FINRA

Exam Alert: FINRA to give mediation directors authority to limit mediator selections

Effective August 6, 2012, FINRA will amend its rules to allow mediation directors to limit the ability of parties to a mediation to select a non-FINRA mediator. Continue reading

Effective August 6, 2012, FINRA will amend its rules to allow mediation directors to limit the ability of parties to a mediation to select a non-FINRA mediator. If the parties wish to use a non-FINRA mediator, the director may choose whether or not to approve that mediator. If the mediator is approved by the director, the mediation process moves forward with that mediator. If the mediator is not approved, then the parties may:

-select a FINRA-approved mediator;

-see if the director will approve a different non-FINRA mediator; or

-mediate their dispute elsewhere (not through FINRA).

Source: FINRA Regulatory Notice 12-35

This alert applies to the Series 7, Series 24, Series 26, Series 62, Series 79, and Series 82.

Exam Alert: FINRA to raise limit for simplified arbitration

The SEC has approved amendments to FINRA’s arbitration rules. These amendments, effective July 23, 2012, raise the limit for claims under simplified arbitration from $25,000 to $50,000. These changes apply to both arbitration claims involving customers and claims involving other members of the securities industry.

Simplified arbitration is a streamlined arbitration process where both parties submit written statements to a single arbitrator, who then evaluates the claim. Note that if a counterclaim raises the amount in dispute to over the $50,000 limit, then the dispute will not be resolved through simplified arbitration.

Source: FINRA Regulatory Notice 12-30

This alert applies to the Series 62, Series 24, Series 82, Series 6, Series 7, Series 79, and Series 26.

Exam Alert: FINRA to implement new communications rules

The SEC has approved new FINRA rules governing communication with the public. The rules will take effect February 4, 2013. While the rules are generally based on current communications rules, several significant changes will be made. Continue reading

Communication Categories

-The six current types of communications will be replaced with three types: institutional communication, retail communication, and correspondence.

-Institutional communication is communication that is only distributed to institutional investors. In order for a communication to count as institutional communication, the firm must not have “reason to believe” that the communication will be forwarded to non-institutional investors (“retail investors”).

-Retail communication consists of communications to more than 25 non-institutional investors within a 30 calendar day period.

-Correspondence includes communications to 25 or fewer non-institutional investors.

-Replacements for current rules may apply to different categories of communication than the present rules do. For full details on which rules will change, see the FINRA Notice.

Approval, Review, and Recordkeeping Requirements

-There are modified standards for pre-approval of communication by principals.

-Series 16 supervisory analysts may approve research that is not a “research report” if they have technical expertise in the product area and the product does not require licenses they do not have.

-The following are exempted from pre-approval: research/analysis on certain broad, limited topics; forum posts; and communications that do not make recommendations or promote a product or service of the firm.

-FINRA may grant an exemption from pre-approval requirements for good cause.

-Any communication filed with the Advertising Regulation Department must be pre-approved.

-Records must include information on the sources of tables, graphs, and charts.

-If a communication wasn’t pre-approved, records must include the name of the person who prepared and distributed the communication.

Filing Requirements and Review Procedures

-The one-year pre-filing period for new firms will start on the date the firm’s FINRA membership becomes effective. Under the current rule, the period starts when a firm first files an advertisement with FINRA.

-The Advertising Regulation Department may require a firm to file any type or types of communications prior to use.

-The pre-use filing requirement is revised to include retail communications regarding investment companies that include self-created rankings, retail communications concerning securities futures, and retail communications that include bond mutual fund volatility ratings.

-All retail communications concerning closed-end registered investment companies, registered CMOs, and derivatives must be filed with FINRA within 10 business days of first use.

-A present requirement to file advertisements concerning government securities within 10 business days of first use has been eliminated.

