[Federal Register Volume 76, Number 125 (Wednesday, June 29, 2011)]
[Notices]
[Pages 38245-38262]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-16232]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-64736; File No. SR-FINRA-2011-028]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change To Adopt 
Rules Regarding Supervision in the Consolidated FINRA Rulebook

 June 23, 2011.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'' or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on June 10, 2011, 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.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to adopt the consolidated FINRA supervision 
rules. Specifically, the proposed rule change would: (1) Adopt FINRA 
Rules 3110 (Supervision) and 3120 (Supervisory Control System) to 
replace NASD Rules 3010 (Supervision) and 3012 (Supervisory Control 
System), respectively; (2) incorporate into FINRA Rule 3110 and its 
supplementary material the requirements of NASD IM-1000-4 (Branch 
Offices and Offices of Supervisory Jurisdiction), NASD IM-3010-1 
(Standards for Reasonable Review), Incorporated NYSE Rule 401A 
(Customer Complaints), and Incorporated NYSE Rule 342.21 (Trade Review 
and Investigation); (3) replace NASD Rule 3010(b)(2) (often referred to 
as the ``Taping Rule'') with new FINRA Rule 3170 (Tape Recording of 
Registered Persons by Certain Firms); (4) replace NASD Rule 3010(e) 
(Qualifications Investigated) with new FINRA Rule 1260 (Responsibility 
of Member to Investigate Applicants for Registration); (5) replace NASD 
Rule 3110(i) (Holding of Customer Mail) with new FINRA Rule 3150 
(Holding of Customer Mail); and (6) delete the following NASD and 
Incorporated NYSE Rules and NYSE Rule Interpretations: (i) NASD Rule 
3010(f) (Applicant's Responsibility); (ii) NYSE Rule 342 (Offices--
Approval, Supervision and Control) and related NYSE Rule 
Interpretations; (iii) NYSE Rule 343 (Offices--Sole Tenancy, and Hours) 
and related NYSE Rule Interpretations; (iv) NYSE Rule 351(e) (Reporting 
Requirements) and NYSE Rule Interpretation 351(e)/01 (Reports of 
Investigation); (v) NYSE Rule 354 (Reports to Control Persons); and 
(vi) NYSE Rule 401 (Business Conduct).
    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA and for 
Web site viewing and printing 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''),\3\

[[Page 38246]]

FINRA is proposing to adopt new FINRA Rules 3110 (Supervision) and 3120 
(Supervisory Control System) and to delete NASD Rule 3010 (Supervision) 
and NASD Rule 3012 (Supervisory Control System), on which they are 
largely based. The proposed rule change also would delete Incorporated 
NYSE Rule 342 and much of its supplementary material and 
interpretations as they are, in main part, either duplicative of, or do 
not align with, the proposed supervision requirements. The proposed 
rule change, however, does incorporate--on a tiered basis--certain 
provisions from Incorporated NYSE Rule 342. The details of the proposed 
rule change are described below.
---------------------------------------------------------------------------

    \3\ The current FINRA rulebook consists of: (1) FINRA Rules; (2) 
NASD Rules; and (3) rules incorporated from the 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).
---------------------------------------------------------------------------

(1) Proposed FINRA Rule 3110 (Supervision)
    Proposed FINRA Rule 3110 is based primarily on existing 
requirements in NASD Rule 3010 and Incorporated NYSE Rule 342 relating 
to, among other things, supervisory systems, written procedures, 
internal inspections, and review of correspondence. Proposed FINRA Rule 
3110 also incorporates provisions in other NASD rules that pertain to 
supervision, including NASD Rule 3012.
(A) Proposed FINRA Rule 3110(a) (Supervisory System) and Proposed 
Supplementary Material .01 \4\
---------------------------------------------------------------------------

    \4\ FINRA published the proposed rules for comment in Regulatory 
Notice 08-24 (May 2008). In response to comments, FINRA, among other 
things, has added new proposed Supplementary Material .01 (Business 
Lines) to proposed FINRA Rule 3110; this amendment to the proposal 
has resulted in a change in numbering of all subsequent 
supplementary material to proposed FINRA Rule 3110. For ease of 
reference, the proposed rule change employs the new proposed numbers 
in all instances.
---------------------------------------------------------------------------

    Proposed FINRA Rule 3110(a) requires a member to have a supervisory 
system for the activities of its associated persons that is reasonably 
designed to achieve compliance with the applicable securities laws and 
regulations and FINRA and Municipal Securities Rulemaking Board 
(``MSRB'') rules. The proposed rule provision is substantially similar 
to NASD Rule 3010(a) except for two revisions. First, proposed FINRA 
Rule 3110(a) refers only to associated persons instead of the current 
reference in NASD Rule 3010(a) to each ``registered representative, 
registered principal, and other associated person.'' Second, proposed 
FINRA Rule 3110(a) requires a member's supervisory system to be 
reasonably designed to achieve compliance with MSRB rules, which NASD 
Rule 3010(a) does not explicitly reference.\5\
---------------------------------------------------------------------------

    \5\ In this regard, SEC staff has confirmed FINRA staff's view 
that a violation of the MSRB rules also would be a violation of the 
Federal securities laws, as it would constitute a violation of 
Exchange Act Section 15B(c)(1). See Letter from James L. Eastman, 
Chief Counsel and Associate Director, Division of Trading and 
Markets, SEC, to Patrice M. Gliniecki, Senior Vice President and 
Deputy General Counsel, FINRA (March 17, 2009).
---------------------------------------------------------------------------

    Proposed Supplementary Material .01 (Business Lines) provides that 
for a member's supervisory system required by proposed FINRA Rule 
3110(a) to be reasonably designed to achieve compliance with FINRA Rule 
2010 (Standards of Commercial Honor and Principles of Trade), it must 
include supervision for all of the member's business lines irrespective 
of whether they require broker-dealer registration.
(i) Proposed FINRA Rule 3110(a)(1)
    Proposed FINRA Rule 3110(a)(1), which is identical to NASD Rule 
3010(a)(1), requires a member's supervisory system to include the 
establishment and maintenance of written procedures.
(ii) Proposed FINRA Rule 3110(a)(2): Designated Principal
    Proposed FINRA Rule 3110(a)(2), which is identical to NASD Rule 
3010(a)(2), requires a member's supervisory system to include the 
designation of an appropriately registered principal(s) with authority 
to carry out the supervisory responsibilities for each type of business 
in which the member engages for which registration as a broker-dealer 
is required.
(iii) Proposed FINRA Rule 3110(a)(3) and Proposed Supplementary 
Material .02-.03
    Proposed FINRA Rule 3110(a)(3) requires the registration and 
designation as a branch office and/or an office of supervisory 
jurisdiction (``OSJ'') of each location, including the main office, as 
those terms are defined in the proposed rule. Proposed FINRA Rule 
3110(a)(3) is based on similar provisions in NASD Rule 3010(a)(3). In 
addition, the proposed rule provision and proposed Supplementary 
Material .02 (Registration of Main Office) incorporate the requirement 
in NASD IM-1000-4 (Branch Offices and Offices of Supervisory 
Jurisdiction) that all branch offices and OSJs must be registered as 
either a branch office or OSJ, respectively. FINRA is deleting NASD IM-
1000-4 as part of this proposed rule change.
    Additionally, the proposed rule change moves, with no substantive 
changes, the provisions in NASD Rule 3010(a)(3) setting forth certain 
factors a member should consider in designating additional locations as 
OSJs into proposed Supplementary Material .03 (Designation of 
Additional OSJs).
(iv) Proposed FINRA Rule 3110(a)(4) and Proposed Supplementary Material 
.04-.05
    Proposed FINRA Rule 3110(a)(4) requires a member to designate one 
or more appropriately registered principals in each OSJ and one or more 
appropriately registered representatives or principals in each non-OSJ 
branch office with authority to carry out the supervisory 
responsibilities assigned to that office by the member. This proposed 
provision replaces the nearly identical provision in NASD Rule 
3010(a)(4) with a minor editorial change to delete the phrase 
``including the main office,'' from the rule text.
    Supplementary Material .04 (One-Person OSJs) codifies existing 
guidance on the supervision of one-person OSJs. Specifically, the 
proposed supplementary material clarifies the core concept that the on-
site principal in a one-person OSJ location cannot supervise his or her 
own activities if such principal is authorized to engage in business 
activities other than the supervision of associated persons or other 
offices as enumerated in proposed FINRA Rule 3110(e)(1)(D) through (G). 
Proposed Supplementary Material .04 also provides that, in such 
instances, the on-site principal must be under the close supervision 
and control of another appropriately registered principal (``senior 
principal''). The senior principal is responsible for supervising the 
activities of the on-site principal at such office and must conduct on-
site supervision of such OSJ on a regular periodic schedule determined 
by the member. The proposed supplementary material requires a member to 
consider, among other factors, the nature and complexity of the 
securities activities for which the location is responsible, the nature 
and extent of contact with customers, and the disciplinary history of 
the on-site principal in determining this schedule.
    Proposed Supplementary Material .05 (Supervision of Multiple OSJs 
by a Single Principal) clarifies the requirement in proposed Rule 
3110(a)(4) to designate an on-site principal in each OSJ with authority 
to carry out the supervisory responsibilities assigned to that office. 
Such on-site principal must have a physical presence, on a regular and 
routine basis, at the OSJ for which the principal has supervisory 
responsibilities. The proposed

[[Page 38247]]

supplementary material establishes a general presumption that a 
principal will not be assigned to supervise more than one OSJ and sets 
forth factors members should consider in making a determination 
regarding whether a single principal can supervise more than one OSJ. 
Where a member determines to assign one principal to supervise more 
than one OSJ, the member must document the factors it considered. There 
is a further general presumption that a determination by a member to 
assign one principal to supervise more than two OSJs is unreasonable. 
If a member determines to designate and assign one principal to 
supervise more than two OSJs, the proposed supplementary material 
provides that such determination will be subject to greater scrutiny, 
and the member will have a greater burden to evidence the 
reasonableness of such structure.
(v) Proposed FINRA Rule 3110(a)(5) through (7) and Proposed 
Supplementary Material .06
    Proposed FINRA Rule 3110(a)(5) requires that each registered person 
be assigned to an appropriately registered representative(s) and/or 
principal(s) who is responsible for supervising that person's 
activities. Proposed FINRA Rule 3110(a)(6) requires a member to use 
reasonable efforts to determine that all supervisory personnel have the 
necessary experience or training to be qualified to carry out their 
assigned responsibilities. Proposed FINRA Rule 3110(a)(7) requires each 
registered representative and registered principal to participate, at 
least once each year, in an interview or meeting at which compliance 
matters relevant to the particular representative or principal are 
discussed. These proposed provisions replace the nearly identical 
provisions in NASD Rule 3010(a)(5) through (7) with only minor 
editorial changes.
    Proposed Supplementary Material .06 (Annual Compliance Meeting) 
codifies existing guidance that a member is not required to conduct in-
person meetings with each registered person or groups of registered 
persons to comply with the annual compliance meetings required by 
proposed FINRA Rule 3110(a)(7).\6\ However, a member that chooses to 
conduct meetings using other methods (e.g., on-demand Web cast, video 
conference, interactive classroom setting, telephone, or other 
electronic means) must ensure, at a minimum, that each registered 
person attends the entire meeting (e.g., an on-demand annual compliance 
Web cast would require each registered person to use a unique user ID 
and password to gain access and use a technology platform to track the 
time spent on the Web cast, provide click-as-you-go confirmation, and 
have an attestation of completion at the end of a Web cast) and is able 
to ask questions regarding the presentation and receive answers in a 
timely fashion (e.g., an on-demand annual compliance Web cast that 
allows registered persons to ask questions via an e-mail to a presenter 
or a centralized address or via a telephone hotline and receive timely 
responses directly or view such responses on the member's intranet 
site).
---------------------------------------------------------------------------

    \6\ See Notice to Members 99-45 (June 1999).
---------------------------------------------------------------------------

(B) Proposed FINRA Rule 3110(b) (Written Procedures)
    FINRA proposes to consolidate various provisions and rules that 
currently require written procedures into proposed FINRA Rule 3110(b), 
including provisions from NASD Rule 3010(d)(1) relating to the 
supervision of registered representatives and Incorporated NYSE Rule 
401A (Customer Complaints) relating to the review of customer 
complaints. In addition, proposed supplementary material, which is 
discussed in detail below, codifies and expands guidance in these 
areas.
(i) Proposed FINRA Rule 3110(b)(1) (General Requirements)
    Proposed FINRA Rule 3110(b)(1) requires a member to establish, 
maintain, and enforce written procedures to supervise the types of 
business in which it engages and the activities of its associated 
persons that are reasonably designed to achieve compliance with 
applicable securities laws and regulations, FINRA rules, and MSRB 
rules. The proposed rule provision is substantially similar to NASD 
Rule 3010(b)(1) except for two revisions that mirror changes in 
proposed FINRA Rule 3110(a). First, proposed FINRA Rule 3110(b)(1) 
refers only to associated persons instead of the current reference in 
NASD Rule 3010(b)(1) to ``registered representatives, registered 
principals, and other associated persons.'' Second, FINRA Rule 
3110(b)(1) requires a member's written supervisory procedures to be 
reasonably designed to achieve compliance with MSRB rules, which NASD 
Rule 3010(b)(1) does not explicitly reference.\7\
---------------------------------------------------------------------------

