All communications by FINRA member firms are subject to the communications rule—Rule 2210—which has approval and review, recordkeeping, filing and content standards. The rule also includes exceptions from many of its requirements. In recent years, FINRA has updated its advice relating to the use of social media by member firms, in response to the rapidly changing social media landscape. The rule covers a firm’s communications to retail and institutional investors, and many of the requirements are somewhat relaxed for institutional communications. In our latest On point, we discuss the requirements and application of FINRA Rule 2210.
FINRA today published its Report on FINRA Examination Findings and highlights private placement related concerns. In its examinations of the practices of many broker-dealers, the report notes FINRA found instances where the diligence review undertaken in connection with private placements was not sufficient in scope or depth to be considered a “reasonable investigation of the issuer and the securities.” In its Regulatory Notice 10-22 issued several years ago, FINRA noted that FINRA member firms have a suitability obligation under FINRA Rule 2111, including in connection with recommending an investment in a private placement. The notice describes the type of investigation that broker-dealers ought to conduct with respect to a private placement.
In its examinations, FINRA noted that member firms that had performed reasonable diligence “conducted meaningful, independent research on material aspects of the offering; identified any red flags with the offering or the issuer; and addressed and resolved concerns that would be relevant to a potential investor. Depending on their size, firms’ diligence processes included creating a due diligence committee (at larger firms) or otherwise formally designating one or more qualified persons (at smaller firms), and charging them with investigating and determining whether to approve the offering for sale to investors. As part of their process, firms independently verified information that was key to the performance of the offering, and some received support from due diligence firms, experts and third-party vendors. Further, in offerings involving issuers that were affiliates of the firm or whose control persons were also employed by the firm, firms used the reasonable diligence process to mitigate conflicts of interest, ensured that the offerings were suitable for investors in spite of such conflicts of interest, and developed comprehensive disclosures. Firms also used insights from the diligence analysis to establish post-approval processes and investment limits based on the complexity or risk level of the offering. After the offering, firms conducted ongoing diligence to ascertain whether offering proceeds were used in a manner consistent with the offering memorandum, particularly when the firms engaged in ongoing sales of an offering after initial closing.”
The report cites examples of other problematic practices, including reliance on the firm’s prior experience with the same issuer without refreshing their diligence, reviewing the offering memorandum without more in-depth diligence, failing to verify independently material aspects of the offerings, and failing to investigate red flags identified during the reasonable diligence process, placing undue reliance on due diligence consultants, experts or other third-party vendors.
On October 30, 2018, the Financial Industry Regulatory Authority, Inc. (“FINRA”) filed a proposed rule change to amend FINRA Rule 5110 (Corporate Financing Rule – Underwriting Terms and Arrangements) (the “Rule”), which is the main FINRA rule regarding compensation in securities offerings, with the Securities and Exchange Commission (“SEC”).
The proposed Rule includes the following changes:
- Decreases the number of documents required to be filed and increases the amount of time in which to file them;
- Codifies the existing exemption for seasoned issuers and streamlines the filing requirement for shelf offerings;
- Clarifies the exemption for corporate issuers and expands the list of exempt offerings;
- Simplifies the underwriting compensation disclosure requirements;
- Consolidates the various provisions relating to underwriting compensation into a single definition and provides for various review periods depending on the type of offering;
- Expands the scope of the existing venture capital exceptions and creates a new exception for co-investments with certain regulated entities;
- Clarifies the treatment of non-convertible or non-exchangeable debt securities and derivatives;
- Provides for exceptions from the lock-up restrictions;
- Clarifies and amends the list of prohibited and unreasonable underwriting terms and arrangements; and
- Consolidates and clarifies the definitions related to the Rule.
The proposed Rule is currently under review by the SEC, and FINRA will announce the implementation date of the proposed rule change in a Regulatory Notice to be filed no later than 90 days following SEC approval. The implementation date will be no later than 180 days following the publication of such Regulatory Notice. To read our Legal Update on the proposed Rule, click here.
Wednesday, November 14, 2018
1:00 PM – 2:00 PM Eastern
During this webinar, we will explore the proposed Regulation Best Interest rule and related developments. Topics include:
- Overview of the proposed regulation;
- Principal areas of comment;
- What we can anticipate in terms of timeline and process and what firms can do now;
- FINRA’s proposed amendments to quantitative suitability; and
- State fiduciary rules.
Wolters Kluwer will provide CLE credit. For more information, or to register for this session, please visit the event website.
Tuesday, November 6, 2018
1:00 p.m. – 2:00 p.m. EDT
Section 3(a)(2) of the Securities Act provides an exemption from registration for securities issued by banks. During this session, Counsel Bradley Berman and Citigroup’s Jack McSpadden will cover the requirements of that exemption, offering structures for non-U.S. banks, the Office of the Comptroller of the Currency’s Securities Offering Regulations, special requirements for branches and agencies of non-U.S. banks regulated by the New York Department of Financial Services, offering documentation and the mechanics of launching a bank note program.
