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  • 2011

    • 11-56 FINRA and ISG Enhance Electronic Blue Sheet Submissions; Effective Date: August 31, 2012

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      Electronic Blue Sheet (EBS) Submissions

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

      Legal
      Compliance
      Operations
      Senior Management
      Key Topics

      Blue Sheets
      Referenced Rules & Notices

      FINRA Rule 8211
      FINRA Rule 8213
      Regulatory Notice 09-18
      SEA Rule 13h-1

      Executive Summary

      FINRA and the other interested members of the Intermarket Surveillance Group (ISG interested members)1 are enhancing the Electronic Blue Sheets (EBS) to improve the regulatory agencies' ability to analyze broker-dealers' trading activities.

      Effective August 31, 2012, firms will be required to submit new data elements to FINRA and the other ISG interested members. Attachment A to this Notice sets forth the changes to the blue sheet record layout and Attachment B outlines the existing transaction type identifiers.

      In addition, effective August 31, 2012, firms will be required to submit blue sheets, when requested, in three additional formats: (1) account number and date; (2) account number, symbol and date; or (3) date range and executing firm CRD number or entering firm MPID.

      This Notice also provides answers to frequently asked questions (FAQ).

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

      Discussion

      The ISG interested members and FINRA are requiring firms to provide new data elements to EBS. The changes will take effect on August 31, 2012.

      To support these new data elements, the Securities Industry Automation Corporation (SIAC) has modified the blue sheet record layout. Changes to the blue sheet record layout are included as Attachment A. In addition, existing transaction type identifiers are outlined in Attachment B. Firms may begin testing the updated format starting on July 31, 2012.

      In addition, the Securities and Exchange Commission (SEC) has mandated that the Large Trader Identification Number (LTID) and Order Execution Time enhancements be ready for transmission to the SEC by April 30, 2012. From April 30, 2012, through August 30, 2012, firms should submit these new data elements only to the SEC. After August 30, 2012, firms may voluntarily submit the LTID to FINRA or the other ISG interested members. After August 30, 2012, firms will be required to submit the Order Execution Time to FINRA or other ISG interested members.

      Firms should pay special attention to the following areas of Attachment A:

      Order Execution Time, Record Sequence Number Five, Field Position 72 to 77
      Firms should use this record to submit the order execution time in 24-hour format and in Eastern Time formatted as HHMMSS. This information is for all blue sheet transactions and is not limited to transactions relating to the SEC Large Trader Reporting Rule (SEA Rule 13h-1). Please note that all firms must synchronize their time clocks to the atomic clock to maintain an accurate audit trail in connection to the reported execution time. (See Frequently Asked Question No. 3 below for more detail on clock synchronization requirements.)
      Large Trader Identification Number 1, Record Sequence Number Seven, Field Position 2 to 14
      Firms should use this record to submit the LTID. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.
      Large Trader Identification Number 2, Record Sequence Number Seven, Field Position 15 to 27
      Firms should use this record to submit the LTID. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.
      Large Trader Identification Number 3, Record Sequence Number Seven, Field Position 28 to 40
      Firms should use this record to submit the LTID. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.
      Large Trader Identification Qualifier, Record Sequence Number Seven, Field Position 41
      Firms should use this record to submit the Large Trader Identification Qualifier. If more than three LTIDs exist for a transaction, then firms should mark the field "Y" for Yes. Otherwise it should be marked "N" for No. This information is requested under the approved SEC Large Trader Reporting Rule (SEA Rule 13h-1) requirements.
      Entering Firm MPID, Record Sequence Number Seven, Field Positions 42 to 45
      Firms should use this record to submit the entering firm's Market Participant Identifier (MPID). The entering firm is the firm that entered the order on the marketplace.
      Employer SIC Code, Record Sequence Number Seven, Field Positions 46 to 49
      Firms should use this record to submit the account holder's employer SIC code. A list of employer SIC codes can be found at www.sec.gov/info/edgar/siccodes.htm.
      Executing Firm CRD Number, Record Sequence Number Seven, Field Positions 50 to 57
      Firms should use this record to submit the executing firm's Central Registration Depository (CRD) number.

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

      Blue Sheet Submission Methodology

      Currently, blue sheet requests are made under specific security symbols and option symbology. Effective August 31, 2012, firms will be required to submit blue sheets, when requested, using three additional formats: (1) account number and date; (2) account number, symbol and date; or (3) date range and executing firm CRD number or entering firm MPID.

      The request by account number would require firms to identify the account number of a specific account at a firm, e.g. John Doe at CC Clearing Co. The request would cover all transactions under the John Doe account number at CC Clearing Co. To reduce data submission size, a blue sheet request may also ask for a specific symbol and date in connection with the account number. Additionally, blue sheet requests may be made for a specific review period under an executing firm CRD number or entering firm MPID. This request would require a firm to identify a clearing firm client's blue sheets for a set number of days, weeks or months, e.g. Firm ABC for the month of January 2011.

      FINRA Blue Sheet Testing

      Starting on July 31, 2012, FINRA will open its customer test website to allow firms to test the enhanced blue sheets. Firms that already have entitlement to FINRA's Regulation Filing Application can proceed with testing their blue sheet modifications by submitting their test data to https://regfilingtest.finra.org. To access the customer test website, firms should enter the same user ID and password they use to access the production website. Firms that do not have entitlement to FINRA's Regulation Filing Application should contact (800) 321-6273.

      Frequently Asked Questions

      Q1. Is there a testing period for the enhanced blue sheets?

      A1. Yes, FINRA and all ISG interested members will be ready to accept the updated blue sheet data and layout starting July 31, 2012. Please contact Michal Skibicki at SIAC ((212) 383-9073, mskibicki@nyx.com) for initial testing instructions before submitting the first enhanced blue sheet.

      Q2. For a blue sheet request with multiple issues under the same investigation number, how should the submission be made?

      A2. FINRA and the ISG interested members will accept multiple symbols submitted under one investigation number. Firms can also submit blue sheets using each symbol and produce separate records for each symbol. It is recommended that firms submit the blue sheet combining all symbols on one blue sheet submission to reduce the overall number of submissions.

      Q3. What time zone should be used for reporting the execution time?

      A3. Execution time should be reported in Eastern Time. Firms must synchronize their time clocks with the atomic clock every business day before market open. To maintain clock synchronization, clocks should be checked against the standard clock and re-synchronized, if necessary, at pre-determined intervals throughout the day. The reported time must be reported in a 24-hour format as HHMMSS. A firm must ensure that the business clocks it uses are accurate to within one-second of the National Institute of Standards and Technology Atomic Clock in Boulder Colorado (NIST Clock) or the United States Naval Observatory Master Clock in Washington, D.C., (USNO Master Clock) and must immediately recalibrate its clocks if the drift is greater than one second. This includes all of the following:

      1. the difference between the NIST/USNO standard and a time provider's clock;
      2. transmission delay from the source; and
      3. the amount of drift of the firm's business clock.

      A firm's written supervisory procedures must include a description of how the firm conducts, documents and maintains synchronization of its business clocks.

      Q4. If the entering firm does not have an MPID, can I leave the field blank?

      A4. Yes, this field may be blank if the entering firm does not have an assigned MPID.

      Q5. How can I locate the list of Employer SIC Codes for use in the blue sheets?

      A5. A list of employer SIC codes can be found at www.sec.gov/info/edgar/siccodes.htm.

      Q6. If a client order is facilitated through an "Average Price Facilitation Account," but the resulting execution of the order is filled through a single execution, should the transaction be reported as "average price"?

      A6. Yes, this execution should be reported as "average price."

      Q7. If a clearing firm receives a batch file from a firm that consolidates executions and reports them as average price executions, can that same consolidated execution report be submitted on the blue sheets?

      A7. No, the underlying executions must be reported. Even if a clearing firm is batch processing aggregate and/or consolidated execution information for continuous net settlement purposes, the underlying trades that were reported to the tape must be reported on the blue sheets. Firms that are unable to provide the underlying trade information must inform FINRA of this before submitting a blue sheet.

      Q8. If a clearing firm receives a batch file from a firm that consolidates executions, can that same consolidated execution report be submitted on the blue sheets?

      A8. No, the underlying trades that were reported to the tape must be reported on the blue sheets. Firms that are unable to provide the underlying trade information must inform FINRA of this before submitting a blue sheet.

      Q9. If a firm receives a request for historical data, will the enhanced blue sheet data format be required?

      A9. No, the enhancements will be required for data beginning August 31, 2012. Requests for older data will not require submission of enhanced blue sheet data elements.

      Q10. Will the options symbology requirements now change?

      A10. No, the symbol field must contain OPTIONXX when Record 6 contains option data. If the symbol field does not contain OPTIONXX, Record 6 should default to blanks in FIELD POSITIONS 2 through 80, and then add Record Sequence Number Seven. Please refer to the prior Blue Sheets Options Symbology (OSI) requirements in Regulatory Notice 09-18.

      Q11. For purposes of the SEC Large Trader Reporting Rule (SEA Rule 13h-1), what is the format of the LTID and the optional suffix?

      A11. An LTID can be a maximum of 13 characters. Specifically, 8 characters for the LTID, followed by a dash, with 4 maximum characters for the optional suffix. As specified in the Instructions to Form 13H, suffixes should initially be limited to three characters. Numbers should be right-justified and zeros should be used in place of blanks.

      Q12. For purposes of the SEC Large Trader Reporting Rule (SEA Rule 13h-1), how should Unidentified Large Traders be designated?

      A12. For Unidentified Large Traders, broker-dealers should assign their own unique identifying number to each person identified as an Unidentified Large Trader. The number should conform to the format for the LTID and should begin with the letters "ULT". For example, "ULT00001".

      The FAQ will be updated from time to time. Please see FINRA's website for the most recent version.


      1 The interested members include the following exchanges and self-regulatory organizations (SROs) as members of the ISG: BATS Exchange, Inc., BATS Y-Exchange, Inc., Chicago Board Options Exchange, Incorporated, C2 Options Exchange, Incorporated, CBOE Stock Exchange, LLC, Chicago Stock Exchange, Inc., EDGA Exchange, Inc., EDGX Exchange, Inc., Internationa Securities Exchange, LLC, The NASDAQ Stock Market LLC, NASDAQ OMX BX, Inc., NASDAQ OMX PHLX LLC, National Stock Exchange, Inc., New York Stock Exchange, LLC, NYSE Amex, LLC, and NYSE Area, Inc.


      Attachment A

      Record Layout for Submission of Trading Information

      Field Position Field Length Field Name/Description/Remarks Field Format Justify Picture Clause Default Value
      From To
            ***This record must be the first record of the file***        
      1 3 3 FILLER A LJ X(3) HDR
      4 5 2 FILLER A LJ X(2) .S
      6 10 5 DTRK-SYSID N LJ 9(5) 12343
      11 12 2 FILLER A LJ X(2) .E
      13 14 2 FILLER N LJ 9(2) 00
      15 16 2 FILLER A LJ X(2) .C
      17 20 4 DTRK-ORIGINATOR

      Please call SIAC for assignment (212) 383-2210
      A LJ X(4)
      21 22 2 FILLER A LJ X(2) .S
      23 26 4 DTRK-SUB-ORIGINATOR

      Please call SIAC for assignment (212) 383-2210
      A LJ X(4)
      27 27 1 FILLER A LJ X(1) B
      28 33 6 DTRK-DATE
      Contains submission date.
      N LJ 9(6) MMDDYY
      34 34 1 FILLER A LJ X(1) B
      35 59 25 DTRK-DESCRIPTION
      Required to identify this file.
      A LJ X(25) FIRM TRADING INFORMATION
      60 80 21 FILLER A LJ X(21) B
      1 1 1 HEADER RECORD CODE
      Value: Low Values OR ZERO
      A X
      2 5 4 SUBMITTING BROKER NUMBER

      If NSCC member use NSCC clearing number.

      If not a NSCC member, use clearing number assigned to you by your clearing agency.
      A-R LJ X(4) B
      6 40 35 FIRM'S REQUEST NUMBER

      Tracking number used by the firm to record requests from an organization.
      A X(35) B
      41 46 6 FILE CREATION DATE
      Format is YYMMDD
      A X(6)
      47 54 8 FILE CREATION TIME
      Format is HH:MM:SS
      A X(8)
      55 55 1 REQUESTOR CODE

      Requesting Organization Identification Values:

      A = New York Stock Exchange
      B = NYSE AMEX
      C = Chicago Stock Exchange
      D = NASDAQ OMX
      E = NYSE Arca
      F = Boston Stock Exchange
      G = National Stock Exchange
      H = BATS Trading
      I = International Securities Exchange
      J = Direct Edge
      K = Chicago Board Options Exchange, C2 Options Exchange and CBOE Stock Exchange
      R = FINRA
      X = Securities Exchange Commission
      Y = BATS Y-Exchange
      Z = Other
      A X
      56 70 15 REQUESTING ORGANIZATION NUMBER

      Number assigned by requesting organization
      A X
      71 80 10 FILLER A X(10) B
      1 1 1 RECORD SEQUENCE NUMBER ONE

      The first record of the transaction. Value: 1
      A X
      2 5 4 SUBMITTING BROKER NUMBER

      Identical to Submitting Broker Number in Header Record
      A-R LJ X(4)
      6 9 4 OPPOSING BROKER NUMBER

      The NSCC clearing house number of the broker on the other side of the trade.
      A-R LJ X(4) B
      10 21 12 CUSIP NUMBER.

      The cusip number assigned to the security.

      Left justified since the number is nine characters at present (8+ check digit) but will expand in the future
      A LJ X(12) B
      22 29 8 TICKER SYMBOL

      The symbol assigned to this security. For options (pre-OSI), the OPRA option symbol (space), OPRA expiration month symbol and OPRA strike price symbol should be used. (Ex. Maytag May 20 call option series would be reported as MYG ED. This example uses six spaces in the field with a space between the OPRA symbol and the OPRA expiration month.)

      Post OSI this field must contain OPTIONXX and a Record Sequence Number Six must be completed
      A-R LJ X(8) B
      30 35 6 TRADE DATE

      The date this trade executed. Format is YYMMDD.
      A-R X(6) B
      36 41 6 SETTLEMENT DATE

      The date this trade will settle. Format is YYMMDD
      A X(6) B
      42 53 12 QUANTITY

      The number of shares or quantity of bonds or option contracts.
      N-R RJ 9(12) Z
      54 67 14 NET AMOUNT

      The proceeds of sales or cost of purchases after commissions and other charges.
      N RJ S9(12) Z
      68 68 1 BUY/SELL CODE

      Values:
      0= Buy
      1= Sale
      2= Short Sale
      3= Buy Open
      4= Sell Open
      5= Sell Close
      6= Buy Close
      A = Buy Cancel
      B = Sell Cancel
      C = Short Sale Cancel
      D = Buy Open Cancel
      E = Sell Open Cancel
      F = Sell Close Cancel
      G = Buy Close Cancel
      Values 3 to 6 and D to G are for options only
      A-R X B
      69 78 10 PRICE

      The transaction price. Format: $$$$ CCCCCC.
      N-R RJ 9(4)V(6) Z
      79 79 1 EXCHANGE CODE

      Exchange where trade was executed. Values:

      A = New York Stock Exchange
      B = NYSE AMEX
      C = Chicago Stock Exchange
      D = NASDAQ OMX PHLX
      E = NYSE Arca
      F = Boston Stock Exchange
      G = National Stock Exchange
      H = BATS Trading
      I = International Securities Exchange
      J = C2 Options Exchange
      K = Chicago Board Options Exchange
      M = Toronto Stock Exchange
      N = Montreal Stock Exchange
      O = TSX Venture Exchange
      P = DirectEdge A
      Q = FINRA ADF
      R = NASDAQ/NASDAQ Options Market
      S = Over-the-Counter
      T = Tokyo Stock Exchange
      V= DirectEdge X
      W = CBSX (CBOE Stock Exchange)
      X = NASDAQ OMX PSX
      Y= BATS Y-Exchange
      Z = Other
      A-R X B
      80 80 1 BROKER/DEALER CODE

      Indicate if trade was done for another Broker/Dealer.

      Values: 0 = No; 1 = Yes
      A-R X B
      1 1 1 RECORD SEQUENCE NUMBER TWO

      Value: 2
      A X
      2 2 1 SOLICITED CODE

      Values: 0 = No; 1 = Yes
      A-R X B
      3 4 2 STATE CODE

      Standard Postal two character identification.
      A-R X(2) B
      5 14 10 ZIP CODE/COUNTRY CODE

      Zip Code — five or nine character (zip plus four)

      Country code — for future use.
      A-R LJ X(10) B
      15 22 8 BRANCH OFFICE/REGISTERED REPRESENTATIVE NUMBER

      Each treated as a four-character field.

      Both are left justified.
      A-R LJ X(8) B
      23 28 6 DATE ACCOUNT OPENED

      Format is YYMMDD
      A-R X(6) B
      29 48 20 SHORT NAME FIELD

      Contains last name followed by comma (or space) then as much of first name as will fit.
      A LJ X(20) B
      49 78 30 EMPLOYER NAME A LJ X(30) B
      79 79 1 TIN 1 INDICATOR

      Values: 1 = SS#; 2 = TIN
      A-R X B
      80 80 1 TIN 2 INDICATOR

      Values: 1 = SS#;
      2 = TIN — for future use.
      A X B
      1 1 1 RECORD SEQUENCE NUMBER THREE

      Value: 3
      A X
      2 10 9 TIN ONE

      Taxpayer Identification Number

      Social Security or Tax ID Number.
      A-R LJ X(9) B
      11 19 9 TIN TWO

      Taxpayer Identification Number #2

      Reserved for future use.
      A LJ X(9) B
      20 20 1 NUMBER OF N&A LINES A X B
      21 50 30 NAME AND ADDRESS LINE ONE A-R LJ X(30) B
      51 80 30 NAME AND ADDRESS LINE TWO A-R LJ X(30) B
      1 1 1 RECORD SEQUENCE NUMBER FOUR

      Value: 4
      A X
      2 31 30 NAME AND ADDRESS LINE THREE A-R LJ X(30) B
      32 61 30 NAME AND ADDRESS LINE FOUR A-R LJ X(30) B
      62 62 1 TRANSACTION TYPE IDENTIFIERS

      See Attachment B for current codes.
      A-R X B
      63 80 18 ACCOUNT NUMBER

      Account number
      A-R LJ X(18) B
      1 1 1 RECORD SEQUENCE NUMBER FIVE

      Value: 5
      A X(1)
      2 31 30 NAME AND ADDRESS LINE FIVE A-R LJ X(30) B
      32 61 30 NAME AND ADDRESS LINE SIX A-R LJ X(30) B
      62 65 4 PRIME BROKER

      Clearing number of the account's prime broker.
      A-R LJ X(4) B
      66 66 1 AVERAGE PRICE ACCOUNT

      1= recipient of average price transaction.

      2= average price account itself.
      N-R 9(1) Z
      67 71 5 DEPOSITORY INSTITUTION IDENTIFIER

      Identifying number assigned to the account by the depository institution.
      A-R LJ X(5) B
      72 77 6 Order Execution Time.

      HHMMSS — Time format will be in Eastern Time and 24 hour format
      N LJ
      78 80 3 FILLER A X B
      1 1 1 RECORD SEQUENCE NUMBER SIX

      Value: 6
      A  
      2 9 8 DERIVATIVE SYMBOL

      The symbol assigned to the derivative
      A LJ B
      10 15 6 EXPIRATION DATE

      The date the option expires. Format is YYMMDD
      A B
      16 16 1 CALL/PUT INDICATOR

      C = Call, P = Put
      A B
      17 24 8 STRIKE DOLLAR

      The dollar amount of the strike price
      N RJ Z
      25 30 6 STRIKE DECIMAL

      The decimal amount of the strike price
      N RJ Z
      31 80 50 FILLER A LJ B
      1 1 1 RECORD SEQUENCE NUMBER SEVEN

      Value: 7
      A  
      2 14 13 Large Trader Identification 1 A RJ Z
      15 27 13 Large Trader Identification 2 A RJ Z
      28 40 13 Large Trader Identification 3 A RJ Z
      41 41 1 Large Trader Identification Qualifier A RJ Z
      42 45 4 Entering Firm MPID A LJ B
      46 49 4 Employer SIC Code N LJ B
      50 57 8 Executing Firm CRD Number N LJ B
      58 80 23 FILLER A LJ B
      1 1 1 TRAILER RECORD DATE

      One record per submission. Must be the last record on the file. Value: High Values or "9"
      A X
      2 17 16 TOTAL TRANSACTIONS

      The total number of transactions. This total excludes Header and Trailer Records.
      N RJ 9(16) B
      18 33 16 TOTAL RECORDS ON FILE

      The total number of 80 byte records. This total includes Header and Trailer Records, but not the Datatrak Header Record (i.e., it does not include the first record on the file).
      N RJ 9(16) Z
      34 80 47 FILLER

      Field Format

      A = Alphanumeric (all caps)
      N = Numeric
      P = Packed
      B = Binary
      R = Validation Required
      A X(47) B
           
      Default
      Values —
      Code
      B = Blanks
      Z = Zero Justify
        RJ = Right Justification of Data
      LJ = Left Justification of Data

      Attachment B

      Record Layout for Submission of Trading Information

      Transaction Type Security Type
      Equity* Options
      Non-Program Trading, Agency A C
      Non-Index Arbitrage, Program Trading, Proprietary C  
      Index Arbitrage, Program Trading, Proprietary D  
      Index Arbitrage, Program Trading, Individual Investor J  
      Non-Index Arbitrage, Program Trading, Individual Investor K  
      Non-Program Trading, Proprietary P F
      Non-Program Trading, Individual Investor I  
      Non-Index Arbitrage, Program Trading, Agency Y  
      Index Arbitrage, Program Trading, Agency U  
      Index Arbitrage, Program Trading, as Agent for Other Member M  
      Non-Index Arbitrage, Program Trading, as Agent for Other Member N  
      Non-Program Trading, as Agent for Other Member W  
      Specialist S S
      Market-Maker M  
      Non-Member Market-Maker/Specialist Account N  
      Stock Specialist — Assignment Y  
      Short Exempt, Agency B  
      Customer Range Account of a Broker/Dealer   B
      Registered Trader G  
      Error Trade Q  
      Competing Market Maker Proprietary Transaction: Affiliated w/ Clearing Member O  
      Competing Market Maker: Unaffiliated Member's Competing Market Maker T  
      Competing Market Maker: Non-Member R  
      Short Exempt Transaction: Proprietary Account of Clearing Member Organization or Affiliated Member/Member Organization E  
      Short Exempt Transaction: Proprietary Account of Unaffiliated Member/Member Organization F  
      Short Exempt Transaction: Individual Customer Account H  
      Short Exempt Transaction: Competing Market Maker this is a Member/Member Organization Trading for own account L  
      Short Exempt Transaction: One Member Acting as Agent for Another Member's Competing Market Maker Account X  
      Short Exempt Transaction: Account of Non Member Competing Market Maker Z  
      Amex Option Specialist/Market Maker Trading Paired Security V  
      Registered Trader Market Maker Transaction Regardless of the Clearing Number   P
      Transactions cleared for a NASDAQ market maker that is affiliated w/ the clearing member that resulted from telephone access to the specialist. Amex Only. 3  
      Transactions cleared for a member's NASDAQ market maker that is not affiliated with the clearing member that resulted from telephone access to the specialist. Amex Only. 4  
      Transactions cleared for a non-member NASDAQ market maker that is not affiliated with the clearing member that resulted from telephone access to the specialist. Amex Only. 5  
      Voluntary Professional   W

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

    • 11-55 FINRA Collection of Short Interest Data for BATS Exchange-Listed Securities; Effective Date: December 15, 2011

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      Short Interest Reporting Requirements

      Regulatory Notice
      Suggested Routing

      Compliance
      Executive Representatives
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Training
      Key Topics

      Short Interest Reporting
      Referenced Rules & Notices

      FINRA Rule 4560
      NTM 06-20
      Regulatory Notice 08-13
       

      Executive Summary

      Effective December 15, 2011, FINRA's Web-based Regulation Filing Applications (RFA) system will include a new exchange/market code "H" for reporting short interest positions in securities for which the BATS Exchange is the primary exchange or market in the United States on which the security is listed as of the designated settlement date.

      Questions regarding this Notice may be directed to:

      •   Legal Section, Market Regulation at (240) 386-5126;
      •   Office of General Counsel at (202) 728-8071;
      •   Jocelyn Mello-Gibbon, Market Regulation at (240) 386-5091; or
      •   Lauren Zito, Market Regulation at (240) 386-5432.

      Background and Discussion

      Short Interest Reporting

      FINRA Rule 4560 requires firms to report short interest positions1 in all customer and proprietary accounts in all equity securities to FINRA twice a month. The mid-month short interest report is based on short positions a firm holds on the settlement date of the 15th of each month. If the 15th falls on a weekend or another non-settlement date, the designated settlement date is the previous business day on which transactions settled. The end-of-month short interest report is based on short positions a firm holds on the last business day of the month on which transactions settle. FINRA must receive short interest reports no later than the second business day after each reporting settlement date.

      Exchange/Market Codes in Short Interest Reports

      As discussed in Regulatory Notice 08-13 and Notice to Members 06-20, the use of accurate exchange/market codes is mandatory in a firm's short interest filing, and firms must include an exchange/market code for every security and short position in each filing.

      In light of the approval of the BATS Exchange's rule change to adopt rules for the qualification, listing and delisting of companies,2 FINRA is adding a new exchange/market code "H" for member firms' use in reporting short positions in securities for which the BATS Exchange is the primary exchange or market in the United States on which the security is listed as of the designated settlement date.3 If a firm appends an exchange/market code other than "H" for a short position in a security for which the BATS Exchange is the primary U.S. market, the RFA system will reject the short position and remove it from the firm's short interest filing. As a result, the firm will be required to resubmit the symbol with the proper exchange/market code. Failure to do so will cause the position to be omitted from the firm's short interest filing with FINRA and may result in a violation of FINRA Rule 4560. The following chart reflects the exchanges that currently have primary listings and the corresponding exchange/market code accepted by the RFA system for short interest reporting purposes.

      Exchange/Market Code Exchange/Market
      A New York Stock Exchange
      B American Stock Exchange
      E NYSE Arca
      H BATS Exchange
      R NASDAQ
      S Over-the-Counter


      1 Firms must report short positions that result from short sales as the term is defined in SEC Rule 200(a) of Regulation SHO, subject to certain limited exceptions.

      2 Securities Exchange Act Release No. 65225 (August 30, 2011), 76 FR 55148 (September 6, 2011)(Order Approving File No. SR-BATS-2011-018).

      3 The exchange/market code must reflect the primary exchange or market in the United States on which the security is listed as of the designated settlement date. The exchanges or markets on which the short sale transactions that gave rise to the short interest positions were executed is not relevant and should not be considered.

    • 11-54 FINRA and the SEC Issue Joint Guidance on Effective Policies and Procedures for Broker-Dealer Branch Inspections

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      Branch Office Inspections

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NASD Rule 3010
      NTM 98-96
      NTM 99-45
      Suggested Routing

      Compliance
      Internal Audit
      Risk
      Senior Management
      Key Topics

      Branch Office Inspections
      Risk Management
      Supervision

      Executive Summary

      FINRA and the Securities and Exchange Commission's Office of Compliance Inspections and Examinations are issuing the attached National Exam Risk Alert to provide broker-dealer firms with information on developing effective policies and procedures for branch office inspections. The Alert reminds firms of supervisory requirements under FINRA's supervision rule and notes common deficiencies and strong compliance practices.

      Questions concerning this Notice should be directed to:

      •   Michael Rufino, Chief Operating Officer, Member Regulation Sales Practice, at (212) 858-4487; or
      •   George Walz, Vice President, Office of Risk, at (202) 728-8211.

      National Examination Risk Alert

      By the Office of Compliance Inspections and Examinations in cooperation with the Financial Industry Regulatory Authority 1

      Information for Managers and Chief Compliance Officers

      Volume I, Issue 2

      November 30, 2011

      In this Alert:

      Topic: Broker-dealer branch inspections

      Objectives: Encourage firms to create effective policies and procedures for their branch inspections.

      Key Takeaways:

      A broker-dealer's branch inspection program is a key part of its supervisory system.

      Exam staff have found a number of deficiencies in branch inspections conducted by firms.

      This Risk Alert presents a joint report by OCIE staff and FINRA staff, highlighting a number of practices that examiners have observed that are found in effective branch office supervisory systems.

      Broker-Dealer Branch Inspections

      The branch inspection process is a critical component of a comprehensive risk management program and can help protect investors and the interests of the firm. OCIE and FINRA examination staff have observed that firms that execute this process well typically:

      •   tailor the focus of branch exams to the business conducted in that branch and assess the risks specific to that business;
      •   schedule the frequency and intensity of exams based on underlying risk, rather than on an arbitrary cycle, but examine branch offices at least annually;
      •   engage in a significant percentage of unannounced exams, selected through a combination of risk based analysis and random selection;
      •   deploy sufficiently senior branch office examiners who understand the business and have the gravitas to challenge assumptions; and
      •   design procedures to avoid conflicts of interest by examiners that may serve to undermine complete and effective inspection.

      Conversely, firms with significant deficiencies in the integrity of their overall branch inspection process, typically:

      •   utilize generic examination procedures for all branch offices, regardless of business mix and underlying risk;
      •   try to leverage novice or unseasoned branch office examiners who do not have significant depth of experience or understanding of the business to challenge assumptions;
      •   perform the inspection in a "check the box" fashion without questioning critically the integrity of underlying control environments and their effect on risk exposure;
      •   devote minimal time to each exam and little, if any, resources to reviewing the effectiveness of the branch office exam program;
      •   fail to follow the firm's own policies and procedures by not inspecting branch offices as required, announcing exams that were supposed to be unannounced, or failing to generate a written inspection report that included the testing and verification of the firm's policies and procedures, including supervisory policies and procedures;
      •   fail to have adequate policies and procedures, particularly in firms that use an independent contractor model and that allow registered personnel to also conduct business away from the firm; and
      •   lack heightened supervision of individuals with disciplinary histories or individuals previously associated with a firm with a disciplinary history.

      A well-designed branch inspection program is both: (1) a necessary element (but not the only element) of a firm's compliance and reasonable supervision of its branch offices and branch office personnel under Section 15(b)(4)(E) of the Securities Exchange Act as well as FINRA rules; and (2) an integral component of the firm's risk management program. The branch inspection provides the firm with the opportunity to validate its surveillance results from branch offices and to gather on-site intelligence that supplements the ongoing management and surveillance of the branch from a business and risk management standpoint.

      Risk-Based Inspections

      An effective risk assessment process will help drive the frequency, intensity and focus of branch office inspections; it should also serve as an important consideration in the decision to conduct the exam on an announced or unannounced basis. Therefore, branch offices should be continuously monitored with respect to changes in the overall business, products, people and practices. Branch inspections should be conducted by persons that have sufficient knowledge and experience to evaluate the activities of the branch, and should be overseen by senior personnel such as the CCO or other knowledgeable principal. Further, procedures should be designed to avoid conflicts of interest that may serve to undermine complete and effective inspections because of the economic, commercial or financial interests that an examiner holds in the associated person or branch being inspected.

      Branch office inspections provide an opportunity for oversight that should enhance the firm's routine surveillance and supervisory activities. For instance, branch office inspections may allow a firm to better identify the nature and extent of outside business activities of registered branch office personnel. Outside business activities conducted by registered persons may carry added risk because these activities may be perceived by customers as part of the member's business. Confirming that the scope of outside business activities of registered branch office personnel conform to those activities authorized by the firm is an important component of the branch office inspection, and addresses a risk that may be more difficult to monitor. For much the same reasons, unannounced inspections (which do not provide an opportunity to hide, alter or destroy documentation or other information reflecting such activities) are a critical element of any well designed branch office inspection program and should constitute a significant percentage of all exams conducted.

      This ongoing risk analysis should be a key element of the firm's exam planning process and lead to more frequent examinations of offices posing higher levels of risk than dictated by the firm's non-risk based cycle, and lead firms to engage in more unannounced exams of such offices. Some areas of high risk to consider are: sales of structured products; sales of complex products, including variable annuities; sales of private or otherwise unregistered offerings of any type; or offices that associate with individuals with a disciplinary history or that previously worked at a firm with a disciplinary history. NASD IM-3010-1 also lists additional factors to consider in making this determination.

      Pursuant to NASD Rule 3010(c)(2), each branch office inspection must include a written report that includes, at a minimum, testing and verification of the firm's policies and procedures in specified areas. As discussed further below, it is a good practice for this report to note any deficiencies and areas of improvement, as well as outline agreed-upon actions, including timelines, to correct the identified deficiencies.

      Oversight of Branch Office Inspections

      A broker-dealer's internal branch inspection program is a necessary part of its supervisory system and a strong indicator of a firm's culture of compliance. To test the quality of broker-dealers' required inspections of branch offices, SEC and FINRA examiners may seek to review and verify items related to an effective branch examination program, particularly matters such as supervisory procedures regarding customer accounts and sales of retail products. For example, examiners may review the following:

      •   policies and procedures, including supervisory procedures as they pertain to the supervision of customer accounts, including those serviced by income producing managers;
      •   policies and procedures relating to the handling of money and securities physically received at the branch;
      •   validation of changes in customer addresses and other account information in accounts serviced by the branch;
      •   procedures related to transmittals of funds between customers and third parties, and between customers and registered representatives ("RRs");
      •   firm testing of policies and procedures related to specific retail products, including:
      •   sales of structured products;
      •   private and other unregistered offerings;
      •   municipal securities;
      •   mutual funds; and
      •   variable annuity sales and exchanges;
      •   firm testing in retail sales practice areas, including:
      •   verification of customer account information;
      •   supervision of customer accounts;
      •   written supervisory procedures ("WSPs");
      •   new account review, suitability of investments;
      •   unauthorized trading;
      •   churning;
      •   allocations of new issues;
      •   licensing; and
      •   training;
      •   advertising and other communications with the public or with customers (such as email and other written correspondence) and compliance with approval procedures;
      •   evidence of unreported outside or other unauthorized business activities by review of: customer files, written materials on the premises and at any satellite locations, branch office accounting records, appointment books and calendars, phone records, bank records;
      •   procedures for handling of customer complaints;
      •   risk-based reviews of bank accounts of the branch and affiliated entities, third-party wire transfers, and branch signature guarantee log; and
      •   procedures to uncover use of unauthorized computers or other electronic devices and/or social media.

      Requirements and Guidance Pertaining to Broker-Dealer Branch Inspections

      The responsibility of broker-dealers to supervise their associated persons is a critical component of the federal regulatory scheme. Sections 15(b)(4)(E) and 15(b)(6)(A) of the Exchange Act authorize the Commission to impose sanctions on a firm or any person that fails to reasonably supervise someone that is subject to the supervision of such firm or person who violates the federal securities laws. In order to defend such a charge, a broker-dealer could show that it has established procedures that would reasonably be expected to prevent and detect a violation by such other person, and has a system for applying such procedures that has been effectively implemented. Such a system must be designed in such a way that it could reasonably be expected to prevent and detect, insofar as practicable, securities law violations.

      The staff of the SEC's Division of Trading and Markets (formerly known as the Division of Market Regulation) has noted that an effective branch office inspection program is a vital component of a supervisory system reasonably designed to oversee activities at remote branch offices.2 A number of Commission decisions in the area, both settled and litigated, set forth principles that can guide firms in constructing an effective branch office inspection program.3 Those cases suggest that regular branch office inspections over reasonably short intervals, including unannounced inspections, are the cornerstone of a well designed branch office inspection program.4 The Commission has sanctioned firms that have not conducted unannounced examinations of their branch offices. 5 Where a firm only conducts pre-announced examinations, that could create opportunities for branch office personnel to alter or destroy, documents, or commit other securities law violations, resulting in major fines for the firm.6 As a result, OCIE and FINRA staff believe that a well-constructed branch office inspection program should include unannounced inspections, based on a combination of random selection, risk-based selection and for cause exams.

      Beyond the timing and nature of the inspections, OCIE and FINRA staff also believe that past guidance suggests that a well-constructed branch office supervisory program should include: procedures for heightened supervision of remote branch offices that have associated persons with disciplinary histories; independent verification of the nature and extent of outside business activities; senior management's involvement in assuring that adequate procedures are in place and that sufficient resources are devoted to implementing those procedures; periodic reassessment of supervisory responsibilities ; adequate delineation of supervisory responsibilities; periodic reassessment of supervisory responsibilities; thorough investigation and documentation of customer complaints; and a system of follow up and review of those and other red flags.7

      FINRA rules and rule interpretations provide additional requirements and guidance in the area. NASD Rule 3010(b) requires every member broker-dealer to establish, maintain and enforce written procedures to supervise the types of business in which it engages and to supervise the activities of RRs, registered principals, and other associated persons that are reasonably designed to achieve compliance with applicable securities laws and regulations, and with the applicable FINRA rules.

      Notice to Members 99-45 instructs broker-dealers to adopt and implement a supervisory system that is "tailored specifically to the member's business and must address the activities of all its registered representatives and associated persons."8 Procedures that merely recite the applicable rules or fail to describe the steps the firm will take to determine compliance with applicable securities laws and regulations are not reasonable.9 A broker-dealer's procedures should instruct the supervisor on the requirements needed to be in compliance with the regulations.10 The procedures should describe the activities the supervisor will conduct along with the frequency as to when the reviews will be conducted.11

      NASD Rule 3010(c)(1) requires each member to conduct a review, at least annually, of the businesses in which it engages. A broker-dealer must conduct on-site inspections of each of its office locations; Office of Supervisory Jurisdictions ("OSJs")12 and non-OSJ branches that supervise non-branch locations at least annually, all non-supervising branch offices at least every three years; and non-branch offices periodically. For these other branch offices, firms should consider whether a cycle of less than three years would be more appropriate, using factors such as the nature and complexity of the branch's securities business, the volume of business done, and the number of associated persons assigned to each branch.13 Pursuant to NASD Rule 3010(c)(1), broker-dealers must document the examination schedules for each non-supervisory branch and non-branch office in their WSPs, including a description of the factors used to determine the examination cycle for such locations. The rule also requires broker-dealers to record the dates each inspection was conducted.14

      Pursuant to NASD Rule 3010(c)(2) the reports reflecting these reviews and inspections must be kept on file by the broker-dealer for a minimum of three years. NASD Rule 3010(c)(3) generally prohibits a branch office manager or any other person within the office with supervisory duties (or any person supervised by such person) from conducting an inspection of the office.15

      Review of Effective Practices

      As noted throughout this Risk Alert, SEC and FINRA examiners have identified some practices that are characteristic of many effective supervisory procedures and effective branch office supervisory systems.16 Such practices are consolidated here:

      •   Using risk analysis to identify whether individual non-supervising branches should be inspected more frequently than the FINRA-required minimum three-year cycle. Branches that meet certain risk criteria based on risk ratings are inspected more often. In addition, some firms conduct "re-audits" more frequently than required when routine inspections reveal a higher than normal number of deficiencies, repeat deficiencies or serious deficiencies. Typically, these re-audits and audits for cause are unannounced inspections.
      •   Using surveillance reports, employing current technology and techniques as appropriate, to help identify risk and develop a customized approach for the firm's compliance program and branch office inspections that considers the type of business conducted at each branch.
      •   Employing comprehensive checklists that incorporate previous inspection findings and trends from internal reports such as audit reports.
      •   Conducting unannounced branch inspections. Firms elected to conduct unannounced examinations either randomly or based on certain risk factors. These "surprise" exams may yield a more realistic picture of a broker-dealer's supervisory system, as it reduces the risk that individual RRs and principals might attempt to falsify, conceal or destroy records in anticipation for an internal inspection.
      •   Including in the written report of each branch inspection any noted deficiencies and areas of improvement. The report should also outline agreed upon actions, including timelines, to correct the identified deficiencies.
      •   Using examiners with sufficient experience to understand the business being conducted at the particular branch being examined and the gravitas to challenge assumptions.
      •   Designing procedures to avoid conflicts of interest by examiners that may serve to undermine complete and effective inspection.
      •   Involving qualified senior personnel in several branch office examinations per year.
      •   Incorporating findings on results of branch office inspections into appropriate management information or risk management systems; and using a compliance database that enables compliance personnel in various offices to have centralized access to comprehensive information about all of the firm's RRs and their business activities. Such a system appears to be highly useful to the compliance personnel at the OSJ and elsewhere for quickly accessing information and for supervising independent contractor RRs dispersed across a broad geographic area.
      •   Providing branch office managers with the firm's internal inspection findings and requiring them to take and document corrective action.
      •   Tracking corrective action taken by each branch office manager in response to branch audit findings.
      •   Elevating the frequency and/or scope of branch inspections where registered personnel are allowed to conduct business activities other than as associated persons of a broker-dealer, for example away from the firm.

      Conclusion

      This alert reminds broker-dealers that their branch office inspections must be conducted with vigilance. It describes certain supervisory tools that, based on OCIE and FINRA staff examinations and Commission enforcement cases, are characteristic of good supervisory procedures for branch office inspections, including the use of unannounced onsite inspections. While this alert summarizes recognized precedent and standards, and provides OCIE and FINRA staff views with regard to means to enhance branch inspections, it does not provide an exhaustive list of steps to effectively discharge responsibilities. A well-designed branch office inspection program is a necessary element — but not the only element — of reasonable supervision of a firm's branch offices and branch office personnel.

      We recognize that each firm is different and that firms need flexibility to adopt procedures to suit their individual structures and business needs. Our suggestions as to compliance methods are not meant to be exclusive or exhaustive and do not constitute a safe harbor. Rather, this report may assist firms in crafting more effective policies and procedures for branch office inspections to prevent and detect misconduct. We urge firms to review their policies and procedures in this regard to determine if they are reasonably designed to prevent and detect violations of applicable law and rules.


      1 The Securities and Exchange Commission ("SEC"), as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the staff of the Office of Compliance Inspections and Examinations ("OCIE") in coordination with other SEC staff, including in the Division of Trading and Markets, and do not necessarily reflect the views of the Commission or the other staff members of the SEC. This document was prepared by OCIE staff in consultation with the staff of the Financial Industry Regulatory Authority ("FINRA") and is not legal advice.

      2 Staff Legal Bulletin No. 17, Remote Office Supervision (March 19, 2004) ("SLB 17").

      3 See, e.g., Consolidated Investment Services, Inc., Rel. No. 34-36687(Jan. 5, 1996) (where the Commission notes that: "We also agree with the law judge that surprise inspections of [the branch office] would have been a prudent course of action;" Signal Securities, Inc.,, Rel. No. 34-43350 (Sep. 26, 2000) ()(citing Consolidated Investment Services); and Quest Capital Strategies, Rel. No. 34-44935 (Oct. 15, 2001) ()(where the Commission stated that : "A surprise inspection is a compliance tool that is necessarily available to every securities firm in carrying out its supervisory responsibilities."); Royal Alliance Associates, Inc., Rel. No. 34-38174 (Jan. 15, 1997) ()(settled matter); see also SLB 17.

      4 See, e.g., Consolidated Investment Services, Inc., Rel. No. 34-36687(Jan.5, 1996); Signal Securities, Inc., Rel. No. 34-43350 (Sep. 26, 2000); Quest Capital Strategies, Rel. No. 34-44935 (Oct. 15, 2001).

      5 See, e.g., Quest Capital Strategies, Inc., Rel. No. 34-44935 (Oct. 15, 2001) and NYLIFE Securities Inc., Rel. No. 34-40459 (September 23, 1998) (settled matter).

      6 See, e.g., Fidelity Brokerage Services, LLC, Rel. No. 34-50138 (Aug. 3, 2004) (pre-announced inspections resulted in, among other things, employees altering and destroying documents; sanctions included a $1,000,000 fine payable to the SEC, plus a $1,000,000 fine payable to the NYSE) (settled matter).

      7 See, e.g., Prospera Financial Services, Admin. Pro. File No. 3-10306, Rel. No. 34-43352 (September 26, 2000) (settled matter) for a discussion of the above elements of a branch office supervisory program; see also SLB 17 for further discussion of these and other elements of an effective branch office supervisory system. See also NASD IM-3010-1 (Standards for Reasonable Review).

      8 NASD Notice to Members 99-45 (June 1999) at 294.

      9 Id. at 295. See also NASD Notice to Members 98-96 (Dec. 1998).

      10 NASD Notice to Members 99-45 (June 1999) at 293-94 (giving examples of situations in which "written supervisory procedures would instruct the supervisor" in how to document compliance)..

      11 Id.

      12 An OSJ is defined under NASD Rule 3010(g) as any office of a member at which any one or more of the following functions take place: (a) order execution and/or market making; (b) structuring of public offerings or private placements; (c) maintaining custody of customers' funds and/or securities; (d) final acceptance (approval) of new accounts; (e) review and endorsement of customer orders; (f) final approval of advertising or sales literature, except for an office that solely conducts final approval of research reports; or, (g) responsibility for supervising the activities of associated persons at one or more other branch offices.

      13 NASD Rule 3010(c)(1)(B).

      14 NASD Rule 3010(c), which governs "Internal Inspections," requires that each broker-dealer review the activities of each of its offices including the periodic examination of customer accounts to detect and prevent irregularities or abuses. The rule also requires that the written inspection report include, without limitation, the testing and verification of the member's policies and procedures, including supervisory policies and procedures in the following areas:

      •   Safeguarding of customer funds and securities;
      •   Maintaining books and records;
      •   Supervision of customer accounts serviced by branch office managers;
      •   Transmittal of funds between customers and RRs and between customers and third parties;
      •   Validation of customer address changes; and
      •   Validation of changes in customer account information.

      15 However, the rule provides an exception from this requirement for a firm so limited in size and resources that it cannot otherwise comply. Under NASD Rule 3010(c)(3) the basis for this exception must be documented in the report for each inspection conducted in reliance on the exception.

      16 Firms are encouraged to consider the practices described herein in assessing their own procedures and implementing improvements that will best protect their clients. Firms are cautioned that these factors and suggestions are not exhaustive, and they constitute neither a safe harbor nor a "checklist" for SEC staff examiners. Other practices besides those highlighted here may be appropriate as alternatives or supplements to these practices. While some of the effective practices above are existing regulatory requirements, the adequacy of a supervisory program can be determined only with reference to the profile of the specific firm and the specific facts and circumstances.

    • 11-53 SEC Approves Amendments to TRACE Reporting Requirements to Conform With Requirements in the Multi Product Platform

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      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6710
      FINRA Rule 6730
      Regulatory Notice 11-20
      Suggested Routing

      Compliance
      Fixed Income
      Legal
      Operations
      Systems
      Trading
      Training
      Key Topics

      Multi Product Platform
      TRACE-Eligible Security
      Transaction Reporting

      Executive Summary

      The SEC approved amendments to FINRA Rule 6730 regarding member firms' reporting obligations when reporting transactions in TRACE-eligible securities other than asset-backed securities.1 FINRA amended the reporting requirements in connection with the consolidation of all TRACE-eligible securities transaction processing and data management on a single technology platform, the multi product platform (MPP).

      The amended rule text is available at www.finra.org/notices/11-53.

      Questions regarding this Notice may be directed to:

      •   FINRA Operations at (866) 776-0800;
      •   Patrick Geraghty, Director, Market Regulation, at (240) 386-4973;
      •   Elliot R. Levine, Associate Vice President and Counsel, Transparency Services, at (202) 728-8405; or
      •   Office of General Counsel at (202) 728-8071.

      Background & Discussion

      Currently, FINRA receives TRACE transaction reports for TRACE-eligible securities that are asset-backed securities and manages the TRACE data regarding those securities (e.g., the TRACE daily list) on FINRA's enhanced technology platform, MPP.2 FINRA intends to migrate TRACE-eligible securities that are not currently on the MPP—corporate bonds and agency debt securities—to the MPP, and, in connection with the migration, has amended certain reporting requirements in FINRA Rule 6730 to conform to the requirements of the MPP.3 The migration and the rule amendments will take effect on February 6, 2012.

      The substantive amendments to FINRA Rule 6730, which apply to transactions other than transactions in asset-backed securities, are as follows:

      •   Transactions executed on a non-business day. FINRA Rules 6730(a)(1)(D) and 6730(a)(2) (B) are amended to permit a firm to report the actual date of execution when reporting a transaction that is executed on a Saturday, a Sunday, a holiday or any day that the TRACE system is not open.4
      •   Size (volume). FINRA Rules 6730(c)(2) and 6730(d)(2) are amended to require a firm to report the size (volume) of a transaction as the total par value or principal value traded, rather than as the number of bonds, as required under the legacy TRACE system.
      •   Commission. FINRA Rules 6730(c)(11) and 6730(d)(1) are amended to require a firm to report the total dollar amount of the commission, rather than the points per bond, as required under the legacy TRACE system.
      •   Settlement. A new provision in FINRA Rule 6730(c)(12) requires a firm to report the date of settlement. FINRA Rule 6730(d)(4)(B), requiring the use of settlement modifiers for certain settlements, is deleted, as are references to the settlement modifiers in FINRA Rule 6730(d)(4)(C).5

      1 See Securities Exchange Act Release No. 65791 (November 18, 2011), 76 FR 72736 (November 25, 2011) (SEC Order Approving File No. SR-FINRA-2011-053)

      2 Asset-backed securities have been reported via MPP since reporting requirements went into effect. (See Securities Exchange Act Release No. 64364 (April 28, 2011), 76 FR 25385 (May 4, 2011) (SEC Order Approving File No. SR-FINRA-2011-012) and Regulatory Notice 11-20 (May 2011).) "TRACE-eligible security" and "asset-backed security" are defined in FINRA Rule 6710(a) and FINRA Rule 6710(m), respectively.

      3 "Agency debt security" is defined in FINRA Rule 6710(1).

      4 The legacy TRACE system did not recognize such days as valid dates of execution.

      The amendments also combine FINRA Rules 6730(a)(1)(B) and 6730(a)(1)(D) as renumbered amended FINRA Rule 6730(a)(1)(D), and delete current FINRA Rule 6730(a)(1)(B). In addition, the amendments reorder the reporting requirements in FINRA Rule 6730(a)(1)(A) through (C) chronologically (i.e., the reporting requirements for transactions that are executed at anytime from midnight through 7:59:59 a.m. Eastern Time are in FINRA Rule 6730(a)(1)(A); the reporting requirements for transactions that are executed during TRACE system hours are in FINRA Rule 6730(a)(1)(B); and the reporting requirements for transactions executed less than 15 minutes before the TRACE system closes are in FINRA Rule 6730(a)(1)(C)).

      5 Under the legacy TRACE system, FINRA Rule 6730(d)(4)(B) required reporting a transaction that would settle on any day other than T+ 3 with a specified settlement modifier.


      ATTACHMENT A

      Text of Amended Rule

    • 11-52 FINRA Reminds Firms of Their Obligations Regarding the Supervision of Registered Persons Using Senior Designations

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      Senior Designations

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Regulatory Notice 07-43
      FINRA Rule 2010
      NASD Rule 2210
      NASD Rule 3010
      NYSE Rule 472
      Suggested Routing

      Advertising
      Compliance
      Continuing Education
      Legal
      Registered Representatives
      Senior Management
      Key Topics

      Communications With the Public
      Designations & Credentials
      Retirement
      Senior Investors
      Supervision

      Executive Summary

      FINRA is publishing this Notice to remind firms of their supervisory obligations regarding the use of certifications and designations that imply expertise, certification, training or specialty in advising senior investors (senior designations). This Notice also outlines findings from a survey of firms and highlights sound practices used by firms with respect to senior designations. Firms are encouraged to adopt the practices that are outlined in this Notice to strengthen their own supervisory procedures, as appropriate to their business.

      Questions or comments concerning this Notice may be directed to Lisa Stepuszek, Associate Director, Office of Risk, at (561) 443-8015.

      Background and Discussion

      For several years, FINRA has focused on firms' fair dealings with senior investors, as well as investors at or approaching retirement (hereinafter together referred to as senior investors). In this regard, in September 2007, FINRA issued Regulatory Notice 07-43, which highlighted certain issues that are common to many senior investors and reminded firms of their obligations in this area. In 20081 and 20102, FINRA joined with other regulators to issue findings and guidance on firms' practices relative to senior investors. Most recently, in the 2011 Annual Regulatory and Examination Priorities Letter, FINRA reiterated that the protection of vulnerable customers, including senior investors, continues to be a high regulatory priority.

      One area of particular focus is the use of certifications and designations that imply expertise, certification, training or specialty in advising senior investors.

      2011 Senior Designation Survey

      To better understand the use and oversight of senior designations, in January 2011, FINRA surveyed retail broker-dealer firms that varied in terms of size, location, product mix and business model. One hundred fifty-seven firms provided responses to the survey, which focused on the prevalence of senior designation usage, the extent to which particular senior designations were used or prohibited and the supervisory systems in place regarding senior designations. Additional survey results are available at www.finra.org/industry/ issues/seniors.

      Survey responses point to widespread use of senior designations in the broker-dealer community. Specifically, 68 percent of firms that completed the survey indicated that they allow the use of senior designations by registered persons. Of the firms that permit the use of senior designations:

      •   89 percent currently have registered persons who use senior designations; and
      •   11 percent do not have any registered persons using senior designations at this time.

      The following chart summarizes the survey responses of those firms that have registered persons who use senior designations.

      Survey respondents that allow registered persons to use senior designations were asked whether they prohibit the use of any particular designations. While 73 percent of the responding firms reported that they prohibit the use of particular senior designations, 27 percent said that they do not have any such prohibitions. Of the firms that prohibit the use of particular designations, some banned the use of only one or two designations while other firms were much more restrictive—i.e., allowing the use of only a small number of designations.

      Firms were also asked whether they require registered persons to obtain senior or other professional designations prior to marketing certain products to senior investors. Only two responding firms indicated that they require designations relative to interactions with senior investors.

      When asked how the firms determined which designations could be used by registered persons, a majority of firms that completed the survey indicated that they review course work, other prerequisites and continuing education requirements prior to allowing or approving a designation. A smaller number of the responding firms indicated that they took a narrower approach by permitting only a select few designations. Other criteria used to determine whether a designation would be permitted included an assessment of state requirements that regulate the use of designations.

      In certain instances, senior designations approved by firms or widely used by registered persons did not require rigorous qualification standards. As a result, the existence of qualification standards to obtain a designation did not ensure that those registered persons holding the designation possessed financial services skills that were unique or valuable to senior investors. This finding was consistent across survey participants and is of concern to FINRA. Investors are unlikely to differentiate between designations that represent an enhanced level of proficiency in dealing with financial matters relevant to senior investors versus a designation that is simply a marketing tool.

      Sound Practices

      This Notice is not intended as a comprehensive summary of all compliance and supervisory matters pertaining to senior designations; rather, it discusses measures that may assist firms in complying with their supervisory obligations. FINRA encourages firms to consider the practices described below in assessing their own procedures and implementing improvements that will best protect their customers.

      Most responding firms indicated that they have adopted and implemented policies governing the use of senior designations. Some firms simply ban the use of senior designations, while other firms establish standards necessary to obtain approval for their use. When standards and approvals are in place, most firms that completed the survey indicated that they monitor whether registered persons have met the criteria to use a particular senior designation.

      NASD Rule 3010 requires each firm to establish and maintain a system to supervise the activities of each registered person that is reasonably designed to achieve compliance with applicable securities laws and regulations and FINRA rules. As discussed in Regulatory Notice 07-43, firms, at a minimum, must have supervisory procedures in place reasonably designed to prevent their registered persons from using a senior designation in a manner that is unethical or misleading. Firms that allow the use of any title or designation that conveys an expertise in senior investments or retirement planning where such expertise does not exist may violate FINRA Rule 2010, NASD Rule 2210, NYSE Rule 472, and possibly the anti-fraud provisions of the federal securities laws and FINRA rules.

      NASD Rule 2210 and NYSE 472 prohibit firms and registered persons from making false, exaggerated, unwarranted or misleading statements or claims in communications with the public. This prohibition includes referencing nonexistent or self-conferred degrees or designations or referencing legitimate degrees or designations in a misleading manner. Firms therefore must have adequate supervisory procedures in place to ensure that their registered persons do not violate this requirement. As with all supervisory procedures, these procedures should be written, clearly communicated to employees, effectively enforced, and they should cover how approved designations may be used. In addition, FINRA reminds firms that all advertisements and sales literature as defined in NASD Rule 2210(a), including communications that include the use of these designations, must be approved prior to use and in writing by a registered principal pursuant to NASD Rule 2210(b)(1).

      Firms may also want to consider adopting some of the practices and procedures described below, as appropriate based on their circumstances. For instance, firms may reduce the risk of confusion or overreliance by their customers by implementing procedures aimed at only permitting their registered persons to use senior designations that instill substantive knowledge to better serve and protect senior investors.

      Designation Standards and Supervision

      Some firms indicated that they prohibit designations that do not have:

      •   a rigorous curriculum;
      •   an emphasis on ethics;
      •   continuing education requirements;
      •   a method for determining the registered person's status regarding the designation; and/or
      •   a public disciplinary process.

      When deciding whether to use or approve designations, certain firms stated that registered persons who want to use a senior designation and represent themselves as experts in senior and retirement investing must remain current with continuing education or other requirements necessary to remain in good standing with the issuing organization. The firms also require registered persons to demonstrate a level of experience in retirement planning and other related matters, as well as the ability to work with senior investors.

      In addition, many firms indicated that they take into consideration whether a designation is recognized by a reputable or accredited organization and whether the issuing organization has a code of ethics or a standard of professional conduct that must be followed.

      Communications With the Public

      Many firms identified valuable practices focused on comprehensive reviews of advertising, sales literature, correspondence and emails to detect:

      •   registered persons who may be using a self-conferred or misleading designation without the knowledge of the firm; and/or
      •   designations being used that have not been earned or approved.

      To detect and prevent these violative practices, some firms only allow registered persons to use business cards or letterhead stationery that is prepared centrally and approved by the firm. Other firms seek to curtail instances where senior investors could be most vulnerable by prohibiting the use of senior designations during sales seminars or "free lunches" with senior investors. Additionally, some firms use key word searches when reviewing correspondence and emails to monitor the use of designations. Certain responding firms also conduct unannounced audits of branch offices to ensure, among other things, that they are aware of all advertising, sales literature and correspondence being used with customers and that all materials are being used appropriately.

      Training

      Certain firms represented that they require registered persons to attend training sessions focused on:

      •   retirement planning;
      •   ethics in working with senior investors; and/or
      •   the proper use of senior designations in advertising, sales literature and correspondence.

      This type of training enables firms to convey information to registered persons regarding the special issues that relate to senior investors.

      Annual Attestations

      In addition to requiring pre-approval to use senior designations, some firms required registered persons to periodically certify:

      •   the designations they use;
      •   that designations they use are not self-conferred;
      •   that they meet the continuing education requirements; and/or
      •   that they are in good standing with the organization that has conferred the designation.

      While this information is self-reported by the registered person, it provides firms with an additional level of information to assist with monitoring and supervising the use of designations.

      Conclusion

      The survey results indicate that while some firms ban senior designations outright, it is more common for firms to permit the use of senior designations pursuant to specified supervisory procedures. The majority of firms responding to the survey that allow the use of senior designations require, at a minimum, registered persons to obtain prior approval or to use only designations that have been pre-approved by the firm. Some firms also verify required credentials underlying designations.

      While these results are positive, the survey indicated that some supervisory procedures were not particularly discerning regarding the quality of the designations that registered persons were permitted to use. In addition, some firms had no meaningful procedures for determining the prerequisites for obtaining designations used by their registered persons. FINRA encourages firms to consider implementing, as appropriate to their business, the sound practices outlined in this Notice to strengthen their own supervisory procedures.


      1 http://www.sec.gov/spotlight/seniors/seniorspracticesreport092208.pdf

      2 http://www.sec.gov/spotlight/seniors/seniorspracticesreport081210.pdf

    • 11-51 Broker-Dealer, Investment Adviser Firm, Agent and Investment Adviser Representative, and Branch Renewals for 2012; Payment Deadline: December 12, 2011

      View PDF

      BD and IA Renewals for 2012

      Regulatory Notice
      Notice Type

      Renewals
      Referenced Rules & Notices

      NTM 02-48
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Senior Management
      Key Topics

      Web CRD®
      IARDTM
      Registration
      Renewals

      Payment Deadline: December 12, 2011

      Executive Summary

      The 2012 Renewal Program begins on November 14, 2011, when FINRA makes the online Preliminary Renewal Statements available to all firms on Web CRD/IARD.

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

      October 24, 2011 Firms may begin submitting post-dated Form U5 and BR Closing/Withdrawal filings via Web CRD/IARD.
      November 1, 2011 Firms may begin submitting post-dated Form BDW and DV-W filings via Web CRD/IARD.

      Please Note: Post-dated filings submitted by 11 p.m., Eastern Time (ET), November 11, 2011, do not appear on the firm's Preliminary Renewal Statement. The only allowed date for post-dated termination filings is December 31, 2011.
      November 14, 2011 Preliminary Renewal Statements are available on Web CRD/IARD.
      December 12, 2011 Full payment of Preliminary Renewal Statements is due.
      January 3, 2012 Final Renewal Statements are available on Web CRD/ IARD.
      February 3, 2012 Full payment of Final Renewal Statements is due.

      FINRA advises FINRA-registered firms that failure to remit full payment of their Preliminary Renewal Statements to FINRA by December 12, 2011, may cause the firm to become ineligible to do business in the jurisdictions where it is registered, effective January 1, 2012. FINRA-registered firms will also be subject to a late fee if payment is not received by this deadline.

      In addition to this Notice, firms should review the renewal instructions, especially the 2012 Renewal Program Bulletin, the 2012 IARD Renewal Program Bulletin (if applicable) on the Investment Adviser Registration Depository (IARD) website, and any information mailed to ensure continued eligibility to do business as of January 1, 2012.

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

      Background & Discussion

      Preliminary Renewal Statements

      Beginning November 14, 2011, 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), NASDAQ OMX BX, Inc. (BX), C2 Options Exchange, Incorporated (C2), Chicago Board Options Exchange (CBOE), Chicago Stock Exchange (CHX), EDGA Exchange, Inc. (EDGA), EDGX Exchange, Inc.(EDGX), International Securities Exchange (ISE), NASDAQ Stock Exchange (NQX), New York Stock Exchange (NYSE), NYSE Arca, Inc. (ARCA), and NASDAQ OMX PHLX, Inc. (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 12, 2011.

      If payment is not received by December 12, 2011, 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 member 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, 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, 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: 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, C2, CBOE, CHX, EDGA, EDGX, ISE, NQX, NYSE, PHLX and state registrations on the Preliminary Renewal Statement. The system displays any 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 to FINRA of renewal fees 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 on the NASAA website.

      For detailed information regarding 2012 investment adviser renewals, you may also visit the IARD website. A matrix of investment adviser renewal fees for states that participate in the 2012 IARD Renewal Program is also posted on the IARD website.

      Renewal Payment

      Firms are encouraged to check their Renewal Statements to confirm payment has been received by FINRA and that the firm's Renewal Statement balance is paid in full. Firms have four payment methods available to pay 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 12, 2011, the Preliminary Renewal Statement payment deadline. FINRA will transfer funds only if a firm has sufficient funds available in its Daily Account on December 12 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.

      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 12, 2011, you must submit payment electronically no later than 8 p.m., ET, on December 8, 2011.

      Check

      The check must be drawn on the FINRA-registered 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 and 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
      P.O. Box 7777-W8705
      Philadelphia, PA 19175-8705

      (Note: This box will not accept courier
      or overnight deliveries.)
      FINRA
      Attention: 8705
      500 Ross Street 154-0455
      Pittsburgh, PA 15262

      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 14, 2011, member 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—This report lists individuals included in the Renewal Program and includes billing codes (if they have been supplied by the firm).
      •   Branches Renewal Report—This 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—This report contains all individuals who are not registered with FINRA, but are registered with one or more jurisdictions. Firms should request this report as soon as possible to determine if it needs to request any FINRA registrations or terminate jurisdiction registrations.

      Post-Dated Form Filings

      Firms can file termination forms with a termination date of December 31, 2011. If a Form U5, BDW, BR Closing/Withdrawal or ADV-W filing indicates a termination date of December 31, 2011, 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 renewal fees. December 31, 2011, 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 24, 2011. In addition, firms can begin filing post-dated Form BDW and ADV-W filings via Web CRD/IARD on November 1, 2011. Firms that submit post-dated termination filings by 11 p.m., ET, on November 11, 2011, 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 14, 2011, will not be assessed renewal fees for the terminated jurisdictions on their Final Renewal Statements in January 2012. 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, 2011.

      Firms should exercise care when submitting all post-dated filings. Web CRD/IARD processes these forms as firms submit them and FINRA cannot withdraw a post-dated termination filing once it is 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, 2012, and Web CRD/IARD will assess new registration fees.

      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 11, 2011, 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.
      •   NASDAQ OMX PHLX, Inc.

      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, 2011. 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 11, 2011, 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, 2011.

      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. Member 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 11, 2011, 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, 2012, 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, 2011. 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 was 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, 2012. 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, 2012, FINRA-registered 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, C2, CBOE, CHX, EDGA, EDGX, 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 3, 2012, 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 2012 Regulatory Notice.

    • 11-50 SEC Approves Amendments to FINRA Rule 9251 to Explicitly Protect From Discovery Those Documents That Federal Law Prohibits FINRA From Disclosing; Effective Date: December 2, 2011

      View PDF

      Discovery

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 9251
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topics

      Code of Procedure
      Discovery

      Executive Summary

      The SEC recently approved an amendment to FINRA Rule 9251 (Inspection and Copying of Documents in Possession of Staff) that explicitly protects from discovery during FINRA proceedings those documents that federal law prohibits FINRA from disclosing.1 The amended rule text is set forth in Attachment A and is effective December 2, 2011.

      Questions concerning this Notice should be directed to:

      •   James S. Wrona, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8270; or
      •   Matthew E. Vitek, Counsel, OGC, at (202) 728-8156.

      Background & Discussion

      FINRA Rule 9251 describes the types of documents that FINRA's Enforcement and Market Regulation Departments must produce to respondents during the discovery phase of a FINRA proceeding. The rule also explicitly protects certain types of documents from production. Enforcement and Market Regulation, for example, may withhold documents that are protected by attorney-client privilege or work-product immunity.2 The rule, however, previously did not explicitly protect from discovery documents that federal law prohibits FINRA from disclosing. Enforcement and Market Regulation had to seek a hearing officer "good cause" determination allowing them to withhold such documents.3 The SEC recently approved an amendment to Rule 9251 that increases efficiency by avoiding the need for the parties to brief and hearing officers to resolve "good cause" motions regarding documents that FINRA cannot legally produce.