    \7\ See supra note 5.
---------------------------------------------------------------------------

(ii) Proposed FINRA Rule 3110(b)(2) (Review of Member's Investment 
Banking and Securities Business) and Proposed Supplementary Material 
.07
    FINRA is retaining the provision in NASD Rule 3010(d)(1) requiring 
principal review, evidenced in writing, of all transactions, but is 
relocating the provision to proposed FINRA Rule 3110(b)(2). FINRA is 
also proposing to amend the provision to clarify that such review 
includes all transactions relating to the member's investment banking 
or securities business. Proposed Supplementary Material .07 (Risk-based 
Review of Member's Investment Banking and Securities Business) permits 
a member to use a risk-based system to review these transactions.
(iii) Proposed FINRA Rule 3110(b)(3)
    FINRA is reserving this provision for future rulemaking.\8\
---------------------------------------------------------------------------

    \8\ As noted in Regulatory Notice 08-24, FINRA proposed to 
delete NASD Rule 3040 (Private Securities Transactions of an 
Associated Person) and replace it with FINRA Rule 3110(b)(3) 
(Supervision of Outside Securities Activities) and proposed 
Supplementary Material .07 (Reliance on Bank or Affiliated Entity to 
Supervise Dual Employees). FINRA, however, has determined to address 
NASD Rule 3040 as a separate proposal.
---------------------------------------------------------------------------

(iv) Proposed FINRA Rule 3110(b)(4) (Review of Correspondence and 
Internal Communications) and Proposed Supplementary Material .08-.11
    Proposed FINRA Rule 3110(b)(4) generally incorporates the substance 
of NASD Rule 3010(d) (Review of Transactions and Correspondence) 
requiring members to have supervisory procedures for the review of 
correspondence. In addition, the proposed provision and proposed 
related supplementary material incorporate certain existing guidance 
regarding the supervision of electronic communications in Regulatory 
Notice 07-59 (December 2007).
    Specifically, proposed FINRA Rule 3110(b)(4) requires that a member 
have supervisory procedures for the review of the member's incoming and 
outgoing written (including electronic) correspondence with the public 
and internal communications that relate to its investment banking or 
securities business. Proposed Supplementary Material .08 (Risk-based 
Review of Correspondence and Internal Communications), however, permits 
a member to use risk-based review principles to review much of its 
incoming and outgoing correspondence with the public and internal 
communications.
    The proposed rule also requires a member to identify and handle in

[[Page 38248]]

accordance with the firm's procedures: Customer complaints, 
instructions, and funds and securities, and communications that are of 
a subject matter that require review under FINRA and MSRB rules and the 
Federal securities laws. Those communications include (without 
limitation):
     Communications between non-research and research 
departments concerning a research report's contents (NASD Rule 
2711(b)(3) and Incorporated NYSE Rule 472(b)(3));
     Certain communications with the public that require a 
principal's pre-approval (NASD Rules 2210 and 2211);
     The identification and reporting to FINRA of customer 
complaints (NASD Rule 3070(c) and Incorporated NYSE Rule 351(d)); \9\ 
and
---------------------------------------------------------------------------

    \9\ FINRA adopted FINRA Rule 4530 to replace NASD Rule 3070 and 
comparable provisions in Incorporated NYSE Rule 351 (Reporting 
Requirements). See Exchange Act Release No. 63260 (November 5, 
2010), 75 FR 69508 (November 12, 2010) (Order Approving File No. SR-
FINRA-2010-034). FINRA Rule 4530 becomes effective on July 1, 2011. 
See Regulatory Notice 11-06 (February 2011). With respect to 
customer complaints, as detailed further below, proposed FINRA Rule 
3110(b)(5) also would affirmatively require members to capture, 
acknowledge, and respond to all written (including electronic) 
customer complaints.
---------------------------------------------------------------------------

     The identification and prior written approval of every 
order error and other account designation change (NASD Rule 3110(j) and 
Incorporated NYSE Rule 410).\10\
---------------------------------------------------------------------------

    \10\ On January 27, 2011, the SEC approved, among other things, 
FINRA Rule 4515 (Approval and Documentation of Changes in Account 
Name or Designation) to replace NASD Rule 3110(j), and the deletion 
of Incorporated NYSE Rule 410. See Exchange Act Release No. 63784 
(January 27, 2011), 76 FR 5850 (February 2, 2011) (Order Approving 
File No. SR-FINRA-2010-052). This rule change becomes effective on 
December 5, 2011. See Regulatory Notice 11-19 (April 2011).
---------------------------------------------------------------------------

    Proposed FINRA Rule 3110(b)(4) also requires that a registered 
principal review correspondence with the public and internal 
communications and evidence those reviews in writing (either 
electronically or on paper). However, proposed Supplementary Material 
.10 (Delegation of Correspondence and Internal Communication Review 
Functions) allows a supervisor/principal to delegate review functions 
to an unregistered person; however, the supervisor/principal remains 
ultimately responsible for the performance of all necessary supervisory 
reviews.
    Proposed Supplementary Material .09 (Evidence of Review of 
Correspondence and Internal Communications) codifies existing FINRA 
guidance that merely opening a communication is not sufficient 
review.\11\ Instead, a member must identify what communication was 
reviewed, the identity of the reviewer, the date of review, and the 
actions taken by the member as a result of any significant regulatory 
issues identified during the review.
---------------------------------------------------------------------------

    \11\ See Regulatory Notice 07-59 (December 2007).
---------------------------------------------------------------------------

    Finally, proposed Supplementary Material .11 (Retention of 
Correspondence and Internal Communications) requires a member to retain 
its internal communications and correspondence of associated persons 
relating to the member's investment banking or securities business in 
accordance with Exchange Act Rule 17a-4(b) \12\ and make those records 
available to FINRA upon request.
---------------------------------------------------------------------------

    \12\ 17 CFR 240.17a-4(b).
---------------------------------------------------------------------------

(v) Proposed FINRA Rule 3110(b)(5) (Review of Customer Complaints)
    Incorporated NYSE Rule 401A requires firms to acknowledge and 
respond to all customer complaints subject to the reporting 
requirements of Incorporated NYSE Rule 351(d) (Reporting Requirements). 
Previously, this meant that firms had to acknowledge and respond to 
both written and oral customer complaints. However, as part of the 
effort to harmonize the NASD and NYSE rules in the interim period 
before completion of the Consolidated FINRA Rulebook, Incorporated NYSE 
Rule 351(d) was amended to limit the definition of ``customer 
complaint'' to include only written complaints, thereby making the 
definition substantially similar to that in NASD Rule 3070(c) 
(Reporting Requirements).\13\
---------------------------------------------------------------------------

    \13\ See Exchange Act Release No. 58533 (September 12, 2008), 73 
FR 54652 (September 22, 2008) (Order Approving File No. SR-FINRA-
2008-036). As noted previously, FINRA Rule 4530 will replace NASD 
Rule 3070 and comparable provisions in Incorporated NYSE Rule 351, 
effective July 1, 2011. See supra note 9.
---------------------------------------------------------------------------

    Proposed FINRA Rule 3110(b)(5), which requires a member's 
supervisory procedures to include procedures to capture, acknowledge, 
and respond to all written (including electronic) customer complaints, 
essentially incorporates the customer complaint requirement in 
Incorporated NYSE Rule 401A, including the limitation on including only 
written (including electronic) customer complaints. FINRA believes that 
oral complaints are difficult to capture and assess, and they raise 
competing views as to the substance of the complaint being alleged. 
Consequently, oral complaints do not lend themselves as effectively to 
a review program as written complaints, which are more readily 
documented and retained. However, FINRA reminds members that the 
failure to address any customer complaint, written or oral, may be a 
violation of FINRA Rule 2010.
(vi) Proposed FINRA Rule 3110(b)(6) (Documentation and Supervision of 
Supervisory Personnel) and Proposed Supplementary Material .12
    Proposed FINRA Rule 3110(b)(6) is based largely on existing 
provisions in NASD Rule 3010(b)(3) requiring a member's supervisory 
procedures to set forth the member's supervisory system and to include 
a record of the member's supervisory personnel with such details as 
titles, registration status, locations, and responsibilities. The 
proposed rule also includes a new provision, proposed FINRA Rule 
3110(b)(6)(C), that would address potential abuses in connection with 
the supervision of supervisors. This provision would replace NASD Rule 
3012(a)(2) concerning the supervision of a producing manager's customer 
account activity and the requirement to impose heightened supervision 
when any producing manager's revenues rise above a specific threshold.
    Specifically, the proposed provision requires members to have 
procedures prohibiting associated persons who perform a supervisory 
function from:
     Supervising their own activities; and
     Reporting to, or having their compensation or continued 
employment determined by, someone they are supervising.

The proposal, however, creates an exception for a member that 
determines, with respect to any of its supervisory personnel, that 
compliance with either of these conditions is not possible because of 
the member's size or a supervisory personnel's position within the 
firm. A member relying on this exception must document the factors the 
member used to reach such determination and how the supervisory 
arrangement with respect to such supervisory personnel otherwise 
comports with proposed FINRA Rule 3110(a). Proposed Supplementary 
Material .12 (Supervision of Supervisory Personnel) explains that a 
member generally will need to rely on this exception only because it is 
a sole proprietor in a single-person firm or where a supervisor holds a 
very senior executive position within the firm. Members relying on this 
exception would not be required to notify FINRA of their reliance.\14\
---------------------------------------------------------------------------

    \14\ See NAIBD letter, infra note 21, requesting clarification 
regarding potential notification requirements for members relying on 
the proposed exception.

---------------------------------------------------------------------------

[[Page 38249]]

    Proposed FINRA Rule 3110(b)(6)(D) requires a member to have 
procedures to prevent the standards of supervision required pursuant to 
proposed FINRA Rule 3110(a) from being reduced in any manner due to any 
conflicts of interest that may be present with respect to the 
associated person being supervised, such as the person's position, the 
amount of the revenue generated by such person, or any other factor 
that would present a conflict. There is no exception from this 
provision.
(vii) Proposed FINRA Rule 3110(b)(7) (Maintenance of Written 
Supervisory Procedures) and Proposed Supplementary Material .13
    Proposed FINRA Rule 3110(b)(7), which replaces the nearly identical 
provision in NASD Rule 3010(b)(4), requires a member to retain, and 
keep current, a copy of the member's written supervisory procedures at 
each OSJ and at each location where supervisory activities are 
conducted on behalf of the member. The member must also communicate any 
amendments to its written supervisory procedures throughout its 
organization. Proposed Supplementary Material .13 (Use of Electronic 
Media to Communicate Written Supervisory Procedures) permits a member 
to distribute and amend its written supervisory procedures using 
electronic media, subject to certain conditions. Those conditions 
include: (1) Quick and easy access to the written supervisory 
procedures; (2) prompt posting of any written supervisory procedure 
amendments; (3) notifying associated persons of such amendments; (4) 
verifying, at least once each calendar year, that associated persons 
have reviewed the written supervisory procedures; (5) having reasonable 
security procedures to ensure that the written supervisory procedures 
cannot be altered by unauthorized persons; and (6) retaining current 
and prior versions of the written supervisory procedures in compliance 
with the applicable record retention requirements of Exchange Act Rule 
17a-4(e)(7).\15\
---------------------------------------------------------------------------

    \15\ 17 CFR 240.17a-4(e)(7).
---------------------------------------------------------------------------

(C) Proposed FINRA Rule 3110(c) (Internal Inspections) and Proposed 
Supplementary Material .14-.16
    Proposed FINRA Rule 3110(c)(1), based largely on NASD Rule 
3010(c)(1), retains the existing requirements for each member to 
review, at least annually, the businesses in which it engages and 
inspect each office on a specified schedule. That inspection schedule 
requires that OSJs and supervisory branch offices be inspected at least 
annually, non-supervisory branch offices be inspected at least every 
three years, and non-branch locations be inspected on a regular 
periodic schedule. The proposed rule provision also clarifies that the 
term ``annually,'' as used in proposed FINRA Rule 3110(c), means on a 
calendar-year basis.
    Proposed Supplementary Material .15 (General Presumption of Three-
Year Limit for Periodic Inspection Schedules) provides a general 
presumption that a non-branch location will be inspected at least every 
three years, even in the absence of any indicators of irregularities or 
misconduct (i.e., ``red flags''). If a member establishes a periodic 
inspection schedule longer than three years, the member must document 
in its written supervisory and inspection procedures the factors used 
in determining that a longer periodic inspection cycle is appropriate. 
As with NASD Rule 3010(c), proposed FINRA Rule 3110(c) requires a 
member to retain a written record of each review and inspection, reduce 
a location's inspection to a written report, and keep each inspection 
report on file either for a minimum of three years or, if the 
location's inspection schedule is longer than three years, until the 
next inspection report has been written.
    The proposal revises NASD Rule 3010(c)(3)'s provisions prohibiting 
certain persons from conducting office inspections to make the 
provisions less prescriptive. To that end, the proposed rule eliminates 
the heightened office inspection requirements members must implement if 
the branch office manager and the person conducting the office 
inspection report to the same person. The proposal replaces these 
requirements with provisions requiring a member to:
     Prevent the inspection standards required pursuant to 
proposed FINRA Rule 3110(c)(1) from being reduced in any manner due to 
any conflicts of interest that may be present, including but not 
limited to, economic, commercial, or financial interests in the 
associated persons and businesses being inspected; and
     Ensure that the person conducting an inspection pursuant 
to proposed FINRA Rule 3110(c)(1) is not an associated person assigned 
to the location or is not directly or indirectly supervised by, or 
otherwise reporting to, an associated person assigned to the location.

