Weekly RoundUp January 07, 2015

Financial Services Weekly News

Editor's Note
Editor’s Note

FINRA Rulemaking: In this issue we report on three recent FINRA rule amendments. The first amends the NASD rule on the use of customer account statements to require that member firms use more accurate per share estimated values of the securities of direct participation programs and unlisted REITs. The final rule amendment reflects a long discussion with the industry in a comment process that began with draft proposals in two FINRA Regulatory Notices published in 2011. The other two amendments, actually related groups of amendments, are part of the continuing process of incorporating legacy NASD and NYSE rules and interpretive guidance into FINRA rules. While this process has the effect of streamlining and simplifying rules in some cases, as with new FINRA Rule 2040, governing the payment of fees and other compensation to non-members and registered representatives of the member, FINRA has also used the process to require added compliance procedures, as in Rule 3010(e), which prescribes procedures to verify the accuracy and completeness of the information contained in the Form U4 of a new applicant for registration. Since every member firm has registered persons, every firm will need to update its compliance procedures to implement the requirements of Rule 3010(e) by the effective date, which has not yet been announced, or later implementation date, if provided.

And Examination Priorities: We also report below on the tenth edition of FINRA’s Regulatory and Examination Priorities Letter. The Letter is a service and a caution to broker-dealer firms. If any of the priorities covered in the Letter applies to a firm’s business, and the firm is examined this year, FINRA will probably ask about it. In this sense the Letter represents the best kind of regulation – not simply “gotcha” enforcement activity but a reminder about important issues a busy compliance department can overlook.
Editor's Note
Editor's Note
Editor's Note

Regulatory Developments

FINRA Regulatory Notice Announces SEC Approval of Amendments to FINRA Rule 2310 and NASD Rule 2340 to Address Values of DPP and Unlisted REIT Shares on Account Statements

On January 5, 2015, FINRA issued Regulatory Notice 15-02 announcing SEC approval of amendments to NASD Rule 2340 and FINRA Rule 2310 relating to the reporting of per share estimated values of shares of direct participation programs (DPPs) and unlisted real estate investment trusts (REITs) on customer account statements. The amendments to Rule 2340 describe methodologies for establishing the value of DPP and REIT shares not listed for trading and required disclosures to be provided to customers when account statements use the “net investment” methodology and the customer has received a distribution that includes a return of capital (a so-called “over-distribution”). Corresponding changes were made to FINRA Rule 2310, which, among other things, provides that a member firm may not participate in a DPP or REIT offering unless the DPP or REIT sponsor has agreed to disclose a per share estimated value of the DPP or REIT security, developed in a manner reasonably designed to ensure that it is reliable, along with an explanation of the method by which the value was developed and the date of the valuation. The effective date of the amendments is April 11, 2016.

SEC Grants Accelerated Approval to Proposed Amendments to FINRA Rule 3110 Concerning Responsibility of Member Firms to Investigate Applicants for Registration

On December 30, 2014, the SEC granted accelerated approval of a proposal by FINRA to add a new paragraph (e) to Rule 3110 relating to the responsibility of member firms to investigate applicants for registration and to remove the remaining provisions of NASD Rule 3010 on which Rule 3110(e) is based. In addition to streamlining and clarifying the language, the amended Rule adds a requirement that firms adopt written procedures that are reasonably designed to (1) verify the accuracy and completeness of the information contained in the applicant’s Form U4 no later than 30 calendar days after filing with FINRA and (2) provide for a national search of reasonably available public records to verify the accuracy and completeness of the information contained in the Form U4. FINRA stated in its initial rule filing that it will announce the effective date of the proposed rule no later than 90 days following SEC approval. 

