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  • Notices

    • 2019

      • 19-28 Guidance Regarding Member Firms' Supervisory Obligations when Participating in Investment-Related Activities with Municipal Clients [PDF]

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      • 19-27 FINRA Requests Comment on Rules and Issues Relating to Senior Investors; Comment Period Expires: October 8, 2019 [PDF]

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      • 19-26 SEC Adopts Best Interest Standard of Conduct [PDF]

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      • 19-25 FINRA Requests Comment on a Proposal to Require Reporting of Transactions in U.S. Dollar-Denominated Foreign Sovereign Debt Securities to TRACE; Comment Period Expires: September 24, 2019

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        Regulatory Notice
        Notice Type

        Request for Comment
        Suggested Routing

        Compliance
        Fixed Income
        Legal
        Operations
        Systems
        Trading
        Training
        Key Topics

        Foreign Sovereign Debt
        Fixed Income
        TRACE
        TRACE-Eligible Security
        Trade Reporting
        Referenced Rules & Notices

        FINRA Rule 6710
        FINRA Rule 6730
        FINRA Rule 6750
        FINRA Rule 7730
        Notice to Members 04-90

        Summary

        FINRA requests comment on a proposal to expand TRACE reporting requirements to collect information on trades in foreign sovereign debt securities that are U.S. dollar-denominated. Issuance activity in these debt securities has accelerated in recent years and FINRA believes the proposal would provide important regulatory information on an increasingly active segment of the market. Under the proposal, trades in U.S. dollar-denominated foreign sovereign debt securities would be subject to same-day reporting and would not be disseminated publicly.

        The proposed rule text is set forth in Attachment A.

        Questions regarding this Notice should be directed to:

        •   Alié Diagne, Director, Transparency Services, at (212) 858-4092 or alie.diagne@finra.org;
        •   Joseph Schwetz, Senior Director, Market Regulation, at (240) 386-6170 or joseph.schwetz@finra.org;
        •   Alex Ellenberg, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8152 or alexander.ellenberg@finra.org; or
        •   Cara Bain, Assistant General Counsel, OGC, at (202) 728-8852 or cara.bain@finra.org.

        Action Requested

        FINRA encourages all interested parties to comment on the proposal. Comments must be received by September 24, 2019.

        Comments must be submitted through one of the following methods:

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

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

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

        Important Notes: The only comments that FINRA will consider are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the FINRA website. Generally, FINRA will post comments as they are received.1

        Before becoming effective, the proposed rule change must be filed with the Securities and Exchange Commission (SEC) pursuant to Section 19(b) of the Securities Exchange Act (SEA).2

        Background and Discussion

        Currently almost all U.S. dollar-denominated debt securities traded in the U.S., excluding money market instruments, are considered "TRACE-Eligible Securities" and therefore subject to TRACE reporting requirements.3 This includes the U.S. dollar-denominated debt of foreign private issuers.4 However, trades in the U.S. dollar-denominated debt of foreign sovereign issuers are not subject currently to TRACE reporting.

        U.S. dollar-denominated foreign sovereign debt issuance has increased substantially since 2013. To further enhance FINRA's regulatory audit trail, FINRA is proposing to require TRACE reporting of U.S. dollar-denominated foreign sovereign debt. FINRA believes this would provide important regulatory information on an increasingly active segment of the market. Based on discussions with member firms and feedback from advisory committees, FINRA understands that U.S. dollar-denominated foreign sovereign debt securities generally trade on desks that already have TRACE reporting workflows in place and therefore, FINRA preliminarily believes the proposal would advance this regulatory goal through incremental measures and would not impose significant burdens and costs on firms. FINRA is requesting additional feedback and comment on the specific economic impacts, as well as the overall goals and impacts of the proposal as discussed in more detail below.

        Scope of Proposed Reporting Requirements

        Under the proposal, FINRA would require members to report transactions in U.S. dollar-denominated foreign sovereign debt securities, a term that would be defined to include debt securities that are issued or guaranteed by the government of a foreign country, any political subdivision of a foreign country, or a supranational entity.5 Supranational entities are multi-national organizations such as the International Bank for Reconstruction & Development ("World Bank"), the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the International Finance Corporation, and the European Investment Bank.

        The proposal would not change FINRA's approach to the regulatory reporting framework or jurisdictional reach over trading activity with some foreign component. The proposed reporting requirements for U.S. dollar-denominated foreign sovereign debt securities would follow the current TRACE approach to foreign trades, which generally considers whether FINRA member firms engage in transactions that involve a beneficial change in ownership.6

        Under the proposal, transaction information for U.S. dollar-denominated foreign sovereign debt securities would be reported for regulatory purposes only and would not be publicly disseminated.

        7

        Transactions in foreign sovereign debt securities would be subject to same-day reporting during current TRACE hours. Specifically, transactions between midnight and 5:00 p.m. Eastern Time (ET) on a business day must be reported on that business day, and transactions between 5:00 p.m. ET and midnight — as well as transactions on any day the TRACE system is not open — must be reported no later than 6:29:59 p.m. ET of the next business day (and designated "as/of" the date of execution).

        For trades in U.S. dollar-denominated foreign sovereign debt securities subject to the proposal, FINRA would require firms to report specific transaction information similar to what is reported for other TRACE-Eligible Securities. Specifically, TRACE trade reports in foreign sovereign debt securities would be required to include:

        •   the CUSIP number or FINRA symbol for the security;
        •   the reporting party's capacity;
        •   an identifier for the contra-party (either MPID, "A" for non-member affiliate, or "C" for customer);
        •   the side the reporting party was on (buy or sell);
        •   the quantity of the transaction (i.e., face value amount of the transaction);
        •   the price of the transaction expressed as a percentage of face/par value;
        •   the time of execution;
        •   the date of execution (for "as/of" trades);
        •   the settlement date;
        •   any commission charged if the member is acting as agent; and
        •   any applicable trade modifiers.

        If U.S. dollar-denominated foreign sovereign debt securities become subject to TRACE reporting requirements, they would also become subject to applicable transaction reporting fees. FINRA is not proposing any change to the current rate structure set out in Rule 7730, which means that U.S. dollar-denominated foreign sovereign debt securities would be treated the same as corporate debt securities for purposes of trade reporting fees under the rule. Similarly, once TRACE-Eligible, U.S. dollar-denominated foreign sovereign debt securities would become subject to the Trading Activity Fee at the rate applicable to bonds set out in Section 1 of Schedule A to FINRA's By-Laws.

        Economic Impact Assessment

        FINRA has undertaken an economic impact assessment, as set forth below, to analyze the potential economic impacts, including anticipated costs, benefits, and distributional and competitive effects relative to the current baseline, and the alternatives FINRA considered in assessing how to best meet its regulatory objectives.

        Regulatory Objective

        FINRA is proposing that members be required to report transactions in U.S. dollar-denominated foreign sovereign debt securities to TRACE subject to same-day reporting. These foreign sovereign debt security transactions would not be disseminated publicly.

        Economic Baseline

        FINRA members are not currently required to report transactions in U.S. dollar-denominated foreign sovereign debt securities to TRACE. As a consequence, there is not current TRACE data to estimate the amount of trading volume that will be subject to reporting. This analysis is therefore informed by data on the issuance and amount outstanding of these securities obtained from other sources.

        As of December 31, 2018, the total amount outstanding of marketable U.S. dollar-denominated foreign sovereign government debt was approximately $2.3 trillion across 4,827 CUSIPs issued by 116 foreign sovereign governments. This compares to approximately $16.0 trillion, $2.3 trillion and $8.4 trillion, respectively, in marketable U.S. Treasury debt, U.S. agency debt and U.S. corporate debt.8

        Governments issued approximately $16.6 trillion of marketable U.S. dollar-denominated debt in calendar year 2018. Foreign sovereign governments issued $396 billion of it, representing approximately 2.4% of the total amount, and the U.S. Government (U.S. Treasury and agencies) issued the remaining amount, $16.2 trillion.9 By comparison, foreign and U.S. firms issued a total of $3.8 trillion of corporate debt denominated in U.S. dollars in calendar year 2018.

        The number of foreign sovereign U.S. dollar-denominated debt issuances has increased from 842 to 929 unique CUSIPs per year from 2009 through 2017; foreign sovereign governments issued 734 unique CUSIPs in U.S. dollar-denominated debt in 2018. As shown in Figure 1, the top five non-U.S. government issuers of marketable U.S. dollar-denominated debt in the years from January 1, 2014 through December 31, 2018, as measured by par value, are Canada, Argentina, South Korea, France and Sweden. In particular, Argentina has increased its issuance of sovereign U.S. dollar-denominated debt by a multiple of 5.25 between the years 2009 and 2018, as measured by the number of unique CUSIPs. Figure 2 shows how the amount of U.S. dollar-denominated sovereign debt issued has changed. For example, Argentina and Sweden increased their debt issuance denominated in U.S. dollars by a multiple of 100.3 and 2.8, respectively, between the years 2009 and 2018.

        In calendar year 2018, the total amount outstanding of marketable U.S. dollar-denominated supranational debt is approximately $552 billion across close to 2,667 CUSIPs issued by 31 supranational organizations. The top-five largest supranational issuers of marketable U.S. dollar-denominated debt from January 1, 2014 to December 31, 2018, as measured by par value is about 64.4% of the total amount outstanding. These five entities are International Bank for Reconstruction and Development (IBRD), International Finance Corporation (IFC), European Investment Bank (EIB), Asian Development Bank (ADB) and Inter-American Development Bank (IADB).

        Figure 3 shows that the number of supranational U.S. dollar-denominated debt issuances has increased slightly from 1,203 to 1,264 unique CUSIPs from 2009 through 2018. In calendar year 2018, the International Bank for Reconstruction and Development made the largest number of issuances, 66 CUSIPs, out of a total of 21 supranational organizations. Figure 4 also shows that the U.S. dollar-denominated debt issued by supranational organizations has increased from $99.1 billion in calendar year 2009 and is $109.1 billion as of calendar year 2018, of which $70.3 billion is issued from the top five largest supranational issuers of U.S. dollar-denominated debt in the time from January 1, 2014 through December 31, 2018, as measured by par value.

        Based on discussions with active broker-dealers in multiple foreign sovereign debt markets, FINRA understands that U.S. dollar-denominated foreign sovereign debt securities are not generally viewed as fungible investment substitutes for foreign currency (i.e., non-U.S. dollar) foreign sovereign debt securities and, as such, that arbitrage trading between these securities is de minimis.

        Economic Impact

        The primary benefit from members reporting transactions in U.S. dollar-denominated foreign sovereign debt securities to TRACE is that FINRA would be better able to supervise the market. In particular, the addition of the transaction price, par value, and other trade information in TRACE would create a better informed surveillance program to help detect fraud, manipulation, unfair pricing and other potential misconduct. Academic studies have found a positive empirical relationship between the strength of market regulation and market quality.10

        As the transactions will initially not be publicly disseminated,11 no additional costs or benefits from increased transparency will be imposed on market participants. FINRA and its members may face some additional development costs, but they are expected to be relatively modest because no new transaction information or modifiers are required beyond that mandated for corporate bonds. Members will pay a Transaction Reporting Fee and Trading Activity Fee for each U.S. dollar-denominated foreign sovereign or supranational debt security reported to TRACE, and FINRA is expected to bear the incremental cost of receiving and storing each of these additional transactions and conducting associated regulation. Because there is not current TRACE data to estimate the amount of trading volume that will be subject to reporting under the proposal, FINRA is not able to estimate the anticipated aggregate amount that would be collected through these fees.

        As there is currently no definitive source for transactions in U.S. dollar-denominated foreign sovereign debt securities, FINRA is not able to ascertain whether transactions between non-FINRA members represent a material (or potentially material) amount of execution activity in this market. Based on preliminary discussions with several market participants, FINRA understands that non-FINRA members hold U.S. dollar denominated foreign sovereign debt securities but generally execute through FINRA members. To the extent the number of transactions between non-FINRA members is significant, the proposal may be anticipated to impose some competitive effects. In particular, some market participants may seek to ensure that their activities are not reported to FINRA so as to avoid surveillance. This could result in trading activities shifting from FINRA members to non-members. However, FINRA believes this impact is mitigated to the extent that U.S. dollar-denominated foreign sovereign debt securities are not exempted securities under the federal securities laws and are required to be transacted in the U.S. through a registered broker-dealer.

        In addition, based on FINRA's understanding, noted above, that market participants do not treat debt issued by a foreign sovereign in dollars as fungible with debt issued by the same foreign sovereign in local or other currency, FINRA does not believe firms would be likely to avoid the proposed reporting requirements by shifting trading from U.S. dollar-denominated foreign sovereign debt to foreign sovereign debt denominated in other currency. FINRA also believes the ability to shift trading activity in U.S. dollar-denominated foreign sovereign debt securities to foreign jurisdictions to avoid the proposed reporting requirements is mitigated to the extent such trades are reportable in those jurisdictions, for example, in Europe. This Notice includes questions below to solicit additional feedback on these potential competitive issues.

        FINRA estimates that the benefit from improved surveillance of the U.S. dollar-denominated foreign sovereign and supranational debt securities to market participants outweighs the costs to members for having to report and to FINRA for receiving these additional transaction reports.

        Alternatives Considered

        No alternatives are under consideration.

        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:

        •   Do you agree with the scope of the proposal?
        •   Is there another definition for the term "foreign sovereign debt security" that FINRA should consider?
        •   Should FINRA consider a different reporting timeframe for trades in U.S. dollar-denominated foreign sovereign debt securities?
        •   Would you propose any changes to the specific transaction information that the proposal would require for trades in U.S. dollar-denominated foreign sovereign debt securities?
        •   Should non-U.S. dollar-denominated foreign sovereign debt securities be included and, if so, how would they be reported?
        •   What other economic impacts, including costs and benefits, might be associated with the proposal? Who might be affected and how?
        •   Is there more specific information on the direct costs of the proposal that FINRA should consider?
        •   For example, are there U.S. dollar-denominated foreign sovereign debt securities that trade on desks that do not already have TRACE-reporting workflows in place?
        •   If so, what are the costs of adding TRACE-reporting workflows to such desks?
        •   Would the proposal, if adopted, encourage investors to change their trading behavior to avoid TRACE reporting? If so, how do you envision investors would do so and what impacts do you think such changes would have?
        •   FINRA understands that today, firms may employ a manual process to determine whether a U.S. dollar denominated foreign debt security is Schedule B eligible and therefore not reportable. Would the proposal reduce the burdens and potential costs associated with determining whether a U.S. dollar-denominated debt security was issued by a foreign private issuer or a foreign sovereign issuer, since both would be reportable?
        •   Would the proposal impose any other competitive impacts that FINRA has not considered?

        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) (NASD Announces Online Availability of Comments) for more information.

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

        3. See Rule 6710(a).

        4. See Rule 6710(a)(1). FINRA guidance states that "foreign private issuer" means a foreign issuer that is not eligible to use the SEC's Schedule B for registering a debt offering in the United States. Schedule B is used to register debt for issuance in the United States by foreign governments or political subdivisions of foreign governments, and in some cases supranational organizations, issuers of government-guaranteed securities, and certain other issuers closely aligned and identified with a sovereign. See Notice to Members 04-90 (December 2004).

        5. The proposal would do this by amending Rule 6710 to add a new definition for "Foreign Sovereign Debt Security" and to add the term to the definition of "TRACE-Eligible Security." The new definition for "Foreign Sovereign Debt Security" would closely track a definition for the same term adopted by the SEC in connection with Regulation ATS.

        6. See, e.g., FINRA TRACE FAQ 3.16 (providing guidance on requirements for reporting trades that involve off-shore subsidiaries).

        7. If the proposed rule change is adopted, FINRA would take a similar measured approach to potential dissemination that it has taken historically with other TRACE-eligible securities, and would first analyze the regulatory data to determine whether a transparency regime in the future may be appropriate for this segment of the market.

        8. These estimates are derived from data sourced from Bloomberg, as are other estimates and figures in the Economic Impact Assessment, unless otherwise noted. The $8.4 trillion in U.S. corporate debt does not include debt securities defined as money market instruments by Rule 6710(o); these money market instruments are debt securities that, at issuance, have a maturity of one calendar year or less.

        9. The estimates for U.S. Government (U.S. Treasury and agencies) issuance amounts are derived from data sourced from Securities Industry and Financial Markets Association (SIFMA).

        10. See generally, e.g., Douglas Cumming et al., Exchange Trading Rules and Stock Market Liquidity, 99 J. Fin. Econ. 651 (2011) (discussing the impact of trading rules on liquidity in the equity markets); Howell E. Jackson & Mark J. Roe, Public and Private Enforcement of Securities Laws: Resource-Based Evidence, 93 J. Fin. Econ. 207 (2009) (discussing the correlation between public enforcement of securities laws and a number of market indicators, including trading volume and capital formation).

        11. As noted in footnote 7, supra, if FINRA proceeds with the proposal, FINRA will analyze the regulatory data to determine whether a transparency regime in the future may be appropriate for this segment of the market.


        Attachment A

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

        6000. QUOTATION, ORDER, AND TRANSACTION REPORTING FACILITIES

        6700. TRADE REPORTING AND COMPLIANCE ENGINE (TRACE)

        6710. Definitions

        The terms used in this Rule 6700 Series shall have the same meaning as those defined in the FINRA By-Laws and rules unless otherwise specified. For the purposes of this Rule 6700 Series, the following terms have the following meaning:

        (a) "TRACE-Eligible Security" means a debt security that is United States ("U.S.") dollar-denominated and is: (1) issued by a U.S. or foreign private issuer, and, if a "restricted security" as defined in Securities Act Rule 144(a)(3), sold pursuant to Securities Act Rule 144A; (2) issued or guaranteed by an Agency as defined in paragraph (k) or a Government-Sponsored Enterprise as defined in paragraph (n); [or] (3) a U.S. Treasury Security as defined in paragraph (p); or (4) a Foreign Sovereign Debt Security as defined in paragraph (jj). "TRACE-Eligible Security" does not include a debt security that is [issued by a foreign sovereign or] a Money Market Instrument as defined in paragraph (o).
        (b) through (ii) No Change.
        (jj) "Foreign Sovereign Debt Security" means a debt security issued or guaranteed by the government of a foreign country, any political subdivision of a foreign country, or a supranational entity.
        * * * * *

        6730. Transaction Reporting

        (a) When and How Transactions are Reported

        Each member that is a Party to a Transaction in a TRACE-Eligible Security must report the transaction. A member must report a transaction in a TRACE-Eligible Security as soon as practicable, but no later than within 15 minutes of the Time of Execution, except as otherwise specifically provided below. Transactions not reported within the specified timeframe will be designated as "late." A member must transmit the report to TRACE during TRACE System Hours.
        (1) through (3) No Change.

        (4) Reporting Requirements — U.S. Treasury Securities and Foreign Sovereign Debt Securities

        Transactions in U.S. Treasury Securities and Foreign Sovereign Debt Securities must be reported as provided in this paragraph (a)(4).
        (A) General Reporting Requirements

        Transactions [in U.S. Treasury Securities] executed on:
        (i) a business day at or after 12:00:00 a.m. Eastern Time through 5:00:00 p.m. Eastern Time must be reported the same day during TRACE System Hours;
        (ii) a business day after 5:00:00 p.m. Eastern Time but before the TRACE system closes must be reported no later than the next business day (T + 1) during TRACE System Hours, and, if reported on T + 1, designated "as/of" and include the date of execution; or
        (iii) a business day at or after 6:30:00 p.m. Eastern Time through 11:59:59 p.m. Eastern Time, or a Saturday, a Sunday, a federal or religious holiday or other day on which the TRACE system is not open at any time during that day (determined using Eastern Time) must be reported the next business day (T + 1) during TRACE System Hours, designated "as/of" and include the date of execution.
        (5) through (7) No Change.
        (b) through (f) No Change.
        * * * * *

        6750. Dissemination of Transaction Information

        (a) through (b) No Change.
        (c) Transaction Information Not Disseminated FINRA will not disseminate information on a transaction in a TRACE-Eligible Security that is:
        (1) through (3) No Change.
        (4) a Securitized Product that is: a CMBS; a CDO; or a CMO if the CMO transaction value is $1 million or more (calculated based upon original principal balance) and the transaction does not qualify for periodic dissemination under paragraph (b) above, except as may be otherwise provided in Rule 7730;[ or]
        (5) a U.S. Treasury Security[.]; or
        (6) a Foreign Sovereign Debt Security.
        * * * * *

      • 19-24 FINRA Encourages Firms to Notify FINRA if They Engage in Activities Related to Digital Assets

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        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Legal
        Operations
        Senior Management
        Trading
        Training
        Key Topics

        Blockchain
        Cryptocurrencies
        Definition of "Security"
        Digital Assets
        Distributed Ledger Technology
        Initial Coin Offerings
        Virtual Coin
        Virtual Token
        Referenced Rules & Notices

        FINRA Rule 1017
        FINRA Rule 3210
        FINRA Rule 3270
        FINRA Rule 3280
        Notice to Members 00-73
        Regulation ATS
        Regulatory Notice 09-46
        Regulatory Notice 18-20
        Section 2(a)(1) of the Securities Act of 1933
        Section 3(a)(10) of the Securities Exchange Act of 1934

        Summary

        Last year, FINRA took several steps to engage with members regarding their current and planned activities relating to digital assets. These efforts included the issuance of Regulatory Notice 18-20, which encouraged firms to keep their Regulatory Coordinator informed if the firm, or its associated persons or affiliates, engaged, or intended to engage, in activities related to digital assets, including digital assets that are non-securities.1 Regulatory Notice 18-20 requested that firms provide these updates to Regulatory Coordinators until July 31, 2019. FINRA appreciates members' cooperation over the past year and is encouraging firms to continue keeping their Regulatory Coordinators abreast of their activities related to digital assets until July 31, 2020.

        Questions concerning this Notice may be directed to:

        •   Kosha Dalal, Associate Vice President & Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6903 or by email at kosha.dalal@finra.org;
        •   Racquel Russell, Associate General Counsel, OGC, at (202) 728-8363 or by email at racquel.russell@finra.org; or
        •   Cara Bain, Assistant General Counsel, OGC, at (202) 728-8852 or by email at cara.bain@finra.org.

        Background & Discussion

        In 2018, FINRA undertook a multifaceted outreach initiative to engage with member firms regarding current and planned activities relating to digital assets, such as cryptocurrencies and other virtual coins and tokens.2 FINRA requested that communication be ongoing and asked that, until July 31, 2019, each member keep its Regulatory Coordinator informed of new activities or plans regarding digital assets, including cryptocurrencies and other virtual coins and tokens (whether or not they meet the definition of "security" for the purposes of the federal securities laws and FINRA rules).3 FINRA greatly appreciates the ongoing cooperation and outreach from members over the past year.

        As securities regulators continue to provide guidance to members regarding the unique regulatory challenges presented by digital assets—e.g., Joint Statement on Broker-Dealer Custody of Digital Asset Securities—FINRA believes it is important to keep the lines of communication with members open on this important topic.4 As a result, FINRA is issuing this Notice to encourage each firm to continue to keep FINRA up to date on the firm's new and planned activities relating to digital assets not previously disclosed.

        As was the case under Regulatory Notice 18-20, FINRA asks that each firm promptly notify its Regulatory Coordinator if it, or its associated persons (including activities under Rules 3270 and 3280),5 or affiliates, currently engages, or intends to engage, in any activities related to digital assets.6 As a reminder, the types of activities of interest to FINRA if undertaken (or planned) by a member, its associated persons or affiliates, include, but are not limited to:

        •   purchases, sales or executions of transactions in digital assets;
        •   purchases, sales or executions of transactions in a pooled fund investing in digital assets;
        •   creation of, management of, or provision of advisory services for, a pooled fund related to digital assets;
        •   purchases, sales or executions of transactions in derivatives (e.g., futures, options) tied to digital assets;
        •   participation in an initial or secondary offering of digital assets (e.g., ICO, pre-ICO);
        •   creation or management of a platform for the secondary trading of digital assets;
        •   custody or similar arrangement of digital assets;7
        •   acceptance of cryptocurrencies (e.g., bitcoin) from customers;
        •   mining of cryptocurrencies;
        •   recommend, solicit or accept orders in cryptocurrencies and other virtual coins and tokens;
        •   display indications of interest or quotations in cryptocurrencies and other virtual coins and tokens;
        •   provide or facilitate clearance and settlement services for cryptocurrencies and other virtual coins and tokens; or
        •   recording cryptocurrencies and other virtual coins and tokens using distributed ledger technology or any other use of blockchain technology.8

        Until July 31, 2020, FINRA encourages firms to promptly notify their Regulatory Coordinator in writing (including email) of these activities. If a firm already has submitted a continuing membership application (CMA)9 regarding its involvement in activities related to digital assets, or has otherwise provided this information to FINRA, additional notice is not requested unless a change has occurred.


        1. See See Regulatory Notice 18-20 (FINRA Encourages Firms to Notify FINRA if They Engage in Activities Related to Digital Assets) (July 6, 2018).

        2. For purposes of this Notice, the term "digital asset" refers to cryptocurrencies and other virtual coins and tokens (including virtual coins and tokens offered in an initial coin offering (ICO) or pre-ICO), and any other asset that consists of, or is represented by, records in a blockchain or distributed ledger (including any securities, commodities, software, contracts, accounts, rights, intangible property, personal property, real estate or other assets that are "tokenized," "virtualized" or otherwise represented by records in a blockchain or distributed ledger).

        3. Firms that engage in activities related to digital assets, whether or not they are securities, are reminded to consider all applicable FINRA rules and federal and state laws, rules and regulations. In addition, digital assets that meet the definition of an "investment contract" under Section 2(a) (1) of the Securities Act of 1933 or under Section 3(a)(10) of the Securities Exchange Act of 1934 are "securities" governed by the federal securities laws and FINRA rules, irrespective of whether or not they are labeled as "securities." On April 3, 2019, the Strategic Hub for Innovation and Financial Technology of the Commission published a framework for analyzing whether a digital asset has the characteristics of an "investment contract" and whether offers and sales of a digital asset are securities transactions. See Strategic Hub for Innovation and Financial Technology of the Securities and Exchange Commission, Framework for "Investment Contract" Analysis of Digital Assets (April 3, 2019) (Framework). See also Securities Exchange Act Release No. 81207 (July 25, 2017), Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO.

        4. See, e.g., Joint Staff Statement on Broker-Dealer Custody of Digital Asset Securities, Division of Trading and Markets, U.S. Securities and Exchange Commission and Office of General Counsel, Financial Industry Regulatory Authority, (July 8, 2019) (Joint Statement).

        5. FINRA continues to be interested in learning how firms handle notifications regarding participation in activities related to digital assets, such as cryptocurrencies and other virtual coins and tokens. See FINRA Rule 3270 (Outside Business Activities of Registered Persons) and Rule 3280 (Private Securities Transactions of an Associated Person). FINRA is not requesting notification or information regarding passive investments and activities of associated persons that are subject to the requirements of Rule 3210 (Accounts at Other Broker-Dealers and Financial Institutions).

        6. This notification is separate from any existing regulatory obligations under FINRA rules that may apply to a firm regarding its involvement in activities relating to digital assets (e.g., trade reporting transactions in digital assets that meet the definition of a "security" or filing a new member application or continuing member application). This notification also is separate from any other regulatory obligations that may apply to a firm regarding its involvement in activities relating to digital assets, such as submitting Form ATS filings as required, including notifications of "material changes" under Regulation ATS, such as changes to the types of securities traded on a platform. See Securities Exchange Act Release No. 40760 (December 8, 1998), 63 FR 70845, 70922 (December 22, 1998) (Regulation ATS adopting release) (including changes to "the operating platform, the types of securities traded, or the types of subscribers" as examples of "material changes" that must be filed under Rule 301(b)(2) of Regulation ATS); see also Regulatory Notice 09-46 (August 2009) (reminding alternative trading systems of the need to submit to FINRA duplicate copies of any filing required by Rule 301(b)(2) of Regulation ATS).

        7. See Joint Statement (stating that "[t]he specific circumstances where a broker-dealer could custody digital asset securities in a manner that the Staffs believe would comply with the Customer Protection Rule remain under discussion, and the Staffs stand ready to continue to engage with entities pursuing this line of business.").

        8. Cryptocurrencies and other virtual coins and tokens use distributed ledger technology, most commonly known as "blockchain," as the primary protocol for exchanging, storing and verifying information.

        9. A material change in a firm's business operations also requires the submission and approval of a CMA. See, e.g., Joint Statement, note 7 and accompanying text. For factors to consider in determining materiality, see Notice to Members 00-73 (SEC Approves Amendments to NASD Membership Rules). See also FINRA Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations).

      • 19-23 FINRA Supplements Prior Guidance on Credit for Extraordinary Cooperation

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        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Legal
        Operations
        Senior Management
        Extraordinary Cooperation Referenced Rules & Notices

        FINRA Rule 4530
        FINRA Rule 8210
        FINRA Rule 8313
        Regulatory Notice 08–70
        Regulatory Notice 11–32
        Regulatory Notice 19–04
        Sanction Guidelines

        Summary

        FINRA is issuing this Notice to restate and supplement prior guidance regarding the circumstances under which a firm or individual may influence the outcome of an investigation by demonstrating extraordinary cooperation. This Notice incorporates FINRA's prior guidance and provides clarification and additional information about how FINRA assesses whether a potential respondent's cooperation is "extraordinary" and distinct from the level of cooperation expected of all member firms and their associated persons.

        Questions concerning this Notice should be directed to:

        •   Lara Thyagarajan, Senior Vice President & Counsel to the Head of Enforcement, at (212) 858–4176 or Lara.Thyagarajan@finra.org; and
        •   Megan Davis, Senior Counsel, Enforcement, at (646) 315–7336 or Megan.Davis@finra.org.

        Background & Discussion

        FINRA recognizes extraordinary cooperation by respondents when making its enforcement determinations. In 2008, FINRA published Regulatory Notice 08–70 to apprise industry participants of the factors FINRA considers in determining whether and how to award credit for extraordinary cooperation in a FINRA investigation. FINRA noted that the types of extraordinary cooperation by a firm or individual that could result in credit can be categorized as follows: (1) self-reporting before regulators are aware of the issue; (2) extraordinary steps to correct deficient procedures and systems; (3) extraordinary remediation to customers; and (4) providing substantial assistance to FINRA's investigation. The guidance set forth in Regulatory Notice 08–70 is restated and incorporated into this Notice.

        Subsequent changes to FINRA's rules, including the adoption of FINRA Rule 4530(b) — which requires member firms to report internal conclusions of violations of certain laws, rules, regulations or standards of conduct — may have created uncertainty around the continued impact that self-reporting may have on a potential respondent's ability to receive credit for extraordinary cooperation. In addition, other FINRA rules and policies — such as FINRA Rule 8210 and FINRA's Sanction Guidelines — expect certain levels of cooperation in every case.

        To provide further clarity on the differences between required cooperation and extraordinary efforts, and in response to comments from the industry requesting further transparency,1 FINRA is issuing this Notice, which incorporates its prior guidance and provides additional information regarding the circumstances under which credit for extraordinary cooperation will be awarded and the nature of credit available. In doing so, FINRA hopes to incentivize firms and associated persons to voluntarily and proactively assist FINRA. This, in turn, will aid FINRA in meeting its objectives of investor protection and market integrity by quickly identifying and remediating misconduct.

        What Is Extraordinary Cooperation?

        FINRA's Sanction Guidelines state, "Sanctions in disciplinary proceedings are intended to be remedial and to prevent the recurrence of misconduct."2 While disciplinary actions are an important tool that FINRA uses to achieve the goals of remediation and prevention, actions taken by member firms and associated persons are also an important part of that effort. Action by member firms and associated persons that demonstrates their commitment to remediating past misconduct and preventing recurrence is essential to furthering FINRA's mission of investor protection and market integrity.

        Therefore, FINRA always considers factors such as corrective measures and payment of restitution in assessing whether a disciplinary action is necessary, and, if so, what sanctions are appropriate. FINRA's Sanction Guidelines direct Enforcement to consider whether a respondent:

        i. accepted responsibility for and acknowledged the misconduct prior to detection and intervention by the firm or a regulator;3
        ii. voluntarily employed subsequent corrective measures, prior to detection or intervention by the firm or by a regulator, to revise general and/or specific procedures to avoid recurrence of the misconduct;4
        iii. voluntarily and reasonably attempted, prior to detection and intervention by a regulator, to pay restitution or otherwise remedy the misconduct;5 and
        iv. provided substantial assistance to FINRA in its examination and/or investigation of the underlying misconduct.6

        FINRA has and will continue to look to these factors when assessing sanctions in disciplinary matters.7 For example, Enforcement may recommend a sanction that is on the low end of the specified range in the Sanction Guidelines based on the presence of these mitigating factors. In certain circumstances, Enforcement also may determine to forgo recommending formal disciplinary action entirely.

        Enforcement may recommend a sanction that is well below the range set forth in the Sanction Guidelines or comparable precedents when respondents have voluntarily provided such material assistance to FINRA in its investigation, or effected such expedient and effective remediation, that FINRA deems these steps to constitute "extraordinary cooperation" beyond what it requires of any member firm or associated person. Member firms and associated persons who take proactive and voluntary steps well beyond those required under FINRA rules materially assist FINRA in meeting its goals of investor protection and market integrity. To recognize and incentivize such conduct, FINRA weighs these mitigating factors so heavily that the outcome of the matter is materially different than it would have been absent the respondent's extraordinary conduct.

        In several matters in recent years, FINRA has granted substantial credit to firms based on their extraordinary cooperation:

        •   Beginning in 2015 through 2018, FINRA ordered a number of firms to pay more than $75 million in restitution, including interest, to affected customers for failing to waive mutual fund sales charges for certain charitable and retirement accounts. FINRA did not impose fines in those matters based on the firms' extraordinary cooperation. Firms initiated, prior to detection or intervention by a regulator, investigations to identify whether the misconduct existed; promptly established a plan of remediation for affected customers; promptly self-reported the conduct to FINRA; promptly took action and remedial steps to correct the violative conduct; and employed subsequent corrective measures, prior to detection or intervention by a regulator, to revise their procedures to avoid recurrence of the misconduct.
        •   In September 2017, FINRA ordered a respondent firm to pay approximately $9.8 million in restitution to customers who were affected by the firm's failure to establish and maintain a supervisory system reasonably designed to detect and prevent unsuitable short-term trading of unit investment trusts. While FINRA fined the firm $3.25 million, this reflected substantial credit for the firm's extraordinary cooperation and remediation to customers. The firm initiated, prior to intervention by a regulator, a firm-wide investigation to identify the scope of potentially unsuitable trades, which included the interview of a substantial number of firm personnel and the retention of an outside consultant to conduct a statistical analysis; identified harmed customers and established a plan to provide remediation; and provided substantial assistance to FINRA in its investigation.
        •   In October 2018, FINRA sanctioned a firm for failures to supervise firm functions it outsourced to a vendor. FINRA did not impose a fine, acknowledging, among other things, the firm's self-report, which extended beyond its obligation to self-report pursuant to FINRA Rule 4530; the extraordinary steps the firm took to remediate, including weekly meetings with the vendor's CEO and COO, hiring two full-time employees to implement controls, and assigning a dedicated manager to oversee the vendor; changing its billing structure to avoid similar issues; and conducting a comprehensive review of all its wealth management accounts to identify impacted investors, whom it voluntarily paid $4.6 million in restitution.

        FINRA resolved these matters in consideration of the factors set forth in both the Sanction Guidelines and Regulatory Notice 08–70, including a consideration of both the timeliness and quality of the respondents' corrective measures and cooperation. FINRA believes these cases are good examples of its existing policy. Although the impact of extraordinary cooperation depended upon the facts and circumstances of each particular case, these matters demonstrate, among other things, that the receipt of substantial credit depended on corrective measures and cooperation aimed at broadly and quickly remediating harm.

        Most recently, in January 2019, FINRA announced in Regulatory Notice 19–04 its 529 Plan Share Class Initiative, encouraging firms to review their supervision of 529 plan sales. FINRA described common supervisory issues it had observed concerning share class recommendations and stated that it would recommend settlements with no fines for firms that choose to review their supervisory systems and procedures, self-report supervisory violations, and provide FINRA with a plan to remediate harmed customers. This initiative was announced to promote firms' compliance with the rules governing 529 plan recommendations, to promptly remedy violations, and to return money to harmed investors as quickly and efficiently as possible.

        As in these prior matters, FINRA will continue to consider the factors that are set forth in the Sanction Guidelines and Regulatory Notice 08–70 when determining whether credit will be given for extraordinary cooperation. Those factors are reiterated below, with additional guidance regarding how they impact FINRA's decision making:

        1. Providing Credit for Steps Taken to Correct Deficient Procedures and Systems

        When a firm identifies a problem involving deficient supervisory systems, procedures and controls, the firm must take corrective steps to fully remediate the problem. In considering whether to provide substantial credit for extraordinary cooperation, FINRA will consider whether a firm's steps to correct deficient systems and procedures go beyond these baseline requirements. Examples of corrective steps that may result in credit for extraordinary cooperation include:

        •   Engaging or conducting an independent audit or investigation that is thorough and far-reaching in scope beyond the immediate issue, with an eye toward identifying and remediating all related misconduct that may have occurred.
        •   Hiring independent consultants to ensure the adoption and implementation of improved supervisory systems, procedures and controls.
        •   Where the root cause of a violation relates to organizational weaknesses such as where a firm dedicated inadequate staff to the supervision of a particular business line, making organizational changes by, for example, creating new supervisory positions, adjusting reporting lines or, if necessary, removing or disciplining responsible individuals, including those in supervisory roles (although personnel changes are not necessarily required to achieve extraordinary cooperation).

        FINRA will consider whether the firm took these or other corrective steps promptly following its discovery of the misconduct, prioritizing the remediation of any deficiencies. Additionally, FINRA will consider whether the firm maintained an open dialogue with FINRA staff regarding improvements to supervisory systems, procedures and controls, and provided FINRA with ready access and information to evaluate whether new systems, procedures and controls are reasonable.

        FINRA staff will also consider the breadth of a firm's remediation. For example, if a firm identifies deficient procedures that affect a particular department or product line, the firm must review and correct the identified procedures. In contrast, FINRA may consider the firm's responses "extraordinary" when the firm conducts a broader assessment, which goes beyond the scope of the original investigation, and looks for and remediates similar deficiencies in procedures that govern other aspects of its business.

        Although FINRA will, consistent with the Sanction Guidelines, take into consideration the timing of steps taken to correct deficient systems or procedures when deciding whether to award credit,8 FINRA recognizes that there is some tension between expecting firms to report misconduct promptly and, at the same time, giving priority to corrective measures that a firm takes prior to detection by FINRA or other regulators (e.g., prior to any self-report). For that reason, and in order to encourage the timely self-reporting of misconduct, FINRA will consider, in appropriate circumstances, giving credit for corrective measures taken promptly after a firm reports the misconduct.
        2. Providing Credit for Restitution to Customers

        FINRA's overarching mission is to protect investors and promote vibrant markets. As FINRA has previously stated, when a member firm or registered representative engages in misconduct, restitution for harmed customers is our highest priority. Therefore, if a respondent's misconduct has caused customer harm, it will be difficult for that respondent to obtain credit for extraordinary cooperation without making complete and timely restitution to injured customers.

        The Sanction Guidelines recognize the importance of prompt restitution and treat as a mitigating factor for sanctions purposes the fact that a firm or associated person voluntarily paid restitution prior to detection or intervention by a regulator.9 Because FINRA expects firms and associated persons to make full restitution to injured customers10 in all cases, the mere payment of restitution will not result in credit for extraordinary cooperation. Rather, as with other corrective measures, FINRA will consider whether a firm or associated person has proactively and voluntarily taken extraordinary steps to ensure that restitution is paid as quickly as possible, in a manner that ensures all harmed customers are made whole.

        This is particularly relevant in matters involving widespread, systemic failures, where identifying injured customers and calculating each individual's losses can be complex and time consuming. For example, where a firm's failure to supervise compliance with its suitability obligations has resulted in customer losses, it could review the recommendations made in each of its customer's accounts, calculate individual losses resulting from the failure to comply with the suitability duty, and pay restitution to the customers who were harmed. This complex process can take significant time. An extraordinary step, in contrast, could be one that significantly accelerates the process in order to return money to investors sooner. For example, implementing a methodology to efficiently identify customers for restitution, such as a statistical approach, could meaningfully reduce the time it would take for investors to receive restitution. Similarly, taking steps to accelerate a trade-by-trade review (such as dedicating staff members, hiring temporary help, paying for overtime, or re-prioritizing other projects) may constitute extraordinary efforts.

        When assessing whether a respondent has exceeded expectations regarding restitution, FINRA will consider whether the respondent is proactive about identifying and proposing an expeditious methodology, and willing to engage in a dialogue with FINRA and other regulators about the appropriate way to identify the pool of affected customers and to calculate the amount of restitution to pay back customers as swiftly as possible. Even where restitution is paid after FINRA becomes aware of the misconduct (for example, if the firm reports the misconduct within 30 days of discovery as required by Rule 4530), FINRA will consider whether to award credit when the restitution remediated all potential harm and was paid promptly at the initiative of the firm, prior to any order by FINRA or another regulator.
        3. Self-Reporting of Violations

        One reason for this updated guidance is to clarify how FINRA considers self-reporting in light of the adoption of Rule 4530. Rule 4530 replaced NASD Rule 3070 in February 2011 and, in subsection (b), unlike its predecessor, requires member firms to self-report internal conclusions regarding violations of certain laws, rules, regulations or standards of conduct. Although self-reporting of such internal conclusions was already required for NYSE member firms under NYSE Rule 351(a)(1), FINRA Rule 4530(b) represented a significant change for many firms.

        As noted previously in the Rule 4530 Frequently Asked Questions, to be considered "extraordinary cooperation," self-reporting must, at a minimum, "go significantly beyond" what is required to comply with regulatory obligations.11 Credit will not be awarded to firms merely for complying with their reporting obligations under Rule 4530. Nor will firms and associated persons be given credit for merely complying with their obligations to provide information or testimony in response to regulatory requests made pursuant to Rule 8210. If, however, a firm self-reports misconduct that does not fall within the reporting requirements of Rule 4530, then self-reporting will be considered in determining whether to award credit.

        In matters where a self-report is required pursuant to Rule 4530, FINRA will consider whether the firm self-reports information beyond that which is required by the rule. For example, a firm exceeds its regulatory obligation when it proactively and voluntarily asks to meet with FINRA staff, provides summaries of key facts, and identifies and explains key documents. This type of substantial assistance is further described below.

        FINRA also will consider whether the firm proactively detected the misconduct through compliance, audits or other surveillance, as opposed to identifying the misconduct only after receiving notice from customers, counterparties or regulators. FINRA also will consider whether the firm made diligent efforts to identify and inform FINRA of the relevant facts as soon as it discovered the issue, and kept FINRA updated as it learned new facts through continuing investigation.

        Finally, FINRA will consider whether the firm reported the misconduct to the public and other regulators, as appropriate. FINRA also may consider the level of the firm's cooperation with other regulators and, if appropriate, law enforcement bodies, particularly in matters where multiple agencies are investigating the misconduct.12
        4. Providing Substantial Assistance to FINRA Investigations In addition to the above factors, FINRA also will consider giving credit to firms or associated persons for providing substantial assistance to FINRA in its investigation of the underlying misconduct.13 In assessing whether firms have provided substantial assistance, FINRA will consider the degree of assistance that might be expected given a firm's size and resources, as well as the scope of the misconduct within the organization and the steps taken to address systemic deficiencies; there is no one-size-fits-all approach to the steps that FINRA would consider substantial assistance. Credit is potentially available to any firm or individual that cooperates substantially, including the largest broker-dealers and single-employee firms.

        To constitute substantial assistance, industry participants should fully inform FINRA about the potential misconduct — including all relevant issues, products, markets and industry participants — in ways that go far beyond merely responding to requests made under Rule 8210. For example, substantial assistance deserving of credit might include:

        •   volunteering relevant information that the firm believes would be helpful even if FINRA did not directly request the specific documents or information;
        •   providing analysis of trading or other activity that assists FINRA in understanding the conduct at issue;
        •   volunteering facts related to the involvement of particular parties who may have committed violations;
        •   providing demonstrations of trading or other systems at issue;
        •   after identifying misconduct by an individual employee, conducting a thorough and expeditious review of the employee's misconduct and promptly sharing the findings with FINRA;
        •   volunteering relevant industry knowledge to help FINRA quickly assimilate information about a complex product or practice. Examples could include providing information about the considerations or issues that affect an industry-wide common practice;
        •   providing detailed summaries or chronologies of relevant events prior to receiving a Rule 8210 or other regulatory request;
        •   voluntarily assisting FINRA in obtaining effective access to firm offices, records or computer systems prior to receiving a Rule 8210 or other regulatory request;
        •   identifying witnesses who possess relevant information, including witnesses over whom FINRA lacks jurisdiction, and making those witnesses available for interviews; and
        •   conducting a thorough and independent audit or investigation, using counsel or consultants where appropriate, and fully disclosing the findings to FINRA.14

        What Type of Credit Will Be Given in Return for Extraordinary Cooperation?

        When FINRA determines that a firm should be given credit for extraordinary cooperation, that credit may take many forms. For example, where a problem has been fully remediated, FINRA often concludes that no enforcement action is warranted and closes an investigation with no further action or with a Cautionary Action Letter.

        In other cases, FINRA might determine that an enforcement action is appropriate to remedy or prevent harm, even where a firm has provided extraordinary cooperation. In those matters, FINRA may provide credit by reducing the sanctions imposed. When credit is given in the form of a reduced fine, the reduction normally will be substantial. Indeed, in appropriate cases, as illustrated in several of the examples above, FINRA may consider imposing formal discipline without any fine. FINRA also may give credit by declining to require an undertaking. For example, FINRA may forego requiring a firm to hire an independent consultant where, although a systemic deficiency is in an extended period of remediation, the firm is taking other extraordinary steps to address the problem.

        How Does FINRA Plan To Be More Transparent About Credit for Extraordinary Cooperation?

        In each case where the applicable principal considerations and the factors set forth in this Regulatory Notice result in a respondent receiving credit for extraordinary cooperation, FINRA will include in the Letter of Acceptance, Waiver and Consent (AWC) memorializing the settlement a new section titled, "Credit for Extraordinary Cooperation." FINRA will describe the factors that resulted in credit being given, as well as the type of credit.

        In order to provide more useful guidance to the industry, FINRA will take additional steps to distribute information about instances when it has deemed cooperation to be extraordinary, in ways that are more accessible and easier to identify. For example, FINRA occasionally issues press releases in connection with individual cases to highlight matters deemed worthy of public attention.15 In press releases, FINRA will note factors that led the respondent to receive credit, as well as the type of credit. Similarly, when FINRA proceeds without formal action in connection with an investigation, traditionally FINRA has not made public a statement regarding the action. Going forward, when FINRA gives credit for extraordinary cooperation that results in FINRA electing to proceed without formal action, FINRA will determine, on a case-by-case basis, whether it would be useful to provide additional transparency regarding the factors that led to FINRA's decision and, when appropriate, publish information about those individual cases. Unless the firm or associated person gives permission to be named, FINRA will preserve their anonymity by describing the respondents' extraordinary cooperation at a sufficiently high level to shield their identities.

        FINRA also seeks to provide clear guidance on the difference between matters characterized by extraordinary cooperation, and matters in which the respondent's conduct did not exceed its regulatory obligations but sanctions determinations were materially affected by other considerations. As described above, FINRA always considers factors such as corrective measures and payment of restitution in assessing whether a disciplinary action is necessary and what sanctions are appropriate. For example, the Principal Considerations in the Sanction Guidelines include "Whether the respondent voluntarily and reasonably attempted, prior to detection and intervention, to pay restitution or otherwise remedy the misconduct." Accordingly, Enforcement may consider a firm's voluntary payment of restitution to be mitigating and recommend a sanction on the low end of the specified range in the Sanction Guidelines. In contrast, Enforcement may consider it "extraordinary" if a firm takes significant steps to effect speedy restitution, such as re-prioritizing other projects or developing a rules-based approach to accelerate the process. Under those circumstances, FINRA may consider these additional steps so extraordinary that it recommends a sanction well below the Sanction Guidelines or other similar cases.

        At other times, the presence of aggravating factors may materially affect the sanction determination. For example, even if a respondent remediates the problem and makes restitution as expected, FINRA may recommend a more severe sanction due to aggravating factors in the matter, such as prior disciplinary history;16 the nature of the underlying misconduct, including whether the misconduct was intentional or reckless,17 involved numerous acts or a pattern of misconduct, and continued over an extended period of time;18 the nature and extent of injury to the investing public, a member firm and other market participants;19 whether the respondent profited from the misconduct;20 and whether the respondent engaged in the misconduct notwithstanding prior warnings from FINRA, another regulator or a supervisor.21

        In general, the factual findings set forth in an AWC should always include any facts that were considered as aggravating or mitigating for sanctions purposes. However, where appropriate an AWC may also include a new section titled, "Sanctions Considerations." In that section, FINRA may identify mitigating or aggravating factors (such as those discussed in the relevant Principal Considerations from the Sanction Guidelines) that affected FINRA's sanction determination.

        Can Individuals Also Receive Credit for Extraordinary Cooperation?

        Credit for extraordinary corrective measures and cooperation is available to individuals as well as firms. FINRA believes many of the principles discussed above may apply equally to individuals. For example, although individuals may not be able to correct deficient firm procedures and systems, they may still self-report misconduct, provide substantial assistance during an investigation, and pay restitution to customers with appropriate notice to and involvement by a member firm. However, the presence of aggravating factors may weigh against credit for extraordinary cooperation, and certain aggravating factors are more likely to be present in cases involving individuals, such as intentional or reckless misconduct,22 attempts to conceal misconduct from a member firm,23 and misconduct notwithstanding prior warnings from a supervisor.24

        In evaluating whether to give credit to an individual, FINRA also will consider the same four general factors outlined in the SEC's policy regarding cooperation by individuals: (1) the assistance provided by the individual; (2) the importance of the underlying matter in which the individual cooperated; (3) the societal interest in holding the individual accountable for his or her misconduct; and (4) the appropriateness of credit based upon the profile of the cooperating individual.25


        1. See May 8, 2017, letter from the Securities Industry and Financial Markets Association to FINRA in response to Special Notice — Engagement Initiative (Mar. 21, 2017), at 8 (urging FINRA to, among other things, "publicize when good credit is given").

        2. Sanction Guidelines (March 2019 version), at 3.

        3. Principal Consideration No. 2.

        4. Principal Consideration No. 3.

        5. Principal Consideration No. 4.

        6. Principal Consideration No. 12.

        7. As was the case with Regulatory Notice 08–70, this Notice is intended to provide the industry with additional guidance concerning the factors that FINRA considers in assessing whether formal discipline is warranted and, if so, the appropriate sanctions in the context of settlement discussions prior to initiation of a disciplinary proceeding. Nothing herein is intended to alter the Sanction Guidelines, FINRA rules or other applicable requirements.

        8. See Principal Consideration No. 3 (treating as a mitigating factor corrective measures taken "prior to detection or intervention" by a regulator).

        9. Principal Consideration No. 4.

        10. FINRA reminds associated persons that paying restitution or otherwise settling a customer complaint without notice to the firm is a violation of FINRA Rule 2010, and can result in sanctions of up to two years or, in egregious cases, a bar. Sanction Guidelines, at 34.

        11. Regulatory Notice 11–32, A6.

        12. Cf. General Principles Applicable to All Sanction Determinations, No. 7 (directing adjudicators to consider, where appropriate, sanctions previously imposed by other regulators for the same conduct).

        13. Principal Consideration No. 12.

        17. Principal Consideration No. 13.

        18. Principal Consideration Nos. 8, 9.

        19. Principal Consideration No. 11.

        20. Principal Consideration No. 16.

        21. Principal Consideration No. 14.

        22. Principal Consideration No. 13.

        23. Principal Consideration No. 10.

        24. Principal Consideration No. 14.

        25. SEC Policy Statement Concerning Cooperation by Individuals in its Investigations and Related Enforcement Actions, Release No. 34–61340, 17 CFR Part 202 (Jan. 19, 2010).

      • 19-22 FINRA Requests Comment on a Proposal to Publish ATS Volume Data for Corporate Bonds and Agency Debt Securities on FINRA's Website; Comment Period Expires: September 7, 2019 [PDF]

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        GASB Accounting Support Fee

        Regulatory Notice
        Notice Type

        Request for Comment
        Suggested Routing

        Compliance
        Fixed Income
        Legal
        Operations
        Senior Management
        Systems
        Trading
        Key Topics

        Alternative Trading Systems
        Fixed Income
        TRACE-Eligible Security
        Transparency
        Referenced Rules

        FINRA Rule 6110
        FINRA Rule 6610
        FINRA Rule 6710
        FINRA Rule 6720
        FINRA Rule 6730
        FINRA Rule 6732
        FINRA Rule 6750

        Summary

        FINRA requests comment on a proposal to expand the alternative trading system (ATS) volume data that it publishes on its website to include information on transactions in corporate bonds and agency debt securities that occur within an ATS and are reported to FINRA's Trade Reporting and Compliance Engine (TRACE).