      Amended Rule 9251 now explicitly allows Enforcement and Market Regulation automatically to withhold from discovery documents that federal law prohibits them from disclosing.4 The amended rule also prohibits a hearing officer from ordering Enforcement or Market Regulation to either produce or reveal information about the existence of a document to a respondent if federal law prohibits such disclosure.5 The amendment, however, contains a procedural safeguard allowing a hearing officer to review a document to determine whether federal law prohibits Enforcement or Market Regulation from disclosing it.6


      1 See Exchange Act Release No. 65281 (September 7, 2011), 76 FR 56848 (September 14, 2011) (Order Approving Proposed Rule Change; File No. SR-FINRA-2011-031).

      2 FINRA Rule 9251(b)(1)(A).

      3 FINRA Rule 9251(b)(1)(D).

      4 See FINRA Rule 9251(b)(2); see also Exchange Act Release No. 65281 (September 7, 2011), 76 FR 56848 (September 14, 2011) (Order Approving Proposed Rule Change; File No. SR-FINRA-2011-031).

      5 FINRA Rule 9251(c).

      6 Id.


      ATTACHMENT A

      Text of Amended Rule

      New language is underlined; deletions are in brackets.

      * * * * *

      9200. DISCIPLINARY PROCEEDINGS

      * * * * *

      9250. Discovery
      9251. Inspection and Copying of Documents in Possession of Staff
      (a) No Change.
      (b) Withheld Documents [That May Be Withheld]
      (1) No Change.
      (2) The Department of Enforcement or the Department of Market Regulation shall withhold a Document if the Document is prohibited from disclosure by federal law.
      (3) Nothing in paragraph (b)(1) authorizes the Department of Enforcement or the Department of Market Regulation to withhold a Document, or a part thereof, that contains material exculpatory evidence.
      (c) Withheld Document List

      The Hearing Officer may require the Department of Enforcement or the Department of Market Regulation to submit to the Hearing Officer a list of Documents withheld pursuant to paragraphs] (b)[(1)(A) through (D)] or to submit to the Hearing Officer any Document withheld. Upon review, the Hearing Officer may order the Department of Enforcement or the Department of Market Regulation to make the list or any Document withheld available to the other Parties for inspection and copying unless federal law prohibits disclosure of the Document or its existence. A motion to require the Department of Enforcement or the Department of Market Regulation to produce a list of Documents withheld pursuant to paragraph (b) shall be based upon some reason to believe that a Document is being withheld in violation of the Code.
      (d) through (g) No Change.

      * * * * *

    • 11-49 FINRA Provides Guidance on Advertising Regulation Issues

      View PDF

      Advertising Regulation

      Regulatory Notice
      Suggested Routing

      Advertising
      Compliance
      Executive Representatives
      Investment Companies
      Legal
      Mutual Funds
      Senior Management
      Key Topics

      Advertising
      Exchange-Traded Funds
      Mutual Funds
      Treasury Inflation-Protected Securities
      Referenced Rules & Notices

      NASD Rule 2210
      NASD IM-2210-4
      Securities Act Rule 482
       

      Executive Summary

      FINRA is providing guidance to firms on certain issues related to the application of NASD Rule 2210 and the filing of communications for review with FINRA's Advertising Regulation Department. FINRA intends to periodically issue guidance to the industry concerning significant interpretive issues or other issues related to FINRA rules govering communications with the public.

      Questions concerning this Notice should be directed to:

      •   Thomas A. Pappas, Vice President, Advertising Regulation, at (240) 386-4553; or
      •   Amy C. Sochard, Director, Advertising Regulation, at (240) 386-4508.

      Background and Discussion

      In order to inform firms of recent developments regarding the application of the rules governing communications with the public, FINRA is providing the following guidance to firms on selected communications with the public issues.

      Exchange-Traded Products

      NASD Rule 2210(c)(2)(A) requires a firm to file advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts, continuously offered closed-end funds and unit investment trusts) with FINRA within 10 business days of first use or publication. This filing requirement applies to any advertisement or sales literature concerning an exchange-traded fund that is registered under the Investment Company Act of 1940 (1940 Act ETF).

      Firms are reminded that these filing requirements apply to all advertisements and sales literature concerning 1940 Act ETFs, including research reports. Accordingly, firms must file research reports on these 1940 Act ETFs that fall within the definition of "advertisement" or "sales literature" within 10 business days of first use or publication.

      Similarly, NASD Rule 2210(c)(2)(B) requires a firm to file advertisements and sales literature concerning public direct participation programs with FINRA within 10 business days of first use or publication. FINRA reminds firms that they must file advertisements and sales literature concerning exchange-traded products that are organized as grantor trusts and that meet the definition of "direct participation program" under FINRA Rule 2310(a)(4) within 10 business days of first use or publication.1

      Treasury Inflation-Protected Securities Funds

      Treasury Inflation-Protected Securities (TIPS) are marketable Treasury securities whose par value is adjusted based upon changes in the Consumer Price Index (CPI). With inflation (a rise in the CPI), the par value of TIPS increases; with deflation (a drop in the CPI), the par value decreases.

      A number of mutual funds and 1940 Act ETFs invest primarily in TIPS (TIPS funds). Often, firms will advertise a TIPS fund's current yield as permitted by Securities Act Rule 482.2 Generally speaking, a fund's current yield is a percentage return expressed on an annualized basis that reflects the dividends and interest earned by the fund net of expenses for the 30-day period named in the communication.

      Because TIPS have an inflation adjustment component that is not specifically addressed in SEC rules governing calculation of a mutual fund's current yield, firms have adopted various treatments of the inflation adjustment when calculating a TIPS fund's yield. Some firms have included the inflation adjustment in a TIPS fund's current yield calculation, while other firms have not. This discrepancy in the calculation method has led to significant differences in the yield advertised by similar TIPS funds for the same periods. FINRA is concerned that investors may not understand that these differences in advertised yield are largely attributable to the different methods used to calculate current yield, rather than differences in performance of the funds themselves.

      Due to this concern, FINRA has interpreted NASD Rule 2210(d) to require certain disclosures in advertisements and sales literature that include a TIPS fund's current yield. Specifically, if the fund's current yield is adjusted monthly based on changes in the rate of inflation, then the communication must explain that these changes can cause the yield to vary substantially from one month to the next. If an advertisement or item of sales literature includes an exceptionally high current yield for a TIPS fund, the material must disclose that the yield is attributable to the rise in the inflation rate, which might not be repeated.

      Use of FINRA in Firm Trademarks

      NASD Interpretive Material 2210-4 places strict limits on how firms may indicate their FINRA membership. Firms may do so only in one of three ways:

      (1) in a communication with the public that complies with the standards of NASD Rule 2210 and neither states nor implies that FINRA or any other corporate name or facility owned by FINRA, or any other regulatory organization, endorses, indemnifies or guarantees the firm's business practices, selling methods, the class or type of securities offered, or any specific security;
      (2) in a confirmation statement for an over-the-counter transaction that includes a specified legend; or
      (3) on a firm's website, so long as the firm provides a hyperlink to the homepage of FINRA's website in close proximity to the firm's indication of FINRA membership.

      Recently, FINRA has observed that some firms have filed applications to register trademarks with the U.S. Patent and Trademark Office that include the FINRA® trademark and a reference to membership in the proposed trademark. Firms and their associated persons may not include the FINRA® trademark or references to FINRA membership in any trademark of the firm or associated person, as such usages violate IM-2210-4 and are likely to cause confusion and to infringe upon FINRA's trademark rights.

      Identification of Related Prior Filings When Submitting New Filings for Review

      FINRA reminds firms when filing material for review by Advertising Regulation staff to identify the reference number of any communication previously submitted by the firm and already reviewed by FINRA that is similar to the current communication filing. This information will assist staff in providing a more consistent and efficient review process. For example, firms should identify a past different filing that FINRA staff reviewed that includes the same or similar marketing content as the current filing. Or, if a firm files a revised version of an advertisement that the firm previously filed in order to address prior FINRA staff comments, the firm should identify the reference number of the prior filing so that prior staff comments can be addressed.


      1. FINRA Rule 2310(a)(4) defines "direct participation program" as "a program which provides for flow-through tax consequences regardless of the structure of the legal entity or vehicle for distribution, including, but not limited to, oil and gas programs, real estate programs, agricultural programs, cattle programs, condominium securities, Subchapter S corporate offerings and all other programs of a similar nature, regardless of the industry represented by the program, or any combination thereof" The definition excludes real estate investment trusts, tax qualified pension and profit sharing plans pursuant to Sections 401 and 403(a) of the Internal Revenue Code and individual retirement plans under Section 408 of that Code, tax sheltered annuities pursuant to the provisions of Section 403(b) of the Internal Revenue Code, and any company, including separate accounts, registered pursuant to the Investment Company Act.

      2. See 17 C.F.R. 230.482(d)(1).

    • 11-48 FINRA Requests Comment on a Proposed New Rule Requiring Carrying/Clearing Member Firms to Maintain and Keep Current Certain Records in a Central Location; Comment Period Expires: December 9, 2011

      View PDF

      Books and Records

      Regulatory Notice
      Notice Type

      Request for Comment
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Books and Records
      Referenced Rules & Notices

      FINRA Rule 4370
      FINRA Rule 4523
      NASD Rule 1160
      NASD Rule 3110
      SEA Rule 15c3-3
      SEA Rule 17a-3
      SEA Rule 17a-4

      Executive Summary

      FINRA is requesting comment on a proposed new rule that would require each carrying or clearing member firm to maintain and keep current certain records in a central location to facilitate a more rapid and orderly transfer of customer accounts to another broker-dealer as well as a more orderly liquidation in the event the member firm can no longer continue to operate due to financial or operational problems.

      The text of proposed FINRA Rule 4516 (Readily Identifiable and Accessible Records) is set forth in Attachment A.

      Questions regarding this Notice should be directed to:

      •   Marshall J Levinson, Vice President, Member Regulation, at (646) 315-8453; and
      •   Adam H. Arkel, Assistant General Counsel, Office of General Counsel, at (202) 728-6961.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by December 9, 2011.

      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 as they are received.1

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

      Background & Discussion

      If a carrying or clearing member firm can no longer continue to operate due to financial or operational problems, it is essential that regulators be able to take prompt action to protect investors. Regulators may need, among other things, to identify a clearing firm that would be able to take all customer accounts of the liquidating member firm in an expedited manner. In order for regulators to act in a timely fashion, certain documents and information must be readily identifiable and accessible. To aid in this process, FINRA believes it is critical that a carrying or clearing member firm maintain and keep current certain documents and information in one central location.3

      To that end, FINRA is proposing new FINRA Rule 4516. Paragraph (a) of the new rule would require that, unless otherwise permitted by FINRA, in writing, each carrying or clearing member firm must maintain, and keep current, in a manner readily identifiable as such, records containing the information set forth in paragraph (b) of the rule at an area within its principal office that the member firm must specially designate. For purposes of compliance wih the new rule, member firms may maintain the records in electronic form.4 Specifically, under paragraph (b) of the rule, the records must contain the following:

      1. description of all accounts and ranges on the general ledger including the names of the associated persons assigned primary and supervisory responsibility for each such account pursuant to Rule 4523(b);
      2. mapping of the general ledger accounts and ranges to the trial balance, including a list of all affiliated accounts;
      3. description of all mission critical systems as defined in FINRA Rule 4370(g),5 including recordkeeping systems and the names of contact persons for each;
      4. list of all bank accounts, authorized signatories, copies of executed agreements with such banks and "no lien" letters where applicable;
      5. identification of all accounts and ranges on the stock record;
      6. identification of all foreign and domestic control locations pursuant to SEA Rule 15c3-3 with the names of contact persons at each institution;
      7. copies of all executed subordination agreements and nonconforming subordination agreements;
      8. copies of all executed agreements with any clearing agencies, clearing banks and custodians;
      9. copies of all executed agreements relating to the outsourcing of any significant activities or functions that are critical to the transfer of customer accounts and the liquidation of the member firm; and
      10. most recent copy of the member firm's business continuity plan.

      The proposed rule requires that these records be immediately available to and accessible by representatives or designees of FINRA, the SEC and Securities Investor Protection Corporation (SIPC). Further, a member firm subject to the rule would be required to enter into an agreement with any clearing agency, clearing bank or custodian with which the member firm does business that requires, upon the commencement of a liquidation of the member firm, that any electronic systems provided to the member firm by the clearing agency, clearing bank or custodian will be made available, on a read only basis, to representatives or designees of FINRA, the SEC and SIPC.6

      The rule would require that all records maintained pursuant to the rule must indicate the date the records were last updated. Lastly, the rule would also require that all member firms subject to the rule must designate a contact person responsible for maintaining and keeping current the records required under the rule. The member firm would be required to report the contact information for the designated contact person to FINRA and to update the contact information pursuant to NASD Rule 1160.7

      Request for Comment

      While FINRA is interested in receiving comments on all aspects of proposed FINRA Rule 4516, FINRA seeks specific comment on whether any adjustments are appropriate as to the list of records that would be subject to the proposed requirement as set forth in paragraph (b) of the rule, and as to the anticipated costs of compliance with the proposed rule.

      The comment period expires December 9, 2011.


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

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

      3. The inability to locate certain documents and information was identified as a concern in connection with the Lehman Brothers Inc. liquidation during the recent credit crisis. See, e.g., In re Lehman Brothers Inc., Trustee's Preliminary Investigation Report and Recommendations (August 25, 2010), pages 112 et seq. (Trustee's Report).

      4. The proposed rule provides that if the member firm maintains the records by means of electronic storage media, such records must be uniquely tagged and appropriately indexed so as to be readily identifiable as such and accessible from the member firm's principal office. Member firms are reminded that they remain subject to the books and records requirements set forth in SEA Rules 17a-3 and 17a-4 and NASD Rule 3110.

      5. FINRA Rule 4370(g) defines "mission critical system" as "any system that is necessary, depending on the nature of a member's business, to ensure prompt and accurate processing of securities transactions, including, but not imited to, order taking, order entry, execution, comparison, allocation, clearance and settlement of securities transactions, the maintenance of customer accounts, access to customer accounts and the delivery of funds and securities."

      6. FINRA is including this provision in large part based on the experience of the Lehman liquidation. See, e.g., Trustee's Report, pages 60–63, 91–92 and 124–25.

      7. NASD Rule 1160 requires, among other things, each member firm to (1) report to FINRA all contact information required by FINRA; (2) update its required contact information promptly, but in any event not later than 30 days following any change in such information; and (3) review and, if necessary, update its required contact information within 17 business days after the end of each calendar year.


      Attachment A

      Below is the text of proposed FINRA Rule 4516.

      FINRA Rule 4516. Readily Identifiable and Accessible Records

      (a) Unless otherwise permitted by FINRA, in writing, each carrying or clearing member shall maintain, and keep current, in a manner readily identifiable as such, records containing the information set forth in paragraph (b) of this Rule at an area within its principal office that the member shall specially designate. If the member maintains such records by means of electronic storage media, the records shall be uniquely tagged and appropriately indexed so as to be readily identifiable as such and accessible from the member's principal office.
      (b) Pursuant to paragraph (a) of this Rule, each carrying or clearing member shall maintain and keep current records containing the following:
      (1) Description of all accounts and ranges on the general ledger including the names of the associated persons assigned primary and supervisory responsibility for each such account pursuant to Rule 4523(b);
      (2) Mapping of the general ledger accounts and ranges to the trial balance, including a list of all affiliated accounts;
      (3) Description of all mission critical systems as defined in Rule 4370(g), including recordkeeping systems and the names of contact persons for each;
      (4) List of all bank accounts, authorized signatories, copies of executed agreements with such banks and "no lien" letters where applicable;
      (5) Identification of all accounts and ranges on the stock record;
      (6) Identification of all foreign and domestic control locations pursuant to SEA Rule 15c3-3 with the names of contact persons at each institution;
      (7) Copies of all executed subordination agreements and nonconforming subordination agreements;
      (8) Copies of all executed agreements with any clearing agencies, clearing banks and custodians;
      (9) Copies of all executed agreements relating to the outsourcing of any significant activities or functions that are critical to the transfer of customer accounts and the liquidation of the member; and
      (10) Most recent copy of the member's business continuity plan.
      (c) Every record maintained pursuant to this Rule shall be immediately available to and accessible by representatives or designees of FINRA, the SEC and SIPC.
      (d) All members subject to this Rule shall enter into an agreement with any clearing agency, clearing bank or custodian with which the member does business that requires, upon the commencement of a liquidation of the member, that any electronic systems provided to the member by the clearing agency, clearing bank or custodian will be made available, on a read only basis, to representatives or designees of FINRA, the SEC and SIPC.
      (e) All records maintained pursuant to this Rule shall indicate the date such records were last updated.
      (f) All members subject to this Rule shall designate a contact person responsible for maintaining and keeping current the records required pursuant to this Rule. The member shall report the contact information for such person to FINRA and shall update such information pursuant to NASD Rule 1160.

    • 11-47 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 2011 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 as such in the document.

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

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

      Questions concerning this Notice should be directed to:

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

    • 11-46 FINRA to Require Electronic Submission of Annual Audit Reports; Effective Date: November 8, 2011, for all annual audit reports with a fiscal year end on or after September 30, 2011

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      Annual Audit Reports

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NASD Rule 3170
      SEA Rule 17a-4
      SEA Rule 17a-5
      Regulatory Notice 08-11
      Notice to Members 06-61
      Suggested Routing

      Compliance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      Annual Audit Report

      Executive Summary

      FINRA is revising the process by which member firms submit to FINRA the annual audited financial statements required pursuant to Securities Exchange Act (SEA) Rule 17a-5(d) (annual audit reports). Specifically, pursuant to NASD Rule 3170, FINRA is requiring, effective November 8, 2011, that firms submit their annual audit report in electronic form.1 This requirement is applicable to annual audit reports with a fiscal year end on or after September 30, 2011.

      This Notice discusses the electronic submission process, which will replace the current submission of annual audit reports in hard copy form to FINRA. Once FINRA has completed the transition to electronic submission of annual audit reports, as described in this Notice, FINRA will no longer accept annual audit reports filed in hard copy form.

      Questions concerning this Notice may be directed to your firm's Regulatory Coordinator.

      Background & Discussion

      SEA Rule 17a-5(d) requires, among other things, that every broker or dealer registered pursuant to SEA Section 15 must file an annual audit report at the principal office of the firm's Designated Examining Authority (DEA).2 Pursuant to NASD Rule 3170, FINRA will, effective November 8, 2011, require member firms for which it is the DEA to submit annual audit reports in electronic form.3 Accordingly, annual audit reports for any fiscal year ending on or after September 30, 2011, must be submitted electronically.

      Firms are required to submit their annual audit report in electronic form via FINRA's Firm Gateway. The required format of the filing is Portable Document Format (PDF). The electronic submission screen on the Firm Gateway will include a list of documents that, if applicable, are required in the audit filing. This list will assist the firm in ensuring that all required schedules are included in its submission. Firms should refer to SEA Rule 17a-5 for information regarding broker-dealer annual audit report requirements.

      In addition to the annual audit report, SEA Rule 17a-5 requires that an oath and affirmation page be completed. Specifically, SEA Rule 17a-5(e)(2) states that there must be attached to the annual audit report an oath or affirmation that, to the best knowledge and belief of the person making such an oath or affirmation, (i) the financial statements and schedules are true and correct and (ii) neither the broker or dealer, nor any partner, officer, or director, as the case may be, has any proprietary interest in any account classified solely as that of a customer. The rule requires that the oath or affirmation must be made before a person duly authorized to administer such oaths or affirmations. If the broker or dealer is a sole proprietorship, the oath or affirmation must be made by the proprietor; if a partnership, by a general partner; or if a corporation, by a duly authorized officer. Firms must submit the oath and affirmation electronically with their annual audit, and must also maintain the oath and affirmation page with an original manual signature (including raised notary seal, where applicable) as part of their books and records under SEA Rule 17a-4(a), along with the accompanying annual audit report in hard copy form.

      In the new annual audit electronic filing platform in Firm Gateway, if a firm wishes (or is required by FINRA)4 to submit an amended annual audit report, when the original audit report was submitted to FINRA electronically, the firm's assigned Regulatory Coordinator will open a "re-file" window in Firm Gateway to permit the firm to submit the amended filing. If a firm needs to amend an annual audit report that was previously filed in hard copy form, the amendment must also be submitted in hard copy form. In all cases, amended audit reports must be submitted in their entirety (i.e., an amended filing must include all schedules and information required pursuant to SEA Rule 17a-5, including the oath and affirmation, whether or not such schedules and information have been amended). FINRA will retain the original audit report filed, as well as all amended filings. Consistent with FINRA's current practice for hard copy filings, FINRA will treat electronically filed annual audit reports as confidential.5

      Firms must use their current FINRA entitlement user ID and password to access the Firm Gateway and submit their annual audit report. Firm personnel should contact their firm's Super Account Administrator (SAA) with any questions regarding how to access Firm Gateway. For Firm Gateway technical questions, contact FINRA's Technical Support Group at (301) 869-6699.


      1. NASD Rule 3170 gives FINRA authority to require firms to file or submit electronically any regulatory notice or other document that a member firm is required to file with or otherwise submit to FINRA. In an earlier Notice, FINRA listed 10 additional financial notifications (and 11 related SEC Rules) to which NASD Rule 3170 applies. See Regulatory Notice 08-11 (March 2008) (Electronic Filing) and Notice to Members 06-61 (November 2006) (Electronic Filing Requirements).

      2. Specifically, Rule 17a-5(d)(6) provides that one copy of the annual audit report must be filed at the regional office of the SEC for the region in which the broker or dealer has its principal place of business and at the principal office of the DEA for said broker or dealer. Two copies must be filed at the SEC's principal office in Washington, DC. Further, copies must be provided to all self-regulatory organizations of which the broker or dealer is a member.

      3. Firms must continue to file annual audit reports in hard copy form with the SEC.

      4. FINRA may require a firm to submit an amended annual audit report to cure inadequacies contained in the original submission. Pursuant to Section 4(g) of Schedule A to FINRA's By-Laws, an annual audit report that contains material inaccuracies or is filed incompletely shall be deemed not to have been filed until a corrected copy of the report has been resubmitted.

      5. Notwithstanding that FINRA will treat the electronically filed annual audit reports as confidential, as commonly understood, FINRA may release such filings pursuant to government or compulsory legal process. In addition, FINRA understands that the SEC will continue to make all statements filed pursuant to SEA Rule 17a-5(d) available to the public, subject to specified exceptions. See SEA Rule 17a-5(e)(3).

    • 11-45 FINRA Revises the Series 7, 17, 37 and 38 Examination Programs; Implementation Date: November 7, 2011

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      Qualification Examinations

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      Incorporated NYSE Rule 10
      Incorporated NYSE Rules 345.10, 345.15(2) and 345.15(3)
      Incorporated NYSE Rule Interpretation 345.15/02
      Information Notice 3/12/08
      MSRB Rule G-3
      NASD Rules 1031(a) and (b)
      NASD Rule 1032
      NASD Rules 1041 and 1042
      NYSE Information Memoranda 91-09 and 96-06
      SEA Section 15A(g)(3)
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Training
      Key Topics

      Canada Securities Representative (Series 37)
      Canada Securities Representative (Series 38)
      General Securities Representative (Series 7)
      Municipal Securities Representative (Series 52)
      Qualification Examinations
      United Kingdom Securities Representative (Series 17)

      Executive Summary

      FINRA periodically reviews the content of qualification examinations to determine whether revisions are necessary or appropriate in view of changes — including laws, rules and regulations — pertaining to the subject matter covered by the examinations.

      Based on these reviews, FINRA has revised the following examination programs:

      •   General Securities Representative (Series 7);
      •   United Kingdom Securities Representative (Series 17);
      •   Canada Securities Representative (Series 37); and
      •   Canada Securities Representative (Series 38).1

      The changes are reflected in the content outlines on FINRA's website and will appear in examinations starting on November 7, 2011.

      Questions regarding this Notice should be directed to:

      •   Joe McDonald, Senior Director, Testing and Continuing Education Department, at (240) 386-5065; or
      •   Patricia Monterosso, Lead Qualifications Analyst, Testing and Continuing Education Department, at (646) 315-8753.

      Background & Discussion

      Section 15A(g)(3) of the Securities Exchange Act of 1934 authorizes FINRA to prescribe standards of training, experience and competence for persons associated with FINRA member firms. In accordance with that provision, FINRA has developed examinations that are designed to establish that persons associated with FINRA member firms have attained specified levels of competence and knowledge, consistent with applicable registration requirements under FINRA Rules.

      NASD Rules and the rules incorporated from NYSE2 require that a "representative," as defined in the respective rules,3 register and qualify as a General Securities Representative,4 subject to certain exceptions. For those representatives who are not engaged in municipal securities activities, the NASD and NYSE Rules provide that registration and qualification as a United Kingdom Securities Representative or a Canada Securities Representative is equivalent to registration and qualification as a General Securities Representative.5

      The Series 7 examination qualifies an individual to function as a General Securities Representative. The Series 17 examination qualifies an individual to function as a United Kingdom Securities Representative. Either the Series 37 examination or the Series 38 examination qualifies an individual to function as a Canada Securities Representative. Series 17, 37 and 38 candidates must also satisfy certain foreign prerequisite training and competence requirements.6

      Committees of industry representatives, together with FINRA staff, recently reviewed the Series 7, 17, 37 and 38 examination programs. As a result of these reviews, FINRA has revised the content outlines to reflect changes to the laws, rules and regulations covered by the examinations. Among other revisions, FINRA has revised the outlines to reflect the adoption of rules in the consolidated FINRA rulebook.

      FINRA also has revised the outlines to better reflect the functions and associated tasks performed by General Securities Representatives, United Kingdom Securities Representatives and Canada Securities Representatives, and to better reflect the relationship between the different components of the outlines.

      FINRA has divided the content outlines into five major job functions denoted F1 through F5:

      •   F1: Seeks Business for the Broker-Dealer through Customers and Potential Customers;
      •   F2: Evaluates Customers' Other Security Holdings, Financial Situation and Needs, Financial Status, Tax Status, and Investment Objectives;
      •   F3: Opens Accounts, Transfers Assets, and Maintains Appropriate Account Records;
      •   F4: Provides Customers with Information on Investments and Makes Suitable Recommendations; and
      •   F5: Obtains and Verifies Customer's Purchase and Sales Instructions, Enters Orders, and Follows Up.

      Additionally, each job function includes certain tasks describing activities associated with performing that function. Each of the revised outlines also includes a knowledge section describing the underlying knowledge required to perform the major job functions and associated tasks, and a rule section listing the laws, rules and regulations related to the job functions, associated tasks and knowledge statements. There are cross-references within each section to the other applicable sections.

      As described in greater detail below, the number of questions associated with each of the five functions, F1 through F5, differs depending on the examination. FINRA has made other revisions to the examinations, which also are described below.

      Lastly, in conjunction with the changes to the content outlines, FINRA has made changes to the weighting of questions on content outline topics and to the question banks for these examinations.

      Series 7

      The number of questions associated with each of the five functions performed by a General Securities Representative (Series 7) are as follows:

      •   F1: 68 questions;
      •   F2: 27 questions;
      •   F3: 27 questions;
      •   F4: 70 questions; and
      •   F5: 58 questions.

      The number of questions on the Series 7 examination remains at 250 multiple-choice questions,7 and candidates continue to have six hours to complete the examination. Currently, a "scaled score" of 70 percent is required to pass the Series 7 examination,8 while a scaled score of 72 percent will be required to pass the revised examination.

      Municipal Securities Activities

      Pursuant to current Municipal Securities Rulemaking Board (MSRB) Rule G-3, either the Municipal Securities Representative (Series 52) examination or the Series 7 examination qualifies an individual to function as a Municipal Securities Representative. In connection with the periodic review of examination content mentioned above, FINRA has revised the Series 7 examination to reduce the emphasis on municipal securities activities. FINRA notes that the MSRB has filed with the SEC a proposed rule change to amend MSRB Rule G-3 to provide, among other things, that, with regard to municipal securities activities, an individual qualifying as a Municipal Securities Representative by passing the Series 7 may engage only in municipal securities sales to, and purchases from, customers.9

      Series 17

      The number of questions associated with each of the five functions performed by a United Kingdom Securities Representative (Series 17) are as follows:

      •   F1: 20 questions;
      •   F2: 15 questions;
      •   F3: 25 questions;
      •   F4: 20 questions; and
      •   F5: 20 questions.

      The number of questions on the Series 17 examination remains at 100 multiple-choice questions. However, candidates will have 150 minutes (2.5 hours) to complete the examination, whereas today they have two hours to complete the examination. Also, currently, a score of 70 percent is required to pass the Series 17 examination, while a score of 72 percent will be required to pass the revised examination.

      Series 37

      The number of questions associated with each of the five functions performed by a Canada Securities Representative (Series 37) are as follows:

      •   F1: 22 questions;
      •   F2: 12 questions;
      •   F3: 18 questions;
      •   F4: 16 questions; and
      •   F5: 22 questions.

      The number of questions on the Series 37 examination remains at 90 multiple-choice questions, and candidates continue to have 150 minutes (2.5 hours) to complete the examination. Currently, a score of 70 percent is required to pass the Series 37 examination. A score of 72 percent will be required to pass the revised examination.

      Series 38

      The number of questions associated with each of the five functions performed by a Canada Securities Representative (Series 38) are as follows:

      •   F1: 7 questions;
      •   F2: 7 questions;
      •   F3: 12 questions;
      •   F4: 10 questions; and
      •   F5: 9 questions.

      The number of questions on the Series 38 examination remains at 45 multiple-choice questions, and candidates continue to have 75 minutes to complete the examination. Currently, a score of 70 percent is required to pass the Series 38 examination. A score of 72 percent will be required to pass the revised examination.

      Content Outlines

      The revised Series 7, 17, 37 and 38 content outlines are available on FINRA's website.


      1 See Securities Exchange Act Release No. 65358 (September 20, 2011), 76 FR 59751 (September 27, 2011) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change; File No. SR-FINRA-2011-045); Securities Exchange Act Release No. 65376 (September 21, 2011), 76 FR 59759 (September 27, 2011) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change; File No. SR-FINRA-2011-046); Securities Exchange Act Release No. 65374 (September 21, 2011), 76 FR 59761 (September 27, 2011) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change; File No. SR-FINRA-2011-047); and Securities Exchange Act Release No. 65375 (September 21, 2011), 76 FR 59757 (September 27, 2011) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change; File No. SR-FINRA-2011-048). These rule filings were filed with the SEC for immediate effectiveness on September 7, 2011.

      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 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, March 12, 2008 (Rulebook Consolidation Process). For convenience, the Incorporated NYSE Rules are referred to as the NYSE Rules.

      3 See NASD Rule 1031(b) and NYSE Rule 10.

      4 See NASD Rules 1031(a) and 1032(a)(1); NYSE Rules 345.10 and 345.15(2); and NYSE Rule interpretation 345.15/02.

      5 See NASD Rules 1032(a)(2)(B) and (a)(2)(C) and NYSE Information Memoranda 91-09 (March 1991) and 96-06 (March 1996).

      6 Series 17 candidates must satisfy certain prerequisite training and competence requirements of the United Kingdom's Financial Services Authority (FSA) and be registered and in good standing with the FSA. Series 37 and Series 38 candidates must satisfy certain prerequisite training and competence requirements of the Canadian regulators and be registered and in good standing with the appropriate Canadian regulator. Series 38 candidates must also complete either: (1) the Options Licensing Course and the Derivatives Fundamental Course; or (2) the Canadian Options Course. Since Series 38 candidates are already subject to a Canadian options prerequisite, the Series 38 examination does not include test questions that assess knowledge of options. More information regarding the prerequisite requirements for the Series 17 and Series 37 and 38 examinations is available on FINRA's website.

      7 Consistent with FINRA's practice of including "pre-test" questions on certain qualification examinations, which is designed to ensure that new examination questions meet acceptable testing standards prior to use for scoring purposes, each Series 7 examination includes 10 additional, unidentified pre-test questions that do not contribute towards a candidate's score. Therefore, the examination actually consists of 260 questions, 250 of which are scored. The 10 pre-test questions are randomly distributed throughout the examination.

      8 The Series 7 examination questions for a given examination are randomly selected from the Series 7 question bank, which may result in slight variations in the difficulty of the examinations. The use of a scaled score accounts for these slight variations and is intended to maintain comparable passing standards across candidates.

      9 See Securities Exchange Act Release No. 65393 (September 26, 2011) (Notice of Filing of Proposed Rule Change; File No. SR-MSRB-2011-17).

    • 11-44 FINRA Requests Comment on Proposed Amendments to NASD Rule 2340 to Address Values of Unlisted Direct Participation Programs and Real Estate Investment Trusts in Customer Account Statements; Comment Period Expires: November 12, 2011

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      Customer Account Statements

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 2231
      FINRA Rule 2310
      NASD Rule 2340
      NASD Rule 5110
      Regulatory Notice 09-09
      Rule 415 under the Securities Act of 1933
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topics

      Customer Account Statements
      Unlisted Direct Participation Programs (DPPs)
      Unlisted Real Estate Investment Trusts (REITs)

      Executive Summary

      FINRA is proposing amendments to NASD Rule 2340 (Customer Account Statements) to address how firms report the per share estimated values of unlisted Direct Participation Programs (DPPs) and unlisted Real Estate Investment Trusts (REITs) on customer account statements.1 The amendments would limit the time period that the offering price may be used as the basis for a per share estimated value to the period provided under Rule 415(a)(5) of the Securities Act of 1933 (Initial Offering Period). The amendments also would require firms to deduct organization and offering expenses from per share estimated values during the Initial Offering Period. The amendments would prohibit a firm from using a per share estimated value, from any source, if it "knows or has reason to know the value is unreliable," based upon publicly available information or nonpublic information that has come to the firm's attention. Finally, the amendments would allow a firm to omit a per share estimated value on a customer account statement if the most recent annual report of the DPP or REIT does not contain a value that complies with the disclosure requirements of Rule 2340.2

      Questions regarding this Notice may be directed to:

      •   Joseph E. Price, Senior Vice President, Corporate Financing/Advertising Regulation, at (240) 386-4623;
      •   Gary L. Goldsholle, Vice President and Associate General Counsel, Office of the General Counsel, at (202) 728-8104; or
      •   Paul Mathews, Director, Corporate Financing Department, at (240) 386-4639.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by November 12, 2011.

      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.3

      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.4

      Background

      NASD Rule 2340 generally requires each general securities member firm to send account statements to customers at least quarterly. The account statements must include a description of any securities positions, money balances and account activity since the firm issued the prior account statement. A firm that does not carry customer accounts and does not hold customer funds or securities is not a general securities member firm and is not subject to the provisions of Rule 2340.

      NASD Rule 2340(c) contains specific provisions addressing the estimated values of DPPs and REITs on customer account statements.5 The rule generally requires that a general securities member firm include an estimated value for a DPP or REIT security held in a customer's account. The rule states that the per share estimated value included on a customer account statement may be obtained from the annual report, an independent valuation service or any other source. The rule requires that firms develop a per share estimated value on a customer account statement from data that is not more than 18 months old.6 The rule also requires a firm to remove or amend a per share estimated value if the firm can demonstrate that the value was inaccurate as of the date of valuation or is no longer accurate as a result of a material change in operations.

      FINRA Rule 2310 (Direct Participation Programs) prohibits a firm from participating in a public offering of a DPP or REIT unless the general partner or sponsor represents that it will include a per share estimated value in each annual report.7 The current industry practice is to use the value in the issuer's annual report as the per share estimated value on a customer account statement.

      Regulatory Notice 09-09 addressed the use of the offering price, or "par value," as the basis of the per share estimated value required under NASD Rule 2340. The Notice discussed the interplay between the use of the offering price from the annual report and the requirement that the per share estimated value on a customer account statement be developed from data that is not more than 18 months old. The Notice explained that 18 months after the conclusion of the offering, the per share estimated value must be derived from an appraisal of the issuer's assets and operations, and may not simply be a restatement of the aged offering price.

      Proposed Amendments8

      Presenting Per Share Estimated Value, Net of Organization and Offering Expenses

      The estimated value of an illiquid security such as a DPP or REIT may be derived from several sources. An appraisal of the issuer's assets and operations will assist investors in understanding the value and relative performance of the DPP and REIT over time. However, in the earlier stages of an offering of a DPP or REIT, as it accumulates assets, the net offering price can be a suitable alternative, particularly since an appraisal would involve recently acquired assets and cash that is yet to be invested during the ramp-up period. Appraisals also may be expensive depending on factors such as the nature and geographic dispersal of assets. In consideration of these concerns, FINRA proposes to permit valuations based on the offering price during the Initial Offering Period when the program is acquiring assets and firms are selling shares at a stable value on a best-efforts basis. However, FINRA proposes to amend the rule to require that all per share estimated values, including those that are based on the offering price, reflect a deduction of all organization and offering expenses (net value).9

      Under Rule 2310(a)(12), organization and offering expenses consist of expenses incurred in connection with registration and distribution, including all forms of compensation paid to broker-dealers and affiliates in connection with the offering. Rule 2310 generally limits organization and offering expenses to 15 percent of the gross proceeds of an offering.

      These expenses have three components: (1) issuer expenses that are reimbursed or paid for with offering proceeds, (2) underwriting compensation, and (3) due diligence expenses.

      While any value of an illiquid security is an estimate, netting out the offering expenses is likely to be a closer approximation to the intrinsic value, particularly since the up-front fees and expenses reduce the amount of the investable capital during the ramp-up period when the assets are acquired by the DPP or REIT.10 Requiring net values on customer account statements during the Initial Offering Period will provide greater transparency to investors about the fees and expenses, which would benefit investors.11

      Close of Initial Offering Period and Appraised Values

      Rule 415(a)(5) provides that certain types of registered securities, including DPPs and REITs, may be offered and sold if no more than three years have elapsed since the initial effective date of the registration statement. Under Rule 415(a)(6), the Securities and Exchange Commission may make another registration statement for a DPP or REIT effective for a second three-year offering period. If a new registration statement is filed, Rule 415(a)(5) (A) permits securities covered by the prior registration statement to continue to be offered and sold until the earlier of the effective date of the new registration statement or 180 days after the third anniversary of the initial effective date. Under the proposed amendments, the three-year period under Rule 415(a)(5) and any "carryover period" under Rule 415(a)(5) (A) constitute the Initial Offering Period in NASD Rule 2340.

      FINRA proposes to limit the period during which a per share estimated value based on the net offering price may be included on an account statement to the Initial Offering Period. Beyond the Initial Offering Period, the volatility in the value of the underlying assets of a DPP or REIT can cause the value to deviate substantially from the initial offering price, rendering the net offering price a poor estimate of the per share estimated value. After the Initial Offering Period, the basis for a per share estimated value included on a customer account statement must be based on an appraisal of a DPP or REIT's assets, liabilities and operations.

      The proposed amendments eliminate the provision in NASD Rule 2340(c)(2) that requires firms to develop a per share estimated value from data that is no more than 18 months old.

      Instead, the proposed amendments require the data that serves as the basis for a per share estimated value to be no less current than the data in the most recent annual report. If a per share estimated value is available that is more recent than the value in the annual report, member firms can disclose that value if it meets the requirements of Rule 2340.12

      Reliability of Estimated Values

      Rule 2340 currently requires a member firm to remove or amend a per share estimated value if the firm can demonstrate that the value was inaccurate as of the date of valuation or is no longer accurate as a result of a material change in operations. The proposed amendments adjust this requirement to prohibit a firm from using a per share estimated value, from any source, if it "knows or has reason to know the value is unreliable," based upon publicly available information or nonpublic information that has come to the firm's attention.

      The proposed amendments also allow a firm to omit the per share estimated value if the most recent annual report of the DPP or REIT does not contain a value that complies with the disclosure requirements of the rule. In the alternative, a firm could decide to provide a reliable value from a source other than the annual report that meets the rule's requirements. The amendments would require, however, that if a per share estimated value does not appear in or has been removed from a customer account statement, the firm must disclose the reason the value does not appear or has been removed.


      1 Unlisted DPPs and unlisted REITs do not trade on a national securities exchange. DPPs are defined in FINRA Rule 2310 and offer investors an equity interest in an entity such as a limited partnership that provides flow-through tax consequences and distributes income generated from underlying assets. REITs are defined in Section 856 of the Internal Revenue Code and are pass-through entities that offer investors an equity interest in a pool of real estate assets, including and, buildings, shopping centers, hotels and office properties. The definitions of DPP and REIT in NASD Rule 2340(d)(3) and (4) exclude securities listed on a national securities exchange as well as securities that are in a depository and settle regular way. The definition of DPP also excludes any program registered as a commodity pool.

      2 NASD Rule 2340 only applies to customer account statements, as defined by that rule. Rule 2340, and as proposed to be amended, would not apply to annual statements of the fair market value of assets provided by retirement account trustees and custodians under Internal Revenue Service Regulations, including Section 1.408-2(e) (5)(ii)(E).

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

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

      5 NASD Rule 2340 applies to DPPs and REITs regardless of whether they are listed or itemized "above the line" or "below the line." The term "below the line" means that securities and other assets are reported on the account statement, but are not in the possession of the member. New platforms that provide processing for alternative investments may result in DPPs and REITs being reported more frequently above the line because the securities are in the possession of member firms.

      6 NASD Rule 2340(c) also requires that account statements provide: (1) a brief description of the estimated value, its source and the method by which it was developed; and (2) disclosure that the investment program securities are generally illiquid securities and the estimated value may not be realized when investors seek to sell the security. Additional disclosure are required if the account statement does not provide an estimated value.

      7 Section 13(a) of the Securities Exchange Act requires annual reports to be distributed to investors.

      8 As part of the rulebook consolidation process, FINRA has proposed new FINRA Rule 2231 to replace NASD Rule 2340. See SR-FINRA-2009-028. The amendments discussed herein would be made to NASD Rule 2340 or new FINRA Rule 2231, depending upon the timing of SEC approval.

      9 Some REITs have begun to calculate a daily net asset value (NAV).The selling price per share is based on the daily NAV calculation and typically includes a selling commission. Under the proposal, the net estimated value required on customer account statements for such programs would be the NAV and could not include any commissions, nor any other organization or offering expense associated with the offering.

      10 If any organization and offering expenses are to be deducted from portfolio assets or income, then under the proposal the net estimated value would have to reflect those deductions that will betaken during the Initial Offering Period, in addition to the deduction for organization and offering expenses paid out of proceeds from the offering.

      11 Regulatory Notice 09-09 reminded firms of their obligation under the suitability rule to determine the amount of dividend distributions that represents a return of investors' capita and whether that amount is changing. In addition, firms must consider whether there are impairments to the real estate investment program's assets or other material events that would affect the distributions and whether disclosure regarding dividend distributions needs to be updated to reflect these events.

      12 Firms would not be required to immediately update the per share estimated values shown in customer account statements when a new value appears in the annual report. However, firms must use reasonable efforts to address operational or technical requirements associated with updating per share estimated values, to ensure that the updating occurs as promptly as practicable. Firms that require more than one statement cycle to update the per share estimated values are likely to raise a presumption that the firm is not making reasonable efforts.


      Attachment A

      Below is the text of the proposed amendments to Rule 2340.

      2340. Customer Account Statements

      (a) General

      No change.
      (b) Delivery Versus Payment/Receive Versus Payment (DVP/RVP) Accounts

      No change.
      (c) Unlisted DPP/REIT Securities
      (1) A general securities member that holds a direct participation program (DPP) or real estate investment trust (REIT) security in a customer's account must provide a per share estimated value of such security on the account statement as provided below:
      (A) The customer account statement must disclose:
      (i) the source of the per share estimated value, which may be from the annual report, independent valuation service or any other source, and the manner in which the per share estimated value was calculated, and
      (ii) that unlisted DPP or REIT securities are illiquid securities and that the per share estimated value may not be realized when the customer seeks to liquidate the security.
      (B) During a period not to exceed the period provided under SEC Rule 415(a)(5) since the initial effective date of the first registration statement under which the DPP or REIT is offered and sold (Initial Offering Period), any per share estimated value based upon the offering price must reflect a deduction of the amount of organization and offering expenses, as defined by FINRA Rule 2310(a)(12).
      (C) After the Initial Offering Period, only a per share estimated value calculated based on an appraisal of the assets, liabilities and operations of the DPP or REIT and derived from data no less current than the data in the most recent annual report may be disclosed.
      (2) Notwithstanding the requirements in paragraph (1):
      (A) A member must refrain from providing a per share estimated value, from any source, if it knows or has reason to know the value is unreliable, based upon publicly available information or nonpublic information that has come to the member's attention; and
      (B) A member may refrain from providing a per share estimated value if the most recent annual report of a DPP or REIT does not contain a per share estimated value that complies with the requirements in paragraphs (1)(B) or (1)(C).
      (3) For any member refraining from providing a per share estimated value as permitted in paragraph (2), the customer account statement must disclose that:
      (i) unlisted DPP or REIT securities are illiquid;
      (ii) the value of the security is different from its purchase and may be less than the purchase price
      (iii) an estimated valuation of the security is unavailable; and
      (iv) the reason the value does not appear in, or has been removed from, the account statement.
      (d) Definitions

      No change.

    • 11-43 FINRA Requests Comment on Proposed Amendments to Rule 5210 Regarding Publication of Indications of Interest; Comment Period Expires: October 21, 2011

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      Indications of Interest

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 2010
      FINRA Rule 2020
      FINRA Rule 5210
      NASD Rule 2210
      NTM 06-50
      Regulatory Notice 09-28
      Suggested Routing

      Compliance
      Institutional
      Legal
      Registered Representatives
      Senior Management
      Trading
      Key Topics

      Indications of Interest

      Executive Summary

      FINRA requests comment on proposed amendments to FINRA Rule 5210 to require that member firms receive a customer order in a security before displaying a quotation or indication of interest (IOI) in a way that purports to represent that the quotation or IOI originated with a customer. Similarly, a firm could not continue to display a quotation or IOI as representing a customer order once the customer order was executed or cancelled.

      The text of the proposed amendments is in Attachment A to this Notice.

      Questions concerning this Notice should be directed to Brant K. Brown, Associate General Counsel, Office of General Counsel, at (202) 728-6927.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by [30 days from publication].

      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 Securities and Exchange Commission (SEC) by the FINRA Board of Governors and then must be filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2

      Background & Discussion

      Indications of interest, or IOIs, are non-firm expressions of trading interest that contain one or more of the following elements: security name, side, size, capacity and/or price. Firms have the ability to communicate or advertise proprietary or customer trading interest in the form of IOIs to the marketplace through their own systems or several service providers that disseminate the information to subscribers and/or the marketplace. For example, some service providers allow firms to publicize trading interest in a particular security relating to firm proprietary interest or interest that the firm represents on an agency basis. A firm may choose to disseminate IOIs to inform other market participants that it seeks to, or represents customer trading interest that seeks to, interact with other order flow in the security.

      One attribute that is often associated with an IOI is whether the IOI originated with a customer (what is commonly referred to as a "natural" IOI), rather than with the firm. Although the meaning of the term "natural" may differ across firms and service providers, a "natural" IOI is generally considered to refer either to customer interest a firm represents on an agency basis or to proprietary interest that was established to facilitate a customer order or as part of an execution of a customer order on a riskless principal basis.

      In May 2009, FINRA published Regulatory Notice 09-28 reminding firms that, to the extent that they disseminate or use services to communicate indications of interest, IOIs must be truthful, accurate and not misleading.3 The Notice stated that FINRA could view as untruthful, inaccurate or misleading a firm's representation of firm proprietary interest as a "natural" IOI without making disclosure to its customers of the circumstances in which such representations are made, or that is inconsistent with disclosures made by a firm with respect to the content of its IOIs, or alternatively through the service provider's system in a manner contrary to the service provider's guidelines. FINRA also could view as untruthful, inaccurate or misleading a firm's continuing dissemination of a "natural" IOI to the marketplace when the firm no longer represents any such interest on behalf of a customer. The Notice also stated that the communication of untruthful, inaccurate or misleading information relating to IOIs would be considered conduct inconsistent with high standards of commercial honor and just and equitable principles of trade under FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade) and, depending on the nature and content of the communication, could also violate FINRA Rule 5210 (Publication of Transactions and Quotations), FINRA Rule 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices), NASD Rule 2210 (Communications with the Public) and the anti-fraud provisions of the federal securities laws.

      Request for Comment

      Notwithstanding the publication of Regulatory Notice 09-28, FINRA remains concerned that firms are disseminating misleading information regarding IOIs, including not accurately labeling them to reflect their origination. Consequently, FINRA is proposing to amend Rule 5210 in several ways.

      First, FINRA is proposing new Supplementary Material to FINRA Rule 5210 that would require that a firm have received a customer order in a security before displaying a quotation or IOI in any way that purports to represent that the quotation or IOI originated with a customer (e.g., by labeling an IOI as "natural"). Thus, firms would not be permitted to label an IOI or quotation in any way that indicates the IOI or quotation represented customer interest until the firm had received a customer order and had recorded the order on its books and records by, for example, creating an order ticket or entering the terms of the order into the firm's order management system. Importantly, the proposed amendment does not prohibit firms from displaying IOIs or quotations when they have not received a customer order; it merely prohibits the firm from labeling any such IOI or quotation in a way that indicates that the interest arose with a customer. Similarly, a firm could not continue to display such a quotation or IOI as representing a customer order once the customer order was executed or cancelled.

      FINRA is also proposing several amendments to Rule 5210 and the existing Supplementary Material to modernize the language in the rule and to align the rule text with the Supplementary Material. Among other things, these amendments would clarify that the prohibitions in Rule 5210 extend to IOIs.

      Although FINRA welcomes comments on any aspect of the proposed amendments discussed in this Notice, FINRA specifically encourages comments on the following:

      •   Should FINRA define the term "indication of interest"? Does the application of the new labeling requirements to both IOIs and quotations adequately cover the situations in which concerns regarding inaccurate labeling arise?
      •   Is the approach taken in the proposed amendments appropriate or should FINRA define terms such as "natural" in the rule? Would specific definitions provide firms with clarity or would they create too narrow an application? Would definitions need regular updating to stay current with industry practice?
      •   Is the requirement that a firm has received a customer order before labeling an IOI or quotation in a manner that indicates the interest originated with a customer too limiting? Are there instances in which a customer would not want to place an order with a firm, but would want the firm to label an IOI in that manner? Is there an alternative standard that could achieve the same regulatory purpose? If so, what should that standard be?
      •   Some buy-side firms have stated that they prefer not to trade with "non-naturals" because "non-naturals" compete with them after the execution. For example, a buy-side firm selling part of a large block to a counterparty may be concerned that the counterparty might create downward pressure on the stock either if it were to sell the position, or if it already sold shares in anticipation of buying from the buy-side firm. Conversely, when trading with a "natural," the buy-side firm's selling pressure is potentially offset by the buying interest of the "natural" counterparty. Are these valid concerns by the buy side? Is it too restrictive to assume that "natural" interest can only come from customer orders?

      The comment period expires on October 21, 2011.


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

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

      3 The Notice also reminded firms that directly disseminate or use services to disseminate 101s that they must establish, maintain and enforce written supervisory procedures and supervisory systems that are reasonably designed to ensure, among other things, that the information disseminated by or on behalf of the member or its associated persons is truthful, accurate and not misleading. In addition, advertising a firm's trading activity or interest in contexts other than indications of interest is also subject to FINRA rules and the anti-fraud provisions of the federal securities laws. See NTM 06-50 (September 2006).


      ATTACHMENT A

      Below is the text of the proposed amendments to Rule 5210. Additional language is underlined; deletions are in brackets.

      5210. Publication of Transaction[s] Reports, [and] Quotations, and Indications of Interest

      No member shall publish or circulate, or cause to be published or circulated: [, any notice, circular, advertisement, newspaper article, investment service, or communication of any kind which purports to]

      (a) any report of any securities transaction as a purchase or sale of [any] such security unless [such] the member believes that such transaction was a bona fide purchase or sale of such security; [or which purports to]
      (b) any quotation [quote the bid price or asked price] for any security, unless [such] the member believes that such quotation represents a bona fide bid for, or offer of, such security; or
      (c) any indication of interest for any security, unless the member believes that such indication of interest represents a bona fide interest in purchasing or selling such security.

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

      .01 Manipulative and Deceptive Transaction Reports, Quotations, and Indications of Interest.
      (a) It shall be deemed inconsistent with Rules 2010 (Standards of Commercial Honor and Principles of Trade), 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices) and 5210 (Publication of Transactions and Quotations) for a member to publish or circulate or cause to be published or circulated, by any means whatsoever, any report of any securities transaction or of any purchase or sale of any security unless such member knows or has reason to believe that such transaction was a bona fide transaction, purchase, or sale.
      (b) [Similarly, i]It shall be deemed inconsistent with Rules 2010, 2020, and 5210 for a member, for itself or for any other person, to publish or circulate or to cause to be published or circulated, by any means whatsoever, any quotation for any security without having reasonable cause to believe that such quotation is a bona fide quotation, is not fictitious, and is not published or circulated or caused to be published or circulated for any fraudulent, deceptive, or manipulative purpose.

      [For the purposes of this Rule, the term "quotation" shall include any bid or offer or any formula, such as "bid wanted" or "offer wanted," designed to induce any person to make or submit any bid or offer.]
      (c) It shall be deemed inconsistent with Rules 2010, 2020, and 5210 for a member, for itself or for any other person, to publish or circulate or to cause to be published or circulated, by any means whatsoever, any indication of interest for any security without having reasonable cause to believe that such indication of interest represents a bona fide interest in purchasing or selling the security, is not fictitious, and is not published or circulated or caused to be published or circulated for any fraudulent, deceptive, or manipulative purpose.
      (d) With respect to any quotation or indication of interest that purports to represent that the interest the member is displaying originated with a customer, the member must have received a customer order in the security before displaying such quotation or indication of interest. Similarly, the member must withdraw the quotation or indication of interest if the customer order represented by such quotation or indication of interest is executed or cancelled.

    • 11-42 Operations Professional Qualification Examination, Examination Fee and Initial Rollout Period

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      Operations Professional Qualification Examination

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 1230
      FINRA Rule 1250
      NASD Rule 1031
      NASD Rule 1070
      NASD Rule 1120
      Regulatory Notice 11-33
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Senior Management
      Key Topics

      Operations Professionals
      Qualification Examinations
      Registration

      Executive Summary

      This Notice provides member firms with information on the Operations Professional qualification examination, related examination fee and special procedures on the initial rollout of the examination. Candidates for the Operations Professional qualification examination will be able to schedule and take the examination beginning on October 17, 2011. The content outline for the examination is available on FINRA's website.

      Questions regarding this Notice should be directed to:

      •   Joe McDonald, Senior Director, Testing and Continuing Education Department, at (240) 386-5065; or
      •   Erika L. Lazar, Counsel, Office of General Counsel, at (202) 728-8013.

      Background & Discussion

      On June 16, 2011, the SEC approved FINRA Rule 1230(b)(6), which establishes a registration category1 and qualification examination requirement for certain operations personnel (Operations Professionals).2 The rule requires registration of certain individuals (covered persons) who are engaged in, responsible for or supervising certain member firm operations functions (covered functions) to enhance the regulatory structure surrounding these areas. See Regulatory Notice 11-33 for detailed information on the Operations Professional registration category, including who must register, the qualification examination requirement, exceptions to the qualification examination requirement, implementation and registration procedures and continuing education requirements for Operations Professionals.

      Subject to specified exceptions, FINRA Rule 1230(b)(6)(C) requires any person who must register as an Operations Professional to pass a new Operations Professional qualification examination (Series 99) before the registration may become effective.3 The Series 99 examination program has been developed to provide reasonable assurance that covered persons 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, a customer, the integrity of the marketplace or the public.4 The Series 99 examination will test applicants on general securities industry knowledge and its associated regulations and rules. The examination fee for the Series 99 examination is $125.5

      As detailed in Regulatory Notice 11-33, FINRA Rule 1230(b)(6)(D)(i) sets forth an exception to the Series 99 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 exception also applies to persons who do not hold an eligible registration, but prefer an alternative to taking the Series 99 examination. Such persons may register in an eligible registration category (subject to passing the corresponding qualification examination or obtaining a waiver) and use the registration to qualify for Operations Professional registration.6

      Exam Content

      The Series 99 examination consists of 100 multiple-choice questions.7 Candidates will be allowed 150 minutes (two and one-half hours) to complete the examination. Candidates will receive an informational breakdown of their performance on each section of the examination, along with their overall score and pass/fail status at the completion of the testing session.

      FINRA has published a content outline for the Series 99 examination. The content outline provides a comprehensive guide to the areas covered on the examination and is intended to familiarize candidates with the range of subjects covered by the examination. Firms may wish to use the content outline to structure or prepare training material, develop lecture notes and seminar programs, and as a training aide for the candidates. The content outline describes the following three major content areas comprising the examination: (1) Basic Knowledge Associated with the Securities Industry; (2) Basic Knowledge Associated with Broker-Dealer Operations; and (3) Professional Conduct and Ethical Considerations. The allocation of test questions for each major content area is listed in the table below.

      Number of Questions by Major Content Area

      Section Major Content Area Number of Questions
      1 Basic Knowledge Associated with the Securities Industry 32
      2 Basic Knowledge Associated with Broker-Dealer Operations 48
      3 Professional Conduct and Ethical Considerations 20
        Total 100

      FINRA will update, as needed, the content outline and questions used in the examination to reflect the most current interpretations of the relevant rules and regulations, changes in practices and/or the introduction of new products. Questions on new rules will be added to the pool of questions for this examination within a reasonable time period of the effective dates of those rules. Questions on rescinded rules will be deleted promptly from the pool of questions. Candidates will be asked rules-based questions pertaining only to rules that are effective at the time they take the exam.

      The Series 99 examination is administered as a closed-book exam. The proctor will provide erasable note boards, dry erase markers and a basic electronic calculator to candidates. These items must be returned to the proctor at the end of the session.

      The Series 99 examination will be administered at test centers operated by Pearson VUE and Prometric professional testing center networks. Appointments to take the examination may be scheduled through either network:

      •   Pearson Professional Centers: contact Pearson VUE Registration Center at (866) 396-6273 (toll free) or (952) 681-3873 (toll number) or go to www.pearsonvue.com/finra.
      •   Prometric Testing Centers: contact Prometric's National Call Center at (800) 578-6273 (toll free) or go to www.prometric.com/finra for Web-based scheduling.

      Initial 60-Day Rollout Period for the Series 99 Examination

      Candidates will be able to schedule and take the Series 99 examination beginning on October 17, 2011. During the initial 60-day rollout period (October 17 through December 16, 2011), FINRA will assess the effectiveness of the new examination, in part, by evaluating how candidates perform. FINRA will not immediately release the results for any examination taken during this initial 60-day rollout period. Instead, FINRA will notify candidates who take the examination during this initial rollout period and their firms of test results (including an informational breakdown of their performance on each section of the examination, along with their overall score and pass/fail status) on or shortly after December 16, 2011, at which time the test results will be posted to the Central Registration Depository (CRD®).8 Candidates who fail the Series 99 examination during the initial 60-day rollout period will be provided an opportunity to retake the examination at no additional cost once the test results are posted.


      1 The Web CRD registration position code for the Operations Professional registration category is "OS."

      2 See Securities Exchange Act Release No. 64687 (June 16, 2011), 76 FR 36586 (June 22, 2011) (Order Approving Proposed Rule Change; File No. SR-FINRA-2011-013). In addition, effective October 17, 2011, NASD Rule 1120 (Continuing Education Requirements) has been adopted as FINRA Rule 1250 (Continuing Education Requirements) in the Consolidated FINRA Rulebook with certain changes, including a requirement that Operations Professionals be subject to both Regulatory Element and Firm Element Programs.

      3 FINRA notes that NASD Rule 1070 (Qualification Examinations and Waiver of Requirements), as well as other applicable provisions regarding registration and qualification set forth in FINRA's rulebook, such as NASD Rule 1031(c) regarding requirements for examination on lapse of registration, applies to the Operations Professional qualification examination and registration category.

      4 See Securities Exchange Act Release No. 65222 (August 30, 2011), 76 FR 55443 (September 7, 2011) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Adopt the Selection Specifications and Study Outline for the Operations Professional ("Series 99") Examination Program; File No. SR-FINRA-2011-041).

      5 See Securities Exchange Act Release No. 65221 (August 30, 2011), 76 FR 55441 (September 7, 2011) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to Fee for the Operations Professional Examination; File No. SR-FINRA-2011-042).

      6 FINRA Rule 1230(b)(6)(D)(ii) provides that the staff may accept as an alternative to the Operations Professional qualification examination requirement any domestic or foreign qualification if it determines that acceptance of the alternative qualification is consistent with the purposes of the rule, the protection of investors and the public interest.

      7 To ensure that new exam questions meet acceptable testing standards prior to use, each examination includes 10 additional, unidentified "pre-test" questions that do not contribute towards the candidate's score. The 10 pre-test questions are randomly distributed throughout the examination.

      8 As noted above, candidates who take the examination after December 16, 2011, (i.e., subsequent to the initial 60-day rollout period) will receive an informational breakdown of their performance on each section of the examination, along with their overall score and pass/fail status, at the completion of the testing session.

    • 11-41 FINRA Provides Guidance on Prohibition Against Offering Favorable Research to Induce Investment Banking Business

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      Research Analysts and Research Reports

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules

      NASD Rule 2711
      NTM 07-04
      SEC Regulation AC
      Suggested Routing

      Compliance
      Investment Banking
      Legal
      Research
      Senior Management
      Key Topics

      Conflicts of Interest
      Research

      Executive Summary

      FINRA is reminding member firms of the need for heightened supervision over solicitation and research activities in circumstances where an issuer has communicated an expectation of favorable research as a condition of participating in an offering.

      Questions concerning this Notice should be directed to Philip Shaikun, Associate Vice President, Office of General Counsel, at (202) 728-8451.

      Background and Discussion

      NASD Rule 2711 fosters objectivity in research reports by, among other things, insulating research analysts from pressure to tailor their coverage to the interests of a firm's current or prospective investment banking clients. To that end, NASD Rule 2711(e) prohibits firms from directly or indirectly offering favorable research or a specific rating or price target as consideration or inducement for the receipt of business or compensation. NASD Rule 2711(c)(4) prohibits research analysts from participating in efforts to solicit investment banking business, including participation in "pitches" to prospective investment banking clients and other communications with issuers for the purpose of soliciting investment banking business. FINRA has interpreted that provision to prohibit in pitch materials any information about a firm's research capacity in a manner that suggests, directly or indirectly, that the firm might provide favorable research coverage.1

      It has come to FINRA's attention that certain issuers may be attempting to extract implicit promises of favorable research by suggesting publicly or directly to potential deal participants in advance of an anticipated offering that positive research coverage will be an implicit or explicit condition to selection as an underwriter or selling group member. The suggestions may take the form of hints, insinuations or other subtle references, but are intended to condition the award of investment banking business on the nature of research attendant to the deal. For example, the CEO of an issuer recently stated in an interview that he was dissatisfied with the tone of research coverage of his company by certain firms that previously served as underwriters for the company. As a result, the CEO reportedly intends to require candidates for the company's next offering to demonstrate "a clear understanding of who [the company] is and our trajectory, and why [the company] is a stock that investors should own." He further is quoted as saying, "If I'm confident they can articulate that well, they will have a chance" at being selected as an offering participant.2

      FINRA views these and similar advance statements as attempts to create an expectation that a firm chosen to participate in a subsequent offering will maintain favorable research on the issuer's stock, irrespective of the stock price or the company's ongoing performance. FINRA views even tacit acquiescence to such overtures to be a violation of NASD Rule 2711(e),3 and under certain facts and circumstances, potentially a violation of NASD Rule 2711(c)(4).

      FINRA understands that such uninvited pronouncements place prospective offering participants in a challenging situation should they seek to compete for a role in the offering. Nonetheless, in circumstances where an issuer makes known, expressly or implicitly, that the selection of an offering participant will be predicated on an expectation of positive research coverage, FINRA will closely scrutinize offering participants' research and other deal-related activities for compliance with, among others, NASD Rule 2711 and SEC Regulation Analyst Certification.

      Member firms that choose to compete for or participate in offerings under such circumstances must expressly repudiate to the issuer any expectation with respect to the content of research coverage and document such repudiation. In addition, the firms must implement heightened supervision of their solicitation activities, including pitch meetings and other communications with the issuer, to ensure there is no express or implied acknowledgement or accedence to the research expectation. Finally, members must increase oversight of the preparation and content of their research on the subject company—both before and after deal participants are chosen—including any permissible communications between research and investment banking personnel.


      1 See Notice to Members 07-04 (January 2007).

      2 Serena Ng, AIG Gets Tough on Analyst Views, Wall Street Journal, August 26, 2011.

      3 While FINRA is concerned with the action of the issuer in such scenarios, FINRA generally does not have jurisdiction over the conduct of non-broker-dealer issuers and their employees and agents.

    • 11-40 SEC Approves Amendments Clarifying Certain Exceptions Under Trade Reporting Rules and Adopting Notice Requirement for Transactions That Are Part of an Unregistered Secondary Distribution; Effective Date: November 1, 2011

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      Trade Reporting

      Regulatory Notice
      Type of Notice

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 5190
      FINRA Rule 6282
      FINRA Rule 6380A
      FINRA Rule 6380B
      FINRA Rule 6622
      NTM 07-25
      Schedule A to the FINRA By-Laws
      SEC Regulation M
      Suggested Routing

      Compliance
      Executive Representatives
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Training
      Key Topics

      Alternative Display Facility
      American Depositary Receipts
      Distributions
      Exchange-Traded Funds
      NMS Stocks
      OTC Equity Securities
      OTC Reporting Facility
      Trade Reporting
      Trade Reporting Facilities

      Executive Summary

      The SEC approved amendments to FINRA rules clarifying that, for purposes of the exception from the trade reporting requirements for transactions that are part of a distribution of securities, "distribution" has the meaning set forth under SEC Regulation M. Effective November 1, 2011, firms that rely on the exception for transactions that are part of an "unregistered secondary distribution" must provide FINRA notice and information relating to the transactions, as described herein.

      The SEC also approved amendments clarifying that transfers of securities for the purpose of creating or redeeming instruments such as American Depositary Receipts and exchange-traded funds are expressly excluded from the trade reporting requirements.

      The text of the amendments can be found at www.finra.org/ rulefilings/2011-027.

      Questions regarding this Notice may be directed to:

      •   Legal Section, Market Regulation, at (240) 386-5126; or
      •   Office of General Counsel at (202) 728-8071.