A member that determines it cannot comply with this last condition due 
to its size or business model must document in the inspection report 
both the factors the member used to make its determination and how the 
inspection otherwise comports with proposed FINRA Rule 3110(c)(1). 
Proposed Supplementary Material .16 (Exception to Persons Prohibited 
from Conducting Inspections) explains that such a determination 
generally will arise only in instances where the member has only one 
office or the member has a business model where small or single-person 
offices report directly to an OSJ manager who is also considered the 
offices' branch office manager. The proposal also retains as 
Supplementary Material .14 (Standards for Reasonable Review) the 
content of NASD IM-3010-1 (Standards for Reasonable Review) relating to 
standards for the reasonable review of offices, which has already been 
harmonized with the review requirements in analogous Incorporated NYSE 
Rule 342.10.
    In addition, the proposal relocates into proposed FINRA Rule 
3110(c)(2) certain provisions in NASD Rule 3012 regarding the review 
and monitoring of certain specific activities, such as transmittals of 
funds and securities and customer changes of address and investment 
objectives. Specifically, proposed FINRA Rule 3110(c)(2)(A) requires a 
member to test and verify a location's procedures for the safeguarding 
of customer funds and securities, maintenance of books and records, 
supervision of supervisory personnel, transmittals of funds or 
securities, and changes of customer account information, including 
address and investment objective changes and validation of such 
changes.
    Proposed FINRA Rule 3110(c)(2)(B) requires a means or method of 
customer confirmation regarding transmittals of funds and securities 
but makes clear that members may use risk-based methods to determine 
the authenticity of the transmittal instructions. Proposed FINRA Rule 
3110(c)(2)(C) also requires a means or method of customer confirmation 
for changes of customer account information. Finally, proposed FINRA 
Rule 3110(c)(2)(D) makes clear that if a location being inspected does 
not engage in all of the activities listed above, the member must 
identify those activities in the location's written inspection report 
and document in the report that supervisory policies and procedures 
must be in place at that location before the location can engage in 
them.

[[Page 38250]]

(D) Proposed FINRA Rule 3110(d) (Transaction Review and Investigation)
    Section 15(g) of the Act,\16\ adopted as part of the Insider 
Trading and Securities Fraud Enforcement Act of 1988 (``ITSFEA''),\17\ 
requires every registered broker or dealer to establish, maintain, and 
enforce written policies and procedures reasonably designed to prevent 
the misuse of material, non-public information by the broker or dealer 
or any associated person of the broker or dealer. Incorporated NYSE 
Rule 342.21 sets forth specific supervisory procedures for compliance 
with ITSFEA by requiring firms to review trades in NYSE-listed 
securities and related financial instruments that are effected for the 
member's account or for the accounts of the member's employees and 
family members. Incorporated NYSE Rule 342.21 also requires members to 
promptly conduct an internal investigation into any trade the firm 
identifies that may have violated insider trading laws or rules.
---------------------------------------------------------------------------

    \16\ 15 U.S.C. 78o(g).
    \17\ See Insider Trading and Securities Fraud Enforcement Act of 
1988, Pub. L. No. 100-704, 102 Stat. 4677.
---------------------------------------------------------------------------

    FINRA is proposing FINRA Rule 3110(d) to incorporate into the 
Consolidated FINRA Rulebook the provisions of Incorporated NYSE Rule 
342.21, with some modifications, and extend the requirement beyond 
NYSE-listed securities and related financial instruments to cover all 
securities. Specifically, proposed FINRA Rule 3110(d)(1) requires a 
member to have supervisory procedures for the review of securities 
transactions that are effected for the account(s) of the member and/or 
associated persons of the member as well as any other ``covered 
account'' \18\ to identify trades that may violate the provisions of 
the Act, the rules thereunder, or FINRA rules prohibiting insider 
trading and manipulative and deceptive devices. The proposed rule 
change also requires members to promptly conduct an internal 
investigation into any identified trades to determine whether a 
violation of those laws or rules has occurred.
---------------------------------------------------------------------------

    \18\ Proposed FINRA Rule 3110(d)(3)(A) defines the term 
``covered account'' to include (i) any account held by the spouse, 
child, son-in-law, or daughter-in-law of a person associated with 
the member where such account is introduced or carried by the 
member; (ii) any account in which a person associated with the 
member has a beneficial interest; and (iii) any account over which a 
person associated with the member has the authority to make 
investment decisions.
---------------------------------------------------------------------------

    Proposed FINRA Rule 3110(d)(2) requires any member that engages in 
``investment banking services,'' \19\ to provide reports to FINRA 
regarding such investigations. These members would be required to make 
reports to FINRA within ten business days of the initiation of an 
investigation, each quarter to update the status of all ongoing 
investigations, and within five business days of the conclusion of an 
investigation.
---------------------------------------------------------------------------

    \19\ Proposed FINRA Rule 3110(d)(3)(B) defines the term 
``investment banking services'' to include, without limitation, 
acting as an underwriter, participating in a selling group in an 
offering for the issuer, or otherwise acting in furtherance of a 
public offering of the issuer; acting as a financial adviser in a 
merger or acquisition; providing venture capital or equity lines of 
credit or serving as placement agent for the issuer or otherwise 
acting in furtherance of a private offering of the issuer. This 
proposed definition is the same definition as in proposed FINRA Rule 
2240(a)(4) (Research Analysts and Research Reports). See Regulatory 
Notice 08-55 (October 2008).
---------------------------------------------------------------------------

(E) Proposed FINRA Rule 3110(e) (Definitions)
    Proposed FINRA Rule 3110(e) retains the definitions of ``branch 
office,'' ``office of supervisory jurisdiction,'' and ``business day'' 
in NASD Rule 3010(g). The branch office definition already has been 
harmonized with the definition of ``branch office'' in Incorporated 
NYSE Rule 342.10.
(2) Proposed FINRA Rule 3120 (Supervisory Control System)
    FINRA is proposing to replace NASD Rule 3012 (Supervisory Control 
System) with FINRA Rule 3120. Proposed FINRA Rule 3120(a) retains NASD 
Rule 3012(a)(1)'s testing and verification requirements for the 
member's supervisory procedures, including the requirement to prepare 
and submit to the member's senior management a report at least annually 
summarizing the test results and any necessary amendments to those 
procedures.
    Proposed FINRA Rule 3120(b) requires a member that reported $150 
million or more in gross revenue (total revenue less, if applicable, 
commodities revenue) on its FOCUS reports in the prior calendar year to 
include in the report it submits to senior management:
     A tabulation of the reports pertaining to customer 
complaints and internal investigations made to FINRA during the 
preceding year; and
     A discussion of the preceding year's compliance efforts, 
including procedures and educational programs, in each of the following 
areas:
    [cir] Trading and market activities;
    [cir] Investment banking activities;
    [cir] Antifraud and sales practices;
    [cir] Finance and operations;
    [cir] Supervision;
    [cir] Anti-money laundering; and
    [cir] Risk management.
    With the exception of risk management, the categories listed above 
are incorporated from the annual report content requirements of 
Incorporated NYSE Rule 342.30 (Annual Report and Certification). The 
requirement to adequately manage the risks of a member's business is an 
inherent part of the member's obligations under FINRA's supervision and 
supervisory control rules. Accordingly, FINRA believes that a 
discussion of the member's compliance efforts in the area of risk 
management should be included in proposed FINRA Rule 3120's additional 
annual report content requirements.
(3) Proposed FINRA Rule 3150 (Holding of Customer Mail)
    The proposed rule change replaces NASD Rule 3110(i) (Holding of 
Customer Mail) with proposed FINRA Rule 3150, a more general rule that 
eliminates the strict time limits in NASD Rule 3110(i) and generally 
allows a member to hold a customer's mail for a specific time period in 
accordance with the customer's written instructions if the member meets 
certain conditions. Specifically, proposed FINRA Rule 3150(a) provides 
that a member may hold mail for a customer who will not be receiving 
mail at his or her usual address, provided that the member:
     Receives written instructions from the customer that 
include the time period during which the member is requested to hold 
the customer's mail. If the time period included in the customer's 
instructions is longer than three consecutive months (including any 
aggregation of time periods from prior requests), the customer's 
instructions must include an acceptable reason for the request (e.g., 
safety or security concerns). Convenience is not an acceptable reason 
for holding mail longer than three months;
     Informs the customer in writing of any alternate methods, 
such as e-mail or access through the member's Web site, that the 
customer may use to receive or monitor account activity and information 
and obtains the customer's confirmation of the receipt of such 
information; and
     Verifies at reasonable intervals that the instructions 
still apply.
    In addition, proposed FINRA Rule 3150(b) requires that the member 
be able to communicate, as necessary, with the customer in a timely 
manner during the time the member is holding the customer's mail to 
provide important account information (e.g., privacy notices, the SIPC 
information disclosures required by FINRA Rule 2266).
    Finally, proposed FINRA Rule 3150(c) requires a member holding a 
customer's mail to take actions reasonably designed

[[Page 38251]]

to ensure that the customer's mail is not tampered with, held without 
the customer's consent, or used by an associated person of the member 
in any manner that would violate FINRA rules, MSRB rules, or the 
Federal securities laws.
(4) Proposed FINRA Rule 3170 (Tape Recording of Registered Persons by 
Certain Firms)
    FINRA proposes to reconstitute NASD Rule 3010(b)(2) (Tape Recording 
of Conversations) without any substantive changes as new FINRA Rule 
3170 (Tape Recording of Registered Persons by Certain Firms). The only 
proposed changes to the rule text are minor editorial changes to assist 
with readability, changes to the definition of disciplinary history to 
reflect the adoption of certain enumerated NASD rules as FINRA rules, 
and a definition clarifying that the term ``tape recording'' includes 
without limitation, any electronic or digital recording that meets the 
requirements of proposed FINRA Rule 3170.
(5) Proposed FINRA Rule 1260 (Responsibility of Member To Investigate 
Applicants for Registration)
    FINRA is proposing to relocate the requirements in NASD Rule 
3010(e) (Qualifications Investigated) concerning a member's 
responsibilities during the pendency of a person's application for 
registration as a representative or principal to a standalone new 
registration rule, FINRA Rule 1260 (Responsibility of Member to 
Investigate Applicants for Registration). In addition, the proposed 
rule change deletes NASD Rule 3010(f) (Applicant's Responsibility) 
requiring an applicant for registration to provide, upon a member's 
request, a copy of his or her Form U5. The provision is no longer 
necessary because members now have electronic access to an applicant's 
Form U5 through the Central Registration Depository.
(6) Proposal To Eliminate Certain NYSE Rules
    As mentioned previously, the proposed rule change deletes 
corresponding provisions in the Incorporated NYSE Rules and 
Interpretations that are, in main part, either duplicative of, or do 
not align with, the proposed supervision requirements discussed above. 
Specifically, the proposed deleted rule provisions are:
     Incorporated NYSE Rule 342;
     NYSE Rule Interpretations 342(a)(b)/01 through 342(a)(b)/
03, 342(b)/01 through 342(b)/02, 342(c)/02, 342(e)/01, 342.10/01, 
342.13/01, 342.15/01 through 342.15/05, 342.16/01 through 342.16/03;
     Incorporated NYSE Rules 343, 343.10 and NYSE Rule 
Interpretation 343(a)/01;
     Incorporated NYSE Rule 351(e) and NYSE Rule Interpretation 
351(e)/01;
     Incorporated NYSE Rule 354; and
     Incorporated NYSE Rule 401.
    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,\20\ 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 also believes that the proposed rule change will 
clarify and streamline the supervision and supervisory rules for 
adoption as FINRA Rules in the Consolidated FINRA Rulebook.
---------------------------------------------------------------------------

    \20\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

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

    FINRA published the proposed rules in Regulatory Notice 08-24 (May 
2008) requesting comment from interested parties. A copy of the 
Regulatory Notice is attached as Exhibit 2a. FINRA received 47 comment 
letters. A list of the commenters and copies of the comment letters 
received are attached as Exhibits 2b and 2c, respectively.\21\ The 
comments and FINRA's responses are discussed below.
---------------------------------------------------------------------------

    \21\ All references to commenters in this rule filing are to the 
commenters as listed in Exhibit 2b.
---------------------------------------------------------------------------

(a) General Comments
    Many of the commenters expressed general support for the proposed 
rules. Commenters especially commended FINRA for proposing rules that 
give members the flexibility to design supervisory procedures that 
reflect their individual business models, as well as eliminating 
obsolete and/or duplicative requirements.\22\
---------------------------------------------------------------------------

    \22\ ProEquities, ICBA Financial, WealthTrust, LPL, Nationwide 
Financial, NAIBD, Northwestern Mutual, ING, Prudential, Comerica, 
WilmerHale, Charles Schwab, CCS.
---------------------------------------------------------------------------

