Securities Regulation and Litigation Lawyer & Attorney : OverRegd Blog : Lindquist & Vennum Law Firm, Minneapolis and Denver

On May 14, FINRA released proposed Rule revisions, reflecting its efforts to merge the old NYSE and NASD rulebooks, refining and clarifying previous rules, and offering a few new wrinkles. The proposed revisions are open for comment until June 13.

The four separate proposed revisions relate to (1) Financial Responsibility (largely relating to net capital issues); (2) Supervision and Supervisory Controls; (3) Books and Records (consolidating and modifying various books and records rules, including in regards to client accounts and complaints); and (4) Investor Education and Protection (extending the scope of current FINRA Rule 2280). The new proposals contain extensive changes and additions, including many consolidations or relocations of existing rule provisions. 

Although there are specific changes in each of the four areas noted above, the changes to FINRA’s Supervision and Supervisory Controls rules (current Rules 3010 and 3012, which will be renumbered 3110 and 3120) are probably the most extensive and dramatic. Highlights include:

     ***  Proposed Rule 3110 provides much-needed clarification regarding the supervision of current Rule 3012’s provisions for supervision of “producing managers.” The new Rule will, more simply, prohibit “supervisory personnel” from (1) supervising themselves; and (2) being supervised by anyone who reports to or whose compensation is determined by the supervised person. The current, rather confusing, language requiring supervisory review of such managers' client accounts by “senior” or “otherwise independent” personnel will be removed.    Proposed Rule 3120 otherwise continues Rule 3012’s testing, verification, and certification requirements, though it now specifies additional information that firms with gross revenues over $150 million must include in the annual report to senior management.

     ***  Current Rule 3010(b)(3), requiring “heightened office inspections” for offices that generate 20% or more of a business unit’s revenue will be completely deleted. Instead, the new Rule 3110 provides a more principles-based approach that requires a firm to have written procedures reasonably designed to “prevent the inspection from being lessened in any manner due to any conflicts of interest.”

     ***  Current Rule 3040 (regarding private securities transactions) will be deleted, and incorporated into new Rule 3110. The proposed rule removes any distinction, for supervisory purposes, between private transactions for which an associated person is compensated and those for which no compensation is paid. Moreover, the new Rule provides a qualified exemption for firms from the supervisory rules regarding private transactions with regard to associated persons who complete the transaction as part of their separate employment by a bank, so long as the member firm is notified of the activity and receives written assurance from the bank that it has reasonable supervisory procedures for such activities.

     ***  New Rule 3110 clarifies that firms must institute written procedures for written customer complaints, dropping the NYSE’s inclusion of procedures for oral complaints. 

     ***  New supplementary material to the rule clarifies, among many other things, that member firms are to follow the previous NYSE Rule 342.21 requirement that firm’s insider trading policies contain specific procedures for reviewing and investigating trades effected for the firm’s account and the accounts of firm employees and family members.

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The recent slew of lawsuits brought against some of the nation's largest broker-dealers that sold Auction Rate Securities ("ARS") to customers has not gone unnoticed. The SEC and FINRA, on the heels of the lawsuit filings, have each launched independent investigations of their own into the sales and marketing practices employed by firms selling ARS. And commentary submitted in recent days suggests emphasis of the investigations will, at least in part, lead to focus on the suitability of the sales.

In a March 31, 2008 investor alert, FINRA discussed the impact the collapse of the ARS market has had on investors. Significantly, a large portion of its discussion concerned the liquidity of the securities and how "due to recent developments in the credit market—including downgrades in the credit ratings of bond issuers and bond insurers—a significant number of auctions have failed, leaving some investors who counted on immediate access to their funds wondering about their options." FINRA also recently sent a survey to brokerage firms specifically inquiring about who the firm sold ARS to (i.e. retail individual, high net worth individual, non-professional institutional, or professional institutional customer) and whether the firm was willing to offer margin loans to customers using ARS as collateral. And in Regulatory Notice 08-17, effective April 1, 2008, FINRA added "three new product categories for use by member firms in reporting customer complaints relating to auction rate securities."

Taken together, these actions leave little doubt that firm ARS sales and supervision may come under the lens of regulatory inquiry for the foreseeable future and likely remain one of the main topics of inquiry for 2008, given the fact hundreds of billions of dollars of ARS were sold.

