Document ID: SEC-2009-0403-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2009-03-26T04:00Z

[Federal Register: March 26, 2009 (Volume 74, Number 57)]
[Notices]               
[Page 13283-13286]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr26mr09-123]                         

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59605; File No. SR-FINRA-2008-055]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Amendment No. 1 and Order Granting 
Accelerated Approval to a Proposed Rule Change, as Modified by 
Amendment No. 1, To Adopt FINRA Rule 2114 (Recommendations to Customers 
in OTC Equity Securities) in the Consolidated FINRA Rulebook

March 19, 2009.

I. Introduction

    On November 4, 2008, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') (f/k/a National Association of Securities Dealers, 
Inc. (``NASD'')) filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt FINRA Rule 2114 
(Recommendations to Customers in OTC Equity Securities) in the 
consolidated FINRA Rulebook. The proposed rule change was published for 
comment in the Federal Register on December 10, 2008.\3\ The Commission 
received three comments in response to the proposed rule change.\4\ On 
February 13, 2009, FINRA filed Amendment No. 1 to amend the proposed 
rule change and respond to the comment letters.\5\ This order provides 
notice of the proposed rule change, as modified by Amendment No. 1, and 
approves the proposed rule change as amended on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 59075 (December 10, 
2008), 73 FR 76429 (December 16, 2008) (SR-FINRA-2008-055) 
(``Rulemaking Notice'').
    \4\ See Ronald C. Long, Director of Regulatory Affairs, Wachovia 
Securities LLC, dated December 9, 2008 (``Wachovia Letter''); Dale 
E. Brown, CAE, President and CEO, Financial Services Institute, 
dated January 6, 2009 (``FSI Letter''); and Amal Aly, Esq., Managing 
Director and Associate General Counsel, Securities Industry and 
Financial Markets Association, dated January 6, 2009 (``SIFMA 
Letter'').
    \5\ Amendment No. 1 permits a General Securities Sales 
Supervisor (i.e., a Series 8 or Series 9/10 qualified supervisor) to 
perform certain reviews the proposed rule would otherwise have 
required a Series 24 principal to perform or supervise.
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    FINRA proposed to adopt NASD Rule 2315 (Recommendations to 
Customers in OTC Equity Securities) as FINRA Rule 2114 in the 
Consolidated FINRA Rulebook, subject to certain amendments including 
those contained in Amendment No. 1 discussed further below.

1. The Current Rule

    NASD Rule 2315 is intended to address potential fraud and abuse in 
transactions involving securities not listed on an exchange and certain 
other higher risk securities. The rule mandates that a member conduct a 
due diligence review of an issuer's current financial and business 
information before recommending a covered security. The rule 
supplements existing FINRA rules and the Federal securities law, 
including suitability obligations and the requirement that any 
recommendation to a customer have a reasonable basis. The rule 
requirements go beyond the basic suitability obligations to ensure that 
a registered representative has, at a minimum, confirmed the existence 
of and reviewed essential information that reveals the financial 
condition and business prospects of these riskier issuers.
    Specifically, the rule requires a member to review ``current 
financial statements'' and ``current material business information'' 
before it recommends the purchase or short sale of those securities 
that are published or quoted in a ``quotation medium'' and are either 
(1) not listed on Nasdaq or a national securities exchange or (2) are 
listed on a regional securities exchange and do not qualify for 
dissemination of transaction reports via the Consolidated Tape. Such 
securities may be more susceptible to fraud and abuse because they 
often are thinly capitalized or lack the profitability, liquidity or 
available business and financial information that listing standards 
require. The rule does not apply to recommendations to sell long 
positions and also exempts certain other transactions, including those 
with an ``institutional account'' under NASD Rule 3110(c)(4), a 
``qualified institutional buyer'' under Rule 144A of the Securities Act 
of 1933 (``Securities Act''), or a ``qualified purchaser'' under 
Section 2(a)(51) of the Investment Company Act of 1940.\6\
---------------------------------------------------------------------------

    \6\ Among the other exemptions, the Rule's requirements also do 
not apply to transactions that meet the requirements of Rule 504 of 
Regulation D of the Securities Act; those involving a security of an 
issuer with at least $50 million in total assets and $10 million in 
shareholder's equity; and those involving a security with worldwide 
average daily trading volume value of at least $100,000 during each 
of the six months preceding the recommendation.
---------------------------------------------------------------------------

    The rule defines ``current financial statements'' to include 
balance sheets, statements of profit and loss and