    One commenter, PIABA, opposed the flexibility within the proposed 
rules, including the proposed risk-based review standards for the 
approval of securities transactions and the review of certain 
correspondence, arguing that such flexibility appears to reduce the 
supervision requirements, thereby diminishing the protection of the 
investing public. FINRA disagrees. The proposed rules include 
prescriptive provisions where necessary, while also providing firms 
with additional flexibility to establish their supervisory programs in 
a manner that reflects their business models, where consistent with the 
principles of investor protection and market integrity. In this regard, 
the proposal retains certain specific requirements of NASD Rules 3010 
and 3012, such as mandatory inspection cycles, prohibitions on who can 
conduct location inspections, and procedures for the monitoring of 
certain enumerated activities, while providing additional prescriptive 
requirements where necessary, including special supervision for 
supervisory personnel rather than just the existing special supervision 
for producing branch managers, specific procedures to detect and 
investigate potential insider trading violations, and additional 
content requirements for certain firms' annual reports. Additionally, 
with respect to the risk-based review of correspondence, as explained 
further below, the proposed rules would codify certain existing 
guidance.
    One commenter requested that all supplementary material be moved 
into the ``body'' of the proposed rules.\23\ FINRA notes that 
supplementary material is considered part of the rule and carries the 
same force of regulation. Supplementary material provisions provide 
additional detail regarding a requirement that either appears elsewhere 
in the rule or is of special significance.
---------------------------------------------------------------------------

    \23\ National Planning.
---------------------------------------------------------------------------

(b) Comments on Proposed FINRA Rule 3110(a) (Supervisory System)
(1) Use of ``Associated Person''
    Several commenters objected to the use of the term ``associated 
person'' in the preamble of proposed FINRA Rule 3110(a), arguing that 
FINRA could

[[Page 38252]]

effectively expand its jurisdiction over non-broker-dealer entities by 
broadly interpreting this term to include a member's affiliates and the 
affiliates' employees.\24\ To avoid this result, the commenters 
suggested retaining the reference in NASD Rule 3010(a) to ``registered 
representative, registered principal, and other associated person.''
---------------------------------------------------------------------------

    \24\ National Planning, Cornerstone Financial, Nationwide 
Financial, Great American Advisors, FSI.
---------------------------------------------------------------------------

    These concerns are unfounded as the FINRA By-Laws specifically 
define who is an ``associated person of a member.'' \25\ Included in 
that definition are all persons who are registered (or have applied for 
registration) with FINRA. Accordingly, in drafting proposed FINRA Rule 
3110(a), FINRA omitted the references to registered representatives and 
principals as duplicative and unnecessary. The elimination of the terms 
``registered representative'' and ``registered principal'' does not 
alter the reach of the provision or expand FINRA's jurisdiction in any 
way. FINRA's jurisdiction continues to extend to all persons, 
regardless of affiliation, that meet the associated person definition.
---------------------------------------------------------------------------

    \25\ See FINRA By-Laws Art. 1(rr); see also Notice to Members 
98-38 n.5 (May 1998) (citing the same By-Laws definition to clarify 
the term ``associated person'').
---------------------------------------------------------------------------

(2) Permissive Licenses
    Commenters also suggested that proposed FINRA Rule 3110(a) should 
acknowledge that associated persons holding permissive licenses who do 
not engage in securities activities can have a different level of 
supervision than registered persons actively engaged in securities 
activities.\26\ To that end, certain commenters even suggested that 
FINRA rewrite proposed FINRA Rule 3110(a) to refer only to associated 
persons who are ``actively engaged in the securities business of the 
firm.'' \27\ In response, FINRA notes that it has separately issued for 
comment the proposed consolidated FINRA rules governing registration 
and qualification requirements.\28\ Among other things, those proposed 
rules address permissive registration categories and members' 
differentiated supervisory obligations with respect to persons 
registered pursuant to such categories.
---------------------------------------------------------------------------

    \26\ FSI, Cornerstone Financial.
    \27\ Great American Advisors, National Planning, M Holdings.
    \28\ See Regulatory Notice 09-70 (December 2009).
---------------------------------------------------------------------------

(3) MSRB Rules
    One commenter questioned the proposed requirement to have a 
supervisory system that is reasonably designed to achieve compliance 
with MSRB rules, arguing that members affiliated with banks that have 
opted to conduct their municipal securities business within a bank 
should not be required to supervise in-bank municipal securities 
activities.\29\ Any member that falls within the Act's definitions of 
``municipal securities broker'' or ``municipal securities dealer'' must 
comply with all applicable obligations, including the obligation to 
supervise the municipal securities activities of its associated persons 
and the conduct of its municipal securities business, set forth in the 
Federal securities law and MSRB rules. Proposed FINRA Rule 3110(a) does 
not alter this basic premise. Rather, it supports the premise by 
expressly requiring members to have supervisory procedures that are 
reasonably designed to achieve compliance with the applicable Federal 
securities laws and regulations, FINRA rules, and MSRB rules.
---------------------------------------------------------------------------

    \29\ ABA.
---------------------------------------------------------------------------

    Additionally, although FINRA enforces and examines its members for 
compliance with MSRB rules, current NASD Rule 3010(a) does not 
expressly require members to design supervisory systems to achieve 
compliance with the MSRB rules. The proposed rule change clarifies that 
supervisory systems must extend to compliance with MSRB rules and also 
aligns FINRA's supervisory system requirement with the existing 
requirement under MSRB rules to have a supervisory system that is 
reasonably designed to achieve compliance with applicable securities 
laws and regulations and MSRB rules.\30\
---------------------------------------------------------------------------

    \30\ See MSRB Rule G-27(b).
---------------------------------------------------------------------------

    FINRA is not making any changes to the preamble in proposed FINRA 
Rule 3110(a) in response to the comments above.
(c) Comments on Proposed FINRA Rule 3110(a)(2): Designated Principal
(1) A Designated Principal for All Business Lines
    As proposed in Regulatory Notice 08-24, FINRA Rule 3110(a)(2) 
required a member to designate an appropriately registered principal(s) 
with authority to carry out the member's supervisory responsibilities 
for all of a member's business lines, regardless of whether a business 
line required broker-dealer registration. Commenters had several 
reactions to this proposed change. Some commenters asked whether the 
proposed change would expand FINRA's jurisdiction and rules into non-
securities activities, such as insurance and investment advisory 
services that are already regulated by other regulators.\31\ Other 
commenters asked about the appropriate principal registration license 
for persons responsible for non-broker-dealer business lines.\32\ One 
commenter asked how a firm would comply with the provision without 
violating the prohibition in NASD Rule 1021(a) (All Principals Must Be 
Registered) prohibiting principal registration of associated persons 
who are not currently engaging in a member's investment banking or 
securities business.\33\
---------------------------------------------------------------------------

    \31\ Cornerstone Financial, National Planning, Comerica, LPL, 
Nationwide Financial, Great American Advisors, Janney, FSI, NAIBD, 
WilmerHale, CAI, Charles Schwab, CCS, NSCP, SIFMA, Wachovia 
Securities, FPA, ING, NFA.
    \32\ Janney, Charles Schwab, SIFMA, Wachovia Securities, FPA, 
NFA.
    \33\ SIFMA. NASD Rule 1021(a) permits a member to maintain a 
principal license for an associated person who performs legal, 
compliance, internal audit, back office operations, or similar 
responsibilities for the member or a person engaged in the 
investment banking or securities business of a foreign securities 
affiliate or subsidiary of the member.
---------------------------------------------------------------------------

    The proposed rule change was intended to explicitly address the 
fact that a member is responsible for having a supervisory system that 
encompasses all of its business lines. Thus, if a member chooses to 
engage in a business that does not require registration as a broker-
dealer, the member is nonetheless responsible for supervising that 
business. To avoid further confusion, FINRA has proposed to retain the 
language in NASD Rule 3010(a) and adopt supplementary material 
explaining this requirement. Consequently, proposed Supplementary 
Material .01 (Business Lines) provides that for a member's supervisory 
system required by proposed FINRA Rule 3110(a) to be reasonably 
designed to achieve compliance with FINRA Rule 2010, it must include 
supervision for all of the member's business lines irrespective of 
whether they require broker-dealer registration.
    As FINRA noted in Regulatory Notice 08-24, the requirement that a 
member supervise all of its business lines is consistent with NASD Rule 
3010(b)(1) (and proposed FINRA Rule 3110(b)(1)), which currently 
requires a member to have supervisory procedures for all business 
activities in which it engages. Additionally, a member's responsibility 
for appropriate supervision for all of its business activities is 
consistent with a member's obligation under FINRA Rule 2010 to observe 
high standards of commercial honor and just and equitable principles of 
trade in the conduct of its business.\34\ These general

[[Page 38253]]

ethical standards protect investors and the securities industry from 
dishonest practices that are unfair to investors or hinder the 
functioning of a free and open market, regardless of whether those 
practices occur in business lines that do not require broker-dealer 
registration or are not illegal or violate a specific rule, law, or 
regulation.\35\ The proposal merely codifies, under proposed FINRA Rule 
3110, a member's duty required by FINRA Rule 2010 to supervise all 
business activities, irrespective of whether they are part of a 
member's investment banking or securities business.\36\
---------------------------------------------------------------------------

    \34\ FINRA is required under the Act to have rules that, among 
other things, are designed to prevent fraudulent and manipulative 
acts and practices and to promote just and equitable principles of 
trade. 15 U.S.C. 78o-3(b)(6).
    \35\ See Ialeggio v. SEC, No. 98-70854, 1999 U.S. App. LEXIS 
10362, at *4-5 (9th Cir. May 20, 1999) (``NASD's disciplinary 
authority is broad enough to encompass business-related conduct that 
is inconsistent with just and equitable principles of trade, even if 
that activity does not involve a security.'') (citations omitted).
    \36\ A number of other FINRA rules apply to conduct irrespective 
of whether securities transactions are directly involved. For 
instance, NASD Rule 2210 (Communications with the Public) requires 
that all member communications with the public be based on 
principles of fair dealing and good faith and prohibits the 
distribution to the public of exaggerated, unwarranted, or 
misleading advertisements and sales literature. See Robert L. 
Wallace, 53 S.E.C. 989, 995 (1998) (Rule 2210 is ``not limited to 
advertisements for securities, but provide[s] standards applicable 
to all NASD member communications with the public''). See also 
Daniel C. Adams, 47 S.E.C. 919, 920-21 (1983) (finding that it was 
within NASD's authority pursuant to NASD Rule 8210 (now FINRA Rule 
8210) to investigate and seek information about a product that the 
broker was selling even assuming that the product was not a 
security).
---------------------------------------------------------------------------

(d) Comments on Proposed Supplementary Material .03 (Designation of 
Additional OSJs)
    Several commenters raised questions regarding the factors set forth 
in proposed Supplementary Material .03 that a member should consider in 
designating additional OSJs.\37\ One commenter requested that FINRA 
delete the factor regarding whether registered persons at the location 
engage in retail sales or other activities involving regular customer 
contact with the public as it was not a previously articulated 
factor.\38\ Two other commenters asked that FINRA clarify the terms 
``diverse'' and ``complex'' as used in the factors.\39\ FINRA notes 
that proposed Supplementary Material .03 transfers NASD Rule 3010(a)(3) 
unchanged into the Consolidated FINRA Rulebook without adding any new 
requirements or language. No single factor is dispositive, but members 
must use these factors, as necessary, to supervise their associated 
persons and activities in accordance with proposed FINRA Rule 3110.
---------------------------------------------------------------------------

    \37\ Thornburg, NAIBD, Cornerstone Financial, FSI.
    \38\ NAIBD.
    \39\ Cornerstone Financial, FSI.
---------------------------------------------------------------------------

(e) Comments on Proposed FINRA Rule 3110(a)(4) and Supplementary 
Material .04 and .05
    Commenters requested clarification regarding several aspects of the 
requirement in proposed Rule 3110(a)(4) for a member to designate an 
appropriately registered principal in each OSJ to carry out supervisory 
responsibilities assigned to that location and the proposed 
Supplementary Material .04 (One-Person OSJs) and .05 (Supervision of 
Multiple OSJs by a Single Principal).\40\ In main part, the commenters' 
concerns are centered on their belief that the proposed provisions do 
not take into account the business and supervisory structure of 
independent dealer firms and appear to be more tailored to 
``wirehouses.'' Specifically, one commenter objected to the requirement 
in proposed Supplementary Material .04 to designate a senior principal 
to supervise the activities of a producing on-site principal at a one-
person OSJ.\41\ The commenter believed that a producing manager at one-
person OSJs should be able to supervise his or her own activities. The 
commenter noted that its firm employs a ``field OSJ'' supervisory 
structure that permits field OSJ staff to conduct supervisory functions 
and also be producing managers. The commenter stated that requiring an 
on-site principal to supervise one-person OSJs would result in the firm 
needing over 3,300 new staff in the field.
---------------------------------------------------------------------------

    \40\ LPL, Cornerstone Financial, FSI.
    \41\ LPL.
---------------------------------------------------------------------------

