[Federal Register Volume 85, Number 63 (Wednesday, April 1, 2020)]
[Notices]
[Pages 18299-18304]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-06722]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88482; File No. SR-FINRA-2019-030]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by
Amendment No. 1, To Amend the Membership Application Program (``MAP'')
Rules To Address the Issue of Pending Arbitration Claims
March 26, 2020.
I. Introduction
On December 13, 2019, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and
[[Page 18300]]
Exchange Commission (``Commission''), pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Exchange Act'') \1\ and Rule
19b-4 thereunder,\2\ a proposed rule change to amend FINRA's Membership
Application Program (``MAP'') rules to help further address the issue
of pending arbitration claims, as well as arbitration awards and
settlement agreements related to arbitrations that have not been paid
in full in accordance with their terms.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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The proposed rule change was published for comment in the Federal
Register on December 30, 2019.\3\ The public comment period closed on
January 21, 2020. The Commission received two comment letters in
response to the Notice, both generally supporting the proposed rule
change.\4\ On January 31, 2020, FINRA responded to the comment letters
received in response to the Notice.\5\ On February 6, 2020, FINRA filed
an amendment to the proposal (``Amendment No. 1'').\6\ On February 10,
2020, FINRA extended the time period in which the Commission must
approve the proposed rule change, disapprove the proposed rule change,
or institute proceedings to determine whether to approve or disapprove
the proposed rule change to March 27, 2020. This order approves the
proposed rule change, as modified by Amendment No. 1.
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\3\ See Exchange Act Release No. 87810 (Dec. 20, 2019), 84 FR
72088 (Dec. 30, 2019) (File No. SR-FINRA-2019-030) (``Notice'').
\4\ See Letter from Steven B. Caruso, Maddox Hargett Caruso,
P.C., dated January 7, 2020 (``Caruso Letter''); and letter from
Christine Lazaro, Director of the Securities Arbitration Clinic and
Professor of Clinical Legal Education, St. John's University School
of Law, dated January 21, 2020 (``SJU Letter''). Comment letters are
available on the Commission's website at https://www.sec.gov.
\5\ See Letter from Victoria Crane, Vice President and Associate
General Counsel, FINRA, to Vanessa Countryman, Secretary, U.S.
Securities and Exchange Commission, dated January 31, 2020 (``FINRA
Letter''). The FINRA Letter is available on FINRA's website at
http://www.finra.org, at the principal office of FINRA, on the
Commission's website at https://www.sec.gov/comments/sr-finra-2019-030/srfinra2019030-6730822-207419.pdf, and at the Commission's
Public Reference Room.
\6\ Amendment No. 1 is available at https://www.finra.org/sites/default/files/2020-02/SR-FINRA-2019-030_Amendment1.pdf. With
Amendment No. 1, FINRA made a technical change to the text of the
proposal reflecting a cross-reference to FINRA Rule 1017(a)(5).
Specifically, FINRA's initial proposal did not amend Rule
1017(a)(5), which currently cross-references Rule 1011(k) defining
``material change in business operations.'' Amendment No. 1 changes
that cross-reference to ``Rule 1011(l)'' to reflect the renumbered
paragraphs as proposed in amended Rule 1011.
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II. Description of the Proposed Rule Change \7\
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\7\ The subsequent description of the proposed rule change is
substantially excerpted from FINRA's description in the Notice. See
Notice, 83 FR at 72088-72093.
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Background
The MAP Rules govern the way in which FINRA reviews a new
membership application (``NMA'') and a continuing membership
application (``CMA'').\8\ They are currently found under the FINRA Rule
1000 Series as FINRA Rules 1011 through 1019. These rules require an
applicant to demonstrate its ability to comply with applicable
securities laws and FINRA rules, including observing high standards of
commercial honor and just and equitable principles of trade. The MAP
rules require FINRA to evaluate an applicant's financial, operational,
and supervisory and compliance systems to ensure that the applicant
meets the standards set forth in the rules.
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\8\ Unless otherwise specified, the term ``application'' refers
to either an NMA (or Form NMA) or CMA (or Form CMA), depending on
context.