-An exclusion from filing exists for:

–Retail communication based on a template that has been filed with FINRA, if the only changes are updating statistical or other “non-narrative” information;

–Retail communications that do not make recommendations or promote a product or service of the firm;

–Online forum posts; and

–Press releases issued by closed-end investment companies listed on the NYSE that are subject to the “immediate release policy.”

-Free writing prospectuses that are prepared by broker-dealers and that will be widely disseminated must be filed with FINRA.

-FINRA may grant an exemption from the concurrent-with-use filing requirement (requirement that states a communication must be filed within 10 business days of first use) for good cause.

Content Standards

-FINRA has added new specifications for illustrations that compare tax-deferred investments with taxable compounding investments. These requirements include using actual federal income tax rates, making a fair comparison, and making appropriate disclosures – the full list of requirements may be found on pages 17-18 of the FINRA Notice.

-A firm must disclose that a testimonial is a paid testimonial if more than $100 is paid for a testimonial (the current rule requires disclosure if more than a “nominal sum” is paid).

-A retail communication that contains a recommendation of securities must disclose if the firm or any associated person involving in preparing the communication has a non-nominal financial interest in the issuer of the security. This is in place of a prior requirement that required disclosure if any of the firm’s officers or partners had a non-nominal financial interest in the issuer.

-Firms are now subject to similar requirements as investment advisers in regards to retail communications about past recommendations – generally specific past recommendations are not allowed. Lists of past recommendations that cover at least one year are acceptable if they include all recommendations for a given type, kind, or classification of security.

Public Appearances

-Public appearances will no longer require pre-approval or filing with FINRA. They still require a reasonable basis for recommendations, proper disclosure, and written supervisory procedures.

Guildlines for Communications With the Public Regarding Security Futures

-Communications about securities futures must be accompanied or preceded by a risk disclosure document if it contains the names of specific securities.

Source: FINRA Regulatory Notice 12-29

This alert applies to the Series 6, Series 62, Series 26, Series 24, Series 7, Series 79, Series 99, and Series 82.

Exam Alert: FINRA prohibits collective action claims from being arbitrated under its Code

Effective July 9, 2012, FINRA will modify its arbitration rules to explicitly state that collective action claims brought under the Fair Labor Standards Act (FLSA), the Age Discrimination in Employment Act (ADEA), or the Equal Pay Act of 1963 (EPA) may not be arbitrated under FINRA’s Code of Arbitration for Industry Disputes. The rule had already prohibited arbitration of class action claims under the Code – this change makes it clear that this prohibition extends to the specified collective action claims as well.

Other rules of procedure were added that govern the determination of whether a specific dispute is a collective claim, and thus not subject to arbitration. These rules are similar to the existing rules for determining whether a dispute is a class action claim. These rules include:

-Someone who opts in to a collective action claim cannot settle the same dispute using arbitration.

-If there is a disagreement over whether a claim is part of a collective action, a panel will review the issue.

-Members and associated persons may not enforce arbitration agreements against members of certified or putative collective actions in relation to any of the claims covered by the collective actions.

Source: FINRA Regulatory Notice 12-28

This alert applies to the Series 79, Series 62, Series 24, Series 82, Series 7, Series 26, and Series 6.

Exam Alert: National exchanges and FINRA to implement new standards for trading halts

Effective February 4, 2013, the national securities exchanges and FINRA will put into place new standards for halting trading both in single stocks and for the whole market. Halts in individual securities will use a “limit up-limit down” mechanism, meaning that it will prevent the security from trading outside of a specified price range based on the average price of the security over the past 5 minutes. Market halts will trigger on smaller drops in the market, and will last for shorter periods of time. Continue reading

Effective February 4, 2013, the national securities exchanges and FINRA will put into place new standards for halting trading both for single stocks and for the whole market.

Halts in individual securities will use a “limit up-limit down” mechanism, meaning that it will prevent the security from trading outside of a specified price range based on the average price of the security over the past 5 minutes. The range is a given percentage above and below that value, as follows:

-For more liquid securities (such as those in the S&P 500) priced above $3, the price range is 5% above and below the average price of the security over the past 5 minutes.

