United States: SEC Approves New Consolidated FINRA Supervision Rules And FINRA Establishes An Effective Date

Overview

Last week, FINRA issued a Regulatory Notice describing changes to its supervision rules and announcing an effective date of December 1, 2014.1 The new rules were approved by the SEC late last year, and will replace NASD Rules 3010 and 3012 and certain incorporated NYSE rules with FINRA Rules 3110 (Supervision) and 3020 (Supervisory Control System) (collectively, the "FINRA Supervision Rules").  

The adoption of the FINRA Supervision Rules follows two earlier attempts by FINRA to adopt consolidated supervision rules. First, in May 2008, FINRA published Regulatory Notice 08-24, proposing new FINRA supervision rules that drew a large number of comment letters. FINRA addressed the comments and filed a rule proposal with the SEC in 2011, but withdrew it a little more than three months later.

While the FINRA Supervision Rules incorporate many features of existing NASD and NYSE rules and some provisions are likely to be helpful to firms, certain aspects of the new rules could require significant changes to current supervisory practices. As such, although the effective date is months away, firms should start assessing their current policies and procedures and identifying areas that may require new processes and additional controls. We focus on the key revisions to the FINRA Supervision Rules below that are most likely to require changes in firms' policies and procedures.

New FINRA Rule 3110 (Supervision)

FINRA Rule 3110 will replace NASD Rule 3010, incorporating much of that rule's substance. The principal requirements of Rule 3010(a), namely that members establish and maintain a system to supervise the activities of their associated persons reasonably designed to achieve compliance with applicable laws and regulations, are retained with minor modifications.
 
Notably, FINRA Rule 3110 does not retain the controversial supplementary material that FINRA proposed in 2011, which would have required members' supervisory systems to provide for supervision of all business lines, including those not related to securities. FINRA did note in its filing, however, that it would continue to apply Rule 2010 (Standards of Commercial Honor and Principles of Trade) to non-securities activities of members and their associated persons.2
 
Additional requirements imposed by FINRA Rule 3110 are discussed below.

1. Review of Member's Securities Transactions

Similar to NASD Rule 3010(d)(2), and as proposed in 2008, FINRA Rule 3110(b)(2) requires principal review, evidenced in writing, "of all transactions relating to the investment banking or securities business of the member." Supplementary Material .05 states that members may use a risk-based system to comply with this review requirement. In its filing with the SEC, FINRA noted that it intended the term "risk-based" to describe "the type of methodology a member may use to identify and prioritize for review those areas that pose the greatest risk of potential securities laws and SRO rule violations."3 Members may prioritize their review processes "due to the volume of information that must be reviewed by using a review methodology based on a reasonable sampling of information in which the sample is designed to discern the degree of overall compliance, the areas that pose the greatest numbers and risks of violation, and any possible needed changes to firm policies and procedures." 

a. Principal Responsibility for Defective Risk-Based Review Criteria

While FINRA Rule 3110(b)(2) permits firms to use risk-based systems to review investment banking and securities transactions, if such review involves certain parameters to assess whether transactions merit further review, firm principals remain responsible for review and documentation of these parameters. Further, under the new rules, all responsibility for deficiencies in a risk-based system's review parameters and criteria remains on firm principals. 

b. Parameters for Heightened Risk

At a recent webinar on supervision, FINRA staff noted that parameters for considering whether a heightened risk is present included the size of the transaction, transactions where associated fees are higher than normal, the type of investors, whether the firm conducts and publishes related research, whether there are any factors related to particular brokers and their disciplinary histories, and any other relevant red flags that firms may have noticed.4

2. Internal Investigations

FINRA Rule 3110(d)(1) incorporates and expands upon the requirements of NYSE Rules 342.21 and 351(e). NYSE Rule 342.21 requires member organizations to review proprietary, employee and employee-related trading and conduct "internal investigations" of trades in NYSE-listed securities and related financial inst ruments that may violate securities laws and rules prohibiting insider trading and use of manipulative or deceptive devices. NYSE Rule 351(e), as interpreted in NYSE Information Memo 06-6, requires member organizations to make quarterly filings to report the commencement of an internal investigation, provide progress reports for ongoing investigations, and report on the conclusion of investigations. If no investigations were active during the preceding quarter, member organizations are nonetheless required to make a filing certifying that they have procedures for reviewing trades pursuant to Rule 342.21 and have no reasonable cause to believe that any trades subject to the rule in the prior quarter violated the laws or rules against insider trading or manipulation.