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FINRA's proposed rule changes would: (1) Amend Rule 1014
(Department Decision) to: (a) Create a rebuttable presumption that an
application for new membership would be denied if the applicant or its
associated persons are subject to a pending arbitration claim, and (b)
permit an applicant to overcome a presumption of denial by
demonstrating its ability to satisfy an unpaid arbitration award, other
adjudicated customer award, unpaid arbitration settlement, or pending
arbitration claim; (2) create a new requirement for a member, that is
not otherwise required to submit an application for continuing
membership for a specified change in ownership, control or business
operations, including a business expansion, to seek a materiality
consultation if the member or its associated persons have a defined
``covered pending arbitration claim,'' unpaid arbitration award, or an
unpaid arbitration settlement; (3) amend Rule 1017 (Application for
Approval of Change in Ownership, Control, or Business Operations) to
require a member to demonstrate its ability to satisfy an unpaid
arbitration award or unpaid settlement related to an arbitration before
effecting the proposed change thereunder; and (4) amend Rule 1013 (New
Member Application and Interview) and Rule 1017 to require an applicant
to provide prompt written notification of any pending arbitration claim
that is filed, awarded, settled, or becomes unpaid before a decision on
an application constituting final action on FINRA is served on the
applicant.\9\ Additionally, FINRA is proposing non-substantive changes
in specified MAP rules.\10\
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\9\ See Notice at 72088.
\10\ See id.
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Proposed Rule Change for Presumption To Deny an Application
FINRA is proposing an amendment to the standard for admission and
the corresponding factors therein relating to the presumption to deny
an application for new or continuing membership.\11\ Currently, FINRA
Rule 1014 sets forth standards for admission FINRA must consider in
determining whether to approve an application. Under Rule 1014(a)(3),
FINRA is required to determine whether an applicant for new or
continuing membership and its associated persons are capable of
complying with the federal securities laws, the rules and regulations
thereunder, and FINRA Rules. Rule 1014(a)(3) sets forth six factors
that FINRA must consider in making that determination. Additionally,
FINRA notes that under Rule 1014(b)(1), where an applicant or its
associated persons are subject to certain regulatory events enumerated
in Rule 1014(a)(3), a presumption exists that the application should be
denied.\12\ However, FINRA notes that ``the existence of a record of a
pending arbitration, as set forth in Rule 1014(a)(3)(B), is currently
not among the enumerated factors that trigger the presumption to deny
an application.'' \13\
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\11\ See id.
\12\ Notice at 72089.
\13\ Id.
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The proposed amendment to Rule 1014 would create the rebuttable
presumption to deny an application in cases where the prospective
applicant or its associated persons are the subject of pending
arbitration claims.\14\ This presumption of denial for a pending
arbitration claim would not apply to an existing member firm filing a
CMA.\15\ Instead, consistent with today's practice, FINRA would
continue to consider whether an applicant or its associated persons are
the subject of a pending arbitration claim in determining whether the
applicant for continuing membership is capable of complying with
applicable federal securities laws and FINRA rules.\16\
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\14\ Id.
\15\ Id.
\16\ Id.
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[[Page 18301]]
Proposed Rule Change To Demonstrate Ability To Satisfy Unpaid
Arbitration Awards, Other Adjudicated Customer Awards, Unpaid
Arbitration Settlements, or for New Member Applications, Pending
Arbitration Claims
FINRA is also proposing to clarify the various ways in which an
applicant for new or continuing membership may demonstrate its ability
to satisfy an unpaid arbitration award, other adjudicated customer
award, unpaid arbitration settlement, or a pending arbitration claim
during the application review process, and to preclude an applicant
from effecting any contemplated change in ownership, control, or
business operations until such demonstration is made and FINRA approves
the application.\17\ For example, proposed IM-1014-1 would allow
applicants to demonstrate the ability to satisfy an unpaid arbitration
award, other adjudicated customer award, unpaid arbitration settlement,
or a pending arbitration claim, through an escrow agreement, insurance
coverage, a clearing deposit, a guarantee, a reserve fund, or the
retention of proceeds from an asset transfer or such other forms of
documentation that FINRA may determine to be acceptable.\18\ Proposed
IM-1014-1 would also allow an applicant to overcome the presumption to
deny the application by guaranteeing that any funds used to evidence
the applicant's ability to satisfy any awards, settlements, or claims
will be used for that purpose.\19\
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\17\ See Notice at 72088.
