Document ID: SEC-2013-1542-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2013-09-03T04:00Z

[Federal Register Volume 78, Number 170 (Tuesday, September 3, 2013)]
[Notices]
[Pages 54350-54359]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-21300]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-70272; File No. SR-FINRA-2013-035]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change to Adopt 
FINRA Rules 4314 (Securities Loans and Borrowings), 4330 (Customer 
Protection--Permissible Use of Customers' Securities) and 4340 
(Callable Securities) in the Consolidated FINRA Rulebook

August 27, 2013.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``SEA'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby 
given that on August 14, 2013, Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been substantially 
prepared by FINRA. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to adopt financial and operational rules 
relating to securities loans and borrowings, permissible use of 
customers' securities, and callable securities as FINRA Rules in the 
consolidated FINRA rulebook. Specifically, the proposed rule change 
would adopt with amendments the following as FINRA Rules: (1) 
Incorporated NYSE Rule 296 (Liquidation of Securities Loans and 
Borrowings) and Supplementary Material paragraphs .10 and .20 regarding 
requirements applicable to a member that is a party to an agreement for 
the loan or borrowing of securities as FINRA Rule 4314 (Securities 
Loans and Borrowings); (2) Incorporated NYSE Rule 402 (Customer 
Protection--Reserves and Custody of Securities) regarding requirements 
applicable to a member borrowing or lending a customer's securities 
that are eligible to be pledged or loaned as FINRA Rule 4330 (Customer 
Protection--Permissible Use of Customers' Securities); and (3) 
Incorporated NYSE Rule 402.30 (Securities Callable in Part) regarding 
requirements applicable to a member that has in its possession or under 
its control any callable securities as FINRA Rule 4340 (Callable 
Securities).
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and at 
the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    As part of the process of developing a new consolidated rulebook 
(``Consolidated FINRA Rulebook''),\3\ FINRA is proposing to amend and 
adopt the following as FINRA Rules in the Consolidated FINRA Rulebook: 
(1) NYSE Rule 296 (Liquidation of Securities Loans and Borrowings) \4\ 
and Supplementary Material paragraphs .10 and .20 as FINRA Rule 4314 
(Securities Loans and Borrowings); (2) NYSE Rule 402 (Customer 
Protection--Reserves and Custody of Securities) as FINRA Rule 4330 
(Customer Protection--Permissible Use of Customers' Securities); and 
(3) NYSE Rule 402.30 (Securities Callable

[[Page 54351]]

in Part) as FINRA Rule 4340 (Callable Securities).
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    \3\ The current FINRA rulebook consists of (1) FINRA Rules; (2) 
NASD Rules; and (3) rules incorporated from NYSE (``Incorporated 
NYSE Rules'') (together, the NASD Rules and Incorporated NYSE Rules 
are referred to as the ``Transitional Rulebook''). While the NASD 
Rules generally apply to all FINRA members, the Incorporated NYSE 
Rules apply only to those members of FINRA that are also members of 
the NYSE (``Dual Members''). The FINRA Rules apply to all FINRA 
members, unless such rules have a more limited application by their 
terms. For more information about the rulebook consolidation 
process, see Information Notice March 12, 2008 (Rulebook 
Consolidation Process).
    \4\ For convenience, the Incorporated NYSE Rules are referred to 
as the NYSE Rules.
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    a. Proposed FINRA Rule 4314 (Securities Loans and Borrowings)
    i. Background
    NYSE Rule 296 (Liquidation of Securities Loans and Borrowings) sets 
forth the obligations of a member that is party to an agreement with 
another member for the loan and borrowing of securities. Specifically, 
the rule provides that a member that is party to an agreement with 
another member for the loan and borrowing of securities has the right 
to liquidate such transaction whenever the other party to the 
transaction: (1) Applies for or consents to a receiver, custodian, 
trustee or liquidator of itself or its property; (2) admits in writing 
its inability, or becomes generally unable, to pay its debts as such 
debts become due; (3) makes a general assignment for the benefit of its 
creditors; or (4) files, or has filed against it, a petition for a 
Chapter 11 bankruptcy filing or a protective decree under Section 5 of 
the Securities Investor Protection Act of 1970 (``SIPA'') 
(``liquidation conditions'').
    The rule further provides that no member may lend or borrow any 
security to or from any non-member of the NYSE, except pursuant to a 
written agreement, which may consist of the exchange of contract 
confirmations that confers upon the member the contractual right to 
liquidate such transaction because of a liquidation condition of the 
kind specified above.
    NYSE Rule 296.10 defines the term ``agreement for the loan and 
borrowing of securities,'' for purposes of NYSE Rule 296. NYSE Rule 
296.20 provides that each member that is subject to SEA Rule 15c3-3 
(Customer Protection--Reserves and Custody of Securities) and that 
borrows securities from a customer (as the term is defined in SEA Rule 
15c3-3) must comply with SEA Rule 15c3-3's provisions requiring a 
written agreement between the borrowing member and the lending 
customer.
    NYSE Rule 296 has been the basis for provisions incorporated in the 
industry standard Master Securities Lending Agreement (``MSLA''). The 
rule provides protection to members that may enter into a securities 
lending transaction without a duly signed MSLA with a counterparty. 
Should one of the counterparties become insolvent, the rule allows the 
other counterparty to liquidate immediately against collateral 
received. For these reasons, FINRA is proposing to adopt NYSE Rule 296 
as FINRA Rule 4314 (Securities Loans and Borrowings) into the 
Consolidated FINRA Rulebook with the changes described below.
    ii. Proposed FINRA Rule 4314
    In 2006, the industry began to adopt voluntary books and records 
and disclosure practices relating to securities lending, as a result of 
an industry-wide initiative to address the risks associated with agency 
lending (the Agency Lending Disclosure Initiative (``ALD 
Initiative'')).\5\ Consistent with the industry-wide initiative, FINRA 
is proposing a new requirement to make clear whether parties are acting 
as principals or agents when entering into an agreement to loan or 
borrow securities. The proposed rule would require a member that acts 
as agent in a loan or borrow transaction to disclose its capacity and, 
in cases where the member lends securities to or borrows securities 
from a counterparty that is acting in an agency capacity, require that 
the member maintain books and records to reflect the details of the 
transaction with the agent and each principal(s) on whose behalf the 
agent is acting and the details of each transaction therewith.
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    \5\ The Commission notes that it recently adopted an amendment 
to Rule 15c3-1(c)(2)(iv)(B) that would deem broker-dealers providing 
securities borrowing and lending settlement services as principals 
subject to certain capital deductions, unless certain steps are 
taken to disclaim principal liability. See Securities Exchange Act 
Release No. 70072 (July 30, 2013), 78 FR 51824, 51846 (August 21, 
2013).
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    Specifically, proposed new FINRA Rule 4314(a) would require a 
member that lends or borrows securities in the capacity of agent to 
disclose such capacity to the other party (or parties) to the 
transaction. The provision would further require a member, prior to 
lending securities to or borrowing securities from a person that is not 
a member of FINRA, to determine whether the other party is acting as 
principal or agent in the transaction. When the other party (who may or 
may not be a member) is acting as agent in the transaction, the member 
would be required to maintain books and records that reflect: (1) The 
details of the transaction with the agent; and (2) each principal(s) on 
whose behalf the agent is acting and the details of each transaction 
therewith. FINRA believes this requirement will help address concerns 
regarding the level of transparency and information disclosure in 
agency lending transactions. The new requirement would improve 
transparency by disclosing the name of the underlying principal(s) to 
the member and thereby give the member the ability to assess its 
creditworthiness, which is needed given the member's ongoing exposure 
in the lending transaction. In addition, the proposal establishes 
uniform books and records requirements.
    Proposed FINRA Rule 4314(b), based on NYSE Rule 296(a), would 
continue to provide each member that is a party to an agreement with 
another member for the loan and borrowing of securities with the right 
to liquidate such transaction whenever the other party to such 
transaction becomes subject to one of the liquidation conditions 
specified in the rule. FINRA is proposing to add the words ``to 
liquidate such transaction'' to the last sentence of proposed paragraph 
(b)(1) to clarify the meaning of the provision. FINRA believes a 
member's right to liquidate the transaction under the specified 
circumstances would assist the member in managing the risk associated 
with such transactions and maintaining compliance with its net capital 
requirements. In addition, the liquidation conditions have largely been 
incorporated into the industry standard MSLA developed as part of the 
ALD Initiative.
    In addition, NYSE Rule 296(b) requires a member to have a written 
agreement with any non-member of the NYSE to whom it lends, or from 
whom it borrows, securities. FINRA is proposing to adopt this 
requirement so that all FINRA members that engage in such transactions 
with non-members of FINRA must have the written agreement as required 
in NYSE Rule 296(b). Specifically, proposed FINRA Rule 4314(c) would 
require that no member shall lend or borrow any security to or from any 
person that is not a member of FINRA, including any customer, except 
pursuant to a written agreement, which may consist of the exchange of 
contract confirmations, that confers upon such member the contractual 
right to liquidate such transaction because of a liquidation condition 
of the kind specified in proposed FINRA Rule 4314(b). FINRA believes 
that applying this requirement to all FINRA members is appropriate for 
the adoption of the rule into the Consolidated FINRA Rulebook because 
it protects the member's interests in the event of a liquidation 
condition specified in proposed FINRA Rule 4314(b) and supports the 
member's compliance with net capital requirements.
    FINRA is proposing to transfer NYSE Rule 296.10, which defines the 
term ``agreement for the loan and borrowing of securities,'' as 
Supplementary Material .01 to proposed FINRA Rule 4314, without 
substantive change. In addition, FINRA is proposing to add new 
Supplementary Material .02 through .05 to the proposed FINRA rule. 
FINRA believes the new Supplementary

