- Is It Safe? Limits of “Safe Harbor” for Temporary Holds on Senior Investor Transactions Under Proposed FINRA Rule 2165
- January 13, 2017 | Authors: Bruce M. Bettigole; Clifford E. Kirsch; Sarah Razaq Sallis; Holly H. Smith
- Law Firms: Sutherland Asbill & Brennan LLP - Washington Office; Sutherland Asbill & Brennan LLP - New York Office; Sutherland Asbill & Brennan LLP - Washington Office
In addition to the recent increase in regulatory focus on senior investors,1 earlier this fall, the Financial Industry Regulatory Authority (FINRA) filed a rulemaking proposal (the filing) with the Securities and Exchange Commission (SEC) to adopt new FINRA Rule 2165 (Financial Exploitation of Specified Adults) (the proposed rule or Rule 2165).2 Rule 2165 would permit, but not require, FINRA member firms (firms) “to place temporary holds on disbursements of funds or securities from the accounts of specified customers where there is a reasonable belief of financial exploitation.”3 The proposed rule would provide firms with only a limited “safe harbor” from certain FINRA rules. It would not provide blanket immunity from FINRA enforcement action, nor would it protect firms from private civil or state actions. This legal alert is the second in a series addressing the ever-changing regulatory landscape relating to senior investors.4
II. Proposed FINRA Rule 2165
The language of Rule 2165 as originally proposed by FINRA in October 2015 stated broadly that the proposed rule “provides members with a safe harbor when they exercise discretion in placing temporary holds on disbursements of funds or securities from the Account of a Specified Adult under the specified circumstances denoted in the Rule.”5 Neither the proposed rule nor the accompanying October 2015 notice provided any detail on the meaning of the term “safe harbor,” its scope, or clarification as to specific rules to which the safe harbor applied.
In October 2016, FINRA filed its proposed rule change with the SEC. While the filing provides some guidance on the scope of the safe harbor, doubt remains as to the extent to which firms may confidently rely on its protections.
a. The Safe Harbor Would Apply Only to FINRA Rules 2010, 2150, and 11870
The proposed rule would provide firms “with a safe harbor from FINRA rules that might otherwise discourage them from exercising discretion to protect customers through placing a temporary hold on disbursements of funds or securities.”6 That safe harbor would be intended to “provide regulatory relief” to firms, rather than grant immunity from civil or administrative actions.7 This narrowed approach varies significantly from the original October 2015 notice, in that the safe harbor is described in the current filing only in terms of protection from enumerated FINRA rules. Specifically, the filing clarifies that Rule 2165 would provide safe harbor only with regard to the following FINRA rules:
- FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade);
- FINRA Rule 2150 (Improper Use of Customers’ Securities or Funds; Prohibition Against Guarantees and Sharing in Accounts);8 and
- FINRA Rule 11870 (Customer Account Transfer Contracts).
b. The Safe Harbor’s Application to Other Rules Remains Uncertain
If adopted as proposed in October 2016, the scope of the Rule 2165 safe harbor would be significantly narrowed from the broad language as originally proposed by FINRA in October 2015.10 This change could result in potentially negative unintended consequences for those firms wishing to avail themselves of the safe harbor. The filing provides some helpful guidance on the proposed limitations of the safe harbor:
- Uniform Application for Securities Industry Registration or Transfer (Form U4). The safe harbor would not apply to the Form U4 reporting of customer complaints that may arise as a result of firm actions taken under Rule 2165.11
- FINRA Rule 4530. The safe harbor also would not apply to reporting required under FINRA Rule 4530. This is particularly relevant for a firm’s reporting of customer complaints made against a firm for activity related to its decision to place, lift or refuse a temporary hold under Rule 2165. Even though a firm would be required to report such complaints, the filing notes that “FINRA would consider whether a member or associated person had acted consistent[ly] with the proposed rule when FINRA assesses reported information about a hold on a disbursement.”12
- Underlying Findings of Financial Exploitation. The safe harbor would not apply to a firm’s prerequisite decision on the existence of underlying financial exploitation under the proposed rule; rather, the safe harbor as outlined in the section above would apply only when firms “exercise discretion in placing temporary holds on disbursements of funds or securities from the account of a specified adult.”13
- Supervision (FINRA Rules 3110 and 3120). The safe harbor would not extend to the requirement that firms establish, maintain, test and verify a supervisory system that is reasonably designed to achieve compliance with applicable securities laws and regulations. In fact, the proposed rule “would require a member that anticipates using a temporary hold in appropriate circumstances to establish and maintain written supervisory procedures reasonably designed to achieve compliance with the Rule, including procedures on the identification, escalation and reporting of matters related to financial exploitation of specified adults.”15
- Recordkeeping (FINRA Rules 4511 and 4513). The safe harbor would not extend to a firm’s duty to make and preserve certain records, including those required under Exchange Act Rules 17a-3 and 17a-4, as well as FINRA rules. This would include, for example, written customer complaints received as a result of firm action or inaction under proposed Rule 2165.
