The US Securities and Exchange Commission (SEC) published for comment on September 30 a proposed rule change by the Financial Industry Regulatory Authority (FINRA) that would amend FINRA Rule 2231—the customer account statement rule. The proposed rule change would amend Rule 2231 by adding new supplementary materials on compliance with FINRA’s rule regarding carrying agreements, third-party receipt of customer account statements, the use of electronic media to satisfy delivery obligations, and compliance with FINRA’s rule regarding the holding of customer mail.
The proposed rule change also will incorporate without substantive change specified provisions derived from Temporary Dual FINRA-New York Stock Exchange (NYSE) Rule Interpretation 409T (Statements of Accounts to Customers) on information disclosed on customer account statements, externally held assets, use of logos and trademarks, and use of summary statements.[1]
The proposed rule change is FINRA’s latest attempt to amend customer account statement requirements after a number of abandoned efforts dating back to 2009. While many of the proposed changes may ultimately be viewed as noncontroversial, the changes attendant to the third-party receipt of customer account statements may still be problematic. Comments on the proposed rule change are due by October 27, 2021.
FINRA Rule 2231 and NYSE Rule 409T govern the obligation of broker-dealers to deliver customer account statements to customers at least quarterly showing security and money positions or account activity during the preceding quarter, except if carried on a delivery versus payment/receive versus payment. The proposed rule change would incorporate several existing provisions from the NYSE provisions into FINRA Rule 2231 to avoid having multiple rules addressing the same obligations, and add additional new requirements through eight additions to the Rule 2231 in the form of supplementary materials.
Supplementary Material .01 (Compliance with Rule 4311 (Carrying Agreements))
New Supplementary Material .01 would remind firms of their obligations under Rule 4311, and in particular the rights and obligations of the carrying firm under Rule 4311(c)(2). That provision requires each carrying agreement under which accounts are carried on a fully disclosed basis by a carrying firm to expressly allocate to the carrying firm the responsibility for the safeguarding of funds and securities for the purposes of Rule 15c3-3 of the Securities Exchange Act of 1934 (Exchange Act) and for preparing and transmitting statements of account to customers.
This requirement appears to be new, yet FINRA provides no discussion explaining the need to include this new material. Given that carrying agreements already have to allocate this function, it is unclear how this amendment would add value.
Supplementary Material .02 (Transmission of Customer Account Statements to Other Persons or Entities)
Proposed Supplementary Material .02 to Rule 2231 addresses the transmission of customer account statements to persons or entities other than the customer:
As explained by FINRA, proposed Supplementary Material .02 would (1) be limited to customer account statements and not include other communications such as transaction confirmations, (2) permit the customer to designate any third party to receive statements (i.e., other person or entities) rather than limiting the designation to persons holding a power of attorney, and (3) continue to provide that duplicate account statements may be sent to FINRA (in the case of an account held by a FINRA employee) or to another broker-dealer (in the case of an account held by an associated person of that other broker-dealer).
The requirement in paragraph (a) that a broker-dealer continue to send account statements directly to customers could benefit from additional guidance. For instance, in the case of a physical address, there may be situations where, out of convenience, customers request that their statements be sent to an address that also is associated with a person acting as a fiduciary over the accounts of customers. In those instances, it is unclear whether a broker-dealer will be deemed to have directly delivered the account statement where one or more customers unrelated to one another (other than having a relationship with the same fiduciary) have provided the same mailing address. This issue also arises in the context of electronic delivery, where customers may provide an email address that the broker-dealer knows other customers use (i.e., shared email addresses) and that corresponds to a fiduciary or other third party.
Based on comments received in response to previous attempts to revise Rule 2231, FINRA has included an exception from having to send a statement directly to the customer where a court has appointed a fiduciary for the customer’s account and the fiduciary requests that statements no longer be sent to the customer. This provision, however, may be subject to criticism in light of recent legal proceedings involving allegations of conservator abuse by a famous singer who has been under a court-appointed conservatorship for more than a decade. To the extent that FINRA is concerned about potential elder abuse or other exploitation, a possible alternative could be to have statements sent to a pre-trusted contact in order to avoid potential abuse at the conservator level. Moreover, in 1994 amendments to Rule 10b-10 under the Exchange Act, the SEC permitted customers to waive receipt of immediate transaction confirmations in situations where a fiduciary of an account received the immediate confirmations, and the customer directly received a periodic statement not less than quarterly containing all of the information required by Rule 10b-10. The customer could not waive this latter requirement, and as matter of practice, the customer account statement serves as the proxy for the periodic statement that a customer is required to receive. It is unclear whether a fiduciary’s request to discontinue the delivery of account statements under paragraph (b) of the proposed rule change can be reconciled with the independent requirement under Rule 10b-10 that a periodic statement be sent directly to the customer in situations where immediate confirmations are sent to the fiduciary.
Supplementary Material. 03 (Use of Electronic Media to Satisfy Delivery Obligations)
Proposed Supplementary Material .03 would expressly allow a broker-dealer to satisfy its customer account statement delivery obligations by using electronic media in accordance with the standards established by the SEC on the use of electronic media for delivery purposes.
