Document ID: SEC-2014-1635-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2014-09-29T04:00Z

[Federal Register Volume 79, Number 188 (Monday, September 29, 2014)]
[Notices]
[Pages 58390-58393]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-23048]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73192; File No. SR-FINRA-2014-025]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Amendment No. 1, and Order 
Granting Accelerated Approval of a Proposed Rule Change, as Modified by 
Amendment No. 1, To Adopt a Supplementary Schedule for Inventory 
Positions Pursuant to FINRA Rule 4524 (Supplemental FOCUS Information)

September 23, 2014.

I. Introduction

    On June 16, 2014, the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission''), pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt a supplementary schedule 
for inventory positions pursuant to FINRA Rule 4524 (Supplemental FOCUS 
Information). The proposed rule change was

[[Page 58391]]

published for comment in the Federal Register on June 26, 2014.\3\ The 
Commission received three comment letters on the proposed rule 
change.\4\ On September 22, 2014, FINRA filed Amendment No. 1 with the 
Commission to respond to the comment letters and to add clarifying 
instructions.\5\ The Commission is publishing this notice and order to 
solicit comments on Amendment No. 1 and to approve the proposed rule 
change, as modified by Amendment No. 1, on an accelerated basis.
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    \1\ See 15 U.S.C. 78s(b)(1).
    \2\ See 17 CFR 240.19b-4.
    \3\ See Exchange Act Release No. 72444 (June 20, 2014), 79 FR 
36357 (June 26, 2014).
    \4\ See Letter from Holly H. Smith, Sutherland Asbill & Brennan 
LLP, to Elizabeth M. Murphy, Secretary, SEC, dated July 17, 2014 
(``Sutherland''); Letter from Howard Spindel, Senior Managing 
Director, and Cassondra E. Joseph, Managing Director, Integrated 
Management Solutions USA LLC, to Elizabeth M. Murphy, Secretary, 
SEC, dated July 17, 2014 (``IMS''); Letter from Suzanne Shatto, 
dated September 7, 2014 (``Shatto'').
    \5\ See SEC File No. SR-FINRA-2014-025 Amendment No. 1, dated 
September 22, 2014 (``Amendment No. 1''). Amendment No. 1 is 
described below in Section III and the text of Amendment No. 1 is 
available on FINRA's Web site at http://www.finra.org, at the 
principal office of FINRA, and on the Commission's Web site at 
http://www.sec.gov/rules/sro.shtml.
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II. Description of Proposal

