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July 20, 2012 at 03:14 AM
On May 30, the U.S. Government Accountability Office (GAO) released a report regarding the Securities and Exchange Commission’s (SEC) oversight of the Financial Industry Regulatory Authority (FINRA). Among other things, the GAO noted that FINRA does not have in place a mechanism to retroactively review its rules. According to the report, absent such a system, “FINRA may be missing an opportunity to systematically assess whether its rules are achieving their intended purpose and take appropriate action, such as maintaining rules that are effective and modifying or repealing rules that are ineffective or burdensome.”
Historically, FINRA has reacted to market events by providing guidance and rules to the industry. By revisiting existing rules and their real-life implications, particularly those rules that no longer work as intended, or have effectively been replaced by other rules or guidance, FINRA will be able to proactively help the U.S. capital markets retain their pre-eminent position.
In response to the GAO recommendation, we propose that FINRA consider revisiting the following rules and making the following changes:
1. FINRA should update and streamline the registration forms and guidance for firms and associated persons relating to arbitrations.
Over time, some of the questions on Forms U4 and U5, and certain corresponding questions on Form BD have required increasing analysis and judgment to answer. For example, under FINRA guidance, a broker-dealer must determine whether an arbitration claim raises sales practice violations not only against the representative(s) named in the caption of the action but also against other representatives. Prior guidance, which required Form U4 and U5 filings only for representatives named in the caption of a statement of claim or complaint, was easy to follow. Requiring legal or compliance personnel to read and analyze each claim or complaint to ascertain whether the action should be reported on filings for additional personnel imposes an unnecessary burden.
2. FINRA should coordinate Form U4 amendments with Rule 4530 filings to reduce duplicative paperwork.
FINRA Rule 4530 requires member firms to report, within 30 calendar days, a number of events, disciplinary actions or conclusions regarding the firm or associated persons. Firms do not have to report certain information about an associated person if that information has already been reported on the associated person’s Form U5, which is the form for reporting information on terminated or former associated personnel. However, because there is no similar exception for information reported on Form U4, firms must report virtually the same information under Rule 4530 as is reported on Form U4. The duplicative reporting does not appear to add to FINRA’s enforcement or other programs, and the disparity in Rule 4530 in reporting requirements between current and former associated persons is confusing.
3. FINRA should clarify when firms need to self-report under FINRA Rule 4530.
Rule 4530, which became effective in July 2011, requires firms to report to FINRA conduct that:
- has widespread or potential widespread impact to the member, its customers or the markets, or
- arises from a material failure of the member’s systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts.
The terms contained in the rule are vague and relatively new to the regulatory vocabulary. For example, in the first bullet, FINRA should explain what “widespread” means. With regard to “customers” in the first bullet, does “widespread” mean a certain percentage of customers (say, over 10%) or does it mean a certain number of customers, regardless of the percentage (say, over 1,000)? With regard to the second bullet, is “numerous” customers different from or the same as “customers” affected by a “widespread impact”? Similarly, is “significant dollars” measured as a percentage (of what, we don’t know) or as an absolute number? If FINRA expects meaningful and consistent reporting, it should clarify the terms in the rule so that firms will know when to report certain conduct to FINRA.
4. FINRA should issue updated cooperation guidelines in light of the new self-reporting requirements.
It is unclear what effect, if any, FINRA intends Rule 4530 to have on the issue of awarding credit for extraordinary cooperation. For example, will FINRA give credit to firms for reporting matters of limited impact? Or has Rule 4530 effectively removed self-reporting as one of the criteria for cooperation credit? Updated guidance with respect to receiving credit for cooperation would be useful for the industry.
5. If FINRA wants to receive non-securities information and documents from broker-dealers, it should undertake to amend FINRA Rule 8210.
FINRA Rule 8210 authorizes FINRA to: (1) require a member or an associated person to provide requested information; and (2) “inspect and copy the books, records, and accounts” of members and persons.
6. FINRA should reconsider whether documents and information produced to it by firms and representatives should be protected from disclosure.
9. FINRA should clarify what internal communications may say.