        Questions regarding this Notice should be directed to the:

        •   Chris Stone, Vice President, Transparency Services, at (202) 728-8457 or chris.stone@finra.org;
        •   Patrick Geraghty, Vice President, Market Regulation, at (240) 386-4973 or patrick.geraghty@finra.org;
        •   Racquel Russell, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8363 or racquel.russell@finra.org; or
        •   Robert McNamee, Assistant General Counsel, OGC, at (202) 728-8012 or robert.mcnamee@finra.org.

        Action Requested

        FINRA encourages all interested parties to comment on the proposal. Comments must be received by September 7, 2019.

        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: The only comments that FINRA will consider are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the FINRA website. Generally, FINRA will post comments as they are received.1

        Before becoming effective, the proposed rule change must be filed with the Securities and Exchange Commission (SEC) pursuant to Section 19(b) of the SEA.2

        Background & Discussion

        To improve market transparency relating to trading occurring on ATSs, in June 2014, FINRA began publishing individual ATS volume information for equity securities on its website.3 In its proposed rule change relating to ATS data publication, FINRA stated that it intended "periodically to assess the reporting and publication of information to consider whether modifications to the scope of securities covered, the delay between the activity and publication, or the frequency of publication of the information are appropriate."4 FINRA also stated that it would not publish data for TRACE-Eligible Securities5 until FINRA "had the opportunity to evaluate the data…and the differences between the existing trade reporting regimes applicable to equity and debt securities."6 Since that time, FINRA has been evaluating ATS data and believes it is now appropriate to include individual ATS volume data for certain TRACE-Eligible Securities.

        Accordingly, FINRA is soliciting comment on a proposal to publish volume and trade count information for corporate and agency debt securities,7 categorized by individual security (i.e., CUSIP) and ATS, in a format similar to that currently published for equity securities.8 The published data would include both the total number of transactions and aggregate dollar volume traded for transactions in a particular corporate bond or agency debt security executed within the ATS and reported to FINRA during the aggregation period. The ATS data would be aggregated on a monthly basis and published with a three-month delay (e.g., aggregate ATS data for the month of February 2019 would be published in June 2019).9 FINRA would not charge for the aggregated ATS fixed income data, which would be published on FINRA's website.

        While FINRA recognizes that there are other significant fixed income electronic trading platforms that are not ATSs, for example, request-for-quote (RFQ) platforms, FINRA believes it is appropriate at this time to take a phased and measured approach, as was done with equity securities. Specifically, the proposal would initially be limited to ATSs, which currently are identifiable in TRACE by a unique market participant identifier (MPID) pursuant to Rule 6720(c) (Alternative Trading Systems). FINRA also believes it is appropriate initially to limit fixed income ATS data publication to corporate and agency debt securities because these product types account for the majority of publicly identified ATS activity in TRACE-Eligible Securities.10 FINRA may consider including additional asset classes in published ATS volume data in the future; e.g., transactions involving Securitized Products.11

        Similar to the approach with the publication of ATS equity volume, FINRA proposes initially to require that each ATS self-report to FINRA its aggregate weekly volume information and number of trades, by security, in corporate and agency debt securities that are TRACE-Eligible Securities. Self-reporting by ATSs would occur on a security-by-security basis within seven business days after the end of each week. FINRA would then publish the data as described above. As with the ATS equity volume data, FINRA staff intends to compare the self-reported ATS volume data with the transaction information firms report to TRACE to verify the accuracy of volume and trade counts.12 Once FINRA is comfortable with relying on trade reporting data to calculate the volume, it would eliminate the self-reporting requirement and would derive the published data directly from the transaction information reported to TRACE.

        FINRA proposes that the published data would reflect: (1) sale trades and related volume reported by the ATS;13 and (2) the sell-side of trades and related volume between member subscribers where the ATS is identified on the trade report pursuant to Rule 6730(c)(13)14 (i.e., an exempt ATS).15 FINRA believes this approach would help ensure that the published trade counts and corresponding volume information do not reflect multi-leg or dually reported transactions more than once.

        Economic Impact Assessment

        FINRA has undertaken an economic impact assessment, as set forth below, to analyze the regulatory need for the proposed rule change and its potential economic impacts, including anticipated costs and benefits.

        Regulatory Need

        FINRA is proposing to publish volume and trade count information for corporate and agency debt securities, with the intent to improve market transparency relating to trading in these instruments on ATSs. As mentioned above, FINRA makes similar information for equity securities available to the public, and has received support from the industry on its transparency initiatives in the equity markets.16

        Economic Baseline

        Pursuant to FINRA Rule 6720(c) (Alternative Trading Systems), since February 2, 2015, TRACE participants that operate an ATS have been required to use a separate MPID to report all transactions that are executed within the ATS to TRACE. Also, since 2016, disseminated TRACE transactions contain a new identifier to indicate when the reporting party or contra-party is an ATS or when a trade is executed on an ATS.17 Therefore, market participants can today observe real-time whether a party to a disseminated transaction is a dealer, non-member affiliate of a member, customer or an ATS.

        However, real-time dissemination does not disclose the identity of the ATSs, as all ATSs are identified using a generic ATS reporting party and contra-party type and an ATS flag. Hence, market participants currently lack a relevant component in evaluating the historical location of liquidity in individual corporate bond and agency debt issues.

        To assess the current structure of the market, FINRA analyzed a sample of corporate bond and agency debt transactions reported to TRACE between August 2016 and November 2018. In the sample period, there were, on average, 923,511 trades in a month for corporate bonds and 32,474 trades in a month for agency debt, corresponding to an average monthly dollar volume of approximately $427 billion and $66 billion, respectively. Trades in corporate bonds occurred on 16 unique ATSs and trades in agency debt securities occurred on nine unique ATSs. While ATS trades accounted for between 25 percent and 30 percent of total transactions in all corporate bonds, for agency debt securities, such statistic increased from approximately 18 percent in the beginning of the sample period to over 30 percent in the last quarter of 2018.

        There were, on average, 20,566 and 3,001 unique corporate bond and agency debt CUSIPs, respectively, that traded in a given month during the sample period. Approximately 59 percent of the corporate bond and 54 percent of the agency debt CUSIPs that traded in a given month traded on at least one ATS. In the sample of bonds that traded on at least one ATS, a corporate bond traded, on average, on 2.43 ATSs in a given month, whereas the same figure was 1.52 for an agency debt security.

        Approximately 98 percent of the trading activity on ATSs occurred against brokerdealers, whereas the remaining were against other market participants; i.e., customers or non-member affiliates of broker-dealers. An ATS had, on average, 63 broker-dealer counterparties in a month in corporate bonds and 31 broker-dealer counterparties in agency debt.

        Economic Impacts

        The current proposal would expand the benefits of FINRA's ATS transparency program to market participants by providing transparency on monthly aggregate trading on ATSs in corporate bond and agency debt securities. The additional information may help broker-dealers and their customers in assessing where liquidity is concentrated, and may mitigate some of the search costs associated with seeking a counterparty to a trade. Economic theory suggests that reduced search costs would be associated with fewer lost opportunities to trade. Similarly, such information may inform routing decisions and may help achieve a better execution, such as by providing a better price or a faster execution.

        As noted above, the proposed rule change initially imposes a new weekly reporting obligation on ATSs. FINRA expects that ATSs impacted by this proposal should already maintain this information pursuant to Regulation ATS. Because of the existing recordkeeping obligations in Regulation ATS, FINRA does not believe that the weekly reporting requirements in the proposed rule change will impose significant costs on firms or will require firms to expend significant resources.

        As discussed above, once FINRA eliminates the self-reporting requirement and starts deriving the published data directly from the transaction data, the proposal to publish aggregate ATS trade counts and volume data would not impose any additional reporting requirements on firms, and as a result would impose no direct costs on firms. Some ATSs may choose to incur costs to verify the information FINRA publishes (e.g., trade counts), but these costs are not anticipated to be material and would be incurred only at the discretion of the ATS.

        In developing this proposal, FINRA considered the potential impacts on competition, both among firms and ATSs. Specifically, FINRA considered the potential that market participants could reverse engineer the aggregated trade counts and volume data. Such data could potentially be analyzed to infer whether there was a single counterparty to an ATS trade in a given CUSIP, in a given month, on an ATS. In such a case, it may be possible for a participant to take advantage of such information when the same counterparty tries to take a position on the opposite side of the trade. However, the publication would be subject to a three month delay, which could mitigate such potential impact.

        The analysis of the trade data between August 2016 and November 2018 indicated that, in the sample period, aggregate monthly trade counts and volume data at the CUSIP and ATS level would include trading activity of, at the median, two (one) broker-dealers in corporate (agency) TRACE-eligible securities on a given ATS. Over the sample period, 38 percent (66 percent) of the transactions in the monthly reports would be associated with a single broker-dealer, assuming no de minimis threshold on the number of parties to transactions on an ATS.

        However, in the sample period, 50 percent of those broker-dealers would have trading activity with at least one other counterparty (for corporate bonds), whereas the same figure is only 19 percent for the broker-dealers in agencies, in a given CUSIP. Furthermore, CUSIPs that traded on at least one ATS in a given month, traded, on average, four to ten times more than CUSIPs that did not trade on at least one ATS. This finding implies that the proposed ATS reports would contain trade information for relatively more liquid securities where reverse engineering of trading patterns would be potentially less likely. Therefore, the proposed ATS reports are not likely to be useful in estimating the trading strategies or complete inventories of broker-dealers.

        FINRA also considered the direct competitive effects on ATSs that may potentially arise from disseminating the proposed trade data. To the extent that this information is not already observed by market participants, ATS subscribers who discover that trading had been concentrated–due to relatively higher liquidity or other reasons–in a single ATS or a few ATSs in a given CUSIP may choose to send orders exclusively to those ATSs. As a result, other ATSs that have relatively smaller trading volume may lose some market share in that CUSIP. Similarly, new ATSs may potentially find it harder to enter the market due to the heightened barriers to entry caused by the disclosure of information regarding concentration of trading in certain ATSs.

        Alternatives Considered

        FINRA will consider alternatives based on the feedback to the proposal.

        Request for Comment

        FINRA seeks comments on the proposal outlined above regarding publication of fixed income ATS volume information. FINRA requests that commenters provide empirical data or other factual support for their comments wherever possible. In addition to general comments, FINRA specifically requests comments on the following questions:

        •  Would expansion of individual ATS volume data to include information on corporate and agency debt securities provide valuable information to the marketplace?
        •  What, if any, benefits would commenters anticipate if FINRA were to begin publishing ATS volume data for corporate and agency debt instruments on its website?
        •  What, if any, concerns, including potential information leakage and reverse engineering concerns, would commenters have if FINRA were to begin publishing this ATS volume data on its website?
        •  Are there any potential competitive advantages or disadvantages to attributing corporate and agency debt transaction volume by ATS?
        •  Could the proposed publication of ATS corporate and agency debt volume data create barriers to entry for new ATSs, and if so, please describe?
        •  Should FINRA consider a de minimis activity threshold under which an ATS would not be identified in the published reports with respect to a security or would be aggregated with the volume of other ATSs, and, if so, what would be an appropriate threshold?
        •  FINRA proposes that the ATS volume and trade count data would reflect the sell-side of trades reported by an ATS and the sell side of inter-dealer trades where the ATS is identified on the trade report pursuant to Rule 6730(c)(13). Do commenters agree that this approach is the most appropriate? If not, what other approach would be more appropriate and why
        •  FINRA proposes to publish volume and trade count data by ATS and CUSIP for corporate and agency debt securities on a monthly aggregation schedule with a three-month delay. Do commenters agree with this approach?
        •  Is there an alternative schedule that might be more appropriate than monthly aggregation, and, if so, why?
        •  Is there an alternative delay period that might be more appropriate than three months, and, if so, why?
        •  Should aggregation periods or publication delays differ for corporates versus agencies, and, if so, why?
        •  Are there other types of tiering of the aggregation period or publication delays, based on volume, number of trades or some other factor, FINRA should consider? If so, what are they and why?
        •  Should FINRA consider groupings other than by CUSIP, such as by investment rating (e.g., investment grade rated and high yield categories by trade size), or some other factor?
        •  FINRA proposes initially to limit publication of ATS data to corporates and agencies. FINRA intends in the future to reconsider the appropriateness of including other types of disseminated TRACE-Eligible Securities.
        •  Do commenters agree with this approach? Would commenters suggest that FINRA include any different assets classes for initial publication, and, if so, why?
        •  What, if any, issues do commenters anticipate if FINRA were to expand publication of fixed income ATS volume data to include other asset classes in the future, such as Securitized Products?
        •  How would commenters like to see corporate and agency debt ATS volume data displayed; e.g., what categories or groupings of data would be most helpful?
        •  FINRA proposes to limit the current fixed income publication initiative to data on transactions that occur within an ATS. However, as noted above, FINRA is aware that there are other types of fixed income electronic trading platforms that are not ATSs. Should FINRA consider broadening the scope of the website publication initiative to include transactions on other fixed income trading mechanisms, such as RFQ platforms? If so, what types of platforms should be included, why, and how should they and/or the transactions executed on those platforms be defined and identified?
        •  Are there any other issues specific to the fixed income markets that FINRA should consider in connection with publishing aggregate ATS corporate and agency debt volume data?

        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 Section 19 of the Securities Exchange Act of 1934 (SEA) and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes, however, take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

        3. See OTC Transparency Data [https://otctransparency.finra.org/otctransparency/Agreement](for the best experience, please view this site using the latest version of Chrome, Firefox, Safari or Internet Explorer).

        4. See Securities Exchange Act Release No. 70676 (October 11, 2013), 78 FR 62862 (October 22, 2013) (Notice of Filing of File No. SR-FINRA-2013-042).

        5. Rule 6710(a) generally defines a "TRACE-Eligible Security" as a debt security that is United States ("U.S.") dollar-denominated and is: (1) issued by a U.S. or foreign private issuer, and, if a "restricted security" as defined in Securities Act Rule 144(a) (3), sold pursuant to Securities Act Rule 144A; (2) issued or guaranteed by an Agency as defined in Rule 6710(k) or a Government-Sponsored Enterprise as defined in Rule 6710(n); or (3) a U.S. Treasury Security as defined in Rule 6710(p). "TRACE-Eligible Security" does not include a debt security that is issued by a foreign sovereign or a Money Market Instrument as defined in Rule 6710(o).

        6. See Securities Exchange Act Release No. 70676 (October 11, 2013), 78 FR 62862 (October 22, 2013) (Notice of Filing of File No. SR-FINRA-2013-042).

        7. See The published ATS data would include the CUSIPs that are disseminated as part of FINRA's Corporate Bond Data Set and Agency Data Set.

        8. See OTC Transparency Data [https://otctransparency.finra.org/otctransparency/Agreement] (for the best experience, please view this site using the latest version of Chrome, Firefox, Safari or Internet Explorer).

        9. See By contrast, ATS data for equity securities is aggregated on a weekly basis and publication delays vary from two weeks for Tier 1 NMS stocks to four weeks for OTC equities. See Rules 6110 and 6610.

        10.FINRA would not include within the published ATS data any information on transactions in corporate or agency debt securities that FINRA does not disseminate pursuant to Rule 6750.

        11."Securitized Product" generally includes a security collateralized by any type of financial asset, such as a loan, a lease, a mortgage, or a secured or unsecured receivable, and includes but is not limited to an asset-backed security as defined in SEA Section 3(a)(79)(A), a synthetic asset-backed security, and any residual tranche or interest of any such security, which tranche or interest is a debt security for purposes of Rule 6710(a) and the Rule 6700 Series.

        12. See Securities Exchange Act Release No. 70676 (October 11, 2013), 78 FR 62862, 62865 (October 22, 2013) (Notice of Filing of File No. SR-FINRA-2013-042); Securities Exchange Act Release No. 76931 (January 8, 2016), 81 FR 4076 (January 25, 2016) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2016-002).

        13. Where the ATS is a reporting party and stands in between a trade on its platform (either between two members or between a member and a non-member), the published data will reflect only the ATS sale in connection with the overall transaction.

        14. Rule 6730(c)(13) requires that, where a member is reporting a transaction that occurred on an exempt ATS (pursuant to an exemption granted under Rule 6732), the member must include the ATS's separate MPID. FINRA would not require exempt ATSs that currently report trade data on a monthly basis under Rule 6732 to separately self-report volume and trade count data for exempt transactions.

        15. The published data would not include the buy-side of any member subscriber trades, or the sell-side of trades by a member subscriber against an ATS.

        16. See Letters in connection with File No. SRFINRA-2015-020 from Kerry Baker Relf, Head of Content Acquisition and Rights Management, Americas, Thomson Reuters, to Brett J. Fields, Secretary, SEC, dated July 20, 2015; and Theodore R. Lazo, Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, to Brett J. Fields, Secretary, SEC, dated July 30, 2015.

        17. See Securities Exchange Act Release No. 77404 (March 18, 2016), 81 FR 05770 (March 24, 2016) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2016-011).

      • 19-21 Margin Requirements for Exchange-Traded Notes

        View PDF

        Discovery in FINRA Arbitration

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

        Regulatory Notice 09-53
        Rule 4210
        Suggested Routing

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

        Exchange-Traded Notes
        Portfolio Margin
        Strategy-Based Margin

        Summary

        Pursuant to FINRA Rule 4210(f)(8)(A), FINRA is establishing higher strategy-based margin requirements for exchange-traded notes (ETNs) and options on ETNs in light of the complex nature of these products. The new requirements for initial and maintenance margin are detailed below.

        In addition, FINRA is clarifying that ETNs and options on ETNs are not eligible for portfolio margining under FINRA Rule 4210(g).

        If these measures would result in undue hardship to a firm or its customers, the firm may submit a written request to FINRA for additional time to comply with this Notice.

        Questions concerning this Notice should be directed to:

        •   Adam Rodriguez, Director, Credit Regulation, at (646) 315-8572 or adam.rodriguez@finra.org;
        •   Joseph David, Principal Specialist, at (646) 315-8444 or joseph.david@finra.org; or
        •   Kathryn Moore, Associate General Counsel, Office of General Counsel, at (202) 728-8200 or kathryn.moore@finra.org.

        Background & Discussion

        An ETN is an unsecured obligation of its issuer, typically a bank or other financial institution. However, ETNs are different from typical corporate bonds as, among other things, they do not pay interest and pay principal based on the performance of a reference index or benchmark. For this reason, an investment in an ETN can have a return similar to an investment in an exchange-traded fund (ETF) that is designed to track the performance of the index or benchmark referenced by the ETN.

        Though these products are also structured products that trade on an exchange, they differ in a few respects. For example, ETFs are generally equity products: an investor in an ETF, which is typically a registered investment company, owns shares of a fund, which represents an ownership interest in an underlying portfolio of assets. In contrast, as noted above, ETNs are unsecured debt, typically of a financial institution. Unlike ETFs, ETNs do not reflect ownership of an underlying portfolio of assets, and this feature exposes holders of an ETN to the creditworthiness of the issuer in addition to the risk of the reference index or benchmark. ETNs may also have "knock-out" features or give their issuers early redemption rights, which can cause the return on an ETN investment to further diverge from the return on an investment in an ETF that tracks the same index.1

        Increase in Strategy-Based Margin

        The maintenance margin requirements on all "margin securities," which include debt securities, are generally set by FINRA Rule 4210(c). The rule requires strategy-based accounts to maintain equity equal to 25% of the current market value of all margin securities long in the account, and the greater of 5% of the principal amount or 30% of the current market value of debt securities short in the account.

        As an exception to this general rule, reduced margin requirements for investment grade debt securities,2 listed non-equity securities3 and "other margin eligible non-equity securities"4 are set out in Rule 4210(e)(2)(C).5 Although ETNs may technically qualify for these reduced margin requirements (because they are listed on national securities exchanges and their issuers are generally rated investment-grade), they have materially different risk profiles than typical debt securities. Typical debt securities expose investors to issuer credit risk and a greater or lesser degree of interest rate risk, while ETN investors are exposed to issuer credit risk and also the risk of the reference index or benchmark. Because of the significance of the reference index or benchmark risk to an ETN position, FINRA believes that the exceptions provided by Rule 4210(e)(2)(C) should not apply to ETN positions in strategy-based accounts.

        Pursuant to FINRA Rule 4210(f)(8)(A),6 FINRA is excluding ETNs from the exceptions available for positions in ordinary investment grade debt securities, listed non-equity securities and "other margin eligible non-equity securities," and establishing for them:

        •  an initial and maintenance margin requirement of 25% of the current market value for ETNs held long in an account, and 30% of the current market value for ETNs held short; and
        •  an initial and maintenance margin requirement on listed options on ETNs of 20% of the underlying current market value of the ETN, and a minimum margin requirement of 10% of the underlying current market value of the ETN, in each case for purposes of the listed options and warrants requirements chart in Rule 4210(f)(2)(E)(i).7

        Further, similar to the approach taken in Regulatory Notice 09-53 with respect to leveraged ETFs, FINRA is increasing the margin requirements (including day trading requirements) for leveraged ETNs and their associated uncovered options by a factor commensurate with their leverage.8 The margin requirement on a leveraged ETN held long in an account is capped at 100% of its value; however, no such cap applies for a leveraged ETN held short.

        Portfolio Margin Treatment

        As an alternative to the strategy-based margin requirements specified in FINRA Rule 4210(c)-(f), FINRA Rule 4210(g) permits members to margin certain products according to a prescribed portfolio margin methodology that is based on the Options Clearing Corporation's (OCC) Theoretical Intermarket Margining System (TIMS) model.9 Portfolio margin is a risk-based margin methodology that was created to align margin requirements for equity securities with the overall risk of the portfolio. Portfolio margin usually results in lower margin requirements on hedged positions than strategy-based margin rules would impose on such hedged positions.

        ETNs and options on ETNs historically have been included in the TIMS file provided by the OCC, and as a result some firms have provided portfolio margin treatment to ETNs and options on ETNs when such products have been included in customer portfolio margin accounts. However, ETNs are not on the list of products that are eligible to be included in portfolio margin as provided in FINRA Rule 4210(g)(6).10 Therefore, firms may not apply the portfolio margin requirements provided by the TIMS model for positions in ETNs and options on ETNs held in portfolio margin accounts.11

        Effective on August 16, 2019, the OCC will be removing all ETNs and related options that are currently in the TIMS file.12

        Hardship Extension

        If the foregoing measures would result in undue hardship to a firm or its customers, the firm may submit a written request to FINRA for additional time to comply with this Notice. Such requests must include an explanation of the specific circumstances leading to the request and must be received by FINRA no later than July 26, 2019. Requests regarding margin may be directed to Adam Rodriguez or Joe David at the contact information stated at the top of this Notice.


        1. See, e.g., SEC Investor Bulletin, Exchange Traded Notes (ETNs) and FINRA Investor Alert, Exchange-Traded Notes–Avoid Unpleasant Surprises.

        2. Rule 4210(a)(10) defines "investment grade debt securities" as "any debt securities … if at the time of the extension of credit the issue, the issuer or guarantor, or any other outstanding obligation of the issuer or guarantor ranked junior to or on a parity with the issue or the guarantee is assigned a rating (implicitly or explicitly) in one of the top four rating categories by at least one nationally recognized statistical rating organization."

        3. Rule 4210(a)(15) defines "listed non-equity securities" as "any non-equity securities that: (A) are listed on a national securities exchange; or (B) have unlisted trading privileges on a national securities exchange."

        4. Rule 4210(a)(16) limits the term "other margin eligible non-equity securities" to:

        A. Any debt securities not traded on a national securities exchange meeting all of the following requirements:
        i. At the time of the original issue, a principal amount of not less than $25 million of the issue was outstanding;
        ii. The issue was registered under Section 5 of the Securities Act and the issuer either files periodic reports pursuant to Section 13(a) or 15(d) of the Exchange Act or is an insurance company which meets all of the conditions specified in Section 12(g)(2)(G) of the Exchange Act; and
        iii. At the time of the extensions of credit, the creditor has a reasonable basis for believing that the issuer is not in default on interest or principal payments; or
        B. Any private pass-through securities (not guaranteed by any agency of the U.S. government) meeting all of the following requirements:
        i. An aggregate principal amount of not less than $25 million (which may be issued in series) was issued pursuant to a registration statement filed with the SEC under Section 5 of the Securities Act;
        ii. Current reports relating to the issue have been filed with the SEC; and
        iii. At the time of the credit extension, the creditor has a reasonable basis for believing that mortgage interest, principal payments and other distributions are being passed through as required and that the servicing agent is meeting its material obligations under the terms of the offering.

        5. The reduced requirements are 10% of the current market value of investment grade debt securities long or short in the accounts and the greater of 20% of the current market value or 7% of the principal amount of any other listed non-equity securities or other margin eligible non-equity securities long or short in the account.

        6. FINRA Rule 4210(f)(8)(A) authorizes FINRA to prescribe higher initial and maintenance margin requirements, and such other terms and conditions as FINRA deems appropriate relating to such requirements, whenever it determines that market conditions so warrant. This provision has been used to raise or clarify the margin requirements for several products. See, e.g., Regulatory Notice 10-53 (exempted securities mutual funds and exempted securities ETFs), Regulatory Notice 09-53 (non-traditional ETFs) and Regulatory Notice 08-08 (certain auction rate securities).

        7. The listed option margin requirements in Rule 4210(f)(2)(E) do not contemplate listed options on debt securities other than U.S. treasury and GNMA obligations. The initial and maintenance requirements we are prescribing for listed options on ETNs are a 5% over the requirements for OTC options on listed non-equity securities under Rule 4210(f)(2)(E)(iii) and are equal to the initial and maintenance margin requirements on listed options on stock and convertible corporate debt securities.

        8. See Regulatory Notice 09-53 (August 2009) detailing increased margin requirements for leveraged ETFs and associated uncovered options.

        9. FINRA Rule 4210(g)(3) requires that theoretical pricing models must be approved by the Securities and Exchange Commission (SEC). The OCC's TIMS model is the only model so approved.

        10. The eligible products listed in FINRA Rule 4210(g) (6)(B) consist of: (1) a margin equity security (including a foreign equity security and option on a foreign equity security, provided the foreign equity security is deemed to have a "ready market" under SEA Rule 15c3-1 or a "no-action" position issued thereunder, and a control or restricted security, provided the security has met the requirements in a manner consistent with Securities Act Rule 144 or an SEC "no-action" position issued thereunder, sufficient enough to permit the sale of the security, upon exercise or assignment of any listed option or unlisted derivative written or held against it, without restriction); (2) a listed option on an equity security or index of equity securities; (3) a security futures product; (4) an unlisted derivative on an equity security or index of equity securities; (5) a warrant on an equity security or index of equity securities; and (6) a related instrument as defined in paragraph (g)(2)(D) of FINRA Rule 4210.

        11. Consistent with FINRA Rule 4210(g)(7)(D), positions on ETNs and options on ETNs may be retained in portfolio margin accounts so long as the strategy-based requirement, as specified in this Notice, is applied.

        12. See OCC Information Memo #45304: ETN Removal from Customer Portfolio Margin Theoretical Output File [file:///C:/Users/u6078323/Downloads/45304.pdf].

      • 19-20 SEC Approves Amendments to Arbitration Codes to Expand Time for Non-Parties to Respond to Arbitration Subpoenas and Orders of Appearance of Witnesses or Production of Documents; Effective Date: July 1, 2019

        View PDF

        Discovery in FINRA Arbitration

        Regulatory Notice
        Notice Type

        Rule Amendment
        Referenced Rules & Notices

        FINRA Rule 12512
        FINRA Rule 12513
        FINRA Rule 13512
        FINRA Rule 13513
        Suggested Routing

        Compliance
        Legal
        Registered Representatives
        Key Topics

        Arbitration
        Codes of Arbitration Procedure
        Discovery
        Dispute Resolution
        Orders to Appear or to Produce Documents
        Subpoenas

        Summary

        The Securities and Exchange Commission (SEC) approved1 amendments to FINRA's customer and industry arbitration rules to expand time for nonparties to respond to arbitration subpoenas and orders of appearance of witnesses or production of documents. The amendments also make related changes to enhance the discovery process for forum users.

        The amendments are effective for cases filed on or after July 1, 2019.

        Questions concerning this Notice should be directed to:

        •   Leslie Leutwiler, Associate Director, Office of Dispute Resolution, at (212) 858-4136 or leslie.leutwiler@finra.org; or
        •   Kristine Vo, Principal Counsel, Office of General Counsel, at (212) 858-4106 or kristine.vo@finra.org.

        Background & Discussion

        Under the Codes of Arbitration Procedure for Customer and Industry Disputes (Codes), parties exchange documents and information to prepare for arbitration through the discovery process.2 Parties who seek discovery from a non-party may request the panel to issue an order of appearance of witnesses or production of documents if the non-party is subject to FINRA's jurisdiction as an associated person or member firm.3 The Codes also authorize arbitrators to issue a subpoena if the non-party is not subject to FINRA's jurisdiction.4 If the panel decides to issue the order or subpoena, FINRA will transmit the signed order or subpoena to the moving party to serve on the non-party.5 If a non-party receiving an order or a subpoena objects to the scope or propriety of the order or subpoena, the non-party may file written objections through the Director of the Office of Dispute Resolution (Director).6

        FINRA amended the Codes to extend the response time for non-parties to object to an order or subpoena from 10 calendar days of service to 15 calendar days of receipt of the order or subpoena. Receipt of overnight mail service, overnight delivery service, hand delivery, email or facsimile is accomplished on the date of delivery. With each of these methods of service, parties will be able to determine the date of delivery. The amendments exclude first-class mail as an option to serve documents on the non-party and as an option for the non-party to file the objection to the scope or propriety of the order or subpoena. Finally, the amendments codify the current practice that the Director send, at the same time, objections and responses to the panel after the reply date has elapsed, unless otherwise directed by the panel.

        Effective Date

        The amendments are effective for cases filed on or after July 1, 2019


        1. See Securities Exchange Act Release No. 85781 (May 6, 2019), 84 Federal Register 91 (May 10, 2019) (Order Approving File No. SR-FINRA-2019-004).

        2. The Codes require parties to cooperate with each other and exchange documents or information to expedite the arbitration. See FINRA Rules 12505 and 13505.

        3. See FINRA Rules 12513 and 13513.

        4. See FINRA Rules 12512 and 13512.

        5. See FINRA Rules 12512 and 12513. See also FINRA Rules 13512 and 13513.

        6. See id.


        Attachment A

        Customer Code

        12512. Subpoenas

        (a)–(c) No change.
        (d) If the arbitrator issues a subpoena, the party that requested the subpoena must serve the subpoena on all parties and, if applicable, on any non-party receiving the subpoena. The party must serve the subpoena on the non-party by [first-class mail,] overnight mail service, overnight delivery service, hand delivery, email or facsimile.
        (e) If a non-party receiving a subpoena objects to the scope or propriety of the subpoena, the non-party may, within [10] 15 calendar days of [service] receipt of the subpoena, file written objections with the Director and the requesting party. The non-party may file the objection by [first-class mail,] overnight mail service, overnight delivery service, hand delivery, email or facsimile. The Director shall forward a copy of the written objections to [the arbitrator and] all other parties. The party that requested the subpoena may respond to the objections within 10 calendar days of receipt of the objections. The party must serve the response on the non-party and all other parties and file proof of service with the Director pursuant to Rule 12300(c)(5). The Director will send, at the same time, objections and responses to the panel after the reply date has elapsed, unless otherwise directed by the panel. After considering all objections, the arbitrator responsible for issuing the subpoena shall rule promptly on the objections.
        (f)–(g) No change.

        * * * * *

        12513. Authority of Panel to Direct Appearances of Associated Person Witnesses and Production of Documents Without Subpoenas

        (a)–(c) No change.
        (d) If the arbitrator issues an order, the party that requested the order must serve the order on all parties and, if applicable, on any non-party receiving the order. The party must serve the order on the non-party[.] by overnight mail service, overnight delivery service, hand delivery, email or facsimile.
        (e) If a non-party receiving an order objects to the scope or propriety of the order, the non-party may, within [10] 15 calendar days of [service] receipt of the order, file written objections with the Director and the requesting party. The non-party may file the objection by [first-class mail,] overnight mail service, overnight delivery service, hand delivery, email or facsimile. The Director shall forward a copy of the written objections to [the arbitrator and] all other parties. The party that requested the order may respond to the objections within 10 calendar days of receipt of the objections. The party must serve the response on the non-party and all other parties and file proof of service with the Director pursuant to Rule 12300(c)(5). The Director will send, at the same time, objections and responses to the panel after the reply date has elapsed, unless otherwise directed by the panel. After considering all objections, the arbitrator responsible for issuing the order shall rule promptly on the objections.
        (f)–(g) No change.

        * * * * *

        Industry Code

        13512. Subpoenas

        (a)–(c) No change.
        (d) If the arbitrator issues a subpoena, the party that requested the subpoena must serve the subpoena on all parties and, if applicable, on any non-party receiving the subpoena. The party must serve the subpoena on the non-party by [first-class mail,] overnight mail service, overnight delivery service, hand delivery, email or facsimile.
        (e) If a non-party receiving a subpoena objects to the scope or propriety of the subpoena, the non-party may, within [10] 15 calendar days of [service] receipt of the subpoena, file written objections with the Director and the requesting party. The non-party may file the objection by [first-class mail,] overnight mail service, overnight delivery service, hand delivery, email or facsimile. The Director shall forward a copy of the written objections to [the arbitrator and] all other parties. The party that requested the subpoena may respond to the objections within 10 calendar days of receipt of the objections. The party must serve the response on the non-party and all other parties and file proof of service with the Director pursuant to Rule 13300(c)(4). The Director will send, at the same time, objections and responses to the panel after the reply date has elapsed, unless otherwise directed by the panel. After considering all objections, the arbitrator responsible for issuing the subpoena shall rule promptly on the objections.
        (f)–(g) No change.

        * * * * *

        13513. Authority of Panel to Direct Appearances of Associated Person Witnesses and Production of Documents Without Subpoenas

        (a)–(c) No change.
        (d) If the arbitrator issues an order, the party that requested the order must serve the order on all parties and, if applicable, on any non-party receiving the order. The party must serve the order on the non-party by [first-class mail] overnight mail service, overnight delivery service, hand delivery, email or facsimile.
        (e) If a non-party receiving an order objects to the scope or propriety of the order, the non-party may, within [10] 15 calendar days of [service] receipt of the order, file written objections with the Director and the requesting party. The non-party may file the objection by [first-class mail,] overnight mail service, overnight delivery service, hand delivery, email or facsimile. The Director shall forward a copy of the written objections to [the arbitrator and] all other parties. The party that requested the order may respond to the objections within 10 calendar days of receipt of the objections. The party must serve the response on the non-party and all other parties and file proof of service with the Director pursuant to Rule 13300(c)(4). The Director will send, at the same time, objections and responses to the panel after the reply date has elapsed, unless otherwise directed by the panel. After considering all objections, the arbitrator responsible for issuing the order shall rule promptly on the objections.
        (f)–(g) No change.

      • 19-19 FINRA Reminds Firms to Register for CAT Reporting by June 27, 2019

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        Consolidated Audit Trail

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Legal
        Operations
        Senior Management
        Systems
        Trading
        Key Topics

        Consolidated Audit Trail (CAT)
        FINRA CAT
        NMS Securities
        OTC Equity Securities
        Referenced Rules & Notices

        Securities Exchange Act Rule 613

        Summary

        FINRA is issuing this Notice to remind firms they must register with FINRA CAT, LLC (FINRA CAT) for reporting to the Consolidated Audit Trail (CAT). CAT registration commenced on March 18, 2019, and will run through June 27, 2019. All Industry Members, as defined under the CAT NMS Plan, that will have a CAT reporting obligation must register during this window.

        All questions regarding CAT registration should be directed to the FINRA CAT Helpdesk at (888) 696-3348 or help@finracat.com.

        Background & Discussion

        On March 19, 2019, the CAT NMS Plan participants presented the timelines and documentation for Industry Members to register with FINRA CAT1 for reporting to the CAT. The registration form, which must be submitted online, and related information can be found at www.catnmsplan.com/registration/.

        Industry Members that must register for the CAT include any:

        •   member of FINRA or a national securities exchange that handles orders or quotes in NMS stocks, OTC equity securities or exchange listed options; and
        •   third-party CAT reporting agent that is or will be authorized to submit data to the CAT on behalf of an Industry Member.

        The CAT rules do not provide for any firms to be excluded or exempted from the CAT reporting obligation.

        For Equities (Phase 2a), Industry Member testing (file submission and data integrity) is scheduled to commence in December 2019, with go-live in April 2020. For Options (Phase 2b), Industry Member testing (file submission and data integrity) is scheduled to start as early as December 2019, with go-live in May 2020.2

        All questions should be directed to the FINRA CAT Helpdesk via phone at (888) 696-3348 or email at help@finracat.com.


        Endnotes

        1 In February 2019, the CAT NMS Plan participants announced they had selected FINRA as the plan processor to perform the CAT processing functions required by SEC Rule 613 and as set forth in the CAT NMS Plan. FINRA created a subsidiary, FINRA CAT, to carry out its obligations as plan processor. As a subsidiary of FINRA, FINRA CAT is part of the registered securities association; however, it is separate and distinct from the other FINRA entities

        2 See www.catnmsplan.com/wp-content/ uploads/2019/03/CAT_Industry_Call_03192019_ Presentation.pdf

      • 19-18 FINRA Provides Guidance to Firms Regarding Suspicious Activity Monitoring and Reporting Obligations

        View PDF

        Anti-Money Laundering (AML) Program

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Legal
        Operations
        Senior Management
        Key Topics

        Anti-Money Laundering
        Compliance Programs
        Referenced Rules & Notices

        Bank Secrecy Act
        FINRA Rule 3310
        Notice to Members 02-21

        Summary

        FINRA is issuing this Notice to provide guidance to member firms regarding suspicious activity monitoring and reporting obligations under FINRA Rule 3310 (Anti-Money Laundering Compliance Program).

        Questions concerning this Notice should be directed to:

        •   Victoria Crane, Associate General Counsel, Office of General Counsel, at (202) 728-8104 or victoria.crane@finra.org; or
        •   Blake Snyder, Senior Director, Member Regulation, at (561) 443-8051 or blake.snyder@finra.org.

        Background and Discussion

        FINRA Rule 3310 (Anti-Money Laundering Compliance Program) requires each member firm to develop and implement a written anti-money laundering (AML) program reasonably designed to achieve and monitor the firm's compliance with the requirements of the Bank Secrecy Act (BSA),1 and the implementing regulations promulgated thereunder by the Department of the Treasury (Treasury).

        FINRA Rule 3310(a) requires firms to "[e]stablish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of transactions required under [the BSA] and the implementing regulation thereunder." The BSA authorizes Treasury to require that financial institutions file suspicious activity reports (SARs).2

        Under Treasury's SAR rule,3 a broker-dealer must report a transaction to the Financial Crimes Enforcement Network (FinCEN) if it is conducted or attempted by, at or through a broker-dealer, it involves or aggregates funds or other assets of at least $5,000, and the broker-dealer knows, suspects or has reason to suspect that the transaction (or a pattern of transactions of which the transaction is a part):

        •   involves funds derived from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity (including, without limitation, the ownership, nature, source, location or control of such funds or assets) as part of a plan to violate or evade any federal law or regulation or to avoid any transaction reporting requirement under federal law or regulation;
        •   is designed, whether through structuring or other means, to evade any regulations promulgated under the BSA;
        •   has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the broker-dealer knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction; or
        •   involves use of the broker-dealer to facilitate criminal activity.4

        Broker-dealers must report the suspicious activity by completing a SAR and filing it in accordance with the requirements of Treasury's SAR rule.5 Broker-dealers must maintain a copy of any SAR filed and supporting documentation for a period of five years from the date of filing the SAR.6 FinCEN has provided guidance7 to the industry advising that if the activity that was the subject of a SAR filing continues, firms should review any continuing activity at least every 90 days to consider whether a continuing activity SAR filing is warranted, with the filing deadline being 120 days after the date of the previously related SAR filing.

        In situations that require immediate attention, such as terrorist financing or ongoing money laundering schemes, broker-dealers must immediately notify by telephone an appropriate law enforcement authority in addition to filing timely a SAR. The firm may call FinCEN's Hotline at (866) 556-3974.

        Money Laundering Red Flags

        FINRA published a list of "money laundering red flags" in Notice to Members 02-21 (NTM 02-21). Since NTM 02-21 was published, guidance detailing additional red flags that may be applicable to the securities industry have been published by a number of U.S. government agencies and international organizations.8 FINRA is issuing this Notice to provide examples of these additional money laundering red flags for firms to consider incorporating into their AML programs, as may be appropriate in implementing a risk-based approach to BSA/AML compliance. This could include, as applicable, incorporation into policies and procedures relating to suspicious activity monitoring or suspicious activity investigation and SAR reporting. Upon detection of red flags through monitoring, firms should consider whether additional investigation, customer due diligence measures or a SAR filing may be warranted.

        The following is not an exhaustive list and does not guarantee compliance with AML program requirements or provide a safe harbor from regulatory responsibility. Further, it is important to note that a red flag is not necessarily indicative of suspicious activity, and that not every item identified in this Notice will be relevant for every broker-dealer, every customer relationship or every business activity.

        Firms should also be aware of emerging areas of risk, such as risks associated with activity in digital assets. Regardless of whether such assets are securities, BSA/AML requirements, including SAR filing requirements apply, and firms should thus consider the relevant risks, monitor for suspicious activity and, as applicable, report any such activity.

        This Notice is intended to assist broker-dealers in complying with their existing obligations under BSA/AML requirements and does not create any new requirements or expectations. In addition, this Notice incorporates the red flags listed in NTM 02-21 so that firms can refer to this Notice only for examples of potential red flags.

        I. Potential Red Flags in Customer Due Diligence and Interactions With Customers

        1. The customer provides the firm with unusual or suspicious identification documents that cannot be readily verified or are inconsistent with other statements or documents that the customer has provided. Or, the customer provides information that is inconsistent with other available information about the customer. This indicator may apply to account openings and to interaction subsequent to account opening.
        2. The customer is reluctant or refuses to provide the firm with complete customer due diligence information as required by the firm's procedures, which may include information regarding the nature and purpose of the customer's business, prior financial relationships, anticipated account activity, business location and, if applicable, the entity's officers and directors.
        3. The customer refuses to identify a legitimate source of funds or information is false, misleading or substantially incorrect.
        4. The customer is domiciled in, doing business in or regularly transacting with counterparties in a jurisdiction that is known as a bank secrecy haven, tax shelter, high-risk geographic location (e.g., known as a narcotics producing jurisdiction, known to have ineffective AML/Combating the Financing of Terrorism systems) or conflict zone, including those with an established threat of terrorism.
        5. The customer has difficulty describing the nature of his or her business or lacks general knowledge of his or her industry.
        6. The customer has no discernable reason for using the firm's service or the firm's location (e.g., the customer lacks roots to the local community or has gone out of his or her way to use the firm).
        7. The customer has been rejected or has had its relationship terminated as a customer by other financial services firms.
        8. The customer's legal or mailing address is associated with multiple other accounts or businesses that do not appear related.
        9. The customer appears to be acting as an agent for an undisclosed principal, but is reluctant to provide information.
        10. The customer is a trust, shell company or private investment company that is reluctant to provide information on controlling parties and underlying beneficiaries.
        11. The customer is publicly known or known to the firm to have criminal, civil or regulatory proceedings against him or her for crime, corruption or misuse of public funds, or is known to associate with such persons. Sources for this information could include news items, the Internet or commercial database searches.
        12. The customer's background is questionable or differs from expectations based on business activities.
        13. The customer maintains multiple accounts, or maintains accounts in the names of family members or corporate entities, with no apparent business or other purpose.
        14. An account is opened by a politically exposed person (PEP),9 particularly in conjunction with one or more additional risk factors, such as the account being opened by a shell company10 beneficially owned or controlled by the PEP, the PEP is from a country which has been identified by FATF as having strategic AML regime deficiencies, or the PEP is from a country known to have a high level of corruption.
        15. An account is opened by a non-profit organization that provides services in geographic locations known to be at higher risk for being an active terrorist threat.11
        16. An account is opened in the name of a legal entity that is involved in the activities of an association, organization or foundation whose aims are related to the claims or demands of a known terrorist entity.12
        17. An account is opened for a purported stock loan company, which may hold the restricted securities of corporate insiders who have pledged the securities as collateral for, and then defaulted on, purported loans, after which the securities are sold on an unregistered basis.
        18. An account is opened in the name of a foreign financial institution, such as an offshore bank or broker-dealer, that sells shares of stock on an unregistered basis on behalf of customers.
        19. An account is opened for a foreign financial institution that is affiliated with a U.S. broker-dealer, bypassing its U.S. affiliate, for no apparent business purpose. An apparent business purpose could include access to products or services the U.S. affiliate does not provide.

        II. Potential Red Flags in Deposits of Securities

        1. A customer opens a new account and deposits physical certificates, or delivers in shares electronically, representing a large block of thinly traded or low-priced securities.
        2. A customer has a pattern of depositing physical share certificates, or a pattern of delivering in shares electronically, immediately selling the shares and then wiring, or otherwise transferring out the proceeds of the sale(s).
        3. A customer deposits into an account physical share certificates or electronically deposits or transfers shares that:
        •   were recently issued or represent a large percentage of the float for the security;
        •   reference a company or customer name that has been changed or that does not match the name on the account;
        •   were issued by a shell company;
        •   were issued by a company that has no apparent business, revenues or products;
        •   were issued by a company whose SEC filings are not current, are incomplete, or nonexistent;
        •   were issued by a company that has been through several recent name changes or business combinations or recapitalizations;
        •   were issued by a company that has been the subject of a prior trading suspension; or
        •   were issued by a company whose officers or insiders have a history of regulatory or criminal violations, or are associated with multiple low-priced stock issuers.
        4. The lack of a restrictive legend on deposited shares seems inconsistent with the date the customer acquired the securities, the nature of the transaction in which the securities were acquired, the history of the stock or the volume of shares trading.
        5. A customer with limited or no other assets at the firm receives an electronic transfer or journal transfer of large amounts of low-priced, non-exchange-listed securities.
        6. The customer's explanation or documents purporting to evidence how the customer acquired the shares does not make sense or changes upon questioning by the firm or other parties. Such documents could include questionable legal opinions or securities purchase agreements.
        7. The customer deposits physical securities or delivers in shares electronically, and within a short time-frame, requests to journal the shares into multiple accounts that do not appear to be related, or to sell or otherwise transfer ownership of the shares.
        8. Seemingly unrelated clients open accounts on or at about the same time, deposit the same low-priced security and subsequently liquidate the security in a manner that suggests coordination.

        III. Potential Red Flags in Securities Trading13

        1. The customer, for no apparent reason or in conjunction with other "red flags," engages in transactions involving certain types of securities, such as penny stocks, Regulation "S" stocks and bearer bonds, which although legitimate, have been used in connection with fraudulent schemes and money laundering activity. (Such transactions may warrant further due diligence to ensure the legitimacy of the customer's activity.)
        2. There is a sudden spike in investor demand for, coupled with a rising price in, a thinly traded or low-priced security.
        3. The customer's activity represents a significant proportion of the daily trading volume in a thinly traded or low-priced security.
        4. A customer buys and sells securities with no discernable purpose or circumstances that appear unusual.
        5. Individuals known throughout the industry to be stock promoters sell securities through the broker-dealer.
        6. A customer accumulates stock in small increments throughout the trading day to increase price.
        7. A customer engages in pre-arranged or other non-competitive securities trading, including wash or cross trades, with no apparent business purpose.
        8. A customer attempts to influence the closing price of a stock by executing purchase or sale orders at or near the close of the market.
        9. A customer engages in transactions suspected to be associated with cyber breaches of customer accounts, including potentially unauthorized disbursements of funds or trades.
        10. A customer engages in a frequent pattern of placing orders on one side of the market, usually inside the existing National Best Bid or Offer (NBBO), followed by the customer entering orders on the other side of the market that execute against other market participants that joined the market at the improved NBBO (activity indicative of "spoofing").
        11. A customer engages in a frequent pattern of placing multiple limit orders on one side of the market at various price levels, followed by the customer entering orders on the opposite side of the market that are executed and the customer cancelling the original limit orders (activity indicative of "layering").
        12. Two or more unrelated customer accounts at the firm trade an illiquid or lowpriced security suddenly and simultaneously.
        13. The customer makes a large purchase or sale of a security, or option on a security, shortly before news or a significant announcement is issued that affects the price of the security.
        14. The customer is known to have friends or family who work at or for the securities issuer, which may be a red flag for potential insider trading or unlawful sales of unregistered securities.
        15. The customer's purchase of a security does not correspond to the customer's investment profile or history of transactions (e.g., the customer may never have invested in equity securities or may have never invested in a given industry, but does so at an opportune time) and there is no reasonable explanation for the change.
        16. The account is using a master/sub structure, which enables trading anonymity with respect to the sub-accounts' activity, and engages in trading activity that raises red flags, such as the liquidation of microcap issuers or potentially manipulative trading activity.
        17. The firm receives regulatory inquiries or grand jury or other subpoenas concerning the firm's customers' trading.
        18. The customer engages in a pattern of transactions in securities indicating the customer is using securities to engage in currency conversion. For example, the customer delivers in and subsequently liquidates American Depository Receipts (ADRs) or dual currency bonds for U.S. dollar proceeds, where the securities were originally purchased in a different currency.
        19. The customer engages in mirror trades or transactions involving securities used for currency conversions, potentially through the use of offsetting trades.
        20. The customer appears to buy or sell securities based on advanced knowledge of pending customer orders.

        IV. Potential Red Flags in Money Movements

        1. The customer attempts or makes frequent or large deposits of currency, insists on dealing only in cash equivalents, or asks for exemptions from the firm's policies and procedures relating to the deposit of cash and cash equivalents.
        2. The customer "structures" deposits, withdrawals or purchases of monetary instruments below a certain amount to avoid reporting or recordkeeping requirements, and may state directly that they are trying to avoid triggering a reporting obligation or to evade taxing authorities.
        3. The customer seemingly breaks funds transfers into smaller transfers to avoid raising attention to a larger funds transfer. The smaller funds transfers do not appear to be based on payroll cycles, retirement needs, or other legitimate regular deposit and withdrawal strategies.
        4. The customer's account shows numerous currency, money order (particularly sequentially numbered money orders) or cashier's check transactions aggregating to significant sums without any apparent business or lawful purpose.
        5. The customer frequently changes bank account details or information for redemption proceeds, in particular when followed by redemption requests.
        6. The customer makes a funds deposit followed by an immediate request that the money be wired out or transferred to a third party, or to another firm, without any apparent business purpose.
        7. Wire transfers are made in small amounts in an apparent effort to avoid triggering identification or reporting requirements.
        8. Incoming payments are made by third-party checks or checks with multiple endorsements.
        9. Outgoing checks to third parties coincide with, or are close in time to, incoming checks from other third parties.
        10. Payments are made by third party check or money transfer from a source that has no apparent connection to the customer.
        11. Wire transfers are made to or from financial secrecy havens, tax havens, highrisk geographic locations or conflict zones, including those with an established presence of terrorism.
        12. Wire transfers originate from jurisdictions that have been highlighted in relation to black market peso exchange activities.
        13. The customer engages in transactions involving foreign currency exchanges that are followed within a short time by wire transfers to locations of specific concern (e.g., countries designated by national authorities, such as FATF, as non-cooperative countries and territories).
        14. The parties to the transaction (e.g., originator or beneficiary) are from countries that are known to support terrorist activities and organizations.
        15. Wire transfers or payments are made to or from unrelated third parties (foreign or domestic), or where the name or account number of the beneficiary or remitter has not been supplied.
        16. There is wire transfer activity that is unexplained, repetitive, unusually large, shows unusual patterns or has no apparent business purpose.
        17. The securities account is used for payments or outgoing wire transfers with little or no securities activities (i.e., account appears to be used as a depository account or a conduit for transfers, which may be purported to be for business operating needs).
        18. Funds are transferred to financial or depository institutions other than those from which the funds were initially received, specifically when different countries are involved.
        19. The customer engages in excessive journal entries of funds between related or unrelated accounts without any apparent business purpose.
        20. The customer uses a personal/individual account for business purposes or vice versa.
        21. A foreign import business with U.S. accounts receives payments from outside the area of its customer base.
        22. There are frequent transactions involving round or whole dollar amounts purported to involve payments for goods or services.
        23. Upon request, a customer is unable or unwilling to produce appropriate documentation (e.g., invoices) to support a transaction, or documentation appears doctored or fake (e.g., documents contain significant discrepancies between the descriptions on the transport document or bill of lading, the invoice, or other documents such as the certificate of origin or packing list).
        24. The customer requests that certain payments be routed through nostro14 or correspondent accounts held by the financial intermediary instead of its own accounts, for no apparent business purpose.
        25. Funds are transferred into an account and are subsequently transferred out of the account in the same or nearly the same amounts, especially when the origin and destination locations are high-risk jurisdictions.
        26. A dormant account suddenly becomes active without a plausible explanation (e.g., large deposits that are suddenly wired out).
        27. Nonprofit or charitable organizations engage in financial transactions for which there appears to be no logical economic purpose or in which there appears to be no link between the stated activity of the organization and the other parties in the transaction.
        28. There is unusually frequent domestic and international automated teller machine (ATM) activity.
        29. A person customarily uses the ATM to make several deposits into a brokerage account below a specified BSA/AML reporting threshold.
        30. Many small, incoming wire transfers or deposits are made using checks and money orders that are almost immediately withdrawn or wired out in a manner inconsistent with the customer's business or history; the checks or money orders may reference in a memo section "investment" or "for purchase of stock." This may be an indicator of a Ponzi scheme or potential funneling activity.
        31. Wire transfer activity, when viewed over a period of time, reveals suspicious or unusual patterns, which could include round dollar, repetitive transactions or circuitous money movements.

