TAMING THE FINRA BEAST: AN INSIDER’S PERSPECTIVE

2. TAMING THE FINRA BEAST: AN INSIDER’S PERSPECTIVE Dean M. Jeske – Foley & Lardner LLP Former Deputy Regional Chief Counsel FINRADepartment of Enforcement

3. 3 Taming The Beast: An Insider’s Perspective • Put Your Best Foot Forward…Early! • Examinations: The Disposition Letter is too late • Rule 4530/U5 Follow-up: Be prepared for supervisory scrutiny • If It Isn’t in Writing…It Didn’t Happen • FINRA Examiners’ View • Examples: Due Diligence…Supervision

4. 4 Taming the Beast: An Insider’s Perspective • Extension Requests: Be Prepared • Reasons for extension • Commitment on Timing • “Feed the Beast” • Should We “Lawyer Up?” • FINRA view of outside counsel • In-house counsel?

5. 5 Taming the Beast: An Insider’s Perspective • Should We “Poke the Beast?” • It’s okay to follow-up • It’s okay to go up the chain • Every discussion is an opportunity • Litigating With FINRA • FINRA is Risk Averse • FINRA Resources • Pushing Back: Respectful, but firm • Need to demonstrate a willingness to litigate

6. 6 FINRA Examination Priorities • Firm “Culture”: What is FINRA Getting At? • 2016 Priorities Letter • February 2016 Notice: Exam Requests • Is this really just supervision and controls? • AML: A Continuing Priority • Supervisory Systems/Procedures • Microcap Trading • New FINCEN Beneficial Owner Rule

7. 7 FINRA Examination Priorities • Cybersecurity • What FINRA means: Protection of investor and firm information from compromise through use of electronic media • FINRA Report: https://www.finra.org/file/report-cybersecurity-practices • Exams Will Test: • Technology Governance • Risk Assessment/Incident Response Plan • Vendor Management • Training

8. 8 FINRA Priorities: What’s Coming? • Market Manipulation • Focus on “Layering” and “Spoofing” • Report Cards: A Trap for the Unwary? • Other Market Reg. Priorities • Reg. SHO • Vendor Display Rule: RN 15-52 • Fixed Income Trading

10. The Market Access Rule Stephen P. Bedell– Foley & Lardner LLP Practice Pointers & Sanity Checks

11. Market Access Rule • (a) For purposes of this section: • (1) The term market access shall mean: • (i) Access to trading in securities on an exchange or alternative trading system . . . • (ii) Access to trading in securities on an alternative trading system provided by a broker-dealer operator . . . • (2) The term regulatory requirements shall mean all federal securities laws, rules and regulations, and rules of self-regulatory organizations, that are applicable in connection with market access.

12. Market Access Rule • (c) The risk management controls and supervisory procedures required by paragraph (b) of this section shall include the following elements: • (b) Regulatory risk management controls and supervisory procedures. The risk management controls and supervisory procedures shall be reasonably designed to ensure compliance with all regulatory requirements, including being reasonably designed to: • (i) Prevent the entry of orders unless there has been compliance with all regulatory requirements that must be satisfied on a pre-order entry basis;

13. ExcerptsProposing Release Market Access Rule • Excerpts from Proposing Release Market Access Rule • Incidents involving algorithmic or other trading errors in connection with market access occur with some regularity. For example, it was reported that, on September 30, 2008, trading in Google became extremely volatile toward the end of the day, dropping 93% in value at one point, due to an influx of erroneous orders onto an exchange from a single market participant. As a result, Nasdaq had to cancel numerous trades, and adjust the closing price for Google and the closing value for the Nasdaq 100 Index. In addition, it was reported that, in September 2009, Southwest Securities announced a $6.3 million quarterly loss resulting from deficient market access controls with respect to one of its correspondent brokers that vastly exceeded its credit limits. Despite receiving intra-day alerts from the exchange, Southwest Securities’ controls proved insufficient to allow it to respond in a timely manner, and trading by the correspondent continued for the rest of the day, resulting in a significant loss. . . . [I]n December 2005 . . . Mizuho Securities intended to enter a customer sell order for one share of a security at price of 610,000 Yen, but the numbers were mistakenly transposed and an order to sell 610,000 shares of the security at price of one Yen was entered instead. A system-driven, pre-trade control reasonably designed to reject orders that are not reasonably related to the quoted price of the security, would have prevented this order from reaching the market. (p. 4009)

