FINRA, in Regulatory Notice 13-29, requested comment on a revised proposal (the “Revised Proposal”) to transfer the NASD Rule 1010 Series (“Membership Proceedings Rules”), with substantive changes, into the consolidated FINRA Rulebook as the FINRA Rule 1100 Series (“Member Application Rules”). The Revised Proposal includes changes in response to comments on the prior proposal set forth in Regulatory Notice 10-01 (the “Prior Proposal”), and additional rule provisions designed to address regulatory issues identified by FINRA staff and to codify existing membership-related interpretations and practices.
The Membership Proceedings Rules provide a means for FINRA, through its Membership Application Program (“MAP”), to assess the proposed business activities of potential and current member firms with the ultimate goal of ensuring that each applicant is capable of conducting its business in compliance with applicable rules and regulations, and that its business practices are consistent with just and equitable principles of trade.
In January 2010, FINRA published the Prior Proposal, seeking comment on a proposal to, among other things, revise the existing membership rules to streamline the standards of review for new member applications (“NMAs”) and continuing membership applications (“CMAs”), clarify administrative aspects of the membership process, update or eliminate outdated terminology, require additional information (including affiliate information) about the applicant and incorporate provisions from the Incorporated NYSE membership rules. The Prior Proposal also proposed eliminating many of the Incorporated NYSE membership rule requirements as redundant or obsolete. The proposed amendments to the Member Application Rules reflect comments received on the Prior Proposal.
The new Member Application Rules are as follows:
1100 – Member Application;
1110 – General Provisions;
1111 – Definitions;
1112 – General Procedures;
1120 – Member Application Process;
1121 – New Member Application, Interview and Department Decision;
1130 – Basis for Department Decision;
1140 – Review by National Adjudicatory Council;
1150 – Discretionary Review by FINRA Board;
1160 – Application for Approval of Change in Ownership, Control, or Business Operations Pursuant to a Continuation of or Withdrawal from Membership;
1170 – Notice of Certain Member Changes;
1180 – Application to the SEC for Review; and
1190 – Foreign Members.
Below is a summary of selected provisions of the Revised Proposal.
The Revised Proposal would adopt NASD Rule 1011 as proposed FINRA Rule 1111 (Definitions) with certain changes and additions. Notably, the Revised Proposal’s definitions of “affiliate” and “control” generally track the corresponding definitions in Form BD; however, the proposed definitions differ from Form BD in certain respects. For example, the definition of “affiliate” excludes natural persons and the definition of “control” replaces the references to “company” with “person” and includes references to limited liability companies (“LLCs”) and LLC managing members.
The Revised Proposal would also make the following changes:
Proposed FINRA Rule 1111(c) would amend the definition of “Associated Person” to expressly include an LLC member as an associated person and to provide a de minimis exception from the definition for less than 10 percent ownership.
Proposed FINRA Rule 1160 would expand the definition of the term “material change in business operations” that would require the filing of a CMA to include (1) any change in exemptive status claimed under SEC Rule 15c3-3(k) (Customer Protection – Reserves and Custody of Securities); (2) settling or clearing transactions for the applicant’s own business or for other broker-dealers for the first time; or (3) carrying accounts of customers for the first time.
The proposed Member Application Rules would also make minor amendments to other existing definitions.
NASD Rule 1012 (General Provisions) sets forth the requirements for submitting MAP applications and supporting documentation. The Revised Proposal would adopt NASD Rule 1012 as FINRA Rule 1112 (General Procedures) with the following changes.
Proposed FINRA Rule 1112(a) (Filing by Applicant or Service by FINRA). The proposed Member Application Rules would retain the Prior Proposal’s methods for filing applications and delivering communications electronically but would also permit FINRA to use the same delivery methods for its communications as are afforded to applicants, so that FINRA would be able to serve a notice or decision electronically.
Proposed FINRA Rule 1112(a) would also address commenters’ concerns about failures or interruptions in FINRA’s electronic systems with respect to the manner in which electronic service by FINRA or filing by an applicant shall be deemed complete by describing the form of electronic record acceptable to evidence receipt.
