Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval to a Proposed Rule Change, as Modified by Amendment No. 1, To Adopt FINRA Rule 2114 (Recommendations to Customers in OTC Equity Securities) in the Consolidated FINRA Rulebook, 13283-13286 [E9-6659]

Download as PDF Federal Register / Vol. 74, No. 57 / Thursday, March 26, 2009 / Notices Number SR–CBOE–018 on the subject line. SECURITIES AND EXCHANGE COMMISSION Paper Comments [Release No. 34–59605; File No. SR–FINRA– 2008–055] • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Amendment No. 1 and Order Granting Accelerated Approval to a Proposed All submissions should refer to File Rule Change, as Modified by Number SR–CBOE–2009–018. This file Amendment No. 1, To Adopt FINRA number should be included on the Rule 2114 (Recommendations to subject line if e-mail is used. To help the Customers in OTC Equity Securities) in Commission process and review your the Consolidated FINRA Rulebook comments more efficiently, please use only one method. The Commission will March 19, 2009. post all comments on the Commission’s I. Introduction Internet Web site (https://www.sec.gov/ On November 4, 2008, the Financial rules/sro.shtml). Copies of the Industry Regulatory Authority, Inc. submission, all subsequent (‘‘FINRA’’) (f/k/a National Association amendments, all written statements of Securities Dealers, Inc. (‘‘NASD’’)) with respect to the proposed rule filed with the Securities and Exchange change that are filed with the Commission (‘‘SEC’’ or ‘‘Commission’’), Commission, and all written pursuant to Section 19(b)(1) of the communications relating to the Securities Exchange Act of 1934 proposed rule change between the (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 a Commission and any person, other than proposed rule change to adopt FINRA those that may be withheld from the Rule 2114 (Recommendations to Customers in OTC Equity Securities) in public in accordance with the the consolidated FINRA Rulebook. The provisions of 5 U.S.C. 552, will be proposed rule change was published for available for inspection and copying in comment in the Federal Register on the Commission’s Public Reference December 10, 2008.3 The Commission Room, on business days between the received three comments in response to hours of 10 a.m. and 3 p.m., located at the proposed rule change.4 On February 100 F Street, NE., Washington, DC 13, 2009, FINRA filed Amendment No. 20549. Copies of such filing also will be 1 to amend the proposed rule change available for inspection and copying at 5 the principal office of the Exchange. All and respond to the comment letters. This order provides notice of the comments received will be posted proposed rule change, as modified by without change; the Commission does Amendment No. 1, and approves the not edit personal identifying proposed rule change as amended on an information from submissions. You accelerated basis. should submit only information that you wish to make available publicly. All II. Description of the Proposed Rule Change submissions should refer to File Number SR–CBOE–2009–018 and FINRA proposed to adopt NASD Rule should be submitted on or before April 2315 (Recommendations to Customers 16, 2009. in OTC Equity Securities) as FINRA For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.8 Florence E. Harmon, Deputy Secretary. [FR Doc. E9–6703 Filed 3–25–09; 8:45 am] BILLING CODE 8010–01–P 8 17 CFR 200.30–3(a)(12). VerDate Nov<24>2008 20:28 Mar 25, 2009 Jkt 217001 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 See Securities Exchange Act Release No. 59075 (December 10, 2008), 73 FR 76429 (December 16, 2008) (SR–FINRA–2008–055) (‘‘Rulemaking Notice’’). 4 See Ronald C. Long, Director of Regulatory Affairs, Wachovia Securities LLC, dated December 9, 2008 (‘‘Wachovia Letter’’); Dale E. Brown, CAE, President and CEO, Financial Services Institute, dated January 6, 2009 (‘‘FSI Letter’’); and Amal Aly, Esq., Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, dated January 6, 2009 (‘‘SIFMA Letter’’). 5 Amendment No. 1 permits a General Securities Sales Supervisor (i.e., a Series 8 or Series 9/10 qualified supervisor) to perform certain reviews the proposed rule would otherwise have required a Series 24 principal to perform or supervise. 