The Financial Industry Regulatory Authority, Inc. ("FINRA") has consolidated NASD rule 3070 and NYSE rule 351 on reporting requirements into FINRA rule 4530. FINRA rule 4530 incorporates most of the current reporting requirements under NASD rule 3070 and NYSE rule 351, pursuant to which member firms are required to report certain disciplinary events involving member firms and their associated persons. Notably, FINRA rule 4530(b) adopts the requirement to report internal conclusions of violations that is akin to the reporting requirement under NYSE rule 351. Specifically, FINRA rule 4530(b) will require member firms to self-report when they have "concluded or reasonably should have concluded" that associated persons or the member firms themselves "have violated any securities, insurance, commodities, financial or investment-related laws, rules, regulations or standards of conduct of any domestic or foreign regulatory body or self-regulatory organization." The requirement to report based upon the "reasonably should have concluded" standard will be new not only for FINRA-only member firms, but also for their legacy NASD regulators.
The Securities and Exchange Commission approved FINRA rule 4530 on November 12, 2010. The rule goes into effect on July 1, 2011.
The requirement to report internal conclusions of violations is intended to capture violative conduct that is significant, and is not intended for minor rule violations or every internal finding of an exception. To trigger the reporting requirement, the violative conduct must have greater impact. According to Supplementary Material .01:
"with respect to violative conduct by a member, FINRA expects a member to report only conduct that has widespread or potential widespread impact to the member, its numerous customers, multiple errors or significant dollar amounts. With respect to violative conduct by an associated person, FINRA expects a member to report only conduct that has widespread or potential widespread impact to the member, its customers or the markets, conduct that has a significant monetary result with respect to a member(s), customer(s), or market(s), or multiple instances of any violative conduct."
Regulatory Notice 11-06 clarifies that specific violations found during internal audits (including, for example, branch office inspections conducted pursuant to NASD rule 3010, or annual supervisory reviews conducted pursuant to FINRA rule 3130) may not necessarily be reportable. Member firms should first determine whether such violations are reportable events under FINRA rule 4530(b).
In determining whether a specific violation is reportable, member firms will be required to apply the "concluded or reasonably should have concluded" standard. FINRA provides in Regulatory Notice 11-06 that the FINRA staff will rely on the member firm's "good faith reasonable determination"1 regarding whether a violation is reportable. FINRA further provides that, in enforcing rule 4530, it will employ a "reasonable person" standard to determine whether a violation should have been reported.2 The reasonable person standard is a subjective standard that would generally call for the examination of all of the facts and circumstances surrounding a specific internal finding of a violation. FINRA acknowledges the subjective nature of the reasonable person standard: "it may be possible that a department within a firm reaches a conclusion of violation, but on review senior management reaches a different conclusion. Nothing in the rule prohibits a firm from relying on senior management's determination, provided such determination is reasonable . . . ."3
To avoid regulatory uncertainty, we recommend that member firms adopt and implement written supervisory procedures requiring reporting decisions to be vetted by designated senior individuals in the compliance and/or legal department. We also recommend that member firms document such consultation and the resulting determination in order to evidence that they have engaged in a process of making a "good faith reasonable determination" in compliance with FINRA rule 4530(b).
Member firms must report an internal conclusion of violations to FINRA within 30 days of the determination. Beginning July 1, 2011, member firms will be able to make the report through the Rule 4530 Application on the Firm Gateway, which is currently the Regulatory Filings Application. The event code for Rule 4530(b) self reporting is 20.4
Footnotes
1 Regulatory Notice 11-06 at 2.
2 Id.
3 Id.
4 Id. at 7, 16
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