[[Page 54352]]

Material provides clarity and guidance by describing how a member firm 
can meet its disclosure obligations under the proposed rule, and 
clarifying the proposed rule's books and records requirements. 
Specifically, proposed Supplementary Material .02 clarifies the methods 
by which a member may satisfy its disclosure obligation in new 
paragraph (a) by, among other things, providing specific disclosure of 
its capacity as agent in the written agreement between the parties or 
in the individual confirmations of each security exchanged between the 
parties for each loan and borrow transaction. Proposed Supplementary 
Material .03 clarifies the books and records requirements imposed by 
new paragraph (a) and requires members to create and maintain records 
for each security loan or borrow transaction in accordance with SEA 
Rules 17a-3 and 17a-4. It also provides that when a member enters into 
a security loan or borrow transaction with a party that is acting as 
agent on behalf of another principal(s), the member must maintain a 
record of details of the transaction with the agent, including 
identifying the specific security and quantity loaned or borrowed, the 
contract value and the type and description of the security collateral 
provided to the agent, and the identity of each underlying principal 
and the amount and description of the collateral allocated to each such 
principal. FINRA believes proposed Supplementary Material .03 will 
establish consistent industry standards regarding the types of 
information firms must maintain for each security loan or borrow 
transaction with an agent and the underlying principal(s) on whose 
behalf the agent is acting. Such detailed records will evidence that 
firms, when entering into security loan or borrow transactions, have 
knowledge of the parties involved to enable them to assess, among other 
things, the creditworthiness of the underlying principal(s).
    Proposed Supplementary Material .04 reminds members of their 
obligations under proposed FINRA Rule 4330(b) (discussed further below) 
to provide written disclosures to customers regarding the risks and 
financial impact associated with the customer's loan(s) of securities, 
and requires that members disclose in such written notice their right 
to liquidate the borrow transactions with customers under the 
conditions specified in paragraph (b) of proposed FINRA Rule 4314. 
Proposed Supplementary Material .05 would require, for purposes of 
paragraph (c) of proposed FINRA Rule 4314, each member that is subject 
to the provisions of SEA Rule 15c3-3 that borrows fully paid or excess 
margin securities from a customer to comply with the provisions of SEA 
Rule 15c3-3 relating to the requirements for a written agreement 
between the borrowing member and the lending customer.
    iii. Eliminated Rules and Requirements
    FINRA is proposing to eliminate NYSE Rule Interpretation 296(b)/01, 
which addresses transactions with non-member organizations and the 
written agreements required in regard to repurchase and reverse 
repurchase transactions not subject to SEA Rule 15c3-3, as the 
interpretation is beyond the scope of proposed FINRA Rule 4314.
    b. Proposed FINRA Rule 4330 (Customer Protection--Permissible Use 
of Customers' Securities)
    i. Background
    NYSE Rule 402 (Customer Protection--Reserves and Custody of 
Securities), NASD Rule 2330(b)-(d) (Customers' Securities or Funds) and 
NASD IM-2330 (Segregation of Customers' Securities) set forth the 
requirements applicable to a member's use of customers' securities. 
Specifically, NYSE Rule 402 and NASD Rule 2330 prohibit a member from 
lending, either to itself or others, securities that are held on margin 
for a customer and that are eligible to be pledged or loaned, unless 
the firm first obtains a written authorization from the customer 
permitting the lending of the customer's securities. NYSE Rule 
Interpretation 402(b)/01 (Agreements for Use of Customers' Securities/
Application) permits a member to use a single customer signed margin 
agreement/loan consent in lieu of obtaining separate written documents. 
Both the NYSE and NASD rules contain similar provisions requiring 
members to comply with SEA Rule 15c3-3 in obtaining custody and control 
of securities and maintaining appropriate cash reserves.
    FINRA is proposing to adopt NYSE Rule 402 as FINRA Rule 4330 
(Customer Protection--Permissible Use of Customers' Securities), 
subject to certain significant changes, and eliminate NASD Rule 2330 
and NASD IM-2330 as duplicative or otherwise unnecessary.\6\ The 
proposed rule adds new disclosure requirements and establishes the need 
for members to conduct appropriateness determinations before engaging 
in the borrowing and lending of customers' fully paid and excess margin 
securities.
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    \6\ NASD Rule 2330(a), (e) and (f) are now marked ``Reserved.'' 
The substantive provisions of these paragraphs were deleted in prior 
rule filings.
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    ii. Proposed FINRA Rule 4330(a) (Authorization to Lend Customers' 
Margin Securities)
    Proposed FINRA Rule 4330(a) would require a member to obtain a 
customer's written authorization prior to lending securities that are 
held on margin for a customer and that are eligible to be pledged or 
loaned. FINRA believes continuing the requirement to have written 
customer consent protects customers. FINRA is also proposing to delete 
the phrase ``either to itself as a broker-dealer or to others'' 
currently contained in NYSE Rule 402(b) that in relevant part provides 
that ``[n]o member organization shall lend, either to itself as a 
broker-dealer or to others, securities which are held on margin for a 
customer and which are eligible to be pledged or loaned, unless . . . 
.'' because FINRA does not believe the language adds to the meaning of 
the sentence and may be confusing. Proposed FINRA Rule 4330(a) instead 
would clearly provide that ``[n]o member shall lend securities that are 
held on margin for a customer and that are eligible to be pledged or 
loaned, unless such member shall first have obtained a written 
authorization from such customer permitting the lending of such 
securities.''
    Proposed Supplementary Material .02 (Authorization to Lend 
Customers' Margin Securities) retains and codifies NYSE Rule 
Interpretation 402(b)/01, thereby continuing to permit a member to 
satisfy the written authorization requirement by using a single 
customer-signed margin agreement/loan consent, in lieu of obtaining a 
separate written authorization, provided that it contains a legend in 
bold type face placed directly above the signature line that states 
substantially the following: ``By Signing this Agreement I Acknowledge 
that My Securities May be Loaned to You or Loaned Out to Others.''
    Consistent with NYSE Rule 402(a) and NASD Rule 2330(b), proposed 
Supplementary Material .01 (Definitions) would provide that the 
definitions contained in SEA Rule 15c3-3 would apply to proposed FINRA 
Rule 4330. However, the proposed rule does not include the requirement 
contained in both the NYSE and NASD rules for members to maintain cash 
reserves as prescribed by SEA Rule 15c3-3 because members continue to 
be subject to SEA Rule 15c3-3.
    iii. Proposed FINRA Rule 4330(b) (Requirements for Borrowing of 
Customers' Fully Paid or Excess Margin Securities)

