The SEC approved a FINRA proposal to address the application of FINRA rules to security-based swaps ("SBS").

As previously covered, the proposal amends FINRA Rules 0180 ("Application of Rules to Security-Based Swaps"), 4120 ("Regulatory Notification and Business Curtailment"), 4210 ("Margin Requirements"), 4220 ("Daily Record of Required Margin"), 4240 ("Margin Requirements for Credit Default Swaps") and 9610 ("Application") to account for its members' SBS activities. As modified by Amendment No. 1 and approved by the SEC, the changes include:

  • the replacement of expiring FINRA Rule 0180 with new FINRA Rule 0180, which makes FINRA rules applicable to members' SBS activities and positions while providing exceptions where FINRA determined them to be appropriate; and
  • requiring that FINRA members that enter into swaps comply with the SEC's amendments to its capital, margin and segregation requirements.

The SEC approval contains a fulsome discussion of the manner in which the SBS regulations apply to FINRA members that may enter into SBS, but that may not be registered security-based swap dealers ("SBSDs"). Amendment No. 1 extended the effective date of the proposed amendments for FINRA Rules 0180, 4120, 9610 until February 6, 2022, and extended 4210, 4220, and 4240 until April 6, 2022.

Commentary Nihal Patel

The FINRA rules should be closely reviewed and built into policies and procedures by (1) broker-dealers that engage in SBS as principal (including those registered as SBSDs), (2) broker-dealers that agent SBS for others (including for affiliates), and (3) broker-dealers that have employees that agent SBS for others (so-called "dual-hatted" personnel).

The proposal is most significant for the first category, as the FINRA rules provide an additional layer of regulation beyond the SEC SBS requirements. Non-SBSD broker-dealers are subject to most FINRA rules on their SBS, including suitability and new margin requirements. Broker-dealers and SBSDs are subject to a more limited subset of FINRA rules for their SBS activities, but must still abide by a number of FINRA requirements in addition to the SEC SBSD rules, including amended FINRA capital (and related financial responsibility) requirements.

Broker-dealers that agent SBS are distinguished by whether they act for a registered SBSD or an entity relying on the de minimis exception in Rule 3a71-3(d), in each case with the ability to rely on some exceptions from FINRA conduct rules given similar SEC SBSD requirements.

Finally, firms that employ "dual-hatted" structures should ensure that personnel are appropriately categorized and the activities are addressed under FINRA Rule 3270 on outside business activities. (In the original proposal, FINRA included a caution as to the "facts and circumstances" nature of a determination of whether a broker-dealer-employed person is acting solely on behalf of an SBSD.)

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