-For other securities priced above $3, the price range is 10% above and below.

-For securities priced between $0.75 and $3, inclusive, the price range is 20% above and below.

-For securities priced under $0.75, the price range is the lesser of $0.15 or 75% above and below.

These percentages will be doubled during the first 15 minutes of trading and the last 25 minutes of trading. Whenever a security cannot trade within the specified price range for over 15 seconds, trading in the security will be paused for 5 minutes.

Market halts will trigger on smaller drops in the market, and will last for shorter periods of time. The new market halts will trigger at the following thresholds, with the following effects:

-Level 1 Halt: triggers on a 7% drop, will halt trading for 15 minutes if it occurs before 3:25 PM (there is no effect if it triggers after 3:25 PM).

-Level 2 Halt: triggers on a 13% drop, will halt trading for 15 minutes if it occurs before 3:25 PM (there is no effect if it triggers after 3:25 PM).

-Level 3 Halt: triggers on a 20% drop, will halt trading for the rest of the day (regardless of when it occurs).

In addition, market halts will reference the S&P 500 as the pricing reference for determining market declines and the trigger thresholds will be recalculated daily. (The current rules reference the Dow Jones Industrial Average and recalculate the thresholds monthly.)

Sources:

SEC Approves Proposals to Address Extraordinary Volatility in Individual Stocks and Broader Stock Market (SEC Release 2012-107)

SEC Approves Market-Wide & Single-Stock Circuit Breakers (Securities Technology Monitor)

Further reading (details current rules and gives reasoning for the limit up-limit down mechanism):

Circuit Breakers and Other Market Volatility Procedures (SEC)

This alert applies to the Series 55, Series 62, Series 24, and Series 7.

Exam Alert: MSRB revises definition of sophisticated municipal market professional

Effective July 9, 2012, the MSRB will modify its definition of a sophisticated municipal market professional (SMMP), bringing an MSRB interpretive notice in line with the new FINRA suitability rule for institutional customers. Specifically, the new notice will define an SMMP as an institutional customer that 1) the dealer has a reasonable basis to believe can independently evaluate investment risks and market value, and 2) affirms that it is using independent judgment when considering the dealer’s recommendations. The revised definition permits natural persons with at least $50 million in assets to be considered institutional customers. The revised definition eliminates a provision that requires a minimum investment of $100 million in municipal securities in order to be considered an institutional customer.

The MSRB notice also changes how Rule G-17 applies to transactions with SMMPs. The Rule G-17 requires broker-dealers to deal fairly when engaged in municipal securities activities. The rule has been interpreted to require a dealer to, prior to selling a security to a customer, disclose all material information known to the dealer about the security along with all material information reasonably accessible to the market from established industry sources. Existing MSRB policy states that the requirement to disclose information from established sources is considered satisfied if the customer is an SMMP and the trade is not recommended by the dealer. The new policy states that the requirement to disclose information from established sources is fulfilled if the customer is an SMMP, regardless of whether the trade is recommended.

Sources:

MSRB Receives SEC Approval on Revised Definition of Sophisticated Municipal Market Professional

MSRB Notice 2012-27

This alert applies to the Series 7.

Exam Alert: FINRA provides guidance on its new suitability rule

FINRA’s new suitability rule, FINRA Rule 2111, will take effect on July 9, 2012. On May 18, 2012, FINRA provided guidance on the new rule by responding to broker-dealer questions, in Regulatory Notice 12-25. This guidance is in addition to the guidance provided in two prior notices, Regulatory Notice 11-02 and Regulatory Notice 11-25.

Some key takeaways:

Acting in a Customer’s Best Interest

-When a broker-dealer makes a recommendation, they must not place their own interests ahead of the customer’s.

Recommendation

-Marketing and offering materials do not count as “recommendations” subject to the suitability rule. See prior notices for further info on what does count as a “recommendation.”