[[Page 54353]]

    In addition, FINRA is proposing new requirements to address the 
borrowing and lending of customers' fully paid or excess margin 
securities. Specifically, proposed FINRA Rule 4330(b)(1) would require 
a member that borrows fully paid or excess margin securities carried 
for the account of any customer to: (A) Comply with the requirements of 
SEA Rule 15c3-3; (B) comply with the requirements of Section 15(e) 
(Notices to Customers Regarding Securities Lending) of the Exchange Act 
to provide notices to customers regarding securities lending; and (C) 
notify FINRA, in such manner and format as FINRA may require, at least 
30 days prior to first engaging in such securities borrows.
    Proposed Supplementary Material .03 (Notification to FINRA) would 
provide that upon FINRA's receipt of such written notification, FINRA 
may request such additional information as it may deem necessary to 
evaluate compliance with SEA Rule 15c3-3, Section 15(e) of the Exchange 
Act and other applicable FINRA rules or federal securities laws or 
rules. Examples of additional information would include, but would not 
be limited to:
    (a) The written agreement authorizing such borrowing of securities, 
which shall reflect the material terms of the arrangement;
    (b) The types of customers that are parties to such securities 
borrows;
    (c) The types of accounts used to effect the securities borrows 
(i.e., whether the subject securities are maintained in customers' cash 
or margin or other accounts);
    (d) The types of collateral provided to customers in connection 
with such securities borrows, the frequency of marking to market of the 
collateral and the custody arrangements for such collateral;
    (e) The operational and recordkeeping processes related to such 
securities borrows;
    (f) The rebates paid/received in connection with such securities 
borrows and any other compensation arrangements related thereto;
    (g) The procedures for handling customers' requests to sell the 
securities subject to such borrows; and
    (h) Disclosures made to customers.
    Proposed FINRA Rule 4330(b)(2) also imposes two new requirements 
that a member must satisfy prior to first entering into securities 
borrows with a customer. FINRA believes that these proposed new 
requirements will strengthen customer protection and increase investor 
confidence. First, proposed FINRA Rule 4330(b)(2)(A) would require that 
a member have reasonable grounds for believing that the customer's 
loan(s) of securities are appropriate for the customer. In making this 
determination, the member shall exercise reasonable diligence to 
ascertain the essential facts relative to the customer, including, but 
not limited to, the customer's financial situation and needs, tax 
status, investment objectives, investment time horizon, liquidity 
needs, risk tolerance and any other information the customer may 
disclose to the member or associated person in connection with entering 
such securities loans. Accordingly, where a member has a securities 
borrow program, the member would be required to determine the 
appropriateness of such activity for the customer prior to the customer 
entering into the first securities borrow. In addition, proposed 
Supplementary Material .04 (Appropriateness of Customer's Loan(s) of 
Securities), clarifies that the member borrowing a customer's fully 
paid or excess margin securities is responsible for making the 
determination regarding the appropriateness of such borrow from a 
customer. The proposal would provide, however, that in making the 
determination, when the member has entered into a carrying agreement 
with an introducing member pursuant to FINRA Rule 4311, the member may 
rely on the representations of the introducing member that has a 
customer relationship with the lender.
    Second, proposed FINRA Rule 4330(b)(2)(B) would require a member, 
prior to first entering into securities borrows with a customer, to 
provide the customer, in writing (which may be electronic), with a 
clear and prominent notice stating that the provisions of SIPA may not 
protect the customer with respect to the customer's securities loan 
transaction and that the collateral delivered to the customer may 
constitute the only source of satisfaction of the member's obligation 
in the event the member fails to return the securities.
    FINRA believes that providing customers with clear and prominent 
disclosure of potential risks associated with customers' loans of 
securities will allow customers to make more informed investment 
decisions. In addition, proposed FINRA Rule 4330(b)(2)(B) would require 
a member to provide the customer with disclosures regarding the 
customer's rights with respect to the loaned securities, and the risks 
and financial impact associated with the customer's loan(s) of 
securities. These disclosures include, but are not limited to: (i) Loss 
of voting rights; (ii) the customer's right to sell the loaned 
securities and any limitations on the customer's ability to do so, if 
applicable; (iii) the factors that determine the amount of compensation 
received by the member and its associated persons in connection with 
the use of the securities borrowed from the customer; (iv) the factors 
that determine the amount of compensation (e.g., interest rate) to be 
paid to the customer and whether or not such compensation can be 
changed by the member under the terms of the borrow agreement; (v) the 
risks associated with each type of collateral provided to the customer; 
(vi) that the securities may be ``hard-to-borrow'' because of short-
selling or may be used to satisfy delivery requirements resulting from 
short sales; (vii) potential tax implications, including payments 
deemed cash-in-lieu of dividend paid on securities while on loan; and 
(viii) the member's right to liquidate the transaction because of a 
condition of the kind specified in FINRA Rule 4314(b) (Securities Loans 
and Borrowings-Right to Liquidate Transaction) (discussed above).
    Proposed FINRA Rule 4330(b)(3) would require that a member create 
and maintain books and records evidencing compliance with proposed 
FINRA Rule 4330(b)(2). Such records must be maintained in accordance 
with the requirements of SEA Rule 17a-4(a).
    Proposed Supplementary Material .05 (Notification to FINRA of Pre-
existing Fully Paid or Excess Margin Securities Borrows and Disclosures 
to Customers) would require members that have any existing fully paid 
or excess margin securities borrows with customers as of the effective 
date of proposed Rule 4330 to notify FINRA in writing, in such manner 
and format as FINRA may require, of such borrows within 30 days from 
the effective date of the rule. Notifications may be provided to a 
member's FINRA Regulatory Coordinator in writing, either in hard copy 
or electronically. FINRA will specify the manner and format of such 
notification in a Regulatory Notice announcing the effectiveness of the 
rule. In addition, such members would be required to provide such 
customers with the disclosures required by proposed FINRA Rule 
4330(b)(2)(B) within 90 days from the effective date of the rule. FINRA 
believes that the requirement to provide notice to FINRA of existing 
programs is necessary for it to have a more complete picture of 
members' activities in this area when the rule becomes effective, and 
that the proposed timeframes for notice to FINRA and providing 
disclosures to existing customers are reasonable.
    iv. Eliminated Rules and Requirements
    Proposed FINRA Rule 4330 would not retain the provisions in NYSE 
Rule 402