        V. Potential Red Flags in Insurance Products

        1. The customer cancels an insurance contract and directs that the funds be sent to a third party.
        2. The customer deposits an insurance annuity check from a cancelled policy and immediately requests a withdrawal or transfer of funds.
        3. The customer cancels an annuity product within the free-look period. This could be a red flag if accompanied with suspicious indicators, such as purchasing the annuity with several sequentially numbered money orders or having a history of cancelling annuity products during the free-look period.
        4. The customer opens and closes accounts with one insurance company, then reopens a new account shortly thereafter with the same insurance company, each time with new ownership information.
        5. The customer purchases an insurance product with no concern for the investment objective or performance.

        VI. Other Potential Red Flags

        1. The customer is reluctant to provide information needed to file reports to proceed with the transaction.
        2. The customer exhibits unusual concern with the firm's compliance with government reporting requirements and the firm's AML policies.
        3. The customer tries to persuade an employee not to file required reports or not to maintain the required records.
        4. Notifications received from the broker-dealer's clearing firm that the clearing firm had identified potentially suspicious activity in customer accounts. Such notifications can take the form of alerts or other concern regarding negative news, money movements or activity involving certain securities.
        5. Law enforcement has issued subpoenas or freeze letters regarding a customer or account at the securities firm.
        6. The customer makes high-value transactions not commensurate with the customer's known income or financial resources.
        7. The customer wishes to engage in transactions that lack business sense or an apparent investment strategy, or are inconsistent with the customer's stated business strategy.
        8. The stated business, occupation or financial resources of the customer are not commensurate with the type or level of activity of the customer.
        9. The customer engages in transactions that show the customer is acting on behalf of third parties with no apparent business or lawful purpose.
        10. The customer engages in transactions that show a sudden change inconsistent with normal activities of the customer.
        11. Securities transactions are unwound before maturity, absent volatile market conditions or other logical or apparent reason.
        12. The customer does not exhibit a concern with the cost of the transaction or fees (e.g., surrender fees, or higher than necessary commissions).
        13. A borrower defaults on a cash-secured loan or any loan that is secured by assets that are readily convertible into currency.
        14. There is an unusual use of trust funds in business transactions or other financial activity.

        1. 31 U.S.C. 5311, et seq.

        2. See 31 U.S.C. 5318(g).

        3. See 31 CFR 1023.320.

        4. See 31 CFR 1023.320(a)(2).

        5. See 31 CFR 1023.320.

        6. See 31 CFR 1023.320(d).

        7. See FinCEN SAR Activity Review Issue 21 [https://www.fincen.gov/sites/default/files/shared/sar_tti_21.pdf] (May 2012).

        8. See, e.g, Financial Action Task Force (FATF), Guidance for a Risk-Based Approach for the Securities Sector [http://www.fatf-gafi.org/media/fatf/documents/recommendations/pdfs/RBA-Securities-Sector.pdf], October 2018; FATF, Money Laundering and Terrorist Financing in the Securities Sector [http://www.fatf-gafi.org/media/fatf/documents/reports/ML%20and%20TF%20in%20the%20Securities%20Sector.pdf], October 2009; FATF, Guidance for Financial Institutions in Detecting Terrorist Financing [http://www.fatf-gafi.org/media/fatf/documents/Guidance%20for%20financial%20institutions%20in%20detecting%20terrorist%20financing.pdf], April 2002; FATF Report, Laundering the Proceeds of Corruption [http://www.fatf-gafi.org/media/fatf/documents/reports/Laundering%20the%20Proceeds%20of%20Corruption.pdf], July 2011; FATF Report, Risk of Terrorist Abuse in Non-Profit Organisations [http://www.fatf-gafi.org/media/fatf/documents/reports/Risk-of-terrorist-abuse-in-non-profit-organisations.pdf], June 2014; FinCEN Advisory FIN2010-A001: Advisory to Financial Institutions on Filing Suspicious Activity Reports regarding Trade Based Money Laundering [https://www.fincen.gov/resources/advisories/fincen-advisory-fin-2010-a001], February 2010; U.S. Department of State, Money Laundering Methods, Trends and Typologies [https://www.state.gov/j/inl/rls/nrcrpt/2003/vol2/html/29910.htm], March 2004; Securities and Exchange Commission (SEC) National Exam Risk Alert on Master/Sub-accounts [https://www.sec.gov/about/offices/ocie/riskalert-mastersubaccounts.pdf], September 2011; SEC National Exam Risk Alert on Broker-Dealer Controls Regarding Customer Sales of Microcap Securities [https://www.sec.gov/about/offices/ocie/broker-dealer-controls-microcap-securities.pdf], October 2014; and SEC Responses to Frequently Asked Questions about a BrokerDealer's Duties When Relying on the Securities Act Section 4(a)(4) Exemption to Execute Customer Orders [https://www.sec.gov/divisions/marketreg/faq-broker-dealer-duty-section4.htm], October 2014. See also Regulatory Notices 09-05 (January 2009) and 10-18 (April 2010); and Federal Financial Institutions Examination Council Bank Secrecy Act/Anti-Money Laundering, Money Laundering and Terrorist Financing "Red Flags." [https://www.ffiec.gov/%5C/bsa_aml_infobase/pages_manual/OLM_106.htm]

        9. A "Politically Exposed Person" is defined by FATF as an individual who is or has been entrusted with a prominent public function, for example, Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations, or important political party officials. See FATF Guidance, Politically Exposed Persons [http://www.fatf-gafi.org/media/fatf/documents/recommendations/Guidance-PEP-Rec12-22.pdf], June 2013.

        10. A "shell company" is an issuer of securities for which a registration statement has been filed with the SEC that has: (1) no or nominal operations; and (2) either: (i) no or nominal assets; (ii) assets consisting solely of cash and cash equivalents; or (iii) assets consisting of any amount of cash or cash equivalents and nominal other assets. See 17 CFR 230.504.

        11. The FATF Report on Risk of Terrorist Abuse in Non-Profit Organisations [file:///C:/Users/HemansD/AppData/Local/Microsoft/Windows/INetCache/Content.Outlook/ZRK9N9QO/Risk%20of%20Terrorist%20Abuse%20in%20Non-Profit%20Organizsations] (FATF Report), June 2014, defines "terrorist threat" as: A person or group of people, object or activity, with the potential to cause harm. Threat is contingent on actors that possess both the capability and intent to do harm.

        12. The FATF Report defines "terrorist entity" as a terrorist and/or terrorist organization identified as a supporter of terrorism by national or international sanctions lists, or assessed by a jurisdiction as active in terrorist activity. See id.

        13. These red flags could also be indicative of securities law violations.

        14. Nostro accounts are accounts that a financial institution holds in a foreign currency in another bank, typically in order to facilitate foreign exchange transactions.

      • 19-17 FINRA Requests Comment on Proposed New Rule 4111 (Restricted Firm Obligations) Imposing Additional Obligations on Firms with a Significant History of Misconduct

        Protecting Investors from Misconduct

        Regulatory Notice
        Notice Type

        Request for Comment
        Referenced Rules & Notices

        FINRA Rule 3110
        FINRA Rule 4110
        FINRA Rule 9559
        Regulatory Notice 18-06
        Regulatory Notice 18-15
        Regulatory Notice 18-16
        Regulatory Notice 18-17
        Suggested Routing

        Compliance
        Legal
        Operations
        Registered Representatives
        Risk
        Senior Management
        Key Topics

        Expedited Proceedings
        Restricted Deposit and other Obligations

        Summary

        As part of FINRA's ongoing initiatives to protect investors from misconduct, FINRA is requesting comment on proposed new Rule 4111 (Restricted Firm Obligations) that would impose tailored obligations, including possible financial requirements, on designated member firms that cross specified numeric disclosure-event thresholds. These thresholds were developed through a thorough analysis and are based on the number of events at similarly sized peers. The member firms that could be subject to these obligations, while small in number, present heightened risk of harm to investors and their activities may undermine confidence in the securities markets as a whole. The proposal would further promote investor protection and market integrity and give FINRA another tool to incentivize member firms to comply with regulatory requirements and to pay arbitration awards.

        FINRA is requesting comment on:

        1. proposed new Rule 4111 (Restricted Firm Obligations), which would authorize FINRA to require "Restricted Firms," identified by a multi-step process involving threshold calculations, to make deposits of cash or qualified securities that could not be withdrawn without FINRA's prior written consent, adhere to other conditions or restrictions on the member's operations that are necessary or appropriate for the protection of investors and in the public interest, or be subject to some combination of those obligations; and
        2. proposed new Rule 9559 (Procedures for Regulating Activities Under Rule 4111) (new Rule 9559) and amendments to existing Rule 9559 (Hearing Procedures for Expedited Proceedings Under the Rule 9550 Series) to be renumbered as Rule 9560 (Rule 9560 or the Hearing Procedures Rule) to create an expedited proceeding that allows a prompt review of the determinations under the Restricted Firm Obligations Rule and grants a member a right to challenge any obligations imposed.1

        The proposed rule text is available in Attachment A. A flow chart describing proposed Rule 4111 is available in Attachment B. A chart presenting examples of restricted deposit requirements is available as Attachment C. The attachments referenced in the Economic Impact Assessment are available in Attachment D (Attachments D-1, D-2 and D-3).

        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; or
        •   Michael Garawski, Associate General Counsel, OGC, at (202) 728-8835 or Michael.Garawski@finra.org.

        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 or Jonathan.Sokobin@finra.org; or
        •   Hammad Qureshi, Senior Economist, OCE, at (202) 728-8150 or Hammad.Qureshi@finra.org.

        Action Requested

        FINRA encourages all interested parties to comment. Comments must be received by July 1, 2019.

        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.2

        Before becoming effective, the proposed rule change must be filed with and approved by the Securities and Exchange Commission (SEC or Commission) pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA or Exchange Act).3

        Background & Discussion

        FINRA has been engaged in an ongoing effort to enhance its programs to address the risks that can be posed to investors and the broader market by individual brokers and member firms that have a history of misconduct. FINRA has a number of tools to deter and remedy misconduct by member firms and the individuals they hire, including review of membership applications, focused examinations, risk monitoring and disciplinary actions. These tools have been effective in identifying and addressing a range of misconduct by individuals and firms, and FINRA has continued to strengthen them. In recent years, for example, we have enhanced our key investor protection rules and examination programs, expanded our risk-based monitoring of brokers and firms and deployed new technologies designed to make our regulatory efforts more effective and efficient.4

        While these efforts have strengthened protections for investors and the markets, persistent compliance issues continue to arise in some FINRA member firms. While historically small in number and a top focus of FINRA regulatory programs, such firms generally do not carry out their supervisory obligations to ensure compliance with applicable securities laws and regulations and FINRA rules, and they often act in ways that harm their customers and erode trust in the brokerage industry. Recent academic studies, for example, find that some firms persistently employ brokers who engage in misconduct, and that misconduct can be concentrated at these firms. These studies also provide evidence that the past disciplinary and other regulatory events associated with a firm or individual can be predictive of similar future events.5 While these firms may eventually be forced out of the industry through FINRA action or otherwise, these patterns indicate a persistent, if limited, population of firms with a history of misconduct that may not be acting appropriately as a first line of defense to prevent customer harm by their brokers.

        Such firms expose investors to real risk. For example, FINRA has identified certain firms that have a concentration of individuals with a history of misconduct, and some of these firms consistently hire such individuals and fail to reasonably supervise their activities. These firms generally have a retail business with vulnerable customers and engage in cold calling to make recommendations of securities. FINRA has also identified groups of individual brokers who move from one firm of concern to another firm of concern. In addition, certain firms, along with their representatives, have substantial numbers of disclosures on their records. For example, as of year-end 2018, there were 20 small firms (i.e., firms with no more than 150 registered persons) with 30 or more disclosure events over the prior five years, 10 mid-size firms (i.e., firms with between 151 and 499 registered persons) with 45 or more disclosure events over the prior five years, and five large firms (i.e., firms with 500 or more registered persons) with 750 or more disclosure events over the prior five years.6 In such situations, FINRA closely examines the firms' and brokers' conduct, and where appropriate, FINRA will bring enforcement actions to bar or suspend the firms and individuals involved.

        However, individuals and firms with a history of misconduct can pose a particular challenge for FINRA's existing examination and enforcement programs. In particular, examinations can identify compliance failures—or imminent failures—and prescribe remedies to be taken, but examiners are not empowered to require a firm to change or limit its business operations in a particular manner. While these constraints on the examination process protect firms from potentially arbitrary or overly onerous examination findings, an individual or firm with a history of misconduct can take advantage of these limits to simply continue ongoing activities that harm or pose risk of harm to investors until they result in an enforcement action.

        Enforcement actions in turn can only be brought after a rule has been violated—and any resulting customer harm has already occurred. In addition, these proceedings can take significant time to develop, prosecute and conclude, during which time the individual or firm is able to continue misconduct, perpetuating significant risks of additional harm to customers and investors. Parties with serious compliance issues often will litigate enforcement actions brought by FINRA, which potentially involves a hearing and multiple rounds of appeals, thereby effectively forestalling the imposition of disciplinary sanctions for an extended period. For example, an enforcement proceeding could involve a hearing before a Hearing Panel, numerous motions, an appeal to the National Adjudicatory Council (NAC), and a further appeal to the SEC. Moreover, even when a FINRA Hearing Panel imposes a significant sanction, the firm can forestall its effectiveness through the appeals process, because sanctions are stayed during appeals to the NAC and potentially the SEC. And when all appeals are exhausted, the firm may have withdrawn its FINRA membership, limiting FINRA's jurisdiction and eliminating the leverage that FINRA has to incent the firm to comply with the sanction, including making restitution to customers.

        Temporary cease and desist proceedings do not always provide an effective remedy for potential ongoing harm to investors during the enforcement process.7 Temporary cease and desist proceedings are available only in narrowly defined circumstances. Moreover, initiation by FINRA of a temporary cease and desist action does not necessarily enable more rapid intervention, because FINRA must be prepared to file the underlying disciplinary complaint at the same time.

        In addition, by the time intervention is practical, as noted above, the firm may have exited the industry, thereby limiting FINRA's jurisdiction over the misconduct. In such circumstance, the firm may also fail to pay arbitration awards in favor of harmed investors, preventing their recovery and potentially diminishing confidence in the arbitration process.

        A typical example of these challenges would be a firm that hires representatives with numerous disclosure events, has a poor supervisory structure and compliance culture, consistently engages in aggressive sales practices to retail customers relating to unregistered penny stocks, private placements or illiquid securities, and affirmatively seeks to stall the imposition of disciplinary sanctions. In FINRA's experience, such a firm may attempt to prolong FINRA's examination and investigation efforts by failing to provide full and timely responses to FINRA's requests for information. This lack of cooperation requires FINRA to increase regulatory pressure to gain cooperation and seek other sources for information, delaying FINRA's investigative efforts.

        When FINRA is ready to pursue enforcement action against such a firm, a temporary cease and desist order may not be available (since many circumstances are not within the scope of that authority) or may not enable more rapid intervention (since the disciplinary complaint must be ready to be filed at the same time). While a disciplinary proceeding will be commenced as soon as possible (with or without a temporary cease and desist proceeding), the firm can further prolong the disciplinary action by litigating through the stages described above.

        In light of these considerations, FINRA has undertaken an initiative to better address the issues created by individuals and firms with a history of misconduct. The initial focus of this initiative has been to strengthen the controls by FINRA and firms over the risks posed by individuals with a history of misconduct, including:

        •   Regulatory Notice 18-15 (Heightened Supervision), which reiterates the existing obligation of member firms to implement for such individuals tailored heightened supervisory procedures under Rule 3110;
        •   Regulatory Notice 18-16 (FINRA Requests Comment on FINRA Rule Amendments Relating to High-Risk Brokers and the Firms That Employ Them), which seeks comment on proposed rule amendments that, among other things, would impose additional restrictions on member firms that employ brokers with a history of specified misconduct events by requiring the filing with FINRA of a materiality consultation when such individuals seek to become owners, control persons, principals or registered persons of a firm; authorize Hearing Panels and Hearing Officers to impose conditions and restrictions on a respondent in a disciplinary proceeding that are reasonably necessary for the purpose of preventing customer harm during that respondent's appeal of a disciplinary decision; and require firms that apply to continue associating with a statutorily disqualified person to include in that application an interim plan of heightened supervision that would be effective throughout the application process; and
        •   Regulatory Notice 18-17 (FINRA Revises the Sanction Guidelines), which announced revisions to the FINRA Sanction Guidelines.

        In addition, FINRA raised fees for statutory disqualification applications,8 and it revised the qualification examination waiver guidelines to more broadly consider past misconduct when considering examination waiver requests.9

        While these efforts should help mitigate the risks posed by individual brokers with a history of misconduct, challenges remain where a member firm itself has a concentration of such brokers without adequate supervision—in some cases because the firm seeks out such brokers—or otherwise has a history of substantial compliance failures.

        As a result, FINRA is proposing to adopt Rule 4111, which would impose obligations on members that have significantly higher levels of risk-related disclosures than similarly sized peers. FINRA would preliminarily identify these members by using numeric, threshold-based criteria and several additional steps that would guard against misidentification. The obligations could include requiring a member to maintain a specific deposit amount, with cash or qualified securities, in a segregated account at a bank or clearing firm, from which the member could make withdrawals only with FINRA's approval. This proposal also aims to preserve firm funds for payment of arbitration awards against them. The proposal would achieve this both through how a member's "covered pending arbitration claims" and unpaid arbitration awards could impact the size of its restricted deposit requirement, and a presumption that a member would continue to maintain a restricted deposit if it has any "covered pending arbitration claims" or unpaid arbitration awards.10

        FINRA also considered proposing a "terms and conditions" rule similar to Investment Industry Regulatory Organization of Canada (IIROC) Consolidated Rule 9208, which permits IIROC, in an effort to strategically target the most problematic firms, to exercise discretion to identify firms and develop appropriate terms and conditions on their operations.11 Although FINRA is still considering such a rule, it is not proposing it at this time.

        Proposed Amendments

        1. Proposed Rule 4111 (Restricted Firm Obligations)

        FINRA is proposing to adopt Rule 4111 (Restricted Firm Obligations), a new rule that would use numeric-based thresholds based on firm-level and individual-level disclosure events or conditions disclosed on the Uniform Registration Forms12 and, subject to an internal Department of Member Supervision (Department) review and member firm consultation process, presumptively impose a "Restricted Deposit Requirement" on members that present a high degree of risk to the investing public. FINRA believes that a restricted deposit is most likely to change such members' behavior—and therefore protect investors—through its direct financial impact.
        •   General/Multi-Step Process for Identifying "Restricted Firms" (Proposed Rule 4111(a))

        The proposed rule would create a multi-step process to guide FINRA's determination of whether a member raises investor-protection concerns substantial enough to require that it be subject to additional obligations. Those obligations could include a requirement to maintain a deposit of cash or qualified securities in an account from which withdrawals would be restricted, or conditions or restrictions on the member's operations that are necessary or appropriate for the protection of investors and in the public interest.13 The proposed rule would give each affected member firm several ways to affect outcomes, including a one-time opportunity to reduce staffing so as to no longer trigger the preliminary identification criteria and numeric thresholds, a consultation with the Department at which the member could explain why it should not be subject to a Restricted Deposit Requirement or propose alternatives, and the right to challenge a Department determination by requesting a hearing before a Hearing Officer in an expedited proceeding.

        The proposed multi-step process includes numerous features designed to focus the obligations on the small number of firms motivating this rule proposal. As the attached flow chart reflects (Attachment B), this process is akin to a "funnel." The top of the funnel applies to a limited set of firms with numerous disclosures, with a narrowing in the middle of the potential member firms that may be subject to additional obligations, and the bottom of the funnel reflecting the small number of member firms that present high risks to the investing public.
        •   Annual Calculation by FINRA of Preliminary Criteria for Identification (Proposed Rule 4111(b))

        The multi-step process would begin with an annual calculation. As explained more below, the Department would calculate annually a member firm's "Preliminary Identification Metrics" to determine if it meets the "Preliminary Criteria for Identification." A key driver of that is whether a firm's "Preliminary Identification Metrics" meet quantitative, risk-based "Preliminary Identification Metrics Thresholds."14

        Several principles guide the Preliminary Criteria for Identification and the Preliminary Identification Metrics Thresholds. The criteria and thresholds are intended to be replicable and transparent to FINRA and affected member firms; employ the most complete and accurate data available to FINRA; are objective; account for different firm sizes and business profiles; and target the sales-practice concerns that are motivating the proposal. FINRA also has sought to develop criteria and thresholds that identify members that present a high risk but limit improperly imposing obligations on firms whose risk profile and activities do not warrant such obligations.

        Using these guiding principles, FINRA is proposing numeric thresholds based on six categories of events or conditions, nearly all of which are based on information disclosed through the Uniform Registration Forms.15 The six categories are:
        1. Registered Person Adjudicated Events;16
        2. Registered Person Pending Events;17
        3. Registered Person Termination and Internal Review Events;18
        4. Member Firm Adjudicated Events;19
        5. Member Firm Pending Events;20 and
        6. Registered Persons Associated with Previously Expelled Firms (also referred to as the Expelled Firm Association category).21
        To calculate whether a member meets the Preliminary Criteria for Identification, which is defined in proposed Rule 4111(i)(9), the Department would first compute the Preliminary Identification Metrics for each category, which are set forth in proposed Rule 4111(i)(10). Each category's Preliminary Identification Metric computation would start with a calculation of the sum of the pertinent disclosure events or, for the Expelled Firm Association category, the sum of the Registered Persons Associated with Previously Expelled Firms. For the adjudicated disclosure-event based categories, the counts would include disclosure events that reached a resolution during the prior five years from the date of the calculation. For the pending-events categories and pending internal reviews, the counts would include disclosure events that are pending as of the date of the calculation. In addition, for the three Registered Person disclosure-event based categories, the counts would include disclosure events across all "Registered Persons In-Scope," defined in proposed Rule 4111(i)(13) as persons registered with the member firm for one or more days within the one year prior to the calculation date.

        Each of those six sums would then be standardized to determine the member's six Preliminary Identification Metrics. For the five Registered Person and Member Firm event categories (Categories 1–5 above), the proposed Preliminary Identification Metrics are in the form of an average number of events per registered broker, calculated by taking each category's sum and dividing it by the number of Registered Persons In-Scope. For the Registered Persons Associated with Expelled Firms category (Category 6), the proposed Preliminary Identification Metric is in the form of a percentage concentration at the member of registered persons who, at any time in their career, were associated with previously expelled firms. This concentration is calculated by taking the number of Registered Persons Associated with Previously Expelled Firms and dividing it by the number of Registered Persons In-Scope.

        A firm's six Preliminary Identification Metrics are used to determine if the member firm meets the Preliminary Criteria for Identification. To meet the Preliminary Criteria for Identification, a firm would need to meet the Preliminary Identification Metrics Thresholds, set forth in proposed Rule 4111(i)(11), for two or more of the appropriate categories listed above for its size and, if it does, one of these categories must be for adjudicated events and the firm must have two or more events (in categories besides the Expelled Firm Association category). This involves analyzing the extent to which the Preliminary Identification Metrics meet the specified numeric Preliminary Identification Metrics Thresholds and meet additional conditions intended to prevent a member from becoming potentially subject to additional obligations solely as a result of pending matters or a single event or condition. Specifically, the Department would:
        •   first, pursuant to proposed Rule 4111(b) and (i)(9)(A), evaluate whether two or more of the member firm's Preliminary Identification Metrics are equal to or more than the corresponding Preliminary Identification Metrics Thresholds for the member firm's size,22 and whether at least one of those Preliminary Identification Metrics is the Registered Person Adjudicated Event Metric, the Member Firm Adjudicated Event Metric, or the Expelled Firm Association Metric; and
        •   second, pursuant to proposed Rule 4111(b) and (i)(9)(B), evaluate whether the member firm has two or more Registered Person or Member Firm Events (i.e., two or more events from Categories 1–5 above).23
        If all these conditions are met, the member would meet the Preliminary Criteria for Identification.

        Each specific numeric threshold in the Preliminary Identification Metrics Thresholds grid in proposed Rule 4111(i)(11) is a number which represents outliers with respect to peers for the type of events in the category (i.e., the firm is at the far tail of the respective category's distribution), which is intended to preliminarily identify member firms that present significantly higher risk than a large percentage of the membership. In addition, there are numeric thresholds for seven different firm sizes, to ensure that each member firm is compared only to its similarly sized peers. As explained more below in the Economic Impact Assessment, based on recent history FINRA expects that its annual calculations will identify between 60–98 member firms that meet the Preliminary Criteria for Identification.

        The following three examples demonstrate—in practical terms—the point at which a member firm's Preliminary Identification Metrics would meet the Preliminary Identification Metrics Thresholds in proposed Rule 4111(i)(11):

          Preliminary Identification Metrics Thresholds Practical Equivalent
        Example 1 (member firm size between 1–4 registered persons) The Preliminary Identification Metrics Threshold for the Registered Person Adjudicated Event Metric, for a member that has between one and four Registered Persons In-Scope as of the Evaluation Date,24 is 0.50 (or 0.50 events per Registered Broker In-Scope). For a member with four Registered Persons In-Scope as of the Evaluation Date, the member would meet the Preliminary Identification Metrics Threshold for the Registered Person Adjudicated Event Metric if the sum of its four Registered Persons In-Scope's Adjudicated Events, which reached a resolution over the five years before the Evaluation Date, was two or more.

        (4 Registered Persons In-Scope) * (0.50 Preliminary Identification Metrics Threshold for the Registered Person Adjudicated Event Metric) = (2 Adjudicated Events)
        Example 2 (member firm size between 20–50 registered persons) The Preliminary Identification Metrics Threshold for the Member Firm Adjudicated Event Metric, for a member that has between 20–50 Registered Persons In-Scope as of the Evaluation Date, is 0.20 (or 0.20 events per Registered Broker In-Scope). For a member with 50 Registered Persons In-Scope as of the Evaluation Date, the member would meet the Preliminary Identification Metrics Threshold for the Member Firm Adjudicated Event Metric if the sum of the member's Adjudicated Events, which reached a resolution over the five years before the Evaluation Date, was ten or more.

        (50 Registered Persons In-Scope) * (0.20 Preliminary Identification Metrics Threshold for the Member Firm Adjudicated Event Metric) = (10 Adjudicated Events)
        Example 3 (member firm size between 51–150 registered persons) The Preliminary Identification Metrics Threshold for the Expelled Firm Association Metric, for a member that has between 51–150 Registered Persons In-Scope as of the Evaluation Date, is 0.25 (or a 25% concentration level). For a member with 100 Registered Persons In-Scope as of the Evaluation Date, the member would meet the Preliminary Identification Metrics Threshold for the Expelled Firm Association Metric if the sum of its Registered Persons Associated with Previously Expelled Firms was 25 or more.

        (100 Registered Persons In-Scope) * (0.25 Preliminary Identification Metrics Threshold for the Expelled Firm Association Metric) = (25 Registered Persons Associated with Previously Expelled Firms)


        FINRA has conducted a thorough analysis of the proposed criteria and thresholds to ensure that the proposed Preliminary Criteria for Identification preliminarily identify the member firms that are motivating this rule proposal.25 As explained below, however, the proposed rule involves several additional steps to guard against the risk of misidentification.
        •   Initial Department Evaluation (Proposed Rule 4111(c)(1))

        For each member firm that meets the Preliminary Criteria for Identification, the Department would conduct, pursuant to proposed Rule 4111(c)(1), an initial internal evaluation to determine whether the member does not warrant further review under Rule 4111. In doing so, the Department would review whether it has information to conclude that the computation of the member's Preliminary Identification Metrics included disclosure events or other conditions that should not have been included because they are not consistent with the purpose of the Preliminary Criteria for Identification and are not reflective of a firm posing a high degree of risk. For example, the Department may have information that the computation included disclosure events that were not sales-practice related, were duplicative (involving the same customer and the same matter), or mostly involved compliance concerns best addressed by a different regulatory response by FINRA. As another example, the Department may have information that the Expelled Firm Association Metric calculation included registered persons who had associated with previously expelled firms only for a brief amount of time. The Department would also consider whether the member has addressed the concerns signaled by the disclosure events or conditions or altered its business operations, including staffing reductions, such that the threshold calculation no longer reflects the member's current risk profile. Essentially, the purpose of the Department's initial evaluation is to determine whether it is aware of information that would show that the member—despite having met the Preliminary Criteria for Identification—does not pose a high degree of risk.

        If the Department determines, after this initial evaluation, that the member does not warrant further review, the Department would conclude that year's Rule 4111 process for the member and would not seek that year to impose any obligations on the member. If, however, the Department determines that the member does warrant further review, the Rule 4111 process would continue.
        •   One-Time Opportunity to Reduce Staffing Levels (Proposed Rule 4111(c)(2))

        If the Department determines, after its initial evaluation, that a member that meets the Preliminary Criteria for Identification warrants further review under Rule 4111, such member—if it would be meeting the Preliminary Criteria for Identification for the first time—would have a one-time opportunity to reduce its staffing levels to no longer meet these criteria, within 30 business days after being informed by the Department. The member would be required to demonstrate the staff reduction to the Department by identifying the terminated individuals. The proposed rule would prohibit the member from rehiring any persons terminated pursuant to this option, in any capacity, for one year. A member that has reduced staffing levels at this stage may not use that staff-reduction opportunity again.

        If the Department determines that the member firm's reduction of staffing levels results in its no longer meeting the Preliminary Criteria for Identification, the Department would close out that year's Rule 4111 process for the member and would not seek that year to impose any obligations on that member. If, on the other hand, the Department determines that the member still meets the Preliminary Criteria for Identification even after its staff reductions, or if the member elects not to use its one-time opportunity to reduce staffing levels, the Department would proceed to determine the member's maximum Restricted Deposit Requirement, and the member would proceed to a Consultation with the Department.
        •   FINRA's Determination of a Maximum Restricted Deposit Requirement (Proposed Rule 4111(i)(15))

        For members that warrant further review after being deemed to meet the Preliminary Criteria for Identification and after the initial Department evaluation, the Department would then determine the member's maximum "Restricted Deposit Requirement."

        The Department would tailor the member's maximum Restricted Deposit Requirement amount to its size, operations and financial conditions. As provided in proposed Rule 4111(i)(15), the Department would consider the nature of the member's operations and activities, annual revenues, commissions, net capital requirements, the number of offices and registered persons, the nature of the disclosure events counted in the numeric thresholds, the amount of any "covered pending arbitration claims" or unpaid arbitration awards, and concerns raised during FINRA exams.26 Based on a consideration of these factors, the Department would determine a maximum Restricted Deposit Requirement for the member that would be consistent with the objectives of the rule, but not significantly undermine the continued financial stability and operational capability of the member as an ongoing enterprise over the next 12 months. FINRA's intent is that the maximum Restricted Deposit Requirement should be significant enough to change the member's behavior but not so burdensome that it would force the member out of business solely by virtue of the imposed deposit requirement.

        To provide increased transparency, Attachment C contains several examples that are intended to demonstrate how, in different scenarios, the Department might exercise its discretion in determining a maximum Restricted Deposit Requirement. Nothing in the examples is intended to suggest that the Department will follow specific formulas in determining a maximum Restricted Deposit Requirement or the weight that any specific circumstances carry. FINRA welcomes comments on alternative ways of calculating the Restricted Deposit Requirement that would be more predictable while remaining impactful but avoiding disproportionate effects on different types of firms.
        •   Consultation (Proposed Rule 4111(d))

        As explained above, if the Department determines, after initially calculating that a member firm meets the Preliminary Criteria for Identification, conducting its internal evaluation, and affording the one-time opportunity to reduce staffing levels (if available), that a member warrants further Rule 4111 review, the Department would consult with the member, pursuant to proposed Rule 4111(d). This Consultation will give the member an opportunity to demonstrate why it does not meet the Preliminary Criteria for Identification, why it should not be designated as a Restricted Firm, and why it should not be subject to the maximum Restricted Deposit Requirement.

        In the Consultation, there would be two rebuttable presumptions: that the member should be designated as a Restricted Firm; and that it should be subject to the maximum Restricted Deposit Requirement. The member would bear the burden of overcoming those presumptions.

        Proposed Rule 4111(d)(1) governs how a member may overcome these two presumptions. Proposed Rule 4111(d)(1)(A) provides that a member may overcome the presumption that it should be designated as a Restricted Firm by clearly demonstrating that the Department's calculation that the member meets the Preliminary Criteria for Identification is inaccurate because, among other things, it included events, in the six categories described above, that should not have been included because, for example, they are duplicative, involving the same customer and the same matter, or are not sales-practice related. Proposed Rule 4111(d)(1)(B) provides that a member may overcome the presumption that it should be subject to the maximum Restricted Deposit Requirement by clearly demonstrating to the Department that the member would face significant undue financial hardship if it were required to maintain the maximum Restricted Deposit Requirement and that a lesser deposit requirement would satisfy the objectives of Rule 4111 and be consistent with the protection of investors and the public interest; or that other conditions and restrictions on the operations and activities of the member and its associated persons would address the concerns indicated by the thresholds and protect investors and the public interest.

        Proposed Rule 4111(d)(2) governs how the Department would schedule and provide notice of the Consultation.

        Proposed Rule 4111(d)(3) provides guidance on what the Department would consider during the Consultation, when evaluating whether a member should be designated as a Restricted Firm and subject to a Restricted Deposit Requirement. This provision also provides members with guidance on how to attempt to overcome the two rebuttable presumptions. For example, proposed Rule 4111(d)(3) requires that the Department consider information provided by the member during any meetings as part of the Consultation; relevant information or documents, if any, submitted by the member, in the manner and form prescribed by the Department, as would be necessary or appropriate for the Department to review the computation of the Preliminary Criteria for Identification; a plan, if any, submitted by the member, in the manner and form prescribed by the Department, proposing in detail the specific conditions or restrictions that the member seeks to have the Department consider; such other information or documents as the Department may reasonably request from the member related to the evaluation; and information provided by the member during any meetings as part of the Consultation. To the extent a member seeks to claim undue financial hardship, it would be the member's burden to support that with documents and information.
        •   Department Decision (Proposed Rule 4111(e)); No Stays

        After the Consultation, proposed Rule 4111(e) would require that the Department render a Department decision. Under proposed Rule 4111(e)(1), there are three paths that decision might take:
        •   If the Department determines that the member has rebutted the presumption that it should be designated as a Restricted Firm, the Department's decision would be required to state that the member will not be designated that year as a Restricted Firm.
        •   If the Department determines that the member has not rebutted the presumption that it should be designated as a Restricted Firm or the presumption that it must maintain the maximum Restricted Deposit Requirement, the Department's decision would designate the member as a Restricted Firm and require the member to promptly establish a Restricted Deposit Account, deposit and maintain in that account the maximum Restricted Deposit Requirement, and implement and maintain specified conditions or restrictions, as necessary or appropriate, on the operations and activities of the member and its associated persons that relate to, and are designed to address the concerns indicated by, the Preliminary Criteria for Identification and protect investors and the public interest.
        •   If the Department determines that the member has not rebutted the presumption that it should be designated as a Restricted Firm but has rebutted the presumption that it must maintain the maximum Restricted Deposit Requirement, the Department's decision would designate the member as a Restricted Firm; would impose no Restricted Deposit Requirement on the member or require the member to promptly establish a Restricted Deposit Account, deposit and maintain in that account a Restricted Deposit Requirement in such dollar amount less than the maximum Restricted Deposit Requirement as the Department deems necessary or appropriate; and would require the member to implement and maintain specified conditions or restrictions, as necessary or appropriate, on the operations and activities of the member and its associated persons that relate to, and are designed to address the concerns indicated by, the Preliminary Criteria for Identification and protect investors and the public interest.
        Pursuant to proposed Rule 4111(e)(2), the Department would be required to provide a written notice of its determination to the member, pursuant to proposed new Rule 9559,27 no later than 30 days from the date of the letter that scheduled the Consultation. Where the Department decision imposes a Restricted Deposit Requirement or other conditions or restrictions, it also would inform the member of its ability to request a hearing with the Office of Hearing Officers in an expedited proceeding, as further described below.

        Proposed Rule 4111(e)(2) would provide that a request for a hearing would not stay the effectiveness of the Department's determination. However, upon requesting a hearing of a Department determination that imposes a Restricted Deposit Requirement, the member would only be required to maintain in a Restricted Deposit Account the lesser of 50% of its Restricted Deposit Requirement or 25% of its average excess net capital during the prior calendar year, until the Office of Hearing Officers or the National Adjudicatory Council (NAC) issues its final written order in the expedited proceeding. This has one exception: a member that is re-designated as a Restricted Firm and is already subject to a previously imposed Restricted Deposit Requirement would be required to maintain the full amount of its Restricted Deposit Requirement until the Office of Hearing Officers or the NAC issues its final written order in the expedited proceeding.
        •   Continuation or Termination of Restricted Firm Obligations (Proposed Rule 4111(f))

        The proposed Restricted Firm Obligations Rule would require FINRA to evaluate annually whether each member is, or continues to be, a Restricted Firm and whether the member should be subject to any obligations. For this reason, proposed Rule 4111(f) contains provisions that set forth how any obligations that were imposed during the Rule 4111 process in one year are continued or terminated in that same year and in subsequent years.

        Proposed Rule 4111(f)(1), titled "Currently Designated Restricted Firms," establishes constraints on a member's ability to seek to modify or terminate, directly or indirectly, any obligations imposed pursuant to Rule 4111. Because the Restricted Firm Obligations Rule would entail annual reviews by the Department to determine whether a member is a Restricted Firm that should be subject to obligations, a Restricted Firm would have an annual opportunity to seek the termination or modification of any obligations that continue to be imposed. For this reason, proposed Rule 4111 does not authorize a Restricted Firm to seek, outside of the Consultation process and any ensuing expedited proceedings after a Department decision, an interim termination or modification of any obligations imposed. Rather, proposed Rule 4111(f)(1) provides that a member that has been designated as a Restricted Firm will not be permitted to withdraw all or any portion of its Restricted Deposit Requirement, or seek to terminate or modify any deposit requirement, conditions, or restrictions that have been imposed on it, without the prior written consent of the Department.

        Proposed Rule 4111(f)(2), titled "Re-Designation as a Restricted Firm," addresses the scenario when the Department determines in one year that a member is a Restricted Firm, and in the following year determines that the member still meets the Preliminary Criteria for Identification. In that instance, the Department would re-designate the member as a Restricted Firm, and the obligations previously imposed on the member would remain effective and unchanged, unless either the member or the Department requests, within 30 days of the Department's decision to re-designate the member as a Restricted Firm, a Consultation. If a Consultation is requested, the obligations previously imposed would remain effective and unchanged unless and until the Department modifies or terminates them after the Consultation. In addition, in the Consultation process, a presumption would apply that any previously imposed Restricted Deposit Requirement, conditions or restrictions would remain effective and unchanged, absent a showing by the party seeking changes that they are no longer necessary or appropriate for the protection of investors or in the public interest. At the end of the Consultation, the Department would be required to provide written notice of its determination to the member, no later than 30 days from the date of the letter provided to the member under Rule 4111(d)(2) that schedules the Consultation.

        Proposed Rule 4111(f)(3), titled "Previously Designated Restricted Firms," addresses the scenario where the Department determines in one year that a member is a Restricted Firm, but in the following years determines that the member either does not meet the Preliminary Criteria for Identification or should not be designated as a Restricted Firm. In that case, the member would no longer be subject to any obligations previously imposed under proposed Rule 4111. There would be one exception: a former Restricted Firm would not be permitted to withdraw any portion of its Restricted Deposit Requirement without submitting an application and obtaining the Department's prior written consent for the withdrawal. Such an application would be required to include, among other things set forth in proposed Rule 4111(f)(3), evidence as to whether the member has "covered pending arbitration claims" or any unpaid arbitration awards outstanding against the member. The Department would determine whether to authorize a withdrawal, in part or in whole, but there would be a presumption that the member would be required to continue to maintain its Restricted Deposit Requirement if it has any "covered pending arbitration claims" or any unpaid arbitration awards. The Department would be required to issue a notice of its decision on an application to withdraw from the Restricted Deposit Account, pursuant to proposed new Rule 9559, within 30 days from the date the application is received.
        •   Restricted Deposit Account (Proposed Rule 4111(i)(14))

        If a Department decision requires a member to establish a Restricted Deposit Account, proposed Rule 4111(i)(14) would govern this account. The underlying policy for the proposed account requirements is that, to make a deposit requirement effective in creating appropriate incentives to members that pose higher risks to change their behavior, the member must be restricted from withdrawing any of the required deposit amount, even if it terminates its FINRA membership.

        The proposed rule would require that the Restricted Deposit Account be established, in the name of the member, at a bank or the member's clearing firm. The account must be subject to an agreement in which the bank or the clearing firm agrees: not to permit withdrawals from the account absent FINRA's prior written consent; to keep the account separate from any other accounts maintained by the member with the bank or clearing firm; that the cash or qualified securities on deposit will not be used directly or indirectly as security for a loan to the member by the bank or the clearing firm, and will not be subject to any set-off, right, charge, security interest, lien, or claim of any kind in favor of the bank, clearing firm or any person claiming through the bank or clearing firm; that if the member becomes a former member, the Restricted Deposit Requirement in the account must be maintained, and withdrawals will not be permitted without FINRA's prior written consent; that FINRA is a third-party beneficiary to the agreement; and that the agreement may not be amended without FINRA's prior written consent. In addition, the account could not be subject to any right, charge, security interest, lien, or claim of any kind granted by the member.

        These account restrictions would impact how a Restricted Firm calculates its net capital levels. As explained in proposed Rule 4111.01, a deposit in the Restricted Deposit Account would be an asset of the member firm that could not readily be converted into cash, due to the restrictions on accessing it. Accordingly, the member would be required to deduct deposits in the Restricted Deposit Account when determining its net capital under Exchange Act Rule 15c3-1 and FINRA Rule 4110.
        •   Books and Records (Proposed Rule 4111(g))

        Proposed Rule 4111(g) would establish new requirements to maintain books and records that evidence the member's compliance with the Restricted Firm Obligations Rule and any Restricted Deposit Requirement or other conditions or restrictions imposed under that rule. In addition, the proposed books and records provision would specifically require a member subject to a Restricted Deposit Requirement to provide to the Department, upon its request, records that demonstrate the member's compliance with that requirement.
        •   Notice of Failure to Comply (Proposed Rule 4111(h))

        FINRA also is proposing a requirement to address the situation when a member fails to comply with the obligations imposed. Under proposed Rule 4111(h), FINRA would be authorized to issue a notice pursuant to proposed new Rule 9559 directing a member that is not in compliance with its Restricted Deposit Requirement, or with any conditions or restrictions imposed under Rule 4111, to suspend all or a portion of its business.
        •   Definitions (Proposed Rule 4111(i))

        The above description of proposed Rule 4111 introduces many of the terms that would be defined by Rule 4111. A complete list of defined terms used in the proposed rule appears in proposed Rule 4111(i).
        •   Compliance with Continuing Membership Application Rule (Proposed Rule 4111.02-Compliance with Rule 1017)

        Proposed Supplementary Material .02 would clarify that nothing in the proposed rule would alter a member's obligations under Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations). A member firm subject to proposed Rule 4111 would need to continue complying with the requirements of Rule 1017 and submit continuing membership applications as necessary.
        •   Periodic Review of Preliminary Identification Metrics Thresholds

        FINRA would review the Preliminary Identification Metrics Thresholds on a periodic basis, to consider whether the thresholds remain targeted and effective at identifying firms that pose higher risks.
        2. Proposed Amendments to the Rule 9550 Series to Establish a New Expedited Proceeding to Implement the Requirements of Proposed Rule 4111

        FINRA is proposing to establish a new expedited proceeding in the Rule 9550 Series (Expedited Proceedings), specifically proposed new Rule 9559 (Procedures for Regulating Activities Under Rule 4111), that would allow member firms to request a prompt review of the Department's determinations under the Restricted Firm Obligations Rule and grant a right to challenge any of the "Rule 4111 Requirements," including any Restricted Deposit Requirements, imposed.28 The new expedited proceeding would govern how the Department provides notice of its determinations and afford affected member firms the right to seek a Hearing Officer's review of those determinations.
        •   Notices Under Proposed Rule 4111 (Proposed New Rule 9559(a))

        Proposed new Rule 9559(a) would establish an expedited proceeding for the Department's determinations under proposed Rule 4111 to designate a member as a Restricted Firm and impose obligations on the member; and to deny a member's request to access all or part of its Restricted Deposit Requirement.

        Proposed new Rule 9559(a) would require the Department to serve a notice that provides its determination and the specific grounds and factual basis for the Department's action; states when the action will take effect; informs the member that it may file, pursuant to Rule 9560, a request for a hearing in an expedited proceeding within seven days after service of the notice; and explains the Hearing Officer's authority. The proposed rule also would provide that, if a member does not request a hearing, the notice of the Department's determination will constitute final FINRA action.

        Proposed new Rule 9559(a) also would provide that any of the Rule 4111 Requirements imposed in a notice issued under proposed new Rule 9559(a) are immediately effective. In general, a request for a hearing would not stay those requirements. There would be one partial exception: when a member requests review of a Department determination under proposed Rule 4111 that imposes a Restricted Deposit Requirement on the member for the first time, the member would be required to deposit, while the expedited proceeding was pending, the lesser of 50% of its Restricted Deposit Requirement or 25% of its average excess net capital over the prior year.
        •   Notice for Failure to Comply with the Proposed Rule 4111 Requirements (Proposed New Rule 9559(b))

        Proposed new Rule 9559(b) would establish an expedited proceeding to address a member's failure to comply with any requirements imposed pursuant to proposed Rule 4111.

        Proposed new Rule 9559(b) would authorize the Department, after receiving authorization from FINRA's CEO, or such other executive officer as the CEO may designate, to serve a notice stating that the member's failure to comply with the Rule 4111 Requirements, within seven days of service of the notice, will result in a suspension or cancellation of membership. The proposed rule would require that the notice identify the requirements with which the member is alleged to have not complied; include a statement of facts specifying the alleged failure; state when the action will take effect; explain what the member must do to avoid the suspension or cancellation; inform the member that it may file, pursuant to Rule 9560, a request for a hearing in an expedited proceeding within seven days after service of the notice; and explain the Hearing Officer's authority. The proposed rule also would provide that, if a member does not request a hearing, the suspension or cancellation will become effective seven days after service of the notice.

        Proposed new Rule 9559(b) also would provide that a member could file a request seeking termination of a suspension imposed pursuant to the rule, on the ground of full compliance with the notice or decision. The proposed rule would authorize the head of the Department to grant relief for good cause shown.
        •   Hearings (Proposed Amendments to the Hearing Procedures Rule)29

        If a member requests a hearing under proposed new Rule 9559, the hearing would be subject to Rule 9560 (Hearing Procedures for Expedited Proceedings Under the Rule 9550 Series). FINRA is proposing several amendments to Rule 9560 that would be specific to hearings requested pursuant to proposed new Rule 9559.

        Hearings in expedited proceedings under proposed new Rule 9559 would have processes that are similar to the hearings in most of FINRA's other expedited proceedings—including requirements for the parties' exchange of documents and exhibits, the time for conducting the hearing, evidence, the record of the hearing, the record of the proceeding, failures to appear, the timing and contents of the Hearing Officer's decision, the Hearing Officer's authority, and the authority of the NAC to call an expedited proceeding for review—and FINRA is proposing amendments to the Rule 9560 provisions that govern these processes to adapt them for expedited proceedings under proposed new Rule 9559. A few features of the proposed amendments to Rule 9560 warrant emphasis or guidance:
        •   Hearing Officer's Authority (Proposed Amended Rule 9560(d) and (n))

        Hearings in expedited proceedings under proposed new Rule 9559 would be presided over by a Hearing Officer. The Hearing Officer's authority would differ depending on whether the hearing is in an action brought under proposed new Rule 9559(a) (Notices Under Rule 4111) or 9559(b) (Notice for Failure to Comply with the Rule 4111 Requirements):
        •   Proposed amended Rule 9560(n)(6) would provide that the Hearing Officer, in actions brought under proposed new Rule 9559(a), may approve or withdraw any and all of the Rule 4111 Requirements, or remand the matter to the Department, but may not modify any of the Rule 4111 Requirements, or impose any other requirements or obligations available under proposed Rule 4111.
        •   Proposed amended Rule 9560(n)(6) would authorize the Hearing Officer, in failure-to-comply actions under proposed new Rule 9559(b), to approve or withdraw the suspension or cancellation of membership, and impose any other fitting sanction. Authorizing a Hearing Officer to impose any other fitting sanction is intended to provide a Hearing Officer with authority that is appropriate for responding to situations involving firms that repeatedly fail to comply with an effective FINRA action under proposed Rule 4111.
        •   Timing Requirements

        The proposed amendments to the Hearing Procedures Rule are intended to give members a prompt process for challenging a Department decision under proposed Rule 4111. Proposed amended Rule 9560(f) would require that a hearing in actions under proposed new Rule 9559(a) be held within 30 days, and that a hearing in failure-to-comply actions under proposed new Rule 9559(b) be held within 14 days, after the member requests a hearing.30

        Proposed amended Rule 9560(o) would require the Hearing Officer, in all actions pursuant to proposed new Rule 9559, to prepare a proposed written decision, and provide it to the NAC's Review Subcommittee, within 60 days of the date of the close of the hearing. Pursuant to Rule 9560(q), the Review Subcommittee could call the proceeding for review within 21 days after receipt of the proposed decision. As in most expedited proceedings, the timing of FINRA's final decision would then depend on whether or not the Review Subcommittee calls the matter for review.31
        •   Contents of the Decision

        Proposed amended Rule 9560(p) governs the contents of the Hearing Officer's decision. The proposed amendments would broaden Rule 9560(p)(6) to account for the kinds of obligations that could be imposed under proposed Rule 4111. Rule 9560(p) would otherwise remain the same. For example, Rule 9560(p) would continue to require that the Hearing Officer's decision include a statement setting forth the findings of fact with respect to any act or practice the respondent was alleged to have committed or omitted or any condition specified in the notice, the Hearing Officer's conclusions regarding the condition specified in the notice, and a statement in support of the disposition of the principal issues raised in the proceeding.

        Additional guidance may be helpful, considering the different kinds of issues that may arise in an expedited proceeding pursuant to proposed new Rule 9559. For example, in a request for a hearing of a Department determination that imposes a Restricted Deposit Requirement or other obligations under Rule 4111, the principal issues raised may include whether: (1) the member firm should not be designated a Restricted Firm; (2) the Department incorrectly included disclosure events when calculating whether the member meets the Preliminary Criteria for Identification; (3) a Restricted Deposit Requirement would impose an undue financial burden on the member; or (4) the obligations imposed are inconsistent with the standards set forth in proposed Rule 4111(e). In a request for a hearing of a Department determination that denies a request to withdraw amounts from a Restricted Deposit Account, the principal issues raised may include whether the member firm has covered pending arbitration claims or unpaid arbitration awards.
        •   No Collateral Attacks on Underlying Disclosure Events

        In expedited proceedings pursuant to proposed new Rule 9559(a) to review a Department determination under the Restricted Firm Obligations Rule, a member firm may sometimes seek to demonstrate that the Department included incorrectly disclosure events when calculating whether the member meets the Preliminary Criteria for Identification. When the member does so, however, it would not be permitted to collaterally attack the underlying merits of those final actions. An expedited proceeding under proposed new Rule 9559 would not be the forum for attempting to re-litigate past final actions.32

        Additional Approach Considered

        FINRA also has considered a "terms and conditions" rule, but is not proposing such a rule at this time. As further discussed below in the Economic Impact Assessment, the numeric threshold-based approach in Rule 4111 has benefits and limitations. Because the rule would provide transparent, objective criteria based on public disclosure events, it would allow firms to understand clearly how they could become subject to the rule. On the other hand, the numeric-based criteria and thresholds may not identify all firms that raise the concerns motivating this proposal; firms may minimally change behavior simply to stay below established criteria and thresholds; firms may attempt to underreport required disclosures on Uniform Registration Forms; and the numerous steps that guard against misidentifications will affect how quickly FINRA can intervene.

        Because of these limitations, FINRA also has considered an additional option for addressing firms with a history of misconduct that may pose a risk to investors. A key objective in developing possible approaches was to strengthen FINRA's ability to take earlier, effective intervention. The firms motivating FINRA action in this area typically have substantial and unaddressed compliance failures over multiple examination cycles that put investors or market integrity at risk. These serious compliance failures may be prolonged by firms while FINRA works to build a case of violations of specific securities requirements, which often requires obtaining the willing cooperation of customers. To meet this challenge, FINRA has considered another option that would permit FINRA to address prolonged noncompliance by the small number of firms whose activities present heightened risk of harm to investors and that may undermine confidence in the securities markets as a whole.