a. Requirements for Covered Accounts

The new rule differs from Rule 342.21 in several respects, including broadening the requirement to review all trading in all securities—not only NYSE-listed securities and related financial instruments. It also applies to all FINRA members—not just NYSE member firms. Under Rule 3110(d)(1), members must have supervisory procedures to review transactions that are affected for the member's account or the accounts of associated persons or certain other "covered accounts" for potential insider trading or use of manipulative or deceptive devices. As under NYSE Rule 342.21, members are required to promptly conduct an internal investigation into any identified trade that appears to be violative.
 
The term "covered account" includes any account introduced or carried by the firm that is held by (1) the spouse of a person associated with the firm; (2) a child of the person associated with the firm or such person's spouse, provided that the child resides in the same household as or is financially dependent upon the person associated with the firm; (3) any other related individual over whose account the person associated with the firm has control; or (4) any other individual over whose account the associated person of the firm has control and to whose financial support such person materially contributes.

b.  Internal Review and Reporting Requirements

Under FINRA Rule 3110(d)(3)(A), members that engage in investment banking services are required to make written reports of internal investigations similar to those reports required by NYSE Rule 342.21 and Information Memo 06-6. The rule requires members that engage in investment banking services to file written quarterly reports providing details of any internal investigations opened or remaining open during the quarter, and the resolution of any investigations closed during the quarter, with or without any finding of a violation.
 
Accordingly, any time an "internal investigation" is undertaken, firms are required to report it even if an innocuous explanation for the trade giving rise to the investigation is ultimately identified. Members do not need to file a certification following quarters in which no internal investigations were active.
 
The Rule also requires members that engage in investment banking services to make a written report within five business days of the completion of any internal investigation that identifies a violation of Exchange Act provisions or rules thereunder, or FINRA rules prohibiting insider trading or manipulative and deceptive devices. As FINRA noted in its filing, FINRA Rule 4530(b) also requires such a filing, but only if the violation is committed by the member or an associated person (and not by an associated person's family members). The timeframe for the Rule 4530 filing, however, is 30 days, rather than the five-day requirement of Rule 3110(d)(3)(B). FINRA did not indicate that making a filing under Rule 3110(d)(3)(B) would excuse firms from being required to also make a filing under Rule 4530(b), but firms may wish to seek clarification of this point.
 
Firms should consider implementing clear policies describing the circumstances in which they will commence an "internal investigation," a term left undefined (as it is under NYSE Rule 342.21). Presumably, not every routine follow-up or inquiry into the circumstances surrounding a trade should constitute an internal investigation. These inquiries generally develop along a continuum from informal to formal as they become more serious and at some point along that continuum will be considered "internal investigations" for Rule 3110(d)(1) purposes.
 
Information Memo 06-6 provides some guidance for firms with respect to developing criteria that indicate circumstances in which the steps taken to conduct a follow-up inquiry will be deemed an "internal investigation" for Rule 342.21 purposes, and this guidance may be useful to firms making this determination under proposed Rule 3110(d)(1). FINRA-only members—for whom this requirement will be new—may also want to consider, by analogy, the factors they review when answering Question 7B on Form U5, which asks whether a terminated individual is or was at termination under internal review for certain kinds of misconduct.
 
Firms will not only need to have policies that clearly indicate which inquiries will be deemed internal investigations, they will also need processes to track internal investigations to ensure that they are reported properly, as required by the new rule. Firms will also need to consider the relationship between reporting required by Rule 3110(d)(2)(A), Rule 4530(b) and Form U5 Questions 7B and 7F. For example, while a filing on Form U5 would obviate the need for a filing pursuant to Rule 4530(b), it would not obviate the need for quarterly filings under Rule 3110(d)(2)(A). Note too that unlike Rule 4530(b), the Rule 3110(d)(2)(A) filing with respect to a particular "internal investigation" needs to be updated each quarter through the quarter in which the "internal investigation" is terminated. Conceivably, firms could be required to make quarterly and closing reports under Rule 3110(d)(2)(A) while at the same time providing information in response to Rule 8210 requests triggered by the 4530(b) or U5 filings.

