Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Proposed Rule Change To Adopt FINRA Rule 4360 (Fidelity Bonds) in the Consolidated FINRA Rulebook, 72850-72855 [2010-29727]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 75, Number 227 (Friday, November 26, 2010)]
[Notices]
[Pages 72850-72855]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-29727]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-63331; File No. SR-FINRA-2010-059]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change To Adopt 
FINRA Rule 4360 (Fidelity Bonds) in the Consolidated FINRA Rulebook

November 17, 2010.
    Pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of 
1934 (``Act'' or ``Exchange Act'') \2\ and Rule 19b-4 thereunder,\3\ 
notice is hereby given that on November 10, 2010, 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'') the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by FINRA. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 15 U.S.C. 78a.
    \3\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to adopt NASD Rule 3020 (Fidelity Bonds) with 
certain changes into the consolidated FINRA rulebook as FINRA Rule 4360 
(Fidelity Bonds), taking into account Incorporated NYSE Rule 319 
(Fidelity Bonds) and its Interpretation.
    The text of the proposed rule change is available on FINRA's Web 
site at https://www.finra.org, at the principal

[[Page 72851]]

office of FINRA and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    As part of the process of developing a new consolidated rulebook 
(``Consolidated FINRA Rulebook''),\4\ FINRA is proposing to adopt NASD 
Rule 3020 as FINRA Rule 4360 (Fidelity Bonds), taking into account NYSE 
Rule 319 (and its Interpretation).\5\ Proposed FINRA Rule 4360 would 
update and clarify the fidelity bond requirements and better reflect 
current industry practices. Unless otherwise noted below, the 
provisions in NASD Rule 3020 would transfer, subject only to non-
substantive changes, as part of proposed FINRA Rule 4360.
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    \4\ The current FINRA rulebook consists of: (1) FINRA Rules; (2) 
NASD Rules; and (3) rules incorporated from NYSE (``Incorporated 
NYSE Rules'') (together, the NASD Rules and Incorporated NYSE Rules 
are referred to as the ``Transitional Rulebook''). While the NASD 
Rules generally apply to all FINRA members, the Incorporated NYSE 
Rules apply only to those members of FINRA that are also members of 
the NYSE (``Dual Members''). The FINRA Rules apply to all FINRA 
members, unless such rules have a more limited application by their 
terms. For more information about the rulebook consolidation 
process, see Information Notice, March 12, 2008 (Rulebook 
Consolidation Process).
    \5\ For convenience, the Incorporated NYSE Rules are referred to 
as the NYSE Rules.
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    NASD Rule 3020 and NYSE Rule 319 (and its Interpretation) generally 
require members to maintain minimum amounts of fidelity bond coverage 
for officers and employees, and that such coverage address losses 
incurred due to certain specified events. The purpose of a fidelity 
bond is to protect a member against certain types of losses, including, 
but not limited to, those caused by the malfeasance of its officers and 
employees, and the effect of such losses on the member's capital.
General Provision
    NASD Rule 3020(a) generally provides that each member required to 
join the Securities Investor Protection Corporation (``SIPC'') that has 
employees and that is not a member in good standing of one of the 
enumerated national securities exchanges must maintain fidelity bond 
coverage; NYSE Rule 319(a) generally requires member organizations 
doing business with the public to carry fidelity bonds. Like NASD Rule 
3020, proposed FINRA Rule 4360 would require each member that is 
required to join SIPC to maintain blanket fidelity bond coverage with 
specified amounts of coverage based on the member's net capital 
requirement, with certain exceptions.
    NASD Rule 3020(a)(1) requires members to maintain a blanket 
fidelity bond in a form substantially similar to the standard form of 
Brokers Blanket Bond promulgated by the Surety Association of America. 