        Specifically, FINRA has considered a proposal that would be similar to the IIROC's "terms and conditions" rule. Under this rule, IIROC may impose terms and conditions on an IIROC Dealer Member's membership when IIROC considers these terms and conditions appropriate to ensure the member's continuing compliance with IIROC requirements. IIROC has indicated that it will use this authority against its dealers that fail to address significant compliance findings or that fail to demonstrate a commitment to the development of a strong compliance culture, and primarily to address situations in which there are outstanding compliance issues that clearly require regulatory action, but that may not be best addressed through an enforcement proceeding.33 IIROC's imposition of terms and conditions may be challenged by requesting a hearing panel review and a further appeal to provincial authorities, but the terms and conditions do not appear to be stayed during an appeal.

        Compared to proposed Rule 4111, the regulatory benefits of a "terms and conditions" rule approach could arise from greater flexibility in identifying firms of concern, which may not trigger Rule 4111's thresholds, and quicker intervention to ensure compliance. Such an approach could also help mitigate the under- and over-inclusive concerns of the threshold-based criteria approach, and it could help fill the gap where a firm might not otherwise meet the numeric thresholds of proposed Rule 4111 but still has a history of serious noncompliance that poses a high degree of risk to investors or the markets. It also could allow for the imposition of tailored limitations and controls on firms and their brokers who might otherwise endanger customers, while motivating changes in the practices, activities and culture of firms seeking to terminate any terms and conditions imposed.

        This approach could empower FINRA—outside of the continuing membership application process, the enforcement process and the proposed new Restricted Firm Obligations Rule—to require that a member abide by identified terms and conditions to incent its compliance with the federal securities laws and FINRA rules. Possible terms and conditions could include operational, conduct, financial, or sales practice obligations; limitations on business expansions; or other obligations on the business of the member or its associated persons.

        Under this "terms and conditions" approach, the circumstances in which FINRA could intervene would be limited to when a member has repeatedly and significantly demonstrated a lack of compliance with the securities laws, the rules thereunder, or FINRA rules in specific ways that threaten investors or market integrity, and has not acted promptly to resolve the noncompliant condition. To ensure that the authority could be used in only the most serious circumstances, the imposition of terms and conditions would require the prior approval of FINRA's Chief Executive Officer or other executive officer not in FINRA's Departments of Member Supervision or Enforcement. In addition, a firm could be given an opportunity to request a prompt review of any terms and conditions imposed through an expedited proceeding process.

        Although FINRA has closely considered, and will continue to further explore, this option, it is not proposing a terms and conditions approach at this time pending consideration of proposed Rule 4111.

        Economic Impact Assessment

        1. Regulatory Need

        FINRA uses a number of measures to deter and discipline misconduct by firms and brokers, and continually strives to strengthen its oversight of the brokers and firms it regulates. These measures span across several FINRA programs, including review of new and continuing membership applications, risk monitoring of broker and firm activity, cycle and cause examinations, and enforcement and disciplinary actions.

        As part of its efforts to monitor and deter misconduct, FINRA has adopted rules that impose supervisory obligations on firms to ensure they are appropriately supervising their brokers' activities. These rules require each firm 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. Under this regulatory framework, FINRA also provides guidance to ensure consistency in interpretation of the rules and to further strengthen compliance across firms. As such, all firms play an important role in ensuring effective compliance with applicable securities laws and FINRA rules to prevent misconduct. This is consistent with the incentives of economic agents.34

        Nonetheless, some firms do not effectively carry out these supervisory obligations to ensure compliance and they act in ways that could harm their customers—sometimes substantially. For example, recent academic studies find that some firms persistently employ brokers who engage in misconduct, and that misconduct can be concentrated at these firms. These studies also provide evidence of predictability of future disciplinary and other regulatory-related events for brokers and firms with a history of past similar events.35 These patterns suggest that some firms may not be acting appropriately as a first line of defense to prevent customer harm. Further, some firms may take advantage of the fair-process protections afforded to them under the federal securities laws and FINRA rules to forestall timely and appropriate regulatory actions, thereby limiting FINRA's ability to curb misconduct promptly. Without additional protections, the risk of potential customer harm may continue to exist at firms that fail to effectively carry out their supervisory obligations or are associated with a significant number of regulatory-related events. Further, even where harmed investors obtain arbitration awards, brokers and firms may still fail to pay those awards. Unpaid arbitration awards harm successful customer claimants and may diminish investors' confidence in the arbitration process.36

        To mitigate these risks, FINRA seeks additional authority to impose obligations on firms that pose these types of greater risk to their customers. The proposed Restricted Firm Obligations Rule would identify firms based upon a concentration of significant firm and broker events on their disclosure records that meet the proposed criteria and specified thresholds. Under the proposal, FINRA seeks the authority to impose obligations on firms that are necessary or appropriate.
        2. Economic Baseline

        The economic baseline used to evaluate the economic impacts of the proposed rules is the current regulatory framework, including FINRA rules relating to supervision, the membership application process, statutory disqualification proceedings and disciplinary proceedings that provide rules to deter and discipline misconduct by firms and brokers. This baseline serves as the primary point of comparison for assessing economic impacts of the proposed rules, including incremental benefits and costs.

        The proposals are intended to apply to firms that pose greater risks to their customers than other firms. One identifier of these types of firms is that they and their brokers generally have substantially more regulatory-related events on their records than do their peers.37 Consistent with this, the proposed Restricted Firm Obligations Rule would specifically apply to firms that have far more Registered Person and Member Firm Events, or far higher concentrations of Registered Persons Associated with Previously Expelled Firms, compared to their peers.38 Based on staff analysis of all firms registered with FINRA between 2013 and 2018, firms that would have met the Preliminary Criteria for Identification had on average 4–8 times more Registered Person and Member Firm Events than peer firms at the time of identification. Specifically, the number of events per firm, for firms that would have met the Preliminary Criteria for Identification, ranged, on average, from 26–42 events during the Evaluation Period, compared to 5–7 events per firm for other firms. The median number of events per firm, for the firms that would have met the Preliminary Criteria for Identification, ranged from approximately 10–17 events, compared to 0 events amongst other firms.

        Although disciplinary and regulatory-related events are one of the identifiers for firms posing higher risk, FINRA recognizes that firms posing higher risks do not always manifest themselves with greater disclosures on their records. These firms may be newer, have recently made changes in management, staff or approach, or simply may be more effective in avoiding regulatory marks.
        3. Economic Impacts
        A. Proposed Restricted Firm Obligations Rule

        To estimate the number and types of firms that would meet the Preliminary Criteria for Identification, FINRA analyzed the categories of events and conditions associated with the proposed criteria for all firms during the 2013–2018 review period. For each year, FINRA determined the approximate number of firms that would have met the proposed criteria. The number of firms that would have met the proposed criteria during the review period serves as a reasonable estimate for the number of firms that would have been directly impacted by this proposal had it been in place at the time. This analysis indicates that there were 60–98 such firms at the end of each year during the review period, as shown in Attachment D-1. These firms represent 1.6–2.4% of all firms registered with FINRA in any year during the review period. The population of firms identified by the proposed criteria reflects the distribution of firm size in the full population of registered firms. Approximately 90–94% percent of these firms were small, 4–10% percent were mid-sized and 0–2% percent were large at the end of each year during the review period, as shown in Attachment D-2.39

        In developing the proposed Preliminary Criteria for Identification, FINRA paid significant attention to the impact of possible misidentification of firms; specifically, the economic trade-off between including firms that are less likely to subsequently pose risk of harm to customers, and not including firms that are more likely to subsequently pose risk of harm to customers. There are costs associated with both types of misidentifications.40 The proposed criteria, including the proposed numerical thresholds, aim to balance these economic trade-offs associated with over- and under-identification.41 Further protection to misidentification would be provided by the proposed initial Department evaluation and the Consultation process.
        •   Anticipated Benefits

        The proposal's primary benefit would be to reduce the risk and associated costs of possible future customer harm. This benefit would arise directly from additional restrictions placed on firms identified as Restricted Firms and increased scrutiny by these firms on their brokers. Further, this benefit would also accrue indirectly from improvements in the compliance culture, both by firms that meet the proposed criteria and by firms that do not. For example, the proposal may create incentives for firms that meet the Preliminary Criteria for Identification to change activities and behaviors, to mitigate the Department's concerns. Similarly, the proposal may have a deterrent effect on firms that do not meet the Preliminary Criteria for Identification, particularly firms that may be close to meeting the proposed criteria. These firms may change behavior and enhance their compliance culture in ways that better protect their customers.

        The proposal also may help address unpaid arbitration awards associated with firms identified as Restricted Firms under the proposal. Under the proposed rule, the Department may require a Restricted Firm to maintain a restricted deposit at a bank or a clearing firm that agrees not to permit withdrawals absent FINRA's approval. Moreover, the proposed rule would have a presumption that the Restricted Firm maintain the deposit if it has any covered pending arbitration claims or unpaid arbitration awards. Accordingly, the proposed rule could potentially create incentives for firms to pay unpaid arbitration awards, thereby alleviating, to some extent, harm to successful claimants and enhancing investor confidence in the arbitration process.42

        To scope these potential benefits and assess the potential risk posed by firms that would meet the proposed Preliminary Criteria for Identification, FINRA evaluated the extent to which firms that would have met the criteria during 2013–201643 (had the criteria existed) and their brokers were associated with "new" Registered Person and Member Firm Events after having met the proposed criteria. These "new" events correspond to events that were identified or occurred after the firm's identification, and do not include events that were pending at the time of identification and subsequently resolved in the years after identification. As shown in Attachment D-3, FINRA estimates that there were 89 firms that would have met the Preliminary Criteria for Identification in 2013. These firms were associated with 1,859 "new" Registered Person and Member Firm Events that occurred after their identification, between 2014 and 2018. Attachment D-3 similarly shows the number of events associated with firms that would have met the Preliminary Criteria for Identification in 2014, 2015 and 2016. Across 2013–2016, there were 183 unique firms44 that would have met the proposed Preliminary Criteria for Identification, and these firms were associated with a total of 2,793 Registered Person and Member Firm Events that occurred in the years after they met the proposed criteria.45

        Attachment D-3 also shows the number of Registered Person and Member Firm Events for these firms compared to other firms. Specifically, FINRA calculated a factor which represents a multiple for the average number of events (on a per registered person basis) for firms that would have met the Preliminary Criteria for Identification relative to other firms of the same size. For example, as shown in Attachment D-3, the factor of 6.3x for 2013 indicates that firms meeting the Preliminary Criteria for Identification in 2013 had 6.3 times more new disclosure events (per registered person) in the years after identification (2014–2018) than other firms of the same size registered in 2013. Overall, this analysis demonstrates that firms that would have met the Preliminary Criteria for Identification during the review period had on average approximately 6–9 times more new disclosure events after their identification than other firms in the industry during the same period.
        •   Anticipated Costs

        The anticipated costs of this proposal would fall primarily upon firms that meet the Preliminary Criteria for Identification and that the Department deems to warrant further review after its initial evaluation. Although FINRA would perform the annual calculation and conduct an internal evaluation, firms may choose to expend effort to determine if they would meet the Preliminary Criteria for Identification, and incur associated costs, at their own discretion. To the extent that a firm deemed to warrant further review under proposed Rule 4111 chooses to rebut the presumption that it is a Restricted Firm subject to the maximum Restricted Deposit Requirement, it would incur costs associated with collecting and providing information to FINRA. For example, these firms may provide information on any disclosure events that may be duplicative or not sales-practice related. These firms may also provide information on any undue financial hardship that would result from a Restricted Deposit Requirement. Likewise, a firm availing itself of the one-time staffing reduction opportunity incurs the separation costs, along with the potential for lost future revenues.

        In addition, firms subject to a Restricted Deposit Requirement or other obligations would incur costs associated with these additional obligations. These would include, for example, costs associated with setting up the Restricted Deposit Account and ongoing compliance costs associated with maintaining the account. Further, as a result of restrictions on the use of cash or qualified securities in the deposit account or other restrictions on the firm's activities, the firm may lose economic opportunities, and its customers may lose the benefits associated with the provision of these services.

        Similarly, a firm required to apply heightened supervision to its brokers would incur implementation and ongoing costs associated with its heightened supervision plan.46 Firms that meet the Preliminary Criteria for Identification also may incur costs associated with enhancing their compliance culture, including possibly terminating registered persons with significant number of disclosure events—through exercising the one-time staffing reduction option under proposed Rule 4111 or otherwise—and reassigning the responsibilities of these individuals to other registered persons. Finally, there may be indirect costs, including greater difficulty or increased cost associated with maintaining a clearing arrangement, loss of trading partners, or similar impairments where third parties can determine that a firm meets the proposed Preliminary Criteria for Identification or has been deemed to be a Restricted Firm.

        Firms that do not meet the proposed Preliminary Criteria for Identification, particularly ones that understand they are close to meeting the proposed criteria, also may incur costs associated with enhancing their compliance culture to avoid meeting the proposed criteria. These costs may include terminating registered persons with disciplinary records, replacing them with existing or new hires, enhancing compliance policies and procedures, and improving supervision of registered persons. Finally, registered persons with significant number of disciplinary or other disclosure events on their records may find it difficult to retain employment, or get employed by new firms.
        •   Other Economic Impacts

        FINRA also has considered the possibility that, in some cases, this proposal may impose restrictions on brokers' and firms' activities that are less likely to subsequently harm their customers. In such cases, these brokers and firms may lose economic opportunities or find it difficult to retain brokers or customers. FINRA believes that the proposal mitigates such risks by requiring an initial layer of Departmental review, and providing affected firms an opportunity to engage in a Consultation with the Department and request a review of FINRA's determination in an expedited proceeding. FINRA recognizes that some firms may elect to terminate the registrations of certain brokers with disclosure events, and these brokers may find it difficult to get employed by other firms.

        FINRA also considered that some firms may consider not reporting, underreporting, or failing to file timely, required disclosures on Uniform Registration Forms in an effort to avoid costs associated with the proposals. However, this potential impact is mitigated because many events are reported by regulators or in separate public notices by third parties and, as a result, FINRA can monitor for these unreported events. Further, failing to update timely Uniform Registration Forms is a violation of FINRA rules and can result in fines and penalties, thereby serving as a deterrent for underreporting or misreporting.

        Considering that the proposed criteria are based on a firm's experience relative to its similarly sized peers, FINRA does not believe that the proposed criteria impose costs on competition between firms of different sizes. Further, because FINRA would perform the annual calculation to determine the firms that meet the Preliminary Criteria for Identification, the costs a firm incurs to monitor its status in relation to the proposed criteria would be discretionary and not likely create any competitive disadvantage based on firm size. Although the proposed rule would not impose these monitoring costs, FINRA would provide transparency around how the Preliminary Identification Metrics are calculated and appropriate guidance to assist firms seeking to determine their status. Similarly, FINRA does not anticipate that the proposed Restricted Firm Obligations Rule, including the Restricted Deposit Requirement or any required conditions and restrictions, would create competitive disadvantages across firms of different sizes. This is, in part, because FINRA would consider firm size, among other factors, when determining the appropriate maximum Restricted Deposit Requirement or any conditions and restrictions, to ensure that the obligations are appropriately tailored to the firms' business models but do not significantly undermine the continued financial stability and operational capability of the firm as an ongoing enterprise over the ensuing 12 months.

        As discussed above, FINRA would exercise some discretion in determining the maximum Restricted Deposit Requirement and tailor it to the size, operations and financial conditions of the firm. This approach is intended to align with FINRA's objective to have the specific financial obligation be significant enough to change a Restricted Firm's behavior but not so burdensome that it would indirectly force it out of business. In determining the specific maximum Restricted Deposit Requirement, FINRA would consider a range of factors, including the nature of the firm's operations and activities, annual revenues, commissions, net capital requirements, the number of offices and registered persons, the nature of the disclosure events counted in the numeric threshold, the amount of any "covered pending arbitration claims" or unpaid arbitration awards, and concerns raised during FINRA exams. In developing the proposal, FINRA considered the possibility of having a transparent formula, based on some of these factors, to determine a maximum Restricted Deposit Requirement. However, given the range of relevant factors and differences in firms' business models, operations, and financial conditions, FINRA decided not to propose a uniform, formulaic approach across all firms. Nonetheless, FINRA recognizes that in the absence of a transparent formulaic approach, firms that meet the Preliminary Criteria for Identification may overestimate or underestimate the maximum Required Deposit Requirement and incur associated costs.47 Accordingly, FINRA seeks comment on alternative approaches that could be used to determine the maximum Restricted Deposit Requirement, and why these alternatives may be more efficient and effective than the proposed rule.

        In developing the proposal, FINRA also considered the possibility that the size of the maximum Restricted Deposit Requirement may be too burdensome for the firms, and could undermine their financial stability and operational capability. FINRA believes that these risks are mitigated by providing affected firms an opportunity to engage in a Consultation process with FINRA and propose a lesser Restricted Deposit Requirement or restrictions or conditions on their operations. Further, as discussed above, Restricted Firms would have the opportunity to request a review of FINRA's determination in an expedited proceeding.
        B. Proposed Expedited Proceeding Rule

        When FINRA imposes obligations on a firm pursuant to the proposed Restricted Firm Obligations Rule, the firm may experience significant limitations to its business activities and incur direct and indirect costs associated with the obligations imposed. The proposed Expedited Proceeding Rule would, in general, require that these obligations apply immediately, even during the pendency of any appeal.

        The proposed rule would be associated with investor protection benefits through the impact of the no-stay provision (proposed new Rule 9559(a)(4)). Under the proposal, obligations imposed by FINRA would be effective immediately, except that a firm subject to a Restricted Deposit Requirement under proposed Rule 4111 would be required to make a partial deposit while the matter is pending review. This would reduce the risk of investor harm during the pendency of a hearing requested by the firm. Similarly, the no-stay provision may limit hearing requests by firms that seek to use them only as a way to forestall FINRA obligations.

        The benefit of the proposed rule accruing to firms would be to permit firms to appeal FINRA's determinations (both to request prompt review of obligations imposed or of determinations for failure to comply) in an expedited proceeding, thereby reducing undue costs where firms may have been misidentified. For example, the proposed rule is anticipated to reduce the costs associated with obligations imposed on misidentified firms by the proceeding's expedited nature. Similarly, the proposed rule's time deadlines may also reduce the costs of the proceedings, in certain cases.

        The costs would be borne by firms that choose to seek review via the proposed expedited proceeding, and these costs can be measured relative to a standard proceeding. These firms would incur costs associated with provisions and procedures specific to this proposed rule, including the provision that the obligations imposed would not be stayed.48 This would include the obligations imposed under the proposed rule, including the Restricted Deposit Requirement, and the requirement that the firm, upon the Department's request, provide evidence of its compliance with these obligations. However, the extent of the costs associated with the Restricted Deposit are mitigated by the expedited nature of the proceeding and by the provision that would require a firm, during an expedited hearing process, to maintain only a partial deposit requirement.

        As with the other proposals, FINRA does not anticipate that the proposed rule would have differential competitive effects based on firm size or other criteria. The costs and benefits are anticipated to apply to all firms that request an expedited hearing.
        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 firms, brokers, 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 and firm misconduct than the proposed amendments.

        In developing this proposal, FINRA considered several alternatives to addressing the risks posed by firms and their brokers that have a history of misconduct, including an alternative to the proposed numeric threshold-based approach and alternative specifications to the proposed numeric threshold based-approach.
        A. Alternative to the Proposed Numeric Threshold-Based Approach

        In addition to the proposed approach based on numeric thresholds, FINRA considered an approach similar to IIROC's "terms and conditions" rule that would allow FINRA to identify a limited number of firms with significant compliance failures and impose on them appropriate terms and conditions to ensure their continuing compliance with the securities laws, the rules thereunder, and FINRA rules. FINRA considered and evaluated the economic impacts of such a Terms and Conditions rule relative to proposed Rule 4111.

        Compared to proposed Rule 4111, a Terms and Conditions rule would provide FINRA with greater flexibility in identifying firms that should be subject to additional obligations. This greater flexibility could help better target its application and reduce misidentification by allowing FINRA to leverage non-public information, including regulatory insights collected as part of its monitoring and examination programs, in identifying firms that pose the greatest risk. Further, under a Terms and Conditions rule, FINRA could quickly update its identification of firms based on emerging risk patterns, to ensure that the rule continues to be effective at addressing firms that presently pose the greatest risk. This flexibility could mitigate the risk that the criteria and thresholds in proposed Rule 4111 no longer identify the appropriate firms.

        Further, as discussed above, the identification criteria in proposed Rule 4111 may not identify all the firms that pose material risk to their customers, such as firms that may act to stay just below the proposed criteria and thresholds by any means, including misreporting or underreporting disclosure events. The absence of a set identification criteria in a Terms and Conditions rule would make it more difficult for firms to evade the identification criteria and thus could provide greater investor protections.

        A Terms and Conditions rule also may have certain disadvantages relative to proposed Rule 4111. For example, a benefit of proposed Rule 4111 is the deterrent effect it may have on firms that do not meet the proposed Preliminary Criteria for Identification, particularly firms that may be close to meeting the criteria. These firms may change behavior and enhance their compliance culture in ways that could better protect their customers. By comparison, under a Terms and Conditions rule, in the absence of transparent criteria, firms must assess FINRA's view of the significance of repeated exam findings to determine whether to change their conduct to avoid potential terms and conditions.

        Although FINRA has considered, and will continue to explore this alternative, it is not proposing a terms and conditions approach at this time.
        B. Alternative Specifications for the Proposed Numeric Threshold-Based Approach

        FINRA also considered several alternatives to the numerical thresholds and conditions for the Preliminary Criteria for Identification. In determining the proposed criteria, FINRA focused significant attention on the economic trade-off between incorrect identification of firms that may not subsequently pose risk of harm to their customers, and not including firms that may subsequently pose risk of harm to customers but do not meet the proposed thresholds. FINRA also considered three key factors: (1) the different categories of reported disclosure events and metrics; (2) the counting criteria for the number of reported events or conditions; and (3) the time period over which the events or conditions are counted. FINRA considered several alternatives for each of these three factors.
        •   Alternatives Associated with the Categories of Disclosure Events and Metrics

        In determining the different types of disclosure events, FINRA considered all categories of disclosure events reported on the Uniform Registration Forms, including the financial disclosures. FINRA decided to exclude financial disclosures because while financial events, such as bankruptcies, civil bonds, or judgments and liens, may be of interest to investors in evaluating whether or not to engage a broker or a firm, these types of events by themselves are not evidence of customer harm.

        In developing the Preliminary Criteria for Identification, FINRA also considered whether pending criminal, internal review, judicial and regulatory events should be excluded from the threshold test. FINRA decided to include these pending events because they often are associated with an emerging pattern of customer harm and capture timely information of potential ongoing or recent misconduct. Further, as with other categories, the proposed Preliminary Identification Metrics Thresholds for the relevant Preliminary Identification Metrics, including the Registered Person Pending Event Metric and the Member Firm Pending Event Metric, are intended to capture firms that are on the far tail of the distributions. Thus, firms meeting these thresholds have far more pending matters on their records than other firms in the industry. Nonetheless, FINRA recognizes that pending matters include disclosure events that may remain unresolved or that may subsequently be dismissed or concluded with no adverse action because they lack merit or suitable evidence.49 In order to ensure that a firm does not meet the Preliminary Criteria for Identification solely because of pending matters, FINRA has proposed the conditions that, to meet the criteria, the firm must meet or exceed at least two of the six Preliminary Identification Metrics Thresholds, and at least one of the thresholds for the Registered Person Adjudicated Event Metric, Member Firm Adjudicated Event Metric, or Expelled Firm Association Metric.50
        •   Alternatives Associated with the Counting Criteria for the Proposed Criteria and Metrics

        FINRA considered a range of alternative counting criteria for the Preliminary Criteria for Identification. For example, FINRA considered whether the Preliminary Criteria for Identification should be based on firms meeting two or more Preliminary Identification Metrics Thresholds, or whether the number of required thresholds should be decreased or increased. Decreasing the number of required thresholds from two to one would increase the number of firms that would have met the Preliminary Criteria for Identification during the review period from 60–98 firms to 150–220 firms, each year. Alternatively, increasing the number of required thresholds from two to three decreases the number of firms that would have met the Preliminary Criteria for Identification from 60–98 to 15–35, each year. FINRA reviewed the list of firms identified under these alternative counting criteria and examined the extent to which they included firms that were subsequently expelled, associated with unpaid awards, or identified as suitable candidates for additional obligations by the Department. FINRA also paid particular attention to firms that would have been identified by these alternative criteria but subsequently were not associated with high-risk activity, as well as firms that would not have been identified by these alternatives that were associated with high-risk events. Based on this review, FINRA believes that the proposed approach—meeting two or more of the Preliminary Identification Metrics Thresholds—more appropriately balances these trade-offs between misidentifications than the alternative criteria.
        •   Alternatives Associated with the Time Period over which the Metrics Are Calculated

        The proposed Preliminary Identification Metrics are based on three different time periods over which different categories of events and conditions are counted (look-back periods). Pending events, including the Registered Person Pending Events and the Member Firm Pending Events categories, are counted in the Preliminary Identification Metrics only if they are pending as of the Evaluation Date. Adjudicated events, including the Registered Person Adjudicated Events and the Member Firm Adjudicated Events categories, are counted in the Preliminary Identification Metrics over a five-year look-back period. The Expelled Firm Association Metric does not have a limit on the look-back period, and is based on the association of Registered Persons In-Scope with a previously expelled firm at any time in their career.51

        In developing the proposal, FINRA considered alternative criteria for the time period over which the disclosure events or conditions are counted. For example, FINRA considered whether adjudicated events should be counted over the individual's or firm's entire reporting period or counted over a more recent period. Based on its experience, FINRA believes that events that are more recent (e.g., events occurring in the last five years) generally pose a higher level of possible future risk to customers than other events. Further, counting events over an individual's or firm's entire reporting period would imply that brokers and firms would always be included in the Preliminary Identification Metrics for adjudicated events, even if they subsequently worked without being associated with any future adjudicated events. Accordingly, FINRA decided to include adjudicated events only in the more recent period (i.e., a five-year period).52

        Similarly, FINRA also considered whether there should be limits on the time period over which the Expelled Firm Association Metric is calculated. For example, FINRA considered alternative metrics that would only be based on firm expulsions over the last three to five years. Further, FINRA considered alternatives where the individual broker's association with the previously expelled firm was within a five-year window around the firm's expulsion. In evaluating these alternatives, FINRA recalculated the underlying thresholds to capture firms that are on the far tail of the distribution for these alternative metrics.53 As with other alternatives, FINRA evaluated these alternatives by paying particular attention to the economic trade-offs of misidentifications, including over- and under-identification of firms. Based on this evaluation, FINRA determined that the Expelled Firm Association Metric proposed in this Notice better accounts for these economic trade-offs. Nonetheless, FINRA specifically seeks comments on alternatives FINRA should consider for the Expelled Firm Association Metric and why these alternatives may be more effective and efficient for identifying the firms that this proposal seeks to address.

        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.

        General

        1. Are there alternative ways to address members that pose a high degree of risk that should be considered? What are the alternative approaches that FINRA should consider?
        2. Are there any material economic impacts, including costs and benefits, to investors, issuers and firms that are associated specifically with the proposal? If so:
        c. What are these economic impacts and what are their primary sources?
        d. To what extent would these economic impacts differ by business attributes, such as size of the firm or differences in business models?
        e. What would be the magnitude of these impacts, including costs and benefits?
        3. 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?

        Proposed Rule 4111

        4. As discussed above, the framework in proposed Rule 4111 for identifying members that pose a high degree of risk is based on identifying members with significantly more reportable events than their peers, based upon six proposed categories of events and conditions.
        a. Does this appear to be a reasonable approach for identifying members that could be subject to additional obligations? Are there other approaches FINRA should consider?
        b. Do the seven firm-size categories in proposed Rule 4111(i)(11) appropriately group firms of similar sizes? Should FINRA consider additional size categories or consider combining certain size categories?
        c. The framework is based on six different categories of events and conditions. Each of these categories is based on a combination of disclosure events. Do these categories appropriately combine similar types of disclosure events? Should FINRA consider additional disclosure categories or consider aggregating or disaggregating certain categories?
        d. FINRA anticipates that the distributions of the six categories of events and conditions would change over time. Should FINRA consider updating the Preliminary Identification Metrics Thresholds periodically, to ensure that they continue to identify members that are significantly different than their peers? If so, how frequently should FINRA consider updating the thresholds?
        5. As discussed above, when developing proposed Rule 4111, FINRA considered several numerical and categorical thresholds for identifying member firms that could potentially be subject to a Restricted Deposit Requirement and other obligations. In determining the proposed metrics and thresholds, FINRA paid significant attention to the economic trade-offs associated with misidentifications, including both over- and under-identification of member firms. FINRA seeks comments on the proposed numerical thresholds and metrics, including the following key factors associated with developing the metrics: (a) the different categories of reported disclosure events and conditions; (b) the counting criteria for the metrics; and (c) the time period over which the metrics are calculated. Specifically, FINRA seeks comment on whether alternative inputs for any of these factors should be considered, and why these alternatives may better identify firms that pose greater risks to their investors.
        6. Should FINRA consider alternative thresholds or look-back periods for the Expelled Firm Association Metric? What factors or conditions should FINRA consider when developing a metric with respect to expelled firm association?
        7. Proposed Rule 4111 includes several processes, including qualitative reviews and consultations, to minimize potential sources of misidentifications. These processes may aid in the identification of the members motivating this proposal, but may also delay the imposition of obligations on them. Are there alternative processes that should be considered?
        8. Proposed Rule 4111 is premised on a notion that the most effective tool to change the behavior of a member firm that presents a high degree of risk is a financial restriction. The proposal, however, affords members that meet the Preliminary Criteria for Identification the opportunity to advocate for a lower Restricted Deposit Requirement or for conditions and restrictions as alternatives to a Restricted Deposit Requirement. Are there better ways to create a potential financial restriction that serves as an effective incentive to change firm behavior?
        9. Proposed Rule 4111 would restrict a member firm from withdrawing any amount from the Restricted Deposit Account, even if it terminates its FINRA membership. However, the proposed Restricted Deposit Account would not be bankruptcy remote and could be used to satisfy claims in a bankruptcy proceeding. Should FINRA consider ways to structure the Restricted Deposit Account so that it is bankruptcy remote or preferentially available to customer claims in the event of a bankruptcy? If so, how should FINRA structure the Restricted Deposit Account, and what conditions and priorities should FINRA consider placing on claims in the event of a bankruptcy?
        10. Proposed Rule 4111 would allow a member firm that meets the Preliminary Criteria for Identification, and that the Department determines warrants further review under Rule 4111, to present why certain disclosure events should not be counted. For example, a member could maintain that disclosure events should not be included in the annual calculation because they involved the same person and the same event or were non-sales-practice related. Are there other characteristics of disclosure events that should lead to not including those events in the calculation of whether the member firm meets the Preliminary Criteria for Identification?
        11. Proposed Rule 4111 uses a principles-based approach for determining a maximum Restricted Deposit Requirement.
        a. FINRA intends to take several factors into account in determining the maximum Restricted Deposit Requirement, including the nature of the member's operations and activities, annual revenues, commissions, net capital requirements, the number of offices and registered persons, the nature of the disclosure events counted in the numeric thresholds, the amount of covered pending arbitration claims or unpaid arbitration awards, and concerns raised during FINRA examinations. Are there other factors FINRA should consider in making this determination? What are those factors, and how should FINRA account for them?
        b. Should FINRA instead consider a formula-based approach(es)? If so, what would be an appropriate formula-based approach that results in a meaningful Restricted Deposit Requirement? How would the formula-based approach account for differences in firms' business models, financial conditions, or other factors discussed above?
        12. Should there be a cap on the maximum Restricted Deposit Requirement? If so, what should the cap be? Should it be expressed as a specific dollar amount? As a number derived from a firm-specific figure, such as a percentage of the member's gross revenues? Or something else?
        13. Apart from having to comply with a Restricted Deposit Requirement or other obligations, are there collateral consequences that could result from being designated as a Restricted Firm, even if FINRA does not publicly disclose that designation? If so, what are those collateral consequences?
        14. This Notice explains that FINRA would review the Preliminary Identification Metrics Thresholds in proposed Rule 4111 on a periodic basis, to consider whether the thresholds remain targeted and effective at identifying member firms that pose higher risks. How frequently should FINRA conduct those periodic reviews?

        Proposed New Rule 9559 and Proposed Amended Rule 9560

        15. Hearings in expedited proceedings under proposed new Rule 9559 would be presided over by a Hearing Officer. By requiring the appointment of a Hearing Officer instead of a Hearing Panel, FINRA intends to create efficiencies, considering the number of potential expedited proceedings that could result from the proposed rule and the substantial amount of time and resources that the Office of Hearing Officers could expend in identifying Hearing Panelists. However, there would be potential benefits to having a Hearing Panel preside over the proceedings, especially due to the industry experience that Hearing Panelists may have. Should FINRA consider requiring that a Hearing Panel be appointed in proceedings under proposed new Rule 9559? Would the benefits of appointing Hearing Panelists outweigh the costs?

        Additional Approaches Considered

        16. Should FINRA consider a rule proposal that would provide it discretion to identify firms that pose significant concerns and impose tailored terms and conditions on a firm, similar to the IIROC's "terms and conditions" rule? If so, should FINRA consider adopting both proposed Rule 4111 and a "terms and conditions" rule, or just one of these kinds of rules? What would be the costs and consequences to member firms of a "terms and conditions" rule, and what kinds of limitations should be placed on such a rule?
        17. FINRA's authority to seek temporary cease and desist orders is limited to alleged violations of specific Exchange Act provisions, specific Exchange Act rules, and specific FINRA rules. It is also limited to circumstances in which the alleged violative conduct is likely to result in significant dissipation or conversion of assets or other significant harm to investors prior to the completion of the underlying disciplinary proceeding.54 Should FINRA consider expanding its authority to seek temporary cease and desist orders?

        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 proposed new rule establishing expedited proceeding procedures for regulating activities under proposed Rule 4111 would be new Rule 9559 (Procedures for Regulating Activities Under Rule 4111); current Rule 9559 (Hearing Procedures for Expedited Proceedings Under the Rule 9550 Series) would be renumbered as Rule 9560. References in this Notice to "new Rule 9559" are to the proposed new rule; references to "Rule 9560" or "the Hearing Procedures Rule" are to current Rule 9559.

        2. 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.

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

        4. For example, in October 2018, FINRA announced plans to consolidate its Examination and Risk Monitoring Programs, integrating three separate programs into a single, unified program to drive more effective oversight and greater consistency, eliminate duplication and create a single point of accountability for the examination of firms. That effort is well underway, and FINRA expects the consolidation will bring those programs under a single framework designed to better direct and align examination resources to the risk profile and complexity of member firms.

        5. For example, in 2015 FINRA's 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 arbitrations and litigations of brokers, have significant power to predict future investor harm. See Hammad Qureshi & Jonathan Sokobin, Do Investors Have Valuable Information About Brokers? (FINRA Office of the Chief Economist Working Paper, Aug. 2015). A subsequent academic research paper presented 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 Mark Egan, Gregor Matvos, & Amit Seru, The Market for Financial Adviser Misconduct, J. Pol. Econ. 127, no. 1 (Feb. 2019): 233–295.

        6. The number of disclosure events correspond to the number of Registered Person and Member Firm Events (defined in proposed Rule 4111(i)(12)) during the Evaluation Period (defined in proposed Rule 4111(i)(6)), as of December 31, 2018. As per the Evaluation Period definition, all final events are counted over the prior five years, and all pending events are counted if they were pending as of December 31, 2018.

        7. See FINRA Rule 9800 Series (Temporary and Permanent Cease and Desist Orders).

        8. See Securities Exchange Act Release No. 83181 (May 7, 2018), 83 FR 22107 (May 11, 2018) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2018-018).

        9. See Regulatory Notice 18-16.

        10. The term "covered pending arbitration claim" is defined in proposed Rule 4111(i)(2) to mean an investment-related, consumer initiated claim filed against the member or its associated persons that is unresolved; and whose claim amount (individually or, if there is more than one claim, in the aggregate) exceeds the member's excess net capital. The claim amount includes claimed compensatory loss amounts only, not requests for pain and suffering, punitive damages or attorney's fees. This term also is proposed in Regulatory Notice 18-06 (February 2018). FINRA anticipates that the term would be amended in proposed Rule 4111(i)(2) to conform to any final definition adopted under the proposal in Regulatory Notice 18-06. For purposes of this Notice, the term "unpaid arbitration awards" also includes unpaid settlements related to arbitrations.

        11. See IIROC Consolidated Rule 9208.

        12. "Uniform Registration Forms" mean Forms BD, U4, U5 and U6.

        13. See proposed Rule 4111(a) and (d).

        14. This part of the Notice uses many terms that are defined in proposed Rule 4111(i). The terms used have the meanings as defined in proposed Rule 4111(i).

        15. See supra note 12. One of the event categories, Member Firm Adjudicated Events, includes events that are derived from customer arbitrations filed with FINRA's dispute resolution forum.

        16. "Registered Person Adjudicated Events," defined in proposed Rule 4111(i)(4)(A), means any one of the following events that are reportable on the registered person's Uniform Registration Forms: (i) a final investment-related, consumer-initiated customer arbitration award or civil judgment against the registered person in which the registered person was a named party, or was a "subject of" the customer arbitration award or civil judgment; (ii) a final investment-related, consumer-initiated customer arbitration settlement, civil litigation settlement or a settlement prior to a customer arbitration or civil litigation for a dollar amount at or above $15,000 in which the registered person was a named party or was a "subject of" the customer arbitration settlement, civil judgment settlement or a settlement prior to a customer arbitration or civil litigation; (iii) a final investment-related civil judicial matter that resulted in a finding, sanction or order; (iv) a final regulatory action that resulted in a finding, sanction or order, and was brought by the SEC or Commodity Futures Trading Commission (CFTC), other federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization; or (v) a criminal matter in which the registered person was convicted of or pled guilty or nolo contendere (no contest) in a domestic, foreign, or military court to any felony or any reportable misdemeanor.

        17. "Registered Person Pending Events," defined in proposed Rule 4111(i)(4)(B), means any one of the following events associated with the registered person that are reportable on the registered person's Uniform Registration Forms: (i) a pending investment-related civil judicial matter; (ii) a pending investigation by a regulatory authority; (iii) a pending regulatory action that was brought by the SEC or CFTC, other federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization; or (iv) a pending criminal charge associated with any felony or any reportable misdemeanor. Registered Person Pending Events does not include pending arbitrations, pending civil litigations, or consumer-initiated complaints that are reportable on the registered person's Uniform Registration Forms.

        18. "Registered Person Termination and Internal Review Events," defined in proposed Rule 4111(i)(4)(C), means any one of the following events associated with the registered person that are reportable on the registered person's Uniform Registration Forms: (i) a termination in which the registered person voluntarily resigned, was discharged or was permitted to resign after allegations; or (ii) a pending or closed internal review by the member.

        19. "Member Firm Adjudicated Events," defined in proposed Rule 4111(i)(4)(D), means any of the following events that are reportable on the member firm's Uniform Registration Forms, or are based on customer arbitrations filed with FINRA's dispute resolution forum: (i) a final investment-related, consumer-initiated customer arbitration award in which the member was a named party; (ii) a final investment-related civil judicial matter that resulted in a finding, sanction or order; (iii) a final regulatory action that resulted in a finding, sanction or order, and was brought by the SEC or CFTC, other federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization; or (iv) a criminal matter in which the member was convicted of or pled guilty or nolo contendere (no contest) in a domestic, foreign, or military court to any felony or any reportable misdemeanor.

        20. "Member Firm Pending Events," defined in proposed Rule 4111(i)(4)(E), means any one of the same kinds of events as the "Registered Person Pending Events," but that are reportable on the member firm's Uniform Registration Forms.

        21. "Registered Persons Associated with Previously Expelled Firms," defined in proposed Rule 4111(i)(4)(F), means any registered person registered for one or more days within the year prior to the "Evaluation Date" (i.e., the annual date as of which the Department calculates the Preliminary Identification Metrics) with the member, and who was associated with one or more previously expelled firms (at any time in his/her career).

        22. For each of the six Preliminary Identification Metrics, proposed Rule 4111(i)(11) establishes numeric thresholds for seven different firm sizes. Firm sizes are based on the number of registered persons, and range from members that have 1–4 registered persons to members that have 500 or more registered persons. Thus, the proposal establishes 42 different numeric thresholds.

        23. "Registered Person and Member Firm Events," a term defined in proposed Rule 4111(i)(12), means the sum of events in the following five categories: (i) Registered Person Adjudicated Events; (ii) Registered Person Pending Events; (iii) Registered Person Termination and Internal Review Events; (iv) Member Firm Adjudicated Events; and (v) Member Firm Pending Events.

        24. The "Evaluation Date" is defined in proposed Rule 4111(i)(5) to mean the date, each calendar year, as of which the Department calculates the Preliminary Identification Metrics to determine if the member firm meets the Preliminary Criteria for Identification.

        25. OCE has tested the Preliminary Criteria for Identification, including the Preliminary Identification Metrics Thresholds, in several ways. For example, OCE has compared the firms captured by the proposed criteria to the firms that have recently been expelled or that have unpaid arbitration awards. OCE also has consulted with Member Supervision staff and examiners about whether, based on their experience, the criteria identifies firms that appear to present high risks to investors.

        26. See supra note 10, for an explanation of references in this Notice to the term "unpaid arbitration awards."

        27. See supra note 1, for explanations of references in this Notice to "new Rule 9559" and references to "Rule 9560" or the "Hearing Procedures Rule."

        28. Proposed new Rule 9559(a)(1) would define the "Rule 4111 Requirements" to mean the requirements, conditions, or restrictions imposed by a Department determination under proposed Rule 4111.

        29. See supra note 1, for explanations of references in this Notice to "new Rule 9559" and references to "Rule 9560" or the "Hearing Procedures Rule."

        30. Proposed amended Rule 9560 contains other related timing requirements for proceedings pursuant to proposed new Rule 9559.

        31. See FINRA Rule 9560(q).

        32. Attempts to collaterally attack final matters are also precluded in other FINRA proceedings. Cf. Dep't of Enforcement v. Amundsen, Complaint No. 2010021916601, 2012 FINRA Discip. LEXIS 54, at *21–24 (FINRA NAC Sept. 20, 2012) (rejecting respondent's attempt to collaterally attack a judgment that was required to be disclosed on Form U4), aff'd, Exchange Act Release No. 69406, 2013 SEC LEXIS 1148 (Apr. 18, 2013), aff'd, 575 F. App'x 1 (D.C. Cir. 2014); Membership Continuance Application of Member Firm, Application No. 20060058633, 2007 FINRA Discip. LEXIS 31, at *51 (July 2007) (holding, in a membership proceeding, that a firm may not address its and its FINOP's past disciplinary history by collaterally attacking those past violations) (citing BFG Sec., Inc., 55 S.E.C. 276, 279 n.5 (2001)); Jan Biesiadecki, 53 S.E.C. 182, 185 (1997) (describing, in eligibility proceedings, FINRA's long-standing policy of prohibiting collateral attacks on underlying disqualifying events).

        33. See IIROC Consolidated Rule 9208; see also IIROC Notice 17-0010, at pp. 2, 14 (Jan. 12, 2017) (IIROC Compliance Priorities), available at www.iiroc.ca/Documents/2017/2461049c-03b1-4bfa-ba16-2ac05bd59ab4_en.pdf.

        34. See, e.g., Roland Strausz, Delegation of Monitoring in a Principal-Agent Relationship, Rev. Econ. Stud. 64(3):337–57 (July 1997). The paper shows that in a standard principal-agent framework, the delegation of monitoring by the principal (e.g., a regulator) to the agent (e.g., a firm) can be economically efficient for both parties.

        35. See supra note 5.

        36. Investors may also file claims in courts or other dispute resolution forums. Successful claimants in these forums may face similar challenges associated with collecting awards or judgments.

        37. As discussed above, recent studies provide evidence of predictability of future regulatory-related events for brokers and firms with a history of past regulatory-related events. As a result, brokers and firms with a history of past regulatory-related events pose greater risk of future harm to their customers than other brokers and firms.

        38. For example, for each of the six Preliminary Identification Metrics, the Preliminary Identification Metrics Threshold was chosen to capture 1%–5% of the firms with the highest number of events per registered broker or the highest concentrations of Registered Persons Associated with Previously Expelled Firms, in respective firm-size categories.

        39. 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.

        40. For example, subjecting firms that are less likely to pose a risk to customers to the proposed Restricted Deposit Requirement or other obligations would impose additional and unwarranted costs on these firms, their brokers and their customers.

        41. In order to evaluate the effectiveness of the proposed criteria at identifying firms that pose greater risks, FINRA examined the overlap between the firms that would have met the Preliminary Criteria for Identification each year during the review period and the firms that were subsequently expelled, associated with unpaid awards, or identified by Department staff as suitable candidates for additional obligations. Finally, as discussed below, FINRA also examined disclosure events associated with firms that would have met the Preliminary Criteria for Identification each year during the review period, subsequent to meeting the criteria, to assess the extent of risk posed by these firms.

        42. Further, as discussed above, the Department would consider unpaid awards as one of the factors in determining the amount of the Restricted Deposit Requirement. As a result, Restricted Firms would have additional incentives to pay unpaid arbitration awards.

        43. This analysis examines firms that would have met the Preliminary Criteria for Identification from 2013 until 2016, to allow sufficient time for the "new" events to resolve in the post-identification period.

        44. Certain firms would have met the criteria in multiple years during the review period. The 183 firms discussed in the text correspond to the unique number of firms that would have met the criteria in one or more years during the review period.

        45. Specifically, FINRA examined and counted all Registered Person and Member Firm Events that occurred any time after the firms were identified until March 15, 2019.

        46. These costs would likely vary significantly across firms. Costs would depend on the specific obligations imposed specific to the firm and its business model. In addition, costs could escalate if a heightened supervision plan applied to brokers that serve as principals, executive managers, owners or in other senior capacities. Such plans may entail re-assignments of responsibilities, restructuring within senior management and leadership, and more complex oversight and governance approaches.

        47. For example, firms may, conservatively, overestimate the amount of the required deposit, and withhold the use of additional funds, thereby losing out on economic opportunities associated with these excess funds, until FINRA informs these firms of their actual maximum Restricted Deposit Requirement.

        48. The effect of the no-stay provision is that imposed obligations would apply immediately, even during the pendency of any hearing request. As a result, the no-stay provision would impose direct costs on misidentified firms.

        49. 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 arbitrators or judges.

        50. In order to assess the impact of removing pending events from the Preliminary Criteria for Identification and restricting the criteria solely to final events, FINRA examined the number of firms that would have met or exceeded at least one Preliminary Identification Metrics Threshold in the Registered Person Adjudicated Events, Member Firm Adjudicated Events, or Registered Persons Associated with Expelled Firms categories, during the relevant period. This analysis showed that the number of firms identified by this alternative criteria would increase from 60–98 firms to 150–220 firms, each year, during the review period. Similarly, FINRA estimates the number of firms that would have met or exceeded at least two thresholds within these categories to be 50–75 firms, each year, during the review period.

        51. Registered Persons In-Scope include all persons registered with the firm for one or more days within the one year prior to the Evaluation Date.

        52. This is consistent with the time period used for counting "specified risk events" in Regulatory Notice 18-16.

        53. These alternatives would have identified approximately the same number of firms as meeting the Preliminary Criteria for Identification, during the review period.

        54. See FINRA Rules 9810(a), 9840(a).

        • Attachment A

          Download the document in PDF format.

        • Attachment B

          Download the document in PDF format.

        • Attachment C

          Download the document in PDF format.

        • Attachment D

          Download the document in PDF format.

      • 19-16 SEC Approves Amendments to FINRA Rule 4570; Effective Date: August 19, 2019 [PDF]

        Please click here to view the full PDF pending the publication of the HTML version as soon as possible.

      • 19-15 FINRA Publishes Consolidated Criteria to Designate Firms for Mandatory Participation in FINRA's Business Continuity/Disaster Recovery Testing [PDF]

        Please click here to view the full PDF pending the publication of the HTML version as soon as possible.

      • 19-14 2019 GASB Accounting Support Fee to Fund the Governmental Accounting Standards Board

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        GASB Accounting Support Fee

        Regulatory Notice
        Notice Type

        Guidance
        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
        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
        Regulatory Notice 18-12
        Securities Act Section 19(g)

        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 its 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 $8,935,500 to adequately fund GASB's annual budget by collecting $2,233,875 from its member firms each calendar quarter beginning in April 2019.

        Questions regarding this Notice should be directed to the:

        •   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 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 member firms. A 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, firms 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 2019, GASB's annual budget expenses of $10,452,300 will be partially funded from $1,516,800 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 $8,935,500;3 therefore, FINRA will collect $2,233,875 from its member firms each quarter beginning in April 2019.4

        Because some firms may seek to pass the GASB Accounting Support Fee onto customers engaged in municipal securities transactions, FINRA will continue to provide an estimated fee rate (per $1,000 par value) based on the GASB recoverable annual budgeted expenses reported to FINRA for that year, as well as 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 2018 and the 2019 GASB budget, FINRA estimates that the GASB Accounting Support Fee for 2019 will be between $0.0024 and $0.0030 per $1,000 par value.

        Firms are reminded that if they choose to pass along the fee, they must ensure any such fees are properly disclosed, including (if applicable) 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 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 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 18-12 (April 17, 2018); 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 GASB, or to affect the setting of generally accepted accounting principles by GASB. See 15 U.S.C. 77s(g)(5)(B).

        3. For purposes of the GASB Accounting Support Fee, the annual budget of 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 2019 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 2019 covers the fourth quarter of GASB's 2018 budget and is based on the amounts set forth in Regulatory Notice 18-12. 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).

      • 19-13 SEC Approves Amendments to FINRA Rule 4512 to Permit the Use of Electronic Signatures for Discretionary Accounts; Effective Date: May 6, 2019

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        Account Authorization Records

        Regulatory Notice
        Notice Type

        Rule Amendment
        Referenced Rules & Notices

        E-Sign Act
        FINRA Rule 4512
        SEA Rule 17a-3
        SEA Rule 17a-4
        Suggested Routing

        Compliance
        Legal
        Operations
        Senior Management
        Key Topics

        Account Authorization
        Discretionary Authority
        Electronic Signatures
        Recordkeeping

        Summary

        The Securities and Exchange Commission (SEC) approved a proposed rule change to amend FINRA Rule 4512 (Customer Account Information) to permit the use of electronic signatures for discretionary accounts and to clarify the scope of the rule.1 These changes become effective on May 6, 2019.

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

        Questions concerning this Notice should be directed to:

        •   Afshin Atabaki, Associate General Counsel, Office of General Counsel, at (202) 728-8902 or Afshin.Atabaki@finra.org.

        Background and Discussion

        For discretionary accounts, FINRA Rule 4512(a)(3) currently requires member firms to maintain a record of the dated, manual (or "wet") signature of each named, natural person authorized to exercise discretion in such accounts. To comply with the current requirement, most firms print a paper copy of the account record and require that the authorized individual physically sign it. They then convert the paper record to an electronic record for retention on electronic storage media consistent with Rule 17a-4(f) under the Securities Exchange Act of 1934 (SEA).

        Given technological advances relating to electronic signatures, including authentication and security, FINRA has amended Rule 4512(a)(3) to permit the use of electronic signatures. The rule change is consistent with the Electronic Signatures in Global and National Commerce Act (E-Sign Act), which facilitates the use of electronic signatures. The rule change is also consistent with the requirements of SEA Rule 17a-3(a)(17)(ii) relating to discretionary accounts,2 which does not prescribe the type of signature that must be obtained from an authorized individual. While FINRA Rule 4512(a)(3) would continue to require member firms to obtain the signature of the authorized individual, it would provide firms the option of obtaining either a manual or an electronic signature.

        For purposes of compliance with amended Rule 4512(a)(3), a valid electronic signature would be any electronic mark that clearly identifies the signatory and is otherwise in compliance with the E-Sign Act, the guidance issued by the SEC relating to the E-Sign Act,3 and the guidance provided by FINRA staff through interpretive letters.4

        FINRA has also amended Rule 4512(a)(3) to clarify that the rule is limited to discretionary accounts maintained by member firms for which associated persons of such firms are authorized to exercise discretion. Specifically, the amended rule provides that for a discretionary account maintained by a member firm, the firm must maintain a record of the dated signature of each named, associated person of the firm authorized to exercise discretion in the account. This change will eliminate any potential confusion regarding the scope of the rule and aid members' compliance efforts.


        1. See Securities Exchange Act Release No. 85282 (March 11, 2019), 84 FR 9573 (March 15, 2019) (Order Approving File No. SR-FINRA-2018-040).

        2. 17 CFR 240.17a-3(a)(17)(ii).