      Background and Discussion

      Under FINRA trade reporting rules, firms are required to report OTC equity transactions1 to FINRA unless they fall within an express exception. As a general matter, when firms report OTC trades, FINRA facilitates the public dissemination of the trade information and/or assesses regulatory transaction fees under Section 3 of Schedule A to the FINRA By-Laws (Section 3)2 and the Trading Activity Fee (TAF).3

      Certain transactions and transfers are not reported to FINRA at all (e.g., trades executed and reported through an exchange and transfers made pursuant to an asset purchase agreement that has been approved by a bankruptcy court), while other transactions must be reported to FINRA for regulatory transaction fee assessment purposes only (e.g., away from the market sales and transfers in connection with certain corporate control transactions).4 Firms must have policies and procedures and internal controls in place, including, as necessary, consultation with their counsel, to determine whether a transaction qualifies for an exception under the rules.

      On August 3, 2011, the SEC approved a rule change relating to certain exceptions to the trade reporting requirements.5 As described more fully below, the amendments:

      1) clarify the exception for transactions that are part of a distribution of securities and impose a new notice requirement relating to unregistered secondary distributions, and
      2) expressly exclude transfers of equity securities for the purpose of creating or redeeming instruments such as American Depositary Receipts (ADRs) and exchange-traded funds (ETFs).

      Transactions that are part of a securities distribution

      FINRA rules contain an exception from the trade reporting requirements for transactions that are effected in connection with a distribution of securities, specifically:

      transactions that are part of a primary distribution by an issuer or of a registered secondary distribution (other than "shelf distributions") or of an unregistered secondary distribution.6

      Thus, transactions that are part of a distribution (other than a secondary shelf distribution) are not reported to FINRA or publicly disseminated, and they are not assessed regulatory transaction fees under Section 3 or the TAF.

      The amendments clarify that for purposes of this trade reporting exception, "distribution" has the meaning set forth under SEC Regulation M.7 A "distribution" is defined under Rule 1 of Regulation M as "an offering of securities, whether or not subject to registration under the Securities Act, that is distinguished from ordinary trading transactions by the magnitude of the offering and the presence of special selling efforts and selling methods."8

      Firms are reminded that under FINRA rules, large block trades (even those at a significant discount from the current market price) must be reported to FINRA for tape dissemination purposes and are assessed regulatory transaction fees under Section 3 and the TAF. The amendments clarify that the trade reporting exception does not apply to block trades, unless they otherwise meet the definition of "distribution" under Regulation M.

      Notice requirement for transactions that are part of an "unregistered secondary distribution"

      Pursuant to new Supplementary Material in Rules 6282, 6380A, 6380B and 6622, firms that would otherwise have the trade reporting obligation under FINRA rules9 must provide notice to FINRA that they are relying on the exception for transactions that are part of an "unregistered secondary distribution." The firm also must provide the following information to FINRA for each transaction that is part of the unregistered secondary distribution and not reported:

      •   security name and symbol;
      •   execution date;
      •   execution time;
      •   number of shares;
      •   trade price; and
      •   FINRA member firms that are parties to the trade.10

      Firms are required to provide such notice and information no later than three business days following trade date. If the trade executions will occur over multiple days, then initial notice and available information must be provided no later than three business days following the first trade date and final notice and information must be provided no later than three business days following the last trade date.

      Such notice and information should be provided on the Regulation M Trading Notification Form. An updated version of the form is available as an attachment to this Notice, and will be available as of November 1, 2011, at www.finra.org/RegM, and should be submitted to FINRA's Market Regulation Department via:

      •   email to secondaryofferings@finra.org;
      •   fax to (301) 339-7403; or
      •   a third-party vendor (e.g., Dealogic, Ipreo).11

      Firms also may obtain a version of the Regulation M Trading Notification Form that can be completed and submitted electronically by emailing a request to FINRA.

      FINRA is combining the form of notice required under the trade reporting rules with the form of notice required under Rule 519012 to streamline firms' reporting obligations since, if a firm is relying on this trade reporting exception, applicable notice requirements under Rule 5190 also must be satisfied. However, firms are reminded that the notice requirement under the trade reporting rules is separate and distinct from the notice requirements under Rule 5190. Accordingly, providing notice under the trade reporting rules does not relieve a firm of any additional notification obligations it may have under Rule 5190 (and vice versa), nor does it impact the timing of any notice required under Rule 5190. Firms must comply with the requirement under Rule 5190 to submit the Regulation M Trading Notification Form no later than the close of business the next business day following pricing of the distribution, irrespective of the fact that firms have until three days after trade date to provide notice and information under the trade reporting rules.13

      The new Supplementary Material also requires that the firm retain records sufficient to document the basis for relying on this trade reporting exception, including, but not limited to, the basis for determining that the transactions are part of a distribution, as defined under Regulation M. Firms must be able to demonstrate that the "magnitude of the offering" and "special selling efforts" criteria under Regulation M have been satisfied. The mere assertion that the order was large sized or a block or that execution of the order was "worked" by a firm will not by itself be sufficient.

      Transfers of equity securities to create or redeem instruments such as ADRs and ETFs

      The amendments expressly exclude from the trade reporting requirements any transfer of equity securities for the sole purpose of creating or redeeming an instrument, such as an ADR or ETF, that evidences ownership of or otherwise tracks the underlying securities transferred. Such transfers are not considered OTC transactions for purposes of the trade reporting rules and thus are not reportable events.

      The amendments codify current guidance and practice in this area. For example, FINRA has previously stated that the conversion of foreign ordinary shares into ADRs (or vice versa) at a bank depository is not a trade reportable event.14 Similarly, when a financial institution or "authorized participant" deposits with an ETF a basket of securities (or other assets) and receives the ETF creation unit in return, these are not trade reportable events.

      FINRA notes that the exception applies irrespective of whether a firm is acting as agent, principal or riskless principal in the creation process. For example, an authorized participant, as riskless principal on behalf of a customer, transfers securities to an ETF and in return receives ETF creation units. The transfer of the shares and receipt of ETF creation units by the authorized participant are not reportable events. Similarly, the subsequent "flip" of the ETF creation units from the authorized participant to its customer also is not reportable.

      Firms are reminded, however, that purchases and sales of the securities that are to be transferred for the purpose of creating or redeeming instruments such as ADRs and ETFs, and subsequent purchases and sales of the instruments themselves in the secondary market, are OTC transactions and must be reported to FINRA in accordance with the trade reporting rules.15 Additionally, purchases and sales of the underlying securities in order to track the performance of an instrument such as an ADR or ETF, without actually creating the instrument, must be reported.


      1 Specifically, OTC equitytransactions are transactions effected otherwise than on an exchange in: (1) NMS stocks, as defined in SEC Rule 600(b) of Regulation NMS, which are reported through the Alternative Display Facility (ADF) or a Trade Reporting Facility (TRF); and (2) OTC equity securities, as defined in FINRA Rule 6420 (i.e., non-NMS stocks), which are reported through the OTC Reporting Facility (ORF).

      2 Pursuant to Section 31 of the 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.

      3 The TAF is one of the member regulatory fees FINRA uses to fund its member regulation activities, market regulation activities, financial monitoring and policymaking, rulemaking and enforcement activities. Among others, the TAF is assessed for the sale of all exchange registered securities wherever executed and OTC equity securities. See FINRA By-Laws, Schedule A, § 1(b)(2).

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

      5 See Securities Exchange Act Release No. 65025 (August 3, 2011), 76 FR 48937 (August 9, 2011) (Order Approving SR-FINRA-2011-027).

      6 See Rules 6282(i)(l)(A), 6380A(e)(l)(A), 6380B(e)(1)(A) and 6622(e)(1)(A).

      7 17 CFR 242.100-105.

      8 17 CFR 242.100.

      9 In transactions between member firms, the "executing party," as defined by rule, is required to report the trade. In transactions between a member firm and a non-member firm or customer, the member firm is required to report. See Rules 6282(b), 6380A(b), 6380B(b) and 6622(b).

      10 Firms must identify FINRA member firms that are the contra parties to the trade; they are not required to identify customers.

      11 FINRA notes that this is a notice requirement only—and not a trade reporting requirement. Accordingly, these transactions are not reported to a FINRA trade reporting facility (i.e., the ADF, a TRF or the ORF), nor is any of the information disseminated to the public. In addition, these transactions are not assessed regulatory transaction fees under Section 3 or the TAF.

      FINRA further notes thatfirms are required to submit notice and information underthe trade reporting rules only to FINRA. A firm would not be required to submit such information as part of any Regulation M-related submission pursuant to the rules of another self-regulatory organization.

      12 Rule 5190 imposes certain notice requirements on member firms participating in distributions of listed and unlisted securities and is designed to ensure that FINRA receives pertinent distribution-related information from firms in a timely fashion to facilitate its Regulation M compliance program.

      13 In other words, firms cannot delay submission of the Regulation M Trading Notification Form in order to provide trade information, as required under the trade reporting rules, and argue that "such later notification is necessary under specific circumstances," as provided for under Rule 5190.

      14 See NTM 07-25 (May 2007).

      15 For example, firms are required by rule to include the date and time of execution in all trade reports submitted to FINRA; the date and time of execution are the date and time when the parties have agreed to all essential terms of the transaction, including trade price and number of shares.


      Regulation M—Trading Notification Form

      Attention: FINRA Market Regulation Department; FINRA ADF Operations; NASDAQ MarketWatch Department

      Please provide the following information

      Original notification:yes no

      Does the original notification include unregistered secondary distribution transaction reports? yes no

      Amended notification: yes no

      Does the amended notification include unregistered secondary distribution transaction reports? yes no

      1. Issuer name and symbol:______________________________________________________________
      2. Symbol(s) of covered securities
      (subject and reference securities, as defined under SEC Regulation M Rule 100):___________________________________________

      Pursuant to FINRA Rule 5190(c)(1)(B), FINRA Rule 5190(d)(2), FINRA Rule 6275(f)(2), and/or NASDAQ Rule 4619(e)(5), the following information regarding the pricing of a distribution of securities is provided. Additionally, for the distribution participants and/or affiliated purchasers identified below, to the extent that they are market makers, rescission of excused withdrawal status or passive market making status is requested:

      3. Type of security offered:____________________________________________________________
      4. Number of shares offered:____________________________________________________________
      5. Offering price:______________________________________________________________________
      6. Last sale before distribution:_______________________________________________________
      7. Pricing basis:_______________________________________________________________________
      (e.g., last sale, discount to last sale, negotiated, at the market, etc.)
      8. Pricing date:________________________________________________________________________
      9. SEC effective date and time:______________________(date)_______________________(time)
      10. Trade date:_________________________________________________________________________
      11. Restricted period: 1 day 5 day not applicable:____________________________(commencement date)______________________________(end date)
      12. Distribution participants and/or affiliated purchasers:

      Member Firm MPID(s)
      1. _________________________________ ________________________________________
      2._________________________________ ________________________________________
      3._________________________________ ________________________________________
      4. _________________________________ ________________________________________
      5._________________________________ ________________________________________
      6._________________________________ ________________________________________
      7._________________________________ ________________________________________
      8._________________________________ ________________________________________

      Pursuant to FINRA Rule 5190(d)(1), the following information regarding the basis for determining the applicability of the "actively traded" securities exception under SEC Regulation M Rule 101 is provided:

      UAR (for a security listed on the NASDAQ Stock Exchange). Date of UAR:_______________________________

      The following:

      1. The ADTV, as defined under SEC Regulation M Rule 100:________________________________________________

      The source of this information:______________________________________________________________
      2. The public float value, as defined under SEC Regulation M Rule 100:___________________________________

      The source of this information:_________________________________________________________________

      Other:___________________________________________________________________________

      Pursuant to FINRA Rule 5190(e)(2), NASDAQ Rule 4614(d)(1) and/or NASDAQ Rule 4624(c), the following information regarding the specified activity, on the date shown, is provided:

      Activity Date(s) of Activity Aggregate # of Shares
      Engaged in a syndicate covering transaction: _________________________ _________________________
      Imposition of penalty bid: _________________________ _________________________
      tabilizing bid: _________________________ _________________________

      Pursuant to FINRA Rules 6282, 6380A, 6380B and 6622, the following information relating to transactions that are part of an unregistered secondary distribution and that have not been trade reported, is provided:

      Security Name Symbol Execution Date Execution Time Number of Shares Execution Price Buying Member Firm Selling Member Firm
                     
                     
                     
                     

      Submitted by

      Firm name:____________________________________________________________________________________________________________

      Date:_________________________________________________________________________________________________________________

      Signature:_____________________________________________Print name:____________________________________________________

      Title:________________________________________________________________________________________________________________

      Contact (if different from above):____________________________________________________________________________________

      Telephone number:_______________________________________Fax number:___________________________________________________

      Email address:______________________________________________________________________________________________________

      Pursuant to the requirements of the aforementioned rules, completed forms may be faxed to FINRA Market Regulation at (301) 339-7403, FINRA ADF Operations at (240) 386-6225 and NASDAQ MarketWatch at (301) 978-8511. For other submission methods, see www.finra.org/RegM.

    • 11-39 Guidance on Social Networking Websites and Business Communications

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      Social Media Websites and the Use of Personal Devices for Business Communications

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NASD Rule 2210
      NASD Rule 2211
      NASD Rule 3010
      FINRA Rule 4511
      NTM 05-48
      Regulatory Notice 08-77
      Regulatory Notice 10-06
      Regulatory Notice 11-14
      SEA Rule 17a-3
      SEA Rule 17a-4
      Suggested Routing

      Advertising
      Compliance
      Legal
      Operations
      Registered Representative
      Senior Management
      Key Topics

      Communications With the Public
      Personal Electronic Devices
      Recordkeeping
      Social Networking Websites
      Supervision

      Executive Summary

      In January 2010, FINRA issued Regulatory Notice 10-06, providing guidance on the application of FINRA rules governing communications with the public to social media sites and reminding firms of the recordkeeping, suitability, supervision and content requirements for such communications. Since its publication, firms have raised additional questions regarding the application of the rules. This Notice responds to these questions by providing further clarification concerning application of the rules to new technologies. It is not intended to alter the principles or the guidance provided in Regulatory Notice 10-06.

      Questions concerning this Notice may be directed to:

      •   Joseph E. Price, Senior Vice President, Advertising Regulation/Corporate Financing, at (240) 386-4623;
      •   Thomas A. Pappas, Vice President, Advertising Regulation, at (240) 386-4553; or
      •   Amy Sochard, Director, Advertising Regulation, at (240) 386-4508.

      Background

      1. Recordkeeping

      The obligations of a firm to keep records of communications made through social media depend on whether the content of the communication constitutes a business communication. Rule 17a-4(b) under the Securities Exchange Act of 1934 (SEA) requires broker-dealers to preserve certain records for a period of not less than three years, the first two in an easily accessible place.1 Among these records, pursuant to SEA Rule 17a-4(b)(4), are "[o]riginals of all communications received and copies of all communications sent (and any approvals thereof) by the member, broker or dealer (including inter-office memoranda and communications) relating to its business as such, including all communications which are subject to rules of a self-regulatory organization of which the member, broker or dealer is a member regarding communications with the public."2 The SEC has stated that the content of an electronic communication determines whether it must be preserved.3
      2. Supervision

      NASD Rule 3010 requires each firm to establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable federal securities laws and FINRA rules. As part of this responsibility, a registered principal must review prior to use any social media site that an associated person intends to employ for a business purpose. The registered principal may approve use of the site for a business purpose only if the registered principal has determined that the associated person can and will comply with all applicable FINRA rules, the federal securities laws, including recordkeeping requirements, and any additional requirements established by the firm.

      The registered principal must review an associated person's proposed social media site in the form in which it will be "launched." Some firms require a registered principal to review the first posting by an associated person on an interactive forum within the site. This approach can help to ensure that the registered principal will be reviewing not only the initial communication, but the social media site itself in its completed design.

      FINRA considers unscripted participation in an interactive electronic forum to come within the definition of "public appearance" under NASD Rule 2210. Public appearances do not require prior approval by a registered principal. Firms may adopt risk-based supervisory procedures utilizing post-use review, including sampling and lexicon-based search methodologies, of unscripted participation in an interactive electronic forum. The procedures a firm adopts must be reasonably designed to ensure that interactive electronic communications do not violate FINRA or SEC rules, including the content requirements of NASD Rule 2210, such as the prohibition on misleading statements or claims and the requirement that communications be fair and balanced. A static posting is deemed an "advertisement" under NASD Rule 2210 and therefore requires a registered principal to approve the posting prior to use.4
      3. Links to Third-Party Sites

      Firms may not establish a link to any third-party site that the firm knows or has reason to know contains false or misleading content. A firm should not include a link on its website if there are any red flags that indicate the linked site contains false or misleading content. Additionally, a firm is responsible under NASD Rule 2210 for content on a linked third-party site if the firm has adopted or has become entangled with its content. For example, a firm may be deemed to have "adopted" third-party content if it indicates on its site that it endorses the content on the third-party site. A firm could be deemed to have become "entangled" with a third-party site if, for example, it participates in the development of the content on the third-party site.
      4. Data Feeds

      Firms must adopt procedures to manage data feeds into their own websites. FINRA is aware of situations in which firms have received data feeds that were inaccurate. Firms must be familiar with the proficiency of the vendor of the data and its ability to provide data that is accurate as of the time it is presented on the firm's website. Firms also must understand the criteria followed by vendors in gathering or calculating the types of data that the firm intends to feed into its website, in order to determine whether the vendor is performing this function in a reasonable manner.5 Firms also should regularly review aspects of these data feeds for any red flags that indicate that the data may not be accurate, and should promptly take necessary measures to correct any inaccurate data.

      Questions & Answers

      Recordkeeping

      Q1: Does determining whether a communication is subject to the recordkeeping requirements of SEA Rule 17a-4(b)(4) depend on whether an associated person uses a personal device or technology to make the communication?
      A1: SEA Rule 17a-4(b)(4) requires a firm to retain records of communications that relate to its "business as such." Whether a particular communication is related to the business of the firm depends upon the facts and circumstances. This analysis does not depend upon the type of device or technology used to transmit the communication, nor does it depend upon whether it is a firm-issued or personal device of the individual; rather, the content of the communication is determinative. For instance, the requirement would apply if the electronic communication was received or sent by an associated person through a third-party's platform or system. A firm's policies and procedures must include training and education of its associated persons regarding the differences between business and non-business communications and the measures required to ensure that any business communication made by associated persons is retained, retrievable and supervised.
      Q2: When an associated person posts autobiographical information, such as place of employment or job responsibilities, does this information constitute a business communication?
      A2: As discussed in question 1 above, firms must develop policies and procedures that include training regarding the difference between business and non-business communications to enable appropriate compliance. In certain contexts, such as sending a resume to a potential employer, the communication could be viewed as not relevant to the business of the firm. In other contexts, such as posting a list of products or services offered by the firm, the communication likely will be viewed as a business communication.
      Q3: May a firm or associated person sponsor a social media site or use a communication device that includes technology which automatically erases or deletes the content?
      A3: No. Technology that automatically erases or deletes the content of an electronic communication would preclude the ability of the firm to retain the communications in compliance with their obligations under SEA Rule 17a-4. Accordingly, firms and associated persons may not sponsor such sites or use such devices.
      Q4: Do the recordkeeping requirements apply to third-party posts to a firm or an associated person's social media sites if the firm or the individual has not adopted or become entangled with the post?
      A4: Regulatory Notice 10-06 addresses the application of NASD Rule 2210 to third-party posts on a social media site established by a firm or its associated persons. Unless the firm or its associated persons have adopted or become entangled with the post, FINRA generally does not treat third-party posts as the firm's or its associated persons' communications under the rule. The recordkeeping requirements, however, require retention of the records of all communications received by a firm or its associated persons relating to its business as such.
      Q5: Do the recordkeeping requirements differ for static and interactive communications?
      A5: They do not—the recordkeeping requirements are governed by the content of the communication. As noted above, the FINRA supervision requirements differ for static and interactive communications.

      Supervision

      Q6: Can interactive content become static?
      A6: Yes. For example, interactive content could be copied or forwarded and posted in a static forum, such as a blog or static area of a Web page, in a manner that renders it static content. It then would constitute an advertisment under NASD Rule 2210, requiring prior approval by a registered principal of the firm.
      Q7: What measures should a firm adopt to monitor compliance with its social media policies?
      A7: A firm must conduct appropriate training and education concerning its policies, including those relating to social media. Firms must follow up on "red flags" that may indicate that an associated person is not complying with firm policies. Some firms require each associated person to certify on an annual or more frequent basis that the associated person is acting in a manner consistent with such policies. When feasible, some firms also have chosen to randomly spot check websites to help them monitor compliance with firm policies.
      Q8: Must material changes to static content posted by a firm or its associated persons on a social media site that contains business communications receive prior approval by a registered principal?
      A8: NASD Rule 2210(1)(b) requires a registered principal to approve each advertisement and item of sales literature before the earlier of its use or filing with FINRA's Advertising Regulation Department. NASD Rule 2210(c)(8) excludes from the filing requirements any advertisement or sales literature that previously had been filed and that is to be used "without material change." Firms are expected to adopt procedures requiring prior registered principal approval of any advertisement or sales literature that has been materially changed, even if it had been previously approved in an earlier version. For example, changes in the description of the advantages of investing in the advertised product or of its risks would typically require registered principal prior approval. Since static content posted by a firm or its associated persons on a social media site that contains business communications is considered to be an advertisement, these procedures must apply to such static content.

      Third-Party Posts, Third-Party Links and Websites

      Q9: If a third party posts a business-related communication, such as a question about a security, on an associated person's personal social media site, may the associated person respond to the communication?
      A9: Yes, provided that the response does not violate the firm's policies concerning participation on a personal social media site. If a firm has a policy that associated persons may not use a personal social media site for business purposes, then a substantive response by the associated person would violate this policy.6 Some firms permit a non-substantive response, and pre-approve statements that their associated persons may make to respond to such posts and that direct the third party to other firm-approved communication media, such as the firm's email system.
      Q10: To what extent is a firm responsible for any third-party website that the firm or its associated person "co-brands"?
      A10: Under NASD Rule 2210, a firm that co-brands any part of a third-party site, such as by placing the firm's logo prominently on the site, is responsible for the content of the entire site. Under these circumstances, FINRA considers the firm to have adopted the content on that site. A firm is responsible under NASD Rule 2210 for content on a linked third-party site if the firm has adopted or become entangled with its content. Regulatory Notice 10-06 describes the "adoption" and "entanglement" theories as they apply to third-party posts on a firm's social media sites. FINRA considers a firm to have adopted content in a third-party post if the firm or its personnel explicitly or implicitly endorse or approve the post.
      Q11: When is a firm not responsible for the content on a third-party site to which it links?
      A11: A firm may establish a link to the site of an independent third party without assuming responsibility for the content of that site under NASD Rule 2210 if:
      •   the firm does not "adopt" or become "entangled" with the content of the third-party site; and
      •   the firm does not know or have reason to know that the site contains false or misleading information.
      Q12: If firm policy requires deletion of inappropriate third-party content, will the firm be considered to have adopted any third-party posts that are not deleted?
      A12: No. The fact that the firm has a policy of routinely blocking or deleting certain types of content in order to ensure the content is appropriate would not mean that the firm had adopted the content of the posts left on the site. For example, most firms using social media sites block or screen offensive material. Such a policy would not indicate that the firm has adopted the remaining third-party content.
      Q13: Does NASD Rule 2210 require firms to approve or maintain records of statistical information that the firm has regularly updated on its website?
      A13: NASD Rule 2210(b)(1) requires that a registered principal approve each advertisement and item of sales literature prior to use or filing with FINRA's Advertising Regulation Department. NASD Rule 2210(b)(2) requires firms to maintain all advertisements and sales literature, including the names of the persons who prepared them or approved their use, for a period beginning on the date of first use and ending three years from the date of last use.

      Statistical information that is posted on a firm's website would be considered an "advertisement" subject to the approval and recordkeeping requirements of NASD Rules 2210(b)(1) and (2). However, some firms establish templates for the presentation of this data, and subject these templates to those provisions. The data that is fed into the website in accordance with such a template would not be subject to the requirements of NASD Rules 2210(b)(1) and (2). The firm must have procedures reasonably designed to ensure that the data can be verified to ensure that it is timely and accurate, and that the firm can promptly correct data that is erroneous when posted or becomes inaccurate over time.

      Accessing Social Media Sites From Personal Devices

      Q14: May associated persons use personal communication devices and other equipment, such as a smart phone or tablet computer, to access firm business applications and perform business activity if the firm employs technology that enables the firm to keep records and supervise the activity?
      A14: Yes. Firms may permit their associated persons to use any personal communication device, whether it is owned by the associated person or the firm, for business communications. FINRA recognizes that the development of new technologies can facilitate the ability of associated persons to perform their responsibilties and, in the case of registered representatives, to serve their clients. Of course, the firm must be able to retain, retrieve and supervise business communications regardless of whether they are conducted from a device owned by the firm or by the associated person.

      In order to ensure that the business communications are readily retrievable without necessitating the capture of personal communications made on the same device, firms should have the ability to separate business and personal communications, such as by requiring that the associated persons use a separately identifiable application on the device for their business communications. If possible, this application should provide a secure portal into the firm's own communication system, particularly if confidential customer information may be shared. If the firm has the ability to separate business and personal communications, and has adequate electronic communications policies and procedures regarding usage, then the firm is not required to supervise the personal emails made on these devices. Of course, firms also are free to treat all communications made through the personal communication device as business communications.

      1 SEA Rule 17a-4(f) permits broker-dealers to maintain and preserve these records on "micrographic media" or by means of "electronic storage media," as defined in the rule and subject to a number of conditions.

      2 See also NASD Rule 2210(b)(2) (requiring the retention of all advertisements, sales literature and independently prepared reprints), NASD Rule 2211(b)(2) (requiring the retention of institutional sales material) and NASD Rule 3010(d)(3) (requiring the retention of correspondence of registered representatives).

      3 See Reporting Requirements for Brokers or Dealers under the Securities Exchange Act of 1934, SEC Rel. No. 34-38245 (Feb. 5, 1997).

      4 FINRA has filed with the SEC a proposed rule change that would replace most of the NASD and NYSE rules governing communications with the public with a series of new FINRA rules. See SR-FINRA-2011-035. Among other changes, the term "advertisement" would be subsumed within a new communication category, "retail communication."

      5 Cf., Regulatory Notice 08-77 (Dec. 2008) (Customer Account Statements) (discussion of "data vendors"). See also Notice to Members (NTM) 05-48 (July 2005) (Members' Responsibilities When Outsourcing Activities to Third-Party Service Providers); Regulatory Notice 11-14 (March 2011) (FINRA Requests Comment on Proposed New FINRA Rule 3190 to Clarify the Scope of a Firm's Obligations and Supervisory Responsibilities for Functions or Activities Outsourced to a Third-Party Service Provider).

      6 Of course, if the firm permits business-related communications on a personal social media site, then the firm must supervise that site for compliance with applicable rules and the federal securities laws.

    • 11-38 Application of the SEC's Financial Responsibility Rules in Response to the Downgrade of U. S. Long Term Credit Rating by Standard & Poor's

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      Financial Responsibility

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules

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

      Compliance
      Finance
      Legal
      Operations
      Regulatory Reporting
      Senior Management
      Key Topics

      Customer Protection
      Financial Responsibility
      Net Capital

      Executive Summary

      This Notice is being issued in response to the downgrade of the United States long-term credit rating by Standard & Poor's, issued on August 5, 2011, and provides guidance to firms on the application of the Securities and Exchange Commission's (SEC) Net Capital and Customer Protection Rules to United States Treasury securities and other securities issued, or guaranteed as to principal and interest, by the United States or any of its governmental agencies.

      Questions concerning this Notice may be directed to your firm's Regulatory Coordinator.

      Background & Discussion

      Following the action taken by Standard & Poor's on August 5, 2011, reducing the long-term credit rating of the United States, FINRA has received inquiries from several member firms regarding the impact of this ratings action to the application of the SEC's Net Capital and Customer Protection rules.

      Under SEA Rule 15c3-1, the credit rating assigned to United States Treasury securities or other securities issued, or guaranteed as to principal or interest, by the United States or any of its governmental agencies (government securities), by any credit ratings agency, is not a factor in determining the net capital treatment for such securities. FINRA staff has confirmed with the staff of the SEC that this ratings action by Standard & Poor's does not alter the net capital treatment of these government securities under SEA Rule 15c3-1(c)(2) (vi)(A).

      In addition, SEC staff has confirmed that the ratings action by Standard & Poor's does not affect the definition of "qualified security" under SEA Rule 15c3-3(a)(6). Broker-dealers may continue to use securities issued, or securities whose principal and interest is guaranteed, by the United States to meet their deposit requirement under SEA Rule 15c3-3(e)(1).

    • 11-37 Trading Pause Rule Expanded to All NMS Stocks; Effective Date: August 8, 2011

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      Trading Halts Due To Extraordinary Market Volatility

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6121
      Regulatory Notice 10-30
      Regulatory Notice 10-43
      Suggested Routing

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

      Single-Stock Circuit Breaker
      Trading Halts
      Trading Pause

      Executive Summary

      Beginning August 8, 2011, the trading pause pilot rule—currently applicable only to securities included in the S&P 500® Index, the Russell 1000® Index and a list of selected exchange-traded products (ETPs)—will be expanded to include all National Market System (NMS) stocks.

      The text of the rule amendments can be found in the online FINRA Manual.

      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 23, 2011, the SEC approved amendments to FINRA Rule 6121 (Trading Halts Due to Extraordinary Market Volatility) (the trading pause pilot rule), along with similar amendments by other self-regulatory organizations (SROs), to expand the scope of the trading pause pilot rules to all NMS stocks.1 Under the current trading pause pilot rule, which applies only to the securities included in the S&P 500 Index and the Russell 1000 Index, along with a list of selected ETPs, the primary market will halt or pause the trading in a stock if the price of the security has declined 10 percent or more within a rolling five-minute period.2 Pursuant to Rule 6121, FINRA also will halt over-the-counter trading in that stock for the duration of the pause.3

      Effective August 8, 2011, the expanded pilot will cover all remaining NMS stocks and will require a threshold move of 30 percent (or more) to trigger a trading pause for these securities where they are priced at least $1.00,4 and a threshold move of 50 percent (or more) where such securities are priced less than $1.00.

      This expansion of the trading pause pilot applies the trading pause protections against excessive volatility to a wider group of securities, and also permits further review and assessment of the operation of the trading pauses, including whether alternative measures are appropriate.5

      For more information, please see FINRA's rule change and Regulatory Notices 10-43 and 10-30.


      1 See Securities Exchange Act Release No. 64735 (June 23, 2011), 76 FR 38243 (June 29, 2011) (Order Approving SR-FINRA-2011-023).

      2 The 10 percent threshold will continue to apply to the securities currently included in the pilot (i.e., the securities in the S&P BOO Index, the Russell 1000 Index and the list of selected ETPs).

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

      4 The price of a security will be based on the closing price on the previous trading day, or, if no closing price exists, the last sale reported to the Consolidated Tape on the previous trading day.

      5 On April 5, 2011, FINRA (along with other SROs) filed a proposed NMS Plan to create a market-wide limit up-limit down mechanism to address extraordinary market volatility in NMS stocks. As proposed, the limit up-limit down mechanism would replace the existing trading pause pilot. See Securities Exchange Act Release No. 64547 (May 25, 2011), 76 FR 31647 (June 1, 2011).

    • 11-36 Changes to Fees for Cancelling or Rescheduling a Qualification Examination or Regulatory Element Continuing Education Session

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      Testing and Continuing Education

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 1250
      NASD Rule 1120
      Regulatory Notice 11-33
      Section 4 of Schedule A to the By-Laws
      Suggested Routing

      Compliance
      Continuing Education
      Legal
      Registered Representatives
      Registration
      Senior Management
      Key Topics

      Continuing Education
      Qualification Examination Fees
      Regulatory Element Fees
      Testing

      Executive Summary

      FINRA has filed for immediate effectiveness amendments to Section 4 of Schedule A to the FINRA By-Laws to establish a fee for individuals who cancel or reschedule a qualification examination or Regulatory Element Continuing Education (Regulatory Element) session three to 10 business days prior to the appointment date.1 The changes are effective September 1, 2011.

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

      Questions concerning this Notice should be directed to Jeanne Hartman, Director of Operations, Testing and Continuing Education, at (240) 386-6348.

      Background & Discussion

      As part of the registration process, securities professionals must pass a qualification examination to demonstrate competence in the areas in which they will work. In addition, such individuals must complete the appropriate Regulatory Element program subsequent to their initial qualification and registration with FINRA, as set forth in NASD Rule 1120.2 FINRA currently administers examinations and Regulatory Element programs via computer at testing centers operated by vendors under contract with FINRA.

      To request and schedule an appointment for a qualification examination, a firm must file a Form U4 (Uniform Application for Securities Industry Registration or Transfer) through the Central Registration Depository (Web CRD®).3 After the request is processed, an enrollment window opens on Web CRD. For Regulatory Element programs, an enrollment window automatically opens for registered persons in covered registration categories for the requisite program on the second anniversary of their initial securities registration and every three years thereafter. Once an individual or an individual's firm receives the enrollment notification for an examination or Regulatory Element session, the individual may then contact a FINRA authorized testing center to schedule an appointment.

      After an individual schedules an examination or Regulatory Element session, he or she may cancel or reschedule the appointment by contacting the testing center. Currently, FINRA does not impose a fee for cancelling or rescheduling an appointment by noon two business days before the scheduled session. However, FINRA charges a cancellation fee equal to the examination or Regulatory Element session fee if this deadline is not met, if an individual does not appear for an appointment, or if an individual arrives so late for an appointment that the examination or Regulatory Element session cannot begin without disrupting the testing center's schedule.4

      Beginning September 1, 2011, FINRA will implement a fee for individuals who cancel or reschedule a qualification examination or Regulatory Element session within three to 10 business days of a scheduled appointment date.5 The amount of the fee will be one-half of the fee of the examination or Regulatory Element session being cancelled or rescheduled, and it will be assessed for any examination or Regulatory Element session that is cancelled or rescheduled on or after September 1, 2011.6


      1 See Securities Exchange Act Release No. 64961 (July 26, 2011), 76 FR 45883 (August 1, 2011) (Notice of Filing and Immediate Effectiveness of SR-FINRA-2011-026). The amendments also add a reference to the fee for individuals who fail to timely appear for a scheduled Regulatory Element session or who cancel or reschedule such a session within two business days prior to the appointment date.

      2 The SEC recently approved the adoption of NASD Rule 1120 (Continuing Education Requirements) as FINRA Rule 1250 (Continuing Education Requirements) in the consolidated FINRA rulebook with certain changes. See Securities Exchange Act Release No. 64687 (June 16, 2011), 76 FR 36586 (June 22, 2011) (Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval of SR-FINRA-2011-013). FINRA Rule 1250 becomes effective on October 17, 2011. See Regulatory Notice 11-33 (July 2011).

      3 Individuals who are not employed or associated with a FINRA member must file a Form U10 (Uniform Examination Request for Non-FINRA Candidates) with FINRA to schedule an examination.

      4 Further information about the cancellation policy is available on FINRA's website.

      5 This fee will be assessed for the qualification examinations set forth in Section 4(c) of Schedule A to the FINRA By-Laws and all Regulatory Element programs. In addition, depending on the terms of agreement, the fee also may apply for those qualification examinations that FINRA delivers for other entities (e.g., the North American Securities Administrators Association, the National Futures Association, the Federal Deposit Insurance Corporation).

      6 The fee must be paid at the time the examination or Regulatory Element session is cancelled or rescheduled. In those circumstances where the fee is not paid in a timely manner, FINRA instead will assess a fee equal to the examination or Regulatory Element session fee if the individual does not appear for the scheduled appointment. Information on cancelling or rescheduling an appointment is available on FINRA's website.


      Attachment A

      Below is the text of the amendments. New language is underlined; deletions are in brackets.

      * * * * *

      SCHEDULE A TO THE BY-LAWS OF THE CORPORATION

      * * * * *

      Section 4 — Fees

      (a) and (b) No change.
      (c) The following fees shall be assessed to each individual who registers to take an examination as described below. These fees are in addition to the registration fee described in paragraph (b) and any other fees that the owner of an examination that FINRA administers may assess.

      Series 4 Registered Options Principal $90
      Series 6 Investment Company Products/Variable Contracts Representative $85
      Series 7 General Securities Representative $265
      Series 9 General Securities Sales Supervisor — Options Module $70
      Series 10 General Securities Sales Supervisor — General Module $110
      Series 11 Assistant Representative — Order Processing $70
      Series 14 Compliance Official $320
      Series 16 Supervisory Analyst $210
      Series 17 Limited Registered Representative $70
      Series 22 Direct Participation Programs Representative $85
      Series 23 General Securities Principal Sales Supervisor Module $85
      Series 24 General Securities Principal $105
      Series 26 Investment Company Products/Variable Contracts Principal $85
      Series 27 Financial and Operations Principal $105
      Series 28 Introducing Broker-Dealer Financial and Operations Principal $85
      Series 37 Canada Module of S7 (Options Required) $160
      Series 38 Canada Module of S7 (No Options Required) $160
      Series 39 Direct Participation Programs Principal $80
      Series 42 Registered Options Representative $65
      Series 51 Municipal Fund Securities Limited Principal $85
      Series 52 Municipal Securities Representative $95
      Series 53 Municipal Securities Principal $95
      Series 55 Limited Representative — Equity Trader $95
      Series 62 Corporate Securities Limited Representative $80
      Series 72 Government Securities Representative $95
      Series 79 Investment Banking Qualification Examination $265
      Series 82 Limited Representative — Private Securities Offering $80
      Series 86 Research Analyst — Analysis $160
      Series 87 Research Analyst — Regulatory $115
      (1) No change.
      (2) There shall be a service charge of $15.00 in addition to those fees specified above for any examination taken in a foreign test center located outside the territorial limits of the United States.
      ([2]3) There shall be a service charge equal to the examination or Regulatory Element session fee assessed to each individual who, having made an appointment for a specific time and place for computer-based administration of an examination listed above or Regulatory Element session, fails to timely appear for such appointment [examination] or [timely] cancels or reschedules such appointment within two business days prior to the appointment date.
      [(3) There shall be a service charge fee of $15.00 in addition to those fees specified above for any examination taken in a foreign test center located outside the territorial limits of the United States.]
      (4) There shall be a service charge equal to one-half of the examination or Regulatory Element session fee assessed to each individual who, having made an appointment for a specific time and place for computer-based administration of an examination listed above or Regulatory Element session, cancels or reschedules such appointment three to 10 business days prior to the appointment date.
      (d) through (h) No change.

      * * * * *

    • 11-35 FINRA Modifies the Process for Firms to Designate Their Allocation Methodology for Options Exercise Assignment Notices; Effective Date: August 8, 2011

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      Options

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 2360
      Suggested Routing

      Compliance
      Institutional
      Legal
      Operations
      Options
      Risk
      Senior Management
      Systems
      Key Topics

      Exercise Assignment Notice
      Options

      Executive Summary

      FINRA is updating the procedures for firms to designate their method of allocating options exercise assignment notices. Effective August 8, 2011, firms initiating an options business, or changing their allocation method, must use the application form in Attachment A of this Notice. FINRA also has updated the designated random selection allocation procedures, which are described in Attachment B.

      Questions concerning this Notice should be directed to:

      •   Max Tourtelot, Director, Options Regulation, at (917) 281-3133; or
      •   Casey McMahon, Associate Director, Options Regulation, at (917) 281-3042.

      Background & Discussion

      FINRA Rule 2360(b)(23)(C) requires member firms conducting transactions in exchange-listed options to establish fixed procedures for allocating options exercise notices to short options positions in its customer accounts. Firms may elect to allocate exercise assignment notices on: (1) a "first in-first out" basis (FIFO); (2) a random selection basis, as described in Attachment B of this Notice; or (3) another equally random selection basis determined by the firm. However, firms must receive prior FINRA approval for the method selected. Any changes to a firm's allocation method must be reported to and approved by FINRA.

      Effective August 8, 2011, firms initiating an options business, or changing their allocation method, must use the application form in Attachment A of this Notice. The revised form updates FINRA rule references and contact information.

      FINRA also has updated its designated procedures for firms employing a random method of allocating options exercise assignment notices. Firms using the random method must ensure that they follow these updated procedures, or seek approval from FINRA for an alternative allocation method. The revised procedures are described in Attachment B.

      FINRA also reminds firms that they must inform customers in writing of the method used to allocate options exercise assignment notices, including explanations of how the system operates and the consequences of that system. Firms also must preserve sufficient work papers and other documentary materials relating to the allocation of options exercise assignment notices to establish the manner in which allocation of the exercise assignment notices is in fact being accomplished.


      Attachment A

      Market Regulation Department Options Surveillance

      Option Exercise Assignment Allocation Method Application

      Submit completed form by email to allocation@finra.org or by fax to (301) 339-7687.

      Firm Name:
      ______________________________________________________________________________________________________________________

      Firm CRD No.:
      ______________________________________________________________________________________________________________________

      Contact Person for Assignment Allocation:
      ______________________________________________________________________________________________________________________

      Address:
      ______________________________________________________________________________________________________________________

      Phone Number:
      ______________________________________________________________________________________________________________________

      Email:
      ______________________________________________________________________________________________________________________

      Please complete either section 1 or 2, as applicable, below:

      1. If your firm has a clearing arrangement on a fully disclosed basis with an OCC member firm, please indicate the OCC member firm name:_____________________________________________________________________.
      2.
      A. If your firm has a clearing arrangement on an omnibus basis with an OCC member firm, please indicate the OCC member firm name_______________________________________, and the method of options exercise allocation below:
      a. First In, First Out (FIFO)
      b. Random Method as designated in FINRA Regulatory Notice 11-35
      c. Other Random Method (please describe and attach methodology)
      B. If your firm is a self-clearing member of the Options Clearing Corporation, please list all OCC Allocated Clearing Member No.(s)_______________________________________and the method of options exercise allocation below:
      a. First In, First Out (FIFO)
      b. Random Method as designated in FINRA Regulatory Notice 11-35
      c. Other Random Method (please describe and attach methodology)
      For firms that have multiple clearing numbers and use different allocation methods, please attach a separate sheet for each Clearing Member Number.

      Authorization

      Requested by:

      Authorized Person (Print or Type)             Title
      ______________________________________________________________________________________________________________________

      Signature                                                    Date
      ______________________________________________________________________________________________________________________

      CRD No. of Authorized Person
      ______________________________________________________________________________________________________________________

      For questions regarding this form, or the allocation process, please contact:

      Casey McMahon (917) 281-3042 casey.mcmahon@finra.org

      Max Tourtelot (917) 281-3133 max.tourtelot@finra.org


      Attachment B

      Random Exercise Allocation Procedure

      A firm may elect to allocate exercise assignments to its short option holders using a random allocation method. A firm electing a random allocation method must use the methodology outlined below.

      Step 1: Sequencing of accounts—Identify and list all customer and firm accounts with open short positions in the option series for which exercise notices have been received.

      Step 2: Assigning Sequence Numbers—Assign a range of sequential numbers to each account based on the number of short contracts held in the account. For example:

      XYZ Jan 50 Calls

      Account No. # of Contracts Short Assigned Sequential Numbers
      1 5 1 through 5
      2 8 6 through 13
      3 2 14 through 15
      4 10 16 through 25
      5 11 26 through 36
      Total: 36 Short Contracts

      In this example, all accounts having a short position in XYZ Jan 50 calls, the series for which exercise notices have been received, are arranged in order according to their account numbers. The number of contracts short in each account is noted, and shows that there are a total of 36 contracts short in all customer and firm accounts. Account #1 is assigned a range of numbers that begins with 1 and ends with the number reflecting the total contracts short in that account, which in this case is 5. Thus, the sequential numbers assigned to Account #1 are 1–5. The sequential numbers for Account #2 must begin with 6 and encompass eight numbers representing the 8 contracts short in that account. This results in the sequential numbers of 6–13 being assigned to Account #2. Account #3 is short 2 contracts and similarly is assigned sequential numbers beginning with 14 and ending with 15. This process continues until all accounts in the sequence have been assigned unique sequential numbers. By assigning sequential numbers in this manner, the likelihood that a particular account will be selected for exercise will be proportional to its share of the total short position.

      Step 3: Random Number Generation—After completing the assignment of sequential numbers, choose a random decimal number using either of the methods described below:

      •   A firm may use any automated application, including Microsoft Excel, which contains a random number generator, to obtain a random number greater than zero and less than or equal to one that contains four decimal places; or
      •   A firm may obtain the NYSE or NASDAQ consolidated stock volume for the previous trading day, and follow these steps:
      •   Select the four digits corresponding to the hundred thousands, ten thousands, thousands, and hundreds positions of the volume figure.
      •   Place a decimal point to the left of the first digit to create a number ranging from .0000 to .9999. Add .0001 to this number to obtain a random number ranging from .0001 to 1.1

      Using either of the above methods, the firm should now have a number that lies in the range from .0001 to 1.

      Step 4: Selection of Starting Point Using the Random Number—Multiply the random number generated above by the total number of contracts short in all accounts and if not a round number, round to the next highest integer. This number will determine the starting point of the exercise assignment.

      Returning to the example, assume that there are 13 contracts for which the firm has received exercise notices, and that the random number .4855 is selected. The result of the multiplication of 36 (the total number of short XYZ Jan 50 Calls) and .4855 is 17.478, which is then rounded to the next highest integer, 18. The starting point for the first contract assigned is 18, which falls in Account #4.

      Step 5: Allocation of the Exercise Notice—The assignment of exercise notices proceeds until all exercise notices have been assigned by continuing down the list of accounts from the starting point determined in Step 4 (returning to the top of the list if additional notices need to be allocated).

      Continuing with the example, since the exercise notice specifies that 13 contracts are to be assigned, and 18 is the starting point, the firm selects the remaining 8 contracts from Account #4. The firm then advances to the next account in the sequence, Account #5, to assign the remaining 5 contracts. If the exercise notice related to more than 13 contracts, the assignment would continue to be absorbed by succeeding accounts in the sequence established in Step 1 until the entire assignment is absorbed. If additional notices need to be allocated after reaching the bottom of the list, continue with the first account at the top to complete the assignment.


      1 This number is generated daily and used for all series in which exercise notices have been received.

    • 11-34 FINRA Reaffirms Its Guidance in NTM 00-02 on Soliciting Business in Foreign Jurisdictions and Withdraws NTM 98-91

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      Soliciting Business Internationally

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      NTM 98-91
      NTM 00-02
      Suggested Routing

      Advertising
      Compliance
      Internal Audit
      Legal
      Senior Management
      Training
      Key Topics

      Advertising
      Foreign Regulators
      Soliciting Business
      Telemarketing

      Executive Summary

      FINRA is reaffirming its guidance in Notice to Members (NTM) 00-02 concerning the solicitation of business in foreign jurisdictions.1 FINRA also is withdrawing NTM 98-91 in light of changes to the legal and regulatory framework in the United Kingdom (U.K.).

      Questions concerning this Notice should be directed to:

      •   Paul Andrews, Vice President, International, at (202) 728-8235; or
      •   Matthew E. Vitek, Counsel, OGC, at (202) 728-8156.

      Background & Discussion

      In NTM 00-02, FINRA alerted member firms and persons associated with firms to their obligations concerning the solicitation of business in foreign jurisdictions. FINRA reminded firms and associated persons of their obligations to comply with applicable U.S. and foreign laws when soliciting business in any foreign jurisdiction. FINRA is publishing this Notice to reaffirm its guidance and remind firms that solicit business or are proposing to solicit business in foreign jurisdictions to carefully review and comply with all applicable U.S. and foreign laws.

      At the same time, FINRA is withdrawing NTM 98-91. In that Notice, FINRA alerted firms and associated persons to their obligations concerning cold calling and advertising to persons in the U.K. by briefly summarizing the legal and regulatory framework in the U.K. regarding these activities. In view of changes to the legal and regulatory framework in the U.K., FINRA believes that it is prudent to formally withdraw NTM 98-91.


      1 This Notice does not address whether soliciting business in a foreign jurisdiction in violation of that jurisdiction's laws may constitute a violation of FINRA rules.

    • 11-33 SEC Approves Operations Professional Registration Category and Consolidated FINRA Continuing Education Rule; Effective Date: October 17, 2011

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      Operations Professionals

      Regulatory Notice
      Notice Type

      Consolidated FINRA Rulebook
      Rule Approval
      Referenced Rules & Notices

      FINRA Rule 1230
      FINRA Rule 1250
      FINRA Rule 4311
      FINRA Rule 8310
      FINRA Rule 8311
      FINRA Rule 8320
      NASD Rule 1021
      NASD Rule 1031
      NASD Rule 1050
      NASD Rule 1070
      NASD Rule 1120
      NASD Rule 3010
      NTM 05-48
      NYSE Rule 345A
      Regulatory Notice 09-70
      Regulatory Notice 11-14
      Regulatory Notice 11-26
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Senior Management
      Key Topics

      Continuing Education
      Examination
      Operations Professionals
      Qualification
      Registration

      Executive Summary

      The SEC approved FINRA's proposal to establish a registration category and qualification examination requirement for certain operations personnel.1 The proposal also adopts continuing education requirements for such operations personnel and adopts NASD Rule 1120 (Continuing Education Requirements) as FINRA Rule 1250 (Continuing Education Requirements) in the consolidated FINRA rulebook2 with certain changes.3

      The amended rule text is available at www.finra.org/notices/11-33. The rules become effective on October 17, 2011.

      Questions regarding this Notice should be directed to:

      •   Joe McDonald, Senior Director, Testing and Continuing Education Department, at (240) 386-5065; or
      •   Erika L. Lazar, Counsel, Office of General Counsel, at (202) 728-8013.

      Background & Discussion

      FINRA Rule 1230(b)(6) establishes a new representative registration category and qualification examination for certain operations personnel (Operations Professionals).4 FINRA is expanding its registration provisions to require registration of certain individuals (covered persons) who are engaged in, responsible for or supervising certain member firm operations functions (covered functions) to enhance the regulatory structure surrounding these areas. Covered persons play an integral role in the business of the member firm, and their activities often have a meaningful connection to customer funds, accounts and transactions.

      Although FINRA's registration regime historically has focused on "front office" personnel who have contact with customers or are otherwise directly involved in effecting securities transactions, persons who perform "back office" functions, such as recordkeeping, trade confirmation, transaction settlement, internal auditing, and securities lending operations are also important to a member firm's ability to comply with its responsibilities under the federal securities laws and regulations, and the rules of FINRA. Moreover, FINRA believes registration, qualification and continuing education requirements for covered persons are needed to help ensure that investor protection mechanisms are in place in all areas of a member firm's business that could harm the firm, a customer, the integrity of the marketplace or the public. FINRA Rule 1230(b)(6) is intended, among other things, to increase covered persons' awareness and knowledge that they are operating in a regulated environment designed to protect investors' interests and the integrity of the operations of a broker-dealer.

      In addition, NASD Rule 1120 (Continuing Education Requirements) has been adopted as FINRA Rule 1250 (Continuing Education Requirements) in the Consolidated FINRA Rulebook with certain changes, including a requirement that Operations Professionals be subject to both Regulatory Element and Firm Element Programs.

      I. Operations Professional Registration
      A. Covered Persons

      FINRA Rule 1230(b)(6)(A) sets forth three categories of persons who are subject to the registration, qualification and continuing education requirements as an Operations Professional. Persons who perform a covered function, but whose responsibilities are below these specified levels, are not required to register as Operations Professionals. Member firms must determine, based on a person's activities and responsibilities, whether such person would be considered a covered person and subject to the requirements for Operations Professionals. The three categories are:
      1. senior management with direct responsibility over the covered functions;
      2. any person designated by senior management specified in FINRA Rule 1230(b)(6)(A)(i) as a supervisor, manager or other person responsible for approving or authorizing work, including work of other persons, in direct furtherance of each of the covered functions, as applicable, provided that there is sufficient designation of such persons by senior management to address each of the applicable covered functions; and
      3. persons with the authority or discretion materially to commit a member firm's capital in direct furtherance of the covered functions or to commit a member firm to any material contract or agreement (written or oral) in direct furtherance of the covered functions.
      Under FINRA Rule 1230.06 (Scope of Operations Professional Requirement), the determination as to what constitutes "materially" or "material" in the third category of covered persons is based on a member firm's pre-established spending guidelines and risk management policies. Generally, persons who do not have the authority or discretion to commit a member firm's capital, or to commit a member firm to a contract or agreement, above such pre-established spending guidelines and risk management policies are not subject to registration as an Operations Professional under this provision.

      Consistent with FINRA guidance, persons subject to the new Operations Professional registration category are considered associated persons of a member firm insofar as they are performing regulated broker-dealer functions on behalf of the member firm, irrespective of their employing entity, and are subject to all FINRA rules applicable to associated persons and/or registered persons.5 Associated person status is not determined at the discretion of a member firm based on the location from which particular personnel are performing functions on behalf of the firm; associated person status attaches to persons who are involved in the securities and investment banking business of a member firm and the covered functions represent a part of that business of a firm. Moreover, FINRA notes that the scope of covered persons and covered functions set forth in FINRA Rule 1230(b)(6) is not exhaustive in terms of who may be considered an associated person of the member firm based on the nature of the operational activities being conducted on behalf of a member firm. Rather, FINRA has made a determination that the persons subject to the new requirements are engaged in members' operational activities of such significance to require registration, qualification and continuing education requirements.

      FINRA notes that a person's job title and/or employer may not be clearly indicative of his or her obligation to register as an Operations Professional. Firms must view each person's responsibilities in connection with the covered functions described below in Section B independently to determine who must register. The Operations Professional registration category is function-based and, therefore, not conditioned upon an individual's relationship to a particular department within a firm.
      B. Covered Functions

      Any person who meets the definition of a covered person in one of the three categories in FINRA Rule 1230(b)(6)(A) and engages in one or more of the following covered functions in FINRA Rule 1230(b)(6)(B) on behalf of a member firm (regardless of their employing entity, e.g., a member firm, an affiliate or a third-party service provider) must register as an Operations Professional:
      1. client on-boarding (customer account data and document maintenance);
      2. collection, maintenance, re-investment (i.e., sweeps) and disbursement of funds;
      3. receipt and delivery of securities and funds, account transfers
      4. bank, custody, depository and firm account management and reconciliation;
      5. settlement, fail control, buy ins, segregation, possession and control;
      6. trade confirmation and account statements;
      7. margin;
      8. stock loan/securities lending;6
      9. prime brokerage (services to other broker-dealers and financial institutions);
      10. approval of pricing models used for valuations;
      11. financial control, including general ledger and treasury;
      12. contributing to the process of preparing and filing financial regulatory reports;
      13. defining and approving 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;
      14. defining and approving business security requirements and policies for information technology, including, but not limited to, systems and data, in connection with the covered functions;
      15. defining and approving information entitlement policies in connection with the covered functions; and
      16. posting entries to a member's books and records in connection with the covered functions to ensure integrity and compliance with the federal securities laws and regulations and FINRA rules.
      FINRA Rule 1230.06 provides that any person whose activities are limited to performing 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 (e.g., internal audit, legal or compliance personnel who review but do not have primary responsibility for any covered function), or who engages solely in clerical or ministerial activities in a covered function is not required to register as an Operations Professional.

      As noted above, as registered persons, Operations Professionals will be subject to all FINRA rules applicable to associated persons and/or registered persons. Accordingly, pursuant to NASD Rule 3010(a)(5), each Operations Professional must be assigned to an appropriately registered representative(s) and/or principal(s) who shall be responsible for supervising that person's activities. Additionally, FINRA expects that each member firm will have at least one registered Operations Professional, who often may be the member firm's Financial and Operations Principal. In this regard, neither principal registration, nor representative registration in another category, obviates the requirement for a covered person to register as an Operations Professional.

      With respect to small firms, the impact of FINRA Rule 1230(b)(6) is expected to be minimal as the majority of the covered functions are typically performed by a carrying and clearing firm pursuant to a clearing arrangement. In such cases, it may be possible for a small firm to rely on limited persons, perhaps the Financial and Operations Principal, to liaise with the carrying and clearing firm regarding those covered functions. Also, a covered person would not be considered an associated person of both the introducing and clearing firms based solely on functions performed pursuant to a carrying agreement approved under FINRA Rule 4311 (Carrying Agreements).7 FINRA would not expect dual registration as an Operations Professional in such cases.
      C. Operations Professional Qualification Examination (Series 99)8

      FINRA Rule 1230(b)(6)(C), subject to the exceptions in subparagraph (D) (described in Section D below), requires any person who must register as an Operations Professional to pass a new Operations Professional qualification examination before the registration may become effective. The examination will provide reasonable assurance that the 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 member, a customer, the integrity of the marketplace or the public.9 The Operations Professional qualification examination will test applicants on general securities industry knowledge and its associated regulations and rules.

      In general, given the diversity of functions performed by covered persons, the Operations Professional qualification examination is a 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. As further detailed in Section E, the continuing education components associated with the Operations Professional registration category will provide competency training specific to the covered functions, as applicable.

      The key content themes of the Operations Professional qualification examination are:
      •   Professional Conduct and Ethical Considerations: This section of the examination assesses a candidate's core knowledge addressed on other FINRA examinations that are appropriate for an Operations Professional. The questions assess knowledge of what are considered serious violations of securities industry rules. This section includes 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 assesses a candidate's basic product and market knowledge, including definitions and characteristics of major product categories (i.e., equities, debt, packaged securities and options). An Operations Professional is not 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 assesses a candidate's broad-based knowledge regarding the covered functions in Section B 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, and credit and margin rules). This section of the examination also includes professional conduct and ethics-based questions in the context of operations activities.
      Consistent with FINRA practice, the content outline for the Operations Professional examination was developed by FINRA staff in conjunction with industry subject matter expert volunteers. FINRA staff conducted several focus panels in mid-2010 with operations professionals working in one or more of the covered functions and from a wide range of FINRA member firms. FINRA then convened an Operations Professional examination committee consisting of more than 40 individuals with significant experience in broker-dealer operations. Such individuals are associated with broker-dealers that fairly represent the FINRA membership in terms of size, geographical location and business model. Both FINRA staff and committee members placed an emphasis on creating a content outline and questions that would be appropriate across all the covered functions and test the appropriate level of knowledge for a person subject to the requirements as an Operations Professional.
      D. Exceptions to Operations Professional Examination Requirement

      FINRA Rule 1230(b)(6)(D)(i) sets forth 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.10 The exception also applies to persons who do not hold an eligible registration, but prefer an alternative to taking the Operations Professional examination. Such persons may register in an eligible registration category (subject to passing the corresponding qualification examination or obtaining a waiver) and use the registration to qualify for Operations Professional registration. FINRA believes the eligible registrations (and corresponding examinations based on their broad content coverage) serve as a valid proxy for the Operations Professional examination requirement.

      Persons who 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, are 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)
      Also, persons who hold (or have held) certain principal-level registration categories are 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 Rule 1230(b)(6)(D) also includes principal-level qualification examinations that do not have a prerequisite, or have a prerequisite that can be met with a qualification examination not on the above list (e.g., Series 62), because it is likely 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. Specifically, 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, are 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 (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)
      A person who wishes to obtain Operations Professional registration under the exception in FINRA Rule 1230(b)(6)(D)(i) will not be automatically waived-in, but must opt-in by requesting Operations Professional registration11 via Form U4 (the Uniform Application for Securities Industry Registration or Transfer) in the Central Registration Depository system (CRD® system).12 If there are no other deficiencies (e.g., fingerprints), the Operations Professional registration will be approved automatically at the time of the request. FINRA will not assess a separate registration fee for persons relying on the exception to register as Operations Professionals.

      The exception does not apply to persons whose eligible registrations are revoked pursuant to FINRA Rules 8310 (Sanctions for Violation of the Rules) or 8320 (Payment of Fines, Other Monetary Sanctions, or Costs; Summary Action for Failure to Pay), suspended or otherwise deemed inactive.13

      FINRA anticipates that many persons subject to the new Operations Professional registration category may qualify for the exception from the qualification examination based on existing registrations, since they are generally acting in a supervisory position, and FINRA would not assess a separate registration fee for persons relying on the exception to register as Operations Professionals. As noted in Section A, entry-level operations personnel typically are not going to be subject to the requirements for Operations Professionals.

      FINRA Rule 1230(b)(6)(D)(ii) provides that the staff may accept as an alternative to the Operations Professional qualification examination requirement any domestic or foreign qualification if it determines that acceptance of the alternative qualification is consistent with the purposes of the rule, the protection of investors and the public interest.
      E. Continuing Education Requirements for Operations Professionals

      Individuals registered as Operations Professionals are subject to FINRA's Regulatory Element and Firm Element Continuing Education requirements as set forth in FINRA Rule 1250 (Continuing Education Requirements).14 The continuing education elements for this registration category provide more specific learning materials appropriate for an Operations Professional, given the diversity of covered functions.

      The Regulatory Element Program for Operations Professionals, the S901, focuses on instruction to:
      •   maintain and improve understanding of the regulatory and ethical aspects associated with the covered functions;
      •   identify suspicious activities and/or red flags that could harm a customer, a firm, issuers of securities or the integrity of the marketplace;
      •   maintain and improve knowledge and understanding of the covered functions; and
      •   assist the Operations Professional in keeping up with changes in the industry and regulations that impact their work.
      Operations Professionals are required to complete scenario-based modules based on the key content themes of the Operations Professional qualification examination described in Section C. The breadth and depth of coverage of the modules is determined through the use of existing industry standards currently used to develop continuing education content and include input and advice from operations professionals active in the securities industry. Individuals are expected to complete the Regulatory Element Continuing Education requirement two years after passing the qualification examination and then every three years thereafter.

      Individuals who avail themselves of the exception to the Operations Professional qualification examination requirement in FINRA Rule 1230(b)(6)(D)(i) with an eligible registration are subject to the Regulatory Element Program appropriate for the other registration category. For example, a person who registers as an Operations Professional by holding a General Securities Representative registration (Series 7) under the exception is subject to the S101 Regulatory Element Program in lieu of the S901 Regulatory Element Program, and a person who registers by holding a General Securities Principal registration (Series 24) is subject to the S201 Regulatory Element Program in lieu of the S901 Regulatory Element Program.

      Operations Professionals also are subject to a Firm Element Continuing Education requirement. To implement this change, as further discussed in Section II, Operations Professionals have been added to the definition of "covered registered persons" in FINRA Rule 1250(b)(1), which requires member firms to deliver Firm Element training to such persons.15
      F. Implementation

      As noted in Section B, any person who meets the definition of a covered person in one of the three categories in FINRA Rule 1230(b)(6)(A) and engages in one or more of the covered functions in FINRA Rule 1230(b)(6)(B) on behalf of a member firm must register as an Operations Professional. Such persons must register by requesting Operations Professional registration via Form U4 in the CRD system and doing one of the following, as applicable:
      •   passing the Operations Professional qualification examination;
      •   opting in to such registration based on their holding, or having held within the past two years at the time of such request, an eligible registration;16 or
      •   registering with FINRA in an eligible registration category and opting in to Operations Professional registration based on such eligible registration.17
      Member firms must identify those persons required to register as an Operations Professional as of October 17, 2011 (Day-One Professionals) (i.e., persons who meet the depth of personnel criteria and are engaged in one or more covered functions as of the effective date of the rule). Day-One Professionals are required to register on or before December 16, 2011 (i.e., a 60-day identification period beginning on the effective date of the rule, during which Day-One Professionals must request registration as an Operations Professional via Form U4 in the CRD system).18 During this 60-day period, a Day-One Professional may function in the capacity of an Operations Professional. Day-One Professionals who are identified during the 60-day period and must pass the Operations Professional examination (or an eligible qualification examination) to qualify (i.e., persons who do not hold, and have not within the past two years held, an eligible registration) must pass such examination on or before October 17, 2012 (i.e., a period of 12 months beginning on the effective date of the rule, during which time such persons may function as an Operations Professional).19

      To be eligible to function as an Operations Professional for the 12-month transition period, Day-One Professionals subject to an examination requirement must request Operations Professional registration via Form U4 in the CRD system on or before December 16, 2011.20 If a Day-One Professional does not pass an acceptable examination on or before October 17, 2012, the individual must cease functioning as an Operations Professional on October 17, 2012.

      The 60-day identification period and the 12-month transition period to pass a qualification examination only apply to Day-One Professionals. Any person who is not subject to the registration requirements for Operations Professionals as of October 17, 2011 (i.e., a person who does not meet the depth of personnel criteria and/or is not engaged in one or more covered functions as of the effective date, or persons hired after October 17, 2011, who will be subject to the registration requirements) (non-Day-One Professionals) must register as an Operations Professional and, if applicable, pass the Operations Professional qualification examination (or an eligible qualification examination), prior to engaging in any activities that require such registration. However, any such person who must pass the Operations Professional qualification examination (or an eligible qualification examination listed in Section D) to qualify for Operations Professional registration shall be allowed a period of 120 days beginning on the date such person requests Operations Professional registration via Form U4 in the CRD system to pass such qualifying examination, during which time such person may function as an Operations Professional.

      Member firms are responsible for tracking and monitoring their associated persons to ensure that they are registered, and conducting their activities, in compliance with the time frames described above.
      II. FINRA Continuing Education Rule

      NASD Rule 1120 (Continuing Education Requirements) has been adopted as new FINRA Rule 1250 (Continuing Education Requirements). In addition to the change noted in Section E, which expands the scope of "covered registered persons" subject to the Firm Element Continuing Education requirement to include persons registered as Operations Professionals, FINRA made additional minor changes to NASD Rule 1120 to update cross-references and reflect the conventions of the Consolidated FINRA Rulebook.

      NASD Rule 1120 and Incorporated NYSE Rule 345A were adopted in 1995 in response to the recommendation of a task force, which subsequently became the Securities Industry Regulatory Council on Continuing Education (Council),21 to create uniform continuing education requirements in the securities industry. As advised by the Council, the continuing education requirements include a Regulatory Element Program and a Firm Element Program. NASD and Incorporated NYSE rules are nearly identical in keeping with the goals of the Council to create uniform continuing education requirements.22

      The Regulatory Element Program consists of periodic computer-based training on regulatory, compliance, ethical, supervisory subjects and sales practice standards. A registered person is required to participate and complete a designated Regulatory Element Program within a 120-day period that commences with the second anniversary of such person's initial securities registration, and recurs every three years thereafter for as long as such person remains in the securities business. Failure to complete the Regulatory Element Program will result in a registered person's registration becoming inactive and such person cannot conduct a securities business on behalf of the member firm until the requirement is met.23

      The Firm Element Continuing Education requirement currently applies to any person registered with a member firm who has 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 NASD Rule 1050, and to the immediate supervisors of such persons (collectively, covered registered persons). However, as noted above, the scope of "covered registered persons" subject to the Firm Element requirement has been expanded to include persons registered as Operations Professionals. The Firm Element Program consists of annual, firm-developed and administered training programs designed to keep covered registered persons current regarding securities products, services and strategies offered by the member firm. The Firm Element Program requires member firms to annually evaluate and prioritize their training needs by conducting a Needs Analysis and developing a written plan.

