No Comment
FINRA Cannot Collect Fines Against Barred Members through Court

On October 5, 2011, the Second Circuit in Fiero v. Financial Industry Regulatory Authority, Inc. held that FINRA was not authorized under the Securities Exchange Act of 1934 to enforce disciplinary fines through judicial enforcement.


Apellants, Fiero Brothers, Inc., was a FINRA member firm and broker-dealer registered with the SEC and John J. Fiero was the sole registered representative of Fiero Brothers, and both were subject to FINRA, and its predecessor, the NASD.

In 1998, the Department of Enforcement initiated disciplinary proceedings against Appellants with a hearing panel holding that Appellants violated Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5 thereunder, and FINRA Conduct rules 2110, 2120 and 3370 and as a result, barred Fiero from association with any member firm and issued a fine of $1 million, jointly and severally. FINRA National Adjudicatory Council (“NAC”) affirmed the decision in its entirety.

Procedural History

Appellants refused to pay the fine and FINRA instituted an action in New York Supreme Court. NY Supreme Court upheld the fines based on ordinary principles of contract law recognizing the right of a private membership organization to impose fines on its members, when authorized to do by statute, charter or by-laws.

Appellate courts in New York initially upheld the Superior Court decision, but granted leave to appeal, and in February 2008, reversed the decision on the ground that state courts lacked jurisdiction – the FINRA complaint constituted an action to enforce a liability or duty created under the Exchange Act, and therefore, fell within the exclusive jurisdiction of the federal courts pursuant to 15 U.S.C. § 78aa.

The United States District Court for the Southern District of New York entered judgment for FINRA based on applicable state contract law.


The Exchange Act does not provide FINRA with the necessary authority

While Section 15A(b) of the Exchange Act, FINRA and other self-regulatory organizations (SROs) have a statutory authority and obligation to appropriately discipline members for violations, there is no express authority or Congressional intent for SRO’s to bring judicial actions to enforce the collection of fines.

1990 Rule Filing does not provide FINRA with authority

FINRA filed a rule proposal with the SEC pursuant to Section 19(b)(1) of the Exchange Act NASD stated its intent “to pursue other available means for the collection of fines and costs imposed…in disciplinary decisions.” The NASD reiterated the policy Notice to Members 90-21.

However, the court determined that for “FINRA to have obtained authority [thereunder], the rule must have been properly promulgated under the procedures established by the Exchange Act [and it] was not.” Section 19(b) of the Exchange Act requires SRO’s must file any proposed rule change with the SEC, with a general statement of the basis and purpose, and then the SEC is required to publish notice and give interested individuals an opportunity to comment prior to either approving or disapproving the rule.

While FINRA (then NASD) defined such rule as “House-Keeping,” whereby FINRA was just stating a current policy of an existing rule, the Court determined that this was not “simply a stated policy change…that could bypass the required notice and comment period of Section 19(b)[, but rather,] it was a new substantive rule.” Therefore, the rule was never properly promulgated and “cannot authorize to judicially enforce the collection of its disciplinary fines.”

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Focus on Sales Literature and Advertising: Tips, Procedures and the BD Use Only Legend

In this, the second of a two-part series, the focus is on communications with the public.(1)  While many of these points below appear more important to managing broker-dealers and product manufacturers (sponsors), retail broker-dealers may value the information in connection with their own materials and review of materials provided by sponsors. Retail firms’ obligations are independent – if your registered reps are distributing a piece of marketing material, you are on the hook for it. A retail firm may have some mitigating factors that help it avoid a big problem (like pointing back at the sponsor), but use of problematic material nonetheless will cause the firm grief.

Picking up from last week’s comments about balance, context, proximity and do’s and don’ts, here are a few more tips before we tackle more substance:

  • If you are highlighting something like a calculated number, consider whether there is anything that the reader should know about that number. What are the underlying assumptions, what could throw it off, what could change? Are the underlying assumptions or leaning too aggressive? Did the market do something special in the period you are presenting?
  • If you are making a positive performance statement (in numbers or words), is there a negative statement nearby to provide balance?(2)
  • Completely identify the source to data or a quote, e.g., Source: Wall Street Journal, June 1, 2010 at page A1; Source: Name of Story, Washington Post Online, May 1, 2010, (visited May 15, 2010).
  • You may not predict or project performance, imply that past performance will reoccur or make any exaggerated or unwarranted claim, opinion or forecast.(3)
  • Certain hypothetical illustrations of mathematical principles are permitted, provided that they do not predict or project the performance of an investment or strategy.(4)
  • Any comparison between investments must disclose all material differences between them, including (as applicable) investment objectives, costs and expenses, liquidity, safety, guarantees or insurance, fluctuation of principal or return, and tax features.(5)   While comparisons sound easy and straightforward, comparisons are one of those areas where an after-the-fact regulatory reviewer will always find something to be unhappy about.
  • All material should disclose the name of the broker-dealer – not just the name of a sponsor or issuer which is not a broker-dealer. When the goal of the material in question is to promote the sale of a security, name the broker-dealer (plus Member SIPC to comply with the SIPC Bylaws).

