on the member firm. For example, Firm 1 receives a buy order from a customer and routes the order to Firm 2 for handling and execution. Firm 2 purchases the shares on an exchange at $10 and executes the order from Firm 1 at $10.01. Firm 1, in turn, provides the shares to its customer at $10.01, the price it received from Firm 2. In this example, Firm 1 must demonstrate compliance with Rule 5310, including that the interpositioning of Firm 2 was acceptable under the circumstances.18

      FINRA is reminding firms that, as discussed in Regulatory Notice 09-58 (October 2009), interpositioning that is unnecessary or that violates a firm's general best execution obligations—either because of unnecessary costs to the customer or improperly delayed executions—is prohibited. Thus, the rule prohibits interpositioning that adversely affects the customer, and the cost to the customer remains a central part of determining whether a firm has met its best execution obligations.19

      FINRA notes that pursuant to Rule 5310(e), the obligations under Rule 5310 exist not only where the firm acts as agent for the account of its customer but also where transactions are executed as principal. Rule 5310(e) further provides that such obligations are distinct from the reasonableness of commission rates, mark-ups or mark-downs, which are governed by Rule 2121 and its supplementary material.

      Prohibition Against Trading Ahead of Customer Orders. Firms are reminded that the net or reported price of a net transaction will trigger their Rule 5320 obligations. Rule 5320 provides that, except as otherwise provided in the rule, a firm that accepts and holds an order in an equity security from its own customer or a customer of another broker-dealer without immediately executing the order is prohibited from trading that security on the same side of the market for its own account at a price that would satisfy the customer order, unless it immediately thereafter executes the customer order up to the size and at the same or better price at which it traded for its own account.

      Firms are reminded that in determining their obligation to execute a customer order under Rule 5320, the "benchmark" price is the net or reported price (i.e., $40.10 in the above example)— not the reported price exclusive of the differential.20 For example, Firm 1 is holding a customer limit order to sell 100 shares of security ABCD at $40.05. If, using the net transaction example above, the firm sells 1,000 shares of ABCD to another customer on a net basis at $40.10 (having bought the shares at $40), the firm would be required to execute the customer limit order to sell 100 shares, because the firm has reported a principal trade (i.e., the trade at the net or reported price of $40.10) at a price that would satisfy the customer limit order at $40.05.21

      FINRA notes that the exception for riskless principal transactions under Rule 5320.03 does not apply to net trades, because, as discussed above, the initial and offsetting legs of a net transaction are effected at different prices.

      Inflated Trade Volume. FINRA has been advised that some firms may be improperly taking advantage of the net trade reporting requirements described above for the express purpose of inflating trading volume. Depending on the facts and circumstances, such conduct may be deemed a violation of FINRA rules, including, but not limited to, Rules 2010, 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices), 5210 (Publication of Transactions and Quotations) and 5310.

      Conclusion

      FINRA encourages firms to review their trading practices and policies and procedures, including written supervisory procedures, in the areas of trade reporting, customer disclosure and best execution and interpositioning, among others, to ensure that their net trading practices comply with applicable FINRA and SEC rules, including the rules discussed above.


      1. Specifically, this Notice applies to OTC trades in NMS stocks, as defined under Rule 600(b) of SEC Regulation NMS, and OTC equity securities, as defined under FINRA Rule 6420. This Notice does not apply to transactions in fixed income securities.

      2. See, e.g., FINRA, Trade Reporting Frequently Asked Questions, FAQ #304.1, which states:

      A net trade is a principal trade in which a brokerdealer, after having received an order to buy (sell) an equity security, purchases (sells) the security at one price and satisfies the original order by selling (buying) the security at a different price.

      3. See Securities Exchange Act Release No. 43103 (August 1, 2000), 65 FR 48774 (August 9, 2000) (Notice of Filing and Immediate Effectiveness of File No. SR-NASD-00-44).

      4. See, e.g., Notice to Members 99-65 (August 1999), Attachment A, #6.

      5. FINRA notes that certain rules applicable to net trading, for example, FINRA Rule 2124 and SEC Rule 10b-10 (Confirmation of Transactions), expressly distinguish between market makers and non-market makers and expressly apply only to transactions with or on behalf of a customer (i.e., a non-broker-dealer). Therefore, the discussion of these rules in this Notice necessarily focuses on market makers versus non-market makers and customer orders, as applicable.

      6. The FINRA facilities are the Alternative Display Facility (ADF) and two Trade Reporting Facilities (TRFs), which are used by firms to report OTC trades in NMS stocks, and the OTC Reporting Facility (ORF), which is used by members to report trades in OTC equity securities and transactions in restricted equity securities effected under Securities Act Rule 144A.

      7. See FINRA Rules 7130(d)(3), 7230A(d)(3), 7230B(d) (3) and 7330(d)(3).

      8. See FINRA Rules 6282(d)(3)(A), 6380A(d)(3)(A), 6380B(d)(3)(A) and 6622(d)(3)(A)

      9. For purposes of OTC transaction reporting requirements applicable to equity securities, a "riskless principal" transaction is a transaction in which a member, after having received an order to buy (sell) a security, purchases (sells) the security as principal and satisfies the original order by selling (buying) as principal at the same price (the offsetting "riskless" leg). Generally, a riskless principal transaction involves two trades, the execution of one being dependent upon the execution of the other; hence, there is no "risk" in the interdependent transactions when completed. See FINRA, Trade Reporting Frequently Asked Questions, FAQ #302.1.

      10. See Rules 6282(d)(3)(B), 6380A(d)(3)(B), 6380B(d) (3)(B) and 6622(d)(3)(B) (a riskless principal transaction shall be reported "excluding the mark-up or mark-down, commissionequivalent, or other fee"); see also NTMs 99-65 (August 1999), 99-66 (August 1999) and 00-79 (November 2000).

      11. Id.

      12. See Notice to Members 06-47 (September 2006).

      13. 17 CFR 240.10b-10(a)(2)(ii)(A). Subparagraph (B) of that Rule requires broker-dealers acting as principal in any other transaction in an NMS stock to disclose the reported trade price, the price to the customer in the transaction, and the difference, if any, between the reported trade price and the price to the customer.

      14. See SEC Responses to Frequently Asked Questions Concerning Rule 611 and Rule 610 of Regulation NMS, FAQ # 3.05.

      15. See Rule 2121.01.

      16. See Notice to Members 99-65 (August 1999) (stating that a firm is not precluded from accumulating a position at one price and executing the offsetting trade with the customer at another price, provided that such arrangement satisfies the member's best execution obligations).

      17. See Rule 5310; see also Regulatory Notice 12-13 (March 2012) and Regulatory Notice 09-58 (October 2009).

      18. FINRA notes that Firm 2 also has an obligation under Rule 5310 (i.e., a duty of best execution for the handling of the customer order from Firm 1).

      19. See Regulatory Notice 09-58 (October 2009).

      20. See, e.g., Notice to Members 95-67 (August 1995).

      21. NTM 95-67 also provides guidance for members that accept limit orders from customers that incorporate a commission or mark-up/markdown in the limit order price. For example, a customer enters a limit order to purchase security ABCD and requests that its total costs not exceed $10 per share, and the firm informs the customer that it charges a mark-up of $0.25. NTM 95-67 provides that the firm may continue to purchase for its own account at $10 without also executing the customer order, because the customer order would be deemed a limit order at $9.75. FINRA notes that this example is not a net transaction, as defined above, and the reported trade price of the customer limit order execution would be $9.75, which is exclusive of the mark-up.

    • 18-28 FINRA Requests Comment on a Proposal to Expand OTC Equity Trading Volume Data Published on FINRA's Website; Comment Period Expires: November 12, 2018

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      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 6110
      FINRA Rule 6160
      FINRA Rule 6170
      FINRA Rule 6480
      FINRA Rule 6610
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Key Topics

      Alternative Display Facility
      ATS Data
      NMS Stocks
      Non-ATS Data
      OTC Equity Securities
      OTC Reporting Facility
      Trade Reporting
      Trade Reporting Facilities (TRFs)

      Summary

      FINRA requests comment on a proposal to expand the summary firm data relating to over-the-counter (OTC) equity trading that FINRA publishes on its website by (1) publishing on a one-month delayed basis new monthly aggregate block-size trading data for OTC trades in NMS stocks executed outside an alternative trading system (ATS); (2) publishing aggregate non-ATS volume for all firms, by eliminating the existing de minimis exception; and (3) separately identifying firms' volume of trading on a single dealer platform (SDP), by requiring firms to use a unique market participant identifier (MPID) when reporting their SDP trades to FINRA.

      The proposed rule text is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Chris Stone, Vice President, Transparency Services, at (202) 728-8457;
      •   Brendan Loonam, Senior Director, Transparency Services, at (212) 858-4203; or
      •   Lisa Horrigan, Associate General Counsel, Office of General Counsel, at (202) 728-8190

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by November 12, 2018.

      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: 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. Generally, FINRA will post comments as they are received.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 SEA.2

      Background & Discussion

      To improve market transparency relating to trading occurring on ATSs, in June 2014, FINRA began publishing individual ATS volume information for equity securities on its website. In April 2016, FINRA expanded its transparency initiative by publishing the remaining equity volume executed OTC by member firms, including their trading activity in non-ATS electronic trading systems and internalized trades.

      FINRA publishes weekly OTC volume information (number of trades and shares) by ATS or firm and by security on a two-week or four-week delayed basis.3 FINRA also publishes aggregate non-ATS volume totals across all NMS stocks and OTC equity securities for each calendar month.4 For firms executing fewer than, on average, 200 non-ATS transactions per day during the reporting period, FINRA combines and publishes the volume for these firms on an aggregated non-attributed basis identified in the data as "de minimis firms."5 FINRA does not charge for this data.

      ATS and non-ATS volume information is derived directly from OTC trades reported to a FINRA equity trade reporting facility (i.e., the Alternative Display Facility, a Trade Reporting Facility or the OTC Reporting Facility). Firms that operate an ATS are required to obtain and use a single separate MPID for exclusive use for reporting trades occurring on the ATS.6 Non-ATS data is published at the firm level and not by individual MPID.

      In October 2016, FINRA further expanded its transparency initiative and began publishing monthly information on block-size trades in all NMS stocks occurring on ATSs. Data regarding ATS block-size trades is aggregated across all NMS stocks (i.e., there is no security-by-security block data), is for a time period of one month of trading, and is published no earlier than one month following the end of the month for which trading was aggregated. Rather than narrowly defining what constitutes a "block-size" trade for purposes of the published data, FINRA provides information on ATS trades using sharebased thresholds, dollar-based thresholds and thresholds that include both shares and dollar amount as follows:

      •   10,000 or more shares;
      •   $200,000 or more in dollar value;
      •   10,000 or more shares and $200,000 or more in dollar value;
      •   2,000 to 9,999 shares;
      •   $100,000 to $199,999 in dollar value; and
      •   2,000 to 9,999 shares and $100,000 to $199,999 in dollar value.

      For each of these categories, FINRA publishes monthly trade count and volume information for each ATS aggregated across all NMS stocks. As a convenience for users, FINRA also calculates and displays the average trade size and each ATS's rank as well as "ATS Block Market Share" (i.e., the proportion of each ATS's block-size trading volume in relation to total block-size trading by all ATSs) and "ATS Block Business Share" (i.e., the proportion of a particular ATS's overall trading volume that was done as block-size trades) and rankings of those metrics for each of the above categories.

      Proposal to Expand Published OTC Equity Trading Volume Data

      FINRA is proposing to expand the OTC equity trading volume data that FINRA publishes on its website as follows.

      First, FINRA is proposing to publish monthly aggregate non-ATS block-size trading data for all NMS stocks,7 which data is not currently published, on the same terms as current ATS block-size data. Specifically, monthly non-ATS block-size data would be published on a one-month delayed basis and would be broken down by firm.8 As with the current ATS block-size data, there would be no security-by-security block data and there would be no differentiation between Tier 1 and the remaining NMS stocks. In addition, non-ATS blocksize data would be published according to the current thresholds for publication of ATS block-size data set forth above.9 Non-ATS block information would be generated from trades reported to a FINRA equity trade reporting facility.

      FINRA believes that non-ATS block-size data would be beneficial to firms and the general public and provide interested parties with more detailed information on non-ATS trading activities, thus enhancing transparency in the OTC market.

      Second, as noted above, if a firm averages fewer than 200 non-ATS transactions per day across all securities during the reporting period, FINRA aggregates the firm's volume with that of similarly situated firms. FINRA is proposing to eliminate this de minimis exception and publish on an attributed basis each firm's aggregate non-ATS volume (number of trades and number of shares). Thus, there would no longer be a de minimis line item on the OTC (non-ATS) Firm Data page.

      Based on a review of trading data for the period from August 21, 2017, through April 22, 2018, FINRA determined that, on average, there are only 36 and 32 firms with attributed volume for Tier 1 NMS stocks and the remaining NMS stocks, respectively, on a weekly basis. For OTC equity securities during the same time period, there are, on average, only 37 firms with attributed volume on a weekly basis. By removing the de minimis category, on average 151 and 182 firms would have their aggregate non-ATS volume in Tier 1 and the remaining NMS stocks, respectively, published. For OTC equity securities, the number of firms that would have their aggregate non-ATS volume published, on average, is 126.

      Since a large number of small trades can add up to significant volume, FINRA believes that the data at the firm level may be more meaningful if each firm's volume is published, irrespective of size. FINRA notes that the de minimis exception would continue to apply for purposes of the security-specific non-ATS volume data. Thus, if a firm averages fewer than 200 non-ATS transactions per day in a given security during the reporting period, FINRA will continue to aggregate the firm's volume in that security with that of similarly situated firms and there will continue to be a de minimis line item on the OTC (non-ATS) Issue Data "Details" page.

      Third, FINRA is proposing to publish information regarding trading by firms through their SDPs. OTC dealer firms offer access to their SDPs to other brokers and active trading customers to provide an efficient way for these customers to execute trades directly with the dealer firm away from an exchange or ATS. Unlike a dark pool, where multiple buyers and sellers can interact and are matched anonymously, the dealer firm operating the SDP always represents either the buy or sell side of the trade on a proprietary basis. Thus, SDPs are electronic trading platforms in which firms are systematically interacting with order flow by dealing on their own accounts.

      SDPs are not registered ATSs, and as such, data relating to trades occurring on an SDP currently is published as part of (and hence indistinguishable from) the operating firm's OTC volume (i.e., non-ATS volume) data. FINRA proposes to separately identify volume data for SDPs in the published data on FINRA's website.

      To gather the SDP data, FINRA proposes to require firms that operate an SDP to obtain and use a unique MPID for purposes of reporting trades executed on the SDP to a FINRA equity trade reporting facility. A firm that already has a single MPID used solely for SDP transactions and no other transactions would be required to notify FINRA; the firm would not be required to obtain a new MPID. If a firm operates multiple SDPs, either directly or through another firm, consistent with the current ATS MPID requirement, it would be required to obtain a separate MPID for each of its SDPs irrespective of where that SDP activity may be situated. If an SDP is embedded in or linked to an ATS, the ATS should not report the SDP trades under the ATS MPID, but instead would report under the SDP MPID to ensure that SDP volume is not included in ATS volume.

      FINRA believes that the proposal will bring additional transparency to this part of the market, and much like with the ATS data, it would highlight important trading platforms firms use. If customers see a significant concentration of volume at a given SDP, it may help inform their order flow routing decisions related to that platform.

      Economic Impacts

      Except for the proposed requirement that firms use a unique MPID for trades occurring on SDPs, the proposal described above would not impose any additional requirements on firms because the data will be derived solely from trade reports submitted to the FINRA equity trade reporting facilities and already disseminated trade-by-trade on an anonymous basis through the securities information processors. In addition, because the data is available free of charge, FINRA does not believe that there would be any direct costs associated with the proposal—to firms, investors or data consumers. Thus, FINRA believes that the proposal would have minimal to no impact on firms with respect to systems development. At the same time, the proposal is anticipated to help market participants better understand the overall OTC trading of equities, by providing information that could be used in assessing where liquidity is concentrated and how order routing strategies could be improved. The proposal would provide additional transparency into OTC trading activity by expanding the availability of information about OTC block-size trading to non-ATS volume at no required cost to firms.

      FINRA believes that, by expanding transparency to all segments of the OTC equity market, the proposal would bridge gaps in information published across ATS versus non-ATS segments of the OTC equity market, thereby reducing any competitive distortions that may be associated with such information gaps.

      Firms that operate SDPs would incur costs associated with systems changes needed to incorporate a separate MPID for their SDP activity. However, FINRA believes that there is no alternative method of identifying SDP transactions on an automated basis (e.g., using an SDP "flag" or other modifier on trade reports) that would provide FINRA with the same degree of comprehensive, reliable information as requiring unique MPIDs, since MPIDs are used across FINRA trade reporting facilities. Some firms may choose to incur costs to verify the information FINRA publishes, but these cost are also likely to be minimal and are not required by the proposal.

      FINRA also considered information leakage concerns, i.e., whether a firm's proprietary trading strategy could be discerned from the published data. FINRA notes that there may be differences in non-ATS block-size trading and ATS block-size trading, e.g., the total number of shares traded in non-ATS block-size trades of 10,000 or more shares tends to be a significantly higher percentage of the overall non-ATS OTC activity as compared to ATS block activity. Nonetheless, given that the proposed non-ATS block-size trading data would be displayed at the firm aggregate level only, with no accompanying security level data, along with the delay in publication and FINRA's previous experience with the parallel publication of ATS OTC trading volume, FINRA believes that the proposal is a well-calibrated effort to reduce information leakage concerns and to provide market participants access to meaningful information on non-ATS trading activity.

      Request for Comment

      Current Proposals

      FINRA seeks comments on the proposals outlined above. Depending on the comments received, FINRA anticipates filing a proposed rule change with the SEC proposing to implement these proposals. In addition to general comments, FINRA specifically requests comments on the following questions:

      •   Would the proposals outlined above provide valuable information to the marketplace? If so, how do you intend to use the information in your operations (input into the routing algorithm, assessment of execution metrics)? Are there any areas outside operations, for example, in regard to investments in technology or connectivity, where such information may potentially impact firm-level decisions?
      •   What (if any) concerns do firms have about the proposals?
      •   What other economic impacts, including costs and benefits, might be associated with the proposals? Who might be affected and how?
      •   What would be an appropriate definition of SDP for purposes of the proposed unique MPID requirement?
      •   What types of activities should fall into the SDP category?
      •   For those firms that conduct both SDP and non-SDP activities, what should distinguish each type of activity within the firm?
      •   For firms that operate ATSs and SDPs, either directly or through another firm, how do firms structure these separate platforms and differentiate for operational and regulatory reporting purposes?
      •   Would data users find the breakdown of SDP data to be of interest or use to them?
      •   Should security-specific SDP data be subject to the de minimis threshold that currently applies to security-specific non-ATS data?

      Future enhancements

      In addition, FINRA is requesting comment on possible future enhancements to the OTC equity trading volume data published on FINRA's website. FINRA notes that such future enhancements would not be part of any proposed rule change to implement the set of current proposals discussed above, but would be proposed at a later time.

      First, should FINRA consider adopting a uniform publication delay across all equity securities, for example, by publishing weekly ATS and non-ATS data on a two-week delayed basis for all NMS stocks and OTC equity securities? Thus, the current four-week delay for NMS stocks that are not in Tier 1 of the Limit Up/Limit Down Plan and OTC equity securities would be shortened to two weeks, and volume data for NMS stocks would no longer be divided into two tiers and instead would be published in a single combined data set.

      •   Do commenters believe a two-week delay for all securities (i.e., all NMS stocks and OTC equity securities) would be appropriate? Is there an alternative uniform schedule for all securities (e.g., three-week delay) that commenters would suggest and why?
      •   Do commenters believe that the current four-week delay is still appropriate for less liquid securities (i.e., non-Tier 1 NMS stocks and OTC equity securities)?
      •   FINRA has heard from firms that the bifurcation of data relating to NMS stocks into two tiers may complicate the data sets for users. Do commenters agree? Do commenters see any value in continuing to bifurcate the NMS data?

      Second, should FINRA consider lowering the de minimis threshold for security-specific data? As noted above, a firm must average 200 non-ATS trades per day during the reporting period in a given security to have its volume attributed at the security level. Alternatively, should FINRA consider eliminating the de minimis threshold for non-ATS data altogether?

      •   Do commenters believe that the current threshold is appropriate? If not, is there an alternative threshold that FINRA should consider and why?
      •   What concerns would commenters have if the de minimis threshold for security specific data were eliminated altogether? For example, would there be a greater possibility for reverse engineering a firm's trading strategy, particularly with respect to more thinly traded securities, if FINRA were to no longer aggregate de minimis volume in the security-specific data?
      •   If FINRA were to eliminate the de minimis threshold for security-specific data, should FINRA nonetheless mask the identity of each firm with de minimis volume, e.g., Firm 1, Firm 2, in the published data?
      •   Do commenters feel that data masked in this way would still provide useful information to the marketplace?

      Third, are there additional statistical offerings that FINRA should consider in the future? For example, ATS heat maps could display time of execution clusters by ATS on average for the trading week. These heat maps could show whether certain ATSs are better able to execute more or larger trades in certain types of stocks (or specific stocks) at different times of the day (e.g., at the open or the close). Another potential offering could be unique Top 10 lists for the most active securities and ETPs. FINRA is interested in any suggestions that commenters may have for other future offerings.

      Fourth, should FINRA consider adding ATS and non-ATS block-size data for OTC equity securities? As noted above, FINRA is not proposing to include such data at this time, due largely to the wide variance of trading activity in these securities and the difficulty associated with determining appropriate block thresholds that would be appropriate across this class of securities.

      FINRA requests that commenters provide empirical data or other factual support for their comments wherever possible.


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

      2. See Section 19 of the Securities Exchange Act of 1934 (SEA) 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. Information on NMS stocks in Tier 1 of the Limit Up/Limit Down NMS Plan is published on a two-week delayed basis; information on the remaining NMS stocks and OTC equity securities is published on a four-week delayed basis. See Rules 6110 and 6610. OTC volume information regarding fixed income securities is not reported or disseminated pursuant to the rules.

      4. Monthly aggregate totals are published on a one month delayed basis, e.g., totals for the month of June are published on or about August 1.

      5. Thus, if a firm averages fewer than 200 non-ATS transactions per day across all securities during the reporting period, FINRA aggregates the firm's volume with that of similarly situated firms. Additionally, because the published volume data is 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 aggregates 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.

      6. See Rules 6160, 6170 and 6480.

      7. As with ATS block-size data, FINRA believes that OTC equity securities should not be included in the initial publication phase, due largely to the wide variance of trading activity in these securities and the difficulty associated with determining appropriate block thresholds that would be appropriate across this class of securities. However, FINRA will continue to assess whether the data should be expanded to include trades in OTC equity securities or some subset thereof and welcomes comment on such an expansion.

      8. As is the case with non-ATS data today, non-ATS block-size data would not be published on an MPID-by-MPID basis.

      9. FINRA notes that there would be no de minimis exception for non-ATS block-size data.

      ATTACHMENT A

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

      6000. QUOTATION, ORDER, AND TRANSACTION REPORTING FACILITIES
      6100. QUOTING AND TRADING IN NMS STOCKS
      6110. Trading Otherwise than on an Exchange
      (a) No Change.
      (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, aggregate weekly 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 or single dealer platform).
      [(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]B) Trading Information by security will be aggregated for members that have executed on average fewer than 200 transactions per day in [an NMS stock] the security during the applicable Trading Information period.
      (3) FINRA will publish on its public web site monthly aggregate block trading statistics, with elements to be determined from time to time by FINRA in its discretion as stated in a Regulatory Notice or other equivalent publication, for each member with the trade reporting obligation under Rules 6282(b), 6380A(b) and 6380B(b). For each member, such block trading statistics shall be aggregated for all Market Participant Identifiers (MPIDs) used by the member (excluding, if applicable, any MPIDs used by the member for reporting trades executed in its alternative trading system), be aggregated across all NMS stocks, be for a minimum time period of one month of trading, and be published no earlier than one month following the end of the month for which trading was aggregated.
      ([3]4) For purposes of this paragraph (b), "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 paragraph (b) shall not include any ATS Trading Information, as that term is defined in paragraph (c)(3).
      (c) Trading Information for OTC Transactions in NMS Stocks Executed on Alternative Trading Systems
      (1) FINRA will publish on its public web site [the] aggregate weekly ATS Trading Information for each ATS 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 ATS Trading Information week, aggregate weekly ATS Trading Information regarding NMS stocks in Tier 1 of the NMS Plan to Address Extraordinary Market Volatility; and
      (B) no earlier than four weeks following the end of the ATS Trading Information week, aggregate weekly ATS 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.
      (2) FINRA will publish on its public web site monthly aggregate ATS block trading statistics, with elements to be determined from time to time by FINRA in its discretion as stated in a Regulatory Notice or other equivalent publication, for each ATS with the trade reporting obligation under Rules 6282(b), 6380A(b) and 6380B(b). For each ATS, such block trading statistics shall be aggregated across all NMS stocks, be for a minimum time period of one month of trading, and be published no earlier than one month following the end of the month for which trading was aggregated.
      (3) For purposes of this paragraph (c):
      (A) "ATS" has the same meaning as the term "alternative trading system" as that term is defined in Rule 300 of SEC Regulation ATS; and
      (B) "ATS Trading Information" includes:
      (i) the number of shares of an NMS stock executed on an ATS with the trade reporting obligation under Rules 6282(b), 6380A(b) and 6380B(b) and reported to FINRA; and
      (ii) the number of trades in an NMS stock executed on an ATS with the trade reporting obligation under Rules 6282(b), 6380A(b) and 6380B(b) and reported to FINRA.
      * * * * *

      6160. Multiple MPIDs for Trade Reporting Facility Participants
      [Note: Identical changes will be made to Rules 6170 (relating to ADF) and 6480 (relating to ORF)]

      (a) through (b) No Change.

      (c) ATS MPID Requirement
      (1) Except as set forth in paragraph ([d]c)(2), a Trade Reporting Facility Participant that operates an alternative trading system ("ATS"), as that term is defined in Rule 300 of SEC Regulation ATS, must obtain a single, separate MPID for each such ATS designated for exclusive use for reporting each ATS's transactions. The member must use such separate MPID to report all transactions executed within the ATS to a Trade Reporting Facility (or Facilities), except if the member is submitting a clearing-only, non-regulatory report pursuant to Rule 7230A(i)(4) or 7230B(h)(4). The member shall not use such separate MPID to report any transaction that is not executed within the ATS. Any member that operates multiple ATSs must obtain a separate MPID for each ATS. Members must have policies and procedures in place to ensure that trades reported with a separate MPID obtained under this paragraph are restricted to trades executed within the ATS.
      ([d]2) An ATS is permitted to use two separate MPIDs only if one MPID is used exclusively for reporting transactions to TRACE and the other MPID is used exclusively for reporting transactions to the equity trade reporting facilities (the Alternative Display Facility, the OTC Reporting Facility, the FINRA/Nasdaq TRF, or the FINRA/ NYSE TRF).
      (d) SDP MPID Requirement
      (1) Except as set forth in paragraph (d)(2), a Trade Reporting Facility Participant that operates a single dealer platform ("SDP"), as that term is defined in paragraph (d) (4), must obtain a single, separate MPID for each such SDP designated for exclusive use for reporting each SDP's transactions. The member must use such separate MPID to report all transactions executed within the SDP to a Trade Reporting Facility (or Facilities), except if the member is submitting a clearing-only, non-regulatory report pursuant to Rule 7230A(i)(4) or 7230B(h)(4). The member shall not use such separate MPID to report any transaction that is not executed within the SDP. Any member that operates multiple SDPs must obtain a separate MPID for each SDP. Members must have policies and procedures in place to ensure that trades reported with a separate MPID obtained under this paragraph are restricted to trades executed within the SDP.
      (2) An SDP is permitted to use two separate MPIDs only if one MPID is used exclusively for reporting transactions to TRACE and the other MPID is used exclusively for reporting transactions to the equity trade reporting facilities (the Alternative Display Facility, the OTC Reporting Facility, the FINRA/Nasdaq TRF, or the FINRA/NYSE TRF).
      (3) If a member has a single MPID and that MPID is used solely for SDP transactions and no other transactions, the member must notify FINRA and must comply with the provisions of this paragraph (d).
      (4) For purposes of this paragraph (d), "single dealer platform" or "SDP" shall mean an electronic trading platform owned and operated by a member on which the member trades solely for its own account when executing orders routed to the SDP and represents either the buy or sell side of each trade on a proprietary basis.
      • • • Supplementary Material: --------------

      .01 through .02 No Change.

      * * * * *

      6600. OTC REPORTING FACILITY

      6610. General

      (a) No Change.

      (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, aggregate weekly 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 or single dealer platform).
      [(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]B) Trading Information by security will be aggregated for members that have executed on average fewer than 200 transactions per day in [an OTC Equity Security] the security during the applicable Trading Information period.
      (3) For purposes of this paragraph (b), "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 paragraph (b) shall not include any ATS Trading Information, as that term is defined in paragraph (c)(3).
      (c) Trading Information for OTC Transactions in OTC Equity Securities Executed on Alternative Trading Systems
      (1) FINRA will publish on its public web site the aggregate weekly ATS Trading Information for each alternative trading system with the trade reporting obligation under Rules 6622(b) no earlier than four weeks following the end of the ATS Trading Information week[,].
      (2) For purposes of this paragraph (c), "ATS Trading Information" includes:
      (A) the number of shares of an OTC Equity Security executed on an alternative trading system with the trade reporting obligation under Rule 6622(b) and reported to FINRA; and
      (B) the number of trades in an OTC Equity Security executed on an alternative trading system with the trade reporting obligation under Rule 6622(b) and reported to FINRA.
      * * * * *

    • 18-27 Restructured Qualification Examinations and Related Examination Fees; Effective Date: October 1, 2018

      View PDF

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      Regulatory Notice 17-30
      Section 4(c) of Schedule A to the FINRA By-Laws
      Suggested Routing

      Compliance
      Finance
      Operations
      Registered Representatives
      Registration
      Senior Management
      Training
      Key Topics

      Qualification Examination Fees
      Representative-Level Examinations
      Securities Industry Essentials™ Examination

      Summary

      Effective October 1, 2018, FINRA is restructuring its representative-level qualification examination program.1 As part of this restructuring, FINRA has developed the Securities Industry Essentials™ (SIE™) examination and revised several of its representative-level qualification examinations. In addition, FINRA has (1) set the fee for the SIE examination; (2) revised the fees for the representative-level examinations that FINRA is retaining; and (3) revised the administration and delivery fee for the Municipal Securities Representative (Series 52) examination.2

      The text of the amendments to Section 4(c) of Schedule A to the FINRA By-Laws relating to examination fees is set forth in Attachment A. The new and revised qualification examination fees will apply for examination requests made on or after October 1, 2018.

      Questions regarding this Notice should be directed to:

      •   John Kalohn, Vice President, Registration and Disclosure, at (240) 386-5800 or by email at john.kalohn@finra.org.

      Background & Discussion

      SIE Examination and FINRA Representative-Level Examinations

      Effective October 1, 2018, FINRA is restructuring its representative-level qualification examination program. As part of the restructuring, FINRA has developed the SIE examination and revised nine of its existing representative-level examinations.3 The SIE examination will test knowledge regarding fundamental securities-related topics, including knowledge of basic products, the structure and function of the securities industry, the regulatory agencies and their functions and regulated and prohibited practices, whereas the revised representative-level qualification examinations will test knowledge relevant to broader day-to-day activities, responsibilities and job functions of representatives. FINRA has also eliminated seven representative-level examinations that have become outdated or have limited utility.4

      A previously unregistered individual who is applying for registration as a representative, for the first time on or after October 1, 2018, will be required to pass both the SIE examination and the appropriate revised representative-level examination for his or her particular registered role (or obtain a waiver of the examinations). This requirement also applies to previously unregistered applicants who are seeking a representative-level registration as a prerequisite to a principal-level registration. In addition, the SIE examination will be available to associated persons of firms who are not required to register as well as to individuals who are not associated persons of firms, including members of the public.5

      FINRA currently administers examinations electronically through the PROCTOR system6 at testing centers operated by a vendor under contract with FINRA. FINRA charges an examination fee to candidates for FINRA-sponsored and co-sponsored examinations to cover the development, maintenance and delivery of these examinations. In establishing or revising an examination fee, FINRA considers, among other factors, the number of test questions on an examination and seat time for the examination.7

      The SIE examination consists of 75 scored questions8 and has a session time of one hour and 45 minutes. The revised representative-level examinations consist of fewer scored questions than the current examinations and have reduced session times, with the exception of the Research Analyst (Series 86 and Series 87) examinations.9

      Consistent with its process for establishing and revising examination fees, FINRA has amended Section 4(c) of Schedule A to the FINRA By-Laws to establish a fee of $60 for the SIE examination. FINRA has also revised the fee for each individual FINRA representativelevel examination that it is retaining, with the exception of the Series 86 and Series 87 examinations, to reflect changes to the test lengths for the examinations.10 The following are the revised fees for each examination: Series 6 ($40); Series 7 ($245); Series 22 ($40); Series 57 ($60); Series 79 ($245); Series 82 ($40) and Series 99 ($40). Further, FINRA has amended Section 4(c) of Schedule A to the FINRA By-Laws to remove the representativelevel examinations that FINRA is eliminating and the associated fees.

      As a result of these changes, the overall examination fees for FINRA representative-level registrations will remain the same11 or be lower12 than the current examination fees, with the exception of the fee for the Private Securities Offerings Representative registration category, which will increase by $5.13

      Series 52 Examination

      FINRA also administers and delivers the Series 52 examination, which is developed by the Municipal Securities Rulemaking Board (MSRB). In conjunction with FINRA's restructuring of its representative-level examination program, the MSRB also restructured the Municipal Securities Representative examination program.14 Under the MSRB's restructured program, individuals registering as Municipal Securities Representatives would be required to take and pass the SIE examination in addition to a revised Series 52 examination.

      Further, the MSRB reduced the number of scored questions on the Series 52 examination (from 115 questions to 75 questions) and the session time for the examination (from three hours and 30 minutes to two hours and 30 minutes),15 which reduces the overall seat time for the examination and, in turn, reduces FINRA's administration and delivery fee for the examination by $20. Accordingly, FINRA has amended Section 4(c) of Schedule A to the FINRA By-Laws to reduce the administration and delivery fee for the Series 52 examination from $130 to $110. FINRA's administration and delivery fee represents a portion of the entire Series 52 examination fee.

      Additional Information

      Descriptions of the SIE examination and the revised FINRA representative-level examinations, including the related fees, are available on FINRA's website [http://www.finra.org/industry/qualification-exams].


      1. See Regulatory Notice 17-30 (October 2017).

      2. See Securities Exchange Act Release No. 84020 (September 4, 2018) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2018-033) (Proposed Rule Change to Amend Section 4(c) of Schedule A to the FINRA By-Laws Relating to Qualification Examination Fees).

      3. The following are the nine representative-level examinations: Investment Company and Variable Contracts Products Representative (Series 6); General Securities Representative (Series 7); Direct Participation Programs Representative (Series 22); Securities Trader (Series 57); Investment Banking Representative (Series 79); Private Securities Offerings Representative (Series 82); Research Analyst (Series 86 and Series 87); and Operations Professional (Series 99). See supra note 1. The SIE examination and the representative-level examinations were filed with the Securities and Exchange Commission for immediate effectiveness, and the outlines for the examinations were published on FINRA's website [http://www.finra.org/industry/qualification-exams].

      4. Specifically, FINRA eliminated the following examinations: Order Processing Assistant Representative (Series 11); United Kingdom Securities Representative (Series 17); Canada Securities Representative (Series 37 and Series 38); Options Representative (Series 42); Corporate Securities Representative (Series 62); and Government Securities Representative (Series 72). See supra note 1. Individuals maintaining the eliminated representative-level registrations will be grandfathered (i.e., they may continue to maintain their current registrations on or after October 1, 2018, unless their registrations lapse).

      5. While these individuals would be eligible to take the SIE examination, passing the SIE examination alone will not qualify them for registration with FINRA.

      6. PROCTOR is a computer system that is specifically designed for the administration and delivery of computer-based testing and training.

      7. FINRA pays its delivery vendor an hourly rate for seat time at test delivery centers. The seat time, which varies based on the length of an examination, includes the session time for an examination as well as an additional 30 minutes to cover administrative procedures relating to the examination process.

      8. The SIE examination and each of the revised representative-level examinations also include five to ten unscored pretest questions. Pretest questions are designed to ensure that new examination items meet acceptable testing standards prior to use.

      9. The revised Series 6, Series 22, Series 82 and Series 99 examinations each consist of 50 scored questions and each have a session time of one hour and 30 minutes. The revised Series 7 examination consists of 125 scored questions with a session time of three hours and 45 minutes. The revised Series 57 examination consists of 50 scored questions with a session time of one hour and 45 minutes. The revised Series 79 examination consists of 75 scored questions with a session time of two hours and 30 minutes. Finally, the revised Series 86 and Series 87 examinations have the same number of scored questions and session times as the current Series 86 and Series 87 examinations.

      10. FINRA is not revising the fees for the Series 86 and Series 87 examinations as the test lengths for these examinations are not changing.

      11. For instance, the current examination fee for registration as an Investment Company and Variable Contracts Products Representative is $100. Under the restructured program, the total examination fee for registration as an Investment Company and Variable Contracts Products Representative will be $100 ($60 for the SIE examination and $40 for the revised Series 6 examination).

      12. For example, the total examination fee for registration as a Research Analyst will be reduced by $245 because, under the restructured program, individuals registering as Research Analysts will no longer be required to take the Series 7 examination.

      13. The current examination fee for registration as a Private Securities Offerings Representative is $95. Under the restructured program, the total examination fee for registration as a Private Securities Offerings Representative will be $100 ($60 for the SIE examination and $40 for the revised Series 82 examination). The $40 fee for the revised Series 82 examination is consistent with the fees of other comparable revised examinations (i.e., the revised Series 6, Series 22 and Series 99 examinations) all of which have similar development, maintenance and delivery costs.

      14. See Securities Exchange Act Release No. 83483 (June 20, 2018), 83 FR 29855 (June 26, 2018) (Notice of Filing and Immediate Effectiveness of File No. SR-MSRB-2018-04). The rule change will become effective on October 1, 2018, which coincides with the effective date of FINRA's rule change.

      15. See Securities Exchange Act Release No. 83572 (June 29, 2018), 83 FR 31580 (July 6, 2018) (Notice of Filing and Immediate Effectiveness of File No. SR-MSRB-2018-05). This rule change will also become effective on October 1, 2018.


      Attachment A

      Below is the 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 (b) No Change.

      (c) The following fees shall be assessed to each individual who [registers to] takes an examination as described below. These fees are in addition to the registration fee described in paragraph (b) and any other fees that the owner of an examination that FINRA administers may assess.

      Examination Number Examination Name Examination Fee
      N/A Securities Industry Essentials (SIE) Examination $60
      Series 4 Registered Options Principal Examination $105
      Series 6 Investment Company Products[/] and Variable Contracts Representative Examination $[100]40
      Series 7 General Securities Representative Examination $[305]245
      Series 9 General Securities Sales Supervisor Examination – Options Module $80
      Series 10 General Securities Sales Supervisor Examination – General Module $125
      [Series 11] [Assistant Representative – Order Processing] [$80]
      Series 14 Compliance Official Examination $350
      Series 16 Supervisory Analyst Examination $240
      [Series 17] [Limited Registered Representative] [$80]
      Series 22 Direct Participation Programs Representative Examination $[100]40
      Series 23 General Securities Principal Examination – Sales Supervisor Module $100
      Series 24 General Securities Principal Examination $120
      Series 26 Investment Company Products[/] and Variable Contracts Principal Examination $100
      Series 27 Financial and Operations Principal Examination $120
      Series 28 Introducing Broker-Dealer Financial and Operations Principal Examination $100
      [Series 37] [Canada Module of S7 (Options Required)] [$185]
      [Series 38] [Canada Module of S7 (No Options Required)] [$185]
      Series 39 Direct Participation Programs Principal Examination $95
      [Series 42] [Registered Options Representative] [$75]
      Series 50 Municipal Advisor Representative Examination $115
      Series 51 Municipal Fund Securities Limited Principal Examination $105
      Series 52 Municipal Securities Representative Examination $[130]110
      Series 53 Municipal Securities Principal Examination $115
      Series 57 Securities Trader Examination $[120]60
      [Series 62] [Corporate Securities Limited Representative] [$95]
      [Series 72] [Government Securities Representative] [$110]
      Series 79 Investment Banking Representative [Qualification] Examination $[305]245
      Series 82 [Limited Representative –] Private Securities Offering Representative Examination $[95]40
      Series 86 Research Analyst Examination – Analysis $185
      Series 87 Research Analyst Examination – Regulatory $130
      Series 99 Operations Professional Examination $[130]40

      (1) through (4) No Change.

      (d) 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 15 No Change.

      * * * * *

    • 18-26 FINRA Requests Comment on Enhancements Under Consideration by the Securities Industry/Regulatory Council on Continuing Education; Comment Period Expires: November 5, 2018

      View PDF

      Continuing Education Program

      Regulatory Notice
      Notice Type

      Request for Comment
      Key Topics

      Annual Requirement
      Continuing Education
      Educational Credits
      Firm Element
      Qualification Status
      Regulatory Element
      Suggested Routing

      Compliance
      Operations
      Registered Persons
      Registration
      Senior Management
      Training

      Summary

      FINRA requests comment from member firms and other interested parties on enhancements to the Securities Industry Continuing Education Program (CE Program) under consideration by the Securities Industry/Regulatory Council on Continuing Education (CE Council). These enhancements include the transition of the Regulatory Element program to a more focused and shorter learning requirement administered annually. The CE Council is also gathering feedback on the current Firm Element program and supporting resources as well as on the overlap of the Firm Element program with other firm training requirements. The overall goal of the program review is to reflect advances in technology and learning theory while continuing to ensure that registered persons receive timely education on the securities business and the regulatory requirements applicable to their respective functions. In addition, the CE Council is exploring program changes that would allow individuals to maintain their qualification status following the termination of their registrations by completing continuing education in an effort to address the challenges that industry professionals face when attempting to re-enter the industry after an absence.

      The program enhancements that are under consideration are published on the CE Council's website [http://cecouncil.com/council/activities-new-initiatives/] and attached to this Notice. The document includes background information, a description of the enhancements under consideration and accompanying questions. FINRA encourages member firms and all other interested parties to comment on the program enhancements under consideration, including providing specific responses to the questions. These comments will inform the CE Council's ongoing work to enhance the CE Program. If the CE Council decides to recommend any program changes, FINRA along with other self-regulatory organizations will issue a Regulatory Notice with the specific program details and any related rule changes.

      Questions regarding this Notice should be directed to:

      •   John Kalohn, Vice President, Registration and Disclosure, at (240) 386-5800; or
      •   David Scrams, Senior Director, Testing and Continuing Education Department, at (240) 386-5950.

      Action Requested

      Comments on this Notice and the attachment published by the CE Council must be received by November 5, 2018, and must be submitted through one of the following methods:

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

      Jennifer Piorko Mitchell
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      Important Note: All comments received in response to this Notice and the attachment published by the CE Council 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, any program changes that result in rule changes must be authorized for filing with the Securities and Exchange Commission (SEC), and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2


      1. Persons submitting comments are cautioned that FINRA does not redact or edit personal identifying information, such as names or email addresses, from comment 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.



      Enhancements Under Consideration for the Securities Industry Continuing Education Program

      Securities Industry/Regulatory Council on Continuing Education

      September 6, 2018

      Background

      Given the increasing complexity of products and services offered through the U.S. financial markets, providing timely, effective training to registered persons is of the utmost importance. Training is a critical factor in ensuring investor protection and preserving the integrity of the U.S. capital markets.

      The Securities Industry/Regulatory Council on Continuing Education (CE Council) is composed of securities industry representatives and self-regulatory organizations (SROs). Formed in 1995 upon a recommendation from the Securities Industry Task Force on Continuing Education, the CE Council was tasked with facilitating the development of uniform continuing education (CE) requirements for registered persons of firms (CE program). The CE program consists of both a Regulatory Element and a Firm Element.

      The CE Council focuses on maintaining and advancing the CE program to meet the needs of the industry in an efficient and cost effective manner. The CE Council also works to promote and provide educational opportunities that support investor protection and market integrity. Pursuing change, when necessary, is one element of how the CE Council strives to help financial professionals keep pace with educational requirements imposed on professionals in other industries. The CE Council seeks to advance important initiatives that enhance the ability of financial service professionals to remain current on regulatory initiatives and other topics that will allow them to service the investing public according to high standards in the industry.

      The CE Council has introduced numerous changes over the past decade, most recently the transition of the Regulatory Element program from brick-and-mortar testing centers to online delivery. Moving the program online resulted in multiple benefits, including greater flexibility to participate at convenient times and locations (i.e., starting and stopping throughout the open window is an option that did not previously exist). Individuals may now complete the Regulatory Element CE on tablets as well. With this transition, fees decreased from $100 to $55, reflecting the lower cost of taking the program outside of testing centers. This represents over $20 million in savings to the industry since 2016. The CE Council is continuing its development of appropriate education for financial professionals while addressing operational and other industry concerns.

      Since 1995, the CE program has consisted of two parts, a Regulatory Element and a Firm Element, facilitating a partnership between firms and regulators. The goal of the two-part CE program has been to provide targeted educational material that facilitates registered persons maintaining adequate knowledge and understanding of the rules and practices necessary to perform their registered activities. The original intent was for the Regulatory Element to focus on regulatory requirements and industry standards, while the Firm Element focused on securities products, services and strategies offered by firms, amongst other topics such as firm policies and industry trends. The CE program provides a baseline CE requirement; firms often provide additional training to registered persons beyond that classified as Firm Element training. Registered persons also obtain additional training on their own by attending conferences and other events.

      Regulatory Element

      The CE program requires each registered person to complete the Regulatory Element within prescribed intervals based on their registration anniversary date. An individual's registration anniversary date is generally the date they initially registered in the Central Registration Depository (CRD®) system. Registered persons who become subject to significant disciplinary action may be required to retake the Regulatory Element within 120 days of the effective date of the disciplinary action, if they remain registered.

      FINRA administers the Regulatory Element through a Web-based delivery platform using a fixed content format. The Web-based delivery method provides participants 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 completion window. Additionally, participants do not need to complete the Regulatory Element in one sitting as previously required in testing centers.

      The Regulatory Element currently includes the following four programs:

      •   S106 (for investment company and variable contracts representatives);
      •   S201 (for registered principals and supervisors);
      •   S901 (for operations professionals); and
      •   S101 (for all other registered persons).

      Each of the programs includes four training modules (e.g., Module A of the S101 program covers responsibilities to customers). Each module leads participants through a case that provides a story depicting situations encountered by registered persons in the course of their work. Each case also contains relevant educational content. Participants must review the story content of each case and respond to a series of related questions that assess participants' understanding of the materials presented. If a participant is unable to answer the questions in a particular case, they will have to retake that case until they can demonstrate proficiency with the subject matter.

      Under the current fixed-content format, registered persons in the same registration category (e.g., investment company and variable contracts representatives) who are subject to the Regulatory Element in a given year (e.g., 2018) must complete the same content, with the exception of the self-selected module included in some programs.

      Since its inception, FINRA has administered more than 4 million Regulatory Element sessions. Over 200,000 individuals complete the Regulatory Element annually.

      Firm Element

      The CE program also requires each firm to develop and administer an annual Firm Element training program for covered registered persons. In general, a covered registered person is any registered person who has direct contact with customers in the conduct of a member firm's securities sales, trading and investment banking activities and the immediate supervisor of any such person. The definition of "covered person" can differ between SROs. For example, the rules of the Cboe Options Exchange specify that a securities trader representative is a covered person.

      The Firm Element must cover specified minimum standards (e.g., suitability and sales practice considerations). Each firm must also consider its size, structure, scope of business, as well as regulatory developments and the performance of covered registered persons in the Regulatory Element, in planning, developing and implementing its Firm Element program. Further, each firm must administer its respective program in accordance with an annual needs analysis and written training plan and must maintain records documenting the content and completion of the program. The CE Council publishes and regularly updates the Firm Element Advisory (FEA), which identifies and recommends pertinent regulatory and sales practice issues for firms to consider including in their training plans.

      Although the CE program has operated effectively for more than 20 years and evolved during that period, changes in technology and learning theory have created opportunities for further improvement. For example, technological constraints that existed at program inception resulted in the current timeframes and format for administering the Regulatory Element. These constraints no longer exist. The 2015 transition to Web-based delivery of the Regulatory Element allows for increased efficiency, such as administering regulatory content in a more timely fashion, granting flexibility to individuals with geographic constraints (i.e., proximity to testing centers), and presenting material in an optimal learning format. Similarly, the Firm Element exists in a changing environment where education standards can be defined to ensure delivery of an adequate level of training to registered individuals at all firms; to give credit to forms of training not recognized in Firm Element programs today; and to potentially allow credentialing programs to play a role in firm training plans.

      CE Program Enhancements Under Consideration

      The CE Council is exploring a variety of options to enhance the CE program to better support the program's purpose and continue to meet the securities industry's needs. Throughout this exploration, the CE Council is focusing on the following goals:

      1. communicating regulatory developments to the industry via the Regulatory Element in a timely fashion;
      2. improving coordination between firm and regulatory training programs;
      3. allowing for diverse instructional formats that facilitate the learning of a variety of content;
      4. identifying and reducing redundancy among training requirements and programs;
      5. ensuring all registered professionals in the industry receive adequate training;
      6. enabling previously registered individuals to maintain their qualification status by satisfying CE requirements while out of the industry; and
      7. considering more defined minimum standards of CE for the industry.

      Based on the analysis completed so far, the CE Council has identified a number of possible program enhancements, as well as a few areas for which the CE Council is interested in gathering additional information on current firm practices and needs. The CE Council has received initial feedback from a series of focus groups composed of industry representatives. The goal of this document is to solicit broader feedback. For the more defined ideas, the CE Council hopes to gauge industry support and to identify challenges that the possible enhancements might create. Other ideas are in an earlier stage of development, and the goal for these is to gather initial feedback, identify important considerations and generate more defined ideas before articulating possible program changes.

      The remainder of this document describes program changes under consideration and the topics for which the CE Council seeks additional information categorized into the general areas of Regulatory Element, Firm Element and Maintaining Qualifications.

      Regulatory Element

      The intended purpose of the Regulatory Element is to address regulatory requirements and industry standards. Based on this, the Regulatory Element should focus on ensuring that registered persons understand recently introduced rule changes and educating registered persons on significant regulatory issues facing the industry. With this in mind, analysis of the current program suggests that there may be opportunities for improvement in terms of relevance and timeliness of regulatory content, as well as synergy with the Firm Element. The CE Council is also interested in identifying opportunities to improve the CE delivery system functionality on which firms rely to ensure compliance with the Regulatory Element requirement.

      Relevance

      In the current Regulatory Element program, FINRA systems assign each registered person to one of four programs based on the individual's active registrations as described above. The majority of representative-level registrants complete the S101 program, and registered principals complete the S201 program. Although there is an opportunity for registered representatives to select from a set of job functions to personalize the content of one of the S101 modules, the remaining three modules are identical for all registered representatives. Similarly, all S201 participants within a given year complete the same material, regardless of their qualifying registrations. One consequence of this structure is that some individuals complete content that is not directly relevant to the registrations they hold or the job roles in which they work. This format is a legacy of technological constraints that no longer exist. The CE Council is exploring methods of restructuring the Regulatory Element program to increase the relevance of content most individuals receive.

      The structure under consideration revolves around identification of significant rule changes and other regulatory issues facing the industry. FINRA, in consultation with and final approval from the CE Council, would analyze the scope of each rule change and regulatory issue to determine which topics to address within the Regulatory Element program, the amount of learning content necessary to address each topic, and the relevance to each registration category. FINRA would then work with the CE Content committee, composed of industry experts, to create targeted learning units. Individuals would only receive those portions of the Regulatory Element that are pertinent to the registrations that they hold. This modular approach to administration, combined with the narrower focus, should reduce the total amount of content individuals complete while making the content more relevant to their roles.

      Timeliness

      Under the current CE program, individuals complete Regulatory Element content on the second anniversary of their initial registration and every three years thereafter. The CE Council originally established this frequency to address the capacity challenges of the test center-based delivery model. The transition to online delivery in 2016 removes this constraint.

      The current frequency is an obstacle to providing timely regulatory training on impactful rule changes and significant industry regulatory issues. The CE Council is considering moving to an annual Regulatory Element requirement to improve timeliness. Initial analysis of the change from narrowly focusing the Regulatory Element suggests that an annual program would consist of approximately one-third of the content of the current program. Administering the new program would not result in increased costs for firms or participants; the annual Regulatory Element for registered persons would have a fee of approximately one-third of the current $55 fee.

      The CE Council recognizes that transitioning to an annual Regulatory Element requirement may increase work related to monitoring and verifying participation at some firms. The CE Council has discussed possible enhancements to FINRA systems to help with these challenges.

      Regulatory Element Systems

      The CRD system is the primary industry system for managing Regulatory Element activities. The CE Council has discussed with FINRA the possibility of CRD system enhancements to improve functionality and address increased compliance work related to the possible transition of the Regulatory Element program to an annual requirement. FINRA is working on a general redesign effort of the CRD system and has already released a number of enhancementsthis year with additional features planned. Based on the work completed thus far, the CE Council believes that FINRA would be able to deliver enhancements to reporting and data access that could assist with the increased frequency of Regulatory Element participation.

      FINRA has also released a system to improve access to data and delivery of services to registered representatives, although the system is not yet widely used. This system, the Financial Professional Gateway, consolidates a number of services already available to current and former registered representatives, such as retrieval of U5 forms and updates of addresses for individuals who have left the industry. The CE Council has discussed with FINRA the possibility of leveraging this system for delivery of the Regulatory Element. One of the core benefits would be the opportunity for firms to opt into systemgenerated email notifications. The system could send notifications directly to registered representatives at the start of their Regulatory Element window and periodically thereafter until they have met the requirement. The system would either notify or include firms in all such communications, depending upon the firm's preference. The CE Council believes that automated notifications to the registered representatives could substantially reduce the challenges faced by firm personnel responsible for monitoring Regulatory Element completion. The CE Council seeks feedback on the specific functionality that would most help firms manage an annual Regulatory Element requirement, including but not limited to reporting functionality and automated notifications.

      Synergy with Firm Element

      The current Regulatory Element and Firm Element programs operate largely independently from one another. This results in duplication between the two programs at some firms. The CE Council believes that firms could better leverage the Regulatory Element as part of their overall training programs if they had a clearer understanding of the specific Regulatory Element content covered each year. Given the narrower focus for the Regulatory Element, the CE Council believes that it may be possible to publish the learning topics for the coming year well in advance. The CE Council seeks input from firms about the value of such information and the timing necessary to support the development of firm training programs to meet the Firm Element requirements.

      Firm Element

      The purpose of the Firm Element program is to address products, services and strategies offered by the firm as well as firm policies and industry trends. In exploring the current Firm Element program, the CE Council seeks feedback on the value of guidance and resources provided by CE Council to help firms and the typical amounts and formats of Firm Element content at various firms. The CE Council is also interested in feedback on redundancy with other industry training requirements, opportunities for reciprocity with other securities or related credential programs, and the sources of Firm Element content used by most firms.

      CE Council Guidance and Resources

      The CE Council maintains a current FEA on the CE Council website (cecouncil.com). This document provides general guidance on conducting an annual needs analysis, access to reports summarizing a firm's performance on the Regulatory Element and a number of regulator-provided training resources. The bulk of the document is devoted to current topics that firms could consider when planning their Firm Element programs. Each topic usually has one or more regulator resources that provide timely information on the subject. The CE Council is interested in feedback on the value of this resource as well as other guidance or tools that the CE Council could provide to help firms meet their Firm Element obligations.

      Typical Characteristics of Firm Element Programs

      Many professions have structured CE programs to maintain professional credentials, including concepts like educational credits or assessment requirements. In contrast, the Firm Element requirement is relatively unstructured. Aside from some high-level content required by regulators, industry rules require firms to complete an annual needs analysis and develop a training program that is appropriate for their scope of business. The needs analysis remains an important component of a firm's program given that it allows firms to identify areas where training is needed or could be helpful while also accounting for the unique nature of the firm. Based on focus group discussions, firms seem to vary considerably in how they meet this requirement. For example, firms may train personnel on matters relating to suitability, confidentiality, anti-money laundering (AML), cybersecurity, products and services, and other topics to provide an effective education experience.

      The CE Council is interested in understanding the typical amount of Firm Element content administered at firms as well as the various types of educational material and formats used. In particular, the CE Council is interested in understanding whether most firms rely solely on traditional and electronic courses or if seminars, conferences or other learning activities are also commonly used.

      Further, the CE Council seeks feedback on providing guidance to firms on expectations for appropriate amounts of Firm Element content. Some firms provide very limited amounts of Firm Element, and the CE Council is concerned that registered representatives at those firms may not be receiving adequate training. The CE Council is interested in suggestions for creating minimum threshold requirement for Firm Element without introducing onerous requirements.

      Other Training Requirements and Credentialing Programs

      The CE Council is aware that there are a number of industry training requirements outside the Firm Element program including AML training and an annual compliance meeting required by some regulators. The CE Council seeks feedback on how most firms coordinate these various training requirements and identifying redundancy when it arises.

      The CE Council also recognizes that registered persons may have additional CE requirements associated with other professional credentials. The CE Council is interested in understanding the most common credential programs within the industry and identifying potential opportunities for reciprocity among programs. Some of the courses that satisfy these other CE requirements may also be appropriate for Firm Element training. Reciprocity between programs is an important consideration for the CE Council given that the time dedicated to training could address multiple requirements.

      Access to Firm Element Content

      Firms have a variety of options for sourcing Firm Element content. Some firms develop materials internally. Others rely on third-party training providers. The CE Council is interested in feedback on challenges faced in developing or acquiring appropriate content to meet Firm Element requirements.

      The CE Council is considering creating a centralized content catalog to serve as an additional source of Firm Element content. FINRA and the CE Council would work together with third-party training providers to offer a large catalog of readily available materials that are centrally located for convenience. Firms would have easy access to necessary courses and could select from multiple providers to satisfy a portion of or their entire Firm Element requirements. Firms may also choose to create and develop content in-house as desired. In addition, FINRA and other SROs have existing educational courses and could develop additional courses as needed. Courses offered by third-party vendors, FINRA and others would be included and available in the course catalog. The CE Council is interested in understanding whether a centralized source of content would be helpful and the value of providing such a resource to the industry.

      Maintaining Qualification Status Post Termination

      Currently, individuals whose registrations have been terminated for two or more years are required to requalify by examination, or obtain a waiver of the examination requirement, in order to re-register. Individuals whose registrations have been terminated cannot maintain their qualification status beyond the two-year period. The CE Council is considering a mechanism to support regulatory efforts to revise this current rule structure. With regard to the Securities Industry Essentials (SIE) Exam qualification (effective October 1, 2018), this qualification will continue to remain valid for four years but will not constitute registration on its own.

      The central idea is to allow previously registered individuals to complete an annual Regulatory Element as well as additional content equivalent to Firm Element while out of the securities industry. If individuals do so, they would not have to requalify by examination or obtain a waiver of the examination requirement upon returning to the industry. These individuals would still be required to satisfy all other conditions of registration, including satisfying the eligibility requirements for association with a firm.

      The CE Council is exploring the details of such a program, identifying necessary eligibility requirements for participation and considering the impact on the two-year termination rule.

      Program Considerations

      Individuals seeking to maintain their qualification status while no longer associated with a firm would need to complete the required annual Regulatory Element and additional assigned learning units (i.e., Firm Element equivalent). Completion of the Regulatory Element is straightforward for these individuals — they would participate in the same way that registered individuals do and use the same systems to complete their CE program. The CE Council is considering how best to account for the additional content equivalent to Firm Element including the appropriate amount and variety of additional content. Without establishing an industry Firm Element baseline expectation, it is difficult to determine the appropriate expectation for individuals who are maintaining their qualification outside the industry. Although the CE Council could make a determination, any decision would likely serve as a benchmark for firm programs. The CE Council seeks feedback from firms on how to best approach this.

      Delivery of the Firm Element content to individuals who are maintaining their qualification status is more straightforward. Such individuals would complete the assigned learning units on FINRA's platform using content from the proposed centralized content catalog. Given that these individuals would not be associated with a firm, the FINRA CE delivery platform provides the most efficient and effective means of tracking their compliance with the proposed CE requirements.

      Both the Regulatory Element and additional learning units assigned to these individuals would correlate to the individual's terminated registration(s) and require annual completion based on their established registration anniversary date.

      The approach under consideration is similar to that taken by other professions, such as the legal profession, and is intended to address industry concerns regarding the challenges securities professionals experience when reentering the industry after an absence.

      Eligibility Requirements and Program Duration

      There would likely be some limits on eligibility to maintain qualification status. For instance, the Financial Services Affiliate Waiver Program (FSAWP) that goes into effect in October 2018 requires an individual to be registered as a representative for five years within the previous 10-year period, as well as to be registered for the entirety of the most recent year. If eligible, an individual can participate within the FSAWP program for up to seven years. Similar eligibility requirements and program length might be used for individuals maintaining their qualification status under the new program. The CE Council seeks feedback on potential eligibility requirements and program durations.

      The CE Council is considering introducing this program to provide a mechanism for individuals to maintain qualification status after leaving the industry. The CE Council is unsure if this program should be available to individuals who remain associated with a firm after terminating their registrations. The expanded availability of permissive registrations for associated persons that will go into effect in October 2018 allows such individuals to maintain their registrations, albeit in a permissive capacity. The CE Council seeks feedback on the appropriateness and importance of allowing associated persons to maintain their qualification status via this program as an alternative to permissive registration.

      The CE Council does not intend for this program to be available to individuals whose registrations have been revoked and who are required to requalify by examination in order to re-register.

      Two-Year Termination Rule

      Under the current registration rules, an individual who re-registers within two years of termination is not required to requalify by examination or obtain a waiver. Consistent with this provision, the CE Council is considering including a two-year "catch-up" opportunity as part of the potential program. Individuals within two years of their termination would have the opportunity to complete any lapsed annual CE requirement in conjunction with their re-registration. This step would be in lieu of completing the annual CE requirements at each registration anniversary.

      Questions

      The CE Council and the SROs have included questions in the section below to highlight the areas of greatest interest. In addition to any general feedback, the CE Council would appreciate consideration of these questions in all responses. In responding to the questions, please provide a discussion of the types (direct vs. indirect) and sources (e.g., compliance, staffing or technology) of potential costs and benefits wherever appropriate. Please also provide empirical data or other factual support for your responses wherever possible and to the extent you feel it would be helpful to articulate your viewpoint.

      Regulatory Element

      1. In order to increase the timeliness of Regulatory Element content, the CE Council is considering recommending moving to an annual requirement. Although the transition would reduce the amount of content included in a session to approximately one-third of the current program, the increased frequency could result in increased effort required to monitor participation. What are the potential impacts of this transition to firms?
      2. The CE Council has discussed with FINRA possible enhancements to the CRD system and the Financial Professional Gateway. Would enhanced reporting and automated notification functions help mitigate the additional efforts required to monitor participation of an annual Regulatory Element requirement? What other system enhancements would firms find helpful?
      3. The CE Council is considering narrowing the focus of the Regulatory Element to rule changes and significant regulatory issues. Does this seem like an appropriate focus? Are there other topics that should be included within the Regulatory Element?
      4. The CE Council is considering adoption of a modular structure in place of the current Regulatory programs. Does this seem like a good way to increase the relevance of the Regulatory Element content? Are there concerns with determining relevance of topics based on registrations held, keeping in mind this will have a de minimis effect on the time required to complete the annual course?
      5. The CE Council is exploring the possibility of publishing the Regulatory Element topics for the coming year in advance of introducing such topics. If this information were available, would firms factor it into their Firm Element training plans? How much detail would be necessary for it to be useful? How early would the CE Council need to publish the information to allow for timely alignment with Firm Element planning activities?

      Firm Element

      6. Is the current Firm Element Advisory (FEA) useful? Do firms reference the FEA when planning their training programs? Which aspects of the FEA are most helpful? Are there other resources the CE Council should provide to help firms meet their Firm Element requirements?
      7. How much Firm Element training does the typical covered person receive? Are electronic and inperson courses the standard format for delivering Firm Element training? Do most courses include an assessment component? What other learning activities do firms commonly use to meet Firm Element requirements?
      8. Is Firm Element generally limited to covered persons? Do firms typically offer similar amounts of training to registered persons who are not covered persons? Do firms offer similar training opportunities to unregistered persons? Should the Firm Element requirement apply to all registered persons? What types of training do covered persons undertake that should be included as Firm Element training?
      9. How could the CE Council communicate reasonable expectations for amounts of Firm Element without introducing an onerous process? Are there other ways to ensure firms provide adequate training to securities professionals?
      10. Aside from Firm Element, what are the most significant regulatory training courses used by firms? Do firms include these other requirements as part of their Firm Element training programs?
      11. Do most firms maintain training programs to ensure associated persons meet the requirements of non-regulatory credentialing programs? Which credentialing programs have the most significant impact on firm training programs? Do firms include these training requirements within their Firm Element training plans? Are there credentialing programs with which the CE Council should consider establishing formal reciprocity agreements?
      12. How often do firms use content from third-party training providers to meet their Firm Element requirements? Would a centralized content catalog with offerings from multiple providers be beneficial for the industry?

      Maintaining Qualification Status Post Termination

      13. Should the CE Council pursue a recommendation to allow previously registered individuals to maintain their qualification status while away from the industry? Does a CE program seem like an appropriate way to accomplish this?
      14. If the CE Council recommended introducing a CE program that allowed individuals to maintain their qualification status while outside the industry, how much CE would be sufficient?
      15. If the CE Council recommended introducing such a program, should it impose an experience requirement for individuals to be eligible? If the CE Council recommended establishing a minimum duration of prior registration, what would be a reasonable requirement?
      16. Should there be a limit to how long a previously registered individual could maintain their qualification status via the CE program under consideration? If so, what duration is appropriate?
      17. Should the program allow previously registered individuals to maintain their qualification status while associated with a firm but working in a capacity that does not require registration? How would this interact with the expanded opportunity for an associated person to hold a permissive registration?
      18. How important is maintaining the two-year termination rule if individuals are able to maintain qualification status while away from the industry? Is the opportunity for individuals to complete lapsed CE when re-registering within two years of termination a sufficient replacement for the two-year termination rule?

      General Questions

      19. In developing a specific recommendation to change the industry CE requirements, what are the most important issues for the CE Council to consider?
      20. Are there alternative approaches, other than the ideas discussed here, that the CE Council should consider? What are the relative benefits and costs of any alternative approach?

    • 18-25 FINRA Reminds Alternative Trading Systems of Their Obligations to Supervise Activity on Their Platforms

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      ATS Supervision Obligations

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 2020
      FINRA Rule 3110
      FINRA Rule 4370
      FINRA Rule 5210
      FINRA Rule 6190
      FINRA Rule 6191
      Regulatory Notice 14-10
      Regulatory Notice 17-22
      SEA Rule 15c3-5
      SEC Regulation ATS
      SEC Regulation NMS
      SEC Regulation SHO
      Suggested Routing

      Compliance
      Legal
      Operations
      Systems
      Trading
      Training
      Key Topics

      Alternative Trading Systems
      Supervision
      Trading Practices

      Summary

      FINRA is issuing this Notice to remind Alternative Trading Systems (ATSs) of their supervision obligations.1 As registered broker-dealers and FINRA members, ATSs—like other broker-dealer trading platforms—are required to maintain supervisory systems that are reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules, including, for example, rules on disruptive or manipulative quoting and trading activity.

      Questions regarding this Notice should be directed to:

      •   Alex Ellenberg, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8152 or alexander.ellenberg@finra.org; or
      •   Cara Bain, Counsel, OGC, at (202) 728-8852 or cara.bain@finra.org.

      Background and Discussion

      When the SEC adopted Regulation ATS, it established a framework for the regulation of trading venues that meet the definition of an "exchange" under Section 3(a)(1) of the Securities Exchange Act and SEA Rule 3b-16: They can either apply for registration as a national securities exchange, or they can register as a broker-dealer and comply with Regulation ATS.2

      Importantly, the requirements of Regulation ATS complement the existing broker-dealer regulatory framework. Regulation ATS specifically requires that "an ATS that registers as a broker-dealer must, in addition to complying with Regulation ATS, comply with the filing and conduct obligations associated with being a registered broker-dealer, including membership in [a Self-Regulatory Organization (SRO)] and compliance with SRO rules."3

      Accordingly, ATSs must comply with all FINRA rules that are applicable to them and their business activity. For example, ATSs are subject to the new and continuing membership and registration rules in the NASD Rule 1000 Series. ATSs are also subject to the financial and operational rules that apply generally to broker-dealers, such as the financial condition rules in the FINRA Rule 4100 Series, the business continuity plan requirements in Rule 4370, and the recordkeeping and reporting obligations in the Rule 4500 Series.

      Other FINRA rules apply to the trading activity that occurs on an ATS. For example, ATSs must report trades—and quotations, to the extent applicable—according to the rules in the FINRA Rule 6000 Series (Quotation, Order, and Transaction Reporting Facilities) and must report order information to FINRA's Order Audit Trail System pursuant to the Rule 7400 Series. Another example can be found in Rule 6190, which requires ATSs to establish, maintain and enforce written policies and procedures that are reasonably designed to comply with the National Market System Plan to Address Extraordinary Market Volatility. ATSs also must comply with the trading halt requirements in Rule 6120.

      Rule 5210 (Publication of Transactions and Quotations) applies to trading activity that occurs on an ATS and states that no member "shall publish or circulate, or cause to be published or circulated, any...communication of any kind which purports to report any transaction as a purchase or sale of any security unless such member believes that such transaction was a bona fide purchase or sale of such security; or which purports to quote the bid price or asked price for any security, unless such member believes that such quotation represents a bona fide bid for, or offer of, such security."

      Rule 5210 includes supplementary material that provides further guidance on the type of conduct prohibited by the rule. Supplementary Material .01 states that it shall be deemed inconsistent with the Rule—as well as Rules 2010 (Standards of Commercial Honor and Principles of Trade) and 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices)—for a member "to publish or circulate or cause to be published or circulated, by any means whatsoever, any report of any securities transaction or of any purchase or sale of any security unless such member knows or has reason to believe that such transaction was a bona fide transaction, purchase or sale."4 Supplementary Material .03 states that a firm shall not "engage in or facilitate" certain quoting and trading activity that is deemed to be disruptive.5

      To promote compliance with these and other applicable FINRA rules and the federal securities laws, Rule 3110 requires each firm to maintain a reasonably designed supervisory system.6 FINRA has provided detailed guidance on the elements of reasonable supervisory procedures, which under Rule 3110(b)(2) must include a review of all transactions relating to a firm's investment banking or securities business.7 In that guidance, FINRA noted that Rule 3110.05 permits firms to satisfy their obligation to review all transactions related to their investment banking or securities business by employing risk-based review systems— e.g., electronic surveillance—with parameters designed to assess which transactions merit further review.