      In planning, developing and implementing the Firm Element Program, each member firm must take into consideration its size, organizational structure, scope of business, types of products and services it offers, as well as regulatory developments and the performance of its covered registered persons in the Regulatory Element Program. FINRA may require a member firm to provide specific training to its covered registered persons as FINRA deems appropriate. Each member firm must administer its Firm Element Program in accordance with its annual Needs Analysis and Written Plan, and must maintain records documenting the content of the program and completion of the program by covered registered persons.
      III. Effective Date

      FINRA Rule 1230(b)(6) and FINRA Rule 1250 take effect on October 17, 2011. FINRA reminds member firms that Day-One Professionals must request Operations Professional registration via Form U4 in the CRD system on or before December 16, 2011 (i.e., 60 days following the effective date of FINRA Rule 1230(b)(6)). Those Day-One Professionals must then pass any necessary examination on or before October 17, 2012.

      1 See Securities Exchange Act Release No. 64687 (June 16, 2011), 76 FR 36586 (June 22, 2011) (Order Approving Proposed Rule Change; File No. SR-FINRA-2011-013).

      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 FINRA Rule 1250 replaces NASD Rule 1120. Accordingly, effective October 17, 2011, NASD Rule 1120 will be deleted from the Transitional Rulebook.

      4 The remainder of FINRA Rule 1230 (Registration Categories) is being addressed as part of a separate rule proposal. See Regulatory Notice 09-70 (December 2009) (FINRA Requests Comment on Proposed Consolidated FINRA Rules Governing Registration and Qualification Requirements).

      5 See Notice to Members 05-48 (July 2005) (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."

      6 Persons engaged in or supervising stock loan/securities lending activities that meet the depth of personnel as a covered person in Section A are required to register as Operations Professionals. FINRA also is proposing separate registration categories for a "Securities Lending Representative" and a "Securities Lending Supervisor." In Regulatory Notice 09-70, FINRA generally proposes to adopt the NYSE registration requirements for Securities Lending Representatives and Securities Lending Supervisors, requiring an associated person who has discretion to commit a member to any contract or agreement (written or oral) involving securities lending or borrowing activities with any other person, and the direct supervisor of the associated person to register as a Securities Lending Representative and Securities Lending Supervisor, respectively. These individuals would be required to register as such for tracking and oversight purposes, regardless of whether they are registered in other categories. However, solely for purposes of registering as a Securities Lending Representative or Securities Lending Supervisor, an individual will not be subject to a qualification examination at this time.

      7 The SEC recently approved new FINRA Rule 4311, which becomes effective on August 1, 2011. See Regulatory Notice 11-26.

      8 FINRA will issue a separate Regulatory Notice addressing the initial rollout of the Series 99 examination, the examination content outline and the fee associated with the examination.

      9 Any individual whose activities go beyond those for the Operations Professional registration category is required to separately qualify and register in the appropriate category or categories of registration attendant to such activities.

      10 FINRA notes that NASD Rule 1070 (Qualification Examinations and Waiver of Requirements), as well as other applicable provisions regarding registration and qualification set forth in FINRA's rulebook, such as NASD Rule 1031(c) regarding requirements for examination on apse of registration, applies to the Operations Professional qualification examination and registration category.

      11 A person who qualifies for the exception based on having held an eligible registration within the two years immediately priorto registering as an Operations Professional must first re-activate such eligible registration priorto requesting Operations Professional registration.

      12 CRD is a registered trademark of the Financial Industry Regulatory Authority, Inc.

      13 If a person's registration in an eligible registration category was revoked within the prior two years, but such person re-qualifies and re-registers in such eligible registration category, he or she may rely on this eligible registration to qualify for the exception to the Operations Professional qualification examination requirement. Further, a suspended registration may not be relied upon as an eligible registration during the suspension period. Similarly, a registration deemed inactive for any reason (e.g., failure to complete continuing education requirements) may not be relied upon as an eligible registration during the inactive period. See also FINRA Rule 8311 (Effect of a Suspension, Revocation, Cancellation, or Bar).

      14 See Section II for further discussion of the adoption of NASD Rule 1120 (Continuing Education Requirements) as FINRA Rule 1250.

      15 NASD Rule 1120(b) (Continuing Education Requirements) is currently 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 NASD Rule 1050, and to the immediate supervisors of such persons. The amendments are reflected in the new FINRA rule governing continuing education, FINRA Rule 1250. See Section II of this Notice.

      16 Persons with an active eligible registration who request Operations Professional registration will be automatically granted Operations Professional registration once they submit the request via Form U4 in the CRD system, regardless of when they apply for Operations Professional registration (provided there are no existing deficiencies). See also supra note 11.

      17 If a person elects to register with FINRA as an Operations Professional by newly qualifying in an eligible registration (i.e., the person wants to obtain an eligible registration and use the registration to qualify for Operations Professional registration), the individual must first submit a Form U4 to request the eligible registration. After the candidate has passed the qualification examination associated with the eligible registration, the individual may then submit an amended Form U4 to request the Operations Professional registration.

      18 FINRA believes that the current Web-based Electronic File Transfer (Web EFT) functionality will enable subscribers to efficiently request Operations Professional registration via batch file uploads to the CRD system.

      19 When a person requests Operations Professional registration via Form U4 in the CRD system during the 60-day identification period, an examination window for the Operations Professional qualification examination will open in the CRD system that expires on October 17, 2012. After the 60-day identification period, the examination window for the Operations Professional qualification examination will open for the standard 120 days.

      20 Member firms should note that the standard examination window in the CRD system applicable to a particular registration category will apply not with standing the 12-month examination window established for purposes of the transition period. The 12-month examination window is only for the Operations Professional qualification examination. Thus, a person who elects to qualify, for example, by passing the Series 7 examination would have only 120 days to take and pass the Series 7 examination once the window for such examination is opened in the CRD system. Member firms should plan accordingly so that associated persons are prepared to take the requisite examination within the prescribed window for that registration category, and that the associated persons pass any requisite examination before the expiration of the 12-month transition period for Day-One Professionals.

      21 The Council is comprised of up to 20 industry members from broker-dealers, representing a broad cross section of industry firms, and representatives from self-regulatory organizations (SROs) as well as liaisons from the SEC and the North American Securities Administrators Association (NASAA).

      22 FINRA expects to address Incorporated NYSE Rule 345A (and its Interpretation) and propose additional changes to FINRA Rule 1250 as part of the consolidated registration and qualification rules. See Regulatory Notice 09-70 (December 2009).

      23 A registered person will be required to retake the Regulatory Element Program in the event such person is: (1) subject to a statutory disqualification as defined by Section 3(a)(39) of the Exchange Act; (2) subject to a suspension or imposition of a fine of $5,000 or more by an SRO or other securities governmental agency; or (3) ordered to do so as a sanction in a disciplinary action by an SRO or other securities governmental agency.

    • 11-32 FINRA Provides Additional Guidance Regarding Reporting Requirements Under Rule 4530

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      Reporting Requirements

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4530
      Incorporated NYSE Rule 351
      NASD Rule 3070
      Regulatory Notice 08-70
      Regulatory Notice 10-39
      Regulatory Notice 11-06
      Regulatory Notice 11-10
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Customer Complaints
      Financial-Related Insurance Matters
      Former Associated Persons
      Internal Conclusions
      Reporting Requirements

      Executive Summary

      In February 2011, FINRA issued Regulatory Notice 11-06 informing member firms of SEC approval of new FINRA Rule 4530 governing reporting requirements. FINRA Rule 4530 became effective on July 1, 2011. In March 2011, FINRA issued Regulatory Notice 11-10 reminding member firms of their obligation to electronically report specified events and quarterly customer complaint information and providing further guidance on automated reporting under the new rule. In this Notice, FINRA is providing questions and answers regarding the application of the new rule to assist member firms in their implementation.

      Questions regarding this Notice should be directed to Afshin Atabaki, Assistant General Counsel, Office of General Counsel, at (202) 728-8902.

      Background & Discussion

      FINRA Rule 4530 requires member firms to:

      1. report to FINRA certain specified events and quarterly statistical and summary information regarding written customer complaints; and
      2. file with FINRA copies of certain criminal actions, civil complaints and arbitration claims.

      FINRA uses the information for regulatory purposes to identify and initiate investigations of member firms, offices and associated persons that may pose a risk. The requirements of FINRA Rule 4530 are based on similar requirements in NASD Rule 3070 and Incorporated NYSE Rule 351. FINRA Rule 4530 strengthens, clarifies and extends these existing requirements. Among other things, the new rule requires member firms to report certain internal conclusions of violations and financial-related insurance civil litigations and arbitrations and clarifies the obligations of member firms with respect to written customer complaints and former associated persons.

      Questions and Answers

      To help member firms implement FINRA Rule 4530, FINRA is publishing the following questions and answers relating to its application. This guidance speaks solely to member firms' reporting obligations pursuant to FINRA Rule 4530, and not to other applicable reporting requirements, including under Forms BD (Uniform Application for Broker-Dealer Registration), U4 (Uniform Application for Securities Industry Registration or Transfer) and U5 (Uniform Termination Notice for Securities Industry Registration). FINRA, however, notes that a member firm is not required to report an event otherwise required to be reported under FINRA Rules 4530(a) or (b) if the member firm discloses the event on the Form U5, consistent with the requirements of that form.1

      Internal Conclusions of Violations

      Q1. Are member firms required to report internal conclusions of all rule violations under FINRA Rule 4530(b)?
      A1. No. FINRA Rule 4530(b) states that each member firm shall promptly report to FINRA, but in any event not later than 30 calendar days, after the firm has concluded or reasonably should have concluded that an associated person of the firm or the firm itself has violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or self-regulatory organization (SRO).

      Further, for purposes of FINRA Rule 4530(b), only those violations that meet the reporting threshold under FINRA Rule 4530.01 are required to be reported. With respect to violations by a firm, FINRA Rule 4530.01 requires the firm to report only conduct that has widespread or potential widespread impact to the firm, its customers or the markets, or conduct that arises from a material failure of the firm's systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts. Regarding violations by an associated person, FINRA Rule 4530.01 requires a firm to report only conduct that has widespread or potential widespread impact to the firm, its customers or the markets; conduct that has a significant monetary result on a member firm(s), customer(s) or market(s); or multiple instances of any violative conduct. For instance, if a firm concludes that a violation has occurred and that it has widespread or potential widespread impact to the markets, the firm is required to report that violation.
      Q2. FINRA Rule 4530.01 requires a member firm to report, among other things, violations that have widespread or potential widespread impact to the markets. Is the term "markets" referring only to the securities markets?
      A2. No. The term "markets" should be read in the context of the enumerated violations under FINRA Rule 4530(b), which requires a member firm to report violations of any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or SRO. Accordingly, the term "markets" in FINRA Rule 4530.01 refers to any organized market relating to any securities, insurance, commodities, financial or investment product.
      Q3. FINRA Rule 4530.01 requires a member firm to report, among other things, if it concludes that an associated person has engaged in multiple instances of any violative conduct. What does the phrase "multiple instances of any violative conduct" mean?
      A3. It generally means multiple instances of the same violative conduct by an associated person that are not administrative or operational in nature. Among other things, such violations may evidence a pattern of behavior on the part of the associated person. Member firms also are required to report multiple instances of different violative conduct by an associated person where such violations are significant in nature or result in significant customer harm. Additionally, member firms should note that certain disciplinary actions taken by firms against associated persons, such as when an associated person is fined by a member firm in excess of $2,500, must be reported under FINRA Rule 4530(a)(2), rather than as an internal conclusion of violation under FINRA Rule 4530(b).
      Q4. FINRA Rule 4530(b) requires a member firm to report to FINRA within 30 calendar days after the firm has concluded, or reasonably should have concluded, that an enumerated violation has occurred. For purposes of the "reasonably should have concluded" requirement, how will FINRA determine whether a firm's conclusions are correct?
      A4. FINRA will apply a "reasonable person" standard to determine whether a violation should have been reported. If a reasonable person, considering the available facts, would have concluded that a violation occurred, then the matter would be reportable. If a reasonable person, considering the available facts, would not have concluded that a violation occurred or would have been unable to conclude whether a violation occurred, then the matter would not be reportable. Further, FINRA Rule 4530(b) is not intended to hinder a member firm's ability to carry out effective supervision of its associated persons and address issues with appropriate remediation. Consequently, FINRA recognizes that a member firm may take remedial steps with respect to its associated persons where the firm nevertheless reasonably does not determine a violation has occurred. It is also the case that a member firm's determination not to take remedial action in respect of certain conduct is not by itself a basis for asserting a reasonable conclusion that a violation has not occurred, and, where a reasonable person would have determined that a violation has occurred, the firm would potentially be in violation of both FINRA Rule 4530(b) and the firm's duty to reasonably supervise its associated persons.
      Q5. With respect to the reporting of internal conclusions of violations under FINRA Rule 4530(b), what should member firms' procedures address?
      A5. Member firms should review existing procedures and develop any necessary enhancements and review processes to address the requirements of FINRA Rule 4530(b). Some firms may find that their existing procedures are adequate. At a minimum, firms' procedures should:
      (1) clearly identify the person(s) responsible for determining whether a violation has occurred and whether it is of a nature that requires reporting under FINRA Rule 4530(b), as well as the level of seniority of such person(s) (e.g., General Counsel, Chief Compliance Officer or a senior staff committee);
      (2) provide a protocol for escalating violations, and potential violations, to such person(s); and
      (3) provide a protocol regarding the reporting of internal conclusions of violations subject to FINRA Rule 4530(b) to FINRA within 30 calendar days after the firm has concluded, or reasonably should have concluded, that an enumerated violation has occurred.
      Q6. Are member firms eligible to receive credit for extraordinary cooperation for matters that are required to be reported pursuant to FINRA Rule 4530(b)?
      A6. Depending on the facts and circumstances and on a case-by-case basis, FINRA will consider credit for self-reporting of violations that are required to be reported pursuant to the new rule. However, the type of self-reporting contemplated as extraordinary and deserving of credit would have to go significantly beyond the requirements of the rule.2 For credit for self-reporting, it would, at a minimum, have to include a detailed account of the discovered conduct and an offer to explain in complete detail all aspects of the conduct and provide relevant documents and witnesses.3 Furthermore, additional factors to be considered in evaluating credit for cooperation include, but are not limited to: (1) extraordinary steps to correct deficient procedures and systems; (2) extraordinary remediation to customers; and (3) other substantial assistance to FINRA investigations.4

      Customer Complaints

      Q7. Are text messages and tweets received from member firm customers complaining about the member firm or its associated persons subject to reporting under FINRA Rule 4530?
      A7. Yes. FINRA Rule 4530(a)(1)(B) requires that a member firm report within 30 calendar days after the firm knows or should have known5 that it or an associated person is the subject of any written customer complaint alleging theft or misappropriation of funds or securities or forgery. FINRA Rule 4530(d) requires that a member firm also report quarterly statistical and summary information regarding written customer complaints that have been received. Received text messages and tweets are in a written format. Thus, a member firm must report text messages and tweets received from firm customers expressing complaints about the firm or its associated persons consistent with the requirements of FINRA Rules 4530(a)(1)(B) and 4530(d). For example, if a firm customer sends a tweet to the firm alleging that an associated person sold him unsuitable securities, the firm must report it pursuant to FINRA Rule 4530(d).
      Q8. A member firm's registered representative is also an insurance agent working for an affiliated insurance company. The member firm recently found out through its affiliate that the registered representative is the subject of a written complaint from an insurance customer alleging that the representative did not adequately disclose the surrender charge in connection with the sale of a fixed annuity. After further inquiry, the member firm also found out that the representative had recommended some securities to the insurance customer when he sold the fixed annuity, but the individual decided not to purchase any securities. Does the member firm have to report the complaint under FINRA Rule 4530?
      A8. No. For purposes of FINRA Rules 4530(a)(1)(B) and 4530(d), a person with whom a member firm has sought to engage in securities activities is considered a customer of the firm. However, the firm is only required to report any securities-related written grievance by such person under FINRA Rule 4530(d) and any written complaints alleging theft or misappropriation of funds or securities, or forgery involving the firm or an associated person under FINRA Rules 4530(a)(1)(B) and 4530(d).6 Here, for purposes of FINRA Rules 4530(a)(1)(B) and 4530(d), the complainant is considered a customer and there is a written grievance involving the representative, but it is not securities-related as the matter involves a fixed annuity insurance product, and it does not allege theft or misappropriation of funds or securities or forgery.
      Q9. In Question 8 above, what if the person complaining about the fixed annuity was someone to whom the member firm had sold securities? Would the complaint then be subject to reporting under FINRA Rule 4530?
      A9. Yes. If a firm has engaged in securities activities with a person, the firm is required to report any written grievance by such person involving the firm or an associated person under FINRA Rule 4530(d).7
      Q10. A registered representative who is also a mortgage broker recently obtained a home loan for a person to whom the representative had sold securities through a member firm. The mortgage is financed and serviced by an unaffiliated bank. The member firm recently received an email from the person complaining about the bank that services his mortgage account. Is the member firm required to report the complaint under FINRA Rule 4530?
      A10. No. As noted in Answer 9 above, if a firm has engaged in securities activities with a person, the firm is required to report any written grievance by such person involving the firm or an associated person. Here, because the complaint does not involve the firm or registered representative, the firm does not have to report it under FINRA Rule 4530. However, the firm may want to inform the bank of the complaint so that the bank can address it.
      Q11. In Question 10 above, what if the person was complaining that the registered representative made some misleading statements during the loan process? Would it then be subject to reporting under FINRA Rule 4530?
      A11. Yes. It would be subject to reporting under FINRA Rule 4530(d) since it would be a written grievance from a customer of the firm involving an associated person.

      Financial-Related Insurance Civil Litigation

      Q12. During a routine annual branch inspection, a member firm's registered representative informed the firm that he was sued a few days ago by one of his insurance customers in connection with the sale of a term life insurance policy and that the insurance company settled the matter immediately on his behalf for $20,000. The lawsuit alleged common law fraud. Is the member firm required to report the settlement under FINRA Rule 4530?
      A12. Yes. FINRA Rule 4530(a)(1)(G) requires a member firm to report, among other things, if an associated person is a defendant in any financial-related insurance civil litigation that has been settled for an amount exceeding $15,000. The term "financial-related" means related to the provision of financial services.8 The term excludes certain insurance products, such as traditional auto and health insurance. However, its scope is not limited to insurance products that are securities. A term life insurance policy would be considered "financial-related."

      Former Associated Persons9

      Q13. A member firm finds out that a registered representative has been indicted, while in the employ of the member firm, on a misdemeanor charge involving the sale of a stock at his previous employer, Firm A. For purposes of FINRA Rule 4530(a)(1)(E), does the member firm have an obligation to report the indictment or does Firm A have to report it?
      A13. In general, the member firm with which the person is associated at the time an event occurs and becomes subject to reporting is responsible for reporting it to FINRA. Consequently, in this example, the employing member firm is responsible for reporting the indictment when it becomes aware of the matter.10

      Moreover, under FINRA Rule 4530.07, member firms should report an event that is required to be reported under the rule relating to a former associated person if the event involves conduct that occurred while the individual was associated with the firm and the firm becomes aware of the event. Here, because the indictment involves the sale of stock by the registered representative at Firm A (his prior employer), Firm A also should report the indictment if Firm A becomes aware of the action.
      Q14. A member firm receives a customer complaint regarding a former registered representative alleging that the representative churned the customer's account. Is the member firm required to report the complaint under FINRA Rule 4530?
      A14. Yes. Under FINRA Rule 4530.07, where a member firm receives or becomes aware of a customer complaint under FINRA Rules 4530(a)(1)(B) or 4530(d) involving a former associated person and the underlying conduct occurred while the individual was associated with the firm, the firm is expected to report the customer complaint.
      Q15. A member firm is in the process of internally investigating a registered representative's involvement in violative conduct when the representative terminates her association with the firm. Following her departure, the member firm reaches an internal conclusion that the former representative violated several securities laws that had a significant monetary result for customers. Is the member firm required to report the conclusion under FINRA Rule 4530 since it reached the conclusion after the representative left the member firm?
      A15. Yes. Notwithstanding that a firm reaches a conclusion of violation regarding an individual after he or she leaves the firm, the firm remains obligated to report that internal conclusion of violation if it meets the reporting thresholds in FINRA Rule 4530(b).

      1 See FINRA Rule 4530(e). The exception does not extend to the reporting of quarterly statistical and summary complaint information under FINRA Rule 4530(d).

      2 See Regulatory Notice 08-70 (November 2008) (FINRA Provides Guidance Regarding Credit for Extraordinary Cooperation).

      3 See note 2 above.

      4 See note 2 above.

      5 The purpose of the "should have known" standard is to ensure that member firms do not intentionally avoid becoming aware of a reportable event.

      6 See FINRA Rule 4530.08.

      7 See note 6 above.

      8 See FINRA Rule 4530.09.

      9 Firms should note that Form U5 requires them to disclose specified events regarding former associated persons, including certain criminal matters, customer complaints and internal reviews. See also Regulatory Notice 10-39 (September 2010) (Obligation to Provide Timely, Complete and Accurate Information on Form U5). Moreover, as noted above, a firm is not required to report an event otherwise required to be reported under FINRA Rules 4530(a) or (b) if the firm discloses the event on Form U5, consistent with the requirements of that form. See FINRA Rule 4530(e). Consequently, if a member firm discloses the matters described in Questions 13, 14 and 15 on Form U5, that member firm is relieved of the obligation to report the matters under FINRA Rules 4530(a) or (b).

      10 The employing member firm would also have to promptly file with FINRA copies of the indictment pursuant to FINRA Rule 4530(f).

    • 11-31 Interim Pilot Program on Margin Requirements for Credit Default Swaps; Effective Date: July 16, 2011

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      Credit Default Swaps

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 4240
      Suggested Routing

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

      Approved Margin Methodology
      Credit Default Swaps
      Margin Requirements

      Executive Summary

      FINRA Rule 4240 established an interim pilot program (the Interim Pilot Program) with respect to margin requirements for certain transactions in credit default swaps (CDS). This Notice addresses FINRA approval of margin methodologies used by clearing agencies or derivatives clearing organizations for purposes of Rule 4240.

      FINRA has extended the Interim Pilot Program to January 17, 2012.

      The text of FINRA Rule 4240 is available in the online FINRA Manual.

      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, Project Manager, Credit Regulation, at (646) 315-8621; or
      •   Adam H. Arkel, Assistant General Counsel, Office of General Counsel, at (202) 728-6961.

      Background & Discussion

      In May 2009, the SEC approved FINRA Rule 4240, which established the Interim Pilot Program with respect to margin requirements for CDS and addresses related risk monitoring procedures and guidelines.1 FINRA has extended the implementation of Rule 4240 so that the rule will expire on January 17, 2012.2

      FINRA Rule 4240(a), as revised effective July 16, 2011,3 provides in part that the Interim Pilot Program applies with respect to margin requirements for any transactions in CDS executed by a member (regardless of the type of account in which the transaction is booked).4 The rule's scope includes certain transactions that are cleared through a clearing agency or derivatives clearing organization that provides central counterparty clearing services using a margin methodology approved by FINRA as announced in a Regulatory Notice (referred to in the rule as an "approved margin methodology"). Paragraph (c)(1) of the rule addresses margin requirements that apply to CDS cleared through a clearing agency or derivatives clearing organization using such an approved margin methodology.5

      Currently, FINRA has approved the use of the margin methodology of the central counterparty clearing facilities of the Chicago Mercantile Exchange (CME) for purposes of FINRA Rule 4240. Further, FINRA has approved the use of the margin methodology of ICE Trust (ICE) for purposes of the rule on an interim basis, pending further review by FINRA. FINRA will consider margin methodology proposals from other clearing agencies or derivatives clearing organizations that provide central counterparty clearing services,6 and will announce the approval of the use of any such margin methodologies in future Regulatory Notice(s) as appropriate. FINRA expects to consider in the future whether to supersede the Interim Pilot Program with a permanent comprehensive rule governing margin requirements for all swap and security-based swap transactions effected by a member.


      1 See Securities Exchange Act Release No. 59955 (May 22, 2009), 74 FR 25586 (May 28, 2009) (Notice of Approval of Proposed Rule Change; File No. SR-FINRA-2009-012) ("Approval Order"). See also Regulatory Notice 09-30 (June 2009) (Credit Default Swaps).

      2 See SR-FINRA-2011-034.

      3 See note 2.

      4 The rule provides that the term CDS includes any product that is commonly known to the trade as a credit default swap and is a swap or security-based swap as defined pursuant to Section 1a(47) of the Commodity Exchange Act and Section 3(a)(68) of the Securities Exchange Act, respectively, or the joint rules and guidance of the CFTC and the SEC and their staff.

      5 Paragraph (c)(2) of the rule addresses margin requirements that apply to CDS that are cleared on central counterparty clearing facilities that do not use an approved margin methodology or that settle over-the-counter.

      6 See the Approval Order at 74 FR 25589.

    • 11-30 FINRA Revises the Treatment of Non-Margin Eligible Equity Securities and Delays the Effective Date; New Effective Date: October 3, 2011

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      Margin Requirements

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4210
      Regulation T
      Regulatory Notice 11-16
      Suggested Routing

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

      Day Trading
      Good Faith Accounts
      Maintenance Loan Value
      Margin Requirements
      Non-Margin Eligible Equity Securities
      Portfolio Margin Accounts
      Regulation T Margin Accounts

      Executive Summary

      To accommodate systems-related concerns, FINRA is deferring the effective date announced in Regulatory Notice 11-16 for the treatment of non-margin eligible equity securities to October 3, 2011.1 In addition, FINRA is revising a provision regarding the day trading of non-margin eligible equity securities.

      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, Project Manager, Credit Regulation, at (646) 315-8621.

      Background & Discussion

      In April 2011, FINRA issued Regulatory Notice 11-16, which clarified margin requirements for both long and short non-margin eligible equity securities in Regulation T and portfolio margin accounts. The Notice also stated that FINRA would permit firms to extend maintenance loan value on non-margin eligible equity securities when used to collateralize non-purpose loans in good faith accounts.

      With respect to day trading non-margin eligible equity securities, the Notice also clarified that customers may day trade a non-margin eligible equity security, provided the special maintenance margin requirement of 100 percent did not exceed one times the regulatory maintenance excess (equity in the account after the maintenance margin requirement is met). The Notice further provided that a firm must issue a day-trade call if a customer day traded in excess of this limit; if the resulting day-trade call was not satisfied within five business days, a firm would be required to cancel any day-trade transactions of such securities.

      FINRA understands that the requirement to cancel the day-trade transactions may cause operational issues. Therefore, FINRA is revising the cancellation requirement to require that for customers who fail to meet a day-trade call that is issued as a result of the day trading of a non-margin eligible equity security, either as one day trade or as part of several day trades, firms will be required to restrict all day-trading activity for such customers to one times the regulatory maintenance excess for a period of 90 calendar days. Firms must have adequate procedures in place to ensure that customers do not continue to day trade without sufficient funds in their account in violation of such restriction. Firms should also be aware of customers who exhibit day-trading patterns that could potentially be viewed as circumventing the rules governing free riding in the cash account.2

      To allow firms additional time to meet the requirements specified in Regulatory Notice 11-16 and this Notice, FINRA is deferring the effective date to October 3, 2011.


      1. See Regulatory Notice 11-16 (Treatment of Non-Margin Eligible Equity Securities) (April 2011). See also Regulation T section 220.2 for the definitions of margin equity security and margin security.

      2. See FINRA Rule 4210(f)(9).

    • 11-29 Frequently Asked Questions on Market Orders and Delayed Implementation Date for FINRA Rule 5131(b) and (d)(4)

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      New Issue Allocations and Distributions

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules

      FINRA Rule 2010
      FINRA Rule 5130
      FINRA Rule 5131
      NASD Rule 2320
      Regulatory Notice 10-60
      Suggested Routing

      Compliance
      Legal
      Systems
      Trading and Market Making
      Training
      Key Topics

      Allocations
      Initial Public Offerings
      Investment Banking
      Market Orders
      New Issues
      NMS Stocks
      OTC Equity Securities
      Spinning

      Executive Summary

      FINRA Rule 5131 sets forth detailed regulatory requirements for the allocation of new issues.1 This Notice announces a new implementation date of September 26, 2011, for the provisions under Rule 5131 that govern spinning and market orders2 and provides interpretive guidance concerning the acceptance of market orders.

      The text of the rule can be found in the online FINRA Manual.

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

      Background and Discussion

      In Regulatory Notice 10-60, FINRA announced SEC approval of new FINRA Rule 5131 to address abuses in the allocation and distribution of new issues.

      Paragraph (b) of the rule (Spinning) implements a recommendation from the IPO Advisory Committee Report to prohibit spinning—i.e., an underwriter's allocation of IPO shares to directors or executives of investment banking clients in exchange for receipt of investment banking business. Paragraph (d)(4) of the rule (Market Orders) prohibits firms from accepting any 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. The implementation date of both of these provisions has been extended to September 26, 2011. All other provisions of Rule 5131 became effective on May 27, 2011.

      As discussed in Regulatory Notice 10-60, the market orders provision addresses the inherent volatility of a new issue as it commences trading in the public markets, and the potential for a wide variance between the public offering price of the new issue and the price at which trading in the secondary market commences. As a result, investors who place market orders for a new issue 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.

      FINRA has received several interpretive questions concerning the market orders provision and, to facilitate member firm compliance, FINRA staff has set forth the following guidance. For more information on Rule 5131, see rule filing SR-NASD-2003-140.

      Frequently Asked Questions

      Q1: Does the market orders provision of Rule 5131 apply to both OTC Equity Securities and NMS Stocks?
      A1: Yes. The market orders provision of Rule 5131 applies to shares of a "new issue." Rule 5130(i)(9), which is referenced in the definitions of Rule 5131, defines "new issue" to mean "any 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," with enumerated exceptions, and does not restrict its scope to either NMS Stocks or OTC Equity Securities.
      Q2: Rule 5131(d)(4) prohibits the acceptance of market orders 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. What constitutes commencement of trading for the purposes of this provision?
      A2: For the purposes of the market orders provision, the commencement of trading in the secondary market of shares of a new issue that is an NMS Stock would be evidenced by the first trade on the national securities exchange listing the security, as indicated by the dissemination of an opening transaction in the security by that exchange. For OTC Equity Securities, commencement of trading in the secondary market would be evidenced by the first regular way, disseminated trade reported to the OTC Reporting Facility during normal market hours.
      Q3: Does Rule 5131(d)(4) apply to "not held" orders?
      A3: Generally, a "not held" order is an unpriced, discretionary order voluntarily categorized as such by the customer and with respect to which the customer has granted the firm price and time discretion. As such, "not held" orders are not considered "market orders" for the purposes of Rule 5131(d)(4).3
      Q4: Does the prohibition on market orders apply only to inbound customer orders?
      A4: Rule 5131(d)(4) applies to the acceptance of any market order, whether from a customer of the firm, a customer of another broker-dealer or another broker-dealer. However, priced orders, such as limit orders, are not subject to the prohibition.
      Q5: Does the prohibition on market orders extend to proprietary trading?
      A5: As noted above, the market order prohibition applies to the acceptance of any market order, including a proprietary market order from another broker-dealer. Therefore, if a member firm were to route its proprietary market order in a new issue to another member firm, that other firm would be prohibited from accepting the market order. To the extent a firm sends its market order directly to an exchange and such order is not otherwise "accepted" by a firm, it would not be prohibited by this rule.
      Q6. Does a member firm need to reject a market order at the time it is first received, or can the firm reject an order previously accepted as long as it does so prior to executing the order or routing the order to another broker-dealer or an exchange?
      A6. For purposes of compliance with Rule 5131(d)(4), a firm may reject a market order for a new issue at any point within its order management system prior to executing or routing the order. If a firm rejects a previously accepted customer order that is OATS reportable, it must indicate in its OATS report that the firm, not the customer, cancelled the order.

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

      2. See Securities Exchange Act Release No. 64512 (May 18, 2011), 76 FR 29808 (May 23, 2011) (Order Approving File No. SR-FINRA-2011-017).

      3. This does not alter other firm obligations with respect to the handling of customer orders, including "not held" orders (see e.g., FINRA Rule 2010 and NASD Rule 2320).

    • 11-28 FINRA Requests Comment on Amendments to Schedule A of the FINRA By-Laws to Implement an Accounting Support Fee to Fund the Governmental Accounting Standards Board; Comment Period Expires: August 1, 2011

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      GASB Accounting Support Fee

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA By-Laws, Schedule A
      MSRB Rule G-14(b)
      Dodd-Frank Act Section 978
      Securities Act Section 19(g)
      Suggested Routing

      Compliance
      Government Securities
      Institutional
      Legal
      Municipal
      Operations
      Senior Management
      Systems
      Trading
      Key Topics

      Financial Accounting Foundation
      GASB Accounting Support Fee
      Governmental Accounting
      Standards Board
      Municipal Securities Transactions

      Executive Summary

      The Securities and Exchange Commission (SEC) has issued an order requiring FINRA to establish a reasonable annual accounting support fee (GASB Accounting Support Fee) to adequately fund the annual budget of the Governmental Accounting Standards Board (GASB), pursuant to Section 19(g) of the Securities Act of 1933. FINRA requests comment on the proposed amendments to Schedule A of the FINRA By-Laws that would establish this fee, which would be allocated among FINRA member firms based on municipal securities transactions reported to the Municipal Securities Rulemaking Board.

      The text of the proposed amendments is in Attachment A to this Notice.

      Questions concerning this Notice should be directed to Brant K. Brown, Associate General Counsel, Office of General Counsel, at (202) 728-6927.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by August 1, 2011.

      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 filed with the SEC pursuant to Section 19(b) of the Securities Exchange Act of 1934 (SEA).2

      Background and Discussion

      The GASB was established in 1984 by agreement of the Financial Accounting Foundation and ten national associations of state and local government officials as an independent organization that establishes and improves standards of accounting and financial reporting for U.S. state and local governments. The GASB is recognized by governments, the accounting industry and the capital markets as the source for the development and publication of the generally accepted accounting principles (GAAP) for state and local governments.3

      The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) became effective on July 21, 2010.4 As added by Section 978 of the Dodd-Frank Act, Section 19(g) of the Securities Act of 1933 (Securities Act) gives the SEC the authority to require a national securities association to establish a reasonable annual accounting support fee to adequately fund the annual budget of the GASB and to draft the rules and procedures necessary to equitably assess the GASB Accounting Support Fee on the member firms.5 On May 11, 2011, the SEC exercised this authority and issued an order requiring FINRA to establish such a fee to provide for an independent and more reliable funding mechanism for the GASB.6

      FINRA is requesting comment on proposed new Section 14 (Accounting Support Fee for Governmental Accounting Standards Board) under Schedule A to the FINRA By-Laws to implement the GASB Accounting Support Fee. FINRA believes that assessing the GASB Accounting Support Fee on a transaction-based basis would be the most equitable and efficient method to assess the fee. Consequently, under proposed Section 14, the GASB Accounting Support Fee would be allocated among FINRA member firms based on municipal securities transactions reported to the Municipal Securities Rulemaking Board (MSRB). Specifically, each calendar quarter, each member firm would be required to pay an assessment to FINRA of its portion of one quarter of the annual GASB Accounting Support Fee amount that reflects the firm's portion of the total par value of municipal securities sales reported by FINRA members to the MSRB under MSRB Rule G-14(b)7 in the previous calendar quarter. Thus, for example, if GASB's recoverable annual budgeted expenses for a given year were $10 million, FINRA would collect $2.5 million from its member firms each quarter.8 Each firm's fee would be based on the firm's portion of municipal securities transactions (based on the par value of reported transactions, not their price) reported by FINRA members to the MSRB in the previous calendar quarter.9 Firms with a quarterly assessment of less than $25 would not be charged the fee for that quarter, and any amounts originally assessed to those firms would be reallocated among the firms with an assessment that quarter of $25 or more.

      As required by Section 19(g) of the Securities Act, any GASB Accounting Support Fees collected by FINRA would be remitted to the Financial Accounting Foundation10 and used to support the efforts of the GASB to establish standards of financial accounting and reporting applicable to state and local governments.11 Collection of the GASB Accounting Support Fee would not allow the SEC or FINRA to have any direct or indirect oversight of the budget or technical agenda of the GASB or to affect the setting of GAAP by the GASB.12

      Because some firms may seek to pass the GASB Accounting Support Fee on to customers engaged in municipal securities transactions, FINRA proposes to publish a Regulatory Notice each year disclosing the total annual GASB Accounting Support Fee FINRA will collect for that year. In this annual Notice, FINRA also anticipates setting out the estimated fee rate based on the GASB's recoverable annual budgeted expenses for that year and historical municipal security trade reporting volumes so that firms will have some basis on which to establish a fee, should they choose to do so. Any firms choosing to pass along the fee, however, would be reminded of the need for proper disclosure of the GASB Accounting Support Fee, including, if applicable, the fact that the fee is an estimate and that the firm ultimately may pay more or less than the fee charged to the customer. In addition, any disclosure used by the firm cannot be misleading and must comport with FINRA rules, including just and equitable principles of trade, as well as any applicable MSRB rules.

      Request for Comment

      FINRA is requesting comment on proposed new Section 14 (Accounting Support Fee for Governmental Accounting Standards Board) under Schedule A to the FINRA By-Laws. FINRA welcomes comments on its proposed methodology for assessing the GASB Accounting Supporting Fee as discussed in this Notice. The comment period expires on August 1, 2011.


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

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

      3 The GASB is not a government entity. It is an operating component of the Financial Accounting Foundation, which is a private-sector, not-for-profit entity. Funding for the GASB comes in part from sales of its own publications and in part from state and local governments and the municipal bond community. Its standards are not federal laws or regulations, and the GASB does not have enforcement authority. See Facts About GASB.

      4 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).

      5 See 15 U.S.C. 77s. For purposes of the GASB Accounting Support Fee, the annual budget of the GASB is the annual budget reviewed and approved according to the internal procedures of the Financial Accounting Foundation. See 15 U.S.C. 77s(g)(2). FINRA anticipates that the GASB's annual budget will include an administrative fee to FINRA of $50,000. The administrative fee is intended to cover FINRA's costs associated with calculating, assessing, and collecting the GASB Accounting Support Fee and was negotiated with the Financial Accounting Foundation.

      6 See Securities Exchange Act Release No. 64462 (May 11, 2011), 76 FR 28247 (May 16, 2011).

      7 MSRB Rule G-14(b) sets out municipal securities transaction reporting requirements.

      8 Section 19(g)(4) of the Securities Act, as added by the Dodd-Frank Act, prohibits FINRA from collecting GASB Accounting Support Fees for a fiscal year in excess of GASB's recoverable annual budgeted expenses. See 15 U.S.C. 77s(g)(4). Because a transaction-based fee is inherently unpredictable and variable, and because FINRA would be statutorily prohibited from collecting amounts in excess of GASB's recoverable annual budgeted expenses, FINRA is proposing a quarterly assessment based on GASB's budget.

      9 Thus, if a member firm does not engage in reportable municipal securities transactions, it would not be subject to the GASB Accounting Support Fee.

      10 See 15 U.S.C. 77s(g)(1).

      11 See 15 U.S.C. 77s(g)(3).

      12 See 15 U.S.C. 77s(g)(B).


      ATTACHMENT A

      The following is the text of the proposed amendments to Schedule A to the FINRA By-Laws. New text is underlined.

      * * * * *

      SCHEDULE A TO THE BY-LAWS OF THE CORPORATION

      * * * * *

      Section 14—Accounting Support Fee for Governmental Accounting Standards Board

      (a) FINRA shall, in accordance with this Section, allocate, assess, and collect a GASB Accounting Support Fee to fund the annual budget of the Governmental Accounting Standards Board. The GASB Accounting Support Fee is based on the recoverable annual budgeted expenses provided to FINRA by the Governmental Accounting Standards Board, and amounts collected under this Section shall be remitted to the Financial Accounting Foundation.
      (b) Except as provided in paragraph (c), each calendar quarter, each member shall pay an assessment to FINRA of its portion of one quarter of the annual GASB Accounting Support Fee amount that reflects the member's portion of the total par value of municipal securities sales reported by members to the Municipal Securities Rulemaking Board under MSRB Rule G-14(b) in the previous calendar quarter.
      (c) If, in a given calendar quarter, a member's GASB Accounting Support Fee amount is less than $25, the member will not be assessed a GASB Accounting Support Fee for that quarter. The amount not assessed to the member will be reallocated among the other members assessed a GASB Accounting Support Fee for that quarter based on each member's portion of the total par value of municipal securities sales reported by members to the Municipal Securities Rulemaking Board under MSRB Rule G-14(b) in the previous calendar quarter.

    • 11-27 SEC Approves Increase in the TAF Rate for Sales of Covered Equity Securities; Effective Date: July 1, 2011

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      Trading Activity Fee (TAF)

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA By-Laws, Schedule A, § 1(a)
      Regulatory Notice 10-56
      Regulatory Notice 09-68
      NTM 04-84
      Suggested Routing

      Compliance
      Finance
      Internal Audit
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Key Topics

      Trading Activity Fee

      Executive Summary

      Effective July 1, 2011, the Trading Activity Fee (TAF) rate for sales of covered equity securities will increase from $0.000075 per share for each sale of a covered equity security to $0.000090 per share, with a corresponding increase to the per-transaction cap for covered equity securities from $3.75 to $4.50.1 The new rate will apply to any sale of a covered equity security subject to the TAF occurring on or after July 1, 2011.

      The text of the new rule is available in the online FINRA Manual.

      Questions regarding this Notice should be directed to:

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

      Background & Discussion

      FINRA's primary member regulatory pricing structure consists of the following fees: the Personnel Assessment (PA), Gross Income Assessment (GIA) and Trading Activity Fee (TAF). These fees are used to fund FINRA's regulatory activities, including examinations; financial monitoring; and FINRA's policymaking, rulemaking and enforcement activities.2

      Because the proceeds from these fees are used to fund FINRA's regulatory mandate, Section 1 of Schedule A to FINRA's By-Laws notes that "FINRA shall periodically review these revenues in conjunction with these costs to determine the applicable rate."3 Although FINRA recently restructured both the GIA and the PA,4 the current TAF rate for covered equity securities of $0.000075 per share has been in place for over six years.5 As a result of the recent decrease in trading volumes in the equity markets, an increase in the TAF rate is now necessary to ensure that FINRA can continue to maintain a robust regulatory program and meet its regulatory obligations effectively, while attempting to remain revenue neutral.

      Accordingly, to stabilize revenue flows necessary to support FINRA's regulatory mission, the SEC approved an increase to the TAF rate for sales of covered equity securities. Effective July 1, 2011, the TAF rate for sales of covered equity securities will increase from $0.000075 per share to $0.000090 per share, with a corresponding increase to the per-transaction cap for covered equity securities from $3.75 to $4.50. The new rate will apply to any sale of a covered equity security subject to the TAF occurring on or after July 1, 2011. The TAF Self-Reporting Form available on FINRA's website6 will reflect this new rate beginning with TAF Self-Reporting Forms due on August 12, 2011,7 which reflect trades subject to the TAF occurring in July 2011.


      1 See Securities Exchange Act Release No. 64590 (June 2, 2011).

      2 See FINRA By-Laws, Schedule A, § 1(a).

      3 Id.

      4 See Securities Exchange Act Release No. 61042 (November 20, 2009), 74 FR 62616 (November 30, 2009); see also Regulatory Notice 09-68 (November 2009).

      5 See Securities Exchange Act Release No. 50485 (October 1, 2004), 69 FR 60445 (October 8, 2004); NTM 04-84 (November 2004).

      6 See www.finra.org/taf. This Web page provides firms with additional guidance on the TAF, including Frequently Asked Questions (FAQ) and applicable forms. See Regulatory Notice 10-56 (October 2010).

      7 The TAF is self-reported by firms on a monthly basis. See TAF FAQ 100.5. TAF Self-Reporting Forms should be submitted to FINRA by the tenth business day following the end of the month. See TAF FAQ 100.7.

    • 11-26 SEC Approves Consolidated Financial Responsibility and Related Operational Rules; Effective Date: August 1, 2011

      View PDF

      Financial Responsibility

      Regulatory Notice
      Notice Type

      Consolidated Rulebook
      New Rules
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topics

      Capital Compliance
      Financial Responsibility
      Operational Rules
      Referenced Rules & Notices

      FINRA Rule 4150
      FINRA Rule 4311
      FINRA Rule 4522
      FINRA Rule 4523
      NTM 94-07
      NYSE Information Memo 82-18
      NYSE Rule 322
      NYSE Rule 382
      NYSE Rule 416A
      NYSE Rule 440
      NYSE Rule Interpretations 382/01 through 382/05
      NYSE Rule Interpretation 409(a)/01
      NYSE Rule Interpretation 440.20/01
      NASD Rule 3230
      SEA Rule 15c3-1
      SEA Rule 15c3-3
      SEA Rule 17a-3
      SEA Rule 17a-4
      SEA Rule 17a-13
      Regulatory Notice 08-76
      Regulatory Notice 09-03
      Regulatory Notice 09-71
      Information Notice 03/12/08

      Executive Summary

      The SEC approved FINRA's proposed rule change1 to adopt a set of financial responsibility and related operational rules for the consolidated rulebook (the Consolidated FINRA Rulebook).2 FINRA Rules 4150, 4311, 4522 and 4523 are new consolidated rules governing financial responsibility as well as certain operational and contractual requirements of members. The new rules are based in part on, and replace, provisions in the NYSE and NASD Rules.3

      The text of the new rules is set forth in Attachment A. The questionnaire that FINRA is specifying for use by carrying firms pursuant to new FINRA Rules 4311(b)(3) and 4311.02 is in Attachment B.4

      Questions regarding 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; or
      •   Adam H. Arkel, Assistant General Counsel, Office of General Counsel, at (202) 728-6961.

      Background

      New FINRA Rules 4150, 4311, 4522 and 4523, in combination with the consolidated financial responsibility rules that the SEC approved in November 2009,5 enhance FINRA's authority to execute effectively its financial and operational surveillance and examination programs. Consistent with the approach that FINRA discussed in SR-FINRA-2008-067 and Regulatory Notice 09-71, many of the requirements set forth in the new rules are substantially the same as requirements found in current rules and, where appropriate, are tiered to apply only to carrying or clearing firms, or to firms that engage in certain specified activities.6 Certain provisions of the rules are new for FINRA members that are not Dual Members (non-NYSE members). Certain other provisions are new for both Dual Members and non-NYSE members alike.

      Discussion

      A. FINRA Rule 4150 (Guarantees by, or Flow Through Benefits for, Members)

      FINRA Rule 4150(a), based in large part on NYSE Rule 322,7 requires that prior written notice be given to FINRA whenever a member guarantees, endorses or assumes, directly or indirectly, the obligations8 or liabilities of another person (including an entity).9 Paragraph (b) of the rule requires that prior written approval must be obtained from FINRA whenever any member receives flow through capital benefits in accordance with Appendix C of SEA Rule 15c3-1. Details of the rule's notice and prior approval requirements are included in Supplementary Material to the new rule (FINRA Rule 4150.01).

      FINRA Rule 4150.02 provides that a member may at any time (i.e., not just within the context of the prior written notice that the member provides or the prior written approval that the member seeks to obtain pursuant to the rule) be required to provide FINRA with information with respect to the arrangement, relationship and dealings with a person referred to in the rule.

      FINRA Rule 4150.03 prohibits any member from entering into an arrangement described in the rule unless the member has the authority to make available promptly the books and records of the other person for inspection by FINRA in the United States. The rule provides that the books and records of the other person must be kept separately from those of the member.

      With respect to persons referred to in the rule that are registered broker-dealers, FINRA Rule 4150.04 requires that the member furnish to FINRA copies of the person's FOCUS Reports simultaneous with their being filed with the person's designated examining authority (DEA). FINRA expects that members shall furnish the person's FOCUS Reports to FINRA on an ongoing basis (the member need not furnish the person's FOCUS Reports to FINRA if FINRA is the person's DEA). For persons that are not registered broker-dealers, the rule requires, in lieu of FOCUS Reports, submission of financial and operational statements, in such format and at such time periods as FINRA may require, sufficient to gauge the capital and operational effects of the arrangement or relationship on the member.

      FINRA Rule 4150.05 provides that guarantees executed routinely in the normal course of business, such as trade guarantees, signature guarantees, endorsement of securities and the writing of options, are not subject to the requirements of the rule provided that, in regard to the guarantee of the writing of options, the transaction is appropriately recorded on the member's books and records in accordance with SEA Rule 17a-3(a)(10) and is reflected in its net capital computation pursuant to SEA Rule 15c3-1.

      FINRA Rule 4150.06 provides that, within 30 days of the implementation date of the rule (i.e., by August 31, 2011), each member must advise FINRA, in writing, of any guarantees, endorsements, assumptions of obligations/liabilities, or flow through capital benefits, in effect as of August 1, 2011 not having otherwise been reported, in writing, to the member's Regulatory Coordinator at FINRA.
      B. FINRA Rule 4311 (Carrying Agreements)

      New FINRA Rule 4311 is based on NASD Rule 3230 and NYSE Rule 382 (including NYSE Rule Interpretations 382/01 through 382/05 and 409(a)/01). The new rule governs the requirements applicable to members when entering into agreements for the carrying of any customer accounts in which securities transactions can be effected. Historically, the purpose of the NASD and NYSE rules upon which new FINRA Rule 4311 is based has been to ensure that certain functions and responsibilities are clearly allocated to either the introducing or carrying firm, consistent with the requirements of the SRO's and SEC's financial responsibility and other rules and regulations, as applicable.10 The new rule continues to serve that same purpose and, accordingly, contains many requirements that are substantially unchanged from NASD Rule 3230 and NYSE Rule 382. New FINRA Rule 4311 also codifies certain provisions that are new for non-NYSE members, or are new for both Dual Members and non-NYSE members alike. Following is a summary of the major provisions of the new rule.

      FINRA Rule 4311(a)(1) prohibits a member, unless otherwise permitted by FINRA, from entering into an agreement for the carrying, on an omnibus or fully disclosed basis, of any customer account in which securities transactions can be effected (for purposes of Rule 4311, "customer account" or "account"), unless the agreement is with a carrying firm that is a FINRA member.11 This is a new requirement for all members; however, the vast majority of carrying firms in the United States are FINRA members. New FINRA Rule 4311(a)(1) also includes a provision requiring that when an introducing firm acts as an intermediary for another introducing firm or firms (so-called "piggyback" or "intermediary clearing arrangements") for the purpose of obtaining clearing services from the carrying firm, the introducing firm must notify the carrying firm of the existence of the arrangement(s) with the other introducing firm(s) and disclose the identity of the firm(s). Based in large part on NYSE Rule Interpretation 382/05, the new rule further requires that each carrying agreement identify and bind every direct and indirect recipient of clearing services as a party to the agreement.

      FINRA Rule 4311(b)(1), consistent with the requirements of NASD Rule 3230(e) and NYSE Rule 382(a), requires that the carrying firm submit to FINRA for prior approval any agreement for the carrying of accounts, whether on an omnibus or fully disclosed basis, before the agreement may become effective. The rule also provides that the carrying firm must also submit to FINRA for prior approval any material changes to an approved carrying agreement before the changes may become effective.12 The rule codifies the practice under NASD Rule 3230 of permitting use of pre-approved standardized forms of agreement, with the exception of agreements with parties that are not U.S.-registered broker-dealers. The rule requires a carrying firm to submit separately to FINRA for approval each carrying agreement with a non-U.S.-registered broker-dealer.13 This is a new requirement for non-NYSE members.

      FINRA Rule 4311(b)(3) codifies the current practice under NYSE Rule 382 of requiring that as early as possible, but not later than 10 business days, prior to the carrying of any accounts of a new introducing firm (including the accounts of any piggyback or intermediary introducing firm(s)), the carrying firm must submit to FINRA a notice identifying each such introducing firm by name and CRD number and include such additional information as FINRA may require.14 This is a new requirement for non-NYSE carrying members, and permits FINRA to obtain additional information that enables it to evaluate the impact of the new carrying arrangement on the financial and operational condition of the member.

      FINRA Rule 4311(b)(4) expressly requires each carrying firm to conduct appropriate due diligence with respect to any new introducing firm relationship. Such due diligence is expected to be conducted prior to the commencement of the relationship. The rule provides that such due diligence must assess the financial, operational, credit and reputational risk that such arrangement will have upon the carrying firm.15 The rule provides that FINRA, in its review of any arrangement, may in its discretion require specific items to be addressed by the carrying firm as part of the firm's due diligence requirement under the rule. The rule further provides that the carrying firm must maintain a record, in accord with the time frames prescribed by SEA Rule 17a-4(b), of the due diligence conducted for each new introducing firm.

      FINRA Rule 4311(c)(1), based in part on NASD Rule 3230(a) and NYSE Rule 382(b), requires that each carrying agreement in which accounts are to be carried on a fully disclosed basis specify the responsibilities of each party to the agreement, including at a minimum the allocation of responsibilities set forth in paragraphs (c)(1)(A) through (c)(1)(I) and (c)(2) of the rule. Under federal securities regulations, the carrying firm is responsible for the safeguarding of the funds and securities held in the accounts that it carries. Consistent therewith, FINRA Rule 4311(c)(2) requires that each carrying agreement in which accounts are to be carried on a fully disclosed basis must expressly allocate to the carrying firm the responsibility for the safeguarding of funds and securities for the purposes of SEA Rule 15c3-3. Further, because FINRA believes that it is important to ensure the accuracy and integrity of customer account statements, FINRA Rule 4311(c)(2) requires that each carrying agreement in which accounts are to be carried on a fully disclosed basis must expressly allocate to the carrying firm the responsibility for preparing and transmitting statements of account to customers. The rule provides that the carrying firm may authorize the introducing firm to prepare and/or transmit such statements on the carrying firm's behalf with the prior written approval of FINRA.16 FINRA will review the circumstances of each such request and anticipates that such exceptions will be infrequent and may require additional time for review and approval of the carrying agreement than would otherwise be required.

      Based in part on NASD Rule 3230(g), NYSE Rule 382(c) and NYSE Rule Interpretation 382/03, FINRA Rule 4311(d) requires that each customer whose account is introduced on a fully disclosed basis must be notified in writing upon the opening of the account of the existence of the carrying agreement and the responsibilities allocated to each respective party. The carrying firm is responsible for the content of the notification to the customer. Further, the rule provides that the customer must be notified promptly and in writing in the event of any change to any of the parties to the agreement or any material change to the allocation of responsibilities thereunder. Supplementary Material to the rule (FINRA Rule 4311.05) provides that, for purposes of FINRA Rule 4311(d), notification to customers of a change to any of the parties to the carrying agreement is not required in instances where, consistent with applicable FINRA rules and the federal securities laws, such customers' accounts are being transferred pursuant to:
      a. ACATS using an authorized Transfer Instruction Form (TIF); or
      b. a process outside of ACATS where notification to customers is provided by means of an alternative mechanism such as affirmative or negative response letters.
      Consistent with NYSE Rule Interpretation 382/03, FINRA Rule 4311(e) requires that each carrying agreement expressly state that to the extent a particular responsibility is allocated to one party, the other party or parties will supply to the responsible organization all appropriate data in their possession pertinent to the proper performance and supervision of that responsibility. This is a new requirement for non-NYSE members.

      Based in large part on NASD Rule 3230(d) and NYSE Rule 382(f), FINRA Rule 4311(f) provides that a carrying agreement may authorize an introducing firm to issue negotiable instruments directly to its customers on the carrying firm's behalf, using instruments for which the carrying firm is the maker or drawer, provided that the parties comply with SEA Rule 15c3-3 and further that the introducing firm represents to the carrying firm in writing that the introducing firm maintains, and will enforce, supervisory policies and procedures with respect to such negotiable instruments that are satisfactory to the carrying firm.

      The provisions of FINRA Rule 4311(g)(1) and (h) generally address the obligations of the parties to provide the referenced information, such as any written customer complaints and exception reports, to each other and/or to FINRA and are based upon existing NASD and NYSE rule provisions. (Note that the July 1 deadline set forth in paragraph (h)(2) of the new rule differs from the current requirement (no later than July 31) specified by the corresponding NASD and NYSE rule provisions.) FINRA Rule 4311(g)(2) provides that, upon a showing of good cause, FINRA, at its discretion, may exclude certain carrying firms from the requirements of FINRA Rule 4311(g)(1) in instances where the introducing firm is an affiliated entity of the carrying firm. This provision is based upon NASD Rule 3230(b)(3) but is not contained in NYSE Rule 382.

      FINRA Rule 4311(i) is based largely on NASD Rule 3230(h) and does not have a corresponding provision to NYSE Rule 382. The new rule provides that all carrying agreements must require each introducing firm to maintain its proprietary and customer accounts, and the proprietary and customer accounts of any introducing firm for which it is acting as an intermediary in obtaining clearing services from the carrying firm, in such a manner as to enable the carrying firm and FINRA to specifically identify the proprietary and customer accounts belonging to each introducing firm. Consistent with NASD Rule 3230(h), the requirements of FINRA Rule 4311(i) apply only to intermediary clearing arrangements that are established on or after February 20, 2006 (the date this requirement as set forth in NASD Rule 3230(h) became effective).
      C. FINRA Rule 4522 (Periodic Security Counts, Verifications and Comparisons)

      FINRA Rule 4522(a), based in large part on NYSE Rule 440.10, requires each member that is subject to the requirements of SEA Rule 17a-13 to make the counts, examinations, verifications, comparisons and entries set forth in SEA Rule 17a-13. FINRA Rule 4522(b), again based in large part on NYSE Rule 440.10, requires each carrying or clearing member subject to SEA Rule 17a-13 to make more frequent counts, examinations, verifications, comparisons and entries where prudent business practice would so require. Each such carrying or clearing member is required to receive position statements no less than once per month with respect to securities held by clearing corporations, other organizations or custodians and, at least once per month, reconcile all such securities and money balances by comparison of the clearing corporations' or custodians' position statements to the member's books and records. The carrying or clearing member must promptly report any differences to the contra organization, and both the contra organization and the member firm must promptly resolve the differences. Where there is a higher volume of activity, the rule provides that good business practice may require a more frequent exchange of statements and performance of reconciliations. The rule further requires that no later than seven business days after each security count, the carrying or clearing member must enter any unresolved differences into a "Difference" account for that security count.

      NASD rules do not have a provision that corresponds to NYSE Rule 440.10. Accordingly, the requirements of FINRA Rule 4522(b) are new to non-NYSE carrying or clearing members that are subject to the requirements of SEA Rule 17a-13.17
      D. FINRA Rule 4523 (Assignment of Responsibility for General Ledger Accounts and Identification of Suspense Accounts)

      FINRA Rule 4523, based in large part on NYSE Rule 440.20, is intended to help assure the accuracy of each member's books and records and includes supervisory measures for their implementation. Paragraph (a) of the new rule requires that each member must designate an associated person to be responsible for each general ledger bookkeeping account and account of like function used by the member, and that the associated person must control and oversee entries into each such account and determine that the account is current and accurate as necessary to comply with all applicable FINRA rules and federal securities laws governing books and records and financial responsibility requirements. The rule requires that a supervisor must, as frequently as is necessary considering the function of the account but, in any event, at least monthly, review each account to determine that it is accurate and that any items that are aged or uncertain as to resolution are promptly identified for research and possible transfer to a suspense account(s).

      FINRA Rule 4523(b) requires that each carrying or clearing member must maintain a record of the name of each individual assigned primary and supervisory responsibility for each account as required by paragraph (a) of the rule. All records made pursuant to Rule 4523(b) must be preserved for a period of not less than six years (the period set forth in SEA Rule 17a-4(a)).

      FINRA Rule 4523(c) provides that each member must record, in an account that must be clearly identified as a suspense account, money charges or credits and receipts or deliveries of securities whose ultimate disposition is pending determination. The rule requires that a record be maintained of all information known with respect to each item so recorded. Again, all records made pursuant to FINRA Rule 4523(c) must be preserved for a period of not less than six years (the period set forth in SEA Rule 17a-4(a)).

      Supplementary Material to the new rule (FINRA Rule 4523.01) provides that, for the purposes of paragraphs (a) and (b) of the rule, members with only one associated person may assign primary and supervisory responsibility for each account to that associated person, subject to applicable registration requirements. Further, the Supplementary Material provides that members of limited size and resources that have more than one associated person may seek FINRA's prior written approval to assign primary and supervisory responsibility for each account to the same associated person. Further, for purposes of clarification, FINRA Rule 4523.02 provides that, for purposes of FINRA Rule 4523, all requirements that apply to a member that clears or carries customer accounts shall also apply to any member that, operating pursuant to the exemptive provisions of SEA Rule 15c3-3(k)(2)(i), either clears customer transactions pursuant to such exemptive provisions or holds customer funds in a bank account established thereunder.

      NASD rules do not have a provision that corresponds to NYSE Rule 440.20. Accordingly, the requirements of new FINRA Rule 4523 are new to non-NYSE members.

      1 See Securities Exchange Act Release No. 63999 (March 1, 2011), 76 FR 12380 (March 7, 2011) (Order Granting Approval to Proposed Rule Change; File No. SR-FINRA-2010-061).

      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). For convenience, the Incorporated NYSE Rules are referred to as the NYSE Rules.

      3 Effective August 1, 2011, NYSE Rules 322, 382, 440.10 and 440.20 and NYSE Rule Interpretations 382/01 through 382/05, 409(a)/01 and 440.20/01 and NASD Rule 3230 will be deleted from the Transitional Rulebook.

      4 See note 14 below.

      5 The consolidated financial responsibility rules went into effect on February 8, 2010. See Securities 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). See also Regulatory Notice 09-71 (December 2009) (SEC Approves Consolidated FINRA Rules Governing Financial Responsibility); Regulatory Notice 09-03 (January 2009) (Financial Responsibility and Related Operational Rules).

      6 For purposes of the new rules—like the consolidated financial responsibility rules that went into effect pursuant to SR-FINRA-2008-067—FINRA has specified in the rule text where appropriate that all requirements that apply to a member that clears or carries customer accounts also apply to any member that, operating pursuant to the exemptive provisions of SEA Rule 15c3-3(k)(2)(i), either clears customer transactions pursuant to such exemptive provisions or holds customer funds in a bank account established thereunder. For further background, see 74 FR 58334. See also new FINRA Rule 4523.02 and further discussion in this Notice.

      7 NASD rules do not have a provision that corresponds to NYSE Rule 322. Accordingly, the requirements of new FINRA Rule 4150 are new to non-NYSE members.

      8 The term "obligations" includes financial obligations, as well as other obligations that may have a financial impact on a member, such as performance obligations.

      9 For purposes of the new rules, all references to "persons" include entities.

      10 See, e.g., Notice to Members 94-07 (February 1994) (SEC Approves New NASD Rule Relating to the Obligations and Responsibilities of Introducing and Clearing Firms) and NYSE Information Memo 82-18 (March 1982) (Carrying Agreements — Amendments to Rules 382 and 405).

      11 Because carrying firms generally are FINRA members, FINRA expects requests to enter into carrying agreements with firms that are not FINRA members to be infrequent.

      12 New FINRA Rule 4311.01 includes guidance as to what constitutes a material change for purposes of paragraph (b)(1) of the rule. Specifically, material changes include, but are not limited to, changes to: the allocation of responsibilities required by the rule; termination clauses applicable to the introducing firm; any terms or provisions affecting the liability of the parties; and the parties to the agreement, including, for example, the addition of a new party to the agreement, such as a "piggyback" arrangement, a new carrying firm or a new introducing firm, but not including a termination of the agreement. (However, as explained in Regulatory Notice 08-76 (December 2008) (Reporting Clearing Arrangements), under NYSE Rule 416A carrying firms that are Dual Members are required to update their Firm Clearing Arrangement Form information on an ongoing basis no later than 30 days after the information has changed. FINRA expects to extend this requirement to all carrying firms later as part of the rulebook consolidation process.)

      13 New FINRA Rule 4311(a)(2) expressly permits a carrying firm to enter into a carrying agreement for the carrying of the customer accounts of a person other than a U.S. registered broker or dealer, subject to the conditions set forth in the rule.

      14 FINRA Rule 4311.02 provides that, for purposes of the notice requirement of paragraph (b)(3) of the rule, the carrying firm must submit a questionnaire in such form as to be specified by FINRA, which may be updated from time to time as FINRA deems necessary. (The questionnaire that FINRA is specifying for use by carrying firms pursuant to FINRA Rules 4311(b)(3) and 4311.02 is in Attachment B.)

      15 New FINRA Rule 4311.03 provides that the due diligence may include, without limitation, inquiry by the carrying firm into the introducing firm's business model and product mix, proprietary and customer positions, FOCUS and similar reports, audited financial statements and complaint and disciplinary history.

      16 Supplementary Material (FINRA Rule 4311.04) reminds members that, for purposes of paragraphs (c)(1)(F) and (c)(2) of the new rule, receipt and delivery of customers' funds and securities and the safeguarding of such funds and securities must comply with the requirements of the SEC's financial responsibility rules, in particular SEA Rule 15c3-3, and applicable SEC guidance.

      17 Note that the rule by its terms does not apply to members that are exempt from SEA Rule 17a-13.


      ATTACHMENT A

      Below is the text of new FINRA Rules 4150, 4311, 4522 and 4523.

      * * * * *

      4150. Guarantees by, or Flow Through Benefits for, Members

      (a) Prior written notice shall be given to FINRA whenever any member guarantees, endorses or assumes, directly or indirectly, the obligations or liabilities of another person.
      (b) Prior written approval must be obtained from FINRA whenever any member receives flow through capital benefits in accordance with Appendix C of SEA Rule 15c3-1.

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

      .01 Financial and Operational Impact. The written notice required by paragraph (a) of this Rule shall be given to FINRA at least 10 business days prior to entering into such arrangement or relationship with another person. Both the written notice required by paragraph (a) of this Rule and the request for approval under paragraph (b) of this Rule shall include the address and general nature of business conducted by such person, a description of the relationship or arrangement between the parties, details regarding the capitalization of such person (including the percentage of ownership or profits by the member), as well as the actual and potential effect of the arrangement or relationship on the member's capital (including net capital) and operations and such other information as FINRA may require. A request for approval under paragraph (b) of this Rule shall further include an opinion of counsel where such is required in conformity with Appendix C of SEA Rule 15c3-1.
      .02 Member Dealings. A member may at any time be required to provide FINRA with information with respect to the arrangement, relationship and dealings with a person referred to in this Rule.
      .03 Books and Records. No member shall enter into an arrangement described in this Rule unless it has the authority to make available promptly the books and records of such other person for inspection by FINRA in the United States. The books and records of such person shall be kept separately from those of the member.
      .04 FOCUS Reporting Requirements. For persons referred to in this Rule that are registered broker-dealers, the member shall furnish to FINRA copies of such person's FOCUS Reports simultaneous with their being filed with the person's designated examining authority. For persons referred to in this Rule that are not registered broker-dealers, FINRA requires, in lieu of FOCUS, submission of financial and operational statements, in such format and at such time periods as may be required by FINRA, sufficient to gauge the capital and operational effects of the arrangement or relationship.
      .05 Routine Guarantees. Guarantees executed routinely in the normal course of business such as trade guarantees, signature guarantees, endorsement of securities and the writing of options, are not subject to the requirements of this Rule provided that, in regard to the guarantee of the writing of options, the transaction is appropriately recorded on the member's books and records in accordance with SEA Rule 17a-3(a)(10) and is reflected in its net capital computation pursuant to SEA Rule 15c3-1.
      .06 Guarantees Already in Effect. Within 30 days of August 1, 2011, each member shall advise FINRA, in writing, of any guarantees, endorsements, assumptions of obligations/ liabilities, or flow through capital benefits, in effect as of August 1, 2011 not having otherwise been reported, in writing, to the appropriate Regulatory Coordinator.