Under NYSE Rule 319(a), the Stockbrokers Partnership Bond and the 
Brokers Blanket Bond approved by the NYSE are the only bond forms that 
may be used by a member organization; NYSE approval is required for any 
variation from such forms. Proposed FINRA Rule 4360 would require 
members to maintain fidelity bond coverage that provides for per loss 
coverage without an aggregate limit of liability. Members may apply for 
this level of coverage with any product that meets these requirements, 
including the Securities Dealer Blanket Bond (``SDBB'') or a properly 
endorsed Financial Institution Form 14 Bond (``Form 14'').\6\
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    \6\ Since 1982, firms electing to acquire coverage through the 
FINRA-sponsored Insurance Program (``Sponsored Program'') have been 
provided with the SDBB. It is the ``default'' insurance for FINRA 
members in that when a firm completes the application for the 
Sponsored Program, they are applying for the SDBB.
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    Most fidelity bonds contain a definition of the term ``loss'' (or 
``single loss''), for purposes of the bond, which generally includes 
all covered losses resulting from any one act or a series of related 
acts. A payment by an insurer for covered losses attributed to a 
``single loss'' does not reduce a member's coverage amount for losses 
attributed to other, separate acts. A fidelity bond with an aggregate 
limit of liability caps a member's coverage during the bond period at a 
certain amount if a loss (or losses) meets this aggregate threshold. 
FINRA believes that per loss coverage without an aggregate limit of 
liability provides firms with the most beneficial coverage since the 
bond amount cannot be exhausted by one or more covered losses, so it 
will be available for future losses during the bond period.
    Under proposed FINRA Rule 4360, a member's fidelity bond must 
provide against loss and have Insuring Agreements covering at least the 
following: fidelity, on premises, in transit, forgery and alteration, 
securities and counterfeit currency. The proposed rule change modifies 
the descriptive headings for these Insuring Agreements, in part, from 
NASD Rule 3020(a)(1) and NYSE Rule 319(d) to align them with the 
headings in the current bond forms available to broker-dealers. FINRA 
has been advised by insurance industry representatives that the 
proposed rule change does not substantively change what is required to 
be covered by the bond.\7\
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    \7\ For example, previous versions of the SDBB and Form 14 
included a separate Insuring Agreement for misplacement; however, in 
the current versions of the bonds, this coverage is included in both 
``on premises'' and ``in transit'' coverage.
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    In addition, proposed FINRA Rule 4360 would eliminate the specific 
coverage provisions in NASD Rule 3020(a)(4) and (a)(5), and NYSE Rule 
319(d)(ii)(B) and (C), and (e)(ii)(B) and (C), that permit less than 
100 percent of coverage for certain Insuring Agreements (i.e., 
fraudulent trading and securities forgery) to require that coverage for 
all Insuring Agreements be equal to 100 percent of the firm's minimum 
required bond coverage. Members may elect to carry additional, optional 
Insuring Agreements not required by proposed FINRA Rule 4360 for an 
amount less than 100 percent of the minimum required bond coverage.
    Like NASD Rule 3020(a)(1)(H) and NYSE Rule 319.12, proposed FINRA 
Rule 4360 would require that a member's fidelity bond include a 
cancellation rider providing that the insurer will use its best efforts 
to promptly notify FINRA in the event the bond is cancelled, terminated 
or ``substantially modified.'' Also, the proposed rule change would 
adopt the definition of ``substantially modified'' in NYSE Rule 319 and 
would incorporate NYSE Rule 319.12's standard that a firm must 
immediately advise FINRA in writing if its fidelity bond is cancelled, 
terminated or substantially modified.\8\
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    \8\ NYSE Rule 319 defines the term ``substantially modified'' as 
any change in the type or amount of fidelity bonding coverage, or in 
the exclusions to which the bond is subject, or any other change in 
the bond such that it no longer complies with the requirements of 
the rule.