      FINRA is issuing this Notice to remind ATSs to evaluate what supervisory systems they use to achieve compliance with FINRA rules including, but not limited to, those referenced above, as well as the federal securities laws including, but not limited to, Regulation ATS, Regulation NMS,8 Regulation SHO, and the SEC's Market Access Rule (SEA Rule 15c3-5), to the extent applicable.9 While FINRA recognizes that ATSs do not exercise self-regulatory authority, ATSs may still set rules to govern subscriber conduct on their trading systems, or exclude subscribers from trading as necessary and appropriate to implement a reasonably designed supervisory system.10 Accordingly, Regulation ATS does not reduce or eliminate a firm's obligation under FINRA rules to supervise the trading activity that occurs on its platform; indeed, as noted above, Regulation ATS requires compliance with FINRA's supervision obligations, as with all other applicable FINRA rules.11

      As a general matter, consistent with existing supervision obligations, FINRA expects that an ATS's supervisory system be reasonably designed to identify "red flags," including potentially manipulative or non-bona fide trading that occurs on or through its systems.12 ATSs must regularly assess and evaluate their supervisory systems and procedures to ensure they are reasonably designed to achieve compliance with applicable FINRA rules and the federal securities laws.13 When reviewing the reasonableness of its supervisory system, an ATS should consider tools that are commonly available and may be used by other similarly situated market participants.14


      1. Although this Notice reminds ATSs of their existing obligations under generally applicable FINRA rules, FINRA also notes that the same supervision expectations apply to other brokerdealer trading systems that are not ATSs, such as single dealer platforms.

      2. See Securities Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70844 (December 22, 1998) (Regulation of Exchanges and Alternative Trading Systems, hereinafter, "Regulation ATS Adopting Release") at 70847.

      3. See id. at 70903. See also Securities Exchange Act Release No. 83663 (July 18, 2018) (Regulation of NMS Stock Alternative Trading Systems) (stating that ATSs "are regulated as broker-dealers, and must comply with the rules of FINRA").

      4. To the extent an ATS publishes, circulates or causes to be circulated quotations for any security, Supplementary Material .01 similarly prohibits such publication or circulation without reasonable cause to believe that the quotations are bona fide.

      5. For more explanation of the types of quoting and trading activity prohibited by Supplementary Material .03, see Regulatory Notice 17-22 (June 2017) and Securities Exchange Act Release No. 76361 (November 21, 2016), 81 FR 85651 (November 28, 2016) (Notice of Filing and Immediate Effectiveness of SR-FINRA-2016-043).

      6. There are similar principles of supervision established in Section 15(b)(4)(E) of the Securities Exchange Act.

      7. See Regulatory Notice 14-10 (March 2014).

      8. See, e.g., Goldman Sachs Execution & Clearing, L.P., FINRA Letter of Acceptance, Waiver and Consent No. 20110307615 (June 5, 2014) (finding that the firm failed to regularly surveil to ascertain the effectiveness of its policies and procedures designed to prevent executions from occurring on its ATS in violation of Rule 611 of Regulation NMS).

      9. An ATS that has only broker-dealer subscribers is not subject to the Market Access Rule. See Securities Exchange Act Release No. 63241 (November 3, 2010), 75 FR 69792, 69797 (November 15, 2010) (Adopting Release for Risk Management Controls for Brokers or Dealers with Market Access). However, these ATSs remain subject to all existing and otherwise applicable obligations, including those cited in this Notice. See id. at 69803 n.93 ("The Commission emphasizes that, as indicated above, the [Market Access] Rule is intended neither to expand nor diminish the underlying substantive regulatory requirements otherwise applicable to brokerdealers.").

      10. See Regulation ATS Adopting Release, supra note 2, at 70847, 70859.

      11. See supra note 3 and accompanying text. Although the SEC noted when adopting Regulation ATS that the Regulation does not require ATSs to surveil activities on their markets in the same manner as an SRO, ATSs still must comply with all applicable FINRA rules, including supervision, which Regulation ATS requires them to follow without exception. See Regulation ATS Adopting Release, supra note 1, at 70848.

      12. Cf. SEC v. U.S. Environmental, Inc., 94-CV-6608, 2003 U.S. Dist. LEXIS 12580, at *23 ("However, even accepting [Broker's] assertion that he was unaware of [customer's] plan [to manipulate prices of OTC equity security through wash sales and other means], the Court does not find that [Broker] reasonably discharged his supervisory duties since the pattern of red flags, apparent from a review of the trading record of [the OTC equity security], would have alerted a supervisor who was reasonably discharging his duties and using the system of procedures in place to detect violations, like the one at issue here.").

      13. ATSs are also reminded that any statements or representations they make about the supervision of their platforms must not be misleading. See, e.g., In the Matter of Barclays Capital, Inc., Securities Exchange Act Release No. 77001 (January 31, 2016) (finding, among other things, that Barclays violated Section 17(a)(2) of the Securities Act by making misleading statements about the surveillance it performed on its ATS). See also FINRA Rule 2210(d) (providing, among other things, that member communications may not be false or misleading).

      14. For example, ATSs appear commonly to use surveillance systems to limit certain types of trading behavior or otherwise maintain market quality. See, e.g., Responses to the Frequently Asked Question Concerning Regulation SCI, published by the Division of Trading and Markets, at FAQ 2.06 ("[T]he Staff understands that many ATSs maintain [surveillance] systems to surveil market-related activities for compliance with certain federal securities laws and the rules and regulations thereunder (such as Regulation SHO). In addition, the Staff understands that many ATSs also maintain such systems to surveil market-related activities for subscriber compliance with the ATS's own rules and governing documents, as applicable, such as those designed to limit certain types of trading behavior or otherwise maintain the quality of its market."). FINRA understands that, particularly for equity ATSs that offer pegged or mid-point orders, such surveillance often evaluates the trading activity on an ATS in comparison to movements in disseminated quotations.

    • 18-24 Update to Security Futures Risk Disclosure Statement and Supplement; Implementation Date: September 5, 2018

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      Security Futures

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Information Notice 9/7/10
      Notice to Members 98-3
      Regulatory Notices 14-24, 17-19
      FINRA Rule 2370
      Suggested Routing

      Compliance
      Institutional
      Legal
      Senior Management
      Trading
      Key Topics

      Security Futures
      Security Futures Risk Disclosure Statement

      Summary

      FINRA has released an updated Security Futures Risk Disclosure Statement to replace the one that was originally issued in 2002, and a new integrated supplement.1 The updated Security Futures Risk Disclosure Statement (Updated Statement) incorporates into the main body of the document the cumulative changes made to date. Among other changes, the Updated Statement reflects that the standard settlement cycle for most broker-dealer transactions is now two business days after the trade date (T+2) and the current cash limit protection of the Securities Investor Protection Corporation (SIPC).2 The new supplement (2018 Supplement) integrates, in a single supplement, all the disclosure updates made through prior supplements released in 2010 and 2014, and the updated disclosures described herein.

      The implementation date of the Updated Statement and 2018 Supplement is September 5, 2018.

      The Updated Statement and 2018 Supplement are set forth in Attachments A and B, respectively. These documents also are posted on FINRA's website at http://www.finra.org/industry/security-futures.

      Questions concerning this Notice should be directed to Sarah Kwak, Assistant General Counsel, Office of General Counsel, at (202) 728-8471 or sarah.kwak@finra.org.

      Background & Discussion

      FINRA, the National Futures Association (NFA), and several other selfregulatory organizations jointly developed the uniform Security Futures Risk Disclosure Statement, which the SEC approved in 2002 (2002 Statement).3 In 2010 and 2014, FINRA supplemented the 2002 Statement to update specified sections, and these supplements were intended to be read in conjunction with the 2002 Statement.4

      The 2002 Statement, composed of nine sections, discusses the characteristics and risks of standardized security futures contracts traded on regulated U.S. exchanges. The 2002 Statement includes a section on settlement by physical delivery, which indicates that the normal clearance and settlement cycle for securities transactions is three business days (T+3). On September 5, 2017, the securities industry moved from a T+3 settlement cycle to a T+2 settlement cycle for most broker-dealer transactions.5 Accordingly, Section 5.2 (Settlement by Physical Delivery) of the Updated Statement now reflects that the standard settlement cycle is T+2.

      The 2002 Statement also includes a section pertaining to protections for securities accounts, which indicates, among other things, that a customer may check whether a firm is a SIPC member by accessing SIPC's website or contacting SIPC by telephone or mail, and that SIPC's cash limit protection for customers is $100,000. Section 6.1 (Protections for Securities Accounts) of the Updated Statement now correctly reflects SIPC's current mailing address6 and that the cash limit protection for customers is $250,000.7 Finally, the Updated Statement incorporates non-substantive and technical changes made to Section 2.4 (How Security Futures Differ from the Underlying Security), Section 5.2, Section 8.1 (Corporate Events), and Section 8.2 (Position Limits and Large Trader Reporting).8

      FINRA Rule 2370(b)(11)(A) requires a firm to deliver a security futures risk disclosure statement to each customer at or prior to the time such customer's account is approved for trading security futures. Thereafter, the firm must distribute each new or revised security futures risk disclosure statement to each customer having an account approved for such trading or, in the alternative, not later than the time a confirmation of a transaction is delivered to each customer that enters into a security futures transaction. The rule requires FINRA to advise members when a new or revised security futures risk disclosure statement is available. The Updated Statement is accessible on FINRA's website.

      In accordance with existing guidance, a firm could also meet its Rule 2370(b)(11)(A) obligations by separately distributing a new supplement to those customers who have already received the 2002 Statement.9 FINRA has released the 2018 Supplement that aggregates all the updates to the 2002 Statement made to date. The 2018 Supplement is posted on FINRA's website as a separate document to continue to afford members with the flexibility to comply with the requirements of the rule by separately distributing the 2018 Supplement to customers who have already received the 2002 Statement.10

      FINRA reminds members that they may electronically transmit documents that they are required to furnish to customers under FINRA rules, including the Updated Statement or 2018 Supplement, provided that members adhere to the standards contained in the SEC's May 1996 and October 1995 releases on electronic delivery,11 and as discussed in Notice to Members 98-3. Members also may transmit the Updated Statement or 2018 Supplement, as appropriate, to customers through the use of a hyperlink, provided that customers have consented to electronic delivery.

      The implementation date of the Updated Statement and 2018 Supplement is September 5, 2018. Firms may elect to use the Updated Statement and 2018 Supplement prior to the implementation date.


      1. See Securities Exchange Act Release No. 83407 (June 11, 2018), 83 FR 28045 (June 15, 2018) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2018-024) and Securities Exchange Act Release No. 83825 (August 10, 2018), 83 FR 40819 (August 16, 2018) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2018-028).

      2. The NFA is expected to make conforming changes to the Statement. See, e.g., Securities Exchange Act Release No. 83589 (July 3, 2018), 83 FR 31804 (July 9, 2018) (Notice of Filing and Immediate Effectiveness of File No. SRNFA-2018-03).

      3. See Securities Exchange Act Release No. 46862 (November 20, 2002), 67 FR 70993 (November 27, 2002) (Order Approving File No. SRNASD-2002-129). See also Securities Exchange Act Release No. 46613 (October 7, 2002), 67 FR 64176 (October 17, 2002) (Notice of Filing and Effectiveness of File No. SR-NFA-2002-05).

      4. See Securities Exchange Act Release No. 62787 (August 27, 2010), 75 FR 53998 (September 2, 2010) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2010-045) and Securities Exchange Act Release No. 71981 (April 21, 2014), 79 FR 23034 (April 25, 2014) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2014-019).

      5. See Securities Exchange Act Release No. 80295 (March 22, 2017), 82 FR 15564 (March 29, 2017) (Securities Transaction Settlement Cycle; Final Rule) (File No. S7-22-16). See also Securities Exchange Act Release No. 80004 (February 9, 2017), 82 FR 10835 (February 15, 2017) (Order Approving File No. SR-FINRA-2016-047) and Securities Exchange Act Release No. 80004A (March 6, 2017), 82 FR 13517 (March 13, 2017) (Correction to Order Approving File No. SRFINRA-2016-047); and Regulatory Notice 17-19 (May 2017).

      6. SIPC's website address and telephone number remain unchanged in the Updated Statement. See Securities Investor Protection Corporation, Contact Us, https://www.sipc.org/contact-us.

      7. See 15 U.S.C. 78fff-3. Effective January 1, 2017, and for the five years immediately thereafter, the Board of Directors of SIPC has determined that the maximum amount of the advance to satisfy a claim for cash will remain at the current level of $250,000 per customer. See Securities Exchange Commission, Release No. SIPA-174 (February 22, 2016), 81 FR 9561 (February 25, 2016).

      8. Specifically, the non-substantive and technical changes include correcting a cross-reference, removing an extraneous word, spelling "broker/ dealer" as "broker-dealer," among other stylistic changes.

      9. See Information Notice 9/7/10 (describing the various ways firms may comply with the requirements of Rule 2370(b)(11)(A) such as conducting a mass mailing of the supplement to all of its security futures customers who have already received the Statement). See also Regulatory Notice 14-24 (May 2014).

      10. The security futures risk disclosure statement, in its original language approved by the SEC in 2002, remains accessible on FINRA's website for those firms whose customers may still refer to the original version of the statement, with a notation that the original version of the statement has been updated and incorporates the paragraphs specified in the 2018 Supplement. In addition, the 2010 and 2014 supplements remain accessible on FINRA's website with a notation that these documents have been updated by the 2018 Supplement.

      11. See Securities Act Release No. 7288 (May 9, 1996), 61 FR 24644 (May 15, 1996) and Securities Act Release No. 7233 (October 6, 1995), 60 FR 53458 (October 13, 1995). See also Securities Act Release No. 7856 (April 28, 2000), 65 FR 25843 (May 4, 2000) (affirming the framework for electronic delivery established in the 1995 and 1996 releases).


      Attachment A

      Security Futures Risk Disclosure Statement

      FINRA and the National Futures Association (NFA), require members to deliver this Security Futures Risk Disclosure Statement to customers at or prior to the time a customer's account is approved for trading security futures. Customers also may receive revisions from time to time.

      This Security Futures Risk Disclosure Statement has been prepared by FINRA and NFA with significant assistance from other futures and securities self-regulatory organizations.

      Additional copes of this document may be obtained by contacting FINRA MediaSource at (240) 386-4200, or the NFA Information Center at (312) 781-1410, or from FINRA's website at www.finra.org, or NFA's website at www.nfa.futures.org.

      Risk Disclosure Statement For Security Futures Contracts

      This disclosure statement discusses the characteristics and risks of standardized security futures contracts traded on regulated U.S. exchanges. At present, regulated exchanges are authorized to list futures contracts on individual equity securities registered under the Securities Exchange Act of 1934 (including common stock and certain exchange-traded funds and American Depositary Receipts), as well as narrow-based security indices. Futures on other types of securities and options on security futures contracts may be authorized in the future. The glossary of terms appears at the end of the document.

      Customers should be aware that the examples in this document are exclusive of fees and commissions that may decrease their net gains or increase their net losses. The examples also do not include tax consequences, which may differ for each customer.

      SECTION 1

      Risks Of Security Futures

      1.1. Risks of Security Futures Transactions

      Trading security futures contracts may not be suitable for all investors. You may lose a substantial amount of money in a very short period of time. The amount you may lose is potentially unlimited and can exceed the amount you originally deposit with your broker. This is because futures trading is highly leveraged, with a relatively small amount of money used to establish a position in assets having a much greater value. If you are uncomfortable with this level of risk, you should not trade security futures contracts.

      1.2. General Risks

      •   Trading security futures contracts involves risk and may result in potentially unlimited losses that are greater than the amount you deposited with your broker. As with any high risk financial product, you should not risk any funds that you cannot afford to lose, such as your retirement savings, medical and other emergency funds, funds set aside for purposes such as education or home ownership, proceeds from student loans or mortgages, or funds required to meet your living expenses.
      •   Be cautious of claims that you can make large profits from trading security futures contracts. Although the high degree of leverage in security futures contracts can result in large and immediate gains, it can also result in large and immediate losses. As with any financial product, there is no such thing as a "sure winner."
      •   Because of the leverage involved and the nature of security futures contract transactions, you may feel the effects of your losses immediately. Gains and losses in security futures contracts are credited or debited to your account, at a minimum, on a daily basis. If movements in the markets for security futures contracts or the underlying security decrease the value of your positions in security futures contracts, you may be required to have or make additional funds available to your carrying firm as margin. If your account is under the minimum margin requirements set by the exchange or the brokerage firm, your position may be liquidated at a loss, and you will be liable for the deficit, if any, in your account. Margin requirements are addressed in Section 4.
      •   Under certain market conditions, it may be difficult or impossible to liquidate a position. Generally, you must enter into an offsetting transaction in order to liquidate a position in a security futures contract. If you cannot liquidate your position in security futures contracts, you may not be able to realize a gain in the value of your position or prevent losses from mounting. This inability to liquidate could occur, for example, if trading is halted due to unusual trading activity in either the security futures contract or the underlying security; if trading is halted due to recent news events involving the issuer of the underlying security; if systems failures occur on an exchange or at the firm carrying your position; or if the position is on an illiquid market. Even if you can liquidate your position, you may be forced to do so at a price that involves a large loss.
      •   Under certain market conditions, it may also be difficult or impossible to manage your risk from open security futures positions by entering into an equivalent but opposite position in another contract month, on another market, or in the underlying security. This inability to take positions to limit your risk could occur, for example, if trading is halted across markets due to unusual trading activity in the security futures contract or the underlying security or due to recent news events involving the issuer of the underlying security.
      •   Under certain market conditions, the prices of security futures contracts may not maintain their customary or anticipated relationships to the prices of the underlying security or index. These pricing disparities could occur, for example, when the market for the security futures contract is illiquid, when the primary market for the underlying security is closed, or when the reporting of transactions in the underlying security has been delayed. For index products, it could also occur when trading is delayed or halted in some or all of the securities that make up the index.
      •   You may be required to settle certain security futures contracts with physical delivery of the underlying security. If you hold your position in a physically settled security futures contract until the end of the last trading day prior to expiration, you will be obligated to make or take delivery of the underlying securities, which could involve additional costs. The actual settlement terms may vary from contract to contract and exchange to exchange. You should carefully review the settlement and delivery conditions before entering into a security futures contract. Settlement and delivery are discussed in Section 5.
      •   You may experience losses due to systems failures. As with any financial transaction, you may experience losses if your orders for security futures contracts cannot be executed 6 normally due to systems failures on a regulated exchange or at the brokerage firm carrying your position. Your losses may be greater if the brokerage firm carrying your position does not have adequate back-up systems or procedures.
      •   All security futures contracts involve risk, and there is no trading strategy that can eliminate it. Strategies using combinations of positions, such as spreads, may be as risky as outright long or short positions. Trading in security futures contracts requires knowledge of both the securities and the futures markets.
      •   Day trading strategies involving security futures contracts and other products pose special risks. As with any financial product, persons who seek to purchase and sell the same security future in the course of a day to profit from intra-day price movements ("day traders") face a number of special risks, including substantial commissions, exposure to leverage, and competition with professional traders. You should thoroughly understand these risks and have appropriate experience before engaging in day trading. The special risks for day traders are discussed more fully in Section 7.
      •   Placing contingent orders, if permitted, such as "stop-loss" or "stop-limit" orders, will not necessarily limit your losses to the intended amount. Some regulated exchanges may permit you to enter into stop-loss or stop-limit orders for security futures contracts, which are intended to limit your exposure to losses due to market fluctuations. However, market conditions may make it impossible to execute the order or to get the stop price.
      •   You should thoroughly read and understand the customer account agreement with your brokerage firm before entering into any transactions in security futures contracts.
      •   You should thoroughly understand the regulatory protections available to your funds and positions in the event of the failure of your brokerage firm. The regulatory protections available to your funds and positions in the event of the failure of your brokerage firm may vary depending on, among other factors, the contract you are trading and whether you are trading through a securities account or a futures account. Firms that allow customers to trade security futures in either securities accounts or futures accounts, or both, are required to disclose to customers the differences in regulatory protections between such accounts, and, where appropriate, how customers may elect to trade in either type of account.

      SECTION 2

      Description of a Security Futures Contract

      2.1. What is a Security Futures Contract?

      A security futures contract is a legally binding agreement between two parties to purchase or sell in the future a specific quantity of shares of a security or of the component securities of a narrow-based security index, at a certain price. A person who buys a security futures contract enters into a contract to purchase an underlying security and is said to be "long" the contract. A person who sells a security futures contract enters into a contract to sell the underlying security and is said to be "short" the contract. The price at which the contract trades (the "contract price") is determined by relative buying and selling interest on a regulated exchange.

      In order to enter into a security futures contract, you must deposit funds with your brokerage firm equal to a specified percentage (usually at least 20 percent) of the current market value of the contract as a performance bond. Moreover, all security futures contracts are marked-to-market at least daily, usually after the close of trading, as described in Section 3 of this document. At that time, the account of each buyer and seller reflects the amount of any gain or loss on the security futures contract based on the contract price established at the end of the day for settlement purposes (the "daily settlement price").

      An open position, either a long or short position, is closed or liquidated by entering into an offsetting transaction (i.e., an equal and opposite transaction to the one that opened the position) prior to the contract expiration. Traditionally, most futures contracts are liquidated prior to expiration through an offsetting transaction and, thus, holders do not incur a settlement obligation.

      Examples:

      Investor A is long one September XYZ Corp. futures contract. To liquidate the long position in the September XYZ Corp. futures contract, Investor A would sell an identical September XYZ Corp. contract.

      Investor B is short one December XYZ Corp. futures contract. To liquidate the short position in the December XYZ Corp. futures contract, Investor B would buy an identical December XYZ Corp. contract.

      Security futures contracts that are not liquidated prior to expiration must be settled in accordance with the terms of the contract. Some security futures contracts are settled by physical delivery of the underlying security. At the expiration of a security futures contract that is settled through physical delivery, a person who is long the contract must pay the final settlement price set by the regulated exchange or the clearing organization and take delivery of the underlying shares. Conversely, a person who is short the contract must make delivery of the underlying shares in exchange for the final settlement price.

      Other security futures contracts are settled through cash settlement. In this case, the underlying security is not delivered. Instead, any positions in such security futures contracts that are open at the end of the last trading day are settled through a final cash payment based on a final settlement price determined by the exchange or clearing organization. Once this payment is made, neither party has any further obligations on the contract.

      Physical delivery and cash settlement are discussed more fully in Section 5.

      2.2. Purposes of Security Futures

      Security futures contracts can be used for speculation, hedging, and risk management. Security futures contracts do not provide capital growth or income.

      Speculation

      Speculators are individuals or firms who seek to profit from anticipated increases or decreases in futures prices. A speculator who expects the price of the underlying instrument to increase will buy the security futures contract. A speculator who expects the price of the underlying instrument to decrease will sell the security futures contract. Speculation involves substantial risk and can lead to large losses as well as profits.

      The most common trading strategies involving security futures contracts are buying with the hope of profiting from an anticipated price increase and selling with the hope of profiting from an anticipated price decrease. For example, a person who expects the price of XYZ stock to increase by March can buy a March XYZ security futures contract, and a person who expects the price of XYZ stock to decrease by March can sell a March XYZ security futures contract. The following illustrates potential profits and losses if Customer A purchases the security futures contract at $50 a share and Customer B sells the same contract at $50 a share (assuming 100 shares per contract).

      Price of XYZ at Liquidation Customer A Profit/Loss Customer B Profit/Loss
      $55 $500 - $500
      $50 $0 $0
      $45 - $500 $500

      Speculators may also enter into spreads with the hope of profiting from an expected change in price relationships. Spreaders may purchase a contract expiring in one contract month and sell another contract on the same underlying security expiring in a different month (e.g., buy June and sell September XYZ single stock futures). This is commonly referred to as a "calendar spread."

      Spreaders may also purchase and sell the same contract month in two different but economically correlated security futures contracts. For example, if ABC and XYZ are both pharmaceutical companies and an individual believes that ABC will have stronger growth than XYZ between now and June, he could buy June ABC futures contracts and sell June XYZ futures contracts. Assuming that each contract is 100 shares, the following illustrates how this works.

      Opening Position Price at Liquidation Gain or Loss Price at Liquidation Gain or Loss
      Buy ABC at 50 $53 $300 $53 $300
      Sell XYZ at 45 $46 -$100 $50 -$500
      Net Gain or Loss   $200   -$200

      Speculators can also engage in arbitrage, which is similar to a spread except that the long and short positions occur on two different markets. An arbitrage position can be established by taking an economically opposite position in a security futures contract on another exchange, in an options contract, or in the underlying security.

      Hedging

      Generally speaking, hedging involves the purchase or sale of a security future to reduce or offset the risk of a position in the underlying security or group of securities (or a close economic equivalent). A hedger gives up the potential to profit from a favorable price change in the position being hedged in order to minimize the risk of loss from an adverse price change.

      An investor who wants to lock in a price now for an anticipated sale of the underlying security at a later date can do so by hedging with security futures. For example, assume an investor owns 1,000 shares of ABC that have appreciated since he bought them. The investor would like to sell them at the current price of $50 per share, but there are tax or other reasons for holding them until September. The investor could sell ten 100- share ABC futures contracts and then buy back those contracts in September when he sells the stock. Assuming the stock price and the futures price change by the same amount, the gain or loss in the stock will be offset by the loss or gain in the futures contracts.

      Price in September Value of 1,000 Shares of ABC Gain or Loss on Futures Effective Selling Price
      $40 $40,000 $10,000 $50,000
      $50 $50,000 $0 $50,000
      $60 $60,000 - $10,000 $50,000

      Hedging can also be used to lock in a price now for an anticipated purchase of the stock at a later date. For example, assume that in May a mutual fund expects to buy stocks in a particular industry with the proceeds of bonds that will mature in August. The mutual fund can hedge its risk that the stocks will increase in value between May and August by purchasing security futures contracts on a narrow-based index of stocks from that industry. When the mutual fund buys the stocks in August, it also will liquidate the security futures position in the index. If the relationship between the security futures contract and the stocks in the index is constant, the profit or loss from the futures contract will offset the price change in the stocks, and the mutual fund will have locked in the price that the stocks were selling at in May.

      Although hedging mitigates risk, it does not eliminate all risk. For example, the relationship between the price of the security futures contract and the price of the underlying security traditionally tends to remain constant over time, but it can and does vary somewhat. Furthermore, the expiration or liquidation of the security futures contract may not coincide with the exact time the hedger buys or sells the underlying stock. Therefore, hedging may not be a perfect protection against price risk.

      Risk Management

      Some institutions also use futures contracts to manage portfolio risks without necessarily intending to change the composition of their portfolio by buying or selling the underlying securities. The institution does so by taking a security futures position that is opposite to some or all of its position in the underlying securities. This strategy involves more risk than a traditional hedge because it is not meant to be a substitute for an anticipated purchase or sale.

      2.3. Where Security Futures Trade

      By law, security futures contracts must trade on a regulated U.S. exchange. Each regulated U.S. exchange that trades security futures contracts is subject to joint regulation by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).

      A person holding a position in a security futures contract who seeks to liquidate the position must do so either on the regulated exchange where the original trade took place or on another regulated exchange, if any, where a fungible security futures contract trades. (A person may also seek to manage the risk in that position by taking an opposite position in a comparable contract traded on another regulated exchange.)

      Security futures contracts traded on one regulated exchange might not be fungible with security futures contracts traded on another regulated exchange for a variety of reasons. Security futures traded on different regulated exchanges may be non-fungible because they have different contract terms (e.g., size, settlement method), or because they are cleared through different clearing organizations. Moreover, a regulated exchange might not permit its security futures contracts to be offset or liquidated by an identical contract traded on another regulated exchange, even though they have the same contract terms and are cleared through the same clearing organization. You should consult your broker about the fungibility of the contract you are considering purchasing or selling, including which exchange(s), if any, on which it may be offset.

      Regulated exchanges that trade security futures contracts are required by law to establish certain listing standards. Changes in the underlying security of a security futures contract may, in some cases, cause such contract to no longer meet the regulated exchange's listing standards. Each regulated exchange will have rules governing the continued trading of security futures contracts that no longer meet the exchange's listing standards. These rules may, for example, permit only liquidating trades in security futures contracts that no longer satisfy the listing standards.

      2.4. How Security Futures Differ from the Underlying Security

      Shares of common stock represent a fractional ownership interest in the issuer of that security. Ownership of securities confers various rights that are not present with positions in security futures contracts. For example, persons owning a share of common stock may be entitled to vote in matters affecting corporate governance. They also may be entitled to receive dividends and corporate disclosure, such as annual and quarterly reports.

      The purchaser of a security futures contract, by contrast, has only a contract for future delivery of the underlying security. The purchaser of the security futures contract is not entitled to exercise any voting rights over the underlying security and is not entitled to any dividends that may be paid by the issuer. Moreover, the purchaser of a security futures contract does not receive the corporate disclosures that are received by shareholders of the underlying security, although such corporate disclosures must be made publicly available through the SEC's EDGAR system, which can be accessed at www.sec.gov. You should review such disclosures before entering into a security futures contract. See Section 8.1 for further discussion of the impact of corporate events on a security futures contract.

      All security futures contracts are marked-to-market at least daily, usually after the close of trading, as described in Section 3 of this document. At that time, the account of each buyer and seller is credited with the amount of any gain, or debited by the amount of any loss, on the security futures contract, based on the contract price established at the end of the day for settlement purposes (the "daily settlement price"). By contrast, the purchaser or seller of the underlying instrument does not have the profit and loss from his or her investment credited or debited until the position in that instrument is closed out.

      Naturally, as with any financial product, the value of the security futures contract and of the underlying security may fluctuate. However, owning the underlying security does not require an investor to settle his or her profits and losses daily. By contrast, as a result of the mark-to-market requirements discussed above, a person who is long a security futures contract often will be required to deposit additional funds into his or her account as the price of the security futures contract decreases. Similarly, a person who is short a security futures contract often will be required to deposit additional funds into his or her account as the price of the security futures contract increases.

      Another significant difference is that security futures contracts expire on a specific date. Unlike an owner of the underlying security, a person cannot hold a long position in a security futures contract for an extended period of time in the hope that the price will go up. If you do not liquidate your security futures contract, you will be required to settle the contract when it expires, either through physical delivery or cash settlement. For cash-settled contracts in particular, upon expiration, an individual will no longer have an economic interest in the securities underlying the security futures contract.

      2.5. Comparison to Options

      Although security futures contracts share some characteristics with options on securities (options contracts), these products are also different in a number of ways. Below are some of the important distinctions between equity options contracts and security futures contracts.

      If you purchase an options contract, you have the right, but not the obligation, to buy or sell a security prior to the expiration date. If you sell an options contract, you have the obligation to buy or sell a security prior to the expiration date. By contrast, if you have a position in a security futures contract (either long or short), you have both the right and the obligation to buy or sell a security at a future date. The only way that you can avoid the obligation incurred by the security futures contract is to liquidate the position with an offsetting contract.

      A person purchasing an options contract runs the risk of losing the purchase price (premium) for the option contract. Because it is a wasting asset, the purchaser of an options contract who neither liquidates the options contract in the secondary market nor exercises it at or prior to expiration will necessarily lose his or her entire investment in the options contract. However, a purchaser of an options contract cannot lose more than the amount of the premium. Conversely, the seller of an options contract receives the premium and assumes the risk that he or she will be required to buy or sell the underlying security on or prior to the expiration date, in which event his or her losses may exceed the amount of the premium received. Although the seller of an options contract is required to deposit margin to reflect the risk of its obligation, he or she may lose many times his or her initial margin deposit.

      By contrast, the purchaser and seller of a security futures contract each enter into an agreement to buy or sell a specific quantity of shares in the underlying security. Based upon the movement in prices of the underlying security, a person who holds a position in a security futures contract can gain or lose many times his or her initial margin deposit. In this respect, the benefits of a security futures contract are similar to the benefits of purchasing an option, while the risks of entering into a security futures contract are similar to the risks of selling an option.

      Both the purchaser and the seller of a security futures contract have daily margin obligations. At least once each day, security futures contracts are marked-to-market and the increase or decrease in the value of the contract is credited or debited to the buyer and the seller. As a result, any person who has an open position in a security futures contract may be called upon to meet additional margin requirements or may receive a credit of available funds.

      Example:

      Assume that Customers A and B each anticipate an increase in the market price of XYZ stock, which is currently $50 a share. Customer A purchases an XYZ 50 call (covering 100 shares of XYZ at a premium of $5 per share). The option premium is $500 ($5 per share X 100 shares). Customer B purchases an XYZ security futures contract (covering 100 shares of XYZ). The total value of the contract is $5000 ($50 share value X 100 shares). The required margin is $1000 (or 20% of the contract value).
      Price of XYZ at Expiration Customer A Profit/Loss Customer B Profit/Loss
      65 $1000 $1500
      60 $500 $1000
      55 $0 $500
      50 - $500 $0
      45 - $500 - $500
      40 - $500 - $1000
      35 - $500 - $1500
      The most that Customer A can lose is $500, the option premium. Customer A breaks even at $55 per share, and makes money at higher prices. Customer B may lose more than his initial margin deposit. Unlike the options premium, the margin on a futures contract is not a cost but a performance bond. The losses for Customer B are not limited by this performance bond. Rather, the losses or gains are determined by the settlement price of the contract, as provided in the example above. Note that if the price of XYZ falls to $35 per share, Customer A loses only $500, whereas Customer B loses $1500.

      2.6. Components of a Security Futures Contract

      Each regulated exchange can choose the terms of the security futures contracts it lists, and those terms may differ from exchange to exchange or contract to contract. Some of those contract terms are discussed below. However, you should ask your broker for a copy of the contract specifications before trading a particular contract.

      2.6.1. Each security futures contract has a set size. The size of a security futures contract is determined by the regulated exchange on which the contract trades. For example, a security futures contract for a single stock may be based on 100 shares of that stock. If prices are reported per share, the value of the contract would be the price times 100. For narrow-based security indices, the value of the contract is the price of the component securities times the multiplier set by the exchange as part of the contract terms.
      2.6.2. Security futures contracts expire at set times determined by the listing exchange. For example, a particular contract may expire on a particular day, e.g., the third Friday of the expiration month. Up until expiration, you may liquidate an open position by offsetting your contract with a fungible opposite contract that expires in the same month. If you do not liquidate an open position before it expires, you will be required to make or take delivery of the underlying security or to settle the contract in cash after expiration.
      2.6.3. Although security futures contracts on a particular security or a narrow-based security index may be listed and traded on more than one regulated exchange, the contract specifications may not be the same. Also, prices for contracts on the same security or index may vary on different regulated exchanges because of different contract specifications.
      2.6.4. Prices of security futures contracts are usually quoted the same way prices are quoted in the underlying instrument. For example, a contract for an individual security would be quoted in dollars and cents per share. Contracts for indices would be quoted by an index number, usually stated to two decimal places.
      2.6.5. Each security futures contract has a minimum price fluctuation (called a tick), which may differ from product to product or exchange to exchange. For example, if a particular security futures contract has a tick size of 1¢, you can buy the contract at $23.21 or $23.22 but not at $23.215.

      2.7. Trading Halts

      The value of your positions in security futures contracts could be affected if trading is halted in either the security futures contract or the underlying security. In certain circumstances, regulated exchanges are required by law to halt trading in security futures contracts. For example, trading on a particular security futures contract must be halted if trading is halted on the listed market for the underlying security as a result of pending news, regulatory concerns, or market volatility. Similarly, trading of a security futures contract on a narrow-based security index must be halted under such circumstances if trading is halted on securities accounting for at least 50 percent of the market capitalization of the index. In addition, regulated exchanges are required to halt trading in all security futures contracts for a specified period of time when the Dow Jones Industrial Average ("DJIA") experiences one-day declines of 10-, 20- and 30-percent. The regulated exchanges may also have discretion under their rules to halt trading in other circumstances—such as when the exchange determines that the halt would be advisable in maintaining a fair and orderly market.

      A trading halt, either by a regulated exchange that trades security futures or an exchange trading the underlying security or instrument, could prevent you from liquidating a position in security futures contracts in a timely manner, which could prevent you from liquidating a position in security futures contracts at that time.

      2.8. Trading Hours

      Each regulated exchange trading a security futures contract may open and close for trading at different times than other regulated exchanges trading security futures contracts or markets trading the underlying security or securities. Trading in security futures contracts prior to the opening or after the close of the primary market for the underlying security may be less liquid than trading during regular market hours.

      SECTION 3

      Clearing Organizations and Mark-to-Market Requirements

      Every regulated U.S. exchange that trades security futures contracts is required to have a relationship with a clearing organization that serves as the guarantor of each security futures contract traded on that exchange. A clearing organization performs the following functions: matching trades; effecting settlement and payments; guaranteeing performance; and facilitating deliveries.

      Throughout each trading day, the clearing organization matches trade data submitted by clearing members on behalf of their customers or for the clearing member's proprietary accounts. If an account is with a brokerage firm that is not a member of the clearing organization, then the brokerage firm will carry the security futures position with another brokerage firm that is a member of the clearing organization. Trade records that do not match, either because of a discrepancy in the details or because one side of the transaction is missing, are returned to the submitting clearing members for resolution. The members are required to resolve such "out trades" before or on the open of trading the next morning.

      When the required details of a reported transaction have been verified, the clearing organization assumes the legal and financial obligations of the parties to the transaction. One way to think of the role of the clearing organization is that it is the "buyer to every seller and the seller to every buyer." The insertion or substitution of the clearing organization as the counter-party to every transaction enables a customer to liquidate a security futures position without regard to what the other party to the original security futures contract decides to do.

      The clearing organization also effects the settlement of gains and losses from security futures contracts between clearing members. At least once each day, clearing member brokerage firms must either pay to, or receive from, the clearing organization the difference between the current price and the trade price earlier in the day, or for a position carried over from the previous day, the difference between the current price and the previous day's settlement price. Whether a clearing organization effects settlement of gains and losses on a daily basis or more frequently will depend on the conventions of the clearing organization and market conditions. Because the clearing organization assumes the legal and financial obligations for each security futures contract, you should expect it to ensure that payments are made promptly to protect its obligations.

      Gains and losses in security futures contracts are also reflected in each customer's account on at least a daily basis. Each day's gains and losses are determined based on a daily settlement price disseminated by the regulated exchange trading the security futures contract or its clearing organization. If the daily settlement price of a particular security futures contract rises, the buyer has a gain and the seller a loss. If the daily settlement price declines, the buyer has a loss and the seller a gain. This process is known as "marking-to-market" or daily settlement. As a result, individual customers normally will be called on to settle daily.

      The one-day gain or loss on a security futures contract is determined by calculating the difference between the current day's settlement price and the previous day's settlement price.

      For example, assume a security futures contract is purchased at a price of $120. If the daily settlement price is either $125 (higher) or $117 (lower), the effects would be as follows:

      (1 contract representing 100 shares)

      Daily Settlement Value Buyer's Account Seller's Account
      $125 $500 gain (credit) $500 loss (debit)
      $117 $300 loss (debit) $300 gain (credit)

      The cumulative gain or loss on a customer's open security futures positions is generally referred to as "open trade equity" and is listed as a separate component of account equity on your customer account statement.

      A discussion of the role of the clearing organization in effecting delivery is discussed in Section 5.

      SECTION 4

      Margin And Leverage

      When a broker-dealer lends a customer part of the funds needed to purchase a security such as common stock, the term "margin" refers to the amount of cash, or down payment, the customer is required to deposit. By contrast, a security futures contract is an obligation and not an asset. A security futures contract has no value as collateral for a loan. Because of the potential for a loss as a result of the daily marked-to-market process, however, a margin deposit is required of each party to a security futures contract. This required margin deposit also is referred to as a "performance bond."

      In the first instance, margin requirements for security futures contracts are set by the exchange on which the contract is traded, subject to certain minimums set by law. The basic margin requirement is 20% of the current value of the security futures contract, although some strategies may have lower margin requirements. Requests for additional margin are known as "margin calls." Both buyer and seller must individually deposit the required margin to their respective accounts.

      It is important to understand that individual brokerage firms can, and in many cases do, require margin that is higher than the exchange requirements. Additionally, margin requirements may vary from brokerage firm to brokerage firm. Furthermore, a brokerage firm can increase its "house" margin requirements at any time without providing advance notice, and such increases could result in a margin call.

      For example, some firms may require margin to be deposited the business day following the day of a deficiency, or some firms may even require deposit on the same day. Some firms may require margin to be on deposit in the account before they will accept an order for a security futures contract. Additionally, brokerage firms may have special requirements as to how margin calls are to be met, such as requiring a wire transfer from a bank, or deposit of a certified or cashier's check. You should thoroughly read and understand the customer agreement with your brokerage firm before entering into any transactions in security futures contracts.

      If through the daily cash settlement process, losses in the account of a security futures contract participant reduce the funds on deposit (or equity) below the maintenance margin level (or the firm's higher "house" requirement), the brokerage firm will require that additional funds be deposited.

      If additional margin is not deposited in accordance with the firm's policies, the firm can liquidate your position in security futures contracts or sell assets in any of your accounts at the firm to cover the margin deficiency. You remain responsible for any shortfall in the account after such liquidations or sales. Unless provided otherwise in your customer agreement or by applicable law, you are not entitled to choose which futures contracts, other securities or other assets are liquidated or sold to meet a margin call or to obtain an extension of time to meet a margin call.

      Brokerage firms generally reserve the right to liquidate a customer's security futures contract positions or sell customer assets to meet a margin call at any time without contacting the customer. Brokerage firms may also enter into equivalent but opposite positions for your account in order to manage the risk created by a margin call. Some customers mistakenly believe that a firm is required to contact them for a margin call to be valid, and that the firm is not allowed to liquidate securities or other assets in their accounts to meet a margin call unless the firm has contacted them first. This is not the case. While most firms notify their customers of margin calls and allow some time for deposit of additional margin, they are not required to do so. Even if a firm has notified a customer of a margin call and set a specific due date for a margin deposit, the firm can still take action as necessary to protect its financial interests, including the immediate liquidation of positions without advance notification to the customer.

      Here is an example of the margin requirements for a long security futures position.

      A customer buys 3 July EJG security futures at 71.50. Assuming each contract represents 100 shares, the nominal value of the position is $21,450 (71.50 x 3 contracts x 100 shares). If the initial margin rate is 20% of the nominal value, then the customer's initial margin requirement would be $4,290. The customer deposits the initial margin, bringing the equity in the account to $4,290.

      First, assume that the next day the settlement price of EJG security futures falls to 69.25. The marked-to-market loss in the customer's equity is $675 (71.50 − 69.25 x 3 contacts x 100 shares). The customer's equity decreases to $3,615 ($4,290 − $675). The new nominal value of the contract is $20,775 (69.25 x 3 contracts x 100 shares). If the maintenance margin rate is 20% of the nominal value, then the customer's maintenance margin requirement would be $4,155. Because the customer's equity had decreased to $3,615 (see above), the customer would be required to have an additional $540 in margin ($4,155 − $3,615).

      Alternatively, assume that the next day the settlement price of EJG security futures rises to 75.00. The mark-to-market gain in the customer's equity is $1,050 (75.00 − 71.50 x 3 contacts x 100 shares). The customer's equity increases to $5,340 ($4,290 + $1,050). The new nominal value of the contract is $22,500 (75.00 x 3 contracts x 100 shares). If the maintenance margin rate is 20% of the nominal value, then the customer's maintenance margin requirement would be $4,500. Because the customer's equity had increased to $5,340 (see above), the customer's excess equity would be $840.

      The process is exactly the same for a short position, except that margin calls are generated as the settlement price rises rather than as it falls. This is because the customer's equity decreases as the settlement price rises and increases as the settlement price falls.

      Because the margin deposit required to open a security futures position is a fraction of the nominal value of the contracts being purchased or sold, security futures contracts are said to be highly leveraged. The smaller the margin requirement in relation to the underlying value of the security futures contract, the greater the leverage. Leverage allows exposure to a given quantity of an underlying asset for a fraction of the investment needed to purchase that quantity outright. In sum, buying (or selling) a security futures contract provides the same dollar and cents profit and loss outcomes as owning (or shorting) the underlying security. However, as a percentage of the margin deposit, the potential immediate exposure to profit or loss is much higher with a security futures contract than with the underlying security.

      For example, if a security futures contract is established at a price of $50, the contract has a nominal value of $5,000 (assuming the contract is for 100 shares of stock). The margin requirement may be as low as 20%. In the example just used, assume the contract price rises from $50 to $52 (a $200 increase in the nominal value). This represents a $200 profit to the buyer of the security futures contract, and a 20% return on the $1,000 deposited as margin. The reverse would be true if the contract price decreased from $50 to $48. This represents a $200 loss to the buyer, or 20% of the $1,000 deposited as margin. Thus, leverage can either benefit or harm an investor.

      Note that a 4% decrease in the value of the contract resulted in a loss of 20% of the margin deposited. A 20% decrease would wipe out 100% of the margin deposited on the security futures contract.

      SECTION 5

      Settlement

      If you do not liquidate your position prior to the end of trading on the last day before the expiration of the security futures contract, you are obligated to either 1) make or accept a cash payment ("cash settlement") or 2) deliver or accept delivery of the underlying securities in exchange for final payment of the final settlement price ("physical delivery"). The terms of the contract dictate whether it is settled through cash settlement or by physical delivery.

      The expiration of a security futures contract is established by the exchange on which the contract is listed. On the expiration day, security futures contracts cease to exist. Typically, the last trading day of a security futures contract will be the third Friday of the expiring contract month, and the expiration day will be the following Saturday. This follows the expiration conventions for stock options and broad-based stock indexes. Please keep in mind that the expiration day is set by the listing exchange and may deviate from these norms.

      5.1. Cash Settlement

      In the case of cash settlement, no actual securities are delivered at the expiration of the security futures contract. Instead, you must settle any open positions in security futures by making or receiving a cash payment based on the difference between the final settlement price and the previous day's settlement price. Under normal circumstances, the final settlement price for a cash-settled contract will reflect the opening price for the underlying security. Once this payment is made, neither the buyer nor the seller of the security futures contract has any further obligations on the contract.

      5.2. Settlement by Physical Delivery

      Settlement by physical delivery is carried out by clearing brokers or their agents with National Securities Clearing Corporation (NSCC), an SEC-regulated securities clearing agency. Such settlements are made in much the same way as they are for purchases and sales of the underlying security. Promptly after the last day of trading, the regulated exchange's clearing organization will report a purchase and sale of the underlying stock at the previous day's settlement price (also referred to as the "invoice price") to NSCC. In general, if NSCC does not reject the transaction by a time specified in its rules, settlement is effected pursuant to the rules of the exchange and NSCC's Rules and Procedures within the normal clearance and settlement cycle for securities transactions, which currently is two business days. However, settlement may be effected on a shorter timeframe based on the rules of the exchange and subject to NSCC's Rules and Procedures.

      If you hold a short position in a physically settled security futures contract to expiration, you will be required to make delivery of the underlying securities. If you already own the securities, you may tender them to your brokerage firm. If you do not own the securities, you will be obligated to purchase them. Some brokerage firms may not be able to purchase the securities for you. If your brokerage firm cannot purchase the underlying securities on your behalf to fulfill a settlement obligation, you will have to purchase the securities through a different firm.

      SECTION 6

      Customer Account Protections

      Positions in security futures contracts may be held either in a securities account or in a futures account. Your brokerage firm may or may not permit you to choose the types of account in which your positions in security futures contracts will be held. The protections for funds deposited or earned by customers in connection with trading in security futures contracts differ depending on whether the positions are carried in a securities account or a futures account. If your positions are carried in a securities account, you will not receive the protections available for futures accounts. Similarly, if your positions are carried in a futures account, you will not receive the protections available for securities accounts. You should ask your broker which of these protections will apply to your funds.

      You should be aware that the regulatory protections applicable to your account are not intended to insure you against losses you may incur as a result of a decline or increase in the price of a security futures contract. As with all financial products, you are solely responsible for any market losses in your account.

      Your brokerage firm must tell you whether your security futures positions will be held in a securities account or a futures account. If your brokerage firm gives you a choice, it must tell you what you have to do to make the choice and which type of account will be used if you fail to do so. You should understand that certain regulatory protections for your account will depend on whether it is a securities account or a futures account.

      6.1. Protections for Securities Accounts

      If your positions in security futures contracts are carried in a securities account, they are covered by SEC rules governing the safeguarding of customer funds and securities. These rules prohibit a broker-dealer from using customer funds and securities to finance its business. As a result, the broker-dealer is required to set aside funds equal to the net of all its excess payables to customers over receivables from customers. The rules also require a broker-dealer to segregate all customer fully paid and excess margin securities carried by the broker-dealer for customers.

      The Securities Investor Protection Corporation (SIPC) also covers positions held in securities accounts. SIPC was created in 1970 as a nonprofit, non-government, membership corporation, funded by member broker-dealers. Its primary role is to return funds and securities to customers if the broker-dealer holding these assets becomes insolvent. SIPC coverage applies to customers of current (and in some cases former) SIPC members. Most broker-dealers registered with the SEC are SIPC members; those few that are not must disclose this fact to their customers. SIPC members must display an official sign showing their membership. To check whether a firm is a SIPC member, go to www.sipc.org, call the SIPC Membership Department at (202) 371-8300, or write to SIPC Membership Department, Securities Investor Protection Corporation, 1667 K Street, NW, Suite 1000, Washington, DC 20006-1620.

      SIPC coverage is limited to $500,000 per customer, including up to $250,000 for cash. For example, if a customer has 1,000 shares of XYZ stock valued at $200,000 and $10,000 cash in the account, both the security and the cash balance would be protected. However, if the customer has shares of stock valued at $500,000 and $250,000 in cash, only a total of $500,000 of those assets will be protected.

      For purposes of SIPC coverage, customers are persons who have securities or cash on deposit with a SIPC member for the purpose of, or as a result of, securities transactions. SIPC does not protect customer funds placed with a broker-dealer just to earn interest. Insiders of the broker-dealer, such as its owners, officers, and partners, are not customers for purposes of SIPC coverage.

      6.2. Protections for Futures Accounts

      If your security futures positions are carried in a futures account, they must be segregated from the brokerage firm's own funds and cannot be borrowed or otherwise used for the firm's own purposes. If the funds are deposited with another entity ( e.g., a bank, clearing broker, or clearing organization), that entity must acknowledge that the funds belong to customers and cannot be used to satisfy the firm's debts. Moreover, although a brokerage firm may carry funds belonging to different customers in the same bank or clearing account, it may not use the funds of one customer to margin or guarantee the transactions of another customer. As a result, the brokerage firm must add its own funds to its customers' segregated funds to cover customer debits and deficits. Brokerage firms must calculate their segregation requirements daily.

      You may not be able to recover the full amount of any funds in your account if the brokerage firm becomes insolvent and has insufficient funds to cover its obligations to all of its customers. However, customers with funds in segregation receive priority in bankruptcy proceedings. Furthermore, all customers whose funds are required to be segregated have the same priority in bankruptcy, and there is no ceiling on the amount of funds that must be segregated for or can be recovered by a particular customer.

      Your brokerage firm is also required to separately maintain funds invested in security futures contracts traded on a foreign exchange. However, these funds may not receive the same protections once they are transferred to a foreign entity ( e.g., a foreign broker, exchange or clearing organization) to satisfy margin requirements for those products. You should ask your broker about the bankruptcy protections available in the country where the foreign exchange (or other entity holding the funds) is located.

      SECTION 7

      Special Risks For Day Traders

      Certain traders who pursue a day trading strategy may seek to use security futures contracts as part of their trading activity. Whether day trading in security futures contracts or other securities, investors engaging in a day trading strategy face a number of risks.

      •   Day trading in security futures contracts requires in-depth knowledge of the securities and futures markets and of trading techniques and strategies. In attempting to profit through day trading, you will compete with professional traders who are knowledgeable and sophisticated in these markets. You should have appropriate experience before engaging in day trading.
      •   Day trading in security futures contracts can result in substantial commission charges, even if the per trade cost is low. The more trades you make, the higher your total commissions will be. The total commissions you pay will add to your losses and reduce your profits. For instance, assuming that a round-turn trade costs $16 and you execute an average of 29 round-turn transactions per day each trading day, you would need to generate an annual profit of $111,360 just to cover your commission expenses.
      •   Day trading can be extremely risky. Day trading generally is not appropriate for someone of limited resources and limited investment or trading experience and low risk tolerance. You should be prepared to lose all of the funds that you use for day trading. In particular, you should not fund day trading activities with funds that you cannot afford to lose.

      SECTION 8

      Other

      8.1. Corporate Events

      As noted in Section 2.4, an equity security represents a fractional ownership interest in the issuer of that security. By contrast, the purchaser of a security futures contract has only a contract for future delivery of the underlying security. Treatment of dividends and other corporate events affecting the underlying security may be reflected in the security futures contract depending on the applicable clearing organization rules. Consequently, individuals should consider how dividends and other developments affecting security futures in which they transact will be handled by the relevant exchange and clearing organization. The specific adjustments to the terms of a security futures contract are governed by the rules of the applicable clearing organization. Below is a discussion of some of the more common types of adjustments that you may need to consider.

      Corporate issuers occasionally announce stock splits. As a result of these splits, owners of the issuer's common stock may own more shares of the stock, or fewer shares in the case of a reverse stock split. The treatment of stock splits for persons owning a security futures contract may vary according to the terms of the security futures contract and the rules of the clearing organization. For example, the terms of the contract may provide for an adjustment in the number of contracts held by each party with a long or short position in a security future, or for an adjustment in the number of shares or units of the instrument underlying each contract, or both.

      Corporate issuers also occasionally issue special dividends. A special dividend is an announced cash dividend payment outside the normal and customary practice of a corporation. The terms of a security futures contract may be adjusted for special dividends. The adjustments, if any, will be based upon the rules of the exchange and clearing organization. In general, there will be no adjustments for ordinary dividends as they are recognized as a normal and customary practice of an issuer and are already accounted for in the pricing of security futures. However, adjustments for ordinary dividends may be made for a specified class of security futures contracts based on the rules of the exchange and the clearing organization.

      Corporate issuers occasionally may be involved in mergers and acquisitions. Such events may cause the underlying security of a security futures contact to change over the contract duration. The terms of security futures contracts may also be adjusted to reflect other corporate events affecting the underlying security.

      8.2. Position Limits and Large Trader Reporting

      All security futures contracts trading on regulated exchanges in the United States are subject to position limits or position accountability limits. Position limits restrict the number of security futures contracts that any one person or group of related persons may hold or control in a particular security futures contract. In contrast, position accountability limits permit the accumulation of positions in excess of the limit without a prior exemption. In general, position limits and position accountability limits are beyond the thresholds of most retail investors. Whether a security futures contract is subject to position limits, and the level for such limits, depends upon the trading activity and market capitalization of the underlying security of the security futures contract.

      Position limits are required for security futures contracts that overlie a security that has an average daily trading volume of 20 million shares or fewer. In the case of a security futures contract overlying a security index, position limits are required if any one of the securities in the index has an average daily trading volume of 20 million shares or fewer. Position limits also apply only to an expiring security futures contract during its last five trading days. A regulated exchange must establish position limits on security futures that are no greater than 13,500 (100 share) contracts, unless the underlying security meets certain volume and shares outstanding thresholds, in which case the limit may be increased to 22,500 (100 share) contracts.

      For security futures contracts overlying a security or securities with an average trading volume of more than 20 million shares, regulated exchanges may adopt position accountability rules. Under position accountability rules, a trader holding a position in a security futures contract that exceeds 22,500 contracts (or such lower limit established by an exchange) must agree to provide information regarding the position and consent to halt increasing that position if requested by the exchange.

      Brokerage firms must also report large open positions held by one person (or by several persons acting together) to the CFTC as well as to the exchange on which the positions are held. The CFTC's reporting requirements are 1,000 contracts for security futures positions on individual equity securities and 200 contracts for positions on a narrow-based index. However, individual exchanges may require the reporting of large open positions at levels less than the levels required by the CFTC. In addition, brokerage firms must submit identifying information on the account holding the reportable position (on a form referred to as either an "Identification of Special Accounts Form" or a "Form 102") to the CFTC and to the exchange on which the reportable position exists within three business days of when a reportable position is first established.

      8.3. Transactions on Foreign Exchanges

      U.S. customers may not trade security futures on foreign exchanges until authorized by U.S. regulatory authorities. U.S. regulatory authorities do not regulate the activities of foreign exchanges and may not, on their own, compel enforcement of the rules of a foreign exchange or the laws of a foreign country. While U.S. law governs transactions in security futures contracts that are effected in the U.S., regardless of the exchange on which the contracts are listed, the laws and rules governing transactions on foreign exchanges vary depending on the country in which the exchange is located.

      8.4. Tax Consequences

      For most taxpayers, security futures contracts are not treated like other futures contracts. Instead, the tax consequences of a security futures transaction depend on the status of the taxpayer and the type of position (e.g., long or short, covered or uncovered). Because of the importance of tax considerations to transactions in security futures, readers should consult their tax advisors as to the tax consequences of these transactions.

      SECTION 9

      Glossary Of Terms

      This glossary is intended to assist customers in understanding specialized terms used in the futures and securities industries. It is not inclusive and is not intended to state or suggest the legal significance or meaning of any word or term.

      Arbitrage

      Taking an economically opposite position in a security futures contract on another exchange, in an options contract, or in the underlying security.

      Broad-based security index

      A security index that does not fall within the statutory definition of a narrow-based security index (see Narrow-based security index). A future on a broad-based security index is not a security future. This risk disclosure statement applies solely to security futures and generally does not pertain to futures on a broad-based security index. Futures on a broad-based security index are under exclusive jurisdiction of the CFTC.

      Cash settlement

      A method of settling certain futures contracts by having the buyer (or long) pay the seller (or short) the cash value of the contract according to a procedure set by the exchange.

      Clearing broker

      A member of the clearing organization for the contract being traded. All trades, and the daily profits or losses from those trades, must go through a clearing broker.

      Clearing organization

      A regulated entity that is responsible for settling trades, collecting losses and distributing profits, and handling deliveries.

      Contract

      (1) the unit of trading for a particular futures contract (e.g., one contract may be 100 shares of the underlying security);
      (2) the type of future being traded (e.g., futures on ABC stock).

      Contract month

      The last month in which delivery is made against the futures contract or the contract is cash-settled. Sometimes referred to as the delivery month.

      Day trading strategy

      An overall trading strategy characterized by the regular transmission by a customer of intra-day orders to effect both purchase and sale transactions in the same security or securities.

      EDGAR

      The SEC's Electronic Data Gathering, Analysis, and Retrieval system maintains electronic copies of corporate information filed with the agency. EDGAR submissions may be accessed through the SEC's website, www.sec.gov.

      Futures contract

      A futures contract is

      (1) an agreement to purchase or sell a commodity for delivery in the future;
      (2) at a price determined at initiation of the contract;
      (3) that obligates each party to the contract to fulfill it at the specified price;
      (4) that is used to assume or shift risk; and
      (5) that may be satisfied by delivery or offset.

      Hedging

      The purchase or sale of a security future to reduce or offset the risk of a position in the underlying security or group of securities (or a close economic equivalent).

      Illiquid market

      A market (or contract) with few buyers and/or sellers. Illiquid markets have little trading activity and those trades that do occur may be done at large price increments.

      Liquidation

      Entering into an offsetting transaction. Selling a contract that was previously purchased liquidates a futures position in exactly the same way that selling 100 shares of a particular stock liquidates an earlier purchase of the same stock. Similarly, a futures contract that was initially sold can be liquidated by an offsetting purchase.

      Liquid market

      A market (or contract) with numerous buyers and sellers trading at small price increments.

      Long

      (1) the buying side of an open futures contact;
      (2) a person who has bought futures contracts that are still open.

      Margin

      The amount of money that must be deposited by both buyers and sellers to ensure performance of the person's obligations under a futures contract. Margin on security futures contracts is a performance bond rather than a down payment for the underlying securities.

      Mark-to-market

      To debit or credit accounts daily to reflect that day's profits and losses.

      Narrow-based security index

      In general, and subject to certain exclusions, an index that has any one of the following four characteristics:

      (1) it has nine or fewer component securities;
      (2) any one of its component securities comprises more than 30% of its weighting;
      (3) the five highest weighted component securities together comprise more than 60% of its weighting; or
      (4) the lowest weighted component securities comprising, in the aggregate, 25% of the index's weighting have an aggregate dollar value of average daily trading volume of less than $50 million (or in the case of an index with 15 or more component securities, $30 million).

      A security index that is not narrow-based is a "broad based security index." (See Broad-based security index).

      Nominal value

      The face value of the futures contract, obtained by multiplying the contract price by the number of shares or units per contract. If XYZ stock index futures are trading at $50.25 and the contract is for 100 shares of XYZ stock, the nominal value of the futures contract would be $5025.00.

      Offsetting

      Liquidating open positions by either selling fungible contracts in the same contract month as an open long position or buying fungible contracts in the same contract month as an open short position.

      Open interest

      The total number of open long (or short) contracts in a particular contract month.

      Open position

      A futures contract position that has neither been offset nor closed by cash settlement or physical delivery.

      Performance bond

      Another way to describe margin payments for futures contracts, which are good faith deposits to ensure performance of a person's obligations under a futures contract rather than down payments for the underlying securities.

      Physical delivery

      The tender and receipt of the actual security underlying the security futures contract in exchange for payment of the final settlement price.

      Position

      A person's net long or short open contracts.

      Regulated exchange

      A registered national securities exchange, a national securities association registered under Section 15A(a) of the Securities Exchange Act of 1934, a designated contract market, a registered derivatives transaction execution facility, or an alternative trading system registered as a broker or dealer.

      Security futures contract

      A legally binding agreement between two parties to purchase or sell in the future a specific quantify of shares of a security (such as common stock, an exchange-traded fund, or ADR) or a narrow-based security index, at a specified price.

      Settlement price

      (1) the daily price that the clearing organization uses to mark open positions to market for determining profit and loss and margin calls,
      (2) the price at which open cash settlement contracts are settled on the last trading day and open physical delivery contracts are invoiced for delivery.

      Short

      (1) the selling side of an open futures contract,
      (2) a person who has sold futures contracts that are still open.

      Speculating

      Buying and selling futures contracts with the hope of profiting from anticipated price movements.

      Spread

      (1) holding a long position in one futures contract and a short position in a related futures contract or contract month in order to profit from an anticipated change in the price relationship between the two,
      (2) the price difference between two contracts or contract months.

      Stop limit order

      An order that becomes a limit order when the market trades at a specified price. The order can only be filled at the stop limit price or better.

      Stop loss order

      An order that becomes a market order when the market trades at a specified price. The order will be filled at whatever price the market is trading at. Also called a stop order.

      Tick

      The smallest price change allowed in a particular contract.

      Trader

      A professional speculator who trades for his or her own account.

      Underlying security

      The instrument on which the security futures contract is based. This instrument can be an individual equity security (including common stock and certain exchange-traded funds and American Depositary Receipts) or a narrow-based index.

      Volume

      The number of contracts bought or sold during a specified period of time. This figure includes liquidating transactions.


      Attachment B

      2018 Supplement to the 2002 Security Futures Risk Disclosure Statement

      The 2002 Security Futures Risk Disclosure Statement is amended as provided below.

      The second paragraph under Section 2.4 (How Security Futures Differ from the Underlying Security) is replaced with the following paragraph:

      The purchaser of a security futures contract, by contrast, has only a contract for future delivery of the underlying security. The purchaser of the security futures contract is not entitled to exercise any voting rights over the underlying security and is not entitled to any dividends that may be paid by the issuer. Moreover, the purchaser of a security futures contract does not receive the corporate disclosures that are received by shareholders of the underlying security, although such corporate disclosures must be made publicly available through the SEC's EDGAR system, which can be accessed at www.sec.gov. You should review such disclosures before entering into a security futures contract. See Section 8.1 for further discussion of the impact of corporate events on a security futures contract.

      * * * * *

      The first paragraph under Section 5.2 (Settlement by Physical Delivery) is replaced with the following paragraph:

      Settlement by physical delivery is carried out by clearing brokers or their agents with National Securities Clearing Corporation (NSCC), an SEC-regulated securities clearing agency. Such settlements are made in much the same way as they are for purchases and sales of the underlying security. Promptly after the last day of trading, the regulated exchange's clearing organization will report a purchase and sale of the underlying stock at the previous day's settlement price (also referred to as the "invoice price") to NSCC. In general, if NSCC does not reject the transaction by a time specified in its rules, settlement is effected pursuant to the rules of the exchange and NSCC's Rules and Procedures within the normal clearance and settlement cycle for securities transactions, which currently is two business days. However, settlement may be effected on a shorter timeframe based on the rules of the exchange and subject to NSCC's Rules and Procedures.

      * * * * *

      The second paragraph under Section 6.1 (Protections for Securities Accounts) is replaced with the following paragraph:

      The Securities Investor Protection Corporation (SIPC) also covers positions held in securities accounts. SIPC was created in 1970 as a nonprofit, non-government, membership corporation, funded by member broker-dealers. Its primary role is to return funds and securities to customers if the broker-dealer holding these assets becomes insolvent. SIPC coverage applies to customers of current (and in some cases former) SIPC members. Most broker-dealers registered with the SEC are SIPC members; those few that are not must disclose this fact to their customers. SIPC members must display an official sign showing their membership. To check whether a firm is a SIPC member, go to www.sipc.org, call the SIPC Membership Department at (202) 371-8300, or write to SIPC Membership Department, Securities Investor Protection Corporation, 1667 K Street, NW, Suite 1000, Washington, DC 20006-1620.

      * * * * *

      The third paragraph under Section 6.1 (Protections for Securities Accounts) is replaced with the following paragraph:

      SIPC coverage is limited to $500,000 per customer, including up to $250,000 for cash. For example, if a customer has 1,000 shares of XYZ stock valued at $200,000 and $10,000 cash in the account, both the security and the cash balance would be protected. However, if the customer has shares of stock valued at $500,000 and $250,000 in cash, only a total of $500,000 of those assets will be protected.

      * * * * *

      The third paragraph under Section 8.1 (Corporate Events) is replaced with the following paragraph:

      Corporate issuers also occasionally issue special dividends. A special dividend is an announced cash dividend payment outside the normal and customary practice of a corporation. The terms of a security futures contract may be adjusted for special dividends. The adjustments, if any, will be based upon the rules of the exchange and clearing organization. In general, there will be no adjustments for ordinary dividends as they are recognized as a normal and customary practice of an issuer and are already accounted for in the pricing of security futures. However, adjustments for ordinary dividends may be made for a specified class of security futures contracts based on the rules of the exchange and the clearing organization.

      * * * * *

      The second paragraph under Section 8.2 (Position Limits and Large Trader Reporting) is replaced with the following paragraph:

      Position limits are required for security futures contracts that overlie a security that has an average daily trading volume of 20 million shares or fewer. In the case of a security futures contract overlying a security index, position limits are required if any one of the securities in the index has an average daily trading volume of 20 million shares or fewer. Position limits also apply only to an expiring security futures contract during its last five trading days. A regulated exchange must establish position limits on security futures that are no greater than 13,500 (100 share) contracts, unless the underlying security meets certain volume and shares outstanding thresholds, in which case the limit may be increased to 22,500 (100 share) contracts.

    • 18-23 FINRA Requests Comment on a Proposal Regarding the Rules Governing the New and Continuing Membership Application Process; Comment Period Expires: October 5, 2018

      View PDF

      Membership Application Proceedings

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA By-Laws Article I(h), Article I(rr) and Section 1 of Article IV
      FINRA By-Laws Section 4(i) of Schedule A
      FINRA Rules 4110, 4120, 4311, 4370, 9143, 9160, 9235, 9242, 9251, 9252, 9262, 9263, 9264, 9311, 9322, 9347 and 9349
      FINRA Rule 9000 and 9300 Series
      NASD Rule 1010 Series
      NASD Rules 1021, 1090 and 3140
      Notices to Members 97-19, 98-38 and 00-73
      NYSE Rules 311, 312, 313 and 321
      NYSE Rule Interpretations 311(f) and (g)
      Regulatory Notices 08-66, 09-42, 10-01, 13-29, 15-10, 18-06, 18-15 and 18-16
      SEA Rules 15c3-1, 15c3-3 and 17a-11
      SEA Section 3(a)(39)
      Securities Investor Protection Act of 1970
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Key Topics

      Continuing Membership
      Membership Rules
      New Membership

      Comment Period Expires: October 5, 2018

      Summary

      FINRA seeks comment on proposed amendments to the NASD Rule 1010 Series (Membership Proceedings) (collectively, the Membership Application Program (MAP) rules). The proposal is the result of FINRA's retrospective review of the MAP rules and processes, and is intended to reduce unnecessary burdens on new and existing firms, while strengthening investor protections. The proposed amendments would replace the NASD Rule 1010 Series with the proposed FINRA Rule 1100 Series (New and Continuing Membership). The proposed amendments would also include additional provisions to address regulatory issues FINRA staff identified and codify existing membership-related interpretations and practices.

      A chart detailing the restructuring of the proposed rules and the text of the proposed rules are set forth in Attachments A and B, respectively.

      Questions regarding this Notice should be directed to:

      •   Kosha Dalai, Associate Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6903;
      •   Sarah Kwak, Assistant General Counsel, OGC, at (202) 728-8471; and
      •   Alissa Robinson, Senior Director, Membership Application Program, at (212) 858-4764.

      Questions concerning the Economic Impact Assessment in this Notice should be directed to:

      •   Lori Walsh, Senior Director, Office of the Chief Economist (OCE), at (202) 728-8323; and
      •   Dror Kenett, Economist, OCE, at (202) 728-8208.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by October 5, 2018.

      Comments must be submitted through one of the following methods:

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

      Jennifer Piorko Mitchell
      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.

      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

      The proposed rule change must be filed with the Securities and Exchange Commission (SEC or Commission) pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA or Exchange Act).2

      Background & Discussion

      The MAP rules govern the way in which FINRA's Department of Member Regulation, through the Membership Application Program Group (together, the Department), reviews new membership applications (NMAs) and continuing membership applications (CMAs).3 These rules require an applicant to demonstrate its ability to comply with rules and laws including observing high standards of commercial honor and just and equitable principles of trade applicable to its business. The Department evaluates an applicant's financial, operational, supervisory and compliance systems to ensure that each applicant meets the standards set forth in the MAP rules. Among other elements, the MAP rules require consideration of whether an applicant and persons associated with an applicant have disciplinary actions taken against them by FINRA and other industry authorities, customer complaints, adverse arbitrations, pending or unadjudicated matters, civil actions, remedial actions imposed, or other industry-related matters that could pose a threat to public investors. Finally, the MAP rules provide for the administration of the MAP appeal process, setting forth specified time periods for holding hearings and satisfying document production requests, the evidence and testimony that may be considered, and the information that the applicant is required to provide to FINRA.

      In Regulatory Notice 15-10 (March 2015), FINRA launched a retrospective review of the MAP rules to assess opportunities to improve their effectiveness and efficiency.4 The retrospective review confirmed that while the rules largely have been effective in meeting their intended investor protection objectives, the rules could benefit from some updating and recalibration to better align their investor protection benefits with their economic impacts. Consistent with a number of recommendations by stakeholders5 during the retrospective review, FINRA is proposing amendments to the MAP rules to address these and other concerns while maintaining strong investor protections. The proposed amendments to the MAP rules would include the following key changes:

      •   restructure the MAP rules to make them more streamlined and eliminate procedural redundancy between NMAs and CMAs;
      •   codify current Department practices aimed at reducing the overall application review period from 180 days to 150 days, such as the initial assessment of an application to determine whether it can proceed under standard review timeframes set forth under the MAP rules or expedited timeframes (i.e., "Fast Track"6 ), and the materiality consultation process;
      •   modify the NMA and CMA processes by, among other things, amending definitions and standards for granting or denying an application, and clarifying the ability of the Department to reject and lapse an application;
      •   modify the CMA process by, among other things, clarifying the events that would require a CMA (e.g., change in ownership or control), and eliminating the related ability of the Department to impose interim restrictions pending review; and
      •   streamline and update the rules relating to the MAP appeal process by codifying current practices and updating terminology and concepts to align more closely with the Rule 9000 Series (Code of Procedure).