[[Page 54354]]

that are duplicative of the requirements in SEA Rule 15c3-3 or the 
outdated provisions regarding the physical segregation of securities. 
In addition, the proposed rule change would eliminate NASD Rule 2330 
and NASD IM-2330, which also contain duplicative provisions relating to 
SEA Rule 15c3-3 and outdated provisions relating to the physical 
segregation of securities.
    c. Proposed FINRA Rule 4340 (Callable Securities)
    i. Background
    NYSE Rule 402.30 (Securities Callable in Part) requires a member 
that has in its possession or control securities that are callable in 
part to identify each such security so that its records clearly show 
for whose account it is held. The following securities are exempt from 
this requirement:
    (1) Certain bonds that have not paid interest for at least two 
interest periods;
    (2) Euro-dollar bonds deposited in a central clearing facility for 
such bonds, provided that customers are notified of the deposit into 
the central clearing facility and also that the member has the right to 
withdraw uncalled bonds from the facility at any time; and
    (3) bonds or preferred stocks, provided that the member has 
satisfied certain requirements, including adopting an impartial lottery 
system in which the probability of a customer's bonds or preferred 
stocks being selected as called is proportional to the holdings of all 
customers of such securities held in bulk by or for the member.
    NYSE Rule 402.30 also requires that a member provide written 
disclosure to all customers of the systems and the manner in which 
securities are held and their rights to withdraw uncalled securities, 
as described above, prior to: (1) The member depositing the securities 
in bulk; or (2) the customer purchasing such securities, except in the 
case of a new account, provided that such notice was sent to the 
customer prior to the settlement date. The rule further requires that 
in the event of a favorable call of the securities, the member shall 
not allocate any securities to any account in which it or its general, 
limited, or special partners, officers, directors, approved persons or 
employees have an interest until all other customers' positions in the 
securities have been satisfied. There is no comparable NASD rule.
    FINRA is proposing to adopt FINRA Rule 4340 (Callable Securities), 
based in part on NYSE Rule 402.30. The proposed rule changes are 
detailed further below.
    ii. Proposed FINRA Rule 4340(a): Allocation Procedures and Customer 
Notice
    Proposed FINRA Rule 4340(a) would retain in substance the provision 
in NYSE Rule 402.30 requiring each member that has in its possession or 
under its control bonds or preferred stocks that are callable in part, 
whether specifically set aside or otherwise, to identify such 
securities and establish an impartial lottery system by which it will 
allocate among its customers the securities to be redeemed or selected 
as called in the event of a partial redemption or call. However, 
proposed FINRA Rule 4340(a) would apply this provision to any security 
that by its terms may be called or redeemed prior to maturity. FINRA 
believes firms should establish allocation procedures for all 
securities that may be partially redeemed, not just securities 
designated as callable securities. The proposed rule change also would 
eliminate the specific requirements in NYSE Rule 402.30 regarding the 
establishment of an impartial lottery system in which the probability 
of a customer's securities being selected as called is proportional to 
the holdings of all customers of such securities held in bulk by the 
member. Instead, proposed FINRA Rule 4340(a)(1) would adopt a more 
flexible approach that would allow a member to establish and make 
available on the member's Web site procedures by which it will allocate 
among its customers, on a fair and impartial basis, the securities to 
be redeemed or selected as called in the event of a partial redemption 
or call. Proposed Supplementary Material .02 (Allocations of Partial 
Redemptions or Calls) would clarify that such procedures may include 
the use of an impartial lottery system, acting on a pro-rata basis, or 
such other means as will achieve a fair and impartial allocation of the 
partially redeemed or called securities.
    Proposed FINRA Rule 4340(a)(2) would require the member to provide 
written notice (which may be electronic) to new customers at the 
opening of an account, and to all customers at least once every 
calendar year, of the manner in which they may access the allocation 
procedures on the member's Web site and that, upon a customer's 
request, the member will provide hard copies of the allocation 
procedures to the customer. FINRA believes the proposed periodic notice 
to customers of the firm's allocation procedures will allow customers 
to be better informed regarding their rights in the event of a partial 
redemption or call of securities in their accounts.
    iii. Proposed FINRA Rule 4340(b) and (c): Favorable and Unfavorable 
Redemptions
    Proposed FINRA Rule 4340(b) would retain in substance the 
restriction in NYSE Rule 402.30 prohibiting a member from allocating 
securities to any of its accounts or those of its ``employees, 
partners, officers, directors, and approved persons'' in a redemption 
offered on terms favorable to the called parties until all other 
customers' positions have been satisfied. However, proposed FINRA Rule 
4340(b) would apply the restriction to a member and its ``associated 
persons,'' rather than to a member's ``employees, partners, officers, 
directors, and approved persons.'' Accordingly, the proposed rule would 
provide that, where redemption of callable securities is made on terms 
favorable to the called parties, a member shall not allocate the 
securities to any account in which it or its associated persons have an 
interest until all other customers' positions in such securities have 
been satisfied.
    Proposed Supplementary Material .01 (Definition of Associated 
Person; Clerical and Ministerial Functions) would clarify that the term 
``associated person'' as used in the proposed rule would have the 
meaning provided in Section 3(a)(18) of the Act, which expressly 
excludes, for certain purposes, any persons associated with the member 
whose functions are solely clerical or ministerial (referred to as 
``clerical and ministerial associated persons'').\7\ The proposed 
supplementary material also would make clear that, in the event of a 
redemption made on terms favorable to the called parties, a member may 
include the accounts of clerical and ministerial associated persons in 
the pool of securities eligible to be called. FINRA believes the 
proposed change strikes the proper balance by prohibiting firms from 
favoring the member and its associated persons in any allocation. 
However, FINRA believes permitting firms to include clerical and 
ministerial associated persons of the firm in the pool of securities 
eligible to be called for a redemption favorable to the called parties 
is reasonable because such allocation does not present the same 
potential for conflicts of interest as positions held by the firm and 
its non-clerical and non-ministerial associated persons, and does not 
unduly burden associated persons engaged in clerical and ministerial 
functions.
---------------------------------------------------------------------------