Clarity counts and you should strive to make the material clear. Obviously, a statement made in an unclear manner can cause a misunderstanding. Likewise, a complex or overly technical explanation may be more confusing than providing too little information. Find a good balance and put yourself in the shoes of the reader.(6)

I’ve heard the excuse many times from sales and marketing departments, “…but, it is broker-dealer use only.” Broker-dealer use only material is generally subject to the same requirements as material that is distributed to customers.(7)   There is a slight amount of flexibility because you are able to consider the nature of the audience to which the communication will be directed. Different levels of explanation or detail may be necessary depending on the audience to which a communication is directed. However, you must keep in mind that it is not always possible to restrict the audience that may have access to a particular piece of material.(8)  Additional information or a different presentation of information may be required depending upon the medium used for a particular communications and the possibility that the communication will reach a larger or different audience that the one initially targeted.

The bottom line on BD Use Only material – don’t expect to get a free pass. Also, consider whether it is really worth it to have separate BD Use Only material. Since your customer material is so well written, balanced and chock full of appropriate disclosure, why is it that you need separate BD Use Only material? To tell them what their commission is? They probably know that already. Spend your resources creating useful and compliant investor materials and then train the sales team and registered representatives how to use them to make sales.

What about BD Use Only’s cousin: Internal Use Only? Firms need to train their sales forces. However, for a long time stretching back to the 1980’s partnership issues, regulators have become wise to focus on materials that are used to train the sales people. Instead of having one problem here and there with a rogue salesperson, problematic Internal Use Only material can pollute an entire sales force. Think more recently about how auction rate securities were sold. It was not that all of those registered reps individually decided to sell them incorrectly; the problem was that the firms trained their reps to sell them incorrectly. Train your sales team, but keep in mind the balance and content standards. Also, make sure that Internal Use Only material is clearly marked – and downright ugly; no pictures and fancy layouts. If it looks like marketing material, there is a higher probability that it will leak beyond the intended audience.

Document security is another tip. Lock those PDFs. Now that you have created a great piece of marketing material with good disclosure, don’t fall to people who cut it up, paste and forward. As above, if it is Internal Use Only – make it ugly and lock it. If it is BD Use Only – mark it prominently and lock it. This is especially important if it is the kind of material that could be used with a customer. While you cannot absolutely prevent a registered rep from showing a customer improper material, you can slow them down with prominent markings and by combining documents in a single file. This latter technique is important with electronic documents. If you want to ensure that the prospectus goes with the color brochure – combine them in the same PDF and lock it down. Don’t distribute separate files if you don’t have to. Consider how your material could be misused and devise ways to make it difficult. Be ready to trumpet your controls to examiners along with proving up your in-house material flow procedures and approval system (documented with control sheets).

To file or not to file, that is the question. Filing will not make you completely bullet-proof, but it is close. Filing comes with risks and headaches and delays, but the “appears consistent with applicable standards” letter is a great thing to have in the file at exam time. Filing helps you learn the boundaries. While certain items are subject to mandatory filing, many are not. You may file some optional material, but not all; you may file more up front and less as time goes on and you build a library of disclosure and templates. Consider it. (Also, if you have never filed anything, file something to get the clock on the one year rule ticking).(9)   You should know your advertising analyst’s name. It is as important for your firm to have a relationship with its advertising analyst in Rockville as it is with your local FINRA district office.