      While many of the proposed amendments are technical and administrative in nature, the proposal is responsive to the issues raised during the assessment phase of the retrospective review. The proposal clarifies a number of provisions or terms; amends or deletes provisions that need recalibration or have become outdated; and streamlines the rule and its attendant processes by eliminating or consolidating duplicative provisions and codifying existing Department practices. As a result, FINRA believes the proposal strikes an appropriate balance between maintaining strong investor protections and enhancing the efficiency of the MAP rules and processes.

      Structure of the MAP Rules

      FINRA proposes to restructure the MAP rules, which currently consist of 11 rules, by organizing them into six distinct areas (See Attachment B):

      •   General Provisions
      •   New Membership
      •   Continuing Membership
      •   Standards for Approval of Application
      •   Department Decision
      •   Review of Department Decision

      General Provisions (Proposed FINRA Rule 1110 Series)

      The rules contained within the proposed FINRA Rule 1110 Series are intended to address the aspects of the membership process that are common to NMAs and CMAs.

      A. Definitions (Proposed FINRA Rule 1111)
      1. "Application"

      The proposed rule would define, for the first time, the term "Application" to refer to either an NMA (or Form NMA) or a CMA (or Form CMA) depending on the context. This label is intended to improve the readability of the MAP rules.
      2. "Associated Person"7

      FINRA is proposing to amend the definition of the term "Associated Person" in NASD Rule 1011(b) to include a member of a limited liability company as an Associated Person. In addition, the proposed rule would exclude from the definition any person with a de minimis ownership interest (i.e., less than 10 percent) in a partnership, corporation, association or other legal entity, unless that person is entitled, under the legal entity's constituent documents, to 10 percent or more of such entity's profits or distributions or otherwise controls the applicant. This proposed de minimis exclusion would provide greater clarity regarding the Associated Person status of owners with small ownership interests in the applicant that do not otherwise control the applicant by virtue of an entitlement to significant portions of an applicant's profits or distributions or otherwise have the power, directly or indirectly, to control the applicant.8
      3. "Control"9

      FINRA is proposing to define, for the first time, the term "control." Currently, the Department relies on the definition of "controlling" under the FINRA By-Laws.10

      The proposed definition for purposes of the MAP rules is derived, in part, from the existing FINRA By-Laws definition, but differs, most notably, by increasing the threshold establishing the presumption of control from 20 percent to 25 percent and including more factors that would lead to a presumption of control. The additional factors are derived, in part, from the definition of "control" in Form BD,11 but, consistent with the existing FINRA By-Laws definition, the definition replaces the references to "company" with "person," which is defined in Rule 0160 to include "any natural person, partnership, corporation, association, or other legal entity."12 In addition, the proposed definition would add "limited liability company" as another legal entity to reflect that such entity is a common organizational structure.

      The proposed new definition would define "control" to mean the possession of the power to direct or cause the direction of the management or policies of a person whether through ownership of voting securities, by contract or otherwise. Under the proposed definition, control over a person would be presumed if such person, directly or indirectly:
      (1) is a director, general partner, managing member, or officer or principal exercising executive responsibility (or person occupying a similar status or performing similar functions) of the other person;
      (2) has the right to vote 25 percent or more of a class of voting securities;
      (3) has the power to sell or direct the sale of 25 percent or more of a class of voting securities;
      (4) is entitled to receive 25 percent or more of the profits; or
      (5) in the case of a partnership or limited liability company, has the right to receive upon dissolution, or has contributed, 25 percent or more of the capital.
      In addition, the proposed definition would clarify that ownership interests of less than 25 percent would not preclude aggregation of such interests for the presumption of control. The proposed definition also would provide that the presumption of control may be rebutted by proving that any of the factors listed above does not exist or by showing other factors that negate the presumption of control. Finally, the proposed definition would set forth that the presumption would not apply where such person holds voting securities of the applicant, in good faith, as an agent, bank, broker, nominee, custodian or trustee for one or more owners who do not individually or as a group have control of such entity.

      FINRA believes that defining "control" for purposes of the MAP rules lends clarity and consistency to the control standards under proposed Rule 1131 (Continuing Membership Application Process) described below.
      4. "Sales Practice Event"13

      Currently, the term "sales practice event" means any customer complaint, arbitration or civil litigation that has been reported to the Central Registration Depository (CRD®) or otherwise has been reported to FINRA. FINRA is proposing to expand the term to include a "statutory disqualification," as defined in Section 3(a)(39) of the Exchange Act, of an applicant or Associated Person.14
      5. Other Proposed Amendments to Definitions

      FINRA is proposing to make several non-substantive changes to the definitions to correct cross-references, relocate portions to other rules as part of the restructuring or update the terminology consistent with other FINRA rules.
      B. General Procedures (Proposed FINRA Rule 1112)

      Currently, NASD Rule 1012 (General Provisions) sets forth the methods of delivery of an NMA or CMA, and their corresponding documents or information. The rule also addresses the Department's service of notice and decision on an application, application lapse, prohibitions on ex parte communications with applicants or Interested FINRA Staff, recusals or disqualifications of Governors and members of the National Adjudicatory Council (NAC) or Subcommittee, and the computation of time periods.

      FINRA is proposing to adopt NASD Rule 1012, with amendments, as proposed Rule 1112. The proposed changes would first, move the provisions pertaining to the prohibitions on ex parte communications, and recusals or disqualifications to the proposed Rule 1160 Series (Review of Department Decision) described below, and the computation of time periods to proposed Rule 1111. Second, the proposed changes would bring together under a single rule the provisions common to the review of NMAs and CMAs. These common provisions currently reside under NASD Rules 1012, 1013 (New Member Application and Interview) and 1017 (Application for Approval of Change in Ownership, Control, or Business Operations) as described below.
      1. Filing and Service; Timing—Proposed FINRA Rule 1112(a)

      Currently, NASD Rule 1012(a) requires an applicant to file an NMA or CMA in the manner prescribed under NASD Rule 1013 or 1017, as appropriate, along with the timely submission of an application fee pursuant to Schedule A to the FINRA By-Laws. Paragraph (a) sets forth the various channels through which an applicant may file its application, documents or information with the Department, and the methods by which the Department must serve notice or a decision upon the applicant. Paragraph (a) also specifies when a filing by an applicant or service by the Department is deemed complete depending upon the delivery method.

      FINRA is proposing to delete NASD Rule 1012(a) in its entirety, and adopt proposed Rule 1112(a). The proposed rule would:
      •   update the method for delivering and filing applications to move away from paper-based methods to an electronic process or such other process as FINRA may prescribe;15
      •   clarify the starting times for submitted and filed applications for purposes of calculating the time by which the Department must issue its decision on an application; and
      •   expressly provide that the timeframes specified in the MAP rules may be extended or shortened upon the mutual written consent of the Department and the applicant.
      2. Rejection of Application Following Department's Initial Assessment-Proposed FINRA Rule 1112(b)

      NASD Rules 1013(a)(3) and 1017(d), which pertain to NMAs and CMAs, respectively, contain nearly identical language for applications that are "not substantially complete" at the time of filing. These provisions give the Department 30 days from the date on which the applicant files the application to reject it as "not substantially complete" and deem it not to have been filed on the basis that the application is so deficient upon initial submission that the Department cannot begin reviewing it.16 In such case, the Department is required to notify the applicant of the reasons underlying the rejection and refund the application fee, less a $500 processing fee. If the applicant determines to apply for approval of an NMA or CMA, the applicant is required to submit a new application and appropriate fee pursuant to Schedule A to the FINRA By-Laws.

      FINRA is proposing to delete NASD Rules 1013(a)(3) and 1017(d) in their entirety, and adopt proposed Rule 1112(b) to reflect current Department practices in handling applications that are deficient upon submission ("Application Submission Date"). The proposed rule would eliminate the concept of an application that is "not substantially complete" at the time of filing and instead, more appropriately focus on whether there are sufficient documents and information accompanying the application for the Department to commence a meaningful review and deem it "filed" for purposes of calculating the date on which the decision is due ("Application Filed Date").

      Under the proposed rule, the Department would have 15 days from the Application Submission Date (as that term is defined under proposed Rule 1112(a)) to conduct an initial assessment to determine whether an application includes the documents or information necessary for the Department to conduct a meaningful review.17 Should the Department determine that the application does not contain sufficient documentation or information to begin a meaningful review, the Department would be required to provide the applicant with written notification of the deficiency. An applicant would then have five business days after notification to cure the deficiency, and failure to timely do so would result in the Department's rejection of the application. In such case, the applicant would receive a refund of the application fee, less a $500 processing fee. If the applicant determines again to apply for approval of an NMA or CMA, the applicant would be required to submit a new one and the appropriate fee pursuant to Schedule A to the FINRA By-Laws. The proposed rule would also clarify that an application that has been rejected does not constitute final action by the Department for purposes of the proposed Rule 1160 Series.
      3. Request for Additional Documents or Information—Proposed FINRA Rule 1112(c)

      NASD Rules 1013(a)(4) and 1017(e), which pertain to NMAs and CMAs, respectively, permit the Department to request, at any time during the application review process, any additional information or documents necessary to render a decision on the application. Depending on whether the application is for new or continuing membership, the provisions provide differing timeframes for when the Department must serve its request on the applicant and when the applicant must respond to such request.

      For an NMA, NASD Rule 1013(a)(4) requires the Department to serve its initial request for any additional information or documents necessary to render a decision on the application within 30 days after the application is filed. Unless otherwise agreed to by the Department and the applicant, the applicant is required to file any additional information and documents with the Department within 60 days thereafter, and for any subsequent requests for information or documents that the Department may serve, the applicant has 30 days in which to respond to such request. For a CMA, NASD Rule 1017(e) requires the Department to serve a request for any additional information or documents necessary to render a decision on the application within 30 days after the application is filed. An applicant has 30 days in which to respond to any such request (unless otherwise agreed to by the Department and the applicant).

      FINRA is proposing to consolidate and adopt NASD Rules 1013(a)(4) and 1017(e), with amendments, as proposed Rule 1112(c). The proposed changes would eliminate the timing differences based on application type. Under the proposed rule, the Department would be required to serve its initial request for any additional documents or information within 30 days after the Application Filed Date (as that term is defined under proposed Rule 1112(a)), and the applicant must respond to the initial request within 30 days after service. In addition, the applicant would be required to respond to any subsequent request for documents or information within 15 days after the Department's request or within such other time period agreed to by the Department and the applicant.
      4. Lapse of Application—Proposed FINRA Rule 1112(d)

      Currently, NASD Rule 1012(b) gives the Department the authority to lapse an NMA or CMA, if, absent a showing of good cause, the applicant fails to timely respond to the Department's request for additional documents or information (or within such other period agreed to by the Department and the applicant), appear at or otherwise participate in a scheduled membership interview, or file an executed membership agreement within 25 days after service of the agreement (or within such other period agreed to by the Department and the applicant). An applicant that determines again to seek approval of its application is required to submit a new one (under either NASD Rule 1013 or 1017, as appropriate) and the appropriate fee pursuant to Schedule A to the FINRA By-Laws.

      FINRA is proposing to adopt NASD Rule 1012(b), with amendments, as proposed Rule 1112(d). The proposed amendments would add a new event that would result in an application to lapse. Currently, the MAP rules provide a 180-day timeframe in which the Department must issue a written decision on an application.18 During this timeframe, the Department has experienced, with some frequency, applicants that make substantial changes to their applications well into the review process.19 To curtail these situations, FINRA is proposing to add a new provision to provide that in instances where an applicant makes a substantial change to the application that materially impacts the Department's review of the application, the Department would have the authority to lapse the application. Under the proposed rule, the Department would be required to notify the applicant, in writing, of the pending lapse and the applicant would have five business days from notification to remedy the application. The applicant's failure to timely remedy the application would result in its lapse.

      Under the proposed rule, an application that has lapsed within 30 days after the Application Filed Date would result in a refund to the applicant of the application fee, less a $500 processing fee. An application that has lapsed after 30 days of the Application Filed Date would not result in a refund of the application fee. An applicant that determines again to seek approval of its application would be required to submit a new one and the appropriate fee pursuant to Schedule A to the FINRA By-Laws. The proposed rule would also clarify that an application that has lapsed does not constitute final action by the Department for purposes of the proposed Rule 1160 Series.
      5. Withdrawal of Application—Proposed FINRA Rule 1112(e)

      NASD Rules 1013(a)(5) and 1017(f), which pertain to NMAs and CMAs, respectively, contain nearly identical language permitting an applicant to withdraw its application. If the applicant withdraws the application within 30 days after filing the application, FINRA will refund the application fee, less a $500 processing fee. An applicant that determines again to seek approval of its application is required to submit a new one (under either NASD Rule 1013 or 1017, as appropriate) and the appropriate fee pursuant to Schedule A to the FINRA By-Laws.

      FINRA is proposing to revise these rules as proposed Rule 1112(e). The proposed changes would clarify that if an applicant withdraws the application after the Application Submission Date, but not later than 30 days after the Application Filed Date, FINRA will refund the application fee, less a $500 processing fee. The proposed rule would also clarify that an applicant that withdraws its application after 30 days of the Application File Date would not receive a refund of the fee. Finally, the proposed rule would clarify that an application that has been withdrawn does not constitute final action by the Department for purposes of the proposed Rule 1160 Series.
      6. Membership Interview—Proposed FINRA Rule 1112(f)

      FINRA is proposing to revise NASD Rules 1013(b) and 1017(g) as proposed Rule 1112(f) to address the membership interview process for NMAs and CMAs, expressly providing that an interview for a new member applicant is mandatory, and discretionary for a continuing member applicant. Proposed paragraph (f) would retain the requirement that the Department conduct the interview in the district office for the district in which the applicant has its principal place of business or at an agreed upon location, and allow the flexibility to conduct more than one membership interview and permit the interview(s) to occur by video conference or by other means. Proposed Rule 1112(f) would also retain the current seven-day timeframe in which the Department must provide the applicant written notice of the interview, but update the delivery method to move away from paper-based methods such as facsimile or overnight courier to an electronic process or such other process as FINRA may prescribe as specified under proposed Rule 1112(a).
      7. Proposed Supplementary Materials
      •   Initial Assessment by Department (Supplementary Material 1112.01)

      FINRA is proposing to add new Supplementary Material .01 to proposed Rule 1112 to codify an existing procedure to conduct an initial assessment of an application. Specifically, the proposed supplementary material would provide that the Department shall conduct an initial assessment of an application to determine, at a minimum, whether the documents or information included with the application are correctly identified and contain the information they purport to address and whether the application may be eligible for expedited review. The proposed supplementary material would further describe that as part of the initial assessment, the Department may also review several aspects of the application including, but not limited to, the disciplinary history of the applicant and its Associated Persons, and scale and scope of the proposed activities of the applicant, the history of sales practice events, disciplinary history, licenses and registrations, and experience of the relevant principals and registered persons of the applicant, and the written supervisory procedures.
      •   Department Decision to Expedite Review (Supplementary Material 1112.02)

      FINRA is proposing to add new Supplementary Material .02 to proposed Rule 1112 providing that as part of the initial assessment, the Department may, in its discretion, determine that the application is eligible for expedited review and notify the applicant of such eligibility.
      •   Membership Interview (Supplementary Material 1112.03)

      FINRA is also proposing to add new Supplementary Material .03 to proposed Rule 1112 to codify existing guidance on membership interviews.20 The proposed supplementary material would provide a general description of the membership interview and the topics that may be discussed during the interview to demonstrate the applicant's ability to satisfy the standards for approval of an application. Topics would include the nature and scope of the business, financial condition, source of funds, the background and experience of the applicant's principals and representatives, documents or information that the Department obtained from CRD or a source other than the applicant and upon which the Department intends to base its decision, among others.21
      •   Waiver of Two-Principal Requirement (Supplementary Material 1112.04)

      Rule 1210.01 requires that a member, except a member with only one Associated Person, have a minimum of two officers or partners who are registered as General Securities Principals, provided that, a member whose activities are limited in scope, may instead have two officers or partners who are registered in a principal category that corresponds to the scope of the member's activities.22 The requirement that a member have a minimum of two principals applies to a broker-dealer seeking to become a new FINRA member, as well as an existing or continuing member. Rule 1210.01 provides that pursuant to the Rule 9600 Series (Procedures for Exemptions), FINRA may waive the requirement that a member have a minimum of two principals in situations that indicate conclusively that only one person associated with an applicant for new or continuing membership should be required to register as a principal.

      In practice, an applicant submits its waiver request in writing, stating the basis on which the applicant believes it has demonstrated that only one person associated with the applicant should be required to be registered as a principal, along with any supporting documentation for the waiver request to the Department as part of the supporting documentation in Form NMA or Form CMA.23 The decision on a two-principal waiver request is made by the Department.24

      Currently, the MAP rules do not expressly address how an applicant may seek a waiver of the two-principal requirement, but Forms NMA and CMA address this waiver.25 FINRA is proposing to add new Supplementary Material .04 to proposed Rule 1112 to make the nexus between the NMA and CMA processes and Rule 1210.01 more evident. In addition, the proposed supplementary material would describe the factors the Department may consider in determining whether to grant a waiver. Factors may include, but are not limited to, the regulatory history of the applicant and its Associated Persons, the type of business the applicant conducts or for which it is approved to conduct, and the number, location and experience of Associated Persons and their designated offices and locations. The proposed supplementary material would also set forth that the decision to grant the waiver rests with the Department, and the applicant's ability to appeal the decision pursuant to the Rule 9600 Series. The proposed supplementary material would clarify that an appeal of the Department's decision on the waiver may cause the underlying application review process to be held in abeyance pending the outcome of the appeal.

      New Membership (Proposed FINRA Rule 1120 Series)

      FINRA proposes to adopt a new rule series dedicated to the unique requirements and processes for new membership. The proposed Rule 1120 Series would encompass rules pertaining to membership waive-in, foreign members and the NMA process.

      A. Membership Waive-In (Proposed FINRA Rule 1121)

      NASD Interpretative Materials 1013-1 and 1013-2 describe a waive-in application process to allow certain New York Stock Exchange (NYSE) and NYSE American LLC (NYSE American) (formerly, NYSE Alternext US LLC) member organizations to automatically become FINRA members and to register automatically all Associated Persons whose registrations are approved with either NYSE or NYSE American, as applicable, in registration categories recognized by FINRA. In general, upon such member organization's submission of a signed waive-in membership application to the Department, the Department is required to review the waive-in application within three business days of receipt and if complete, issue a letter notifying the applicant that it has been approved for FINRA membership.

      FINRA is proposing to consolidate, with amendments, the Interpretative Materials as proposed Rule 1121. The proposed amendments would delete the description of the waive-in application process that was established in connection with the consolidation of NASD and NYSE Regulation, Inc. in 2007, which has now become obsolete, but would retain some aspects of the Interpretative Materials.26 The proposed rule would clarify that a member organization would be required to execute a membership agreement prior to expanding its business operations, and that if such expansion would be considered a "material change in business operations" as that term is described under proposed Rule 1131(b), then such member organization would be required to undergo the CMA process described under the proposed Rule 1130 Series. The proposed rule would also provide that upon approval of the business expansion, the member organization would be subject to all NASD rules, in addition to the consolidated FINRA rules and those NYSE rules incorporated by FINRA.
      B. Foreign Members (Proposed FINRA Rule 1122)

      NASD Rule 1090 (Foreign Members) requires a foreign broker-dealer that does not maintain an office in the United States responsible for preparing and maintaining regulatory filings to meet specific requirements for FINRA membership. The requirements enable FINRA to ensure a foreign member's compliance with applicable securities laws and regulations, and with applicable FINRA rules. Paragraph (d) of the rule requires foreign members to "utilize, either directly or indirectly, the services of a broker-dealer registered with the Commission, a bank or a clearing agency registered with the Commission located in the United States in clearing all transactions involving members of the Association, except where both parties to a transaction agree otherwise." FINRA is proposing to adopt NASD Rule 1090, with one substantive change, as proposed Rule 1122.27 The proposed change would delete NASD Rule 1090(d) because the provision is addressed by Rule 4311 (Carrying Agreements).
      C. New Membership Application Process (Proposed FINRA Rule 1123)

      NASD Rule 1013 sets forth the requirements for an NMA, including how to file the application, the documents and information that must be submitted with the application,28 and the requirement for an applicant to file its uniform registration forms (Forms U4, U5, BD) electronically. The rule also addresses the Department's ability to reject an application that is "not substantially complete" and the Department's ability to request additional documents or information, the applicant's withdrawal of the application and the process for conducting the membership interview.

      FINRA is proposing to revise NASD Rule 1013 as proposed Rule 1123. The proposed revisions would streamline the rule by moving to one consolidated rule, proposed Rule 1112, procedural elements of the NMA review process that are common with the CMA process, such as the procedures for application rejection, the request for additional documents or information, application withdrawal and the membership interview. The proposed rule also would add a new provision that would indicate the actions a prospective applicant would need to undertake before filing an NMA. Those actions would include, among others as FINRA may prescribe, filing Form BD with the SEC, reserving a firm name, completing the necessary forms to establish access to FINRA systems, submitting fingerprints for each Associated Person and paying the appropriate fee pursuant to Schedule A to the FINRA By-Laws.29 Finally, FINRA is proposing to delete references to the detailed list of items because these items are already included in Form NMA or are referenced in the standards for admission.30

      Continuing Membership (Proposed FINRA Rule 1130 Series)

      FINRA is proposing to adopt a new rule series dedicated to aspects of FINRA membership that are unique to continuing FINRA membership. The proposed Rule 1130 Series would encompass the rules pertaining to the CMA process, the circumstances that would obviate the filing of a CMA, the materiality consultation process and the safe harbor provision.

      A. Continuing Membership Application Process (Proposed FINRA Rule 1131)

      Currently, NASD Rule 1017 describes the events requiring a CMA and sets forth the documents or information required to support the application, depending upon the nature of the application.31 In addition, the rule sets forth the timing and conditions for filing a CMA. Most notably, for a member that is filing an application for approval of a change in ownership or control, the member must file the application at least 30 days before the Regulatory Notice event takes place. While a member may effect such change prior to the conclusion of the Department's review of the application, the Department may place new interim restrictions on the member based upon the standards contained in NASD Rule 1014 (Department Decision) pending final action. For other specified events, a CMA for approval by the Department can be filed at any time before effectuating such event.

      NASD Rule 1017 also addresses the Department's ability to reject an application that is "not substantially complete" and to request additional documents or information, the applicant's withdrawal of the application, the process for conducting the membership interview, the Department's decision on the application, the Department's ability to remove or modify a restriction on its own initiative, and the lapse or denial of an application for a change in ownership. Other areas covered by the rule include service and effectiveness of the Department's decision on an application and the applicant's ability to file a written request for a review of the Department's decision with the NAC.

      FINRA is proposing to revise NASD Rule 1017 as proposed Rule 1131 described below.
      1. Streamlining Amendments
      •   Redesignation and Consolidation of Procedural Elements in NASD Rule 1017 to Proposed Rule 1112

      FINRA is proposing to limit proposed Rule 1131 to the CMA process by deleting procedural elements of the CMA review process that either duplicate or closely parallel those elements that exist in the NMA process. Common elements include the procedures for application rejection, the request for additional documents or information, application withdrawal, application lapse and the membership interview. FINRA is proposing to consolidate these aspects of the application review process in proposed Rule 1112 as described above.
      •   Submission of One Application for an Event Affecting Two or More Members32

      With some frequency, two or more member firms are involved in the same event requiring a CMA. In an effort to bring more efficiency to the review process for CMAs, FINRA is proposing to add a new provision under proposed Rule 1131(a) that would provide the Department with the discretion to permit the filing of a single CMA where two or more members are involved in the same contemplated event. The filing of a single CMA would be subject to a single fee pursuant to Schedule A to the FINRA By-Laws.
      2. Events Requiring Submission of Application and Department Approval

      The criteria for a CMA appear under paragraphs (a) and (b) of NASD Rule 1017. FINRA is proposing to integrate these paragraphs, with amendments described below, in proposed Rule 1131(b).33 In addition, FINRA is proposing to add headers to more easily discern among the various events requiring a CMA. The clarifying headers would include merger, acquisition, divestiture or transfer, change in capital structure, business expansion, material change in business operations, and removal or modification of a membership agreement restriction. These headers describe events covered by NASD Rule 1017.34

      Currently, NASD Rule 1017(a) specifies the changes in a member firm's ownership, control or business operations that require a CMA and Department approval. Specifically, the events that require a member firm to file a CMA and obtain Department approval thereon are:
      •   a merger of the member with another member, unless both members are members of the NYSE or the surviving entity will continue to be a member of the NYSE;
      •   a direct or indirect acquisition by the member of another member, unless the acquiring member is a member of the NYSE;
      •   direct or indirect acquisitions or transfers of 25 percent or more in the aggregate of the member's assets or any asset, business or line of operation that generates revenues composing 25 percent or more in the aggregate of the member's earnings measured on a rolling 36-month basis,35 unless both the seller and acquirer are members of the NYSE;
      •   a change in the equity ownership or partnership capital of the member that results in one person or entity directly or indirectly owning or controlling 25 percent or more of the equity or partnership capital; or
      •   a material change in business operations as defined in NASD Rule 1011(k).
      •   Elimination of Exclusion for NYSE Member Organizations36

      In the case of a merger, acquisition or transfer in which a NYSE member organization is involved, NASD Rule 1017(a) currently excludes such member organization from the requirement to file an application for approval of the specified event. FINRA is proposing to eliminate this exclusion on the basis that NYSE Regulation, Inc. no longer conducts its own review of such transactions. The proposed rule would require a member seeking to effect any of these events to file a CMA for the Department's review whether or not the other broker-dealer is a member of FINRA.
      •   Addition of Event Requiring a CMA-Change in Control Person37

      FINRA is proposing to add a new event that would require the submission of a CMA for a change in control person because the Department has encountered with some frequency situations where a member has changed its control person without filing a CMA. Proposed Rule 1131(b)(5) would require a CMA for a direct or indirect change of a member's control person, other than the appointment or election of a natural person as a partner, officer, director, principal of the member, or any person occupying a similar status or performing similar function, in the normal course of business, regardless of whether the change resulted from a change in capital structure.
      •   Additions to List of Activities Viewed as "Material Change in Business Operations"

      Currently, the term "material change in business operations," defined in NASD Rule 1011(k) and referenced in NASD Rule 1017(a)(5), includes, but is not limited to, three categories of changes:
      •   removing or modifying a membership agreement restriction;
      •   market making, underwriting or acting as a dealer for the first time; and
      •   adding business activities that require a higher minimum net capital under SEA Rule 15c3-1.
      Consistent with the prior proposals presented in Notices 10-01 and 13-29, FINRA is proposing to supplement this list to include a member engaging, for the first time, in settling or clearing of transactions for the member's own business or for other broker-dealers, or carrying customer accounts.38 FINRAis also proposing to require a member to submit a CMA for the Department's approval before making a business change that would change its SEA Rule 15c3-3(k) exemptive status, which would effectively incorporate NASD Rule 3140 (Approval of Change in Exempt Status Under SEC Rule 15c3-3).39
      •   Removal or Modification of a Membership Agreement Restriction

      Currently, the removal or modification of a membership agreement restriction is addressed under NASD Rule 1017(a)(5), which cross-references to NASD Rule 1011(k)'s definition of "material change in business operations."40 For clarity, FINRA is proposing to move NASD Rule 1011(k)(1)—removing or modifying a membership agreement restriction—to proposed Rule 1131(b)(8). FINRA believes that positioning this event as a separate subparagraph represents a more sensible presentation of the criteria requiring a CMA and Department approval thereon.
      3. Elimination of Timing of CMA Filings and Pre-approval of Changes

      NASD Rule 1017(c) sets forth three timing considerations for filing specified types of CMAs. The first timing consideration concerns whether a member is contemplating a change in ownership or control. NASD Rule 1017(c)(1) requires a member to file an application for approval of such change at least 30 days before the change is expected to occur. Occasionally, it may take the Department more than 30 days to complete its review of the application. In such case, the member may decide to proceed with the proposed change before the Department has completed its review. If the member elects to do so, then the Department may impose new interim restrictions on the member consistent with the standards set forth under NASD Rule 1014, pending final Department action. A member may encounter difficulty if it decides to proceed with the change when the Department determines that the application is in need of additional documents or information, or that the member must to reverse or unwind the effected change.

      The second timing consideration under NASD Rule 1017(c)(2) involves whether a member is seeking to remove or modify a membership agreement restriction. In this case, the member may file the CMA at any time, but any existing restriction would remain in place until the Department has completed its review.

      The third timing consideration under NASD Rule 1017(c)(3) pertains to whether a member is contemplating a material change in business operations. In such situation, the member may file a CMA at any time, but must wait for the Department's final determination, unless the Department and member agree otherwise.
      •   Elimination of Timing Considerations

      FINRA is proposing to eliminate the timing considerations for filing a CMA depending upon the type of contemplated change or event because these varied timing considerations tend to generate confusion. FINRA believes that requiring a member to file an application before effecting any change specified in paragraph (b) under proposed Rule 1131 establishes more clarity and certainty in the process.
      •   Pre-approval of Changes

      The purpose of interim restrictions is to protect investors. During the retrospective review, various stakeholders said that the nature and scope of interim restrictions were unclear or hampered real-time business decisions. In addition, interim restrictions may result in costly logistical impacts to the member should they require the member to reverse or unwind the transaction or event. Moreover, NASD Rule 1017 contains an incongruity in the way in which the Department handles the risks inherent in changes in ownership, control or business operations. For example, because of the potential risk to the investing public, a member cannot effect a material change in business operations before obtaining the Department's approval, but a member can effect a change in ownership or control while the Department processes the application. Given the inherent risks under both types of changes, FINRA believes that any change specified under proposed Rule 1131(b), including a change in ownership or control, should not be permitted until such time as the CMA has been approved by the Department. FINRA is proposing to eliminate NASD Rule 1017(c) in its entirety in order to bring more uniformity to the CMA review process.
      4. Permissible Events for Form CMA Waiver (Proposed Supplementary Material 1131.01)

      FINRA is proposing new supplementary material to set forth the circumstances under which the Department may consider waiving the CMA filing requirement.41 The proposed supplementary material would describe the circumstances under which a member contemplating a change in capital structure or control person may request a waiver of the CMA filing requirement. Under the proposed provision, the Department may grant a member's request to waive the CMA filing requirement where the contemplated change does not make any material changes in the applicant's business activities, management, supervision, assets or liabilities, and the applicant is only proposing a change in the: (1) applicant's legal structure (e.g., changing from a corporation to a limited liability company) or (2) equity ownership, partnership capital or other ownership interest in an applicant held by a corporate legal structure that is due solely to a reorganization of ownership or control of the applicant within the corporate legal structure (e.g., reorganizing only to add a holding company to the corporate legal structure's ownership or control chain of the applicant).

      The proposed supplementary material would also provide that the Department may grant a member's request to waive the CMA filing requirement for an acquisition, or divestiture or transfer of 25 percent or more in the aggregate of the member's assets or any asset, business or line of business that generates revenues composing 25 percent or more in the aggregate of the member's earnings measured on a calendar-year basis for the three years preceding the event where the member is: (1) ceasing operations as a broker-dealer; (2) filing a Form BDW (Uniform Request for Broker-Dealer Withdrawal) with the SEC; and (3) neither the member nor any of its Associated Persons is the subject of any claim (including, but not limited to, arbitration awards, or pending or settled arbitration claims or litigation actions) that could be disadvantaged by the proposed transaction. In any instance where a claim against a member or any of its Associated Persons is awarded or settled, such claim will not be deemed satisfied for purposes of proposed Rule 1131 until all payments are satisfied in full including any payments to be made on behalf of the member by a third party, pursuant to an agreement among the parties. Under the proposed provision, a member would be required to seek a waiver in the manner prescribed under the materiality consultation process set forth under proposed Rule 1132.42
      B. Materiality Consultation (Proposed FINRA Rule 1132)

      A member is required to file a CMA when it plans to undergo an event specified under NASD Rule 1017 (e.g., merger, acquisition, material change in business operations). Before taking this step, a member has the option of seeking guidance, or a materiality consultation, from the Department on whether or not such proposed change would require a CMA. The materiality consultation process is voluntary and no fee is assessed, and the Department has publicly shared guidelines about this process on FINRA.org.43

      In general, a member initiates a materiality consultation with the Department by submitting a letter, requesting the Department's determination on whether a proposed change is material such that it requires the submission of a CMA. The characterization of a proposed change as material depends upon an assessment of all the relevant facts and circumstances. The Department may communicate with the member to obtain further information regarding the proposed change and its anticipated impact on the member. Where the Department determines that a proposed change is material, the Department will instruct the member to file a CMA if the member intends to proceed and will advise that effecting the change without approval would constitute a violation of NASD Rule 1017.

      FINRA is proposing to further codify the materiality consultation process under proposed Rule 1132. The proposed rule would retain the voluntary nature of this process, except that it would mandate consultation where there is a request to waive the submission of a CMA under the circumstances in proposed Supplementary Material 1131.01 described above.44 The proposed rule would also mandate a materiality consultation where an applicant seeks to engage in, for the first time, retail foreign currency exchange activities, variable life settlement sales to retail customers, options activities or municipal securities activities.45 The proposed rule would set forth the Department's ability to, among other things, assess the nature and scope of the contemplated activity; the history of sales practice events and disciplinary history of the applicant and its Associated Persons; the impact on the member's supervisory and compliance structure, personnel and finances; and any other impact on investor protection raised by the contemplated activity.
      C. Safe Harbor from the CMA Process (Proposed FINRA Rule 1133)

      While NASD Rule 1017 sets forth the events that require a CMA, NASD IM-1011-1 (Safe Harbor for Business Expansions) creates a safe harbor for three categories of business expansions that a member may undergo without filing a CMA. The permissible areas of business expansion under the safe harbor include the number of Associated Persons involved in sales, number of offices (registered or unregistered), and number of markets made,46 with those expansions measured on a rolling 12-month basis. The safe harbor is unavailable to a member that has a membership agreement that contains a specific restriction as to one or more of those three areas of expansion or to a member that has a "disciplinary history" as defined in NASD IM-1011-1.47

      FINRA is proposing to revise NASD IM-1011-1 as proposed Rule 1133. The proposed rule would retain the existing three areas of expansion and their corresponding thresholds, as well as the recordkeeping obligations for increases in personnel, offices and markets to determine whether they are within the safe harbor. The proposed rule would also continue to exclude a member from relying on this provision if such member has a defined "disciplinary history."

      The proposed amendments would relocate the defined terms "disciplinary history"48 and "Associated Person involved in sales" from NASD IM-1011-1 to proposed Rule 1111. The proposed amendments would adjust the way in which the expansions are measured from a rolling 12-month basis to a 12-month period preceding the event.49 In addition, the proposed rule would modify the existing practice of prohibiting any expansion in the safe harbor areas if any one type of expansion was restricted, and instead permit a member to rely upon the safe harbor for those types of business expansions from which it is not restricted.50

      Standards for Approval of Application (Proposed FINRA Rule 1140 Series)

      NASD Rule 1014 sets forth the standards for admission for an application, the process and timing for granting or denying an application, the timing and content requirements for the Department's decision and submission of a membership agreement, and the effectiveness of restrictions in the membership agreement. The Department evaluates both NMAs and CMAs to determine whether the applicant meets the 14 standards set forth in NASD Rule 1014(a)51 and for that reason, FINRA is proposing to restructure NASD Rule 1014 for clarity by separating key milestones in the application review process into separate rules housed under the proposed Rule 1140 Series and Rule 1150 Series (Department Decision). The proposed Rule 1140 Series (and the Rule 1150 Series described below) would encompass rules applicable to NMAs and CMAs.

      A. General Provisions (Proposed FINRA Rule 1141)

      FINRA is proposing to adopt proposed Rule 1141 to expressly state that all applications shall satisfy the standards set forth in proposed Rule 1142, but would permit an applicant to identify any standard that it believes is not applicable to the Department's review by providing a detailed written description of its rationale to the Department.52 The Department would have the authority to make the final determination of the applicability of any standard, and the applicant would be bound by that determination. The proposed rule would also make clear that such determination would not represent final action on the application for purposes of an appeal under the proposed Rule 1160 Series.
      B. Standards (Proposed FINRA Rule 1142)

      FINRA is proposing to revise standards for admission in NASD Rule 1014(a) as proposed Rule 1142. As discussed further below, FINRA is also proposing to revise the other remaining paragraphs in NASD Rule 1014 concerning the decision-making aspects of an application such as granting or denying an application, the presumption to deny an application, the effectiveness of a restriction, and the content, service and effectiveness of the Department's decision, as the proposed Rule 1150 Series.

      NASD Rule 1014(a) provides that after considering the application, the membership interview, other information and documents, the public interest and the protection of investors, the Department must determine whether the applicant meets 14 standards for admission set forth below.
      NASD Rule 1014 Standard Description
      Standard 1 Complete and Accurate Application (Overview of the Applicant)
      Standard 2 Licenses and Registrations Required by State and Federal Authorities and Self-Regulatory Organizations
      Standard 3 Compliance with Industry Rules, Regulations, and Laws
      Standard 4 Contractual or Other Arrangements and Business Relationships
      Standard 5 Business Facilities
      Standard 6 Adequacy of Communications and Operational Systems
      Standard 7 Determining the Adequacy of Net Capital
      Standard 8 Financial Controls
      Standard 9 Control Mechanisms Consistent with Industry Practices
      Standard 10 Adequate Supervisory System
      Standard 11 Recordkeeping System
      Standard 12 Continuing Education
      Standard 13 Other Information Possessed by FINRA
      Standard 14 Consistency with Federal Securities Laws


      FINRA is proposing to streamline the standards under proposed Rule 1142 by deleting those that are obsolete and redundant, and consolidating others with the standards that are closely related. This streamlining effort would result in the reduction of the total number of standards from 14 to 10.
      •   Consolidation of Standards 1 and 14—Complete and Accurate Application

      Standard 1 requires that an application and all supporting documentation are complete and accurate. Standard 14 requires that an application and all supporting documents are consistent with applicable securities laws and regulations, and with applicable FINRA rules. FINRA is proposing to consolidate Standard 14 into Standard 1 to require that an application and all supporting documents are complete, accurate, and consistent with the federal securities laws, the rules and regulations thereunder, and FINRA rules.53
      •   Consolidation of Standards 2 and 12—Licenses and Registrations, and Continuing Education

      Standard 2 requires that an applicant and its Associated Persons have all licenses and registrations required by state and federal authorities and self-regulatory organizations (SROs). Standard 12 requires that an applicant has completed a training needs assessment and has a written continuing education plan. FINRA is proposing to consolidate Standard 12 into Standard 2 because both standards pertain to registration and qualification. The proposed standard would also include the requirement that the applicant and its Associated Persons have paid all applicable fees.54
      •   Consolidation of Standards 7 and 8—Financial and Operational Controls; Capital; and Clarification of Criteria

      Under Standard 7, an applicant must meet the provisions set forth under SEA 15c3-1, the SEC's net capital rule. If necessary, the Department may impose a reasonably determined higher net capital requirement beyond the minimum requirement after considering six specified factors. These factors include, among others, the applicant's ability to comply with SEA Rule 17a-11, the SEC's early warning rule, and meet expenses net of revenues for at least 12 months, based on reliable projections agreed to by the applicant and the Department. Under Standard 8, an applicant must have financial controls to ensure compliance with the federal securities laws, the rules and regulations thereunder, and FINRA rules.

      FINRA is proposing to consolidate Standard 8 into Standard 7 because both standards pertain to an applicant's financial and operational responsibilities, and to amend the consolidated standard to clarify that an applicant's financial and operational controls comply with SEA Rules 15c3-1 and 15c3-3, and Rule 4110 (Capital Compliance).55 In addition, FINRA is proposing to amend the consolidated standard to clarify that the Department may consider the amount of net capital sufficient to avoid early warning level reporting requirements, such as SEA Rule 17a-11 and Rule 4120 (Regulatory Notification and Business Curtailment), as applicable.56

      Finally, FINRA is also proposing a clarifying amendment to Standard 7, deleting the phrase "net of revenues" to clarify the Department's current practice to consider the amount of capital necessary to meet expenses for at least 12 months based on reliable projections of revenue agreed to by the applicant and the Department.
      •   Consolidation of Standards 9 and 10—Supervisory System; and Clarification of Criteria

      Standard 9 requires that the applicant demonstrate that its compliance, supervisory, operational and internal control practices and standards are consistent with practices and standards regularly employed in the investment banking or securities business, taking into account the nature and scope of applicant's proposed business. Standard 10 requires the applicant to demonstrate that it has an adequate supervisory system, including written supervisory procedures, internal operating procedures (including operational and internal controls), and compliance procedures designed to prevent and detect, to the extent practicable, violations of federal securities laws and rules and regulations thereunder, and with applicable FINRA rules. In evaluating Standard 10, the Department is required to consider the overall nature and scope of the applicant's intended business operations and other specified factors that include, among others, whether each Associated Person identified in the applicant's business plan to discharge a supervisory function has at least one year of direct experience or two years of related experience in the subject area to be supervised; whether the applicant will recommend securities to customers; and whether the applicant should be required to place one or more Associated Persons under heightened supervision pursuant to Notice to Members 97-19.

      FINRA is proposing to consolidate Standard 9 into Standard 10 because both standards pertain to an applicant's supervisory responsibilities,57 and to amend some of the specified factors that the Department is required to consider under Standard 10 in the following ways. First, one of the factors concerns the requirement that an Associated Person have at least one year of direct experience and two years of related experience in the subject area to be supervised. FINRA is proposing to amend this factor to permit the applicant to identify that each Associated Person in the application is qualified, either by virtue or experience or training, to carry out his or her assigned responsibilities. This amendment would align with Rule 3110(a)(6), which specifies the minimum requirements for a member's supervisory system including "[t]he use of reasonable efforts to determine that all supervisory personnel are qualified, either by virtue of experience or training, to carry out their assigned responsibilities."

      Second, another factor is whether the applicant will recommend securities to customers. FINRA is proposing to extend this factor to include whether the applicant will recommend transactions or investment strategies involving a security or securities to customers.58 Finally, with respect to the factor concerning whether the applicant should be required to place Associated Persons on heightened supervision pursuant to Notice to Members 97-19, FINRA is proposing to amend the standard to clarify that the Department will consider whether the applicant will implement heightened supervisory procedures on any Associated Person whose record reflects a history of industry or regulatory-related incidents, including one or more disciplinary actions or sales practice events.59
      •   Elimination of Standard 5—Business Facilities

      Standard 5 requires an applicant to have adequate plans to obtain facilities that are sufficient to initiate the operations described in the applicant's business plan, considering the nature and scope of operations and the number of personnel, and comply with the federal securities laws, the rules and regulations thereunder, and FINRA rules. In reviewing NMAs and CMAs under this standard, the Department considers not only the obvious factors, such as office space and computer equipment, but also the location of such facilities to determine whether the applicant's business plan can be effected with adequate supervision of the applicant's business activities for compliance with all relevant securities rules. During the retrospective review, various stakeholders said that Standard 5 does not reflect modern business operations. For example, an applicant that does not have the traditional "bricks and mortar" presence because it operates through online electronic platforms would not clearly satisfy this standard. FINRA is proposing to delete this standard because it currently has little utility in the Department's review of an application.
      •   Codification of Department Practice to Review Source of Funding

      FINRA is proposing to codify the Department's existing practice to evaluate whether direct and indirect funding sources present any regulatory concerns or may be derived from a person subject to a statutory disqualification. The proposed standard would require an applicant to fully disclose and establish through documentation all direct and indirect sources of funding.60
      C. Pending Qualifications for Associated Persons (Proposed Supplementary Material 1142.01)

      FINRA is proposing to add new Supplementary Material .01 to proposed Rule 1142. The proposed supplementary material would permit the Department, at its discretion, to approve a CMA where one or more Associated Persons have applied for, but not acquired, all licenses and registrations required by federal and state authorities, and SROs, subject to specified conditions. The conditions would include that all Associated Persons must acquire their required licenses and registrations within 90 days of the date of approval of the CMA; the applicant promptly notifies the Department when such licenses and registrations are acquired; the applicant does not engage in business activities that require a license or registration that has not been acquired; and if all required licenses and registrations are not acquired within the 90-day timeframe, the applicant must cease business operations until all such licenses and registrations have been acquired. FINRA believes that this proposed supplementary material would allow the Department to exercise its discretion, based on the facts and circumstances of the applicant and its Associated Persons, to provide some leeway to applicants for continuing membership and their Associated Persons to obtain the requisite licenses and registrations after the CMA has been approved. This proposed supplementary material would not apply to an applicant for new membership.

      Department Decision (Proposed FINRA Rule 1150 Series)

      As noted above, FINRA is proposing to redesignate and amend, as the Rule 1150 Series, the other remaining paragraphs of NASD Rules 1014 concerning the decision-making aspects of an application, such as granting or denying of an application, the presumption to deny an application, the effectiveness of a restriction, the content, service and effectiveness of the Department's decision, and membership agreement. Moreover, NASD Rule 1017, which pertains to CMAs, includes similar concepts and language on the decision-making aspects of a CMA. FINRA believes that redesignating these provisions under a single set of rules would bring more clarity to the review process for both NMAs and CMAs.

      A. Timing of Decision (Proposed FINRA Rule 1151)

      NASD Rules 1014(c)(3) and 1017(h)(3) contain nearly identical language. Both provisions provide that if the Department fails to issue a written decision within 180 days after the filing of the application (new or continuing) or such later date as the Department and the applicant have agreed in writing, the applicant may file a written request with the FINRA Board requesting that the FINRA Board direct the Department to serve a decision. Within seven days after the filing of such a request, the FINRA Board shall direct the Department to serve its written decision immediately or to show good cause for an extension of time. However, under NASD Rule 1014(c)(3), if the Department shows good cause for an extension of time, the FINRA Board may extend the 180-day time limit for issuing a decision on an NMA by not more than 90 days and under NASD Rule 1017(h)(3), the FINRA Board may extend the time limit for issuing a decision on a CMA by not more than 30 days.

      FINRA is proposing to revise NASD Rules 1014(c)(3) and 1017(h)(3) as proposed Rule 1151. The proposed rule would adjust the timeframes by directing the Department to issue its written decision on an application within 150 days of the Application Filed Date (or such other date as the Department and the applicant have agreed to in writing) and retain the current seven-day timeframe in which the FINRA Board must direct the Department to serve a decision, and if the Department shows good cause for an extension of time, the FINRA Board may extend the 150-day time limit by not more than 90 days.
      B. Department Decision on Application (Proposed FINRA Rule 1152)
      •   Department Decision on Application and Effectiveness of Restriction

      NASD Rules 1014(b) and 1017(h) set forth the various decision outcomes on an application: the Department may grant the application in whole or in part subject to one or more restrictions, or deny the application. NASD Rule 1014(f) addresses the effectiveness of a restriction. FINRA is proposing to redesignate these provisions to paragraphs (a) and (b), respectively, under proposed Rule 1152. FINRA is also proposing to add a new provision under paragraph (a) to clarify that contingent upon the applicant's submission of an executed membership agreement, the Department's decision would become effective upon service and would remain in effect during an appeal under the proposed Rule 1160 Series.
      •   Presumption to Deny Application

      NASD Rules 1014(b)(1) and 1017(h)(1) provide that the existence of specified events enumerated in Standard 3 (NASD Rule 1014(a)(3)) will create a rebuttable presumption to deny the application.61 FINRA is proposing to redesignate and adopt these provisions, with no substantive changes, as proposed Rule 1152(c).62
      C. Content of Decision (Proposed FINRA Rule 1153)

      NASD Rules 1014(c)(2) and 1017(h)(2) set forth the content requirements of the Department's decision on an application. If the Department denies an application, NASD Rule 1014(c)(2) requires the Department to issue a decision that explains the reason for denial, referencing the applicable standard(s). Under NASD Rule 1014(c)(2), if the Department grants an application subject to restrictions, the Department's decision must explain in detail the reason for each restriction, referencing the applicable standard(s) upon which the restriction is based, and identify the specific financial, operational, supervisory, disciplinary, investor protection or other regulatory concern that the restriction is designed to address, and the manner in which the restriction is reasonably designed to address the concern. Similarly, NASD Rule 1017(h)(2) provides that for a CMA that is granted or denied in whole or in part, the Department's decision must explain its reasons, referencing the applicable standard in NASD Rule 1014. FINRA is proposing to consolidate and adopt these provisions as proposed Rule 1153, and include a provision to address the Department's obligation to provide written notification to the applicant when the application is granted.63
      D. Submission of Executed Written Membership Agreement (Proposed FINRA Rule 1154)

      Currently, NASD Rules 1012(b), 1014(d) and 1017(h)(4) pertain to the submission of a membership agreement for NMAs and CMAs. Under NASD Rule 1012(b), if an applicant fails to file an executed membership agreement within 25 days after the Department serves the membership agreement (or within such other period agreed to by the Department and the applicant), the NMA or CMA will lapse. Under NASD Rule 1014(d), if the Department grants an NMA (with or without a restriction), the Department's final approval on the NMA is contingent upon the applicant's submission of an executed membership agreement pursuant to which the applicant agrees to abide by any restriction specified in the Department's decision, and obtain the Department's approval of a change in ownership, control or business operations under NASD Rule 1017. This contingency, however, is not present for a CMA. If the Department approves a CMA in whole or in part, NASD Rule 1017(h)(4) provides that the Department may require the applicant to submit an executed membership agreement.

      To bring more clarity and uniformity to the submission of membership agreements, FINRA is proposing to consolidate and adopt these provisions, with amendments, as proposed Rule 1154. The amendments would require an applicant to submit an executed written membership agreement for an approved (with or without restrictions) NMA or CMA, and would shorten the timeframe in which the applicant must do so from 25 days to 15 days. The shorter timeframe would align with the general practice of applicants submitting their executed written membership agreements well within 25 days. Moreover, the proposed rule would clarify that upon submission of the membership agreement, the applicant may begin operating subject to the terms of such agreement.
      E. Service and Effectiveness of Decision; Final Action (Proposed FINRA Rule 1155)

      Currently, NASD Rules 1014(e) and 1017(i), which pertain to NMAs and CMAs, respectively, address the service and effectiveness of a decision on an application in nearly identical language. In an effort to bring more efficiency to the review process for the application review process, FINRA is proposing to consolidate and adopt these two provisions, with non-substantive changes, as proposed Rule 1155.

      Review of Department Decision (Proposed FINRA Rule 1160 Series)

      Unlike disciplinary procedures, where FINRA determines when and if to initiate a proceeding, an applicant for new or continuing membership determines when to file an application, and when to initiate a proceeding with the NAC to review the Department's decision on an application.

      In general, NASD Rule 1015 (Review by National Adjudicatory Council) permits an applicant to submit a request for review by the NAC of an adverse decision rendered on a NMA or CMA. NASD Rule 1016 (Discretionary Review by FINRA Board) also permits a Governor of the FINRA Board to call for discretionary review of a membership proceeding. Finally, a person aggrieved by final action of FINRA under the NASD Rule 1010 Series may apply to the SEC for appellate review. Collectively, these rules provide for the administration of MAP appeals. Among other things, these rules set forth specified time periods for holding hearings, satisfying document production requests, specify the evidence and testimony that may be considered, and identify information that the applicant must provide to FINRA.

      As noted above, FINRA is proposing to incorporate within the proposed Rule 1160 Series, paragraphs (c) and (d) of NASD Rule 1012, which address ex parte communications and recusal or disqualification, respectively, and NASD Rules 1015, 1016 and 1019 (together, the MAP appeal rules). FINRA is also proposing to restructure these provisions by separating key milestones within NASD Rule 1015 into five distinct rules within the proposed Rule 1160 Series to present the MAP appeal process in a more sequential manner:

      •   Appeal to the NAC;
      •   Appointment and Powers of the Subcommittee; Recusal and Disqualification, or Withdrawal;
      •   Transmission of Record, Exhibit and Witness Lists; Withheld Documents;
      •   Hearing; and
      •   Recommended Decision of the Subcommittee and Decision of the NAC.

      In addition, FINRA is proposing to amend the provisions to reflect current practices that would align, in large part, with the Rule 9000 Series (Code of Procedure), and update nomenclature to reflect usage consistent with the Rule 9000 Series.64

      A. Ex Parte Communications (Proposed FINRA Rule 1161)

      Currently, NASD Rule 1012(c) pertains to ex parte communications with applicants or Interested FINRA Staff, and is derived from paragraphs (a) and (b) under Rule 9143 (Ex Parte Communications). FINRA is proposing to redesignate, with technical changes, NASD Rule 1012(c) to proposed Rule 1161. The technical changes would align with Rule 9143(a) and (b).
      B. Appeal to the National Adjudicatory Council (Proposed FINRA Rule 1162)

      FINRA is proposing to consolidate under proposed Rule 1162, the elements associated with initiating or ending the MAP appeal process by the aggrieved applicant by incorporating paragraphs (a) and (h) under Rule 1015, which pertain to the initiation, content of a request for review and abandonment of a request for review. In addition, FINRA is proposing to include within proposed Rule 1162 new provisions that would clarify the logistical aspects of initiating an appeal, such as directing where the applicant must file the notice of appeal and methods of service, the effect of an appeal and the applicant's ability to withdraw the notice of appeal.65

      Currently, NASD Rule 1015(h) provides that if the applicant fails to specify the grounds for the appeal, appear at a hearing for which the applicant has notice, or file information or briefs as directed, the NAC or Subcommittee may dismiss the appeal as abandoned, and the Department decision shall become the final action of FINRA. FINRA is proposing to include other circumstances that would cause an appeal to be viewed as abandoned. Under the proposed provision, the other circumstances would include when an applicant files Form BDW, becomes expelled from FINRA membership or enters into liquidation proceedings under the Securities Investor Protection Act of 1970.
      C. Appointment and Powers of Subcommittee; Recusal and Disqualification, or Withdrawal (Proposed FINRA Rule 1163)

      Paragraph (d) of NASD Rule 1012 sets forth the procedures for the recusal or disqualification of a Governor or member of the NAC or Subcommittee. Paragraphs (d) and (e) of NASD Rule 1015 address the appointment and powers of the Subcommittee, respectively, and paragraph (g) pertains to the filing of additional information or briefs. FINRA is proposing to incorporate these provisions, with amendments, under proposed Rule 1163. The proposed amendments are described below.
      •   Powers of Subcommittee

      FINRA is proposing to add new provisions to clarify the powers of the Subcommittee. Under the proposed rule, the Subcommittee may extend or shorten any time limits set forth in the Rule 1160 Series, and do all things necessary and appropriate to regulate the course of a proceeding including, but not limited to, resolving any and all procedural and evidentiary matters. In an effort to enhance procedural efficiency, FINRA is also proposing to add a new provision that would expressly require the applicant and the Department to participate in a scheduling conference at which the parties to the appeal may agree to a hearing date and the date for the Subcommittee to present its recommended decision to the NAC. The proposed rule would also permit the Subcommittee to cancel a previously scheduled hearing for good cause shown due to abandonment or other similar unreasonable unavailability of the applicant.66
      •   Recusal and Disqualification, or Withdrawal

      As noted above, FINRA is proposing to redesignate NASD Rule 1012(d), which governs recusals or disqualifications, to proposed Rule 1163.67 In addition, FINRA is proposing to add new provisions that would set forth the procedures for an applicant or the Department to move for disqualification of a member of the NAC or Subcommittee. This motion would be based upon a reasonable, good faith belief that a conflict of interest or bias exists or circumstances otherwise exist where the fairness of the member of the NAC or a Subcommittee thereof might reasonably be questioned. The proposed rule would also set forth a process for such member to withdraw from appointment should the member have a conflict of interest of bias, or circumstances otherwise exist where the fairness of the member might reasonably be questioned.68
      D. Transmission of Record, Exhibit and Witness Lists; Withheld Documents (Proposed FINRA Rule 1164)
      •   Transmission of Record, Exhibit and Witness Lists

      Paragraphs (b) and (f)(3) under NASD Rule 1015 govern the transmission of documents and the exchange of hearing exhibit and witness lists, respectively.

      NASD Rule 1015(b) requires the Department to transmit the documents the Department considered in connection with the Department's decision and an index to the NAC and the applicant within 10 days after the filing of the request for review. FINRA is proposing to redesignate this provision, with amendments, to proposed Rule 1164. The proposed amendments would include lengthening the timeframe from 10 days to 21 days after the filing of the notice of appeal, which would align more closely with the timeframe under Rule 9321 (Transmission of Record), and specifying that such transmission is to be made electronically or in any other manner FINRA may prescribe.

      NASD Rule 1015(f)(3) sets forth the time in which the parties on appeal must exchange their proposed hearing exhibits and witness lists.69 Currently, such lists must be exchanged not later than five days before the hearing. FINRA is proposing to lengthen the time in which the parties must exchange their exhibit and witness lists from five days to 21 days before the hearing. In practice, five days is insufficient time to review these materials. Extending the timeframe to 21 days would afford the parties to the appeal and the Subcommittee a more reasonable amount of time to review exhibits and witness lists as well as afford the parties to the appeal more time to make objections to the proposed hearing exhibits or witnesses.70 In addition, FINRA is proposing to add a new provision concerning expert witnesses. Under the proposed provision, at any time prior to the hearing, the Subcommittee or NAC, in the exercise of its discretion, may order the applicant and Department to disclose any expert witness and information related to the expert, including a statement of the expert's qualifications, a listing of other proceedings in which the expert has given expert testimony, a list of the expert's publications and copies of those publications.71
      •   Withheld Documents

      FINRA is proposing to add a new provision to address the circumstances under which the Department may withhold documents and submit a list of documents withheld. This proposed new provision is derived from paragraphs (b) and (c) under Rule 9251 (Inspection and Copying of Documents in Possession of Staff), which addresses withheld documents and the list of withheld documents, respectively. FINRA believes that it would be prudent to include this provision to explicitly permit the Department to withhold a document from production under specified criteria. Criteria would include, among others, a document that is privileged or constitutes attorney work product, would reveal examination or investigative information, or is prohibited from disclosure by federal law. In addition, the amendment would include a provision governing the Subcommittee or NAC's authority to require the Department to submit a withheld document list, or submit to the Subcommittee or the NAC any document withheld. Upon review, the Subcommittee or the NAC may order the Department to make the list or any document withheld available to the other parties for inspection and copying unless federal law prohibits disclosure of the document or its existence. A motion to require the Department to produce a list of documents withheld would be based upon some reason to believe that a document is being withheld in violation of the proposed rule.
      E. Hearing (Proposed FINRA Rule 1165)

      Paragraphs (f)(1), (f)(2), (f)(3) and (f)(4) under NASD Rule 1015 set forth the hearing process, including the timing and notice of the hearing, the ability of the applicant and Department to be represented by counsel at the hearing, evidence and the hearing transcript, respectively. FINRA is proposing to redesignate these subparagraphs, with amendments, as proposed Rule 1165. As described below, the proposed amendments pertain to the time in which a hearing must be held, and evidence, and introduces a new provision concerning testimony.
      •   Lengthening Time for Hearing to be Held from 45 Days to 90 Days

      Currently, NASD Rule 1015(f)(1) provides that a hearing must be held within 45 days after the filing of the request for review. In practice, this 45-day timeframe is difficult to meet, and in most cases, the hearing is held well after the 45-day timeframe. The proposed amendment to this provision would lengthen the time in which a hearing must be held from 45 days to 90 days. This expansion of time represents a more reasonable and practical approach to the appeal process for the parties involved. In addition, the proposed amendment would move away from paper-based methods of delivery of notice to an electronic process or in any other manner FINRA may prescribe.
      •   Evidence

      As noted above, NASD Rule 1015(f)(3) provides in part, that the formal rules of evidence do not apply to a hearing before the NAC or Subcommittee. FINRA is proposing to redesignate the reference to the applicability of the formal rules of evidence in NASD Rule 1015(f) (3) to proposed Rule 1165 and add a new provision that would expressly provide that the Subcommittee or NAC may exclude all evidence that is irrelevant, immaterial, unduly repetitious or prejudicial.72

      In addition, FINRA is proposing to add a new provision that would expressly indicate that the Subcommittee or NAC's review would be limited to the documents and information the Department considered in connection with the Department's decision on the application, admitted exhibits submitted by the Department and the applicant in accordance with proposed Rule 1164, witness testimony, and any additional information or briefs the Department or applicant files as ordered by the Subcommittee or the NAC. The proposed new provision would also provide that other than the information specified above, any other evidence would be presumptively irrelevant, but that upon a showing of good cause by the parties to the appeal, the Subcommittee or NAC may admit other evidence presented by the parties to the appeal.
      •   Testimony

      Currently, the MAP appeal rules do not address testimony given at a hearing. In order to address this gap in the hearing process, FINRA is proposing to include a new provision that would expressly provide that an applicant and its representative, and any other person subject to FINRA's jurisdiction must testify under oath or affirmation.73
      F. Recommended Decision of Subcommittee and Decision of National Adjudicatory Council (Proposed FINRA Rule 1166)

      Paragraphs (i) and (j) under NASD Rule 1015 pertain to the Subcommittee's recommended decision and the NAC's decision after considering the Subcommittee's recommended decision and all matters presented on appeal. FINRA is proposing to redesignate these two provisions, with amendments, as proposed Rule 1166.74
      •   Lengthening Time in Which Subcommittee Must Present Recommended Decision to the NAC from 60 days to 75 Days

      Currently, NASD Rule 1015(i) provides that the Subcommittee's written recommended decision must be presented to the NAC within 60 days after the conclusion of the hearing. FINRA believes that 75 days reflects a more reasonable amount of time for the Subcommittee to make this presentation.
      •   Adding "Remand" as a Disposition

      Currently, NASD Rule 1015(j)(2) provides that the NAC's decision must include, among others items, a statement on whether the Department's decision is affirmed, modified or reversed, and a rationale underlying the disposition, referencing the application standards under NASD Rule 1014(a). The proposed change would clarify that the NAC's decision may remand the Department's decision, while giving a rationale for the remand. Adding this disposition to the rule would align with the NAC's ability to remand the membership proceeding currently set forth under NASD Rule 1015(j)(1), which describes the NAC's decision, and NASD Rule 1015(j)(3), which describes the issuance of the NAC's decision after the expiration of the call for review period.75
      G. Discretionary Review by FINRA Board (Proposed FINRA Rule 1167)

      FINRA is proposing to adopt NASD Rule 1016, with no substantive changes, as proposed Rule 1167.
      H. Application to SEC for Review (Proposed FINRA Rule 1168)

      FINRA is proposing to adopt NASD Rule 1019, with no substantive changes, as proposed Rule 1168.

      Other Proposed Amendments

      A. Amendment to Section 4(i) of Schedule A to the FINRA By-Laws

      Section 4(i)(3) of Schedule A to the FINRA By-Laws specifies the changes that may qualify for a waiver of the fee associated with filing a CMA. As described above, FINRA is proposing to recast the changes specified under Section 4(i)(3)(A)(i) and (ii) to proposed Rule 1131.01 (Permissible Events for Form CMA Waiver) as events that may qualify for a waiver from the CMA filing requirement.

      Section 4(i)(3) also includes other examples of changes in ownership, control or business operations that may qualify a CMA for a fee waiver. Under Section 4(i)(3)(A)(iii) a CMA may qualify for a fee waiver where the proposed change does not make any day-to-day changes in the applicant's business activities, management, supervision, assets or liabilities, and the applicant is only proposing a change in the "percentage of ownership interest or partnership capital of an applicant's existing owners or partners resulting in an owner or partner owning or controlling 25 percent or more of the ownership interest or partnership and that owner or partner has no disclosure or disciplinary issues in the preceding five years[.]"

      In addition, Section 4(i)(3)(B) provides that a CMA may qualify for a fee waiver where the proposed change is filed by an applicant in connection with a direct or indirect acquisition or transfer of 25 percent or more in the aggregate of the applicant's assets or any asset, business or line of operation that generates revenues composing 25 percent or more in the aggregate of the applicant's earnings measured on a rolling 36-month basis where the applicant also is ceasing operations as a broker-dealer (including filing a Form BDW with the SEC) and there are either:
      (i) no pending or unpaid settled customer related claims (including, but not limited to, pending or unpaid settled arbitration or litigation actions) against the applicant or any of its Associated Persons; or
      (ii) pending or unpaid settled customer related claims (including, but not limited to, pending or unpaid settled arbitration or litigation actions) against the applicant or its Associated Persons, but the applicant demonstrates in the CMA its ability to satisfy in full any unpaid customer related claim (e.g., sufficient capital or escrow funds, proof of adequate insurance for customer related claims).
      In addition to deleting Section 4(i)(3)(A)(i) and (ii) as they would be recast as proposed Rule 1131.01, FINRA is proposing to delete the remaining provisions under Section 4(i)(3), specifically Section 4(i)(3)(A)(iii) and Section 4(i)(3)(B), in their entirety. FINRA has found that in practice, such circumstances do not qualify a CMA for a fee waiver because of the Department's review of such situations is substantial.
      B. Deletion of Incorporated NYSE Rules and Related Interpretations

      FINRA is proposing to delete the following Incorporated NYSE rules and related rule interpretations as they are either redundant or obsolete:
      •   Incorporated NYSE Rule 311 (Formation and Approval of Member Organizations);
      •   Incorporated NYSE Rule Interpretation 311(f) (Principal Place of Business);
      •   Incorporated NYSE Rule Interpretation 311(g)/02 (Divisions of Member Organizations-Names);
      •   Incorporated NYSE Rule 312 (Changes Within Member Organizations);
      •   Incorporated NYSE Rule 313 (Submission of Partnership Articles-Submission of Corporate Documents); and
      •   Incorporated NYSE Rule 321 (Formation or Acquisition of Subsidiaries).

      Economic Impact Assessment

      A. Regulatory Need

      FINRA's retrospective review of the MAP rules, coupled with both internal and external stakeholder input, indicate that the current rules and their attendant processes may benefit from changes that would enhance their efficiency, and better achieve investor protection.
      B. Economic Baseline

      The economic baseline for this proposal is the current set of MAP rules, and related guidance and Department practices. To obtain the Department's approval (in whole or part) of an application, an applicant must not only ensure that its application includes the necessary documents and information for the Department to undertake the review, but the applicant must also navigate a series of steps for the review process to proceed in a timely manner under either the regular timeframes described in the current rules or expedited (i.e., Fast Track) timeframes, or risk the Department's rejection or lapse of the application. This proposal would affect all prospective (or new) member firms and existing (or continuing) member firms (and their Associated Persons).
      1. Number of Submissions of NMAs, CMAs and Materiality Consultations by Year

      As displayed in Figure 1 below, in 2017, the Department received 125 NMAs, 340 CMAs and 407 materiality consultations (known as "MatCons"). Over the past 10 years, from 2008 through 2017, the number of NMAs and CMAs the Department has received has decreased, but the number of MatCons the Department has received has increased. The decrease in the number of CMAs could be due to the increased use of MatCons.



      Figure 1: Number of NMA, CMA and MatCon submissions received, on an annual basis, for the period 2008 through 2017.

      In general, NMAs are submitted by small firms76 or firms without any registered representatives. CMAs are submitted by firms of varying sizes. The number of CMAs submitted by large firms and mid-size firms has remained relatively flat over the past 10 years, and the number of CMAs submitted by small firms has declined. The number of MatCons submitted by large firms has remained relatively flat, number of submissions by mid-size firms has shown a small increase and number of submissions by small firms has shown a substantial increase over the same period. Based on these trends, it is likely that most of the costs and benefits associated with this proposal will accrue to small firms, which account for the majority of all submissions.
      2. Department Processing Times

      As displayed in Figure 2, the average processing time per submission for all three categories has decreased since 2013 following the introduction of the Fast Track review process. As described further below, the MAP Triage Program and the Fast Track review process have dramatically reduced processing times for all applications and MatCons. During the retrospective review, stakeholders had provided positive feedback on the Fast Track review process.



      Figure 2: Average processing time of NMA, CMA and MatCon submissions, on an annual basis, for the period 2008 through 2017.
      3. Costs of Compliance with Current MAP Rules and Processes

      As part of the retrospective review, a survey sent to all FINRA members provided information about the economic impacts of complying with the current MAP rules and processes.77 The costs of compliance included those associated with business interruptions, employing third-party resources (such as outside external professional assistance), internal expenses (such as staff hours, technology and other resources) and application fees. Most notably, the retrospective review revealed that for an NMA that underwent a full review, on average, the costs associated with employing third-party resources and internal costs each represented approximately 35 percent of the total compliance costs. About 20 percent of the costs were attributable to application fees and the remainder to indirect costs, such as business interruption. For an NMA that underwent an expedited review and a CMA that either underwent an expedited review or was subject to regular timeframes as described under the current rules, the greatest source of cost was associated with internal expenses, representing approximately 40 percent of the total compliance costs. For all applications, on average, the application fees accounted for approximately 20 to 33 percent of the total compliance costs.
      C. Economic Impacts

      The proposed amendments to the MAP rules are designed to make them more concise through restructuring and streamlining, codifying existing guidance and Department practices, and updating terms consistent with other FINRA By-Laws and rules. FINRA believes that these proposed amendments will have a positive impact on the membership application and MatCon processes that will ease burdens on firms without materially diminishing investor protections.
      1. Restructuring and Streamlining the MAP Rules

      The proposed restructuring and streamlining amendments to the MAP rules would lead to a more concise and efficient MAP process, updated to reflect technological advancements and changes in the industry, and will ultimately benefit the applicant firms, with a potential cost reduction to the investor community. An updated, streamlined set of the MAP rules and attendant processes would ultimately reduce costs for firms, including those associated with third-party resources. Lower direct costs to the application process that accrue to firms may benefit investors to the extent that firms may pass those cost-savings to them. While FINRA does not anticipate any increased risks to investors, periodic reviews of the new processes would help ensure that the changes are working as anticipated.
      2. Proposed Codification of Existing Department Practices

      Under the proposal, several existing Department practices would be incorporated into the MAP rules, which would positively impact the overall review period for applications and MatCons. Most notably, the proposal would reference the Department's discretion to determine whether an application may be eligible for expedited review and incorporate the MatCon process into the MAP rules.
      •   Initial Assessment and Expedited Review

      FINRA is proposing to codify existing Department practices that would result in reducing the overall application review period from 180 days to 150 days. This 30-day reduction reflects the success of the MAP Triage Program. Under this Program, the Department conducts an initial assessment of the risk, complexity, regulatory significance, completeness, scale and scope of all applications and other MAP-related matters to determine whether the application or matter is eligible for expedited review, subject to shorter timeframes, or full review, subject to standard timeframes set forth under the MAP rules. During the retrospective review, stakeholders had viewed the expedited review process favorably, indicating that it effectively achieves its intended goal of identifying low-risk and low-complexity matters, and reducing processing times.

      Since the program's launch in 2013, the overall processing times for applications and MatCons have decreased. As the program has matured, the number of applications and MatCons eligible for expedited review have significantly increased. As Figure 3 indicates below, in 2013, the number of NMAs, CMAs and MatCons that underwent expedited review was 5, 71 and 182, respectively. In 2017, the number of NMAs, CMAs and MatCons that underwent expedited review increased to 35, 189 and 358, respectively, representing 28 percent of the NMAs, 55 percent of the CMAs and 87 percent of MatCons submitted for Department review. The benefit of the expedited or Fast Track option is a better use of limited staff resources and more efficient handling of ex ante lower risk submissions. The program's impact on reducing the Department's overall review process is clear. As shown in Figure 2 above, in 2017, the overall processing timeframes for NMAs, CMAs and MatCons was 120 days, 63 days and 12 days, respectively.



      Figure 3: Number of NMA, CMA and MatCon submissions eligible for Fast Track review, on an annual basis, for the period of 2008 through 2017.

