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  • 2010

    • 10-62 SEC Approval and Effective Date for New Consolidated FINRA Rule; Effective Date: June 17, 2011

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      SEC Approves New Consolidated FINRA Rule

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      Rule Approval
      Referenced Rules & Notices

      FINRA Rule 2232
      Incorporated NYSE Rule 409(f)
      Information Notice 03/12/08
      Information Notice 10/06/08
      NASD Rule 2230
      NASD IM-2110-6
      Regulatory Notice 08-57
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Customer Confirmations
      Effective Dates of Consolidated Rule
      FINRA Manual
      Rulebook Consolidation

      Executive Summary

      Following the consolidation of NASD and the member regulation, enforcement and arbitration functions of NYSE Regulation into FINRA, FINRA established a process to develop a new consolidated rulebook (Consolidated FINRA Rulebook), which FINRA has discussed in previous Information Notices.1 FINRA is proposing new consolidated rules in phases for approval by the Securities and Exchange Commission (SEC) as part of the Consolidated FINRA Rulebook.2 In October and November, the SEC approved four new consolidated FINRA Rules.3 This Regulatory Notice specifically addresses the approval and effective date of new FINRA Rule 2232 (Customer Confirmations).4

      The text of new FINRA Rule 2232 is available in the online FINRA Manual at www.finra.org/finramanual.5

      Questions regarding this Notice should be directed to Adam H. Arkel, Assistant General Counsel, Office of General Counsel, at (202) 728-6961.

      Background & Discussion

      On October 21, 2010, the SEC approved FINRA's proposed rule change to adopt FINRA Rule 2232 (Customer Confirmations) in the Consolidated FINRA Rulebook and delete NASD Rule 2230, NASD IM-2110-6 and Incorporated NYSE Rule 409(f). New FINRA Rule 2232 streamlines and combines basic customer confirmation requirements in the NASD and Incorporated NYSE Rules. Specifically:

      •   FINRA Rule 2232(a) provides that a member must, at or before the completion of any transaction in any security effected for or with an account of a customer, give or send to such customer written notification ("confirmation") in conformity with the requirements of SEA Rule 10b-10.
      •   FINRA Rule 2232(b) provides that a confirmation given or sent pursuant to the rule must further disclose:
      (1) with respect to any transaction in any NMS stock, as defined in Rule 600 of SEC Regulation NMS, or any security subject to the reporting requirements of the FINRA Rule 6600 Series, other than direct participation programs as defined in FINRA Rule 6420, the settlement date of the transaction; and
      (2) with respect to any transaction in a callable equity security, that: (A) the security is a callable equity security; and (B) a customer may contact the member for more information concerning the security.

      Rule Conversion Charts

      As discussed in additional detail in Information Notice 10/06/08 and Regulatory Notice 08-57, FINRA has posted three Rule Conversion Charts on its website to help firms become familiar with the new rules, and show how the new rules relate to the NASD and/or Incorporated NYSE Rules in the Transitional Rulebook that they will replace.

      Firms should be aware that the charts are intended as a reference aid only. FINRA reminds firms that the charts do not in any way serve as a substitute for diligent review of the relevant new rule language. The Rule Conversion Charts are located at www.finra.org/ruleconversionchart.


      1 See Information Notice 10/06/08 (Rulebook Consolidation Process: Effective Dates of New Consolidated Rules; Introduction of Rule Conversion Chart); see also Information Notice 03/12/08 (Rulebook Consolidation Process).

      2 The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The new FINRA Rules apply to all member firms, unless such rules have a more limited application by their terms. As the Consolidated FINRA Rulebook expands with the SEC's approval and with the new FINRA Rules taking effect, the rules in the Transitional Rulebook that address the same subject matter of regulation will be eliminated. When the Consolidated FINRA Rulebook is completed, the Transitional Rulebook will have been eliminated in its entirety.

      3 In October and November 2010, the SEC approved three FINRA proposed rule changes to adopt four new rules in the Consolidated FINRA Rulebook. See Securities Exchange Act Release No. 63150 (October 21, 2010), 75 FR 66173 (October 27, 2010) (SR-FINRA-2009-058); Securities Exchange Act Release No. 63260 (November 5, 2010), 75 FR 69508 (November 12, 2010) (SR-FINRA-2010-034); Securities Exchange Act Release No. 63325 (November 17, 2010), 75 FR 71479 (November 23, 2010) (SR-FINRA-2010-039).

      4 See Securities Exchange Act Release No. 63150 (October 21, 2010), 75 FR 66173 (October 27, 2010) (SR-FINRA-2009-058); see also SR-FINRA-2010-066. FINRA will issue separate Regulatory Notices announcing the effective dates of the approved rules set forth in SR-FINRA-2010-034 and SR-FINRA-2010-039. See supra note 3.

      5 FINRA updates the rule text on its online Manual within two business days of SEC approval of changes to the rule text.

    • 10-61 SEC Approves New FINRA Rule 4160 Relating to the Verification of Assets at a Non-Member Financial Institution; Effective Date: February 1, 2011

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      Independent Verification of Assets

      Regulatory Notice
      Notice Type

      New Rule
      Referenced Rules & Notices

      SEA Rule 15c3-1
      SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Finance
      Legal
      Operations
      Senior Management
      Key Topics

      Asset Transfers
      Asset Verification
      Custody
      Record Ownership

      Executive Summary

      Effective February 1, 2011, new FINRA Rule 4160 (Verification of Assets) prohibits a member, when notified by FINRA, from continuing to custody or retain record ownership of assets at a non-member financial institution, which, upon FINRA staff's request, fails promptly to provide FINRA with written verification of assets maintained by the member at such financial institution.1 The text of FINRA Rule 4160 is set forth in Attachment A of this Notice.

      Questions concerning this Notice should be directed to:

      •   Anand Ramtahal, Senior Vice President, Risk Oversight & Operational Regulation, at (646) 315-8565; or
      •   Matthew E. Vitek, Counsel, Office of General Counsel, at (202) 728-8156.

      Background & Discussion

      FINRA has adopted a rule to strengthen its ability to independently verify assets maintained by a member at a non-member financial institution. FINRA Rule 4160 prohibits a member, when notified by FINRA, from continuing to custody or retain record ownership of assets, whether such assets are proprietary or customer assets, at a non-member financial institution, which, upon FINRA's staff's request, fails promptly to provide FINRA with written verification of assets maintained by the member at such financial institution. At this time, FINRA is not requiring members to enter into written contracts with non-member financial institutions maintaining their proprietary or customer assets that would obligate the institutions to comply with FINRA staff's requests for verification; however, FINRA strongly encourages members to enter into such contracts. Irrespective of whether such a contract exists, FINRA Rule 4160 precludes a member, when notified by FINRA, from continuing to maintain assets at the financial institution and requires the member to transfer the assets to another financial institution.

      FINRA Rule 4160(b) provides two exemptions from the rule. The rule does not apply to:

      •   proprietary assets of members that are treated as non-allowable assets under SEA Rule 15c3-1; or
      •   instances where FINRA determines that there is no independent custody or record ownership of the assets.

      Supplementary Material .01 (Asset Transfers) to the rule sets forth that in the event a member is required to transfer its assets pursuant to the rule, the member shall effect such transfer in a reasonable period of time. Supplementary Material .02 (Member Obligations Under SEA Rule 15c3-3) to the rule clarifies that nothing in the rule shall be construed as altering in any manner a member's obligations under SEA Rule 15c3-3.


      1 See Exchange Act Release No. 63044 (October 5, 2010), 75 FR 62911 (October 13, 2010) (Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1; File No. SR-FINRA-2010-042). See also Exchange Act Release No. 63383 (November 29, 2010), 75 FR 75529 (December 3, 2010) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2010-062 to Extend the Implementation Period for SR-FINRA-2010-042).


      ATTACHMENT A

      The following is the text of new Rule 4160.

      * * * * *

      4000. FINANCIAL AND OPERATIONAL RULES

      4100. FINANCIAL CONDITION

      * * * * * * * * * *

      4160. Verification of Assets

      (a) A member, when notified by FINRA, may not continue to custody or retain record ownership of assets, whether such assets are proprietary or customer assets, at a financial institution that is not a member of FINRA, which, upon FINRA staff's request, fails promptly to provide FINRA with written verification of assets maintained by the member at such financial institution.
      (b)The Rule shall not apply:
      (1) to proprietary assets of members that are treated as non-allowable assets under SEA Rule 15c3-1; or
      (2) in instances where FINRA determines that there is no independent custody or record ownership of the assets.

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

      .01 Asset Transfers. Any member required to transfer its proprietary and/or customer assets pursuant to this Rule shall effect such transfer within a reasonable period of time.
      .02 Member Obligations Under SEA Rule 15c3-3. Nothing in this Rule shall be construed as altering in any manner a member's obligations under SEA Rule 15c3-3.

    • 10-60 SEC Approves New FINRA Rule to Address Abuses in the Allocation and Distribution of New Issues; Effective Date: May 27, 2011

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      Approval of New Issue Rule

      Regulatory Notice
      Notice Type

      New Rule
      Referenced Rules

      FINRA Rule 5130
      FINRA Rule 5131
      SEC Regulation FD
      SEC Regulation M
      Suggested Routing

      Compliance
      Corporate Financing
      Legal
      Operations
      Senior Management
      Syndicate
      Underwriting
      Key Topics

      Allocations
      Conflicts of Interest
      Flipping
      Initial Public Offerings
      Investment Banking
      Issuer-Directed Securities
      New Issues
      Public Offerings
      Quid Pro Quo
      Returned Shares
      Spinning

      Executive Summary

      New FINRA Rule 5131 (New Issue Allocations and Distributions), which further and more specifically prohibits certain abuses in the allocation and distribution of new issues1 goes into effect on May 27, 2011. Among other things, the rule prohibits quid pro quo allocations and "spinning," and addresses the conduct of member firms and associated persons in the areas of book-building, new issue pricing, penalty bids, trading and waivers of lock-up agreements.

      The text of the amendments can be found in the online FINRA Manual at www.finra.org/finramanual.

      Questions regarding this Notice should be directed to:

      •   Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104; or
      •   Racquel L. Russell, Assistant General Counsel, OGC, at (202) 728-8363.

      Background and Discussion

      New FINRA Rule 5131 is intended to sustain public confidence in the initial public offering (IPO) process by establishing specific and detailed regulatory requirements with respect to the allocation, pricing and trading of new issues. Rule 5131 implements many of the recommendations made by the NYSE/NASD IPO Advisory Committee for improving the integrity of the IPO process.2

      Rule 5131 incorporates the definition of "new issue" from Rule 5130 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings). FINRA believes that this definition, with its enumerated exceptions, addresses the types of IPOs for which the protections of the rule are most appropriate. The term "new issue" refers to "an initial public offering of an equity security as defined in Section 3(a)(11) of the Exchange Act, made pursuant to a registration statement or offering circular."3

      Prohibition on Abusive Allocation Arrangements

      Paragraph (a) of Rule 5131 (Quid Pro Quo Allocations) prohibits a member firm from using an allocation of a new issue as a means of obtaining a "kick back" from the recipient in the form of excessive compensation for other services offered by the member. Specifically, the new provision provides that no member or person associated with a member may offer or threaten to withhold shares it allocates of a new issue as consideration or inducement for the receipt of compensation that is excessive in relation to the services provided by the member.

      This provision prohibits so-called quid pro quo activity, not only with respect to trading services, but any service offered by the member.4 An assessment of whether compensation is excessive will be based upon all relevant facts and circumstances, including, where applicable, the level of risk and effort involved in the transaction and the rates generally charged for such services.5

      Spinning

      Paragraph (b) of Rule 5131 (Spinning) prohibits allocations of new issues to executive officers and directors of current, and certain former or prospective, investment banking clients. Because such persons are often in a position to hire members on behalf of the companies they serve, allocating new issues to such persons creates the appearance of impropriety and has the potential to divide the loyalty of the agents of the company (i.e., the executive officers and directors) from the principal (i.e., the company) on whose behalf they must act.

      The spinning prohibition requires that members establish, maintain and enforce policies and procedures reasonably designed to ensure that investment banking personnel have no involvement or influence, directly or indirectly, in the new issue allocation decisions of the member.

      The spinning prohibition also provides, as a prophylactic measure, that no member or person associated with a member may allocate shares of a new issue to any account in which an executive officer or director of a public company or a "covered non-public company,"6 or a person materially supported by such executive officer or director, has a beneficial interest:

      •   if the company is currently an investment banking services client of the member or the member has received compensation from the company for investment banking services in the past 12 months;
      •   if the person responsible for making the allocation decision knows or has reason to know that the member intends to provide, or expects to be retained by the company for, investment banking services within the next three months;7 or
      •   on the express or implied condition that such executive officer or director, on behalf of the company, will retain the member for the performance of future investment banking services.

      To facilitate compliance with the spinning prohibition, Supplementary Material .02 permits members to rely on written representations obtained within the prior 12 months from the beneficial owner(s) of an account (or a person authorized to represent the beneficial owner(s)) as to whether such beneficial owner(s) is an executive officer or director (or person materially supported by an executive officer or director) and if so, the company or companies on whose behalf such executive officer or director serves. The initial representation must be an affirmative representation, but subsequently may be updated annually through the use of negative consent letters.8

      Supplementary Material .01 clarifies that the spinning prohibition does not apply to allocations directed in writing by the issuer, its affiliates or selling shareholders—so long as the member has no involvement or influence, directly or indirectly, in the allocation decisions of the issuer, its affiliates or selling shareholders with respect to such issuer-directed allocations.

      Finally, the spinning prohibition excepts allocations of new issues to certain types of accounts—generally consistent with the types of accounts excepted from the restrictions imposed by Rule 5130.9 The one area of divergence between the exceptions in Rules 5130 and 5131 pertains to accounts in which multiple persons have a beneficial interest. Paragraph (b)(3) permits allocations of new issues to an account in which the collective beneficial interests of executive officers and directors of the company and persons materially supported by such executive officers and directors in the aggregate do not exceed 25 percent of such account.10

      Flipping

      The term "flipping" refers to the practice of selling new issues into the secondary market at a profit within 30 days following the offering date. Because these sales create downward pressure on the secondary market trading price, underwriters and selling group members may seek to discourage such sales. Under most syndicate selling agreements, a managing underwriter is permitted to impose a "penalty bid" on syndicate members to reclaim the selling concession for allocations that were flipped.

      Separately, and independent of any syndicate penalty bid, some firms have sought to recoup selling concessions from particular brokers when their customers—typically retail customers—flip a new issue. The incentives created by linking a broker's compensation to whether or not a customer holds onto a particular security position has the potential of favoring institutional investors at the expense of retail customers.

      Accordingly, paragraph (c) of Rule 5131 prohibits any member or person associated with a member from directly or indirectly recouping, or attempting to recoup, any portion of a commission or credit paid or awarded to an associated person for selling shares of a new issue that are subsequently flipped by a customer, unless the managing underwriter has assessed a penalty bid on the entire syndicate.11 FINRA believes that it is only appropriate for a firm to recoup a particular broker's compensation for selling a new issue in connection with a customer's decision to flip a security when the firm itself is required to forfeit its compensation to the managing underwriter(s).

      Reports of Indications of Interest and Final Allocations

      Paragraph (d)(1) of Rule 5131 seeks to provide issuers and their pricing committees with greater transparency into the book-building process by mandating certain disclosures about the demand for the issuer's securities. In particular, paragraph (d)(1) requires that, in connection with a new issue, the book-running lead manager provide the issuer's pricing committee (or, if the issuer has no pricing committee, its board of directors) with:

      (a) a regular report of indications of interest, including the names of interested institutional investors and the number of shares indicated by each, as reflected in the book-running lead manager's book of potential institutional orders, and a report of aggregate demand from retail investors; and
      (b) after the settlement date of the new issue, a report of the final allocation of shares to institutional investors as reflected in the books and records of the book-running lead manager, including the names of purchasers and the number of shares purchased by each, and aggregate sales to retail investors.

      Lock-Up Agreements

      The existence of lock-ups or other restrictions on the transfer of the issuer's shares by officers and directors of the issuer is often an important factor for investors in an IPO. Paragraph (d)(2) helps ensure the broad and consistent application of lock-ups by requiring that any lock-up agreement or other restriction on the transfer of the issuer's shares by officers and directors of the issuer is applied consistently to include their issuer-directed shares.

      Moreover, given the importance of lock-ups for investors, FINRA believes that underwriters should not be permitted to waive certain lock-up restrictions without providing prior notice to market participants. Paragraph (d)(2) requires that any lock-up agreement applicable to the officers and directors of the issuer stipulate that, at least two business days before the release or waiver of any lock-up or other restriction on the transfer of the issuer's shares, the book-running lead manager must notify the issuer of the impending release or waiver and announce the impending release or waiver through a major news service,12 except where the release or waiver is effected solely to permit a transfer of securities that is not for consideration and where the transferee has agreed in writing to be bound by the same lock-up agreement terms in place for the transferor.13

      Supplementary Material .03 further clarifies that the requirement that the book-running lead manager announce the impending release or waiver of a lock-up or other restriction on the transfer of the issuer's shares is satisfied where the announcement is made by the book-running lead manager, another member or the issuer—so long as such announcement otherwise complies with the requirements of paragraph (d)(2).

      Agreement Among Underwriters

      Occasionally, shares in a new issue allocated to a customer will be returned to the syndicate member. If the new issue shares are trading at a premium to the IPO price, the syndicate member reallocating such shares would be able to confer an almost instantaneous and risk-free profit. To prevent this occurrence, paragraph (d)(3) requires that the agreement between the book-running lead manager and other syndicate members require, to the extent not inconsistent with SEC Regulation M, that any shares trading at a premium to the public offering price that are returned to a syndicate member after secondary market trading commences:

      •   be used to offset the existing syndicate short position; or
      •   if no syndicate short position exists, the member must either:
      •   offer returned shares at the public offering price to unfilled customers' orders pursuant to a random allocation methodology, or
      •   sell returned shares on the secondary market and donate profits from the sale to an unaffiliated charitable organization with the condition that the donation be treated as an anonymous donation to avoid any reputational benefit to the member.

      Market Orders

      New issues are inherently more volatile than securities with an established public trading history. Given the absence of an established trading market, the potential exists for a wide variance between the public offering price of a new issue and the price at which trading on the secondary market commences. As a result, investors who place market orders for an IPO may find their orders filled at prices beyond their reasonable expectations, and such transactions may further contribute to the unconstrained increase in the price of a new issue in the secondary market.

      To protect against this occurrence, paragraph (d)(4) of Rule 5131 prohibits members from accepting a market order for the purchase of shares of a new issue in the secondary market prior to the commencement of trading of such shares in the secondary market. FINRA believes that requiring investors to place limit orders prior to the commencement of trading will serve the dual purposes of protecting investors and facilitating price discovery.

      New Rule 5131 becomes effective May 27, 2011. For more information, go to www.finra.org to see rule filing SR-NASD-2003-140.


      1 See Securities Exchange Act Release No. 63010 (September 29, 2010); 75 FR 61541 (October 5, 2010) (Order Approving SR-NASD-2003-140).

      2 In 2002, the SEC requested that FINRA (then NASD) and NYSE convene a special IPO Advisory Committee to "review the IPO underwriting process, particularly price setting and allocation practices, in light of recent experience, and to recommend to the securities industry community such changes as may be necessary to address the problems that have been observed."

      3 The definition of "new issue" contains a series of exceptions. See Rule 5130(i)(9)(A)-(J).

      4 FINRA does not intend that this prohibition interfere with legitimate customer relationships. For example, this provision is not intended to prohibit a member from allocating new issue shares to a customer because the customer has separately retained the member for other services, when the customer has not paid excessive compensation in relation to those services.

      5 Trading activity that serves no economic purpose other than to generate compensation for the member (such as certain wash sales) would be considered excessive. If a wash sale has an economic purpose, such as tax planning, that factor will be considered in assessing whether the transaction has an economic purpose and, in turn, whether the trading fees for such sales are excessive.

      6 A "covered non-public company" means any non-public company with: (i) income of at least $1 million in the last fiscal year or in two of the last three fiscal years and shareholders' equity of at least $15 million; (ii) shareholders' equity of at least $30 million and a two-year operating history; or (iii) total assets and total revenue of at least $75 million in the latest fiscal year or in two of the last three fiscal years.

      7 If an executive officer or director receives an allocation and the allocating member is subsequently retained by such executive officer or director's employing firm to perform investment banking services within the three-month window, FINRA will investigate the particular information about the business relationship that was known (and by whom) at the time of the allocation, including a review of the communications between the broker-dealer and the investment banking client, and between the investment banking and syndicate departments, as well as the member's systems for logging and managing prospective and current client and transaction information.

      8 Members and associated persons are reminded that they may not rely upon any representation they believe, or have reason to believe, is inaccurate. Additionally, members are required to maintain a copy of all records and information relating to whether an account is eligible to receive an allocation of the new issue for at least three years following the firm's allocation to that account.

      9 The prohibitions of the spinning provision do not apply to allocations of shares of a new issue to any account described in paragraphs (c)(1) through (3) and (5) through (10) of Rule 5130, or to any other account in which the beneficial interests of executive officers and directors of the company and persons materially supported by such executive officers and directors in the aggregate do not exceed 25 percent of such account.

      10 Under Rule 5130(b)(4), the aggregate beneficial interests of restricted persons must not exceed 10 percent of such account.

      11 In addition to any obligation to maintain records relating to penalty bids under SEA Rule 17a-2(c)(1), a member must promptly record and maintain information regarding any penalties or disincentives assessed on its associated persons in connection with a penalty bid.

      12 Any news service used by issuers for providing public disclosure of material information pursuant to SEC Regulation FD would satisfy the rule's requirement that public disclosure be made "through a major news service." However, also as required pursuant to Regulation FD, it is important that members utilize a method (or combination of methods) of disclosure reasonably designed to provide broad, non-exclusionary distribution of the required information to the public. Therefore, in announcing the required information, members are expected to select a method that is likely to result in the actual public dissemination of the specified information. FINRA also would consider disclosure of a release or wavier in a publicly filed registration statement in connection with a secondary offering as satisfying the requirement for an announcement through a major news service.

      13 Notice and public disclosure is not necessary for the natural expiration of a lock-up already disclosed in the prospectus.

    • 10-59 SEC Approves Amendments to FINRA Rule 8210 to Require Encryption of Information Provided Via Portable Media Device; Effective Date: December 29, 2010

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      Encryption of Rule 8210 Information

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 8210
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Encryption
      Investigations

      Executive Summary

      Beginning December 29, 2010, information provided via a portable media device in response to requests under FINRA Rule 8210 must be encrypted.

      The text of FINRA Rule 8210, as amended, is set forth in Attachment A.

      Questions regarding this Notice should be directed to:

      •   Emily Gordy, Senior Vice President and Director Of Policy, Enforcement, at (202) 974-2916;
      •   Laurie Dzien, Chief Privacy Officer and Associate General Counsel, Data Privacy & Protection, Office of General Counsel (OGC), at (240) 386-6339; or
      •   Stan Macel, Assistant General Counsel, OGC, at (202) 728-8056.

      Background and Discussion

      The SEC recently approved amendments to FINRA Rule 8210 (Provision of Information and Testimony and Inspection and Copying of Books) that require information provided via a portable media device pursuant to a request under the rule be encrypted, as described in more detail below.1 These amendments take effect on December 29, 2010.

      FINRA Rule 8210 confers on FINRA staff the authority to compel a member firm, person associated with a member firm or other person over which FINRA has jurisdiction, to produce documents, provide testimony or supply written responses or electronic data in connection with an investigation, complaint, examination or adjudicatory proceeding.2 FINRA Rule 8210(c) provides that a firm's or person's failure to provide information or testimony or to permit an inspection and copying of books, records or accounts is a violation of the rule.

      Frequently, member firms and persons that respond to requests pursuant to FINRA Rule 8210 provide information in electronic format. Because of the size of the electronic files, often this information is provided in electronic format using a portable media device such as a CD-ROM, DVD or portable hard drive.3 In many instances, the response contains personal information that, if accessed by an unauthorized person, could be used inappropriately.4

      Data security issues regarding personal information have become increasingly important in recent years.5 In this regard, FINRA believes that requiring persons to encrypt information on portable media devices provided to FINRA in response to Rule 8210 requests will help ensure that personal information is protected from improper use by unauthorized third parties.

      As amended, the rule requires that when information responsive to a request pursuant to Rule 8210 is provided on a portable media device, it must be "encrypted"—i.e., the data must be encoded into a form in which meaning cannot be assigned without the use of a confidential process or key. To help ensure that encrypted information is secure, persons providing encrypted information to FINRA via a portable media device are required:

      (1) to use an encryption method that meets industry standards for strong encryption; and
      (2) to provide FINRA staff with the confidential process or key regarding the encryption in a communication separate from the encrypted information itself (e.g., a separate email, fax or letter).

      Currently, FINRA views industry standards for strong encryption to be 256-bit or higher encryption. Encryption software meeting this standard is widely available as embedded options in desktop applications and through various vendors via the Internet at no cost or minimal cost to the user.


      1 See Exchange Act Release No. 63016 (Sept. 29, 2010), 75 FR 61793 (Oct. 6, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2010-021).

      2 The rule applies to all member firms, associated persons and other persons over which FINRA has jurisdiction, including former associated persons subject to FINRA's jurisdiction as described in the FINRA By-Laws. See FINRA By-Laws, Article V, Section 4(a) (Retention of Jurisdiction).

      3 The amended rule defines "portable media device" as a storage device for electronic information, including but not limited to a flash drive, CD-ROM, DVD, portable hard drive, laptop computer, disc, diskette or any other portable device for storing and transporting electronic information.

      4 For example, a response may include a person's first and last name, or first initial and last name, in combination with that person's: (1) social security number; (2) driver's license, passport or government-issued identification number; or (3) financial account number (including, but not limited to, number of a brokerage account, debit card, credit card, checking account or savings account).

      5 For example, some jurisdictions, including Massachusetts and Nevada, have recently enacted legislation that establishes minimum standards to safeguard personal information in electronic records. See, e.g., Commonwealth of Massachusetts, 201 CMR 17.00 (Standards for the Protection of Personal Information of Residents of the Commonwealth), effective March 1, 2010; State of Nevada, NRS 603A.215 (Security Measures for Data Collector that Accepts Payment Card; Use of Encryption; Liability for Damages; Applicability), effective January 1, 2010. These laws contain potential penalties against persons and entities for failures to adequately safeguard electronic information containing personal information.


      ATTACHMENT A

      New language is underlined.

      * * * * *

      8200. INVESTIGATIONS

      8210. Provision of Information and Testimony and Inspection and Copying of Books

      (a) through (f) No Change.
      (g) Encryption of Information Provided in Electronic Form
      (1) Any member or person who, in response to a request pursuant to this Rule, provides the requested information on a portable media device must ensure that such information is encrypted.
      (2) For purposes of this Rule, a "portable media device" is a storage device for electronic information, including but not limited to a flash drive, CD-ROM, DVD, portable hard drive, laptop computer, disc, diskette, or any other portable device for storing and transporting electronic information.
      (3) For purposes of this Rule, "encrypted" means the transformation of data into a form in which meaning cannot be assigned without the use of a confidential process or key. To ensure that encrypted information is secure, a member or person providing encrypted information to FINRA staff pursuant to this Rule shall (a) use an encryption method that meets industry standards for strong encryption, and (b) provide the confidential process or key regarding the encryption to FINRA staff in a communication separate from the encrypted information itself.

    • 10-58 Broker-Dealer, Investment Adviser Firm, Agent and Investment Adviser Representative, and Branch Renewals for 2011; Payment Deadline: December 13, 2010

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      BD and IA Renewals for 2011

      Regulatory Notice
      Notice Type

      Renewals
      Referenced Rules & Notices

      NTM 02-48
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Registration
      Senior Management
      Key Topics

      IARDTM
      Registration
      Renewals
      Web CRD®

      Executive Summary

      The 2011 Renewal Program begins on November 15, 2010, when FINRA makes available the online Preliminary Renewal Statements to all firms on Web CRD/IARD.

      Firms should note the following key dates in the 2011 renewal process:

      October 25, 2010* Firms may begin submitting post-dated Form U5 and BR Closing/Withdrawal filings via Web CRD/IARD.
      November 1, 2010* Firms may begin submitting post-dated Form BDW and ADV-W filings via Web CRD/IARD.
      November 15, 2010 Preliminary Renewal Statements are available on Web CRD/IARD.
      December 13, 2010 Full payment of Preliminary Renewal Statements is due.
      January 3, 2011 Final Renewal Statements are available on Web CRD/IARD.
      February 4, 2011 Full payment of Final Renewal Statements is due.

      *Please Note: Post-dated filings submitted by 11 p.m., Eastern Time (ET), November 12, 2010, do not appear on the firm's Preliminary Renewal Statement. The only allowed date for post-dated termination filings is December 31, 2010.

      FINRA advises firms that failure to remit full payment of their Preliminary Renewal Statements by December 13, 2010, may cause the firm to become ineligible to do business in the jurisdictions where it is registered, effective January 1, 2011.

      In addition to this Notice, firms should review the instructions posted at www.finra.org/renewals, especially the 2011 Renewal Program Bulletin, the 2011 IARD Renewal Program Bulletin (if applicable) on the Investment Adviser Registration Depository (IARD) website at www.iard.com/renewals.asp, and any information mailed to ensure continued eligibility to do business as of January 1, 2011.

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

      Background & Discussion

      Preliminary Renewal Statements

      Beginning November 15, 2010, Preliminary Renewal Statements are available for viewing and printing on Web CRD/IARD. The statements include the following fees:

      •   Web CRD system processing fees;
      •   FINRA branch office fees;
      •   FINRA branch renewal processing fees;
      •   American Stock Exchange (AMEX), BATS Y-Exchange, Inc. (BATS-YX), BATS Z-Exchange, Inc. (BATS-ZX), Boston Stock Exchange (BX), Chicago Board Options Exchange (CBOE), Chicago Stock Exchange (CHX), International Securities Exchange (ISE), NASDAQ Stock Exchange (NQX), New York Stock Exchange (NYSE), NYSE Arca, Inc. (ARCA) and Philadelphia Stock Exchange (PHLX) maintenance fees;
      •   state agent renewal fees;
      •   state BD renewal fees;
      •   state BD branch fees;
      •   investment adviser firm and representative renewal fees, if applicable; and
      •   broker-dealer and/or investment adviser branch renewal fees.

      FINRA must receive full payment of the Preliminary Renewal Statement fees no later than December 13, 2010.

      If payment is not received by December 13, 2010, FINRA-registered firms will be assessed a Renewal Payment Late Fee. FINRA includes this late fee as part of the Final Renewal Statement and calculates the fee as follows: 10 percent of a firm's cumulative final renewal assessment or $100, whichever is greater, with a cap of $5,000. Please see Notice to Members (NTM) 02-48 for details. In addition, if FINRA fails to receive payment by the deadline, firms also risk becoming ineligible to do business in the jurisdictions where their registrations are not renewed.

      Fees

      FINRA assesses a fee of $30 for each registered representative who renews his/her registration with any regulator through Web CRD. Firms can access a listing of agents assessed this fee by requesting the Renewals—Firm Renewal Roster.

      In addition, any investment adviser fees assessed by the North American Securities Administrators Association (NASAA) for state-registered investment adviser firms and investment adviser representatives (RA) who renew through IARD will also be included on the Preliminary Renewal Statement.

      Based on the number of active FINRA branches on December 31, 2010, FINRA assesses each firm a branch office assessment fee of $75 per branch. FINRA waives one branch office assessment fee per firm.

      Based on the number of active FINRA branches on December 31, 2010, FINRA assesses each firm a FINRA branch renewal processing fee of $20 per branch. FINRA waives one branch renewal processing fee per firm.

      Please note that FINRA does not assess the personnel assessment fees through the annual Renewal Program. FINRA will mail all FINRA-registered firms a separate invoice for these fees. Firms can obtain a listing of agents 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 AMEX, ARCA, BATS-YX, BATS-ZX, BX, CBOE, CHX, ISE, NQX, NYSE, PHLX and state registrations on the Preliminary Renewal Statement. The system displays the applicable fees for the number of individuals registered in each SRO and jurisdiction.

      Web CRD/IARD assesses branch office renewal fees for those regulators that choose to renew branches registered with them in Web CRD/IARD.

      Some participating jurisdictions may require steps beyond the payment of renewal fees to FINRA to complete the broker-dealer or investment adviser renewal process. Firms should contact each jurisdiction directly for further information on state renewal requirements. A Regulator Directory is located at www.nasaa.org/QuickLinks/ContactYourRegulator.cfm.

      For detailed information regarding 2011 investment adviser renewals, you may also visit the IARD website, www.iard.com. A matrix of investment adviser renewal fees for states that participate in the 2011 IARD Renewal Program is posted at www.iard.com/fees.asp.

      Renewal Payment

      Firms have four payment methods available to pay 2011 renewal fees:

      1. Automatic Daily Account-to-Renewal Account Transfer
      2. Web CRD/IARD E-Pay
      3. Check
      4. Wire Transfer

      Automatic Daily Account-to-Renewal Account Transfer

      FINRA will automatically transfer funds from a firm's Daily Account to its Renewal Account to facilitate payment of renewal fees on December 13, 2010, the Preliminary Renewal Statement payment deadline. FINRA will transfer funds only if a firm has sufficient funds available in its Daily Account on December 13 to cover the amount due. Please Note: If a firm does not want funds automatically transferred, the firm should ensure FINRA receives payment in its Renewal Account by the deadline. Separately, if a firm wishes to transfer funds between affiliated firms, the firm should submit a Web CRD/IARD Account Transfer Form available on the FINRA website at www.finra.org/crd/transferform.

      Web CRD/IARD E-Pay

      The Web CRD/IARD E-Pay application is accessible from both the Preliminary and Final Renewal Statements and the FINRA (www.finra.org/crd) or IARD (www.iard.com) websites. This application allows a firm to make an electronic payment from a designated bank account to the firm's Renewal Account with FINRA. Please note that in order for funds to post to your firm's Renewal Account by December 13, 2010, submit payment electronically no later than 8 p.m., ET, on December 9, 2010.

      Check

      The check must be drawn on the firm's account and include the firm's CRD number and "Renewal" in the memo line. Firms paying by check should account for U.S. mail delivery and payment processing time. To ensure prompt processing of your renewal payment check:

      •   Include a print-out of the first page of your Preliminary Renewal Statement with payment.
      •   Do not include any other forms or fee submissions.
      •   Make the check payable to FINRA. Write your firm's CRD number and "Renewal" on the check memo line.
      •   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 Overnight or Express Delivery
      FINRA FINRA
      P.O. Box 7777-8705 8705
      Philadelphia, PA 19175-8705 Mellon Bank Room 3490
        701 Market Street
      (Note: This box will not accept courier or overnight deliveries.) Philadelphia, PA 19106
        Telephone: (301) 869-6699

      Please Note: The addresses for renewal payments are different from the addresses for funding firms' Web CRD/IARD Daily Accounts.

      Wire Payment

      Firms may wire full payment of their Preliminary Renewal Statements by requesting their banks to initiate wire transfers to: "Mellon Financial, Philadelphia, PA." Firms should provide their banks with the following information:

      Transfer funds to: Mellon Financial, Philadelphia, PA
      ABA Number: 031 000 037
      Beneficiary: FINRA
      FINRA Account Number: 8-234-353
      Reference Number: Firm CRD number and "Renewal"

      To ensure prompt processing of a renewal payment by wire transfer, remember to:

      •   Inform the bank to credit funds to the FINRA bank account.
      •   Provide the firm's CRD number and "Renewal" as reference only.
      •   Record the confirmation number of the wire transfer provided by the bank.

      Renewal Reports

      Beginning November 15, 2010, firms can request, print and/or download renewal reports via Web CRD/IARD. Three reports are available for reconciliation with the Preliminary Renewal Statement:

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

      Post-Dated Form Filings

      This functionality allows firms to file termination forms with a termination date of December 31, 2010. If a Form U5, BDW, BR Closing/Withdrawal or ADV-W filing indicates a termination date of December 31, 2010, an agent (AG), investment adviser representative, broker-dealer and/or investment adviser (firm) and the branch may continue doing business in that jurisdiction until the end of the calendar year without being assessed 2011 renewal fees. December 31, 2010, is the only date allowed for a post-dated form filing.

      Firms can begin filing post-dated Form U5 and BR Closing/Withdrawal filings via Web CRD/IARD on October 25, 2010. In addition, firms can begin filing post-dated Form BDW and ADV-W filings via Web CRD/IARD on November 1, 2010. Firms that submit post-dated termination filings by 11 p.m., ET, on November 12, 2010, will not be assessed renewal fees for the terminated registrations on their Preliminary Renewal Statements. Firms that submit post-dated termination filings on, or after, November 15, 2010, will not be assessed renewal fees for the terminated jurisdictions on their Final Renewal Statements in January 2011. Those firms should see a credit balance on their Final Renewal Statements if the firm has not requested additional registrations during that time period to offset the credit balance.

      After submitting any termination filing, firms should query individual, branch and/or firm registrations to ensure that Form U5, BDW, BR Closing/Withdrawal and ADV-W filings process by the renewal filing deadline date of 6 p.m., ET, on December 23, 2010.

      Firms should exercise care when submitting all post-dated filings. Web CRD/IARD processes these forms as firms submit and FINRA cannot withdraw a post-dated termination filing once submitted. 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 3, 2011, and Web CRD/IARD will assess new registration fees as a result.

      Filing Form BDW

      The CRD Phase II Program allows firms requesting broker-dealer termination (either full or partial) to file their Forms BDW via Web CRD. Firms that file either a full or partial Form BDW by 11 p.m., ET, November 12, 2010, avoid the assessment of the applicable renewal fees on their Preliminary Renewal Statements, provided that the regulator is a CRD Phase II participant. Currently, only five regulators participate in Web CRD renewals for agent fees, but do not participate in CRD Phase II:

      •   American Stock Exchange
      •   Chicago Stock Exchange
      •   National Stock Exchange
      •   NYSE Arca, Inc.
      •   Philadelphia Stock Exchange

      Firms requesting termination with any of those five regulators must submit a paper Form BDW directly to that regulator, as well as submit one electronically via Web CRD.

      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 23, 2010. This same date applies to the filing of any Form BDW with regulators that are not Phase II participants.

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

      Firms that file either a Form ADV Amendment, unmarking a state (generating the status of "Removal Requested at End of Year") or a Form ADV-W by 11 p.m., ET, November 12, 2010, avoid the assessment of applicable renewal fees on their Preliminary Renewal Statements. The deadline to file Form ADV Amendments or Form ADV-W for firms that want to cancel a notice filing or terminate a state registration before year-end is 6 p.m., ET, December 23, 2010.

      Removing Open Registrations

      Throughout the year, firms have access to the "Approved AG Reg Without FINRA Approval Report" via Web CRD. This report identifies agents with an approved jurisdiction registration but who do not have an approved FINRA registration. Firms should use this report to terminate obsolete jurisdiction registrations through the submission of a Form U5 or reinstate the FINRA positions through the filing of a Form U4 Amendment. Firms should request this report as soon as possible so they can identify individuals to terminate by November 12, 2010, to avoid renewal charges for those individuals on their Preliminary Renewal Statements. This report also advises the firm if there are no agents at the firm within this category.

      Final Renewal Statements

      On January 3, 2011, FINRA makes available all Final Renewal Statements on Web CRD/IARD. These statements reflect the status of broker-dealer, registered representative (AG), investment adviser firm and investment adviser representative (RA) registrations and/or notice filings as of December 31, 2010. Any adjustments in fees owed resulting from registration terminations, approvals, notice filings or transitions after the Preliminary Renewal Statement appear on the Final Renewal Statement in Web CRD/IARD.

      •   Web CRD/IARD reflects an amount owed if a firm has more individuals, branch offices or jurisdictions registered and/or notice filed on Web CRD/IARD at year-end than it did when the Preliminary Renewal Statement generated.
      •   Web CRD/IARD issues a refund if a firm has fewer individuals, branch offices or jurisdictions registered or notice filed at year-end than it did on the Preliminary Renewal Statement. Note that FINRA transfers overpayments to the firms' Daily Accounts on January 3, 2011. Firms that have a credit balance in their Daily Accounts may submit a written and signed refund request by mail to: FINRA, Finance Department, 9509 Key West Avenue, Rockville, MD 20850; or by fax to: (240) 386-5344. The request should include a print-out of the firm's credit balance as reflected on Web CRD/IARD.

      On or after January 3, 2011, FINRA member firms and joint BD/IA firms should access the Web CRD reports functionality for the Firm Renewal Report, which will list all individuals renewed with FINRA, AMEX, ARCA, BATS-YX, BATS-ZX, BX, CBOE, CHX, ISE, NQX, NYSE, PHLX and each jurisdiction. Agents 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 February 4, 2011, 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 Renewal Statement and renewal reports will be available in a January 2011 Regulatory Notice.

    • 10-57 Funding and Liquidity Risk Management Practices

      View PDF

      Risk Management

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules and Notices

      NTM 99-92
      SEA 15c3-3
      Suggested Routing

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

      Concentration Risk
      Contingency Funding Plan
      Funding and Liquidity Risk Management
      Independent Inventory and Collateral Valuation

      Executive Summary

      In adverse circumstances, whether the result of firm-specific events or systemic credit events, the cost of funding a broker-dealer's operations could become prohibitively expensive; in extreme cases funding could become unavailable. FINRA expects broker-dealers to develop and maintain robust funding and liquidity risk management practices to prepare for adverse circumstances. Further, FINRA expects broker-dealers affiliated with holding companies to undertake these efforts at the broker-dealer level, in addition to their planning at the holding-company level. We are publishing this Notice to provide guidance in this effort.

      Many of the practices outlined in this Notice were identified through FINRA examinations and a survey of 15 mid-sized and large broker-dealers that hold inventory positions and carry customer accounts. This Notice does not provide a comprehensive description of all appropriate funding and liquidity risk management practices. Each broker-dealer should determine which practices are best suited to its particular business, whether or not they are mentioned in this Notice. While much of the content in this Notice is directed to broker-dealers that carry inventory positions, other broker-dealers may also find it to be a valuable resource.

      Questions regarding this Notice may be directed to:

      •   Eric Moss, Vice President, Emerging Regulatory Issues, or Mo Saleh, Director, Emerging Regulatory Issues, at (202) 728-8472.
      •   Amr M. El-Sabbagh, Director, Risk Oversight and Operational Risk, at (646) 315-8739.

      Background and Discussion

      The effectiveness of broker-dealer risk management practices is a subject of longstanding regulatory interest.1 The recent financial crisis has provided many important lessons for risk managers.2 One lesson, and the primary theme of this Notice, is that broker-dealers need to develop and monitor funding and liquidity risk management programs that take into consideration a broad range of adverse circumstances, including extraordinary credit events. The first days of a crisis may be the most critical; therefore, broker-dealers must prepare for distressed credit markets before a crisis hits.

      Sound Practices for Funding and Liquidity Risk Management

      FINRA expects broker-dealers to regularly assess their funding and liquidity risk management practices to maximize the likelihood that they can continue to operate under adverse circumstances, whether the result of broker-dealer-specific events or systemic credit events. Broker-dealers affiliated with holding companies are expected to conduct this analysis and develop contingency funding plans at the broker-dealer level, in addition to their planning at the holding-company level. Assessing funding and liquidity risks at the broker-dealer level enables the governing boards and senior management of broker-dealers to measure, monitor and control for risks unique to the broker-dealer. Further, this level of analysis can help broker-dealers plan for the challenges they would face should access to funding from affiliated entities become limited or even unavailable.

      The following practices can help broker-dealers prepare for various market scenarios, such as loss of funding sources, unanticipated deteriorations of asset quality, contagion across markets and future earnings volatility that could affect their liquidity positions and ability to fund operations. This Notice does not provide an exhaustive description of all appropriate funding and liquidity risk management practices. Each broker-dealer should consider the practices that are best suited to its operations, whether or not they are mentioned in this Notice.

      Risk Limits and Reporting

      The governing board and senior management of a broker-dealer should be fully informed on the firm's risk management policies and procedures, and should participate in setting and periodically re-evaluating the level of funding and liquidity risk the organization is willing to accept to meet its business goals. Senior management should ensure that these determinations are communicated throughout the organization so that management in the various business lines can set appropriate funding and liquidity risk limits and evaluate existing risks presented by various markets and counterparties.3

      It is equally important for broker-dealers to maintain robust systems that timely capture funding and liquidity exposure across all of their business lines. The scope and frequency of the information analyzed by broker-dealers should occur as necessary given an organization's size, complexity and the presence of red flags discussed below. It is critical that broker-dealers have escalation procedures to report instances where pre-established funding and liquidity limits are exceeded to the appropriate level of management, including provisions for determining when such breaches should be immediately reported to senior management. The appropriate broker-dealer staff (e.g., treasury) also should consider reviewing with senior management on a regular basis formal risk reports—both quantitative and qualitative—that summarize key measures of funding and liquidity, such as:

      •   the amount of excess liquidity currently available;
      •   future cash-flow projections based on multiple scenarios, including under stressed conditions;
      •   the maturity profile of available funding sources;
      •   liquidation and mark-down assumptions for inventory positions, including those based on mark-to-model values;
      •   price volatility and correlation trends with respect to certain asset classes;
      •   inventory concentrations in related asset classes;
      •   the usage and limits of secured and unsecured lines of credit;
      •   how existing risk levels compare with pre-established risk limits;
      •   the level of funding through particular markets and position concentrations for certain counterparties; and
      •   the ability to timely monetize assets that have been set aside in an excess liquidity pool.

      Independent Risk Oversight

      Broker-dealers are encouraged to use staff that is independent of business lines to ensure that the firm does not exceed the levels of risk tolerance set by the governing board and senior management. The staff may perform such functions as analyzing exposure across business lines, monitoring for early warning signs concerning potential funding and liquidity problems, evaluating pricing decisions, performing stress tests, and maintaining and regularly updating contingency funding plans. Regardless of whether the staff works in departments dedicated to risk management functions or in other departments independent of business lines, firms should ensure that the staff has sufficient resources and authority.

      Further, many broker-dealer funding and liquidity risk management programs are supported by committees that include senior managers who oversee key functions such as trading desks, treasury operations, credit risk, market risk and collateral management. These committees can help evaluate risk across business lines at the broker-dealer and ensure that relevant information is appropriately shared. Broker-dealers are encouraged to periodically review the charters and mission statements for these committees to ensure that they reflect prevailing market developments and organizational structures.

      Maturity Profile of Funding Sources

      Over reliance on shorter-term funding to finance longer-term assets was a significant factor in the severe difficulties faced by some financial firms during the credit crisis. Broker-dealers that use shorter-term financing to fund longer-term positions should regularly assess their ability to continue operating under a variety of market conditions and firm-specific events. Some broker-dealers that use shorter-term funding to finance longer-term assets have determined that they should reduce their exposure to the very short-term credit market. These broker-dealers are diversifying funding sources and laddering the maturity profile of liabilities. Broker-dealers should consider the following steps in order to match-fund holding periods:

      •   extend maturity terms beyond overnight for repuchase agreement (repo) positions or other short-term funding sources;4 and
      •   establish irrevocable lines of credit or other supplementary sources of short-term funding.

      Greater reliance on shorter-term financing to fund longer-term assets elevates the significance of funding and liquidity risk indicators, such as the level of excess liquidity, inventory quality and holding periods, inventory and counterparty concentration exposure, costs of funding and projected cash-flows.

      Red Flags of Potential Funding and Liquidity Problems

      Many broker-dealers have programs designed to monitor for early warning signs of potential funding and liquidity problems. Red flags should trigger management to take immediate action or perform additional monitoring. Broker-dealers should consider the following red flags:

      •   significant increases in the cost of funding operations, including those that are firm specific and those based on changes in the interest rate environment;
      •   unexpected increases in exposure to certain asset classes, markets and counterparties;
      •   elevated costs of holding particular asset classes;
      •   sudden difficulty in entering into longer-term funding arrangements;
      •   significant increases in the proportion of the broker-dealer's longer-term assets funded through shorter-term markets, such as the overnight repo market;
      •   downgrades or announcements of potential downgrades of the credit ratings assigned to the public debt of the broker-dealer or its parent;
      •   downgrades or announcements of potential downgrades of the credit ratings assigned to collateral pledged by the broker-dealer;
      •   negative publicity or rumors targeted at the broker-dealer or parent that could reduce its perceived credit worthiness;
      •   widening spreads in the credit default swap market that suggest concerns about the credit worthiness of the broker-dealer or its parent;
      •   significantly widened credit spreads for the public debt of the broker-dealer or its parent;
      •   significant decline in earnings or projected earnings for the broker-dealer or its parent;
      •   increases in demands for funding by affiliates, as this may negatively affect the parent's ability to fund the broker-dealer;
      •   cancellation of external funding sources and non-renewal of maturing debt (e.g., uncommitted repo or revolving credit facilities);
      •   imposition of increased collateral requirements and wider haircuts by counterparties, carrying broker-dealers5 and clearing organizations;
      •   excessive reliance on customer assets (cash and securities held in margin accounts) to help fund operations;
      •   significant reductions in the market value of certain asset classes held in inventory;
      •   breaches of pre-established risk limits;
      •   difficulty in timely monetizing the broker-dealer's assets in an excess liquidity pool;
      •   significant decline in the amount of excess liquidity available;
      •   unexpected demands for cash arising from contingent liabilities (e.g., pending lawsuit);
      •   notable increases in collateral disputes with counterparties;
      •   assets returning to the balance sheet from customers with explicit or implicit puts that require immediate unanticipated funding; and
      •   deterioration in the financial condition of the broker-dealer or its parent that may trigger loan covenants or other credit events.

      Inventory Valuation

      Strong practices for identifying the true liquidation value of inventory holdings are essential for an effective funding and liquidity management program. The recent financial crisis highlighted the value of using staff that is technically competent and independent from the lines of business to evaluate pricing decisions, and empowering them to challenge pricing assumptions. Additionally, broker-dealers should consider using controls to ensure that:

      •   they value securities and derivative instruments daily based on current fair values;
      •   each business line correctly and consistently categorize assets;
      •   they use consistent prices across business lines, so that each security has only one price across the broker-dealer's inventory positions, reverse repo, repo and customer collateral;
      •   re-evaluate valuation methodologies periodically (with greater frequency in rapidly changing market conditions) and when realized results have deviated from results that were expected based on the firm's methodologies; and
      •   inputs and resources used in verifying prices are well-documented and independent from the trader.

      It is important that material deviations from expected results be reviewed with senior management for all product lines. Materiality thresholds for bringing discrepancies to the attention of senior management should be reasonable and agreed to by internal and external auditors. Senior management also should be informed of modeling assumptions used to value securities held in inventory, particularly less liquid products. Broker-dealers are encouraged to establish procedures for senior management to formally approve price modeling assumptions. Further, broker-dealers are encouraged to develop policies and procedures for determining the circumstances under which they share pricing information with the governing board.

      Stress Testing

      An effective stress-testing program can help a broker-dealer identify and quantify sources of potential liquidity strains and analyze effects on its cash-flows, profitability and solvency. Accordingly, broker-dealers should consider performing stress tests on a regular basis that contemplate firm-specific and market-wide events, for varying time horizons (e.g., one day, one month, one year), and varying levels of liquidity duress (e.g., moderate, high and severe). The test results can help a broker-dealer assess whether it has sufficient excess liquidity in the form of unencumbered and highly marketable securities to meet possible funding shortfalls without the need to sell less liquid assets at fire-sale prices or depend on additional funding from credit-sensitive markets. Broker-dealers should consider including the impact of the following in their stress testing programs:

      •   significant increases in the cost of funding operations, including those that are firm-specific and those based on broad credit market conditions;
      •   significant increases in the exposure to certain asset classes, markets and counterparties;
      •   significant erosion in inventory value resulting from a contagion across multiple asset classes or a change in the interest rate environment;
      •   loss of partial or complete access to particular funding sources or ability to finance particular asset classes;
      •   withdrawal of customer assets (cash and securities held in cash and margin accounts) that the broker-dealer uses to finance operations;
      •   sudden reductions in the market value of collateral, including those that could lead a counterparty, clearing broker-dealer and clearing organization to demand additional collateral or the broker-dealer to liquidate positions at fire-sale prices;
      •   reduction in the value of assets held in an excess liquidity pool;
      •   off-balance sheet assets (e.g., securitized loans) coming back on to the balance sheet;
      •   unexpected demands for cash arising from contingent liabilities (e.g., pending lawsuit);
      •   significant declines in earnings or projected earnings of the broker-dealer or parent;
      •   deterioration in the financial condition of the broker-dealer or parent that may trigger loan covenants or other credit event;
      •   increased demands for funding by affiliates, as this may affect the parent's ability to fund the broker-dealer;
      •   rating downgrade of the broker-dealer, its parent or collateral pledged by the broker-dealer; and
      •   negative publicity or rumors about the broker-dealer or parent that could make it more difficult to obtain funding.

      The results of stress testing should be reviewed with senior management. Broker-dealers are encouraged to establish procedures for senior management to formally sign-off on the test results. Additionally, the test results may provide useful information for updating contingency funding plans.

      Contingency Funding Plan

      In a credit crisis, management may have little time to react and few options available to access funding and generate liquidity. A contingency funding plan can help a broker-dealer prepare for such situations and assist in its efforts to prudently and efficiently manage extraordinary fluctuations in liquidity. Accordingly, the governing boards and senior management of broker-dealers should consider maintaining and regularly updating contingency funding plans to:

      •   clarify responsibilities and decision-making authority, so that all personnel understand their role during a potential credit crunch;
      •   match sources of funds with contractual and potential obligations;
      •   list contingency funding sources and identify when they should be employed;
      •   identify business restrictions and reductions that may be employed to counteract a strain on liquidity, such as reducing certain trading positions, limiting or reducing margin loans, calling for additional margin or collateral from customers or other measures that may be needed to manage liquidity risks; and
      •   identify the various operational conditions that could affect access to back-up credit lines, such as credit rating triggers or loan covenants (e.g., leverage ratios) and outline plans in the event of loss of such funding sources.

      Broker-dealers are encouraged to establish procedures for senior management and governing boards to formally sign off on the contingency funding plans.

      Use of Customer Assets

      Under Exchange Act Rule 15c3-3, a carrying broker-dealer must calculate what amount, if any, it must deposit on behalf of customers in its reserve bank account for the exclusive benefit of customers (reserve bank account), according to the prescribed formula (reserve formula). Generally, under the reserve formula, a carrying broker-dealer must determine the amount of cash it owes to its customers and the amount of funds generated through the hypothecation of customer securities (i.e., credits), and compare this amount to any amounts its customers owe it (i.e., debits). If customer credits exceed customer debits, a carrying broker-dealer must deposit the net amount in its reserve bank account. Under Rule 15c3-3, this computation must be made weekly, for those firms that carry customer funds exceeding $1 million, as of the close of the last business day of the week, and the deposit must be made no later than the second business day following the computation.

      Carrying broker-dealers are cautioned that taking advantage of the fact that the reserve formula is only required to be computed weekly by using customer assets (cash and securities held in margin accounts) in the interim period to help fund operations can create unacceptable risks. Excessive reliance on this approach may be an indication of funding and liquidity stress. Carrying broker-dealers are encouraged to:

      •   establish and enforce limits on the use of customer cash and the hypothecation of customer securities; and
      •   consider developing contingency plans to prepare for possible customer withdrawal of assets, particularly at an accelerated rate.6

      Conclusion

      FINRA urges broker-dealers to take a proactive approach to reviewing and improving their funding and liquidity risk management practices. We recognize that the appropriateness of particular policies and procedures will vary depending on a broker-dealer's size and structure, and are publishing the above sound practices as a tool for firms to draw upon. FINRA notes that even the most elaborate procedures will not be effective unless they are rigorously followed.


      1 In 1999, in response to changes in the industry and breakdowns in some risk management programs, the Securities and Exchange Commission, New York Stock Exchange and NASD issued the Broker-Dealer Risk Management Practices Joint Statement that emphasized the importance of maintaining an appropriate risk management system. See NASD Notice to Members 99-92.

      2 Regulators and industry groups have published several reports that describe the lessons for risk managers from the recent financial crisis. Among these is a report issued by the Senior Supervisors Group (SSG) on October 21, 2009, entitled Risk Management Lessons from the Global Banking Crisis of 2008. The SSG is a forum composed of regulators, including the Securities and Exchange Commission, the Federal Reserve System and the Office of the Comptroller of the Currency.

      Further, in response to concerns about the infrastructure of the tri-party repurchase agreement (repo) market, a major source of funding for some broker-dealers, the Federal Reserve Bank of New York (FRBNY) asked market participants in the fall of 2009 to review and make recommendations regarding opportunities for improvement to the tri-party repurchase infrastructure. The Task Force on Tri-Party Repo Infrastructure was subsequently formed, and on May 17, 2010, the FRBNY published for comment the Task Force on Tri-Party Repo Infrastructure's recommendations and its initial response to them. Although the Task Force focused on eliminating to the greatest extent possible clearing banks' extensions of intraday credit (a significant risk to the tri-party market), the Task Force discussed other important issues, such as the importance of effective funding and liquidity risk management.

      In addition, in April (and revised in May) 2010, the FRBNY also published a staff report entitled Repo Runs that highlights risks related to short-term funding through the repo market, including the possibility that the failure of a large dealer could prompt the liquidation of large amounts of assets and create fire-sale conditions.

      Other reports that provide guidance to institutions on risk management practices in response to the recent financial crisis include Observations on Risk Management Practices during the Recent Market Turbulence (SSG, March 6, 2008); Containing Systemic Risk: The Road to Reform (Counterparty Risk Management Policy Group III, August 6, 2008); Final Report of the IIF Committee on Market Best Practices: Principles of Conduct and Best Practice Recommendations (Institute of International Finance, July 2008); Financial Risk Outlook 2010 (Financial Services Authority).

      3 While it may be appropriate for senior management to delegate certain funding and liquidity risk functions to others in the organization, senior management nevertheless retains ultimate responsibility for the broker-dealer's funding and liquidity risk management issues. Accordingly, senior management should take reasonable and appropriate action to ensure that functions are properly delegated and executed.

      4 A repo is economically similar to a secured loan, whereby a borrower surrenders securities for a cash loan generally at a fixed rate of interest. In a repo, the borrower agrees to sell immediately the securities to the lender, and the borrower agrees to buy back the same securities from the lender at a fixed price and date. Most repo transactions mature on a daily basis although some are for longer periods. A reverse repo is the same transaction, but from the lender's perspective.

      5 Many introducing broker-dealers rely on their carrying broker-dealer as the primary source of funding to facilitate customer and proprietary trading. Carrying broker-dealers may obtain such funding through bank credit lines or the repo and securities lending markets.

      6 In March 2008, Bear Stearns' prime brokerage customers became concerned about the firm's ability to meet its obligations. These customers transferred their accounts to competitors perceived to be of higher credit quality and, in the process, withdrew substantial amounts of customer credit balances within the course of one week.

    • 10-56 SEC Approves Amendments to the Trading Activity Fee and FINRA Announces Publication of Frequently Asked Questions; Effective Date: November 1, 2010

      View PDF

      Trading Activity Fee

      Regulatory Notice
      Notice Type

      Guidance
      Rule Amendment
      Referenced Rules & Notices

      FINRA By-Laws, Schedule A, Section 1
      NTM 02-63
      NTM 02-75
      NTM 03-30
      NTM 05-03
      NTM 05-23
      NTM 06-37
      Regulatory Notice 08-37
      SEA Rule 17d-2
      Suggested Routing

      Compliance
      Legal
      Operations
      Options
      Senior Management
      Systems
      Trading
      Key Topics

      Trading Activity Fee

      Executive Summary

      Effective November 1, 2010, FINRA is removing the exemption from the Trading Activity Fee (TAF) for transactions in exchange-listed options effected by a member firm when FINRA is not the designated options examining authority for that firm.1 Because FINRA now has sole regulatory responsibility for the public options activities of all of its member firms, the exemption is no longer necessary. FINRA is also issuing this Notice to announce publication on its website of Trading Activity Fee Frequently Asked Questions (FAQ), which provides guidance for firms on the assessment of the TAF. The TAF FAQ can be found at www.finra.org/taf/faq.

      Questions concerning this Notice should be directed to:

      •   FINRA Finance, at (240) 386-5397; or
      •   The Office of General Counsel, at (202) 728-8071.

      Background & Discussion

      Amendments to the Trading Activity Fee

      The TAF is one of the member regulatory fees FINRA uses to fund its member regulation activities, which include examinations, financial monitoring and FINRA's policymaking, rulemaking and enforcement activities. In 2003, FINRA created an exemption from the TAF for transactions in exchange-listed options effected by a member firm when FINRA is not the designated options examining authority (DOEA) for that firm.2 The exemption reflected the fact that FINRA's regulatory responsibilities with respect to such activity were reassigned to another self-regulatory organization (SRO) through FINRA's participation in a plan under Rule 17d-2 of the Securities Exchange Act of 19343 (17d-2 Agreement). Under the 17d-2 Agreement, regulatory responsibilities for certain FINRA firms that conducted a public options business were assumed by other SROs that would act as the firm's DOEA.4 Subsequent amendments to the 17d-2 Agreement have consolidated within FINRA sole regulatory responsibility for the public options activities of all of its firms.5 Consequently, FINRA now assumes all regulatory responsibility for FINRA firms under the 17d-2 Agreement, and effective November 1, 2010, FINRA is eliminating the exemption from the TAF for transactions in exchange-listed options when FINRA is not the DOEA for the firm.6

      Trading Activity Fee FAQ

      FINRA is publishing the TAF FAQ to provide additional guidance to firms regarding the TAF. Over the years, FINRA has published numerous Notices on the TAF, many of which include a list of questions and answers, in an effort to clarify calculation of the TAF and to help firms develop and monitor their processes around TAF payments.7 FINRA is publishing the TAF FAQ on its website to consolidate, and in some cases to update, the guidance previously published and to add additional questions and answers that firms have asked. The TAF FAQ addresses several topics, including general questions about how the TAF is assessed and calculated as well as specific questions on assessing the TAF on transactions in equity securities, debt securities, options and security futures. The TAF FAQ supersedes any previous guidance published in the various Notices.

      The TAF FAQ can be found on FINRA's website at www.finra.org/taf/faq. Firms should review the FAQ and check the website periodically for updates to ensure that their processes and procedures for calculating the TAF are up to date and accurate. New questions will be marked "new," and previously published questions will be marked "updated" when they are updated or revised.

      Firms are encouraged to contact FINRA at the numbers listed above to suggest additional topics or questions for inclusion in the TAF FAQ.


      1 See Securities Exchange Act Release No. 63196 (October 27, 2010).

      2 See Securities Exchange Act Release No. 47946 (May 30, 2003), 68 FR 34021 (June 6, 2003). Transactions in over-the-counter ("conventional") options are exempted from the TAF with respect to all FINRA members. See FINRA By-Laws, Schedule A, § 1(b)(2)(H).

      3 17 CFR 240.17d-2.

      4 See Securities Exchange Act Release No. 46800 (November 8, 2002), 67 FR 69774 (November 19, 2002).

      5 See Securities Exchange Act Release No. 57987 (June 18, 2008), 73 FR 36156 (June 25, 2008).

      6 Following the consolidation of NASD and NYSE member regulation operations in 2007, FINRA announced that it serves as the DOEA for all FINRA member firms. See Regulatory Notice 08-37 (July 2008). FINRA had previously published a list of firms that had a DOEA other than FINRA. See NTM 05-03 (January 2005).

      7 See, e.g., NTM 06-37 (August 2006); NTM 05-23 (March 2005); NTM 03-30 (June 2003); NTM 02-75 (November 2002); NTM 02-63 (September 2002)

    • 10-55 FINRA Establishes a New Effective Date for Reporting Asset-Backed Securities to TRACE and Related Rule Changes; Effective Date: May 16, 2011

      View PDF

      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6710
      FINRA Rule 6720
      FINRA Rule 6730
      FINRA Rule 6750
      FINRA Rule 6760
      FINRA Rule 7730
      Regulatory Notice 10-23
      Suggested Routing

      Compliance
      Fixed Income
      Legal
      Operations
      Research
      Systems
      Trading
      Key Topics

      Asset-Backed Securities
      Effective Date
      TRACE-Eligible Security

      Executive Summary

      FINRA is establishing a new effective date of May 16, 2011, for reporting Asset-Backed Securities to TRACE.

      Questions regarding this Notice should be directed to:

      •   Patrick Geraghty, Director, Market Regulation, at (240) 386-4973;
      •   Elliot R. Levine, Associate Vice President and Counsel, Transparency Services, at (202) 728-8405; or
      •   Sharon Zackula, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8985.

      Discussion and Background

      FINRA's TRACE Rules (the Rule 6700 Series) provide for the reporting of transactions in TRACE-Eligible Securities to TRACE and the dissemination of transaction information, with limited exceptions. TRACE reporting and data fees are set forth in FINRA Rule 7730.

      In February 2010, the SEC approved SR-FINRA-2009-065 (TRACE ABS filing), which:

      •   amends the TRACE Rules to classify asset-backed securities, mortgage-backed securities and other similar securities (collectively, Asset-Backed Securities) as TRACE-Eligible Securities;
      •   requires that transactions in Asset-Backed Securities be reported to TRACE;
      •   modifies certain other reporting requirements and notification provisions; and
      •   establishes reporting fees for transactions in Asset-Backed Securities.1

      In April 2010, FINRA published Regulatory Notice 10-23, which announced the SEC's approval of the TRACE ABS filing and established an effective date of February 14, 2011.

      However, pursuant to this Notice, FINRA is establishing a new effective date of May 16, 2011, for the rule amendments in the TRACE ABS filing.2 FINRA believes that an extended effective date will allow sufficient time to make additional systems enhancements and allow for coordinated testing of the technology.3


      1 See Securities Exchange Act Release No. 61566 (February 22, 2010), 75 FR 9262 (March 1, 2010) (SEC Order Approving File No. SR-FINRA-2009-065) (TRACE ABS filing). See also Securities Exchange Act Release No. 61948 (April 20, 2010), 75 FR 22670 (April 29, 2010) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2010-019 to Extend the Implementation Period for SR-FINRA-2009-065).

      2 See Securities Exchange Act Release No. 63223 (November 1, 2010), 75 FR 68654 (November 8, 2010) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2010-054 to Extend the Implementation Period for SR-FINRA-2009-065).

      3 In Regulatory Notice 10-23, FINRA also announced that the six-month pilot program, during which the period to report a transaction in an Asset-Backed Security is extended from the date of trade during TRACE System Hours to T + 1 during TRACE System Hours, would end on Sunday, August 14, 2011, at 11:59:59 p.m., Eastern Time, based on the then designated effective date of February 14, 2011. Based on the new effective date of May 16, 2011, the pilot program will end on November 16, 2011.

    • 10-54 FINRA Requests Comment on Concept Proposal to Require a Disclosure Statement for Retail Investors at or Before Commencing a Business Relationship; Comment Period Expires: December 27, 2010

      View PDF

      Disclosure of Services, Conflicts and Duties

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      Conflicts of Interest
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      NASD Rule 3110
      Regulatory Notice 09-34

      Executive Summary

      FINRA requests comment on a concept proposal to require member firms, at or prior to commencing a business relationship with a retail customer, to provide a written statement to the customer describing the types of accounts and services it provides, as well as conflicts associated with such services and any limitations on the duties the firm otherwise owes to retail customers.

      Questions concerning this Notice should be directed to:

      •   Philip Shaikun, Associate Vice President, Office of General Counsel, at (202) 728-8451.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by December 27, 2010.

      Member firms and other interested parties can submit their comments using the following methods:

      •   Emailing comments to pubcom@finra.org; or
      •   Mailing comments in hard copy to:
      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

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

      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 on its site one week after the end of the comment period.1

      Before becoming effective, a proposed rule change must be authorized for filing with the SEC by the FINRA Board of Governors, and then must be approved by the SEC, following publication for public comment in the Federal Register.2

      Background and Discussion

      Even as the legislation that became the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was being developed, FINRA staff considered how it might implement a heightened standard of care with respect to broker-dealers. The staff determined that no matter how the ultimate contours of such a standard would be concluded, retail customers would benefit from an up-front disclosure document that sets forth in plain English a firm's accounts and services, its associated conflicts of interest and any limitations on duties owed to the customer. The staff conceived of a document similar in purpose to Form ADV, which is required under the Investment Advisers Act to be provided to each advisory customer. The staff believed that such a document would not only provide useful information to a retail customer, but also would help clearly define the scope of the duties owed to that customer.

      With the enactment of Dodd-Frank, the staff believes the concept is even more appropriate, if not an outright necessity. The legislation requires the SEC to conduct a study of the obligations of broker-dealers and investment advisers, and authorizes subsequent SEC rulemaking to establish a fiduciary duty for broker-dealers. Notably, the study must consider the regulatory gaps between broker-dealer and investment adviser regulation, and the SEC has asked for comment as to how such gaps may be closed. Additionally, the legislation requires the SEC to facilitate simple and clear disclosures of material conflicts by both broker-dealers and investment advisers. Accordingly, in anticipation of satisfying any resultant rulemaking mandates and to enhance retail investors' understanding of the business, relationships and conflicts of their brokers, FINRA staff is seeing comment on the contours of a proposal that would require each firm to timely provide to retail customers a statement of services, conflicts and duties. Firms would continue to provide the more particularized sales practice disclosures currently required in interactions between registered representatives and customers.

      As conceived by FINRA staff, a possible new rule proposal would require a firm, at or prior to commencing a business relationship with a retail customer, to provide to the customer a written statement that sets forth the types of brokerage accounts and services the firm provides to retail customers and the conflicts associated with such services. A "retail customer" would mean a customer that does not qualify as an institutional account under NASD Rule 3110(c)(4). The definition of "institutional account" under that rule consists of a bank, savings and loan, insurance company, registered investment company, registered investment adviser or any entity (which includes natural persons) with total assets of at least $50 million.

      FINRA staff further conceives that the document would include the following characteristics and subject matter:

      •   The types of brokerage accounts and services the firm provides to retail customers, such as research, underwriting and recommendations of securities, products and strategies.
      •   Disclosures that are reasonably designed to permit existing and prospective retail customers of the firm to evaluate:
      •   the scope of services provided by the firm to its retail customers and any limitations on the scope of the services offered (e.g., that the universe of research covered may be limited or influenced by the issuers with which the firm maintains an investment banking relationship or the securities for which the firm acts as a market maker or otherwise engages in proprietary trading);
      •   the scope of products offered to the firm's retail customers;
      •   to the extent applicable, that the firm may not offer all products of a certain class or type and that it or its affiliates may be the sponsor or originator of certain products and may determine in some cases to act as a distributor or placement or sales agent for a fee from the issuer or sponsor of the product; and
      •   all fees associated with each brokerage account and service offered to retail customers, a specific description of the service provided for each fee and whether fees are negotiable presented in a manner to allow customers to make comparisons between broker-dealers.
      •   Disclosures as to financial or other incentives that a firm or its registered representatives have to recommend certain products, investment strategies or services over similar ones, including:
      •   in the case of investment company securities, the information required by proposed FINRA Rule 2341(l)(4);3
      •   any arrangement in which the firm receives any economic benefit (including cash, revenue sharing, commissions, equipment, research or non-research services) from any person, including an issuer or product manufacturer in connection with providing a particular product, investment strategy or service to a customer;
      •   any arrangement in which the firm compensates or receives any economic incentive for customer referrals from or to any individual or firm; and
      •   any arrangement in which a registered representative receives different payouts or other rates of compensation for certain products or services that are reasonably likely to provide an incentive for the registered representative to offer that product in lieu of similar products offered by the firm.
      •   Disclosure of conflicts that may arise between a firm and its customers, as well as those that may arise in meeting the competing needs of multiple customers, and how the firm manages such conflicts.
      •   Limitations on the duties a firm owes to its customers; for example, that the firm:
      •   does not assure the ongoing suitability of an investment or portfolio of investments;
      •   takes no responsibility for the propriety of unsolicited orders, other than to discharge its best execution obligation; or
      •   may execute any transaction on a principal basis, absence instructions to act only in an agency capacity.