I’d like to wrap up with a question that we occasionally receive: “Can’t you just give me some standard language that I can use on everything?” No. That is not just to sell more legal services. Rather, it gets to the heart of one of the most important tips: customization of disclosure and analysis of each piece is important – because that is the way that the regulators and plaintiff’s lawyers are going to look at it after the fact…

  1. To review the previous practice update, please visit the Resources Section of Evans & Kob’s website at
  2. NASD Rule 2210(d)(1)(A).
  3. NASD Rule 2210(d)(1)(D).
  4. Id.
  5. NASD Rule 2210(d)(2)(B).
  6. Remember, you must consider the nature of the reader or audience – different levels of explanation or detail may be necessary depending on the audience to which a communication is directed. See NASD IM 2210-1.
  7. NASD Rule 2211(d)(1).
  8. Keep in mind, NASD Rule 2211 states that “[n]o member may treat a communication as having been distributed to an institutional investor if the member has reason to believe that the communication or any excerpt thereof will be forwarded or made available to any person other than an institutional investor.”
  9. NASD Rule 2210(c)(5)(A).

Contact Evans & Kob for experienced regulatory and legal counsel regarding any sales literature or advertising review and filing, responding to any regulatory inquiry, or any other regulatory or arbitration related legal matter at

Link: Broker-Dealer Advisory Services

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FINRA Issues Further Guidance on Know Your Customer and Suitability Rule and Extends Effective Date – Regulatory Notice 11-25

On May 18, 2011, FINRA issued Regulatory Notice 11-25, which provides further guidance on new consolidated consolidated FINRA rules governing Know Your Customer (Rule 2090) and Suitability (Rule 2111) and extending the implementation date to July 9, 2012 (previously, October 7, 2011).


FINRA Rule 2090 (Know Your Customer) requires firms to “use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer….” The rule explains that essential facts are “those required to (a) effectively service the customer’s account, (b) act in accordance with any special handling instructions for the account, (c) understand the authority of each person acting on behalf of the customer, and (d) comply with applicable laws, regulations, and rules.”

FINRA Rule 2111 (Suitability) requires that a firm or associated person “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile.

Discussion and Guidance

FINRA provided guidance on the following:

Know Your Customer

Authority of Person Acting on Behalf of the Customer – firms need to know: (1) names of persons authorized to act and (2) any limits on their authority. (FINRA notes that firms may decide to limit business to persons without limited scope of authority).


Customer’s Investment Profile

Updating Documentation – firms are not required to update all customer account documentation, and does not contain any explicit documentation requirements, but allows firms to take a risk-based approach with respect to documenting suitability determinations.” The suitability rule applies to recommendations, but the extent to which a firm needs to evidence suitability generally depends on the complexity of the security or strategy in structure and performance and/or the risks involved. However, firms must keep in mind that when suitability is not evident from the recommendation itself, lack of documentation may create examination and enforcement issues.

As a reminder, Rule 2111 adds additional, specific factors to consider in making suitability determinations prior to any recommendation, including customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation ((old rule only included financial status, tax status, and investment objectives).

Lack of Certain Customer-Specific Information – absence of some customer information that is not material under the circumstances generally should not affect a firm’s ability to make a recommendation. To meet its suitability obligations, a firm must obtain and analyze enough customer information to have a reasonable basis to believe the recommendation is suitable. The significance of specific types of customer information generally will depend on the facts and circumstances of the particular case, including the nature and characteristics of the product or strategy at issue. Firms should document the rationale for factors not requiring analysis.

Guidance on Terms:

  • Liquidity Needs: extent of customer’s desired ability or financial obligations that dictate the need to quickly and easily convert to cash all or a portion of an investment or investments without experiencing significant loss in value
  • Time Horizon: expected number of months, years, or decades of planned customer investment to achieve a particular financial goal
  • Risk Tolerance: ability and willingness to lose some or all of the original investment in exchange for greater potential returns.

Different Investment Profiles on Separate Accounts – possible, but firm should evidence customer’s intent and must not allow factors from other accounts to justify recommendations

Terminology – specific terminology is not required when seeking relevant information


Scope of Term “Strategy” – interpreted broadly, including recommendations that: (i) do not result in a securities transaction, (ii) do not reference a specific security, (iii) explicit recommendation to hold a security regardless of involvement in original purchase (but not an implicit one)

Reasonable-Basis Suitability

Firm Approval Does Not Mean Suitable for Particular Customer – Even if a firm’s product committee has approved a product for sale, an individual broker’s lack of understanding of a recommended product or strategy could violate the obligation. Reasonable-basis suitability has two main components: a broker must (1) perform reasonable diligence to understand the potential risks and rewards associated with a recommended security or strategy and (2) determine whether the recommendation is suitable for at least some investors based on that understanding. A broker can violate reasonable-basis suitability under either prong of the test. Firms should educate its associated persons on the potential risks and rewards of the products that the firm permits them to recommend.

