Rule News

Federal Elections and MSRB Rules

The next President or Vice President of the United States can cause and create big trouble for municipal securities dealers.  And, it all goes back to MSRB Rule G-37, which governs political contributions - it prohibits dealers from engaging in municipal securities business with issuers for 2 years if they make certain contributions to the political campaigns of officials of such issuers. 

MSRB created Rule G-37 in 1994 to preserve the integrity of the municipal securities industry by seeking to end the practice of dealers being awarded municipal securities business based on political contributions. 

“In light of political campaign fundraising efforts going on around the country, we are reminding dealers that the MSRB’s political contribution rule applies to state and local government officials running for federal office.  We want to ensure that dealers do not inadvertently violate this important rule.”  -  MSRB Executive Director Lynnette Kelly Hotchkiss.

Today’s notice to dealers also cites prior interpretations of Rule G-37 that address indirect rule violations involving contributions to non-dealer associated political action committees and payments to political parties. These interpretations underscore the Rule G-37 requirement that dealers may not indirectly do what they are prohibited from doing directly.   [MSRB News Release, 9/28/11]

SEC 'Red Flags' Master/Sub-Account Structures

SEC staffers from the Office of Compliance Inspections and Examination (OCIE) expressed significant concerns regarding the practice of trading through sub-accounts, and offered securities firms suggestions on how they might address those risks, namely:  (i) money laundering;   (ii) insider trading.  (iii) market manipulation;  (iv) account intrusions;  (v) unregistered broker-dealer activity;  (vi) excessive leverage.

OCIE identified as a potential risk associated with the master/sub-account trading model.  Customers who open master accounts with a registered B/D usually subdivide it for use by individual traders or groups of traders.  In some instances, the sub-accounts may be divided to such an extent that the master account customer and the firm where the account is held might not know the identity of the traders in the sub-accounts.

OCIE National Exam Risk Alert.   The alert, which is the first of a series of risk alerts that OCIE plans on issuing, includes suggestions to help B/D's address concerns that can arise from trading in sub-accounts, and comply with the SEC’s Market Access Rule.  That rule requires firms to have controls and procedures to limit risks associated with offering market access to customers, including those with master/sub-accounts.

FINRA Proposes Changes in DPP and REIT Rules

FINRA is proposing changes in the way firms report information pertaining to unlisted Direct Participation Programs (DPPs) and unlisted Real Estate Investment Trusts (REITs) on customer account statements.  NASD Rule 2340, Customer Account Statements, would be amended for how firms report the per share estimated values of DPPs and REITs. 

FINRA Seeks Comments on these Changes.   FINRA asks that comments be submitted by 11/12/11 on the following amendments: 

• 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 - i.e., Initial Offering Period.  

• Require firms to deduct organization and offering expenses from per share estimated values during the Initial Offering Period.

• 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.

• 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

Currently, NASD Rule 2340(c) ...  contains specific provisions addressing the estimated values of DPPs and REITs on customer account statements.  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.  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. 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.

FINRA Staff Contacts.   Direct questions to:   Joseph Price, SVP - CorpFin/Advertising Regulation;  (240) 386-4623];  Gary Goldsholle, VP and Assoc. GC - Office of the General Counsel;  (202) 728-8104; or  Paul Mathews, Director - CorpFin Dept;  (240) 386-4639.

For further details, go to:   [FINRA RegNote 11-44, September 2011].

FINRA Says: 'Its Time We Revised Some Registration Exams'

As C-I reported earlier this month, FINRA has changed the form, subjects tested, and pass rates for qualification examinations required for several registration categories -

• General Securities Representative (Series 7);
• U.K. Securities Representative (Series 17);
• Canada Securities Representative (Series 37); and
• Canada Securities Representative (Series 38).

The changes are reflected in the content outlines on FINRA’s website and will appear in examinations starting on 11/7/11. 