      After the Department considers various factors as described in proposed Rule 1112.01, an application may be eligible to undergo Fast Track review. As an option that is provided to the applicant, FINRA believes that a firm is likely to agree to the expedited processing if the incurred cost savings are deemed to be greater than the increased costs (e.g., faster turnaround times for document requests) resulting from the expedited nature of the process. However, some firms may not want to expedite the application, as they will deem that such a process will not provide a net benefit and thus opt to go through the standard processing track. Shortening the timelines could potentially benefit the investor community by enabling the firms to provide services to their customers more quickly. As with the other efficiency improving process changes, risks to investors could arise from the expedited nature of the process, potentially leading to applications being approved that should not have been.
      •   MatCon Process

      As described above, with a MatCon, a member has the option of seeking guidance from the Department on whether a proposed change in ownership, control or business operations would require a CMA. The MatCon process is voluntary and no fee is assessed, and guidance on this process appears on FINRA's website.78 Because this process has existed for several years, FINRA expects that the economic impact that members may sustain as a result of codifying this process to be minimal. Currently, there is no fee assessed for this process, and this would remain so under the proposal. While the proposal would retain the voluntary nature of this process, it would mandate consultation in two instances where there is a request to waive the submission of a CMA under specified circumstances and when an applicant seeks to engage in a specified activity for the first time.79 Even with these two instances mandating a member to submit to the MatCon process, the economic impact of codifying this practice would be minimal as members would not be assessed a fee for this option.
      3. Proposed Amendments to the MAP Rules Affecting the NMA and CMA Processes
      •   Definition of New Term, "Control"

      FINRA is proposing to define, for the first time, "control" to apply only to the MAP rules.80 FINRA believes that the proposed definition would provide clarity to the control standards under the CMA process set forth under the proposed Rule 1130 Series described above. As the concept of control is entwined in several provisions of the MAP rules, the proposed definition would benefit firms in terms of the constraints and conditions relating to internal organizational structure. This would provide more transparency on the roles and ownership structures of the firms, which would provide additional monitoring capabilities and ultimately decrease potential risks to the investor community. It is possible that firms could strategically allocate ownership percentages to keep certain individuals from meeting the definition, possibly leading to increased risks to customers. However, to mitigate this potential risk, the Department will maintain discretion in defining an individual as a control person. Moreover, the Department will maintain its discretion in aggregating ownership interests when considering the designation of control and control persons, even in cases where Associated Persons meet the de minimis definition per interest.
      •   Expansion of Definition of "Sales Practice Event"

      Consistent with the prior proposals presented in Notices 10-01 and 13-29, FINRA is proposing to amend the existing definition of "sales practice event" to include an applicant or Associated Person who is subject to a "statutory disqualification" as defined in SEA Section 3(a)(39). This proposed change would be in conjuncture with FINRA's separate initiative on high-risk brokers. FINRA believes that while this potentially imposes a burden on the applicant, it would enhance investor protections.
      •   Application Rejection and Application Lapse

      Currently, the MAP rules specify the circumstances that will either preclude an applicant from proceeding with the application at the outset (via rejection) or cause the Department to cease its review of the application (via lapse).

      With respect to the rejection of an application, FINRA is proposing to eliminate the concept of an application that is "not substantially complete" by shifting the focus to whether an application includes the documents or information necessary for the Department to commence a "meaningful review" and deem the application "filed" for purposes of rendering a decision. As described above, under the proposed rule, the Department would have 15 days in which to make this assessment and should the Department determine that the application is deficient, then the applicant would have five business days to cure the deficiency. The applicant's failure to do so would result in a rejection of the application. Should the applicant wish to submit another application, it would be required to start the process anew thereby incurring additional time and expense.

      With respect to a lapsed application, FINRA is proposing to expand the Department's authority to cease reviewing (or lapse) an application where the applicant makes substantial changes to the application well into the review process.81 The proposed amendment would give the Department the authority to stop reviewing an application where the applicant makes substantial changes to it. The proposed expansion of the Department's authority to lapse an application is intended to discourage applicants from trying to manipulate the Department's decision-making process towards approval by presenting insufficient or incomplete information with the application either at the outset of the review process or while it is well underway. Under the proposed amendment, if the Department views the circumstances as potentially causing the application to lapse, then the applicant would have five business days to remedy the situation. The applicant's failure to do so would result in a lapse of the application and should the applicant wish to submit another application, it would be required to start the process anew thereby incurring additional time and expense.

      The aim of these proposed amendments is to provide clarity on the circumstances that may impede the application review process and the consequences of the specified circumstances. While these amendments may result in reduced flexibility and potentially higher initial costs for certain applicants, FINRA believes that overall, these review process safeguards would result in a more efficient and timely process that would ultimately benefit both applicants and the Department in terms of resource allocation. These proposed amendments may also encourage applicants to provide more complete information at the outset of the application review process, which would foster a more efficient MAP process.
      •   Standards for Approval of an Application

      The MAP rules currently set forth 14 standards for admission. FINRA is proposing amendments to the standards that would reduce the total number of standards to 10 by deleting those that are obsolete and redundant, and consolidating closely related standards. The proposed amendments would likely have some economic impact on applicants without adversely affecting investor protection. The consolidation and elimination of standards may reduce the amount of information collected by minimizing the potential for an applicant having to provide duplicative information without reducing the relevant information the Department would need to review the application against the standards. The proposal also provides the applicant an option to identify any standard that it determines is not applicable to the application, along with sufficient justification for this determination. In such situations, if approved, the applicant would benefit from the reduction in information and documentation required for application. In addition, FINRA is proposing to add a new standard that would codify the Department's existing practice to evaluate whether direct and indirect funding sources present any regulatory concerns such as funding that may be derived from a person subject to a statutory disqualification. Given that FINRA has already been requesting this information from submitting firms, this addition should have minimal impact on firms.
      •   Amendments to the Membership Interview Procedures

      The proposed amendments will provide more flexibility in the number, timing and location of interviews that are required throughout the application process. The proposed amendments will further eliminate the tie between the conclusion of the interview and when the decision is due. FINRA believes that this will benefit the applicants in terms of potentially reducing the costs associated with the interview process, without incurring any risks to the investor community.
      4. Proposed Amendments to the MAP Rules Affecting the CMA Process
      •   Waiver of the CMA Filing Requirement

      FINRA is proposing to add a new provision that would describe the circumstances that may qualify for a waiver of the CMA filing requirement (e.g., Form BDW, no material change in the operations of the member firm). The proposed provision would provide examples of scenarios that may qualify for a waiver from filing a CMA and provide clarity on the waiver process, providing firms more clarity regarding the CMA submission process and when a waiver could be appropriately requested. Moreover, the proposed amendments could lead to greater future utilization of the CMA waiver request process, which would reduce the costs and resources firms incur throughout the CMA process without material diminution of investor protections.
      •   Pending Qualifications for Associated Persons

      FINRA is proposing to add a new provision to the MAP rules that would permit the Department, at its discretion, to approve a CMA where one or more Associated Persons have applied for, but not acquired, all licenses and registrations required by federal and state authorities, and SROs, subject to specified conditions.82 This proposed provision would lend members some flexibility in obtaining the requisite licenses and registrations within 90 days of CMA approval.83 However, this proposed new provision could increase risks to investors of utilizing the services of unlicensed or unregistered Associated Persons. Once the CMA is approved, there is risk that the unqualified Associated Persons could act in the capacity of a registered person during the pending period in violation of the proposed provision or that the Associated Persons fail to acquire the necessary licenses and registrations within the 90-day period.
      D. Alternatives Considered

      FINRA considered various suggestions in developing the proposal. The proposal reflects the changes that FINRA believes at this time to be the most appropriate for the reasons discussed herein.
      •   Definition of "Affiliate"

      In Notice 13-29, FINRA had proposed defining, for the first time, the term "Affiliate" to mean: (1) A person that directly or indirectly controls an applicant (excluding natural persons that control an applicant solely in his or her role as a director, general partner, limited liability company, managing member or officer exercising executive responsibility (or having similar status or functions); or (2) An entity that is controlled by, or is under common control with, an applicant.84 FINRA staff has determined to refrain from defining "Affiliate" in this proposal vis-á-vis the proposed definition of "control" and the proposed amendment to the definition of "Associated Person" to exclude a person with a de minimis ownership interest that does not otherwise control the applicant.
      •   Standards for Approval of an Application

      Standard 3 requires that an applicant and its Associated Persons are capable of complying with federal securities laws, the rules and regulations thereunder, and FINRA rules, including observing high standards of commercial honor and just and equitable principles of trade. This standard specifies various factors that the Department must consider to determine whether the applicant and its Associated Persons meet this standard.

      FINRA considered additional factors for the Department to consider including whether the applicant or a percentage of its Associated Persons had a history of sales practice events (as that term is defined under proposed Rule 1111). FINRA staff considered various percentage thresholds for such factor and their respective impact on firms. FINRA staff has determined to refrain from specifying additional factors in Standard 3 pending further development of other separate initiatives to strengthen controls on brokers with a history of significant past misconduct and to ensure greater accountability for firms that choose to employ high-risk brokers, and to incentivize payment of arbitration awards.85

      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.

      1. What are the alternative approaches, other than the proposal, that FINRA should consider?
      2. The proposal seeks to modify the NMA and CMA processes by, among other things, amending definitions and standards for granting or denying an application. Is there any potential uncertainty regarding the proposed definitions?
      3. Do the proposed shortened timelines for different MAP processes, including the Fast Track option, increase the risk that an application is approved when it would not have been under the normal review? If yes, do you believe the higher risk unduly reduces investor protections? If so, are there ways to mitigate these risks?
      4. The proposal allows for the conditional approval of a CMA where one or more Associated Persons have applied for, but not acquired, all required licenses and registrations. Does this conditional approval increase the risk of customer harm either by Associated Persons acting in a registered capacity during the window or by Associated Persons failing to acquire the licenses and registrations within the window? If so, do customers have adequate ability to seek redress? Are there ways to mitigate these risks?
      5. What are the costs and benefits of the proposed provision to provide the Department discretion in lapsing applications, in addition to rejecting applications? What are the investor protection implications?
      6. Are there other costs and benefits associated with the proposal that are not currently captured in the Economic Impact Assessment? If so, what are they? How likely are they to occur? How large or important are these economic impacts? Are there alternative approaches that would mitigate the costs or increase the benefits?

      1. Persons submitting comments are cautioned that FINRA does not redact or edit personal identifying information, such as names or email addresses, from comment 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. An applicant is required to submit its application for new or continuing membership using Form NMA or Form CMA, respectively. FINRA expects to make conforming amendments to the standardized forms.

      4. FINRA has previously sought comment on prior proposals to amend the MAP rules. See Regulatory Notices 10-01 (January 2010) (Notice 10-01) and 13-29 (September 2013) (Notice 13-29). Where applicable, the proposed amendments presented therein that have been carried over into this proposal are noted.

      5. The term "stakeholder" is used to describe those entities, organizations and persons who may be impacted by or otherwise have an interest in the MAP rules and this proposal.

      6. In 2013, the Department launched the MAP Triage Program to speed approval of non-complex applications. Under this program, the Department evaluates applications to determine whether the matter is eligible for expedited (or Fast Track) review, subject to shorter timeframes, or full review, subject to standard timeframes set forth under the MAP rules. During the retrospective review, stakeholders had provided positive feedback on the Fast Track review process, indicating that it effectively reduced processing times for low risk matters. In fact, the Triage Program and the Fast Track process have dramatically reduced processing times for all applications. In 2012, before the existence of the Triage Program and the Fast Track review process, the average processing time for an NMA was 213 days; in 2017, 117 days. For a CMA, the average processingtime in 2012 was 134 days; in 2017, 61 days. In 2017, the average processing time for a CMA that underwent Fast Track review was 34 days. For a materiality consultation, the average processingtime in 2012 was 67 days and in 2017, 11 days.

      7. This definition of "Associated Person" only applies to the MAP rules. For other FINRA rules, the FINRA By-Laws definition of "associated person of a member" applies. FINRA By-Laws Article 1(rr) defines a "person associated with a member" or "associated person of a member" as: "(1) a natural person who is registered or has applied for registration under the Rules of the Corporation; (2) a sole proprietor, partner, officer, director, or branch manager of a member, or other natural person occupying a similar status or performing similar functions, or a natural person engaged in the investment banking or securities business who is directly or indirectly controlling or controlled by a member, whether or not any such person is registered or exempt from registration with the Corporation under these By-Laws or the Rules of the Corporation; and (3) for purposes of Rule 8210, any other person listed in Schedule A of Form BD of a member[.]"

      8. These proposed amendments to the definition remain substantively unchanged from the language presented in Notice 13-29 for public comment.

      9. This term was first presented in Notice 10-01. In response to commenters' concerns, the term was revised and presented in Notice 13-29 for comment. The proposed definition presented herein differs from the definition proposed in Notice 13-29.

      10. See FINRA By-Laws, Art. I(h): "'controlling' shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting stock, by contract or otherwise. A person who is the owner of 20% or more of the outstanding voting stock of any corporation, partnership, unincorporated association or other entity shall be presumed to have control of such entity, in the absence of proof by a preponderance of the evidence to the contrary. Notwithstanding the foregoing, a presumption of control shall not apply where such person holds voting stock, in good faith, as an agent, bank, broker, nominee, custodian or trustee for one or more owners who do not individually or as a group have control of such entity[.]"

      11. Contained within Form BD (Uniform Application For Broker-Dealer Registration) is an "Explanation of Terms," which defines "control" as follows:

      CONTROL—The power, directly or indirectly, to direct the management or policies of a company, whether through ownership of securities, by contract, or otherwise. Any person that (i) is a director, general partner or officer exercising executive responsibility (or having similar status or functions); (ii) directly or indirectly has the right to vote 25% or more of a class of a voting security or has the power to sell or direct the sale of 25% or more of a class of voting securities; or (iii) in the case of a partnership, has the right to receive upon dissolution, or has contributed, 25% or more of the capital, is presumed to control that company. (This definition is used solely for the purpose of Form BD.)

      FINRA notes that the proposed factors establishing the presumption of control are well-established as they appear, in varying degrees of similarity, in other definitions of "control." See, e.g., Form U4's "Explanation of Terms" and the New York Stock Exchange (NYSE) and NYSE American membership application for FINRA member firms.

      12. See also the "Explanation of Terms" for Form BD and Form BR (Uniform Branch Office Registration Form), each defining a "person" to mean "[a]n individual, partnership, corporation, trust, or other organization."

      13. This proposed amendment remains unchanged from the language presented in Notices 10-01 and 13-29 for public comment.

      14. 15 U.S.C. 78c(a)(39).

      15. This update would align with Article IV, Section 1(a) to the FINRA By-Laws which provides, in part, that an "Application for membership in [FINRA], properly signed by the applicant, shall be made to [FINRA] via electronic process or such other process as [FINRA] may prescribe[.]"

      16. See Securities Exchange Act Release No. 43157 (August 15, 2000), 65 FR 51377 (August 23, 2000) (Order Approving File No. SR-NASD-99-67) (stating in part, "if an application is so deficient upon submission that the Department staff cannot begin processing (e.g., it is missing major components of the application, such as written supervisory procedures or a business plan), the Department staff may reject the application.").

      17. The concept of "meaningful review" is not new. See Notice to Members 00-73 (October 2000) (providing, "if an application is so deficient upon initial submission that the staff cannot begin conducting a meaningful review, then the staff may reject the application and deem it to not have been filed."). See also What to Expect After you Apply as a New Broker-Dealer Firm (stating, "[a]n application is considered substantially complete if it provides sufficient information allowing the staff to conduct a meaningful review.").

      18. See NASD Rules 1014(c)(3) and 1017(h)(3).

      19. For example, an applicant may add a business line or change key personnel as the review period is well underway or approaching completion.

      20. See The Membership Interview.

      21. FINRA is proposing to delete subparagraphs (b)(5), (b)(6) and (b)(7) under NASD Rule 1013, which address topics pertaining to financial condition, the standards for admissions and other information, as these provisions would be addressed in the proposed supplementary material.

      22. Rule 1210.01, which becomes effective on October 1, 2018, is the successor to NASD Rule 1021(e). See Securities Exchange Act Release No. 81098 (July 7, 2017), 82 FR 32419 (July 13, 2017) (Order Approving File No. SR-FINRA-2017-007). NASD Rule 1021(e)(1) currently requires that a member (new or existing), except a sole proprietorship, have a minimum of two registered principals with respect to each aspect of the member's investment banking and securities business pursuant to the applicable provisions of NASD Rule 1022. NASD Rule 1021(e)(2) provides that, pursuant to the Rule 9600 Series, FINRA may waive the two-principal requirement in situations that indicate conclusively that only one person associated with an applicant for membership should be required to register as a principal. NASD Rule 1021(e) (3) provides that an applicant for membership, if the nature of its business so requires, must also have a Financial and Operations Principal (or an Introducing Broker-Dealer Financial and Operations Principal) and a Registered Options Principal.

      23. See Standard 2 in Forms NMA and CMA.

      24. See supra note 22. The Rule 9600 Series (Procedures for Exemptions) sets forth the procedures under which a member and its associated person(s) may seek exemptive relief from the rules enumerated in Rule 9610(a). Among those rules is NASD Rule 1021, which governs qualification examinations and waiver of requirements. Under Rule 9610, a member seeking relief from NASD Rule 1021 (or Rule 1210, effective on October 1, 2018) outside of the new or continuing membership process, is required to file a written application with the appropriate department or staff of FINRA. Such application must contain the information specified under Rule 9610(b).

      25. Forms NMA and CMA direct the applicant to provide a detailed explanation that demonstrates the reason(s)for the exemption and a contingency plan for situations where the sole General Securities Principal becomes unavailable to carry out his or her responsibilities. The Forms include a place for an applicant to indicate whether it is seeking a waiver or seeking to maintain a waiver already in place of the two-principal requirement under NASD Rule 1021, the predecessor to Rule 1210.01.

      26. The proposed rule would retain the language specifying that NYSE and NYSE American member organizations would be subject to the FINRA By-Laws and Schedules to the By-Laws, including Schedule A, the consolidated FINRA rules and the NYSE rules incorporated by FINRA, provided that their respective securities businesses are limited to floor-based activities, or routing away to other markets orders that were ancillary to their core NYSE or NYSE American floor business under NYSE Rule 70.40 or NYSE American Equities Rule 70.40, as applicable.

      27. This proposed amendment remains substantively unchanged from the language presented in Notice 13-29 for public comment.

      28. NASD Rule 1013(a)(1) sets forth a detailed list of items that must be submitted with an NMA. These items include: Form NMA; Form BD; a fingerprint card; a new member assessment report; a business plan; list of Associated Persons; documentation of disciplinary history and certain regulatory, civil, and criminal actions, arbitrations, and customer complaints for the applicant and its Associated Persons; a description of remedial action or heightened supervision imposed on an Associated Person by a state or federal authority or SRO; a written acknowledgment that heightened supervisory procedures may be required for Associated Persons whose records reflect disciplinary actions or sales practice events; a copy of proposed or final contracts with banks, clearing entities, and service bureaus; a description of the nature and source of the applicant's capital; a description of financial controls; a description of the applicant's supervisory system; a description of the number, experience, and qualifications of supervisory personnel; a description of the proposed recordkeeping system; a copy of the applicant's written training plan; and FINRA entitlement forms. Many of these items are duplicated, in varying degrees, in the standards themselves or are referenced in the NMA (or Form NMA) itself.

      29. The actions specified in proposed Rule 1123(a) are also set forth in guidance posted on FINRA. org. As set forth on the website, these actions are subject to review and processing by FINRA's Registration and Disclosure Department. See How to Apply as a New Broker-Dealer Firm.

      30. The proposal to delete the specific items to accompany an application is not without precedent. During the effort to adopt Form CMA, the SEC approved amendments to NASD Rule 1017(b) to delete references to the specific items to accompany a CMA. See Securities Exchange Act Release No. 67082 (May 31, 2012), 77 FR 33539 (June 6, 2012) (Notice of Filing of Amendment No. 1 and Order Approving File No. SR-FINRA-2012-018) (deleting references to a business plan, pro forma financials, organization chart and written supervisory procedures as they would be included as part of Form CMA).

      31. See, e.g., Rule 1017(b)(2)(A) (providing that an application for approval of a change in ownership or control must include "the names of the new owners, their percentage of ownership, and the sources of their funding for the purchase and recapitalization of the member.").

      32. This proposed amendment remains substantively unchanged from the language presented in Notices 10-01 and 13-29 for public comment.

      33. As a result of this integration, NASD Rule 1017(b) would be deleted in its entirety. FINRA intends to amend Form CMA to conform to the requirements specified under this provision.

      34. See paragraphs (a)(1) through (a)(5), paragraphs (b)(2)(B) and (C), and paragraph (k) of NASD Rule 1017.

      35. FINRA is also proposing to adjust the unit of measure used to review an acquisition, and divestiture or transfer from a rolling 36-month basis to a three-year period immediate preceding the event.

      36. This proposed amendment remains substantively unchanged from the language presented in Notices 10-01 and 13-29 for public comment.

      37. This proposed provision remains substantively unchanged from the language presented in Notice 13-29 for public comment.

      38. In Notice 10-01, FINRA had proposed supplementing the term, "material change in business operations," to include "settling or clearing transactions for the Applicant's own business for the first time, settling or clearing transactions for other broker-dealers forthe first time, carrying accounts of customers for the first time, or any change in exemptive status claimed under paragraph (k) of SEA Rule 15c3-3." In Notice 13-29, FINRA had proposed supplementing this term to also include variable life settlement sales to retail customers and retail foreign currency exchange activities consistent with existing guidance. See Regulatory Notice 09-42 (July 2009) (stating, "firms should be aware that expansion into business activities related to variable life settlements constitutes a material change in business operations under NASD Rule 1011(k). Therefore, before engaging in variable life settlements, a firm must first file a [CMA] and receive approval of this change in business operations under NASD Rule 1017."); and Regulatory Notice 08-66 (November 2008) (stating, "firms should also be aware that expansion into retail forex constitutes a material change in business operations under NASD Rule [1011(k)]. Therefore, before engaging in over-the-counter forex business, a firm must first file for and receive approval of change in business operations under NASD Rule 1017."). However, FINRA believes that these activities, among others, would be better addressed in the materiality consultation process described below.

      39. FINRA is proposing to delete NASD Rule 3140 in its entirety.

      40. The removal or modification of a membership agreement restriction is also addressed in other paragraphs under NASD Rule 1017. FINRA is proposing to integrate these provisions under proposed Rule 1131(b). See NASD Rule 1017(b) (2)(B) (indicating that an application requesting the removal or modification of a membership agreement restriction must present facts showing that the circumstances that gave rise to the restriction have changed and state with specificity why the restriction should be modified or removed in light of the standards set forth in NASD Rule 1014 and the articulated rationale for the imposition of the restriction); NASD Rule 1017(c)(2) (providing, in part, that "[a] member may file an application to remove or modify a membership agreement restriction at any time."); and NASD Rule 1017(k) (permitting the Department to modify or remove a restriction on its own initiative).

      41. The concept of waiving the CMA filing requirement was presented in Notice 10-01 for public comment. In response to comments, FINRA made some adjustments to the original proposal, which were presented in Notice 13-29. Among the changes was to add another circumstance that may qualify for a waiver of the CMA filing requirement. Upon the member's written request, the Department would consider waiving the CMA filing requirement for a member that was proposing a change in the "percentage of ownership interest, [limited liability company] membership interest, or partnership capital of an Applicant's existing owners or partners resulting in an existing owner or partner owning or controlling 25 percent or more of the ownership interest or partnership and that owner or partner [had] no disclosure or disciplinary issues in the preceding five years." After further consideration, FINRA has found that in practice, this circumstance would require a CMA because such change has raised issues concerning, for example, registration and qualification of that existing owner or partner now owning or controlling 25 percent or more of the ownership interest.

      42. As described below, FINRA is proposing to delete Sections 4(i)(3)(A)(i) and (ii) of Schedule A to the FINRA By-Laws.

      43. See Overview of Materiality Consultation Process. See also Notice to Members 00-73 (October 2000) (stating, in the context of determining whether, based upon all the facts and circumstances, a change that falls outside of the safe harbor limits is material, "[a] member may, but is not required to, contact the District Office to obtain guidance on this issue.") and NASD IM-1011 (stating, "[f]or any expansion beyond these [safe harbor] limits, a member should contact its district office prior to implementing the change to determine whether the proposed expansion requires an application under Rule 1017.").

      44. In separate proposals, FINRA is proposing to mandate materiality consultations under additional circumstances. See Regulatory Notice 18-06 (February 8, 2018) (requesting comment on proposed amendments to the MAP rules to incentivize payment of arbitration awards); and Regulatory Notice 18-16 (April 30, 2018) (requesting comment on proposed rule amendments relating to high-risk brokers and the firms that employ them).

      45. See supra note 38.

      46. NASD IM-1011-1 defines "Associated Persons involved in sales" to include all associated persons, "whether or not registered, who are involved in sales activities with public customers, including sales assistants and cold callers, but excludes clerical, back office, and trading personnel who are not involved in sales activities." FINRA is proposing to redesignate this defined term, with non-substantive changes, to proposed Rule 1111.

      47. For purposes of NASD IM-1011-1, "disciplinary history" means "a finding of a violation by the member or a principal of the member in the past five years by the Securities and Exchange Commission, a self-regulatory organization, or a foreign financial regulatory authority of one or more of the following provisions (or a comparable foreign provision) or rules or regulations thereunder: violations of the types enumerated in Section 15(b)(4)(E) of the Securities Exchange Act of 1934; Section 15(c) of the Securities Exchange Act of 1934; Section 17(a) of the Securities Act of 1933; SEC Rules 10b-5 and 15g-1 through 15g-9; NASD Rules 2110 (only if the finding of a violation is for unauthorized trading, churning, conversion, material misrepresentations or omissions to a customer, front-running, trading ahead of research reports or excessive markups), 2120, 2310, 2330, 2440, 3010 (failure to supervise only), 3310, and 3330; and MSRB Rules G-19, G-30, and G-37(b) & (c)."

      48. The term "disciplinary history" would undergo technical changes to update rule cross-references.

      49. This proposed amendment to the unit of measure would align with the methodology under NASD Rule 1017(b)(2)(C) (providing, "[i]f the application requests approval of an increase in Associated Persons involved in sales, offices, or markets made, the application shall set forth the increases in such areas during the preceding 12 months.").

      50. This proposed amendment remains substantively unchanged from the language presented in Notice 13-29 for public comment.

      51. See NASD Rules 1014(a) and 1017(h).

      52. The concept underlying the proposed amendment was presented in Notices 10-01 and 13-29 for public comment.

      53. This proposed amendment remains unchanged from the language presented in Notices 10-01 and 13-29 for public comment.

      54. The proposed amendment concerning fees remains unchanged from the language presented in Notices 10-01 and 13-29 for public comment.

      55. This proposed amendment remains substantively unchanged from the language presented in Notices 10-01 and 13-29 for public comment.

      56. This proposed amendment remains substantively unchanged from the language presented in Notices 10-01 and 13-29 for public comment.

      57. In Notices 10-01 and 13-29, FINRA proposed to delete Standard 9.

      58. This proposed amendment remains unchanged from the language presented in Notice 13-29 for public comment.

      59. See Regulatory Notice 18-15 (Guidance on Implementing Effective Heightened Supervisory Procedures for Associated Persons with a History of Past Misconduct) (April 30, 2018).

      60. This proposed new standard was previously presented in Notices 10-01 and 13-29 for public comment. The proposed new standard was presented in Notice 13-29 as "[t]he Applicant has fully disclosed and established through documentation satisfactory to FINRA all direct and indirect sources of its funding, and FINRA has determined that such sources of funding are otherwise consistent with the standards set forth in this Rule." The proposed language herein is consistent with Funding Portal Rule 110(a)(10)(D) (providing, "[t]he FP Applicant has fully disclosed and established through documentation all direct and indirect sources of funding.").

      61. See NASD Rule 1014(a)(3)(A), (C), (D) and (E).

      62. In a separate proposal, FINRA is proposing to amend NASD Rules 1014(a) and (b) to specify that a presumption of denial would exist if a new member applicant or its Associated Persons are subject to pending arbitration claims. This presumption of denial for pending arbitration claims would not apply to a continuing membership applicant. See Regulatory Notice 18-06 (February 8, 2018) (requesting comment on proposed amendments to the MAP rules to incentivize payment of arbitration awards).

      63. Currently, this obligation is set forth under NASD Rules 1014(c)(1) and 1017(h)(2).

      64. Most notably, FINRA is proposing to replace "review" with "appeal" to more accurately align with that term as it is used in the Rule 9300 Series (Review of Disciplinary Proceeding by National Adjudicatory Council and FINRA Board; Application for SEC Review). FINRA is also proposing to delete NASD Rule 1015(c), which pertains to the use of a membership application docket because the Department no longer maintains such a docket.

      65. These proposed provisions are derived, in part, from paragraphs (a), (b), and (f) of Rule 9311 (Appeal by Any Party; Cross-Appeal), which pertain to the time to file a notice of appeal, the effect of an appeal, and the withdrawal of a notice of appeal.

      66. These proposed provisions are derived, in part, from paragraph (a) of Rule 9235 (Hearing Officer Authority) and paragraph (a) of Rule 9322 (Extensions of Time, Postponements, Adjournments).

      67. This provision is akin to paragraphs (a) and (b) under Rule 9160 (Recusal or Disqualification).

      68. These proposed provisions are derived, in part, from paragraphs (a) and (b) under Rule 9233 (Hearing Panel or Extended Hearing Panel: Recusal and Disqualification of Hearing Officers), which sets forth the process for a party to move for disqualification of a hearing officer.

      69. NASD Rule 1015(f)(3) also expressly provides that the formal rules of evidence do not apply to MAP appeals. As described below, FINRA is proposing to redesignate the reference to the applicability of the formal rules of evidence to proposed Rule 1165 (Hearing).

      70. The extended timeframe is derived from paragraph (d) under Rule 9251 (Inspection and Copying of Documents in Possession of Staff), which requires production of documentation to occur not later than 21 days after service of a respondent's answer to a complaint filed by FINRA in connection with a disciplinary proceeding. This 21-day timeframe relating to the production of documents is also present under other rules within the Rule 9000 Series such as Rules 9252 (Requests for Information), 9264 (Motion for Summary Disposition), and 9347 (Filing of Papers in National Adjudicatory Council Proceedings).

      71. This provision is derived from subparagraph (a)(5) of Rule 9242 (Pre-hearing Submission).

      72. The proposed criteria are derived from Rule 9263 (Evidence: Admissibility).

      73. The proposed provision is derived from Rule 9262 (Testimony).

      74. FINRA is proposing to redesignate paragraphs (j)(1), (j)(3), and (j)(4) under NASD Rule 1015 to proposed Rule 1166 with no material changes.

      75. The proposed change would also align with Rule 9349 (National Adjudicatory Council Formal Consideration; Decision).

      76. A small firm has at least one and no more than 150 registered persons; a mid-size firm has at least 151 and no more than 499 registered persons; and a large firm has 500 or more registered persons. See Article I of the FINRA By-Laws (defining the terms, "Small Firm," "Mid-Size Firm," and "Large Firm").

      77. See Retrospective Rule Review Report—Membership Application Rules and Processes (March 2016).

      78. See supra note 43 and the accompanying text.

      79. See supra notes 38 and 44, and the accompanying text.

      80. The term "control" is also defined in other FINRA rules. See, e.g., Rules 2360 (Options), 5121 (Public Offerings of Securities with Conflicts of Interest), 5122 (Private Placements of Securities Issued by Members), and 6710 (Definitions).

      81. See supra notes 18 and 19, and the accompanying text.

      82. The conditions would include that all Associated Persons must acquire their required licenses and registrations within 90 days of the date of approval of the CMA; the applicant promptly notifies the Department when such licenses and registrations are acquired; the applicant does not engage in business activities that require a license or registration that has not been acquired; and if all required licenses and registrations are not acquired within the 90-day timeframe, the applicant must cease business operations until all such licenses and registrations have been acquired.

      83. This proposed provision would not apply to an applicant for new membership.

      84. FINRA had also previously proposed defining "affiliate," in slightly different terms, in Notice 10-01.

      85. See Regulatory Notice 18-06 (February 8, 2018) (requesting comment on proposed amendments to the MAP rules to incentivize payment of arbitration awards), and Regulatory Notice 18-16 (April 30, 2018) (requesting comment on proposed rule amendments relating to high-risk brokers and the firms that employ them).


      Attachment A

      The chart below compares the existing NASD rule numbers against the proposed FINRA rule numbering convention for the MAP rules.

      Current NASD Rules Proposed FINRA Rules
      1000. MEMBERSHIP AND REGISTRATION RULES
      1000. MEMBER APPLICATION AND ASSOCIATED PERSON REGISTRATION
         
       
      1100. NEW AND CONTINUING MEMBERSHIP
         
      1010. MEMBERSHIP PROCEEDINGS
      1110. GENERAL PROVISIONS
       
      1011. Definitions
      1111. Definitions
      1011(a) "Applicant" 1111(a) "Applicant"
      1011(b) "Associated Person" 1111(b) "Application"
      1011(c) "Department" 1111(c) "Associated Person"
      1011(d) "Director" 1111(d) "Associated Person Involved in Sales"
      1011e) "district" 1111(e) "Control"
      1011(f) "district office" 1111(f) "Day"
      1011(g) "FINRA Board" 1111(g) "Department"
      1011(h) "FINRA Regulation Board" 1111(h) "Director"
      1011(i) "Governor" 1111(i) "Disciplinary History"
      1011(j) "Interested FINRA Staff" 1111(j) "District"
      1011(k) "material change in business operations" 1111(k) "District Office"
      1011(l) "principal place of business" 1111(l) "FINRA Board"
      1011(m) "sales practice event" 1111(m) "FINRA Regulation Board"
      1011(n) "Subcommittee" 1111(n) "Governor"
        1111(o) "Interested FINRA Staff"
        1111(p) "Principal Place of Business"
        1111(q) "Sales Practice Event"
        1111(r) "Subcommittee"
         
      IM-1011-1. Safe Harbor for Business Expansions  
         
      1012. General Provisions
      1112. General Procedures
      1012(a) Filing by Applicant or Service by FINRA 1112(a) Filing and Service; Timing
      1012(b) Lapse of Application 1112(b) Rejection of Application Following Department's Initial Assessment
      1012(c) Ex Parte Communications 1112(c) Request for Additional Documents or Information
      1012(d) Recusal or Disqualification 1112(d) Lapse of Application
      1012(e) Computation of Time 1112(e) Withdrawal of Application
      1012(e)(1) Calendar Day 1112(f) Membership Interview
      1012(e)(2) Formula 1112(f)(1) New Membership Interview Mandatory
        1112(f)(2) Continuing Membership Interview Discretionary
        1112(f)(3) Service of Notice of Membership Interview; Where Held
        1112(f)(3)(A) Service of Notice of Membership Interview
        1112(f)(3)(B) Where Held
        • • • Supplementary Material:------------------
      •   1112.01. Initial Assessment by Department
      •   1112.02. Department Decision to Expedite Review
      •   1112.03. Membership Interview
      •   1112.04. Waiver of Two-Principal Requirement
      (a) Department Review
      (b) Department Decision
         
       
      1113. Restrictions Pertaining to New Member Applications1
         
       
      1114. Filing of Misleading Information as to Membership or Registration2
         
       
      1120. NEW MEMBERSHIP3
         
      IM-1013-1. Membership Waive-In Process for Certain New York Stock Exchange Member Organizations

      IM-1013-2. Membership Waive-In Process for Certain NYSE Alternext US LLC Member Organizations
      1121. Membership Waive-In
         
      1090. Foreign Members
      1122. Foreign Members
         
      1013. New Member Application and Interview
      1123. New Membership Application Process
      1013(a) Filing of Application 1123(a) General
      1013(a)(1) How to File 1123(b) New Membership Application (Form NMA)
      1013(a)(2) Uniform Registration Forms  
      1013(a)(3) Rejection of Application That Is Not Substantially Complete  
      1013(a)(4) Request For Additional Documents or Information  
      1013(a)(5) Withdrawal of Application  
      1013(b) Membership Interview  
      1013(b)(1) Requirement for Interview  
      1013(b)(2) Service of Notice  
      1013(b)(3) Time  
      1013(b)(4) Place  
      1013(b)(5) Updated Financial Documents  
      1013(b)(6) Review Standards for Admission  
      1013(b)(7) Information from Other Sources  
         
       
      1130. CONTINUING MEMBERSHIP
         
      1017. Application for Approval of Change in Ownership, Control, or Business Operations
      1131. Continuing Membership Application Process
      1017(a) Events Requiring Application 1131(a) Continuing Membership Application (Form CMA)
      1017(a)(1)—merger 1131(b) Events Requiring Form CMA and Department Approval
      1017(a)(2)—acquisition 1131(b)(1) Merger
      1017(a)(3)—acquisition or transfer of 25% or more 1131(b)(2) Acquisition
      1017(a)(4)—change in equity ownership or partnership capital 1131(b)(3) Divestiture or Transfer
      1017(a)(5)—material change in business operations 1131(b)(4) Change in Capital Structure
      1017(b) Filing and Content of Application 1131(b)(5) Change in Control Person
      1017(c) Effecting Change and Imposition of Interim Restrictions 1131(b)(6) Business Expansion
      1017(d) Rejection of Application That Is Not Substantially Complete 1131(b)(7) Material Change in Business Operations
      1017(e) Request for Additional Documents and Information 1131(b)(8) Removal or Modification of Restriction in Membership Agreement
      1017(f) Withdrawal of Application 1131(b)(8)(A) Applicant's Initiative
      1017(g) Membership Interview 1131(b)(8)(B) Department's Initiative
      1017(h) Department Decision  
      1017(i) Service and Effectiveness of Decision  
      1017(j) Request for Review; Final Action  
      1017(k) Removal or Modification of Restriction on Department's Initiative  
      1017(l) Lapse or Denial of Application for Approval of Change in Ownership  
        • • • Supplementary Material:------------------
      •   1131.01. Permissible Events for Form CMA Waiver
         
       
      1132. Materiality Consultation
        1132(a) When Required
        1132(b) Content of Request for Materiality Consultation
        1132(c) Department Review
         
       
      1133. Safe Harbor from the CMA Process
        1133(a) General
        1133(b) Permissible Events for Safe Harbor
        1133(b)(1) Number of Associated Persons Involved in Sales
        1133(b)(2) Number of Offices or Locations (Registered or Unregistered)
        1133(b)(3) Number of Markets Made
        1133(c) Exclusions from Safe Harbor
         
       
      1140. STANDARDS FOR APPROVAL OF APPLICATION
       
       
      1141. General Provisions
         
      1014(a) Standards for Admission
      1142. Standards
      1014(a)(1)—complete and accurate application [or overview of applicant] 1142(a) Complete and Accurate Application
      1014(a)(2)—licenses and registrations 1142(b) Licenses and Registrations, and Continuing Education
      - 1142(c) Source of Funding
      1014(a)(3)—compliance with securities laws, and just and equitable principles of trade 1142(d) Compliance with Securities Laws, and Just and Equitable Principles of Trade
      1014(a)(4)—contractual and business relationships 1142(e) Contractual and Business Relationships
      1014(a)(5)—facilities -
      1014(a)(6)—communications and operational systems 1142(f) Communications and Operational Systems
      1014(a)(7)—net capital 1142(g) Financial and Operational Controls; Capital
      1014(a)(8)—financial controls -
      1014(a)(9)—control mechanisms consistent with industry practices -
      1014(a)(10)—supervisory system 1142(h) Supervisory System
      1014(a)(11)—recordkeeping system 1142(i) Recordkeeping System
      1014(a)(12)—continuing education -
      1014(a)(13)—other information possessed by FINRA 1142(j) Other Information Possessed by FINRA
      1014(a)(14)—consistency with federal securities laws -
        • • • Supplementary Material:------------------
      •   1142.01. Pending Qualifications for Associated Persons
         
      1014. Department Decision
      1150. DEPARTMENT DECISION
      1014(a) Standards for Admission
      1151. Timing of Decision
      1014(b) Granting or Denying Application
      1152. Department Decision on the Application
      1014(c) Decision 1152(a) Granting or Denying the Application
      1014(c)(1) Time 1152(b) Effectiveness of Restriction
      1014(c)(2) Content 1152(c) Presumption to Deny the Application
      1014(c)(3) Failure to Serve Decision
      1153. Content of Decision
      1014(d) Submission of Membership Agreement
      1154. Submission of Executed Written Membership Agreement
      1014(e) Service and Effectiveness of Decision
      1155. Service and Effectiveness of Decision; Final Action
      1014(f) Effectiveness of Restriction 1155(a) Service and Effectiveness of Decision
      1014(g) Final Action 1155(b) Final Action
         
       
      1160. REVIEW OF DEPARTMENT DECISION
         
       
      1161. Ex Parte Communications
        1161(a) Prohibited Communications
        1161(b) Disclosure of Prohibited Communications
         
      1015. Review by National Adjudicatory Council
      1162. Appeal to the National Adjudicatory Council
      1015(a) Initiation of Review by Applicant 1162(a) Time to File Notice of Appeal
      1015(b) Transmission of Documents 1162(b) Where to File Notice of Appeal; Methods of Service
      1015(c) Membership Application Docket 1162(c) Effect
      1015(d) Appointment of Subcommittee 1162(d) Content of Notice of Appeal
      1015(e) Powers of Subcommittee 1162(e) Withdrawal of Notice of Appeal
      1015(f) Hearing 1162(f) Abandonment of Appeal
      1015(f)(1) Notice  
      1015(f)(2) Counsel  
      1015(f)(3) Evidence  
      1015(f)(4) Transcript  
      1015(g) Additional Information, Briefs  
      1015(h) Abandonment of Request for Review  
      1015(i) Subcommittee Recommendation  
      1015(j) Decision  
      1015(j)(1) Proposed Written Decision  
      1015(j)(2) Contents  
      1015(j)(3) Issuance of Decision After Expiration of Call for Review Periods  
      1015(j)(4) Failure to Issue Decision  
         
       
      1163. Appointment and Powers of Subcommittee; Recusal and Disqualification, or Withdrawal
        1163(a) Appointment of Subcommittee by National Adjudicatory Council
        1163(b) Powers of Subcommittee
        1163(b)(1) General
        1163(b)(2) Scheduling Conference
        1163(b)(3) Function
        1163(b)(4) Additional Information, Briefs
        1163(c) Recusal and Disqualification, or Withdrawal
        1163(c)(1) Recusal and Disqualification
        1163(c)(1)(A) FINRA Board
        1163(c)(1)(B) National Adjudicatory Council
        1163(c)(1)(C) Motion for Disqualification
        1163(c)(2) Withdrawal
         
       
      1164. Transmission of Record, Exhibit and Witness Lists; Withheld Documents
        1164(a) Transmission of Record
        1164(b) Exhibit and Witness Lists
        1164(c) Withheld Documents
        1164(d) Withheld Document List
         
       
      1165. Hearing
        1165(a) When Held; Notice
        1165(b) Counsel
        1165(c) Evidence
        1165(d) Testimony
        1165(e) Transcript
         
       
      1166. Recommended Decision of Subcommittee and Decision of National Adjudicatory Council
        1166(a) Recommended Decision of Subcommittee
        1166(b) Decision of National Adjudicatory Council
        1166(b)(1) Decision
        1166(b)(2) Contents of Decision
        1166(b)(3) Issuance of Decision After Expiration of Call for Review Period
        1166(b)(4) Failure to Issue Decision
         
      1016. Discretionary Review by FINRA Board
      1167. Discretionary Review by FINRA Board
      1016(a) Call For Review By Governor 1167(a) Call for Review by Governor
      1016(b) 15 Day Period; Waiver 1167(b) 15-Day Period; Waiver
      1016(c) Review At Next Meeting 1167(c) Review at Next Meeting
      1016(d) Decision of FINRA Board, Including Remand 1167(d) Decision of FINRA Board, Including Remand
      1016(e) Issuance of Decision 1167(e) Issuance of Decision
         
      1019. Application to Commission for Review
      1168. Application to SEC for Review
         

      1 Not yet effective.

      2 Current FINRA rule number is 1122.

      3 Current FINRA rule title is Member Application Process.


      Attachment B

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

      * * * * *

      Text of Proposed FINRA Rules

      (Marked to Show Changes from NASD Rules 1011, IM-1011-1, 1012, 1013, IM-1013-1, IM-1013-2, 1014, 1015, 1016, 1017, 1019, 1090; NASD Rules 1011, IM-1011-1, 1012, 1013, IM-1013-1, IM-1013-2, 1014, 1015, 1016, 1017, 1019, 1090 to be Deleted in their Entirety from the Transitional Rulebook

      * * * * *

      1000. MEMBER APPLICATION AND ASSOCIATED PERSON REGISTRATION

      * * * * *

      1100. NEW AND CONTINUING MEMBERSHIP [APPLICATION]

      * * * * *

      1110. General Provisions

      * * * * *

      [1010. Membership Proceedings]

      * * * * *

      [1011]1111. Definitions

      Unless otherwise provided, terms used in the Rule [10101]1100 Series shall have the meaning as defined in Rules [0120]0160 and 9120. References within the Rule 1100 Series to FINRA offices or departments refer to offices so designated by FINRA or FINRA Regulation.
      (a) "Applicant"

      The term "Applicant" means a person that applies for approval of new FINRA membership [in FINRA] under Rule [1013]1123 or a member that [fileslapplies for approval of a[n] continuing membership application [for approval of a change in ownership, control, or business operations] under Rule [1017]1131. An Applicant may also be referred to as a "member" in the context of the Rule 1100 Series.
      (b) "Application"

      The term "Application" means a new membership application (or Form NMA) filed under Rule 1123, or a continuing membership application (or Form CM A) filed under the Rule 1130 Series, as applicable, including all information and documents reguested therein and as otherwise specified in the Rule 1100 Series.
      [(b)](c) "Associated Person"
      (1) The term "Associated Person" means:
      [(1)](A) a natural person registered under [NASD]FINRA [R]rules; [or]
      [(2)](B) a sole proprietor, [or any] partner, officer, member of a limited liability company, director, or branch manager of the Applicant, or any person occupying a similar status or performing similar functions;
      (C) any employee of the Applicant, except any person whose functions are solely clerical or ministerial;
      [(3)](D) any company, government or political subdivision or agency or instrumentality of a government controlling or controlled by [or controlling] the Applicant;
      [(4) any employee of the Applicant, except any person whose functions are solely clerical or ministerial;]
      [(5)](E) any person directly or indirectly controlling the Applicant whether or not such person is registered or exempt from registration under the FINRA By-Laws or [NASD]FINRA [R]rules;
      [(6)](F) any person engaged in investment banking or securities business controlled directly or indirectly by the Applicant whether such person is registered or exempt from registration under the FINRA By-Laws or [NASD1FINRA [R]rules; or
      [(7)](G) any person who will be or is anticipated to be a person described in subparagraphs (A) through (F) above.
      (2) The term "Associated Person" in this paragraph excludes any person with a de minimis ownership interest of less than 10 percent in a partnership, corporation, association or other legal entity, unless that person is entitled under the legal entity's constituent documents to 10 percent or more of the legal entity's profits or distributions or otherwise controls the Applicant.
      [IM-1011-1](d) "Associated Person Involved in Sales"

      The term "Associated Person involved in sales" includes [all]any Associated Person[s], [whether or not] registered or unregistered, who [are]is involved in sales activities with public customers, including functioning as a sales assistants] and cold caller[s], but [excludeslexcluding an Associated Person whose function is solely clerical [back office,] or ministerial, and [trading] other personnel who are not involved in sales activities.
      (e) "Control"
      (1) The term "control" (including the terms "controlling" or "controlled by") means the possession, direct or indirect, of the power or ability to direct or cause the direction of the management or policies of a person, whether through ownership of voting securities, by contract, or otherwise.
      (2) A person shall be presumed to control another person if such person, directly or indirectly (ownership interest of less than 25 percent will not preclude aggregation):
      (A) is a director, general partner, managing member, officer or principal exercising executive responsibility (or person occupying a similar status or performing similar functions) of the other person;
      (B) has the right to vote 25 percent or more of a class of voting securities;
      (C) has the power to sell or direct the sale of 25 percent or more of a class of voting securities;
      (D) is entitled to receive 25 percent or more of the profits; or
      (E) in the case of a partnership or limited liability company, has the right to receive upon dissolution, or has contributed, 25 percent or more of the capital.
      (3) Control, presumed by one or more of the above powers, abilities or circumstances may be rebutted by proving that the factor does not exist or by showing other factors that negate the presumption of control. The presumption of control shall not apply where such person holds voting securities of the Applicant, in good faith, as an agent, bank, broker, nominee, custodian or trustee for one or more owners who do not individually or as a group have control of such entity.
      [1012(e)](f) [Computation of Time]"Day"
      [(1) Calendar Day]

      [In the Rule 1010 Series,]The term "day" means calendar day.
      [(2) Formula]

      In [computing] calculating a period of time under the Rule [1010]1100 Series, the day of the act[,] [event, default, or lapse] from which the period of time designated begins to run shall not be included[.]; provided, however, that where [T]the last day of the period so [computed]calculated [shall be included unless it] is a Saturday, Sunday[,] or [Federal holiday, in which event the period runs until the end of the next day that is not a Saturday, Sunday, or Federal holiday. Intermediate Saturdays, Sundays, and Federal holidays shall be excluded from the computation when the period prescribed is ten days or less]a day on which FINRA is otherwise closed, the period shall run until the end of the next business day.
      [(c)](g) "Department"

      The term "Department" means the Department of Member Regulation of FINRA.
      [(d)](h) "Director"

      The term "Director" means a member of the FINRA Regulation Board.
      (i) "Disciplinary History"

      The [safe harbor is not available to any member that has disciplinary history. For purposes of this Interpretation,] term "disciplinary history" means a finding of a violation by the member or a principal of the member with in the past five years by the [Securities and Exchange Commission]SEC, a self-regulatory organization, or a foreign financial regulatory authority [of] involving one or more of the following provisions (or [a] comparable foreign provisions) or rules or regulations thereunder:
      (1) [v]Violations of the types enumerated in; Sections 15(b)(4)(E) and [Section] 15(c) of the [Securities] Exchange Act [of 1934]; Section 17(a) of the Securities Act [of 1933]; SE[C]A Rules 10b-5 and 15g-1 through 15g-9;
      (2) Violations of the following [NASD]FINRA [R]rules and all predecessor NASD rules to such FINRA rules:
      (A) Rule [2110]2010 (Standards of Commercial Honor and Principles of Trade) (only if the finding of a violation is for unauthorized trading, churning, conversion, material misrepresentations or omissions to a customer, front[-] running, trading ahead of research reports or excessive markups)[,];
      (B) Rule [2120]2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices)[,1;
      (C) Rule [2310]2110 (Suitability)[,];
      (D) Rule 2121 (Fair Prices and Commissions);
      (E) Rules [2330]2150 (Improper Use of Customers' Securities or Funds; Prohibition Against Guarantees and Sharing in Accounts) and 4330 (Customer Protection—Permissible Use of Customers' Securities)[,] [2440,];
      (F) Rule [3010]3110 (Supervision) (only if the finding of a violation is for failure to supervise [only])[,];
      (G) Rule [3310]5210 (Publication of Transactions and Quotations)[,]; [and]
      (H) Rule [3330]5230 (Payments Involving Publications that Influence the Market Price of a Security);
      (I) Rule 5280 (Trading Ahead of Research Reports); and
      (3) Violations of MSRB Rules G-19 (Suitability of Recommendations and Transactions), G-30 (Prices and Commissions), and paragraphs (b) and (c) under G-37[(b)] (Political Contributions and Prohibitions on Municipal Securities Business and Municipal Advisory Business) [&(c)].
      [(e)](j) "[d]District"

      The term "district" means a district established by the FINRA Regulation Board.
      [(f)](k) "[d]District [o]Office"

      The term "district office" means an office of FINRA located in a district.
      [(g)](l) "FINRA Board"

      The term "FINRA Board" means the Board of Governors of FINRA.
      [(h)](m) "FINRA Regulation Board"

      The term "FINRA Regulation Board" means the Board of Directors of FINRA Regulation.
      [(i)](n) "Governor"

      The term "Governor" means a member of the FINRA Board.
      [(j)](o) "Interested FINRA Staff"

      The term "Interested FINRA Staff" means
      (1) The Executive Vice President of the Department;
      (2) [a]An employee of the Department who directly participates in a decision under the Rule [1014 or 101711150 Series[,];
      (3) [a]An employee of the Department who directly supervises an employee with respect to such decision[,];
      (4) [a]An employee of the Department who conducted an examination or investigation [or examination of a member that files an application under Rule 1017,]of an Applicant; and
      (5) [t]The District Director for the relevant district [,] [and the head of the Department].
      [(k) "material change in business operations" redesignated to paragraph (b) under proposed Rule 1131]
      [(l)](p ) "[p]Principal [p]Place of [b]Business"

      The term "principal place of business" means the executive office from which the sole proprietor or the officers, partners, managing members, or other managers of the Applicant direct, control, and coordinate the activities of the Applicant, unless the Department determines that the principal place of business is where:
      (1) the largest number of Associated Persons of the Applicant are located; or
      (2) the books and records necessary to provide information and data to operate the business and comply with applicable rules are located.
      [(m)](q) "[s]Sales [p]Practice [e]Event"

      The term "sales practice event" means any customer complaint, arbitration, "statutory disgualification" as defined in Section 3(a)(39) of the Exchange Act, or civil litigation that has been reported to the Central Registration Depository, currently is required to be reported to the Central Registration Depository, or otherwise has been reported to FINRA.
      [(n)](r) "Subcommittee"

      The term "Subcommittee" means [a subcommittee of]an Adjudicator (as that term is defined in Rule 9120) that is appointed by the National Adjudicatory Council [that is constituted pursuant to Rule 1015] to [conduct]participate in [a review]an appeal of a Department decision issued under the Rule [1010]1100 Series. A Subcommittee shall be composed of two or more persons who shall be current or former members of the National Adjudicatory Council or former Directors or Governors.

      * * * * *

      [IM-1011-1. Safe Harbor for Business Expansions]

      [This interpretive material concerns the types of business expansions that will not require a member to submit a Rule 1017 application to obtain FINRA's approval of the expansion. This safe harbor applies to: (1) firms that do not have a membership agreement, and (2) firms that have a membership agreement that does not contain a restriction on the factors listed below.]

      [The safe harbor is not available to a member that has a membership agreement that contains a specific restriction as to one or more of the factors listed below. In that case, the agreement takes precedence because FINRA has determined that a particular restriction should apply as to one or more of the factors, and FINRA has issued a decision with a rationale for that restriction. Similarly, the safe harbor also does not apply if the member has a membership agreement that permits expansion beyond the limits set forth below (e.g., an Applicant requests and obtains approval for ten registered representatives in the first six months with an additional ten registered representatives in the next year); in such case, FINRA has specifically considered the firm's expansion plans and approved them.]

      [The term "disciplinary history" redesignated as paragraph (i) under proposed Rule 1111]

      [For those firms to which the safe harbor is available, the following types of expansions are presumed not to be a material change in business operations and therefore do not require a Rule 1017 application. For any expansion beyond these limits, a member should contact its district office prior to implementing the change to determine whether the proposed expansion requires an application under Rule 1017. Expansions in each area are measured on a rolling 12-month basis; members are required to keep records of increases in personnel, offices, and markets to determine whether they are within the safe harbor.]

      [The term "Associated Persons involved in sales" redesignated as paragraph (d) under proposed Rule 1111]

      [

      Number of Associated Persons Involved in Safe Sales Harbor—Increase Permitted Within One Year Period Without Rule 1017 Application
      1–10 10 persons
      11 or more 10 persons or a 30 percent increase, whichever is greater
         
      Number of Offices (registered or unregistered)  
      1–5 3 offices
      6 or more 3 offices or a 30 percent increase, whichever is greater
         
      Number of Markets Made  
      1–10 10 markets
      11 or more 10 markets or a 30 percent increase, whichever is greater

      ]

      * * * * *

      [1012]1112. General [Provisions]Procedures
      [(a) Filing by Applicant or Service by FINRA]
      [(1) An Applicant for membership shall file an application in the manner prescribed in Rule 1013, including the timely submission of an application fee pursuant to Schedule A to the FINRA By-Laws.]
      [(2) An Applicant seeking approval of a change of ownership, control, or business operations shall file an application in the manner prescribed in Rule 1017, including the timely submission of an application fee pursuant to Schedule A to the FINRA By-Laws.]
      [(3) Except where FINRA has otherwise prescribed an electronic or alternative filing process, an Applicant may file an application or any document or information requested under the Rule 1010 Series by first-class mail, overnight courier, or hand delivery. If the Department and the Applicant agree, the Applicant also may file a requested document or information by facsimile.]
      [(4) FINRA shall serve a notice or decision issued under the Rule 1010 Series by first-class mail on the Applicant or its counsel, unless a Rule specifies a different method of service.]
      [(5) For purposes of the Rule 1010 Series, service by FINRA or filing by an Applicant shall be deemed complete as follows:]
      [(A) Service or filing by first-class mail shall be deemed complete on the date of postmark;]
      [(B) Service or filing by overnight courier shall be deemed complete on the date of delivery to the overnight courier as specified in the airbill;]
      [(C) Service or filing by hand delivery shall be deemed complete on the date of receipt as evidenced by a date stamp;]
      [(D) Service or filing by facsimile shall be deemed complete on the date specified in the document and on the written confirmation of transmission; and]
      [(E) Filing by an electronic system shall be deemed complete on the date specified on the confirmation page generated by the electronic filing system.]
      (a) Filing and Service; Timing
      (1) An Applicant shall file an Application and submit any other correspondence with the Department via electronic process or such other process as FINRA may prescribe. FINRA shall serve a notice or decision, or any other correspondence, by electronic delivery. For purposes of the Rule 1100 Series, filing by an Applicant or service by FINRA shall be deemed complete on the date recorded by FINRA's electronic systems for electronic communications or such other process as FINRA may prescribe.
      (2) The date on which the Department decision is due under the Rule 1150 Series shall be calculated from the date the Department accepts the Application. An Application will be accepted and deemed filed for purposes of calculating the date on which the Department decision is due under the Rule 1150 Series when the Department provides written notification to the Applicant that the Department has completed the initial assessment of the Application and determined that the Application includes the documents or information necessary for the Department to commence a meaningful review ("Application Filed Date"). The date on which the Application is submitted in accordance with this paragraph ("Application Submission Date") shall not be used to calculate the date on which the Department decision is due under the Rule 1150 Series.
      (3) The timeframes specified in the Rule 1100 Series may be extended or shortened upon the mutual written consent of the Department and the Applicant.
      (b) Rejection of Application Following Department's Initial Assessment
      (1) Within 15 days of the Application Submission Date, the Department shall conduct an initial assessment to determine whether it includes the documents or information necessary for the Department to commence a meaningful review. Where the Department has completed its initial assessment of the Application and determined that the Application omits the documents or information necessary to commence a meaningful review, the Department shall notify the Applicant, in writing, that such Application is incomplete and describe the deficiency. The Applicant shall have five business days after the date on which the Department has issued the written notification of deficiency to cure the deficiency described therein. Upon the Applicant's failure to timely cure the deficiency, the Department shall reject the Application. FINRA shall refund the Application fee, less $500, which FINRA shall retain as a processing fee. An Application that has been rejected does not constitute final action by FINRA for purposes of the Rule 1160 Series.
      (2) If the Applicant determines again to apply for approval of a new or continuing membership application subseguent to its rejection, the Applicant shall submit a new Application, including the timely submission of the appropriate fee pursuant to Schedule A to the FINRA By-Laws.
      [1017(e)](c) Request for Additional Documents [and]or Information

      Within 30 days after the [filing of an applicationlApplication Filed Date, the Department shall serve an initial reguest for any additional documents or information [or documents] necessary to render a decision on the [alApplication, and the Applicant shall file any additional information or documents with the Department within 30 days after service of the Department's initial reguest. The Department may also reguest additional documents or information [or documents] at any time during the [a]Application review process. [Unless otherwise agreed to by the Department and the Applicant,] [t]The Applicant shall file such additional documents or information [or documents] with the Department within [30]15 days after the Department's reguest, or within such other time period agreed to by the Department and the Applicant.
      [1012(b)][d] Lapse of Application
      (1) Absent a showing of good cause, an [a]Application [filed under Rule 1013 or 1017] shall lapse if an Applicant fails to:
      (A) respond fully within [60]30 days after service of any initial written request for information or documents under paragraph (c) of this Rule [1013, within 30 days after service of an initial written request for information or documents under Rule 1017], within [30]15 days after service of any [subsequent]additional written request for information or documents under paragraph (c) of this Rule [1013 or 1017], or within such other time period agreed to by the Department and the Applicant;
      (B) appear at or otherwise participate in a scheduled membership interview [pursuant to Rule 1013(b) or 1017(f)]; or
      (C) file an executed membership agreement under Rule [1014(d) or Rule 1017(g)(4) within [25]15 days after service of the agreement, or within such other period agreed to by the Department and the Applicant]1154.
      (2) The Department may, in its discretion, lapse the Application if the Applicant makes substantial changes to the Application that materially impacts the Department's review of the Application. Where the Department has determined that the Application has materially changed from the initial submission, the Department shall notify the Applicant, in writing, that such Application may lapse and describe the reasons therefor. The Applicant shall have five business days after the date on which the Department has issued the written notification of the pending lapse to remedy the Application. Failure to timely remedy the Application shall result in its lapse.
      [(2)](3) If an Application has lapsed within 30 days after the Application Filed Date, FINRA shall refund the Application fee, less $500, which FINRA shall retain as a processing fee. If an Applicant [wishes to continue]determines again to [seek]apply for approval of a new or continuing membership [or approval of a change in ownership, control, or business operations]application subseguent to its lapse, [then] the Applicant shall [be required to] submit a new [a]Application [in the manner prescribed in Rule 1013 or 1017, respectively], including the timely submission of [an application]the appropriate fee pursuant to Schedule A to the FINRA By-Laws. FINRA shall not refund [any]the Application fee for an Application that has lapsed [application] after 30 days of the Application Filed Date. An Application that has lapsed does not constitute final action by FINRA for purposes of the Rule 1160 Series.
      [(c) Ex Parte Communications redesignated as proposed Rule 1161]
      [(d) Recusal or Disqualification redesignated as paragraph (c) under proposed Rule 1163]
      [(e) Computation of Time redesignated as paragraph (f) under proposed Rule 1111]
      [1013(a)(5)](e) Withdrawal of Application

      If an Applicant withdraws [an]the [a]Application after the Application Submission Date, but not later than [within] 30 days after [filing the applicationlthe Application Filed Date, FINRA shall refund the [a]Application fee, less $500, which FINRA shall [be] retain[ed by FINRA] as a processing fee. If the Applicant determines to again [to seek]apply for approval of a new or continuing membership application subseguent to the withdrawal, the Applicant shall submit a new [a]Application [under this Rule and], including the timely submission of the appropriate fee pursuant to Schedule A to the FINRA By-Laws. FINRA shall not refund the fee for an Application that the Applicant has withdrawn under this subparagraph after 30 days of the Application Filed Date. An Application that has been withdrawn under this paragraph does not constitute final action by FINRA for purposes of the Rule 1160 Series.
      [1013(b)](f) Membership Interview
      [1013(b)(1)](1) [Requirement for]New Membership Interview Mandatory

      Before the Department serves its decision pursuant to the Rule 1150 Series on [an application for new membership in FINRA] a Form NMA, the Department shall conduct [a]one or more membership interviews at any time during the new membership application review process with a representative or representatives of the Applicant.
      [1017(g)](2) Continuing Membership Interview Discretionary
      [(1)] Before [T]the Department serves its decision pursuant to the Rule 1150 Series on a Form CMA, the Department may, in its discretion, [require the Applicant to participate inlconduct [a]one or more continuing membership interviews [within 30 days after the filing of the application, or if the Department requests additional information or documents, within 30 days after the filing of the additional information or documents by the Applicant]at any time during the continuing membership application review process with a representative or representatives of the Applicant.
      [(2) At least seven days before the membership interview, the Department shall serve on the Applicant a written notice that specifies the date and time of the interview and persons who are required to participate in the interview. The Department shall serve the notice by facsimile or overnight courier. The Applicant and the Department may agree to a shorter or longer period for notice or a different method of service.]
      [(3) Unless the Department and the Applicant otherwise agree, the membership interview shall be conducted in the district office for the district in which the Applicant has its principal place of business.]
      [(4) During the membership interview, the Department shall review the application and the considerations for the Department's decision set forth in paragraph (g)(1) with the Applicant's representative or representatives. The Department shall provide to the Applicant's representative or representatives any information or document that the Department has obtained from the Central Registration Depository or a source other than the Applicant and upon which the Department intends to base its decision under paragraph (g). If the Department receives such information or document after the membership interview or decides to base its decision on such information after the membership interview, the Department shall promptly serve the information or document and an explanation thereof on the Applicant]
      [1013(b)(2)](3) Service of Notice of Membership Interview; Where Held
      (A) Service of Notice of Membership Interview

      At least seven days before [the]a scheduled membership interview, the Department shall serve on the Applicant a written notice that specifies the date and time of the interview and the representative(s) [or representatives] of the Applicant who are required to participate in the interview. The Department shall serve the notice [by facsimile or overnight courier]in a manner consistent with Rule 1112. The Applicant and the Department may agree to a [shorter or longer]different period for notice or [a different]method of service under this [sub]paragraph.
      (B) Where Held

      The membership interview(s) shall be conducted in the district office for the district in which the Applicant has its principal place of business or at an agreed upon location provided, however, that the Department and the Applicant may agree to conduct the membership interview by video conference or by other means.

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

      .01 Initial Assessment by Department. Under Rule 1112(a), the Department shall conduct an initial assessment of an Application to determine, at a minimum, whether the documents or information included with the Application are correctly identified and contain the information they purport to address and whether the Application may be eligible for expedited review. As part of the initial assessment, the Department may also review several aspects of the Application including, but not limited to, the disciplinary history of the Applicant and its Associated Persons, and scale and scope of the proposed activities of the Applicant, the history of sales practice events, disciplinary history, licenses and registrations, and experience of the relevant principals and registered persons of the Applicant, and the written supervisory procedures.
      .02 Department Decision to Expedite Review. As a part of the initial assessment, the Department may, in its discretion, determine that the Application is eligible for expedited review and shall notify the Applicant of such eligibility.
      .03 Membership Interview. A membership interview is a meeting between the Department (and may include other Interested FINRA Staff), and the Applicant's counsel or representative(s), including the persons who own, control, or manage the Applicant. The Applicant and its counsel or representative(s) must be prepared to discuss topics that may include, among others, the nature and scope of the business, the Applicant's ability to satisfy the standards set forth in Rule 1142 that are applicable to such Applicant in accordance with Rule 1141, the rules applicable to the Applicant's intended business, financial condition, source of funds, the supervisory structure, the background and experience of the Applicant's principals and representative(s), documents or information that the Department obtained from CRD or a source other than the applicant and upon which the Department intends to based its decision, and plans for future direction and business expansion.
      .04 Waiver of Two-Principal Requirement. An Applicant may apply, in the manner prescribed in Rule 9610, and Form NMA or Form CMA, as applicable, for a waiver of the two-principal reguirement of Rule 1210.01 based on the Applicant's limited scope of activities or the Applicant having only one person associated with the Applicant.

      The Applicant shall submit, in writing, the basis on which the Applicant believes it has demonstrated that only one person associated with the Applicant should be reguired to be registered as a principal, along with any supporting documentation for the waiver reguest to the Department as part of the Application.
      (a) Department Review

      The Department shall assess factors that include, but are not limited to:
      (1) the regulatory history of the Applicant and its Associated Persons;
      (2) the type of business the Applicant conducts or for which it is approved to conduct; and
      (3) the number, location and experience of Associated Persons, and their designated offices and locations.
      (b) Department Decision

      The decision to grant a reguest for a waiver rests solely with the Department. Where a waiver reguest is granted, FINRA may reguire the registration of the specified number of principals at some future date if changes occur that alter the factors on which the waiver decision was based. Where a reguest for a waiver is denied prior to the issuance of a Department decision under the Rule 1150 Series, the Applicant may file an appeal pursuant to the Rule 9600 Series. The Application review process may be held in abeyance pending the outcome of the appeal.

      * * * * *

      1113. Restriction Pertaining to New Member Applications

      No Change.

      * * * * *

      [1122]1114. Filing of Misleading Information as to Membership or Registration

      No Change.

      * * * * *

      1115. Reserved

      * * * * *

      1116. Reserved

      * * * * *

      1117. Reserved

      * * * * *

      1118. Reserved

      * * * * *

      1119. Reserved

      * * * * *

      1120. NEW MEMBERSHIP [APPLICATION PROCESS]

      * * * * *

      1121. Membership Waive-In

      FINRA previously permitted, through an application process, a waive-in to FINRA membership for certain New York Stock Exchange ("NYSE") and NYSE American LLC ("NYSE American") member organizations. The period for seeking such a waive-in has expired.

      NYSE member organizations that were admitted pursuant to the waive-in process are subject to the FINRA By-Laws and Schedules to By-Laws, including Schedule A, the consolidated FINRA rules and the NYSE rules incorporated by FINRA, provided that their securities business is limited to floor brokerage on the NYSE, or routing away to other markets orders that are ancillary to their core floor business under NYSE Rule 70.40 ("permitted floor activities"). If an NYSE-only member organization admitted pursuant to the waive-in process seeks to expand its business operations to include any activities other than the permitted floor activities or makes changes to its securities business that would otherwise reguire FINRA membership, such firm shall execute a membership agreement prior to expanding its business operations. If such business expansion would be considered a material change in business operations, as that term is described in Rule 1131(b), such firm also shall apply for and must receive approval prior to engaging in such business activity pursuant to Rule 1131. Upon approval of such business expansion, the firm shall be subject to all NASD rules, in addition to the consolidated FINRA rules and those NYSE rules incorporated by FINRA.

      NYSE American member organizations that were admitted pursuant to the waive-in process are member organizations of both NYSE and NYSE American and as such are subject to the FINRA By-Laws and Schedules to By-Laws, including Schedule A, the consolidated FINRA rules and the NYSE rules incorporated by FINRA, provided that their NYSE or NYSE American securities business is limited to floor-based activities in either NYSE-traded or NYSE American-traded securities, or routing away to other markets orders that are ancillary to their core NYSE or NYSE MKT floor business under NYSE Rule 70.40 or NYSE American Eguities Rule 70.40 ("permitted floor activities"). If a firm admitted pursuant to the waive-in process seeks to expand its business operations to include any activities other than the permitted floor activities or makes changes to its securities business that would otherwise reguire FINRA membership, such firm shall execute a membership agreement prior to expanding its business operations. If such business expansion would be considered a material change in business operations, as that term is described in Rule 1131(b), such firm also shall apply for and must receive approval prior to engaging in such business activity pursuant to Rule 1131. Upon approval of such business expansion, the firm shall be subject to all NASD rules, in addition to the consolidated FINRA rules and those NYSE rules incorporated by FINRA.

      * * * * *

      [1090]1122. Foreign Members

      A member [which]that does not maintain an office in the United States responsible for preparing and maintaining financial and other reports required to be filed with the [Commission]SEC and [the AssociationlFINRA must:
      (a) prepare all such reports, and maintain a general ledger chart of account and any description thereof, in English and U.S. dollars;
      (b) reimburse [the Association]FINRA for any expenses incurred in connection with examinations of the member to the extent that such expenses exceed the cost of examining a member located within the continental United States in the geographic location most distant from the [D]district [O]office of appropriate jurisdiction; and
      (c) ensure the availability of an individual fluent in English and knowledgeable in securities and financial matters to assist representatives of [the AssociationlFINRA during examinations.[; and]
      [(d) utilize, either directly or indirectly, the services of a broker/dealer registered with the Commission, a bank or a clearing agency registered with the Commission located in the United States in clearing all transactions involving members of the Association, except where both parties to a transaction agree otherwise.]

