The Financial Industry Regulatory Authority’s (“FINRA”) struggle to obtain the U.S. Securities and Exchange Commission’s (“SEC”) approval of its proposed revisions to its Communications with the Public Rules continues.1 On Dec. 22, 2011, FINRA filed with the SEC Amendment No. 2 to the proposed rule as well as a rebuttal to the comments FINRA received in response to the SEC’s call for additional public comment on whether to approve or disapprove the rule proposals.2 Most notably, Amendment No. 2 seeks to withdraw proposed Supplemental Material 2210.01, which, if withdrawn, would effectively exclude internal communications from the definition of “institutional communications.” It also seeks to exclude from the filing requirements retail communications that are posted on an online interactive electronic forum.3 Other than these proposed changes, FINRA rejected the other suggested changes to its existing rule proposal. The deadline for submitting written comments on both FINRA Amendment No. 1 and Amendment No. 2 expires on Jan. 18, 2012.
FINRA’s Proposal to Delete Supplementary Material 2210.01— A Wolf in Sheep’s Clothing?
FINRA’s proposed Supplementary Material 2210.01 provides that “a member’s internal written (including electronic) communications that are intended to educate or train registered persons about the products or services offered by a member are considered institutional communications.”
In its rebuttal letter, FINRA steadfastly maintained that the proposed Supplemental Material was not a new requirement and that the plain language of the definition of “institutional investor” includes any broker-dealer and its associated persons. FINRA emphasized that the definition of institutional investor did not contain an express “carve-out” for a firm’s internal communications to its associated persons. Furthermore, citing a National Association of Securities Dealers (“NASD”) Regulatory & Compliance Alert from 1998, FINRA maintained that it has previously issued public guidance “making clear that the content standards of the rules governing member communications with the public apply to a member’s internal communications.”
Notwithstanding its position, FINRA seeks to withdraw Supplementary Material 2210.01 and revised the proposed rule change so that going forward (if the rule is approved) internal member communications would no longer be governed by proposed FINRA Rule 2210. Instead, FINRA states that internal communications, including internal communications to train and educate registered representatives, will be governed by NASD Rule 3010 (supervision rules).
FINRA’s move to delete the Supplementary Material, however, should be met with caution. Indeed, in its letter, FINRA stated that the regulatory guidance under NASD Rule 3010 relating to the review and supervision of electronic communications, as well as the books and record requirements, taken together, effectively lead to the “same review and content standards as is set forth in proposed Supplementary Material 2210.01.” FINRA appears to be engrafting the proposed standards of the Supplementary Material onto NASD Rule 3010 and in at least one respect expanding them to apply to communications to all associated persons and not just registered persons. Once again in the guise of claiming that it is merely restating an existing rule, FINRA appears to be rulemaking. Further comment to the SEC may be merited.
Interactive Electronic Forums
Since the initial rule proposal filing some two years ago, there has been much commentary about FINRA’s proposed treatment of “interactive electronic forums.” In its proposed rule, FINRA seeks to eliminate “public appearances” as a separate category of communications and include them in proposed FINRA Rule 2210(f), but not include participation in an “interactive electronic forum” as a public appearance. Under the proposed rule, participation in interactive electronic forums would fall under the term “retail communications” (assuming the forum is generally available to the public).
The practical effect of treating interactive electronic forums as retail communications under the proposed rule appear daunting to many firms. Despite commenters urging FINRA to reconsider its position, the organization has maintained that online interactive forums are more analogous to electronic communications on the basis that “an online interactive forum post generally remains available to the public for an extended period of time.” While, on the other hand, in FINRA’s view, public appearances, such as interviews or other public speaking, unless recorded, are transitory and not permanently available to the public. Therefore, FINRA stated that it continues to believe that it is more appropriate to classify online interactive forum posts as retail communications. It remains to be seen whether FINRA’s approach will open it up to having to create more rules to address institutional communications and the use of such interactive electronic forums since its present rule proposal addresses such forums solely in terms of retail communications.
The bright spot in FINRA’s proposed Amendment No. 2 in terms of interactive electronic forums relates to the filing requirements. Under proposed Amendment No. 2, FINRA seeks to exclude from the filing requirements retail communications that are posted on an online interactive forum. Of course, FINRA pointed out that this exemption does not apply to any filing requirements that may arise under either federal law or SEC rules.
