Chapter 9 - Other Relevant Regulations/Interpretations Flashcards
Written Supervisory Procedures manual (WSP)
Required under FINRA rules for all policies and procedures that are used to supervise a firm. Manual must cover scope and nature of all business activities, methods of operation, detailed responsibilities of all supervisors and review procedures, and method of documentation. Must be designed so designated supervisor can implement the plan and is able to detect and prevent violations of the procedures. Copy must be kept in each office where supervisory activities are conducted.
Must include titles, registrations, and location of supervisory personnel and their responsibilities. Record of names and dates of effective designation must be prepared and kept for 3 years, including first 2 years in an easily accessible location.
Amendments must be made in a reasonable timeframe.
Old WSP also must be maintained 3 years.
New FINRA member application
FINRA reviews membership applications within 180 days. Preliminary review to determine if application is complete – any deficiencies must be corrected within 5 days. If complete, FINRA has 30 days to complete its review. Must make written request for additional information if needed, then applicant has 60 days to fully respond to FINRA’s request.
FINRA Supervisory control system
BDs must notify FINRA of at least one principal who will establish/maintain a system of policies and procedures to ensure compliance with applicable securities laws and regulations. Must verify that its SCS is effectively monitoring registered person activities. Designated principal must report to senior management at least once a year and must detail the firm’s SCP.
Supervisory control system must include:
Procedures to monitor customer account activity as conducted by branch office managers, sales managers and other personnel. General requirement for oversight of these procedures to be done by a person senior to the manager whose accounts are being monitored. There can be an exception for small firms – then, must be done by a principal who is sufficiently knowledgeable.
Procedures to monitor the following:
- All transmittals of funds/securities from customer accounts to third party accounts, outside entities, alternative addresses, PO boxes
- Transmittals between customers and RRs
- Customer address changes or customer investment objectives and validation of such changes
Annual certification of compliance and supervisory processes
Must designate a CCO (compliance officer). Can have more than one if primary responsibilities of each are documented.
Annually, CEO must certify the firm has policies and procedures in place to achieve compliance with all rules. CEO must meet with the CCO annually to discuss policies and procedures.
Certification report must be submitted to audit committee earlier of next scheduled AC meeting or within 45 days of execution.
FINRA Dues, fees, and assessments
Members pay annual assessment of 0.125% of annual gross revenues from:
- State and muni transactions
- Other OTC transations
- US govt transactions
- Exchange securities transactions (only for firms whose books/records/operations are examined by FINRA)
Also fixed fee per registered person and per branch office.
If fail to pay, will receive a notice of suspension/cancellation of membership effective 21 days after notice.
Dealing with non-members of FINRA
To encourage membership in FINRA, only members may transact on a preferential basis. Non-members must be treated same as general public, substantially limiting ability of non-members to transact (no price concessions or discounts)
Doesn’t apply to exempted securities (includes Treasury/municipal securities) or exchange transactions
A member of FINRA may pay a commission to a non-member for execution of an order on an exchange (but not OTC)
Suspended FINRA members
Become non-member on effective date of expulsion or from date of suspension to termination of suspension.
Revocation of BD registration with SEC (or resignation from FINRA) automatically terminates FINRA membership.
If a BD is a member of FINRA and an exchange and gets suspended from FINRA, it may continue trading on the exchange without violating FINRA rules
Foreign BDs
Restrictions that apply to non-members don’t apply to foreign BDs that are ineligible for membership
Must have an agreement that on subsequent sales in the US, the foreign BD will comply as if it’s a FINRA member
Foreign BD will deal with non-member BDs as it deals with general public
Continuing commissions
Under certain circumstances, a former RR will continue to receive commissions. This is allowed but the former RR may not solicit new orders or accounts during retirement.
Business continuity plan
BDs must establish written BCP identifying procedures to be followed in the event of an emergency/disruption.
Must verify that all customer obligations will be met and must address the firm’s existing relationship with other BDs and counterparties.
Must be reviewed annually
Must be made available promptly after FINRA request
Must include:
- Data backup/recovery (hard copy and electronic)
- All mission critical systems
- Financial/operational assessments
- Alternate communications between customers and BD
- Alternate communications between BD and employees
- Alternate physical location of employees
- Critical business constituent/bank/counterparty impact
- Regulatory reporting
- Communications with regulators
- How the member will assure customers prompt access to their funds and securities in the event that the member determines its unable to continue business
Required to report emergency contact info to FINRA - 2 designated associated persons. At least one must be senior management and registered principal. If there’s a second one, if not registered principal, must be senior management with knowledge of business ops.
