Industry observers are worried that a new Finra reporting rule — set to go into effect July 1 — could open up brokerage firms to enforcement actions.
Rule 4530 will require the self-reporting of violations, which means that broker-dealers will have to report to the
Financial Industry Regulatory Authority Inc. within 30 calendar days whenever they have “concluded, or reasonably should have concluded,” that a firm or a broker “has 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.”
The new rule, which consolidates NASD Rule 3070 and NYSE Rule 351, largely parallels existing
New York Stock Exchange rules but will be new for legacy NASD firms.
“The reporting of internal conclusions is a big change,” said Dave Bellaire, general counsel of the Financial Services Institute Inc., which represents independent-contractor firms.
“It's a different mindset to look internally” and report problems, he said.
Broker-dealers always have reported external findings to Finra, including regulatory actions or certain arbitration awards and other information.
“Some of the internal-control reporting is going to be very problematic,” said Lisa Crossley, regulatory-compliance liaison for the National Society of Compliance Professionals. It “will be an administrative burden, and firms can get into trouble over something that Finra says should have been reported,” but wasn't.
Broker-dealers will have to develop procedures to determine what they need to report, Mr. Bellaire said.
“With July 1 fast approaching, broker-dealers need to be designing systems,” he said.
Indeed, the new rules will catch some broker-dealers unaware because of the long rulemaking process and the fact that firms are now busy with annual compliance reviews, Ms. Crossley said.
“This sort of thing goes off the radar until it starts brewing again,” she said.
FINRA GIVES GUIDANCE
The new standard, requiring a report when a firm “reasonably should have concluded” that a violation occurred, was floated in a draft last summer — and came as a surprise. The similar NYSE rule has no such standard.
In fact, the Securities Industry and Financial Markets Association and other industry groups protested the reporting trigger in comment letters.
In the final rule approved by the SEC in November and in its notice this month, Finra provided more guidance on the type of internal conclusions that must be reported.
Firms, the regulator said, should report “conduct that has widespread or potential widespread impact,” arose from “a material failure of the firm's systems” or involves “numerous customers, multiple errors or significant dollar amounts.”
Finra has said in other SEC filings that the purpose of the should-have-known standard is to ensure that firms do not intentionally ignore a reportable event.
A Finra spokeswoman declined to comment further.
“We think Finra has largely resolved those concerns” over the should-have-known standard, said James McHale, managing director and associate general counsel at SIFMA.
“[Finra has] clarified the types of events that would need to be reported, and clarified a reasonable-man standard” for what has to be reported, he said.
But some industry observers said Finra has given itself too much leeway to go after broker-dealers.
“At some point, I think you're going to see regulators beat up on some firms for not reporting allegations or findings that the regulators deem should have been reported,” said Joel Beck, founder of The Beck Law Firm LLC and a former Finra attorney.
“It's not necessarily an objective standard,” he said.
In the past, Finra enforcers have taken into consideration whether a firm self-reports problems and fixes them, Mr. Beck added. But that might change.
“With the new rule, it appears a firm will have to report a problem; it's no longer optional,” Mr. Beck said.
As a result, self-reporting may no longer earn any leniency with enforcers.
The rules also expand reporting requirements in other areas. More customer disputes may have to be reported, for example. Firms report to Finra customer settlements or awards with damages against a broker of $15,000 or more and against a firm of $25,000 or more.
Finra now wants firms to include in those threshold calculations attorney's fees and interest penalties, a change that will increase the number of cases firms have to report, Ms. Crossley said.
Industry observers also have been concerned about the duplicate reporting of information through the new Rule 4530 and disclosure forms. In response, Finra said firms won't have to file disclosures that have been made on the Form U5, the broker termination report. Finra told the SEC that it will work to eliminate duplicate filings for disclosures made on Forms U4 and BD.
The FSI isn't buying that promise.
In a December comment letter, the group noted that in 1995, Finra, then known as NASD, made the very same pledge “without [any] resulting progress.”
Finra is “trying to move in the direction of reporting information once,” Mr. Bellaire said, “but there's still a lot of ... ground to be taken” in eliminating duplicate filings.
E-mail Dan Jamieson at [email protected].