      * * * * *

      [1013]1123. New Membership Application [and Interview]Process
      (a) [Filing of Application]General

      Before applying for new FINRA membership, a prospective Applicant must undertake, as FINRA may prescribe, reguisite actions which include, but are not limited to filing Form BD with the SEC pursuant to Section 15(b) of the Exchange Act, reserving a firm name in accordance with Article IV, Section 2 of the FINRA By-Laws, completing the necessary forms to access FINRA systems, submitting fingerprints for each Associated Person, and paying the appropriate fee pursuant to Schedule A to the FINRA By-Laws.
      [(1)](b) [How to File]New Membership Application (Form NMA)

      A[n] prospective Applicant for new FINRA membership shall [file its application in the manner prescribed by FINRAlfile Form NMA, including all documents and information reguested therein, with the Department [of Member Regulation ("the Department")]in accordance with Rule 1112, and submit the appropriate fee pursuant to Schedule A to the FINRA By-Laws. [An Applicant shall submit an application that includes:]
      [(A) Form NMA;]
      [(B) an original signed and notarized paper Form BD, with applicable schedules;]
      [(C) an original FINRA-approved fingerprint card for each Associated Person who will be subject to SEC Rule 17f-2;]
      [(D) a new member assessment report;]
      [(E) a detailed business plan that adeguately and comprehensively describes all material aspects of the business that will be, or are reasonably anticipated to be, performed at and after the initiation of business operations, including future business expansion plans, if any, and includes:]
      [(i) a trial balance, balance sheet, supporting schedules, and computation of net capital, each of which has been prepared as of a date that is within 30 days before the filing date of the application;]
      [(ii) a monthly projection of income and expenses, with a supporting rationale, for the first twelve months of operations;]
      [(iii) an organizational chart;]
      [(iv) the intended location of the Applicant's principal place of business and all other offices, if any, whether or not such offices would be required to be registered under NASD Rules, and the names of the persons who will be in charge of each office;]
      [(v)] a list of the types of securities to be offered and sold and the types of retail or institutional customers to be solicited;]
      [(vi) a description of the methods and media to be employed to develop a customer base and to offer and sell products and services to customers, including the use of the Internet, telephone solicitations, seminars, or mailings;]
      [(vii) a description of the business facilities and a copy of any proposed or final lease;]
      [(viii) the number of markets to be made, if any, the type and volatility of the products, and the anticipated maximum inventory positions;]
      [(ix) any plan to enter into contractual commitments, such as underwritings or other securities-related activities;]
      [(x) any plan to distribute or maintain securities products in proprietary positions, and the risks, volatility, degree of liquidity, and speculative nature of the products;]
      [(xi) any other activity that the Applicant may engage in that reasonably could have a material impact on net capital within the first twelve months of business operations; and]
      [(xii) a description of the communications and operational systems the Applicant will employ to conduct business with customers or other members and the plans and procedures the Applicant will employ to ensure business continuity, including: system capacity to handle the anticipated level of usage; contingency plans in the event of systems or other technological or communications problems or failures that may impede customer usage or firm order entry or execution; system redundancies; disaster recovery plans; system security; disclosures to be made to potential and existing customers who may use such systems; and supervisory or customer protection measures that may apply to customer use of, or access to, such systems;]
      [(F) a copy of any decision or order by a federal or state authority or self-regulatory organization taking permanent or temporary adverse action with respect to a registration or licensing determination regarding the Applicant or an Associated Person;]
      [(G) a list of all Associated Persons;]
      [(H) documentation of any of the following events, unless the event has been reported to the Central Registration Depository:]
      [(i) a regulatory action against or investigation of the Applicant or an Associated Person by the Commission, the Commodity Futures Trading Commission, a federal, state, or foreign regulatory agency, or a self-regulatory organization that is pending, adjudicated, or settled;]
      [(ii) an investment-related civil action for damages or an injunction against the Applicant or an Associated Person that is pending, adjudicated, or settled;]
      [(iii) an investment-related customer complaint or arbitration that is required to be reported on Form U4;]
      [(iv) a criminal action (other than a minor traffic violation) against the Applicant or an Associated Person that is pending, adjudicated, or that has resulted in a guilty or no contest plea; and]
      [(v) a copy of any document evidencing a termination for cause or a permitted resignation after investigation of an alleged violation of a federal or state securities law, a rule or regulation thereunder, a self-regulatory organization rule, or an industry standard of conduct;]
      [(I) a description of any remedial action, such as special training, continuing education requirements, or heightened supervision, imposed on an Associated Person by a state or federal authority or self-regulatory organization;]
      [(J) a written acknowledgment that heightened supervisory procedures and special educational programs may be required [pursuant to Notice to Members 97-19 for an Associated Person whose record reflects disciplinary actions or sales practice events;]
      [(K) a copy of final or proposed contracts with banks, clearing entities, or service bureaus, and a general description of any other final or proposed contracts;]
      [(L) a description of the nature and source of Applicant's capital with supporting documentation, including a list of all persons or entities that have contributed or plan to contribute financing to the Applicant's business, the terms and conditions of such financing arrangements, the risk to net capital presented by the Applicant's proposed business activities, and any arrangement for additional capital should a business need arise;]
      [(M) a description of the financial controls to be employed by the Applicant;]
      [(N) a description of the Applicant's supervisory system and a copy of its written supervisory procedures, internal operating procedures (including operational and internal controls), internal inspections plan, written approval process, and qualifications investigations required by Rule 3010;]
      [(O) a description of the number, experience, and qualifications of supervisors and principals and the number, experience, and qualifications of persons to be supervised by such personnel, the other responsibilities of the supervisors and principals with the Applicant, their full-time or part-time status, any business activities that the supervisors or principals may engage in outside of their association with the Applicant, the hours per week devoted to such activities, and an explanation of how a part-time supervisor or principal will be able to discharge his or her designated functions on a part-time basis;]
      [(P) a description of Applicant's proposed recordkeeping system;]
      [(Q) a copy of the Applicant's written training plan to comply with Firm Element continuing education requirements described in Rule 1120(b), including the name of the Associated Person responsible for implementation; and]
      [(R) a FINRA Entitlement Program Agreement and Terms of Use and a FINRA Member Firm Account Administrator Entitlement Form.]
      [(2) Uniform Registration Forms]

      [Upon approval of the Applicant's FINRA Member Firm Account Administrator Entitlement Form, the Applicant shall submit its Forms U4 for each Associated Person who is required to be registered under NASD Rules, any amendments to its Forms BD or U4, and any Form U5 electronically via Web CRD.]
      [(3) Rejection of Application that is Not Substantially Complete]

      [If the Department determines within 30 days after the filing of an application that the application is not substantially complete, the Department may reject the application and deem it not to have been filed. In such case, within the 30 day period, the Department shall serve a written notice on the Applicant of the Department's determination and the reasons therefor. FINRA shall refund the application fee, less $500, which shall be retained by FINRA as a processing fee. If the Applicant determines to continue to seek membership, the Applicant shall submit a new application under this Rule and fee pursuant to Schedule A to the FINRA By-Laws.]
      [(4) Request For Additional Documents Or Information]

      [Within 30 days after the filing of an application, the Department shall serve an initial request for any additional information or documents necessary to render a decision on the application. The Department may serve subsequent requests for additional information or documents at any time during the membership application process.]

      [Unless otherwise agreed by the Department and the Applicant, the Applicant shall file any additional information and documents with the Department within 60 days after service of the Department's initial request and 30 days after service of any subsequent request.]
      [(5) Withdrawal of Application redesignated as paragraph (e) under proposed Rule 1112]
      [(b) Membership Interview redesignated as paragraph (f) under proposed Rule 1112]
      [(1) Requirement for Interview redesignated as paragraph (f) under proposed Rule 1112]
      [(2) Service of Notice redesignated as paragraph (f) under proposed Rule 1112]
      [(3) Time]

      [Unless the Department directs otherwise for good cause shown, a membership interview shall be scheduled to occur within 90 days after the filing of an application or within 60 days after the filing of all additional information or documents requested, whichever is later.]
      [(4) Place]

      [Unless the Department and the Applicant otherwise agree, the membership interview shall be conducted in the district office for the district in which the Applicant has or intends to have its principal place of business.]
      [(5) Updated Financial Documents]

      [On or before the date of the membership interview, the Applicant shall file an updated trial balance, balance sheet, supporting schedules, and computation of net capital. The Applicant shall prepare such documents as of a date that is within 45 days before the date of the membership interview, unless the Applicant and the Department agree on a longer period. The Applicant shall promptly notify the Department in writing of any material adverse change in its financial condition that occurs before a decision constituting final action of FINRA is served on the Applicant]
      [(6) Review of Standards for Admission]

      [During the membership interview, the Department shall review the application and the standards for admission to membership with the Applicant's representative or representatives.]
      [(7) Information From Other Sources]

      [During the membership interview, the Department shall provide to the Applicant's representative or representatives any information or document that the Department has obtained from the Central Registration Depository or a source other than the Applicant and upon which the Department intends to base its decision under Rule 1014. If the Department receives such information or document after the membership interview or decides to base its decision on such information after the membership interview, the Department shall promptly serve the information or document and an explanation thereof on the Applicant]

      * * * * *

      1124. Reserved

      * * * * *

      1125. Reserved

      * * * * *

      1126. Reserved

      * * * * *

      1127. Reserved

      * * * * *

      1128. Reserved

      * * * * *

      1129. Reserved

      * * * * *

      [IM-1013-1. Membership Waive-In Process for Certain New York Stock Exchange Member Organizations]

      [This Interpretive Material sets forth a membership waive-in process for certain New York Stock Exchange ("NYSE") member organizations to become members of FINRA as part of the consolidation of the member firm regulatory functions of NASD and NYSE Regulation, Inc. ("NYSE Regulation"). It applies to firms that, as of July 25, 2007, (1) are approved NYSE member organizations or (2) have submitted an application to become an NYSE member organization and are subsequently approved for NYSE membership (together "NYSE-only member organizations"), provided that such firms were not also NASD members as of July 30, 2007. Such firms are eligible to automatically become FINRA members and to automatically register all associated persons whose registrations are approved with NYSE in registration categories recognized by FINRA upon submission to FINRA's Member Regulation Department ("the Department") of a signed waive-in membership application ("Waive-In Application") with the following information:]

      [(1) General company information, including Central Registration Depository (CRD®) Number and contact person.]
      [(2) An attestation that all information on the applicant's CRD form, as of the date of submission of the Waive-In Application is accurate and complete and fully reflects all aspects of the applicant's current business, including, but not limited to, ownership structure, management, product lines and disclosures.]
      [(3) The identity of the firm's Executive Representative.]
      [(4) Completed and signed Entitlement Forms.]
      [(5) A signed FINRA Membership Agreement.]
      [(6) Representations that the NYSE applicant's Uniform Application for Broker-Dealer Registration (Form BD) will be amended as needed to keep current and accurate; that all individual and entity registrations with FINRA will be kept current; and that all information and statements contained in the Waive-In Application are current, true and complete.]

      [The Department shall review the Waive-In Application within three (3) business days of receipt and, if complete, issue a letter notifying the applicant that it has been approved for membership. The Membership Agreement shall become effective on the date of such notification letter.]

      [Firms admitted pursuant to this Interpretive Material shall be subject to the FINRA By-Laws and Schedules to By-Laws, including Schedule A, the consolidated FINRA rules and the NYSE rules incorporated by FINRA, provided that their securities business is limited to floor brokerage on the NYSE, or routing away to other markets orders that are ancillary to their core floor business under NYSE Rule 70.40 ("permitted floor activities"). If an NYSE-only member organization admitted pursuant to this Interpretive Material seeks to expand its business operations to include any activities other than the permitted floor activities, such firm must apply for and receive approval to engage in such business activity pursuant to NASD Rule 1017. Upon approval of such business expansion, the firm shall be subject to all NASD rules, in addition to the consolidated FINRA rules and those NYSE rules incorporated by FINRA.]

      [Pursuant to IM-Section 4(b)(1) and (e) to Schedule A of the FINRA By-Laws, a firm applying to waive in for membership pursuant to this Interpretive Material shall not be assessed certain registration and application fees set forth in Sections 4(b)(1) and (e) to Schedule A of the FINRA By-Laws.]

      * * * * *

      [IM-1013-2. Membership Waive-In Process for Certain NYSE Alternext US LLC Member Organizations]

      [This Interpretive Material sets forth a membership waive-in process for certain NYSE Alternext US LLC ("NYSE Alternext") member organizations to become members of FINRA as part of the acquisition by NYSE Euronext of the Amex Membership Corporation. It applies to any NYSE Alternext member organization that (i) holds a valid 86 Trinity Permit as of the date such firm transfers its equities operations to the NYSE Alternext Trading Systems and (ii) is not currently a FINRA member. Such firms are eligible to automatically become FINRA members and to automatically register all associated persons whose registrations are approved with NYSE Alternext in registration categories recognized by FINRA upon submission to FINRA's Member Regulation Department ("the Department") of a signed waive-in membership application ("Waive-In Application") with the following information:]

      [(1) General company information, including Central Registration Depository (CRD®) Number and contact person;]
      [(2) An attestation that all information on the applicant's form, as of the date of submission of the Waive-In Application, is accurate and complete and fully reflects all aspects of the applicant's current business, including, but not limited to, ownership structure, management, product lines and disclosures;]
      [(3) The identity of the firm's Executive Representative;]
      [(4) Completed and signed Entitlement Forms (unless previously submitted);]
      [(5) A signed FINRA Membership Agreement; and]
      [(6) Representations that the NYSE Alternext applicant's Uniform Application for Broker-Dealer Registration (Form BD) will be amended as needed to keep current and accurate; that all individual and entity registrations with FINRA will be kept current; and that all information and statements contained in the Waive-In Application are current, true and complete.]

      [The Department shall review the Waive-In Application within three (3) business days of receipt and, if complete, issue a letter notifying the applicant that it has been approved for membership. The Membership Agreement shall become effective on the date of such notification letter.]

      [Firms admitted pursuant to this Interpretive Material shall be member organizations of both NYSE and NYSE Alternext and as such are subject to the consolidated FINRA rules (provided that firms admitted to FINRA membership under IM-1013-1 also are subject to the consolidated FINRA rules), the NYSE rules incorporated by FINRA, the FINRA By-Laws and Schedules to By-Laws, including Schedule A, and the NASD Rule 8000 and Rule 9000 Series, provided that their NYSE or NYSE Alternext securities business is limited to floor-based activities in either NYSE-traded or NYSE Alternext-traded securities, or routing away to other markets orders that are ancillary to their core NYSE or NYSE Alternext floor business under NYSE Rule 70.40 or NYSE Alternext Equities Rule 70.40 ("permitted floor activities"). If a firm admitted pursuant to this Interpretive Material seeks to expand its business operations to include any activities other than the permitted floor activities or makes changes to its securities business that would otherwise require FINRA membership, such firm must apply for and receive approval to engage in such business activity pursuant to NASD Rule 1017. Upon approval of such business expansion, the firm shall be subject to all NASD rules, in addition to the consolidated FINRA rules and those NYSE rules incorporated by FINRA.]

      [Pursuant to IM-Section 4(b)(1) and (e) to Schedule A of the FINRA By-Laws, a firm applying to waive in for membership pursuant to this Interpretive Material shall not be assessed certain registration and application fees set forth in Sections 4(b)(1) and (e) to Schedule A of the FINRA By-Laws.]

      * * * * *

      [1014. Department Decision redesignated to proposed Rule 1150]
      [(a) Standards for Admission redesignated to proposed Rule 1142]
      [(b) Granting or Denying Application redesignated as paragraphs (a) and (c) under proposed Rule 1152]
      [(c) Decision redesignated as proposed Rules 1151 and 1153]
      [(1) Time]

      [The Department shall serve a written decision on the membership application within 30 days after the conclusion of the membership interview or after the filing of additional information or documents, whichever is later.]
      [(2) Content redesignated as paragraphs (b) and (c) under proposed Rule 1153]
      [(3) Failure to Serve Decision redesignated as paragraph (a) under proposed Rule 1151]
      [(d) Submission of Membership Agreement redesignated as proposed Rule 1154]
      [(e) Service and Effectiveness of Decision as paragraph (a) under proposed Rule 1155]
      [(f) Effectiveness of Restriction redesignated as paragraph (b) under proposed Rule 1152]
      [(g) Final Action redesignated as paragraph (b) under proposed Rule 1155]

      * * * * *

      [1015. Review by National Adjudicatory Council redesignated to the proposed Rule 1160 Series]

      * * * * *

      [1016. Discretionary Review by FINRA Board redesignated as proposed Rule 1167]

      * * * * *

      1130. CONTINUING MEMBERSHIP

      * * * * *

      [1017]1131. [Application for Approval of Change in Ownership, Control, or Business Operations]Continuing Membership Application Process
      (a) Continuing Membership Application (Form CMA)
      (1) An Applicant for continuing FINRA membership shall file Form CMA, including all documents and information reguested therein and as otherwise specified in this Rule, with the Department in accordance with Rule 1112, and submit the appropriate fee pursuant to Schedule A to the FINRA By-Laws.
      (2) The circumstances of a particular transaction or event that would reguire the filing by two or more members, of an application under paragraph (a) of this Rule may, at the discretion of the Department, be satisfied through the filing of an Application by one of the parties involved in the transaction so designated by the Department for that purpose, or by one filing that is adopted by all parties to the transaction.
      [a](b) Events Requiring [Application]Form CMA and Department Approval

      Prior to effectuating any change set forth in this Rule, [A member] an Applicant shall file [an application]Form CMA [for] and obtain approval [of any of the following changes to its ownership, control, or business operationslthereon from the Department:
      (1) Merger

      [a]A merger of the member with another [member, unless both are members of the New York Stock Exchange, Inc. or the surviving entity will continue to be a member of the New York Stock Exchange, Inc.lbroker-dealer, whether or not such broker-dealer is a member of FINRA;
      (2) Acquisition
      (A) a member's direct or indirect acquisition [by the member] of another [member, unless the acquiring member is a member of the New York Stock Exchange, Inc.]broker-dealer, whether or not such broker-dealer is a member of FINRA;
      (B) a direct or indirect acquisition of 25 percent or more in the aggregate of the member's assets or any asset, business, or line of business that generates revenues composing 25 percent or more in the aggregate of the member's earnings measured on a calendar-year basis for the three years immediately preceding the proposed event;
      (3) Divestiture or Transfer

      [a]A direct or indirect [acquisitions] divestiture or transfers] of 25[%] percent or more in the aggregate of the member's assets or any asset, business, or line of [operation]business that generates revenues [comprising]composing 25[%] percent or more in the aggregate of the member's earnings measured on a [rolling 36-month]calendar-year basis for the three years immediately preceding the proposed event[, unless both the seller and acquirer are members of the New York Stock Exchange, Inc.];
      (4) Change in Capital Structure

      [a]A change in the [equity ownership or partnership] capital structure of the member that results in one person or entity, directly or indirectly, owning or controlling 25 percent or more of the [equity or partnership capital; or]member (or holding a presently exercisable option to own or control the member).

      [(5) a material change in business operations as defined in Rule 1011(k).]
      (5) Change in Control Person

      A direct or indirect change of the member's control person(s), other than the appointment or election of a natural person as a partner, officer, director, principal of the member, or any person occupying a similar status or performing similar function, in the normal course of business and regardless of paragraph (b)(4).
      [1017(b)(2)(C)](6) Business Expansion

      [If the application reguests approval of an increase inlExcept as provided in Rule 1133, a member that seeks to expand its business by increasing the number of: (A) Associated Persons involved in sales[,1; (B) offices (registered or unregistered)[,1; or (C) markets made[, the application shall set forth the increases in such areas during the preceding 12 months].
      (7) Material Change in Business Operations

      [The term]A ["]material change in business operations["] includes, but is not limited to, a member:
      [(1) removing or modifying a membership agreement restriction;]
      [(2)](A) engaging, for the first time, in:
      (i) market making[,];
      (ii) underwriting[,]; [or]
      (iii) acting as a dealer [for the first time]; [and]
      (iv) settling or clearing transactions for the member's own business;
      (v) settling or clearing transactions for other broker-dealers; or
      (vi) carrying accounts of customers;
      [(3)](B) adding business activities that reguire a higher minimum net capital under SE[C]A Rule 15c3-1; or
      (C) changing an exemptive status claimed under SEA Rule 15c3-3(k).
      (8) Removal or Modification of Restriction in Membership Agreement
      [1017(b)(2)(B)] (A) Applicant's Initiative

      [If the application requests the removal]A member that seeks to remove or [modification ofjmodify any restriction in its membership agreement [restriction, the application also] shall include with Form CMA, and all information and supporting documents requested therein, a detailed description of[:]
      [(i)] [present facts showing that]the circumstances that [gave rise tolobviate the restriction's) [have changed;] and
      [(ii)] [state with specificity why]the rationale for removing or modifying the restriction(s) [should be modified or removed in light of the standards set forth in Rule 1014 and the articulated rationale for the imposition of the restriction].
      [1017(k)](B) [Removal or Modification of Restriction on]

      Department's Initiative

      The Department shall modify or remove an existing restriction on its own initiative if the Department determines such action is appropriate in light of [the considerations set forth in paragraph (g)(1)]Form CMA and Rule 1142, and any information elicited during a membership interview, if held. The Department shall notify the member in writing of the Department's determination and inform the member that it may apply for further modification or removal of a restriction by filing an application [under paragraph (a)] in the manner prescribed in this Rule.
      [(b) Filing and Content of Application]
      [(1) The member shall file the application in the manner prescribed by FINRA with the Department of Member Regulation ("the Department").]
      [(2) An applicant shall submit an application that includes a Form CMA including a detailed description of the change in ownership, control, or business operations.]
      [(A) If the application requests approval of a change in ownership or control, the application also shall include the names of the new owners, their percentage of ownership, and the sources of their funding for the purchase and recapitalization of the member.]
      [(B) redesignated to paragraph (b) under proposed Rule 1131]
      [(C) redesignated to paragraph (b) under proposed Rule 1131]
      [(c) Effecting Change and Imposition of Interim Restrictions]
      [(1) A member shall file an application for approval of a change in ownership or control at least 30 days prior to such change. A member may effect a change in ownership or control prior to the conclusion of the proceeding, but the Department may place new interim restrictions on the member based on the standards in Rule 1014, pending final Department action.]
      [(2) A member may file an application to remove or modify a membership agreement restriction at any time. An existing restriction shall remain in effect during the pendency of the proceeding.]
      [(3) A member may file an application for approval of a material change in business operations, other than the modification or removal of a restriction, at any time, but the member may not effect such change until the conclusion of the proceeding, unless the Department and the member otherwise agree.]
      [(d) Rejection Of Application That Is Not Substantially Complete]

      [If the Department determines within 30 days after the filing of an application that the application is not substantially complete, the Department shall reject the application and deem it not to have been filed. In such case, within the 30 day period, the Department shall serve a written notice on the Applicant of the Department's determination and the reasons therefor. FINRA shall refund the application fee, less $500, which shall be retained by FINRA as a processing fee. If the Applicant determines to continue to apply for approval of a change in ownership, control, or business operations, the Applicant shall submit a new application under this Rule and fee pursuant to Schedule A to the FINRA By-Laws.]
      [(e) Request for Additional Documents and Information redesignated as paragraph (c) under proposed Rule 1112]
      [(f) Withdrawal of Application]

      [If an Applicant withdraws an application within 30 days after filing the application, FINRA shall refund the application fee, less $500, which shall be retained by FINRA as a processing fee. If the Applicant determines to again apply for approval of a change in ownership, control, or business operations, the Applicant shall submit a new application under this Rule and fee pursuant to Schedule A to the FINRA By-Laws.]
      [(g) Membership Interview redesignated as paragraph (f) under proposed Rule 1112]
      [(h) Department Decision]
      [(1) The Department shall consider the application, the membership interview, other information and documents provided by the Applicant or obtained by the Department, the public interest, and the protection of investors. In rendering a decision on an application submitted under Rule 1017(a), the Department shall consider whether the Applicant and its Associated Persons meet each of the standards in Rule 1014(a). Where the Department determines that the Applicant or its Associated Person are the subject of any of the events set forth in Rule 1014(a)(3)(A) and (C) through (E), a presumption exists that the application should be denied. The Applicant may overcome the presumption by demonstrating that it can meet each of the standards in Rule 1014 (a), notwithstanding the existence of any of the events set forth in Rule 1014(a)(3)(A) and (C) through (E).]
      [(A) In rendering a decision on an application for approval of a change in ownership or control, or an application for approval of a material change in business operations that does not involve modification or removal of a membership agreement restriction, the Department shall determine if the Applicant would continue to meet the standards in Rule 1014(a) upon approval of the application.]
      [(B) In rendering a decision on an application requesting the modification or removal of a membership agreement restriction, the Department shall consider whether maintenance of the restriction is appropriate in light of:]
      [(i) the standards set forth in Rule 1014;]
      [(ii) the circumstances that gave rise to the imposition of the restriction;]
      [(iii) the Applicant's operations since the restriction was imposed;]
      [(iv) any change in ownership or control or supervisors and principals; and]
      [(v) any new evidence submitted in connection with the application.]
      [(2) The Department shall serve a written decision on the application within 30 days after the conclusion of the membership interview or the filing of additional information or documents, whichever is later. If the Department does not require the Applicant to participate in a membership interview or request additional information or documents, the Department shall serve a written decision within 45 days after the filing of the application under paragraph (a). The decision shall state whether the application is granted or denied in whole or in part, and shall provide a rationale for the Department's decision, referencing the applicable standard in Rule 1014.]
      [(3) If the Department fails to serve a decision within 180 days after filing of an application or such later date as the Department and the Applicant have agreed in writing, the Applicant may file a written request with the FINRA Board requesting that the FINRA Board direct the Department to issue a decision. Within seven days after the filing of such a request, the FINRA Board shall direct the Department to issue a written decision immediately or to show good cause for an extension of time. If the Department shows good cause for an extension of time, the FINRA Board may extend the time limit for issuing a decision by not more than 30 days.]
      [(4) If the Department approves an application under this Rule in whole or part, the Department may require an Applicant to file an executed membership agreement.]
      [(i) Service and Effectiveness of Decision]

      [The Department shall serve its decision on the Applicant in accordance with Rule 1012. The decision shall become effective upon service and shall remain in effect during the pendency of any review until a decision constituting final action of FINRA is issued under Rule 1015 or 1016, unless otherwise directed by the National Adjudicatory Council, the FINRA Board, or the Commission.]
      [(j) Request for Review; Final Action]

      [An Applicant may file a written request for review of the Department's decision with the National Adjudicatory Council pursuant to Rule 1015. The procedures set forth in Rule 1015 shall apply to such review, and the National Adjudicatory Council's decision shall be subject to discretionary review by the FINRA Board pursuant to Rule 1016. If the Applicant does not file a request for a review, the Department's decision shall constitute final action by FINRA.]
      [(k) Removal or Modification of Restriction on Department's Initiative redesignated to paragraph (b) under proposed Rule 1131]
      [(l) Lapse or Denial of Application for Approval of Change in Ownership]

      [If an application for approval of a change in ownership lapses, or is denied and all appeals are exhausted or waived, the member shall, no more than 60 days after the lapse or exhaustion or waiver of appeal:]
      [(1) submit a new application under this Rule and fee pursuant to Schedule A to the FINRA By-Laws;]
      [(2) unwind the transaction; or]
      [(3) file a Form BDW.]
      [For the protection of investors, the Department may shorten the 60-day period. For good cause shown by the member, the Department may lengthen the 60-day period. The Department shall serve written notice on the Applicant of any change in the 60-day period and the reasons therefor. During the 60-day or other imposed period, the Department may continue to place interim restrictions on the member for the protection of investors.]

      * * * * *

      ••• Supplementary Material:..............

      .01 Permissible Events for Form CMA Waiver. A member may seek, in the manner prescribed by Rule 1132, a waiver of the reguirement to file Form CMA in the following circumstances:
      (a) Under Rule 1131(b)(2)(B) and Rule 1131(b)(3) where:
      (1) the member is ceasing operations as a broker-dealer:
      (2) the member is filing a Form BDWwith the SEC: and
      (3) neither the member nor any of its Associated Persons is the subject of any claim (including, but not limited to, arbitration awards, or pending or settled arbitration claims, or litigation actions) that could be disadvantaged by the proposed transaction. In any instance where a claim against a member or any of its Associated Persons is awarded or settled, such claim will not be deemed satisfied for purposes of this Rule until all payments are satisfied in full, including any payments to be made on behalf of the member by a third party, pursuant to an agreement among the parties.
      (b) Under Rule 1131(b)(4) or Rule 1131(b)(5) where:
      (1) the events described therein do not make any material changes in the Applicant's business activities, management, supervision, assets, or liabilities: and
      (2) the Applicant is proposing a change only in the:
      (i) member's legal structure (e.g., changing from a corporation to an limited liability company): or
      (ii) eguity ownership, partnership capital, or other ownership interest in an Applicant held by a corporate legal structure that is due solely to a reorganization of ownership or control of the Applicant within the corporate legal structure (e.g., reorganizing only to add a holding company to the corporate legal structure's ownership or control chain of the Applicant).

      * * * * *

      1132. Materiality Consultation
      (a) When Voluntary

      A member may seek guidance from the Department to determine whether the member's contemplated change in business operations or activities would reguire the submission of a Form CMA by submitting a written letter to the Department in accordance with Rule 1112.
      (b) When Mandatory

      A materiality consultation is mandatory under the following circumstances:
      (1) When an applicant seeks a waiver of filing Form CMA for contemplated events described under Rule 1131.01; or
      (2) When an applicant seeks to engage in, for the first time:
      (A) retail foreign currency exchange activities:
      (B) variable life settlement sales to retail customers:
      (C) options activities: or
      (D) municipal securities activities.
      (c) Content of Request for Materiality Consultation

      There is no fee associated with a materiality consultation. A member's written reguest for a materiality consultation for a contemplated change in business operations or activities must include a detailed description of:
      (1) The nature and scope of the contemplated activity;
      (2) The member's rationale for determining that the contemplated change in activity, business operations or product is similar in scope or nature to its existing business;
      (3) The anticipated impact the contemplated change will have to the member's supervisory structure;
      (4) Any impact the contemplated change will have to the member's capital or liquidity;
      (5) The nature and scope of updates required to the member's written supervisory procedures, systems and operations;
      (6) Any recent disciplinary matters that relate to the proposed activities;
      (7) How the member's overall regulatory history may impact the ability of the member to effectively conduct the activity; and
      (8) Any other relevant documentation or information to support the contemplated change.
      (d) Department Review
      (1) The Department shall assess factors that include, but are not limited to:
      (A) the nature and scope of the contemplated activity;
      (B) the history of sales practice events and disciplinary history of the member and its Associated Persons, if applicable; and
      (C) the impact of the contemplated activity on the member's supervisory and compliance structure, personnel, and finances; and
      (D) any other impact on investor protection raised by the contemplated activity.
      (2) The Department shall consider the letter and other documents or information, and determine in the public interest and the protection of investors that either (A) the member is not required to file Form CMA in accordance with Rule 1131 and may effect the contemplated activity; or (B) the member is required to file Form CMA in accordance with Rule 1131 and the member may not effect the contemplated activity, unless the Department approves Form CMA. Upon completion of the review of the materiality consultation, the Department shall provide the member a written response as to the materiality of the contemplated activity. If the Department determines that the member's contemplated activity would be subject to Rule 1131, the member must submit Form CMA, and all the information and supporting documents requested therein, before the member effects such change. If, however, the Department deems that the contemplated change is not material in nature that would reguire the submission of Form CMA, the member may implement such change without having to engage in the CMA process under Rule 1131.

      * * * * *

      [IM-1011-1]1133. Safe Harbor from the CMA Process
      (a) General

      For the types of events listed in this Rule, a member will not be reguired to submit Form CMA and obtain Department approval of the change before effecting such change. An expansion in each enumerated category as set forth in paragraph (b) below shall be measured on a 12-month period preceding the event. A member that elects to avail itself of the Safe Harbor shall make and preserve the records reflecting the underlying rationale for the business expansion made for any of the events listed herein.
      (b) Permissible Events for Safe Harbor

      A member that seeks to expand in the categories listed herein are presumed not to constitute a type of event that would reguire such member to submit Form CMA. The safe harbor is available to a member that seeks to expand in the following categories:
      (1) Number of Associated Persons Involved in Sales
      (A) A member with up to 10 Associated Persons involved in sales, and adds not more than 10 Associated Persons involved in sales; or
      (B) A member with 11 or more Associated Persons involved in sales, and adds the greater of 10 Associated Persons or 30 percent;
      (2) Number of Offices or Locations (Registered or Unregistered)
      (A) A member maintains up to five offices or locations, and adds not more three offices or locations; or
      (B) A member maintains six or more offices or locations, and adds the greater of three offices or locations, or 30 percent.
      (3) Number of Markets Made
      (A) A member makes up to 10 markets, and adds not more than 10 markets; or
      (B) A member makes 11 or more markets, and adds the greater of 10 markets or the number of markets that reflects a 30 percent increase.
      (c) Exclusions from Safe Harbor

      The safe harbor is not available to a member under the following circumstances:
      (1) A member is subject to a membership agreement that contains a restriction directly related to one or more of the enumerated categories listed in paragraph (b) of this Rule; or
      (2) A member has disciplinary history.

      * * * * *

      1134. Reserved

      * * * * *

      1135. Reserved

      * * * * *

      1136. Reserved

      * * * * *

      1137. Reserved

      * * * * *

      1138. Reserved

      * * * * *

      1139. Reserved

      * * * * *

      [1018. Reserved]

      * * * * *

      [1019. Application to Commission for Review redesignated as proposed Rule 1168]

      * * * * *

      [1014]1140. [Department Decision]STANDARDS FOR APPROVAL OF APPLICATION

      * * * * *

      1141. General Provisions
      (a) An Applicant that seeks approval of an Application shall satisfy the standards set forth in Rule 1142 subject to paragraph (b) below.
      (b) An Applicant may identify any standard that it believes is not applicable to the Department's review of the Application by providing a detailed written description of its rationale to the Department in the manner prescribed in Rule 1112. The Department shall make the final determination of the applicability of any standard, and the Applicant shall comply with the Department's determination. Such determination does not represent final action on the Application for purposes of the Rule 1160 Series.

      * * * * *

      [1014(a)]1142. Standards [for Admission]

      After considering the [a]Application, the membership interview, if held, other information and documents provided by the Applicant, other documents and information [and documents] obtained by the Department and the public interest and the protection of investors, the Department shall determine whether the Applicant [meets]satisfies each of the following standards that are applicable to such Applicant in accordance with Rule 1141:
      [(1)](a) Complete and Accurate Application

      The [a]Application and all supporting documents and information requested therein are complete, [and] accurate, and consistent with applicable securities laws and regulations, and with applicable FINRA rules.
      [(2)](b) Licenses and Registrations, and Continuing Education
      (1) The Applicant and its Associated Persons have all licenses and registrations required by state and federal authorities and self-regulatory organizations and have paid all applicable feesf[.]; and
      (2) The Applicant has completed a training needs evaluation and has a written training plan that complies with the continuing education requirements imposed by applicable securities laws and regulations, and with applicable FINRA rules.
      (c) Source of Funding

      The Applicant has fully disclosed and established through documentation all direct and indirect sources of funding.
      [(3)](d) Compliance with Securities Laws, and Just and Eguitable Principles of Trade

      The Applicant and its Associated Persons are capable of complying with [the federal]applicable securities laws[, the rules] and regulations [thereunder], and with applicable [NASD]FINRA [R]rules, including observing high standards of commercial honor and just and equitable principles of trade. In determining whether this standard is met, the Department shall take into consideration all documents and information in its possession, including whether:
      [(A)](1) a state or federal authority or self-regulatory organization has taken permanent or temporary adverse action with respect to a registration or licensing determination regarding the Applicant or an Associated Person;
      [(B)](2) an Applicant's or Associated Person's record reflects a sales practice event, a pending arbitration, or a pending private civil action;
      [(C)](3) [an]the Applicant or an Associated Person is the subject of.
      (A) a pending, adjudicated, or settled regulatory action or investigation by the [Commission]SEC, the Commodity Futures Trading Commission, a federal[,] or state regulatory agency, [or]a foreign financial regulatory [agency]authorjty, or a self-regulatory organization;
      (B) an adjudicated[,] or settled investment-related private civil action for damages^ or an injunction; or
      (C) a criminal action (other than a minor traffic violation) that is pending, adjudicated, or that has resulted in a guilty or no contest plea; [or]
      (4) an Applicant, its control persons, principals, registered representatives, other Associated Persons, any lender of 5[%]percent or more of the Applicant's net capital, and any other member with respect to which these persons were a control person or a 5F%lpercent lender of its net capital is subject to unpaid arbitration awards, other adjudicated customer awards, or unpaid arbitration settlements;
      [(D)](5) an Associated Person was terminated for cause or permitted to resign after an investigation of an alleged violation of a federal or state securities law, a rule or regulation thereunder, a self-regulatory organization rule, or industry standard of conduct;
      [(E)](6) a state or federal authority or self-regulatory organization has imposed a remedial action, such as special training, continuing education requirements, or heightened supervision, on an Associated Person; and
      [(F)](7) a state or federal authority or self-regulatory organization has provided information indicating that the Applicant, [or] an Associated Person otherwise poses a threat to public investors.
      [(4)](e) Contractual and Business Relationships

      The Applicant has established all contractual or other arrangements and business relationships with banks, other brokers or dealers, clearing corporations, service bureaus, or others necessary to[:]
      [(A)] initiate the operations described in the Applicant's [business plan]Application, considering the nature and scope of operations and the number of personnel[; and].
      [(B) comply with the federal securities laws, the rules and regulations thereunder, and NASD Rules.]
      [(5) The Applicant has or has adequate plans to obtain facilities that are sufficient to:]
      [(A) initiate the operations described in the Applicant's business plan, considering the nature and scope of operations and the number of personnel; and]
      [(B) comply with the federal securities laws, the rules and regulations thereunder, and NASD Rules.]
      [(6)](f) Communications and Operational Systems

      The communications and operational systems that the Applicant intends to employ for the purpose of conducting business with customers and other members are adequate and provide reasonably for business continuity pursuant to Rule 4370 [in each area set forth in Rule 1013(a)(2)(E)(xii);].
      [(7)](g) Financial and Operational Controls; Capital
      (1) The Applicant has adequate financial and operational controls to comply with SEA Rules 15c3-1 and 15c3-3 and is capable of maintaining a level of net capital in excess of the minimum net capital requirements set forth in SE[C]A Rule 15c3-1 and Rule 4110, as applicable, and adequate to support the Applicant's intended business operations on a continuing basis[, based on information filed under Rule 1013(b)(5)].
      (2) The Department may impose a reasonably determined higher [net] capital requirement for the initiation of operations after considering:
      (A) the amount of net capital sufficient to avoid early warning level reporting requirements, such as SE[C]A Rule 17a-11 and Rule 4120, as applicable;
      (B) the amount of capital necessary to meet expenses [net of revenues] for at least [twelve]12 months, based on reliable projections of revenue agreed to by the Applicant and the Department;
      (C) any planned market making activities, the number of markets to be made, the type and volatility of products, and the anticipated maximum inventory positions;
      (D) any plan to enter into other contractual commitments, such as underwritings or other securities-related activities;
      (E) any plan to distribute or maintain securities products in proprietary positions, and the risks, volatility, degree of liquidity, and speculative nature of the products; and
      (F) any other activity that the Applicant will engage in that reasonably could have a material impact on the Applicant's net capital within the first [twelve]12 months of business operations.
      [(8) The Applicant has financial controls to ensure compliance with the federal securities laws, the rules and regulations thereunder, and NASD Rules.]
      [(9) The Applicant has compliance, supervisory, operational, and internal control practices and standards that are consistent with practices and standards regularly employed in the investment banking or securities business, taking into account the nature and scope of Applicant's proposed business.]
      [(10)](h) Supervisory System

      The Applicant has a supervisory system, including written supervisory procedures, internal operating procedures (including operational and internal controls), and compliance procedures to supervise the activities of each Associated Person that is reasonably designed to [prevent and detect, to the extent practicable, violations of the]achieve compliance with applicable [federal] securities laws[, the rules] and regulations [thereunder], and with applicable [NASD]FINRA [R]rules. In evaluating the adequacy of a supervisory system, the Department shall consider the overall nature and scope of the Applicant's intended business operations and shall consider [whether]:
      [(A)](1) the adequacy of the number, location, experience, and qualifications of supervisory personnel [are adequate] in light of the number, location, experience, and qualifications of persons to be supervised;
      (2) the Central Registration Depository record or other disciplinary history of supervisory personnel and persons to be supervised; [and]
      (3) the number and locations of the offices that the Applicant intends to open and the nature and scope of business to be conducted at each office;
      [(B)](4) the Applicant^ [has identifiedlidentification of specific Associated Persons to:
      (A) supervise and discharge each of the functions specified in the Applicant's [business plan]Application[,]; and
      (B) [to] supervise each of the Applicant's intended offices and locations, whether or not such offices or locations are required to be registered under [NASD]FINRA [R]rules;
      [(C)](5) the Applicant's [has identified]identification of the functions to be performed by each Associated Person and [has adopted]adoption of procedures to assure the registration with FINRA and applicable states of all persons whose functions are subject to such registration requirements;
      [(D)](6) the Applicant's identification of each Associated Person [identified] in the [business plan]Application to discharge a supervisory function [has at least one year of direct experience or two years of related experience in the subject area to be supervised]is qualified, either by virtue of experience or training, to carry out his or her assigned responsibilities;
      [(E)](7) whether the Applicant will solicit retail or institutional business;
      [(F)](8) whether the Applicant will recommend transactions or investment strategies involving a security or securities to customers;
      [(G)](9) whether the location or part-time status of a supervisor or principal will affect such person's ability to be an effective supervisor;
      [(H)](10) whether the Applicant [should be required to place one or morelwill implement heightened supervisory procedures on any Associated Person[s] [under heightened supervision pursuant to Notice to Members 97-19]whose record reflects a history of industry or regulatory-related incidents, including one or more disciplinary actions or sales practice events;
      [(i)](11) any remedial action, such as special training or continuing education requirements or heightened supervision, that has heretofore been imposed on an Associated Person by a state or federal authority or self-regulatory organization; and
      [(J)](12) any other condition that is identified that [will]may have a material impact on the Applicant's ability to detect and prevent violations of [the federal]applicable securities laws[, the rules] and regulations [thereunder], and applicable [NASD]FINRA [R]rules.
      [(11)](i) Recordkeeping System

      The Applicant has a recordkeeping system that enables the Applicant to comply with applicable federal, state, and self-regulatory organization recordkeeping requirements and a staff that is sufficient in qualifications and number to prepare and preserve required records.
      [(12) The Applicant has completed a training needs assessment and has a written training plan that complies with the continuing education requirements imposed by the federal securities laws, the rules and regulations thereunder, and NASD Rules.]
      [(13)](j) Other Information Possessed by FINRA

      FINRA does not possess any information indicating that the Applicant may circumvent, evade, or otherwise avoid compliance with [the federal]applicable securities laws[, the rules] and regulations [thereunder], or with applicable [NASD]FINRA [R]rules.
      [(14) The application and all supporting documents otherwise are consistent with the federal securities laws, the rules and regulations thereunder, and NASD Rules.]

      • • • Supplementary Material:..................

      .01 Pending Qualifications for Associated Persons. The Department may, in its discretion, approve an application for continuing membership where one or more of the Applicant's Associated Persons have applied for, but not acquired, all licenses and registrations required by federal and state authorities, and self-regulatory organizations, subject to the following conditions:
      (a) All Associated Persons must acguire all reguired licenses and registrations within 90 days of the date of the approval of the application;
      (b) The Applicant shall promptly notify the Department when such licenses and registrations are acguired;
      (c) The Applicant shall not engage in business activities that reguire a license or registration that has not been acguired; and
      (d) If all reguired licenses and registrations are not acguired within 90 days of the date of approval of the application, the Applicant must cease business operations until all such licenses and registrations have been acguired.

      * * * * *

      1143. Reserved

      * * * * *

      1144. Reserved

      * * * * *

      1145. Reserved

      * * * * *

      1146. Reserved

      * * * * *

      1147. Reserved

      * * * * *

      1148. Reserved

      * * * * *

      1149. Reserved

      * * * * *

      [1014]1150. DEPARTMENT DECISION

      * * * * *

      [1014(c)(3)]1151. [Failure to Serve] Timing of Decision
      (a) [If t]The Department [fails to]shall serve a written decision on the Applicant within [180]150 days [after]of the [filing of an applicationlApplication Filed Date or such [later]other date as the Department and the Applicant have agreed to in writing[,]. The Department shall serve its decision on the Applicant in accordance with Rule 1112.
      (b) If the Department fails to serve a written decision within the requisite timeframe under paragraph (a), the Applicant may file a written request with the FINRA Board requesting that the FINRA Board direct the Department to serve a decision. Within seven days after the filing of such a request, the FINRA Board shall direct the Department to serve its written decision immediately or to show good cause for an extension of time. If the Department shows good cause for an extension of time, the FINRA Board may extend the [180 day] time [limit]within which the Department must issue a decision by not more than 90 days from the FINRA Board's good cause determination.

      * * * * *

      [1014(b)]1152. [Granting or Denying] Department Decision on the Application
      [(1)] In reviewing [an]the [a]Application [for membership], the Department shall consider whether the Applicant and its Associated Persons [meet each ofsatisfy the standards in [paragraph (a)]Rule 1142 that are applicable to such Applicant in accordance with Rule 1141. [Where the Department determines that the Applicant or its Associated Persons are the subject of any of the events set forth in Rule 1014(a)(3)(A) and (C) through (E), a presumption exists that the application should be denied. The Applicant may overcome the presumption by demonstrating that it can meet each of the standards in paragraph (a), notwithstanding the existence of any of the events set forth in Rule 1014(a)(3)(A) and (C) through (E)].
      [(2)]
      (a) Granting or Denying the Application
      (1) If the Department determines that the Applicant [meets each oflsatisfies the applicable standards [in paragraph (a)]set forth under Rule 1142, the Department shall grant the [a]Application [for membership].
      [(3)](2) If the Department determines that the Applicant does not [meet]satisfy one or more of the applicable standards [in paragraph (a)]set forth under Rule 1142 in whole or in part, the Department shall:
      (A) grant the application subject to one or more restrictions reasonably designed to address a specific financial, operational, supervisory, disciplinary, investor protection, or other regulatory concern based on the applicable standards [for admission in]under Rule [1014(a)]1142; or
      (B)deny the application.
      (3) Contingent upon Rule 1154, the decision shall become effective upon service and shall remain in effect during the pendency of any review pursuant to the Rule 1160 Series until a decision constituting final action of FINRA is issued under the Rule 1160 Series unless otherwise directed by the National Adjudicatory Council, the FINRA Board or the SEC.
      [1014(f)](b) Effectiveness of Restriction

      A restriction imposed under this Rule shall remain in effect and bind the Applicant and all successors to the ownership or control of the Applicant unless[:]
      [(1)] it is is removed or modified by a decision constituting final action of FINRA issued under this Rule or Rules [1015]1166, [1016]1167, or [1017;]
      [(2)] stayed by the National Adjudicatory Council, the FINRA Board, or the [Commission]SEC.
      [1014(b)(1)](c) Presumption to Deny the Application

      [In reviewing an application for membership, the Department shall consider whether the Applicant and its Associated Persons meet each of the standards in paragraph (a). Where the Department determines that the Applicant or its Associated Persons are the subject of any of the events set forth in Rule 1014(a)(3)(A) and (C) through (E),] [a]A presumption exists that the [a]Application should be denied if the Applicant or its Associated Persons are the subject of any of the events set forth in Rule 1142(d)(1), and Rule 1142(d)(3) through (d)(6). The Applicant may overcome the presumption to deny the Application by demonstrating that it can [meet]satisfy [each of] the applicable standards in [paragraph (a)]Rule 1142, notwithstanding the existence of any of the events set forth in [Rule 1014(a)(3)(A) and (C) through E]the aforementioned subparagraphs of Rule 1142(d).

      * * * * *

      [1014(c)]1153. Content of Decision
      (a) If the Department grants the Application, the Department shall provide written notification to the Applicant.
      [1014(c)(2)](b) [If the Department denies the application, the decision shall explain in detail the reason for denial, referencing the applicable standard or standards in paragraph (a).] If the Department grants the [a]Application subject to one or more restrictions under this paragraph, the written decision shall explain, in detail, the reason for each restriction, referencing the applicable standard(s) [or standards] in [paragraph (a)]Rule 1142 upon which the restriction is based, and identify the specific financial, operational, supervisory, disciplinary, investor protection, or other regulatory concern that the restriction is designed to address and the manner in which the restriction is reasonably designed to address the concern.
      [1014(c)(2)](c) If the Department denies the [a]Application, the written decision shall explain, in detail, the reason for denial, referencing the applicable standard [or standards] in [paragraph (a)]Rule 1142 upon which the denial is based. [If the Department grants the application subject to restrictions, the decision shall explain in detail the reason for each restriction, referencing the applicable standard or standards in paragraph (a) upon which the restriction is based and identify the specific financial, operational, supervisory, disciplinary, investor protection, or other regulatory concern that the restriction is designed to address and the manner in which the restriction is reasonably designed to address the concern.]

      * * * * *

      [1014(d)]1154. Submission of Executed Written Membership Agreement

      [If the Department grants an application, with or without restriction, the Applicant's approval for membership shall be contingent upon the Applicant's filing of an executed written membership agreement, satisfactory to the Department, undertaking to:]
      (a) The Department's grant of the Application under Rule 1152 shall be contingent upon the Applicant's submission of an executed written membership agreement to the Department. Within 15 days after the Department's service of the membership agreement on the Applicant or within such other period agreed to by the Department and the Applicant, the Applicant shall submit an executed written membership agreement to the Department in the manner consistent with Rule 1112. The terms of such agreement shall reflect that, at a minimum, the Applicant agrees to:
      (1) abide by all provisions of the membership agreement, including any restriction(s) specified in the Department's decision; and
      (2)[obtain the Department's approval of a change in ownership, control, or business operations pursuant to Rule 1017, including the modification or removal of a membership agreement restriction]comply with the Rule 1130 Series.
      (b) Upon submission of the membership agreement, the Applicant may begin operating subject to the terms of such agreement. The Applicant shall not waive the right to file a written [request for review]notice of appeal under Rule [1015]1162 by executing a written membership agreement under this paragraph.

      * * * * *

      [1014(e)] 1155. Service and Effectiveness of Decision; Final Action
      (a) Service and Effectiveness of Decision

      The Department shall serve its decision [and the membership agreement] on the Applicant in accordance with Rule [1012]1112. The decision shall become effective upon service and shall remain in effect during the pendency of any review until a decision constituting final action of FINRA is issued under the Rule [1015 or 1016]1160 Series, unless otherwise directed by the National Adjudicatory Council, the FINRA Board, or the [Commission]SEC.
      [1014(g)](b) Final Action

      [Unless the]An Applicant may file[s] a written [request for a review]notice of appeal of the Department's decision with the National Adjudicatory Council [under]pursuant to Rule [1015]1162[,]. The procedures set forth in the Rule [1015]1160 Series shall apply to such review, and the National Adjudicatory Council's decision shall be subject to discretionary review by the FINRA Board pursuant to Rule [1016]1167. If the Applicant does not file a [request for a review]notice of appeal, the Department's decision shall constitute final action by FINRA for purposes of SEA Rule 19d-3.

      * * * * *

      1156. Reserved

      * * * * *

      1157. Reserved

      * * * * *

      1158. Reserved

      * * * * *

      1159. Reserved
      1160. REVIEW OF DEPARTMENT DECISION

      * * * * *

      [1012(c)]1161. Ex Parte Communications
      [(1)] The prohibitions against ex parte communications shall become effective when FINRA staff has knowledge that an Applicant intends to file a written [request for review by] notice of appeal with the National Adjudicatory Council under Rule [1015]1162.
      (a) Prohibited Communications
      [(2)] Unless on notice and opportunity for an Applicant and Interested FINRA Staff to participate, or to the extent required for the disposition of ex parte matters as authorized by [NASD1FINRA [R]rules:
      [(A)](1) No [an] Applicant, [a]or counsel to or representative of an Applicant, or [an] Interested FINRA Staff shall [not] make or knowingly cause to be made an ex parte communication relevant to the merits of a membership proceeding under the Rule [1010]1100 Series to a Governor, a member of the National Adjudicatory Council or a Subcommittee thereof, or a FINRA employee who is participating or advising in a decision of such a person with respect to that proceeding; and
      [(B)](2) No [a] Governor, [a] member of the National Adjudicatory Council or a Subcommittee thereof, or [a] FINRA employee who is participating or advising in the decision of such a person with respect to a membership proceeding shall [not] make or knowingly cause to be made to an Applicant, [a] counsel to or representative of the Applicant, or [an] Interested FINRA Staff an ex parte communication relevant to the merits of that proceeding.
      (b) Disclosure of Prohibited Communications
      [(3)] A Governor, a member of the National Adjudicatory Council or a Subcommittee thereof, or a FINRA employee participating or advising in the decision of such a person, who receives, makes, or knowingly causes to be made a communication prohibited by this [paragraph]Rule shall place in the record of the membership proceeding:
      [(A)](1) [a]AII such written communications;
      [(B)](2) [m]Memoranda stating the substance of all such oral communications and
      [(C)](3) [a]All written responses and memoranda stating the substance of all oral responses to all such communications.

      * * * * *

      [1015]1162. [Review by] Appeal to the National Adjudicatory Council
      (a) [Initiation of Review by ApplicantlTime to File Notice of Appeal

      An Applicant may file a written notice of appeal with the National Adjudicatory Council [Wjwithin 25 days after service of a decision issued under the Rule [1014 or 101711150 Seriesf, an Applicant may file a written request for review with the National Adjudicatory Council. A request for review shall state with specificity why the Applicant believes that the Department's decision is inconsistent with the membership standards set forth in Rule 1014, or otherwise should be set aside, and state whether a hearing is requested. The Applicant simultaneously shall file by first-class mail a copy of the request to the district office where the Applicant filed its application].
      [(b) Transmission of Documents redesignated as paragraph (a) under proposed Rule 1164]
      (b) Where to File Notice of Appeal; Methods of Service

      The Applicant shall file the notice of appeal with FINRA's Office of General Counsel and simultaneously shall serve a copy of the notice of appeal with the Department. The Applicant is permitted to file and serve the notice of appeal by personal service, by first class mail, first class certified mail, first class registered mail, or express mail through the U.S. Postal Service, by courier, or via electronic process or such other process as FINRA may prescribe.

      Filing or service by personal service or courier are complete upon delivery. Filing or service by mail is complete upon mailing. Filing or service is complete on the date recorded by FINRA's electronic systems for electronic communications or such other process as FINRA may prescribe.
      [(c) Membership Application Docket]

      [The Department shall promptly record in FINRA's membership application docket each request for review filed with the National Adjudicatory Council under this Rule and each material subsequent event, filing, and change in the status of a membership proceeding.]
      (c) Effect

      An appeal to the National Adjudicatory Council of a Department decision issued under the Rule 1150 Series shall not operate as a stay of that decision pending a decision from the National Adjudicatory Council issued under Rule 1166(b).
      [(d) Appointment of Subcommittee redesignated as paragraph (a) under proposed Rule 1163]
      [1015(a)](d) [Initiation of Review by Applicant]Content of Notice of Appeal

      [Within 25 days after service of a decision under Rule 1014 or 1017, an Applicant may file a written reguest for review with the National Adjudicatory Council. A reguest for review shalllThe notice of appeal must:
      (1) Be accompanied by the Department's written decision issued under the Rule 1150 Series;
      (2) [s]State with specificity why the Applicant believes that the Department's decision is inconsistent with the [membership]applicable standards set forth in Rule [1014]1142, or otherwise should be set aside[,]; and
      (3) [s]State whether a hearing is reguested. [The Applicant simultaneously shall file by first-class mail a copy of the reguest to the district office where the Applicant filed its application.]
      [(e) Powers of Subcommittee redesignated as paragraph (b) under proposed Rule 1163]
      (e) Withdrawal of Notice of Appeal

      An Applicant may withdraw its notice of appeal at any time by filing a written notice of withdrawal of appeal with the National Adjudicatory Council and serving notice thereof on the Department.
      [(f) Hearing redesignated as proposed Rule 1165]
      [(1) Notice redesignated as paragraph (a) under proposed Rule 1165]
      [(2) Counsel redesignated as paragraph (b) under proposed Rule 1165]
      [(3) Evidence redesignated in part as paragraph (b) under proposed Rule 1164 and paragraph (c) under proposed Rule 1165]
      [(4) Transcript redesignated as paragraph (e) under proposed Rule 1165]
      [(g) Additional Information, Briefs redesignated as paragraph (b) under proposed Rule 1163]
      [(h)](f) Abandonment of [Request for Review]Appeal

      The National Adjudicatory Council or Subcommittee may dismiss the appeal as abandoned, and the decision of the Department shall become the final action of FINRA under any of the following circumstances:
      (1) [If]When an Applicant fails to:
      (A) [fails to] specify the grounds for its [request for review]appeal under this Rule [1015(a)(1),];
      (B) appear at a hearing for which it has notice[,]; or
      (C) file information or briefs as [directed,lordered; or
      (2) When an Applicant:
      (A) files Form BDW;
      (B) becomes expelled from FINRA membership: or
      (C) enters into liquidation proceedings under the Securities Investor Protection Act of 1970.
      [the National Adjudicatory Council or the Review Subcommittee may dismiss the request for review as abandoned, and the decision of the Department shall become the final action of FINRA.] Upon a showing of good cause, the National Adjudicatory Council or [the Review] Subcommittee may withdraw a dismissal entered pursuant to this paragraph.
      [(i) Subcommittee Recommendation redesignated as paragraph (a) under proposed Rule 1166]
      [(j) Decision redesignated as paragraph (b) under proposed Rule 1166]

      * * * * *

      1163. Appointment and Powers of Subcommittee; Recusal and Disqualification, or Withdrawal
      [1015(d)](a) Appointment of Subcommittee by National Adjudicatory Council

      Following the filing of a notice of appeal pursuant to Rule 1162, [T]the National Adjudicatory Council or the Review Subcommittee (as defined in Rule 9120} shall appoint a Subcommittee to participate in the [reviewlappeal. [The Subcommittee shall be composed of two or more persons who shall be current or past members of the National Adjudicatory Council or former Directors or Governors.]
      [1015(e)](b) Powers of Subcommittee
      (1) General
      (A) For good cause shown, or with the consent of all of the parties to a proceeding, the Subcommittee may extend or shorten any time limits set forth in the Rule 1160 Series.
      (B) The Subcommittee shall have the authority to do all things necessary and appropriate to regulate the course of a proceeding under the Rule 1160 Series, including but not limited to, resolving any and all procedural and evidentiary matters.
      (2) Scheduling Conference

      Within 10 days following the filing of a written notice of appeal or within such other time prescribed by the Subcommittee, the Applicant and the Department shall participate in a scheduling conference. Subject to approval from the Subcommittee, the Applicant and the Department may agree to a hearing date and the date for the Subcommittee to present a recommended decision to the National Adjudicatory Council.
      (3) Function
      (A) If the Applicant reguests a hearing [is reguested], the Subcommittee shall conduct the hearing. If the Applicant does not reguest a hearing [is not requested], the Subcommittee may [serve a notice directing]order that a hearing be held.
      (B) If the Applicant does not request a hearing [is not requested] or [directed]the Subcommittee does not order that a hearing be held, the Subcommittee shall conduct its review of the appeal on the basis of the record developed before the Department and any written submissions made by the Applicant or the Department in connection with the [request for review]appeal.
      (C) The Subcommittee may cancel in writing a previously scheduled hearing for good cause shown due to abandonment or other similar unreasonable availability of the Applicant.
      [1015(g)](4) Additional Information, Briefs

      At any time during its consideration, the Subcommittee or the National Adjudicatory Council may [direct]order the Applicant or the Department to file additional information or briefs. Any additional information or brief filed shall be provided to all parties before the National Adjudicatory Council renders its decision.
      [1012(d)](c) Recusal [or]and Disqualification, or Withdrawal
      (1) Recusal and Disqualification

      No [A] Governor,, [or a] member of the National Adjudicatory Council or a Subcommittee thereof shall [not] participate in a matter governed by the Rule [1010]1100 Series as to which that person has a conflict of interest or bias, or [if] circumstances otherwise exist where his or her fairness might reasonably be questioned. In any such [a] case, the person shall recuse himself or herself or shall be disqualified as follows:
      (A) FINRA Board
      [(1)] The Chair of the FINRA Board shall have authority to [direct]order the disqualification of a Governor, and a majority of [the Governors of] the FINRA Board excluding the Chair of the FINRA Board, shall have authority to [direct]order the disqualification of the Chair of the FINRA Board.
      (B) National Adjudicatory Council
      [(2)] The Chair of the National Adjudicatory Council shall have authority to [direct]order the disqualification of a member of the National Adjudicatory Council or a [member of a] Subcommittee thereof appointed pursuant to this Rule [1015], and the Vice Chair of the National Adjudicatory Council shall have authority to [direct]order the disqualification of the Chair of the National Adjudicatory Council. and decide on a motion for disqualification. If a member of a Subcommittee is disqualified, the Chair or the Vice Chair of the National Adjudicatory Council shall appoint a replacement of such member.
      (C) Motion for Disqualification

      An Applicant or the Department may move for the disqualification of a member of the National Adjudicatory Council or a Subcommittee thereof appointed pursuant to this Rule. A motion shall be based upon a reasonable, good faith belief that a conflict of interest or bias exists or circumstances otherwise exist where the fairness of the member of the National Adjudicatory Council or a Subcommittee thereof might reasonably be Questioned, and shall be accompanied by an affidavit setting forth in detail the facts alleged to constitute grounds for disgualification, and the dates on which the Applicant or Department learned of those facts. Such motion shall be filed not later than 15 days after the later of:
      (i) when the Applicant or Department learned of the facts believed to constitute the disgualification; or
      (ii) when the Applicant or Department was notified of the assignment of the members of the Subcommittee.
      (2) Withdrawal

      If at any time a member of the National Adjudicatory Council or a Subcommittee thereof has a conflict of interest or bias or circumstances otherwise exist where the fairness of the member of the National Adjudicatory Council or a Subcommittee thereof might reasonably be guestioned, such member shall notify the Chair or the Vice Chair of the National Adjudicatory Council, and the Chair or the Vice Chair of the National Adjudicatory Council shall issue and serve on the Applicant and Department a notice stating that the member of the National Adjudicatory Council or a Subcommittee thereof has withdrawn from the matter. In the event that such member withdraws, is incapacitated, or is otherwise unable to continue service after a hearing has been convened, the Chair or Vice Chair of the National Adjudicatory Council shall appoint a replacement member.

      * * * * *

      1164. Transmission of Record, Exhibit and Witness Lists; Withheld Documents
      [1015(b)](a) Transmission of [Documents]Record

      Except as provided in paragraph (c) of this Rule, [W]within [ten]21 days after the filing of a [request for review]written notice of appeal or at such other time as the Subcommittee or National Adjudicatory Council may designate, the Department shall:
      (1) Assemble and prepare an index of the documents that were considered in connection with the Department's decision;
      [(1)](2) [t]Transmit the documents and index to [the National Adjudicatory Council] FINRA's Office of General Counsel [copies of all documents that were considered in connection with the Department's decision and an index to the documents]; [and]
      [(2)](3) [s]Serve on the Applicant a copy of such documents (other than those documents originally submitted by Applicant) and a copy of the indexf.l; and
      (4) Serve the record on the Applicant electronically or in any other manner FINRA may prescribe.
      [1015(f)(3)](b) [Evidence]Exhibit and Witness Lists
      (1) [Formal rules of evidence shall not apply to a hearing under this Rule.] Not later than [five]21 days before the hearing, the Applicant and the Department shall exchange copies of their proposed hearing exhibits and witness lists^ and provide copies of the same to the Subcommittee or National Adjudicatory Council. If the Applicant or the Department fails to provide copies of its proposed hearing exhibits or witness list within such time, the Subcommittee or National Adjudicatory Council shall exclude the evidence or witnesses from the proceeding, unless the Subcommittee or National Adjudicatory Council determines that good cause is shown for failure to comply with the production date set forth in this [subparagraph]Rule.
      (2) At any time prior to the hearing, the Subcommittee or National Adjudicatory Council, in the exercise of its discretion, may order the Applicant and Department to disclose any expert witness and information related to the expert, including a statement of the expert's gualifications, a listing of other proceedings in which the expert has given expert testimony, a list of the expert's publications, and copies of those publications.
      (c) Withheld Documents
      (1) The Department may withhold a document if:
      (A) the document is privileged or constitutes attorney work product;
      (B) the document is an examination or investigative report, an internal memorandum, or other note or writing prepared by a FINRA employee that shall not be offered in evidence;
      (C) the document would disclose:
      (i) an examination, investigatory or enforcement technigue or guideline of FINRA, a federal, state, or foreign regulatory authority, or a self-regulatory organization;
      (ii) the identity of a source, including a federal, state, or foreign regulatory authority or a self-regulatory organization that furnished information or was furnished information on a confidential basis regarding an investigation, an examination, an enforcement proceeding, or any other type of civil or criminal enforcement action; or
      (iii) an examination, an investigation, an enforcement proceeding, or any other type of civil or criminal enforcement action under consideration by, or initiated by, FINRA, a federal, state, or foreign regulatory authority, or a self-regulatory organization; or
      (D) the Subcommittee or National Adjudicatory Council grants leave to withhold a document or category of documents as not relevant to the subject matter of the proceeding, or for other good cause shown.
      (2) The Department shall withhold a document if the document is prohibited from disclosure by federal law.
      (3) Nothing in paragraph (c)(1) authorizes the Department to withhold a document, or a part thereof, that contains material exculpatory evidence.
      (d) Withheld Document List

      The Subcommittee or National Adjudicatory Council may reguire the Department to submit to the Subcommittee or National Adjudicatory Council a list of documents withheld pursuant to paragraph (c) or to submit to the Subcommittee or National Adjudicatory Council any document withheld. Upon review, the Subcommittee or National Adjudicatory Council may order the Department to make the list or any document withheld available to the other parties for inspection and copying unless federal law prohibits disclosure of the document or its existence. A motion to reguire the Department to produce a list of documents withheld pursuant to paragraph (c) shall be based upon some reason to believe that a document is being withheld in violation of this Rule.

      * * * * *

      [1015(f)]1165. Hearing
      [1015(f)(1)](a) When Held; Notice

      If a hearing is requested by the Applicant or [directed]ordered by the Subcommittee or National Adjudicatory Council, the hearing shall be held within [45190 days after the filing of the [request]notice of appeal with the National Adjudicatory Council or service of the notice by the Subcommittee or National Adjudicatory Council. Not later than 14 days before the hearing, [T]the Subcommittee or National Adjudicatory Council shall serve written notice of the date and time of the hearing to the Applicant [by facsimile or overnight courier] electronically or in any other manner FINRA may prescribe [not later than 14 days before the hearing].
      [1015(f)(2)](b) Counsel

      The Applicant and the Department may be represented by counsel at a hearing conducted pursuant to this Rule.
      [1015(f)(3)](c) Evidence

      The [F]formal rules of evidence shall not apply to a hearing under this Rule Series. [Not later than five days before the hearing, the Applicant and the Department shall exchange copies of their proposed hearing exhibits and witness lists and provide copies of the same to the National Adjudicatory Council. If the Applicant or the Department fails to provide copies of its proposed hearing exhibits or witness list within such time, the Subcommittee shall exclude the evidence or witnesses from the proceeding, unless the Subcommittee determines that good cause is shown for failure to comply with the production date set forth in this subparagraph.] The Subcommittee or National Adjudicatory Council may exclude all evidence that is irrelevant, immaterial, unduly repetitious or prejudicial.
      (1) The review of the Subcommittee or the National Adjudicatory Council shall be limited to consideration of:
      (A) all documents and information the Department considered in connection with the Department's decision under the Rule 1150 Series;
      (B) admitted exhibits submitted by the Department or the Applicant in accordance with Rule 1164;
      (C) witness testimony; and
      (D) any additional information or briefs the Department or Applicant has filed in accordance with Rule 1163(b)(4).
      (2) Other than the information specified in paragraph (c)(1) of this Rule, any other evidence is presumptively irrelevant. Upon a showing of good cause by the parties to the appeal, the Subcommittee or National Adjudicatory Council may admit other evidence presented by the parties to the appeal.
      (d) Testimony

      The Applicant and its representative, and any other person who are subject to the jurisdiction of FINRA shall testify under oath or affirmation. The oath or affirmation shall be administered by a court reporter or a notary public.
      [1015(f)(4)](e) Transcript

      The hearing shall be recorded and a transcript prepared by a court reporter. A transcript of the hearing shall be available for purchase from the court reporter at prescribed rates. The Applicant, the Department, or a witness may seek to correct the transcript. A proposed correction of the transcript shall be submitted to the Subcommittee or National Adjudicatory Council within a reasonable period of time prescribed by the Subcommittee or National Adjudicatory Council. Upon notice to the Applicant and the Department, the Subcommittee or National Adjudicatory Council may [direct]order the correction to the transcript as requested or sua sponte.

      * * * * *

      1166. Recommended Decision of Subcommittee and Decision of National Adjudicatory Council
      [1015(i)](a) Recommended Decision of Subcommittee [Recommendation]

      The Subcommittee shall present [a]its written recommended decision [in writing] to the National Adjudicatory Council within [60]75 days after the [date]conclusion of the hearing held pursuant to [paragraph (f)]Rule 1165, and not later than seven days before the meeting of the National Adjudicatory Council at which the membership proceeding shall be considered.
      [1015(j)](b) Decision of the National Adjudicatory Council
      (1) [Proposed Written] Decision

      After considering all matters presented [in the review]on appeal and the Subcommittee's written recommended [written] decision, the National Adjudicatory Council may affirm, modify, or reverse the Department's decision or remand the membership proceeding with instructions. The National Adjudicatory Council shall prepare a proposed written decision pursuant to [sub]paragraph (b)(2) of this Rule.
      (2) Contents of Decision

      The decision shall include:
      (A) a description of the Department's decision, including its rationale;
      (B) a description of the principal issues raised in the [review]proceeding;
      (C) a summary of the evidence on each issue; and
      (D) a statement whether the Department's decision is affirmed, modified, [or] reversed, or remanded, and a rationale therefor that references the applicable standards in Rule [1014]1142.
      (3) Issuance of Decision After Expiration of Call for Review Period[s]

      The National Adjudicatory Council shall provide its proposed written decision to the FINRA Board. The FINRA Board may call the membership proceeding for review pursuant to Rule [1016]1167. If the FINRA Board does not call the membership proceeding for review, the proposed written decision of the National Adjudicatory Council shall become final. [The National Adjudicatory Council shall serve the Applicant with a written notice specifying the date on which the call for review period expired and stating that the final written decision will be served within 15 days after such date.] The National Adjudicatory Council shall serve its final written decision within 15 days after the date on which the call for review period expired. The written decision shall constitute the final action of FINRA for purposes of SE[C]A Rule 19d-3, unless the National Adjudicatory Council remands the membership proceeding.
      (4) Failure to Issue Decision

      If the National Adjudicatory Council fails to serve its final written decision within the time prescribed in [sub]paragraph (b)(3) of this Rule, the Applicant may file a written request with the FINRA Board requesting that the FINRA Board direct the National Adjudicatory Council to serve its decision immediately or to show good cause for an extension of time. Within seven days after the filing of such a request, the FINRA Board shall direct the National Adjudicatory Council to serve its written decision immediately or to show good cause for an extension of time. If the National Adjudicatory Council shows good cause for an extension of time, the FINRA Board may extend the 152day time limit by not more than 15 days.