The changes in content or subjects tested on the exams reflect changes to the laws, rules and regulations - i.e., to reflect adoption of rules in the consolidated FINRA rulebook.  FINRA also revised the outlines to better reflect the functions and associated
tasks performed by each of the 4 registration categories, and to better reflect the relationship between the different components of the outlines. 

FINRA Proposes Changes to Market Wide Circuit Breaker Rules

FINRA is proposing new methodologies for determining when to trigger market-wide circuit breakers in NMS and OTC stocks.  Today's markets need more meaningful measures for effecting trading halts in NMS and OTC stocks on a market-wide basis. 

As proposed, FINRA Rule 6121, Trading Halts Due to Extraordinary Market Volatility, would be updated with new methodologies for determining when to halt trading in NMS stocks due to extraordinary market volatility.  FINRA Rule 6440, Trading and Quotation Halt in OTC Equity Securities, would be amended to halt trading in all OTC Equity Securities until the market-wide circuit breaker no longer is in effect for NMS stocks.

Since the Flash Crash of 5/6/10, when the markets experienced excessive volatility in an abbreviated time period, FINRA and the national securities exchanges have implemented market-wide measures designed to restore investor confidence by reducing the potential for excessive market volatility.  Pilot plans were adopted for stock-by-stock trading pauses and related changes to the clearly erroneous rules.  In April, FINRA and other SROs proposed the “Limit Up-Limit Down Plan” pursuant to Rule 608 of Reg. NMS which would prevent trades in individual NMS stocks from occurring outside specified price bands.

In addition, the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues has recommended that SROs consider reforming existing market-wide circuit breakers - e.g., (i) replace the DJIA with the S&P 500;  (ii) revise the 10%, 20% and 30% decline percentages;  (iii) reduce the length of trading halts;  and, (iv) allow halts to be triggered up to 3:30 p.m.

FINRA Alert: Reporting Sales of 'Worthless' OTC Equities

FINRA asks the question:  Does your firm always report sales of low-value OTC equity securities positions from customer accounts?   Such securities, often deemed by the customer and firm to be “worthless,” are subject to FINRA trade reporting rules and must be reported to FINRA for publication purposes.

Facilitating Sales of Customer Positions.   Some firms facilitate the sale of low-value positions held by customers that the customer may deem “worthless.”  The firm purchases the shares to remove the position from the customer’s account, which also enables the customer to claim a capital loss for tax purposes.  The purchase price typically is nominal and set solely for purposes of liquidating the position. Sometimes the entire lot is priced at one penny or one dollar - i.e., sometimes referred to as “penny for the lot” transactions.  These sales are considered trades - i.e., there's a beneficial change in ownership - and are not expressly excluded from FINRA trade reporting rules.  Thus, firms must report these sales to FINRA for public dissemination purposes as they would any other trade.

Because many of these sales are effected at a per lot price, the per share price may extend beyond six decimal places, which is okay because the OTC Reportng Facility (ORF) can accommodate 6 decimal places for purposes of reporting a per share price.  If the per share price is equal to or less than $.000001, firms should report a price of $.000001.  Any trade reported at a per share price less than $.0001 will be publicly disseminated with a price of $.0000.

FINRA also notes that some firms deem a security “worthless” solely on the basis that it currently has no bid and no longer trades.  In such cases, best execution obligations under NASD Rule 2320 apply, and firms are required to use reasonable diligence to ascertain whether there is a market for the security.

For further details, go to:   [FINRA Trade Reporting Notice, 9/23/11, ".. Customer Sales of Low-Value OTC Equity Securiies"]

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

FINRA Alert: Trade Reporting for OTC Equities and 144A Restricted Equities

FINRA asks:  Is your firm properly reporting OTC trades in OTC Equities and trades in 144A equity securities?  FINRA reminds firms that both types types of trades must be reported to FINRA - even if a firm executes a trade in a security for which there's no valid OTC symbol.  In such cases, the firm must obtain a symbol so it can fulfill its trade reporting obligations. 