Contact our firm for experienced regulatory and legal counsel regarding broker-dealer operations, including drafting new account forms and customer agreements, subscription agreements, written supervisory procedures or any broker-dealer and investment adviser, arbitration, regulatory or securities matter at

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Focus on Sales Literature and Advertising

In this, the first of a two-part series, the focus is on communications with the public. While many of these points below appear more important to managing broker-dealers and product manufacturers (sponsors), retail broker-dealers may value the information in connection with their own materials and review of materials provided by sponsors. Retail firms’ obligations are independent – if your registered reps are distributing a piece of marketing material, you are on the hook for it. Don’t let anybody tell you otherwise. A retail firm may have some mitigating factors that help it avoid a big problem (like pointing back at the sponsor), but use of problematic material nonetheless will cause the firm grief.

In the broker-dealer business, marketing materials are a formidable source of risk exposure. What you say – and what your registered representatives hand out – can and will be used against you in… an arbitration brought by the formerly nicest little old lady who trots out her old and tattered Salvation Army uniform to wear at every hearing session for the all-public panel of arbitrators (new rule!).(1)  Our firm has been assisting several clients and hearing from industry friends of FINRA’s focus of late on sales literature and advertising material.(2)  Given the aggressiveness that we have seen in connection with both routine examinations and more focused reviews, we thought that we would take this opportunity to cover some general principles of marketing and disclosure.

At the risk of grossly oversimplifying the complex regulatory requirements surrounding sales literature and advertising, you should strive to create and use material that is fair, balanced, accurate and complete. The rules and regulations are designed to push you in that direction,(3)  so it is good to know where you are trying to go.

In general, all communications with the public (you know the difference between advertising, sales literature, correspondence, institutional sales material and independently prepared reprints, right?) are to be based on principles of fair dealing and good faith, must be fair and balanced and must provide a sound basis for evaluating the facts in regard to any particular security, industry or service. You may not:

  • Omit any material fact or qualification if the omission, in light of the context of the material presented, would cause the communication to be misleading;
  • Make any false, exaggerated, unwarranted or misleading statement or claim; or
  • Produce any communication that you know or have reason to know contains any untrue statement of a material fact or is otherwise false or misleading.

You should seek to weave balancing information and disclosure into the text of the material. Do not try to relegate the disclosure to a little space on the bottom of the last page – it does not work. The rules provide that information may be placed in a legend or footnote only in the event that such placement would not inhibit the recipient’s understanding of the communication. Better results are achieved by drafting in a balanced manner from the start and then sprinkling disclosure throughout; some on the front, some in the middle and some on the back. Make disclosure proximate to what it is balancing and also consider different techniques to cause disclosure to be more prominent where warranted. Boxes, borders, bolding, typeface and color changes and other types of ‘set-off’ should be considered where disclosure is separated and not incorporated in with text. And, don’t cheat on the size of the text – your disclosure should be near the size of the main text or maybe just a point or two smaller.

Should you have bullet point disclosures? Regulators have been known to ignore claims that the PPM/prospectus “always accompanied the color marketing material” when alleging that same marketing material had thin disclosure. Reasonable or not, there have been enforcement actions basically asserting that the marketing material must be able to stand on its own. I call the remedy “Altegris factors” after the enforcement case from many years ago.(4)  Where appropriate, it may be helpful to bullet point the biggest and most relevant risk factors right in the marketing material. While I am sure that every PPM/prospectus always stays together with the color materials, just in case they get separated on accident there are sufficient risks disclosed in the color materials to give an investor – or a regulator wanting to bring an enforcement action – pause before they decide to come after you.

Context counts. You must ensure that statements in the material are not misleading within the context in which they are made. A statement made in one context may be misleading even though such a statement could be appropriate in another context. An essential test in this regard is the balanced treatment of risks and potential benefits. Communications should be consistent with the risks of fluctuating prices and the uncertainty of distributions and rates of return inherent to investments.

Speaking of context, I found it to be helpful to always consider the “Mom Test,” whether working on an issuer communication or something subject to FINRA rules. If mom isn’t going to understand it, then you have an ineffective piece of communication that you should change before wasting your money. If it is not clear, make it clear. If mom is going to be misled or duped by what is in the material, you’ll need to fix it. If you are going to feel guilty because mom is missing some key facts that have been omitted, you’ll need to include them.