    Proposed Supplementary Material .04 codifies existing FINRA 
guidance on the designation and supervision of one-person OSJs. The 
provision makes clear that a member may establish a one-person OSJ and 
also clarifies how a member can establish reasonable on-site 
supervision on a regular periodic schedule determined by the member at 
a one-person OSJ in light of the core concept that a principal cannot 
supervise his or her own activities. A one-person office that is 
designated an OSJ because it engages in final approval of new accounts 
or sales literature presents an inherently different supervisory 
challenge than a one-person OSJ location where the single on-site 
principal engages in structuring public offerings and/or is a producer. 
In the latter instance, the proposed supplementary material makes clear 
that the principal cannot supervise his or her own sales activities due 
to the conflict of interest such situation presents. Accordingly, FINRA 
believes that the requirement to have a senior principal regularly 
supervise the activities of an on-site producing principal is necessary 
to ensure that the on-site principal's activities are appropriately 
supervised.
    With respect to concerns regarding the need for additional 
personnel to meet the proposed requirements, FINRA believes that the 
proposed supplementary material provides members with flexibility in 
designing a supervisory scheme for these locations by not mandating a 
specific schedule, but rather, permitting the member to establish the 
schedule after considering certain factors (e.g., the nature and 
complexity of the securities activities for which the location is 
responsible, the nature and extent of contact with customers, and the 
disciplinary history of the on-site principal). Consequently, FINRA has 
not revised the proposed supplementary material as requested by the 
commenters.
    Several commenters requested that FINRA revise the presumption in 
proposed Supplementary Material .05 that a principal cannot supervise 
more than one OSJ to allow a registered principal to supervise 
additional OSJs.\42\ In addition, at least one commenter stated that 
firms and their registered principals should be allowed to determine 
the appropriate number of offices assigned to each OSJ manager and the 
rules ``should clearly reflect that firms have this freedom in 
designing their supervisory system.'' \43\ Commenters further stated 
that the requirement of a ``physical presence'' on a regular and 
routine basis is overly burdensome and biased against independent 
broker-dealer firms.\44\
---------------------------------------------------------------------------

    \42\ LPL, Cornerstone Financial, FSI.
    \43\ Cornerstone Financial.
    \44\ Thornburg, Cornerstone Financial, FSI, NAIBD, SIFMA.
---------------------------------------------------------------------------

    FINRA does not agree that the proposed supplementary material is 
biased against independent dealer firms. Members are currently required 
under NASD Rule 3010(a)(4) to designate an appropriately registered 
principal in each OSJ and an appropriately registered representative or 
principal in each non-OSJ branch office with authority to carry out 
supervisory responsibilities. Proposed FINRA Rule 3110(a)(4) transfers 
that provision unchanged into the Consolidated FINRA Rulebook. The one-
principal-per-OSJ presumption in proposed Supplementary Material .05 
explains the meaning of the term ``in each OSJ'' in proposed FINRA Rule 
3110(a)(4). This presumption does not limit a

[[Page 38254]]

member's ability to have more than one principal in the supervisory 
chain for an OSJ. Rather, FINRA believes that the presumption is 
consistent with the long-standing requirement in NASD Rule 3010(a)(4) 
for members to have an on-site principal in each OSJ location, which is 
a cornerstone of a member's supervisory structure. Moreover, FINRA 
believes that physical presence, on a regular and routine basis, by a 
supervisor at a location that engages in significant activities is 
necessary for effective oversight. The presumption ensures that such 
on-site principal has sufficient time and resources to engage in 
meaningful supervision. However, in response to the comments, FINRA has 
modified proposed Supplementary Material .05 to make it clear that the 
presumption applies only to the designation of the on-site principal 
supervisor required for FINRA Rule 3110(a)(4) purposes in each OSJ 
location.
(f) Comments on Proposed Supplementary Material .06 (Annual Compliance 
Meeting)
    Several commenters supported proposed Supplementary Material .06, 
which allows a member to conduct annual compliance meetings through 
electronic means rather than holding in-person meetings.\45\ Two 
commenters, however, asked that the text be simplified or 
clarified.\46\ One of the commenters also asked that the term 
``presenter'' be deleted, as ``many webcasts have audio recordings and 
screens, rather than presenters, and employees with questions may be 
directed to an email address or group of individuals, rather than to a 
single presenter.'' \47\ FINRA believes that the proposed rule text 
provides significant flexibility as to the methods members may choose 
to conduct their annual compliance meetings; however, in response to 
commenters' concerns, FINRA has revised the proposed rule to eliminate 
the term ``presenter,'' thereby further recognizing that members may 
employ methods that may not necessarily involve a specific presenter. 
The proposed rule would continue to require that registered persons 
attending the meeting be able to ask questions regarding the 
presentation and receive answers in a timely fashion (e.g., an on-
demand annual compliance Web cast that allows registered persons to ask 
questions via an e-mail to a presenter or a centralized address or via 
a telephone hotline and receive timely responses directly or view such 
responses on the member's intranet site). FINRA also reminds members 
that the proposed supplementary material requires a member to ensure, 
at a minimum, that each registered person attends the entire meeting.
---------------------------------------------------------------------------

    \45\ NAIBD, ING, SIFMA.
    \46\ ING, SIFMA.
    \47\ SIFMA.
---------------------------------------------------------------------------

(g) Comments on Proposed FINRA Rule 3110(b)(1) (General Requirements) 
(1) Use of ``Associated Person''
    Several commenters objected to the use of the term ``associated 
person'' by itself in proposed FINRA Rule 3110(b)(1), arguing that its 
use could effectively expand FINRA's jurisdiction to include a member's 
affiliates.\48\ This argument is similar to those raised by commenters 
objecting to the same proposed change in FINRA Rule 3110(a). As noted 
in FINRA's response to that argument, the use of ``associated person'' 
by itself does not effectively expand FINRA's jurisdiction as the FINRA 
By-Laws specifically define who is considered an ``associated person of 
a member.'' \49\ Included in the definition are persons who are 
registered (or have applied for registration) with FINRA, which 
includes registered representatives and registered principals. 
Accordingly, FINRA drafted proposed FINRA Rule 3110(b)(1) without the 
references to registered representatives and principals because such 
persons are already included in the term ``associated person.''
---------------------------------------------------------------------------

    \48\ National Planning, Cornerstone Financial, Nationwide 
Financial, Great American Advisors.
    \49\ See FINRA By-Laws, Art. 1(rr); see also Notice to Members 
98-38 n.5 (May 1998) (citing the same By-Laws definition to clarify 
the term ``associated person'').
---------------------------------------------------------------------------

(2) Scope of Supervisory Procedures
    Some commenters suggested narrowing the scope of FINRA Rule 
3110(b)(1) by having a member's written supervisory procedures address 
only those types of business for which broker-dealer registration is 
required.\50\ FINRA declines to adopt this suggestion for several 
reasons. First, NASD Rule 3010(b)(1) currently requires a member to 
have supervisory procedures to supervise all types of business in which 
it engages. Proposed FINRA Rule 3010(b)(1) merely retains this existing 
requirement. Second, as explained above, a member's supervisory system 
must include appropriate supervision for all of its business activities 
in order to comply with its obligations under FINRA Rule 2010 to 
protect investors and the securities industry from dishonest practices 
that are unfair to investors or hinder the functioning of a free and 
open market.
---------------------------------------------------------------------------

    \50\ National Planning, Cornerstone Financial, FSI.
---------------------------------------------------------------------------

(h) Comments on Proposed FINRA Rule 3110(b)(2) (Review of a Member's 
Investment Banking and Securities Business)
(1) ``One Size Fits All''
    Two commenters objected to the proposed provision requiring a 
member to review its investment banking and securities business on the 
basis that a firm's investment banking business and its securities 
business are inherently different and that any supervisory review for 
these businesses should not be subject to a ``one-size-fits-all 
approach.'' \51\ The commenters build on their objection with the 
arguments that since members adopt specific supervisory structures and 
supervisory procedures specific to their investment banking businesses, 
implementing this proposed requirement would be ``unnecessary'' and 
``duplicative.'' \52\ These objections do not take into account the 
fact that a member's supervisory procedures should be tailored to a 
member's business. As long as a member has supervisory procedures that 
meet the requirements of the proposed rule, a member may design 
procedures specific to its individual business lines.
---------------------------------------------------------------------------

    \51\ Janney, SIFMA.
    \52\ Id.
---------------------------------------------------------------------------

(2) Use of Risk-Based Principles
    Several commenters requested that the risk-based provision in 
proposed Supplementary Material .07 be inserted into the body of the 
rule.\53\ As noted previously, supplementary material is part of the 
rule. FINRA believes that locating the risk-based discussion as 
supplementary material improves the readability of the rule without 
affecting the weight or significance of the provision. Finally, one 
commenter requested that FINRA clarify the meaning of the term ``risk-
based.'' \54\ The term ``risk-based,'' which the proposed rule uses in 
several places, describes the type of methodology a member may use to 
identify and prioritize for review those areas that pose the greatest 
risk of potential securities laws and self-regulatory organization 
(``SRO'') rule violations. FINRA acknowledges that members may need to 
prioritize their review processes due to the volume of information that 
must be reviewed by using a review methodology based on a reasonable 
sampling of information in

[[Page 38255]]

which the sample is designed to discern the degree of overall 
compliance, the areas that pose the greatest numbers and risks of 
violation, and any possibly needed changes to firm policies and 
procedures. In addition, FINRA believes that allowing risk-based review 
in limited circumstances improves investor protection by ensuring that 
those areas that pose the greatest potential for investor harm are 
reviewed more quickly to uncover potential violations.
---------------------------------------------------------------------------

    \53\ Cornerstone Financial, FSI, LPL, Nationwide Financial, 
Great American Advisors, Janney, NSCP, SIFMA, ING.
    \54\ PIABA.
---------------------------------------------------------------------------

(i) Comments on Proposed FINRA Rule 3110(b)(3) (Supervision of Outside 
Securities Activities)
    As noted above, proposed FINRA Rule 3110(b)(3) is reserved for 
future rule making. Accordingly, FINRA is not addressing any comments 
received on proposed FINRA Rule 3110(b)(3) and related Supplementary 
Material .07 as such comments are outside of the scope of this proposed 
rule change.
(j) Comments on Proposed FINRA Rule 3110(b)(4) (Review of 
Correspondence and Internal Communications) and Supplementary Material 
.08-.11
    One commenter suggested that proposed FINRA Rule 3110(b)(4) and 
proposed Supplementary Material .08 (Risk-based Review of 
Correspondence and Internal Communications) could be read to create a 
new affirmative obligation to supervise all written and electronic 
internal communications relating to investment banking and securities 
activities.\55\ This conclusion appears to be a misreading of the 
proposed rule change. As explained in the Purpose section, although 
there are certain communications that members must review, members may 
use risk-based review principles to determine the extent to which 
additional communications should be reviewed.\56\
---------------------------------------------------------------------------

    \55\ Charles Schwab.
    \56\ In a related comment, several commenters requested that 
FINRA move the proposed supplementary material regarding the use of 
risk-based review and delegation of review into the body of proposed 
FINRA Rule 3110(b)(4). SIFMA, Janney, Baum, Cornerstone Financial, 
Nationwide Financial, Great American Advisors, FSI. As previously 
explained, the proposed supplementary material is part of the 
proposed rule.
---------------------------------------------------------------------------

    Proposed FINRA Rule 3110(b)(4) requires each member to have 
supervisory procedures to review its incoming and outgoing (including 
electronic) correspondence with the public and internal communications 
relating to the member's investment banking or securities business to 
ensure that the member properly identifies and handles in accordance 
with firm procedures, among other things, customer complaints, 
instructions, and funds and securities. Two commenters noted that this 
requirement conflicted with the guidance in Regulatory Notice 07-59, 
which the commenters contend does not instruct members to review 
internal communications for these topics (outside of those relating to 
the identifying and reporting of customer complaints).\57\ FINRA 
believes that proposed FINRA Rule 3110(b)(4) and the guidance in 
Regulatory Notice 07-59 do not conflict. Regulatory Notice 07-59 
specifically notes that a member must have procedures for the review of 
its associated persons' incoming, outgoing, and internal electronic 
communications that are of a subject matter that require review under 
FINRA rules and the Federal securities laws. It is FINRA's view that 
the categories at issue are of a subject matter that would require 
review under the Federal securities laws and FINRA rules, including 
current NASD Rule 3010(d)(2).
---------------------------------------------------------------------------

    \57\ SIFMA, Janney.
---------------------------------------------------------------------------

    Several commenters also requested that FINRA replace the phrase 
``to ensure'' in proposed FINRA Rule 3110(b)(4) with ``reasonably 
designed to ensure.'' \58\ FINRA declines to make this requested 
change. Proposed FINRA Rule 3010(b)(1) already requires a member to 
have reasonably designed written procedures. The term ``to ensure'' is 
the standard around which those supervisory procedures must be 
designed. Altering the standard to read ``reasonably designed to 
ensure'' is a redundancy and would only serve to weaken the standard.
---------------------------------------------------------------------------

    \58\ Cornerstone Financial, Nationwide Financial, Great American 
Advisors, FSI, NAIBD, ING.
---------------------------------------------------------------------------

    SIFMA and Janney requested that FINRA delete the provision in 
proposed Supplementary Material .09 (Evidence of Review of 
Correspondence and Internal Communications) stating that merely opening 
a communication is not sufficient review. NAIBD also supported deleting 
this provision, noting that electronic review systems could become more 
sophisticated and thus, render the sentence obsolete. FINRA declines to 
delete this provision as it codifies existing guidance that FINRA 
believes remains appropriate.\59\ Whether technological advances would 
render this provision obsolete in the future is an issue that FINRA 
will address when, and if, such technology exists.
---------------------------------------------------------------------------

    \59\ See Regulatory Notice 07-59 (December 2007).
---------------------------------------------------------------------------