Applicable Rules and Definitions.  FINRA Rules 6600, 7300 Series.   All OTC transactions in OTC Equity Securities must be reported to the OTC Reporting Facility (ORF), unless they fall within an express exception.  As defined in FINRA Rule 6420, “OTC Equity Security” is any equity security that's not an “NMS stock”;  provided, however, that the term OTC Equity Security shall not include any “Restricted Equity Security.”  Thus, “OTC Equity Security” is broadly defined and could include non-exchange-listed equity securities of issuers that have recently emerged from bankruptcy, have no visible public market or are closely held, and non-exchange-listed contingent value rights.   As defined in Rule 6420, “Restricted Equity Security” is any equity security that meets the definition of “restricted security” as contained in Securities Act Rule 144(a)(3).  Transactions in Restricted Equity Securities effected under Securities Act Rule 144A must be reported to the ORF.  Transactions in Restricted Equity Securities that are not effected under Rule 144A are not reportable.

Reason for the FINRA Notice.   FINRA receives inquiries about whether certain securities are OTC Equity Securities or Restricted Equity Securities and finds that these firms are uncertain as to whether FINRA trade reporting obligations are triggered.  The answer, which generally is "yes," indicates that firms need to create or strengthen pols and procedures and internal controls in place - e.g., including consultations with counsel - which can help them comply with FINRA rules in response to such situations. 

In this Notice, FINRA also explains what to do when a security does not have a valid OTC symbol assigned - e.g., request FINRA Operations to assign a symbol so that the firm can fulfill its trade reporting obligations.  If the trade is not reported on the trade date, it should be reported on an “as/of” basis using the original execution date as the trade date.  Failure to go through the process results in a violation of FINRA trade reporting rules and, firms will be disciplined if FINRA detects a pattern and practice of executing reportable trades without obtaining a symbol and reporting the trade to FINRA.

For further details, go to:  [FINRA Trdae Reporting Notice, 9/23/11, ".. OTC Equity Securities and Restricted Equity Securities"]

Direct Questions.   Legal Section, Market Reg:  (240) 386-5126;  FINRA Operations:  (866) 776-0800; or  Office of General Counsel:  (202) 728-8071.

FINRA Board of Governors Authorizes Rule Changes

From whistleblowers, to new centralized record retention, to changes with Member Applications.  The Board authorized FINRA staff to move forward on rule changes.  

1.  Arbitration Procedures: Whistleblower Claims.   Authorized: a revision to the Code of Arbitration to provide that a dispute arising under a whistleblower statute that prohibits the use of predispute arbitration agreements is not required to be arbitrated - although the parties may agree to go to arbitration, if they so choose.  Also authorized:  a revised disclosures about arbitration procedures, provided to associated persons signing or acknowledging a Form U4.   [Changes to be filed with SEC].

2.  Publicly Disseminate Transactions in Agency Pass-Through Mortgage-Backed Securities Traded "To Be Announced" (TBA).   Authorized:  amending FINRA Rule 6700 Series (TRACE rules) to require dissemination of TBA transactions in Agency Pass-Through MBSs.  Authorized:  reducing reporting period for TBA transactions in 2 phases:  (i) first, to 45 minutes;  (ii) after six months, to 15 minutes.  In connection with the dissemination of TBA transactions, FINRA would set a $50 million dissemination cap for TBA transactions, with the result that the disseminated size (volume) of a TBA transaction in excess of $50 million would be displayed as "$50M+."   Authorized:   amending FINRA Rule 7730 to reduce TRACE reporting fee for TBA transactions to $1.50/transaction, and creating ABS data sets in connection with TBA transaction data.   [Changes to be filed with SEC].

FINRA Proposes Big Changes to TRACE

FINRA proposes to amend its TRACE rules with an eye to consolidating all TRACE-Eligible Securities transaction processing and data management on a single technology platform, the Multi Product Platform (“MPP”). 