    \7\ 15 U.S.C. 78c(a)(18).
---------------------------------------------------------------------------

    Similarly, where the redemption of callable securities is made on 
terms unfavorable to the called parties, proposed FINRA Rule 4340(c) 
and proposed Supplementary Material .03 would make clear that a member 
cannot exclude its positions or those of its

[[Page 54355]]

associated persons, including the accounts of clerical and ministerial 
associated persons, from the pool of securities eligible to be called. 
FINRA believes that requiring a firm to include the positions of the 
firm and all its associated persons (including those engaged in 
clerical and ministerial functions) when a redemption is on terms 
unfavorable to the called parties is reasonable because the provision 
ensures that all parties are on parity. In addition, proposed 
Supplementary Material .03 (Accounts of an Introducing Member and its 
Associated Persons) would codify that where an introducing member is a 
party to a carrying agreement with another member that is conducting an 
allocation pursuant to proposed FINRA Rule 4340(a), any accounts in 
which the introducing member or its associated persons have an interest 
shall be subject to the provisions regarding participation in favorable 
and unfavorable calls or redemptions. In addition, the introducing 
member must identify such accounts to the member conducting the 
allocation.
    iv. Eliminated Rules and Requirements
    Finally, the proposed rule change would eliminate as unnecessary 
NYSE Rule 402.30 in its entirety, including eliminating the rule's 
provision permitting customers to withdraw uncalled fully paid 
securities at any time prior to a partial call, and also to withdraw 
excess margin securities, provided that the customers' accounts are not 
subject to restrictions under Regulation T, or such withdrawals will 
not cause an under-margined condition.
    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 90 days following 
Commission approval. The effective date will be no later than 180 days 
following Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\8\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes that the proposed rule change will 
clarify and streamline the financial and operational rules relating to 
securities loans and borrowings, permissible use of customers' 
securities and callable securities for adoption as FINRA Rules in the 
new Consolidated FINRA Rulebook. FINRA notes that the proposed rule 
change transfers provisions from NASD Rule 2330 and NYSE Rules 296, 402 
and 402.30 unchanged into the Consolidated FINRA Rulebook and, as such, 
those transferred provisions do not impose any new requirements for the 
industry and member firms engaging in securities loans and borrows that 
are already subject to the requirements of the current rules. FINRA 
believes the proposed changes to the current rules address concerns 
regarding transparency and disclosure under various borrowing and 
lending arrangements, both among members and with customers. 
Specifically, FINRA believes the new disclosure and recordkeeping 
requirements in proposed FINRA Rule 4314 adopt industry practices 
consistent with industry-wide initiatives that were developed in 2006, 
through the ALD Initiative. FINRA further believes that the new 
requirements in proposed FINRA Rule 4330 that a member, prior to first 
entering into a securities borrow with a customer, have reasonable 
grounds to believe the customer's loans of securities are appropriate, 
and send certain specified disclosures to the customer regarding the 
possible risks associated with securities loan transactions, are 
reasonable investor protections given the increasing number of retail 
customers involved in these types of transactions. In general, FINRA 
believes that the proposed rule change will provide consistency with 
respect to disclosures and recordkeeping in the marketplace to members, 
customers and other parties under various borrowing and lending 
arrangements. Similarly, FINRA believes that proposed FINRA Rule 4340, 
which adds new disclosure requirements to make the process of partial 
redemption of callable securities more transparent to customers, 
provides enhanced investor protection to the market.
---------------------------------------------------------------------------

    \8\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. FINRA believes that the 
proposed rule change is necessary because clarifying and streamlining 
the financial and operational rules relating to securities loans and 
borrowings, permissible use of customers' securities and callable 
securities for adoption as FINRA Rules in the new Consolidated FINRA 
Rulebook will provide consistency with respect to disclosures to 
customers and other parties and to the recordkeeping requirements of 
members, under various borrowing and lending arrangements. 
Specifically, FINRA believes the new disclosure and recordkeeping 
requirements proposed in FINRA Rule 4314 adopt industry practices 
consistent with industry-wide initiatives that were developed in 2006, 
through the ALD Initiative. FINRA further believes that the new 
requirements in proposed FINRA Rule 4330 that a member, prior to first 
entering into a securities borrow with a customer, have reasonable 
grounds to believe the customer's loans of securities are appropriate, 
and send certain specified disclosures to the customer regarding the 
possible risks associated with securities loan transactions, are 
reasonable investor protections given the increasing number of retail 
customers involved in these types of transactions. Similarly, FINRA 
believes proposed FINRA Rule 4340, which adds new disclosure 
requirements to make the process of partial redemption of callable 
securities more transparent to customers, provides enhanced investor 
protection to the market. FINRA notes that the proposed rule change 
transfers certain provisions from NASD Rule 2330 and NYSE Rules 296, 
402 and 402.30 unchanged into the Consolidated FINRA Rulebook and, as 
such, those transferred provisions do not impose any new requirements 
for the industry and member firms engaging in securities loans and 
borrows that are already subject to the requirements of the current 
rules.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    In January 2010, FINRA published Regulatory Notice 10-03 soliciting 
comment on proposed FINRA Rules 4314, 4330 and 4340. FINRA received 
four comment letters in response to the Notice,\9\ which are discussed 
below. A copy of the Notice is attached as Exhibit 2a. A list of the 
comment letters

[[Page 54356]]

received in response to the Notice is attached as Exhibit 2b. Copies of 
the comment letters received in response to the Notice are attached as 
Exhibit 2c.
---------------------------------------------------------------------------

    \9\ See Letter from Peter J. Chepucavage, Executive Director, 
CFAW General Counsel Plexus Consulting LLC, received January 20, 
2010 (``Plexus''); letter from Erica M. Vaters, Vice President--
Fidelity Institutional Compliance, Fidelity Brokerage Services LLC, 
to Marcia E. Asquith, Corporate Secretary, FINRA, dated March 5, 
2010 (``Fidelity''); letter from Daniel C. Rome, Executive 
Consultant, Accounting and Compliance International, to Marcia E. 
Asquith, Corporate Secretary, FINRA, dated March 8, 2010 (``ACI''); 
and letter from Ira D. Hammerman, Senior Managing Director and 
General Counsel, Securities Industry and Financial Markets 
Association, to Marcia E. Asquith, Corporate Secretary, FINRA, dated 
March 8, 2010 (``SIFMA'').
---------------------------------------------------------------------------

    One commenter had a general comment on the proposed rules.\10\ The 
commenter strongly supported FINRA's efforts to streamline and add 
clarity to the new consolidated rulebook. Specifically, the commenter 
noted that ``[t]he proposed consolidation of the rules governing 
securities loans and borrowing seems to be an example of a simplified 
rule that eliminates duplicative and/or outdated provisions. 
Furthermore, the elimination of specific allocation requirements will 
allow members to establish procedures more tailored to their unique 
operation.'' \11\
---------------------------------------------------------------------------

    \10\ See ACI letter.
    \11\ See ACI letter.
---------------------------------------------------------------------------