    Pursuant to Exchange Act Rule 17a-5,\6\ most firms are required to 
file with FINRA reports concerning their financial and operational 
status using the Financial and Operational Combined Uniform Single 
(FOCUS) Report.\7\ In general, firms with a FOCUS filing requirement 
must either file a FOCUS Report Part II if they clear transactions or 
carry customer accounts \8\ or file a FOCUS Report Part IIA if they do 
not.\9\ Firms that are government securities broker-dealers registered 
under Section 15C of the Exchange Act \10\ do not file a FOCUS Report 
and instead are required to file reports concerning their financial and 
operational status using the Report on Finances and Operations of 
Government Securities Brokers and Dealers (``FOGS Report'').\11\ These 
firms are required to file a FOGS Report Part I and either a FOGS 
Report Part II if they clear transactions or carry customer accounts or 
FOGS Report Part IIA if they do not.\12\
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    \6\ See 17 CFR 240.17a-5.
    \7\ See SEC Form X-17A-5.
    \8\ Firms that calculate net capital using Appendix E to 
Exchange Act Rule 15c3-1 file FOCUS Report Part II CSE, rather than 
FOCUS Report Part II.
    \9\ See 17 CFR 240.17a-5.
    \10\ See 15 U.S.C. 78o-5.
    \11\ See Department of the Treasury Form G-405.
    \12\ See 17 CFR 405.2; 17 CFR 240.17a-5.
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    FINRA Rule 4524 (Supplemental FOCUS Information) requires each 
firm, as FINRA shall designate, to file such additional financial or 
operational schedules or reports as FINRA may deem necessary or 
appropriate for the protection of investors or in the public interest 
as a supplement to the FOCUS Report.\13\ Pursuant to FINRA Rule 4524, 
FINRA is proposing the adoption of a supplemental schedule to the FOCUS 
Report Part II, FOCUS Report Part IIA and the FOGS Report Part I that 
would provide more detailed information about inventory positions held 
by firms. The proposed Supplemental Inventory Schedule (``SIS'') would 
be due 20 business days after the end of a firm's FOCUS or FOGS 
reporting period.\14\
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    \13\ The reference to FOCUS Reports under FINRA Rule 4524 
includes FOGS Reports required to be filed by government securities 
broker-dealers registered under Section 15C of the Exchange Act in 
lieu of FOCUS Reports.
    \14\ Firms that file FOCUS Report Part II CSE would not be 
subject to the proposed SIS. As part of FOCUS Report Part II CSE, 
the Aggregate Securities and OTC Derivative Positions schedule 
requires firms to provide information that is similar to the 
proposed SIS.
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    The proposal requires the SIS to be filed by firms that are 
required to file FOCUS Report Part II, FOCUS Report Part IIA or FOGS 
Report Part I with inventory positions as of the end of the FOCUS or 
FOGS reporting period with two exceptions. The first exception is for 
firms that have a minimum dollar net capital or liquid capital 
requirement \15\ of less than $100,000. Such firms are not allowed to 
engage in dealer activities and are limited to 10 proprietary 
transactions per year. Further, such firms are not permitted to self-
clear or carry customer accounts. The second exception is for firms 
that have inventory positions consisting only of money market mutual 
funds. Money market mutual funds limit their investments to short-term, 
high-quality debt securities and are permitted to sell and redeem 
shares at a stable price, typically at $1.00 per share, without regard 
to small variations in the value of the funds' underlying 
securities.\16\ A firm with inventory positions consisting only of 
money market mutual funds would need to affirmatively indicate through 
functionality on the eFOCUS system that no SIS filing is required for 
the reporting period. FINRA believes that firms that meet either of 
these two criteria pose significantly less risk to customers and other 
market participants. These exceptions would not only minimize the 
burden on firms, but also would allow FINRA to focus its resources 
where the risk is most concerning.
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    \15\ Firms that file the FOCUS Report must comply with a minimum 
dollar net capital requirement, while firms that file the FOGS 
Report must comply with a minimum liquid capital requirement.
    \16\ See Securities Act Release No. 9408 (June 5, 2013), 78 FR 
36834, 36835 (June 19, 2013) (Proposed Rule: Money Market Fund 
Reform; Amendments to Form PF).
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    The proposed SIS is intended to capture more details of a firm's 
long and short inventory positions than what is captured on the FOCUS 
Report Part II, FOCUS Report Part IIA and FOGS Report Part I. For 
example, FOCUS Report Part II, FOCUS Report Part IIA and FOGS Report 
Part I require total inventory of securities sold short to be reported 
in aggregate (Item 1620), providing no information on the types of 
securities sold short by firms. In addition, FOGS Report Part I 
requires that all long inventory be reported in aggregate (Item 850). 
Further, on FOCUS Report Part II and IIA, long inventory is reported in 
categories that aggregate securities with different market risk 
profiles (e.g., the Corporate Obligations category on the FOCUS Report 
Part II (Item 400) and Debt Securities category on the FOCUS Report 
Part IIA (Item 419) include single name corporate bonds, private-label 
mortgage-backed securities and foreign issuer debt obligations). The 
proposed SIS would enhance FINRA's ongoing surveillance monitoring of 
firms' financial condition by providing greater transparency into the 
market risk posed by a firm's inventory positions and the potential 
impact to a firm's net capital or liquid capital, as well as related 
funding and liquidity needs. In addition, the information provided by 
the proposed SIS would enable FINRA staff to perform more targeted 
examinations of firms' market risk exposure.
    The proposed rule change will be effective upon Commission 
approval. FINRA will announce the implementation date of the proposed 
supplemental schedule in a Regulatory Notice to be published no later 
than 60 days following Commission approval. The due date for the first 
proposed schedule will be no later than 90 days following Commission 
approval of the proposed rule change.

III. Summary of Comment Letters, FINRA's Response, and Amendment No. 1

    As stated above, the Commission received three comment letters in 
response to the proposed rule change.\17\ One commenter opposed the 
definition of ``arbitrage'' in the instructions for the SIS and 
questioned why the definition was limited to firms that have a separate 
arbitrage trading desk.\18\ The commenter stated that the SIS should 
take into account arbitrage strategies and