Mission critical system
Any system that’s necessary, depending on the nature of the business, to ensure prompt and accurate procession of securities transactions, including order taking, order entry, execution, comparison, allocation, clearance and settlement of securities transactions, the maintenance of customer accounts, access to customer accounts and delivery of funds/securities
Registration of representatives
All persons engaged in the investment banking/securities business of a member firm must be registered, except clerical/admin roles. BDs must investigate the good character/qualifications/experience of potential RRs. Application for registration is accomplished on Form U4.
If person was previously registered with FINRA, BD must obtain latest Form U5 (Termination Notice) within 60 days of application. Applicants must provide U5 within two business days if requested (or if they don’t have a copy, must request from their former employer and provide to new employer within 2 days of receipt)
Qualification exams
RRs must pass the appropriate exam, depending on products they sell. Series 7 is the most inclusive – allows RR to sell any security. Other licenses limit activity.
Exam confidentiality
FINRA considers the content of its exams confidential; therefore, it’s a violation of FINRA rules to:
- Remove an exam or portion of exam from test center
- Reproduce parts of an exam
- Disclose parts of an exam
- Receive parts of an exam
- Compromise contents of exam in any way
Violators are subject to sanctions under Code of Procedure, may include suspension/revocation of registration
Form U4
Uniform Application for Securities Industry Registration or Transfer
Satisfies SEC Rule 17a-3.
Each individual who’s to be licensed under SRO rules must complete Form U4
Filed with/reviewed by FINRA’s CRD
Applicant must answer questions about personal data, history of violations of laws/SRO rules
RR is required to keep Form U4 updated if any info changes
Fingerprint required
Does NOT include education history
SEC Rule 17a-3
Requires a BD to keep a current questionnaire or application for employment executed by each associated person, excluding clerical/admin roles
CRD
Central Registration Depository – digital system maintained by FINRA and provides registration info regarding BDs/RRs to state regulators, other SROs, and the SEC. Disciplinary info about an RR may be requested through the CRD.
Statutory disqualification – Form U4
Yes answer to some questions on Form U4 may result in automatic denial of application, such as:
- Being expelled/suspended from SRO
- Having registration denied/suspended/revoked by SEC or other regulatory agency
- Violating or assisting in violation of securities laws
- Failing to reasonably supervise
- Being convicted of a felony or misdemeanor involving false reports, bribery, perjury, crimes related to securities, or any other felony
A person convicted of a felony or certain misdemeanors is barred from the securities business for 10 years from the date of the conviction. However, a disqualified person may apply to an SRO to enter or reenter the securities industry before the 10-year period has elapsed
Fingerprinting requirements
Any employees of a BD must be fingerprinted if they:
- Engage in sale of securities
- Regularly come into contact with money/securities
- Have access to keeping, handling, or processing of securities, or the firm’s records of original entry
- Have direct supervisory responsibility over someone with the above activities
Requirement may be waived for certain security types
Must be maintained for at least 3 years after RR’s termination
Ineligible fingerprints
After three good faith fingerprint attempts, firms are not required to submit a 4th. FINRA will request for the FBI to conduct a search of its databases based on the associated person’s name rather than fingerprints, to check for criminal history.
Qualifications of supervisors
SRO rules require all supervisory personnel to be qualified to assume their responsibilities by either experience or training. Most supervisors are required to pass either Series 9/10 (General Securities Sales) or Series 24 (General Securities Principal), depending on responsibilities.
Typically, officers, general partners, managers of an office or director who’s actively engaged in securities business of the member firm are required to be registered.
For specialized areas, may be required to take other exams too
Series 24
General Securities Principal – manage or supervise investment banking/securities business for corporate securities, direct participation programs, investment company products/variable contracts.
Doesn’t qualify for roles with options, municipal securities, FinOps principal
Series 9/10
General Securities Sales Supervisor – supervise sales activities in corporate, municipal, options securities, direct participation programs, investment company products, variable contracts
Series 26
Investment Company Products/Variable Contracts Limited Principal – supervise sale of open end investment companies (mutual funds), closed end funds, variable annuities, variable life insurance
Series 27
Financial and Operations Principal – Supervise BD’s financial responsibility and recordkeeping functions (prep of FOCUS reports and ensuring compliance with UPC)
Series 99
Operations Professional – required for covered persons.
