FINRA Seeks Comment on Revised Proposal to Adopt a Consolidated Rule on Discretionary Accounts and Transactions

Practical Law Legal Update 8-616-5590 (Approx. 5 pages)

FINRA Seeks Comment on Revised Proposal to Adopt a Consolidated Rule on Discretionary Accounts and Transactions

by Practical Law Corporate & Securities

Discretionary Transactions by Member Firms and Their Associated Persons

Proposed FINRA Rule 3260(a) would:

Prohibit a firm or an associated person of the firm from effecting for a customer's account over which the firm, or an agent or employee of the firm, has any discretionary power any transactions that are excessive in size or frequency in view of the financial resources and character of the account.
Prohibit firms and their registered representatives from exercising any discretionary power in a customer's account unless:
- the customer has given a dated and signed prior written authorization to a named associated person or associated persons;
- the account documentation has been signed by a partner, officer or manager designated by the firm; and
- the account has been accepted in writing by a designated partner, officer or manager of the firm (other than the associated person vested with discretionary power) denoting that the account has been accepted in accordance with the firm's policies and procedures for acceptance of discretionary accounts.
The associated person and the firm would be permitted to exercise discretionary power in the account only in the manner, and under the terms and conditions, specified in the customer's prior written authorization.
Require that the firm or designated partner, officer or manager approve promptly in writing each discretionary order entered and review all discretionary accounts at frequent intervals to detect and prevent transactions that are excessive in size or frequency in view of the financial resources and character of the account. Firms could approve discretionary trades post-trade and in bulk, provided that the designated partner, officer or manager approves the trade promptly.

Proposed FINRA Rule 3260(a) would apply to an associated person of a firm who is either:

Engaged in investment adviser discretionary activities in a customer's account at the firm.
Granted non-broker-dealer and non-investment adviser discretionary authority by a customer of the firm, such as a family member who has given a power of attorney to the associated person.

Fee-based only accounts, including accounts that are charged only a flat fee or a fee based on assets under management, would not be subject to the requirements of proposed FINRA Rule 3260(a).

Transactions by Agents of Customers

Under proposed FINRA Rule 3260(b), no firm or associated person of the firm would be permitted to accept an order for a customer's accounts from a person other than the customer without first obtaining the customer's signed and dated prior written authorization. The revised proposal would require that an order placed by a person other than the customer be within the scope of that person's authority as specified in the customer's authorization.

Proposed FINRA Rule 3260(b) would only apply to circumstances where the order is from a person other than the customer and would not require a firm or an associated person to look through an intermediary (such as an investment adviser) to the underlying beneficial owners where the intermediary is identified as the firm's customer. The requirements of proposed FINRA Rule 3260(b) would not apply to:

A customer that is itself a legal entity and that has authorized its personnel to trade on behalf of the legal entity.
Online brokerage activities where a customer has provided account access to another person and the firm or associated person does not know or have reason to know that a particular order is being placed by someone other than the customer.

Temporary Time or Price Discretion

Proposed FINRA Rule 3260(c)(1)(A) would provide an exception to the requirements of proposed FINRA Rule 3260(a) for a customer's limited authorization for time or price discretion for the purchase or sale of a definite dollar amount or quantity of a specified security. A firm would be able to exercise time or price discretion either:

Given by a customer during a normal trading session, provided the discretion is only valid during that session.
Given by a customer after the close of a normal trading session, provided the discretion is only valid during the next normal trading session.

For institutional accounts, the revised proposal also provides an exception to the requirements of proposed FINRA Rule 3260(a) for a firm that exercises time or price discretion for the accounts under valid good-'til'-canceled instructions issued on a "not-held" basis, without time limits.

Mergers and Acquisitions of Money Market Mutual Funds

Proposed FINRA Rule 3260(c)(1)(B) would provide an exception to the requirements of proposed FINRA Rule 3260(a) for firms using negative response letters to effect a bulk exchange at net asset value of money market mutual funds in situations involving a merger or acquisition of the mutual funds. Under the proposal:

The bulk exchange would need to be no sooner than 30 calendar days after the date on which the negative response letter was sent to the customer.
Where the bulk exchange involves money market mutual funds in a sweep program, the negative response letter used to effect the bulk exchange would need to describe:
- the new terms and conditions of the new product; and
- the options available to the customer if the customer does not accept the new terms and conditions of the new product consistent with Rule 15c3-3(j)(2)(ii)(B)(3)(ii) under the Exchange Act.