- Best Execution (FINRA Rule 5310). The safe harbor would not extend to the existing requirement that firms use “reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions.” In other words, the proposed rule would apply only to the temporary hold on the disbursement of funds or securities, not to the execution of the order itself. The latter must be carefully administered to ensure that the customers’ buy or sell orders still receive the best possible prices as required under FINRA rules.
Although Rule 2165 is not yet final, it is important for all firms to begin contemplating a supervisory structure that would take into consideration temporary holds as allowed under the proposed rule. For example, firms should proactively establish written supervisory policies and procedures to address, among others: (i) preliminary findings of financial exploitation; (ii) internal escalation processes, including identifying individuals responsible for such escalations; and (iii) providing documentation on the firm’s decision to place or lift a temporary hold. Firms should also take particular care to make and preserve all records related to temporary holds, because these documents will likely be the subject of future FINRA scrutiny.
Firms also may want to consider the potential impact of the proposed rule on their financial policies and procedures, specifically policies and procedures designed to comply with Exchange Act Rules 15c3-1 and 15c3-3. To the extent that a firm is prohibited from holding customer funds and securities, it may need to consider how this prohibition could be impacted by a decision to place a temporary hold on disbursements of customer funds or securities. Engaging in these and other preemptive measures may help minimize the chances of Rule 2165-related findings in future FINRA examinations and, in turn, decrease the likelihood of future Rule 2165-related FINRA enforcement actions.
1 “[P]rotecting senior investors will remain a top priority [for FINRA] in 2017.” 2017 FINRA Regulatory and Examination Priorities Letter at p. 3 (Jan. 2017), available at http://www.finra.org/sites/default/files/2017-regulatory-and-examination-priorities-letter.pdf. The SEC’s Office of Compliance Inspections and Examinations (OCIE) recently released its 2017 priorities letter, which also focuses on senior investors and retirement investments. See SEC OCIE Examination Priorities for 2017 at p. 3 (Jan. 2017), available at https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf (noting that OCIE “will evaluate how firms manage their interactions with senior investors, including their ability to identify financial exploitation of seniors”).
2 See Notice of Filing of a Proposed Rule Change to Amend Rule 4512 (Customer Account Information) and Adopt FINRA Rule 2165 (Financial Exploitation of Specified Adults), 81 Fed. Reg. 78238 (Nov. 7, 2016). The comment period closed on November 28, 2016. The SEC received 20 comment letters in response to the filing. For more information, see “Comments on FINRA Rulemaking,” available at https://www.sec.gov/comments/sr-finra-2016-039/finra2016039.shtml. This article focuses on the issues presented in proposed new FINRA Rule 2165, not on FINRA’s proposed related amendments to FINRA Rule 4512.
3 81 Fed. Reg. at 78238.
4 The first legal alert in this series focused on highlights from the joint FINRA and Securities Industry and Financial Markets Association (SIFMA) Senior Investor Protection Conference, held in Washington, DC in October 2016, available at http://www.sutherland.com/NewsCommentary/Legal-Alerts/194018/Legal-Alert-FINRA-SEC-Renew-Focus-on-Senior-Investors-in-Immediate-Aftermath-of-FINRA-Submission-of-Proposed-Rulemaking-to-SEC.
5 FINRA Regulatory Notice 15-37, Financial Exploitation of Seniors and Other Vulnerable Adults, Supplementary Material .01 (Oct. 2015), available at http://www.finra.org/sites/default/files/notice&under;doc&under;file&under;ref/Regulatory-Notice-15-37.pdf.
6 Id. at 78244.
7 81 Fed. Reg. at 78250 (“FINRA believes that members today make judgments with regard to making or withholding disbursements and already face litigation risks with respect to these decisions. The proposed rule change is designed to provide regulatory relief to members by providing a safe harbor from FINRA rules for a determination to place a hold. Some states may separately provide immunity to members under state law”).
8 81 Fed. Reg. at 78240. One commenter argued against including FINRA Rules 2010 and 2150 within the safe harbor. For more information, see the comment letter from the Georgia State University College of Law Investor Advocacy Clinic (Nov. 28, 2016), available at https://www.sec.gov/comments/sr-finra-2016-039/finra2016039-8.pdf.
9 81 Fed. Reg. at 78244. The safe harbor would apply to both firms and their associated persons.
10 See supra note 4. The October 2015 release did not specify to which rules the safe harbor would or would not apply.
11 81 Fed. Reg. at 78244. Two commenters urged FINRA and the SEC to change their position on the exclusion of Rule 4530 and Form U4 reporting obligations from the safe harbor. For additional detail, see comment letters from SIFMA (Nov. 28, 2016), available at https://www.sec.gov/comments/sr-finra-2016-039/ finra2016039-12.pdf, and Janney Montgomery Scott LLC (Nov. 28, 2016), available at https://www.sec.gov/ comments/sr-finra-2016-039/finra2016039-6.pdf.
12 81 Fed. Reg. at 78244.
14 This list is not intended to be exhaustive.
15 81 Fed. Reg. at 78241 (citing Rule 2165(c)(1)).