1. Proposed FINRA Rule 4314 (Securities Loans and Borrowings)
    As discussed above, proposed FINRA Rule 4314(a) requires a member 
that enters into a transaction to lend or borrow securities as agent to 
disclose its capacity to the other party (or parties) to the 
transaction. In addition, the paragraph would require a member, prior 
to lending securities to or borrowing securities from a person that is 
not a member of FINRA, to determine whether the other party is acting 
as principal or agent in the transaction.
    Only one of the four commenters commented on this proposed 
rule.\12\ The commenter ``supports FINRA's goals of enhancing the 
current safeguards within the securities lending market to further 
address investor protection concerns, and promote the fundamental goal 
of lenders--incremental income with limited risk.'' However, the 
commenter would like FINRA to explicitly recognize in the proposed rule 
the ALD Initiative and that transfer of data between the agent lender 
and broker-dealer under the ALD regime is sufficient to meet the books 
and records requirements. In addition, the commenter strongly 
recommends that FINRA work with the SEC to adopt the final version of 
the SEC's ALD no-action letter prior to or simultaneous with the 
adoption of proposed Rule 4314. The commenter further notes that 
``[d]ue to the procedural nature of the no-action letter, firms believe 
it could prove unwieldy to incorporate all of the detailed requirements 
of the no-action relief into the proposed rule.'' The commenter 
suggests that firms would rather FINRA adopt an ``interpretation to the 
rule (set forth in the Supplementary Material) that references the fact 
that firms should structure their operations in a manner consistent 
with the cited SEC no-action letter.'' \13\
---------------------------------------------------------------------------

    \12\ See SIFMA letter.
    \13\ See SIFMA letter.
---------------------------------------------------------------------------

    FINRA recognizes the work of the ALD Initiative and has been 
actively involved for several years with SIFMA, industry participants, 
the SEC and other regulators regarding the procedures that broker-
dealers borrowing securities through intermediaries should follow in 
order to have adequate information regarding the principals on whose 
behalf the securities are being loaned. Based on FINRA's involvement 
with the ALD no-action letter initiative to date, FINRA believes 
proposed Rule 4314 is consistent with the ALD Initiative. In addition, 
FINRA believes that it is appropriate to move forward with the proposed 
rule to address concerns regarding transparency and disclosure under 
these lending arrangements. If the Commission approves proposed FINRA 
Rule 4314 and thereafter an ALD no-action letter were to be issued by 
the SEC staff, and there were inconsistencies between the two, FINRA 
would carefully review the rule at that time and consider amendments, 
as necessary, to eliminate such inconsistencies.
    The commenter also urges FINRA to clarify that, with respect to 
certain ``anonymous loan markets,'' where the actual counterparty to 
securities loans and borrows is a central counterparty, that the 
required disclosures of Rule 4314 would be made to the central 
counterparty, and not any underlying counterparty.\14\ FINRA 
understands that with respect to such ``anonymous loan markets'' the 
borrower's and lender's transactions are matched by an electronic 
borrow/loan system in a manner that does not disclose the borrowing and 
lending parties' identity to each other and the only known counterparty 
to both the borrower and the lender is the central counterparty, which 
acts as principal in the transactions with both the borrower and 
lender. In such cases, the disclosures required by Rule 4314 would be 
required to be made to the central counterparty.
---------------------------------------------------------------------------

    \14\ See SIFMA letter.
---------------------------------------------------------------------------

2. Proposed FINRA Rule 4330 (Customer Protection--Permissible Use of 
Customers' Securities)
    a. Comments on Proposed FINRA Rule 4330(a)
    As described above, proposed FINRA Rule 4330(a) would retain the 
requirement in NYSE Rule 402(b) that a member obtain a customer's 
written authorization prior to lending the customer's margin 
securities. In addition, proposed Supplementary Material .02 would 
retain and codify NYSE Rule Interpretation 402(b)/01, which permits a 
member to satisfy the written authorization requirement by using a 
single customer signed margin agreement/loan consent, provided that it 
contains a legend in bold type face directly above the signature line 
substantially stating the following: ``By Signing this Agreement I 
Acknowledge that My Securities May be Loaned to You or Loaned Out to 
Others.''
    One commenter generally supports the retention of NYSE Rule 402(b) 
and NYSE Rule Interpretation 402(b)/01.\15\ However, that commenter and 
another commenter believe that firms currently have similar, but not 
identical language in the legends of their customer margin agreements, 
and they request that, to avoid substantial repapering costs for firms, 
existing customer margin agreements be grandfathered and the new 
language in the legend of proposed Supplementary Material .02 be 
required only for new margin customer agreements.\16\ In response, 
FINRA notes that, since the legend in proposed Supplementary Material 
.02 is identical to the legend required by NYSE Rule Interpretation 
402(b)/01, and since that legend, as explained in the interpretation, 
applies to ``margin eligible securities,'' any existing customer margin 
account agreements containing such legend that includes the words 
``margin securities'' would be deemed in compliance with the NYSE Rule 
Interpretation 402(b)/01 legend requirement and would continue to 
comply with proposed Supplementary Material .02. However, FINRA would 
expect firms to review existing customer margin account agreements for 
compliance and if, upon finding any non-compliant customer margin 
account agreements, have customers sign new customer margin account 
agreements.
---------------------------------------------------------------------------

    \15\ See Fidelity letter.
    \16\ See Fidelity letter and SIFMA letter.
---------------------------------------------------------------------------

    In addition, one of the commenters requests that the proposed 
legend refer to ``margin securities'' to clarify that ``the language is 
only meant to apply to margin securities (i.e., not excess margin 
securities or fully paid securities) in customer margin account 
agreements.'' \17\ FINRA notes that proposed FINRA Rule 4330(a) and 
Supplementary Material .02 specifically address a member's obligation 
to obtain a customer's written authorization prior to lending the 
customer's margin securities. As such, while the legend does not 
specify ``margin securities,''

[[Page 54357]]

FINRA believes that its inclusion in the section of the rule that is 
specific to the requirements for borrowing customer's margin 
securities, clarifies its applicability to margin securities. 
Accordingly, FINRA does not believe the change recommended by the 
commenter is necessary.
---------------------------------------------------------------------------

    \17\ See SIFMA letter.
---------------------------------------------------------------------------

    b. Comments on Proposed FINRA Rule 4330(b)(1)(C)--Notification to 
FINRA
    As discussed further above, FINRA Rule 4330(b)(1)(C), as required 
in the Notice, would require a member borrowing a customer's fully paid 
or excess margin securities carried for the account of any customer, to 
notify FINRA in writing at least 30 days prior to engaging in such 
borrow activities.
    One commenter recommends that FINRA clarify that the 30-day 
notification period applies only to a firm's initiation of a fully paid 
customer securities lending program and does not impose a separate 
requirement prior to entering into securities borrows with specific 
customers.\18\ In addition, the commenter recommends that with respect 
to existing securities lending programs, notification could be provided 
to FINRA within a certain period of time after the new rules become 
effective.\19\ Another commenter generally agrees with FINRA Rule 
4330(b)(1)(C) as applied going forward to members that currently do not 
have programs in place to borrow customer fully paid or excess margin 
securities, but does not believe that there is any benefit to imposing 
this requirement on firms with existing programs that FINRA already 
reviews during both routine and ``sweep'' FINRA examinations.\20\
---------------------------------------------------------------------------

