FINRA Aims to Change Three Financial Rules

On April 12, 2017, the Financial Industry Regulatory Authority (FINRA) published three regulatory notices proposing amendments to three of their rules regarding capital formation, corporate financing, and safe harbor, respectively. The first notice describes FINRA as a self-regulatory organization (SRO) with primary emphases on “investor protection” and “market integrity,” while striving to create and empower “vibrant capital markets.” Recently, FINRA created FINRA360, “an initiative that focuses on the continued revision of its rules, operations, and administrative processes,” to encourage and propose changes. Each regulatory notice involves amendments to Rules 5110, 2241, and 2242. FINRA is open to feedback on any content discussed in these notices.

Regulatory Notice 17-14 – Capital Formation

In this notice, FINRA desires to refine their rules on capital formation to increase the capital of affiliated businesses and improve their overall ability to raise capital, citing that today, small business, “which represent more than 99 percent of employers in the United States and which create significant numbers of new jobs,” primarily focus on capital-raising. In the notice, FINRA further highlights that the ability to raise capital is crucial for the economy and to create jobs. FINRA recently implemented the Capital Acquisition Broker (CAB) rule set, which was created for members engaged in a “limited range of activities,” primarily to manage those other than traditional broker-dealers. FINRA describes that the followers of CAB rules “cannot carry or maintain customer accounts, handle customers’ funds or securities, accept customers’ trading orders, or engage in proprietary trading or market-making.” They also implemented funding portal rules, which allow businesses to offer and sell securities through crowdfunding. FINRA describes that funding portals participating in crowdfunding “on behalf of issuers are required to become a member of a national securities association.” Learn about Colonial’s crowdfunding services.

Regulatory Notice 17-15 – Rule 5110

This notice proposes amendments to the Corporate Financing Rule – Underwriting Terms and Arrangements, or Rule 5110. Rule 5110 was approved by the SEC in 1992, and since then, FINRA has made numerous amendments to modernize it. They desire to simplify its contents while retaining market participant protections. The rule regulates how underwriters oversee issuers when they publicly offer securities and, FINRA describes, requires those who publicly offer these securities to file information with FINRA about the underwriting terms and arrangements. FINRA proposes several changes to this rule, including: filing requirements; filing exemptions; disclosure requirements; underwriting compensation; lock-up restrictions; valuation of securities; prohibited terms and arrangements; and defined terms. To view the official rule, click here.

Regulatory Notice 17-16 – Rule 2241 and Rule 2242

FINRA describes that notice 17-16 proposes changes to FINRA Rule 2241 (Research Analysts and Research Reports) and FINRA Rule 2242 (Debt Research Analysts and Debt Research Reports) to create a “limited safe harbor.” These rules deal with equity and debt research respectively. The former seeks to improve and maintain research analysts’ reliability as well as the research reports’ quality and conciseness. FINRA describes that Rule 2241 encourages disclosure of any research analysts’ conflicts of interest. Rule 2242 has similar requirements to Rule 2241. However, it focuses on debt research and has three major differences that further regulate specific aspects of research process. FINRA further explains that this safe harbor would have to comply with Rules 2241 and 2242 to limit “research related conflicts.” They would also “require companies to include a health warning on desk commentary.” FINRA notes that they ultimately aim to reduce research conflicts and find an effective, compliant way to author and distribute desk commentary.

Read below for a summary of some of the rules that FINRA desires to amend.

Rule 2310 – DPPs and REITs

Like Rule 5110, Rule 2310 involves underwriting terms and arrangements, but with direct participation programs (DPPs) and unlisted real estate investment trusts (REITs). According to FINRA, a DPP is “a business venture designed to let investors participate directly in the cash flow and tax benefits of an underlying investment (e.g., oil and gas programs and equipment leasing programs).” DPPs give investors more control over their investments. REITs “are investment vehicles for income-generating real estate that benefit from the tax advantages of a trust” which further provide investors with benefits throughout the investment process, if the trust complies with Internal Revenue Code requirements. The rule focuses on maintaining investor protection and fair compensation. To see the official Rule 2310, click here.

Rule 5131 – Managing New Issue Securities

This rule entails problems involved in the allocation and distribution of new issue securities, and aims to maintain firm compliance throughout this process.  They further explain, “the rule prohibits quid pro quo allocations and ‘spinning,’ and addresses the conduct of members and associated persons in the areas of book-building, new issue pricing, penalty bids, trading and waivers of lock-up agreements.” FINRA recently amended this rule by creating an additional rule, Rule 5141, that simplified the former while maintaining member protections.

Smaller Companies – Rule 6432 and the Trading Activity Fee (TAF)

FINRA notes that smaller companies have become concerned about the trading of their stocks and how certain rules may exclusively harm them. Rule 6432 and the Trading Activity Fee (TAF) provide examples of such rules.

Rule 6432 – Form 15c2-11 Compliance

Rule 6432 requires compliance in the form of physical forms to “[initiate] or [resume] quotations in a nonexchange-listed security.” FINRA explains that some members argue this detrimentally affects smaller companies: “the requirements it imposes on market makers may unintentionally create burdens on the quoting of stocks of smaller companies and thus impede capital formation.” Members must also comply with SEA 15c2-11 filings before trading, purchasing, or selling unlisted assets. In addition, FINRA describes that “a member is required to provide the price at which it intends to initiate quotations along with the basis upon which such price was determined.” Regulatory notice 17-14 (link below) goes into greater detail concerning exceptions to this rule.

Learn more about Colonial’s 15c211 filing services.

Trading Activity Fee (TAF)

According to FINRA, the TAF is a “one member regulatory fee [they charge] that is based on trading activity and generally applies to all sales of a covered security, including both sales for the member’s own account and sales on behalf of a customer, regardless of where the trade is executed.” Like with Rule 6432, smaller companies have expressed concerns about their ability to trade and quote stocks with this fee in place.

Click on the links below to view the three FINRA regulatory notices.

Regulatory Notice 17-14

Regulatory Notice 17-15

Regulatory Notice 17-16


Regulatory Notice 17-14

Regulatory Notice 17-15

Regulatory Notice 17-16

Eric Mellmer
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