      Request for Comment

      FINRA staff welcomes all comments on the concept proposal. Among other things, FINRA staff is interested in comments on the following:

      Scope: Is the proposal either overbroad or too narrow in the products, services and conflicts requiring disclosure?
      Delivery method: Should the disclosure statement be delivered in writing in hard copy or made electronically available or both?
      Form and content: How detailed should the disclosures be? How best to ensure meaningful disclosure without overwhelming retail investors? Should there be two-tiered disclosure, such as a general disclosure document with hyperlinks or website references where investors can obtain more detailed disclosures of a firm's products, services and attendant conflicts and limitations?
      Timing: How often should a firm update and provide the disclosure statement to retail customers?

      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 NASD Notice to Members 03-73 (November 2003) (NASD Announces Online Availability of Comments) for more information.

      2 Section 19 of the Securities Exchange Act of 1934 (SEA or Exchange Act) permits certain limited types of proposed rule changes to take effect upon filing with the SEC. The SEC has the authority to summarily abrogate these types of rule changes within 60 days of filing. See Exchange Act Section 19 and rules thereunder.

      3 See Regulatory Notice 09-34 (June 2009).

    • 10-53 Margin Requirements for Exempted Securities Mutual Funds and Exempted Securities ETFs; Effective Date: October 26, 2010

      View PDF

      Margin Requirements

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Incorporated NYSE Rule 431
      Investment Company Act of 1940
      NASD Rule 2520
      Regulation T
      Regulatory Notice 08-60
      Regulatory Notice 09-31
      Regulatory Notice 09-53
      SEA Section 3(a)(12)
      Suggested Routing

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

      Exchange Traded Funds (ETFs)
      Exempted Securities ETFs
      Exempted Securities Mutual Funds
      Leveraged Exempted Securities ETFs
      Margin Requirements
      Money Market Mutual Funds

      Executive Summary

      Effective October 26, 2010, FINRA is advising firms of customer margin requirements for exempted securities mutual funds and exempted securities exchange traded funds (ETFs) in Regulation T margin accounts. FINRA is also reminding firms of customer margin requirements for money market mutual funds.

      Questions concerning this Notice should be directed to:

      •   Rudolph R. Verra, Managing Director, Risk Oversight and Operational Regulation, at (646) 315-8811;
      •   Glen Garofalo, Director, Credit Regulation, at (646) 315-8464; or
      •   Steve Yannolo, Principal Credit Specialist, Credit Regulation, at (646) 315-8621.

      Background & Discussion

      An exempted securities mutual fund is defined in Section 220.2 of Regulation T, as "any security issued by an investment company registered under section 8 of the Investment Company Act of 1940 (15 U.S.C.80a-8), provided that the company has at least 95% of its assets continuously invested in exempt securities (as defined in section 3(a)(12) of the [Exchange] Act."

      ETFs are typically registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Some ETFs, similar to exempted securities mutual funds discussed above, have at least 95 percent of their assets continuously invested in exempt securities (exempted securities ETFs). Further, some exempted securities ETFs are leveraged ETFs that are designed to generate multiples (e.g., 200 percent, 300 percent or greater) of the performance of the underlying benchmark they track. FINRA reminded firms of the sales practice obligations with respect to leveraged ETFs in Regulatory Notice 09-31 (June 2009).

      Margin Requirements for Exempted Securities Mutual Funds and Exempted Securities ETFs

      Regulation T, issued by the Board of Governors of the Federal Reserve Board pursuant to the Exchange Act, among other things, sets the initial amount of margin required for equity securities.1 Regulation T excepts from this initial margin requirement selected types of securities, including exempted securities, money market mutual funds and exempted securities mutual funds, and provides that the margin for such products may be established by the creditor in good faith or by the regulatory authority, whichever is greater.2 Pursuant to Regulation T, NASD Rule 2520(e)(2)(A) and (B) and Incorporated NYSE Rule 431(e)(2)(A) and (B) prescribe margin requirements for obligations for selected exempted securities (specifically for (1) government debt securities and (2) all other exempted securities).

      FINRA has received several inquiries requesting clarification on the appropriate margin treatment for exempted securities mutual funds and exempted securities ETFs. Firms have questioned whether such products may be margined as equity securities or exempted securities.

      Pursuant to NASD Rule 2520(f)(8)(A) and Incorporated NYSE Rule 431(f)(8)(A), FINRA is advising firms that the margin requirement for an exempted securities mutual fund and exempted securities ETF shall be commensurate with the margin requirements for other exempted securities. Accordingly, effective October 26, 2010, exempted securities mutual funds and exempted securities ETFs shall have an initial and maintenance requirement of 7 percent of the current market value for Regulation T margin accounts. In the case of a leveraged, exempted securities ETF, the initial and maintenance margin requirement in a Regulation T margin account shall increase by a percentage commensurate with the leverage of the ETF. For example, a 200 percent leveraged exempted securities ETF will have a maintenance requirement of 14 percent (2 × 7 percent). FINRA notes that it increased the maintenance margin requirements for leveraged ETFs as prescribed in Regulatory Notice 09-53 that became effective on December 1, 2009.

      FINRA believes that this margin treatment is appropriate in Regulation T margin accounts as such products are treated similarly in portfolio margin accounts. FINRA notes in portfolio margin accounts The Options Clearing Corporation applies comparable stress ranges for exempted securities ETFs. For example, ETFs comprised of U.S. Treasury and municipal debt securities are stressed +/- 7 percent.3

      Money Market Mutual Funds Requirements

      FINRA reminds firms that a money market mutual fund, as defined in Section 220.2 of Regulation T and excepted from Regulation T,4 has an initial and maintenance requirement of 1 percent of the current market value for both Regulation T margin accounts and portfolio margin accounts, provided the net asset value (NAV) of the fund is not below $1.00 per share.5 If the NAV of a money market mutual fund falls below $1.00 (i.e., "breaks the buck"), firms must abide by the provisions promulgated in Regulatory Notice 08-60.

      FINRA also reminds firms that before extending credit on money market mutual funds, they must ensure that (1) the customer waives any right to redeem the shares without the firm's consent, (2) the firm (or if the shares are deposited with a clearing organization, the clearing organization) obtains the right to redeem the shares for cash upon request and (3) the fund agrees to satisfy any conditions necessary or appropriate to ensure that the shares may be redeemed for cash promptly upon request.6


      1 See Regulation T Section 220.12(a).

      2 See Regulation T Section 220.12(b).

      3 For a list of ETFs, please see www.optionsclearing.com/components/docs/risk-management/rbh/bond_treasury_debt_etfs.pdf

      4 A money market mutual fund means any security issued by an investment company registered under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a-8) that is considered a money market mutual fund under SEC Rule 2a-7 (17 CFR 270.2a-7).

      5 See Regulatory Notice 08-60 (Money Market Mutual Funds).

      6 See NASD Rule 2520(g)(7)(D) and Incorporated NYSE Rule 431(g)(7)(D).

    • 10-52 Application of Rules on Communications With the Public and Institutional Sales Material and Correspondence to Certain Free Writing Prospectuses

      View PDF

      Free Writing Prospectuses

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 5110
      FINRA Rule 5120
      NASD Rule 2210
      NASD Rule 2211
      Securities Act Rule 164
      Securities Act Rule 405
      Securities Act Rule 433
      Suggested Routing

      Advertising
      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      Communications With the Public
      Free Writing Prospectus
      Supervision

      Executive Summary

      The content standards, the principal review requirements and applicable filing requirements in NASD Rules 2210 (Communications with the Public) and 2211(Institutional Sales Material and Correspondence) shall apply to free writing prospectuses distributed by broker-dealers in a manner reasonably designed to lead to their broad unrestricted dissemination, as described in Securities Act Rule 433. By this Notice, FINRA is withdrawing, in part, previous interpretive guidance that excluded free writing prospectuses from the requirements of NASD Rules 2210 and 2211.

      Questions regarding this Notice should be directed to:

      •   Joseph E. Price, Senior Vice President, Corporate Financing/Advertising Regulation, at (240) 386-4623; or
      •   Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8104.

      Background and Discussion

      This Notice addresses the application of NASD Rules 2210 and 2211 to free writing prospectuses distributed by broker-dealers in a manner reasonably designed to lead to their broad unrestricted dissemination, as described in Securities Act Rule 433.

      Securities Act Rule 405 defines a free writing prospectus as a written communication, including an electronic communication, that constitutes an offer to sell or a solicitation to buy securities in a registered offering by means other than the statutory prospectus.1 The free writing prospectus was introduced as part of the SEC's Securities Offering Reform2 and was intended to provide issuers with greater flexibility in the use of communications during the registered offering process. A free writing prospectus may include information that is not included in the registration statement, but it may not conflict with information in the filed registration statement, including any prospectus and any Securities Exchange Act reports incorporated by reference.3 A free writing prospectus must contain a legend advising investors that:

      •   the issuer has filed a registration statement (including a prospectus) with the SEC for the offering to which the communication relates;
      •   before investing, the investor should read the prospectus and other documents filed by the issuer; and
      •   copies of these documents can be obtained for free through the SEC's website or from the issuer or any underwriter or dealer participating in the offering.4

      Securities Act Rule 433 requires any offering participant other than the issuer to file any free writing prospectus that is distributed by or on behalf of the offering participant in a manner reasonably designed to lead to its broad unrestricted dissemination.5 Previously, FINRA issued interpretive guidance excluding free writing prospectuses from the requirements of NASD Rules 2210 and 2211.6 These NASD rules establish standards for the content of communications with the public by broker-dealers, which are designed to ensure that the communications are fair, balanced and not misleading. Rule 2210(b)(1) requires a registered principal to review and approve each advertisement and item of sales literature before it is distributed; this provision has helped ensure compliance with the content standards. Rule 2210(c)(2) requires that firms file advertisements and sales literature regarding certain types of securities, such as registered investment companies and public direct participation programs, with FINRA within 10 business days of first use.

      Withdrawal of Previous Interpretive Guidance

      By this Notice, FINRA is withdrawing previous interpretive guidance on free writing prospectuses that are distributed by a broker-dealer in a manner reasonably designed to lead to broad unrestricted dissemination.7 Since FINRA issued that guidance it has become apparent that a free writing prospectus that is distributed by a broker-dealer in a manner reasonably designed to lead to its broad unrestricted dissemination as described by Rule 433 presents the same investor protection concerns as communications regulated by NASD Rules 2210 and 2211. For example, FINRA has seen sales material that seemed to be in serious noncompliance with the content standards of Rule 2210, but was excluded from the application of that rule merely because the broker-dealer asserted that it constituted a free writing prospectus.

      While our interpretive guidance was intended to promote the objectives of Rule 433, it has led to inconsistent regulatory treatment of communications that present similar investor protection concerns. For example, investment companies registered under the Investment Companies Act of 1940 are not eligible to use a free writing prospectus under Securities Act Rule 164(f). Thus, a communication concerning an exchange traded fund (ETF) that is a registered investment company must comply with the content, registered principal approval and filing requirements of Rule 2210. On the other hand, a free writing prospectus concerning an ETF that is not a registered investment company would be exempt from the application of Rule 2210.

      Therefore, FINRA now interprets Rules 2210 and 2211 to apply to free writing prospectuses distributed by a broker-dealer in a manner reasonably designed to lead to broad unrestricted dissemination. These requirements include the content standards, the principal review requirement and any applicable filing requirement.8 FINRA notes that broker-dealers are already required to file such free writing prospectuses with the SEC, and, therefore, filing them with FINRA will not cause delays in the offering process.9

      Scope of "Broad Unrestricted Dissemination"

      The SEC has provided guidance concerning the meaning of the term "broad unrestricted dissemination" and FINRA explicitly incorporates that guidance. Specifically, the SEC has noted that examples of broad unrestricted dissemination of a free writing prospectus by a broker-dealer would include posting such prospectus on an unrestricted website or releasing it to the media.10 Conversely, the SEC has stated that a broker-dealer does not make a broad unrestricted dissemination if a free writing prospectus is posted to a restricted website or sent directly to its customers, regardless of the number of customers.11


      1 17 CFR 230.405.

      2 Securities Exchange Act Release No. 52056 (July 19, 2005), 70 FR 44722 (August 3, 2005) (Order Approving SEC File No. S7-38-04, Securities Offering Reform).

      3 17 CFR 230.433(c)(1).

      4 17 CFR 230.433(c)(2).

      5 17 CFR 230.433(d)(1)(ii). Well-known seasoned issuers and their offering participants, including underwriters, are permitted to use free writing prospectuses at any time. Other eligible issuers and their offering participants may use a free writing prospectus after a registration statement has been filed. Participants in offerings of the securities of non-reporting and unseasoned issuers are required in some instances to accompany or precede the free writing prospectus with the most recent statutory prospectus.

      6 See Letter from Lisa C. Horrigan, Assistant General Counsel, NASD, to Eileen Ryan, Vice President and Associate General Counsel, Securities Industry Association, and Sarah Starkweather, Regulatory Counsel, The Bond Market Association (August 1, 2006), available at www.finra.org/Industry/Regulation/ Guidance/InterpretiveLetters/P017285.

      7 This Notice does not withdraw the guidance in that letter pertaining to any free writing prospectus that is distributed by a broker-dealer in a manner that is not reasonably designed to lead to its broad unrestricted dissemination. Accordingly, free writing prospectuses continue to be exempt from the provisions of NASD Rules 2210 and 2211 to the extent they are not part of a broad unrestricted dissemination. This Notice also does not withdraw the guidance in that letter pertaining to NASD Rules 2710 and 2720 (now FINRA Rules 5110 and 5120).

      8 For example, if a member uses such a free writing prospectus on behalf of a public direct participation program, the member must file the free writing prospectus with FINRA within 10 business days of first use. Free writing prospectuses for ETFs that are not registered investment companies are not subject to the filing requirements.

      9 Rule 433(d)(1)(ii) requires filing with the SEC no later than the date of first use. When applicable, Rule 2210(c) generally requires filing with FINRA within 10 business days after first use or publication.

      10 Securities Exchange Act Release No. 52056, supra at 2.

      11 Id.

    • 10-51 Sales Practice Obligations for Commodity Futures-Linked Securities

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      Commodity Futures-Linked Securities

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules

      Incorporated NYSE Rule 342
      NASD Rule 2210
      NASD Rule 2310
      NASD IM-2310-2(e)
      NASD Rule 3010
      NASD Rule 3012
      Regulatory Notice 09-31
      Suggested Routing

      Advertising
      Compliance
      Legal
      Senior Management
      Key Topics

      Commodity Futures-Linked Securities
      Communications with the Public
      Exchange-Traded Products
      Futures Contracts
      Suitability
      Supervision and Training

      Executive Summary

      Securities that offer exposure to commodities have become increasingly popular and accessible to retail investors in recent years. Given the practical difficulties that can be associated with investing directly in many commodities, commodity-linked securities often use futures contracts to track an underlying commodity or commodity index. Commodity futures-linked securities can be an effective tool for gaining exposure to an asset class that in some cases can be difficult for retail investors to access. However, firms should be aware that, in some cases, the performance of the commodity futures-linked security can deviate significantly from the performance of the referenced commodity, especially over longer periods. The deviation could be either positive or negative, depending on market conditions and the product's investment strategy. This deviation can produce unexpected results for investors who are not familiar with futures markets, or who mistakenly believe that commodity futures-linked securities are designed to track commodity spot prices.

      FINRA is issuing this Notice to remind firms that offer commodity futures-linked securities that they must ensure that communications with the public about these securities are fair and balanced, that recommendations to customers are suitable, and that their registered representatives adequately understand and are able to inform their customers about these securities before they recommend them. To meet these obligations, firms must train registered personnel about the characteristics, risks, and rewards of each product before they allow registered persons to sell that product to investors. Firms must also have adequate written supervisory procedures and supervisory controls that are reasonably designed to ensure that sales of commodity futures-linked securities comply with the federal securities laws and applicable FINRA rules.

      Questions concerning this Notice should be directed to:

      •   Laura Gansler, Associate Vice President, Office of Emerging Regulatory Issues, at 202-728-8275; or
      •   Richard Vagnoni, Senior Economist, Office of Economic Analysis, at 202-728-6934

      Background and Discussion

      Commodity prices can be volatile. For example, the price of crude oil declined nearly 80 percent between July and December 2008; in the first six months of 2009, it rose nearly 50 percent. Nonetheless, some research suggests that investments in commodities can be a valuable part of an overall diversification strategy. Some investors may also be attracted to commodities as a hedge against inflation, or as a strategy for taking advantage of growth in emerging markets.

      Over the past several years, the number of products designed to provide retail investors exposure to either a particular commodity or a diversified basket of multiple commodities has grown.1 Given the practical difficulties associated with investing in some commodities, many products that offer exposure to commodities use futures contracts as their investment strategy. Standardized futures contracts are exchange-traded derivatives that guarantee delivery of a commodity on an agreed-upon date for an agreed-upon price. To avoid taking physical delivery of the commodity, commodity futures-linked securities that seek to provide investors with continuous exposure to commodities typically sell their next-to-expire contracts (those with the nearest delivery date) prior to expiration and replace them with contracts with more distant delivery dates—for example, those expiring in the next month. This is called rolling the position.

      A futures contract reflects the expected value of the commodity upon delivery in the future, whereas the spot price reflects the immediate delivery value of the commodity.2 The price movements of a futures contract are typically correlated with the movements of the spot price of the referenced commodity, but the correlation is generally imperfect and price moves in the spot market may not be reflected in the futures market (and vice versa). Prices for futures contracts with more distant delivery dates can differ from each other as well as the spot price.3 Futures and spot prices generally converge as the futures contract expiration approaches, and they should be equal upon expiration of the futures contract, which then becomes a contract for immediate delivery.

      A commodity futures-linked security will typically roll its position before a contract's expiration and can face differing prices between the contract it sells and the new contract—for more distant delivery—that it buys. This difference is called the roll yield.

      In some cases a commodity futures-linked security will have to roll its position into a more expensive contract (that is, the contract that is sold has a lower price than the one with which it is replaced), resulting in a loss, or negative roll yield. This is typical of a futures market in contango, in which futures contracts with more distant delivery dates are more expensive.4 In other cases, it may roll its position into a less expensive contract (that is, the contract that is sold has a higher price than the one with which it is replaced), resulting in a gain, or positive roll yield. This is typical of a futures market in backwardation, in which futures contracts with more distant delivery dates are less expensive.5 Due to these and other market forces, commodity futures-linked securities can perform differently—either better or worse—than the spot price for the commodity itself.6 Moreover, over time, any performance differential can be magnified if a specific condition persists in the market for a given commodity, such as contango or backwardation. This deviation is not tracking error, because the futures-linked products are designed to track futures. However, it can lead to unexpected results for investors or registered representatives who do not understand the product, or who mistakenly believe that the product will replicate the performance of the commodity's spot price.

      Commodity futures-linked securities can have different methodologies for achieving their investment objectives, and they may or may not employ strategies that address roll yield. Some invest in a single futures contract, often the one with the closest delivery date. Others invest in multiple contracts along the futures curve (e.g., holding contracts for each of the next 12 months), which can allow them to diversify across different futures contracts. Others pursue more complicated investment strategies, such as tracking indices that attempt to optimize roll yield by minimizing the impact of contango or maximizing the impact of backwardation. Each strategy has different benefits, risks and costs, and the appropriateness of a particular methodology depends, in part, on an investor's needs and preferences.

      Sales Practice Obligations

      Firms have an obligation to understand the products they sell in order to ensure that their communications with the public about the products are fair, balanced, and not misleading, that their recommendations to customers are suitable, that customers are adequately informed about the product and that their sales force is adequately trained and supervised.

      Under NASD Rule 2210, firms must ensure that all communications with the public are fair and balanced, and provide a sound basis for evaluating the facts about any particular security or type of security, industry or service. No firm may omit any material fact or qualification if the omission, in the light of the context of the material presented, would cause the communications to be misleading. In particular, firms should not suggest that a commodity-futures linked security offers direct exposure to the commodity's spot price, overstate the degree of correlation between the two or understate the risks inherent in investing in commodity futures. Firms should also not overstate the hedging value of commodity futures-linked products, or commodities generally, for, by example, implying that their performance is always negatively correlated with equities or other asset classes. The fact that a prospectus makes it clear that the goal of the product is to use futures to track the price of the commodity or index, or discloses that there is a potential for a performance gap between the futures and spot prices does not alleviate a firm's duty to ensure that its communications regarding the product are fair, balanced and not misleading.

      In addition, NASD Rule 2310 requires that, before recommending the purchase, sale or exchange of a security, a firm must have a reasonable basis for believing that the transaction is suitable for the customer to whom the recommendation is made. NASD IM-2310-2(e) (Fair Dealing with Customers with Regard to Derivative Products or New Financial Products) emphasizes the obligation of firms to deal fairly with customers when making recommendations or accepting orders for new financial products. The IM states that "[a]s new products are introduced from time to time, it is important that members make every effort to familiarize themselves with each customer's financial situation, trading experience, and ability to meet the risks involved with such products and to make every effort to make customers aware of the pertinent information regarding the products." For commodity futures-linked securities, the registered representative and retail customer should discuss, among other things:

      •   the commodity, basket of commodities or commodities index that a given product tracks;
      •   the product's goals, strategy and structure;
      •   that commodities prices, and the performance of commodity futures-linked securities, can be volatile;
      •   that the use of futures contracts can affect the performance of the product as compared to the performance of the underlying commodity or index;
      •   the product's methodology, including its strategy, if any, for managing roll yield and other factors that may affect performance; and
      •   the product's tax implications. (Commodity pools have different tax implications than mutual funds or exchange-traded notes.)

      The fact that commodity futures-linked securities can perform differently from the spot price of a given commodity does not mean that they are not suitable for any investor or that they cannot be effective investment vehicles. However, firms that sell commodity futures-linked securities must ensure that their registered representatives understand each product's goals, strategy and structure, and how those factors may affect the product's suitability for specific customers, given, among other things, the customers' investment objectives, investment horizons and tax status.

      Training and Supervision

      Firms that sell commodity futures-linked securities must provide adequate training to ensure that their registered persons understand the products they recommend, and that they describe them in a manner that is fair, balanced and not misleading. Firms must also train registered personnel about the characteristics, risks, and rewards of each product before they allow registered persons to sell that product to investors. In connection with such training, firms should train registered persons about how to make customers aware of the pertinent information regarding the products and train them about the factors that would make the products either suitable or unsuitable for certain investors. Training should not be limited to representatives selling such products. Firms should also provide appropriate training to supervisors of registered persons selling commodity futures-linked securities. Firms must also have adequate written supervisory procedures and supervisory controls that are reasonably designed to ensure that sales of commodity futures-linked securities comply with the federal securities laws and FINRA rules.7


      1 One such example is the commodity-linked exchange-traded product (ETP). ETPs can be organized as, among other things, 1940 Act investment companies (e.g., exchange-traded funds), commodity pools, grantor trusts, or exchange-traded notes. At the end of July 2010 there was over $80 billion in commodity ETPs, or about 10 percent of total ETP assets, up from around $60 billion at the same point in 2009. Other investment products offering retail investors exposure to commodities can include mutual funds and closed-end funds, structured notes linked to commodities, and hedge and managed futures funds. Some commodity-linked products offer leveraged or inverse exposure to the commodity or index they track. Leveraged and inverse commodity-linked products could present similar issues to those highlighted by FINRA in Regulatory Notice 09-31 regarding non-traditional exchange-traded funds (ETFs).

      2 A variety of factors can lead to a disparity between the expected future price of a commodity and the spot price at a given point in time, such as the cost of storing the commodity for the term of the futures contract, interest charges incurred to finance the purchase of the commodity, and expectations concerning supply and demand for the commodity.

      3 The difference between the price of a futures contract and the spot price of a commodity is often referred to as the basis. The difference between prices for futures contracts with different expiration dates is often called the spread.

      4 Contango does not necessarily lead to negative returns, but can be a drag on performance relative to the spot commodity. A futures market can experience contango because the price of the underlying commodity is expected to rise.

      5 Backwardation does not necessarily lead to positive returns, but can boost performance relative to the spot commodity. A futures market can experience backwardation because the price of the underlying commodity is expected to decline.

      6 The roll yield is only one factor that can cause the performance of a commodity futures-linked security to deviate from the performance of the spot price of a commodity. The previously noted imperfect correlation between futures and spot prices is another. Like any product that tracks an asset or index, other factors that can affect the performance of a futures-linked security include transaction costs, management fees and taxes.

      7 See NASD Rules 3010 and 3012, and Incorporated NYSE Rule 342 and its related supplementary material and interpretations.

    • 10-50 Securities Industry/Regulatory Council on Continuing Education Issues Firm Element Advisory Update

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      Continuing Education

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

      Compliance
      Continuing Education
      Legal
      Registration
      Senior Management
      Key Topics

      Continuing Education
      Firm Element
       

      The Securities Industry/Regulatory Council on Continuing Education (Council) has released its Fall 2010 Firm Element Advisory (FEA). The Council produces the FEA to identify regulatory and sales practice topics that firms should consider in their Firm Element training plans. Topics updated or added since the prior FEA are indicated in the document as such.

      The updated FEA is available at www.cecouncil.com/publications/council_ publications/FEA_Semi_Annual_Update.pdf.

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

      In addition to the FEA, the Council offers the Firm Element Content Builder, a Web-based tool that can assist firms in developing their Firm Element training plans. It enables users to search an extensive database of regulatory resources related to specific investment products or services and is available at www.cecouncil.com/firm_element/organizer.

      Questions concerning this Notice should be directed to:

      •    Roni Meikle, Director, Continuing Education, FINRA, at (646) 315-8688.

    • 10-49 SEC Approval and Effective Date for New Consolidated FINRA Rules; Effective Date: December 15, 2010

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      SEC Approves New Consolidated FINRA Rules

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      Rule Approvals
      Referenced Rules & Notices

      FINRA Rule 3270
      FINRA Rule 5121
      FINRA Rule 11000 Series
      Information Notice 03/12/08
      Information Notice 10/06/08
      Regulatory Notice 08-57
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topic(s)

      Effective Dates of Consolidated Rules
      FINRA Manual
      Rulebook Consolidation
      Outside Business Activities
      Public Offerings
      Uniform Practice Code

      Executive Summary

      Following the consolidation of NASD and the member regulation, enforcement and arbitration functions of NYSE Regulation into FINRA, FINRA established a process to develop a new consolidated rulebook (Consolidated FINRA Rulebook), which FINRA has discussed in previous Information Notices.1 FINRA is proposing new consolidated rules in phases for approval by the Securities and Exchange Commission (SEC) as part of the Consolidated FINRA Rulebook.2

      In August and September 2010, the SEC approved three rule filings relating to the Consolidated FINRA Rulebook. FINRA Rule 5121(Public Offerings of Securities With Conflicts of Interest) and the FINRA Rule 11000 Series (Uniform Practice Code) will take effect on December 15, 2010. The effective date of FINRA Rule 3270 (Outside Business Activities of Registered Persons) is also December 15, 2010; however, for registered persons who are actively engaged in an outside business activity prior to December 15, 2010, firms have until June 15, 2011, to review such pre-existing activities under the standards set forth in FINRA Rule 3270, including the requirement that firms keep a record of their compliance with such standards.

      Questions regarding this Notice should be directed to:

      •   Kosha Dalal, Associate Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6903 (regarding the FINRA Rule 11000 Series);
      •   Gary Goldsholle, Vice President and Associate General Counsel, OGC, at (202) 728-8104 (regarding FINRA Rule 3270); or
      •   Stan Macel, Assistant General Counsel, OGC, at (202) 728-8056 (regarding FINRA Rule 5121).

      Discussion

      In August and September 2010, the SEC approved the following new consolidated FINRA Rules as part of the Consolidated FINRA Rulebook:

      •   Rule 3270 (Outside Business Activities of Registered Persons)3
      •   Rule 5121 (Public Offerings of Securities With Conflicts of Interest)4
      •   Rule 11000 Series (Uniform Practice Code)5

      The attachment to this Notice sets forth additional information regarding these new consolidated rules and includes a hyperlink to each related rule filing. The filings provide, among other things, FINRA's statement of the purpose of the rule changes and an exhibit showing the changes between the new rule text and the text of the NASD rule as it exists in the Transitional Rulebook. Also, the text of the new FINRA rule is available in the online FINRA Manual at www.finra.org/finramanual.6

      Rule Conversion Charts

      As discussed in additional detail in Information Notice 10/06/08 and Regulatory Notice 08-57, FINRA has posted three Rule Conversion Charts on its website to help firms become familiar with the new rules and show how the new rules relate to the NASD and/or Incorporated NYSE Rules in the Transitional Rulebook that they will replace.

      Firms should be aware that the charts are intended as a reference aid only. FINRA reminds firms that the charts do not in any way serve as a substitute for diligent review of the relevant new rule language. The Rule Conversion Charts are located at www.finra.org/ruleconversionchart.


      1 See Information Notice 10/06/08 (Rulebook Consolidation Process: Effective Dates of New Consolidated Rules; Introduction of Rule Conversion Chart); see also Information Notice 03/12/08 (Rulebook Consolidation Process).

      2 The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The new FINRA Rules apply to all member firms, unless such rules have a more limited application by their terms. As the Consolidated FINRA Rulebook expands with the SEC's approval and with the new FINRA Rules taking effect, the rules in the Transitional Rulebook that address the same subject matter of regulation will be eliminated. When the Consolidated FINRA Rulebook is completed, the Transitional Rulebook will have been eliminated in its entirety.

      3 See Exchange Act Release No. 62762 (Aug. 23, 2010), 75 FR 53362 (Aug. 31, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-042).

      4 See Exchange Act Release No. 62702 (Aug. 12, 2010), 75 FR 51147 (Aug. 18, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2010-026).

      5 See Exchange Act Release No. 62842 (Sept. 3, 2010), 75 FR 55842 (Sept. 14, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2010-030).

      6 FINRA updates the rule text on its online Manual within two business days of SEC approval of changes to the rule text.


      ATTACHMENT A

      List of Approved FINRA Rules (and Related Rule Filings)

      The SEC approved the following rule filings relating to the Consolidated FINRA Rulebook in August and September 2010. The effective date for FINRA Rule 5121 (Public Offerings of Securities With Conflicts of Interest) and the FINRA Rule 11000 Series (Uniform Practice Code) is December 15, 2010. The effective date of FINRA Rule 3270 (Outside Business Activities of Registered Persons) is also December 15, 2010; however, for registered persons who are actively engaged in an outside business activity prior to December 15, 2010, firms have until June 15, 2011, to review such pre-existing activities under the standards set forth in FINRA Rule 3270, including the requirement that firms keep a record of their compliance with such standards.

      FINRA Rule Filing SR-FINRA-2009-042

      www.finra.org/rulefilings/2009-042

      The rule change adopts, with certain modifications, NASD Rule 3030 (Outside Business Activities of an Associated Person) as FINRA Rule 3270 (Outside Business Activities of Registered Persons) in the Consolidated FINRA Rulebook, and deletes Incorporated NYSE Rule 346 (Limitations—Employment and Association with Members and Member Organizations) and its Interpretation.

      FINRA Rule 3270 prohibits any registered person from being an employee, independent contractor, sole proprietor, officer, director or partner of another person, or being compensated, or having the reasonable expectation of compensation, from another person as a result of any business activity outside the scope of the relationship with his or her member firm, unless he or she has provided prior written notice to the firm in the form specified by the firm. Passive investments and activities subject to the requirements of NASD Rule 3040 are exempted from this requirement.

      Supplementary Material .01 (Obligations of Member Receiving Notice) to FINRA Rule 3270 sets forth the obligations of a member upon receipt of a written notice of a proposed outside business activity. FINRA Rule 3270 requires that, upon receipt of a written notice, a firm must consider whether the proposed activity will: (1) interfere with or otherwise compromise the registered person's responsibilities to the firm and/or the firm's customers or (2) be viewed by customers or the public as part of the firm's business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered. Additionally, based on the firm's review of such factors, the firm must evaluate the advisability of imposing specific conditions or limitations on a registered person's outside business activity, including where circumstances warrant, prohibiting the activity. A firm also must evaluate the proposed activity to determine whether the activity properly is characterized as an outside business activity or whether it should be treated as an outside securities activity subject to the requirements of NASD Rule 3040. A firm must keep a record of its compliance with these obligations with respect to each written notice received and must preserve this record for the period of time and accessibility specified in Exchange Act Rule 17a-4(e)(1).

      Rule/Series No. Rule Title
      Rule 3000 Series SUPERVISION AND RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS
      Rule 3200 Series RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS
      Rule 3270 Outside Business Activities of Registered Persons

      FINRA Rule Filing SR-FINRA-2010-026

      www.finra.org/rulefilings/2010-026

      The rule change adopts NASD Rule 2720 (Public Offerings of Securities With Conflicts of Interest) as FINRA Rule 5121 in the Consolidated FINRA Rulebook.

      Rule 5121 governs public offerings of securities in which a firm with a conflict of interest participates. It generally prohibits a firm with a "conflict of interest," as defined in the rule, from participating in a public offering, unless certain other requirements are met. Such requirements include prominent disclosure of the nature of the conflict, and in certain circumstances, the participation of a qualified independent underwriter. Firms also must comply with certain net capital, discretionary accounts and filing requirements, as applicable.

      Rule/Series No. Rule Title
      Rule 5000 Series SECURITIES OFFERING AND TRADING STANDARDS AND PRACTICES
      Rule 5100 Series SECURITIES OFFERINGS, UNDERWRITING AND COMPENSATION
      Rule 5120 Series Offerings of Members' Securities
      Rule 5121 Public Offerings of Securities With Conflicts of Interest

      FINRA Rule Filing SR-FINRA-2010-030

      www.finra.org/rulefilings/2010-030

      The rule change adopts NASD Rule 11000 Series (Uniform Practice Code (UPC)), with certain changes, as FINRA Rule 11000 Series in the Consolidated FINRA Rulebook. The rule change also deletes NASD Rule 3370 (Purchases) and the following corresponding provisions in the Incorporated NYSE Rules and Interpretations:

      •   176 (Delivery Time);
      •   180 (Failure to Deliver);
      •   282 (Buy-in Procedures) and its Supplementary Material paragraphs .10–.80; 291 (Failure to Fulfill Closing Contract);
      •   292 (Restrictions on Members' Participation in Transaction to Close Defaulted Contracts);
      •   293 (Closing Contracts in Suspended Securities);
      •   294 (Default in Loan of Money);
      •   387 (COD Orders) and its Supplementary Material paragraphs .10–.60;
      •   Rule 387 Interpretations /01–/18; 430 (Partial Delivery of Securities to Customers on C.O.D. Purchases); and

      The UPC prescribes the manner in which over-the-counter securities transactions other than those cleared through a registered clearing agency are compared, cleared and settled between member firms. As a general matter, the UPC does not apply to:

      •   transactions in securities between firms that are compared, cleared or settled through the facilities of a registered clearing agency, except to the extent that the rules of the clearing agency provide that rules of other organizations shall apply;
      •   transactions in securities exempted under Section 3(a)(12) of the Exchange Act or municipal securities as defined in Section 3(a)(29) of the Exchange Act;
      •   transactions in redeemable securities issued by companies registered under the Investment Company Act of 1940, except for secondary market transactions between members in unit investment trusts; and
      •   transactions in Direct Participation Program securities, except as otherwise provided in the UPC.

      Much of the NASD Rule 11000 Series has been transferred with minor changes into the Consolidated FINRA Rulebook, to update certain references and terminology.1 FINRA Rules 11111 (Refusal to Abide by Rulings of the Committee) and 11112 (Review by Panels of the UPC Committee) consolidate and clarify the scope of reviews by the UPC Committee. FINRA Rules 11820 (Selling-Out), 11860 (COD Orders), 11810 (Buying-In) and 11810.03 (Sample Buy-In Forms) harmonize the differences between the corresponding NYSE rules and the NASD rules and update certain procedures and time frames. New FINRA Rule 11810(b)(4) (Notice of "Buy-In" and Confirmation of Receipt) provides that a seller that receives notice of a "buy-in" must reject it in the manner and time frame provided or will be deemed to have accepted such notice.

      FINRA Rules 11870 (Customer Account Transfer Contracts) and 11870.03 (Sample Transfer Instruction Forms) incorporate certain guidance from NYSE Rule 412 (Customer Account Transfer Contracts).2

      Rule/Series No. Rule Title
      Rule 11000 Series UNIFORM PRACTICE CODE ("UPC")
      Rule 11100 Scope of Uniform Practice Code
      Rule 11110 Committees
      Rule 11111 Refusal to Abide by Rulings of the Committee
      Rule 11112 Review by Panels of the UPC Committee
      Rule 11120 Definitions
      Rule 11121 Trade Date
      Rule 11130 When, As and If Issued/Distributed Contracts
      Rule 11140 Transactions in Securities "Ex-Dividend," "Ex-Rights" or "Ex-Warrants"
      Rule 11150 Transactions "Ex-Interest" in Bonds Which Are Dealt in "Flat"
      Rule 11160 "Ex" Liquidating Payments
      Rule 11170 Transactions in "Part-Redeemed" Bonds
      Rule 11190 Reconfirmation and Pricing Service Participants
      Rule 11200 Series COMPARISONS OR CONFIRMATIONS AND "DON'T KNOW NOTICES"
      Rule 11210 Sent by Each Party
      Rule 11220 Description of Securities
      Rule 11300 Series DELIVERY OF SECURITIES
      Rule 11310 Book-Entry Settlement
      Rule 11320 Dates of Delivery
      Rule 11330 Payment
      Rule 11340 Stamp Taxes
      Rule 11350 Part Delivery
      Rule 11360 Units of Delivery
      Rule 11361 Units of Delivery—Stocks
      Rule 11362 Units of Delivery—Bonds
      Rule 11363 Units of Delivery—Unit Investment Trust Securities
      Rule 11364 Units of Delivery—Certificates of Deposit for Bonds
      Rule 11365 Trading Securities As "Units" or Bonds "With Stock"
      Rule 11400 Series DELIVERY OF SECURITIES WITH DRAFT ATTACHED
      Rule 11410 Acceptance of Draft
      Rule 11500 Series DELIVERY OF SECURITIES WITH RESTRICTIONS
      Rule 11510 Delivery of Temporary Certificates
      Rule 11520 Delivery of Mutilated Securities
      Rule 11530 Delivery of Securities Called for Redemption or Which Are Deemed Worthless
      Rule 11540 Delivery Under Government Regulations
      Rule 11550 Assignments and Powers of Substitution; Delivery of Registered Securities
      Rule 11560 Certificate of Company Whose Transfer Books Are Closed
      Rule 11570 Certificates in Various Names
      Rule 11571 Certificate in Name of Corporation
      Rule 11572 Certificate in Name of Firm
      Rule 11573 Certificate in Name of Dissolved Firm Succeeded by New Firm
      Rule 11574 Certificate in Name of Deceased Person, Trustee, etc.
      Rule 11580 Transfer of Limited Partnership Securities
      Rule 11581 Limited Partnership Transfer Forms
      Rule 11600 Series DELIVERY OF BONDS AND OTHER EVIDENCES OF INDEBTEDNESS
      Rule 11610 Liability for Expenses
      Rule 11620 Computation of Interest
      Rule 11630 Due-Bills and Due-Bill Checks
      Rule 11640 Claims for Dividends, Rights, Interest, etc.
      Rule 11650 Transfer Fees
      Rule 11700 Series RECLAMATIONS AND REJECTIONS
      Rule 11710 General Provisions
      Rule 11720 Irregular Delivery—Transfer Refused—Lost or Stolen Securities
      Rule 11721 Obligations of Members Who Discover Securities in Their Possession to Which They Are Not Entitled
      Rule 11730 Called Securities
      Rule 11740 Marking to the Market
      Rule 11800 Series CLOSE OUT PROCEDURES
      Rule 11810 Buy-In Procedures and Requirements
      Rule 11820 Selling-Out
      Rule 11830 Reserved
      Rule 11840 Rights and Warrants
      Rule 11860 COD Orders
      Rule 11870 Customer Account Transfer Contracts
      Rule 11880 Settlement of Syndicate Accounts
      Rule 11900 Clearance of Corporate Debt Securities

      1 NASD Rules 11890 (Clearly Erroneous Transactions), IM-11890-1 (Refusal to Abide by Rulings) and IM-11890-2 (Review by Panels of the UPC Committee) were adopted, with significant changes, into the Consolidated FINRA Rulebook as the FINRA Rule 11890 Series (Clearly Erroneous Transactions) pursuant to a separate rule filing and were not addressed as part of this rule filing. See Exchange Act Release No. 61080 (Dec. 1, 2009), 74 FR 64117 (Dec. 7, 2009) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-068).

      2 FINRA eliminated NYSE Rule 412 and its interpretations from the Transitional Rulebook as part of a rule change to reduce regulatory duplication for Dual Members during the period before completion of the Consolidated FINRA Rulebook. See Exchange Act Release No. 58533 (Sept. 12, 2008), 73 FR 54652 (Sept. 22, 2008) (Order Approving Proposed Rule Change; File No. SR-FINRA-2008-036). The NYSE subsequently amended its version of NYSE Rule 412 to state that NYSE members and member organizations shall comply with NASD Rule 11870, concerning the transfer of customer accounts between members, and any amendments thereto, as if such rule is part of the NYSE's rules.

    • 10-48 Amendments to FINRA Trade Reporting and OATS Rules to Reinstitute Short Sale Exempt Marking and to Require Price and Short Exempt Identifier on Route Reports; Effective Date: November 10, 2010

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      The effective date was extended to February 28, 2011.

      Short Sales

      Regulatory Notice
      Notice Type

      Rule Amendment
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading and Market Making
      Key Topics

      OATS
      ShortSales
      Trade Reporting
      Referenced Rules

      FINRA Rule 6182
      FINRA Rule 6282
      FINRA Rule 6380A
      FINRA Rule 6380B
      FINRA Rule 6622
      FINRA Rule 7230A
      FINRA Rule 7230B
      FINRA Rule 7330
      FINRA Rule 7440
      NASD IM-2110-2

      Executive Summary

      The SEC has approved a FINRA rule change that, among other things, reinstitutes the short sale exempt marking category for trade reports to a FINRA trade reporting facility (TRF) or to FINRA's Alternative Display Facility (ADF) (together, "FINRA Facilities"). The rule change also requires FINRA Order Audit Trail System (OATS) route reports to include price and a short exempt identifier, if applicable.1 The amendments are effective on November 10, 2010,2 consistent with the compliance date of the amendments to SEC Regulation SHO.3

      The text of the amendments are available in the FINRA Manual at www.finra.org/finramanual.

      Questions regarding this Notice should be directed to:

      •   FINRA Operations at (866) 776-0800; or
      •   OATS Helpdesk at (800) 321-6273
      •   Racquel Russell, Assistant General Counsel, Office of General Counsel, at (202) 728-8363.

      Background and Discussion

      On February 26, 2010, the SEC adopted amendments to Regulation SHO that, among other things, implement a short-sale circuit breaker for NMS stocks4 triggered by a 10 percent or more decrease in the price of the security from the security's closing price at the end of regular trading hours on the prior trading day. Once a circuit breaker is triggered, Regulation SHO, as amended, generally requires trading centers to establish, maintain and enforce written policies and procedures reasonably designed to prevent the execution or display of short sale orders of an NMS stock at a price that is less than or equal to the current national best bid (NBB) for the remainder of the day and the following day, unless an exemption applies ("short sale price test restriction").5

      As amended, Regulation SHO provides several exemptions to the short sale price test restriction and sets forth provisions under which a short sale order may be marked "short exempt." These provisions include:

      •   broker-dealer policies and procedures;
      •   seller's delay in delivery;
      •   odd lot transactions;
      •   domestic arbitrage;
      •   international arbitrage;
      •   over-allotments and lay-off sales;
      •   riskless principal transactions; and
      •   transactions on a volume-weighted average price basis (or VWAP).6

      Consistent with these amendments to Regulation SHO, FINRA is reinstituting the "short sale exempt" marking category in FINRA's trade reporting rules for over-the-counter transactions in NMS stocks. Thus, firms must indicate on trade reports submitted to a FINRA Facility if a transaction is "short exempt," consistent with Regulation SHO.7

      In addition, the OATS rules have been amended to provide that, when an order is received or originated, firms must record the designation of the order as "short sale exempt" if the order is marked "short exempt" for Regulation SHO purposes. The amendments also require that firms include on route reports, if applicable, the price at which the order is routed and a short exempt identifier.8

      On October 6, 2010, SEC staff issued Responses to Frequently Asked Questions Concerning Rule 201 of Regulation SHO (the SEC Rule 201 FAQ) that address, among other things, a firm's compliance obligations under self-regulatory organization customer order protection rules when a short sale price test restriction is in effect. In cases where a firm is short in a security and buys shares of that security during a short sale price test restriction (at a price that would trigger a fill of a customer limit order to buy under NASD IM-2110-2), SEC staff stated that the firm must fill the customer order (by selling short to the customer), regardless of whether such sale would meet the requirements of the price test restrictions of Rule 201 of Regulation SHO.9 The SEC Rule 201 FAQ further provides that, in this instance, the firm may mark the short sale order to fill the customer limit order as "short exempt."

      The SEC Rule 201 FAQ also clarifies, among other things, that where a customer limit order to sell short at the NBB is triggered by a firm's long sale at the NBB in the same security, the firm's long sale would not require the execution of the customer's short sale limit order because the customer's limit order would not have been executable under Rule 201 (because it is a short sale priced at the NBB).10

      These amendments to FINRA rules are effective on November 10, 2010, consistent with the compliance date of the amendments to SEC Regulation SHO.


      1 See Securities Exchange Act Release No. 63032 (October 4, 2010), 75 FR 62439 (October 8, 2010) (Order Approving SR-FINRA-2010-043).

      2 As noted in the OATS Reporting Technical Specifications dated August 30, 2010, the new fields will be required on OATS route reports beginning on November 8, 2010; however, members are not required to populate the fields until November 10, 2010. If a firm populates the fields prior to November 10, 2010, all relevant field validations will apply. Firms should consult the OATS Reporting Technical Specifications for more information. See also OATS Frequently Asked Questions, Question C85.

      3 The amendments to Regulation SHO became effective on May 10, 2010 with a compliance date of November 10, 2010.

      4 "NMS stock" means any "NMS security" other than an option. See 17 CFR 242.600(b)(47). Rule 600(b)(46) of SEC Regulation NMS defines "NMS security" as any security or class of securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options. See 17 CFR 242.600(b)(46).

      5 See Securities Exchange Act Release No. 61595 (February 26, 2010), 75 FR 11232 (March 10, 2010) (Adopting Release for Regulation SHO, as amended).

      6 SEC staff has indicated that firms may use the existing weighted average price (W) trade reporting modifier to satisfy the requirement in the VWAP exception that the transaction be reported using a special VWAP trade modifier. See Rule 201(d)(7) of Regulation SHO. The use of the W modifier would be in addition to the requirement to report the trade as "short sale exempt."

      7 Generally, FINRA expects firms to report transactions to FINRA Facilities in a manner that is consistent with the marking of the order for the purposes of Regulation SHO. However, we understand that, in some cases, the status of an order may change between the time of order origination and execution such that the trade report is marked differently than the order (e.g., a circuit breaker is triggered or the NBB changes). If the trade report differs from the order, members must be prepared to provide, upon request from FINRA, documentation or evidence as to the reason for the difference.

      8 Whenever a firm transmits an order to another member firm, electronic communications network, non-member firm or national securities exchange for handling or execution, the routing firm is responsible for recording and reporting a route report to OATS. As amended, the OATS rules require route reports to include the price at which the order was routed, which may be different from the price received from the customer, and whether the routed order is short exempt.

      The short exempt identifier is important for purposes of route reports because certain short sale orders will be eligible to be marked exempt solely as a result of the timing and price of the routed order. See Rule 201(c) of SEC Regulation SHO. As of November 10, 2010, firms are also required to indicate the order type on route reports (i.e., whether the order is a limit order and, consequently, requires that the limit price be included on the route report). For a complete description of these and other changes to OATS that go into effect on November 10, 2010, firms should consult the OATS Reporting Technical Specifications on FINRA's website.

      9 See Question # 8.1 of the SEC Rule 201 FAQ.

      10 See Question # 8.2 of the SEC Rule 201 FAQ.

    • 10-47 SEC Approves Consolidated FINRA Rule on the Sale of Securities in a Fixed Price Offering; Effective Date: February 8, 2011

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      Fixed Price Offerings

      Regulatory Notice
      Notice Type

      Consolidated FINRA Rulebook
      New Rule
      Suggested Routing

      Corporate Financing
      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Fixed Price Offerings
      Referenced Rules & Notices

      NASD Rule 0120
      NASD Rule 2730
      NASD Rule 2740
      NASD Rule 2750
      NASD IM-2730
      NASD IM-2740
      NASD IM-2750
      FINRA Rule 5130
      FINRA Rule 5141

      Executive Summary

      The SEC approved FINRA's proposed rule change1 to adopt a new rule governing fixed price offerings for the consolidated FINRA rulebook (the Consolidated FINRA Rulebook).2 The new rule—FINRA Rule 5141—protects the integrity of fixed price offerings by ensuring that securities in such offerings are sold to the public at the stated public offering price or prices. The new rule is based in part on, and replaces, provisions in the NASD Rules.3

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

      The rule change takes effect on February 8, 2011.

      Questions concerning this Notice should be directed to:

      •   Adam H. Arkel, Assistant General Counsel, Office of General Counsel (OGC), at (202) 728-6961; or
      •   Gary L. Goldsholle, Vice President and Associate General Counsel, OGC, at (202) 728-8104.

      Background & Discussion

      FINRA Rule 5141 is a new, consolidated rule that protects the integrity of fixed price offerings4 by ensuring that securities in such offerings are sold to the public at the stated public offering price or prices. The rule prohibits the grant of certain preferences (e.g., selling concessions, discounts, other allowances or various economic equivalents) in connection with fixed price offerings of securities.

      General Requirements; Definition of "Reduced Price"

      FINRA Rule 5141(a) provides that no member or person associated with a member that participates in a selling syndicate or selling group5 in connection with a fixed price offering may offer or grant, directly or indirectly, to any person6 or account that is not a member of the selling syndicate or selling group any securities in the offering at a price below the stated public offering price (i.e., a "reduced price").7 The term "reduced price" is defined under FINRA Rule 5141.01 to include, without limitation, any offer or grant of any selling concession, discount or other allowance, credit, rebate, reduction of any fee (including any advisory or service fee), any sale of products or services at prices below reasonable commercially available rates for similar products and services (except for research, which, as discussed below, is subject to FINRA Rule 5141.02), or any purchase of or arrangement to purchase securities from the person or account at more than their fair market price in exchange for securities in the offering.8

      The requirements of the new rule apply until the termination of the offering or until a member, having made a bona fide public offering of the securities, is unable to continue selling such securities at the stated public offering price. For purposes of the rule, securities in a fixed price offering are presumed salable if the securities immediately trade in the secondary market at a price or prices which are above the stated public offering price.

      Sales to Affiliated Persons

      FINRA Rule 5141(a) provides that, subject to the requirements of FINRA Rule 5130,9 a member of a selling syndicate or selling group is permitted to sell securities in the offering to an affiliated person, provided the member does not sell the securities to the affiliated person at a reduced price as set forth under the rule. FINRA Rule 5141.03 provides that transactions between a member of a selling syndicate or selling group and an affiliated person that are part of the normal and ordinary course of business and are unrelated to the sale or purchase of securities in a fixed price offering shall not be deemed to confer a reduced price under the new rule.

      Research

      FINRA Rule 5141.02 states that nothing in the new rule prohibits a member or person associated with a member that participates in a selling syndicate or selling group from selling securities in the offering to a person or account to which it has provided or will provide research, as long as the person or account pays the stated public offering price for the securities and the research is provided pursuant to the requirements of Section 28(e) of the Exchange Act. The rule provides that investment management or investment discretionary services are not research for purposes of the provision. The rule further requires that any product or service provided by a member or person associated with a member that does not qualify as research must not confer a reduced price as set forth under FINRA Rule 5141.01 (see above).

      Investment Advisers

      FINRA Rule 5141.05 permits a member that is an investment adviser to exempt securities that are purchased as part of a fixed price offering from the calculation of annual or periodic asset-based fees that the member charges a customer, provided the exemption is part of the member's normal and ordinary course of business with the customer and is not in connection with an offering.


      1 For more information, see Securities Exchange Act Release No. 62539 (July 21, 2010), 75 FR 44033 (July 27, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2010-029).

      2 The current FINRA rulebook consists of: (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA member firms, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice 03/12/08 (Rulebook Consolidation Process).

      3 Effective February 8, 2011, NASD Rules 0120(h), 2730, 2740 and 2750, and NASD IM-2730, IM-2740 and IM-2750 will be deleted from the Transitional Rulebook.

      4 FINRA Rule 5141.04—transferred from NASD Rule 0120(h) in substantially identical form—defines "fixed price offering" to mean the offering of securities at a stated public offering price or prices, all or part of which securities are publicly offered in the United States or any territory thereof, whether or not registered under the Securities Act, except that the term does not include offerings of "exempted securities" or "municipal securities" as those terms are defined in Sections 3(a)(12) and 3(a)(29), respectively, of the Exchange Act or offerings of redeemable securities of investment companies registered pursuant to the Investment Company Act which are offered at prices determined by the net asset value of the securities.

      5 FINRA Rule 5141(b) provides that nothing in the rule prohibits the purchase and sale of securities in a fixed price offering between members of the selling syndicate or selling group. The terms "selling group" and "selling syndicate" are defined in NASD Rules 0120(p) and (q), respectively, and will be addressed later in the rulebook consolidation process. Other than to reflect the new conventions of the Consolidated FINRA Rulebook, FINRA does not plan to alter these two definitions.

      6 NASD Rule 0120(n), which will be addressed later in the rulebook consolidation process, defines "person" to include any natural person, partnership, corporation, association or other legal entity. Other than to reflect the new conventions of the Consolidated FINRA Rulebook, FINRA does not plan to alter this definition.

      7 The new rule's requirements also apply to any member or person associated with a member that acts as the single underwriter in connection with a fixed price offering. For convenience, all references in this Notice to requirements that apply to the selling syndicate or selling group include single underwriters. See FINRA Rules 5141(a), 5141.02 and 5141.03; see also 75 FR 44033 at 44034.

      8 FINRA Rule 5141.01 provides that "fair market price" refers generally to a price or range of prices at which a buyer and a seller, each unrelated to the other, would purchase the securities in the ordinary course of business in transactions that are of similar size and similar characteristics and are independent of any other transaction. FINRA notes that this definition of "fair market price" is solely for purposes of FINRA Rule 5141 and is not intended to affect any other provisions with respect to pricing that are set forth in the FINRA rulebook.

      9 FINRA Rule 5130 (former NASD Rule 2790) addresses restrictions on the purchase and sale of initial equity public offerings. The rule generally prohibits sales to and purchases by a broker-dealer and accounts in which a broker-dealer has a beneficial interest.


      ATTACHMENT A

      Below is the text of new FINRA Rule 5141.

      * * * * *

      5141. Sale of Securities in a Fixed Price Offering

      (a) No member or person associated with a member that participates in a selling syndicate or selling group or that acts as the single underwriter in connection with a fixed price offering shall offer or grant, directly or indirectly, to any person or account that is not a member of the selling syndicate or selling group or that is a person or account other than the single underwriter any securities in the offering at a price below the stated public offering price ("reduced price"). Subject to the requirements of Rule 5130, a member of a selling syndicate or selling group, or a member that acts as the single underwriter, is permitted to sell securities in the offering to an affiliated person, provided such member does not sell the securities to the affiliated person at a reduced price under this Rule. The requirements of this Rule shall apply until the termination of the offering or until a member, having made a bona fide public offering of the securities, is unable to continue selling such securities at the stated public offering price. For purposes of this Rule, securities in a fixed price offering shall be presumed salable if the securities immediately trade in the secondary market at a price or prices which are above the stated public offering price.
      (b) Nothing in this Rule shall prohibit the purchase and sale of securities in a fixed price offering between members of the selling syndicate or selling group.

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

      .01 Reduced Price. For the purposes of this Rule, "reduced price" includes, without limitation, any offer or grant of any selling concession, discount or other allowance, credit, rebate, reduction of any fee (including any advisory or service fee), any sale of products or services at prices below reasonable commercially available rates for similar products and services (except for research subject to Rule 5141.02), or any purchase of or arrangement to purchase securities from the person or account at more than their fair market price in exchange for securities in the offering. For purposes of this Supplementary Material, "fair market price" refers generally to a price or range of prices at which a buyer and a seller, each unrelated to the other, would purchase the securities in the ordinary course of business in transactions that are of similar size and similar characteristics and are independent of any other transaction.
      .02 Research. Nothing in this Rule shall prevent a member or person associated with a member that participates in a selling syndicate or selling group, or a member that acts as the single underwriter, from selling securities in the offering to a person or account to which it has provided or will provide research, provided the person or account pays the stated public offering price for the securities and the research is provided pursuant to the requirements of Section 28(e) of the Exchange Act. Investment management or investment discretionary services are not research for purposes of this Supplementary Material. Any product or service provided by a member or person associated with a member that does not qualify as research under this Supplementary Material must not confer a reduced price as set forth in Rule 5141.01.
      .03 Affiliated Persons. Transactions between a member of a selling syndicate or selling group, or between a member that acts as the single underwriter, and an affiliated person that are part of the normal and ordinary course of business and are unrelated to the sale or purchase of securities in a fixed price offering shall not be deemed to confer a reduced price under this Rule.
      .04 Fixed Price Offering. The term "fixed price offering" means the offering of securities at a stated public offering price or prices, all or part of which securities are publicly offered in the United States or any territory thereof, whether or not registered under the Securities Act, except that the term does not include offerings of "exempted securities" or "municipal securities" as those terms are defined in Sections 3(a)(12) and 3(a)(29), respectively, of the Exchange Act or offerings of redeemable securities of investment companies registered pursuant to the Investment Company Act which are offered at prices determined by the net asset value of the securities.
      .05 Asset-Based Fees. A member that is an investment adviser may exempt securities that are purchased as part of a fixed price offering from the calculation of annual or periodic asset-based fees that such member charges to a customer, provided such exemption is part of the member's normal and ordinary course of business with the customer and is not in connection with an offering.

      * * * * *

    • 10-46 Supplemental FOCUS Filing Requirement Applicable to Certain Joint Broker-Dealers/Futures Commission Merchants; Effective Date: FOCUS Report Due on November 23, 2010, Covering the October 2010 Reporting Period

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      FOCUS Reporting

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      SEA Rule 17a-5
      FINRA Rule 4521
      Suggested Routing

      Accounting
      Compliance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      FOCUS Reporting

      Executive Summary

      Beginning with the monthly FOCUS Report that is due on November 23, 2010 (covering the October 2010 reporting period), each member firm that is a futures commission merchant (FCM) and clears OTC derivatives for customers through Chicago Mercantile Exchange Inc. (CME)—either as a CME clearing member itself or as a carrying, non-clearing firm through a CME clearing member—must file with FINRA a new statement pertaining to customer cleared OTC derivatives. This requirement arises from recent amendments by CME to its financial reporting rules and forms and by National Futures Association (NFA) to its financial requirements rules.

      The new statement—the Statement of Sequestration Requirements and Funds in Cleared OTC Derivatives Sequestered Accounts (Sequestration Statement)—is a supplemental schedule to FOCUS Report Parts II and II CSE and firms must file it with FINRA as part of their monthly FOCUS Reports.

      The Sequestration Statement is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •  Yui Chan, Managing Director, Risk Oversight & Operational Regulation (ROOR), at (646) 315-8426; or
      •  Kathryn Mahoney, Director, ROOR, at (646) 315-8428.

      Background and Discussion

      Effective May 6, 2010, the Commodity Futures Trading Commission (CFTC) adopted new amendments to the CFTC's Regulation Part 1901 that, among other things, create a new customer account class for "cleared OTC derivatives" (as defined in new CFTC Regulation 190.01(oo)), applicable only to the bankruptcy of a commodity broker that is an FCM.2 As stated in the CFTC adopting release for these new regulations, "... a position in an OTC derivative (and relevant collateral) that a customer clears through an FCM with a DCO [derivatives clearing organization], which position (and collateral) is not subject to a Section 4d [of the Commodity Exchange Act] Order, would be considered part of the cleared OTC derivative account class, as soon as, but only after, a DCO rule... that requires such positions (and relevant collateral) to be held in a separate account for cleared OTC derivatives becomes effective..."3

      Following the CFTC's adoption of the new Regulation Part 190 requirements, CME, as a DCO, adopted new rules requiring that customer "cleared OTC derivatives" be held in a separate account, titled "Customer Cleared OTC Derivatives Sequestered Account," subject to specified requirements, including the preparation of a Sequestration Statement.4 NFA also adopted rule amendments that would require its carrying, non-clearing FCM members that clear OTC derivatives for customers through a CME clearing member to comply with CME's new rules as well.5

      In June, CME advised FCMs to develop the necessary accounting and operational systems, procedures and controls to ensure that they are able to adhere to the new requirements when the rules become effective.6 Among other things, CME stated that FCMs should open new bank and safekeeping accounts for cleared OTC customer assets. The new CME sequestration requirements became effective on October 4, 2010.7

      Pursuant to FINRA Rule 4521(a), FINRA member firms that are FCMs and that clear OTC derivative products through a DCO or any other facility that has OTC derivatives sequestration requirements, in complying with such facility's requirements, must file with FINRA the Sequestration Statement, or such similar form as the facility may require, as a supplement to the electronic FOCUS Report filing (FOCUS Report Parts II and II CSE). FINRA member firms that are FCMs and subject to CME's requirements must file the Sequestration Statement in eFOCUS and WinJammer, commencing with the monthly FOCUS Report that is due November 23, 2010 (covering the October 2010 reporting period).


      1 See 17 CFR Chapter 1 Part 190 (Bankruptcy).

      2 See 75 FR 17297 (April 6, 2010).

      3 See supra note 2 at 17301.

      4 CME's new cleared OTC derivatives sequestration rules are set forth in CME Group Audit Information Bulletin #10-07 (issued July 16, 2010). For further information regarding the CME's implementation of the new rules, see also CME Group Audit Information Bulletin #10-09 (issued August 17, 2010) and CME Group Advisory Notice #10-256 (Updates #1 and #2) (issued June 17, 2010).

      5 See Letter from Thomas W. Sexton, Senior Vice President and General Counsel, NFA, to David A. Stawick, Office of the Secretariat, CFTC, dated August 30, 2010. The new NFA rule—NFA Financial Requirements Section 4(b)—states that any NFA member FCM "that receives money, securities and/or other property from, for or on behalf of a customer to margin, guarantee or secure the customer's positions in cleared OTC derivatives... must comply with CFTC requirements and the requirements established by the applicable contract market and/or derivatives clearing organization for such activity."

      6 See CME Group Advisory Notice #10-256 (Update #1).

      7 See CME Group Audit Information Bulletin #10-09.


      ATTACHMENT A

      View PDF

    • 10-45 SEC Approval and Effective Date for New Consolidated FINRA Rules Regarding Margin Requirements, Daily Record of Required Margin, and Extension of Time Requests; Effective Date: December 2, 2010

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      Margin and Extension of Time Requests

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      Rule Approval
      Referenced Rules & Notices

      FINRA Rule 2360
      FINRA Rule 2370
      FINRA Rule 4110
      FINRA Rule 4120
      FINRA Rule 4210
      FINRA Rule 4220
      FINRA Rule 4230
      SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Institutional
      Legal
      Margin
      Operations
      Regulatory Reporting
      Senior Management
      Systems
      Trading
      Key Topic(s)

      Extension of Time Requests
      Margin
      Regulation T
      SEA Rule 15c3-3

      Executive Summary

      FINRA's rule change1 to adopt consolidated rules regarding margin requirements, daily record of required margin and extension of time requests under Regulation T and SEA Rule 15c3-3 for the Consolidated FINRA Rulebook2 becomes effective December 2, 2010.

      The new FINRA rules are based on and replace provisions in the NASD and Incorporated NYSE Rules.3 The new rules also clarify that a firm must take into account the special deductions from net capital set forth in FINRA Rule 4210 (Margin Requirements) in determining its status under FINRA Rule 4120 (Regulatory Notification and Business Curtailment).4

      This Notice also announces the adoption of the Incorporated NYSE Rule 431 Interpretations, subject to certain amendments, as interpretations to FINRA Rule 4210, which also become effective December 2, 2010.

      The text of the new rules is in Attachment A on our website at www.finra.org/notices/10-45. The FINRA Rule 4210 interpretations are available at www.finra.org/rules/4210interpretations.

      Questions concerning this Notice should be directed to:

      •  Rudolph R. Verra, Managing Director, Risk Oversight and Operational Regulation, at (646) 315-8811;
      •  Glen Garofalo, Director, Credit Regulation, at (646) 315-8464;
      •  Steve Yannolo, Principal Credit Specialist, Credit Regulation, at (646) 315-8621; or
      •  Kathryn Moore, Assistant General Counsel, Office of General Counsel, at (202) 974-2974.

      Background and Discussion

      A. FINRA Rule 4210 (Margin Requirements)

      FINRA has adopted the requirements set forth in NASD Rule 2520 (Margin Requirements) and related NASD margin rules and interpretations (NASD Rules 2521, 2522 and IM-2522), subject to certain amendments discussed below, as new FINRA Rule 4210 (Margin Requirements).

      The amendments, among other things, reflect certain requirements in Incorporated NYSE Rule 431 (Margin Requirements). FINRA Rule 4210, like its predecessor rules, prescribes requirements governing the extension of credit by firms that offer margin accounts to customers, as permitted in accordance with Regulation T of the Board of Governors of the Federal Reserve System (Regulation T).5 The rule promulgates the margin requirements that determine the amount of collateral customers are expected to maintain in their margin accounts, including strategy-based margin accounts and portfolio margin accounts. Maintenance margin requirements for equity, fixed income, warrants and option securities are also established under the rule.

      Rule Structure

      FINRA has restructured the consolidated rule to improve its organization and make it easier to read. FINRA Rule 4210(h) provides that any firm for which another self-regulatory organization acts as the designated examining authority is exempt from FINRA Rule 4210.

      In addition, FINRA Rule 4210(f)(2)(A) contains streamlined definitions for margining options, currency warrants, currency index warrants and stock index warrant transactions. FINRA also combined the margin provisions regarding currency warrants, currency index warrants and stock index warrants from NASD Rule 2520(f)(10) together with similar sections in paragraph (f)(2) of FINRA Rule 4210.

      Finally, the supplementary material to FINRA Rule 4210 provides illustrations on how to calculate the number of elapsed days for accrued interest on Treasury bonds or notes.

      Net Capital Calculations

      In certain instances, FINRA Rule 4210 specifies that firms should reference SEA Rule 15c3-1 and, if applicable, FINRA Rule 4110 (Capital Compliance), when computing net capital charges against net capital and haircut requirements.6 Firms may be subject to greater net capital requirements pursuant to the provisions of paragraph (c) of FINRA Rule 4110.

      Joint Accounts Exemption

      FINRA integrated Incorporated NYSE Rule 431 Supplementary Material .10 into FINRA Rule 4210(e)(3) regarding joint accounts in which the carrying firm or a partner or stockholder has an interest. The provision permits a firm to seek an exemption under the FINRA Rule 9600 Series if the account is confined exclusively to transactions and positions in exempted securities. FINRA Rule 4210(e)(3) provides the required information to be included in any such application.

      Additional Requirements on Control and Restricted Securities and Relationship to FINRA Rule 4120

      FINRA adopted provisions from Incorporated NYSE Rule 431 pertaining to deductions from net capital on control and restricted securities. These provisions, set forth in FINRA Rule 4210(e)(8)(C)(ii), (iii) and (v), require that a firm make deductions from its net capital if it extends credit over specified thresholds on control and restricted securities, and it must take such deductions into account when determining if it has reached any of the financial triggers specified in FINRA Rule 4120 (Regulatory Notification and Business Curtailment).7 The rule change also made conforming amendments to FINRA Rule 4120(a)(1)(F) and (c)(1)(F) to clarify that a firm must take into account the special deductions from net capital set forth in FINRA Rule 4210(e)(8)(C) in determining its status under FINRA Rule 4120.

      Day Trading

      FINRA integrated Supplementary Material .60 from Incorporated NYSE Rule 431 in FINRA Rule 4210(f)(8)(B)(iii) to provide that the day-trading buying power for non-equity securities may be computed using the applicable special maintenance margin requirements pursuant to other provisions of the margin rule. In addition, FINRA adopted Supplementary Material .30 from Incorporated NYSE Rule 431 as FINRA Rule 4210(f)(8)(B)(iv)b. to provide that in the event that the firm at which a customer seeks to open an account or resume day trading in an existing account knows or has a reasonable basis to believe that the customer will engage in pattern day trading, then the minimum equity requirement of $25,000 must be deposited in the account prior to commencement of day trading.

      Portfolio Margining

      FINRA amended FINRA Rule 4210(g)(5)(B) to highlight that portfolio margin-eligible participants, in addition to being required to be approved to engage in uncovered short option contracts pursuant to FINRA Rule 2360 (Options), must be approved to engage in security futures transactions pursuant to FINRA Rule 2370 (Security Futures), if eligible participants engage in such transactions.

      Conforming Amendments

      FINRA added the terms "approved market maker," "market maker" and "market making" to FINRA Rule 4210(f)(10)(F) to conform to rule changes made by the NYSE.8 The NYSE changes were made in connection with the operation of the NYSE's Market Model.9 As a result of the implementation of these changes, the NYSE amended several of its rules, including NYSE Rule 431(f)(10)(F), to add the terms "approved market maker," "market maker" and "market making" to reflect the current Designated Market Makers operating on the NYSE. FINRA amended the definitions of the same terms used in FINRA Rule 4210(e)(5)(A) and (f)(10)(E) for consistency purposes.

      Clarifying and Technical Amendments

      Finally, FINRA made several technical changes to the margin rule text to update terminology and similar clarifications. First, FINRA added definitions regarding "listed" and "OTC" options.

      Second, in FINRA Rule 4210(f)(2)(I)(iv), FINRA made several clarifications to terminology where no margin may be required if the specified options or warrants are carried "short" in the account of a customer, against an escrow agreement, and either are held in the account at the time the options or warrants are written or received in the account promptly thereafter. The rule change clarified that with respect to such options or warrants, an escrow agreement is used, in a form satisfactory to FINRA, issued by a third-party custodian bank or trust company, and in compliance with the requirements of Rule 610} of The Options Clearing Corporation.

      The rule change also replaced the term "guarantor" with the term "custodian" to more accurately reflect the third party's role. In addition, the rule change revised the definition of what constitutes a qualified security by eliminating the reference to the list of Over-the-Counter Margin Stocks published by the Board of Governors of the Federal Reserve System as the Federal Reserve no longer publishes such a list.

      Margin Interpretations

      FINRA is also adopting Incorporated NYSE Rule 431 Interpretations, subject to certain amendments, as interpretations to FINRA Rule 4210. The FINRA Rule 4210 interpretations, which become effective on December 2, 2010, are available on our website at www.finra.org/rules/4210interpretations.
      B. FINRA Rule 4220 (Daily Record of Required Margin)

      FINRA adopted Incorporated NYSE Rule 432(a) (Daily Record of Required Margin) as FINRA Rule 4220 in substantially the same form. The rule sets forth the requirements for daily recordkeeping of initial and maintenance margin calls that are issued pursuant to Regulation T and the margin rules.
      C. FINRA Rule 4230 (Required Submissions of Requests for Extension of Time Under Regulation T and SEA Rule 15c3-3)

      FINRA adopted NASD Rule 3160 (Extensions of Time Under Regulation T and SEC Rule 15c3-3) as FINRA Rule 4230. FINRA added a provision to FINRA Rule 4230 to clarify that for the months when no broker-dealer for which a clearing firm clears exceeds the extension-of-time ratio criteria specified by FINRA (currently set at 2 percent), the clearing firm must submit a report indicating such.

      As noted above, the new rules become effective December 2, 2010.

      1 See Securities Exchange Act Release No. 62482 (July 12, 2010) 75 FR 41562 (July 16, 2010) (SEC Order Granting Approval to File No. SR-FINRA-2010-024).

      2 The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA firms, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice 3/12/08 (Rulebook Consolidation Process).

      3 Effective December 2, 2010, NASD Rules 2520, 2521, 2522 and 3160; NASD IM-2522; Incorporated NYSE Rules 431, 432 and 434; and all Incorporated NYSE Rule 431 Interpretations will be deleted from the Transitional Rulebook.