1. Senior management with direct responsibility over covered functions
2. Any person who’s designated by senior management as a supervisor, manager, or other person responsible for approving/authorizing work
3. Persons with authority to materially commit a member’s capital/material contract or agreement
Covered functions for Series 99
- Client on boarding
- Collection, maintenance, reinvestment, disbursement of funds
- Receipt/delivery of securities and funds or account transfers
- Bank, custody, depository and firm account management and reconciliation
- Settlement, fail control, buy ins, segregation, possession/control
- Trade confirmations and account stmts
- Margin, stock loan, securities lending
- Prime brokerage (services to other BDs and financial institutions)
- Approval of pricing methods that are used for valuations
- Financial control, including general ledger/treasury
- Contributing to the process of preparing/filing financial regulatory reports
- Defining and approving business requirements for sales and trading systems and any other systems relating to the covered functions
- Defining/approving business security requirements and IT policies
- Defining/approving information entitlement policies in connection with covered functions
- Posting entries to a member’s books and records in connection with covered functions
Series 16
Supervisory Analyst – understand rules applicable to preparation and approval of research reports
Series 53
Municipal Securities Principal – supervise activities of Municipal Securities reps, supervise sale of muni bonds
Series 4
Registered Options Principal – responsible for supervising a firm’s options trading, ensuring compliance with exchange rules/OCC rules
Producing managers
Supervisory personnel who also produces business. Example – branch manager who services customer accounts. Written procedures must be in place to supervise these supervisory personnel, prevent conflicts of interest.
Exception for supervising own activity if firm is too small (must document)
Executive representative
Firms are required to designate a point person who will interface with FINRA, typically a principal with broad understanding of the operations. Review designation quarterly. Must be met within 17 business days of each of each calendar year. If firm needs to update, must notify FINRA no later than 30 days after change.
Assignment of responsibility for GL accounts
Under FINRA rules, must designate an associated person who’s responsible for each GL account. A supervisor must review each account as frequently as necessary, at least monthly.
Keep record of these names for at least 6 years
Continuing education
Requirements divided into two parts:
1. Regulatory
2. Firm
Continuing education – Regulatory
RRs are required to participate in Regulatory Element training on an annual basis for each registration that they hold. Tailored to each registration category. Calendar year basis. Written by Securities Industry/Regulatory Council on Continuing Education. Computer based/online training.
Registration will become inactive if not completed timely (prohibited from performing any activity or receiving compensation requiring securities registration)
Continuing education – Firm
Each firm must demonstrate it has analyzed and prioritized training needs of covered personnel (any registered person with contact with customers and their immediate supervisors)
Maintain records documenting content, but not required to be submitted.
Particular emphasis on:
- General investment features and associated risks
- Suitability and sales practice considerations
- Applicable regulatory requirements
Supervisory responsibilities – conduct rules
All BDs are required to diligently supervise business, including activities of RRs. Must establish and maintain supervisory procedures, reviewed by at least one principal.
FINRA manual
In addition to requirement to maintain a copy of WSP, must make a current copy of the FINRA manual available for examination by customers if a request is made
Office of Supervisory Jurisdiction (OSJ)
BD must appoint a principal to supervise activity of any OSJ and must have a Series 24 (General Securities Principal) on the premises to approve/review new accounts, transactions, correspondence, retail communication, and responses to customer complaints. For options, must have a Registered Options Principal, and a FINOP for reporting.
OSJ = Any location where at least one of the following occurs:
- Market making
- Order execution
- IPO/private placement structuring
- Custody of customer funds/securities
- Final acceptance/approval of new accounts
- Review/endorsement of customer orders
- Final approval of retail communication
- Responsibility of supervising other branch offices
Supervision of multiple OSJs by one principal
FINRA generally assumes only one principal per OSJ, as they must have a routine/regular physical presence. If a BD determines it necessary to assign a principal to >1 OSJ, BD must take into consideration the following:
- Whether principal is qualified by virtue of experience/training
- Has capacity/time
- Whether principal is a producing RR
- Whether OSJ locations are in sufficiently close proximity
- Nature of activities at each location (size, scope, complexity, etc)
Must document in WSP why BD considers supervisory structure to be reasonable. Don’t need FINRA pre-approval.
Creation of additional OSJs
Should consider:
- Whether RRs at new location engage in retail sales or other activities involving regular contact with customers
- Whether a substantial number of registered persons conduct securities activities at, or are otherwise supervised from, such location
- Whether it’s geographically distant from other OSJs
- Whether RRs are geographically dispersed
- Whether securities activities are diverse/complex
Branch office
Location where firm’s personnel conduct business of effecting transactions in, or induce/attempt to purchase/sell securities
As long as not involved in OSJ activities, its considered non-OSJ.
May be supervised by principal or competent RR
Moving a branch
Form BR is used to notify FINRA as to the status of a given branch location. Must revise Form BR whenever there is a change, within 30 days.
Non-branch locations
Not required to be registered as a branch office on Form BR.