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    FINRA is proposing to add supplementary material to proposed FINRA 
Rule 4360 that would require members that do not qualify for a bond 
with per loss coverage without an aggregate limit of liability to 
secure

[[Page 72852]]

alternative coverage. Specifically, a member that does not qualify for 
blanket fidelity bond coverage as required by proposed FINRA Rule 
4360(a)(3) would be required to maintain substantially similar fidelity 
bond coverage in compliance with all other provisions of the proposed 
rule, provided that the member maintains written correspondence from 
two insurance providers stating that the member does not qualify for 
the coverage required by proposed FINRA Rule 4360(a)(3). The member 
would be required to retain such correspondence for the period 
specified by Exchange Act Rule 17a-4(b)(4). FINRA has been advised by 
insurance industry representatives that the proposed alternative 
coverage requirement is necessary for firms that, for example, have had 
a covered loss paid by an insurer within the past five years or firms 
that may present certain risk factors that would prevent an insurer 
from offering per loss coverage without an aggregate limit of 
liability.
Minimum Required Coverage
    NASD Rule 3020 requires fidelity bond coverage for officers and 
employees of a member. Under NASD Rule 3020(e), the term ``employee'' 
or ``employees'' means any person or persons associated with a member 
firm (as defined in Article I, paragraph (rr) of the FINRA By-Laws) 
except: (1) Sole proprietors, (2) sole stockholders and (3) directors 
or trustees of a member who are not performing acts coming within the 
scope of the usual duties of an officer or employee. Under NYSE Rule 
319(a), any member organization doing business with the public must 
maintain fidelity bond coverage for general partners or officers and 
its employees.\9\
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    \9\ Under NYSE Rule Interpretation 319/02 (Additional 
Coverages), the required coverage of the Brokers Blanket Bond must 
apply, through rider or otherwise, as applicable to: all domestic 
and foreign guaranteed and non-guaranteed affiliates, subsidiaries 
and branches; bearer instruments if the member organization handles 
such securities; limited partners of a member firm if they are also 
employees; and the partners, officers and employees or person acting 
in a similar capacity of electronic data processing agencies in 
their activities on behalf of the member organizations.
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    Proposed FINRA Rule 4360, similar to NASD Rule 3020 and NYSE Rule 
319, would require each member to maintain, at a minimum, fidelity bond 
coverage for any person associated with the member, except directors or 
trustees of a member who are not performing acts within the scope of 
the usual duties of an officer or employee. As further detailed below, 
the proposed rule change would eliminate the exemption in NASD Rule 
3020 for sole stockholders and sole proprietors.
    The proposed rule change would increase the minimum required 
fidelity bond coverage for members, while continuing to base the 
coverage on a member's net capital requirement. To that end, proposed 
FINRA Rule 4360 would require a member with a net capital requirement 
that is less than $250,000 to maintain minimum coverage of the greater 
of 120 percent of the firm's required net capital under Exchange Act 
Rule 15c3-1 or $100,000. The increase to $100,000 would modify the 
present minimum requirement of $25,000. FINRA believes this increase is 
warranted since the NASD and NYSE fidelity bond rules have not been 
materially modified since their adoption--over 30 years ago--and 
$25,000 in 1974 (the year the NASD rule was adopted) is equal to 
approximately $110,000 today (adjusted for inflation). Although members 
may experience a slight increase in costs for their premiums under the 
proposed rule change, FINRA believes that the proposed amendments to 
the fidelity bond minimum requirements are necessary to provide 
meaningful and practical coverage for losses covered by the bond.
    Under proposed FINRA Rule 4360, members with a net capital 
requirement of at least $250,000 would use a table in the rule to 
determine their minimum fidelity bond coverage requirement. The table 
is a modified version of the tables in NASD Rule 3020(a)(3) and NYSE 
Rule 319(e)(i). The identical NASD and NYSE requirements for members 
that have a minimum net capital requirement that exceeds $1 million 
would be retained in proposed FINRA Rule 4360; however, the proposed 
rule would adopt the higher requirements in NYSE Rule 319(e)(i) for a 
member with a net capital requirement of at least $250,000, but less 
than $1 million.\10\
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    \10\ For example, NASD Rule 3020 requires a small clearing and 
carrying firm (i.e., one subject to a $250,000 net capital 
requirement) to obtain $300,000 in coverage. The same firm, had it 
been designated to NYSE, would have needed $600,000 in coverage. 
