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  • 2018

    • 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

      View PDF

      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
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Systems
      Key Topics

      Outside Business Activities
      Private Securities Transactions
      Recordkeeping
      Supervision

      Comment Period Expires: April 27, 2018

      Summary

      FINRA seeks comment on a proposed new rule to address the outside business activities of registered persons. The proposal is the result of FINRA's recent retrospective review of FINRA's rules governing outside business activities and private securities transactions, FINRA Rule 3270 (Outside Business Activities of Registered Persons) and FINRA Rule 3280 (Private Securities Transactions of an Associated Person), respectively. The proposed rule would replace FINRA Rules 3270 and 3280 and is intended to reduce unnecessary burdens while strengthening investor protections relating to outside activities.

      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 April 27, 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

      Before becoming effective, 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

      In May 2017, FINRA launched a retrospective review of its outside business activities and private securities transactions rules to assess their effectiveness and efficiency.3 These rules serve important goals—they seek to protect the investing public when a member's registered or associated persons engage in potentially problematic activities that are unknown to the member but could be perceived by the investing public as part of the member's business. An ancillary benefit is that the rules protect the member from resulting reputational and litigation risks.

      The retrospective rule review confirmed the continuing importance of rules relating to outside activities, but also indicated that the current rules, as well as related guidance,4 could benefit from changes to better align the investor protection goals with the current regulatory landscape and business practices.5 In particular, FINRA received significant feedback on members' obligations with respect to the investment advisory (IA) activities of their registered persons, which is addressed in detail below.

      Consistent with a number of recommendations by stakeholders6 during the retrospective review, FINRA is proposing a single streamlined rule to address the outside business activities of registered persons.7 The proposed rule would clarify the obligations in this area and reduce unnecessary burdens while strengthening protections relating to activities that may pose a greater risk to the investing public. The proposed rule would require registered persons to provide their members with prior written notice of a broad range of outside activities, while imposing on members a responsibility to perform a reasonable risk assessment of a narrower set of activities that are investment related, allowing members to focus on outside activities that are most likely to raise investor protection concerns. The proposed rule also would generally exclude from the rule a registered person's personal investments (sometimes referred to as "buying away") and work performed on behalf of a member's affiliates. Moreover, the proposed rule would not impose supervisory and recordkeeping obligations for most other outside activities, including IA activities at an unaffiliated third-party IA. At the same time, the proposal would hold a member responsible for approved activities that could not take place but for the registered person's association with a member.

      The following illustration summarizes core concepts of the proposed rule, which are discussed in greater detail in this Notice.

      Registered Persons' Obligation to Provide Notice of Outside Activities

      A majority of stakeholders that provided feedback during the retrospective review believed that the scope of activities subject to the outside business activities rule, Rule 3270, should be narrowed.8 On the other hand, a significant minority of stakeholders favored the rule's current notice requirement to ensure that registered persons report a broad range of outside activities to their employing firms. Moreover, a number of stakeholders believed that notice of private securities transactions under Rule 3280 should not be narrowed.9 The proposed rule takes a balanced approach that would ensure that members are apprised of their registered persons' outside activities, while tailoring members' responsibilities to those activities that are most likely to raise investor protection concerns.

      To that end, FINRA is proposing a single rule that would require registered persons to provide their firms with prior written notice for all investment-related or other business activities outside the scope of their relationship with the member. The proposed rule would require that a registered person include in the notice a description of the proposed activity and the registered person's proposed role therein, and that the registered person update the notice in the event of a material change to the activity.10 With respect to investment-related activities only, a registered person would be required to receive prior written approval from the member before participating in the activity.

      The rule would define "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)." This definition is also used for purposes of the Uniform Application for Securities Industry Registration or Transfer (Form U4) and would better harmonize the Form U4 reporting requirements and the notice obligations under FINRA rules, an issue frequently raised during the retrospective review.11 The concept of "business activity" would be similar to current Rule 3270, with minor clarifying changes, and would be defined in the rule as (1) acting as an employee, independent contractor, sole proprietor, officer, director or partner of another person; or (2) receiving compensation, or having the reasonable expectation of compensation, from any other person as a result of the activity.12

      Similar to current Rule 3270, the proposed rule would apply only to the outside activities of registered persons. It would not apply to the activities of members' non-registered associated persons because the risk of potential conflicts is more prevalent with regard to registered persons.13 However, the proposed rule would not preclude members from instituting policies and procedures relating to the outside activities of associated persons more broadly.

      Members' Responsibilities Upon Receiving Notice

      Although the proposed rule would require registered persons to provide prior written notice of a broad range of outside activities, the focus of a member's responsibilities is on investment-related activities.14 If an activity is not investment related, the member has no obligation under the rule. If the activity is investment related, then the member would be required to perform a reasonable risk assessment, as described below.

      Assessment

      Upon receiving written notice of an outside investment-related activity, the proposed rule would require that a member perform an upfront reasonable assessment of the risks created by the engagement of the registered person in the proposed activity. Specifically, the member would be required to evaluate whether the proposed activity will: (1) interfere with or otherwise compromise the registered person's responsibilities to the member's customers; or (2) be viewed by customers or the public as part of the member's business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered. These considerations are similar to those required by current Rule 3270 and are aimed at assessing possible conflicts that could negatively impact the member's customers or the investing public. Although the risk assessment must be reasonable and will vary depending on the facts and circumstances, the rule's focus is on the registered person's participation in the activity and ordinarily would not require the member to perform an analysis of the underlying outside business activity.15 In addition to this risk assessment, the member would be required to consider whether the person is relying on a member's registration as a broker or dealer to conduct the activity, in which case the activity would be deemed to be that of the member, if approved.16

      Then, based on the foregoing, the member would determine whether to approve the registered person's participation, to approve it subject to conditions or limitations or to disapprove it. The member would be required to advise the registered person in writing of its determination.

      By focusing the member's assessment on investment-related activities, the proposed rule would allow members to concentrate their compliance resources on those activities that may pose a greater chance of harm to investors. Members would no longer be required to conduct a risk assessment on a non-investment-related activity, such as a registered person driving for a car service or holding seasonal retail employment, regardless of whether the registered person receives compensation.17

      Supervision

      The proposed rule would impose a supervisory obligation in two situations. First, if a member imposes conditions or limitations on a registered person's participation in an investment-related activity, the member would be required to reasonably supervise the registered person's compliance with those conditions or limitations. The proposed rule would not require members to supervise the underlying activities. For example, after conducting the required risk assessment of an investment-related activity, a member may approve a registered person to act as a registered investment adviser through an unaffiliated, third-party IA; however, the member also may condition that approval on the IA's custody of its clients' advisory assets with the member. In this example, the proposed rule would require the member to reasonably supervise the registered person's adherence to that condition, but the member would not be required by the rule to otherwise supervise the IA activity.18

      Second, to the extent that a member approves a registered person's participation in a proposed investment-related activity and such activity would require, if not for the person's association with a member, registration as a broker or dealer under the Exchange Act and the person is not so registered, the activity would be deemed to be the member's business. In other words, if the person can only legally engage in the outside business activity because the person is associated with a member, the member approving that activity must treat it as its own. Accordingly, all applicable securities laws and regulations and FINRA rules, including supervision and recordkeeping, would apply to the member with respect to that activity. This provision serves a critical investor protection interest and requires the member's supervision over the types of activities that the private securities transactions rule was originally adopted to address.19 It would ensure that a registered person's outside broker-dealer activity—for example, selling private placements away from the member in a manner that would require broker-dealer registration—would be reported to the member and that such activity, if approved, would be under the supervision and control of a broker-dealer and subject to the same supervisory safeguards as any of the member's other broker-dealer business.

      Under this second scenario, if the registered person is associated with more than one member, the proposed rule would allow members to develop a formal allocation arrangement whereby at least one member agrees in writing with specificity to comply with all applicable securities laws and regulations and FINRA rules regarding the proposed activity, including those covering supervision and recordkeeping.20

      Recordkeeping

      The proposed rule would require a member to maintain and preserve records demonstrating compliance with the obligations of the rule for at least three years after the registered person's employment or association with the member has terminated.21 Records required to demonstrate compliance with the rule would depend upon the facts and circumstances, but would include, for example, the registered person's written notice of the proposed activity, a record of the member's risk assessment, the member's written determination and whether any conditions or limitations are imposed. The proposed rule would not impose a general obligation to record transactions resulting from a registered person's outside activities on the member's books and records, except in the circumstance discussed above where a member approves an activity for which the registered person is relying on a member's broker-dealer registration.

      Proposed Exclusions from the Rule

      The proposed rule has several exclusions that would reduce unnecessary burdens without lessening investor protection. First, the proposal would exclude from the rule's coverage registered persons' personal investments (e.g., buying away), which commenters and stakeholders consistently noted do not raise the same investor protection concerns as selling away activities. Second, the proposed rule would exclude activities conducted on behalf of a member's affiliate, unless those activities would require registration as a broker or dealer if not for the person's association with a member. Therefore, a registered person generally would not be required to provide prior written notice, and a member would not be required to conduct the assessment required by the proposed rule, of any non-broker-dealer activity conducted for a member's affiliate, such as an affiliated IA, insurance entity or bank. In addition, any non-broker-dealer activity conducted on behalf of the member (e.g., any IA activities for a dually registered broker-dealer/investment adviser (BD/IA)) would not be subject to the rule. These exclusions recognize members' ability to implement meaningful controls across business lines and are consistent with functional regulation—that such activities are subject to other regulatory regimes and oversight.22 They also ensure that dually registered BD/IAs or members that share employees with affiliates are not faced with unnecessary additional burdens. The rule would define an "affiliate" as "any entity that controls, is controlled by or is under common control with a member," which is consistent with other FINRA rules.23 For these purposes, a member would not be deemed to control an IA firm merely because it is owned by the member's registered person.

      Finally, similar to the current private securities transactions rule, the proposed rule would not apply to transactions in accounts that are subject to FINRA Rule 3210 or to transactions on behalf of the registered person's immediate family members (as defined in FINRA Rule 5130) for which the registered person receives no transaction-related compensation.24

      Application to Registered Persons' Investment Advisory Activities

      The proposed rule would change the current approach with respect to IA activities of registered persons. Under Rule 3280 and related guidance, members must supervise and record on the members' books and records the transactions resulting from most outside IA activities of their associated persons.25 This approach has caused significant confusion and practical challenges, including, for example, privacy challenges with a member obtaining account information for customers of an unaffiliated IA through which a member's registered person may be acting in an IA capacity. Given these challenges, and in light of the fact that these activities are subject to another regulatory regime, some stakeholders argued that the current approach imposes unnecessary burdens without providing meaningful investor protections over the activities.

      Based on FINRA's review of the rules, public comment and other stakeholder feedback, and the evolving environment in which members operate, modifications to the current approach appear appropriate. Under the proposed rule, as discussed above, any IA activity conducted on behalf of a dually registered BD/IA or for an IA affiliate of a member would be excluded from the rule. Any IA activity conducted for a third-party, non-affiliated IA would constitute an "investment-related" activity under the rule. As such, the rule would require that the registered person provide prior written notice of such activity, and the member would be required to conduct the upfront risk assessment described above and, based on its assessment, to approve the registered person's participation, to approve it subject to conditions or limitations or to disapprove it. However, the proposed rule would not impose a general supervisory obligation over the IA activities and would not require the member to record on its books and records transactions resulting from such IA activities. Although this proposed approach streamlines members' obligations over IA activities, these IA activities would continue to be subject to regulatory oversight by the SEC and states under a different regulatory scheme.26

      Economic Impact of the Proposal

      Regulatory Need

      FINRA's recent review of the current rules on outside business activities and private securities transactions and industry and stakeholder input indicate that the current rules may benefit from substantive changes that clarify the obligations and tailor them to better achieve investor protection.

      Economic Baseline

      The current rules governing member employees' business and securities activities outside the regular course or scope of their employment with their firms, Rules 3270 and 3280, and related guidance, serve as the economic baseline for the analysis. These rules impact a broad spectrum of members, irrespective of business model, client base and product type.

      A survey on the rules sent to all FINRA members provided insights into the extent to which registered and associated persons are conducting, or proposing to engage in, activities subject to the rules.

      Rule 3270 requires registered persons to provide prior written notice before engaging in an outside business activity. Approximately 80 percent of the members responding to the survey stated that they have received at least one written notice in the last five years pursuant to Rule 3270. Approximately 40 percent of the registered persons within those members provided written notices. Also, approximately 89 percent of the respondents stated that they had internal policies to limit or prohibit outside business activities, and 42 percent stated that they have limited or prohibited a registered person's participation in an outside business activity before, mostly due to potential conflicts of interest and potential confusion by the customer as to whether the activity falls within the firm's business.

      Rule 3280 requires associated persons to provide prior written notice before participating in any manner in private securities transactions. In the survey, approximately 40 percent of the responding members stated that they have received at least one written notice in the last five years pursuant to Rule 3280. Approximately 19 percent of the associated persons within those members provided written notices. Also, approximately 89 percent of the respondents stated that they had internal policies to limit or prohibit private securities transactions for compensation to address the potential conflicts of interest between associated persons and the firm or its customers and to mitigate the litigation risk.

      Economic Impacts

      The proposed rule would directly impact registered persons that seek to engage in outside investment-related or other business activities and the members that employ them, and may potentially provide benefits for customers through better investor protection.

      Streamlining the rules into a single combined rule will benefit both members and registered persons by reducing the likelihood of regulatory confusion, as raised by stakeholders and identified in the survey, and should make it easier for both members and registered persons to determine the activities that are within the proposed rule's scope. Stakeholders noted that the potential overlap between the two rules may lead to inconsistent interpretation and application of the rules. Moreover, some outside business activities may evolve into private securities transactions, resulting in confusion over which rule applies. The simplified approach may encourage registered persons who have previously avoided these activities because of the perceived regulatory uncertainty to pursue outside activities.

      The proposal's requirement that registered persons provide their firms with prior written notice for all investment-related or other business activities will benefit members by ensuring they receive notice of a broad range of registered persons' outside activities. At the same time, there could be marginal costs for registered persons who would be required to report a broad range of activities. It may also increase compliance costs for members to the extent that members must determine which of the reported activities are subject to a risk assessment under the rule.

      With respect to a narrower set of activities—investment-related activities—the rule requires the member to conduct a reasonable assessment of the risks created by the registered person's engagement in the proposed activity and to approve or disapprove the registered person's participation. Imposing these requirements on the narrower set of activities will reduce unnecessary burdens to members of having to conduct a risk assessment of non-investment-related activities that may pose little harm to the member or the investing public. Specifically, members may benefit from employing compliance resources on those outside activities that are more likely to raise investor protection concerns.

      Unlike current Rule 3270, the proposed rule imposes a requirement, with respect to investment-related activities only, to determine whether to approve or disapprove the activity, and to provide the registered person with written notice of this determination. Although FINRA understands that many members already do so, members may incur compliance costs associated with the proposal in providing written responses to registered persons regarding approval or disapproval decisions. On the other hand, this requirement will provide clarity for registered persons, as they will have a clear understanding of the member's determination. However, it may delay registered persons' participation in the activity until the member's written approval decision, if provided, which could result in additional costs to registered persons up to and including the possibility of lost business opportunities. At the same time, where the member disapproves of the investment-related activity, ex post costs of such prohibition would be relatively lower under the proposal as the registered person receives the information before engaging in the activity. In addition, requiring registered persons to receive an approval determination before engaging in an investment-related activity may also benefit the investing public as registered persons will not have the opportunity to engage in activities that the member ultimately disapproves.27

      The current rules apply to different populations, with Rule 3270 applying to registered persons and Rule 3280 applying to associated persons. The proposed rule would eliminate this disparate treatment and apply uniformly to registered persons. In doing so, the proposal relieves associated persons from some obligations, which could potentially impact behaviors. Because non-registered associated persons would not be subject to the rule, they would have lower costs to engage in the covered activities under the proposal. This may create an incentive for associated persons to remain unregistered, to the extent that costs associated with the notification and, with respect to investment-related activities, assessment and approval requirements outweigh the benefits of being a registered person. The possible negative impact of this hypothetical may be tempered, however, by the fact that many activities require a person to be registered in one capacity or another before the person may engage in them.

      Under current Rule 3280, if a member approves an associated person's participation in a private securities transaction for compensation, the member must record the transaction on the member's books and records and supervise the associated person's participation as if the transaction were executed on behalf of the member. The proposed rule, which imposes supervision only in the two limited situations described above, would eliminate those current requirements with respect to the majority of activities that fall within the current rule and, accordingly, should simplify the supervisory efforts and lower the direct compliance costs.

      In addition, the proposed rule excludes non-broker-dealer activities conducted on behalf of a dually registered firm, such IA or banking activities, and activities conducted for an affiliate of the member (unless those activities would require registration as a broker or dealer if not for the person's association with a member). These exclusions should potentially alleviate some of the burdens that are associated with reporting and assessing outside activities that may pose relatively little risk to the member and investing public.

      FINRA also considered the potential impacts of the proposed amendments on investors. Limiting the risk assessment and approval requirements of the proposed rule to investment-related activities, as defined in the Form U4, mitigates the confusion and misalignment between the Form U4 and Rule 3270, and should enhance the investor protection purpose of the rule.

      Alternatives Considered

      FINRA staff also considered a principles-based approach, as suggested by some stakeholders, which potentially would provide members with more flexibility in developing the systems and the protocols to assess and approve or disapprove outside business activities and private securities transactions. However, the approach presented here was deemed to better balance the costs and benefits of governing registered persons' outside business and private securities activities. It also takes into account the views of numerous other stakeholders that favored a rules-based approach with specific requirements.

      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. How would consolidation of the rules governing outside business activities and private securities transactions in this proposal simplify compliance? What impact would it have on the cost of compliance?
      3. Unlike Rule 3280, the proposed rule would apply to registered persons, rather than to associated persons. Should the proposed rule be expanded to apply to all associated persons? If so, why?
      4. Is the proposed scope of the notice requirement appropriately tailored to balance the interest of members to receive information regarding their registered persons' outside activities and any investor protection concerns?
      a. Should the proposal be modified to require registered persons to provide notice with respect to a narrower set of activities? If so, should notice be required only with respect to investment-related or some other categorization of activities?
      b. Would narrowing the scope of the proposal impose any additional risks to investors?
      5. A member's obligation to conduct a risk assessment is only triggered under the proposal with respect to investment-related activities.
      a. Does limiting the required risk assessment to activities that are "investment-related" properly balance the interest of allowing members to focus compliance efforts on activities that pose the greatest concerns and any potential harm to investors?
      b. Is the definition of "investment-related," which is based on the definition used by the Form U4, appropriate given the regulatory objectives of the proposal, or should other activities be included in or excluded from the definition? If so, why?
      c. The proposed rule's focus is on assessing the risks created by the registered person's engagement in the outside investment-related activity, rather than the underlying activity itself. Is this an appropriate focus? Should the risk assessment include a requirement for the member to perform due diligence of the underlying outside activity?
      d. The member would be required in the risk assessment to evaluate whether the proposed activity will: (i) interfere with or otherwise compromise the registered person's responsibilities to the member's customers; or (ii) be viewed by customers or the public as part of the member's business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered. Are these appropriate criteria to evaluate conflicts of interests and other potential areas of harm to investors?
      6. The proposal has several exclusions, including for registered persons' personal investments and activities conducted on behalf of an affiliate of a member, unless those activities would require registration as a broker or dealer if not for the person's association with a member. Are the proposed exclusions appropriate?
      a. Should any other activities be excluded from the rule? If so, why?
      b. Should the proposed exclusions, including the exclusion for activities on behalf of affiliates, be limited in any manner? For example, should the exclusion be limited to activities on behalf of affiliates that are subject to federal or state financial registration or licensing requirements, such as registered investment advisers, banks and insurance companies?
      7. Unlike current Rule 3280 and related guidance, the proposed rule would not impose a general supervisory obligation over IA activities and would not require the member to record on its books and records transactions resulting from such IA activities. Does the treatment of IA activities under the proposed rule appropriately address investor protection concerns while recognizing that separate obligations exist under the IA regulatory regime?
      8. Under paragraph (b)(4), if a member approves a person's participation in a proposed activity that would require, if not for the person's association with a member, registration as a broker or dealer under the Exchange Act, the activity is deemed to be the member's business and the member must supervise accordingly.
      a. Is registration under the Exchange Act the appropriate trigger for this provision?
      b. Should paragraph (b)(4) be expanded to require a member to supervise a registered person's sale of securities through an entity that is not required to register under the Exchange Act?
      c. When the registered person is associated with more than one member, the proposed rule allows members to develop a formal allocation arrangement whereby at least one member has the regulatory responsibility, including the supervision and recordkeeping of the proposed outside business activity. Are there any competitive effects of such allocation arrangements? Does this flexibility potentially create a disadvantage for some firms regarding how the costs are allocated? Should FINRA consider any other approaches?
      9. 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 firm or differences in business models?
      c. What would be the magnitude of these impacts, including costs and benefits?
      10. 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?

      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 17-20 (May 2017).

      4. See, e.g., Notice to Members 94-44 (May 1994); Notice to Members 96-33 (May 1996).

      5. FINRA Rule 3270 is incorporated by reference into the Capital Acquisition Broker (CAB) Rules. See CAB Rule 327. Persons associated with a capital acquisition broker may not participate in any manner in a private securities transaction as defined in Rule 3280(e). See CAB Rule 328. FINRA will consider whether conforming changes to the CAB rules are appropriate as a result of any changes to FINRA Rules 3270 and 3280.

      6. The term "stakeholder" is used to describe those entities, organizations and persons who may be impacted by or otherwise have an interest in FINRA Rules 3270 and 3280 and this proposed rule.

      7. A number of stakeholders commented on the similar notice requirements of Rules 3270 and 3280 and noted confusion over the often overlapping concepts. A combined rule would eliminate this confusion and streamline the requirements.

      8. Subject to specified exemptions, Rule 3270 prohibits a registered person from being an employee, independent contractor, sole proprietor, officer, director or partner of another person, or being compensated, or having the reasonable expectation of compensation, from another person as a result of any business activity outside the scope of the relationship with his or her member firm, unless he or she has provided prior written notice to the member. In a survey sent to all FINRA members as part of the retrospective review, approximately 60 percent of the respondents believed that there are outside business activities that should not be included within the scope of Rule 3270.

      9. Rule 3280 provides that, prior to participating in any private securities transaction, an associated person must provide written notice to the member with which he or she is associated, describing the transaction and the associated person's role, and disclosing whether the associated person has received or may receive selling compensation in connection with the transaction. The rule defines "private securities transaction" as any securities transaction outside the regular course or scope of an associated person's employment with a member, including, though not limited to, new offerings of securities which are not registered with the Commission, but excludes transactions subject to the notification requirements of FINRA Rule 3210 (Accounts At Other Broker-Dealers and Financial Institutions), transactions among immediate family members (as defined in FINRA Rule 5130 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings)), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities.

      10. For example, some stakeholders noted that an outside business activity that appears on its face to pose little risk to the investing public may evolve into a private securities transaction if the registered person seeks to sell interests in an outside business. Such a material change in the activity would require the registered person to provide updated written notice and, in this example, would trigger the member to conduct a risk assessment and, depending on the activity and whether the member approves the registered person's participation, may require the member's supervision.