    NAIBD requested that FINRA acknowledge that a reviewer can be an 
electronic system. A reviewer may decide to use an electronic review 
system to assist with his or her review functions but the assigned 
supervisor/principal remains responsible for the adequacy of the 
review.
    SIFMA and Janney requested that FINRA clarify what reasonable and 
appropriate standards would be sufficient to demonstrate overall 
supervisory control of delegated functions pursuant to proposed 
Supplementary Material .10 (Delegation of Correspondence and Internal 
Communication Review Functions). What may be reasonable and appropriate 
for each firm will depend on the firm's size, business, structure, etc. 
Members should look to these factors to determine how they should 
structure their procedures to demonstrate adequate supervision of 
delegated functions.
    Finally, PIABA requested that FINRA expand the record retention 
period in proposed Supplementary Material .11 (Retention of 
Correspondence and Internal Communications) to six years to match the 
eligibility provisions for customer arbitration disputes in FINRA Rule 
12206 (Time Limits). The proposed rule purposefully aligns the record 
retention period for communications with the SEC's record retention 
period for the same types of communications to achieve consistent 
regulation in this area. Accordingly, FINRA declines to extend the 
record retention period beyond the three-year period stipulated in Rule 
17a-4(b) of the Act.\60\
---------------------------------------------------------------------------

    \60\ 17 CFR 240.17a-4(b).
---------------------------------------------------------------------------

(k) Comments on Proposed FINRA Rule 3110(b)(5)
    One commenter questioned the necessity of proposed FINRA Rule 
3110(b)(5) as proposed FINRA Rule 3110(b)(4) would require members to 
review communications to ensure that customer complaints are identified 
and handled in accordance with a member's supervisory procedures.\61\ 
Proposed FINRA Rule 3110(b)(5) makes clear that members have an 
affirmative obligation to capture, acknowledge, and respond to every 
written customer complaint. The review requirement in proposed FINRA 
Rule 3110(b)(4) supplements this affirmative responsibility.
---------------------------------------------------------------------------

    \61\ ING.
---------------------------------------------------------------------------

    Another commenter, SIFMA, supported proposed FINRA Rule 3110(b)(5), 
including the decision to include only written customer complaints. 
PIABA, on the other hand, argued that members should be required to 
reduce an oral complaint to writing or to provide the customer with a 
form. As stated previously, the proposed rule change does not include 
oral complaints because they are difficult to capture and assess, 
whereas members can more

[[Page 38256]]

readily capture and assess written complaints. FINRA encourages members 
to provide customers with a form or other format that will allow 
customers to detail their complaints in writing. However, as noted 
above, FINRA reminds members that the failure to address any customer 
complaint, written or oral, may be a violation of FINRA Rule 2010.
    A couple of commenters were concerned with the requirement that 
members ``acknowledge'' customer complaints. One commenter argued that 
this would be a new requirement for firms currently required to comply 
only with NASD rules.\62\ Another commenter questioned the relevancy of 
requiring firms to acknowledge complaints when the proposed rule does 
not include the Incorporated NYSE Rule 401A requirement to do so within 
15 days.\63\ While FINRA acknowledges that this would be a new 
requirement for many FINRA members, the investor protection that this 
provision would provide outweighs any potential compliance burdens. 
Finally, the absence in the proposed rule of a specific time period in 
which members must acknowledge their receipt of customer complaints 
provides members a certain amount of flexibility in designing their 
supervisory procedures. Members, however, would be expected to explain 
the reasonableness of a period in excess of 30 days.
---------------------------------------------------------------------------

    \62\ Charles Schwab.
    \63\ ING.
---------------------------------------------------------------------------

(l) Comments on Proposed FINRA Rule 3110(b)(6)
    Commenters generally supported FINRA's proposal to eliminate NASD 
Rule 3012's producing manager supervision requirements.\64\ 
Nevertheless, some commenters requested clarification and guidance 
regarding certain aspects of the proposed supervisory requirements that 
would replace the current producing manager supervision provisions.
---------------------------------------------------------------------------

    \64\ ProEquities, NAIBD, Charles Schwab, SIFMA.
---------------------------------------------------------------------------

    One commenter, concerned about the meaning of the term 
``supervisory function,'' asked FINRA whether an associated person 
performing a supervisory function needed to be a principal.\65\ The 
proposed rule language does not impose a registration requirement. 
Whether an associated person performing a supervisory function should 
be licensed as a principal depends on whether the person is acting in a 
capacity that requires principal registration.\66\ Furthermore, the 
term ``supervisory function'' does not have a static definition. 
Whether an associated person is performing a supervisory function 
depends on the member's supervisory structure and the associated 
person's assigned duties. Members may delegate supervisory functions to 
associated persons who are not registered principals. However, FINRA 
expects members to supervise those persons in accordance with proposed 
FINRA Rule 3110(b)(6).
---------------------------------------------------------------------------

    \65\ CCS.
    \66\ See NASD Rule 1021.
---------------------------------------------------------------------------

    One commenter asked why a member's written supervisory procedures 
should prohibit a supervisor from engaging in conduct (supervising 
one's own activities and reporting to, or having compensation 
determined by, a person being supervised) when such conduct is not 
expressly prohibited by any other FINRA rule.\67\ The same commenter 
also questioned how a member should apply the prohibitions to certain 
supervisory personnel, such as finance, continuing education, and 
registration supervisors, who supervise people who could ``affect'' the 
supervisors' compensation. Other commenters requested, without 
explanation, that ``home office personnel'' be exempted from the 
prohibitions.\68\
---------------------------------------------------------------------------

    \67\ ING.
    \68\ Cornerstone Financial, Nationwide Financial, FSI.
---------------------------------------------------------------------------

    The proposed supervisory requirements are designed to prevent 
supervisory situations from occurring that regulators previously have 
found do not lead to effective supervision.\69\ Additionally, the 
requirement to have supervisory procedures prohibiting a supervisor 
from supervising one's own activities and reporting to, or having 
compensation determined by, a person being supervised also serves as 
the general substantive prohibition against that conduct.\70\ However, 
FINRA understands, and has provided a limited exception for, certain 
situations and member business models (i.e., senior executive 
management and/or sole proprietors) where, for example, it is not 
possible to avoid having someone supervise his or her own activities or 
supervise someone who determines (not merely ``affects'') his or her 
compensation. FINRA believes that this exception provides sufficient 
flexibility for a member to design an appropriate supervisory system 
for all of its supervisory personnel, irrespective of their place in 
the member's organizational structure.
---------------------------------------------------------------------------

    \69\ See SEC v. Frank D. Gruttadauria, Civil Action No. 
1:02CV324 (N.D. Ohio Apr. 23, 2004), SEC Litigation Release No. 
17369 (Feb. 21, 2002).
    \70\ FINRA also notes that the SEC has consistently recognized 
that FINRA rules do not generally permit someone to supervise his or 
her own activities. See, e.g., Bradford John Titus, 52 S.E.C. 1154, 
1158 (1996) (compliance director held liable, under FINRA (then 
NASD) rules, for supervisory failure based on finding that 
salesperson, who was operating as independent contractor out of two-
person ``non-branch'' office, could not supervise himself).
---------------------------------------------------------------------------

    Two commenters also requested that FINRA add rule language 
explaining that a supervisor receiving commission overrides does not 
equate to having ``compensation determined by'' a person who is 
supervised.\71\ FINRA does not believe that additional rule language is 
necessary. Although a supervised person may affect his or her 
supervisor's compensation (through overrides or in other ways), 
proposed FINRA Rule 3110(b)(6)(C) concerns only those situations where 
a supervised person directly controls a supervisor's compensation or 
continued employment. In this context, however, the member would still 
need to address this conflict in its procedures pursuant to proposed 
FINRA Rule 3110(b)(6)(D).
---------------------------------------------------------------------------

    \71\ Cornerstone Financial, FSI.
---------------------------------------------------------------------------

    Several commenters questioned the necessity of proposed FINRA Rule 
3110(b)(6) given the requirement that a member's supervisory system and 
written procedures be reasonably designed to achieve compliance with 
applicable securities laws and regulations and SRO rules.\72\ As noted 
above, proposed FINRA Rule 3110(b)(6), among other things, requires 
members to address conflicts of interest that may reduce the standards 
of supervision applicable to an associated person. Serious conflicts of 
interest have, in the past, caused diminished supervision standards 
that, in turn, have resulted in inadequate supervision. Accordingly, 
FINRA believes that supervisory procedures to address potential 
conflicts of interest are necessary.
---------------------------------------------------------------------------

    \72\ Janney, Charles Schwab, SIFMA.
---------------------------------------------------------------------------

    Several commenters suggested that the standards within FINRA Rule 
3110(b)(6) (e.g., procedures ``to prohibit'' supervisory personnel from 
supervising their own activities and to prevent supervision from being 
``lessened in any manner'' due to conflicts of interest) should be 
changed to ``a reasonably designed'' standard. As noted previously, 
proposed FINRA Rule 3110(b) already requires that members have 
procedures that are reasonably designed to achieve compliance with the 
applicable laws, regulations, and SRO rules. To alter the standards 
within the rule that describe the outcome the procedures should try to 
achieve suggest an impermissible relaxation of the standard around 
which the rule is

[[Page 38257]]

designed. FINRA, however, has revised proposed FINRA Rule 3110(b)(6) to 
clarify that a member must have procedures to prevent the standards of 
supervision required pursuant to proposed FINRA Rule 3110(a) from being 
reduced in any manner due to any conflicts of interest that may be 
present.
(m) Comments on Proposed FINRA Rule 3110(b)(7) and Proposed 
Supplementary Material .13
    Commenters requested clarification regarding several aspects of 
proposed FINRA Rule 3110(b)(7), which requires each member to keep and 
maintain a copy of its written supervisory procedures at each OSJ and 
at each location where supervisory activities are conducted. 
Specifically, several commenters requested that FINRA clarify whether 
members can electronically maintain their written supervisory 
procedures and also electronically communicate to their associated 
persons any amendments or updates to the written supervisory 
procedures.\73\ One commenter also suggested that it would be 
inappropriate to communicate a written supervisory procedures amendment 
throughout the firm if the amendment was relevant only to a limited 
business line or set of associated persons.\74\
---------------------------------------------------------------------------

    \73\ Cornerstone Financial, Great American Advisors, FSI, SIFMA, 
Baum, ING.
    \74\ Charles Schwab.
---------------------------------------------------------------------------

    Written supervisory procedures are records subject to the 
recordkeeping requirements of Exchange Act Rule 17a-4,\75\ which 
permits a member to store records electronically so long as they are 
accessible. However, in response to commenters' concerns regarding the 
use of electronic means to communicate written supervisory procedures 
amendments to their associated person, FINRA has added proposed 
Supplementary Material .13 (Use of Electronic Media to Communicate 
Written Supervisory Procedures), which clarifies that a member may 
electronically amend and distribute its written supervisory procedures 
as long as the member meets certain conditions (e.g., providing easy 
access to the written supervisory procedures, promptly posting written 
supervisory procedures amendments, and notifying associated persons of 
the amendments).
---------------------------------------------------------------------------

    \75\ 17 CFR 240.17a-4.
---------------------------------------------------------------------------

(n) Comments on Proposed FINRA Rule 3110(c)
(1) Flexibility To Conduct Location Inspections
    Several commenters raised concerns regarding the flexibility 
members have in conducting location inspections.\76\ In particular, 
four commenters expressed concern regarding the three-year presumption 
in proposed Supplementary Material .15 (General Presumption of Three-
Year Limit for Periodic Inspection Schedules) for inspecting non-branch 
locations (also referred to as ``unregistered locations'').\77\ While 
one commenter expressed concern that the presumption would be 
interpreted as a ``three-year pass,'' \78\ two other commenters viewed 
the presumption as becoming a de facto three-year requirement.\79\ 
These same two commenters suggested that the proposed rule include a 
risk-based inspection scheme similar to that in Incorporated NYSE Rules 
342.24 and 342.25, arguing that, otherwise, Dual Members will be forced 
to change inspection programs previously approved by the NYSE 
permitting firms to conduct branch office examinations less frequently 
than once each calendar year.
---------------------------------------------------------------------------

    \76\ Janney, SIFMA.
    \77\ Janney, SIFMA, CAI, Nekvasil.
    \78\ Nekvasil.
    \79\ Janney, SIFMA.
---------------------------------------------------------------------------

    FINRA believes the timing requirements for location inspections in 
proposed FINRA Rule 3110(c)(1), which are carried over from the 
existing NASD requirements, are appropriate and provide all members 
with sufficient flexibility to meet their inspection requirements. In 
addition, irrespective of any annual branch office inspection 
exemptions that may have been granted by the NYSE pursuant to NYSE Rule 
342.24, Dual Members have always been required to comply with the 
annual inspection requirements for supervisory branch offices pursuant 
to NASD Rule 3010(c)(1)(A).
    Regarding the periodic inspection of non-branch locations, proposed 
Supplementary Material .15 does not set forth either a three-year 
requirement or a three-year gap between inspections. The proposed 
supplementary material merely establishes a three-year presumption and 
provides members with the flexibility to use a periodic inspection 
schedule that is either shorter or longer than three years. Members may 
choose to examine non-branch locations more frequently than every three 
years if the member determines such examinations are necessary to 
detect and prevent violations of, and achieve compliance with, 
applicable securities laws and regulations and with applicable FINRA 
and MSRB rules. Conversely, if a member chooses to use a periodic 
inspection schedule that is longer than three years, then the proposed 
supplementary material requires the member to properly document the 
factors used in determining the appropriateness of the longer 
schedule.\80\
---------------------------------------------------------------------------