-Implicit recommendations to trade, such as trading on the customer’s behalf without informing them, require a suitability determination. Explicit recommendations to trade or to hold securities also require a suitability determination. Implicit recommendations to hold (i.e. when the broker-dealer remains silent about the customer’s holdings) do not trigger the suitability requirement.

-A call center informing a customer that they can keep their account with a firm does not constitute a recommendation.

-Broker-dealers still have suitability obligations when recommending private placements – this was not changed by the JOBS Act.

Customer

-The suitability rule applies to anyone the broker-dealer makes a recommendation to besides another broker-dealer. This includes potential investors that do not currently have accounts with the firm.

Investment Strategy

-Communications are not subject to the suitability rule if they 1) do not recommend a particular security or group of securities, and 2) are based on an acceptable asset allocation model. For example, suggestions to invest certain percentages of assets in equities or in fixed-income securities would not generally be subject to the rule, but more specific recommendations would be subject to the rule.

Risk-Based Approach to Documenting Compliance With Suitability Obligations

-The extent to which the firm needs to document suitability compliance depends on the risk and complexity of the recommended security/strategy. Recommendations of riskier, more complex securities/strategies are more likely to require documentation.

-Explicit hold recommendations should be documented for certain securities where holding them would be particularly unusual or risky.

-Firms can choose how they want to document hold recommendations.

Information-Gathering Requirements

-The customer info described in the rule only needs to be acquired if/when the broker-dealer makes recommendations.

-Asking a customer for their info is usually good enough, though the broke-dealer may not rely on the customer’s response if there are “red flags” indicating the info may be inaccurate.

-Broker-dealers must use reasonable diligence when trying to get customer info. If they do not get all the info, firms must carefully consider whether they understand the customer well enough to analyze the suitability of an investment before making a recommendation.

-Broker-dealers must consider all information disclosed by a customer in connection with a recommendation when making a suitability analysis.

-If a customer has multiple goals that appear inconsistent, the firm should clarify/reconcile the customer’s goals.

-A broker-dealer may consider the experience of an account manager when making recommendations.

-A broker may make recommendations based on a customer’s overall portfolio, including investments held at other institutions, if the customer give their approval and the broker knows the details of the customer’s overall portfolio.

Reasonable-Basis Suitability

-The reasonable-basis suitability determination has two components.

1) The broker must understand the recommended security or strategy and the risks involved.

2) The broker must determine whether the recommendation is suitable for at least some investors.

Quantitative Suitability

-The quantitative suitability obligation prohibits churning.

Institutional-Customer Exemption

-FINRA has not endorsed or approved any “Institutional Suitability Certificates.”

-The new suitability rule does not use the old rule’s definition of an “institutional customers” – it instead uses the more common definition of an “institutional account.”

-The new institutional customer exemption requires an affirmation from the institutional customer that they are exercising independent judgment. The broker-dealer must also have reasonable basis to believe that the institutional customer is capable of independently evaluating investment risks.

-If the institutional customer does not meet both conditions (capable of evaluating risk and affirming that they will exercise independent judgment) for all of the broker-dealer’s recommendations, the broker-dealer may narrow the scope of the types of securities/strategies it recommends so as to meet the institutional customer exemption.

-The firm may use a risk-based approach to documenting an affirmation from an institutional customer. The affirmation does not need to be in writing.

Source: FINRA Regulatory Notice 12-25

This alert applies to the Series 6, Series 7, Series 24, Series 26, Series 55, Series 62, Series 79, and Series 82.

Exam Alert: FINRA to implement new electronic filing system for public offerings

Firms that participate in initial public offerings must submit certain information about the offered security to FINRA, including the registration statement/offering circular and the underwriting agreement. FINRA will be shifting from the current system for filing this information to a new system in the near future:
-The last day firms may file using the old system (COBRADesk) is May 31, 2012.
-The firms may first file under the new system (Public Offering System) on June 4, 2012.
-Firms will no longer have access to the old system for data retrieval after June 20, 2012. Continue reading

FINRA will generally not be migrating data from the old system to the new one. However, FINRA will transfer over base prospectuses submitted for shelf offerings.

