Document ID: SEC-2021-0694-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2021-05-12T04:00Z

[Federal Register Volume 86, Number 90 (Wednesday, May 12, 2021)]
[Notices]
[Pages 26084-26109]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-10055]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-91789; File No. SR-FINRA-2021-008]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of a Proposed Rule Change Relating to 
Security-Based Swaps

May 7, 2021.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 26, 2021, the 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 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 amend FINRA Rules 0180, 4120, 4210, 4220, 
4240 and 9610 to clarify the application of its rules to security-based 
swaps (``SBS'') following the SEC's completion of its rulemaking 
regarding SBS dealers (``SBSDs'') and major SBS participants 
(``MSBSPs'') (collectively, ``SBS Entities'').
    The text of the proposed rule change is available on FINRA's 
website 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
Background
    On July 21, 2010, President Obama signed into law the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank 
Act'').\3\ Title VII of the Dodd-Frank Act, entitled the ``Wall Street 
Transparency and Accountability Act of 2010,'' \4\ established a 
comprehensive new regulatory framework for over-the-counter (``OTC'') 
derivatives known in the industry as ``swaps,'' which were generally 
unregulated in the United States prior to passage of the Dodd-Frank 
Act. Among other things, Title VII of the Dodd-Frank Act was intended 
to implement in the United States the mandate agreed by the G20 in 
September 2009 for its members to improve the OTC derivatives markets 
by improving transparency, mitigating systemic risk and protecting 
against market abuse.\5\
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    \3\ Public Law 111-203, 124 Stat. 1376 (2010).
    \4\ See Dodd-Frank Act Section 701.
    \5\ See G20 Leaders' Statement from The Pittsburgh Summit (Sept. 
24-25, 2009), https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
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    Generally, Title VII of the Dodd-Frank Act divided regulatory 
jurisdiction over swap products between the Commodity Futures Trading 
Commission (``CFTC'') and the SEC, with the CFTC regulating ``swaps'' 
and the SEC regulating SBS.\6\

[[Page 26085]]

The Dodd-Frank Act directed the SEC to promulgate rulemakings 
implementing the new regulatory framework for SBS, including rules 
requiring SBS Entities to register with the SEC; business conduct and 
supervision requirements, risk mitigation techniques and other rules 
specifically applicable to SBS Entities; recordkeeping and financial 
reporting rules for SBS Entities; capital, margin and segregation 
requirements for SBS Entities; rules requiring regulatory reporting and 
public dissemination of SBS information; and processes to require SBS 
to become subject to mandatory clearing and execution on a registered 
or exempt execution facility or exchange.\7\ The Commission has now 
finalized a majority of its rulemakings pursuant to Title VII of the 
Dodd-Frank Act (the ``Title VII rulemakings'').\8\ The Commission has 
also established the compliance date for registration of SBS Entities, 
which will be October 6, 2021 (the ``Registration Compliance Date''), 
and has broadly coordinated the compliance date for a number of other 
Title VII rulemakings with the Registration Compliance Date.\9\ 
Accordingly, beginning on October 6, 2021, registered SBS Entities will 
become subject to the Title VII rulemakings, and the deadline for the 
initial wave of SBS Entity registrations is November 1, 2021.\10\
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    \6\ The terms ``swap'' and ``security-based swap'' are defined 
in Sections 721 and 761 of the Dodd-Frank Act. The Commission and 
the CFTC have jointly promulgated rules further defining these 
terms. See Securities Exchange Act Release No. 67453 (July 18, 
2012), 77 FR 48208 (August 13, 2012) (Further Definition of 
``Swap,'' ``Security-Based Swap,'' and ``Security-Based Swap 
Agreement''; Mixed Swaps; Security-Based Swap Agreement 
Recordkeeping) (``Product Definitions''). Very generally, SBS are 
swaps referencing a single security or loan, or a narrow-based 
security index. Certain products sharing characteristics of both 
swaps and SBS are regulated as ``mixed swaps'' subject to both CFTC 
and SEC jurisdiction.
    \7\ See Dodd-Frank Act Section 763.
    \8\ See Securities Exchange Act Release No. 74244 (February 11, 
2015), 80 FR 14564 (March 19, 2015) (Regulation SBSR--Reporting and 
Dissemination of Security-Based Swap Information) (``Regulation SBSR 
Release''); Securities Exchange Act Release No. 75611 (August 5, 
2015), 80 FR 48964 (August 14, 2015) (Final Rule: Registration 
Process for Security-Based Swap Dealers and Major Security-Based 
Swap Participants) (``Registration Process Release''); Securities 
Exchange Act Release No. 77617 (April 14, 2016), 81 FR 29960 (May 
13, 2016) (Final Rule: Business Conduct Standards for Security-Based 
Swap Dealers and Major Security-Based Swap Participants) (``Business 
Conduct Standards Release''); Securities Exchange Act Release No. 
78011 (June 8, 2016), 81 FR 39808 (June 17, 2016) (Final Rule: Trade 
Acknowledgment and Verification of Security-Based Swap Transactions) 
(``Trade Acknowledgment and Verification Release''); Securities 
Exchange Act Release No. 86175 (June 21, 2019), 84 FR 43872 (August 
22, 2019) (Final Rule: Capital, Margin, and Segregation Requirements 
for Security-Based Swap Dealers and Major Security-Based Swap 
Participants and Capital and Segregation Requirements for Broker-
Dealers) (``Capital, Margin, and Segregation Release''); Securities 
Exchange Act Release No. 87005 (September 19, 2019), 84 FR 68550 
(December 16, 2019) (Final Rule: Recordkeeping and Reporting 
Requirements for Security-Based Swap Dealers, Major Security-Based 
Swap Participants, and Broker-Dealers) (``Recordkeeping Release''); 
Securities Exchange Act Release No. 87780 (December 18, 2019), 85 FR 
6270 (February 4, 2020) (Final Rules; Guidance: Rule Amendments and 
Guidance Addressing Cross-Border Application of Certain Security-
Based Swap Requirements) (``Cross-Border Release''); Securities 
Exchange Act Release No. 87782 (December 18, 2019), 85 FR 6359 
(February 4, 2020) (Final Rule: Risk Mitigation Techniques for 
Uncleared Security-Based Swaps) (``Risk Mitigation Release''). The 
SEC has also proposed, but not yet finalized, rules governing SBS 
execution facilities (``SBSEFs'') and rules regarding fraud in the 
SBS market. See Securities Exchange Act Release No. 63236 (November 
3, 2010), 75 FR 68560 (November 8, 2010) (Prohibition Against Fraud, 
Manipulation, and Deception in Connection with Security-Based Swaps; 
Proposed Rule); Securities Exchange Act Release No. 63825 (February 
2, 2011), 76 FR 10948 (February 28, 2011) (Registration and 
Regulation of Security-Based Swap Execution Facilities; Proposed 
Rule; Proposed Interpretation).
    \9\ See Cross-Border Release supra note 8, at 6345. The 
Commission stated that the Registration Compliance Date for SBS 
Entities will be 18 months after the effective date of the rules 
adopted pursuant to the Cross-Border Release, which was April 6, 
2020. See Cross-Border Release at 6270. Generally, the other Title 
VII rulemakings will apply to SBS Entities upon registration with 
the SEC. The first compliance date for SBS reporting under 
Regulation SBSR will be the first Monday that is the later of (1) 
six months after the date on which the first SBS data repository 
(``SBSDR'') that can accept reports in a given asset class registers 
with the SEC and (2) one month after the Registration Compliance 
Date. See Cross-Border Release at 6346. No SBSDRs are currently 
registered with the SEC.
    \10\ The Registration Compliance Date is October 6, 2021. The 
SEC has also clarified that the transitional period before a person 
that is deemed to be an SBSD must register with the SEC runs until 
two months after the end of the month in which the person is no 
longer able to satisfy the de minimis exception from the SBSD 
definition. Therefore, entities exceeding the de minimis threshold 
on the first counting date of August 6, 2021 or later in August 2021 
must register no later than November 1, 2021. See SEC, Key Dates for 
Registration of Security-Based Swap Dealers and Major Security-Based 
Swap Participants, https://www.sec.gov/page/key-dates-registration-security-based-swap-dealers-and-major-security-based-swap-participants (``SEC Transitional Period Guidance'').
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    Title VII of the Dodd-Frank Act also amended the definition of 
``security'' under the Act to expressly encompass SBS.\11\ Therefore, 
in addition to the comprehensive new SBS-specific regulatory framework 
discussed above, SBS are now also defined as securities under the Act 
and the rules thereunder. This amendment to the Act was effective as of 
July 16, 2011, the effective date of Title VII of the Dodd-Frank Act. 
However, to allow sufficient time to consider the potentially complex 
interpretive issues that may arise by defining SBS as securities, the 
SEC issued a series of temporary exemptive orders beginning in July 
2011.\12\ With limited exceptions, the SEC's temporary exemptive orders 
relating to the regulation of SBS as securities have now expired or 
will expire on the Registration Compliance Date.\13\
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    \11\ See Dodd-Frank Act Section 761(a)(2) (inserting ``security-
based swap'' in the definition of ``security'' in Section 3(a)(10) 
of the Act); see also 15 U.S.C. 78c(a)(10).
    \12\ See, e.g., Securities Exchange Act Release No. 64795 (July 
1, 2011), 76 FR 39927 (July 7, 2011) (Order Granting Temporary 
Exemptions Under the Securities Exchange Act of 1934 in Connection 
With the Pending Revision of the Definition of ``Security'' To 
Encompass Security-Based Swaps, and Request for Comment) (``2011 
Exemptive Order''); Securities Exchange Act Release No. 71485 
(February 5, 2014), 79 FR 7731 (February 10, 2014) (Order Extending 
Temporary Exemptions Under the Securities Exchange Act of 1934 in 
Connection With the Revision of the Definition of ``Security'' to 
Encompass Security-Based Swaps, and Request for Comment).
    \13\ See Securities Exchange Act Release No. 84991 (January 25, 
2019), 84 FR 863 (January 31, 2019) (Order Granting a Limited 
Exemption from the Exchange Act Definition of ``Penny Stock'' for 
Security-Based Swap Transactions between Eligible Contract 
Participants; Granting a Limited Exemption from the Exchange Act 
Definition of ``Municipal Securities'' for Security-Based Swaps; and 
Extending Certain Temporary Exemptions under the Exchange Act in 
Connection with the Revision of the Definition of ``Security'' to 
Encompass Security-Based Swaps) (``2019 Exemptive Order''); 
Securities Exchange Act Release No. 90308 (November 2, 2020), 85 FR 
70667 (November 5, 2020) (Order Granting Exemptions from Sections 8 
and 15(a)(1) of the Securities Exchange Act of 1934 and Rules 3b-
13(b)(2), 8c-1, 10b-10, 15a-1(c), 15a-1(d) and 15c2-1 Thereunder in 
Connection with the Revision of the Definition of ``Security'' to 
Encompass Security-Based Swaps and Determining the Expiration Date 
for a Temporary Exemption from Section 29(b) of the Securities 
Exchange Act of 1934 in Connection with Registration of Security-
Based Swap Dealers and Major Security-Based Swap Participants). 
Generally, the SEC has extended the expiration date for the 
temporary exemptions directly related to pending SBS rulemakings 
until the compliance date for the related SBS rulemakings. Temporary 
exemptions not directly linked to SBS rulemakings have either 
expired or, in certain limited circumstances, been extended or made 
permanent.
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    The addition of SBS to the definition of ``security'' under the Act 
had similar implications for FINRA rules. In particular, under the 
amended definition, any FINRA rule that applies to FINRA members' 
activities involving a security, securities business, a transaction 
involving a security or a securities position applies by its terms to 
those activities involving SBS. Therefore, consistent with the SEC's 
actions in this area, on July 8, 2011, FINRA filed for immediate 
effectiveness FINRA Rule 0180, which, with certain exceptions noted 
below, temporarily limits the application of FINRA rules with respect 
to SBS, thereby avoiding undue market disruptions resulting from the 
change to the definition of ``security'' under the Act.\14\ Pending the 
SEC's final implementation of the Title

[[Page 26086]]

VII rulemakings, FINRA has extended the expiration date of FINRA Rule 
0180 a number of times, mostly recently in January 2020.\15\ FINRA Rule 
0180 is currently set to expire on September 1, 2021.
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    \14\ See Securities Exchange Act Release No. 64884 (July 14, 
2011), 76 FR 42755 (July 19, 2011) (Notice of Filing and Immediate 
Effectiveness of File No. SR-FINRA-2011-033).
    \15\ See Securities Exchange Act Release No. 88023 (January 23, 
2020), 85 FR 5261 (January 29, 2020) (Notice of Filing and Immediate 
Effectiveness of File No. SR-FINRA-2020-001).
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    FINRA Rule 0180 broadly excepts SBS activities from most FINRA 
requirements. Specifically, FINRA Rule 0180(a) provides that FINRA 
rules shall not apply to members' activities and positions with respect 
to SBS, except for FINRA Rule 2010 (Standards of Commercial Honor and 
Principles of Trade), FINRA Rule 2020 (Use of Manipulative, Deceptive 
or Other Fraudulent Devices), FINRA Rule 3310 (Anti-Money Laundering 
Compliance Program) and FINRA Rule 4240 (Margin Requirements for Credit 
Default Swaps).\16\ In addition, FINRA Rule 0180(b) provides that the 
following rules apply to members' activities and positions with respect 
to SBS only to the extent they would have applied as of July 15, 2011 
(i.e., the day before the effective date of Title VII of the Dodd-Frank 
Act): (i) NASD Rule 3110 and all successor FINRA Rules to such NASD 
Rule, (ii) the FINRA Rule 4500 Series and (iii) the FINRA Rule 4100 
Series.\17\ Finally, FINRA Rule 0180(c) provides that certain other 
rules apply as necessary to effectuate members' compliance with the 
rules applicable to SBS as noted above, including, for example, 
supervision requirements and rules relating to FINRA investigations and 
sanctions.
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    \16\ FINRA Rule 4240 establishes an interim pilot program with 
respect to margin requirements for any transactions in credit 
default swaps (``CDS'') held in an account at a FINRA member. Like 
FINRA Rule 0180, the interim pilot program under FINRA Rule 4240 
will automatically expire on September 1, 2021. See FINRA Rule 
4240(a); see also Securities Exchange Act Release No. 89036 (June 
10, 2020), 85 FR 36458 (June 16, 2020) (Notice of Filing and 
Immediate Effectiveness of File No. SR-FINRA-2020-016).
    \17\ These FINRA rules relate to books and records requirements 
and financial responsibility standards.
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    In light of the expiration of the SEC's temporary exemptive orders, 
the finalization of the SEC's regulatory framework for SBS, and the 
upcoming Registration Compliance Date, FINRA believes it is appropriate 
and in the public interest for current FINRA Rule 0180 to expire and 
for FINRA to clarify the treatment of SBS under FINRA rules going 
forward.\18\ Accordingly, FINRA is proposing to amend FINRA Rules 0180, 
4120, 4210, 4220, 4240 and 9610 to take into account members' SBS 
activities once SBS Entities begin registering with the SEC on October 
6, 2021. These proposed amendments generally fall into three 
categories. First, the proposed rule change would adopt a new FINRA 
Rule 0180, to replace expiring current FINRA Rule 0180, that would 
generally apply FINRA rules to members' activities and positions with 
respect to SBS, while providing limited exceptions for SBS in 
circumstances where FINRA believes such exceptions are appropriate. 
Second, the proposed rule change would amend FINRA's financial 
responsibility and operational rules to conform to the SEC's amendments 
to its capital, margin and segregation requirements for SBSDs and 
broker-dealers, and to otherwise take into account members' SBS 
activities. Finally, the proposed rule change would adopt a new margin 
rule specifically applicable to SBS, which would replace the expiring 
interim pilot program establishing margin requirements for CDS. Each 
aspect of the proposed rule change is discussed in greater detail 
below.
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    \18\ FINRA intends to extend the expiration dates of existing 
FINRA Rules 0180 and 4240 to October 6, 2021 to align with the 
Registration Compliance Date and implementation of the proposed rule 
change.
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General Presumption of Applicability
    As described above, FINRA Rule 0180 currently provides a broad, 
temporary exception from the application of FINRA requirements to SBS 
by providing that FINRA rules shall not apply to members' activities 
and positions with respect to SBS, with limited exceptions. Under the 
proposed rule change, current FINRA Rule 0180 would be replaced by a 
new FINRA Rule 0180 on October 6, 2021, which would effectively flip 
the existing presumption that FINRA rules do not apply to SBS, with 
certain exceptions, and instead provide that, going forward, FINRA 
rules do apply to SBS, with certain exceptions.\19\ Specifically, 
proposed FINRA Rule 0180(a) would provide that, except as otherwise 
provided in FINRA Rule 0180, FINRA rules shall apply to members' 
activities and positions with respect to SBS.\20\ As discussed in 
greater detail below, proposed FINRA Rules 0180(b) through (g) would 
specify the exceptions from this general presumption of applicability 
that FINRA believes it should provide to members engaged in SBS 
activity. Proposed FINRA Rule 0180(i) also would provide FINRA with 
exemptive authority to consider exemptive relief from the application 
of specific FINRA rules to SBS on a case-by-case basis.
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    \19\ Supplementary Material .01 to FINRA Rule 0180 provides that 
for purposes of FINRA Rule 0180, ``security-based swap'' has the 
same meaning as defined in Section 3(a)(68) of the Act and the rules 
and guidance of the SEC or its staff. FINRA is not proposing to 
modify the definition of ``security-based swap'' in Supplementary 
Material .01.
    \20\ FINRA notes that since the definition of ``security'' now 
includes SBS, once current FINRA Rule 0180 expires all FINRA rules 
applicable to securities will apply by their terms to SBS, 
regardless of whether a FINRA rule specifically states that FINRA 
rules apply to SBS. However, FINRA believes that including an 
affirmative statement regarding the application of FINRA rules to 
SBS in proposed FINRA Rule 0180(a) will promote legal certainty and 
provide greater clarity for its members.
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    As discussed above, Title VII of the Dodd-Frank Act amended the 
definition of ``security'' under the Act to specifically encompass 
SBS.\21\ As the Commission has noted, in ``making this change, Congress 
intended for [SBS] to be treated as securities under the Exchange Act 
and the underlying rules and regulations.'' \22\ FINRA is a registered 
national securities association under Section 15A of the Act, which 
requires, among other things, that FINRA rules be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, 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.\23\ FINRA adopted existing 
Rule 0180 to avoid undue market disruption while the SEC completed its 
Title VII rulemaking, but this broad exception was always intended to 
be temporary. Now that the SEC has largely finalized its regulatory 
framework for SBS and set the Registration Compliance Date for SBS 
Entities, FINRA believes it would be consistent with Congress's intent 
and FINRA's regulatory responsibility to generally apply FINRA rules to 
members' activities and positions with respect to SBS, subject to 
specified exceptions.
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    \21\ See supra note 11.
    \22\ See 2011 Exemptive Order, supra note 12, at 39929.
    \23\ 15 U.S.C. 78o-3(b)(6).
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    Under proposed Rule 0180(a), FINRA rules would generally apply to 
SBS in the same manner that such rules apply to securities 
generally.\24\ FINRA notes that while the proposed rule change would 
therefore regulate SBS activities similarly to any other securities

[[Page 26087]]