2 17 PO 00000 Frm 00111 Fmt 4703 Sfmt 4703 13283 Rule 2114 in the Consolidated FINRA Rulebook, subject to certain amendments including those contained in Amendment No. 1 discussed further below. 1. The Current Rule NASD Rule 2315 is intended to address potential fraud and abuse in transactions involving securities not listed on an exchange and certain other higher risk securities. The rule mandates that a member conduct a due diligence review of an issuer’s current financial and business information before recommending a covered security. The rule supplements existing FINRA rules and the Federal securities law, including suitability obligations and the requirement that any recommendation to a customer have a reasonable basis. The rule requirements go beyond the basic suitability obligations to ensure that a registered representative has, at a minimum, confirmed the existence of and reviewed essential information that reveals the financial condition and business prospects of these riskier issuers. Specifically, the rule requires a member to review ‘‘current financial statements’’ and ‘‘current material business information’’ before it recommends the purchase or short sale of those securities that are published or quoted in a ‘‘quotation medium’’ and are either (1) not listed on Nasdaq or a national securities exchange or (2) are listed on a regional securities exchange and do not qualify for dissemination of transaction reports via the Consolidated Tape. Such securities may be more susceptible to fraud and abuse because they often are thinly capitalized or lack the profitability, liquidity or available business and financial information that listing standards require. The rule does not apply to recommendations to sell long positions and also exempts certain other transactions, including those with an ‘‘institutional account’’ under NASD Rule 3110(c)(4), a ‘‘qualified institutional buyer’’ under Rule 144A of the Securities Act of 1933 (‘‘Securities Act’’), or a ‘‘qualified purchaser’’ under Section 2(a)(51) of the Investment Company Act of 1940.6 The rule defines ‘‘current financial statements’’ to include balance sheets, statements of profit and loss and 6 Among the other exemptions, the Rule’s requirements also do not apply to transactions that meet the requirements of Rule 504 of Regulation D of the Securities Act; those involving a security of an issuer with at least $50 million in total assets and $10 million in shareholder’s equity; and those involving a security with worldwide average daily trading volume value of at least $100,000 during each of the six months preceding the recommendation. E:\FR\FM\26MRN1.SGM 26MRN1 13284 Federal Register / Vol. 74, No. 57 / Thursday, March 26, 2009 / Notices publicly available financial statements and reports. The definition makes certain distinctions between foreign private issuers and all other issuers. FINRA has interpreted the term ‘‘current material business information’’ to mean information that is available or relates to events that have occurred in the 12 months prior to the recommendation. The proposed definition of ‘‘current material business information,’’ discussed below, would supersede this prior interpretation.7 The required review must be conducted by a Series 24 principal or someone supervised by a Series 24 principal. Members are required to keep a written record of the information reviewed, the date of the review and the name of the person who conducted the review. 2. Proposed Changes to the Current Rule The proposed rule change would expand the scope of the rule to cover a recommendation to buy any ‘‘OTC Equity Security,’’ irrespective of whether the security is published on a quotation medium. The term ‘‘OTC Equity Security’’ would have the same meaning as in NASD Rule 6610 (which has been renumbered as FINRA Rule 6420 in the Consolidated FINRA Rulebook 8) and encompasses any nonexchange-listed security and certain exchange-listed securities that do not otherwise qualify for real-time trade dissemination. FINRA believes that those OTC Equity Securities not published on a quotation medium pose the same, if not greater, risk of fraud and manipulation that the rule seeks to redress. The proposed rule change also would add a definition of ‘‘current material business information’’ to include ‘‘information that is ascertainable through the reasonable exercise of professional diligence and that a reasonable person would take into account in reaching an investment decision.’’ The proposed rule change would eliminate the exemption from the rule for a security with a worldwide average daily trading volume value of at least $100,000 during each of the six calendar months preceding the recommendation, as well as a related exemption for a 7 Telephone conference among Philip Shaikun, Associate Vice President and Associate General Counsel, FINRA, and Haimera Workie, Branch Chief, Securities and Exchange Commission, and Darren Vieira, Attorney Advisor, Commission, on December 3, 2008. 8 See Securities Exchange Act Release No. 58643 (September 25, 2008), 73 FR 57174 (October 1, 2008) (Order Approving SR–FINRA–2008–021; SR– FINRA–2008–022; SR–FINRA–2008–026; SR– FINRA–2008–028 and SR–FINRA–2008–029). VerDate Nov<24>2008 20:28 Mar 25, 2009 Jkt 217001 convertible security where the underlying security satisfies the trading volume exemption requirements. FINRA believes that the advent of the Internet and the increased number of trading venues has rendered that threshold unreliable to screen out less risky securities. Finally, as modified by Amendment No. 1, the proposed rule requires that the due diligence review must be conducted by a person registered as a General Securities Principal (Series 24) or General Securities Sales Supervisor (Series 8 or 9/10), or someone supervised by a General Securities Principal or General Securities Sales Supervisor.9 Members are required to keep a written record of the information reviewed, the date of the review and the name of the person who conducted the review. The proposed rule change would add a requirement that, in the event the person designated to perform the review is not registered as a General Securities Principal or General Securities Sales Supervisor, the member must document the name of the General Securities Principal or General Securities Sales Supervisor who supervised the designated person. FINRA believes this change will help document the person with supervising responsibility in association with review.10 III. Comment Letters The Commission received three comments on the proposal,11 as well as FINRA’s response to comments,12 all of which are discussed below. Two commenters, a full service brokerage firm and a trade association of securities firms, banks and asset managers, offered qualified support for the proposed rule change.13 One commenter, a trade association for the independent broker9 Series references relate to the relevant FINRA qualifying examination series. The Series 8 examination was replaced by the Series 9 and 10 examinations effective August 16, 1999. A list of qualifying series examinations is available at FINRA’s Web site, https://www.finra.org. 10 Telephone conference among Philip Shaikun, Associate Vice President and Associate General Counsel, FINRA, and Haimera Workie, Branch Chief and Darren Vieira, Attorney Advisor, on December 3, 2008. 11 Ronald C. Long, Director of Regulatory Affairs, Wachovia Securities LLC, dated December 9, 2008 (‘‘Wachovia Letter’’); Dale E. Brown, CAE, President and CEO, Financial Services Institute, dated January 6, 2009 (‘‘FSI Letter’’); and Amal Aly, Esq., Managing Director and Associate General Counsel, Securities Industry and Financial Markets Association, dated January 6, 2009 (‘‘SIFMA Letter’’). 12 Letter from Philip Shaikun, Associate Vice President and Associate General Counsel, FINRA, dated February 13, 2009 (‘‘FINRA Letter’’). 13 See SIFMA and Wachovia Letters. PO 00000 Frm 00112 Fmt 4703 Sfmt 4703 dealer community, opposed the proposed rule change.14 1. Review by a Series 24 Principal Proposed Rule 2114 would require a member to conduct a due diligence review of an issuer’s current financial and business information before recommending a covered security. The proposed rule provides that the due diligence review must be performed by a Series 24 registered principal, or by a designee of the Series 24 registered principal, in which case the member must keep a record of the Series 24 principal who supervised the review. Two commenters suggested that a person with a Series 9/10 registration should be permitted to perform the reviews instead of Series 24 principals under the rule.15 One of those commenters also suggested that a person with a Series 8 registration also should be permitted to perform these reviews.16 In response