[[Page 58392]]

recommended amending the SIS to allow firms ``to indicate how much of 
the gross market value reported in the long or short columns 
represented positions that were offsets or related to other positions, 
directly or indirectly.'' \19\ In addition, the commenter recommended 
eliminating line 10 (Arbitrage) and the parenthetical description on 
line 9 (Stocks and Warrants (other than arbitrage positions)) on the 
SIS on the grounds that they would become redundant if the columns for 
offsets were added.\20\ Finally, the commenter suggested the definition 
of ``arbitrage'' in the instructions ``be changed to indicate something 
to the effect that arbitrage is whatever the reporting firm thinks it 
is.'' \21\
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    \17\ See supra note 4.
    \18\ See IMS.
    \19\ See IMS.
    \20\ See IMS.
    \21\ See IMS.
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    In response to the commenter's concern regarding the definition of 
``arbitrage,'' FINRA agrees that the definition should not be limited 
to firms that have a separate arbitrage trading desk and is proposing 
to amend the instructions to provide that firms would report the market 
value of all securities that are part of a ``bona fide arbitrage.'' For 
purposes of the SIS, a security would be considered part of a ``bona 
fide arbitrage'' if a security is convertible into or exchangeable for 
another security within a period of 90 days, subject to no conditions 
other than the payment of money, and the other securities into which 
such security is convertible or for which it is exchangeable, are short 
in the accounts of such broker or dealer. The definition of ``bona fide 
arbitrage'' is substantially similar to the provision in Exchange Act 
Rule 15c3-1(c)(2)(vi)(J)(1). With respect to the additional changes 
requested by the commenter, FINRA believes, at this time, that the 
proposed SIS captures the information that is needed to enable FINRA 
staff to assess the related market risk and impact on firms' liquidity 
and funding needs arising from inventory holdings.
    Another commenter had concerns ``with FINRA's piecemeal approach to 
requesting supplemental financial and operational information'' and 
recommended ``that FINRA coordinate with the SEC to propose an amended 
FOCUS report that requests all of the information FINRA is collecting 
or plans to collect from firms via supplementary schedules or 
reports.'' \22\ In addition, the commenter requested that FINRA: (1) 
``define the term `inventory' by reference to specific reporting lines 
of the FOCUS report, so that member firms know exactly what FOCUS line 
items are required to be dis-aggregated for the SIS''; (2) confirm that 
``investments held by member firms for the purpose of funding employee 
benefit plans for a member firm's associated persons'' would not be 
considered inventory under the SIS; and (3) publish general directions 
for firms with nothing to report because they have no inventory.\23\
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    \22\ See Sutherland.
    \23\ See Sutherland.
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    In response to the commenter's recommendation that FINRA coordinate 
with the SEC to propose an amended FOCUS Report, FINRA proposed the SIS 
pursuant to FINRA Rule 4524, which, subject to FINRA meeting the 
requirements of Section 19(b)(1) of the Exchange Act \24\ and Rule 19b-
4 thereunder,\25\ provides an independent basis for FINRA to supplement 
information provided on FOCUS and FOGS Reports filed pursuant to 
Exchange Act Rule 17a-5 and FINRA Rule 2010.\26\ In response to this 
commenter, FINRA further notes that Form X-17A-5 is an SEC form, and 
any changes to it must be proposed and adopted by the SEC. However, 
FINRA would support updates to Form X-17A-5 by the SEC that would 
incorporate more detailed reporting, and, if such updates were made, 
FINRA staff would seek to reduce accordingly the requirement for firms 
to file supplemental information. With respect to the term 
``inventory,'' for purposes of the SIS, FINRA is proposing to define 
the term ``inventory positions'' to mean securities or commodities 
positions (long, short or both) which are required to be reported on 
the balance sheet pursuant to GAAP. Consequently, if ``investments held 
by member firms for the purpose of funding employee benefit plans for a 
member firm's associated persons'' fall within the term ``inventory 
positions,'' as defined in the proposed SIS, then such investments 
would be required to be reported. Finally, in regard to firms with 
nothing to report, the eFOCUS system would not require an affirmative 
indication from the firm that no filing is required for the reporting 
period.
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    \24\ See 15 U.S.C. 78s(b)(1).
    \25\ See 17 CFR 240.19b-4.
    \26\ See Securities Exchange Act Release No. 66364 (Feb. 9, 
2012), 77 FR 8938 (Feb. 15, 2012) (Order Granting Accelerated 
Approval of SR-FINRA-2011-064).
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    A third commenter raised a number of issues that are outside the 
scope of the proposal.\27\ This commenter, however, also suggested 
daily reporting for the proposed SIS.\28\ FINRA believes daily 
reporting for the proposed SIS would be overly burdensome on firms 
without a concomitant benefit to FINRA regarding its understanding of a 
firm's market risk.
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    \27\ See Shatto.
    \28\ See Shatto.
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    In addition to the changes proposed in response to some of the 
comments the SEC received, discussed above, FINRA is proposing to 
clarify that the capital exception for filing the proposed SIS is based 
on the minimum dollar net capital requirement or liquid capital 
requirement. Firms that have a minimum dollar net capital or liquid 
capital requirement, as applicable, of less than $100,000 would not 
have to file the proposed SIS.