Topics will include:
- What Is a “Bank”?;
- Non-U.S. Banks and Branches;
- The OCC’s Securities Offering Regulations;
- Rule 144A Offering Alternative;
- FINRA Matters;
- Offering Documentation;
- Launching a Bank Note Program; and
West LegalEdcenter will provide CLE credit. For more information, or to register for this session, please visit the event website.
Elder financial exploitation has been recognized by many state and national agencies as a concern as the population ages and elders shoulder more responsibility for managing their retirement assets under defined contribution plans. For investment advisers and broker-dealers, balancing the protection of customer information and reporting financial exploitation is challenging. Fortunately, state and national authorities have taken actions to ease the regulatory tension.
Most states have laws in place to address elder financial exploitation. Under state laws, a financial institution, such as an investment adviser or a broker-dealer, that complies with the rules is immune from civil and administrative liability for reporting suspected elder financial exploitation. State regulatory regimes that apply to financial institutions can be split into two groups: the permissive and the mandatory. Under the mandatory reporting regime, a financial institution has a duty to report suspected elder financial exploitation. In the permissive reporting regime, a financial institution reporting elder financial exploitation is immune from liabilities but has no obligation to report such exploitation. In addition, some state laws permit a financial institution to put a temporary hold on disbursals upon a reasonable suspicion of financial exploitation.
On the national level, three notable efforts were taken to address the elder financial exploitation. Earlier this year, FINRA amended two rules to curb elder financial exploitation. FINRA Rule 2165 allows a broker-dealer to place a temporary hold on disbursements from a client’s account when elder financial exploitation is suspected. If the member firm places a hold on a customer’s account, FINRA Rule 4512 requires the firm to take reasonable efforts to notify the trusted contact of that account to address possible financial exploitation.
More recently, President Trump signed the Senior Safe Act of 2018 (the “Act”) into law. The Act encourages reporting of elder financial exploitation by providing immunity for covered financial institutions that make reporting in good faith and with reasonable care. Covered financial institutions under the Act include credit unions, depository institutions, investment advisers, broker-dealers, insurance companies, insurance agencies, and transfer agents. The Act also encourages training at covered financial institutions by making the immunity from liability contingent on certain training specified in the Act. Under the Act, covered individuals and financial institutions will not be liable for disclosure of information made to certain state and federal regulatory agencies. The Act also has limited preemption provisions. State laws that do not provide immunities for covered financial institutions and individuals for reporting elder financial exploitation will presumably be preempted by the Act.
In addition, a recent bipartisan bill introduced in Congress titled the “National Senior Investor Initiative Act of 2018” proposes to create a task force within the SEC to focus on the challenges senior investors face. The task force would work with national and state authorities and issue biennial reports with recommendations for regulatory or statutory changes benefiting senior investors. Furthermore, the bill would require a study on direct and indirect costs resulting from elder financial exploitation.
While the Senior Safe Act is a positive step towards a uniform regulatory regime on elder financial exploitation, it does not resolve all the issues. Because the Act has only limited preemption of state laws, there are potential inconsistent regulatory requirements across states.
Who are covered financial institutions and individuals?
Under the Act, covered financial institutions include credit unions, depository institutions, investment advisers, broker-dealers, insurance companies, insurance agencies, and transfer agents. The individuals covered under the Act are limited to certain individuals with specified roles. Under some state statutes, covered financial institutions include only depository institutions and credit unions, but all officers and employees of the covered financial institutions are covered.
Who are protected adults?
The Act only protects adults age 65 and older, while FINRA Rule 2165 and some state laws protect both elder adults and adults with a mental or physical impairment.
What is financial exploitation?
The definition of financial exploitation varies from state to state and from agency to agency. For example, under the Act, exploitation is defined to include “fraudulent or otherwise illegal, unauthorized, or improper act or process of an individual… that … results in depriving a senior citizen of rightful access to or use of benefits, resources, belongings, or assets.” This definition does not require wrongful use. Some state statutes, on the other hand, require “wrongful use.” Furthermore, only an individual is capable of committing financial exploitation under the Act and FINRA Rule 2165, while in some states, both an individual and entity are capable of committing financial exploitation.
Finally, even when reporting elder financial exploitation is optional, a financial institution should carefully consider the potential risks of inconsistent practices across different offices and the reputational risks in the event an incident of elder financial exploitation goes unreported. Consequently, a financial institution should balance the risk and benefits when developing or revisiting reporting policies and procedures. To be eligible for the immunity provided by the Act, a financial institution must implement training programs, or update existing programs, to meet the requirements of the Act.
Read our full REVERSEinquiries issue here.