Document ID: SEC-2020-0480-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2020-04-01T04:00Z

[Federal Register Volume 85, Number 63 (Wednesday, April 1, 2020)]
[Notices]
[Pages 18299-18304]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-06722]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-88482; File No. SR-FINRA-2019-030]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by 
Amendment No. 1, To Amend the Membership Application Program (``MAP'') 
Rules To Address the Issue of Pending Arbitration Claims

March 26, 2020.

I. Introduction

    On December 13, 2019, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and

[[Page 18300]]

Exchange Commission (``Commission''), pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 
19b-4 thereunder,\2\ a proposed rule change to amend FINRA's Membership 
Application Program (``MAP'') rules to help further address the issue 
of pending arbitration claims, as well as arbitration awards and 
settlement agreements related to arbitrations that have not been paid 
in full in accordance with their terms.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on December 30, 2019.\3\ The public comment period closed on 
January 21, 2020. The Commission received two comment letters in 
response to the Notice, both generally supporting the proposed rule 
change.\4\ On January 31, 2020, FINRA responded to the comment letters 
received in response to the Notice.\5\ On February 6, 2020, FINRA filed 
an amendment to the proposal (``Amendment No. 1'').\6\ On February 10, 
2020, FINRA extended the time period in which the Commission must 
approve the proposed rule change, disapprove the proposed rule change, 
or institute proceedings to determine whether to approve or disapprove 
the proposed rule change to March 27, 2020. This order approves the 
proposed rule change, as modified by Amendment No. 1.
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    \3\ See Exchange Act Release No. 87810 (Dec. 20, 2019), 84 FR 
72088 (Dec. 30, 2019) (File No. SR-FINRA-2019-030) (``Notice'').
    \4\ See Letter from Steven B. Caruso, Maddox Hargett Caruso, 
P.C., dated January 7, 2020 (``Caruso Letter''); and letter from 
Christine Lazaro, Director of the Securities Arbitration Clinic and 
Professor of Clinical Legal Education, St. John's University School 
of Law, dated January 21, 2020 (``SJU Letter''). Comment letters are 
available on the Commission's website at https://www.sec.gov.
    \5\ See Letter from Victoria Crane, Vice President and Associate 
General Counsel, FINRA, to Vanessa Countryman, Secretary, U.S. 
Securities and Exchange Commission, dated January 31, 2020 (``FINRA 
Letter''). The FINRA Letter is available on FINRA's website at 
http://www.finra.org, at the principal office of FINRA, on the 
Commission's website at https://www.sec.gov/comments/sr-finra-2019-030/srfinra2019030-6730822-207419.pdf, and at the Commission's 
Public Reference Room.
    \6\ Amendment No. 1 is available at https://www.finra.org/sites/default/files/2020-02/SR-FINRA-2019-030_Amendment1.pdf. With 
Amendment No. 1, FINRA made a technical change to the text of the 
proposal reflecting a cross-reference to FINRA Rule 1017(a)(5). 
Specifically, FINRA's initial proposal did not amend Rule 
1017(a)(5), which currently cross-references Rule 1011(k) defining 
``material change in business operations.'' Amendment No. 1 changes 
that cross-reference to ``Rule 1011(l)'' to reflect the renumbered 
paragraphs as proposed in amended Rule 1011.
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II. Description of the Proposed Rule Change \7\
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    \7\ The subsequent description of the proposed rule change is 
substantially excerpted from FINRA's description in the Notice. See 
Notice, 83 FR at 72088-72093.
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Background