      4 FINRA notes that, in devoting this Notice to announcing the effective date of a single set of rules and rule amendments, it is deviating from the protocol by which FINRA generally announces the effective dates of the new FINRA rules that are being adopted as part of the consolidated rulebook. See Information Notice 10/06/08 (Rulebook Consolidation Process: Effective Dates of New Consolidated Rules; Introduction of Rule Conversion Chart). FINRA believes that a single Notice devoted to the new margin and extension of time request rules is warranted in view of the regulatory subject matter.

      5 See Regulation T Section 220.4.

      6 See, e.g., FINRA Rule 4210(e)(2)(D), (e)(2)(F), (e)(2)(G), (e)(4), (e)(5) and (e)(6).

      7 See Regulatory Notice 09-71 (SEC Approves Consolidated FINRA Rules Governing Financial Responsibility) (December 2009) regarding FINRA Rule 4120.

      8 See Securities Exchange Act Release No. 59077 (December 10, 2008) 73 FR 76691 (December 17, 2008) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change by New York Stock Exchange LLC Amending Exchange Rule 104T to Make a Technical Amendment to Delete Language Relating to Orders Received by NYSE Systems and DMM Yielding; Clarifying the Duration of the Provisions of Rule 104T; Making Technical Amendments to Rule 98 and Rule 123E to Update Rule References for DMM Net Capital Requirements; Rescinding Paragraph (g) of Rule 123; and Making Conforming Changes to Certain Exchange Rules to Replace the Term "Specialist" with "DMM"; File No. SR-NYSE-2008-127).

      9 See Securities Exchange Act Release No. 58845 (October 24, 2008), 73 FR 64379 (October 29, 2008) (SEC Approval Order of SR-NYSE-2008-46 approving certain rules to operate as a pilot scheduled to end October 1, 2009.) See also Securities Exchange Act Release No. 60756 (October 1, 2009), 74 FR 51628 (October 7, 2009) (SR-NYSE-2009-100); Securities Exchange Act Release No. 61031 (November 19, 2009), 74 FR 62368 (November 27, 2009); and Securities Exchange Act Release No. 61724 (March 17, 2010), 75 FR 14221 (March 24, 2010) (extending the operation of the pilot until the earlier of SEC approval to make permanent or September 30, 2010). As part of this new model, the functions formerly carried out by specialists on the NYSE were replaced by a new market participant, known as a Designated Market Maker (DMM).

    • 10-44 New Alert-Reporting Criterion for Leverage in FOCUS Reports

      View PDF

      Financial and Operational Surveillance

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4120
      FINRA Rule 4521
      SEA Rule 15c3-1
      SEA Rule 17a-5
      Suggested Routing

      Finance
      Operations
      Regulatory Reporting
      Key Topic(s)

      Financial and Operational Surveillance

      Executive Summary

      In its continued effort to effectively monitor the financial and operational condition of firms, FINRA is publishing the alert-reporting criteria for FOCUS Reports and adding a new criterion for leverage. The new leverage criterion will be implemented with the next scheduled quarterly FOCUS filing.

      Questions concerning this Notice should be directed to:

      •  Ornella Bergeron, Managing Surveillance Director, Risk Oversight and Operational Regulation (ROOR), at (646) 315-8410
      •  Rosemarie Fanelli, Managing Surveillance Director, ROOR, at (646) 315-8452.

      Background & Discussion

      SEA Rule 17a-5(a) requires that every broker-dealer registered with the SEC file a periodic FOCUS Report (Part II or Part IIA of Form X-17A-5 Financial and Operational Combined Uniform Single Report) depending upon a firm's activities. These reports, which detail a firm's financial and operational conditions, are submitted electronically to FINRA and serve as the foundation for our financial and operational surveillance program. Our internal technology system compares FOCUS data to pre-established criteria to identify variances and discrepancies, and alerts staff to items that may require further review.

      FINRA closely monitors the net capital position as well as the profitability of firms for early signs of potential problems. A pattern of sizeable losses provides a warning signal that if such losses were to continue unchecked, the firm could be approaching financial difficulty in the near future.

      More detailed reporting may be required to provide a more complete picture of the condition of the firm. When deemed necessary, pursuant to FINRA Rule 4521, FINRA may require a single carrying or clearing firm or group of carrying or clearing firms to report certain financial and operational information weekly, or even daily, where FINRA deems such reports essential for the protection of investors and the public interest.

      FINRA's alert-monitoring criteria is designed to more closely surveil those firms that carry customer accounts or self-clear transactions that may be experiencing financial or operational problems that warrant special monitoring. The criteria that historically have been used include:

      1. Cumulative losses in two consecutive months equal to or in excess of 25 percent of current excess net capital.
      2. Cumulative losses in three consecutive months equal to or in excess of 30 percent of current excess net capital.
      3. Net capital ratio at or in excess of 1,000 percent or less than 5 percent of SEA Rule 15c3-3 aggregate debits.
      4. Net capital of less than 150 percent of a firm's minimum net capital requirement.
      5. Debt/equity ratio of 70 percent or greater for a period of 30 days or more.
      6. Net capital of less than 25 percent of haircuts, excluding contractual commitment haircuts.
      7. Restriction or reduction in business pursuant to FINRA Rule 4120.
      8. Other internal or external factors as determined by the staff, including but not limited to, severe operational or books and records problems, cash flow problems and proprietary and/or customer concentrations.

      FINRA is adding an additional criterion to the above list that is intended to measure leverage. The new leverage ratio will be computed by dividing total balance sheet assets, less U.S. Treasury and U.S. government agency inventory by total regulatory capital (the sum of stockholder's equity and subordinated debt). Any carrying or clearing firm whose ratio of such assets to regulatory capital exceeds 20 to one will be identified for further follow-up. If a firm meets this criterion, it should expect to be contacted by its Regulatory Coordinator with a request for more information, including a breakdown of the collateral between government-guaranteed and other securities collateralizing reverse repurchase and securities borrowed agreements.

      Firms that continue to exceed the 20 to one ratio, after excluding government-guaranteed assets, will be subject to heightened monitoring. This monitoring may include, but not be limited to, a request for high, low and average monthly balances for certain balance sheet line items, weekly net capital and reserve formula computation estimates, as well as more detail on specific balance sheet line items.

      FINRA intends to use the information obtained through this additional monitoring during the next year to determine whether it should implement rulemaking regarding leverage limits.

    • 10-43 Amendments to FINRA Rules on Trading Pauses Due to Extraordinary Market Volatility and Clearly Erroneous Transactions in Exchange-Listed Securities

      Effective Dates: Amendments to Rule 11892 Became Effective September 10, 2010; Amendment to Rule 6121 Became Effective September 14, 2010

      View PDF

      Single-Stock Circuit Breakers And Potentially Erroneous Trades

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 5260
      FINRA Rule 6121
      FINRA Rule 11892
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading and Market Making
      Key Topic(s)

      Clearly Erroneous Transactions
      Quotations
      Trading Halts

      Executive Summary

      On September 14, 2010, FINRA's individual stock trading-pause (also called a single-stock circuit breaker) pilot was expanded to include securities in the Russell 1000® Index as well as a pilot list of exchange traded products (ETPs).1

      On September 10, 2010, amendments to FINRA's clearly erroneous rules that refine and clarify the process for making clearly erroneous determinations for over-the-counter (OTC) transactions in exchange-listed securities, including events involving multiple stocks, became effective on a pilot basis. Both pilots are set to end on December 10, 2010.

      The text of the amendments can be found in the FINRA Manual at www.finra.org/finramanual.

      Questions concerning this Notice should be directed to:

      •  FINRA Operations at (866) 776-0800; or
      •  Racquel Russell, Assistant General Counsel, Office of General Counsel, at (202) 728-8363.

      Background & Discussion

      On September 10, 2010, the SEC approved amendments to FINRA Rule 6121 (Trading Halts Due to Extraordinary Market Volatility) to expand the trading-pause pilot, originally adopted on June 10, 2010,2 to include all stocks in the Russell 1000 Index and specified ETPs.3 Consistent with the original pilot, the expanded pilot provides that whenever a primary listing market issues a trading pause in a security, FINRA will similarly halt OTC trading by FINRA member firms, including alternative trading systems and market makers. As was the case under the original pilot, FINRA will generally halt OTC trading until trading has resumed on the primary listing market.4 FINRA reminds firms of their obligation to have policies and procedures in place that are reasonably designed to ensure that, among other things, they promptly cease effecting transactions during a trading halt as required by FINRA Rule 5260 (Prohibition on Transactions, Publication of Quotations, or Publication of Indications of Interest During Trading Halts).

      The SEC also approved amendments to FINRA Rule 11892 (Clearly Erroneous Transactions in Exchange-Listed Securities) that include changes to clarify the process for reviewing potentially erroneous trades in exchange-listed securities.5 The amendments are intended to, among other things, provide for uniform treatment of clearly erroneous reviews of: (1) multi-stock events involving 20 or more securities; and (2) transactions that trigger an individual stock trading pause by a primary listing market and subsequent transactions that occur before the trading halt is in effect for OTC trading.6

      With respect to multi-stock events, the amended rule creates a new category—multi-stock event involving 20 or more securities—to address clearly erroneous reviews regarding executions in 20 or more securities that occur within a period of five minutes or less. Once a multi-stock event is triggered, FINRA will coordinate with the exchanges and nullify as clearly erroneous all transactions at prices equal to or greater than 30 percent away from the reference price in each affected security, consistent with the following chart (also set forth in Rule 11892 (b)(1)).

      Reference Price: Circumstance or Product Normal Market Hours (9:30 a.m. to 4 p.m. Eastern Time) Numerical Guidelines (Subject Transaction's % Difference From Reference Price): Outside Normal Market Hours Numerical Guidelines (Subject Transaction's % Difference From Reference Price):
      Greater than $0.00 up to and including $25.00 10% 20%
      Greater than $25.00 up to and including $50.00 5% 10%
      Greater than $50.00 3% 6%
      Multi-stock event—events involving five or more, but less than 20, securities whose executions occurred within a period of five minutes or less 10% 10%
      Multi-stock event—events involving 20 or more securities whose executions occurred within a period of five minutes or less 30%, subject to the terms of paragraph (b)(2)7 30%, subject to the terms of paragraph (b)(2)
      Leveraged ETF/ETN securities Normal market hours numerical guidelines multiplied by the leverage multiplier (i.e., 2x) Normal market hours numerical guidelines multiplied by the leverage multiplier (i.e., 2x)

      The amended rule also provides that FINRA will use the Trading Pause Trigger Price in an individual stock8 as the reference price for clearly erroneous execution reviews of: (i) the transaction that triggered a trading pause; and (ii) subsequent transactions that occur immediately after a transaction that triggered a trading pause, but before a trading halt is in effect for OTC trading, and will apply the guidelines provided in the above chart (other than the numerical guidelines applicable to multi-stock events).9

      Both rule changes were proposed by FINRA in cooperation with the SEC and the exchanges in response to the market disruption of May 6, 2010, and are intended to address the impact of sudden price changes and provide additional parameters and transparency around reviews of potentially clearly erroneous transactions.

      For more information on the individual stock trading-pause pilot, go to www.finra.org to see FINRA rule filings FINRA-2010-025 and FINRA-2010-033, and Regulatory Notice 10-30. For more information on the amendments to FINRA Rule 11892, see FINRA rule filing FINRA-2010-032. As stated above, the amended rules will operate on a pilot basis. If the pilot is not extended or approved as permanent by December 10, 2010, the prior versions of the rules will be in effect on December 11, 2010.


      1 See Exhibit 3 of SR-FINRA-2010-033 for the pilot list of ETPs.

      2 See Securities Exchange Act Release No. 62251 (June 10, 2010); 75 FR 34183 (June 16, 2010) (Order Approving SR-FINRA-2010-025).

      3 See Securities Exchange Act Release No. 62883 (September 10, 2010); 75 FR 56608 (September 16, 2010) (Order Approving SR-FINRA-2010-033). On September 10, 2010, the SEC also approved similar rules by several exchanges to expand the single-stock circuit breaker pilot to Russell 1000 securities and certain ETPs.

      4 When trading has resumed on the primary listing market at the end of the five-minute pause, OTC trading may resume immediately in that security. If a primary listing market extends the trading pause beyond the initial five-minute pause period and reopens the security at or before the end of 10 minutes, OTC trading may resume immediately at that time. In very limited circumstances, FINRA may permit the resumption of OTC trading prior to the resumption of trading on the primary listing market. See Regulatory Notice 10-30, Question #6.

      5 See Securities Exchange Act Release No. 62885 (September 10, 2010); 75 FR 56641 (September 16, 2010) (Order Approving SR-FINRA-2010-032). On September 10, 2010, the SEC also approved similar rule changes filed by several exchanges.

      6 FINRA also proposed changes to Rule 11892 that, among other things, reduce the ability of FINRA to deviate from the objective standards set forth in the rule.

      7 During multi-stock events involving 20 or more securities, FINRA will determine the appropriate review period and may use a reference price other than the consolidated last sale in its review of potentially clearly erroneous executions. Decisions made by FINRA in consultation with the exchanges during multi-stock events involving 20 or more securities are not appealable. If a security that is part of a multi-stock event also is subject to a trading pause, the trading-pause review parameters will be applied.

      8 The Trading Pause Trigger Price is the price calculated by the primary listing market over a rolling five-minute period and may differ from the execution price of the transaction that triggered a trading pause. For example, the Trading Pause Trigger Price for a stock may be calculated as $15.00, so that any purchases at or below $15.00 would trigger a trading pause. However, the trade that ultimately triggers a trading pause may be executed at a price lower than the Trading Pause Trigger Price (i.e., $14.50 in this example). FINRA will use the Trading Pause Trigger Price calculated and communicated by the primary listing market as the Reference Price for calculating clearly erroneous executions, and not the execution price of a transaction that triggered a trading pause.

      9 Trades that occur when a trading halt is in effect are in violation of FINRA Rule 5260 and will be deemed clearly erroneous.

    • 10-42 SEC Approves Amendments to Establish Regulation NMS-Principled Rules in Market for OTC Equity Securities

      Effective Dates: FINRA Rules 6434, 6437 and 6450: February 11, 2011; FINRA Rule 6460 and NASD Rule 2320: May 9, 2011

      View PDF

      REG NMS-Principled Rules

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6240
      FINRA Rule 6434
      FINRA Rule 6437
      FINRA Rule 6450
      FINRA Rule 6460
      FINRA Rule 6540
      NASD Rule 2320
      SEA Regulation NMS
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Technology
      Trading and Market Making
      Key Topic(s)

      Access Fees
      Limit Order Display
      Locking and Crossing Quotations
      Minimum Pricing Increment
      OTC Equity Securities
      Quotations

      Executive Summary

      Effective February 11, 2011, and May 9, 2011, are new FINRA rules that extend certain Regulation NMS protections to quoting and trading of over-the-counter (OTC) Equity Securities.1 For OTC Equity Securities, these new rules:

      •  set forth the permissible pricing increments for the display of quotations and acceptance of orders;
      •  require firms to avoid locking and crossing quotations within an inter-dealer quotation system;
      •  establish a cap on access fees imposed against a firm's published quotation; and
      •  require an OTC Market Maker, subject to certain exceptions, to display the full size of customer limit orders that improve the price of the marker maker's displayed quotation or that represent more than a de minimis change in the size of the market maker's quote if at the best bid or offer (BBO).

      The text of the amendments can be found in the FINRA Manual at www.finra.org/finramanual.

      Questions regarding this Notice should be directed to Racquel Russell, Assistant General Counsel, Office of General Counsel, at (202) 728-8363.

      Background and Discussion

      FINRA is implementing new rules to extend certain SEC Regulation NMS protections to quoting and trading in OTC Equity Securities2 (NMS-Principled Rules). The NMS-Principled Rules include rules:

      •  defining quotation pricing increments;
      •  prohibiting locked and crossed quotations;
      •  implementing a cap on access fees; and
      •  requiring the display of customer limit orders by OTC Market Makers.3

      FINRA believes that applying these Regulation NMS principles to OTC Equity Securities will enhance market quality and investor protection in this market.

      The rules addressing minimum pricing increments for OTC Equity Securities (Rule 6434), prohibiting locked and crossed quotations in OTC Equity Securities (Rule 6437) and restricting access fees imposed against a firm's published quotation in OTC Equity Securities (Rule 6450) will become effective on February 11, 2011. The rule requiring the display of customer limit orders in OTC Equity Securities (Rule 6460) will become effective on May 9, 2011.

      Restrictions on Sub-penny Quoting

      FINRA Rule 6434 provides that, for OTC Equity Securities priced equal to or greater than $1.00 per share, no firm shall display, rank or accept a bid or offer, an order or an indication of interest in any OTC Equity Security that is priced in an increment smaller than $0.01. For OTC Equity Securities priced less than $1.00 per share, Rule 6434 prohibits firms from displaying, ranking or accepting a bid or offer, an order or an indication of interest priced in an increment smaller than $0.0001. However, in recognition of the smaller price points of OTC Equity Securities, where an order or indication of interest itself is priced less than $0.0001, a firm may rank or accept (but not display) such order or indication of interest in an increment of $0.000001 or greater.

      Locked and Crossed Markets

      FINRA Rule 6437 requires firms to implement policies and procedures to reasonably avoid displaying, or engaging in a pattern or practice of displaying, locking or crossing quotations in any OTC Equity Security.

      The rule defines a "crossing quotation" as "the display of a bid for an OTC Equity Security at a price that is higher than the displayed price of an offer for such OTC Equity Security in the same inter-dealer quotation system, or the display of an offer for an OTC Equity Security at a price that is lower than the displayed price of a bid for such OTC Equity Security in the same inter-dealer quotation system."4

      The term "locking quotation" is defined as "the display of a bid for an OTC Equity Security at a price that equals the displayed price of an offer for such OTC Equity Security in the same inter-dealer quotation system, or the display of an offer for an OTC Equity Security at a price that equals the displayed price of a bid for such OTC Equity Security in the same inter-dealer quotation system."5

      Access Fee Cap

      FINRA Rule 6450 provides that a firm may not impose, nor permit to be imposed, non-subscriber access or post-transaction fees against its published quotation in any OTC Equity Security that exceed or accumulate to more than certain specified limits. Specifically, if a published quotation is priced equal to or greater than $1.00, the access fee cap is $0.003 per share, which is the same cap under SEC Regulation NMS. However, with respect to published quotations priced under $1.00, the access fee cap for OTC Equity Securities is the lesser of: (i) 0.3% of the published quotation price on a per share basis, or (ii) 30% of the minimum pricing increment under Rule 6434 relevant to the display of the quotation on a per-share basis.

      Consistent with Regulation NMS's framework, FINRA's new NMS-Principled Rules also make clear that market makers, as well as alternative trading systems (ATSs), are permitted to charge access fees within the parameters of the access fee cap. In addition, FINRA Rule 6540(c) previously required that an ATS or electronic communication network (ECN) reflect non-subscriber access or post-transaction fees in the ATS's or ECN's posted quote in the OTC Bulletin Board montage—but this requirement is being eliminated.

      Limit Order Display

      FINRA Rule 6460 requires OTC Market Makers displaying a priced quotation in any OTC Equity Security in an inter-dealer quotation system to immediately6 publish a bid or offer that reflects:

      •  the price and the full size of each customer limit order held by the OTC Market Maker that is at a price that would improve the bid or offer of such OTC Market Maker in such security; and
      •  the full size of each customer limit order held by the OTC Market Maker that:
      •  is priced equal to the bid or offer of such OTC Market Maker for such security;
      •  is priced equal to the BBO of the inter-dealer quotation system in which the OTC Market Maker is quoting; and
      •  represents more than a de minimis change7 in relation to the size associated with the OTC Market Maker's bid or offer.

      Rule 6460 also includes parallel exceptions currently in place in Regulation NMS's limit order display rule (Rule 604 of SEC Regulation NMS). Thus, the new rule excepts any customer limit order that is:

      •  executed upon receipt of the order;
      •  placed by a customer who expressly requests, either at the time that the order is placed or prior thereto pursuant to an individually negotiated agreement with respect to such customer's orders, that the order not be displayed;
      •  an odd-lot order;
      •  a block size order, unless a customer placing such order requests that the order be displayed;
      •  delivered immediately upon receipt to a national securities exchange or an ECN that widely disseminates such order and that complies with enumerated requirements with respect to that order;8
      •  delivered immediately upon receipt to another OTC Market Maker that complies with the requirements of this rule with respect to that order; or
      •  an all-or-none order.

      Because FINRA Rule 6434 provides that firms may rank and accept (but not display) orders and indications of interest in an increment of $0.000001 or greater where an order or indication of interest itself is priced less than $0.0001, the limit order display rule likewise exempts from the display requirement any customer limit order that is priced less than $0.0001 per share.

      Frequently Asked Questions

      Question 1: FINRA Rule 6460 contains a de minimis standard applicable in situations where a customer limit order equals an OTC Market Maker's displayed price and that price is equal to the BBO. Will FINRA use the SEC's Regulation NMS Rule 604 interpretation of de minimis of 10 percent or less?

      Response: Yes. In connection with all of FINRA's NMS-Principled Rules, FINRA generally intends to adopt the same interpretive positions taken by the SEC in connection with the comparable provisions of Regulation NMS, unless explicitly noted otherwise. Thus, the size of a customer limit order is considered de minimis for purposes of Rule 6460 if it is less than or equal to 10 percent of the displayed size associated with an OTC Market Maker's bid or offer.

      Question 2: Must firms aggregate multiple, same-priced customer limit orders to determine whether the de minimis standard has been exceeded?

      Response: Yes. As is required by the SEC in connection with Regulation NMS's limit order display rule, firms must aggregate same-priced customer limit orders in OTC Equity Securities at the BBO in order to determine if the de minimis standard has been exceeded and the currently displayed quotation size updated.9 The SEC specifically stated that all orders previously considered de minimis and not displayed must be added to the order under consideration for purposes of the de minimis calculation.10 The same requirement shall apply under FINRA Rule 6460.

      Question 3: Rule 6460 generally requires OTC Market Makers to display the full size of any customer limit order that improves the price of the firm's quote if at the BBO. If the size of the customer limit order is less than the tier size requirements of Rule 6450 (Minimum Quotation Size Requirements for OTC Equity Securities), is the firm required to display the limit order?

      Response: No. If a firm receives a customer limit order in an OTC Equity Security at a price that improves such firm's displayed quotation, but for a size that is less than the tier size requirements of Rule 6450, the firm is not required to display the price and full size of such customer limit order.

      For example, if an OTC Market Maker's quote is $9.98–$10.00 (500x500) and the market maker receives a customer limit order to buy 200 shares at $9.99, the market maker is not required to display the customer limit order because it is less than the minimum tier-size requirement for securities priced between $1.01 and $10.00 (500 shares) under Rule 6450. However, if the market maker receives additional customer limit orders to buy at $9.99 that, together, equal 500 shares or greater, the market maker would be required to change its quotation to $9.99–$10.00 and to reflect the aggregate size of such orders.


      Question 4: Rule 6460 generally requires OTC Market Makers to publish "immediately" customer limit orders. What is FINRA's definition of "immediately?"

      Response: As stated above, FINRA generally intends to adopt those interpretative positions taken by the SEC in connection with comparable requirements under Regulation NMS. The SEC has stated that, unless relying on one of the exceptions to the limit order display rule, specialists or OTC Market Makers must display customer limit orders as soon as is practicable after receipt which, under normal market conditions, would require display no later than 30 seconds after receipt.11

      Question 5: Under Regulation NMS, a "block size" with respect to an order means it is: (A) of at least 10,000 shares or (B) for a quantity of stock having a market value of at least $200,000. Does this same definition apply to Rule 6460?

      Response: No. Rule 6460(d)(2) provides that "block size" with respect to an order means it is of at least 10,000 shares and has a market value of at least $100,000, which also is consistent with the large order size exception under NASD IM-2110-2 (Trading Ahead of Customer Limit Order). As discussed in the Proposing Release,12 because of the lower average trade prices (and corresponding higher average total share amount) of orders in OTC Equity Securities, FINRA believes that a 10,000 share standard alone would potentially exclude customer limit orders that should be displayed.

      Question 6: Rule 6460 provides an exception from the limit order display requirement for orders where the customer "expressly requests, either at the time that the order is placed or prior thereto pursuant to an individually negotiated agreement with respect to such customer's orders, that the order not be displayed." What type of documentation does FINRA expect firms to maintain in connection with such customer requests?

      Response: As similarly stated by the SEC in connection with Regulation NMS's limit order display rule, FINRA expects firms to discharge their responsibilities in such a manner as to allow adequate supervision of compliance with the customer's request not to display the full size of a limit order or to display pursuant to discretionary authority provided by the customer, and does not believe it necessary to mandate a particular method of recordkeeping.13 In addition, as stated in other contexts, FINRA believes that firms relying on this or any other exception should be able to proffer evidence of its eligibility for and compliance with the exception.

      However, FINRA notes that standardized disclaimers or contractual language in new account agreements would not be deemed an individual request by a customer that its order or orders not be displayed.14 In contrast, adequate evidence of a customer's request that a firm not display a limit order may, for example, include an affirmative letter from (or contract with) the customer specifically providing that the firm refrain from displaying the full size of a single order or a class of orders, or a notation entered on an order ticket or in the firm's order-management system made contemporaneously at the time of order receipt.

      Question 7: Must ECNs displaying a quotation on an inter-dealer quotation service comply with the limit order display rule?

      Response: No. FINRA Rule 6460 applies only to OTC Market Makers. However, we note that an exception exists for OTC Market Makers that deliver immediately a customer limit order to a national securities exchange or an ECN that widely disseminates such order and that complies with certain other requirements. Such requirements prescribe, among other things, that the ECN must provide to an inter-dealer quotation system the prices and sizes of the orders at the highest buy price and the lowest sell price for such security entered in, and widely disseminated by, the ECN.15

      Question 8: Rule 6437 requires a firm to implement policies and procedures that reasonably avoid displaying, or engaging in a pattern or practice of displaying, locking or crossing quotations in any OTC Equity Security. What is a firm's obligation if it is unable to access another firm's quote?

      Response: FINRA recognizes that a firm's quotation may, on occasion, inadvertently lock or cross another firm's quotation. Thus, similar to Rule 6240 (Prohibition from Locking or Crossing Quotations in NMS Stocks), FINRA expects firms' policies and procedures to require the quoting participant to make "reasonable efforts" to first contact or route an order to execute against the full displayed size of any quotation before locking and crossing that quotation.

      For example, a firm may also include so-called "ship and post" procedures that require that it attempt to execute against a relevant displayed quotation while posting a quotation that could lock or cross such a quotation. In addition, firms' policies and procedures must be reasonably designed to enable the reconciliation of locked or crossed quotations, including requiring the firm to take reasonable action to resolve the locked or crossed market when such firm is responsible for displaying the locking or crossing quotation. If a firm has made reasonable attempts to access another firm's already-existing quotation but is unable to do so, such firm may then display its quotation, even if it would lock or cross the quotation of the other firm.

      Question 9: If a firm is holding a customer order that must be re-priced because of a corporate action (e.g., a stock dividend, split or reverse split), may the firm round the adjusted price to a permissible increment?

      Response: Yes. As similarly stated by SEC staff in connection with Regulation NMS's minimum pricing increment rule, FINRA Rule 6434 does not require a firm to cancel an order that was permissible when accepted, but for which the price must be adjusted due to a corporate action.16 However, the firm would violate the rule by displaying or ranking the re-priced order at an increment not permitted by the rule.

      The same principle applies to other types of orders that were permissible when accepted, but whose prices must be adjusted; e.g., an order accepted before the rule's effective date may be re-priced to conform to the requirements of the rule without canceling the order. Firms always must round down in the case of an order to buy, and up in the case of an order to sell.

      Question 10: If a firm receives a customer limit order priced in an increment that may be accepted but not displayed pursuant to Rule 6434, must the firm provide order protection to such un-displayed customer order?

      Response: Yes. While firms would not be required to display customer limit orders priced in an increment less than $0.0001 (pursuant to Rule 6460), a firm's order protection obligations under IM-2110-2 (Trading Ahead of Customer Limit Order) would continue to apply.17


      1 See Securities Exchange Act Release No. 62359 (June 22, 2010), 75 FR 37488 (June 29, 2010) (Order Approving File No. SR-FINRA-2009-054). In this order, the SEC also approved proposed changes to FINRA Rules 6430, 6431, 6432, 6433, 6435, 6440, and Rule 6540. The changes to FINRA Rules 6430, 6431, 6432, 6433, 6435, 6440, and Rule 6540 will become effective on February 11, 2011.

      2 "OTC Equity Security" means any equity security that is not an "NMS stock" as that term is defined in Rule 600(b)(47) of Regulation NMS; provided, however, that the term OTC Equity Security shall not include any Restricted Equity Security. See FINRA Rule 6420(c). Rule 600(b)(47) of Regulation NMS defines "NMS stock" as "any NMS security other than an option." NMS security means "any security or class of securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options." See Rule 600(b)(47) of Regulation NMS.

      3 "OTC Market Maker" refers to a FINRA firm that holds itself out as a market maker by entering proprietary quotations or indications of interest for a particular OTC Equity Security in any inter-dealer quotation system, including any system that the SEC has qualified pursuant to Section 17B of the Exchange Act. A firm is an OTC Market Maker only in those OTC Equity Securities in which it displays market making interest via an inter-dealer quotation system. See FINRA Rule 6420.

      4 See Rule 6437(b)(1).

      5 See Rule 6437(b)(2).

      6 See Frequently Asked Question # 4 above for a discussion of FINRA's expectations with regard to the timing of display of customer limit orders.

      7 See Frequently Asked Question # 1 above for a discussion of the meaning of "de minimis."

      8 The ECN must (1) provide to a national securities exchange, national securities association or inter-dealer quotation system the prices and sizes of the orders at the highest buy price and the lowest sell price for such security entered in, and widely disseminated by, the ECN; and (2) provide, to any broker or dealer, the ability to effect a transaction with a priced order widely disseminated by the ECN entered therein by an OTC market maker that is: (A) equivalent to the ability of any broker or dealer to effect a transaction with an OTC market maker pursuant to the rules of the applicable national securities exchange, national securities association or inter-dealer quotation system to which the ECN supplies such bids and offers; and (B) at the price of the highest priced buy order or lowest priced sell order, or better, for the lesser of the cumulative size of such priced orders entered therein by OTC market makers at such price, or the size of the execution sought by the broker or dealer, for such security.

      9 See Securities Exchange Act Release No. 37619A (September 6, 1996); 61 FR 48290 (September 12, 1996) ("SEC Display Rule Adopting Release").

      10 Id. at note 179.

      11 See SEC Display Rule Adopting Release. Also, as stated in Notice to Members 99-99 in connection with the SEC's limit order display requirements, FINRA notes that any systematic delay in the display of customer limit orders, regardless of how long, would constitute a violation of FINRA's limit order display rule. However, there is no "bright line, absolute" standard governing the number of seconds an OTC Market Maker has to complete its choice of displaying, executing, or routing a customer limit order. In addition, a firm may operate an automated system that defaults to display customer limit orders within 30 seconds of receipt, so long as the firm makes every effort to display the limit orders as soon as possible manually or otherwise.

      12 See Securities Exchange Act Release No. 60515 (August 17, 2009), 74 FR 43207 (August 26, 2009) ("Proposing Release").

      13 See SEC Display Rule Adopting Release at note 186.

      14 See also SEC Display Rule Adopting Release at 48304.

      15 See Rule 6460(c)(1).

      16 Division of Market Regulation: Responses to Frequently Asked Questions Concerning Rule 612 (Minimum Pricing Increment) of Regulation NMS at Question #3.

      17 For customer limit orders priced less than $.00001, the minimum amount of price improvement required is the lesser of $0.000001 or one-half (½) of the current inside spread. See NASD IM-2110-2(a).

    • 10-40 Non-Party Witness' Attorney May Attend Hearing While Witness Is Testifying; Effective Date: October 14, 2010

      View PDF

      Arbitration Hearings

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 12512
      FINRA Rule 12513
      FINRA Rule 12602
      FINRA Rule 13602
      FINRA Rule 13512
      FINRA Rule 13513
      Suggested Routing

      Compliance
      Legal
      Registered Representatives
      Senior Management
      Key Topic(s)

      Arbitration
      Attendance at Hearings
      Code of Arbitration Procedure
      Dispute Resolution

      Executive Summary

      Effective October 14, 2010, a non-party witness' attorney may attend an arbitration hearing while the witness is testifying. Unless otherwise authorized by the arbitrators, the attorney's role will be limited to asserting recognized privileges, such as the attorney-client and work-product privileges, and the privilege against self-incrimination.1 The amendments to the Customer and Industry Codes of Arbitration Procedure (Codes) apply to all hearings taking place on or after October 14, 2010. The text of the amendments is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •  Richard W. Berry, Senior Vice President and Director of Case Administration and Regional Office Services, Dispute Resolution, at (212) 858-4307 or richard.berry@finra.org; or
      •  Margo A. Hassan, Assistant Chief Counsel, Dispute Resolution, at (212) 858-4481 or margo.hassan@finra.org.

      Background & Discussion

      A non-party witness may testify at a hearing: 1) voluntarily; 2) pursuant to a subpoena;2 or 3) in compliance with an arbitrator's order for an associated person to appear and give testimony.3 For example, a customer claimant may not have named the broker who handled the customer's account as a respondent in a case, but the broker may be called to testify at the FINRA arbitration hearing. In such a case, if the broker wants to bring an attorney to the hearing, the Codes currently provide that the arbitrators will determine if the attorney may attend.4

      Generally, FINRA arbitrators permit non-party witnesses to bring their attorneys to the hearing while they are testifying. During the hearing, the attorney's participation usually involves the attorney making objections based on generally recognized privileges. To enhance the appearance of fairness in the arbitration process, however, FINRA is amending Rule 12602 of the Code of Arbitration Procedure for Customer Disputes and Rule 13602 of the Code of Arbitration Procedure for Industry Disputes to provide expressly that a non-party witness' attorney may attend a hearing while the witness is testifying. Unless otherwise authorized by the panel, the attorney's role will be limited to the assertion of recognized privileges, such as the attorney-client and work-product privileges, and the privilege against self-incrimination. The attorney must be in good standing and admitted to practice before the Supreme Court of the United States or the highest court of any state of the United States, the District of Columbia or any commonwealth, territory or possession of the United States, unless state law prohibits such representation.

      The amendments become effective on October 14, 2010, and apply to all hearings taking place on or after that date.


      1 Exchange Act Release No. 62521 (July 16, 2010). 75 Federal Register 42795 (July 22, 2010) (File No. SR-FINRA-2010-006).

      2 Rules 12512 and 13512 (Subpoenas) provide that arbitrators have the authority to issue subpoenas for the production of documents or the appearance of witnesses. The rules permit a party to make a written motion requesting that an arbitrator issue a subpoena to a party or a non-party.

      3 Rules 12513 and 13513 (Authority of Panel to Direct Appearances of Associated Person Witnesses and Production of Documents Without Subpoenas) provide that the panel may order the appearance of any employee or associated person of a FINRA member firm.

      4 Rules 12602 and 13602 (Attendance at Hearings) provide that parties and their representatives are entitled to attend all hearings and that, absent persuasive reasons to the contrary, expert witnesses should also be permitted to attend. The panel determines who else may attend any or all hearings.


      Attachment A

      Code of Arbitration Procedure for Customer Disputes
      And
      Code of Arbitration Procedure for Industry Disputes

      Customer Code

      12602. Attendance at Hearings

      (a) The parties and their representatives are entitled to attend all hearings. Absent persuasive reasons to the contrary, expert witnesses should be permitted to attend all hearings.
      (b) An attorney for a non-party witness may attend a hearing while that non-party witness is testifying. Unless otherwise authorized by the panel, the attorney's role is limited to the assertion of recognized privileges, such as the attorney client and work product privileges, and the privilege against self-incrimination. The attorney must be in good standing and admitted to practice before the Supreme Court of the United States or the highest court of any state of the United States, the District of Columbia, or any commonwealth, territory, or possession of the United States, unless state law prohibits such representation.
      (c) The panel will decide who else may attend any or all of the hearings.

      Industry Code

      13602. Attendance at Hearings

      (a) The parties and their representatives are entitled to attend all hearings. Absent persuasive reasons to the contrary, expert witnesses should be permitted to attend all hearings.
      (b) An attorney for a non-party witness may attend a hearing while that non-party witness is testifying. Unless otherwise authorized by the panel, the attorney's role is limited to the assertion of recognized privileges, such as the attorney client and work product privileges, and the privilege against self-incrimination. The attorney must be in good standing and admitted to practice before the Supreme Court of the United States or the highest court of any state of the United States, the District of Columbia, or any commonwealth, territory, or possession of the United States, unless state law prohibits such representation.
      (c) The panel will decide who else may attend any or all of the hearings.

      * * * * *

    • 10-41 FINRA Reminds Firms of Their Sales Practice and Due Diligence Obligations When Selling Municipal Securities in the Secondary Market

      View PDF

      Municipal Securities

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Exchange Act Rule 15c2-12
      FINRA Regulatory Notice 09-35
      MSRB Rule G-15
      MSRB Rule G-17
      MSRB Rule G-19
      MSRB Rule G-27
      MSRB Rule G-30
      MSRB Rule G-32
      MSRB Notice 2004-3
      MSRB Notice 2005-01
      MSRB Notice 2007-17
      MSRB Notice 2009-41
      MSRB Notice 2009-42
      MSRB Interpretation of March 4, 1986
      MSRB Interpretation of June 12, 1995
      Suggested Routing

      Compliance
      Legal
      Municipal Securities
      Registered Representatives
      Senior Management
      Key Topic(s)

      Credit Ratings
      Disclosure
      EMMA
      Municipal Securities
      Suitability
      Supervision

      Executive Summary

      Brokers, dealers and municipal securities dealers (dealers) must fully understand the municipal securities they sell in order to meet their disclosure, suitability and pricing obligations under the rules of the Municipal Securities Rulemaking Board (MSRB) and federal securities laws. These obligations are not limited to firms involved in primary offerings. Dealers must also obtain, analyze and disclose all material facts about secondary market transactions that are known to the dealer, or that are reasonably accessible to the market through established industry sources.

      Those sources include, among other things, official statements, continuing disclosures, trade data and other information made available through the MSRB's Electronic Municipal Market Access system (EMMA). Firms may also have a duty to obtain and disclose information that is not available through EMMA, if it is material and available through other public sources. The public availability of material information, through EMMA or otherwise, does not relieve a firm of its duty to disclose that information. Firms must also have reasonable grounds for determining that a recommendation is suitable based on information available from the issuer of the security or otherwise. Firms must use this information to determine the prevailing market price of a security as the basis for establishing a fair price in a transaction with a customer. To meet these requirements, firms must perform an independent analysis of the securities they sell, and may not rely solely on a security's credit rating.

      Continuing disclosures made by issuers to the MSRB via EMMA are part of the information that dealers must obtain, disclose and consider in meeting their regulatory obligations. The Securities and Exchange Commission (SEC) has recently approved amendments to Securities Exchange Act Rule 15c2-12, governing continuing disclosures. Firms that sell municipal securities should review and, if necessary, update their procedures to reflect the amendments, which have a compliance date of December 1, 2010.

      Questions concerning this Notice should be directed to FINRA's Member Regulation Fixed Income Group at (202) 728-8085 or (202) 728-8133.

      For information about compliance with MSRB rules, including the recent amendments to Rule 15c2-12, contact FINRA at the numbers above, or the MSRB at (703) 797-6600.

      Background and Discussion

      MSRB Disclosure, Suitability and Pricing Rules

      MSRB Rule G-17 provides that, in the conduct of its municipal securities activities, each dealer must deal fairly with all persons and may not engage in any deceptive, dishonest or unfair practice. The MSRB has interpreted its Rule G-17 to require a dealer, in connection with any transaction in municipal securities, to disclose to its customer, at or prior to the sale, all material facts about the transaction known by the dealer, as well as material facts about the security that are reasonably accessible to the market.1 This includes the obligation to give customers a complete description of the security, including a description of the features that likely would be considered significant by a reasonable investor and facts that are material to assessing the potential risks of the investment.

      Such disclosures must be made at the "time of trade," which the MSRB defines as at or before the point at which the investor and the dealer agree to make the trade. MSRB Rule G-17 applies to all sales of municipal securities, whether or not a transaction was recommended by a broker-dealer.2 This means that municipal securities dealers must disclose all information required to be disclosed by the rule even if the trade is self-directed.3

      MSRB Rule G-19 requires that a dealer that recommends a municipal securities transaction have reasonable grounds for believing that the recommendation is suitable for the customer based upon information available from the issuer of the security or otherwise and the facts disclosed by, or otherwise known about, the customer.4

      MSRB Rule G-30 requires that dealers trade with customers at prices that are fair and reasonable, taking into consideration all relevant factors.5 The MSRB has stated that the concept of a "fair and reasonable" price includes the concept that the price must "bear a reasonable relationship to the prevailing market price of the security." The impetus for the MSRB's Real-time Transaction Reporting System (RTRS), which was implemented in January 2005, was to allow market participants to monitor market price levels on a real-time basis and thus assist them in identifying changes in market prices that may have been caused by news or market events.6 The MSRB now makes the transaction data reported to RTRS available to the public through EMMA.

      In meeting these disclosure, suitability and pricing obligations, firms must take into account all material information that is known to the firm or that is available through "established industry sources," including official statements, continuing disclosures, and trade data, much of which is now available through EMMA. Resources outside of EMMA may include press releases, research reports and other data provided by independent sources. Established industry sources can also include material event notices and other data filed with former nationally recognized municipal securities information repositories (NRMSIRs) before July 1, 2009.7 Therefore, firms should review their policies and procedures for obtaining material information about the municipal securities they sell to make sure they are reasonably designed to access all material information that is available, whether through EMMA or other established industry sources. The MSRB has also noted that the fact that material information is publicly available through EMMA does not relieve a firm of its duty to specifically disclose it to the customer at the time of trade, or to consider it in determining the suitability of a security for a specific customer.8 Importantly, the dealer may not simply direct the customer to EMMA to fulfill its time-of-trade disclosure obligations under MSRB Rule G-17.9

      Amendments to Rule 15c2-12 Concerning Continuing Disclosure

      Securities Exchange Act Rule 15c2-12 requires underwriters participating in municipal securities offerings that are subject to that rule10 to receive, review, and distribute official statements of issuers of primary municipal securities offerings, and prohibits underwriters from purchasing or selling municipal securities covered by the rule unless they have first reasonably determined that the issuer or an obligated person11 has contractually agreed to make certain continuing disclosures to the MSRB, including certain financial information and notice of certain events. The MSRB makes such disclosure public via EMMA.

      Financial information to be disclosed under the rule consists of the following:

      •  annual financial information updating the financial information in the official statement;
      •  audited financial statements, if available and not included within the annual financial information; and
      •  notices of failure to provide such financial information on a timely basis.

      Currently, the rule enumerates the following as notice events, if material:

      •  principal and interest payment delinquencies;
      •  non-payment related defaults;
      •  unscheduled draws on debt service reserves reflecting financial difficulties;
      •  unscheduled draws on credit enhancements reflecting financial difficulties;
      •  substitution of credit or liquidity providers or their failure to perform;
      •  adverse tax opinions or events affecting the tax-exempt status of the security;
      •  modifications to rights of security holders;
      •  bond calls;
      •  defeasances;
      •  release, substitution or sale of property securing repayment of the securities; and
      •  rating changes.

      SEA Rule 15c2-12(c) also prohibits any dealer from recommending the purchase or sale of a municipal security unless it has procedures in place that provide reasonable assurance that it will receive prompt notice of any event notice reported pursuant to the rule. Firms should review any applicable continuing disclosures made available through EMMA and other established industry sources and take such disclosures into account in undertaking its suitability and pricing determinations.

      On May 26, 2010, the SEC amended the rule's disclosure obligations, with a compliance date of December 1, 2010, to: (1) apply continuing disclosure requirements to new primary offerings of certain variable rate demand obligations; (2) add four new notice events;12 (3) remove the materiality standard for certain notice events;13 and (4) require that event notices be filed in a timely manner but no later than 10 business days after their occurrence. With respect to the tax status of the security, the rule has been broadened to require disclosure of adverse tax opinions, issuance by the IRS of proposed or final determinations of taxability and other material notices, and determinations or events affecting the tax status of the bonds (including a Notice of Proposed Issue). Firms that deal in municipal securities should familiarize themselves with these amendments, and, if necessary, modify their policies and procedures to incorporate this additional disclosure accordingly.

      In addition, as FINRA noted in Regulatory Notice 09-35, if a firm discovers through its SEA Rule 15c2-12 procedures or otherwise that an issuer has failed to make filings required under its continuing disclosure agreements, the firm must take this information into consideration in meeting its disclosure obligations under MSRB Rule G-17 and in assessing the suitability of the issuer's securities under MSRB Rule G-19.

      Credit Ratings

      In order to meet their obligations under MSRB Rules G-17 and G-19, firms must analyze and disclose to customers the risks associated with the securities they sell, including, but not limited to, the security's credit risk. A credit rating is a third-party opinion of the credit quality of a municipal security. While the MSRB generally considers credit ratings and rating changes to be material information for purposes of disclosure, suitability and pricing, they are only one factor to be considered, and dealers should not solely rely on credit ratings as a substitute for their own assessment of a security's credit risk.14 Moreover, different agencies use different quantitative and qualitative criteria and methodologies to determine their rating opinions. Dealers should familiarize themselves with the rating systems used by rating agencies in order to understand and assess the relevance of a particular rating to the firm's overall assessment of the security.15

      With respect to credit or liquidity enhanced securities, the MSRB has stated that material information includes the following, if known to the dealer or if reasonably available from established industry sources: (1) the credit rating of the issue or lack thereof; (2) the underlying credit rating or lack thereof, (3) the identity of any credit enhancer or liquidity provider; and (4) the credit rating of the credit provider and liquidity provider, including potential rating actions (e.g., downgrade).16 Additionally, material terms of the credit facility or liquidity facility should be disclosed (e.g., any circumstances under which a standby bond purchase agreement would terminate without a mandatory tender).

      Other Material Information

      In addition to a security's credit quality, firms must obtain, analyze and disclose other material information about a security, including but not limited to whether the security may be redeemed prior to maturity in-whole, in-part or in extraordinary circumstances,17 whether the security has non-standard features that may affect price or yield calculations,18 whether the security was issued with original issue discount or has other features that would affect its tax status,19 and other key features likely to be considered significant by a reasonable investor. For example, for variable rate demand obligations, auction rate securities or other securities for which interest payments may fluctuate, firms should explain to customers the basis on which periodic interest rate resets are determined.20 The MSRB has stated that firms should take particular care with respect to new products that may be introduced into the municipal securities market, existing products that may have complex structures that can differ materially from issue to issue, and outstanding securities that may trade infrequently, may be issued by less well-known issuers, or may have unusual features.21

      Supervision

      Firms are reminded that MSRB Rule G-27 requires firms to supervise their municipal securities business, and to ensure that they have adequate policies and procedures in place for monitoring the effectiveness of their supervisory systems. Specifically, firms must:

      •  supervise the conduct of the municipal securities activities of the firm and associated persons to ensure compliance with all MSRB rules, the Exchange Act and the rules there under;
      •  have adequate written supervisory procedures; and
      •  implement supervisory controls to ensure that their supervisory procedures are adequate.

      MSRB Rule G-27 requires that a firm's supervisory procedures provide for the regular and frequent review and approval by a designated principal of customer accounts introduced or carried by the dealer in which transactions in municipal securities are effected, with such review being designed to ensure that transactions are in accordance with all applicable rules and to detect and prevent irregularities and abuses. Although the rule does not establish a specific procedure for ensuring compliance with the requirement to provide disclosures to customers pursuant to MSRB Rule G-17, firms should consider including in their procedures for reviewing accounts and transactions specific processes for documenting or otherwise ascertaining that such disclosures have been made.

      Questions to Consider

      Before selling any municipal security, dealers should make sure that they fully understand the security they are selling in order to make adequate disclosure to customers under MSRB Rule G-17, to ensure that recommendations are suitable under MSRB Rule G-19, and to ensure that they are fairly priced under MSRB Rule G-30. Among other things, dealers should ask and be able to answer the following questions:

      •  What are the security's key terms and features and structural characteristics, including but not limited to its issuer, source of funding (e.g., general obligation or revenue bond), repayment priority, and scheduled repayment rate? Much of this information will be in the Official Statement, which for many municipal securities can be obtained by entering the CUSIP number in the MuniSearch box at www.emma.msrb.org. Be aware, however, data in the Official Statement may have been superseded by the issuer's on-going disclosures.
      •  Does information available through EMMA or other established industry sources indicate that an issuer is delinquent in its material event notice and other continuing disclosure filings? Delinquencies should be viewed as a red flag.
      •  What other public material information about the security or its issuer is available through established industry sources other than EMMA?
      •  What is the security's rating? Has the issuer recently been downgraded? Has the issuer filed any recent default or other event notices, or has any other information become available through established industry sources that might call into question whether the published rating has been revised to take such event into consideration?
      •  Is the security insured, or does it benefit from liquidity support, a letter of credit or is it otherwise supported by a third party? If so, check the credit rating of the insurer or other backing, and the security's underlying rating (without third party support). If supported by a third party, review the terms and conditions under which the third party support may terminate.
      •  How is it priced? Be aware that a municpal security can be priced above or below its par value for many reasons, including changes in the creditworthiness of the issuer and prevailing interest rates.
      •  How and when will interest on the security be paid? For example most municipal bonds pay semiannually, but zero coupon municipal bonds pay all interest at the time the bond matures. Variable rate bonds typically will pay interest more frequently, usually on a monthly basis in variable amounts.
      •  What is the security's tax status, under both state and federal laws? Is it subject to the Federal Alternate Minimum Tax? Is it fully taxable (e.g., Build America Bonds)?
      •  What are its call provisions? Call provisions allow the issuer to retire the security before it matures. How would a call affect expected future income?

      1 MSRB Rule G-17 applies to all transactions in municipal securities, including those in both the primary and secondary market. MSRB Rule G-32 specifically addresses delivery of the official statement in connection with primary offerings.

      2 See MSRB Notice 2009-42 (July 14, 2009).

      3 A dealer's specific investor protection obligations, including its disclosure, fair practice and suitability obligations under MSRB Rules G-17 and G-19, may be affected by the status of an institutional investor as a Sophisticated Municipal Market Professional (SMMP). See Rule G-17 Interpretation—Notice Regarding the Application of MSRB Rules to Transactions with Sophisticated Municipal Market Professionals (April 30, 2002)

      4 See MSRB Notice 2009-42, supra n.2.

      5 Rule G-18 requires that a dealer effecting an agency trade with a customer make a reasonable effort to obtain a price for the customer that is fair and reasonable in relation to prevailing market conditions.

      6 See MSRB Notice 2004-3 (January 26, 2004).

      7 Since July 1, 2009, material event notices are required to be filed through EMMA, which has replaced Bloomberg Municipal Repository; DPC DATA Inc.; Interactive Data Pricing and Reference Data, Inc.; and Standard & Poor's Securities Evaluations, Inc. as the sole NRMSIR.

      8 The MSRB has also stated that providing adequate disclosure does not relieve a firm of its suitability obligations. See MSRB Notice 2007-17 (March 30, 2007).

      9 MSRB Rule G-32 does allow a dealer to satisfy its obligation to deliver an official statement to its customer during the primary offering disclosure period no later than the settlement of the transaction by advising the customer of how to obtain it on EMMA, unless the customer requests a paper copy. The delivery obligation under MSRB Rule G-32 is distinct from the duty to disclose material information under Rule G-17, which applies to all primary and secondary market transactions.

      10 Certain limited offerings, variable rate demand obligations, and small issues are exempt from SEA Rule 15c2-12.

      11 "Obligated person" is defined as "any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund or account of such person committed by contract or other arrangement to support payment of all, or part of the obligations of the municipal securities to be sold in the offering (other than providers of municipal bond insurance, letters of credit, or other liquidity facilities)."

      12 The new notice events are (1) tender offers, (2) bankruptcy, insolvency, receivership, or similar events, (3) consummation of mergers, consolidations, acquisitions, or asset sales, or entry into or termination of a definitive agreement related to do the same, if material, and (4) appointment of a successor or additional trustee or a change in the name of the trustee, if material.

      13 The amendments removed the materiality standard and require notices for the following events: (1) principal and interest payment delinquencies with respect to the securities being offered; (2) unscheduled draws on debt service reserves reflecting financial difficulties; (3) unscheduled draws on credit enhancements reflecting financial difficulties; (4) substitution of credit or liquidity providers, or their failure to perform; (5) defeasances: and (6) rating changes. The amendments retained the materiality standard for the following events: (1) non-payment related defaults; (2) modifications to rights of security holders; (3) bond calls; and (4) release, substitution, or sale of property securing repayment of the securities.

      14 See MSRB Notice 2009-42, supra n.2. Ratings changes are reportable events under Rule 15c2-12.

      15 Not all municipal securities are rated. While an absence of a credit rating is not, by itself, a determinant of low credit quality, it is a factor that dealers should consider, and may warrant additional due diligence of the security and its issuer by the dealer. In addition, MSRB Rule G-15 requires confirmation statements for customer trades in unrated municipal securities to disclose that the securities are not rated.

      16 See MSRB Notice 2009-42. The SEC has approved the MSRB's proposal to require dealers to submit copies of credit enhancement and liquidity facility documents to EMMA pursuant to amended MSRB Rule G-34(c), which may increase the availability of such information to dealers. See Securities Exchange Act Release No. 62755, August 20, 2010 (File No. SR-MSRB-2010-02).

      17 See Notice Concerning Disclosure of Call Information to Customers of Municipal Securities, MSRB Interpretation of March 4, 1986.

      18 See Transactions in Municipal Securities With Non-Standard Features Affecting Price/Yield Calculations, MSRB Interpretation of June 12, 1995.

      19 See MSRB Notice 2005-01 (January 5, 2005); MSRB Notice 2009-41 (July 10, 2009).

      20 See MSRB Notice 2008-09 (February 19, 2008).

      21 See MSRB Notice 2009-42, supra n.2.

    • 10-39 Obligation to Provide Timely, Complete and Accurate Information on Form U5

      View PDF

      Form U5

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NTM 04-09
      Article V, Section 2 of the FINRA By-Laws
      Article V, Section 3 of the FINRA By-Laws
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Registration
      Senior Management
      Training
      Key Topic(s)

      Form U5

      Executive Summary

      This Notice reminds firms of their obligation to provide timely, complete and accurate information on Form U5 (Uniform Termination Notice for Securities Industry Registration).1

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

      Background and Discussion

      Under Article V, Section 3 of the FINRA By-Laws, firms are required to file Form U5 no later than 30 days after terminating an associated person's registration. In addition, firms must file an amended Form U5 when they learn of facts or circumstances that make a previously filed Form U5 inaccurate or incomplete.2 Further, firms are required to provide the person whose registration has been terminated with a copy of any Form U5 (initial or amended) at the same time that it is filed with FINRA.

      Form U5 requires an appropriate signatory of a firm to verify the accuracy and completeness of the information contained in it prior to filing with FINRA. It is imperative that firms file complete and accurate Forms U5 in a timely manner because the reported information is used by a number of constituencies for a variety of reasons. For instance, FINRA uses the information to help identify and sanction individuals who violate FINRA rules and applicable federal statutes and regulations. FINRA, other self-regulatory organizations and state regulatory and licensing authorities also use the information to make informed registration and licensing decisions. Firms use the information to help them make informed employment decisions. Further, investors use the Form U5 information that is displayed through BrokerCheck when considering whether to do business with a registered (or formerly registered) person.

      FINRA notes that each question on Form U5 stands on its own, and firms should carefully read each question on the form and respond appropriately to each question. For example, when reporting information relating to the reason for termination, firms must separately consider and respond to both Section 3 of the form and any of the disclosure-related questions found in Section 7. FINRA emphasizes that reporting the reason for termination in Section 3 does not abrogate the requirement that a firm complete any of the questions in Section 7 appropriately, including, in particular, Questions 7B and 7F. In this regard, FINRA notes that, with respect to factual situations that would cause a reasonable person to answer affirmatively any disclosure question in Form U5, a firm may not parse through the questions in a manner that would allow the firm to avoid responding affirmatively to a question. FINRA further notes that:

      •   A firm must provide sufficient detail when responding to Form U5 questions such that a reasonable person may understand the circumstances that triggered the affirmative response. For example, for purposes of Section 3 on Form U5, it is not sufficient for a firm to report only that a person's registration was terminated because that person violated “firm policy.” If a firm is obligated to report that a registered person was terminated because he or she violated a firm policy, the firm must identify the policy, provide sufficient facts and circumstances to enable the reader to understand what conduct was involved, and review other questions on the form to determine whether an affirmative response to any other question is required.
      •   A firm that is terminating a registered person for misconduct subject to disclosure specified in Question 7F is required to answer that question in the affirmative, irrespective of whether or not the firm is the entity making the allegations of misconduct. Question 7F asks whether the individual who is the subject of the Form U5 voluntarily resigned, or was discharged or permitted to resign, after allegations were made that accused the individual of certain types of misconduct. Question 7F does not specify or require that the terminating firm be the source of those allegations. For example, if an affiliate of a firm employing a registered person discharges the registered person after making allegations of fraud against that person and the firm thereafter discharges the person, the firm would need to provide an affirmative answer to the appropriate part of Question 7F and indicate that it was discharging the person after allegations of fraud had been made against him or her.
      •   A firm should err on the side of interpreting the term “investment-related” in an expansive manner in line with the scope of the term when reporting information on Form U5. The scope of the term pertains to securities, commodities, banking, insurance or real estate (including, but not limited to, acting as or being associated with a broker-dealer, issuer, investment company, investment adviser, futures sponsor, bank or savings association). Accordingly, a firm may be required to provide an affirmative answer to a question even if the matter is not securities-related. Furthermore, the type of conduct described in Form U5 questions need not always pertain to or involve a customer of the terminating firm in order to require an affirmative answer. Several questions ask about specific types of misconduct without regard to whether such misconduct involved a customer of the terminating firm. Therefore, the issue of whether the conduct involved a customer of the terminating firm is not necessarily determinative as to whether the conduct may require an affirmative answer to a Form U5 question.

      FINRA notes that firms may be subject to administrative and civil penalties for failing to provide complete and accurate information on Form U5 in a timely manner.3


      1 See Article V, Section 3(a) of the FINRA By-Laws; Notice to Members (NTM) 04-09 (SEC Announces Immediate Effectiveness of Amendments to Section 4 of Schedule A to the NASD By-Laws). Although this Notice focuses on Form U5, FINRA notes that firms also must provide timely, complete and accurate disclosure on Form U4 (Uniform Application for Securities Industry Registration or Transfer). See Article V, Section 2(c) of the FINRA By-Laws.

      2 FINRA reminds firms that this obligation to file an amended Form U5 when it learns of facts or circumstances that make a previously filed Form U5 inaccurate or incomplete applies to those instances when a firm has reported that it has initiated an internal review in response to Question 7B. In such instances, FINRA expects a firm to file an amended Form U5 to report, at a minimum, the date the internal review was concluded and the findings of such review, and to respond to any other questions on the form as appropriate.

      3 See, e.g., DBCC v. Nichols, Complaint No. C01950004, 1996 NASD Discip. LEXIS 30 at *30 (NASD NBCC Nov. 13, 1996); see also NTM 04-09, which reminds firms, among other things, that they may be assessed late fees for failure to timely file accurate and complete Forms U5.

    • 10-38 SEC Approves New FINRA Rule Relating to the Processing of and Fees for Company-Related Actions for Non-Exchange-Listed Securities; Effective Date: September 27, 2010

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      Obligation of Issuers to Provide Notice of Company-Related Actions

      Regulatory Notice
      Notice Type

      Rule Approval
      Referenced Rules & Notices

      NASD Rule 11140
      FINRA Rule 6490
      SEA Rule 10b-17
      UPC Rules
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading and Market Making
      Key Topic(s)

      Fees
      Non-Exchange-Listed Securities
      Over-the-Counter Trading

      Executive Summary

      Effective September 27, 2010, new FINRA Rule 6490 (Processing of Company-Related Actions) codifies the requirements in SEA Rule 10b-17 for issuers of a class of publicly trading securities to provide timely notice to FINRA of certain corporate actions (e.g., dividend or other distribution of cash or securities, stock split or reverse split, rights or subscription offering). Issuers must also provide timely notification to FINRA of certain other specified corporate actions. The rule clarifies the scope of FINRA's regulatory authority and discretionary power when processing documents related to announcements for company-related actions for non-exchange-listed equity and debt securities, and implements fees for these services.1 Issuers must complete the necessary forms and pay the applicable fees within the required time periods or they will be subject to late fees and delayed processing of documents to announce corporate actions.

      The text of the new rule is set forth on FINRA's website at www.finra.org/rulefilings/2009-089.

      Questions regarding this Notice should be directed to:

      •   FINRA Operations at (866) 776-0800; select option 1; or
      •   Kosha K. Dalal, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-6903.

      Background

      Historically, FINRA has performed certain limited functions relating to the processing of non-exchange-listed issuer company actions in the over-the-counter (OTC) securities market. Specifically, FINRA reviews and processes documents related to announcements for company-related actions pursuant to SEA Rule 10b-17 (Untimely Announcements of Record Dates),2 and other company actions, including the issuance of or change to a trading symbol or company name, mergers, acquisition, dissolutions or other company control transactions, bankruptcy or liquidations. FINRA announces company-related actions pursuant to requests from issuers and their agents on its website in a document known as the "Daily List," establishes the ex-date for distributions and dividends and adjusts the trading price of the securities where applicable.3 These functions are important to trading and settlement in the OTC marketplace and help promote investor protection and market integrity.

      Discussion

      Issuer Obligations Under New FINRA Rule 6490

      FINRA Rule 6490 (Processing of Company-Related Actions) codifies the requirements in SEA Rule 10b-17 for issuers of a class of publicly trading securities to provide timely notice to FINRA of certain corporate actions (e.g., dividend or other distribution of cash or securities, stock split or reverse split, rights or subscription offering). Generally pursuant to SEA Rule 10b-17, issuers must notify FINRA at least 10 days prior to the record date for such corporate action. Issuers must also notify FINRA of certain other corporate actions (e.g., the issuance of or change of trading symbols, mergers, bankruptcy) no later than 10 days prior to the effective date of the company action. Issuers must complete the required forms and pay the applicable fees within such time periods or they will be subject to late fees and delayed processing of documents to announce corporate actions.

      The new rule further permits FINRA to request other documents that may be necessary to verify information issuers provide on the forms. FINRA may, in its discretion, conduct detailed reviews of submissions, on a case-by-case basis. Moreover, the new rule authorizes FINRA to not process a request to announce a corporate action if FINRA determines that the request is deficient and not processing is necessary to protect investors and the public interest and to maintain fair and orderly markets.

      SEA Rule 10b-17 Company-Related Actions

      SEA Rule 10b-17, an anti-fraud rule of the federal securities laws, provides that issuers must notify FINRA no later than 10 days prior to the record date involved. In case of a rights subscription or other offering, if the 10-day advance notice is not practical, issuers must notify FINRA on or before the record date and in no event later than the effective date of the registration statement to which the offering relates. Generally, issuers must notify FINRA of the following actions:

      •   a dividend or other distribution in cash or in kind, except an ordinary interest payment on a debt security, but including a dividend or distribution of any security of the same or another issuer;
      •   a stock split or reverse split; or
      •   a rights or other subscription offering (collectively, referred to as "SEA Rule 10b-17 Actions"). For example, an issuer of non-exchange-listed publicly traded securities that is planning a stock split on shares of its common stock to holders of record on February 25 would be required under SEA Rule 10b-17 and FINRA Rule 6490 to provide written notice to FINRA no later than 10 days prior to the record date for the transaction, or by February 15.

      Moreover, SEA Rule 10b-17 prescribes information that must be included in the notice, including, but not limited to:

      •   the title of the security;
      •   date of declaration;
      •   record date;
      •   payment or distribution date;
      •   for cash distributions, the amount to be paid per share;
      •   for distribution of securities, generally the amount of the security outstanding immediately prior to and immediately following the dividend or distribution and the rate of the dividend or distribution;
      •   details of any conditions that must be satisfied to enable the payment or distribution; and
      •   additional details relating to stock or reverse splits.

      Issuers should review the text of SEA Rule 10b-17 to fully understand their obligations, which may be amended from time to time.

      Other Company-Related Actions

      Issuers with a class of publicly trading securities also undertake other corporate actions relating to such securities, including the issuance of or change to a trading symbol or company name, merger, acquisition, dissolution or other company control transaction, bankruptcy or liquidation ("Other Company-Related Actions"; and together with SEA Rule 10b-17 Actions, are collectively referred to as "Company-Related Actions").

      In accordance with Rule 6490, FINRA may prescribe the necessary forms, supporting documentation and fees to process announcements for Company-Related Actions.

      Submitting Notice of Company-Related Actions

      An issuer or other duly authorized representative that is obligated to notify FINRA of a Company-Related Action must:

      1. Complete, sign and submit the Company-Related Action Notification Form to FINRA Operations at least ten (10) days prior to the record date or effective date (as applicable) involved for the Company-Related Action. The form is available on FINRA's website at www.finra.org/upc/forms.
      2. Ensure that the issuer's duly authorized transfer agent signs and submits a completed Transfer Agent Verification Form to FINRA Operations simultaneously.
      3. Attach supporting documentation (e.g., copy of board resolutions authorizing the Company-Related Action, amendment to the charter of incorporation) as required by the Company-Related Action Notification Form.
      4. Pay all applicable fees, including late fees, in the manner prescribed on the Company-Related Action Notification Form.
      5. Submit the above package either electronically or via overnight mail to FINRA Operations at the addresses specified on the applicable Form.

      FINRA Operations will assign a unique, identifying number to each request to process documentation for a Company-Related Action. Issuers or their duly authorized representatives must include the number on all future submissions, notices and correspondence from them to FINRA Operations relating to the action.

      Applicable Fees

      Rule 6490 requires issuers to pay the following fees to FINRA:

      SEA RULE 10b-17 ACTION FEE
      Timely SEA Rule 10b-17 Notification $200
      Late SEA Rule 10b-17 Notification (Notice submitted at least 5 calendar days prior to corporate action date) $1,000
      Late SEA Rule 10b-17 Notification (Notice submitted at least 1 calendar day prior to corporate action date) $2,000
      Late SEA Rule 10b-17 Notification (Notice submitted on or after corporate action date) $5,000
      OTHER COMPANY-RELATED ACTION FEE
      Voluntary Symbol Request Change $500
      Initial Symbol Set Up No Charge
      Symbol Deletion No Charge
      APPEALS FEE
      Action Determination Appeal Fee $4,000


      FINRA Operations Determination

      Once an issuer or its duly authorized representative submits a Company-Related Action Notification Form, FINRA Operations will review the submission and may request additional information or documentation as may be necessary to verify the accuracy of the information. If the party that submits the form does not sufficiently respond within 90 calendar days of the date FINRA Operations requests additional information or documentation, the request will be deemed "lapsed" and will be closed.

      During the course of the review, if FINRA Operations believes that one of five explicitly enumerated factors outlined in Rule 6490 may be triggered, it generally will conduct an in-depth review of the Company-Related Action and may seek additional information or documentation from the issuer or duly authorized representative as outlined above. Where a Company-Related Action is deemed deficient, FINRA Operations may determine that it is necessary for the protection of investors, the public interest and to maintain fair and orderly markets, that documentation related to a Company-Related Action will not be processed. Factors that may be considered by the FINRA Operations in finding a request to process documentation related to a Company-Related Action deficient are explicitly limited to the following:

      1. FINRA staff reasonably believes the forms and all supporting documentation, in whole or in part, may not be complete, accurate or with proper authority;
      2. the issuer is not current in its reporting obligations, if applicable, to the SEC or other regulatory authority;
      3. FINRA has actual knowledge that parties related to the Company-Related Action are the subject of pending, adjudicated or settled regulatory action or investigation by a regulatory body, or civil or criminal action related to fraud or securities laws violations4;
      4. a government authority or regulator has provided information to FINRA, or FINRA has actual knowledge, indicating that persons related to the Company-Related Action may be potentially involved in fraudulent activities related to the securities market and/or pose a threat to public investors; and/or
      5. there is significant uncertainty in the settlement and clearance process for the security.

      Appeal Process

      If FINRA Operations determines that a request to process a Company-Related Action is deficient, FINRA will provide written notice to the requesting party. The written notice will state the specific factor(s) that caused the request to be deemed deficient. The issuer or its duly authorized representative may request an appeal of such determination by submitting a written request for an appeal to FINRA Operations within seven (7) calendar days after service of notice of the deficiency by FINRA. A three-member subcommittee composed of current and/or former industry members of FINRA's Uniform Practice Code Committee will review the appeal. The written request for an appeal must be accompanied by proof of payment of the non-refundable Action Determination Appeal Fee and must set forth with specificity any and all defenses to the determination by FINRA Operations that a request is deficient.

      While the appeal is pending, FINRA will stay the processing of the Company-Related Action. The UPC subcommittee convenes once a month to consider all appeals received during the prior month and will render a determination within three (3) business days following the day the appeal is considered by the UPC subcommittee. The UPC subcommittee's determination will constitute final action by FINRA. If the issuer or its duly authorized agent fails to file a written request for an appeal within seven (7) calendar days after service of notice, FINRA Operations' determination shall constitute final action by FINRA.

      Submissions by Third-Parties

      Supplementary Material .02 (Requests by Third-Parties), permits FINRA, in its discretion, to announce a Company-Related Action when it is contacted by a third party, such as The Depository Trust & Clearing Corporation (DTCC), foreign exchanges or regulators, member firms or associated persons. In such instances, FINRA would request that the third-party contact the issuer in question regarding its obligations under SEA Rule 10b-17 or other rules and regulations, as applicable, and instruct the issuer to contact FINRA directly to provide notice and complete the requisite forms. However, FINRA Operations may in its discretion review and process a Company-Related Action based on information from a third-party when it believes the action is necessary for the protection of the market and investors and/or FINRA Operations has been unable to obtain notification of the Company-Related Action from the issuer. In all cases, FINRA notes that it must have actual substantiated knowledge of a Company-Related Action from a credible source before it can consider announcing such action.

      Referral of Possible Non-Compliance with SEA Rule 10b-17 to SEC Staff

      Non-compliance with SEA Rule 10b-17 has been an ongoing concern, and FINRA expects the new rule to reduce such non-compliance. An issuer that fails to notify FINRA of a proposed corporate action, as required by SEA Rule 10b-17, is potentially violating an anti-fraud rule of the federal securities laws. The possible sanctions for violating federal securities laws are significant. In addition, transfer agents that knowingly aid and abet such violations may also be subject to possible sanctions. Where FINRA Operations staff has actual knowledge, it will use its best efforts to provide a list of non-complying issuers to the SEC staff.

      Development of Electronic Forms and Payment Processing System

      FINRA is developing electronic forms and a payment processing system to process documents for Company-Related Actions more efficiently. Until the system is ready, FINRA requires parties to use paper forms and the payment methods listed on the UPC page on FINRA's website. FINRA expects to have the electronic system available by the first quarter of 2011 and will announce the effective date of the new system in a future Regulatory Notice.

      FINRA encourages all interested parties to review its dedicated Web page for UPC matters which, among other things, provides detailed guidance on the necessary forms, required supporting documentation, methods to submit the required fees and a Frequently Asked Questions section.


      1 See Securities Exchange Act (SEA) Release No. 62434 (July 1, 2020; 75 FR 39603 (July 9, 2010); SR-FINRA-2009-089 (Order Approving Proposed FINRA Rule 6490 (Processing of Company-Related Actions) to Clarify the Scope of FINRA's Authority When Processing Documents Related to Announcements for Company-Related Actions for Non-Exchange Listed Securities and To Implement Fees for Such Services).

      2 See Securities Exchange Act Rule 10b-17 (SEA Rule 10b-17).

      3 See NASD Rule 11000 Series (UPC rules). See also, NASD Rule 11140 relating to setting of ex-dates.

      4 This includes instances where FINRA has actual knowledge that the SEC has issued an order pursuant to Section 12(k) of the Exchange Act temporarily suspending the issuer's securities or pursuant to Section 12(j) of the Exchange Act revoking registration of the issuer's securities.