Proposed FINRA Rule 1112.01 (Applications to be Kept Current) would provide that each applicant is under a duty throughout the application process to promptly correct, amend or modify any NMA or CMA filed with FINRA pursuant to the Member Application Rules that is or becomes inaccurate or misleading.
Other Provisions Retained. Proposed FINRA Rule 1112(b) generally retains NASD Rule 1012(b)’s provision regarding the lapse of an application, including the time period for an applicant to respond to a request for information and the failure to schedule or pass required examinations.
Proposed FINRA Rule 1112(c) through (e) would adopt without significant changes NASD Rule 1012(c) through (e), which, in the context of the Member Application Rules, addresses certain prohibitions against ex parte communications, the recusal or disqualification of a FINRA Board of Governors (“FINRA Board”) or National Adjudicatory Council (“NAC”) member that has a conflict of interest and the meaning and computation method for the term “day.”
New Member Application, Interview and Department Decision
NASD Rule 1013 (New Member Application and Interview) sets forth the content and interview requirements for NMAs. The Revised Proposal would adopt with certain changes NASD Rule 1013 as FINRA Rule 1121 (New Member Application, Interview, and Department Decision).
Proposed FINRA Rules 1121(a)(1) (Filing Requirements) and (a)(2) (Uniform Registration Forms). Proposed FINRA Rule 1121(a)(1)-(2) would adopt without substantive changes (i) NASD Rule 1013(a)’s provisions requiring a new member applicant to file its application with the Department of Member Regulation (Department) in the manner prescribed by FINRA and detailing the required information an applicant must include in its application and (ii) the requirement that the applicant submit its uniform registration forms. Proposed FINRA Rule 1121(a)(1) also includes provisions that would require the following additional information to be included in an NMA, along with other information currently required:
Investment Advisory-Related Contractual Information -- “any plan to enter into contractual commitments, such as underwritings or other securities-related activities.”
Affiliate Organizational Chart -- an organizational chart that identifies the applicant and any affiliate that controls the applicant, is controlled by the applicant or has a business relationship requiring disclosure in the Summary of Affiliate Business Relationship (see following point).
Summary of Affiliate Business Relationship -- requires an applicant to provide a summary of the business relationship between the applicant and certain affiliates whose business relationships could impact an applicant’s financial condition, including an affiliate with whom the applicant consolidates financial statements and an affiliate whose liabilities or obligations have been directly or indirectly guaranteed by the applicant.
Anti-Money Laundering Procedures and Independent Audit Firm Identification -- retains the provision in the Prior Proposal requiring that an applicant for membership provide a copy of its anti-money laundering procedures but deletes the requirement that a new member applicant provide certain information regarding its audit, including its independent audit firm.
Proposed FINRA Rule 1121(a)(4) (Rejection of Application that is Not Substantially Complete) and Opportunity to Re-File NMA. Proposed FINRA Rule 1121(a)(4) would adopt NASD Rule 1013(a)’s provision that the Department may reject an application and deem it not to have been filed if the Department determines that an NMA is not substantially complete within 30 days of the application’s filing. The proposed rule would remove a provision in the Prior Proposal that would have provided a one-time opportunity for an applicant to re-file an NMA within 30 days of service of a notice that the NMA is not substantially complete by submitting only a new Form NMA and the application fee, rather than the entire application.
Proposed FINRA Rule 1121(a)(5) (Application Timing). To help eliminate the problem of membership applications remaining “in limbo” with both the SEC and FINRA, proposed FINRA Rule 1121(a)(5) would retain, without change, the provision in the Prior Proposal requiring that an applicant file its Form NMA no later than 180 days after submission of its Form BD or FINRA will deem the application process to be abandoned.
Proposed FINRA Rule 1121(b) (Membership Interview). Proposed FINRA Rule 1121(b) would expand the membership interview process to permit the Department to review membership standards with additional representatives of the applicant identified by the applicant or other persons as deemed necessary by the Department in one or more NMA interviews.