activities of its members, it expects that the practical impact of the 
proposed rule change will be limited. As an initial matter, in 
developing the proposed rule change, FINRA solicited input from its 
members regarding their anticipated SBS activities, including through 
direct conversations with a number of members that currently engage or 
have affiliates that engage in SBS activity, an invitation for 
submission of views and information on SBS activities on the FINRA 
website,\25\ and issuance of Regulatory Notice 20-36 soliciting comment 
on a concept proposal relating to SBS.\26\ Based on feedback received, 
FINRA understands that only a small number of its members will register 
as SBSDs or otherwise directly engage in SBS activities. In addition, 
FINRA notes that many of its rules relate to specific activities or 
lines of business that are unlikely to be relevant to SBS given the 
unique and limited characteristics of SBS. For example, FINRA's rules 
relating to securities offerings and underwriting are unlikely to 
implicate SBS.\27\ Moreover, at present SBS generally may only be 
entered into with persons who qualify as ``eligible contract 
participants'' (``ECPs''),\28\ such that FINRA rules specific to 
activities involving retail customers are unlikely to apply to SBS at 
this time.
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    \24\ As for any other activity or product, members are 
responsible for determining the regulatory characterization of SBS 
and the applicability of specific rules to such products.
    \25\ See FINRA, Views and Information on Activity Related to 
Security-Based Swaps, https://www.finra.org/rules-guidance/requests-for-comments/security-based-swaps.
    \26\ See FINRA Regulatory Notice 20-36 (October 2020).
    \27\ FINRA notes that certain rules in the FINRA Rule 5200 
Series (Quotation and Trading Obligations and Practices) and 5300 
Series (Handling of Customer Orders) apply by their terms to 
``securities'' generally, and therefore would apply to SBS under the 
proposed rule change. FINRA believes such rules are likely to have 
limited impact on SBS at present because SBS are generally bilateral 
OTC derivatives transactions negotiated and entered into between two 
counterparties. However, these trading and quoting rules may become 
more relevant to SBS in the future, particularly if trading or 
execution of SBS on exchanges or SBSEFs becomes prevalent. FINRA 
will monitor developments in the SBS market and evaluate the 
appropriateness of applying these rules to SBS transactions if 
quoting and trading activity develops.
    \28\ ``Eligible contract participant'' is defined under the Act 
to have the same meaning as under the Commodity Exchange Act 
(``CEA''). See 15 U.S.C. 78c(a)(65). Under the CEA, ECPs are defined 
to include certain regulated entities, such as broker-dealers, 
futures commission merchants (``FCMs''), financial institutions and 
insurance companies, as well as government entities and certain 
qualifying individuals and entities meeting net worth or total 
assets thresholds. See 7 U.S.C. 1a(18). Generally, an individual 
qualifying as an ECP must have amounts invested on a discretionary 
basis in excess of $10,000,000, or $5,000,000 if hedging. See 7 
U.S.C. 1a(18)(A)(xi). The Dodd-Frank Act amended the Securities Act 
of 1933 (``Securities Act'') and the Act to require that SBS 
transactions involving a person that is not an ECP must be 
registered under the Securities Act and effected on a national 
securities exchange. See Product Definitions, supra note 6, at 48246 
n.429. FINRA understands that no SBS are currently registered or 
available for execution on an exchange, and therefore all SBS at 
present must be entered into with ECPs.
    FINRA's retail customer-focused rules generally apply to 
accounts of customers that do not meet the definition of an 
``institutional account'' under FINRA Rule 4512(c). In addition to 
certain types of regulated entities, an ``institutional account'' 
under FINRA Rule 4512(c) includes any person with total assets of at 
least $50 million. See FINRA Rule 4512(c)(3). Certain FINRA rules 
also exclude other specified types of entities or persons from the 
coverage of retail customer-focused provisions. See, e.g., FINRA 
Rule 2210(a)(4) (defining ``institutional investor'' for purposes of 
the communications with the public requirements as an institutional 
account under FINRA Rule 4512(c) or certain other specified 
entities, plans or persons). Given the differences between the ECP 
definition and the definition of ``institutional account'' (or other 
variations used to define non-retail customers in the FINRA 
rulebook), it is possible that FINRA members may engage in SBS with 
customers that qualify as ECPs but that do not qualify as 
``institutional accounts,'' and therefore would be covered by FINRA 
retail customer-focused rules. For example, an individual may have 
more than $10 million invested on a discretionary basis, but not 
total assets of at least $50 million. Given the nature of the SBS 
market, FINRA believes that this scenario is likely to occur 
infrequently, but believes it would be appropriate to apply FINRA 
rules applicable to activities involving retail customers in such 
situations. FINRA notes that its retail customer-focused rules would 
also apply to SBS if non-ECP markets develop.
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    FINRA notes that current FINRA Rule 0180(a) provides: ``The Rules 
shall not apply to members' activities and positions with respect to 
security-based swaps, except for'' certain rules noted above. Article I 
of the FINRA By-Laws defines the ``Rules'' as used in FINRA Rule 
0180(a) to mean ``the numbered rules set forth in the [FINRA manual] 
beginning with the Rule 0100 Series, as adopted by the Board pursuant 
to these By-Laws, as hereafter amended or supplemented.'' Current FINRA 
Rule 0180 does not provide an exception from other parts of the FINRA 
manual, including the FINRA By-Laws and related governance documents, 
the Capital Acquisition Broker (CAB) rulebook, the Funding Portal 
rulebook or the Temporary Dual FINRA-NYSE Member Rules Series. 
Therefore, to the extent any of FINRA's governance documents or other 
rule sets apply to securities activities, they already apply to SBS by 
their terms. However, FINRA believes that these other parts of the 
FINRA manual likely have little direct relevance to SBS activities, 
since they relate primarily to governance or, as is the case for the 
CAB and Funding Portal rulebooks, are likely generally inapplicable due 
to the restricted nature of activities covered. FINRA also notes that 
Schedule A to the FINRA By-laws lists various fees that FINRA may 
assess, including two types of transaction fees. First, Section 1 of 
Schedule A provides for assessment of Member Regulatory Fees, including 
the Trading Activity Fee or ``TAF.'' The TAF applies only to sales of 
``covered securities'' as defined in paragraph (b) of Section 1 of 
Schedule A. FINRA does not currently consider SBS to be ``covered 
securities'' as currently defined in paragraph (b), and therefore has 
not assessed the TAF with respect to SBS transactions entered into by 
its members. Second, Section 3 of Schedule A provides that each member 
shall be assessed a Regulatory Transaction Fee, which shall be 
determined periodically in accordance with Section 31 of the Act.\29\ 
The SEC has addressed whether SBS are subject to Section 31 fees, 
stating that SBS are not currently subject to Section 31 fees and will 
not become subject to Section 31 fees until such time as the SEC 
implements real-time public reporting of SBS transactions.\30\ FINRA 
will monitor developments with respect to the applicability of Section 
31 fees to SBS and apply its Regulatory Transaction Fee coextensively 
with Section 31 fees. Therefore, FINRA expects that its Regulatory 
Transaction Fee will apply to SBS if real-time reporting for SBS comes 
into effect without the SEC providing an exemption for SBS from Section 
31 fees. However, if the SEC grants an exemption from Section 31 for 
SBS, the Regulatory Transaction Fee would likewise not apply to SBS.
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    \29\ See 15 U.S.C. 78ee.
    \30\ Specifically, the SEC has stated:
    A sale of a security is subject to Section 31 fees only if (1) 
the sale occurs on a national securities exchange, or (2) the sale 
is transacted by or through a member of a national securities 
association otherwise than on a national securities exchange and the 
security is registered on a national securities exchange or subject 
to prompt last-sale reporting pursuant to the rules of the 
Commission or a registered national securities association. Although 
security-based swaps are securities, they do not meet any of the 
conditions noted above. Thus, security-based swaps are currently not 
subject to Section 31 fees and would not become subject to Section 
31 fees due to the expiration of the Unlinked Temporary Exemptions 
or the full implementation of Regulation SBSR as it currently 
exists.
    The Dodd-Frank Act created a new Section 13(m) of the Exchange 
Act that requires ``real-time public reporting'' of security-based 
swap transactions. Once real-time public reporting is fully-
implemented, security-based swaps will be subject to prompt last-
sale reporting pursuant to the rules of the Commission, which will 
subject them to Section 31 fees. Thus, when the Commission proposes 
to implement prompt last-sale reporting for security-based swap 
transactions, it may also revisit the appropriateness of exempting 
security-based swaps from Section 31 fees at such time.
    See 2019 Exemptive Order, supra note 13, at 866 (citations 
omitted).
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    FINRA believes that applying the general presumption of 
applicability of FINRA rules to SBS under proposed

[[Page 26088]]

FINRA Rule 0180(a) as described above is appropriate and in the public 
interest. In formulating the proposed rule change, however, FINRA 
reviewed its rulebook to evaluate whether it would be appropriate to 
provide exceptions for SBS from particular FINRA rules or rule series 
and, if so, under what circumstances such exceptions should apply. 
Based on this review and feedback from its members and others, FINRA is 
proposing to provide three categories of exceptions: (1) General 
exceptions based on impracticability or operational burdens; (2) 
limited exceptions for SBS Entities and associated persons of SBS 
Entities; and (3) limited exceptions in connection with the conditions 
to the SEC's cross-border SBS counting exception. In addition, FINRA is 
proposing to provide exemptive authority to exempt a person from the 
application of specific FINRA rules to the person's SBS activities in 
circumstances not already covered by the proposed rule change. Each of 
these aspects of the proposed rule change is discussed in greater 
detail below.
General Exceptions From Presumption of Applicability
    Proposed FINRA Rule 0180(b) would provide that the following FINRA 
rules shall not apply to members' activities and positions with respect 
to SBS: (1) The FINRA Rule 6000 Series; (2) the FINRA Rule 7000 Series; 
and (3) the FINRA Rule 11000 Series. While some of these rules could 
potentially be interpreted as applying to SBS activities by their 
terms, FINRA believes that these rules were intended for other types of 
securities and could create operational difficulties if so applied. 
Therefore, FINRA believes the proposed rule change would provide legal 
certainty and clarity for its members by specifically excepting these 
rules from applying to members' activities and positions with respect 
to SBS.
    The FINRA Rule 6000 Series (Quotation, Order, and Transaction 
Reporting Facilities) and 7000 Series (Clearing, Transaction and Order 
Data Requirements, and Facility Charges) include various rules relating 
to trading, quoting, clearing and reporting for different types of 
securities. These rule series includes rules relating to quoting and 
trading in NMS stocks, quoting and trading in OTC Equity Securities, 
the Alternative Display Facility (the ADF, a facility for display of 
quotations in, and reporting OTC transactions in, NMS stocks), the 
Trade Reporting Facilities (the TRFs, facilities for reporting OTC 
transactions in NMS stocks), the OTC Reporting Facility (the ORF, a 
facility for reporting transactions in OTC Equity Securities), the OTC 
Bulletin Board Service (the OTCBB, an interdealer quotation system for 
OTC Equity Securities), the Trade Reporting and Compliance Engine 
(TRACE, a facility for reporting transactions in eligible debt 
securities), the Order Audit Trail system (OATS, a system to capture 
order information in NMS stocks and OTC Equity Securities), compliance 
with the Consolidated Audit Trail (CAT), and fees and charges 
associated with various FINRA facilities. Many of these rules would 
clearly not apply to SBS by their terms. For example, SBS are not NMS 
stocks, nor are SBS subject to the CAT. However, FINRA understands that 
the characterization of SBS may be unclear in some circumstances, which 
could raise the possibility that certain of these rules could be 
interpreted as applying to SBS. FINRA does not intend for the FINRA 
Rule 6000 or 7000 Series to apply to SBS, as these rules were 
specifically designed for other types of securities and would be 
operationally burdensome if applied to SBS. In addition, reporting to 
FINRA's various trade reporting facilities would be unnecessarily 
duplicative with the SEC's Title VII rulemakings related to regulatory 
reporting and public dissemination of SBS information.\31\ Therefore, 
the proposed rule change would provide clarity in this area by 
specifically providing exceptions for SBS from the FINRA Rule 6000 and 
7000 Series.\32\
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    \31\ See Regulation SBSR Release, supra note 8.
    \32\ FINRA notes that the FINRA Rule 6400 Series (Quoting and 
Trading in OTC Equity Securities) includes certain rules governing 
quoting and trading practices for OTC Equity Securities. FINRA 
believes these rules are not relevant to SBS at present because SBS 
are generally OTC derivatives transactions negotiated and entered 
into between two counterparties. However, these type of trading and 
quoting rules may become more relevant to SBS in the future, 
particularly if market centers begin quoting or trading SBS. FINRA 
will monitor developments in the SBS market and evaluate the 
appropriateness of applying these or similar rules to SBS 
transactions at such time.
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    In addition, the FINRA Rule 11000 Series sets forth the Uniform 
Practice Code (``UPC''). The UPC is a series of rules, interpretations 
and explanations designed to make uniform, where practicable, custom, 
practice, usage, and trading technique in the investment banking and 
securities business, particularly with regards to operational and 
settlement issues. These can include such matters as trade terms, 
deliveries, payments, dividends, rights, interest, reclamations, 
exchange of confirmations, stamp taxes, claims, assignments, powers of 
substitution, computation of interest and basis prices, due-bills, 
transfer fees, ``when, as and if issued'' trading, ``when, as and if 
distributed'' trading, marking to the market, and close-out procedures. 
The UPC was created so that the transaction of day-to-day business by 
members may be simplified and facilitated, that business disputes and 
misunderstandings, which arise from uncertainty and lack of uniformity 
in such matters, may be eliminated, and that the mechanisms of a free 
and open market may be improved and impediments thereto removed. For 
example, FINRA Rules 11310 through 11365 address matters relating to 
the delivery of securities, FINRA Rules 11510 through 11581 address 
certificated security matters, FINRA Rules 11610 through 11650 address 
the delivery of bonds and other evidence of indebtedness and FINRA 
Rules 11810 through 11894 address close-out procedures.
    By its terms, the UPC applies to all OTC secondary market 
transactions in securities between members, with enumerated 
exceptions.\33\ Therefore, the UPC could be interpreted as applying to 
SBS transactions in some circumstances. However, FINRA notes that the 
UPC is limited to transactions between members. It would therefore 
apply only in the very limited circumstances involving SBS transacted 
between FINRA members. As discussed above, FINRA understands that only 
a small number of its members will register as SBSDs or otherwise 
directly engage in SBS activities. The UPC would therefore only 
potentially be invoked for a small portion of the SBS market, which 
FINRA believes has the potential to create confusion and uncertainty. 
In addition, while FINRA recognizes the importance of operational and 
settlement risks in SBS transactions, FINRA believes these risks are 
more appropriately addressed through other means, including through the 
contractual provisions utilized by SBS counterparties under industry-
standard SBS documentation and, where applicable, the SEC's risk 
mitigation requirements.\34\ By contrast,

[[Page 26089]]

the UPC was designed to facilitate and make uniform the operational 
aspects of cash securities transactions. These operational provisions 
were not designed for, and are not well-suited to, the particular 
characteristics of SBS transactions involving bilateral contractual 
negotiations between counterparties. FINRA therefore believes it is 
appropriate to except the FINRA Rule 11000 Series from applying to 
members' activities and positions with respect to SBS.
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    \33\ See FINRA Rule 11100(a). Under FINRA Rule 11100(a)(1), 
transactions in securities between members which are compared, 
cleared or settled through the facilities of a registered clearing 
agency are not subject to the UPC, except to the extent that the 
rules of the clearing agency provide that rules of other 
organizations shall apply. Paragraphs (a)(2) through (a)(5) of FINRA 
Rule 11100 also provide exceptions for specific types of securities, 
including exempted securities, municipal securities, redeemable 
securities issued by investment companies and Direct Participation 
Program Securities.
    \34\ For example, the SEC's SBS trading relationship 
documentation rules require SBS Entities to have in place trading 
relationship documentation including all terms governing the trading 
relationship between the SBS Entity and its counterparty, including, 
without limitation, terms addressing payment obligations, netting of 
payments, events of default or other termination events, calculation 
and netting of obligations upon termination, transfer of rights and 
obligations, governing law, valuation, and dispute resolution. See 
17 CFR 240.15Fi-5(b)(1).
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Exceptions for SBS Entities and Associated Persons
    As discussed above, the SEC has now completed the majority of its 
Title VII rulemakings, including business conduct standards, trade 
acknowledgement and verification requirements, risk mitigation 
techniques and recordkeeping rules for SBS Entities.\35\ These rules 
will apply to SBS Entities once they register with the SEC on or after 
the Registration Compliance Date. As described below, certain of these 
new SBS-specific rules are similar to existing FINRA rules that apply 
to members' securities activities generally. FINRA believes that 
applying both the SEC's rules for SBS Entities and FINRA's parallel 
rules for its members to the same SBS activity would result in 
unnecessary regulatory duplication. Therefore, to promote regulatory 
clarity and avoid unnecessary regulatory duplication, the proposed rule 
change would provide exceptions from specific FINRA rules in 
circumstances where the SEC's SBS Entity rules will apply to the SBS 
activity. As described in further detail below, proposed FINRA Rules 
0180(c), (d), (f) and (g) would specify the FINRA rules subject to 
these exceptions and the conditions to such exceptions.
---------------------------------------------------------------------------

    \35\ See Business Conduct Standards Release; Trade 
Acknowledgment and Verification Release; Risk Mitigation Release; 
Recordkeeping Release, supra note 8.
---------------------------------------------------------------------------

    Proposed FINRA Rules 0180(c) and (d) would provide that certain 
specified FINRA rules shall not apply to members' activities and 
positions with respect to SBS, to the extent that the member is acting 
in its capacity as an SBS Entity or the associated person of the member 
is acting in his or her capacity as an associated person of an SBS 
Entity, as applicable, and that such activities or positions relate to 
the business of the SBS Entity within the meaning of the Exchange Act 
Rule 15Fh-3(h)(1).\36\ As described below, each rule listed in proposed 
FINRA Rules 0180(c) and (d) is similar to a particular SEC rule or set 
of rules applicable to SBS Entities (or specifically applicable to 
SBSDs, but not MSBSPs, in the case of proposed FINRA Rule 0180(d)). 
FINRA believes it is appropriate to provide exceptions from these 
specific FINRA rules, but only to the extent that the SEC's parallel 
SBS Entity rules will apply to the SBS activity.\37\ The exceptions are 
therefore limited to circumstances where the member engaged in the SBS 
activity is acting in its capacity as an SBS Entity, or where the 
associated person engaged in the SBS activity is acting in his or her 
capacity as an associated person of an SBS Entity.\38\ To ensure that 
the exceptions apply only where the SBS activity is covered by the 
SEC's rules and subject to the oversight and supervision of an SBS 
Entity (which itself is subject to oversight by the Commission and, if 
a FINRA member, FINRA), proposed FINRA Rules 0180(c) and (d) include a 
further condition that the SBS activities or positions relate to the 
business of the SBS Entity within the meaning of the SEC's SBS Entity 
supervision rule.\39\
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    \36\ See 17 CFR 240.15Fh-3(h)(1). These exceptions are split 
between paragraphs (c) and (d) of proposed FINRA Rule 0180 to 
account for certain SEC rules that apply only to SBSDs, but not 
MSBSPs. Specifically, the exceptions in proposed FINRA Rule 0180(c) 
would apply for all Swap Entities, while the exceptions in proposed 
FINRA Rule 0180(d) would apply only for SBSDs.
    \37\ Conversely, the proposed exceptions would not apply in 
circumstances where the SEC's SBS Entity rules do not apply. For 
example, the exceptions in proposed FINRA Rules 0180(c) and (d) 
would not apply to a member engaged in SBS brokerage activity. FINRA 
notes that the SEC has contemplated that a registered broker-dealer 
engaged in SBS brokerage activity would be subject to applicable 
self-regulatory organization rules. See, e.g., Cross-Border Release 
at 6284, Business Conduct Standards Release at 29966-68, supra note 
8. The exceptions would also not apply to a member entering into SBS 
below the de minimis threshold for SBSD registration or engaging in 
other SBS activity not requiring SBS Entity registration (e.g., SBS 
hedging activity). In these circumstances, the FINRA rules would 
apply to the SBS activity.
    \38\ FINRA's business conduct rules apply both to the FINRA 
member and persons associated with the member. Similarly, the SEC's 
SBS Entity rules apply to activity undertaken by an SBS Entity or 
its associated persons. Therefore, proposed Rule 0180(c) applies to 
the SBS activities engaged in by a member that is also registered as 
an SBS Entity as well as SBS activities engaged in by an associated 
person of a member where the associated person is acting in their 
capacity as an associated person of an SBS Entity, since the SBS 
Entity rules would apply in those circumstances. The exceptions 
would therefore apply to an associated person of a member that is 
also registered as an SBS Entity where the associated person is 
acting in his or her capacity as an associated person of the SBS 
Entity.
     FINRA understands that certain firms engaged in SBS activity 
may employ a ``dual-hatted'' personnel structure. In this structure, 
an affiliate of the member is registered as an SBS Entity, but the 
member itself is not dually-registered as an SBS Entity. However, 
certain personnel of the member may be ``dual-hatted'' such that 
they act as associated persons of the member with respect to general 
securities activities but as associated persons of the affiliated 
SBS Entity with respect to the SBS Entity's SBS activities. FINRA 
intends for the exceptions in proposed FINRA Rule 0180(c) to apply 
to SBS activities undertaken by an associated person of a member 
acting in his or her capacity as an associated person of an 
affiliated SBS Entity under the dual-hatted structure described 
above. FINRA is providing this guidance to promote legal certainty 
and provide clarity to its members regarding the application of the 
particular rules covered by the proposed exceptions in FINRA Rule 
0180(c). The proposed rule change does not address whether or to 
what extent other FINRA rules not covered by proposed FINRA Rule 
0180(c) might apply to a dual-hatted associated person when he or 
she is acting in his or her capacity as an associated person of an 
affiliated SBS Entity.
     FINRA also notes that whether a particular individual is acting 
as an associated person of the member or of an SBS Entity (whether 
the same entity as the member or an affiliated entity) is a facts 
and circumstances determination and is not dependent on the 
particular method in which such arrangements are documented. 
However, FINRA reminds members that they must be able to demonstrate 
how a particular individual is designated and for what purposes, as 
well as the specific capacity in which an individual is acting with 
respect to any particular transaction or activity.
    \39\ The SEC's SBS supervision rule states: ``A security-based 
swap dealer or major security-based swap participant shall establish 
and maintain a system to supervise, and shall diligently supervise, 
its business and the activities of its associated persons. Such a 
system shall be reasonably designed to prevent violations of the 
provisions of applicable federal securities laws and the rules and 
regulations thereunder relating to its business as a security-based 
swap dealer or major security-based swap participant, 
respectively.'' 17 CFR 240.15Fh-3(h)(1). Therefore, to qualify for 
the exceptions in proposed FINRA Rules 0180(c) and (d), the 
particular SBS activity must be within the scope of the business of 
the SBS Entity that is subject to the SBS Entity's supervisory 
system. If an SBS Entity were to engage in other SBS activity that 
it did not consider within the scope of its business as an SBS 
Entity, and therefore not subject to the SEC's rules applicable to 
SBS Entities, the exceptions would not be available and the 
applicable FINRA rules would apply to that activity.
---------------------------------------------------------------------------

    Under proposed FINRA Rules 0180(c) and (d), these proposed 
exceptions would be available for eight FINRA rules, subject to the 
conditions described above. Specifically, proposed FINRA Rule 0180(c) 
would provide exceptions for the following FINRA rules:
     FINRA Rule 2210(d) (Communications with the Public--
Content Standards) requires members to adhere to content standards with 
respect to all of their communications, whether correspondence, retail 
communications or institutional communications. Among other things, 
FINRA Rule 2210(d) requires that member communications be based on 
principles

[[Page 26090]]

of fair dealing and good faith, be fair and balanced, and not omit any 
material facts or make false or exaggerated claims. The SEC's business 
conduct rules for SBS Entities include Exchange Act Rule 15Fh-3(g), 
which generally requires SBS Entities to communicate with 
counterparties in a fair and balanced manner based on principles of 
fair dealing and good faith.\40\ The SEC's business conduct rules also 
include requirements for SBS Entities to make certain disclosures to 
their SBS counterparties, including disclosures of material risks and 
characteristics of the SBS and material incentives or conflicts of 
interest (Exchange Act Rule 15Fh-3(b)), daily mark disclosures 
(Exchange Act Rule 15Fh-3(c)) and disclosures regarding clearing rights 
(Exchange Act Rule 15Fh-3(d)).\41\
---------------------------------------------------------------------------

    \40\ See 17 CFR 240.15Fh-3(g); Business Conduct Standards 
Release, supra note 8, at 30000-02.
    \41\ See 17 CFR 240.15Fh-3(b), (c) and (d); Business Conduct 
Standards Release, supra note 8, at 29980-93.
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     FINRA Rule 2232 (Customer Confirmations) generally 
requires members to provide customers with written confirmations in 
conformity with Exchange Act Rule 10b-10,\42\ along with specified 
additional disclosures for certain types of securities. Exchange Act 
Rule 15Fi-2 requires SBS Entities to provide trade acknowledgements and 
to establish, maintain and enforce written policies and procedures 
reasonably designed to obtain prompt verification of the terms of such 
trade acknowledgments.\43\ FINRA also notes that the SEC's trade 
acknowledgement and verification rule provides that an SBS Entity that 
is also a broker or dealer, is purchasing from or selling to any 
counterparty, and that complies with the relevant requirements of the 
trade acknowledgement and verification rule, is exempt from the 
requirements of Exchange Act Rule 10b-10 with respect to the SBS 
transaction.\44\
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    \42\ See 17 CFR 240.10b-10.
    \43\ See 17 CFR 240.15Fi-2; see generally Trade Acknowledgment 
and Verification Release, supra note 8.
    \44\ See 17 CFR 240.15Fi-2(g); Trade Acknowledgement and 
Verification Release, supra note 8, at 39824-25.
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     FINRA Rules 3110 (Supervision), 3120 (Supervisory Control 
System) and 3130 (Annual Certification of Compliance and Supervisory 
Processes) require, among other things, each member to establish and 
maintain a supervisory system; establish, maintain and enforce written 
supervisory procedures; designate principals to establish, maintain and 
enforce a system of supervisory control policies and procedures; 
designate a chief compliance officer; and submit annual certifications 
to FINRA related to the member's compliance policies and written 
supervisory procedures. The SEC's business conduct rules for SBS 
Entities include Exchange Act Rules 15Fh-3(h) and 15Fk-1.\45\ Exchange 
Act Rule 15h-3(h) requires, among other things, an SBS Entity to 
establish and maintain a system to supervise, and to diligently 
supervise, its business and the activities of its associated persons; 
designation of at least one person with authority to carry out 
supervisory responsibilities; and establishment, maintenance and 
enforcement of written policies and procedures addressing supervision 
of the SBS Entity's SBS business. Exchange Act Rule 15Fk-1 requires 
each SBS Entity to designate a chief compliance officer and submit 
annual compliance reports to the SEC.
---------------------------------------------------------------------------