3. Review of Correspondence, Including Internal Communications

FINRA Rule 3110(b)(4) requires a firm to have supervisory procedures to review incoming and outgoing written (including electronic) correspondence and internal communications relating to its investment banking or securities business. The new rule explicitly requires monitoring of internal communications. The procedures must require review of incoming and outgoing correspondence and internal communications that are of a subject matter that require review under FINRA rules and federal securities laws. These include, without limitation, certain communications between research and non-research personnel (NASD Rule 2711(b)(3) and NYSE Rule 472(b)(3)), certain communications with the public that require a principal's preapproval (FINRA Rule 2210), and identification and reporting of customer complaints (FINRA Rule 4530). Firms that have not already done so may need to identify FINRA and other securities rules that require review of communications and adjust their review protocols accordingly.
 
Note that consistent with existing FINRA guidance in Regulatory Notice 07-59 on supervising internal communications, a supervisor or principal may delegate certain review functions to persons who need not be registered. 

4. Reporting of Customer Complaints

The new FINRA Rule 3110(b)(5) requires a firm to have supervisory procedures to capture, acknowledge and respond to all written (including electronic) customer complaints. In line with prior pronouncements, FINRA recognized that oral complaints are "difficult to capture and assess, and may raise competing views as to the substance of the complaint being alleged," and did not include oral complaints in the new requirements. In addition, FINRA is encouraging firms to facilitate reporting of written customer complaints.

5. Supervision of Supervisory Personnel

The FINRA Supervision Rules eliminate explicit producing manager supervisory requirements in favor of procedures designed to address conflicts more generally. Instead, a firm must have procedures to prohibit its supervisory personnel from (1) supervising their own activities; and (2) reporting to, or having their compensation or continued employment determined by, a person the supervisor is supervising. FINRA noted that it believes addressing the supervision of all supervisory personnel, rather than just producing managers, is better designed to prevent supervisory situations from occurring that would not lead to effective supervision.
 
FINRA Rule 3110(b)(6) also requires a firm to have procedures reasonably designed to prevent the required standards of supervision from being compromised by conflicts of interest. Conflicts of interest may arise from the supervised person's position, the amount of revenue such person generates for the firm or any compensation that the supervisor may derive from the associated person being supervised. Importantly, FINRA noted that this provision does not impose a strict liability obligation to eliminate all conflicts of interest, but rather requires that the supervisory procedures be reasonably designed despite the firm's conflicts of interest.
 
At the Supervision Webinar, FINRA personnel explained that for small firms, multiple principals should review key firm documents such as FOCUS reports to ensure compliance with the new rule.

New FINRA Rule 3120 (Supervision)

For firms with $200 million or more in gross revenue, the new rules added specific topics that must be covered in supervisory control reports. New FINRA Rule 3120(b) adds specific content requirements for the annual report to senior management for members with reported gross revenues of more than $200 million (total revenue less, if applicable, commodities revenue) on their prior year's FOCUS reports, based largely on requirements in NYSE rule 342.30. These firms are required to include in the report detailed information about customer complaints and internal investigations made to FINRA during the preceding year, as well as the year's compliance efforts in a number of specific areas, and supervision and anti-money laundering efforts.

1In addition, new FINRA Rules 3150 (Holding of Customer Mail) and 3170 (Tape Recording of Registered Persons by Certain Firms) replace NASD Rules 3110(i) and 3010(b)(2) (often referred to as the "Taping Rule"), respectively. Consolidated Supervision Rules; Regulatory Notice 14-10, March 2014, available at: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p465940.pdf
2 Financial Industry Regulatory Authority; Notice of Filing of a Proposed Rule Change to Adopt Rules Regarding Supervision in the Consolidated FINRA Rulebook, 78 Fed. Reg. 40792 (Jul. 8, 2013) ("Proposal"), at 40801.
3 Proposal at 40803.
4 See http://www.finra.org/Industry/Education/OnlineLearning/Webinars/P441139 ("Supervision Webinar").

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Ayşe Kiraz Bulut
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.