• FINRA Rulebook Consolidation Developments -- Repeal of NYSE Rule 312(f)(1)
  • October 23, 2009 | Authors: Amy Natterson Kroll; Charles A. Sweet
  • Law Firm: Bingham McCutchen LLP - Washington Office
  • On October 15, 2009, FINRA announced that the SEC had approved further consolidation of former NYSE and NASD rules.1 Of particular interest to member firms is the repeal of NYSE Rule 312(f)(1) and the corresponding retention of NASD Rule 2240, to be renumbered as FINRA Rule 2262.2 These changes will be effective on December 14, 2009.

    NYSE Rule 312(f)(1) prohibits NYSE member firms, after completion of a distribution of their equity or non-investment grade debt securities (or those of any organizations controlling the member or of any Material Associated Persons of the member organization), from recommending transactions and effecting transactions (other than unsolicited transactions) in such securities. The rule applies not only to stock and debt issued in the name of the member firm or an affiliate, but also to a variety of structured notes, reverse convertibles and other structured products issued by the member firm or its affiliates, even if the reference security determining the price of the structured product is that of a completely different issuer.

    NASD Rule 2240 (which will become FINRA Rule 2262) requires FINRA members controlled by, controlling or under common control with the issuer of any security to disclose to a customer the existence of the control relationship prior to entering into any contract for the purchase or sale of that security. If the disclosure is not in writing, then the member firm must supplement the disclosure in writing at or before completion of the transaction.3

    The effect of the repeal of NYSE Rule 312(f)(1) is significant. NYSE member firms subject to Rule 312(f)(1) have implemented policies and procedures and related supervisory oversight in connection with both trading and research functions (including Rule 2711 research reports) to prevent traders and others from soliciting or otherwise recommending transactions in equity and non-investment grade debt of parent and other controlling persons’ securities.

    Elimination of Rule 312(f)(1) will allow member firms to solicit transactions in their own equity and non-investment grade debt securities and similar securities of their control persons, to write research that discusses their own operations and those of their control persons and their own and their control persons’ equity and non-investment grade debt, and to effect solicited as well as unsolicited transactions in those securities.

    Member firms that solicit and effect transactions in their own securities and the securities of their affiliates will have to be mindful of the requirements of the Securities Act of 1933. Because the SEC takes the position that transactions by a member firm in its own securities and those of its affiliates do not qualify for the Section 4(3) dealer exemption from the registration provisions of the Securities Act, and because of the very broad definition of “underwriter” in Section 2(11) of the Securities Act, member firms likely will have to deliver a current market-making prospectus when selling those securities.

    The requirement of FINRA Rule 22624 to provide written disclosure at or before completion of any transaction in any security of a person controlling, controlled by or under common control with the issuer will remain important. FINRA may focus on the policies and procedures around compliance with this requirement once Rule 312(f)(1) no longer prohibits many of these transactions for NYSE member firms. To the extent that member firms wish to write research and otherwise recommend their own securities, member firms also will have to determine whether they have reasonable controls to assure that such research and recommendations are fair and balanced and otherwise satisfy all content standards articulated in NASD Rule 2210. This will be true even if the recommendations and other communications are not “communications with the public” as defined in Rule 2210. Finally, because the Section 4(3) dealer exemption is unavailable, a member firm’s research on its own securities and those of its affiliates will have to comply with another exemption from the registration requirements of the Securities Act (such as the safe harbor of Rule 138 or 139) in order not to be considered a prohibited prospectus, even after the normal statutory prospectus delivery period.


    1 SEC Approves New Consolidation FINRA Rules, FINRA Regulatory Notice 09-60 (October 2009).

    2 In addition, FINRA is deleting from the NYSE rules Rules 312(f)(2) and 312(f)(3). Rule 312(f)(2) is in effect duplicative of NASD Rule 2240 (to be renumbered FINRA Rule 2262); Rule 312(f)(3) requires NYSE member corporations to obtain approval from the NYSE prior to disposing of any of its own securities held in its own accounts, and prior to acquiring such securities for its own account or for the account of any corporation controlling, controlled by or under common control with the member corporation, unless the member corporation and the holder of such securities have entered into an agreement previously filed with and approved by the NYSE.

    3 SEC Rule 15c1-5 also defines the failure to make this disclosure as a manipulative, deceptive, or other fraudulent device or contrivance for purposes of Section 15(c)(1) of the Securities Exchange Act of 1934.

    4 And of SEC Rule 15c1-5.