- Non-sales office (back office/operations office only)
- Location of convenience that’s used occasionally and by appt only
- Floor of an exchange
- Temporary location used in a business continuity plan
- Location primarily used for non-securities business and from which fewer than 25 securities transactions executed annually
- Rep’s primary residence not used as an office for the public
- Temporary location used for securities business (not a primary residence) for <30 business days in a year
Primary residence business locations
Exempt from branch treatment if:
- Only one associated person (or more if all same family) conduct business there
- Not represented as an office of the firm
- Cannot meet with customers there
- Funds/securities not handled there
- Associated person is assigned to a branch office and the address for that branch is listed on business cards, etc.
- Correspondence of that associated person is subject to supervision
- Electronic communications are done through the firm’s system
- All orders are entered through the branch of the associated person (or through firm’s system)
- Written procedures regarding supervision of sales activities conducted at an associated person’s residence must be maintained by the firm
- Firm must maintain list of all residence locations
On-site review of personal residence may take place and this must be documented in WSP
Office inspection requirements
- OSJs must be inspected annually by a principal of the firm
- Branch offices which supervise non-branch locations – inspected annually
- Branch offices which don’t supervise – inspected every 3 years
- Non-branch offices – reviewed on periodic cycle which depends on nature/complexity/volume of transactions, number of personnel, etc.
- Personal residence – periodically
May not be done by associated person who works at the location
Supervision of each business line
A BD must appoint a supervisor to oversee each type of business in which it engages. Rules don’t specify what “type of business” means, but includes retail sales, investment banking, research, trading, clearing, etc.
Required to conduct annual reviews of business lines
Written approvals
A sales supervisor’s responsibilities (approving new accounts, reviewing transactions, etc) must be documented in writing (usually initials)
Ex. Initialing each trade ticket for the principal’s review or initial each page of the trade blotter
New Issue (Equity IPO) Rule
Member firms are required to make a bona fide offering of new issues to the public and not withhold shares for its own account (or employee accounts) or accounts in which a restricted person has a beneficial interest
Exemption – limited BDs may allow personnel to purchase
Limited broker dealer
Restricts business to investment company/variable contract securities or direct participation programs
New issues
Include all IPOs of equity securities sold under a registration stmt or offering circular.
Excludes:
- Secondary offerings
- Debt offerings
- Private offerings
- Preferred stock
- Investment company offerings
- Exempt securities (defined under Securities Act of 1933)
- DPPs/REITs
Preconditions for sale
Prior to selling a new issue to an account, firm must obtain representation from the account holder stating that the account is eligible to purchase New Issues in accordance with the New Issue Rule. This may be an affirmative statement
For accounts held by banks, foreign bankers, BDs, investment advisers, or other conduits, firm must obtain representation that all of the conduit’s purchasers are in compliance
May be done electronically, cannot rely on oral statements.
Must re-verify each 12 months and retain copies
Prohibited new issue sales
A member firm or any person associated with member firm is prohibited from offering/selling a new issue to any account in which a restricted person has a beneficial interest. Also may not purchase a new issue. There are exemptions
Restricted persons
Include:
- FINRA member firms and any associated person of the firm
- Immediate family member of an employee of a member firm (spouse, children, parents, sibling, in laws)
- Finders/fiduciaries (attorneys, accountants) involved in the new issue
- Portfolio managers purchasing for their own accounts (because they can direct future business of the firm)
- >10% owners of BD
Immediate family members are only considered restricted persons if any of the following:
1. Employee gives/receives material support (25%) from family member
2. Employee is employed by the member firm that’s selling the new issue
3. Employee has the ability to control the allocation of the new issue
Form BD
Required to report >10% ownership of broker dealer
General exemptions to New Issue Rule
New issue may be sold to:
- Investment companies registered under Investment Company Act of 1940
- The general or separate account of an insurance company
- Common trust fund
- Publicly traded entities (other than a BD/affiliates of BD)
- Account in which beneficial interest of restricted persons is <10%
- Foreign investment companies
- ERISA accounts, state and local benefit plans, and other tax-exempt plans
- BDs IF the new issue is undersubscribed (still not restricted persons)
- (Anti dilution) Restricted persons IF the purchase will keep their current equity ownership % the same (must have held shares for 1 year prior)
Issuer directed securities (Relating to new issues)
Issuer can direct shares to:
- Parent company of issuer
- Subsidiary of issuer
- Employees/directors of issuer
Allows RR/other restricted persons to purchase shares of equity IPO in her BD, or parent/sub of BD.
Public offering by a member firm
Proceeds must be held in escrow until:
- Member firm has notified FINRA when the offering has been terminated/settlement effected
- Firm has filed with FINRA a computation of its net capital under 15c3-1 (with proceeds taken into account)
Note that if NC is >10:1, <120% of minimum dollar requirement, or <7% ADI (alternative method) – then proceeds must be returned to purchasers and offering withdrawn (unless they have exemption from capital rule)
Employee requirements on brokerage accounts
Employees who wish to open a securities account at another firm need prior written consent of their firm and need to provide written notification to the outside firm.