      * * * * *

      * * * * *

      [1016]1167. Discretionary Review by FINRA Board
      (a) Call [F]for Review [B]by Governor

      A Governor may call a membership proceeding for review by the FINRA Board if the call for review is made within the period prescribed in paragraph (b) of this Rule.
      (b) 15-Day Period; Waiver
      (1) A Governor shall make his or her call for review at the next meeting of the FINRA Board that is at least 15 days after the date on which the FINRA Board receives the proposed written decision of the National Adjudicatory Council.
      (2) By unanimous vote of the FINRA Board, the FINRA Board may shorten the period to less than 15 days. By an affirmative vote of the majority of the FINRA Board then in office, the FINRA Board may, during the 15zday period, vote to extend the period to more than 15 days.
      (c) Review [A]at Next Meeting

      If a Governor calls a membership proceeding for review within the time prescribed in paragraph (b), the FINRA Board shall review the membership proceeding not later than the next meeting of the FINRA Board. The FINRA Board may order the Applicant and the Department to file briefs in connection with review proceedings pursuant to this [paragraphjrule.
      (d) Decision of FINRA Board, Including Remand

      After review, the FINRA Board may affirm, modify, or reverse the proposed written decision of the National Adjudicatory Council. Alternatively, the FINRA Board may remand the membership proceeding with instructions. The FINRA Board shall prepare a written decision that includes all of the elements described in Rule [1015]1166(b).
      (e) Issuance of Decision

      The FINRA Board shall serve its written decision on the Applicant within 15 days after the meeting at which it conducted its review. The decision shall constitute the final action of FINRA for purposes of SE[C]A Rule 19d-3, unless the FINRA Board remands the [membership] proceeding.

      * * * * *

      [1019]1168. Application to the [Commission]SEC for Review

      A person aggrieved by final action of FINRA under the Rule [1010]1100 Series may apply for review by the [Commission]SEC pursuant to Section 19(d)(2) of the Exchange Act. The filing with the SEC of an application for review [by the SEC] shall not stay the effectiveness of a decision constituting final action of FINRA, unless the [Commission]SEC orders otherwise [orders].

      * * * * *

      1169. Reserved

      * * * * *

      Text of Proposed Changes to Section 4 of Schedule A to the FINRA By-Laws

      * * * * *

      SCHEDULE A TO THE BY-LAWS OF THE CORPORATION

      * * * * *

      Section 4—Fees

      (a) through (h) No Change.
      (i)
      (1) through (2) No Change.
      [(3) FINRA shall waive the fee assessed pursuant to paragraph (i)(1) for a continuing membership application where FINRA determines that such application is proposing less significant changes that do not require substantial staff review. For example, a continuing membership application may qualify for a fee waiver under this paragraph (i)(3) where the proposed change:]
      [(A) does not make any day-to-day changes in the applicant's business activities, management, supervision, assets, or liabilities, and the applicant is only proposing a change in the:]
      [(i) applicant's legal structure (e.g., changing from a corporation to an LLC);]
      [(ii) equity ownership, partnership capital, or other ownership interest in an applicant held by a corporate legal structure that is due solely to a reorganization of ownership or control of the applicant within the corporate legal structure (e.g., reorganizing only to add a holding company to the corporate legal structure's ownership or control chain of the applicant); or]
      [(iii) percentage of ownership interest or partnership capital of an applicant's existing owners or partners resulting in an owner or partner owning or controlling 25 percent or more of the ownership interest or partnership and that owner or partner has no disclosure or disciplinary issues in the preceding five years; or]
      [(B) is filed in connection with a direct or indirect acquisition or transfer of 25 percent or more in the aggregate of the applicant's assets or any asset, business, or line of operation that generates revenues composing 25 percent or more in the aggregate of the applicant's earnings, measured on a rolling 36-month basis, where the applicant also is ceasing operations as a broker or dealer (including filing a Form BDWwith the SEC); and there are either:]
      [(i) no pending or unpaid settled customer related claims (including, but not limited to, pending or unpaid settled arbitration or litigation actions) against the applicant or any of its associated persons; or]
      [(ii) pending or unpaid settled customer related claims (including, but not limited to, pending or unpaid settled arbitration or litigation actions) against the applicant or its associated persons, but the applicant demonstrates in the continuing membership application its ability to satisfy in full any unpaid customer related claim (e.g., sufficient capital or escrow funds, proof of adequate insurance for customer related claims).]

      * * * * *

      Text of NASD Rules, Incorporated NYSE Rules and Incorporated NYSE Rule
      Interpretations to be Deleted in their Entirety from the Transitional Rulebook

      * * * * *

      NASD Rules

      * * * * *

      [3140. Approval of Change in Exempt Status Under SEC Rule 15c3-3]

      Entire text deleted.

      * * * * *

      Incorporated NYSE Rules

      * * * * *

      [Rule 311. Formation and Approval of Member Organizations]

      Entire text deleted.

      * * * * *

      [Rule 312. Changes Within Member Organizations]

      Entire text deleted.

      * * * * *

      [Rule 313. Submission of Partnership Articles—Submission of Corporate Documents]

      Entire text deleted.

      * * * * *

      [Rule 321. Formation or Acquisition of Subsidiaries]

      Entire text deleted.

      * * * * *

      Incorporated NYSE Rule Interpretations

      * * * * *

      [Rule 311 Formation and Approval of Member Organizations]1

      [(b)]
      [(5) OFFICERS]
      [/01 Reserved.]
      [/02 Reserved.]
      [/03 Reserved.]
      [/06 Limitations on Principal Executives]

      [Principal Executives may be part-time employees, subject to the prior approval of the member organization pursuant to Rule 346(e).]
      [(f) PRINCIPAL PLACE OF BUSINESS]
      [/01 Criteria]

      [In order to satisfy the rule's requirement that a member organization's principal place of business be maintained within the U.S., at least the following must be located within the U.S., at a definite and manned physical location which is adequate to serve as the site for Exchange inspection of the organization:]
      [a) Assets of customers who are citizens or residents of the U.S. and assets associated with transactions effected in the U.S., except for:
      (1) funds which are ordinarily held in branch offices or in transit, and
      (2) securities which are held as provided for in SEA Rule 15c3-3(c).] [To the extent that the broker-dealer introduces customer accounts on a fully disclosed basis to a carrying firm which is located in the U. S., such customer assets may be located at the carrying firm.]
      [b) Books and records customarily maintained by brokers and dealers at their principal place of business and sufficient to permit the Exchange to conduct its inspection of the member organization.]

      [The utilization of a clearing broker, a bank, or a service bureau which prepares or maintains the member organizations' books and records in accordance with SEA Rules 17a-3 and 17a-4 would satisfy thi criterion if such broker, bank or bureau is located in the U.S., and the records would be readily accessible to the Exchange.]
      [c) Member organization capital sufficient to meet applicable capital requirements.]
      [d) All allied members, qualified and authorized to perform Rule 342 functions.]
      [e) Clearance, settlement and securities handling operations which pertain to securities transactions effected in the U.S., to the extent that such operations are maintained by the broker-dealer.]
      [f) Operations pertaining to foreign securities transactions effected on behalf of customers who are citizens or residents of the U.S., to the extent that such operations are customarily maintained by a broker-dealer at a principal place of business.]
      [(g) MINIMUM OF ACTIVE PARTNERS IN MEMBER ORGANIZATIONS—USE OF MEMBER ORGANIZATION NAME]
      [/01 Reserved.]
      [/02 Divisions of Member Organizations—Names]

      [Divisions that are not separate legal entities may not be identified by the use of such words as "Company", "Corporation" or "Incorporation", which connote separate entities. Persons staffing such divisions should not have the title of "President", which indicates a separate entity. The titles, "Vice President" or "Assistant Vice President" are satisfactory when used in a context which does not convey the existence of authority on behalf of the member organization not, in fact, possessed by that individual.]

      1 This version also reflects changes that becomes effective on October 1, 2018. See Securities Exchange Act Release No. 81098 (July 7, 2017), 82 FR 32419 (July 13, 2017) (Order Approving File No. SR-FINRA 2017-007).

    • 18-22 FINRA Requests Comment on Proposed Amendments to Its Discovery Guide to Require Production of Insurance Information in Arbitration; Comment Period Expires: September 24, 2018

      View PDF

      Discovery of Insurance Information in Arbitration

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 12212
      FINRA Rule 12407
      FINRA Rule 12506
      Suggested Routing

      Compliance
      Legal
      Registered Representatives
      Senior Management
      Key Topics

      Arbitration
      Code of Arbitration Procedure
      Discovery Guide
      Firm/Associated Persons Document Production List
      Insurance Information

      Summary

      FINRA is requesting comment on proposed amendments to the Discovery Guide's (Guide) Firm/Associated Persons Document Production List (Firm/ Associated Persons List) to require firms and associated persons, upon request, to produce documents concerning third-party insurance coverage in a customer arbitration proceeding. The proposed amendments would strictly limit the circumstances under which insurance coverage information could be presented to the arbitrators.

      The text of the proposed amendments is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Kenneth L. Andrichik, Senior Vice President and Chief Counsel, Office of Dispute Resolution, at (212) 858-3915; or
      •   Kristine Vo, Assistant Chief Counsel, Office of Dispute Resolution, at (212) 858-4106.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by September 24, 2018.

      Comments must be submitted through one of the following methods:

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

      Jennifer Piorko Mitchell
      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

      The proposed rule change must be filed with the Securities and Exchange Commission (SEC) pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2

      Background & Discussion

      The Guide supplements the discovery rules contained in the FINRA Code of Arbitration Procedure for Customer Disputes (Customer Code).3 It includes an introduction that describes the discovery process generally, and explains how arbitrators should apply the Guide in arbitration proceedings. The introduction is followed by two Document Production Lists, one for firms and associated persons and one for customers, which enumerate the documents that are presumptively discoverable in customer cases. As presumptively discoverable, parties do not have to expressly request the documents. FINRA expects the parties to exchange the documents without arbitrator or staff intervention. The Guide only applies to customer arbitration proceedings, not to intra-industry cases.

      FINRA's Dispute Resolution Task Force (Task Force)4 reviewed the Guide and concluded that insurance information would be beneficial to customers in arbitration proceedings. Therefore, the Task Force recommended that FINRA amend the Firm/Associated Persons List to provide for the production of insurance policies that may be applicable to a claimant's claims. Most state statutes require the production of insurance information, and insurance information is also discoverable under Federal discovery procedures.5 Although insurance information is presumptively discoverable in court, it is not usually introduced as evidence.

      Practitioners who represent customers at the forum have told FINRA staff that insurance information is important during settlement discussions, especially with firms for which the ability to pay a potential award may be uncertain. These customer representatives believe that having knowledge of possible insurance, if any, would make them better able to advise their clients and determine a litigation strategy. Practitioners who represent the industry have raised concerns about insurance information being presumptively discoverable because of the potential for an opposing party to leak the information to the arbitrators, which would be prejudicial to a firm or associated person. They caution that disclosing the existence of a policy could be misleading because insurance policies often contain exclusions and limits that might preclude payment to a customer. They also believe that FINRA should not require firms to produce insurance information automatically in every case because it may not be relevant if the ability to pay a potential award is not an issue in the case.

      Since insurance information is not included on the Firm/Associated Persons List, and the Guide does not otherwise address the issue of insurance, customer representatives currently request insurance information separately under the Customer Code.6 Firms and associated persons often object to these requests, thereby requiring customer representatives to seek an arbitrator's ruling on a proposed order for production. Because the Guide does not currently provide guidance for arbitrators on the issue of insurance information, the lack of guidance can lead to inconsistent arbitrator rulings relating to production.

      Proposed Amendments

      FINRA is proposing to amend the Firm/Associated Persons List to add a new List Item (Item) requiring the production of information relating to insurance policies obtained through third-party carriers. The Item would not require production of documents relating to self-insurance. FINRA generally expects parties to produce documents responsive to the Items on their respective Document Production List without parties requesting them, and without staff or arbitrator intervention. However, FINRA believes it is important to address the industry concern that firms with sufficient capital to pay arbitration awards should not be required to produce insurance information automatically in every arbitration case. For this reason, FINRA is proposing to require a party seeking the production of insurance information to expressly request that an opposing party produce insurance information. FINRA believes that few claimants will request insurance information from well-capitalized firms.

      Specifically, the Item would require firms and associated persons, upon request, to produce documents sufficient to provide details concerning the coverage and limits of any insurance policy regarding a named party under which any third-party insurance carrier might be liable to satisfy in whole or in part an award issued by an arbitrator in the subject arbitration proceeding or to indemnify or reimburse a party for payments made to satisfy an award. The Item would state that it may be prejudicial for arbitrators to be given information related to the coverage or lack of coverage by liability insurance. FINRA will train arbitrators to address potential prejudice by providing training materials on ODR's webpage and publications including The Neutral Corner. Any party wishing to submit evidence at a hearing relating to insurance must demonstrate to the arbitration panel that: (1) there are extraordinary circumstances warranting admission of the insurance information; or (2) the existence of an insurance policy is directly related to the dispute outlined in the statement of claim. The party must seek express authorization from the arbitration panel to submit the evidence.

      Even though FINRA would require production only upon request, the presence of the Item in the Document Production List would alert arbitrators that insurance information is a typical type of information that parties use to prepare in an arbitration proceeding. Adding the Item might result in fewer customer motions to compel production of insurance information and more consistent arbitrator rulings on the subject of insurance. However, since arbitrators only make rulings when firms or associated persons dispute discoverability, there also may be fewer instances in which arbitrators are exposed in any way to issues related to insurance.

      Economic Impact Assessment

      A. Regulatory Need

      Insurance information describing the policies of firms and associated persons can benefit customers to determine a litigation strategy in arbitration cases. Insurance policies, however, are not presumptively discoverable. The proposed amendments would provide customers the ability to request insurance information in all arbitration cases under the Customer Code.
      B. Economic Baseline

      The economic baseline for the proposal is the current discovery rules and supplemental Guide contained in the Customer Code. The current discovery rules and Guide enumerate the documents that are presumptively discoverable in customer cases. The proposal would affect the parties to customer cases including customers, firms and associated persons. The proposal would also affect insurance companies and FINRA arbitrators.

      Currently, customers may make a request under the Customer Code for a firm or an associated person to produce insurance information. If a firm or an associated person does not produce the information, then customers can seek an arbitrator's order for production. The lack of guidance from the Firm/Associated Persons List and the Guide, however, can lead to inconsistent arbitrator rulings regarding whether insurance documents must be produced.

      Information is not available for FINRA to measure the extent to which firms and associated persons currently produce insurance information, either from responses to a customer's request or by an arbitrator's order for production, nor the outcomes when insurance information is produced.
      C. Economic Impact

      Under the proposed amendments, the insurance information of a firm or an associated person would be presumptively discoverable, if requested, in all customer cases. The proposed amendments would therefore increase the number of cases in which a firm or an associated person produces the information.

      The benefits of the proposed amendments accrue primarily to claimants in arbitration cases. Insurance information can provide valuable information to a claimant when determining a litigation strategy. By receiving details of the existence and scope of any third-party insurance coverage, a customer can decide whether to amend the statement of claim to fit within the coverage. Insurance information can be particularly important during settlement discussions when the ability of a firm or an associated person to pay an award is otherwise less certain. For example, when the insurance coverage of a firm or an associated person is not known and their ability to pay an award is less certain, then a customer may have difficulty determining whether to settle a claim and for what amount. In this instance, a customer may be more likely to settle a claim for a lesser amount to ensure some monetary compensation for damages. The discovery of insurance information, therefore, could increase the ability of customers to determine a litigation strategy to maximize the monetary compensation they could expect to receive.

      The proposed amendments would also increase the consistency and efficiency of the arbitration forum. Insurance information would be presumptively discoverable in all customer cases upon request. Customers would seek an arbitrator's order for production in fewer cases and, therefore, reduce the forum fees associated with the requests.7

      Under the proposed amendments, firms and associated persons could incur additional costs associated with arbitration. Firms and associated persons that would otherwise not have provided the information would now have exposure to the risk that the opposing party could leak the information and prejudice the arbitrators. The proposed amendments, however, would restrict the ability of parties to submit evidence relating to insurance, thereby reducing the possibility that arbitrators could be prejudiced.

      The proposed amendments could also increase the use of policies by firms and associated persons when customers receive monetary compensation for damages. An increase in payout by insurance companies could result in an increase in premiums, reducing the incentive for firms and associated persons to purchase coverage. Although customers could also increase their claim amount in response to knowledge of insurance coverage, FINRA staff believes that arbitrators would continue to determine monetary awards based on actual damages.

      Customers would request insurance information if they believe the information is important to their litigation strategy. For example, customers could be more likely to request insurance information from less capitalized or smaller firms. Customers filed 4,811 claims in arbitration against firms and associated persons in 2016 and 2017. FINRA staff is able to identify 377 cases (8 percent) where the claim amount was greater than the excess net capital of a firm named as a respondent. The majority (3,958 or 73 percent) of the firms named as a respondent were either large or mid-sized, whereas the remaining firms (1,459 or 27 percent) were small.8

      Customers could also be more likely to request insurance information from firms or associated persons with multiple arbitration claims. Although FINRA does not publish information on open cases, customers could become aware of other arbitration cases involving a firm or associated person by searching for concluded cases on FINRA's Awards Online database or by searching for the firm or associated person in BrokerCheck.9 For example, among the 4,811 cases customers filed in 2016 and 2017, 3,804 (79 percent) of the cases had as a respondent a firm or an associated person who was also a respondent to a case that closed within the previous three months and that resulted in either (1) a settlement or (2) a monetary award in which the firm or associated person was partially or fully liable.10
      D. Alternatives Considered

      An alternative to the proposed amendments is the automatic production of insurance information by a firm or an associated person. However, evidence of insurance is less valuable to claimants when the respondent firm is self-insured and highly capitalized. FINRA believes that relative to the proposed amendments, this additional benefit to customers would not be commensurate to the additional costs to firms to produce the information in all cases.

      Request for Comment

      FINRA is interested in receiving comments on all aspects of the proposed amendments. In particular, FINRA requests comment on the following:

      1. The proposed amendments provide for the production of documents sufficient to provide details concerning coverage and limits of any insurance policy under which any third-party insurance carrier might be liable to satisfy in whole or in part an award. What type of documents should a party produce in order to comply with this requirement? What information contained in the documents, if any, should a party be allowed to redact before production to the other parties in the arbitration proceeding?
      2. The proposed amendments provide that a party must seek express authorization from the arbitration panel to submit evidence to the panel relating to insurance information. Under FINRA Rule 12212 (Sanctions), the arbitrators would be permitted to sanction a party for providing evidence of insurance information to the panel without seeking express authorization to do so. Should FINRA take any additional steps relating to sanctions if a party provides insurance information to the arbitration panel without express authorization? What steps should FINRA consider taking?
      3. What other rule requirements, if any, should FINRA consider to address a party's submission of insurance information to the arbitration panel without express authorization?
      4. Are there any material economic impacts, including costs and benefits, to customers, firms or associated persons that are associated specifically with the proposed amendments? If so: a) What are these economic impacts and what are their primary sources? b) To what extent would these economic impacts differ by business attributes, such as size of the firm or differences in business models? c) What would be the magnitude of these impacts, including costs and benefits?
      5. Are there any expected economic impacts associated with the proposed amendments not discussed in this Notice? What are they and what are the estimates of those impacts?

      1. Persons submitting comments are cautioned that FINRA does not redact or edit personal identifying information, such as names or email addresses, from comment 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 Rule 12506 (Document Production Lists). The Discovery Guide is available at www.finra.org/sites/default/files/ArbMed/p394527.pdf.

      4. The Task Force, which was composed of individuals representing a broad range of interests in securities dispute resolution, issued a report in December 2015, and action has been taken on most of its recommendations. More information about the Task Force, its recommendations and related status updates can be found at www.finra.org/arbitration-and-mediation/finra-dispute-resolution-task-force.

      5. See Federal Rules of Civil Procedures, Rule 26-Dutyto Disclose; General Provisions Governing Discovery.

      6. See FINRA Rule 12507 (Other Discovery Requests), which provides that parties may request additional documents or information from any party by serving a written request directly on the party.

      7. Parties would incur fewer forum fees relating to these requests for production. The panel determines which party or parties pay the forum fees associated with its rulings. Arbitrators would also receive less honorarium to decide these requests.

      8. The definition of firm size is based on Article 1 of the FINRA By-Laws. A firm is defined as "small" if it has at least one and no more than 150 registered persons, "mid-size" if it has at least 151 and no more than 499 registered persons, and "large" if it has 500 or more registered persons. In 289 of the 377 cases (77 percent) at least one of the firms with excess net capital less than the initial claim amount was small.

      9. A customer's counsel might also become aware of similar cases through their own caseload involving a firm or associated person, or through contact with other claimants' counsel.

      10. In 3,210 of the 3,804 cases (84 percent), FINRA staff is able to identify at least one of the firms as large or mid-size, and in 903 of the 3,804 cases (24 percent) FINRA staff is able to identify at least one of the firms as small. In a small number of cases (14) the total liability of the firm from the previous monetary awards was greater than its excess net capital.


      Attachment A

      Proposed new language is underlined.

      DISCOVERY GUIDE
      DOCUMENT PRODUCTION LISTS

      LIST 1

      Documents the Firm/Associated Persons Shall Produce in All Customer Cases

      * * *

      23) (a) If requested, the firm/associated persons shall produce documents sufficient to provide details concerning the coverage and limits of any insurance policy under which any third party insurance carrier might be liable to satisfy in whole or in part an award issued by an arbitrator in the subject arbitration proceeding or to indemnify or reimburse a party for payments made to satisfy an award.
      (b) It may be prejudicial for arbitrators to be given information related to the coverage or lack of coverage by liability insurance. Therefore, any party wishing to submit evidence at a hearing relating to insurance must demonstrate to the arbitration panel that: (1) there are extraordinary circumstances warranting admission of the insurance information; or (2) the existence of an insurance policy is directly related to the dispute outlined in the statement of claim. The party must seek express authorization from the arbitration panel to submit the evidence.

      * * *

    • 18-21 SEC Approves Amendments to Arbitration Codes to Provide an Additional Hearing Option in Simplified Arbitration; Effective Date: September 17, 2018

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      Simplified Arbitration

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 12600
      FINRA Rule 12800
      FINRA Rule 13600
      FINRA Rule 13800
      Suggested Routing

      Compliance
      Legal
      Registered Representatives
      Key Topics

      Arbitration
      Codes of Arbitration Procedure
      Simplified Arbitration

      Summary

      FINRA has amended its rules to provide a new option for simplified arbitration.1 The amendments provide an additional hearing option for parties in arbitration with claims of $50,000 or less, excluding interest and expenses.

      The amendments are effective September 17, 2018.

      The text of the amendments is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   David Carey, Associate Director, Office of Dispute Resolution, at (212) 858-4333 or david.carey@finra.org; or
      •   Kristine Vo, Assistant Chief Counsel, Office of Dispute Resolution, at (212) 858-4106 or kristine.vo@finra.org.

      Background & Discussion

      The Code of Arbitration Procedure for Customer Disputes (Customer Code) and the Code of Arbitration Procedure for Industry Disputes (Industry Code, and together with the Customer Code, the Codes) provide two options for administering cases with claims involving $50,000 or less, excluding interest and expenses. The default option is a decision by a single arbitrator based on the parties' pleadings and other materials submitted by the parties. The alternative option is a full hearing with a single arbitrator. Under the Customer Code, a customer may request a hearing (regardless of whether the customer is a claimant or respondent),2 and under the Industry Code, only the claimant may request a hearing.3 If a hearing is requested, it is generally held in person, and there are no limits on the number of hearing sessions that can take place.

      FINRA amended the Codes to provide an additional hearing option for parties in arbitration with claims of $50,000 or less, excluding interest and expenses (Special Proceeding). When filing a statement of claim through the Dispute Resolution Portal (DR Portal), a claimant will be prompted to choose one of the three options, including a Special Proceeding. When FINRA transmits the statement of claim to the respondent, FINRA will advise the respondent if the claimant has elected a Special Proceeding. The Special Proceeding option is subject to regular provisions of the Codes relating to prehearings and hearings, including all fee provisions, with several limiting conditions. The conditions are intended to ensure that parties have an opportunity to present their case to an arbitrator in a convenient and cost-effective manner that is less demanding than a regular hearing. Specifically:

      •   a Special Proceeding is held by telephone unless the parties agree to another method of appearance;
      •   the claimants, collectively, are limited to two hours to present their case(s) and half hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions;
      •   the respondents, collectively, are limited to two hours to present their case and half hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions;
      •   notwithstanding the above conditions, the arbitrator would have the discretion to cede his or her allotted time to the parties;4
      •   in no event could a Special Proceeding exceed two hearing sessions, exclusive of prehearing conferences, to be completed in one day;
      •   the parties will not be permitted to question the opposing parties' witnesses;
      •   the Customer Code provides that the customer could not call the opposing party, a current or former associated person of a member party, or a current or former employee of a member party as a witness, and members and associated persons could not call the customer of a member party as a witness; and
      •   the Industry Code provides that members and associated persons could not call an opposing party as a witness.

      FINRA anticipates that arbitrators will follow the usual order of proceedings. The claimant(s) will present an opening statement, followed by the respondent(s)' opening statement. The claimants will then present their case-in-chief, followed by the respondent(s)' case-in-chief. Any rebuttal would occur afterwards. The arbitrator will proceed with his or her questioning. The claimant(s) will present a closing statement, followed by the respondent(s)' closing statement. With the exception of the requirements for Special Proceedings, an arbitrator may vary the hearing procedure in his or her discretion, provided all parties are allowed a full and fair opportunity to present their respective cases.

      FINRA will create a dedicated hearing script for Special Proceedings that the arbitrator will read at the start of the Special Proceeding. FINRA will also modify its Initial Pre Hearing Conference Script (IPHC Script) so that parties in Special Proceedings will have advance knowledge of the rule's requirements, including the pre-hearing exchanges of documents and exhibits. Unlike regular hearings, parties will need to file their exhibits with FINRA before the Special Proceeding so that FINRA may send the exhibits to the arbitrators. The IPHC Script will also address the need for parties to have all exhibits available while they testify telephonically.

      FINRA will train arbitrators on Special Proceedings by producing a unique video training module and distributing training materials on ODR's webpage and publications including The Neutral Corner.

      FINRA will monitor how the process is working to determine whether it should modify the program in anyway.

      Effective Date

      The amendments are effective September 17, 2018, and apply to cases filed on or after that date.


      1. See Securities Exchange Act Release No. 83276 (May 17, 2018), 83 Federal Register 100 (May 23, 2018) (Order Approving File No. SR-FINRA-2018-003).

      2. See FINRA Rule 12800(c).

      3. See FINRA Rule 13800(c).

      4. Except for the two-hearing-session time limit for a Special Proceeding, FINRA would not impose any restrictions on the arbitrator's ability to ask the parties questions and has incorporated a substantial amount of time for arbitrator questions. Specifically, since FINRA would limit the parties' combined presentations to five hours, the arbitrator would have up to three hours to ask questions. In addition, FINRA would not prohibit the arbitrator from allowing parties additional time for their presentations or witness testimonies, so long as the hearing on the merits is completed within the two-hearing-session limit.


      Attachment A

      Proposed new language is underlined; deletions are in brackets.

      Customer Code

      12600. Required Hearings
      (a) Hearings will be held, unless:
      •   (1) The arbitration is administered under Rule 12800(c) or Rule 12801;
      •   (2) The parties agree otherwise in writing; or
      •   (3) The arbitration has been settled, withdrawn or dismissed.
      (b)–(c) No change.
      12800. Simplified Arbitration
      (a) Applicability of Rule

      This rule applies to arbitrations involving $50,000 or less, exclusive of interest and expenses. All arbitrations administered under this rule will be decided on the pleadings and other materials submitted by the parties unless the customer requests a hearing under paragraph (c) of this rule. Except as otherwise provided in this rule, all provisions of the Code apply to such arbitrations.
      (b) No change
      (c) Hearings
      (1) No hearing will be held in arbitrations administered under this rule unless the customer requests a hearing.
      (2) If no hearing is [held] requested, no initial prehearing conference or other prehearing conference will be held, and the arbitrator will render an award based on the pleadings and other materials submitted by the parties. [If a hearing is held, the regular provisions of the Code relating to prehearings and hearings, including fee provisions, will apply.]
      (3) If the customer requests a hearing, the customer must select between one of two hearing options under this rule.
      (A) Option One — the regular provisions of the Code relating to prehearings and hearings, including all fee provisions.
      (B) Option Two — a special proceeding, subject to the regular provisions of the Code relating to prehearings and hearings, including all fee provisions, except as modified by subparagraphs (i) through (viii) of this paragraph:
      (i) a special proceeding will be held by telephone unless the parties agree to another method of appearance;
      (ii) the claimants, collectively, are limited to two hours to present their case and 1/2 hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions;
      (iii) the respondents, collectively, are limited to two hours to present their case and 1/2 hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions;
      (iv) notwithstanding subparagraphs (ii) and (iii) above, the arbitrator has the discretion to cede his or her allotted time to the parties;
      (v) in no event shall a special proceeding exceed two hearing sessions, exclusive of prehearing conferences, to be completed in one day;
      (vi) the parties may not question the opposing parties' witnesses;
      (vii) a customer may not call an opposing party, a current or former associated person of a member party or a current or former employee of a member party as a witness; and
      (viii) members and associated persons may not call a customer of a member party as a witness.
      (d) – (e) No change.
      (f) Arbitrator Honoraria

      FINRA will pay the arbitrator an honorarium of $350 for each arbitration [administered underthis rule] decided on the pleadings and other materials submitted by the parties. In cases where the customer requests a hearing, the regular provisions of the Code relating to arbitrator honoraria will apply.

      * * * * *

      Industry Code

      13600. Required Hearings
      (a) Hearings will be held, unless:
      •   (1) The arbitration is administered under Rule 13800(c), Rule 13801 or Rule 13806(e)(1);
      •   (2) The parties agree otherwise in writing; or
      •   (3) The arbitration has been settled, withdrawn or dismissed.
      (b) – (c) No change.
      13800. Simplified Arbitration
      (a) – (b) No change.
      (c) Hearings
      (1) No hearing will be held in arbitrations administered under this rule unless the claimant requests a hearing.
      (2) If no hearing is [held] requested, no initial prehearing conference or other prehearing conference will be held, and the arbitrator will render an award based on the pleadings and other materials submitted by the parties. [If a hearing is held, the regular provisions of the Code relating to prehearings and hearings, including fee provisions, will apply.]
      (3) If the claimant requests a hearing, the claimant must select between one of two hearing options under this rule.
      (A) Option One — the regular provisions of the Code relating to prehearings and hearings, including all fee provisions.
      (B) Option Two — a special proceeding, subject to the regular provisions of the Code relating to prehearings and hearings, including all fee provisions, except as modified by subparagraphs (i) through (vii) of this paragraph:
      (i) a special proceeding will be held by telephone unless the parties agree to another method of appearance;
      (ii) the claimants, collectively, are limited to two hours to present their case and 1/2 hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions;
      (ii) the respondents, collectively, are limited to two hours to present their case and 1/2 hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions;
      (iv) notwithstanding subparagraphs (ii) and (iii) above, the arbitrator has the discretion to cede his or her allotted time to the parties;
      (v) in no event shall a special proceeding exceed two hearing sessions, exclusive of prehearing conferences, to be completed in one day;
      (vi) the parties may not question the opposing parties' witnesses; and
      (vii) members and associated persons may not call an opposing party as a witness.
      (d) – (e) No change.
      (f) Arbitrator Honoraria

      FINRA will pay the arbitrator an honorarium of $350 for each arbitration [administered under this rule] decided on the pleadings and other materials submitted by parties. In cases where the claimant requests a hearing, the regular provisions of the Code relating to arbitrator honoraria will apply.

    • 18-20 FINRA Encourages Firms to Notify FINRA if They Engage in Activities Related to Digital Assets

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      Digital Assets

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 3210
      FINRA Rule 3270
      FINRA Rule 3280
      NASD Rule 1017
      Notice to Members 00-73
      Regulation ATS
      Section 2(a)(1) of the Securities Act of 1933
      Section 3(a)(10) of the Securities Exchange Act of 1934
      Suggested Routing

      Compliance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Trading
      Training
      Key Topics

      Blockchain
      Cryptocurrencies
      Definition of "Security"
      Digital Assets
      Distributed Ledger Technology
      Initial Coin Offerings
      Virtual Coin
      Virtual Token

      Summary

      FINRA is monitoring developments in the digital asset marketplace and is undertaking efforts to ascertain the extent of FINRA member involvement related to digital assets. To supplement FINRA's efforts to date, FINRA is issuing this Notice to encourage each firm to promptly notify FINRA if it, or its associated persons or affiliates, currently engages, or intends to engage, in any activities related to digital assets, such as cryptocurrencies and other virtual coins and tokens. In addition, until July 31, 2019, FINRA encourages each firm to keep its Regulatory Coordinator abreast of changes in the event the firm, or its associated persons or affiliates, determines to engage in activities relating to digital assets not previously disclosed. If a firm recently has provided notice to its Regulatory Coordinator in response to a direct request, has provided this information by way of the 2018 Risk Control Assessment (RCA) Survey, or has submitted a continuing membership application (CMA) regarding its involvement in activities related to digital assets, FINRA does not request additional notification pursuant to this Notice unless a change has occurred.

      Questions concerning this Notice may be directed to:

      •   Kosha Dalal, Associate Vice President & Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6903 or by email at kosha.dalal@finra.org;
      •   Racquel Russell, Associate General Counsel, OGC, at (202) 728-8363 or by email at racquel.russell@finra.org; or
      •   Cara Rosen, Counsel, OGC, at (202) 728-8852 or by email at cara.rosen@finra.org

      Background & Discussion

      The market for digital assets,1 such as cryptocurrencies and other virtual coins and tokens, has grown significantly and has increasingly been of interest to retail investors. At the same time, investor protection concerns exist, including incidences of fraud and other securities law violations involving digital assets and the platforms on which they trade.2 As such, FINRA has a keen interest in remaining abreast of the extent of member involvement in this space. Firms that engage or begin to engage in such activities are reminded to consider all applicable federal and state laws, rules and regulations, including FINRA and SEC rules and regulations.3

      A firm, its associated persons or affiliates may be involved with digital assets in a myriad of ways. To better understand the scope of such activities, FINRA Regulatory Coordinators conducted a survey regarding firms' involvement in activities related to digital assets. In addition, the 2018 RCA Survey contained questions regarding digital assets. FINRA is supplementing these efforts by publishing this Notice to request that each firm promptly provide notification to its Regulatory Coordinator if it, or its associated persons (including activities under Rules 3270 and 3280)4 or affiliates, currently engages, or intends to engage, in activities related to digital assets, including digital assets that are non-securities.5 The types of activities of interest to FINRA if undertaken (or planned) by a member, its associated persons or affiliates, include, but are not limited to:

      •   purchases, sales or executions of transactions in digital assets;
      •   purchases, sales or executions of transactions in a pooled fund investing in digital assets;
      •   creation of, management of, or provision of advisory services for, a pooled fund related to digital assets;
      •   purchases, sales or executions of transactions in derivatives (e.g., futures, options) tied to digital assets;
      •   participation in an initial or secondary offering of digital assets (e.g., ICO, pre-ICO);
      •   creation or management of a platform for the secondary trading of digital assets;
      •   custody or similar arrangement of digital assets;
      •   acceptance of cryptocurrencies (e.g., bitcoin) from customers;
      •   mining of cryptocurrencies;
      •   recommend, solicit or accept orders in cryptocurrencies and other virtual coins and tokens;
      •   display indications of interest or quotations in cryptocurrencies and other virtual coins and tokens;
      •   provide or facilitate clearance and settlement services for cryptocurrencies and other virtual coins and tokens; or
      •   recording cryptocurrencies and other virtual coins and tokens using distributed ledger technology or any other use of blockchain technology.6

      FINRA encourages firms to promptly notify their Regulatory Coordinator in writing (including email) of its or its associated persons' or affiliates' involvement in activities related to digital assets. A material change in a firm's business operations also requires the submission and approval of a CMA.7 If a firm already has submitted a CMA regarding its involvement in activities related to digital assets, or provided notification to its Regulatory Coordinator in response to a direct request, or by way of the 2018 RCA Survey, FINRA does not request additional notice unless a change has occurred. Until July 31, 2019, each firm is encouraged to keep its Regulatory Coordinator updated if it, or its associated persons or affiliates, begins or intends to begin, engaging in a new type of activity relating to digital assets not previously disclosed.


      1. For purposes of this Notice, the term "digital asset" refers to cryptocurrencies and other virtual coins and tokens (including virtual coins and tokens offered in an initial coin offering (ICO) or pre-ICO), and any other asset that consists of, or is represented by, records in a blockchain or distributed ledger (including any securities, commodities, software, contracts, accounts, rights, intangible property, personal property, real estate or other assets that are "tokenized," "virtualized" or otherwise represented by records in a blockchain or distributed ledger).

      2. See e.g., SEC press release, SEC Emergency Action Halts ICO Scam (December 4, 2017); SEC press release, SEC Halts Fraudulent Scheme Involving Unregistered ICO (April 2, 2018); SEC public statement, Divisions of Enforcement and Trading and Markets, Statement on Potentially Unlawful Online Platforms for Trading Digital Assets (March 7, 2018); SEC Investor Alert, Public Companies Making ICO-Related Claims (August 28, 2017); and FINRA Investor Alert, Don't Fall for Cryptocurrency-Related Stock Scams (last updated December 21, 2017).

      3. Digital assets that meet the definition of an "investment contract" under Section 2(a)(1) of the Securities Act of 1933 or under Section 3(a)(10) of the Securities Exchange Act of 1934 are "securities" governed by the federal securities laws and FINRA rules, irrespective of whether or not they are labeled as "securities." See generally Securities Exchange Act Release No. 81207 (July 25, 2017), Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO.

      4. FINRA is interested in learning from firms how they currently handle notifications regarding participation in activities related to digital assets, such as cryptocurrencies and other virtual coins and tokens. See FINRA Rule 3270 (Outside Business Activities of Registered Persons) and Rule 3280 (Private Securities Transactions of an Associated Person). FINRA is not requesting notification or information regarding passive investments and activities of associated persons that are subject to the requirements of Rule 3210 (Accounts at Other Broker-Dealers and Financial Institutions).

      5. This notification is separate from any existing regulatory obligations under FINRA rules that may apply to a firm regarding its involvement in activities relating to digital assets (e.g., trade reporting transactions in digital assets that meet the definition of a "security" or filing a new member application or continuing member application). This notification also is separate from any other regulatory obligations that may apply to a firm regarding its involvement in activities relating to digital assets, such as submitting Form ATS filings as required, including notifications of "material changes" under Regulation ATS, such as changes to the types of securities traded on a platform. See Securities Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70845, 70922 (December 22, 1998) (Regulation ATS adopting release) (including changes to "the operating platform, the types of securities traded, or the types of subscribers" as examples of "material changes" that must be filed under Rule 301(b) (2) of Regulation ATS); see also Regulatory Notice 09-46 (August 2009) (reminding alternative trading systems of the need to submit to FINRA duplicate copies of any filing required by Rule 301(b)(2) of Regulation ATS).

      6. Cryptocurrencies and other virtual coins and tokens use distributed ledger technology, most commonly known as "blockchain," as the primary protocol for exchanging, storing and verifying information.

      7. For factors to consider in determining materiality, see Notice to Members 00-73 (SEC Approves Amendments to NASD Membership Rules). See also NASD Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations).

    • 18-19 FINRA Amends Rule 3310 to Conform to FinCEN's Final Rule on Customer Due Diligence Requirements for Financial Institutions

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      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      Bank Secrecy Act
      FINRA Rule 3310
      Regulatory Notice 17-40
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Anti-Money Laundering
      Compliance Programs

      Summary

      FINRA has filed for immediate effectiveness amendments to FINRA Rule 3310 (Anti-Money Laundering Compliance Program) to reflect the Financial Crimes Enforcement Network's (FinCEN) adoption of a final rule on Customer Due Diligence Requirements for Financial Institutions (CDD Rule).1 The implementation date is May 11, 2018. This implementation date aligns with the compliance date for FinCEN's CDD Rule.

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

      Questions concerning this Notice should be directed to:

      •   Michael Rufino, Executive Vice President, Head of Member Regulation – Sales Practice, at (202) 728-8381 or by email at Michael.Rufino@finra.org;
      •   Victoria Crane, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104 or by email at Victoria.Crane@finra.org; or
      •   Julia Bogolin, Counsel, OGC, at (202) 728-8111 or by email at Julia.Bogolin@finra.org.

      Background & Discussion

      On May 11, 2016, FinCEN, the bureau of the Department of the Treasury responsible for administering the Bank Secrecy Act2 (BSA) and its implementing regulations, issued the CDD Rule3 to clarify and strengthen customer due diligence for covered financial institutions,4 including broker-dealers. In its CDD Rule, FinCEN identifies four components of customer due diligence: (1) customer identification and verification; (2) beneficial ownership identification and verification; (3) understanding the nature and purpose of customer relationships; and (4) ongoing monitoring for reporting suspicious transactions and, on a risk basis, maintaining and updating customer information.5 As the first component is already an AML program requirement, the CDD Rule focuses on the other three components.

      Specifically, the CDD Rule focuses particularly on the second component by adding a new requirement that covered financial institutions identify and verify the identity of the beneficial owners of all legal entity customers at the time a new account is opened, subject to certain exclusions and exemptions. The CDD Rule also addresses the third and fourth components by amending the existing AML program rules for covered financial institutions to explicitly require these components to be included in AML programs as a new "fifth pillar."

      On November 21, 2017, FINRA published Regulatory Notice 17-40 to provide guidance to member firms regarding their obligations under FINRA Rule 3310 in light of the adoption of FinCEN's CDD Rule.6 In addition, the Notice summarized the CDD Rule's impact on member firms, including the ongoing customer due diligence requirement, or "fifth pillar," required for member firms' AML programs.

      The recently filed amendments to FINRA Rule 3310 incorporate into the rule this ongoing customer due diligence requirement to conform the rule to the CDD Rule and aid member firms in complying with the CDD Rule's requirements. Specifically, FINRA Rule 3310(f) requires member firms' AML programs to, at a minimum include appropriate risk-based procedures for conducting ongoing customer due diligence, to include, but not be limited to: (1) understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile; and (2) conducting ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.

      As stated in the CDD Rule, these provisions are not new and merely codify existing expectations for firms to adequately identify and report suspicious transactions as required under the BSA, and encapsulate practices generally already undertaken by securities firms to know and understand their customers.

      Member firms should ensure that their AML programs are updated, as necessary, to comply with the CDD Rule by May 11, 2018.


      1. See Securities Exchange Act Release No. 83154 (May 2, 2018) (Notice of Filing and Immediate Effectiveness File No. SR-FINRA-2018-016).

      2. 31 U.S.C. 5311, et seq.

      3. FinCEN Customer Due Diligence Requirements for Financial Institutions; CDD Rule, 81 FR 29397 (May 11, 2016) (CDD Rule Release); 82 FR 45182 (September 28, 2017) (making technical correcting amendments to the final CDD Rule published on May 11, 2016). FinCEN is authorized to impose AML program requirements on financial institutions and to require financial institutions to maintain procedures to ensure compliance with the BSA and associated regulations. 31 U.S.C. 5318(h)(2) and (a)(2). The CDD Rule is the result of the rulemaking process FinCEN initiated in March 2012. See 77 FR 13046 (March 5, 2012) (Advance Notice of Proposed Rulemaking) and 79 FR 45151 (Aug. 4, 2014) (Notice of Proposed Rulemaking).

      4. See 31 C.F.R. 1010.230(f) (defining "covered financial institution").

      5. See CDD Rule Release at 29398.

      6. See Regulatory Notice 17-40 (November 2017).


      ATTACHMENT A

      Below is the text of the amended rule text. New language is underlined; deletions are in brackets.

      * * * * *

      3000. SUPERVISION AND RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS

      * * * * *

      3300. ANTI-MONEY LAUNDERING
      3310. Anti-Money Laundering Compliance Program
      Each member shall develop and implement a written anti-money laundering program reasonably designed to achieve and monitor the member's compliance with the requirements of the Bank Secrecy Act (31 U.S.C. 5311, et seq.), and the implementing regulations promulgated thereunder by the Department of the Treasury. Each member's anti-money laundering program must be approved, in writing, by a member of senior management. The anti-money laundering programs required by this Rule shall, at a minimum,
      (a) through (c) No change.
      (d) Designate and identify to FINRA (by name, title, mailing address, e-mail address, telephone number, and facsimile number) an individual or individuals responsible for implementing and monitoring the day-to-day operations and internal controls of the program (such individual or individuals must be an associated person of the member) and provide prompt notification to FINRA regarding any change in such designation(s); [and]
      (e) Provide ongoing training for appropriate personnel;[.] and
      (f) Include appropriate risk-based procedures for conducting ongoing customer due diligence, to include, but not be limited to:
      (i) Understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile; and
      (ii) Conducting ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information. For purposes of paragraph (f)(ii), customer information shall include information regarding the beneficial owners of legal entity customers (as defined in 31 CFR 1010.230(e)).

    • 18-18 FINRA Extends Effective Date of Margin Requirements for Covered Agency Transactions

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      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4210
      Regulatory Notice 16-31
      Regulatory Notice 17-28
      SEA Rule 15c3-1
      SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Legal
      Margin Department
      Operations
      Regulatory Reporting
      Risk Management
      Senior Management
      Key Topics

      Covered Agency Transactions
      Margin

      Summary

      In June 2016, the SEC approved1 FINRA's rule change (referred to as the "rule change") amending FINRA Rule 4210 to establish margin requirements for Covered Agency Transactions.2 FINRA is extending, to March 25, 2019, the effective date of the requirements pursuant to the rule change that otherwise would have become effective on June 25, 2018.3

      Questions regarding this Notice should be directed to:

      •   Kris Dailey, Vice President, Risk Oversight & Operational Regulation (ROOR), at (646) 315-8434 or Kris.Dailey@finra.org;
      •   Adam Rodriguez, Director, Credit Regulation, ROOR, at (646) 315-8572 or Adam.Rodriguez@finra.org;
      •   Adam Arkel, Associate General Counsel, Office of General Counsel, at (202) 728-6961 or Adam.Arkel@finra.org.

      Questions may also be directed to covered.agency.margin@finra.org. FINRA will publish additional guidance as appropriate to address questions that FINRA receives.

      Background & Discussion

      FINRA issued Regulatory Notice 16-31 in August 2016 to announce the SEC's approval of the rule change and the effective dates of the new requirements. FINRA announced that the risk limit determination requirements as set forth in paragraphs (e)(2)(F), (e)(2)(G) and (e)(2)(H) of Rule 4210, and Supplementary Material .05 of Rule 4210, each as respectively amended or established by the rule change (collectively referred to as the "risk limit determination requirements") would become effective on December 15, 2016.

      In September 2017, FINRA issued Regulatory Notice 17-28 to announce the extension of the implementation date for all other requirements pursuant to the rule change—broadly, the substantive margin requirements for Covered Agency Transactions—to June 25, 2018.

      FINRA is issuing this Notice to announce that FINRA is extending, until March 25, 2019, the effective date of the requirements that otherwise would have become effective on June 25, 2018.4 Members should note that the risk limit determination requirements became effective on December 15, 2016, and are not affected by this Notice.

      Members are reminded that, in response to questions received from industry participants, FINRA has made available a set of Responses To Frequently Asked Questions & Guidance Regarding Covered Agency Transactions Under FINRA Rule 4210 [http://www.finra.org/sites/default/files/faq_coveredtransactions_rule4210.pdf] to facilitate members' efforts to comply with the new requirements.5 Further, FINRA has made available a set of Frequently Asked Questions Regarding SEA Rule 15c3-1 and Rule 15c3-3 in Connection With Covered Agency Transactions Under FINRA Rule 4210 [http://www.finra.org/sites/default/files/faq_coveredtransactions_sec.pdf] provided by the staff of the SEC's Division of Trading and Markets.


      1. See Securities Exchange Act Release No. 78081 (June 15, 2016), 81 FR 40364 (June 21, 2016) (Notice of Filing of Amendment No. 3 and Order Granting Accelerated Approval to a Proposed Rule Change To Amend FINRA Rule 4210 (Margin Requirements) To Establish Margin Requirements for the TBA Market, as Modified by Amendment Nos. 1, 2, and 3; File No. SR-FINRA-2015-036); see also Regulatory Notice 16-31 (August 2016) (announcing the SEC's approval of the rule change).

      2. Covered Agency Transactions include (1) To Be Announced (TBA) transactions, inclusive of adjustable rate mortgage (ARM) transactions, (2) Specified Pool Transactions and (3) transactions in Collateralized Mortgage Obligations (CMOs), issued in conformity with a program of an agency or Government-Sponsored Enterprise (GSE), with forward settlement dates, as defined more fully in paragraph (e)(2)(H)(i)c. of FINRA Rule 4210.

      3. See Securities Exchange Act Release No. 83155 (May 2, 2018) (Notice of Filing and Immediate Effectiveness of a Proposed Rule Change to Extend the Implementation Date of Certain Amendments to FINRA Rule 4210 Approved Pursuant to SR-FINRA-2015-036; File No. SRFINRA-2018-017) (extending, until March 25, 2019, the implementation date of the amendments to FINRA Rule 4210 pursuant to SR-FINRA-2015-036, other than the amendments pursuant to SR-FINRA-2015-036 that were implemented on December 15, 2016).

      4. See note 3.

      5. FINRA will periodically update the frequently asked questions and guidance as appropriate.

    • 18-17 FINRA Revises the Sanction Guidelines; Effective Date: June 1, 2018

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      Regulatory Notice
      Notice Type

      Guidance
      Key Topics

      FINRA Sanction Guidelines
      Suggested Routing

      Legal
      Registered Representatives
      Senior Management

      Sanction Guidelines

      Summary

      FINRA is revising its Sanction Guidelines to instruct adjudicators in the disciplinary process to consider customer-initiated arbitrations that result in adverse arbitration awards or settlements when assessing sanctions. Thus, when a respondent's disciplinary history, and history of arbitration awards and arbitration settlements together with the violation found in a disciplinary case, form a pattern, the Sanction Guidelines advise that adjudicators should consider imposing more stringent sanctions.

      These revisions to the Sanction Guidelines take effect for all complaints filed in FINRA's disciplinary system beginning on June 1, 2018. They are available on FINRA's website at www.finra.org/Industry/Enforcement/SanctionGuidelines.

      Questions concerning this Notice may be directed to Alan Lawhead, Office of General Counsel, at (202) 728-8853 or alan.lawhead@finra.org.

      Background & Discussion

      FINRA's Sanction Guidelines provide both general principles that apply to the overall process of determining sanctions for every case and specific recommendations of a range of sanctions for particular rule violations. The Sanction Guidelines familiarize firms with a wide variety of typical securitiesindustry rule violations, and the range of disciplinary sanctions that may result from those rule violations. The goals of the Sanction Guidelines are to assist FINRA's adjudicators in determining the appropriate sanctions in disciplinary proceedings and to provide consistency in the imposition of sanctions.

      Revisions to General Principle No. 2 to Include Consideration of Customer-Initiated Disputes Resolved in Arbitration

      The Sanction Guidelines begin with "General Principles Applicable to All Sanction Determinations." General Principles Nos. 1 and 2 emphasize that FINRA's disciplinary sanctions are designed to protect the investing public, deter misconduct and uphold high standards of business conduct. They also advise adjudicators to impose progressively escalating sanctions on repeat violators to deter future misconduct.

      Currently, the Sanction Guidelines instruct that a respondent's disciplinary history should trigger higher sanctions when that disciplinary history: (a) is similar to the misconduct in the current disciplinary case; or (b) evidences a "reckless disregard for regulatory requirements, investor protection, or market integrity." The newly added section in General Principal No. 2 of the Sanction Guidelines instructs adjudicators to consider customer-initiated arbitrations that result in adverse arbitration awards or settlements when evaluating an individual respondent's background. The revisions replace the term "disciplinary history" with "Disciplinary and Arbitration History," which is defined as:

      disciplinary history by regulators, and arbitration awards and arbitration settlements resulting from disputes between a customer and the respondent, including those when the respondent is the subject of an arbitration claim that only names a FINRA member firm.

      Disciplinary and Arbitration History includes in its definition arbitrations that a customer filed involving investment-related disputes that have been resolved through an adverse award or settlement. The definition excludes customer-initiated arbitration claims that have been filed but not resolved.1 It also excludes customer complaints when no arbitration claim has been filed and settlements reached with a customer when no arbitration claim was filed. Dismissals and withdrawals of customers' arbitration claims also will not be relevant to determinations of disciplinary sanctions. The Sanction Guidelines revisions apply only to individual respondents; they do not apply to member firms.2

      Pattern of Causing Harm

      By enabling adjudicators to consider arbitration settlements and adverse arbitration awards, in addition to the traditionally considered final disciplinary actions, the Sanction Guidelines will allow adjudicators to take such settlements and awards into account in appropriate cases when determining whether a pattern of harm to investors or market integrity, or disregard of regulatory requirements exists. When such a pattern is established, an adjudicator should consider imposing more severe sanctions than what would have been imposed if no pattern existed. These Sanction Guidelines revisions will bolster the ability of adjudicators to fulfill the goals of General Principles Nos. 1 and 2 to protect investors and deter misconduct.

      FINRA is posting on its website guidance specifically for these Sanction Guidelines revisions. Questions and answers 19 to 22 have been added to the frequently asked questions related to the Sanction Guidelines, which can be found at www.finra.org/industry/march-2006- revisions-nasd-sanction-guidelines-faq.

      Finality

      The Sanction Guidelines currently provide that pending investigations or ongoing regulatory proceedings prior to a final decision are not disciplinary history. There has been no change to this finality requirement for the treatment of regulatory matters. A similar finality rule will also apply to the consideration of arbitration awards and arbitration settlements. An arbitration award that a party has not moved to vacate qualifies as arbitration history, but pending arbitrations do not. If a respondent lost an arbitration award and has filed a motion to vacate, the arbitration award does not qualify as arbitration history while the motion to vacate is pending.3 Arbitration settlements reflect the voluntary agreement of the parties and, accordingly, are final.

      Effective Date

      These revisions will take effect for disciplinary matters on June 1, 2018. For disciplinary cases, the revisions will apply to all complaints filed on or after June 1, 2018. The revisions will not apply to cases in which the complaint is filed before June 1, 2018, or to cases that are currently pending before the Office of Hearing Officers or are on appeal.


      1. The definition of "investment-related" is the same as the definition supplied in the Form U4 or U5 Explanation of Terms (version 2014.1): "Pertains to securities, commodities, banking, insurance, or real estate (including, but not limited to, acting as or being associated with a broker-dealer, issuer, investment company, investment adviser, futures sponsor, bank, or savings association)."

      2. Disciplinary history has been defined by case law to include, but not be limited to, final disciplinary actions and settlements by FINRA, other selfregulatory organizations, the Securities and Exchange Commission, CFTC, and state securities regulators.

      3. Once a court has denied a motion to vacate the arbitration award, the award is included in the category of arbitration history. The Sanction Guidelines follow the same rule that FINRA does for requiring associated persons to pay arbitration awards. See Michael Albert DiPietro, Exchange Act Release No. 77398 (Mar. 17, 2016) (holding that FINRA may suspend or cancel an associated person's registration for failure to pay an arbitration award when a motion to vacate the award has been denied, and need not stay its proceedings to await a decision on an appeal).

    • 18-16 FINRA Requests Comment on FINRA Rule Amendments Relating to High-Risk Brokers and the Firms That Employ Them; Comment Period Expires: June 29, 2018

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      High-Risk Brokers

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 3110
      FINRA Rule 3170
      FINRA Rule 8312
      FINRA Rule 9200 Series
      FINRA Rule 9300 Series
      FINRA Rule 9520 Series
      FINRA Rule 9556
      NASD IM-1011-1
      NASD IM-1011-2
      NASD Rule 1010 Series
      Regulatory Notice 18-15
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      BrokerCheck Disclosure
      Disciplinary Proceedings
      Eligibility Proceedings
      Heightened Supervision
      Statutorily Disqualified Persons
      Supervision
      Taping Rule

      Comment Period Expires: June 29, 2018

      Summary

      FINRA seeks comment on proposed rule amendments that would impose additional restrictions on member firms that employ brokers with a history of significant past misconduct. These brokers, while relatively small in number, may present heightened risk of harm to investors, and any misconduct by them also may undermine confidence in the securities markets as a whole. The rule proposals would strengthen the existing controls, some of which are highlighted below, FINRA has applied to such brokers to further promote investor protection and market integrity.

      The new proposals are one part of FINRA's initiatives to confront high-risk brokers. FINRA will continue to evaluate various rules, examination and risk-monitoring programs, and technologies to determine further enhancements that FINRA can make to keep high-risk brokers from potentially harming investors and compromising the integrity of the financial markets.

      FINRA is requesting comment on proposed amendments to:

      1. the Rule 9200 Series (Disciplinary Proceedings) and the 9300 Series (Review of Disciplinary Proceedings by National Adjudicatory Council and FINRA Board; Application for SEC Review) to allow a Hearing Panel to impose conditions or restrictions on the activities of member firms and brokers while a disciplinary matter is on appeal to the National Adjudicatory Council (NAC), and to require member firms to adopt heightened supervisory procedures for brokers during the period the appeal is pending;
      2. the Rule 9520 Series (Eligibility Proceedings) to require member firms to adopt heightened supervisory procedures for brokers during the period a statutory disqualification (SD) eligibility request is under review by FINRA;
      3. Rule 8312 (FINRA BrokerCheck Disclosure) to disclose the status of a member firm as a "taping firm" under Rule 3170 (Tape Recording of Registered Persons by Certain Firms); and
      4. the NASD Rule 1010 Series (Membership Proceedings) (MAP rules) to place additional limitations on member firms by requiring a member firm to first submit a written letter to FINRA's Department of Member Regulation, through the Membership Application Program Group (MAP Group), seeking a materiality consultation when a natural person that has, in the prior five years, one or more final criminal actions or two or more specified risk events seeks to become an owner, control person, principal or registered person of an existing member firm. Specified risk events (as described in detail below) generally means final, adjudicated disclosure events disclosed on a person's or firm's Uniform Registration Forms.1

      The proposed rule text is available in Attachment A. With respect to proposal number 4, FINRA also seeks specific comment on the proposed numeric threshold and criteria that would trigger a materiality consultation. A detailed economic analysis of the proposed rule amendments, including the numeric threshold and criteria used for identifying brokers that would be impacted by the proposed amendments, is discussed below, and the exhibits referenced in this economic impact assessment are available in Attachment B, Exhibits 1, 2, 3 and 4.

      In addition, FINRA is focusing attention on high-risk brokers by publishing Regulatory Notice 18-15 to reiterate the existing obligation of member firms to adopt and implement tailored heightened supervisory procedures under Rule 3110 (Supervision) for high-risk brokers;2 and revising FINRA's qualification examination waiver guidelines and related procedures to more broadly consider past misconduct when considering examination waiver requests.3

      Questions concerning this Notice should be directed to:

      •   Kosha Dalal, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-6903.

      Questions concerning the Economic Impact Assessment in this Notice should be directed to:

      •   Jonathan Sokobin, Senior Vice President and Chief Economist, Office of the Chief Economist (OCE), at (202) 728-8248; and
      •   Hammad Qureshi, Senior Economist, OCE, at (202) 728-8150.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. The comment period ends June 29, 2018.

      Comments must be submitted through one of the following methods:

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

      Jennifer Piorko Mitchell
      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.4

      The proposed rule change must be filed with the Securities and Exchange Commission (SEC) pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA or Exchange Act).5

      Background & Discussion

      FINRA uses a combination of tools to reduce misconduct by member firms and the brokers they hire, including SD processes, review of membership applications, disclosure of brokers' regulatory backgrounds,6 supervision requirements, focused examinations, risk monitoring and disciplinary actions. These tools, among others, serve to further the Exchange Act goals reflected in FINRA's mission of protecting investors and market integrity, including protecting investors from brokers with a history of significant past misconduct and the firms that choose to employ them.

      Formal action to bar or suspend a broker requires FINRA to satisfy procedural safeguards established by federal law and FINRA rules to ensure fair process and to protect the rights of brokers to engage in business unless proven guilty of serious misconduct. Those safeguards include the right to defend oneself before a hearing panel and the right to appeal to the NAC, the SEC, and ultimately the federal courts. In addition, federal law and regulations define the types of misconduct that presumptively disqualify a broker from associating with a firm, and also govern the standards and procedures FINRA must follow when a broker who was found to have engaged in such misconduct applies to remain in or re-enter the industry.7

      Current Programs

      As discussed further below, FINRA strives to prevent and deter misconduct by member firms and the individuals they hire through a number of different measures.

      •   Licensing and Registration

      To become a FINRA member, a firm is subject to review through FINRA's membership application program. As part of a new membership application (NMA) or a continuing membership application (CMA) under the Rule 1010 Series, FINRA reviews, among other factors, whether persons associated with an applicant have material disciplinary history, customer complaints, pending and final arbitrations, civil actions or other industry-related matters that could pose a threat to public investors. Where FINRA can show strong cause for concern, we can deny membership or place restrictions on membership to mitigate the risk. The membership application process also provides procedural safeguards for the applicant: applicants have the right to request review by the NAC of an adverse decision or the FINRA Board may call for a discretionary review of a membership proceeding. The applicant also may appeal final FINRA decisions to the SEC and the circuit courts.
      •   Statutory Disqualifications — Eligibility Proceedings

      FINRA administers the SD process by assessing applications from member firms that wish to retain or employ an individual who is the subject of an SD. In conducting the assessment, FINRA seeks to exclude individuals who pose a risk of recidivism from continuing in the securities business. As a general framework, the Exchange Act sets out the types of broker misconduct that presumptively exclude brokers from engaging in the securities business. These types of misconduct, entitled "statutory disqualifications," are actions against an individual or member firm taken by a regulator or court based on a finding of serious misconduct that calls into question the integrity of the broker or firm. SDs include any felony and certain misdemeanors for a period of 10 years from the date of conviction; expulsions or bars (and current suspensions) from membership or participation in a self-regulatory organization; bars (and current suspensions) ordered by the SEC, Commodity Futures Trading Commission, or other appropriate regulatory agency or authority; willful violations of the federal securities and commodities laws or MSRB rules; and certain final orders of a state securities commission.
      •   Monitoring and Examinations

      FINRA addresses high-risk brokers or high-risk activity through several of its examination programs. First, FINRA executes a High-Risk Registered Representative (HRR) Program that uses various methodologies to identify brokers from across the entire securities industry whose individual risk profiles suggest they are more likely than the general broker population to engage in misconduct. A specialized High-Risk Registered Representative Examination Unit is responsible for the identification, monitoring and examination activities of high-risk registered representatives with additional examination support provided by examiners located in FINRA's various district offices.

      FINRA also reviews individual brokers as part of the firm examination program where every broker-dealer receives an examination at least once every four years. Because our firm examinations are risk-based, the focus on individual brokers varies depending on the specific firm. Also covered during these examinations are assessments of the firms' supervisory and compliance controls over the conduct of brokers.

      Further, FINRA examines individual brokers through its cause examination program. These examinations are allegation driven, and triggered by specific and sometimes high-risk events such as a customer complaint, whistleblower tip, arbitration referral or call to the FINRA Securities Helpline for SeniorsTM.

      Lastly, FINRA conducts high-risk branch office examinations that focus on business conduct risks at the point of sale. Branch office examinations look at the core activities conducted from the specific branch location, including customer transactions, money and security movements, customer complaints, communications, account designation changes and credit extensions. The identification of high-risk branch offices is determined in large part by the aggregation of individual registered representative risk assessments.
      •   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 who are registered with national securities exchanges that use the Central Registration Depository (CRD®). BrokerCheck information is derived from the CRD system to, among other things, help investors make informed choices about the individuals and firms with which they conduct business. In addition to BrokerCheck disclosure, FINRA publishes on its website a list of individuals who have been barred by FINRA from association with any member firm in any capacity.8 The list is updated on a monthly basis.
      •   Supervision Obligations of Member Firms

      FINRA Rule 3110 requires member firms 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 FINRA rules. Further, the rule requires member firms to establish, maintain and enforce written procedures to supervise the types of business in which it engages and the activities of its associated persons that are reasonably designed to achieve compliance with applicable securities laws and regulations and FINRA rules. An effective supervisory system plays an essential role in the prevention of sales abuses, and thus, enhances investor protection and market integrity. As such, FINRA has long emphasized that member firms have a fundamental obligation to implement a supervisory system, including written supervisory procedures, that is tailored specifically to the member firm's business and addresses the activities of all its associated persons.9
      •   Enforcement and Disciplinary Actions

      An important part of FINRA's supervision of firms and the individuals they employ is our ongoing enforcement of FINRA and MSRB rules, and federal securities laws and rules. We aggressively investigate potential securities violations and, when warranted, bring formal disciplinary actions against member firms and their associated persons.

      With respect to problem individuals, FINRA can take a range of formal actions, including barring them from the industry. As previously noted, formal action to bar or suspend a broker requires satisfying procedural safeguards required by the Exchange Act and, with respect to FINRA actions, safeguards include the right to a hearing before a FINRA hearing panel; appeal to the NAC; appeal to the SEC; and ultimately to the circuit courts of appeal.

      Proposed Amendments

      As part of FINRA's ongoing initiatives to protect investors from high-risk brokers, FINRA is proposing rule amendments that would impose additional obligations on member firms that seek to associate with high-risk brokers. The proposed rule amendments are designed to strengthen oversight of high-risk brokers and the firms that employ them.

      1. Proposed Amendments to the Rule 9200 Series (Disciplinary Proceedings) and Rule 9300 Series (Review of Disciplinary Proceedings by National Adjudicatory Council and FINRA Board; Application for SEC Review)
      A. Overview of Current Disciplinary Process

      FINRA's Department of Enforcement initiates a formal disciplinary action by filing a complaint with FINRA's Office of Hearing Officers (OHO) when it believes that a member firm or associated person of a member firm is violating or has violated any FINRA rule, SEC regulations or federal securities laws, and formal disciplinary action is necessary. Following the filing of the complaint, the Chief Hearing Officer will assign a Hearing Officer to preside over the disciplinary proceeding, and appoint a Hearing Panel, or an Extended Hearing Panel, if applicable, to conduct a hearing and issue a decision.10

      At a hearing, the parties present evidence for the Hearing Panel to determine whether a member firm or broker has engaged in conduct that violates FINRA rules, MSRB rules, SEC regulations or federal securities laws. The Hearing Panel also considers previous court, SEC, NAC and Hearing Panel decisions to determine if violations occurred.

      For each case, the Hearing Panel, or the Hearing Officer in the case of default decisions,11 will issue a written decision explaining the reasons for its ruling and consult the FINRA Sanction Guidelines to determine the appropriate sanctions if violations have occurred. FINRA also, when feasible and appropriate, can order member firms and brokers to make restitution to harmed customers.

      Under FINRA's disciplinary procedures, a member firm or broker has the right to appeal a Hearing Panel or Hearing Officer decision to the NAC, or the NAC may on its own initiate a review of a decision. On appeal, the NAC will determine if a Hearing Panel's or Hearing Officer's findings were legally correct, factually supported and consistent with FINRA's Sanction Guidelines. The NAC's decision constitutes a final disciplinary action of FINRA, unless the FINRA Board calls the case for review and issues its own decision. A member firm or broker may appeal a final disciplinary action of FINRA to the SEC, and further to a U.S. Court of Appeals.

      Currently, while a Hearing Panel or Hearing Officer decision is on appeal to the NAC, any sanctions imposed by the Hearing Panel or Hearing Officer, including bars or expulsions, are automatically stayed and not enforced against the member firm or broker during the pendency of the appeal.12
      B. Proposed Rule 9285 (Interim Orders While on Appeal)

      FINRA is proposing new FINRA Rule 9285 (Interim Orders While on Appeal) to bolster investor protection during the pendency of an appeal to the NAC of a Hearing Panel or Hearing Officer decision.
      •   Conditions and Restrictions

      Proposed Rule 9285(a) would provide that the Hearing Panel or, if applicable, the Extended Hearing Panel, or Hearing Officer may impose such conditions or restrictions on the activities of a respondent as the Hearing Panel or Hearing Officer considers reasonably necessary for the purpose of preventing customer harm.13 This approach would be consistent with the rules of several exchanges that have provisions that allow an exchange adjudicator to impose restrictions on the respondent during the exchange's appeal process.14

      Under the proposal, as part of the hearing, FINRA's Department of Enforcement could request that the Hearing Panel or Hearing Officer order conditions and restrictions imposed against the respondent. The Hearing Panel or Hearing Officer would consider the request at the same time it makes findings of violations and imposes sanctions for the misconduct. FINRA believes the Hearing Panel's or Hearing Officer's knowledge about the violations would provide the qualifications to evaluate the potential for customer harm and craft tailored conditions and restrictions to minimize that potential harm. The order would describe the activities that the respondent shall refrain from taking and any conditions imposed.

      In considering whether conditions or restrictions should be imposed on the activities of a respondent, the Hearing Panel or Hearing Officer would be guided by the principle of imposing conditions and restrictions reasonably necessary for the purpose of preventing customer harm. These conditions or restrictions could include, for example, prohibiting a member firm or broker from offering private placements in cases of misrepresentations and omissions made to customers, or prohibiting penny stock liquidations in cases involving violations of the penny stock rules. A condition could also include posting a bond to cover harm to customers before the sanction imposed becomes final or precluding a broker from acting in a specified capacity. The conditions and restrictions would be tailored to the specific risks posed by the member firm or broker during the appeal period.

      Unlike sanctions imposed in the Hearing Panel or Hearing Officer decision, the proposal would amend FINRA Rule 9311 (Appeal by Any Party; Cross-Appeal) to expressly state that the conditions and restrictions imposed by the Hearing Panel or Hearing Officer would not be stayed during the pendency of the appeal to the NAC. The interim order of conditions and restrictions would remain effective and enforceable until issuance of the NAC's decision in the matter.

      FINRA believes authorizing the Hearing Panel or Hearing Officer to order conditions and restrictions during an appeal would allow FINRA to target the demonstrated bad conduct of a respondent during the pendency of the appeal to the NAC. In addition, the proposal would amend FINRA Rule 9556 to grant FINRA staff the authority to start an expedited proceeding in accordance with Rule 9556 if a respondent failed to abide by the conditions and restrictions ordered.15
      •   Expedited Review

      Proposed Rule 9285(b) would establish an expedited review process to allow a respondent that has conditions or restrictions imposed by a Hearing Panel or Hearing Officer to file a motion with the Review Subcommittee of the NAC to modify or remove any or all of the restrictions.