Definition of Institutional Investor Remains Unchanged, While FINRA Provides Some Guidance as to a Firm’s Duty to Police the Distribution of Institutional Communications
In its rebuttal letter, FINRA rejected commenters’ requests that it revise the definition of an “institutional investor” in its proposed rule.4 FINRA stated that the current broader definition establishes an appropriate standard for institutional communications and that a change would harm firms that are relying on the current definition of “institutional investor” under NASD Rule 2211(a)(3). Accordingly, FINRA declined to change the definition.
Despite its refusal to budge on the definition of an institutional investor, FINRA informed firms that it does not intend to impose an affirmative obligation on firms to inquire whether an institutional communication will be forwarded to a retail investor each time such communication is distributed. However, according to FINRA, firms are still required to “have policies and procedures in place reasonably designed to ensure that institutional communications are not forwarded to retail investors, and make appropriate efforts to implement such policies and procedures.” Notably, FINRA informed firms that “legends” on institutional communications that are intended to limit a communication’s distribution can be part of the policies and procedures, but their use alone would be insufficient in terms of the firm’s obligations under the proposed rule. Instead, FINRA suggested that firms consider obtaining “periodic” assurances from institutional investors that they will not forward institutional communications to retail investors as a way to assist firms in their obligations under the proposed rule. Furthermore, FINRA stated that to the extent a firm or its associated persons learns that an institutional investor is forwarding or making available institutional communications to retail investors, the firm must treat future communications sent to that institutional investor as retail communications until such time as the firm reasonably concludes that the improper practice has ceased.
Conclusion
Firms should consider commenting again on both Amendment No. 1 and No. 2 as there remain practical problems associated with many aspects of the proposed rules, including internal communications, public appearances and interactive electronic communications, and the definition of institutional investor. Given the SEC’s willingness to continue to assess these proposed rules, firms may still have an opportunity to effect additional changes. The comment period ends on Jan. 18, 2012.
For more information, please contact:
David C. Boch, Partner, Broker-Dealer Group
david.boch@bingham.com, 617.951.8485
Amy Kroll, Partner, Broker-Dealer Group
amy.kroll@bingham.com, 202.373.6118
Roger P. Joseph, Practice Group Leader, Investment Management Group; Co-chair, Financial Services Area
roger.joseph@bingham.com, 617.951.8247
Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area
timothy.burke@bingham.com, 617.951.8620
Edwin E. Smith, Partner, Financial Restructuring Group; Co-chair, Financial Services Area
edwin.smith@bingham.com, 617.951.8615
Michael R. Weissmann, Partner, Broker-Dealer Group
michael.weissmann@bingham.com, 617.951.8705
1 See Bingham’s Client Alerts dated Oct. 5, 2009 (“FINRA Proposes New Rules Governing Communications with the Public”) and Aug. 3, 2011 (“SEC Publishes FINRA Proposal for Complete Rewrite of Communications with the Public Rules”).
2 See Bingham Client Alert dated Nov. 15, 2011 (“One Step Closer to a New Advertising Rule: FINRA Revises Proposed Rule, SEC Announces Proceedings on Whether to Approve”); see also SEC Release No. 34-65663 (Nov. 1, 2011). The proceedings were announced in the Federal Register on Nov. 7, 2011, and comments were due on Dec. 22, 2011, 76 Fed. Reg. 215 (Nov. 7, 2011). The SEC’s decision to initiate proceedings under Section 19(b)(2) of the Exchange Act is part of a recent trend in the way it handles proposed SRO rule changes, prompted in part by recent procedural amendments required under Section 916 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. See 76 Fed. Reg. 15 (Jan. 24, 2011). According to the SEC’s January 2011 release announcing the new procedural rules, the most recent proceeding was in 1984. Under the new rules, SRO member firms may have greater opportunity for comment and an opportunity to request an oral presentation of its views to the commission on proposed rules.
3 Amendment No. 2 also seeks to amend proposed FINRA Rule 2210 to allow a member that is subject to the new member pre-use filing requirements to file a broker-prepared free writing prospectus within 10 business days of first use, rather than at least 10 business days prior to first use.
4 See Bingham Client Alerts fn 1 and 2, supra, for further discussion of the proposed definition of institutional investors under FINRA’s proposed rules.
This article was originally published by Bingham McCutchen LLP.