[[Page 13284]]

publicly available financial statements and reports. The definition 
makes certain distinctions between foreign private issuers and all 
other issuers. FINRA has interpreted the term ``current material 
business information'' to mean information that is available or relates 
to events that have occurred in the 12 months prior to the 
recommendation. The proposed definition of ``current material business 
information,'' discussed below, would supersede this prior 
interpretation.\7\
---------------------------------------------------------------------------

    \7\ Telephone conference among Philip Shaikun, Associate Vice 
President and Associate General Counsel, FINRA, and Haimera Workie, 
Branch Chief, Securities and Exchange Commission, and Darren Vieira, 
Attorney Advisor, Commission, on December 3, 2008.
---------------------------------------------------------------------------

    The required review must be conducted by a Series 24 principal or 
someone supervised by a Series 24 principal. Members are required to 
keep a written record of the information reviewed, the date of the 
review and the name of the person who conducted the review.

2. Proposed Changes to the Current Rule

    The proposed rule change would expand the scope of the rule to 
cover a recommendation to buy any ``OTC Equity Security,'' irrespective 
of whether the security is published on a quotation medium. The term 
``OTC Equity Security'' would have the same meaning as in NASD Rule 
6610 (which has been renumbered as FINRA Rule 6420 in the Consolidated 
FINRA Rulebook \8\) and encompasses any non-exchange-listed security 
and certain exchange-listed securities that do not otherwise qualify 
for real-time trade dissemination. FINRA believes that those OTC Equity 
Securities not published on a quotation medium pose the same, if not 
greater, risk of fraud and manipulation that the rule seeks to redress.
---------------------------------------------------------------------------

    \8\ See Securities Exchange Act Release No. 58643 (September 25, 
2008), 73 FR 57174 (October 1, 2008) (Order Approving SR-FINRA-2008-
021; SR-FINRA-2008-022; SR-FINRA-2008-026; SR-FINRA-2008-028 and SR-
FINRA-2008-029).
---------------------------------------------------------------------------

    The proposed rule change also would add a definition of ``current 
material business information'' to include ``information that is 
ascertainable through the reasonable exercise of professional diligence 
and that a reasonable person would take into account in reaching an 
investment decision.''
    The proposed rule change would eliminate the exemption from the 
rule for a security with a worldwide average daily trading volume value 
of at least $100,000 during each of the six calendar months preceding 
the recommendation, as well as a related exemption for a convertible 
security where the underlying security satisfies the trading volume 
exemption requirements. FINRA believes that the advent of the Internet 
and the increased number of trading venues has rendered that threshold 
unreliable to screen out less risky securities.
    Finally, as modified by Amendment No. 1, the proposed rule requires 
that the due diligence review must be conducted by a person registered 
as a General Securities Principal (Series 24) or General Securities 
Sales Supervisor (Series 8 or 9/10), or someone supervised by a General 
Securities Principal or General Securities Sales Supervisor.\9\ Members 
are required to keep a written record of the information reviewed, the 
date of the review and the name of the person who conducted the review. 
The proposed rule change would add a requirement that, in the event the 
person designated to perform the review is not registered as a General 
Securities Principal or General Securities Sales Supervisor, the member 
must document the name of the General Securities Principal or General 
Securities Sales Supervisor who supervised the designated person. FINRA 
believes this change will help document the person with supervising 
responsibility in association with review.\10\
---------------------------------------------------------------------------

    \9\ Series references relate to the relevant FINRA qualifying 
examination series. The Series 8 examination was replaced by the 
Series 9 and 10 examinations effective August 16, 1999. A list of 
qualifying series examinations is available at FINRA's Web site, 
http://www.finra.org.
    \10\ Telephone conference among Philip Shaikun, Associate Vice 
President and Associate General Counsel, FINRA, and Haimera Workie, 
Branch Chief and Darren Vieira, Attorney Advisor, on December 3, 
2008.
---------------------------------------------------------------------------

III. Comment Letters

    The Commission received three comments on the proposal,\11\ as well 
as FINRA's response to comments,\12\ all of which are discussed below. 
Two commenters, a full service brokerage firm and a trade association 
of securities firms, banks and asset managers, offered qualified 
support for the proposed rule change.\13\ One commenter, a trade 
association for the independent broker-dealer community, opposed the 
proposed rule change.\14\
---------------------------------------------------------------------------