Proposed FINRA Rule 1121(c) through (h): Procedures Applicable to the Decision to Grant or Deny an NMA. The only proposed substantive change would be the addition of a provision specifying that if the Department fails to serve a decision on an NMA within the specified time period and the applicant files a written request with the FINRA Board for a decision, the FINRA Board may extend the time for issuing a decision by 90 days if the Department has shown good cause for the extension, beginning from the date of the FINRA Board’s good cause determination.
Proposed FINRA Rule 1121.02 (Membership Waive-In). Proposed FINRA Rule 1121.02 would transfer, with certain changes, the provisions of NASD IM-1013-1 (Membership Waive-in Process for Certain New York Stock Exchange Member Organizations) and NASD IM-1013-2 (Membership Waive-in Process for Certain NYSE Alternext US LLC Member Organizations) permitting certain NYSE and NYSE MKT (identified in NASD IM-1013-2 as NYSE Alternext) member organizations to be eligible for a streamlined application process for FINRA membership, including deleting the descriptions of the application processes. In addition, the proposed supplementary material would clarify that a waive-in member must execute a membership agreement prior to expanding its business operations.
Basis for Department Decision
Proposed FINRA Rule 1130 would adopt NASD Rule 1014 (Department Decision), which sets forth the standards or criteria the Department uses to evaluate whether to grant or deny an NMA or CMA (e.g., completeness and accuracy of the application and supporting documentation, the acquisition of all requisite licenses and registrations, a sufficient level of net capital, the establishment of all necessary contractual agreements and business relationships, an adequate supervisory system). As further described below, the Revised Proposal would streamline and consolidate the standards to reduce their total number from 14 to 11 and would make a few substantive changes, including the following:
Proposed FINRA Rule 1130(c) (Direct and Indirect Funding Sources). Proposed FINRA Rule 1130 would add a new application evaluation standard, revised to address certain commenters’ concerns regarding the Prior Proposal, requiring an applicant to fully disclose and establish through documentation satisfactory to FINRA all direct and indirect sources of its funding and providing that FINRA determine that such sources are otherwise consistent with the standards set forth in proposed FINRA Rule 1130.
Proposed FINRA Rule 1130(i) (Supervisory System). Proposed FINRA Rule 1130(i) would carry over NASD Rule 1014(a)(8)’s requirement that the Department determine whether the applicant has a supervisory system designed to prevent and detect, to the extent practicable, violations of the federal securities laws, the rules and regulations thereunder and FINRA rules, taking into consideration enumerated factors, including whether the applicant will recommend securities to customers. Consistent with recent amendments to Rule 2111 (Suitability), the Revised Proposal would extend this factor to include whether the applicant will recommend “investment strategies involving a security.”
In addition, the Revised Proposal would modify the provision directing the Department to consider whether the applicant should be required to place associated persons on heightened supervision pursuant to Notice to Members 97-19 (April 1997) to clarify that the applicant will impose appropriate remedial action, such as special training, continuing education or heightened supervision on any associated persons whose record reflects one or more disciplinary actions or sales practice events.
Review by National Adjudicatory Council
NASD Rule 1015 (Review by National Adjudicatory Council) permits an applicant to submit to the NAC a request for review of an adverse decision. The Revised Proposal would adopt NASD Rule 1015 as proposed FINRA Rule 1140, but would increase the time for an applicant to file an appeal with the NAC from 25 days after service of the Department’s decision to 30 days after service of the Department’s decision and also would increase from 10 days to 15 days the time for the Department to submit the record to the NAC.
The proposed rule would not carry over NASD Rule 1015’s provision requiring the Department to maintain a record in the “membership application docket” for each request relating to appeals to the NAC, as the Department does not maintain such a docket.
Discretionary Review by FINRA Board
NASD Rule 1016 (Discretionary Review by FINRA Board) permits a Governor of the FINRA Board to call for a discretionary review of a membership proceeding. The Revised Proposal would adopt NASD Rule 1016 as proposed FINRA Rule 1150 with no substantive changes.
Application for Approval of Change in Ownership, Control, or Business Operations Pursuant to a Continuation of or Withdrawal from Membership
Proposed FINRA Rule 1160 would adopt with some changes NASD Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations), which requires a member to file a CMA for approval of specific changes to its ownership, control or business operations. Proposed FINRA Rule 1160.01 (Safe Harbor from Application in Limited Circumstances) would relocate with changes the contents of NASD IM-1011-1 (Safe Harbor for Business Expansion) as supplementary material to proposed FINRA Rule 1160.
