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NASD Rule 3040 & Proposed FINRA Rule 3110: Oversight of Dual-Hatted Employees

NASD Rule 3040 & Proposed FINRA Rule 3110: Oversight of Dual-Hatted Employees. Joan R. Dindoffer, VP and Chief Compliance Officer, Private Fiduciary Services, Comerica Bank, Detroit, Michigan (313)222-9386 jrdindoffer@comerica.com April 29, 2009. NASD Rule 3040.

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NASD Rule 3040 & Proposed FINRA Rule 3110: Oversight of Dual-Hatted Employees

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  1. NASD Rule 3040 &Proposed FINRA Rule 3110:Oversight of Dual-Hatted Employees Joan R. Dindoffer, VP and Chief Compliance Officer, Private Fiduciary Services, Comerica Bank, Detroit, Michigan (313)222-9386 jrdindoffer@comerica.com April 29, 2009

  2. NASD Rule 3040 “3040. Private Securities Transactions of an Associated Person (a) Applicability No person associated with a member shall participate in any manner in a private securities transaction except in accordance with the requirements of this Rule. (b) Written Notice Prior to participating in any private securities transaction, an associated person shall provide written notice to the member with which he is associated describing in detail the proposed transaction and the person's proposed role therein and stating whether he has received or may receive selling compensation in connection with the transaction; provided however that, in the case of a series of related transactions in which no selling compensation has been or will be received, an associated person may provide a single written notice. (c) Transactions for Compensation(1) In the case of a transaction in which an associated person has received or may receive selling compensation, a member which has received notice pursuant to paragraph (b) shall advise the associated person in writing stating whether the member: (A) approves the person's participation in the proposed transaction; or (B) disapproves the person's participation in the proposed transaction. (2) If the member approves a person's participation in a transaction pursuant to paragraph (c)(1), the transaction shall be recorded on the books and records of the member and the member shall supervise the person's participation in the transaction as if the transaction were executed on behalf of the member. (3) If the member disapproves a person's participation pursuant to paragraph (c)(1), the person shall not participate in the transaction in any manner, directly or indirectly. (d) Transactions Not for Compensation In the case of a transaction or a series of related transactions in which an associated person has not and will not receive any selling compensation, a member which has received notice pursuant to paragraph (b) shall provide the associated person prompt written acknowledgment of said notice and may, at its discretion, require the person to adhere to specified conditions in connection with his participation in the transaction. (e) Definitions For purposes of this Rule, the following terms shall have the stated meanings: (1) "Private securities transaction" shall mean any securities transaction outside the regular course or scope of an associated person's employment with a member, including, though not limited to, new offerings of securities which are not registered with the Commission, provided however that transactions subject to the notification requirements of Rule 3050, transactions among immediate family members (as defined in Rule 2790), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities, shall be excluded. (2) "Selling compensation" shall mean any compensation paid directly or indirectly from whatever source in connection with or as a result of the purchase or sale of a security, including, though not limited to, commissions; finder's fees; securities or rights to acquire securities; rights of participation in profits, tax benefits, or dissolution proceeds, as a general partner or otherwise; or expense reimbursements.”

  3. Proposed FINRA Rule 3110(b)(3)Note: This rule has been proposed by FINRA, but has not been adopted as of 3/31/09. “(3) Supervision of Outside Securities Activities (A) Unless a member provides prior written approval, no associated person may conduct any investment banking or securities business outside the scope of the member’s business. If the member gives such written approval, such activity is within the scope of the member’s business and shall be supervised in accordance with this Rule, subject to the exceptions set forth in subparagraph (B). (B) Dual Employees (i) The supervision required by subparagraph (A) shall not be required with respect to the bank-related securities activities of dual employees when such activities are included within any of the statutory or regulatory exemptions from registration as a broker or dealer, provided that the member receives written notice of, and approves, such activities. (ii) A member shall not approve the activities of dual employees pursuant to subparagraph (i) unless the member has written assurance that the bank or a supervised bank affiliate will: a. have a comprehensive view of the dual employee’s securities activities; b. employ policies and procedures reasonably designed to achieve compliance with the anti-fraud provisions of the federal securities laws; and c. give prompt notice to the member of any dual employee’s violation of such policies and procedures.

  4. Proposed FINRA Rule 3110(b)(3) Cont’d. (iii) A member may rely upon the written representation of any enumerated entity in subparagraph (ii) that it is employing the policies and procedures required in subparagraph b. provided the member supplies access and information, in compliance with SEC Regulation S-P, as is necessary for the execution of such policies and procedures. Upon receiving notice of a dual employee’s violation of the policies and procedures required in subparagraph b., the member shall assure itself that the policies and procedures of the enumerated entity in subparagraph (ii) are reasonably designed to achieve compliance with the anti-fraud provisions of the federal securities laws or have been amended to achieve such compliance. In the event a member cannot reach such assurance, the member must revoke its approval of the dual employee’s bank-related securities activities. (iv) For purposes of this subparagraph (B), the term “dual employee” means a natural person who has prior written approval from the member to perform as both an associated person of a member and a bank employee. (v) For purposes of this subparagraph (B), the term “supervised bank affiliate" means a bank affiliate that is subject to consolidated supervision by the Board of Governors of the Federal Reserve System, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, or the Director of the Office of Thrift Supervision.”