    The MAP Rules govern the way in which FINRA reviews a new 
membership application (``NMA'') and a continuing membership 
application (``CMA'').\8\ They are currently found under the FINRA Rule 
1000 Series as FINRA Rules 1011 through 1019. These rules require an 
applicant to demonstrate its ability to comply with applicable 
securities laws and FINRA rules, including observing high standards of 
commercial honor and just and equitable principles of trade. The MAP 
rules require FINRA to evaluate an applicant's financial, operational, 
and supervisory and compliance systems to ensure that the applicant 
meets the standards set forth in the rules.
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    \8\ Unless otherwise specified, the term ``application'' refers 
to either an NMA (or Form NMA) or CMA (or Form CMA), depending on 
context.
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    FINRA's proposed rule changes would: (1) Amend Rule 1014 
(Department Decision) to: (a) Create a rebuttable presumption that an 
application for new membership would be denied if the applicant or its 
associated persons are subject to a pending arbitration claim, and (b) 
permit an applicant to overcome a presumption of denial by 
demonstrating its ability to satisfy an unpaid arbitration award, other 
adjudicated customer award, unpaid arbitration settlement, or pending 
arbitration claim; (2) create a new requirement for a member, that is 
not otherwise required to submit an application for continuing 
membership for a specified change in ownership, control or business 
operations, including a business expansion, to seek a materiality 
consultation if the member or its associated persons have a defined 
``covered pending arbitration claim,'' unpaid arbitration award, or an 
unpaid arbitration settlement; (3) amend Rule 1017 (Application for 
Approval of Change in Ownership, Control, or Business Operations) to 
require a member to demonstrate its ability to satisfy an unpaid 
arbitration award or unpaid settlement related to an arbitration before 
effecting the proposed change thereunder; and (4) amend Rule 1013 (New 
Member Application and Interview) and Rule 1017 to require an applicant 
to provide prompt written notification of any pending arbitration claim 
that is filed, awarded, settled, or becomes unpaid before a decision on 
an application constituting final action on FINRA is served on the 
applicant.\9\ Additionally, FINRA is proposing non-substantive changes 
in specified MAP rules.\10\
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    \9\ See Notice at 72088.
    \10\ See id.
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Proposed Rule Change for Presumption To Deny an Application

    FINRA is proposing an amendment to the standard for admission and 
the corresponding factors therein relating to the presumption to deny 
an application for new or continuing membership.\11\ Currently, FINRA 
Rule 1014 sets forth standards for admission FINRA must consider in 
determining whether to approve an application. Under Rule 1014(a)(3), 
FINRA is required to determine whether an applicant for new or 
continuing membership and its associated persons are capable of 
complying with the federal securities laws, the rules and regulations 
thereunder, and FINRA Rules. Rule 1014(a)(3) sets forth six factors 
that FINRA must consider in making that determination. Additionally, 
FINRA notes that under Rule 1014(b)(1), where an applicant or its 
associated persons are subject to certain regulatory events enumerated 
in Rule 1014(a)(3), a presumption exists that the application should be 
denied.\12\ However, FINRA notes that ``the existence of a record of a 
pending arbitration, as set forth in Rule 1014(a)(3)(B), is currently 
not among the enumerated factors that trigger the presumption to deny 
an application.'' \13\
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    \11\ See id.
    \12\ Notice at 72089.
    \13\ Id.
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    The proposed amendment to Rule 1014 would create the rebuttable 
presumption to deny an application in cases where the prospective 
applicant or its associated persons are the subject of pending 
arbitration claims.\14\ This presumption of denial for a pending 
arbitration claim would not apply to an existing member firm filing a 
CMA.\15\ Instead, consistent with today's practice, FINRA would 
continue to consider whether an applicant or its associated persons are 
the subject of a pending arbitration claim in determining whether the 
applicant for continuing membership is capable of complying with 
applicable federal securities laws and FINRA rules.\16\
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    \14\ Id.
    \15\ Id.
    \16\ Id.

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[[Page 18301]]

Proposed Rule Change To Demonstrate Ability To Satisfy Unpaid 
Arbitration Awards, Other Adjudicated Customer Awards, Unpaid 
Arbitration Settlements, or for New Member Applications, Pending 
Arbitration Claims

    FINRA is also proposing to clarify the various ways in which an 
applicant for new or continuing membership may demonstrate its ability 
to satisfy an unpaid arbitration award, other adjudicated customer 
award, unpaid arbitration settlement, or a pending arbitration claim 
during the application review process, and to preclude an applicant 
from effecting any contemplated change in ownership, control, or 
business operations until such demonstration is made and FINRA approves 
the application.\17\ For example, proposed IM-1014-1 would allow 
applicants to demonstrate the ability to satisfy an unpaid arbitration 
award, other adjudicated customer award, unpaid arbitration settlement, 
or a pending arbitration claim, through an escrow agreement, insurance 
coverage, a clearing deposit, a guarantee, a reserve fund, or the 
retention of proceeds from an asset transfer or such other forms of 
documentation that FINRA may determine to be acceptable.\18\ Proposed 
IM-1014-1 would also allow an applicant to overcome the presumption to 
deny the application by guaranteeing that any funds used to evidence 
the applicant's ability to satisfy any awards, settlements, or claims 
will be used for that purpose.\19\
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    \17\ See Notice at 72088.
    \18\ Id. at 72089. Proposed IM-1014-1 would also allow an 
applicant to provide a written opinion of an independent, reputable 
U.S. licensed counsel knowledgeable in the area as to the value of 
the arbitration claims.
    \19\ Notice at 72090.
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    Any demonstration by an applicant of its ability to satisfy these 
outstanding obligations would be subject to a reasonableness assessment 
by FINRA.\20\
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    \20\ Id.
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Proposed Rule Change To Mandate Materiality Consultations