      * * * * *

      4311. Carrying Agreements

      (a)
      (1) Unless otherwise permitted by FINRA, a member shall not enter into an agreement for the carrying, on an omnibus or fully disclosed basis, of any customer account in which securities transactions can be effected ("customer account" or "account"), unless such agreement is with a carrying firm that is a FINRA member. An introducing firm that acts as an intermediary for another introducing firm(s) for the purpose of obtaining clearing services from the carrying firm must notify such carrying firm of the existence of such arrangement(s) and the identity of the other introducing firm(s). Each such carrying agreement(s) shall identify and bind every direct and indirect recipient of clearing services as a party thereto.
      (2) A carrying firm may enter into a carrying agreement(s) for the carrying of the customer accounts of a person other than a U.S. registered broker or dealer, subject to the conditions set forth in this Rule.
      (b)
      (1) The carrying firm shall submit to FINRA for prior approval any agreement for the carrying of accounts, whether on an omnibus or fully disclosed basis, before such agreement may become effective. The carrying firm also shall submit to FINRA for prior approval any material changes to an approved carrying agreement before such changes may become effective.
      (2) A carrying firm may use a standardized form of agreement that has been approved by FINRA pursuant to paragraph (b)(1) of this Rule, to enter into new carrying arrangements with other U.S. registered brokers or dealers, without the re-submission and re-approval of such agreement. However, a carrying firm must submit to FINRA for approval each carrying agreement that includes a party that is not a U.S. registered broker or dealer.
      (3) As early as possible, but not later than 10 business days, prior to the carrying of any accounts of a new introducing firm (including the accounts of any introducing firm(s) for which a new or existing introducing firm is acting as an intermediary in obtaining clearing services from the carrying firm) the carrying firm shall submit to FINRA a notice identifying each such introducing firm by name and CRD number and shall include such additional information as FINRA may require.
      (4) Each carrying firm shall conduct appropriate due diligence with respect to any new introducing firm relationship to assess the financial, operational, credit and reputational risk that such arrangement will have upon the carrying firm. FINRA, in its review of any arrangement, may in its discretion require specific items to be addressed by the carrying firm as part of such firm's due diligence requirement under this Rule. The carrying firm shall maintain a record, in accordance with the timeframes prescribed by SEA Rule 17a-4(b), of the due diligence conducted for each new introducing firm.
      (c)
      (1) Each carrying agreement in which accounts are to be carried on a fully disclosed basis shall specify the responsibilities of each party to the agreement, including at a minimum the allocation of the responsibilities set forth in paragraphs (c)(1)(A) through (I) and (c)(2) of this Rule. The allocation of such responsibilities shall be subject to approval by FINRA pursuant to paragraph (b)(1) of this Rule.
      (A) Opening and approving accounts.
      (B) Acceptance of orders.
      (C) Transmission of orders for execution.
      (D) Execution of orders.
      (E) Extension of credit.
      (F) Receipt and delivery of funds and securities.
      (G) Preparation and transmission of confirmations.
      (H) Maintenance of books and records.
      (I) Monitoring of accounts.
      (2) Each carrying agreement in which accounts are to be carried on a fully disclosed basis shall expressly allocate to the carrying firm the responsibility for the safeguarding of funds and securities for the purposes of SEA Rule 15c3-3 and for preparing and transmitting statements of account to customers. However, the carrying firm may authorize the introducing firm to prepare and/or transmit statements of account to customers on the carrying firm's behalf with the prior written approval of FINRA.
      (d) Each customer whose account is introduced on a fully disclosed basis shall be notified in writing upon the opening of the account of the existence of the carrying agreement and the responsibilities allocated to each respective party. The carrying firm shall be responsible for the content of such notification to the customer. The customer shall be notified promptly and in writing in the event of any change to any of the parties to the agreement or any material change to the allocation of responsibilities thereunder.
      (e) Each carrying agreement shall expressly state that to the extent that a particular responsibility is allocated to one party, the other party or parties will supply to the responsible organization all appropriate data in their possession pertinent to the proper performance and supervision of that responsibility.
      (f) A carrying agreement may authorize an introducing firm to issue negotiable instruments directly to its customers on the carrying firm's behalf, using instruments for which the carrying firm is the maker or drawer, provided that the parties comply with SEA Rule 15c3-3 and further that the introducing firm represents to the carrying firm in writing that such introducing firm maintains, and will enforce, supervisory policies and procedures with respect to the issuance of such negotiable instruments that are satisfactory to the carrying firm.
      (g)
      (1) Each carrying agreement shall expressly authorize and direct the carrying firm to:
      (A) furnish promptly to the introducing firm and the introducing firm's designated examining authority (or, if none, to its appropriate regulatory agency or authority) any written customer complaint received regarding the conduct of the introducing firm or firms and its associated persons; and
      (B) notify the complaining customer, in writing, that it has received the complaint and that such complaint has been furnished to the introducing firm and its designated examining authority (or, if none, to its appropriate regulatory agency or authority).
      (2) Upon a showing of good cause, FINRA, at its discretion, may exclude certain carrying firms from the requirements of paragraph (g)(1) in instances where the introducing firm is an affiliated entity of the carrying firm.
      (h)
      (1) At the commencement of the agreement and annually thereafter, the carrying firm must furnish to each of its introducing firms a list of all reports (e.g., exception reports) available to assist the introducing firm with the responsibilities allocated to it pursuant to the carrying agreement. The introducing firm must promptly request of the carrying firm, in writing, those offered reports that it requires.
      (2) No later than July 1 of each year, the carrying firm shall notify the introducing firm's chief executive and chief compliance officer(s) in writing of the list of reports offered to, requested by and supplied to the introducing firm as of the date of the notice. A copy of this written notice must at the same time be provided to the introducing firm's designated examining authority (or if none, to its appropriate regulatory agency or authority).
      (3) The carrying firm shall maintain as part of its books and records those reports requested by and supplied to the introducing firm. The carrying firm may satisfy the requirements of this paragraph by furnishing, upon request of the introducing firm's designated examining authority (or if none, to its appropriate regulatory agency or authority):
      (A) a re-created copy of the report originally produced; or
      (B) the format of the report and the applicable data elements contained in the original report.
      (4) Upon a showing of good cause, FINRA, at its discretion, may exclude certain carrying firms from the requirements of this paragraph (h) in instances where the introducing firm is an affiliated entity of the carrying firm.
      (i) All carrying agreements shall require each introducing firm to maintain its proprietary and customer accounts, and the proprietary and customer accounts of any introducing firm for which it is acting as an intermediary in obtaining clearing services from the carrying firm, in such a manner as to enable the carrying firm and FINRA to specifically identify the proprietary and customer accounts belonging to each introducing firm. The requirements of this paragraph (i) shall apply to intermediary clearing arrangements that are established on or after February 20, 2006.

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

      .01 Material Changes. For purposes of paragraph (b)(1) of this Rule, material changes include, but are not limited to, changes to: (a) the allocation of responsibilities required by this Rule; (b) termination clauses applicable to the introducing firm; (c) any terms or provisions affecting the liability of the parties; and (d) the parties to the agreement (including, for example, the addition of a new party to the agreement, such as a "piggyback" arrangement, a new carrying firm or a new introducing firm, but not including a termination of the agreement).
      .02 Notice of New Introducing Firm Arrangement. For purposes of the notice requirements of paragraph (b)(3) of this Rule, the carrying firm shall submit a questionnaire in such form as to be specified by FINRA in a Regulatory Notice, which questionnaire may be updated from time to time as FINRA deems necessary.
      .03 Due Diligence. For purposes of paragraph (b)(4) of this Rule, the carrying firm's due diligence may include, without limitation, inquiry by the carrying firm into the introducing firm's business model and product mix, proprietary and customer positions, FOCUS and similar reports, audited financial statements and complaint and disciplinary history.
      .04 Allocation of Responsibilities. For purposes of paragraphs (c)(1)(F) and (c)(2) of this Rule, members are reminded that receipt and delivery of customers' funds and securities and the safeguarding of such funds and securities must comply with the requirements of the SEC's financial responsibility rules, in particular SEA Rule 15c3-3, and applicable SEC guidance.
      .05 Notice to Customers. For purposes of paragraph (d) of this Rule, notification to customers of a change to any of the parties to the carrying agreement is not required in instances where, consistent with applicable FINRA rules and the federal securities laws, such customers' accounts are being transferred pursuant to: (a) ACATS using an authorized Transfer Instruction Form (TIF); or (b) a process outside of ACATS where notification to customers is provided by means of an alternative mechanism such as affirmative or negative response letters.

      * * * * *

      4522. Periodic Security Counts, Verifications and Comparisons

      (a) Each member that is subject to the requirements of SEA Rule 17a-13 shall make the counts, examinations, verifications, comparisons and entries set forth in SEA Rule 17a-13.
      (b) Each carrying or clearing member subject to the requirements of SEA Rule 17a-13 shall make more frequent counts, examinations, verifications, comparisons and entries where prudent business practice would so require. In addition, each such carrying or clearing member shall:
      (1) Receive position statements as frequently as good business practice requires, but no less than once per month with respect to securities held by clearing corporations, other organizations or custodians. Each such member shall at least once per month reconcile all such securities and money balances by comparison of the clearing corporations' or custodians' position statements to the member's books and records and promptly report differences to the contra organization and such differences shall be promptly resolved by both. Where there is a higher volume of activity, good business practice may require a more frequent exchange of statements and their reconciliation; and
      (2) At a maximum of seven business days after each security count, enter all unresolved differences into a "Difference" account, for that security count. The Difference account shall identify the unverified securities and reflect the number of shares or principal amount long or the number of shares or principal amount short of each security difference and the date of the security count that disclosed such difference. Thereafter, any adjustment of a difference position shall be made by entry into such account.

      4523. Assignment of Responsibility for General Ledger Accounts and Identification of Suspense Accounts

      (a) Each member shall designate an associated person who shall be responsible for each general ledger bookkeeping account and account of like function used by the member and such associated person shall control and oversee entries into each such account and shall determine that the account is current and accurate as necessary to comply with all applicable FINRA rules and federal securities laws governing books and records and financial responsibility requirements. A supervisor shall, as frequently as is necessary considering the function of the account but, in any event, at least monthly, review each account to determine that it is current and accurate and that any items that become aged or uncertain as to resolution are promptly identified for research and possible transfer to a suspense account(s).
      (b) Each carrying or clearing member shall maintain a record of the names of the associated persons assigned primary and supervisory responsibility for each account as required by paragraph (a) of this Rule. All records made pursuant to this paragraph (b) shall be preserved for a period of not less than six years.
      (c) Each member must record, in an account that shall be clearly identified as a suspense account, money charges or credits and receipts or deliveries of securities whose ultimate disposition is pending determination. A record must be maintained of all information known with respect to each item so recorded. Such suspense accounts include, but are not limited to, DK fails, unidentified fails, unallocable securities receipts versus payment, returned deliveries, and any other receivable or payable (money or securities) "suspended" because of doubtful ownership, collectibility or deliverability. To the extent that suspense items can be distinguished by type, separate accounts may be used provided that the word "suspense" is made a prominent part of the account title. All records made pursuant to this paragraph shall be preserved for a period of not less than six years.

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

      .01 Supervisory Responsibility. For the purposes of paragraphs (a) and (b) of this Rule, each member with only one associated person may assign primary and supervisory responsibility for each account to that associated person, subject to applicable registration requirements. Members of limited size and resources that have more than one associated person may seek FINRA's prior written approval to assign primary and supervisory responsibility for each account to the same associated person.
      .02 Members Operating Pursuant to the Exemptive Provisions of SEA Rule 15c3-3(k)(2)(i). For purposes of this Rule, all requirements that apply to a member that clears or carries customer accounts shall also apply to any member that, operating pursuant to the exemptive provisions of SEA Rule 15c3-3(k)(2)(i), either clears customer transactions pursuant to such exemptive provisions or holds customer funds in a bank account established thereunder.

      * * * * *


      Attachment B: Carrying Firm Questionnaire

      Questionnaire to be submitted by the carrying firm prior to the carrying of any accounts of a new introducing firm(s) (including omnibus firms whose accounts are to be carried by the carrying firm) ("correspondents") pursuant to FINRA Rules 4311(b)(3) and 4311.02. The completed questionnaire shall be sent to the carrying firm's Regulatory Coordinator at FINRA no later than 10 business days prior to the carrying of any accounts of a new correspondent.

      If using a pre-approved form of carrying agreement pursuant to FINRA Rule 4311(b)(2), please specify form and date of FINRA's approval of such form:

      _________________________________________________________________________________________________

      Section I: Correspondent Profile

      1. Name of correspondent:______________________________________________________
      2. Is the correspondent acting as an intermediary introducing firm for any other introducing firm(s) that is a party(ies) to the carrying agreement?

      Yes If yes, please list the names of the other introducing firms and provide separate correspondent profile questionnaires for each: ______________________________________________________

      ______________________________________________________

      No
      3. Is the correspondent a FINRA member?

      Yes (if yes, please skip to Question 4)

      No If no, please provide the following information:

      Is the proposed correspondent a US-registered broker-dealer?

      Yes If yes, please provide its SEC Registration No.:____________________

      No If no, please list the foreign jurisdiction(s) in which the correspondent operates:______________________________________
      4. Method of Conversion of Accounts:

      ACATS? Yes

      No

      Bulk Transfer?

      Yes If yes, expected conversion date: ________________________________

      No

      Name of Delivering Broker: ___________________________________________________

      Other? Please specify: ___________________________________________________
      5. Amount of clearing deposit collected from correspondent $ _____________________
      6. Is this an arrangement for the carrying of an omnibus account(s)?

      Yes (If yes, please skip to Question 8)

      No
      7. Approximate number of retail accounts:_____________ Institutional accounts:_____________
      8. Expected correspondent customer:

      Debit balances: $__________________________

      Credit balances: $__________________________
      9. Customer Business Mix: (Please indicate approximate number of monthly tickets):

      Listed equities _______________ Asset Backed Securities _______________
      Unlisted equities _______________ Commodities _______________
      Municipals _______________ Options _______________
      Governments _______________ Other (please specify type(s) of product(s)) _______________
      Corporate Bonds _______________
      10. Does the correspondent engage in proprietary trading activities to be cleared and/ or carried by the firm? If yes, please specify trading strategies (e.g., market making, speculative trading, customer facilitation, risk arbitrage, statistical arbitrage, etc.) and indicate products traded below:

      Trading strategies engaged in:__________________________________________________________

      __________________________________________________________

      __________________________________________________________

      Listed equities _______________ Asset Backed Securities _______________
      Unlisted equities _______________ Commodities _______________
      Municipals _______________ Options _______________
      Governments _______________ Other (please specify type(s) of product(s)) _______________
      Corporate Bonds _______________
      11. Will the correspondent be provided the following special margin privileges and/or have special margin requirements been established for the correspondent's customer and/or proprietary accounts?

      If yes, please specify by completing a.– d. below:
      a. Portfolio Margining: Proprietary Accounts: Yes No Customer Accounts: Yes No
      b. Day Trading: Proprietary Accounts: Yes No Customer Accounts: Yes No
      c. Special house requirements: Proprietary Accounts: Yes No Customer Accounts: Yes No
      d. Other (specify):______________________________________________________________________
      12. Has a Proprietary Accounts of Introducing Brokers (PAIB) agreement been executed with the correspondent?

      Yes

      No If no, please explain. _________________________________________________

      _________________________________________________

      _________________________________________________

      Section II: Correspondent Risk Management

      Please respond to the following questions as they apply to the proposed correspondent relationship.

      Please note that FINRA Rule 4311(b)(4) requires that each carrying firm shall conduct appropriate due diligence with respect to any new introducing firm relationship to assess the financial, operational, credit and reputational risk that such arrangement will have upon the carrying firm. The questions below are representative of the type of reviews FINRA expects firms to conduct as part of their correspondent due diligence performed in accordance with this rule. However, the firm is expected to assess the extent of the review required for each correspondent and perform additional reviews as it deems necessary. Please note that a record of the due diligence conducted for each new introducing firm must be maintained by the carrying firm in accordance with the timeframes prescribed by Exchange Act Rule 17a-4(b).

      1. Has a review been conducted of the correspondent's business mix and customer account activities? Yes No NA
      2. Is your operational staff familiar with the clearance and settlement requirements and the associated risks of the products in which the correspondent and its customers will transact? Yes No NA
      3. Has a review of the correspondent's proprietary (including error account) and customer positions been conducted to assess any potential financial or credit risks that may result from: Yes No NA
      a. Low-priced securities? Yes No NA
      b. Concentrated securities? Yes No NA
      c. Control or restricted securities? Yes No NA
      d. Unique trading strategies? Yes No NA
      e. Other? (please specify) _______________________ Yes No NA
      4. Has a review been conducted of the correspondent's FOCUS or similar reports (if non-broker-dealer) for the past year? Yes No NA
      5. Has a review of the correspondent's last audited financial report been performed? Yes No NA
      6. Has a review of complaint and disciplinary history for the correspondent and its principal officers and Form U4 information for persons named on Form BD, as applicable, been conducted? Yes No NA
      7. Have the accounts of the correspondent been reviewed for Master and Sub-Account structures in light of the guidance of FINRA Regulatory Notice 10-18 (April 2010) (Master and Sub-Accounts)? Yes No NA
      8. If direct market access or sponsored access is being provided to the correspondent or its customers, has the firm reviewed, and is the firm satisfied with, the correspondent's procedures for such activities? Yes No NA

      With respect to the questions above (in this Section II), any "no" response must be accompanied by a written explanation included with this questionnaire, indicating why management believes that the omission of this review is appropriate (or why a "no" answer is otherwise appropriate) and does not represent an undue risk to the carrying firm.

      _______________________________________________________________________________________________
      Signature of Chief Executive, Financial or Operational Officer/Partner Date

      _______________________________________________________________________________________________
      Print Name Title

    • 11-25 New Implementation Date for and Additional Guidance on the Consolidated FINRA Rules Governing Know-Your-Customer and Suitability Obligations; Implementation Date: July 9, 2012

      View PDF

      Know Your Customer and Suitability

      Regulatory Notice
      Notice Type

      Consolidated FINRA Rulebook
      Guidance
      Suggested Routing

      Compliance
      Legal
      Senior Management
      Key Topics

      Know Your Customer
      Suitability
      Referenced Rules & Notices

      Bank Secrecy Act
      FINRA Rule 2090
      FINRA Rule 2111
      FINRA Rule 2130
      FINRA Rule 2264
      FINRA Rule 2270
      NTM 04-89
      NTM 05-26
      Regulatory Notice 09-31
      Regulatory Notice 11-02
      SEA Rule 17a-3

      Executive Summary

      On November 17, 2010, the Securities and Exchange Commission (SEC) approved FINRA's proposal to adopt rules governing know-your-customer and suitability obligations1 for the consolidated FINRA rulebook.2 On January 10, 2011, FINRA issued Regulatory Notice 11-02, which provided guidance regarding the new rules and announced an implementation date. This Notice announces a new implementation date of July 9, 2012, and provides additional guidance in response to some recent industry questions and concerns.

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

      Background

      New FINRA Rule 2090 (Know Your Customer) requires firms to "use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer...." The rule explains that essential facts are "those required to (a) effectively service the customer's account, (b) act in accordance with any special handling instructions for the account, (c) understand the authority of each person acting on behalf of the customer, and (d) comply with applicable laws, regulations, and rules."3

      New FINRA Rule 2111 (Suitability) requires that a firm or associated person "have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile."4

      In general, the new FINRA rules retain the core features of the previous NASD and NYSE rules covering the same subject areas and codify well-settled interpretations of those rules. A few aspects of the FINRA rules, however, have created new or modified obligations. Numerous firms asked that FINRA delay the implementation date to allow more time to prepare new or update current procedures, modify automated systems, and educate their associated persons regarding compliance with the new or modified requirements. Given these concerns and the significance of the rules to both the industry and the public, FINRA believes it is appropriate to provide firms with a reasonable extension of the implementation date to comply with the new or modified requirements. Accordingly, FINRA filed with the SEC a rule change effective immediately to delay the rules' implementation date until July 9, 2012.5

      Discussion

      A number of firms have asked FINRA to provide additional guidance to assist them in preparing to comply with the new rules. The most frequently asked questions and FINRA's answers are discussed below.6 FINRA reiterates, however, that many of the obligations under the new rules are the same as those under the predecessor rules and interpretations of those rules. FINRA emphasizes that existing guidance and interpretations regarding know-your-customer and suitability obligations continue to apply to the extent that they are not inconsistent with the new rules.

      Know Your Customer

      Q1. Does the know-your-customer obligation to "understand the authority of each person acting on behalf of the customer" require a firm to know more than the names of the persons acting on behalf of the customer?
      A1. Rule 2090 generally requires a member firm to know the names of any persons authorized to act on behalf of a customer and any limits on their authority that the customer establishes and communicates to the member firm. FINRA understands, however, that some member firms may decide as a business practice to accept only those customers that do not qualify the scope of authority of persons acting on the customers' behalf in their dealings with the member firms.

      Suitability

      Firms' questions regarding the new suitability rule have focused on information-gathering requirements in relation to a customer's investment profile, the scope of the term "strategy," and reasonable-basis obligations.

      Customer's Investment Profile

      Q2. Does a firm have to update all customer-account documentation by the suitability rule's implementation date to capture the new "customer investment profile" factors (age, investment experience, time horizon, liquidity needs and risk tolerance) that were added to the existing list (other holdings, financial situation and needs, tax status and investment objectives)?7
      A2. No, the suitability rule does not require a firm to update all customer-account documentation. The rule requires that a broker seek to obtain8 and consider relevant customer-specific information when making a recommendation. Although a firm has a general obligation to evidence compliance with applicable FINRA rules, aside from the situation where a firm determines not to seek certain information (addressed in Question 3 below),9 Rule 2111 does not include any explicit documentation requirements.10 The suitability rule allows firms to take a risk-based approach with respect to documenting suitability determinations. For example, the recommendation of a large-cap, value-oriented equity security generally would not require written documentation as to the recommendation. In all cases, the suitability rule applies to recommendations, but the extent to which a firm needs to evidence suitability generally depends on the complexity of the security or strategy in structure and performance and/or the risks involved. Compliance with suitability obligations does not necessarily turn on documentation of the basis for the recommendation. However, firms should understand that, to the degree that the basis for suitability is not evident from the recommendation itself, FINRA examination and enforcement concerns will rise with the lack of documentary evidence for the recommendation. In addition, documentation by itself does not cure an otherwise unsuitable recommendation.
      Q3. Would a firm violate the suitability rule if it makes recommendations to customers for whom it has not obtained all of the customer-specific information listed in FINRA Rule 2111(a)?
      A3. The essential requirement of this provision is that the member firm or associated person exercise "reasonable diligence" to ascertain the customer's investment profile. In most instances, asking a customer for the information would constitute reasonable diligence. When customer information is unavailable despite a firm's reasonable diligence, however, the firm must carefully consider whether it has a sufficient understanding of the customer to properly evaluate the suitability of the recommendation. While the rule lists some of the aspects of a typical investment profile, not every factor may be relevant to all situations. Indeed, Supplementary Material .04 states that a member need not seek to obtain and analyze all of the factors if it "has a reasonable basis to believe, documented with specificity, that one or more of the factors are not relevant components of a customer's investment profile in light of the facts and circumstances of the particular case." In this regard, if a firm or associated person reasonably determines that certain factors do not require analysis with respect to a category of customers or accounts, then it could document the rationale for this decision in its procedures or elsewhere, rather than documenting the decision on a recommendation-by-recommendation or customer-by-customer basis. For example, a firm may conclude that age is irrelevant regarding all customers that are entities or liquidity needs are irrelevant regarding all customers for whom only liquid securities will be recommended.

      The absence of some customer information that is not material under the circumstances generally should not affect a firm's ability to make a recommendation. To meet its suitability obligations, a firm must obtain and analyze enough customer information to have a reasonable basis to believe the recommendation is suitable. The significance of specific types of customer information generally will depend on the facts and circumstances of the particular case, including the nature and characteristics of the product or strategy at issue.
      Q4. How does FINRA define the terms "liquidity needs," "time horizon" and "risk tolerance" for purposes of the suitability rule?
      A4. FINRA Rule 2111 does not define the terms. As a general matter, these terms are to be understood commensurate with their meaning in financial analysis. FINRA, however, offers the following guidelines:
      •   Liquidity Needs: The extent to which a customer desires the ability or has financial obligations that dictate the need to quickly and easily convert to cash all or a portion of an investment or investments without experiencing significant loss in value from, for example, the lack of a ready market, or incurring significant costs or penalties.11
      •   Time Horizon: "[T]he expected number of months, years, or decades [a customer plans to invest] to achieve a particular financial goal."12
      •   Risk Tolerance: A customer's "ability and willingness to lose some or all of [the] original investment in exchange for greater potential returns."13
      FINRA recognizes that there can be an inverse relationship between an investment time horizon and liquidity needs in that the longer a customer's time horizon, the less the need for liquidity. However, a customer may have a long time horizon, but also may need or want to invest all or a portion of his or her portfolio in liquid assets to pay for unexpected expenses or take advantage of unforeseen opportunities. Furthermore, although customers with a long time horizon generally may be in a position to seek greater returns by taking on greater risk because they "can wait out slow economic cycles and the inevitable ups and downs of" the markets,14 that is not always the case. Some customers with long time horizons may not desire to take on such risk and others, because of considerations outside their time horizons, are unable to do so.
      Q5. Can a customer with multiple accounts at a single firm have different investment profiles or investment-profile factors (e.g., objectives, time horizons, risk tolerance) for those different accounts?
      A5. A customer could proceed in such a manner, but a firm should evidence the customer's intent to use different investment profiles or investment-profile factors for the different accounts. Nothing in this guidance, however, relieves a firm from having to ensure that the investment profiles or factors accurately reflect the customer's decisions. In addition, where a firm allows a customer to use different investment profiles or factors for different accounts rather than using a single customer profile for all of the customer's accounts, a firm could not borrow profile factors from the different accounts to justify a recommendation that would not be appropriate for the account for which the recommendation was made.
      Q6. Does a firm have to use the exact rule terminology when seeking to obtain customer-specific information?
      A6. No. FINRA is aware that some firms currently ask customers for relevant information without using the exact rule terminology or separately designating factors (e.g., investment objectives that include a risk-tolerance component that is not separately labeled as such). Firms may continue to use such approaches. Firms must attempt to obtain and analyze relevant customer-specific information. Although firms should be capable of explaining how they are doing so and, where appropriate, evidencing that they are doing so, the rule does not dictate use of a specific method or process or of particular terminology.

      Strategies

      Q7. What is the scope of the term "strategy" as used in FINRA Rule 2111?
      A7. The rule explicitly states that the term "strategy" should be interpreted broadly.15 The rule would cover a recommended investment strategy regardless of whether the recommendation results in a securities transaction or even references a specific security or securities. For instance, the rule would cover a recommendation to purchase securities using margin16 or liquefied home equity17 or to engage in day trading,18 irrespective of whether the recommendation results in a transaction or references particular securities.

      The term also would capture an explicit recommendation to hold a security or securities.19 While a decision to hold might be considered a passive strategy, an explicit recommendation to hold does constitute the type of advice upon which a customer can be expected to rely. An explicit recommendation to hold is tantamount to a "call to action" in the sense of a suggestion that the customer stay the course with the investment. The rule would apply, for example, when an associated person meets with a customer during a quarterly or annual investment review and explicitly advises the customer not to sell any securities in or make any changes to the account or portfolio. The rule, however, would not cover an implicit recommendation to hold.20 The rule, for instance, would not apply where an associated person remains silent regarding, or refrains from recommending the sale of, securities held in an account. That is true regardless of whether the associated person previously recommended the purchase of the securities, the customer purchased them without a recommendation, or the customer transferred them into the account from another firm where the same or a different associated person had handled the account.21
      Q8. What is the nature of the obligation under the suitability rule created by a hold recommendation?
      A8. The new rule does not change the longstanding application of the suitability rule on a recommendation-by-recommendation basis. In general, the focus remains on whether the recommendation was suitable at the time when it was made. Absent an agreement, course of conduct or unusual fact pattern that might alter the normal broker-customer relationship, a hold recommendation would not create an ongoing duty to monitor and make subsequent recommendations.22
      Q9. What is the scope of the provision in Supplementary Material .03 that excludes from the rule's coverage certain types of strategy-related communications that are educational in nature?23
      A9. What could be considered a "safe-harbor" provision in Supplementary Material .03 is limited in scope. Firms seeking to rely on the provision should take a conservative approach to determining whether a particular communication is eligible for such treatment. Any significant variation from the list in the safe-harbor provision would be subject to regulatory scrutiny. It is important to note, however, that the suitability rule would not apply to a firm's explanation of a strategy falling outside the safe-harbor provision if a reasonable person would not view the communication as a recommendation. Accordingly, the suitability rule would cover a firm's recommendation that a customer purchase securities using margin, whereas the rule generally would not cover a firm's brochure that simply explains the risks and benefits of margin without suggesting that the customer take action.24
      Q10. For purposes of the suitability rule, how should a firm document recommendations to hold in particular and recommendations of strategies more generally?
      A10. As discussed above, aside from the instances when a firm determines not to seek certain information (addressed in Question 3), FINRA Rule 2111 does not impose explicit documentation requirements. Each firm has a general obligation to evidence compliance with applicable FINRA rules. A firm may use a risk-based approach to evidencing compliance with the suitability rule. In that context, a firm may want to focus on hold recommendations involving securities that by their nature or due to particular circumstances could be viewed as having a shorter-term investment component, that have a periodic reset or similar mechanism that could alter the product's character over time, that are particularly susceptible to changes in certain market conditions, or that are otherwise potentially risky to hold at the time when the recommendations are made. A risk-based approach also may lead a firm to pay particular attention to hold recommendations where, at the time the recommendation is made, a customer's account has a heavy concentration in a particular security or industry sector or the security or securities in question are inconsistent with the customer's investment profile.25 The same approach applies to other recommended strategies. In general, the more complex and risky the strategy, the more the firm using a risk-based approach should focus on the recommendation.

      In regard to the type or form of documentation that may be needed, the facts and circumstances must inform that decision. Consistent with the discussions above, however, the complexity of and risks associated with a particular security or strategy likely will impact the level of documented analysis that is appropriate.

      Reasonable-Basis Suitability

      Q11. For purposes of compliance with the reasonable-basis obligation,26 is it sufficient that a firm's "product committee," which conducts due diligence on products, has approved a product for sale?
      A11. Although due diligence reviews by such committees can be extremely beneficial,27 a firm's approval of a product for sale does not necessarily mean that an associated person has complied with the reasonable-basis obligation. Reasonable-basis suitability has two main components: a broker must (1) perform reasonable diligence to understand the potential risks and rewards associated with a recommended security or strategy and (2) determine whether the recommendation is suitable for at least some investors based on that understanding. A broker can violate reasonable-basis suitability under either prong of the test. That is, even if a firm's product committee has approved a product for sale, an individual broker's lack of understanding of a recommended product or strategy could violate the obligation, notwithstanding that the recommendation is suitable for some investors.28

      A firm should educate its associated persons on the potential risks and rewards of the products that the firm permits them to recommend. In general, an associated person may rely on a firm's fair and balanced explanation of the potential risks and rewards of a product. However, if the associated person remains uncertain about the potential risks and rewards of a product or has reason to believe that the firm failed to address a particular issue or has done so in an incomplete or inaccurate manner, then the associated person would need to engage in further inquiry before recommending the product.

      1 See Securities Exchange Act Release No. 63325 (November 17, 2010), 75 FR 71479 (November 23, 2010) (Order Approving Proposed Rule Change; File No. SR-FINRA-2010-039).

      2 The current FINRA rulebook consists of (1) FINRA rules; (2) NASD rules; and (3) rules incorporated from NYSE (NYSE rules). While the NASD rules generally apply to all FINRA member firms, the NYSE rules apply only to those members of FINRA that also are members of the NYSE. 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, March 12, 2008 (Rulebook Consolidation Process).

      3 FINRA Rule 2090.01.

      4 FINRA Rule 2111(a).

      5 See Securities Exchange Act Release No. 64260 (April 8, 2011), 76 FR 20759 (April 13, 2011) (Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Delay the Implementation Date of FINRA Rule 2090 Know Your Customer) and FINRA Rule 2111 (Suitability); File No. SR-FINRA-2011-016).

      6 Nothing in this guidance shall be construed as altering in any manner a member firm's obligations under other applicable federal securities laws or FINRA rules, including SEA Rule 17a-3 and the Bank Secrecy Act, 31 U.S.C.§§ 5311, et seq.

      7 See FINRA Rule 2111(a).

      8 The term "obtained," as used in the rule's information-gathering section, does not require a firm to document the information in all instances.

      9 See FINRA Rule 2111.04 (explaining that a firm that decides not to seek to obtain and analyze information about a customer-specific factor must document its reasonable basis for believing that the factor is not a relevant consideration).

      10FINRA notes that there are SEC and other FINRA rules that explicitly require specific types of documentation.See, e.g., SEA Rule 17a-3(a)(17)(i)(A) (discussing "books and records" requirements for certain account information, including, among other things, date of birth, employment status, annual income, net worth and investment objectives, regarding an account with a natural person as a customer).See also supra note 6.

      11For purposes of considering liquidity needs in the context of FINRA Rule 2111, examples of possible liquid investments include money market funds, Treasury bills and many blue chip stocks, exchange-traded funds and mutual funds. FINRA emphasizes, however, that a high level of liquidity does not, in and of itself, mean that the recommended product is suitable for all customers. For instance, some relatively liquid products can be complex and/or risky and therefore unsuitable for some customers. See, e.g., Regulatory Notice 09-31(June 2009) (reminding firms of their sales-practice obligations relating to leveraged and inverse exchange-traded funds).

      12 seewww.sec.gov/investor/pubs/assetallocation.htm.

      13 Id.

      14 Id.

      15 See FINRA Rule 2111.03.

      16 For certain requirements related to margin, see FINRA Rule 2264.

      17See Notice to Members (NTM) 04-89 (December 2004) (reminding firms that "recommending liquefying home equity to purchase securities may not be suitable for all investors and that [firms] should perform a careful analysis to determine whether liquefying home equity is a suitable strategy for an investor").

      18For certain requirements related to day trading, see FINRA Rules 2130 and 2270.

      19See FINRA Rule 2111.03.

      20See FINRA Rule 2111.03. In limited circumstances, FINRA and the SEC have recognized that certain actions constitute implicit recommendations that can trigger suitability obligations. For example, FINRA and the SEC have held that associated persons who effect transactions on a customer's behalf without informing the customer have implicitly recommended those transactions, thereby triggering application of the suitability rule.See, e.g., Rafael Pinchas, 54 S.E.C. 331, 341 n.22 (1999) ("Transactions that were not specifically authorized by a client but were executed on the client's behalf are considered to have been implicitly recommended within the meaning of the NASD rules."); Paul C. Kettler, 51 S.E.C. 30, 32 n.11 (1992) (stating that transactions a broker effects for a discretionary account are implicitly recommended). Although such holdings continue to act as precedent regarding those issues, the new rule does not broaden the scope of implicit recommendations. The new rule does not apply to implicit recommendations to hold.

      21 Firms also have asked whether the absence of a sell order in a discretionary account amounts to an implicit hold recommendation covered by the rule.To the extent that a customer account at a broker-dealer can be discretionary under applicable federal securities laws,the suitability rule generally would not apply where a firm refrains from selling a security. The rule states that it applies to explicit recommendations to hold.See FINRA Rule 2111.03. Unless the facts indicate that an associated person's failure to sell securities in a discretionary account was intended as or tantamount to an explicit recommendation to hold, FINRA would not view the associated person's inaction or silence in such circumstances as a recommendation to hold the securities for purposes of the suitability rule.

      22 Similarly, and as noted previously, the absence of a recommendation to sell would not amount to a hold recommendation subject to the rule.

      23See FINRA Rule 2111.03.

      24 Regulatory Notice 11-02 (January 2011) discusses several guiding principles that are relevant to determining whether a particular communication could be viewed as a recommendation for purposes of the suitability rule

      25 As discussed in Question 8 above, absent an agreement, course of conduct or unusual fact pattern that might alter the normal broker-customer relationship, a hold recommendation would not create an ongoing duty to monitor and make subsequent recommendations.

      26 See FINRA Rule 2111.05(a).

      27 See, e.g., NTM 05-26 (April 2005) (recommending best practices for reviewing new products).

      28 See FINRA Rule 2111.05(a). This position is consistent with requirements under the previous suitability rule. In Dep't of Enforcement v. Siegel, for instance, FINRA's National Adjudicatory Council explained that a "recommendation may lack 'reasonable-basis' suitability if the broker: (1) fails to understand the transaction, which can result from, among other things, a failure to conduct a reasonable investigation concerning the security; or (2) recommends a security that is not suitable for any investors." Dep't of Enforcement v. Siegel, No. C05020055, 2007 NASD Discip. LEXIS 20, at *38 (NAC May 11, 2007), aff'd, Exchange Act Release No. 58737, 2008 SEC LEXIS 2459 (Oct. 6, 2008), aff'd in relevant part, 592 F.3d 147 (D.C. Cir. 2010),cert. denied, 2010 U.S. LEXIS 4340 (May 24, 2010).

    • 11-24 SEC Approves Consolidated FINRA Customer Order Protection Rule; Effective Date: September 12, 2011

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      Customer Order Protection

      Regulatory Notice
      Notice Type

      Consolidated FINRA Rulebook
      New Rule
      Referenced Rules

      FINRA Rule 4512
      FINRA Rule 5320
      FINRA Rule 6420
      NASD IM-2110-2
      NASD Rule 2111
      NASD Rule 2320
      NASD Rule 3110
      NTM 95-43
      NTM 97-57
      NTM 05-51
      SEC Regulation NMS Rule 600
      Suggested Routing

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

      Limit Orders
      Manning Rule
      Market Orders
      Minimum Price-Improvement
      Standards
      NMS Stocks
      Order Protection
      OTC Equity Securities
      Rulebook Consolidation

      Executive Summary

      On February 11, 2011, the SEC approved new FINRA Rule 5320 (Prohibition Against Trading Ahead of Customer Orders) for the consolidated FINRA rulebook (the Consolidated FINRA Rulebook).1 Rule 5320 consolidates, updates and simplifies NASD IM-2110-2 (Trading Ahead of Customer Limit Order) and NASD Rule 2111 (Trading Ahead of Customer Market Orders).2 Rule 5320 becomes effective on September 12, 2011.

      Text of new FINRA Rule 5320 is available in the online FINRA Manual at www.finra.org/finramanual.3

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

      Background and Discussion

      On February 11, 2011, the SEC approved a proposed rule change consolidating, updating and simplifying NASD IM-2110-2 (Trading Ahead of Customer Limit Order) and NASD Rule 2111 (Trading Ahead of Customer Market Orders) into FINRA Rule 5320 (Prohibition Against Trading Ahead of Customer Orders).4 FINRA Rule 5320 generally provides that a member firm that accepts and holds an order in an equity security from its own customer or a customer of another broker-dealer without immediately executing the order is prohibited from trading that security on the same side of the market for its own account at a price that would satisfy the customer order, unless it immediately thereafter executes the customer order up to the size and at the same or better price at which it traded for its own account.5

      FINRA Rule 5320 applies to customer market and limit orders in securities that meet the definition of "OTC Equity Security" as defined in FINRA Rule 6420,6 as well as securities that meet the definition of "NMS stock" as defined in Rule 600 of SEC Regulation NMS.7 With respect to customer limit orders (marketable and non-marketable), as was the case with NASD IM-2110-2, new FINRA Rule 5320 includes minimum price improvement amounts that are necessary for a firm to execute an order on a proprietary basis when holding an unexecuted limit order in that same security, and not be required to execute the held limit order (unless an exception applies).8 The Supplementary Material to Rule 5320 provides several exceptions, including for large orders and orders from institutional accounts; a "no-knowledge" exception; and an exception for trades made to offset a customer odd-lot order or to correct a bona fide error.9

      Large Orders and Institutional Account Exceptions

      Rule 5320.01 generally continues to permit firms to negotiate terms and conditions on the acceptance of certain large-sized orders (orders of 10,000 shares or more and greater than $100,000 in value) and orders from institutional accounts (as defined in NASD Rule 3110(c))10 that would permit firms to trade ahead of or along with such orders, provided that firms give clear and comprehensive written disclosure to such customer at account opening and annually thereafter that:

      a. discloses that the firm may trade proprietarily at prices that would satisfy the customer order, and
      b. provides the customer with a meaningful opportunity to opt in to the Rule 5320 protections with respect to all or any portion of its order.11

      In lieu of providing the written disclosure to customers at account opening and annually thereafter, Rule 5320.01 would permit firms to provide clear and comprehensive oral disclosure to, and obtain oral consent from, a customer on an order-by-order basis, provided that the firm documents who provided the consent and that the consent evidences the customer's understanding of the terms and conditions of the order. When a customer has opted in to the Rule 5320 protections, a firm may still obtain consent on an order-by-order basis to trade ahead of or along with an order from that customer, provided that the firm documents who provided the consent and that the consent evidences the customer's understanding of the terms and conditions of the order.

      No-Knowledge Exception

      Rule 5320.02 provides an exception for a firm's proprietary trading in NMS stocks where the proprietary trading unit does not have knowledge of the customer order. Specifically, if a firm implements and uses an effective system of internal controls—such as appropriate information barriers—that operate to prevent one trading unit from obtaining knowledge of customer orders held by a separate trading unit, those other trading units trading in a proprietary capacity may continue to trade at prices that would satisfy the customer orders held by the separate trading unit.12

      If a firm structures its order-handling practices in NMS stocks to permit its market-making desk to trade at prices that would satisfy customer orders held by a separate trading unit, the firm must disclose in writing to its customers, at account opening and annually thereafter, a description of the manner in which customer orders are handled by the firm and the circumstances under which it may trade proprietarily at its market-making desk at prices that would satisfy the customer order.

      With respect to OTC Equity Securities, if a firm implements and uses an effective system of internal controls, such as appropriate information barriers, that operate to prevent a non-market-making trading unit from obtaining knowledge of customer orders held by a separate trading unit, the non-market-making trading unit trading in a proprietary capacity may continue to trade at prices that would satisfy the customer orders held by the separate trading unit. The no-knowledge exception does not extend to the market-making desk for trading in OTC Equity Securities.

      Odd Lot and Bona Fide Error Transaction Exceptions

      The rule also provides an exception for firm proprietary trading made to offset a customer order that is in an amount less than a normal unit of trading (an "odd lot"). In addition, a transaction made to correct a bona fide error also is excepted. Firms are required to demonstrate and document the basis upon which a transaction meets the bona fide error exception.

      Trading Outside Normal Market Hours

      Supplementary Material .08 of Rule 5320 clarifies that the rule applies to a customer order at all times that the order is executable by the firm. Therefore, while firms generally may limit the life of a customer order to the period of normal market hours of 9:30 a.m. to 4:00 p.m. Eastern Time, if the customer and firm agree to the processing of the customer's order outside normal market hours, then the protections of this rule also apply to that customer's order outside of normal market hours.

      FINRA Rule 5320 becomes effective on September 12, 2011.


      1 See Securities Exchange Act Release No. 63895 (February 11, 2011); 76 FR 9386 (February 17, 2011) (Order Approving SR-FINRA-2009-090) (Approval Order). 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. For more information about the rulebook consolidation process, see Information Notice 03/12/08 (Rulebook Consolidation Process).

      2 Consistent with existing policy, where a provision of new FINRA Rule 5320 is not substantively different from NASD IM-2110-2 or NASD Rule 2111, previously issued interpretations generally will continue to apply (unless rescinded or updated by FINRA).

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

      4 See Approval Order. FINRA understands that NYSE intends to file a proposed rule change to harmonize NYSE Rule 92 with the changes implemented in FINRA Rule 5320.

      5 Rule 5320(b) provides that firms must have a written methodology in place governing the execution and priority of all pending orders that is consistent with the requirements of the rule and NASD Rule 2320 (Best Execution and Interpositioning). Firms also are required to ensure that their methodology is consistently applied.

      6 "OTC Equity Security" means any equity security that is not an "NMS stock" as that term is defined in Rule 600(b)(47) of SEC Regulation NMS, provided, however, that the term "OTC Equity Security" does not include any restricted equity security. See FINRA Rule 6420(e).

      7 A firm that is holding a customer order that is marketable and has not been immediately executed must make every effort to cross the order with any other order received by the firm on the other side of the market up to the size of such order at a price that is no less than the best bid and no greater than the best offer at the time that the subsequent order is received by the firm and that is consistent with the terms of the orders. In the event that a firm is holding multiple orders on both sides of the market that have not been executed, the firm must make every effort to cross or otherwise execute the orders in a manner that is reasonable and consistent with the objectives of this rule and with the terms of the orders. A firm can satisfy the crossing requirement by contemporaneously buying from the seller and selling to the buyer at the same price. See Rule 5320.07.

      8 See Rule 5320.06.

      9 Rule 5320 also includes two additional exceptions, similar to existing provisions under NASD IM-2110-2 and NASD Rule 2111—specifically, a limited exception for riskless principal transactions and the intermarket sweep order exception. See Rule 5320.03 and .04.

      10 As part of the Rulebook Consolidation Process, as of December 5, 2011, NASD Rule 3110(c) will become FINRA Rule 4512. See Securities Exchange Act Release No. 63784 (January 27, 2011); 76 FR 5850 (February 2, 2011) (Order Approving File No. FINRA-2010-052).

      11 If a customer does not opt in to the Rule 5320 protections with respect to all or any portion of its order(s), the firm may reasonably conclude that the customer has consented to the firm trading a security on the same side of the market for its own account at a price that would satisfy the customer's order. Even if a customer does not opt in to the Rule 5320 protections, the firm's conduct must continue to be consistent with the guidance provided in NTM 05-51 (August 2005) which, among other things, reminds firms that adherence to just and equitable principles of trade as mandated by Rule 2010 "requires that members handle and execute any order received from a customer in a manner that does not disadvantage the customer or place the firm's financial interests ahead of those of its customer." See also NASD Rule 2320.

      12 Firms should indicate the existence of these information barriers in information submitted to FINRA's Order Audit Trail System (OATS) in accordance with the OATS rules and the OATS Reporting Technical Specifications on FINRA's website at www.finra.org/OATS.

    • 11-23 Five-Day Period for Replies to Responses to Motions in Arbitration; Effective Date: June 6, 2011

      View PDF

      Motion Practice

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      Rule 12206
      Rule 12503
      Rule 12504
      Rule 13206
      Rule 13503
      Rule 13504
      Suggested Routing

      Compliance
      Legal
      Registered Representatives
      Key Topics

      Arbitration
      Codes of Arbitration Procedure
      Motions

      Executive Summary

      Effective June 6, 2011, a moving party (the party that makes the original motion in an arbitration) will have a five-day period to reply to a response to a motion.1 This five-day period gives parties an opportunity to brief fully the issues in dispute, and ensures that arbitrators deciding a motion have all the motion papers before issuing a final decision.

      The amendments to the Customer and Industry Codes of Arbitration Procedure (the Codes) apply to motions in all cases and are 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 (DR), at (212) 858-4307 or richard.berry@finra.org; or
      •   Margo A. Hassan, Assistant Chief Counsel, DR, at (212) 858-4481 or margo.hassan@finra.org.

      Background & Discussion

      The Codes specify time periods for a party to respond to a motion, including a motion to dismiss. They do not provide expressly for a moving party to reply to a response. FINRA staff observed that occasionally, the moving party submitted a reply to a response. FINRA's practice had been to forward the reply to the arbitrators, even when FINRA receives the reply after it has already sent the motion and response to the arbitrators. Since the Codes do not prescribe a time period for replying to responses to motions, there have been instances where arbitrators reviewed the motion papers and even ruled on a motion before receiving a moving party's reply. On June 21, 2010, FINRA revised its practice relating to replies to responses to motions and published Notice to Parties—Time to Reply to Objections on its website, stating that moving parties have five calendar days from receipt of a response to a motion to submit a reply to the response.

      FINRA amended Rules 12206 and 13206 (Time Limits), Rules 12503 and 13503 (Motions), and Rules 12504 and 13504 (Motions to Dismiss) to provide a moving party with a five-day period to reply to a response to a motion. The amendments codify FINRA's current practice, as outlined in the Notice to Parties, and make it transparent. The amendments also provide parties with an opportunity to brief fully the issues in dispute, and ensure that arbitrators have all of the motion papers before issuing a final decision on the motion.

      Effective Date

      The amendments to the Codes are effective on June 6, 2011, and apply to motions in all cases.


      1 See Securities Exchange Act Rel. No. 64225 (April 7, 2011), 76 Federal Register 20757 (April 13, 2011) (File No. SR-FINRA-2011-006).


      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

      12206. Time Limits
      (a) No Change.
      (b) Dismissal under Rule

      Dismissal of a claim under this rule does not prohibit a party from pursuing the claim in court. By filing a motion to dismiss a claim under this rule, the moving party agrees that if the panel dismisses a claim under this rule, the non-moving party may withdraw any remaining related claims without prejudice and may pursue all of the claims in court.
      (1) Motions under this rule must be made in writing, and must be filed separately from the answer, and only after the answer is filed.
      (2) Unless the parties agree or the panel determines otherwise, parties must serve motions under this rule at least 90 days before a scheduled hearing, and parties have 30 days to respond to the motion. Moving parties may reply to responses to motions. Any such reply must be made within 5 days of receipt of a response.
      (3)–(10) No change.
      (c)–(d) No change.

      * * *

      12503. Motions
      (a)–(b) No change.
      (c) Replying to Responses to Motions

      Parties have 5 days from the receipt of a response to a motion to reply to the response unless the responding party agrees to an extension of time, or the Director or the panel decides otherwise. Replies to responses must be served directly on each other party, at the same time and in the same manner. Replies to responses must also be filed with the Director, with additional copies for each arbitrator, at the same time and in the same manner in which they are served on the parties.
      [c] (d) Authority to Decide Motions
      (1)–(5) No change.

      * * *

      12504. Motions to Dismiss
      (a) Motions to Dismiss Prior to Conclusion of Case in Chief
      (1) Motions to dismiss a claim prior to the conclusion of a party's case in chief are discouraged in arbitration.
      (2) Motions under this rule must be made in writing, and must be filed separately from the answer, and only after the answer is filed.
      (3) Unless the parties agree or the panel determines otherwise, parties must serve motions under this rule at least 60 days before a scheduled hearing, and parties have 45 days to respond to the motion. Moving parties may reply to responses to motions. Any such reply must be made within 5 days of receipt of a response.
      (4)–(11) No change.
      (b)–(e) No change.

      * * *

      Industry Code

      13206. Time Limits
      (a) No change.
      (b) Dismissal under Rule

      Dismissal of a claim under this rule does not prohibit a party from pursuing the claim in court. By filing a motion to dismiss a claim under this rule, the moving party agrees that if the panel dismisses a claim under this rule, the non-moving party may withdraw any remaining related claims without prejudice and may pursue all of the claims in court.
      (1) Motions under this rule must be made in writing, and must be filed separately from the answer, and only after the answer is filed.
      (2) Unless the parties agree or the panel determines otherwise, parties must serve motions under this rule at least 90 days before a scheduled hearing, and parties have 30 days to respond to the motion. Moving parties may reply to responses to motions. Any such reply must be made within 5 days of receipt of a response.
      (3)–(10) No change.
      (c)–(d) No change.

      * * *

      13503. Motions
      (a)–(b) No change.
      (c) Replying to Responses to Motions

      Parties have 5 days from the receipt of a response to a motion to reply to the response unless the responding party agrees to an extension of time, or the Director or the panel decides otherwise. Replies to responses must be served directly on each other party, at the same time and in the same manner. Replies to responses must also be filed with the Director, with additional copies for each arbitrator, at the same time and in the same manner in which they are served on the parties.
      [c] (d) Authority to Decide Motions
      (1)–(5) No change.

      * * *

      13504. Motions to Dismiss
      (a) Motions to Dismiss Prior to Conclusion of Case in Chief
      (1) Motions to dismiss a claim prior to the conclusion of a party's case in chief are discouraged in arbitration.
      (2) Motions under this rule must be made in writing, and must be filed separately from the answer, and only after the answer is filed.
      (3) Unless the parties agree or the panel determines otherwise, parties must serve motions under this rule at least 60 days before a scheduled hearing, and parties have 45 days to respond to the motion. Moving parties may reply to responses to motions. Any such reply must be made within 5 days of receipt of a response.
      (4)–(11) No change.
      (b)–(e) No change.

      * * *

    • 11-22 Arbitration Panel Composition for Promissory Note Disputes; Effective Date: June 6, 2011

      View PDF

      Promissory Note Proceedings

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      Notice 09-48
      Rule 12400 (c)
      Rule 13802
      Rule 13806
      Suggested Routing

      Compliance
      Legal
      Registered Representatives

      Key Topics
      Arbitration
      Associated Person
      Code of Arbitration Procedure
      Promissory Note

      Executive Summary

      Effective June 6, 2011, FINRA will appoint chair-qualified public arbitrators to panels resolving promissory note disputes instead of appointing chair-qualified public arbitrators also qualified to resolve statutory discrimination claims.1

      The amendments apply to all promissory note proceedings in which FINRA has not sent lists of arbitrators to the parties as of 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 (DR), at (212) 858-4307 or richard.berry@finra.org; or
      •   Margo A. Hassan, Assistant Chief Counsel, DR, at (212) 858-4481 or margo.hassan@finra.org.

      Background & Discussion

      In 2009, FINRA implemented new procedures to expedite the administration of cases that solely involve a brokerage firm's claim that an associated person failed to pay money owed on a promissory note.2 Under the procedures, FINRA appoints a single chair-qualified public arbitrator from the roster of arbitrators approved to hear statutory discrimination claims (a statutory discrimination-qualified arbitrator)3 to resolve the dispute.4 These specially qualified arbitrators are public chair-qualified arbitrators who also are attorneys familiar with employment law and have at least ten years of legal experience. In addition, they may not have represented primarily the views of employers or of employees within the last five years. FINRA proposed using statutory discrimination qualified arbitrators because of the depth of their experience and their familiarity with employment law.

      Since implementing the new procedures, FINRA found that promissory note cases did not require such extensive experience or depth of knowledge. In a majority of completed cases, arbitrators decided the case on the pleadings and the respondent broker did not appear. In addition, the number of promissory note cases has more than doubled in the past two years. As a result of this substantial increase, it became more difficult to appoint panels in these cases using only statutory discrimination-qualified arbitrators. Therefore, FINRA amended the Code of Arbitration Procedure for Industry Disputes (Industry Code) to provide that FINRA will appoint a chair-qualified public arbitrator to a panel resolving a promissory note dispute instead of appointing a statutory discrimination qualified arbitrator. Chair-qualified arbitrators have completed chair training and are attorneys who have served through award on at least two cases, or, if not attorneys, are arbitrators who have served through award on at least three cases.5 The rule amendments ensure that FINRA has a sufficient number of qualified arbitrators readily available to resolve these matters.

      Effective Date

      The amendments to the Industry Code are effective on June 6, 2011, and apply to all promissory note proceedings in which FINRA has not sent lists of arbitrators to the parties.


      1 See Securities Exchange Act Rel. No. 64226 (Apri 7, 2011), 76 Federal Register 20741 (April 13, 2011) and Rel. No. 64226A (April 13, 2011), 76 Federal Register 21932 (April 19, 2011) (File No. SR-FINRA 2011-005).

      2 See Securities Exchange Act Rel. No. 34-60132 (June 17, 2009), 74 FR 30191 (June 24, 2009) (File No. SR-FINRA-2009-01B). FINRA announced implementation of New Rule 13806 (Promissory Note Proceedings) in Regulatory Notice 09-48. The effective date was September 14, 2009.

      3 See Rule 13802(c)(3).

      4 Under Rule 13806, if an associated person does not file an answer, or files an answer but does not assert any counterclaims or third party claims, regardless of the amount in dispute, a single statutory discrimination-qualified arbitrator decides the case. If an associated person files a counterclaim or third-party claim, FINRA bases panel composition on the amount of the counterclaim or third-party claim. For counterclaims and third-party claims that are not more than $100,000, FINRA appoints a single statutory discrimination-qualified arbitrator. For counterclaims and third-party claims of more than $100,000, FINRA appoints a three-arbitrator panel comprising a statutory discrimination-qualified arbitrator, a public arbitrator and a non-public arbitrator.

      5 See Rule 12400(c).


      Attachment A

      New language is underlined; deletions are in brackets.

      Code of Arbitration Procedure for Industry Disputes

      * * *

      13806 Promissory Note Proceedings
      (a)–(b) No change.
      (c) Composition of Panel
      (1) If the panel consists of one arbitrator, the arbitrator will be a public arbitrator [qualified to resolve a statutory discrimination claim as set forth in Rule 13802(c) (3)] selected from the chairperson roster described in Rule 12400(c) of the Code of Arbitration Procedure for Customer Disputes, unless the parties agree in writing otherwise.
      (2) If the panel consists of three arbitrators, one arbitrator will be a public arbitrator [who meets the qualifications in Rule 13802(c)(3)] selected from the chairperson roster described in Rule 12400 (c) of the Code of Arbitration Procedure for Customer Disputes, unless the parties agree in writing otherwise; one arbitrator will be selected from the roster of public arbitrators; and one arbitrator will be selected from the roster of non-public arbitrators. [The arbitrator who meets the criteria in Rule 13802(c)(3) will serve as the chairperson of the panel.]
      (3) If the Director appoints a panel pursuant to (c)(1) above, and an associated person subsequently files a counterclaim or third party claim that requires appointment of a three-arbitrator panel, the appointed arbitrator will remain on the panel, and will serve as chairperson. In addition, one arbitrator will be selected from the roster of public arbitrators; and one arbitrator will be selected from the roster of non-public arbitrators.
      (d)–(f) No change.

      * * *

    • 11-21 SEC Approves Consolidated FINRA Rule Governing Fidelity Bonds; Effective Date: January 1, 2012

      View PDF

      Fidelity Bonds

      Regulatory Notice
      Notice Type

      Consolidated FINRA Rulebook
      Rule Approval
      Referenced Rules & Notices

      FINRA Rule 4360
      NASD Rule 3020
      NYSE Rule 319 and its Interpretation
      SEA Rule 15c3-1
      SEA Rule 17a-4
      Suggested Routing

      Compliance
      Finance
      Legal
      Operations
      Senior Management
      Key Topics

      Fidelity Bonds

      Executive Summary

      The SEC approved FINRA's proposal to adopt a rule governing fidelity bonds1 for the consolidated FINRA rulebook.2 The new rule, FINRA Rule 4360, is based on NASD Rule 3020, taking into account certain requirements under NYSE Rule 319 and its Interpretation.3

      The text of the new rule is set forth in Attachment A. The rule takes effect on January 1, 2012.

      Questions regarding this Notice should be directed to:

      •   Susan DeMando Scott, Associate Vice President, Financial Operations Policy, at (202) 728-8411; or
      •   Erika L. Lazar, Counsel, Office of General Counsel, at (202) 728-8013.

      Background & Discussion

      FINRA Rule 4360 (Fidelity Bonds) updates and clarifies the fidelity bond requirements in NASD Rule 3020 and NYSE Rule 319 (and its Interpretation) and better reflects current industry practices. The requirements are set forth in detail below.

      General Provision

      FINRA Rule 4360 requires each member firm that is required to join the Securities Investor Protection Corporation (SIPC) to maintain blanket fidelity bond coverage with specified amounts of coverage based on the firm's net capital requirement, with certain exceptions.4 Such firms must maintain fidelity bond coverage that provides for per loss coverage without an aggregate limit of liability.5 Firms may apply for this level of coverage with any product that meets these requirements, including the Securities Dealer Blanket Bond (SDBB) or a properly endorsed Financial Institution Form 14 Bond (Form 14).6

      Most fidelity bonds contain a definition of the term "loss" (or "single loss"), for purposes of the bond, which generally includes all covered losses resulting from any one act or a series of related acts. A payment by an insurer for covered losses attributed to a single loss does not reduce a firm's coverage amount for losses attributed to other, separate acts. A fidelity bond with an aggregate limit of liability caps a firm's coverage during the bond period at a certain amount if a loss (or losses) meets this aggregate threshold. FINRA believes that per loss coverage without an aggregate limit of liability provides firms with the most beneficial coverage since the bond amount cannot be exhausted by one or more covered losses, which means it will be available for future losses during the bond period.

      A firm that does not qualify for a fidelity bond with per loss coverage and no aggregate limit of liability must maintain substantially similar fidelity bond coverage in compliance with all other provisions of the rule, provided that the firm maintains written correspondence from two insurance providers stating that the firm does not qualify for such coverage.7 The firm must retain such correspondence for the period specified by Exchange Act Rule 17a-4(b)(4).8

      A firm's fidelity bond must provide against loss and have Insuring Agreements covering at least the following: fidelity, on premises, in transit, forgery and alteration, securities and counterfeit currency.9 These Insuring Agreements are defined in the fidelity bond forms available to firms. FINRA Rule 4360 modifies the descriptive headings for these Insuring Agreements, in part, from NASD Rule 3020(a)(1) and NYSE Rule 319(d) to align them with the headings in the current bond forms.10 In addition, FINRA Rule 4360 replaces the specific coverage provisions in the NASD and NYSE rules that permit less than 100 percent of coverage for certain Insuring Agreements (i.e., fraudulent trading and securities forgery)11 so that coverage for all Insuring Agreements must be equal to 100 percent of the firm's minimum required bond coverage.12

      A firm's fidelity bond must include a cancellation rider providing that the insurer will use its best efforts to promptly notify FINRA in the event the bond is cancelled, terminated or substantially modified. FINRA Rule 4360 adopts the definition of "substantially modified" in NYSE Rule 31913 and incorporates NYSE Rule 319.12's standard that a firm must immediately advise FINRA in writing if its fidelity bond is cancelled, terminated or substantially modified.14

      Minimum Required Coverage

      Each firm subject to the rule must maintain, at a minimum, fidelity bond coverage for any person associated with the firm, except directors or trustees who are not performing acts within the scope of the usual duties of an officer or employee.15

      A firm with a minimum net capital requirement that is less than $250,000 must maintain minimum coverage of the greater of 120 percent of its required minimum net capital under Exchange Act Rule 15c3-1 or $100,000.16 The $100,000 minimum coverage requirement modifies the present minimum requirement of $25,000. FINRA believes this increase is warranted since the NASD and NYSE fidelity bond rules have not been materially modified since their adoption more than 30 years ago. Although firms may experience a slight increase in costs for their premiums under the new rule, FINRA believes that the amendments to the fidelity bond minimum requirements are necessary to provide meaningful and practical coverage for losses covered by the bond.

      Firms with a minimum net capital requirement of at least $250,000 must use a table in FINRA Rule 4360 to determine their minimum fidelity bond coverage requirement.17 The table is a modified version of the tables in NASD Rule 3020(a)(3) and NYSE Rule 319(e)(i). The identical NASD and NYSE requirements for members that have a minimum net capital requirement that exceeds $1 million have been retained in FINRA Rule 4360; however, the rule adopts the higher requirements in NYSE Rule 319(e)(i) for a member with a net capital requirement of at least $250,000, but less than $1 million.

      The entire amount of a firm's minimum required coverage must be available for covered losses and may not be eroded by the costs an insurer may incur if it chooses to defend a claim. Specifically, any defense costs for covered losses must be in addition to a firm's minimum coverage requirements.18 A firm may include defense costs as part of its fidelity bond coverage, but only to the extent that it does not reduce its minimum required coverage under the rule.

      Deductible Provision

      FINRA Rule 4360 provides for an allowable deductible amount of up to 25 percent of the fidelity bond coverage purchased by a firm. Any deductible amount elected by the firm that is greater than 10 percent of the coverage purchased by the firm19 must be deducted from its net worth in the calculation of its net capital for purposes of Exchange Act Rule 15c3-1.20 Like the legacy NASD and NYSE rules, if the firm is a subsidiary of another FINRA member firm, this amount may be deducted from the parent's rather than the subsidiary's net worth, but only if the parent guarantees the subsidiary's net capital in writing.21

      Annual Review of Coverage

      A member firm (including a firm that signs a multi-year insurance policy) must review, annually as of the yearly anniversary date of the issuance of its fidelity bond, the adequacy of its fidelity bond coverage and make any required adjustments to its coverage, as set forth in the rule.22 A firm's highest net capital requirement during the preceding 12-month period, based on the applicable method of computing net capital (dollar minimum, aggregate indebtedness or alternative standard), is the basis for determining the firm's minimum required fidelity bond coverage for the succeeding 12-month period.23 The "preceding 12-month period" includes the 12-month period that ends 60 days before the yearly anniversary date of a firm's fidelity bond to provide the firm time to determine its required fidelity bond coverage by the anniversary date of the bond.

      A firm that has only been in business for one year and elected the aggregate indebtedness ratio for calculating its net capital requirement may use, solely for the purpose of determining the adequacy of its fidelity bond coverage for its second year, the 15 to 1 ratio of aggregate indebtedness to net capital in lieu of the 8 to 1 ratio (required for broker-dealers in their first year of business) to calculate its net capital requirement. Notwithstanding the above, such member may not carry less minimum fidelity bond coverage in its second year than it carried in its first year.24

      Exemptions

      FINRA Rule 4360 exempts from the fidelity bond requirements firms in good standing with a national securities exchange that maintain a fidelity bond subject to the requirements of such exchange that are equal to or greater than the requirements set forth in the rule.25 Additionally, consistent with NYSE Rule Interpretation 319/01, FINRA Rule 4360 exempts from the fidelity bond requirements any firm that acts solely as a Designated Market Maker (DMM), floor broker or registered floor trader and does not conduct business with the public.26

      FINRA Rule 4360 does not maintain the exemption in NASD Rule 3020(e) for a one-person firm.27 Historically, a sole proprietor or sole stockholder member was excluded from the fidelity bond requirements based upon the assumption that such firms were one-person shops and, therefore, could not obtain coverage for their own acts. FINRA has determined that these firms can and often do acquire fidelity bond coverage, even though it is currently not required, since all claims (irrespective of firm size) are likely to be paid or denied on a facts-and-circumstances basis. In addition, FINRA believes that each Insuring Agreement required by FINRA Rule 4360 has the potential to benefit a one-person firm.28 Moreover, FINRA believes that requiring all SIPC member firms, regardless of size or structure, to maintain fidelity bond coverage promotes investor protection objectives and mitigates the effects of unforeseen losses.