    • 10-37 Increase in Number of Arbitrators Available for Review When Parties Choose Arbitration Panels; Effective Date: September 27, 2010

      View PDF

      Arbitrator Selection

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 12403
      FINRA Rule 12404
      FINRA Rule 13403
      FINRA Rule 13404
      Suggested Routing

      Compliance
      Legal
      Registered Representatives
      Senior Management
      Key Topics

      Arbitration
      Code of Arbitration Procedure
      Generating and Sending Lists
      Neutral List Selection System

      Executive Summary

      Effective September 27, 2010, FINRA will increase the number of proposed arbitrators available for review when parties choose arbitration panels from lists generated randomly by the Neutral List Selection System (NLSS).1 The amendments to the Customer and Industry Codes of Arbitration Procedure (Codes) will apply to lists generated on or after the effective date. The text of the amendments is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Richard W. Berry, Senior Vice President and Director of Case Administration and Regional Office Services, Dispute Resolution, at (212) 858-4307 or richard.berry@finra.org; or
      •   Margo A. Hassan, Assistant Chief Counsel, Dispute Resolution, at (212) 858-4481 or margo.hassan@finra.org.

      Background & Discussion

      NLSS is a computer system that generates, on a random basis, lists of proposed arbitrators from FINRA's rosters of arbitrators (i.e., public, non-public and chairperson rosters) for each arbitration case. The parties select their panel through a process of striking and ranking the arbitrators on the lists.

      Currently, FINRA sends parties lists of available arbitrators, along with detailed biographical information. In a single arbitrator case, the parties receive a list of eight chairperson arbitrators.2 In a three-arbitrator case, other than a dispute involving only FINRA firms, the parties receive three lists—one public, one public chairperson and one non-public—each containing eight arbitrator names. In a three-arbitrator case involving only firms, the panel consists of non-public arbitrators, so the parties receive a list of 16 arbitrators from the non-public roster and a list of eight arbitrators from the non-public chairperson roster.

      Each party is permitted to strike up to four of the eight names on each list and rank the remaining names in order of preference. FINRA appoints the panel from the names remaining on the parties' lists. When there are no names remaining on a list because all of them have been struck by the parties, or when no mutually acceptable arbitrator is able to serve, FINRA uses NLSS to "extend the list" by randomly selecting an additional arbitrator to complete the panel.3 Parties may only challenge an extended-list arbitrator for cause.

      Parties in arbitration cases have expressed concerns about extended-list appointments because they are not able to strike arbitrators from these lists. To address these concerns, FINRA is amending the Codes to increase the number of arbitrators on the initial lists generated by NLSS from eight to 10 (or from 16 to 20, depending on the type of case), while retaining the current limitation on strikes.

      The amendments provide parties with more control in the arbitrator selection process because of the increased likelihood that arbitrators from each initial list will remain on the list after the parties complete the striking and ranking process. Having additional arbitrator names on the list will also reduce the need for extended-list appointments if vacancies occur in a panel later in a case. FINRA believes the amendments will enhance the arbitration process.

      Customer Disputes

      FINRA Rule 12403 of the Customer Code of Arbitration Procedure is amended to expand the number of arbitrators on each list (public, public chairperson and non-public) generated through NLSS from eight arbitrators to 10 arbitrators, while keeping the number of available strikes at four per party.4 The new procedure will ensure that in most cases at least two proposed arbitrators will remain on each list of 10 potential arbitrators—thus significantly increasing the likelihood that the parties will get panelists they chose and ranked, as opposed to extended list appointments.

      Firm and Associated Person Disputes

      FINRA is also amending FINRA Rule 13403 the Industry Code of Arbitration Procedure to expand the number of arbitrators on lists generated through NLSS. For disputes between firms, FINRA is expanding the number of arbitrators on the non-public chairperson list from eight arbitrators to 10 arbitrators and the number of arbitrators on the non-public list from 16 arbitrators to 20 arbitrators.

      For disputes between associated persons or between or among firms and associated persons, FINRA is expanding the number of arbitrators on each list (public, public chairperson and non-public) from eight arbitrators to 10 arbitrators. FINRA is not expanding the number of allowable strikes for each party.5

      Effective Date

      Before implementing the amendments, FINRA needs to make programming changes to its case management computer system, MATRICS. Therefore, the amendments become effective on September 27, 2010, for lists generated on or after that date. The amendments apply to cases in which FINRA has not yet generated lists, and cases which require a new list on or after the effective date. In pending cases, however, FINRA will honor any joint request of the parties to wait until September 27, 2010, to generate lists.


      1 Exchange Act Release No. 62480 (July 9, 2010) 75 Federal Register 41262 (July 15, 2010) (File No. SR-FINRA-2010-022).

      2 In a case involving only FINRA member firms, the parties receive a list of eight arbitrators from the non-public chairperson roster. In all other cases, the parties receive a list of eight arbitrators from the public chairperson roster.

      3 The Codes provide that each separately represented party may strike up to four of the arbitrators from each list for any reason. If, for example, a case involves a customer, a firm and an associated person, and each party is separately represented, all eight arbitrators on a list may be stricken. In such a case, FINRA uses NLSS to extend the list by generating additional arbitrator names.

      4 Currently, FINRA Rule 12404 provides that each separately represented party may strike up to four of the arbitrators from each eight arbitrator list and that at least four names must remain on the list. FINRA is making a conforming change to FINRA Rule 12404 to reflect that at least six names must remain on each 10 arbitrator list.

      5 Currently, FINRA Rule 13404 provides that each separately represented party may strike up to four of the arbitrators from each eight arbitrator list and eight arbitrators from each 16 arbitrator list. FINRA is making conforming changes to FINRA Rule 13404 to reflect that at least six names must remain on each list of 10 arbitrators and that at least 12 names must remain on a list of 20 arbitrators.


      Attachment A

      New language is underlined; deleted language is in brackets.

      Code of Arbitration Procedure for Customer Disputes

      And

      Code of Arbitration Procedure for Industry Disputes

      Customer Code

      12403. Generating and Sending Lists to the Parties

      (a) Generating Lists
      (1) If the panel consists of one arbitrator, the Neutral List Selection System will generate a list of [eight] 10 public arbitrators from the FINRA chairperson roster.
      (2) If the panel consists of three arbitrators, the Neutral List Selection System will generate:
      •   A list of [eight] 10 arbitrators from the FINRA non-public arbitrator roster;
      •   A list of [eight] 10 arbitrators from the FINRA public arbitrator roster; and
      •   A list of [eight] 10 public arbitrators from the FINRA chairperson roster.
      (3)–(4) No change.
      (b) No Change.

      * * *

      12404. Striking and Ranking Arbitrators

      (a) Each separately represented party may strike up to four of the arbitrators from each list for any reason by crossing through the names of the arbitrators. At least [four] six names must remain on each list.
      (b)–(c) No Change.

      * * *

      Industry Code

      13403. Generating and Sending Lists to the Parties

      For disputes involving statutory employment discrimination claims, see Rule 13802.

      (a) Lists Generated in Disputes Between Members
      (1) If the panel consists of one arbitrator, the Neutral List Selection System will generate a list of [eight] 10 non-public arbitrators from the FINRA non-public chairperson roster.
      (2) If the panel consists of three non-public arbitrators, the Neutral List Selection System will generate:
      •   A list of [16] 20 arbitrators from the FINRA non-public roster; and
      •   A list of [eight] 10 non-public arbitrators from the FINRA non-public chairperson roster.
      (3)–(4) No change.
      (b) Lists Generated in Disputes Between Associated Persons or Between or Among Members and Associated Persons
      (1) If the panel consists of one arbitrator, the Neutral List Selection System will generate a list of [eight] 10 public arbitrators from the FINRA public chairperson roster.
      (2) If the panel consists of three arbitrators, the Neutral List Selection System will generate:
      •   A list of [eight] 10 arbitrators from the FINRA non-public arbitrator roster;
      •   A list of [eight] 10 arbitrators from the FINRA public arbitrator roster; and
      •   A list of [eight] 10 public arbitrators from the FINRA public chairperson roster.
      (3)–(4) No change.
      (c) No change.

      * * *

      13404. Striking and Ranking Arbitrators

      (a) Except for lists generated pursuant to Rule 13403(a)(2), each separately represented party may strike up to four of the arbitrators from each list for any reason by crossing through the names of the arbitrators. At least [four] six names must remain on each list.
      (b) For lists generated pursuant to Rule 13403(a)(2), each separately represented party may strike up to eight of the arbitrators from the non-public list and up to four of the arbitrators from the non-public chairperson list for any reason by crossing through the names of the arbitrators. At least [eight] 12 names must remain on the non-public list and at least [four] six names must remain on the non-public chairperson list.
      (c)–(d) No change.

      * * * * *

    • 10-36 Amendments to Standardized Options Exercise Procedures and Extension of Contrary Exercise Advice Cut-Off Time; Effective Date: September 7, 2010

      View PDF

      Options: Contrary Exercise Advice

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 2360
      Suggested Routing

      Compliance
      Institutional
      Legal
      Operations
      Options
      Senior Management
      Trading
      Key Topics

      Contrary Exercise Advice (CEA)
      Expiring Exercise Declaration (EED)
      Options Expiration
      Standardized Options

      Executive Summary

      Effective September 7, 2010, amendments to FINRA Rule 2360 (Options) extend the cut-off time for the submission of certain contrary exercise advices (CEAs)1 by one hour to 7:30 p.m. Eastern Time (ET).2 Additionally, in the event of a modified close of trading, the amendments extend the deadline for option holders to make a final exercise decision for an expiring standardized option by two minutes to one hour and 30 minutes following the modified closing time.

      The amended rule text is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Gary Goldsholle, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104; or
      •   Kathryn Moore, Assistant General Counsel, OGC, at (202) 974-2974.

      Background & Discussion

      FINRA Rule 2360(b)(23)(A) and similar rules of the options exchanges set forth procedures for the exercise of standardized options on the last business day before expiration. An option holder with an expiring standardized option has two choices:

      •   take no action and permit the option to automatically be exercised in accordance with The Options Clearing Corporation's (OCC) exercise-by-exception (Ex-by-Ex) procedures3; or
      •   submit a CEA that overrides the Ex-by-Ex procedures; i.e., an instruction to let expire an option that otherwise would be exercised, or an instruction to exercise an option that otherwise would expire.

      The rule provides that option holders have until 5:30 p.m. ET on the business day immediately prior to the expiration date to make a final decision to exercise or not exercise an expiring option. Firms may not accept exercise instructions for any account (customer or non-customer) after this time. This deadline has not been changed.

      If the option holder elects not to follow the Ex-by-Ex procedure, then the firm must submit a CEA. The rule change has extended by one hour (from 6:30 p.m. to 7:30 p.m. ET) the time by which firms must submit a CEA for customer accounts, and for non-customer accounts if the firm uses an electronic submission procedure with a time stamp for the submission of exercise instructions by option holders. For firms that do not use such electronic time stamps, the deadline to submit such CEAs continues to be 5:30 p.m. ET.

      In addition, if a modified close of trading is announced (i.e., a time other than 4 p.m. ET), the rule change extends by two minutes (from one hour and 28 minutes to one hour and 30 minutes) the time by which option holders must make a final exercise decision following the modified closing time.4 In these circumstances, the rule change affords a firm up to 7:30 p.m. ET to submit a CEA for customer accounts, and for non-customer accounts if the firm uses an electronic submission procedure with a time stamp for the submission of exercise instructions by option holders. However, for firms that do not employ an electronic time stamp, the rule change only extends by two minutes the time by which firms must submit a CEA, requiring such CEAs to be submitted within one hour and 30 minutes after the modified close of trading for its non-customer accounts.

      Finally, FINRA made certain changes to reorganize the rule text to improve readability.

      As noted above, the implementation date of these amendments is September 7, 2010.


      1 Contrary exercise advices also are referred to as expiring exercise declarations (EEDs) in The Options Clearing Corporation rules.

      2 See Securities Exchange Act Release No. 62711 (August 12, 2010), 75 FR 51124 (August 19, 2010) (Notice of Filing and Immediate Effectiveness of File No. SR-FINRA-2010-041).

      3 Under the Ex-by-Ex procedures an option will be automatically exercised if the option contract is in-the-money by a requisite amount.

      4 This change conforms with the rules of the options exchanges, which were modified to correspond to the two-minute difference in trading time created by the change in the close of trading time from 4:02 p.m. to 4 p.m. ET. See Securities Exchange Act Release Nos. 53519 (March 20, 2006), 71 FR 15229 (March 27, 2009) (SR-AMEX-2006-26); 53249 (February 7, 2006), 71 FR 8035 (February 15, 2006) (SR-PCX-2005-138); 53407 (March 3, 2006), 71 FR 12764 (March 13, 2006) (SR-PHLX-2006-12); 53439 (March 7, 2006), 71 FR 13643 (March 16, 2006) (SR-ISE-2006-11); and 53438 (March 7, 2006), 71 FR 13641 (March 16, 2006) (SR-CBOE-2006-19).


      Attachment A

      Text of Amended Rule
      Proposed new language is underlined; proposed deletions are in brackets.

      * * * * *

      2300. Special Products

      * * * * *

      2360. Options

      (a) No Change.
      (b) Requirements
      (1) through (22) No Change.
      (23) Tendering Procedures for Exercise of Options
      (A) Exercise of Options Contracts
      (i) No Change.
      [(ii) Final exercise decisions of options holders to either exercise or not to exercise an expiring standardized equity option must be indicated to an options exchange that is a national securities exchange (national options exchange) that lists and trades the option, either directly to such national options exchange or via a member of such national options exchange if it is not a member of such exchange, by the respective member no later than 5:30 p.m. Eastern time ("ET") on the business day immediately prior to the expiration date. For customer accounts, members may not accept exercise instructions after 5:30 p.m. ET but have until 6:30 p.m. ET to submit a Contrary Exercise Advice (as defined below). For non-customer accounts, members may not accept exercise instructions after 5:30 p.m. ET but have until 6:30 p.m. ET to submit a Contrary Exercise Advice if such member employs an electronic submission procedure with time stamp for the submission of exercise instructions by option holders. Members are required to submit a Contrary Exercise Advice by 5:30 p.m. ET for non-customer accounts if such members do not employ an electronic submission procedure with time stamp for the submission of exercise instructions by option holders. Each member shall establish fixed procedures to ensure secure time stamps in connection with their electronic systems employed for the recording of submissions to exercise or not exercise expiring options. For purposes of this Rule 2360(b)(23)(A), the terms "customer account' and non-customer account" shall have the meanings as defined in The Options Clearing Corporation By-laws.]
      [(iii)](ii) Special procedures apply to the exercise of standardized equity options on the last business day before their expiration ("expiring options"). Unless waived by The Options Clearing Corporation, expiring standardized equity options are subject to the Exercise-by-Exception ("Ex-by-Ex") procedure under The Options Clearing Corporation Rule 805. This Rule provides that, unless contrary instructions are given, standardized equity option contracts that are in-the-money by specified amounts shall be automatically exercised. In addition to The Options Clearing Corporation rules, the following FINRA requirements apply with respect to expiring standardized equity options. Option holders desiring to exercise or not exercise expiring standardized equity options must either:
      a. take no action and allow exercise determinations to be made in accordance with The Options Clearing Corporation's Ex-by-Ex procedure where applicable; or
      b. submit a "Contrary Exercise Advice" by the deadline specified [in paragraph (ii) above]below.
      (iii) Exercise cut-off time. Option holders have until 5:30 p.m. Eastern Time ("ET") on the business day immediately prior to the expiration date to make a final exercise decision to exercise or not exercise an expiring option. Members may not accept exercise instructions for customers or non-customers accounts after 5:30 p.m. ET.
      (iv) Submission of Contrary Exercise Advice. A Contrary Exercise Advice is a form approved by the national options exchanges, FINRA or The Options Clearing Corporation for use by a member to submit a final exercise decision committing an options holder to either: (1) not exercise an option position which would automatically be exercised pursuant to The Options Clearing Corporation's Ex-by-Ex procedure; or (2) to exercise a standardized equity option position which would not automatically be exercised pursuant to The Options Clearing Corporation's Ex-by-Ex procedure. A Contrary Exercise Advice may be canceled by filing an "Advice Cancel" or resubmitted at any time up to the submission cut-off times specified herein[in subparagraph (ii)]. For customer accounts, members have until 7:30 p.m. ET to submit a Contrary Exercise Advice. For non-customer accounts, members have until 7:30 p.m. ET to submit a Contrary Exercise Advice if such member employs an electronic submission procedure with time stamp for the submission of exercise instructions by option holders. Members are required to manually submit a Contrary Exercise Advice by 5:30 p.m. ET for non-customer accounts if such members do not employ an electronic submission procedure with time stamp for the submission of exercise instructions by option holders. Each member shall establish fixed procedures to ensure secure time stamps in connection with their electronic systems employed for the recording of submissions to exercise or not exercise expiring options. For purposes of this Rule 2360(b)(23)(A), the terms "customer account" and "non-customer account" shall have the meanings as defined in The Options Clearing Corporation By-laws. Contrary Exercise Advices and/or Advice Cancels may be submitted by any member to:
      [1]a. a place designated for that purpose by any national options exchange of which it is a member and where the standardized equity option is listed;
      [2]b. a place designated for that purpose by any national options exchange that lists and trades the standardized equity option via a member of such exchange if the member is not a member of such exchange;
      [3]c. any national options exchange of which it is a member and where the standardized equity option is listed via The Options Clearing Corporation in a form prescribed by The Options Clearing Corporation; or
      [4]d. any national options exchange where the standardized equity option is listed via The Options Clearing Corporation in a form prescribed by The Options Clearing Corporation, provided the member is a member of The Options Clearing Corporation.
      [(iv)] (v) In those instances when The Options Clearing Corporation has waived the Ex-by-Ex procedure for an options class, members must either:
      a. submit to any of the places listed in subparagraphs [(iii)b.1. through 4.] (iv)a. through d. above, a Contrary Exercise Advice, within the time limits specified in subparagraph [(ii)](iv) above if the holder intends to exercise the standardized equity option, or
      b. take no action and allow the standardized equity option to expire without being exercised.
      The applicable underlying security price in such instances will be as described in The Options Clearing Corporation Rule 805(1), which is normally the last sale price in the primary market for the underlying security. In cases where the Ex-by-Ex procedure has been waived for an options class, The Options Clearing Corporation rules require that members wanting to exercise such options must submit an affirmative Exercise Notice to The Options Clearing Corporation, whether or not a Contrary Exercise Advice has been filed.
      [(v)](vi) Members that maintain proprietary or public customer positions in expiring standardized equity options shall take necessary steps to ensure that final exercise decisions are properly indicated to the relevant national options exchange with respect to such positions. Members that have accepted the responsibility to indicate final exercise decisions on behalf of another member also shall take necessary steps to ensure that such decisions are properly indicated to the relevant national options exchange. Members may establish a processing cut-off time prior to FINRA's exercise cut-off time at which they will no longer accept final exercise decisions in expiring standardized equity options from customers.
      [(vi)](vii) Members may effect or amend exercise decisions for standardized equity options after the exercise cut-off time (but prior to expiration) under the following circumstances:
      a. in order to remedy mistakes or errors made in good faith;
      b. to take appropriate action as the result of a failure to reconcile unmatched option transactions; or
      c. where extraordinary circumstances restricted a customer's or member's ability to inform the respective member of such decisions (or a member's ability to receive such decisions) by the cut-off time.
      The burden of establishing an exception for a proprietary or customer account of a member rests solely on the member seeking to rely on such exception.
      [(vii)] (viii) In the event a national options exchange or The Options Clearing Corporation provides advance notice on or before 5:30 p.m. ET on the business day immediately prior to the last business day before the expiration date indicating that a modified time for the close of trading in standardized equity options on such last business day before expiration will occur, then the deadline for an option holder to make a final decision to exercise or not exercise an expiring option shall be 1 hour [28] 30 minutes following the time announced for the close of trading on that day instead of the 5:30 p.m. ET deadline found in paragraph [(ii)](iii) above. However, members have until 7:30 p.m. ET to [may] deliver a Contrary Exercise Advice or Advice Cancel to the places specified in paragraphs [(iii)b.1. through 4.](iv)a. through d. above [within 2 hours 28 minutes following the time announced for the close of trading in standardized equity options on that day instead of the 6:30 p.m. ET deadline found in paragraph (ii) above] for customer accounts and non-customer accounts where such member firm employs an electronic submission procedure with time stamp for the submission of exercise instructions. For non-customer accounts, members that do not employ an electronic procedure with time stamp for the submission of exercise instructions are required to manually deliver a Contrary Exercise Advice or Advice Cancel within 1 hour and [28] 30 minutes following the time announced for the close of trading on that day instead of the 5:30 p.m. ET deadline found in paragraph [(ii)] (iv) above.
      [(viii)](ix) The filing of a final exercise decision, exercise instruction, exercise advice, Contrary Exercise Advice or Advice Cancel required by subparagraph (A) hereof does not serve as a substitute to the effective notice required to be submitted to The Options Clearing Corporation for the exercise or non-exercise of expiring standardized equity options.
      [(ix)](x) Submitting or preparing an exercise instruction after the exercise cut-off time in any expiring standardized equity option on the basis of material information released after the exercise cut-off time is activity inconsistent with just and equitable principles of trade.
      [(x)](xi) The exercise cut-off requirements contained in this subparagraph (A) do not apply to any currency option or standardized index option products listed on a national options exchange.
      (B) through (D) No Change.
      (24) No Change.
      (c) No Change.

      * * * * *

    • 10-35 SEC Approval and Effective Date for New Consolidated FINRA Rule; Effective Date: October 15, 2010

      View PDF

      SEC Approves New Consolidated FINRA Rule

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      Rule Approval
      Referenced Rules & Notices

      FINRA Rule 4320
      Information Notice 03/12/08
      Information Notice 10/06/08
      Regulatory Notice 08-57
      Regulation SHO
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Trading and Market Making
      Key Topics

      Short Sale Delivery
      Short Sales

      Executive Summary

      Following the consolidation of NASD and the member regulation, enforcement and arbitration functions of NYSE Regulation into FINRA, FINRA established a process to develop a new consolidated rulebook (Consolidated FINRA Rulebook), which FINRA has discussed in previous Information Notices.1 FINRA is proposing new consolidated rules in phases for approval by the Securities and Exchange Commission (SEC) as part of the Consolidated FINRA Rulebook.2 In June and July, the SEC approved five new consolidated FINRA Rules.3 This Regulatory Notice specifically addresses the approval and effective date of new FINRA Rule 4320 (Short Sale Delivery Requirements).4

      Text of new FINRA Rule 4320 is available in the online FINRA Manual at www.finra.org/finramanual/rules/r4320.5

      Questions regarding this Notice should be directed to Racquel Russell, Assistant General Counsel, Office of General Counsel, at (202) 728-8363.

      Background & Discussion

      On July 20, 2010, the SEC approved a FINRA proposed rule change to adopt NASD Rule 3210, with minor changes, as FINRA Rule 4320 in the Consolidated FINRA Rulebook.6 FINRA Rule 4320 applies short sale delivery requirements to equity securities not otherwise covered by the close-out requirements of Regulation SHO.7 Among other things, FINRA Rule 4320 requires participants of registered clearing agencies to take action on failures to deliver that exist for 13 consecutive settlement days in certain non-reporting securities. In addition, if the fail to deliver position is not closed out in the requisite time period, a participant of a registered clearing agency or any broker-dealer for which it clears transactions is prohibited from effecting further short sales in the particular specified security without borrowing, or entering into a bona fide arrangement to borrow, the security until the fail to deliver position is closed out.8

      With a few exceptions, new FINRA Rule 4320 is identical to former NASD Rule 3210, and the changes made to the text do not alter the operation and application of the rule. For example, the new FINRA rule omits language that provided allowances for "grandfathered" securities during the initial implementation period of NASD Rule 3210 which no longer is relevant. In addition, FINRA Rule 4320 clarifies, consistent with Regulation SHO, the borrowing requirements for clearing agency participants—including broker-dealers for which they clear transactions—that sell short non-reporting threshold securities for which a fail to deliver position has not been closed out in the requisite time.9

      In addition, FINRA will apply to FINRA Rule 4320 all interpretive positions issued by the SEC and its staff with respect to the parallel provisions of Regulation SHO (i.e., Rule 203(b)(3) of Regulation SHO), as was the case with NASD Rule 3210. Therefore, FINRA continues to expect firms to observe all interpretive views issued by the SEC and its staff with respect to Rule 203(b)(3) and apply such positions to FINRA Rule 4320.10

      Rule Conversion Charts

      As discussed in additional detail in Information Notice 10/06/08 and Regulatory Notice 08-57, FINRA has posted three Rule Conversion Charts on its website to help firms become familiar with the new rules and show how the new rules relate to the NASD and/or Incorporated NYSE Rules in the Transitional Rulebook that they will replace.

      Firms should be aware that the charts are intended as a reference aid only. FINRA reminds firms that the charts do not in any way serve as a substitute for diligent review of the relevant new rule language. The Rule Conversion Charts are located at www.finra.org/ruleconversionchart.


      1 See Information Notice 10/06/08 (Rulebook Consolidation Process: Effective Dates of New Consolidated Rules; Introduction of Rule Conversion Chart); see also Information Notice 03/12/08 (Rulebook Consolidation Process).

      2 The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The new FINRA Rules apply to all member firms, unless such rules have a more limited application by their terms. As the Consolidated FINRA Rulebook expands with the SEC's approval and with the new FINRA Rules taking effect, the rules in the Transitional Rulebook that address the same subject matter of regulation will be eliminated. When the Consolidated FINRA Rulebook is completed, the Transitional Rulebook will have been eliminated in its entirety.

      3 In July 2010, the SEC approved three FINRA proposed rule changes to adopt five new rules in the Consolidated FINRA Rulebook. See Securities Exchange Act Release No. 62482 (July 12, 2010), 75 FR 41562 (July 16, 2010) (SR-FINRA-2010-024); Securities Exchange Act Release No. 62533 (July 20, 2010), 75 FR 43588 (July 26, 2010) (SR-FINRA-2010-028); and Securities Exchange Act Release No. 62539 (July 21, 2010), 75 FR 44033 (July 27, 2010) (SR-FINRA-2010-029).

      4 See Securities Exchange Act Release No. 62533 (July 20, 2010), 75 FR 43588 (July 26, 2010) (SR-FINRA-2010-028). FINRA will issue separate Regulatory Notices announcing the effective dates of the approved rules set forth in SR-FINRA-2010-024 and SR-FINRA-2010-029. See supra note 3.

      5 FINRA updates the rule text on its online Manual within two business days of SEC approval of changes to the rule text.

      6 See Securities Exchange Act Release No. 62533 (July 20, 2010), 75 FR 43588 (July 26, 2010) (SR-FINRA-2010-028).

      7 The Regulation SHO close-out requirements apply only to "reporting" securities (i.e., issuers that are registered pursuant to Section 12 of the Exchange Act or that are required to file reports pursuant to Section 15(d) of the Exchange Act).

      8 In July 2009, the SEC adopted Rule 204 under Regulation SHO as a permanent rule. This rule is intended to further the goal of reducing fails to deliver and addressing potentially abusive "naked" short selling in all equity securities by requiring the delivery of securities by settlement date or, in connection with a short sale, the immediate purchase or borrow of such securities to close out the fail to deliver position by no later than the beginning of regular trading hours on the following settlement day.

      Notwithstanding the SEC's adoption of Rule 204, the provisions of NASD Rule 3210 continue to be necessary to provide regulatory coverage for fails to deliver in non-reporting over-the-counter equity securities that pre-exist the SEC's implementation of temporary Rule 204 in September 2008. Thus, FINRA has adopted NASD Rule 3210 with minor changes as FINRA Rule 4320.

      9 Specifically, if a fail to deliver position is not closed out in accordance with FINRA Rule 4320(a), the clearing agency participant and any broker-dealer for which it clears, including market makers otherwise entitled to rely on the Rule 203(b)(2)(iii) exception of Regulation SHO, would not be able to short sell the non-reporting threshold security either for itself or for the account of another, unless it has previously arranged to borrow or borrowed the security, until the participant closes out the fail to deliver position by purchasing securities of like kind and quantity and that purchase has cleared and settled at a registered clearing agency.

      10 For example, with respect to the requirement that participants "immediately" close out a fail to deliver position by purchasing securities of like kind and quantity, the SEC has clarified that "immediately" should be interpreted to mean that close out is required no later than the morning of the fourteenth business day. Likewise FINRA expects that, under FINRA Rule 4320, firms "immediately" close out fail to deliver positions no later than the morning of the fourteenth business day.

    • 10-34 SEC Approves Changes to Expand the Information Released Through BrokerCheck and Establish a Process to Dispute (or Update) Information Disclosed Through BrokerCheck

      Effective Date—Historic Complaints and Dispute Process: August 23, 2010; Effective Date—Disclosure Period and Permanently Available Information: November 6, 2010

      View PDF

      FINRA BrokerCheck

      Regulatory Notice
      Notice Type

      Rule Approval
      Referenced Rules & Notices

      FINRA Rule 8312
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topics

      BrokerCheck
      BrokerCheck Dispute Process
      Central Registration Depository
      Historic Complaints
      Uniform Registration Forms

      Executive Summary

      The SEC approved amendments to FINRA Rule 8312, which governs the release of information through BrokerCheck.1 The amendments:

      (1) make publicly available in BrokerCheck all historic customer complaints that became non-reportable after the implementation of Web CRD;
      (2) permanently make publicly available in BrokerCheck information about former associated persons of a member firm, as reported to CRD on a uniform registration form if they were (a) convicted of or pled guilty or no contest to certain crimes; (b) subject to a civil injunction involving investment-related activity or found in a civil court to have been involved in a violation of investment-related statutes or regulations; or (c) named as a respondent or defendant in an arbitration or civil litigation in which they were alleged to have committed a sales practice violation, and which resulted in an award or civil judgment against them;
      (3) expand the BrokerCheck disclosure period for former associated persons of a member firm to 10 years from two years; and
      (4) codify FINRA's current process for disputing the accuracy of (or updating) information disclosed through BrokerCheck.

      The amendments involving the public availability of historic customer complaints and the process for disputing the accuracy of information disclosed through BrokerCheck become effective on August 23, 2010. The effective date for the amendments pertaining to the expansion of the disclosure period for former associated persons and the permanent public availability of certain information about former associated persons of a member firm is November 6, 2010.

      The text of the amendments to FINRA Rule 8312 is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Richard E. Pullano, Associate Vice President and Chief Counsel, Registration and Disclosure, at (240) 386-4821; or
      •   Stan Macel, Assistant General Counsel, Office of General Counsel, at (202) 728-8056.

      This Notice was updated to renumber the footnotes. [Update made July 24, 2012]

      Background & Discussion

      FINRA Rule 8312 governs the information FINRA releases to the public via BrokerCheck. FINRA established BrokerCheck (formerly known as the Public Disclosure Program) in 1988 to provide the public with information on the professional background, business practices, and conduct of FINRA member firms and their associated persons. Via BrokerCheck, FINRA releases to the public certain information reported on uniform registration forms to the Central Registration Depository (CRD® or Web CRD).2 Among other things, BrokerCheck helps investors make informed choices about the individuals and firms with which they may wish to do business.

      The SEC recently approved amendments to FINRA Rule 8312. As discussed in more detail below, the amendments:

      •   make publicly available in BrokerCheck all historic customer complaints that became non-reportable after the implementation of Web CRD;
      •   expand the BrokerCheck disclosure period for former associated persons of a member firm to 10 years from two years;
      •   permanently make publicly available in BrokerCheck certain information about former associated persons of a member firm if any of the following applies, as reported to CRD on a uniform registration form: (i) the person was convicted of or pled guilty or nolo contendere to a crime; (ii) the person was the subject of a civil injunction in connection with investment-related activity or a civil court finding of involvement in a violation of any investment-related statute or regulation; or (iii) the person was named as a respondent or defendant in an investment-related, consumer-initiated arbitration or civil litigation which alleged that the person was involved in a sales practice violation and which resulted in an arbitration award or civil judgment against the person; and
      •   codify FINRA's current process for disputing the accuracy of (or updating) information disclosed through BrokerCheck.

      The amendments involving the public availability of historic customer complaints and the process for disputing the accuracy of information disclosed through BrokerCheck become effective on August 23, 2010. The effective date for the amendments pertaining to the expansion of the disclosure period for former associated persons and the permanent public availability of certain information about former associated persons of a member firm is November 6, 2010.

      Revisions Regarding Historic Customer Complaints

      Pursuant to FINRA Rule 8312, Historic Complaints are customer complaints that were reported on a uniform registration form, are more than two years old and that have not been settled or adjudicated; and customer complaints, arbitrations or litigations that have been settled for an amount less than the specified dollar amount (identified on the customer complaint question) and are therefore no longer reportable on a uniform registration form. FINRA Rule 8312 currently provides that Historic Complaints be displayed in BrokerCheck only after the following conditions have been met: (1) a matter became a Historic Complaint on or after March 19, 2007; (2) the most recent Historic Complaint or currently reported customer complaint, arbitration or litigation is less than 10 years old; and (3) the person has a total of three or more currently disclosable regulatory actions, currently reported customer complaints, arbitrations or litigations, or Historic Complaints (subject to the limitation that they became Historic Complaints on or after March 19, 2007), or any combination thereof. Unless all three conditions are met, a person's Historic Complaints are not disclosed through BrokerCheck.3

      Effective August 23, 2010, FINRA will eliminate the conditions set forth in FINRA Rule 8312 that must be met before Historic Complaints will be displayed in BrokerCheck. Eliminating these conditions will result in the disclosure of all Historic Complaints via BrokerCheck that became non-reportable after the implementation of Web CRD (i.e., on or after August 16, 1999).

      In conjunction with this change, FINRA will simplify the process by which member firms may add or revise comments to, or otherwise update information pertaining to, Historic Complaints.4 Currently, a member firm must contact FINRA and request that a Historic Complaint be "un-archived" if the member firm wants to change the information that it reported with respect to that Historic Complaint. After the member firm makes the necessary changes, the Historic Complaint is once again "archived," if appropriate.

      FINRA will simplify the process to amend Historic Complaints by allowing member firms to amend "archived" Historic Complaints without first contacting FINRA.5 With this change, member firms will be able to amend Historic Complaints in the same manner that they currently amend other reported disclosure events.

      Expansion of the Disclosure Period for Former Associated Persons and the Information Permanently Available in BrokerCheck

      Currently, as described in FINRA Rule 8312, BrokerCheck provides information regarding current and former member firms, as well as current associated persons and persons who were associated with a member firm within the preceding two years (i.e., a two year "post-registration disclosure period"). In addition, BrokerCheck makes publicly available on a permanent basis certain information about former associated persons of a member firm who were the subject of a final regulatory action as defined in Form U4 that has been reported to CRD via a uniform registration form.

      Beginning November 6, 2010, FINRA will expand the post-registration disclosure period to 10 years from two years. Furthermore, FINRA will permanently make publicly available in BrokerCheck certain information about former associated persons of a member firm who were registered on or after August 16, 1999, if any of the following applies, as reported to CRD on a uniform registration form: (1) the person was convicted of or pled guilty or nolo contendere to a crime;6 (2) the person was the subject of a civil injunction in connection with investment-related activity or a civil court finding of involvement in a violation of any investment-related statute or regulation;7 or (3) the person was named as a respondent or defendant in an investment-related, consumer-initiated arbitration or civil litigation which alleged that the person was involved in a sales practice violation and which resulted in an arbitration award or civil judgment against the person.8

      FINRA will disclose through BrokerCheck information concerning any of the disclosure events described above, as well as certain administrative information (e.g., employment and registration history) and information as to qualification examinations, if available, regarding these formerly registered individuals. FINRA also will provide the most recently submitted comment, if any has been provided by the subject person, presuming the comment is in the form and in accordance with the procedures established by FINRA and relates to the information provided through BrokerCheck.

      BrokerCheck Dispute Process

      FINRA occasionally receives telephonic and written inquiries from persons subject to BrokerCheck who believe that information disclosed about them through BrokerCheck is inaccurate. When FINRA receives these inquiries, FINRA typically reviews the alleged inaccuracy and, if appropriate, contacts the entity that reported the information to determine whether the information is accurate. Once FINRA obtains all of the available pertinent information, FINRA determines whether the information is still accurate or whether the information should be modified or removed from BrokerCheck.

      Effective August 23, 2010, FINRA will enhance and codify this process, which will allow individuals and firms to dispute the accuracy of information displayed through BrokerCheck. The dispute process will be available both for challenges alleging the information was incorrect when filed and challenges asserting that the information has become incorrect due to events subsequent to filing.

      Under the dispute process, only an "eligible party" will be able to dispute the accuracy of information disclosed in that party's BrokerCheck report. An eligible party consists of any current member firm, any former member firm (subject to a condition discussed below), and any associated person of a member firm or person formerly associated with a member firm for whom a BrokerCheck report is available. With respect to former member firms, a dispute may be submitted only by a natural person who served as the former member firm's Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Chief Legal Officer or Chief Compliance Officer, or individual with similar status or function, as identified on Schedule A of Form BD at the time the former member firm ceased being registered with FINRA.

      To dispute the accuracy of BrokerCheck information, an eligible party must submit a BrokerCheck Dispute Form, which will be available on FINRA's website. The eligible party must identify the information that the party alleges is inaccurate and provide an explanation as to the reason the information is believed to be inaccurate. Additionally, the eligible party must submit with the BrokerCheck Dispute Form all available supporting documentation (if any exists).

      After receiving the BrokerCheck Dispute Form, FINRA will determine whether the dispute is eligible for investigation. To be eligible for investigation, the dispute must pertain only to factual information and not to information that is subjective in nature or a matter of interpretation. FINRA will presume that a dispute involving factual information is eligible for investigation; however, the following non-exhaustive list of situations will be ineligible for investigation, even if they involve factual information:

      •   a dispute that involves information that was previously disputed under this process and that does not contain any new or additional evidence;
      •   a dispute that is brought by an individual or entity that is not an eligible party;
      •   a dispute that does not challenge the accuracy of information contained in a BrokerCheck report but only provides an explanation of such information;
      •   a dispute that constitutes a collateral attack on or otherwise challenges the allegations underlying a previously reported matter such as a regulatory action, customer complaint, arbitration, civil litigation or termination;
      •   a dispute that consists of a general statement contesting information in a BrokerCheck report with no accompanying explanation; and
      •   a dispute that involves information contained in CRD that is not disclosed through BrokerCheck.

      If FINRA determines that a dispute is not eligible for investigation, it will notify the individual or firm of this determination in writing, including a brief description of the reason for the determination. A determination by FINRA that a dispute is not eligible for investigation is not subject to appeal.

      If FINRA determines that a dispute is eligible for investigation, FINRA will add a general notation to the eligible party's BrokerCheck report stating that the eligible party has disputed certain information included in the report.9 FINRA will evaluate the BrokerCheck Dispute Form and supporting documentation submitted by the eligible party. If FINRA concludes that the documentation submitted is sufficient to make a determination regarding the information that is the subject of the request, FINRA will make the appropriate change(s), if any. If, however, the BrokerCheck Dispute Form and supporting documentation do not include sufficient information upon which FINRA can make a determination, FINRA will, under most circumstances, contact the entity that reported the information to CRD (i.e., a firm, other regulator or FINRA department (the "reporting entity")) and request that the reporting entity verify that the information is accurate.10 Where a reporting entity other than FINRA is involved, FINRA will defer to that reporting entity regarding the accuracy of the information provided to FINRA and disclosed through BrokerCheck.11 If the reporting entity acknowledges that the information is not accurate, FINRA will update, modify or remove the information, as appropriate, based on the information provided by the reporting entity. If the reporting entity verifies the accuracy of the information or the reporting entity no longer exists or is unable to verify the accuracy of the information, FINRA will not change the information.

      Upon making its determination, FINRA will notify the disputing eligible party in writing that the investigation resulted in a determination that (1) the information is inaccurate or not accurately presented and has been updated, modified or deleted; (2) the information is accurate in content and presentation and no changes have been made; or (3) the accuracy of the information or its presentation could not be verified and no changes have been made. In addition, FINRA will remove the dispute notation from the eligible party's BrokerCheck report. A determination by FINRA regarding a dispute, including a determination to leave unchanged or to update, modify or delete disputed information, will not be subject to appeal.12


      1 See Securities Exchange Act Release No. 62476 (July 8, 2010), 75 FR 41254 (July 15, 2010) (Order Approving File No. SR-FINRA-2010-012).

      2 The uniform registration forms are Form BD (Uniform Application for Broker-Dealer Registration), Form BDW (Uniform Request for Broker-Dealer Withdrawal), Form BR (Uniform Branch Office Registration Form), Form U4 (Uniform Application for Securities Industry Registration or Transfer), Form U5 (Uniform Termination Notice for Securities Industry Registration), and Form U6 (Uniform Disciplinary Action Reporting Form).

      3 In addition, even if a person meets the criteria established for disclosing Historic Complaints, only those Historic Complaints that became Historic Complaints after March 19, 2007, currently are displayed through BrokerCheck.

      4 FINRA will also revise the customer dispute disclosure section of the BrokerCheck report to identify those customer disputes that were reported by a member firm as closed with no action, withdrawn, dismissed or denied. FINRA will continue to evaluate all aspects of its BrokerCheck program, including whether additional changes to the BrokerCheck report format should be implemented to make the reports easier to read and understand.

      5 FINRA will continue to review all changes made to Historic Complaints to determine if further action is warranted.

      6 This information is currently elicited by Questions 14A(1)(a) and 14B(1)(a) on Form U4 and Questions 7C(1) and 7C(3) on Form U5.

      7 This information is currently elicited by Questions 14H(1)(a) and 14H(1)(b) on Form U4.

      8 This information is currently elicited by Question 14I(1)(b) on Form U4 and Question 7E(1)(b) on Form U5.

      9 In those circumstances where a dispute involves a court order to expunge information from BrokerCheck, FINRA will, as it does today, prevent the disputed information from being displayed via BrokerCheck while FINRA evaluates the matter.

      10 FINRA will not contact the reporting entity if the entity is unlikely to have information regarding the disputed information.

      11 If the reporting entity obtained its information from a third party (e.g., a firm reported to CRD that an associated individual had declared bankruptcy based on information from a consumer reporting agency), FINRA will not contact the third party (in this example, the consumer reporting agency) to try to verify the accuracy of the information. The reporting entity will have the responsibility of verifying the accuracy of the information it received from the third party.

      12 Although FINRA determinations under the dispute process will not be subject to appeal, individuals and firms will continue to have the ability to challenge BrokerCheck information they believe to be inaccurate through other processes that are available today (e.g., an arbitration or court proceeding).


      Attachment A

      New language is underlined; deletions are in brackets.

      * * * * *

      8000. Investigations and Sanctions

      * * * * *

      8300. Sanctions

      * * * * *

      8312. FINRA BrokerCheck Disclosure

      (a) No Change.
      (b) (1) Except as otherwise provided in paragraph (d) below, FINRA shall release the information specified in subparagraph (2) below f[F]or inquiries regarding a current or former member, a current associated person, or a person who was associated with a member within the preceding ten [two] years.[, except as otherwise provided in paragraph (d) below, FINRA shall release:]
      (2) The following information shall be released pursuant to this paragraph (b):
      [(1)] (A) any information reported on the most recently filed Form U4, Form U5, Form U6, Form BD, and Form BDW (collectively "Registration Forms");
      [(2)] (B) currently approved registrations;
      [(3)] (C) summary information about certain arbitration awards against a member involving a securities or commodities dispute with a public customer;
      [(4)] (D) the most recently submitted comment, if any, provided to FINRA by a person who is covered by BrokerCheck, in the form and in accordance with the procedures established by FINRA, for inclusion with the information provided through BrokerCheck. Only comments that relate to the information provided through BrokerCheck will be included;
      [(5)] (E) information as to qualifications examinations passed by the person and date passed. FINRA will not release information regarding examination scores or failed examinations;
      [(6)] (F) in response to telephonic inquiries via the BrokerCheck toll-free telephone listing, whether a particular member is subject to the provisions of NASD Rule 3010(b)(2) ("Taping Rule");
      [(7)] (G) Historic Complaints (i.e., the information last reported on Registration Forms relating to customer complaints that are more than two (2) years old and that have not been settled or adjudicated, and customer complaints, arbitrations or litigations that have been settled for an amount less than $10,000 prior to May 18, 2009 or an amount less than $15,000 on or after May 18, 2009 and are no longer reported on a Registration Form), provided that any such matter became a Historic Complaint on or after August 16, 1999; and [:]
      [(A) any such matter became a Historic Complaint on or after March 19, 2007;]
      [(B) the most recent Historic Complaint or currently reported customer complaint, arbitration or litigation is less than ten (10) years old; and]
      [(C) the person has a total of three (3) or more currently disclosable regulatory actions, currently reported customer complaints, arbitrations or litigations, or Historic Complaints (subject to the limitation that they became a Historic Complaint on or after March 19, 2007), or any combination thereof; and]
      [(8)](H) the name and succession history for current or former members.
      (c) (1) Except as otherwise provided in paragraph (d) below, FINRA shall release the information specified in subparagraph (2) below f[F]or inquiries regarding a person who [(1)] was formerly associated with a member, but who has not been associated with a member within the preceding ten [two] years, and:
      (A) [(2)] was ever the subject of a final regulatory action as defined in Form U4 that has been reported to CRD on a Registration Form; or
      (B) was registered with FINRA on or after August 16, 1999, and any of the following applies, as reported to CRD on a Registration Form:
      (i) was convicted of or pled guilty or nolo contendere to a crime;
      (ii) was the subject of a civil injunction in connection with investment-related activity or a civil court finding of involvement in a violation of any investment-related statute or regulation; or
      (iii) was named as a respondent or defendant in an investment-related, consumer-initiated arbitration or civil litigation which alleged that the person was involved in a sales practice violation and which resulted in an arbitration award or civil judgment against the person.
      [, except as provided in paragraph (d) below, FINRA shall release, to the extent available:]
      (2) The following information shall be released pursuant to this paragraph (c):
      (A) [(1)] information regarding the [final regulatory action] event(s) enumerated in paragraph (c)(1)(A) or (B) as reported on a Registration Form;
      (B) [(2)] administrative information, including employment history and registration history derived from information reported on a Registration Form;
      (C) [(3)] the most recently submitted comment, if any, provided to FINRA by the person who is covered by BrokerCheck, in the form and in accordance with the procedures established by FINRA, for inclusion with the information provided through BrokerCheck. Only comments that relate to the information provided through BrokerCheck will be included; and
      (D) [(4)] information as to qualifications examinations passed by the person and date passed. FINRA will not release information regarding examination scores or failed examinations.
      For purposes of this paragraph (c), a final regulatory action as defined in Form U4 may include any final action, including any action that is on appeal, by the SEC, the Commodity Futures Trading Commission, a federal banking agency, the National Credit Union Administration, another federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization (as those terms are used in Form U4).
      (d) No Change.
      (e) Eligible parties may dispute the accuracy of certain information disclosed through FINRA BrokerCheck pursuant to the administrative process described below:
      (1) Initiation of a Dispute
      (A) The following persons (each an "eligible party") may initiate a dispute regarding the accuracy of information disclosed in that eligible party's BrokerCheck report:
      (i) any current member;
      (ii) any former member, provided that the dispute is submitted by a natural person who served as the former member's Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Chief Legal Officer or Chief Compliance Officer, or individual with similar status or function, as identified on Schedule A of Form BD at the time the former member ceased being registered with FINRA; or
      (iii) any associated person of a member or person formerly associated with a member for whom a BrokerCheck report is available.
      (B) To initiate a dispute, an eligible party must submit a written notice to FINRA, in such manner and format that FINRA may require, identifying the alleged inaccurate factual information and explaining the reason that such information is allegedly inaccurate. The eligible party must submit with the written notice all available supporting documentation.
      (2) Determination of Disputes Eligible for Investigation
      (A) FINRA will presume that a dispute of factual information is eligible for investigation unless FINRA reasonably determines that the facts and circumstances involving the dispute suggest otherwise.
      (B) If FINRA determines that a dispute is eligible for investigation, FINRA will, except in circumstances involving court-ordered expungement, add a general notation to the eligible party's BrokerCheck report stating that the eligible party has disputed certain information included in the report. The notation will be removed from the eligible party's BrokerCheck report upon resolution of the dispute by FINRA. In disputes involving a court order to expunge information from BrokerCheck, FINRA will prevent the disputed information from being displayed via BrokerCheck while FINRA evaluates the matter.
      (C) If FINRA determines that a dispute is not eligible for investigation, it will notify the eligible party of this determination in writing, including a brief description of the reason for the determination. A determination by FINRA that a dispute is not eligible for investigation is not subject to appeal.
      (3) Investigation and Resolution of Disputes
      (A) If FINRA determines that the written notice and supporting documentation submitted by the eligible party is sufficient to update, modify or remove the information that is the subject of the request, FINRA will make the appropriate change. If the written notice and supporting documentation do not include sufficient information upon which FINRA can make a determination, FINRA, under most circumstances, will contact the entity that reported the disputed information (the "reporting entity") to the Central Registration Depository and request that the reporting entity verify that the information, as disclosed through BrokerCheck, is accurate in content and presentation. If a reporting entity other than FINRA is involved, FINRA will defer to the reporting entity about whether the information received is accurate. If the reporting entity acknowledges that the information is not accurate, FINRA will update, modify or remove the information, as appropriate, based on the information provided by the reporting entity. If the reporting entity confirms that the information is accurate in content and presentation or the reporting entity no longer exists or is otherwise unable to verify the accuracy of the information, FINRA will not change the information.
      (B) FINRA will notify the eligible party in writing that the investigation has resulted in a determination that:
      (i) the information is inaccurate or not accurately presented and has been updated, modified or deleted;
      (ii) the information is accurate in content and presentation and no changes have been made; or
      (iii) the accuracy of the information or its presentation could not be verified and no changes have been made.
      (C) A determination by FINRA, including a determination to leave unchanged or to modify or delete disputed information, is not subject to appeal.
      Existing paragraph (e) to be re-designated as paragraph (f).

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

      .01 No Change.
      .02 Disputes Not Eligible for Investigation. For purposes of paragraph (e) of this Rule, examples of situations in which FINRA will determine that a dispute is not eligible for investigation include, but are not limited to:
      (a) a dispute that involves information that was previously disputed under this process and that does not contain any new or additional evidence;
      (b) a dispute that is brought by an individual or entity that is not an eligible party;
      (c) a dispute that does not challenge the accuracy of information contained in a BrokerCheck report but only provides an explanation of such information;
      (d) a dispute that constitutes a collateral attack on or otherwise challenges the allegations underlying a previously reported matter such as a regulatory action, customer complaint, arbitration, civil litigation, or termination;
      (e) a dispute that consists of a general statement contesting information in a BrokerCheck report with no accompanying explanation; and
      (f) a dispute that involves information contained in the Central Registration Depository that is not disclosed through BrokerCheck.

      * * * * *

    • 10-33 FINRA Requests Comment on Proposed Rule Requiring the Filing of Supplemental FOCUS Information and Proposed Supplementary Schedule to the Statement of Income (Loss) Page of FOCUS Report Parts II and IIA; Comment Period Expires: August 18, 2010

      View PDF

      Supplemental FOCUS Information

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      SEA Rule 17a-5
      FINRA Rule 2010
      Suggested Routing

      Compliance
      Finance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      FOCUS Reporting

      Executive Summary

      FINRA requests comment on a proposed rule to require each member firm to file certain additional financial or operational schedules or reports to supplement SEC FOCUS Reports. FINRA further requests comment on one such proposed schedule, a supplement to the Statement of Income (Loss) page of FOCUS Report Parts II and IIA.

      The text of proposed FINRA Rule 4524 (Supplemental FOCUS Information) is set forth in Attachment A. The proposed supplementary schedule for the Statement of Income (Loss) page of the FOCUS Report Parts II and IIA, including the proposed Operational Page, is set forth in Attachment B.

      Questions concerning this Notice should be directed to:

      •   Kris Dailey, Vice President, Risk Oversight & Operational Regulation, at (646) 315-8434; or
      •   Susan DeMando Scott, Associate Vice President, Financial Operations Department, at (202) 728-8411.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by August 18, 2010.

      Member firms and other interested parties can submit their comments using the following methods:

      •   Emailing comments to pubcom@finra.org; or
      •   Mailing comments in hard copy to:
      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

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

      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 Web site. Generally, FINRA will post comments on its site one week after the end of the comment period.1

      Before becoming effective, a proposed rule change must be authorized for filing with the SEC by the FINRA Board of Governors, and then must be approved by the SEC, following publication for public comment in the Federal Register.2

      Background & Discussion

      SEA Rule 17a-5 requires member firms to file with FINRA monthly and quarterly reports concerning their financial and operational status (FOCUS Reports). FOCUS Reports provide FINRA with valuable information regarding a member firm's business; however, FINRA believes that it can better discharge its regulatory obligations with the benefit of additional information that gives FINRA a more complete and detailed view of a member firm's business operations. FINRA, therefore, is requesting comment on a proposed rule that requires firms 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. The content of any future proposed schedules and reports, their formats and the frequency of such supplemental filings, would be specified in a future Regulatory Notice (or similar communication) to be filed with the SEC.

      In connection with the proposed rule, FINRA is proposing a supplementary schedule to capture with more specificity information from the Statement of Income (Loss) page of the FOCUS Report Parts II and IIA. The forms currently in use do not contain sufficient detail of revenues earned or expenses incurred by product or other more specific categories, thereby driving firms to report much of their revenue and expense as "other" (miscellaneous). FINRA believes the expanded revenue and expense information on the proposed supplementary schedule would provide FINRA greater transparency into a member firm's business activities and would better illuminate industry trends, allowing for more focused examinations. Many line items are not applicable to firms with limited product offerings, thereby reducing the burden of completing the form.

      As part of the proposed supplementary schedule, FINRA would require additional information with respect to a member firm's underwriting and/or selling group activities when revenue from unregistered offerings exceeds 10 percent of total revenue. Member firms that exceed the 10 percent threshold would need to complete the corresponding section of a new Operational Page that is referenced in the proposed supplementary schedule.


      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 NASD Notice to Members 03-73 (November 2003) (NASD Announces Online Availability of Comments) for more information.

      2 Section 19 of the Securities Exchange Act of 1934 (SEA or Exchange Act) permits certain limited types of proposed rule changes to take effect upon filing with the SEC. The SEC has the authority to summarily abrogate these types of rule changes within 60 days of filing. See Exchange Act Section 19 and rules thereunder.


      Attachment A

      4524. Supplemental FOCUS Information

      As a supplement to filing FOCUS reports required pursuant to SEA Rule 17a-5 and FINRA Rule 2010, each member shall file such additional financial or operational schedules or reports as FINRA may deem necessary or appropriate for the protection of investors or in the public interest. The content of such schedules and reports, their formats, and the frequency of such supplemental filings shall be specified in a Regulatory Notice (or similar communication) issued pursuant to this Rule. FINRA shall file with the SEC any Regulatory Notice (or similar communication) issued pursuant to this Rule.


      Attachment B

      View PDF

    • 10-32 SEC Approves Amendments to FINRA Dispute Resolution By-Laws; Effective Date: August 2, 2010

      View PDF

      Dispute Resolution By-Laws

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Dispute Resolution By-Laws
      Suggested Routing

      Legal
      Senior Management
      Key Topics

      By-Laws
      Dispute Resolution

      Executive Summary

      Effective August 2, 2010, the Board composition and governance structure of FINRA Dispute Resolution, Inc. (a subsidiary of FINRA) will more closely parallel the composition and governance structure of the FINRA, Inc. Board of Governors (FINRA Board).1 The revisions to the FINRA Dispute Resolution, Inc. By-Laws (By-Laws) also reflect current business and legal practices concerning the administration of FINRA Dispute Resolution. In addition, the revisions make non-substantive or conforming changes to the By-Laws, including updates to reflect the corporate name change. The revised By-Laws are available at www.finra.org/finramanual/drbylaws.

      Questions concerning this Notice should be directed to Kenneth L. Andrichik, senior vice president, chief counsel and director of Mediation and Strategy, Dispute Resolution, at (212) 858-3915 or ken.andrichik@finra.org.

      Background and Discussion

      On July 30, 2007, NASD and the New York Stock Exchange consolidated their member regulation, enforcement, and arbitration functions and became FINRA. As part of the consolidation, the Securities and Exchange Commission (SEC) approved amendments to the NASD By-Laws to implement governance and related changes,2 including a FINRA Board governance structure that balances public and industry representation. At the time of the consolidation, the By-Laws of FINRA Dispute Resolution, a subsidiary of FINRA, were not amended.

      On May 24, 2010, the SEC approved amendments to the FINRA Dispute Resolution By-Laws that:

      •   modify the composition of the FINRA Dispute Resolution Board;
      •   conform the FINRA Dispute Resolution By-Laws to the FINRA By-Laws; and
      •   reflect the corporate name change and other similar matters.

      These changes complete the process of updating the By-Laws to reflect the consolidation and harmonize them with the FINRA By-Laws. The changes are effective August 2, 2010.

      Revisions to FINRA Dispute Resolution By-Laws

      The FINRA Dispute Resolution By-Laws, as revised, will more closely parallel the composition and governance structure of the FINRA Board, reflect current business and legal practices concerning the administration of FINRA Dispute Resolution and make non-substantive or conforming changes.

      For example, FINRA amended the definitions of “broker” and “dealer” in Article I of the By-Laws to conform them to the definitions of “broker” and “dealer” in the Exchange Act, as amended by the Gramm-Leach-Bliley Act of 1999.3 FINRA is incorporating by reference the definitions of the terms “broker” and “dealer” as set forth in Sections 3(a)(4) and 3(a)(5), respectively, of the Exchange Act.4

      FINRA amended Article IV, Section 4.3(a), of the By-Laws to reflect FINRA's current governance structure and establish that FINRA Dispute Resolution Board members will be drawn exclusively from the FINRA Board. FINRA also amended Section 4.3(a) to streamline the composition of FINRA Dispute Resolution's Board and implement a requirement that it contain more public directors5 than industry directors.6

      To that end, FINRA amended Section 4.13 to remove the requirement that an executive committee of the FINRA Dispute Resolution Board include at least one public director, and institute the requirement that public directors must exceed industry directors on a FINRA Dispute Resolution Executive Committee of the Board.7

      FINRA is also making certain other non-substantive changes to all articles of the FINRA Dispute Resolution By-Laws, including replacing the terms “the NASD” or “NASD” with “FINRA” or “the Corporation,” and changing the name of the dispute resolution subsidiary from “NASD Dispute Resolution” to “FINRA Dispute Resolution, Inc.”

      The amendments become effective August 2, 2010.


      1 See Exchange Act Rel. No. 62156 (May 24, 2010), 75 FR 30453 (June 1, 2010) (SEC Order Approving File No. SR-FINRA-2010-007).

      2 See Exchange Act Rel. No. 56145 (July 26, 2007), 72 FR 42169 (August 1, 2007), as amended by Exchange Act Release No. 56145A (May 30, 2008), 73 FR 32377 (June 6, 2008) (File No. SR-NASD-2007-023).

      3 Pub. L. 106-102, 113 Stat. 1338 (1999).

      4 15 U.S.C. 78c(a)(4) and (a)(5).

      5 A public director is a director of the Board who is not an industry director and who otherwise has no material business relationship with a broker or dealer or a self-regulatory organization registered under the Act (other than serving as a public director of such a selfregulatory organization). See FINRA Dispute Resolution By-Laws, Article I, Definitions (x).

      6 An industry director is a director of the Board (other than the chairman of the FINRA Board and the chief executive officer of FINRA) who: (1) is or has served in the prior year as an officer, director (other than as an independent director), employee or controlling person of a broker or dealer, or (2) has a consulting or employment relationship with or provides professional services to a self-regulatory organization registered under the Act, or has had any such relationship or provided any such services at any time within the prior year. See FINRA Dispute Resolution By-Laws, Article I, Definitions (r).

      7 See Article IV, §4.12(f) (Executive Committee).

    • 10-31 Change to Expedited Proceedings for Failure to Comply with an Arbitration Award or Related Settlement; Effective Date: July 2, 2010

      View PDF

      Expedited Proceedings

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 9554
      FINRA Rule 10330(h)
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topics

      Arbitration Awards
      Expedited Proceedings
      Inability to Pay

      Executive Summary

      Firms and associated persons will be unable to rely on an inability-to-pay defense in expedited actions1 for failure to comply with arbitration awards involving customers if the FINRA Rule 9554 notice initiating the action is sent on or after July 2, 2010.2

      The text of amended FINRA Rule 9554 is set forth in Attachment A.

      Questions regarding this Notice should be directed to James S. Wrona, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8270.

      Background & Discussion

      FINRA Rule 9554 allows FINRA to bring expedited actions to address failures to comply with FINRA arbitration awards and related settlements. Once a monetary award has been issued in a FINRA arbitration proceeding, the party has 30 days to pay the award.3 FINRA coordinates with its dispute resolution and enforcement programs by verifying whether a firm or associated person (the respondent) has paid a monetary award on time. If the respondent has not paid, FINRA ordinarily initiates an expedited proceeding by sending a notice explaining that the respondent will be suspended unless the respondent pays the award or requests a hearing.

      A respondent that requests a hearing may raise a number of defenses to the suspension. One of those defenses previously had been establishing a bona fide inability to pay.4 When a respondent successfully demonstrated an inability to pay, that was a complete defense to the suspension.

      FINRA's expedited proceedings under Rule 9554 use the leverage of a potential suspension to help ensure that a firm or an associated person promptly pays a valid arbitration award. However, if a respondent demonstrated a financial inability to pay the award—regardless of the reason—the leverage was removed. When FINRA's efforts to suspend a respondent who had not paid an award were defeated, a claimant was much less likely to be paid.

      Consequently, FINRA proposed, and the SEC recently approved, an amendment to FINRA Rule 9554 that explicitly eliminates the inability-to-pay defense in the expedited-proceedings context when a respondent fails to comply with an arbitration award or related settlement involving a customer. The amendment becomes effective on July 2, 2010. A bona fide inability to pay will not be a valid defense in an expedited action for failure to pay an arbitration award or related settlement involving a customer if the notice issued pursuant to FINRA Rule 9554 is sent on or after July 2, 2010.

      However, a respondent still will have the following four defenses available:

      •   The firm or person paid the award in full or fully complied with the settlement agreement;
      •   The arbitration claimant has agreed to installment payments or has otherwise settled the matter;
      •   The firm or person has filed a timely motion to vacate or modify the arbitration award and such motion has not been denied; and
      •   The firm or person has filed a petition in bankruptcy and the bankruptcy proceeding is pending, or the bankruptcy court has discharged the award or payment owed under the settlement agreement.5

      1 Expedited actions allow FINRA to address certain types of misconduct more quickly than would be possible using the ordinary disciplinary process. In general, these actions focus on encouraging respondents to comply with the law or take corrective action rather than on sanctioning them for past misconduct.

      2 See Exchange Act Release No. 62211 (June 2, 2010), 75 FR 32525 (June 8, 2010) (SR-FINRA-2010-014) (Order Approving Proposed Rule Change Relating to FINRA Rule 9554 to Eliminate Explicitly the Inability-to-Pay Defense in the Expedited Proceedings Context). The approved amendment does not affect the defenses available in actions that do not involve customers.

      3 FINRA Rule 10330(h).

      4 The inability-to-pay defense emerged from a series of Securities and Exchange Commission decisions that require FINRA to consider the defense in disciplinary cases (as opposed to expedited actions), including disciplinary cases involving failures to pay arbitration awards and restitution. See Exchange Act Release No. 62211 (June 2, 2010), 75 FR 32525, 32526 (June 8, 2010) (citing Toney L. Reed, 52 S.E.C. 944 (1996), recons. denied, Exchange Act Release No. 39354 (Nov. 25, 1997); Bruce M. Zipper, 51 S.E.C. 928 (1993)).

      5 Bankruptcy judges are experts in evaluating whether a debtor's obligations should be legally discharged. The bankruptcy process and associated filings are designed to consider fully and evaluate the financial condition of bankruptcy debtors. See 4 COLLIER ON BANKRUPTCY, 521.01, 521.09 (15th ed. 2009). In addition, bankruptcy filings, which are subject to federal perjury charges, provide greater penalties for hiding assets. See 18 U.S.C. §§ 151–58 (2010) (stating that bankruptcy fraud is punishable by a fine, or by up to five years in prison, or both).


      ATTACHMENT A

      (New language is underlined.)

      * * * * *

      9554. Failure to Comply with an Arbitration Award or Related Settlement or an Order of Restitution or Settlement Providing for Restitution

      (a) Notice of Suspension or Cancellation

      If a member, person associated with a member or person subject to FINRA's jurisdiction fails to comply with an arbitration award or a settlement agreement related to an arbitration or mediation under Article VI, Section 3 of the FINRA By-Laws or a FINRA order of restitution or FINRA settlement agreement providing for restitution, FINRA staff may provide written notice to such member or person stating that the failure to comply within 21 days of service of the notice will result in a suspension or cancellation of membership or a suspension from associating with any member. When a member or associated person fails to comply with an arbitration award or a settlement agreement related to an arbitration or mediation under Article VI, Section 3 of the FINRA By-Laws involving a customer, a claim of inability to pay is no defense.
      (b) through (h) No Change.

      * * * * *

    • 10-30 SEC Approves Amendments Permitting FINRA to Halt Trading by Firms Otherwise Than on an Exchange Where a Primary Listing Market Has Issued a Trading Pause Due to Extraordinary Market Volatility; Effective Date: June 10, 2010

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      Trading-Pause Pilot Program

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      NTM 02-82
      FINRA Rule 6121
      FINRA Rule 5260
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading and Market Making
      Key Topics

      Extraordinary Market Volatility
      Quotations
      Trading Halts

      Executive Summary

      On June 10, 2010, FINRA began a pilot program in which it will halt trading otherwise than on an exchange with respect to securities included in the S&P 500® Index where the primary listing market has issued a trading pause due to extraordinary market volatility. The pilot is set to end on December 10, 2010.

      Frequently asked questions about the trading-pause pilot are in Attachment A of this Notice. The text of the amendments to FINRA Rule 6121 can be found in the online FINRA Manual at www.finra.org/finramanual.

      Questions regarding this Notice should be directed to:

      •   FINRA Operations at (866) 776-0800; or
      •   Racquel Russell, Assistant General Counsel, Office of General Counsel, at (202) 728-8363.

      Background and Discussion

      On June 10, 2010, the Securities and Exchange Commission (SEC) approved an amendment to FINRA Rule 6121 to permit FINRA to halt trading in individual securities where the primary listing market has issued a trading pause in that security due to a move of 10 percent or more from a sale in a preceding five-minute period (the trading-pause rule).1 This rule change was a part of a coordinated effort among FINRA, the SEC and other self-regulatory organizations to provide for a coordinated means to address potentially destabilizing market volatility, such as the type of sudden price declines that were experienced on the afternoon of May 6, 2010.

      As set forth in the similar, recently approved rule changes filed by several national securities exchanges, the primary listing markets will issue trading pauses for individual securities if the price of such security moves 10 percent or more from a sale in a preceding five-minute period.2 The primary listing markets will notify FINRA, the other exchanges and market participants of the imposition of a trading pause by immediately disseminating a special indicator over the consolidated tape.

      New Supplementary Material .01 to FINRA Rule 6121 provides that FINRA will similarly pause trading otherwise than on an exchange by FINRA member firms when the primary listing market has issued a trading pause.3 Thus, whenever the primary listing market issues an individual security trading pause under its rules, trading otherwise than on an exchange in that security also will be halted until trading has resumed on the primary listing market.4

      Firms must have policies and procedures in place that are reasonably designed to ensure that, among other things, they promptly cease effecting transactions during a halt, as required by FINRA Rule 5260.

      FINRA is implementing the trading-pause rule on a pilot basis. The pilot period will enable the SEC, FINRA and the exchanges to assess the effect of the new rules on the marketplace. Initially, the rule is in effect only for securities included in the S&P 500 Index, but FINRA anticipates that these rules will be expanded in the near future to additional securities, such as ETFs, within the pilot period.


      1 See Securities Exchange Act Release No. 62251 (June 10, 2010) (Order Approving SR-FINRA-2010-025).

      2 See Securities Exchange Act Release No. 62252 (June 10, 2010) (Order Approving File Nos. SR-BATS-2010-014; SR-EDGA-2010-01; SR-EDGX-2010-01; SR-BX-2010-037; SR-ISE-2010-48; SR-NYSE-2010-39; SR-NYSEAmex-2010-46; SR-NYSEArca-2010-41; SR-NASDAQ-2010-061; SR-CHX-2010-10; SR-NSX-2010-05; SR-CBOE-2010-047).

      3 The exchanges' trading-pause rules apply from 9:45 a.m., ET until 3:35 p.m., ET on days when the exchanges are open during regular trading hours.

      4 See Question #6, in Attachment A, for a discussion of the sole circumstance under which trading otherwise than on an exchange will be permitted to resume prior to the resumption of trading on the primary listing market.


      Attachment A: Frequently Asked Questions

      Question 1: When will the trading-pause pilot begin and how long will it last?

      FINRA's trading pause rule became effective on June 10, 2010, and currently is set to end on December 10, 2010.

      Question 2: When can trading pauses occur during the trading day?

      A trading pause can be triggered between 9:45 a.m., Eastern Time (ET) and 3:35 p.m., ET. No trading pause in an individual security will be called outside of these times. While a trading pause will not be implemented after 3:35 p.m., ET, a trading pause can remain in effect as late as 3:45 p.m., ET.

      Question 3: What securities will be included in the pilot?

      Consistent with the national securities exchanges, the trading pause pilot includes all S&P 500 Index stocks and may be expanded to include additional securities during the course of the pilot.

      Question 4: Can all market center prints, including transactions executed otherwise than on an exchange, trigger a trading pause, or just the primary listing market?

      All regular way, in-sequence prints, including transactions executed otherwise than on an exchange, sent to the Consolidated Tape or NASDAQ UTP SIP that are "last sale" eligible can trigger a trading pause. For more information regarding what types of trades are "last sale" eligible, consult the relevant plan's technical specification document at www.utpplan.com and www.nyxdata.com/CTA.

      Question 5: During a trading pause, can a security trade otherwise than on an exchange?

      No. Upon the receipt of notice from the primary listing market that the market has issued a trading pause in an individual security, trading otherwise than on an exchange in that security also is halted.

      Question 6: When can trading in a paused security resume?

      Consistent with the operation of trading halts in exchange-listed securities today, when trading has resumed on the primary listing market at the end of the five-minute pause, trading otherwise than on an exchange also may resume immediately in that security.

      If a primary listing market extends the trading pause beyond the initial five-minute pause and reopens the security at or before the end of ten minutes, trading otherwise than on an exchange likewise may resume immediately at that time.

      In the unusual circumstance where the primary listing market does not reopen for trading at the end of the ten-minute pause, FINRA may permit the resumption of trading otherwise than on an exchange in such security. FINRA expects that in most cases, it will not resume trading until the primary listing market resumes trading. However, if the primary listing market has issued notice that it cannot resume trading for a reason other than a significant imbalance and trading has commenced on at least one other national securities exchange, FINRA may determine to permit the resumption of trading otherwise than on an exchange. In such cases, FINRA will notify firms via its website at www.finra.org/traderesumption if it determines that trading otherwise than on an exchange may resume. If no such notice is provided, then trading otherwise than on an exchange may not resume until the primary listing market has resumed trading.

      Question 7: If a member firm routes an order for execution on behalf of a customer prior to the primary listing market issuing a trading pause in that security, but the halt takes effect before the member firm has filled the customer order, can the member firm fill the customer order during the halt with the execution received prior to the halt?

      No. As stated in Notice to Members (NTM) 02-82, a member firm cannot execute any part of an order once a trading halt is in effect. Therefore, member firms may not, for example, complete the second leg of a riskless principal transaction or otherwise fill a customer order with shares received in an execution prior to a halt taking effect until the halt has been lifted.

      Question 8: If an issue that is listed on a foreign market is subject to a trading halt on a U.S. market, but not halted on the foreign market, may a firm trade the security on the foreign market consistent with FINRA Rule 5260?

      No. As stated in NTM 02-82, member firms may not directly effect trades on international markets for their own accounts and may not solicit customer orders in these securities. If a member firm receives an unsolicited customer order in a security subject to a trading halt, it may route the order to a non-member entity or non-member affiliate not covered by the halt for execution in a foreign market.