        3. See Securities Exchange Act Release No. 44238 (May 1, 2001), 66 FR 22916 (May 7, 2001) (Commission Guidance to Broker-Dealers on the Use of Electronic Storage Media Under the Electronic Signatures in Global and National Commerce Act of 2000 with Respect to Rule 17a-4(f)).

        4. See, e.g., Letter from Nancy Libin, NASD, to Jeffrey W. Kilduff, O'Melveny & Myers, LLP, dated July 5, 2001, www.finra.org/industry/ interpretive-letters/july-5-2001-1200am.


        Attachment A

        Below is the amended rule text. New language is underlined; deletions are in brackets.

        * * * * *

        4500. BOOKS, RECORDS AND REPORTS

        * * * * *

        4512. Customer Account Information

        (a) Each member shall maintain the following information:
        (1) through (2) No Change.
        (3) for discretionary accounts maintained by a member, in addition to compliance with subparagraph (1) and, to the extent applicable, subparagraph (2) above, and NASD Rule 2510(b), the member shall maintain a record of the dated, [manual] signature of each named, [natural] associated person of the member authorized to exercise discretion in the account. This recordkeeping requirement shall not apply to investment discretion granted by a customer as to the price at which or the time to execute an order given by a customer for the purchase or sale of a definite dollar amount or quantity of a specified security. Nothing in this Rule shall be construed as allowing members to maintain discretionary accounts or exercise discretion in such accounts except to the extent permitted under the federal securities laws.
        (b) through (c) No Change.

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

        .01 through .06 No Change.

        * * * * *

      • 19-12 FINRA Requests Comment on a Proposed Pilot Program to Study Recommended Changes to Corporate Bond Block Trade Dissemination; Comment Period Expires: June 11, 2019

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        Trade Reporting and Compliance Engine (TRACE)

        Regulatory Notice
        Notice Type

        Request for Comment
        Referenced Rules & Notices

        Notice to Member 06-01
        Notice to Members 03-73
        Notice to Member 03-12
        Notice to Members 01-18
        Regulatory Notice 17-23
        Regulatory Notice 13-35
        Rule 6710
        Rule 6730
        Rule 6750
        SEC Rule 144A
        Suggested Routing

        Compliance
        Fixed Income
        Legal
        Operations
        Research
        Systems
        Trading
        Training
        Key Topics

        ETFs
        Fixed Income
        TRACE
        TRACE-Eligible Security
        TRACE Transaction Data
        Trade Reporting

        Summary

        FINRA requests comment on a proposed pilot program to study changes to corporate bond block trade dissemination based on recommendations of the Securities and Exchange Commission's (SEC) Fixed Income Market Structure Advisory Committee (FIMSAC or Committee). Specifically, the proposed pilot is designed to study two primary changes recommended by the FIMSAC: an increase to the current dissemination caps for corporate bond trades, and delayed dissemination of any information about trades above the proposed dissemination caps for 48 hours. The proposed pilot incorporates these primary elements of the FIMSAC Recommendation and other features, including a control group, designed to support a meaningful analysis of the pilot's impact.

        Questions concerning this Notice should be directed to:

        •   Shawn O'Donoghue, Economist, Office of the Chief Economist (OCE), at (202) 728-8273 or shawn.odonoghue@finra.org; or Yue Tang, Economist, OCE, at (202) 728-8237 or yue.tang@finra.org; or
        •   Alex Ellenberg, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8152 or alexander.ellenberg@finra.org.

        Action Requested

        FINRA encourages all interested parties to comment on the proposal. Comments must be received by June 11, 2019.

        Comments must be submitted through one of the following methods:

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

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

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

        Important Notes: The only comments that FINRA will consider are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the FINRA website. Generally, FINRA will post comments as they are received.1

        Before becoming effective, the proposed rule change must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act (SEA).2

        Background and Discussion

        FINRA's Trade Reporting and Compliance Engine (TRACE) provides information to investors and other market participants about secondary market trades in corporate bonds and other debt securities. Currently, TRACE disseminates information to the marketplace about corporate bond trades, including trade price and size, immediately upon receipt. FINRA launched TRACE in 2002 following an SEC staff review of the U.S. debt markets and a corresponding call for FINRA "to develop systems to receive and redistribute [corporate bond] transaction prices on an immediate basis."3 As FINRA noted at the time, it had worked closely with the SEC, the dealer community and other market participants "to ensure that TRACE maximizes transparency, while optimizing liquidity."4

        To promote transparency without negatively impacting liquidity, FINRA adopted a measured, phased approach to corporate bond trade dissemination that began in 2002 with the most actively traded and liquid bonds.5 In 2003, FINRA phased in dissemination for transactions in smaller investment grade (IG) issues,6 and in 2005 FINRA expanded dissemination for non-investment grade (non-IG) corporate bonds, with delayed dissemination for certain non-IG trades.7 Beginning in 2006, all over-the-counter (OTC) secondary market trades in corporate bonds were disseminated immediately upon receipt, except for trades executed pursuant to SEC Rule 144A.8 FINRA began immediate dissemination for trades in corporate bonds executed pursuant to SEC Rule 144A in 2014.9

        FINRA also leverages academic study to evaluate the impact of TRACE in support of its mission. FINRA performs and publishes economic analysis of TRACE impacts10 and it provides substantial support for independent research.11 Academic research generally has found that liquidity conditions proxied by aggregate activity have improved or have not deteriorated with the introduction of TRACE transparency. However, some market participants have raised concerns about difficulty executing block-size trades in recent years, and some have pointed to metrics or questions they feel are not fully addressed in the academic research, including turnover (aggregate trading activity as a fraction of total bonds outstanding) and the concept of unexecuted trades.

        The FIMSAC was empaneled by the SEC in 2017 "to provide the Commission with diverse perspectives on the structure and operations of the U.S. fixed income markets, as well as advice and recommendations on matters related to fixed income market structure."12 In particular, the FIMSAC has been asked to help the Commission ensure that regulation of the fixed income markets is designed "to meet the needs of retail investors, as well as companies and state and local governments."13

        The state of bond market liquidity was the first issue taken up by the FIMSAC. Discussion at the first FIMSAC meeting cited a number of factors that may be impacting current liquidity conditions and the ability to execute block trades, including technology-driven changes to fixed income market structure and the regulation of bank capital.14 The FIMSAC discussion also identified the perceived dealer cost of TRACE's immediate post-trade transparency as an area to study further. Following on this discussion, at the second FIMSAC meeting the Committee introduced a recommendation for a pilot to study specific changes to FINRA's current post-trade transparency protocols for block-size trades in corporate bonds.15 The FIMSAC Recommendation includes two primary elements: an increase to the current trade size dissemination caps for large corporate bond trades, and a 48-hour dissemination delay for trades above the caps. While a majority of the FIMSAC ultimately approved the Recommendation, several members questioned aspects of the recommended pilot and raised concerns, which are discussed in more detail below.

        The proposed pilot described in this Notice, developed in consultation with SEC staff, incorporates the two primary elements of the FIMSAC Recommendation. It also includes elements designed to produce pilot data that can be measured against a baseline, so that the pilot's effect can be assessed in relation to FINRA's core regulatory objectives of market integrity and investor protection.

        Below, this Notice discusses:

        •   the current protocols for TRACE dissemination of corporate bond trades;
        •   research concerning the impact of TRACE dissemination;
        •   the FIMSAC Recommendation for a pilot;
        •   comments on the FIMSAC Recommendation;
        •   a description of FINRA's proposed pilot;
        •   an analysis of the pilot's expected economic impacts; and
        •   questions for comment on FINRA's pilot proposal.

        As noted throughout, FINRA encourages comment on all aspects of a potential pilot, including the need for a pilot, the potential impact of a pilot, the proposed pilot design, the economic impact assessment and possible alternatives to a pilot.

        Current TRACE Dissemination Protocols

        Today, all OTC secondary market trades in TRACE-eligible16 corporate bonds must be reported to FINRA as soon as practicable, but no later than within 15 minutes of the time of execution.17 FINRA then publicly disseminates information about these trades immediately upon receipt.18

        FINRA currently applies dissemination caps to large-size trades in corporate bonds—i.e., trades that exceed $5 million for IG corporate bonds, and $1 million for non-IG corporate bonds.19 For trades at or below the caps, FINRA disseminates the security identifier, whether the trade was between dealers, or between a dealer and a customer or affiliate, whether the FINRA member involved in the trade bought or sold the security, and the price and full size of the trade. For trades above the dissemination caps, FINRA disseminates all of the same information, but with the size of the trade capped as "5MM+" (for IG) and "1MM+" (for non-IG). The full, uncapped size of trades above the caps is later published as part of an historical dataset six months after the calendar quarter in which they are reported.20

        Research Concerning the Impact of TRACE Dissemination

        Most of the empirical literature on corporate fixed income trading occurred after transaction prices became publicly available through TRACE beginning in 2002. The initial studies of transparency in the corporate bond market are summarized below. These studies used complementary methods and generally reached similar conclusions: that improved post-trade transparency is associated with lower transaction costs and price dispersion and not associated with greater trading volume for actively traded, recently issued and IG bonds.

        Goldstein, Hotchkiss and Sirri (2007) studied a set of BBB-rated bonds, phased into price dissemination in April 2003. In coordination with FINRA, the release of data was structured as a randomized experiment with a control group. They created a stratified sample of bonds to be disseminated along with controls of non-disseminated bonds. They reported that transaction costs on newly transparent bonds declined relative to bonds that experienced no transparency change, except for very large trades. They also reported that transaction costs declined as trade sizes increased, and did not demonstrate further decline on average for sizes above 1,000 bonds. One measure of transaction costs that FINRA's proposed pilot will use is the dealer round-trip measure that is defined in Goldstein, Hotchkiss and Sirri (2007).

        Edwards, Harris and Piwowar (2007) also studied the impact of transparency on transactions costs. The authors employed a design that compared the experience of a set of bonds for which trades were disseminated through TRACE to another set that had not yet been made transparent. By comparing the two sets of bonds before and after the introduction of public dissemination, they were able to isolate the impacts of transparency directly. This type of analysis is referred to as a "difference-in-difference" methodology in the academic literature. Looking at data for the period between January 2003 and January 2005, they found that dissemination was associated with lower trading costs for corporate bonds with larger issue size, better credit quality, more recently issued bonds and bonds closer to maturity. The empirical methodology for this proposed pilot is informed by Edwards, Harris and Piwowar (2007), as it examines the impact of a dissemination delay by comparing trading behavior before versus after its implementation, and uses the same measure of transaction costs. Another closely related paper by Bessembinder, Maxwell and Venkataraman (2006) used insurance company transaction data before July 2002 to find that improved information in disseminated bonds improved market quality for non-disseminated bonds. This study also showed a reduction in institutional trading costs around the initiation of TRACE reporting in July 2002.

        In more recent papers, academics have studied a variety of questions that are related to transparency using TRACE corporate bond data. Harris (2015) found that the lack of a consolidated quote system in bond markets limits the ability of retail and smaller institutional investors to observe best available prices. A consequence of this opacity is that brokers may arrange trades at prices inferior to those readily available. Bao, O'Hara and Zhou (2018) and Bessembinder, Jacobsen, Maxwell and Venkataraman (2018) found empirical evidence that the Volcker Rule reduced the willingness of dealers to commit capital to market making. Financial institutions also attribute some of their decline in capital commitment to fixed income trading to the greater capital costs associated with higher bank capital requirements. This decline is attributable to bank-affiliated dealers, as non-bank dealers have increased their capital commitment. Schultz (2017) and Choi and Huh (2017) found that there has been a greater move to riskless principal trading away from trading that would be intermediated by dealers relying on dealer inventory. Jacobsen and Venkataraman (2018) examined the impact of post-trade reporting of Rule 144A corporate bond transactions. They found that TRACE dissemination had no measureable impact on turnover or dealers' participation in interdealer trades, facilitation of block transactions or willingness to hold inventory. Small dealers increased market share and reduced the cost advantage of large dealers.

        Dick-Nielsen and Rossi (2016) found that hedge funds and buy-side traders fill the void created by reduced bank involvement in market making, and concluded that this change is associated with less immediacy and demands greater customer patience. In addition, another study finds that mutual funds are an important source of liquidity supply when other investors sell bonds (Wang, Zhang and Zhang 2018). Furthermore, Anand, Jotikasthira and Venkataraman (2018) found that some bond mutual funds exhibit a persistent trading style that provides liquidity by absorbing dealer inventory positions. Cici, Gibson and Merrick (2011) focused on the dispersion of month-end valuations placed on identical bonds by different mutual funds when calculating net asset value (NAV). They found that this bond price dispersion declined over their sample period, and may be related to improved transparency in the corporate bond market from TRACE.

        FIMSAC Recommendation for Block Pilot

        At the second FIMSAC meeting on April 9, 2018, the FIMSAC's Transparency Subcommittee introduced a Preliminary Recommendation for a Pilot Program to Study the Market Implications of Changing the Reporting Regime for Block-Size Trades in Corporate Bonds. At the same meeting, the FIMSAC modified and approved the Recommendation by a vote of 15 to four.21

        The FIMSAC Recommendation includes two primary elements. First, it would increase the current dissemination caps from $5 million to $10 million for IG corporate bonds, and from $1 million to $5 million for non-IG corporate bonds.22 This would result in the dissemination of additional size information for trades between the current and proposed caps. Second, the Recommendation would delay dissemination of any information about trades above the proposed $10 and $5 million caps for at least 48 hours.23 This would result in no price or size transparency for these trades during the dissemination delay period. After 48 hours, the trade price and capped size of the trade would be disseminated and the full size of the capped trade would be published three months after the calendar quarter in which the capped trade was reported to FINRA, rather than the current six-month delay.

        The following example illustrates where the Recommendation would decrease price transparency. Today, for an IG trade with a size of $11 million par value, FINRA disseminates immediately upon receipt the price of the trade, and a capped trade size ($5MM+). Under the Recommendation, for the same trade, no information about the trade would be disseminated for 48 hours. After 48 hours, the trade's time of execution, the price of the trade and a capped trade size ($10MM+) would be disseminated. A second example illustrates where the Recommendation would increase size transparency, with no change to price transparency. Today, for an IG trade with a size of $6 million par value, FINRA disseminates immediately upon receipt the price of the trade, and a capped trade size ($5MM+). Under the Recommendation, for the same trade, FINRA would disseminate immediately upon receipt the price of the trade and the full, uncapped trade size.

        The FIMSAC included data tables in its Recommendation that help estimate the impact of the recommended changes. Between 2013 and 2017, there was an average of 350 trades per day above the proposed $10 million cap for IG corporate bonds. These are the trades in IG corporate bonds for which no information would be disseminated for at least 48 hours (different from today, where there is immediate dissemination of price and other trade information but with the size capped). As noted in the FIMSAC Recommendation, these trades represented 1.2% of the total number of trades and 32.6% of total par value traded. Similarly, there was an average of 545 daily trades in non-IG corporate bonds above the proposed $5 million cap that would be subject to the dissemination delay and withheld for 48 hours. These trades represented 3.2% of the total number of trades and 40.8% of total par value traded.

        For pilot design, the FIMSAC Recommendation proposed that the new dissemination protocols apply to all trades in TRACE-eligible corporate bonds for a period of one year, subject to an early termination mechanism linked to market quality indicators. The FIMSAC Recommendation did not contemplate a control group. It also identified a list of proposed measurement criteria that contemplate the evaluation of, in relation to the current dissemination protocols, average daily trading volume of capped and uncapped trades, the number of capped and uncapped trades, the proportion of volume in block trades, the price impact of block trades, transaction cost analysis, and changes in dealer capital, inventory and behavior.

        The FIMSAC Recommendation did not include written supporting rationale. During discussion at the April 9th meeting, the Recommendation was framed as exploring the balance between transparency, which was said to promote efficient markets through lower search costs and greater price competition, and too much transparency, which was said could impair liquidity and market quality in certain market segments if it increases risk in the provision of capital or the likelihood of market impact.24 As explained by the chair of the Transparency Subcommittee, the Recommendation was based on a "general consensus . . . within the [Transparency Subcommittee] and also through outreach to other market participants that maybe the corporate bond market—restraints in the corporate bond market, especially for larger blocks, wasn't working as it should and was perhaps being hindered by some of the TRACE reporting requirements."25

        Proponents of the Recommendation stated at the meeting that that a dissemination delay could help encourage dealers to provide more block liquidity. One panelist at the meeting stated that dealers "have a very asymmetric risk profile when [they] bid or offer a block of securities to a client," and he offered data to show declining trade size between 2007 and 2017.26 The same panelist further noted that a two-day dissemination delay would allow his firm to recycle 50% of block trade risk, while today it recycles 30% of block trade risk on T+0 (the date of the block trade). Proponents also discussed the ways they believed the Recommendation would benefit institutional investors, the people those institutions represent and individual investors.27

        Others, however, raised questions during the meeting about the Recommendation.One member of the FIMSAC and the Transparency Subcommittee strongly urged the inclusion of a control group in the study design.28 Another FIMSAC member asked whether the Recommendation's increase in size transparency was a sufficient balance against the complete reduction in transparency for block-size trades during the dissemination delay.29 Other points of discussion included the impact of reduced price transparency on investors,30 and potential pilot gaming or manipulation by dealers.31

        Comments on FIMSAC Recommendation

        Nine comments have been submitted to date on the FIMSAC Recommendation.32 Four commenters expressed support for the Recommendation, while five opposed it. Commenters generally addressed the need for the block pilot advanced by the FIMSAC Recommendation, the potential impact of the pilot and pilot design.

        Comments on the Need for the Pilot

        Commenters that supported the FIMSAC Recommendation generally felt the pilot was needed based on their view of market conditions for block-size trades in corporate bonds. SIFMA stated that "block size transactions have become substantially more difficult to execute and counterparties are more frequently choosing to break up blocks into smaller transactions or delay transactions to avoid market frictions." SIFMA's statement is based on the observation of its members that there has been a "decline in the proportion of block trades to total volume during a period associated with an increase in the average and median size of corporate bond new issues."33

        JPMorgan Chase also commented that "[p]roviders of liquidity accept heightened risk when transacting in block trades, and these trades are immediately disclosed to the market with masked trade sizes." According to JPMorgan Chase, "as a result of this immediate disclosure, broker dealers now prefer smaller trade sizes on average, particularly for less liquid and lower rated bonds" and adjust their pricing to reflect the cost of immediate post-trade transparency.34 Similarly, Eaton Vance stated that "[f]inding block trade size liquidity in the market is often difficult," and that "[t]he quick publication of all post-trade prices is a significant cause of this difficulty."35 Eaton Vance explained that immediate TRACE dissemination of trades reduces dealers' incentives to provide block-size liquidity because immediate post-trade transparency "lowers transaction costs for market participants, but imposes costs on the Market Makers who give up valuable information on trade details without having received any pre-trade benefit."

        In contrast, three FIMSAC members jointly submitted a comment letter that disagreed with the Recommendation and questioned the FIMSAC's justification for the pilot. In the Harris Letter, these FIMSAC members took issue with the argument that immediate trade dissemination—in place currently—imposes material additional costs on dealers that need to be addressed.36 According to the Harris Letter, despite dealer concerns about being "front run" after printing large trades, it is not likely that other traders will sell ahead of the block dealer either because they would not want to sell a bond they've chosen to own, or because it is expensive to sell bonds short. The Harris Letter further stated that, "in comparison to equity markets, the price moves associated with fundamental information in the bond markets—especially for IG bonds—are small so that the profits associated with front running are not likely large." To the extent dealers encounter significant price impact when engaging in block trades, the Harris Letter contended that dealers "can reduce that impact by selling slowly," and that market structure should not "favor large traders to the detriment of smaller traders."

        The Harris Letter also pointed to alternative explanations—besides TRACE post-trade transparency—to explain changes to large dealer inventory and capital commitment.37 Specifically, the Harris Letter cited as primary factors the growth of electronic trading and competition with traditional dealers from new liquidity-providing proprietary trading firms, and post-financial crisis bank regulation that has affected the willingness or ability of bank-affiliated dealers to commit capital. In addition, the Harris Letter noted as secondary factors a decrease in bond volatility because of low interest rates and substantial economic growth.

        Comments on the Potential Impact of the Pilot

        JPMorgan Chase supported the FIMSAC Recommendation on the grounds that "the recommended pilot would provide a data-driven approach to consider regulatory changes and calibrate a well-tailored transparency regime."38 According to JPMorgan Chase, "[t] ransparency is important to the price discovery process, but the risk of mis-calibration is significant, with the potential to undermine the overall functioning of the market." SIFMA similarly stated that "[t]he pilot recalibration recommended by the SEC FIMSAC offers an opportunity to better balance both transparency and liquidity objectives to promote health and robust markets."39 Eaton Vance supported the Recommendation because it believes the pilot "will encourage market participants to target larger trade sizes in order to take advantage of the forty-eight hour dissemination delay," and "produce more liquidity in block size trades" as a result.40

        On the other hand, several commenters expressed concern about the potential impacts of the pilot. The Harris Letter observed that "[s]ubstantial empirical evidence has shown that public dissemination of TRACE trade reports has saved public investors about $1B/ year."41 The Harris Letter contended that, by reducing price transparency during the 48-hour dissemination delay, "[t]he proposed change will transfer power and thus wealth from receiving investors, who are typically smaller investors, to dealers and the large block initiating traders."42 The Harris Letter further stated that that such a transfer "is inefficient as dealers undoubtedly would capture some or even much of the benefit of knowing the block trade prices," and it questioned the value of the Recommendation's proposal to increase size transparency by raising dissemination caps. In addition, the Harris Letter expressed concern that delayed dissemination of block-size trades could mislead the market about supply and demand conditions, with particular impacts on smaller dealers. The Harris Letter offered the following example: "if a dealer crosses $20 million in bonds from one seller to four buyers each buying $5 million on a riskless-principal basis, under the recommended proposal, FINRA would delay dissemination of the $20 million dealer buy report but would immediately disseminate reports [for] each of the $5M dealer sales. The immediately disseminated reports would give the appearance of surplus buying demand and the possibility that one or more dealers have been left short facilitating this customer demand."43

        Similarly, The Credit Roundtable, an organization of institutional fixed income managers, objected to the Recommendation's proposed 48-hour dissemination delay, which it believed would create information asymmetry that would ultimately benefit "broker/ dealers, very large institutional investors, and high frequency leveraged players at the expense of other participants in the corporate bond market."44 Vanguard also objected to the significant reduction in price transparency that would be caused by a 48-hour dissemination delay. Vanguard expressed concern that imposing a dissemination delay on a third of recorded market volume "could have a meaningful negative impact on daily price discovery and execution costs while advantaging a segment of market participants over others."45 Vanguard further observed that "[b]y bifurcating the market into those with access to information and those without, [the FIMSAC Recommendation] may even create additional barriers to entry for newer or smaller market participants, and further entrench those with the largest market positions."46

        Separately, two Exchange Traded Fund (ETF) market makers expressed concerns that the Recommendation would diminish price transparency in the corporate bond markets and degrade the market for overlying ETFs and other related derivatives. Jane Street stated that a 48-hour dissemination delay "would introduce a material amount of information asymmetry and adverse selection to the corporate bond market."47 As a result, Jane Street noted it would need to adjust its behavior when trading with a block liquidity provider because of the risk the block liquidity provider has information about large block trades it executed that have not yet been disseminated to the market. Specifically, Jane Street stated it would be forced to widen its quotes for corporate bond ETFs, and "that wider spreads in ETFs would impose significant costs on ETF end-users, who are in substantial part retail investors."48 Flow Traders offered similar observations about ETF spreads and also pointed to other derivative products, like total return swaps, credit default swaps and the credit default swap index, that would become more difficult to price because of the information asymmetry that would be created by the Recommendation.49 Vanguard also stated that diminished price transparency would create pricing challenges for market makers who create and redeem ETFs, which would translate into higher costs for ETF investors.50

        Comments on Pilot Design

        Several commenters provided specific feedback on particular elements of the FIMSAC's recommended pilot design. JPMorgan Chase suggested that the non-IG dissemination cap should be raised to $3 million, as originally proposed in the FIMSAC Preliminary Recommendation, instead of $5 million, as proposed in the final FIMSAC Recommendation.51 With respect to the FIMSAC Recommendation's proposed measurement criteria for the pilot, JPMorgan Chase stated that the objective criteria concerning trading activity should be measured separately for bonds with large and small outstanding values to compare impact across issue sizes. JPMorgan Chase further suggested that, to the extent price impact or transaction cost analysis are studied, the calculation methodology should be better defined. And JPMorgan Chase questioned whether the proposed measurement criteria concerning changes in dealer capital and inventory, or changes in dealer behavior, should be included at all, because they could be influenced by other factors outside the pilot and therefore misleading.

        The Harris Letter proposed to change the pilot design altogether. The Harris Letter recommended a decrease in the dissemination caps, from $5 million to $2.5 million for IG, and from $1 million to $750,000 for non-IG.52 The Harris Letter stated that the decrease "would protect the dealers by further hiding the full sizes of the blocks that they have purchased and must distribute," but "the receiving investors would still know the actual trade prices." To offset its proposed decrease in size transparency, the Harris Letter recommended publishing the full size of IG trades between $1 and $10 million, and non-IG trades between $750,000 and $2.5 million, two market days after they occur, and publishing the full size of larger IG and non-IG trades four market days after they occur.

        Vanguard expressed concern that if the FIMSAC Recommendation were to proceed without a control group, the study would result in "data that is open to misinterpretation." Vanguard specifically noted that volume alone is not an appropriate measure of success in fixed income markets and urged more comprehensive data study before the implementation of a pilot. In addition, Vanguard stated that the proposed thresholds for delayed dissemination in the FIMSAC Recommendation—i.e., the proposed increased dissemination caps of $10 million for IG corporate bonds and $5 million for non-IG corporate bonds—are "far too low" and "could lead to gaming and data distortions that would impair the credibility of the results."53

        Description of FINRA's Proposed Pilot

        FINRA is soliciting comment on a proposed modified pilot design based on careful study of the FIMSAC Recommendation and associated comment letters, and after consultation with SEC staff. FINRA's modifications are intended to allow for a more meaningful study of the pilot's impacts on market integrity and investor protection, including large investors who trade in block sizes, smaller investors who do not, and investors in derivative or other related markets.

        Proposed Pilot Design

        As discussed in this Notice, the FIMSAC Recommendation essentially combines two different proposed changes to the current transparency framework. First, it proposes to increase the number of trade reports that would report the full size of the transaction, which effectively increases size transparency for those trades. And second, it proposes a complete dissemination delay for trade reports above the new dissemination cap size, which effectively reduces price (and other information) transparency for those trades. Because the FIMSAC Recommendation includes elements designed both to increase and decrease transparency for different size trades, FINRA's primary challenge is to design a pilot that can reasonably assess the impact of the different changes proposed, and the trade-off between them, without imposing unnecessary costs and disruptions to markets and market participants.

        The proposed pilot would last for a duration of one year. As the FIMSAC recommended, and based on consultation with SEC staff, the pilot would be subject to early termination if market quality indicators demonstrate a significant disruption. The pilot would include non-convertible, callable and non-callable TRACE-eligible corporate debt securities, except for bonds issued by religious organizations or for religious purposes (e.g., church bonds), and equity-linked notes. New issues would be included in the pilot the first day after they begin trading in the secondary market. There would be three pilot study groups and one control group. The three test groups are:

        •   Test Group 1, which would study a 48-hour dissemination delay with no change to the current dissemination caps. In other words, for bonds in this test group, TRACE would apply a 48-hour dissemination delay to trades above $5 million in IG corporate bonds, and trades above $1 million in non-IG corporate bonds.
        •   Test Group 2, which would study increased dissemination caps with no change to the current dissemination timeframes. In other words, for bonds in this test group, TRACE would increase dissemination caps to $10 million for IG corporate bond trades and $5 million for non-IG corporate bonds trades, without applying a 48-hour dissemination delay.
        •   Test Group 3, which would study both a 48-hour dissemination delay and increased dissemination caps. In other words, for bonds in this test group, TRACE would apply a 48-hour dissemination delay to trades above $10 million in IG corporate bonds, and trades above $5 million in non-IG corporate bonds.

        Similar to the SEC's approach to test and control group creation for its recently adopted Transaction Fee Pilot, FINRA proposes to implement stratified sampling for this pilot in a manner that permits comparison between each test group and the control group.54 Pilot bonds would be stratified along the characteristics of bond issue size, age of bond issue, bond rating and 144A status.

        FINRA would use these variables to create categories, or buckets, of bonds. Bonds in each of the buckets will be randomly assigned before the start of the pilot to the four pilot groups (three test and one control), with Test Groups 1, 2 and 3 each containing one-third of the bonds randomized to the control group.

        These stratification variables are proposed because they have been identified as capturing differences in liquidity among corporate bonds (Bessembinder, Jacobsen, Maxwell and Venkataraman 2018). For example, investors may trade larger offerings more than smaller ones simply because they are more liquid at the issuance date due to their size. Alternatively, larger offerings are usually issued by large issuers. Large issuers, in turn, may have better informational environments, thereby reducing the cost of acquiring information about the issuer. This may make the bonds more liquid. Similarly, younger bonds could be more liquid than older ones because the time to maturity is greater for a given transaction cost. Should investors believe that credit ratings truly proxy for credit worthiness, they may prefer to transact in corporate bonds with higher ratings. Different credit ratings may also attract different type of traders which could affect their liquidity. Lastly, corporate bonds subject to Rule 144A may trade differently than non-144A corporate bonds.55

        FINRA further proposes to rotate pilot bonds halfway through the pilot. After 126 days of trading—there are approximately 252 trading days per year—bonds that are initially randomized to one of the test groups would be rotated to the control group, and the bonds initially in the control group would be divided equally into the three test groups. The sole exceptions to the rotation approach would be bonds that are newly issued close to the rotation date, or bonds that default during the pilot. New issues that trade fewer than 50 total trading days before rotation occurs on the 126th day of the pilot would not be moved from the test or control group to which they were initially randomized, and bonds that default would not be moved from the test or control group to which they were initially randomized. Rotation of the bonds between test and control group is intended to address concerns that test and control assignment could impose unfair costs and burdens.56

        FINRA understands that a potential consequence of the proposed rotation is that market participants may have different expectations about the impact of delayed dissemination or an increase in cap size for test and control group bonds at the pilot's start than at the time when rotation occurs. As a result, the evidence generated from the first half of the pilot may differ from that of the second half. If so, interpretation may be more difficult because of potential differences that may arise from latent differences in bond assignment to a given test group as market participants update expectations from learning. However, if market participants quickly understand the impact of a change in transparency, then bonds initially randomized to a given Test Group in the first 126-day period are likely to be affected in a similar manner by the same change in transparency when bonds in the control group are randomized to the same Test Group in the second 126-day period. The list of existing CUSIPs assigned to each Group will be publicly posted before the proposed pilot begins and before rotation. In addition, the list of assigned CUSIPs will be updated throughout the term of the pilot as new issues are assigned to pilot groups.

        Methodology

        This section provides a high-level description of the proposed criteria for evaluating the impact of the pilot.

        The primary method proposed to evaluate the impacts associated with the pilot is a "difference-in-difference" method used by academics to identify changes in transparency on corporate bond trading from the implementation of TRACE. The benefit of employing this method is that it is generally accepted as an effective way to assess changes in transparency for corporate bonds and it permits a comparison of the pilot's findings to earlier studies. There are two types of comparisons that are made in this difference-indifference pilot design. The first comparison is the effect of a change in transparency on a given outcome variable by comparing the outcome variable's average change over time for a Test Group versus its control group. For example, one may examine the difference in average transaction costs between bonds in Test Group 1, which would be subject to a dissemination delay, versus those in the control group, which would not be subject to a dissemination delay. The second comparison is the effect of a change in transparency on a given outcome variable by comparing the outcome variable's average change over time for one Test Group versus another Test Group. For example, one may examine the difference in average transaction costs between bonds in Test Group 1, which would be subject to a dissemination delay, versus those in Test Group 2, which would be subject to increased dissemination caps.

        By construction, Test Group 1 reduces transparency by introducing a dissemination delay. The identification strategy is to compare the effect of the dissemination delay on outcome measures, such as aggregate trading volume including the amount attributable to institutional and non-institutional sized trades, transaction costs and market participation for bonds in Test Group 1 versus the control group and bonds in Test Group 1 versus Test Group 2 or 3.

        Test Group 2 potentially improves size transparency, with no change to price transparency, by increasing the dissemination cap, thereby increasing the number of bond trades subject to uncapped dissemination, without imposing any dissemination delay. This identification strategy compares bonds in Test Group 1 versus the control group and bonds in Test Group 2 versus Test Group 1 or 3.

        Test Group 3 combines these two primary elements of the FIMSAC Recommendation. By construction, it potentially mitigates the reduction in transparency relative to Test Group 1 by increasing the dissemination caps, thereby increasing the number of bond trades subject to real-time, uncapped dissemination and reducing the number of trades that are subject to a dissemination delay. At the same time, Test Group 3 reduces transparency relative to Test Group 2 by introducing a dissemination delay for the size capped trades. This identification strategy compares the effect of the dissemination delay with increased cap size to the control group in addition to the other two test groups. Test Group 3 permits a comparison of the joint effect of the dissemination delay or increased cap size relative to trades affected by a lower threshold for a delayed dissemination alone in Test Group 157 or an increased cap alone in Test Group 2.

        The proposed pilot tests delayed dissemination versus a new trade size dissemination cap. Such a design permits those evaluating the pilot to discriminate between the relative impacts of each of those changes and assess the trade-off between the two elements. In this framework, for example, the public would be able to assess directly how any benefits arising from increasing the trade size dissemination cap offsets any costs associated with delaying any dissemination of larger sized trade reports. Without this framework, such a comparison would likely be extremely uncertain.

        In order to best provide this comparability, the proposed pilot would extend the trade delay beyond the FIMSAC Recommendation to the current trade size dissemination caps in one of the test groups for the duration of the pilot. The FIMSAC Recommendation does not provide evidence for the basis of the thresholds recommended. If those thresholds best reflect the trade-off between investor protection and well-functioning markets, extending the reporting delay to more trades may impose greater costs than intended by the FIMSAC.

        FINRA considered alternatives that would potentially avoid these costs. One option considered was to limit the dissemination delay in Test Group 1 to the FIMSAC recommended thresholds of $10 and $5 million respectively for IG and non-IG bonds, without increasing the dissemination caps for Test Group 1. In other words, under this alternative construction for Test Group 1, for an IG bond in Test Group 1, a trade with a size of $6 million par value would not be subject to the 48-hour dissemination delay and would be disseminated immediately according to current dissemination caps with a capped size of $5MM+. For the same IG bond under this alternative construction for Test Group 1, a trade with a size of $11 million par value would be subject to the 48-hour dissemination delay and would be disseminated after the delay according to current dissemination caps with a capped size of $5MM+. FINRA recognizes that such an alternative construction would conflate the impact of both the delay and the change in the dissemination caps. Accordingly, FINRA believes this alternative would be more likely to provide evidence that is harder to interpret. FINRA asks commenters to consider the importance of design and how it can affect the ability of FINRA, the SEC and the public to evaluate the outcome of the pilot in their comments.

        Outcome Measure and Research Questions

        As FIMSAC's proposed pilot is a test of a joint hypothesis, FINRA suggests that the optimal experimental design is a direct test of the delay in the dissemination of block trades, an increase in the cap size and a dissemination delay combined with an increased cap size to determine whether dealers will provide increased liquidity for block trades. To this end, FINRA solicits comments on whether this proposed pilot can provide reliable answers to the following research questions organized by type of measure, and if so, how these questions would be measured empirically.

        1. Trade-based

        Is either a dissemination delay or a delay with increased cap associated with changes in aggregate trading activity?

        In particular, does a decrease in transparency:
        1. increase trading activity;
        2. increase liquidity58;
        3. decrease time between transactions; or
        4. decrease uncertainty/error in prices?
        2. Blocks and block activity

        Are there differences in block trading between groups at the threshold where the dissemination is delayed or the dissemination is delayed with increased cap?

        In particular, does a decrease in transparency:
        1. increase the frequency or size of block trades;
        2. decrease liquidity in block trades; or
        3. increase the time between block trades?
        3. Trading costs

        Is either a dissemination delay or a delay with increased cap associated with changes in trading costs for investors?

        In particular, does a decrease in transparency:
        1. decrease transaction costs (e.g., dealer roundtrip costs); or
        2. decrease costs from adverse selection (i.e., price impact)?
        4. Dealer behavior

        Is either a dissemination delay or a delay with increased cap associated with changes in dealer behavior?

        In particular, does a decrease in transparency:
        1. increase market making (measured as volume or inventory) of large broker-dealers that are active in blocks;
        2. benefit large broker-dealers that are active in blocks at expense of less informed ones in trades when block traders have an information advantage after the block executes but before that transaction is disseminated; or
        3. increase the probability of gaming by dealers, for example, altering their trading pattern to selectively release prices or make information more asymmetric?
        5. Dealer compensation

        Is either a dissemination delay or a delay with increased cap associated with changes in dealer compensation?

        In particular, does a decrease in transparency:
        1. increase the likelihood of principal activity relative to agency trades;
        2. increase markups;
        3. decrease the size of dealer networks; or
        4. increase profitability of larger dealers at center of the dealer network?
        6. Buy side behavior

        Is either a dissemination delay or a delay with increased cap associated with increased adverse selection for less informed institutional investors?

        In particular, does a decrease in transparency benefit more informed institutional investors at expense of less informed institutional investors?
        7. ETFs, mutual funds and derivative markets

        Bond ETFs and bond mutual funds derive their value from an underlying basket of corporate bonds. Efficient pricing of these derivative baskets and their individual securities requires up-to-date information on the pricing of holdings. Is either a dissemination delay or delay with increased cap associated with more pricing errors in ETFs, mutual funds or derivatives? Are these delays associated with profitable trading strategies for these instruments by market participants that trade blocks of securities that underlie the instruments and are subject to delayed dissemination?

        In particular, does a decrease in transparency:
        1. decrease the accuracy of average ETF and mutual fund pricing;
        2. increase the information content in ETFs and mutual funds associated with more informed market participants relative to others; or
        3. increase profitable trading of derivatives by dealers that trade blocks in corporate bonds?

        Economic Impact Assessment

        FINRA developed the pilot proposal described in this Notice based on the FIMSAC Recommendation. The discussion below presents a framework to evaluate the potential economic impacts of the specific changes recommended by the FIMSAC. However, as discussed throughout the Notice, there are different views on the need for and potential impact of studying these changes as a pilot. As the SEC has discussed, pilot studies may be particularly useful to inform policy decisions where there is not sufficient empirical evidence otherwise available. For example, when the SEC adopted the Transaction Fee Pilot, it explained the pilot was needed because available data was too limited to permit researchers to isolate and study the contested policy issue in question—specifically, the impact of transaction fees on order routing behavior, execution quality and market quality. Accordingly, the SEC stated that the Transaction Fee Pilot was uniquely capable of generating the empirical evidence to inform regulatory decisions.59 The SEC further noted that better informed regulatory decisions generally are more likely to result in regulatory approaches that better balance costs and benefits relative to regulatory decisions based on less precise information.60

        The SEC also recognized that pilots may impose costs and can face limitations that may impact pilot design. The SEC noted that pilots can be unpredictable and may face the limitation that market participants may adjust their behavior differently for a pilot than for a rule change.61 In addition, while the pilot described in this Notice may impose less compliance cost because it does not require any change to the way market participants report trades to TRACE, the pilot likely will impose some costs on market participants to remain aware of the dissemination protocols associated with the bonds in each pilot group. This is in addition to the costs discussed below concerning the changes that would be implemented by the pilot.

        FINRA includes questions below and encourages comments on the need for and potential impacts of studying the recommended changes with a pilot, including whether the current data is sufficient or insufficient to inform the policy questions raised by the FIMSAC Recommendation, whether the proposed pilot's benefits outweigh the costs, and whether other methods or data sets should be considered rather than a pilot to measure impacts or "lost opportunities" to trade.

        Economic Baseline

        The current regime of post-trade transparency was created with the introduction of TRACE in 2002. Since then, as noted above, numerous studies examined the impact of TRACE post-trade transparency on the liquidity and competitiveness of the U.S. corporate bond market. The current market conditions inform the economic baseline and are the result of these impacts. The studies of the impacts serve as reference in evaluating the effect(s) of the pilot.

        Several papers examined the impact of transparency on realized bid-ask spread, which is considered either as a proxy for liquidity or the transaction cost of a customer roundtrip (completing a buy and sell of a corporate bond). These papers concluded that the increased transparency associated with TRACE transaction reporting is generally associated with a substantial decline in investors' trading costs and the cost reduction is greater for smaller trade sizes, potentially accruing to retail investors.62 Researchers also found reductions in intraday price dispersion, which could translate into reductions in trading costs.63 Some studies found that trading volume in the dealer market had remained the same or decreased with the introduction of TRACE; a possible explanation was that TRACE might have helped trading volume shift to the electronic platform.64 Other studies examined the impact on dealer competition and found evidence of increased competitiveness of small dealers.65 Finally, another study found improved valuation precision of mutual funds holdings in the presence of increased TRACE transparency.66

        This section briefly describes the market for corporate bonds as captured by the TRACE dataset, focusing on the sample of transactions in pilot eligible corporate instruments reported to TRACE in calendar year 2018. Pilot-eligible securities are defined as non-convertible, callable and non-callable TRACE-eligible corporate debt securities, including 144A bonds (and excluding religious institution bonds and equity linked notes).

        Table 1 presents secondary market trading statistics of corporate bonds grouped by the bond characteristics used for stratification in the pilot. In particular, it shows the number of CUSIPs, total par value traded and mean par value per trade in calendar year 2018.67 TRACE data indicates that 32,408 bonds were traded in 12.4 million transactions during calendar year 2018. During that same period the total par value traded was $7.0 trillion, and the average par value per trade was $561.4 thousand.

        Table 2 describes the mean number of trades and par value traded by CUSIP and per day in calendar year 2018. The average bond was traded 384 times with a total traded par value per CUSIP of $215.3 million in 2018. An average of 49,524 trades representing $27.8 billion in par value exchanged hands per day. Larger issues were traded more frequently and typically in larger trade size.

        Table 3 reports the number of issues, trades, total and mean par value traded per day by rating and trade size for all corporate bonds in the year 2018. The table indicates that there were significantly more trades in smaller size than in larger institutional sizes, yet this is not true for the total dollar par value traded. For example, there were 31,628 trades of less than $1 million per day for investment grade bonds, but only 403 trades of larger than $10 million. Yet the total par value traded in less than one million dollar trades is $2.8 billion, compared to $6.3 billion for trades larger than $10 million.

        Figure 1 presents the number of new issuances per year by type, grade and size for each year from 2009 to 2018. The period post-2009 shows a strong secular growth in new corporate bond issuance. The issuance of non-IG, non-144A and smaller issue size (size less than $500 million) corporate bonds increased 536% from 2009 to 2018. The issuance of IG, non-144A corporate bonds increased for all issue sizes.

        Figure 2 presents the par value of new issuances per year by type, grade and size for each year from 2009 to 2018. For non-144A and non-IG issues, issuances of less than $500 million increased 48.3%, $500 million to $1 billion increased 39.8%, while larger than $1 billion decreased 21.6%. For non-144A and IG issues, issuances of less than $500 million increased 2.4%, $500 million to $1 billion increased 92.9%, while larger than $1 billion increased 24.5%.

        Figure 3 shows secondary market trading of corporate bonds in TRACE from 2013 to 2018.68 The sample reflects the set of corporate bonds proposed to be included in the pilot. To account for the difference in total bonds outstanding across years, annual traded dollar par value is standardized by the total dollar par value of outstanding bonds as of June 30th of the corresponding year.

        Figure 3–1 indicates that there has been some time series variation in IG bond turnover, but the aggregate difference over the period is very small ranging from 0.608 in 2013 to 0.602 in 2018. There appears to be at least some secular growth in the turnover from smallest and largest trade size groupings. Figure 3–2 represents the share that each trade size group represents as a fraction of all trading activity. In this view, the share of trades in IG bonds less than $1 million increased from 13.4% in 2013 to 15.0% in 2018. The share of trades larger than $10 million increased from 32.1% in 2013 to 33.8% in 2018.

        For non-IG bonds, Figure 3-3 shows that total turnover increased from 76.4% in 2013 to 94.2% in 2018. Turnover is generally increasing for smaller trade sizes. Figure 3–4 shows that the share of trades less than $1 million increased from 11.2% in 2013 to 14.6% in 2018. The share of trades larger than $10 million decreased from 20.0% in 2013 to 17.6% in 2018.

        Economic Impacts

        A discussion of the anticipated economic impacts, including costs and benefits associated with each pilot test group, is presented below. Based on the sample population affected by the pilot, approximately 3% and 18% of trades and 56% and 85% of par volume in investment grade and non-investment grade bonds may be candidates subject to delayed dissemination at some point during the pilot. Similarly, based on the sample population affected by the pilot, approximately 2% and 15% of trades and 22% and 45% of par volume in investment grade and non-investment grade bonds may be candidates potentially affected by the pilot cap size change. These estimates do not account for changes in behavior in response to the pilot.

        Test Group 1: 48-hour Dissemination Delay with No Change to Dissemination Caps

        Potential Benefits

        The primary goal of the FIMSAC Recommendation is to test whether delayed dissemination of reported transactions can increase liquidity in blocks, without imposing significant indirect and direct costs on market participants and investors. The FIMSAC Recommendation and supporting comments cite observational evidence that finding block-size liquidity in the current market (i.e., the baseline) may be difficult because of the relatively quick publication of post-trade prices. Although TRACE post-trade transparency lowers transaction costs for market participants, proponents of the dissemination delay believe that post-trade transparency may impose costs on dealers and other liquidity providers by making public valuable trade information. When larger trades are publicly disseminated, dealers with recently acquired blocks may be more vulnerable to adverse price movements from traders who are aware of these recent executions. This may cause larger trades to incur greater costs for dealers, which could reduce the incentive for them to provide liquidity in blocks or require them to receive greater compensation for providing block liquidity.

        Under this rationale, providing a delay in dissemination for larger trade sizes could be associated with greater provision of liquidity to those seeking to conduct larger trades. Delayed dissemination of large trades could provide dealers with more time to offset positions. During the delayed dissemination, dealer positions may be less vulnerable to price movements that negatively impact profits, because other traders have less information on these recent large trades. Consequently, existing dealers of large trade sizes may trade larger trade sizes more frequently, further increase the size of larger trades, or offer more attractively priced quotes. The benefits from the dissemination delay may disproportionately accrue to dealers who trade larger sizes, if transaction prices convey information about bond quality or future prices that are no longer shared.

        Institutional investors may also benefit, as they may trade faster or more frequently because dealers might find counterparties faster or carry more inventory. In addition, institutional investors might save time and effort in contacting dealers for quoted prices, as more dealers may be willing to provide aggressively priced bid-ask quotes or trade in larger size. If liquidity in larger trade sizes improves for particular bonds and these bonds are a close substitute for bonds that are typically more costly to trade, then institutional investors may benefit from substituting a more liquid bond for a less liquid one.

        This benefit may be limited to the extent block-size trades are not relatively more difficult to execute in the current market, as suggested in certain of the baseline data discussed above.

        Potential Costs

        Dealers and institutional investors that regularly transact in these larger block sizes would have more non-public information during the dissemination delay than in the absence of the pilot. This may give them an even greater competitive advantage during that 48-hour dissemination delay window relative to market participants who do not typically trade these larger blocks. Back, Liu and Tequia (2018) theoretically showed that disclosure of transaction prices conveys information on the security's quality and reduces dealer's rents when trading inventory in the secondary market. Consequently, the reduction in transparency could potentially reduce information content of prices and could increase dealers' rents. Dealers and institutional investors that trade larger sizes may profit from this informational advantage on trade prices at the expense of dealers and investors that do not larger block sizes.

        This economic rent is a cost imposed by Test Group 1 from the perspective of market participants not regularly transacting in blocks subject to the 48-hour dissemination delay. Smaller brokers that do not regularly trade blocks benefitting from the 48-hour dissemination delay may be more likely to provide less attractively priced quotes, thereby increasing trading costs, or reduce the size at a given quoted price. Under this scenario, retail traders may find increased costs and lower returns from participating in the corporate bond market. Furthermore, some institutional investors and less active dealers may need to contact more dealers, thereby increasing search costs.

        Delayed reporting of large trades could increase price uncertainty to less informed traders, thereby potentially reducing liquidity in corporate bonds. Delayed block price reporting exposes buy and sell side participants to additional risk, as they may be transacting at prices inferior to those that they would have accepted had dissemination of block trades not been delayed. Limited information on large transactions is particularly problematic during periods of market stress when the benefit of timely pricing information is large. It may also introduce misleading information to the market about supply and demand conditions, with particular impacts on smaller dealers, as noted in the Harris Letter.

        An implicit assumption of the FIMSAC Recommendation is that an increase in the size or frequency of block trades or improved ability for dealers to manage inventory risk associated with block trades will improve fixed income market quality. In addition to the informational advantages that might accrue to dealers participating in block trades discussed above, the ability of those dealers to reduce their inventory risk exposures more quickly or more easily where they take on large positions may effectively represent a risk transfer between those dealers and the ultimate holders of the securities. The aggregate efficiency of the transfer depends, in part, if the resultant prices reflect the risk transfer and on whether the dealer or the ultimate customer represents the most efficient holder of the risk.

        Authorized participants (APs) are important to the creation and redemption process for exchange-traded funds (ETFs). These market participants have the exclusive right to change the supply of ETF shares on the market. When they identify a shortage of ETF shares in the market, they create more shares by buying the underlying corporate bonds. Conversely, when there's an excess supply of ETF shares on the market, they reduce the number of ETF shares by selling the underlying corporate bonds. Price transparency helps ensure that APs and other market makers engaged in deposit and redemption transactions continue to participate in the markets. As their trades facilitate liquidity transfer, they tend to stabilize prices. This creation and redemption mechanism keeps the share price of an ETF aligned with its underlying NAV.

        The impact of delayed reporting may well have an amplified effect on securities deriving their value from corporate bonds. The impact could lead to less efficient pricing of index-based products, such as ETFs, and derivatives, such as total return and credit default swaps. If the pilot makes it more difficult to mark-to-market the relevant securities, market participants, who do not trade blocks benefitting from delayed reporting dissemination, may be more likely to use stale prices for operational and accounting purposes. For example, ETFs and mutual funds may incorrectly estimate net asset value with greater probability. In addition, market makers that do not trade these blocks may not be able to confidently assess the price at which the basket of bonds and bonds should trade. Consequently, market makers may provide less attractively priced quotes or be less willing to take on inventory. Such an outcome could suppress innovation, such as electronification of the corporate bond market.

        There is a potential for spillover effects in demand and liquidity for bonds that trade less frequently, because these instruments are typically priced using matrix pricing or other relative valuation methods. In this view, decreasing certainty about the primary instrument could lead to greater market uncertainty about securities whose value is assigned on a relative basis, whether or not those bonds are likely to trade in block size.

        Test Group 2: Increased Dissemination Caps with No Dissemination Delay

        Potential Benefits

        The incremental increase in size transparency is limited to observing the actual size on trades between $1 million and $5 million for non-IG and between $5 million and $10 million for IG corporate bonds. There is no change in price transparency in Test Group 2 relative to the baseline. If transaction costs are decreasing in trade size (as found by Edwards, Harris and Piwowar (2007)) and the differences in trade size within this group are economically important, then the increased transparency with respect to size may help some investors better interpret the price for trades. This would potentially improve price formation for these bonds and for ETFs and other derivatives that contain bonds that are frequently traded in the size between $1 and $5 million and between $1 and $10 million for non-IG and IG corporate bonds.

        Potential Costs

        If the optimal size trade for some institutional investors is between $1 and $5 million and $5 and $10 million for non-IG and IG corporate bonds, then a change in the dissemination caps could impose costs, such as price impact, on these institutional investors or on overall market efficiency.

        If these same investors choose to trade in a size above the new $5 and $10 million cap thresholds, then delayed reporting of large trades may encourage traders to trade blocks with qualifying size rather than the typical smaller blocks or blocks broken into smaller pieces. This could decrease price and size transparency, which may distort incentives to trade slowly and responsibly.

        Test Group 3: 48-Hour Dissemination Delay and Increased Dissemination Caps

        Potential Benefits and Costs

        Test Group 3 has the same potential benefits that are described above for Test Group 1 and 2. These benefits are not outlined again for the purpose of brevity.

        However, the increase in dissemination caps limits the costs and benefits to Test Group 1 to only those trades executed at sizes above the increased trade dissemination caps of Test Group 2. This is anticipated to mitigate the informational advantage accruing to dealers and institutional investors who trade blocks created by the 48-hour dissemination delay that is evaluated in Test Group 1.

        Alternatives Considered

        As discussed above, FINRA considered but is not proposing to design the pilot without a control group, as the FIMSAC recommended.

        Also discussed above, FINRA considered alternate specification of Test Group 1 to limit its application to only those trades with reported size at or above the new dissemination cap recommended by the FIMSAC.

        In addition, consistent with another part of the FIMSAC proposal, FINRA considered disseminating the actual trade size of capped transactions three months instead of six months after the end of the calendar quarter in which they are reported. The rationale for not proposing this modification is: (1) its impact on block size trades in corporate bonds would be difficult to evaluate given the pilot's proposed duration is one year, and (2) it would add additional complexity to the pilot.

