• Last-Minute Holiday Present From MSRB Expands Record Retention Obligations to Support New Risk-Based Examinations
  • December 29, 2011 | Authors: W. Hardy Callcott; Paul M. Tyrrell
  • Law Firms: Bingham McCutchen LLP - San Francisco Office ; Bingham McCutchen LLP - Boston Office
  • Introduction 

    On Dec. 16, 2011, the Securities and Exchange Commission (“SEC”) approved amendments to both the Municipal Securities Rulemaking Board (“MSRB”) Rule G-16 concerning periodic compliance examinations of broker, dealers and municipal securities dealers (“dealers”) registered with FINRA as well as MSRB Rule G-9 on the preservation of records for dealers. The Rule G-16 amendments seek to modernize the examination process and harmonize the examination cycle of FINRA-member dealers. The Rule G-9 amendments require that records relating to municipal securities be retained for four years, rather than the three years required under SEC Rule 17a-4 for most other similar broker-dealer books and records.

    The Rule G-16 amendments are effective as of the date of the SEC’s approval on Dec. 16, 2011. Dealers have until June 16, 2012 to comply with the new Rule G-9 record retention requirements.

    Previously, Rule G-16 provided that, at least once every two calendar years, dealers had to be examined to determine whether they were in compliance with MSRB rules and applicable provisions of the Securities Exchange Act of 1934. Since 1998, FINRA and the MSRB have used a protocol allowing for a questionnaire (the Alternative Municipal Examination module (“AME”)) to be completed by certain firms every two calendar years. Over the years, the AME served as an off-site examination of certain “low-risk” dealers: those that conducted limited municipal securities business, did not conduct any public finance business and were not otherwise identified as “high risk” firms for regulatory purposes.

    Because of advances in information technology and transparency within the municipal securities markets, the MSRB desires to modernize the examination process to address changes within the municipal securities industry. The MSRB also argues as a justification for the changes that the industry has consolidated so that only a small number of large firms account for the majority of public finance business (with the bulk of dealers being less active in the municipal securities markets, i.e., solely effecting municipal securities transactions as an accommodation to their customers or engaging solely in the sale of interests in 529 College Savings Plans).

    “High-Risk” Dealers Likely to Be Subject to Annual FINRA Examinations, While Others Likely to See Less Frequent Cycle Examinations Absent Specific Risk Indicators

    As a result of the Rule G-16 amendments, dealers will now be subject to a risk-based examination protocol that permits up to a four-year examination cycle for FINRA-member dealer firms. Although FINRA will use quantitative and qualitative criteria to rank dealers by identified risk measures and size, the MSRB believes that it is important to maintain the confidentiality of the specific risk factors. Because “risk factors are dynamic, and additional risk factors may be utilized as new risks emerge and existing risks are mitigated by market conditions or business practices,” the MSRB does not believe it is necessary to identify the specific risk factors FINRA will use in ranking dealers.

    Despite the lack of transparency of the specific risk indicators that may determine whether the dealer will be subject to more or less frequent cycle examinations, the MSRB anticipates that firms that pose the highest risks, as well as firms that have the greatest systemic impact based on the scope and scale of their underlying municipal securities business activities, will be examined annually (i.e. large public finance firms). Depending upon the risk ranking and size of the dealer’s municipal securities business, other dealers will be examined less frequently, between every two to four years. All broker-dealer firms with a municipal securities business will be examined at least once every four calendar years. Dealers’ risk rankings will be re-assessed at least on an annual basis.

    FINRA-Member Dealer Firms Must Retain Certain Records for Four Years

    MSRB Rule G-9 currently requires that certain records be preserved for three years, six years or the life of the enterprise, depending upon the type of record, in parallel to the requirements of SEC Rule 17a-4. For example, copies of confirmations and other such notices defined in MSRB Rule G-8 are required to be kept for three years. Despite comment that the recordkeeping requirements under Rule G-9 have long been the industry standard and that a change from a three-year to a four-year recordkeeping requirement was unnecessary and burdensome, the SEC approved the Rule G-9 amendments to require dealers to retain records for four years, six years or the life of the enterprise, depending upon the particular record. As a result, the records under Rule G-9 that were previously required to be retained only for three years now must be retained for four years. In order to provide dealers with sufficient time to modify their policies and systems, they will have until June 16, 2012, to comply with the new four-year record retention requirement.

    Conclusion

    The Rule G-16 amendments will likely result in annual FINRA cycle examinations of dealer firms that conduct a significant municipal securities public finance business. The good news, however, is that dealers that are not engaged in financial advisory activities or municipal securities underwriting, research or trading and also conduct limited municipal securities business are likely to be placed on a cycle of between two to four years (absent specific risk factors that relate to that dealer’s municipal securities business).

    As a result of the Rule G-9 amendments, dealers should assess their policies and systems. In making those assessments, dealers should determine how, and whether, their systems will be able to meet the new four-year record retention requirement for many records under Rule G-9 on or before June 16, 2012.