    \11\ Ronald C. Long, Director of Regulatory Affairs, Wachovia 
Securities LLC, dated December 9, 2008 (``Wachovia Letter''); Dale 
E. Brown, CAE, President and CEO, Financial Services Institute, 
dated January 6, 2009 (``FSI Letter''); and Amal Aly, Esq., Managing 
Director and Associate General Counsel, Securities Industry and 
Financial Markets Association, dated January 6, 2009 (``SIFMA 
Letter'').
    \12\ Letter from Philip Shaikun, Associate Vice President and 
Associate General Counsel, FINRA, dated February 13, 2009 (``FINRA 
Letter'').
    \13\ See SIFMA and Wachovia Letters.
    \14\ See FSI Letter.
---------------------------------------------------------------------------

1. Review by a Series 24 Principal

    Proposed Rule 2114 would require a member to conduct a due 
diligence review of an issuer's current financial and business 
information before recommending a covered security. The proposed rule 
provides that the due diligence review must be performed by a Series 24 
registered principal, or by a designee of the Series 24 registered 
principal, in which case the member must keep a record of the Series 24 
principal who supervised the review. Two commenters suggested that a 
person with a Series 9/10 registration should be permitted to perform 
the reviews instead of Series 24 principals under the rule.\15\ One of 
those commenters also suggested that a person with a Series 8 
registration also should be permitted to perform these reviews.\16\ In 
response to these comments, FINRA amended the proposed rule to provide 
that either a General Securities Principal (i.e., a Series 24 
principal) or a General Securities Sales Supervisor (i.e., a Series 8 
or 9/10 supervisor) may perform the due diligence review.\17\
---------------------------------------------------------------------------

    \15\ Wachovia and SIFMA Letters.
    \16\ SIFMA Letter.
    \17\ Amendment No. 1 to SR-FINRA-2008-055.
---------------------------------------------------------------------------

2. Expanded Scope of the Rule to Any Non-Exempt OTC Equity Security

    FINRA's proposed rule is based on existing NASD Rule 2315. This 
rule requires a member to review ``current financial statements'' and 
``current material business information'' before it recommends the 
purchase or short sale of securities that are published or quoted in a 
``quotation medium'' and are either (1) not listed on Nasdaq or a 
national securities exchange or (2) are listed on a regional securities 
exchange and do not qualify for dissemination of transaction reports 
via the Consolidated Tape.\18\ The proposed rule change would expand 
the scope of the rule to cover a recommendation to buy any ``OTC Equity 
Security,'' irrespective of whether the security is published on a 
quotation medium.
---------------------------------------------------------------------------

    \18\ NASD Rule 2315 had not been amended to reflect Nasdaq's 
registration as a national securities exchange.
---------------------------------------------------------------------------

    The proposed rule would also eliminate the exemption in NASD Rule 
2315(e)(1)(E) for a security with a worldwide average daily trading 
volume value of at least $100,000 during each month of the six full 
calendar months immediately before the date of the recommendation, and 
a related exemption for a convertible security

[[Page 13285]]

where the underlying security meets the requirements of NASD Rule 
2315(e)(1)(E). Two commenters opposed eliminating this exemption.\19\ 
One commenter indicated that the elimination of the exemption would 
require a due diligence review to be conducted for large, well-
capitalized companies whose securities, in the commenter's opinion, 
likely do not pose the type of risk that is intended to be addressed by 
the proposed rule.\20\ The commenter also suggested, as an alternative 
or in addition to the exemption for securities with a worldwide average 
daily trading volume value of over $100,000, that FINRA adopt an 
exemption based on the underlying company's market capitalization.\21\ 
FINRA responded that it proposed to eliminate average daily trading 
volume and convertible security exemptions out of concern that the 
advent of the Internet and the increased number of trading venues has 
rendered the trading volume threshold unreliable to screen out less 
risky securities.\22\ FINRA noted that bringing certain larger 
companies within the purview of the rule does not dissipate this 
investor protection concern, and FINRA additionally noted that certain 
larger companies may qualify for another exemption to the rule applying 
to the securities of issuers that have at least $50 million of total 
assets and $10 million in shareholders' equity.\23\
---------------------------------------------------------------------------

    \19\ SIFMA and FSI Letters.
    \20\ SIFMA Letter.
    \21\ Id.
    \22\ FINRA Letter.
    \23\ Id.
---------------------------------------------------------------------------