Extending TRACE System Beyond Asset-Backed Securities.    Currently, TRACE-Eligible Securities that are Asset-Backed Securities (ABSs) are processed on FINRA’s enhanced technology platform, MPP.  FINRA now would like to migrate all other TRACE-Eligible Securities to MPP.  FINRA believes that the proposed consolidation of all TRACE-Eligible Securities on MPP will improve TRACE reporting and provide several benefits to broker-dealers. 

    First, the MPP program incorporates more current industry standards, conventions and terms, and the proposed amendments to Rule 6730 to incorporate those standards will clarify and simplify the reporting requirements, and reduce reporting errors and costs. 

e.g. - when quoting, trading and recording positions in books and records, generally the size (volume) of a transaction or a position is stated as the total par or principal value, which is how size (volume) of a TRACE transaction would be reported on MPP.

The proposed amendments should reduce the incidences of data “translations” made by a broker-dealer when transaction data is both recorded in internal firm systems and reported to TRACE, and therefore should reduce operational complexities and reporting errors and fees, improve compliance, and reduce system-related costs.

FINRA Changes Series 17 Exam for U.K. Reps

FINRA filed for immediate effectiveness to revise the content outline and selection specifications for the U.K Securities Representative (Series 17) exam program, which is administered by FINRA.  The revised Series 17 exam program will go into effect on 11/7/11 - look for the Regulatory Notice.

NASD Rules and the NYSE Incorporated Rules require ... that a “representative,” as defined in the respective rules, register and qualify as a General Securities Representative, subject to certain exceptions.  For those reps who are not engaged in municipal securities activities, both sets of rules provide that registration and qualification as a United Kingdom Securities Representative is equivalent to registration and qualification as a General Securities Representative.

The proposed revisions update the material to reflect changes to the laws, rules and reg covered by the exam and to better reflect the functions and associated tasks performed by a General Securities Rep and the relationships between the different components of the outline. 

FINRA Series 7 Examination - New and Improved

FINRA filed for immediate effectiveness to revise the content outline and selection specifications for the General Securities Representative (Series 7) exam program, which is administered by FINRA.  The revised Series 7 exam program will go into effect on 11/7/11 - look for the Regulatory Notice.

The proposed revisions update the material to reflect changes to the laws, rules and reg covered by the exam and to better reflect the functions and associated tasks performed by a General Securities Rep and the relationships between the different components of the outline. 

Proposed Revisions.   FINRA has divided the content outline into the following 5 major job functions performed by a securities rep:

1. Seeks Business for the B/D through Customers and Potential Customers (68 questions);
2. Evaluates Customers’ Other Security Holdings, Financial Situation and Needs, Financial Status, Tax Status, and Investment Objectives (27 q's);
3. Opens Accounts, Transfers Assets, Maintains Appropriate Account Records (27 q's);
4. Provides Customers with Information on Investments, Makes Suitable Recommendations (70 q's); 
5. Obtains and Verifies Customer’s Purchase and Sales Instructions, Enters Orders, Follows Up (58 q's).

FINRA Looks to Revise Rules for Indications of Interest

FINRA is proposing to restrict the use of indications of interest by member firms, particularly as they relate to customer orders.  FINRA has opened a comment period on its proposal that runs through 10/21/11.  Comments will be posted on FINRA's site one week after the comment period ends;  thereafter FINRA will file the rule proposal with the SEC.

Indications of interest, or IOIs.  Non-firm expressions of trading interest that contain one or more of the following elements:  (i) security name, (ii) side, (iii) size, (iv) capacity and/or (v) 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.

e.g. - 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's often associated with an IOI is whether the IOI originated with a customer - i.e., a “natural” IOI - rather than with the firm.  A natural IOI can be done on an agency or proprietary (riskless principal) basis. 

What Would Change, and Why.   FINRA remains concerned that firms are disseminating misleading information regarding IOIs, including not accurately labeling them to reflect their origination.  So, it's proposing to amend Rule 5210 in several ways.