SEC Approval and Effective Dates for New Consolidated FINRA Rules

In October and November 2009, the SEC approved eight new consolidated FINRA rules (Rule 2060, Rule 2130, Rule 2251, Rule 2270, Rule 2330, Rule 5210, Rule 5220, and Rule 5290). All of the new rules take effect on February 15, 2010, except for FINRA Rule 2330, which has an implementation date of February 8, 2010.

FINRA has posted three Rule Conversion Charts on its Web site to help firms become familiar with the new rules and show how the new rules relate to the NASD and/or Incorporated NYSE Rules in the Transitional Rulebook that they will replace. For more information on these eight rules, please view notice 09-72 or visit www.finra.org/ruleconversionchart to view the FINRA Rule Conversion Charts.

FINRA Reminds Firms of Their Sales Practice Obligations Relating to Principal-Protected Notes

FINRA is providing member firms with an overall description of Principal-Protected Notes (PPNs) and explaining how these products are sometimes thought of as being risk-free, which has recently added to the increase in their retail market. However PPNs are not without risk and their terms and structures can be complex. Misleading advertising of these products is one factor that FINRA wants member firms to pay close attention to. 

Member firms must ensure that their promotional materials or communications to the public regarding these products are fair and balanced, and do not overstate either the level of protection offered or an investment’s potential returns. Also, appropriate disclosures concerning:

• The level of principal protection offered;
• The credit-worthiness of the guarantor;
• The potential returns and pay-out structure (including any limits on upside potential);
• The investor’s ability to access funds pending the maturity date or the expiration of a lock-up period; and
• Any costs or fees that might affect the return of principal are required.

FINRA is emphasizing, based on NASD Rule 2310, that member firms must review the suitability of a PPN, both generally and for specific customers, before recommending it.  
Lastly, ensuring that a firm’s registered representatives understand the characteristics, risks and rewards of each product before they recommend it to clients is very important. Also, representatives should be able to determine suitability and understand the product completely before recommending it. 

SEC Approves Changes to Arbitration Rules on Definition of Associated Person, Distribution of the FINRA Discovery Guide and Applicability of Hearing Session Fees

The SEC has approved a proposal to amend FINRA Rules 12100(r), 12506(a) and 12902(a) of the Code of Arbitration Procedure for Customer Disputes and Rule 13100(r) of the Code of Arbitration Procedure for Industry Disputes regarding the definition of “associated person,” the distribution of the FINRA Discovery Guide and the applicability of the hearing session fees.  This amendment will be effective January 18, 2010 and will apply to claims filed on or after the effective date. The amendment will do three (3) things:

• Clarify the definition of “associated person” and make it conform to the same term in the FINRA by-laws;
• Streamline a case administration procedure; and

Proposed Consolidated FINRA Rules Governing FINRA’s Membership Application Proceedings

FINRA’s current membership rules (NASD Rule 1010 Series (Membership Proceedings)) help FINRA to know and assess the proposed business activities of its potential and current member firms through its Membership Application Process (MAP). FINRA has proposed to transfer the NASD membership rules, with substantive changes, into the Consolidated FINRA Rulebook.  Proposed amendments will include items such as further clarifications of the MAP process, updating terminology that is outdated, incorporating provisions from the NYSE membership rules, and requiring more information about the firm and their affiliates. Please see a brief description of proposed rules below; for more detail please visit FINRA’s website at http://www.finra.org/Industry/Regulation/Notices/2010/index.htm .

• Proposed FINRA Rule 1111 provides new definitions of affiliate, control, material change in business operations, and sales practice event. FINRA Rule 1111 also creates amendments to the definitions of the terms “applicant,” “associated person,” “interested FINRA staff,” and “principal place of business.”

• Proposed FINRA Rule 1112 provides general procedures. It clarifies that filing an application via electronic delivery includes facsimile, email or electronic filing system.  This rule reduces from 60 to 30 days the time for an applicant to respond to an initial written request by FINRA for information or documentation before the application is deemed to have lapsed. If a firm fails to register its representatives for all qualifying examinations within 30 days of filing the form NMA or CMA, and representatives fail to successfully complete these required exams within 120 days of filing the form NMA or CMA, the application will lapse. The proposed change also eliminates the requirement that an applicant pay a new fee if it resubmits, subsequent to a lapse, a CMA or MAC application as FINRA does not currently charge a fee for filing those applications. Also, applicant stated is the requirement to update documentation throughout the application process with any information that changes or becomes inaccurate.

• Currently NASD Rule 1013 requires applicants to submit certain information regarding their associated persons, business models, finances and supervisory structures. Proposed FINRA Rule 1121 will require this information, along with certain additional information about the firm. FINRA Rule 1121 will also require an applicant to provide a detailed and comprehensive summary of the business relationship between the applicant and any affiliate.