    To further incentivize members to pay arbitration awards and 
settlements, FINRA is proposing to mandate that a member seek a 
materiality consultation in two situations in which specified pending 
arbitration claims, unpaid arbitration awards, or unpaid arbitration 
settlements are involved.\21\ Currently, the materiality consultation 
process is voluntary, and exists to provide a member with the option of 
seeking guidance, or a materiality consultation, from FINRA on whether 
certain proposed events (e.g., acquisition or transfer of the member's 
assets, or a business expansion) would be material and thus require the 
member to file a CMA when it plans to undergo an event specified under 
Rule 1017.\22\ According to FINRA, ``[t]he characterization of a 
contemplated change as material depends on an assessment of all the 
relevant facts and circumstances, including, among others, the nature 
of the contemplated change, the effect the contemplated change may have 
on the firm's capital, the qualifications and experience of the firm's 
personnel, and the degree to which the firm's existing financial, 
operational, supervisory, and compliance systems can accommodate the 
contemplated change.'' \23\ Where FINRA determines that a contemplated 
change is material, FINRA instructs the member to file a CMA if it 
intends to proceed with the change.\24\
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    \21\ See id. at 72089.
    \22\ See Notice at 72090. A request for a materiality 
consultation, for which there is no fee, is a written request from a 
member firm for FINRA's determination on whether a contemplated 
change in business operations or activities is material and would 
therefore require a CMA or whether the contemplated change can fit 
within the framework of the firm's current activities and structure 
without the need to file a CMA. Id.
    \23\ Notice at 72090 (citing Notice to Members 00-73 (October 
2000) (FINRA Requests Comment on a Proposal Regarding the Rules 
Governing the New and Continuing Membership Application Process)).
    \24\ See id. As FINRA explains in the Notice, the member is 
responsible for compliance with Rule 1017. If FINRA determines 
during the materiality consultation that the contemplated business 
change is material, then the member potentially could be subject to 
disciplinary action for failure to file a CMA under Rule 1017. Id.
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Mandatory Materiality Consultation for Business Expansion To Add One or 
More Associated Persons Involved in Sales (Proposed IM-1011-2 and 
Proposed Rules 1011(c)(1) and 1017(a)(6)(B))

    Current Rule 1017 specifies the changes in a member's ownership, 
control, or business operations that require a CMA and FINRA's 
approval.\25\ However, current IM-1011-1 creates a safe harbor for 
incremental increases in certain business expansions that are presumed 
not to be material changes in business operations.\26\ Under this safe 
harbor, a member, subject to specified conditions and thresholds, may 
undergo such business expansions without filing a CMA.\27\
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    \25\ See id.
    \26\ See Notice at 72090.
    \27\ See id.
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    Proposed IM-1011-2 (Business Expansions and Covered Pending 
Arbitration Claims) would provide that if a member is contemplating to 
add one or more associated persons involved in sales and one or more of 
those associated persons: (1) Has a ``covered pending arbitration 
claim'' \28\ (as that term is defined in proposed Rule 1011(c)(1) 
described below), an unpaid arbitration award or an unpaid settlement 
related to an arbitration, and (2) the member is not otherwise required 
to file a CMA, the member may not effect the contemplated business 
expansion unless the member complies with the proposed new requirements 
in Rule 1017(a)(6)(B).\29\ Proposed Rule 1017(a)(6)(B) would require a 
member firm to file a CMA for approval of the business expansion 
described in proposed IM-1011-2 unless the member first submits a 
written request to FINRA seeking a materiality consultation for the 
contemplated business expansion. As part of the materiality 
consultation, FINRA would determine whether: (1) The member is not 
required to file a CMA in accordance with Rule 1017 and may effect the 
contemplated business expansion; or (2) the member is required to file 
a CMA in accordance with Rule 1017 and the member may not effect the 
contemplated business expansion unless FINRA approves the CMA.\30\
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    \28\ Proposed Rule 1011(c)(1) would define a ``covered pending 
arbitration claim'' as an investment-related, consumer-initiated 
claim filed against the associated person in any arbitration forum 
that is unresolved; and whose claim amount (individually or, if 
there is more than one claim, in the aggregate) exceeds the hiring 
member's excess net capital. See id. at 72091.
    For purposes of this definition, FINRA explains that the claim 
would only include claimed compensatory loss amounts, not requests 
for pain and suffering, punitive damages, or attorney's fees, and 
shall be the maximum amount for which the associated person is 
potentially liable regardless of whether the claim was brought 
against additional persons or the associated person reasonably 
expects to be indemnified, share liability, or otherwise lawfully 
avoid being held responsible for all or part of such maximum amount.
    \29\ See id. at 72091.
    \30\ See Notice at 72091.
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Mandatory Materiality Consultation for Any Acquisition or Transfer of 
Member's Assets (Proposed Rule 1011(c)(2) and Proposed Rule 
1017(a)(6)(A))