      Specifically, proposed Rule 9285(b)(1) would establish an expedited review process available to a respondent that has conditions or restrictions imposed by a Hearing Panel or Hearing Officer to file a motion with the Review Subcommittee of the NAC to modify or remove any or all of the restrictions. Proposed Rule 9285(b)(2) would provide that the respondent has the burden to show that the Hearing Panel or Hearing Officer committed an error by ordering the condition or restrictions imposed. The respondent must show that the conditions or restrictions are not reasonably necessary for the purpose of preventing customer harm. The respondent's motion to modify or remove conditions or restrictions must be filed with FINRA's Office of General Counsel and served simultaneously on OHO and all other parties to the disciplinary proceedings.

      Proposed Rule 9285(b)(3) would give FINRA's Department of Enforcement five days from service of the respondent's motion to file an opposition to the motion. As proposed, unless ordered otherwise by the Review Subcommittee, the motion to modify or remove conditions or restrictions would be decided based on the moving and opposition papers and would be decided in an expeditious manner and no later than 30 days after the filing of the opposition.

      Proposed Rule 9285(b)(4) would provide that the filing of such an expedited motion to modify or remove a condition or restriction would stay the effectiveness of the ordered conditions and restrictions until the Review Subcommittee issues its ruling.
      •   Mandatory Heightened Supervision

      Proposed Rule 9285(c) would require any firm with which a respondent is associated to adopt a written plan of heightened supervision if any party appeals a Hearing Panel or Hearing Officer decision to the NAC, or if the NAC calls the case for review.16 The proposed amendments would require a firm to adopt a plan of heightened supervision regarding such respondents within ten days of filing an appeal, and this requirement would need to take into account any conditions or restrictions imposed by the Hearing Panel or Hearing Officer.

      Specifically, when a Hearing Panel or Hearing Officer issues a decision pursuant to Rule 9268 or Rule 9269 in which the adjudicator finds that an associated person, the respondent, has violated a statute or rule provision, the proposed rule would require any firm with which the respondent is associated to adopt a written plan of heightened supervision that must remain in place until FINRA's final decision takes effect.17 The member firm would be required to submit the written plan of heightened supervision within ten days of any party filing an appeal or the case being called for review by filing a copy of the plan of heightened supervision with FINRA's Office of General Counsel and serving a copy on the Department of Enforcement. If a respondent becomes associated with another firm while the Hearing Panel's or Hearing Officer's decision is on appeal to the NAC, that member firm must file a copy of a plan of heightened supervision, taking into account any conditions or restrictions imposed by the Hearing Panel or Hearing Officer, with the Office of General Counsel and serve a copy on the Department of Enforcement within ten days of the respondent becoming associated with the firm.

      The proposed rule would require a member firm to implement tailored supervisory procedures that are reasonably designed to prevent or detect a reoccurrence of the violations found by the Hearing Panel or Hearing Officer. In addition, the plan of heightened supervision must comply with Rule 3110, which requires firms to establish and maintain supervisory systems for each of their associated persons that are reasonably designed to achieve compliance with applicable securities laws and FINRA rules. The plan of heightened supervision must, at a minimum, include the designation of an appropriately registered principal who is responsible for carrying out the plan of heightened supervision. The plan of heightened supervision also must be signed by the designated principal, and include an acknowledgement that the principal is responsible for implementing and maintaining the plan of heightened supervision.
      2. Proposed Amendments to the Rule 9520 Series (Eligibility Proceedings)
      A. Overview of Current Statutory Disqualification Eligibility Process

      Brokers who have engaged in the types of misconduct specified in the Exchange Act statutory disqualification provisions must undergo special review by FINRA before they are permitted to re-enter or continue working in the securities industry. In conducting its review, FINRA seeks to exclude brokers who pose a risk of recidivism from continuing in the securities business, subject to the limits developed in SEC case law.

      As a general framework, the Exchange Act sets out the types of misconduct that presumptively exclude brokers from engaging in the securities business, identified as statutory disqualifications or SDs.18 These SDs are the result of actions against a broker taken by a regulator or court based on a finding of serious misconduct that calls into question the integrity of the broker, and include any felony and certain misdemeanors for a period of ten years from the date of conviction; expulsions or bars (and current suspensions) from membership or participation in a self-regulatory organization; bars (and current suspensions) ordered by the SEC, Commodity Futures Trading Commission, or other appropriate regulatory agency or authority; willful violations of the federal securities and commodities laws or MSRB rules; and certain final orders of a state securities commission.

      The Exchange Act and SEC rules thereunder establish a framework within which FINRA evaluates whether to allow individuals who are the subject of an SD to associate with a member firm.19 A member firm that seeks to employ or continue the employment of an individual who is the subject of an SD therefore files an application (SD Application) seeking approval from FINRA.20 FINRA Rule 9520 Series sets forth eligibility proceedings under which FINRA may allow a member, person associated with a member, potential member, or potential associated person subject to an SD to enter or remain in the securities industry.21 A firm's SD Application is subject to careful scrutiny by FINRA to best ensure that the individual's association with the member firm is subject to heightened supervision and is consistent with the public interest and the protection of investors. To determine whether the SD Application will be approved or denied, FINRA takes into account factors that include the nature and gravity of the disqualifying event; the length of time that has elapsed since the disqualifying event and any intervening misconduct occurring since; the regulatory history of the disqualified individual, the firm and individuals who will act as supervisors; and any proposed plan of supervision.22

      If FINRA recommends approval of the SD Application, the recommendation is submitted either directly to the SEC for its review or to the NAC and ultimately to the SEC for their reviews and approvals. If FINRA recommends disapproval of the SD Application, the member firm has the right to a hearing before a panel of the Statutory Disqualification Committee and the opportunity to demonstrate why the SD Application should be approved.23 If the NAC denies the SD Application, the member firm can appeal the decision to the SEC and the federal circuit courts.24

      As part of an SD Application, a member firm will propose a written plan of heightened supervision to closely monitor the SD individual's securities-related activities. A heightened supervisory plan must be acceptable to FINRA, and FINRA will reject any plan that is not specifically tailored to address the SD individual's prior misconduct and to mitigate the risk of future misconduct. In this regard, FINRA's primary consideration is a heightened supervisory plan carefully constructed to best ensure investor protection.

      Despite the requirement of heightened supervision to receive approval of an SD Application, there is currently no explicit rule requirement that these SD individuals be placed on heightened supervision by their employing member firm during the pendency of the SD Application review.25

      B. Proposed Amendments to Require Automatic Heightened Supervision During Review Period

      FINRA is proposing to amend Rule 9523 (Acceptance of Member Regulation Recommendations and Supervisory Plans by Consent Pursuant to SEA Rule 19h-1) to require a member firm to immediately place an individual on an interim plan of heightened supervision once an SD Application is filed. The proposed amendments would delineate the circumstances under which an individual who is statutorily disqualified may remain associated with a FINRA member while FINRA is reviewing his or her SD Application.

      As with proposed Rule 9285 that would require a plan of heightened supervision during an appeal of a disciplinary action, proposed amendments to Rule 9523 provides flexibility regarding the details of specific interim plans of heightened supervision. However, the proposal would provide that, in order for supervision over a disqualified individual to be reasonable under Rule 3110, the interim plan of heightened supervision must be tailored to the disqualified individual, and must take into account the nature of the disqualification, the nature of the firm's business, the disqualified person's current and proposed activities at the firm, and the qualifications of the supervisor. Every interim plan would be required to identify a qualified principal responsible for carrying out such plan who has evidenced his or her acknowledgement of such responsibility by signing such plan.

      The proposed amendments would require that a copy of the interim plan of heightened supervision be submitted with the SD Application, and that the plan be in effect throughout the entire SD Application review process. The proposal would also make clear that an interim plan of heightened supervision may be modified by FINRA through the SD eligibility proceeding, that compliance with the interim plan of heightened supervision will be monitored through FINRA's examination program, and that the firm or individual could be subject to further disciplinary proceedings for failure to comply with the interim plan. The proposed amendments also would provide that an SD Application may be determined to be substantially incomplete if the interim plan is not reasonably designed in compliance with the standards of the proposed amendments. If the applicant fails to timely remedy a substantially incomplete SD Application, FINRA will provide written notice to the member that the SD Application has been rejected, its reasons for so doing, and refund the application fee, less $1,000 as a FINRA processing fee. Upon such rejection, the SD Application is terminated and the member firm must promptly disassociate with the individual. FINRA would generally cover compliance with interim plans of heightened supervision as part of its examination program.
      3. Proposed Amendments to Rule 8312 (FINRA BrokerCheck Disclosure)

      Rule 8312 governs the information FINRA releases to the public through its BrokerCheck system.26 BrokerCheck helps investors make informed choices about the brokers and member firms with which they conduct business by providing extensive registration and disciplinary history to investors at no charge. FINRA has required member firms to inform their customers of the availability of BrokerCheck.27

      FINRA is proposing to amend Rule 8312 to disclose the status of a member firm as a "taping firm" under Rule 3170 (Tape Recording of Registered Persons by Certain Firms)28 through BrokerCheck. Rule 3170 is designed to ensure that member firms with a significant number of registered persons that previously were employed by "disciplined firms" have specific supervisory procedures in place to prevent fraudulent and improper sales practices or other customer harm.29 Under the rule, a member that hires a specified percentage of registered persons from disciplined firms is designated as a "taping firm" and must establish, maintain, and enforce special written procedures for supervising the telemarketing activities of all its registered persons.30

      A taping firm must adopt procedures that include tape-recording all telephone conversations between such firms' registered persons and both existing and potential customers. Such firms also are required to review the tape recordings, maintain appropriate records, and file quarterly reports with FINRA.

      To assist member firms in complying with Rule 3170, FINRA publishes on its website a "Disciplined Firms List" identifying those member firms that meet the definition of "disciplined firm."31 A member firm that either is notified by FINRA or otherwise has actual knowledge that it is a taping firm is subject to the requirements of the rule.

      FINRA believes disclosing the status of a member firm as a taping firm through BrokerCheck will help inform investors of the heightened procedures required of the firm, which may incent the investors to research more carefully the background of a broker associated with the firm.

      Currently, Rule 8312 provides that FINRA will release whether a particular member firm is a taping firm subject to Rule 3170 in response to telephonic inquiries via the BrokerCheck toll-free telephone listing. To better inform investors, the proposed amendment would permit FINRA to release information through BrokerCheck, in general, as to whether a particular member is subject to the provisions of Rule 3170.
      4. Proposed Amendments to the NASD Rule 1010 Series (MAP Rules)
      A. Current MAP Process

      FINRA also seeks to prevent member firm recidivism by reviewing new member applications or membership changes pursuant to the NASD Rule 1010 Series.

      Rule 1014(a) (Standards for Admission) sets forth the 14 standards for admission applied by FINRA's Department of Member Regulation, through the MAP Group (collectively, the Department) in determining whether to approve a New Member Application (NMA) or a Continuing Member Application (CMA). The MAP rules require an applicant to demonstrate its ability to comply with the federal securities laws and FINRA rules, including observing high standards of commercial honor and just and equitable principles of trade applicable to its business. The Department evaluates an applicant's financial, operational, supervisory and compliance systems to ensure that each applicant meets these standards for admission. The Department considers whether persons associated with an applicant have material disciplinary actions taken against them by other industry authorities, customer complaints, adverse arbitrations, pending or unadjudicated matters, civil actions, remedial actions imposed or other industry-related matters that could pose a threat to public investors.

      In addition, Rule 1017 provides, among other things, that a member shall file a CMA when there are certain changes in ownership, control or business operations.32 IM-1011-1 creates a safe harbor for specified changes that are presumed not to be a "material change in business operations" and, therefore, do not require a member to file a CMA for approval of the change. One such change is an increase in the number of associated persons involved in sales within the parameters prescribed in the safe harbor. FINRA is concerned about instances where a member may onboard high-risk associated persons without prior consultation or review by FINRA.

      Currently the materiality consultation process is used when a member contemplates a change in business operations that may not squarely fall within one of the categories or definitions that would require a CMA under Rule 1017 and the member firm seeks guidance to determine how best to proceed with the proposed change by voluntarily seeking a materiality consultation from the Department. A request for a materiality consultation is a written request from a member firm for a determination from the Department of whether a proposed change is material. There is no fee associated with submitting this request to the Department. The characterization of a proposed change as material depends on an assessment of all the relevant facts and circumstances. The Department may communicate with the member firm to obtain further information regarding the proposed change and its anticipated impact on the member firm. Where the Department determines that a proposed change is material, the Department will instruct the member to file a CMA if it intends to proceed and will advise that effecting the change without approval would constitute a violation of NASD Rule 1017.
      B. Proposed Amendments to MAP Rules

      FINRA is proposing amendments to the MAP rules to impose additional obligations on member firms that associate with persons who have, in the prior five years, either one or more final criminal matters, or two or more specified risk events. The proposed amendments to the MAP rules would allow FINRA to review and potentially restrict or deny a member firm from allowing such a person to become an owner, control person, principal or registered person. FINRA believes the proposed MAP rules would further promote investor protection by applying stronger standards for continuing membership with FINRA and for changes to a current member firm's ownership, control or business operations.
      •   Materiality Consultation

      Proposed IM-1011-2 (Business Expansions and Persons with Specified Risk Events) would require an existing member firm to submit a written letter seeking a materiality consultation to the Department, if the member is not otherwise required to file a CMA, when a natural person that has, in the prior five years, one or more final criminal matters or two or more specified risk events seeks to become an owner, control person, principal or registered person of the member.

      In addition, the proposed rule would expressly state that the safe harbor for business expansion in IM-1011-1 (Safe Harbor for Business Expansions) would not be available to member firms in this circumstance.

      The proposed rule would provide that the member may not effect the contemplated activity until the member has first submitted a written letter to the Department seeking a materiality consultation for the contemplated activity, and would require that the letter address the issues that are central to the materiality consultation, in a manner prescribed by FINRA. The Department would consider the letter and other information or documents and determine in the public interest and the protection of investors that either (1) the member is not required to file a CMA in accordance with Rule 1017 and may effect the contemplated activity; or (2) the member is required to file a CMA in accordance with Rule 1017 and the member may not effect the contemplated activity, unless the Department approves the CMA.

      In this regard, the materiality consultation would focus on, and the submitting member firm would need to provide information relating to, the conduct underlying the specified risk events, as well as other matters relating to the subject person such as disciplinary actions taken by FINRA or other industry authorities, adverse examination findings, customer complaints, pending or unadjudicated matters, terminations for cause or other incidents that could pose a threat to public investors. The Department's assessment would factor in, among other things, whether the events are customer-related; represent discrete actions or are based on the same underlying conduct; the anticipated activities of the person; the disciplinary history, experience and background of the proposed supervisor, if applicable; the disciplinary history, supervisory practices, standards, systems and internal controls of the member firm and whether they are reasonably designed to achieve compliance with applicable securities laws and regulations, and FINRA rules; whether the member firm employs or intends to employ in any capacity multiple persons with one or more final criminal matters or two or more specified risk events in the prior five years; and any other impact on investor protection raised by seeking to make the person an owner, control person, principal or registered person of the member firm.
      •   Definitions

      The proposal would amend Rule 1011 to define a "final criminal matter" as a criminal matter that resulted in a conviction of, or guilty plea or nolo contendere (no contest) by, a person that is disclosed, or was required to be disclosed, on the applicable Uniform Registration Forms.33

      The proposal would further amend Rule 1011 to define a "specified risk event" as any one of the following events that are disclosed, or are or were required to be disclosed, on the applicable Uniform Registration Forms:
      i. a final investment-related,34 consumer-initiated customer arbitration award or civil judgment against the person for a dollar amount at or above $15,000 in which the person was a named party;
      ii. a final investment-related, consumer-initiated customer arbitration settlement or civil litigation settlement for a dollar amount at or above $15,000 in which the person was a named party;
      iii. a final investment-related civil action where the total monetary sanctions (including civil and administrative penalties or fines, disgorgement, monetary penalties other than fines, or restitution) were ordered for a dollar amount at or above $15,000; and iv. a final regulatory action where (A) the total monetary sanctions (including civil and administrative penalties or fines, disgorgement, monetary penalties other than fines, or restitution) were ordered for a dollar amount at or above $15,000; or (B) the sanction against the person was a bar (permanently or temporarily), expulsion, rescission, revocation or suspension from associating with a member.
      As noted above, the proposed additional MAP obligations would apply only where the person has, within the prior five years, one or more final criminal matters or two or more specified risk events, and seeks to become an owner, control person, principal or registered person of the member firm.35

      Economic Impact Assessment

      1. Regulatory Need

      As discussed above, FINRA continually strives to strengthen its oversight of the brokers and firms it regulates in order to further its mission of protecting investors and market integrity, including protecting investors from brokers with a history of significant past misconduct and the firms that choose to employ them. Moreover, recent studies provide evidence of the predictability of future regulatory-related events for brokers with a history of past regulatory-related events such as repeated disciplinary actions, arbitrations and customer complaints.36 Therefore, notwithstanding the extensive protections afforded by the federal securities laws and FINRA rules, investors may reasonably continue to be concerned that without additional protections, the risk of potential customer harm may continue where these patterns exist. The proposals discussed in this Notice are designed to further promote investor protection by mitigating these concerns while recognizing the need to preserve principles of fairness.
      2. Economic Baseline

      The following provides the economic baseline for each of the current proposals. These baselines serve as the primary points of comparison for assessing economic impacts, including incremental benefits and costs of the proposed rule amendments. For this proposal, FINRA reviewed and analyzed relevant data over the 2013-2016 period (review period).
      A. Proposed Amendments to the Rule 9200 Series and Rule 9300 Series

      The economic baseline used to evaluate the economic impacts of the proposed rule changes to the Rule 9200 Series and Rule 9300 Series is the current regulatory framework under these rules. FINRA analyzed disciplinary matters that were appealed to the NAC over the review period that reached a final decision by the NAC.37 During the review period, there were approximately 18 such appeals filed each year, of which approximately 82 percent were filed by brokers, 8 percent were filed by firms, and the remaining 10 percent were filed jointly by brokers and firms.38 FINRA determined that, on average, these disciplinary decisions were on appeal for approximately 14 months.39
      B. Proposed Amendments to the Rule 9520 Series

      The economic baseline used to evaluate the economic impacts of the proposed rule changes to the Rule 9520 Series is the current regulatory framework under these rules. FINRA analyzed SD Applications filed during the review period and determined that there were 122 SD Applications filed for 119 individuals by 105 firms, or approximately 31 requests that were filed by 26 firms each year.40 Approximately 54 percent of these applications were associated with small firms, 17 percent with mid-sized firms and 29 percent with large firms.41 FINRA also examined the resolution of these applications and determined that approximately 21 percent of the SD Applications were approved, 8 percent were denied, 9 percent were pending during the review period, and the remaining applications (62 percent) did not require a resolution because the SD individual's registration with the filing firm was terminated or the SD Application was subsequently withdrawn.42 FINRA determined that, on average, the processing time for an SD Application that reached a final resolution (i.e., an approval or a denial) was approximately 10 months.43
      C. Proposed Amendments to the BrokerCheck Rule

      The economic baseline used to evaluate the economic impacts of the proposed rule changes to the BrokerCheck Rule is the current regulatory framework under Rules 8312 and 3170. During the review period, FINRA determined that 13 firms hired or retained enough registered persons from previously disciplined firms to be designated as a "taping firm" under Rule 3170 and were notified about their status during this period. All of these firms were small firms with the average size of approximately 40 registered persons. Of these 13 firms, nine firms did not become subject to the rule's tape-recording requirements because they either took advantage of the onetime opportunity to reduce the number of their registered persons from previously disciplined firms below the specified thresholds or terminated their FINRA membership, and one firm was exempted from the requirements of the rule pursuant to Rule 3170(d). As a result, only three of the 13 firms designated as "taping firms" during the review period became subject to the requirements of Rule 3170.
      D. Proposed Amendments to the MAP Rules

      The economic baseline used to evaluate the economic impacts of the proposed rule changes to the MAP rules is the current regulatory framework under these rules. The proposed rule change would directly impact individuals with one or more final criminal matters or two or more specified risk events within the prior five years, who seek to become owners, control persons, principals or registered persons of a member firm. The criteria used for identifying individuals for this proposal and the number of individuals meeting the proposed criteria are discussed below.
      3. Economic Impacts

      The following provides the economic impacts, including the anticipated benefits and the anticipated costs for each of the current proposals.
      A. Proposed Amendments to the Rule 9200 Series and Rule 9300 Series

      The proposed rule amendments would directly impact firms and brokers whose disciplinary matters are on appeal to the NAC. These impacts would vary across appeals and depend on, amongst other factors, the nature and severity of the conditions or restrictions imposed on the activities of respondents and the likely risk that they would continue to harm customers if permitted to remain working during the appeal period without those conditions or restrictions. As discussed above, the scope of these conditions or restrictions would depend on what the Hearing Panel determines to be reasonably necessary for the purpose of mitigating the risk of customer harm. Further, the conditions and restrictions would be tailored to the specific risks posed by the brokers or firms during the appeal period. Accordingly, the conditions and restrictions are not intended to rise to the level of the underlying sanctions and would likely not be economically equivalent to imposing the sanctions during the appeal.

      The primary benefit of this proposal accrues from limiting the potential risk of continued harm to customers by respondents during the appeal period by imposing conditions or restrictions on their activities as well as imposing mandatory heightened supervision of brokers while their disciplinary matter is on appeal. In order to evaluate these benefits and assess the potential risk posed by brokers during the appeal period, FINRA examined cases that were appealed to the NAC during the review period and determined whether the brokers associated with an appeal to the NAC had a disclosure event at any time from the filing of the appeal through 2016. Specifically, FINRA identified brokers that were associated with one or more final criminal matters or specified risk events, as defined above, that occurred after they filed their appeals to the NAC.44 Based on this analysis, FINRA estimates that 16 of the 65 brokers who appealed to the NAC were associated with a total of 21 disclosure events that occurred subsequent to the filing of their appeal to the NAC.45 FINRA anticipates that the proposed heightened supervision requirement and the conditions or restrictions placed on the activities of these brokers would lead to greater oversight of their activities by their firm during the appeal period, thereby reducing the potential risk of future customer harm during this period.

      The cost of this proposal would primarily fall upon brokers or firms whose activities during the appeal period would be subject to the specific conditions or restrictions imposed by the Hearing Panel. In addition, firms would incur costs associated with implementing heightened supervision for brokers while their disciplinary matters are under appeal. These costs would likely vary significantly across firms and could escalate if the broker acts in a principal capacity. For example, firms employing brokers that serve as principals, executive management, owners, or operate in other senior capacities would likely take on more costs in developing and implementing tailored supervisory plans. Such plans may entail re-assignments of responsibilities, restructuring within senior management and leadership, and more complex oversight and governance approaches. These potential costs, in turn, may result in some brokers voluntarily leaving the industry rather than waiting for the resolution of the appeal process.46

      The costs associated with this proposal would apply to brokers and their employing firms only while the brokers are employed during the pendency of the NAC appeals. While the disciplinary decisions are on appeal for approximately 14 months on average, many brokers filing an appeal to the NAC are not employed at the time the appeal is filed or leave shortly after the appeal is filed. FINRA examined the employment history, including the employment start and end dates, of the 65 brokers associated with NAC appeals during the review period, and estimates that 31 (or 48 percent) of these brokers were not employed by any member firm at any point during the appeal process, 14 (or 21 percent) of the brokers were employed by a member firm only for part of the appeal process, and the remaining 20 (or 31 percent) of the brokers were employed by a member firm throughout the appeal process.

      In developing the proposal, FINRA considered the possibility that, in some cases, this proposal may limit activities of brokers and firms, while their disciplinary matter is under appeal, in instances where the restricted activities do not pose a risk to customers. In such cases, these brokers and firms may lose economic opportunities and their customers may lose the benefits associated with the provision of these services. FINRA believes that the proposed rule changes mitigate such risks by requiring the conditions or restrictions imposed to be reasonably necessary for the purpose of reducing the potential risk of future customer harm and by providing a respondent with the right to seek to modify or remove any or all of the conditions and restrictions in an expedited proceeding. Further, as discussed above, only 31 percent of the brokers associated with NAC appeals were employed by a member firm for the full duration of their appeals. Approximately 69 percent of the brokers were not employed by a member firm at any time during the appeal process or were employed by a member firm only for part of the appeal process. Accordingly, these brokers would not be impacted by this proposal or would be subject to the proposed limitations only for a limited period of time.
      B. Proposed Amendments to the Rule 9520 Series

      The proposed rule amendments would impact SD individuals and their firms while the SD Application goes through an eligibility proceeding. The primary benefit of this proposed rule change would arise from greater oversight by firms of the activities of SD individuals during the pendency of their SD Applications. In order to assess the potential risk posed by these individuals during the pendency of their SD Applications, FINRA examined whether individuals associated with an SD Application filed during the review period had a disclosure event at any time from the filing of the application through 2016. Based on this analysis, FINRA estimates that 18 (or 15 percent) of the 119 individuals that filed SD Applications during the review period were associated with a total of 20 disclosure events subsequent to the filing of their SD Application.47 FINRA anticipates that the proposed heightened supervision requirement would lead to greater oversight by firms of the activities of these individuals during the pendency of their SD Application, thereby reducing the potential risk of customer harm during this period.

      Firms may incur costs associated with implementing a tailored heightened supervision program for these individuals while their SD Application is under review. As discussed above, the costs would likely vary significantly across firms and could escalate if the SD individuals also serve as principals, executive management, owners or operate in other senior capacities. Moreover, the heightened supervision requirement may deter some firms from filing an SD Application for these individuals who, as a result, may find it more difficult to remain in the industry.
      C. Proposed Amendments to the BrokerCheck Rule

      The proposed amendments would impact taping firms and their registered persons. Taping firms have a proportionately significant number of registered persons that were associated with firms that were expelled by a self-regulatory organization or had their registration revoked by the SEC for sales practice violations, and as a result, may pose greater risk to their customers. Disclosing a firm's status as a "taping firm" through BrokerCheck would help investors make more informed choices about the brokers and firms with which they conduct business. This proposal to disclose a firm's status as a "taping firm" would not impose any direct costs on brokers or firms. Nonetheless it may impact their businesses, as investors may also rely on this information in determining whom to engage for financial services and brokerage activities. Disclosing the status of a firm as a "taping firm" through BrokerCheck may also further deter firms from hiring or retaining brokers that previously were employed by disciplined firms in order to avoid the "taping firm" disclosure on BrokerCheck.
      D. Proposed Amendments to MAP Rules

      The primary benefit of the proposed amendments would be to reduce the potential risk of future customer harm by individuals who meet the proposed criteria and seek to become an owner, control person, principal, or registered person of a member firm. FINRA believes the proposed rule change would further promote investor protection by applying stronger standards for continuing membership with FINRA and for changes to a current member firm's ownership, control or business operations. These benefits would primarily arise from changes in broker and firm behavior and increased scrutiny by FINRA of brokers who meet the proposed criteria during the review of the applications.

      The cost of these proposals would fall on the firms that seek to add owners, control persons, principals or registered persons who meet the proposed criteria. These firms would be directly impacted by the proposals through the requirement to seek a materiality consultation with FINRA and potential requirement to file a CMA. While there is no FINRA fee for seeking a materiality consultation, firms may incur internal costs or costs associated with engaging external experts in conjunction with the filing of a CMA if necessary. The requirement of a materiality consultation could result in delays to a firm's ability to add owners, control persons, principals or registered persons who meet the proposed criteria. Based on its review of the materiality consultation, FINRA may require the firm to file a CMA and the firm may not effect the applicable activity until the CMA is approved. FINRA examined the time to process materiality consultations and determined that, on average, these consultations are completed within 8-10 days, although this time period could be longer depending on the complexity of the contemplated expansion or transaction. FINRA recognizes that these anticipated costs may deter some firms from hiring individuals meeting the proposed criteria, who as a result may find it difficult to remain in the industry or bear other labor market related costs.

      To provide transparency regarding the application of this proposal, the proposed criteria is based on disclosure events required to be reported on the Uniform Registration Forms. These Uniform Registration Forms are generally available to firms and FINRA.48 Accordingly, firms, with a few exceptions, can identify the specific set of disclosure events that would count towards the proposed criteria and replicate the proposed thresholds using available data.49 In determining the proposed numeric threshold, FINRA considered three key factors: (1) the different types of reported disclosure events; (2) the counting criteria or number of reported events required to trigger the obligations; and (3) the time period over which the events are counted. In evaluating the proposed numeric threshold versus alternative criteria, significant attention was given to the impact of possible misidentification of individuals; specifically, the economic trade-off between including individuals who are less likely to subsequently pose risk of harm to customers, and not including individuals who are more likely to subsequently pose risk of harm to customers but do not meet the proposed numeric threshold. There are costs associated with both types of misidentifications. For example, subjecting individuals who are less likely to pose a risk to customers to the MAP process would impose additional costs on these individuals, their affiliated firms and customers. The proposed numerical threshold aims to appropriately balance these costs in the context of economic impacts associated with the proposed amendments to the MAP rules.

      The proposal may create incentives for changes in behavior to avoid meeting the proposed threshold. For example, brokers and firms may be more likely to try to settle customer complaints or arbitrations below $15,000 so that their settlements do not count towards the proposed threshold.50 To the extent, if any, that customers also would be willing to settle for less, this change may reduce the compensation provided to customers. Brokers and firms also may consider underreporting the disclosure events in an effort to avoid the attendant costs. However, this potential impact is mitigated by the fact that many of the events are reported by FINRA or other regulators and any incorrect or missing reports can trigger regulatory action by FINRA. FINRA rules require firms to take appropriate steps to verify the accuracy and completeness of the information contained in the Uniform Registration Forms before they are filed. FINRA also has the ability to check for unreported events, particularly those that are reported in a separate public notice by a third party, such as the outcome of some civil proceedings.

      FINRA recognizes that in some instances, firms may not be able to identify certain individuals with disclosure events that may seek to become owners, control persons, principals or registered persons of the firm. Similarly, firms may have less incentive to conduct appropriate due diligence on those individuals for whom firms may not have readily available disclosure history.51 Firms, in these instances, would however still be required to seek information on relevant disclosure events from those individuals who seek to become principals or otherwise act as registered persons of the firm as part of their employment and registration process and take reasonable steps (e.g., by conducting background checks) to verify the accuracy and completeness of the information provided by them. Nonetheless, FINRA recognizes that in some cases, even after conducting reasonable due diligence, firms may not have the required information to identify certain individuals that meet the proposed criteria, and these individuals may continue to pose risk of future investor harm to investors. FINRA believes that these risks are mitigated by its own examination risk programs that monitor and examine individuals for which there are concerns of ongoing misconduct or imminent risk of harm to investors. These programs identify high-risk individuals based on the analysis of data available to the firms as well as additional regulatory data available to FINRA.52

      In developing this proposal, FINRA analyzed disclosure events reported on the Uniform Registration Forms for all individuals during the review period. For each year, FINRA evaluated the data and determined the approximate number of individuals who would have met the proposed numeric threshold of one or more final criminal matters or two or more specified risk events in the prior five years. Exhibit 1 shows the disclosure categories that FINRA considered and the subcategories that were used for identifying final criminal matters and specified risk events. The exhibit also shows the mapping of these disclosure categories to the underlying questions in the Uniform Registration Form U4.53 Exhibit 2 shows the corresponding mapping between these disclosure categories to the questions in the Uniform Registration Form BD.54 Exhibit 3 provides a breakdown of the disclosure categories for all individuals registered with FINRA in 2016.55 The exhibit illustrates the impact of refining subcategories of reported disclosure events and the impact of different numeric thresholds on the number of disclosure events and registered persons associated with these events.56 This analysis has led FINRA to initially propose the numeric threshold set forth in the current proposal.

      The additional proposed obligations would only apply to individuals with one or more final criminal matters or two or more specified risk events within the prior five years who seek to become owners, control persons, principals or registered persons of a firm. Accordingly, FINRA examined registration information in order to identify all individuals that would have met the proposed criteria during the review period. Those identified serve as a reasonable estimate for the number of individuals who would have been directly impacted by this proposal had it been in place at the time they were seeking to become an owner, control person, principal or registered person of a firm. This analysis indicates that there were approximately 100–160 such individuals, per year, as shown in Exhibit 4. These individuals represent 0.09 percent–0.14 percent of individuals who became owners, control persons, principals, or registered persons with a new member in any year during the review period.57

      FINRA also analyzed firms that employed individuals who would be directly impacted by this proposal. The analysis shows that in each year over the review period, there were between 115 and 170 firms employing individuals meeting the proposed conditions. Approximately 50 percent of these firms were small, 13 percent were mid-sized and the remaining 37 percent were large firms.58 FINRA estimates that approximately 38 percent of the individuals meeting the proposed criteria were employed by small firms, 17 percent by mid-sized firms and 45 percent by large firms.
      4. Alternatives Considered

      FINRA recognizes that the design and implementation of the rule proposals may impose direct and indirect costs on a variety of stakeholders, including member firms, associated persons, regulators, investors and the public. Accordingly, in developing its rule proposals, FINRA seeks to identify ways to enhance the efficiency and effectiveness of the proposals while maintaining their regulatory objectives. FINRA seeks comment on potential alternatives to the proposed amendments in this Notice and why these alternatives may be more efficient or effective at addressing broker misconduct than the proposed amendments.

      FINRA considered several alternatives to the numerical and categorical thresholds for identifying individuals that would be subject to the proposed MAP rules amendments. In determining the proposed threshold, FINRA focused significant attention on the economic trade-off between incorrect identification of individuals that may not subsequently pose risk of harm their customers, and not including individuals that may subsequently pose risk of harm to customers but do not meet the proposed numeric threshold. FINRA also considered three key factors: (1) the different types of reported disclosure events, (2) the counting criteria or number of reported events, and (3) the time period over which the events are counted. FINRA considered several alternatives for each of these three factors.
      A. Alternatives Associated With the Types of Disclosure Events

      In determining the different types of disclosure events, FINRA considered all categories of disclosures events reported on the Uniform Registration Forms, including the financial disclosures and the termination disclosures. FINRA decided to exclude financial disclosures because they include personal bankruptcies, civil bonds, or judgments and liens. While these events may be of interest to investors in evaluating whether or not to engage a broker, these types of events by themselves are not evidence of customer harm. FINRA also considered whether termination disclosures should be included as specified risk events. Termination disclosures include job separations after allegations against the brokers.59 FINRA notes that certain termination disclosures reflect conflicts of interest between the firm and the broker and, as a result, may not necessarily be indicative of misconduct. Further, the underlying allegations in the termination disclosures may result in other disclosure events, such as those associated with customer settlements or awards, regulatory actions or civil actions, which are already included in the proposed criteria. If so, the underlying customer harm conduct would be captured in the proposed criteria. As a result, FINRA did not include termination disclosures as specified risk events. Accordingly, FINRA considered the remaining five categories of disclosure events listed in Exhibit 1.

      Within each disclosure category included in the proposed criteria, FINRA considered whether pending matters should be included or if the criteria should be restricted to final matters that have reached a resolution not in favor of the broker. Pending matters include disclosure events that may remain unresolved or subsequently get dismissed because they lack merit or suitable evidence. For example, customers may file complaints that are false or erroneous and such complaints may subsequently be withdrawn by the customers or get dismissed by firms or arbitrators. Accordingly, FINRA excluded pending matters from the proposed criteria because these events may not always be associated with customer harm or misconduct.60

      Exhibit 1 shows the five categories of disclosure events that were considered and the subcategories that were included in the proposed criteria. For criminal matters, FINRA considered whether criminal charges that do not result in a conviction, or guilty plea or nolo contendere (no contest), should be included in the proposed criteria. These events correspond to criminal matters in which the associated charges were subsequently dismissed or withdrawn, and, as a result, are not necessarily evidence of misconduct. Accordingly, FINRA only included criminal convictions, including guilty plea or nolo contendere (no contest), in the proposed criteria.

      For customer settlements and awards, FINRA considered whether settlements and awards in which the broker was not "named" should be considered as a specified risk event. These "subject of" customer settlements and awards correspond to events where the customer initiates a claim against the firm and does not specifically name the broker, but the firm identifies the broker as required by the Uniform Registration Forms.61 In these cases, the broker is not party to the proceedings or settlement. There may be conflicts of interest between the firm and the broker such that the claim may be attributed to the broker without the ability of that broker to directly participate in the resolution. Accordingly, FINRA excluded "subject of" customer settlements and awards from the proposed criteria. FINRA recognizes that excluding these events may also undercount instances where the broker may have been responsible for the alleged customer harm.

      For civil actions and regulatory actions, FINRA considered whether all sanctions associated with final matters should be included or certain less severe sanctions be excluded from the proposed criteria. Final regulatory action or civil action disclosures may be associated with a wide variety of activities, ranging from material customer harm to more technical rule violations, such as a failure to file in time or other events not directly related to customer harm. However, due to the way in which such information is currently reported, it is not straightforward to distinguish regulatory or civil actions associated with customer harm from other such actions.62 In the absence of a reliable way to identify regulatory and civil actions associated with customer harm, FINRA considered using a proxy of severity of the underlying sanctions as a way to exclude events that are likely not associated with material customer harm. Specifically, FINRA only included regulatory actions or civil actions that are associated with more severe sanctions, such as bars and suspensions or monetary sanctions above a de minimis dollar threshold of $15,000. FINRA notes that relying strictly on a proxy for severity would likely exclude certain regulatory actions or civil actions that are associated with customer harm.

      FINRA also considered several alternative de minimis dollar thresholds used for identifying disclosure events that are included in the proposed criteria. For example, FINRA considered higher dollar thresholds of $25,000, $50,000 and $100,000 for customer settlements, customer awards, and monetary sanctions associated with regulatory actions and civil actions. A dollar threshold may capture a dimension of severity of the alleged customer harm. FINRA has established a de minimis dollar reporting threshold of $10,000 for complaints filed prior to 2009 and $15,000 afterwards. The reporting threshold may, however, be low and possibly include instances where the payment was made to end the complaint and minimize litigation costs. However, the dollar threshold does not account for the value of the customers' account and there are likely cases where even low dollar amounts represent remuneration of a significant portion of customer investments. Accordingly, a dollar threshold may be both under-inclusive and over-inclusive, and as a result FINRA considered a range of alternative thresholds. Increasing the dollar threshold from $15,000 to $25,000, $50,000 and $100,000 for identifying individuals that would have met the proposed criteria would decrease the number of individuals impacted by this proposal from 100–160 individuals each year to approximately 90–155 individuals, 80–145 individuals and 65–135 individuals each year, respectively, over the review period. Finally, FINRA notes that establishing a de minimis dollar threshold that is different from that for the current reporting requirements would likely create incentives for individuals and firms to keep future settlements below the dollar level that would trigger the restrictions.
      B. Alternatives Associated With the Counting Criteria

      FINRA considered a range of alternative criteria used for counting criminal matters or specified risk events for classifying individuals. For example, FINRA considered whether the counting criteria for final criminal matters should be two or more final criminal matters or one final criminal matter and another specified risk event. This alternative would effectively count final criminal matters the same way as other specified risk events. FINRA believes that final criminal matters are generally more directly tied to serious misconduct than some of the other specified risk events. Accordingly, FINRA believes that one final criminal matter, as defined by this proposal, by itself should be sufficient to trigger the proposed criteria.63 FINRA also considered alternative criteria for counting specified risk events. For example, FINRA considered decreasing the proposed threshold for counting specified risk events from two to one such event during the prior five-year period. This alternative would change the proposed criteria to one or more final criminal matters or one (instead of two) or more specified risk events during the prior five-year period. This approach would increase the number of individuals impacted by this proposal from 100–160 individuals to 360–620 individuals each year, over the review period. FINRA also considered increasing the proposed threshold for counting specified risk events from two to three such events, thereby changing the proposed criteria to one or more final criminal matter or three (instead of two) or more specified risk events during the prior five year period. This approach would decrease the number of individuals impacted by this proposal from approximately 100–160 individuals to 55–105 individuals each year, over the review period.
      C. Alternatives Associated With the Time Period Over Which the Disclosure Events Are Counted

      FINRA also considered alternative criteria for the time period over which final criminal matters and specified risk events are counted for classifying individuals. For example, FINRA considered whether final criminal matters or specified risk events should be counted over the individual's entire reporting period or counted over a more recent period. Based on its experience, FINRA believes that events that are more than ten years ago do not necessarily pose the same level of possible future risk to customers as more recent events. Further, counting final criminal matters or specified risk events over an individual's entire reporting period would imply that individuals with such events would be subject to the criteria for their entire career, even if they subsequently worked without being associated with any future events. Accordingly, FINRA decided only to include final criminal matters or specified risk events in the more recent period. In addition to the proposed criteria based on a five year period, FINRA considered a criteria that would count two (or more) specified risk events in individuals' reported histories over a ten-year and a five-year period; specifically, the first specified risk event having resolved during the previous ten years and the second specified risk event resolved during the previous five years, or one or more final criminal matters having resolved in the prior five-year period. This approach would increase the number of individuals impacted by this proposal from 100–160 individuals to 115–200 individuals each year, over the review period.

      Request for Comment

      FINRA requests comment on all aspects of the proposal, including specifically the proposed amendments to the MAP rules. FINRA requests that commenters provide empirical data or other factual support for their comments wherever possible. FINRA specifically requests comment concerning the following issues.

      1. How could current FINRA rules be amended to better address the problem(s) of broker misconduct? To what extent have the original purposes of and need for the rules been affected by subsequent changes to the markets, the delivery of financial services, the applicable regulatory framework, or other considerations?
      2. What have been your experiences with current FINRA rules, including specifically Rule 3110 (Supervision), including any ambiguities in the rules or challenges to effectively address the problem(s) of broker misconduct?
      3. Are there alternative ways to address broker misconduct that should be considered? What are the alternative approaches, other than the proposal, that FINRA should consider?
      4. Are there any material economic impacts, including costs and benefits, to investors, issuers and firms that are associated specifically with the proposal? If so:
      a. What are these economic impacts and what are their primary sources?
      b. To what extent would these economic impacts differ by business attributes, such as size of the firm or differences in business models?
      c. What would be the magnitude of these impacts, including costs and benefits?
      5. Are there any expected economic impacts associated with the proposal not discussed in this Notice? What are they and what are the estimates of those impacts?
      6. As discussed above, FINRA considered several numerical and categorical thresholds for identifying individuals that would be subject to the proposed MAP rules amendments. In determining the proposed threshold, FINRA paid significant attention to the economic trade-offs associated with misidentifications, including both over- and under-identification of individuals. FINRA specifically seeks comments on the proposed numerical threshold, including (1) the different types of reported disclosure events, (2) the counting criteria, and (3) the time period of which the events are counted:
      a. Are there any other types of disclosure events that FINRA should consider including in the proposed criteria? Which other disclosure events should FINRA consider including and how does including them improve the economic trade-offs associated with misidentifications?
      i. What counting criteria should FINRA consider for counting these additional disclosure events? What time period should FINRA consider for counting these events?
      b. Are there any reported disclosure events in Exhibit 1 that FINRA should consider excluding from the proposed criteria? Which events should FINRA consider excluding and how does excluding these events impact the economic trade-offs associated with misidentifications?
      c. Should FINRA consider alternative counting criteria for the specified risk events or the final criminal matter? What are these alternative counting criteria and why are they a better alternative to the proposed counting criteria of one or more final criminal matters or two or more specified risk events?
      d. Should FINRA consider alternative time periods over which one or more final criminal matters or two or more specified risk events are counted? Should FINRA consider using different time periods for criminal matters and specified risk events? Should FINRA consider different time periods for the four different types of specified risk events? What are these alternative approaches and why could they be better alternatives to the proposed period of prior five years?
      7. As discussed above, the proposed MAP rules amendments would apply to individuals that meet the proposed criteria and seek to become an owner, control person, principal or registered person of a member firm. Should FINRA consider expanding the scope of the MAP requirements to:
      a. all individuals who meet the proposed criteria and are currently owners, control persons, principals, or registered persons with a firm; or
      b. all individuals who meet the proposed criteria and are currently associated with a firm, irrespective of their registration type or ownership and control status?
      What are the incremental economic impacts, including incremental costs and benefits associated with these alternatives and why are they better than the proposed requirements?
      8. Should FINRA consider expanding the scope of the proposed MAP rule amendments to individuals meeting the proposed numerical threshold who are already a principal and seek to add an additional principal registration with their existing firm?
      9. FINRA is proposing to disclose information through BrokerCheck on the status of a firm as a "taping firm." Should FINRA also consider disclosing information of a broker's association with a "taping firm" through BrokerCheck?

      In addition to comments responsive to these questions, FINRA invites comment on any other aspects of the rules that commenters wish to address. FINRA further requests any data or evidence in support of comments. While the purpose of this Notice is to obtain input as to whether or not the current rules are effective and efficient, FINRA also welcomes specific suggestions as to how the rules should be changed.


      1. The Uniform Registration Forms for firms and brokers are the Uniform Application for Broker-Dealer Registration (Form BD), the Uniform Application for Securities Industry Registration or Transfer (Form U4), the Uniform Termination Notice for Securities Industry Registration (Form U5) and the Uniform Disciplinary Action Reporting Form (Form U6). Firms have access to disclosure events reported on the Form U4, U5, and U6 filings for brokers who were previously registered with the same firms or with other firms. Firms, however, do not readily have available to them disclosure events for persons who were not previously registered, including control affiliates, that are reported on another firm's Form BD. FINRA would expect firms to take reasonable steps to obtain information on the disciplinary history of non-registered individuals that may be disclosed on another firm's Form BD through for example, questionnaires, certifications, and reasonable background checks for those individuals seeking to become an owner, control person, principal or registered person of the firm.

      2. See Regulatory Notice 18-15 (Heightened Supervision, Guidance on Implementing Effective Heightened Supervisory Procedures for Associated Persons With a History of Past Misconduct (April 2018)).

      3. FINRA also expects to file a proposed rule change to amend Schedule A to the FINRA By-Laws to increase current application fees for individuals, and impose new application fees for member firms, subject to an SD that are seeking approval by FINRA to enter or remain in the securities industry. In connection with our on-going efforts to address high-risk brokers, FINRA also will be publishing revised Sanction Guidelines shortly.

      4. Persons submitting comments are cautioned that FINRA does not redact or edit personal identifying information, such as names or email addresses, from comment 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.

      5. 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.

      6. See Individuals Barred by FINRA [http://www.finra.org/industry/individuals-barred-finra-a]. The list is updated monthly.

      7. See General Information on FINRA's Eligibility Requirements [http://www.finra.org/industry/general-information-finras-eligibility-requirements].

      8. See supra note 6.

      9. See supra note 2.

      10. This Notice will refer to both a Hearing Panel and Extended Hearing Panel collectively as "Hearing Panel" unless otherwise noted. The Hearing Panel is chaired by the assigned Hearing Officer who is an employee of OHO. The Chief Hearing Officer appoints two industry panelists, drawn primarily from a pool of current and former securities industry members of FINRA's District Committees, as well as its Market Regulation Committee, former members of FINRA's NAC and former FINRA Governors. The NAC is the national committee that reviews initial decisions rendered in FINRA disciplinary and membership proceedings.

      11. If a respondent fails to answer the complaint, or a party fails to appear at a pre-hearing conference, or a party fails to appear at any hearing that the party is required to attend, the Hearing Officer may issue a default decision in accordance with Rule 9269.

      12. See FINRA Rule 9311(b), which further provides that an appeal will not stay a decision, or part of a decision, that imposes a permanent cease and desist order.

      13. As such terms are defined in Rule 9120 (Definitions).

      14. See, e.g., CBOE Rule 17.11(b) ("Pending effectiveness of a decision imposing a sanction on the Respondent, the Business Conduct Committee may impose such conditions and restrictions on the activities of the Respondent as the Committee considers reasonably necessary for the protection of investors and the Exchange"); BATS Rule 8.11 ("Pending effectiveness of a decision imposing a penalty on the Respondent, the CRO, Hearing Panel or committee of the Board, as applicable, may impose such conditions and restrictions on the activities of the Respondent as he, she or it considers reasonably necessary for the protection of investors, creditors and the Exchange."); CHX Article 12, Rule 6 (explaining that sanctions are stayed during appeal process "subject, however, to the power of the Hearing Officer to impose such limitations on the respondent as are necessary or desirable, in the judgment of the Hearing Officer for the protection of the respondent's customers, creditors or the Exchange or for the maintenance of just and equitable principles of trade"); Nasdaq PHLX Rule 960.10(b) ("Pending effectiveness of a decision imposing sanctions on a Respondent, the Hearing Panel may impose such conditions and restrictions on the activities on such Respondent which it finds to be necessary or appropriate for the protection of the investing public, members, member organizations and the Exchange and its subsidiaries.")

      15. Proposed Rule 9556(a)(2) would permit FINRA staff to issue a notice to a respondent stating that the failure to comply with the conditions or restrictions imposed under Rule 9285 within seven days of service of the notice will result in a suspension or cancellation of membership or a suspension or bar from associating with any member. Proposed Rule 9556(c)(2) would govern the content of the notice similar to current Rule 9556(c).

      16. See FINRA Rule 3110. The rule requires member firms 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 FINRA rules. An effective supervisory system plays an essential role in the prevention of sales abuses, and thus, enhances investor protection and market integrity. As such, irrespective of whether a matter is on appeal or under review, a firm should routinely evaluate its supervisory procedures to ensure they are appropriately tailored for each associated person and take into consideration, among other things, the person's activities and history of industry and regulatory-related incidents. FINRA and the SEC have emphasized the need for heightened supervision when a member firm associates with persons who have a history of industry or regulatory-related incidents.

      17. See supra note 16.

      18. SDs are defined in Section 3(a)(39) of the Exchange Act.

      19. See 15 U.S.C. § 78o-3(g)(2) ("A registered securities association may, and in cases in which the Commission, by order, directs as necessary or appropriate in the public interest orforthe protection of investors shall, deny membership to any registered broker or dealer, and barfrom becoming associated with a member any person, who is subjectto a statutory disqualification."); see also Exchange Act Rule 19h-l.

      20. See supra note 7.

      21. The Rule 9520 Series stems from Section 3(a) (39) of the Exchange Act, which sets forth the definition of SD. In 2007, FINRA amended the definition of SD in its By-Laws to incorporate by reference Exchange Act Section 3(a)(39). This change incorporated three additional SD categories, including willful violations of the federal securities or commodities laws, grounds for SD that were enacted by the Sarbanes-Oxley Act of 2002, and associations with certain other persons subjectto SD. As a result, there was an increase in the number of individuals subjectto SD pursuant to FINRA's By-Laws, and by derivation, an increase in the number of individuals seeking FINRA's approval to enter or remain in the securities industry despite their status as a disqualified individual.

      22. FINRA's review of many SD applications is governed by the standards set forth in Paul Edward Van Dusen, 47 S.E.C. 668 (1981) and Arthur H. Ross, 50 S.E.C. 1082 (1992). These standards provide that in situations where an individual's misconduct has already been addressed by the SEC or FINRA, and certain sanctions have been imposed for such misconduct, FINRA should not consider the individual's underlying misconduct when it evaluates an SD application. In Van Dusen, the SEC stated that when the period of time specified in the sanction has passed, in the absence of "new information reflecting adversely on [the applicant's] ability to function in his proposed employment in a manner consonant with the public interest," it is inconsistent with the remedial purposes of the Exchange Act and unfair to deny an application for re-entry. 47 S.E.C. at 671. The SEC also noted in Van Dusen, however, that an applicant's re-entry is not "to be granted automatically" after the expiration of a given time period. Id. Instead, the SEC instructed FINRA to consider other factors, such as: (1) "other misconduct in which the applicant may have engaged"; (2) "the nature and disciplinary history of a prospective employer"; and (3) "the supervision to be accorded the applicant." Id. Further, in Ross, the SEC established a narrow exception to the rule that FINRA confine its analysis to "new information." 50 S.E.C. at 1085. The SEC stated that FINRA could considerthe conduct underlying a disqualifying order if an applicant's later misconduct was so similar that it formed a "significant pattern." Id. n.10.

      23. The hearing panel considers evidence and other matters in the record and makes a written recommendation on the SD Application to the Statutory Disqualification Committee. See Rule 9524(a)(10). The Statutory Disqualification Committee, in turn, recommends a decision to the NAC, which issues a written decision to the member firm that filed the SD Application. See Rule 9524(b).

      24. Approximately 75 percent of the applications filed in 2016that have reached a resolution were either denied by FINRA, withdrawn because the applicant expected FINRA would recommend denial of its application or closed as the SD application was not required by operation of law. For the other 25 percent, FINRA approval resulted from legal principles, including those embodied in the Exchange Act and in case law, as noted above, which limits FINRA's discretion to deny an application.

      25. But see Regulatory Notice 18-15 (reminding member firms of their obligation to tailor the firm's supervisory systems to account for brokers with a history of industry or regulatory-related incidents, including disciplinary actions).

      26. See BrokerCheck [https://brokercheck.finra.org/].

      27. See Rules 2210(d)(8) and 2267.

      28. Rule 3170(a)(5)(A) defines a "taping firm" to mean:

      (i) A member with at least five but fewer than ten registered persons, where 40% or more of its registered persons have been associated with one or more disciplined firms in a registered capacity within the last three years;
      (ii) A member with at least ten but fewer than twenty registered persons, where four or more of its registered persons have been associated with one or more disciplined firms in a registered capacity within the last three years;
      (iii) A member with at least twenty registered persons where 20% or more of its registered persons have been associated with one or more disciplined firms in a registered capacity within the last three years.

      29. Rule 3170(a)(2) defines a "disciplined firm" to mean:

      (A) a member that, in connection with sales practices involving the offer, purchase, or sale of any security, has been expelled from membership or participation in any securities industry self-regulatory organization or is subject to an order of the SEC revoking its registration as a broker-dealer;
      (B) a futures commission merchant or introducing broker that has been formally charged by either the Commodity Futures Trading Commission or a registered futures association with deceptive telemarketing practices or promotional material relating to security futures, those charges have been resolved, and the futures commission merchant or introducing broker has been closed down and permanently barred from the futures industry as a result of those charges; or
      (C) a futures commission merchant or introducing brokerthat, in connection with sales practices involving the offer, purchase, or sale of security futures is subjectto an order of the SEC revoking its registration as a broker or dealer.

      30. Rule 3170 provides member firms that trigger application of the taping requirement a one-time opportunity to adjust their staffing levels to fall below the prescribed threshold levels and thus avoid application ofthe rule.

      31. There are currently 11 firms identified as "disciplined firms," and one firm is identified as a taping firm under Rule 3170.

      32. Specifically, such changes are (1) a merger of the member with another member, unless both are members ofthe New York Stock Exchange (NYSE) or the surviving entity will continue to be a member of the NYSE; (2) a direct or indirect acquisition by the member of another member, unless the acquiring member is a member of the NYSE; (3) direct or indirect acquisitions or transfers of 25 percent or more in the aggregate ofthe member's assets or any asset, business or line of operation that generates revenues composing 25 percent or more in the aggregate ofthe member's earnings measured on a rolling 36-month basis, unless both the seller and acquirer are members of the NYSE; (4) a change in the equity ownership or partnership capital of the memberthat results in one person or entity directly or indirectly owning or controlling 25 percent or more of the equity or partnership capital; or (5) a material change in business operations as defined in Rule 1011(k). The term "material change in business operations" includes, but is not limited to: (1) removing or modifying a membership agreement restriction; (2) market making, underwriting or acting as a dealer for the first time; and (3) adding business activities that require a higher minimum net capital under Rule 15c3-l of the Exchange Act.

      33. Proposed Rule 1011(p) would define the "Uniform Registration Forms," to mean the Uniform Application for Broker-Dealer Registration (Form BD),the Uniform Application for Securities Industry Registration or Transfer (Form U4), the Uniform Termination Notice for Securities Industry Registration (Form U5) and the Uniform Disciplinary Action Reporting Form (Form U6).

      34. Form U4 Explanation of Terms defines the term "investment-related" as pertaining to securities, commodities, banking, insurance, or real estate (including, but not limited to, acting as or being associated with a broker-dealer, issuer, investment company, investment adviser, futures sponsor, bank, or savings association).

      35. The proposed MAP rules amendments would apply to individuals that meet the proposed criteria and seek to obtain their first principal registration at one of their existing firms or at a new firm. It would not apply to individuals who meet the proposed numerical threshold and are already a principal but seek to add an additional principal registration with one of their existing firms.

      36. For example, in 2015 the Office of the Chief Economist (OCE) published a study that examined the predictability of disciplinary and other disclosure events associated with investor harm based on past similar events. The OCE study showed that past disclosure events, including regulatory actions, customer complaints, arbitrations and litigations of brokers have significant power to predict investor harm. In a subsequent research paper by academics at the University of Chicago and the University of Minnesota, the authors present evidence that suggests a higher rate of new disciplinary and other disclosure events is highly correlated with past disciplinary and other disclosure events, as far back as nine years prior. See Oureshi & Sokobin, Do Investors Have Valuable Information About Brokers?[http://www.finra.org/sites/default/files/OCE-Working-Paper.pdf] (2015); Mark Egan et al., The Market for Financial Adviser Misconduct [https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2739170] (2016).

      37. This analysis included all NAC appeals filed during the review period that reached a final decision by the end of 2017. The analysis includes all NAC decisions, including affirmations, modifications or reversals of the findings in the disciplinary matters. The analysis excludes appeals that were withdrawn prior to the resolution of the appeal process.

      38. FINRA further estimates that approximately 94 percent of the appeals filed by brokers involved one broker and the remaining 6 percent involved two brokers. All the appeals filed by firms were associated with one firm.

      39. The median processing time was approximately 15 months, while the 25th and the 75th percentiles were approximately 11 months and 18 months, respectively.

      40. Three of these 119 individuals were associated with multiple SD Applications over the review period. Approximately 90 percent of the firms filed one request duringthe review period, and the remaining 10 percent filed two or more requests.

      41. FINRA defines a small firm as a member with at least one and no more than 150 registered persons, a mid-size firm as a member with at least 151 and no more than 499 registered persons, and a large firm as a member with 500 or more registered persons. See FINRA By-Laws, Article I.

      42. In approximately 12 percent of the SD Applications, the application was withdrawn because the decision leading to the disqualifying event was overturned, thus the individual was no longer subject to an SD orthe sanctions were no longer in effect. In one of the 122 SD Applications, the resolution of the application was subsequently reversed.

      43. The median processing time was approximately 9 months and the 25th and the 75th percentiles were approximately 3 months and 14 months, respectively.

      44. To be consistent with the definitions used for classifying brokers for the proposed MAP requirements, FINRA based its analysis on the occurrence of one or more final criminal matters or specified risk events, as defined in the proposed amendments to the NASD Rule 1010 Series discussed above.

      45. These estimates are based on appeals filed by brokers, or jointly filed by brokers and firms, and excludes appeals that were filed only by firms. These estimates likely under represent the overall risk of customer harm posed by these brokers because they are based on a specific set of events and outcomes used for classifying brokers for the proposed amendments to the MAP rules. In addition, these brokers had other disclosure events after their appeal was filed and some of these other events may also be associated with risk of customer harm.

      46. The proposal may also impose costs on issuers in limited instances where a firm is enjoined from participating in a private placement and the issuer is especially reliant on that firm. The private issuer may incur search costs to find a replacement firm or individual and incur other direct and indirect costs associated with the offering.

      47. These estimates are based on the definitions for specified risk events and final criminal matters used for the proposed the MAP requirements, and as result, likely under represents the overall risk of customer harm posed by these SD individuals.

      48. Firms have access to disclosure events reported on the Form U4, U5 and U6 filings for individuals who were previously registered with the same firms or with other firms. Firms do not, however, readily have available to them disclosure events for individuals where such individuals were not previously registered, including control affiliates, or where information regarding such individuals is reported on anotherfirm's Form BD

      49. See supra note 48.

      50. The proposed $15,000 threshold for customer settlement corresponds to the reporting threshold forthe Uniform Registration Forms and forthe settlement information to be displayed through BrokerCheck. As a result, brokers and firms already have incentives to settle below the $15,000 amount. Accordingly, FINRA does not anticipate that the proposed dollar threshold would result in a material change in customer settlements.

      51. For example, FINRA uses disclosure events reported on Form BD across all firms to identify disclosure records of non-registered control affiliates.

      52. For example, as discussed above, firms do not have access to disclosure events for non-registered control affiliates at other firms.

      53. The Uniform Registration Forms U5 and U6 have questions similarto Form U4 that can also be mapped to the disclosures categories in Exhibit 1.

      54. The Uniform Registration Form BD includes information on disclosures events for individual control affiliates, including non-registered control affiliates, that may not have Form U4, U5 or U6 filings. Form BD is the primary source of information on disclosure events for these unregistered control affiliates. Form BD includes information on final criminal matters and certain specified risk events associated with regulatory actions and civil actions, but does not include information on customer awards or settlements.

      55. Exhibit 3 does not include information on individuals that were not registered with FINRA in 2016. These non-registered individuals may include non-registered associated persons, including non-registered control affiliates.

      56. Exhibit 3 shows the number of criminal disclosures and disclosures considered in developing specified risk events (regulatory action disclosures, civil judicial disclosures, and customer complaint, arbitration and civil litigation disclosures), including pending and final disclosures, overthe entire reporting history of brokers who were registered with FINRA in 2016. The exhibit also reports the number of brokers associated with these disclosure events and the impact of refining the disclosure categories and the period over which these events are counted. For example, the exhibit shows that there are a total of approximately 20,900 criminal disclosures and 140,200 disclosures considered in developing specified risk events overthe entire reporting history of these brokers. Refining the disclosure categories to include final criminal matters and specified risk events, as defined in this proposal, would result in approximately 155 final criminal matters and 3,425 specified risk events. Exhibit 3 also shows that there were approximately 490 brokers who were registered with FINRA in 2016 and met the proposed numeric threshold of one or more final criminal matters or two or more specified risk events in the prior five years.

      57. These percentages are calculated by dividing FINRA's estimate of the number of individuals who met the proposed criteria each year duringthe review period (approximately 100 -160 individuals per year), by the number of individuals who became owners, control persons, principals, or registered persons with a new member each year during the review period (approximately 105,500–112,800 individuals peryear).

      58. See supra note 41.

      59. Termination disclosures involve situations where the individual voluntarily resigned, was discharged, or was permitted to resign after allegations.

      60. More than 50 percent of the pending matters duringthe review period remain unresolved or were subsequently dismissed. For example, Exhibit 3 shows that approximately 69,000 (or 49 percent) of the 140,000 disclosures considered in developing specified risk events resulted in final matters. Accordingly, more than 50 percent of the pending matters remain unresolved or were subsequently dismissed or did not reach a resolution that was unfavorable to the broker.

      61. For example, the Instructions to Form U4, Questions 141(4) or 141(B) provide that the answer should be "yes" if the broker was not named as a respondent/defendant but (1) the Statement of Claim or Complaint specifically mentions the individual by name and alleges the broker was involved in one or more sales practice violations or (2) the Statement of Claim or Complaint does not mention the broker by name, but the firm has made a good faith determination that the sales practice violation(s) alleged involves one or more particular brokers.

      62. For example, the Uniform Registration Forms contain a description on the allegation, which could be useful in identifying regulatory actions or civil actions associated with customer harm, but this information is stored as "free-text" and, therefore, cannot be reliably compared across disclosures.

      63. FINRA recognizes that final criminal matters include felony convictions that may not be investment related (e.g., a conviction associated with multiple DUIs).


      Attachment 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 Rules

      (Marked to Show Changes from NASD Rule 1010 Series; NASD Rule 1010 Series to be

      Deleted in their Entirety from the Transitional Rulebook)i

      * * * * *

      1000. MEMBERSHIP APPLICATION AND ASSOCIATED PERSON REGISTRATION

      * * * * *

      [1010. Membership Proceedings] 1011. Definitions

      * * * * *

      (g) "final criminal matter"

      The term "final criminal matter" means a final criminal matter that resulted in a conviction of, or guilty plea or nolo contendere ("no contest") by a person that is disclosed, or was required to be disclosed, on the applicable Uniform Registration Forms.
      (g) through (m) renumbered to (h) through (n)
      (o) "specified risk event"

      The term "specified risk event" means any one of the following events that are disclosed, or are or were required to be disclosed, on an applicable Uniform Registration Form;
      (1) a final investment-related, consumer-initiated customer arbitration award or civil judgment against the person for a dollar amount at or above $15,000 in which the person was a named party;
      (2) a final investment-related, consumer-initiated customer arbitration settlement or civil litigation settlement for a dollar amount at or above $15,000 in which the person was a named party;
      (3) a final investment-related civil action where the total monetary sanctions (including civil and administrative penalties or fines, disgorgement, monetary penalties other than fines, or restitution) were ordered for a dollar amount at or above $15,000; and
      (4) a final regulatory action where (A) the total monetary sanctions (including civil and administrative penalties or fines, disgorgement, monetary penalties other than fines, or restitution) were ordered for a dollar amount at or above $15,000; or (B) the sanction against the person was a bar (permanently or temporarily), expulsion, rescission, revocation, or suspension from associating with a member.
      ([n]p) "Subcommittee"

      The term "Subcommittee" means a subcommittee of the National Adjudicatory Council that is constituted pursuant to Rule 1015 to conduct a review of a Department decision issued under the Rule [1010]1000 Series.
      (q) "Uniform Registration Forms"

      The term "Uniform Registration Forms" means the Uniform Application for Broker-Dealer Registration (Form BD), the Uniform Application for Securities Industry Registration or Transfer (Form U4), the Uniform Termination Notice for Securities Industry Registration (Form U5) and the Uniform Disciplinary Action Reporting Form (Form U6), as such may be amended or any successor(s) thereto.

      * * * * *

      IM-1011-2. Business Expansions and Persons with Specified Risk Events

      If a natural person who has, in the prior five years, one or more final criminal matters or two or more specified risk events seeks to become an owner, control person, principal, or registered person of a member, and the member is not otherwise required to file a Form CMA in accordance with Rule 1017, the member may not effect the contemplated activity until the member has first submitted a written letter to the Department, in a manner prescribed by FINRA, seeking a materiality consultation for the contemplated activity. The letter must address the issues that are central to the materiality consultation. The Department will consider the letter and other information or documents and determine in the public interest and the protection of investors that either (1) the member is not required to file a CMA in accordance with Rule 1017 and may effect the contemplated activity; or (2) the member is required to file a CMA in accordance with Rule 1017 and the member may not effect the contemplated activity, unless the Department approves the CMA.

      * * * * *

      1017. Application for Approval of Change in Ownership, Control, or Business Operations
      (a) Events Requiring Application

      A member shall file an application for approval of any of the following changes to its ownership, control, or business operations:
      (1) through (5) No Change.
      (6) Notwithstanding subparagraphs (4) and (5) of Rule 1017(a), whenever the natural person seeking to become an owner, control person, principal or registered person of a member has, in the prior five years, one or more final criminal matters or two or more specified risk events, and the member is not otherwise required to file a Form CMA in accordance with Rule 1017, unless the member has submitted a written letter to the Department, in a manner prescribed by FINRA, seeking a materiality consultation for the contemplated activity. The letter must address the issues that are central to the materiality consultation. As part of the materiality consultation, the Department shall consider the letter and other information or documents provided by the member to determine in the public interest and the protection of investors that either (A) the member is not required to file a CMA in accordance with Rule 1017 and may effect the contemplated activity; or (B) the member is required to file a CMA in accordance with Rule 1017 and the member may not effect the contemplated activity, unless the Department approves the CMA. The safe harbor for business expansions under IM-1011-1 shall not be available to the member in such circumstance.

      * * * * *

      8310. Sanctions for Violation of the Rules

      * * * * *

      8312. FINRA BrokerCheck Disclosure
      (a) No Change.
      (b)
      (1) No Change.
      (2) The following information shall be released pursuant to this paragraph (b):
      (A) any information reported on the most recently filed Form U4, Form U5, Form U6, Form BD, and Form BDW (collectively "Registration Forms");
      (B) currently approved registrations;
      (C) summary information about certain arbitration awards against a BrokerCheck Firm involving a securities or commodities dispute with a public customer;
      (D) the most recently submitted comment, if any, provided to FINRA by the person who is covered by BrokerCheck, in the form and in accordance with the procedures established by FINRA, for inclusion with the information provided through BrokerCheck. Only comments that relate to the information provided through BrokerCheck will be included;
      (E) information as to qualifications examinations passed by the person and date passed. FINRA will not release information regarding examination scores or failed examinations;
      (F) [in response to telephonic inquiries via the BrokerCheck toll-free telephone listing, ]information as to whether a particular member is subject to the provisions of Rule 3170 ("Taping Rule");
      (G) Historic Complaints (i.e., the information last reported on Registration Forms relating to customer complaints that are more than two (2) years old and that have not been settled or adjudicated, and customer complaints, arbitrations or litigations that have been settled for an amount less than $10,000 prior to May 18, 2009 or an amount less than $15,000 on or after May 18, 2009 and are no longer reported on a Registration Form), provided that any such matter became a Historic Complaint on or after August 16, 1999; and
      (H) the name and succession history for current or former BrokerCheck Firms.
      (c) through (f) No Change.

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

      .01 through .03 No Change.

      * * * * *

      9000. CODE OF PROCEDURE

      * * * * *

      9200. DISCIPLINARY PROCEEDINGS

      * * * * *

      9285. Interim Orders While on Appeal
      (a) Conditions and Restrictions

      The Hearing Panel or, if applicable, the Extended Hearing Panel ("Hearing Panel"), or Hearing Officer may impose such conditions or restrictions on the activities of a Respondent as the Hearing Panel or Hearing Officer considers reasonably necessary for the purpose of preventing customer harm.
      (b) Expedited Review
      (1) Availability

      A Respondent that has conditions or restrictions imposed by a Hearing Panel or Hearing Officer may file a motion with the Review Subcommittee of the National Adjudicatory Council to modify or remove any or all of the conditions or restrictions.
      (2) Requirements for the Motion

      The Respondent has the burden to show that the Hearing Panel or Hearing Officer committed an error by ordering the conditions or restrictions imposed. The Respondent must show that the conditions or restrictions are not reasonably necessary for the purpose of preventing customer harm. The Respondent's motion to modify or remove conditions or restrictions shall be filed with FINRA's Office of General Counsel and shall be served simultaneously on the Office of Hearing Officers and all other parties to the disciplinary proceeding. Respondent's motion and the opposition to the motion shall comply with Rules 9133, 9134, 9135, 9136 and 9137.
      (3) Opposition to the Motion

      The Department of Enforcement shall have five days from service of Respondent's motion to file an opposition to the motion. The Respondent may not file a reply to the opposition. Unless ordered otherwise by the Review Subcommittee, the motion to modify or remove conditions or restrictions shall be decided based on the moving and opposition papers and without oral argument. The Review Subcommittee shall issue a written order ruling upon a motion to modify or remove conditions or restrictions in an expeditious manner and no later than 30 days after any opposition filed pursuant to this paragraph (b)(3), and serve the order on all parties.
      (4) Effectiveness

      The filing of a motion to modify or remove a condition or restriction shall stay the effectiveness of the conditions or restrictions ordered by a Hearing Panel or Hearing Officer until the Review Subcommittee rules on the motion.
      (c) Mandatory Heightened Supervision
      (1) Requirement

      When a Hearing Panel or Hearing Officer issues a decision pursuant to Rule 9268 or Rule 9269 in which the adjudicator finds that a Respondent violated a statute or rule provision, any firm with which the Respondent is associated must adopt a written plan of heightened supervision if any party appeals the decision to the National Adjudicatory Council, or if the National Adjudicatory Council calls the case for review. The firm must submit the written plan of heightened supervision within ten days of any party filing an appeal or the case being called for review. Respondent shall file a copy of the plan of heightened supervision with FINRA's Office of General Counsel and shall serve a copy on the Department of Enforcement. If a Respondent becomes associated with another firm while the Hearing Panel's or Hearing Officer's decision is on appeal to the National Adjudicatory Council, that firm, within ten days of the Respondent becoming associated with the firm, shall file a copy of a plan of heightened supervision with FINRA's Office of General Counsel and shall serve a copy on the Department of Enforcement.
      (2) Provisions

      The plan of heightened supervision shall comply with Rule 3110, and shall be reasonably designed and tailored to include specific supervisory policies and procedures that address the violations found by the Hearing Panel or Hearing Officer and shall be reasonably designed to prevent or detect a reoccurrence of those violations. The plan of heightened supervision shall, at a minimum, include the designation of an appropriately registered principal who is responsible for carrying out the plan of heightened supervision, and take into account any conditions and restrictions imposed by the Hearing Panel or Hearing Officer pursuant to paragraph (a) of this Rule.
      (3) Signature of Principal

      The plan of heightened supervision shall be signed by the designated principal, and shall include an acknowledgement that the principal is responsible for implementing and maintaining the plan of heightened supervision.
      (4) Duration

      The plan of heightened supervision shall remain in place until FINRA's final decision takes effect.