    \80\ National Planning requested that this documentation appear 
in a member's written supervisory procedures. However, FINRA 
believes that such documentation is more appropriate in an 
inspection report for a particular location because it explains why 
a member established a longer periodic inspection schedule for a 
particular location.
---------------------------------------------------------------------------

(2) Reliance on Existing Guidance Regarding Unannounced Inspections
    One commenter asked that FINRA clarify the continued viability of 
those sections of Notices to Members 99-45 (June 1999) and 98-38 (May 
1998) alerting members to specific SEC cases where the SEC found one 
pre-announced annual inspection of unregistered locations to be an 
inadequate discharge of a firm's supervisory obligations for those 
locations.\81\ As indicated by the commenter, these portions of the 
referenced Notices alerted members to SEC decisions regarding the 
failure to adequately supervise unregistered locations. Although this 
is not FINRA guidance, these SEC decisions continue to provide valuable 
information that firms may wish to consider when establishing 
inspection cycles for unregistered locations. The actual guidance in 
the referenced Notices is applicable unless overridden by the content 
of proposed rules.
---------------------------------------------------------------------------

    \81\ NAIBD.
---------------------------------------------------------------------------

    FINRA is not making any changes to proposed FINRA Rule 3110(c)(1) 
in response to the comments received.
(3) Minimum Content Requirements of Inspection Reports
    Several commenters argued that a location's written inspection 
report should not have to include the testing and verification of a 
member's policies and procedures for all of the activities enumerated 
in proposed FINRA Rule 3110(c)(2)(A)(i) through (v) (e.g., transmittals 
of funds and securities, changes of customer account information, 
safeguarding of customer funds and securities, supervision of 
supervisory personnel, maintaining books and records) if that location 
did

[[Page 38258]]

not conduct all of those activities.\82\ In response to these concerns, 
FINRA has amended the proposed rule language to make clear that a 
location's inspection report has to include the testing and 
verification of only those enumerated activities conducted by the 
location.
---------------------------------------------------------------------------

    \82\ Cornerstone Financial, Great American Advisors, FSI, ING 
(referring to activities in proposed FINRA Rule 3110(c)(2)(A)(i) 
through (v)).
---------------------------------------------------------------------------

    One commenter suggested that the proposed customer confirmation 
requirements for transmittals of funds and securities and changes of 
customer account information be moved to another section of the 
proposed rule as they did not pertain to the internal inspection 
requirements.\83\ FINRA disagrees. It is clear from the proposed rule 
text that the customer confirmation requirements must be included in 
the policies and procedures for the transmittals of funds and 
securities and changes of customer account information that a member 
must test and verify during its inspection of any location at which 
those activities are performed.
---------------------------------------------------------------------------

    \83\ Charles Schwab.
---------------------------------------------------------------------------

    This commenter also objected as ``unnecessarily broad'' the 
proposed requirement to test and verify the policies and procedures 
regarding a location's supervision of its supervisory personnel and 
argued that this language could potentially include off-site 
supervisory personnel who supervise a branch office manager's 
activities. FINRA, however, does not view this requirement as overly 
broad. Rather, the provision is intended to further ensure that the 
activities of supervisory personnel are subject to supervision, and 
FINRA would expect, for example, an inspection report to address, as 
applicable, off-site supervision of the branch office manager's 
activities.
    One commenter asked whether anything other than an account 
statement would be appropriate to comply with the requirement in 
proposed FINRA Rule 3110(c)(2)(B) to provide a means or method of 
customer confirmation for transmittals of customer funds and 
securities.\84\ Additionally, the commenter requested guidance on how 
to comply with the proposed requirement that members test and verify 
procedures for the transmittal of funds, especially the hand-delivery 
of checks. The proposed requirements are already existing requirements 
of NASD Rule 3012 that FINRA is moving into proposed FINRA Rule 3110. 
As such, members should already be aware of how to comply with these 
requirements. Additionally, FINRA has previously provided guidance in 
Notice to Members 05-08 (January 2005) regarding the appropriate means 
or method of customer confirmation, notification, or follow-up that 
members should use to comply with this requirement. That guidance 
remains applicable to the relocated provisions. FINRA does not believe 
additional guidance is necessary.
---------------------------------------------------------------------------

    \84\ ING.
---------------------------------------------------------------------------

    Commenters also objected to the rule requirement, as originally 
proposed in the Notice, requiring a member to identify in its written 
supervisory procedures the activities in which it does not engage.\85\ 
In response to these concerns and the proposed changes made above, 
FINRA has amended the proposed rule change to retain the requirement 
that a member identify in a location's written inspection report any 
enumerated activities the member does not engage in at that location 
and document in that location's report that the member must have in 
place at that location supervisory policies and procedures for those 
activities before the location can engage in them.
---------------------------------------------------------------------------

    \85\ Thornburg, Charles Schwab.
---------------------------------------------------------------------------

(4) Associated Persons Who May Conduct Inspections
    Several commenters questioned whether the proposed requirement that 
a location be inspected by someone who is not an associated person 
assigned to that location or is not supervised by an associated person 
assigned to that location would require members to hire outside 
consultants to conduct inspections.\86\ FINRA believes that the 
proposed rule change, similar to existing NASD Rule 3010(c), provides 
members with sufficient flexibility to conduct their inspections using 
only firm personnel.\87\ Pursuant to the proposed rule, a member that 
determines it cannot comply with the restriction, either because of its 
size or business model, must document in the inspection report the 
factors the member used to make its determination and how the 
inspection otherwise comports with proposed FINRA Rule 3110(c)(1).
---------------------------------------------------------------------------

    \86\ Nationwide Financial, Cornerstone Financial, Great American 
Advisors, FSI.
    \87\ Charles Schwab also argued that the proposed restriction 
would prevent personnel based in the same location from inspecting 
other business units at the same location. To the extent that this 
comment refers to business departments within a location, the 
proposed restriction pertains only to office (both registered and 
unregistered) location inspections. If the comment is referring to 
multiple locations within one geographical place, a member may use 
personnel from one location in a particular setting to inspect 
another location in that same setting.
---------------------------------------------------------------------------

    One commenter requested that FINRA permit members to rely on the 
exception described above for home office personnel conducting home 
office inspections.\88\ As noted in proposed Supplementary Material .16 
(Exception to Persons Prohibited from Conducting Inspections), a 
member's determination that it cannot meet the requirement on who can 
conduct a location's inspection will generally arise only in instances 
where a member has only one office or has an independent contractor 
business model. However, this general presumption does not prohibit a 
member from relying on the exception in other instances provided it 
complies with the conditions in proposed FINRA Rule 3110(c)(3)(C).
---------------------------------------------------------------------------

    \88\ ING.
---------------------------------------------------------------------------

(5) Preventing Conflicts of Interest from Lessening an Inspection
    Some commenters have argued that the proposed rule's requirement 
that members prevent conflicts of interest from lessening an inspection 
in any manner is vague and overly broad and should be altered to a 
``reasonably designed'' standard.\89\ One commenter also suggested that 
firms be permitted to design their own procedures to safeguard against 
conflicts of interest. The proposed requirement does not pertain to a 
member's supervisory procedures, which a member must ``reasonably 
design'' to achieve compliance with applicable Federal laws and 
regulations and SRO rules. Instead, it defines a standard around which 
inspections must be conducted. The proposed requirement does not 
prohibit conflicts of interest. Additionally, FINRA has revised the 
proposed rule text to make clear that a member, for each inspection, 
must prevent the inspection standards required pursuant to proposed 
FINRA Rule 3110(c)(1) from being reduced in any manner due to any 
conflicts of interest that may be present.
---------------------------------------------------------------------------

    \89\ LPL, Cornerstone Financial, Great American Advisors, 
Janney, FSI, Charles Schwab, NSCP, SIFMA.
---------------------------------------------------------------------------

(o) Comments on Proposed Supplementary Material .14 (Standards for 
Reasonable Review)
    Several commenters suggested that proposed Supplementary Material 
.14 be amended to adopt a ``reasonably designed to ensure'' 
standard.\90\ Another commenter suggested that the experience of a 
representative and/or length of service of a representative with the 
firm be added as a factor to be considered in determining the 
reasonableness of review for one-person

[[Page 38259]]

or small remote locations.\91\ Proposed Supplementary Material .14 
transfers NASD IM-3010-1 with minor changes into the Consolidated FINRA 
Rulebook. NASD IM-3010-1 was adopted in connection with the uniform 
branch office definition in 2005 after several years of discussions 
with the NYSE, NASAA, and NASD. As such, FINRA does not believe that 
this provision should be further modified at this time. Additionally, 
FINRA notes the factors listed are not exhaustive, and no single factor 
is dispositive. Members can and should consider additional factors that 
are relevant to their business model.
---------------------------------------------------------------------------

    \90\ Cornerstone Financial, Great American Advisors, FSI.
    \91\ Nekvasil.
---------------------------------------------------------------------------

(p) Comments on Proposed FINRA Rule 3110(d)
    FINRA received numerous comments on the proposal to require members 
to include in their supervisory procedures a process for the review of 
securities transactions that are effected for the accounts of the 
member and certain accounts of associated persons of the member and 
their family members to identify trades that may violate the Federal 
securities laws, rules thereunder, or FINRA rules. The provision was 
originally proposed in Regulatory Notice 08-24 as supplementary 
material to proposed FINRA Rule 3110; however, as reflected above, 
FINRA has amended the proposed rule change so that the provision is now 
contained in the rule as proposed FINRA Rule 3110(d) (Transaction 
Review and Investigation) rather than as supplementary material. As 
described below, FINRA made several other changes to the rule in 
response to comments.
(1) Scope of Provision
    Several commenters expressed concern that the proposed provision 
was too broad in that it failed to recognize different types of 
business models or to account for transactions in securities such as 
mutual funds or variable contracts that do not raise the types of 
concerns addressed by the rule.\92\ Other commenters believed the 
provision was overly broad, vague, or inconsistent with existing FINRA 
Rules, such as NASD Rule 3050.\93\
---------------------------------------------------------------------------

    \92\ CAI, Liberty Life, NSCP, PFS, Thornburgh.
    \93\ FSI, ING.
---------------------------------------------------------------------------

    As noted above, proposed FINRA Rule 3110(d) is intended to help 
members comply with their existing obligations under Section 15(g) of 
the Act,\94\ which requires all registered brokers or dealers to 
``establish, maintain, and enforce written policies and procedures 
reasonably designed, taking into consideration the nature of such 
broker's or dealer's business, to prevent the misuse in violation of 
[the Act] * * * or regulations thereunder, of material, nonpublic 
information by such broker or dealer or any person associated with such 
broker or dealer.'' FINRA recognizes that not all members will have the 
same procedures and that not all transactions present the same risks. 
Consistent with the requirements of Section 15(g) of the Act and 
proposed FINRA Rule 3110(b), the procedures adopted by the member would 
need to be reasonably designed to prevent violations of the Act, the 
rules thereunder, and FINRA rules prohibiting insider trading and 
manipulative and deceptive devices. Accordingly, each member's 
procedures should take into consideration the nature of the member's 
business, which includes an assessment of the risks presented by 
different transactions and different departments within a firm. Thus, 
while some members may need to develop restricted lists and/or watch 
lists, other members may only need to periodically review employee and 
proprietary trading. Like the incorporated NYSE rule on which the 
proposal is based, there is no requirement that a member examine every 
trade of every employee or every proprietary trade.
---------------------------------------------------------------------------

    \94\ 15 U.S.C. 78o(g).
---------------------------------------------------------------------------

(2) Family Member and Other Accounts
    One commenter stated that, as proposed in Regulatory Notice 08-24, 
the proposal would require family members of persons associated with a 
member to hold their accounts at the associated person's firm.\95\ 
Other commenters suggested changes to the rule to include those 
accounts in which the associated person of the member had a beneficial 
interest or accounts over which an associated person of the member had 
control.\96\ In response to these comments, FINRA has revised the text 
in the proposed rule change regarding a member's responsibility to 
monitor trading in certain accounts of an associated person of a member 
and his or her family members. As revised, the proposed rule change 
would require a member to review the account activity of any account 
held by the spouse, child, son-in-law, or daughter-in-law of a person 
associated with the member where such account is introduced or carried 
by the member, not every family member of a person associated with the 
member. In addition, the revised proposed rule change would require 
members to review any account in which a person associated with the 
member has a beneficial interest and any account over which a person 
associated with the member has the authority to make investment 
decisions. This revised language is based, in large part, on the 
obligations established by the NYSE in Information Memo 88-21 (July 28, 
1988) regarding the accounts of certain family members of persons 
associated with a member and accounts in which the associated person 
has an interest or has the power, directly or indirectly, to make 
investment decisions. Finally, proposed FINRA Rule 3110(d) does not 
require family members of persons associated with a member to hold 
their accounts at the associated person's firm.
---------------------------------------------------------------------------

    \95\ ING. Another commenter requested that FINRA clarify the 
term ``family member'' if the provision was not removed. Charles 
Schwab.
    \96\ FSI, Northwestern Mutual.
---------------------------------------------------------------------------

(3) Required Reports
    Several commenters expressed concern with the provision in the 
proposed rule change requiring that members that engage in investment 
banking activities report to FINRA the status of internal 
investigations.\97\ Although some commenters supported the quarterly 
report requirement, but not the additional reporting requirements,\98\ 
another commenter believed the reports were unnecessary in light of 
information reported to FINRA pursuant to NASD Rule 3070 \99\ (to be 
replaced by FINRA Rule 4530 (Reporting Requirements, effective July 1, 
2011)).\100\
---------------------------------------------------------------------------

    \97\ Janney, NSCP, Charles Schwab, SIFMA,
    \98\ Janney, SIFMA.
    \99\ Charles Schwab.
    \100\ See supra note 9.
---------------------------------------------------------------------------

    FINRA believes that the proposed rule change strikes the 
appropriate balance by only requiring certain members to report 
information (i.e., those members that conduct investment banking 
activities). Additionally, unlike FINRA Rule 4530,\101\ the proposed 
rule change would require more targeted and detailed reporting, 
following a review of whether a securities transaction effected for the 
account(s) of the member, the member's associated person, or other 
covered account may have violated the Exchange Act or FINRA rules 
prohibiting insider trading and manipulative and deceptive devices.