    Currently, Rule 1017(a) requires a member to file a CMA for direct 
or indirect acquisitions or transfers of 25 percent or more in the 
aggregate of the member's assets or any asset, business, or line of 
operation that generates revenues composing 25 percent or more in the 
aggregate of the member's earnings measured on a rolling 36-month 
basis, unless both the seller and acquirer are NYSE members.\31\
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    \31\ See id.
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    FINRA is proposing to add a new subparagraph (6)(A) to Rule 1017(a) 
to provide that if a member is contemplating any direct or indirect

[[Page 18302]]

acquisition or transfer of a member's assets or any asset, business, or 
line of operations where the transferring member or an associated 
person of the transferring member: (1) Has a ``covered pending 
arbitration claim,'' \32\ an unpaid arbitration award or an unpaid 
settlement related to an arbitration, and (2) the member is not 
otherwise required to file a CMA, the member may not effect the 
contemplated transaction unless the member first submits a written 
request to FINRA seeking a materiality consultation for the 
contemplated acquisition or transfer.\33\ As part of the materiality 
consultation, FINRA would determine whether: (1) The member is not 
required to file a CMA in accordance with Rule 1017 and may effect the 
contemplated acquisition of transfer; or (2) the member is required to 
file a CMA in accordance with Rule 1017 and the member may not effect 
the contemplated acquisition or transfer unless FINRA approves the 
CMA.\34\
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    \32\ Proposed Rule 1011(c)(2) would define a ``covered pending 
arbitration claim'' as an investment-related, consumer-initiated 
claim filed against the transferring member or its associated 
persons in any arbitration forum that is unresolved; and whose claim 
amount (individually or, if there is more than one claim, in the 
aggregate) exceeds the transferring member's excess net capital. See 
id. at 72092.
    For purposes of this definition, FINRA explains that the claim 
would only include claimed compensatory loss amounts, not requests 
for pain and suffering, punitive damages or attorney's fees, and 
shall be the maximum amount for which the associated person is 
potentially liable regardless of whether the claim was brought 
against additional persons or the associated person reasonably 
expects to be indemnified, share liability or otherwise lawfully 
avoid being held responsible for all or part of such maximum amount.
    \33\ See Notice at 72091.
    \34\ See id.
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Proposed Rule Change Requiring Notification of Unpaid Arbitration 
Awards