      11. See Form U4 Explanation of Terms, available at https://www.finra.org/file/explanation-terms-crd-forms.

      12. FINRA notes that, irrespective of whether an outside activity is investment related, other rules may apply, depending on the facts and circumstances, to business-related conduct, including FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade).

      13. FINRA Rule 3270 applies to registered persons, while FINRA Rule 3280 applies to associated persons. The proposed rule would harmonize this distinction, which was an issue raised by stakeholders during the retrospective review.

      14. Because a member's obligations under the rule apply with respect to investment-related activities, a member necessarily must have a process for reasonably determining which activities are investment related.

      15. As part of the risk assessment, FINRA would expect a member, for example, to consider the registered person's proposed role in the activity, whetherthe registered person intends to use separate or shared facilities or electronic presence, whether the registered person intends to solicit the member's customers and the general nature of the underlying activity. A member also must consider any "red flags" indicating problematic activities that raise the risks of the engagement of the registered person in the proposed activity. See, e.g., Dep't of Enforcement v. Fox Fin. Mgmt. Corp., Complaint No. 2012030724101, 2017 FINRA Discip. LEXIS 3, at *17&ndashndash;18 (FINRA NAC Jan. 6, 2017) (stating that the "supervisory duties imposed under NASD Rule 3010 include a responsibility to investigate and act upon 'red flags' that reveal irregularities or the potential for misconduct" and finding that the firm failed to investigate and act upon red flags indicating that an outside business activity in fact involved private securities transactions); Dep't of Enforcement v. Merrimac Corp. Securities, Inc., Complaint No. 2009017195204, 2015 FINRA Discip. LEXIS 4, at *9 (FINRA NAC Apr. 29, 2015) (affirming the imposition of sanctions for the firm's failure to adequately consider red flags of outside business activities and private securities transactions, for example, by neglecting "to investigate after it learned of allegations on a website that one of the outside businesses was a Ponzi scheme and was suffering serious financial difficulties").

      16. As discussed more fully infra, in this circumstance, a firm would be responsible for complying with all applicable securities laws and FINRA rules, including supervision and recordkeeping.

      17. The rule would not prohibit a member from deciding for its own business reasons to create additional obligations and procedures for its registered or associated persons regarding outside business activities.

      18. In this example, the member would have other obligations related to its custodial role, but those are separate and apart from the proposed rule's treatment of outside business activities.

      19. See, e.g., Notice to Members 85-21 (March 1985) (requesting comment on private securities transactions rule, which was aimed at addressing transactions that had long been a regulatory concern, namely "transactions in which an associated person is selling securities to public investors on behalf of another party, e.g., as part of a private offering of limited partnership interests, without the participation of the person's employer firm").

      20. This provision is consistent with current guidance regarding the application of the private securities transactions rule to the activities of registered persons employed by more than one member. See Notice to Members 96-33 (May 1996), Question 5 (allowing members to develop a detailed, formal allocation arrangement whereby at least one member agrees and is able to provide required supervision and recordkeeping under the private securities transactions rule with respect to outside investment advisory activities of a registered person employed with more than one member).

      21. This retention period is consistent with the retention period in the current rule on outside business activities and with the retention period of other records relating to associated persons required to be made and preserved underthe Exchange Act. See SEA Rule 17a-4(e)(l) (setting forth the retention period for specified records relatingto associated persons).

      22. For example, investment advisers registered with the SEC are overseen by the SEC and subject to the obligations of the Investment Advisers Act of 1940 (Advisers Act) and the regulations and rules promulgated thereunder. Other investment advisers are subject to state registration systems, many of which have requirements similar to the Advisers Act.

      23. See, e.g., FINRA Rule 5121(f)(1) (defining "affiliate" for purposes of the rule governing public offerings of securities when a participating firm has a conflict of interest); FINRA Rule 6710(ee) (defining "Non-member Affiliate" for purposes of the rules relating to the Trade Reporting and Compliance Engine (TRACE)).

      24. The proposal would not alter the obligations under FINRA Rule 3210.

      25. See Rule 3280(c)(2) (requiring a member that approves an associated person's participation in a private securities transaction for compensation to record the transaction on the member's books and records and supervise the associated person's participation as if the transaction were executed on behalf of the member); see also Notice to Members 94-44 (May 1994) (providing that an associated person is considered to be participating in the execution of the transaction, and, therefore, triggering the application of Rule 3280, if the person's investment advisory activities exceed the mere recommendation of securities).

      26.. See supra note 22. To the extent that FINRA becomes aware of potentially problematic IA or other non-broker-dealer activities during the course of its oversight of broker-dealers, FINRA would take appropriate action within the scope of its authority, including, but not limited to, referring the matter to the SEC or states.

      27. Under Rule 3270, a registered person must provide prior written notice to the firm of outside business activity, but there is no requirement in the rule that the member approve the activity before the registered person may engage in it.


      ATTACHMENT A

      Below is the text of the proposed rule change. Proposed new language is underlined.

      * * * * *

      3290. Outside Business Activities
      (a) Obligations of a Registered Person

      No registered person may participate in any manner in an investment-related or other business activity outside the scope of the relationship with the person's member firm unless the person provides prior written notice to and, with respect to any investment-related activity, receives prior written approval from, the member. In the case of a material change to the activity, a registered person must provide the member with updated prior written notice and, with respect to any investment-related activity, receive updated prior approval. The notification shall be provided in such form as specified by the member, describing the proposed activity and the person's proposed role therein. If the member disapproves the proposed activity or places conditions or limitations on it, the registered person shall not participate in the activity or shall comply with such conditions or limitations.
      (b) Obligations of a Member Receiving Notice of an Investment-Related Activity
      (1) Upon receipt of a written notice of any investment-related activity, a member shall:
      (A) perform a reasonable assessment of the risks created by the engagement of the registered person in the proposed activity, including an evaluation of whether the proposed activity will:
      (i) interfere with or otherwise compromise the registered person's responsibilities to the member's customers; or
      (ii) be viewed by customers or the public as part of the member's business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered;
      (B) consider whether the activity would require the person's registration as a broker or dealer under the Exchange Act if not for the person's association with a member; and
      (C) make a reasonable determination of whether to approve the registered person's participation in the proposed activity, to approve it subject to specific conditions or limitations, or to disapprove it.
      (2) Upon completion of the member's assessment, a member shall advise the registered person in writing whether the member:
      (A) approves the person's participation in the proposed activity and imposes any conditions or limitations on that participation; or
      (B) disapproves the person's participation in the proposed activity.
      (3) If the member imposes conditions or limitations on its approval of the person's participation in the proposed activity, the member shall reasonably supervise the registered person's compliance with such conditions or limitations.
      (4) If the member approves the person's participation in the proposed activity and such activity would require, if not for the person's association with a member, registration as a broker or dealer under the Exchange Act and the person is not so registered, the activity shall be deemed to be that of the member and the member shall be subject to all applicable securities laws and regulations and FINRA rules, including those requiring supervision and recordkeeping, with respect to that activity. If the person is associated with more than one member, the members may develop a detailed, formal allocation arrangement, which must be in writing, whereby at least one member agrees to be responsible for compliance with respect to all applicable securities laws and regulations and FINRA rules regarding the proposed activity, including those requiring supervision and recordkeeping.
      (5) A member must keep a record demonstrating its compliance with the obligations pursuant to this Rule and must preserve this record at least three years after the registered person's employment or association with the member has terminated.

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

      .01 This Rule shall not apply to:
      (a) a registered person's personal investments (including transactions in accounts that are subject to FINRA Rule 3210);
      (b) transactions on behalf of the registered person's immediate family members (as defined in FINRA Rule 5130) for which the registered person receives no transaction-related compensation;
      (c) activities conducted on behalf of a member's affiliate, unless those activities would require, if not for the person's association with a member, registration as a broker or dealer under the Exchange Act and the person is not so registered; or
      (d) a member's non-broker-dealer activities.
      .02 For purposes of this Rule:
      (a) "Affiliate" means any entity that controls, is controlled by or is under common control with a member.
      (b) "Business activity" means: (i) acting as an employee, independent contractor, sole proprietor, officer, director or partner of another person; or (ii) receiving compensation, or having the reasonable expectation of compensation, from any other person as a result of the activity.
      (c) "Investment-related" means 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).

    • 18-07 Extension of Time Requests Relating to FINRA Rule 4210

      View PDF

      Regulatory Extension (REX) System Update

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4210
      SEA Rule 15c3-3
      Regulation T
      Regulatory Notice 17-28
      Regulatory Notice 16-31
      Regulatory Notice 14-13
      Regulatory Notice 10-28
      Suggested Routing

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

      Extension of Time Requests

      Executive Summary

      FINRA is updating the Regulatory Extension (REX) system1 to include enhanced functionality that will better enable firms to request extensions of time related to FINRA Rule 4210, inclusive of requests for extensions of time in connection with the margin requirements for Covered Agency Transactions that will become effective beginning June 25, 2018.2 This Notice contains information about the REX system update, including a REX Customer Test Environment (CTE) that FINRA will make available to assist firms in testing their systems to ensure their readiness for the updated system.

      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 so that, beginning June 25, 2018, firms may submit requests for an extension of time pursuant to FINRA Rule 4210 by:

      •   completing an online form via the FINRA Firm Gateway [https://ews.finra.org/auth/ews_logon.jsp?CTAuthMode=BASIC&login_form_location_basic&aa_param=user]; or
      •   submitting a batch file by logging into the REX system.

      Appendix A of this Notice describes the new data elements firms will be required to submit when requesting extensions of time related to Rule 4210. Appendix B of this Notice provides updated reason codes and validation identifiers for use when making such requests.

      Firms should note that the updated REX system will permit them, when making requests related to FINRA Rule 4210 via the batch file process, to use the REX batch XML file format that currently is in use for requests related to Regulation T and SEA Rule 15c3-3. As such, firms will be able to use the REX batch XML file format for all extension of time requests related to Regulation T, SEA Rule 15c3-3 and FINRA Rule 4210. In order to be able to file Rule 4210 extension of time requests via the batch file process, firms must update their batch file data fields. Information about the batch file process and the required changes is available at FINRA's How to Use the REX System [http://www.finra.org/industry/rex/how-to-use-the-rex-system] page.

      As with the current REX system, the updated REX system will permit a firm to review the status of each extension of time request immediately through the FINRA Firm Gateway after it is submitted and, on the next business day, via the firm's daily extension report, which provides a report for all extensions filed by the firm. Also, as with the current REX system, the updated REX system will permit a firm to search, amend and resubmit its extension of time requests through the FINRA Firm Gateway.

      Test Phases: REX Customer Test Environment (CTE)

      To assist firms in preparing for the update, FINRA has created a REX CTE that firms may use to test extension of time requests using the online form or the batch file process. FINRA is dividing testing into two phases and encourages firms to begin testing as soon as possible to ensure their readiness to file extension of time requests when the updated REX system is implemented on June 25, 2018. The two test phases are summarized below and in Appendix C of this Notice. Firms may consult FINRA's How to Use the REX System [http://www.finra.org/industry/rex/how-to-use-the-rex-system] page for further information.

      Phase 1–available beginning February 20, 2018

      During Phase 1, firms will be able to preview the online form for extension of time requests related to Rule 4210. The form will be available under the "Forms and Filing" section in the FINRA CTE Gateway [https://ews.finra.org/auth/ews_logon.jsp?CTAuthMode=BASIC&login_form_location_basic&aa_param=user]. Through the CTE, firms will be able to submit, search and modify extension of time requests. Validation and summary reports will not be available during this phase.

      Phase 2–available beginning March 16 through June 15, 2018

      During Phase 2, firms will be able to submit extension of time requests related to Rule 4210 via both the FINRA CTE Gateway online request form and the batch process. 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 on March 9, 2018.

      FINRA will begin accepting test files through the REX batch file CTE on March 16, 2018. During Phase 2, firms will have access to reports with details of all the extension of time requests submitted. Firms will also be able to query the REX test environment for information on all extension of time requests granted, denied or rejected. The reports will be available the business day after the request(s) was submitted.

      During both testing phases, firms must use their current FINRA Gateway user ID and password to log into the CTE. Firms that encounter technical problems, or that need to request a FINRA user ID and password, may contact the FINRA Help Desk at (800) 321-6273.


      1. FINRA introduced the REX system in August 2010 and implements updates as appropriate. See, e.g., Regulatory Notice 10-28 (June 2010) (Extension of Time Requests) and Regulatory Notice 14-13 (March 2014) (REX System Update).

      2. See Regulatory Notice 16-31 (August 2016) (announcing the SEC's approval of amendments to FINRA Rule 4210 to establish margin requirements for Covered Agency Transactions (the "Covered Agency Transactions amendments")) and Regulatory Notice 17-28 (September 2017) (announcing availability of a set of frequently asked questions and guidance in connection with the Covered Agency Transactions amendments and extending, to June 25, 2018, the effective date of the requirements pursuant to such amendments that otherwise would have become effective on December 15, 2017). 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.


      Appendix A

      Updated Data Elements For Extension of Time Requests Relating To FINRA Rule 4210 (Effective June 25, 2018)

      •   Submitter Filing reference ID— This field is optional and is provided to enable the submitting firm to identify or track each extension of time request for internal purposes.
      •   Reason Code — Select one of the following reason codes:
      •   060 — Mark to Market Disputes
      •   061 — Collateral Valuation Disputes
      •   062 — Non US Holiday
      •   063 — Acts of God
      •   067 — Other – Covered Agency Transaction (FINRA Rule 4210(e)(2)(H)(ii)d. & FINRA Rule 4210(e)(2)(H)(ii)e.)
      •   068 — Other – Interpretation /02 of FINRA Rule 4210(f)(6)
      •   069 — Other – FINRA 4210(g)(10)(D)
      •   Days Requested — The number of days being requested for the extension of time. For Reason Codes 060, 061, 063 and 067, the system will default to 14 calendar days for each request submitted. For Reason Codes 062, 068 and 069, firms may request up to 7 calendar days for each extension of time request filed.
      •   Date of Mark to Market Loss or Deficiency — The date the mark to market loss or deficiency, as applicable, occurred.
      •   Mark to Market Loss or Deficiency Amount — The current mark to market loss or deficiency amount, as applicable.
      •   Branch CRD — The CRD number of the branch assigned to the counterparty.
      •   Account Number — The counterparty's account number.
      •   Account Name — The counterparty's name.
      •   Is the counterparty a US B/D? — For online requests, indicate either "Yes" or "No" whether the counterparty is a broker/dealer. If responding, "Yes", include the CRD number assigned to the broker-dealer counterparty.
      •   Is the extension of time request on behalf of a US correspondent? — For online requests, indicate either "Yes" or "No" whether the extension of time request is filed on behalf of a correspondent for its counterparty. If responding, "Yes", include the CRD number of the correspondent.
      •   Withdrawn Flag — Indicate "Yes" if withdrawing a previously submitted extension of time request. Firms must complete the "Comment" field explaining why the extension of time is being withdrawn. If the extension of time is not being withdrawn, this field will default to "No."
      •   Comment — This field is mandatory for Reason Codes 063, 067, 068 and 069.

      Appendix B

      FINRA Rule 4210 Extension of Time Request Reason Codes and Request Validation Identifiers

      FINRA Rule 4210 — Reason Codes
      Reason
      Code
      Reason
      No. of Days
      Permitted
      Limit Per
      Code
      Special Remarks
      060 Mark to Market Disputes
      14 Calendar days
      2
      Final on Second Extension of
      Time Request
      061 Collateral Valuation Disputes
      14 Calendar days
      2
      Final on Second Extension of
      Time Request
      062 Non-US Holiday
      7 Calendar days
      2
      Final on Second Extension of
      Time Request
      063 Acts of God
      14 Calendar days
      0
      Requires FINRA Approval
      Reason Codes 064 – 066 reserved for future assignment
      067 Other – Covered Agency Transaction
      (FINRA Rule 4210(e)(2)(H)(ii)d. &
      FINRA Rule 4210(e)(2)(H)(ii)e.)
      14 Calendar days
      2
      Final on Second Extension of
      Time Request: Third Extension
      of Time Request Requires
      FINRA Approval
      068 Other – Interpretation /02 of
      FINRA Rule 4210(f)(6)
      7 Calendar days
      0
      Requires FINRA Approval
      069 Other – FINRA Rule 4210(g)(10)(D)
      7 Calendar days
      0
      Requires FINRA Approval

      Appendix B

      Extension of Time Request Validation Identifiers
      Extension Type
      Validation
      Identifier
      Rex Message
      Disposition
      If Pass
      Validation
      Disposition
      If Fail
      Validation
      Covered Agency Transaction
      (FINRA Rule 4210(e)(2)(H)(ii)d. &
      FINRA Rule 4210(e)(2)(H)(ii)e.)
      BR5000
      For FINRA Rule 4210 extension of time
      requests filed under codes 060, 061,
      062 and 067, the request must be
      made on the date the mark to market
      loss or deficiency, as applicable, occurs
      + 5 business days.
      Approve
      Deny
      Interpretation /02 of
      FINRA Rule 4210(f)(6)
      BR5100
      For FINRA Rule 4210 extension of time
      requests filed under code 068, the
      request must be made on the date the
      margin or mark to market deficiency,
      as applicable, occurs + 15 business
      days.
      Pending
      Deny
      FINRA 4210(g)(10)(D)
      BR5200
      For FINRA Rule 4210 extension of time
      requests filed under code 069, the
      request must be made on the date the
      portfolio margin deficiency occurs + 3
      business days.
      Pending
      Deny
      Covered Agency Transaction
      (FINRA Rule 4210(e)(2)(H)(ii)d. &
      FINRA Rule 4210(e)(2)(H)(ii)e.)
      BR5300
      For the first FINRA Rule 4210
      extension of time follow-on request
      under code 060, 061, 062 or 067,
      the request must be made on the
      expiration date (or the next business
      day after such date) of the previous
      request.
      Approve
      Deny
      Interpretation /02 of
      FINRA Rule 4210(f)(6) &
      FINRA 4210(g)(10)(D)
      BR5400
      For FINRA Rule 4210 follow-on
      extension of time requests under
      codes 068 and 069, the request must
      be made on the expiration date (or
      the next business day after such date)
      of the previous request.
      Pending
      Deny
      Covered Agency Transaction
      (FINRA Rule 4210(e)(2)(H)(ii)d. &
      FINRA Rule 4210(e)(2)(H)(ii)e.)
      BR5500
      For FINRA Rule 4210 extension of time
      requests filed under code 063, the
      request must be made on the date the
      mark to market loss or deficiency, as
      applicable, occurs +5 business days.
      Pending
      Deny

      Appendix B

      Extension of Time Request Validation Identifiers
      Extension Type
      Validation
      Identifier
      Rex Message
      Disposition
      If Pass
      Validation
      Disposition
      If Fail
      Validation
      Covered Agency Transaction
      (FINRA Rule 4210(e)(2)(H)(ii)d. &
      FINRA Rule 4210(e)(2)(H)(ii)e.)
      BR5600
      For FINRA Rule 4210 extension of time
      follow-on requests under code 063,
      the request must be made on the
      expiration date (or the next business
      day after such date) of the previous
      request.
      Pending
      Deny
      Covered Agency Transaction
      (FINRA Rule 4210(e)(2)(H)(ii)d. &
      FINRA Rule 4210(e)(2)(H)(ii)e.)
      BR5700
      For all extension of time requests
      after the first FINRA Rule 4210
      extension of time follow-on request,
      the request must be made on the
      expiration date (or the next business
      day) of the previous request and filed
      under reason code 067.
      Pending
      Deny

      Note:

      The REX system permits a firm to search for specific extension of time requests or groups of extension of time requests that the firm has submitted, based on a wide variety of search criteria, including Disposition Status (Granted, Denied, Pending). When a firm elects to use the REX batch file format, the firm receives an enhanced XML results report via FTP or SFTP (depending on how the batch file was submitted). The results report is an XML-formatted file that contains all of the information regarding all extension of time requests the firm submitted, including extension requests submitted via the online request form.


      Appendix C

      REX System Testing and Implementation Timeline

      REX System Testing and Implementation Timeline
      Week
      Action
      February 20 - March 15, 2018 Preview the online form for FINRA Rule 4210 at
      https://firmstest.finra.org/.
      Friday, March 09, 2018 Batch connectivity testing will be available at
      https://filetransfer.ct.finra.org/.
      March 16 - June 15, 2018 Testing cycle begins for both online and batch filers
      for FINRA Rule 4210 extension of time requests.
      End of testing cycle, June 15, 2018.
      Friday, June 15, 2018 End of testing cycle for FINRA Rule 4210 extension
      of time requests
      Monday, June 25, 2018 Implementation date of Covered Agency Transaction
      margin requirements.
      Monday, July 02, 2018 First date available to file FINRA Rule 4210 extension
      of time requests.

    • 18-06 FINRA Requests Comment on Proposed Amendments to its Membership Application Program to Incentivize Payment of Arbitration Awards; Comment Period Expires: April 9, 2018

      View PDF

      Membership Application Program

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      NASD IM-1011-1
      NASD Rule 1011
      NASD Rule 1013
      NASD Rule 1014
      NASD Rule 1017
      SEA Rule 15c3-1
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Registration
      Senior Management
      Key Topics

      Arbitration
      Membership Application Program
      Supervision

      Summary

      FINRA is requesting comment on proposed amendments to its Membership Application Program (MAP) rules to create further incentives for the timely payment of arbitration awards by preventing an individual from switching firms, or a firm from using asset transfers or similar transactions, to avoid payment of arbitration awards while staying in business. The amendments would address situations where: (1) a FINRA member firm hires individuals with pending arbitration claims, where there are concerns about the payment of those claims should they go to award or result in a settlement, and the supervision of those individuals; and (2) a member firm with substantial arbitration claims seeks to avoid payment of the claims should they go to award or result in a settlement by shifting its assets, which are typically customer accounts, or its managers and owners, to another firm and closing down.

      The text of the proposed amendments can be found at www.finra.org/notices/18-06.

      Questions concerning this Notice should be directed to Victoria Crane, Associate General Counsel, Office of General Counsel, at (202) 728-8104.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by April 9, 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, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board of Governors, and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2

      Background & Discussion

      FINRA's membership application rules are intended to promote investor protection by applying strong standards for admission to FINRA as a member firm and for material changes to a current member firm's ownership, control or business operations. These 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.

      FINRA's Department of Member Regulation, through the MAP Group (collectively, the Department), evaluates an applicant's financial, operational, supervisory and compliance systems to ensure that the applicant meets FINRA's standards for admission. In addition, 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 arbitration claims, unpaid arbitration awards, pending or unadjudicated matters, civil actions, remedial actions imposed or other industry-related matters that could pose a threat to public investors.

      FINRA is proposing to amend the MAP rules to allow FINRA to take a stronger approach to addressing the issue of pending arbitration claims, as well as arbitration awards and settlement agreements related to arbitrations that have not been paid in full in accordance with their terms, in connection with the new membership application (NMA) or continuing membership application (CMA) processes.3 In addition, the proposed amendments would enable the Department to consider the supervision of individuals with pending arbitration claims and, therefore, who may have a history of non-compliance.

      Among other things, the proposed amendments are intended to address concerns regarding situations where: (1) a FINRA member firm hires individuals with pending arbitration claims, where there are concerns about the payment of those claims should they go to award or result in a settlement, and the supervision of those individuals; and (2) a member firm with substantial arbitration claims seeks to avoid payment of the claims should they go to award or result in a settlement by shifting its assets, which are typically customer accounts, or its managers and owners, to another firm and closing down.