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Yesterday the NASD released a Notice to Members soliciting comments on two proposed rule changes. The proposed amendments appear driven by the NYSE and NASD's ongoing efforts to consolidate member regulation into a single SRO with the expectation and anticipation of reducing regulatory redundancy and inefficiency.

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Announced yesterday, the NASD fined Raymond James Financial Services, Inc. $2.75 million for failing to adequately supervise sales activities of 1000 producing branch managers dispersed throughout the United States.

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Effective March 6, 2007, NASD member general securities firms that issue monthly account statements (electronic or written) will be required to include on customer monthly account statements language that advises the customer to promptly report any inaccuracy or discrepancy in that person's account to his or her brokerage firm and to reconfirm any conversation the customer has with the firm in writing.

These mandatory changes stem from the SEC's recent approval of amendments made to NASD Rule 2340, in light of efforts by the NASD and other self-regulatory organizations to heighten customer attentiveness to account activity and to address specific concerns brought to the attention of the SEC and SIPC by the U.S. General Accounting Office. The amendments to Rule 2340 in no way restrict customer rights.

A complete discussion and analysis of the amendments to Rule 2340 and a copy of the amended rule can be found on the NASD website. Link

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A Warning Flag From The NASD For The Life Settlement Industry:
"A variable life settlement may be a valuable option for insureds who otherwise would surrender their policies or allow them to lapse. However, variable life settlements are not for everyone."

NASD Notice to Members 06-38 August 2006. Here it comes insurance folks - suitability review by the NASD. If you are encouraging a policy holder to sell a variable life insurance product in the secondary market, you are subject to NASD regulation.

What is a life settlement? What does the regulation of it by the NASD mean?

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New York's highest court has been asked to clarify just how much protection employer statements about terminated employees on NASD termination forms are entitled to. The NASD requires member firms to fill out a termination form ("Form U-5") whenever a registered employee is let go, explaining the reason for the termination. These forms are then available to any member firm upon request. Currently, New York law is unclear as to whether statements made in a Form U-5 deserve a qualified or an absolute privilege. If these forms are protected by an absolute privilege, then employers are immune from lawsuits based on claims by employees that statements in the form were defamatory. If, however, these forms are only entitled to a qualified privilege, if an employee can demonstrate that the defamatory statements were made with malice, the protection an employer had against suit dissolves.

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Effective May 25, 2006, trade shredding is a thing of the past as a result of new Rule 3380, Order Entry and Execution Practices. No, this new Rule doesn't regulate the use of shredding machines. What it does do is prohibit the splitting of any customer order for securities into multiple smaller orders for execution where the primary purpose is to maximize in-kind or monetary payments.

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As Martha Stewart found out recently, lying to investigators may land you in worse trouble than whatever it is they are investigating. NASD members should take note. Recent NASD Panel decisions confirm that lying to the NASD could have severe consequences.

For example, in Department of Enforcement v. D.M.W., Amended Hearing Panel Decision, NASD Office of Hearing Officers Disciplinary Proceeding, No. C06030035 (October 12, 2005), an NASD examiner, during a routine examination, requested a copy of a Management Agreement between the brokerage firm and its holding company. After several requests, a Management Agreement, dated August 1, 2002, was provided. But the examiner discovered an email dated November 5, 2002 appearing to reflect that D.M.W., an officer, director, and owner, was directing the firm's compliance officer to arrange to have the Management Agreement typed up, executed and backdated. At the hearing, D.M.V. testified that he intended the e-mail to be a joke to "jerk [the examiner's] chain." The Panel did not understand how the email could be interpreted as humorous or calculated to anger the examiner, and instead found it more likely that D.M.W. realized that the original Management Agreement had expired, and that a new Agreement should have been in place.

The Panel found that the email was an attempt to mislead the NASD staff, a violation of NASD Conduct Rule 2110. As a sanction, D.M.W. was barred from associating with any member firm in any capacity for misleading NASD staff in violation of Conduct Rule 2210.

By the way, the defense - "I was just joking" - is rarely successful. It reminds me of Don Howard, a Minnesota businessman who hired a man to murder his wife. After the murder, Howard was an immediate suspect because he had, unsuccessfully tried to hire several people to commit the murder. His defense - "I was just joking." He was quickly convicted.

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