Proposed FINRA Rule 1160(a) (Events Requiring Application). Proposed FINRA Rule 1160(a) would require a member to file a CMA in the following situations: (i) a merger of a member with another broker-dealer (whether or not it is a FINRA member), (ii) a direct or indirect acquisition (including purchases or transfers) by a member of another broker-dealer (whether or not it is a FINRA member), (iii) acquisition, divestiture, transfer, or sale of 25% or more of a member’s assets, or an asset, business or line of operation that generates revenues representing 25% or more of the member’s earnings, (iv) a change, direct or indirect, in ownership interest of the member that results in one person owning or controlling, or holding a presently exercisable option to own or control, 25% of the member, (iv) a change, direct or indirect, in the control persons of the member (other than the election or appointment of an officer or director in the ordinary course of business) or (v) a material change in business operations.
Proposed FINRA Rule 1160(b) (Filing and Content of Application) and Related Supplementary Material would adopt the provisions of NASD Rule 1017(b) with the following substantive changes:
The Revised Proposal would also provide the Department with discretion to require only one CMA in circumstances where a proposed business change would require two or more members to each file a CMA and, in such circumstances, the Department could seek information and documentation from all members involved in the proposed business change.
Proposed FINRA Rule 1160 would provide that the Department may waive the CMA filing requirement under certain circumstances involving the acquisition or divestiture of the member’s assets, businesses or lines of operation. As stated in the Prior Proposal, the CMA waiver provisions originally provided that ownership or control changes qualifying for a CMA waiver would not result in any “practical change in the business activities, management, supervision, assets, liabilities, or ultimate ownership or control of the member.” In response to commenters’ questions, FINRA has made certain revisions to the Prior Proposal, including to the ownership or control change standard to replace the term “practical change” with “day-to-day change” and delete the requirement that the ownership or control change not result in any change in the member’s “ultimate ownership or control.”
Proposed FINRA Rule 1160(c) through (e): Interim Restrictions, Additional Information Requests and Not Substantially Complete Determination. Proposed FINRA Rule 1160(c)-(e) would adopt with limited changes the provisions of NASD Rule 1017(c) through (e).
Proposed FINRA Rule 1160(f) (Continuing Membership Application Interview). Proposed FINRA Rule 1160(f) would adopt the provisions of NASD Rule 1017(f) (Membership Interview), which permits the Department to require a continuing membership applicant to participate in an interview before the Department serves its decision on a CMA, but includes language clarifying that the Department may conduct more than one CMA interview, based on the facts and circumstances of each application.
Proposed FINRA Rule 1160(g) (Department Decision). Proposed FINRA Rule 1160(g) would adopt with minor changes the procedural provisions of NASD Rule 1017(g) applicable to the Department’s decision to grant or deny a CMA. In light of historical practices, the proposed rule revision would eliminate the disparity in treatment of members based solely on the date on which they became a member.
Proposed FINRA Rules 1160(h) (Service and Effectiveness of Decision) and (i) (Effectiveness of Restriction). Proposed FINRA Rule 1160(h) would adopt with only minor changes NASD Rule 1017(h), the provision detailing the manner in which the Department shall serve its decision on a CMA and the effectiveness of that decision pending any FINRA final action, unless otherwise directed by the NAC, the FINRA Board or the SEC. Proposed FINRA Rule 1160(i) would be a new provision that clarifies that a restriction on a CMA decision shall remain in effect and binds the applicant and all ownership or control successors unless removed or modified by a FINRA final action or stayed by the NAC, the FINRA Board or the SEC.
Proposed FINRA Rules 1160(j) (Request for Review; Final Action) and (k) (Removal or Modification of Restriction on Department’s Initiative). Proposed FINRA Rule 1160(j), (k) would adopt with no substantive changes the provisions in NASD Rules 1017(i) and (j) regarding an applicant’s right to file a written request for review of the Department’s CMA decision with the NAC and the Department’s right to modify or remove a membership agreement restriction on its own initiative if the Department determines such action is appropriate.