    The proposal would require an applicant for new or continuing 
membership to notify FINRA of any pending arbitration claims that are 
filed, awarded, settled, or become unpaid before FINRA renders a 
decision on the application.\35\ Current Rule 1013(a) lists items that 
must be submitted with an NMA and Rule 1017(b) sets forth the documents 
and other information required to accompany a CMA, depending on the 
nature of the CMA.\36\ FINRA is proposing to add Rules 1013(c) and 
1017(h) to require an applicant to provide prompt notification, in 
writing, of any pending arbitration claim involving the applicant or 
its associated persons that is filed, awarded, settled, or becomes 
unpaid before a decision on the application constituting final action 
of FINRA is served on the applicant.\37\ FINRA indicated that any such 
unpaid arbitration award, other adjudicated customer award, unpaid 
arbitration settlement, or pending arbitration claim (for a new member 
applicant only) that comes to light in this manner during the 
application review process would result in FINRA being able to 
presumptively deny the application under the applicable factors set 
forth in Rule 1014(a)(3), and the ability of the applicant to overcome 
such presumption by demonstrating its ability to satisfy the 
obligation.\38\
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    \35\ See id. at 72089.
    \36\ See id. at 72092.
    \37\ See id.
    \38\ See id. at 72092.
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    Current Rule 1017(c) describes the timing and conditions for 
effecting a change under Rule 1017.\39\ Rule 1017(c)(1) requires a 
member to file a CMA for approval of a change in ownership or control 
at least 30 days before the change is expected to occur.\40\ A member 
may effect the change prior to the conclusion of FINRA's review of the 
CMA, however, FINRA may place interim restrictions on the member based 
upon the standards in Rule 1014 pending a final determination. Under 
Rule 1017(c)(2), a member may file a CMA to remove or modify a 
membership agreement restriction at any time, but any such existing 
restriction shall remain in effect during the pendency of the 
proceeding.\41\ Finally, Rule 1017(c)(3) permits a member to file a CMA 
for approval of a material change in business operations at any time, 
but the member may not effect such change until the conclusion of the 
proceeding, unless FINRA and the member otherwise agree.\42\ FINRA is 
proposing to add subparagraph (4) to Rule 1017(c), providing that, 
notwithstanding the existing timing and conditions for effecting a 
change as described under Rule 1017(c)(1) through (3), where a member 
or an associated person has an unpaid arbitration award or unpaid 
settlement related to an arbitration at the time of filing a CMA, the 
member may not effect such change until demonstrating that it has the 
ability to satisfy such obligations in accordance with Rule 1014 and 
proposed IM-1014-1, as discussed above, and obtaining FINRA's approval 
of the CMA.\43\
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    \39\ See id.
    \40\ See id.
    \41\ See id.
    \42\ See id.
    \43\ See Notice at 72092.
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Additional Proposed Changes

    The proposal would also make non-substantive changes in the MAP 
rules by renumbering paragraphs in Rules 1011, 1014, and 1017, as well 
as updating cross-references.\44\
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    \44\ See id. at 72088. FINRA will also make conforming changes 
to Forms NMA and CMA.
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III. Comment Summary

    As noted above, the Commission received two comment letters on the 
proposed rule change supporting the proposal.\45\ While both commenters 
were generally supportive of the proposal, they believed that further 
action was necessary to address the issue of unpaid financial 
obligations that broker-dealers and their associated persons owe to 
their customers.\46\
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    \45\ See supra note 4.
    \46\ Id.
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Supportive Comments

    In one commenter's view, the proposed rule changes represented a 
``fair, equitable and reasonable approach that would expedite and 
facilitate the efficiency of the arbitration process'' and recommended 
that they should be ``approved by the SEC on an expedited basis.'' \47\ 
The second commenter noted the proposed rules changes would provide 
FINRA with ``another tool with which it may scrutinize the business of 
its members and new member applicants to ensure they can comply with 
the relevant rules and regulations, and that investors are protected.'' 
\48\
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    \47\ Caruso Letter.
    \48\ SJU Letter.
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Proposal Is Insufficient

    As stated above, both commenters believed that FINRA needed to take 
further action to address unpaid financial obligations that broker-
dealers and their associated persons owe to their customers.\49\ One 
commenter stated ``it is clear that these rule amendments . . . will 
not completely solve the large number of customer awards that remain 
unpaid each year.'' \50\ The second commenter suggested that either in 
this rulemaking or a subsequent rulemaking, FINRA should consider 
addressing all investor settlements that have not been fully paid, such 
as a settled mediation claim or a settlement resulting from a written 
or oral complaint.\51\ The commenter believes that the proposal should 
cover these settlements because these types of settlements also may 
never be fully satisfied by a firm.\52\
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    \49\ See Caruso Letter and SJU Letter.
    \50\ Caruso Letter.
    \51\ See SJU Letter.
    \52\ See id.