Simple? Unfortunately, simple-sounding concepts obscure the complexity of communications with the public. Also working against you is a relatively short rule containing somewhat mushy language that gives the regulators a lot of flexibility to find a part of the material to be unhappy about.

More to follow next week…

  1. As of January 31, 2011, FINRA Rule 12403 allows customers the option in three panel member arbitrations to either choose the customary “majority public panel” with one non-public arbitrator or the “optional all public panel” that guarantees that any party could select an all public panel.
  2. See also FINRA’s Targeted Examination Letters regarding the “Sale and Promotion of Non-Traded REITs” (located at and “Spot-check of Hedge Fund Advertisements and Sales Literature” (
  3. In particular, see NASD Rule 2210 and related interpretative material.
  4. See “NASD Fines Altegris Investments for Hedge Fund Sales Violations” (located at

Contact Evans & Kob for experienced regulatory and legal counsel regarding any sales literature or advertising review and filing, responding to any regulatory inquiry, or any other regulatory or arbitration related legal matter at

Link: Broker-Dealer Advisory Services

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Arbitration Practice – Motion Response and Promissory Note Proceedings

Motion Practice – Five Day Reply Period for Responses in Arbitration – Regulatory Notice 11-23

Effective June 6, 2011, a moving party will have five days to reply to a response to a motion.  FINRA amended Rules 12206 and 13206 (Time Limits), Rules 12503 and 13503 (Motions), and Rules 12504 and 13504 (Motions to Dismiss) to provide the moving party with a five-day period to reply to a response to a motion.

Promissory Note Proceedings – Regulatory Notice 11-22

Effective June 6, 2011, FINRA will appoint chair-qualified public arbitrators to panels resolving promissory disputes for disputes arising from claims that an associated person failed to pay money owed on a promissory note.  No longer will the chair-qualified public arbitrators be required to be also qualified to resolve statutory discrimination claims. Per Rule 12400(c), chair-qualified arbitrators have completed chair training and are attorneys who have served through award on at least two cases, or, if not attorneys, are arbitrators who have served through award on at least three cases.

Contact Evans & Kob PC if you need experienced legal representation and advice regarding any FINRA arbitration or other regulatory or securities matter at

Link: Litigation and Arbitration

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Fidelity Bonds – Regulatory Notice 11-21

FINRA Rule 4360 requires each member firm that is required to join the Securities Investor Protection Corporation (SIPC) to maintain blanket fidelity bond coverage with specified amounts of coverage based on the firm’s net capital requirement, with certain exceptions. Such firms must maintain fidelity bond coverage that provides for per loss coverage without an aggregate limit of liability. The new rule is based on NASD Rule 3020, taking into account certain requirements under NYSE Rule 319 and its Interpretation.

A firm not qualifying for a fidelity bond with per loss coverage and no aggregate limit of liability must maintain substantially similar cover with compliance with all other provisions of the rule, providing that the firm is able to show through correspondence from two insurance carriers that the firm does qualify for such coverage.

A firm’s fidelity bond must provide against loss and have Insuring Agreements covering at least the following: fidelity, on premises, in transit, forgery and alteration, securities and counterfeit currency. Also, the rule replaces the specific coverage provisions in the NASD and NYSE rules that permit less than 100 percent of coverage for certain agreements, thus coverage for all Insuring Agreements must be equal to 100 percent of the firm’s minimum required bond coverage. A firm’s fidelity bond must include a cancellation rider providing that the insurer will use its best efforts to promptly notify FINRA in the event the bond is cancelled, terminated or substantially modified.

The minimum required coverage increased under the new rule for firm’s with minimum net capital requirements that are less than $250,000 to the greater of 120% of its required minimum net capital or $100,000 (presently $25,000).

Deductibles are allowed up to 25% of the fidelity bond coverage purchased by a firm, but any deductible amount greater than 10% of the coverage purchased must be deducted from its net worth in the net capital calculation for purposes of Exchange Act Rule 15c3-1.

A member firm (even for a multi-year insurance policy) must review annually the adequacy of its fidelity bond and make required adjustments to its coverage, based on its highest net capital requirement for the preceding 12-month period.

Further, Rule 4360 removes the historical exemption of NASD Rule 3020(e) for a one-person firm.

FINRA Rule 4360 takes effect on January 1, 2012.