    • 10-29 SEC Approves Amendments to Rules on Reporting Transactions to the OTC Reporting Facility; Effective Date: November 1, 2010

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      Trade Reporting

      Regulatory Notice
      Type of Notice

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6420
      FINRA Rule 6622
      Suggested Routing

      Compliance
      Executive Representatives
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Training
      Key Topics

      Direct Participation Program Securities
      Non-NMS Stocks
      OTC Equity Securities
      OTC Reporting Facility
      Restricted Equity Securities
      Stop Stock Transactions
      Trade Reporting

      Executive Summary

      Effective Monday, November 1, 2010, firms must comply with amended rules on applicable trade report modifiers when reporting OTC transactions in non-NMS stocks to the OTC Reporting Facility.

      The text of the amendments can be found at www.finra.org/rulefilings/2009-061.

      Questions regarding this Notice may be directed to:

      •   The Legal Section, Market Regulation, at (240) 386-5126; or
      •   The Office of General Counsel at (202) 728-8071.

      Background and Discussion

      The SEC recently approved amendments to FINRA Rule 6622(a) (When and How Transactions are Reported) relating to the reporting of over-the-counter (OTC) transactions in non-NMS stocks1 to the OTC Reporting Facility (ORF).2

      The amendments reorganize the format and structure of FINRA Rule 6622(a) so that it conforms generally to the trade reporting rules of the Alternative Display Facility (ADF) and Trade Reporting Facilities (TRFs).3 Rule 6622(a) identifies the types of transactions (e.g., Stop Stock) that must have a unique trade report modifier associated with them; the specific modifiers are labeled in the ORF technical specifications and not in the rule.4 Firms must use such modifiers on all trade reports submitted to the ORF, including reports of "as/of" trades. In the event that the rules require multiple modifiers on any given trade report, firms must report in accordance with guidance FINRA has published regarding priorities among modifiers.5

      Additionally, the amendments require that firms now use:

      •   modifiers that denote Seller's Option, Cash and Next Day settlement options;
      •   a modifier for trade pricing based on an average weighting or another special pricing formula; and
      •   a modifier for Stop Stock transactions, as defined in FINRA Rule 6420 (firms currently are required to report such transactions with the ".W" modifier).6

      Although not required under current FINRA Rule 6622(a), firms can use the above-referenced modifiers when reporting to the ORF today.


      1 Reportable transactions in non-NMS stocks include, for example, OTC equity securities (such as OTC Bulletin Board and Pink Sheets securities), direct participation program securities (See Regulatory Notice 10-24) and restricted equity securities sold pursuant to Securities Act Rule 144A (See Regulatory Notice 10-26).

      2 See Securities Exchange Act Release No. 61819 (March 31, 2010), 75 FR 17806 (April 7, 2010) (Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval of File No. SR-FINRA-2009-061).

      3 See generally FINRA Rules 6282(a), 6380A(a) and 6380B(a).

      4 See www.nasdaqtrader.com/content/technicalsupport/specifications/TradingProducts/ctci_act.pdf and www.nasdaqtrader.com/content/technicalsupport/specifications/TradingProducts/fixactspec.pdf.

      5 See, e.g., Section 401, Trade Reporting Frequently Asked Questions, available at www.finra.org/tradereportingfaq.

      6 Stop Stock transactions will be disseminated to the public with the weighted average price modifier, which is consistent with the current dissemination policy for Stop Stock transactions that are submitted to the ADF and TRFs.

    • 10-28 New System for Processing Regulation T and SEA Rule 15c3-3 Extension of Time Requests; Effective Dates: August 23, 2010 (Phase I); November 8, 2010 (Phase II)

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      Extension of Time Requests

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NASD Rule 3160
      NTM 06-62
      Regulatory Notice 08-32
      Regulation T §§ 220.4 and 220.8
      SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Institutional
      Legal
      Operations
      Registered Representatives
      Senior Management
      Systems
      Key Topic(s)

      Extension Processing

      Executive Summary

      Beginning August 23, 2010, FINRA will introduce, in phases, a new Regulatory Extension (REX) system that replaces FINRA's existing Reg T system to collect Regulation T and SEA Rule 15c3-3 extension of time requests. The new REX system offers enhanced functionality that will:

      •   give firms the ability to amend or update submitted extension requests;
      •   offer firms a wider variety of search fields for reviewing their submitted extension requests;
      •   introduce text fields that firms can use to input their own, internal identifiers for each extension request; and
      •   offer firms that submit extension requests via batch submission a daily report of submissions.

      Also effective August 23, 2010, clearing firms must submit their monthly reporting of correspondent firms' extensions to transaction ratio by completing an online form accessible via the FINRA Firm Gateway through the new REX system. FINRA has revised the layout of the form, but it is otherwise unchanged.

      This Notice also details new and modified data elements for the REX system.

      Questions concerning this Notice should be directed to:

      •   Rudolph Verra, Managing Director, Risk Oversight and Operational Regulation, at (646) 315-8811;
      •   Glen Garofalo, Director, Credit Regulation, at (646) 315-8464; or
      •   Vincent Rotolo, Senior Credit Specialist, Credit Regulation, at (646) 315-8576.

      Background & Discussion

      Regulation T, issued by the Federal Reserve Board pursuant to the Securities Exchange Act of 1934 (SEA), governs, among other things, the extension of credit by broker-dealers to customers to pay for the purchase of securities.1 SEA Rule 15c3-3, among other things, requires broker-dealers to promptly obtain and maintain physical possession or control of customer securities, and designates periods of time within which broker-dealers must satisfy any deficiency (including those that arise from a customer "long" sale for which the customer has not delivered the securities within the requisite time period) by buying-in or otherwise obtaining possession or control of the securities.2

      Under SEA Rule 15c3-3(n), a self-regulatory organization (SRO) may extend certain specified periods to buy-in a security, for one or more limited periods commensurate with the circumstances, where the SRO: (1) is satisfied that the broker-dealer is acting in good faith in making the request; and (2) exceptional circumstances warrant such action.3 Regulation T has a similar standard to allow an extension of time for payment for the purchase of securities.4

      NASD Rule 3160 requires all clearing firms for which FINRA is the designated examining authority (DEA) to submit extension of time requests under Regulation T or SEA Rule 15c3-3(n) to FINRA. Since the SRO designated as a firm's DEA has responsibility for examining its firms' compliance with applicable financial responsibility rules such as Regulation T and SEA Rule 15c3-3, requiring a firm to submit extension requests to its DEA helps to ensure that the DEA receives complete extension information to assist it in performing this regulatory function. As further detailed below, each clearing firm for which FINRA is the DEA also must file a monthly report with FINRA indicating all broker-dealers for which it clears that exceed a given ratio of requested extensions of time to total transactions.

      Personnel preparing extension of time requests are expected to obtain supporting documentation authorizing or requesting them to apply for an extension of time on behalf of a customer. Firms are reminded that a customer is not entitled to an extension of time. As noted above, firms may only request extensions of time in exceptional circumstances, and they are responsible for determining the appropriateness of requesting any such extension.

      New REX System

      The new REX system will permit FINRA to process, monitor and service firms' extension of time requests more accurately and efficiently. It will also enhance FINRA's surveillance and examination capabilities. Historically, firms have requested extensions of time through FINRA's Reg T system via the FINRA Firm Gateway and Regulation Filing Applications system. Effective August 23, 2010, the new REX system will replace the Reg T system. As with the legacy Reg T system, firms will be able to request extensions of time through the new REX system via the FINRA Firm Gateway by completing an online request form, or by transmitting a file via a batch-processing feed using FTP or SFTP. However, firms will no longer have the ability to upload files directly on the REX system interface, as was permitted with the Reg T system.

      Following are the implementation dates for the new REX System:

      Submission Method for Extension of Time Requests Date Firm Must Use New REX Online Format for Extension of Time Requests
      Online Request Form August 23, 2010
      Batch File* No Later Than November 8, 2010**

      * Firms that file through the batch process will be required to use a new directory for batch submissions beginning August 23, 2010 (the location of the "drop off" and "pick up" directory will be changing). See the "Testing" section below for details.

      ** Firms that transmit extension of time requests by batch file may begin using the new REX batch file format on August 23, 2010, but may continue to submit extension of time requests using the current Reg T batch file format until November 8, 2010.

      Firms that use a service bureau to submit extension of time requests on their behalf must ensure that the information in this Notice is promptly communicated to their service bureaus so that any programming changes are effective by August 23, 2010. Please note that new user access is not required for the REX system: all user IDs and passwords will automatically transfer from the Reg T system to the new REX system. See the "Testing" section below for details regarding submission procedures.

      The new REX system, which is XML-based,5 will allow firms to amend and re-submit extension requests that, for example, do not initially meet the rule requirements upon submission. Firms can review extension request status immediately using the online Web interface and on the firm's daily extension report that will be delivered on the business day following submission (see the "Reports" section below). It is the firm's responsibility to review these reports on a daily basis. FINRA expects firms to submit all changes to extension requests by the business day following initial submission. Clearing firms will have the capability to correct extension requests both online and through the batch submission process. All firm-initiated corrections will require final approval from FINRA's Credit Regulation Department. It will be the firm's responsibility to follow up on amended extension requests and take any necessary action if the extension request does not get approved.

      Expanded File Format/Layout and Data Elements

      As noted above, the REX system contains new and modified data elements that firms must implement depending on their submission method. Firms that submit extension of time requests via the online request form must use the new REX online format effective August 23, 2010. Accordingly, such firms must implement the new and modified data elements by August 23, 2010. Firms that transmit extension of time requests by batch file have the option to begin using the new REX batch file format on August 23, 2010; if they elect to do so, they must implement the new and modified data elements at that time (firms may continue to submit extension of time requests using legacy Reg T batch file format until November 8, 2010). The system will assign default values for the new and modified data elements when the legacy Reg T batch file format is used as specified in the table below. On November 8, 2010, firms must submit all batch file extension of time requests via the new REX batch format, and the new and modified data elements will be required from all batch submitters.

      The table below lists and describes the new and modified data elements. FINRA reminds firms to review Regulatory Notice 08-32 (June 2008), which discusses in detail the current data elements' requirements.

      DATA ELEMENT OPTIONAL/REQUIRED NOTES DEFAULT VALUE FOR LEGACY FORMAT BATCH FILE SUBMISSIONS6
      Product Code Required This data field captures the type of product traded for which an extension is being requested (e.g., the type of product identified by the Issue Symbol/CUSIP field value). Firms must select one of the following values:
      •   Equity
      •   Option
      •   Derivative
      •   Mutual fund
      •   Bond
      In the case of multiple trades, firms must choose one product code, Issue Symbol/CUSIP and share amount, and enter the aggregate value of all of the trades in the submission for that account.
      Equity
      Correspondent Firm Type Required Firms must indicate if they are submitting the extension on behalf of a correspondent firm. This element is a modification of the Correspondent Firm Flag data element in the legacy Reg T system. Firms must select one of the following values:
      •   Domestic
      •   If this value is selected, the Correspondent Firm CRD Number, the Correspondent Branch CRD Number, Customer Contact CRD Type and Customer Contact CRD ID fields must be completed.
      •   Foreign
      •   If this value is selected, the name of the foreign correspondent broker-dealer must be submitted in the new Foreign IB Name data field below.
      •   None
      •   If this value is selected, the Branch CRD Number of the clearing firm must be completed.7
      Legacy "Y" → Domestic

      Any other value → None
      Foreign IB Name Required Foreign correspondent firm name must be provided if the extension is being requested on behalf of a foreign correspondent firm and the Correspondent Firm Type indicator has been set to Foreign.

      ***Note: It is important to be consistent when submitting names in this field. For example, please do not use "Acme, Inc." in one extension request, and "Acme, Incorporated" in another extension request for the same firm.
      Field will be blank
      Customer Contact CRD Type Required This field indicates the CRD number of the Registered Representative assigned to the account, if any. Firms must select one of the following values:
      •   RegisteredRep
      •   If this value is selected, the customer contact CRD ID field must contain the Registered Representative CRD number.
      •   SelfDirected
      •  ; This option is reserved explicitly for online accounts and hedge funds that are self directed and do not have a Registered Representative assigned to the account.
      ***Note: If the extension of time request relates to paragraph (d)(2),(d)(3) or (h) of SEA Rule 15c3-3, this field is not required. This field is also not required when the Correspondent Firm Type is Foreign.
      Registered Rep.
      Contra ID Code for (d)(2) extensions Required This field is a modification of the Contra Broker Dealer CRD Number field from the legacy Reg T system. This field indicates the type of identification from the broker-dealer failing to deliver the securities. Firms must select one of the following values:
      •   CRD
      •   If this value is selected, the Contra ID field must contain the CRD number of the contra firm.
      •   DTCC
      •   If this value is selected, the Contra ID field must contain the DTCC number of the contra firm.
      DTCC
      Original Request Date Required This field was previously named "Request Date" and is renamed to clarify the meaning of the data value. The Original Request Date does not change for subsequent requests on the same extension. Existing required field so no default value is necessary
      Submitter's Job Reference ID Optional This field allows the submitting firm to include its own identifier for a batch submission for firm internal tracking purposes. It is being maintained and available for searching by FINRA systems. Field will be blank
      Request Action Required This field will indicate if the current extension request is an Amendment or New extension request. Note that if the value Amendment is selected, it means the submitter is correcting an error in a previously submitted extension request.

      Creating a "follow-on" (or "subsequent extension," "second extension," "third extension," etc.) for an expired extension request is not an Amendment. It is considered a New extension request (albeit a new extension request that is requesting additional time for the expired request).

      ***Note that Amendments for an extension request are expected to be submitted within one business day following the submission of the original extension request.
      New
      Submitter Comment Required for Amendments Submitters must include in this field a detailed explanation of the reason for the amendment. Field will be blank
      Received By Required This field indicates the pathway by which the extension request was entered into the REX system. Firms must select one of the following values:
      •   Batch V1 (Legacy Reg T batch file format)
      •   Batch V2 (new REX batch file format)
      •   UI (online request form).
      BatchV1
      Withdrawn Flag Required This field should be set to Yes when a firm is withdrawing a previously submitted extension request. A withdrawal is considered an amendment, and therefore the submitter must complete the Submitter Comment field as to why the extension request is being withdrawn. This field should be set to No unless the intent is to withdraw the extension request. No
      Submitter's Filing Reference ID Optional This field allows the submitting firm to include its own identifier for a particular extension request for firm internal tracking purposes. This field will be maintained and available for searching by FINRA systems. Field will be blank
      FINRA Filing ID Future use This field will be blank at the time of initial release and will be programmed at a later date. FINRA will issue a subsequent Regulatory Notice with details about the requirements and timing. Field will be blank
      FINRA Filing Version Future Use This field will be blank at the time of initial release and will be programmed at a later date. FINRA will issue a subsequent Regulatory Notice with details about the requirements and timing. Field will be blank

      Additional information about the new file format is available at www.finra.org/rex/technicalinformation, including a mapping of legacy batch file data elements to the new XML-based batch file data elements, and the technical XSD, which provides a standards-based definition for the new batch XML file format. To accommodate the new batch XML file format, firms will need to make significant changes to their automated processes that generate batch files that adhere to the legacy Reg T file format in order to submit extension of time requests using the new file format. See the "Testing" section below for details about submission procedures.

      Monthly Reporting Requirement—Correspondent Firm Extensions

      NASD Rule 3160(b) requires each clearing firm for which FINRA is the DEA to file a monthly report with FINRA indicating all broker-dealers for which it clears (i.e., correspondent firms) that have overall ratios of extension of time requests to total transactions for the month that exceed a percentage specified by FINRA (the current extension-to-transaction ratio is 2 percent).8 Clearing firms must continue to submit the monthly report by completing an online form via the FINRA Firm Gateway; however, with the introduction of the REX system, firms will need to use a revised form beginning August 23, 2010. A sample of the form is available at www.finra.org/rex/sampleextensionform. The same information and reporting time periods and thresholds are required as detailed in Notice to Members 06-62, though the REX application will pre-populate the correspondent broker-dealer's CRD number(s) and the number of extension requests submitted (based on the Regulation T and SEA Rule 15c3-3 extension requests received during the previous month). Firms will be able to override the pre-populated information as necessary.

      Reports

      Firms will have access, via the new REX system, to functionality that will allow users to search for specific extensions or groups of extensions, based on a wide variety of search criteria, including Disposition Status (Granted, Denied, Pending). From the search results, users will be able to view all of the data for any submitted extension of time request.

      Effective August 23, 2010, if a firm elects to use the new REX batch file format, the firm will receive two results reports via FTP or SFTP (depending on how the batch file was submitted). One of the results reports is a flat text file that is formatted similarly to the batch report file used in the legacy Reg T system. This flat file format for the results report will not be available after November 8, 2010.

      The other results report is an XML-formatted file that contains all of the information regarding all extension of time requests the firm submitted, including extension requests submitted via the online request form. This file will be delivered to batch submitters on a nightly basis, and will also contain information regarding "finalized"9 customers. The details regarding the format for this XML file can be reviewed at www.finra.org/rex/technicalinformation. This results report will be available beginning August 23, 2010. This results report will also be available online upon request for firms that submit extension requests via the online request form.

      The Disposition Status (Granted, Denied, Pending) of submitted extensions can be viewed on the daily report. Firms need to review this report on a daily basis and all necessary change requests are expected to be submitted by the following business day.

      Testing

      Because the new REX system will require firms to make modifications to their systems, FINRA has created a REX Customer Test Environment (CTE) for the online request form, which is available now for testing at https://gateway1.firms.qc.finra.org.

      For firms that will transmit batch files via FTP or SFTP, FINRA will now accept test data files transmitted through its testing environment. Firms should send files via FTP or SFTP to their current Reg T FTP or SFTP test server, but dropped off in the RPT_REGT2/in subdirectory. The results reports will be posted to the same server, in the firm's RPT_REGT2/out subdirectory. Please Note: to test batch submissions in the new REX system, regardless of which file format is used, firms must drop off files in the RPT_REGT2/in subdirectory.

      Firms must use the same subdirectory names in the production environment once the REX system goes live on August 23, 2010. Users should be able to use their existing FINRA CTE user ID and password for the testing. Firms that encounter technical problems, or need to request a FINRA user ID and password, should contact the FINRA Help Desk at (800) 321-6273. FINRA encourages firms to begin testing as soon as possible to ensure a smooth transition to the REX system.

      File Format Layout

      The REX and Reg T file format layouts are available at www.finra.org/rex/technicalinformation.

      Additional Support

      For additional support with the changes addressed in this Notice, see the REX tutorial at www.finra.org/Industry/Tools.


      1 12 CFR 220.4(c) and 220.8(d). Regulation T provides that a customer has one payment period (currently five business days) to submit payment for purchases of securities in a cash account or in a margin account.

      2 17 CFR 240.15c3-3.

      3 See SEA Rule 15c3-3(n), authorizing SROs to extend the periods of time to buy-in a security specified in SEA Rules 15c3-3(d)(2), (d)(3), (h)and (m).

      4 Under Regulation T, a firm's examining authority may grant an extension unless the examining authority believes that the broker-dealer is not acting in good faith or that the broker-dealer has not sufficiently determined that exceptional circumstances warrant such action. See Regulation T §§ 220.4(c) and 220.8(d).

      5 XML (extensible mark up language) is a commonly used file formatting standard that is easily validated, human-readable, and readily digested by computer systems.

      6 Since these data elements do not exist in the legacy Reg T batch file format, the application will provide a default value for these data elements for all extension requests submitted between August 23 and November 8, 2010, using the legacy Reg T batch file format.

      7 See Regulatory Notice 08-32 for further discussion of the Branch CRD Number data element.

      8 See NTM 06-62. Self-clearing firms that do not clear for other firms are not required to file these reports because such firms do not have any correspondent broker extension information to provide to FINRA.

      9 The term "finalized" refers to individual customers who have reached their allowable limit of extensions; i.e., the customer has received five Regulation T extensions or nine SEA Rule 15c3-3 extensions in the preceding 12 months.

    • 10-26 SEC Approves Amendments to Trade Reporting Requirements for Restricted Equity Securities and Revisions to the Definition of OTC Equity Security; Effective Date: June 28, 2010

      View PDF

      Trade Reporting

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 4560
      FINRA Rule 6420
      FINRA Rule 6610
      FINRA Rule 6622
      FINRA Rule 6630 Series
      FINRA Rule 7410
      SEC Rule 144A
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Key Topics

      OTC Equity Securities
      OTC Reporting Facility
      PORTAL Rules
      Restricted Equity Securities
      Trade Reporting

      Executive Summary

      Effective June 28, 2010, firms must report transactions in restricted equity securities traded pursuant to SEC Rule 144A to the OTC Reporting Facility no later than 8 p.m. Eastern Time.1 These reporting requirements replace the trade reporting obligations for restricted equity securities in FINRA's PORTAL rules (FINRA Rule 6630 Series).2

      Additionally, FINRA is changing the definition of "OTC Equity Security," which will also be effective on June 28, 2010. The amendments align the term "OTC Equity Security" more closely with SEC rule terminology and improve consistency across the FINRA rulebook. The amendments also clarify the application of the OTC Reporting Facility reporting requirements to transactions reported on or through an exchange.

      The text of the amendments is available at www.finra.org/rulefilings/2010-003.

      Questions concerning this Notice should be directed to:

      •   The Legal Section, Market Regulation, at (240) 386-5126; or
      •   The Office of General Counsel at (202) 728-8071.

      Background & Discussion

      On April 23, 2010, the SEC approved several amendments to the reporting provisions regarding the OTC Reporting Facility (ORF).3 The amendments add reporting requirements to the ORF rules regarding transactions in restricted equity securities traded pursuant to Rule 144A under the Securities Act of 19334 (SEC Rule 144A) to replace the reporting requirements in the FINRA PORTAL rules (FINRA Rule 6630 Series) in light of the cessation of the PORTAL Market; revise the definition of "OTC Equity Security" in the FINRA trade reporting rules and improve consistency of the use of the term in the FINRA rulebook; and clarify the scope of the ORF rules with respect to transactions reported on or through an exchange.

      Reporting Trades in Restricted Equity Securities

      FINRA's transaction reporting rules for restricted equity securities are currently tied to whether a security is designated for inclusion in the PORTAL Market (i.e., is a "PORTAL security").5 In September 2008, NASDAQ ceased the operation of the PORTAL Market,6 and on October 26, 2009, NASDAQ terminated the PORTAL security designation process and removed rules related to the PORTAL Market from its rulebook.7 Although securities previously designated as PORTAL securities remained subject to the reporting requirements in the PORTAL rules,8 the cessation of the designation of securities as PORTAL securities creates a gap in FINRA's transaction reporting requirements for restricted equity securities that are traded pursuant to SEC Rule 144A.9 To address this gap, effective June 28, 2010, the PORTAL reporting rules are eliminated10 and the ORF rules include reporting requirements for all equity securities that are defined as "restricted securities" pursuant to Rule 144(a)(3) under the Securities Act of 193311 and that are traded pursuant to SEC Rule 144A, irrespective of whether they are designated as PORTAL securities. Beginning on that date, transactions in all restricted equity securities effected pursuant to SEC Rule 144A must be reported to the ORF no later than 8 p.m. Eastern Time. Transactions in restricted equity securities effected pursuant to SEC Rule 144A and executed between 8 p.m. and midnight must be reported the following business day (T+1) by 8 p.m.

      Definition of "OTC Equity Security"

      The amendments described above also change the definition of "OTC Equity Security" in Rule 6420 by deleting the outdated reference to securities that "qualify for real-time trade reporting." Beginning June 28, 2010, the term is defined as any equity security that is not an "NMS stock" as defined by the SEC in Regulation NMS.12 The amendments also eliminate the defined term "non-exchange-listed security" from Rule 6420.13 Because of these changes, any security or class of securities for which transaction reports are collected, processed and made available pursuant to an effective transaction reporting plan will be excluded from the definition of "OTC Equity Security" in Rule 6420. These changes result in the FINRA definitions being more closely aligned with current SEC rule terminology and more consistent across the FINRA rulebook.14

      Transactions Reported On or Through an Exchange

      FINRA also amended the ORF rules to explicitly address transactions in OTC Equity Securities that are executed on an exchange. FINRA's trade reporting rules historically have required that transactions be reported to FINRA only if they were executed "otherwise than on an exchange."15 The reporting rules for the FINRA/NASDAQ Trade Reporting Facility (TRF), the FINRA/NYSE TRF and the Alternative Display Facility all include an exception from the reporting obligations for transactions reported on or through an exchange and thus require the submission of trade reports to FINRA for transactions in NMS stocks only if the transaction is executed over the counter.16 The ORF rules, however, have not included a similar exception for transactions in otherwise eligible securities that are reported on or through an exchange.17 Consequently, FINRA amended Rules 6622, 6420(k) and 6610 to add an exception from the reporting requirements for transactions in OTC Equity Securities reported on or through an exchange.


      1 Transactions in restricted equity securities effected pursuant to SEC Rule 144A and executed between 8 p.m. and midnight must be reported to the OTC Reporting Facility the following business day (T+1) by 8 p.m.

      2 The amendments discussed in this Notice are limited in scope to restricted equity securities and do not affect the Trade Reporting and Compliance Engine Service (TRACE) or the reporting requirements with respect to any transaction involving debt securities.

      3 See Securities Exchange Act Release No. 61979 (April 23, 2010), 75 FR 23316 (May 3, 2010) (Order Approving File No. SR-FINRA-2010-003).

      4 17 CFR 230.144A.

      5 FINRA created the PORTAL Market in 1990, at the same time the SEC adopted SEC Rule 144A, to serve as a system for quoting, trading and reporting trades in certain designated restricted securities that were eligible for resale under SEC Rule 144A (PORTAL securities). See Securities Exchange Act Release No. 27956 (April 27, 1990), 55 FR 18781 (May 4, 1990). As part of the separation of The Nasdaq Stock Market (NASDAQ) from FINRA, certain functionality relating to the PORTAL Market, including the qualification and designation of PORTAL securities, became part of NASDAQ's rules and were eliminated from the FINRA rules. See Securities Exchange Act Release No. 53128 (January 13, 2006), 71 FR 3550 (January 23, 2006).

      6 See Securities Exchange Act Release No. 58638 (September 24, 2008), 73 FR 57188 (October 1, 2008). In addition to NASDAQ ceasing operation of the PORTAL Market, the SEC also approved the deletion of the Depository Trust Company (DTC) requirement that an SEC Rule 144A security, other than investment-grade securities, be included in an "SRO Rule 144A System" in order to be eligible for DTC's deposit, book-entry delivery and other depository services. See Securities Exchange Act Release No. 59384 (February 11, 2009), 74 FR 7941 (February 20, 2009). The PORTAL Market was the only "SRO Rule 144A System." Id.

      7 Securities Exchange Act Release No. 60991 (November 12, 2009), 74 FR 60006 (November 19, 2009).

      8 Although, as of October 26, 2009, NASDAQ no longer accepted new applications for debt or equity securities seeking PORTAL designation, the termination of this function was not "intended to impact securities previously designated as PORTAL securities or alter any existing regulatory obligation applicable to such securities, including, but not limited to, any trade reporting obligation imposed by any self-regulatory organization." Id.

      9 As noted above, the amendments discussed in this Notice are limited in scope to equity securities and do not affect TRACE or the reporting requirements with respect to any transactions in debt securities.

      10 In addition to the reporting rules, the PORTAL rules also include FINRA Rule 6635, which specifies those FINRA rules that are and are not applicable to transactions and business activities relating to PORTAL securities. The amendments renumber Rule 6635 as FINRA Rule 6630 to maintain the status quo with respect to the application of FINRA rules to securities previously designated as PORTAL securities prior to October 26, 2009.

      11 See 17 CFR 230.144(a)(3).

      12 Regulation NMS defines "NMS stock" as "any NMS security other than an option." 17 CFR 242.600(b)(47). "NMS security" is defined as "any security or class of securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options." 17 CFR 242.600(b)(46).

      13 FINRA Rule 6440 (Submission of SEA Rule 15c2-11 Information on Non-Exchange-Listed Securities) and NASD Rule 2320(f), which is often referred to as the Three Quote Rule, will continue to use the term "non-exchange-listed security." Because the amendments delete the term "non-exchange-listed security" from Rule 6420, FINRA added a definition of that term to FINRA Rule 6440 and NASD Rule 2320(f) that is identical to the definition as it appeared in FINRA Rule 6420. Consequently, there is no change in the application of either rule as a result of the amendments.

      14 FINRA amended the definition of "OTC equity security" in Rule 7410 of the Order Audit Trail System (OATS) rules to conform to the new definition used in Rule 6420. The amendments will not result in any change to the scope of securities required to be reported to OATS. In addition, the amendments codify prior FINRA guidance that the OATS rules do not apply to orders for restricted equity securities. See Regulatory Notice 06-70 n.2 (December 2006). The amendments also eliminate the separate definition of "OTC Equity Security" in FINRA Rule 4560 (Short-Interest Reporting) and clarify that the rule applies to all equity securities except restricted equity securities.

      15 See, e.g., FINRA Rule 6100, 6200 and 6300 Series.

      16 See FINRA Rules 6282(i)(1)(C), 6380A(e)(1)(C), 6380B(e)(1)(C).

      17 The ORF rules include an exception for transactions in foreign equity securities when the transaction is executed on and reported to a foreign securities exchange or the transaction is executed over the counter in a foreign country and is reported to the regulator of securities markets for that country. See FINRA Rule 6622(g).

    • 10-27 Changes to Customer Complaint Reporting Procedures Under NASD Rule 3070(c) and NYSE Rule 351(d); Effective Date: July 1, 2010

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      Customer Complaint Reporting

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NASD Rule 3070(c)
      NYSE Rule 351(d)
      NYSE Rule 351.13
      Suggested Routing

      Legal and Compliance
      Operations
      Senior Management
      Key Topics

      Customer Complaint Reporting
      Problem and Product Code Changes

      Executive Summary

      Starting on July 1, 2010, the beginning of the third calendar quarter, firms must use revised and new product codes to report statistical information regarding written customer complaints relating to annuities and life settlement products. The first report using the revised and new codes is due by October 15, 2010, which is the reporting deadline for customer complaints received during the third calendar quarter.

      Questions concerning this Notice should be directed to Anthony Cavallaro, Central Review Group, at (646) 315-7319.

      Background & Discussion

      NASD Rule 3070(c) and Incorporated NYSE Rule 351(d) require all member firms to report on quarterly basis statistical information regarding written customer complaints.1 Firms must report this information by the 15th calendar day of the month following the end of each calendar quarter (e.g., by April 15 for the first quarter). The statistics that firms report provide FINRA with important regulatory information that assists with the timely identification of potential sales practice and operational issues. FINRA is revising the product code relating to annuities and adding new product codes to better categorize the customer complaint information.

      New Product Codes & Descriptions

      Based on a review of the underlying products reported under current Product Code 20 (Annuities), FINRA is redefining that code and adding two additional codes. Revised Product Code 20 will refer only to variable annuities, whereas new Product Codes 43 and 44 will relate to fixed and equity indexed annuities, respectively. In addition, FINRA has added Product Code 45 to capture customer complaints relating to life settlement products.

      The revised and new product codes are as follows:

      •   Product Code 20 (Variable Annuities)

      A variable annuity is an insurance company contract that allows the owner to elect to receive immediate or future periodic payments. A variable annuity is purchased, either with a lump sum or over time, with premiums allocated among various, separate account funds offered in the annuity contract. During the accumulation phase, the rate of return and the contract fund value on a variable annuity fluctuates with the performance of the underlying investments in the separate account funds, sometimes called investment portfolios or subaccounts.
      •   Product Code 43 (Fixed Annuities)

      A fixed annuity is an insurance contract that is purchased either in a lump sum or over time. A fixed annuity is credited with a fixed or set interest rate and allows the owner to elect to receive immediate or future periodic payments. The insurance company guarantees both earnings and principal.
      •   Product Code 44 (Equity-Indexed Annuities)

      An equity-indexed annuity is an insurance company product purchased either in a lump sum or with a series of payments. The insurance company credits the holder with a return that is based on performance of an equity index, such as the S&P 500 Composite Stock Price Index. The insurance company may guarantee a minimum return. After the accumulation period, the insurance company makes periodic payments under the terms of the contract or in a lump sum.
      •   Product Code 45 (Life Settlements)

      A life settlement is a financial transaction in which a policy owner sells an existing life insurance policy to a third party for more than the policy's cash surrender value, but less than the net death benefit.

      1 FINRA has incorporated into its rulebook certain rules of the NYSE, including NYSE Rule 351. The Incorporated NYSE rules apply solely to those members of FINRA that are also members of NYSE (Dual Members).

    • 10-25 FINRA Requests Comment on Proposed Registration Category, Qualification Examination and Continuing Education Requirements for Operations Professionals; Comment Period Expires: July 12, 2010

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      The comment period was extended to July 30, 2010.

      Registration and Qualification Requirements for Certain Operations Personnel

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 8310
      NASD Rule 1021
      NASD Rule 1031
      NASD Rule 1120
      Incorporated NYSE Rule 345.10
      Information Notice 03/12/08
      Information Notice 10/06/08
      Regulatory Notice 08-57
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Senior Management
      Key Topics

      Continuing Education
      Examination
      Qualification
      Registration
      Representative

      Executive Summary

      FINRA requests comment on a proposal to establish a registration category, qualification examination and continuing education requirements for certain operations personnel. The proposal would expand FINRA's registration requirements to include as qualified and registered persons certain individuals who are engaged in, or supervising, activities relating to sales and trading support and the handling of customer assets to enhance the regulatory structure surrounding a member firm's back-office operations. As further detailed in this Notice, the proposed Operations Professional registration category generally is aimed at capturing those persons with decision-making and/or oversight authority in direct furtherance of the covered operations functions. Persons required to register under this proposal also would be subject to FINRA's continuing education requirements.

      The text of the proposed rules is set forth in Attachment A.

      Questions regarding this Notice should be directed to:

      •   Joe McDonald, Director, Testing and Continuing Education Department, at (240) 386-5065; or
      •   Erika L. Lazar, Counsel, Office of General Counsel, at (202) 728-8013.

      Action Requested

      FINRA encourages all interested parties to comment on the proposed rules. Comments must be received by July 12, 2010.

      Firms and other interested parties can submit their comments using the following methods:

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

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

      To help FINRA process and review comments more efficiently, persons should only use 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 Web site. Generally, FINRA will post comments on its site one week after the end of the comment period.1

      Before becoming effective, a proposed rule change must be authorized for filing with the SEC by the FINRA Board of Governors, and then must be approved by the SEC, following publication for public comment in the Federal Register.2

      I. Background

      Given the growing complexity of the financial services industry and the importance of services provided by a firm's so-called "back-office" personnel, FINRA has concerns about the potential for regulatory gaps in the area of licensing and education requirements for individuals performing operations functions. Historically, federal and state law and self-regulatory organization rules, including NASD Rules 1021 and 1031, have required that individuals engaged in or supervising the securities or investment banking business of a member firm be qualified and registered persons. These requirements generally have applied to, among others, individuals with customer contact providing advice (sales persons and investment bankers) or effecting securities transactions (traders), and their supervisors. However, unregistered individuals who perform operations functions within a member firm also play an integral role in the business of the firm, and their activities often have a meaningful connection to client funds, accounts and transactions.

      II. Proposal

      FINRA believes that licensing and education requirements for certain operations personnel are needed to help ensure that investor protection mechanisms are in place in all areas of a member firm's business that could harm a customer, a firm, the integrity of the marketplace or the public. Accordingly, FINRA proposes expanding its registration requirements to include as qualified and registered persons certain individuals (as further detailed in Section II.A. below) who are engaged in, or supervising, activities relating to sales and trading support and the handling of customer assets (Operations Professionals) to enhance the regulatory structure surrounding a firm's back-office operations.

      A. Depth of Personnel Included in the New Registration Category

      Generally, the proposed registration category for Operations Professionals is aimed at capturing those persons with decision-making and/or oversight authority in direct furtherance of the covered operations functions, which are described in detail in Section II.B. below (the covered functions). Persons subject to the new registration category generally are those persons who are directly responsible for overseeing that tasks within the covered functions are performed correctly in accordance with industry rules, firm protocols, policies and procedures, and who are charged with protecting the functional and control integrity of the covered functions for the firm.

      More specifically, the following persons would be required to register with FINRA as an Operations Professional (collectively, covered persons):
      (1) Senior management with responsibility over the covered functions;
      (2) Supervisors, managers or other persons responsible for approving or authorizing work in direct furtherance of the covered functions, including work of other persons in the covered functions;
      (3) Persons with the authority or discretion to commit the firm's capital in direct furtherance of the covered functions or to commit the firm to any contract or agreement (written or oral) in direct furtherance of the covered functions (including, e.g., a person who has the discretion to commit the firm to any contract or agreement involving securities lending or borrowing activities).
      The requirements would not apply to persons who perform a covered function, but whose responsibilities are below these three specified levels, or persons who perform a function ancillary to a covered function or whose function is to serve a role that can be viewed as supportive of, or advisory to, the performance of a covered function, such as internal audit, legal or compliance personnel. Also, the requirements would not apply to persons who are engaged solely in clerical or ministerial activities in any of the covered functions.

      Importantly, those persons subject to the new Operations Professional registration category would be considered associated persons of a firm irrespective of their employing entity and would be subject to all FINRA rules applicable to associated persons and/or registered persons.3

      To implement this proposal, FINRA is proposing amendments to proposed FINRA Rule 1230 (Registration Categories) to add a new representative registration category for Operations Professionals.4 Also, in light of the fact that the Operations Professional registration category would encompass individuals engaged in or supervising stock loan/securities lending activities, the proposed registration categories for a "Securities Lending Representative" and a "Securities Lending Supervisor" would be eliminated.5
      B. Functions for Inclusion in the New Registration Category

      The three categories of persons identified in Section II.A. above that conduct activities or functions for the firm in one or more of the following covered functions would be required to register as an Operations Professional:
      •   Development and approval of pricing models used for valuations;
      •   Trade confirmation, account statements, settlement, margin;
      •   Stock loan/securities lending;
      •   Prime brokerage (services to other broker-dealers and financial institutions);
      •   Client on-boarding (customer account data and document maintenance);
      •   Capturing of business requirements for sales and trading systems and any other systems related to the covered functions, and validation that these systems meet such business requirements;
      •   With respect to the covered functions, defining and approving business security requirements and policies for information technology (including, but not limited to, systems and data);
      •   Defining information entitlement policy in connection with the covered functions;
      •   Financial Controller (including general ledger);
      •  Collection, maintenance, re-investment (i.e., sweeps) and disbursement of funds;
      •   Bank, custody, depository and firm account management and reconciliation;
      •   Segregation, possession and control, fail control, buy ins;
      •   Receipt and delivery of securities and funds, account transfers;
      •   Financial regulatory reporting; and
      •   Posting entries to the books and records of a firm in connection with the covered functions.
      C. Operations Professional Qualification Examination

      FINRA proposes the establishment of a new qualification examination for Operations Professionals that would provide reasonable assurance that such individuals understand their professional responsibilities, including key regulatory and control themes, as well as the importance of identifying and escalating red flags that may harm a firm, its customers, the integrity of the marketplace or the public. The SEC staff has previously indicated its support for the establishment of a qualification examination for covered persons to heighten their awareness of operating in a regulated environment and to demonstrate a basic understanding of the securities industry.

      In general, given the diversity of functions performed by covered persons, FINRA proposes the development of a single principles-based qualification examination with a regulatory focus to test for a broad understanding of a broker-dealer's business at a basic level; a basic understanding of the operations functions that support a broker-dealer's business; and the regulations designed to achieve investor protection and market integrity that drive the operations processes and procedures conducted at a broker-dealer. Any individual whose activities go beyond those proposed for the Operations Professional registration category would be required to separately qualify and register in the appropriate category or categories of registration attendant to such activities.

      The proposed Operations Professional qualification examination is not intended to be a competency examination, but would test for general securities industry knowledge with a regulatory focus to alert such persons that they are functioning in a heavily regulated industry. The continuing education components associated with the Operations Professional registration category (described in detail in Section II.E. below) would provide competency training specific to the covered functions.

      The breadth and depth of coverage of the qualification examination would be determined through the use of testing industry standards used to develop examinations, and would include input and advice from covered persons active in the securities industry.

      The following are the three key content themes of the new Operations Professional qualification examination:
      •   Professional Conduct and Ethical Considerations: This section of the examination would assess a candidate's core knowledge addressed on other FINRA examinations that is appropriate for the Operations Professional. The questions in this section would assess knowledge of what are considered serious violations of securities industry rules. This category would include ethics-based questions that address issues such as data integrity, escalation of regulatory red flags and separation of duties.
      •   Essential Product and Market Knowledge for an Operations Professional: This section of the examination would assess a candidate's basic product and market knowledge, including definitions and characteristics of major product categories (i.e., equities, debt, packaged securities, options and markets). The Operations Professional would not be expected to know the same level of detail about the products and markets as a product specialist or a representative selling products to customers.
      •   Knowledge Associated With Operations Activities: This section of the examination would assess a candidate's broad-based knowledge regarding the covered functions outlined above that support a broker-dealer's business, and the underlying rules that drive the processes associated with these activities (i.e., customer account set-up and transfers, recordkeeping requirements, rules associated with the protection of customer assets and transaction processing, uniform practices associated with making good delivery of securities, making payments for securities and meeting settlement requirements, credit and margin rules, and how to obtain supervisory approval for any of the above).
      D. Exception to Operations Professional Examination Requirement

      FINRA is proposing an exception to the Operations Professional qualification examination requirement for persons who currently hold certain registrations (each an eligible registration) or have held one during the two years immediately prior to registering as an Operations Professional. The proposed exception also would apply to persons who do not hold an eligible registration, but prefer an alternative to taking the Operations Professional examination. Such persons would be permitted to register in an eligible registration category (subject to passing the corresponding qualification examination or obtaining a waiver) and use such registration to qualify for Operations Professional registration.

      A person who wishes to obtain Operations Professional registration under the proposed exception would not be automatically waived-in, but would have to opt-in by requesting Operations Professional registration via Form U4 (the Uniform Application for Securities Industry Registration or Transfer) in the Central Registration Depository (CRD®).6 If there are no other deficiencies (funds, fingerprints, etc.), the Operations Professional registration would be approved automatically at the time such request is made. (See also Section II.F. below regarding the transition period and implementation date.) FINRA would not assess a separate registration fee for persons relying on the proposed exception to register as Operations Professionals.

      FINRA conducted a review of the content outlines for each qualification examination it recognizes and identified examinations with broad content coverage that would be eligible for an exception to the Operations Professional examination requirement.

      Accordingly, persons that hold the following representative level registration categories, or who have held such registration categories within the two years immediately prior to registering as an Operations Professional, would be qualified to register as an Operations Professional without passing the Operations Professional qualification examination:
      •   Investment Company Products/Variable Contracts Representative (Series 6)
      •   General Securities Representative (Series 7)
      •   United Kingdom Securities Representative (Series 17) or Canada Securities Representative (Series 37 or 38)
      Additionally, persons who hold (or have held) certain principal-level registration categories would be qualified to register as an Operations Professional without passing the Operations Professional examination. Most principal-level qualification examinations have a prerequisite examination requirement that is satisfied with one of the representative qualification examinations listed above; however, FINRA also proposes to include principal-level qualification examinations that do not have a prerequisite, or that have a prerequisite that can be met with a qualification examination not on the above list (e.g., Series 62), because it is likely that such principals are familiar with the content to be covered in the Operations Professional qualification examination as a result of the requirements of their positions.

      Accordingly, persons who hold the following principal-level registration categories, or who have held such registration categories within the two years immediately prior to registering as an Operations Professional, would be qualified to register as an Operations Professional without passing the Operations Professional qualification examination:
      •   Registered Options Principal (Series 4)
      •   General Securities Sales Supervisor (Series 9/10)
      •   Compliance Officer (Series 14)
      •   Supervisory Analyst (Series 16)
      •   General Securities Principal—Sales Supervisor (Series 23)
      •   General Securities Principal (Series 24)
      •   Investment Company Products/Variable Products Principal (Series 26)
      •   Financial and Operations Principal (Series 27)
      •   Introducing Broker/Dealer Financial and Operations Principal (Series 28)
      •   Municipal Fund Securities Limited Principal (Series 51)
      •   Municipal Securities Principal (Series 53)
      The proposed exception would not apply to persons whose eligible registrations have been revoked or terminated pursuant to FINRA Rule 8310 (Sanctions for Violations of the Rules) within the two years immediately prior to registering as an Operations Professional.

      FINRA notes that operations personnel who would be subject to the Operations Professional registration requirements are generally acting in a supervisory position, so many persons will already hold one of the eligible registrations that would qualify for the exception to the Operations Professional examination requirement. As noted above, entry-level operations personnel would not typically be subject to the proposed requirements for Operations Professionals.
      E. Continuing Education Requirements for Operations Professionals

      FINRA would require that individuals registered as Operations Professionals be subject to FINRA's Regulatory Element and Firm Element continuing education requirements as set forth in NASD Rule 1120 (Continuing Education Requirements). The continuing education elements for this registration category would provide learning materials appropriate for Operations Professionals, given the breadth of functions that are covered by this registration requirement.

      The Regulatory Element program for Operations Professionals would provide instruction for Operations Professionals to:
      (1) maintain and improve understanding of the regulatory and ethical aspects associated with the covered functions;
      (2) identify suspicious activities and/or red flags that could harm a customer, a firm, issuers of securities or the integrity of the marketplace;
      (3) maintain and improve knowledge and understanding of the covered functions; and
      (4) assist the Operations Professionals in keeping up with changes in the industry and regulations that impact their work.
      Operations Professionals would be required to complete scenario-based modules based on the key content themes of the Operations Professional qualification examination, as described in Section II.C. above. The breadth and depth of coverage of the modules would be determined through the use of existing industry standards currently used to develop continuing education content and would include input and advice from operations professionals active in the securities industry. Individuals would be expected to complete the Regulatory Element continuing education requirement two years after passing the qualification examination and then every three years thereafter. FINRA expects that the continuing education content for Operations Professionals would be available two years after the launch of the qualification examination.

      Individuals who avail themselves of the proposed exception to the Operations Professional qualification examination requirement with an eligible registration (described in Section II.D. above) would be subject to the Regulatory Element program appropriate for such other registration category. For example, a person who registers as an Operations Professional by holding a General Securities Representative registration under the exception would be subject to the S101 continuing education program.

      Operations Professionals would also be subject to Firm Element training. To implement this change, FINRA would expand NASD Rule 1120(b) to include Operations Professionals in the definition of "covered registered persons," and to require that firms deliver Firm Element training to Operations Professionals subject to the new registration and qualification requirements.7
      F. Transition Period and Implementation Date
      1. Persons Acting as Operations Professionals as of the Effective Date of the New Registration Requirement

      FINRA is proposing a six- to nine-month transition period for existing personnel that meet the depth of personnel criteria and are engaged in the covered functions as of the effective date of the proposed registration category. During this six- to nine-month period (which would begin on the date the proposed registration category takes effect), covered persons would be required to register with FINRA as Operations Professionals. FINRA believes that a six- to nine-month transition period will provide firms with an opportunity to identify persons who would be subject to the Operations Professional requirements, and provide such covered persons an opportunity to register as an Operations Professional by doing one of the following, as applicable:
      (1) requesting Operations Professional registration via Form U4 in CRD and passing the Operations Professional qualification examination;
      (2) requesting Operations Professional registration via Form U4 in CRD pursuant to the proposed exception, based on their holding, or having held within the past two years, an eligible registration (see Section II.D. above);8 or
      (3) registering with FINRA in one of the eligible registrations and, pursuant to the proposed exception (see Section II.D. above), requesting Operations Professional registration via Form U4 in CRD.
      2. Persons Who Begin Work as Operations Professionals Following the Effective Date of the New Registration Requirement

      The six- to nine-month transition period would not apply to persons who meet the depth of coverage criteria and begin work in the covered functions following the effective date of the proposed registration category (i.e., new hires or existing associated persons who transition into the covered functions). Such persons would be required to register as an Operations Professional prior to engaging in any of the activities that would qualify them as covered persons, regardless of whether they begin work during the transition period or after it expires, and would be permitted to register as described in paragraphs (1)–(3) of Section II.F.1. above.

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

      2 Section 19 of the Securities Exchange Act of 1934 (SEA or Exchange Act) permits certain limited types of proposed rule changes to take effect upon filing with the SEC. The SEC has the authority to summarily abrogate these types of rule changes within 60 days of filing. See SEA Section 19 and rules thereunder.

      3 See Notice to Members 05-48 (Members' Responsibilities When Outsourcing Activities to Third-Party Service Providers). The Notice reminds members that "in the absence of specific NASD [or FINRA] rules, MSRB rules, or federal securities laws or regulations that contemplate an arrangement between members and other registered broker-dealers with respect to such activities or functions (e.g., clearing agreements executed pursuant to NASD Rule 3230), any third-party service providers conducting activities or functions that require registration and qualification under NASD [or FINRA] rules will generally be considered associated persons of the member and be required to have all necessary registrations and qualifications."

      4 See Regulatory Notice 09-70 (FINRA Requests Comment on Proposed Consolidated FINRA Rules Governing Registration and Qualification Requirements). The proposed amendments discussed in this Notice would be included in proposed FINRA Rule 1230 (Registration Categories).

      5 See supra note 4. In Regulatory Notice 09-70, FINRA proposed generally adopting the NYSE registration requirement for securities lending representatives and securities lending supervisors (Incorporated NYSE Rule 345.10), which requires the registration of securities lending representatives and their direct supervisors. Under NYSE rules, such persons are not subject to any training or examination requirements; however, these individuals are required to file a Form U4 and sign a "code of ethics" agreement.

      6 A person who qualifies for the proposed exception based on their having held an eligible registration within the two years immediately prior to registering as an Operations Professional would be required to first re-activate such eligible registration prior to requesting Operations Professional registration.

      7 NASD Rule 1120 (Continuing Education Requirements) is limited to registered persons who have direct contact with customers in the conduct of the firm's securities sales, trading and investment banking activities, any person registered as a research analyst pursuant to Rule 1050, and to the immediate supervisors of such persons. The proposed amendments would be included in the new FINRA rule governing continuing education, FINRA Rule 1250, which would be filed concurrently with this proposal.

      8 See supra note 6.

      9 This would include, for example, a person who takes and passes the Series 7 examination, or qualifies for a waiver of the requirement to take the examination, and registers in CRD as a General Securities Representative.


      ATTACHMENT A

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

      * * * * *

      Text of Proposed New FINRA Rule

      * * * * *

      1200. REGISTRATION AND QUALIFICATION
      1230. Registration Categories
      (a) Definition of Principal and Principal Registration Categories
      (1) through (11) Reserved.
      (b) Definition of Representative and Representative Registration Categories
      (1) through (5) Reserved.
      (6) Operations Professional
      (A) Requirement

      Each of the following persons shall be required to register with FINRA as an Operations Professional:
      (i) Senior management with responsibility over the covered functions in paragraph (b)(6)(B) of this Rule;
      (ii) Supervisors, managers or other persons responsible for approving or authorizing work in direct furtherance of the covered functions in paragraph (b)(6)(B) of this Rule, including work of other persons in the covered functions in paragraph (b)(6)(B) of this Rule; and
      (iii) Persons with the authority or discretion to commit the member's capital in direct furtherance of the covered functions in paragraph (b)(6)(B) of this Rule or to commit the member to any contract or agreement (written or oral) in direct furtherance of the covered functions in paragraph (b)(6)(B) of this Rule.
      (B) Covered Functions
      (i) Development and approval of pricing models used for valuations;
      (ii) Trade confirmation, account statements, settlement, margin;
      (iii) Stock loan/securities lending;
      (iv) Prime brokerage (services to other broker-dealers and financial institutions);
      (v) Client on-boarding (customer account data and document maintenance);
      (vi) Capturing of business requirements for sales and trading systems and any other systems related to the covered functions, and validation that these systems meet such business requirements;
      (vii) With respect to the covered functions, defining and approving business security requirements and policies for information technology (including, but not limited to, systems and data);
      (viii) Defining information entitlement policy in connection with the covered functions;
      (ix) Financial Controller (including general ledger);
      (x) Collection, maintenance, re-investment (i.e., sweeps) and disbursement of funds;
      (xi) Bank, custody, depository and firm account management and reconciliation;
      (xii) Segregation, possession and control, fail control, buy ins;
      (xiii) Receipt and delivery of securities and funds, account transfers;
      (xiv) Financial regulatory reporting; and
      (xv) Posting entries to the books and records of a member in connection with the covered functions.
      (C) Qualification Examination

      Subject to the exception in paragraph (b)(6)(D) of this Rule, any person who is required to register as an Operations Professional shall pass the Operations Professional qualification examination before such registration may become effective.
      (D) Exception

      Any person who is registered with FINRA as an Investment Company Products/Variable Contracts Representative, General Securities Representative, United Kingdom Securities Representative or Canada Securities Representative, Registered Options Principal, General Securities Sales Supervisor, Compliance Officer, Supervisory Analyst, General Securities Principal—Sales Supervisor, General Securities Principal, Investment Company Products/Variable Products Principal, Financial and Operations Principal, Introducing Broker/Dealer Financial and Operations Principal, Municipal Fund Securities Limited Principal or Municipal Securities Principal, and any person who has been registered in one of these categories within the two years immediately prior to registering as an Operations Professional, shall be qualified to register as an Operations Professional without passing the Operations Professional qualification examination, provided that such registration has not been terminated or revoked pursuant to FINRA Rule 8310.
      (E) Implementation

      Any person who is required to register as an Operations Professional under this Rule as of [insert the effective date of the rule] shall register as an Operations Professional within the time period prescribed by FINRA for such persons. Any person who is not required to register as an Operations Professional under this Rule as of [insert the effective date of the rule] shall register as an Operations Professional prior to engaging in any activities that would require such registration.
      (7) through (13) Reserved.

      * * * * *

      1250. Continuing Education Requirements
      (a) Reserved.
      (b) Firm Element
      (1) Persons Subject to the Firm Element

      The requirements of this subparagraph shall apply to any person registered with a member who has direct contact with customers in the conduct of the member's securities sales, trading and investment banking activities, any person registered as an operations professional, any person registered as a research analyst or a supervisory analyst and the immediate supervisors of such persons (collectively, "covered registered persons"). "Customer" shall mean any natural person and any organization, other than another broker or dealer, executing securities transactions with or through or receiving investment banking services from a member.

      * * * * *

    • 10-24 SEC Approves Amendments to Require Reporting of OTC Trades in Equity Securities Within 30 Seconds of Execution; Effective Date: November 1, 2010

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      Trade Reporting

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 2010
      FINRA Rule 6282
      FINRA Rule 6380A
      FINRA Rule 6380B
      FINRA Rule 6622
      FINRA Rule 7130
      FINRA Rule 7230A
      FINRA Rule 7230B
      FINRA Rule 7330
      Schedule A to the FINRA By-Laws
      Suggested Routing

      Compliance
      Executive Representatives
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Training
      Key Topics

      Alternative Display Facility
      Direct Participation Program Securities
      NMS Stocks
      OTC Equity Securities
      OTC Reporting Facility
      Trade Reporting Facilities

      Executive Summary

      Effective Monday, November 1, 2010, firms are required to report over-the-counter transactions in equity securities1 to FINRA within 30 seconds of execution. The new reporting time frame also applies to trade cancellations that currently are subject to 90-second reporting, as well as stop stock and prior reference price trades.

      Also effective as part of the November 1, 2010, changes, firms are required to report secondary market transactions in non-exchange-listed direct participation program securities within 30 seconds of execution. Therefore, such transactions will be subject to regulatory transaction fees under Section 3 of Schedule A to the FINRA By-Laws.

      Firms that rely on manual trade reporting processes may qualify for an additional six months for implementation, as described in this Notice.

      The text of the amendments is available at www.finra.org/rulefilings/2009-061.

      Questions regarding this Notice may be directed to:

      •   The Legal Section, Market Regulation, at (240) 386-5126; or
      •   The Office of General Counsel at (202) 728-8071.

      Background and Discussion

      30-Second Trade Reporting Requirement

      The SEC recently approved amendments to require firms to report over-the-counter (OTC) transactions in equity securities that are executed during the hours that the FINRA trade reporting facilities are open within 30 seconds of execution.2 Trades not reported within 30 seconds of execution, unless expressly subject to a different reporting requirement or excluded from the trade reporting rules altogether, are late.

      Thus, the amendments reduce the reporting time frame from 90 to 30 seconds, and all references to 90 seconds in FINRA trade reporting rules are replaced with 30 seconds.3 The amendments also apply to trade cancellations that currently are subject to 90-second reporting. Specifically, trades executed during normal market hours and canceled during normal market hours on trade date must be reported within 30 seconds of cancellation. Additionally, the amendments apply to stop stock and prior reference price trades. If the trade is executed within 30 seconds of the time the parties agree to the stop stock price, the stop stock modifier should not be used. Similarly, if the trade is executed within 30 seconds of the prior reference point in time, firms should not use the prior reference price modifier.

      FINRA reminds firms that they must report trades as soon as practicable and cannot withhold trade reports; e.g., by programming their systems to delay reporting until the last permissible second. Additionally, FINRA reiterates the importance of timely reporting. A pattern and practice of late reporting may be considered inconsistent with high standards of commercial honor and just and equitable principles of trade in violation of FINRA Rule 2010.

      Reporting Trades in Non-Exchange-Listed DPP Securities

      Pursuant to the amendments, firms are required to report secondary market transactions in non-exchange-listed direct participation program (DPP) securities to FINRA within 30 seconds of execution.4 For purposes of the 30-second reporting requirement, the "date of execution" and the "time of execution" are defined under the amendments (as well as current rules) as the date and time, respectively, when the parties to a transaction in a DPP have agreed to all of the essential terms of the transaction, including the price and number of units to be traded.5

      As a result of the amendments, transactions in non-exchange-listed DPPs are now subject to regulatory transaction fees under Section 3 of Schedule A to the FINRA By-Laws (Section 3).6

      Implementation Schedule

      The amendments above become effective pursuant to the following implementation schedule:

      Phase I implementation date (for all firms other than qualifying Manual Reporting Firms): Monday, November 1, 2010
      Phase II implementation date (for qualifying Manual Reporting Firms only): Monday, May 2, 2011

      A "Manual Reporting Firm" is a firm that uses a manual process such as WeblinkACT (also commonly referred to as the NASDAQ or ACT workstation) for all, or substantially all, of its trade reporting of OTC trades. Firms with automated processes that—on occasion—manually report trades do not fall within the scope of this definition and must comply with the Phase I implementation date for all of their trade reporting.7

      Firms must submit advance written notice to FINRA that they are a "Manual Reporting Firm" and thereby qualify for Phase II implementation, and they must include a description of their current manual process. Such notice should be submitted at least 30 business days prior to the Phase I implementation date—by September 20, 2010—to FINRA's Market Regulation Department:

      FINRA
      Market Regulation Department
      Attn: Director of Trade Reporting
      9509 Key West Avenue
      Rockville, MD 20850

      Firms with manual trade reporting systems that do not provide advance notice must comply with the amendments beginning on November 1, 2010.

      Prior to May 2, 2011, qualifying Manual Reporting Firms are required to report as promptly as practicable—and in no event more than 90 seconds—following trade execution.8 However, as of November 1, 2010, all trades reported more than 30 seconds after execution will be modified as late for reporting and dissemination purposes. In this way, market participants will have certainty that any trade disseminated as timely reported was executed within the prior 30 seconds.

      Effective May 2, 2011, all firms must comply with the 30-second trade reporting requirement.


      1 Specifically, these are (1) transactions in NMS stocks effected otherwise than on an exchange, which are reported through the Alternative Display Facility (ADF) or a Trade Reporting Facility (TRF); and (2) transactions in OTC equity securities (e.g., OTC Bulletin Board, Pink Sheets and non-exchange-listed direct participation program securities), which are reported through the OTC Reporting Facility (ORF).

      FINRA notes that "OTC equity security" does not include restricted securities under Securities Act Rule 144(a)(3). Hence, transactions in these securities are not subject to 90-second reporting, nor are they impacted by the amendments discussed herein. See SR-FINRA-2010-003.

      2 See Securities Exchange Act Release No. 61819 (March 31, 2010), 75 FR 17806 (April 7, 2010) (Notice of Filing of Amendment No. 2 and Order Granting Accelerated Approval of File No. SR-FINRA-2009-061).

      3 See FINRA Rules 6282(a); 6380A(a) and (g); 6380B(a) and (f); 6622(a) and (f); 7130(b); 7230A(b); 7230B(b); and 7330(b).

      4 See FINRA Rule 6622. These transactions are no longer subject to a separate rule series (the FINRA Rule 6640 Series has been deleted in its entirety) and must be reported as any other OTC equity security pursuant to the FINRA Rule 6620 and 7300 Series.

      5 See FINRA Rule 6622.01.

      6 Pursuant to Section 31 of the Exchange Act, FINRA and the national securities exchanges are required to pay transaction fees and assessments to the SEC that are designed to recover the costs related to the government's supervision and regulation of the securities markets and securities professionals. FINRA obtains its Section 31 fees and assessments from its membership in accordance with Section 3.

      7 In other words, firms with automated trade reporting processes cannot qualify for Phase I implementation for some trades and Phase II implementation for other trades.

      8 These firms also will continue to be subject to all other reporting time frames under FINRA rules (e.g., the obligation to report trades executed between midnight and 8 a.m. by 8:15 a.m. Eastern Time on trade date).

      Additionally, FINRA notes that qualifying Manual Reporting Firms will be required to report transactions in non-exchange-listed DPPs within 90 seconds of execution, and such transactions will be subject to Section 3 fees.

    • 10-23 SEC Approves Reporting Asset-Backed Securities Transactions to TRACE and Related Fees; Effective Date: February 14, 2011

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      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules

      FINRA Rule 6710
      FINRA Rule 6720
      FINRA Rule 6730
      FINRA Rule 6750
      FINRA Rule 6760
      FINRA Rule 7730
      Securities Act Rule 144A
      SEA Section 19
      Suggested Routing

      Compliance
      Fixed Income
      Legal
      Operations
      Research
      Systems
      Trading
      Key Topics

      Asset-Backed Securities
      Fees
      Mortgage-Backed Securities
      Reporting
      TRACE-Eligible Security

      Executive Summary

      Effective February 14, 2011, firms must begin reporting asset- and mortgage-backed securities transactions to TRACE. FINRA will not disseminate the data; it will collect and study the transaction data and may propose to disseminate it in the future.

      In addition, reporting fees for asset- and mortgage-backed securities transactions, and other related amendments to TRACE and FINRA rules will go into effect on this day.1

      The amended rule text is available at www.finra.org/notices/10-23.

      Questions regarding this Notice should be directed to:

      •   Patrick Geraghty, Director, Market Regulation, at (240) 386-4973;
      •   Elliot R. Levine, Associate Vice President and Counsel, Transparency Services, at (202) 728-8405; or
      •   Sharon Zackula, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8985.

      Background & Discussion

      The TRACE Rules (the FINRA Rule 6700 Series) provide for the reporting of transactions in TRACE-Eligible Securities to TRACE and the dissemination of transaction information, with limited exceptions.2 TRACE reporting and data fees are set forth in FINRA Rule 7730.

      In 2009, FINRA proposed two major expansions of TRACE.3 The first major expansion, which became effective March 1, 2010, added debt securities issued or guaranteed by U.S. federal agencies and government-sponsored enterprises (GSEs) (collectively, Agency Debt Securities) as TRACE-Eligible Securities.4 In addition, primary market transactions became reportable to TRACE, fee provisions were amended regarding both Agency Debt Securities and primary market transactions, and FINRA was granted certain emergency authority.5

      On February 22, 2010, the SEC approved the second major proposed expansion of TRACE to include Asset-Backed Securities as TRACE-Eligible Securities, to require the reporting of Asset-Backed Securities transactions and to establish reporting fees. The significant changes to the TRACE Rules and FINRA Rule 7730 related to Asset-Backed Securities include:

      •   amendments to the definition of TRACE-Eligible Security in Rule 6710(a) to include Asset-Backed Securities, which is broadly defined in Rule 6710(m) and includes, but is not limited to, asset-backed securities, mortgage-backed securities, collateralized mortgage obligations, synthetic asset-backed securities, collateralized debt obligations, collateralized bond obligations, collateralized debt obligations of Asset-Backed Securities, collateralized debt obligations of collateralized debt obligations, including any residual tranches of such instruments, and similarly structured securities;
      •   amendments to the definition of Reportable TRACE Transaction to include specific requirements regarding Asset-Backed Securities in Rule 6710(c);
      •   the adoption of several new defined terms used in connection with Asset-Backed Securities—Sponsor, Issuing Entity, TBA, Agency Pass-Through Mortgage-Backed Security, Factor, Specified Pool Transaction, Stipulation Transaction, Dollar Roll and Remaining Principal Balance, in, respectively, Rule 6710(s), Rule 6710(t), Rule 6710(u), Rule 6710(v), Rule 6710(w), Rule 6710(x), Rule 6710(y), Rule 6710(z) and Rule 6710(aa)—and the term TRACE System Hours in Rule 6710(bb);
      •   amendments to the defined terms List or Fixed Offering Price Transaction and Takedown Transaction in, respectively, Rule 6710(q) and Rule 6710(r), to exclude Asset-Backed Securities;
      •   amendments to Rule 6730(a)(6), Rule 6730(c) and Rule 6730(d) to require the reporting of Asset-Backed Securities transactions to TRACE, including:
      •   permitting the use of mortgage pool numbers and similar numeric identifiers when reporting if a CUSIP number is not available;6
      •   reporting the original face value as the size (volume) of a transaction for transactions involving amortizing Asset-Backed Securities where par value is not used to indicate size (volume);
      •   reporting the Factor used in the transaction if the Factor is not the most current Factor that is publicly available at the Time of Execution for the Asset-Backed Security;
      •   reporting the total dollar amount of the commission;
      •   reporting the actual date of settlement of the transaction and an indicator that the settlement is regular way or not regular way for the type of Asset-Backed Security traded; and
      •   reporting the appropriate indicator if a transaction is a Specified Pool Transaction, a Stipulation Transaction, a Dollar Roll, or both a Dollar Roll and a Stipulation Transaction.
      •   amendments to Rule 6730(a)(6), for a six-month pilot, to extend the reporting period for Asset-Backed Securities transactions to no later than T+1 during TRACE System Hours, and, after the expiration of the six-month pilot, to require the reporting of Asset-Backed Securities transactions no later than the date of trade during TRACE System Hours, with certain exceptions for trades executed late in the trading day and outside of TRACE System Hours;7
      •   amendments to Rule 6750(b) to provide that FINRA will not disseminate information on Asset-Backed Securities transactions;
      •   amendments to Rule 6760 regarding the obligations of firms, including those that are a Sponsor or an Issuing Entity of an Asset-Backed Security, to provide notice to FINRA Operations regarding TRACE-Eligible Securities; and
      •   amendments to Rule 7730 to require firms reporting transactions in Asset-Backed Securities to pay reporting fees, and to calculate the fee based on the lesser of original face value or Remaining Principal Value (or the equivalent) at the Time of Execution for transactions in Asset-Backed Securities where par value is not used to determine the size (volume) of the transaction.

      The text of all amendments to the Rule 6700 Series and Rule 7730 is set forth at www.finra.org/notices/10-23.

      As noted on the previous page, FINRA will not disseminate transactions in Asset-Backed Securities when the Asset-Backed Securities amendments become effective. Instead, FINRA intends to collect and study the transaction data. After a review is undertaken, FINRA may propose to disseminate Asset-Backed Securities transaction data. Any proposal to do so will be filed with the SEC under Section 19(b) of the Securities Exchange Act as a proposed rule change, providing firms and the public an opportunity to comment.

      FINRA is aware that the Asset-Backed Securities amendments will require firms to make significant operational and technological changes to incorporate the requirements in firms' business operations, technologies, and compliance and supervisory systems. Accordingly, FINRA has designated the effective date as February 14, 2011.

      In addition, FINRA has extended the period to report a transaction in an Asset-Backed Security from the date of trade during TRACE System Hours to T+1 during TRACE System Hours under a six-month pilot program. Extending the reporting period during the six-month pilot program also will provide firms the time needed to make the changes required to timely and accurately report Asset-Backed Securities transactions. The pilot program will end on Sunday August 14, 2011, at 11:59:59 p.m., Eastern Time.


      1 See Exchange Act Release No. 61566 (February 22, 2010), 75 FR 9262 (March 1, 2010) (Order Approving File No. SR-FINRA-2009-065) (Asset-Back Securities filing).

      2 FINRA disseminates information on publicly traded TRACE-Eligible Securities immediately upon receipt of the transaction report by TRACE. Under Rule 6750(b), a transaction is not disseminated if it is: (1) effected under Securities Act Rule 144A; (2) part of a transfer of multiple proprietary positions to effect an acquisition, merger or a similar combination involving multiple broker-dealers that qualifies under Rule 6750(b)(2); or (3) a primary market transaction that is a List or Fixed Offering Price Transaction or a Takedown Transaction. As discussed below, primary market transactions, including List or Fixed Offering Price Transactions and Takedown Transactions, became subject to TRACE reporting on March 1, 2010.

      3 See Exchange Act Release No. 60727 (September 28, 2009), 74 FR 50991 (October 2, 2009) (Order Approving File No. SR-FINRA-2009-010) (the Agency Debt Securities filing) and Asset-Backed Securities filing, supra note 1.

      4 See Agency Debt Securities filing, supra note 3. The amended definition of TRACE-Eligible Security that became effective on March 1, 2010, continued to exclude Asset-Backed Securities.

      5 See Agency Debt Securities filing, supra note 3. The rule change modified the definition of "Reportable TRACE Transaction" in Rule 6710(c), which previously was limited to secondary market transactions. Certain primary market transactions—those defined as List or Fixed Price Offering Transactions in Rule 6710(q) and Takedown Transactions in Rule 6710(r)—are not required to be reported until close of business on T+1. Also, such transactions are not disseminated. See supra note 2.

      The amendments to Rule 7730 established TRACE reporting and data fees for transactions in Agency Debt Securities at the same rates applicable to corporate bonds, Also, under amended Rule 7730, a member is not required to pay a reporting fee when reporting a List or Fixed Offering Price Transaction or a Takedown Transaction.

      New Rule 6770 provides FINRA emergency authority to suspend the reporting and/or dissemination of certain transactions in TRACE-Eligible Securities or the reporting of certain data elements as market conditions warrant and in consultation with the SEC.

      6 A firm's use of a numeric identifier other than a CUSIP is not limited to Asset-Backed Securities.

      7 See Rule 6730(a)(6)(A)(ii) and Rule 6730(a)(6)(B).

      8 See Exchange Act Release No. 61948 (April 20, 2010), 75 FR 22670 (April 29, 2010)(Notice of Filing and Request for Comment of Immediately Effective Proposed Rule Change SR-FINRA-2010-019).


      Attachment A

      View PDF

    • 10-22 Obligation of Broker-Dealers to Conduct Reasonable Investigations in Regulation D Offerings

      View PDF

      Regulation D Offerings

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Regulation D
      Securities Act Section 17
      SEA Section 10(b)
      Rule 10b-5
      FINRA Rule 2010
      FINRA Rule 2020
      NASD Rule 2210
      NASD Rule 2310
      NASD Rule 3010
      NTM 03-71
      NTM 05-18
      NTM 05-48
      Regulatory Notice 09-05
      Suggested Routing

      Compliance
      Legal
      Registered Representatives
      Senior Management
      Key Topics

      Communications With the Public
      Private Placements
      Suitability
      Supervision

      Executive Summary

      FINRA reminds broker-dealers of their obligation to conduct a reasonable investigation of the issuer and the securities they recommend in offerings made under the Securities and Exchange Commission's Regulation D under the Securities Act of 1933—also known as private placements.

      Regulation D provides exemptions from the registration requirements of Section 5 under the Act. Regulation D transactions, however, are not exempt from the antifraud provisions of the federal securities laws. A broker-dealer has a duty—enforceable under federal securities laws and FINRA rules—to conduct a reasonable investigation of securities that it recommends, including those sold in a Regulation D offering.

      Moreover, any broker-dealer that recommends securities offered under Regulation D must meet its suitability requirements under NASD Rule 2310 (Suitability), and must comply with the advertising and supervisory rules of FINRA and the SEC.

      Questions regarding this Notice should be directed to:

      •   Joseph E. Price, Senior Vice President Corporate Financing/Advertising, at (240) 386-4623;
      •   Paul Mathews, Director, Corporate Financing Department, at (240) 386-4639; or
      •   Gary Goldsholle, Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8104.