\18\ Id. at 72089. Proposed IM-1014-1 would also allow an
applicant to provide a written opinion of an independent, reputable
U.S. licensed counsel knowledgeable in the area as to the value of
the arbitration claims.
\19\ Notice at 72090.
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Any demonstration by an applicant of its ability to satisfy these
outstanding obligations would be subject to a reasonableness assessment
by FINRA.\20\
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\20\ Id.
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Proposed Rule Change To Mandate Materiality Consultations
To further incentivize members to pay arbitration awards and
settlements, FINRA is proposing to mandate that a member seek a
materiality consultation in two situations in which specified pending
arbitration claims, unpaid arbitration awards, or unpaid arbitration
settlements are involved.\21\ Currently, the materiality consultation
process is voluntary, and exists to provide a member with the option of
seeking guidance, or a materiality consultation, from FINRA on whether
certain proposed events (e.g., acquisition or transfer of the member's
assets, or a business expansion) would be material and thus require the
member to file a CMA when it plans to undergo an event specified under
Rule 1017.\22\ According to FINRA, ``[t]he characterization of a
contemplated change as material depends on an assessment of all the
relevant facts and circumstances, including, among others, the nature
of the contemplated change, the effect the contemplated change may have
on the firm's capital, the qualifications and experience of the firm's
personnel, and the degree to which the firm's existing financial,
operational, supervisory, and compliance systems can accommodate the
contemplated change.'' \23\ Where FINRA determines that a contemplated
change is material, FINRA instructs the member to file a CMA if it
intends to proceed with the change.\24\
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\21\ See id. at 72089.
\22\ See Notice at 72090. A request for a materiality
consultation, for which there is no fee, is a written request from a
member firm for FINRA's determination on whether a contemplated
change in business operations or activities is material and would
therefore require a CMA or whether the contemplated change can fit
within the framework of the firm's current activities and structure
without the need to file a CMA. Id.
\23\ Notice at 72090 (citing Notice to Members 00-73 (October
2000) (FINRA Requests Comment on a Proposal Regarding the Rules
Governing the New and Continuing Membership Application Process)).
\24\ See id. As FINRA explains in the Notice, the member is
responsible for compliance with Rule 1017. If FINRA determines
during the materiality consultation that the contemplated business
change is material, then the member potentially could be subject to
disciplinary action for failure to file a CMA under Rule 1017. Id.
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Mandatory Materiality Consultation for Business Expansion To Add One or
More Associated Persons Involved in Sales (Proposed IM-1011-2 and
Proposed Rules 1011(c)(1) and 1017(a)(6)(B))
Current Rule 1017 specifies the changes in a member's ownership,
control, or business operations that require a CMA and FINRA's
approval.\25\ However, current IM-1011-1 creates a safe harbor for
incremental increases in certain business expansions that are presumed
not to be material changes in business operations.\26\ Under this safe
harbor, a member, subject to specified conditions and thresholds, may
undergo such business expansions without filing a CMA.\27\
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\25\ See id.
\26\ See Notice at 72090.
\27\ See id.
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Proposed IM-1011-2 (Business Expansions and Covered Pending
Arbitration Claims) would provide that if a member is contemplating to
add one or more associated persons involved in sales and one or more of
those associated persons: (1) Has a ``covered pending arbitration
claim'' \28\ (as that term is defined in proposed Rule 1011(c)(1)
described below), an unpaid arbitration award or an unpaid settlement
related to an arbitration, and (2) the member is not otherwise required
to file a CMA, the member may not effect the contemplated business
expansion unless the member complies with the proposed new requirements
in Rule 1017(a)(6)(B).\29\ Proposed Rule 1017(a)(6)(B) would require a
member firm to file a CMA for approval of the business expansion
described in proposed IM-1011-2 unless the member first submits a
written request to FINRA seeking a materiality consultation for the
contemplated business expansion. As part of the materiality
consultation, FINRA would determine whether: (1) The member is not
required to file a CMA in accordance with Rule 1017 and may effect the
contemplated business expansion; or (2) the member is required to file
a CMA in accordance with Rule 1017 and the member may not effect the
contemplated business expansion unless FINRA approves the CMA.\30\
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\28\ Proposed Rule 1011(c)(1) would define a ``covered pending
arbitration claim'' as an investment-related, consumer-initiated
claim filed against the associated person in any arbitration forum
that is unresolved; and whose claim amount (individually or, if
there is more than one claim, in the aggregate) exceeds the hiring
member's excess net capital. See id. at 72091.