      * * * * *

      9300. REVIEW OF DISCIPLINARY PROCEEDING BY NATIONAL ADJUDICATORY COUNCIL AND FINRA BOARD; APPLICATION FOR SEC REVIEW
      9310. Appeal to or Review by National Adjudicatory Council
      9311. Appeal by Any Party; Cross-Appeal
      (a) No Change.
      (b) Effect

      An appeal to the National Adjudicatory Council from a decision issued pursuant to Rule 9268 or Rule 9269 shall operate as a stay of that decision until the National Adjudicatory Council issues a decision pursuant to Rule 9349 or, in cases called for discretionary review by the FINRA Board, until a decision is issued pursuant to Rule 9351. Any such appeal, however, will not stay a decision, or that part of a decision, that imposes a permanent cease and desist order. Notwithstanding the stay of sanctions under this Rule, the Hearing Panel or Hearing Officer may impose such conditions and restrictions on the activities of a Respondent as the Hearing Panel or Hearing Officer considers reasonably necessary for the purpose of preventing customer harm in accordance with Rule 9285(a).
      (c) through (f) No Change.

      * * * * *

      9500. OTHER PROCEEDINGS

      * * * * *

      9520. Eligibility Proceedings

      * * * * *

      9523. Acceptance of Member Regulation Recommendations and Supervisory Plans by Consent Pursuant to SEA Rule 19h-1, and Requirements for an Interim Plan of Heightened Supervision
      (a) through (b) No Change.
      (c) Submission of an Interim Plan of Heightened Supervision An application filed pursuant to FINRA Rule 9522(a)(3) or FINRA Rule 9522(b)(1)(B) or (C) that seeks the continued association of a disqualified person must include:
      (1) An interim plan of heightened supervision. The application shall identify an appropriately registered principal responsible for carrying out the interim plan of heightened supervision, who has signed the plan and acknowledged his or her responsibility for implementing and maintaining such plan. The interim plan of heightened supervision shall be in effect throughout the entirety of the application review process which shall be considered concluded only upon the final resolution of the eligibility proceeding. The interim plan of heightened supervision shall comply with the provisions of Rule 3110, and be reasonably designed and tailored to include specific supervisory policies and procedures that address any regulatory concerns related to the nature of the disqualification, the nature of the sponsoring member's business, and the disqualified person's current and proposed activities during the review process. As a condition to the eligibility proceeding, the Department of Member Regulation, in its discretion and consistent with the public interest and the protection of investors, may modify any interim plan of heightened supervision.
      (2) A written representation from the sponsoring member that the disqualified person is currently subject to an interim plan of heightened supervision as set forth in paragraph (c)(1) of this Rule.
      (d) Determination that an Application is Substantially Incomplete

      If the Department of Member Regulation determines that an application is substantially incomplete, it may reject the application and deem it not to have been filed. In such case, the Department of Member Regulation shall provide the disqualified member or sponsoring member notice of the delinquency and its reasons for so doing. The disqualified member or sponsoring firm shall have ten business days to remedy the application, or such other time period prescribed by FINRA. An application will be deemed to be substantially incomplete if:
      (1) It does not include the representation required by paragraph (c)(2) of this Rule; or
      (2) FINRA determines that it does not include a reasonably designed interim plan of heightened supervision that complies with the standards of paragraph (c)(1) of this Rule.
      (e) Consequences for Failure to Timely Remedy an Application that is Substantially Incomplete

      If an applicant fails to remedy an application that is substantially incomplete, the Department of Member Regulation shall serve a written notice on the disqualified member or sponsoring member of its determination to reject the application and its reasons for so doing. FINRA shall refund the application fee, less $1,000, which shall be retained by FINRA as a processing fee. Upon such rejection, the disqualified member or sponsoring member must promptly terminate association with the disqualified person.

      * * * * *

      9550. Expedited Proceedings

      * * * * *

      9556. Failure to Comply with Temporary and Permanent Cease and Desist Orders, or Hearing Panel or Hearing Officer Decisions that Impose Conditions or Restrictions
      (a) Notice of Suspension, Cancellation or Bar
      (1) If a member, person associated with a member or person subject to FINRA's jurisdiction fails to comply with a temporary or permanent cease and desist order issued under the Rule 9200, 9300 or 9800 Series, FINRA staff, after receiving 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 such member or person stating that the failure to comply with the temporary or permanent cease and desist order within seven days of service of the notice will result in a suspension or cancellation of membership or a suspension or bar from associating with any member.
      (2) If a respondent fails to comply with conditions or restrictions imposed pursuant to Rule 9285 in a Hearing Panel's or Hearing Officer's decision issued pursuant to Rule 9268 or Rule 9269, FINRA staff may issue a notice to a respondent stating that the failure to comply with the conditions or restrictions within seven days of service of the notice will result in a suspension or cancellation of membership or a suspension or bar from associating with any member.
      (b) No Change.
      (c) Contents of Notice
      (1) [The]A notice issued pursuant to paragraph (a)(1) shall explicitly identify the provision of the permanent or temporary cease and desist order that is alleged to have been violated and shall contain a statement of facts specifying the alleged violation. The notice shall state when the FINRA action will take effect and explain what the respondent must do to avoid such action. The notice shall state that the respondent may file a written request for a hearing with the Office of Hearing Officers pursuant to Rule 9559. The notice also shall inform the respondent of the applicable deadline for filing a request for a hearing and shall state that a request for a hearing must set forth with specificity any and all defenses to the FINRA action. In addition, the notice shall explain that, pursuant to Rules 8310(a) and 9559(n), a Hearing Officer or, if applicable, Hearing Panel, may approve, modify or withdraw any and all sanctions or limitations imposed by the notice, and may impose any other fitting sanction.
      (2) A notice issued pursuant to paragraph (a)(2) shall explicitly identify conditions or restrictions that are alleged to have been violated and shall contain a statement of facts specifying the alleged violation. The notice shall state when the FINRA action will take effect and explain what the respondent must do to avoid such action. The notice shall state that the respondent may file a written request for a hearing with the Office of Hearing Officers pursuant to Rule 9559. The notice also shall inform the respondent of the applicable deadline for filing a request for a hearing and shall state that a request for a hearing must set forth with specificity any and all defenses to the FINRA action. In addition, the notice shall explain that, pursuant to Rules 8310(a) and 9559(n), a Hearing Officer or, if applicable, Hearing Panel, may approve, modify or withdraw any and all sanctions imposed by the notice, and may impose any other fitting sanction.
      (d) through (h) No Change.

      * * * * *


      i FINRA will separately issue a Regulatory Notice soliciting comment on proposed changes to the membership application rules resulting from a retrospective review of the rules.


      Exhibit 1: Disclosures Categories Considered for Criminal Matters and Specified Risk Events (Mapped to the Uniform Form U4)

      Subcategories Considered Subcategories Included
      Disclosure Categories* Subcategories U4 Question # Subcategories U4 Question #
      Final Criminal Matters
      I) Convictions
      II) Adjudicated charges with unspecified outcomes
      I) 14A(1)a, (2)a; 14B(1)a, (2)a
      II)14A(1)b, (2)b; 14B(1)b,(2)b
      I) Convictions
      I) 14A(1)a, (2)a; 14B(1)a, (2)a
      Specified Risk Events        
      a) Customer Awards (above de minimis threshold)**
      Customer awards in which:
      I) Individual was named
      II)Individual was subject of
      I) 14I (1)b
      II) 14I (4)b
      Customer awards in which:
      I) Individual was named
      I) 14I (1)b
      b) Customer Settlements (above de minimis threshold)**
      Customer settlements in which:
      I) Individual was named
      II)Individual was subject of
      I)14I (1)c–d
      II)14I (2)a–b; 14I (4)a
      Customer settlements in which:
      I) Individual was named
      I) 14I (1)c–d
      c) Final Civil Judicial
      Sanctions ordered:
      I) Monetary Sanctions
      II) Cease and Desist Sanctions
      III) Other Sanctions
      Civil Judicial DRP, Q12A
      I)Civil and Administrative penalties, Disgorgement, Monetary Penalty other than fines, Restitution
      II)Cease and Desist, Injunction
      III)Other Sanctions
      Sanctions ordered:
      I) Monetary Sanctions (above de minimis threshold)**
      Civil Judicial DRP, Q12A
      I) Civil and Administrative penalties, Disgorgement, Monetary Penalty other than fines, Restitution
      d) Final Regulatory Actions
      Sanctions ordered:
      I)Bars and Suspensions
      II)Monetary Sanctions
      III)Cease and Desist Sanctions
      IV)Other Sanctions
      Regulatory Action-DRP 13 A.
      I)Bar(permanent), Bar (temporary), Rescission, Suspension, Revocation, Expulsion
      II)Civil and Admin Penalties/Fines, Restitution, Disgorgement, Monetary penalties and other fines
      III)Censure, Cease and Desist, Prohibition
      IV)Undertaking, Requalification, Denial, Letter of Reprimand, Other
      Sanctions ordered:
      I)Bars and Suspensions
      II)Monetary Sanctions (above de minimis threshold)**
      Regulatory Action-DRP 13 A.
      I)Bar(permanent), Bar (temporary), Rescission, Suspension, Revocation, Expulsion
      II)Civil and Admin Penalties/Fines, Restitution, Disgorgement, Monetary penalties and other fines

      Notes and Assumptions:

      * Excludes matters that are pending or are known to have reached a resolution in favor of the Individual (e.g. pending or dismissed complaints).

      ** Corresponds to a dollar threshold of $15,000.

      Exhibit 2: Disclosures Categories Considered for Criminal Matters and Specified Risk Events (Mapped to the Uniform Form BD)

      Subcategories Considered Subcategories Included
      Disclosure Categories* Subcategories Form BD Question # Subcategories Form BD Question #
      Final Criminal Matters
      I)Convictions
      II)Adjudicated charges with unspecified outcomes
      I) 11A(1), 11B(1)
      II) 11A(2), 11B(2)
      I) Convictions
      I) 11A(1), 11B(1)
      Specified Risk Events
      a) Customer Awards (above de minimis threshold)**
      Customer awards in which:
      I) Individual was named
      II) Individual was subject of
      NA*** Customer awards in which:
      I) Individual was named
      NA***
      b) Customer Settlements (above de minimis threshold)**
      Customer settlements in which:
      I) Individual was named
      II) Individual was subject of
      NA*** Customer settlements in which:
      I) Individual was named
      NA***
      c) Final Civil Judicial
      Sanctions ordered:
      I)Monetary Sanctions
      II)Cease and Desist Sanctions
      III)Other Sanctions
      Civil Action-DRP Part II, 13 A.
      I)Bar, Suspension, Revocation, Expulsion
      II)Disgorgement, Restitution, Monetary Fine
      III)Censure, Cease and Desist Injunctions
      IV)Other Sanctions
      Sanctions ordered:
      I) Monetary Sanctions (above de minimis threshold)**
      Civil Action-DRP Part II, 13 A.
      I) Bar, Suspension, Revocation, Expulsion
      II) Disgorgement, Restitution, Monetary Fine
      d) Final Regulatory Actions
      Sanctions ordered:
      I) Bars and Suspensions
      II) Monetary Sanctions
      III) Cease and Desist Sanctions
      IV) Other Sanctions
      Regulatory Action-DRP Part II, 12 A.
      I) Bar, Suspension, Revocation, Expulsion
      II) Disgorgement, Restitution, Monetary Fine
      III) Censure, Cease and Desist Injunctions
      IV) Other Sanctions
      Sanctions ordered:
      I) Bars and Suspensions
      II)Monetary Sanctions (above de minimis threshold)**
      Regulatory Action-DRP Part II, 12 A.
      I) Bar, Suspension, Revocation, Expulsion
      II) Disgorgement, Restitution, Monetary Fine

      Notes and Assumptions:

      * Form BD includes information on these disclosure categories for individual control affiliates. These disclosure categories exclude matters that are pending or are known to have reached a resolution in favor of the Individual (e.g. pending or dismissed complaints).

      ** Corresponds to a dollar threshold of $15,000.

      *** Form BD does not include information on customer awards or settlements.

      Exhibit 3: Breakdown of Criminal Matters and Specified Risk Events

      Disclosures Considered in Developing Specified Risk Events (SREs)
      Look-back Period? Criminal Matters Regulatory Action Disclosures Civil Judicial Disclosures Customer Complaint, Arbitration, Civil Litigation Disclosures Any SREs Criminal Matters OR SREs
          Disclosure Subcategory Events Individuals with ≥1 events Disclosure Subcategory Events Disclosure Subcategory Events Disclosure Subcategory Events Events Individuals with ≥1 events Individuals with ≥2 events Events Individuals with ≥1 Criminal Event Or ≥2 SREs
      [1] All years All Criminal Disclosures 20,895 17,813 All Regulatory Action Disclosures 13,567 All Civil Judicial Disclosures 1,282 Complaint, Arbitration, Civil Litigation Disclosures 125,348 140,197 69,376 27,924 161,092 44,060
      [2] All years Final Criminal Matters 17,491 14,970 Final Regulatory Actions 12,298 Final Civil Judicial Disclosures 529 Customer Awards and Settlements above de minimis threshold Customer Awards 55,731 68,558 39,658 12,858 86,049 26,957
      [3] 5 years Final Criminal Matters 846 805 Final Regulatory Actions 2,296 Final Civil Judicial Disclosures 117 Customer Awards and Settlements above de minimis threshold 7,435 12,410 9,271 1,551 13,256 2,345
      [4] 5 years Criminal Convictions 154 145 Final Regulatory Actions associated with i) bars and suspensions or ii) monetary sanctions above de minimis threshold 1,311 Final Civil Judicial Actions with monetary sanctions above de minimis threshold 10 Customer Awards and Settlements above de minimis threshold in which Individual was "named" 2,105 3,426 2,870 348 3,578 493

      Notes and Assumptions:

      [1]: Disclosures within each subcategory include all disclosures including pending and resolved events, regardless of the resolution.
      [2]: Final events exclude matters that are pending or are known to have reached a resolution in favor of the Individual. Final criminal matters include convictions and outcome that are not specified.
      [3]: 5 year look-back is based on resolution date being within the last 5 years.
      [4]: Regulatory Actions corresponding to bars and suspensions include, permanent or temporary bar, suspension, revocation, rescission or expulsion. Customer Awards and Settlements in which the individual was "named" exclude any settlements prior to initiation of arbitration or civil litigation.
      [5]: De minimis threshold corresponds to a dollar threshold of $15,000

      Exhibit 4: Individuals and Firms Impacted by the Proposed MAP Requirement

      Year Individuals impacted by proposed MAP requirement Firms impacted by the Proposed MAP requirement
      Individuals meeting the Proposed Criteria who became:*        
      (1) Principal (2) Registered Person (3) Owner or Control Person (1) or (2) or (3) Small Firms Medium Firms Large Firms All Firms
      2013 42 146 11 160 91 24 55 170
      2014 30 111 13 124 72 14 59 145
      2015 34 114 10 129 72 20 49 141
      2016 17 94 7 99 51 16 46 113

      Notes and Assumptions

      * Proposed criteria corresponds to individuals with one final criminal matter or two or more specified risk events within the prior five years reported on Uniform Registration Forms U4, U5, U6 and Form BD.

    • 18-15 Guidance on Implementing Effective Heightened Supervisory Procedures for Associated Persons With a History of Past Misconduct

      View PDF

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 3110
      Notice to Members 97-19
      Notice to Members 98-38
      Regulatory Notice 18-16
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      Heightened Supervision
      Supervision

      Heightened Supervision

      Summary

      FINRA is publishing this Notice to reiterate the supervisory obligations of member firms regarding associated persons with a history of past misconduct that may pose a risk to investors. FINRA Rule 3110 (Supervision) requires member firms 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 FINRA rules. An effective supervisory system plays an essential role in the prevention of sales abuses, and thus, enhances investor protection and market integrity. As such, FINRA has long emphasized that member firms have a fundamental obligation to implement a supervisory system that is tailored specifically to the member firm's business and addresses the activities of all its associated persons. This Notice highlights particular instances where heightened supervision of an associated person may be appropriate. Firms are encouraged to adopt the practices that are outlined in this Notice to strengthen their own supervisory procedures, as appropriate to their business.

      This Notice is one of several FINRA initiatives focused on associated persons with a history of past misconduct that pose a risk to investors and the firms that employ them. These initiatives are designed to strengthen oversight of such associated persons and firms through a combination of guidance, rule changes, and FINRA examination and surveillance programs. FINRA also is simultaneously issuing Regulatory Notice 18-16 seeking comment on proposed rule amendments to further efforts to protect investors.1

      Questions concerning this Notice should be directed to Kosha Dalal, Associate Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6903 or kosha.dalal@finra.org.

      Background & Discussion

      FINRA administers comprehensive regulatory programs designed to help our members maintain trust in the financial markets. These programs serve multiple purposes in advancing FINRA's mission of protecting investors and market integrity—including promoting compliance with applicable rules, creating a level playing field, and enhancing transparency and access to information. One of their most important purposes is to protect investors from bad actors: those who seek to evade regulatory requirements and harm investors for their own personal gain. FINRA continues to evaluate and augment its regulatory programs to better identify and supervise potential bad actors.

      Member firms also have a key role to play in protecting investors from bad actors. While FINRA believes that the vast majority of registered representatives seek to serve their clients in accordance with all applicable regulatory requirements, ongoing vigilance by member firms is critical. Member firms should be reviewing and updating their supervisory systems and procedures for hiring practices, monitoring brokers and investigating red flags suggestive of misconduct. FINRA requires member firms to establish and maintain supervisory systems for each of their associated persons and to test and verify annually that they have established reasonable procedures, including procedures for heightened supervision of associated persons, where necessary. FINRA and the SEC have emphasized the need for heightened supervision when a member firm associates with persons who have a history of industry or regulatory-related incidents.2 These heightened supervisory procedures are a critical element in a member firm's supervisory system. As such, it is essential that firms monitor the histories of their associated persons and establish heightened measures to supervise the activities of those associated persons with greater potential of creating customer harm.

      FINRA previously issued guidance regarding the application of heightened supervisory plans for associated persons with a history of industry or regulatory-related incidents.3 For example, a firm that hires an associated person with a recent history of customer complaints, disciplinary actions involving sales practice abuse or other customer harm, or adverse arbitration decisions should determine whether it needs special supervisory procedures for that associated person, or whether its existing supervisory procedures are sufficient to address the circumstances.4 Firms also should make this determination where an associated person, during his or her employment with the firm, develops a history of problems.

      Member firms often serve as the first line of defense against customer harm through establishing and maintaining effective supervisory systems, particularly with regard to associated persons who may pose higher risks of causing customer harm. In order to provide additional guidance to firms, FINRA has identified certain circumstances under which firms are encouraged to consider implementing heightened supervisory procedures for an associated person.5 Implementation of the suggested recommendations may help to reduce future customer harm by brokers; however, the recommendations below are not intended to be an exhaustive list of circumstances firms should consider when determining whether to implement heightened supervisory procedures. Moreover, a firm's implementation of the recommendations in and of themselves would not necessarily satisfy its obligations under Rule 3110(a) to establish and maintain a supervisory system reasonably designed to achieve compliance with applicable securities laws and applicable FINRA rules or other obligations that may arise under FINRA rules.

      Heightened Supervisory Procedures

      A firm should routinely evaluate its supervisory procedures to ensure they are appropriately tailored for each associated person and take into consideration, among other things, the person's activities and history of industry and regulatory-related incidents. When an associated person of the firm has a history of industry or regulatory-related incidents, the firm must make a reasonable determination as to whether its standard supervisory and educational programs are adequate to address the issues such person's history raises or whether the firm should develop tailored heightened supervisory procedures to address such issues. The failure to assess the adequacy of its supervisory procedures in light of an associated person's history of industry or regulatory-related incidents would be closely evaluated in determining whether the firm itself should be subject to disciplinary action for a failure to supervise should that person be the subject of a future industry or regulatoryrelated incident.

      A. Identifying Individuals for Heightened Supervision

      In identifying which associated persons to place on heightened supervision, firms should consider, among other things, customer-related regulatory actions; criminal matters; the firm's pre-registration investigation; internal investigations; firm-imposed discipline; disciplinary actions; final, pending and settled arbitrations; past, open or settled customer complaints; terminations for cause; and other items disclosed on the person's uniform registration forms.6 While final adverse adjudicated matters such as disciplinary actions, criminal matters and arbitrations clearly indicate a disciplinary problem, a pattern of unadjudicated matters, such as unadjudicated customer complaints, also may be indicative of a history that should be carefully reviewed.

      In addition, FINRA believes that the following two circumstances raise significant investor protection concerns, and firms should evaluate the facts and circumstances to make a determination of whether heightened supervision would be appropriate.7

      •   Heightened Supervision of Statutorily Disqualified Persons During Eligibility Review Process

      Currently, if an associated person who has an industry or regulatory-related event that qualifies as a statutory disqualification (SD) under the Securities Exchange Act of 1934 (Exchange Act) wants to continue associating with a member firm, he or she must undergo a FINRA eligibility proceeding.8 Under FINRA's current rules, a person who becomes statutorily disqualified while associated with a member firm is allowed to remain associated with that member firm during FINRA's review process, so long as the member firm promptly files a Form MC-400 application (SD Application). In reviewing an SD Application, FINRA can seek to prevent the statutorily disqualified person from associating with a member firm or can permit the statutorily disqualified person to associate with a member firm if it is consistent with the public interest and protection of investors. Generally, where FINRA permits the statutorily disqualified person to associate or continue association with a member firm, FINRA will condition the association on the establishment of certain safeguards, including the adoption and implementation of a heightened supervisory plan by the member firm of the person's business activities. To further promote investor protection, member firms should consider adopting and implementing an interim plan of heightened supervision for any statutorily disqualified person associated with the firm once the SD Application is filed with FINRA and to keep such heightened supervisory plan in place while the review is pending. FINRA believes heightened supervision may be appropriate for such persons because they have already been statutorily disqualified, and, in nearly every case, the continued association of a statutorily disqualified person approved through a FINRA eligibility proceeding is conditioned on the individual being subject to a robust heightened supervision plan.
      •   Heightened Supervision of Persons While Disciplinary Case Is On Appeal

      Currently, when an associated person or member firm in a litigated disciplinary case appeals a Hearing Panel decision to the National Adjudicatory Council (NAC), sanctions are generally stayed pending an appeal.9 In cases where the Hearing Panel has rendered a decision making a finding of violation against the associated person and where an appeal is filed, to further promote investor protection, firms should consider adopting and implementing an interim plan of heightened supervision for such associated person and keep such heightened supervisory plan in place while the appeal is pending. FINRA believes heightened supervision may be appropriate for such persons because they have already been found to have violated a rule.

      B. Developing and Implementing a Heightened Supervision Plan

      Once a firm determines that heightened supervision is necessary, the firm should develop written, tailored heightened supervisory procedures designed to address the nature of the particular concerns the associated person's incident history raises and the nature of such person's ongoing activities. When developing a heightened supervision plan, the firm should determine the parameters of the plan on a case-by-case basis for each associated person that the firm has identified as requiring heightened supervision.

      In making this determination, a firm should consider whether the nature of the concerns the associated person's incident history raises involved a particular product, customer type or activity. In any of these instances, the firm should examine the product, customer type or activity to identify the level and type of risk it presents. The firm should then determine what type of supervision might best control and limit this type of risk. The plan should reflect a firm's reasonable consideration of how to effectively supervise the individual through tailored provisions designed to prevent and deter future incidents.

      FINRA has provided a number of factors that firms should consider including in a heightened supervision plan. Firms are cautioned that these factors are neither exhaustive nor will they constitute a safe harbor for FINRA rules. Based on staff experience, FINRA believes effective heightened supervision plans should include, at a minimum:

      •   designating a principal with the appropriate training and experience to implement and enforce the plan;
      •   requiring appropriate additional training for the associated person subject to the plan to address the nature of incidents resulting in the plan;
      •   requiring the written acknowledgment of the heightened supervisory plan by the associated person subject to the plan and the designated supervisory principal; and
      •   periodically reviewing the heightened supervision plan to assess its effectiveness.

      In addition to these minimum provisions, FINRA has seen, among other things, effective heightened supervision plans that provide for:

      •   heightened supervision of the associated person's business activities, including customer-related activities, employee personal trading accounts, outside business activities and private securities transactions;
      •   proximity of the supervisor to the associated person;
      •   more frequent contact between the supervisor and the associated person;
      •   more frequent review of the associated person's communications, particularly with customers;
      •   more frequent monitoring or inspection of the associated person's office(s); and
      •   expediting the handling of customer complaints related to the associated person.

      A member firm's supervisory system is critical to protecting investors and market integrity, particularly where persons associated with the firm have a history of industry or regulatory-related incidents. It is essential that firms monitor the regulatory histories of their associated persons and establish additional measures to supervise the activities of those individuals with greater potential of creating customer harm. The implementation of heightened supervision does not diminish the importance of a member firm's overall supervisory obligations. Member firms must continue to have supervisory systems reasonably designed to ensure compliance with applicable securities laws and FINRA rules for each type of business conducted by the firm and its associated persons.


      1. See Regulatory Notice 18-16 (FINRA Requests Comment on FINRA Rule Amendments Relating to High-Risk Brokers and the Firms that Employ Them) (April 2018). In connection with our on-going efforts to address high-risk brokers, FINRA also will be publishing revised Sanction Guidelines shortly.

      2. See, e.g., Dep't of Enforcement v. J. Alexander Sec., Inc., No. CAF010021, 2004 NASD Discip. LEXIS 16, at *51 (NAC Aug. 16, 2004), aff'd sub nom. Robert J. Prager, Exchange Act Rel. No. 51974, 2005 SEC LEXIS 1558 (July 6, 2005); Signal Sec., Inc., Exchange Act Rel. No. 43350, 2000 SEC LEXIS 2030, at *17 (Sept. 26, 2000); James Harvey Thornton, 53 S.E.C. 1210, 1216 (1999); Consolidated Inv. Serv., Inc., 52 S.E.C. 582, 588-89 (1996); Notice to Members 97-19 (April 1997); Notice to Members 98-39 (May 1998).

      3. See Notice to Members 97-19 (stating that a member firm with a registered representative who develops a history of customer complaints, final disciplinary actions involving sales practice abuse or other customer harm, or adverse arbitration decisions should consider developing special supervisory procedures for that registered representative); and Notice to Members 98-39 (indicating that unexpected supervisory visits to offices with personnel who have disciplinary records may be appropriate). See also, Robert W. Cook, President and CEO, FINRA, Address at the McDonough School of Business, Georgetown University: Protecting Investors From Bad Actors (June 12, 2017), available at www.finra. org/newsroom/speeches/061217-protectinginvestors-bad-actors; and FINRA 2018 Regulatory and Examination Priorities Letter (January 8, 2018), available at www.finra.org/industry/2018- regulatory-and-examination-priorities-letter.

      4. See FINRA Rule 3110(e), which requires a firm to ascertain by investigation the good character, business reputation, qualifications and experience of an applicant before it registers that applicant with FINRA. Firms are advised to consider all available information gathered in the pre-registration process for this purpose, including Form U4 and U5 responses, searches of the CRD system, fingerprint results, private background checks and communications with previous employers. In addition, FINRA strengthened the background check obligations of firms by requiring firms to adopt written procedures reasonably designed to verify the accuracy of completeness of the information contained in the applicant's Form U4. See also Notice to Members 97-19.

      5. FINRA also requires heightened supervision in some cases when a firm hires numerous individuals from a disciplined firm. In such cases, a firm can become a "taping firm," and be required to tape record all of its registered persons' phone calls with investors. See FINRA Rule 3170 (Tape Recording of Registered Person by Certain Firms).

      6. See the Uniform Application for Securities Industry Registration or Transfer (Form U4), the Uniform Termination Notice for Securities Industry Registration (Form U5) and the Uniform Disciplinary Action Reporting Form (Form U6).

      7. See Regulatory Notice 18-16 (April 2018), in which FINRA is seeking, among other things, comment on proposals to require mandatory heightened supervision in the two instances described.

      8. Events triggering statutory disqualification include, for example, certain enumerated misdemeanor and all felony criminal convictions for a period of ten years from the date of conviction; temporary and permanent injunctions (regardless of their age) involving a broad range of unlawful investment activities; bars (and current suspensions) ordered by the SEC or a self-regulatory organization (SRO); and findings that a person willfully has made or caused to be made false statements of a material fact to an SRO. See Sections 3(a)(39) and 15(b)(4) (A) of the Exchange Act; FINRA By-Laws Article III, Section 4. Persons who are or become subject to a statutory disqualification may seek to enter, reenter, or in the case of incumbents, continue in the securities industry.

      9. See FINRA Rule 9311(b).

    • 18-14 FINRA Requests Comment on the Effectiveness and Efficiency of Its Rule on the Annual Compliance Meeting; Comment Period Expires: June 25, 2018

      View PDF

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 3110
      NTM 99-45
      NTM 05-44
      Suggested Routing

      Compliance
      Continuing Education
      Legal
      Operations
      Registered Representatives
      Registration
      Senior Management
      Training
      Key Topics

      Annual Compliance Meeting

      Retrospective Rule Review

      Summary

      FINRA is conducting a retrospective review of Rule 3110 (Supervision), governing annual compliance meetings to assess its effectiveness and efficiency. This Notice outlines the general retrospective rule review process and seeks responses to several questions related to firms' experiences with this specific rule.

      Questions regarding this Notice should be directed to:

      •    Kosha Dalal, Associate Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6903 or Kosha.Dalal@finra.org;
      •    Sarah Kwak, Assistant General Counsel, OGC, at (202) 728-8471 or Sarah.Kwak@finra.org; or
      •    Lori Walsh, Deputy Chief Economist, Office of the Chief Economist, at (202) 728-8323 or Lori.Walsh@finra.org.

      Action Requested

      FINRA encourages all interested parties to comment. Comments must be received by June 25, 2018.

      Comments must be submitted through one of the following methods:

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

      Jennifer Piorko Mitchell
      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.

      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

      Background & Discussion

      FINRA believes that it is appropriate, after a reasonable period of time, to look back at its significant rulemaking to determine whether a FINRA rule or rule set2 is meeting its intended investor-protection objectives by reasonably efficient means. FINRA further believes that a retrospective review should include a review not only of the substance and application of a rule or rule set, but also FINRA's processes to administer the rules. FINRA intends to select relevant rules and to conduct retrospective rule reviews on an ongoing basis to ensure that its rules remain relevant and appropriately designed to achieve their objectives, particularly in light of environmental, industry and market changes.

      In conducting the review, FINRA staff will follow a similar process to previous retrospective rule reviews. In general, the review process consists of an assessment and action phase. During the assessment phase, FINRA will evaluate the efficacy and efficiency of the rule or rule set as currently implemented, including FINRA's internal administrative processes. FINRA will seek input from affected parties and experts, including its advisory committees, subject-matter experts inside and outside of the organization, and other stakeholders, including industry members, investors, interested groups and the public. FINRA staff will assess issues including the existence of duplicative, inconsistent or ineffective regulatory obligations; whether market or other conditions have changed to suggest there are ways to improve the efficiency or effectiveness of a regulatory obligation without loss of investor protections; and potential gaps in the regulatory framework. Upon completion of this assessment, FINRA staff will consider appropriate next steps, which may include some or all of the following: modifications to the rule, updated or additional guidance, administrative changes or technology improvements, or additional research or information gathering.

      The action phase will then follow. To the extent action involves modification of rules, FINRA will separately engage in its usual rulemaking process to propose amendments to the rules based on the findings. This process will include input from FINRA's advisory committees and an opportunity for comment on specific proposed revisions in a Regulatory Notice or rule filing with the SEC, or both.

      Request for Comment

      FINRA has identified Rule 3110(a)(7) and Supplementary Material .04 (Annual Compliance Meeting) for review. Rule 3110(a)(7) requires each registered representative and registered principal to participate, at least once each year, in an interview or meeting at which compliance matters relevant to the particular representative or principal are discussed. Supplementary Material .04 provides that a firm is not required to conduct in-person meetings with each registered person or groups of registered persons to comply with the annual compliance meetings (or interviews) required by Rule 3110(a)(7).3 However, a firm that chooses to conduct compliance meetings using other methods (e.g., on-demand webcast or course, video conference, interactive classroom setting, telephone or other electronic means) must ensure, at a minimum, that each registered person attends the entire meeting. For example, the firm might use an on-demand annual compliance webcast requiring each registered person to use a unique user ID and password to gain access and use a technology platform to track the time spent on the webcast, provide click-as-you-go confirmation and have an attestation of completion at the end of a webcast. The firm also must ensure that registered persons are able to ask questions regarding the presentation and receive answers in a timely fashion. For example, a firm could host an on-demand annual compliance webcast that allows registered persons to ask questions via an email to a presenter or a centralized address or via a telephone hotline and receive timely responses directly or view such responses on the firm's intranet site.

      FINRA seeks answers to the following questions with respect to these rules:

      1. Has the rule effectively addressed the problem(s) it was intended to mitigate? To what extent has the original purposes of and need for the rule been affected by subsequent changes to the markets, the delivery of financial services, the applicable regulatory framework, or other considerations? Are there alternative ways to achieve the goals of the rule that FINRA should consider?
      2. What has been your experience with implementation of the rule, including any ambiguities in the rule or challenges to comply with them?
      3. What have been the economic impacts, including costs and benefits, from conducting compliance meetings? Has the rule furthered the supervision of registered persons, and are the benefits of compliance meetings commensurate with their costs? To what extent do the costs and benefits relate to the business attributes of the firm, such as its size and business model? Has the rule led to any negative unintended consequences?
      4. Are compliance meetings held in-person or by other methods (e.g., on-demand webcast or course, video conference, interactive classroom setting, telephone or other electronic means)? To what extent is the method chosen dependent on the business attributes of the firm? Which methods are the most effective to conduct a compliance meeting?
      5. What are the costs and benefits to conduct compliance meetings either in-person or using other methods (e.g., on-demand webcast or course, video conference, interactive classroom setting, telephone or other electronic means)? Relative to conducting meetings in-person, to what extent do the other methods decrease costs or increase efficiency? When using the other methods to conduct compliance meetings, are firms able to use existing, internal technologies? Is a firm's ability to use existing, internal technologies dependent on the business attributes of the firm?
      6. Can FINRA make the rules, interpretations or attendant administrative processes more efficient and effective? Are there alternatives to the rule that would better communicate compliance obligations to registered persons or would reduce its costs?

      In addition to comments responsive to these questions, FINRA invites comment on any other aspects of the rule that commenters wish to address. FINRA further requests any data or evidence in support of comments. While the purpose of this Notice is to obtain input as to whether or not the current rule is effective and efficient, FINRA also welcomes specific suggestions as to how the rule should be changed. As discussed above, FINRA will separately consider during the action phase specific changes to the rules.


      1. Persons submitting comments are cautioned that FINRA does not redact or edit personal identifying information, such as names or email addresses, from comment 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. A rule set is a group of rules identified by FINRA staff to contain a similar subject, characteristics or objectives.

      3. See Rule Rule 3110.04 (Annual Compliance Meeting); see also Notices to Members 99-45 (June 1999) and 05-44 (June 2005); see also letter from Afshin Atabaki [http://www.finra.org/industry/interpretive-letters/november-30-2006-1200am], FINRA, to Evan Charkes, Citigroup Global Markets, Inc., dated November 30, 2006 (firms may use on-demand webcast technology to satisfy the annual compliance meeting requirement, subject to specified safeguards and conditions); letter from Afshin Atabaki [http://www.finra.org/industry/interpretive-letters/february-5-2013-1200am], FINRA, to S. Kendrick Dunn, Pacific Select Distributors, Inc., dated February 5, 2013 (firms may use on-demand course without voice narration to satisfy annual compliance meeting requirement, subject to specified safeguards and conditions).

    • 18-13 FINRA Requests Comment on Proposed Amendments to the Quantitative Suitability Obligation Under FINRA Rule 2111; Comment Period Expires: June 19, 2018

      View PDF

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 2111
      Notice to Members 01-23
      Regulatory Notice 11-02
      Regulatory Notice 11-25
      Regulatory Notice 12-25
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      Excessive Trading
      Quantitative Suitability
      Suitability

      Quantitative Suitability

      Summary

      FINRA seeks comment on proposed rule amendments that would revise the quantitative suitability obligation under FINRA Rule 2111 (Suitability) to more effectively address instances of excessive trading in customers' accounts. The proposed rule amendments would remove the element of control that currently must be proved to demonstrate a violation, but would not change the obligations to prove that the transactions were recommended and that the level of trading was excessive and unsuitable in light of the customer's investment profile.

      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; or
      •    Meredith Cordisco, Associate General Counsel, OGC, at (202) 728-8018.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by June 19, 2018.

      Comments must be submitted through one of the following methods:

      •    Emailing comments to pubcom@finra.org; or
      •    Mailing comments in hard copy to:
      Jennifer Piorko Mitchell
      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 filed with the Securities and Exchange Commission (SEC) pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA or Exchange Act).2

      Background & Discussion

      In 2010, when FINRA amended its longstanding suitability rule, it codified the line of cases on excessive trading (sometimes referred to as "churning") as the rule's quantitative suitability obligation.3 Consistent with the case law, FINRA's quantitative suitability obligation requires a broker who has control over a customer's account to have a reasonable basis for believing that a series of transactions the broker recommends is not excessive and unsuitable for the customer, even if the individual transactions are suitable when viewed in isolation. However, if a broker does not control a customer's account, the quantitative suitability obligation does not apply when the broker recommends a series of transactions, even if that series of transactions is excessive and unsuitable for the customer. FINRA has reconsidered the appropriateness of the control element in light of its experience with the rule, the other requirements of the rule and, more recently, the SEC's proposed Regulation Best Interest (Regulation BI).4 FINRA seeks comment on its proposal to amend Supplementary Material .05(c) of Rule 2111 to remove the control element from the quantitative suitability obligation.

      A. Actual or De Facto Control Under Quantitative Suitability

      Under the quantitative suitability obligation, control can be actual or de facto. In general, actual control exists when a broker has formal discretionary authority over a customer's account.5 A showing of de facto control over a customer's account depends on whether the customer routinely follows the broker's advice because the customer is unable to evaluate the broker's recommendations and exercise independent judgment.6 In practice, however, these assessments can be difficult to make and they place a heavy and unnecessary burden on customers by, in effect, asking them to admit that they lack sophistication or the ability to evaluate a broker's recommendations. This is true even where it is otherwise clear that the broker recommended the transactions and that they were excessive and unsuitable. FINRA is concerned that the control element serves as an impediment to investor protection and an unwarranted defense to unscrupulous brokers.

      B. Proposed Amendments

      The proposed amendments would remove the phrase "who has actual or de facto control over a customer account" from the quantitative suitability obligation under Supplementary Material .05(c) of Rule 2111. The original basis for requiring the control element is unnecessary under the suitability rule. The inclusion of the control element has its historic roots, in part, in the perceived need to ensure that the culpability for excessive trading rested with the party responsible for initiating the transactions in actions brought pursuant to the antifraud provisions of the federal securities laws.7 That concern is not present under FINRA's suitability rule. Because FINRA must show that the broker recommended the transactions in order to prove a Rule 2111 violation, culpability for excessive trading will still rest with the appropriate party even absent the control element.8 Moreover, the existence of the control element may impede investor protection by acting as an unintended shield for unscrupulous brokers engaged in excessive trading. Indeed, as the SEC noted in proposing Regulation BI, "the fact that a customer may have some knowledge of financial markets or some 'control' should not absolve the broker-dealer of its ultimate responsibility to have a reasonable basis for any recommendations that it makes."9

      Finally, the proposed rule would continue to require FINRA to prove that the series of recommended transactions was excessive and unsuitable, and the proposed amendments would not affect the extensive case law concerning whether trading activity is excessive. Whether trading activity in a customer's account is excessive would still depend on the facts and circumstances of a particular case and would continue to be assessed in light of the customer's investment profile.10 Although no single test defines excessive activity, factors such as turnover rate,11 cost-to-equity ratio12 or the use of in-and-out trading13 may provide a basis for a finding of excessive trading.14 A turnover rate of six or a cost-toequity ratio above 20 percent generally is indicative of excessive trading.15 However, lower ratios have supported findings of excessive trading for customers with very conservative investment objectives,16 while somewhat higher ratios have not supported findings of excessive trading for some customers with highly speculative investment objectives and the financial resources to withstand potential losses.17 In addition to these ratios, a pattern of in-and-out trading in relatively short periods of time is a "hallmark" of excessive trading, which, by itself, can provide a basis for finding excessive trading.18

      Economic Impact Assessment

      A. Economic Baseline

      The economic impact of the proposed rule is dependent on the effects of removing the control element from the quantitative suitability obligation. The control element in the current rule makes it difficult to enforce the quantitative suitability obligation, even where the excessiveness of the trading and the broker's responsibility for the recommendations are clear. As a result, brokers may be able to recommend excessive levels of trading to their customers but avoid disciplinary actions for violating the quantitative suitability obligation because of the difficulty in assessing and proving de facto control over their customers' accounts.

      B. Economic Impact

      The proposed amendment to Rule 2111 would promote investor protection. Removing the control element from the quantitative suitability obligation would likely increase FINRA's ability to hold brokers responsible for recommendations resulting in excessive trading and serve as a deterrent to possible future misconduct.

      As a general proposition, a potential impact of reducing the threshold for establishing a violation of any rule may be that it increases the probability of establishing a violation in the presence of less evidence. However, FINRA does not believe the removal of the control element would lead to disciplinary actions against brokers for excessive trading when the brokers are not responsible for initiating the transactions. In the absence of the control element, FINRA's suitability rule will continue to require FINRA to prove that the broker recommended the transactions and that the transactions were excessive and unsuitable in light of the customer's investment profile. These elements ensure that the culpability for excessive trading continues to rest with the appropriate party. The control element is an unnecessary layer of proof regarding the identity of the responsible party (i.e., the party initiating the transactions) and does not in any way touch on the proof needed to establish the underlying, substantive misconduct (i.e., the excessive trading activity inconsistent with the customer's investment profile).

      FINRA believes, moreover, that the proposed change would impose minimal, if any, additional compliance burdens on members because FINRA understands that firms already routinely perform compliance reviews for excessive trading activity without consideration of whether a broker controls the account. The primary cost may be that member firms would need to update written supervisory procedures.

      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 questions:

      1. How does your firm currently monitor for potentially excessive trading in customer accounts? Does your firm consider whether brokers have de facto control over customers' accounts when monitoring for potential excessive trading? If so, how does your firm conduct such monitoring?
      2. The proposal would remove the element of control from the quantitative suitability obligation. Would the requirement to prove that the transactions were recommended continue to ensure that the culpability for excessive trading rests with the appropriate party?
      3. Are there alternative ways to address excessive trading that should be considered? If so, what are the alternative approaches that FINRA should consider?
      4. Are there any material economic impacts, including costs and benefits, to investors, brokers and firms that could result from implementation of the proposed amendments?

      1. Persons submitting comments are cautioned that FINRA does not redact or edit personal identifying information, such as names or email addresses, from comment submissions. Persons should submit only information that they wish to make publicly available. See Notice to Members 03-73 (Online Availability of Comments) (November 2003) 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 Regulatory Notice 12-25, at 14 (May 2012). Although the terms "churning" and "excessive trading" are often used interchangeably, churning requires scienter in order to prove a fraud, whereas "excessive trading," now known as quantitative suitability, does not. See David A. Roche, 53 S.E.C. 16, 22 (1997).

      4. On April 18, 2018, the SEC proposed Regulation Best Interest, which would create a new rule under the Exchange Act and establish a "best interest" standard of conduct for brokerdealers and associated persons when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer. See Regulation Best Interest, Exchange Act Release No. 83062 (Apr. 18, 2018) (Regulation BI Proposing Release). One element of the multi-pronged approach proposed by the SEC would incorporate and go beyond existing suitability obligations under the federal securities laws and FINRA Rule 2111. Id. at 10. In incorporating a prohibition on excessive trading, the SEC expressly excluded the "control" element currently present in FINRA's quantitative suitability rule, noting that the SEC proposed requirement would apply irrespective of whether a broker-dealer exercises actual or de facto control over a customer's account. Id. at 150. As a result, in order to satisfy the best interest standard, the SEC proposal would require that a broker-dealer or associated person exercise reasonable diligence, care, skill, and prudence to, among other things, have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer's best interest when viewed in isolation, is not excessive and is in the retail customer's best interest when taken together in light of the retail customer's investment profile. Id. at 133. The SEC's decision to eliminate the "control" element from its proposal is consistent with FINRA's proposed amendment to the quantitative suitability obligation described herein. FINRA notes, as well, that it will consider the potential impact of Regulation BI, if adopted, on FINRA's suitability rule more generally.

      5. See Peter C. Bucchieri, 52 S.E.C. 800, 805 n.11 (1996). Where a broker exercises discretion over an account or engages in unauthorized trading, he or she is viewed as having implicitly recommended the transactions. See Dep't of Enforcement v. Murphy, No. 2005003610701, 2011 FINRA Discip. LEXIS 42, *42 n.33 (NAC Oct. 20, 2011) ("Any violation of the suitability rule also requires proof that there was a 'recommendation.' When a broker exercises discretion to make trades or engages in unauthorized trading, . . . such trades are considered to be implicitly recommended for purposes of the suitability rule.").

      6. See Harry Gliksman, 54 S.E.C. 471, 475 (1999).

      7. See E.H. Rollins & Sons, Inc., 18 S.E.C. 347, 380 (1945) (stating that a broker "cannot be held guilty of overtrading in an account where transactions are initiated by the customer" and that, with regard to excessive trading liability under the antifraud provisions of the Exchange Act, the question is whether the broker occupied "such a status with respect to the customer that he may be held responsible for excessive trading in such customer's account").

      8. Although FINRA has not defined "recommendation," FINRA has provided several guiding principles through past Notices that are relevant to the analysis. See, e.g., Regulatory Notice 12-25; Regulatory Notice 11-02 (January 2011); Regulatory Notice 01-23 (April 2001). These guiding principles remain applicable for the determination of a recommendation under the proposed amendments to the quantitative suitability obligation.

      9. Regulation BI Proposing Release, supra note 4, at 155.

      10. See Richard G. Cody, Exchange Act Release No. 64565, 2011 SEC LEXIS 1862, at *40-41 (May 27, 2011), aff'd sub. nom., Cody v. SEC, 693 F.3d 251 (1st Cir. 2012).

      11. Turnover rate is calculated by "dividing the aggregate amount of purchases in an account by the average monthly investment. The average monthly investment is the cumulative total of the net investment in the account at the end of each month, exclusive of loans, divided by the number of months under consideration." Rafael Pinchas, 54 S.E.C. 331, 339-40 n.14 (1999).

      12. The cost-to-equity ratio represents "the percentage of return on the customer's average net equity needed to pay broker-dealer commissions and other expenses." Id. at 340.

      13. In-and-out trading refers to the "sale of all or part of a customer's portfolio, with the money reinvested in other securities, followed by the sale of the newly acquired securities." Costello v. Oppenheimer & Co., 711 F.2d 1361, 1369 n.9 (7th Cir. 1983).

      14. See Dep't of Enforcement v. Medeck, No. E9B2003033701, 2009 FINRA Discip. LEXIS 7, *34 (NAC July 30, 2009).

      15. See Howard, 55 S.E.C. at 1100-01 ("While there is no definitive turnover rate or cost-to-equity ratio that establishes excessive trading, a turnover rate of 6 or a cost-to-equity ratio in excess of 20% generally indicates that excessive trading has occurred."); Pinchas, 54 S.E.C. at 340 (recognizing that "a cost-to-equity ratio in excess of 20% indicates excessive trading"); Mihara v. Dean Witter & Co., 619 F.2d 814, 821 (9th Cir. 1980) (recognizing that "an annual turnover rate of six reflects excessive trading"); Arceneaux v. Merrill Lynch, Pierce, Fenner & Smith, 767 F.2d 1498, 1502 (11th Cir. 1985) (same); Craighead v. E.F. Hutton & Co., 899 F.2d 485, 490 (6th Cir. 1990) (same).

      16. Turnover rates between three and six may trigger liability for excessive trading, depending on the facts and circumstances. See Cody, 2011 SEC LEXIS 1862, at *51 (finding turnover rate of 3.21 to be excessive given customers' conservative investment objectives); Dep't of Enforcement v. Stein, No. C07000003, 2001 NASD Discip. LEXIS 38, at *17 (NAC Dec. 3, 2001) ("Turnover rates between three and five have triggered liability for excessive trading"), aff'd sub. nom., Jack H. Stein, 56 S.E.C. 108 (2003). Even turnover rates below three may provide a basis for finding excessive trading. See Sandra K. Simpson, 55 S.E.C. 766, 794 (2002) (finding turnover rate as low as 2.10 provided support that trading was excessive for customers with conservative investment objectives); Jenny v. Shearson, Hammill & Co., 1978 U.S. Dist. LEXIS 15077, at *6 (S.D.N.Y. Oct. 6, 1978) (refusing to hold, as a matter of law, that a turnover rate of 1.84 cannot be excessive for any account). In addition, cost-to-equity ratios as low as 8.7 percent have been considered indicative of excessive trading and ratios above 12 percent generally are viewed as strong evidence of excessive trading. See Cody, 2011 SEC LEXIS 1862, at *49 and *55 (finding cost-to-equity ratio of 8.7 percent excessive); Thomas F. Bandyk, Exchange Act Release No. 35415, 1995 SEC LEXIS 481, at *2–3 (Feb. 24, 1995) (finding cost-to-equity ratios ranging between 12.1 percent and 18 percent excessive).

      17. See DBCC v. Zandford, No. WA-530, 1989 NASD Discip. LEXIS 39, *21 (DBCC June 7, 1989) (finding that a turnover rate of 9.6 was not excessive under the unique facts of the case, including that the customers had highly speculative investment objectives and financial resources such that they could withstand potential losses).

      18. See Howard, 55 S.E.C. at 1100-01; Pinchas, 54 S.E.C. at 339.


      Attachment A

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

      * * * * *

      2000. DUTIES AND CONFLICTS

      * * * * *

      2100. TRANSACTIONS WITH CUSTOMERS

      * * * * *

      2110. Recommendations

      * * * * *

      2111. Suitability
      (a) through (b) No Change.

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

      .01 through .04 No Change
      .05 Components of Suitability Obligations. Rule 2111 is composed of three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability.
      (a) through (b) No Change.
      (c) Quantitative suitability requires a member or associated person [who has actual or de facto control over a customer account] to have a reasonable basis for believing that a series of [recommended] transactions the member or associated person recommended to the customer account, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile, as delineated in Rule 2111(a). No single test defines excessive activity, but factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.
      .06 through .07 No Change.

    • 18-12 2018 GASB Accounting Support Fee to Fund the Governmental Accounting Standards Board

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      GASB Accounting Support Fee

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Dodd-Frank Act Section 978
      FINRA By-Laws, Schedule A
      Regulatory Notice 12-15
      Regulatory Notice 13-17
      Regulatory Notice 14-17
      Regulatory Notice 15-12
      Regulatory Notice 16-16
      Regulatory Notice 17-10
      Securities Act Section 19(g)
      Suggested Routing

      Compliance
      Government Securities
      Institutional
      Legal
      Municipal
      Operations
      Senior Management
      Systems
      Trading
      Key Topics

      Financial Accounting Foundation
      GASB Accounting Support Fee
      Governmental Accounting Standards Board
      Municipal Securities Transactions

      Summary

      In February 2012, pursuant to an SEC order, FINRA established an accounting support fee (GASB Accounting Support Fee) to adequately fund the annual budget of the Governmental Accounting Standards Board (GASB). The GASB Accounting Support Fee is collected on a quarterly basis from member firms that report trades to the Municipal Securities Rulemaking Board (MSRB). Each member firm's assessment is based on the member firm's portion of the total par value of municipal securities transactions reported by all FINRA member firms to the MSRB during the previous quarter. FINRA will assess and collect a total of $8,346,300 to adequately fund the GASB's annual budget by collecting $2,086,575 from its member firms each calendar quarter beginning in April 2018.

      Questions regarding this Notice should be directed to:

      •    Finance Department at (240) 386-5910; or
      •    Office of General Counsel at (202) 728-8071.

      Background & Discussion

      Pursuant to Section 14 of Schedule A to FINRA's By-Laws, which was adopted in response to the SEC's 2011 order under Section 19(g) of the Securities Act of 1933 (Securities Act),1 FINRA assesses a reasonable annual accounting support fee to adequately fund the annual budget of the GASB.2 The GASB Accounting Support Fee is assessed on a quarterly basis and is based on member firms' municipal securities trading volume reported to the MSRB during the previous calendar quarter. Each quarter, FINRA collects one-fourth of the annual GASB Accounting Support Fee from its members. A member firm's quarterly assessment reflects its portion of the total par value of municipal securities transactions reported to the MSRB by all FINRA members in the previous calendar quarter. To exclude firms with de minimis transactions in municipal securities in a given quarter from being assessed the fee, members with a quarterly assessment of less than $25 are not charged the fee for that quarter, and any amounts originally assessed to those firms are reallocated among the firms with an assessment that quarter of $25 or more. Firms that do not engage in reportable municipal securities transactions during a particular calendar quarter are not subject to the GASB Accounting Support Fee for that quarter.

      For 2018, GASB's annual budget expenses of $10,080,700 will be partially funded from $1,734,400 of excess reserves of the Financial Accounting Foundation. As a result, the recoverable annual budgeted expense for purposes of the GASB Accounting Support Fee is $8,346,300;3 therefore, FINRA will collect $2,086,575 from its members each quarter beginning in April 2018.4

      Because some firms may seek to pass the GASB Accounting Support Fee onto customers engaged in municipal securities transactions, FINRA will continue to provide firms with an estimated fee rate (per $1,000 par value) based on the GASB recoverable annual budgeted expenses reported to FINRA for that year and historical municipal security trade reporting volumes so that firms will have a basis on which to establish a fee. Based on reported municipal trading activity by FINRA member firms in 2017 and the 2018 GASB budget, FINRA estimates that the GASB Accounting Support Fee for 2018 will be between $0.0024 and $0.0030 per $1,000 par value. Member firms are reminded that, if they choose to pass along the fee, they must ensure that any such fees are properly disclosed, including, if applicable, the fact that the fee is an estimate and that the firm ultimately may pay more or less than the fee charged to the customer. In addition, any disclosure used by a member firm cannot be misleading and must conform to FINRA rules, including just and equitable principles of trade, as well as any applicable MSRB rules.


      1. Securities Exchange Act Release No. 64462 (May 11, 2011), 76 FR 28247 (May 16, 2011). Section 19(g) of the Securities Act, as added by Section 978 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), gave the SEC the authority to require a national securities association to establish a reasonable annual accounting support fee to adequately fund the annual budget of the GASB and to draft the rules and procedures necessary to equitably assess the fee on the association's members. See 15 U.S.C. 77s(g); Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).

      2. See Securities Exchange Act Release No. 66454 (February 23, 2012), 77 FR 12340 (February 29, 2012); see also Regulatory Notice 17-10 (March 2017); Regulatory Notice 16-16 (May 2016); Regulatory Notice 15-12 (April 2015); Regulatory Notice 14-17 (April 2014); Regulatory Notice 13-17 (April 2013); Regulatory Notice 12-15 (February 2012). In accordance with Section 19(g) (5)(B) of the Securities Act, collection of the GASB Accounting Support Fee shall not be construed to provide the SEC or FINRA direct or indirect oversight of the budget or technical agenda of the GASB or to affect the setting of generally accepted accounting principles by the GASB. See 15 U.S.C. 77s(g)(5)(B).

      3. For purposes of the GASB Accounting Support Fee, the annual budget of the GASB is the annual budget reviewed and approved according to the internal procedures of the Financial Accounting Foundation (FAF). See 15 U.S.C. 77s(g)(2). GASB's 2018 budget includes an administrative fee to FINRA of $30,000 that is intended to cover FINRA's costs associated with calculating, assessing, and collecting the GASB Accounting Support Fee. The amount of the administrative fee is reviewed and evaluated each year by FINRA and the FAF in light of FINRA's experience in assessing and collecting the GASB Accounting Support Fee and the actual costs incurred by FINRA.

      4. The invoice firms received in January 2018 covers the fourth quarter of GASB's 2017 budget and is based on the amounts set forth in Regulatory Notice 17-10. As required by Section 19(g) of the Securities Act, any GASB Accounting Support Fees collected by FINRA are remitted to the FAF and used to support the efforts of the GASB to establish standards of financial accounting and reporting applicable to state and local governments. See 15 U.S.C. 77s(g)(1), (3). Section 19(g)(4) of the Securities Act prohibits FINRA from collecting GASB Accounting Support Fees for a fiscal year in excess of GASB's recoverable annual budgeted expenses. See 15 U.S.C. 77s(g)(4).

    • 18-11 FINRA Cautions Members Regarding Recommending and Entering Unpriced Customer Orders at and Around the Opening on the First Day of Trading of a Direct Listing

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      Regulatory Notice
      Notice Type

      Guidance

      Suggested Routing

      Compliance
      Internal Audit
      Legal
      Operations
      Risk
      Senior Management
      Systems
      Trading
      Training
      Key Topics

      Direct Listing
      Limit Orders
      Market Orders

      Unpriced Customer Orders

      Summary

      FINRA advises firms to exercise caution in recommending and entering unpriced customer orders at and around the opening on the first day of trading of a direct listing of a security. FINRA is concerned that, without the use of a limit price, customers may receive executions at prices that are not in line with their expectations and ultimate investment decision. FINRA encourages firms to consider the appropriateness of using and recommending (and discussing with customers the benefits of using) priced, limit orders at and around the opening on the first day of trading of a direct listing.

      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.

      Discussion

      Exchange rules may permit the direct initial listing of shares by an issuer where such listing is not accompanied by a concurrent underwritten offering (sometimes called a "direct listing").1 In such circumstances, a public market has not yet been established for the security and a prior public market price does not exist.

      In the absence of an established trading history for a security, even where volatility is not anticipated or present, the potential exists for substantial variance in the opening price of a direct listing and in the subsequent prices at which trading on the secondary market occurs on the first day of trading. As a result, investors who place unpriced orders, such as market orders,2 for a direct listing may find their orders filled at prices beyond their reasonable expectations.

      For these reasons, FINRA is advising firms to exercise caution when recommending or entering unpriced customer orders at and around the opening on the first day of trading of a direct listing of a security. FINRA encourages firms to consider the appropriateness of using and recommending priced, customer limit orders at and around the opening on the first day of trading of a direct listing.3 Firms should consider the benefits of using limit orders, including that a limit price can be used as a tool for managing market risk and achieving a desired target price rather than obtaining an immediate execution irrespective of price. Similarly, firms should consider discussing the use of limit orders with customers that intend to enter orders at and around the opening on the first day of trading of a direct listing.4


      1. See e.g., Securities Exchange Act Release No. 80933 (June 15, 2017), 82 FR 28200 (June 20, 2017); Securities Exchange Act Release No. 82627 (February 2, 2018), 83 FR 5650 (February 8, 2018).

      2. A "market order" generally is an order for immediate execution to buy or sell at the best price obtainable in the market during normal trading hours.

      3. A "limit order" generally is an order to buy or sell a security at or better than a specified price (i.e., "limit price").

      4. See FINRA Investor Alert, Understanding Order Types Can Save Time and Money [http://www.finra.org/investors/alerts/understanding-order-types-can-save-time-and-money].

    • 18-10 FINRA Requests Comment on the Effectiveness and Efficiency of Its Carrying Agreements Rule; Comment Period Expires: June 22, 2018.

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 4311
      Regulatory Notice 11–26
      SEA Rule 15c3–3
      Suggested Routing

      Compliance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      Capital Compliance
      Carrying Agreements
      Financial Responsibility
      Operational Rules

      Retrospective Rule Review

      Summary

      FINRA is conducting a retrospective review of the rule governing carrying agreements to assess its effectiveness and efficiency. This Notice outlines the general retrospective rule review process and seeks responses to several questions related to firms' experiences with this specific rule.

      Questions regarding this Notice should be directed to:

      •    Kris Dailey, Vice President, Risk Oversight & Operational Regulation (ROOR), at (646) 315-8434 or Kris.Dailey@finra.org; or
      •    Adam Arkel, Associate General Counsel, Office of General Counsel, at (202) 728-6961 or Adam.Arkel@finra.org.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by May 23, 2018.

      Comments must be submitted through one of the following methods:

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

      Jennifer Piorko Mitchell
      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.

      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

      Background & Discussion

      FINRA believes that it is appropriate, after a reasonable period of time, to look back at its significant rulemaking to determine whether a FINRA rule or rule set2 is meeting its intended investor-protection objectives by reasonably efficient means. FINRA further believes that a retrospective review should include a review not only of the substance and application of a rule or rule set, but also FINRA's processes to administer the rules. FINRA intends to select relevant rules and to conduct retrospective rule reviews on an ongoing basis to ensure that its rules remain relevant and appropriately designed to achieve their objectives, particularly in light of environmental, industry and market changes.

      In conducting the review, FINRA staff will follow a similar process to previous retrospective rule reviews. In general, the review process consists of an assessment and action phase. During the assessment phase, FINRA will evaluate the efficacy and efficiency of the rule or rule set as currently implemented, including FINRA's internal administrative processes. FINRA will seek input from affected parties and experts, including its advisory committees, subject-matter experts inside and outside of the organization, and other stakeholders, including industry members, investors, interested groups and the public. FINRA staff will assess issues including the existence of duplicative, inconsistent or ineffective regulatory obligations; whether market or other conditions have changed to suggest there are ways to improve the efficiency or effectiveness of a regulatory obligation without loss of investor protections; and potential gaps in the regulatory framework. Upon completion of this assessment, FINRA staff will consider appropriate next steps, which may include some or all of the following: modifications to the rule, updated or additional guidance, administrative changes or technology improvements, or additional research or information gathering.

      The action phase will then follow. To the extent action involves modification of rules, FINRA will separately engage in its usual rulemaking process to propose amendments to the rules based on the findings. This process will include input from FINRA's advisory committees and an opportunity for comment on specific proposed revisions in a Regulatory Notice or rule filing with the SEC, or both.

      Request for Comment

      FINRA has identified FINRA Rule 4311 (Carrying Agreements) for review. The rule, which governs requirements applicable to members when entering into agreements for the carrying of customer accounts, was approved by the SEC in 2011 and is the consolidated successor to former NASD Rule 3230, Incorporated NYSE Rule 382 and corresponding interpretations (the predecessor rules).3 Broadly, based on the predecessor rules, current Rule 4311 prohibits a member, unless otherwise permitted by FINRA, from entering into an agreement for the carrying, on an omnibus or fully disclosed basis, of any customer account in which securities transactions can be effected unless the agreement is with a carrying firm that is a FINRA member. Among other things, the rule requires that each carrying agreement must identify and bind every direct and indirect recipient of clearing services as a party to the agreement. The rule also requires that the carrying firm shall submit to FINRA for prior approval any agreement for the carrying of accounts, whether on an omnibus or fully disclosed basis, before such agreement may become effective. The carrying firm is also required to submit to FINRA for prior approval any material changes to an approved carrying agreement before such changes may become effective. Under the rule, each carrying agreement in which accounts are to be carried on a fully disclosed basis must specify the responsibilities of each party to the agreement, including certain responsibilities as set forth in the rule. Further, Rule 4311, like the predecessor rules, allows FINRA members to allocate between themselves responsibility for each of the functions enumerated therein. Allocation between the parties to the agreement can effectively assign responsibility for rule compliance to one (or more, if applicable) of the other parties. Thus, a smaller firm can, for example, maintain relationships with its customers and take responsibility for opening accounts and accepting orders from its customers, while the carrying firm takes responsibility for the extension of credit, the receipt and delivery of funds and securities and safeguarding funds and securities for purposes of SEA Rule 15c3-3, without exposing a firm to potential liability for a function allocated to another firm.

      Additionally, the rule includes requirements that address such areas as notification to be submitted to FINRA when a new introducing firm is added to a carrying agreement; the carrying firm's due diligence with respect to new introducing firm relationships; notification to customers with respect to the existence of the carrying agreement; the furnishing of written customer complaints and specified reports, such as exception reports, to the introducing firm; books and records requirements as to reports requested by and furnished to the introducing firm; and requirements as to maintenance and identification of proprietary and customer accounts.

      FINRA seeks answers to the following questions with respect to this rule:

      1. Is the rule effective in ensuring clear allocation of responsibilities between parties to a carrying agreement? If not, why not? Are there additional responsibilities that the rule should specifically require to be allocated? Are there responsibilities that the rule should not permit to be allocated? Why?
      2. Has the rule served its intended purposes? To what extent have the original purposes of and need for the rule been affected by subsequent changes to the markets, the delivery of financial services, the applicable regulatory framework or other considerations? Are there alternative ways to achieve the goals of the rule that FINRA should consider?
      3. What has been your experience with implementation of the rule, including any ambiguities in the rule or challenges to complying with it?
      4. What has been your experience with FINRA's approval process for carrying agreements and changes to carrying agreements? What modifications to the process, if any, would be appropriate? Why?
      5. The rule sets forth specified requirements with respect to the furnishing of reports by the carrying firm to the introducing firm. Are these requirements effective? What modifications, if any, would be appropriate? Why?
      6. To what extent does the rule impact the availability of clearing services to small firms? How could the rule or FINRA's approval process be changed to help small firms obtain access to clearing consistent with investor protection?
      7. What are the challenges for small firms in coordinating with clearing firms to respond to regulatory inquiries or to assist their customers? How could these challenges be addressed by FINRA consistent with investor protection? Are there uniform templates or formats that could be used to increase the efficiency of such coordination?
      8. With respect to "intermediary" or "piggyback" clearing, does the rule and approval process provide sufficient flexibility and clarity to establish such clearing arrangements? What, if any, changes should be made to the rule and process to accommodate such arrangements consistent with investor protection?
      9. What have been the economic impacts, including costs and benefits, arising from FINRA's rule? Have the economic impacts been in line with expectations described in the rulemaking? To what extent would these economic impacts differ by business attributes, such as size of the firm or differences in business models? Has the rule led to any negative unintended consequences?
      10. Can FINRA make the rule, interpretations or attendant administrative processes more efficient and effective? If so, how?

      In addition to comments responsive to these questions, FINRA invites comment on any other aspects of the rule that commenters wish to address. FINRA further requests any data or evidence in support of comments. While the purpose of this Notice is to obtain input as to whether or not the current rule is effective and efficient, FINRA also welcomes specific suggestions as to how the rule should be changed. As discussed above, FINRA will separately consider during the action phase specific changes to the rule.


      1. Persons submitting comments are cautioned that FINRA does not redact or edit personal identifying information, such as names or email addresses, from comment 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. A rule set is a group of rules identified by FINRA staff to contain a similar subject, characteristics or objectives.

      3. See Securities Exchange Act Release No. 63999 (March 1, 2011), 76 FR 12380 (March 7, 2011) (Order Granting Approval to Proposed Rule Change; File No. SR-FINRA-2010-061); see also Regulatory Notice 11-26 (May 2011) (announcing the SEC's approval of FINRA Rule 4311, among other consolidated financial responsibility and related operational rules).

      The current FINRA rulebook consists of: (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE ("Incorporated NYSE Rules"). 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. 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 3/12/08 (Rulebook Consolidation Process).

    • 18-09 FINRA Updates Designation Criteria to Require Firms Reporting U.S. Treasury Securities to TRACE to Participate in FINRA's Business Continuity/Disaster Recovery Testing

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4380
      SEC Rule 1001
      SEC Rule 1004
      Regulatory Notice 15-43
      Suggested Routing

      Compliance
      Legal
      Operations
      Systems
      Trading
      Training
      Key Topics

      Business Continuity
      Disaster Recovery Planning
      Regulation SCI
      TRACE
      U.S. Treasury Securities

      Summary

      As required by Regulation Systems Compliance and Integrity (Regulation SCI), FINRA, in 2015, adopted Rule 4380 requiring member firm participation in business continuity and disaster recovery (BC/DR) testing.1 The rule authorizes FINRA to designate firms that must participate in FINRA's annual BC/DR test based on established standards, which FINRA published in Regulatory Notice 15-43. Since FINRA published Notice 15-43, it began collecting transaction reports for U.S. Treasury securities. This Notice updates the criteria in Notice 15-43 to include criteria for designating firms that report a significant volume of transactions in U.S. Treasury securities to TRACE for mandatory BC/DR testing participation.

      Questions regarding this Notice should be directed to:

      •   Ron Miller, Senior Principal Compliance Analyst, Transparency Services, at (212) 858-5178 or ron.miller@finra.org; or
      •   Alex Ellenberg, Associate General Counsel, Office of General Counsel, at (202) 728-8152 or alexander.ellenberg@finra.org.

      Background and Discussion

      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…."2 In addition, Regulation SCI requires each SCI entity, including FINRA, to designate firms that must participate in the testing of the entity's BC/DR plans.3

      To comply with these Regulation SCI requirements, FINRA, in 2015, adopted Rule 4380, which authorizes FINRA to 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 then published Regulatory Notice 15-43 to establish the criteria that FINRA uses to designate firms under Rule 4380. Consistent with Notice 15-43, FINRA designates firms for mandatory BC/DR test participation that account for significant activity on FINRA's 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).

      Since Notice 15-43, FINRA expanded its TRACE system to create a new reporting process for U.S. Treasury securities.4 This Notice updates the criteria from Notice 15-43 to include criteria for designating firms that report a significant volume of transactions in Treasury securities to TRACE for mandatory BC/DR test participation. Specifically:

      •   With respect to TRACE for Treasuries, FINRA will designate participants that account for at least 5 percent or more of the average dollar volume 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 in Treasury securities reported to TRACE during the applicable six-month period.

      The criteria contained in Notice 15-43, including the criteria for designating TRACE participants that account for specified activity in corporate and agency debt securities and securitized products, remain otherwise unchanged. The designation process and test-related guidance in Notice 15-43 also remain unchanged. FINRA expects that the designation and test schedule will be similar this year to last year, with designation occurring in April and the test occurring in October.


      1. See Securities Exchange Act Release No. 76360 (November 5, 2015), 80 FR 70043 (November 12, 2015) (Notice of Filing and Immediate Effectiveness of SR-FINRA-2015-046).

      2. SEC Rule 1001(a)(2)(v).

      3. SEC Rule 1004.

      4. See Regulatory Notice 16-39 (October 2016).

    • 18-08 FINRA Requests Comment on Proposed New Rule Governing Outside Business Activities and Private Securities Transactions; Comment Period Expires: April 27, 2018

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      Outside Business Activities

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 2010
      FINRA Rule 3210
      FINRA Rule 3270
      FINRA Rule 3280
      FINRA Rule 5130
      Notice to Members 85-21
      Notice to Members 94-44
      Notice to Members 96-33
      Regulatory Notice 17-20