14. ExcerptsProposing Release Market Access Rule • The proposed financial and regulatory risk management controls should reduce risks to broker-dealers and markets, as well as systemic risk associated with market access . . . by effectively prohibiting the practice of ‘‘unfiltered’’ or ‘‘naked’’ access to an exchange or ATS. (p. 4021) • Without systematic risk protection, erroneous trades, whether resulting from manual errors or a faulty automated, high-speed algorithm, could potentially expose a broker or dealer to enormous financial burdens and disrupt the markets. (p. 4021)

15. ExcerptsProposing Release Market Access Rule • The mitigation of significant systemic risks should help ensure the integrity of the U.S. markets and provide the investing public with greater confidence that intentional, bona fide transactions are being executed across the national market system. (p. 4021)

16. ExcerptsAdopting Release Market Access Rule • Excerpts from Adopting Release Market Access Rule • Market participants recognize the risks associated with naked sponsored access, with one commenter noting, for example, that the potential systemic risk is now “too large to ignore.” (p.8)

17. ExcerptsAdopting Release Market Access Rule • As noted in the Proposing Release, while incidents involving algorithmic or other trading errors in connection with market access occur with some regularity, the Commission also is concerned about preventing other, potentially severe, widespread incidents that could arise as a result of inadequate risk controls on market access. As trading in the U.S. securities markets has become more automated and high-speed trading more prevalent, the potential impact of a trading error or a rapid series of errors, caused by a computer or human error, or a malicious act, has become more severe. In addition, the inter-connectedness of the financial markets can exacerbate market movements, whether they are in response to actual market sentiment or trading errors.

18. ExcerptsAdopting Release Market Access Rule • For instance, on May 6, 2010, the financial markets experienced a brief but severe drop in prices, falling more than 5% in a matter of minutes, only to recover a short time later. This incident provides a striking example of just how quickly and severely today’s financial markets can move across a wide range of securities and futures products. (p. 9-11) • If a price shock in one or more securities were to occur as a result of computer or human error, for example, it could spread rapidly across the financial markets, potentially with systemic implications. (p. 11)

19. ExcerptsAdopting Release Market Access Rule • The financial and regulatory risk management controls should reduce risks to broker-dealers and markets, as well as systemic risk associated with market access and enhance market integrity and investor protection in the securities markets by effectively prohibiting the practice of “unfiltered” or “naked” access to an exchange or ATS. (p. 95) • One of the benefits of the Rule should be the reduction of systemic risk associated with market access through the elimination of “unfiltered” or “naked” access. (p. 95)

20. ExcerptsAdopting Release Market Access Rule • Without systematic risk protection, erroneous trades, whether resulting from manual errors or a faulty automated, high-speed algorithm, could potentially expose a broker or dealer to enormous financial burdens and disrupt the markets. (p. 96) • The Rule requirements are intended to minimize unnecessary and inefficient systemic risk from the markets. (p. 98)

21. ExcerptsAdopting Release Market Access Rule • The Commission notes that the term “regulatory requirements” references existing regulatory requirements applicable to broker-dealers in connection with market access, and is not intended to substantively expand upon them. (p. 14 n. 22) • The Commission notes that, as stated in the Proposing Release, it intends these controls and procedures to encompass existing regulatory requirements applicable to broker-dealers in connection with market access, and does not intend to substantively expand upon them. (p. 42)