      Background and Discussion

      Part I of this Notice describes Regulation D. Part II describes broker-dealers' regulatory responsibilities to engage in a reasonable investigation of a Regulation D offering, enforceable under the antifraud provisions of the federal securities laws and FINRA rules. Part II also describes specific issues that pertain to a broker-dealer's (BD's) responsibilities and how the scope of a BD's responsibility to conduct a reasonable investigation will necessarily depend upon its affiliation with the issuer, its role in the transaction, and other facts and circumstances of the offering, including whether the offerees are retail investors or more sophisticated institutional investors.1

      Part III describes practices that some broker-dealers have adopted to help them discharge their reasonable investigation obligations. These practices are especially relevant to Regulation D offerings of securities of companies that are non-reporting under the Securities Exchange Act of 1934. BDs, however, may find that many of the practices are appropriate for other types of offerings.

      I. Regulation D

      The private placement market is an essential source of capital for American business, particularly small firms. According to one estimate, in 2008 companies intended to issue approximately $609 billion of securities in Regulation D offerings.2 While the private placement market is an important source of capital for many U.S. companies, especially smaller issuers, FINRA has found significant problems in several recent examinations and investigations. These problems include fraud and sales practice abuses in Regulation D offerings. Recently, for example, broker-dealers were sanctioned for providing private placement memoranda and sales materials to investors that contained inaccurate statements or omitted information necessary to make informed investment decisions.3

      Rule 504 under Regulation D provides an exemption from the registration provisions under Section 3(b) of the Securities Act for limited offerings for which the aggregate offering price of securities within a 12-month period does not exceed $1,000,000. Rule 505 provides an exemption under Section 3(b) of the Act for limited offerings for which the aggregate offering price of securities within a 12-month period does not exceed $5,000,000. Rule 505 permits an offering to an unlimited number of "accredited investors" and up to 35 non-accredited investors. Rule 501 defines "accredited investor" as any person who meets, or who the issuer reasonably believes meets, certain requirements, including natural persons with a net worth in excess of $1,000,000, or annual income in excess of $200,000 (or $300,000 jointly with a spouse).

      Rule 506 provides a legal safe harbor for an exemption from registration under Section 4(2) of the Act for the sale of securities to an unlimited number of accredited investors and up to 35 non-accredited investors. Rule 506 (unlike Rule 505) does not limit the permissible size of the offering, but requires that non-accredited investors possess a degree of financial sophistication. Specifically, Rule 506 requires that each non-accredited investor, "either alone or with his purchaser representative(s)," have "such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment," or the issuer must reasonably believe immediately prior to making any sale that the purchaser comes within this description.

      Rule 505 and Rule 506 do not require that an issuer provide any specific written information concerning the offering to accredited investors, although issuers must provide specified information to a non-accredited investor who purchases in an offering. In practice, issuers often provide a private placement memorandum that describes the offering to all prospective purchasers, including accredited investors.4

      II. BD Regulatory Requirements in Regulation D Offerings

      A. Antifraud Provisions and FINRA Rules

      The Securities and Exchange Commission (SEC) and federal courts have long held that a BD that recommends a security is under a duty to conduct a reasonable investigation concerning that security and the issuer's representations about it.5 This duty emanates from the BD's "special relationship" to the customer, and from the fact that in recommending the security, the BD represents to the customer "that a reasonable investigation has been made and that [its] recommendation rests on the conclusions based on such investigation."6 Failure to comply with this duty can constitute a violation of the antifraud provisions of the federal securities laws and, particularly, Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder.7 It also can constitute a violation of FINRA Rule 2010, requiring adherence to just and equitable principles of trade, and FINRA Rule 2020, prohibiting manipulative and fraudulent devices.8

      Courts have found that the amount and nature of the investigation required depends, among other factors, upon the nature of the recommendation, the role of the broker in the transaction, its knowledge of and relationship to the issuer, and the size and stability of the issuer.9 For example, the SEC and courts recognize that a more thorough investigation is required for "securities issued by smaller companies of recent origin,"10 which could include many Regulation D issuers. While there are no "iron clad rules as to what a broker must do to meet his responsibility,"11 the presence of any "red flags" also would alert the broker to the need for further inquiry.12 Each BD must make a determination of the scope of its investigation based upon the facts and circumstances.

      A BD that lacks essential information about an issuer or its securities when it makes a recommendation, including recommendations of securities in Regulation D offerings, must disclose this fact as well as the risks that arise from its lack of information.13 The degree to which a broker-dealer that relies on information supplied by the issuer may be found to have conducted a reasonable investigation as a basis for its recommendation will depend on the facts and circumstances. With respect to reporting companies under the Securities Exchange Act, in the absence of red flags, a BD that is not an underwriter typically may rely upon the current registration statement and periodic reports of the public company.

      In general, however, a BD "may not rely blindly upon the issuer for information concerning a company,"14 nor may it rely on the information provided by the issuer and its counsel in lieu of conducting its own reasonable investigation.15 While BDs are not expected to have the same knowledge as an issuer or its management, firms are required to exercise a "high degree of care" in investigating and independently verifying an issuer's representations and claims.16 Indeed, when an issuer seeks to finance a new speculative venture, BDs "must be particularly careful in verifying the issuer's obviously self-serving statements."17

      The fact that a BD's customers may be sophisticated and knowledgeable does not obviate the duty to investigate.18 Moreover, in Regulation D offerings the SEC advises issuers to provide the same information to accredited investors as they are required to provide to non-accredited investors, in view of the antifraud provisions.19
      B. FINRA Suitability Obligations

      NASD Rule 2310 states that a BD must have reasonable grounds to believe that a recommendation to purchase, sell or exchange a security is suitable for the customer.20 This analysis has two principal components. First, the "reasonable basis" suitability analysis requires the BD to have a reasonable basis to believe, based on a reasonable investigation, that the recommendation is suitable for at least some investors. Second, the "customer specific suitability" analysis requires that the BD determine whether the security is suitable for the customer to whom it would be recommended.21

      In the context of a Regulation D offering, Rule 2310 requires broker-dealers to conduct a suitability analysis when recommending securities to both accredited and non-accredited investors that will take into account the investors' knowledge and experience. The fact that an investor meets the net worth or income test for being an accredited investor is only one factor to be considered in the course of a complete suitability analysis. The BD must make reasonable efforts to gather and analyze information about the customer's other holdings, financial situation and needs, tax status, investment objectives and such other information that would enable the firm to make its suitability determination. A BD also must be satisfied that the customer "fully understands the risks involved and is...able...to take those risks."22

      In order to ensure that it has fulfilled its suitability responsibilities, a BD in a Regulation D offering should, at a minimum, conduct a reasonable investigation concerning:
      •   the issuer and its management;
      •   the business prospects of the issuer;
      •   the assets held by or to be acquired by the issuer;
      •   the claims being made; and
      •   the intended use of proceeds of the offering.23
      A BD must conduct a reasonable investigation in connection with each offering, notwithstanding that a subsequent offering may be for the same issuer.24
      C. Specific Issues Related to a BD's Responsibilities

      The scope of a BD's investigation will necessarily depend upon a number of factors, including the BD's affiliation with the issuer, its role in the transaction, and other facts and circumstances of the offering, including whether the offerees are retail customers or more sophisticated institutional investors.
      1. BD That Is Affiliated With the Issuer

      A BD that is an affiliate of an issuer in a Regulation D offering must ensure that its affiliation does not compromise its independence as it performs its investigation.25 The BD must resolve any conflict of interest that could impair its ability to conduct a thorough and independent investigation. Indeed, its affiliation with the issuer typically would raise expectations by its customers, particularly some retail customers, that the BD has special expertise concerning the issuer.26
      2. BD That Prepares the Private Placement Memorandum

      A BD that prepares the private placement memorandum or other offering document has a duty to investigate securities offered under Regulation D and representations made by the issuer in the private placement memorandum or other offering document.27 In a recent enforcement action, FINRA found that a BD that prepared a private placement memorandum containing material misstatements and omissions about such matters as the amount and timing of distributions and the targeted return of principal to investors violated FINRA Rule 2010, which requires BDs to comply with just and equitable principles of trade.28

      A BD that assists in the preparation of a private placement memorandum or other offering document should expect that it will be considered a communication with the public by that BD for purposes of NASD Rule 2210, FINRA's advertising rule. If a private placement memorandum or other offering document presents information that is not fair and balanced or that is misleading, then the BD that assisted in its preparation may be deemed to have violated NASD Rule 2210. Moreover, sales literature concerning a private placement that a BD distributes will generally be deemed to constitute a communication by that BD with the public, whether or not the BD assisted in its preparation.
      3. The Presence of Red Flags

      In the course of a reasonable investigation, a BD must note any information that it encounters that could be considered a "red flag" that would alert a prudent person to conduct further inquiry. Red flags might arise from information that is publicly available or information that is discovered during the course of the investigation. A BD's reasonable investigation responsibilities would obligate it to follow up on any red flags that it encounters during its inquiry as well as to investigate any substantial adverse information about the issuer.29

      When presented with red flags, the BD must do more than simply rely upon representations by issuer's management, the disclosure in an offering document or even a due diligence report of issuer's counsel. In Kunz and Cline, the SEC found that the broker could not justifiably rely on financial statements in private placement memoranda that had been audited and certified by an accountant when numerous "red flags" indicated that the financial statements were inaccurate.30 The broker had a duty, which it failed to discharge, to conduct a further, independent investigation of the financial condition of the issuer under the circumstances. The SEC also found that the broker acted contrary to just and equitable principles of trade when the private placement memorandum failed to disclose both the broker's consulting relationship with the issuer and the litigation history of the issuer's president and CEO.

      An issuer's refusal to provide a broker-dealer with information that is necessary for the broker-dealer to meet its duty to investigate could itself constitute a red flag. If an issuer is not forthcoming with information requested by a broker-dealer (or provides information that is non-responsive or out-of-date), the broker-dealer must determine whether sufficient information is otherwise obtainable. While issuers are not required to provide accredited investors with a private placement memorandum in order to qualify for the exemptions in Rule 505 or Rule 506, these memoranda typically are used in Regulation D offerings and firms may need to consider whether the absence of a private placement memorandum itself might constitute a red flag.
      4. Reliance on Counsel and Syndicate Managers

      A BD may retain counsel or other experts to assist the firm in undertaking and fulfilling its reasonable investigation obligation. A BD must carefully review the qualifications and competency of counsel or experts retained to perform an investigation on its behalf31 and must ensure that all gaps or omissions in the investigation by such counsel or experts are separately addressed by the BD. Moreover, the use of counsel or experts does not necessarily complete the BD's investigation responsibilities, insofar as a review of the counsel's or expert's report may identify issues or concerns that require further investigation by the BD.

      It may be appropriate in a Regulation D offering in which a BD is merely a member of a syndicate or selling group to rely upon a reasonable investigation by the syndicate manager, provided the BD has reason to believe that the syndicate manager has the expertise and absence of conflicts to engage in a thorough and independent inquiry, and that it has in fact performed such an inquiry with respect to the particular Regulation D offering. Any BD who intends to rely upon the efforts of a syndicate manager should meet with the manager, obtain a description of the manager's reasonable investigation efforts, and ask questions of the manager concerning the independence and thoroughness of the manager's exercise of its responsibilities. A BD that relies upon the efforts of the syndicate manager retains its own responsibilities, to the extent that they are not addressed by the syndicate manager's efforts. For example, if there is reason to believe that the syndicate manager has not addressed a particular issue, then each BD participating in the offering will be responsible to the extent that it implicates the BD's own suitability analysis.
      D. Supervision

      A firm that engages in Regulation D offerings must have supervisory procedures under NASD Rule 3010 that are reasonably designed to ensure that the firm's personnel, including its registered representatives:
      •   engage in an inquiry that is sufficiently rigorous to comply with their legal and regulatory requirements;
      •   perform the analysis required by NASD Rule 2310;
      •   qualify their customers as eligible to purchase securities offered pursuant to Regulation D; and
      •   do not violate the antifraud provisions of the federal securities laws or FINRA rules in connection with their preparation or distribution of offering documents or sales literature.
      These procedures must be reasonably designed to ensure that each Regulation D offering is properly supervised before it is marketed to other firms or sold directly to customers.32
      E. Documentation of Reasonable Investigation

      To demonstrate that it has performed a reasonable investigation, a BD should retain records documenting both the process and results of its investigation. Such records may include descriptions of the meetings that were conducted in the course of the investigation, including meetings with the issuer or other parties, the tasks performed, the documents and other information reviewed, the results of such reviews, the date such events occurred, and the individuals who attended the meetings or conducted the reviews.

      III. Reasonable Investigation Practices

      A BD's reasonable investigation must be tailored to each Regulation D offering in a manner that best ensures that it meets its regulatory responsibilities. Accordingly, a single checklist of possible practices for a BD engaged in a Regulation D offering will not suffice for every offering, and mechanical reliance upon a single checklist may result in an inadequate investigation. Nevertheless, we are providing a list of practices that some firms have adopted to help them adequately discharge their responsibilities. Many of the practices described below are designed to satisfy BDs' regulatory requirements. These practices are especially relevant to Regulation D offerings of securities of companies that are non-reporting under the Securities Exchange Act.

      Industry participants that we surveyed described the following as practices that help ensure they meet their reasonable investigation obligations.

      A. Issuer and Management

      Reasonable investigations of the issuer and its management concerning the issuer's history and management's background and qualifications to conduct the business might include:
      •   Examining the issuer's governing documents, including any charter, bylaws and partnership agreement, noting particularly the amount of its authorized stock and any restriction on its activities. If the issuer is a corporation, a BD might determine whether it has perpetual existence.
      •   Examining historical financial statements of the issuer and its affiliates, with particular focus, if available, on financial statements that have been audited by an independent certified public accountant and auditor letters to management.
      •   Looking for any trends indicated by the financial statements.
      •   Inquiring about the business of affiliates of the issuer and the extent to which any cash needs or other expectations for the affiliate might affect the business prospects of the issuer.
      •   Inquiring about internal audit controls of the issuer.
      •   Contacting customers and suppliers regarding their dealing with the issuer.
      •   Reviewing the issuer's contracts, leases, mortgages, financing arrangements, contractual arrangements between the issuer and its management, employment agreements and stock option plans.
      •   Inquiring about past securities offerings by the issuer and the degree of their success while keeping in mind that simply because a certain product or sponsor historically met obligations to investors, there are no guarantees that it will continue to do so, particularly if the issuer has been dependent on continuously raising new capital. This inquiry could be especially important for any blind pool or blank-check offering.
      •   Inquiring about pending litigation of the issuer or its affiliates.
      •   Inquiring about previous or potential regulatory or disciplinary problems of the issuer. A BD might make a credit check of the issuer.
      •   Making reasonable inquiries concerning the issuer's management. A BD might inquire about such issues as the expertise of management for the issuer's business and the extent to which management has changed or is expected to change. For example, a BD might inquire about any regulatory or disciplinary history on the part of management and any loans or other transactions between the issuer or its affiliates and members of management that might be inappropriate or might otherwise affect the issuer's business.
      •   Inquiring about the forms and amount of management compensation, who determines the compensation and the extent to which the forms of compensation could present serious conflicts of interest. A BD might make similar inquiries concerning the qualifications and integrity of any board of directors or similar body of the issuer.
      •   Inquiring about the length of time that the issuer has been in business and whether the focus of its business is expected to change.
      B. Issuer's Business Prospects

      Reasonable investigations of the issuer's business prospects, and the relationship of those prospects to the proposed price of the securities being offered, might include:
      •   Inquiring about the viability of any patent or other intellectual property rights held by the issuer.
      •   Inquiring about the industry in which the issuer conducts its business, the prospects for that industry, any existing or potential regulatory restrictions on that business and the competitive position of the issuer.
      •   Requesting any business plan, business model or other description of the business intentions of the issuer and its management and their expectations for the business, and analyzing management's assumptions upon which any business forecast is based. A BD might test models with information from representative assets to validate projected returns, break-even points and similar information provided to investors.
      •   Requesting financial models used to generate projections or targeted returns.
      •   Maintaining in the BD's files a summary of the analysis that was performed on financial models provided by the issuer that detail the results of any stress tests performed on the issuer's assumptions and projections.
      C. Issuer's Assets

      Reasonable investigations of the quality of the assets and facilities of the issuer might include:
      •   Visiting and inspecting a sample of the issuer's assets and facilities to determine whether the value of assets reflected in the financial statements is reasonable and that management's assertions concerning the condition of the issuer's physical plants and the adequacy of its equipment are accurate.
      •   Carefully examining any geological, land use, engineering or other reports by third-party experts that may raise red flags.
      •   Obtaining, with respect to energy development and exploration programs, expert opinions from engineers, geologists and others are necessary as a basis for determining the suitability of the investment prior to recommending the security to investors.

      1 As a general matter, any reference in this Notice to the obligations of a BD firm is also intended to cover the concomitant responsibilities of any registered representative who recommends a Regulation D offering to his/her customers and any registered principal who is charged by his/her firm with supervising this registered representative.

      2 Office of the Inspector General, Securities and Exchange Commission, Regulation D Exemption Process 2 (March 31, 2009).

      3 See, e.g., Provident Asset Management, LLC, FINRA Case No. 2009017497201 (2010); Pacific Cornerstone Capital, Inc. FINRA AWC No. 2007010591701 (2009).

      4 A note to Rule 502(b)(1) states that when an issuer provides required information to any non-accredited investor, it should consider providing the information to accredited investors, too, "in view of the anti-fraud provisions of the federal securities laws."

      5 See Hanly v. SEC, 415 F.2d 589, 595–96 (2d. Cir. 1969); SEC v. Great Lake Equities Co., 1990 U.S. Dist. LEXIS 19819 at *16–17 (E.D. Mich. 1990); SEC v. North American Research and Development Corp., 424 F.2d 63,84 (2d Cir. 1970). See also SEC v. Current Financial Services, Inc., 100 F. Supp. 2d 1, 14–15 (D.D.C. 2000); District Business Conduct Committee for District No. 4 v. Everest Securities, Inc., 1994 NASD Discip. Lexis 188 (Sept. 2, 1994), aff'd, 52 S.E.C. 958, 962–63 (Aug. 26, 1996), aff'd, 116 F. 3d 1235 (8th Cir. 1997); Securities Act Release No. 4445, 27 Fed. Reg. 1415 (Feb. 2, 1962).

      6 Hanly, supra note 5 at 597.

      7 See generally Hanly, supra note 5.

      8 See Everest Securities, Inc, supra note 5.

      9 See Hanly, supra note 5. See also University Hill Foundation v. Goldman, Sachs & Co., 422 F. Supp. 879, 898 (S.D.N.Y. 1976).

      10 Hanly, supra note 5 at 597.

      11 University Hill Foundation, supra note 9 at 898.

      12 See, e.g., SEC v. Milan Capital Group, Inc., 2000 U.S. Dist. LEXIS 16204 (S.D.N.Y. 2000), where the court held that the duty to independently investigate is greater "where promotional materials are in some ways questionable, for example by promising unusually high returns."

      13 See Hanly, supra note 5 at 597 ("Where the salesman lacks essential information about a security, he should disclose this as well as the risks which arise from his lack of information"). See also Securities Act Release No. 4445, supra note 5; Regulatory Notice 09-05 (Guidance to Member Firms Participating in Unregistered Resales of Restricted Securities) (January 2009).

      14 Hanly, supra note 5 at 597. The duty of inquiry under the antifraud provisions is distinguished from the "reasonable investigation" that, under Section 11(b) of the Securities Act, permits an underwriter to escape liability for misrepresentations in a registration statement. Courts have compared the Section 11 reasonable investigation and the BD's general duty to investigate and concluded that "somewhat more is required of an underwriter than a broker to discharge its obligation to the investing public." University Hill Foundation, supra note 9 at 898–99. This is because "an underwriter's relationship to the issuer is more substantial" than a BD that is only recommending a security, and the underwriter "plays a more central role in the marketing process." Id.

      15 See Everest Securities, Inc. v. US, supra note 5 at 1239 ("reliance on others does not excuse [the respondents] own lack of investigation").

      16 Everest Securities, Inc., supra note 5 at 963.

      17 Everest Securities, Inc., supra note 5 at 963.

      18 Hanly at 596, supra note 5.

      19 Note to Rule 502(b)(1).

      20 FINRA has previously discussed the responsibilities of a BD to conduct a reasonable investigation of securities it is recommending. See, e.g., Notice to Members 03-71 (concerning non-conventional investments)(November 2003); Notice to Members 05-18 (concerning private placements of tenants-in-common interests) (March 2005).

      21 F.J. Kaufman & Co., 50 S.E.C. 164, 168–69 (Dec. 13, 1989). See also In the Matter of Michael Frederick Siegel, Securities Exchange Act Release No. 58737 (October 6, 2008), 2008 SEC Lexis 2459, at *28.

      22 See James B. Chase, 56 S.E.C. 149, 159 (2003).

      23 BDs should analyze whether the investor's money is likely to be applied according to the stated use of proceeds, and whether the stated use of proceeds is reasonable in light of the issuer's business purpose and prospects. See In Re Brian Prendergast, 2001 SEC LEXIS 1533 (August 1, 2001); Legend Merchant Group, Inc., NASD No. C10030058, summarized in NASD Disciplinary Actions (July 2004); Shelman Securities, Inc., NASD No. C06030013, summarized in NASD Disciplinary Actions (February 2004).

      24 See, e.g., Shelman Securities, supra note 23 (private placement memoranda contained material misrepresentations and omissions about use of proceeds in a previous offering).

      25 See In the Matter of C. Gilman Johnston, 42 S.E.C. 217 (Aug. 14, 1964) (broker-dealer's control person prepared memorandum describing broker-dealer's own "highly speculative" securities without any reasonable basis for believing that the securities were suitable for some purchasers). See generally Pacific Cornerstone Capital, supra note 3 at 10 (person providing information for and reviewing and approving private placement memorandum and sales literature was BD's control person and issuer's founder). Regulation D generally prohibits a broker or other person that is affiliated with the issuer from serving as a purchaser representative to an investor. See Rule 501(h)(1)(definition of "purchaser representative").

      26 Cf. FINRA Rule 5122 (requiring members to comply with certain requirements when engaging in private placement of securities issued by the member or a control entity).

      27 SEC v. Kunz and Cline Investment Management, Inc. Admin. Proc. File No. 3-9960, aff'd 2003 U.S. App. LEXIS 6011 (10th Cir. 2003) (unpublished opinion).

      28 Pacific Cornerstone Capital, Inc., supra note 3.

      29 Everest Securities, Inc. v. SEC, supra note 5 at 1239 (finding "the investigation that was performed was itself insufficient," and even a cursory investigation would have uncovered facts showing offering memorandum was materially misleading).

      30 Kunz and Cline, supra note 27.

      31 See Notice to Members 05-48 (Members' Responsibilities When Outsourcing Activities to Third-Party Service Providers) (July 2005) (discussing a member's accountability and supervisory responsibility for outsourced functions).

      32 Pacific Cornerstone Capital, Inc., supra note 3 at 9.

    • 10-21 SEC Approval and Effective Date for New Consolidated FINRA Rules and the Repeal of Certain NASD and Incorporated NYSE Rules; Effective Date: June 14, 2010

      View PDF

      SEC Approves New Consolidated FINRA Rules

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      Rule Approval
      Referenced Rules & Notices

      FINRA Rule 2261
      FINRA Rule 3160
      FINRA Rule 3240
      Information Notice 03/12/08
      Information Notice 10/06/08
      Regulatory Notice 08-57
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Borrowing From or Lending to Customers
      Disclosure of Financial Condition
      Networking Arrangements

      Executive Summary

      Following the consolidation of NASD and the member regulation, enforcement and arbitration functions of NYSE Regulation into FINRA, FINRA established a process to develop a new consolidated rulebook (Consolidated FINRA Rulebook), which FINRA has discussed in previous Information Notices.1 FINRA is proposing new consolidated rules in phases for approval by the SEC as part of the Consolidated FINRA Rulebook.2

      In February and March 2010, the SEC approved six rule filings relating to the Consolidated FINRA Rulebook. The effective date for all of the proposed rule changes is June 14, 2010.

      Questions regarding this Notice should be directed to:

      •   Afshin Atabaki, Assistant General Counsel, Office of General Counsel (OGC), at (202) 728-8902 (regarding FINRA Rule 3240);
      •   Kosha Dalal, Associate Vice President, OGC, at (202) 728-6903 (regarding the repeal of Incorporated NYSE Rule 405(4));
      •   Erika L. Lazar, Counsel, OGC, at (202) 728-8013 (regarding FINRA Rule 3160 and the repeal of NASD Rules 2760 and 2780, Incorporated NYSE Rules 2B and 411, and the Interpretation to Incorporated NYSE Rule 411(a)(ii)(5));
      •   Stan Macel, Assistant General Counsel, OGC, at (202) 728-8056 (regarding the repeal of NASD Rule 2450, NASD IM-2830-2 and Incorporated NYSE Rule 413); or
      •   Racquel Russell, Assistant General Counsel, OGC, at (202) 728-8363 (regarding FINRA Rule 2261).

      Discussion

      In February and March 2010, the SEC approved the following three FINRA rules for adoption as part of the Consolidated FINRA Rulebook:

      •   Rule 2261 (Disclosure of Financial Condition);3
      •   Rule 3160 (Networking Arrangements Between Members and Financial Institutions);4 and
      •   Rule 3240 (Borrowing From or Lending to Customers).5

      The attachment to this Notice sets forth additional information regarding these new consolidated rules and includes a hyperlink to the related rule filings. The filings provide, among other things, FINRA's statement of the purpose of the rule changes and an exhibit showing the changes between the new rule text and the text of the NASD and/or Incorporated NYSE Rules as they exist in the Transitional Rulebook. Also, the text of each new FINRA Rule is available in the online FINRA Manual at www.finra.org/finramanual.6

      The attachment to this Notice further summarizes three additional rule filings relating to the Consolidated FINRA Rulebook approved by the SEC in February and March 2010. The rule filings address FINRA's repeal of: (1) NASD Rules 2760 and 2780, Incorporated NYSE Rules 2B and 411, and the Interpretation to Incorporated NYSE Rule 411(a)(ii)(5));7 (2) NASD Rule 2450, NASD IM-2830-2 and Incorporated NYSE Rule 413;8 and (3) Incorporated NYSE Rule 405(4).9

      Rule Conversion Charts

      As discussed in additional detail in Information Notice 10/06/08 and Regulatory Notice 08-57, FINRA has posted three Rule Conversion Charts on its Web site to help firms become familiar with the new rules and show how the new rules relate to the NASD and/or Incorporated NYSE Rules in the Transitional Rulebook that they will replace.

      Firms should be aware that the charts are intended as a reference aid only. FINRA reminds firms that the charts do not in any way serve as a substitute for diligent review of the relevant new rule language. The Rule Conversion Charts are located at www.finra.org/ruleconversionchart.


      1 See Information Notice 10/06/08 (Rulebook Consolidation Process: Effective Dates of New Consolidated Rules; Introduction of Rule Conversion Chart); see also Information Notice 03/12/08 (Rulebook Consolidation Process).

      2 The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The new FINRA Rules apply to all member firms, unless such rules have a more limited application by their terms. As the Consolidated FINRA Rulebook expands with the SEC's approval and with the new FINRA Rules taking effect, the rules in the Transitional Rulebook that address the same subject matter of regulation will be eliminated. When the Consolidated FINRA Rulebook is completed, the Transitional Rulebook will have been eliminated in its entirety.

      3 See Exchange Act Release No. 61540 (February 18, 2010), 75 FR 8778 (February 25, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-081).

      4 See Exchange Act Release No. 61706 (March 15, 2010), 75 FR 13632 (March 22, 2010) (Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1; File No. SR-FINRA-2009-047).

      5 See Exchange Act Release No. 61537 (February 18, 2010), 75 FR 8772 (February 25, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-095).

      6 FINRA updates the rule text on its online Manual within two business days of SEC approval of changes to the rule text.

      7 See Exchange Act Release No. 61473 (February 2, 2010), 75 FR 6422 (February 9, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-087).

      8 See Exchange Act Release No. 61542 (February 18, 2010), 75 FR 8768 (February 25, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-093).

      9 See Exchange Act Release No. 61808 (March 31, 2010), 75 FR 17456 (April 6, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2010-005).


      ATTACHMENT A

      List of Approved Rules (and Related Rule Filings)

      In February and March 2010, the SEC approved new FINRA Rules 2261, 3160 and 3240 and the repeal of NASD Rules 2450, 2760 and 2780, NASD IM-2830-2, Incorporated NYSE Rules 2B, 405(4), 413 and 411, and the Interpretation to Incorporated NYSE Rule 411(a)(ii)(5). The effective date for the new FINRA rules and the repeal of the NASD and Incorporated NYSE rules is June 14, 2010. The hyperlinks to the rule filings are included.

      FINRA Rule Filing SR-FINRA-2009-081

      www.finra.org/Industry/Regulation/RuleFilings/2009/P120399

      FINRA Rule 2261

      The rule change combines NASD Rule 2270 (Disclosure of Financial Condition to Customers) and NASD Rule 2910 (Disclosure of Financial Condition to Other Members), with certain modifications, into new FINRA Rule 2261 (Disclosure of Financial Condition). FINRA Rule 2261 sets forth members' obligations regarding making available to customers and other members information contained in a member's most recent balance sheet. Specifically, FINRA Rule 2261 provides that a member must make available to inspection by any bona fide regular customer, upon request, the information relative to such member's financial condition as disclosed in its most recent balance sheet prepared either in accordance with such member's usual practice or as required by any state or federal securities laws, or any rule or regulation thereunder.

      FINRA Rule 2261 also permits a member to deliver the balance sheet to the requesting customer in paper or electronic form in lieu of making such balance sheet available to inspection, provided that, with respect to electronic delivery, the customer has consented to receive the balance sheet in electronic form. Rule 2261 defines the term "customer" as any person who, in the regular course of such member's business, has cash or securities in the possession of such member.

      Additionally, FINRA Rule 2261 requires that any member who is party to an open transaction (or who has on deposit cash or securities of another member) deliver upon written request by the other member, in paper or electronic form, a statement of its financial condition as disclosed in its most recent balance sheet prepared either in accordance with such member's usual practice or as required by any state or federal securities laws, or any rule or regulation thereunder. Consent of the other member is not required to permit electronic delivery of the balance sheet.

      Rule/Series No. Rule Title
      Rule 2000 Series DUTIES AND CONFLICTS
      Rule 2200 Series COMMUNICATIONS AND DISCLOSURES
      Rule 2260 Series Disclosures
      Rule 2261 Disclosure of Financial Condition

      FINRA Rule Filing SR-FINRA-2009-047

      www.finra.org/Industry/Regulation/RuleFilings/2009/P119402

      FINRA Rule 3160

      The rule change adopts NASD Rule 2350 into the Consolidated FINRA Rulebook as FINRA Rule 3160 (Networking Arrangements Between Members and Financial Institutions), subject to certain changes to streamline the rule and to reflect applicable provisions of the Gramm-Leach-Bliley Act (GLB) and Regulation R. The rule change conforms the scope of FINRA Rule 3160 to the networking exception in GLB. With the exception of those requirements addressing the physical setting, FINRA Rule 3160 applies to a member that is a party to a networking arrangement with a financial institution under which the member offers broker-dealer services, regardless of whether the member is conducting broker-dealer services on or off the premises of a financial institution. Additionally, the rule change aligns the setting provision in FINRA Rule 3160 with GLB and its associated rules in Regulation R. It also clarifies that a member's networking agreement must include all broker-dealer obligations, as applicable, in Regulation R Rule 701 and that, independent of its contractual obligations, the member must comply with all such broker-dealer obligations.

      FINRA Rule 3160 requires that a member that is a party to a networking arrangement with a financial institution provide certain written disclosures, at or prior to the opening of a customer account, including that securities products are: (1) not FDIC insured; (2) not deposits or other obligations of the financial institution and are not guaranteed by the financial institution; and (3) subject to investment risk, including possible loss of the principal invested (the "disclosures"). FINRA Rule 3160 also requires that such a member make the disclosures orally at or prior to the time that a customer account is opened if the account is opened on the premises of a financial institution. In addition, FINRA Rule 3160 expands the disclosure requirements with respect to a member's advertisements and sales literature so a member must include the disclosures on any advertisements and sales literature that: (1) announce the location of a financial institution where broker-dealer services are provided by the member; (2) are distributed by the member on the premises of a financial institution; (3) promote the name or services of the financial institution; or (4) are distributed by the member at any other location where the financial institution is present or represented.

      Rule/Series No. Rule Title
      Rule 3000 Series SUPERVISION AND RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS
      Rule 3100 Series SUPERVISORY RESPONSIBILITIES
      Rule 3160 Networking Arrangements Between Members and Financial Institutions

      FINRA Rule Filing SR-FINRA-2009-095

      www.finra.org/Industry/Regulation/RuleFilings/2009/P120660

      FINRA Rule 3240

      The rule change adopts NASD Rule 2370 (Borrowing From or Lending to Customers), with several changes, into the Consolidated FINRA Rulebook as FINRA Rule 3240 (Borrowing From or Lending to Customers). FINRA Rule 3240 prohibits registered persons from borrowing money from or lending money to their customers unless the firm has written procedures allowing such lending arrangements and: (1) the customer is a member of the registered person's immediate family; (2) the customer is in the business of lending money; (3) the customer and the registered person are both registered persons of the same firm; (4) the lending arrangement is based on a personal relationship outside of the broker-customer relationship; or (5) the lending arrangement is based on a business relationship outside of the broker-customer relationship. Additionally, with the exception of lending arrangements between immediate family members and lending arrangements between registered persons and customers in the business of lending money, firms are required to pre-approve in writing the other lending arrangements described above.

      The rule change amends the provision regarding permissible lending arrangements between registered persons and customers in the business of lending money to indicate more explicitly that such customers must be acting in the course of such business. Further, the rule change requires expressly that registered persons notify their member firms of the lending arrangements that require pre-approval and clarifies that any modifications to such lending arrangements (including any extension of the duration of such arrangements) are also subject to notification and pre-approval. The rule change also requires that firms preserve the written pre-approval required by the rule for at least three years after the date that the lending arrangement has terminated or for at least three years after the registered person's association with the firm has terminated.

      Rule/Series No. Rule Title
      Rule 3000 Series SUPERVISION AND RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS
      Rule 3200 Series RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS
      Rule 3240 Borrowing From or Lending to Customers

      FINRA Rule Filing SR-FINRA-2009-087

      www.finra.org/Industry/Regulation/RuleFilings/2009/P120494

      The rule change repeals NASD Rule 2760 (Offerings "At the Market") and NASD Rule 2780 (Solicitation of Purchases on an Exchange to Facilitate a Distribution of Securities) to reduce confusion and regulatory overlap. NASD Rule 2760 is similar to Exchange Act Rule 15c1-8, which FINRA believes appropriately protects investors without duplication by NASD Rule 2760. NASD Rule 2780 duplicates Exchange Act Rule 10b-2, which was rescinded by the SEC in 1993 because it was duplicative of other provisions of the federal securities laws, including SEC Regulation M. Therefore, FINRA believes NASD Rule 2780 should be deleted. The rule change also repeals Incorporated NYSE Rule 2B (No Affiliation between Exchange and any Member Organization), Incorporated NYSE Rule 411 (Erroneous Reports), and the Interpretation to Incorporated NYSE Rule 411(a)(ii)(5)1 because such rules and interpretation relate to activity that concerns solely the NYSE marketplace and, in the case of Rule 411(b)(2), is duplicative of existing SEC recordkeeping requirements.

      FINRA Rule Filing SR-FINRA-2009-093

      www.finra.org/Industry/Regulation/RuleFilings/2009/P120633

      The rule change repeals NASD Rule 2450 (Installment or Partial Sales), NASD IM-2830-2 (Maintaining the Public Offering Price) and Incorporated NYSE Rule 413 (Uniform Forms) to eliminate duplicative and unnecessary rules and remove outdated provisions from FINRA's rulebook.

      The requirements of NASD Rule 2450 are no longer necessary in light of the explicit provisions in Regulation T requiring the deposit of sufficient funds within the specified payment period. In addition, the hypothecation prohibition in NASD Rule 2450 is no longer relevant because it is predicated on a partial or installment payment under the rule. NASD IM-2830-2 is no longer relevant since today virtually all broker-dealers doing business with the public are FINRA members. In addition, NASD IM-2830-2 duplicates the requirement in Investment Company Act Section 22(d) to sell mutual fund shares to investors at the current public offering price. Incorporated NYSE Rule 413 is duplicative of several provisions in the FINRA By-Laws by which FINRA may prescribe processes for members' activities, including the use of uniform forms.

      FINRA Rule Filing SR-FINRA-2010-005

      www.finra.org/Industry/Regulation/RuleFilings/2010/P120754

      The rule change repeals Incorporated NYSE Rule 405(4) (Common Sales Accounts) because it contains terms that are not clearly defined and may raise potential investor protection concerns. Incorporated NYSE Rule 405(4) permits a member to effect sales of securities for customers without expressly requiring prior customer consent and without the need to send periodic account statements to the customer. FINRA notes that in the event a member may seek permission not to send customer account statements under certain limited circumstances, proposed FINRA Rule 2231 which relates to customer account statements, would authorize FINRA to exempt members from the provisions of such rule, including the requirement to deliver periodic account statements, pursuant to the Rule 9600 Series.


      1 Although this Interpretation relates to NYSE Rule 411(a)(ii)(5), it appears in the Transitional Rulebook and in NYSE's Rulebook under the Interpretation to NYSE Rule 410.

    • 10-20 Securities Industry/Regulatory Council on Continuing Education Issues Firm Element Advisory Update

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      Continuing Education

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

      Compliance
      Continuing Education
      Legal
      Registration
      Senior Management
      Key Topics

      Continuing Education
      Firm Element
       

      The Securities Industry/Regulatory Council on Continuing Education (Council) has released its Spring 2010 Firm Element Advisory (FEA). The Council produces the FEA to identify regulatory and sales practice topics that firms should consider in their Firm Element training plans. Topics updated or added since the prior FEA are indicated in the document as such.

      The updated FEA is available at www.cecouncil.com/publications/council_publications/FEA_Semi_Annual_Update.pdf.

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

      In addition to the FEA, the Council offers the Firm Element Content Builder (formerly the Firm Element Organizer), a Web-based tool that can assist firms in developing their Firm Element training plans. It enables users to search an extensive database of regulatory resources related to specific investment products or services and is available at www.cecouncil.com/firm_element/organizer.

      Questions concerning this Notice should be directed to:

      •   Roni Meikle, Director, Continuing Education, FINRA, at (646) 315-8688.

    • 10-19 FINRA Reminds Firms of Responsibilities When Providing Customers with Consolidated Financial Account Reports

      View PDF

      Consolidated Reports

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NASD Rule 2210
      NASD Rule 2340
      NASD Rule 3010
      NASD Rule 3012
      NYSE Rule 342
      NYSE Rule 409
      Regulatory Notice 08-27
      NTM 05-48
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Systems
      Training
      Key Topics

      Account Statements
      Communications with the Public
      Correspondence
      Internal Controls
      Supervision
      Supervisory Controls Systems


      Executive Summary

      The practice of providing customers with consolidated financial account reporting has become increasingly common in the financial services industry. In many cases, these reports offer a single document that combines information regarding most or all of the customer's financial holdings, regardless of where those assets are held. Firms are reminded that these reports represent communications with the public by the firm; the dissemination of these reports must comply with all applicable FINRA rules as well as the federal securities laws.

      As investor demand for this service has grown and as increasingly sophisticated software and data service providers have become available, firms have developed differing practices for generating these communications. If not rigorously supervised, this activity can raise a number of regulatory concerns, including the potential for communicating inaccurate, confusing or misleading information to customers, lapses in supervisory controls, and the use of these reports for fraudulent or unethical purposes.

      This Notice reminds firms of their responsibilities to ensure that they comply with all applicable rules when engaging in this activity, and highlights a number of sound practices. Firms are strongly encouraged to review the overall adequacy and effectiveness of their current policies and procedures relating to their consolidated reporting. Any firm that cannot properly supervise the dissemination of consolidated reports by its registered representatives must prohibit the dissemination of those reports and take the necessary steps to ensure that its registered representatives comply with this prohibition.

      General questions about this Notice should be directed to:

      •   Steve Kasprzak, Associate Director & Principal Counsel, Sales Practice Policy, Member Regulation, at (646) 315-8603; or
      •   Bill Hayden, Director, Emerging Regulatory Issues, at (202) 728-8860.

      For questions about communications with the public, contact Amy Sochard, Director, Programs & Investigations, Advertising Regulation, at (240) 386-4508.

      Discussion and Background

      Many firms, as a service to their customers, provide documents that consolidate information regarding a customer's various financial holdings.1 For the purpose of this Notice we will refer to this practice and document as "consolidated reporting" and "consolidated reports," respectively. These consolidated reports offer a broad view of customers' investments, may include assets held away from the firm, and may provide not only account balances and valuations, but performance data as well. In many cases these consolidated reports are prepared at the request of the customer, who may also direct which of his or her accounts to include and provide access to data for non-held accounts. These communications may supplement, but do not replace, the customer account statement required pursuant to NASD Rule 2340 and NYSE Rule 409,2 which is prepared and disseminated to the customer through a separate process. Consolidated reports may not be represented as a substitute for, and must be distinguished from, account statements that are required by rule.

      Firms create consolidated reports through fully integrated, in-house data gathering and reporting systems, fully outsourced solutions from third-party vendors,3 "off-the-shelf" software applications or a combination of these methods. Firms also disseminate these consolidated reports through a variety of means, such as direct mailing to customers, providing access to secure servers via the Internet and hand delivery during face-to-face meetings. The consolidated reports themselves may contain a variety of information and may be produced as a highly customized document created by an individual representative, or as a standardized report created by a firm system. To the extent individual representatives create consolidated reports, firms are required to supervise this activity, and both the firm and the individual representatives are responsible for compliance with all applicable rules.

      Consolidated reports are communications with the public. Therefore, they must be clear, accurate and not misleading.4 For assets held at the firm, this includes providing information, including valuations, that is consistent with the customer's official account statement.5 For assets held away, this includes, among other things, taking reasonable steps to accurately reproduce information obtained regarding outside accounts and not to include information that is false or misleading.

      Consolidated reports, particularly those published on firm letterhead, can create a misconception that the firm produced or verified all of the data, including the valuation of assets held away. Therefore, these reports should be constructed and provided in such a manner that neither customers nor third parties with whom the customer interacts (e.g., banks, mortgage companies, other broker-dealers) are likely to be confused or misled as to the nature of the information presented, or mistake these documents for official account statements regarding the reported assets. The reports should clearly delineate between information regarding assets held on behalf of the customer, which are included on the firm's books and records, and other external accounts or assets.

      If a firm is unable to test or otherwise validate data for non-held assets, including valuation information, the firm should clearly and prominently disclose that the information provided for those assets is unverified. In addition, to the extent a consolidated report contains information regarding financial products that are outside a registered representative's area of proficiency, representatives must discuss and present these financial products in a manner that does not mislead customers as to the scope of the representative's financial expertise.6

      Consolidated reports are also subject to the regulatory requirements regarding supervision and internal controls, records retention, privacy and safeguarding of customer information.7 Effective firm controls would include procedures to vet and approve consolidated report templates for compliance with regulatory requirements before they are put into production. These reviews can help ensure that any new consolidated report-generating process complies with regulatory requirements and firm policies, and that it is integrated into the firm's supervisory control program. Similar controls should be put in place for any programming that permits customization, as well as any subsequent changes to the approved templates or programming.

      The risks associated with a firm's failure to maintain adequate safeguards over the use and dissemination of customer account information are well established. Beyond the obvious concern regarding the use of account information for fraudulent activity, even well-intentioned but incautious consolidated reporting could result in customers being misled or confused. Given the reliance that customers may place on consolidated reports and the potential consequences if these communications contain mistakes or are misused by firm personnel, firms must review their consolidated reporting programs with particular care. The more complex a firm's program for consolidated reporting, the more difficult it may be to conform that reporting to applicable rule requirements. Factors that contribute to program complexity include:

      •   the production within a firm of a large number of varying types of consolidated reports, especially consolidated reports that are highly customizable;
      •   reporting on a wide variety of asset classes, especially assets held outside the firm; and
      •   a decentralized consolidated reporting structure employing multiple reporting systems.8

      If a firm provides this service to customers, it must ensure that the size and complexity of the consolidated reporting program does not exceed the firm's ability to supervise the activity and to subject it to a rigorous system of internal controls. Any firm that cannot properly supervise the dissemination of consolidated reports by its registered representatives must prohibit the dissemination of those reports and take necessary steps to ensure that its registered representatives comply with this prohibition.

      Sound Practices

      FINRA encourages firms to consider the practices described below when reviewing their consolidated reporting programs. This Notice is not intended to be a comprehensive roadmap for compliance and supervision; rather, it outlines measures that may assist firms in complying with their various supervisory obligations. Firms should consider these practices in assessing their own procedures and in implementing improvements that will best protect their customers. Firms must adopt procedures and controls that are most effective given the firm's size, structure and operations.

      1. Ongoing audits and reviews

      Due to the potential risks related to consolidated reporting, some firms have incorporated a review of the consolidated reporting process as a standard element in their testing and oversight programs. These firms test for regulatory compliance, data accuracy and adherence to supervisory procedures in audits, branch office reviews and as an ongoing part of their program of internal inspections required by NASD Rule 3010. Some firms require branch offices that produce consolidated reports to obtain an annual third-party audit of the process.
      2. Centralize reporting systems

      Maintaining multiple consolidated reporting systems can create a patchwork of processes and applications that may be difficult to adequately supervise. Some firms have chosen to centralize their consolidated reporting programs by requiring use of a single firm-wide system. Other firms that allow multiple report-producing systems, subject them to a centralized review and approval process. Participants in this review and approval process may include personnel from information technology, compliance and legal departments.
      3. Customer addresses

      Some of the stronger programs require that all consolidated reports be mailed centrally using the customer's address of record,9 and have processes in place that reconcile address information used for account statements and consolidated reports. In the limited circumstances where different addresses are used to deliver customer account statements and consolidated reports, firms should maintain documentation explaining the discrepancy and indicating that the customer was provided notice or acknowledged the differing addresses.10
      4. Assets held away

      Some firms verify, when possible, information pertaining to assets held away. Some of these firms have opted not to include assets in the consolidated report when the firm cannot verify their existence or cannot validate the valuations.
      5. Supporting documentation

      Some firms maintain supporting documentation for reported assets with the customer file, or otherwise have it available to be reviewed alongside the consolidated report. This documentation may include information regarding source of data and methods used to determine accuracy and asset valuation. The information may be useful in discussing the consolidated reports with customers, in validating the accuracy of consolidated report-generating systems and for internal control/audit testing purposes.
      6. Source documents

      It is sound practice to encourage customers to review and maintain the original source documents that are integrated into the consolidated report, such as the statements for individual accounts held away from the broker-dealer. Customers may be tempted to disregard these source documents because of the convenience of the consolidated report. However, source documents may contain notices, disclosures and other information important to the customer, and may also serve as a reference should questions arise regarding the accuracy of the information in the consolidated report.
      7. Report design

      The design and formatting of consolidated reports is important for ensuring information is clearly communicated. In addition to the requirements outlined above, firms are encouraged to include, when applicable, the following disclosures:11
      •   that the consolidated report is provided for informational purposes and as a courtesy to the customer, and may include assets that the firm does not hold on behalf of the customer and which are not included on the firm's books and records;
      •   the names of the entities providing the source data or holding the assets, their relationship with each other (e.g., parent, subsidiary or affiliated organization) and their respective functions (introducing/carrying brokerage firms, fund distributor, banking/insurance product providers, etc.);
      •   a statement clearly distinguishing between assets held or categories of assets held by each entity included in the consolidated report;
      •   the customer's account number and contact information for customer service at each entity included in the consolidated report;
      •   identify that assets held away may not be covered by SIPC12; and
      •   if the consolidated report provides aggregate values for several different assets, an explanation of how the aggregated values of the different types of assets were arithmetically derived from separate asset totals.
      8. Disclosures and attestations

      To help ensure that a customer is apprised of the nature of the consolidated reporting process, and to ensure delivery of any disclosures or other pertinent information, firms may consider obtaining the customer's signed acknowledgement that he or she has been provided with the relevant disclosures and understands the nature and limitations of the consolidated reporting process. These disclosures may, for example, be included with applicable communications regarding privacy protections. Firms should consider a means to refresh this notice on a periodic basis.

      1 This reporting is most commonly issued by firms that maintain an affiliated investment adviser or by registered representatives who also provide investment advisory services to their customers.

      2 The FINRA rulebook currently consists of: (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and the Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA member firms, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice 3/12/08 (Rulebook Consolidation Process). For convenience, the Incorporated NYSE Rules are referred to as the NYSE Rules.

      3 Vendors include Web-based application service providers (ASPs) that aggregate financial data and create reports to firm specifications that may be mailed to customers or, if the firm desires, can be accessed on a read-only basis from the ASP's Web server. To the extent that firms rely on third-party vendors, firms are responsible for complying with applicable requirements regarding outsourcing, as discussed in Notice to Members 05-48. The Notice clarifies firm responsibilities when outsourcing "covered activities," which the Notice identifies as activities or functions that, if performed directly by firms, would be required to be the subject of a supervisory system and written supervisory procedures pursuant to NASD Rule 3010.

      4 Depending on the form, content and method of dissemination, these consolidated reports may be considered sales literature or correspondence. As such, they may be subject to various requirements outlined in NASD Rules 2210 and 2211 and associated guidance, such as the requirement for clear and prominent display of the firm's name on communications and disclosures related to use of performance information.

      5 Inaccuracies may include discrepancies associated with having consolidated reports and customer account statements produced through separate systems or by different entities. For example, firms have reported finding numerous instances in which the same in-house transaction was reflected differently in each document, thereby requiring a correction before publication or dissemination.

      6 NASD Rule 2210(d)(1)(A). See also Regulatory Notice 08-27 (May 2008) (Misleading Communications About Expertise).

      7 The better information security programs routinely test controls over access to systems and data related to the reporting process as part of the firm's internal controls regime. Access controls must be rigorously supervised to avoid unauthorized use or manipulation of customer account data.

      8 These multi-system situations often arise when a firm affiliates with or acquires a new group of representatives or branch offices that bring with them legacy systems. In some instances, a reporting system may be unique to a single branch office, even to the extent that a single branch may maintain a separate contractual relationship with a third-party vendor to provide these services.

      9 Firms are required to have procedures to review, monitor and validate customer changes of address. These policies and procedures must include "a means or method of customer confirmation, notification, or follow-up that can be documented." NASD Rule 3012(a)(2)(B) and NYSE Rule 401.

      10 This is consistent with NYSE Rule 409(b) and FINRA's proposed rule change to adopt NASD Rule 2340 (Customer Account Statements) as FINRA Rule 2231. Proposed Supplementary Material .01 (Transmission of Customer Account Statements to Other Persons or Entities) would expressly require a firm to obtain written instructions from the customer in order to send/deliver customer statements, confirmations or other communications to other persons or entities. See Securities Exchange Act Release No. 59921 (May 14, 2009), 74 FR 23912 (May 21, 2009).

      11 These elements are drawn from existing guidance relating to multi-account reporting practices for customer account statements in NYSE Rule Interpretations 409(a)/04 (Assets Externally Held and Included on Statements Solely as a Service to Customers) and (a)/06 (Use of Summary Statements) and are consistent with FINRA's proposed rule change to adopt NASD Rule 2340 (Customer Account Statements) as FINRA Rule 2231. The multi-account reporting guidance in proposed FINRA Rule 2231, Proposed Supplementary Material .04 (Assets Externally Held and Included on Statements Solely as a Service to Customers) and Proposed Supplementary Material .06 (Use of Summary Statements) are substantially unchanged from existing NYSE Rule Interpretations 409(a)/4 and 409(a)/6. See Securities Exchange Act Release No. 59921 (May 14, 2009), 74 FR 23912 (May 21, 2009).

      12 Firms should consider including a disclosure clarifying that their firm's SIPC coverage would only apply to those assets held at the firm, and to the extent some of the other reported entities may be SIPC members, customers should contact their financial representative or the other entity or refer to the other entity's statement regarding SIPC membership.

    • 10-18 FINRA Issues Guidance on Master and Sub-Account Arrangements

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      Master Accounts and Sub-Accounts

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

      Compliance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      Master/Sub-Accounts
       

      Executive Summary

      FINRA reminds firms that maintain master/sub-account arrangements that, depending on the facts and circumstances of such arrangements, a firm may be required to recognize the sub-accounts as separate customer accounts for the purposes of applying FINRA rules, the federal securities laws and other applicable federal laws.1

      Questions concerning this Notice should be directed to:

      •   Kris Dailey, Vice President, Risk Oversight & Operational Regulation, at (646) 315-8434;
      •   Glen Garofalo, Director, Credit Regulation, at (646) 315-8464; or
      •   Kathryn M. Moore, Assistant General Counsel, Office of General Counsel, at (202) 974-2974.

      Background & Discussion

      The application of many FINRA rules, federal securities laws and other applicable federal laws depends on the nature of the account and the identity of its beneficial owners. At times, an account may take the form of a master/sub-account arrangement where the beneficial ownership interests in the various sub-accounts may or may not be identified to the firm. FINRA recognizes there are bona fide reasons to establish master/sub-account arrangements whereby the same beneficial owner maintains multiple sub-accounts (for example, to employ different trading strategies or to trade in different asset classes). However, certain master/sub-account arrangements raise questions regarding whether the master account and all sub-accounts have the same beneficial owner and, therefore, whether they can legitimately be viewed as one customer account for purposes of FINRA rules, the federal securities laws and other applicable federal laws.

      In some instances, an investment adviser or introducing firm may establish a master account that maintains multiple sub-accounts that differentiate and identify the beneficial ownership of each sub-account. In such instances, the firm knows the identity of each beneficial owner of the sub-accounts and must recognize such sub-accounts as separate customer accounts for purposes of applying FINRA rules, the federal securities laws and other applicable federal laws.

      However, there are other legitimate business arrangements where the identities of the beneficial owners are not disclosed to the firm. For example, FINRA recognizes that an "investment adviser" as defined by the Investment Advisers Act of 1940 and acting in such bona fide capacity (referred to as a "bona fide IA"), may employ sub-accounts for each account it advises without identifying the beneficial owner of each account for which it advises. Similarly, in omnibus clearing arrangements, a broker-dealer that is registered with the Securities and Exchange Commission (SEC) pursuant to the Securities Exchange Act of 1934 (referred to as a "registered IBD") may procure clearing services for the customer accounts it services on a basis in which the identities of the sub-account owners are not disclosed to the clearing broker-dealer. In these limited cases involving a bona fide IA or a registered IBD, FINRA generally will permit a firm to rely upon the information provided to it by the bona fide IA or the registered IBD as to whether to treat a master/sub-account as having a single beneficial owner.

      Apart from the general principles outlined above, if a firm has actual notice that the sub-accounts of a master account have different beneficial ownership (but does not know the identities of the beneficial owners) or the firm is privy to facts and/or circumstances that would reasonably raise the issue as to whether the sub-accounts, in fact, may have separate beneficial owners (and therefore is on "inquiry notice"), then the firm must inquire further and satisfy itself as to the beneficial ownership of each such sub-account. A firm would be on inquiry notice if, for example:

      1. the sub-accounts are separately documented and/or receive separate reports from the firm;
      2. the firm addresses the sub-accounts separately in terms of transaction, tax or other reporting;
      3. the services provided to the sub-accounts engender separate surveillance and supervision of the sub-account for compliance with rules or for risk management purposes consistent with the review of separately owned accounts;
      4. the firm has financial arrangements or transactions with the sub-accounts, or separate account terms, that reasonably raise questions concerning whether such accounts represent separate beneficial owners;
      5. the sub-accounts incur charges for commissions, clearance and similar expenses, separately, based upon the activity only of that subject sub-account;
      6. the firm has evidence of financial transactions or transfers of assets or cash balances that would reasonably evidence separate beneficial ownership of the sub-accounts;
      7. the firm is aware of or has access to a master account or like agreement that evidences that the sub-accounts have different beneficial owners;
      8. the firm has evidence that a party maintaining a master/sub-account arrangement has interposed sub-accounts that have or are intended to have the effect of hiding the beneficial ownership interest; or
      9. the number of sub-accounts maintained is so numerous as to reasonably raise questions concerning whether such accounts represent separate beneficial owners.
      10. Items 3, 4, 5, 6, 8 and 9 above would not apply in the case of a registered IBD or a bona fide IA arrangement described in this Notice.

      This list is not exhaustive and is only included to reflect some types of "red flags" that would put a firm on inquiry notice that the sub-accounts may have separate beneficial owners.

      When a firm becomes aware of the identities of the beneficial owners of the sub-accounts pursuant to its duties arising from actual notice or inquiry notice outlined above, the firm will be required to recognize the sub-accounts as separate customer accounts for purposes of applying FINRA rules, the federal securities laws and other applicable federal laws.


      1 For purposes of this Notice, reference to the term "laws" shall include any rules and regulations that apply in furtherance of those provisions.

    • 10-17 Amendments to the Arbitration Rules on Hearing Locations; Effective Date: May 3, 2010

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      Hearing Locations

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      Rule 12213(a)
      Rule 13213(a)
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topic(s)

      Arbitration
      Code of Arbitration Procedure
      Hearing Location

      Executive Summary

      Effective May 3, 2010, amendments to the Codes of Arbitration Procedure for Customer and Industry Disputes expand the criteria for selecting a hearing location for an arbitration proceeding.1

      The text of the amendments to the rules is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Kenneth L. Andrichik, Senior Vice President, Chief Counsel and Director of Mediation and Strategy, Dispute Resolution (DR), at (212) 858-3915 or ken.andrichik@finra.org; or
      •   Mignon McLemore, Assistant Chief Counsel, DR, at (202) 728-8151 or mignon.mclemore@finra.org.

      Background and Discussion

      Hearing Location Criteria Under the Customer Code

      Currently, Rule 12213(a) of the Code of Arbitration Procedure for Customer Disputes (Customer Code) states that generally, the Director of FINRA Dispute Resolution (Director) will select the hearing location closest to the customer's residence at the time of the events giving rise to the dispute. For example, if a customer in an arbitration proceeding lives in Hoboken, New Jersey, the Director will select the New York City hearing location, because this hearing location is closer to the customer's residence2 than the FINRA hearing location in Newark, New Jersey.

      FINRA amended Rule 12213(a) to expand the criteria for selecting a hearing location. Specifically, the rule now states that the Director will select the hearing location closest to the customer's residence at the time of the events giving rise to the dispute, unless the hearing location closest to the customer's residence is in a different state. In that case, the customer may request a hearing location in the state where the customer resided at the time of the events giving rise to the dispute. Applying the amended rule to the example above, if the customer requests the Newark, New Jersey, hearing location, the Director generally will grant the request, even though the closest hearing location to the customer's residence is the New York City location.

      Under the rule, the Director will continue to select the hearing location closest to the customer's residence at the time of the events giving rise to the dispute. However, the Director will grant a customer's request for a different hearing location in the customer's state of residence, if the customer makes the request before the arbitrator or arbitrators are selected. After the arbitration panel is appointed, the customer must submit to the panel any request to change the hearing location.

      Hearing Location Criteria Under the Industry Code

      Rule 13213(a) of the Code of Arbitration Procedure for Industry Disputes (Industry Code) currently states, in relevant part, that in cases involving an associated person, the Director will generally select the hearing location closest to where the associated person was employed at the time of the dispute.

      To maintain uniformity between the Codes, FINRA amended Rule 13213(a) to permit an associated person to select a hearing location in the state where the person was employed at the time of the events giving rise to the dispute,3 if the closest hearing location to the place of employment is in a different state. Specifically, the rule now states that the Director will select the hearing location closest to where the associated person was employed at the time of the events giving rise to the dispute, unless the hearing location closest to the associated person's employment is in a different state. In that case, the associated person may request a hearing location in the state where the person was employed at the time of the events giving rise to the dispute.

      Under the rule, the Director will continue to select the hearing location closest to where the associated person was employed at the time of the events giving rise to the dispute. However, the Director will grant an associated person's request for a different hearing location in the associated person's state of employment, if the associated person makes the request before the arbitrator or arbitrators are selected. After the arbitration panel is appointed, the associated person must submit to the panel any request to change the hearing location.

      Effective Date Provisions

      The amendments will become effective on May 3, 2010, and will apply to claims filed on or after that date.


      1 Exchange Act Release No. 61497 (Feb. 4, 2010), 75 Federal Register 6769 (Feb. 10, 2010) (File No. SR-FINRA-2009-073).

      2 Hoboken, New Jersey, is less than a mile by ferry across the Hudson River from FINRA's New York City hearing location.

      3 The amendment to Rule 13213(a) broadens the criteria for selecting the appropriate hearing location under the Industry Code by referring to "the time of the events giving rise to the dispute." This amendment clarifies current practice and makes the rule language under the Industry Code consistent with the same rule under the Customer Code.


      ATTACHMENT A

      New language is underlined.

      Code of Arbitration Procedure for Customer Disputes and Code of Arbitration Procedure for Industry Disputes

      *****

      Customer Code

      12213. Hearing Locations

      (a) U.S. Hearing Location
      (1) The Director will decide which of FINRA's hearing locations will be the hearing location for the arbitration. Generally, the Director will select the hearing location closest to the customer's residence at the time of the events giving rise to the dispute, unless the hearing location closest to the customer's residence is in a different state, in which case the customer may request a hearing location in the customer's state of residence at the time of the events giving rise to the dispute.
      (2)–(4) No change.
      (b) No change.

      * * * * *

      Industry Code

      13213. Hearing Locations

      (a) U.S. Hearing Location
      (1) The Director will decide which of FINRA's hearing locations will be the hearing location for the arbitration. In cases involving an associated person, the Director will generally select the hearing location closest to where the associated person was employed at the time of the events giving rise to the dispute, unless the hearing location closest to the associated person's employment is in a different state, in which case the associated person may request a hearing location in his or her state of employment at the time of the events giving rise to the dispute. In cases involving members only or more than one associated person, the Director will consider a variety of factors, including:
      •   The parties' signed agreement to arbitrate, if any;
      •   Which party initiated the transaction or business in issue; and
      •   The location of essential witnesses and documents.
      (2)–(4) No change.
      (b) No change.

      * * * * *

    • 10-16 Amendments to the Arbitration Rules on Fees Assessed Under the Postponement and Hearing Session Fee Rules; Effective Date: May 3, 2010

      View PDF

      Arbitration Fee Changes

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      Rule 12601(b)(3)
      Rule 12902(a)(1)
      Rule 13601(b)(3)
      Rule 13902(a)(1)
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topic(s)

      Arbitration
      Code of Arbitration Procedure
      Postponement Rule
      Hearing Session Fee Rule

      Executive Summary

      Effective May 3, 2010, the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes clarify the applicability of the fee waiver provision of the postponement rule and codify the hearing session fee for an unspecified damages claim heard by one arbitrator.1

      The text of the amendments to the rules is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Kenneth L. Andrichik, Senior Vice President, Chief Counsel and Director of Mediation and Strategy, Dispute Resolution (DR), at (212) 858-3915 or ken.andrichik@finra.org; or
      •   Mignon McLemore, Assistant Chief Counsel, DR, at (202) 728-8151 or mignon.mclemore@finra.org.

      Background and Discussion

      FINRA is amending the Code of Arbitration Procedure for Customer Disputes (Customer Code) and Code of Arbitration Procedure for Industry Disputes (Industry Code) (together, the Codes) to address the fee waiver provision of the postponement rule and the hearing session fee for one arbitrator in an unspecified damages claim. First, amendments to Rules 12601(b)(3) and 13601(b)(3)—referred to as the fee waiver provision of the postponement rule—clarify that FINRA will not waive the late postponement fee, as set forth in Rule 12601(b)(2), if parties request a postponement within three business days before the scheduled hearing session. Second, amendments to Rules 12902(a)(1) and 13902(a)(1) codify the forum's current practice of charging $450 per hearing session for an unspecified damages claim heard by one arbitrator.

      Each amendment is discussed separately below.2

      Amendment to Fee Waiver Provision of Postponement Rule

      The Codes require arbitration hearings to be postponed if the parties agree.3 Hearings may also be postponed by the Director of FINRA Dispute Resolution (Director), by the panel in its own discretion, or by the panel on a motion of a party.4 If a hearing is postponed, the arbitration panel assesses a postponement fee against one or more of the parties, which is typically equivalent to the applicable hearing session fee that would have been assessed had the hearing been held.5

      There are instances, however, in which a postponement fee is not assessed against the parties. For example, under the Codes, parties are not charged a postponement fee if they agree to submit the matter to mediation at FINRA.6 If the parties agree to mediation administered through FINRA, the Director waives the postponement fee.

      Under Rule 12601(b)(2), if parties request and are granted a hearing postponement within three business days of a scheduled hearing session (i.e., a late postponement request), the Director assesses a fee of $100 per arbitrator.7 Some parties who make late postponement requests believe they should not be charged the $100 late postponement fee if they express intent to mediate through FINRA.

      To correct this misinterpretation and ensure uniform application of the fee waiver provision of the postponement rule, FINRA is amending the Codes8 to state, in relevant part, that 1) FINRA will not assess a postponement fee if a hearing is postponed because the parties agree to submit the matter to mediation administered through FINRA; and 2) the parties must pay the additional fees described in the rules for late postponement requests.

      Amendment to the Hearing Session Fee for One Arbitrator in Unspecified Damages Claim

      In the arbitration forum, if the parties and the arbitrator(s) meet to discuss the issues giving rise to the arbitration dispute, the meeting is called a "hearing session."9 The Codes authorize FINRA to assess hearing session fees against the parties for each hearing session.10 The total amount charged to the parties for each hearing session is based on the amount in dispute.11 For claims that do not request or specify money damages (i.e., an unspecified damages claim), however, the Codes give the Director the discretion to determine the amount of the hearing session fee, except that the fee cannot exceed $1,200.12

      Currently, the fee charged for each hearing session in an unspecified damages claim heard by three arbitrators is $1,000.13 However, for an unspecified damages claim heard by one arbitrator, the rules list the hearing session fee as not applicable (N/A).14 FINRA is amending the Codes to change the current amount for an unspecified damages claim heard by one arbitrator from N/A to $450.15

      FINRA notes that because hearing sessions with a single arbitrator in unspecified damage claims do occur, the chart of fees should not reflect that this scenario is "not applicable." FINRA also notes that the Codes authorize the Director to determine whether the hearing session fee for an unspecified damages claim should be more or less than the amount specified in the fee schedules of the arbitration rules. The amendment will not change FINRA's practice of reducing or waiving fees in documented cases of financial hardship.

      Effective Date Provisions

      The amendments become effective on May 3, 2010, and apply to claims filed on or after that date.


      1 Exchange Act Release No. 61505 (Feb. 4, 2010), 75 Federal Register 7297 (Feb. 18, 2010) (File No. SR-FINRA-2009-075).

      2 The amendments to the rules of the Customer Code are identical to those of the Industry Code. Thus, for simplicity, the discussion will focus on the amendments to Codes because the explanation and rationale apply to the same rules of each Code.

      3 Rule 12601(a)(1) of the Customer Code, and Rule 13601(a)(1) of the Industry Code.

      4 Rule 12601(a)(2) of the Customer Code, and Rule 13601(a)(2) of the Industry Code.

      5 Rule 12601(b)(1) of the Customer Code, and Rule 13601(b)(1) of the Industry Code.

      6 Rule 12601(b)(3) of the Customer Code and Rule 13601(b)(3) of the Industry Code.

      7 Rule 12601(b)(2) of the Customer Code, and Rule 13601(b)(2) of the Industry Code.

      8 Rule 12601(b)(3) of the Customer Code and Rule 13601(b)(3) of the Industry Code.

      9 A hearing session can either be an arbitration hearing or a prehearing conference. Rule 12100(n) of the Customer Code and Rule 13100(n) of the Industry Code.

      10 Rule 12902(a)(1) of the Customer Code and Rule 13902(a)(1) of the Industry Code.

      11 Id.

      12 Rule 12902(a)(2) of the Customer Code and Rule 13902(a)(2) of the Industry Code.

      13 Note 10.

      14 Id.

      15 Id.


      ATTACHMENT A

      New language is underlined; deletions are in brackets.

      Code of Arbitration Procedure for Customer Disputes and Code of Arbitration Procedure for Industry Disputes

      * * * * *

      Customer Code

      12601. Postponement of Hearings

      (a) No change.
      (b) Postponement Fees
      (1)–(2) No change.
      (3) No postponement fee will be charged if a hearing is postponed:
      •   Because the parties agree to submit the matter to mediation [at] administered through FINRA, except that the parties shall pay the additional fees described in Rule 12601(b)(2) for late postponement requests;
      •   By the panel in its own discretion; or
      •   By the Director in extraordinary circumstances.
      (c) No change.

      * * * *

      12902. Hearing Session Fees, and Other Costs and Expenses

      (a) Hearing Session Fees
      (1) Hearing session fees will be charged for each hearing session. The total amount chargeable to the parties for each hearing session is based on the amount in dispute, as specified in the schedule below. In the award, the panel will determine the amount of each hearing session fee that each party must pay.

      Hearing Session Fees
      Amount of Claim Hearing Session W/One Arbitrator Hearing Session W/Three Arbitrators
      Up to $2,500 $50 N/A
      $2,500.01 to $5,000 $125 N/A
      $5000.01 to $10,000 $250 N/A
      $10,000.01 to $25,000 $450 N/A
      $25,000.01 to $50,000 $450 $600
      $50,000.01 to $100,000 $450 $750
      $100,000.01 to $500,000 $450 $1,125
      Over $500,000 $450 $1,200
      Unspecified Damages [N/A] $450 $1,000
      (2)–(4) No change.
      (b)–(e) No change.

      * * * * *

      Industry Code

      13601. Postponement of Hearings

      (a) No change.
      (b) Postponement Fees
      (1)–(2) No change.
      (3) No postponement fee will be charged if a hearing is postponed:
      •   Because the parties agree to submit the matter to mediation [at] administered through FINRA, except that the parties shall pay the additional fees described in Rule 13601(b)(2) for late postponement requests;
      •   By the panel in its own discretion; or
      •   By the Director in extraordinary circumstances.
      (c) No change.

      * * * *

      13902. Hearing Session Fees, and Other Costs and Expenses

      (a) Hearing Session Fees
      (1) Hearing session fees will be charged for each hearing session. The total amount chargeable to the parties for each hearing session is based on the amount in dispute, as specified in the schedule below. In the award, the panel will determine the amount of each hearing session fee that each party must pay.

      Hearing Session Fees
      Amount of Claim Hearing Session W/One Arbitrator Hearing Session W/Three Arbitrators
      Up to $2,500 $50 N/A
      $2,500.01 to $5,000 $125 N/A
      $5000.01 to $10,000 $250 N/A
      $10,000.01 to $25,000 $450 N/A
      $25,000.01 to $50,000 $450 $600
      $50,000.01 to $100,000 $450 $750
      $100,000.01 to $500,000 $450 $1,125
      Over $500,000 $450 $1,200
      Unspecified Damages [N/A] $450 $1,000
      (2)–(3) No change.
      (b)–(e) No change.

      * * * * *

    • 10-15 FINRA Requirements for Subordinations; Availability of New Standard Forms

      View PDF

      Financial Responsibility

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4110(e)(1)
      NYSE Rule 313(d)
      NYSE Rule 420
      NTM 02-32
      Regulatory Notice 09-71
      SEA Rule 15c3-1
      SEA Rule 15c3-1d (Appendix D)
      SEA Rule 17a-4
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topic(s)

      Capital Compliance
      Consolidated Rulebook
      Financial Responsibility
      Subordination Agreements

      Executive Summary

      Firms are reminded that, pursuant to new FINRA Rule 4110(e)(1),1 subordinated loans and notes collateralized by securities (together referred to as subordinations) must be approved by FINRA in order to receive beneficial regulatory capital treatment.2 This Notice explains the requirements for all subordinations for which firms intend to receive beneficial regulatory capital treatment, including certain provisions that all such subordinations, both standard and non-standard,3 must contain. It also describes the submission and approval process of proposed subordinations.