    \45\ See 17 CFR 240.15Fh-3(h) and 15Fk-1; Business Conduct 
Standards Release, supra note 8, at 30002-07 and 30050-61.
---------------------------------------------------------------------------

    Proposed FINRA Rule 0180(d) would provide exceptions for the 
following FINRA Rules:
     FINRA Rule 2030 (Engaging in Distribution and Solicitation 
Activities with Government Entities) is FINRA's ``pay-to-play'' rule, 
which imposes restrictions on member firms engaging in distribution or 
solicitation activities with government entities. Exchange Act Rule 
15Fh-6 imposes pay-to-play restrictions on SBSDs (but not MSBSPs), 
including similar restrictions on an SBSD engaging in SBS transactions 
with a municipal entity within two years after specified types of 
political contributions have been made to officials of the municipal 
entity.\46\
---------------------------------------------------------------------------

    \46\ See 17 CFR 240.15Fh-6; Business Conduct Standards Release, 
supra note 8, at 30045-50.
---------------------------------------------------------------------------

     FINRA Rule 2090 (Know Your Customer) generally requires 
that each member use reasonable diligence to know and retain essential 
facts concerning every customer and the authority of each person acting 
on behalf of such customer. The SEC's business conduct rules for SBS 
Entities include Exchange Act Rules 15Fh-3(a) and (e).\47\ Exchange Act 
Rule 15Fh-3(a) generally requires SBS Entities to verify the status of 
their SBS counterparties, including verification that the counterparty 
is an ECP and whether the counterparty is a ``special entity.'' \48\ 
Exchange Act Rule 15Fh-3(e) requires each SBSD (but not MSBSP) to 
establish, maintain and enforce written policies and procedures 
reasonably designed to obtain and retain a record of the essential 
facts concerning each counterparty whose identify is known to the SBSD 
that are necessary for conducting business with such counterparty.
---------------------------------------------------------------------------

    \47\ See 17 CFR 240.15Fh-3(a) and (e); Business Conduct 
Standards Release, supra note 8, at 29978-80 and 29993-94.
    \48\ ``Special entity'' is defined in Exchange Act Rule 15Fh-
2(d) and includes certain government entities, employee benefit 
plans and endowments. See 17 CFR 240.15Fh-2(d).
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     FINRA Rule 2111 (Suitability) is FINRA's suitability rule, 
which generally requires a member or associated person to have a 
reasonable basis that a recommended transaction or investment strategy 
is suitable for the customer.\49\ The SEC's business conduct rules for 
SBS Entities include Exchange Act Rules 15Fh-3(f) and 15Fh-5.\50\ 
Exchange Act Rule 15Fh-3(f) imposes similar suitability obligations on 
SBSDs (but not MSBSPs) with respect to recommendations of SBS or 
trading strategies.\51\ In addition, Exchange Act

[[Page 26091]]

Rule 15Fh-5 applies special, enhanced requirements when SBS Entities 
act as counterparties to special entities.
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    \49\ Specifically, FINRA Rule 2111 is composed of three main 
obligations: reasonable-basis suitability, customer-specific 
suitability, and quantitative suitability. The reasonable-basis 
obligation requires a member or associated person to have a 
reasonable basis to believe, based on reasonable diligence, that the 
recommendation is suitable for at least some investors. A member's 
or associated person's reasonable diligence must provide the member 
or associated person with an understanding of the potential risks 
and rewards associated with the recommended security or strategy. 
The customer-specific obligation requires that a member or 
associated person have a reasonable basis to believe that the 
recommendation is suitable for a particular customer based on that 
customer's investment profile, with the ability to fulfill this 
obligation for an institutional account if (i) the member or 
associated person has a reasonable basis to believe that the 
institutional customer is capable of evaluating investment risks 
independently, both in general and with regard to particular 
transactions and investment strategies involving a security or 
securities, and (ii) the institutional customer affirmatively 
indicates that it is exercising independent judgment in evaluating 
the member's or associated person's recommendations. Quantitative 
suitability requires a member or associated person to have a 
reasonable basis for believing that a series of recommended 
transactions, even if suitable when viewed in isolation, are not 
excessive and unsuitable for the customer when taken together in 
light of the customer's investment profile. See Supplementary 
Material .05 to FINRA Rule 2111.
    \50\ See 17 CFR 240.Fh-3(f) and Fh-5; Business Conduct Standards 
Release, supra note 8, at 29994-30000 and 30007-45.
    \51\ Specifically, Exchange Act Rule 15Fh-3(f)(1)(i) provides 
that an SBSD that recommends an SBS or trading strategy involving an 
SBS to a counterparty (other than an SBS Entity, swap dealer or 
major swap participant) must undertake reasonable diligence to 
understand the potential risks and rewards associated with the 
recommended SBS or trading strategy involving an SBS. FINRA notes 
that, as proposed, Exchange Act Rule 15Fh-3(f)(1)(i) would have 
required an SBSD to have a reasonable basis to believe, based on 
reasonable diligence, that the recommended SBS or trading strategy 
is suitable for at least some counterparties (similar to FINRA Rule 
2111's reasonable-basis obligation). See Business Conduct Standards 
Release, supra note 8 at 29994. When adopting its final business 
conduct rules, the SEC modified Exchange Act Rule 15Fh-3(f)(1)(i) to 
``rephrase the suitability obligation . . . to make it consistent 
with the CFTC's parallel suitability requirement in Commodity 
Exchange Act Rule 23.434(a)(1), which explicitly requires [SBSDs] to 
understand the risk-reward tradeoff of their recommendations.'' In 
doing so, the SEC noted that the SEC's ``proposed formulation and 
the CFTC's formulation would have achieved the same purpose.'' See 
id. at 29996. The SEC also noted that the ``new formulation is also 
consistent with FINRA's approach to this aspect of suitability 
[i.e., the reasonable-basis obligation as described in Supplementary 
Material .05(a) to FINRA Rule 2111].'' See id. at 29996 n.493. As 
with the reasonable-basis obligation in FINRA Rule 2111, SBSDs ``are 
always required to meet their suitability obligation in [Exchange 
Act] Rule 15Fh-3(f)(1)(i), regardless of whether they avail 
themselves of the institutional suitability alternative to meet 
their customer-specific obligations.'' See id. at 29997.
    In addition, Exchange Act Rule 15Fh-3(f)(1)(ii) requires the 
SBSD to have a reasonable basis to believe that a recommended SBS or 
trading strategy involving an SBS is suitable for the counterparty 
(similar to FINRA Rule 2111's customer-specific obligation). Also 
similar to the institutional account alternative in FINRA Rule 2111, 
an SBSD may fulfill its obligations under Exchange Act Rule 15Fh-
3(f)(1)(ii) with respect to an institutional counterparty if it 
complies with specified conditions, including reasonably determining 
that the counterparty or its agent is capable of independently 
evaluating investment risks with regard to the relevant SBS or 
trading strategy involving an SBS and that the counterparty or its 
agent affirmatively represents in writing that it is exercising 
independent judgment in evaluating the recommendations of the SBSD 
with regard to the relevant SBS or trading strategy involving an 
SBS. See Exchange Act Rules 15Fh-3(f)(2) and (3).
    FINRA acknowledges that the SEC's suitability rule differs in 
some respects from FINRA's suitability requirements under FINRA Rule 
2111. For example, Exchange Act Rule 15F-3(f) does not explicitly 
include a quantitative suitability obligation. However, FINRA 
believes that, while not identical, Exchange Act Rule 15Fh-3(f) 
serves similar purposes to FINRA Rule 2111, such that requiring 
members that are SBSDs to also comply with FINRA Rule 2111 in 
circumstances where Exchange Act Rule 15Fh-3(f) applies would be 
unnecessarily duplicative.
---------------------------------------------------------------------------

    Proposed FINRA Rule 0180(f) would provide that FINRA Rules 2231 
(Customer Account Statements) and 4512 (Customer Account Information) 
shall not apply to members' activities and positions with respect to 
SBS, to the extent that the member is acting in its capacity as an SBS 
Entity and the customer's account solely holds SBS and collateral 
posted as margin in connection with such SBS, provided that the member 
complies with the portfolio reconciliation requirements of Exchange Act 
Rule 15Fi-3 with respect to such account and that such portfolio 
reconciliations include collateral posted as margin in connection with 
SBS in the account. FINRA Rule 2231 generally requires each member to 
provide, on at least a quarterly basis, an account statement to each 
customer containing a description of any securities positions, money 
balances or account activity during the period since the last customer 
account statement. FINRA Rule 4512 generally requires each member to 
maintain specified information for each customer account, including 
specified identifying information about the customer.
    FINRA believes that the customer account statements required under 
FINRA Rule 2231 generally should reflect a holistic view of a member's 
relationship with its customer, including SBS transactions, positions 
and related collateral, if applicable. Therefore, to the extent that a 
customer's account includes SBS along with other securities positions 
or activity, or related money balances, then FINRA believes that the 
account statement under FINRA Rule 2231 should include SBS. However, 
FINRA understands that members that are also registered SBS Entities 
may have customer accounts that hold solely SBS and related collateral, 
and do not hold any other securities positions or have any other 
securities activity. While SBS Entities are not subject to a customer 
account statement requirement with respect to SBS, the SEC's risk 
mitigation requirements for SBS Entities include Exchange Act Rule 
15Fi-3, which requires SBS Entities to engage in portfolio 
reconciliation with their counterparties.\52\ Exchange Act Rule 15Fi-
3(a) generally requires SBS Entities to engage in portfolio 
reconciliation for all SBS with their SBS Entity counterparties, with 
the frequency of such portfolio reconciliations ranging from once each 
business day (for SBS portfolios that include 500 or more SBS), to once 
each week (for SBS portfolios that include more than 50 but fewer than 
500 SBS on any business day during the week), to once each calendar 
quarter (for SBS portfolios that include no more than 50 SBS at any 
time during the calendar quarter).\53\ Exchange Act Rule 15Fi-3(b) 
requires each SBS Entity to establish, maintain, and follow written 
policies and procedures reasonably designed to ensure that it engages 
in portfolio reconciliation for all SBS with non-SBS Entity 
counterparties, with the frequency of such portfolio reconciliations 
ranging from once each calendar quarter (for SBS portfolios that 
include more than 100 SBS at any time during the calendar quarter) to 
once annually (for SBS portfolios that include no more than 100 SBS at 
any time during the calendar year).\54\
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    \52\ See 17 CFR 240.15Fi-3; Risk Mitigation Release, supra note 
8, at 6362-70. For purposes of Exchange Act Rule 15Fi-3, ``portfolio 
reconciliation'' is defined as any process by which counterparties 
to one or more SBS (1) exchange the material terms of all SBS in the 
SBS portfolio between the counterparties, (2) exchange each 
counterparty's valuation of each SBS in the SBS portfolio between 
the counterparties as of the close of business on the immediately 
preceding day and (3) resolve any discrepancy in valuations or 
material terms. See 17 CFR 240.15Fi-1(l).
    \53\ See 17 CFR 240.15Fi-3(a).
    \54\ See 17 CFR 240.15Fi-3(b).
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    FINRA acknowledges that the SEC's SBS portfolio reconciliation rule 
differs in some respects from the customer account statement 
requirements under FINRA Rule 2231. For example, the frequency of 
portfolio reconciliations varies as described above, while customer 
account statements must be delivered at least quarterly. In addition, 
as described above, an SBS entity must have policies and procedures in 
place to ensure that it engages in portfolio reconciliation with non-
SBS Entity counterparties, while a member must provide a customer 
account statement to each customer unless a specific exception under 
FINRA Rule 2231(b) applies. However, FINRA believes that, while not 
identical, Exchange Act Rule 15Fi-3 serves similar purposes to FINRA 
Rule 2231, such that requiring members that are SBS Entities to also 
provide customer account statements for accounts holding solely SBS and 
related collateral would be unnecessarily duplicative. Accordingly, to 
promote regulatory clarity and avoid unnecessary duplication, proposed 
FINRA Rule 0180(f) would provide an exception from FINRA Rule 2231 in 
the limited circumstances where the member is acting in its capacity as 
an SBS Entity and the account solely holds SBS and collateral posted as 
margin in connection with such SBS. FINRA notes that collateral in a 
customer's account would be included in account statements provided 
under FINRA Rule 2231. The proposed rule change therefore includes as a 
condition to the proposed exception that the member comply with 
Exchange Act Rule 15Fi-3 with respect to an account qualifying for the 
exception and include collateral in the portfolio reconciliation and 
dispute resolutions requirements as applied to such an account.
    The SEC's risk mitigation requirements for SBS also include 
Exchange Act Rule 15Fi-5, which requires SBS Entities to have in place 
SBS trading relationship documentation with their SBS counterparties, 
including all terms governing the trading relationship between the SBS 
and its counterparty.\55\ In addition, SBS Entities that are also 
registered broker-dealers are subject to the SEC's recordkeeping 
requirements under Exchange Act Rule

[[Page 26092]]

17a-3, which require, among other things, certain records to be kept 
for each SBS account.\56\ These SEC rules generally require SBS 
Entities to obtain and keep records of certain information in 
connection with their SBS accounts, including SBS-specific identifying 
information. FINRA believes that, while not identical to FINRA Rule 
4512, these SEC rules serve similar purposes, and that also applying 
FINRA Rule 4512 to SBS-only accounts would be duplicative. Accordingly, 
in order to promote regulatory clarity and avoid unnecessary 
duplication, FINRA believes it is appropriate to provide an exception 
from FINRA Rule 4512 in the limited circumstances where the member is 
acting in its capacity as an SBS Entity and the account solely holds 
SBS and collateral posted as margin in connection with such SBS. Both 
exceptions under proposed FINRA Rule 0180(f) would not apply to 
accounts holding SBS together with other securities or to members that 
are not also registered SBS Entities.
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    \55\ See 17 CFR 240.15Fi-5; Risk Mitigation Release, supra note 
8, at 6372-6377. SEC rules also require SBS Entities to maintain 
records of SBS trading relationship documentation. See 17 CFR 17a-
4(e)(12)(ii).
    \56\ See 17 CFR 240.17a-3; see generally Recordkeeping Release, 
supra note 8. FINRA notes in particular Exchange Act Rule 17a-
3(a)(9)(iv), which requires an SBS Entity to keep a record, for each 
SBS account, of the unique identification code of the counterparty, 
the name and address of the counterparty, and a record of the 
authorization of each person the counterparty has granted authority 
to transact business in the SBS account. See 17 CFR 240.17a-
3(a)(9)(iv).
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    Finally, proposed FINRA Rule 0180(g) would provide that persons 
associated with a member whose functions are related solely and 
exclusively to SBS undertaken in such person's capacity as an 
associated person of an SBS Entity are not required to be registered 
with FINRA.\57\ Generally, FINRA Rule 1210 requires that each person 
engaged in the investment banking or securities business of a member 
must be registered with FINRA as a representative or principal in each 
category of registration appropriate to his or her functions and 
responsibilities as specified in FINRA Rule 1220. Individuals seeking 
to become registered with FINRA generally must pass an appropriate 
qualification examination, and registered individuals are subject to 
continuing education (``CE'') requirements under FINRA Rule 1240. These 
registration, licensing and CE requirements would generally apply to 
associated persons of a member engaged in SBS activities due to the 
change to the definition of ``security'' to encompass SBS. Accordingly, 
FINRA believes that associated persons of a member who are engaged in 
SBS activities generally should be registered--and subject to 
accompanying licensing and CE requirements--as appropriate based on the 
scope of their activities (e.g., Series 7 for general SBS activities, 
Series 24 for SBS principals, etc.). However, FINRA understands that 
members that are also registered SBS Entities may in some limited 
circumstances have an associated person whose securities-related 
activities relate solely and exclusively to transactions conducted in 
the individual's capacity as an associated person of the SBS Entity. 
Such individuals engage solely in SBS activities on behalf of the SBS 
Entity (and potentially non-securities activities, such as swaps), but 
do not engage in any other securities activities that would require 
registration under FINRA Rule 1210.
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    \57\ This exception is structured similarly to existing 
exceptions from registration for persons associated with a member 
whose functions are related solely and exclusively to certain other 
product types (such as municipal securities, commodities or security 
futures), as found in FINRA Rule 1230.
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    FINRA's current registration, licensing and CE requirements are not 
specifically tailored to SBS. To reduce unnecessary regulatory burdens, 
FINRA therefore believes it is appropriate for the proposed rule change 
to provide an exception at the current time from these requirements in 
the limited circumstances where an associated person of a member is 
engaged solely and exclusively in SBS activities in his or her capacity 
as an associated person of an SBS Entity. Under this proposed 
exception, such persons would not be required to register with FINRA, 
and therefore would not be required to pass any qualification 
examinations or become subject to CE requirements under FINRA Rule 
1240. This proposed exception is based on FINRA's analysis of its 
existing registration and related requirements, and its understanding 
that the number of such associated persons is limited. FINRA will 
monitor developments with respect to the SBS activities of its members 
and will continue to consider whether it would be appropriate to tailor 
the registration and related requirements to SBS, for example through 
targeted SBS-related registration categories or the addition of SBS-
specific content to qualification examinations or CE content. FINRA 
will consider whether it would be appropriate to rescind the exception 
under proposed FINRA Rule 0180(g) in such circumstances. The exception 
under proposed FINRA Rule 0180(g) would not apply to associated persons 
of a member engaged in any other securities activities or to associated 
persons of members that are not also registered SBS Entities.\58\ FINRA 
also notes that, although individuals qualifying for the proposed 
exception would not be required to register with FINRA (and therefore a 
member firm would not be required to file a Form U4 on behalf of such 
individuals), they would remain associated persons of the member 
subject to all FINRA and SEC rules applicable to such associated 
persons, including fingerprinting requirements under Exchange Act Rule 
17f-2.\59\
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    \58\ FINRA notes that associated persons of SBS Entities are not 
independently subject to registration, licensing or CE requirements. 
However, an SBS Entity is prohibited from permitting an associated 
person that is subject to a statutory disqualification to effect or 
be involved in effecting SBS on behalf of the SBS Entity. See 15 
U.S.C. 78o-10(b)(6). The SEC's SBS Entity registration rules also 
require an SBS Entity to certify that it neither knows, nor in the 
exercise of reasonable care should have known, of any such statutory 
disqualification. Such certifications must be supported by 
questionnaires or employment applications serving as the basis for 
background checks. See 17 CFR 240.15Fb6-2; Registration Process 
Release, supra note 8, at 48973-79.
    \59\ See 17 CFR 240.17F-2.
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Exceptions in Connection With the SEC's Cross-Border Exception
    In connection with finalizing the Title VII rulemakings, the SEC 
also adopted a number of rules and provided guidance to address the 
cross-border application of various SBS requirements. One of these 
rules, Exchange Act Rule 3a71-3(d), provides a conditional exception to 
the provisions of Exchange Act Rule 3a71-3 that otherwise would require 
non-U.S. persons to count--against the thresholds associated with the 
de minimis exception to the SBSD definition--SBS dealing transactions 
with non-U.S. counterparties when U.S. personnel arrange, negotiate or 
execute those transactions.\60\ To qualify for this exception, all such 
arranging, negotiating or executing activity must be conducted by U.S. 
personnel in their capacity as persons associated with a registered 
broker-dealer or a registered SBSD that is a majority-owned affiliate 
of the non-U.S. person relying on the exception (the ``U.S. Registered 
Affiliate'').\61\ Further, to qualify for the exception, the U.S. 
Registered Affiliate must comply with specified SBS Entity rules with 
respect to such SBS transactions as if the counterparties to the non-
U.S. person relying on the exception also were counterparties to the 
U.S. Registered Affiliate and as if the U.S. Registered Affiliate were 
registered as an SBSD, if not so registered.\62\ The

[[Page 26093]]

specified SBS Entity rules under this exception are Exchange Act Rule 
15Fh-3(b) (disclosures of material risks and characteristics and 
material incentives or conflicts of interest), Exchange Act Rule 15Fh-
3(f)(1) (recommendations and suitability), Exchange Act Rule 15Fh-3(g) 
(fair and balanced communications) and Exchange Act Rule 15Fi-2 
(acknowledgement and verification of SBS transactions).\63\
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    \60\ See 17 CFR 240.3a71-3(d); Cross-Border Release, supra note 
8, at 6276-92.
    \61\ See 17 CFR 240.3a71-3(d)(1)(i).
    \62\ See 17 CFR 240.3a71-3(d)(1)(ii)(A).
    \63\ See 17 CFR 240.3a71-3(d)(1)(ii)(B).
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    Where a member is acting as the U.S. Registered Affiliate for a 
foreign affiliate pursuant to the exception in Exchange Act Rule 3a71-
3(d), the member would be required to comply with the SEC's SBS Entity 
rules noted above. The consequence of the member not complying with 
these rules is that the member's foreign affiliate would be required to 
count such SBS toward its de minimis SBSD registration threshold. In 
these circumstances, FINRA believes it is appropriate to provide 
exceptions from the parallel FINRA rules to provide clarity and avoid 
unnecessary regulatory duplication, but only where the member is in 
fact complying with the specified SEC rules. Specifically, proposed 
FINRA Rule 0180(e) would provide that the following rules shall not 
apply to members' activities and positions with respect to SBS, to the 
extent that the member or the associated person of the member, as 
applicable, is arranging, negotiating or executing SBS on behalf of a 
non-U.S. affiliate pursuant to, and in compliance with the conditions 
of, the exception from counting certain SBS under Exchange Act Rule 
3a71-3(d)(1): (1) FINRA Rule 2111 (Suitability); (2) FINRA Rule 2210(d) 
(Communications with the Public--Content Standards); and (3) FINRA Rule 
2232 (Customer Confirmations).\64\ As noted above, the availability of 
the exceptions under proposed FINRA Rule 0180(e) would be conditioned 
on the member's compliance with the rules specified in Exchange Act 
Rule 3a71-3(d)(1)(ii)(B) as if the member were the counterparty to the 
SBS transactions.\65\
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    \64\ FINRA believes these proposed exceptions are appropriate 
for similar reasons as the proposed exceptions for SBS Entities in 
proposed FINRA Rules 0180(c) and (d). See supra notes 40 through 44 
and 49 through 51 and accompanying text.
    \65\ A member acting as the U.S. Registered Affiliate under 
Exchange Act Rule 3a71-3(d) would remain subject to all other FINRA 
rules applicable to such SBS brokerage activity. See supra note 37.
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Exemptive Authority
    As discussed above, in formulating the proposed rule change, FINRA 
consulted with its members and reviewed its rulebook to determine 
whether continuing exceptions from any of its rules are appropriate. 
FINRA recognizes, however, that the SBS market continues to evolve and 
that particular circumstances may arise in which applying specific 
FINRA rules not otherwise covered by the proposed exceptions to SBS 
activities may not be appropriate or feasible. Therefore, proposed 
FINRA Rule 0180(i) would provide that, pursuant to the FINRA Rule 9600 
Series, FINRA may, taking into consideration all relevant factors, 
exempt a person unconditionally or on specified terms from the 
application of FINRA rules (other than an exemption from the general 
application of paragraph (a) of proposed FINRA Rule 0180) to the 
person's SBS activities or positions as it deems appropriate consistent 
with the protection of investors and the public interest. Under this 
proposed provision, FINRA would consider written applications for 
exemptive relief pursuant to FINRA Rule 9610 from the application of 
specific rules to a member's SBS activities or positions. Such 
applications would be required to address the need for exemptive relief 
from specific FINRA rules on a rule-by-rule basis, and FINRA would not 
provide exemptive relief from the application of FINRA rules generally 
to a member's SBS activities or positions. Therefore, proposed FINRA 
Rule 0180(i) would not provide for exemptive authority from the general 
application of FINRA rules to SBS under proposed FINRA Rule 0180(a). 
Pursuant to FINRA Rule 9620, FINRA would consider such an application 
and issue a written decision to the requesting member, which may be 
made publicly available.\66\ A member would have the ability to appeal 
such a decision pursuant to FINRA Rule 9630. FINRA believes it is 
appropriate and in the public interest to provide this exemptive 
authority so that FINRA can account for specific situations that may 
arise with respect to SBS in the future on a case-by-case basis.
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    \66\ FINRA would consider any such application based on the 
specific circumstances described in the application and whether the 
requested exemptive relief would be consistent with the protection 
of investors and the public interest. FINRA expects that it would 
apply heightened scrutiny to applications for exemptive relief from 
members that are not also registered with the SEC as SBS Entities, 
and therefore not subject to the SEC's regulatory framework for SBS.
---------------------------------------------------------------------------