      First, the proposed amendments would provide the Department with rule-based authority to presumptively deny an NMA if the applicant or its associated persons are subject to pending arbitration claims. Today, the Department considers if an applicant's or its associated person's record reflects a pending arbitration in determining if the applicant meets the standards for admission, but a record of a pending arbitration does not create a presumption of denial. Under the proposal, the applicant could overcome the presumption of denial if the applicant demonstrates its ability to satisfy the pending arbitration claims such as through an escrow agreement, insurance coverage, a clearing deposit, a guarantee, a reserve fund, or the retention of proceeds from an asset transfer, or such other forms that the Department may determine to be acceptable.

      This presumption of denial for pending arbitration claims would not apply to a CMA. Instead, consistent with today's practice, the Department would consider if an applicant's or its associated person's record reflects a pending arbitration in determining if the applicant meets the standards for admission.

      Second, the proposed amendments would not permit a member to effect a business expansion that involves adding one or more associated persons with a "covered pending arbitration claim" (as discussed in further detail below), unpaid arbitration award or unpaid settlement related to an arbitration, and the member is not otherwise required to file a CMA, unless the member first seeks a materiality consultation for the contemplated expansion with the Department and the Department determines that the member may effect the contemplated business expansion without a CMA.

      Third, the proposed amendments would not permit any direct or indirect acquisitions or transfers of a member's assets or any asset, business or line of operation where the transferring member or one or more of its associated persons has a covered pending arbitration claim, unpaid arbitration award or unpaid settlement related to an arbitration, and the member is not otherwise required to file a CMA, unless the member first seeks a materiality consultation for the contemplated acquisition or transfer and the Department has determined that the member is not required to file a CMA for approval of the acquisition or transfer.4

      As further detailed below, "covered pending arbitration claims" for purposes of the proposed amendments are those whose amount (either individually or in the aggregate) exceed the member's excess net capital. In conducting its materiality consultation and determining whether a CMA is required, the Department would consider the risk that the proposed business expansion, acquisition or transfer would result in non-payment of an arbitration claim if it goes to award, or the continued non-payment of an arbitration award or settlement related to an arbitration, and would permit transactions to proceed where there is no material risk of non-payment.

      Proposed Amendments

      A. Standards for Admission

      Rule 1014(a) sets forth 14 standards for admission applied by the Department in determining whether to approve an NMA or a CMA. Currently, Rule 1014(a)(3) specifies the factors that the Department considers to determine an applicant's ability to comply with the 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. The standard enumerates factors that the Department will consider when making this assessment, some of which have a presumption of denial.

      One such factor in Rule 1014(a)(3)(C) to be considered by the Department, and that creates a presumption of denial, is whether the applicant, its control persons, principals, registered representatives, other associated persons, any lender of five 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 five percent lender of its net capital is subject to unpaid arbitration awards, other adjudicated customer awards or unpaid arbitration settlements.

      The rebuttable presumption does not apply, however, to pending arbitration claims. As noted above, today, the Department considers if an applicant's or its associated person's record reflects a pending arbitration in determining if the applicant meets the standard for admission under Rule 1014(a)(3), but a record of a pending arbitration does not create a presumption of denial.

      FINRA is concerned about new members onboarding principals and registered representatives with pending arbitration claims without the firm having to demonstrate how those claims would be paid if they go to award. In addition, FINRA is concerned about the new firm's supervision of such individuals who may have a history of non-compliance. Accordingly, FINRA is proposing to amend Rules 1014(a) and (b) to specify that a presumption of denial exists if the new member applicant or its associated persons are subject to pending arbitration claims. Creating a presumption of denial in connection with pending arbitration claims for NMAs would shift the burden to the new member to demonstrate how its claims would be paid should they go to award. In addition, it would shine a spotlight on the individuals with the pending arbitration claims and the firm's supervision of such individuals.

      This presumption of denial for pending arbitration claims would not apply to a member firm filing a CMA. Instead, consistent with today's practice, the Department would consider if an applicant's or its associated person's record reflects a pending arbitration in determining if the applicant meets the standards for continued membership, but the record of a pending arbitration would not create a presumption of denial.5

      In addition, to allow an applicant to demonstrate that it has the resources to satisfy such claims (with respect to a new member applicant), as well as unpaid arbitration awards and unpaid arbitration settlement agreements, FINRA is proposing to add new supplementary material to Rule 1014 to provide that an applicant can overcome the presumption of denial, if the applicant demonstrates its ability to satisfy the pending arbitration claims (with respect to a new member applicant), unpaid arbitration awards, other adjudicated customer awards or unpaid arbitration settlements. The applicant could demonstrate its ability to satisfy such obligations through an escrow agreement, insurance coverage, a clearing deposit, a guarantee, a reserve fund, or the retention of proceeds from an asset transfer, or such other forms that the Department may determine to be acceptable.6 The applicant could provide a written opinion of an independent, reputable U.S. licensed counsel knowledgeable in the area as to the value of the arbitration claims (which might be zero). Any demonstration by an applicant of its ability to satisfy these outstanding obligations would be subject to a reasonableness assessment by the Department.
      B. Materiality Consultation for Business Expansions and Asset Acquisitions and Transfers
      1. Business Expansions

      To help further incentivize payment of arbitration awards, FINRA is proposing not to permit a member to effect a business expansion that would involve adding one or more associated persons with a "covered pending arbitration claim," unpaid arbitration award or unpaid settlement related to an arbitration, and the member is not otherwise required to file a CMA, unless the member first seeks a materiality consultation for the contemplated expansion with the Department and the Department determines that the member may effect the contemplated business expansion without a CMA.

      For purposes of a business expansion, FINRA is proposing to define a "covered pending arbitration claim" as: (1) an investment-related, consumer-initiated claim filed against the associated person that is unresolved; and (2) whose claim amount (individually or, if there is more than one claim, in the aggregate) exceeds the member's excess net capital. For purposes of this definition, the claim would include only claimed compensatory loss amounts, not requests for pain and suffering, punitive damages or attorney's fees.

      Rule 1017(a) provides, among other things, that a member shall file a CMA for a material change in business operations. A "material change in business operations" includes: (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 SEA Rule 15c3-1. 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 includes increases in the number of associated persons involved in sales within the parameters prescribed in the safe harbor.

      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.

      FINRA is concerned that the definition of a material change in business operations and the availability of the safe harbor for business expansions could allow a member to, for example, onboard principals and registered representatives with substantial pending arbitration claims without consideration as to the supervision of those individuals.

      Accordingly, FINRA is proposing to add IM-1011-2 (Business Expansions and Covered Pending Arbitration Claims) to provide that if a member is seeking to add one or more associated persons involved in sales and one or more of those associated persons has a covered pending arbitration claim, an unpaid arbitration award or an unpaid settlement related to an arbitration, and the member is not otherwise required to file a CMA, the member may not effect the contemplated business expansion unless the member has first submitted a written letter to the Department, in a manner prescribed by FINRA, seeking a materiality consultation for the contemplated business expansion and the Department determines that the member is not required to file a CMA in accordance with Rule 1017 and may effect the contemplated business expansion. Thus, under such circumstances, a member would not be able to avail itself of the safe harbor for business expansions.

      The materiality consultation would allow the Department to, among other things, assess the nature of the anticipated activities of the principals and registered representatives with the arbitration claims; the impact on the firm's supervisory and compliance structure, personnel and finances; and any other impact on investor protection raised by adding the principals and registered representatives.

      The Department would consider the letter and other information or documents provided, 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 proposed business expansion; or (2) the member is required to file a CMA in accordance with Rule 1017 and the member may not effect the proposed business expansion unless the Department approves the CMA.

      If the Department determines that a member must file a CMA, the member's application would be subject to the full membership application process, including a review of any record of a pending arbitration and the presumption of denial with respect to any unpaid arbitration awards, other adjudicated customer awards or unpaid arbitration settlements.
      2. Asset Acquisitions and Transfers

      In addition, FINRA believes that member firms engaging in asset acquisitions or transfers that have covered pending arbitration claims, unpaid arbitration awards or unpaid settlement agreements related to an arbitration should be required to seek a materiality consultation for the contemplated acquisition or transfer. Under the current requirements for filing a CMA, a member must file an application for approval for 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, unless both the seller and acquirer are members of the New York Stock Exchange (NYSE).7 FINRA is concerned that this 25 percent threshold permits firms with pending claims that ultimately produce awards to avoid satisfying those awards by transferring assets without encumbrance and then closing down.

      Accordingly, FINRA is proposing not to permit any direct or indirect acquisitions or transfers of a member's assets or any asset, business or line of operation where the transferring member or an associated person of the transferring member has a covered pending arbitration claim, unpaid arbitration award or unpaid settlement related to an arbitration, and the member is not otherwise required to file a CMA, unless the member has submitted a written letter to the Department, in a manner prescribed by FINRA, seeking a materiality consultation for the contemplated transfer and the Department has determined that the member is not required to file for approval of the transfer. As part of the materiality consultation, the Department would consider the letter and other information or documents provided by the member to determine if the acquisition or transfer could result in non-payment of an arbitration claim should it go to award, or the continued non-payment of an arbitration award or settlement related to an arbitration.

      For purposes of this proposed amendment, FINRA is proposing to define a "covered pending arbitration claim" as: (1) an investment-related, consumer initiated claim filed against the transferring member or its associated persons that is unresolved; and (2) whose claim amount (individually or, if there is more than one claim, in the aggregate) exceeds the transferring member's excess net capital. The claim amount would include claimed compensatory loss amounts only, not requests for pain and suffering, punitive damages or attorney's fees.

      The proposed materiality consultation would allow the Department to consider whether the transferring member has documentation with regard to the pending arbitration claims and whether the member could pay the claims, or any unpaid arbitration awards or unpaid settlements related to an arbitration, if the member engages in the contemplated transaction. FINRA would make its determination through, for example, discussions with the firm and reviewing relevant documentation and any other information submitted by the firm in the materiality consultation process.

      Following its review, the Department would 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 proposed transaction; or (2) the member is required to file a CMA in accordance with Rule 1017 and the member may not effect the proposed transaction unless the Department approves the CMA.

      If the Department determines that a member must file a CMA, the member's application would be subject to the full membership application process, including a review of any record of a pending arbitration and the presumption of denial with respect to any unpaid arbitration awards, other adjudicated customer awards or unpaid arbitration settlements.
      3. Other Proposed Amendments
      a. Notification of Changes

      FINRA also proposes to amend Rules 10138 and 1017 to add a new provision to require an applicant to provide prompt notification, in writing, of any pending arbitration claim that is filed, awarded, settled or becomes unpaid before a decision constituting final action of FINRA is served on the applicant. Any such pending claim (for a new member applicant), unpaid arbitration award or unpaid arbitration settlement would result in the Department being able to presumptively deny the application under the standards in Rule 1014(a)(3) and the ability of the applicant to overcome such presumption by demonstrating its ability to satisfy its obligation as discussed above.
      b. Effecting Change and Imposition of Interim Restrictions

      Rule 1017(c) sets forth the timing and conditions for effecting a change under Rule 1017. Under paragraph (1), an application for a change in ownership or control requires an application for approval to be filed at least 30 days prior to the proposed change. While a member may effect the change prior to the conclusion of the Department's review of the application, the Department may place interim restrictions on the member based upon the standards in Rule 1014 pending a final determination. Under paragraph (2), a member may file an application to remove or modify a membership agreement restriction at any time, but such existing restriction shall remain in effect during the pendency of the proceeding. Finally, paragraph (3) permits a member to file an application for approval of a material change in business operations 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.

      FINRA proposes to amend Rule 1017(c) by adding new paragraph (4) that would provide that notwithstanding the existing conditions under paragraphs (1) through (3), where a member or an associated person has an unpaid arbitration award or unpaid settlement agreement related to an arbitration at the time of filing an application under Rule 1017, the member may not effect such change until the member has demonstrated its ability to satisfy such obligation in accordance with Rule 1014 and the proposed supplementary material, as discussed above.

      Economic Impact Assessment

      A. Need for the Rule

      The MAP rules are intended to promote investor protection by applying uniform standards for admission to FINRA as a member firm, and for the review of changes to a current member firm's ownership, control, or business operations. For new and continuing member applications, however, the MAP rules do not take as strong of an approach with respect to the issue of pending arbitrations as they do with respect to the issue of unpaid arbitration awards and unpaid settlements related to an arbitration. The MAP rules also include a safe harbor from having to file a CMA for changes presumed not to be material, and a 25 percent threshold above which member firms must file a CMA for asset acquisitions and transfers. These provisions reduce the Department's ability to oversee changes to the business of member firms. The proposed amendments would strengthen the MAP rules when claimants and investors may need additional protections.
      B. Economic Baseline

      The economic baseline for the proposal is the current set of MAP rules. The MAP rules include the non-presumption of denial for pending arbitration claims for NMAs and CMAs, the definition of a material change in business operations and the availability of the safe harbor for some business expansions, and the requirements for a member firm to file a CMA relating to asset acquisitions and transfers.

      The proposed amendments would affect new member applicants (and their associated persons) if the applicant or an associated person is subject to a pending arbitration claim. In addition, the proposed amendments would affect member firms (and their associated persons) that, but for the proposed amendments, may not file a CMA because they believe the contemplated transaction is not a material change in business operations or avail themselves of the safe harbor for business expansions. The proposed amendments would also affect member firms (and their associated persons) that, but for the proposed amendments, would not be required to file a CMA due to reliance on the provision relating to asset acquisitions and transfers. Lastly, the proposed amendments would affect the claimants to arbitrations filed against the applicant or an associated person of the applicant, and other investors exposed to individuals or firms with a history of non-compliance.

      Currently, claimants to arbitration claims or awards are at risk for non-payment when the individuals or firms responsible for those claims or awards actively maneuver to avoid payment. For instance, individuals may join a new firm without being required to demonstrate an ability to pay should the claim go to award. Further, member firms may transfer assets or engage in similar transactions, in an attempt to avoid payment of arbitration awards.

      When deciding NMAs and CMAs, the Department considers pending arbitration claims and unpaid arbitration awards and unpaid settlements related to an arbitration. The Department, however, may not have the ability to ascertain how new member applicants would pay pending arbitration claims if they go to award. In addition, the Department may not receive notification from member firms of business expansions and asset acquisitions and transfers. In these instances, the Department is not able to review any related pending arbitration claims or unpaid arbitration awards or settlements related to an arbitration. Claimants to these arbitrations may therefore be at a greater risk for nonpayment of awards or settlements.

      The Department received 246 NMAs from January 2015 to December 2016. Among these applications, FINRA staff identified few new member applicants or their associated persons as having a pending arbitration claim at the time of the NMA filing. Among the 246 NMAs, FINRA staff identified seven NMAs (or three percent) as having a pending arbitration claim at the time of the filing.9

      The Department also received 786 CMAs from January 2015 to December 2016. The Department does not receive notice from member firms that do not file a CMA, including those member firms that do not file a CMA because they either believe the contemplated transaction is not a material change in business operations or they avail themselves of the safe harbor for business expansions or the provision relating to asset acquisitions and transfers. The number of these transactions, therefore, is not known to the staff.

      The member firms identified above as not providing notice may be different from the member firms that currently file a CMA. Thus, the sample only provides a potential indication of the scope of the proposed amendments. Of the CMAs that member firms filed, 276 CMAs related to material changes in business operations. These CMAs could have related to an increase in one or more associated persons involved in sales, or could have related to other business expansions that required the filing of a CMA. Another 122 CMAs related to asset acquisitions (nine) and transfers (113). FINRA staff identified 35 (or 29 percent) as having pending arbitration claims or unpaid arbitration awards or settlements related to an arbitration at the time of the filing.10
      C. Economic Impact

      The proposed amendments are designed to enhance the review of membership applications by strengthening the MAP rules in relation to pending arbitration claims, as well as unpaid arbitration awards and unpaid settlements related to arbitrations.

      The proposed amendments would shift the burden to the new member applicant to demonstrate how pending arbitration claims would be paid if they go to an award. The proposed amendments would also help to ensure that member firms are not engaging in business expansions or asset acquisitions and transfers to avoid the payment of arbitration claims should the claims go to award.

      The proposed amendments would benefit claimants by decreasing the risk that firms are avoiding the payment of awards by shifting their assets, including capital and customer accounts, to another firm. A decrease in the ability of firms to avoid satisfying their arbitration awards in this manner could result in a higher likelihood that arbitration claims that eventually go to award are paid in full in accordance with their terms. The proposed amendments would also benefit investors by increasing the oversight of associated persons who may have a history of non-compliance.

      The proposed amendments would impose both direct and indirect costs on new member applicants. New member applicants with pending arbitration claims would incur direct costs to demonstrate their ability to satisfy pending arbitration claims. These costs include the time and expense of firm staff and outside experts to demonstrate the ability to satisfy the claims. New member applicants could also incur the costs to notify FINRA of changes to pending arbitration claims.11 In addition, they could incur the opportunity costs associated with setting aside funds that could otherwise be used for new business. A new member applicant could incur more opportunity costs than is necessary if it sets aside more capital than the actual award amount.

      New member applicants could also incur indirect costs if the rebuttal process delays the applicant's ability to begin earning revenues or otherwise negatively impacts the business. The magnitude of these costs is related to the ability of the new member applicant and FINRA to adequately gauge the likelihood of an award and the size of the award (conditional on its grant). However, as noted above, FINRA estimates that few associated persons related to new member applicants have pending arbitration claims at the time of the filing.12 Most new member applicants are therefore unlikely to be affected by the proposed amendments.

      Member firms that are seeking to add one or more associated persons involved in sales or an asset transfer or acquisition, and are not otherwise required to file a CMA, would incur the direct costs associated with seeking a materiality consultation. The direct costs of a materiality consultation include the expense to hire outside experts (where applicable), the time of firm staff, and the expense to submit documentation describing the covered pending arbitration claim as well as the ability of the firm to pay the claim should it go to award.

      Member firms that seek a materiality consultation would also incur costs that are dependent on its outcome. If the member firm does not have to file a CMA, the only additional cost would be the delay in effecting the contemplated expansion or transaction. A delay could negatively impact the value of the expansion or transaction, and potentially lead to a loss of business opportunities. Given the experience of FINRA staff, this delay is anticipated to be small as the time for a materiality consultation averages approximately ten days; although this time period could be longer depending on the complexity of the contemplated expansion or transaction.

      Alternatively, if the member firm must file a CMA, the costs to member firms would increase. The increase in costs relate to the fees associated with a CMA, time of firm staff, the submission of documentation, and the notification of changes to any pending arbitration claim.13 The filing of a CMA would also delay the effectuation of the contemplated expansion or transaction. In the event of a delay, member firms, associated persons and the customers of member firms could lose the benefits associated with lost business opportunities. A determination that a CMA must be filed, however, would indicate that the risks to claimants, and therefore the potential benefits of a closer examination, would be higher. If the actual risks to claimants are low (e.g., the amount awarded is a small percentage of that claimed), then the higher costs to member firms would not correspond to a similar increase in benefits.

      FINRA believes that the proposed definition of a covered pending arbitration claim would mitigate the risk that a member firm would be required to file a CMA when the risk to claimants is small. Only pending arbitration claims (individually or, if there is more than one claim, in the aggregate) that exceed the member's excess net capital would trigger a materiality consultation. Member firms, however, could become more constrained in their future business activities to the extent that those activities would require additional capital. Future business activities that require additional capital could increase the likelihood of a materiality consultation in the event of a business expansion or asset acquisition or transfer. As noted above, the evidence suggests that a number of member firms that engage in asset acquisitions or transfers could have covered pending arbitration claims and, therefore, would be required to seek a materiality consultation with the Department to determine if they must file a CMA.14

      Lastly, member firms that file a CMA would not be able to effect the transaction if at the time of filing the application, the member firm or an associated person has an unpaid arbitration award or unpaid settlement related to an arbitration. Although this aspect of the proposed amendments would increase the likelihood of payment, it could also delay the effectuation of the transaction. A delay could cause member firms, associated persons, and the customers of member firms to lose the benefits associated with lost business opportunities.
      D. Alternatives Considered

      FINRA considered a range of 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.

      An alternative that FINRA considered involved proposing a presumption of denial for pending arbitration claims for CMAs. This alternative would increase the costs to member firms associated with CMAs. Member firms would incur costs to demonstrate their ability to satisfy the claims, as well as the opportunity costs associated with setting aside funds that could otherwise be used for other business opportunities. A presumption of denial, however, would reduce concern with respect to how the pending arbitration claims would be paid if they go to award. FINRA requests comment below as to whether there are circumstances under which member firms that file a CMA should have a presumption of denial for pending arbitration claims.

      Other alternatives that FINRA considered include the elimination of the safe harbor to file a CMA for changes presumed not to be material, and the elimination of the 25 percent threshold to file a CMA for asset acquisitions and transfers. These alternatives would increase the number of member firms that file a CMA. The member firms that would file a CMA under this alternative would incur additional costs. FINRA staff believes that the requirement under the proposed amendments for member firms to instead seek a materiality consultation would provide for additional investor protections while minimizing the costs to member firms.

      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. Should FINRA consider proposing to apply a presumption of denial in connection with pending arbitration claims and CMAs? If so, under what circumstances?
      2. If an applicant designates a clearing deposit or the proceeds from an asset transfer for purposes of demonstrating its ability to satisfy a pending arbitration claim, unpaid award or unpaid arbitration settlement, should FINRA require the applicant to provide some form of guarantee that the funds would be used for that purpose?
      3. The proposed amendments would not permit any direct or indirect acquisitions or transfers of a member's assets or any asset, business or line of operation where one or more of the transferring member's associated persons has a covered pending arbitration claim, unpaid arbitration award or unpaid settlement related to an arbitration, unless the member first seeks a materiality consultation for the contemplated acquisition or transfer and the Department has determined that the member is not required to file a CMA for approval of the acquisition or transfer. Should the proposed amendment be limited to principals, control persons or officers? Please explain.
      4. Are there any material economic impacts associated with the proposed definition of a "covered pending arbitration claim"? Should FINRA include in the definition only those pending arbitration claims filed prior to a specified time period or event? For example, should FINRA limit the definition of a covered pending arbitration claim to those claims filed prior to public announcement of the contemplated transaction? Please explain.
      5. Are there any material economic impacts, including costs and benefits, to investors, issuers and firms 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?
      6. 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 (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. In addition, FINRA intends to transfer the NASD Rule 1010 Series (Membership Proceedings), which governs FINRA's membership application program to the FINRA Rule 1000 Series in the Consolidated FINRA Rulebook, either as part of this proposal or a separate rulemaking. For purposes of this Notice, all references to the MAP rules will be to the NASD Rule 1010 Series. The proposed amendments would also update cross-references and make other non-substantive, technical changes, and make corresponding changes to the Forms NMA and CMA. FINRA is separately developing changes to the MAP rules in connection with the retrospective review of this rule set. See Retrospective Rule Review Report—Membership Application Rules and Processes (March 2016) at http://www.finra.org/sites/default/files/RetroRuleReview-03-2016.pdf.

      4. These changes would not prevent other slower ways of closing down potentially to avoid arbitration awards, such as the firm terminating while the registered representatives moved en masse to another firm. Note that in this case the new firm would need the customers' individual consent to transfer their accounts, rather than moving them as a group based on a negative consent notice as permitted when the terminating firm arranges for transfer of the accounts.