      Effective Date

      FINRA Rule 4360 takes effect on January 1, 2012. Member firms subject to the rule (including a firm that signs a multi-year insurance policy) must have a fidelity bond in place as of January 1, 2012, that meets all of the requirements set forth in FINRA Rule 4360. Firms should contact their fidelity bond insurance providers in advance of the effective date of the rule to ensure that necessary updates to their policies are in place as of the effective date.


      1 See Securities Exchange Act Release No. 63961 (February 24, 2011), 76 FR 11542 (March 2, 2011) (Order Approving Proposed Rule Change; File No. SR-FINRA-2010-059).

      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 memberfirms, 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). For convenience, the Incorporated NYSE Rules are referred to as the NYSE Rules.

      3 FINRA Rule 4360 replaces NASD Rule 3020 and the corresponding provisions in NYSE Rule 319 and its Interpretation. Accordingly, effective January 1, 2012, NASD Rule 3020 and NYSE Rule 319 (and its Interpretation) will be deleted from the Transitional Rulebook.

      4 See FINRA Rule 4360(a)(1).

      5 See FINRA Rule 4360(a)(3).

      6 Since 1982, firms electing to acquire coverage through the FINRA-sponsored Insurance Program (Sponsored Program) have been provided with the SDBB. It is the "default" insurance for FINRA memberfirms in that when a firm completes the application for the Sponsored Program, they are applying for the SDBB.

      7 See FINRA Rule 4360.02.

      8 FINRA has been advised by insurance industry representatives that the alternative coverage requirement is necessary for firms that, for example, have had a covered loss paid by an insurer within the past five years or firms that may present certain risk factors that would prevent an insurer from offering per loss coverage without an aggregate limit of liability.

      9 See FINRA Rule 4360(a)(1)(A)–(F).

      10 FINRA has been advised by insurance industry representatives that the rule change does not substantively change what is required to be covered by the bond. For example, previous versions of the SDBB and Form 14 included a separate Insuring Agreement for misplacement; however, in the current versions of the bonds, this coverage is included in both "on premises" and "in transit" coverage.

      11 See NASD Rule 3020(a)(4) and (a)(5), and NYSE Rule 319(d)(ii)(B) and (C), and (e)(ii)(B) and (C).

      12 Firms may elect to carry additional, optional Insuring Agreements not required by FINRA Rule 4360 for an amount less than 100 percent of the minimum required bond coverage.

      13 FINRA Rule 4360.01 defines the term "substantially modified" as "any change in the type or amount of fidelity bonding coverage, or in the exclusions to which the bond is subject, or any other change in the bond such that it no longer complies with the requirements of this Rule."

      14 See FINRA Rule 4360(a)(2) and (e).

      15 See FINRA Rule 4360(b)(2).

      16 See FINRA Rule 4360(b)(1).

      17 See FINRA Rule 4360(b)(1).

      18 See FINRA Rule 4360(b)(3).

      19 FINRA notes that a firm may elect, subject to availability, a deductible of less than 10 percent of the coverage purchased.

      20 FINRA Rule 4360 eliminates the current concept of an "excess deductible" linked to a member firm's required minimum bond requirement in NASD Rule 3020 and bases such deduction from net worth on coverage purchased by the firm.

      21 See FINRA Rule 4360(c).

      22 See FINRA Rule 4360(d)(1).

      23 See FINRA Rule 4360(d)(2).

      24 See FINRA Rule 4360(d)(3).

      25 See FINRA Rule 4360(f)(1)(A). In general, the notification provisions of the corresponding exchange rules (i.e., cancellation rider and notification upon cancellation, termination or substantial modification of the bond) require notification to the respective exchange rather than to FINRA. Accordingly, the practical effect for a firm that avails itself of the exemption is that such firm must maintain a fidelity bond subject to the same or greater requirements as in FINRA Rule 4360; however, such firm would be exempt from the requirement that FINRA be notified of changes to the bond and would alternatively comply with the notification provisions of the respective exchange.

      26 See FINRA Rule 4360(f)(1)(B). See also Securities Exchange Act Release No. 58845 (October 24, 2008), 73 FR 64379 (October 29, 2008) (Order Approving File No. SR-NYSE-2008-46). In this rule filing, the role of the specialist was altered in certain respects and the term "specialist" was replaced with the term "Designated Market Maker."

      27 A one-person member (that is, a firm owned by a sole proprietor or stockholder that has no other associated persons, registered or unregistered) has no "employees" for purposes of NASD Rule 3020, and therefore such a firm currently is not subject to the fidelity bonding requirements. Conversely, a firm owned by a sole proprietor or stockholder that has other associated persons has "employees" for purposes of NASD Rule 3020, and currently is, and will continue to be, subject to the fidelity bonding requirements.

      28 Insuring Agreement A—Fidelity is premised on the acts of an "employee" of the insured, which is currently broadly defined in the SDBB to include, among others, an officer or other employee of the insured, while employed in, at or by any of the insured's offices or premises, an attorney retained by the insured while performing legal services for the insured and any natural person performing acts coming within the scope of the usual duties of an officer or employee of the insured, including any persons provided by an employment contractor. Based on this definition, FINRA believes that while a sole proprietor or sole stockholder may not have other associated persons or registered persons, it may have "employees" for purposes of a fidelity bond and therefore may benefit from Fidelity coverage (e.g., outside counsel). Insuring Agreements B through F in FINRA Rule 4360 (i.e., those covering property losses on premises or in transit, forgery and alteration, securities and counterfeit currency) are premised on losses suffered by the insured that are not limited to the acts of an "employee."


      ATTACHMENT A

      Below is the text of the new FINRA rule.

      * * * * *

      4360. Fidelity Bonds
      (a) General Provision
      (1) Each member required to join the Securities Investor Protection Corporation shall maintain blanket fidelity bond coverage which provides against loss and has Insuring Agreements covering at least the following:
      (A) Fidelity
      (B) On Premises
      (C) In Transit
      (D) Forgery and Alteration
      (E) Securities
      (F) Counterfeit Currency
      (2) The fidelity bond must include a cancellation rider providing that the insurance carrier will use its best efforts to promptly notify FINRA in the event the bond is cancelled, terminated or substantially modified.
      (3) A member's fidelity bond must provide for per loss coverage without an aggregate limit of liability.
      (b) Minimum Required Coverage
      (1) A member with a net capital requirement of less than $250,000 must maintain minimum fidelity bond coverage for all Insuring Agreements required by paragraph (a) of this Rule of the greater of (A) 120% of the member's required net capital under SEA Rule 15c3-1 or (B) $100,000. A member with a net capital requirement of $250,000 or more must maintain minimum fidelity bond coverage for all Insuring Agreements required by paragraph (a) of this Rule in accordance with the following table:

      Net Capital Requirement under SEA Rule 15c3-1 Minimum Coverage
      250,000–300,000 600,000
      300,001–500,000 700,000
      500,001–1,000,000 800,000
      1,000,001–2,000,000 1,000,000
      2,000,001–3,000,000 1,500,000
      3,000,001–4,000,000 2,000,000
      4,000,001–6,000,000 3,000,000
      6,000,001–12,000,000 4,000,000
      12,000,001 and above 5,000,000
      (2) At a minimum, a member must maintain fidelity bond coverage for any person associated with the member, except directors or trustees who are not performing acts within the scope of the usual duties of an officer or employee.
      (3) Any defense costs for covered losses must be in addition to the minimum coverage requirements as set forth in paragraph (b)(1) of this Rule.
      (c) Deductible Provision

      A provision may be included in a fidelity bond to provide for a deductible of up to 25% of the coverage purchased by a member. Any deductible amount elected by the member that is greater than 10% of the coverage purchased by the member must be deducted from the member's net worth in the calculation of its net capital for purposes of SEA Rule 15c3-1. If the member is a subsidiary of another FINRA member, this amount may be deducted from the parent's rather than the subsidiary's net worth, but only if the parent guarantees the subsidiary's net capital in writing.
      (d) Annual Review of Coverage
      (1) A member, including a member that signs a multi-year insurance policy, shall, annually as of the yearly anniversary date of the issuance of the fidelity bond, review the adequacy of its coverage and make any required adjustments, as set forth in paragraphs (d)(2) and (d)(3) of this Rule.
      (2) A member's highest net capital requirement during the preceding 12-month period, based on the applicable method of computing net capital (dollar minimum, aggregate indebtedness or alternative standard), shall be used as the basis for determining the member's required minimum fidelity bond coverage for the succeeding 12-month period. For the purpose of this paragraph, the "preceding 12-month period" shall include the 12-month period that ends 60 days before the yearly anniversary date of a member's fidelity bond.
      (3) A member that has only been in business for one year and elected the aggregate indebtedness ratio for calculating its net capital requirement may use, solely for the purpose of determining the adequacy of its fidelity bond coverage for its second year, the 15 to 1 ratio of aggregate indebtedness to net capital in lieu of the 8 to 1 ratio (required for broker-dealers in their first year of business) to calculate its net capital requirement. Notwithstanding the above, such member shall not carry less minimum bonding coverage in its second year than it carried in its first year.
      (e) Notification of Change

      A member shall immediately advise FINRA in writing if its fidelity bond is cancelled, terminated or substantially modified.
      (f) Exemptions
      (1) The requirements of this Rule shall not apply to:
      (A) members that maintain a fidelity bond as required by a national securities exchange, registered with the SEC under Section 6 of the Exchange Act, provided that the member is in good standing with such national securities exchange and the fidelity bond requirements of such exchange are equal to or greater than the requirements of this Rule; and
      (B) members whose business is solely that of a Designated Market Maker, Floor broker or registered Floor trader and who does not conduct business with the public.
      (2) Any member may apply for an exemption, pursuant to the Rule 9600 Series, from the requirements of paragraphs (d)(2) and (d)(3) of this Rule. An exemption may be granted, at the discretion of FINRA, upon a showing of good cause, including a substantial change in the circumstances or nature of the member's business that would result in a lower net capital requirement.

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

      .01 Definitions. For purposes of this Rule, the term "substantially modified" shall mean any change in the type or amount of fidelity bonding coverage, or in the exclusions to which the bond is subject, or any other change in the bond such that it no longer complies with the requirements of this Rule.
      .02 Alternative Coverage. A member that does not qualify for blanket fidelity bond coverage as required by paragraph (a)(3) of this Rule shall maintain substantially similar fidelity bond coverage in compliance with all other provisions of this Rule, provided that the member maintains written correspondence from two insurance providers stating that the member does not qualify for the coverage required by paragraph (a)(3) of this Rule. The member must retain such correspondence for the period specified by SEA Rule 17a-4(b)(4).

    • 11-20 SEC Approves Amendments to Transaction Reporting and Trading Activity Fee Rules Related to the Reporting of Asset-Backed Securities Transactions; Effective Date: May 16, 2011

      View PDF

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 6710
      FINRA Rule 6730
      FINRA Rule 6760
      FINRA Rule 7730
      FINRA By-Laws, Schedule A, Section 1
      Regulatory Notice 10-55
      Suggested Routing

      Compliance
      Corporate Finance
      Government Securities
      Institutional
      Internal Audit
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Training
      Key Topics

      Asset-Backed Securities
      Notification
      Securitized Products
      TRACE-Eligible Securities
      TRACE Reporting Fees
      Trading Activity Fee
      Transaction Reporting

      Executive Summary

      The SEC approved proposed amendments to transaction reporting and notification requirements in the FINRA Rule 6700 Series (TRACE rules) and reporting fees in FINRA Rule 7730, which relate primarily to Asset-Backed Securities,1 and the method of calculating the Trading Activity Fee (TAF) for such securities in Schedule A of the FINRA By-Laws.2

      The effective date is May 16, 2011. The amended text of Schedule A of the FINRA By-Laws and the rules is set forth at www.finra.org/notices/11-20.

      Questions regarding this Notice should be directed to:

      •  Brant Brown, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6927 (regarding TAF);
      •  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, OGC, at (202) 728-8985.

      Background & Discussion

      FINRA's TRACE rules provide for the reporting of transactions in TRACE-Eligible Securities to TRACE, and the dissemination of transaction information, with some exceptions. TRACE reporting and data fees are set forth in FINRA Rule 7730. The TAF, a regulatory fee FINRA uses to fund its member regulation activities—which include examinations, financial monitoring and FINRA's policymaking, rulemaking and enforcement activities—is set forth in Schedule A of the FINRA By-Laws.

      In February 2010, the SEC approved a rule filing (the TRACE ABS filing)3 which:

      •  amends the TRACE rules to classify asset-backed securities, mortgage-backed securities and other similar securities (collectively, Asset-Backed Securities or ABS) as TRACE-Eligible Securities;
      •  requires that transactions in ABS be reported to TRACE;
      •  modifies certain other reporting requirements and notification provisions; and
      •  in FINRA Rule 7730, establishes reporting fees for transactions in ABS.

      As previously announced in Regulatory Notice 10-55 (October 2010), the above-referenced rule changes in the TRACE ABS filing become effective on May 16, 2011.4

      ABS Technical Corrections Filing

      On April 28, 2011, the SEC approved additional amendments to the TRACE rules and FINRA Rule 7730, which, in large part, address issues relating to the reporting of, and fees applicable to, ABS transactions. The amendments to the TRACE rules and FINRA Rule 7730 include:

      •  adding the defined term "Securitizer"; incorporating minor amendments to clarify, simplify or conform the defined terms "TRACE-Eligible Security," "Reportable TRACE Transaction," "Agency Debt Security," "Asset-Backed Security" and "TRACE System Hours"; and deleting the defined terms "Issuing Entity" and "Sponsor" in FINRA Rule 6710;
      •  renumbering as FINRA Rule 6730(a)(3) the ABS reporting requirements previously set forth in FINRA Rule 6730(a)(6);
      •  re-setting the expiration of the Pilot Program for reporting ABS transactions to provide that the Pilot Program will expire on Friday, November 18, 2011, in FINRA Rule 6730(a) (3)(A)(i);
      •  consolidating and simplifying reporting requirements for ABS transactions that are executed other than during TRACE System Hours in FINRA Rule 6730(a)(3)(B)(ii);
      •  adding alternative reporting requirements for ABS transactions that are collateralized mortgage obligation (CMO) or real estate mortgage investment conduit (REMIC) transactions that occur prior to the issuance of the CMO or REMIC (called pre-issuance CMOs/REMICs) as:
      1. FINRA Rule 6730(a)(3)(C)(i) during the Pilot Program; and
      2. FINRA Rule 6730(a)(3)(C)(ii) after the expiration of the Pilot Program;
      •  simplifying how settlement is reported for ABS transactions by deleting the requirement to select an indicator that the transaction will be settled regular way (or not settled regular way) in FINRA Rule 6730(d)(4)(B)(ii);
      •  adding notification requirements to apply to Securitizers of ABS and alternative notification requirements for pre-issuance CMOs/REMICs in FINRA Rule 6760; and
      •  adding the Financial Information eXchange (FIX) as a method to report transactions to TRACE and establish a system-related FIX fee in FINRA Rule 7730.

      In addition, FINRA incorporates additional minor amendments to the FINRA Rule 6700 Series and FINRA Rule 7730, including renumbering and conforming the text of parallel reporting provisions in FINRA Rule 6730(a).

      TAF

      On March 4, 2011, the SEC approved amendments to Section 1 of Schedule A to the FINRA By-Laws to provide a method of calculating the TAF for ABS transactions based on the "reported value of the sale" of such securities. Although the method for calculating the TAF will differ among TRACE-Eligible Securities due to differences in how size (volume) is reported to TRACE and TRACE system differences, for all TRACE-Eligible Securities, ultimately, the TAF is assessed based on the size of the transaction.

      Currently, when reporting the size (volume) of a transaction other than an ABS, the number of bonds is reported and the TRACE system, which is programmed to reflect that one bond equals $1,000 par value, calculates the size (expressed as total par value) of the transaction (e.g., 10 bonds x $1,000 = $10,000). Based on this reporting structure, the TAF is assessed on a per-bond basis, which indirectly is an assessment based on size, as the number of bonds is a proxy for the size of a transaction in $1,000 increments.

      The revisions to Section 1 of Schedule A to the FINRA By-Laws provide a method of calculating the TAF for sales of ABS based on the "reported value of the sale" of the transaction. When a member reports a transaction in an ABS where the par value (or original principal value or original face value) does not decrease (or in some circumstances, increase) over time due to the amortization of assets underlying the security, the total par value is reported to TRACE (and not the number of bonds, even if ascertainable) as required under FINRA Rule 6730(d)(2), and the TAF is assessed based upon the total par value reported.5 However, the requirements to report the size (volume) of an ABS differ if the security amortizes over time. In the sale of an ABS where the original face value (or original principal value) is anticipated to decrease (or increase) over time due to the amortization of assets underlying the security, such as in the sale of a mortgage-backed security, size (volume) is not specifically reported, but is calculated, and the TAF is assessed, by multiplying (a) the reported original face value times (b) the applicable Factor. The Factor is either reported by the member, or, in most cases, is incorporated in the TRACE system by FINRA and not reported by the member as provided in Rule 6730(d)(2).6 The rate is $0.00000075 times the size of the transaction as reported to TRACE, with a maximum charge of $0.75 per trade.

      Effective Date

      The changes to the TRACE rules, FINRA Rule 7730 and Section 1 of Schedule A to the FINRA By-Laws become effective on May 16, 2011 (the same day that the rule changes in the TRACE ABS filing become effective).


      1 See Securities Exchange Act Release No. 64364 (April 28, 2011),__FR______(May__, 2011) (SEC Order Approving File No. SR-FINRA-2011-012).

      2 See Securities Exchange Act Release No. 64041 (March 4, 2011), 76 FR 13248 (March 10, 2011) (SEC Order Approving File No. SR-FINRA-2011-004).

      3 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).

      4 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-2010-054to Extend the Operational Date of SR-FINRA- 2009-065) and Regulatory Notice 10-55 (October 2010).

      5 For example, the size of a $100,000 parvalue transaction in an ABS that does not amortize overtime is reported to TRACE as $100,000. In contrast, a corporate bond transaction of $100,000 par value is reported to TRACE as 100 bonds. See FINRA Rule 6730(d)(2).

      6 If an ABS amortizes overtime, a member must report the Factor only if the Factor that the member uses to execute the transaction is not the most current Factor publicly available for the ABS at the Time of Execution. When the Factor's the most current Factor publicly available, the member is not required to report it because FINRA incorporates such Factors in the TRACE system. A member must always reportthe original face value. See FINRA Rule 6730(d)(2).

    • 11-19 SEC Approves Consolidated FINRA Rules Governing Books and Records; Effective Date: December 5, 2011

      View PDF

      Books and Records

      Regulatory Notice
      Notice Type

      Consolidated FINRA Rulebook
      Rule Approval
      Referenced Rules & Notices

      E-Sign Act
      FINRA Rule 2070
      FINRA Rules 2268, 4511, 4512, 4513, 4514, 4515, 5340 and 7440
      FINRA Rule 12904
      Information Notice 3/12/08
      Investment Advisers Act
      NASD Rules 2510 and 3110
      NYSE Rule 410
      NYSE Rule Interpretations 410/01 and 410/02
      NYSE Rule 440
      Regulatory Notices 09-63 and 11-05
      SEA Rule 17a-3
      SEA Rule 17a-4
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Account Name and Designation
      Books and Records
      Customer Account Information
      Customer Complaints
      Electronic Signature and Approval
      Investment Adviser Orders
      Negotiable Instruments
      Pre-Time Stamping
      Predispute Arbitration Agreements
      Recording of Order Information
      Retention Requirements

      Executive Summary

      The SEC approved FINRA's proposal to adopt rules governing books and records1 for the consolidated FINRA rulebook.2 The new rules, FINRA Rules 2268, 4511, 4512, 4513, 4514, 4515, 5340 and 7440(a)(4), are based in large part on NASD Rule 3110, NYSE Rule 440 and NYSE Rule Interpretations 410/01 and 410/02.

      The text of the new rules is set forth in Attachment A. The rules take effect on December 5, 2011.

      Questions regarding this Notice should be directed to Afshin Atabaki, Assistant General Counsel, Office of General Counsel, at (202) 728-8902.

      Background & Discussion

      The new rules, which are modeled after NASD Rule 3110, NYSE Rule 440 and NYSE Rule Interpretations 410/01 and 410/02, require member firms to make and preserve certain books and records to show compliance with applicable securities laws, rules and regulations—and to enable FINRA and SEC staffs to conduct effective examinations. In general, the new rules streamline, strengthen and clarify existing requirements, as explained below.3

      General Requirements

      FINRA Rule 4511, which is based on the general recordkeeping requirements of NASD Rule 3110(a) and NYSE Rule 440, clarifies that firms are obligated to: (1) make and preserve books and records as required under the rules of FINRA, the Securities Exchange Act (SEA) and the applicable SEA rules;4 and (2) preserve the books and records required to be made pursuant to the FINRA rules in a format and media that complies with SEA Rule 17a-4.5

      Additionally, FINRA Rule 4511 requires firms to preserve for a period of at least six years those FINRA books and records for which there is no specified retention period under the FINRA rules or applicable SEA rules.6 This six-year retention period is a default retention period for those FINRA rules that require firms to preserve certain books and records, but do not specify a retention period, and where there is no retention period specified under the SEA rules. In the absence of contrary guidance in a rule, if the books and records pertain to an account, the retention period is for six years after the date the account is closed; otherwise, the retention period is for six years after such books and records are made.

      Customer Account Information

      FINRA Rule 4512 requires firms to maintain certain information relating to customer accounts. The new rule is based on existing requirements in NASD Rule 3110(c), with several changes as described below.

      The new rule requires firms to maintain the name of the associated person, if any, responsible for the account, rather than requiring firms to maintain the signature of the registered representative introducing the account.7 Where a member firm designates multiple individuals as being responsible for an account, the firm is required to maintain each of their names and a record indicating the scope of their responsibilities with respect to the account. For purposes of the rule, it is the member firm's obligation to determine whether a particular individual is responsible for the account based on the scope of the individual's activities with respect to that account.

      The new rule continues to require a firm to maintain the signature of a partner, officer or manager of the firm with respect to an account,8 but it clarifies that the purpose of this signature is to denote that the account has been accepted in accordance with the firm's policies and procedures for acceptance of accounts.9 The signature also serves to validate the identity of the named associated person, if any. The rule does not require a partner, officer or manager to provide any particular representations. Further, this signature requirement may be satisfied through the use of electronic means. In this regard, FINRA will consider a valid electronic signature to be any electronic mark that clearly identifies the signatory and is otherwise in compliance with the Electronic Signatures in Global and National Commerce Act (E-Sign Act), the guidance issued by the SEC relating to the E-Sign Act10 and the guidance provided by FINRA through its interpretive letters,11 which address electronic approval processes generally.

      With respect to a discretionary account maintained by a member firm, the new rule requires firms to obtain the manual dated signature of each named, natural person authorized to exercise discretion in the account.12 For retention purposes, firms may choose to maintain and preserve the signature record on electronic storage media consistent with SEA Rule 17a-4(f). The new rule no longer requires firms to record the date discretion was granted,13 or to record the age or approximate age of the customer in connection with exempted securities. The new rule also clarifies that: (1) the requirements of the rule do not apply to investment discretion granted by a customer as to the price at which or the time to execute an order given by the customer for the purchase or sale of a definite dollar amount or quantity of a specified security; and (2) nothing in the rule shall be construed as allowing member firms to maintain discretionary accounts or exercise discretion in such accounts except to the extent permitted under the federal securities laws.

      For an account that was opened pursuant to a prior FINRA rule, FINRA Rule 4512 requires member firms to update the information for such an account in compliance with the new rule whenever they update the account information in the course of their routine and customary business, or as required by other applicable laws or rules.14 FINRA believes that to promote greater consistency and uniformity of account record information, it is necessary that firms update the account information in such a manner.

      Finally, the new rule includes the following additional provisions:

      •  It requires firms to preserve: (1) any customer account information that subsequently is updated for at least six years after that update; and (2) the last update to any customer account information, or the original account information if there are no updates, for at least six years after the account is closed.15
      •  It reminds firms that they may be subject to additional recordkeeping requirements under the SEA.16
      •  It also reminds firms of their obligation to comply with the requirements of FINRA Rule 2070 (Transactions Involving FINRA Employees).17
      •  It provides general explanations of the terms "maintain" and "preserve" for purposes of FINRA Rule 4512 only.18

      Records of Written Customer Complaints

      Consistent with existing requirements under NASD Rule 3110, FINRA Rule 4513 addresses a member's obligation to preserve records of written customer complaints at each office of supervisory jurisdiction (OSJ)19 and defines the term "customer complaint" for purposes of this requirement.20

      The new rule clarifies that the obligation to keep customer complaint records in each OSJ applies only to complaints that relate to that office, including complaints that relate to activities supervised from that office, and provides that firms may maintain the required records at the OSJ or make them promptly available at such office upon FINRA's request. Lastly, to take into account FINRA's four-year routine examination cycle for certain member firms, FINRA Rule 4513 requires that firms preserve the customer complaint records for a period of at least four years.21

      Authorization Records for Negotiable Instruments

      FINRA Rule 4514 provides, similar to NASD Rule 3110(g), that member firms or associated persons must get a customer's express written authorization before obtaining from a customer, or submitting for payment, a negotiable instrument drawn on the customer's checking, savings, share or similar account. As is the case today, the new rule requires that firms preserve the written authorization and provides that the customer's signature on the negotiable instrument would satisfy the authorization requirement, in which case the member firm is not required to preserve that negotiable instrument.

      However, FINRA Rule 4514 clarifies that where the required authorization is separate from the negotiable instrument, firms must preserve that required authorization. The new rule further clarifies that the applicable retention period is three years following the date such authorization expires since a customer authorization may remain in effect beyond three years from the date of the request.22

      Changes in Account Name or Designation

      FINRA Rule 4515, which is modeled after NASD Rule 3110(j) and NYSE Rule 410, requires that, before a customer order is executed, the account name or designation must be placed upon the order form or other similar record for the transaction,23 and it addresses the approval and documentation procedures for changes in such account name or designation. FINRA Rule 4515 clarifies that with respect to any change in account name or designation that takes place prior to execution of the trade, the essential facts the principal relied on in approving such change must be documented in writing prior to execution. Firms may use electronic means to satisfy the approval and documentation requirements of FINRA Rule 4515, consistent with the guidance above regarding the use of electronic means to denote acceptance of accounts under FINRA Rule 4512.

      Additionally, FINRA Rule 4515.01, which is generally based on NYSE Rule Interpretation 410/02, provides that when accepting orders from investment advisers, the member firm may allow such investment advisers to make allocations on their orders for customers on whose behalf the investment advisers submit the orders, as long as the firm receives specific account designations or customer names from such investment advisers by noon of the next business day following the trading session.24 FINRA Rule 4515.01 is not limited to block orders, but it only applies where there is more than one customer for any particular order. Moreover, the provision extends to investment advisers that are registered under the Investment Advisers Act or that, but for Investment Advisers Act Section 203(b) or 203A, would be required to register under the Investment Advisers Act.25 The provision does not extend to accounts handled by individual registered representatives of firms who otherwise exercise discretionary authority over accounts pursuant to NASD Rule 2510.

      Lastly, FINRA Rule 4515.01 clarifies that member firms may not knowingly facilitate the allocation of orders from investment advisers in a manner other than in compliance with both (i) the investment adviser's intent at the time of trade execution to allocate shares on a percentage basis to the participating accounts and (ii) the investment adviser's fiduciary duty with respect to allocations for such participating accounts, including but not limited to allocations based on the performance of a transaction between the time of execution and the time of allocation. The "knowingly facilitate" standard means that a broker-dealer may not act recklessly or with knowledge in facilitating an investment adviser's breach of its fiduciary duty to its clients, and compliance with that standard turns on the facts and circumstances.

      Predispute Arbitration Agreements

      FINRA Rule 2268 requires, among other things, that predispute arbitration agreements contain certain highlighted disclosures so that customers are advised about what they are agreeing to when they sign them. The new rule continues the requirements of NASD Rule 3110(f) and updates the disclosure language to reflect amendments to FINRA Rule 12904, which requires arbitrators to provide an explained decision to the parties in eligible cases26 if there is a joint request by all parties at least 20 days before the first scheduled hearing date.27 The disclosure provision regarding explained decisions will apply prospectively to predispute arbitration agreements entered into on or after December 5, 2011, the effective date of FINRA Rule 2268.28

      Order Audit Trail System (OATS) Recordkeeping Requirements

      FINRA Rule 7440(a)(4) sets forth the OATS recordkeeping requirements for member firms that are "Reporting Members," as defined in the OATS rules, for orders received or executed at their trading departments. The new rule is modeled after NASD Rule 3110(h).

      Pre-Time Stamping

      FINRA Rule 5340 states that pre-time stamping of order tickets in connection with block positioning is contrary to FINRA Rule 4511. This requirement is based on a similar requirement in NYSE Rule Interpretation 410/01.


      1 See Securities Exchange Act Release No. 63784 (January 27, 2011), 76 FR 5850 (February 2, 2011) (Order Approving Proposed Rule Change; File No. SR-FINRA-2010-052) (Approval Order).

      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). For convenience, the Incorporated NYSE Rules are referred to as the NYSE Rules.

      3 This Notice highlights the most significant changes. For a detailed description of all the changes, firms should review the Approval Order.

      4 See FINRA Rule 4511(a). In contrast, the general recordkeeping obligation in NASD Rule 3110(a) extends to all applicable laws, rules and regulations.

      5 See FINRA Rule 4511(c).

      6 See FINRA Rule 4511(b).

      7 See FINRA Rule 4512(a)(1)(C). Member firms would continue to be subject to any additional requirements imposed by SEA Rule 17a-3. For example, SEA Rule 17a-3(a)(17) requires that for each account with a natural person, the account record must indicate whether it has been signed by the associated person (if any) responsible for the account. However, this requirement only applies to accounts for which the member is, or within the past 36 months has been, required to make a suitability determination under the federal securities laws or the requirements of a self-regulatory organization of which it is a member.

      8 See FINRA Rule 4512(a)(1)(D).

      9 NASD Rule 3110(c) simply provides that firms are required to maintain the signature of the partner, officer, or manager "who accepts the account."

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

      11 See, e.g., Letter to Jeffrey W. Kilduff, O'Melveny & Myers, LLP, from Nancy Libin, NASD, dated July 5, 2001.

      12 See FINRA Rule 4512(a)(3). NASD Rule 3110(c) requires firms to obtain the signature of each person authorized to exercise discretion in the account. FINRA will address the requirements applicable to other types of accounts in which a person is authorized by a customer to act on the customer's behalf in the context of the proposed changes to NASD Rule 2510 (Discretionary Accounts). See Regulatory Notice 09-63 (November 2009) (Proposed Consolidated FINRA Rule Governing Discretionary Accounts and Transactions).

      13 Pursuant to NASD Rule 2510, firms would still be required to obtain the customer's prior written authorization. As part of the proposed changes to NASD Rule 2510, FINRA is proposing to require firms to obtain the customer's "dated" prior written authorization. See Regulatory Notice 09-63.

      14 See FINRA Rule 4512(b).

      15 See FINRA Rule 4512.01.

      16 See FINRA Rule 4512.02.

      17 See FINRA Rule 4512.03. FINRA Rule 2070 plays a vital role in helping FINRA monitor whether employees are abiding by trading restrictions imposed by the FINRA Code of Conduct.

      18 See FINRA Rule 4512.04.

      19 See FINRA Rule 4513(a).

      20 See FINRA Rule 4513(b).

      21 Currently, firms are required to preserve these records for a period of at least three years. See SEA Rules 17a-3(a)(18) and 17a-4(b)(4).

      22 NASD Rule 3110(g) requires firms to preserve the required written authorization (other than a copy of a negotiable instrument signed by the customer) for a period of three years.

      23 See also SEA Rule 17a-3(a)(6).

      24 NYSE Rule Interpretation 410/02 only applies to block orders and requires members to obtain the required information by the end of the business day.

      25 NYSE Rule Interpretation 410/02 only applies to investment advisers that are either registered under the Investment Advisers Act or subject to state regulation pursuant to Section 203A of the Investment Advisers Act.

      26 Pursuant to FINRA Rule 12904(g)(6), the requirement does not apply to simplified cases decided without a hearing under FINRA Rule 12800 or to default cases conducted under FINRA Rule 12801.

      27 See FINRA Rule 2268(a)(4).

      28 FINRA is considering additional changes to FINRA Rule 2268 to reflect amendments to the Code of Arbitration Procedure for Customer Disputes allowing customers to choose an all public arbitration panel. See Regulatory Notice 11-05 (February 2011) (Customer Option to Choose an All Public Arbitration Panel in All Cases).


      ATTACHMENT A

      Below is the text of the new FINRA rules.

      * * * * *

      2268. Requirements When Using Predispute Arbitration Agreements for Customer Accounts

      (a) Any predispute arbitration clause shall be highlighted and shall be immediately preceded by the following language in outline form.

      This agreement contains a predispute arbitration clause. By signing an arbitration agreement the parties agree as follows:
      (1) All parties to this agreement are giving up the right to sue each other in court, including the right to a trial by jury, except as provided by the rules of the arbitration forum in which a claim is filed.
      (2) Arbitration awards are generally final and binding; a party's ability to have a court reverse or modify an arbitration award is very limited.
      (3) The ability of the parties to obtain documents, witness statements and other discovery is generally more limited in arbitration than in court proceedings.
      (4) The arbitrators do not have to explain the reason(s) for their award unless, in an eligible case, a joint request for an explained decision has been submitted by all parties to the panel at least 20 days prior to the first scheduled hearing date.
      (5) The panel of arbitrators will typically include a minority of arbitrators who were or are affiliated with the securities industry.
      (6) The rules of some arbitration forums may impose time limits for bringing a claim in arbitration. In some cases, a claim that is ineligible for arbitration may be brought in court.
      (7) The rules of the arbitration forum in which the claim is filed, and any amendments thereto, shall be incorporated into this agreement.
      (b)
      (1) In any agreement containing a predispute arbitration agreement, there shall be a highlighted statement immediately preceding any signature line or other place for indicating agreement that states that the agreement contains a predispute arbitration clause. The statement shall also indicate at what page and paragraph the arbitration clause is located.
      (2) Within thirty days of signing, a copy of the agreement containing any such clause shall be given to the customer who shall acknowledge receipt thereof on the agreement or on a separate document.
      (c)
      (1) A member shall provide a customer with a copy of any predispute arbitration clause or customer agreement executed between the customer and the member, or inform the customer that the member does not have a copy thereof, within ten business days of receipt of the customer's request. If a customer requests such a copy before the member has provided the customer with a copy pursuant to paragraph (b)(2) above, the member must provide a copy to the customer by the earlier date required by this paragraph (c)(1) or by paragraph (b)(2).
      (2) Upon request by a customer, a member shall provide the customer with the names of, and information on how to contact or obtain the rules of, all arbitration forums in which a claim may be filed under the agreement.
      (d) No predispute arbitration agreement shall include any condition that:
      (1) limits or contradicts the rules of any self-regulatory organization;
      (2) limits the ability of a party to file any claim in arbitration;
      (3) limits the ability of a party to file any claim in court permitted to be filed in court under the rules of the forums in which a claim may be filed under the agreement;
      (4) limits the ability of arbitrators to make any award.
      (e) If a customer files a complaint in court against a member that contains claims that are subject to arbitration pursuant to a predispute arbitration agreement between the member and the customer, the member may seek to compel arbitration of the claims that are subject to arbitration. If the member seeks to compel arbitration of such claims, the member must agree to arbitrate all of the claims contained in the complaint if the customer so requests.
      (f) All agreements shall include a statement that "No person shall bring a putative or certified class action to arbitration, nor seek to enforce any pre-dispute arbitration agreement against any person who has initiated in court a putative class action; or who is a member of a putative class who has not opted out of the class with respect to any claims encompassed by the putative class action until: (i) the class certification is denied; or (ii) the class is decertified; or (iii) the customer is excluded from the class by the court. Such forbearance to enforce an agreement to arbitrate shall not constitute a waiver of any rights under this agreement except to the extent stated herein."
      (g) The provisions of this Rule shall become effective on May 1, 2005. The provisions of paragraph (c) shall apply to all members as of the effective date of this Rule regardless of when the customer agreement in question was executed. Otherwise, agreements signed by a customer before May 1, 2005 are subject to the provisions of this Rule in effect at the time the agreement was signed.

      * * * * *

      4510. Books and Records Requirements

      4511. General Requirements

      (a) Members shall make and preserve books and records as required under the FINRA rules, the Exchange Act and the applicable Exchange Act rules.
      (b) Members shall preserve for a period of at least six years those FINRA books and records for which there is no specified period under the FINRA rules or applicable Exchange Act rules.
      (c) All books and records required to be made pursuant to the FINRA rules shall be preserved in a format and media that complies with SEA Rule 17a-4.

      4512. Customer Account Information

      (a) Each member shall maintain the following information:
      (1) for each account:
      (A) customer's name and residence;
      (B) whether customer is of legal age;
      (C) name(s) of the associated person(s), if any, responsible for the account and if multiple individuals are assigned responsibility for the account, a record indicating the scope of their responsibilities with respect to the account;
      (D) signature of the partner, officer or manager denoting that the account has been accepted in accordance with the member's policies and procedures for acceptance of accounts; and
      (E) if the customer is a corporation, partnership or other legal entity, the names of any persons authorized to transact business on behalf of the entity;
      (2) for each account other than an institutional account, and accounts in which investments are limited to transactions in open-end investment company shares that are not recommended by the member or its associated persons, each member shall also make reasonable efforts to obtain, prior to the settlement of the initial transaction in the account, the following information to the extent it is applicable to the account:
      (A) customer's tax identification or Social Security number;
      (B) occupation of customer and name and address of employer; and
      (C) whether customer is an associated person of another member; and
      (3) for discretionary accounts, in addition to compliance with subparagraph (1) and, to the extent applicable, subparagraph (2) above, and NASD Rule 2510(b), the member shall maintain a record of the dated, manual signature of each named, natural person authorized to exercise discretion in the account. This recordkeeping requirement shall not apply to investment discretion granted by a customer as to the price at which or the time to execute an order given by a customer for the purchase or sale of a definite dollar amount or quantity of a specified security. Nothing in this Rule shall be construed as allowing members to maintain discretionary accounts or exercise discretion in such accounts except to the extent permitted under the federal securities laws.
      (b) A member need not meet the requirements of this Rule with respect to any account that was opened pursuant to a prior FINRA rule until such time as the member updates the information for the account either in the course of the member's routine and customary business or as otherwise required by applicable laws or rules.
      (c) For purposes of this Rule, the term "institutional account" shall mean the account of:
      (1) a bank, savings and loan association, insurance company or registered investment company;
      (2) an investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act or with a state securities commission (or any agency or office performing like functions); or
      (3) any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.

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

      .01 Customer Account Information Retention Periods. For purposes of this Rule, members shall preserve a record of any customer account information that subsequently is updated for at least six years after the date that such information is updated. Members shall preserve a record of the last update to any customer account information, or the original account information if there are no updates to the account information, for at least six years after the date the account is closed.
      .02 Additional Customer Account Records Under the Exchange Act. Members should be aware that they may be required to make and preserve additional customer account records as required under Section 17(a) of the Exchange Act and the applicable associated Exchange Act rules.
      .03 Compliance With Rule 2070. With respect to paragraph (a)(2)(B) of this Rule, members should be aware that they have an obligation to comply with the requirements of Rule 2070(a) if they have actual notice that a customer having a financial interest in, or controlling trading in, an account is an employee of FINRA.
      .04 "Maintain" and "Preserve." For purposes of Rule 4512 only, as a general matter, the term "maintain" is used to reflect customer account information that is current or in use. The term "preserve" is used to reflect customer account information that is no longer current or in use.

      4513. Records of Written Customer Complaints

      (a) Each member shall keep and preserve in each office of supervisory jurisdiction either a separate file of all written customer complaints that relate to that office (including complaints that relate to activities supervised from that office) and action taken by the member, if any, or a separate record of such complaints and a clear reference to the files in that office containing the correspondence connected with such complaints. Rather than keep and preserve the customer complaint records required under this Rule at the office of supervisory jurisdiction, the member may choose to make them promptly available at that office, upon request of FINRA. Customer complaint records shall be preserved for a period of at least four years.
      (b) For purposes of this Rule, "customer complaint" means any grievance by a customer or any person authorized to act on behalf of the customer involving the activities of the member or a person associated with the member in connection with the solicitation or execution of any transaction or the disposition of securities or funds of that customer.

      4514. Authorization Records for Negotiable Instruments Drawn From a Customer's Account

      No member or person associated with a member shall obtain from a customer or submit for payment a check, draft or other form of negotiable paper drawn on a customer's checking, savings, share or similar account, without that person's express written authorization, which may include the customer's signature on the negotiable instrument. Where the written authorization is separate from the negotiable instrument, the member shall preserve the authorization for a period of three years following the date the authorization expires. This provision shall not, however, require members to preserve copies of negotiable instruments signed by customers.

      4515. Approval and Documentation of Changes in Account Name or Designation

      Before any customer order is executed, there must be placed upon the order form or other similar record of the member for each transaction, the name or designation of the account (or accounts) for which such order is to be executed. No change in such account name(s) (including related accounts) or designation(s) (including error accounts) shall be made unless the change has been authorized by a qualified and registered principal designated by the member. Such person must, prior to giving his or her approval of the account designation change, be personally informed of the essential facts relative thereto and indicate his or her approval of such change in writing on the order or other similar record of the member. The essential facts relied upon by the person approving the change must be documented in writing and preserved for the period of time and accessibility specified in SEA Rule 17a-4(b). With respect to any change that takes place prior to execution of the trade, the required approval and documentation must take place prior to execution.

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

      .01 Allocations of Orders Made by Investment Advisers. Members may accept orders from investment advisers as described below and allow such investment advisers to make allocations on their orders for customers on whose behalf the investment advisers submit the orders, provided that members receive specific account designations or customer names from such investment advisers by noon of the next business day following the trading session. This exception only applies where there is more than one customer for any particular order.

      In addition, this exception applies to: (a) outside investment advisers; and (b) associated persons of a member who provide investment advisory services on behalf of a member acting as an investment adviser. However, in either instance, the investment adviser must be one who is registered under the Investment Advisers Act or who, but for Investment Advisers Act Section 203(b) or 203A, would be required to register under the Investment Advisers Act. It does not apply to accounts handled by individual registered representatives of members who otherwise exercise discretionary authority over accounts pursuant to NASD Rule 2510. Nothing in this Rule or Supplementary Material may be construed as allowing a member knowingly to facilitate the allocation of orders from investment advisers in a manner other than in compliance with both (i) the investment adviser's intent at the time of trade execution to allocate shares on a percentage basis to the participating accounts and (ii) the investment adviser's fiduciary duty with respect to allocations for such participating accounts, including but not limited to allocations based on the performance of a transaction between the time of execution and the time of allocation.

      * * * * *

      5340. Pre-Time Stamping

      Pre-time stamping of order tickets in connection with block positioning is contrary to Rule 4511.

      * * * * *

      7440. Recording of Order Information

      (a) Procedures
      (1) through (3) No Change.
      (4) With respect to each order that is received or executed at its trading department, each Reporting Member shall record an identification of:
      (A) each registered person who receives the order directly from a customer;
      (B) each registered person who executes the order; and
      (C) the department that originated the order if the order is originated by the member and transmitted manually to another department.
      (5) Maintaining and Preserving Records
      (A) through (B) No Change.
      (b) through (d) No Change.

      * * * * *

    • 11-18 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 2011 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 as such in the document.

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

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

      Questions concerning this Notice should be directed to:

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

    • 11-17 Revised Discovery Guide and Document Production Lists for Customer Arbitration Proceedings; Effective Date: May 16, 2011

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      Arbitration

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      FINRA Rule 12506
      FINRA Rule 12508
      NTM 99-90
      Suggested Routing

      Compliance
      Legal
      Registered Representatives
      Senior Management
      Key Topics

      Arbitration
      Discovery

      Executive Summary

      FINRA is revising the Discovery Guide to expand the guidance it gives to parties and arbitrators on the discovery process and to update the Document Production Lists.1 FINRA is consolidating the Document Production Lists from the 14 current Lists (two general Lists and 12 separate Lists for specific types of claims) to two lists of “presumptively discoverable” documents—one for firms/associated persons to produce and one for customers to produce. Many of the documents on the current Lists are included in the revised Discovery Guide. In addition, under the revised Guide, FINRA is requiring parties to produce additional types of documents that forum users have indicated they need to develop a case.

      The amendments are effective on May 16, 2011, and will apply to all customer cases filed on or after the effective date. The amendments to Rules 12506 and 12508 are set forth in Attachment A, and the revised Discovery Guide is available on our website at www.finra.org/arbitration/discoveryguide.

      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 (DR), at (212) 858-4307 or richard.berry@finra.org; or
      •   Margo A. Hassan, Assistant Chief Counsel, DR, at (212) 858-4481 or margo.hassan@finra.org.

      Background & Discussion

      In 1999, FINRA adopted the Discovery Guide (Guide), which includes Document Production Lists (Lists), for use in customer arbitration proceedings.2 The Guide provides direction on which documents parties should exchange without arbitrator or staff intervention, and the Lists specifically indentify the documents parties should exchange before the hearing, depending on the type of dispute. After years of experience with the Guide, FINRA is revising it to expand the guidance given to parties and arbitrators on the discovery process and to update the Lists.

      FINRA is replacing the current 14 Lists with just two Lists of presumptively discoverable documents: one for firms/associated persons to produce and one for customers to produce. As noted above, many of the documents on the current Lists are included in the revised Guide. In addition, the revised Guide requires parties to produce additional types of documents that users indicated they need to develop a case. Although each item on the Lists (with a few exceptions) will be presumptively discoverable in every customer case, the revised Guide encourages arbitrators to tailor the Guide to the facts and circumstances of each case. FINRA is also making conforming changes to Rules 12506 (Document Production Lists) and 12508 (Objecting to Discovery Requests; Waiver of Objection) that reflect the List consolidations.

      Discovery Guide Introduction

      FINRA is revising the Guide's introduction to expand its guidance to parties and arbitrators on the discovery process generally, and to clarify how arbitrators should apply the Guide in arbitration proceedings. The revised introduction addresses, among other matters:

      •   Flexibility: The parties and arbitrators retain their flexibility in the discovery process. Arbitrators can:
      •   order the production of documents not provided for by the Lists;
      •   order that parties do not have to produce certain documents on the Lists; and
      •   alter the production schedule.
      •   Objections Based on Cost/Burden: A party may object to producing a document on the List because of the cost or burden of production. If a party demonstrates that the cost or burden of production is disproportionate to the need for the document, the arbitrators should determine if the document is relevant or likely to lead to relevant evidence and, if so, the arbitrators should consider whether there are alternatives that can lessen the impact.
      •   Requests for Additional Documents: Arbitrators must use their judgment in considering requests for additional documents and may not deny document requests on the ground that the documents are not expressly listed in the Guide.
      •   Party and Non-Party Production: Only named parties must produce documents pursuant to the guidelines. Non-parties may be required to produce documents pursuant to a subpoena or an order of the arbitrator.
      •   Consideration of Firm Business Models and Customer Claims: Not all firms have the same business operations model and certain items on the Lists may not apply to a particular case when the firm's business model is considered. In addition, certain items on the Customer List may not apply to a particular case depending on the claims asserted.
      •   Electronic Discovery: Electronic files are "documents" within the meaning of the Guide.
      •   Confidentiality: When deciding contested requests for confidentiality orders, arbitrators should consider factors specified in the Guide including, among others, whether disclosure would constitute an unwarranted invasion of personal privacy, or whether the information contains proprietary confidential business plans and procedures or trade secrets.
      •   Privilege: Parties are not required to produce documents that are otherwise subject to an established privilege.
      •   Affirmations: If a party responds that there are no responsive documents in the party's possession, custody or control, the customer or the appropriate person in the brokerage firm who has knowledge must:
      1. state in writing that the party conducted a good faith search;
      2. describe the extent of the search; and
      3. state that, based on the search, there are no requested documents in the party's possession, custody or control.
      •   No Obligation to Create Documents: Parties are not required to create documents in response to items on the Lists.
      •   Admissibility: Production of documents in discovery does not create a presumption that the documents are admissible at the hearing.

      Documents the Firm/Associated Persons Shall Produce in All Customer Cases (List 1)

      Document Production List 1 specifies the presumptively discoverable documents that firms/associated persons are required to produce in customer cases. Subject to the limited exceptions specified in certain List items, firms/associated persons are required to produce every document in every case unless the required production is narrowed either by party agreement or by order of the arbitrator. Highlights of the items follow. See the attached Guide for the full details and requirements of each item, including relevant time frames.

      Item 1: Account record information for the customer parties, documents concerning the customer parties' risk tolerance and agreements with the customer parties.

      Item 2: Correspondence sent to the customer parties or received by the firm/associated persons, and advertising materials sent to customers of the firm.

      Item 3: Documents evidencing any investment or trading strategies used or recommended in the customer parties' accounts.

      Item 4: For claims alleging unauthorized trading, all documents the firm/associated persons relied upon to establish that the customer parties authorized the transactions at issue, all documents relating to the customer parties' authorization of the transactions and all order tickets for the transactions.

      Item 5: Materials the firm and/or associated persons prepared or used and/or provided to the customer parties relating to the transactions or products at issue, and worksheets or notes indicating that the associated persons reviewed or read such documents.

      Item 6: Notes the firm/associated persons made relating to the customer parties and/ or the customer parties' claims, accounts, transactions or products or types of products at issue.

      Item 7: Notes or memoranda evidencing supervisory, compliance or managerial review of the customer parties' accounts or transactions, or of the associated persons assigned to the customer parties' accounts; and correspondence between the customer parties and firm/associated persons relating to the customer parties' claims, accounts, transactions or products or types of products at issue bearing indications of managerial, compliance or supervisory review.

      Item 8: Recordings, telephone logs and notes of telephone calls or conversations about the transactions at issue that occurred between the associated persons and the customer parties, and/or between the firm and the associated persons.

      Item 9: Writings reflecting communications between the associated persons assigned to the customer parties' accounts at issue and members of the firm's compliance department relating to the securities/products at issue and/or the customer parties' claims, accounts or transactions.

      Item 10: Forms RE-3, U4 and U5 and Disclosure Reporting Pages for the associated persons assigned to the customer parties' accounts at issue, customer complaints identified in the forms, and customer complaints filed against the associated persons.

      Item 11: Sections of the firm's manuals relating to the claims alleged, including separate or supplemental manuals governing the duties and responsibilities of the associated persons and supervisors, bulletins the firm issued and the table of contents/index to the manuals/bulletins.

      Item 12: Analyses and reconciliations of the customer parties' accounts, including those relating to reviews of the customer parties' claims, accounts, transactions or the product or types of products at issue.

      Item 13: Exception reports, supervisory activity reviews, concentration reports, active account runs and similar documents produced to review for activity in the customer parties' accounts related to the allegations. For claims alleging failure to supervise, the firm/associated persons must produce the documents listed in this Item that were produced to review for activity in customer accounts handled by associated persons and related to the allegations.

      Item 14: Portions of internal audit reports for the branch in which the customer parties maintained accounts that concern associated persons or the accounts or transactions at issue and discussed alleged improper behavior in the branch against other individuals similar to the improper conduct alleged.

      Item 15: Records of disciplinary action taken against associated persons by any regulator or employer for all sales practice violations or conduct similar to the conduct alleged.

      Item 16: Investigations, charges, or findings by any regulator and the firm/associated persons' responses.

      Item 17: Portions of examination reports or similar reports following an examination or inspection conducted by any regulator that focused on the associated persons or the customer parties' claims, accounts or transactions, or the product or types of products, or that discussed alleged improper behavior in the branch against other individuals similar to the conduct alleged.

      Item 18: Documents related to the case that the firm/associated persons received by subpoena or by document request directed to third parties.

      Item 19: For the transactions at issue, documentation showing the compensation, gross and net, to the associated persons.

      Item 20: For claims related to solicited trading activity, a record of all compensation, including, but not limited to, monthly commission runs for the associated persons.

      Item 21: A record of all agreements pertaining to the relationship between the associated persons and the firm, summarizing the associated persons' compensation arrangement or plan with the firm.

      Item 22: For allegations regarding an insurance product that includes a death benefit, information concerning the customer parties' insurance holdings and recommendations, if any, regarding insurance products.

      Documents the Customer Parties Shall Produce in All Customer Cases (List 2)

      Document Production List 2 specifies the presumptively discoverable documents that customer parties are required to produce in customer cases. Subject to the limited exceptions specified in certain List items, customer parties are required to produce every document in every case unless the required production is narrowed either by party agreement or by order of the arbitrator. Highlights of the items follow. See the attached Guide for the full details and requirements of each item, including relevant time frames.

      Item 1: Customer party federal income tax returns, limited to pages 1 and 2 of Form 1040; Schedules A, B, D and E; and the IRS worksheets related to these schedules, redacted to delete the customer parties' Social Security numbers. Customer parties may redact information relating to medical and dental expenses and names of charities on Schedule A unless the information is related to allegations in the Statement of Claim.

      Item 2: Financial statements, including statements within a loan application, or similar statements of the customer parties' assets, liabilities and/or net worth.

      Item 3: Documents the customer parties received from the firm/associated persons and from entities in which the customer parties invested through the firm/associated persons, including account opening documents and/or forms, prospectuses, research reports, annual and periodic reports, and correspondence.

      Item 4: Account statements for each non-party securities firm where the customer parties maintained an account.

      Item 5: Documents, including agreements and forms, relating to accounts at the firm or transactions with the firm.

      Item 6: Account analyses and reconciliations prepared by or for the customer parties relating to the customer parties' accounts at the firm or transactions with the firm.

      Item 7: Notes, including entries in diaries or calendars, relating to the accounts at the firm or the transactions at issue.

      Item 8: Recordings and notes or logs of telephone calls or conversations about the customer parties' accounts or transactions at issue that occurred between the associated persons and the customer parties, and telephone records evidencing telephone contact between the customer parties and the firm/associated persons.

      Item 9: Correspondence the customer parties sent or received relating to the accounts or transactions at issue.

      Item 10: Previously prepared written statements by persons with knowledge of the facts and circumstances related to the accounts or transactions at issue.

      Item 11: Complaints/Statements of Claim and answers filed in civil actions involving securities and securities arbitration proceedings in which the customer parties have been a party, and all final decisions or awards or non-confidential settlements entered in these matters. If a person is a party to a confidential settlement agreement that by its terms does not preclude identification of the existence of the agreement, the party shall identify the documents comprising the agreement.

      Item 12: Documents showing the customer parties' ownership in or control over any business entity. If the customer parties are trustees, documents showing the accounts over which the customer parties have trading authority.

      Item 13: Documents the customer parties received, including documents found through the customer parties' own efforts, relating to the investments at issue.

      Item 14: For claims alleging unauthorized trading, documents the customer parties relied upon to show that they did not know about or consent to the transactions at issue.

      Item 15: Materials the customer parties received or obtained relating to the claims, transactions or products at issue, and materials received relating to other investment opportunities.

      Item 16: Customer parties' resumes.

      Item 17: Existing descriptions of the customer parties' educational and employment background if not set forth in resumes.

      Item 18: Documents related to the case that the customer parties received by subpoena or by document request directed to third parties.

      Item 19: To the extent that an insurance product that provides a death benefit is included in the Statement of Claim, information received from an insurance sales agent or securities broker relating to such insurance.

      Effective Date

      The amendments are effective on May 16, 2011, and will apply to all customer cases filed on or after the effective date.


      1 Exchange Act Release No. 64166 (April 1, 2011), 76 Federal Register 19155 (April 6, 2011) (File No. SR-FINRA-2010-035).

      2 See Notice to Members (NTM) 99-90 (November 1999).


      Attachment A

      Deletions are in brackets.

      Code of Arbitration Procedure for Customer Disputes

      * * *

      12506. Document Production Lists

      (a) Applicability of Document Production Lists

      When the Director serves the statement of claim, the Director will notify parties of the location of the FINRA Discovery Guide and Document Production Lists on FINRA's Web site, but will provide a copy to the parties upon request. Document Production Lists 1 and 2 describe the documents that are presumed to be discoverable in all arbitrations between a customer and a member or associated person. [Other Document Production Lists may also apply, depending on the specific cause(s) of action alleged.]
      (b) Time for Responding to Document Production Lists
      (1) Unless the parties agree otherwise, within 60 days of the date that the answer to the statement of claim is due, or, for parties added by amendment or third party claim, within 60 days of the date that their answer is due, parties must either:
      •   Produce to all other parties all documents in their possession or control that are described in [the] Document Production Lists 1 and 2[, and any other Document Production List that is applicable based on the cause(s) of action alleged];
      •   Identify and explain the reason that specific documents described in Document Production Lists 1 and 2[, and any other Document Production List that is applicable based on the cause(s) of action alleged,] cannot be produced within the required time, and state when the documents will be produced; or
      •   Object as provided in Rule 12508.
      (2) No change.
      (c) No change.

      * * *

      12508. Objecting to Discovery; Waiver of Objection

      (a) If a party objects to producing any document described in Document Production Lists 1 or 2[, any other applicable Document Production List,] or any document or information requested under Rule 12507, it must specifically identify which document or requested information it is objecting to and why. Objections must be in writing, and must be served on all other parties at the same time and in the same manner. Objections should not be filed with the Director. Parties must produce all applicable listed documents, or other requested documents or information not specified in the objection.
      (b)–(c) No change.

      * * *

    • 11-16 Treatment of Non-Margin Eligible Equity Securities; Effective Date: July 1, 2011

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      Margin Requirements

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      FINRA Rule 4210
      Regulation T
      Regulatory Notice 09-53
      Suggested Routing

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

      Day Trading
      Good Faith Accounts
      Maintenance Loan Value
      Margin Requirements
      Non-Margin Eligible Equity Securities
      Non-Purpose Loans
      Portfolio Margin Accounts
      Regulation T Margin Accounts

      Executive Summary

      This Notice clarifies customer maintenance margin requirements and the application of maintenance loan value for equity securities that do not meet the definition of a margin equity security under Regulation T.1 Firms have until July 1, 2011, to comply with these requirements.

      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, Project Manager, Credit Regulation, at (646) 315-8621.

      Background & Discussion

      Regulation T stipulates that the initial margin requirement for an equity security is 50 percent of the current market value,2 provided the security meets the definition of a margin equity security. This initial requirement is applied at the time a trade is executed. Once the trade has been executed, FINRA imposes a daily maintenance margin requirement, which for long equity securities is generally 25 percent of the current market value.3 In addition, the current maintenance margin requirement for a short equity security is the greater of: (1) $2.50 per share or 100 percent of the current market value of each short equity security priced at less than $5.00 per share, or (2) $5.00 per share or 30 percent of the current market value of each short equity security priced at $5.00 per share or greater.4 Detailed below are the initial and maintenance margin requirements for non-margin eligible equity securities.

      Long Positions

      Regulation T permits a long position of a non-margin eligible equity security to be held in a margin account, provided an initial requirement of 100 percent of the current market value is deposited.5

      Pursuant to FINRA Rule 4210(f)(8)(A)(ii), FINRA is clarifying that the maintenance margin requirement for a non-margin eligible equity security held long in a Regulation T margin account shall be 100 percent of the current market value. This is consistent with the maintenance margin requirement for a non-margin eligible equity security held in a portfolio margin account.6

      FINRA is further clarifying that firms may apply a maintenance loan value based on current maintenance margin requirements (for example, 25 percent for long equity securities or higher for leveraged ETFs7) to a long non-margin eligible equity security held in a Regulation T or portfolio margin account only when there is the presence of a maintenance margin deficiency in such account, provided the amount of maintenance loan value does not exceed the amount of the maintenance margin deficiency. The maintenance loan value permitted above cannot be extended for the purpose of financing additional transactions or for withdrawals. The examples below illustrate how the maintenance loan value may be applied.

      Example 1

      Maintenance Margin Deficiency $5,000
      Non-Margin Eligible Equity Securities Market Value $4,000
      Usable Maintenance Loan Value ($4,000 x .75) $3,000
      Adjusted Maintenance Margin Deficiency ($5,000–$3,000) $2,000

      In this example, 100 percent of the maintenance loan value may be used.

      Example 2

      Maintenance Margin Deficiency $5,000
      Non-Margin Eligible Equity Securities Market Value $10,000
      Maintenance Loan Value ($10,000 x .75) $7,500
      Usable Maintenance Loan Value
      (Loan value cannot exceed the maintenance margin deficiency)
      $5,000

      In this example, only $5,000 of the maintenance loan value may be extended.

      Short Positions

      For short positions, the initial margin requirement pursuant to Regulation T is 150 percent of the current market value of a non-margin eligible equity security.8 In a Regulation T margin account, the current maintenance margin requirements for all short equity securities and leveraged ETFs set forth in FINRA Rule 4210(c)(2) and (3) and in Regulatory Notice 09-53, respectively, continue to apply. Pursuant to FINRA Rule 4210(f)(8)(A)(ii), FINRA is clarifying that in a portfolio margin account, the maintenance margin requirement for a short non-margin eligible equity security shall be the greater of: (1) $2.50 per share or 100 percent of the current market value of each short equity security priced at less than $5.00 per share, or (2) $5.00 per share or 50 percent of the current market value of each short equity security priced at $5.00 per share or greater.

      Non-Purpose Loans in Good Faith Accounts

      Pursuant to Regulation T 220.6(e), non-purpose loans must be executed in the good faith account. FINRA is clarifying that firms may extend maintenance loan value on non-margin eligible equity securities when used to collateralize non-purpose loans. Firms are reminded that non-purpose loans are to be extended in accordance with the requirements promulgated under Regulation T,9 and that any debit balances are not to be included in the Reserve Formula computation.10

      Day Trading

      Pursuant to FINRA Rule 4210(f)(8)(A)(ii), FINRA is clarifying that for customers who day trade in a Regulation T margin account or portfolio margin account, the special maintenance margin requirement for non-margin eligible equity securities is 100 percent. In addition, firms cannot extend maintenance loan value for the purpose of calculating day-trading buying power. Customers will be permitted to day trade a non-margin eligible equity security in such accounts, provided the special maintenance margin requirement of 100 percent does not exceed one times the regulatory maintenance excess (equity in the account after the maintenance margin requirement is met). In the event a customer does day trade in excess of this limit, the firms are required to issue a day-trade call. If the customer does not meet the day-trade call within the required number of business days pursuant to Rule 4210(f)(8)(B)(iii) or 4210(g)(13), then the firm will be required to cancel the day-trade transactions.


      1 See Regulation T section 220.2 for the definitions of margin equity security and margin security.

      2 See Regulation T section 220.12(a).

      3 FINRA imposes higher maintenance margin requirements for leveraged Exchange Traded Funds (ETFs) and related options. See Regulatory Notice 09-53.

      4 See FINRA Rule 4210(c) for the maintenance margin requirements for long and short securities.

      5 See Regulation T section 220.12(e).

      6 See FINRA Rule Interpretation 4210(g)(6)(B)(i) (a)/01.

      7 See note 3.

      8 See Regulation T section 220.12(c).

      9 See Regulation T section 220.6(e).

      10 See SEA Rule 15c3-3 (Exhibit A—Item 10)/032.

    • 11-15 Guidance on Low-Priced Equity Securities in Customer Margin and Firm Proprietary Accounts

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      Low-Priced Equity Securities

      Regulatory Notice
      Notice Type

      Special Alert
      Referenced Rules & Notices

      FINRA Rule 4210
      Regulatory Notice 09-53
      Regulatory Notice 09-65
      SEA Rule 15c3-1
      Suggested Routing

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

      Low-Priced Equity Securities
      Margin
      Net Capital

      Executive Summary

      This Notice provides guidance to firms on low-priced equity securities in customer margin and firm proprietary accounts.

      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
      • Steve Yannolo, Project Manager, Credit Regulation, at (646) 315-8621.

      Background & Discussion

      Price volatility is more often associated with low-priced, rather than higher-priced, equity securities. Low-priced equity securities tend to trade with bid and ask spreads that make up a greater percentage of the security's price. This is especially true for newer companies whose stock is priced low and whose earnings may be more volatile. In addition, due to lower volumes, low-priced equity securities can experience large price swings during a given trading day, which translates into greater price risk. Further, low-priced equity securities may be removed from an index, which can increase the volatility and exacerbate the price risk.

      In a strategy-based margin account, the current maintenance margin requirement for any long equity security is generally 25 percent of the current market value,1 and generally 30 percent of the current market value for any short equity security.2 In a portfolio margin account, the current maintenance margin requirement for both long and short eligible equity securities is determined by the Options Clearing Corporation's TIMS stress range of +/- 15 percent.3

      Firms are reminded to consider the risks associated with low-priced equity securities when extending credit in a strategy-based or portfolio margin account. Firms should take into account volatility and concentrated positions in a single customer account and across all customer accounts, as well as the daily volume and market capitalization of each security when imposing "house" maintenance margin requirements.4 Firms should also consider the fundamental business drivers and financial performance of the issuer in setting house requirements. Increased maintenance margin requirements can help to ensure that the equity in each customer account is sufficient to cover any large variances in the price of a security. FINRA believes that a best practice is for firms to pay close attention to low-priced equity securities when considering the dollar amount of credit to be extended to any one customer.5 Similarly, in a portfolio margin account, FINRA believes that a best practice is for firms to subject low-priced or concentrated positions to heightened review and daily monitoring, subjected to higher margin requirements, where appropriate, and to include such positions in exception reporting to senior management.6

      Firms are also reminded that, pursuant to SEA Rule 15c3-1, if markets can absorb only a limited number of shares of a security for which a ready market exists (a marketplace blockage), the non-marketable portion in the proprietary or other accounts of a broker-dealer is subject to a 100 percent deduction to net capital, and is treated as a non-allowable asset.7


      1 See FINRA Rule 4210(c). FINRA prescribes higher maintenance margin requirements for leveraged exchange-traded funds (ETFs) and uncovered options overlying leveraged ETFs. See Regulatory Notices 09-53 and 09-65.