    FINRA also is proposing a conforming change to FINRA Rule 9610 to 
add FINRA Rule 0180 to the list of rules pursuant to which FINRA has 
exemptive authority.
Financial Responsibility and Operational Requirements
    In June 2019, the Commission adopted final capital, margin and 
segregation requirements for SBS Entities, along with amendments to the 
existing capital and segregation requirements for broker-dealers, in 
the Capital, Margin, and Segregation Release. As with many of its other 
Title VII rulemakings, the SEC aligned the compliance date for the 
amendments under the Capital, Margin, and Segregation Release with the 
Registration Compliance Date.\67\ Among other things, the Capital, 
Margin, and Segregation Release amended the existing net capital rule 
for broker-dealers, Exchange Act Rule 15c3-1,\68\ in two key respects 
relevant to FINRA's rules:
---------------------------------------------------------------------------

    \67\ See Capital, Margin, and Segregation Release, supra note 8, 
at 43954.
    \68\ 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

     First, the SEC adopted new minimum net capital 
requirements for broker-dealers that are also registered as SBSDs, but 
that do not operate pursuant to the alternative net capital (``ANC'') 
requirements of Exchange Act Rule 15c3-1 (``Non-ANC Firms'').\69\ Non-
ANC Firms that are also registered as SBSDs will need to comply with a 
new minimum dollar net capital requirement and a new component for 
determining their minimum capital requirement that is based on a 
percentage of initial margin computed for SBS (in addition to other 
minimum requirements applicable to the broker-dealer).\70\ These 
changes do not apply to broker-dealers that operate pursuant to the ANC 
requirements of the rule (``ANC Firms''). These new minimum net capital 
requirements also will not impact Non-ANC Firms that are not also 
registered as SBSDs, regardless of whether such Non-ANC Firms engage in 
SBS activities.\71\
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    \69\ Generally, a broker-dealer may apply to the SEC for 
authorization to use the alternative method for computing net 
capital contained in Appendix E to Exchange Act Rule 15c3-1. See 17 
CFR 240.15c3-1(a)(7). Such broker-dealers are known as ``ANC broker-
dealers.'' There are currently five approved ANC broker-dealers. See 
SEC, Broker-Dealers Using the Alternative Net Capital Computation 
under Appendix E to Rule 15c3-1, https://www.sec.gov/tm/broker-dealers-alternative-net-capital-computation. Other broker-dealers 
are known as non-ANC broker-dealers and must compute net capital 
pursuant to the provisions of Exchange Act Rule 15c3-1.
    \70\ See 17 CFR. 240.15c3-1(a)(10).
    \71\ For example, the new minimum net capital requirements do 
not apply to a Non-ANC Firm engaged in SBS dealing activity below 
the de minimis threshold for SBSD registration, or to a Non-ANC Firm 
engaged in SBS brokerage activity or entering into non-dealing SBS 
transactions (e.g., hedging). FINRA notes that the SEC also adopted 
new minimum capital requirements for MSBSPs, including that such 
entities must at all times have and maintain a tangible net worth. 
See Capital, Margin, and Segregation Release, supra note 8, at 
43906-07. FINRA does not believe any changes to FINRA rules are 
necessary with respect to the new MSBSP capital requirements.

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[[Page 26094]]

     Second, the SEC changed the minimum net capital 
requirements for ANC Firms, regardless of whether they transact in SBS. 
For ANC Firms, the SEC increased the minimum dollar net capital 
requirement, added a new component for determining the minimum capital 
requirement that is based on a percentage of initial margin computed 
for SBS (in addition to other minimum requirements applicable to the 
broker-dealer), increased the minimum tentative net capital requirement 
and amended the early warning notification requirement for tentative 
net capital.\72\
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    \72\ See 17 CFR 240.15c3-1(a)(7). The compliance date for the 
amended minimum net capital requirements for all ANC Firms is the 
Registration Compliance Date, i.e., October 6, 2021.
---------------------------------------------------------------------------

    FINRA Rule 4120 (Regulatory Notification and Business Curtailment) 
sets forth certain early warning notification and business curtailment 
requirements if a member's capital falls below certain thresholds. 
Specifically, FINRA Rule 4120(a) requires each carrying or clearing 
member to notify FINRA if its net capital falls below certain specified 
levels.\73\ FINRA Rule 4120(b) allows FINRA to restrict a member from 
expanding its business in certain circumstances and FINRA Rule 4120(c) 
allows FINRA to require a member to reduce its business if its net 
capital falls below certain specified levels (generally lower than 
those required for notification under FINRA Rule 4120(a)). These 
requirements are based on the minimum capital requirements applicable 
to a member broker-dealer under Exchange Act Rule 15c3-1. FINRA 
believes it is necessary to amend FINRA Rule 4120 to conform the rule 
to the new and increased minimum capital requirements for Non-ANC Firms 
that are also registered as SBSDs and for ANC Firms, as described 
above.\74\
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    \73\ As discussed below, FINRA is also proposing to apply all 
requirements in the FINRA Rule 4000 Series applicable to carrying or 
clearing firms to members that act as principal counterparty to an 
SBS, clear or carry an SBS, guarantee an SBS or otherwise have 
financial exposure to an SBS.
    \74\ As noted above, the SEC did not amend Exchange Act Rule 
15c3-1 to apply increased minimum capital requirements to Non-ANC 
Firms that engage in SBS activities but that are not registered 
SBSDs. FINRA is therefore not proposing to amend FINRA Rule 4120 to 
impose any additional minimum thresholds on such members. However, 
FINRA notes that, as a general matter, FINRA Rule 4120 would apply 
to all members that engage in SBS transactions (and any related 
transactions) because net capital is a holistic calculation based on 
a firm's liquid net worth, which includes all of a firm's 
activities.
---------------------------------------------------------------------------

    FINRA Rule 4120(a) requires each carrying or clearing firm to 
promptly, but in any event within 24 hours, notify FINRA in writing if 
its net capital falls below any of the percentages specified in 
subparagraphs (A) through (F) of FINRA Rule 4120(a)(1). The proposed 
rule change would modify subparagraph (D), which applies to ANC Firms, 
and also add new subparagraph (E), applicable to Non-ANC Firm members 
that are also registered SBSDs.\75\
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    \75\ The proposed rule change would also make non-substantive 
and conforming changes to other subparagraphs of FINRA Rule 4120(a) 
to reflect the insertion of new subparagraph (E), update cross-
references to SEC rules that have been amended and reflect FINRA 
rulebook format conventions.
---------------------------------------------------------------------------

    Existing Exchange Act Rule 15c3-1(a)(7)(i) requires an ANC Firm to 
maintain minimum tentative net capital of not less than $1 billion and 
minimum net capital of not less than $500 million. In addition, 
existing Exchange Act Rule 15c3-1(a)(7)(ii) requires an ANC Firm to 
provide an ``early warning'' notice to the SEC when its tentative net 
capital falls below $5 billion (or a lower threshold if the SEC has 
granted an ANC Firm's application to use such lower threshold). 
Subparagraph (D) of FINRA Rule 4120(a) is based on these net capital 
requirements, requiring notification to FINRA if the member is an ANC 
Firm and (i) its tentative net capital under Exchange Act Rule 15c3-
1(c)(15) is less than 50 percent of the early warning notification 
amount required by Exchange Act Rule 15c3-1(a)(7)(ii) or (ii) its net 
capital is less than $1.25 billion. In other words, notification to 
FINRA is required if an ANC Firm's tentative net capital falls below 
$2.5 billion (or a lower amount, if the ANC Firm has been permitted to 
use a lower early warning notice threshold), which is half of the SEC's 
early warning notification amount, or its net capital falls below $1.25 
billion, which is 2.5 times the SEC's net capital requirement for ANC 
Firms.
    In the Capital, Margin, and Segregation Release, the SEC amended 
the net capital requirements for ANC Firms in three ways. First, the 
SEC raised the tentative net capital requirement for ANC Firms from $1 
billion to $5 billion. Second, the SEC raised the minimum net capital 
requirement for ANC Firms from $500 million to the greater of $1 
billion or the sum of the applicable ratio requirement under Exchange 
Act Rule 15c3-1(a)(1) \76\ and two percent of the risk margin 
amount.\77\ Third, the SEC raised the tentative net capital early 
warning notification threshold from $5 billion to $6 billion. In light 
of these increased capital requirements under the SEC's net capital 
rule, FINRA believes it is appropriate to also modify the thresholds 
for required notification to FINRA for ANC Firms under FINRA Rule 
4120(a)(1)(D). Specifically, under the proposed rule change, an ANC 
Firm would be required to notify FINRA if, in addition to the 
conditions currently prescribed under FINRA Rule 4120(a)(1)(A), (E) and 
(F):
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    \76\ See 17 CFR 240.15c3-1(a)(7)(i)(A). Under Exchange Act Rule 
15c3-1(a)(1)(i), a broker-dealer generally may not permit its 
aggregate indebtedness to exceed 1500 percent of its net capital. A 
broker-dealer may elect not to be subject to the aggregate 
indebtedness standard if it complies with an alternative method of 
computing net capital. See 17 CFR 240.15c3-1(a)(1)(ii).
    \77\ The ``risk margin amount'' means the total initial margin 
for SBS. See 17 CFR 15c3-1(c)(17). Exchange Act Rule 15c3-
1(a)(7)(i)(A) provides that initially the requirement will be two 
percent of the risk margin amount. However, the SEC may issue an 
order raising the requirement to four percent on or after the third 
anniversary of the amended rule's compliance date and to eight 
percent on or after the fifth anniversary of the amended rule's 
compliance date. See 17 CFR 15c3-1(a)(7)(i)(A)(2) and (3) and 15c3-
1(a)(7)(i)(B).
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     Its tentative net capital is less than 150 percent of the 
minimum tentative net capital amount required by Exchange Act Rule 
15c3-1(a)(7)(i)(A) (i.e., $5 billion, such that the notification amount 
would be $7.5 billion),
     the member is subject to the aggregate indebtedness 
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital 
is less than the sum of 1/10th of its aggregate indebtedness and 150 
percent of the required percentage of the risk margin amount,\78\ or
---------------------------------------------------------------------------

    \78\ See supra note 77.
---------------------------------------------------------------------------

     the member elects to use the alternative method of 
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii), 
and its net capital is less than the sum of the level specified in 
Exchange Act Rule 17a-11(b)(2) \79\ and 150 percent of the required 
percentage of the risk margin amount.\80\
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    \79\ See 17 CFR 240.17a-11(b)(2). Exchange Act Rule 17a-11 
requires broker-dealers to promptly notify the SEC after the 
occurrence of certain events. Exchange Act Rule 17a-11(b)(2) 
requires such notification for broker-dealers using the alternative 
method of computing net capital pursuant to Exchange Act Rule 15c3-
1(a)(1)(ii) when net capital is less than five percent of aggregate 
debit items under the Exchange Act Rule 15c3-3 reserve formula.
    \80\ See supra note 77.
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    FINRA believes these modified thresholds are appropriately 
calibrated to provide FINRA with sufficient early warning that an ANC 
Firm's capital levels may be deteriorating. By revising the early 
warning levels as proposed, the proposed rule change aligns the 
historical thresholds in FINRA Rule

[[Page 26095]]

4120(a) for early warning notification for ANC Firms with the revised 
capital requirements applicable to such firms under the SEC's amended 
rules. Additionally, ANC Firms historically maintain capital far in 
excess of the proposed amounts, so FINRA does not expect these levels 
to be problematic for firms to maintain.
    In the Capital, Margin, and Segregation Release, the SEC also added 
a new minimum net capital requirement for Non-ANC Firms that are also 
registered as SBSDs.\81\ Specifically, a Non-ANC Firm that is 
registered as an SBSD must maintain minimum net capital of not less 
than the greater of $20 million or the sum of the ratio requirements 
under Exchange Act Rule 15c3-1(a)(1) \82\ and two percent of the risk 
margin amount.\83\ Accordingly, FINRA believes it is necessary to add 
corresponding new thresholds for required notification to FINRA for 
Non-ANC Firms that are also registered SBSDs under new FINRA Rule 
4120(a)(1)(E). Specifically, under the proposed rule change, a Non-ANC 
Firm that is also a registered SBSD would be required to notify FINRA 
if, in addition to the conditions currently prescribed under FINRA Rule 
4120(a)(1)(A), (E) and (F):
---------------------------------------------------------------------------

    \81\ See 17 CFR 15c3-1(a)(10).
    \82\ See supra note 76.
    \83\ See supra note 77.
---------------------------------------------------------------------------

     The member is subject to the aggregate indebtedness 
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital 
is less than the sum of 1/10th of its aggregate indebtedness and 150 
percent of the required percentage of the risk margin amount,\84\ or
---------------------------------------------------------------------------

    \84\ See supra note 77.
---------------------------------------------------------------------------

     the member elects to use the alternative method of 
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii), 
and its net capital is less than the sum of the level specified in 
Exchange Act Rule 17a-11(b)(2) \85\ and 150 percent of the required 
percentage of the risk margin amount.\86\
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    \85\ See supra note 79.
    \86\ See supra note 77.
---------------------------------------------------------------------------

    FINRA believes it is appropriate to include specific thresholds for 
early notification to FINRA based on the new minimum net capital 
requirements for Non-ANC Firms that are registered SBSDs. FINRA also 
believes that the thresholds described above are appropriately 
calibrated to provide FINRA with sufficient early warning that such a 
firm's capital levels may be deteriorating. By defining the early 
warning levels as proposed, the proposed rule change aligns the 
historical thresholds in FINRA Rule 4120(a) for early warning 
notification with the new capital requirements applicable to Non-ANC 
Firms that are registered SBSDs under the SEC's amended rules.
    FINRA Rule 4120(b) allows FINRA to require a member that carries 
customer accounts or clears transactions to not expand its business 
during any period in which any of the conditions described in paragraph 
(a)(1) of FINRA Rule 4120 continue to exist for more than 15 
consecutive business days, provided that such condition(s) has been 
known to FINRA or the member for at least five consecutive business 
days. Since the proposed rule change would modify the conditions 
specified in FINRA Rule 4120(a)(1) as described above, the triggers for 
the application of restrictions under FINRA Rule 4120(b) would be 
similarly affected. However, FINRA does not believe that any conforming 
changes are needed at this time to the restrictions on business 
expansion requirements under FINRA Rule 4120(b). FINRA notes that FINRA 
Rule 4120(b)(3)(A)-(G) includes a non-exclusive list of activities that 
may constitute an ``expansion of business'' for these purposes, and 
FINRA Rule 4120(b)(3)(H) provides that the term ``expansion of 
business'' may include such other activities as FINRA deems appropriate 
under the circumstances, in the public interest or for the protection 
of investors. FINRA believes that a member firm's SBS activities would 
be within the scope of ``other activities'' contemplated by FINRA Rule 
4120(b)(3)(H).
    FINRA Rule 4120(c) allows FINRA to require a member to reduce its 
business if its net capital falls below any of the percentages 
specified in subparagraphs (A) through (F) of FINRA Rule 4120(c)(1). 
Similar to the proposed modifications to FINRA Rule 4120(a) described 
above, the proposed rule change would modify subparagraph (D) of FINRA 
Rule 4120(c)(1), which applies to ANC Firms, and also add new 
subparagraph (E), applicable to Non-ANC Firm members that are also 
registered SBSDs.\87\
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    \87\ The proposed rule change would also make non-substantive 
and conforming changes to other subparagraphs of FINRA Rule 
4120(c)(1) to reflect the insertion of new subparagraph (E), update 
cross-references to SEC rules that have been amended and reflect 
FINRA rulebook format conventions. Similar non-substantive changes 
would be made to paragraph (b)(1) and Supplementary Material .01 to 
FINRA Rule 4120 to reflect FINRA rulebook format conventions.
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    Current subparagraph (D) of FINRA Rule 4120(c)(1) permits business 
curtailment if the member is an ANC Firm and (i) its tentative net 
capital under Exchange Act Rule 15c3-1(c)(15) is less than 40 percent 
of the early warning notification amount required by Exchange Act Rule 
15c3-1(a)(7)(ii) or (ii) its net capital is less than $1 billion. These 
thresholds are based on the current broker-dealer net capital rule. As 
described above, the SEC amended the net capital requirements for 
broker-dealers in the Capital, Margin, and Segregation Release. 
Accordingly, under the proposed rule change, a member that is an ANC 
Firm would be subject to the business curtailment provisions of FINRA 
Rule 4120(c)(1) if, in addition to the conditions currently prescribed 
under FINRA Rule 4120(c)(1)(A), (E) and (F):
     Its tentative net capital is less than the amount 
specified under Exchange Act Rule 15c3-1(a)(7)(ii) (i.e., the early 
warning amount, $6 billion),
     the member is subject to the aggregate indebtedness 
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital 
is less than the sum of 1/12th of its aggregate indebtedness and 125 
percent of the required percentage of the risk margin amount,\88\ or
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    \88\ See supra note 77.
---------------------------------------------------------------------------

     the member elects to use the alternative method of 
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii), 
and its net capital is less than the sum of one percentage point below 
the level specified in Exchange Act Rule 17a-11(b)(2) \89\ and 125 
percent of the required percentage of the risk margin amount.\90\
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    \89\ See supra note 79.
    \90\ See supra note 77.
---------------------------------------------------------------------------

    FINRA believes these modified thresholds are appropriately 
calibrated to provide FINRA with the ability to require ANC Firms to 
reduce their business when their capital levels have deteriorated to a 
level that may jeopardize their ability to continue to comply with 
their capital requirements.
    As described above, in the Capital, Margin, and Segregation 
Release, the SEC also added a new minimum net capital requirement for 
Non-ANC Firms that are also registered as SBSDs. Accordingly, the 
proposed rule change would add corresponding new thresholds for 
business curtailment for Non-ANC Firms that are also registered SBSDs 
under new FINRA Rule 4120(c)(1)(E). Specifically, under the proposed 
rule change, a Non-ANC Firm that is also a registered SBSD would be 
subject to the business curtailment provisions of FINRA Rule 4120(c)(1) 
if, in addition to the conditions currently prescribed under FINRA Rule 
4120(c)(1)(A), (E) and (F):
     The member is subject to the aggregate indebtedness 
requirement of

[[Page 26096]]

Exchange Act Rule 15c3-1(a)(1)(i), and its net capital is less than the 
sum of 1/12th of its aggregate indebtedness and 125 percent of the 
required percentage of the risk margin amount,\91\ or
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    \91\ See supra note 77.
---------------------------------------------------------------------------

     the member elects to use the alternative method of 
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii), 
and its net capital is less than the sum of one percentage point below 
the level specified in Exchange Act Rule 17a-11(b)(2) \92\ and 125 
percent of the required percentage of the risk margin amount.\93\
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    \92\ See supra note 79.
    \93\ See supra note 77.
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    FINRA believes it is appropriate to include specific thresholds for 
business curtailment based on the new minimum net capital requirements 
for Non-ANC Firms that are registered SBSDs. FINRA also believes that 
the thresholds described above are appropriately calibrated to provide 
FINRA with the ability to require such firms to reduce their business 
when their capital levels have deteriorated to a level that may 
jeopardize their ability to continue to comply with their capital 
requirements.
    Lastly, FINRA notes that FINRA Rule 4120(c)(3)(A)-(J) includes a 
non-exclusive list of activities that may constitute a ``business 
reduction'' for these purposes, and FINRA Rule 4120(c)(3)(K) provides 
that the term ``business reduction'' may include such other activities 
as FINRA deems appropriate under the circumstances, in the public 
interest or for the protection of investors. FINRA believes that a 
member firm's SBS activities would be within the scope of ``other 
activities'' contemplated by FINRA Rule 4120(c)(3)(K).
    In addition to these conforming changes to FINRA Rule 4120, the 
proposed rule change would apply FINRA's financial and operational 
rules more broadly to firms that enter into, or otherwise have exposure 
to, SBS. Specifically, certain rules in the FINRA Rule 4000 Series 
(Financial and Operational Rules) include provisions that impose higher 
standards, or provide FINRA the authority to impose additional 
requirements, on firms that carry or clear transactions or accounts 
(generally referred to as ``carrying or clearing firms''). This 
``tiering'' structure was built into certain rules so that firms that 
only introduce their customer accounts and do not have exposure to the 
settlement system are provided relief from the higher standards 
required of firms that carry or clear transactions and accounts. Below 
is a list of rules in the FINRA Rule 4000 Series where tiering has been 
employed for carrying or clearing firms and a brief description of the 
tiered requirements for such firms:
     FINRA Rule 4110 (Capital Compliance) includes requirements 
for carrying or clearing firms to keep greater net capital, seek 
permission for withdrawals of capital and seek approval for certain 
add-backs to net capital.
     FINRA Rule 4120 (Regulatory Notification and Business 
Curtailment) includes restrictions on expanding, or requirements to 
reduce business, if sufficient capital levels are not maintained.
     FINRA Rule 4521 (Notifications, Questionnaires and 
Reports) allows FINRA to collect additional data and require reporting 
of a material decline in tentative net capital.
     FINRA Rule 4522 (Periodic Security Counts, Verification 
and Comparison) requires more frequent security counts, verifications 
and comparisons than would be required under Exchange Act Rule 17a-
13.\94\
---------------------------------------------------------------------------

    \94\ See 17 CFR 240.17a-13. Exchange Act Rule 17a-13 generally 
requires broker-dealers to perform quarterly security counts.
---------------------------------------------------------------------------