FINRA believes the increased coverage requirements are appropriate 
given the larger number/amount of claims that can be satisfied at 
these levels.
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    Under the proposed rule, the entire amount of a member's minimum 
required coverage must be available for covered losses and may not be 
eroded by the costs an insurer may incur if it chooses to defend a 
claim. Specifically, any defense costs for covered losses must be in 
addition to a member's minimum coverage requirements. A member may 
include defense costs as part of its fidelity bond coverage, but only 
to the extent that it does not reduce a member's minimum required 
coverage under the proposed rule.
Deductible Provision
    Under NASD Rule 3020(b), a deductible provision may be included in 
a member's bond of up to $5,000 or 10 percent of the member's minimum 
insurance requirement, whichever is greater. If a member desires to 
maintain coverage in excess of the minimum insurance requirement, then 
a deductible provision may be included in the bond of up to $5,000 or 
10 percent of the amount of blanket coverage provided in the bond 
purchased, whichever is greater. The excess of any such deductible 
amount over the maximum permissible deductible amount based on the 
member's minimum required coverage must be deducted from the member's 
net worth in the calculation of the member's net capital for purposes 
of Exchange Act Rule 15c3-1. Where the member is a subsidiary of 
another member, the excess may be deducted from the parent's rather 
than the subsidiary's net worth, but only if the parent guarantees the 
subsidiary's net capital in writing.
    Under NYSE Rule 319(b), each member organization may self-insure to 
the extent of $10,000 or 10 percent of its minimum insurance 
requirement as fixed by the NYSE, whichever is greater, for each type 
of coverage required by the rule. Self-insurance in amounts exceeding 
the above maximum may be permitted by the NYSE provided the member or 
member organization certifies to the satisfaction of the NYSE that it 
is unable to obtain greater bonding coverage, and agrees to reduce its 
self-insurance so as to comply with the above stated limits as soon as 
possible, and appropriate charges to capital are made pursuant to 
Exchange Act Rule 15c3-1. This provision also contains identical 
language to the NASD rule regarding net worth deductions for 
subsidiaries.
    Proposed FINRA Rule 4360 would provide for an allowable deductible 
amount of up to 25 percent of the fidelity bond coverage purchased by a 
member. Any deductible amount elected by the firm that is greater than 
10 percent of the coverage purchased by the member \11\ would be 
deducted from the member's net worth in the calculation of its net 
capital for purposes of Exchange Act Rule 15c3-1.\12\ Like the NASD and 
NYSE rules, if

[[Page 72853]]

the member is a subsidiary of another FINRA member, this amount may be 
deducted from the parent's rather than the subsidiary's net worth, but 
only if the parent guarantees the subsidiary's net capital in writing.
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    \11\ FINRA notes that a member may elect, subject to 
availability, a deductible of less than 10 percent of the coverage 
purchased.
    \12\ NASD Rule 3020 bases the deduction from net worth for an 
excess deductible on a firm's minimum required coverage, while 
proposed FINRA Rule 4360 would base such deduction from net worth on 
coverage purchased by the member.