      2 FINRA Rule 4210(c) prescribes a maintenance margin requirement of $2.50 per share or 100 percent of the current market value, whichever is greater, for each short stock priced at less than $5.00 per share; and $5.00 per share or 30 percent of the current market value, whichever is greater, for each short stock priced at $5.00 per share or greater.

      3 See FINRA Rule 4210(g). TIMS stands for Theoretical Intermarket Margin System.

      4 See FINRA Rule 4210(f)(1) and its associated Interpretation /01 for concentrated or volatile securities (providing, among other things, that substantial additional margin must be required: (1) when there are concentrations in single securities (either in particular accounts or in all margin accounts carried) which, due to their size, may not be liquidated promptly; and (2) for accounts with positions in volatile securities subject to unusually rapid or violent changes in value. Accordingly, steps should be taken to increase margin requirements when it appears that accumulated positions will be difficult to liquidate promptly; and prevent such positions from being acquired).

      5 See FINRA Rule 4210(d) and its associated Interpretation /01 (requiring, among other things, that members determine the total dollar amount of credit to be extended to any one customer or on any one security to limit the potential loss or exposure to the member. It is important that specific limits be established to prevent any one customer or group of customers from endangering the member's capital).

      6 See FINRA Rule 4210(g)(1)(I) and its associated Interpretation /01 (requiring, among other things, member firms to have procedures that describe the identification and monitoring of concentrated positions within individual portfolio margin accounts and across all portfolio margin accounts, including what department is responsible for the daily monitoring of such positions, what the escalation procedures are, and a detailed description of what additional margin requirements, if any, are applied to concentrated positions).

      7 See Interpretation /01 of SEA Rule 15c3-1(c) (2)(vii). In an October 5, 1987, letter from the Division of Trading and Markets, the Division provided guidance for determining which portion of a particular position is considered non-marketable when a broker-dealer is confronted with a marketplace blockage. The Division indicated that it would recommend no action to the SEC if a broker-dealer, when faced with a blockage in securities, treats as readily marketable securities that portion of the block which equals the aggregate of the most recent four-week, inter-dealer trading volume. The number of shares exceeding this amount should be considered non-marketable and subject to a 100 percent deduction from net capital, and is treated as a non-allowable asset, unless the broker-dealer can demonstrate to its Designated Examining Authority that a ready market exists for the excess shares. The shares purchased by the broker-dealer during the most recent four-week period are to be excluded when determining trading volume.

    • 11-14 FINRA Requests Comment on Proposed New FINRA Rule 3190 to Clarify the Scope of a Firm's Obligations and Supervisory Responsibilities for Functions or Activities Outsourced to a Third-Party Service Provider; Comment Period Expires: May 13, 2011

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      Third-Party Service Providers

      Regulatory Notice
      Notice Type

      Request for Comment
      Suggested Routing

      Compliance
      Legal
      Operations
      Risk
      Senior Management
      Key Topics

      Clearing and Carrying Activities
      Due Diligence
      Outsourcing
      Supervisory Responsibilities
      Third-Party Service Providers
      Referenced Rules & Notices

      FINRA Rule 4311
      FINRA Rule 8210
      Incorporated NYSE Rule 382
      NTM 99-45
      NTM 03-73
      NTM 05-48
      NASD Rule 3010
      NASD Rule 3230
      SEA Rule 17a-4

      Executive Summary

      FINRA is requesting comment on a proposed new rule to clarify a member firm's obligations and supervisory responsibilities regarding outsourcing arrangements. Specifically, proposed FINRA Rule 3190 (Use of Third-Party Service Providers) makes clear that:

      •   when a member firm outsources a function or activity related to its business as a regulated broker-dealer to a third-party service provider, it does not relieve the firm of its obligation to comply with applicable securities laws and regulations and FINRA and Municipal Securities Rulemaking Board (MSRB) rules; and
      •   the firm cannot delegate its responsibilities for, or control over, any outsourced functions or activities.

      The proposal also requires a member firm to have supervisory procedures, including due diligence measures, to ensure that its arrangements with third-party service providers are reasonably designed to achieve compliance with applicable securities laws and regulations and FINRA and MSRB rules. Further, the proposed rule imposes additional restrictions and obligations that apply solely to a clearing and carrying member firm and its third-party service provider arrangements.

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

      Questions concerning this Notice should be directed to Patricia Albrecht, Associate General Counsel, Office of General Counsel, at (202) 728-8026.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by May 13, 2011.

      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

      Recognizing member firms' increasing use of outside entities—both regulated and unregulated—to perform certain activities and functions related to their business operations and the compliance risks that can accompany the use of such outside entities, FINRA has provided substantial guidance regarding member firms' responsibilities when outsourcing activities to third-party service providers.3 However, FINRA has continued to receive inquiries regarding outsourcing and the scope of the guidance, including, among other things, requests to identify specific functions that a clearing or carrying member firm may outsource to a third-party service provider and the appropriateness of any member firm outsourcing activities to a third-party service provider that is not registered as a broker-dealer.

      In view of these questions and continued concerns regarding the risks related to outsourcing, FINRA is proposing new Rule 3190 to clarify a member firm's obligations and supervisory responsibilities regarding its outsourcing arrangements, including imposing additional restrictions and obligations that would apply solely to a clearing and carrying member firm and its third-party service provider arrangements.

      I. Member Firms' Responsibilities for Activities Outsourced to Third-Party Service Providers and Activities Requiring Registration and Qualification

      Proposed FINRA Rule 3190(a)(1) clarifies that a member firm's use of a third-party service provider (including any sub-vendor) to perform functions or activities related to the member firm's business as a regulated broker-dealer does not relieve the firm of its obligation to comply with applicable securities laws and regulations and with applicable FINRA and MSRB rules. Proposed Supplementary Material .01 (Scope of Third-Party Service Provider) clarifies that the term "third-party service provider (including any sub-vendor)" shall include any person controlling, controlled by or under common control with a member firm, unless otherwise determined by FINRA.4 The proposed provision also prohibits a member firm from delegating its responsibilities for, or control over, any functions or activities performed by a third-party service provider. Proposed FINRA Rule 3190(a)(1) is consistent with FINRA's current guidance that a member firm's use of a third-party service provider for such activities does not relieve the firm of its ultimate responsibility to achieve compliance with all applicable securities laws and regulations and FINRA and MSRB rules, and that the ultimate responsibility for supervision of outsourced activities lies with the firm.5

      Additionally, FINRA Rule 3190(a)(3) clarifies that nothing in the proposed rule's provisions shall be construed to permit any person to engage in activities that require registration and qualification under FINRA rules without obtaining the necessary registrations and qualifications.
      II. Member Firms' Supervision and Due Diligence Analysis of Third-Party Service Providers

      Proposed FINRA Rule 3190(a)(2) requires each member firm, pursuant to its obligations under FINRA rules, to establish and maintain a supervisory system and written procedures for any functions or activities performed by a third-party service provider that are reasonably designed to achieve compliance with applicable securities laws and regulations and applicable FINRA and MSRB rules.

      Additionally, proposed FINRA Rule 3190(b) requires that a member firm include in these supervisory procedures an ongoing due diligence analysis of each current or prospective third-party service provider to determine, at a minimum, whether: (1) the third-party service provider is capable of performing the activities being outsourced; and (2) with respect to any activities being outsourced, the member firm can achieve compliance with applicable securities laws and regulations and applicable FINRA and MSRB rules. These provisions are consistent with existing guidance noting that, if a member firm outsources activities, its supervisory system and written supervisory procedures required by NASD Rule 3010 (Supervision) must include supervisory procedures for its outsourcing practices to ensure such compliance and that those procedures should include, without limitation, conducting a due diligence analysis of all of its current or prospective third-party service providers to determine whether they are capable of performing the outsourced activities.6
      III. Clearing or Carrying Member Firms' Restrictions and Obligations Regarding Outsourced Activities

      In addition to the requirements discussed above in proposed FINRA Rule 3190(a) and (b), the proposed rule imposes certain heightened requirements on a clearing or carrying member firm's outsourcing arrangements. Given the additional responsibilities of a clearing or carrying member firm to protect customer funds and securities, these heightened requirements are designed to address concerns regarding the great potential harm that could result from its third-party service providers' non-compliance (either accidental or intentional) with the federal securities laws and FINRA and MSRB rules. The involvement by improperly authorized or inadequately supervised persons may cause systemic risk and undermine investor confidence in the securities industry. As detailed further below, FINRA believes these concerns can be mitigated by requiring a clearing or carrying member firm to limit certain enumerated activities to persons directly subject to the control and supervision of the member firm, have additional supervisory procedures to oversee third-party service providers and notify FINRA of its outsourcing arrangements.
      A. Restrictions Applicable to Certain Clearing or Carrying Member Firms' Activities

      Specifically, proposed FINRA Rule 3190(c) requires a clearing or carrying member firm to vest an associated person of the firm with the authority and responsibility for the following activities:
      (1) the movement of customer or proprietary cash or securities;
      (2) the preparation of net capital or reserve formula computations; and
      (3) the adoption or execution of compliance or risk management systems.
      However, pursuant to proposed FINRA Rule 3190(a)(3), the clearing or carrying member firm would have to vest authority and responsibility for any functions related to these activities that would require registration and qualification under FINRA rules with an associated person of the firm who has the necessary registrations and qualifications.

      With respect to the movement of customer or proprietary cash or securities, FINRA has found this area to be subject to additional risk for errors, fraud or other violative conduct. The involvement of improperly authorized persons could, in certain circumstances, cause systemic risk and undermine investor confidence in the securities industry. FINRA believes these concerns would be mitigated by expressly limiting authority and responsibility for this activity to an associated person directly subject to the clearing or carrying member firm's supervision and control. Accordingly, the proposed rule would require that persons responsible for the handling, transfer or disposition of cash or securities as they enter and flow from the firm be associated persons of the member firm.

      Proposed Supplementary Material .02 (Posting to Books and Records) clarifies that the restriction regarding the movement of funds or securities would not preclude a designated third-party service provider from posting items to a clearing or carrying member firm's books or records, provided the firm reviews each posting prior to the close of the business day following the posting. In this regard, FINRA generally would permit the prompt supervisory review required by proposed Supplementary Material .02 to be performed by substantiation of financial balances and spot-check reviews of individual entries, rather than an actual sign off on each individual entry. FINRA believes that the proposed approach balances the need to protect the integrity of the clearing or carrying member firm's books and records with the efficiencies of having the work performed by a third-party service provider.7

      FINRA also has concerns about the use of third-party service providers in the preparation of net capital or reserve formula computations. The execution of the SEC's financial responsibility rules8 enables firm management and regulators to ascertain the financial state of a firm and helps to ensure protection of customer assets. Accordingly, FINRA believes that a properly registered associated person of the clearing or carrying member firm should be directly responsible for this function. For purposes of proposed FINRA Rule 3190(c), FINRA would consider the performance of calculations in aid of the preparation of these computations to be ministerial functions that could be performed by a third-party service provider; however, the review and understanding of the computations and the ability to explain the mechanics and rationale of the computations to FINRA staff would reside with the firm's properly registered associated person vested with authority and responsibility for this function.

      With respect to the adoption or execution of compliance or risk management systems, the proposed rule does not prohibit a firm from using a third-party service provider or its systems as part of the member firm's compliance and risk management solutions, provided the member firm adopts such services and systems in a manner consistent with the regulatory requirements as they apply in light of the firm's size, businesses and business model, retains control over their implementation and use within the firm, and independently determines that they achieve compliance with the applicable securities laws and FINRA and MSRB rules. Further, basic calculations, logging or maintaining lists that are preparatory to creating related books and records and review of output from these systems could be performed by a third-party service provider; however, any analysis or conclusions based upon the data would have to be performed by an associated person of the firm.
      B. Oversight of Third-Party Service Providers by Clearing or Carrying Member Firms

      Proposed FINRA Rule 3190(d) requires that a clearing or carrying member firm include additional supervisory procedures that would: (1) enable the firm to take prompt corrective action where necessary to achieve compliance with applicable securities laws and regulations and with applicable FINRA and MSRB rules; and (2) require the firm to approve any transfer of duties by a third-party service provider to a sub-vendor. As with the restrictions in proposed FINRA Rule 3190(c), FINRA believes that these supplementary procedures will help prevent potential harm that could result from possible non-compliance by a clearing or carrying member firm's third-party service provider with the federal securities laws and FINRA and MSRB rules.
      C. Notifications by Clearing or Carrying Member Firms

      Proposed FINRA Rule 3190(e) requires a clearing or carrying member firm to notify FINRA within 30 calendar days after entering into any outsourcing agreement with a third-party service provider to perform any functions or activities related to the firm's business as a regulated broker-dealer that is permitted to be outsourced pursuant to the proposed rule.9 Pursuant to proposed FINRA Rule 3190, a clearing or carrying member firm's notification must include:
      (1) the function(s) being performed by the third-party service provider;
      (2) the identity and location of the third-party service provider;
      (3) the identity of the third-party service provider's regulator (if any); and
      (4) a description of any affiliation between the firm and the third-party service provider.
      The clearing or carrying member firm also would be required to maintain a copy of each notification and any underlying written agreement(s) with the third-party service provider, in accordance with SEA Rule 17a-4(b).10

      FINRA notes that proposed FINRA Rule 3190 and its heightened requirements for clearing or carrying member firms does not necessarily require a clearing or carrying member firm to alter any contracts with its third-party service providers. Nonetheless, a clearing or carrying member firm remains responsible for maintaining control over any outsourced activity and effecting any necessary changes to achieve compliance with the proposed rule's requirements. Consequently, upon approval of proposed FINRA Rule 3190, FINRA would expect each clearing or carrying member firm to consider whether amendments or addendums to any such contracts would be necessary to comply with the rule's requirements.11
      IV. Exceptions to Proposed FINRA Rule 3190's Requirements

      Proposed FINRA Rule 3190 excepts from its requirements ministerial activities performed on behalf of a member firm, unless otherwise prohibited by applicable securities laws and regulations or applicable FINRA and MSRB rules, and clarifies that its provisions would not restrict activities performed pursuant to a carrying agreement approved under FINRA Rule 4311 (Carrying Agreements).12

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

      2 Section 19 of the Securities Exchange Act of (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 temporarily suspend these types of rule changes within 60 days of filing. If the SEC takes such action, the SEC shall institute proceedings to determine whether the proposed rule should be approved or disapproved. See Exchange Act Section 19 and rules thereunder.

      3See NTM 05-48 (April 2005) (Members' Responsibilities When Outsourcing Activities to Third-Party Service Providers); see also FINRA Office of General Counsel Interpretive Memorandum, dated August 15, 2006 (A Member's Responsibilities Regarding the Outsourcing of Certain Activities). Among other things, the guidance notes that parties conducting activities or functions requiring registration under FINRA rules generally will be considered associated persons of the member firm, absent the service provider separately being registered as a broker-dealer and such arrangement being contemplated by FINRA rules (such as in the case of carrying arrangements), MSRB rules or applicable federal securities laws or regulations. See NTM 05-48 (April 2005).

      4 Although proposed FINRA Rule 3190 uses "third-party service provider (including any sub-vendor)" throughout the rule text, for readability, this Notice generally uses the term "third-party service provider" without the reference "including any sub-vendor."

      5 See NTM 05-48 (April 2005); see also NTM 99-45 (June 1999).

      6 See NTM 05-48 (April 2005).

      7 Member firms are reminded that SEA Rule 17f-2 (Fingerprinting of Securities Industry Personnel) mandates that persons with regular access to the keeping, handling or processing of securities, money or original books and records relating to securities or money must be fingerprinted and have those fingerprints submitted to the U.S. Attorney General or its designee for identification and appropriate processing.

      8 See, e.g., SEA Rule 15c3-1 (Net Capital Requirements for Brokers or Dealers) and SEA Rule 15c3-3 (Customer Protection — Reserves and Custody of Securities).

      9 The proposed rule also requires that, within three months of the effective date of the rule, a clearing or carrying member firm must notify FINRA of all outsourcing arrangements related to the firm's business as a regulated broker-dealer in effect as of that effective date.

      10 See generally SEA Rule 17a-4(b) (requiring a member firm to preserve certain enumerated records for a period of not less than three years, the first two years in an easily accessible place). Additionally, as with all member firm books and records, such notifications and underlying written agreements would be subject to inspection by or production under FINRA Rule 8210 (Provision of Information and Testimony and Inspection and Copying of Books).

      11 Additionally, although not required by proposed FINRA Rule 3190, a clearing or carrying member firm may want to consider submitting prospective outsourcing arrangements for FINRA for review prior to entering into such outsourcing arrangements.

      12 FINRA Rule 4311 replaces NASD Rule 3230 (Clearing Agreements) and NYSE Rule 382 (Carrying Agreements) and will govern the requirements applicable to member firms when entering into agreements for the carrying of customer accounts. See Securities Exchange Act Release No. 63999 (March 1, 2011), 76 FR 12380 (March 7, 2011) (Order Approving File No. SR-FINRA-2010-061). FINRA will announce the new rule's effective date in a future Regulatory Notice.


      Attachment A

      * * * * *

      3000. SUPERVISION AND RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS

      3100. SUPERVISORY RESPONSIBILITIES

      * * * * *

      3190. Use of Third-Party Service Providers

      (a) General Requirements
      (1) The use by a FINRA member of a third-party service provider (including any sub-vendor) to perform functions or activities related to the member's business as a regulated broker-dealer does not relieve the member of its obligation to comply with applicable securities laws and regulations and with applicable FINRA and MSRB rules. No member shall delegate its responsibilities for, or control over, any functions or activities performed by a third-party service provider (including any sub-vendor).
      (2) Pursuant to its obligations under FINRA rules, a member shall establish and maintain a supervisory system and written procedures for any functions or activities performed by a third-party service provider (including any sub-vendor) that are reasonably designed to achieve compliance with applicable securities laws and regulations and with applicable FINRA and MSRB rules.
      (3) Nothing in this Rule shall be construed to permit any person to engage in functions or activities that require registration and qualification under FINRA rules without obtaining the necessary registrations and qualifications.
      (b) Due Diligence Analysis of Third-Party Service Providers

      The procedures required by paragraph (a)(2) shall include an ongoing due diligence analysis of each current and prospective third-party service provider (including any sub-vendor) to determine, at a minimum, whether:
      (1) the third-party service provider (including any sub-vendor) is capable of performing the activities being outsourced; and
      (2) the member can achieve compliance with applicable securities laws and regulations and with applicable FINRA and MSRB rules with respect to any functions or activities being outsourced.
      (c) Restrictions Applicable to Clearing or Carrying Members

      A clearing or carrying member shall vest an associated person of the member with the authority and responsibility for:
      (1) the movement of customer or proprietary cash or securities;
      (2) the preparation of net capital or reserve formula computations; and
      (3) the adoption or execution of compliance or risk management systems.
      (d) Oversight of Third-Party Service Providers by Clearing or Carrying Members

      In the case of a clearing or carrying member, the procedures required by paragraph (a) (2) shall include procedures that:
      (1) enable the member to take prompt corrective action where necessary to achieve compliance with applicable securities laws and regulations and with applicable FINRA and MSRB rules; and
      (2) require the member to approve any transfer of duties by a third-party service provider to a sub-vendor.
      (e) Notifications by Clearing or Carrying Members
      (1) A clearing or carrying member entering into any outsourcing agreement with a third-party service provider (including any sub-vendor) to perform any function or activities related to the member's business as a regulated broker-dealer that is permitted to be outsourced by this Rule shall notify FINRA within 30 calendar days after the date the member enters into such outsourcing agreement.
      (2) Within three months of [insert effective date of the proposed rule change], a clearing or carrying member shall notify FINRA of all outsourcing arrangements in effect as of [insert effective date of the proposed rule change].
      (3) All notifications provided pursuant to this paragraph (e) shall include:
      (A) the function or functions being performed by the third-party service provider (including any sub-vendor, if known);
      (B) the identity and location of the third-party service provider (including any sub-vendor, if known);
      (C) the identity of the third-party service provider's regulator (including any sub-vendor's regulator, if the identities of sub-vendors are known), if any; and
      (D) a description of any affiliation between the member and the third-party service provider (including any sub-vendor).
      (4) A copy of each notification provided pursuant to this paragraph (e) and the underlying written agreement(s) with the third-party service provider (including any sub-vendor) shall be maintained by the member, in accordance with SEA Rule 17a-4(b).
      (f) Exceptions
      (1) The provisions of this Rule shall not apply to ministerial activities performed on behalf of a member, unless otherwise prohibited by applicable securities laws and regulations or applicable FINRA or MSRB rules.
      (2) The provisions of this Rule shall not restrict activities performed pursuant to a carrying agreement approved under FINRA Rule 4311.

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

      .01 Scope of Third-Party Service Provider. The term "third-party service provider (including any sub-vendor)" shall include any person controlling, controlled by, or under common control with a member, unless otherwise determined by FINRA.
      .02 Posting to Books and Records. The provisions of paragraph (c)(1) of this Rule do not preclude a designated third-party service provider (including any sub-vendor) from posting items to a member's books or records, provided that the member reviews each posting prior to the close of the business day following the posting.

    • 11-13 FINRA Revises Sanction Guidelines; Effective Immediately

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      Sanction Guidelines

      Regulatory Notice
      Notice Type

      Guidance
      Key Topics

      FINRA Sanction Guidelines
      Suggested Routing

      Legal
      Registered Representatives
      Senior Management
       

      Executive Summary

      FINRA has revised two sections of its Sanction Guidelines—the General Principles Applicable to All Sanctions Determinations and the Principal Considerations in Determining Sanctions—to reflect recent developments in FINRA disciplinary cases. Specifically, the revisions:

      •   clarify the causation standard for when FINRA adjudicators order restitution;
      •   recognize that FINRA adjudicators may order that a respondent's ill-gotten gains be paid to those injured by the respondent's misconduct, where appropriate;
      •   reflect that not every factor listed in the principal considerations has the potential to be aggravating and mitigating; and
      •   direct adjudicators to consider sanctions imposed by another regulator for the same misconduct when determining a sanction.

      The revised Sanction Guidelines are effective immediately and available on FINRA's website at www.finra.org/Industry/Enforcement/SanctionGuidelines.

      You may direct questions concerning this Notice to:

      •   Gary Dernelle, Office of General Counsel, at (202) 728-8255, and
      •   Jennifer Brooks, Office of General Counsel, at (202) 728-8083.

      Background & Discussion

      The FINRA Sanction Guidelines address a wide variety of potential violations of FINRA's rules and provide fact-specific guidance for crafting sanctions. FINRA adjudicators rely on the guidelines to determine appropriate remedial sanctions, and FINRA's Departments of Market Regulation and Enforcement and the defense bar rely on them when negotiating settlements in disciplinary matters. In order to promote consistency in their application, the Sanction Guidelines outline certain General Principles Applicable to All Sanctions Determinations and the Principal Considerations in Determining Sanctions. These general principles and principal considerations enumerate certain factors for consideration in all cases. The National Adjudicatory Council approved the revisions to the general principles and principal considerations discussed below.

      Revisions to General Principles Applicable to All Sanction Determinations

      To address federal court, SEC and NAC precedent in recent FINRA disciplinary cases, FINRA amended the general principles concerning the use of restitution and disgorgement to remediate misconduct.

      General Principle 5 of the Sanction Guidelines recognizes that FINRA adjudicators may order restitution where necessary to remediate misconduct. Restitution is a traditional remedy used to restore the status quo ante where a respondent's victim would otherwise unjustly suffer loss. General Principle 5 instructs adjudicators to calculate orders of restitution based on the actual amount of the loss sustained because of a respondent's misconduct. Such orders may thus exceed the amount of a respondent's ill-gotten gain.

      As a result of a recent FINRA disciplinary matter, the SEC, upon remand from the United States Court of Appeals for the District of Columbia Circuit, requested that FINRA articulate the causation standard required under General Principle 5 when its adjudicators order restitution.1 Revised General Principle 5 makes clear that "proximate causation" is the causation standard required for restitution orders in FINRA disciplinary proceedings.

      General Principle 6 of the Sanction Guidelines instructs FINRA adjudicators to consider the disgorgement of a respondent's ill-gotten gain where the respondent has obtained a financial benefit from his wrongdoing. Disgorgement seeks to remediate misconduct by depriving a respondent of his or her unlawful profits irrespective of the actual losses suffered by the respondent's victims.

      General Principle 6 traditionally recognized the ability of adjudicators to require the disgorgement of ill-gotten gains by fining away the amount of some or all of the financial benefit derived, directly or indirectly, through a respondent's misconduct. Although compensation of injured victims is not a primary purpose of disgorgement, the NAC and the SEC recognized that it nevertheless is a valid secondary purpose.2 The amendments to General Principle 6 therefore reflect that FINRA adjudicators may order, where appropriate, the use of disgorged funds to remedy harms suffered by customers, rather than adding that amount of money as a fine payable to FINRA.

      Revisions to Principal Considerations in Determining Sanctions

      FINRA amended the introductory section of the Principal Considerations in Determining Sanctions to reflect that not every enumerated factor has the potential to be aggravating and mitigating.3 The relevancy and characterization of a factor depends on the facts and circumstances of a case and the type of violation.4

      Principal Consideration 14 directs adjudicators to consider whether individual respondents were disciplined by their firms for the misconduct before regulatory detection. FINRA amended Principal Consideration 14 to direct adjudicators also to consider sanctions imposed by another regulator, such as a state regulator, for the same misconduct and determine whether that sanction was sufficiently remedial.


      1 See Michael Frederick Siegel, Exchange Act Rel. No. 62324, 2010 SEC LEXIS 2015, at *3 (June 18, 2010).

      2 See Dep't of Enforcement v. Mission Secs. Corp., Complaint No. 200600378501, 2010 FINRA Discip. LEXIS 1, at *47-48 (FINRA NAC Feb. 4, 2010), affd, Exchange Act Rel. No. 63453, 2010 SEC LEXIS 4053, at*54-55 (Dec. 7, 2010).

      3 See, e.g., Siegel v. SEC, 592 F.3d 147,157 (D.C. Cir. 2010) ("[N]ot every consideration listed in the [Guidelines has the potential to be mitigating..." (internal quotation omitted)).

      4 See, e.g., Rooms v. SEC, 444 F.3d 1208, 1214-15 (10th Cir. 2006) (explaining that while the existence of a disciplinary history is an aggravating factor when determining the appropriate sanction, its absence is not mitigating).

    • 11-12 FINRA Reminds Firms of Their Obligations Under the Foreign Corrupt Practices Act

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      Foreign Corrupt Practices Act

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Risk
      Senior Management
      Key Topics

      Accounting
      Anti-Bribery
      Books and Records
      Domestic Concerns
      Foreign Corrupt Practices Act
      Foreign Members
      Internal Controls
      Issuers
      Referenced Rules & Notices

      FINRA Rule 2010
      NASD Rule 3110
      SEA Rule 17a-3
      SEA Rule 17a-4

      Executive Summary

      The Foreign Corrupt Practices Act of 1977 (FCPA) was enacted to prohibit bribery of foreign officials and restore public confidence in the integrity of the American business system. This Notice provides a brief overview of the FCPA and discusses the application of the anti-bribery prohibitions to member firms.

      Member firms that are considered to be "issuers" under the FCPA also must comply with the FCPA's accounting provisions, which generally require an "issuer" to make and keep books and records that accurately and fairly reflect the company's transactions and to devise and maintain an adequate system of internal accounting controls.

      FINRA advises member firms to review their business practices to ensure they are complying with all of their obligations under the FCPA. A member firm's failure to comply with its FCPA obligations will be considered conduct inconsistent with high standards of commercial honor and just and equitable principles of trade in violation of FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade).

      Questions concerning this Notice should be directed to Patricia Albrecht, Associate General Counsel, Office of General Counsel, at (202) 728-8026.

      Background and Discussion

      The FCPA was enacted to prohibit bribery of foreign officials and to restore public confidence in the integrity of the American business system. The FCPA includes anti-bribery and accounting provisions. The anti-bribery provisions make it unlawful to bribe foreign officials to obtain or retain business in a foreign country. The accounting provisions generally require each company considered to be an "issuer" under the FCPA to make and keep books and records that accurately and fairly reflect the company's transactions and to devise and maintain an adequate system of internal accounting controls.

      I. Anti-Bribery Provisions
      A. Applicability

      The FCPA's anti-bribery prohibitions apply to "issuers" and "domestic concerns" (and their officers, directors, employees, agents and any stockholders acting on their behalf).1 An "issuer" is any company that is registered pursuant to Section 12 (Registration Requirements for Securities) of the Securities Exchange Act of 1934 (Exchange Act or SEA)2 or that is required to file reports with the SEC pursuant to Exchange Act Section 15(d) (Supplementary and Periodic Information).3 A "domestic concern" is any U.S. citizen, national, resident or business (other than an issuer).4 The FCPA also contains an anti-bribery provision that applies to foreign nationals or businesses (other than an issuer) (and their officers, directors, employees, agents and any stockholders acting on their behalf) while they are in the territory of the U.S.5
      B. Enforcement

      The FCPA's anti-bribery provisions for issuers are incorporated into the federal securities laws as Exchange Act Section 30A (Prohibited Foreign Trade Practices by Issuers), and the SEC is responsible for its civil enforcement. The FCPA's anti-bribery provisions for domestic concerns and for foreign nationals and businesses are not incorporated into the Exchange Act. The U.S. Department of Justice is responsible for all criminal enforcement of the FCPA and for civil enforcement of the anti-bribery provisions regarding domestic concerns and foreign nationals and businesses.6
      C. General Prohibitions

      An (1) issuer, (2) domestic concern or (3) foreign national or business while it is in the territory of the U.S. (and their officers, directors, employees, agents and any stockholders acting on their behalf) generally violates the FCPA's anti-bribery prohibitions when it makes use of the mails or any means or instrumentality of interstate commerce:7
      •   corruptly;8
      •   in furtherance of an offer, payment, promise to pay, or authorization of the payment of any money, or offer, gift, promise to give or authorization of the giving of anything of value to any:
      •   foreign official;
      •   foreign political party or party official;
      •   candidate for foreign political office; or
      •   person, while knowing that all or a portion of such money or thing of value will be offered, given or promised, directly or indirectly, to any foreign official, political party, party official or candidate;
      •   for the purpose of:
      •   influencing any act or decision of the foreign official, political party, party official or candidate in his or its official capacity;
      •   inducing the foreign official, political party, party official or candidate to do or omit to do an act in violation of his or its lawful duty;
      •   securing any improper advantage;9 or
      •   inducing the foreign official, political party, party official or candidate to use his or its influence with a foreign government or instrumentality to affect or influence any act or decision of such government or instrumentality;
      •   in order to assist in obtaining or retaining business for or with, or directing business to, any person.10
      D. Affirmative Defenses and Exception for Facilitating Payments for "Routine Governmental Actions"

      The FCPA provides two affirmative defenses to an anti-bribery violation. One is if a payment, gift, offer or promise of anything of value that was made to a foreign official, political party, party official or candidate was lawful under the written laws and regulations of the foreign official's, political party's, party official's or candidate's country.11 The other is if the payment, gift, offer or promise of anything of value that was made was a reasonable and bona fide expenditure (e.g., travel and lodging expenses) incurred by or on behalf of the foreign official, political party, party official or candidate and was directly related to the promotion, demonstration or explanation of products or services or the execution or performance of a contract with a foreign government or agency.12

      The FCPA also provides an exception to the anti-bribery prohibitions for facilitating or expediting payments to a foreign official, political party or party official to expedite or secure performance of a "routine governmental action" by a foreign official, political party or party official.13 Examples include:
      •   obtaining permits, licenses or other official documents to qualify a person to do business in a foreign country;
      •   processing governmental papers (e.g., visas and work orders);
      •   providing police protection, mail pickup and delivery or scheduling inspections associated with contract performance or related to transit of goods across country;
      •   providing phone service, power and water supply, loading and unloading cargo or protecting perishable products or commodities from deterioration; or
      •   actions of a similar nature.14
      A "routine governmental action" does not include any decision by a foreign official whether, or on what terms, to award new business to or continue business with a particular party or any action taken by a foreign official involved in the decision-making process to encourage a decision to award new business to or continue business with a particular party.15
      II. FCPA Accounting Provisions

      Exchange Act Section 13 codifies the FCPA's accounting provisions for issuers,16 and the SEC is responsible for their civil enforcement. Generally, these provisions require every issuer that has securities registered pursuant to Exchange Act Section 12 to file:
      •   such information and documents as the SEC shall require to keep reasonably current the information and documents required to be included in or filed pursuant to Exchange Act Section 12; and
      •   such annual reports (certified by independent public accountants if required by the SEC's rules and regulations) and quarterly reports as the SEC may prescribe.17
      The accounting provisions also require every issuer that has securities registered pursuant to Exchange Act Section 12 or that is required to file reports pursuant to Exchange Act Section 15(d) to:
      •   make and keep books, records and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the issuer's assets; and
      •   devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that:
      •   transactions are executed in accordance with management's authorization;
      •   transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles or other applicable criteria, and to maintain accountability for assets;
      •   access to assets is permitted only in accordance with management's authorization; and
      •   the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences.18
      III. Application of the FCPA to FINRA Member Firms

      The FCPA's anti-bribery prohibitions apply to every FINRA member firm (and its officers, directors, employees, agents and any stockholders acting on its behalf). Specifically, FINRA member firms that are considered issuers pursuant to the FCPA must comply with both the FCPA's anti-bribery provisions for issuers and the accounting provisions that are incorporated into the Exchange Act.19 FINRA member firms meeting the definition of "domestic concern" and that are not considered issuers must comply with the FCPA's anti-bribery provisions for domestic concerns. Any FINRA member firms that are foreign broker-dealers registered with the SEC may be considered foreign businesses that must comply with the FCPA anti-bribery provisions for foreign businesses.20 Member firms that are considered either domestic concerns or foreign businesses should be aware that the FCPA's anti-bribery prohibitions apply to them under the statutory terms of those provisions even though they are not incorporated into the Exchange Act, as is the case for members that are issuers.

      FINRA advises all member firms to review the FCPA's provisions and their business practices to ensure they are complying with their applicable obligations under the FCPA. A member firm's failure to comply with its FCPA obligations will be considered conduct inconsistent with high standards of commercial honor and just and equitable principles of trade in violation of FINRA Rule 2010.

      1 See generally 15 U.S.C. §§ 78dd-1 (Prohibited foreign trade practices by issuers) & 78dd-2 (Prohibited foreign trade practices by domestic concerns).

      2 15 U.S.C. § 78l.

      3 15 U.S.C. § 78o(d). Certain foreign companies are considered "issuers" within the meaning of the FCPA, and therefore subject to the FCPA provisions applicable to issuers. See, e.g., In the Matter of Statoil, Securities Exchange Act Release No. B4B99, 2006 SEC LEXIS 2321, at *3–4 (Oct. 13, 2006) (cease-and-desist order against foreign issuer found to be violating the FCPA's anti-bribery and books and records provisions).

      4 See 15 U.S.C. § 78dd-2(h)(1)(B) (defining "domestic concern" to mean "(A) any individual who is a citizen, national, or resident of the United States; and (B) any corporation, partnership, association, joint-stock company, business trust, unincorporated organization, or sole proprietorship which has its principal place of business in the United States, or which is organized under the laws of a State of the United States or a territory, possession, or commonwealth of the United States").

      5 See generally 15 U.S.C. § 78dd-3 (Prohibited foreign trade practices by persons other than issuers or domestic concerns); see also 15 U.S.C. §§ 78dd-3(f)(1) (the foreign national or business anti-bribery provisions apply to "any natural person other than a national of the United States... or any corporation, partnership, association, joint-stock company, business trust, unincorporated organization, or sole proprietorship organized underthe law of a foreign nation or a political subdivision thereof") and 78dd-3(a) (requiring compliance while a foreign national or business is "in the territory of the United States").

      6 See U.S. Department of Justice, Lay-Person's Guide to FCPA (overview of the FCPA's anti-bribery provisions, including enforcement authority).

      7 A foreign national or business (and its officers, directors, employees, agents and any stockholders acting on its behalf) may also violate the FCPA while in the territory of the U.S., irrespective of whether it makes use of the mails or any means or instrumentality of interstate commerce. See 15 U.S.C. § 78dd-3(a). In addition, the FCPA's provisions for issuers and domestic concerns include provisions addressing alternative jurisdiction for acts taken by U.S. issuers and domestic concerns outside of the U.S. irrespective of whether such parties make use of the mails or other means or instrumentality of interstate commerce. See 15 U.S.C. §§ 78dd-1(g) and 78dd-2(i).

      8 See Stichting Ter Behartiging Van de Belangen Van Oudaandeelhouders In Het Kapitaal Van Saybolt Int'l B. V. v. Schreiber, 327 F.3d 173, 183 (2d Cir. 2003) (referring to the FCPA's legislative history to conclude that the term "corruptly," as used in the FCPA, signifies, in addition to the element of "general intent" present in most criminal statutes, a bad or wrongful purpose and an intent to influence a foreign official to misuse his official position). See also Department of Justice, Lay-Person's Guide to FCPA, supra note 6 (explaining that the person making or authorizing the payment must have a corrupt intent, and the payment must be intended to induce the recipient to misuse his official position to direct business wrongfully to the payor or to any other person).

      9 See U.S. v. Kay, 359 F.3d 738, 743 (5th Cir. 2004) (noting that the FCPA criminalizes payments that are intended to: (1) influence a foreign official to act or make a decision in his official capacity; (2) induce such an official to perform or refrain from performing some act in violation of his duty; (3) or secure some wrongful advantage to the payor).

      10 See 15 U.S.C. §§ 78dd-1(a), 78dd-2(a), 78dd-3(a).

      11 See 15 U.S.C. §§ 78dd-1(c)(1), 78dd-2(c)(1), 78dd-3(c)(1).

      12 See 15 U.S.C. §§ 78dd-1(c)(2), 78dd-2(c)(2), 78dd-3(c)(2).

      13 See 15 U.S.C. §§ 78dd-1(b), 78dd-2(b), 78dd-3(b).

      14 See 15 U.S.C. §§ 78dd-1(f)(3), 78dd-2(h)(4), 78dd-3(f)(4) (defining "routine governmental action").

      15 Id.

      16 See 15 U.S.C. §§78m(a), (b)(2)(A)–(B), (b)(3)–(7).

      17 See Exchange Act Section 13(a).

      18 See Exchange Act Section 13(b)(2)(A)-(B).

      19 Member firms are reminded that they must comply with FINRA's books and records obligations and other applicable federal securities laws and regulations, including NASD Rule 3110 (Books and Records) and SEA Rules 17a-3 (Records to Be Made By Certain Exchange Members, Brokers, and Dealers) and 17a-4 (Records to be Preserved by Certain Exchange Members, Brokers, and Dealers), irrespective of their compliance obligations underthe FCPA's books and records provision. See also Securities Exchange Act Release No. 63784 (January 27, 2011), 76 FR 5850 (February 2, 2011) (Order approving the adoption of certain paragraphs of NASD Rule 3110 as FINRA Rules in the Consolidated FINRA Rulebook; File No. SR-FINRA-2010-052). FINRA will announce the effective date of the consolidated books and records rules in a Regulatory Notice.

      20 A foreign FINRA member firm also may need to consider whether it would be an issuer for purposes of FCPA compliance.

    • 11-11 FINRA Requests Comment on Concept Proposal to Identify and Manage Conflicts Involving the Preparation and Distribution of Debt Research Reports; Comment Period Expires: April 25, 2011

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      Debt Research Reports

      Regulatory Notice
      Notice Type

      Request for Comment
      Suggested Routing

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

      Conflicts of Interest
      Fixed Income
      Research
      Trading
      Referenced Rules & Notices

      FINRA Rule 2010
      FINRA Rule 2020
      NASD Rule 2711
      NTM 06-36
      Regulatory Notice 08-55
      SEC Regulation AC

      Executive Summary

      FINRA seeks comment on a concept proposal to apply objectivity safeguards and disclosure requirements to the publication and distribution of debt research reports. The proposal has a tiered approach that generally would provide retail debt research recipients with most of the same protections provided to recipients of equity research, while exempting debt research provided solely to institutional investors from many of those provisions.

      Questions concerning this Notice should be directed to:

      •   Philip Shaikun, Associate Vice President, Office of General Counsel (OGC), at (202) 728-8451; and
      •   Racquel Russell, Assistant General Counsel, OGC, at (202) 728-8363.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by April 25, 2011.

      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

      FINRA has long been monitoring firms' management of conflicts of interest related to the publication and distribution of debt research. In a 2005 report3 to the SEC, legacy NASD and the NYSE indicated that they would examine the extent to which firms voluntarily adopted the Guiding Principles of the Bond Market Association (BMA).4 The self-regulatory organizations (SROs) subsequently surveyed certain firms' debt research supervisory systems and found many instances where firms failed to adhere to the Guiding Principles. More significantly, the SROs found certain cases where firms lacked any policies and procedures to manage debt research conflicts to ensure compliance with applicable SRO ethical and anti-fraud rules. Those findings were published in Notice to Members (NTM) 06-365 as a means to prompt better conflict management, but FINRA expressly noted that it would continue to consider more definitive rulemaking that might differ from or expand on the Guiding Principles.

      The staff believes now is the appropriate time to engage in such definitive rulemaking. Among other things, the staff has observed increased retail investment risk in complex debt securities. The allegations of misconduct in the sale of auction rate securities (ARS) illuminated this fact and provided a very concrete example that potential conflicts of interest in the publication and distribution of debt research can exist just as they do for equity research.

      Currently, FINRA's research rules apply only to "equity securities," as that term is defined under the Securities Exchange Act of 1934 (Exchange Act), subject to certain exceptions. In contrast, SEC Regulation Analyst Certification (Reg AC), the SEC's primary vehicle to foster objective and transparent research, applies to both debt and equity research. In addition, several foreign regulators have enacted research rules that apply to debt research, many of which are more extensive than Reg AC.

      In consultation with industry members including buy-side, the staff has reviewed the appropriateness of applying the provisions of the equity research rules to debt research, taking into consideration the unique nature of debt trading and its market participants. Based on this review, the staff has developed a conceptual debt research rule that would recognize a bifurcated debt research regulatory approach in which retail investors and institutional investors are treated as customers and counterparties, respectively. Thus, the envisioned rule extends to debt research distributed to retail investors the vast majority of the protections currently afforded to equity research, while debt research distributed solely to institutional investors would require a more general "health warning" in lieu of many of the structural safeguards and disclosures applicable to retail debt research. Importantly, the concept would allow for an institutional investor to choose to receive the full protections accorded retail debt research. The concept further would delineate the permissible communications between debt research analysts and sales and trading personnel. As conceived, the rule would contain the following elements:

      Definitions

      First, a "debt security" would be defined as any "security" other than an "equity security," a "treasury security" or a "municipal security" (as those terms are defined in the federal securities laws). The definition of "debt research report" would closely follow the current definition of research report in NASD Rule 2711 (i.e., a communication that includes an analysis of securities and that provides information reasonably sufficient upon which to base an investment decision). The definition of "debt research report" would be subject to the same exceptions currently in place for equity in NASD Rule 2711 (e.g., discussions of broad-based indices, commentaries on economic, political or market conditions, etc. would be excepted).

      The definition of "institutional investor" would be the same as "institutional account" in FINRA's suitability rule.6 Thus, the proposed definition generally would cover: (a) a bank, savings and loan association, insurance company or registered investment company; (b) an investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act of 1940 or with a state securities commission (or any agency or office performing like functions); or (c) any other entity (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.

      Standards Applicable to Retail Debt Research

      The majority of the existing structural safeguards and disclosures in NASD Rule 2711 for equity research would apply to retail debt research.7 In addition, unlike the equity research rules, the proposal addresses conflicts between debt research and sales and trading personnel.8

      Thus, the staff envisions that the debt research rule would:

      •   Generally require member firms to establish, maintain and enforce policies and procedures reasonably designed to identify and effectively manage conflicts of interest related to:
      •   the preparation, content and distribution of debt research reports;
      •   public appearances by debt research analysts; and
      •   the interaction between debt research analysts and those outside of the research department, including investment banking department personnel, sales and trading department personnel, subject companies and customers.
      •   Prohibit prepublication review, clearance or approval of debt research by investment banking and sales and trading, as well as restrict (or prohibit) prepublication review, clearance or approval by a subject company (except for fact checking) or by member firm personnel who are not directly responsible for the preparation, content and distribution of debt research.
      •   Prohibit input by investment banking and sales and trading into the determination of the research department budget.
      •   Limit the supervision and compensatory evaluation of debt analysts to persons not engaged in investment banking services or sales and trading.
      •   Require the review and approval of debt analyst compensation by the same type of committee required to review equity analyst compensation, and prohibit compensation based on specific investment banking or sales and trading transactions or contributions to the member firm's investment banking or sales and trading activities.
      •   Restrict or limit debt analyst account trading in the securities, derivatives and funds related to the securities covered by the debt analyst, including to:
      •   ensure that debt analyst accounts, supervisors of such analysts and associated persons with the ability to influence the content of research reports do not benefit in their trading from knowledge of the content or timing of a debt research report; and
      •   prohibit trading contrary to the analyst's recommendations (except in cases of financial hardship). Member firm policies and procedures also would be required.
      •   Prohibit promises of favorable debt research coverage.
      •   Prohibit retaliation against debt analysts by investment banking personnel or other employees as the result of an adverse, negative or otherwise unfavorable research report or public appearance.
      •   Restrict or limit activities by debt analysts that can reasonably be expected to compromise objectivity, including participation in pitches, road shows and certain three-way meetings involving debt analysts and customers where either investment banking personnel or issuer management are present.
      •   Prohibit investment banking from directing debt analysts to engage in sales or marketing efforts or any communication with a customer about an investment banking services transaction.

      Likewise, the staff envisions that the disclosures applicable to equity research largely should apply to debt. They include disclosure of personal and firm financial interests; the receipt of investment banking services compensation from the subject company; and the meaning of each rating employed in any rating system used by the member firm in the research report.9 The staff also believes that the supervisory review and disclosure obligations applicable to the distribution of third-party equity research should similarly apply to third-party retail debt research.

      Institutional Investor Exemption

      FINRA staff understands that, unlike in the equity market, institutional investors trading in debt securities tend to interact with broker-dealers in a manner more closely resembling that of a counterparty than a customer. Based on discussions with industry participants, the staff further understands that these institutional investors value the timely flow of analysis and trade ideas related to debt securities, are aware of the types of potential conflicts that may exist between a member's recommendations and trading interests, and are capable of exercising independent judgment in evaluating such recommendations (and instead incorporate the research as a data point in their own analytics) and reaching pricing decisions.

      Given these unique aspects of the debt market and the needs of its participants, the concept proposal exempts debt research disseminated solely to institutional investors from most of the structural safeguards and disclosures described above for retail debt research. However, firms availing themselves of this institution-only exemption would be required to provide on the first page of a debt research report a prominent "health warning" disclosure, including that:

      •   the research is intended for institutional investors only and is not subject to all of the independence and disclosure standards applicable to research provided to retail investors;
      •   if applicable, that the firm trades the securities covered in the research for its own account and on behalf of certain clients; such trading interests may be contrary to the recommendations offered in the research and the research may not be independent of the firm's proprietary interests; and
      •   if applicable, that the research may be inconsistent with recommendations offered in the firm's research that is disseminated to retail investors.

      The staff believes that this approach appropriately acknowledges the arm's-length nature of transactions between trading desk personnel and institutional buyers. The staff also notes that this approach alleviates the need for a firm to determine whether any particular communication sent only to institutional investors meets the definition of "debt research report." Of course, if a communication does not meet the definition of "debt research," these contemplated rules would not apply, irrespective of whether disseminated to retail or institution-only investors. Firms that avail themselves of this institutional carve-out would be required to clearly distinguish such research from debt research disseminated to retail investors. However, the staff believes that not all institutional investors are necessarily alike and therefore an important part of the proposed regulatory scheme is to allow for such investors to opt out of this exemption.

      Notwithstanding the sophistication of institutional debt investors, the staff believes certain of the basic safeguards applicable to retail research should apply to all debt research; specifically the prohibitions/restrictions on:

      •   promises of favorable research;
      •   debt research analyst involvement in pitches, road shows and other marketing;
      •   certain three-way meetings about an investment banking services transaction that involve debt analysts and customers where either investment banking personnel or issuer management are present;
      •   input into research coverage by investment banking personnel;
      •   retaliation against debt research analysts for unfavorable research;
      •   review of research by the subject company (beyond fact-checking) or investment banking personnel; and
      •   investment banking directing debt research analysts to engage in sales or marketing efforts or any communication with a customer about an investment banking services transaction.

      The staff notes that other FINRA rules would continue to apply to member conduct in connection with debt research, including research disseminated pursuant to the institutional investor carve-out (e.g., FINRA Rules 2010 and 2020). In addition, nothing in this concept proposal obviates a member's obligation to comply with the antifraud provisions of the federal securities laws.

      Communication Firewalls Unique to Debt

      The staff's discussions with industry members illuminated certain necessary communications between debt analysts and sales and trading personnel to allow each to perform their primary functions.10 Therefore, the concept proposal delineates the permissible interactions between debt analysts and sales and trading personnel. Expressly permitted communications would include the following:11

      •   Sales and trading personnel seeking information from debt analysts regarding the creditworthiness of an issuer (and other information regarding a debt issuer that is reasonably related to the price/performance of the debt security), so long as, with respect to any covered issuer, such information is consistent with the debt analyst's published research. All such communications would have to be consistent with the types of communications the analyst might have with customers.12
      •   Debt analysts seeking information from sales and trading personnel regarding a particular bond instrument, current prices, spreads, liquidity and similar market information relevant to the debt analyst's valuation of a particular debt security.
      •   Sales and trading personnel providing input to Research Management regarding debt research coverage decisions, provided that final coverage decisions are made by Research Management.

      The following would be expressly prohibited communications:

      •   Sales and trading personnel attempting to influence a debt analyst's opinion or views for the purpose of benefiting the trading position of the firm, a customer or a class of customers.
      •   Debt analysts identifying or recommending specific potential trading transactions to sales and trading personnel that are not contained in such debt analyst's currently published reports; disclosing the timing of, or material investment conclusions in, a pending debt research report; or otherwise having any communication for the purpose of determining the profile of a customer to whom research should be directed.

      Request for Comment

      FINRA welcomes all comments on the concept proposal, and specifically encourages buy-side investors to comment on the proposal's tiered approach. Among other things, FINRA is interested in comments on the following:

      Definitions

      •   Is the definition of "debt security" overbroad or under-inclusive?
      •   FINRA recognizes that no "institutional investor" definition is a perfect proxy for sophistication and has proposed the same definition as found in FINRA's suitability rule as a starting point for discussion. Are there other definitions more appropriate in the context of debt research conflicts of interest that would better identify those individuals and entities that would benefit from the protections proposed for retail investors?

      Opt-In/Out Provision

      •   Should this option be structured as an "opt-in" or an "opt-out" provision? Should fund managers be permitted to opt-in/opt-out on a fund-by-fund basis?

      Effect on Availability of Retail Debt Research

      •   How might the institution-only carve-out impact the availability to retail customers of certain types of debt research, such as research on foreign sovereign debt? Would firms with both retail and institutional clients reduce or eliminate debt research provided to retail investors due to the differing regulatory requirements? Are there certain categories of debt research that should be exempted from all of the contemplated rules for both retail and institutional investors?

      Disclosures for Institutional Debt Research

      •   Should there be additional disclosures required for members to avail themselves of the institution-only carve-out? For example, should members be required to disclose to institutional investors any substantial proprietary acquisitions or divestments in the covered debt security immediately prior to the issuance of an institution-only report on that security?

      Comments must be received by April 25, 2011.


      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 permits certain limited types of proposed rule changes to take effect upon filing with the SEC. The SEC has the authority to summarily temporarily suspend these types of rule changes within 60 days of filing. If the SEC takes such action, the SEC shall institute proceedings to determine whether the proposed rule should be approved or disapproved. See Exchange Act Section 19 and rules thereunder.

      3 Joint Report by NASD and the NYSE on the Operation and Effectiveness of the Research Analyst Conflict of Interest Rules (December 2005).

      4 In 2005, the BMA merged with the Securities Industry Association (SIA) to form the Securities Industry and Financial Markets Association (SIFMA).

      5 NTM 06-36 (July 2006).

      6 See Securities Exchange Act Release No. 63325 (November 17, 2010), 75 FR 71479 (November 23, 2010) (Order Approving File No. SR-FINRA-2010-039 to adopt FINRA Rule 2111 (Suitability) in the consolidated FINRA rulebook) ("Suitability" rule).

      7 The staff does not envision proposing with respect to debt research the ban on research analysts receiving pre-lPO shares orthe imposition of quiet periods around the issuance of research reports.

      8 The staff notes that Regulatory Notice 08-55 proposed changes to current NASD Rule 2711. Generally, Regulatory Notice 08-55 sought to streamline the NASD Rule 2711 provisions and apply several overarching principles for the management of conflicts of interest in connection with member firm research. This concept proposal builds on that approach, and further proposes additional safeguards in connection with debt research not included in current NASD Rule 2711 or Regulatory Notice 08-55 (e.g., the prohibition on investment banking and sales and trading input into the determination of the research department budget). FINRA will consider whether any of these additional safeguards are appropriate for debt.

      9 However, the staff believes that certain disclosures must be modified in light of unique characteristics of the debt market. Thus, instead of member firm disclosure if it acts as a market maker in the subject security, the rule would require disclosure if the member firm generally engages in principal trading in the subject debt security. And while the envisioned rule provides that the rating distributions and related disclosures also apply to debt research,the staff believes that minor modifications would be appropriate because the lack of daily closing information may otherwise make a price chart difficult to create for debt securities.

      10 The staff understands that the uniqueness of the debt market as compared to equities (e.g., limited last sale transparency information) necessitates communication between analysts and traders in certain fundamental regards.

      11 Communications between debt research analysts and sales and trading personnel that are not related to sales and trading or research activities may take place without restriction.

      12 A debt analyst's communications with sales and trading personnel would not be deemed "inconsistent" with the analyst's published research where the investment objectives or time horizons being discussed differ from those underlying the analyst's published views.

    • 11-10 FINRA Reminds Firms of Their Obligation to Electronically Report Specified Events and Quarterly Customer Complaint Information and Provides Additional Guidance on Automated Reporting Under FINRA Rule 4530

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      Reporting Requirements

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Customer Complaints
      Disclosure Events
      Electronic Reporting
      Reporting Application
      Technical Changes
      Referenced Rules & Notices

      FINRA Rule 4530
      Incorporated NYSE Rule 351
      NASD Rule 3070
      NTM 95-81
      Regulatory Notice 08-40
      Regulatory Notice 11-06

      Executive Summary

      FINRA is issuing this Notice to remind member firms of their obligation to electronically report specified events and quarterly customer complaint information required under current NASD Rule 3070 and Incorporated NYSE Rule 351, and new FINRA Rule 4530, which is effective July 1, 2011.1 This Notice also provides additional guidance on automated reporting via the Rule 4530 Application for matters that become subject to reporting on or after July 1, 2011.

      Questions regarding this Notice should be directed to Afshin Atabaki, Assistant General Counsel, Office of General Counsel, at (202) 728-8902.

      Technical questions regarding the Rule 4530 Application, including testing, should be directed to the FINRA Help Desk, at (800) 321-6273 (if your question relates to testing, rather than an actual submission, please indicate this to the help desk representative).

      Background & Discussion

      Obligation to Report Required Information Electronically

      NASD Rule 3070 and Incorporated NYSE Rule 351 require member firms to, among other things, report to FINRA certain specified events (paragraphs (a)(1) through (a)(10) of the rules) and quarterly statistical and summary information regarding written customer complaints (paragraphs (c) and (d) of the rules, respectively). As stated in Regulatory Notice 11-06, these rules will remain in effect for matters that become subject to reporting prior to July 1, 2011. Moreover, firms are reminded that they are required to report these matters, including the specified events, electronically via the Regulatory Filings Application on the FINRA Firm Gateway.2 The current application is named Disclosure Events and Complaints.3

      For matters that become subject to reporting on or after July 1, 2011, under new FINRA Rule 4530, member firms must continue to report specified events (paragraphs (a)(1)(A) through (a)(1)(H), (a)(2) and (b) of Rule 4530) and quarterly statistical and summary information on written customer complaints (paragraph (d) of Rule 4530) electronically via the Regulatory Filings Application on the FINRA Firm Gateway.4 The Disclosure Events and Complaints application will be renamed the Rule 4530 Application on July 1, 2011.5

      Automated Reporting via Rule 4530 Application6

      Firms logging in to the reporting application on July 1, 2011, will notice the following changes:7

      •   As noted above, the name of the reporting application will be changed from "Disclosure Events and Complaints" to the "Rule 4530 Application."
      •   Beginning July 1, the drop-down menu in the Rule 4530 Application will provide descriptions of reportable events that correlate with FINRA Rule 4530, and it will no longer include the numeric codes currently in use.8 (Right now, when reporting specified events, firms are required to select the appropriate event from a drop-down menu that includes a numeric code and description of the event.9)

      There are no other significant changes to the reporting application.


      1 FINRA Rule 4530 takes effect on July 1, 2011, replacing NASD Rule 3070 and the corresponding provisions in Incorporated NYSE Rule 351. See Regulatory Notice 11-06 (February 2011) (SEC Approves Consolidated FINRA Rule Governing Reporting Requirements).

      2 See Securities Exchange Act Release No. 35956 (July 11, 1995), 60 FR 36838 (July 18, 1995) (Notice of Filing of Proposed Rule Change; File No. SR-NASD-95-16); Notice to Members (NTM) 95-81 (September 1995) (SEC Approves Rules For Reporting Customer Complaint Information); and Regulatory Notice 08-40 (August 2008) (Technology Changes for Reporting Certain Complaint and Disclosure Information).

      3 The application can be accessed directly through the following hyperlink: https://regfiling.finra.org.

      4 See Regulatory Notice 11-06.

      5 See supra note 4.

      6 Firms with a higher volume of reporting may find that a batch submission is more efficient than reporting matters one at a time using the Regulatory Filings Application on the FINRA Firm Gateway. A batch submission via the file transfer protocol (FTP) allows a member firm to submit multiple reports directly to a secure server. For more information regarding batch submissions, please see the Regulation Filing Applications FTP Submission Fact Sheet at www.finra.org/web/ groups/industry/@ip/@comp/@rj/documents/appsupportdocs/pll7146.pdf

      Firms that will submit reports via FTP, rather than via the Rule 4530 Application, must use new event codes (11 through 20) for batch reporting specified events on or after July 1, 2011. See Regulatory Notice 11-06, Attachment B.

      7 Firms should use their existing user ID and password to access the Rule 4530 Application.

      8 The following will be the available selections in the new drop-down menu as of July 1, 2011: External Finding; Customer Complaint Involving Certain Allegations; Named in a Regulatory Proceeding; Subject to Other Regulatory Actions; Criminal Actions Involving Felonies and Certain Misdemeanors; Associated with a Financial Entity Subject to Certain Actions; Civil Litigation, Arbitration Matters, or Certain Claims for Damages; Statutory Disqualification; Disciplinary Action Taken by a Firm Against an Associated Person; and Internal Conclusion.

      9 The following are the available selections in the current drop-down menu: 01—Securities, Law, Rule, or Regulation Violation; 02—Customer Complaint; 03—Regulatory or Self-regulatory Proceeding; 04—Regulatory or Self-regulatory Membership; 05—Criminal Offense; 06—Association with Investment Company; 07—Civil Litigation or Arbitration; 08—Damages Claim; 09—Statutory Disqualification; and 10—Disciplinary Action.

    • 11-09 New Electronic System for Submitting and Processing Company-Related Actions for Non-Exchange Listed Securities Under Rule 6490; Effective Date: March 14, 2011

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      Company-Related Actions

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

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

      Company-Related Actions
      Dividends
      Fees
      Non-Exchange Listed Securities
      Over-the-Counter Trading
      Stock Splits
      Referenced Rules & Notices

      FINRA Rule 6490
      Regulatory Notice 10-38
      SEA Rule 10b-17
      UPC Rules

      Executive Summary

      Beginning March 14, 2011, issuers, American Depositary Receipt (ADR) depositary banks and other parties that provide notice of company-related actions to FINRA under Rule 6490 must use a new electronic system to provide such notice to FINRA. As of this effective date, FINRA will no longer accept paper copies of the Company-Related Action Notification Forms.

      The new electronic Company-Related Action Forms will be available on March 14, 2011, via www.finra.org/upc/forms.

      The text of FINRA Rule 6490 is available on FINRA's website.

      Questions regarding this Notice should be directed to:

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

      Background & Discussion

      FINRA Rule 6490 (Processing of Company-Related Actions), which became effective on September 27, 2010,1 codifies the requirements in SEA Rule 10b-17 for issuers of a class of publicly traded over-the-counter (OTC) 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, or a rights or subscription offering). Generally (pursuant to SEA Rule 10b-17), issuers must provide notice at least 10 days prior to the record date for the corporate action. Issuers must also notify FINRA of certain other corporate actions (e.g., the issuance or change of trading symbols, mergers or 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.

      Under Rule 6490, FINRA's Operations Department has the authority to request other documents that may be necessary to verify information provided on the forms. The Operations Department may, in its discretion, conduct detailed reviews of submissions on a case-by-case basis. Moreover, the rule authorizes FINRA not to process a request to announce a corporate action if it determines that the request is deficient and not processing is necessary for the protection of investors and the public interest, and to maintain fair and orderly markets.

      Currently, issuers and other parties submit notifications of company-related actions under Rule 6490 by completing the appropriate Company-Related Action Notification Form from FINRA's website and then submitting a paper copy of it to the Operations Department. On March 14, 2011, issuers and other parties must begin using FINRA's new electronic system to provide these notifications. As of this date, FINRA will no longer accept paper copies of Company-Related Action Notification Forms.

      The new system offers enhanced functionality that will give issuers and other parties:

      •   the ability to complete Company-Related Action Forms electronically, including the ability to amend or update the form prior to submission;
      •   a unique case number for each company-related action to allow for better tracking;
      •   the ability to create templates for frequently submitted information;
      •   more streamlined form completion, as the system will automatically direct the issuer or other party only to necessary sections of the form based on the nature of the company-related action notification being submitted; and
      •   a separate processing system for ADR company-related action notifications for ADR depositary banks.

      New Steps for Submitting Company-Related Actions

      As of March 14, 2011, an issuer or other duly authorized representative that is obligated to provide notice of a company-related action to FINRA must follow these steps:

      1. Complete and submit the appropriate electronic Company-Related Action Notification Form at least 10 days prior to the record date or effective date (as applicable) for the company-related action. On March 14, the electronic forms and instructions will be available via FINRA's website at www.finra.org/upc/forms.
      2. Ensure that the issuer's duly authorized transfer agent simultaneously signs and submits a completed "Transfer Agent Verification Form" to FINRA's Operations Department as required by the Company-Related Action Form.
      3. Attach supporting documentation (e.g., copies of Board resolutions authorizing the company-related action, amendments to charters of incorporation) as required by the Company-Related Action Form (which may be attached electronically with the initial submission, or may be submitted subsequently in paper format or by email).
      4. Pay all applicable fees, including late fees, as prescribed on the Company-Related Action Notification Form.
      5. A unique, identifying case number will be assigned by the Operations Department to each request to process documentation for a Company-Related Action and must be prominently placed on all future submissions, notices and correspondence from the issuer or its duly authorized representative to FINRA relating to the action.

      FINRA believes the new electronic system will make compliance with Rule 6490 more efficient. In addition, issuers and other parties that submit corporate action requests will have expanded payment options under the new system for submission of the required Rule 6490 fees that will allow payment by credit card, PayPal or ACH.


      1 See Securities Exchange Act (SEA) Release No. 62434 (July 1, 2010; 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). See also Regulatory Notice 10-38 (Obligation of Issuers to Provide Notice of Company-Related Actions) (August 2010).

    • 11-08 FINRA Requests Comment on Proposed Consolidated FINRA Rules Governing Markups, Commissions and Fees; Comment Period Expires: March 28, 2011

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      Markups, Commissions and Fees

      Regulatory Notice
      Notice Type

      Request for Comment
      Consolidated FINRA Rulebook
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Markups and Markdowns
      Commissions
      Commission Schedule
      Service Fees and Charges
      Service Fee Schedule
      Referenced Rules & Notices

      FINRA Rule 2010
      NASD Rule 2430
      NASD Rule 2440
      NASD IM-2440-1
      NASD IM-2440-2
      NTM 92-11
      NYSE Rule 375 and Interpretation 375/01
      Regulatory Notice 08-80
      SEA Section 19

      Comment Period Expires: March 28, 2011

      Executive Summary

      As part of the process to develop a new consolidated rulebook (the Consolidated FINRA Rulebook)1 FINRA is requesting comment on the proposed consolidated FINRA rules governing markups, markdowns, commissions and fees.

      The text of the proposed rules is available as Attachment A on our website at www.finra.org/notices/11-08.

      Questions regarding this Notice should be directed to Sharon K. Zackula, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8985.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by March 28, 2011.

      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.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

      Background

      NASD Rule 2440 (Fair Prices and Commissions), NASD IM-2440-1 (Mark-Up Policy) and NASD IM-2440-2 (Additional Mark-Up Policy For Transactions in Debt Securities, Except Municipal Securities)—collectively referred to as the "markup rules"—govern markups, markdowns and commissions in transactions with customers. Charges or fees that are not transaction-related, such as charges for safekeeping or collecting dividends or interest for a customer, are governed by NASD Rule 2430 (Charges for Services Performed).

      NYSE Rule 375 (Missing the Market) prohibits a member from charging a customer a commission without the customer's knowledge and consent on an order if the member has accepted the order for execution and, by neglecting to execute the order or otherwise, takes or supplies for its own account the securities named in the order.4 NYSE Rule Interpretation 375/01 (Customer Contact and "As of" Reports) states that a member that has "missed the market" should contact the customer, inform the customer of the circumstances and permit the customer to choose one of two ways the member will fill the order.

      Proposal

      As further detailed below, FINRA proposes to transfer NASD Rule 2440, NASD IM-2440-1 and NYSE Rule 375 to the Consolidated FINRA Rulebook as FINRA Rule 2121 (Fair Prices and Markups, Markdowns and Commissions), subject to significant changes. Among other things, FINRA proposes to eliminate the "5% policy" and the "proceeds provision" in NASD Rule IM-2440-1. FINRA also proposes to require firms to provide commission schedule(s) for equity securities to retail customers, and to notify and obtain consent from a customer to charge a commission when a firm misses the market and trades with the customer on a principal basis.

      In addition, FINRA proposes to transfer the requirements set forth in NASD IM-2440-2 to the Consolidated FINRA Rulebook as FINRA Rule 2122 (Markups and Markdowns for Transactions in Debt Securities, Except Municipal Securities), without significant change. FINRA proposes not to incorporate in the Consolidated FINRA Rulebook the substantive provisions of NYSE Rule Interpretation 375/01 (Customer Contact and "As of" Reports), which addresses the execution price of orders where a member has missed the market.