• Proposed FINRA Rule 1121 also increases the processing fee to $500, if the staff determines within 30 days after the application’s filing that the application is not substantially complete. Proposed FINRA Rule 1121 permits a one-time opportunity for an applicant to re-file its membership application within 30 days of service of written notice that the application is not substantially complete by submitting only a new Form NMA and the application fee, rather than being required to submit the entire application. An applicant must file its Form NMA no later than 180 days after the submission of its Form BD or FINRA will deem the application to be abandoned. A membership interview shall be scheduled within 90 days after the filing of an application or within 60 days after the filing of all additional information requested by FINRA, whichever is later.

• Proposed FINRA Rule 1130 requires all NMAs, CMAs and MAC applications to address all of the application evaluation standards outlined, but permits a CMA or MAC applicant to provide a written explanation regarding why the applicant believes a particular standard(s) is not applicable based on the nature and scope of the application. Also, an applicant must fully disclose and document all of its funding sources and permit FINRA to determine that such sources are not objectionable. This rule requires firms to have adequate financial and operational controls to comply with its net capital requirements. Additionally, the proposed rule expands the circumstances when FINRA staff may impose a higher minimum net capital on an applicant to include situations where an applicant is entering into contractual commitments regarding any investment advisory business. Proposed FINRA Rule 1130 permits FINRA staff to consider certain information regarding an applicant’s affiliates in determining whether an applicant meets the standard requiring it to be capable of complying with the federal securities laws and regulations and FINRA rules.

• Proposed FINRA Rule 1140 permits an applicant to submit a request for review by the National Adjudicatory Council of an adverse decision.

• Proposed FINRA Rule 1150 permits a governor of the FINRA board to call for a discretionary review of a membership proceeding.

• First, Proposed FINRA Rule 1160 adopts NASD Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations), which requires a member to file an application for approval of certain changes to its ownership, control or business operations, subject to amendments, including encompassing the standards in FINRA Rule 1130 discussed above. FINRA Rule 1160 states that FINRA will reply to applications within 30 days and applicants have 30 days from then to provide requested information to FINRA. This rule extends to 45 days, the time frame for the Department of Member Regulation to issue a written decision on CMA after the conclusion of the final interview or filing of additional information. Decisions will also let firms know if they are subject to further restrictions. Second, this rule will expand the criteria under which a CMA filing is triggered and permits FINRA staff to waive a CMA when the change does not result in any practical change of the firm. Third, this rule will require a member firm to file its application “in the manner prescribed by FINRA.” Lastly, this change prohibits the safe harbor from being available if the member is looking to acquire an office or if associated persons involved have a “disciplinary history.”

• Proposed FINRA Rule 1170 encompasses NASD Rule 1017 that firms are required to file a CMA if there is a 25% or more change in its equity ownership or partnership capital. Under the proposed rule, firms must also provide written notice of significant changes in business 30 days prior, if the changes do not trigger a CMA filing.

• Proposed FINRA Rule 1180 adopts NASD Rule 1019 and permits a person aggrieved by final action of FINRA under the NASD Rule 1010 Series to apply for review by the SEC.

FINRA Requests Comments on Proposed Consolidated FINRA Rules Governing Securities Loans and Borrowings, Permissible Use of Customers' Securities and Callable Securities

FINRA is requesting comments on three proposed FINRA rules, and addressing that these comments are due by March 8, 2010. The proposed rules are Proposed FINRA Rule 4314 (Securities Loans and Borrowings), Proposed FINRA Rule 4330 (Customer Protection- Permissible Use of Customers’ Securities), and Proposed FINRA Rule 4340 (Callable Securities).

• Proposed FINRA Rule 4314 Securities Loans and Borrowings requires a member firm that acts as agent in a loan or borrow transaction to disclose its capacity, and where transactions are from a counterparty that is acting in an agency capacity, it requires that firm to maintain books and records to reflect the identity of the agent and the principal on whose behalf the agent is acting. Furthermore, this rule requires that no member firm can lend or borrow securities from any person that is not a member of FINRA, except if there is written agreement.

• Proposed FINRA Rule 4330(a) will require a member firm to obtain a customer’s written authorization prior to lending the customer’s eligible margin securities. Members are permitted to satisfy the agreement by using a single customer-signed margin agreement/loan consent as long as in boldface type directly above the signature appears: “BY SIGNING THIS AGREEMENT I ACKNOWLEDGE THAT MY SECURITIES MAY BE LOANED TO YOU OR LOANED OUT TO OTHERS.”  Proposed FINRA Rule 4330(b)(1) requires a member firm to notify FINRA, at least 30 days prior to engaging in borrowing and lending customers’ fully paid or excess margin securities. Proposed FINRA Rule 4330(b)(2) requires a member firm to provide the customer, in writing, prior to borrowing, a notice that the provisions of SIPA may not protect the customer. A member firm must also determine suitability for the customer prior to engaging in the transaction. Proposed FINRA Rule 4330(b)(3) requires a member firm to maintain books and records showing compliance with FINRA Rule 4330(b)(2).