  5. History • 1933- Glass Stegall Act enacted, separating commercial and investment banking. • 1934- Securities and Exchange Act enacted, excluding banks from definition of broker. • 1985- NASD Rule 3040 enacted, “selling away” rule. • 1999- GLBA enacted removing blanket exemption for banks and introducing functional regulation. • 2001- ABA and others requested NASD interpretation that 3040 did not apply to dual employees of banks. • 2007- Reg R finalized interpreting GLBA Title II. • 2008- FINRA Rule 3110 proposed to replace NASD Rule 3040.

  6. Current Status • Regulatory Notice 08-24: Issued by FINRA May 14, 2008; can be found at http://www.finra.org/web/groups/rules_regs/documents/notice_to_members/p038506.pdf • Comment Period Expired June 13, 2008 • 48 Comments filed

  7. Next Steps Next steps before becoming effective: • Authorization by FINRA Board of Governors for filing with SEC • Publication for comment in Federal Register • Approval by SEC; OR • Revise Proposal Note: The FINRA Board of Governors had not authorized the proposed rule to be filed with the SEC as of 3/31/09

  8. Dissecting Proposed Rule 3110

  9. Section 3110(b)(3)(A) “Unless a member provides prior written approval, no associated person may conduct any investment banking or securities business outside the scope of the member’s business. If the member gives such written approval, such activity is within the scope of the member's business and shall be supervised in accordance with this Rule, subject to the exceptions set forth in subparagraph (B).” Requires: • Associated persons to obtain prior written approval of member to conduct outside investment banking or securities activity. • Outside activity is brought within scope of member’s business for supervision.

  10. However, Section 3110(b)(3)(B)(i) “(B) Dual Employees (i) The supervision required by subparagraph (A) shall not be required with respect to the bank-related securities activities of dual employees when such activities are included within any of the statutory or regulatory exemptions from registration as a broker or dealer, provided that the member receives written notice of, and approves, such activities.” Grants an Exemption • Exemption for activities fitting within the 11 exemptions provided in Title II of GLBA and Reg. R, primarily trust and fiduciary, sweep, and custody activity.

  11. But, strings are attached The exemption is subject to 5 conditions.

  12. Condition 1: 3110(b)(3)(B)(i) Member firm must receive written notice and approve activities of dual employees.

  13. Condition 2: 3110(b)(3)(B)(ii) Member firm must receive written assurance that the bank or a supervised bank affiliate will: • Have a comprehensive view of the dual employee’s securities activities; • Employ policies and procedures reasonably designed to achieve compliance with the anti-fraud provisions of the federal securities laws; and • Give prompt notice to the member of any dual employee’s violation of such policies and procedures.

  14. Condition 3: 3110(b)(3)(B)(iii) Member may rely on the bank or bank affiliate’s written representation that it is employing required policies and procedures, provided member supplies access and information in compliance with SEC Regulation S-P.

  15. Condition 4: 3110(b)(3)(B)(iii) If notified of a violation, member must assure itself that bank policies and procedures are reasonably designed to comply with anti-fraud provisions, or have been amended to do so.

  16. Condition 5: 3110(b)(3)(B)(iii) If not assured, member must revoke approval of dual employee’s bank related securities activity.

  17. Questions Raised • UNCONDITIONAL EXEMPTION for activities falling under Title II of GLBA, primarily trust & fiduciary, sweep, and custody. - Isn’t this provided by Title II of GLBA? • Oversight by BANK or SUPERVISED AFFILIATE. - Could the B-D provide this oversight? What would this entail? • COMPREHENSIVE VIEW of the Dual Employee’s security activities. - Does this mean oversight of respective areas or total oversight? • ANTI-FRAUD PROVISIONS. - Rule 10b-5 or other? • EXEMPT BANKING ACTIVITY. - Will it be subject to securities standards?

  18. Challenges • Ability for either the B-D of the Bank to oversee all activity • Compliance Gaps, including: • Insider Trading • Front Running • Unfair Trade Allocation • Churning • Best Execution • Subjecting banks to securities rules, including: • Correspondence • Customer Complaints • Advertising

  19. Solutions Erect Fences or Build Bridges

  20. The Fences Re-examine Dual Employee Need & Roles • Compensation issues • Seamless delivery of services • Better definition of role in which service is being provided by Dual Employees

  21. The Bridges Build comprehensive oversight structures • Expand oversight by B-D • Expand oversight by Bank • Formalize communication channels between B-D and Bank

  22. Round Table Discussion Q&A

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