A new Finra rule could put a crimp in the business of brokers who run outside investment advisory and insurance businesses.
Some observers worry that the rule, due to go into effect next month, expands the
Financial Industry Regulatory Authority Inc.'s power over outside businesses and could cause some broker-dealers to prohibit those activities, causing problems for hybrid advisers.
Right now, under legacy NASD rules, brokers simply are required to provide their broker-dealers with “prompt notice” of an outside business.
But under the new Rule 3270, first proposed last year and approved by the Securities and Exchange Commission in September, brokers will have to provide prior written notice. What's more, member firms will have to review the activity to determine if the business will “interfere” with brokers' responsibilities to customers and be “viewed by customers or the public as part of the member's business,” Finra said in its rule filing.
Based on that review, broker-dealers will have to “consider limiting or prohibiting the activity,” the rule says. In addition, they will have to keep written records to document the review process.
“Broker-dealers are going to get much more restrictive in the interests of protecting themselves,” said Gary Sanders, vice president of securities and state government relations at the National Association of Insurance and Financial Advisors, which represents insurance agents. About 70% of NAIFA's members are registered to sell securities.
“It boils down to prior review [and approval]” of outside businesses, Mr. Sanders said.
Broker-dealers always have been able to prohibit outside businesses as a matter of policy, but with “this [new] rule on their side, it makes it much easier” to deny a broker, said Karen Fischer, a compliance consultant.
The rule could “cause broker-dealers to narrow the activities that they approve,” the Financial Services Institute Inc. wrote in a comment letter. It would cause virtually every broker-dealer to question any outside activity that is financial in nature, wrote the FSI, whose members are independent-contractor broker-dealers and individual registered representatives.
“Some broker-dealers are now requiring [brokers] to provide a copy of an independent review of their RIA businesses and their Form ADVs as part of the branch office inspection,” said Victor Shier, owner of Broker Dealer Services LLC, a compliance consultant.
Firms didn't ask for those documents last year, he said.
“I believe it is due to this [pending new] rule,” Mr. Shier said.
For brokers engaged in an outside business activity prior to Dec. 15, firms will have until June 15 to conduct the reviews.
FEW ADDITIONAL BURDENS
Finra dismisses the idea that the rule creates much in the way of additional burdens for brokers with outside business interests.
“The idea that it's ... new ground is wrong,” said Marc Menchel, Finra's executive vice president and general counsel for regulation.
“What we changed is not the territory, but what the members' responsibilities are in that territory,” he said.
The rule provides more certainty about how member firms should supervise outside activities, Mr. Menchel said.
Although legacy NASD rules don't require a review of outside activity, in practice, broker-dealers have reviewed it, he said.
“It would be silly to say you have to get notice [of an outside business, but then] don't have to pay it any attention,” Mr. Menchel said.
Under the new rule, a firm doesn't have to supervise the outside business, he said, “but it has to make a threshold determination as to whether [it is] going to allow that business ... It simply [tells firms to] assess” it.
In response to comments, Finra backed off from earlier language that would have required its members to determine if an outside business activity raised investor protection concerns.
Industry commentators howled at that idea, and Finra amended its proposal in August, replacing the investor protection review with the “viewed by customers” language.
But the FSI still isn't happy.
“We would prefer a bright-line test rather than the subjective "viewed by customers' standard,” David Bellaire, FSI's general counsel, wrote in an e-mail.
“We are concerned that the views of customers are likely to change to fit the needs of an arbitration case,” he wrote.
One investor advocate thinks the rule doesn't go far enough.
William Jacobson, director of the Cornell Law School Securities Law Clinic, wants to see broker-dealers approve all outside businesses.
“The approval process creates a bright line, so you know the broker-dealer actually reviewed it,” he said.
“It's a brand-new rule,” Mr. Menchel said.
“It seems to me everyone needs to have a period of experience with a rule” before knowing enough to change it, he said.
E-mail Dan Jamieson at [email protected].