[[Page 38260]]

Such information would include reporting the initiation of an 
investigation (including such information as the identity of the 
member, the date the internal investigation commenced, and the identity 
of the security, trades, accounts, associated persons, or associated 
person's family members holding a covered account, under review), a 
quarterly report providing progress of any open investigation, and a 
written report detailing the completion of an investigation, including 
the investigation's results. Providing such detailed information, even 
if a member's investigation does not uncover violations in association 
with the suspected securities transactions, could prove vital to FINRA 
in connecting the underlying conduct to other conduct about which the 
member may not know. Thus, FINRA believes that the reporting 
obligations pursuant to the proposed rule change are necessary to help 
protect investors and market integrity.
---------------------------------------------------------------------------

    \101\ FINRA Rule 4530 is based in large part on NASD Rule 3070 
and takes into account requirements under NYSE Rule 351, including 
the requirement that the firm report whenever the firm has concluded 
on its own that an associated person of the firm or the firm itself 
has violated any securities, insurance, commodities, financial or 
investment-related laws, rules, regulations or standards of conduct 
of any domestic or foreign regulatory body or SRO. See FINRA Rules 
4530(b) and 4530.01.
---------------------------------------------------------------------------

(q) Comments on Proposed FINRA Rule 3110(e)
    Two commenters requested that FINRA make several amendments to the 
definition of the term ``branch office'' in proposed FINRA Rule 
3110(e).\102\ Both commenters stated that additional exemptions from 
branch office registration need to be established for certain 
categories of activities. Specifically, one of the commenters asked 
that FINRA add an exemption from branch office registration for 
wholesalers of mutual funds who use their primary residences for 
business purposes but do not meet with customers at such 
locations.\103\ The other commenter asked that FINRA add an exemption 
from branch office registration for certain non-U.S. locations because 
registration can create potentially adverse consequences for the member 
in the local jurisdiction.\104\ FINRA notes that the definition of 
branch office is being transferred unchanged from current NASD Rule 
3010(g)(2). The uniform branch office definition was developed in 2005 
after several years of discussions with the NYSE, NASAA, and NASD. As 
such, FINRA believes the current definition provides appropriate 
exemptions from registration, and such exemptions should not be 
expanded at this time.
---------------------------------------------------------------------------

    \102\ Nationwide Financial, SIFMA.
    \103\ Nationwide Financial.
    \104\ SIFMA.
---------------------------------------------------------------------------

(r) Comments on Proposed FINRA Rule 3120
    All of the comments FINRA received regarding proposed FINRA Rule 
3120 addressed the new provisions concerning the report requirements in 
paragraph (b). As noted above, these requirements are based on 
provisions that had previously been adopted by the NYSE; however, FINRA 
determined to apply the requirements only to members that reported $150 
million or more in gross revenue on their FOCUS reports for the 
previous year.
    Several commenters noted that the requirements would impose new 
burdens on certain FINRA members that had previously been members of 
only NASD and would continue to impose a burden for certain firms that 
had previously created the report under the Incorporated NYSE 
Rule.\105\ Commenters also questioned the need for the report,\106\ and 
several commenters suggested that the report was duplicative of 
existing requirements.\107\ Finally, several commenters suggested that 
the $150 million revenue threshold was inappropriate.\108\ One 
commenter suggested that all members be required to include the 
supplemental information in the report, not merely those members 
reporting more than $150 million in revenue.\109\
---------------------------------------------------------------------------

    \105\ Cornerstone Financial, FSI, Great American Advisors, 
Janney, SIFMA.
    \106\ Charles Schwab, ING, SIFMA.
    \107\ FSI, Northwestern Mutual, Charles Schwab, ING, Wachovia 
Securities.
    \108\ Cornerstone Financial, GAA, FSI, CAI, ING, Charles Schwab.
    \109\ PIABA.
---------------------------------------------------------------------------

    As FINRA stated in Regulatory Notice 08-24, FINRA believes that the 
additional information required of members with more than $150 million 
in gross revenue will prove to be valuable information for FINRA's 
regulatory program, in addition to being valuable compliance 
information for the senior management of the firm. FINRA recognizes the 
burden the additional content requirements may place on some members 
and, as a result, proposed only requiring certain members to include 
the specific information listed in paragraph (b) of the proposed rule 
in their reports. Although FINRA considered several alternative metrics 
(e.g., number of registered persons), FINRA attempted to balance the 
value of the information with the burden and determined that using a 
gross revenue threshold of $150 million struck the appropriate balance. 
The metric also is easily determined by reference to the member's most 
recent annual FOCUS report.
    With respect to the specific supplemental information required in 
the report, for members reporting more than $150 million in gross 
revenue, the proposed rule requires that those reports include the 
preceding year's compliance effort in seven areas: Trading and market 
activity, investment banking activities, antifraud and sales practices, 
finance and operations, supervision, anti-money laundering, and risk 
management. In addition, the report is required to include a tabulation 
of the reports made to FINRA in the previous year regarding customer 
complaints and internal investigations. As noted above, several 
commenters stated that some of the information (such as the tabulation 
of customer complaints) was duplicative of existing requirements while 
other information was too broad or could be outside the scope of a 
member's compliance structure (such as risk management or finance). The 
proposed requirements to include a tabulation of information provided 
to FINRA regarding complaints and internal investigations are not 
duplicative of existing requirements. Whereas FINRA Rule 4530 requires 
reporting certain information to FINRA, the requirement in proposed 
FINRA Rule 3120(b) covers information required to be provided to a 
firm's senior management. Thus, each rule serves a distinct purpose.
    Several commenters also suggested that the provisions in proposed 
FINRA Rule 3120 are duplicative of requirements in NASD Rule 3013 and 
IM-3013.\110\ FINRA disagrees. Paragraph (b) of proposed FINRA Rule 
3120 does not create a new report requirement; it merely specifies 
several specific topics that the report (already required under NASD 
Rule 3012) must address for firms reporting $150 million or more in 
gross revenue. Since the adoption of NASD Rules 3012 and 3013, FINRA 
has addressed the issue regarding the interplay between the 
requirements of NASD Rules 3012 and 3013, noting that the requirements 
are complementary, not duplicative. For example, in Notice to Members 
04-71 (October 2004), FINRA stated that the supervisory system required 
under NASD Rule 3010 results from the processes that are the subject of 
certification under FINRA Rule 3130.

[[Page 38261]]

NASD Rule 3012 (proposed FINRA Rule 3120) requires members to have 
supervisory control procedures to test and verify that the member's 
supervisory procedures are reasonably designed to achieve compliance 
with applicable securities laws and regulations and FINRA rules, as 
well as to, where necessary, amend or create new supervisory 
procedures. This same relationship between the rules (proposed FINRA 
Rules 3110 and FINRA Rule 3120) remains present.
---------------------------------------------------------------------------

    \110\ The SEC approved the adoption of NASD Rule 3013 and IM-
3013 into the Consolidated FINRA Rulebook as FINRA Rule 3130. See 
Exchange Act Release No. 58661 (September 26, 2008), 73 FR 57395 
(October 2, 2008) (Order Approving File No. SR-FINRA-2008-030). The 
rule became effective on December 15, 2008. See Regulatory Notice 
08-57 (October 2008).
---------------------------------------------------------------------------

    With respect to the specific topics covered by the rule, although 
most were taken from the existing provisions of Incorporated NYSE Rule 
342.30, FINRA determined to add risk management as a required area of 
discussion in the report. For those firms that did not have compliance 
efforts in that area (or in any of the enumerated areas) during the 
year covered by the report, the report should so state.
    Finally, one commenter stated that ``it should be clear that such 
`testing and verification' also may be risk-based in light of the 
member's particular business and circumstances.'' \111\ The commenter 
also suggested that the language in the proposed rule be changed from 
``test and verify'' to ``regularly test or otherwise monitor.'' FINRA 
has previously provided guidance in Notice to Members 05-29 (April 
2005) regarding a member's ability to use risk-based methodologies and 
sampling to test a subset of policies and procedures annually when 
conducing the testing and verification required by NASD Rule 3012. That 
guidance remains applicable to proposed FINRA Rule 3120. FINRA does not 
believe additional guidance or rule text is necessary.
---------------------------------------------------------------------------

    \111\ Baum.
---------------------------------------------------------------------------

(s) Comments on Proposed FINRA Rule 3150
    FINRA received several comments on proposed FINRA Rule 3150 
regarding the holding of customer mail. One commenter requested 
clarification that members are not required to hold a customer's mail 
if, for example, the member lacks the systems, processes, and personnel 
to provide this service.\112\ Proposed FINRA Rule 3150, like NASD Rule 
3110(i), does not impose an obligation on members to hold a customer's 
mail upon request. Rather, the rule establishes minimum requirements if 
a member does provide this service to its customers.
---------------------------------------------------------------------------

    \112\ NSCP.
---------------------------------------------------------------------------

    Three commenters expressed concern regarding the requirement that a 
member holding a customer's mail be able to communicate with the 
customer in a timely manner during the time the member is holding the 
customer's mail.\113\ All three commenters noted that mail is often 
held by a member because the customer is unreachable (e.g., when the 
customer is overseas or in active military service). These commenters 
also requested that the rule include a specific time limit rather than 
requiring that a member periodically verify the customer's instructions 
if the customer instructs the member to hold his or her mail for ``an 
extended time.''
---------------------------------------------------------------------------

    \113\ Cornerstone Financial, Great American Advisors, FSI.
---------------------------------------------------------------------------

    Under NASD Rule 3110(i), a member is prohibited from holding a 
customer's mail for more than two months if the customer is on vacation 
or traveling, or for more than three months if the customer is going 
abroad. FINRA determined to eliminate the specific maximum time periods 
from the rule and allow members to create appropriate procedures 
regarding the holding of customer mail; however, to ensure that a 
member does not hold a customer's mail indefinitely, FINRA has 
clarified in the proposed rule that members must receive written 
instructions from the customer that include the time period during 
which the member is requested to hold the customer's mail. 
Additionally, if the requested time period included in the instructions 
is longer than three consecutive months (including any aggregation of 
time periods from prior requests), the customer's instructions must 
include an acceptable reason for the request (e.g., safety or security 
concerns). Convenience is not an acceptable reason for holding mail 
longer than three months. Proposed FINRA Rule 3150 also requires 
members to periodically verify the customer's instructions if they 
agree to hold mail for that customer for an extended time. As noted 
above, there is no requirement that members hold customer mail at all, 
and there is similarly no restriction on a member's ability to limit 
the time period it offers to hold mail for a customer. Consequently, 
FINRA believes that providing each member with the flexibility to 
devise a system that best meets the member's capabilities and the 
customers' needs is appropriate. Thus, for example, if a member knows a 
customer will be unreachable, the member may reasonably agree not to 
hold that customer's mail for more than a specified time or may agree 
to hold mail only if the customer will be reachable.
    Three commenters recommended that FINRA revise the standard for 
holding customer mail so that rather than a requirement that members 
``take actions reasonably designed to ensure that the customer's mail 
is not tampered with, held without the customer's consent, or used by 
an associated person of the member in any manner that would violate'' 
applicable laws, members only be required to ``take actions reasonably 
designed to avoid tampering with the customer's mail.'' \114\ FINRA 
believes that the current standard in the proposal is the correct 
standard. If a member chooses to hold a customer's mail, FINRA believes 
that the member must accept responsibility for the protection of any 
information in that mail and take reasonable steps to prevent the 
misuse of that information.
---------------------------------------------------------------------------

    \114\ Cornerstone Financial, Great American Advisors, FSI.
---------------------------------------------------------------------------

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 such 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 (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-FINRA-2011-028 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-2011-028. This 
file number should be included on the

[[Page 38262]]

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 Internet Web site 
(http://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 such 
filing also will 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 available publicly. All submissions should refer to File Number 
SR-FINRA-2011-028 and should be submitted on or before July 20, 2011.
---------------------------------------------------------------------------

    \115\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\115\
Cathy H. Ahn,
Deputy Secretary.
[FR Doc. 2011-16232 Filed 6-28-11; 8:45 am]
BILLING CODE 8011-01-P