      5. FINRA is continuing to consider under what circumstances a presumption of denial in connection with pending arbitration claims and CMAs may be appropriate.

      6. FINRA is considering whether to provide that, if an applicant designates a clearing deposit or the proceeds from an asset transfer for purposes of demonstrating its ability to satisfy a pending arbitration claim, unpaid award or unpaid arbitration settlement, the applicant would have to provide some form of guarantee that the funds would be used for that purpose.

      7. See NASD Rule 1017(a). Other events that require a member to file a CMA for approval before effecting the proposed event include:

      •   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 ofthe 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).

      8. Rule 1013 sets forth the requirements for the filing of an NMA, including how to file the documents that must be submitted with the application, the ability of the Department to request additional documentation and to reject an application that is "not substantially complete," and the process and information needed for conducting membership interviews.

      9. The seven NMAs relate to four arbitration claims filed against associated persons. Of the four pending arbitration claims, three related to customer claims. One of the customer claims resulted in a settlement, and two were withdrawn. The total amount of compensatory damages sought by customers was over $500,000 (including the claims that resulted in a settlement). The fourth claim was an industry claim that resulted in a $4.5 million award. FINRA staff is not able to identify an NMA in the sample that relates to an unpaid award or an unpaid settlement related to an arbitration.

      10. FINRA staff identified 211 pending customer arbitration claims relating to the 35 CMAs including claims made against both member firms and associated persons of member firms. Of the 211 pending arbitration claims, 16 claims resulted in an arbitration award in favor of customers, 37 claims resulted in no arbitration award (including cases withdrawn), 131 claims resulted in a settlement, and 27 claims were still pending. Customers requested a total of $244 million in compensatory relief (including the claims that resulted in a settlement); and in the claims resulting in an arbitration award in favor of customers, customers were awarded approximately $4 million in compensatory damages. Among these member firms, seven reported excess net capital greater than the total compensatory damages customers requested for relief. FINRA staff also identified one CMA in the sample relating to asset acquisitions and transfers where the member firm and an associated person had an unpaid arbitration award of approximately $1.5 million. The member firm later withdrew the CMA and is no longer registered. The associated person was suspended for non-payment of the award. The suspension was later terminated based on evidence of a settlement agreement between the parties.

      11. FINRA staff identified three NMAs as relating to a pending arbitration claim either filed or closed after the filing of the NMA but before the Department's decision. Two of the three NMAs relate to a pending arbitration claim filed after the filing of the NMA. The third NMA relates to a pending arbitration claim that closed prior to the Department's decision.

      12. See supra note 9 and related text.

      13. FINRA staff identified 115 of the 786 CMAs (or 15 percent) as relating to a pending arbitration claim either filed or closed after the filing of the CMA but before the Department's decision. Eighty-six of the CMAs relate to pending arbitration claims filed after the filing of the CMA, and 73 of the CMAs relate to pending arbitration claims that closed prior to the Department's decision. Forty-four of the 115 CMAs had both pending arbitration claims that were filed after the filing of the CMA and had pending arbitration claims that closed prior to the Department's decision. The median number of changes to a pending arbitration claim for the 115 CMAs is two.

      14. See supra note 10 and related text. Customers may have a new incentive to file an arbitration claim for the sole purpose of disrupting a contemplated transaction. This incentive could increase the number of member firms that would be required to seek a materiality consultation and potentially to file a CMA. This new incentive is not reflected in the numbers above. FINRA staff has no reasonable basis on which to predict the frequency of this occurring if the rule proposal is adopted.

    • 18-05 FINRA Requests Comment on the Application of Certain Rules to Government Securities and to Other Debt Securities More Broadly; Comment Period Expires: April 9, 2018

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      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      Exchange Act Sections 3(a)(10), (12), (29) and (42)
      FINRA Rules 0150, 2010, 2241, 2242, 2320, 4370, 5240, 5250, 5270, 5280, 5310, 5320, 6420 and 6710
      NASD Rules 1021, 1022, 1031, 1032 and 1050
      SEA Regulation NMS
      SEC Regulation AC
      Suggested Routing

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

      Anti-Intimidation and Coordination
      Customer Order Protection
      Exempted Securities
      Fixed Income Securities
      Front Running
      Government Securities
      Investment Banking
      Market Making
      Research Activities
      Securities Trading
      Trading Ahead
      Treasury Securities

      Government Securities Initiative

      Comment Period Expires: April 9, 2018

      Summary

      FINRA is requesting comment on the application of the following rules to government securities, including U.S. Treasury securities: FINRA Rules 2242 (Debt Research Analysts and Debt Research Reports);1 5240 (Anti-Intimidation/Coordination); 5250 (Payments for Market Making); 5270 (Front Running of Block Transactions); 5280 (Trading Ahead of Research Reports); 5320 (Prohibition Against Trading Ahead of Customer Orders); and NASD Rules 1032(f) (Securities Trader), 1032(i) (Limited Representative—Investment Banking) and 1050 (Registration of Research Analysts).2 In addition, FINRA is requesting comment on the application of FINRA Rule 5320 as well as NASD Rules 1032(f) and 1050 to all debt securities, in addition to government securities.

      Questions regarding this Notice should be directed to:

      •   Afshin Atabaki, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8902; or
      •   Meredith Cordisco, Associate General Counsel, OGC, at (202) 728-8018.

      Action Requested

      FINRA encourages all interested parties to comment. Comments must be received by April 9, 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 Note: 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.3

      Background and Discussion

      A number of FINRA rules do not apply to government securities or other exempted securities.4 FINRA Rule 0150 (Application of Rules to Exempted Securities Except Municipal Securities) lists the FINRA rules5 that expressly apply to transactions in, and business activities relating to, exempted securities, including government securities6 (other than municipal securities7).

      In August 2016, the SEC's Division of Trading and Markets, in consultation with the staff of the U.S. Department of the Treasury, requested that FINRA undertake a comprehensive review of its rulebook to identify existing FINRA rules that exclude or do not clearly apply to U.S. Treasury securities (or government securities more generally), and to assess the continuing validity for such exclusions.8 In response, FINRA undertook a review of its rulebook for this purpose.9

      As a result of its review, FINRA identified several rules that apply to exempted securities, including government securities (other than municipal securities), but that are not currently listed in FINRA Rule 0150. These include rules that generally apply to the activities of all FINRA members, without regard to the type of products they sell, such as FINRA Rule 4370 (Business Continuity Plans and Emergency Contact Information).10

      In assessing the application of its rules to government securities, FINRA identified several rules that would benefit from additional industry comment. Specifically, as discussed below, FINRA is requesting comment on the implications of expressly applying FINRA Rules 2242, 5240, 5250, 5270, 5280 and 5320 as well as NASD Rules 1032(f), 1032(i) and 1050 to government securities, including U.S. Treasury securities. FINRA is also requesting comment on the implications of applying FINRA Rule 5320 and NASD Rules 1032(f) and 1050 to other types of debt securities, in addition to government securities.

      FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports)

      FINRA Rule 2242 governs conflicts of interest in connection with the publication of debt research reports and public appearances by debt research analysts. The rule defines "debt research report" to mean any written communication that includes an analysis of a debt security or issuer of a debt security and that provides information reasonably sufficient upon which to base an investment decision. The rule defines "debt security" to mean any security as defined in Section 3(a)(10) of the Exchange Act but excludes, among other securities, U.S. Treasury securities.

      In general, FINRA Rule 2242 requires firms to implement policies and procedures to identify and manage research-related conflicts of interest. Among other things, the policies must restrict or, in some cases, prohibit investment banking and sales and trading and principal trading personnel from the supervision and compensation determination of debt research analysts and research budget determinations. The rule further prohibits promises of favorable research and analyst participation in solicitation of investment banking business and road shows. The rule also requires disclosure of investment banking relationships and other material conflicts of interest, such as personal and firm ownership of a subject company's securities and principal trading of those securities. In addition, the rule specifies the prohibited and permissible interactions between the debt research personnel and sales and trading and principal trading personnel.

      In many ways, FINRA Rule 2242 mirrors FINRA Rule 2241 (Research Analysts and Research Reports), the equity research rule, with respect to debt research distributed to retail investors. However, unlike FINRA Rule 2241, the rule also exempts from many of its provisions and all of the specific disclosure requirements debt research that is distributed only to eligible institutional investors from which the firm has obtained consent to receive the less protected research.

      In explaining the exclusion of U.S. Treasury securities from FINRA Rule 2242, FINRA stated that it was reticent to become involved with direct obligations of the United States.11 However, FINRA differentiated agency securities, which are subject to FINRA Rule 2242, noting that it already required reporting of transactions in those securities to the Trade Reporting and Compliance Engine (TRACE).12 That distinction has since disappeared as FINRA, with the encouragement of the U.S. Department of the Treasury, now requires reporting of trades in U.S. Treasury securities to TRACE. FINRA also notes that FINRA Rule 2242 currently applies to research reports on foreign sovereign securities since many of the conflicts that rule addresses are present with respect to research on those securities. Further, the SEC's Regulation AC does not exclude U.S. Treasury securities from its certification requirements.

      Questions

      1. FINRA Rule 2242 governs conflicts of interest in connection with the publication of debt research reports and public appearances by debt research analysts. Is the nature of conflicts related to research on U.S. Treasury securities similar to those related to other debt securities? Is the magnitude of conflicts related to research on U.S. Treasury securities more than, less than or the same as those associated with other debt securities?
      2. If FINRA Rule 2242 applied to U.S. Treasury securities, firms would be required to establish and implement policies and procedures to identify and manage conflicts of interest if they prepare research on U.S. Treasury securities that does not qualify for an exception to the definition of "debt research report." What are the associated costs of establishing and implementing such policies and procedures? What are the implementation challenges that member firms may face, such as challenges relating to walling off research analysts in U.S. Treasury securities from the government securities trading desk? Are associated costs and implementation challenges similar for small and large member firms?
      3. FINRA understands that there are existing regulations by the U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System on the auction process for U.S. Treasury securities. Given such regulations, would an additional layer of regulation be necessary? What would be the direct and indirect impacts of such additional layer of regulation?
      4. Are there any other potential costs associated with extending the rule to U.S. Treasury securities?
      5. What are the potential benefits of extending the rule to U.S. Treasury securities? Who would potentially be receiving the benefits?

      FINRA Rule 5280 (Trading Ahead of Research Reports)

      FINRA Rule 5280(a) states that no member firm shall establish, increase, decrease or liquidate an inventory position in a security or derivative of such security based on non-public advance knowledge of the content or timing of a research report in that security. FINRA Rule 5280(b) requires a member firm to establish, maintain and enforce policies and procedures reasonably designed to restrict or limit the information flow between research department personnel, or other persons with knowledge of the content or timing of a research report, and trading department personnel, so as to prevent trading department personnel from utilizing non-public advance knowledge of the issuance or content of a research report for the benefit of the firm or any other person.

      The objective of this rule is to prevent an unfair trading advantage for a firm or select customers based on knowledge of non-public research department information that is intended for a broader audience of customers. The rule, therefore, aims to ensure that where a firm chooses to provide information from its research department to its customers that may result in a transaction, it must give those customers priority in acting on the information vis-à-vis the member firm's own trading or that of select customers.

      As FINRA noted in the proposed rule change adopting FINRA Rule 5280 and in an FAQ published in March 2016,13 because of the differing objective of FINRA Rule 5280, the definition of research report in the rule is not only intended to apply to both debt and equity research reports, but also to be broader than the definitions of "research report" and "debt research report" in FINRA Rules 2241 and 2242, respectively. Instead, it captures any written information from the research department that a reasonable person would expect to result in a transaction based on that information. Thus, for example, whereas FINRA Rules 2241 and 2242 exclude research reports distributed to fewer than 15 persons, those communications would be covered by FINRA Rule 5280.

      Questions

      1. The rule currently applies to debt and equity research reports as defined in FINRA Rules 2241 and 2242 as well as to any written information from the research department that a reasonable person would expect to result in a transaction based on that information. Is there any reason to exclude research reports relating to government securities from the scope of the rule?
      2. What are the potential costs, including the costs associated with establishing policies and procedures regarding information barriers, and potential benefits of expressly extending the rule to government securities?

      FINRA Rule 5240 (Anti-Intimidation/Coordination)

      FINRA Rule 5240 generally prohibits member firms and their associated persons from coordinating prices (including quotations) and trades or trade reports with any other person, asking or directing a member firm to alter a price, and attempting, directly or indirectly, to improperly influence any other person. The rule's prohibition includes but is not limited to behavior such as attempts to influence a member firm or associated person to adjust or maintain a price or quotation or other conduct that retaliates against or discourages the activities of another market maker or market participant.

      The rule is designed to prevent behavior that could impair the fair and orderly functioning of the market by prohibiting specific conduct that is inconsistent with just and equitable principles of trade.14 FINRA's policy concerning unlawful coordination and retribution or retaliatory conduct was originally codified by FINRA (then NASD) in 1997 as NASD IM-2110-5 (Anti-Intimidation/Coordination).15 NASD noted at that time that it believed the conduct covered by the rule was already prohibited by then-NASD Rule 2110 (now FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade)), which requires member firms to observe high standards of commercial honor and just and equitable principles of trade. However, NASD adopted the specific prohibitions of IM-2110-5 as part of an undertaking that NASD agreed to in response to a 1996 SEC report on the activities of certain Nasdaq market makers that impeded price competition in the Nasdaq market.16 FINRA then adopted the language of IM-2110-5 without material change in FINRA Rule 5240 in 2009 as part of FINRA's effort to develop its consolidated rulebook.17

      The rule identifies seven types of business activity by a firm that would not be prohibited, provided such activity is otherwise in compliance with all applicable law: (1) unilaterally setting its own bid or ask in a security at a bona fide price in a bona fide quantity; (2) unilaterally setting its own dealer spread, quote increment or quantity of shares for its quotations; (3) communicating its own bid or ask or bona fide prices or quantities in which it is willing to buy or sell in order to negotiate for or agree to a purchase or sale; (4) communicating its own bid or ask or bona fide prices or quantities in which it is willing to buy or sell to a person to retain that person as an agent or subagent for the member firm or its customer, and to negotiate for or agree to the purchase or sale; (5) underwriting; (6) taking unilateral action or making unilateral decisions regarding which market maker it will trade with and the relevant terms as long as such action is not otherwise prohibited by the rule; and (7) delivering an order to another member firm for handling.

      Questions

      1. The rule is not currently limited to equity securities. However, priced quotes are not as prevalent in the debt markets as in the equities markets, and there is not a "consolidated tape" of transactions. Are the policy goals underlying the rule—promoting price competition and preventing unlawful coordination, retribution and retaliatory conduct—still equally important in the context of debt securities, including government securities? Is there a risk of harm from price coordination or collusion in the government securities markets?
      2. If the rule were extended to government securities, what would be the practical impacts? Would there be a need for any exceptions to the requirements, for example for primary dealers in the government securities market? If so, why?
      3. What are the potential costs and benefits of expressly extending the rule to government securities?

      FINRA Rule 5250 (Payments for Market Making)18

      FINRA Rule 5250 prohibits member firms and their associated persons from accepting any payment or other consideration, directly or indirectly, from an issuer (or an issuer's affiliate or promoter), for publishing a quotation,19 acting as a market maker or submitting an application in connection therewith. The rule contains exceptions that permit a firm to accept: (1) payments for bona fide services, including but not limited to investment banking services; (2) reimbursement of registration and listing fees; and (3) payments provided for under the effective rules of a national securities exchange.

      The rule is designed to assure that member firms act in an independent capacity when publishing a quotation or making a market in an issuer's securities. FINRA's policy concerning payments for market making was originally set forth in Notice to Members 75-16 and later codified as NASD Rule 2460 (now FINRA Rule 5250) in 1997.20 Among other things, FINRA (then NASD) recognized that firms generally have considerable latitude and freedom to make or terminate market-making activities and was concerned that payments by an issuer to a market maker could influence a firm's decision to make a market. In particular, the existence of undisclosed, private arrangements between market makers and an issuer or its promoters may make it difficult for investors to ascertain the true market for the securities.21

      Questions

      1. The rule is not currently limited to equity securities. The rule may have limited applicability to government securities where the "issuer" of such securities is the U.S. government, such as in the case of U.S. Treasury securities. However, the rule may have applicability to other types of government securities, such as government-sponsored enterprise issues, or possibly in the context of payments by a "promoter," which is broadly defined to include, among others, employees, advisors and any other person with a similar interest in promoting the entry of quotations or market making in an issuer's securities. Are payments for market making a meaningful concern in the context of the government securities market?
      2. What are the potential costs and benefits of expressly extending the rule to government securities?

      FINRA Rule 5270 (Front Running of Block Transactions)

      General Prohibition

      FINRA Rule 5270 prohibits trading ahead of customer block transactions. Specifically, the rule prohibits trading, while in possession of material, non-public market information concerning an imminent customer block transaction, in the same security that is the subject of the block transaction as well as any "related financial instrument."22 The reverse is also true: When the imminent block transaction involves a related financial instrument, the rule prevents trading in the underlying security. The rule applies to trading ahead orders for: (1) any account in which a member firm or a person associated with a firm has an interest; (2) any account with respect to which the member firm or associated person exercises investment discretion; or (3) accounts of customers or affiliates of the firm when the customer or affiliate has been provided with the material, non-public market information concerning the imminent block transaction by the firm or associated person. FINRA Rule 5270 provides that the trading prohibitions in the rule apply until the time the information concerning the block transaction has been made publicly available or has otherwise become stale or obsolete.

      Although FINRA Rule 5270 applies to most debt securities, it does not currently apply to block transactions involving government securities, which include U.S. Treasury securities.23 However, in the rule filing to adopt FINRA Rule 5270, FINRA noted that it has long been FINRA's view that front running conduct of the type contemplated by FINRA Rule 5270 in a government security would be prohibited pursuant to FINRA Rule 2010 requiring that member firms observe high standards of commercial honor and just and equitable principles of trade.24 Thus, although general standards of just and equitable principles of trade prohibit firms from trading in front of a customer block order in government securities to benefit the firm, this type of trading activity is not currently subject to the more detailed and specific provisions in FINRA Rule 5270.

      Supplementary Material

      FINRA Rule 5270 includes five separate Supplementary Material provisions addressing different aspects of the rule.

      •   Knowledge of Block Transactions. Supplementary Material .01 provides that the prohibitions in the rule may include transactions that are executed based upon knowledge of less than all of the terms of the block transaction, so long as there is knowledge that all of the material terms of the transaction have been or will be agreed upon imminently.
      •   Publicly Available Information. Supplementary Material .02 provides guidance on when information is deemed to be "publicly available" for purposes of the rule and states that information will be considered "publicly available" when it is disseminated via a last sale reporting system or other similar system and only when the entire block transaction has been completed and publicly reported.
      •   Examples of Block Transactions. Supplementary Material .03 provides that, in the context of equity securities, a transaction involving 10,000 shares or more of a security or a related financial instrument overlying such number of shares is "generally deemed to be a block transaction." The Supplementary Material notes, however, that a transaction of fewer than 10,000 shares could be considered a block transaction.
      •   Permitted Transactions. Supplementary Material .04 lists several types of transactions that would generally not violate FINRA Rule 5270, including transactions that the firm can demonstrate are unrelated to the material, non-public market information received in connection with the customer order (such as where information barriers exist, transactions related to prior customer orders, and transactions to correct errors or offset odd-lot orders) and transactions undertaken for the purpose of fulfilling or facilitating the execution of the customer order.
      •   Front Running of Non-Block Transactions. Supplementary Material .05 notes that, although the prohibitions in FINRA Rule 5270 are limited to imminent block transactions, front running of other types of orders that place the financial interests of the member firm or associated person ahead of those of its customer, or the misuse of knowledge of an imminent customer order, may violate other FINRA rules, including FINRA Rules 2010 and 5320, or provisions of the federal securities laws.

      Questions

      1. The rule is not currently limited to equity securities. If the rule were extended to government securities, would any modifications to the rule be necessary, including to the restrictions on the trading of "related financial instruments," in light of the unique characteristics of the government securities market and the use of government securities as part of larger trading strategies? Are these concerns true across all types of government securities, or are they more significant for certain types of government securities (e.g., "on-the-run" U.S. Treasury securities)?
      2. If the rule were extended to government securities, should FINRA define, or provide guidance on, the types or sizes of transactions in government securities that could be considered "block transactions" for purposes of the rule? What is considered a typical block transaction in the government securities market? Is this the same across all government securities or is it different for different categories of government securities?
      3. Would extending the rule to government securities have an impact on firms' hedging activities or on transactions that are undertaken involving government securities to facilitate other transactions?
      4. What are the potential costs, including the costs associated with establishing policies and procedures regarding information barriers and modifying trading systems, and potential benefits of extending the rule to government securities? Are there operational and business challenges associated with such extension of the rule?
      5. Would extending the rule to government securities have an impact on member firms' ability to execute workup trades?25

      FINRA Rule 5320 (Prohibition Against Trading Ahead of Customer Orders)

      General Prohibition

      FINRA Rule 5320 generally addresses a firm's obligations with respect to handling customer orders in an equity security when also trading proprietarily in the same security. Specifically, the rule prohibits a member firm from trading for its own account in a security on the same side of the market at a price that would satisfy a customer order in the same security, 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.

      If a member firm trades proprietarily at a price and size that would satisfy a pending customer order in an equity security, a firm would not violate the rule if it "cures" the trading ahead by immediately executing the customer order up to the size and at the same or better price at which it traded for its own account. FINRA has also provided guidance on the timeframe required to meet the "immediately" aspect of the cure obligation (i.e., within one minute of the execution of the proprietary transaction).

      The rule also requires that a member firm have a written methodology in place governing the execution and priority of all pending orders that is consistent with the requirements of FINRA Rules 5310 (Best Execution and Interpositioning) and 5320, and a firm further must ensure that such methodology is consistently applied.

      Exceptions

      FINRA Rule 5320.01 (Large Orders and Institutional Account Exceptions) provides an exception for large-sized customer orders and customer orders from an institutional account, if the member firm has provided the customer clear and comprehensive disclosure at account opening and annually thereafter that it may trade proprietarily at prices that would satisfy the customer order and provides the customer a meaningful opportunity to opt in to the rule's protections. Under the exception, a "large order" in an equity security is an order of 10,000 shares or more (unless such orders are less than $100,000 in value).

      FINRA Rule 5320.02 (No-Knowledge Exception) generally provides firms with an exception for proprietary trading activity that occurs in a separate trading unit where the firm utilizes information barriers that prevent that trading unit from obtaining knowledge of customer orders held at another trading unit. For NMS stocks, all proprietary trading units may be walled off pursuant to the exception, whereas, for OTC equity securities, only non-market making desks may be walled off. Firms relying on the no-knowledge exception are required to comply with FINRA's Order Audit Trail System (OATS) reporting rules by providing a unique identifier on order information where information barriers are in place at departments within the firm where orders are received or originated.

      FINRA Rule 5320.03 (Riskless Principal Exception) generally provides that the prohibitions of the rule would not apply to a member firm's proprietary trade if such proprietary trade is for the purposes of facilitating the execution, on a riskless principal basis, of an order from a customer. Among other things, the exception is conditioned upon member firms submitting a contemporaneous regulatory report identifying the trade as "riskless principal." The firm also must have in place policies and procedures requiring, among other things, that the customer order was received prior to the offsetting principal transaction, that the offsetting principal transaction is at the same price as the customer order (exclusive of any markup or markdown, commission equivalent or other fee), and that the securities be allocated to a riskless principal or customer account in a consistent manner within 60 seconds of execution. Member firms also must have supervisory systems in place that produce records that enable the firm and FINRA to reconstruct accurately, readily, and in a time-sequenced manner all facilitated orders for which the firm relies on this exception.