to these comments, FINRA amended the proposed rule to provide that either a General Securities Principal (i.e., a Series 24 principal) or a General Securities Sales Supervisor (i.e., a Series 8 or 9/10 supervisor) may perform the due diligence review.17 2. Expanded Scope of the Rule to Any Non-Exempt OTC Equity Security FINRA’s proposed rule is based on existing NASD Rule 2315. This rule requires a member to review ‘‘current financial statements’’ and ‘‘current material business information’’ before it recommends the purchase or short sale of securities that are published or quoted in a ‘‘quotation medium’’ and are either (1) not listed on Nasdaq or a national securities exchange or (2) are listed on a regional securities exchange and do not qualify for dissemination of transaction reports via the Consolidated Tape.18 The proposed rule change would expand the scope of the rule to cover a recommendation to buy any ‘‘OTC Equity Security,’’ irrespective of whether the security is published on a quotation medium. The proposed rule would also eliminate the exemption in NASD Rule 2315(e)(1)(E) for a security with a worldwide average daily trading volume value of at least $100,000 during each month of the six full calendar months immediately before the date of the recommendation, and a related exemption for a convertible security 14 See FSI Letter. and SIFMA Letters. 16 SIFMA Letter. 17 Amendment No. 1 to SR–FINRA–2008–055. 18 NASD Rule 2315 had not been amended to reflect Nasdaq’s registration as a national securities exchange. 15 Wachovia E:\FR\FM\26MRN1.SGM 26MRN1 Federal Register / Vol. 74, No. 57 / Thursday, March 26, 2009 / Notices where the underlying security meets the requirements of NASD Rule 2315(e)(1)(E). Two commenters opposed eliminating this exemption.19 One commenter indicated that the elimination of the exemption would require a due diligence review to be conducted for large, well-capitalized companies whose securities, in the commenter’s opinion, likely do not pose the type of risk that is intended to be addressed by the proposed rule.20 The commenter also suggested, as an alternative or in addition to the exemption for securities with a worldwide average daily trading volume value of over $100,000, that FINRA adopt an exemption based on the underlying company’s market capitalization.21 FINRA responded that it proposed to eliminate average daily trading volume and convertible security exemptions out of concern that the advent of the Internet and the increased number of trading venues has rendered the trading volume threshold unreliable to screen out less risky securities.22 FINRA noted that bringing certain larger companies within the purview of the rule does not dissipate this investor protection concern, and FINRA additionally noted that certain larger companies may qualify for another exemption to the rule applying to the securities of issuers that have at least $50 million of total assets and $10 million in shareholders’ equity.23 One commenter opposed any expansion of the scope of the proposed rule beyond the scope of the NASD rule.24 In this commenter’s view, the expansion of the scope of the proposed rule would: (1) ‘‘result in reduced investor access to these securities by increasing the barriers to entry in the marketplace’’; (2) delay the processing of purchases of non-exempt OTC Equity Securities; (3) reduce competition as firms leave the market of providing OTC Equity Security execution; (4) subject firms that remain in the market to higher compliance burdens; and (5) cause ‘‘overwhelming’’ recordkeeping and compliance burdens. FINRA disagreed that the proposed amendment would cause such deleterious effects.25 FINRA stated that it believes investors will be better protected by the proposed rule amendment because recommendations of OTC Equity Securities that trade in the unlisted and FSI Letters. 20 SIFMA Letter. 21 Id. 22 FINRA Letter. 23 Id. 24 FSI Letter. 25 FINRA Letter. 