This rule also applies to spouses, children, related person if employee has control over their account, or any person if employee has control over account AND materially contributes to support
If previously opened account, employee must obtain written consent within 30 days of employment (and provide written consent to outside firm)
Outside firm is required to send duplicate copies of trade confirmations, statements, etc. to the employer
Exemptions to employee rules on brokerage accounts
Accounts with limited transactions such as investment company securities (mutual fund shares), unit investment trusts, variable contracts, or 529 plans
FINRA suitability rules
All recommendations made to customers must be suitable based on facts disclosed by the customer regarding their financial situation
“know your customer”
BDs must have reasonable basis for their recommendations, based on investment profile which includes:
- Age
- Investment experience
- Other investments
- Time horizon
- Financial situation/needs
- Liquidity needs
- Tax status
- Risk tolerance
- Objectives
- Any other info provided by customer
FINRA 3 main suitability obligations
- Reasonable basis (to believe a particular product/strategy is suitable for at least some customers, i.e. must understand product)
- Customer specific (based on investment profile)
- Quantitative (transactions aren’t excessive for investment profile)
Suitability for institutional customers
- BD must have reasonable basis to believe the institutional customer is capable of evaluating investment risks
- Institutional customers must affirmatively state that it’s exercising its own judgment in evaluating recommendations
Firms are exempt from customer-specific obligation when dealing with institutional customers
Specific recommendation violations
- Recommending low price securities without obtaining information about customer’s current holdings/financial situation
- Recommending purchases beyond customer’s ability to pay
- Engaging in excessive activity in customers’ accounts (churning)
- Trading in mutual fund shares which by nature are not suitable trading vehicles
- Engaging in fraudulent activities (opening fictitious accounts, using discretion without customer authorization, etc)
Criteria of reasonable diligence when making recommendations to customers
- Price, volatility, liquidity of security
- General character of market for the security
- Size/type of transaction
- Number of markets checked
- Accessibility of the quotation
- Terms and conditions
If BD and financial institution operate together…
Must comply with special provisions to ensure customers can distinguish between the products/activities of the bank vs BD.
- Setting – operate in different physical spaces and clearly display name
- Agreements between the entities – must be in writing, spell out responsibilities, compensation, and allow SEC/FINRA examination access
- Customer disclosures – at/before opening a customer account, BD must disclose that it’s not FDIC insured, not deposits of the financial institution, and subject to investment risks
- Communications – Confirmations/statements must clearly state the BD provides the brokerage services. Advertising must contain the customer disclosures above (can be shortened if needed)
- Terminations – BD must promptly notify financial institution if its terminates for cause an associated person who is also employed by the bank
Must make a reasonable effort to get written acknowledgment of those disclosures from the customer
Shortened version of customer disclosures
- Not FDIC insured
- No bank guarantee
- May lose value
Taping Rule
If a BD hires personnel from a previously disciplined firm (registration revoked/expelled), must tape conversations between the all registered personnel and customers for three years.
Different thresholds:
- Employ 5-9 RRs, at least 40% have been employed by a disciplined firm in the last three years
- Employ 10-19 RRs, at least 4 have been employed by a disciplined firm in the last three years
- Employ 20+ RRs, at least 20% have been employed by a disciplined firm in the last three years
Once FINRA notifies that a BD is subject to the Taping Rule, it has 60 days to comply. Must have procedures for reviewing, retaining, classifiying the recordings. Must report quarterly to FINRA.
Exception: One-time opportunity to reduce staffing to lower threshold level. Then must notify FINRA and can’t hire employees back for 180 days
Holding Funds of customers purchasing deferred variable annuities
If a customer purchases a deferred variable annuity, a registered principal of the firm is required to approve the purchase within 7 BDs. Allows firm to maintain customer funds received prior to this approval if the firm is permitted to hold customer funds under 3-1 and 3-3.
FINRA rule on manipulative, deceptive or fraudulent devices
No member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive of fraudulent device or contrivance
Marking the close
Example of manipulative practice. Refers to a series of transactions that are executed at or near close of trading (4pm) with either upticks or downticks a security. Marks a departure from normal forces of supply/demand that result in fair auction price.