    \18\ See SIFMA letter.
    \19\ See SIFMA letter.
    \20\ See Fidelity letter.
---------------------------------------------------------------------------

    In response to comments, FINRA seeks to clarify that the 
notification requirement in proposed FINRA Rule 4330(b)(1)(C) applies 
prior to the time a firm first enters into either a fully paid or 
excess margin securities borrow program or if it has no program, prior 
to first entering into such fully paid securities borrows with one or 
more customers, and is proposing to amend the rule text accordingly. A 
notice is not required for each new customer that enters an established 
program. FINRA also is replacing the terms ``borrow activities,'' 
``transaction'' and ``program'' with the term ``securities borrows'' to 
make the terminology consistent throughout the provision. In addition, 
FINRA is adding proposed Supplementary Material .05 to address fully 
paid or excess margin securities borrows with customers that exist as 
of the effective date of this proposed rule, either as part of a 
program or outside of a program. In such cases, a member with any 
existing fully paid or excess margin securities borrows with customers 
as of the effective date of this rule, would be required to provide (1) 
written notification to FINRA within 30 days of the effective date of 
the new rule, in such manner and form as FINRA may require; and (2) 
such customers with the disclosures required by FINRA Rule 
4330(b)(2)(B) within 90 days of the effective date of the new rule. 
FINRA recognizes that it may have knowledge of firms' existing fully 
paid securities borrow programs or fully paid borrows done outside of a 
program, through the examination process; however, FINRA believes the 
proposed notification requirement for such existing activities is not 
overly burdensome and would provide FINRA with a comprehensive view of 
a firm's activities after the effectiveness of the proposed rule.
    c. Comments on Proposed FINRA Rule 4330(b)(2)(A)--Suitability
    FINRA Rule 4330(b)(2)(A) as proposed in the Notice would require a 
member that borrows a customer's fully paid or excess margin 
securities, prior to entering into a securities borrow transaction with 
a customer, to determine that such transaction is suitable for the 
customer.
    One commenter asks FINRA to clarify that suitability for purposes 
of this proposed new rule should apply with respect to a customer's 
overall participation in a fully paid securities lending program, and 
not on a transaction-by-transaction basis because this would be unduly 
burdensome and negatively impact the efficiency of security loans.\21\ 
Another commenter requests further clarification on what would make a 
customer unsuitable to participate after a customer has been fully 
informed of the risks associated with the transaction, executes a 
master securities lending agreement with the firm which sets forth the 
terms and conditions of the loan, the loan is fully collateralized in 
accordance with SEA Rule 15c3-3(b)(3), and there are no limitations 
placed upon the customer's ability to sell the loaned security or draw 
upon the collateral.\22\ The commenter further notes that it does not 
believe that a customer's investment objectives or net worth are 
applicable in determining whether customers should be able to generate 
additional income from their securities positions. The commenter agrees 
with FINRA's concern about customers buying hard-to-borrow securities 
for the sole intention of loaning them, but the commenter believes that 
NASD Rule 2310 (Recommendations to Customers--Suitability) would 
already cover this activity.\23\
---------------------------------------------------------------------------

    \21\ See SIFMA letter.
    \22\ See Fidelity letter.
    \23\ NASD Rule 2310 (Recommendations to Customers--Suitability) 
has been superseded by FINRA Rule 2111 (Suitability). See SR-FINRA-
2010-039, which was amended by SR-FINRA-2011-016 and SR-FINRA-2012-
027 eff. July 9, 2012.
---------------------------------------------------------------------------

    In response to the commenters' concerns, FINRA is proposing to 
substantially revise the suitability provision in proposed paragraph 
(b)(2)(A) of Rule 4330. As revised, proposed paragraph (b)(2)(A) 
requires a member to have reasonable grounds for believing that the 
customer's loan(s) of securities are appropriate for the customer. In 
making this determination, the member must exercise reasonable 
diligence to ascertain the essential facts relative to the customer, 
including, but not limited to, the customer's financial situation and 
needs, tax status, investment objectives, investment time horizon, 
liquidity needs, risk tolerance and any other information the customer 
may disclose to the member or associated person in connection with 
entering such securities loans. To further address commenters' concerns 
about when this obligation arises in the customer relationship, FINRA 
is clarifying that a member must undertake this determination prior to 
first entering into securities borrows with a customer and not on a 
transaction-by-transaction basis. Accordingly, where a member has a 
securities borrow program, it would be required to determine the 
appropriateness of such activity for the customer prior to the customer 
entering into the first securities borrow. FINRA believes these 
proposed changes respond to commenters' concerns regarding the scope 
and application of the review.
    d. Comments on Proposed FINRA Rule 4330(b)(2)(B)--Risk Disclosures
    Proposed FINRA Rule 4330(b)(2)(B), as proposed in the Notice, would 
require members to provide a customer with certain specific information 
regarding the risks associated with the customer's securities loan 
transaction, prior to entering into a securities borrow transaction 
with a customer. Several commenters raise general concerns regarding 
the proposed disclosure requirement, as well as concerns about specific 
required disclosures.\24\
---------------------------------------------------------------------------

    \24\ See Plexus letter, SIFMA letter and Fidelity letter.
---------------------------------------------------------------------------

    i. Standardized Risk Disclosure Form

[[Page 54358]]

    Two commenters support the idea that customers should be fully 
informed of the risks associated with lending their fully paid and 
excess margin securities but believe that an industry standard risk 
disclosure form should be developed to help ensure consistent standards 
across the industry.\25\ In response, FINRA does not object to the 
development by the industry of a standardized risk disclosure form but 
cautions that such form may not be able to capture all of the risk 
disclosures specific to every member's individual fully paid or excess 
margin securities lending activities, and members should carefully 
evaluate their activities and disclosure obligations when considering 
adopting a standardized disclosure document to address their compliance 
with the proposed rule.
---------------------------------------------------------------------------

    \25\ See SIFMA letter and Fidelity letter.
---------------------------------------------------------------------------

    ii. Disclosure of Limitation on the Customer's Ability to Sell the 
Loaned Securities
    Several commenters raise issues regarding the proposed requirement 
to disclose to the customer any limitations on the customer's ability 
to sell the loaned securities. Specifically, two commenters appear to 
raise issues relating to Regulation SHO and the SEC's guidance that if 
a person that has loaned a security to another person sells the 
security and a bona fide recall is initiated within two business days 
after trade date, the person that has loaned the security is ``deemed 
to own'' the security for purposes of Rule 200(g)(1) Regulation SHO, 
and such sale will not be treated as a short sale for purposes of the 
close-out requirements under Rule 204 of Regulation SHO. In addition, a 
broker-dealer may mark such orders as long sales provided such marking 
is in compliance with Rule 200(c) of Regulation SHO.\26\ In particular, 
one of the commenters contends that, since the proposed disclosure is 
not intended to provide guidance on the marking of customers' sales as 
``long'' or ``short,'' or otherwise provide guidance concerning 
Regulation SHO, FINRA should either eliminate this proposed disclosure 
to avoid potential confusion or clarify that such orders to sell may be 
marked ``long,'' provided there is compliance with applicable guidance 
regarding Regulation SHO.\27\ The other commenter notes the SEC's 
guidance and states that there should not be any distinction between 
hypothecated margin securities (securities bought by the customer with 
funds borrowed from the firm) and fully paid or excess margin 
securities on loan, as long as it is reasonable to believe they can be 
recalled by settlement date for the sale.\28\
---------------------------------------------------------------------------