20:28 Mar 25, 2009 3. Miscellaneous Comments One commenter suggested that FINRA provide an exemption from the proposed rule for firms that (1) generate less than 5% of their commission revenue from OTC Equity Securities transactions, and (2) do not make a market in such securities.28 The commenter asserted that such an exemption would allow FINRA to meet its investor protection goals without causing ‘‘unintended consequences’’ such as increasing compliance burdens or reducing competition.29 FINRA stated that it believes that such an exemption would undermine the purpose of the rule by allowing a significant volume of OTC Equity Securities to escape the rule’s review requirements.30 IV. Discussion and Commission Findings After careful review of the proposed rule change, the comments, and FINRA’s response to the comments, the Commission finds that the proposed rule change is consistent with the requirements of the Act, and the rules and regulations thereunder that are applicable to a national securities association.31 In particular, the Commission believes the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act,32 which requires, among other things, that FINRA rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. The Commission believes that the proposed rule change 26 Id. 27 Id. 28 FSI 19 SIFMA VerDate Nov<24>2008 market, absent the due diligence required by the rule, pose substantial risk to investors.26 FINRA also noted that the proposal would apply only to recommendations (as does the current rule), and not to unsolicited transactions, and therefore would not deny investors access to the OTC Equity Securities market. FINRA also disagreed that the proposal will result in processing delays for purchases of OTC Equity Securities, noting that the required due diligence should be completed before the recommendation is made.27 Letter. 29 Id. 30 FINRA Letter. approving this proposal, the Commission has considered the proposed rule’s impact on efficiency, competition and capital formation. See 15 U.S.C. 78c(f). 32 15 U.S.C. 78o–3(b)(6). 31 In Jkt 217001 PO 00000 Frm 00113 Fmt 4703 Sfmt 4703 13285 will help protect investors against fraud in the trading of unlisted and certain other securities and will clarify and streamline NASD Rule 2315 for adoption as a FINRA Rule in the new Consolidated FINRA Rulebook. The Commission has found NASD Rule 2315, upon which the proposed rule is based, to be consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities association.33 The Commission also finds good cause for approving Amendment No. 1 to the proposed rule change prior to the thirtieth day after the date of publication of notice in the Federal Register. Amendment No. 1 clarifies the operation of the proposed rule in response to a comment. The changes in Amendment No. 1 do not significantly alter the proposed rule which was subject to a full notice and comment period. The Commission finds that it is in the public interest to approve the proposed rule change, as modified by Amendment No. 1, as soon as possible to expedite its implementation. Accordingly, the Commission finds that there is good cause, consistent with and in furtherance of the objectives of Sections 6(b)(5) 34 and 19(b) 35 of the Act, to approve Amendment No. 1 on an accelerated basis. V. Solicitation of Comments Interested persons are invited to submit written data, views and arguments concerning the foregoing, including whether the proposed rule change, as modified by Amendment No. 1, is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–FINRA–2008–055 on the subject line. Paper Comments • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. 33 See Order Approving Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 2 to the Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Microcap Initiative—Recommendation Rule, Securities Exchange Act Release No. 46376 (August 19, 2002), 67 FR 54832 (August 26, 2002) (SR–NASD–99–04). 34 15 U.S.C. 78f(b)(5). 35 15 U.S.C. 78s(b). E:\FR\FM\26MRN1.SGM 26MRN1 13286 Federal Register / Vol. 74, No. 57 / Thursday, March 26, 2009 / Notices All submissions should refer to File Number SR–FINRA–2008–055. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of such filing also will be available for inspection and copying at the principal office of FINRA. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–FINRA–2008–055 and should be submitted on or before April 16, 2009. VI. Conclusions It is therefore ordered, pursuant to Section 19(b)(2) of the Act,36 that the proposed rule change (SR–FINRA– 2008–055), as modified by Amendment No. 1, be, and hereby is, approved on an accelerated basis. For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.37 Florence E. Harmon, Deputy Secretary. [FR Doc. E9–6659 Filed 3–25–09; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–59600; File No. SR–ISE– 2009–09] Self-Regulatory Organizations; International Securities Exchange, LLC; Notice of Filing and Immediate Effectiveness of a Proposed Rule Change to Amend Rule 623 (Communications to Customers) March 19, 2009. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’),1 and Rule 19b–4 thereunder,2 notice is hereby given that on March 11, 2009, the International Securities Exchange, LLC (the ‘‘Exchange’’ or the ‘‘ISE’’) filed with the Securities and Exchange Commission the proposed rule change, as described in Items I and II below, which items have been prepared by the Exchange. ISE has designated the proposed rule change as constituting a noncontroversial rule change under Rule 19b–4(f)(6) under the Act,3 which renders the proposal effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange proposes to remove or otherwise amend elements of ISE Rule 623 (‘‘Communications to Customers’’) that incorporate provisions of the Securities Act of 1933 (‘‘Securities Act’’) 4 because options traded on the Exchange consist solely of standardized options issued by the Options Clearing Corporation (‘‘OCC’’), a registered clearing agency, that are exempt under Rule 238 of the Securities Act from all provisions of the Securities Act except the antifraud provisions of Section 17. Additionally, the proposed amendments expand the types of communications governed by Rule 623 to include independently prepared reprints and other communications between a member or member organization and a customer. The proposed amendments also exempt certain options communications from the pre-approval requirement by a Registered Options Principal (‘‘ROP’’). The text of the proposed rule change is available at the Exchange, the Commission’s Public 1 15 U.S.C. 78s(b)(1). CFR 240.19b–4. 3 17 CFR 240 19b–4(f)(6). 4 15 U.S.C. 77a et seq. 2 17 36 15 37 17 U.S.C. 78s(b)(2). CFR 200.30–3(a)(12). VerDate Nov<24>2008 20:28 Mar 25, 2009 Jkt 217001 PO 00000 Frm 00114 Fmt 4703 Sfmt 4703 Reference Room, and https:// www.ise.com. II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, the self-regulatory organization 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. The self-regulatory organization has prepared summaries, set forth in sections A, B and C below. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose On December 23, 2002, the Commission published final rules that exempt standardized options, as defined in Rule 9b–1 5 of the Exchange Act, that are issued by a registered clearing agency and traded on a registered national securities exchange or on a registered national securities association, from all provisions of the Securities Act (other than the anti-fraud provisions) and the registration requirements of the Exchange Act.6 Because the Securities Act and the rules thereunder (other than the anti-fraud provisions) are no longer applicable to such standardized options, the Exchange proposes to remove elements of the Securities Act that are embedded in ISE Rule 623. In particular, ISE proposes to remove all references to a ‘‘prospectus’’ from Rule 623. Prospectuses are no longer required for such standardized options, and the OCC has, in fact, ceased publication of a prospectus.7 In addition, the proposed amendments will update and reorganize Rule 623. The proposed amendments are similar to amendments filed with and approved by the Commission by the Financial Industry Regulatory Authority, Inc. and the Chicago Board Options Exchange, and, if adopted, would provide a more uniform 5 17 CFR 240.9b–1. Exemption for Standardized Options From Provisions of the Securities Act of 1933 and From the Registration Requirements of the Securities Exchange Act of 1934; Final Rule, Securities Act Release No. 8171 and Exchange Act Release No. 47082 (December 23, 2002), 68 FR 188 (January 2, 2003). 7 The options disclosure document (‘‘ODD’’) prepared in accordance with Rule 9b–1 under the Exchange Act is not deemed to be a prospectus. 17 CFR 230.135b. See, e.g., Securities Act Release No. 8049 (Dec. 21, 2001), 67 FR 228 (Jan. 2, 2002). 6 See E:\FR\FM\26MRN1.SGM 26MRN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 74, Number 57 (Thursday, March 26, 2009)]
[Notices]
[Pages 13283-13286]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-6659]