For purposes of this definition, FINRA explains that the claim
would only include claimed compensatory loss amounts, not requests
for pain and suffering, punitive damages, or attorney's fees, and
shall be the maximum amount for which the associated person is
potentially liable regardless of whether the claim was brought
against additional persons or the associated person reasonably
expects to be indemnified, share liability, or otherwise lawfully
avoid being held responsible for all or part of such maximum amount.
\29\ See id. at 72091.
\30\ See Notice at 72091.
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Mandatory Materiality Consultation for Any Acquisition or Transfer of
Member's Assets (Proposed Rule 1011(c)(2) and Proposed Rule
1017(a)(6)(A))
Currently, Rule 1017(a) requires a member to file a CMA for direct
or indirect acquisitions or transfers of 25 percent or more in the
aggregate of the member's assets or any asset, business, or line of
operation that generates revenues composing 25 percent or more in the
aggregate of the member's earnings measured on a rolling 36-month
basis, unless both the seller and acquirer are NYSE members.\31\
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\31\ See id.
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FINRA is proposing to add a new subparagraph (6)(A) to Rule 1017(a)
to provide that if a member is contemplating any direct or indirect
[[Page 18302]]
acquisition or transfer of a member's assets or any asset, business, or
line of operations where the transferring member or an associated
person of the transferring member: (1) Has a ``covered pending
arbitration claim,'' \32\ an unpaid arbitration award or an unpaid
settlement related to an arbitration, and (2) the member is not
otherwise required to file a CMA, the member may not effect the
contemplated transaction unless the member first submits a written
request to FINRA seeking a materiality consultation for the
contemplated acquisition or transfer.\33\ As part of the materiality
consultation, FINRA would determine whether: (1) The member is not
required to file a CMA in accordance with Rule 1017 and may effect the
contemplated acquisition of transfer; or (2) the member is required to
file a CMA in accordance with Rule 1017 and the member may not effect
the contemplated acquisition or transfer unless FINRA approves the
CMA.\34\
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\32\ Proposed Rule 1011(c)(2) would define a ``covered pending
arbitration claim'' as an investment-related, consumer-initiated
claim filed against the transferring member or its associated
persons in any arbitration forum that is unresolved; and whose claim
amount (individually or, if there is more than one claim, in the
aggregate) exceeds the transferring member's excess net capital. See
id. at 72092.
For purposes of this definition, FINRA explains that the claim
would only include claimed compensatory loss amounts, not requests
for pain and suffering, punitive damages or attorney's fees, and
shall be the maximum amount for which the associated person is
potentially liable regardless of whether the claim was brought
against additional persons or the associated person reasonably
expects to be indemnified, share liability or otherwise lawfully
avoid being held responsible for all or part of such maximum amount.
\33\ See Notice at 72091.
\34\ See id.
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Proposed Rule Change Requiring Notification of Unpaid Arbitration
Awards
The proposal would require an applicant for new or continuing
membership to notify FINRA of any pending arbitration claims that are
filed, awarded, settled, or become unpaid before FINRA renders a
decision on the application.\35\ Current Rule 1013(a) lists items that
must be submitted with an NMA and Rule 1017(b) sets forth the documents
and other information required to accompany a CMA, depending on the
nature of the CMA.\36\ FINRA is proposing to add Rules 1013(c) and
1017(h) to require an applicant to provide prompt notification, in
writing, of any pending arbitration claim involving the applicant or
its associated persons that is filed, awarded, settled, or becomes
unpaid before a decision on the application constituting final action
of FINRA is served on the applicant.\37\ FINRA indicated that any such
unpaid arbitration award, other adjudicated customer award, unpaid
arbitration settlement, or pending arbitration claim (for a new member
applicant only) that comes to light in this manner during the
application review process would result in FINRA being able to
presumptively deny the application under the applicable factors set
forth in Rule 1014(a)(3), and the ability of the applicant to overcome
such presumption by demonstrating its ability to satisfy the
obligation.\38\
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\35\ See id. at 72089.