22. ExcerptsAdopting Release Market Access Rule • Whether compliance is pre-trade or post-trade, however, Proposed Rule 15c3-5(c)(2) would not impose new substantive regulatory requirements on the broker-dealer, but rather establish a clear requirement that the broker-dealer have appropriate mechanisms in place that are reasonably designed to effectively with its existing regulatory requirements in an automatic high-speed trading environment. (p. 43)

24. Communicating with Regulators Ellen M. Wheeler – Foley & Lardner LLP Thomas P. Krebs – Foley & Lardner LLP Dean M. Jeske – Foley & Lardner LLPSteven Schweitzer – CME Group Inc. Avoiding Individual Liability and False Statements

25. Communicating with Regulators: Avoiding Individual Liability and False Statements • This panel will cover • The authority of regulators to hold individuals – including compliance officers, counsel, or operational employees tasked with communicating with regulators – liable for making false statements or failing to cooperate • The implications of such authority when communicating with regulators in an investigation, examination or other proceeding, including the intersection of such authority and an attorney’s ethical obligations

26. Communicating with Regulators: Avoiding Individual Liability and False Statements • Cooperation – FINRA Rule 8210 (a) Authority of Adjudicator and FINRA Staff For the purpose of an investigation, complaint, examination, or proceeding authorized by the FINRA By-Laws or rules, an Adjudicator or FINRA staff shall have the right to: (1) require a member, person associated with a member, or any other person subject to FINRA's jurisdiction to provide information orally, in writing, or electronically (if the requested information is, or is required to be, maintained in electronic form) and to testify at a location specified by FINRA staff, under oath or affirmation administered by a court reporter or a notary public if requested, with respect to any matter involved in the investigation, complaint, examination, or proceeding; and (2) inspect and copy the books, records, and accounts of such member or person with respect to any matter involved in the investigation, complaint, examination, or proceeding that is in such member's or person's possession, custody or control. (c) Requirement to Comply No member or person shall fail to provide information or testimony or to permit an inspection and copying of books, records, or accounts pursuant to this Rule.

27. Communicating with Regulators: Avoiding Individual Liability and False Statements • Cooperation – Securities Exchanges • BATS Rule 8.2(e): Failure to furnish testimony, documentary evidence or other information requested by the Exchange in the course of an Exchange inquiry, investigation, hearing or appeal … on the date or within the time period the Exchange specifies shall be deemed to be a violation of this Rule 8.2. • CBOE Rule 15.1: …. No Trading Permit Holder shall refuse to make available to the Exchange such books, records or other information as may be called for under the Rules or as may be requested in connection with an investigation by the Exchange.

28. Communicating with Regulators: Avoiding Individual Liability and False Statements • Cooperation – CBOT, CME, NYMEX, and COMEX • Rule 432.L: It shall be an offense: 1. to fail to appear before the Board, Exchange staff or any investigative or hearing committee at a duly convened hearing, scheduled staff interview or in connection with any investigation; 2. to fail to fully answer all questions and produce all books and records at such hearing or in connection with any investigation, or to make false statements; 3. to fail to produce any books or records requested by duly authorized Exchange staff, in the format and medium specified in the request, within 10 days after such request is made or such shorter period of time as determined by the Market Regulation Department in exigent circumstances;

29. Communicating with Regulators: Avoiding Individual Liability and False Statements • False Statements – Perjury • Perjury – Section 1621 of Title 18 of the United States Code • “Whoever … having taken an oath before a competent tribunal, officer, or person, in any case in which a law of the United States authorizes an oath to be administered, that he will testify, declare, depose, or certify truly, or that any written testimony, declaration deposition or certificate by him subscribed, is true, willfully and contrary to such oath states or subscribes any material matter which he does not believe to be true … is guilty of perjury and shall, except as otherwise expressly provided by law, be fined under this title or imprisoned not more than five years, or both.”