IV. Commission's Findings

    After careful consideration of the proposed rule change, as 
modified by Amendment No. 1, the comment letters received, and FINRA's 
response to the comment letters, the Commission finds that the proposed 
rule change, as modified by Amendment No. 1, is consistent with the 
requirements of the Exchange Act, and the rules and regulations 
thereunder that are applicable to a national securities 
association.\29\ In particular, the Commission finds that the proposal, 
as modified by Amendment No. 1, is consistent with Section 15A(b)(6) of 
the Exchange Act,\30\ which requires, among other things, that the 
rules of a national securities association be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest. The 
Commission believes that FINRA adequately addressed the comments raised 
in response to FINRA's notice.
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    \29\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \30\ See 15 U.S.C. 78o-3(b)(6).
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    The proposed SIS should provide FINRA with the ability to obtain 
more specific information about the inventory of a member broker-
dealer. Thus, the Commission believes that the proposed rule change, as 
modified by Amendment No. 1, is consistent with the provisions of the 
Exchange Act noted above in that the proposed SIS could provide FINRA 
with greater insights into the types of securities held in inventory by 
firms and the related market risk associated with such inventory 
positions. In addition, the proposed SIS would enable FINRA staff to 
review inventory

[[Page 58393]]

trends and assess the related impact on firms' liquidity and funding 
needs. The information provided on the proposed SIS would be used by 
FINRA to monitor firms' financial condition and perform more targeted 
examinations of firms' market risk exposure.
    The Commission believes that the proposed rule change, as modified 
by Amendment No. 1, works in conjunction with the existing Commission 
broker-dealer financial responsibility rules and will further FINRA's 
ability to oversee its members by, among other things, capturing trends 
in the securities held in broker-dealers' inventory.
    The Commission does not believe that the proposed rule change, as 
modified by Amendment No. 1, will result in burden on competition that 
is not necessary or appropriate in furtherance of the purposes of the 
Exchange Act. As stated above, the Commission believes the proposed SIS 
will allow FINRA to better understand the potential impact of broker-
dealers' inventory on net capital, leverage and liquidity, and ability 
to fulfill customer protection obligations. Ready access to the 
information in the proposed SIS is important for FINRA to efficiently 
monitor on an ongoing basis the financial condition of firms.
    The Commission also believes FINRA has carefully crafted the 
proposed SIS to achieve its intended and necessary regulatory purpose 
while being cognizant of the burden on firms. The information required 
to complete the proposed SIS should be readily available to firms due 
to firms' obligations to maintain books and records and apply 
applicable capital charges to their inventory. Further, for smaller 
firms, the proposed SIS contains exceptions for firms that (1) have a 
minimum dollar net capital or liquid capital requirement, as 
applicable, of less than $100,000, or (2) have inventory positions 
consisting only of money market mutual funds.

V. Accelerated Approval

    The Commission finds good cause, pursuant to Section 19(b)(2) of 
the Exchange Act \31\ for approving the proposal, as modified by 
Amendment No. 1, prior to the 30th day after publication of Amendment 
No. 1 in the Federal Register. The changes proposed in Amendment No. 1 
are technical or clarifying changes and do not raise regulatory 
concerns.
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    \31\ See 15 U.S.C. 78s(b)(2).
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    Accordingly, the Commission finds that good cause exists to approve 
the proposal, as modified by Amendment No. 1, on an accelerated basis.

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether Amendment No. 1 
to the proposed rule change is consistent with the Exchange 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-2014-025 on the subject line.

Paper Comments

     Send paper comments in triplicate to Brent J. Fields, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2014-025. 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-2014-025 and should be 
submitted on or before October 20, 2014.

VII. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Exchange Act,\32\ that the proposed rule change (SR-FINRA-2014-025), as 
modified by Amendment No. 1, be and hereby is approved on an 
accelerated basis.
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    \32\ See 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\33\
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    \33\ See 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2014-23048 Filed 9-26-14; 8:45 am]
BILLING CODE 8011-01-P