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[[Page 18303]]

    In response, FINRA recognizes that the issue of unpaid financial 
obligations that broker-dealers and their associated persons owe to 
their customers is not unique to the FINRA arbitration forum or the 
broker-dealer industry and that investors may have claims that arise 
outside of FINRA arbitration.\53\ But FINRA also believes this 
particular rule filing is only one of the ways it is proceeding to 
implement additional steps to strengthen its rules on this topic.\54\ 
In addition, FINRA noted that it has ``encouraged a continuing dialogue 
about addressing the challenges of customer recovery across the 
financial services industry while directly informing the further 
enhancement of recovery in FINRA's forum[.]'' \55\ For example, FINRA 
cited to its 2018 White Paper and ``additional data regarding the 
circumstances under which awards may be unpaid, along with a discussion 
of potential regulatory and legislative responses.'' \56\ For these 
reasons, FINRA declined to amend this proposal in response to 
commenters.\57\
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    \53\ See FINRA Letter.
    \54\ Id. See e.g., Exchange Act Release No. 88254 (Feb. 20, 
2020), 85 FR 11157 (Feb 26, 2020) (File No. SR-FINRA-2019-027) 
(amending FINRA rules to expand customers' options in arbitration 
with respect to claims brought against inactive member firms and 
associated persons).
    \55\ FINRA Letter.
    \56\ Id. In FINRA Perspectives on Customer Recovery, available 
at https://www.finra.org/sites/default/files/finra_perspectives_on_customer_recovery.pdf. FINRA also makes 
available additional data on unpaid arbitration awards arising in 
the forum for the past five years, available at https://www.finra.org/arbitration-mediation/statistics-unpaid-customer-awardsfinra-arbitration (``White Paper''). In addition, FINRA has 
published a list of firms and associated persons responsible for 
unpaid arbitration awards, available at https://www.finra.org/arbitration-mediation/member-firms-and-associated-personsunpaid-customer-arbitration-awards. See FINRA Letter at note 3.
    \57\ See FINRA Letter.
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IV. Discussion and Commission Findings

    After careful review of the proposed rule change and the comment 
letters, the Commission finds that the proposal is consistent with the 
requirements of the Exchange Act and the rules and regulations 
thereunder that are applicable to a national securities association. 
\58\ Specifically, the Commission finds that the proposed rule change 
is consistent with Section 15A(b)(6) of the Exchange Act,\59\ 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, and, in general, to protect investors 
and the public interest.
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    \58\ In approving this rule change, the Commission has 
considered the rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \59\ 15 U.S.C. 78o-3(b)(6).
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Presumption To Deny an Application

    The Commission agrees with FINRA that this proposal to add a 
presumption to deny an NMA helps to address concerns related to 
prospective applicants for new membership planning to hire principals 
and registered persons with pending arbitration claims without being 
able to adequately demonstrate: (1) How those claims would be paid if 
they go to award or result in a settlement; and (2) how the new member 
applicant would be able to effectively supervise such individuals who 
may have a history of noncompliance. In particular, the Commission 
agrees with FINRA that creating a presumption of denial in connection 
with a pending arbitration claim for an NMA would appropriately shift 
the burden to the new member applicant to demonstrate how its pending 
arbitration claim would be paid should it go to award or result in a 
settlement. As FINRA notes, this proposed amendment promotes investor 
protection by requiring more thorough scrutiny of certain prospective 
member firms to help protect the potential customers of those 
firms.\60\
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    \60\ See Notice at 72093. FINRA noted that the majority of new 
member applicants are unlikely to be effected by the proposed 
amendments. FINRA reviewed the 317 NMAs that it received from 
January 2015 through December 2017 and found that of those 317 NMAs 
only 13 NMAs included a new member applicant or its associated 
persons that had a pending arbitration claim at the time of FINRA's 
receipt of the NMA. Under the proposed amendments, FINRA could have 
presumptively denied those NMAs. See id. at 72093, 72094.
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Demonstration of Ability To Pay

    The Commission agrees with FINRA that it would improve the 
efficiency of the MAP process to institute the proposal requiring 
evidence of an applicant's ability to satisfy unpaid arbitration 
awards, other adjudicated customer awards, unpaid arbitration 
settlements, or, in the case of NMAs, pending arbitration claims. 
Specifically, the Commission agrees with FINRA that this rule will 
increase the ability of applicants to anticipate the information 
necessary to demonstrate their ability to satisfy outstanding 
obligations or potential obligations, and reduce the need for 
applicants to submit additional information after the initial filing. 
The Commission also believes the proposal could help reduce the number 
of unpaid arbitration awards by permitting an applicant to overcome the 
presumption to deny an application by guaranteeing that any funds used 
to evidence the applicant's ability to satisfy any awards, settlements, 
or claims will be used specifically for that purpose.