        Finally, FINRA considered a number of alternatives in the specification of the pilot, including the set of bonds eligible for the pilot, the characteristics necessary for control in the stratified assignment to test groups and the appropriate length of time for the pilot. FINRA requests comments on these topics.

        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:

        Comments on the Need for the Pilot

        1. Is there a need for this pilot? What evidence can you provide to support this conclusion?
        2. Is the objective of the pilot clearly defined?

        Comments on the Potential Impact of the Pilot

        1. What potential impacts of the pilot does this proposal fail to consider or inadequately describe?
        2. Are there particular risks, economic or otherwise, inherent in a pilot that reduces transparency that already exists in the marketplace?
        3. One suggested need for the pilot is that block size transactions have become substantially more difficult to execute and may result in breaking the block into smaller transactions. To the extent blocks have in fact become more difficult to trade, is this a valid concern? Do potential delays in block size trades and related strategies to execute those block trades, such as more smaller-size trades, lead to a more accurate and appropriate risk transfer? Would delays in dissemination improperly mask the risk of block-size trades to the individual firm and instead shift such risk to other market participants or the overall market?
        4. FINRA cannot directly measure the impact on "lost opportunities," particularly to asset managers. How would this negatively impact the success of the pilot? What other measure or data sets should FINRA consider in order to measure "lost opportunities" to trade?
        5. Are there ways market participants can alter their behavior during the course of the pilot to affect its outcome? What are other similar negative impacts or concerns that could occur as a result of the pilot? What changes can FINRA make to the pilot design to limit or mitigate the impact of such "gaming"?

        Comments on Pilot Design

        1. Is the pilot adequately designed with respect to its objective?
        2. Are Test Groups 1, 2 and 3 and the control group clearly defined?
        3. What should the test groups be?
        4. Is it appropriate to have a market-wide pilot or should it be limited to a small number of CUSIPs?
        5. Should other types of securities, aside from corporate bonds, be included in the pilot?
        6. Should the corporate bond CUSIPs in Test Groups 1, 2 and 3 switch with those in the control group with respect to the three treatments, which are the dissemination delay, dissemination cap, dissemination cap and delay?
        7. Should all of the CUSIPs in each test group be published or should some or all not be made known?
        8. Should the pilot include a control group?
        9. Should the test groups be designed such that the impact is limited to the thresholds identified in the FIMSAC Recommendation? Is it appropriate to expand the test in the way proposed in the pilot design here?
        10. Does the pilot propose to use the most appropriate outcome measures? If not, which ones are preferable and why?
        11. Is the proposed methodology of examining pilot data appropriate?
        12. Are the dimensions on which the corporate bonds are sorted (size of issue, age of issue, rating and 144A versus non-144A categories) appropriate? If not, which additional dimensions should be included (e.g. inclusion status with respect to an index or ETF, maturity, standardized versus complex, degree of substitutability for other CUSIPs, mean frequency of trading in prior year, etc.)?
        13. Are there other methods that could be used to determine the control and test groups? For example, should the corporate bonds be assigned to the control group and test groups by a more random approach—such as based on the last digit of the CUSIP for each bond, instead of assigning bonds to groups based on the stratification characteristics like those discussed above (size of issue, age of issue, rating and 144A status)?
        14. How should FINRA seek to measure the impact of the pilot on assets that derive their value from corporate bonds, such as ETFs and mutual funds?
        15. Should the pilot's duration be increased to two years to better incorporate trading in illiquid corporate bonds?
        16. Is there a risk that traders can easily substitute CUSIPs in a test group for ones in the control group? If so, to what extent might this happen and on which dimensions (e.g. CUSIP from the same issuer, CUSIP from a different issuer having the same maturity and age)?
        17. Are there additional research questions that should be addressed?
        18. Are there other changes to the pilot that should be considered to better study the impact of dissemination (i.e., transparency) on the corporate bond market?
        19. Should the dissemination delay or caps only apply to trades on which a broker-dealer makes a capital commitment?
        20. Will market participants and other users of the TRACE data need to make any system changes as a result of the pilot? For example, will pricing, compliance or other systems, including systems used to determine or supervise prevailing market price for fair pricing and calculating mark-ups for retail and other customers, need to be updated to reflect delayed dissemination of certain trades? If so, how long will those changes take to implement and what would be the estimated costs associated with such changes?
        21. Should new issues be randomized to test groups or the control group while controlling for the issuer?

        Comments on the Economic Impact Assessment

        1. Does the economic baseline accurately describe current trading of TRACE-reportable corporate bonds?
        2. What will be the overall impact of the pilot on liquidity, trade size, competition among dealers or competition among issuers?
        3. With respect to the 48-hour dissemination delay (i.e., Test Group 1), have its benefits or costs be adequately described?
        a. Will the 48-hour dissemination delay improve liquidity for those trade sizes affected? If so, would transaction costs decline, or trade sizes or dealer inventory increase? Would buy-side firms need to contact fewer dealers for quotes?
        b. Would traders that do not typically trade the sizes affected by the dissemination delay be negatively affected by the informational asymmetry? If so, how?
        c. Would delayed reporting have an amplified effect on securities deriving their value from corporate bonds leading to ineffective pricing of index-based products, such as ETFs, and derivatives, such as total return and credit default swaps?
        d. Would the reduced price transparency caused by the 48-hour dissemination delay have particular impacts on retail investors, for example, by reducing the market information used to determine prevailing market price for fair pricing and to calculate mark-ups?
        4. With respect to the increased dissemination caps (i.e., Test Group 2), have its benefits or costs been adequately described?
        a. Would the increase in the reporting cap size mitigate the informational advantage accruing to dealers and institutional investors who trade blocks created by the 48-hour dissemination delay? If so, would smaller dealers step in and begin providing quotes for trades having benefited from the increased reporting cap?
        b. If trade sizes do increase in response to the increase in the reporting cap size, are traders more likely to trade blocks with qualifying size rather than the typical smaller blocks or blocks broken into smaller pieces?
        5. With respect to the increase of the reporting cap size and the 48-hour dissemination delay (i.e., Test Group 3), have its benefits and costs relative to Test Group 1 or 2 been adequately described?
        6. The comparison of Test Group 3 and Test Group 1 is confounded by the increase in the threshold for the dissemination delay. Should FINRA consider the alternative construction for Test Group 1 discussed above, where Test Group 1 would maintain the current size dissemination cap while implementing a delay threshold consistent with the threshold in Test Group 3? Would such an alternative construction for Test Group 1 provide a cleaner test of the impact of the dissemination delay? Would such an alternative construction for Test Group 1 create complications that affect the implementation of the pilot?
        7. What impact would the dissemination delay or cap have on broker-dealer routing to or trades occurring on alternative trading systems or on electronic trading innovations? Are these impacts different from those experienced by those transacting OTC?
        8. Will the dissemination delay or cap create opportunities for market manipulation, and if so, what specific behaviors should either be measured or guarded against?
        9. The current assignment of CUSIPs to Test and control groups does not control for the issuer's identity. If CUSIPs are not normally distributed by issuer across control and a particular Test Group or across Test Groups, will there be difficulty interpreting the empirical results? If so, how?
        10. Would assignment of an issuer to a particular Test Group change competition between issuers? If so, how?
        11. What will the impact on competition be between issuers when some issuers' bonds are in the Test Groups versus the control group?
        12. Will the dissemination delay or cap have an impact on competition among dealers? Are dealers who trade larger blocks sizes likely to benefit at the expense of dealers who do not make such trades? If so, how will the dealer network be affected?
        13. Will the dissemination delay discourage institutional investors who do not trade larger block sizes from trading with those dealers who do trade larger block sizes? Alternatively, will the dissemination delay encourage institutional investors who do trade larger block sizes to selectively trade with those dealers who do not trade larger block sizes?

        Comments on Alternatives to Consider

        1. Should FINRA consider other potential designs, for example, as described in the Harris Letter? If so, what designs should be considered and how do they improve over the design described here?
        2. Should FINRA consider an alternate reporting design for the dissemination delay test group whereby brokers could report capped trades up to 48 hours after transaction and FINRA would disseminate the trade report when received? Under what conditions would brokers report capped trades earlier than the maximum delay permitted under the pilot? What are the costs and benefits associated with this approach?
        3. Should FINRA consider an alternate design that would study, in place of delayed dissemination, suppression of the buy/sell indicator for block-size trades in corporate bonds? As noted above, FINRA currently disseminates this indicator, among other information, for corporate bond trades. However, for trades in Asset-Backed Securities (ABS), FINRA suppresses the buy/sell indicator (and information about contra party type) to balance concerns about transparency and liquidity in the ABS market, which is generally smaller and more institutional than the corporate bond market. What are the costs and benefits associated with an alternative approach that would study ABS-like dissemination protocols for block-size trades in corporate bonds?
        4. Can the goals of the pilot be achieved through other means, such as study of currently available data or supplemented with other specific data requests?
        5. As discussed above, certain baseline data suggests that block-size trades in IG bonds have not become more difficult to execute. Does the current data support an alternative approach that would limit the study of delayed dissemination to non-IG bonds? What are the costs and benefits associated with such an alternative approach?

        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) (NASD Announces Online Availability of Comments) for more information.

        2. See Section 19 of the Securities Exchange Act of 1934 (SEA) and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes, however, take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

        3. See Securities Exchange Act Release No. 43873 (January 23, 2001), 66 FR 8131 (January 29, 2001) (Order Approving File No. SR-NASD-99-65) (citing a speech by SEC Chairman Levitt, September 9, 1998, at Media Studies Center, New York, NY).

        4. See NASD Press Release: NASD Launches TRACE Bond Trade Data System (July 1, 2002).

        5. See Notice to Members 01-18 (March 2001).

        6. See Notice to Members 03-12 (February 2003).

        7. See Notice to Members 06-01 (January 2006) (describing the categories of non-IG trades that were subject to delayed dissemination, specifically, newly issued securities rated BBB or lower, and non-IG transactions greater than $1 million).

        8. See id.

        9. See Regulatory Notice 13-35 (October 2013).

        10. See FINRA Office of the Chief Economist Research Note: Analysis of Corporate Bond Liquidity (2015).

        11. See FINRA catalogue of TRACE Independent Academic Studies, available at www.finra.org/industry/trace/trace-independent-academic-studies.

        12. See Securities Exchange Act Release No. 81958 (October 26, 2017), 82 FR 50460 (October 31, 2017) (Notice of Federal Advisory Committee Establishment for the Fixed Income Market Structure Advisory Committee).

        13. See SEC Press Release 2017-209, SEC Announces the Formation and First Members of Fixed Income Market Structure Advisory Committee (November 9, 2017), available at www.sec.gov/news/press-release/2017-209; see also Opening Remarks of Chairman Jay Clayton at the Inaugural Meeting of the Fixed Income Market Structure Advisory Committee (January 11, 2018), available at www.sec.gov/news/public-statement/opening-remarks-inaugural-meeting-fixed-income-market-structure-advisory (emphasizing the "long term interests of retail investors").

        14. See Transcript of FIMSAC Meeting (January 11, 2018), available at www.sec.gov/spotlight/fixed-income-advisory-committee/fimsa-011118-transcript.txt.

        15. See Recommendation for a Pilot Program to Study the Market Implications of Changing the Reporting Regime for Block-Size Trades in Corporate Bonds (April 9, 2018), available at www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-block-trade-recommendation.pdf ("FIMSAC Recommendation").

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

        17. Rule 6730 (Transaction Reporting) describes members' TRACE reporting obligations.

        18. See Rule 6750 (Dissemination of Transaction Information).

        19. See, e.g., Securities Exchange Act Release No. 71607 (February 24, 2014), 79 FR 11481 (February 28, 2014 (Order Approving File No. SR-FINRA-2013-046) at 11483 n. 30 (describing the IG and non-IG dissemination caps). FINRA notes that bonds without ratings are generally treated as non-IG for current TRACE dissemination purposes. See Rule 6710(i) (stating that "if a TRACE-Eligible Security is unrated, FINRA may classify the TRACE-Eligible Security as a Non-Investment Grade security").

        20. See Regulatory Notice 17-23 (July 2017).

        21. See Transcript of FIMSAC Meeting (April 9, 2018), available at www.sec.gov/spotlight/fixed-income-advisory-committee/fimsa-040918transcript.txt ("April 9th FIMSAC Transcript").

        22. The FIMSAC Transparency Subcommittee's preliminary recommendation proposed to increase the dissemination cap for non-IG corporate bonds from $1 million to $3 million; during discussion at the FIMSAC meeting, the recommended new dissemination cap for non-IG corporate bonds was increased from $3 million to $5 million.

        23. This document refers generally to a 48-hour dissemination delay for shorthand. However, as the FIMSAC Recommendation noted, the dissemination delay is at least 48 hours, because trades reported after normal TRACE hours will be disseminated more than 48 hours after execution time. In addition, FINRA believes the FIMSAC Recommendation intended that the 48-hour delay would not include any hours from days on which TRACE was not open, such as weekends and holidays.

        24. See April 9th FIMSAC Transcript at pg. 13–14 (opening remarks of Brett Redfearn, Director, Division of Trading and Markets).

        25. See id. at pg. 25.

        26. See id. at pg. 38–41.

        27. See id. at pg. 43–46.

        28. See id. at pg. 32–35.

        29. See id. at pg. 50–55.

        30. See id. at pg. 76–78.

        31. See id. at pg. 64.

        32. See Letter from Kenneth E. Bentsen, Jr., President & CEO, Securities Industry and Financial Markets Association, to Chairman Jay Clayton, SEC, and Robert Cook, President & CEO, FINRA (July 6, 2018) ("SIFMA Letter"); Letter from Matt Berger, Global Head of Fixed Income and Commodities, Jane Street Capital, LLC, to Brent J. Fields, Federal Advisory Committee Management Officer and Secretary, SEC (May 16, 2018) ("Jane Street Letter"); Letter from Wouter Buitenhuis, Flow Traders U.S. LLC, to Federal Advisory Committee Management Officer and Secretary, SEC (July 5, 2018) ("Flow Traders Letter"); Letter from Gregory Davis, Chief Investment Officer, Vanguard, to Brent Fields, Secretary, SEC (January 2, 2019) ("Vanguard Letter"); Letter from Larry Harris, Fred V. Keenan Chair in Finance, USC Marshall School of Business, Kumar Venkataraman, James M. Collins Chair in Finance, Southern Methodist University, and Elisse Walter, Former Chairman, SEC, to Brent J. Fields, Federal Advisory Committee Management Officer and Secretary, SEC (August 21, 2018) ("Harris Letter"); Letter from Michael O'Brien, Head of Global Income Trading, Eaton Vance Management, to Brent J. Fields, Federal Advisory Committee Management Officer and Secretary, SEC, and Robert Cook, President & CEO, FINRA (September 24, 2018) ("Eaton Vance Letter"); Letter from Sandra E O'Connor, Chief Regulatory Affairs Officer, JPMorgan Chase & Co., to SEC and FINRA (June 29, 2018) ("JPMorgan Chase Letter"); Letter from Cathy Scott, Director, Fixed Income Forum on behalf of The Credit Roundtable, to Brent Fields, Secretary, SEC, and SEC Complaint Center (November 27, 2018) ("Credit Roundtable Letter"); and Letter from Jed Stevenson, Senior Managing Director, Wellington Management Company LLP, to Brent J. Fields, Federal Advisory Committee Management Officer and Secretary, SEC, and Robert Cook, President & CEO, FINRA (February 4, 2019) ("Wellington Management Letter"). These comments were submitted to the FIMSAC comment file (File No. 265-30), available at www.sec.gov/comments/265-30/265-30.htm.

        33. See SIFMA Letter at 2.

        34. See JPMorgan Chase Letter at 3. Wellington Management offered a similar observation, stating that "[o]ur experience in trading both investment grade and high yield bonds suggests that the immediate [TRACE] dissemination could result in broker-dealers preferring smaller trade sizes." See Wellington Management Letter at 1.

        35. See Eaton Vance Letter at 2.

        36. See Harris Letter at 2–3.

        37. See Harris Letter at 5.

        38. See JPMorgan Chase Letter at 3.

        39. See SIFMA Letter at 2.

        40. See Eaton Vance Letter at 2. Similarly, Wellington Management stated its expectation that the pilot "will allow for improved market liquidity, as broker-dealers will have 48 hours to find purchasers who are willing to purchase the subject securities at prices that are not artificially reduced by the expectation of an eager seller." See Wellington Management Letter at 2.

        41. See Harris Letter at 4.

        42. See id. at 2.

        43. See Harris Letter at 3.

        44. See The Credit Roundtable Letter at 2. Although The Credit Roundtable opposed the 48-hour dissemination delay proposed in the FIMSAC Recommendation, it supported the Recommendation's proposal to increase the IG dissemination cap from $5 million to $10 million and the non-IG dissemination cap from $1 million to $5 million. See The Credit Roundtable Letter at 1.

        45. See Vanguard Letter at 2.

        46. See id.

        47. See Jane Street Letter at 2–3.

        48. Jane Street further stated that the information asymmetry that would be created by the FIMSAC Recommendation would make market participants less willing to provide liquidity on "all-to-all" trading platforms, stifling the growth of such trading platforms. See Jane Street Letter at 2.

        49. See Flow Traders Letter at 3–4.

        50. See Vanguard Letter at 2.

        51. See JPMorgan Chase Letter at 4–6.

        52. See Harris Letter at 4.

        53. See Vanguard Letter at 3.

        54. See Securities Exchange Act Release No. 84875 (December 19, 2018), 84 FR 5202, 5215 (February 20, 2019) (Transaction Fee Pilot Adopting Release).

        55. The manner in which bonds are stratified by 144A type in this proposed pilot is consistent with the peer reviewed academic literature (Bessembinder, Jacobsen, Maxwell and Venkataraman 2018).

        56. See April 9th FIMSAC Transcript at pg. 30–31 (expressing concern about picking "winners and losers, both in terms of issuers, in terms bonds owned by asset managers, bonds owned by individuals and bonds owned on dealer balance sheets").

        57. FINRA notes that the comparison between Test Group 1 and 3 involves two changes because the delayed dissemination in Test Group 3 would occur at a higher trade size threshold and Test Group 3 includes an increase in the dissemination cap. An alternative construction considered for Test Group 1 is discussed below.

        58. Liquidity is the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.

        59. See Transaction Fee Pilot Adopting Release, 84 FR at 5244.

        60. See id. at 5259.

        61. See id. at 5266.

        62. Bessembinder, Maxwell and Venkataraman (2006), Edwards, Harris and Piwowar (2007) and Goldstein, Hotchkiss and Sirri (2007) found that TRACE reduced transaction costs for investors. The latter two papers also found the reduction in cost is greater for smaller size trades. Jacobsen and Venkataraman (2018) found reduced trading cost in 144A corporate bonds. On the other hand, Goldstein, Hotchkiss and Sirri (2007) found that the reduction in bid-ask spread was limited to certain type of bonds and less frequently traded bonds and very large trades showed no significant reduction in bid-ask spread.

        63. See Goldstein and Hotchkiss (2007) and Asquith, Covert and Pathak (2013).

        64. Goldstein, Hotchkiss and Sirri (2007) and Asquith, Covert and Pathak (2013) did not find that TRACE increased trading activity. Indeed, Asquith, Covert and Pathak (2013) found that TRACE reduced trading activity for high-yield (i.e., non-IG) bonds. Bessembinder and Maxwell (2008) offered a possible explanation of the reduced trading activity in the dealer market. The paper noted the dramatic increase in corporate bond trading volume on the electronic platform that followed the introduction of TRACE and that TRACE might have improved the viability of the electronic market. Bessembinder and Maxwell (2008) noted that while investors had benefited from the increased transparency through reduced trading cost, bond dealers had experienced reductions in employment and compensation. Market participants found it more difficult to trade large size orders as dealers were reluctant to carry inventory.

        65. Bessembinder, Maxwell and Venkataraman (2006) found the concentration ratio of trades completed by the largest 12 dealers decreased. Jacobsen and Venkataraman (2018) found small dealers gained market share and closed the trading cost advantage enjoyed by large dealers. Similar effects also have been observed in other markets. For example, Schultz and Song (2017) found trading costs fell for institutional investors and less active dealers received better prices in their trades with more active dealers in the To Be Announced mortgage-backed securities market.

        66. Cici, Gibson and Merrick (2011) found that TRACE contributed to the general decline in the valuation dispersion of bonds across mutual funds.

        67. For the purposes of the economic baseline, consistent with Rule 6710, IG includes bonds in the four highest generic rating categories (AAA, AA, A, BBB). Non-IG includes bonds rated in lower credit categories (BB, B, CCC, CC, C, C, NA/NR).

        68. The trend of block size trades are similar across issue sizes. Larger issue sizes attract more block trades. The graphs are available upon request.

      • 19-11 FINRA Announces Update of the Interpretations of Financial and Operational Rules

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        SEC Financial Responsibility Rules

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Finance
        Legal
        Operations
        Regulatory Reporting
        Senior Management
        Key Topics

        Backstop Agreements
        Net Capital
        Open Contractual Commitments
        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
        Regulatory Notice 18-03
        Regulatory Notice 18-42
        SEA Rule 15c3-1

        Summary

        FINRA is making available an update to the Interpretations of Financial and Operational Rules that the staff of the SEC's Division of Trading and Markets (SEC staff) has communicated to FINRA staff. The update relates to Securities Exchange Act (SEA) Rule 15c3-1(c)(2)(viii) (Open Contractual Commitments).

        Questions concerning this Notice should be directed to:

        •   Yui Chan, Senior Director, Risk Oversight and Operational Regulation (ROOR), at (646) 315-8426 or Yui.Chan@finra.org; or
        •   Ann Duguid, Senior Director, ROOR, at (646) 315-7260 or Ann.Duguid@finra.org.

        Background & Discussion

        FINRA is updating the Interpretations of Financial and Operational Rules to add the following new interpretation:

        •   SEA Rule 15c3-1(c)(2)(viii)(C)/06 (Underwriting Backstop Agreement). This interpretation relates to the conditions under which an underwriting backstop agreement in a firm commitment underwriting would not give rise to an open contractual commitment charge.

        This interpretation update is 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, 15-25, 18-03 and 18-42.

        FINRA member firms and others that maintain a hardcopy version of the Interpretations of Financial and Operational Rules may replace the existing page in their hardcopy version by printing the accompanying updated page. The filing instruction for the new page is as follows:

        SEA Rule Remove Old Page Add New Page
        15c3-1 654 654

      • 19-10 FINRA Provides Guidance on Customer Communications Related to Departing Registered Representatives

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        Customer Communications

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Legal
        Registered Representatives
        Senior Management
        Key Topics

        Customer Accounts
        Customer Communications
        Registered Representative Departures
        Referenced Rules & Notices

        FINRA Rule 2210

        Executive Summary

        This Notice addresses the responsibilities of member firms when communicating with customers about departing registered representatives.

        Questions regarding this Notice should be directed to:

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

        Background and Discussion

        FINRA has consistently sought to ensure that customers can make a timely and informed choice about where to maintain their assets when their registered representative (i.e., a person registered with the member who has direct contact with customers in the conduct of the member's securities sales) leaves a member firm. Accordingly, FINRA expects that:

        1. in the event of a registered representative's departure, the member firm should promptly and clearly communicate to affected customers how their accounts will continue to be serviced; and
        2. the firm should provide customers with timely and complete answers, if known, when the customer asks questions about a departing registered representative.

        Registered Representative Departures

        Registered representatives move with some frequency between member firms and across financial firms under various regulatory jurisdictions, such as investment advisory firms and insurance companies. In addition, registered representatives may leave the financial industry entirely. A registered representative's departure may prompt customer questions about the departing representative and the status of their accounts following the departure.

        FINRA recognizes that member firms' different business models give rise to different approaches to managing the customer relationship, and that the expectations regarding a member firm's handling of a departing registered representative will vary accordingly. For instance, the departure of a registered representative who works closely with customers in a one-on-one relationship will likely be handled differently than the departure of a registered representative in a customer advisory center model or a group service model. While member firms have flexibility in reassigning customer accounts and communicating with customers about the reassignments, they should provide timely and complete answers, if known, to all customer questions resulting from a departing representative, so that customers may make informed decisions about their accounts.

        Communications with Customers

        Customers should not experience an interruption in service as a result of a registered representative's departure. FINRA understands that decisions about the reassignment of customer accounts, if applicable, are typically made promptly following the departure of a registered representative. In the event of a registered representative's departure, FINRA expects that the member firm will have policies and procedures reasonably designed to assure that the customers serviced by that registered representative are aware of how the customers' account will be serviced at the member firm, including how and to whom the customer may direct questions and trade instructions following the representative's departure and, if and when assigned, the representative to whom the customer is now assigned at the member firm.

        In addition, a member firm should communicate clearly, and without obfuscation, when asked questions by customers about the departing registered representative. Consistent with privacy and other legal requirements, these communications may include, when asked by a customer:

        1. clarifying that the customer has the choice to retain his or her assets at the current firm and be serviced by the newly assigned registered representative or a different registered representative or transfer the assets to another firm; and
        2. provided that the registered representative has consented to disclosure of his or her contact information to customers, providing reasonable contact information, such as phone number, email address or mailing address, of the departing representative.

        FINRA would not expect a member firm to seek to obtain the departing registered representative's contact information if not known by those responsible for reassigning and continuing to service the account (e.g., the branch supervisor responsible for reassigning the customer account or newly assigned registered representative) at the time of a customer's question. As with all communications with customers, information provided by the member firm about the departing registered representative must be fair, balanced and not misleading.

      • 19-09 FINRA Reminds Firms of Their Obligations Under SEC Rule 15c2-11(a)(4)

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        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Legal
        Registered Representatives
        Systems Trading Training
        Key Topics

        Foreign Private Issuers
        Form 211
        OTC Equity Securities
        Quoting
        Trading
        Referenced Rules & Notices

        FINRA Rule 6432
        Securities Exchange Act Rule 12g3-2(b)
        Securities Exchange Act Rule 15c2-11

        OTC Quotations in Foreign Private Issues

        Summary

        In consultation with the staff of the Securities and Exchange Commission (SEC staff), FINRA is issuing this Notice to remind firms of their obligations under Securities Exchange Act (SEA) Rule 15c2-11 and FINRA Rule 6432 (Compliance with the Information Requirements of Rule 15c2-11) regarding quotations in the securities of foreign private issuers that rely on SEA Rule 12g3-2(b). Specifically, we are reminding firms that Rule 15c2-11(a)(4) requires that they make paragraph (a)(4) information reasonably available upon request to any person expressing an interest in a transaction involving the security, such as by providing the requesting person with appropriate instructions regarding how to obtain the information electronically. Firms cannot comply with this requirement by directing customers to an issuer's website if, by its terms, the website restricts access by U.S. persons to the paragraph (a)(4) information.

        Questions regarding this Notice should be directed to:

        •   Yvonne Huber, Vice President, Market Regulation (MR), at (240) 386-5034 or yvonne.huber@finra.org;
        •   Sewall Lee, Director, MR, at (240) 386-6054 or sewall.lee@finra.org; or
        •   for legal and interpretive questions, Racquel Russell, Associate General Counsel, Office of General Counsel, at (202) 728-8363 or racquel.russell@finra.org.

        Background and Discussion

        Rule 15c2-111 generally prohibits a broker-dealer from publishing (or submitting for publication) a quotation2 in an unlisted security on a quotation medium3 unless it has obtained and reviewed current information about the issuer. The specific information required under Rule 15c2-11 differs depending upon the circumstances surrounding the issuer and security to be quoted. A broker-dealer must have a reasonable basis for believing that the information, when considered along with any supplemental information, is accurate and from a reliable source.

        With respect to quotations in the security of a foreign private issuer, paragraph (a)(4) of Rule 15c2-11 requires a broker-dealer to review and make reasonably available upon request the information the issuer published pursuant to Rule 12g3-2(b) since the beginning of its last fiscal year.4 The broker-dealer can make paragraph (a)(4) information available by providing instructions to investors on how to obtain the information electronically, such as from the issuer's website.5 However, some foreign private issuers may prohibit persons not domiciled in their jurisdiction from accessing paragraph (a)(4) information. For example, the issuer's website may require the investor to confirm or attest they are a resident of, or domiciled in, the non-U.S. jurisdiction prior to being permitted to access the page that contains the paragraph (a)(4) information. SEC staff has advised that paragraph (a)(4) information on such a website would not be considered "reasonably available" to U.S. persons and, therefore, may not be used by a broker-dealer to fulfill its obligations under Rule 15c2-11(a)(4). Similarly, firms cannot rely on a website that restricts access by U.S. persons to the paragraph (a)(4) information to comply with FINRA Rule 6432.6


        1. 17 CFR 240.15c2-11(a).

        2. Rule 15c2-11(e)(3) provides that, except as otherwise specified in Rule 15c2-11, the term "quotation" means "any bid or offer at a specified price with respect to a security, or any indication of interest by a broker or dealer in receiving bids or offers from others for a security, or any indication by a broker or dealer that he wishes to advertise his general interest in buying or selling a particular security." See 17 CFR 240.15c2-11(e)(3).

        3. Rule 15c2-11(e)(1) provides that the term "quotation medium" means any "'interdealer quotation system' or any publication or electronic communications network or other device which is used by brokers or dealers to make known to others their interest in transactions in any security, including offers to buy or sell at a stated price or otherwise, or invitations of offers to buy or sell." See 17 CFR 240.15c2-11(e)(1). Rule 15c2-11(e)(2) provides that the term "interdealer quotation system" means "any system of general circulation to brokers or dealers which regularly disseminates quotations of identified brokers or dealers." 17 CFR 240.15c2-11(e)(2).

        4. See 17 CFR 240.15c2-11(a)(4); see also 17 CFR 240.12g3-2.

        5. See Securities Exchange Act Release No. 58465 (Exemption From Registration Under Section 12(G) of the Securities Exchange Act of 1934 for Foreign Private Issuers).

        6. To demonstrate compliance with Rule 15c2-11, FINRA Rule 6432 requires, among other things, that firms submit a Form 211 to FINRA prior to initiating or resuming a quotation in a nonexchange-listed security. In the case of a Form 211 for a foreign private issuer under Rule 15c2-11(a)(4), Form 211 requires that firms provide the: (i) foreign exchange(s) on which the subject class of securities is listed that, either singly or together with the trading of the same class of the issuer's securities in another foreign jurisdiction, constitutes the primary trading market for the securities; (ii) the symbol(s) of the security(ies) that trade on the foreign exchange(s); and (iii) the location of the internet website or electronic information delivery system that the firm would provide upon request to any person to direct them to the information that the issuer published electronically pursuant to Rule 12g3-2(b). FINRA is advising firms that, with respect to item (iii) above, a firm may not provide a website address on a Form 211 where U.S. persons are restricted from accessing the paragraph (a)(4) information.

      • 19-08 Guidance on FOCUS Reporting for Operating Leases

        View PDF

        FOCUS Reporting

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Finance
        Legal
        Operations
        Registered Representatives
        Systems Trading Training
        Key Topics

        FOCUS Reporting
        Referenced Rules & Notices

        SEA Rule 15c3-1
        SEA Rule 17a-5
        Form X-17A-5

        Summary

        In October 2018, the staff of the SEC Division of Trading and Markets (the SEC staff) issued no-action relief1 (the no-action relief letter) regarding the treatment of operating leases under SEA Rule 15c3-1 (Rule 15c3-1) in connection with the Financial Accounting Standards Board's (FASB) Accounting Standards Update for Leases (the Lease Accounting Update).2 Based on discussions with the SEC staff, and in response to member inquiries, FINRA is issuing this Notice to provide guidance to members for reporting lease assets and lease liabilities on their FOCUS reports.3

        Members should apply the guidance in this Notice going forward when preparing their FOCUS reports. Members are not required to refile any FOCUS reports that they have already submitted to comply with this guidance.

        Questions concerning this Notice should be directed to:

        •  Yui Chan, Senior Director, Risk Oversight & Operational Regulation (ROOR), at (646) 315-8426 or Yui.Chan@finra.org;
        •  Ann Duguid, Senior Director, ROOR, at (646) 315-7260 or Ann.Duguid@finra.org; or
        •  Anthony Vinci, Director, ROOR, at (646)315-8335 or Anthony.Vinci@finra.org.

        Background & Discussion

        SEC Staff's No-Action Relief

        The FASB's Lease Accounting Update introduced changes to the treatment of operating leases by requiring that a lessee must include on its balance sheet an asset and liability arising from an operating lease.4 However, in the no-action relief letter, the SEC staff noted that under paragraph (c)(2)(iv) of Rule 15c3-1,5 the operating lease asset would be a non-allowable asset for purposes of determining net worth. As such, absent relief, a broker-dealer lessee would need to deduct the operating lease asset from its net worth when computing net capital. Further, the SEC staff noted that a broker-dealer lessee using the aggregate indebtedness standard under Rule 15c3-1 to determine its minimum net capital requirement would be required to include the operating lease liability in its aggregate indebtedness calculation.

        In the no-action relief letter, the SEC staff stated that it will not recommend enforcement action to the Commission under Rule 15c3-1 in the following circumstances:

        •  if a broker-dealer computing net capital adds back an operating lease asset to the extent of the associated operating lease liability. The SEC staff stated that a broker-dealer cannot add back an operating lease asset to offset an operating lease liability unless the asset and the liability arise from the same operating lease and the amount of the asset as to each lease may not exceed the liability arising from that lease;
        •  if a broker-dealer determining its minimum net capital requirement using the aggregate indebtedness standard does not include in its aggregate indebtedness an operating lease liability to the extent of the associated operating lease asset. The SEC staff stated that if the value of the operating lease liability exceeds the associated operating lease asset, the amount by which the lease liability exceeds the lease asset must be included in the broker-dealer's aggregate indebtedness.

        FOCUS Reporting Guidance

        To assist members in their FOCUS reporting obligations, and in response to member inquiries, FINRA is providing the following guidance to members for reporting lease assets and lease liabilities on their FOCUS reports based on discussions with the SEC staff.

        To Report the Operating Lease Asset on FOCUS Report Part II, Part IIA and Part II CSE

        •  Members should report the operating lease asset on the line "Property, furniture, equipment, leasehold improvements and rights under lease agreements" as follows:

        •  report the portion of the asset to be added back in Box 490 (under the "Allowable" column);

        •  report any non-allowable portion of the asset in Box 680 (under the "Non-Allowable" column).

        To Report the Operating Lease Liability…

        …On FOCUS Report Part II
        •  Members should report the operating lease liability on the line "Accounts payable and accrued liabilities and expenses – F. Other" as follows:

        •  report the portion that is not an aggregate indebtedness liability in Box 1380 (under the "Non-A.I. Liabilities" column);

        •  report the portion that is an aggregate indebtedness liability in Box 1200 (under the "A.I. Liabilities" column).
        …On FOCUS Report Part IIA
        •  Members should report the operating lease liability on the line "Accounts payable, accrued liabilities, expenses and other" as follows:
        •  report the portion that is not an aggregate indebtedness liability in Box 1385 (under the "Non-A.I. Liabilities" column);
        •  report the portion that is an aggregate indebtedness liability in Box 1205 (under the "A.I. Liabilities" column).
        …On FOCUS Report Part II CSE
        •  Members should report the operating lease liability on the line "Accounts payable and accrued liabilities and expenses – F. Other" in Box 1680.

        As noted above, members should apply the guidance in this Notice going forward when preparing their FOCUS reports. Members are not required to refile any FOCUS reports that they have already submitted to comply with this guidance.


        1. See letter from Michael A. Macchiaroli, Associate Director, Division of Trading and Markets, SEC, to Securities Industry and Financial Markets Association (SIFMA) (October 23, 2018), available on the SEC website [https://www.sec.gov/divisions/marketreg/mr-noaction/2018/sifma-treatment-of-operating-leases-15c3-1.pdf].

        2. See FASB ASU No. 2016-02, Leases (Topic 842) (February 2016), available on the [https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167901010&acceptedDisclaimer=true] FASB website. For broker-dealers generally, the Lease Accounting Update is effective for fiscal years beginning after December 15, 2018.

        3. "FOCUS" stands for Financial and Operational Combined Uniform Single. Pursuant to SEA Rule 17a-5, members are required to file with FINRA, through the eFOCUS System, reports concerning their financial and operational status using SEC Form X-17A-5 (referred to as the FOCUS Report). Members must submit their FOCUS Reports electronically through the eFOCUS System via the FINRA Firm Gateway.

        4. The SEC staff noted that, under U. S. generally accepted accounting principles (GAAP) prior to the effectiveness of the Lease Accounting Update, a lessee was not required to record an asset or liability on its balance sheet with respect to an operating lease.

        5. Paragraph (c)(2)(iv) generally requires broker-dealers to deduct fixed assets and assets which cannot be readily converted into cash from their net worth for purposes of computing net capital.

      • 19-07 FINRA Revises Indexed Amounts for Monetary Sanctions in the Sanction Guidelines; Effective Immediately

        View PDF

        Sanction Guidelines

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Legal
        Registered Representatives
        Senior Management
        Key Topics

        FINRA Sanction Guidelines
        Referenced Rules & Notices

        Regulatory Notice 15-15

        Summary

        FINRA has revised the Sanction Guidelines to reflect the effects of inflation, per a policy established in May 2015.

        The revised Sanction Guidelines are effective immediately and available on FINRA's website [HTML version].

        Questions concerning this Notice should be directed to Megan Rauch, Associate General Counsel, Office of General Counsel, at (202) 728-8863.

        Background & Discussion

        FINRA's Sanction Guidelines familiarize FINRA firms with some of the typical securities industry rule violations that occur and the range of disciplinary sanctions that may result from those rule violations. The goal of the Sanction Guidelines is to assist FINRA's adjudicators in determining the appropriate sanctions in disciplinary proceedings.

        In May 2015, the National Adjudicatory Council (NAC) announced a policy of indexing the high-end of the monetary sanctions for each sanction guideline in the Sanction Guidelines to the Consumer Price Index.1 In addition, the NAC established that FINRA would index the sanction guidelines every three years, rounding the fine amounts to the nearest $1,000. In this adjustment to the fine amounts, the high-end of the monetary sanctions increases by 5.86 percent, before rounding. The low-end of the monetary sanction ranges in the Sanction Guidelines remains the same.


        1. See Regulatory Notice 15-15 (The National Adjudicatory Council (NAC) Revises the Sanction Guidelines Related to Misrepresentations and Suitability).

      • 19-06 FINRA Requests Comment on the Effectiveness and Efficiency of Its Rule on Business Continuity Plans and Emergency Contact Information; Comment Period Expires: April 26, 2019

        View PDF

        Retrospective Rule Review

        Regulatory Notice
        Notice Type

        Request for Comment
        Suggested Routing

        Compliance
        Legal
        Operations
        Senior Management
        Systems
        Key Topics

        Business Continuity Plans
        Cybersecurity
        Emergency Contact Information
        Referenced Rules & Notices

        FINRA Rule 4370
        NTM 04-37
        Regulatory Notice 09-59
        Regulatory Notice 09-60

        Summary

        FINRA is conducting a retrospective review of Rule 4370 (Business Continuity Plans and Emergency Contact Information), FINRA's emergency preparedness rule, 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:

        •   Jeanette Wingler, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8013 or Jeanette.Wingler@finra.org;
        •   Sarah Kwak, Assistant General Counsel, OGC, at (202) 728-8471 or Sarah.Kwak@finra.org;
        •   Lori Walsh, Deputy Chief Economist, Office of the Chief Economist (OCE), at (202) 728-8323 or Lori.Walsh@finra.org; or
        •   Meghan Burns, Associate Principal Analyst, OCE, at (202) 728-8062 or Meghan.Burns@finra.org.

        Action Requested

        FINRA encourages all interested parties to comment. Comments must be received by April 26, 2019.

        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 conducts 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 of Rule 4370, 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

        Rule 4370 is the successor rule to NASD Rules 3510 (Business Continuity Plans) and 3520 (Emergency Contact Information).3 After the events of September 11, 2001, FINRA closely studied the securities markets and industry's recovery capability to assess whether any regulatory action would be needed to assure swift recovery in the event of any future significant business disruptions. As a result of that study, FINRA (then NASD) adopted in 2004 NASD Rules 3510 and 3520 to help ensure that member firms would be able to continue their business operations in the event of such disruptions. In 2009, FINRA adopted those rules, without substantive change, as Rule 4370 in the consolidated FINRA rulebook.4

        Rule 4370 requires a member firm to create, maintain, annually review and update upon any material change a written business continuity plan identifying procedures relating to an emergency or significant business disruption. While each member firm needs to conduct its own risk analysis to determine where critical impact points and exposures exist within the firm and with its counterparties and suppliers, significant business disruptions for purposes of business continuity planning may include, among other things, natural disasters, pandemics, terrorist attacks and cyber events.5 In addition, member firms that heavily leverage technology for their business systems and infrastructure may have an increased risk of significant business disruptions associated with cyber events and technology-related disruptions.

        Each member firm has flexibility to tailor the business continuity plan to the size and needs of its business, provided that the plan addresses the enumerated minimum elements to the extent applicable and necessary to the firm. The rule also requires each member firm to disclose (at a minimum, in writing at account opening, by posting on its website, and by mailing upon request) to its customers how the business continuity plan addresses the possibility of a future significant business disruption and how the member firm plans to respond to events of varying scope.

        In addition, Rule 4370 requires each member firm to provide (and promptly update upon any material change) to FINRA prescribed emergency contact information for the member firm. This requirement is intended to ensure that FINRA has a reliable means of contacting each member firm in the event of an emergency. The rule requires the member firm to designate two associated persons as emergency contact persons, at least one of whom is a member of senior management and a registered principal of that firm. If a member firm designates a second emergency contact person who is not a registered principal, the rule requires the person to be a member of senior management who has knowledge of the member firm's business. For a member firm with only one associated person (e.g., a sole proprietorship), the second emergency contact person may be an individual, either registered with another firm or nonregistered, who has knowledge of the member firm's business operations, such as the firm's attorney, accountant or clearing firm contact.

        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 risk environment, 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 it?
        3. What have been the economic impacts, including costs and benefits, of creating, maintaining or updating a business continuity plan? To what extent do the costs and benefits have a disproportionate impact on firms based on size and business model? Has the rule led to any negative unintended consequences?
        4. Can FINRA make the rule, guidance or attendant administrative processes more efficient and effective?
        5. Have you ever needed to activate your BCP and if so, was it effective? Please describe the circumstances that led to the activation of your BCP.
        6. How do you determine what may constitute a significant business disruption? To what extent do you address specific types of significant business disruptions in your BCP (e.g., cyber events, terrorist attacks, pandemics or natural disasters)?
        7. What other rules, if any, conflict with or get in the way of business continuity planning?
        8. To what degree does your business or BCP rely on vendors or other external providers? Would the rule be more effective if it addressed expectations around additional diligence into vendor resiliency?

        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 Exchange Act Release No. 49537 (Apr. 7, 2004), 69 Fed. Reg. 19586 (Apr. 13, 2004) (SEC Notice of Order Approving File No. SR-NASD-2002-108). See also Notice to Members 04-37 (May 2004).

        4. See Exchange Act Release No. 60534 (Aug. 19, 2009), 74 FR 44410 (Aug. 28, 2009) (Order Granting Accelerated Approval of Proposed Rule Change, as Modified by Amendment No. 1; File No. SR-FINRA-2009-036) (approving the adoption, without material change, of NASD Rule 3510 (Business Continuity Plans) and NASD Rule 3520 (Emergency Contact Information) as FINRA Rule 4370). See also Regulatory Notice 09-60 (Oct. 2009).

        5. See, e.g., Regulatory Notice 09-59 (Oct. 2009) and FINRA's Small Firm Business Continuity Plan Template [http://www.finra.org/industry/small-firm-business-continuity-plan-template]. See also FINRA's Business Continuity Planning FAQ 16 [http://www.finra.org/industry/faq-business-continuity-planning-faq].

      • 19-05 FINRA Extends Effective Date of Margin Requirements for Covered Agency Transactions; New Effective Date: March 25, 2020

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        Covered Agency Transactions

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Legal
        Margin Department
        Operations
        Regulatory Reporting
        Risk Management
        Senior Management
        Key Topics

        Covered Agency Transactions
        Margin
        Referenced Rules & Notices

        FINRA Rule 4210
        Regulatory Notice 16-31
        Regulatory Notice 17-28
        Regulatory Notice 18-18

        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, 2020, the effective date of the requirements pursuant to the rule change that otherwise would have become effective on March 25, 2019.3

        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; or
        •    Adam Arkel, Associate General Counsel, Office of General Counsel, at (202) 728-6961 or Adam.Arkel@finra.org.

        Background & Discussion

        In June 2016, the SEC approved4 FINRA's rule change amending FINRA Rule 4210 to establish margin requirements for Covered Agency Transactions. 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 May 2018, FINRA issued Regulatory Notice 18-18 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 March 25, 2019.5

        In extending the implementation date of the margin requirements for Covered Agency Transactions, FINRA noted that FINRA is considering whether any revisions to the requirements are appropriate. FINRA's consideration of potential revisions is ongoing.

        FINRA is issuing this Notice to announce that FINRA is extending by an additional year, until March 25, 2020, the effective date of the margin requirements that otherwise would have become effective on March 25, 2019. Members should note that the risk limit determination requirements became effective on December 15, 2016, and are not affected by this Notice.


        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. 85083 (February 8, 2019) (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. SR-FINRA-2019-005) (extending, until March 25, 2020, 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 1.

        5. See Securities Exchange Act Release No. 83155 (May 2, 2018), 83 FR 20889 (May 8, 2018) (Notice of Filing and Immediate Effectiveness of a Proposed Rule Change To Extend the Implementation Date of Certain Amendments to Rule 4210 Approved Pursuant to SR-FINRA-2015-036; File No. SR-FINRA-2018-017). FINRA previously extended the implementation date of the amendments, other than the amendments relating to the risk limit determination requirements, in September 2017. See Regulatory Notice 17-28.

      • 19-04 FINRA's 529 Plan Share Class Initiative Encourages Firms to Self-Report Potential Violations

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        529 Plans

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Legal
        Registered Representatives
        Senior Management
        Key Topics

        529 Plans
        Share Classes
        Suitability
        Supervision
        Referenced Rules & Notices

        MSRB Rule G-19
        MSRB Rule G-27

        Summary

        Over the past several years, FINRA has found that some firms have failed to reasonably supervise brokers' recommendations of multi-share class products.1 FINRA has raised concerns specifically regarding firms' supervision of share-class recommendations to customers of 529 savings plans ("529 plans").2

        FINRA is launching a 529 Plan Share Class Initiative to promote firms' compliance with the rules governing 529 plan recommendations, to promptly remedy potential supervisory and suitability violations related to recommendations that customers of 529 plans buy share classes that are inconsistent with the accounts' investment objectives, and to return money to harmed investors as quickly and efficiently as possible. As described in this Notice, to encourage voluntary reporting under this initiative, FINRA's Department of Enforcement (Enforcement) will recommend that FINRA accept favorable settlement terms for firms that self-report these potential violations and provide FINRA with a detailed remediation plan.3

        Questions concerning this Notice should be directed to:

        •    Christopher Kelly, Senior Vice President, Enforcement, at (732) 596-2082; or
        •    Christopher Burky, Senior Director, Enforcement, at (312) 899-4348.

        Background & Discussion

        529 plans are tax-advantaged municipal securities that are designed to encourage saving for the future educational expenses of a designated beneficiary. Because 529 plans are municipal securities, the sale of 529 plans are governed by the rules of the Municipal Securities Rulemaking Board (MSRB).4 MSRB Rule G-19 (Suitability of Recommendations and Transactions) requires, in part, that firms and brokers that sell municipal securities have a reasonable basis to believe that a recommended transaction is suitable in light of the customer's investment profile. MSRB Rule G-27 (Supervision) requires firms to establish and maintain a supervisory system that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable MSRB rules.5

        Shares of 529 plans are commonly sold in different classes with differing fee structures.6 Class A shares typically impose a front-end sales charge but charge lower annual fees compared to other classes.7 Class C shares typically impose no front-end sales charge but impose higher annual fees than Class A shares. These classes have a differing cost impact depending on the length of time the customer holds the securities. The MSRB has stated that information known about the designated beneficiary generally would be relevant in weighing the investment objectives of the customer, including information regarding the age of the beneficiary and the number of years until the funds will be needed to pay qualified education expenses of the beneficiary.8 Further, the MSRB has stated that information regarding the designated beneficiary should be treated as information relating to the customer's investment objective for purposes of Rule G-19. 9

        Similarly, in the mutual fund context, FINRA has repeatedly cautioned that firms must supervise recommendations to purchase higher-expense share classes, particularly when an investor is seeking a long-term investment.10 With regard to Class C share sales, for example, FINRA has cautioned that customers should be informed "of the potential long- term effect of the higher ongoing sales charges" associated with holding Class C shares, and that firms should "maintain written records of [such] discussions in their files."11

        Effective in January 2018, amendments to the Internal Revenue Code expanded the use of 529 plans for tuition for grades K-12, subject to certain limitations. While 529 plan distributions were tax-free when used to pay for qualified higher education expenses (i.e., expenses incurred at or around the time the beneficiary is college-aged, typically 18 years or older), now, in addition, up to $10,000 per year in 529 plan withdrawals would be tax-free if used for elementary or secondary educational expenses (e.g., expenses incurred when the beneficiary is as young as four or five years old). These additional considerations underscore the importance of recommending a share class that is tailored to the unique circumstances and needs of the customer, as well as the importance of supervising such recommendations.

        FINRA is concerned that because of the unique features of 529 plans, some member firms may not provide adequate supervision. For example, 529 plan transactional data, including account asset levels, may not be available in the systems that firms use to monitor other types of transactions. This initiative is intended to encourage firms to assess their supervisory systems and procedures governing 529 plan share-class recommendations, to identify and remediate any defects, and to compensate any investors harmed by supervisory failures.

        The 529 Plan Share Class Initiative

        Who should consider self-reporting?

        Firms are encouraged to review their supervisory systems and procedures governing 529 plan share-class recommendations and self-report to FINRA areas where their supervision may not have been reasonable.12 Potential areas of concern include the failure to:

        •   provide training regarding the costs and benefits of different 529 plan share classes;
        •   understand and assess the different costs of share classes for individual transactions;
        •   receive or review data reflecting 529 plan share classes sold; and
        •   review share-class information, including potential breakpoint discounts or sales charge waivers, when reviewing the suitability of 529 plan recommendations.

        Firms that identify and self-report issues with 529 plan share-class supervision should also assess and self-report the potential impact of such supervisory failures. Firms may choose to assess the potential impact by conducting a customer-specific analysis, reviewing each customer's investment objectives and investment horizon, and assessing whether the firm recommended a suitable share class for that customer given his or her facts and circumstances. Alternatively, firms may choose to assess the potential impact of supervisory failures using a statistical approach to identify categories of 529 plan customers invested in share classes that are not economically advantageous if held for the accounts' expected investment horizon. For example, in many plans that offer both A and C share classes, the aggregate costs of a C share tend to exceed the aggregate costs of an A share after approximately six to seven years. Therefore, when assets are expected to be invested for more than six to seven years (for example, in a 529 plan purchased for the future college expenses of a beneficiary younger than 12), an A share might be the more cost-effective choice. Thus, firms could consider identifying 529 plan customers who invested in Class C shares for the future college expenses of beneficiaries younger than 12.13 FINRA will work with firms that prefer to develop different statistical models as a more effective way to assess potential impact.

        When and what firms should self-report?14

        To be eligible for the 529 Plan Share Class Initiative, firms must self-report by providing written notification to FINRA Enforcement by 12:00 a.m. E.T. on April 1, 2019. Notification can be made by email to 529Initiative@finra.org or by mail to 529 Plan Initiative, FINRA, Department of Enforcement, Brookfield Place, 200 Liberty Street, New York, New York 10281. A firm that has timely self-reported must, by May 3, 2019,15 confirm its eligibility for the 529 Plan Share Class Initiative by submitting all of the following information for the period of January 2013 through June 2018 (the "disclosure period").

        i. A list of the 529 plans sold by the firm, including the 529 plan name and the dates the firm offered each 529 plan.
        ii. The total aggregate principal amount invested in each 529 plan sold by the firm during the disclosure period.
        iii. A description of the firm's supervisory systems and procedures relating to 529 plan sales during the disclosure period.
        iv. A description of the changes to the firm's supervisory systems and procedures that the firm has implemented or will implement in order to strengthen compliance with its supervisory obligations. To the extent the firm identifies changes that have not yet been implemented, the firm should identify the individual supervisor at the firm who is responsible for the implementation.
        v. The firm's assessment of potential impact on customers of supervision weaknesses, including a description of the firm's methodology for assessing impact on customers and a description of the firm's proposal to make restitution payments to harmed customers.
        vi. Any other information the firm believes would assist Enforcement in understanding the firm's assessment of an account's expected investment horizon, the suitability of the firm's recommendations, or the reasonableness of the firm's supervisory system regarding share class recommendations.