Proposed FINRA Rule 1160(l) (Denial of Application for Approval of Change in Ownership, Control, or Business Operations). Proposed FINRA Rule 1160(l) would adopt with substantive changes NASD Rule 1017(k) (Lapse or Denial of Application for Approval of Change in Ownership) and provides that if a CMA for a change in ownership lapses or is denied and all appeals are exhausted or waived, an applicant must, not more than 60 days after the lapse or exhaustion or waiver of appeal (or such shorter time as required by FINRA): (1) cease the activities that required the application; (2) unwind the transaction; or (3) file a Form BDW.
Proposed FINRA Rule 1160.01 (Safe Harbor from Application in Limited Circumstances). As noted above, proposed FINRA Rule 1160.01 would adopt the contents of NASD IM-1011-1 (Safe Harbor for Business Expansion) as supplementary material to proposed FINRA Rule 1160. The safe harbor would provide parameters for increases a member may make in the number of its sales personnel, office locations (registered and unregistered) or markets made within a one-year period that are presumed not to be considered a material change in business and thus do not require the filing of a CMA. In response to commenters’ concerns, FINRA revised the supplementary material so that it would permit a member to rely upon the safe harbor for those types of business expansions from which it is not restricted. This proposed change would modify existing practice which has prohibited any expansion in the safe harbor areas if any one type of expansion was restricted.
Notice of Certain Member Changes
Proposed FINRA Rule 1170 would require each member to provide the Department with timely prior written notice of any:
direct or indirect acquisition (including purchases or transfers) or divestitures (including sales or transfers) of 10 percent or more in the aggregate of the member’s assets (including, but not limited to, cash, securities, notes, real estate ownership interests, inventories and accounts receivable) or any asset, business or line of operation (including customer accounts) that generates revenues composing 10 percent or more in the aggregate of the member’s earnings measured on a rolling 36-month basis; or
change, directly or indirectly, in the equity ownership, partnership capital, LLC membership interest or other ownership interest in the member that results in one person directly or indirectly owning, controlling or holding a presently exercisable option to own or control, 10 percent or more of the equity, partnership capital, LLC membership interest or other ownership interest in the member.
For purposes of the proposed rule, “timely” would mean at least 30 days prior to the event except when 30 days is impracticable given the circumstances of the event, in which case the member would have to provide prior written notice as soon as practicable.
Application to the SEC for Review
Proposed FINRA Rule 1180 would transfer without significant changes NASD Rule 1019 (Application to Commission for Review), providing that: (1) a person aggrieved by any final FINRA action pursuant to proposed FINRA Rules 1140 or 1150 may apply for review to the SEC pursuant to Section 19(d)(2) of the Securities Exchange Act of 1934; and (2) the filing of an application for review shall not stay the effectiveness of a decision constituting a final action of FINRA unless the SEC orders otherwise.
Proposed FINRA Rule 1190 would adopt without substantive change paragraphs (a), (b) and (c) of NASD Rule 1090 (Foreign Members), which impose specific requirements on members that do not maintain an office in the United States responsible for preparing and maintaining financial and other reports required to be filed by the SEC and FINRA). The Revised Proposal would delete NASD Rule 1090(d), which requires foreign members to “utilize, either directly or indirectly, the services of a broker/dealer registered with the Commission, a bank or a clearing agency registered with the Commission located in the United States in clearing all transactions involving members of the Association, except where both parties to a transaction agree otherwise.” FINRA noted in the Revised Proposal that this provision has become outdated and such arrangements are better addressed by FINRA Rule 4311 (Carrying Agreements).
Requirements Proposed to Be Eliminated
The Revised Proposal would delete Incorporated NYSE Rule 311 and Incorporated NYSE Rule Interpretations 311(f) and (g), Incorporated NYSE Rules 312, 313, 321, 416 and related supplementary materials and rule interpretations and Incorporated NYSE Rule Interpretation 401/03 as either redundant or obsolete.
Request for Comments
FINRA has requested comments on the Revised Proposal. Comments are due on or before November 4, 2013
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.