On February 26, 2018, the U.S. Financial Industry Regulatory Authority (FINRA) proposed new FINRA Rule 3290 (the Proposed Rule) that will greatly simplify a member’s obligation to supervise its personnel engaged in both investment advisory and broker-dealer activities and clarify the treatment of “dual-hatted” personnel who perform services both for the member and a non-broker-dealer affiliate (such as an affiliated investment adviser, a bank or an insurance company). The Proposed Rule will consolidate and replace current FINRA Rule 3270 (Outside Business Activities of Registered Persons) and FINRA Rule 3280 (Private Securities Transactions of an Associated Person) and, according to FINRA, is intended to reduce unnecessary burdens and confusion while strengthening investor protections relating to outside activities.
In addition to simplifying and clarifying a member’s supervisory obligations regarding the outside business activities of registered persons, the Proposed Rule maintains existing notice requirements and clarifies FINRA’s expectations regarding the review of a registered person’s outside, investment-related activities. We set forth a summary of the Proposed Rule and an analysis of its potential implications below.
Supervisory and Recordkeeping Requirements
In response to the significant feedback FINRA received concerning members’ obligations with respect to their registered persons’ investment advisory (IA) activities, the Proposed Rule would not impose supervisory and recordkeeping obligations for IA activities and most other outside activities at an unaffiliated third-party investment adviser (however, these activities would continue to be subject to the prior notice and risk assessment obligations under the Proposed Rule). Instead, the Proposed Rule would impose a supervisory obligation in two situations: (1) where the member imposes conditions or limitations on a registered person’s participation in an investment-related activity (in which case, the member would be required to reasonably supervise the registered person’s compliance with those conditions or limitations but not the underlying activity) and (2) for member-approved investment-related activities that could not take place but for the registered person’s association with a member (i.e., activities that would otherwise require registration as a broker or dealer), such as selling private placements away from the member. In the second situation, the member would be required to consider whether the person is relying on a member’s registration as a broker or dealer to conduct the activity, in which case the activity would be deemed to be that of the member, if approved, and all applicable securities laws and regulations and FINRA rules, including supervision and recordkeeping, would apply to the member with respect to that activity.1 Importantly, if the registered person is associated with more than one member, the members could establish a formal allocation arrangement whereby at least one member agrees in writing with specificity to comply with all applicable securities laws and regulations and FINRA rules regarding the proposed activity.
Under the Proposed Rule, a member would be required to maintain and preserve records demonstrating compliance with the obligations of the Proposed Rule for at least three years after the registered person’s employment or association with the member has terminated.
The Proposed Rule would also remedy the challenges posed by current FINRA Rule 3280 with respect to IA, bank and other non-broker-dealer activities of registered persons (e.g., “dual-hatted” registered persons who also work for a bank affiliate or who engage in IA activities for a dually registered broker-dealer/investment adviser, etc.) by specifically excluding such activities from the Rule. More specifically, the new Proposed Rule would not apply to (1) work performed on behalf of a member’s affiliates that does not otherwise require registration as a broker or dealer and (2) non-broker-dealer work performed on behalf of the member. FINRA notes that these exclusions are appropriate because these activities are already subject to other regulatory regimes and oversight.
The following activities are also outside the scope of the new Proposed Rule: (1) a registered person’s personal investments (or “buying away”), including transactions in accounts that are subject to FINRA Rule 3210, and (2) transactions effected on behalf of a registered person’s immediate family members for which the registered person receives no transaction-related compensation.
The Proposed Rule would continue to require registered persons to provide prior written notice of a broad range of outside business activities to their members, whether they are investment-related, such as driving for a car service or seasonal retail employment. Consistent with current FINRA Rule 3270, “business activities” would include (1) acting as an employee, independent contractor, sole proprietor, officer, director or partner of another person or (2) receiving compensation, or having the reasonable expectation of compensation, from any other person as a result of the activity. Also consistent with current FINRA Rule 3270, the Proposed Rule would apply only to the outside activities of registered persons (although FINRA notes that members could continue to effectuate policies and procedures governing outside activities of associated persons more broadly).
Member’s Risk Assessment of Outside Activity
In response to feedback that the scope of activities subject to current FINRA Rules 3270 and 3280 should be narrowed, the Proposed Rule would limit the following requirements to a narrower set of investment-related activities: (1) the registered person’s receipt of the member’s written approval prior to participation in the activity and (2) the member’s performance of a reasonable risk assessment of the activity upon receipt of notice. According to FINRA, this will allow members to focus on outside activities that are most likely to raise investor protection concerns. Notably, the definition of “investment-related” in the Proposed Rule would be consistent with the definition in Form U4,2thereby harmonizing these notice requirements with the Form U4 disclosure requirements. Further, the reasonable risk assessment would remain consistent with current FINRA Rule 3270, namely, the member would be required to evaluate whether the proposed activity will (1) interfere with or otherwise compromise the registered person’s responsibilities to the member’s customers or (2) be viewed by customers or the public as part of the member’s business based on, among other factors, the nature of the proposed activity and the manner in which it will be offered. Based on this reasonable risk assessment, the member would determine whether to approve, disapprove or approve subject to conditions or limitations the registered person’s participation in the activity and would be required to notify the registered person in writing of its determination.
We again commend FINRA’s ongoing retrospective review of its rules and believe the Proposed Rule reasonably addresses member concerns regarding the application of current Rules 3270 and 3280, clarifies members’ supervisory obligations in this area and protects the investing public. The exclusion from the Proposed Rule for non-broker-dealer activities engaged on behalf of a member’s affiliates should be very helpful with respect to dual-hatted registered persons, who may work for a bank or investment adviser affiliate. Likewise, not imposing supervisory and recordkeeping obligations for IA activities and most other outside activities at an unaffiliated third-party investment adviser brings certainty and efficiency to members’ supervisory obligations and programs.
By consolidating current FINRA Rules 3270 and 3280 into a single rule, the Proposed Rule should help mitigate the confusion and inconsistent interpretations that exist under the current dual-rule structure. For example, current FINRA Rule 3270 applies only to registered persons, while current FINRA Rule 3280 applies to all associated persons; the Proposed Rule would apply uniformly to registered persons.
Further, the Proposed Rule explicitly defines “business activity,” thereby providing some clarification as to what FINRA intends to be reported under the Proposed Rule; however, by using the same language as in current FINRA Rule 3270, there continue to be gaps in the definition that may lead to confusion, including whether the definition should capture certain other activities, such as acting as a member or trustee.
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The full text of proposed new FINRA Rule 3290, along with a detailed summary of the Proposed Rule, can be found in Regulatory Notice 18-08, available here.
FINRA is accepting comments on the Proposed Rule through April 27, 2018.