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Annual Review of Coverage
    Consistent with NASD Rule 3020(c) and NYSE Rule 319.10, proposed 
FINRA Rule 4360 would require a member (including a firm that signs a 
multi-year insurance policy), annually as of the yearly anniversary 
date of the issuance of the fidelity bond, to review the adequacy of 
its fidelity bond coverage and make any required adjustments to its 
coverage, as set forth in the proposed rule. Under proposed FINRA Rule 
4360(d), a member's highest net capital requirement during the 
preceding 12-month period, based on the applicable method of computing 
net capital (dollar minimum, aggregate indebtedness or alternative 
standard), would be used as the basis for determining the member's 
minimum required fidelity bond coverage for the succeeding 12-month 
period. The ``preceding 12-month period'' includes the 12-month period 
that ends 60 days before the yearly anniversary date of a member's 
fidelity bond. This would give a firm time to determine its required 
fidelity bond coverage by the anniversary date of the bond.
    Similar to NASD Rule 3020(c)(2), proposed FINRA Rule 4360 would 
allow a member that has only been in business for one year and elected 
the aggregate indebtedness ratio for calculating its net capital 
requirement to use, solely for the purpose of determining the adequacy 
of its fidelity bond coverage for its second year, the 15 to 1 ratio of 
aggregate indebtedness to net capital in lieu of the 8 to 1 ratio 
(required for broker-dealers in their first year of business) to 
calculate its net capital requirement. Notwithstanding the above, such 
member would not be permitted to carry less minimum fidelity bond 
coverage in its second year than it carried in its first year.
Exemptions
    Based in part on NASD Rule 3020(a), proposed FINRA Rule 4360 would 
exempt from the fidelity bond requirements members in good standing 
with a national securities exchange that maintain a fidelity bond 
subject to the requirements of such exchange that are equal to or 
greater than the requirements set forth in the proposed rule.\13\ 
Additionally, consistent with NYSE Rule Interpretation 319/01, proposed 
FINRA Rule 4360 would continue to exempt from the fidelity bond 
requirements any firm that acts solely as a Designated Market Maker 
(``DMM''),\14\ floor broker or registered floor trader and does not 
conduct business with the public.
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    \13\ In general, the notification provisions of the 
corresponding exchange rules (i.e., cancellation rider and 
notification upon cancellation, termination or substantial 
modification of the bond) require notification to the respective 
exchange rather than to FINRA. Accordingly, the practical effect for 
a firm that avails itself of the proposed exemption is that such 
firm must maintain a fidelity bond subject to the same or greater 
requirements as in proposed FINRA Rule 4360; however, such firm 
would be exempt from the requirement that FINRA be notified of 
changes to the bond and would alternatively comply with the 
notification provisions of the respective exchange.
    \14\ See Securities Exchange Act Release No. 58845 (October 24, 
2008), 73 FR 64379 (October 29, 2008) (Order Approving File No. SR-
NYSE-2008-46). In this rule filing, the role of the specialist was 
altered in certain respects and the term ``specialist'' was replaced 
with the term ``Designated Market Maker.''
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    Proposed FINRA Rule 4360 would not maintain the exemption in NASD 
Rule 3020(e) for a one-person firm.\15\ Historically, a sole proprietor 
or sole stockholder member was excluded from the fidelity bond 
requirements based upon the assumption that such firms were one-person 
shops and, therefore, could not obtain coverage for their own acts. 
FINRA has determined that sole proprietors and sole stockholder firms 
can and often do acquire fidelity bond coverage, even though it is 
currently not required, since all claims (irrespective of firm size) 
are likely to be paid or denied on a facts-and-circumstances basis. 
Also, certain coverage areas of the fidelity bond benefit a one-person 
shop (e.g., those covering customer property lost in transit).
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    \15\ A one-person member (that is, a firm owned by a sole 
proprietor or stockholder that has no other associated persons, 
registered or unregistered) has no ``employees'' for purposes of 
NASD Rule 3020, and therefore such a firm currently is not subject 
to the fidelity bonding requirements. Conversely, a firm owned by a 
sole proprietor or stockholder that has other associated persons has 
``employees'' for purposes of NASD Rule 3020, and currently is, and 
will continue to be, subject to the fidelity bonding requirements.