This provision simply reiterates the SEC’s existing framework regarding electronic delivery, which contains the following elements: (1) notice to the investor that information is available electronically; (2) access to information comparable to that which would have been provided in paper form and that is not so burdensome that the intended recipients cannot effectively access it; and (3) evidence to show delivery, i.e., reason to believe that electronically delivered information will result in the satisfaction of the delivery requirements under the federal securities laws. While the use of this framework has been reiterated by the SEC, most recently when it adopted the requirements for Form CRS 2019, that framework is not without criticism given its inconsistencies with the Electronic Signatures in Global and National Commerce Act (ESIGN). For instance, where the SEC’s framework requires notice of the availability of electronic communications, ESIGN simply requires consumer disclosure of any notice that may be provided. In addition, the SEC has apparently foreclosed on the ability to condition account opening on consent to electronic delivery. ESIGN contains no such limitations.
Supplementary Material. 04 (Compliance with Rule 3150 (Holding of Customer Mail))
Proposed Supplementary Material .04 to Rule 2231 would permit broker-dealers to hold customer mail, including customer account statements, subject to the requirements of Rule 3150. That rule allows a firm to hold a customer’s mail for a specific time period in accordance with the customer’s written instructions if the broker-dealer: (1) receives written instructions from the customer that include the time period during which the member is requested to hold the customer’s mail, which if longer than three months must include an acceptable reason other than convenience (e.g., safety risks); (2) informs the customer of alternative means of receiving information (e.g., electronic delivery and account access) and confirms the customer’s receipt of that information; (3) periodically verifies that the customer’s instructions still apply; (4) has a means to communicate with the customer in a timely manner to provide important account information; and (5) ensures that the customer’s mail is not tampered with, held without consent, or misused.
This requirement appears to be new, and FINRA provided no discussion on the need to include this new material. That said, while outside the scope of the proposed rule change, FINRA may want to reconsider the requirement under Rule 3150 that a broker-dealer have a means to communicate with customers, especially where mail is held because of safety reasons. While one of the original purposes of Rule 3150 was to ensure that a customer’s safety or security was not compromised if physical mail were intercepted where a customer was temporarily in a country that could make the customer susceptible to extortion or kidnapping for financial gain, the use of phishing and other electronic intrusion methods has only increased this risk.
Supplementary Material .05 (Information to Be Disclosed on Statement)
Proposed Supplementary Material .05 to Rule 2231 would require that account statements include the following information clearly and prominently on the front of the account statement: (1) the identity of the introducing and clearing firm, if different, and their respective contact information for customer service, permitting the identity of the clearing firm and its contact information to appear on the back of the statement provided such information is in bold or highlighted letters; (2) that the clearing firm is a member of Securities Investor Protection Corp. (SIPC); and (3) the opening and closing balances for the account. This proposed requirement incorporates existing requirements under Rule 409T without modification.
Supplementary Material .06 (Assets Externally Held)
Under proposed Supplementary Material .06, in the case of an account statement that includes assets that the broker-dealer does not carry on behalf of a customer and that are not included on the broker-dealer’s books and records, such assets would have to be listed clearly and distinguishably separate on the statement. In addition, in such cases, the statement must: (1) clearly indicate that such externally held assets are included on the statement solely as a courtesy to the customer; (2) disclose that information, including valuation, for such externally held assets is derived from the customer or other external source for which the broker-dealer is not responsible; and (3) identify that such externally held assets may not be covered by SIPC. This requirement simply incorporates existing requirements under Rule 409T without modification.
Supplementary Material .07 (Use of Logos, Trademarks, Etc.)
Proposed Supplementary Material .07 provides that where the logo, trademark, or other identification of a person (other than the introducing firm or clearing firm) appears on an account statement, then the identity of such person and the relationship to the introducing, carrying, or other organization included on the statement must be provided and may not be misleading or confusing to customers. This requirement simply incorporates existing requirements under Rule 409T without modification.
Supplementary Material .08 (Use of Summary Statements)
Under proposed Supplementary Material .08, if a summary statement that includes information from multiple entities is sent to customers, it must:
Proposed Supplementary Material .08 would also require a broker-dealer to:
This requirement simply incorporates existing requirements under Rule 409T without modification.
While the proposed rule change primarily recodifies into FINRA Rule 2231 existing NYSE Rule 409T obligations, there are provisions that may require thoughtful industry comment. In particular, broker-dealers may want to consider how the provisions related to sending account statements to third parties may impact business operations and whether there are additional practices that FINRA may want to consider including in the revised rule.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Washington DC
Amy Natterson Kroll
Ivan P. Harris
Ignacio A. Sandoval
Steven W. Stone
Karin Khominsky
Kyle D. Whitehead
Boston
David C. Boch
Philadelphia
Christine M. Lombardo
[1] The proposed rule change would also delete Temporary Dual FINRA-NYSE Rule 409T (Statements of Accounts to Customers) and Temporary Dual FINRA-NYSE Rule Interpretation 409T, and make other non-substantive and technical changes in Rule 2231 and to other FINRA rules due to this proposed rule change.