      FINRA Rule 5320.04 (ISO Exception) provides firms with an exception under certain circumstances for proprietary trading resulting from an intermarket sweep order (ISO) routed in compliance with Rule 600(b)(30)(ii) of SEC Regulation NMS where the customer order is received after the firm routed the ISO. ISO orders are specific to trading in NMS stocks and are not applicable to trading in debt securities.

      FINRA Rule 5320.05 (Odd Lot and Bona Fide Error Transaction Exceptions) provides an exception for a firm's proprietary trade to (1) offset a customer order that is in an amount less than a normal unit of trading; or (2) correct a bona fide error.

      Other Provisions

      FINRA Rule 5320.06 (Minimum Price Improvement Standards) prescribes the minimum amount of price improvement necessary for a member firm to execute an order on a proprietary basis when holding an unexecuted limit order in that same security without violating the rule's requirements. This provision is intended to prevent firms from "pennying" their customer order by trading ahead at a price in a very small increment better than the customer order. It also relies on best bid and offer (BBO) quotation information for calculation of the minimum amount of price improvement required for lower priced securities.

      FINRA Rule 5320.07 (Order Handling Procedures) requires that: (1) a firm must make every effort to execute a marketable customer order that it receives fully and promptly; (2) a firm that is holding a marketable customer order that has not been immediately executed must make every effort to cross such order with any other order received at a price that is no less than the best bid and no greater than the best offer; and (3) in the event a firm is holding multiple orders on both sides of the market that have not been executed, the firm must make every effort to cross or otherwise execute such orders in a manner that is reasonable and consistent with the objectives of the rule and with the terms of the orders.

      Finally, FINRA Rule 5320.08 (Trading Outside Normal Market Hours) provides that member firms generally may limit the life of a customer order to the period of normal market hours of 9:30 a.m. to 4:00 p.m. ET; however, if the customer and firm agree to the processing of the customer's order outside normal market hours, the protections of the rule shall apply to that customer's order(s) at all times the customer order is executable by the firm.

      Questions

      1. The rule is currently limited to equity securities. Should FINRA consider extending the rule to debt securities, including government securities, corporates and other types of TRACE-eligible securities? Are the conflicts related to the prohibition against trading ahead of customer orders in equity securities similar to those for debt securities?
      2. If the rule were extended to debt securities, to what universe of debt securities should it apply—e.g., would "TRACE-Eligible Security," as defined in FINRA Rule 6710 (Definitions), be the appropriate universe?26
      3. The rule currently requires firms to have a written methodology governing the execution and priority of all pending orders in equity securities. Are there any concerns with applying this requirement to debt securities?
      4. If the rule were extended to debt securities, what timeframe should be considered "immediately" within which a member firm must execute a customer order in a debt security following a proprietary trade by the firm under paragraph (a) of FINRA Rule 5320 (for equities, "immediately" means within one minute of the execution of the proprietary transaction)? In addition, should the timeframe to be considered "immediately" differ depending upon the type of debt security at issue (e.g., a U.S. Treasury security versus a corporate bond, a securitized product or other type of debt security)?
      5. If the rule were extended to debt securities, is an exception for institutional accounts sufficient or should an exception for large orders also be adopted? If so, what is the appropriate minimum par value for an order in a debt security to be considered a "large order" and, therefore, not due protection under FINRA Rule 5320 (subject to the disclosure and opt-in conditions of the exception)? Should the "large order" threshold amount differ for different types of debt securities?
      6. If the rule were extended to debt securities, should the no-knowledge exception be available for any proprietary desk, whether market-making or non-market-making?27
      7. If the rule were extended to debt securities, is a riskless principal exception useful for member firms in the debt context? If the riskless principal exception were to apply to debt securities, use of the exception would be subject to the policy and procedures and supervisory systems conditions that exist for equity securities. However, instead of a 60-second allocation timeframe, is 15 minutes more appropriate for all types of debt securities? Are there any other distinctions that should be drawn in the operation of a riskless principal exception for different types of debt securities? Would a "riskless principal" capacity type in TRACE reporting be useful in connection with a riskless principal exception?
      8. FINRA notes that the concept of round and odd lots differ for debt and equities (e.g., in the debt market, trades in less than 100 bonds are common). If the rule were extended to debt securities, should the odd lot exception not apply to debt for this reason? The exception for bona fide errors could be applicable to debt securities. Is this distinction appropriate?
      9. If the rule were extended to debt securities, should any additional exceptions be made available for debt securities?
      10. If the rule were extended to debt securities, the order handling provisions of Supplementary Material .07 would, at a minimum, be modified such that the best bid and offer crossing requirement (i.e., that a member firm make every effort to cross a marketable customer order that has not been immediately executed with any other order received at a price that is no less than the best bid and no greater than the best offer) would not apply to debt securities because best bid and offer information is not widely available for debt securities. The full and prompt execution requirement and the requirement regarding multiple orders would apply. Is this approach to order handling appropriate for debt securities?
      11. If the rule were extended to debt securities, should the rule prescribe a minimum amount of price improvement necessary for a member firm's proprietary trade in a debt security not to be considered trading ahead of a customer limit order? Is this provision necessary to prevent firms from "pennying" their customer order by trading ahead at a price in a very small increment better than the customer order? Should a minimum price improvement amount be prescribed for certain types of debt securities but not others? If so, please explain. The current minimum price improvement provision calculation approach relies on best bid and offer quotation information for lower-priced securities. What would be an appropriate methodology for determining a minimum price improvement amount for debt securities, given that best bid and offer quotation information is not widely available? When placed, are limit orders used differently in the debt market or do they operate differently? Are priced orders used more for certain types of debt securities than others?
      12. Trading in debt securities does not observe the same normal market hours as equity securities. Moreover, uniform normal market hours do not exist for debt securities. For example, the Treasury market is a 24-hour market and platforms that trade debt securities may operate according to differing schedules. In addition, TRACE system hours generally run from 8:00 a.m. ET through 6:29:59 p.m. ET. Thus, if the rule were extended to debt securities, should the rule's protections apply to a customer order at all times the customer order is executable by the member firm?
      13. If the rule were extended to debt securities, are any other modifications to the rule necessary in light of the unique characteristics of debt securities, the market for debt securities, and the current regulatory framework for debt securities, which have not been addressed above? If so, please explain.
      14. Are there potential impacts on firms' ability to provide services to clients on an agency basis, or to engage in principal trading activity, in U.S. Treasury securities?
      15. What are the potential costs and benefits of extending the rule to debt securities? What are the potential direct and indirect impacts of extending the rule in such a manner? Would firms potentially adopt a different compliance regime and alter business practices because of such extension?
      16. What are the potential impacts on trading behavior and liquidity provision by member firms? How likely are clients to be impacted by any potential change in trading behavior?

      NASD Rule 1032(f) (Securities Trader)

      Currently, associated persons engaged in trading are subject to different representative-level qualification and registration requirements depending on whether the trading activity involves an equity or a debt security. Specifically, associated persons engaged in equity trading are subject to the qualification and registration requirements of NASD Rule 1032(f), whereas associated persons engaged in debt trading are subject to the qualification and registration requirements of NASD Rules 1032(a) (General Securities Representative), 1032(e) (Limited Representative—Corporate Securities) or 1032(g) (Limited Representative—Government Securities), as applicable.

      By way of background, in 1995, FINRA (then NASD) became concerned about the escalating number of rule violations by associated persons trading in the equity securities markets. Subsequently, in 1998, NASD adopted NASD Rule 1032(f) with the view that better training and qualification of individuals engaged in equity trading was necessary. Thus, the rule has historically applied to equity or equity-like securities, but not debt securities in general.

      Pursuant to NASD Rule 1032(f), each associated person of a member firm who is included within the definition of "representative" in NASD Rule 1031 (Registration Requirements) is required to register as a Securities Trader if, with respect to transactions in equity (including equity options), preferred or convertible debt securities28 effected otherwise than on a securities exchange, such person is engaged in proprietary trading, the execution of transactions on an agency basis or the direct supervision of such activities.29 The rule provides an exception from the registration requirement for any associated person whose trading activities are conducted principally on behalf of an investment company that is registered with the SEC pursuant to the Investment Company Act of 1940 and that controls, is controlled by, or is under common control with the member firm. Individuals registering as Securities Traders must pass the Securities Trader qualification examination (Series 57).

      Unlike associated persons engaged in equity trading, associated persons engaged in debt trading are not required to pass a specific qualification examination or to register as traders. Rather, associated persons who are included within the definition of "representative" in NASD Rule 1031 and who are trading government securities are required to register as General Securities Representatives or Government Securities Representatives and pass the General Securities Representative qualification examination (Series 7) or the Government Securities Representative qualification examination (Series 72), respectively.30 In addition, associated persons who meet the definition of "representative" and who are trading other types of debt, such as corporate debt, are required to register as General Securities Representatives or Corporate Securities Representatives and pass the Series 7 or the Corporate Securities Representative qualification examination (Series 62), respectively.31

      The principal-level qualification and registration requirements for associated persons supervising trading also vary depending on whether the trading activity involves an equity or a debt security. Paragraph (a)(6) of NASD Rule 1022 (Categories of Principal Registration) currently requires that each associated person who is included within the definition of "principal" in NASD Rule 1021 (Registration Requirements) with supervisory responsibility over the securities trading activities described in NASD Rule 1032(f) register as a Securities Trader Principal.32 To qualify for registration as a Securities Trader Principal, an individual must be registered as a Securities Trader and pass the General Securities Principal qualification examination (Series 24). However, associated persons functioning as principals responsible for supervising debt trading currently are required to register as General Securities Principals and pass the Series 24 examination,33 provided that if their activities are limited solely to the supervision of government securities trading, they may instead register as Government Securities Principals.34

      The debt market constitutes a significant portion of the overall securities market and includes numerous complex product types with unique attributes. Moreover, debt securities are subject to specific laws, rules and regulations, which may require specialized knowledge. For instance, member firms engaged in over-the-counter secondary market transactions in eligible fixed income securities are required to report such transactions to TRACE, which has distinct reporting requirements and conventions.

      Questions

      1. The rule does not currently apply to associated persons who are engaged in the trading of debt securities or their supervisors. Should FINRA extend the existing qualification and registration requirements for Securities Traders to associated persons who are engaged in the trading of debt securities, including the trading of government securities, or in the direct supervision of such activities? Alternatively, should FINRA adopt a separate qualification examination and registration category for associated persons engaged in debt trading and their direct supervisors?
      2. How likely are potential costs to be passed on to associated persons or clients? Are individuals likely to be discouraged from associating with a member firm in a capacity that requires registration? Would a potential increase in the compliance costs lead to any competitive disadvantages for member firms, as some non-FINRA debt dealers would not be subject to similar registration requirements?
      3. Is there a need for a more specialized qualification requirement, such as an expanded Series 57 or a new examination, for debt traders? Would the costs of such requirements be passed on to associated persons or customers? Would some individuals be discouraged from associating with a member firm in a capacity that requires registration based on such requirements? Are there increased compliance costs associated with such requirements and would such costs lead to competitive disadvantages for firms (to the extent that some non-FINRA debt dealers would not be subject to similar requirements)? What are the other costs of such requirements on firms' compliance and supervisory systems, including on supervisors and principals responsible for supervising debt trading? Should associated persons who are currently registered and engaged in debt trading be grandfathered or provided other relief, from any new requirements?

      NASD Rule 1032(i) (Limited Representative—Investment Banking)

      NASD Rule 1032(i) requires each person associated with a member firm who is engaged in specified investment banking activities to register as an Investment Banking Representative and to pass the Series 79 qualification examination. The requirement is triggered if the individual's activities involve:

      •   advising on or facilitating debt or equity securities offerings through a private placement or a public offering, including but not limited to origination, underwriting, marketing, structuring, syndication, and pricing of such securities and managing the allocation and stabilization activities of such offerings; or
      •   advising on or facilitating mergers and acquisitions, tender offers, financial restructurings, asset sales, divestitures or other corporate reorganizations or business combination transactions, including but not limited to rendering a fairness, solvency or similar opinion.

      The rule provides exceptions to the registration requirement for persons whose activities involve only retail or institutional sales and trading activities, advising on or facilitating placement of direct participation program securities (as those activities are defined in the registration requirements for Direct Participation Programs Representatives), or effecting private securities offerings (as those activities are defined in the registration requirements for Private Securities Offering Representatives). There is currently no exception for investment banking activities related to government securities.

      The purpose of this registration provision was to create a core competency examination requirement more specifically tailored to the activities of investment bankers than the more generalized Series 7 qualification examination previously required of most investment bankers. To that end, the triggers for this registration requirement encompass a broad range of investment banking activities, including advising on or facilitating all types of debt and equity offerings, other than the narrow exceptions noted above.35

      Questions

      1. The rule currently applies to debt securities offerings. What are the significant differences between investment banking activities in the government securities market and investment banking activities in the corporate debt space? Are there any specific rules and regulations relating to investment banking activities in the government securities market that would warrant excluding such activities from the scope of the rule?
      2. What are the potential costs and benefits of extending the rule to government securities? How likely are member firms going to be required to register additional associated persons?

      NASD Rule 1050 (Registration of Research Analysts)

      NASD Rule 1050 requires all persons associated with a member firm who are to function as research analysts to register with FINRA as such and pass the Series 86 (Analysis) and Series 87 (Regulatory Administration) qualification examinations.36 For the purposes of the rule, "research analyst" means an associated person whose primary job function is to provide investment research and who is primarily responsible for the preparation of the substance of a research report or whose name appears on a research report. Registration as a General Securities Representative is currently a prerequisite to taking the research analyst qualification examinations.

      The rule became effective in 2004, when only an equity research conflict of interest rule existed. In July 2016, FINRA Rule 2242, a dedicated debt research conflict of interest rule became effective. However, as FINRA noted in proposing FINRA Rule 2242 and in an FAQ after its approval,37 NASD Rule 1050 was not amended and applies only to equity research analysts. FINRA also noted that it was considering whether a similar requirement should apply to debt research analysts.38

      Questions

      1. The rule does not currently apply to debt research analysts or their supervisors. Should FINRA extend the existing qualification and registration requirements for equity research analysts to debt research analysts, including associated persons primarily responsible for the substance of research reports on government securities? Is the current content covered on the Series 86 appropriate for debt research analysts, or should the content be modified? Alternatively, should FINRA adopt a separate qualification examination and registration category for debt research analysts?
      2. Is there is a need for a qualification and registration requirement for debt research analysts? Would some individuals be discouraged from associating with a member firm in a capacity that requires registration based on such requirements? What is the impact of such requirements on firms' compliance and supervisory systems, including on supervisors and principals responsible for supervising debt research analysts? Are there any associated persons primarily responsible for the substance of debt research reports that should be exempted from such requirements based on their job function? Should associated persons who are currently registered and functioning as debt research analysts be grandfathered or provided other relief, from such requirements?

      Other Exempted Securities

      The rules listed in FINRA Rule 0150 are applicable to transactions in, and business activities relating to, other exempted securities39 (excluding municipal securities), depending on the context of a particular rule. For example, FINRA Rule 2320(g) (Member Compensation), which is listed in FINRA Rule 0150, is applicable to group variable contracts that are exempted securities, but not to government securities.

      Question

      1. As a general matter, are there any potential issues with applying the rules discussed in this Notice to other exempted securities (excluding municipal securities)?

      Potential Economic Impact of the Proposals

      The rules discussed above are intended to create benefits for member firms and the investing public. Specifically, these rules, among other things, mitigate the research-related conflicts of interest, prevent an unfair trading advantage for a firm or select customers based on knowledge of non-public research department information, maintain fair and orderly functioning of the markets, assure that member firms act in an independent capacity when publishing a quotation or making a market, and set the qualification and registration requirements for individuals engaged in trading or investment banking activities. However, FINRA also acknowledges that these rules may currently impose compliance costs on member firms, in the form of staffing costs, costs associated with establishing and implementing policies and procedures, fees associated with qualification examinations and registration as well as supervision and monitoring costs. In some instances, compliance with these rules may limit a member firm's ability to transact in a security at a given time and there may be an opportunity cost associated with the restrictions.

      The anticipated costs and benefits associated with expressly applying these rules to government securities and, in some cases, to debt securities more broadly, may be substantially the same or may differ in important ways from the securities already covered by the rules. FINRA invites comment generally and in connection with the questions above on any economic impacts that might be associated with the application of the rules discussed in this Notice to government securities, including U.S. Treasury securities, and other debt securities more broadly. FINRA understands that the application of these rules to government securities and other debt securities may potentially have both direct and indirect impacts on member firms, the government securities market, customers and the investing public. FINRA requests that commenters provide a discussion of the types (direct vs. indirect) and sources (e.g., compliance, staffing or technology) of potential costs and benefits wherever possible.

      Request for Comments

      FINRA seeks comments on the implications of expressly applying the rules discussed in this Notice to government securities, including U.S. Treasury securities, and, in some cases, to debt securities more broadly. In responding to the questions above or in providing general comments, FINRA requests that commenters provide empirical data or other factual support for their comments wherever possible.


      1. FINRA Rule 2242 currently applies to debt securities, including most government securities. However, the rule expressly excludes U.S. Treasury securities.

      2. The SEC approved a proposed rule change to adopt NASD Rules 1032(f), 1032(i) and 1050 as FINRA Rules 1220(b)(4) (Securities Trader), 1220(b)(5) (Investment Banking Representative) and 1220(b)(6) (Research Analyst), respectively, in the consolidated FINRA rulebook. The consolidated FINRA registration rules have been approved by the SEC and will become effective 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); Regulatory Notice 17-30 (October 2017) (SEC Approves Consolidated FINRA Registration Rules, Restructured Representative-Level Qualification Examinations and Changes to Continuing Education Requirements).

      3. 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.

      4. The term "exempted securities" is defined in Section 3(a)(12) of the Securities Exchange Act of 1934 (SEA or Exchange Act).

      5. Some of these rules have been expressly approved by the Securities and Exchange Commission (SEC). See, e.g., Securities Exchange Act Release No. 37588 (August 20,1996), 61 FR 44100 (August 27, 1996) (Order Approving File No. SR-NASD-95-39). Others were filed with the SEC for immediate effectiveness. See, e.g., Securities Exchange Act Release No. 61747 (March 19, 2010), 75 FR 15470 (March 29, 2010) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2010-010).

      6. The term "government securities" is defined in Section 3(a)(42) of the Exchange Act.

      7. The term "municipal securities" is defined in Section 3(a)(29) of the Exchange Act.

      8. See letter from Stephen Luparello, Director, Division of Trading and Markets, SEC, to Robert W. Cook, President and Chief Executive Officer, FINRA, dated August 19, 2016, available at https://www.sec.gov/divisions/marketreg/letter-to-finra-regulation-of-us-treasury-securities.pdf.

      9. See letter from Robert W. Cook, President and Chief Executive Officer, FINRA, to Stephen Luparello, Director, Division of Trading and Markets, SEC, dated October 17, 2016, available at https://www.sec.gov/divisions/marketreg/letter-from-finra-regulation-of-us-treasury-securities.pdf.

      10. FINRA is considering filing a proposed rule change with the SEC to codify these rules under FINRA Rule 0150(c).

      11. See Securities Exchange Act Release No. 73623 (November 18, 2014) 79 FR 69905, 69922 (November 24, 2014) (Notice of Filing of File No. SR-FINRA-2014-048).

      12. See id.

      13. See Securities Exchange Act Release No. 59254 (January 15, 2009) 74 FR 4271, 4272 (January 23, 2009) (Order Approving File No. SR-FINRA-2008-054) and Research Rules Frequently Asked Questions (FAQ), Applicability of Rule 5280 (Trading Ahead of Research Reports), 01, posted March 4, 2016, available at http://www.finra.org/industry/faq-research-rules-frequently-asked-questions-faq#5280.

      14. See Securities Exchange Act Release No. 59119 (February 2, 2009) 74 FR 6335 (February 6, 2009) (Order Approving File No. SR-FINRA-2008-061).

      15. See Securities Exchange Act Release No. 38845 (July 17,1997) 62 FR 39564 (July 23,1997) (Order Approving File No. SR-NASD-97-37).

      16. See Order Approving File No. SR-FINRA-2008-061, supra note 14.

      17. See id.

      18. In November 2017, FINRA published Regulatory Notice 17-41 announcing its retrospective rule review to assess the effectiveness and efficiency of FINRA Rule 5250 and soliciting comment on the rule. Upon completion of its assessment, FINRA staff will consider appropriate next steps, which may include some or all of the foilowing: modifications to the rule, updated or additional guidance, administrative changes ortechnology improvements, or additional research or information gathering.

      19. "Quotation" is defined under FINRA Rule 5250 as (1) any bid or offer at a specified price with respect to a security, (2) any indication of interest by a member firm in receiving bids or offers from others for a security, or (3) an indication by a firm that it wishes to advertise its general interest in buying or selling a particular security.

      20. See Notice to Members 75-16 (February 20,1975) and Securities Exchange Act Release No. 38812 (July 3, 1997), 62 FR 37105 (July 10, 1997) (Order Approving File No. SR-NASD-97-29).

      21. As stated in the SEC's approval order, "If payments... were permitted, investors would not be able to ascertain which quotations in the marketplace are based on actual interest and which quotations are supported by issuers or promoters. This structure would harm investor confidence in the overall integrity of the marketplace." Securities Exchange Act Release No. 38812, 62 FR at 37107.

      22. A "related financial instrument" is defined as an option, derivative, or other financial instrument that overlies a security that is the subject of an imminent block transaction if the value of the underlying security is materially related to, or otherwise acts as a substitute for, such security, as well as any contract that is the functional economic equivalent of a position in such security.

      23. See Regulatory Notice 12-52, n. 9 (December 2012).

      24. See Securities Exchange Act Release No. 67774 (September 4, 2012), 77 FR 55519, 55520 n.6 (September 10, 2012); see also Regulatory Notice 12-52, n. 9 and Notice to Members 96-66 (October 1996).

      25. In a "workup," the execution of a marketable order opens a short time window where participants can transact additional volume at the same price. For a detailed description of the workup process, please see http://libertystreeteconomics.newyorkfed.org/2015/08/the-evolution-of-workups-in-the-us-treasury-securities-market.html.

      26. FINRA would also clarify the meaning of "equity security" under the rule. Specifically, FINRA would replace the term "equity security" with the terms "NMS stock," as defined in Rule 600 of SEC Regulation NMS, and "OTC equity security," as defined in FINRA Rule 6420, which would make clear that the rule does not apply to options.

      27. The unique identifier requirement would not apply because debt securities would not be subject to the OATS reporting rules.

      28. FINRA included convertible debt securities under the rule because, under specific conditions, convertible debt securities trade similarly to equity securities.

      29. The rule also requires that associated persons primarily responsible for the design, development or significant modification of algorithmic trading strategies (or responsible for the day-to-day supervision or direction of such activities) register as Securities Traders.

      30. See NASD Rules 1032(a) and (g).

      31. See NASD Rules 1032(a) and (e).

      32. The corresponding consolidated registration rule is FINRA Rule 1220(a)(7) (Securities Trader Principal). See supra note 2.