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    FINRA understands that changes to a firm's fidelity bond policy, in 
coordination with insurance providers, may be impacted by bond renewal 
cycles and changes required by the insurance industry. FINRA will 
consider such factors in establishing an implementation date for the 
proposed rule change upon approval by the SEC.
    FINRA will announce the implementation date of the proposed rule 
change in a Regulatory Notice to be published no later than 90 days 
following Commission approval. The implementation date will be no later 
than 365 days following Commission approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\16\ which requires, among 
other things, that FINRA rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. FINRA believes that the proposed rule change will 
update and clarify the requirements governing fidelity bonds for 
adoption as FINRA Rule 4360 in the Consolidated FINRA Rulebook.
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    \16\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

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

    In July 2009, FINRA published Regulatory Notice 09-44 (FINRA 
Requests Comment on Proposed Consolidated FINRA Rule Governing Fidelity 
Bonds) requesting comment on the proposed rule change. The comment 
period expired on September 14, 2009. Thirteen comment letters were 
received in response to the Regulatory Notice. A copy of the Regulatory 
Notice is attached as Exhibit 2a to this rule filing. A list of the 
commenters, and copies of the comment letters, are attached as Exhibit 
2b to this rule filing.\17\
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    \17\ All references to commenters under this Item are to the 
commenters as listed and defined in Exhibit 2b.
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    As originally proposed in Regulatory Notice 09-44, FINRA Rule 4360 
provided that any member that is required to be a member of SIPC must 
maintain fidelity bond coverage with the SDBB, unless they are unable 
to obtain this coverage, in which case they may use the Form 14. 
Several commenters noted that only a limited number of insurance 
carriers offer the SDBB, the standard form of which provides per loss 
(i.e., per event) coverage without an aggregate limit of liability, and 
requested that FINRA provide flexibility with respect to bond

[[Page 72854]]

forms under the proposed rule.\18\ These commenters suggested that 
limiting the bond form requirement to the SDBB restricts competition 
among insurance carriers, limits the potential of broker-dealers to 
secure superior coverage at more favorable terms and is likely to 
result in unfair pricing of such policies, raising costs for firms. The 
commenters further noted that the proposal creates an uneven playing 
field in that it promotes certain underwriters and products to the 
disadvantage of others that offer commensurate coverage, such as a 
properly endorsed Form 14. One commenter suggested that FINRA amend the 
proposed rule to set forth the parameters of the preferred bond form 
instead of prescribing a particular product.\19\
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    \18\ FFS, Gallagher, HBHA, ISO, Kwiecinski, SFAA and Travelers.
    \19\ SFAA.
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    Many commenters noted that an aggregate limit of liability is 
standard in the industry and important to most underwriters because it 
quantifies and controls the underwriter's maximum exposure to loss 
during the bond period.\20\ Further, the commenters noted that without 
an aggregate limit of liability, members' premium costs are likely to 
increase. Certain commenters believe that a bond with a ``restoration 
of the aggregate'' option is the equivalent of ``per event'' 
coverage.\21\
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    \20\ FFS, Kwiecinski, SFAA and Travelers.
    \21\ Kwiecinski and SFAA.
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    In response to the comments, FINRA made certain changes to the 
original proposal. Specifically, FINRA has amended the proposed rule to 
remove the requirement that a member maintain fidelity bond coverage 
with the SDBB, and alternatively with the Form 14. As detailed in the 
Purpose section of this rule filing, the proposed rule would require a 
member to maintain blanket fidelity bond coverage with a bond that 
would provide for per loss coverage without an aggregate limit of 
liability (e.g., the SDBB or a properly endorsed Form 14). FINRA 
believes the amendments to the proposal address the issues noted by the 
commenters while maintaining the aims of the proposed rule to provide 
blanket per loss fidelity bond coverage unrestricted by an aggregate 
limit of liability. As noted in detail in the Purpose section of this 
rule filing, FINRA believes that a member's fidelity bond coverage 
should not include an aggregate limit of liability because it is 
important that a member's coverage not be eroded by covered losses 
within the bond period, thus exposing a member to future losses with a 
reduced bond limit.