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SECURITIES AND EXCHANGE COMMISSION

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

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

March 19, 2009.

I. Introduction

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

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

II. Description of the Proposed Rule Change

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

1. The Current Rule

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

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

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

[[Page 13284]]

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

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

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

2. Proposed Changes to the Current Rule

The proposed rule change would expand the scope of the rule to
cover a recommendation to buy any ``OTC Equity Security,'' irrespective
of whether the security is published on a quotation medium. The term
``OTC Equity Security'' would have the same meaning as in NASD Rule
6610 (which has been renumbered as FINRA Rule 6420 in the Consolidated
FINRA Rulebook \8\) and encompasses any non-exchange-listed security
and certain exchange-listed securities that do not otherwise qualify
for real-time trade dissemination. FINRA believes that those OTC Equity
Securities not published on a quotation medium pose the same, if not
greater, risk of fraud and manipulation that the rule seeks to redress.
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\8\ See Securities Exchange Act Release No. 58643 (September 25,
2008), 73 FR 57174 (October 1, 2008) (Order Approving SR-FINRA-2008-
021; SR-FINRA-2008-022; SR-FINRA-2008-026; SR-FINRA-2008-028 and SR-
FINRA-2008-029).
---------------------------------------------------------------------------

The proposed rule change also would add a definition of ``current
material business information'' to include ``information that is
ascertainable through the reasonable exercise of professional diligence
and that a reasonable person would take into account in reaching an
investment decision.''
The proposed rule change would eliminate the exemption from the
rule for a security with a worldwide average daily trading volume value
of at least $100,000 during each of the six calendar months preceding
the recommendation, as well as a related exemption for a convertible
security where the underlying security satisfies the trading volume
exemption requirements. FINRA believes that the advent of the Internet
and the increased number of trading venues has rendered that threshold
unreliable to screen out less risky securities.
Finally, as modified by Amendment No. 1, the proposed rule requires
that the due diligence review must be conducted by a person registered
as a General Securities Principal (Series 24) or General Securities
Sales Supervisor (Series 8 or 9/10), or someone supervised by a General
Securities Principal or General Securities Sales Supervisor.\9\ Members
are required to keep a written record of the information reviewed, the
date of the review and the name of the person who conducted the review.
The proposed rule change would add a requirement that, in the event the
person designated to perform the review is not registered as a General
Securities Principal or General Securities Sales Supervisor, the member
must document the name of the General Securities Principal or General
Securities Sales Supervisor who supervised the designated person. FINRA
believes this change will help document the person with supervising
responsibility in association with review.\10\
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\9\ Series references relate to the relevant FINRA qualifying
examination series. The Series 8 examination was replaced by the
Series 9 and 10 examinations effective August 16, 1999. A list of
qualifying series examinations is available at FINRA's Web site,
https://www.finra.org.
\10\ Telephone conference among Philip Shaikun, Associate Vice
President and Associate General Counsel, FINRA, and Haimera Workie,
Branch Chief and Darren Vieira, Attorney Advisor, on December 3,
2008.
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III. Comment Letters

The Commission received three comments on the proposal,\11\ as well
as FINRA's response to comments,\12\ all of which are discussed below.
Two commenters, a full service brokerage firm and a trade association
of securities firms, banks and asset managers, offered qualified
support for the proposed rule change.\13\ One commenter, a trade
association for the independent broker-dealer community, opposed the
proposed rule change.\14\
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\11\ Ronald C. Long, Director of Regulatory Affairs, Wachovia
Securities LLC, dated December 9, 2008 (``Wachovia Letter''); Dale
E. Brown, CAE, President and CEO, Financial Services Institute,
dated January 6, 2009 (``FSI Letter''); and Amal Aly, Esq., Managing
Director and Associate General Counsel, Securities Industry and
Financial Markets Association, dated January 6, 2009 (``SIFMA
Letter'').
\12\ Letter from Philip Shaikun, Associate Vice President and
Associate General Counsel, FINRA, dated February 13, 2009 (``FINRA
Letter'').
\13\ See SIFMA and Wachovia Letters.
\14\ See FSI Letter.
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1. Review by a Series 24 Principal