SEC Approves Proposed Rule Change Adopting FINRA Rule 2040 (Payments to Unregistered Persons) and Amending FINRA Rules 0190 and 8311

On December 30, 2014, the SEC approved rule changes proposed by FINRA to adopt FINRA Rule 2040, remove NASD Rule 2420 on which it is based, and amend FINRA Rules 0190 and 8311. New FINRA Rule 2040, which incorporates and replaces NASD Rules 2420 and 1060(b), Incorporated NYSE Rule 353, and related NASD and NYSE interpretive materials, prohibits payments of fees, commissions, discounts or similar compensation to (1) any person that is not registered as a broker-dealer but, by reason of the receipt of such compensation, would be required to be registered under applicable federal law or rules or (2) any registered person, unless the payment complies with applicable federal securities laws and SEC and FINRA rules. The amendments to FINRA Rule 8311 eliminate duplicative provisions and clarify the scope of the rule on payments by members to persons subject to suspension, revocation, cancellation, bar or other disqualification. Finally, New FINRA Rule 0190 will adopt a new general standard providing that a member firm will be treated as a non-member of FINRA from the effective date of any order or notice from FINRA or the SEC issuing a revocation, cancellation, expulsion or suspension of its membership, and thus affect when another member may and may not make payments to the member subject to the order or notice. In its rule filing, FINRA stated that it will announce the effective date of the proposed rule change in a Regulatory Notice to be published no later than 90 days following SEC approval, and that the effective date will be no later than 240 days following SEC approval.

FINRA Releases 2015 Regulatory and Examination Priorities Letter

FINRA published a new Regulatory and Examination Priorities Letter on its website on January 6, 2015. The Letter, the tenth edition of a letter that FINRA has provided annually, identifies shortcomings FINRA has continued to observe in examinations of firms and key issues that it plans to focus on in the coming year. Shortcomings were observed in these key areas: alignment of firms' interests with those of their customers; standards of ethical behavior; development of strong supervisory and risk management systems; development, marketing and sale of novel products and services; and management of conflicts of interest. Key issues for examination include: abusive trading algorithms; high-frequency trading; cross-market and cross-product manipulation; order routing practices, best execution and disclosure; and market access controls.

NFA Announces Effectiveness of Amendment Broadening Conduct Standard Under NFA Compliance Rule 2 4 to Cover Member Swap Activities

The National Futures Association (NFA) issued Notice to Members I-15-01 announcing the approval by the CFTC of NFA’s amendment to NFA Compliance Rule 2-4. Effective immediately, the amendment, which is detailed in NFA's December 1, 2014 Rule Submission Letter to the CFTC, extends the requirement under the Rule to observe high standards of commercial honor and just and equitable principles of trade in the conduct of its commodity futures business to each member’s swaps business. This NFA ethical conduct standard applies not only to NFA member swap dealers and major swap participants, but also to the swap activities of futures commission merchants (FCMs), introducing brokers (IBs), commodity pool operators (CPOs), and commodity trading advisors (CTAs).

SEC Staff Provides Guidance on Key Employee Trusts Under the Family Office Rule
The Staff of the SEC’s Division of Investment Management issued IM Guidance Update No. 2014-13 in response to inquiries regarding whether certain key employee trusts would qualify as family clients under Rule 202(a)(11)(G)-1 (the “Family Office Rule”) under the Investment Advisers Act of 1940. The Guidance Update discusses the Staff’s views regarding how a key employee trust may qualify as a family client when a non-key employee is involved in trust decision-making, provided those decisions are not investment decisions, which must be made by a key employee. The Guidance Update also discusses the Staff’s view that it generally is consistent with the intent of the Family Office Rule for one key employee to make investment decisions on behalf of another key employee’s trust. 

Litigation & Enforcement

FINRA Fines Broker-Dealer Over Systems Error Resulting in Failure to Deliver Mutual Fund Trade Confirmations Over Nine-Year Period

FINRA entered into a settlement with member firm Thrivent Investment Management Inc. related to FINRA’s findings that over an approximately nine-year period the firm failed to deliver thousands of trade confirmations for certain categories of mutual fund transactions to customers due to coding errors in the computerized system established through an outside vendor to generate and send customer confirmations. An independent consultant engaged by the firm to determine the full magnitude of the delivery failures reported that the firm had failed to deliver customer confirmations for over 450,000 transactions, with an aggregate value of over $3 million, in more than 207,000 mutual fund positions held by over 131,000 customers. In determining sanctions, FINRA considered, in addition to the foregoing engagement of an independent consultant by the firm, that the firm internally investigated the causes and scope of the delivery failures, reported them to FINRA, and took remedial action to correct its confirmation delivery system, including hiring the same independent consultant to review and test that system. The firm agreed to a $375,000 fine. The settlement includes no finding of financial harm to the firm’s customers.