Contact Evans & Kob PC for experienced legal representation regarding securities, broker-dealer and investment advisers, arbitration or litigation or any other regulatory related matter at

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Third Party Service Providers – Regulatory Notice 11-14

In March 2011, FINRA issued Regulatory Notice 11-14, requesting comments on proposed new rule 3190 clarifying the scope of a member firm’s obligations and supervisory responsibilities for functions or activities outsourced to a third-party service provider.

FINRA Rule 3190 clarifies that:

  • Outsourced functions of a broker-dealer to a third-party service provider does not relieve the firm of its obligation to comply with applicable securities laws and regulations
  • The firm cannot delegate its responsibilities for, or control over, any outsourced functions or activities
  • The firm must maintain supervisory procedures, including due diligence measures, reasonably designed to ensure that third-party service provider arrangements achieve compliance with applicable securities laws and regulations
  • Additional restrictions and obligations apply solely to clearing and carrying member firms and third-party service provider arrangements

Comments Requested by May 13, 2011

Member Firms’ Responsibilities for Activities Outsourced to Third-Party Service providers and Activities Requiring Registration and Qualification

FINRA Rule 3190(a)(1) – member firm’s use of a third-party service provider (including any sub-vendor) to perform functions or activities related to the firm’s business as a regulated broker-dealer does not relieve the firm of its obligation to comply with applicable securities laws and regulations.

  • Third-party service provider (including any sub-vendor) – defined to include any person controlling, controlled by or under common control with a member firm, unless otherwise determined by FINRA.
  • Prohibits the firm from delegating its responsibilities for, or control over, any functions or activities performed by such provider

FINRA Rule 3190(a)(3) – proper registration and qualification required to engage in activities requiring such under FINRA rules

Member Firms’ Supervision and Due Diligence Analysis of Third-Party Service Providers

FINRA Rule 3190(a)(2) – requires firms to establish and maintain a supervisory system and written procedures reasonably designed to achieve compliance with applicable securities laws and regulations for any functions or activities performed by a third-party service provider

FINRA Rule 3190(b) – requires firms include in their WSPs an ongoing due diligence analaysis to determine, at a minimum, whether:

  1. the provider is capable of performing the activities being outsourced; and
  2. as to such activities, if the firm can achieve compliance that are reasonably designed to achieve compliance with applicable securities laws and regulations

Clearing or Carrying Member Firms’ Restrictions and Obligations Regarding Outsourced Activities

The proposed rule imposes heightened requirements on a clearing or carrying firm’s outsourcing arrangements designed to address concerns regarding the potential harm that could result from its third-party service providers’ non-compliance. FINRA believes the concerns are mitigated by limiting certain activities to persons directly subject to the control and supervision of the firm, having additional supervisory procedures to oversee third-party service providers and notify FINRA of its outsourcing arrangements.

FINRA Rule 3190(c) – requires a clearing or carrying member firm to vest an associated person of the firm with the authority, responsibility and necessary registrations and qualifications for the following activities:

  1. the movement of customer or proprietary cash or securities;
  2. the preparation of net capital or reserve formula computations; and
  3. the adoption or execution of compliance or risk management systems.

FINRA Rule 3190(d) – requires that a clearing or carrying member firm include additional supervisory procedures to:

  1. enable the firm to take prompt corrective action where necessary to achieve compliance with applicable securities laws and regulations; and
  2. require the firm to approve any transfer of duties by a third-party service provider to a sub-vendor.

FINRA Rule 3190(e) – requires a clearing or carrying member firm to notify FINRA within 30 days after entering into any outsourcing agreement and such notification must include:

  1. the function(s) being performed by the third-party service provider;
  2. the identity and location of the third-party service provider;
  3. the identity of the third-party service provider’s regulator (if any); and
  4. a description of any affiliation between the firm and the third-party service provider.

Further, the firm would be required to maintain a copy of each notification and underlying agreement in accordance with SEA Rule 17a-4(b).

Exceptions to Proposed FINRA Rule 3190’s Requirements

FINRA Rule 3190 excepts from its requirements ministerial activities performed on behalf of a member firm, unless otherwise prohibited, and clarifies it does not restrict activities performed pursuant to carrying agreement approved under FINRA Rule 4311.