    Additionally, FINRA has amended its original proposal for 
alternative coverage in the supplementary material to the proposed rule 
to provide that a member that does not qualify for blanket fidelity 
bond coverage as required by proposed FINRA Rule 4360(a)(3) must 
maintain substantially similar fidelity bond coverage in compliance 
with all other provisions of the proposed rule, provided that the 
member maintains written correspondence from two insurance providers 
stating that the member does not qualify for the coverage required by 
proposed FINRA Rule 4360(a)(3). The member would be required to retain 
such correspondence for the period specified by Exchange Act Rule 17a-
4(b)(4).
    One commenter agreed with FINRA's proposal to increase the minimum 
bond limit requirement because losses often exceed the current minimum 
bond requirements, which exposes firms' net capital and, in some cases, 
results in a SIPC liquidation proceeding.\22\ Other commenters noted 
that the proposed increased minimum requirements remain inadequate.\23\ 
According to one commenter, the proposed minimum fidelity bond 
requirements do not meet comparable limits of liability set for any 
other insurable exposure in the commercial marketplace and, when 
registered representatives steal from clients, the losses frequently 
range from $250,000 to $5 million or more.\24\
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    \22\ Travelers.
    \23\ First Asset and Gallagher.
    \24\ Gallagher.
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    Certain other commenters opposed the increase in the minimum bond 
requirement arguing that it will have a disproportionately negative 
effect on small firms, including small firms that engage in certain 
business areas that require a higher net capital amount.\25\ Two 
commenters requested that FINRA provide specific data to justify why 
the increased minimum fidelity bond requirements are necessary.\26\ One 
commenter suggested that the expansion of the definition of ``branch 
office'' will increase fees for securing fidelity bond coverage.\27\
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    \25\ FGS, First Asset, HBHA and PCI.
    \26\ First Asset and Schriner.
    \27\ First Asset.
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    FINRA does not propose to make any changes to the proposed minimum 
requirements set forth in Regulatory Notice 09-44. As stated above in 
the Purpose section of this rule filing, FINRA believes the increase in 
the minimum fidelity bond requirements is warranted since the NASD and 
NYSE fidelity bond rules have not been materially modified since their 
adoption over 30 years ago; members that have maintained minimum 
coverage of $25,000 have had claims that exceed this amount; and 
notwithstanding a slight increase in premium costs for certain members 
under the proposed rule change, the proposed amendments are necessary 
to provide meaningful and practical coverage for losses covered by the 
bond. With respect to the comment regarding the ``branch office'' 
definition, FINRA notes that the proposed fidelity bond rule does not 
implicate the definition of ``branch office.'' Irrespective of FINRA's 
definition of ``branch office,'' the insurance provider makes the 
determination as to whether the number of branch offices associated 
with a member is a relevant criterion in assessing a member's fidelity 
bond coverage and premiums. FINRA neither imposes a requirement that 
insurance providers use branch offices as a factor in evaluating a 
member's qualifications to obtain fidelity bond coverage nor does it 
require them to use its current definition of branch office to make 
this determination.
    One commenter suggested that the proposed rule require notification 
to FINRA in the event that the member has experienced a loss or losses 
that have exhausted its fidelity bond coverage.\28\ FINRA did not make 
any changes to the proposal in this respect because a bond without an 
aggregate limit of liability by its terms cannot be exhausted.
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    \28\ Kwiecinski.
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    Two commenters suggested that FINRA incorporate an exemption into 
the proposed rule for firms that are a subsidiary of a larger parent 
organization.\29\ According to the commenters, parent organizations of 
members typically purchase their own fidelity bonds, include the member 
subsidiary as an insured under that program, and provide substantially 
greater coverage than the minimum requirements under the proposed rule. 