        Standardized Settlement Terms

        To the extent that a firm meets the requirements of the 529 Plan Share Class Initiative, and Enforcement decides to recommend a formal enforcement action based on the facts disclosed by the firm through the 529 Initiative and any other relevant information, Enforcement will recommend that FINRA accept a settlement that includes restitution for the impact on affected customers16 and a censure, but no fine.17 Recommended settlements also will include either an acknowledgement that the firm has voluntarily taken corrective actions or undertakings to do so. Enforcement anticipates that settlements entered into pursuant to this 529 Initiative will include charges under MSRB Rule G-27 (Supervision). Settlements under this rule would not result in a firm's "statutory disqualification" as that term is defined in Section 3(a)(39) of the Securities Exchange Act of 1934.

        No Assurances for Firms That Do Not Self-Report

        In 2019, FINRA's Member Supervision and Enforcement departments will continue to examine and investigate firms' supervision of share-class recommendations to customers of 529 plans. If a firm does not self-report under the 529 Initiative but FINRA later identifies supervisory failures by that firm, any resulting disciplinary action likely will result in the recommendation of sanctions beyond those described under the initiative.18

        No Assurances Offered With Respect to Individual Liability

        The 529 Plan Share Class Initiative covers only member firms. Enforcement provides no assurance that individuals associated with these firms will be offered similar terms if they sold 529 plans to customers in violation of MSRB rules, or violated any securities laws. Enforcement may recommend enforcement action against such individuals and may seek sanctions beyond those resulting from the initiative. Assessing whether to recommend enforcement action against an individual necessarily involves a case-by-case assessment of specific facts and circumstances.


        1 See 2017 Report on FINRA Examination Findings [http://www.finra.org/industry/2017-report-exam-findings], at 7 (Dec. 2017).

        2 FINRA's 2016 Regulatory and Examination Priorities Letter [http://www.finra.org/industry/2016-regulatory-and-examination-priorities-letter], at 7 (Jan. 2016). A 529 plan is structured as a trust. The trust is divided into investment options and those investment options then may invest in mutual funds. A customer purchases units in the trust. Most 529 plans offer different "unit" class pricing options similar to the share class pricing offered by open-end mutual funds. For purposes of this initiative, the terms "unit class" and "share class" are used interchangeably.

        3 FINRA settlements must be accepted by Enforcement prior to submission to the Office of Disciplinary Affairs (ODA) or the National Adjudicatory Council (NAC) Review Subcommittee. The NAC, or ODA on behalf of the NAC, must then approve the Letter of Acceptance Waiver and Consent (AWC) before it becomes final.

        4 FINRA is responsible for examining FINRA members that are municipal securities dealers or municipal advisors and for enforcing MSRB rules.

        5 In addition, MSRB Rule G-17 (Conduct of Municipal Securities and Municipal Advisory Activities) requires that firms and their associated persons deal fairly with all persons and not engage in any deceptive, dishonest, or unfair practice. See Interpretation on Customer Obligations Related to Marketing of 529 College Savings Plans (Aug. 7, 2006) ("[D]ealers must ensure that they do not engage in transactions primarily designed to increase commission revenues in a manner that is unfair to customers under Rule G-17.").

        6 Direct-sold 529 plans, versus broker-sold 529 plans, may have different share-class fee structures.

        7 Breakpoint discounts typically cause the front-end sales charge to decrease as the amount invested increases.

        8 See Interpretation on Customer Obligations Related to Marketing of 529 College Savings Plans (Aug. 7, 2006).

        9 Id.

        10 See Notices to Members 94-16 (March 1994) and 95-80 (Sept. 1995).

        11 NASD Regulatory & Compliance Alert (Summer 2000), at 15.

        12 Firms that already have been contacted by Enforcement as of the date of this announcement regarding potential violations related to 529 plan share class sales are not required to self-report under the initiative. Firms that are subject to pending examinations by FINRA are eligible to self- report under the initiative.

        13 Importantly, a recommendation that a customer purchase 529 plan Class C shares for an account with a beneficiary age 12 or younger is not per se unsuitable. There may be circumstances in which the recommendation of higher-expense Class C shares is suitable in light of the customer's facts and circumstances.

        14 Self-reporting under the initiative does not replace firms' obligations to determine whether to self- report under FINRA Rule 4530. However, a firm's reporting obligation under Rule 4530 is triggered only if the firm concludes that it violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or self-regulatory organization. Further, for purposes of FINRA Rule 4530(b), only those violations that meet the reporting threshold under FINRA Rule 4530.01 are required to be reported. With respect to violations by a firm, FINRA Rule 4530.01 requires the firm to report only conduct that has widespread or potential widespread impact to the firm, its customers or the markets, or conduct that arises from a material failure of the firm's systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts. If the firm concludes (or reasonably should have concluded) that such a violation has occurred, it is obligated to report pursuant to FINRA Rule 4530(b). However, under the 529 Plan Share Class Initiative, FINRA is asking member firms to self-report any areas of concern regarding the reasonableness of their supervisory policies and procedures.

        15 Enforcement may grant an extension of time to submit the required information. To obtain an extension, member firms must email requests to 529Initiative@finra.org at least two days before the deadline.

        16 Enforcement will confer with the firm on an acceptable methodology for calculating restitution. The relevant time periods under any settlement, including the period for calculating any restitution, may differ from the disclosure period.

        17 Alternatively, Enforcement may, based on the particular facts and circumstances presented, determine that formal action is not appropriate and instead resolve the matter informally or with no further action. FINRA also will consider whether widespread violations are best addressed through the issuance of additional regulatory guidance.

        18 Assessing whether to recommend enforcement action necessarily involves a case-by-case assessment of specific facts and circumstances.

      • 19-03 FINRA Reminds ATS Subscribers and ATSs of the April 13, 2019, Effective Date for Disaggregated Transaction Reporting

        View PDF

        TRACE Reporting of U.S. Treasury Securities

        Regulatory Notice
        Notice Type

        Guidance
        Suggested Routing

        Compliance
        Fixed Income
        Legal
        Trading
        Key Topics

        TRACE-Eligible Securities
        Trade Reporting
        00U.S. Treasury Securities
        Referenced Rules

        FINRA Rule 6730

        Summary

        FINRA is reminding firms that, after April 12, 2019, member subscribers on an alternative trading system (ATS) and ATSs will be required to report to TRACE each transaction in U.S. Treasury securities executed in trading sessions on an ATS on a disaggregated basis.

        Questions regarding this Notice should be directed to:

        •  Joseph Schwetz, Senior Director, Market Regulation (MR), at (240) 386-6170 or by email at joseph.schwetz@finra.org;
        •  Russell Kemp, Associate Director, MR, at (240) 386-5081 or by email at russell.kemp@finra.org; or
        •  for legal and interpretive questions, Racquel Russell, Associate General Counsel, Office of General Counsel, at (202) 728-8363 or by email at racquel.russell@finra.org.

        Background and Discussion

        On July 10, 2017, members began reporting transactions in U.S. Treasury securities to TRACE.1 In advance of the July 10 implementation date, members expressed concerns regarding their ability to accurately report transactions in U.S. Treasury securities that were executed on an ATS in discrete trading sessions (sometimes referred to as "work-up sessions"). These concerns arose because trades executed in trading sessions may involve more than one market participant (on one or both sides of the market), and the ATS usually confirms resulting executions through an aggregated trade message sent by the ATS to its subscribers (e.g., a single message aggregating all orders executed for each subscriber in a security during the session). The ATS and member subscribers use these aggregated trade messages for TRACE trade reporting purposes.2 Because Rule 6730 requires members to report separately each individual trade that occurs in a trading session, members expressed a need for additional time to complete the systems changes necessary to disaggregate trade reporting by the July 10, 2017, effective date for reporting transactions in U.S. Treasury securities to TRACE.

        To assist members in their compliance efforts, on June 23, 2017, FINRA filed a proposal to, on a temporary basis, adopt Supplementary Material .06 to Rule 6730 (Temporary Exception for Aggregate Transaction Reporting of U.S. Treasury Securities Executed in ATS Trading Sessions) to permit members to report trades that occurred in U.S. Treasury securities executed within discrete ATS trading sessions on an aggregate, rather than individual, basis.3 The relief granted afforded members flexibility concerning the number of transactions reported and the price reported, as well as the time of execution reported to TRACE.4

        The relief provided by Rule 6730.06 originally was scheduled to expire on July 10, 2018. However, members requested additional time to complete necessary systems changes and testing to comply with Rule 6730. Therefore, on April 16, 2018, FINRA provided a onetime, nine-month extension to permit aggregated trade reporting to continue through April 12, 2019, while member ATSs performed the development work necessary to report individual execution information, including the development of an additional data feed to deliver execution-level information to subscribers and vendors.5 FINRA also understood that member subscribers required additional time to update their systems to consume the new execution information to be provided by the ATSs and to systematically incorporate this information in their TRACE reporting to FINRA. In the filing, FINRA stated that it expects that necessary testing of the new functionality will commence well in advance of the extended date of April 12, 2019, but at a minimum, no later than January 12, 2019.

        In its 2017 filing, FINRA also provided an example of how trade reporting for transactions executed in a work-up session will need to change for both subscribers and ATSs after the end of the exception.6 For ease of reference, the example is provided as Attachment A to this Notice and FINRA encourages firms to review the example as they update their systems.

        FINRA is reminding members — both ATS subscribers and ATSs — of these deadlines. After April 12, 2019, member ATSs and member ATS subscribers will be required to comply with Rule 6730 by separately reporting each individual trade that occurs during a trading session, as well as the actual time and price at which each individual trade is executed.


        1 See Securities Exchange Act Release No. 79116 (October 18, 2016), 81 FR 73167 (October 24, 2016) (Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval of File No. SR-FINRA-2016-027). See also Regulatory Notice 16-39 (October 2016).

        2 For additional information on the types of trading sessions that may occur on ATSs and on the operation of the exception in varying trade reporting scenarios, see Securities Exchange Act Release No. 81018 (June 26, 2017), 82 FR 29956 (June 30, 2017) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2017-023).

        3 Id.

        4 Specifically, the exception provided that ATSs and member subscribers are permitted to report transactions in U.S. Treasury securities executed within discrete trading sessions by submitting a transaction report reflecting the aggregate amount of a U.S. Treasury security purchased (sold) to another party during a single trading session at the average price of such transactions, with the time of execution communicated by the ATS, irrespective of the number of trades in the trading session. Id.

        5 See Securities Exchange Act Release No. 83098 (April 24, 2018), 83 FR 18866 (April 30, 2018) (Notice of Filing and Immediate Effectiveness of a Proposed Rule Change To Extend the Temporary Exception That Permits Aggregate Reporting for Certain ATS Transactions in U.S. Treasury Securities).

        6 See supra note 2.


        Attachment A

        Example of required trade reporting by ATSs and subscribers of transactions executed in a work-up session after April 12, 2019

        Assume that the following events occur in an ATS trading session:

        Trade No.
        Time
        Subscriber
        Buy/Sell
        Amount (in millions)
        11:34:02.000 Subscriber A Sell $25
        1 11:34:03.155 Subscriber B Buy $10
        2 11:34:03.483 Subscriber C Buy $15
        11:34:04.003 Subscriber D Sell $10
        3 11:34:05.002 Subscriber E Buy $5
        4 11:34:05.877 Subscriber B Buy $5
        11:34:07.877
        Trading Session Closes

        At the end of the trading session, the ATS provides each subscriber with an aggregate trade message indicating the subscriber's aggregate activity during the trading session (including, for example, an aggregate size and average price). The trade messages contain a single time of execution (e.g., the time the trading session closed), rather than the actual time at which each respective trade was executed during the trading session. The temporary exception permits the subscriber and ATS to use the aggregate size and average price information contained in the trade message for purposes of TRACE reporting. The temporary exception also permits all parties to use the time of execution contained in the ATS's trade message, rather than the actual time the parties executed the individual transactions.

        After April 12, 2019, members must comply with existing TRACE reporting requirements in Rule 6730 and must submit trade reports for the following transactions executed in a trading session, including the actual price and time of execution for each trade:

        Trade No.
        TRACE Reports
        Quantity (in millions)
        Time of Execution
        1 Subscriber A sell to ATS
        ATS buy from Subscriber A
        ATS sell to Subscriber B
        Subscriber B buy from ATS
        $10
        $10
        $10
        $10
        11:34:03.155
        11:34:03.155
        11:34:03.155
        11:34:03.155
        2 Subscriber A sell to ATS
        ATS buy from Subscriber A
        ATS sell to Subscriber C
        Subscriber C buy from ATS
        $15
        $15
        $15
        $15
        11:34:03.483
        11:34:03.483
        11:34:03.483
        11:34:03.483
        3 Subscriber D sell to ATS
        ATS buy from Subscriber D
        ATS sell to Subscriber E
        Subscriber E buy from ATS
        $5
        $5
        $5
        $5
        11:34:05.002
        11:34:05.002
        11:34:05.002
        11:34:05.002
        4 Subscriber D sell to ATS
        ATS buy from Subscriber D
        ATS sell to Subscriber B
        Subscriber B buy from ATS
        $5
        $5
        $5
        $5
        11:34:05.877
        11:34:05.877
        11:34:05.877
        11:34:05.877

      • 19-02 FINRA Updates Supplemental Statement of Income; Implementation Date: The updated SSOI applies beginning with all SSOI filings that report on the period January 1 through March 31, 2019, and are due by April 26, 2019.

        View PDF

        Supplemental FOCUS Information

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

        FINRA Rule 4524
        Regulatory Notice 12-11
        Regulatory Notice 18-38
        Suggested Routing

        Compliance
        Finance
        Legal
        Operations
        Regulatory Reporting
        Senior Management
        Key Topics

        FOCUS Reporting
        Supplemental Statement of Income

        Summary

        FINRA is updating the Supplemental Statement of Income (SSOI) to conform with amendments adopted by the SEC1 that simplify and update certain of the FOCUS reporting requirements for broker-dealers.2 Pursuant to Rule 4524, the SSOI must be filed by all FINRA members as a supplement to the FOCUS Report3 within 20 business days after the end of each calendar quarter.4 FINRA is making available the updated SSOI instructions and form, as well as a resource that illustrates the SSOI form updates.

        The updated SSOI applies beginning with all SSOI filings that report on the period January 1 through March 31, 2019, and are due by April 26, 2019.

        Questions concerning this Notice should be directed to:

        •   Yui Chan, Senior Director, Risk Oversight and Operational Regulation (ROOR), at (646) 315-8426 or Yui.Chan@finra.org;
        •   Ann Duguid, Senior Director, ROOR, at (646) 315-7260 or Ann.Duguid@finra.org; or
        •   Anthony Vinci, Director, ROOR, at (646) 315-8335 or Anthony.Vinci@finra.org.

        Background & Discussion

        On August 17, 2018, the SEC adopted amendments that simplify and update, among other rules and forms, certain of the FOCUS reporting requirements for brokers and dealers and make changes to the annual audit requirements.5 As previously announced in Regulatory Notice 18-38, FINRA has updated the eFOCUS forms to reflect the SEC's FOCUS Report amendments. Further, to assist members in their financial reporting obligations, FINRA is updating the SSOI instructions and form to conform with the SEC's amendments:

        The following resource illustrates the SSOI form updates:

        The updated eFOCUS forms are available on Firm Gateway. The updated SSOI form will be available on Firm Gateway beginning February 8, 2019. Requests for technical assistance with the eFOCUS and SSOI forms may be directed to the FINRA Gateway Call Center at (800) 321-6273.

        As noted above, the updated SSOI applies beginning with all SSOI filings that report on the period January 1 through March 31, 2019, and are due by April 26, 2019.


        1 See Exchange Act Release No. 83875 (August 17, 2018), 83 FR 50148 (October 4, 2018) (Final Rule: Disclosure Update and Simplification) (the SEC's Adopting Release). FINRA issued Regulatory Notice 18-38 to announce updates to the FINRA eFOCUS System designed to correspond with the new FOCUS requirements and to inform members of the effective date of the new requirements pursuant to specified relief granted by the staff of the SEC Division of Trading and Markets. See also letter from Michael A. Macchiaroli, Associate Director, Division of Trading and Markets, SEC, to Ann Duguid, Senior Director, FINRA, dated October 29, 2018.

        2 See Exchange Act Release No. 84855 (December 19, 2018), 83 FR 66828 (December 27, 2018) (Notice of Filing and Immediate Effectiveness of a Proposed Rule Change to Make Technical Revisions and One Minor Correction to the Supplemental Statement of Income Required to be Filed Pursuant to FINRA Rule 4524 (Supplemental FOCUS Information); File No. SR-FINRA-2018-041).

        3 Members must submit their FOCUS Reports and SSOIs electronically through the eFOCUS System via the FINRA Firm Gateway.

        4 FINRA Rule 4524 (Supplemental FOCUS Information) requires each member, as FINRA shall designate, to 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 as a supplement to filing FOCUS reports. FINRA implemented the SSOI pursuant to Rule 4524 in 2012. See Regulatory Notice 12-11 (Supplemental FOCUS Information) (February 2012) (announcing the SEC's approval of Rule 4524 and the SSOI).

        5 See note 1. See also, for example, the SEC's Adopting Release at 83 FR 50179, 50182 and 50183.

      • 19-01 Final Statements for Broker-Dealers, Investment Adviser Firms, Agents and Investment Adviser Representatives, and Branches; Payment Deadline: January 21, 2019

        View PDF

        BD and IA Renewals for 2019

        Regulatory Notice
        Notice Type

        Renewals


        Suggested Routing

        Compliance
        Legal
        Operations
        Registration
        Senior Management
        Key Topics

        IARD™
        Registration
        Renewals
        Web CRD®

        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 21, 2019.

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

        Background & Discussion

        Final Statements

        On January 2, 2019, 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, 2018. 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 21, 2019. 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, 2019. 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 21, 2019. 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 deposited into a firm's Flex-Funding Account. Beginning January 21, 2019, if sufficient funds are available, FINRA will systematically transfer funds from Flex-Funding Accounts to Renewal Accounts. A systematic transfer will only occur if the entire outstanding renewal amount is available in the firm's FlexFunding Account. Firms that intend to transfer funds to their Renewal Accounts using E-Bill should do so before January 21.

        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 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 2019; 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). See the new Firm Renewal Report Guide [http://www.finra.org/industry/firm-renewal-report-guide] for more information.
        •   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 21, 2019. 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.

    • 2018

      • 18-42 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
        Regulatory Notice 18-03
        SEA Rule 15c3-1g
        SEA Rule 17a-5
        Suggested Routing

        Compliance
        Finance
        Legal
        Operations
        Regulatory Reporting
        Senior Management
        Key Topics

        Books and Records
        Financial Reporting
        Net Capital

        Summary

        FINRA is updating the imbedded text of Securities Exchange Act (SEA) financial responsibility and reporting rules in the Interpretations of Financial and Operational Rules to reflect the effectiveness of certain amendments the Securities and Exchange Commission (SEC) adopted.1 The updated imbedded text relates to SEA Rules 15c3-1g and 17a-5.

        Questions concerning this Notice should be directed to:

        •   Yui Chan, Senior Director, Risk Oversight and Operational Regulation (ROOR), at (646) 315-8426 or Yui.Chan@finra.org;
        •   Ann Duguid, Senior Director, ROOR, at (646) 315-7260 or Ann.Duguid@finra.org; or
        •   Anthony Vinci, Director, ROOR, at (646) 315-8335 or Anthony.Vinci@finra.org.

        Background & Discussion

        In August 2018, the SEC adopted amendments to several rules for broker-dealers. FINRA is updating the imbedded SEC rule text in the Interpretations of Financial and Operational Rules to reflect certain amendments to the financial responsibility and reporting rules that became effective on November 5, 2018.2 The updated imbedded text relates to SEA Rules 15c3-1g and 17a-5.

        These rule text 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, 15-25 and 18-03.

        FINRA member firms and others that maintain the hardcopy version of the Interpretations of Financial and Operational Rules may refer to the accompanying updated pages, containing the aforementioned rule text 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
        15c3-1g 1611-1614 1611-1615
        17a-5 3232-3235 3232-3236

        1 See Exchange Act Release No. 83875 (August 17, 2018), 83 FR 50148 (October 4, 2018) (Final Rule: Disclosure Update and Simplification).

        2 See note 1.

      • 18-41 Optional One-Day Extension for Customer and PAB Reserve Formula Computations and Required Deposits Around the December 2018 Month-End Holidays

        View PDF

        Financial Reporting and Month-End Holidays

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

        Regulatory Notice 07-60
        Regulatory Notice 12-54
        SEA Rule 15c3-3
        Suggested Routing

        Compliance
        Legal
        Operations
        Regulatory Reporting
        Senior Management
        Key Topics

        Customer Reserve Formula Computation
        FOCUS Filing
        PAB Reserve Formula Computation
        Reserve Bank Account Deposit

        Summary

        FINRA is notifying member firms of an optional one-day extension for making the deposit of amounts required to be reserved pursuant to SEA Rule 15c3-3, based on the customer and PAB reserve formula computations required under SEA Rule 15c3-3(e)(3) and computed by firms as of Friday, December 21 and Friday, December 28, 2018.1 The extension is based upon discussions with staff of the SEC Division of Trading and Markets and is similar to extensions previously announced in 2007 and 2012.2

        Questions regarding this Notice should be directed to:

        •   Yui Chan, Senior Director, Risk Oversight and Operational Regulation (ROOR), at (646) 315-8426 or Yui.Chan@finra.org;
        •   Kathryn Mahoney, Director, ROOR, at (646) 315-8428 or Kathryn.Mahoney@finra.org; or
        •   Peter Tennyson, Director, ROOR, at (646) 315-8403 or Peter.Tennyson@finra.org.

        Background and Discussion

        Weekly Reserve Formula Computation Deposit Requirement

        Because the 2018 Christmas Day and 2019 New Year's Day holidays both occur on a Tuesday, member firms will have an optional one-day extension for making the requisite SEA Rule 15c3-3 Reserve Bank Account deposits that may be required based on the Friday, December 21 and Friday, December 28 weekly customer and PAB reserve formula computations. This one-day extension recognizes that many firm employees may not be working on Monday, December 24 and Monday, December 31 and may need an additional day to complete their customer and PAB reserve formula computations.

        The revised reserve bank account deposit due dates are noted below:

        Revised Weekly Reserve Formula Computation Deposit Requirement

        Week Ending Original Deposit Due Date Extended Date
        Friday, December 21 Wednesday, December 26 Thursday, December 27
        Friday, December 28 Wednesday, January 2 Thursday, January 3

        Month-End Reserve Formula Computation Deposit Requirement

        Ordinarily, member firms that file a FOCUS report as of the last business day of the month would compute their month-end customer and PAB reserve formula computations as of Monday, December 31, 2018, and would make any requisite SEA Rule 15c3-3 Reserve Bank Account deposit on Thursday, January 3, 2019.3 Such member firms would also compute their weekly customer and PAB reserve formula computation as of Friday, December 28, 2018, and make any required SEA Rule 15c3-3 Reserve Bank Account deposit on Wednesday, January 2, 2019. However, if a member firm elects to use the above one-day extension to make the required deposit for the weekly computations as of Friday, December 28, they may be subject to a "double reserve bank account deposit" on Thursday, January 3.4 To avoid this potential double reserve bank account deposit, member firms may compute their month-end customer and PAB reserve formula computations as of Monday, December 31, 2018, and elect to prepare a weekly customer and PAB reserve formula computation as of Friday, January 4, in lieu of their Friday, December 28 weekly computations. This option is only available for December 2018 for those member firms that file their FOCUS report as of the last business day of the month and elect to avail themselves of the one-day extension.


        1 Paragraph (e)(3) of SEA Rule 15c3-3 requires a broker-dealer to prepare the reserve formula computations, necessary to determine the amount required to be deposited as specified in paragraph (e)(1) of SEA Rule 15c3-3, to be made weekly, as of the close of the last business day of the week, and the deposit so computed to be made no later than one hour after the opening of banking business on the second following business day.

        2 See FINRA Regulatory Notice 12-54 (December 2012) and FINRA Regulatory Notice 07-60 (December 2007).

        3 For firms that elect to file their month-end FOCUS report on a day that is other than the last business day of the month, the required month-end customer and PAB reserve formula computations would be as of the same date as the last required weekly computations for that month. For such firms, no additional computations would be required to be prepared as of the last business day of that month. Alternatively, pursuant to SEC Rule Interpretation 15c3-3(e)(3)/01 (Weekly Computation), firms that elect to file their month-end FOCUS report as of the last business day of the month would be required to prepare the month-end customer and PAB reserve formula computations as of such date and would not be required to also prepare weekly customer and PAB reserve formula computations as of the last business day of the week that includes the monthend date (unless the two computation dates happen to fall on the same day).

        4 A "double reserve bank account deposit" may occur for firms that opt to avail themselves of the one-day extension because, in such cases, the Reserve Bank Account deposit would be due on January 3, 2019, for both the December 28, 2018, weekly customer and PAB reserve formula computations and the December 31, 2018, month-end customer and PAB reserve formula computations.

      • 18-40 SEC Approves Amendments to the Codes of Arbitration Procedure to Establish a $200 Honorarium for Contested Subpoenas or Orders; Effective Date: January 7, 2019

        View PDF

        Arbitrator Honorarium

        Regulatory Notice
        Notice Type

        Rule Amendment
        Referenced Rules & Notices

        FINRA Rule 12214
        FINRA Rule 13214
        Suggested Routing

        Compliance
        Legal
        Key Topics

        Arbitration
        Codes of Arbitration Procedure
        Contested Orders for Production or Appearance
        Contested Subpoena Requests
        Payment of Arbitrators

        Summary

        The Securities and Exchange Commission (SEC) approved1 amendments to FINRA's customer and industry arbitration rules to pay each arbitrator a $200 honorarium to decide without a hearing session a contested subpoena request or a contested order for production or appearance.

        The amendments are effective for cases filed on or after January 7, 2019.

        Questions concerning this Notice should be directed to:

        •   David Carey, Associate Director, Office of Dispute Resolution, at (212) 858-4333 or david.carey@finra.org; or
        •   Mignon McLemore, Assistant Chief Counsel, Office of Dispute Resolution, at (202) 728-8151 or mignon.mclemore@finra.org.

        Background & Discussion

        Under the Codes of Arbitration Procedure for Customer and Industry Disputes (Codes), the parties exchange documents and information to prepare for the arbitration through the discovery process.2 If an individual or entity objects to a discovery request, the party seeking the documents or information may request that the panel3 issue a subpoena4 or an order of production or appearance.5

        A party may request that the panel issue a subpoena to parties in an arbitration, non-parties, as well as entities and individuals who are not FINRA members.6 If the request will be served on a FINRA member, FINRA rules favor the use of orders rather than subpoenas, unless circumstances dictate otherwise.7 A party's request (or motion) to issue a subpoena or order becomes “contested” if there is an objection raised to the scope or propriety of the subpoena or order.

        FINRA has amended Rules 12214(c) and 13214(c) of the Codes to provide that FINRA will pay each arbitrator an honorarium of $200 to decide, without a hearing session: (i) a discovery-related motion; (ii) a motion that contains one or more8 contested subpoena requests or contested orders for production or appearance; or (iii) a motion that contains one or more contested subpoena requests and contested orders for production or appearance.9

        Effective Date

        The amendments are effective for cases filed on or after January 7, 2019.


        1 See Securities Exchange Act Release No. 84418 (October 12, 2018), 83 Federal Register 52857 (October 18, 2018) (Order Approving File No. SRFINRA-2018-026).

        2 The Codes require parties to cooperate with each other and exchange documents or information to expedite the arbitration. See FINRA Rules 12505 and 13505.

        3 The claim amount or non-monetary claim determines whether a single arbitrator or panel will decide the arbitration case. See FINRA Rules 12401 and 13401. The chairperson of a panel will decide the contested subpoena or order request without a hearing session.

        4 See FINRA Rules 12512 and 13512.

        5 See FINRA Rules 12513 and 13513.

        6 See FINRA Rules 12512(a)(1) and 13512(a)(1).

        7 See supra note 5.

        8 The rules will permit a party or parties to use one motion to request issuance of one or more subpoenas or orders. Thus, if a party or the parties request one or more subpoenas in one motion, for example, and one or all of the subpoena requests become contested, each arbitrator who decides the motion will receive one honorarium payment of $200.

        9 When there is a contested motion requesting the issuance of one or more subpoenas or orders, FINRA will send to the arbitrator or panel the motion, the draft subpoena(s) or order(s), a written objection from the party opposing the motion, and any other documents supporting a party's position.


        Attachment A

        Customer Code

        12214. Payment of Arbitrators

        (a) Except as provided in paragraph (b) and in Rule 12800, FINRA will pay the panel an honorarium, as follows:
        [•  ] (1) $300 to each arbitrator for each hearing session in which he or she participates;
        [•  ] (2) an additional $125 per day to the chairperson for each hearing on the merits;
        [•  ] (3) $50 for travel to a hearing session that is postponed pursuant to Rule 12601; and
        [•  ] (4) $600 for each arbitrator if a hearing session other than a prehearing conference is postponed within 10 days before a scheduled hearing session pursuant to Rules 12601(a)(2) and (b)(2).
        (b) No change.
        (c) Payment for Deciding Discovery-Related Motions [Without a Hearing Session], Contested Subpoena Requests, and Contested Orders for Production or Appearance without a Hearing Session
        (1) FINRA will pay each arbitrator an honorarium of $200 to decide without a hearing session: (i) a discovery-related motion [without a hearing session], (ii) a motion that contains one or more contested subpoena requests or contested orders for production or appearance; or (iii) a motion that contains one or more contested subpoena requests and contested orders for production or appearance. This paragraph does not apply to cases administered under Rule 12800.
        (2) For purposes of paragraph (c)(1):
        i. a discovery-related motion and any replies or other correspondence relating to the motion shall be considered to be a single motion;
        ii. a contested motion requesting the issuance of one or more subpoenas shall include the motion, the draft subpoena(s), a written objection from the party opposing the motion, and any other documents supporting a party's position; and
        iii. a contested motion requesting the issuance of one or more orders for production or appearance shall include the motion, the draft order(s), a written objection from the party opposing the motion, and any other documents supporting a party's position.
        (3) No change.
        (d) [Payment for Deciding Contested Subpoena Requests Without a Hearing Session]
        [(1) The honorarium for deciding one or more contested motions requesting the issuance of a subpoena without a hearing session shall be $250. The honorarium shall be paid on a per case basis to each arbitrator who decides the contested motion(s). The parties shall not be assessed more than $750 in fees under this paragraph in any arbitration proceeding. The honorarium shall not be paid for cases administered under Rule 12800.]
        [(2) For purposes of paragraph (d)(1), a contested motion requesting the issuance of a subpoena shall include a motion requesting the issuance of a subpoena, the draft subpoena, a written objection from the party opposing the issuance of the subpoena, and any other documents supporting a party's position.]
        [(3) The panel will allocate the cost of the honorarium under paragraph (d)(1) to the parties pursuant to Rule 12902(c).]
        [(e)] Payment for Explained Decisions
        (1) No change.
        (2) No change.
        * * * * *

        Industry Code

        13214. Payment of Arbitrators

        (a) Except as provided in paragraph (b), Rule 13800, and Rule 13806(f), FINRA will pay the panel an honorarium, as follows:
        [•  ] (1) $300 to each arbitrator for each hearing session in which he or she participates;
        [•  ] (2) an additional $125 per day to the chairperson for each hearing on the merits;
        [•  ] (3) $50 for travel to a hearing session that is postponed pursuant to Rule 13601; and
        [•  ] (4) $600 for each arbitrator if a hearing session other than a prehearing conference is postponed within 10 days before a scheduled hearing session pursuant to Rules 13601(a)(2) and (b)(2).
        (b) No change.
        (c) Payment for Deciding Discovery-Related Motions [Without a Hearing Session], Contested Subpoena Requests, and Contested Orders for Production or Appearance without a Hearing Session
        (1) FINRA will pay each arbitrator an honorarium of $200 to decide without a hearing session: (i) a discovery-related motion [without a hearing session], (ii) a motion that contains one or more contested subpoena requests or contested orders for production or appearance; or (iii) a motion that contains one or more contested subpoena requests and contested orders for production or appearance. This paragraph does not apply to cases administered under Rule 13800 or pursuant to Rule 13806(d)(1).
        (2) For purposes of paragraph (c)(1):
        i. a discovery-related motion and any replies or other correspondence relating to the motion shall be considered to be a single motion;
        ii. a contested motion requesting the issuance of one or more subpoenas shall include the motion, the draft subpoena(s), a written objection from the party opposing the motion, and any other documents supporting a party's position; and
        iii. a contested motion requesting the issuance of one or more orders for production or appearance shall include the motion, the draft order(s), a written objection from the party opposing the motion, and any other documents supporting a party's position.
        (3) No change.
        (d) [Payment for Deciding Contested Subpoena Requests Without a Hearing Session]
        [(1) The honorarium for deciding one or more contested motions requesting the issuance of a subpoena without a hearing session shall be $250. The honorarium shall be paid on a per case basis to each arbitrator who decides the contested motion(s). The parties shall not be assessed more than $750 in fees under this paragraph in any arbitration proceeding. The honorarium shall not be paid for cases administered under Rule 13800 or pursuant to Rule 13806(d)(1).]
        [(2) For purposes of paragraph (d)(1), a contested motion requesting the issuance of a subpoena shall include a motion requesting the issuance of a subpoena, the draft subpoena, a written objection from the party opposing the issuance of the subpoena, and any other documents supporting a party's position.]
        [(3) The panel will allocate the cost of the honorarium under paragraph (d)(1) to the parties pursuant to Rule 13902(c).]
        [(e)] Payment for Explained Decisions
        (1) No change.
        (2) No change.

      • 18-39 Unexpected Close of Securities Markets

        View PDF

        Day of Closure

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

        Federal Reserve Board Regulation T
        FINRA Rule 4210
        FINRA Rule 4230
        FINRA Rule 4521
        FINRA Rule 4524
        SEA Rule 15c3-1
        SEA Rule 15c3-3
        SEA Rule 17a-5
        Regulation SHO
        Suggested Routing

        Compliance
        Legal
        Margin Department
        Operations
        Regulatory Reporting
        Senior Management
        Systems
        Key Topics

        Audit Reports
        Customer Protection
        Day Trading
        Extensions of Time
        FOCUS Report
        Form Custody
        Maintenance Margin
        Margin Requirements
        Net Capital
        Regulation SHO
        Reporting Requirements
        Supplemental FOCUS Information

        Summary

        On occasion, the securities markets may unexpectedly close for business, for example, on the national day of mourning declared in memory of President George H.W. Bush on December 5, 2018.1 This Notice provides guidance to members regarding SEA Rules 15c3-1, 15c3-3, 17a-5(a) through (d), Rule 204 under Regulation SHO, FINRA Rules 4210, 4230(b), 4521 and 4524, and Federal Reserve Board Regulation T in the event of such an unexpected close. The Notice addresses, among other things, the circumstances under which the day of the unexpected close should be considered a regular business day versus a non-business day for purposes of these rules.

        This Notice replaces the guidance previously set forth in Notice 05-47.

        Questions concerning this Notice should be directed to:

        •   Yui Chan, Senior Director, Risk Oversight and Operational Regulation (ROOR), at (646) 315-8426 or Yui.Chan@finra.org;
        •   Ann Duguid, Senior Director, ROOR, at (646) 315-7260 or Ann.Duguid@finra.org;
        •   Adam Rodriguez, Director, Credit Regulation, at (646) 315-8572 or Adam.Rodriguez@finra.org; or
        •   Theresa Reynolds, Senior Credit Regulatory Coordinator, Credit Regulation, at (646) 315- 8567 or Theresa.Reynolds@finra.org.

        Background and Discussion

        On occasion, the securities markets may unexpectedly close for business, for example, on the national day of mourning declared in memory of President George H.W. Bush on December 5, 2018. On such days, it is possible that the Federal Reserve regional banks and Depository Trust & Clearing Corporation (DTCC) may elect to remain open for clearance and settlement of securities. In such an event, members have requested that FINRA provide guidance as to the circumstances under which the day of the unexpected close should be considered a regular business day versus a non-business day for purposes of key financial, operational and reporting rules. To assist members, this Notice, based on discussions with SEC staff and Federal Reserve staff, provides members with guidance regarding SEA Rules 15c3-1, 15c3-3, 17a-5(a) through (d), Rule 204 under Regulation SHO, FINRA Rules 4210, 4230(b), 4521 and 4524, and Federal Reserve Board Regulation T in the event of an unexpected close of the securities markets.

        Members should note that FINRA may publish further or additional guidance as appropriate at the time the event occurs. For purposes of this Notice, an unexpected close of the securities markets is referred to as "the day of closure." As noted above, this Notice replaces the guidance previously set forth in Notice 05-47.

        1. Net Capital and Customer Protection
        A. SEA Rule 15c3-1 (Net Capital)

        For aging purposes, in determining net capital charges (for example, fail to deliver and suspense charges), "the day of closure" should be considered as a regular business day.
        B. SEA Rule 15c3-3 (Reserve Formula and Possession or Control)

        For purposes of reserve formula computation requirements, "the day of closure" should be considered as a regular business day.
        1. If "the day of closure" occurs on a Friday, the weekly reserve formula computation should be prepared, as usual, as of close of business on Friday, with the deposit requirement (if any) to be made by 10 a.m. on the second business day following the computation date.
        2. If "the day of closure" occurs on the normal month-end date, the reserve formula computation should be prepared, as usual, as of close of business on the monthend date with the deposit requirement (if any) to be made by 10 a.m. on the second business day following the computation date.
        3. For purposes of possession or control requirements, bank loan and stock loan recalls, if required, should be effected on "the day of closure."
        2. Financial Reporting
        A. FINRA Rules 4230(b), 4521 and 4524

        For purposes of reporting requirements under FINRA Rules 4230(b) (Required Submissions for Requests for Extensions of Time Under Regulation T and SEA Rule 15c3-3), 4521 (Notifications, Questionnaires and Reports) and 4524 (Supplemental FOCUS Information), "the day of closure" may be treated as a non-business day.
        B. SEA Rules 17a-5(a) through (d)
        For purposes of reporting requirements under paragraphs (a) through (d) of SEA Rule 17a-5 (Reports to be Made by Certain Brokers and Dealers), "the day of closure" may be treated as a non-business day.
        3. Extension of Time and Close-Out Requirements
        A. Federal Reserve Board Regulation T (Extensions of Time)

        Margin extensions due on "the day of closure" may be filed either on "the day of closure" or on the next business day (as of "the day of closure"). If an extension is filed on the next business day, FINRA staff will work with firms to ensure extensions are appropriately processed. All follow-on extensions required to be filed after "the day of closure" should be filed on the normal due date, counting "the day of closure" as a business day. However, if the extension has expired or is denied, "the day of closure" should be treated as a non-business day, and securities should be liquidated when the market where the securities are traded is reopened.
        B. FINRA Rule 4210 (Margin Calls)

        "The day of closure" should be counted as a regular business day for purposes of aging uncollected margin calls. Extensions of time due on "the day of closure" may be filed either on "the day of closure" or on the next business day (as of "the day of closure"). If an extension is filed on the next business day, FINRA staff will work with firms to ensure extensions are appropriately processed. All follow-on extensions required to be filed after "the day of closure" should be filed on the normal due date, counting "the day of closure" as a business day. However, if the extension has expired or is denied, "the day of closure" should be treated as a non-business day, and securities should be liquidated when the market where the securities are traded is reopened.
        C. FINRA Rule 4210(f)(8)(B)(iv)(f) (Day Trading Requirements)

        Funds deposited into a day trader's account to meet the minimum equity or maintenance margin requirements of FINRA Rule 4210(f)(8)(B) cannot be withdrawn for a minimum of two business days following the close of business on the day of deposit. In making this determination, "the day of closure" should be counted as a business day.
        D. SEA Rules 15c3-3(d), (h) and (m) (Extensions of Time)

        Extensions on customers' sell orders under SEA Rules 15c3-3(d), (h) and (m) due on "the day of closure" may be filed either on "the day of closure" or on the next business day (as of "the day of closure"). If an extension is filed on the next business day, FINRA staff will work with firms to ensure extensions are appropriately processed. All follow-on extensions required to be filed after "the day of closure" should be filed on the normal due date, counting "the day of closure" as a business day. However, if the extension has expired or is denied, "the day of closure" should be treated as a nonbusiness day, and securities should be purchased when the market where the securities are traded is reopened.
        4. Rule 204 under Regulation SHO (Fail to Deliver Close-Out)

        For purposes of Rule 204 under Regulation SHO, "the day of closure" should be treated as a non-business day. Participants of registered clearing agencies or firms that have been allocated a fail to deliver position by a participant of a registered clearing agency pursuant to the rule may delay closing out fail to deliver positions that have become due on "the day of closure" since U.S. equity exchanges would be closed. Close-out would be required no later than the beginning of trading on the day that major U.S. equity exchanges re-open. A participant of a registered clearing agency should not count the days that major U.S. equity exchanges are closed for purposes of determining the relevant time period for its close-out obligations.

        Members may contact their Regulatory Coordinator with any questions in connection with an unexpected market close.


        1 See Presidential Proclamation Announcing the Death of George H.W. Bush [https://www.whitehouse.gov/presidential-actions/presidential-proclamation-announcing-death-george-h-w-bush/], issued on December 1, 2018.

      • 18-38 Amendments to the SEC's Financial Reporting Requirements—eFOCUS System Updates and Annual Audit Requirements

        View PDF

        Financial Reporting Requirements

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

        FINRA Rule 4524
        Form X-17A-5
        Regulation S-X
        SEA Rule 17a-5
        Suggested Routing

        Compliance
        Finance
        Legal
        Operations
        Regulatory Reporting
        Senior Management
        Key Topics

        Annual Audit Reports
        FOCUS Reporting

        Summary

        The Securities and Exchange Commission (SEC) has adopted amendments1 that simplify and update, among other rules and forms, certain of the FOCUS2 reporting requirements for brokers and dealers and make changes to the annual audit requirements. FINRA is updating the electronic FOCUS filing system (the eFOCUS System) to incorporate the SEC's amendments.3 To facilitate members' efforts to comply with the new requirements, FINRA is making available on the FINRA website resources that illustrate the eFOCUS System updates.

        Pursuant to no-action relief issued by the staff of the SEC Division of Trading and Markets (the SEC staff),4 the SEC staff stated that it will not recommend enforcement action to the SEC if a broker-dealer continues to file the FOCUS Report as required prior to these amendments when reporting for periods ending on or before December 31, 2018. Therefore, the new FOCUS reporting requirements apply beginning with FOCUS reports filed for the period ending January 2019 and after. For example, for firms filing as of the last day of the month, the FOCUS reporting requirements apply beginning with FOCUS reports filed for the period ending January 31, 2019, and after. The new annual audit requirements apply to annual audit reports due for fiscal years ending in January 2019 and after.

        Questions concerning this Notice should be directed to:

        •   Yui Chan, Senior Director, Risk Oversight and Operational Regulation (ROOR), at (646) 315-8426 or Yui.Chan@finra.org;
        •   Ann Duguid, Senior Director, ROOR, at (646) 315-7260 or Ann.Duguid@finra.org; or
        •   Anthony Vinci, Director, ROOR, at (646) 315-8335 or Anthony.Vinci@finra.org.

        Background & Discussion

        eFOCUS Updates

        Pursuant to SEA Rule 17a-5, members are required to file with FINRA, through the eFOCUS System, reports concerning their financial and operational status using SEC Form X-17A-5 (referred to as the FOCUS Report). The SEC's amendments update the FOCUS Report to reflect updated U.S. Generally Accepted Accounting Principles (U.S. GAAP) requirements.5 More specifically, the amendments revise the Statement of Financial Condition and the Statement of Income in the FOCUS Reports to include new line items added for the reporting of comprehensive income, including other comprehensive income and accumulated other comprehensive income. The amendments update line items to eliminate references to extraordinary gains or losses and the cumulative effect of changes in accounting principles.

        FINRA is updating the eFOCUS System to incorporate the SEC's FOCUS Report amendments. To assist members' efforts to comply with the new requirements, FINRA has made available the following resources on the FINRA website that illustrate the eFOCUS System updates:

        As noted above, the new FOCUS reporting requirements apply beginning with FOCUS reports filed for the period ending January 2019 and after. For example, for firms filing as of the last day of the month, the FOCUS reporting requirements apply beginning with FOCUS reports filed for the period ending January 31, 2019, and after.

        FINRA will make available the updated eFOCUS forms on Firm Gateway beginning December 31, 2018. Requests for technical assistance with the new eFOCUS forms may be directed to the FINRA Gateway Call Center at (800) 321-6273.

        Annual Audit Requirements

        Members should note that, pursuant to the SEC's amendments, the annual audit report must contain a Statement of Comprehensive Income, in place of a Statement of Income, if there is other comprehensive income in the period presented.6 As noted above, this requirement applies to annual audit reports due for fiscal years ending in January 2019 and after.

        FINRA is separately considering revisions to the Supplementary Statement of Income (SSOI) designed to conform to the SEC's new requirements.7


        1 See Exchange Act Release No. 83875 (August 17, 2018), 83 FR 50148 (October 4, 2018) (Final Rule: Disclosure Update and Simplification) (the SEC's Adopting Release). The SEC has also made available a Demonstration Version [https://www.sec.gov/rules/proposed/2018/33-10532-demonstration.pdf] of the amendments. As discussed further in this Notice, the SEC staff has issued a no-action letter granting specified relief with respect to the new requirements. See note 4.

        2 "FOCUS" stands for Financial and Operational Combined Uniform Single.

        3 Members must submit their FOCUS Reports electronically through the eFOCUS System via the FINRA Firm Gateway.

        4 See letter from Michael A. Macchiaroli, Associate Director, Division of Trading and Markets, SEC, to Ann Duguid, Senior Director, FINRA (October 29, 2018), available on the SEC website.

        5 See, for example, the SEC's Adopting Release at 83 FR 50179, 50182 and 50183.

        6 See the SEC's Adopting Release at 83 FR 50223. The requirement is set forth in a new note that has been added to SEA Rule 17a-5(d)(2)(i). "Statement of Comprehensive Income" is defined in § 210.1-02 under Regulation S-X, as amended pursuant to the SEC's Adopting Release. See the SEC's Adopting Release at 83 FR 50198.

        7 FINRA implemented the SSOI pursuant to FINRA Rule 4524 in 2012. See Regulatory Notice 12-11 (Supplemental FOCUS Information) (February 2012).

      • 18-37 Broker-Dealer, Investment Adviser Firm, Agent and Investment Adviser Representative, and Branch Renewals for 2019; Payment Deadline: December 17, 2018

        View PDF

        BD and IA Renewals for 2019

        Regulatory Notice
        Notice Type

        Renewals
        Referenced Rules & Notices

        NTM 02-48
        Suggested Routing

        Compliance
        Legal
        Operations
        Registration
        Senior Management
        Key Topics

        IARDTM
        Registration
        Renewals
        Web CRD®

        Summary

        The 2019 Renewal Program begins on November 12, 2018, when FINRA makes the Preliminary Statements available to all firms in E-Bill. Preliminary Statements are not mailed to firms.

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

        October 22, 2018 Firms may begin submitting post-dated Form U5 and BR Closing/Withdrawal filings via Web CRD/IARD.
        November 1, 2018 Firms may begin submitting post-dated Form BDW and ADV-W filings via Web CRD/IARD.

        Please Note: Registrations terminated by postdated filings submitted by 11 p.m., Eastern Time (ET), November 9, 2018, do not appear on the firm's Preliminary Statement. The only allowed date for post-dated filings is December 31, 2018.
        November 12, 2018 Preliminary Statements are available in E-Bill.
        December 17, 2018 Full payment of Preliminary Statements is due.
        January 2, 2019 Final Statements are available in E-Bill.
        January 21, 2019 Full payment of Final Statements is due

        FINRA advises FINRA-registered firms that failure to remit full payment of their Preliminary Statements to FINRA by December 17, 2018, may cause the firm to become ineligible to do business in the jurisdictions where it is registered, effective January 1, 2019. FINRA-registered firms will also be subject to a late fee if payment is not received by December 17, 2018.

        In addition to this Notice, firms should review the renewal instructions [http://www.finra.org/industry/renewal], the IARD Renewal Program Bulletin (if applicable) on the Investment Adviser Registration Depository [https://www.iard.com/renewal-program] (IARD) website, and any information mailed to ensure continued eligibility to do business in 2019.

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

        Background & Discussion

        Preliminary Statements

        Beginning November 12, 2018, Preliminary Statements are available for viewing and printing in E-Bill [https://ews.finra.org/auth/ews_logon.jsp?CTAuthMode=BASIC&login_form_location_basic&aa_param=user]. The statements include the following fees:

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

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

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

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

        Web CRD/IARD assesses renewal fees for participating state regulators, exchanges and self-regulatory organizations (SROs). Renewal statements reflect any applicable renewal fees assessed for BD and IA firms, branches, and individuals with each SRO and/or jurisdiction.

        Some participating jurisdictions may require steps beyond the payment to FINRA of renewal fees to complete their renewal process. Firms should contact each jurisdiction directly for further information on state renewal requirements. A Regulator Directory [http://www.nasaa.org/about-us/contact-us/contact-your-regulator] is located on the NASAA website.

        For detailed information regarding IA renewals, you may also visit the IARD website [https://www.iard.com/]. For information on states' participation in the IARD Renewal Program, review the Fees and Accounting page [https://www.iard.com/fees] on the IARD website.

        FINRA must receive full payment of the Preliminary Statement fees by December 17, 2018.

        If payment is not received by December 17, 2018, FINRA-registered firms will be assessed a Renewal Late Fee. FINRA includes this late fee as part of the Final Statement and calculates the fee as follows: 10 percent of a firm's cumulative final renewal assessment or $100, whichever is greater, with a cap of $5,000. Please see Notice to Members (NTM) 02-48 for details. In addition, if FINRA fails to receive payment by the deadline, firms risk becoming ineligible to do business in the jurisdictions where their registrations are not renewed.

        Renewal Payment

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

        Fund Transfers (Flex-Funding to Renewal Account)

        Wire transfer and check payments are initially deposited into a firm's Flex-Funding Account in E-Bill. E-Bill users with the proper entitlement may transfer funds from their Flex-Funding Account directly to their Renewal Account (or to an affiliated firm) at any time prior to the December 17 payment deadline to ensure their firm's renewal payment is processed. Beginning December 17, FINRA will systematically transfer funds from Flex-Funding Accounts to Renewal Accounts if the entire outstanding renewal amount is available in the firm's Flex-Funding Account. This automatic transfer process will occur daily for firms that still owe fees on their Preliminary Statements until the system shuts down for renewal processing on December 27. On or after December 17, firms should refrain from initiating a funds transfer from their Flex-Funding Accounts to their Renewal Accounts since that may interfere with the systematic daily transfer that FINRA will conduct.

        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

        (Note: If your firm is located outside of the United States, FINRA's SWIFT-BIC is BOFAUS3N.)

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

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

        Checks

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

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

        Note: This P.O. Box will not accept
        courier or overnight deliveries.



        Bank of America Lockbox Sevices
        FINRA 418911
        MA5-527-02-07

        2 Morrissey Blvd.
        Dorchester, MA 02125

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

        Renewal Reports

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

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

        Post-Dated Form Filings

        Post-dated termination filings permit firms to indicate before year-end that they are terminating one or more registrations on December 31, 2018. The affected individual, firm and/or branch may continue doing business in that jurisdiction until the end of the calendar year. December 31, 2018, is the only date allowed for a post-dated form filing. Firms that submit termination filings before the generation of the Preliminary Statement will not be assessed renewal fees for the terminated registrations. Firms that submit termination filings after the generation of the Preliminary Statement, but before the year-end system shutdown, should see a credit balance on their Final Statements (provided the firm has not requested additional registrations that offset the credit balance). See the Summary section for key dates related to post-dated termination filings.

        After submitting a termination filing, firms should query individual, branch and/or firm registrations to ensure that Form U5, BR Closing/Withdrawal, BDW and ADV-W filings process by the renewal filing deadline date of 6 p.m., ET, on December 27, 2018.

        Firms should exercise care when submitting all post-dated filings. Web CRD/IARD processes these forms when they are submitted; FINRA cannot withdraw a post-dated termination filing. A firm that submits a post-dated termination filing in error will have to file a new Form U4, BD, Form BR or Form ADV when Web CRD/IARD resumes normal processing on January 2, 2019, and Web CRD/IARD will assess new registration fees.

        Filing Form BDW

        The deadline for electronic filing of a Form BDW for any firm that wants to terminate a registration before year-end is 6 p.m., ET, December 27, 2018.

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

        Firms that either unmark a state notice filing on a Form ADV Amendment, (generating the status of "Removal Requested at End of Year") or terminate a state registration on a Form ADV-W filed by 11 p.m., ET, November 9, 2018, will avoid the assessment of applicable renewal fees on their Preliminary Statements. The deadline to submit a form filing that will cancel a notice filing or terminate a state registration before year-end is 6 p.m., ET, December 27, 2018.

        Renewals Mass Transfer Moratorium

        A mass transfer is used to systematically transfer individuals and branch offices from one firm to another firm as a result of a merger, acquisition, succession or consolidation. December 5, 2018, is the last day firms will be able to request that a mass transfer occur in 2018. There will be a moratorium on mass transfer processing from December 28, 2018, through January 1, 2019.