      In addition, the Notice provides information about new, standard subordination forms (and a revised Lender's Attestation) that are available at www.finra.org/subordinations.4 This Notice also explains how to obtain approval of proposed amendments to or renewals of previously approved subordinations.

      Questions concerning this Notice should be directed to:

      •   Kris Dailey, Vice President, Risk Oversight & Operational Regulation (ROOR), at (646) 315-8434;
      •   Susan DeMando Scott, Associate Vice President, Financial Operations Department, at (202) 728-8411;
      •   Joseph Sheirer, Director & Special Counsel, ROOR, at (646) 315-8691; or
      •   Maria Rabinovich, Principal Counsel, ROOR, at (646) 315-8461.

      Background and Discussion

      A. Regulation of Subordination Agreements

      Generally, brokers and dealers use subordinations to borrow funds or securities from investors to increase their regulatory net capital. Under Securities Exchange Act (SEA) Rule 15c3-1, in order to receive beneficial regulatory capital treatment, funds or securities loaned to a broker or dealer must be subordinated to the claims of creditors pursuant to a satisfactory subordination agreement as defined under Appendix D.5 New FINRA Rule 4110(e)(1) requires that subordinations meet such standards as FINRA may require to ensure the firm's continued financial stability and operational capability, in addition to the standards set forth in Appendix D. Any subordination entered into by a firm where it wishes to receive beneficial regulatory capital treatment must be acceptable to FINRA prior to becoming effective.
      B. Required Provisions

      In addition to the requirements set forth in Appendix D, FINRA requires that certain provisions be included in standard and non-standard subordinations.6 These required provisions are based in large part on requirements and regulatory practices already used by FINRA (f/k/a NASD) and NYSE Regulation. Firms should note that FINRA may require additional terms or modifications based on the circumstances and/or provisions of a particular subordination agreement.
      1. Provisions for Approval and Notification; Other Required Representations

      All subordinations submitted to FINRA for approval must include provisions for FINRA approval and notification requirements, as well as certain other required representations. Specifically:
      a. the agreement is not effective until approved by FINRA and executed by the parties;
      b. any and all amendments to the agreement require the prior written approval of FINRA;
      c. the rights and obligations of the parties under the agreement may not be transferred, sold, assigned, pledged or otherwise encumbered or disposed of, and no lien, charge or other encumbrance may be created or permitted thereon without the prior written approval of FINRA;
      d. the submitted agreement represents the entire agreement and no other evidence of such agreement has been or will be executed or effective without prior written approval of FINRA;
      e. FINRA will be provided written notice(s) of suspension, acceleration or any notice(s) required pursuant to the agreement or Appendix D;
      f. the lender is not making or entering into the loan based on the firm's standing as a member of FINRA or in reliance on FINRA, nor is FINRA or any director, officer or employee of FINRA liable to the lender with respect to the agreement or any rights or obligations thereunder; and
      g. the parties represent that the executed agreement is a legally valid and binding obligation of the parties that fully conforms to any drafts submitted to and approved by FINRA for execution.
      2. Obligation of Firm to Reduce Business if in Suspended Repayment

      FINRA requires that all subordinations submitted to FINRA for approval include provisions obligating the firm, if it enters a state of "suspended repayment" (as defined in Appendix D and the FINRA standard forms), to promptly reduce its business, consistent with the protection of its customers, to a condition whereby payments under the subordinations could be made without violating applicable requirements of Appendix D and/or FINRA rules. Firms should be aware that this required provision differs from the optional provision of paragraph (b)(8)(i) of Appendix D, which, if and when incorporated by the parties to a subordination, requires the firm to effect a rapid and orderly liquidation if the firm's obligation to pay is suspended for a period of not less than six months. A firm that is in, or has reason to believe it is about to enter, a state of suspended repayment must immediately notify its Regulatory Coordinator.
      3. Repayment and Return Provisions

      FINRA requires that any subordination submitted for approval include provisions obligating the lender to repay or return any amounts, collateral and/or notes received from or made by the firm in contravention of the financial requirements contained in Appendix D and/or FINRA rules, provided that the firm must make demand for recovery of such amounts or return of such collateral and/or notes within 120 calendar days from the date such improper payment or return was made. Firms should note that FINRA will not view a firm's demand for recovery (regardless of whether the demand is successful) as a defense in the event of a violation of financial responsibility or other requirements under FINRA or SEC rules.
      C. Process for Submission and Approval of Proposed Subordination Agreements
      1. Submission of Draft Agreements

      All proposed subordination agreements, whether drafted independently by the parties or prepared using FINRA standard forms (which are discussed further in Section D of this Notice), must be submitted in draft form (i.e., unexecuted) to the firm's Regulatory Coordinator and Regulatory Specialist, if applicable.7

      The draft agreement must include the proposed effective date of the agreement, which should generally be at least 10 business days after the date of submission to FINRA if a standard form is used (or longer if a non-standard form is being used).8 Firms are advised that FINRA may require the parties to cancel—and provide evidence of cancellation with respect to—proposed agreements that are submitted in executed form if FINRA finds the terms of the agreement unacceptable and the parties continue to seek beneficial regulatory capital treatment of the agreement.
      2. Supporting Documentation Required

      A firm seeking approval of a subordination must also submit to FINRA, concurrent with the draft agreement discussed in Section C.1 of this Notice, certain additional supporting documentation. Specifically:
      a. a draft of the Lender's Attestation (see Section C.3 of this Notice);
      b. if the lender is other than an individual, evidence of the lender's authority to make the loan and evidence of any signatory's authority (e.g., corporate resolutions or analogous documents, trust agreement). Note, however, that where the lender is an unaffiliated bank, a resolution of the lender is generally not required;
      c. documentation evidencing the source of funds that must align with the identity of the proposed lender; and
      d. pro-forma financial statements of the member accounting for the proposed subordination, along with a calculation of the firm's debt-equity ratio, in accordance with paragraph (d) of SEA Rule 15c3-1.
      Proposed secured demand note agreements must include details regarding the collateral to be pledged by the lender. Proposed revolving subordinated loan agreements must be accompanied by evidence that the lender meets the definition of a Qualified Lender (as that term is defined in SEC Division of Trading and Markets Interpretation /01 of SEA Rule 15c3-1d(a)(2)(v)(F) (see Interpretations of Financial and Operational Rules at www.finra.org/finops)).

      FINRA reserves the right to request additional documentation based on the type of lender or agreement proposed. Additionally, firms should note that evidence of the completed funding of a subordination agreement is required once agreements are executed.
      3. Lender's Attestation and Investor Disclosure Document

      All firms seeking approval of a subordination agreement are required to submit Lender's Attestations and Investor Disclosure Documents (IDDs) (both must be signed and submitted to FINRA as part of the final documents—see Section C.5 of this Notice).9 The Lender's Attestation contains several representations required of the lender with regard to information received by the lender from the firm, including certain financial information regarding the firm and a copy of Appendix D.
      4. Amount of Time for Review

      The amount of time FINRA generally needs to review a proposed subordination and the supporting documentation varies depending on the form and content of the proposed agreement, as well as the completeness of the supporting documentation provided to FINRA. Firms seeking approval for a subordination using standard FINRA forms with little or no modification should submit the draft forms and draft supporting documentation at least 10 business days in advance of the proposed effective date. Agreements prepared by the parties (i.e., non-standard agreements) or agreements prepared using standard FINRA forms that contain additional provisions or substantial modification should be submitted in draft form at least 30 calendar days in advance of the proposed effective date (as such forms require substantially more detailed review by FINRA staff).10
      5. Approval, Execution and Funding; Submission of Final Documents

      Following the submission and review of all pertinent draft documentation, FINRA will advise the firm of the acceptability of the proposed subordination and supporting documentation. The firm and lender may subsequently execute the agreements and related supporting documentation on the proposed effective date stated in the draft documents. The funding of the subordination, other than a revolving subordinated loan agreement not drawn down at execution, must be accomplished on the same day as execution of the final documents. Prior notification to FINRA is required for any drawdown under a revolving subordinated loan agreement. The firm must submit to FINRA proof of funding of the subordination.

      The executed documents must conform, in all respects, to any draft documents previously submitted to and approved by FINRA. Upon execution, the firm must submit a copy of the executed agreement and supporting documentation (e.g., resolutions, Lender's Attestation, IDD, proof of funding), either electronically or in paper form, to FINRA, immediately after funding, but in no case later than two business days after funding is completed. Firms are responsible for maintaining original agreements in accordance with applicable recordkeeping requirements.11 FINRA will provide firms with a written approval letter for the subordination following the receipt of all required executed documents.
      6. Amending or Renewing Previously Approved Subordinations

      Any amendment or renewal of a previously approved subordination, including but not limited to an extension of maturity (other than an automatic extension of maturity already included as a provision to an approved subordination), must be reviewed and approved by FINRA prior to becoming effective. FINRA will approve amendments or renewals that are consistent with the requirements of SEA Rule 15c3-1 and Appendix D and satisfy all other requirements of FINRA, as outlined in this Notice.

      Firms seeking to amend or renew an existing subordination must follow the procedures outlined above in this Notice for submitting documents in draft form and submitting supporting documentation. Firms and lenders should be aware that subordination agreements (or provisions in such agreements) that have matured are not eligible for amendment. As with newly proposed subordinations, firms should contact their assigned Regulatory Coordinator and Regulatory Specialist, if applicable (see endnote 7), regarding proposed amendments.
      D. FINRA's Standard Forms
      1. Types of Standard Forms

      To ease the preparation and review burdens associated with subordinations, FINRA provides seven standard forms of agreements. Firms may, but are not required to, use these standard forms for proposed subordinations.

      The table below provides a summary of the standard forms of subordination agreements and key characteristics of each form. Firms are encouraged to contact their assigned Regulatory Coordinator and Regulatory Specialist, if applicable (see endnote 7), regarding questions about which forms they should or can use given their particular circumstances.

      FINRA Form Type of Subordination SEA Rule 15c3-1(d) Debt-Equity Treatment Type of Lender Maturity
      SL—31D Cash Borrowing Debt Generally unrestricted 1 Year Minimum
      SL—31E Cash Borrowing Equity Partner/Stockholder 3 Year Minimum (Debt treatment in last 12 months)
      SL—31T* Cash Borrowing Debt (Temporary) Generally unrestricted 45 Day Maximum
      SDN—32D Secured Demand Note Agreement Debt Generally unrestricted 1 Year Minimum
      SDN—32E Secured Demand Note Agreement Equity Partner/Stockholder 3 Year Minimum (Debt treatment in last 12 months)
      SDN—32T* Secured Demand Note Agreement Debt (Temporary) Generally unrestricted 45 Day Maximum
      REV—33R Revolving Cash Borrowing Debt Qualified Lender 1 Year Minimum (from the end of the Credit Period)


      * FINRA Forms SL—31T and SDN—32T are Temporary Subordination Agreements permitted under paragraph (c)(5)(i) of Appendix D. No more than three such agreements are permissible in a 12-month period, each with a stated term of no more than 45 days from the date the agreement became effective. Firms should note that such agreements are for the purpose of enabling a broker or dealer, as set forth in paragraph (c)(5)(i) of Appendix D, to participate as an underwriter of securities or for other extraordinary activities in compliance with SEA Rule 15c3-1.
      2. Certain Optional Provisions in the Standard Forms

      The standard forms include references to two types of optional provisions:
      (1) provisions that are permitted by Appendix D, but not required thereunder; and
      (2) optional provisions FINRA has included, which are not referenced in—and not precluded by—Appendix D. The optional provisions can be incorporated as part of the agreement if the parties mutually agree to do so.
      The optional provisions have been written in a manner that requires the parties, when submitting a proposed subordination for approval, to affirmatively select and clearly indicate any optional provisions they choose to incorporate as part of their agreement. Optional provisions that are not affirmatively included are thereby excluded from the terms of the agreement. Following are examples of the optional provisions available:
      a. For non-equity12 loans only, a provision allowing the lender, for any reason, to accelerate maturity to a time no earlier than six months from the date of written notice to the firm and FINRA, with such written notice given no earlier than six months from the effective date of the agreement.
      b. For non-equity13 loans only, a provision allowing the lender to accelerate maturity based on the occurrence of Events of Acceleration or Events of Default. Such events must be clearly stated in the agreement and must be measurable, related to the business of the member, acceptable to FINRA and consistent with Appendix D limitations for such events. Parties wishing to incorporate Events of Acceleration or Events of Default in a subordination may not incorporate the lender's acceleration provision discussed in item a. above.
      c. A provision allowing, subject to prior written approval of FINRA and compliance with the requirements of Appendix D and FINRA rules, the firm, at its option, to make a prepayment of its obligations after one year following the effective date of the agreement. (Note: FINRA Form REV-33R, dealing with revolving cash borrowings, includes this permissive prepayment provision as standard and also allows for permissive prepayment prior to one year from the effective date under certain conditions).
      d. A provision allowing for a rapid and orderly liquidation of the firm if the payment obligations under the agreement are ever suspended for six months or more.
      e. A provision providing for the automatic extension of the maturity date for an additional year if written notice to the contrary is not provided by the lender to the member firm (who must in turn notify FINRA) within certain prescribed time frames.
      f. A provision providing for accrual of eligible interest for the period of the subordination (excluding the last twelve months of the subordination).
      3. Modifying Standard Forms (Other Options)

      Although standardized, FINRA forms may be modified prior to submission for approval. The parties to a proposed subordination may agree to incorporate the "optional rider" provision contained in each standard form. The optional rider provision allows the parties to modify the standard form and/or add any mutually agreed upon term that is not inconsistent with SEA Rule 15c3-1 or Appendix D and is acceptable to FINRA. When incorporating the optional rider provision, the parties must prepare and submit a draft rider containing the proposed terms as part of the proposed draft subordination.
      E. Effect of this Notice on Previously Approved Agreements

      This Notice does not affect subordinations previously approved by FINRA (f/k/a NASD) or NYSE Regulation. Agreements previously deemed to be satisfactory subordinations shall continue to be acceptable until they mature. However, any member firm wishing to amend or renew a previously approved agreement must follow the guidance set forth in this Notice.14

      1 The current FINRA rulebook consists of: (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA member firms, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice 03/12/08 (Rulebook Consolidation Process).

      2 FINRA Rule 4110(e)(1), which went into effect on February 8, 2010, as part of the new, consolidated financial responsibility rules, requires that subordinations meet standards set by FINRA in addition to those set forth in SEA Rule 15c3-1d (referred to as Appendix D of SEA Rule 15c3-1, the SEC's net capital rule). Appendix D authorizes FINRA to establish additional requirements deemed necessary or appropriate. For more information about the new financial responsibility rules, see Regulatory Notice 09-71 (SEC Approves Consolidated FINRA Rules Governing Financial Responsibility) (December 2009). See also Exchange Act Release No. 60933 (November 4, 2009), 74 FR 58334 (November 12, 2009) (Order Granting Approval to Proposed Rule Change; File No. SR-FINRA-2008-067); Exchange Act Release No. 61408 (January 22, 2010), 75 FR 4596 (January 28, 2010) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change; File No. SR-FINRA-2010-004); and Exchange Act Release No. 61513 (February 12, 2010), 75 FR 7532 (February 19, 2010) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change; File No. SR-FINRA-2010-008).

      3 Generally, standard subordinations are those that utilize the standard forms provided by FINRA and/or certain optional provisions as discussed within this Notice. Non-standard subordinations are agreements drafted independently by the parties. Firms are not required to use the standard forms.

      4 The new forms replace the forms previously made available to FINRA member firms (they were not accessible online).

      5 A subordination agreement must be a satisfactory subordination agreement as set forth in Appendix D in order that the respective amounts may be included in the firm's net capital. See, e.g., Rule 15c3-1(c)(2).

      6 Firms should note that FINRA will not view the possible unenforceability of an agreement under the laws of any jurisdiction or a contracting party's failure to perform as a defense in the event of a member's violation of financial responsibility or other requirements under FINRA or SEC rules.

      7 If a firm is assigned to the Risk Oversight and Operational Regulation (ROOR) Department of FINRA, the documentation and information pertaining to proposed or amended subordination agreements must also be submitted to the firm's assigned Regulatory Specialist in ROOR, in addition to its Regulatory Coordinator. Firms may submit draft agreements and supporting documentation via email to the required staff person(s).

      8 In exigent circumstances, FINRA will undertake to expedite the review and approval of proposed subordination agreements.

      9 This is new for Dual Members, which, historically, have been required to submit an opinion of counsel pursuant to Incorporated NYSE Rules 420 and 313(d), both of which have been deleted in connection with the adoption of the new, consolidated financial responsibility rules. See note 2. For background regarding IDDs, see Notice to Members 02-32 (Subordinated Loan Agreements) (June 2002).

      10 See note 8.

      11 See, e.g., SEA Rule 17a-4.

      12 See paragraph (d) of SEA Rule 15c3-1.

      13 See note 12.

      14 See also Section C.6 of this Notice.

    • 10-14 SEC Approves Access to Historic TRACE Data and Related Fees Effective Date: March 31, 2010

      View PDF

      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6750(b)
      FINRA Rule 7730
      Securities Act Rule 144A
      Suggested Routing

      Compliance
      Fixed Income
      Legal
      Operations
      Research
      Systems
      Trading
      Key Topic(s)

      Fees
      Historic TRACE Data

      Executive Summary

      Effective March 31, 2010, the public will have access to Historic TRACE Data, and fees for professional users of Historic TRACE Data will go into effect.1

      The text of the amendments is available in Attachment B at www.finra.org/notices/10-14.

      Questions regarding this Notice should be directed to:

      •   Ola Persson, Director, Transparency Services, at (212) 858-4796; or
      •   Elliot R. Levine, Associate Vice President and Counsel, Transparency Services, at (202) 728-8405.

      For inquiries regarding how to access Historic TRACE Data, please contact TRACE Data Services at (888) 507-3665.

      Background & Discussion

      Transaction-level information on publicly traded TRACE-Eligible Securities is available in real-time as the transactions are reported to TRACE (TRACE Market Data). However, transaction-level information is not available in TRACE Market Data, or otherwise publicly available, if such information is not disseminated as provided in Rule 6750(b).2

      Currently, for each transaction the data released as TRACE Market Data includes, among other fields:

      •   bond identifiers (FINRA symbol and CUSIP number);
      •   date/time—execution time for current day's transactions, execution date and time for as/of trades and reversals;
      •   price;
      •   yield;
      •   quantity, subject to certain volume limits or caps3;
      •   contra-party type (customer or dealer) & buy or sell side indicator (in TRACE Market Data, only the sell side of an inter-dealer report is subject to dissemination);
      •   various modifiers, indicators (e.g., the trade was executed at a special price; the settlement does not follow market convention) and administrative messages.

      The fees FINRA charges for TRACE data are set forth in Rule 7730. FINRA makes the real-time TRACE Market Data available to professional users for a fee, while Non-Professionals have access to transaction-level data at no charge at www.finra.org/marketdata and other publicly accessible Web sites.4

      Historic TRACE Data

      FINRA believes that it is important to provide access to historical transaction-level data, particularly for research purposes. Effective March 31, 2010, transaction-level data for transactions in all TRACE-Eligible Securities reported to TRACE since July 1, 2002, except Rule 144A transactions, will be made available as Historic TRACE Data. Historic TRACE Data will include transactions that, at the time of reporting, were not subject to dissemination, such as Non-Investment Grade corporate bond transactions. (As a group, such transactions were reported to TRACE as of July 1, 2002, but were only later subject to dissemination.) Also, Historic TRACE Data will include certain transaction-level information—such as actual trade volume (or size)—that currently is not publicly available for larger transactions.

      The release of Historic TRACE Data is subject to the following protocols:

      •   transaction data must have aged at least 18 months before FINRA will include it in Historic TRACE Data. For example, when historic data becomes available on March 31, 2010, TRACE corporate bond transaction data from 2009 will not be available at that time, because the data was captured and created less than 18 months ago.
      •   Historic TRACE Data will not include the identity of any broker-dealer that is a party to a transaction.

      The data elements and fields that FINRA will include in Historic TRACE Data for each transaction are set forth in Attachment A. Additional information regarding the fields is available in "Historic TRACE Data: Enhanced Historical Time and Sales—Trade Record File Layout" in the technical specifications at www.finra.org/trace/historicaldata.

      FINRA may change the fields and data elements of Historic TRACE Data to respond to user needs, improve the usefulness of the data or foster the extensive use of such data in research on the bond markets. FINRA will notify firms and other data users of any changes to Historic TRACE Data in a Regulatory Notice (or an equivalent publication).

      Fees

      In Rule 7730(d)(1), FINRA incorporates fees for Historic TRACE Data that apply to financial services professionals, such as broker-dealers and data vendors, and to Non-Professionals. Corporate bond TRACE-Eligible Security transactions will be organized and sold as the Historic Corporate Bond Data Set. After transactions in Agency Debt Securities have been reported to TRACE for more than 18 months, FINRA will organize and sell the aged transactions in Agency Debt Securities as the Historic Agency Data Set.5 Fees are payable per data set. Under Rule 7730(d)(1)(B), fees for Historic TRACE Data are reduced for qualifying tax-exempt organizations.

      FINRA also will respond to ad-hoc requests for Historic TRACE Data from Non-Professionals—that is, individuals who are not affiliated with or engaged in financial services as defined in Rule 7730(f)(1)(A) through (C) who intend to receive and use the information solely for their personal, non-commercial use. Under Rule 7730(d)(2), if FINRA charges Non-Professionals a fee, it will be limited to cover the administrative and operational costs of responding to such requests.

      Historic TRACE Data will be available, and the amendments to Rule 7730 will become effective, on March 31, 2010.


      1 See Securities Exchange Act Release No. 61012 (November 16, 2009), 74 FR 61189 (November 23, 2009) (Order Approving File No. SR-FINRA-2007-006).

      2 Currently, under Rule 6750(b), transaction-level information is not disseminated for a transaction in a TRACE-Eligible Security that is: (1) effected pursuant to Securities Act Rule 144A (a Rule 144A transaction); and (2) a transfer of proprietary securities positions between a member and another member or non-member broker-dealer where the transfer (a) is effected in connection with a merger of one broker-dealer with the other broker-dealer or a direct or indirect acquisition of one broker-dealer by the other broker-dealer or the other broker-dealer's parent company, and (b) is not in furtherance of a trading or investment strategy.

      3 Currently, under TRACE dissemination protocols, FINRA does not make publicly available in TRACE Market Data or otherwise the actual number of bonds traded in Investment Grade debt if the par value of a transaction exceeds $5 million and in Non-Investment Grade debt if the par value of a transaction exceeds $1 million. "Investment Grade"and "Non-Investment Grade"are defined for purposes of the Rule 6700 Series in Rule 6710(h) and Rule 6710(i), respectively.

      4 The term "Non-Professional" is defined in Rule 7730(f)(1) as a natural person who uses TRACE transaction data solely for his personal, non-commercial use (and will not re-distribute such data), and is not engaged as a professional in the financial services industry (i.e., is not licensed in any of the specific capacities in the financial services industry and is not otherwise engaged in financial services as specified in Rule 7730(f)(1)(A) through (C)).

      The site www.finra.org/marketdata includes real-time TRACE data provided free of charge to Non-Professionals for personal, noncommercial use. The descriptive information includes, among other things, the bond symbol and issuer name; coupon, maturity and redemption features such as call or put options; and Moody's, S&P and/or Fitch credit ratings, if the security is rated.

      Currently, FINRA also releases aggregated data regarding both disseminated and non-disseminated transactions, but in a manner that protects transaction-level non-disseminated data from being ascertained. See, e.g., FINRA's TRACE Fact Book (www.finra.org/TRACE/FactBook) and market aggregate statistics (published daily at www.finra.org/marketdata).

      5 "Agency Debt Security"is defined in Rule 6710(l).


      ATTACHMENT A

      HISTORIC TRACE DATA

      Historic TRACE Data will include the following transaction-level information:

      •   bond identifier (FINRA symbol and CUSIP number);
      •   date/time: execution time for current day's transactions, and execution date and time for reports for as/of trades and reversals;
      •   price;
      •   yield;
      •   quantity (as reported and not subject to caps);
      •   indicators: when issued; commission; as/of; buy or sell; contra-party (dealer or customer); automatic give up (AGU); special price;
      •   buyer commission and seller commission;
      •   buyer capacity (principal or agency) and seller capacity (principal or agency);
      •   security type;
      •   dissemination flag; and
      •   other fields for trade status, days to settlement, additional modifiers or indicators regarding other conditions of sale or relating to reporting, and administrative messages, such as Message Sequence Number.

      Additional information about the fields and data elements is available in "Historic TRACE Data: Enhanced Historical Time and Sales—Trade Record File Layout"in the Technical Specifications at www.finra.org/trace/historicaldata.


      ATTACHMENT B to Regulatory Notice 10-14

      New text is underlined; deletions are in brackets.

      * * * * *

      7730. Trade Reporting and Compliance Engine (TRACE)

      The following charges shall be paid by participants for the use of the Trade Reporting and Compliance Engine ("TRACE"):

      System Fees Transaction Reporting Fees [Market]Data Fees
      Level I Trade Report Only Web Browser Access—$20/month per user ID

      Level II Full Service Web Browser Access—Subscription for a single user ID or the first user ID—$50/month (includes one Data Set); $80/month (includes two Data Sets)

      Subscription for additional user IDs—$80/month per user ID (includes one Data Set); $140/month per user ID (includes two Data Sets)
      Trades up to and including $200,000 par value—$0.475/trade;
      Trades between $200,001 and $999,999 par value—$0.000002375 times the par value of the transaction (i.e., $0.002375/$1000);

      Trades of $1,000,000 par value or more—$2.375/trade
      Market Data: BTDS Professional Real-Time Data Display—$60/month per terminal per Data Set of Real-Time TRACE transaction data, or a flat fee of $7,500/month per Data Set of Real-Time TRACE transaction data, entitling Professionals to make unlimited internal use of such Data Set(s) on any number of interrogation or display devices.
      CTCI/Third Party—$25/month/per firm Cancel/Correct—$1.50/trade Market Data: Vendor Real-Time Data Feed—$1,500/month per Data Set of Real-Time TRACE transaction data for receipt of continuous Real-Time TRACE transaction data in such Data Sets, except for qualifying Tax-Exempt Organizations, or $250/month per Data Set of Snapshot Real-Time TRACE transaction data for daily receipt of such Data Set(s).
        "As/of" Trade Late—$3/trade Market Data: Vendor Real-Time Data Feed—$400/month per Data Set of Real-Time TRACE transaction data for such Data Set(s) for qualifying Tax-Exempt Organizations.
          Market Data: BTDS Non-Professional Real-Time Data Display—No charge.
          Historic TRACE Data: Set-Up Fee—a single fee of $2,000 for development and set-up to receive Historic TRACE Data, except for qualifying Tax-Exempt Organizations.
          Historic TRACE Data: Set-Up Fee—a single fee of $1,000 for development and set-up to receive Historic TRACE Data for qualifying Tax-Exempt Organizations.
          Historic TRACE Data: Fee—$2,000/calendar year per Data Set for receipt of Historic TRACE Data, except for qualifying Tax-Exempt Organizations. The 2003 Historic Corporate Bond Data Set also includes the 2002 Historic Corporate Bond Data Set. The data is enabled for internal use and internal and/or external desktop display distribution. Bulk redistribution of data is not permitted.
          Historic TRACE Data: Bulk Re-Distribution Fee—except for qualifying Tax-Exempt Organizations, $1/CUSIP per calendar year (or part thereof) within a single Data Set of Historic TRACE Data per each recipient of redistributed data; maximum fee per Data Set of $1,000/calendar year (or part thereof) per each recipient of redistributed data.
          Historic TRACE Data: Bulk Re-Distribution Fee—for qualifying Tax-Exempt Organizations, $500/calendar year per Data Set for receipt of Historic TRACE Data. The 2003 Historic Corporate Bond Data Set also includes the 2002 Historic Corporate Bond Data Set. The data is enabled for internal use and internal and/or external desktop display. Bulk redistribution of data is permitted with certain restrictions.


      (a) through (b) No Change.
      (c) Market Data Fees

      Real-Time TRACE transaction data disseminated by FINRA comprises the following databases ("Data Set(s)"): corporate bonds ("Corporate Bonds Data Set") and Agency Debt Securities ("Agency Data Set"). Market data fees are charged for each Data Set. Professionals and Non-Professionals may subscribe to receive one or both Data Sets of Real-Time TRACE transaction data disseminated by FINRA in one or more of the following ways for the charges specified, as applicable. Members, vendors and other redistributors shall be required to execute appropriate agreements with FINRA.
      (1) Professional Fees

      Professionals may subscribe for the following:
      (A) through (B) No Change.
      (C) Vendor Real-Time Data Feed Fee of $400 per month per Data Set for Real-Time TRACE transaction data received by a Tax-Exempt Organization as defined in Rule 7730[(c)].[for the] A Tax-Exempt Organization qualifies to receive Real-Time TRACE transaction data under this paragraph if it does not redistribute such data in bulk, or it redistributes such data in bulk or otherwise at no charge solely to Non-Professionals or other Tax-Exempt Organizations that agree to be subject to the same restrictions.[to use solely to provide Non-Professionals access to such Data Set(s) of Real-Time TRACE transaction data at no charge.]
      (D) A natural person otherwise subject to market data fees under Rule 7730[(c)] is not subject to such fees when he or she accesses and uses TRACE transaction data solely for his or her personal, non-commercial use.
      (2) No Change.
      [(3) Definitions]
      [(A) "Non-Professional"—As used in Rule 7730(c) a "Non-Professional" is a natural person who uses TRACE transaction data solely for his or her personal, non-commercial use. A Non-Professional subscriber must agree to certain terms of use of the TRACE data, including that he or she receive and use the TRACE transaction data solely for his or her personal, non-commercial use. As used in Rule 7730(c) a "Non-Professional" is not:]
      [(i) registered nor qualified in any capacity with the SEC, the Commodity Futures Trading Commission, any state securities agency, any securities exchange or association, or any commodities or futures contract market or association, nor an employee of the above and, with respect to any person identified in this subparagraph i., uses TRACE transaction data for other than personal, non-commercial use;]
      [(ii) engaged as an "investment adviser" as that term is defined in Section 202(a)(11) of the Investment Advisers Act of 1940 (whether or not registered or qualified under that Act), nor an employee of the above and, with respect to any person identified in this subparagraph ii., uses TRACE transaction data for other than personal, non-commercial use;]
      [(iii) employed by a bank, insurance company or other organization exempt from registration under federal or state securities laws to perform functions that would require registration or qualification if such functions were performed for an organization not so exempt, nor any other employee of a bank, insurance company or such other organization referenced above and, with respect to any person identified in this subparagraph iii., uses TRACE transaction data for other than personal, noncommercial use; nor]
      [(iv) engaged in, nor has the intention to engage in, any redistribution of all or any portion of the TRACE transaction data.]
      [(B) "Tax-Exempt Organization" as used in Rule 7730(c) means an organization that is described in Section 501(c) of the Internal Revenue Code (26 U.S.C.§501(c)); has received recognition of the exemption from federal income taxes from the Internal Revenue Service; and obtains and uses Real-Time TRACE transaction data solely for redistribution to Non-Professionals, as defined for purposes of Rule 7730(c), at no charge.]
      [(C) "Real-Time" as used in Rule 7730(c) shall mean that period of time starting from the time of dissemination by FINRA of transaction data on a TRACE-eligible security, and ending no more than four hours thereafter.]
      (d) Historic TRACE Data

      Historic TRACE Data comprises the following Data Set(s): corporate bonds ("Historic Corporate Bonds Data Set") and Agency Debt Securities ("Historic Agency Data Set"). Historic TRACE Data fees, except the Set-Up Fee, are charged for each Data Set. Professionals and Non-Professionals may receive Historic TRACE Data provided by FINRA in one or more of the following ways for the charges specified, as applicable. Recipients of Historic TRACE Data shall be required to execute appropriate agreements with FINRA.
      (1) Professional Fees

      Professionals may subscribe for the following:
      (A) Persons or Organizations Other Than Qualifying Tax-Exempt Organizations
      (i) Set-Up Fee—a single fee of $2,000 for development and set-up to begin receiving Historic TRACE Data.
      (ii) Data Fee—$2,000 per calendar year per Data Set for receipt of Historic TRACE Data. The 2003 Historic Corporate Bond Data Set also includes the 2002 Historic Corporate Bond Data Set. Historic TRACE Data is enabled for internal use and internal and/or external desktop display distribution. Bulk redistribution of such data is not permitted.
      (iii) Bulk Re-Distribution Fee—$1 per CUSIP per calendar year (or part thereof) within a single Data Set of Historic TRACE Data per each recipient of re-distributed data, with a maximum fee per Data Set of $1,000 per calendar year (or part thereof) per each recipient of re-distributed data.
      (B) Qualifying Tax-Exempt Organizations

      A Tax-Exempt Organization qualifies for development and set-up and to receive Historic TRACE Data under this paragraph (d)(1)(B) if it does not re-distribute such data in bulk, or it re-distributes such data in bulk or otherwise at no charge solely to Non-Professionals or other Tax-Exempt Organizations that agree to be subject to the same restrictions.
      (i) Set-Up Fee—$1,000 for development and set-up to begin receiving Historic TRACE Data.
      (ii) Data and Bulk Re-Distribution Fee—$500 per calendar year per Data Set for receipt of Historic TRACE Data. The 2003 Historic Corporate Bond Data Set also includes the 2002 Historic Corporate Bond Data Set. Historic TRACE Data is enabled for internal use and internal and/or external desktop display, and bulk redistribution, and may be re-distributed subject to the restrictions in paragraph (d)(1)(B).
      (2) Non-Professional Fees

      If FINRA provides all or any portion of one or both Data Sets of Historic TRACE Data to a Non-Professional, FINRA will charge a cost-neutral fee under Rule 7730(e) comprised solely of the cost of the media and the cost of delivery (e.g., U.S. Postal Service or other requested delivery service).
      (e[4]) Other Requests for Data

      FINRA may impose and collect charges for data FINRA supplied upon request, where there is no provision elsewhere in this Rule 7730[(c)] for charges for such service or sale.
      (f) Definitions
      (1) "Non-Professional"—As used in Rule 7730, a "Non-Professional" is a natural person who uses TRACE transaction data solely for his or her personal, non-commercial use. A Non-Professional subscriber must agree to certain terms of use of the TRACE data, including that he or she receive and use the TRACE transaction data solely for his or her personal, non-commercial use. As used in Rule 7730, a "Non-Professional" is not:
      (A) registered nor qualified in any capacity with the SEC, the Commodity Futures Trading Commission, any state securities agency, any securities exchange or association, or any commodities or futures contract market or association, nor an employee of the above and, with respect to any person identified in this subparagraph (A), uses TRACE transaction data for other than personal, non-commercial use;
      (B) engaged as an "investment adviser" as that term is defined in Section 202(a)(11) of the Investment Advisers Act (whether or not registered or qualified under that Act), nor an employee of the above and, with respect to any person identified in this subparagraph (B), uses TRACE transaction data for other than personal, non-commercial use;
      (C) employed by a bank, insurance company or other organization exempt from registration under federal or state securities laws to perform functions that would require registration or qualification if such functions were performed for an organization not so exempt, nor any other employee of a bank, insurance company or such other organization referenced above and, with respect to any person identified in this subparagraph (C), uses TRACE transaction data for other than personal, non-commercial use; nor
      (D) engaged in, nor has the intention to engage in, any redistribution of all or any portion of the TRACE transaction data.
      (2) "Tax-Exempt Organization" as used in Rule 7730 means an organization that is described in Section 501(c) of the Internal Revenue Code (26 U.S.C.§501(c)) and has received recognition of the exemption from federal income taxes from the Internal Revenue Service.
      (3) "Real-Time" as used in Rule 7730 means that period of time starting from the time of dissemination by FINRA of transaction data on a TRACE-Eligible Security, and ending no more than four hours thereafter.
      (4) "Historic TRACE Data" as used in Rule 7730 means historic transaction-level data with elements to be determined from time to time by FINRA in its discretion and as stated in a Regulatory Notice or other equivalent publication. Historic TRACE Data will be delayed a minimum of 18 months and will not include MPID information.

      1 Charges that may be imposed by third parties, such as CTCI line providers, are not included in these fees.

      2 Under the Vendor Real-Time Data Feed Fee and service, Real-Time TRACE transaction data (or Data Set(s) of such data) may not be used in any interrogation display devices or any systems that permit end users to determine individual transaction pricing.

    • 10-13 SEC Approves Amendments to the FINRA Rule 9550 Series Governing Expedited Proceedings; Effective Date: March 25, 2010

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      Expedited Proceedings

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 9550 Series
      Article VI, Section 3(b) of the FINRA By-Laws
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topic(s)

      Expedited Proceedings
      Hearings
      Restitution
      Sanctions

      Executive Summary

      The FINRA Rule 9550 Series provides a procedural mechanism for FINRA to address certain types of misconduct more quickly than would be possible using the ordinary FINRA disciplinary process. The SEC recently approved amendments that make the following changes to the rule series:

      •   Modify various time requirements regarding expedited proceedings;
      •   Add an expedited proceeding for failure to pay restitution; and
      •   Harmonize a remedy in an expedited procedure with a remedy in the FINRA By-Laws.1

      The amended rule text is set forth in Attachment A and is effective March 25, 2010.

      Questions regarding this Notice should be directed to James S. Wrona, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8270.

      Background & Discussion

      On December 28, 2009, the SEC approved amendments to the Rule 9550 Series governing expedited proceedings.2 The changes are discussed on the following pages.

      Shortening Time Periods

      The Rule 9550 Series provides a procedural mechanism for FINRA to address certain types of misconduct in an accelerated timeframe. However, the rule series allows firms and associated persons to request a hearing that often results in a stay of the action. The amendments shorten the time within which a hearing must be held from 60 days after a hearing request to 30 days after the request in relation to the following FINRA rules:

      •   Rule 9551 (Failure to Comply with Public Communication Standards);
      •   Rule 9552 (Failure to Provide Information or Keep Information Current);
      •   Rule 9553 (Failure to Pay FINRA Dues, Fees and Other Charges);
      •   Rule 9554 (Failure to Comply with an Arbitration Award or Related Settlement); and
      •   Rule 9555 (Failure to Meet the Eligibility or Qualification Standards or Prerequisites for Access to Services).3

      In addition to modifying the timing of hearings, the amendments shorten the period before a suspension automatically turns into an expulsion or bar under Rule 9552. That rule generally allows FINRA to suspend a firm or associated person for failure to provide any information requested or required to be filed pursuant to the FINRA By-Laws or rules. Under Rule 9552, FINRA may provide written notice to such firm or person specifying the nature of the failure and stating that failure to take corrective action within 21 days after service of the notice will result in suspension. The rule previously provided that a firm or person suspended under the rule who fails to request termination of the suspension within six months is automatically expelled or barred. The recently approved amendments shorten that timeframe from six months to three months.

      Adding an Expedited Procedure for Failure to Pay Restitution

      The amendments modify Rule 9554, which contains expedited procedures for failures to comply with FINRA arbitration awards, to also explicitly permit FINRA to take expedited action for failures to comply with FINRA orders of restitution or FINRA settlements providing for restitution. In general, restitution is a remedy used to restore victims to their position before the wrongful conduct occurred and to compensate them for unjust losses or injury suffered as the result of another's wrongdoing.4 The SEC and FINRA have long stressed the significance of imposing restitution where an "identifiable person... has suffered a quantifiable loss as a result of a respondent's misconduct."5

      Harmonizing Remedies

      The amendments also harmonize the remedy for an individual's failure to comply with an arbitration award in Rule 9554 with the remedy for the same misconduct in Article VI, Section 3(b) of the FINRA By-Laws. Specifically, the amendments limit the remedy available in such actions to suspensions.


      1 See Exchange Act Release No. 61242 (December 28, 2009), 75 FR 167 (January 4, 2010) (Order Approving File No. SR-FINRA-2009-076).

      2 Id.

      3 FINRA implemented the changes regarding the timing of the hearings by amending Rule 9559, which contains the hearing provisions for the Rule 9550 Series. FINRA also made conforming changes to Rule 9559 regarding the pre-hearing exchange of documents between the parties to the expedited proceeding.

      4 See David Joseph Dambro, 51 S.E.C. 513, 518 (1993).

      5 FINRA Sanction Guidelines, at 4; see also Dambro, 51 S.E.C. at 518.


      ATTACHMENT A

      Text of Amended Rules

      New language is underlined; deletions are in brackets.

      * * * * *

      9550. Expedited Proceedings

      * * * * *

      9552. Failure to Provide Information or Keep Information Current

      (a) through (g) No Change.
      (h) Defaults

      A member or person who is suspended under this Rule and fails to request termination of the suspension within three [six] months of issuance of the original notice of suspension will automatically be expelled or barred.
      (i) No Change.

      * * * * *

      9554. Failure to Comply with an Arbitration Award or Related Settlement or an Order of Restitution or Settlement Providing for Restitution

      (a) Notice of Suspension or[,] Cancellation [or Bar]

      If a member, person associated with a member or person subject to FINRA's jurisdiction fails to comply with an arbitration award or a settlement agreement related to an arbitration or mediation under Article VI, Section 3 of the FINRA By-Laws or a FINRA order of restitution or FINRA settlement agreement providing for restitution, FINRA staff may provide written notice to such member or person stating that the failure to comply within 21 days of service of the notice will result in a suspension or cancellation of membership or a suspension [or bar] from associating with any member.
      (b) Service of Notice of Suspension[,] or Cancellation [or Bar]

      FINRA staff shall serve the member or person with such notice in accordance with Rule 9134. A copy of a notice under this Rule that is served on a person associated with a member also shall be served on such member.
      (c) No Change.
      (d) Effective Date of Suspension[,] or Cancellation [or Bar]

      The suspension[,] or cancellation [or bar] referenced in a notice issued and served under this Rule shall become effective 21 days after service of the notice, unless stayed by a request for a hearing pursuant to Rule 9559.
      (e) No Change.
      (f) Failure to Request Hearing

      If a member or person does not timely request a hearing, the suspension[,] or cancellation [or bar] specified in the notice shall become effective 21 days after the service of the notice and the notice shall constitute final FINRA action.
      (g) through (h) No Change.

      * * * * *

      9559. Hearing Procedures for Expedited Proceedings Under the Rule 9550 Series

      (a) through (e) No Change.
      (f) Time of Hearing
      (1) through (2) No Change.
      (3) A hearing shall be held within 30 [60] days after a respondent subject to a notice issued under Rules 9551 through 9555 files a written request for a hearing with the Office of Hearing Officers.
      (4) No Change.
      (g) No Change.
      (h) Transmission of Documents
      (1) Not less than two business days before the hearing in an action brought under Rule 9557, not less than seven days before the hearing in an action brought under Rules 9556 and 9558, and not less than 14 [40] days before the hearing in an action brought under Rules 9551 through 9555, FINRA staff shall provide to the respondent who requested the hearing, by facsimile or overnight courier, all documents that were considered in issuing the notice unless a document meets the criteria of Rule 9251(b)(1)(A), (B) or (C). A document that meets such criteria shall not constitute part of the record, but shall be retained by FINRA until the date upon which FINRA serves a final decision or, if applicable, upon the conclusion of any review by the SEC or the federal courts.
      (2) Not less than two business days before the hearing in an action brought under Rule 9557, not less than three days before the hearing in an action brought under Rules 9556 and 9558, and not less than seven [14] days before the hearing in an action brought under Rules 9551 through 9555, the parties shall exchange proposed exhibit and witness lists. The exhibit and witness lists shall be served by facsimile or by overnight courier.
      (i) through (s) No Change.

      * * * * *

    • 10-12 Guidance on FAS 167 for FOCUS Reporting

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      FOCUS Reporting

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      SEA Rule 15c3-1
      SEA Rule 15c3-3
      SEA Rule 17a-5
      Suggested Routing

      Accounting
      Compliance
      Legal
      Regulatory Reporting
      Senior Management
      Key Topic(s)

      FAS 167
      FOCUS Reporting
      Variable Interest Entities

      Executive Summary

      This Notice provides FINRA member firms with guidance from the staff of the Division of Trading and Markets of the Securities and Exchange Commission (SEC) on the procedures for reporting adjustments on the FOCUS Report resulting from the Financial Accounting Standard Board's Statement of Financial Accounting Standards No. 167 (FAS 167), Amendments to FASB Interpretation No. 46(R). The provisions of FAS 167 are effective at the start of a firm's first fiscal year beginning after November 15, 2009, or as of January 1, 2010, for firms reporting earnings on a calendar-year basis.

      Questions concerning this Notice should be directed to:

      •   Kris Dailey, Vice President, Risk Oversight & Operational Regulation (ROOR), at (646) 315-8434;
      •   Yui Chan, Managing Director, ROOR, at (646) 315-8426; or
      •   Susan DeMando Scott, Associate Vice President, Financial Operations Department, at (202) 728-8411.

      Questions regarding the applicability of FAS 167 to your firm should be discussed with your independent public accountant. Questions regarding the procedures for reporting the adjustments resulting from the application of FAS 167 on the FOCUS Report may be directed to your FINRA Regulatory Coordinator.

      Background and Discussion

      FAS 167, among other things, established new standards for reporting transfers of assets to special-purpose entities, known as variable interest entities (VIEs) under Generally Accepted Accounting Principles (GAAP) and for consolidating VIEs. FAS 167 may require firms to consolidate assets, liabilities and equity in certain VIEs that were not previously consolidated. Rule 15c3-1 of the Securities Exchange Act of 1934 (SEA) requires that broker-dealers' FOCUS Reports be prepared in accordance with GAAP. Accordingly, firms are required to consider the impact of the FAS 167 provisions on all future FOCUS Report filings, commencing with the January 2010 FOCUS Report.

      FINRA has sought guidance from the staff of the Division of Trading and Markets of the SEC as to the appropriate reporting of balances resulting from the application of FAS 167 on firms' FOCUS Reports. Based on the SEC staff's guidance, firms shall report balances resulting from the application of FAS 167 within existing line items on the FOCUS Report, in accordance with the procedures outlined below.

      Firms affected by the requirements of FAS 167 shall report the balances resulting from the application of such standards on their FOCUS Report as follows:

      •   Any assets and liabilities resulting from the application of FAS 167 shall be reported in FOCUS line items #537 (SPE Assets) and #1687 (SPE Liabilities), respectively. As these line items are not exclusively designated for FAS 167-related adjustments, the line items may also contain balances unrelated to FAS 167 assets and liabilities. Firms shall use the line item "memo" function within the eFOCUS Filing System1 to identify the amount of the total balances reported in these line items that resulted from the application of FAS 167. Assets and liabilities reported on FOCUS resulting from the application of FAS 167 shall have no impact on the computation of net capital under SEA Rule 15c3-1 and the reserve formula computation under SEA Rule 15c3-3. Haircut charges and aggregate indebtedness shall not be applicable on FAS 167 balance sheet classifications.
      •   Any revenues and expenses resulting from the application of FAS 167 shall be reported in FOCUS line items #3995 (Other Revenue) and #4100 (Other Expenses), respectively. Firms shall use the line item "memo" function within the eFOCUS Filing System to identify the amount of the total balances reported in these line items that resulted from the application of FAS 167.
      •   Any changes to a firm's ownership equity accounts shall be reported in the respective line item on the FOCUS Report. Firms shall use the line item "memo" function within the eFOCUS Filing System to identify the amount of the total balances reported in these line items that resulted from the application of FAS 167.
      •   Any asset or liability, such as a proprietary inventory position, that is eliminated as a result of a consolidation from the application of FAS 167 shall be reclassified for FOCUS reporting purposes, so that it continues to be reflected in the FOCUS line item on which it was reported prior to the consolidation. Firms shall use the line item "memo" function within the eFOCUS Filing System to disclose each balance that is reclassified. Firms shall continue to mark to market such reclassified proprietary inventory positions and apply the appropriate net capital treatment (e.g., haircuts) related to these reclassified items in their computation of net capital, as well as continue to include such reclassified items as proprietary inventory positions for purposes of the reserve formula computation allocation.

      The consolidation resulting from the application of FAS 167 does not preclude firms from the requirement to consolidate any subsidiary or affiliate for which it guarantees, pursuant to the requirements under Appendix C of SEA Rule 15c3-1.


      1 FINRA's eFOCUS Filing System (eFOCUS) provides firms with the ability to use the line item "memo" feature to provide additional information about a particular balance reported on the FOCUS Report.

    • 10-11 Amendments to the Arbitration Rules Regarding Deficient Claims; Effective Date: March 22, 2010

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      Deficient Claims

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      Rule 12307(b)
      Rule 13307(b)
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topic(s)

      Arbitration
      Code of Arbitration Procedure
      Corrected Deficiency
      Deficient Claims

      Executive Summary

      Effective March 22, 2010, the Codes of Arbitration Procedure for Customer and Industry Disputes are amended to clarify that if a claim deficiency is corrected within 30 days from the time a party receives notice of a deficiency, the claim will be considered filed on the date the initial statement of claim was filed.1

      The text of the amendments is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Kenneth L. Andrichik, Senior Vice President, Chief Counsel and Director of Mediation and Strategy, Dispute Resolution (DR), at (212) 858-3915 or ken.andrichik@finra.org; or
      •   Mignon McLemore, Assistant Chief Counsel, DR, at (202) 728-8151 or mignon.mclemore@finra.org.

      Background and Discussion

      When parties initiate claims in FINRA's arbitration forum, they must file a signed and dated Submission Agreement and a statement of claim explaining the facts and outlining the remedies requested.2 Parties must also pay all required filing fees at the time they file their claims.3 If the parties' claims do not meet the criteria for filing a claim under the Codes or otherwise do not comply with the Codes—for instance, the party failed to file the correct number of supporting documents for the claim—the claims are considered deficient.4

      Currently, Rule 12307 of the Code of Arbitration Procedure for Customer Disputes (Customer Code) and Rule 13307 of the Code of Arbitration Procedure for Industry Disputes (Industry Code), which address deficient claims (the "deficient claims rules"), state that the Director of FINRA Dispute Resolution (Director) will not serve a claim that is deficient. Under the current deficient claims rules, parties are permitted to correct all deficiencies; if all deficiencies are not corrected within 30 days from the time a party receives notice of a deficiency, the Director will close the case without serving the claim and refund part of the filing fee.5 However, the rules do not specify which date the Director will use as the date of filing if a party corrects a deficient claim within 30 days of receiving notice of a deficiency.

      As amended, Rules 12307(b) and 13307(b) of the Codes state that if the deficiency is corrected within 30 days from the time the party receives notice of a deficiency, the claim will be considered filed on the date the initial statement of claim was filed. The amendments should help resolve issues concerning whether a claim is eligible for submission to arbitration under the Codes,6 and whether statutes of limitation, if applicable, should apply.

      Effective Date Provisions

      The amendments become effective on March 22, 2010, and apply to claims filed on or after that date.


      1 Exchange Act Release No. 61311 (Jan. 7, 2010), 75 Federal Register 2179 (Jan. 7, 2010) (File No. SR-FINRA-2009-072).

      2 Rule 12302(a)(1) of the Customer Code and Rule 13302(a)(1) of the Industry Code.

      3 Id.

      4 Rule 12307 of the Customer Code and Rule 13307 of the Industry Code. A claim may be deficient because, for example, the party failed to file a properly signed and dated Submission Agreement, failed to pay all required filing fees, or failed to file the correct number of copies of the Submission Agreement, statement of claim or other supporting documents.

      5 Rules 12307(b) and 13307(b) of the Codes.

      6 Under the Codes, no claim shall be eligible for submission to arbitration where six years have elapsed from the occurrence or event giving rise to the claim. See Rule 12206(a) of the Customer Code and Rule 13206(a) of the Industry Code.


      ATTACHMENT A

      New language is underlined; deletions are in brackets.

      Code of Arbitration Procedure for Customer Disputes and Code of Arbitration Procedure for Industry Disputes

      * * * * *

      Customer Code

      12307. Deficient Claims

      (a) No change.
      (b) The Director will notify the claimant in writing if the claim is deficient. If the deficiency is corrected within 30 days from the time the claimant receives notice, the claim will be considered filed on the date the initial statement of claim was filed with the Director under Rule 12300(a). If all deficiencies are not corrected within 30 days [from the time the claimant receives notice], the Director will close the case without serving the claim, and will refund part of the filing fee in the amount indicated in the schedule under Rule 12900(c).
      (c) No change.

      * * * * *

      Industry Code

      13307. Deficient Claims

      (a) No change.
      (b) The Director will notify the claimant in writing if the claim is deficient. If the deficiency is corrected within 30 days from the time the claimant receives notice, the claim will be considered filed on the date the initial statement of claim was filed with the Director under Rule 13300(a). If all deficiencies are not corrected within 30 days [from the time the claimant receives notice], the Director will close the case without serving the claim, and will refund part of the filing fee in the amount indicated in the schedule under Rule 13900(c).
      (c) No change.

      * * * * *

    • 10-10 SEC Approval and Effective Date for New Consolidated FINRA Rules; Effective Date: April 19, 2010

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      SEC Approves New Consolidated FINRA Rules

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      Rule Approval
      Referenced Rules & Notices

      FINRA Rule 4570
      FINRA Rule 5160
      FINRA Rule 5330
      Information Notice 03/12/08
      Information Notice 10/06/08
      Regulatory Notice 08-57
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Adjustment of Orders
      Books and Records
      Selling Agreements

      Executive Summary

      Following the consolidation of NASD and the member regulation, enforcement and arbitration functions of NYSE Regulation into FINRA, FINRA established a process to develop a new consolidated rulebook (Consolidated FINRA Rulebook), which FINRA has discussed in previous Information Notices.1 FINRA is proposing new consolidated rules in phases for approval by the SEC as part of the Consolidated FINRA Rulebook.2 In January, the SEC approved three new consolidated FINRA rules, all of which take effect on April 19, 2010.

      Questions regarding this Notice should be directed to:

      •   Brant Brown, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6927 (regarding FINRA Rule 5330);
      •   Erika Lazar, Senior Attorney, OGC, at (202) 728-8013 (regarding FINRA Rule 5160); or
      •   Matthew Vitek, Counsel, OGC, at (202) 728-6961 (regarding FINRA Rule 4570).

      Background & Discussion

      In January 2010, the SEC approved three FINRA rules as part of the Consolidated FINRA Rulebook:

      •   Rule 4570 (Custodian of Books and Records);3
      •   Rule 5160 (Disclosure of Price and Concessions in Selling Agreements);4 and
      •   Rule 5330 (Adjustment of Orders).5

      The attachment to this Notice sets forth additional information regarding these new consolidated rules and includes a hyperlink to each related rule filing. The filings provide, among other things, FINRA's statement of the purpose of the rule changes and an exhibit showing the changes between the new rule text and the text of the NASD rule as it exists in the Transitional Rulebook. Also, the text of each new FINRA Rule is available in the online FINRA Manual at www.finra.org/finramanual.6

      Rule Conversion Charts

      As discussed in additional detail in Information Notice 10/06/08 and Regulatory Notice 08-57, FINRA has posted three Rule Conversion Charts on its Web site to help firms become familiar with the new rules and show how the new rules relate to the NASD and/or Incorporated NYSE Rules in the Transitional Rulebook that they will replace.

      Firms should be aware that the charts are intended as a reference aid only. FINRA reminds firms that the charts do not in any way serve as a substitute for diligent review of the relevant new rule language. The Rule Conversion Charts are located at www.finra.org/ruleconversionchart.


      1 See Information Notice 10/06/08 (Rulebook Consolidation Process: Effective Dates of New Consolidated Rules; Introduction of Rule Conversion Chart); see also Information Notice 03/12/08 (Rulebook Consolidation Process).

      2 The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The new FINRA Rules apply to all member firms, unless such rules have a more limited application by their terms. As the Consolidated FINRA Rulebook expands with the SEC's approval and with the new FINRA Rules taking effect, the rules in the Transitional Rulebook that address the same subject matter of regulation will be eliminated. When the Consolidated FINRA Rulebook is completed, the Transitional Rulebook will have been eliminated in its entirety.

      3 See Exchange Act Release No. 61332 (January 12, 2010); 75 FR 3270 (January 20, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-080).

      4 See Exchange Act Release No. 61417 (January 25, 2010); 75 FR 5157 (February 1, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-086).

      5 See Exchange Act Release No. 61338 (January 12, 2010); 75 FR 2899 (January 19, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2009-084).

      6 FINRA updates the rule text on its online Manual within two business days of SEC approval of changes to the rule text.


      ATTACHMENT A

      List of Approved Rules (and Related Rule Filings)

      The SEC approved the following new FINRA Rules in January 2010. The effective date of all of the rules is April 19, 2010.

      FINRA Rule Filing SR-FINRA-2009-080

      www.finra.org/rulefilings/2009-080

      FINRA Rule 4570

      The rule change adopts, with minor changes, NASD Rule 3121 (Custodian of the Record) as FINRA Rule 4570 (Custodian of Books and Records) in the Consolidated FINRA Rulebook.

      Rule 4570 provides that, at the time a firm files a Form BDW, the firm must designate a person associated with the member on the Form BDW as the custodian of the firm's books and records. The rule change made minor revisions to the text and the title of the rule to reflect that the associated person is designated as the custodian of the member's "books and records" (rather than "the record") to be consistent with the terminology used in Form BDW.

      Rule/Series Number Rule Title
      Rule 4000 Series FINANCIAL AND OPERATIONAL RULES
      Rule 4500 Series BOOKS, RECORDS AND REPORTS
      Rule 4570 Custodian of Books and Records

      FINRA Rule Filing SR-FINRA-2009-084

      www.finra.org/rulefilings/2009-084

      FINRA Rule 5330

      The rule change adopts, with several changes, NASD Rule 3220 (Adjustment of Open Orders) as FINRA Rule 5330 (Adjustment of Orders) in the Consolidated FINRA Rulebook.

      Rule 5330 sets forth the requirements for a member firm regarding orders held by the firm that involve a security that is subject to a dividend, payment or distribution. The rule establishes different requirements depending upon whether the dividend, payment or distribution is in cash, stock, combined cash and stock, or determined by the stockholder.

      In addition to making numerous formatting and technical changes to the rule to conform it more closely to analogous rules of other self-regulatory organizations, the rule change also included several substantive changes. First, the rule change amended the provision regarding the adjustment of an order in the case of a stock dividend or split to require that the order be rounded down to the next lowest share, rather than the next lowest round lot. Second, the rule change clarified the treatment of orders involving securities that are subject to a combined cash and stock dividend/split by specifying that, in these circumstances, firms should calculate the cash portion of the adjustment using the existing formula in subparagraph (1) of the rule and should calculate the stock portion of the adjustment using the existing formula in subparagraph (2) of the rule. Third, the rule change broadened the obligation of firms to cancel orders involving securities subject to a reverse split so that the rule now requires that all such orders be cancelled. Finally, the rule change amended the rule to require that firms notify customers who have pending orders that are not otherwise required to be adjusted under the rule of any stock splits in the security.

      Rule/Series Number Rule Title
      Rule 5000 Series SECURITIES OFFERING AND TRADING STANDARDS AND PRACTICES
      Rule 5300 Series HANDLING OF CUSTOMER ORDERS
      Rule 5330 Adjustments of Orders

      FINRA Rule Filing SR-FINRA-2009-086

      www.finra.org/rulefilings/2009-086

      FINRA Rule 5160

      The rule change adopts, without material change, NASD Rule 2770 (Disclosure of Price in Selling Agreements) as FINRA Rule 5160 (Disclosure of Price and Concessions in Selling Agreements) in the Consolidated FINRA Rulebook.

      Rule 5160 requires that selling syndicate agreements or selling group agreements: (1) set forth the price at which securities are to be sold to the public or the formula by which such price can be ascertained and (2) state clearly to whom and under what circumstances concessions, if any, may be allowed. The rule change amended only the title of the rule to clarify the rule's scope.

      Rule/Series Number Rule Title
      Rule 5000 Series SECURITIES OFFERING AND TRADING STANDARDS AND PRACTICES
      Rule 5100 Series SECURITIES OFFERINGS, UNDERWRITING AND COMPENSATION
      Rule 5160 Disclosure of Price and Concessions in Selling Agreements

    • 10-09 FINRA Reminds Firms of Their Sales Practice Obligations With Reverse Exchangeable Securities (Reverse Convertibles)

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      Reverse Convertibles

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Incorporated NYSE Rule 342
      NASD Rule 2210
      NASD Rule 2310
      NASD Rule 3010
      NASD Rule 3012
      NTM 05-26
      NTM 05-59
      Suggested Routing

      Advertising
      Compliance
      Legal
      Senior Management
      Key Topics

      Communications With the Public
      Options
      Reverse Exchangeable Securities (Reverse Convertibles)
      Structured Products
      Suitability
      Supervision and Training

      Executive Summary

      Reverse exchangeable securities, commonly called "reverse convertibles," are popular structured products with retail investors, due in large part to the high yields they offer. However, reverse convertibles are complex investments that often involve terms, features and risks that can be difficult for retail investors and registered representatives to evaluate. Firms that sell reverse convertibles are reminded to ensure that their promotional materials or communications to the public regarding these products are fair and balanced, and do not understate the risks associated with them. Firms are also reminded to ensure that their registered representatives understand the risks, terms and costs associated with these products, and that they perform an adequate suitability analysis before recommending them to any customer.

      General questions concerning this Notice should be directed to:

      •   Laura Gansler, Associate Vice President, Emerging Regulatory Issues, at (202) 728-8275; or
      •   Donald Lopezi, Director, Examination Programs, at (202-728-8132).

      Questions relating to communications with the public should be directed to Amy C. Sochard, Director, Programs & Investigations, Advertising Regulation, at (240) 386-4508.

      Background & Discussion

      A reverse convertible is a structured product that typically consists of a high-yield, short-term note of the issuer that is linked to the performance of an unrelated reference asset, usually common stock, a basket of stocks, an index or another instrument. The initial investment for most reverse convertibles is $1,000 per security, and most have maturity dates ranging from three months to one year. The coupon rate on the note component of a reverse convertible is usually higher than the yield on a conventional debt instrument of the issuer with a similar maturity, or of an issuer with a comparable debt rating. Some recently issued reverse convertibles have annualized coupon rates of 30 percent or more.

      The higher yield reflects the risk that, instead of a full return of principal at maturity, the investor could receive less than a full return of principal if the value of the reference asset has fallen below a certain level, often referred to as the "knock-in" or "barrier" level. Depending on the underlying asset, the investor could receive a predetermined number of shares of common stock (or cash equivalent), which would amount to less than the investor's original investment. Each reverse convertible has its own terms and conditions, but, generally, if the price of the reference asset remains above the knock-in level throughout the life of the note, the investor will receive a full return of principal. In some cases, the investor will also receive a full return of principal if the price of the reference asset ends above the knock-in level at maturity, even if it has fallen below it during the term of the investment; in other cases, any breach of the knock-in level will trigger repayment of less than the original principal (e.g., in shares of stock). However, the investor typically will not participate in any appreciation in the value of the reference asset during the life of the note.

      In effect, the investor in the reverse convertible is selling the issuer a put option on the reference asset in exchange for an above-market coupon during the life of the note. Generally speaking, the higher the coupon rate, the higher the expected volatility of the reference asset, which in turn means a greater likelihood that the knock-in price will be breached and the investor will receive less than a full return of principal at maturity.

      Reverse convertibles can have complex pay-out structures involving multiple variables that can make it difficult for registered representatives and their customers to accurately assess their risks, costs and potential benefits. For example,1 the pay-out structure of reverse convertibles with common stock as the reference asset could result in the following scenarios:

      Scenario2 Stock Price Visual At maturity, the investor gets
      1. The stock price never declines below the knock-in level, but ends below the original price. The stock price never declines below the knock-in level, but ends below the original price Full return of principal in cash (despite the decline in the stock price), plus any fixed coupon payments.
      2. The stock price never declines below the knock-in level, and ends above the original price. The stock price never declines below the knock-in level, and ends above the original price Full return of principal in cash, plus any fixed coupon payments, but no participation in the increase in the stock price.
      3. The stock price ends below the knock-in level. The stock price ends below the knock-in level Predetermined number of shares of stock (or cash equivalent), worth less than the principal amount, plus any fixed coupon payments.
      4. The stock price declines below the knock-in level, but ends between the original price and knock-in level. The stock price declines below the knock-in level, but ends between the original price and knock-in level Predetermined number of shares of stock (or cash equivalent) worth less than the principal amount, plus any fixed coupon payments; or full return of principal in cash, plus any fixed coupon payments, depending on the issuer and product.
      5. The stock price declines below the knock-in level, but ends above the original price. The stock price declines below the knock-in level, but ends above the original price Full return of principal in cash, plus any fixed coupon payments, but no participation in the increase in the stock price.

      Because the note component of a reverse convertible is an unsecured debt obligation of the issuer, the payment of the coupon is subject to the credit risk of the issuer. While the note component carries the issuer's rating, that rating does not reflect the product's market risk, including the risk that the price of the reference asset will fall below the knock-in level. Some reverse convertibles have call provisions that give the issuer the option to require redemption of the investment before maturity. There may also be complex tax implications associated with reverse convertibles, with tax treatment depending on whether the investor receives a return of principal or stock at maturity.

      Communications With the Public and Other Sales Practices

      Reverse convertibles are complex investments that may be difficult for investors to understand. Before recommending a reverse convertible to a retail customer, a registered representative should discuss the product with the customer to ensure that the customer makes an informed decision about whether to purchase the reverse convertible. The registered representative and retail customer should discuss such matters as the following:

      •   How the product works, including its payout structure, relevant information about the reference asset and, if applicable, that the investor will not participate in any appreciation in the value of the reference asset;
      •   The fact that the principal value of the investment is not guaranteed and the customer might suffer a loss on the investment;
      •   The ability of an investor to sell the product prior to maturity, and the potential sales price, may depend on the willingness of the issuer or another party to maintain a secondary market; and
      •   If applicable, the fact that the firm has published its own research reports regarding the reference asset, the content of that research and how the research is or is not relevant to a recommendation to purchase or sell the reverse convertible.

      Under NASD Rule 2210, firms must ensure that all communications with the public are based on principles of fair dealing and good faith, fair and balanced, and provide a sound basis for evaluating the facts about any particular security or type of security, industry or service. No firm may omit any material fact or qualification if the omission, in the light of the context of the material presented, would cause the communications to be misleading. For example, communications with the public should disclose the product and liquidity information noted above to the extent reasonably necessary to balance any discussion of the benefits and advantages of a reverse convertible. In addition, no firm may make any false, exaggerated, unwarranted or misleading statement or claim in any communication with the public, or publish, circulate or distribute any public communication that the firm knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading.

      Firms are reminded that providing risk disclosure in a prospectus or supplement does not cure otherwise deficient disclosure in sales material, even if that sales material is accompanied or preceded by the prospectus or prospectus supplement.

      Firms and their registered representatives should not suggest that reverse convertibles are ordinary debt securities. If a firm or registered representative refers to the product's credit rating, they may not suggest that the rating has any bearing on the expected performance of the reference asset, nor may they exaggerate the probability that the investor will receive a full return of principal.

      Firms must not present annualized yield or coupon information for reverse convertibles in a misleading manner. For example, a 10 percent per annum coupon provides an actual return of roughly 2.5 percent (based on a 360-day year) over a three-month term. For products that mature in less than a year, firms must balance any communication that promotes or touts annualized yield with prominent disclosure of the actual percentage return and the term of the note.

      Suitability

      NASD Rule 2310 requires that, before recommending the purchase or sale of a security, firms must have a reasonable basis for determining that the product is both suitable for at least some investors, and suitable for each specific customer to whom it is recommended. To assess the general suitability of a reverse convertible for at least some investors, firms must carefully review and understand the risks, costs, terms and conditions of the product. The firm must fully understand a reverse convertible's terms and features, including its payout structure, call features, the conditions under which the investor would and would not receive a full return of principal, the volatility of the reference asset and the product's credit, market and other risks. Because each reverse convertible is unique, firms must perform this analysis for each reverse convertible they recommend.3

      To assess the suitability of an investment for a specific customer, Rule 2310 requires that firms "shall make reasonable efforts to obtain information concerning: (1) the customer's financial status; (2) the customer's tax status; (3) the customer's investment objectives; and (4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer. "The firm's consideration of the benefits of the product to a particular customer (such as the promise of an above market coupon rate) must take into account the potential volatility of the reference asset, the risk that the investor may receive less than the value of the principal upon maturity, and the other risks and costs associated with the product. Depending upon the terms of a specific reverse convertible, even an above market coupon rate may not be reasonable given the risks and costs associated with the product for a particular customer. Firms should also consider the equity position that would result should the customer receive shares in the reference asset instead of a return of principal, and whether that position would be suitable for the customer.4

      In addition, NASD IM-2310-2(e) (Fair Dealing with Customers with Regard to Derivative Products or New Financial Products) emphasizes the obligation of firms to deal fairly with customers when making recommendations or accepting orders for new financial products. The IM states that "[a]s new products are introduced from time to time, it is important that firms make every effort to familiarize themselves with each customer's financial situation, trading experience, and ability to meet the risks involved with such products and to make every effort to make customers aware of the pertinent information regarding the products."

      Eligible Accounts

      Given the put option component of reverse convertibles, firms should also consider whether purchases of reverse convertibles should be restricted to investors whose accounts have been approved for options trading, and whether it would be appropriate to apply the suitability requirements for option trading to those products, including the requirement for firms recommending opening transactions in option contracts to have reasonable grounds for believing that the customer has such knowledge and experience in financial matters that he may reasonably be expected to be capable of evaluating these risks.5 Firms that do not limit reverse convertibles to accounts approved for options trading should develop other comparable procedures designed to ensure that reverse convertibles are only sold to persons for whom the risk of such products is appropriate. These firms should be prepared to demonstrate the basis for allowing investors with accounts not approved for trading options to purchase reverse convertibles. Firms also are reminded that approving an account to trade reverse convertibles is not a substitute for a thorough suitability analysis.6

      Supervision and Training

      FINRA firms must have adequate written supervisory procedures and supervisory controls that are reasonably designed to ensure that sales of reverse convertibles comply with the federal securities laws and FINRA rules.7 Firms must also adequately train employees who sell, or who supervise those who sell, reverse convertibles. Among other things, that training should emphasize the need to understand and consider:

      •   the costs and risks associated with the product;
      •   the terms and conditions of the product, including the pay-out structure at maturity;
      •   the reference stock, index or other asset;
      •   the investment's potential for growth;
      •   the product's liquidity before maturity; and
      •   any other features that might impact the product's suitability, both generally and for a specific customer.

      1 The examples in this Notice are hypothetical composites based on terms and structures of real notes, and are included for illustrative purposes only.

      2 These scenarios assume that the reverse convertibles are not callable. If one is called, generally the investor would receive the principal amount plus accrued interest.

      3 See NTM 05-59.

      4 Ibid.

      5 See FINRA Rule 2360(b)(19).

      6 See NTM 05-59. Also see NTM 05-26 regarding vetting new products.

      7 See NASD Rules 3010; NASD Rule 3012; and Incorporated NYSE Rule 342 and its related supplementary material and interpretations. The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those member firms of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA member firms, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice 3/12/08 (Rulebook Consolidation Process).

    • 10-08 Filing Requirements for Members that Carry Customer Margin Accounts; New Customer Margin Balance Form; Effective Date of Rule Requirements: February 8, 2010; Availability of New Form: March 1, 2010

      View PDF

      Customer Margin Accounts

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4521(d)
      FINRA Rule 4521(e)
      FINRA Rule 4521(f)
      Incorporated NYSE Rules 421(2)
      and 421.40
      Section 4(g) of Schedule A to the FINRA By-Laws
      Regulatory Notice 09-71
      Suggested Routing

      Compliance
      Legal
      Margin
      Operations
      Regulatory Reporting
      Senior Management
      Key Topic(s)

      Financial Responsibility
      Customer Margin Accounts

      Executive Summary

      Beginning March 1, 2010, members subject to new FINRA Rule 4521(d)1 must file FINRA's new Customer Margin Balance Form (covering the February 2010 reporting period).2

      FINRA Rule 4521(d) governs filing requirements for customer margin accounts and became effective on February 8, 2010. The rule, adopted as part of the new consolidated financial responsibility rules, replaces Incorporated NYSE Rules 421(2) and 421.40 and applies to all FINRA members that carry customer margin accounts.3

      The text of FINRA Rule 4521(d) is in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Glen Garofalo, Director, Credit Regulation, at (646) 315-8464;
      •   Debra German, Senior Credit Coordinator, Credit Regulation, at (646) 315-8467; or
      •   Theresa Reynolds, Credit Regulation Coordinator, Credit Regulation, at (646) 315-8567.