      With respect to service charges and fees, FINRA proposes to transfer NASD Rule 2430 to the Consolidated FINRA Rulebook as FINRA Rule 2123 (Charges and Fees for Services Performed). Similar to the proposed commission disclosure requirement, FINRA proposes to require members to provide retail customers with schedule(s) of charges and fees for services.5

      The most significant proposed changes are described generally below. However, FINRA encourages member firms to carefully review the entire proposed rule text (in Attachment A at www.finra.org/notices/11-08) to understand the full extent of the proposed changes.

      A. Fair Prices and Markups, Markdowns and Commissions (Proposed FINRA Rule 2121)
      1. Fair and Reasonable Markups, Markdowns and Commissions (Proposed FINRA Rule 2121(a))

      Proposed FINRA Rule 2121(a) incorporates the requirements of NASD Rule 2440 with minor changes.6 Generally, NASD Rule 2440 requires that securities be sold to or purchased from customers at fair and reasonable prices and, if firms act as agents, be subject to fair and reasonable commissions or commission-equivalent charges. Fairness is judged by the facts and circumstances of the particular transaction. NASD Rule 2440 also lists a few of the circumstances or factors that are generally relevant in determining a markup (or a markdown); the rule sets forth similar factors to apply when a firm acts as agent and charges a commission.7

      In the new rule, FINRA proposes to clarify a provision in NASD Rule 2440 regarding a member engaged in a principal transaction, which provides: "he shall buy or sell at a price which is fair, taking into consideration all relevant circumstances, includingå the fact that he is entitled to a profit." FINRA proposes to amend the provision to state: "the member shall buy or sell at a price which is fair and reasonable, taking into consideration all relevant facts and circumstances, includingå the fact that the member is entitled to remuneration." While members may set customer transaction remuneration charges that are profitable, the markups, markdowns and commissions charged by a member must be established in line with the considerations set forth in the rule. For example, a member that charges a fixed commission of $20 per transaction generally would be entitled to charge this same commission for a purchase transaction of 20 shares of a security at an execution price of $2. However, a member's right to set profitable transaction charges does not obviate the requirement to comply with the standards of the rule; is not a license to set high minimum markup, markdown or commission charges; and does not allow a member to factor into such charges realized and unrealized market losses on securities that a member holds or has held in inventory.
      2. General Considerations; Deletion of the "5% Policy" (Proposed FINRA Rule 2121(b))

      FINRA proposes two significant changes to NASD-IM-2440-1 to be transferred to FINRA Rule 2121. First, FINRA proposes not to incorporate the existing "5% Policy" in proposed FINRA Rule 2121(b) (General Considerations).

      The "5% Policy" of NASD IM-2440-1 is set forth and discussed in the preamble of NASD IM-2440-1 and referenced in NASD IM-2440-1(a). The preamble states that the question of fair markups (or spreads) is one for which there is no definitive answer or single interpretation because a markup that may be considered fair in one transaction could be unfair in another transaction based on the different circumstances of the two transactions. The preamble also refers to a 1943 survey of the FINRA (then NASD) membership, which revealed that 71 percent of respondents indicated that transactions were executed with markups of 5 percent or less.8 The Board then determined that in most transactions, markups of 5 percent or less would fall within the "fair and reasonable" standard and adopted the "5% Policy" as guidance.9 In addition, NASD IM-2440-1(a) provides several "General Considerations." Two address the "5% Policy," stating that the "5% Policy" is a guide and not a rule (NASD IM-2440-1(a)(1)), and that a markup pattern of 5 percent or even less may be considered unfair or unreasonable under the "5% Policy" (NASD IM-2440-1(a)(4)).

      FINRA believes that the "5% Policy"—which is based on the execution practices and market efficiencies of nearly 70 years ago—should not be transferred to proposed FINRA Rule 2121. The "5% Policy" is viewed by many as establishing a presumption that markups, markdowns and commissions in excess of 5 percent are prohibited, or, at best, are subject to additional scrutiny, requiring the firm to provide more justification to prove that such remuneration is not "excessive." Conversely, the "5% Policy" is also viewed by many as establishing a specific ceiling or cap below which most markups, markdowns or commissions will not be viewed as excessive (or will not be questioned).

      Five percent is significantly higher than the average markup, markdown or commission currently charged by most firms in equity transactions. In a recent study conducted by an independent consultant, based on a sample of more than 161,000 equity transactions with customers, the mean markup was 2.2 percent and the average or median markup was 2 percent.10 Markdowns were even lower: the mean markdown was 1.9 percent and the median markdown was 1.3 percent.11

      For debt securities transactions, FINRA also believes that 5 percent is higher than the average markup or markdown charged currently. In this regard, FINRA's preliminary review indicates that debt markups and markdowns in TRACE-Eligible Securities transactions are generally lower than 5 percent.12 Such markups and markdowns are consistent with the SEC staff's position that debt markups and markdowns generally are expected to be lower than equivalent remuneration in equity transactions.13

      As the markups, markdowns and commissions that members currently charge in equity and debt transactions are generally lower than 5 percent, FINRA believes the "5% Policy" is outdated and should be deleted. FINRA emphasizes that the elimination of the "5% Policy" would not be an opportunity to increase markups, markdowns and commissions, but instead reflects FINRA's determination that the "5% Policy" does not reflect current industry practices. The decision to delete the "5% Policy" also reflects FINRA's view that competition, market pricing efficiency and automation generally have reduced markups, markdowns and commissions materially below 5 percent, and rather than base remuneration for transaction executions off an outdated metric from 1943, a member must use the factors in proposed FINRA Rule 2121(c) to rationalize its remuneration for the execution of a transaction.

      At this time, FINRA also does not propose a new policy based upon a lower percentage as this may encourage members to artificially peg (or cap) their markups, markdowns and commissions based upon the new percentage,14 instead of using the factors in the rule to rationalize their remuneration for the execution of transactions.

      With the deletion of the "5% Policy," proposed FINRA Rule 2121(b) is based upon three "General Considerations" from NASD IM-2440-1(a) and an additional provision regarding sales from inventory previously located in NASD IM-2440-1(c)(2). More specifically, FINRA proposes to transfer:15
      •   NASD IM-2440-1(a)(2) regarding excessive expenses as proposed FINRA Rule 2121(b)(1), and to amend the provision to reference explicitly markdowns and commissions.
      •   NASD IM-2440-1(a)(3) as proposed FINRA Rule 2121(b)(2), subject to certain amendments to clarify the presumption that the member's own contemporaneous cost is the best indication of the prevailing market price, unless other bona fide, more credible evidence of the prevailing market price can be evidenced. Currently, NASD IM-2440-1(a)(3) provides: "In the absence of other bona fide evidence of the prevailing market, a member's own contemporaneous cost is the best indication of the prevailing market price of a security." In contrast, proposed FINRA Rule 2121(b)(2) provides: "For a markup, a member's own contemporaneous cost is the best indication of the prevailing market price of a security, and for a markdown, a member's own contemporaneous proceeds are the best indication of the prevailing market price of a security, unless other bona fide, more credible evidence of the prevailing market price can be evidenced."
      •   NASD IM-2440-1(c)(2), regarding sales from or to inventory, as proposed FINRA Rule 2121(b)(3). The provision provides that in a principal transaction, when a member sells a security from inventory to a customer, the amount of profit or loss to the member from market appreciation or depreciation before, or after, the date of the transaction with the customer would not ordinarily enter into the determination of the amount or fairness of the dealer's markup. FINRA proposes to amend this provision to apply explicitly to markdowns in the case where the member purchases a security into inventory from a customer.
      •   NASD IM-2440-1(a)(5),which provides that determination of the fairness of a markup must be based on a consideration of all the relevant factors, of which the percentage of markup is only one, as FINRA Rule 2121(b)(4). FINRA proposes to amend the provision to reference explicitly markdowns and commissions.
      3. Deletion of the "Proceeds Provision"

      In addition to the elimination of the "5% Policy," the second significant change to the consolidation and transfer of IM-2440-1 to FINRA Rule 2121 is the elimination of the "proceeds provision" (NASD IM-2440-1(c)(5)). Currently, when a customer sells one security and buys a second security at the same time, using the proceeds of the securities position liquidated to pay for the second position, the "proceeds provision" requires that both trades be treated as a single transaction for markup, markdown or commission purposes. Consequently, the total remuneration for both transactions would generally not be allowed to exceed the remuneration amount for a single transaction. FINRA proposes to eliminate it because the provision is confusing and raises concerns that it represents a standard that may not be susceptible to consistent application. For example, it is not always clear when two transactions occurring close in time are related (the two transactions may represent unrelated investment decisions) or how close in time transactions must be to be considered "proceeds" transactions. Further, the "proceeds provision" cannot be applied where a customer decides to sell a position at one broker-dealer to purchase a position at another broker-dealer. FINRA believes the more rational approach is that transaction remuneration be determined on a fair basis pertaining to each transaction.
      4. Relevant Factors (Proposed FINRA Rule 2121(c))

      FINRA proposes to transfer to FINRA Rule 2121(c) (Relevant Factors) the non-exclusive list of seven relevant factors that a member should take into consideration in determining if a markup, markdown or commission is fair and reasonable. The factors are:
      (1) type of security involved;
      (2) availability of the security in the market;
      (3) price of the security;
      (4) amount of money involved in a transaction;
      (5) disclosure;
      (6) pattern of markups; and
      (7) nature of the firm's business.
      Also, the transferred provisions incorporate minor stylistic changes to delete certain outdated language.
      5. Transactions to Which the Rule is Not Applicable (FINRA Rule 2121(d))

      Proposed FINRA Rule 2121(d) includes, with minor, non-substantive amendments, the provision that the markup rule (formerly "policy") does not apply to the sale of securities where a prospectus or offering circular must be delivered and the securities are sold at the specific public offering price (NASD IM-2440-1(d)). Also, proposed FINRA Rule 2121(d) is updated to reflect that FINRA Rule 2121 does not apply to a transaction with a qualified institutional buyer (QIB) that meets the conditions of proposed FINRA Rule 2122(b)(9) (current NASD IM-2440-2(b)(9)).
      6. Commission Schedules (Proposed FINRA Rule 2121(e))

      In proposed FINRA Rule 2121(e), FINRA proposes an additional requirement regarding transaction-based remuneration. The proposed rule requires a member to establish and make available to retail customers the schedule(s) of standard commission charges for transactions in equity securities with retail customers.16 A member would be allowed to establish and publish multiple schedules of standard commission charges, as long as it discloses in or with the schedule(s) how the commissions are stratified among all retail customers.

      In addition, the prior disclosure of commissions for equity securities transactions would not preclude a member from negotiating lower commission rates with retail customers, provided that the member discloses, in or with the schedule(s), that the member may do so from time to time. A member would be required to provide in writing (which may be electronic) the schedule(s) of commissions to new retail customers at the opening of an account, and all retail customers at least once every calendar year. In addition, a member would be required to provide in writing (which may be electronic) any amendments to the schedule(s) of commissions (including any new forms of commissions or new disclosures) to all retail customers at least 30 days prior to imposing any change in the commissions set forth in the schedules or any new forms of commission charges for retail customers.

      Alternatively, a member would be permitted to make available to retail customers its schedule(s) of standard commission charges applicable to retail customers by posting them on its website if the member provides written notice (which may be electronic) to new retail customers at the opening of an account, and all retail customers at least once every calendar year, of the manner in which they may access the commission schedules, and that, upon a retail customer's request, the member will provide a copy of the commission schedules to the customer. In such case, a member also would be required to provide written notice (which may be electronic) to all retail customers at least 30 days prior to imposing any change in the commissions set forth in the schedules or any new forms of commission charges for retail customers.

      The proposed requirement is limited to commissions on equity securities because such commissions are most easily compared by retail customers and more readily reduced to fixed amount or ranges than are commissions applicable to other securities transactions, such as debt, or negotiated by institutional accounts. FIINRA anticipates that a retail customer's ability to compare equity commissions among members may, by competition, result in lower commissions (and markups and markdowns).
      7. Notice of "Missing the Market" and Consent to Commission Charge (Proposed FINRA Rule 2121(f))

      FINRA proposes to incorporate the substantive requirements of NYSE Rule 375 in proposed FINRA Rule 2121(f). NYSE Rule 375 prohibits a member from charging a commission without the customer's knowledge and consent on an order if the member has accepted the order for execution and, by reason of neglect to execute the order or otherwise, takes or supplies for its own account the securities named in the order. FINRA proposes to transfer these requirements to proposed FINRA Rule 2121 because there are no similar requirements in the NASD markup rules regarding whether, and under what circumstances, a member may charge a commission if a member "misses the market." Proposed FINRA Rule 2121(f) would be a new requirement for former NASD-only members.
      8. Other Provisions Transferring With Minor Changes or to be Deleted (Paragraphs (a), (b) and (d) of Proposed FINRA Rule 2121)

      FINRA also proposes the following minor amendments and deletions as part of the transfer and consolidation of NASD Rule 2440, NASD IM-2440-1 and NYSE Rule 375 into FINRA Rule 2121:
      •   FINRA proposes deleting (in addition to the "proceeds provision" in IM-2440-1(c) as discussed above) the remaining provisions in NASD IM-2440-1(c) because they are redundant or readily implied in other provisions to be incorporated in FINRA Rule 2121. Specifically, the following provisions would not be transferred to FINRA Rule 2121:
      •   IM-2440-1(c)(1), stating that "riskless" transactions are subject to the markup rules;
      •   IM-2440-1(c)(3), providing that member purchases from customers are subject to the markup rules and the price paid to the customer or the markdown applied by the member must be reasonably related to the prevailing market price of the security; and
      •   IM-2440-1(c)(4), stating that transactions where the member acts as agent are subject to the markup rules and a commission charged a customer must be fair in light of all relevant circumstances.
      •   FINRA also proposes several conforming changes to FINRA Rule 2121 to add the term "reasonable" when referring to markups, markdowns and commissions that must be "fair" to incorporate the more widely used phrase "fair and reasonable."
      •   The proposed amendments include additional non-substantive, technical changes to FINRA Rule 2121 not specifically referenced above to modify outdated language; to clarify that generally the provisions of FINRA Rule 2121 refer to markups, markdowns and commissions; and to reflect the new format, terminology and other conventions of the Consolidated FINRA Rulebook.
      B. Markups and Markdowns for Transactions in Debt Securities, Except Municipal Securities (Proposed FINRA Rule 2122)

      FINRA proposes to transfer NASD IM-2440-2 to the Consolidated FINRA Rulebook as FINRA Rule 2122 without significant changes.17 Proposed FINRA Rule 2122 contains:
      •   the standards for determining a markup or a markdown in a transaction with a customer in a debt security (except a municipal security);
      •   the procedures to identify prevailing market price;
      •   the role of the dealer's contemporaneous cost in determining prevailing market price;
      •   the characteristics of "similar securities"; and
      •   the role of similar securities in determining a markup or a markdown that are currently set forth in NASD IM-2440-2.
      The proposed rule also includes an exemption from the requirements of proposed FINRA Rule 2121 and FINRA Rule 2122 for certain transactions in non-investment grade securities effected with certain QIBs that is currently in NASD IM-2440-2(b)(9). In addition, proposed FINRA Rule 2122 includes minor changes to update rule cross-references and to reflect the new format, terminology and other conventions of the Consolidated FINRA Rulebook.
      C. Charges and Fees for Services Performed (Proposed FINRA Rule 2123)

      FINRA proposes to transfer NASD Rule 2430, with a significant change, to the Consolidated FINRA Rulebook as FINRA Rule 2123.18 Proposed FINRA Rule 2123(a) restates the current requirement that charges and fees for services must be reasonable and not unfairly discriminate among customers and, like NASD Rule 2430, applies to all charges and fees for services provided by a member that are not related to the execution of a transaction.

      Similar to the proposed commission disclosure requirement discussed above, FINRA proposes to require a member to establish and make available to retail customers a member's schedule(s) of standard charges and fees for services for retail customers (proposed FINRA Rule 2123(b)).19 A member that establishes and publishes more than one schedule of standard charges and fees for services for retail customers would be required to disclose, in or with the schedule(s), the manner in which such schedules apply to various types or classes of retail customers, accounts or services. Also, a member would not be precluded from negotiating lower charges and fees with retail customers, provided that the member discloses, in or with the schedule(s), that it may do so from time to time. A member would be required to provide in writing (which may be electronic) the schedule(s) of standard charges and fees for services to new retail customers at the opening of an account, and all retail customers at least once every calendar year. In addition, a member would be required to provide in writing (which may be electronic) any amendments to the schedule(s) of standard charges and fees for services (including any new charges or fees) to all retail customers at least 30 days prior to imposing any change in the charges and fees or disclosures set forth in the schedule(s) or any new charges or fees for retail customers.

      Alternatively, a member would be permitted to make available to retail customers the member's schedule(s) of standard charges and fees for services by posting them on its website if it provides written notice (which may be electronic) to new retail customers at the opening of any account, and all retail customers at least once every calendar year, of the schedule(s) and the manner in which they may be accessed. Upon a retail customer's request, the member would provide a copy of the schedule(s) of standard charges and fees to the customer. In such case, a member also would be required to provide written notice (which may be electronic) to all retail customers at least 30 days prior to imposing any change in the charges and fees or disclosures set forth in the schedule(s) or any new charges or fees for retail customers.20

      Proposed FINRA Rule 2123(a) also includes additional non-substantive, technical changes to reflect the new format, terminology and other conventions of the Consolidated FINRA Rulebook.
      D. NYSE Provision Proposed for Deletion (NYSE Rule Interpretation 375/01)

      FINRA proposes not to incorporate NYSE Rule Interpretation 375/01 in the Consolidated FINRA Rulebook, relating to the execution price of orders where a member has missed the market. A member's existing obligations under NASD Rule 2320,21 which broadly requires that a member execute a customer order in the best market for that security "so that the resultant price to the customer is as favorable as possible under prevailing market conditions," and NASD Rule 2111, which requires a member to "make every effort to execute a customer market order that it receives fully and promptly," adequately address such situations.22
      E. Market Makers

      Proposed FINRA Rule 2121 and proposed FINRA Rule 2122, as is the case with the current markup rules, do not address a market maker's allowance, subject to the limitations in regulation, to capture the trading spread between the bid and the ask prices. Nothing in the proposed markup rules affects that body of law and regulation.

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

      3 Section 19 of the Securities Exchange Act of 1934 (SEA or Exchange Act) permits certain imited types of proposed rule changes to take effect upon filing with the SEC. The SEC has the authority to summarily temporarily suspend these types of rule changes within 60 days of filing. If the SEC takes such action, the SEC shall institute proceedings to determine whetherthe proposed rule should be approved or disapproved. See SEA Section 19 and rules thereunder.

      4 For convenience, the Incorporated NYSE Rules are referred to as the NYSE Rules.

      5 NASD Rules 2440 and 2430, NASD IMs 2440-1 and 2440-2, and NYSE Rule 375 would be deleted in their entirety from the Transitional Rulebook with the adoption of FINRA Rules 2121, 2122 and 2123. NYSE Rule Interpretation 375/01 (Customer Contact and "As of" Reports) would not be transferred to the Consolidated FINRA Rulebook and would be deleted in its entirety from the Transitional Rulebook.

      6 There is no NYSE rule equivalent to NASD Rule 2440 or to NASD IM-2440-1.

      7 Additional factors that are generally relevant in determining a markup, markdown or commission are set forth in NASD IM-2440-1.

      8 Although the entire membership was surveyed, 82 percent of the membership responded.

      9 The preamble also states that a firm violates NASD Rule 2110 (now FINRA Rule 2010) and NASD Rule 2440 if it enters into any transaction with a customer at any price not reasonably related to the current market price of the security or charges a commission that is not reasonable.

      10 Ferrell, A., The Law and Finance of Broker-Dealer Mark-Ups (2007) (Ferrell Study). The Ferrell Study was conducted at FINRA's request, and is based on more than 161,000 equity transactions. The data is a sample largely consisting of lower-priced, less liquid securities (the median price of stock purchased by customers was $5.50), which were purchased or sold over-the-counter to retail customers. (Approximately 98 percent of the transactions were executed over-the-counter.) FINRA collected the data from 14 broker-dealers that had certain compliance issues in their records, tended to be small to medium-sized firms and tended to deal primarily with retail customers. Most of the transaction data was collected as part of a FINRA sweep examination conducted in 2004 of the firms, which preceded the study and was not done for purposes of the study. The Ferrell Study uses the term "markup" (or "markdown") to also include agency remuneration (commissions).

      11 To compare some of the recent transaction data with the 1943 markup data, Ferrell also identified markup levels atthe 71st percentile and the 47th percentile. Ferrell found that markups in recent transactions at the 71st percentile were 2.95 percent (compared to 5 percent in 1943) and markups in the 47th percentile were 1.8 percent (compared to 3 percent in 1943).

      12 FINRA has commenced, but has not yet completed, a review of transactions in TRACE-Eligible Securities (as defined in FINRA Rule 6710) executed during the first two quarters of 2008 to determine the median and mean markups and markdowns currently charged in such debt securities transactions. (Very few transactions in TRACE-Eligible Securities are executed in an agency capacity.)

      13 The SEC staff made a similar statement in 1987. Zero Coupon Securities, Exchange Act Release No. 24368 (April 21, 1987), 52 FR 15575 (April 29, 1987).

      14 In lieu of stating in proposed FINRA Rule 2121 that a markup, markdown or commission of ess than a specified amount or percentage, such as 3 percent or 3.5 percent, may not be excessive, FINRA expects to provide guidance in a Regulatory Notice that markups, markdowns and commissions above certain specified percentages will be subjectto additional regulatory scrutiny, requiring members to provide additiona justification to establish that such markups, markdowns, and commissions are not excessive.

      15 NASD IM-2440-l(a)(l) and NASD IM-2440-l(a)(4) are based upon the "5% Policy" and, as discussed above, would not be transferred to proposed FINRA Rule 2121.

      16 For purposes of the requirement, the term "retail customer" means a customer that does not qualify as an institutional account under NASD Rule 3110(c)(4). The SEC recently approved the adoption of NASD Rule 3110(c)(4) as FINRA Rule 4512(c) without material change. See Exchange Act Release No. 63784 (January 27, 2011), 76 FR 5850 (February 2, 2011) (Order Approving File No. SR-FINRA-2010-052). FINRA will announce the effective date of FINRA Rule 4512 in a Regulatory Notice.

      17 There is no NYSE rule equivalent to NASD IM-2440-2.

      18 There is no NYSE rule equivalent to NASD Rule 2430.

      19 For purposes of the requirement, the term "retail customer" means a customer that does not qualify as an institutional account under NASD Rule 3110(c)(4). The SEC recently approved the adoption of NASD Rule 3110(c)(4) as FINRA Rule 4512(c) without material change. See supra note 16.

      20 The requirement to disclose a member's fees and charges to new retail customers and to notify all retail customers of changes to existing fees or new fees at least 30 days prior to imposing the changes in the fees or the new fees is based on current guidance. See NTM 92-11 (February 1992).

      21 FINRA has proposed to adopt new FINRA Rule 5310 (Best Execution and Interpositioning), based largely on NASD Rule 2320. See Regulatory Notice 08-80 (December 2008).

      22 FINRA has proposed to adopt NASD IM-2110-2 (Trading Ahead of Customer Limit Order) and NASD Rule 2111 (Trading Ahead of Customer Market Orders) with significant changes as new FINRA Rule 5320 (Prohibition Against Trading Ahead of Customer Orders). See Exchange Act Release No. 61168 (December 15, 2009), 74 FR 68084 (December 22, 2009) (Notice of Filing SR-FINRA-2009-090).


      Attachment A

    • 11-07 FINRA Revises the Sanction Guidelines; Effective Date: February 9, 2011

      View PDF

      Sanction Guidelines

      Regulatory Notice
      Notice Type

      Guidance
      Suggested Routing

      Legal
      Registered Representatives
      Senior Management
      Key Topics

      FINRA Sanction Guidelines
      Referenced Rules & Notices

      FINRA Rule 2010
      FINRA Rule 2114
      FINRA Rule 2265
      FINRA Rule 5260
      FINRA Rule 8210
      NASD Rule 2230
      NASD Rule 2310
      NASD Rule 2320
      SEA Rule 10b-10
      SEA Rule 19d-1
      Section 5 of the Securities Act of 1933

      Effective Immediately

      Executive Summary

      This Notice advises FINRA firms of modifications to the FINRA Sanction Guidelines. The changes reflect the experience of FINRA's Departments of Market Regulation and Enforcement in settling and litigating cases, and incorporate the teachings of federal appellate court and SEC precedent in recent FINRA disciplinary cases. Specifically, the revisions:

      •   remove the Minor Rule Violation Plan Letter from the definition of a disciplinary "action" for purposes of considering prior actions and the provision that discusses respondents charging fines and costs to credit cards;
      •   modify the guidelines for violations related to the sale of unregistered securities to reflect that adjudicators should consider higher fines and firm suspensions in egregious cases;
      •   incorporate into the FINRA Rule 8210 guidelines relevant federal court and SEC precedent. The FINRA Rule 8210 guidelines also now delineate principal considerations for the three categories of violations. And for a partial but incomplete response to a FINRA Rule 8210 request, the guidelines now reflect parity with the fine for a failure to respond or respond truthfully;
      •   expressly provide for restitution or disgorgement in certain trading halt and best execution cases, and amend the suitability guidelines for use in cases where respondents have violated the "Recommendation Rule";
      •   add new guidelines for failing to comply with rule requirements related to customer confirmations and extended hours trading risk disclosure; and
      •   reflect the new FINRA rule numbers for rules that have been adopted into the consolidated FINRA rulebook.

      The revised Sanction Guidelines are effective immediately and available on FINRA's website at www.finra.org/Industry/Enforcement/SanctionGuidelines.

      Questions concerning this Notice may be directed to:

      •   Emily Gordy, Department of Enforcement, at (202) 974-2916;
      •   Louise Corso, Department of Market Regulation, at (240) 386-5241; and
      •   Jennifer Brooks, Office of General Counsel, at (202) 728-8083.

      Background & Discussion

      The FINRA Sanction Guidelines are designed to address a wide variety of potential violations of FINRA's rules and provide fact-specific guidance for crafting appropriately remedial sanctions. FINRA's adjudicators rely on the guidelines to determine sanctions, and FINRA's Departments of Market Regulation and Enforcement and the defense bar rely on them when negotiating settlements in disciplinary matters. The National Adjudicatory Council approved these revisions, several of which are small adjustments designed to reflect the experience of FINRA's Departments of Market Regulation and Enforcement in settling and litigating disciplinary cases.

      Revisions to Technical Matters

      The revised Sanction Guidelines remove the Minor Rule Violation Plan Letter (MRVP) from the definition of an "action." MRVPs (that do not exceed $2,500) are not "final disciplinary actions" as that term is defined in SEA Rule 19d-1 and therefore, FINRA is not obligated to file notice of the "action" with the Securities and Exchange Commission (SEC). Eliminating the MRVPs from the definition of an action is consistent with their being a nonreportable event. While MRVPs, Cautionary Action Letters and other informal actions are not "actions" as defined in the Sanction Guidelines, FINRA's Departments of Market Regulation and Enforcement retain the option of considering them in settlement discussions when negotiating an appropriate level of monetary sanction or when determining whether subsequent findings of violations should result in formal or informal action.

      The revised Sanction Guidelines also remove the sentence that respondents may charge fines and costs to credit cards. Because FINRA seeks to minimize the credit card fees that it pays when it accepts payments via credit cards, going forward FINRA will be managing the payment method for fines and costs through its Billing Services Department. FINRA is not immediately changing its acceptance of credit card payments; it will communicate a new policy before it takes effect.

      Revisions to Distributions of Securities Guidelines

      FINRA amended the guidelines for sales of unregistered securities, which address the unlawful distributions of securities in violation of Section 5 of the Securities Act of 1933 and FINRA Rule 2010. The rules prohibiting the sale of unregistered securities are an important component of maintaining the integrity of the securities registration process. Broker-dealers perform an important gatekeeper role. When broker-dealers properly assume their regulatory responsibilities, they guard against the entry of unregistered securities into the markets and against market manipulations and pump-and-dump schemes. These schemes are often accompanied by unlawful distributions of unregistered securities. The revisions emphasize that adjudicators consider, in egregious cases, suspending a firm with respect to any or all activities or functions for up to 30 business days or until procedural deficiencies are remedied and imposing a fine higher than the recommended range in the Sanction Guidelines. These revisions allow adjudicators to impose increased sanctions, in egregious situations, and reflect the importance of deterring market manipulations that are often accompanied by unregistered securities.

      Revisions to Impeding Regulatory Investigations Guidelines

      In order to harmonize the Sanction Guidelines with federal court and SEC precedent, and to clarify several aspects, FINRA amended the FINRA Rule 8210 guidelines. The revisions reflect that violations of FINRA Rule 8210 threaten FINRA's ability to ensure investor protection and market integrity and should, in appropriate cases, result in significant sanctions to protect the public from industry members who prevent FINRA from fully investigating their activities.

      •   The revisions delineate principal considerations for the three categories of violations under FINRA Rule 8210: failure to respond or to respond truthfully, providing a partial but incomplete response, and a failure to respond in a timely manner.
      •   The revisions incorporate the SEC's guidance that the importance of the information sought is from FINRA's perspective.1
      •   The guidelines also clarify that a failure to respond completely is really a partial but incomplete response. Consistent with the existing sanction for a complete failure to respond, the revised guidelines state that if a respondent does not respond to an information request until after FINRA files a complaint in a matter, a bar should be the presumptive sanction.2
      •   Likewise, to emphasize the seriousness of failing to provide FINRA with complete information, the guidelines revise the high end of the fine range for a partial but incomplete response from $25,000 to $50,000 to reflect parity with the fine for a failure to respond or respond truthfully. The amendment further reflects this point by stating that a bar is recommended for a partial but incomplete response unless the person can demonstrate that the information provided substantially complied with all aspects of the information request.
      •   The revised guidelines also make clear that the lack of customer harm or benefit to a violator does not mitigate a FINRA Rule 8210 violation.3

      Revisions to Quality of Markets Guidelines

      The revised Sanction Guidelines expressly allow for restitution or disgorgement in cases where respondents have executed trades or published quotes or indications of interest during a trading halt in violation of FINRA Rules 2010 and 5260 and where respondents failed to comply with best execution requirements under FINRA Rule 2010 and NASD Rule 2320. Inclusion of these provisions aims to deprive respondents of monetary benefits from their misconduct when it resulted in quantifiable losses for customers.

      Revisions to Sales Practices Guidelines

      The revisions address the lack of guidelines for the "Recommendation Rule," FINRA Rule 2114 (Recommendations to Customers in OTC Equity Securities, formerly NASD Rule 2315), by specifying that the suitability guidelines for violations of FINRA Rule 2010 and NASD Rule 2310 are appropriate for use in cases where respondents have violated the Recommendation Rule.

      New Guidelines

      The revisions create two new Sanction Guidelines for the failure to comply with SEA Rule 10b-10 and NASD Rule 2230 requirements related to customer confirmations, and FINRA Rule 2265 related to extended hours trading risk disclosure. The addition of these new guidelines sets forth violation-specific principal considerations and eliminates the need to use analogous guidelines. The extended hours trading risk disclosure guidelines are located in the Quality of Markets section of the Sanction Guidelines, and the customer confirmations guidelines are in the Financial and Operational Practices section.

      Revisions to Reflect FINRA Rule Numbers

      The revised Sanction Guidelines refer to "FINRA" instead of "NASD," where appropriate, and to the new FINRA rule numbers for rules that have been adopted into the new consolidated FINRA rulebook.


      1 See PAZ Sec, Inc., Exchange Act Rel. No. 57656, 2008 SEC LEXIS 820, at *21 (Apr. 11, 2008) ("We emphasize that the importance of the information requested must be viewed from NASD's perspective at the time it seeks information."), aff'd, 566 F.3d 1172 (D.C. Cir. 2009).

      2 See Joseph Ricupero, Exchange Act Rel. No. 62891, 2010 SEC LEXIS 2988, at *12 (Sept. 10, 2010) ("Ricupero's failure to respond until after NASD filed a complaint constitutes a complete failure to respond ....").

      3 See PAZ Sec, 566 F.3d at 1175 ("We hold the Commission did not abuse its discretion in determining the lack of direct harm or benefit does not mitigate a complete failure to respond in violation of Procedural Rule 8210.").

    • 11-06 SEC Approves Consolidated FINRA Rule Governing Reporting Requirements; Effective Date: July 1, 2011

      View PDF

      Reporting Requirements

      Regulatory Notice
      Notice Type

      Consolidated FINRA Rulebook
      Rule Approval
      Referenced Rules & Notice

      FINRA Rule 4530
      Information Notice 3/12/08
      NASD Rule 3070
      NYSE Rule 351
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Customer Complaints
      Disclosure Events
      Filing Requirements
      Internal Conclusions
      Reporting Deadlines
      Reporting Requirements
      Quarterly Reporting
      Form U5

      Executive Summary

      The SEC approved FINRA's proposal to adopt a rule governing reporting requirements1 for the consolidated FINRA rulebook.2 The new rule, FINRA Rule 4530, is based in large part on NASD Rule 3070, taking into account certain requirements under NYSE Rule 351.3

      The text of the new rule is set forth in Attachment A. The new event codes for batch reporting specified events via the Rule 4530 Application are set forth in Attachment B. The rule takes effect on July 1, 2011.

      Questions regarding this Notice should be directed to Afshin Atabaki, Assistant General Counsel, Office of General Counsel, at (202) 728-8902.

      Technical questions regarding the Rule 4530 Application, including testing, should be directed to the FINRA Help Desk, at (800) 321-6273 (if your question relates to testing, please indicate that your question is about a test system issue, and not an actual submission).

      Background & Discussion

      FINRA Rule 4530, which is modeled after NASD Rule 3070 and NYSE Rule 351, requires member firms to:

      (1) report to FINRA certain specified events and quarterly statistical and summary information regarding written customer complaints; and
      (2) file with FINRA copies of certain criminal actions, civil complaints and arbitration claims.

      FINRA uses the information for regulatory purposes to identify and initiate investigations of firms, offices and associated persons that may pose a risk. The new rule applies to all FINRA member firms. In most cases, the requirements of FINRA Rule 4530 are based on similar requirements in the NASD and NYSE rules. FINRA Rule 4530 strengthens and clarifies these requirements, as explained below.

      Internal Conclusions

      FINRA Rule 4530(b) requires a member firm to report to FINRA within 30 calendar days after the firm has concluded, or reasonably should have concluded, on its own that the firm or an associated person of the firm has violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or self-regulatory organization (SRO). This requirement is generally modeled after a requirement in the NYSE rule.

      The new rule does not require firms to report every instance of noncompliant conduct. With respect to violative conduct by a firm, this provision requires the firm to report only conduct that has widespread or potential widespread impact to the firm, its customers or the markets, or conduct that arises from a material failure of the firm's systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts.4 Regarding violative conduct by an associated person, the provision requires a firm to report only conduct that has widespread or potential widespread impact to the firm, its customers or the markets; conduct that has a significant monetary result on a member firm(s), customer(s) or market(s); or multiple instances of any violative conduct.5

      For purposes of compliance with the "reasonably should have concluded" standard, FINRA will rely on a firm's good faith reasonable determination. If a reasonable person would have concluded that a violation occurred, then the matter is reportable; if a reasonable person would not have concluded that a violation occurred, then the matter is not reportable.

      Additionally, a firm determines the person(s) within the firm responsible for reaching such conclusions, including the person's required level of seniority. However, stating that a violation was of a nature that did not merit consideration by a person of such seniority is not a defense to a failure to report such conduct. Further, it may be possible that a department within a firm reaches a conclusion of violation, but on review senior management reaches a different conclusion. Nothing in the rule prohibits a firm from relying on senior management's determination, provided such determination is reasonable as described above.

      Moreover, the reporting obligation under FINRA Rule 4530 and the internal review processes set forth under other rules (e.g., FINRA Rule 3130) are mutually exclusive. While internal review processes may inform a firm's determination that a specific violation occurred, they do not by themselves lead to the conclusion that the matter is reportable.6 For example, FINRA would not view a discussion in an internal audit report regarding the need for enhanced controls in a particular area, standing alone, as determinative of a reportable violation. It should also be noted that an internal audit finding would serve only as one factor, among others, that a firm should consider in determining whether a reportable violation occurred.

      Lastly, the new rule provides that certain disciplinary actions taken by a firm against an associated person must be reported under a separate provision (discussed below),7 rather than under the internal conclusion provision.8

      Other Reportable Events

      In addition to internal conclusions, FINRA Rule 4530 requires a member firm to report to FINRA within 30 calendar days9 after the firm knows or should have known10 of the existence of certain other events relating to the firm or an associated person of the firm. These events are based on existing requirements in NASD Rule 3070 or NYSE Rule 351, with a few modifications as described below.

      External Findings

      FINRA Rule 4530(a)(1)(A) requires the reporting of certain external findings similar to the NASD rule,11 but limits the scope of the requirement to where the firm or an associated person has been found12 by an external body13 to have violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body, SRO or business or professional organization.14

      Complaints Involving Certain Allegations

      FINRA Rule 4530(a)(1)(B) requires that a firm report any written customer complaint against the firm or an associated person alleging theft or misappropriation of funds or securities or forgery. The new rule clarifies that, for purposes of this requirement, a "customer" includes any person (other than a broker or dealer) with whom the firm has engaged, or has sought to engage, in securities activities.15 Further, it codifies existing staff guidance reminding firms to report quarterly statistical and summary information regarding such complaints.16

      Named in a Regulatory Proceeding; Subject to Other Regulatory Actions; or Associated with a Financial Entity Subject to Certain Actions

      FINRA Rules 4530(a)(1)(C), (D) and (F) generally require firms to report whenever they or their associated persons are:

      (1) named as a defendant or respondent in a regulatory proceeding alleging the violation of securities, insurance or commodities laws, rules or regulations;
      (2) denied registration or membership or disciplined by a securities, insurance or commodities regulator; or
      (3) associated with certain financial entities that were denied registration, suspended, expelled or had their registration revoked by a regulator or associated with a financial institution that was convicted of, or pleaded no contest to, any felony or misdemeanor.

      These provisions apply to domestic and foreign matters,17 including actions by a foreign regulatory body or, in the case of criminal actions, actions brought in a foreign court. The term "regulatory body," which is used in these provisions and the provisions relating to internal conclusions and external findings,18 is defined as a governmental regulatory body or an authorized non-governmental regulatory body, such as the Financial Services Authority.19

      Criminal Actions Involving Felonies and Certain Misdemeanors

      FINRA Rule 4530(a)(1)(E) generally requires that a firm report any indictment, conviction, or guilty or no contest plea of the firm or an associated person involving:

      (1) any felony or certain misdemeanors, such as a misdemeanor involving the purchase or sale of a security or involving forgery;
      (2) a conspiracy to commit any of these offenses; or
      (3) substantially equivalent actions.

      Civil Litigation; Arbitration Matters; or Certain Claims for Damages

      FINRA Rule 4530(a)(1)(G) generally requires that a firm submit a report if it or an associated person is a defendant or respondent in any securities- or commodities-related civil litigation or arbitration, or is subject to a claim for damages by a customer, broker or dealer, that is disposed of for certain dollar thresholds (above $15,000 for associated persons; above $25,000 for firms).

      The new rule extends this requirement to any financial-related insurance civil litigation or arbitration. "Financial-related" means related to the provision of financial services.20 By its terms, the rule excludes certain insurance products, such as traditional auto and health insurance. However, the scope of the rule is not limited to insurance products that are securities. Civil litigation or arbitration involving a non-securities insurance product that is related to the provision of financial services is subject to the rule.

      Additionally, the new rule limits the scope of the requirement to report certain claims for damages by requiring the reporting of claims that relate to the provision of financial services or relate to a financial transaction, such as a loan by a customer to an associated person.

      When calculating the dollar thresholds for reporting civil litigations, arbitrations or claims for damages subject to reporting, the new rule requires firms to include attorney's fees and interest.21 Further, it codifies existing staff guidance regarding "joint and several" liability.22 If parties are subject to "joint and several" liability, firms must use the aggregate dollar amount for reporting purposes since each party is separately liable for the aggregate amount. For instance, if two parties have "joint and several" liability for $40,000, the amount reported would be $40,000 for each party.

      Statutory Disqualifications

      FINRA Rule 4530(a)(1)(H) requires that firms report certain "statutory disqualification" matters. The rule provides that a firm is required to report whenever the firm or an associated person is subject to a "statutory disqualification." In addition, it provides that firms are required to report whenever they or their associated persons are "involved in the sale of any financial instrument, the provision of any investment advice or the financing of any such activities" with any person who is subject to a "statutory disqualification."23

      Disciplinary Actions Taken by a Firm Against an Associated Person

      FINRA Rule 4530(a)(2) requires that a firm report any disciplinary action taken by the firm against an associated person involving a suspension or termination, the imposition of fines above $2,500, or any other disciplinary action that would have a significant limitation on the associated person's activities. The rule clarifies that any disciplinary action involving the withholding of compensation or of any other remuneration above $2,500 is also reportable.24

      Obligation of Associated Persons

      Under FINRA Rule 4530(c), associated persons continue to have an obligation to promptly report to their member firms the existence of the events described above. The new rule clarifies that this obligation does not extend to internal conclusions and disciplinary actions taken by a firm against an associated person.

      Exception for Information Disclosed on the Form U5

      FINRA Rule 4530(e) provides, similar to the NASD rule, that firms and associated persons have a separate obligation to disclose required information on the Uniform Forms, as applicable, to make any other required filings and to respond to FINRA with respect to any customer complaint, examination or inquiry. Further, the new rule clarifies that the reporting obligations under the rule apply regardless of whether the information is reported or disclosed pursuant to any other rule or requirement.

      However, the rule creates an exception for information disclosed on the Form U5. More specifically, a firm is not required to report an event otherwise required to be reported under the provisions discussed above if the firm discloses the event on the Form U5, consistent with the requirements of that form.25 This exception does not extend to the reporting of quarterly statistical and summary complaint information, which is addressed below.

      Reporting an Event Under the Most Appropriate Provision

      Member firms have an obligation to report an event under the most appropriate provision of FINRA Rule 4530 and not to report the same event under more than one provision.26 The rule recognizes that related events may have to be reported under more than one provision, such as being named as a respondent in an SRO proceeding alleging violation of the SRO's rules and subsequently found to have violated those rules.

      Quarterly Statistical and Summary Complaint Information

      FINRA Rule 4530(d) retains the requirement of the NASD and NYSE rules that firms report quarterly statistical and summary written customer complaint information, with the following modification. If a firm has engaged in securities activities with a person (other than a broker or dealer), the firm is required to report any written grievance by such person involving the firm or an associated person.27 If a firm has sought to engage in securities activities with a person (other than a broker or dealer), the firm is only required to report any securities-related written grievance by such prospective customer involving the firm or an associated person or any written complaints alleging theft or misappropriation of funds or securities or forgery.28

      Obligation to Report Matters Relating to Former Associated Persons

      Under the new rule, a firm is required to report a matter relating to a former associated person if it occurred while the person was associated with the firm.29 If a firm, however, becomes aware of a matter, but based on its records or information available through Web CRD® the firm cannot determine that the person was an associated person of the firm, the firm is not obligated to report it.30

      Filing Requirements

      FINRA Rule 4530(f) keeps the requirement of the NASD rule that firms promptly file with FINRA copies of certain: (1) criminal complaints and plea agreements; (2) civil complaints; and (3) arbitration claims. FINRA Rule 4530 extends this filing requirement to any financial-related insurance civil complaint filed against the firm or any financial-related insurance arbitration claim against the firm. FINRA Rule 4530(g) retains the exception for any arbitration claim that is originally filed in the FINRA Dispute Resolution forum and for those documents that have already been requested by FINRA's Registration and Disclosure (RAD) staff, provided that the firm produces those requested documents to RAD staff within 30 days after receipt of such request.

      Technical Changes to Reporting Application

      Member firms should continue to report specified events and quarterly statistical and summary information on written customer complaints via the Regulatory Filings Application on the FINRA Firm Gateway.31 Beginning July 1, 2011, the application will be renamed the Rule 4530 Application.

      Firms must use new event codes for batch reporting specified events on or after July 1, 2011. The new codes are 11 through 20, and are described in detail in Attachment B. The old event codes, 01 through 10, will continue to be available for amending batch events that were reported prior to July 1, 2011, pursuant to NASD Rule 3070 or NYSE Rule 351. There are no changes to the codes for reporting quarterly statistical and summary information regarding written customer complaints.

      Beginning June 6, 2011, firms will have an opportunity to test the new event codes for batch reporting through FINRA's test site at: https://regfilingtest.finra.org.

      Effective Date

      Any matter that becomes subject to reporting32 or filing prior to July 1, 2011, must be reported or filed in accordance with the requirements of NASD Rule 3070 and NYSE Rule 351, as applicable, including the reporting and filing deadlines of those rules. Any matter that becomes subject to reporting or filing on or after July 1, 2011, must be reported or filed in accordance with the requirements of FINRA Rule 4530.

      For purposes of compliance with FINRA Rule 4530(d) (quarterly statistical and summary complaint information), starting on July 1, 2011, the beginning of the third calendar quarter, firms must report such information in accordance with the requirements of the new rule. The first report based on the requirements of FINRA Rule 4530(d) is due by October 15, 2011, which is the reporting deadline for customer complaints received during the third calendar quarter.


      1 See Securities Exchange Act (SEA) Release No. 63260 (November 5, 2010), 75 FR 69508 (November 12, 2010) (Notice of Filing of Amendment Nos. 1 and 2 and Order Granting Accelerated Approval to Proposed Rule Change; File No. SR-FINRA-2010-034).

      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). For convenience, the Incorporated NYSE Rules are referred to as the NYSE Rules.

      3 FINRA Rule 4530 replaces NASD Rule 3070 and the corresponding provisions in NYSE Rule 351. Accordingly, effective July 1, 2011, NASD Rule 3070, paragraphs (a) through (d) of NYSE Rule 351, and NYSE Rules 351.10 and 351.13 will be deleted from the Transitional Rulebook.

      4 See FINRA Rule 4530.01.

      5 Id.

      6 During the rulemaking process, some commenters asked whether a settlement with a customer creates the presumption that a reportable violation has occurred. FINRA reiterates that it is not the fact that a firm has settled a matter that makes it a reportable event under the rule; rather, it is whether the firm has reached an internal conclusion or reasonably should have reached an internal conclusion that the firm or an associated person has engaged in the enumerated violative conduct. Firms should note that certain settlements will have to be reported based on other reporting requirements [e.g., securities-related civil litigation settled for certain dollar thresholds set forth in the rule).

      7 See FINRA Rule 4530(a)(2).

      8 See FINRA Rule 4530.01.

      9 The reporting deadline under NASD Rule 3070 is 10 business days. The reporting deadline under NYSE Rule 351 is 30 calendar days, which is also consistent with the reporting deadline for disclosing information on the Forms BD (Uniform Application for Broker-Dealer Registration), U4 (Uniform Application for Securities Industry Registration or Transfer) and U5 (Uniform Termination Notice for Securities Industry Registration) (collectively referred to as the Uniform Forms).

      10 The purpose of the "should have known" standard is to ensure that member firms do not intentionally avoid becoming aware of a reportable event.

      11 NASD Rule 3070 extends to a finding of violation of "any" rule or standard of conduct of "any" governmental agency, SRO, or financial business or professional organization.

      12 FINRA Rule 4530.03 defines the term "found" generally consistent with the definition of the term in the Uniform Forms. In addition, the term includes any formal finding (regardless of whether the finding will be appealed), but it does not include a minor rule violation involving a fine of $2,500 or less.

      13 An external body includes, but is not limited to, a court, domestic or foreign regulatory body, 5RO or business or professional organization. See FINRA Rule 4530.02.

      14 During the rulemaking process, FINRA provided the following examples of the types of reportable external findings: (1) court finding relating to the violation of insurance laws; (2) finding of violation of an SRO's just and equitable principles of trade rule, such as FINRA Rule 2010; or (3) finding of violation of the Code of Professional Conduct of the American Institute of Certified Public Accountants. These examples are provided for illustrative purposes and are not exhaustive.

      15 See FINRA Rule 4530.08.

      16 Id.

      17 Other provisions of FINRA Rule 4530 also apply to domestic and foreign matters, including the provisions relating to internal conclusions, external findings and criminal actions involving felonies and certain misdemeanors. See FINRA Rules 4530(a)(1)(A), (a)(1)(E) and (b).

      18 See FINRA Rules 4530(a)(1)(A) and (b).

      19 See FINRA Rule 4530.04.

      20 See FINRA Rule 4530.09. The term "financial-related" is also used in other provisions, including the provisions regarding internal conclusions, external findings and filing requirements. See FINRA Rules 4530(a)(1)(A), (b) and (f).

      21 See FINRA Rule 4530.06. Based on FINRA's experience, some firms have considered structuring settlements using attorney's fees to avoid the dollar thresholds for reporting. The inclusion of attorney's fees and interest is intended to address this concern.

      22 See id.

      23 The requirement in the NASD and NYSE rules is based on whether the firm or associated person is "associated in any business or financial activity" with a person who is subject to a "statutory disqualification."

      24 The requirement in the NASD and NYSE rules is limited to the withholding of commissions above $2,500.

      25 While this exception only applies to information that is disclosed on the Form U5, FINRA will work toward the goal of extending this exception to information that is disclosed on the Forms BD and U4.

      26 See FINRA Rule 4530.05.

      27 See FINRA Rule 4530.08.

      28 See id.

      29 See FINRA Rule 4530.07.

      30 Firms are reminded that records relating to associated persons must be preserved consistent with the requirements of SEA Rule 17a-4(e)(1).

      31 In general, firms should report the information in their custody, possession or control or to which they have knowledge and provide an explanation in the appropriate Rule 4530 Application fields of the information that they were unable to obtain due to circumstances beyond their control, with the understanding that firms cannot intentionally avoid becoming aware of a reportable event.

      32 Firms should continue to use the Regulatory Filings Application on the FINRA Firm Gateway for purposes of reporting such matters.


      ATTACHMENT A

      Below is the text of the new FINRA rule.

      * * * * * *

      4530. Reporting Requirements

      (a) Each member shall promptly report to FINRA, but in any event not later than 30 calendar days, after the member knows or should have known of the existence of any of the following:
      (1) the member or an associated person of the member:
      (A) has been found to have violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body, self-regulatory organization or business or professional organization;
      (B) is the subject of any written customer complaint involving allegations of theft or misappropriation of funds or securities or of forgery;
      (C) is named as a defendant or respondent in any proceeding brought by a domestic or foreign regulatory body or self-regulatory organization alleging the violation of any provision of the Exchange Act, or of any other federal, state or foreign securities, insurance or commodities statute, or of any rule or regulation thereunder, or of any provision of the by-laws, rules or similar governing instruments of any securities, insurance or commodities domestic or foreign regulatory body or self-regulatory organization;
      (D) is denied registration or is expelled, enjoined, directed to cease and desist, suspended or otherwise disciplined by any securities, insurance or commodities industry domestic or foreign regulatory body or self-regulatory organization or is denied membership or continued membership in any such self-regulatory organization; or is barred from becoming associated with any member of any such self-regulatory organization;
      (E) is indicted, or convicted of, or pleads guilty to, or pleads no contest to, any felony; or any misdemeanor that involves the purchase or sale of any security, the taking of a false oath, the making of a false report, bribery, perjury, burglary, larceny, theft, robbery, extortion, forgery, counterfeiting, fraudulent concealment, embezzlement, fraudulent conversion, or misappropriation of funds, or securities, or a conspiracy to commit any of these offenses, or substantially equivalent activity in a domestic, military or foreign court;
      (F) is a director, controlling stockholder, partner, officer or sole proprietor of, or an associated person with, a broker, dealer, investment company, investment advisor, underwriter or insurance company that was suspended, expelled or had its registration denied or revoked by any domestic or foreign regulatory body, jurisdiction or organization or is associated in such a capacity with a bank, trust company or other financial institution that was convicted of or pleaded no contest to, any felony or misdemeanor in a domestic or foreign court;
      (G) is a defendant or respondent in any securities- or commodities-related civil litigation or arbitration, is a defendant or respondent in any financial-related insurance civil litigation or arbitration, or is the subject of any claim for damages by a customer, broker or dealer that relates to the provision of financial services or relates to a financial transaction, and such civil litigation, arbitration or claim for damages has been disposed of by judgment, award or settlement for an amount exceeding $15,000. However, when the member is the defendant or respondent or is the subject of any claim for damages by a customer, broker or dealer, then the reporting to FINRA shall be required only when such judgment, award or settlement is for an amount exceeding $25,000; or
      (H) is, or is involved in the sale of any financial instrument, the provision of any investment advice or the financing of any such activities with any person who is, subject to a "statutory disqualification" as that term is defined in the Exchange Act. The report shall include the name of the person subject to the statutory disqualification and details concerning the disqualification; or
      (2) an associated person of the member is the subject of any disciplinary action taken by the member involving suspension, termination, the withholding of compensation or of any other remuneration in excess of $2,500, the imposition of fines in excess of $2,500 or is otherwise disciplined in any manner that would have a significant limitation on the individual's activities on a temporary or permanent basis.
      (b) Each member shall promptly report to FINRA, but in any event not later than 30 calendar days, after the member has concluded or reasonably should have concluded that an associated person of the member or the member itself has violated any securities-, insurance-, commodities-, financial- or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or self-regulatory organization.
      (c) Each person associated with a member shall promptly report to the member the existence of any of the events set forth in paragraph (a)(1) of this Rule.
      (d) Each member shall report to FINRA statistical and summary information regarding written customer complaints in such detail as FINRA shall specify by the 15th day of the month following the calendar quarter in which customer complaints are received by the member.
      (e) Nothing contained in this Rule shall eliminate, reduce or otherwise abrogate the responsibilities of a member or person associated with a member to promptly disclose required information on the Forms BD, U4 or U5, as applicable, to make any other required filings or to respond to FINRA with respect to any customer complaint, examination or inquiry. In addition, members are required to comply with the reporting obligations under paragraphs (a), (b) and (d) of this Rule, regardless of whether the information is reported or disclosed pursuant to any other rule or requirement, including the requirements of the Forms BD or U4. However, a member need not report an event otherwise required to be reported under paragraphs (a) or (b) of this Rule if the member discloses the event on the Form U5, consistent with the requirements of that form.
      (f) Each member shall promptly file with FINRA copies of:
      (1) any indictment, information or other criminal complaint or plea agreement for conduct reportable under paragraph (a)(1)(E) of this Rule;
      (2) any complaint in which a member is named as a defendant or respondent in any securities- or commodities-related private civil litigation, or is named as a defendant or respondent in any financial-related insurance private civil litigation;
      (3) any securities- or commodities-related arbitration claim, or financial-related insurance arbitration claim, filed against a member in any forum other than the FINRA Dispute Resolution forum;
      (4) any indictment, information or other criminal complaint, any plea agreement, or any private civil complaint or arbitration claim against a person associated with a member that is reportable under question 14 on Form U4, irrespective of any dollar thresholds Form U4 imposes for notification, unless, in the case of an arbitration claim, the claim has been filed in the FINRA Dispute Resolution forum.
      (g) Members shall not be required to comply separately with paragraph (f) in the event that any of the documents required by paragraph (f) have been the subject of a request by FINRA's Registration and Disclosure staff, provided that the member produces those requested documents to the Registration and Disclosure staff not later than 30 days after receipt of such request. This paragraph does not supersede any FINRA rule or policy that requires production of documents specified in paragraph (f) sooner than 30 days after receipt of a request by the Registration and Disclosure staff.

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

      .01 Reporting of Firms' Conclusions of Violations. For purposes of paragraph (b) of this Rule, with respect to violative conduct by a member, FINRA expects a member to report only conduct that has widespread or potential widespread impact to the member, its customers or the markets, or conduct that arises from a material failure of the member's systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts. With respect to violative conduct by an associated person, FINRA expects a member to report only conduct that has widespread or potential widespread impact to the member, its customers or the markets, conduct that has a significant monetary result with respect to a member(s), customer(s) or market(s), or multiple instances of any violative conduct. In addition, with respect to violative conduct by an associated person, the reporting obligation under paragraph (b) must be read in conjunction with the reporting obligation under paragraph (a)(2) of this Rule. If a member has concluded that an associated person has engaged in violative conduct and imposes the discipline set forth under paragraph (a)(2) of this Rule, then the member is required to report the event under paragraph (a)(2), and it need not report the event under paragraph (b).
      .02 Firms' Conclusions of Violations versus External Findings. Members should be aware that paragraph (b) of this Rule is limited to situations where the member has concluded or reasonably should have concluded on its own that violative conduct has occurred. Paragraph (a)(1)(A) of this Rule is limited to situations where there has been a finding of violative conduct by an external body, such as a court, domestic or foreign regulatory body, self-regulatory organization or business or professional organization.
      .03 Meaning of "Found." The term "found" as used in paragraph (a)(1)(A) of this Rule includes among other formal findings, adverse final actions, including consent decrees in which the respondent has neither admitted nor denied the findings, but does not include informal agreements, deficiency letters, examination reports, memoranda of understanding, cautionary actions, admonishments and similar informal resolutions of matters. For example, a Letter of Acceptance, Waiver and Consent or an Offer of Settlement is considered an adverse final action. The term "found" also includes any formal finding, regardless of whether the finding will be appealed. The term "found" does not include a violation of a self-regulatory organization rule that has been designated as "minor" pursuant to a plan approved by the SEC, if the sanction imposed consists of a fine of $2,500 or less, and if the sanctioned person does not contest the fine.
      .04 Meaning of "Regulatory Body." For purposes of this Rule, the term "regulatory body" refers to governmental regulatory bodies and authorized non-governmental regulatory bodies, such as the Financial Services Authority.
      .05 Reporting of Individual and Related Events. With respect to a reportable event under paragraphs (a) or (b) of this Rule, members should not report the same event under more than one paragraph or subparagraph. Members should report the event under the most appropriate paragraph or subparagraph. However, members should be aware that they may be required to report related events under more than one paragraph or subparagraph. For instance, if a member is named as a respondent in a proceeding brought by a self-regulatory organization alleging the violation of the self-regulatory organization's rules, the member would be required to report that event under paragraph (a)(1)(C) of this Rule. In addition, if the member subsequently is found to have violated the self-regulatory organization's rules, the member would be required to report that finding under paragraph (a)(1)(A) of this Rule.
      .06 Calculation of Monetary Thresholds. For purposes of paragraph (a)(1)(G) of this Rule, when determining the dollar amount that would require a report, members must include any attorneys fees and interest in the total amount. In addition if the parties are subject to "joint and several" liability, the amount for each party must be aggregated and reported, if above the dollar thresholds under paragraph (a)(1)(G), as if each party is separately liable for the aggregated amount. For instance, if two parties have "joint and several" liability for $40,000, the amount reported would be $40,000 for each party.
      .07 Former Associated Persons. For purposes of paragraphs (a), (b) and (d) of this Rule, members should report an event relating to a former associated person if the event occurred while the individual was associated with the member. A member is not required to report such an event where, based on its records or information available through Web CRD, the member cannot determine that the person was an associated person of the member.
      .08 Customer Complaints. For purposes of paragraph (a)(1)(B) of this Rule, a "customer" includes any person, other than a broker or dealer, with whom the member has engaged, or has sought to engage, in securities activities. Any written customer complaint reported under paragraph (a)(1)(B) of this Rule also must be reported pursuant to paragraph (d) of this Rule. For purposes of paragraph (d) of this Rule, with respect to a person, other than a broker or dealer, with whom the member has engaged in securities activities, the member must report any written grievance by such person involving the member or a person associated with the member. In addition, with respect to a person, other than a broker or dealer, with whom the member has sought to engage in securities activities, the member must report any securities-related written grievance by such person involving the member or a person associated with the member and any written complaint reportable under paragraph (a)(1)(B) of this Rule.
      .09 Financial Related. For purposes of this Rule, the term "financial related" means related to the provision of financial services.

      * * * * *


      ATTACHMENT B

      New Event Codes for Batch Reporting Pursuant to FINRA Rule 4530

      Event Code Paragraph Description
      11 (a)(1)(A) External Finding
      12 (a)(1)(B) Customer Complaint Involving Certain Allegations
      13 (a)(1)(C) Named in a Regulatory Proceeding
      14 (a)(1)(D) Subject to Other Regulatory Actions
      15 (a)(1)(E) Criminal Actions Involving Felonies and Certain Misdemeanors
      16 (a)(1)(F) Associated with a Financial Entity Subject to Certain Actions
      17 (a)(1)(G) Civil Litigation; Arbitration Matters; or Certain Claims for Damages
      18 (a)(1)(H) Statutory Disqualification
      19 (a)(2) Disciplinary Action Taken by a Firm Against an Associated Person
      20 (b) Internal Conclusion

    • 11-04 FINRA Requests Comment on Proposed Amendments to FINRA Rule 5122 to Address Member Firm Participation in Private Placements; Comment Period Expires: March 14, 2011

      View PDF

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      FINRA Rule 2010
      FINRA Rule 2020
      FINRA Rule 2111
      FINRA Rule 5122
      FINRA Rule 5110
      NASD Rule 2210
      NASD Rule 3010
      NTMs 03-71, 05-18 and 05-48
      Regulation D
      Regulatory Notices 09-05 and 09-27
      SEA Section 10(b)
      SEA Rule 10b-5
      Securities Act Section 17
      Suggested Routing

      Compliance
      Corporate Financing
      Executive Representative
      Legal
      Operations
      Senior Management
      Key Topics

      Affiliates
      Institutional Accounts
      Member Private Offerings
      Offering Proceeds
      Private Placements
      Private Placement Memoranda
      Regulation D

      Executive Summary

      FINRA requests comment on a proposal to amend FINRA Rule 5122, which requires, subject to certain exemptions, disclosure in the offering document of the intended use of offering proceeds, expenses, and the amount of selling compensation to be paid to the broker-dealer and its associated persons, in any private placement in which a participating broker-dealer (or its control entity) is the issuer.1 The rule also requires that at least 85 percent of the offering proceeds must be used for the business purposes identified in the offering document. Lastly, the rule requires each offering document to be submitted to FINRA to allow the staff to conduct ex post reviews to assess compliance with the rule and to identify problematic terms and conditions.

      The amendments proposed in this Notice expand Rule 5122 to reach all private placements in which a member firm participates—not just those in which the member firm (or its control entity) is the issuer—while retaining nearly all of the existing exemptions, including those for offerings sold solely to certain institutions, qualified purchasers and other sophisticated investors. However, to reflect the broader scope of the proposed rule and its prior experience with Rule 5122, FINRA proposes to eliminate the exemption for offerings in which a member acts primarily in a wholesaling capacity.

      The text of the proposed rules is available as Attachment A to this Notice.

      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.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by March 14, 2011.

      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.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

      Background and Discussion

      FINRA Rule 5122 was developed in response to abuses in the sale of private placements issued by broker-dealers and their control entities.4 Rule 5122 generally requires, subject to certain exemptions, that a member firm or associated person engaging in a private placement of unregistered securities issued by the firm (or a control entity of the firm):

      •   disclose to investors in a private placement memorandum, term sheet or other offering document the intended use of offering proceeds, the offering expenses and the amount of compensation that will be paid to the broker-dealer and its associated persons;
      •   submit, via email, the offering document to the FINRA Corporate Financing Department at or prior to the time it is provided to any prospective investor; and
      •   comply with the requirement that at least 85 percent of the offering proceeds raised may not be used to pay for offering costs, discounts, commissions or any other cash or non-cash sales incentives, and must be used for the business purposes disclosed in the offering document.5

      FINRA staff conducts ex post reviews of offering documents to assess compliance with the rule and to identify problematic terms and conditions. Occasionally, when warranted, FINRA will contact a member firm and request additional information regarding the use of proceeds or other clarifying information. The rule does not require that completion of an offering be delayed until FINRA staff has issued a "no-objections" letter, as FINRA Rule 5110 requires with respect to public offerings.

      Rule 5122 defines "control" as beneficial interest of more than 50 percent of the outstanding voting securities of a corporation or the right to more than 50 percent of the distributable profits or losses of a non-corporate entity. The rule also provides various exemptions, including offerings of private placements:

      •   to institutional accounts, qualified purchasers, qualified institutional buyers, investment companies and banks;
      •   to employees of the issuer (or its control entity) and securities issued in certain conversions, stock splits and restructuring transactions;
      •   of exempted securities, certain notes with short-term maturities, variable contracts, modified guaranteed annuity contracts and life insurance policies, commodity pools, options and other derivatives not based principally on the member's (or its control entity's) securities, unregistered investment grade rated debt and preferred securities; and
      •   in which the member acts primarily in a wholesaling capacity, as evidenced by an agreement to sell less than 20 percent of the offered securities in retail transactions.

      Rule 5122 plays an important part in the effort to protect investors in the narrow segment of the private placement market it was designed to address. It does not, however, address private placements in which the issuer is neither a broker-dealer nor its control entity.6 The vast majority of private placements remain outside the scope of the rule. As an illustration, FINRA has received approximately 300 filings pursuant to Rule 5122 during the first year that the rule has been in effect, whereas several thousand Form Ds are filed annually with the SEC in connection with private placements.7

      To provide investors with additional protection from fraud and abuse, FINRA proposes to amend Rule 5122 to govern all private placements in which a member participates, subject to certain exemptions.

      Proposed Rule Changes

      As described below, FINRA proposes to expand the rule to reach any private placement in which a member participates, subject to all but one of the exemptions that exist in the rule today.

      Participation in a Private Placement

      The proposed amendments incorporate the definition of "participation" from Rule 5110 (Corporate Financing Rule), which corresponds to the types of services typically provided by a broker-dealer in a private placement.8 Because designation as a "control entity" would no longer be relevant to the scope of the rule, the proposed amendments delete that term.

      Disclosure Requirements

      Given the expanded scope of the amended rule, FINRA proposes that member firms participating in a private placement of securities issued by an affiliate alert investors to potential conflicts of interest. Specifically, the proposed amendments require that the offering document disclose if a participating member is an affiliate of the issuer and the nature of the affiliation.9 In several recent SEC and FINRA enforcement cases concerning private placements, a participating broker-dealer was affiliated with the issuer, and this affiliation facilitated the broker-dealer's misuse or conversion of offering proceeds.10

      To ensure that the disclosure requirements reach the amount and type of any compensation that will be paid directly or indirectly to a participating member firm for its associated persons in connection with a private placement subject to the rule, the proposed amendments replace the term "selling compensation" with the term "compensation."11

      Filing With FINRA </