Called marking the opening if done at market open
Motivation for marking the close
- BDs use closing price to determine margin requirements, so marking the close could manipulate these
- Closing price is what’s shown as final price of trading session
When the practice is repeated, a pattern develops
Marking the open can manipulate options prices (expire at open) or certain program trading strategies
Other types of price manipulation
- Wash sales – Sell at one BD while buying from another BD – to create illusion of trading activity
- Matched orders
- Pool activities
- Pegging/capping – activity designed to keep price from either rising or falling
When these transactions appear on Consolidated Tape, activity is referred to as painting the tape
FINRA 5% markup policy
FINRA members are prohibited from charging unfair prices/commissions. This policy (which also applies to markdowns and commissions)
Under this policy, BDs must consider “all relevant factors” which determining markups. 5% is merely a guideline; it can still be too much or too little depending on circumstances. Must also consider how the markup is calculated when interdealer price isn’t obvious.
5% markup policy – factors that influence markups
- Type of security involved
- Availability of security in the market
- Price of security
- Total transaction value
- Disclosure
- Pattern of markups
- Nature of BDs business (market makers are risking their own capital and therefore can earn higher markup, for non-market makers the price they would sell contemporaneously to another firm is the prevailing price)
Markup
Difference between interdealer ask price and sales price to customers
Markdown
Difference between interdealer bid price and purchase price from customer
FINRA policy for calculating markups
BD must determine
- Whether its acting as market maker
- Whether market is active and competitive, or dominated and controlled
- Whether actual transactions or validated quotes are the best evidence of the prevailing price
Market maker
Firm which actively participates in the market
A price quote can be considered validated when
- A competitive market for the security exists
- Interdealer sales occur with relative frequency, although not necessarily contemporaneously
- When interdealer sales do occur, they are consistently executed at or around the the quoted offer price
Note that its possible that the inside offer might not be the prevailing price, i.e. stock quoted at $24.50 - $25.00 but most interdealer trades are $24.75 – prevailing price is $24.75
Proceeds transactions and markups
Customer directs firm to sell a security and use the proceeds to purchase another security. When computing markups, BDs should calculate % markup on just the purchase – not the combined sale and purchase.
Exemptions from 5% markup policy
Securities sold under prospectus or offering circular as a fixed offering price, registered secondaries, exchange transactions or mutual fund shares
Firm charges for other services
Firms may charge reasonable fees for services like collection of dividends or safekeeping of securities, must not discriminate against customers
Rules around borrowing from/lending to customers
RRs can’t, unless certain criteria are met. Must be written procedures permitting the activity and satisfying one of the following:
1. Immediate family member (including spouse, in-laws) or someone the RR materially supports
2. Customer is a financial institution and this is course of business
3. Customer and RR are both registered with same firm
4. Loan is based on personal relationship only
5. Loan is based on business relationship independent of customer-broker relationship
Prior to loan, RR must notify firm. If 3, 4, or 5 above, firm must approve (and maintain written pre-approval until 3 years after termination of loan or employment)
Information obtained as a fiduciary
Firms acting as agent are prohibited from using information obtained about the security’s holders in order to solicit other business
Disclosure of interest in a distribution
Investment adviser (BD receiving a fee for advising) cannot attempt to sell securities which are part of a distribution the adviser takes part in (conflict of interest) – must disclose interest to the customer at or before completion of the transaction
Control relationships
Written disclosure is required when selling a security whose issuer is under common control as the firm (either in advisory accounts or discretionary accounts)
Activities prohibited by FINRA
- Payments to influence market prices
- Sharing in P&L from accounts (there are exceptions)
- Influencing/rewarding employees of other firms >$100 (except for services rendered with written agreement, events also attended by the firm and except family relationship gifts like baby shower)
- Outside business activities without written notice to the firm
- Private securities transactions (aka selling away) without written notice (and approval if earning compensation)
Exceptions to profit sharing rules
Employee may share in P&L from accounts if:
- Employee made financial contribution
- Sharing is directly proportional to contribution
- Prior written consent of firm
FINRA rules – Complaints
Required to maintain record of complaints in an OSJ for 4 years (even if there are none), and actions taken to resolve. (May be kept at another location if available to OSJ upon request by FINRA)
Required to file a report with FINRA within 30 calendar days of discovering certain triggers
Complaints – FINRA reporting requirements
Triggers (based on date of discovery):
- Complaint involving theft, misappropriation of funds, forgery
- Violation of any securities law/regulation or standard of conduct of regulatory body
- Denial of registration or suspension/expulsion from regulatory body
- Named defendant in proceeding by regulatory body
- Indicted/convicted of any crime involving securities, theft, forgery, etc
- Is a director or associated person with a firm which was suspended/expelled (or convicted of a crime)
- Is a defendant/respondent in securities related litigation with settlement >$15k (for individuals) or >$25k (for firms)
- Is the subject of any action taken by member firm resulting in suspension, termination, fines >$2500
Quarterly reports – complaints
Required to provide quarterly report (due 15th of the month following a calendar quarter) with statistical/summary information about customer complaints, even those that don’t trigger ad hoc reporting. No report due if no complaints.