Assuming the rule is approved, there is not a substantial change from the previously issued guidance in NTM 05-48, except for heightened restrictions on certain clearing and carrying member firms’ activities. However, please contact our firm if you need experienced legal representation and advice or if you need assistance updating your written supervisory procedures, providing comments to FINRA, or any other regulatory or arbitration related legal assistance at

Link: Broker-Dealer Advisory Services

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FINRA Proposes Rules on Debt Research Reports – Regulatory Notice 11-11

In March 2011, FINRA issued Regulatory Notice 11-11 requesting comments on a concept proposal to apply objectivity safeguards and disclosure requirements to the publication and distribution of debt research reports. The proposal would provide retail debt research recipients with most of the same protections provided to recipients of equity research, while exempting research provided solely to institutional investors from many of the provisions.

Comments must be received by April 25, 2011


FINRA is concerned over firms’ management of conflicts of interest related to the publication and distribution of debt research, including certain cases where firms lacked any policies and procedures to manage debt research conflicts to ensure compliance with applicable SRO ethical and anti-fraud rules and recent allegations of misconduct in the sale of auction rate securities (ARS). Currently, FINRA’s research rules apply only to “equity securities” as defined under the Securities Exchange Act of 1934, subject to certain exemptions.

In response, FINRA developed this concept debt research rule that would recognize a bifurcated debt research regulatory approach – the proposed rule extends protections similar to equity research to retail investors, while research distributed solely to institutional investors would require a more general “health warning,” but would allow such institutional investors to choose to receive the full protections accorded to retail investors.

Standards Applicable to Retail Debt Research

The majority of NASD Rule 2711 would apply to debt research with the proposed addition addressing conflicts between debt research and sales and trading personnel. Thus, the rule would:

  • Require member firms to establish, maintain and enforce policies and procedures reasonably designed to identify and effectively manage conflicts of interest
  • Prohibit prepublication review, clearance or approval by investment banking and sales and trading, as well as restrict (or prohibit) such by a subject company (except for fact checking)
  • Prohibit input by investment banking and sales and trading into the determination of the research department budget.
  • Limit the supervision and compensatory evaluation of debt analysts to persons not engaged in investment banking services or sales and trading.
  • Require similar compensation rules and review as equity analysts
  • Restrict or limit debt analyst account trading in the securities, derivatives and funds related to the securities covered by the debt analyst
  • Prohibit promises of favorable debt research coverage.
  • Prohibit retaliation against debt analysts by investment banking personnel or other employees as the result of an unfavorable research
  • Restrict or limit activities by debt analysts that can reasonably be expected to compromise objectivity
  • Prohibit investment banking from directing debt analysts to engage in sales or marketing efforts

Further, FINRA envisions disclosures applicable to equity research largely should apply to debt, including:

  • personal and firm financial interests;
  • receipt of investment banking services compensation from the subject company; and
  • the meaning of each rating employed in any rating system used by the member firm in the research report.

Institutional Investor Exemption

The general exemption is based on the assumption that institutional investors are aware of the types of potential conflicts that may exist between a member’s recommendations and trading interests, and are capable of exercising independent judgment in evaluating such recommendations (and instead incorporate the research as a data point in their own analytics) and reaching pricing decisions. However, the institution-only exemption, if not opted out by the institution, requires a “health warning” disclosure on the first page, including:

  • the research is intended for institutional investors only and is not subject to all of the independence and disclosure standards applicable to research provided to retail investors;
  • if applicable, that the firm trades the securities covered in the research for its own account and on behalf of certain clients; such trading interests may be contrary to the recommendations offered in the research and the research may not be independent of the firm’s proprietary interests; and
  • if applicable, that the research may be inconsistent with recommendations offered in the firm’s research that is disseminated to retail investors.

In addition, specific prohibitions and restrictions are placed on:

  • promises of favorable research;
  • debt research analyst involvement in pitches, road shows and other marketing;
  • certain three-way meetings with analysts, investment banking and issuer management
  • input into research coverage by investment banking personnel;
  • retaliation against debt research analysts for unfavorable research;
  • review of research by the subject company (beyond fact-checking) or investment banking personnel; and
  • FINRA rules would continue to apply to member conduct, including Rules 2010 and 2020

Communication Firewalls Unique to Debt

While certain communications between debt analysts and sales and trading personnel are necessary to allow each to perform their primary functions, the following are expressly prohibited:

  • Sales and trading personnel attempting to influence a debt analyst’s opinion
  • Debt analysts identifying or recommending specific potential trading transactions to sales and trading personnel not contained in such debt analyst’s published reports; disclosing the timing of, or material investment conclusions in, a pending debt research report; or otherwise having any communication for the purpose of determining the profile of a customer