\36\ See id. at 72092.
\37\ See id.
\38\ See id. at 72092.
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Current Rule 1017(c) describes the timing and conditions for
effecting a change under Rule 1017.\39\ Rule 1017(c)(1) requires a
member to file a CMA for approval of a change in ownership or control
at least 30 days before the change is expected to occur.\40\ A member
may effect the change prior to the conclusion of FINRA's review of the
CMA, however, FINRA may place interim restrictions on the member based
upon the standards in Rule 1014 pending a final determination. Under
Rule 1017(c)(2), a member may file a CMA to remove or modify a
membership agreement restriction at any time, but any such existing
restriction shall remain in effect during the pendency of the
proceeding.\41\ Finally, Rule 1017(c)(3) permits a member to file a CMA
for approval of a material change in business operations at any time,
but the member may not effect such change until the conclusion of the
proceeding, unless FINRA and the member otherwise agree.\42\ FINRA is
proposing to add subparagraph (4) to Rule 1017(c), providing that,
notwithstanding the existing timing and conditions for effecting a
change as described under Rule 1017(c)(1) through (3), where a member
or an associated person has an unpaid arbitration award or unpaid
settlement related to an arbitration at the time of filing a CMA, the
member may not effect such change until demonstrating that it has the
ability to satisfy such obligations in accordance with Rule 1014 and
proposed IM-1014-1, as discussed above, and obtaining FINRA's approval
of the CMA.\43\
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\39\ See id.
\40\ See id.
\41\ See id.
\42\ See id.
\43\ See Notice at 72092.
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Additional Proposed Changes
The proposal would also make non-substantive changes in the MAP
rules by renumbering paragraphs in Rules 1011, 1014, and 1017, as well
as updating cross-references.\44\
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\44\ See id. at 72088. FINRA will also make conforming changes
to Forms NMA and CMA.
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III. Comment Summary
As noted above, the Commission received two comment letters on the
proposed rule change supporting the proposal.\45\ While both commenters
were generally supportive of the proposal, they believed that further
action was necessary to address the issue of unpaid financial
obligations that broker-dealers and their associated persons owe to
their customers.\46\
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\45\ See supra note 4.
\46\ Id.
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Supportive Comments
In one commenter's view, the proposed rule changes represented a
``fair, equitable and reasonable approach that would expedite and
facilitate the efficiency of the arbitration process'' and recommended
that they should be ``approved by the SEC on an expedited basis.'' \47\
The second commenter noted the proposed rules changes would provide
FINRA with ``another tool with which it may scrutinize the business of
its members and new member applicants to ensure they can comply with
the relevant rules and regulations, and that investors are protected.''
\48\
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\47\ Caruso Letter.
\48\ SJU Letter.
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Proposal Is Insufficient
As stated above, both commenters believed that FINRA needed to take
further action to address unpaid financial obligations that broker-
dealers and their associated persons owe to their customers.\49\ One
commenter stated ``it is clear that these rule amendments . . . will
not completely solve the large number of customer awards that remain
unpaid each year.'' \50\ The second commenter suggested that either in
this rulemaking or a subsequent rulemaking, FINRA should consider
addressing all investor settlements that have not been fully paid, such
as a settled mediation claim or a settlement resulting from a written
or oral complaint.\51\ The commenter believes that the proposal should
cover these settlements because these types of settlements also may
never be fully satisfied by a firm.\52\
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\49\ See Caruso Letter and SJU Letter.
\50\ Caruso Letter.
\51\ See SJU Letter.
\52\ See id.