Bulk Transfer of Customer Accounts and Change of Broker-Dealer of Record

Proposed FINRA Rule 3260(c)(1)(C) codifies FINRA's guidance on the use of negative response letters to effect a bulk transfer of customers' accounts. It expands FINRA's existing guidance on bulk transfers and incorporates published SEC guidance on the applicability of Rule 15c3-3 under the Exchange Act to bulk transfers. The revised proposal provides an exception to the requirements of proposed FINRA Rule 3260(a) for the use of negative response letters to effect bulk transfers of customers' accounts in the following situations:

An introducing firm that has entered into a clearing arrangement with a different clearing firm is seeking to transfer its customer accounts to the new clearing firm.
An introducing firm or a clearing firm that is experiencing financial or operational difficulties is seeking to transfer all of its customer accounts, including in the case of a clearing firm all of the accounts carried by the clearing firm, to another introducing firm or clearing firm.
An introducing firm or a clearing firm that is going out of business, other than for financial or operational difficulties, is seeking to transfer all of its customer accounts to another introducing firm or clearing firm.
An introducing firm or a clearing firm that is divesting itself of a specific business line or area, such as its retail brokerage business or some of its branch offices, is seeking to transfer the affected customer accounts to another introducing firm or clearing firm.
A clearing firm, for an introducing firm that has gone out of business, is seeking to transfer all of the introducing firm's customer accounts to another introducing firm at the same clearing firm.
A firm that is acquired by or merged with another firm is seeking to transfer all of its customer accounts to the new firm.
On the conclusion or termination of a networking arrangement between a firm and a financial institution under FINRA Rule 3160 (Networking Arrangements Between Members and Financial Institutions), the firm is seeking to transfer all customer accounts established under the arrangement to a new firm with which the financial institution has formed a networking arrangement under FINRA Rule 3160.

Firms would be required to send the negative response letters to the customers, absent exigent circumstances, at least 30 calendar days before the firm effects the transfer. The revised proposal would also impose certain additional conditions on the bulk transfer of customer accounts using negative response letters.

Treatment of Free Credit Balances

All transactions involving free credit balances are subject to the SEC's requirements under Rule 15c3-3 of the Exchange Act. The revised proposal incorporates the SEC's requirements as exceptions to the requirements of proposed FINRA Rule 3260(a), as follows:

Treatment of free credit balances outside of a sweep program. Proposed FINRA Rule 3260(c)(1)(D) provides that a firm may invest, or transfer to another account or institution, free credit balances in a customer's account outside of a sweep program only on a specific order, authorization or draft from the customer, and only in the manner, and under the terms and conditions, specified in the order, authorization or draft. A firm would not be subject to these requirements if it effects:
- a bulk exchange of money market mutual funds using negative response letters consistent with proposed FINRA Rule 3260(c)(1)(B); or
- a bulk transfer of customer accounts using negative response letters consistent with proposed FINRA Rule 3260(c)(1)(C).
Treatment of free credit balances in a sweep program. Proposed FINRA Rule 3260(c)(1)(E) permits a firm to transfer free credit balances held in a customer's securities account to a product in the firm's sweep program or transfer a customer's interest in one product in a sweep program to another product in a sweep program, subject to certain conditions. For accounts opened on or after the effective date of the revised proposal, the proposal would require the firm to obtain the customer's prior written affirmative consent to having free credit balances in the customer's securities account included in the firm's sweep program after the customer has been notified:
- of the general terms and conditions of the products available through the sweep program; and
- that the firm may change the products available under the program.
A firm would not be subject to these requirements if it effects a bulk exchange of money market mutual funds using negative response letters consistent with proposed FINRA Rule 3260(c)(1)(B), provided that the negative response letter used to effect the bulk exchange also complies with the disclosure requirements of Rule 15c3-3(j)(2)(ii)(B)(3)(ii).

Money Market Mutual Fund Redemption Programs and Transactions to Satisfy Indebtedness

Proposed FINRA Rule 3260(c)(1)(F) sets out exceptions to the requirements of proposed FINRA Rule 3260(a):

For automatic money market mutual fund redemptions.
To address situations where a firm effects a transaction to satisfy an indebtedness to the firm.

Additional Supplementary Material and Eliminated Rules

The revised proposal would add the following supplementary material:

FINRA Rule 3260.01 (Compliance With Federal Securities Laws Governing Discretionary Accounts and Transactions).
FINRA Rule 3260.05 (Definition of Free Credit Balances and Sweep Program).

The revised proposal would delete NYSE Rule 408 and NYSE Rule Interpretation 408.

FINRA Seeks Comment on Revised Proposal to Adopt a Consolidated Rule on Discretionary Accounts and Transactions | Practical Law