        Final Statements

        On January 2, 2019, FINRA makes available all Final Statements in E-Bill. These statements reflect the status of BD, AG, IA firm and RA registrations, exempt reporting, or notice filings as of December 31, 2018. Any adjustments in fees owed resulting from registration terminations, approvals, notice filings or transitions after the Preliminary Statement appear on the Final Statement.

        •   The Final Statement reflects an amount owed if a firm has more individuals, branch offices or jurisdictions registered and/or notice filed at year-end than it did when the Preliminary Statement was generated.
        •   If a firm has fewer individuals, branch offices or jurisdictions registered or notice filed at year end than it did on the Preliminary Statement, FINRA transfers any overpayments to firms' Flex-Funding Accounts on January 2, 2019. Firms that have a credit balance in their Flex-Funding Account may submit a refund request through E-bill [http://www.finra.org/industry/web-crd/flex-funding-account-refund-requests].

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

        Firms have until January 21, 2019, to report any discrepancies on the renewal reports. This is also the deadline for receipt of final payment. Specific information and instructions concerning the Final Statement and renewal reports will be available in a January 2019 Regulatory Notice.

      • 18-36 FINRA Amends Capital Acquisition Broker Rule 331 to Conform to FinCEN's Final Rule on Customer Due Diligence Requirements for Financial Institutions; Implementation Date: November 19, 2018

        View PDF

        Capital Acquisition Brokers

        Regulatory Notice
        Notice Type

        Rule Amendment
        Referenced Rules & Notices

        Bank Secrecy Act
        CAB Rule 203
        CAB Rule 331
        CAB Rule 458
        FINRA Rule 3310
        Regulatory Notice 17-40
        Regulatory Notice 18-19
        Suggested Routing

        Compliance
        Legal
        Operations
        Senior Management
        Key Topics

        Anti-Money Laundering
        Compliance Programs

        Summary

        FINRA has filed for immediate effectiveness amendments to Capital Acquisition Broker (CAB) Rule 331 (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 November 19, 2018.

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

        Questions regarding this Notice should be directed to:

        •   Joseph P. Savage, Vice President and Counsel, Office of Regulatory Analysis, at (240) 386-4534 or by email at joe.savage@finra.org; or
        •   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 and Discussion

        FINRA CAB Rules

        In 2016, FINRA adopted a separate set of FINRA rules for firms that meet the definition of a "capital acquisition broker" and that elect to be governed under this rule set. CABs are member firms that engage in a limited range of activities, essentially advising companies and private equity funds on capital raising and corporate restructuring, and acting as placement agents for sales of unregistered securities to institutional investors under limited conditions.

        Member firms that elect to be governed under the CAB rule set are not permitted, among other things, to carry or maintain customer accounts, handle customers' funds or securities, accept customers' trading orders, or engage in proprietary trading or market making.

        The CAB Rules became effective on April 14, 2017, after SEC approval.2 In order to provide new CAB applicants with lead time to apply for FINRA membership and obtain the necessary qualifications and registrations, CAB Rules 101-125 became effective on January 3, 2017.3

        FinCEN CDD Rule

        On May 11, 2016, FinCEN, the bureau of the Department of the Treasury responsible for administering the Bank Secrecy Act4 (BSA) and its implementing regulations, issued the CDD Rule5 to clarify and strengthen customer due diligence for covered financial institutions,6 including broker-dealers that have elected CAB status. 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.7 As the first component is already required to be part of a covered financial institution's AML program under the BSA, 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.8 The CDD Rule also addresses the third and fourth components, which FinCEN states "are already implicitly required for covered financial institutions to comply with their suspicious activity reporting requirements," 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."

        Amendment to FINRA Rule 3310

        On November 21, 2017, FINRA published Regulatory Notice 17-40 to provide guidance to member firms regarding their obligations under FINRA Rule 3310 (Anti-Money Laundering Compliance Program) in light of the adoption of FinCEN's CDD Rule.9 In addition, the Notice summarized the CDD Rule's impact on member firms, including the addition of the ongoing customer due diligence obligations, or "fifth pillar," required for such firms' AML programs.

        On April 20, 2018, FINRA filed for immediate effectiveness amendments to FINRA Rule 3310 to reflect FinCEN's adoption of the CDD Rule.10 On May 3, 2018, FINRA published Regulatory Notice 18-19, which announced its amendments to FINRA Rule 3310.11 The 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.

        Addition of CDD Rule to CAB AML Rule

        For the same reasons that FINRA amended FINRA Rule 3310 to reflect FinCEN's adoption of the CDD Rule, FINRA has amended CAB Rule 331. CAB Rule 331 requires each CAB to develop and implement a written AML program reasonably designed to achieve and monitor the CAB's compliance with the BSA and implementing regulations.

        FinCEN's CDD Rule does not change the requirements of CAB Rule 331 and CABs must continue to comply with its requirements.12 However, FinCEN's CDD Rule amends the minimum regulatory requirements for CABs' AML programs by explicitly requiring such programs to include risk-based procedures for conducting ongoing customer due diligence.13 Accordingly, the recently filed amendments to CAB Rule 331 incorporate into the rule this ongoing customer due diligence element, or "fifth pillar" required for AML programs to conform the rule to the CDD Rule and aid CABs in complying with its requirements. Specifically, CAB Rule 331(f) provides that the AML programs required by this rule shall, 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 broker-dealers, including CABs, 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.14

        The amendments to CAB Rule 331 become effective on November 19, 2018.


        1 See Securities Exchange Act Release No. 84363 (October 4, 2018), 83 FR 51532 (October 11, 2018) (SR-FINRA-2018-035) (Notice of Filing and Immediate Effectiveness of a Proposed Rule Change to Amend CAB Rule 331 (Anti-Money Laundering Compliance Program) to Conform to FinCEN's Final Rule on Customer Due Diligence Requirements for Financial Institutions).

        2 See Securities Exchange Act Release No. 78617 (August 18, 2016), 81 FR 57948 (August 24, 2016) (SR-FINRA-2015-054) (Order Approving Rule Change as Modified by Amendment Nos. 1 and 2 To Adopt FINRA Capital Acquisition Broker Rules).

        3 On September 29, 2017, the SEC approved CAB Rule 203 (Engaging in Distribution and Solicitation Activities with Government Entities) and CAB Rule 458 (Books and Records Requirements for Government Distribution and Solicitation Activities), which applied established "pay-to-play" and related recordkeeping rules to the activities of CABs. See Securities Exchange Act Release No. 81781 (September 29, 2017), 82 FR 46559 (October 5, 2017) (SR-FINRA-2017-027) (Order Approving CAB Rules 203 and 458). CAB Rules 203 and 458 became effective on December 6, 2017.

        4 31 U.S.C. 5311, et seq.

        5 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 (August 4, 2014) (Notice of Proposed Rulemaking).

        6 See 31 CFR 1010.230(f) (defining "covered financial institution").

        7 See CDD Rule Release at 29398.

        8 See 31 CFR 1010.230(d) (defining "beneficial owner") and 31 CFR 1010.230(e) (defining "legal entity customer").

        9 See Regulatory Notice 17-40 (November 2017).

        10 See Securities Exchange Act Release No. 83154 (May 2, 2018), 83 FR 20906 (May 8, 2018) (SR-FINRA-2018-016) (Notice of Filing and Immediate Effectiveness of a Proposed Rule Change Relating to FINRA Rule 3310 to Conform FINRA Rule 3310 to FinCEN's Final Rule on Customer Due Diligence Requirements for Financial Institutions).

        11 See Regulatory Notice 18-19 (May 3, 2018).

        12 In fact, FinCEN notes that broker-dealers must continue to comply with FINRA rules, notwithstanding differences between the CDD Rule and the FINRA rules. See CDD Rule Release at 29421, n. 85.

        13 See CDD Rule Release at 29420; 31 CFR §1023.210.

        14 See CDD Rule Release at 29419.


        ATTACHMENT A

        Below is the amended rule text. New language is underlined; deletions are in brackets.

        CAPITAL ACQUISITION BROKER RULES

        * * * * *

        300. SUPERVISION AND RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS

        * * * * *

        331. Anti-Money Laundering Compliance Program

        Each capital acquisition broker shall develop and implement a written anti-money laundering program reasonably designed to achieve and monitor its 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 capital acquisition broker'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 must, 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 capital acquisition broker) 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)).

        •   •   •   Supplementary Material: —————————

        .01 through .02 No change.

        * * * * *

      • 18-35 SEC Approves Rule Change to Modify the Dissemination Protocols for Agency Debt Securities; Effective Date: November 19, 2018

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        Trade Reporting and Compliance Engine (TRACE)

        Regulatory Notice
        Notice Type

        Rule Amendment
        Referenced Rules & Notices

        FINRA Rule 7730
        Suggested Routing

        Fixed Income
        Operations
        Systems
        Trading
        Key Topics

        Agency Debt Securities
        Dissemination
        TRACE Eligible Security

        Summary

        The Securities and Exchange Commission (SEC) approved a rule change to modify the dissemination protocols for transactions in agency debt securities1 to apply a $5 million dissemination cap uniformly, regardless of the rating assigned to the security. The change will go into effect on November 19, 2018.

        The new rule text is available on FINRA's website.

        Questions regarding this Notice should be directed to:

        •   Alie Diagne, Director, Transparency Services, at (212) 858-4092 or by email at alie.diagne@finra.org; or
        •   for legal and interpretive questions, Racquel Russell, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8363 or racquel.russell@finra.org, or Cara Bain, Counsel, OGC, at (202) 728-8852 or cara.bain@finra.org.

        Background and Discussion

        FINRA disseminates transaction information on agency debt securities and displays either the actual size (volume) of the transaction or a capped amount, depending on the size of the transaction and the rating assigned to the security. Currently, for transactions in agency debt securities that are non-investment grade,2 FINRA disseminates the actual size of the trade for transactions less than or equal to $1 million in par value traded, and disseminates "1MM+" for trades exceeding $1 million in par value. For all other agency debt securities (i.e., investment grade3 or unrated), FINRA disseminates the actual size of the trade for transactions less than or equal to $5 million in par value traded, and disseminates "5MM+" for trades exceeding $5 million in par value traded. Beginning on November 19, 2018, FINRA will disseminate transactions in agency debt securities with a $5 million dissemination cap, irrespective of the rating assigned to the security.4 This change does not alter firm trade reporting obligations and will not necessitate any technological changes by firms.


        1. "Agency Debt Security" generally includes a debt security (i) issued or guaranteed by an agency as defined in Rule 6710(k); (ii) issued or guaranteed by a government-sponsored enterprise (GSE) as defined in Rule 6710(n); or (iii) issued by a trust or other entity that was established or sponsored by a GSE for the purpose of issuing debt securities, where such enterprise provides collateral to the trust or other entity or retains a material net economic interest in the reference tranches associated with the securities issued by the trust or other entity. Rule 6710(n) provides that "Government-Sponsored Enterprise" has the same meaning as defined in 2 U.S.C. § 622(8).

        2. Rule 6710 (Definitions) provides that "Non-Investment Grade" means "a TRACE-Eligible Security that, if rated by only one NRSRO, is rated lower than one of the four highest generic rating categories; or if rated by more than one NRSRO, is rated lower than one of the four highest generic rating categories by all or a majority of such NRSROs. Except as provided in paragraph (h), if a TRACE-Eligible Security is unrated, FINRA may classify the TRACE-Eligible Security as a Non-Investment Grade security." See FINRA Rule 6710(i).

        3. Rule 6710 provides that "Investment Grade" means "a TRACE-Eligible Security that, if rated by only one nationally recognized statistical rating organization ("NRSRO"), is rated in one of the four highest generic rating categories; or if rated by more than one NRSRO, is rated in one of the four highest generic rating categories by all or a majority of such NRSROs; provided that if the NRSROs assign ratings that are evenly divided between (i) the four highest generic ratings and (ii) ratings lower than the four highest generic ratings, FINRA will classify the TRACE-Eligible Security as Non-Investment Grade for purposes of TRACE. If a TRACE-Eligible Security is unrated, for purposes of TRACE, FINRA may classify the TRACE-Eligible Security as an Investment Grade security. FINRA will classify an unrated Agency Debt Security as defined in [Rule 6710(l)] as an Investment Grade security for purposes of the dissemination of transaction volume." See FINRA Rule 6710(h).

        4. See Securities Exchange Act Release No. 84374 (October 5, 2018), 83 FR 51722 (October 12, 2018) (Order Approving File No. SR-FINRA-2018-032).

      • 18-34 SEC Approves Amendment to Require Alternative Trading Systems to Identify Non-FINRA Member Subscribers in TRACE Reports for U.S. Treasury Securities; Effective Date: April 1, 2019

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        ATS Reporting of Transactions in U.S. Treasury Securities

        Regulatory Notice
        Notice Type

        Rule Amendment
        Referenced Rules & Notices

        FINRA Rule 6730
        Suggested Routing

        Compliance
        Fixed Income
        Government Securities
        Legal
        Operations
        Systems
        Trading
        Training
        Key Topics

        Alternative Trading System
        Fixed Income
        TRACE Eligible Security
        Trade Reporting
        U.S. Treasury Security

        Summary

        Effective April 1, 2019, large alternative trading systems (ATSs) will be required to identify non-FINRA member subscriber counterparties in TRACE reports for transactions in U.S. Treasury securities using FINRA-assigned market participant identifiers (MPIDs). This information will be used for regulatory purposes, and will not be made public.

        The rule text is available in the online FINRA Manual.

        Questions regarding this Notice should be directed to:

        •   Chris Stone, Vice President, Transparency Services, at (202) 728-8457 or by email at chris.stone@finra.org;
        •   for inquiries regarding how to submit a list of non-FINRA member subscribers and obtain FINRA-assigned MPIDs, please contact FINRA Market Operations at (866) 776-0800 or by email at atsadmin@finra.org; or
        •   for legal and interpretive questions, please contact Racquel Russell, Associate General Counsel, Office of General Counsel, at (202) 728-8363 or by email at racquel.russell@finra.org.

        Background and Discussion

        On August 9, 2018, the SEC approved an amendment to Rule 6730 (Transaction Reporting) to adopt new Supplementary Material .07 (ATS Identification of Non-FINRA Member Counterparties for Transactions in U.S. Treasury Securities) to require "covered ATSs" to identify non-FINRA member counterparties in TRACE reports for transactions in U.S. Treasury Securities, using FINRA-assigned MPIDs.1 This information will improve the information available to FINRA and the official sector for transactions in Treasury securities. Rule 6730.07 defines a "covered ATS" as an ATS2 that executed transactions in U.S. Treasury securities with non-FINRA member subscribers3 of $10 billion or more in monthly par value (computed by aggregating buy and sell transactions) for any two months in the preceding calendar quarter.

        Each ATS initially must determine if it is a "covered ATS" based on its activity level with non-FINRA member counterparties for the calendar quarter ending on December 31, 2018, and, if so, such ATS must submit to FINRA's Market Operations Department a list of its non-FINRA member subscribers by January 31, 2019. FINRA Market Operations staff will assign MPIDs for each listed non-FINRA member subscriber, and, beginning April 1, 2019, ATSs must use the assigned MPIDs to identify non-FINRA member subscribers for purposes of populating the counterparty field in TRACE reports for transactions in U.S. Treasury securities.4 If a covered ATS onboards new subscribers after January 31, 2019, it must contact FINRA to obtain MPIDs for these additional subscribers and begin using the assigned MPIDs on the effective date.5

        Any ATS that does not meet the $10 billion threshold for the calendar quarter ending on December 31, 2018, must monitor its quarterly activity on an ongoing basis to determine if its activity level reaches the rule's "covered ATS" threshold in the future. If the activity threshold is met, such ATS must commence complying with the non-FINRA member counterparty identification requirements within 60 calendar days of the end of the calendar quarter in which it becomes a covered ATS. Thus, for example, if a member ATS first meets the $10 billion threshold in the calendar quarter ending on June 30, 2019, such ATS must begin complying with the non-FINRA member identification requirement within 60 calendar days of June 30, 2019 (i.e., by August 29, 2019).6

        Once an ATS becomes a covered ATS under the rule, it must continue to comply with the non-FINRA member counterparty identification requirement irrespective of whether in the future its volume of executed transactions in U.S. Treasury securities against non-FINRA member subscribers falls below the $10 billion threshold.

        Implementation

        The effective date of the non-FINRA member counterparty identification requirement is April 1, 2019. ATSs that meet the "covered ATS" definition for the quarter ending December 31, 2018, must submit to FINRA's Market Operations Department a list of its non-FINRA member subscribers by January 31, 2019. All other ATSs must monitor their activity level on a going-forward basis to determine if, in the future, their activity level falls within the scope of the rule's definition of "covered ATS."

        To obtain FINRA-assigned MPIDs, a covered ATS should email a list of its non-FINRA member subscribers to FINRA Market Operations at atsadmin@finra.org. For each non-FINRA member subscriber, the email should provide identifying information about the subscriber including, but not limited to, the subscriber name (and subaccount, if applicable);7 and the street address, city, state, zip code and country.


        1. See Securities Exchange Act 83815, 83 FR 40601 (August 15, 2018) (Order Approving File No. SR-FINRA-2018-023).

        2. For purposes of this rule, an ATS or "alternative trading system" has the same meaning as set forth in Rule 300 of SEC Regulation ATS.

        3. For purposes of this rule, "subscriber" has the same meaning as set forth in Rule 300 of SEC Regulation ATS. See also infra note 6.

        4. Rule 6730(c) (Transaction Reporting) sets forth members' TRACE reporting obligations. Paragraph (c) (Transaction Information To Be Reported) provides the items of information that must be included in members' TRACE reports, including item #6—the counterparty's identifier—which is either an MPID, customer, or non-member affiliate, as applicable. Under the new supplementary material, covered ATSs no longer are permitted to identify a non-FINRA member subscriber generically as a customer or a non-member affiliate, but must use the FINRA-assigned MPID.

        5. Similarly, as a covered ATS onboards additional non-member subscribers going forward, it should contact FINRA as early in the process as possible to obtain an MPID for reporting all trades with the subscriber. At a minimum, a covered ATS must begin using a FINRA-assigned MPID to identify a new non-member subscriber within five business days of the date of its first trade with the subscriber.

        6. After the implementation date, the rule provides a 60-calendar day period to afford sufficient time for a newly covered ATS to provide to FINRA a list of, and obtain MPIDs for, non-FINRA member subscribers, and to perform any programming changes necessary to accurately identify non-FINRA member counterparties using the FINRA-assigned MPIDs. Once an ATS sends the list of non-FINRA member subscribers to FINRA, FINRA will require at least 14 calendar days to return a list of MPID assignments. Therefore, a newly covered ATS should factor this time into its plans for complying with the rule within 60 calendar days of the end of the calendar quarter in which it becomes a "covered ATS."

        7. Some non-FINRA member subscribers may have multiple MPIDs assigned to them, for example if they use separate aggregation units or desks to access or trade through the ATS, in which case the unit/subaccount assigned the MPID is the "subscriber" for purposes of this rule.

      • 18-33 SEC Approves Amendments to the Codes of Arbitration Procedure to Establish a Per-Arbitrator Fee and Honorarium for Late Cancellation of Prehearing Conferences; Effective Date: October 29, 2018

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        Prehearing Conference Late Cancellation Fee and Arbitrator Honorarium

        Regulatory Notice
        Notice Type

        Rule Amendment
        Referenced Rules & Notices

        FINRA Rule 12214
        FINRA Rule 12500
        FINRA Rule 12501
        FINRA Rule 13214
        FINRA Rule 13500
        FINRA Rule 13501
        Suggested Routing

        Compliance
        Legal
        Key Topics

        Arbitration
        Codes of Arbitration Procedure
        Initial Prehearing Conference
        Other Prehearing Conferences
        Payment of Arbitrators

        Summary

        The Securities and Exchange Commission (SEC) approved1 amendments to FINRA's customer and industry arbitration rules to charge parties who request cancellation of a prehearing conference within three business days a $100 per-arbitrator fee. The amendment also provides for a $100 honorarium to each arbitrator scheduled to attend the cancelled prehearing conference.

        The amendments are effective for cases filed on or after October 29, 2018.

        Questions regarding this Notice should be directed to:

        •   David Carey, Associate Director, FINRA Office of Dispute Resolution, at (212) 858-4333 or david.carey@finra.org; or
        •   Mignon McLemore, Assistant Chief Counsel, FINRA Office of Dispute Resolution, at (202) 728-8151 or mignon.mclemore@finra.org.

        Background and Discussion

        In arbitration proceedings, prehearing conferences are typically scheduled before the hearing on the merits. For example, after the parties select arbitrators and a panel is appointed,2 the Director3 will schedule an Initial Prehearing Conference (IPHC) with the panel.4 During these conferences, the arbitrator or panel meets with the parties, generally by telephone, to set deadlines, schedule the hearing and consider other preliminary matters.5 Prehearing conferences may also address other matters, such as discovery disputes or substantive motions (e.g., motions to dismiss or motions to amend).6

        Prior to the amendments, parties could cancel prehearing conferences up to and including on the same day without penalty (unlike postponements of arbitration hearings).7 Considerable preparation by arbitrators and logistical work by FINRA staff is required prior to prehearing conferences. Cancellations of prehearing conferences that occur within three or fewer business days of a prehearing conference (late cancellations) often result in scheduling inconvenience for arbitrators, uncompensated work and an operational challenge for FINRA staff who must quickly notify arbitrators about the cancellation.

        Late Cancellation Fee to Parties

        FINRA has amended FINRA Rules 12500 and 12501 of the Customer Code and FINRA Rules 13500 and 13501 of the Industry Code to provide that if a cancellation request is agreed to by the parties or requested by one or more parties within three business days before a scheduled prehearing conference and is granted, the party or parties shall be charged a fee of $100 per arbitrator scheduled to attend the prehearing conference. In the event that an extraordinary circumstance prevents a party or parties from making a timely cancellation request, the arbitrator(s) may use their discretion to waive the fee, provided a written explanation of such circumstance is received.

        Arbitrator Honorarium for Late Cancellations

        FINRA has also amended FINRA Rules 12214(a) and 13214(a) to pay a $100 honorarium to each arbitrator who is scheduled to attend a prehearing conference that is cancelled within three business days.

        Example of How the Rules Will Be Applied

        The following examples illustrate how the rule will work. The Director schedules an IPHC for Wednesday, February 20, 2019, and three arbitrators8 are scheduled to attend. A FINRA holiday falls on Monday, February 18, 2019. The parties notify the Director of their agreement to cancel9 the IPHC10 on Wednesday, February 13, 2019. They will not be charged the fee because they will have provided notice11 four business days before the scheduled prehearing conference.12 If the parties notify the Director of the cancellation on Thursday, February 14, 2019, they will be assessed a $100 per-arbitrator fee (or $300),13 because they will have provided the cancellation notice within three business days before the scheduled prehearing conference. If the parties do not agree to a fee allocation, the arbitrator(s) will have the discretion, under the amendments, to allocate the fee among the parties.

        Under the scenario above, if one party requests cancellation and notifies the Director on Thursday, February 14, 2019,14 the arbitrators will allocate the $300 fee to that party. However, the arbitrator(s) will have the discretion, under the amendments, to allocate the fee to the non-requesting party or parties if the arbitrator(s) determine that the nonrequesting party or parties caused or contributed to the need for the cancellation.15

        Effective Date

        The amendments are effective for cases filed on or after October 29, 2018.


        1. See Securities Exchange Act Release No. 83752 (July 31, 2018), 83 Federal Register 38327 (August 6, 2018) (Order Approving File No. SR-FINRA-2018-019).

        2. See generally Part IV (Appointment, Disqualification, and Authority of Arbitrators) of the FINRA Rule 12000 Series and the FINRA Rule 13000 Series.

        3. The term "Director" means the Director of the Office of Dispute Resolution. Unless the Code provides that the Director may not delegate a specific function, the term includes FINRA staff to whom the Director has delegated authority. See FINRA Rules 12100(m) and 13100(m).

        4. See FINRA Rules 12500(a) and 13500(a). Parties may agree to forego the IPHC only if they jointly provide the Director, in writing, with the information listed in subparagraphs (1) through (6) of FINRA Rules 12500(c) and 13500(c).

        5. See FINRA Rules 12500(c) and 13500(c).

        6. See FINRA Rules 12501(b) and 13501(b).

        7. Under the Code of Arbitration Procedure for Customer Disputes (Customer Code) and the Code of Arbitration Procedure for Industry Disputes (Industry Code) (together, Codes), a party or parties that make postponement requests within 10 days before a scheduled hearing session are required to pay a $600 per-arbitrator late cancellation fee. See FINRA Rules 12601(b)(2) and 13601(b)(2).

        8. If the amount of the claim is more than $100,000, the panel will consist of three arbitrators, unless the parties agree in writing to one arbitrator. See FINRA Rules 12401(c) and 13401(c).

        9. References to cancellations of prehearing conferences include postponements of such conferences.

        10. See supra note 4.

        11. The date of the party or party's cancellation request will control whether the fee is assessed, not the date of the arbitrators' decision on such a request. A decision would be required if only one party requests that the prehearing conference be cancelled.

        12. The intent of the rule is to ensure that arbitrators receive three full business days' notice of the cancellation, excluding the day of the prehearing conference. Therefore, weekend days and FINRA holidays would be excluded in determining the three-business-day window outside of which a party or parties would be required to provide notice of cancellation. In the example, therefore, the parties must provide notice on Wednesday, February 13 (or four business days, excluding the weekend and the FINRA holiday, before the scheduled prehearing conference) to avoid the late cancellation fee.

        13. In this instance, the parties will be charged $300 because the three arbitrators are scheduled to attend the IPHC.

        14. If an extraordinary circumstance (e.g., a serious car accident) causes a party to miss the deadline, to avoid the late cancellation fee, the party may provide a written explanation before the case closes for the arbitrators to consider waiving the fee. If the arbitrators waive the fee, FINRA will pay the $100 per-arbitrator honorarium to those arbitrators scheduled to attend the conference. If the fee is waived, the party or parties' obligation to pay the fee is eliminated. Absent such a waiver, the $100 per-arbitrator fee will be charged to the party as a fee assessment at the time the case is closed.

        15. If the arbitrators cancel a prehearing conference on their own, the parties will not be charged.


        Attachment A

        Customer Code

        12214. Payment of Arbitrators

        (a) Except as provided in paragraph (b) and in Rule 12800, FINRA will pay the panel an honorarium, as follows:
        [•  ] (1) $300 to each arbitrator for each hearing session in which he or she participates;
        [•  ] (2) an additional $125 per day to the chairperson for each hearing on the merits;
        [•  ] (3) $50 to each arbitrator for travel to a hearing session that is postponed pursuant to Rule 12601; [and]
        [•  ] (4) $600 [for] to each arbitrator if a hearing session other than a prehearing conference is postponed within 10 days before a scheduled hearing session pursuant to Rules 12601(a)(2) and (b)(2); and
        (5) $100 to each arbitrator scheduled to attend a prehearing conference that is cancelled within three business days of the prehearing conference by agreement of the parties or is requested by one or more parties within three business days of the prehearing conference and granted, pursuant to Rules 12500(d) and 12501(d).
        (b) – (e) No change.
        * * * * *

        12500. Initial Prehearing Conference

        (a) – (b) No change.
        (c) At the Initial Prehearing Conference, the panel will set discovery, briefing, and motions deadlines, schedule subsequent hearing sessions, and address other preliminary matters. The parties may agree to forgo the Initial Prehearing Conference only if they jointly provide the Director with the following information, in writing, with additional copies for each arbitrator, before the Initial Prehearing Conference is scheduled to be held:
        [•  ] (1) A statement that the parties accept the panel;
        [•  ] (2) Whether any other prehearing conferences will be held, and if so, for each prehearing conference, a minimum of four mutually agreeable dates and times, and whether the chairperson or the full panel will preside;
        [•  ] (3) A minimum of four sets of mutually agreeable hearing dates;
        [•  ] (4) A discovery schedule;
        [•  ] (5) A list of all anticipated motions, with filing and response due dates; and
        [•  ] (6) A determination regarding whether briefs will be submitted, and, if so, the due date for the briefs and any reply briefs.
        (d) If a cancellation request is agreed to by the parties or requested by one or more parties within three business days before a scheduled prehearing conference and granted, the party or parties shall be charged a fee of $100 per arbitrator scheduled to attend the prehearing conference. If more than one party requests the cancellation, the arbitrator(s) may allocate the $100 per-arbitrator fee between or among the requesting parties. If one party requests the cancellation, the arbitrator(s) shall allocate the fee to that party; provided, however, the arbitrator(s) may allocate all or a portion of the $100 per-arbitrator fee to the non-requesting party or parties if the arbitrator(s) determine that the nonrequesting party or parties caused or contributed to the need for the cancellation. In the event that an extraordinary circumstance prevents a party or parties from making a timely cancellation request, the arbitrator(s) may use their discretion to waive the fee, provided a written explanation of such circumstance is received.

        12501. Other Prehearing Conferences

        (a) No change.
        (b) At a party's request, or at the discretion of the panel, the panel may schedule one or more additional prehearing conferences regarding any outstanding preliminary matters, including:
        [•  ] (1) Discovery disputes;
        [•  ] (2) Motions;
        [•  ] (3) Witness lists and subpoenas;
        [•  ] (4) Stipulations of fact;
        [•  ] (5) Unresolved scheduling issues;
        [•  ] (6) Contested issues on which the parties will submit briefs; and
        [•  ] (7) Any other matter that will simplify or expedite the arbitration.
        (c) No change.
        (d) If a cancellation request is agreed to by the parties or requested by one or more parties within three business days before a scheduled prehearing conference and granted, the party or parties shall be charged a fee of $100 per arbitrator scheduled to attend the prehearing conference. If more than one party requests the cancellation, the arbitrator(s) may allocate the $100 per-arbitrator fee between or among the requesting parties. If one party requests the cancellation, the arbitrator(s) shall allocate the fee to that party; provided, however, the arbitrator(s) may allocate all or a portion of the $100 per-arbitrator fee to the non-requesting party or parties if the arbitrator(s) determine that the nonrequesting party or parties caused or contributed to the need for the cancellation. In the event that an extraordinary circumstance prevents a party or parties from making a timely cancellation request, the arbitrator(s) may use their discretion to waive the fee, provided a written explanation of such circumstance is received.
        * * * * *

        Industry Code

        13214. Payment of Arbitrators

        (a) Except as provided in paragraph (b), Rule 13800, and Rule 13806(f), FINRA will pay the panel an honorarium, as follows:
        [•  ] (1) $300 to each arbitrator for each hearing session in which he or she participates;
        [•  ] (2) an additional $125 per day to the chairperson for each hearing on the merits;
        [•  ] (3) $50 to each arbitrator for travel to a hearing session that is postponed pursuant to Rule 13601; [and]
        [•  ] (4) $600 [for] to each arbitrator if a hearing session other than a prehearing conference is postponed within 10 days before a scheduled hearing session pursuant to Rules 13601(a)(2) and (b)(2); and (5) $100 to each arbitrator scheduled to attend a prehearing conference that is cancelled within three business days of the prehearing conference by agreement of the parties or is requested by one or more parties within three business days of the prehearing conference and granted, pursuant to Rules 13500(d) and 13501(d).
        (5) $100 to each arbitrator scheduled to attend a prehearing conference that is cancelled within three business days of the prehearing conference by agreement of the parties or is requested by one or more parties within three business days of the prehearing conference and granted, pursuant to Rules 13500(d) and 13501(d).
        (b) – (e) No change.
        * * * * *

        13500. Initial Prehearing Conference

        (a) – (b) No change.
        (b) At the Initial Prehearing Conference, the panel will set discovery, briefing, and motions deadlines, schedule subsequent hearing sessions, and address other preliminary matters. The parties may agree to forgo the Initial Prehearing Conference only if they jointly provide the Director with the following information, in writing, with additional copies for each arbitrator, before the Initial Prehearing Conference is scheduled to be held:
        [•  ] (1) A statement that the parties accept the panel;
        [•  ] (2) Whether any other prehearing conferences will be held, and if so, for each prehearing conference, a minimum of four mutually agreeable dates and times, and whether the chairperson or the full panel will preside;
        [•  ] (3) A minimum of four sets of mutually agreeable hearing dates;
        [•  ] (4) A discovery schedule;
        [•  ] (5) A list of all anticipated motions, with filing and response due dates; and
        [•  ] (6) A determination regarding whether briefs will be submitted, and, if so, the due date for the briefs and any reply briefs.
        (c) If a cancellation request is agreed to by the parties or requested by one or more parties within three business days before a scheduled prehearing conference and granted, the party or parties shall be charged a fee of $100 per arbitrator scheduled to attend the prehearing conference. If more than one party requests the cancellation, the arbitrator(s) may allocate the $100 per-arbitrator fee between or among the requesting parties. If one party requests the cancellation, the arbitrator(s) shall allocate the fee to that party; provided, however, the arbitrator(s) may allocate all or a portion of the $100 per-arbitrator fee to the non-requesting party or parties if the arbitrator(s) determine that the nonrequesting party or parties caused or contributed to the need for the cancellation. In the event that an extraordinary circumstance prevents a party or parties from making a timely cancellation request, the arbitrator(s) may use their discretion to waive the fee, provided a written explanation of such circumstance is received.

        13501. Other Prehearing Conferences

        (a) No change.
        (b) At a party's request, or at the discretion of the panel, the panel may schedule one or more additional prehearing conferences regarding any outstanding preliminary matters, including:
        [•  ] (1) Discovery disputes;
        [•  ] (2) Motions;
        [•  ] (3) Witness lists and subpoenas;
        [•  ] (4) Stipulations of fact;
        [•  ] (5) Unresolved scheduling issues;
        [•  ] (6) Contested issues on which the parties will submit briefs; and
        [•  ] (7) Any other matter that will simplify or expedite the arbitration.
        (c) No change.
        (d) If a cancellation request is agreed to by the parties or requested by one or more parties within three business days before a scheduled prehearing conference and granted, the party or parties shall be charged a fee of $100 per arbitrator scheduled to attend the prehearing conference. If more than one party requests the cancellation, the arbitrator(s) may allocate the $100 per-arbitrator fee between or among the requesting parties. If one party requests the cancellation, the arbitrator(s) shall allocate the fee to that party; provided, however, the arbitrator(s) may allocate all or a portion of the $100 per-arbitrator fee to the non-requesting party or parties if the arbitrator(s) determine that the nonrequesting party or parties caused or contributed to the need for the cancellation. In the event that an extraordinary circumstance prevents a party or parties from making a timely cancellation request, the arbitrator(s) may use their discretion to waive the fee, provided a written explanation of such circumstance is received.

      • 18-32 FINRA Reminds Firms of Their Obligations Regarding Transactions in OTC Equity Securities Quoted Pursuant to a Submitted Form 211

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        Transactions in OTC Equity Securities

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

        FINRA Rule 6432
        Section 4 of the Securities Act
        Section 5 of the Securities Act
        Securities Exchange Act Rule 15c2-11 ("SEA Rule 15c2-11")
        Suggested Routing

        Compliance
        Legal
        Registered Representatives
        Trading
        Training
        Key Topics

        Form 211
        OTC Equity Securities
        Quoting and Trading
        Unregistered Securities

        Summary

        In consultation with SEC staff, FINRA is reminding members of legal obligations that apply when initiating a quote in an OTC security in addition to filing a Form 211.

        Questions regarding this Notice should be directed to:

        •   Yvonne Huber, Vice President, Market Regulation (MR), at (240) 386-5034 or by email at yvonne.huber@finra.org;
        •   Sewall Lee, Director, MR, at (240) 386-6054 or by email at sewall.lee@finra.org; or
        •   for legal and interpretive questions, Racquel Russell, Associate General Counsel, Office of General Counsel, at (202) 728-8363 or by email at racquel.russell@finra.org; or Cara Bain, Counsel, OGC, at (202) 728-8852 or at cara.bain@finra.org.

        Background and Discussion

        SEA Rule 15c2-11 is intended to deter broker-dealers from initiating or resuming quotations for OTC securities that may facilitate a fraudulent or manipulative scheme.1 The rule generally prohibits a broker-dealer from publishing (or submitting for publication) a quotation in an OTC security in a quotation medium unless it has obtained and reviewed current information about the issuer. Among other things, a broker-dealer must have a reasonable basis for believing that such information, when considered along with any supplemental information, is accurate and is from a reliable source.

        FINRA Rule 6432 provides that a firm must file a Form 211 with FINRA to demonstrate compliance with SEA Rule 15c2-11. Among other things, the Form 211 requires that members provide information on the subject security, the issuer, the circumstances surrounding the member's quotation and current information as set forth in SEA Rule 15c2-11(a), such as the issuer's prospectus, annual report or similar information, as applicable. FINRA conducts a review of the Form 211 and accompanying information and notifies the firm whether it is permitted to initiate or resume quotations in the subject security. The firm is not permitted to initiate or resume quotations without such notification (unless the member may rely upon an exception to, exemption or other relief from SEA Rule 15c2-11 and FINRA Rule 6432 to quote the security).2

        FINRA is reminding members that filing a Form 211 is not a substitute for a firm's responsibility to fully discharge its obligations under other applicable rules or regulations, including complying with the provisions of Section 5 of the Securities Act of 1933 ("Section 5")3 or determining whether the security, by its terms, limits trading in the U.S.4 The submission of a Form 211 relates solely to the firm's obligation to comply with FINRA Rule 6432 and SEA Rule 15c2-11 when quoting a security. Thus, for example, the fact that a firm is permitted to publish a quotation in a security pursuant to a submitted and processed Form 211, or may rely on an exception to Rule 15c2-11 when publishing a quotation, would have no bearing on the application of Section 5, which generally prohibits the offer or sale of securities in interstate commerce without an effective registration statement, unless an exemption is available.5 In this regard, in evaluating the application of Section 5 or a potential exemption thereto, such as Section 4(a)(4) of the Securities Act,6 the SEC has stated that firms cannot act as a mere order taker, and must make "whatever inquiries are necessary under the circumstances to determine that the transaction is a normal 'brokers' transaction' and not part of an unlawful distribution."7

        Multiple considerations can come to bear on whether a particular transaction is permissible under all applicable regulatory requirements for the parties involved in the activity, and each firm is responsible for complying with the regulatory obligations applicable to its activities, despite being permitted to quote a security pursuant to a Form 211 it submitted or pursuant to an exception from Rule 15c2-11. Firms serve an "important gatekeeping function" in the securities markets and have a responsibility to ensure that they do not become involved in an unregistered transaction in securities if the requirements of the Securities Act of 1933 are not being followed.8

        In consultation with SEC staff, FINRA reminds members that they should check whether securities have been the subject of a suspension or revocation prior to seeking to initiate or resume quotations in such securities. Members also are reminded that, to satisfy the requirements of Rule 15c2-11 to resume quotations after a trading suspension, members will need to obtain information that they reasonably believe resolves the information issues that resulted in the trading suspension. For instance, before seeking to resume quoting in previously suspended products, a member's Rule 15c2-11 analysis should, at minimum, address the issues raised in the suspension order, including the member's reasonable basis for a conclusion that these instruments appropriately can be traded in the U.S. in light of the suspension.9


        1. See Securities Exchange Act Release No. 41110 (February 25, 1999), 64 FR 11124, 11126 (March 8, 1999); see also Securities Exchange Act Release No. 29094 (April 17, 1991), 56 FR 19148 (April 25, 1991).

        2. See 17 CFR 240.15c2-11(f)(1), (2), (3) and (5) and 15c2-11(h); and FINRA Rule 6432(a).

        3. See 15 U.S.C. § 77e.

        4. For example, foreign ETFs, including Undertakings for Collective Investments in Transferable Securities (UCITS), generally are not permitted to publicly offer their shares in the U.S. See Section 7(d) of the Investment Company Act of 1940.

        5. See 15 U.S.C. § 77e. In addition, Section 5(a) of the Securities Act generally prohibits any person, including broker-dealers, from using interstate means to sell, either directly or indirectly, any security unless a registration statement is in effect or an exemption from the registration requirements of Section 5 applies. Section 5(c) of the Securities Act generally prohibits any person, including broker-dealers, from using interstate means to offer to sell or offer to buy, either directly or indirectly, any security unless a registration statement has been filed or an exemption from the registration requirements of Section 5 applies.

        The SEC has stated that broker-dealers "have a responsibility to be aware of the requirements necessary to establish an exemption from the registration requirements of the Securities Act and should be reasonably certain such an exemption is available." See Responses to Frequently Asked Questions About a BrokerDealer's Duties When Relying on the Securities Act Section 4(a)(4) Exemption to Execute Customer Orders, SEC's Division of Trading and Markets (Oct. 9, 2014) ("SEC Section (4)(a)(4) FAQs"). See also In the Matter of World Trade Financial Corp., Exchange Act Release No. 66114, 13 (Jan. 6, 2012) (quoting Stone Summers & Co., Exchange Act Release No. 9839, 3 (Nov. 3, 1972)) ("World Trade Financial"). The SEC stated in World Trade Financial that "the responsibility to be aware of the requirements necessary to establish an exemption from the registration requirements of the Securities Act" applies to both the broker and the registered representative executing the transactions.

        6. See 15 U.S.C. § 77d. Section 4 of the Securities Act ("Section 4") provides enumerated exemptions from the registration requirements of Section 5 for offers and sales of securities. For example, Section 4(a)(4) provides an exemption for a broker-dealer with respect to brokers' transactions executed upon customers' orders on any exchange or in the over-the-counter market, but not the solicitation of such orders. Other exemptions that may be available include those contained in Section 4(a)(1), Section 4(a)(2), and SEC Rule 144.

        7. See In the Matter of Midas Securities, LLC and Jay S. Lee, Exchange Act Release No. 66200 (Jan. 20, 2012); see also In the Matter of Merrill Lynch, Pierce, Fenner & Smith Incorporated, Exchange Act Release No. 82826 (March 8, 2018); SEC Section (4)(a)(4) FAQs.

        8. See e.g., U.S. Securities and Exchange Commission, SEC Charges Current and Former E*TRADE Subsidiaries With Improperly Selling Penny Stocks Through Unregistered Offerings, Press Release No. 2014-225 (Oct. 9, 2014). See also U.S. Securities and Exchange Commission, SEC Staff Issue Risk Alert and FAQs on Customer Sales of Securities, Press Release No. 2014-226 (Oct. 9, 2014).

        9. See e.g., Securities Exchange Act Release No. 41110, 64 FR 11124 (March 8, 1999) (File No. S7-5-99) at 11149.

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

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        Third-Party Recordkeeping

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

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

        Compliance
        Finance
        Legal
        Operations
        Regulatory Reporting
        Senior Management
        Key Topics

        Recordkeeping
        Third-Party Services

        Summary

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

        Questions concerning this Notice may be directed to:

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

        Background & Discussion

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

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

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

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


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

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

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

        4. See note 3.

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

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        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

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

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

        Extension of Time Requests

        Effective Date:

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

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

        Summary

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

        Questions concerning this Notice may be directed to:

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

        Background & Discussion

        REX System Update

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

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

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

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

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

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

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

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

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


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

        Appendix A

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

        Appendix B

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

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

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        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

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

        Compliance
        Legal
        Operations
        Senior Management
        Systems
        Trading
        Key Topics

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

        Summary

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

        Questions regarding this Notice should be directed to:

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

        Background & Discussion

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

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

        Trade Reporting Requirements Applicable to Riskless Principal and Net Transactions

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

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

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

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

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

        Other FINRA and SEC Rules Applicable to Net Transactions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

        Conclusion

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


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

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

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

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

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

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

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

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

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

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

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

        11. Id.

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

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

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

        15. See Rule 2121.01.

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

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

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

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

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

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

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

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        Regulatory Notice
        Notice Type

        Request for Comment
        Referenced Rules & Notices

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

        Compliance
        Legal
        Operations
        Senior Management
        Systems
        Trading
        Key Topics

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

        Summary

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

        The proposed rule text is set forth in Attachment A.

        Questions concerning this Notice should be directed to:

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

        Action Requested

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

        Comments must be submitted through one of the following methods:
        •   Emailing comments to pubcom@finra.org; or
        •   Mailing comments in hard copy to:

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

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

        Important Notes: The only comments that FINRA will consider are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the FINRA website. Generally, FINRA will post comments as they are received.1

        Before becoming effective, the proposed rule change must be filed with the Securities and Exchange Commission (SEC) pursuant to Section 19(b) of the SEA.2

        Background & Discussion

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

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

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

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

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

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

        Proposal to Expand Published OTC Equity Trading Volume Data

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

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

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

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

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

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

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

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

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

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

        Economic Impacts

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

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

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

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

        Request for Comment

        Current Proposals

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

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

        Future enhancements

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

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

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

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

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

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

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

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


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

        2. See Section 19 of the Securities Exchange Act of 1934 (SEA) and rules thereunder. After a proposed rule change is filed with the SEC, the proposed rule change generally is published for public comment in the Federal Register. Certain limited types of proposed rule changes, however, take effect upon filing with the SEC. See SEA Section 19(b)(3) and SEA Rule 19b-4.

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

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

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

        6. See Rules 6160, 6170 and 6480.

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

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

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

        ATTACHMENT A

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

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

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

        (a) through (b) No Change.

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

        .01 through .02 No Change.

        * * * * *

        6600. OTC REPORTING FACILITY

        6610. General

        (a) No Change.

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

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

        View PDF

        Regulatory Notice
        Notice Type

        Rule Amendment
        Referenced Rules & Notices

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

        Compliance
        Finance
        Operations
        Registered Representatives
        Registration
        Senior Management
        Training
        Key Topics

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

        Summary

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

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

        Questions regarding this Notice should be directed to:

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

        Background & Discussion

        SIE Examination and FINRA Representative-Level Examinations

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

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

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

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

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

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

        Series 52 Examination

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

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

        Additional Information

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


        Attachment A

        Below is the rule text. New language is underlined; deletions are in brackets.

        * * * * *

        By-Laws of the Corporation

        * * * * *

        Schedule A to the By-Laws of the Corporation

        Assessments and fees pursuant to the provisions of Article VI of the By-Laws of the Corporation shall be determined on the following basis.

        Section 1 through Section 3 No Change.

        Section 4 — Fees

        (a) through (b) No Change.

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

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

        (1) through (4) No Change.

        (d) through (i) No Change.

        IM-Section 4(b)(1) and (e) Exemption from Certain Registration and Membership Application Fees for Certain NYSE and NYSE Alternext US LLC Member Organizations

        No Change.

        Section 5 through Section 15 No Change.

        * * * * *

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

        View PDF

        Continuing Education Program

        Regulatory Notice
        Notice Type

        Request for Comment
        Key Topics

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

        Compliance
        Operations
        Registered Persons
        Registration
        Senior Management
        Training

        Summary

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

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

        Questions regarding this Notice should be directed to:

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

        Action Requested

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

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

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

        Important Note: All comments received in response to this Notice and the attachment published by the CE Council will be made available to the public on the FINRA website. In general, FINRA will post comments as they are received.1

        Before becoming effective, any program changes that result in rule changes must be authorized for filing with the Securities and Exchange Commission (SEC), and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2


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

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



        Enhancements Under Consideration for the Securities Industry Continuing Education Program

        Securities Industry/Regulatory Council on Continuing Education

        September 6, 2018

        Background

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

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

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

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

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

        Regulatory Element

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

        FINRA administers the Regulatory Element through a Web-based delivery platform using a fixed content format. The Web-based delivery method provides participants with the flexibility to complete the Regulatory Element at a location of their choosing, including their private residence, at any time during their 120-day completion window. Additionally, participants do not need to complete the Regulatory Element in one sitting as previously required in testing centers.

        The Regulatory Element currently includes the following four programs:

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

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

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

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

        Firm Element

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

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

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

        CE Program Enhancements Under Consideration

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

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

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

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

        Regulatory Element

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

        Relevance

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

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

        Timeliness

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

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

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

        Regulatory Element Systems

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

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

        Synergy with Firm Element

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

        Firm Element

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

        CE Council Guidance and Resources

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

        Typical Characteristics of Firm Element Programs

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

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

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

        Other Training Requirements and Credentialing Programs

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

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

        Access to Firm Element Content

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

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

        Maintaining Qualification Status Post Termination

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

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

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

        Program Considerations

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

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

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

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

        Eligibility Requirements and Program Duration

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

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

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

        Two-Year Termination Rule

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

        Questions

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

        Regulatory Element

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

        Firm Element

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

        Maintaining Qualification Status Post Termination

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

        General Questions

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

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

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        ATS Supervision Obligations

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

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

        Compliance
        Legal
        Operations
        Systems
        Trading
        Training
        Key Topics

        Alternative Trading Systems
        Supervision
        Trading Practices

        Summary

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

        Questions regarding this Notice should be directed to:

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

        Background and Discussion

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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        Security Futures

        Regulatory Notice
        Notice Type

        Guidance
        Referenced Rules & Notices

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

        Compliance
        Institutional
        Legal
        Senior Management
        Trading
        Key Topics

        Security Futures
        Security Futures Risk Disclosure Statement

        Summary

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

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

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

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

        Background & Discussion

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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


        Attachment A

        Security Futures Risk Disclosure Statement

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

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

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

        Risk Disclosure Statement For Security Futures Contracts

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

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

        SECTION 1

        Risks Of Security Futures

        1.1. Risks of Security Futures Transactions

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

        1.2. General Risks

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

        SECTION 2

        Description of a Security Futures Contract

        2.1. What is a Security Futures Contract?

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

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

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

        Examples:

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

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

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

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

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

        2.2. Purposes of Security Futures

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

        Speculation

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

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

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

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

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

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

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

        Hedging

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

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

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

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

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

        Risk Management

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

        2.3. Where Security Futures Trade

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

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

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

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

        2.4. How Security Futures Differ from the Underlying Security

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

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

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

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

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

        2.5. Comparison to Options

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

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

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

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

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

        Example:

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

        2.6. Components of a Security Futures Contract

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

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

        2.7. Trading Halts

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

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

        2.8. Trading Hours

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

        SECTION 3

        Clearing Organizations and Mark-to-Market Requirements

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

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

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

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

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

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

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

        (1 contract representing 100 shares)

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

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

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

        SECTION 4

        Margin And Leverage

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

        SECTION 5

        Settlement

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

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

        5.1. Cash Settlement

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

        5.2. Settlement by Physical Delivery

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

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

        SECTION 6

        Customer Account Protections

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

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

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

        6.1. Protections for Securities Accounts

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

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

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

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

        6.2. Protections for Futures Accounts

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

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

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

        SECTION 7

        Special Risks For Day Traders

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

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

        SECTION 8

        Other

        8.1. Corporate Events

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

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

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

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

        8.2. Position Limits and Large Trader Reporting

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

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

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

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

        8.3. Transactions on Foreign Exchanges

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

        8.4. Tax Consequences

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

        SECTION 9

        Glossary Of Terms

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

        Arbitrage

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

        Broad-based security index

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

        Cash settlement

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

        Clearing broker

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

        Clearing organization

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

        Contract

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

        Contract month

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

        Day trading strategy

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

        EDGAR

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

        Futures contract

        A futures contract is

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

        Hedging

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

        Illiquid market

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

        Liquidation

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

        Liquid market

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

        Long

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

        Margin

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

        Mark-to-market

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

        Narrow-based security index

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

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

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

        Nominal value

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

        Offsetting

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

        Open interest

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

        Open position

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

        Performance bond

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

        Physical delivery

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

        Position

        A person's net long or short open contracts.

        Regulated exchange

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

        Security futures contract

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

        Settlement price

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

        Short

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

        Speculating

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

        Spread

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

        Stop limit order

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

        Stop loss order

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

        Tick

        The smallest price change allowed in a particular contract.

        Trader

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

        Underlying security

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

        Volume

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


        Attachment B

        2018 Supplement to the 2002 Security Futures Risk Disclosure Statement

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

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

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

        * * * * *

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

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

        * * * * *

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

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

        * * * * *

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

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

        * * * * *

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

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

        * * * * *

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

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

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

        View PDF

        Membership Application Proceedings

        Regulatory Notice
        Notice Type

        Request for Comment
        Referenced Rules & Notices

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

        Compliance
        Legal
        Operations
        Senior Management
        Systems
        Key Topics

        Continuing Membership
        Membership Rules
        New Membership

        Comment Period Expires: October 5, 2018

        Summary

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

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

        Questions regarding this Notice should be directed to:

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

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

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

        Action Requested

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

        Comments must be submitted through one of the following methods:

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

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

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

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

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

        Background & Discussion

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

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

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

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

        Structure of the MAP Rules

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

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

        General Provisions (Proposed FINRA Rule 1110 Series)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

        New Membership (Proposed FINRA Rule 1120 Series)

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

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

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

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

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

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

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

        Continuing Membership (Proposed FINRA Rule 1130 Series)

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

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

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

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

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

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

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

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

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

        In the case of a merger, acquisition or transfer in which a NYSE member organization is involved, NASD Rule 1017(a) currently excludes such member organization from the requirement to file an application for approval of the specified event. FINRA is proposing to eliminate this exclusion on the basis that NYSE Regulation, Inc. no longer conducts its own review of such transactions. The proposed rule would require a