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[[Page 18303]]
In response, FINRA recognizes that the issue of unpaid financial
obligations that broker-dealers and their associated persons owe to
their customers is not unique to the FINRA arbitration forum or the
broker-dealer industry and that investors may have claims that arise
outside of FINRA arbitration.\53\ But FINRA also believes this
particular rule filing is only one of the ways it is proceeding to
implement additional steps to strengthen its rules on this topic.\54\
In addition, FINRA noted that it has ``encouraged a continuing dialogue
about addressing the challenges of customer recovery across the
financial services industry while directly informing the further
enhancement of recovery in FINRA's forum[.]'' \55\ For example, FINRA
cited to its 2018 White Paper and ``additional data regarding the
circumstances under which awards may be unpaid, along with a discussion
of potential regulatory and legislative responses.'' \56\ For these
reasons, FINRA declined to amend this proposal in response to
commenters.\57\
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\53\ See FINRA Letter.
\54\ Id. See e.g., Exchange Act Release No. 88254 (Feb. 20,
2020), 85 FR 11157 (Feb 26, 2020) (File No. SR-FINRA-2019-027)
(amending FINRA rules to expand customers' options in arbitration
with respect to claims brought against inactive member firms and
associated persons).
\55\ FINRA Letter.
\56\ Id. In FINRA Perspectives on Customer Recovery, available
at https://www.finra.org/sites/default/files/finra_perspectives_on_customer_recovery.pdf. FINRA also makes
available additional data on unpaid arbitration awards arising in
the forum for the past five years, available at https://www.finra.org/arbitration-mediation/statistics-unpaid-customer-awardsfinra-arbitration (``White Paper''). In addition, FINRA has
published a list of firms and associated persons responsible for
unpaid arbitration awards, available at https://www.finra.org/arbitration-mediation/member-firms-and-associated-personsunpaid-customer-arbitration-awards. See FINRA Letter at note 3.
\57\ See FINRA Letter.
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IV. Discussion and Commission Findings
After careful review of the proposed rule change and the comment
letters, the Commission finds that the proposal is consistent with the
requirements of the Exchange Act and the rules and regulations
thereunder that are applicable to a national securities association.
\58\ Specifically, the Commission finds that the proposed rule change
is consistent with Section 15A(b)(6) of the Exchange Act,\59\ which
requires, among other things, that FINRA rules 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.
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\58\ In approving this rule change, the Commission has
considered the rule's impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
\59\ 15 U.S.C. 78o-3(b)(6).
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Presumption To Deny an Application
The Commission agrees with FINRA that this proposal to add a
presumption to deny an NMA helps to address concerns related to
prospective applicants for new membership planning to hire principals
and registered persons with pending arbitration claims without being
able to adequately demonstrate: (1) How those claims would be paid if
they go to award or result in a settlement; and (2) how the new member
applicant would be able to effectively supervise such individuals who
may have a history of noncompliance. In particular, the Commission
agrees with FINRA that creating a presumption of denial in connection
with a pending arbitration claim for an NMA would appropriately shift
the burden to the new member applicant to demonstrate how its pending
arbitration claim would be paid should it go to award or result in a
settlement. As FINRA notes, this proposed amendment promotes investor
protection by requiring more thorough scrutiny of certain prospective
member firms to help protect the potential customers of those
firms.\60\
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\60\ See Notice at 72093. FINRA noted that the majority of new
member applicants are unlikely to be effected by the proposed
amendments. FINRA reviewed the 317 NMAs that it received from
January 2015 through December 2017 and found that of those 317 NMAs
only 13 NMAs included a new member applicant or its associated
persons that had a pending arbitration claim at the time of FINRA's
receipt of the NMA. Under the proposed amendments, FINRA could have
presumptively denied those NMAs. See id. at 72093, 72094.
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Demonstration of Ability To Pay
The Commission agrees with FINRA that it would improve the
efficiency of the MAP process to institute the proposal requiring
evidence of an applicant's ability to satisfy unpaid arbitration
awards, other adjudicated customer awards, unpaid arbitration
settlements, or, in the case of NMAs, pending arbitration claims.
Specifically, the Commission agrees with FINRA that this rule will
increase the ability of applicants to anticipate the information
necessary to demonstrate their ability to satisfy outstanding
obligations or potential obligations, and reduce the need for
applicants to submit additional information after the initial filing.
The Commission also believes the proposal could help reduce the number
of unpaid arbitration awards by permitting an applicant to overcome the
presumption to deny an application by guaranteeing that any funds used
to evidence the applicant's ability to satisfy any awards, settlements,
or claims will be used specifically for that purpose.