30. Communicating with Regulators: Avoiding Individual Liability and False Statements • False Statements – SEC and CFTC • Lying to federal agents - Section 1001 of Title 18 of the U.S. Code • “Whoever, in any matter within the jurisdiction of the executive, legislative, or judicial branch of the Government of the United States, knowingly and willfully (1) falsifies, conceals, or covers up by any trick, scheme, or device a material fact; (2) makes any materially false, fictitious, or fraudulent statement or representation; or (3) makes or uses any false writing or document knowing the same to contain any materially false, fictitious or fraudulent statement or entry; shall be fined under this title, imprisoned not more than 5 years…or both.”

31. Communicating with Regulators: Avoiding Individual Liability and False Statements • False Statements - CFTC • Commodities Exchange Act: Section 6(c)(2) – False Statements • “It shall be unlawful for any person to make any false or misleading statement of a material fact to the [CFTC] … or to omit to state in any such statement any material fact that is necessary to make any statement of a material fact made not misleading in any material respect, if the person knew, or reasonably should have known, the statement to be false or misleading.”

32. Communicating with Regulators: Avoiding Individual Liability and False Statements • False Statements - CME • CME Rule 432.L. • It shall be an offense: 2. to fail to fully answer all questions and produce all books and records at such hearing or in connection with any investigation, or to make false statements…. • CME Rule 432.I. • It shall be an offense: to make a verbal or written material misstatement to the Board, a committee, or Exchange employees….

33. Communicating with Regulators: Avoiding Individual Liability and False Statements • False Statements - FINRA • Rule 8210 • Addendum A To Request for Testimony • “At the OTR, you are obligated to provide testimony that is truthful, accurate and complete. Should you fail to do so, you may be subject to an FINRA disciplinary action, and the imposition of disciplinary sanctions, including a bar from the securities industry, suspension, censure and/or fine. You may also be subject to prosecution for perjury for false testimony under oath.”

34. Communicating with Regulators: Avoiding Individual Liability and False Statements • Overview of Relevant Attorney Ethical Obligations • Rule 1.2(d) – A lawyer shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows is criminal or fraudulent, but a lawyer may       (1) discuss the legal consequences of any proposed course of conduct with a client,       (2)  counsel or assist a client to make a good-faith effort to determine the validity, scope, meaning or application of the law, and       (3) counsel or assist a client in conduct expressly permitted by Illinois law that may violate or conflict with federal or other law, as long as the lawyer advises the client about that federal or other law and its potential consequences.

35. Communicating with Regulators: Avoiding Individual Liability and False Statements • Overview of Relevant Attorney Ethical Obligations • Rule 4.1: Truthfulness in Statements to Others In the course of representing a client a lawyer shall not knowingly:       (a) make a false statement of material fact or law to a third person; or       (b) fail to disclose a material fact when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client, unless disclosure is prohibited by Rule 1.6.

36. Communicating with Regulators: Avoiding Individual Liability and False Statements • Overview of Relevant Attorney Ethical Obligations • Rule 1.6: Confidentiality of Information       (a) A lawyer shall not reveal information relating to the representation of a client unless the client gives informed consent, the disclosure is impliedly authorized in order to carry out the representation, or the disclosure is permitted by paragraph (b) or required by paragraph (c).

37. Communicating with Regulators: Avoiding Individual Liability and False Statements • Overview of Relevant Attorney Ethical Obligations • Rule 1.6: Confidentiality of InformationCont. (b) A lawyer may reveal information relating to the representation of a client to the extent the lawyer reasonably believes necessary:       (1) to prevent the client from committing a crime in circumstances other than those specified in paragraph (c);       (2) to prevent the client from committing fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in furtherance of which the client has used or is using the lawyer’s services;       (3) to prevent, mitigate or rectify substantial injury to the financial interests or property of another that is reasonably certain to result or has resulted from the client’s commission of a crime or fraud in furtherance of which the client has used the lawyer’s services; ….