Moreover, the commenters believe that the premiums paid for the FINRA 
bond are an unnecessary expense since the coverage already exists. The 
commenters also noted that, in many cases, a duplication of coverage 
complicates loss settlements where the bonds of both the member firm 
and its parent organization are affected by a single loss.
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    \29\ Kwiecinski and Travelers.
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    FINRA notes that neither the current fidelity bond rule nor the 
proposed fidelity bond rule precludes a member from being part of its 
parent organization's fidelity bond coverage as long as the coverage 
under the parent's bond provides equal to or greater

[[Page 72855]]

coverage than the member's minimum required coverage under the rule. 
The parent organization's bond must contain a rider that provides for 
the subsidiary broker-dealer's coverage by enumerating the requirements 
of the FINRA rule and providing for, at a minimum, the subsidiary's 
minimum required coverage. Accordingly, FINRA does not propose to amend 
the proposed rule in this respect as it is unnecessary.
    Two commenters urged FINRA to maintain an exemption from the 
fidelity bond requirements for one-person firms.\30\ The commenters 
noted that FINRA could be requiring coverage that is not available in 
the marketplace, since the alter ego concept applies to fidelity bond 
claims for these entities.
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    \30\ SFAA and Travelers.
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    As noted above in the Purpose section of this rule filing, many 
one-person firms currently maintain fidelity bond coverage 
notwithstanding the exemption in NASD Rule 3020, and claims are likely 
to be paid based on a facts-and-circumstances analysis, not on a firm's 
size or structure. As such, FINRA is not proposing any changes to the 
original proposal in this respect.
    One commenter noted that the proposed rule serves no purpose to 
investors of the financial markets in its application to small firms 
that do not hold customer funds, execute transactions in securities on 
public markets, or engage in trading or underwriting (e.g., a firm that 
solely provides corporate financial advisory services for fee 
income).\31\
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    \31\ Akin Bay.
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    FINRA believes that all members of SIPC should maintain fidelity 
bond coverage. FINRA does not agree with the commenter's assessment, 
since any firm could be the target of malfeasance of one of its 
employees. Thus, FINRA is not proposing to incorporate an exemption for 
these small firms.
    One commenter encouraged FINRA to incorporate a requirement for an 
insuring agreement for Computer Theft.\32\ FINRA did not amend the 
proposal to add this insuring agreement at this time; however, FINRA 
understands that this coverage is already included in most basic riders 
obtained by members at no extra cost, so a member will likely obtain 
this coverage automatically as part of its fidelity bond coverage.
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    \32\ Travelers.
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    One commenter supported increased deductible thresholds; however, 
the commenter suggested deleting the haircut provision because the 
proposed rule may discourage a firm from pursuing or accepting higher 
deductibles if it has to take a haircut in its net capital computation 
for deductibles over 10 percent.\33\ Another commenter suggested that 
the annual review requirement is duplicitous and unnecessary and that 
the proposed rule should speak solely to minimum bond requirements for 
members.\34\ The commenter noted that fidelity bond reviews should be 
triggered by changes in a firm's net capital requirement and not 
subject to an annual requirement, since the firm would likely review 
how any changes in net capital affect all aspects of the firm when such 
changes occur. FINRA did not make any amendments to the proposal in 
these areas as these concepts have not been substantively amended from 
the legacy NASD rule, and FINRA believes that they are achieving their 
intended purposes.
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    \33\ Travelers.
    \34\ IBI.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve or disapprove the proposed rule change, or (B) 
institute proceedings to determine whether the proposed rule change 
should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2010-059 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.

All submissions should refer to File Number SR-FINRA-2010-059. 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 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of the filing will also 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 publicly available. All 
submissions should refer to File Number SR-FINRA-2010-059 and should be 
submitted on or before December 17, 2010.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-29727 Filed 11-24-10; 8:45 am]
BILLING CODE 8011-01-P