    \26\ See Fidelity letter and SIFMA letter. See also Securities 
Exchange Act Release No. 60388 (July 27, 2009), 74 FR 38266, 38270, 
n.55 (July 31, 2009); and ``SEC Division of Trading and Market 
Guidance Regarding Sale of Loaned But Recalled Securities'' 
(Published on the SEC's Web site on October 20, 2008).
    \27\ See SIFMA letter.
    \28\ See Fidelity letter.
---------------------------------------------------------------------------

    FINRA included the requirement to disclose ``limitations on 
customer's ability to sell the loaned securities,'' in the original 
proposal as a result of concerns noted with regard to the adequacy of 
certain disclosures of material information to customers participating 
in the member's fully paid lending program including, specifically, 
failing to adequately disclose to customers that shares on loan could 
be sold at any time prior to recalling the shares or waiting for the 
delivery of shares back to their account. The proposed disclosure is 
not intended to address members' obligations under Regulation SHO or 
otherwise require members to provide guidance regarding Regulation SHO. 
FINRA believes the proposed disclosure will alert customers regarding 
their right to sell the securities and any limitations on the 
customer's ability to do so. However, to further clarify its intent, 
FINRA has modified the rule text to require members to disclose ``the 
customer's right to sell the loaned securities and any limitations on 
the customer's ability to do so, if applicable.''
    iii. Economics of the Transaction
    With respect to the proposed disclosure of the economics of the 
securities loan transaction, one commenter does not agree that this 
disclosure should include the rate that the firm would earn on the 
loaned securities because it would be irrelevant to the customer's 
decision.\29\ In addition, the commenter argues that any such disclosed 
rate would not provide the customer with meaningful information to 
assist the customer in making any decision, since this rate would be 
only a rough estimate as there would be no way of knowing exactly what 
rate the security would be lent out at initially or over the life of 
the loan.\30\ Another commenter, noting that there may be different 
prices for securities borrow transactions involving the same security, 
requests that FINRA clarify in its rule filing that firms will be 
expected to provide adequate disclosure to customers that the price for 
a securities lending transaction can be affected by a variety of 
different factors (e.g., size of the transaction, expected stability of 
the borrow, collateral posted).\31\
---------------------------------------------------------------------------

    \29\ See Fidelity letter.
    \30\ See Fidelity letter. The commenter does believe that a 
disclosure regarding the economics of the transaction should include 
the rate the customer will be paid for the securities borrow loan 
transaction.
    \31\ See SIFMA letter.
---------------------------------------------------------------------------

    Although not specifically addressed to the proposed ``economics of 
the transaction'' disclosure, one commenter states that the required 
disclosures should include the most opaque parts of short selling and 
stock lending practices.\32\ In the same vein, the commenter suggests 
that the broker-dealer be required to explain the rebate it receives 
and the fact that the resulting short sale may be against the 
customer's own interest and perhaps that other more powerful customers 
may indeed participate in these stock loan profits.
---------------------------------------------------------------------------

    \32\ See Plexus letter.
---------------------------------------------------------------------------

    After reviewing the comments received, FINRA has amended proposed 
FINRA Rule 4330(b)(2)(B) to remove the term ``economics of the 
transaction,'' and is proposing to add more specific guidance on the 
types of disclosures that should be provided to customers. 
Specifically, pursuant to the amended rule text, a member must 
disclose, among other things, the customer's rights with respect to the 
loaned securities, and the risks and financial impact associated with 
the customer's loan(s) of securities. Such disclosures would include, 
but not be limited to, (i) the loss of voting rights; (ii) the 
customer's right to sell the loaned securities and any limitations on 
the customer's ability to do so, if applicable; (iii) the factors that 
determine the amount of compensation received by the member and its 
associated persons in connection with the use of the securities 
borrowed from the customer; (iv) the factors that determine the amount 
of compensation (e.g., interest rate) to be paid to the customer and 
whether or not such compensation can be changed by the member under the 
terms of the borrow agreement; (v) the risks associated with each type 
of collateral provided to the customer; (vi) that the securities may be 
``hard-to-borrow'' because of short-selling or may be used to satisfy 
delivery requirements resulting from short sales; (vii) potential tax 
implications, including payments deemed cash-in-lieu of dividends paid 
on securities while on loan; and (viii) the member's right to liquidate 
the transaction because of a condition of the kind specified in 
proposed Rule 4314(b). FINRA believes this list provides greater 
clarity to members regarding the disclosures on rights and risks that 
must be given to customers prior to engaging in such securities 
borrows. This list is not intended to be

[[Page 54359]]

exhaustive, and firms need to carefully consider the disclosures that 
are applicable to their specific activity/program.
    One commenter seeks clarification that ``for those principal 
lenders utilizing lending agents the recipient of the required 
disclosures should be lending agents in their capacity as such, and not 
the underlying principals.'' \33\ FINRA believes that where the 
customer lender has legally authorized an agent to act on such 
customer's behalf in making a determination about whether to lend fully 
paid or excess margin securities to the member, the disclosures 
required pursuant to the proposed rule may be made to the lending agent 
in the lending agent's capacity as such, in lieu of being made to the 
underlying principal. FINRA also is proposing certain technical changes 
to the rule text as proposed in the Notice by adding headings to 
improve readability.

---------------------------------------------------------------------------

    \33\ See SIFMA letter.
---------------------------------------------------------------------------

3. Proposed FINRA Rule 4340 (Callable Securities)
    As detailed further above, proposed FINRA Rule 4340(a) would, among 
other things, require each member that has in its possession or under 
its control any security which, by its terms, may be called or redeemed 
prior to maturity, to establish and make available on the member's Web 
site procedures by which it will allocate among its customers the 
securities to be redeemed or selected as called in the event of a 
partial redemption or call.
    One commenter requests that FINRA clarify whether the requirement 
that a member post its allocation procedures on its Web site would 
require a firm ``to provide detailed, granular procedures'' or whether 
it would be sufficient to provide a general statement describing its 
allocation procedures.\34\ The commenter is concerned that, if detailed 
procedures are required, firms that clear through third parties and 
self-clearing firms using service bureaus systems would be unable to 
comply with the requirement as such procedures would constitute the 
third-parties' proprietary information that firms would not be able to 
disclose without permission from the third parties. In response, FINRA 
notes that the proposed rule requirement is intended to require a 
member to describe its allocation procedures in sufficient detail to 
allow customers to understand the process for partial redemptions and 
the outcome of such processes. FINRA does not believe that such 
description generally would require a member to disclose a third-
party's proprietary information.
---------------------------------------------------------------------------

    \34\ See SIFMA letter.
---------------------------------------------------------------------------

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2013-035 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2013-035. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. All comments 
received will be posted without change; the Commission does not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly.
    All submissions should refer to File Number SR-FINRA-2013-035 and 
should be submitted on or before September 24, 2013.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-21300 Filed 8-30-13; 8:45 am]
BILLING CODE 8011-01-P