    One commenter opposed any expansion of the scope of the proposed 
rule beyond the scope of the NASD rule.\24\ In this commenter's view, 
the expansion of the scope of the proposed rule would: (1) ``result in 
reduced investor access to these securities by increasing the barriers 
to entry in the marketplace''; (2) delay the processing of purchases of 
non-exempt OTC Equity Securities; (3) reduce competition as firms leave 
the market of providing OTC Equity Security execution; (4) subject 
firms that remain in the market to higher compliance burdens; and (5) 
cause ``overwhelming'' recordkeeping and compliance burdens. FINRA 
disagreed that the proposed amendment would cause such deleterious 
effects.\25\ FINRA stated that it believes investors will be better 
protected by the proposed rule amendment because recommendations of OTC 
Equity Securities that trade in the unlisted market, absent the due 
diligence required by the rule, pose substantial risk to investors.\26\ 
FINRA also noted that the proposal would apply only to recommendations 
(as does the current rule), and not to unsolicited transactions, and 
therefore would not deny investors access to the OTC Equity Securities 
market. FINRA also disagreed that the proposal will result in 
processing delays for purchases of OTC Equity Securities, noting that 
the required due diligence should be completed before the 
recommendation is made.\27\
---------------------------------------------------------------------------

    \24\ FSI Letter.
    \25\ FINRA Letter.
    \26\ Id.
    \27\ Id.
---------------------------------------------------------------------------

3. Miscellaneous Comments

    One commenter suggested that FINRA provide an exemption from the 
proposed rule for firms that (1) generate less than 5% of their 
commission revenue from OTC Equity Securities transactions, and (2) do 
not make a market in such securities.\28\ The commenter asserted that 
such an exemption would allow FINRA to meet its investor protection 
goals without causing ``unintended consequences'' such as increasing 
compliance burdens or reducing competition.\29\ FINRA stated that it 
believes that such an exemption would undermine the purpose of the rule 
by allowing a significant volume of OTC Equity Securities to escape the 
rule's review requirements.\30\
---------------------------------------------------------------------------

    \28\ FSI Letter.
    \29\ Id.
    \30\ FINRA Letter.
---------------------------------------------------------------------------

IV. Discussion and Commission Findings

    After careful review of the proposed rule change, the comments, and 
FINRA's response to the comments, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act, 
and the rules and regulations thereunder that are applicable to a 
national securities association.\31\ In particular, the Commission 
believes the proposed rule change is consistent with the provisions of 
Section 15A(b)(6) of the Act,\32\ 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. The Commission believes that the proposed rule change 
will help protect investors against fraud in the trading of unlisted 
and certain other securities and will clarify and streamline NASD Rule 
2315 for adoption as a FINRA Rule in the new Consolidated FINRA 
Rulebook. The Commission has found NASD Rule 2315, upon which the 
proposed rule is based, to be consistent with the requirements of the 
Act and the rules and regulations thereunder applicable to a national 
securities association.\33\
---------------------------------------------------------------------------

    \31\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition and capital 
formation. See 15 U.S.C. 78c(f).
    \32\ 15 U.S.C. 78o-3(b)(6).
    \33\ See Order Approving Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval to Amendment No. 2 to 
the Proposed Rule Change by the National Association of Securities 
Dealers, Inc. Relating to Microcap Initiative--Recommendation Rule, 
Securities Exchange Act Release No. 46376 (August 19, 2002), 67 FR 
54832 (August 26, 2002) (SR-NASD-99-04).
---------------------------------------------------------------------------

    The Commission also finds good cause for approving Amendment No. 1 
to the proposed rule change prior to the thirtieth day after the date 
of publication of notice in the Federal Register. Amendment No. 1 
clarifies the operation of the proposed rule in response to a comment. 
The changes in Amendment No. 1 do not significantly alter the proposed 
rule which was subject to a full notice and comment period. The 
Commission finds that it is in the public interest to approve the 
proposed rule change, as modified by Amendment No. 1, as soon as 
possible to expedite its implementation. Accordingly, the Commission 
finds that there is good cause, consistent with and in furtherance of 
the objectives of Sections 6(b)(5) \34\ and 19(b) \35\ of the Act, to 
approve Amendment No. 1 on an accelerated basis.
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78f(b)(5).
    \35\ 15 U.S.C. 78s(b).
---------------------------------------------------------------------------

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as modified by Amendment No. 1, 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 e-mail to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2008-055 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.

[[Page 13286]]

All submissions should refer to File Number SR-FINRA-2008-055. This 
file number should be included on the subject line if e-mail 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 inspection 
and copying 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-2008-055 and should be 
submitted on or before April 16, 2009.

VI. Conclusions

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\36\ that the proposed rule change (SR-FINRA-2008-055), as modified 
by Amendment No. 1, be, and hereby is, approved on an accelerated 
basis.
---------------------------------------------------------------------------

    \36\ 15 U.S.C. 78s(b)(2).

For the Commission, by the Division of Trading and Markets, pursuant 
to delegated authority.\37\
---------------------------------------------------------------------------

    \37\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-6659 Filed 3-25-09; 8:45 am]

BILLING CODE 8010-01-P