      33. See NASD Rule 1022(a)(1).

      34. Individuals registering as Government Securities Principals are not subject to a principal qualification examination. However, they are required to satisfy the General Securities Representative or Government Securities Representative prerequisite registration. See NASD Rule 1022(h) (Limited Principal–Government Securities).

      35. In addition, NASD Rule 1022(a)(1)(B) currently requires that a General Securities Principal with responsibility over the investment banking activities specified in NASD Rule 1032(i) also satisfy the Investment Banking Representative registration requirement. The corresponding consolidated registration rule is FINRA Rule 1220(a)(5) (Investment Banking Principal). See supra note 2.

      36. Associated persons supervising the conduct of equity research analysts are also subject to specific principal-level qualification and registration requirements. Specifically, NASD Rule 1022(a)(5) requires persons who supervise the conduct of "research analysts" under NASD Rule 1050 to register as Research Principals. The corresponding consolidated registration rule is FINRA Rule 1220(a)(6) (Research Principal). See supra note 2. Currently, a Research Principal is required to be registered as a General Securities Principal and pass either the Series 87 or the Supervisory Analyst qualification examination (Series 16).

      37. See Securities Exchange Act Release No. 73623 (November 18, 2014) 79 FR 69905 (November 24, 2014) (Notice of Filing of File No. SR-FINRA-2014-048) and Research Rules Frequently Asked Questions (FAQ), Registration Requirements, 01, posted March 4, 2016, available at http://www.finra.org/industry/faq-research-rules-frequently-asked-questions-faq#registration.

      38. See Research Rules Frequently Asked Questions (FAQ), Registration Requirements, 01, posted March 4, 2016, available at http://www.finra.org/industry/faq-research-rules-frequently-asked-questions-faq#registration.

      39. Exempted securities, other than government securities, include, for example, interests or participations in specified qualified plans and insurance company contracts, interests or participations in specified church plans, pooled income funds, and various collective investment vehicles that are excluded from the definition of "investment company" under Section 3(c) of the Investment Company Act, and such other securities as determined by SEC rule.

    • 18-04 FINRA and ISG Announce Extension of Effective Date for Certain Electronic Blue Sheet Data Elements and Updates to Certain Requestor and Exchange Codes Effective Date: November 15, 2018; Updates to Requestor and Exchange Codes are Effective Immediately

      View PDF

      Electronic Blue Sheet Submissions

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 8211
      FINRA Rule 8213
      Notice to Members 05-58
      Notice to Members 06-33
      Regulatory Notice 11-56
      Regulatory Notice 12-36
      Regulatory Notice 12-47
      Regulatory Notice 13-16
      Regulatory Notice 13-38
      Regulatory Notice 15-44
      Regulatory Notice 16-24
      Regulatory Notice 17-05
      SEA Rule 13h-1
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Blue Sheets

      Summary

      FINRA and the other U.S. members of the Intermarket Surveillance Group1 (ISG members) have extended the effective date for compliance with certain data elements for Electronic Blue Sheets (EBS) identified in FINRA Regulatory Notice 15-44 to November 15, 2018. FINRA and the other ISG members are extending the effective date for these data elements to be consistent with the exemptive relief recently granted by the SEC, which extended the compliance date for certain broker-dealer recordkeeping and reporting requirements of SEA Rule 13h-1 (Large Trader Rule) from November 1, 2017, to November 15, 2018.

      FINRA and the other ISG members are also updating certain data elements for EBS in response to Cboe Options Regulatory Circular RG17-144, C2 Options Regulatory Circular RG17-058, CFE Regulatory Circular RG17-014, NYSE MKT Trade Update Dated July 21, 2017, Securities Exchange Act Release Nos. 80325 and 81917. The updates are effective immediately.

      Attachments A to this Notice set forth the EBS record layout and reflect the modifications noted below and changes from the version previously published in FINRA Regulatory Notice 17-05.

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

      Discussion

      FINRA and the other ISG members have extended the effective date for compliance with certain data elements to be consistent with the exemptive relief provided by the SEC, which recently extended the compliance date for certain broker-dealer recordkeeping and reporting requirements of the Large Trader Rule from November 1, 2017, to November 15, 2018.2 FINRA and the other ISG members are extending the effective date for compliance with certain data elements accordingly, to November 15, 2018.

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

      •   Phase One required clearing broker-dealers for large traders to keep records of and report, upon SEC request, specified data concerning (1) proprietary trades by large traders that are U.S.-registered broker-dealers; and (2) transactions effected by large traders through a sponsored access arrangement.3 Transaction data includes both the large trader identification number (LTID) and execution time. The compliance date for Phase One was November 30, 2012.
      •   Phase Two extended the recordkeeping and reporting requirements for clearing broker-dealers to transactions effected pursuant to a direct market access arrangement.4 As with Phase One, this requires clearing broker-dealers to report Transaction Data that includes both LTID and execution time. With respect to all other types of transactions, the prime broker or other carrying broker broker-dealer that carries an account for a Large Trader will have to report Transaction Data other than execution time, e.g., the applicable LTID. The compliance date for Phase Two was November 1, 2013.
      •   The remaining types of large traders and the transactions not covered by Phases One and Two are covered by Phase Three. Phase Three will therefore apply to all other broker-dealers subject to the recordkeeping and reporting requirements of the rule (i.e., broker-dealers that are large traders but do not self-clear, and broker-dealers effecting transactions directly or indirectly for a large trader where a non-broker-dealer carries the account for the large trader). Phase Three will require all remaining broker-dealers subject to the recordkeeping and reporting requirements of Rule 13h-1 to come into full compliance with those provisions. The compliance date for Phase Three was November 1, 2017,5 and as noted above, has been extended to November 15, 2018.

      Given the SEC's extension of the Phase Three reporting requirements and the corresponding extension of the EBS data elements, broker-dealers must be in EBS reporting compliance by November 15, 2018, for the Order Execution Time, Large Trader Identification Number 1-3 and Large Trader Identification Qualifier fields as outlined in Phase Three of the recordkeeping, reporting and monitoring requirements of SEA Rule 13h-1.

      The EBS fields that are subject to this extension are set forth below and are unchanged from Regulatory Notice 17-05. Attachment A contains additional detail on these fields.

      Order Execution Time, Record Sequence Number Five, Field Position 72 to 77
      Firms should use this record to submit the order execution time in 24-hour format and in Eastern Time formatted as HHMMSS. This information is not limited to the blue sheet transactions relating to the SEC Large Trader Reporting Rule (SEA Rule 13h-1). Please note that all firms must synchronize their time clocks to the atomic clock to maintain an accurate audit trail in connection to the reported execution time.
      Large Trader Identification Number 1, Record Sequence Number Seven, Field Position 2 to 14
      Firms should use this record to submit the Large Trader Identification Number. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.
      Large Trader Identification Number 2, Record Sequence Number Seven, Field Position 15 to 27
      Firms should use this record to submit the Large Trader Identification Number. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.
      Large Trader Identification Number 3, Record Sequence Number Seven, Field Position 28 to 40
      Firms should use this record to submit the Large Trader Identification Number. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.
      Large Trader Identification Qualifier, Record Sequence Number Seven, Field Position 41
      Firms should use this record to submit the Large Trader Identification Qualifier. If more than three LTIDs exist for a transaction, then firms should mark the field "Y" for Yes. Otherwise it should be marked "N" for No. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.
      FINRA and the other ISG members are also updating certain data elements for EBS in response to Cboe Options Regulatory Circular RG17-144, C2 Options Regulatory Circular RG17-058, CFE Regulatory Circular RG17-014, NYSE MKT Trade Update Dated July 21, 2017, Securities Exchange Act Release Nos. 80325 and 81917.6 The updates are effective immediately.

      Attachments A to this Notice set forth the EBS record layout and reflect the modifications noted below and changes from the version previously published in Regulatory Notice 17-05.

      FINRA and the other ISG members have updated the data elements for EBS noted below.

      The following Requestor Codes were updated and a modification was made to Attachment A of this Notice:

      •   NYSE American, LLC = 'B'
      •   The Nasdaq Stock Market, LLC = 'D'
      •   Nasdaq BX, Inc. = 'F'
      •   NYSE National, Inc. = 'G'
      •   Cboe BZX Exchange, Inc. = 'H'
      •   Nasdaq ISE, LLC, Nasdaq GEMX, LLC, Nasdaq MRX, LLC = 'I'
      •   Cboe EDGA Exchange, Inc. and Cboe EDGX Exchange, Inc. = 'J'
      •   Cboe Exchange, Inc. and Cboe C2 Exchange, Inc. = 'K'
      •   Cboe BYX Exchange, Inc. = 'Y'

      The following Exchange Codes were updated and a modification was made to Attachment A of this Notice:

      •   NYSE American, LLC = 'B'
      •   Nasdaq PHLX, LLC = 'D'
      •   Nasdaq BX, Inc. = 'F'
      •   NYSE National, Inc. = 'G'
      •   Cboe BZX Exchange, Inc. = 'H'
      •   Nasdaq ISE, LLC = 'I'
      •   Cboe C2 Exchange, Inc. = 'J'
      •   Cboe Exchange, Inc. = 'K'
      •   Cboe EDGA Exchange, Inc. = 'P'
      •   The Nasdaq Stock Market, LLC, The Nasdaq Options Market, LLC = 'R'
      •   Cboe EDGX Exchange, Inc. = 'V'
      •   For Future Use = 'W'
      •   Nasdaq PSX, LLC = 'X'
      •   Cboe BYX Exchange, Inc. = 'Y'
      •   Nasdaq GEMX, LLC = '1'
      •   Nasdaq MRX, LLC = '2'

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


      1. The U.S. members of the ISG include the following exchanges and self-regulatory organizations (SROs): Cboe BZX Exchange, Inc., Cboe BYX Exchange, Inc., Cboe Exchange, Inc., Cboe C2 Exchange, Inc., Chicago Stock Exchange, Inc., Cboe EDGA Exchange, Inc., Cboe EDGX Exchange, Inc., FINRA, Nasdaq ISE, LLC, The Nasdaq Stock Market, LLC, Nasdaq BX, Inc., Nasdaq PHLX LLC, Nasdaq PSX, LLC, NYSE National, Inc., New York Stock Exchange, LLC, NYSE American, LLC, NYSE Area, Inc., BOX Options Exchange, LLC, Miami International Securities Exchange, Nasdaq GEMX, LLC, Nasdaq MRX, LLC, Investors Exchange, LLC and MIAX PEARL.

      2. See Securities Exchange Act Release No. 81993 (October 31, 2017), 82 FR 51449 (November 6, 2017) ("Extension Order").

      3. The SEC defines a sponsored access arrangement as one where a broker-dealer permits a customer to enter orders into a trading center without using the broker-dealer's trading system (i.e., using the customer's own technology or that of a third party provider). See Extension Order.

      4. The SEC defines a direct market access arrangement as an arrangement whereby a broker-dealer permits customers to enter orders into a trading center but such orders flow through the broker-dealer's trading systems prior to reaching the trading center. See Extension Order.

      5. The SEC previously extended the compliance date for Phase Three from November 1, 2015, to November 1, 2017, and FINRA and the other ISG members granted a corresponding extension of certain EBS data elements. See Regulatory Notice 15-44 (November 2015).

      6. See Securities Exchange Act Release No. 80325 (March 29, 2017), 82 FR 16445 (April 4, 2017) (Notice of Filing and Immediate Effectiveness of File No. SR-ISE-2017-25) and Securities Exchange Act Release No. 81917 (October 23, 2017), 82 FR 49879 (October 27, 2017) (Notice of Filing and Immediate Effectiveness of File No. SR-NASDAQ-2017-111).


      Attachment A

      Record Layout for Submission of Trading Information

      Field Position Field Length Field Name/Description/Remarks Field Format Justify Picture Clause Default Value
      From To
      ***This record must be the first record of the file***
      1 3 3 FILLER A LJ X(3) HDR
      4 5 2 FILLER A LJ X(2) .S
      6 10 5 DTRK-SYSID N LJ 9(5) 12343
      11 12 2 FILLER A LJ X(2) .E
      13 14 2 FILLER N LJ 9(2) 00
      15 16 2 FILLER A LJ X(2) .C
      17 20 4 DTRK-ORIGINATOR
      Please contact SIAC for assignment at
      efp-support@nyse.com
      A LJ X(4) --
      21 22 2 FILLER A LJ X(2) .S
      23 26 4 DTRK-SUB-ORIGINATOR
      Please contact SIAC for assignment at
      efp-support@nyse.com
      A LJ X(4) --
      27 27 1 FILLER A LJ X(1) B
      28 33 6 DTRK-DATE
      Contains submission date.
      N LJ 9(6) MMDDYY
      34 34 1 FILLER A LJ X(1) B
      35 59 25 DTRK-DESCRIPTION
      Required to identify this file.
      A LJ X(25) FIRM TRADING INFORMATION
      60 80 21 FILLER A LJ X(21) B
      1 1 1 HEADER RECORD CODE Value: Low Values OR ZERO A -- X --
      2 5 4 SUBMITTING BROKER NUMBER
      If NSCC member use NSCC clearing number.
      If not a NSCC member, use clearing number assigned to you by your clearing agency.
      A-R LJ X(4) B
      6 40 35 FIRM'S REQUEST NUMBER Tracking number used by the firm to record requests from an organization. A -- X(35) B
      41 46 6 FILE CREATION DATE Format is YYMMDD A -- X(6) --
      47 54 8 FILE CREATION TIME
      Format is HH:MM:SS
      A -- X(8) --
      55 55 1 REQUESTOR CODE
      Requesting Organization Identification Values:
      A -- X --
        A = New York Stock Exchange  
      B = NYSE American, LLC
      C = Chicago Stock Exchange
      D = The Nasdaq Stock Market, LLC
      E = NYSE Arca
      F = Nasdaq BX, Inc.
      G = NYSE National, Inc.
      H = Cboe BZX Exchange, Inc. (Equity and Options)
      I = Nasdaq ISE, LLC, Nasdaq GEMX, LLC, Nasdaq MRX, LLC
      J = Cboe EDGA Exchange, Inc. and Cboe EDGX Exchange, Inc. (Equity and Options)
      K = Cboe Exchange, Inc. and Cboe C2 Exchange, Inc.
      R = FINRA
      U = BOX Options Exchange, LLC
      X = U.S. Securities and Exchange Commission
      Y = Cboe BYX Exchange, Inc.
      3 = Investors Exchange, LLC
      7 = Miami International Securities Exchange
      8 = MIAX PEARL
      56 70 15 REQUESTING ORGANIZATION NUMBER
      Number assigned by requesting organization
      A LJ X(15) B
      71 80 10 FILLER A -- X(10) B
      1 1 1 RECORD SEQUENCE NUMBER ONE The first record of the transaction. Value: 1 A -- X --
      2 5 4 SUBMITTING BROKER NUMBER Identical to Submitting Broker A-R LJ X(4) --
      6 9 4 OPPOSING BROKER NUMBER The NSCC clearing house number of the broker on the other side of the trade. A-R LJ X(4) B
      10 21 12 CUSIP NUMBER
      The cusip number assigned to the security.
      Left justified since the number is nine characters at present (8+ check
      A LJ X(12) B
      22 29 8 TICKER SYMBOL The symbol assigned to this security. For options (pre-OSI), the OPRA option symbol (space), OPRA expiration month symbol and OPRA strike price symbol should be used. (Ex. Maytag May 20 call option series would be reported as MYG ED. This example uses six spaces in the field with a space between the OPRA symbol and the OPRA expiration month.)
      Post OSI this field must contain OPTIONXX and a Record Sequence Number Six must be completed
      A-R LJ X(8) B
      30 35 6 TRADE DATE
      The date this trade executed.
      Format is YYMMDD.
      A-R -- X(6) B
      36 41 6 SETTLEMENT DATE
      The date this trade will settle.
      Format is YYMMDD
      A -- X(6) B
      42 53 12 QUANTITY
      The number of shares or quantity o bonds or option contracts.
      N-R RJ 9(12) Z
      54 67 14 NET AMOUNT
      The proceeds of sales or cost of purchases after commissions and other charges.
      N RJ S9(12) V99 Z
      68 68 1 BUY/SELL CODE
      Values: 0 = Buy, 1 = Sale, 2 = Short Sale, 3 = Buy Open, 4 = Sell Open, 5 = Sell Close, 6 = Buy Close. A = Buy Cancel, B = Sell Cancel, C = Short Sale Cancel, D = Buy Open Cancel, E = Sell Open Cancel, F = Sell Close Cancel, G = Buy Close Cancel. Value 3 to 6 and D to G are for options
      A-R -- X B
      69 78 10 PRICE
      The transaction price. Format: $$$$
      CCCCCC.
      N-R RJ 9(4) V(6) Z
      79 79 1 EXCHANGE CODE Exchange where trade was executed. Values: A-R -- X B
            A = New York Stock Exchange        
            B = NYSE American, LLC        
            C = Chicago Stock Exchange        
            D = Nasdaq PHLX, LLC        
            E = NYSE Arca        
            F = Nasdaq BX, Inc.        
        G = NYSE National, Inc.  
      H = Cboe BZX Exchange, Inc. (Equity and Options)
      I = Nasdaq ISE, LLC (Options Only)
      J = Cboe C2 Exchange, Inc.
      K = Cboe Exchange, Inc.
      L = London Stock Exchange
      M =Toronto Stock Exchange
      N = Montreal Stock Exchange
      O =TSX Venture Exchange
      P = Cboe EDGA Exchange, Inc.
      Q=FINRA ADF
      R = The Nasdaq Stock Market, LLC, The Nasdaq Options Market, LLC
      S = Over-the-Counter
      T = Tokyo Stock Exchange
      U = BOX Options Exchange, LLC
      V = Cboe EDGX Exchange, Inc. (Equity and Options)
      W = For Future Use
      X = Nasdaq PSX, LLC
      Y = Cboe BYX Exchange, Inc.
      Z = Other
      1 = Nasdaq GEMX, LLC
      2 = Nasdaq MRX, LLC
      3 = Investors' Exchange, LLC
      7 = Miami International Securities Exchange
      8 = MIAX PEARL
      80 80 1 BROKER/DEALER CODE
      Indicate if trade was done for another Broker/Dealer.
      Values: 0 = No; 1 = Yes
      A-R -- X B
      1 1 1 RECORD SEQUENCE NUMBER TWO Value: 2 A -- X --
      2 2 1 SOLICITED CODE Values: 0 = No; 1 = Yes A-R -- X B
      3 4 2 STATE CODE
      Standard Postal two character identification.
      A-R -- X(2) B
      5 14 10 ZIP CODE/COUNTRY CODE
      Zip Code—five or nine character (zip plus four)
      Country code—for future use.
      A-R LJ X(10) B
      15 22 8 BRANCH OFFICE/REGISTERED
      REPRESENTATIVE NUMBER
      Each treated as a four-character field.
      Both are left justified.
      A-R LJ X(8) B
      23 28 6 DATE ACCOUNT OPENED Format is YYMMDD A-R -- X(6) B
      29 48 20 SHORT NAME FIELD Contains last name followed by comma (or space) then as much of first name as will fit. A LJ X(20) B
      49 78 30 EMPLOYER NAME A LJ X(30) B
      79 79 1 TIN 1 INDICATOR Values: 1 = SS#; 2 = TIN A-R -- X B
      80 80 1 TIN 2 INDICATOR
      Values: 1 = SS#; 2 = TIN—for future use.
      A -- X B
      1 1 1 RECORD SEQUENCE NUMBER THREE Value: 3 A -- X --
      2 10 9 TIN ONE
      Taxpayer Identification Number
      Social Security or Tax ID Number.
      A-R LJ X(9) B
      11 19 9 TIN TWO
      Taxpayer Identification Number #2
      Reserved for future use.
      A LJ X(9) B
      20 20 1 NUMBER OF N&A LINES A -- X B
      21 50 30 NAME AND ADDRESS LINE ONE A-R LJ X(30) B
      51 80 30 NAME AND ADDRESS LINE TWO A-R LJ X(30) B
      1 1 1 RECORD SEQUENCE NUMBER FOUR Value: 4 A -- X --
      2 31 30 NAME AND ADDRESS LINE THREE A-R LJ X(30) B
      32 61 30 NAME AND ADDRESS LINE FOUR A-R LJ X(30) B
      62 62 1 TRANSACTION TYPE IDENTIFIERS
      See Attachment B for current codes.
      A-R -- X B
      63 80 18 ACCOUNT NUMBER Account number A-R LJ X(18) B
      1 1 1 RECORD SEQUENCE NUMBER FIVE
      Value: 5
      A -- X(1) --
      2 31 30 NAME AND ADDRESS LINE FIVE A-R LJ X(30) B
      32 61 30 NAME AND ADDRESS LINE SIX A-R LJ X(30) B
      62 65 4 PRIME BROKER
      Clearing number of the account's prime broker.
      A-R LJ X(4) B
      66 66 1 AVERAGE PRICE ACCOUNT
      1= recipient of average price transaction.
      2= average price account itself.
      N-R -- 9(1) Z
      67 71 5 DEPOSITORY INSTITUTION
      IDENTIFIER
      Identifying number assigned to the account by the depository institution.
      A-R LJ X(5) B
      72 77 6 Order Execution Time
      HHMMSS—Time format will be in Eastern Time and 24 hour format.
      A-R LJ -- --
      78 80 3 FILLER A -- X B
      1 1 1 RECORD SEQUENCE NUMBER SIX Value: 6 A -- --  
      2 9 8 DERIVATIVE SYMBOL
      The symbol assigned to the derivative
      A-R LJ -- B
      10 15 6 EXPIRATION DATE
      The date the option expires. Format is YYMMDD
      A-R -- -- B
      16 16 1 CALL/PUT INDICATOR C = Call, P = Put A-R -- -- B
      17 24 8 STRIKE DOLLAR
      The dollar amount of the strike price
      N-R RJ -- Z
      25 30 6 STRIKE DECIMAL
      The decimal amount of the strike price
      N-R LJ -- Z
      31 80 50 FILLER A LJ -- B
      1 1 1 RECORD SEQUENCE NUMBER SEVEN Value: 7 A -- --  
      2 14 13 Large Trader Identification 1 A-R LJ -- Z
      15 27 13 Large Trader Identification 2 A-R LJ -- Z
      28 40 13 Large Trader Identification 3 A-R LJ -- Z
      41 41 1 Large Trader Identification Qualifier A-R LJ -- Z
      42 49 8 Primary Party Identifier
      Identity of the party to the trade that is represented by the Submitting Broker of an EBS. Acceptable values include MPID, CRD or OCC Clearing Number.
      A-R LJ -- B
      50 57 8 Contra Party Identifier
      Identity of the contra party to the trade that is represented by the Opposing Broker of an EBS. Acceptable values include MPID, CRD or OCC Clearing Number.
      A-R LJ -- B
      58 80 23 FILLER A LJ -- B
      1 1 1 TRAILER RECORD DATE One record per submission. Must be the last record on the file. Value: High Values or "9" A -- X --
      2 17 16 TOTAL TRANSACTIONS The total number of transactions. This total excludes Header and Trailer Records. N RJ 9(16) B
      18 33 16 TOTAL RECORDS ON FILE The total number of 80 byte records. This total includes Header and Trailer Records, but not the Datatrak Header Record (i.e., it does not include the first record on the file). N RJ 9(16) Z
      34 80 47 FILLER A -- X(47) B

      Field Format

      A = Alphanumeric (all caps)

      N = Numeric

      P = Packed

      B = Binary

      R = Validation Required

      Default Values

      B = Blanks

      Z= Zero

      Justify

      RJ = Right Justification of Data

      LJ = Left Justification of Data


      Attachment B

      Record Layout for Submission of Trading Information

      Transaction Type Security Type
      Equity* Options
      Agency A C
      Proprietary P F
      Market-Maker   M
      Non-Member Market-Maker/Specialist Account   N
      Customer Range Account of a Broker/Dealer   B
      Error Trade Q  
      Professional Customer   W
      Joint Back Office   J
      Riskless Principal R  

      * Equity securities include those securities that trade like equities (e.g., ETFs and structured products).
      © 2018 FINRA. All rights reserved.