• Proposed FINRA Rule 4340(a) will require a member firm that has control of securities that can be called or redeemed prior to maturity and all callable securities to establish procedures of how it will allocate among customers the shares to be redeemed. Also, the member firm must post its allocation procedures on its Web site and provide written notice to new customers at the opening of an account, and to existing customers on an annual basis. Proposed FINRA Rule 4340(b) and (c) prohibits firms from allocating securities to any of its associated persons’ accounts in a redemption offered on terms favorable to a customer, until all other customers’ positions are satisfied.

Comments on these proposed changes must be received by March 8, 2010.

SEC Approves Consolidated FINRA Rules Governing Clearly Erroneous Transactions

The SEC has approved FINRA’s proposal to move NASD Rule 11890, IM-11890-1 and IM-11890-2 into the Consolidated FINRA Rulebook as part of a new FINRA Rule 11890 Series governing clearly erroneous transactions. This series includes FINRA Rule 11891, which specifies that “the terms of a transaction are ‘clearly erroneous’ when there is an obvious error in any term, such as price, number of shares or other unit of trading, or identification of the security.” Along with this definition, FINRA has adopted supplementary material to address more broad issues that arise under the clearly erroneous rules.

• FINRA Rule 11892 sets forth the standards FINRA uses to determine whether a transaction in an exchange-listed security is clearly erroneous. For OTC transactions in exchange-listed securities that are reported to a FINRA system, FINRA will typically follow the determination of the national securities exchange to break a trade. If FINRA sees that any of the national securities exchanges, which have multiple trades unbroken at or near the price range in question at or near the time in question, FINRA will follow the exchanges’ criteria when making a clearly erroneous determination. However, for OTC transactions in exchange-listed securities that are reported to a FINRA system, such as but do not have related on-exchange trading activity, FINRA will generally make its own clearly erroneous determination. FINRA Rule 11892 also establishes provisions for the use of alternative reference prices in unusual circumstances.

• FINRA Rule 11893 governs clearly erroneous determinations involving transactions in OTC Equity Securities.  The structure for FINRA Rule 11893 is similar to that of FINRA Rule 11892. FINRA establishes that it does not expect to use its clearly erroneous authority in most situations; rather, FINRA expects the parties to settle any dispute privately.

• FINRA Rule 11894 gives a FINRA officer the authority only to declare transactions null and void. With OTC Equity Securities, a FINRA officer must make a determination as soon as possible after becoming aware of the transaction, but in all cases by 3 p.m., ET, on the next trading day following the date of the transaction at issue. If an officer declares a transaction null and void, FINRA will notify all parties involved, at which point they may appeal the decision.
  
  The rule changes are effective February 15, 2010.

FINRA Reminds Firms of Their Responsibilities under FINRA Rule 2330 for Recommended Purchases or Exchanges of Deferred Variable Annuities

FINRA Rule 2330, which establishes sales practice standards regarding recommended purchases and exchanges of deferred variable annuities, will be in effect as of February 8. 2010.

The former rules on this subject generally require firms to transmit promptly to the issuer’s applications and purchase payments for variable contracts. FINRA provided limited interpretive relief from these rules to allow firms to perform reviews of this type of recommended transactions.

FINRA initially stated that a firm could hold an application for a deferred variable annuity and/or a customer’s check payable to an insurance company for up to seven business days. However, the SEC approved amendments that changed the starting point for the review period to the date when a firm’s office of supervisory jurisdiction (OSJ) receives a complete and correct application package. Concerns about FINRA's interpretive relief have been expressed and FINRA released a list of conditions that must be present for it to apply.

1. The reason that the firm is holding the application and/or a customer’s check payable to a third party is to allow completion of principal review of the transaction.
2. The associated person who recommended the purchase or exchange makes reasonable efforts to safeguard the check and to promptly prepare and forward a complete and correct copy of the application package to an OSJ.
3. The firm has policies and procedures in place to ensure that the check is safeguarded and that efforts are made to promptly prepare and forward a complete and correct copy of the application package to an OSJ.
4. A principal reviews and makes a determination of whether to approve or reject the purchase or exchange.
5. The firm holds the application and/or check no longer than seven business days from the date an OSJ receives a complete and correct copy of the application package.
6. The firm maintains a copy of each check and creates a record of the date the check was received from the customer and the date the check was transmitted to the insurance company or returned to the customer.
7. The firm creates a record of the date when the OSJ receives a complete and correct copy of the application package.

Guidance on Blogs and Social Networking Web Sites

SEC Approves Amendments to FINRA Rules on Reporting Cancellations of Previously Reported OTC Trades in Equity Securities

Effective April 12, 2010, FINRA is requiring that if a trade executed during normal market hours (9:30 a.m. to 4 p.m. ET) is canceled on the trade date, the firm must report the cancellation to FINRA in one of three ways:

1. The firm must report the cancellation within 90 seconds.
2. If the trade is cancelled after 4 p.m. and before the FINRA facility closes, the firm shall use its best efforts to report the cancellation on the date of execution, and otherwise it shall report on the following business day.
3. If the trade is canceled after the FINRA facility closes, the firm must report the cancellation on the following business day.