     FINRA Rule 4523 (Assignment of Responsibility for General 
Ledger Accounts and Identification of Suspense Accounts) requires a 
record of primary and supervisory named individuals over general ledger 
bookkeeping accounts.
    The intent of the tiering employed in these rules in the FINRA Rule 
4000 Series is to impose higher capital, recordkeeping and operational 
standards on firms that carry or clear transactions and accounts, and 
therefore may have financial exposure to customers, other broker-
dealers, central counterparties or others. FINRA believes that similar 
considerations apply for members with exposure to SBS. SBS are complex 
transactions that will, by their nature, require detailed 
recordkeeping, margining, legal agreements, collateral management, 
reconciliation and risk management. FINRA therefore believes it is 
appropriate to also employ tiering in the FINRA Rule 4000 Series for 
members that enter into SBS on a principal basis or otherwise have 
financial exposure to SBS. Specifically, under the proposed rule 
change, proposed FINRA Rule 0180(h) would provide that, for purposes of 
the FINRA Rule 4000 Series, all requirements that apply to a member 
that clears or carries customer accounts shall also apply to any member 
that acts as a principal counterparty to an SBS, clears or carries an 
SBS, guarantees an SBS or otherwise has financial exposure to an 
SBS.\95\ FINRA believes that applying these higher standards when a 
member enters into SBS or otherwise has exposure to SBS is appropriate 
and consistent with the protection of investors and the public 
interest.
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    \95\ Although this proposed tiering provision relates to the 
financial responsibility and operational rules, FINRA believes it 
should be included as a paragraph in proposed FINRA Rule 0180 so 
that all provisions relating to the treatment of SBS under FINRA 
rules are found in a single, consolidated rule.
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Margin Requirements
    As discussed above, in June 2019 the Commission adopted its final 
Capital, Margin, and Segregation Release, with a compliance date 
aligned with the Registration Compliance Date.\96\ Among other things, 
the Capital, Margin, and Segregation Release adopted new Exchange Act 
Rule 18a-3, which prescribes margin requirements for nonbank SBSDs with 
respect to uncleared SBS.\97\ Generally, Exchange Act Rule 18a-3 
requires a nonbank SBSD to calculate, for each account of an SBS 
counterparty as of the close of business of each day: (i) The amount of 
current exposure in the account (i.e., variation margin) and (ii) the 
initial margin amount for the account.\98\ Under Exchange Act Rule 18a-
3, variation margin must be calculated by marking the position to 
market, while initial margin must generally be calculated using 
standardized haircuts, which are prescribed in Exchange Act Rule 15c3-1 
for nonbank SBSDs that are registered broker-dealers.\99\ Nonbank SBSDs 
may apply to the SEC for authorization to use models to calculate 
initial margin instead of the standardized haircuts (including the 
option to use the more risk sensitive methodology in Exchange Act Rule 
15c3-1a), but nonbank SBSDs that are

[[Page 26097]]

registered broker-dealers must use standardized haircuts to calculate 
initial margin for uncleared equity SBS.\100\ Based on these 
calculations, Exchange Act Rule 18a-3 generally requires a nonbank SBSD 
to collect and deliver variation margin, and to collect (but not 
deliver) initial margin.\101\ Exchange Act Rule 18a-3 also provides 
certain exceptions from the margin requirements, establishes thresholds 
and minimum transfer amounts, specifies collateral requirements 
(including collateral haircuts), establishes risk monitoring 
requirements and includes other miscellaneous provisions, such as 
definitions. All nonbank SBSDs, including nonbank SBSDs that are FINRA 
members, will become subject to the margin requirements set forth in 
Exchange Act Rule 18a-3 beginning on the Registration Compliance Date.
---------------------------------------------------------------------------

    \96\ See Capital, Margin, and Segregation Release, supra note 8, 
at 43954.
    \97\ See 17 CFR 240.18a-3. Exchange Act Rule 18a-3 also 
prescribes margin requirements for nonbank MSBSPs with respect to 
uncleared SBS. As discussed above, Exchange Act Rule 18a-3 generally 
requires SBSDs to collect or deliver variation margin, and also to 
collect initial margin, with respect to its SBS counterparties. 
However, Exchange Act Rule 18a-3 requires that a nonbank MSBSP only 
collect and deliver variation margin, without prescribing any 
initial margin requirement. See Capital, Margin, and Segregation 
Release, supra note 8, at 43877. As discussed below, FINRA believes 
it is appropriate to apply variation margin and initial margin 
requirements to all of its members that transact in uncleared SBS. 
Therefore, proposed FINRA Rule 4240 would provide an exception for 
members that are registered as SBSDs (and therefore subject to the 
variation and initial margin requirements of Exchange Act Rule 18a-
3), but not for members that are registered as MSBSPs.
    \98\ See 17 CFR 240.18a-3(c)(1)(i); Capital, Margin, and 
Segregation Release, supra note 8, at 43876.
    \99\ See 17 CFR 240.18a-3(d).
    \100\ See supra note 99; Capital, Margin, and Segregation 
Release, supra note 8, at 43876.
    \101\ See 17 CFR 240.18a-3(c)(1)(ii).
---------------------------------------------------------------------------

    The FINRA Rule 4200 Series sets forth margin requirements 
applicable to FINRA members. In particular, FINRA Rule 4210 describes 
the margin requirements that determine the amount of equity or 
``margin'' customers are expected to maintain in their securities 
accounts, including margin requirements for equity and fixed income 
securities as well as options, warrants and security futures. Current 
FINRA Rule 4240 separately establishes an interim pilot program with 
respect to margin requirements for any transactions in CDS held in an 
account at a member (the ``Interim Pilot Program''). Under current 
FINRA Rule 0180, FINRA Rule 4210 does not apply to members' activities 
and positions with respect to SBS, but current FINRA Rule 4240 does 
apply to activities and positions within its scope. Therefore, to the 
extent that a FINRA member enters into SBS that are CDS, the margin 
requirements under the Interim Pilot Program apply to such SBS.\102\ 
However, the Interim Pilot Program is a temporary rule, and SBS that 
are not CDS are not currently subject to any margin requirements under 
FINRA rules.
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    \102\ For purposes of current FINRA Rule 4240, the term ``credit 
default swap'' includes any product that is commonly known to the 
trade as a ``credit default swap'' and is an SBS as defined pursuant 
to Section 3(a)(68) of the Act or the rules and guidance of the SEC 
and its staff. See FINRA Rule 4240(a).
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    The Interim Pilot Program was originally proposed by FINRA and 
approved by the Commission in 2009 specifically to address concerns 
arising from systemic risk posed by CDS.\103\ Pending the SEC's final 
implementation of the Title VII rulemakings, FINRA has extended the 
expiration date of the Interim Pilot Program a number of times, mostly 
recently in June 2020.\104\ The Interim Pilot Program under current 
FINRA Rule 4240 is currently set to expire on September 1, 2021, the 
same date that current FINRA Rule 0180 is set to expire.\105\
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    \103\ See Securities Exchange Act Release No. 59955 (May 22, 
2009), 74 FR 25586 (May 28, 2009) (Order Approving File No. SR-
FINRA-2009-012).
    \104\ See supra note 16.
    \105\ See supra note 18.
---------------------------------------------------------------------------

    In light of the finalization of the SEC's margin requirements for 
nonbank SBSDs under Exchange Act Rule 18a-3 and the upcoming 
Registration Compliance Date, FINRA believes it is appropriate and in 
the public interest for the Interim Pilot Program to expire and for 
FINRA to adopt a new margin rule specifically applicable to SBS.\106\ 
Accordingly, under the proposed rule change, current FINRA Rule 4240 
would be replaced by a new FINRA Rule 4240 on October 6, 2021 that 
would prescribe margin requirements for SBS. Consistent with Exchange 
Act Rule 18a-3--and unlike the Interim Pilot Program--proposed new Rule 
4240 would apply margin requirements to all SBS, not just CDS. However, 
proposed new FINRA Rule 4240 would not apply to any member that is 
registered as an SBSD, as such members will be subject to the margin 
requirements of Exchange Act Rule 18a-3 as summarized above. 
Additionally, and consistent with the SEC's approach under the Act and 
Exchange Act Rule 18a-3, proposed FINRA Rule 4240 would defer to 
registered clearing agencies to set the margin requirements for cleared 
SBS, and as such would only specify new variation margin and initial 
margin requirements for uncleared SBS. Therefore, the specific new 
margin requirements prescribed under proposed FINRA Rule 4240 would 
only apply to uncleared SBS transacted by FINRA members that are not 
registered SBSDs. FINRA believes that, by applying margin requirements 
in these circumstances, the proposed rule change would fill an 
important regulatory gap, protect FINRA members against counterparty 
credit risk, maintain a level playing field for members and prevent 
regulatory arbitrage. As described in further detail below, the margin 
requirements under proposed FINRA Rule 4240 would be structurally 
aligned with the margin requirements that will apply to nonbank SBSDs 
under Exchange Act Rule 18a-3, with certain modifications that FINRA 
believes are necessary given that such members will not be subject to 
the SEC's comprehensive regulatory framework for SBSDs. Thus, subject 
to certain exceptions described in the proposed rule, proposed FINRA 
Rule 4240 would require members that are not SBSDs to collect and 
deliver variation margin on a daily basis to cover the member's current 
exposure to or from each uncleared SBS counterparty, and also to 
collect (but not deliver) initial margin from each SBS counterparty.
---------------------------------------------------------------------------

    \106\ FINRA notes that, under the proposed rule change, proposed 
FINRA Rule 0180 would no longer provide an exception from current 
FINRA Rule 4210 applying to members' activities and positions with 
respect to SBS. Absent additional changes, therefore, the general 
margin requirements under FINRA Rule 4210 would apply to SBS. 
However, as described above, FINRA believes specifically listing SBS 
within the exceptions listed in FINRA Rule 4210, and adopting a 
separate, new FINRA Rule 4240 applicable to SBS, would promote legal 
certainty and provide clarity to its members.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240 is divided into a header followed by 
paragraphs (a) through (d). The header would specify the scope of the 
margin requirements under proposed FINRA Rule 4240. Paragraph (a) would 
describe the margin requirements for cleared SBS. Paragraph (b) would 
describe the margin requirements for uncleared SBS. Specifically, 
paragraph (b)(1) would set forth how variation margin must be 
calculated, paragraph (b)(2) would set forth how initial margin must be 
calculated, paragraph (b)(3) would prescribe the collection and 
delivery requirements for variation and initial margin, paragraph 
(b)(4) would specify the manner and time of collection or delivery of 
variation and initial margin, and paragraph (b)(5) would list certain 
exceptions from the margin requirements. Paragraph (c) would require 
members to employ specified risk monitoring procedures and guidelines 
for uncleared SBS. Finally, paragraph (d) would define certain terms 
used in proposed FINRA Rule 4240. Each of these aspects of the proposed 
rule change is described in further detail below.
    Proposed FINRA Rule 4240 would be entitled ``Security-Based Swap 
Margin Requirements.'' \107\ The header text to

[[Page 26098]]

the rule would state that each member that is a party to an SBS with a 
customer, broker or dealer, or other Counterparty,\108\ or who has 
guaranteed or otherwise become responsible for any other person's SBS 
obligations, shall comply with the requirements of proposed FINRA Rule 
4240, except that a member that is registered as an SBSD shall instead 
comply with Exchange Act Rule 18a-3. This provision of the proposed 
rule is intended to clarify that the margin requirements under proposed 
FINRA Rule 4240 apply in all circumstances where a member is a party to 
a SBS, regardless of the type of counterparty, and also where a member 
has financial exposure to an SBS, whether through a guarantee or other 
arrangements under which the member is responsible for another person's 
SBS obligations. FINRA believes that this provision is necessary to 
ensure that the proposed margin requirements adequately protect member 
firms against counterparty credit risk, regardless of the specific 
manner through which the member has become exposed to such risk. 
Additionally, as discussed above, this provision clarifies that members 
that are registered SBSDs are not subject to the proposed margin 
requirements because they are instead required to comply with Exchange 
Act Rule 18a-3. FINRA believes it should defer to the SEC's margin 
framework for registered SBSDs rather than impose additional or 
different requirements on such entities.
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    \107\ In addition to the new provisions under proposed FINRA 
Rule 4240 discussed above, the implementation of new margin 
requirements for SBS under proposed FINRA Rule 4240 will also 
require a conforming change to FINRA Rule 4220 (Daily Record of 
Required Margin). FINRA Rule 4220 requires each member carrying 
securities margin accounts for customers to make a record each day 
of every case in which initial or additional margin must be obtained 
in a customer's account. To ensure that similar records are 
maintained for SBS margin required under proposed new FINRA Rule 
4240, the proposed rule change would update FINRA Rule 4220 to also 
require such records for each member subject to proposed FINRA Rule 
4240.
     In addition, the proposed rule change would add new 
Supplementary Material .06 to FINRA Rule 4210 to clarify that a 
Regulation T good faith account, other than a non-securities 
account, is a margin account for purposes of FINRA Rule 4210. This 
provision is intended merely to codify FINRA's existing 
interpretation regarding the scope of FINRA Rule 4210. The proposed 
rule change would also include a parallel provision in new 
Supplementary Material .01 to proposed new Rule 4240.
     Finally, the proposed rule change would make two other 
conforming changes to FINRA Rule 4210, including to add proposed new 
FINRA Rule 4240(e)(9) and to make a technical adjustment to FINRA 
Rule 4240(g)(2)(H). These proposed changes are discussed below.
    \108\ ``Counterparty'' would be defined under proposed FINRA 
Rule 4240(d)(5) to mean a person with whom a member has entered into 
an Uncleared SBS. An ``SBS'' would be defined in proposed FINRA Rule 
4240(d)(16) by reference to the definition of ``security-based 
swap'' under Section 3(a)(68) of the Act and ``Uncleared'' would be 
defined in proposed FINRA Rule 4240(d)(18) as an SBS that is not 
Cleared. Under proposed FINRA Rule 4240(d)(3), an SBS would be 
considered Cleared if it is cleared through a Clearing Agency by or 
on behalf of the member, and Clearing Agency would be defined under 
proposed FINRA Rule 4240(4) as a clearing agency registered pursuant 
to Section 17A of the Act or exempted by the SEC from such 
registration by a rule or order pursuant to Section 17A of the Act.
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    Proposed FINRA Rule 4240(a), entitled ``Cleared SBS Margin 
Requirements,'' would state that, except as provided in paragraph 
(b)(5) (i.e., specified exceptions from proposed FINRA Rule 4240, 
discussed below), the margin to be maintained on any Cleared SBS is the 
margin on such Cleared SBS required by the Clearing Agency through 
which such SBS is Cleared. As discussed above, this provision clarifies 
that proposed FINRA Rule 4240 defers to registered clearing agencies to 
set the margin requirements for cleared SBS. FINRA believes that it is 
appropriate to defer to clearing agencies to establish margin 
requirements for cleared SBS in light of the SEC's comprehensive 
regulation of clearing agencies, including their required margin 
levels, under the Act.
    Proposed FINRA Rule 4240(b), entitled ``Uncleared SBS Margin 
Requirements,'' would set forth the substantive margin requirements 
applicable to members that are not SBSDs when such members transact in 
Uncleared SBS. Paragraph (b)(1), entitled ``Current Exposure 
Calculation,'' would require that, as of the close of business of each 
business day, the member calculate with respect to each Uncleared SBS 
Account \109\ the Counterparty's Current Exposure to the member (if 
positive) or the member's Current Exposure to the Counterparty (if 
negative). Current Exposure would be calculated as an amount equal to 
the net Value \110\ of all Uncleared SBS in the Uncleared SBS Account 
plus the Value of all Variation Margin collected from the Counterparty 
minus the Value of all Variation margin delivered to the 
Counterparty.\111\ This provision would define a member's Current 
Exposure for purposes of collecting or delivering Variation Margin 
under proposed FINRA Rule 4240(b)(3), discussed below, by taking into 
account the net Value of SBS in the Counterparty's account together 
with any Variation Margin that has already been collected or delivered. 
FINRA believes this calculation is consistent with the variation margin 
requirements under Exchange Act Rule 18a-3.
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    \109\ Under proposed FINRA Rule 4240(d)(19), an ``Uncleared SBS 
Account'' would be defined to mean an account with respect to a 
Counterparty consisting of all Uncleared SBS between the member and 
the Counterparty, together with long or short positions for 
Variation Margin in the form of securities collected or delivered, 
respectively, credit or debit balances for Variation Margin in the 
form of cash collected or delivered, respectively, and long 
positions or credit balances for Initial Margin collected in the 
form of securities or cash, respectively. The definitions of 
``Variation Margin'' and ``Initial Margin'' are discussed below.
    \110\ ``Value'' would be defined in proposed FINRA Rule 
4240(d)(20). Under this definition, the Value of one or more SBS 
would be the mid-market replacement cost for such SBS. The Value of 
a security position would be the current market value of such margin 
securities, as defined in FINRA Rule 4210(a)(2) and determined in 
accordance with FINRA Rule 4210(f)(1) (i.e., the provisions of 
FINRA's general margin rule used to determine the current market 
value of margin securities). Alternatively, a member could elect to 
determine the Value of margin securities collected as Variation 
Margin or Initial Margin by applying a haircut to the current market 
value of such securities equal to the margin requirement that would 
be applicable to them under FINRA Rule 4210 if they were held in the 
Counterparty's margin account (in which case, however, such margin 
securities would not be required to be themselves margined under 
proposed FINRA Rule 4240(b)(2)(A)(iii)). The Value of cash in U.S. 
dollars would be the amount of such cash, while the Value of freely 
convertible foreign currency would be the amount of U.S. dollars 
into which the currency could be converted, provided the currency is 
marked-to-market daily.
    \111\ Under proposed FINRA Rule 4240(d)(21), ``Variation 
Margin'' would be defined to mean the cash or margin securities 
collected from, or delivered to, a Counterparty in accordance with 
proposed FINRA Rule 4240(b)(3)(A), as discussed below. Under 
proposed FINRA Rule 4240(b)(2)(A)(iii), all securities deposited as 
Variation Margin for Uncleared SBS would themselves be margined in 
accordance with FINRA Rule 4210, unless the member has chosen to 
haircut them for purposes of determining their Value. See supra note 
110.
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    Proposed FINRA Rule 4240(b)(2), entitled ``Initial Margin 
Computation,'' would require that, as of the close of business on each 
business day, the member compute the Initial Margin Requirement for 
each Uncleared SBS Account equal to the sum of the Initial Margin 
Requirements on the Uncleared SBS and securities positions in that 
Uncleared SBS Account. The remainder of proposed FINRA Rule 4240(b)(2) 
describes how a member must calculate the Initial Margin Requirement, 
which is then used for purposes of collecting Initial Margin under 
proposed FINRA Rule 4240(b)(3), discussed below.\112\ Under the 
proposed rule change, the Initial Margin Requirement would depend on 
the type of uncleared SBS involved, with different requirements 
depending on whether the uncleared SBS is (i) a ``plain vanilla'' CDS; 
(ii) a

[[Page 26099]]

``plain vanilla'' SBS other than an CDS (i.e., an SBS that is the 
economic equivalent of a margin account containing a portfolio of long 
or short positions in securities or options, such as a ``plain 
vanilla'' equity total return swap (``TRS'')); or (iii) any other type 
of SBS (e.g., a complex CDS or equity TRS that would not be considered 
``plain vanilla'' under the proposed rule, including for example a CDS 
swaption, or a dividend swap). FINRA believes that differentiation as 
to initial margin requirements among these different types of SBS is 
appropriate and necessary given the unique characteristics and risks 
posed by different SBS products.
---------------------------------------------------------------------------