Proposed Rule 2114 would require a member to conduct a due
diligence review of an issuer's current financial and business
information before recommending a covered security. The proposed rule
provides that the due diligence review must be performed by a Series 24
registered principal, or by a designee of the Series 24 registered
principal, in which case the member must keep a record of the Series 24
principal who supervised the review. Two commenters suggested that a
person with a Series 9/10 registration should be permitted to perform
the reviews instead of Series 24 principals under the rule.\15\ One of
those commenters also suggested that a person with a Series 8
registration also should be permitted to perform these reviews.\16\ In
response to these comments, FINRA amended the proposed rule to provide
that either a General Securities Principal (i.e., a Series 24
principal) or a General Securities Sales Supervisor (i.e., a Series 8
or 9/10 supervisor) may perform the due diligence review.\17\
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\15\ Wachovia and SIFMA Letters.
\16\ SIFMA Letter.
\17\ Amendment No. 1 to SR-FINRA-2008-055.
---------------------------------------------------------------------------

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

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

\18\ NASD Rule 2315 had not been amended to reflect Nasdaq's
registration as a national securities exchange.
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The proposed rule would also eliminate the exemption in NASD Rule
2315(e)(1)(E) for a security with a worldwide average daily trading
volume value of at least $100,000 during each month of the six full
calendar months immediately before the date of the recommendation, and
a related exemption for a convertible security

[[Page 13285]]

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

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

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

3. Miscellaneous Comments

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

\28\ FSI Letter.
\29\ Id.
\30\ FINRA Letter.
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IV. Discussion and Commission Findings

After careful review of the proposed rule change, the comments, and
FINRA's response to the comments, the Commission finds that the
proposed rule change is consistent with the requirements of the Act,
and the rules and regulations thereunder that are applicable to a
national securities association.\31\ In particular, the Commission
believes the proposed rule change is consistent with the provisions of
Section 15A(b)(6) of the Act,\32\ which requires, among other things,
that FINRA rules must be designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. The Commission believes that the proposed rule change
will help protect investors against fraud in the trading of unlisted
and certain other securities and will clarify and streamline NASD Rule
2315 for adoption as a FINRA Rule in the new Consolidated FINRA
Rulebook. The Commission has found NASD Rule 2315, upon which the
proposed rule is based, to be consistent with the requirements of the
Act and the rules and regulations thereunder applicable to a national
securities association.\33\
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\31\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition and capital
formation. See 15 U.S.C. 78c(f).
\32\ 15 U.S.C. 78o-3(b)(6).
\33\ See Order Approving Proposed Rule Change and Notice of
Filing and Order Granting Accelerated Approval to Amendment No. 2 to
the Proposed Rule Change by the National Association of Securities
Dealers, Inc. Relating to Microcap Initiative--Recommendation Rule,
Securities Exchange Act Release No. 46376 (August 19, 2002), 67 FR
54832 (August 26, 2002) (SR-NASD-99-04).
---------------------------------------------------------------------------

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

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

V. Solicitation of Comments

Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change, as modified by Amendment No. 1, is consistent with the Act.
Comments may be submitted by any of the following methods:

Electronic Comments

Use the Commission's Internet comment form (https://www.sec.gov/rules/sro.shtml); or
Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-FINRA-2008-055 on the subject line.

Paper Comments

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

[[Page 13286]]

All submissions should refer to File Number SR-FINRA-2008-055. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (https://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments,
all written statements with respect to the proposed rule change that
are filed with the Commission, and all written communications relating
to the proposed rule change between the Commission and any person,
other than those that may be withheld from the public in accordance
with the provisions of 5 U.S.C. 552, will be available for inspection
and copying in the Commission's Public Reference Room, 100 F Street,
NE., Washington, DC 20549, on official business days between the hours
of 10 a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of FINRA. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly. All
submissions should refer to File Number SR-FINRA-2008-055 and should be
submitted on or before April 16, 2009.

VI. Conclusions

It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\36\ that the proposed rule change (SR-FINRA-2008-055), as modified
by Amendment No. 1, be, and hereby is, approved on an accelerated
basis.
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\36\ 15 U.S.C. 78s(b)(2).

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

\37\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-6659 Filed 3-25-09; 8:45 am]
BILLING CODE 8010-01-P

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