Confidential settlement of complaints
Settlement of complaints may be confidential (customer may not disclose terms), but firm/RR is still required to report the terms to FINRA’s CRD system
Code of Procedure
FINRA’s disciplinary process under Rule Series 9000. Covers disciplinary proceedings and actions.
FINRA disciplinary proceedings
- Dept of Enforcement believes a rule has been violated
- Requests authorization from Office of Disciplinary Affairs to issue a complaint
- Respondent must respond to complaint within 25 days
- If no response, DOE will issue a second notice – if no response to second notice, viewed as admission of guilt
- Respondent may request a hearing as answer to complaint
- Hearing is held before a Hearing Panel (Office + two panelists)
- Hearing Office = attorney employed by FINRA
- Panelists are associated persons (or retired) from member firms
- Hearing Officer may call a pre-hearing conference to prepare the parties for the hearing
- Documentary evidence is submitted before the hearing
- Witnesses provide testimony under oath at the hearing
- Within 60 days after the Hearing Panel has stopped accepting evidence, it must render a written decision that’s arrived at by majority vote
- At any point before the hearing, respondent may propose settlement offer, and Hearing Panel can either accept or reject
FINRA disciplinary sanctions
Hearing Panel may:
- Censure
- Fine (within limits)
- Suspend membership
- Expel/revoke registration
- Bar an associated person from associating with other member firms
- Impose other fitting sanction
Note that if an associated person’s registration is suspended/revoked, they can’t associate with a member firm in any capacity
Bar/expulsion are immediate. Other sanctions are effective in 30 days.
FINRA disciplinary process – appeals
Hearing Panel -> NAC -> SEC -> Fed Courts
Respondent (or DOE) has 25 days to appeal with the NAC (National Adjudicatory Council). NAC also has the right to review a decision. Appeals place the decision on hold. After review, NAC can affirm, modify, or reverse any sanction. Respondent has the right to then appeal to SEC and then Fed Courts.
Acceptance, Waiver and Consent (AWC)
DOE believes violation has occurred and respondent hasn’t disputed. DOE can request the respondent sign an AWC (accept finding, waive right to appeal, consent to sanctions)
Minor rule violations (FINRA)
If DOE believes certain minor rule violations have occurred and respondent doesn’t dispute, it can fine up to $2500 and censure. Respondent can accept and waive right to appeal, or reject and go through normal process.
Includes charges like:
- Failure to have advertising approved by a principal
- Failure to file timely reports of short positions
- Violations of books/records rules
Release of disciplinary information
Available to the public via PDP (public disclosure program), on file at CRD (central registration depository) or through phone or FINRA website (Broker Check)
BrokerCheck
Through FINRA’s website. Provides the following information about registered individuals:
- Current employing firm, 10 years of employment history, and all approved registrations
- Certain legal and regulatory charges/actions
- Pending customer-initiated proceedings
- Written customer complaints alleging sales practice violations and compensatory damages >$5k
- Formal investigations involving criminal or regulatory matters
- Terminations of employment after allegations of violations
Code of Arbitration
Establishes process for settling disputes. Any disputes between members (or between member and clearing corporation) must be settled by arbitration. Also applies to disputes between member firm and someone associated with a member, except for sexual discrimination/harassment.
You agree to this in the U4
Does not apply to disputes between a firm and FINRA
No appeals in arbitration!
Rules around customers and arbitration
Arbitration is required if a public customer intends to arbitrate a dispute with a member or person associated with a member (if vice versa, the customer must agree to it). Customer may initiate arbitration by filing a Submission Agreement of Claim
Pre-dispute Arbitration Clause
FINRA rules require specific wording for any clause in new account paperwork regarding required arbitration for disputes.