    \112\ Under proposed FINRA Rule 4240(d)(9), the term ``Initial 
Margin'' would be defined to mean all cash or marginable securities, 
excluding Variation Margin, received by the member for a 
Counterparty's Uncleared SBS Account or transferred to the 
Counterparty's Uncleared SBS Account from another account at the 
member, including margin collected from a Counterparty in accordance 
with proposed FINRA Rule 4240(b)(3)(B), as discussed below, that in 
each case have not been returned to the Counterparty or applied to 
an obligation of the Counterparty. Under proposed FINRA Rule 
4240(b)(2)(A)(iii), all securities deposited as Initial Margin for 
Uncleared SBS would themselves be margined in accordance with FINRA 
Rule 4210, unless the member has chosen to haircut them for purposes 
of determining their Value. See supra note 110.
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    Proposed paragraphs (b)(2)(A)(i) and (ii) would define the Initial 
Margin Requirements for uncleared plain vanilla CDS (referred to as 
``Basic CDS'') \113\ and other uncleared ``plain vanilla'' SBS 
(referred to as ``Basic SBS''),\114\ respectively. First, the Initial 
Margin Requirement for an Uncleared Basic CDS would generally be 
computed based on the term and spread of the Uncleared Basic CDS, using 
the chart and offsets set out in Exchange Act Rule 15c3-
1(c)(2)(vi)(P).\115\ The proposed rule would therefore follow Exchange 
Act Rule 18a-3(d)(1)(i) by determining the Initial Margin Requirement 
for Uncleared Basic CDS using the haircuts applicable to such SBS under 
the SEC's net capital rule. FINRA believes that determining initial 
margin for CDS in this manner would promote regulatory consistency and 
reduce potential arbitrage. Additionally, the haircuts prescribed in 
Exchange Act Rule 15c3-1(c)(2)(vi)(P) are substantially similar to 
existing FINRA Rule 4240 margin requirements, so in effect the proposed 
requirements have already been used during the Interim Pilot Program. 
Second, the Initial Margin Requirement for a Basic SBS would generally 
be computed by applying FINRA Rule 4210 to the Equivalent Margin 
Account. Since an Uncleared Basic SBS would be the economic equivalent 
of a margin account that would otherwise be governed by the margin 
provisions of FINRA Rule 4210, FINRA believes it is appropriate to 
treat such SBS similarly.
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    \113\ Under proposed FINRA Rule 4240(d)(1), a ``Basic CDS'' 
would be defined to mean a Basic Single Name Credit Default Swap or 
a Basic Narrow-Based Index Credit Default Swap. A Basic Single-Name 
Credit Default Swap would mean an SBS in which one party pays either 
a single fixed amount or periodic fixed amounts or floating amounts 
determined by reference to a specified notional amount, and the 
other party pays either a fixed amount or an amount determined by 
reference to the value of one or more loans, debt securities or 
other financial instruments issued, guaranteed or otherwise entered 
into by a third party (i.e., the ``Reference Entity'') upon the 
occurrence of one or more specified credit events with respect to 
the Reference Entity (for example, bankruptcy or payment default). 
The term ``Basic Single-Name Credit Default Swap'' would also 
include a swap that, upon the occurrence of one or more specified 
credit events with respect to the Reference Entity, is physically 
settled by payment of a specified fixed amount by one party against 
delivery by the other party of eligible obligations of the Reference 
Entity. A Basic Narrow-Based Index Credit Default Swap would be 
defined to mean an SBS consisting of multiple component Basic 
Single-Name Credit Default Swaps.
    \114\ Under proposed FINRA Rule 4240(d)(2), a ``Basic SBS'' 
would be defined to mean an SBS, other than a CDS, under which each 
party is contractually obligated to provide the other the economic 
equivalent of a margin account containing a portfolio of long or 
short positions in securities or options (i.e., an ``Equivalent 
Margin Account'').
    \115\ See 17 CFR 240.15c3-1(c)(2)(vi)(P). This provision of the 
SEC's broker-dealer net capital rule defines the haircuts applicable 
to uncleared SBS.
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    In addition, proposed FINRA Rule 4240(b)(2)(A) would permit the 
Initial Margin Requirements for both Uncleared Basic CDS and Uncleared 
Basic SBS to be computed based on a combination of multiple SBS and 
securities or options positions, as applicable and subject to certain 
conditions. Specifically, proposed FINRA Rule 4240(b)(2)(A)(i) would 
provide that, if the member has a netting or collateral agreement that 
is legally enforceable against the Counterparty and covers any 
combination of Uncleared Basic CDS or securities specified in clause 
(iii), (iv) or (v) of Exchange Act Rule 15c3-1(c)(2)(vi)(P)(1) (i.e., 
specified offsetting debt securities), the member may compute the 
Initial Margin Requirement on such combination of positions equal to 
the ``haircut'' on that combination under Exchange Act Rule 15c3-
1(c)(2)(vi)(P)(1). Proposed FINRA Rule 4240(b)(2)(A)(ii) would 
similarly provide that, if the member has a netting or collateral 
agreement that is legally enforceable against the Counterparty and 
covers any combination of Uncleared Basic SBS, securities or options 
positions, the member may compute the Initial Margin Requirement on the 
combination of such positions equal to the margin that FINRA Rule 4210 
would require to be maintained on the combination of Equivalent Margin 
Accounts for such Uncleared Basic SBS and securities or options 
positions. Proposed FINRA Rule 4240(b)(2)(B) would impose conditions on 
computing the Initial Margin Requirement using these combination 
methods, including that (i) securities positions must be in the 
Counterparty's Uncleared SBS Account or margin account at the member; 
(ii) securities may not be included if the member has chosen to haircut 
them for purposes of determining their Value; \116\ (iii) options 
positions must be in the Counterparty's margin account at the member; 
(iv) no SBS, security or option positions may be included in more than 
one combination; and (v) no combinations may include securities or 
options positions for which reduced margin requirements are computed 
under FINRA Rule 4210(e)(1) (i.e., reduced margin requirements for 
offsetting long and short positions) or 4210(f)(2)(F)(ii) through 
(f)(2)(l) (i.e., various reduced margin requirements for certain 
options, including covered options and offsetting options positions). 
FINRA believes these conditions would ensure that the Initial Margin 
Requirement calculated using the combination method is based on 
securities and options positions that the member actually has in its 
possession and does not reflect reductions in value that would 
inappropriately lower the margin requirement. In addition, proposed 
FINRA Rule 4240(b)(2)(B) would provide that if the Initial Margin 
Requirement is computed on a combination as described above, the 
Initial Margin Requirement on the Uncleared SBS included in the 
combination shall be reduced (but not below zero) by the aggregate 
maintenance margin requirements under FINRA Rule 4210 applicable to 
such margin account positions. FINRA believes that this provision would 
appropriately take into account margin already collected under FINRA 
Rule 4210 with respect to such positions.\117\
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    \116\ See supra note 110.
    \117\ In connection with this proposed provision of FINRA Rule 
4240(b)(2)(B), the proposed rule change would also add a new 
paragraph (e)(9) to FINRA Rule 4210, entitled ``Security-Based 
Swaps; SBS Offsets.'' Specifically, where the Initial Margin 
Requirement on the combination of SBS and a securities or options 
position in the margin account would be less than the FINRA Rule 
4210 maintenance requirement on the margin account positions, 
proposed FINRA Rule 4210(e)(9) would reduce the FINRA Rule 4210 
maintenance requirement on the margin account positions to equal the 
computed Initial Margin Requirement.
     In addition, proposed FINRA Rule 4210(e)(9) would clarify that, 
except for SBS carried by a member in a portfolio margin account 
subject to the requirements of FINRA Rule 4210(g), as discussed 
below, margin requirements on SBS and positions in Uncleared SBS 
Accounts are determined by proposed FINRA Rule 4240, rather than 
FINRA Rule 4210. FINRA believes that including this express 
statement regarding the applicability of each of its margin rules to 
SBS would enhance clarity and reduce legal uncertainty for its 
members.
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    The proposed rule change would not specify Initial Margin 
Requirements for other Uncleared SBS that do not qualify as Basic CDS 
or Basic SBS. Instead, proposed FINRA Rule 4240(b)(2)(A)(iv) would 
provide that the Initial Margin Requirement for any Uncleared SBS other 
than a Basic CDS or Basic SBS

[[Page 26100]]

would be determined in a manner approved by FINRA pursuant to proposed 
FINRA Rule 4240(b)(2)(C), which would permit a member to apply to FINRA 
for the approval of an Initial Margin Requirement for any other type of 
SBS. Under the proposed rule change, any such application would be 
required to:
     Define the specific type of SBS covered by the 
application;
     describe the purpose(s) that the member and its 
Counterparties would have for entering that type of SBS;
     identify all variables that influence the value of that 
type of SBS;
     explain all risks of that type of SBS;
     propose a specific Initial Margin Requirement (not a 
margin model) for that type of SBS;
     explain how the proposed specific Initial Margin 
Requirement would adequately protect a member and its capital against 
each of those risks;
     attach copies of the member's SBS risk management 
procedures and describe the application of those procedures to that 
type of SBS; and
     provide the results of backtesting of the proposed 
specific Initial Margin Requirement over periods of significant 
volatility in the variables influencing the value of that type of SBS.
    Proposed FINRA Rule 4240(b)(2)(C) would further provide that, if 
FINRA approves any such application, the approval may be unconditional 
or conditional, including in the form of a time-limited pilot program; 
may approve the use of the specific Initial Margin Requirement only by 
the applicant; or may take the form of a Regulatory Notice or other 
communication approving the use of the specific margin requirements by 
members generally. Under proposed FINRA Rule 4240(b)(2)(C), no member 
would be permitted to become a party to an SBS other than a Basic CDS 
or Basic SBS unless FINRA has approved an Initial Margin Requirement 
for such member's use with respect to that type of SBS. As described 
above, the Initial Margin Requirements for Basic CDS are based on the 
SEC's treatment of such SBS under its net capital rule, while the 
Initial Margin Requirements for Basic SBS are based on the margin that 
would be required for a margin account that would be the economic 
equivalent of such SBS. However, other types of SBS--including CDS and 
equity TRS with complex features--may not be easily accommodated under 
these frameworks, and the specific risks that accompany such SBS may 
not be readily apparent or quantifiable to FINRA without additional 
information. Moreover, as noted above SBS can be complex financial 
instruments that pose substantial risks to members and margin serves as 
an important means of protecting member firms, and thereby their 
customers and investors, from such risks. FINRA therefore believes that 
members that are not SBSDs (and therefore not subject to the SEC's 
comprehensive regulatory framework for registrants under Title VII of 
Dodd-Frank) should not be permitted to enter into other types of SBS 
unless and until FINRA has evaluated the risks of such SBS and approved 
margin requirements that adequately address such risks. If FINRA 
determines that a proposed margin requirement does not adequately 
address the risks for a particular type of SBS, FINRA would not approve 
the application under proposed FINRA Rule 4240(b)(2)(C), and members 
would not be permitted to enter into such SBS. To FINRA's knowledge, 
this SBS activity by members that do not plan to register as SBSDs is 
relatively limited.
    Proposed FINRA Rule 4240(b)(3), entitled ``Collection or Delivery 
of Variation and Initial Margin,'' would set forth a member's 
obligation to collect or deliver margin as calculated pursuant to 
proposed FINRA Rule 4240(b)(1) and (2), described above. Paragraph 
(b)(3)(A) would require each member to deliver or return to each 
Counterparty cash or margin securities with a Value equal to the 
Counterparty's Current Exposure (if any) to the member, or collect or 
retrieve from the Counterparty cash or margin securities with a Value 
equal to the member's Current Exposure (if any) to the Counterparty. 
Paragraph (b)(3)(B) would require each member to collect from each 
Counterparty cash or margin securities with a Value at least equal to 
any Initial Margin Deficit.\118\ Therefore, consistent with Exchange 
Act Rule 18a-3, proposed FINRA Rule 4240(b)(3) would require members 
that are not SBSDs to collect and deliver Variation Margin, and also to 
collect (but not deliver) Initial Margin, in amounts determined 
pursuant to the provisions of FINRA Rule 4240(b)(1) and (2) described 
above, for their transactions in Uncleared SBS.\119\
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    \118\ Under proposed FINRA Rule 4240(d)(10), the term ``Initial 
Margin Deficit'' would be defined as the amount, if any, by which 
(A) the sum of the Value of the Initial Margin in an Uncleared SBS 
Account and the Counterparty's Rule 4210 Excess is less than (B) the 
Initial Margin Requirement for the Uncleared SBS Account. A person's 
``Rule 4210 Excess'' would be defined in proposed FINRA Rule 
4240(d)(15) to mean the amount, if any, by which the equity (as 
defined in FINRA Rule 4210(a)(5)) in the Counterparty's margin 
account at the member exceeds the amount required by FINRA Rule 
4210.
    \119\ To account for situations where a member is not the actual 
party to an SBS, but nonetheless has financial exposure for 
Uncleared SBS (e.g., through a guarantee), proposed FINRA Rule 
4240(b)(3)(C) would also require a member to collect both Variation 
Margin and Initial Margin from the party that has obligations under 
the Uncleared SBS for which the member has responsibility, to the 
extent that such collection would be required if the member were a 
party to the Uncleared SBS, unless the member can establish that 
such margin has been delivered to the other party.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(b)(4), entitled ``Manner and Time of 
Collection or Delivery of Variation and Initial Margin; Prohibited 
Returns and Withdrawals,'' would set forth additional detailed 
requirements and clarifications regarding the manner and time of 
collection or delivery of variation and initial margin, as calculated 
pursuant to proposed FINRA Rules 4240(b)(1) and (2) and collected or 
delivered in accordance with proposed FINRA Rule 4240(b)(3), as 
described above. Specifically, proposed FINRA Rule 4240(b)(4) would 
provide for the following:
     Under proposed FINRA Rule 4240(b)(4)(A), margin would be 
deemed collected or returned to the member when it is received in the 
Counterparty's Uncleared SBS Account at the member (or transferred to 
such account from another account at the member).
     Under proposed FINRA Rule 4240(b)(4)(B), margin would be 
deemed collected or returned to the Counterparty when it is transferred 
from the Counterparty's Uncleared SBS Account at the member in 
accordance with the Counterparty's instructions or agreement with the 
member, which could potentially include transfer to another account of 
the Counterparty carried by the member.
     Under proposed FINRA Rule 4240(b)(4)(C), margin would be 
required to be collected or delivered pursuant to proposed FINRA Rule 
4240(b)(3) as promptly as possible, but in any case no later than the 
close of business on the business day after the date on which the 
Current Exposure or Initial Margin Requirement was required to be 
computed in accordance with proposed FINRA Rule 4240(b)(1) or (2) 
(i.e., margin would generally be required to be delivered or collected 
on a T+1 basis). Further, unless FINRA has specifically granted the 
member additional time, a member that has not collected margin as 
required by the close of business on the third business day (i.e., by 
T+3) would be required to take prompt steps to liquidate positions in 
the Counterparty's Uncleared SBS Account to eliminate the margin 
deficiency.
     Proposed FINRA Rule 4240(b)(4)(D) would require a member 
to net the

[[Page 26101]]

delivery or return of Variation Margin against the collection of 
Initial Margin, if applicable, and would further permit a member to net 
the return of Initial Margin against the collection or retrieval of 
Variation Margin, if applicable.
     Proposed FINRA Rule 4240(b)(4)(E) would prohibit a member 
from returning Initial Margin to a Counterparty, or permitting a 
Counterparty to make a withdrawal from the Counterparty's margin 
account, if doing so would create or increase an Initial Margin 
Deficit.
    FINRA believes it is appropriate and consistent with the protection 
of member firms and investors to require margin for uncleared SBS to be 
delivered or collected, as applicable, on a T+1 basis, and to further 
require that uncleared SBS positions be liquidated if margin is not 
collected within a T+3 timeframe. FINRA also believes the other 
clarifications described above are necessary to ensure that members and 
their uncleared SBS counterparties have a clear and consistent 
understanding of when and how margin must be delivered or collected 
under the proposed rule change.
    Proposed FINRA Rule 4240(b)(5), entitled ``Exceptions,'' would 
provide eight specific exceptions from a member's general obligation to 
collect or deliver margin, as applicable, under proposed FINRA Rule 
4240(b)(3), described above. FINRA believes the proposed exceptions 
would further align the requirements of proposed FINRA Rule 4240 with 
the margin requirements applicable to SBSDs under Exchange Act Rule 
18a-3 and provide members with additional flexibility in managing their 
risk exposures, while still ensuring that the risks to members with 
respect to their uncleared SBS exposures are adequately addressed. The 
proposed exceptions under FINRA Rule 4240(b)(5) would include the 
following:
     Clearing Agencies. A member would not be required to 
deliver Variation Margin to, or collect Initial Margin or Variation 
Margin from, any Clearing Agency, and would also not be required to 
deduct otherwise required Variation Margin or Initial Margin in the 
computation of its net capital under Exchange Act Rule 15c3-1 or, if 
applicable, FINRA Rule 4110(a). FINRA believes this exception is 
consistent with its determination to defer to Clearing Agency margin 
requirements with respect to Cleared SBS.
     Legacy SBS. A member would be permitted to omit all (but 
not less than all) Legacy SBS with a Counterparty from the 
Counterparty's Uncleared SBS Account when computing Current Exposure 
and the Initial Margin Requirement, provided that the member collects 
and delivers margin on Legacy SBS to the extent of its contractual 
rights and obligations to do so.\120\ However, a member would be 
required to take a capital deduction under Exchange Act Rule 15c3-1 or, 
if applicable, FINRA Rule 4110(a), to reflect the amount of any margin 
that it would have otherwise been required to collect if the Legacy SBS 
had been included in the Counterparty's Uncleared SBS Account. FINRA 
believes it is appropriate to provide a general exception for legacy 
SBS, as members would not be in a position to require their 
counterparties to legacy SBS to exchange margin under existing SBS 
agreements as would otherwise be required under proposed FINRA Rule 
4240. However, in such cases FINRA believe it is appropriate to require 
a member to take a corresponding capital charge to account for the 
member's ongoing risk exposure under such SBS.
---------------------------------------------------------------------------

    \120\ Under proposed FINRA Rule 4240(d)(12), a ``Legacy SBS'' 
would be defined as an Uncleared SBS entered into before October 6, 
2021. Proposed FINRA Rule 4240(b)(2)(A)(iv) would also clarify that 
for any Legacy SBS for which proposed Rule 4240 does not specify an 
Initial Margin Requirement (i.e., an SBS other than a Basic CDS, 
Basic SBS or other SBS for which FINRA has approved specific margin 
requirements), the Initial Margin Requirement must be calculated 
using the applicable method specified in Exchange Act Rule 15c3-
1(c)(2)(vi)(P). The Initial Margin Requirement for Legacy SBS 
calculated under this provision would be used for purposes of 
determining the appropriate corresponding capital charge, as well as 
to determine the Initial Margin Requirement for a Legacy SBS to the 
extent that a member elects not to utilize the Legacy SBS exception 
under proposed FINRA Rule 4240(b)(5).
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     Multilateral Organizations. A member would not be required 
to deliver Variation Margin to, or collect Initial Margin or Variation 
Margin from, any Multilateral Organization.\121\ However, a member 
would be required to take a capital deduction to reflect the amount of 
any margin that it would otherwise have been required to collect from 
such a Multilateral Organization. FINRA believes it is appropriate to 
follow Exchange Act Rule 18a-3 by providing an exception for 
Multilateral Organizations and requiring the risk posed by such SBS to 
be accounted for in a member's capital computations.
---------------------------------------------------------------------------

    \121\ Under proposed FINRA Rule 4240(d)(13), a ``Multilateral 
Organization'' would be defined to mean the Bank for International 
Settlements, the European Stability Mechanism, the International 
Bank for Reconstruction and Development, the Multilateral Investment 
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African 
Development Bank, the European Bank for Reconstruction and 
Development, the European Investment Bank, the European Investment 
Fund, the Nordic Investment Bank, the Caribbean Development Bank, 
the Islamic Development Bank, the Council of Europe Development 
Bank, or any other multilateral development bank that provides 
financing for national or regional development in which the U.S. 
government is a shareholder or contributing member.
---------------------------------------------------------------------------

     Financial Market Intermediaries. A member would not be 
required to collect Initial Margin from a Counterparty that is a 
Financial Market Intermediary (but would still be required to collect 
or deliver Variation Margin, as applicable).\122\ In such case, a 
member would be required to take a capital deduction to reflect the 
amount of any Initial Margin that it would have otherwise been required 
to collect from such Financial Market Intermediary. A Counterparty that 
is a Financial Market Intermediary generally would be subject to a 
comprehensive regulatory framework, including capital requirements. 
FINRA therefore believes it is appropriate to account for the reduced 
counterparty credit risk posed by such Counterparties by permitting a 
member to take a capital charge in lieu of requiring such 
Counterparties to post Initial Margin. However, FINRA continues to 
believe that Variation Margin should be exchanged with such 
Counterparties to account for ongoing the market risk posed by such 
uncleared SBS.
---------------------------------------------------------------------------

    \122\ Under proposed FINRA Rule 4240(d)(8), a ``Financial Market 
Intermediary'' would be defined to mean an SBSD, swap dealer, broker 
or dealer, FCM, bank, foreign bank, or foreign broker or dealer.
---------------------------------------------------------------------------

     Sovereign Counterparties. A member would generally be 
required to deliver Variation Margin to, and collect Initial Margin or 
Variation Margin from, a Sovereign Counterparty.\123\ However, under 
proposed FINRA Rule 4240(b)(5)(E), if the member has determined 
pursuant to policies and procedures or credit risk models established 
pursuant to Exchange Act Rule 15c3-1(c)(2)(vi)(l) that the Sovereign 
Counterparty has only a minimal amount of credit risk, the member would 
not be required to collect Initial Margin from such Sovereign 
Counterparty (but would still be required to collect or deliver 
Variation Margin, as applicable). In such case, a member would be 
required to take a capital deduction to reflect the amount of any 
Initial Margin that it would have otherwise been required to collect 
from such Sovereign Counterparty. As for Financial Market 
Intermediaries, FINRA believes it is appropriate to account for the 
reduced

[[Page 26102]]

counterparty credit risk posted by highly creditworthy Sovereign 
Counterparties by permitting a member to take a capital charge in lieu 
of requiring such Counterparties to post Initial Margin. However, FINRA 
continues to believe that Variation Margin should be exchanged with 
such Counterparties to account for ongoing the market risk posed by 
such uncleared SBS.
---------------------------------------------------------------------------

    \123\ Under proposed FINRA Rule 4240(d)(17), a ``Sovereign 
Counterparty'' would be defined as a Counterparty that is a central 
government (including the U.S. government) or an agency, department, 
ministry or central bank of a central government.
---------------------------------------------------------------------------

     Majority Owners; ANC Firms Transacting with Majority 
Owners or Registered or Foreign SBS Dealers Under Common Ownership. 
FINRA understands that members may enter into uncleared SBS with 
affiliated entities for a variety of reasons, including for risk 
management purposes. FINRA does not believe a broad exception from the 
proposed margin requirements for uncleared SBS with all affiliates 
would adequately account for the risks posed to its members by 
uncleared SBS in such circumstances. However, FINRA does believe that 
two specific, more limited exceptions for SBS entered into with certain 
affiliates would be appropriate. First, under proposed FINRA Rule 
4240(b)(5)(F), a member would not be required to collect Initial Margin 
from a Counterparty that is a direct or indirect owner of a majority of 
the equity and voting interests in the member (a ``Majority Owner'') 
(but would still be required to collect or deliver Variation Margin, as 
applicable). In such case, a member would be required to take a capital 
deduction to reflect the amount of any Initial Margin that it would 
have otherwise been required to collect from such Majority Owner. 
Second, under proposed FINRA Rule 4240(b)(5)(G), a member that is an 
ANC Firm would not be required to collect Initial Margin from a 
Counterparty that is a Majority Owner or a Registered or Foreign SBS 
Dealer under common ownership (but would still be required to collect 
or deliver Variation Margin, as applicable).\124\ In such case, an ANC 
Firm member would be required to take a deduction for credit risk on 
such transactions computed in accordance with Exchange Act Rule 15c3-
1e(c).\125\ FINRA believes that the proposed exception from the Initial 
Margin Requirements for uncleared SBS with Majority Owners, provided 
that the member takes a capital charge in lieu of collecting Initial 
Margin, would adequately protect members in such circumstances due to 
the lower risk presented by Majority Owners, which typically must 
satisfy capital and other requirements applicable to bank holding 
companies and similar entities. FINRA also believes that the proposed 
exception for ANC Firms with respect to SBS with Majority Owners and 
Registered or Foreign SBS Dealer affiliates, provided that the member 
takes a corresponding credit risk charge, would adequately protect such 
members while reducing potential competitive disparity as between ANC 
Firms that are registered SBSDs (and therefore subject to Exchange Act 
Rule 18a-3) and ANC Firms that are not registered SBSDs (and therefore 
would be subject to proposed FINRA Rule 4240 with respect to their 
uncleared SBS).
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    \124\ Under proposed FINRA Rule 4240(d)(14), a ``Registered or 
Foreign SBS Dealer'' would be defined to mean (i) any person 
registered with the SEC as an SBSD or (ii) any foreign person if the 
SEC has made a substituted compliance determination under Exchange 
Act Rule 3a71-6(a)(1) that compliance by a SBSD or class thereof 
with specified requirements of a foreign regulatory system that are 
applicable to such foreign person may satisfy the capital 
requirements of Section 15F(e) of the Act and Exchange Act Rule 18a-
1 that would otherwise apply to such SBSD or class thereof. 
Therefore, the definition would cover registered SBSDs and entities 
that are subject to equivalent SBSD capital requirements in a 
foreign jurisdiction.
    \125\ FINRA notes that an ANC Firm transacting with a 
Counterparty that is its Majority Owner would also benefit from the 
general exception for collecting Initial Margin from Majority 
Owners, described above. However, under this additional exception, 
an ANC Firm would be permitted to take only a deduction for the 
credit risk on its transactions with Majority Owner counterparties 
as calculated in accordance with Exchange Act Rule 15c3-1e, rather 
than the full amount of the Initial Margin Requirement that would 
otherwise have applied.
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     Portfolio Margin. Proposed FINRA Rule 4240(b)(5)(H) would 
provide that proposed FINRA Rule 4240 would not apply to any unlisted 
derivative, as defined in FINRA Rule 4120(g)(2)(H), carried by the 
member in a portfolio margin account subject to the requirements of 
FINRA Rule 4210(g) if such unlisted derivative is of a type addressed 
in the comprehensive written risk analysis methodology filed by the 
member with FINRA in accordance with FINRA Rule 4210(g)(1).\126\ In 
addition, proposed FINRA Rule 4240 would not apply to any SBS carried 
in a commodity account or other account under the jurisdiction of the 
CFTC in accordance with an SEC rule, order or no-action letter 
permitting SBS and swaps to be carried and portfolio margined together 
in such an account. Portfolio margining provides members with the 
flexibility to manage their risk exposures based on a broader view of 
their overall relationship with a particular Counterparty. FINRA 
believes it is appropriate to provide an exception from proposed FINRA 
Rule 4240 for any SBS in a portfolio margin account if the SBS is of a 
type whose risk is appropriately addressed by an approved theoretical 
pricing model (e.g., TIMS) and covered by portfolio risk management 
procedures filed by the member with FINRA, as well as for SBS permitted 
by the SEC to be portfolio margined in a commodity account. In these 
circumstances, the risks presented by such SBS would already be subject 
to a comprehensive risk management framework, and therefore FINRA does 
not believe it necessary to apply the proposed new margin requirements 
to such SBS.
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    \126\ FINRA is also proposing a technical adjustment to the 
definition of ``unlisted derivative'' under FINRA Rule 4210(g)(2)(H) 
to clarify that, to qualify under the definition, the option, 
forward contract or SBS must be able to be valued by a theoretical 
pricing model that is approved by the SEC for valuing that type of 
options, forward contract or SBS.
---------------------------------------------------------------------------