    • 18-03 FINRA Announces Updates of the Interpretations of Financial and Operational Rules

      View PDF

      SEC Financial Responsibility Rules

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Regulatory Notice 08-56
      Regulatory Notice 13-44
      Regulatory Notice 14-06
      Regulatory Notice 14-12
      Regulatory Notice 14-25
      Regulatory Notice 14-38
      Regulatory Notice 15-25
      SEA Rule 15c3-1
      SEA Rule 15c3-3
      SEA Rule 15c6-1
      Suggested Routing

      Compliance
      Finance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      Customer Protection
      Net Capital

      Executive Summary

      FINRA is making available updates to interpretations in the Interpretations of Financial and Operational Rules that have been communicated to FINRA by the staff of the SEC's Division of Trading and Markets (SEC staff). The updated interpretations relate to amendments that the SEC adopted to Securities Exchange Act (SEA) Rule 15c6-1 in connection with the standard settlement cycle.1

      Questions concerning this Notice should be directed to:

      •   Yui Chan, Managing Director, Risk Oversight & Operational Regulation (ROOR), at (646) 315-8426 or Yui.Chan@finra.org; or
      •   Adam Rodriguez, Director, Credit Regulation, ROOR, at (646) 315-8572 or Adam.Rodriguez@finra.org.

      Background & Discussion

      On March 22, 2017, the SEC adopted amendments to SEA Rule 15c6-1 in connection with the standard settlement cycle.2 FINRA is updating interpretations in the Interpretations of Financial and Operational Rules that relate to the amendments, as set forth below. Page references are to the hardcopy version. These interpretations are being updated with specific revisions.

      The following interpretations have been revised:

      •   SEA Rule 15c3-1(c)(2)(iv)(E)/11 (Foreign Issued, Foreign Settled Securities—Haircut Alternative to Buy-In for Aged Items) on page 328;
      •   SEA Rule 15c3-3(d)(1)/01 (Margin Section) on pages 2301-2302;
      •   SEA Rule 15c3-3(n)/04 (Date Extensions Due) on page 2562; and
      •   SEA Rule 15c3-3(n)/13 (Reason for Extension Under Paragraph (m)) on pages 2567-2568.

      These interpretation updates are available in portable digital format (pdf) on FINRA's Interpretations of Financial and Operational Rules [http://www.finra.org/industry/interpretationsfor] page.

      Further, SEC staff continues to communicate and issue written and oral interpretations of the financial responsibility and reporting rules. FINRA has previously updated the Interpretations of Financial and Operational Rules on its website in Regulatory Notices 08-56, 13-44, 14-06, 14-12, 14-25, 14-38 and 15-25.

      FINRA member firms and others that maintain the hardcopy version of the Interpretations of Financial and Operational Rules may refer to the accompanying updated pages [http://www.finra.org/sites/default/files/Regulatory-Notice-18-03-Attachment.pdf], containing the aforementioned interpretation updates, which are being made available to enable the replacement of existing pages in the hardcopy version of the Interpretations of Financial and Operational Rules. The filing instructions for the new pages are as follows:

      SEA Rule Remove Old Pages Add New Pages
      15c3-1 328 328
      15c3-3 2301-2302 2301-2302
      15c3-3 2562 2562
      15c3-3 2567-2568 2567-2568

      1. See Securities Exchange Act Release No. 80295 (March 22, 2017), 82 FR 15564 (March 29, 2017) (Securities Transaction Settlement Cycle) (shortening the standard settlement cycle for most broker-dealer transactions from three business days after the trade date ("T+3") to two business days after the trade date ("T+2")). The SEC set September 5, 2017, as the compliance date for the amendments.

      2. See note 1.

    • 18-02 FINRA Requests Comment on Proposed Amendments to FINRA Rule 4521 and New Supplemental Liquidity Schedule; Comment Period Expires: March 8, 2018

      View PDF

      Liquidity Reporting and Notification

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 4521
      FINRA Rule 4524
      FINRA Rule 6710
      Notice to Members 99-92
      Regulatory Notice 10-57
      Regulatory Notice 15-33
      SEA Rule 15c3-3
      SEA Rule 17a-5
      Suggested Routing

      Compliance
      Legal
      Operations
      Regulatory Reporting
      Risk Management
      Senior Management
      Key Topics

      FOCUS Reports
      Liquidity Reporting and Notification
      Supplemental Liquidity Schedule

      Comment Period Expires: March 8, 2018

      Summary

      FINRA is seeking comment on proposed amendments to FINRA Rule 4521 (Notifications, Questionnaires and Reports) that would require specified member firms to notify FINRA no more than 48 hours after specified events that may signal an adverse change in liquidity risk. FINRA also seeks comment on a proposed new Supplemental Liquidity Schedule (SLS) that member firms with the largest customer and counterparty exposures would file as a supplement to the FOCUS Report. On the new SLS, these firms would report information related to specified financing transactions and other sources or uses of liquidity. The information would include among other things financing term, collateral types and large counterparties.

      FINRA is seeking comment on all aspects of the proposed amendments to Rule 4521 and the proposed new SLS (together, referred to as the "proposal"), including the impact of the proposal on market participants. The proposed amendments to Rule 4521 are available as Attachment A. The proposed SLS and instructions to the SLS are available as Attachments B and C, respectively.

      Questions regarding this Notice should be directed to:

      •   Kris Dailey, Vice President, Risk Oversight & Operational Regulation, at (646) 315-8434;
      •   Kathryn E. Mahoney, Director, Financial Operations Policy Group, at (646) 315-8428; or
      •   Adam H. Arkel, Associate General Counsel, Office of General Counsel, at (202) 728-6961.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by March 8, 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, a proposed rule change must be authorized for filing with the SEC by the FINRA Board of Governors, and then must be filed with the SEC pursuant to SEA Section 19(b).2

      Background & Discussion

      Effective monitoring of liquidity and funding risks is an essential element of firms' financial responsibility and an ongoing focus for FINRA's financial supervision programs. To that end, FINRA is issuing this Notice to seek comment on proposed amendments to FINRA Rule 4521 (Notifications, Questionnaires and Reports) and on a new Supplemental Liquidity Schedule (SLS) that specified member firms would file as a supplement to the FOCUS Report. The proposed rule amendments and the new SLS, in combination, are tailored requirements that will improve FINRA's ability to monitor for events that signal an adverse change in the liquidity risk of the firms that would be subject to the new requirements.

      Firms' liquidity and funding stress was a significant factor in the financial crisis of 2008.3 Since that time, FINRA has looked closely at firms' liquidity and funding risk management practices.4 Regulatory Notice 10-57 expressed FINRA's expectation that firms develop and maintain robust funding and liquidity risk management practices and discussed examinations that FINRA had conducted of the practices of selected firms. Regulatory Notice 15-33 provided guidance on liquidity risk management practices and described FINRA's review of policies and practices at selected firms related to managing liquidity needs in a stressed environment. FINRA believes that the proposed requirements are a logical complement to ongoing priorities and guidance that FINRA has communicated to firms.

      In developing the proposal, FINRA has engaged in discussions with industry participants and has tailored the proposal to firms with the largest customer and counterparty exposures. As discussed further below, FINRA is seeking comment on all aspects of the proposal, including the proposal's impact on market participants.

      Following is a summary of the key aspects of the proposal.

      New SLS

      The new, proposed SLS is tailored to larger firms and is intended to provide more detailed information about such firms' liquidity profile than is reflected on the FOCUS Report (Part II, Part IIA or Part II CSE, as appropriate). Under the proposal, unless otherwise permitted by FINRA in writing, the SLS is required to be filed by each carrying or clearing FINRA firm with $25 million or more in total credits, as determined pursuant to the customer reserve formula computation as set forth in SEA Rule 15c3-3 Exhibit A, and by each FINRA firm whose aggregate amount outstanding under repurchase agreements, securities loan contracts and bank loans is equal to or greater than $1 billion, as reported on the most recently filed FOCUS Report.5

      These firms would report information related to specified financing transactions and other sources or uses of liquidity.

      Specifically, they would provide detailed reporting as to their reverse repurchase and repurchase agreements, securities borrowed and securities loaned, bank loans and other credit facilities, total available collateral, margin loans, collateral securing margin loans, deposits at clearing organizations, and cash and securities received and delivered on derivative transactions not cleared through a central clearing counterparty. The required information will enable FINRA to more effectively assess these firms' ability to continue to fund their operations and to meet their settlement, customer and counterparty obligations, thereby enabling FINRA to more effectively evaluate these firms' liquidity and funding profiles and to identify higher risk firms. In particular, the information would facilitate FINRA's efforts to distinguish among firms that may have similar balance sheets but very different liquidity risk profiles that could impact their ability to fund their operations during stress scenarios.6

      Amendments to FINRA Rule 4521

      The SEC approved Rule 4521 as part of FINRA's new, consolidated financial responsibility rules in 2009.7 The rule provides FINRA authority to request information from firms to carry out its surveillance and examination responsibilities. Paragraph (c) of the rule currently requires each carrying or clearing firm to notify FINRA in writing, no more than 48 hours after its tentative net capital as computed pursuant to SEA Rule 15c3-1 has declined 20 percent or more from the amount reported in its most recent FOCUS Report or, if later, the most recent such notification filed with FINRA.

      Under the proposal, additional notification requirements would be applied to the same firms that would be subject to the SLS (that is, unless otherwise permitted by FINRA in writing, each carrying or clearing firm with $25 million or more in total credits, as determined pursuant to the customer reserve formula computation as set forth in SEA Rule 15c3-3 Exhibit A, and each firm whose aggregate amount outstanding under repurchase agreements, securities loan contracts and bank loans is equal to or greater than $1 billion, as reported on the most recently filed FOCUS Report).8 Specifically, the specified firms would be required to notify FINRA in writing, no more than 48 hours after:

      •   the firm becomes aware of a loss of access to secured funding through repurchase agreements, and where such loss, excluding funding collateralized by U.S. Treasury Securities,9 or funding collateralized by securities issued by a U.S. Government Agency10 or Government-Sponsored Enterprise (GSE),11 in the aggregate, across all counterparties, represents 20 percent or more of the highest amount borrowed through such contracts within a 35 rolling calendar day period;
      •   the firm becomes aware of a loss of access to secured funding through securities loans, and where such loss, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or GSE, in the aggregate, across all counterparties, represents 20 percent or more of the highest amount borrowed through such contracts within a 35 rolling calendar day period;
      •   any one of the firm's five largest repurchase agreement counterparties or any one of the firm's five largest securities loan counterparties increases collateral haircuts on the counterparty's repurchase agreements or securities loan contracts with the firm, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or GSE, by 20 percent or more within a 35 rolling calendar day period;
      •   any one of the firm's five largest repurchase agreement counterparties, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or GSE, initiates termination of outstanding repurchase contracts prior to maturity, initiates the option not to renew or rollover the contract, or reduces access to undrawn or unused financing through repurchase contracts by 20 percent or more from the highest amount borrowed through such counterparty within a 35 rolling calendar day period;
      •   any one of the firm's five largest securities loan counterparties, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or GSE, initiates termination of securities loaned contracts prior to maturity, or reduces access to financing through securities loans by 20 percent or more of the highest amount borrowed through such counterparty within a 35 rolling calendar day period;
      •   the firm becomes aware of a reduction in or termination of committed or uncommitted lines of credit from banks, whether secured or unsecured, by 20 percent or more within a 35 rolling calendar day period;
      •   the firm triggers a material adverse change clause in any contract containing such clause, including events of acceleration or default, provided that the notification required pursuant to the rule shall be required within 48 hours after the expiration of any applicable cure period without remedy; or
      •   (only for firms that, pursuant to Rule 4210(g), have received approval from FINRA, or the firm's DEA if other than FINRA, to establish a portfolio margin methodology for eligible participants) the total change in the firm's customer margin balances, or decrease in the firm's free credit balances, in the gross aggregate, is greater than or equal to five percent or $5 billion in one business day, whichever is lower. For purposes of this requirement, the daily customer margin balances and free credit balances would be as determined pursuant to current paragraphs (d)(3)(A) and (d)(3)(B) of the rule.12

      These notification requirements should enable FINRA to be promptly alerted by a firm whose ability to fund its operations has been reduced significantly within a short period of time. FINRA believes that the notifications are consistent with the types of events or conditions that many firms currently monitor for as part of prudent funding and liquidity risk management programs. Further, the notifications dovetail with the reporting that the specified firms would provide pursuant to the proposed SLS, as discussed above.

      Impact on Market Participants and Request for Comment on the Proposal

      The purpose of the proposed SLS is to provide FINRA with more detailed information about the specified firms' liquidity profiles than what is reflected on the current FOCUS Reports. This will enable FINRA to more effectively assess firms' ability to meet their settlement, customer and counterparty obligations and to differentiate between high and low risk firms by analyzing firm-specific risk factors. The primary anticipated net benefit would be that FINRA is provided a more granular level of detail on firms' funding sources such as term or maturity information, collateral quality, haircuts and use of secured versus unsecured financing, so that FINRA can assess whether firms possess adequate liquidity pools to fund their daily operations without relying on relatively less stable sources such as short-term unsecured loans or borrowing against customer collateral.

      A potential significant benefit of this proposal may also arise from the information that can be generated on the interconnectedness of firms through significant counterparty exposure, which is a key component in FINRA's efforts to effectively monitor liquidity and funding risks as a part of its regulatory programs.

      FINRA estimates that, based on the quarterly FOCUS data from 2016, approximately 110 firms, of which approximately half are part of a bank holding company, would be required to file the SLS under the proposal, though the actual number may fluctuate from month to month as a firm will not be required to file the SLS for any month where the firm does not meet the specified thresholds. Based on discussions with a select number of firms, FINRA does not expect the filing of the SLS to create significant direct compliance costs for these firms, as the information required to complete the SLS should be readily available to the firms. However, firms may potentially incur costs associated with processing data to compute certain items on the SLS.

      Similarly, the new notification requirements in the proposed amendments to FINRA Rule 4521 are expected to cause minimal direct burdens on firms that are subject to the SLS, as FINRA believes that firms already monitor events that trigger notification to FINRA as a part of funding and liquidity risk management programs. Some level of one-time direct costs may be incurred by firms that establish automated monitoring tools to comply with the rule. However, to the extent that firms and liquidity providers alter their demand and supply for funding as a result of the proposal, there might be an indirect impact on competition in the funding markets. Firms may choose to diversify their counterparties to mitigate counterparty risk and to report less concentration of counterparties in the SLS. As a result, current counterparties would have to search for other firms that demand funding. Similarly, liquidity providers may potentially shift their client base from specified FINRA firms, to non-specified FINRA firms or to non-firms, to avoid being reported as a counterparty on the SLS. Such change in behavior is expected to be more likely for firms and liquidity providers that are at the margin with respect to the reporting thresholds. These effects may lead to greater search costs or funding costs for some impacted firms.

      As discussed above, FINRA is seeking comment on all aspects of the proposed new SLS and the proposed notification amendments to Rule 4521, including the impact of the proposal on market participants.

      Request for Comment with Regard to the Proposed SLS

      •   Do the items on the proposed SLS sufficiently capture the material secured and unsecured exposures of firms that would be subject to reporting?
      •   Are the proposed thresholds for firms that would be required to report under the proposed SLS appropriate? Are there alternative thresholds that would be more effective in capturing the liquidity risk profiles of firms?
      •   Are the proposed thresholds for the activities that would be required to be reported under the proposed SLS appropriate? What other, if any, information should FINRA consider capturing in order to meet its goals? Should FINRA consider any changes to the proposed items to increase the efficiency or reduce the costs of compliance while maintaining FINRA's ability to meet its goals?
      •   Is the proposed SLS expected to create significant compliance costs, including data collection and processing costs, for the impacted firms? If so, please provide information about these costs, including their potential magnitude, cost drivers that might differ among firms based on their business or business model, and ways that FINRA could mitigate these costs through the design of the collection or reporting mechanism.
      •   Are there additional costs for firms that are part of a bank holding company, stemming from potential discrepancies between the computation and reporting of items on the proposed SLS and other regulatory forms?
      •   To what extent do firms report substantially the same information to other regulators today? Do the proposed SLS items overlap with or differ from items that are reported to other regulators? Should any changes be made to the proposed SLS? If so, why?
      •   What are the potential impacts of the proposed SLS on counterparties? Are some counterparties more likely to be impacted by the proposed requirements than others?
      •   The proposed SLS will require firms to report the gross contract value of all reverse repurchase and repurchase agreements by collateral type, including all intercompany and third party agreements. Should FINRA exclude from the SLS reverse repurchase contracts where the collateral is used to satisfy the SEA Rule 15c3-3 reserve deposit?
      •   Are there any other economic impacts or competitive effects of the proposed SLS?

      Request for Comment with Regard to the Proposed Amendments to FINRA Rule 4521

      •   Under the proposed amendments to Rule 4521, is the specified 35 rolling calendar day timeframe appropriate? Would use of a fixed time period, such as the most recent month-end date or most recently filed report, be more operationally feasible or more cost effective to implement than use of the highest open amount in a rolling period? If yes, would use of a fixed date cause the rule to be less effective?
      •   Should the proposed notification requirement with respect to margin and free credit balances exclude changes resulting from the firm sweeping customer funds to a bank or money market sweep? Should there be other exclusions?
      •   The proposed amendments to Rule 4521 include specified notification requirements with respect to any of the firm's five largest repurchase agreement counterparties or five largest securities loan counterparties. Are the specified requirements appropriate? Why? If not, why not?
      •   The proposed amendments include specified reporting requirements when a firm triggers a material adverse change clause. Are the specified requirements appropriate? Should there be any exclusions from the requirement? Why? If not, why not?

      Additional Request for Comment with Regard to the Impact of the Proposal

      •   Has FINRA identified the appropriate events to trigger notification of a material change in liquidity and funding risk? Are there other events that FINRA should consider?
      •   Instead of listing specific events that trigger notification, should FINRA use different notification triggers? If yes, what should the different triggers be? What are the benefits and drawbacks of such different triggers?
      •   Are the proposed thresholds that would trigger notification to FINRA relevant and do they appropriately address material changes in liquidity and funding risks? Are there alternative thresholds that FINRA should consider?
      •   Do the proposed notifications with respect to secured and unsecured funding sources appropriately address the sources of funding risk? Are there other unsecured financing sources and collateral types that FINRA should consider for notification events?
      •   Do impacted firms currently monitor events that may potentially trigger notification to FINRA? How likely are firms to change their risk management practices due to the proposed notification requirements?
      •   Are the proposed notification requirements with respect to liquidity and funding events likely to impact the supply and demand for funding? Specifically, are impacted firms likely to alter their behavior, collateral management and choice of counterparties in the funding markets?
      •   Are there any other economic impacts or competitive effects of the proposed notification requirements?

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

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

      3. See, e.g., Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (January 2011).

      4. See Regulatory Notice 10-57 (November 2010) (Risk Management) and Regulatory Notice 15-33 (September 2015) (Liquidity Risk). However, even prior to the financial crisis, FINRA noted the importance of risk management practices. See, e.g., Notice to Members 99-92 (November 1999) (Risk Management Practices) (setting forth a joint statement by the SEC, NASD and NYSE on broker-dealer risk management practices). FINRA has also discussed liquidity risk in its recent Annual Regulatory and Examination Priorities Letters.

      5. Under the proposal, the SLS must be filed within 22 business days after the end of each month. The SLS need not be filed for any period where the firm does not meet the $25 million or $1 billion thresholds.

      6. Upon receiving comment on the proposed SLS, FINRA proposes to file the SLS with the SEC pursuant to Rule 4524. Rule 4524 provides that, as a supplement to filing FOCUS reports required pursuant to SEA Rule 17a-5 and FINRA Rule 2010, each member, as FINRA shall designate, shall file such additional financial or operational schedules or reports as FINRA may deem necessary or appropriate for the protection of investors or in the public interest. The rule provides that the content of such schedules or reports, their format, and the timing and the frequency of such supplemental filings shall be specified in a Regulatory Notice (or similar communication) issued pursuant to the rule. The rule further provides that FINRA shall file with the SEC pursuant to Section 19(b) of the Exchange Act the content of any such Regulatory Notice (or similar communication) issued pursuant to the rule.

      7. See Regulatory Notice 09-71 (December 2009) (SEC Approves Consolidated FINRA Rules Governing Financial Responsibility).

      8. Supplementary Material .01 of Rule 4521 provides that, for purposes of the rule, all requirements that apply to a member that clears or carries customer accounts shall also apply to any member that, operating pursuant to the exemptive provisions of SEA Rule 15c3-3(k)(2) (i), either clears customer transactions pursuant to such exemptive provisions or holds customer funds in a bank account established thereunder. By way of clarification, FINRA notes that firms otherwise subject to the rule by virtue of Supplementary Material .01 would not be subject to the new requirements if they do not meet the specified $25 million or $1 billion thresholds.

      9. FINRA Rule 6710(p) defines "U.S. Treasury Security" to mean "a security issued by the U.S. Department of the Treasury to fund the operations of the federal government or to retire such outstanding securities."

      10. FINRA Rule 6710(k) defines "agency" to mean a United States executive agency as defined in 5 U.S.C. 105 that is authorized to issue debt directly or through a related entity, such as a government corporation, or to guarantee the repayment of principal or interest of a debt security issued by another entity. The term excludes the U.S. Department of the Treasury in the exercise of its authority to issue U.S. Treasury Securities as defined under FINRA Rule 6710(p). Under 5 U.S.C. 105, the term "executive agency" is defined to mean an "Executive department, a Government corporation, and an independent establishment."

      11. FINRA Rule 6710(n) defines GSE to have the meaning set forth in 2 U.S.C. 622(8). Under 2 U.S.C. 622(8), a GSE is defined, in part, to mean a corporate entity created by a law of the United States that has a Federal charter authorized by law, is privately owned, is under the direction of a board of directors, a majority of which is elected by private owners, and, among other things, is a financial institution with power to make loans or loan guarantees for limited purposes such as to provide credit for specific borrowers or one sector and raise funds by borrowing (which does not carry the full faith and credit of the Federal Government) or to guarantee the debt of others in unlimited amounts.

      12. Paragraphs (d)(3)(A) and (d)(3)(B) address free credit balances and margin balances for purposes of specified monthly reporting requirements under current paragraph (d) of Rule 4521.