FINRA requires:
- Highlighted
- Arbitration final and binding
- Parties are waiving rights to seek remedy in court, including jury
- Pre-arbitration discovery is generally more limited than court proceedings
- Arbitrator’s award is not required to include factual findings or legal reasoning, and right to appeal or seek modification of rulings is limited
- Typically the arbitration panel will include a minority of people affiliated with the securities industry
- Immediately before the signature line, a highlighted statement that the agreement includes a pre-dispute arbitration clause
- Copy must be given to customer
- 6 year statute of limitations
Arbitration process
- National Arbitration Committee appoints panel of 1-3 (number depends on $ in dispute)
- If a customer is involved, majority of arbitrators will be public (not affiliated with industry) unless agreed otherwise
- Customer has right to reject on a peremptory basis, right to unlimited challenges for cause
- If <$50k in dispute, simplified process
- Party initiating the arbitration pays the filing fee
- Panel decides what evidence is allowed (not required to follow state/fed rules)
- Arbitrator makes determination after hearing evidence and will make awards as deemed appropriate
- Only deal with monetary or other compensation outcomes, not fines, censure, etc
- Unless law says otherwise, finding is final and binding (no appeals)
Simplified customer arbitration
One arbitrator decides the case based on written evidence and arguments (unless customer or arbitrator want a hearing)
Simplified industry arbitration
One non-public arbitrator decides the case without a hearing, unless one of the parties demands one
Mediation – FINRA rules
Informal process in which two parties to a dispute attempt to reach a settlement without resorting to arbitration or litigation. FINRA now offers this option due to increasing delays in arbitration. Involves a third person, the mediator, to attempts to facilitate discussion.
Mediation process
- Select a mediator – FINRA will select one, but the parties can also choose their own
- Fee is split between parties
- Parties provide mediator with information they think is necessary
- Parties presents case to mediator
- Parties meet separately with mediator in confidential caucuses to look at their case and consider possible settlements
- Mediation continues until the dispute is resolved, the mediator declares an impasse, or either party withdraws (in writing)
- Can run concurrently with arbitration
Partial success possible (mediation)
Even if no settlement is reached, mediation can help reach a clearer understanding and any further action is often shorter
Rule 10b-5 (Exchange Act)
It’s unlawful, in connection with the purchase or sale of any security, to:
- Employ any device/scheme to defraud
- Make any untrue statement of a material fact/omit material fact necessary in order to make a statement not misleading
- Engage in any act/practice that operates as fraud/deceit upon any person
What is one of the most important applications of Rule 10b-5?
Insider Trading
Insider trading
If a company has material information, it must be public before anyone uses it to trade
Public = released to media and disseminated (not to BDs or analysts)
Insider trading tippers and tippees
Both can be liable if the tippee knew or should have known the information was non public
Insider trading laws in the 1980s
ITSA (Insider Trading Sanctions Act of 1984
ITSFEA (Insider Trading and Securities Enforcement Act of 1988)
These required BDs to establish, maintain and enforce written policies and procedures that are reasonably designed to prevent misuse of material non-public info, and ensure those rules are being implemented.
Any individual who trades while in possession of MNPI may be liable for trading violations
Insider trading – BDs procedures must include:
- System for monitoring employee trading/accounts
- Restricting or monitoring trading of securities for which the firm has access to inside information
- Restricting access to files containing confidential info
- Educating employees on insider trading laws
Information barrier (fka Chinese Walls)
Set of procedures/physical barriers for preventing transmission of confidential information from one department to another
Consequences of insider trading violations
Civil (disgorgement of profits) and criminal (fines up to $5m and/or 20 years prison time)
Corporations can be charged criminally with fines up to $25m
Private securities transactions
Transactions outside the normal scope of business of their employer (private securities transactions) must notify their employer in writing.
Employer must approve in writing if compensation is involved.
If approved, the transaction must be recorded on the books of the employing broker-dealer.
If the representative will not be compensated for the transaction, the employing broker-dealer must provide written acknowledgment of the employee’s notice and may place conditions on the participation of the employee in the transaction
MQP and related requirements
If a previously registered individual participates in the Maintaining Qualifications Program (MQP) remains current with his continuing education requirements and becomes re-registered within five years, he’s not required to retake a qualifying exam. Individuals who choose not to participate in the MQP only have two years to re-register without taking a qualifying exam. However, individuals who are out of the industry for more than five years must retake the appropriate qualifying exam before their registration becomes effective.
Rules around person convicted of felony coming back to work at a BD
A person convicted of a felony or certain misdemeanors is barred from the securities business for 10 years from the date of the conviction. This type of ban is referred to as a statutory disqualification. However, a disqualified person may apply to an SRO to enter or reenter the securities industry before the 10-year period has elapsed. If the SRO grants the waiver, it must notify the SEC, which can overturn the waiver if it chooses. Other grounds for statutory disqualification include:
Having been suspended or expelled from another SRO
Being subject to an order from the SEC, appropriate regulatory agency, or a foreign regulatory authority denying or suspending or revoking a registration
Having willfully made a false or misleading statement of a material fact or having omitted a material fact from any application, report, or proceeding before any self-regulatory body
Maximum fine FINRA can levy
SROs, such as FINRA, may fine their member firms and employees for violations of their rules. Although FINRA publishes its Sanctions Guidelines publication, there is no limit as to the monetary fine that it may levy against a member firm or its employees.