      Background & Discussion

      FINRA Rule 4521(d) Requirements

      FINRA Rule 4521(d) provides that, unless otherwise permitted by FINRA in writing, each member carrying margin accounts for customers is required to submit, on a settlement date basis, as of the last business day of the month: (A) the total of all debit balances in securities margin accounts; and (B) the total of all free credit balances in all cash accounts and all securities margin accounts.

      Please note: members must submit three separate data points, as the free credit balance total for cash accounts and the free credit balance total for securities margin accounts are two separate items.

      If a member has no information to submit, it should note that on the report. Reports are due as promptly as possible after the last business day of the month, but in no event later than the sixth business day of the following month. In connection with this requirement, members should note:

      •   The data in the member's report should reflect the status of all accounts on a settlement date basis, as of the last business day of each month.
      •   Each member must submit a single combined report (including all domestic and foreign main offices and branches).
      •   Customer balances in the account(s) of guarantors and in the related guaranteed accounts should not be combined.

      Rule 4521(d) requires that a member must only include free credit balances in cash and securities margin accounts in the report. Balances in short accounts and in special memorandum accounts (see Regulation T of the Board of Governors of the Federal Reserve System) are not considered free credit balances. Members should note:

      •   "Balances in short accounts" refers to balances derived from the proceeds of short sales.
      •   Credit balances in cash accounts and securities margin accounts are considered free (withdrawable) when the firm has no lien or claim against them, nor has imposed any other encumbrance, irrespective of whether the same customer has offsetting debits in another account.

      Lastly, Rule 4521(d) requires that reported debit or credit balance information not include the accounts of other FINRA members, or of the associated persons of the member submitting the report where such associated person's account is excluded from the definition of "customer" pursuant to Exchange Act Rule 15c3-3.

      New FINRA Customer Margin Balance Form

      Members that are required to file information pursuant to FINRA Rule 4521(d) must do so through the FINRA Firm Gateway (www.finra.org/firmgateway), where the new Customer Margin Balance Form will be available beginning March 1, 2010.4

      Late Fee

      Members should note that, unless FINRA grants a specific temporary extension of time, a late fee of $100 shall apply for each day (for a period not to exceed ten business days) that information required pursuant to Rule 4521(d) is not timely filed.5

      Public Availability of Data

      Data collected pursuant to NYSE Rules 421(2) and 421.40 has historically been made available to the public in aggregate form on the NYSE Web site.6 Beginning in March 2010, FINRA will post the data collected pursuant to FINRA Rule 4521(d), also in aggregate form, on FINRA's Web site.


      1 Effective with the rule change, NYSE Form R-1, which Dual Members currently file pursuant to Incorporated NYSE Rule 421.40, has been discontinued.

      2 The current FINRA rulebook consists of: (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA member firms, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice 3/12/08 (Rulebook Consolidation Process).

      3 FINRA Rule 4521(d) is substantively similar to Incorporated NYSE Rule 421.40. See Regulatory Notice 09-71 (SEC Approves Consolidated FINRA Rules Governing Financial Responsibility) (December 2009). See also Exchange Act Release No. 60933 (November 4, 2009), 74 FR 58334 (November 12, 2009) (Order Granting Approval to Proposed Rule Change; File No. SR-FINRA-2008-067); Exchange Act Release No. 61408 (January 22, 2010), 75 FR 4596 (January 28, 2010) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change; File No. SR-FINRA-010-004).

      4 Members should note that their Regulation Filing Applications Account Administrator can provide access to the Customer Margin Balance Form in the Firm Gateway, and also provide a FINRA user ID, if needed. Members can also contact the FINRA Help Desk at (800) 321-6273 and refer to www.finra.org/regulationfiling for additional information on requesting entitlement.

      5 See FINRA Rules 4521(e) and (f) and Section 4(g) of Schedule A to the FINRA By-Laws.

      6 Similar information, in modified form, has also been posted on FINRA's Web site at www.finra.org/statistics/margin.


      ATTACHMENT A

      Below is the text of new FINRA Rule 4521(d).

      *****

      4521. Notifications, Questionnaires and Reports

      *****

      (d)
      (1) Unless otherwise permitted by FINRA in writing, members carrying margin accounts for customers are required to submit, on a settlement date basis, the information specified in paragraphs (d)(2)(A) and (d)(2)(B) of this Rule as of the last business day of the month. If a member has no information to submit, a report should be filed with a notation thereon to that effect. Reports are due as promptly as possible after the last business day of the month, but in no event later than the sixth business day of the following month. Members shall use such form as FINRA may prescribe for these reporting purposes.
      (2) Each member carrying margin accounts for customers shall submit reports containing the following customer information:
      (A) Total of all debit balances in securities margin accounts; and
      (B) Total of all free credit balances in all cash accounts and all securities margin accounts.
      (3) For purposes of this paragraph (d):
      (A) Only free credit balances in cash and securities margin accounts shall be included in the member's report. Balances in short accounts and in special memorandum accounts (see Regulation T of the Board of Governors of the Federal Reserve System) shall not be considered as free credit balances.
      (B) Reported debit or credit balance information shall not include the accounts of other FINRA members, or of the associated persons of the member submitting the report where such associated person's account is excluded from the definition of customer pursuant to SEA Rule 15c3-3.

      *****

    • 10-07 SEC Approves Amendments to FINRA Rules on Reporting Cancellations of Previously Reported OTC Trades in Equity Securities; Effective Date: April 12, 2010

      View PDF

      Trade Reporting

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6282
      FINRA Rule 6380A
      FINRA Rule 6380B
      FINRA Rule 6622
      Suggested Routing

      Compliance
      Executive Representatives
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Training
      Key Topic(s)

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

      Executive Summary

      Effective Monday, April 12, 2010, firms are no longer prohibited from reporting trade cancellations to the FINRA/NASDAQ Trade Reporting Facility and the OTC Reporting Facility after 5:15 p.m. Eastern Time on trade date, as described more fully in this Notice. Firms are reminded that they must report the cancellation of any previously reported over-the-counter transaction in an equity security to FINRA, in accordance with FINRA trade reporting rules.

      The text of the amendments is available at www.finra.org/rulefilings/2009-082.

      Questions regarding this Notice may be directed to:

      •   FINRA Operations at (866) 776-0800; or
      •   The Office of General Counsel at (202) 728-8071.

      Background and Discussion

      FINRA rules require firms to report the cancellation of any over-the-counter (OTC) trade that was previously submitted to a FINRA trade reporting facility within certain prescribed time periods.1 On January 14, 2010, the SEC approved amendments to the rules to (1) allow firms to submit reports of trade cancellations on trade date until the close of the FINRA/NASDAQ Trade Reporting Facility (FINRA/NASDAQ TRF) and the OTC Reporting Facility (ORF) at 8 p.m. Eastern Time (ET); and (2) make certain changes to the requirements applicable to reporting trade cancellations to the Alternative Display Facility (ADF) to conform to the rules relating to the other FINRA trade reporting facilities.2

      Thus, for example, in accordance with the amendments, if a trade executed during normal market hours (i.e., 9:30 a.m. to 4 p.m. ET) is canceled on trade date, the firm must report the cancellation to FINRA as follows:

      1) if the trade is canceled during normal market hours, the firm must report the cancellation within 90 seconds;
      2) if the trade is canceled after 4 p.m. and before the FINRA facility closes, the firm shall use its best efforts to report the cancellation on the date of execution, and otherwise it shall report on the following business day; and
      3) if the trade is canceled after the FINRA facility closes, the firm must report the cancellation on the following business day.3

      Prior to the amendments, the rules governing the reporting of trade cancellations to the FINRA/NASDAQ TRF and ORF were based on the traditional 5:15 p.m. ET "media" cut-off time (i.e., for the submission of trades for public dissemination purposes) and prohibited the reporting of trade cancellations after 5:15 p.m. on trade date; if a firm did not report a trade cancellation by 5:15 p.m. on trade date, then it was required—by rule and systems limitations—to wait until the next day to report the cancellation. The amendments eliminate this prohibition.

      As a result, trade cancellations will be submitted to the Securities Information Processors (SIPs) by the FINRA/NASDAQ TRF and to the Trade Data Dissemination Service (TDDS) feed by the ORF after 5:15 p.m. on trade date, and the SIP high price/low price/last sale price calculations for the day will be updated after 5:15 p.m. FINRA notes that the current rules governing the reporting of cancellations to the ADF and FINRA/NYSE Trade Reporting Facility (FINRA/NYSE TRF) are not based on the 5:15 p.m. media cut-off, and, as such, cancellations of trades submitted to the ADF and FINRA/NYSE TRF after 5:15 p.m. update the SIP high/low/last calculations today.

      Firms are reminded that they are required to report the cancellation of a trade to the same FINRA facility to which the trade was originally reported.4


      1 See Rules 6282(j), 6380A(g), 6380B(f) and 6622(f).

      2 See Securities Exchange Act Release No. 61359 (January 14, 2010), 75 FR 3772 (January 22, 2010) (Order Approving SR-FINRA-2009-082).

      3 FINRA notes that, as a technical matter, the firm would reverse the trade on any date other than trade date (if on trade date, the firm would cancel the trade). See, e.g., Trade Reporting Frequently Asked Questions, #305.6. The rules apply uniformly to cancellations and reversals.

      4 See Rules 6282(j), 6380A(g), 6380B(f) and 6622(f).

    • 10-06 Guidance on Blogs and Social Networking Web Sites

      View PDF

      Social Media Web Sites

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      ICA Section 24(b)
      NASD Rule 2210
      NASD Rule 2310
      NASD Rule 2711
      NASD Rule 3010
      NASD Rule 3070
      NASD Rule 3110
      NYSE Rule 351
      NYSE Rule 401A
      NYSE Rule 410
      NYSE Rule 472
      NTM 01-23
      NTM 03-33
      Regulatory Notice 07-59
      Regulatory Notice 09-55
      SEA Rule 17a-3
      SEA Rule 17a-4
      Securities Act Rule 482
      Suggested Routing

      Advertising
      Compliance
      Legal
      Operations
      Registered Representative
      Senior Management
      Key Topics

      Blogs
      Communications with the Public
      Recordkeeping
      Social Networking Web Sites
      Supervision

      Executive Summary

      Americans are increasingly using social media Web sites, such as blogs and social networking sites, for business and personal communications. Firms have asked FINRA staff how the FINRA rules governing communications with the public apply to social media sites that are sponsored by a firm or its registered representatives. This Notice provides guidance to firms regarding these issues.

      Questions concerning this Notice may be directed to:

      •   Joseph E. Price, Senior Vice President, Advertising Regulation/Corporate Financing, at (240) 386-4623; or
      •   Thomas A. Pappas, Vice President and Director, Advertising Regulation, at (240) 386-4500.

      Background

      According to a recent report by the Pew Internet and American Life Project, 46 percent of American adults who use the Internet logged onto a social networking site in 2009, which is up from 8 percent in 2005.1 Other studies have shown that use of social media sites by businesses to communicate with customers and the public has grown significantly in the past few years.2

      FINRA has provided guidance concerning particular applications of the communications rules to interactive Web sites in the past. For example, in March 1999, FINRA stated that a registered representative's participation in an Internet chat room is subject to the same requirements as a presentation in person before a group of investors.3 This guidance was codified in 2003, when FINRA defined the term "public appearance" in NASD Rule 2210 to include participation in an interactive electronic forum.4

      FINRA also has provided guidance regarding the application of the communication rules in its Guide to the Internet for Registered Representatives,5 and has released podcasts on these issues to help educate firms and their personnel.6 Nevertheless, FINRA staff has continued to receive numerous inquiries from firms and others concerning how the FINRA rules governing communications with the public apply to the use of social media sites by firms and their registered representatives. Firms also have inquired regarding their recordkeeping responsibilities for communications posted on social media sites.

      In September 2009, FINRA organized a Social Networking Task Force composed of FINRA staff and industry representatives to discuss how firms and their registered representatives could use social media sites for legitimate business purposes in a manner that ensures investor protection. Based on input from the Task Force and others, and further staff consideration of these issues, FINRA is issuing this Notice to guide firms on applying the communications rules to social media sites, such as blogs and social networking sites. The goal of this Notice is to ensure that—as the use of social media sites increases over time—investors are protected from false or misleading claims and representations, and firms are able to effectively and appropriately supervise their associated persons' participation in these sites. At the same time, FINRA is seeking to interpret its rules in a flexible manner to allow firms to communicate with clients and investors using this new technology.

      While many firms may find that the guidance in this Notice is useful when establishing their own procedures, each firm must develop policies and procedures that are best designed to ensure that the firm and its personnel comply with all applicable requirements. Every firm should consider the guidance provided by this Notice in the context of its own business and its compliance and supervisory programs.

      This Notice only addresses the use by a firm or its personnel of social media sites for business purposes. The Notice does not purport to address the use by individuals of social media sites for purely personal reasons.

      Questions & Answers

      Recordkeeping Responsibilities

      Q1: Are firms required to retain records of communications related to the broker-dealer's business that are made through social media sites?
      A1: Yes. Every firm that intends to communicate, or permit its associated persons to communicate, through social media sites must first ensure that it can retain records of those communications as required by Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 and NASD Rule 3110. SEC and FINRA rules require that for record retention purposes, the content of the communication is determinative and a broker-dealer must retain those electronic communications that relate to its "business as such."7

      FINRA is aware that some technology providers are developing systems that are intended to enable firms to retain records of communications made through social media sites. Some systems might interface with a firm's network to capture social media participation and feed it into existing systems for the review and retention of email. Other providers are developing technology that might permit a registered representative working off-site to elect to access social media through platforms that will retain the communications on behalf of the firm.

      Of course, it is up to each firm to determine whether any particular technology, system or program provides the retention and retrieval functions necessary to comply with the books and records rules. FINRA does not endorse any particular technology necessary to keep such records, nor is it certain that adequate technology currently exists.

      Suitability Responsibilities

      Q2: If a firm or its personnel recommends a security through a social media site, does this trigger the requirements of NASD Rule 2310 regarding suitability?
      A2: Yes. Whether a particular communication constitutes a "recommendation" for purposes of Rule 2310 will depend on the facts and circumstances of the communication. Firms should consult Notice to Members (NTM) 01-23 (Online Suitability) for additional guidance concerning when an online communication falls within the definition of "recommendation" under Rule 2310.

      Various social media sites include functions that make their content widely available or that limit access to one or more individuals. Rule 2310 requires a broker-dealer to determine that a recommendation is suitable for every investor to whom it is made.
      Q3: What factors should firms consider when developing procedures for supervising interactive electronic communications on a social media site that recommend specific investment products?
      A3: Communications that recommend specific investment products often present greater challenges for a firm's compliance program than other communications. As discussed above, they may trigger the FINRA suitability rule, thus creating possible substantive liability for the firm or a registered representative. These communications must often include additional disclosure in order to provide the customer with a sound basis for evaluating the facts with respect to the product. They also might trigger other requirements under the federal securities laws.8 FINRA has brought disciplinary actions regarding interactive electronic communications that contained misleading statements about investment products that the communications recommended.9

      For these reasons, firms must adopt policies and procedures reasonably designed to address communications that recommend specific investment products. As a best practice, firms should consider prohibiting all interactive electronic communications that recommend a specific investment product and any link to such a recommendation unless a registered principal has previously approved the content.

      Alternatively, many firms maintain databases of previously approved communications and provide their personnel with routine access to these templates. Firms might consider prohibiting communications that recommend a specific investment product unless the communication conforms to a pre-approved template and the specific recommendation has been approved by a registered principal. Firms also should consider adopting policies and procedures governing communications that promote specific investment products, even if these communications might not constitute a "recommendation" for purposes of our suitability rule or otherwise.

      Types of Interactive Electronic Forums

      The definition of "public appearance" in NASD Rule 2210 includes unscripted participation in an interactive electronic forum such as a chat room or online seminar. Rule 2210 does not require firms to have a registered principal approve in advance the extemporaneous remarks of personnel who participate in public appearances. However, these interactive electronic forums are subject to other supervisory requirements and to the content requirements of FINRA's communications rule.

      Q4: Does a blog constitute an "interactive electronic forum" for purposes of Rule 2210?
      A4: The treatment of a blog under Rule 2210 depends on the manner and purposes for which the blog has been constructed. Merriam-Webster's Online Dictionary defines "blog" as "a Web site that contains an online personal journal with reflections, comments, and often hyperlinks provided by the writer."10 Historically, some blogs have consisted of static content posted by the blogger. FINRA considers static postings to constitute "advertisements" under Rule 2210. If a firm or its registered representative sponsors such a blog, it must obtain prior principal approval of any such posting. Today, however, many blogs enable users to engage in real-time interactive communications. If the blog is used to engage in real-time interactive communications, FINRA would consider the blog to be an interactive electronic forum that does not require prior principal approval; however, such communications must be supervised, as discussed below.11
      Q5: Social networking sites, such as Facebook, Twitter and LinkedIn, typically include both static content and interactive functions. Are these sites interactive electronic forums for purposes of Rule 2210?
      A5: Social networking sites typically contain both static and interactive content. The static content remains posted until it is changed by the firm or individual who established the account on the site. Generally, static content is accessible to all visitors to the site.

      Examples of static content typically available through social networking sites include profile, background or wall information. As with other Web-based communications such as banner advertisements, a registered principal of the firm must approve all static content on a page of a social networking site established by the firm or a registered representative before it is posted.12 Firms may use an electronic system to document these approvals.

      Social networking sites also contain non-static, real-time communications, such as interactive posts on sites such as Twitter and Facebook. The portion of a social networking site that provides for these interactive communications constitutes an interactive electronic forum, and firms are not required to have a registered principal approve these communications prior to use. Of course, firms still must supervise these communications, as discussed below.

      Supervision of Social Media Sites

      Q6: How must firms supervise interactive electronic communications by the firm or its registered representatives using blogs or social networking sites?
      A6: The content provisions of FINRA's communications rules apply to interactive electronic communications that the firm or its personnel send through a social media site. While prior principal approval is not required under Rule 2210 for interactive electronic forums, firms must supervise these interactive electronic communications under NASD Rule 3010 in a manner reasonably designed to ensure that they do not violate the content requirements of FINRA's communications rules.13

      Firms may adopt supervisory procedures similar to those outlined for electronic correspondence in Regulatory Notice 07-59 (FINRA Guidance Regarding Review and Supervision of Electronic Communications). As set forth in that Notice, firms may employ risk-based principles to determine the extent to which the review of incoming, outgoing and internal electronic communications is necessary for the proper supervision of their business.

      For example, firms may adopt procedures that require principal review of some or all interactive electronic communications prior to use or may adopt various methods of post-use review, including sampling and lexicon-based search methodologies as discussed in Regulatory Notice 07-59. We are aware that technology providers are developing or may have developed systems that are intended to address both the books and records rules and supervisory procedures for social media sites that are similar or equivalent to those currently in use for emails and other electronic communications. FINRA does not endorse any particular technology. Whatever procedures firms adopt, however, must be reasonably designed to ensure that interactive electronic communications do not violate FINRA or SEC rules.

      Firms are also reminded that they must have policies and procedures, as described in Regulatory Notice 07-59, for the review by a supervisor of employees' incoming, outgoing and internal electronic communications that are of a specific subject matter that require review under FINRA rules and federal securities laws, including:
      •   NASD Rule 2711(b)(3)(A) and NYSE Rule 472(b)(3), which require that a firm's legal and compliance department be copied on communications between non-research and research departments concerning the content of a research report;
      •   NASD Rule 3070(c) and NYSE Rule 351(d), which require the identification and reporting of customer complaints; NYSE Rule 401A requires that the receipt of each complaint be acknowledged by the firm to the customer within 15 business days; and
      •   NASD Rule 3110(j) and NYSE Rule 410, which require the identification and prior written approval of every order error and other account designation change.
      Q7: What restrictions should firms place on which personnel may establish an account with a social media site?
      A7: Firms must adopt policies and procedures reasonably designed to ensure that their associated persons who participate in social media sites for business purposes are appropriately supervised, have the necessary training and background to engage in such activities, and do not present undue risks to investors. Firms must have a general policy prohibiting any associated person from engaging in business communications in a social media site that is not subject to the firm's supervision. Firms also must require that only those associated persons who have received appropriate training on the firm's policies and procedures regarding interactive electronic communications may engage in such communications.

      As firms develop their policies, they should consider prohibiting or placing restrictions on any associated person who has presented compliance risks in the past, particularly compliance risks concerning sales practices, from establishing accounts for business purposes with a social media site. In its supervision of social networking sites, each firm must monitor the extent to which associated persons are complying with the firm's policies and procedures governing the use of these sites. Firms also should consider policies that address associated persons' continued use of such sites if the firm's supervisory systems demonstrate compliance risks. Firms should take disciplinary action if the firm's policies are violated.

      Third-Party Posts

      Q8: If a customer or other third party posts content on a social media site established by the firm or its personnel, does FINRA consider the third-party content to be the firm's communication with the public under Rule 2210?
      A8: As a general matter, FINRA does not treat posts by customers or other third parties as the firm's communication with the public subject to Rule 2210. Thus, the prior principal approval, content and filing requirements of Rule 2210 do not apply to these posts.

      Under certain circumstances, however, third-party posts may become attributable to the firm. Whether third-party content is attributable to a firm depends on whether the firm has (1) involved itself in the preparation of the content or (2) explicitly or implicitly endorsed or approved the content.

      The SEC has referred to circumstance (1) above as the "entanglement" theory (i.e., the firm or its personnel is entangled with the preparation of the third-party post) and (2) as the "adoption" theory (i.e., the firm or its personnel has adopted its content).14 Although the SEC has employed these theories as a basis for a company's responsibility for third-party information that is hyperlinked to its Web site, a similar analysis would apply to third-party posts on a social media site established by the firm or its personnel.

      For example, FINRA would consider such a third-party post to be a communication with the public by the firm or its personnel under the entanglement theory if the firm or its personnel paid for or otherwise was involved with the preparation of the content prior to posting. FINRA also would consider a third-party post to be a communication with the public by the firm or its personnel under the adoption theory if, after the content is posted, the firm or its personnel explicitly or implicitly endorses or approves the post.15
      Q9: Must a firm also use a disclaimer to inform customers that third-party posts do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy?
      A9: Assuming the disclaimer was sufficiently prominent to inform investors of the firm's position, such a disclaimer would be part of the facts and circumstances that FINRA would consider in an analysis of whether a firm had adopted or become entangled with a posting.
      Q10: Must a firm monitor third-party posts?
      A10: FINRA does not consider a third-party post to be a firm communication with the public unless the firm or its personnel either is entangled with the preparation of the third-party post or has adopted its content. Nevertheless, FINRA has found through its discussions with members of the Social Networking Task Force and others that many firms monitor third-party posts on firm Web sites. For example, some firms monitor third-party posts to mitigate the perception that the firm is adopting a third-party post, to address copyright issues or to assist compliance with the "Good Samaritan" safe harbor for blocking and screening offensive material under the Communications Decency Act.16

      Some of the other best practices adopted by Task Force members include:
      •   establishing appropriate usage guidelines for customers and other third parties that are permitted to post on firm-sponsored Web sites;
      •   establishing processes for screening third-party content based on the expected usage and frequency of third-party posts; and
      •   disclosing firm policies regarding its responsibility for third-party posts.

      1 See Amanda Lenhart, Pew Internet and American Life Project, The Democratization of Online Social Networks (Oct. 8, 2009), http://fe01.pewinternet.org/Presentations/2009/41—The-Democratization-of-Online-Social-Networks.aspx.

      2 Sharon Gaudin, Business Use of Facebook, Twitter Exploding, Computerworld (Nov. 9, 2009), at www.computerworld.com/s/article/9140579/Business_use_of_Twitter_Facebook_exploding.

      3 See "Ask the Analyst—Electronic Communications," NASD Regulation, Regulatory & Compliance Alert (Mar. 1999) ("March 1999 Ask the Analyst").

      4 See NASD Rule 2210(a)(5).

      5 See Guide to the Internet for Registered Representatives, at www.finra.org/Industry/Issues/Advertising/p006118.

      6 See "Electronic Communications: Blogs, Bulletin Boards and Chat Rooms" (Feb. 23, 2009), and "Electronic Communications: Social Networking Web Sites" (Mar. 10, 2009) at www.finra.org/podcasts.

      FINRA is also hosting webinars on compliance considerations for social networking sites on February 3 and March 17, 2010. Find more information at www.finra.org/webinars.

      7 See, SEC Rel. No. 34-37182 (May 9, 1996), 61 Fed. Reg. 24644 (May 15, 1996); SEC Rel. No. 34-38245 (Feb. 5, 1997), 62 Fed. Reg. 6469 (Feb. 12, 1997); Notice to Members 03-33 (July 2003).

      8 For example, even if FINRA considers a communication made through an interactive electronic forum to be a public appearance, the SEC staff could still conclude that Rule 482 under the Securities Act of 1933 and the filing requirements of Section 24(b) of the Investment Company Act of 1940 apply to the communication. Accordingly, firms must consider these requirements in determining whether to permit interactive electronic communications that discuss registered investment companies.

      9 For example, in a Default Decision dated November 23, 2009, FINRA fined and suspended a registered principal who held put options for himself and issued unapproved bulletin board messages that urged investors to sell the underlying stock. The bulletin board messages omitted material disclosure regarding his interest in the stock.

      10 Merriam-Webster's Online Dictionary, definition of "blog," at http://www.merriam-webster.com/dictionary/BLOG.

      11 The key to this distinction between whether a blog is considered an advertisement versus an interactive electronic forum is whether it is used to engage in real-time interactive communications with third parties. Thus, the mere updating of a non-interactive blog (or any other firm Web page) does not cause it to become an interactive electronic forum, even if the updating occurs frequently.

      12 Currently, NASD Rule 2210(b) requires that a registered principal of a firm approve all advertisements and sales literature prior to use either electronically or in writing. FINRA has proposed amendments to this rule. These amendments would retain this prior to use principal approval requirement for "retail communications" as defined in the proposal. See Regulatory Notice 09-55 (Sept. 2009).

      13 See, e.g., March 1999 Ask the Analyst, supra note 3.

      14 See Commission Guidance on the Use of Company Web Sites, SEC Rel. No. 34-58288 (Aug. 1, 2008), 73 Fed. Reg. 45862, 45870 (Aug. 7, 2008) ("2008 SEC Release"); Use of Electronic Media, SEC Rel. No. 33-7856 (April 28, 2000), 65 Fed. Reg. 25843, 25848–25849 (May 4, 2000).

      15 See 2008 SEC Release, supra note 14, 65 Fed. Reg. 45870 n.78.

      16 See 47 U.S.C. § 230(c).

    • 10-05 FINRA Reminds Firms of Their Responsibilities Under FINRA Rule 2330 for Recommended Purchases or Exchanges of Deferred Variable Annuities

      View PDF

      Deferred Variable Annuities

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 2150
      FINRA Rule 2320
      FINRA Rule 2330
      NASD Rule 2330
      NASD Rule 2820
      NASD Rule 2821
      SEA Rule 15c3-1
      SEA Rule 15c3-3
      Regulatory Notice 07-53
      Regulatory Notice 09-32
      Regulatory Notice 09-72
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topic(s)

      Deferred Variable Annuities
      Principal Review
      Sales Practices
      Suitability
      Supervision

      Executive Summary

      FINRA reminds firms of their responsibilities under the new consolidated FINRA rule on deferred variable annuities.1 The implementation date of the FINRA rule—as well as previously approved amendments to parts of the rule covering principal review and supervisory procedures—is February 8, 2010.2 This Notice also addresses issues raised about a firm's ability to hold checks made payable to entities other than itself (third parties) pursuant to interpretive relief that FINRA previously issued.3

      For easy reference, the text of new FINRA Rule 2330 is set forth in Attachment A.

      Questions regarding this Notice should be directed to:

      •   James S. Wrona, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8270; or
      •   Lawrence N. Kosciulek, Director, Investment Companies Regulation, at (240) 386-4535.

      Background & Discussion

      FINRA Rule 2330 (formerly NASD Rule 2821) establishes sales practice standards regarding recommended purchases and exchanges of deferred variable annuities.4 The rule has the following six main sections:

      •   General considerations, such as the rule's applicability;
      •   Recommendation requirements, including suitability and disclosure obligations;
      •   Principal review and approval obligations;
      •   Requirements for establishing and maintaining supervisory procedures;
      •   Training obligations; and
      •   Supplementary material that addresses a variety of issues ranging from the handling of customer funds and checks to information gathering and sharing.

      As noted above, all of the rule's provisions are applicable as of February 8, 2010.

      Recently, questions have been raised regarding FINRA's limited interpretive relief from the requirements of FINRA Rule 2150(a) (formerly NASD Rule 2330(a)) and FINRA Rule 2320(d) (formerly NASD Rule 2820(d)).5 The former rule generally prohibits firms from making improper use of customer funds, and the latter requires firms to transmit promptly to issuers applications and purchase payments for variable contracts. FINRA provided limited interpretive relief from these rules to allow firms to perform comprehensive and rigorous reviews of recommended transactions in deferred variable annuities under FINRA Rule 2330.6

      FINRA originally stated that "a firm may hold an application for a deferred variable annuity and a customer's non-negotiated check payable to an insurance company for up to seven business days without violating either NASD Rule 2330 or 2820 if the reason for the hold is to allow completion of principal review of the transaction pursuant to NASD Rule 2821."7 After the SEC approved amendments that changed the starting point for the review period—from the date when the customer signs the application to the date when a firm's office of supervisory jurisdiction (OSJ) receives a complete and correct application package—FINRA explained that its limited interpretive relief "continues to apply even though the triggering event for the principal review period has changed via the recently approved amendments."8

      Concerns have been expressed, however, regarding the breadth of the interpretive relief and the conditions that must be present for it to apply. FINRA now clarifies that the interpretive relief applies only if the seven conditions delineated below are present.9

      1. The reason that the firm is holding the application for a deferred variable annuity and/or a customer's non-negotiated check payable to a third party is to allow completion of principal review of the transaction pursuant to FINRA Rule 2330.
      2. The associated person who recommended the purchase or exchange of the deferred variable annuity makes reasonable efforts to safeguard the check and to promptly prepare and forward a complete and correct copy of the application package to an OSJ.
      3. The firm has policies and procedures in place that are reasonably designed to ensure that the check is safeguarded and that reasonable efforts are made to promptly prepare and forward a complete and correct copy of the application package to an OSJ.
      4. A principal reviews and makes a determination of whether to approve or reject the purchase or exchange of the deferred variable annuity in accordance with the provisions of FINRA Rule 2330.
      5. The firm holds the application and/or check no longer than seven business days from the date an OSJ receives a complete and correct copy of the application package.
      6. The firm maintains a copy of each such check and creates a record of the date the check was received from the customer and the date the check was transmitted to the insurance company or returned to the customer.
      7. The firm creates a record of the date when the OSJ receives a complete and correct copy of the application package.

      If these seven conditions are not present, FINRA's interpretive relief will not apply and it will enforce FINRA Rules 2150(a) and 2320(d), as appropriate.


      1 On November 20, 2009, the Financial Industry Regulatory Authority, Inc. (FINRA) filed with the Securities and Exchange Commission (SEC or Commission) a proposed rule change, for immediate effectiveness, to transfer NASD Rule 2821 into the Consolidated FINRA Rulebook, as FINRA Rule 2330, without any substantive changes. See Exchange Act Release No. 61122 (December 7, 2009), 74 FR 65816 (December 11, 2009) (File No. SR-FINRA-2009-083); Regulatory Notice 09-72 (December 2009) (discussing adoption of consolidated FINRA rules, including FINRA Rule 2330 covering deferred variable annuities). The current FINRA rulebook consists of (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA members, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA members, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice, 3/12/08 (Rulebook Consolidation Process).

      2 See Exchange Act Release No. 61122 (December 7, 2009), 74 FR 65816 (December 11, 2009) (File No. SR-FINRA-2009-083); Regulatory Notice 09-72 (December 2009) (discussing adoption of consolidated FINRA rules and an operative date for FINRA Rule 2330 of February 8, 2010); Exchange Act Release No. 59772 (April 15, 2009), 74 FR 18419 (April 22, 2009) (Order Approving File No. SR-FINRA-2008-019); Regulatory Notice 09-32 (June 2009) (announcing SEC approval of amendments to NASD Rule 2821 governing purchases and exchanges of deferred variable annuities and an effective date for those amendments of February 8, 2010). FINRA notes that paragraphs (a) (General Considerations), (b) (Recommendation Requirements), and (e) (Training) of NASD Rule 2821 became effective on May 5, 2008. See Regulatory Notice 07-53 (November 2007).

      3 See Regulatory Notice 07-53 (November 2007); see also Regulatory Notice 09-32 (June 2009).

      4 In general, a variable annuity is a contract between an investor and an insurance company, whereby the insurance company promises to make periodic payments to the contract owner or beneficiary, starting immediately (an immediate variable annuity) or at some future time (a deferred variable annuity). See Joint SEC and NASD Staff Report on Broker-Dealer Sales of Variable Insurance Products (June 2004), available at www.sec.gov/news/studies/secnasdvip.pdf.

      5 See Regulatory Notice 07-53 (November 2007); see also Regulatory Notice 09-32 (June 2009).

      6 See Regulatory Notice 07-53 (November 2007); see also Regulatory Notice 09-32 (June 2009). The SEC previously has noted that "many broker-dealers are subject to lower net capital requirements under SEA Rule 15c3-1 and are exempt from the requirement to establish and fund a customer reserve account under SEA Rule 15c3-3 because they do not carry customer funds or securities." See Exchange Act Release No. 56376 (Sept. 7, 2007), 72 FR 52400 (Sept. 13, 2007) (Order Granting Exemption to Broker-Dealers from Requirements in SEA Rules 15c3-1 and 15c3-3 to Promptly Transmit Customer Checks). Although some of these firms receive checks from customers made payable to third parties, the SEC does not deem a firm to be carrying customer funds if it "promptly transmits" the checks to third parties. The SEC has interpreted "promptly transmits" to mean that "such transmission or delivery is made no later than noon of the next business day after receipt of such funds or securities." Id. at 52400.

      The SEC provided a conditional exemption for broker-dealers from any additional requirements of Rules 15c3-1 and 15c3-3 due solely to a failure to promptly transmit a check made payable to an insurance company for the purchase of a deferred variable annuity product by noon of the business day following the date the broker-dealer receives the check from the customer, provided (i) the transaction is subject to the principal review requirements of NASD Rule 2821 and a registered principal has reviewed and determined whether he or she approves of the purchase or exchange of the deferred variable annuity within seven business days in accordance with that rule; (ii) the broker-dealer promptly transmits the check no later than noon of the business day following the date a registered principal reviews and determines whether he or she approves of the purchase or exchange of the deferred variable annuity; and (iii) the broker-dealer maintains a copy of each such check and creates a record of the date the check was received from the customer and the date the check was transmitted to the insurance company if approved, or returned to the customer if rejected. Id. at 52400. In its order approving recent amendments, the SEC explained that the exemption order continues to apply, notwithstanding the new starting point for the principal review period under NASD Rule 2821. See Exchange Act Release No. 59772 (April 15, 2009), 74 FR 18419, at 18422 n.37 (April 22, 2009) (Order Approving File No. SR-FINRA-2008-019).

      7 Regulatory Notice 07-53 (November 2007).

      8 Regulatory Notice 09-32 (June 2009).

      9 FINRA emphasizes that firms are not required to collect and hold checks or funds prior to principal review and approval. A firm may elect to wait until after a principal approves the transaction to collect the check or funds for a deferred variable annuity. Moreover, in accordance with Supplementary Material .03 under FINRA Rule 2330, a firm can forward a check made payable to the insurance company or, if the firm is fully subject to SEA Rule 15c3-3, transfer "funds for the purchase of a deferred variable annuity to the insurance company prior to the member's principal approval of the deferred variable annuity, as long as the member fulfils the following requirements: (a) the member must disclose to the customer the proposed transfer or series of transfers of the funds and (b) the member must enter into a written agreement with the insurance company under which the insurance company agrees that, until such time as it is notified of the member's principal approval and is provided with the application or is notified of the member's principal rejection, it will (1) segregate the member's customers' funds in a 'Special Account for the Exclusive Benefit of Customers' (set up as described in SEA Rules 15c3-3(k)(2)(i) and 15c3-3(f)) to ensure that the customers' funds will not be subject to any right, charge, security interest, lien, or claim of any kind in favor of the member, insurance company, or bank where the insurance company deposits such funds or any creditor thereof or person claiming through them and hold those funds either as cash or any instrument that a broker or dealer may deposit in its Special Reserve Account for the Exclusive Benefit of Customers, (2) not issue the variable annuity contract prior to the member's principal approval, and (3) promptly return the funds to each customer at the customer's request prior to the member's principal approval or upon the member's rejection of the application."


      Attachment A

      Text of FINRA Rule 2330

      * * * * *

      2000. DUTIES AND CONFLICTS

      * * * * *

      2300. SPECIAL PRODUCTS

      * * * * *

      2330. Members' Responsibilities Regarding Deferred Variable Annuities

      * * * * *

      (a) General Considerations
      (1) Application

      This Rule applies to recommended purchases and exchanges of deferred variable annuities and recommended initial subaccount allocations. This Rule does not apply to reallocations among subaccounts made or to funds paid after the initial purchase or exchange of a deferred variable annuity. This Rule also does not apply to deferred variable annuity transactions made in connection with any tax-qualified, employer-sponsored retirement or benefit plan that either is defined as a "qualified plan" under Section 3(a)(12)(C) of the Exchange Act or meets the requirements of Internal Revenue Code Sections 403(b), 457(b), or 457(f), unless, in the case of any such plan, a member or person associated with a member makes recommendations to an individual plan participant regarding a deferred variable annuity, in which case the Rule would apply as to the individual plan participant to whom the member or person associated with the member makes such recommendations.
      (2) Creation, Storage, and Transmission of Documents

      For purposes of this Rule, documents may be created, stored, and transmitted in electronic or paper form, and signatures may be evidenced in electronic or other written form.
      (3) Definitions

      For purposes of this Rule, the term "registered principal" shall mean a person registered as a General Securities Sales Supervisor (Series 9/10), a General Securities Principal (Series 24) or an Investment Company Products/Variable Contracts Principal (Series 26), as applicable.
      (b) Recommendation Requirements
      (1) No member or person associated with a member shall recommend to any customer the purchase or exchange of a deferred variable annuity unless such member or person associated with a member has a reasonable basis to believe
      (A) that the transaction is suitable in accordance with NASD Rule 2310 and, in particular, that there is a reasonable basis to believe that
      (i) the customer has been informed, in general terms, of various features of deferred variable annuities, such as the potential surrender period and surrender charge; potential tax penalty if customers sell or redeem deferred variable annuities before reaching the age of 59½; mortality and expense fees; investment advisory fees; potential charges for and features of riders; the insurance and investment components of deferred variable annuities; and market risk;
      (ii) the customer would benefit from certain features of deferred variable annuities, such as tax-deferred growth, annuitization, or a death or living benefit; and
      (iii) the particular deferred variable annuity as a whole, the underlying subaccounts to which funds are allocated at the time of the purchase or exchange of the deferred variable annuity, and riders and similar product enhancements, if any, are suitable (and, in the case of an exchange, the transaction as a whole also is suitable) for the particular customer based on the information required by paragraph (b)(2) of this Rule; and
      (B) in the case of an exchange of a deferred variable annuity, the exchange also is consistent with the suitability determination required by paragraph (b)(1)(A) of this Rule, taking into consideration whether
      (i) the customer would incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits (such as death, living, or other contractual benefits), or be subject to increased fees or charges (such as mortality and expense fees, investment advisory fees, or charges for riders and similar product enhancements);
      (ii) the customer would benefit from product enhancements and improvements; and
      (iii) the customer has had another deferred variable annuity exchange within the preceding 36 months.
      The determinations required by this paragraph shall be documented and signed by the associated person recommending the transaction.
      (2) Prior to recommending the purchase or exchange of a deferred variable annuity, a member or person associated with a member shall make reasonable efforts to obtain, at a minimum, information concerning the customer's age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred variable annuity, investment time horizon, existing assets (including investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, tax status, and such other information used or considered to be reasonable by the member or person associated with the member in making recommendations to customers.
      (3) Promptly after receiving information necessary to prepare a complete and correct application package for a deferred variable annuity, a person associated with a member who recommends the deferred variable annuity shall transmit the complete and correct application package to an office of supervisory jurisdiction of the member.
      (c) Principal Review and Approval

      Prior to transmitting a customer's application for a deferred variable annuity to the issuing insurance company for processing, but no later than seven business days after an office of supervisory jurisdiction of the member receives a complete and correct application package, a registered principal shall review and determine whether he or she approves of the recommended purchase or exchange of the deferred variable annuity.

      A registered principal shall approve the recommended transaction only if he or she has determined that there is a reasonable basis to believe that the transaction would be suitable based on the factors delineated in paragraph (b) of this Rule.

      The determinations required by this paragraph shall be documented and signed by the registered principal who reviewed and then approved or rejected the transaction.
      (d) Supervisory Procedures

      In addition to the general supervisory and recordkeeping requirements of NASD Rules 3010, 3012, and 3110, and Rule 3130, a member must establish and maintain specific written supervisory procedures reasonably designed to achieve compliance with the standards set forth in this Rule. The member also must (1) implement surveillance procedures to determine if any of the member's associated persons have rates of effecting deferred variable annuity exchanges that raise for review whether such rates of exchanges evidence conduct inconsistent with the applicable provisions of this Rule, other applicable FINRA rules, or the federal securities laws ("inappropriate exchanges") and (2) have policies and procedures reasonably designed to implement corrective measures to address inappropriate exchanges and the conduct of associated persons who engage in inappropriate exchanges.
      (e) Training

      Members shall develop and document specific training policies or programs reasonably designed to ensure that associated persons who effect and registered principals who review transactions in deferred variable annuities comply with the requirements of this Rule and that they understand the material features of deferred variable annuities, including those described in paragraph (b)(1)(A)(i) of this Rule.

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

      .01 Depositing of Funds by Members Prior to Principal Approval. Under Rule 2330, a member that is permitted to maintain customer funds under SEA Rules 15c3-1 and 15c3-3 may, prior to the member's principal approval of the deferred variable annuity, deposit and maintain customer funds for a deferred variable annuity in an account that meets the requirements of SEA Rule 15c3-3.
      .02 Treatment of Lump-Sum Payment for Purchases of Different Products. If a customer provides a member that is permitted to hold customer funds with a lump sum or single check made payable to the member (as opposed to being made payable to the insurance company) and requests that a portion of the funds be applied to the purchase of a deferred variable annuity and the rest of the funds be applied to other types of products, Rule 2330 would not prohibit the member from promptly applying those portions designated for purchasing products other than a deferred variable annuity to such use. A member that is not permitted to hold customer funds can comply with such requests only through its clearing firm that will maintain customer funds for the intended deferred variable annuity purchase in an account that meets the requirements of SEA Rule 15c3-3. In such circumstances, the checks would need to be made payable to the clearing firm.
      .03 Forwarding of Checks/Funds to Insurer Prior to Principal Approval. Rule 2330 does not prohibit a member from forwarding a check made payable to the insurance company or, if the member is fully subject to SEA Rule 15c3-3, transferring funds for the purchase of a deferred variable annuity to the insurance company prior to the member's principal approval of the deferred variable annuity, as long as the member fulfills the following requirements: (a) the member must disclose to the customer the proposed transfer or series of transfers of the funds and (b) the member must enter into a written agreement with the insurance company under which the insurance company agrees that, until such time as it is notified of the member's principal approval and is provided with the application or is notified of the member's principal rejection, it will (1) segregate the member's customers' funds in a bank in an account equivalent to the deposit of those funds by a member into a "Special Account for the Exclusive Benefit of Customers" (set up as described in SEA Rules 15c3-3(k)(2)(i) and 15c3-3(f)) to ensure that the customers' funds will not be subject to any right, charge, security interest, lien, or claim of any kind in favor of the member, insurance company, or bank where the insurance company deposits such funds or any creditor thereof or person claiming through them and hold those funds either as cash or any instrument that a broker or dealer may deposit in its Special Reserve Account for the Exclusive Benefit of Customers, (2) not issue the variable annuity contract prior to the member's principal approval, and (3) promptly return the funds to each customer at the customer's request prior to the member's principal approval or upon the member's rejection of the application.
      .04 Forwarding of Checks/Funds to IRA Custodian Prior to Principal Approval. A member is not prohibited from forwarding a check provided by the customer for the purpose of purchasing a deferred variable annuity and made payable to an IRA custodian for the benefit of the customer (or, if the member is fully subject to SEA Rule 15c3-3, funds) to the IRA custodian prior to the member's principal approval of the deferred variable annuity transaction, as long as the member enters into a written agreement with the IRA custodian under which the IRA custodian agrees (a) to forward the funds to the insurance company to complete the purchase of the deferred variable annuity contract only after it has been informed that the member's principal has approved the transaction and (b), if the principal rejects the transaction, to inform the customer, seek immediate instructions from the customer regarding alternative disposition of the funds (e.g., asking whether the customer wants to transfer the funds to another IRA custodian, purchase a different investment, or provide other instructions), and promptly implement the customer's instructions.
      .05 Gathering of Information Regarding Customer Exchanges. Rule 2330 requires that the member or person associated with a member consider whether the customer has had another deferred variable annuity exchange within the preceding 36 months. Under this provision, a member or person associated with a member must determine whether the customer has had such an exchange at the member and must make reasonable efforts to ascertain whether the customer has had an exchange at any other broker-dealer within the preceding 36 months. An inquiry to the customer as to whether the customer has had an exchange at another broker-dealer within 36 months would constitute a "reasonable effort" in this context. Members shall document in writing both the nature of the inquiry and the response from the customer.
      .06 Sharing of Office Space and/or Employees. Rule 2330 requires principal review and approval "[p]rior to transmitting a customer's application for a deferred variable annuity to the issuing insurance company for processing...." In circumstances where an insurance company and its affiliated broker-dealer share office space and/or employees who carry out both the principal review and the issuance process, FINRA will consider the application "transmitted" to the insurance company only when the broker-dealer's principal, acting as such, has approved the transaction, provided that the affiliated broker-dealer and the insurance company have agreed that the insurance company will not issue the contract prior to principal approval by the broker-dealer.
      .07 Sharing of Information. Rule 2330 does not prohibit using the information required for principal review and approval in the issuance process, provided that the broker-dealer and the insurance company have agreed that the insurance company will not issue the contract prior to principal approval by the broker-dealer. For instance, the rule does not prohibit a broker-dealer from inputting information used as part of its suitability review into a shared database (irrespective of the media used for that database, i.e., paper or electronic) that the insurance company uses for the issuance process, provided that the broker-dealer and the insurance company have agreed that the insurance company will not issue the contract prior to principal approval by the broker-dealer.

      * * * * *

    • 10-04 SEC Approves Consolidated FINRA Rules Governing Clearly Erroneous Transactions; Effective Date: February 15, 2010

      View PDF

      Clearly Erroneous Transactions

      Regulatory Notice
      Notice Type

      Consolidated FINRA Rulebook
      Rule Approval
      Referenced Rules & Notices

      Information Notice 3/12/08
      Information Notice 10/6/08
      FINRA Rule 11890
      FINRA Rule 11891
      FINRA Rule 11892
      FINRA Rule 11893
      FINRA Rule 11894
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Trading
      Key Topic(s)

      Clearly Erroneous Transactions

      Executive Summary

      On December 1, 2009, the SEC approved FINRA's proposed rule change1 to adopt a new set of rules governing clearly erroneous transactions in the consolidated rulebook.2 The new FINRA Rule 11890 Series replaces NASD Rule 11890, IM-11890-1 and IM-11890-2 and was adopted as part of a market-wide effort by multiple self-regulatory organizations to provide transparency and finality with respect to clearly erroneous executions. Among other things, the new rule series includes a new general rule defining "clearly erroneous" transactions, separate provisions for the determination of clearly erroneous transactions depending upon whether the transaction involves an exchange-listed security or an over-the-counter equity security and procedures for appealing FINRA clearly erroneous determinations. In addition, the new rule series codifies minimum numerical criteria necessary for a transaction to qualify as clearly erroneous.3

      The text of the new rules is set forth on FINRA's Web site at www.finra.org/rulefilings/2009-068.

      Questions concerning this Notice should be directed to Brant K. Brown, Associate General Counsel, Office of General Counsel, at (202) 728-6927.

      Background

      NASD Rule 11890 provides that, in the event of a disruption or malfunction related to the use or operation of any quotation, communication or trade reporting system owned or operated by FINRA, or under extraordinary market conditions, designated officers of FINRA can review an over-the-counter (OTC) transaction arising out of or reported through any such quotation, communication or trade reporting system. If any such officer determines that the transaction is clearly erroneous or that action is necessary for the maintenance of a fair and orderly market or the protection of investors and the public interest, the officer may declare the transaction null and void or modify its terms. IM-11890-1 and IM-11890-2 address rulings made by FINRA and the UPC Committee pursuant to NASD Rule 11890 and the review of those rulings. These three rules provide important safeguards against market disruptions caused by trader errors, system malfunctions or other extraordinary events that result in erroneous executions affecting multiple market participants and/or securities. FINRA has used NASD Rule 11890 in the context of events affecting a single stock, such as an extraordinary erroneous order causing a large number of trades involving multiple market participants in a single stock, and events affecting multiple stocks, such as a system malfunction resulting in a more widespread problem.

      As part of the process of developing the consolidated rulebook (Consolidated FINRA Rulebook), the SEC has approved FINRA's proposal to move NASD Rule 11890, IM-11890-1 and IM-11890-2 into the Consolidated FINRA Rulebook as part of a new FINRA Rule 11890 Series governing clearly erroneous transactions.4 FINRA has also amended these rules as part of a market-wide effort among multiple self-regulatory organizations (SROs) designed to provide transparency and finality with respect to clearly erroneous executions.5 This market-wide effort among SROs seeks to achieve consistent results for participants across U.S. equities exchanges while maintaining a fair and orderly market, protecting investors and protecting the public interest. Unlike the rules of the U.S. equities exchanges, however, FINRA's rules also address clearly erroneous executions in OTC Equity Securities.6

      Discussion

      The new FINRA Rule 11890 Series includes:

      (1) a general rule defining the term "clearly erroneous" (Rule 11891) with accompanying supplementary material;
      (2) a rule governing clearly erroneous determinations for transactions in exchange-listed securities (Rule 11892) with accompanying supplementary material;
      (3) a rule governing clearly erroneous determinations for transactions in OTC Equity Securities (Rule 11893) with accompanying supplementary material; and
      (4) a rule governing the review by the UPC Committee of FINRA staff determinations that a transaction was clearly erroneous (Rule 11894).

      Each of these rules, and their accompanying supplementary material, are described in detail below.

      FINRA Rule 11891: Definition & General Guidelines

      FINRA Rule 11891 defines the term "clearly erroneous" for purposes of the FINRA Rule 11890 Series. The rule specifies that "the terms of a transaction are 'clearly erroneous' when there is an obvious error in any term, such as price, number of shares or other unit of trading, or identification of the security. "This definition is consistent with the definitions used by other SROs in the recently approved market-wide clearly erroneous rule amendments.7

      FINRA has also adopted four paragraphs of supplementary material to Rule 11891 to address broader issues that arise under the clearly erroneous rules. Supplementary Material .01 is based on NASD IM-11890-1 regarding a member firm's failure to abide by clearly erroneous determinations made by FINRA or the UPC Committee. Supplementary Material .02 and .03 set forth the general standards applicable to clearly erroneous determinations and clarify that FINRA generally considers a transaction to be clearly erroneous when there is a systemic problem that involves large numbers of parties or trades, or conditions where it would be in the best interests of the market. Further, extraordinary market conditions may include situations where an extraordinary event has occurred or is ongoing that has had a material effect on the market for a security traded over the counter or has caused major disruption to the marketplace. Supplementary Material .02 also emphasizes that firms are responsible for ensuring that the appropriate price and type of order are entered into FINRA systems.

      Finally, Supplementary Material .04 specifically addresses suspicious trading activities, such as unauthorized trading activity or attempts to manipulate stock prices by illegally gaining access to legitimate accounts or opening new accounts using false information (often referred to as "account intrusion"). Although FINRA continues to be concerned about protecting markets from unauthorized or illegal activity like account intrusion that could disrupt a fair and orderly market, FINRA's clearly erroneous authority does not extend to such suspicious trading activities. Rather, such activities relate to allegations of fraud and fall outside the scope of the clearly erroneous rules. Consequently, the supplementary material clarifies this position while also noting that firms should routinely review the adequacy of their internal controls and ensure that appropriate system safeguards are in place to minimize or eliminate the potential for account intrusion.

      FINRA Rule 11892: Review of Transactions in Exchange-Listed Securities

      Unlike NASD Rule 11890, which applies to transactions in both exchange-listed securities and OTC Equity Securities, the new FINRA Rule 11890 Series establishes different rules for determining whether a transaction is clearly erroneous depending upon whether the transaction involves an exchange-listed security or an OTC Equity Security. FINRA Rule 11892 establishes the criteria for exchange-listed securities, and FINRA Rule 11893 governs determinations involving transactions in OTC Equity Securities.

      FINRA Rule 11892 and its supplementary material set forth the standards FINRA uses to determine whether a transaction in an exchange-listed security is clearly erroneous. Coordinating with other SROs with the goal of having consistency and transparency regarding the clearly erroneous process is important to the marketplace and to investors. For this reason, for OTC transactions in exchange-listed securities that are reported to a FINRA system, such as a FINRA Trade Reporting Facility (TRF) or the Alternative Display Facility (ADF), FINRA will generally follow the determination of a national securities exchange to break a trade (or multiple trades) when that national securities exchange has broken one or more trades at or near the price range in question at or near the time in question (in FINRA staff's sole discretion) such that FINRA breaking such trade(s) would be consistent with market integrity and investor protection. When multiple national securities exchanges have related trades, FINRA will leave a trade(s) unbroken when any of those national securities exchanges has left a trade(s) unbroken at or near the price range in question at or near the time in question (in FINRA staff's sole discretion) such that FINRA breaking such trade(s) would be inconsistent with market integrity and investor protection.8

      With respect to OTC transactions in exchange-listed securities for which there is no corresponding or related on-exchange trading activity, FINRA will follow the exchanges' criteria when making a clearly erroneous determination. In this sector of the market, consistency in application of clearly erroneous authority across markets is critical to ensure that one investor does not receive disparate treatment based solely on the ultimate execution or reporting venue of his or her order. Consequently, for OTC transactions in exchange-listed securities that are reported to a FINRA system, such as a FINRA TRF or the ADF, but for which there is no corresponding or related on-exchange trading activity, FINRA will generally make its own clearly erroneous determination.9 As part of the market-wide effort to provide transparency to clearly erroneous determinations, the new rules establish minimum numerical thresholds for clearly erroneous transactions. To ensure that transactions in exchange-listed securities are treated consistently regardless of where the trade is executed (i.e., on an exchange or OTC), Rule 11892 replicates the numerical thresholds used by the exchange SROs to determine whether a transaction is eligible for consideration as clearly erroneous.10 The rule also establishes provisions for the use of alternative reference prices in unusual circumstances, additional factors that FINRA may consider when making a clearly erroneous determination and numerical guidelines applicable to volatile market opens. Each of these provisions is modeled on similar provisions in the recently approved market-wide amendments.11

      The numerical guidelines for clearly erroneous determinations for transactions in exchange-listed securities are as follows:

      Reference Price: Consolidated Last Sale Normal Market Hours (9:30 a.m. Eastern Time (ET) to 4 p.m. ET) Numerical Guidelines (Subject Transaction's % Difference From the Consolidated Last Sale): Outside Normal Market Hours Numerical Guidelines (Subject Transaction's % Difference From the Consolidated Last Sale):
      Greater than $0.00 up to and including $25.00 10% 20%
      Greater than $25.00 up to and including $50.00 5% 10%
      Greater than $50.00 3% 6%
      Multi-stock event—filings involving five or more securities by the same member will be aggregated into a single filing 10% 10%
      Leveraged ETF/ETN securities Normal market hours numerical guidelines multiplied by the leverage multiplier (i.e., 2x) Normal market hours numerical guidelines multiplied by the leverage multiplier (i.e., 2x)

      FINRA Rule 11893: Review of Transactions in OTC Equity Securities

      FINRA Rule 11893 governs clearly erroneous determinations involving transactions in OTC Equity Securities. The rule is structured similarly to FINRA Rule 11892, including numerical guidelines, the use of alternative reference prices in unusual circumstances and additional factors FINRA officers may consider when making a clearly erroneous determination. Because of the differences in the OTC and exchange markets, the numerical guidelines in Rule 11893 for transactions in OTC Equity Securities differ from the guidelines used for transactions in exchange-listed securities. In some instances, the percentage deviations set forth in the numerical guidelines for OTC Equity Security transactions are based on a sliding scale where the maximum percentage deviation applies to the lower execution price in the range and the minimum percentage deviation applies to the higher execution price in the range. The provisions in Rule 11893 regarding alternative reference prices and additional factors are substantially similar to those set forth in Rule 11892 for exchange-listed securities.

      The numerical guidelines for clearly erroneous determinations for transactions in OTC Equity Securities are as follows:

      Reference Price Numerical Guidelines (Subject Transaction's Percentage Difference From the Reference Price)
      $0.9999 and under 20%
      $1.0000 and up to and including $4.9999 Low end of range minimum 20%
      High end of range minimum 10%
      $5.0000 and up to and including $74.9999 10%
      $75.0000 and up to and including $199.9999 Low end of range minimum 10%
      High end of range minimum 5%
      $200.0000 and up to and including $499.9999 5%
      $500.0000 and up to and including $999.9999 Low end of range minimum 5%
      High end of range minimum 3%
      $1,000.0000 and over 3%

      Supplementary material to Rule 11893 emphasizes that FINRA has historically exercised its clearly erroneous authority in very limited circumstances, particularly with respect to OTC Equity Securities. This more narrow approach for OTC Equity Securities is due to the differences in the OTC equity and exchange-listed markets, including the lack of compulsory information flows in the OTC equity market that come as a result of the listing process and the fact that aberrant trading in the OTC market is often due to issues other than systems problems or extraordinary events. The supplementary material also explains that FINRA does not expect to use its clearly erroneous authority in most situations; rather, FINRA expects the parties to settle any dispute privately.

      FINRA Rule 11894: Review Procedures

      As noted above, the new clearly erroneous rules remove language that allows a FINRA officer to modify one or more of the terms of a transaction under review. Under the new rules, a FINRA officer will have the authority only to declare transactions null and void. An executive vice president of FINRA's Market Regulation Department or Transparency Services Department, or any officer designated by such executive vice president, may, on his or her own motion, review any transaction arising out of or reported through any FINRA facility. With respect to determinations involving transactions in exchange-listed securities, absent extraordinary circumstances, the officer shall take action generally within 30 minutes after becoming aware of the transaction. When extraordinary circumstances exist, any such action of the officer must be taken no later than the start of trading on the day following the date of execution(s) under review. With respect to determinations involving transactions in OTC Equity Securities, a FINRA officer must make a determination as soon as possible after becoming aware of the transaction, but in all cases by 3 p.m., ET, on the next trading day following the date of the transaction at issue. If a FINRA officer declares any transaction null and void, FINRA will notify each party involved in the transaction as soon as practicable, and any party aggrieved by the action may appeal such action in accordance with Rule 11894, unless the officer making the determination also determines that the number of affected transactions is such that immediate finality is necessary to maintain a fair and orderly market and to protect investors and the public interest.

      Rule 11894 codifies the provisions governing the appeal to the UPC Committee of a FINRA officer's determination to declare an execution null and void.12 NASD IM-11890-2, which concerns review by panels of the UPC Committee, has been incorporated into the text of Rule 11894. Under the rule, an appeal must be made in writing and must be received by FINRA within 30 minutes after the person making the appeal is given the notification of the determination being appealed. With respect to appeals regarding exchange-listed securities, the UPC Committee will render determinations as soon as practicable, but generally on the same trading day as the execution(s) under review. On requests for appeal received after 3 p.m., ET, the UPC Committee will render a determination as soon as practicable, but in no case later than the trading day following the date of the execution(s) under review. With respect to appeals regarding OTC Equity Securities, the committee will render determinations as soon as practicable, but in no case later than two trading days following the date of the execution(s) under review.


      1 See Securities Exchange Act Release No. 61080 (December 1, 2009), 74 FR 64117 (December 7, 2009) (Order Granting Approval to Proposed Rule Change; SR-FINRA-2009-068).

      2 The current FINRA rulebook consists of: (1) FINRA Rules; (2) NASD Rules; and (3) rules incorporated from NYSE (Incorporated NYSE Rules) (together, the NASD Rules and Incorporated NYSE Rules are referred to as the Transitional Rulebook). While the NASD Rules generally apply to all FINRA member firms, the Incorporated NYSE Rules apply only to those members of FINRA that are also members of the NYSE (Dual Members). The FINRA Rules apply to all FINRA member firms, unless such rules have a more limited application by their terms. For more information about the rulebook consolidation process, see Information Notice 3/12/08 (Rulebook Consolidation Process).

      3 FINRA notes that, in devoting this Notice to announcing the effective date of a single set of rules and rule amendments, it is deviating from the protocol by which FINRA generally announces the effective dates of the new FINRA rules that are being adopted as part of the Consolidated FINRA Rulebook. See Information Notice 10/06/08 (Rulebook Consolidation Process: Effective Dates of New Consolidated Rules; Introduction of Rule Conversion Chart). FINRA believes that a single Notice devoted to the new clearly erroneous rules is warranted in view of the market-wide amendments to multiple SRO clearly erroneous rules and the nature of the changes.

      4 The rules concerning clearly erroneous transactions are part of the Uniform Practice Code (UPC). The rule filing approved by the SEC approved only the transfer of NASD Rule 11890, IM-11890-1 and IM-11890-2 into the Consolidated FINRA Rulebook. FINRA will address the remaining rules in the UPC in a separate rule filing.

      5 See, e.g., Securities Exchange Act Release No. 60706 (September 22, 2009), 74 FR 49416 (September 28, 2009) (approving NYSEArca's amendments to its clearly erroneous rules); Securities Exchange Act Release No. 60776 (October 2, 2009), 74 FR 51891 (October 8, 2009) (approving Nasdaq's amendments to its clearly erroneous rules); Securities Exchange Act Release No. 60781 (October 2, 2009), 75 FR 51926 (October 8, 2009) (approving NYSE's amendments to its clearly erroneous rules for equity securities).

      6 For purposes of the clearly erroneous rules, the term "OTC Equity Security" has the same meaning as defined in FINRA Rule 6420, except that the term does not include any equity security that is traded on any national securities exchange.

      7 See NASDAQ Rule 11890(a)(1); NYSE Rule 128(a); NYSE Arca Rule 7.10(a). See also Securities Exchange Act Release No. 60706 (September 22, 2009), 74 FR 49416 (September 28, 2009) (approving SR-NYSE-Arca-2009-36).

      8 Under NASD Rule 11890, if a FINRA officer determined that a transaction was clearly erroneous, the officer could modify the terms of a transaction or declare the transaction null and void. Under FINRA Rules 11892 and 11893, FINRA's ability to modify a clearly erroneous execution has been eliminated, and a FINRA officer can only declare the transaction null and void.

      9 The FINRA rules do not allow member firms to initiate reviews of transactions. All reviews conducted by FINRA are conducted on FINRA's own motion.

      10 See FINRA Rule 11892(b)(1); NASDAQ Rule 11890(a)(2)(C); NYSE Rule 128(c)(1); NYSE Arca Rule 7.10(c)(1).

      11 See FINRA Rule 11892; NASDAQ Rule 11890; NYSE Rule 128; NYSE Arca Rule 7.10.

      12 A FINRA officer's determination not to break a trade is not appealable.

    • 10-03 FINRA Requests Comments on Proposed Consolidated FINRA Rules Governing Securities Loans and Borrowings, Permissible Use of Customers' Securities and Callable Securities; Comment Period Expires: March 8, 2010

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      Financial Responsibility and Operational Rules

      Regulatory Notice
      Notice Type

      Request for Comment
      Consolidated FINRA Rulebook
      Referenced Rules & Notices

      NASD IM-2330
      NASD Rule 2330
      NYSE Rule 296
      NYSE Rule 402
      NYSE Rule 402.30
      NYSE Rule Interpretation 402(b)/01
      SEA Rule 15c3-3
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Key Topic(s)

      Books and Records
      Callable Securities
      Customer Funds and Securities
      Disclosure of Agency Capacity
      Lendingand Borrowing Arrangements
      Liquidation
      Loan Consent Agreements
      Margin Securities
      Redemptions
      SIPC Protection

      Executive Summary

      As part of the process of developing a new, consolidated rulebook (the Consolidated FINRA Rulebook),1 FINRA is requesting comment on three proposed FINRA rules. Proposed FINRA Rule 4314 (Securities Loans and Borrowings) sets forth the requirements applicable to a member firm that is a party to an agreement for the loan or borrowing of securities. Proposed FINRA Rule 4330 (Customer Protection—Permissible Use of Customers' Securities) sets forth the requirements applicable to a member firm's borrowing or lending of a customer's margin securities that are eligible to be pledged or loaned. Proposed FINRA Rule 4340 (Callable Securities) sets forth the obligations applicable to any callable securities a member firm has in its possession or control.

      The text of the proposed rules is set forth in Attachment A.

      Questions regarding this Notice should be directed to:

      •   Kris Dailey, Vice President, Risk Oversight & Operational Regulation, at (646) 315-8434; or
      •   Yui Chan, Managing Director, Risk Oversight & Operational Regulation, at (646) 315-8426.

      Action Requested

      FINRA encourages all interested parties to comment on the proposed rule. Comments must be received by March 8, 2010. Member firms and other interested parties can submit their comments using the following methods:

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

      Marcia E. Asquith
      Office of the Corporate Secretary
      FINRA
      1735 K Street, N.W.
      Washington, D.C. 20006-1506

      To help FINRA process and review comments more efficiently, persons should only use 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 Web site. Generally, FINRA will post comments on its site one week after the end of the comment period.2

      Before becoming effective, a proposed rule change must be authorized for filing with the SEC by the FINRA Board of Governors, and then must be approved by the SEC, following publication for public comment in the Federal Register.3

      Discussion

      I. Proposed FINRA Rule 4314 (Securities Loans and Borrowings)

      A. Background

      NYSE Rule 296 (Liquidation of Securities Loans and Borrowings)4 sets forth the obligations of a member that is party to an agreement with another member for the loan and borrowing of securities. Specifically, the rule provides that a member that is party to an agreement with another member for the loan and borrowing of securities has the right to liquidate such transaction whenever the other party to the transaction:
      (1) applies for or consents to a receiver, custodian, trustee or liquidator of itself or its property;
      (2) admits in writing its inability, or becomes generally unable, to pay its debts as such debts become due;
      (3) makes a general assignment for the benefit of its creditors; or
      (4) files, or has filed against it, a petition for a Chapter 11 bankruptcy filing or a protective decree under Section 5 of the Securities Investor Protection Act of 1970 (SIPA) (liquidation conditions).
      The rule further provides that no member may lend or borrow any security to or from any non-member of the NYSE, except pursuant to a written agreement, which may consist of the exchange of contract confirmations, which confers upon the member the contractual right to liquidate such transaction because of a liquidation condition of the kind specified above.

      NYSE Rule 296.10 defines the term "agreement for the loan and borrowing of securities," for purposes of NYSE Rule 296. NYSE Rule 296.20 provides that each member that is subject to SEA Rule 15c3-3 and that borrows from a customer (as the term is defined in SEA Rule 15c3-3) must comply with Rule 15c3-3's provisions requiring a written agreement between the borrowing member and the lending customer.

      FINRA believes that the rule has been the basis for similar provisions incorporated in the industry standard Master Securities Lending Agreement (MSLA). Furthermore, FINRA believes that the rule provides protection to members that may enter into a securities lending transaction without a duly signed MSLA with a counterparty, should one of the counterparties become insolvent, allowing for the ability to immediately liquidate against collateral received.

      FINRA proposes to adopt NYSE Rule 296 as FINRA Rule 4314 (Securities Loans and Borrowings) into the Consolidated FINRA Rulebook with the changes described below.
      B. Proposed FINRA Rule 4314

      In 2006, the industry began to adopt voluntary practices initiated by the SEC, including books and records and disclosure practices, as a result of an industry-wide initiative to address the risks associated with agency lending (the Agency Lending Disclosure Initiative). Consistent with the industry-wide initiative, FINRA is proposing a new requirement to address concerns about whether parties are acting as principals or agents when entering into an agreement to loan or borrow securities. The proposed rule requires a member firm that acts as agent in a loan or borrow transaction to disclose its capacity, and, in cases where the member firm lends securities to or borrows securities from a counterparty that is acting in an agency capacity, requires that the member firm maintain books and records to reflect the identity of both the agent and the principal(s) on whose behalf the agent is acting and the contract terms between the parties.

      Specifically, proposed new FINRA Rule 4314(a) requires a member firm that enters into a transaction to lend or borrow securities as agent to disclose its capacity to the other party (or parties) to the transaction. The provision further requires the member firm, prior to lending securities to or borrowing securities from a person that is not a member of FINRA, to determine whether the other party is acting as principal or agent in the transaction. When the other party (who may or may not be a member) is acting as agent in the transaction, the member firm is required to maintain books and records that: (1) reflect the details of the transaction with each such agent; and (2) reflect each principal(s) on whose behalf the agent is acting and the details of each transaction therewith.

      Proposed FINRA Rule 4314(b), based on NYSE Rule 296(a), continues to provide each member firm that is a party to an agreement with another member firm for the loan and borrowing of securities with the right to liquidate such transaction whenever the other party to such transaction becomes subject to one of the liquidation conditions specified in the rule.

      In addition, FINRA is proposing to expand upon the written agreement requirement in NYSE Rule 296(b). Specifically, proposed FINRA Rule 4314(c) requires that no member firm shall lend or borrow securities to or from any person that is not a member of FINRA, except pursuant to a written agreement, which may consist of the exchange of contract confirmations, which confers upon such member the contractual right to liquidate such transaction because of a liquidation condition of the kind specified in proposed FINRA Rule 4314(b), as detailed above. In contrast, NYSE Rule 296(b) requires a member to have a written agreement only with any non-member of the NYSE. FINRA believes that expanding the requirement to have a written agreement with all non-members of FINRA, including any customer, protects the member firm's interests in the event of a liquidation condition specified in proposed FINRA Rule 4314(b) and supports the member's compliance with net capital requirements.

      Further, FINRA is proposing to transfer NYSE Rule 296.10, which defines the term "agreement for the loan and borrowing of securities,"as Supplementary Material .01 to proposed FINRA Rule 4314, without substantive change. In addition, FINRA is proposing to add new Supplementary Material .02 through .04 to the proposed FINRA rule. Proposed Supplementary Material .02 clarifies the methods by which a member firm may satisfy its disclosure obligation in new paragraph (a) by, among other things, providing specific disclosure of its capacity as agent in the written agreement between the parties or in the individual confirmations of each transaction between the parties. Proposed Supplementary Material .03 clarifies the books and records requirements imposed by new paragraph (a). Proposed Supplementary Material .04 reminds member firms of their obligations under proposed FINRA Rule 4330(b) (discussed further below) to provide a written notice when borrowing securities from customers regarding the associated risks of such transactions, and requires that member firms disclose in such written notice their right to liquidate under the conditions specified in paragraph (c) of proposed FINRA Rule 4314.
      C. Eliminated Rules and Requirements

      FINRA is proposing to eliminate existing NYSE Rule 296.20, which, as discussed above, requires each member firm that is subject to the provisions of SEA Rule 15c3-3 and that borrows securities from a customer to comply with the provisions relating to the requirements for a written agreement between the borrowing member and the lending customer, as the substance of this provision has been included in proposed FINRA Rule 4330(b).

      FINRA is also proposing to eliminate NYSE Rule Interpretation 296(b)/01, which addresses transactions with non-member organizations and the written agreements required in regard to repurchase and reverse repurchase transactions not subject to SEA Rule 15c3-3, as the interpretation is beyond the scope of the proposed rule.

      II. Proposed FINRA Rule 4330 (Customer Protection—Permissible Use of Customers' Securities)

      A. Background

      NYSE