      ATTACHMENT A

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

      * * * * *

      4000. FINANCIAL AND OPERATIONAL RULES

      * * * * *

      4520. Financial Records and Reporting Requirements
      4521. Notifications, Questionnaires and Reports
      (a) Each carrying or clearing member shall submit to FINRA, or its designated agent, at such times as may be designated, or on an ongoing basis, in such form and within such time period as may be prescribed, such financial and operational information regarding the member or any of its correspondents as FINRA deems essential for the protection of investors and the public interest.
      (b) Every member approved by the SEC pursuant to SEA Rule 15c3-1 to use the alternative method of computing net capital contained in Appendix E to that Rule shall file such supplemental and alternative reports as may be prescribed by FINRA.
      (c)
      (1) Each carrying or clearing member shall notify FINRA in writing, no more than 48 hours after its tentative net capital as computed pursuant to SEA Rule 15c3-1 has declined 20 percent or more from the amount reported in its most recent FOCUS Report or, if later, the most recent such notification filed with FINRA. For purposes of this paragraph, "tentative net capital as computed pursuant to SEA Rule 15c3-1" shall exclude withdrawals of capital previously approved by FINRA.
      (2) Unless otherwise permitted by FINRA in writing, each carrying or clearing member with $25 million or more in total credits, as determined pursuant to the customer reserve formula computation as set forth in SEA Rule 15c3-3 Exhibit A, and each member whose aggregate amount outstanding under repurchase agreements, securities loans contracts and bank loans is equal to or greater than $1 billion, as reported on the member's most recently filed FOCUS Report, shall notify FINRA in writing, no more than 48 hours after:
      (A) the member becomes aware of a loss of access to secured funding through repurchase agreements, and where such loss, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or Government-Sponsored Enterprise, in the aggregate, across all counterparties, represents 20 percent or more of the highest amount borrowed through such contracts within a 35 rolling calendar day period;
      (B) the member becomes aware of a loss of access to secured funding through securities loans, and where such loss, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or Government-Sponsored Enterprise, in the aggregate, across all counterparties, represents 20 percent or more of the highest amount borrowed through such contracts within a 35 rolling calendar day period;
      (C) any one of the member's five largest repurchase agreement counterparties or any one of the member's five largest securities loan counterparties increases collateral haircuts on the counterparty's repurchase agreements or securities loan contracts with the member, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or Government-Sponsored Enterprise, by 20 percent or more within a 35 rolling calendar day period;
      (D) any one of the member's five largest repurchase agreement counterparties, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or Government-Sponsored Enterprise, initiates termination of outstanding repurchase contracts prior to maturity, initiates the option not to renew or rollover the contract, or reduces access to undrawn or unused financing through repurchase contracts by 20 percent or more from the highest amount borrowed through such counterparty within a 35 rolling calendar day period;
      (E) any one of the member's five largest securities loan counterparties, excluding funding collateralized by U.S. Treasury Securities, or funding collateralized by securities issued by a U.S. Government Agency or Government-Sponsored Enterprise, initiates termination of securities loaned contracts prior to maturity, or reduces access to financing through securities loans by 20 percent or more of the highest amount borrowed through such counterparty within a 35 rolling calendar day period;
      (F) the member becomes aware of a reduction in or termination of committed or uncommitted lines of credit from banks, whether secured or unsecured, by 20 percent or more within a 35 rolling calendar day period;
      (G) the member triggers a material adverse change clause in any contract containing such clause, including events of acceleration or default, provided that the notification required pursuant to this Rule shall be required within 48 hours after the expiration of any applicable cure period without remedy; or
      (H) the total change in the member's customer margin balances, or decrease in the member's free credit balances, in the gross aggregate, is greater than or equal to five percent or $5 billion in one business day, whichever is lower; provided, however, that paragraph (c)(2)(H) of this Rule shall apply to members that, pursuant to Rule 4210(g), have received approval from FINRA, or the member's DEA if other than FINRA, to establish a portfolio margin methodology for eligible participants. For purposes of this paragraph (c)(2)(H), the daily customer margin balances and free credit balances shall be as determined pursuant to paragraphs (d)(3)(A) and (d)(3)(B) of this Rule.
      (d)
      (1) Unless otherwise permitted by FINRA in writing, members carrying margin accounts for customers are required to submit, on a settlement date basis, the information specified in paragraphs (d)(2)(A) and (d)(2)(B) of this Rule as of the last business day of the month. If a member has no information to submit, a report should be filed with a notation thereon to that effect. Reports are due as promptly as possible after the last business day of the month, but in no event later than the sixth business day of the following month. Members shall use such form as FINRA may prescribe for these reporting purposes.
      (2) Each member carrying margin accounts for customers shall submit reports containing the following customer information:
      (A) Total of all debit balances in securities margin accounts; and
      (B) Total of all free credit balances in all cash accounts and all securities margin accounts.
      (3) For purposes of this paragraph (d):
      (A) Only free credit balances in cash and securities margin accounts shall be included in the member's report. Balances in short accounts and in special memorandum accounts (see Regulation T of the Board of Governors of the Federal Reserve System) shall not be considered as free credit balances.
      (B) Reported debit or credit balance information shall not include the accounts of other FINRA members, or of the associated persons of the member submitting the report where such associated person's account is excluded from the definition of customer pursuant to SEA Rule 15c3-3.
      (e) Unless a specific temporary extension of time has been granted, there shall be imposed upon each member required to file any report, notification or information pursuant to this Rule, a late fee as set forth in Schedule A Section 4(g)(1) to the FINRA By-Laws.
      (f) For purposes of this Rule, any report filed pursuant to this Rule containing material inaccuracies shall be deemed not to have been filed until a corrected copy of the report has been resubmitted.

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

      .01 Members Operating Pursuant to the Exemptive Provisions of SEA Rule 15c3-3(k)(2)(i). For purposes of this Rule, all requirements that apply to a member that clears or carries customer accounts shall also apply to any member that, operating pursuant to the exemptive provisions of SEA Rule 15c3-3(k)(2)(i), either clears customer transactions pursuant to such exemptive provisions or holds customer funds in a bank account established thereunder.

      * * * * *


      ATTACHMENT B

      FINRA SLS

      Supplemental Report to FOCUS REPORT

      Supplemental Liquidity Schedule ("SLS")

      (Please read instructions before completing form)

      NAME OF BROKER-DEALER   SEC FILE NO.
      ADDRESS OF PRINCIPAL PLACE OF BUSINESS FIRM ID NO.
      (No. and Street)     FOR PERIOD ENDING (MM/DD/YY)
      (City) (State) (Zip Code)  
      NAME OF PERSON COMPLETING THIS REPORT
      TELEPHONE NO. OF PERSON COMPLETING THIS REPORT
       

      All amounts should be reported in thousands.

      REVERSE REPURCHASE AND REPURCHASE AGREEMENTS Reverse Repurchase (000s) Repurchase (000s)
      1. U.S. Treasury Securities    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity _______________ _______________
         c. Forward Starting $ $
      2. U.S. Government Agency & Government-Sponsored Enterprise Securities    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity _______________ _______________
         c. Forward Starting $ $
      3. Equity Securities    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity _______________ _______________
         c. Forward Starting $ $
      4. Investment Grade Corporate Obligations    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity _______________ _______________
         c. Forward Starting $ $
      5. Other Collateral    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity _______________ _______________
         c. Forward Starting $ $
           
      6. Total at Tri-Party Custodian or DTCC $ $
      7. TOTAL $ $
      Top 5 Counterparties: Reverse Repurchase and Repurchase Agreements
      Reverse Repurchase Counterparty Name Contract Value (000s) Repurchase Counterparty Name Contract Value (000s)
             
      1. $ 1. $
      2. $ 2. $
      3. $ 3. $
      4. $ 4. $
      5. $ 5. $
      SECURITIES BORROWED AND SECURITIES LOANED Securities Borrowed (000s) Securities Loaned (000s)
      1. U.S. Treasury Securities    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity ______________ ______________
         c. Forward Starting $ $
      2. U.S. Government Agency & Government-Sponsored Enterprise Securities    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity ______________ ______________
         c. Forward Starting $ $
      3. Equity Securities    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity ______________ ______________
         c. Forward Starting $ $
      4. Investment Grade Corporate Obligations    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity ______________ ______________
         c. Forward Starting $ $
      5. Other Collateral    
         a. Open and Overnight $ $
         b. Term $ $
      Weighted Average Maturity ____________ _____________
         c. Forward Starting $ $
           
      6. Total Guaranteed by a CCP $ $
      7. TOTAL $ $
      Top 5 Counterparties: Securities Borrowed and Securities Loaned
      Securities Borrowed Counterparty Name Contract Value (000s) Securities Loaned Counterparty Name Contract Value (000s)
             
      1. $ 1. $
      2. $ 2. $
      3. $ 3. $
      4. $ 4. $
      5. $ 5. $
      BANK LOAN AND OTHER CREDIT FACILITIES
        Total (000s) Affiliate Non-Affiliate
        Committed (000s) Uncommitted (000s) Committed (000s) Uncommitted (000s)
       
      1. U.S. Treasury, U.S. Government Agency & Government-Sponsored Enterprise Securities          
         a. Open and Overnight $ $ $ $ $
         b. Term $ $ $ $ $
      2. Equity Securities  
         a. Open and Overnight $ $ $ $ $
         b. Term $ $ $ $ $
      3. Other Collateral          
         a. Open and Overnight $ $ $ $ $
         b. Term $ $ $ $ $
      4. Unused Portion of Secured Credit Facilities $ $ $ $ $
      5. Unsecured Credit Facilities          
         a. Drawn Amounts $ $ $ $ $
         b. Undrawn Amounts $ $ $ $ $
      TOTAL AVAILABLE COLLATERAL (Free Box)
        Total Market Value
      1. U.S. Treasury Securities $
       
      MARGIN LOANS
        Balance (000s)
      1. Demand Loans $
      2. Term Loans—Drawn $
         a. Weighted Average Maturity of Term Loans ______________  
      3. Term Loans—Undrawn $
      COLLATERAL SECURING MARGIN LOANS    
      a. Top 5 Equity Securities
      CUSIP # ISSUER Market Value (000s)
      1.   $
      2.   $
      3.   $
      4.   $
      5.   $
      b. Top 5 Fixed Income Securities (excluding U.S. Treasury, Government Agency & Government-Sponsored Enterprise Securities)
      CUSIP ISSUER Market Value (000s)
      1.   $
      2.   $
      3.   $
      4.   $
      5.   $
      DEPOSITS AT CLEARING ORGANIZATIONS
        Amount Required (000s) Amount Posted (000s) Proprietary Largest Single Intra-Month Call (000s) Date
      1. DTCC (total) $ $ $ $  
         a. NSCC $ $ $ $  
         b. FICC $ $ $ $  
      2. OCC $ $ $ $  
      3. CME $ $ $ $  
      4. ICE $ $ $ $  
      5. Other>10% of $ $ $ $  
      CASH AND SECURITIES RECEIVED AND DELIVERED ON DERIVATIVE TRANSACTIONS NOT CLEARED THROUGH A CCP
      Cash and Securities Delivered In to Collateralize Receivables  
      Counterparty Name Affiliate (Y/N) Total Cash (000s) Total Securities
             
      1.   $ $
      2.   $ $
      3.   $ $
      4.   $ $
      5.   $ $
      Cash and Securities Delivered Out to Collateralize Payables
      Counterparty Name Affiliate (Y/N) Total Cash (000s) Total Securities
      1.   $ $
      2.   $ $
      3.   $ $
      4.   $ $
      5.   $ $

      ATTACHMENT C

      SUPPLEMENTAL SCHEDULE TO FOCUS REPORT

      Supplemental Liquidity Schedule

      GENERAL INSTRUCTIONS

      The Supplemental Liquidity Schedule ("SLS") is intended to provide more detailed information about a member's liquidity profile than what is reflected on the FOCUS Report (Part II, Part IIA or Part II CSE, as appropriate). Unless otherwise permitted by FINRA in writing, the SLS is required to be filed by each carrying or clearing FINRA member with $25 million or more in total credits, as determined pursuant to the customer reserve formula computation as set forth in SEA Rule 15c3-3 Exhibit A, and by each FINRA member whose aggregate amount outstanding under repurchase agreements, securities loans contracts and bank loans is equal to or greater than $1 billion, as reported on the member's most recently filed FOCUS report.

      The SLS must be filed within 22 business days after the end of each month. A member need not file the SLS for any period where the member does not meet the $25 million or $1 billion thresholds.

      SPECIFIC INSTRUCTIONS

      Note: For explanations of the types of securities to be included in the requested line items of the SLS, please refer to "Explanation of Terms" on pages 3 and 4 of these instructions.

      Reverse Repurchase and Repurchase Agreements

      Report the gross contract value of all reverse repurchase and repurchase agreements by collateral type, including all intercompany and third party agreements. Exclude intracompany agreements between desks within the same legal entity. Report collateral upgrade transactions based on the contract type for each leg of the transaction (i.e., report Master Repurchase Agreements ("MRA") contracts in the Reverse Repurchase and Repurchase Agreements section and Master Stock Loan Agreement ("MSLA") contracts in the Securities Borrowed and Securities Loaned section, as discussed further below).

      Compute the "Weighted Average Maturity" on term agreements only (i.e., exclude open and overnights). For contracts that contain an option feature that permits the counterparty to choose not to renew with an agreed-upon notice period ("evergreen contracts"), use the earliest possible close date.

      Report in "Other Collateral" the gross contract value of all reverse repurchase and repurchase agreements not otherwise reported in the previous product categories.

      For "Total at Tri-Party Custodian or DTCC," report the gross contract value of all reverse repurchase and repurchase agreements where the collateral is held at a tri-party custodian or at Depository Trust & Clearing Corporation (DTCC), including DTCC's subsidiary Fixed Income Clearing Corporation (FICC).

      For "Top 5 Counterparties: Reverse Repurchase and Repurchase Agreements," report the top 5 counterparties after netting (in accordance with ASC 210-20-45-1 and ASC 210-20-45-11). Where contracts have been novated to FICC, FICC should be reported as the counterparty. Where the counterparty contracted with the member through an agent (Agency Repo), report the name of the underlying principal as counterparty.

      Securities Borrowed and Securities Loaned

      Report the gross contract value of all securities borrowed and securities loaned agreements by collateral type, including all intercompany and third party agreements. Exclude intracompany agreements between desks within the same legal entity. Report collateral upgrade transactions based on the contract type for each leg of the transaction (i.e., report Master Repurchase Agreement contracts in the Reverse Repurchase and Repurchase Agreements section and Master Securities Lending Agreement contracts in the Securities Borrowed and Securities Loaned section).

      Compute the "Weighted Average Maturity" on term agreements only (i.e., exclude open and overnight contracts).

      Report in "Other Collateral" the gross contract value of all securities borrowed and securities loaned agreements not otherwise reported in the previous product categories, if applicable.

      "Total Guaranteed by a CCP" shall include the gross contract value of all securities borrowed and securities loaned agreements guaranteed by a Central Clearing Counterparty.

      "Top 5 Counterparties: Securities Borrowed and Securities Loaned" shall include the Top 5 Counterparties after netting (in accordance with ASC 210-20-45-1 and ASC 210-20-45-11). Where the counterparty contracted with the member through an agent bank (Agency Lending), report the name of the underlying principal as the counterparty.

      Bank Loan and Other Credit Facilities

      Report the dollar value of bank loan and other credit facilities (for example, subordinated loans, liens of credit, secured demand notes, etc.) by collateral type for secured lines, separating affiliated sources from unaffiliated sources.

      For purposes of this SLS, a committed line of credit is one where the lender is contractually committed to lend to the member, provided the member has not violated any conditions or covenants in the terms of the contract.

      Total Available Collateral (Free Box)

      Report U.S. Treasury Securities (see "Explanation of Terms") in the member's possession or control that can be re-hypothecated, are otherwise unencumbered and are not required to be returned upon demand of the owner.

      Margin Loans

      Report margin loans, including non-purpose loans extended by the member. For purposes of this SLS, "Demand" loans are those that are callable for immediate repayment. "Term" loans are those that are not callable for immediate repayment and have stated maturity dates.

      Collateral Securing Margin Loans

      For "Top 5 Equity Securities," report the top five equity securities by total market value, collateralizing all margin loans.

      For "Top 5 Fixed Income Securities," report the top five fixed income securities, excluding U.S. Treasury, Government Agency & Government-Sponsored Enterprise Securities, collateralizing all margin loans.

      Deposits at Clearing Organizations

      Report the total amount required to be on deposit, as well as the total amount of cash and securities on deposit, at clearing organizations at the report date. The amount may include the clearing deposit, adequate assurance deposits, additional liquidity deposits, guarantee fund deposits, etc. In addition, report in this section the largest single call intra-month by the clearing organization.

      For "Other>10% Total," report the total clearing deposit at any one clearing organization that is greater than 10% of the total amounts required and on deposit at all clearing organizations, if applicable.

      Cash and Securities Received and Delivered on Derivative Transactions Not Cleared Through a CCP

      Report cash and securities used to collateralize marks to market on derivative transactions that are not cleared through a central clearing counterparty ("CCP"). For purposes of this SLS, "derivatives transactions" include non-regular way settlement transactions (including To Be Announced ("TBA") securities and delayed delivery and settlement transactions) as well as swap contracts.

      For "Cash and Securities Delivered In to Collateralize Receivables," report the top five counterparties with gross derivative mark-to-market receivables, by counterparty name, and identify whether the derivative counterparty is an affiliate.

      For "Cash and Securities Delivered Out to Collateralize Payables," report the top five counterparties with gross derivative mark-to-market payables, by counterparty name, and identify whether the derivative counterparty is an affiliate.

      EXPLANATION OF TERMS

      U.S. Treasury Securities

      Direct obligations of the U.S. Treasury, including but not limited to, bills, notes, bonds, Treasury Inflation-Protected Securities (TIPS), U.S. Treasury Strips (IO) or (PO), and Treasury floating rate notes.

      U.S. Government Agency & Government-Sponsored Enterprise Securities

      Securities issued by a United States federal agency, or a United States Government-Sponsored Enterprise, including agency securities guaranteed as to principal or interest by the U. S. government (e.g., GNMA securities).

      Equity Securities

      Preferred and common stocks, warrants and ETFs issued by any domestic or foreign issuer.

      Investment Grade Corporate Obligations

      Investment grade debt securities issued by any corporation, whether domestic or foreign. Corporate obligations include but are not limited to non-convertible, convertible, floating rate debt securities and ETNs.

      Other Collateral

      All other securities not otherwise included in the other categories.

    • 18-01 Final Statements for Broker-Dealers, Investment Adviser Firms, Agents and Investment Adviser Representatives, and Branches; Payment Deadline: January 22, 2018

      View PDF

      BD and IA Renewals for 2018

      Regulatory Notice
      Notice Type

      Renewals
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Senior Management
      Key Topics

      IARDTM
      Registration
      Renewals
      Web CRD®

      Executive Summary

      FINRA is issuing this Notice to help firms review, reconcile and respond to their Final Statements in E-Bill as well as view the reports that are currently available in Web CRD/IARD for the annual registration renewal process. The payment deadline is January 22, 2018.

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

      Background & Discussion

      Final Statements

      On January 2, 2018, Final Statements became available for viewing and printing in E-Bill. These statements reflect the final status of broker-dealer, registered representative, investment adviser firm, investment adviser representative, and branch registrations and/or notice filings as of December 31, 2017. Any adjustments in fees owed because of registration terminations, approvals, IA firm registrations, reporting status or notice filings subsequent to the Preliminary Statement are included in this final reconciled statement. Renewal reports are available in Web CRD/IARD for request, print and/or download.

      If the amount assessed on the Final Statement is greater than the amount assessed on the Preliminary Statement, the additional renewal fees are due by January 22, 2018. If the amount assessed on the Final Statement is less than the amount assessed on the Preliminary Statement, FINRA has issued a credit to the firm's Flex-Funding Account.

      The Final Statements include the following fees (if applicable):

      •   Web CRD/IARD system processing fees;
      •   FINRA branch office and branch processing fees;
      •   participating Self-Regulatory Organization (SRO) maintenance fees, if applicable;
      •   state broker-dealer firm, branch and agent (AG) renewal fees, if applicable;
      •   state investment adviser firm, branch and investment adviser representative (RA) renewal fees, if applicable; and
      •   FINRA annual statutory disqualification fees for registered individuals.

      Renewal Payment

      Web CRD/IARD issues a refund if a firm owes less for registrations at year-end than what was reflected on the Preliminary Statement. FINRA transferred overpayments to firms' Flex-Funding Accounts on January 2, 2018. Firms that have a credit balance in their FlexFunding Accounts may submit a refund request [http://www.finra.org/industry/e-bill-user-guide#Refunds] through E-Bill or leave the funds in their account to pay for other future fees.

      If the Final Statement reflects an amount due, FINRA must receive payment no later than January 22, 2018. Firms may pay electronically through E-Bill, send a wire transfer or mail a check; however, FINRA highly recommends that firms remit funds via E-Bill. Firms are encouraged to check their Renewal Statements to confirm FINRA has received payment and that the firm's Renewal Statement balance is paid in full.

      Electronic Payment via E-Bill

      Firms may submit electronic payments to fund their Renewal Accounts through E-Bill [http://www.finra.org/industry/finra-e-bill]. FINRA does not charge for using E-Bill; however, firms should verify if their banks charge additional fees. Firms must enroll to use E-Bill.

      Please Note: Firm users with the proper entitlement may transfer funds from their Flex-Funding Account to their Renewal Account or transfer funds between affiliated firms at any time by using E-Bill. For further details, please refer to the E-Bill User Guide [http://www.finra.org/industry/e-bill-user-guide].

      ACH/Wire Transfer and Check Payments

      Wire transfer and check payments are initially deposited into a firm's Flex-Funding Account. Beginning January 22, 2018, if sufficient funds are available, FINRA will systematically transfer funds from Flex-Funding Accounts to Renewal Accounts. Firms do not have to wait for FINRA to systematically transfer funds on January 22 as firms have the ability to transfer funds to their Renewal Accounts using E-Bill. Funds will only be systematically transferred if the entire renewal amount owed is available in the firm's Flex-Funding Account.

      ACH/Wire Transfer

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

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

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

      If you send your wire transfer by 2 p.m., ET, your firm may confirm receipt the next business day by reviewing your Flex-Funding Account online or calling the FINRA Gateway Call Center at (301) 869-6699. Wire payments received after 2 p.m., ET, should be available in two business days. Please note that while wire transfers are received by FINRA on the same day they are initiated, ACH bank transfers typically take several days longer to be received by FINRA.

      Checks

      Checks should be made payable to FINRA and your firm's CRD number should be written on the check memo line. Processing of check payments may take up to two business days. Please account for mail delivery and payment processing time when sending payment. Write the address on an envelope exactly as noted in this Notice:

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

      Note: This P.O. Box will not accept courier or overnight deliveries.
      Bank of America Lockbox Services
      FINRA 418911
      MA5-527-02-07
      2 Morrissey Blvd.
      Dorchester, MA 02125

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

      Renewal Reports

      Renewal reports include all individual registrations renewed for 2018; however, they do not include registrations that were "pending approval" or "deficient" at year-end. Firms should examine their reports carefully to ensure that all registration approvals are correct. FINRA also suggests that firms include these reports in firms' permanent records.

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

      Discrepancies

      If your firm believes there are discrepancies on your Final Statement, report them in writing directly to FINRA by January 22, 2018. Along with your letter describing the discrepancy, please include a copy of your Final Statement and any supporting documentation to:

      FINRA
      Registration & Disclosure—Regulatory Services & Operations
      9509 Key West Avenue
      Rockville, MD 20850

      If you have questions regarding renewal discrepancies, please call FINRA at (240) 386-4182.