Assuming the rules are approved, broker-dealers will need to significantly alter policies and procedures regarding debt research to ensure and monitor compliance Please contact our firm if you need experienced legal representation and advice if you need assistance updating your written supervisory procedures, providing comments to FINRA, or any other regulatory or arbitration related legal assistance at

Link: Broker-Dealer Advisory Services

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No Comment
SEC Approves FINRA New Member Restrictions Regarding Disqualified Persons

On February 18, 2011, the Securities and Exchange Commission issued Release No. 34-63933, approving FINRA Rule 1113 (Restrictions Pertaining to New Member Applications) and amendments to the FINRA Rule 9520 Series (Eligibility Proceedings) to restrict new applicants’ and certain members’ association with disqualified persons based on the belief that “new member applicant[s] should enter FINRA membership free of the supervisory and operating concerns raised by association with a statutorily disqualified person or being itself subject to a statutory disqualification.”

FINRA Rule 1113 (Restrictions Pertaining to New Member Applications)

FINRA shall reject any application for membership in which either the applicant or an associated person is subject to a statutory disqualification. Further, any approval in error shall be subject to cancellation.

FINRA Rule 9520 Series (Eligibility Proceedings)

The amendments to Rule 9520, which sets forth the eligibility proceedings for membership, would:

  1. remove the ability of new members to sponsor the association of a disqualified person;
  2. clarify that a new member applicant is not eligible to submit an application for relief  if the new member itself is subject to disqualification; and
  3. preclude any member from sponsoring the association the association or continued association of a disqualified person, who is directly or indirectly a beneficial owner or more than 5% of the sponsoring member, to be admitted, readmitted or permitted to continue in association.

Statutory Disqualification – Securities Exchange Act Section 3(a)(39)

A person is subject to a “statutory disqualification” with respect to a membership or participation in, or association with a member of, a self-regulatory organization if such person, among others: (1) has been convicted of certain misdemeanors or any felony criminal convictions within the ten years preceding the date of the filing of an application for membership or participation in, or to become associated with a member of, such SRO; (2) is subject to a temporary or permanent injunction (regardless of its age) issued by a court of competent jurisdiction involving at least one of a broad range of unlawful investment activities; (3) has been expelled or suspended from membership or participation in an SRO; or, (4) is subject to an SEC order denying, suspending, or revoking broker-dealer registration.

Experienced counsel is important in the new membership application phase with FINRA. Our attorneys have not only advised broker-dealers, but also formed and operated national and wholesale broker-dealers. If you have a question regarding about a potential or ongoing membership application, contact Evans & Kob PC for expert legal representation and counsel at

Link: Broker-Dealer Advisory Services

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No Comment
FINRA Rule 4530 – Self-Reporting Misconduct

New FINRA Rule 4530, representing a consolidation of NASD Rule 3070 and NYSE Rule 351, takes effect on July 1, 2011. The rule increases the level of self-reporting by firms by requiring firms to not only report when a court or self-regulatory body determines a securities violation, but also when the firm concludes or “reasonably should have concluded” that the firm or an associated person violated securities laws.

In particular, FINRA Rule 4530(b) requires the firm to report to FINRA within 30 calendar days after the firm has concluded, “or reasonably should have concluded” that the firm or an associated person of the firm 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. As Regulatory Notice 11-06 spells out, the reporting is limited to only “conduct that has widespread or potential widespread impact to the firm, its customers or the markets, or conduct that arises from a material failure of the firm’s systems, policies or practices, involving numerous customers, multiple errors or significant dollar amounts.” The standard of “reasonably should have concluded” is defined as “[i]f a reasonable person would have concluded that a violation occurred, then the matter is reportable[.]” The determination is to be made by the person designated as such in the firm’s written supervisory or operating procedures.

Obviously, a reasonable conclusion as to a potential violation may differ among firms as well as with FINRA due to its subjective interpretation leaving the door open for confusion and potential liability by member firms. Further, 4530(b) is only one parameter of the new rule with Regulatory Notice 11-06 discussing several other amendments to the self-reporting framework for member firms.

One thing is certain; firms will need to update their written supervisory procedures to account for additional self-reporting. Please contact our firm if you need experienced legal representation and advice if you need assistance updating your written supervisory procedures as a result of FINRA Rule 4530(b) or any other regulatory or arbitration related legal assistance at

Link: Broker-Dealer Advisory Services

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