Materiality Consultation
FINRA has expressed concern that, under current Rule 1017 and the
existing safe harbor for business expansions to increase the number of
associated persons involved in sales,\61\ a member could hire
principals and registered representatives with substantial pending
arbitration claims without considering how the firm would supervise
such individuals or the potential financial impact on the firm if the
individual, while employed at the hiring firm, engages in potential
misconduct that results in a customer arbitration.\62\ The Commission
agrees with FINRA that requiring a materiality consultation for this
type of business expansion would allow FINRA to, among other things,
assess the nature of the anticipated activities of the principals and
registered representatives with pending arbitration claims, unpaid
arbitration awards, or arbitration settlements; the impact on the
firm's supervisory and compliance systems, personnel, and finances; and
any other impact on investor protection raised by adding such
individuals.
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\61\ See FINRA IM-1011-1 (Safe Harbor for Business Expansions).
\62\ See Notice at 72090.
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Additionally, the Commission agrees that FINRA is better able to
assess, among other things, the adequacy of any plan a member firm has
in place to satisfy pending arbitration claims, unpaid arbitration
awards, or unpaid arbitration settlements, by requiring a materiality
consultation when a member firm is contemplating any direct or indirect
acquisition or transfer of assets involving a ``covered pending
arbitration claim.'' The Commission further agrees that this proposal
helps reduce the risk that a firm with pending arbitration claims that
ultimately produce awards or settlements could avoid satisfying those
awards or settlements by transferring assets without encumbrance and
then closing down. The Commission agrees with FINRA that a decrease in
the ability of firms to avoid satisfying their arbitration awards or
settlements in this manner may result in a higher likelihood that they
are paid in full in accordance with their terms.
Notification of Unpaid Arbitration Awards
The Commission agrees with FINRA that requiring applicants to
provide prompt notification to FINRA of a pending arbitration claim
that is filed,
[[Page 18304]]
awarded, settled, or becomes unpaid before a decision on the
application is served will improve FINRA's ability to oversee and
review the pending arbitrations of applicants to help ensure that
arbitration awards and settlements are paid in full in accordance with
their terms.
In sum, the Commission agrees with FINRA and the commenters who
supported the proposed rule change that it would help address the issue
of unpaid arbitration awards. Specifically, the proposal would link a
firm's or associated person's unpaid arbitration awards, unpaid
arbitration settlement, or specified pending arbitration claims
(collectively, ``unpaid and potential financial obligations related to
arbitration'') to FINRA's membership application review process, in
certain instances, to provide FINRA greater oversight.\63\ These
changes will enable FINRA to more directly address concerns over unpaid
and potential financial obligations related to arbitration, as well as
the adequacy of the supervision of individuals with unpaid and
potential financial obligations related to arbitration in situations
where, for example: (1) A FINRA member firm hires individuals with
pending arbitration claims, where there are concerns about: (a) The
payment of those claims should they go to award or result in
settlement, and (b) the supervision of those individuals; and (2) a
member firm with pending arbitration claims seeks to avoid payment of
the claims should they go to award or result in a settlement by
shifting its assets, or its managers and owners, to another firm and
closing down. Additionally, the Commission agrees with FINRA that
amendments adopted here will enable FINRA to place greater emphasis on
the adequacy of the supervision of individuals with pending arbitration
claims given their history of noncompliance. While the Commission
acknowledges the concerns of commenters regarding the potential for
further action to address unpaid claims that arise outside of FINRA
arbitration, as FINRA noted, this proposal represents one step in the
ongoing process of addressing these issues and FINRA continues to
evaluate further action.\64\
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\63\ See Notice at 72089.
\64\ See FINRA Letter.
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V. Conclusion
It is therefore ordered pursuant to Section 19(b)(2) of the
Exchange Act \65\ that the proposal (SR-FINRA-2019-030), as modified by
Amendment No. 1, be, and hereby is, approved.
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\65\ 15 U.S.C. 78s(b)(2).
\66\ 17 CFR 200.30-3(a)(12).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\66\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-06722 Filed 3-31-20; 8:45 am]
BILLING CODE 8011-01-P