The Securities and Exchange Commission (SEC) has approved the new Financial Industry Regulatory Authority (FINRA) Rule 45301 that, after it takes effect, will be a key governing rule concerning the reporting of violations and complaints to FINRA. Any matter that becomes subject to reporting or filing on or after July 1, 2011 must be reported or filed in accordance with the requirements of new FINRA Rule 4530.2
While FINRA Rule 4530 is based in large part on the National Association of Securities Dealers (NASD) Rule 3070, there are some material differences, certain of which are summarized below.
- Old NASD Rule 3070 required a member to report to FINRA if the member or an associated person of the member is “associated in any business or financial activity with any person who is subject to a ‘statutory disqualification’ as that term is defined in the [Securities Exchange Act of 1934 as amended], and the member knows or should have known of the association.” Rule 4530 adds in a requirement that members report whenever they or their associated persons are “involved in the sale of any financial instrument, the provision of any investment advice or the financing of any such activities” with any person who is subject to a “statutory disqualification.”
- New FINRA Rule 4530 requires a member firm to report to FINRA within 30 calendar days after the firm has concluded, or reasonably should have concluded, on its own, that the firm or an associated person of the firm 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 (SRO). This requirement is generally modeled after a similar New York Stock Exchange requirement currently in force. The new Rule does not require firms to report every instance of noncompliant conduct, just those that meet the test.
The “internal conclusion” provision of Rule 4530 requires a member firm to report conduct that has “widespread or potential widespread impact to the firm, its customers or the markets, or conduct that arises from a material failure of the firm’s systems, policies or practices involving numerous customers, multiple errors or significant dollar amounts.” For purposes of compliance with the “reasonably should have concluded” standard, FINRA will rely on a firm’s good-faith reasonable determination. If a reasonable person would have concluded that a “material failure,” etc., occurred, then the matter is reportable; if a reasonable person would not have concluded that a material failure occurred, then the matter is not reportable.
- FINRA Rule 4530 requires the reporting of certain external findings similar to the NASD Rule but limits the scope of the requirement to situations in which the firm or an associated person has been found by an external body to have violated any laws, rules, regulations or standards of conduct related to securities, insurance, commodities, finance or investments, of any domestic or foreign regulatory body, SRO or business or professional organization. Reporting is generally required to be done not later than 30 calendar days after the member knows or should have known of the finding or event (i.e., a registered representative being the subject of any written customer complaint involving allegations of theft or misappropriation of funds or securities or of forgery). Associated persons must still inform their firm “promptly” of any reportable event (but this is clarified to exclude their member firm’s internal conclusions and disciplinary actions).
Pepper Point: NASD Rule 3070 required reporting of a finding of a violation of “any” rule or standard of conduct of “any” governmental agency, SRO, or financial business or professional organization, but did not explicitly include foreign bodies other than with respect to certain indictments, convictions and pleas in foreign courts. Under new Rule 4530, “external bodies” now include but are not limited to courts, regulatory bodies, SROs and business or professional organizations (the Code of Professional Conduct of the American Institute of Certified Public Accountants is a “professional organization” specifically noted by FINRA in the Regulatory Notice).
- NASD Rule 3070 required reporting of a claim for damages by a customer, broker, or dealer and settlements of securities- or commodities-related civil litigation or arbitration, and claims for damages by a customer, broker, or dealer above a certain threshold ($15,000 if against an associated person or $25,000 if against a member). While the dollar thresholds have not changed, the new Rule adds complaints and awards concerning “financial-related insurance” civil litigations and arbitrations to the mix.
Pepper Point: With regard to insurance products sold by registered broker representatives, new Rule 4530 coverage is not limited to insurance products that are securities. Civil litigation or arbitration involving a non-securities insurance product that is related to the provision of financial services is also subject to Rule 4530 obligations.
- Under old NASD Rule 3070, some member firms did not consider attorney’s fees (especially in the context of structured settlements) when calculating the dollar thresholds for FINRA reporting. Under the new Rule, when determining the dollar amount that would require a report, members must include any attorney’s fees and interest paid to or on behalf of the complainant in the total amount. In addition, if parties are subject to “joint and several” liability, the amount for each party must be aggregated and reported if above the dollar thresholds as if each party is separately liable for the aggregated amount. For instance, if two parties have “joint and several” liability for $40,000, the amount reported would be $40,000 for each party.
- Under new Rule 4530, a member is required to report a matter relating to a former associated person if it occurred while the person was associated with the firm. If a member becomes aware of a matter, but based on its records or information available through Web CRD the firm cannot determine that the person was an associated person of the firm, the firm is not obligated to report the matter.
- The new Rule (like the old Rule 3070) requires a member to report any written customer complaint against the firm or an associated person alleging theft or misappropriation of funds or securities or forgery. However the new Rule clarifies that for the purposes of such reporting, a “customer” includes any person (other than a broker or dealer) with whom the firm has engaged, or has sought to engage,3 in securities activities. Rule 4530 also codifies existing staff guidance reminding firms to report quarterly statistical and summary information regarding such complaints.
Pepper Point: The enhanced disclosures required under Rule 4530 are required to be made to FINRA only and not necessarily reported on a Form BD or an individual’s Form U-4 (each of which is summarized for the public via the FINRA BrokerCheck system). However, a firm should evaluate each disclosure made under Rule 4530 and must consider if items that meet the new Rule 4530 threshold are significant enough to warrant some form of disclosure to clients.