The new system includes new features. FINRA will be releasing further information on the new system on its website.

Emerging growth companies that choose to file their IPOs confidentially with the SEC must still file information with FINRA (all filings with FINRA under the Corporate Financing Rules are nonpublic).

Firms remain responsible for the accuracy of their filings even if the filing is made by a third party.

Source: FINRA Regulatory Notice 12-22

This exam alert applies to the Series 62, Series 79, Series 24, Series 7, and Series 82.

Exam Alert: FINRA rules to change to reflect Dodd-Frank changes to whistleblower laws

Dodd-Frank changes to federal law have prohibited predispute arbitration agreements from applying to whistleblower claims made under the Sarbanes-Oxley Act. Effective May 21, 2012, FINRA’s rules on predispute arbitration agreements will be revised to reflect this change. Continue reading

FINRA’s amended rules will state that disputes that arise under whistleblower statutes that prohibit predispute arbitration agreements are not required to be arbitrated. These disputes may only be arbitrated if both parties agree to do so after the dispute arises.

Source: FINRA Regulatory Notice 12-21

This exam alert applies to the Series 62, Series 79, Series 24, Series 7, and Series 82.

Exam Alert: JOBS Act will change standards for IPOs, securities registration

The Jumpstart Our Business Startups Act (JOBS Act) was signed into law on April 5, 2012. The act lessens regulations for the initial public offerings of certain companies and alters other federal rules. FINRA is expected to change some of its rules to reflect the new standards. Continue reading

Here is a breakdown of the changes:

-IPOs for “emerging growth companies” are subject to fewer restrictions limiting communication between research analysts and investment bankers (Chinese Walls). An emerging growth company is defined as a company with less than $1 billion in annual revenue that had its first IPO no more than five years ago. This has been estimated to cover as much as 90% of companies looking to go public (Source: Reuters).

-Banks are allowed to publish research reports on emerging growth companies immediately after they take them public. The old rule required a 40 calendar day quiet period for IPOs.

-There are fewer restrictions on advertising emerging growth companies to accredited investors.

-Emerging growth companies are exempt from certain disclosure requirements.

-Startup companies can sell small amounts of shares to several investors to raise up to $1 million without being required to register the security (crowdfunding). An investor can contribute up to at most $10,000, though the individual maximum may be lower based on the investor’s annual income or net worth.

-The Act increases the number of shareholders a non-bank company may have before it is required to go public, from 500 persons to 2000 persons or 500 non-accredited investors.

-The Act increases the amount of funds that can be raised before a company is forced to register with the SEC, from $5 million (under Regulation A) to $50 million.

-Up to 2,000 shareholders may invest in a bank holding company before registration is required (up from 500).

-Various other issuer registration requirements have been modified (see the SEC’s JOBS Act FAQ).

The Act itself may be found here.

Sources, further reading:

http://dealbook.nytimes.com/2012/04/04/wall-st-examines-fine-print-in-a-new-jobs-bill/

http://dealbook.nytimes.com/2012/04/11/regulator-seeks-feedback-on-jobs-act/

http://www.sec.gov/divisions/corpfin/cfjobsact.shtml

http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf

http://www.reuters.com/article/2012/04/11/us-jobsact-ipos-idUSBRE83A0Z820120411

http://www.reversemergerblog.com/2012/03/17/summary-of-jobs-bill-and-update/

http://www.csmonitor.com/USA/Politics/2012/0308/What-does-the-JOBS-Act-actually-do-Six-questions-answered/What-s-in-the-JOBS-Act

http://www.pcmag.com/article2/0,2817,2402657,00.asp