    Proposed FINRA Rule 4240(c), entitled ``Risk Monitoring Procedures 
and Guidelines,'' would require members to monitor the risk of any 
Uncleared SBS Accounts and maintain a comprehensive risk analysis 
methodology for assessing the potential risk to the member's capital 
over a specified range of possible market movements over a specified 
time period. For purposes of this requirement, members would be 
required to employ the following risk monitoring procedures and 
guidelines:
     Obtaining and reviewing the required documentation and 
financial information necessary for assessing the amount of credit to 
be extended to SBS Counterparties;
     determining and documenting the legal enforceability of 
netting or collateral agreements, including enforceability in the event 
a Counterparty becomes subject to bankruptcy or other insolvency 
proceedings;
     assessing the determination, review and approval of credit 
limits to each Counterparty, and across all Counterparties;
     monitoring credit risk exposure to the member from SBS, 
including the type, scope and frequency of reporting to senior 
management;
     the use of stress testing of accounts containing SBS 
contracts in order to monitor market risk exposure from individual 
accounts and in the aggregate;
     managing the impact of credit extended related to SBS 
contracts on the member's overall risk exposure;
     determining the need to collect additional margin from a 
particular customer or broker or dealer, including whether that 
determination was based upon the creditworthiness of the

[[Page 26103]]

customer or broker or dealer and/or the risk of the specific contracts;
     determining the need for higher margin requirements than 
required by proposed FINRA Rule 4240 and formulating the member's own 
margin requirements, including procedures for identifying unusually 
volatile positions, concentrated positions (with a particular 
Counterparty and across all Counterparties and customers), or positions 
that cannot be liquidated promptly;
     monitoring the credit exposure resulting from concentrated 
positions with a single Counterparty and across all Counterparties, and 
during periods of extreme volatility;
     identifying any Uncleared SBS Accounts with intraday risk 
exposures that are not reflected in their end of day positions (e.g., 
Uncleared SBS Accounts that frequently establish positions and then 
trade out of, or hedge, those positions by the end of the day) and 
collecting appropriate margin to address those intraday risk exposures;
     identifying any Uncleared SBS Account that, in light of 
current market conditions, could not be promptly liquidated for an 
amount corresponding to the Current Exposure computed with respect to 
such account and determining the need for higher margin requirements on 
such accounts or the positions therein;
     maintaining sufficient Initial Margin in the accounts of 
each Counterparty to protect against the largest individual potential 
future exposure of an Uncleared SBS in such Counterparty's Uncleared 
SBS Account, as measured by computing the largest maximum possible loss 
that could result from the exposure; and
     increasing the frequency of calculations of Current 
Exposure and Initial Margin Requirements during periods of extreme 
volatility and for accounts with concentrated positions.
    Proposed FINRA Rule 4240(c) would further require a member to 
review, in accordance with the member's written procedures, at 
reasonable periodic intervals, the member's SBS activities for 
consistency with these risk monitoring procedures and guidelines, and 
to determine whether the data necessary to apply the risk monitoring 
procedures and guidelines is accessible on a timely basis and 
information systems are available to adequately capture, monitor, 
analyze and report relevant data.
    The risk monitoring procedures and guidelines under proposed FINRA 
Rule 4240(c) are similar to the risk monitoring and procedure 
requirements applicable to nonbank SBSDs with respect to their 
uncleared SBS transactions under Exchange Act Rule 18a-3.\127\ These 
requirements are also based in part on aspects of FINRA Rule 4210, 
including procedures related to the need for additional margin under 
FINRA Rule 4210(d) and the portfolio margin risk monitoring 
requirements under FINRA Rule 4210(g)(1). SBS are complex financial 
instruments that may expose a member to significant risks, including, 
for example, market risk, counterparty credit risk, operational risk 
and legal risk. FINRA accordingly believes it is appropriate and 
necessary, and consistent with the protection of investors, for members 
with exposure to uncleared SBS to maintain a comprehensive risk 
monitoring program, including the specific elements described above, to 
address such risks.
---------------------------------------------------------------------------

    \127\ See 17 CFR 240.18a-3(e); Capital, Margin, and Segregation 
Release, supra note 8, at 43930.
---------------------------------------------------------------------------

    If the Commission approves the proposed rule change, the effective 
date of the proposed rule change will be October 6, 2021.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\128\ 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, by affirmatively addressing the 
treatment of SBS under FINRA rules, the proposed rule change will serve 
to promote regulatory clarity and consistency. FINRA also believes that 
this aspect of the proposed rule change is consistent with Congress's 
intent to define SBS as securities under the Act and its underlying 
regulations, and that such treatment will enhance investor protection. 
FINRA further believes that, by providing limited exceptions from the 
application of FINRA rules to SBS, the proposed rule change will 
promote legal certainty, provide clarity regarding the application of 
its rules and avoid unnecessary regulatory duplication.
---------------------------------------------------------------------------

    \128\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The proposed rule change will also promote regulatory consistency 
by conforming FINRA's capital-related requirements to the SEC's amended 
net capital rule. FINRA also believes that, by applying higher 
financial responsibility and operational standards to members with 
financial exposure to SBS, the proposed rule change will serve to 
protect investors and the public interest.
    Finally, the proposed rule change will also protect investors and 
the public interest by establishing a new margin rule for SBS 
applicable to members that are not registered SBSDs. FINRA believes 
that the proposed rule change will thereby fill an important regulatory 
gap, protect members against counterparty credit risk, maintain a level 
playing field for members and prevent regulatory arbitrage.

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.
Economic Impact Assessment
    FINRA has undertaken an economic impact assessment, as set forth 
below, to analyze the regulatory need for the proposed rule change, its 
potential economic impacts (including anticipated costs, benefits, and 
distributional and competitive effects, relative to the current 
baseline) and the alternatives considered in assessing how best to meet 
FINRA's regulatory objective.
1. Regulatory Need
    As detailed above, the SEC has adopted final rules under Title VII 
of the Dodd-Frank Act implementing the new regulatory framework for 
SBS, including rules requiring SBS Entities to register with the SEC, 
business conduct and supervision requirements, risk mitigation 
techniques, and margin, capital and segregation requirements for SBS 
Entities, among many other detailed requirements. For SBS Entities, the 
compliance date for the SEC's key SBS requirements will be October 6, 
2021, and the deadline for the first wave of SBS Entities to register 
is November 1, 2021. FINRA currently has in place a temporary, broad 
exception from the application of its rules to its members' SBS 
activities and positions, which will expire on September 1, 2021. In 
light of the upcoming Registration Compliance Date, FINRA is proposing 
to amend its rules as detailed above to clarify the application of its 
rules to SBS and take into account member's SBS activities once SBS 
Entities begin registering with the SEC.
2. Economic Baseline
    The economic baseline for the proposed rule change is based on the 
relevant existing regulatory framework, existing firm practices and 
information

[[Page 26104]]

collected through outreach efforts. FINRA believes that the proposed 
rule change should be evaluated against a baseline where the SEC's new 
rules for SBS have come into effect and FINRA's existing exceptions 
have expired--i.e., if current FINRA Rule 0180 were to expire as 
scheduled on September 1, 2021 and new FINRA Rule 0180 not adopted as 
proposed--as well as applying FINRA's existing margin and financial 
operational rules and requirements to SBS without the proposed changes 
described above. Under this baseline, all member firms contemplating 
offering SBS services to clients would be subject to FINRA's applicable 
rules with regard to business conduct requirements, financial 
responsibility and operational requirements, and margin. As discussed 
above, these rules as applied to SBS Entities, may in some cases be 
duplicative of SEC rules, and thus may impose unnecessary material 
obligations given the firms' activities in the space, could result in 
operational difficulties or be insufficient to provide appropriate risk 
controls. Under this scenario, some member firms may choose to limit or 
not provide SBS services, which may result in decreased choice and 
increased costs to customers.
    Through outreach efforts and discussions with individual member 
firms, FINRA has learned about current member firm SBS activities and 
their preparations for the Registration Compliance Date. The majority 
of member firms that participated in the outreach efforts indicated 
that they intend to register a bank affiliate, foreign affiliate or 
stand-alone dealer affiliate as the SBSD. Some of the firms indicated 
some involvement in SBS activities on the part of their FINRA-
registered associated persons, but typically in the person's capacity 
as an associated person of the affiliated SBSD. Firms further indicated 
that their SBS activities will be focused on their existing trading 
programs related to CDS, equity index and single-name TRS, and asset-
backed security swaps. FINRA also solicited input from member firms 
that may conduct an SBS business below the SEC's registration 
thresholds. Generally, FINRA has found that the number of member firms 
that are planning to register as an SBSD, or engage in SBS activities 
below the SEC's registration thresholds, is small and concentrated in 
larger firms. FINRA also discussed with firms their practices with 
respect to margin practices for SBS transactions. Most firms reported 
they would be using the standard initial margin model (``SIMM'') for 
margin purposes,\129\ and rely on existing margin collection and 
governance systems and infrastructure.
---------------------------------------------------------------------------

    \129\ The SIMM is a methodology proposed by ISDA to help market 
participants calculate initial margin on non-cleared derivatives 
under the framework developed by the Basel Committee on Banking 
Supervision and the International Organization of Securities 
Commissions. See ISDA, Standard Initial Margin Model for Non-Cleared 
Derivatives (December 2013), https://www.isda.org/a/cgDDE/simm-for-non-cleared-20131210.pdf.
---------------------------------------------------------------------------

    FINRA has also engaged with other relevant regulators, including 
the SEC, the CFTC and the National Futures Association (``NFA''). 
Through these efforts, FINRA has gained further insight into the 
application of the SEC's SBS rules to its member firms, as well as the 
similarities and differences between the SEC and CFTC regulatory 
frameworks. Furthermore, FINRA gathered further information about the 
approach taken by the NFA for regulating the activities of FCMs and 
other registrants engaged in swap activities. For example, FINRA notes 
that an FCM generally does not need to comply with NFA rules specific 
to swaps (e.g., margin) unless it is also a registered swap dealer. 
Finally, FINRA discussed the implications of member firms engaging in 
SBS activities under Exchange Act Rule 15a-6.\130\
---------------------------------------------------------------------------

    \130\ Exchange Act Rule 15a-6 provides conditional exemptions 
from registration under the Exchange Act that permit non-US broker-
dealers to engage in certain activities in the US or with US persons 
without having to register with the SEC.
---------------------------------------------------------------------------

    In parallel to the outreach efforts conducted through engagement 
with individual member firms, as discussed above, FINRA posted on its 
public website an open-ended request for feedback on how FINRA rules 
should be applied to SBS and invited interested parties to submit views 
and information via a dedicated email box.\131\ The responses received 
largely echoed FINRA's discussion with member firms. In addition, FINRA 
issued Regulatory Notice 20-36 to solicit further comment on the 
proposal, including any potential economic impacts.\132\ As discussed 
in Item II. C. of this filing, FINRA received one comment letter in 
response to Regulatory Notice 20-36.
---------------------------------------------------------------------------

    \131\ See supra note 25.
    \132\ See supra note 26.
---------------------------------------------------------------------------

3. Economic Impacts
    FINRA has analyzed the potential costs and benefits of the proposed 
rule change, and the different parties that are expected to be 
affected. FINRA has identified member firms that engage in SBS 
activities and their customers as the parties that would primarily be 
affected by the proposed rule change. In particular, these include 
member firms that will register as SBSDs, firms seeking to broker SBS 
transactions, firms engaging in SBS activities under the de minimis 
threshold for SBSD registration, and firms engaging in SBS activities 
in other capacities (e.g., risk management). As discussed above, based 
on existing information, FINRA understands that the number of such 
member firms is small and concentrated among larger member firms. The 
proposed rule change is expected to reduce regulatory arbitrage and 
establish a regulatory framework for FINRA member firms that wish to 
engage in SBS activities, without diminishing investor protections.
A. Anticipated Benefits
    FINRA believes that the proposed rule change would benefit member 
firms by reducing regulatory uncertainty, unnecessary regulatory 
duplication and the potential for arbitrage with the SEC's regulatory 
framework for SBSDs that are not FINRA member firms. Furthermore, FINRA 
believes that the proposed rule change would alleviate some of the 
potential competitive disadvantages for FINRA member firms that wish to 
engage in SBS activities without registering as SBSDs. FINRA believes 
this goal is achievable through the increased regulatory clarity 
resulting from the proposed rule change. Finally, FINRA believes that 
the combination of these accrued benefits could incentivize member 
firms to engage in SBS activities. This could lead to an increase in 
consumer choice, and potentially increase member firms' ability to 
compete in SBS products.
    A primary benefit of the proposed rule change is that it permits 
firms that are registered with the SEC to rely on relevant SEC rules 
governing business conduct requirements with respect to their SBS 
activities. In so doing, the proposed rule change ensures that there 
would be no unintended differences between the firms' obligations under 
SEC and FINRA rules and would impose no additional direct or indirect 
costs to firms that are registered SBSDs engaging in SBS activities. 
The proposed rule change is also expected to reduce potential 
regulatory arbitrage across the relevant regulatory frameworks of 
FINRA, the SEC and the CFTC. Increased consistency across regulatory 
frameworks would benefit member firms seeking to engage in SBS 
activities through multiple affiliates and those firms engaging in an 
SBS business without registering with the SEC.
    Member firms would be expected to be able to use their existing 
governance and compliance systems and procedures, including in 
situations where member firms will have dual-hatted personnel or have 
an affiliate that

[[Page 26105]]

is registered with the CFTC as a swaps dealer. Finally, member firms 
are expected to benefit from the proposed exception for current rules 
that otherwise might otherwise apply but are not feasible or 
appropriate in the context of SBS activities. This will reduce 
operational and compliance costs for firms without diminishing investor 
protections. Similarly, with respect to financial responsibility and 
operational requirements, the proposed rule change would benefit member 
firms by aligning FINRA rules with SEC rules, thus reducing the costs 
and risks of regulatory arbitrage.
    With respect to margin requirements, the proposed rule change also 
seeks to rely on the SEC's rules and framework to provide consistent 
protections and regulatory requirements. First, member firms that 
register as SBSDs would be exempted from the FINRA margin requirements, 
thus eliminating any regulatory burden that might arise from a 
different approach. Second, for other firms, the margin requirements 
for uncleared Basic CDS would conform with the standard SEC margin 
requirements, thus reducing risk of regulatory arbitrage. Third, the 
proposal is expected to benefit member firms by providing additional 
mitigation of counterparty risks for SBS-related activities that fall 
outside of the SEC regulatory framework. Fourth, the margin 
requirements are expected to enhance member firms' ability to compete 
in these products. Fifth, replacing the current FINRA Rule 4240, which 
by its terms is a temporary rule, with an ongoing rule would reduce 
regulatory uncertainty and benefit firms with respect to compliance 
systems and associated costs. Finally, FINRA believes that the 
anticipated benefits of the proposed margin requirements might accrue 
to counterparties, customers and the financial system as a whole, as it 
decreases the chance of unexpected firm failure and dampens shock 
transmission.
B. Anticipated Costs
    FINRA believes that the proposed rule change would result in some 
direct costs to member firms that choose to engage in SBS activities in 
various capacities. In particular, member firms would be required to 
develop a regulatory compliance program for SBS activities and monitor 
for their compliance.
    FINRA believes that the proposed rule change's exceptions from 
applying some of its rules to SBS activities benefits member firms. 
However, such exceptions could potentially further result in costs to 
member firms. These can be either near-term costs, stemming from 
FINRA's decision to provide exceptions for certain rules but not 
others, or long-term costs, if trading in SBS evolves in ways that 
would require a reconsideration of the exceptions.
    Some costs are also expected to stem from the proposal to treat 
member firms with financial exposure to SBS the same as carrying or 
clearing firms for purposes of FINRA's financial and operational rules. 
However, FINRA believes that the majority of member firms that will be 
engaged in SBS activities already qualify as carrying or clearing firms 
under these rules. Thus, it is expected that any incurred compliance 
costs resulting from this proposed requirement would be minimal. 
Further, for member firms not registering as SBSDs, the proposal to 
align FINRA's regulatory notification and business curtailment rule 
requirements to the SEC's amended net capital rule may result in 
increased associated costs.
    The proposed margin requirements may impose some costs on member 
firms seeking to engage in SBS activities without registering as SBSDs. 
The new margin requirements would require such member firms engaged in 
SBS activities to have comprehensive written credit risk management 
procedures appropriate for the business and to ensure compliance with 
them. Moreover, additional costs would arise from allowing firms to 
take a capital charge in lieu of margin, where permitted. These costs 
are associated with managing capital accounts, related compliance 
costs, and any opportunity costs that might arise from committing 
capital. FINRA notes that firms would be permitted to take this 
approach and thus would only be anticipated to do so in instances where 
the costs are lower than the alternative margin requirements.
    FINRA recognizes that the proposal should be considered relative to 
alternative regulatory regimes available to member firms and their 
affiliates. Firms will consider whether the costs and benefits of 
providing SBS services are most efficient under these proposed rules, 
alternative domestic rules, such as those of the CFTC, or through a 
foreign entity. FINRA has considered the potential impacts of the 
proposal on competition among financial service providers and how that 
competition may limit investor choice or impose higher, or additional, 
risks or costs to investors. FINRA sought information and comments on 
this specific issue in Regulatory Notice 20-36. FINRA believes that 
given the current set of SBS activities, and member firms identified as 
engaged in such activities, the extent of such potential competitive 
impacts and outcomes is unclear. Moreover, FINRA believes that such 
competitive impacts would depend on a firm's interest in, and the scope 
of, its SBS activities.
4. Alternatives Considered
    FINRA has considered various alternatives to the proposed rule 
change. For example, FINRA considered an option to allow current FINRA 
Rule 0180 to expire without replacing it with a new rule. This would 
result in no exceptions from the applications of the FINRA rules to 
member firms engaging in SBS activities. A different alternative that 
considered would be to delete the expiration date from current FINRA 
Rule 0180 and rely solely on the SEC's SBS regulatory framework going 
forward. FINRA considered similar alternatives with respect to the 
proposed margin requirements and amendments to its financial 
responsibility and operational rules. FINRA believes that the proposed 
rule change strikes an appropriate balance among establishing a 
regulatory framework for SBS activities, regulatory burdens and 
investor protection considerations.

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

    A concept proposal summarizing the proposed rule change was 
published for comment in Regulatory Notice 20-36 (October 2020).\133\ 
One comment was received in response to the Regulatory Notice.\134\ The 
comment letter is summarized below.
---------------------------------------------------------------------------

    \133\ See Regulatory Notice 20-36 (October 2020) (``Concept 
Proposal'').
    \134\ See Letter from Kyle L Brandon, Managing Director, Head of 
Derivatives Policy, Securities Industry and Financial Markets 
Association (``SIFMA''), to Jennifer Piorko Mitchell, Office of the 
Corporate Secretary, FINRA, dated November 16, 2020 (``SIFMA 
Letter'').
---------------------------------------------------------------------------

    SIFMA expressed overall support for many aspects of the Concept 
Proposal, but suggested further tailoring to seek greater clarity 
regarding the application of FINRA rules to SBS, ensure that standalone 
broker-dealers are not placed at a disadvantage to broker-dealers that 
are also registered as SBSDs, and better harmonize certain FINRA rules 
with the SEC's SBS Entity rules.\135\ In the Concept Proposal, FINRA 
noted that it was considering extending its existing exceptions under 
current FINRA Rule 0180 until the Registration Compliance

[[Page 26106]]

Date on October 6, 2021.\136\ SIFMA noted that, per the SEC 
Transitional Period Guidance, most, if not all, SBSDs will wait to 
register until November 1, 2021, and therefore SIFMA recommended that 
FINRA instead extend the expiration date of current FINRA Rule 0180 
until November 1, 2021.\137\ After consideration, FINRA believes that 
the Registration Compliance Date is the most appropriate date to 
implement the proposed rule change in order to align with the 
implementation of the SEC's Title VII rulemakings and avoid unnecessary 
confusion. FINRA also understands that existing, temporary exemptions 
from some SEC rules expire on the Registration Compliance Date, and 
that SBSDs are likely to register on that date to align with the 
expiration of those exemptions. Therefore, as discussed above, FINRA 
intends to extend the expiration date of current FINRA Rule 0180, as 
well as the interim CDS margin pilot program under current FINRA Rule 
4240, to the Registration Compliance Date on October 6, 2021.\138\
---------------------------------------------------------------------------

    \135\ See SIFMA Letter at 1.
    \136\ See Concept Proposal at 3.
    \137\ See SIFMA Letter at 1-2; see also supra note 10.
    \138\ See supra note 18.
---------------------------------------------------------------------------

    In the Concept Proposal, FINRA stated that it was considering 
providing general exceptions from the presumption of applicability of 
FINRA rules to SBS for certain rules that were intended for other types 
of securities and could create operational difficulties if applied to 
SBS.\139\ SIFMA supported FINRA's proposal to except these rules from 
the general presumption of applicability, including the FINRA Rule 6000 
Series (Quotation, Order, and Transaction Reporting Facilities), the 
FINRA Rule 7000 Series (Clearing, Transaction and Order Data 
Requirements, and Facility Charges) and the FINRA Rule 11000 Series 
(Uniform Practice Code). SIFMA stated that providing exceptions for 
these rules will promote clarity, considering that these rules are not 
designed to apply to SBS and arguable overlap with some of the SEC's 
rules such as Regulation SBSR.\140\ The proposed rule change would 
provide such exceptions under proposed FINRA Rule 0180(b).
---------------------------------------------------------------------------