Materiality Consultation

    FINRA has expressed concern that, under current Rule 1017 and the 
existing safe harbor for business expansions to increase the number of 
associated persons involved in sales,\61\ a member could hire 
principals and registered representatives with substantial pending 
arbitration claims without considering how the firm would supervise 
such individuals or the potential financial impact on the firm if the 
individual, while employed at the hiring firm, engages in potential 
misconduct that results in a customer arbitration.\62\ The Commission 
agrees with FINRA that requiring a materiality consultation for this 
type of business expansion would allow FINRA to, among other things, 
assess the nature of the anticipated activities of the principals and 
registered representatives with pending arbitration claims, unpaid 
arbitration awards, or arbitration settlements; the impact on the 
firm's supervisory and compliance systems, personnel, and finances; and 
any other impact on investor protection raised by adding such 
individuals.
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    \61\ See FINRA IM-1011-1 (Safe Harbor for Business Expansions).
    \62\ See Notice at 72090.
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    Additionally, the Commission agrees that FINRA is better able to 
assess, among other things, the adequacy of any plan a member firm has 
in place to satisfy pending arbitration claims, unpaid arbitration 
awards, or unpaid arbitration settlements, by requiring a materiality 
consultation when a member firm is contemplating any direct or indirect 
acquisition or transfer of assets involving a ``covered pending 
arbitration claim.'' The Commission further agrees that this proposal 
helps reduce the risk that a firm with pending arbitration claims that 
ultimately produce awards or settlements could avoid satisfying those 
awards or settlements by transferring assets without encumbrance and 
then closing down. The Commission agrees with FINRA that a decrease in 
the ability of firms to avoid satisfying their arbitration awards or 
settlements in this manner may result in a higher likelihood that they 
are paid in full in accordance with their terms.

Notification of Unpaid Arbitration Awards

    The Commission agrees with FINRA that requiring applicants to 
provide prompt notification to FINRA of a pending arbitration claim 
that is filed,

[[Page 18304]]

awarded, settled, or becomes unpaid before a decision on the 
application is served will improve FINRA's ability to oversee and 
review the pending arbitrations of applicants to help ensure that 
arbitration awards and settlements are paid in full in accordance with 
their terms.
    In sum, the Commission agrees with FINRA and the commenters who 
supported the proposed rule change that it would help address the issue 
of unpaid arbitration awards. Specifically, the proposal would link a 
firm's or associated person's unpaid arbitration awards, unpaid 
arbitration settlement, or specified pending arbitration claims 
(collectively, ``unpaid and potential financial obligations related to 
arbitration'') to FINRA's membership application review process, in 
certain instances, to provide FINRA greater oversight.\63\ These 
changes will enable FINRA to more directly address concerns over unpaid 
and potential financial obligations related to arbitration, as well as 
the adequacy of the supervision of individuals with unpaid and 
potential financial obligations related to arbitration in situations 
where, for example: (1) A FINRA member firm hires individuals with 
pending arbitration claims, where there are concerns about: (a) The 
payment of those claims should they go to award or result in 
settlement, and (b) the supervision of those individuals; and (2) a 
member firm with pending arbitration claims seeks to avoid payment of 
the claims should they go to award or result in a settlement by 
shifting its assets, or its managers and owners, to another firm and 
closing down. Additionally, the Commission agrees with FINRA that 
amendments adopted here will enable FINRA to place greater emphasis on 
the adequacy of the supervision of individuals with pending arbitration 
claims given their history of noncompliance. While the Commission 
acknowledges the concerns of commenters regarding the potential for 
further action to address unpaid claims that arise outside of FINRA 
arbitration, as FINRA noted, this proposal represents one step in the 
ongoing process of addressing these issues and FINRA continues to 
evaluate further action.\64\
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    \63\ See Notice at 72089.
    \64\ See FINRA Letter.
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V. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the 
Exchange Act \65\ that the proposal (SR-FINRA-2019-030), as modified by 
Amendment No. 1, be, and hereby is, approved.
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    \65\ 15 U.S.C. 78s(b)(2).
    \66\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\66\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-06722 Filed 3-31-20; 8:45 am]
 BILLING CODE 8011-01-P