    \139\ See Concept Proposal at 4.
    \140\ See SIFMA Letter at 2. SIFMA also noted that the Concept 
Proposal also stated FINRA's preliminary intention to provide a 
general exception from FINRA Rule 2210, other than the content 
standards in paragraph (d). See id. at 2 n.3. After further 
consideration, FINRA does not believe a general exception from the 
remainder of FINRA Rule 2210 is appropriate, and therefore the 
proposed rule change does not provide this exception under proposed 
FINRA Rule 0180(b). The remainder of FINRA Rule 2210 includes 
specified principal approval, review, filing and recordkeeping 
requirements applicable to certain types of communications, as well 
as limitations on the use of FINRA's name and standards applicable 
to public appearances. FINRA believes these requirements should 
apply to communications relating to SBS to the extent the rule 
otherwise applies to the communication.
---------------------------------------------------------------------------

    In the Concept Proposal, FINRA stated that it was considering 
providing exceptions from the presumption of applicability of FINRA 
rules to SBS for certain business conduct rules that are similar to the 
SEC's new SBS Entity rules. Specifically, FINRA stated its preliminary 
belief that it would be appropriate to permit an SBS Entity that is a 
FINRA member and an associated person of an SBS Entity who is acting in 
his or her capacity as an associated person of an SBS Entity to comply 
with the parallel SEC requirements in lieu of the similar FINRA 
Rules.\141\ FINRA noted the following rules in particular: (1) FINRA 
Rule 2030 (Engaging in Distribution and Solicitation Activities with 
Government Entities); (2) FINRA Rule 2090 (Know Your Customer); (3) 
FINRA Rule 2111 (Suitability); (4) FINRA Rule 2210(d) (Communications 
with the Public--Content Standards); (5) FINRA Rule 2232 (Customer 
Confirmations); and (6) FINRA Rules 3110 (Supervision), 3120 
(Supervisory Control System) and 3130 (Annual Certification of 
Compliance and Supervisory Processes). SIFMA expressed general support 
for this aspect of the Concept Proposal, noting FINRA's observation 
that these rules would unnecessarily duplicate certain of the SEC's SBS 
Entity rules if they applied to SBS Entities or their associated 
persons.\142\ However, SIFMA made four recommendations for FINRA to 
make certain clarifications and expand the proposed exceptions. The 
proposed rule change would provide these exceptions in proposed FINRA 
Rules 0180(c) and (d), with certain modifications as noted below.\143\
---------------------------------------------------------------------------

    \141\ See Concept Proposal at 4-5.
    \142\ See SIFMA Letter at 2.
    \143\ In addition to the modifications described above in 
response to SIFMA's feedback, the proposed rule change also splits 
these exceptions into two paragraphs of proposed FINRA Rule 0180 to 
account for SEC rules that apply to only SBSDs rather than all SBS 
Entities. See supra note 36.
---------------------------------------------------------------------------

    First, in the Concept Proposal, FINRA stated that the proposed 
exceptions would apply both where the member itself is registered as an 
SBS Entity and where the associated person of the member is ``dual-
hatted'' as an associated person of an affiliated SBS Entity.\144\ 
SIFMA requested that FINRA clarify the treatment of dual-hatted 
personnel under these proposed exceptions in two respects. First, SIFMA 
requested that FINRA confirm that, by adopting these exceptions and 
applying such exceptions to dual-hatted individuals, FINRA is not 
addressing whether or to what extent the rules not covered by these 
exceptions might apply to dual-hatted personnel when acting in their 
capacity as associated persons of an affiliated entity. Second, SIFMA 
requested that FINRA confirm that regardless of how the dual-hatting 
arrangement is documented, if in substance the relevant individual is 
designated as an associated person of an SBS Entity and is in fact 
acting in that capacity, then such individual would benefit from 
FINRA's proposed exceptions.\145\ FINRA has addressed both aspects of 
SIFMA's request relating to dual-hatted personnel above.\146\
---------------------------------------------------------------------------

    \144\ See Concept Proposal at 4.
    \145\ See SIFMA Letter at 3.
    \146\ See supra note 38.
---------------------------------------------------------------------------

    Second, in the Concept Proposal, FINRA noted the SEC's cross-border 
counting exception under Exchange Act Rule 3a71-3(d) and stated that it 
was considering also providing an exception for members acting in 
compliance with that exception from the FINRA rules that are parallel 
to the SEC's SBS Entity rules that are conditions of the 
exception.\147\ SIFMA expressed support for this additional exception 
and requested that FINRA expand its exceptions for FINRA Rules 2111 
(Suitability), 2210(d) (Communications with the Public--Content 
Standards) and 2232 (Customer Confirmations) to cover a FINRA member 
when it is acting as the registered entity for a foreign affiliate 
pursuant to Exchange Act Rule 3a71-3(d).\148\ As discussed above, the 
proposed rule change would include these exceptions in proposed FINRA 
Rule 0180(e).
---------------------------------------------------------------------------

    \147\ See Concept Proposal at 16 n.14.
    \148\ See SIFMA Letter at 3-4.
---------------------------------------------------------------------------

    Third, SIFMA requested that FINRA also adopt exceptions from 
associated person registration and CE requirements in FINRA Rules 1210, 
1220 and 1240 for a person associated with a broker-dealer dually 
registered as an SBS Entity whose securities-related activities relate 
solely and exclusively to transactions in SBS conducted in his or her 
capacity as an associated person of an SBS Entity.\149\ SIFMA noted 
that FINRA's existing registration, proficiency testing and CE 
requirements are not tailored to SBS and it would therefore seem to 
provide little, if any, benefit to apply those requirements to such 
associated persons. In this regard, SIFMA noted that similar 
considerations led the NFA initially to exclude swaps associated 
persons from its proficiency testing

[[Page 26107]]

requirements until tests tailored to swaps could be developed. SIFMA 
also stated that associated persons of standalone SBSDs are not subject 
to registration or CE requirements and, since SBSDs generally are not 
required to register as broker-dealers or become FINRA members, it 
would be inappropriate to subject associated persons of SBSDs to 
differing requirements solely depending on whether the SBSD happened, 
for other reasons, to be a FINRA member.\150\ FINRA believes that an 
exception along the lines requested by SIFMA is appropriate, at least 
until such time as FINRA may develop registration, licensing and CE 
requirements tailored to SBS. As discussed above, the proposed rule 
change therefore includes proposed FINRA Rule 0180(g), which would 
provide that persons associated with a member whose functions are 
related solely and exclusively to SBS undertaken in such person's 
capacity as an associated person of an SBS Entity are not required to 
be registered with FINRA.
---------------------------------------------------------------------------

    \149\ See SIFMA Letter at 4.
    \150\ See SIFMA Letter at 4.
---------------------------------------------------------------------------

    Finally, SIFMA requested that FINRA provide exceptions for a member 
dually registered as an SBS Entity from FINRA Rules 2231 (Customer 
Account Statements) and 4512 (Customer Account Information), in each 
case, for an account solely holding SBS and related collateral.\151\ In 
the Concept Proposal, FINRA explained its preliminary belief that the 
account statements required under FINRA Rule 2231 should reflect a 
holistic view of a member's relationship with its customer, including 
SBS transactions and positions, if applicable. FINRA further stated 
that while FINRA members that are SBS Entities would also be subject to 
the SEC's portfolio reconciliation requirements, given the importance 
of customer account statements and the different purposes of the rules, 
under the Concept Proposal FINRA was considering not proposing an 
exception from FINRA Rule 2231 for members that are SBS Entities.\152\ 
SIFMA acknowledged this rationale generally, but stated its belief that 
if an account only holds SBS and related collateral, the SEC's 
portfolio reconciliation requirement should be sufficient because it 
will provide the counterparty with information on a periodic basis 
regarding the parties' SBS portfolio and address the resolution of 
disputes, including collateral-related disputes.\153\ SIFMA also noted 
that the SEC's amended recordkeeping rules, specifically Exchange Act 
Rule 17a-3(a)(9)(iv), cover much of the information required by FINRA 
Rule 4512, and that such rules are specifically tailored to SBS while 
FINRA Rule 4512 requires information that is unlikely to be relevant to 
SBS.\154\ FINRA believes that limited exceptions along the lines 
requested by SIFMA are appropriate where an account solely holds SBS 
and related collateral for a counterparty to a member that is acting in 
its capacity as an SBS Entity. Accordingly, as discussed above, the 
proposed rule change includes proposed FINRA Rule 0180(f), which would 
provide that FINRA Rules 2231 and 4512 shall not apply to members' 
activities and positions with respect to SBS, to the extent that the 
member is acting in its capacity as an SBS Entity and the customer's 
account solely holds SBS and collateral posted as margin in connection 
with such SBS.
---------------------------------------------------------------------------

    \151\ See SIFMA Letter at 5.
    \152\ See Concept Proposal at 16 n.15.
    \153\ See SIFMA Letter at 5. SIFMA also stated that although the 
SEC's portfolio reconciliation rule does not expressly cover 
collateral-related disputes, the NFA has interpreted the parallel 
CFTC rule to cover such disputes, and the SEC indicated that an SBS 
Entity that is following NFA's processes in relation to disputes 
would also be compliant with Exchange Act Rule 15Fi-3. See id. at 5 
n.4. As discussed above, the proposed rule change would include as a 
condition to proposed FINRA Rule 0180(f) that portfolio 
reconciliations and related dispute resolution requirements as 
applied to a customer's account qualifying for the proposed 
exception must include SBS-related collateral.
    \154\ See SIFMA Letter at 5.
---------------------------------------------------------------------------

    In the Concept Proposal, FINRA requested comment on a proposed 
framework for a new SBS-specific margin rule, which would replace the 
Interim Pilot Program under existing FINRA Rule 4240 and apply to all 
SBS in lieu of FINRA's general margin requirements under FINRA Rule 
4210.\155\ SIFMA expressed support for the steps noted by FINRA in the 
Concept Proposal with respect to harmonizing the new SBS-specific 
margin rule with the SEC's margin rule for SBSDs, including by 
including exceptions from Initial Margin Requirements for Sovereign 
Entities and Financial Market Intermediaries, as well as the Variation 
Margin and Initial Margin Requirements for Multilateral 
Organizations.\156\ However, SIFMA noted that the proposed margin rule 
as described in the Concept Proposal would still diverge from Exchange 
Act Rule 18a-3 in several significant respects. SIFMA expressed concern 
that these differences would impose significant limitations on the 
ability of members that are not SBSDs to transact in SBS, including for 
risk management purposes. SIFMA therefore suggested that FINRA allow a 
member subject to the proposed new rule to opt into compliance with 
Exchange Act Rule 18a-3 if the member (a) is affiliated with a 
registered SBSD subject to Exchange Act Rule 18a-3 and (b) uses initial 
margin models, if any, that the SEC has approved for use by that 
affiliate.\157\ FINRA acknowledges that proposed new FINRA Rule 4240 
would diverge from Exchange Act Rule 18a-3 in some respects, which 
FINRA believes are important to protect its members given that members 
subject to the rule would not be subject to the comprehensive 
regulatory framework applicable to SBSDs. For example, registered SBSDs 
are subject to higher minimum capital requirements, and the SEC's 
margin requirements under Exchange Act Rule 18a-3 were designed to 
apply to entities subject to those higher capital requirements. FINRA 
notes in this regard that firms engaged in a level of SBS dealing below 
the de minimis threshold requiring SBSD registration may nonetheless 
elect to register as SBSDs, and thereby become subject to the SEC's 
comprehensive regulatory framework for such entities, including the 
margin requirements under Exchange Act Rule 18a-3 tailored to such 
entities. FINRA does not believe it would be appropriate to permit 
members to opt-in to only one aspect of the SEC's financial 
responsibility rules for SBSDs instead of complying with proposed FINRA 
Rule 4240, which, as described below, would in some respects provide a 
higher level of protection for non-SBSD members engaged in uncleared 
SBS than SBSDs because such members are not comprehensively regulated 
with respect to their SBS activities.
---------------------------------------------------------------------------

    \155\ See Concept Proposal at 8-9.
    \156\ See SIFMA Letter at 6.
    \157\ See SIFMA Letter at 7.
---------------------------------------------------------------------------

    Alternatively, SIFMA requested that, if FINRA does not adopt its 
suggested opt-in approach, FINRA harmonize the new margin rule with 
Exchange Act Rule 18a-3 in certain respects.\158\ First, SIFMA noted 
that the proposed new margin rule as described in the Concept Proposal 
would not include the same exceptions as Exchange Act Rule 18a-3, 
including an Initial Margin collection exception for affiliates and an 
exception from both Initial Margin and Variation Margin for legacy 
accounts. As described above, FINRA believes an exception from 
including Legacy SBS in a Counterparty's Uncleared SBS Account for 
purposes of the margin requirements under proposed FINRA Rule 4240 is 
appropriate to the extent

[[Page 26108]]

the member does not have a contractual right or obligation to collect 
or deliver such margin, and is therefore including such an exception 
under the proposed rule change, provided that members take a 
corresponding capital charge to account for the risk of Legacy SBS 
(consistent with the SEC's approach to legacy accounts under Exchange 
Act Rule 18a-3). Also as described above, while FINRA does not believe 
a broad exception from the Initial Margin Requirements for SBS with all 
affiliates would be consistent with investor protection, the proposed 
rule change includes more limited exceptions (i) for all members, from 
collection of Initial Margin for SBS with Majority Owners, subject to a 
corresponding capital charge; and (ii) for ANC Firms, from collection 
of Initial Margin for SBS with Majority Owners and Registered or 
Foreign SBS Dealers, subject to taking a corresponding credit risk 
charge (as discussed in further detail below). FINRA believes these 
proposed exceptions, together with the proposed exception for SBS with 
Financial Market Intermediaries, should account for the vast majority 
of uncleared SBS entered into by non-SBSDs with affiliates and thus 
reduce the competitive disparity noted by SIFMA, while still 
sufficiently addressing the potential risks raised by SBS with other 
affiliated entities.
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    \158\ See SIFMA Letter at 7.
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    Second, SIFMA noted that an SBSD generally may use an approved 
model to calculate initial margin requirements and stated that, if 
standalone broker-dealers are not able to use similar models, the rule 
may result in competitive disparities between standalone broker-dealers 
and broker-dealers dually-registered as SBSDs. SIFMA therefore 
requested that FINRA modify the proposed margin rule to provide that, 
if the SEC has approved an affiliate of a standalone broker-dealer to 
use an initial margin model, such as the ISDA ``Standard Initial Margin 
Model,'' then such broker-dealer should be able to use the same model 
to the same extent as a broker-dealer dually-registered as an SBSD 
would be able to under the SEC's margin rules.\159\ SIFMA further 
requested that the use of such a model should not be limited to 
products that are Basic CDS or Basic SBS.\160\ FINRA believes similar 
considerations apply with respect to the use of SEC-approved Initial 
Margin models as for permitting a non-SBSD member to opt-in to Exchange 
Act Rule 18a-3. Proposed FINRA Rule 4240 would apply only to members 
that are not registered SBSDs, and therefore such members would not be 
subject to the comprehensive regulatory framework applicable to SBSDs, 
including higher capital requirements. Similarly, FINRA does not 
believe it would be appropriate to permit a non-SBSD member to opt-in 
to using models that the SEC has approved for an affiliate that is 
itself registered as an SBSD.
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    \159\ See SIFMA Letter at 8.
    \160\ See SIFMA Letter at 8 n.6.
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    Third, SIFMA requested that, when ANC Firms transact pursuant to an 
exception from the proposed new margin rule, they should be permitted 
to use credit risk charges set forth in Exchange Act Rule 15c3-1e in 
lieu of capital charges computed using the Initial Margin methodology 
required under the proposed new margin rule.\161\ SIFMA stated that 
this approach should not pose undue risks to ANC Firms given the 
significantly higher minimum net capital and tentative net capital 
requirements applicable to such firms, and cited the SEC's decision to 
allow ANC Firms to apply Exchange Act Rule 15c3-1e's credit risk 
charges to all derivatives transactions not subject to margin 
collection requirements.\162\ FINRA acknowledges that not permitting 
all ANC Firms subject to the rule to use credit risk charges in lieu of 
capital charges could create certain competitive disparities as between 
ANC Firms that are registered SBSDs (and therefore are subject to 
Exchange Act Rule 18a-3) and ANC Firms that are not registered SBSDs 
(and therefore would be subject to the Initial Margin requirements 
under proposed FINRA Rule 4240). However, FINRA notes that the credit 
risk charges calculated under Exchange Act Rule 15c3-1e represent a 
fraction of the Initial Margin Requirement that would otherwise be 
required to be collected under proposed FINRA Rule 4240 (or to be taken 
as a capital deduction in certain circumstances as described 
above).\163\ Therefore, as described above, FINRA believes it is 
appropriate to provide a limited exception permitting ANC Firms to use 
credit risk charges when they transact with registered SBSD affiliates 
or affiliates that are subject to comparable capital requirements in a 
foreign jurisdiction. FINRA believes this proposed exception should 
substantially address the potential competitive disparity highlighted 
by SIFMA, while providing the heightened protection provided by 
collecting the full Initial Margin Requirement, or taking the 
associated full capital charge in certain circumstances, for SBS with 
other Counterparties.
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    \161\ See SIFMA Letter at 8.
    \162\ See SIFMA Letter at 8-9.
    \163\ Specifically, these charges are the are the product of (x) 
8%, (y) the counterparty risk weighting (20% for internal AAA/AA 
rating, 50% for internal investment grade rating or 150% for 
internal non-investment grade rating), and (z) a potential exposure 
computed using a VaR model (or if not modeled, by applying the 
capital rule haircut to the underlying). See 17 CFR 15c3-1e.
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    Fourth, SIFMA requested that FINRA include an Initial Margin 
threshold consistent with Exchange Act Rule 18a-3's $50 million 
threshold.\164\ SIFMA noted that, because Exchange Act Rule 18a-3 
includes such a threshold while FINRA's proposed new margin rule would 
not, members subject to the proposed margin rule would face a 
significant competitive disadvantage relative to SBSDs. SIFMA suggested 
that, if FINRA permitted a member to take a capital charge in lieu of 
collecting Initial Margin up to the threshold, similar to that 
permitted by the SEC for SBSDs, then FINRA could ensure protection 
against credit risks without creating an unlevel playing field or 
increasing market concentration. Fifth, SIFMA requested that FINRA 
adopt a $500,000 minimum transfer amount to minimize operational 
burdens and competitive disadvantages that would otherwise be imposed 
on broker-dealers, including when facing SBSDs, in which case broker-
dealers would be required to collect or post Variation Margin when its 
SBSD counterparty would not.\165\ FINRA acknowledges that these aspects 
of the proposed rule change differ from the SEC's margin rule for SBSDs 
under Exchange Act Rule 18a-3. However, FINRA does not believe the 
application of a large threshold or minimum transfer amount would be 
appropriate for uncleared SBS entered into by non-SBSD members that 
would be subject to proposed FINRA Rule 4240, as such members will not 
be subject to the comprehensive regulatory framework applicable to 
SBSDs, including higher minimum capital requirements. FINRA also notes 
that, from an operational perspective, member broker-dealers should 
already have operational processes in place for the collection of 
margin without any threshold or minimum transfer amount. Further, FINRA 
believes that adopting a threshold or minimum transfer amount under 
proposed FINRA Rule 4240 would incentivize restructuring of margin 
accounts as Basic SBS given that FINRA Rule 4210 does not provide for 
any threshold or minimum transfer amount. To prevent regulatory 
arbitrage, FINRA is therefore not proposing to include any threshold or 
minimum

[[Page 26109]]

transfer amount under proposed FINRA Rule 4240.
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    \164\ See SIFMA Letter at 9.
    \165\ See SIFMA Letter at 9.
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    Fifth, SIFMA noted that the definition of Basic CDS as described in 
the Concept Proposal would not seem to cover an option on a CDS, i.e., 
CDS swaptions. SIFMA requested that FINRA change the definition of 
Basic CDS to include swaptions, so that swaptions are treated the same 
as the underlying CDS, to avoid a situation that would make it 
difficult for FINRA members to employ CDS swaption hedging 
techniques.\166\ SIFMA noted that such a change would also eliminate 
the added costs market participants would otherwise incur in requesting 
approval from FINRA of the appropriate Initial Margin Requirement for 
swaptions. FINRA notes that there is some uncertainty regarding the 
appropriateness of applying the generally applicable haircut grid for 
CDS under Exchange Act Rule 15c3-1(c)(2)(vi)(P)(1) to CDS swaptions. As 
such, FINRA believes it would be beneficial for SIFMA or other market 
participants to submit an application for approval of an Initial Margin 
Requirement for CDS swaptions under proposed FINRA Rule 4240(2)(C), as 
described above. FINRA notes that it would consider such a request 
expeditiously provided that such an application included all relevant 
supporting information. SIFMA also expressed concern that the Basic CDS 
definition could be read to require physical settlement of CDS. Given 
the prevalence of auction settlement in the CDS market, SIFMA requested 
that the definition of Basic Single-Name Credit Default Swap (a 
component of Basic CDS) specifically contemplate auction settlement as 
well.\167\ FINRA notes that it intends for the definition of Basic CDS, 
as described in greater detail above, to cover both physical and 
auction settlement.
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    \166\ See SIFMA Letter at 9-10.
    \167\ See SIFMA Letter at 10.
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    Finally, SIFMA made several comments regarding paragraph (g) (the 
portfolio margin section) of FINRA Rule 4210:\168\
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    \168\ See SIFMA Letter at 6.
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     SIFMA requested that FINRA conform FINRA Rule 4210's 
definitions of ``related instrument'' and ``underlying instrument'' to 
the definitions in Appendix A to Exchange Act Rule 15c3-1, which now 
include swaps and SBS. FINRA will consider these suggestions, but does 
not believe these changes are necessary as a part of this rulemaking.
     SIFMA further requested that FINRA clarify FINRA Rule 4210 
to permit house margin and stress test requirements for portfolio 
margin accounts to recognize risk offsets across all types of swaps, 
SBS and other positions permitted in the account. FINRA notes that this 
request relates to ``house margin,'' which generally refers to margin 
requirements that a member's portfolio margin risk management 
procedures may impose in addition to, or parallel to, the requirements 
under the applicable portfolio margin model. FINRA believes that the 
practice of recognizing risk offsets across all types of swaps, SBS and 
other positions permitted in the account for purposes of calculating 
house margin and related stress test requirements is permissible under 
current FINRA Rule 4210, and FINRA does not intend to alter such 
permissibility under the proposed rule change.
     SIFMA also requested that FINRA clarify that SBS may be 
held in a portfolio margin account even if the underlier for the SBS 
would not be eligible for portfolio margining, given that Exchange Act 
Rule 18a-3 imposes no limitation on the types of SBS that can be 
margined using the methodology set forth in Appendix A to Exchange Act 
Rule 15c3-1. FINRA notes that, under the proposed rule change, the 
eligibility of specific SBS for portfolio margining would depend on 
whether such SBS can be valued by a theoretical pricing model approved 
by the SEC for valuing that type of SBS. As such, an SBS would be 
permitted to be held in a portfolio margin account if it satisfies this 
condition, regardless of whether the underlier for the SBS would itself 
be eligible for portfolio margining.

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-2021-008 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2021-008. 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 website (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 website 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. Persons submitting comments are cautioned that 
we do not redact or edit personal identifying information from comment 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
FINRA-2021-008 and should be submitted on or before June 2, 2021.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\169\
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    \169\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2021-10055 Filed 5-11-21; 8:45 am]
BILLING CODE 8011-01-P