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  • New FINRA Rules Demonstrate the Gradual Expansion of FINRA’s Reach

    May 3, 2011 by Benjamin Skjold

    5/2/2011 COMMENTS (0)

     

    By Benjamin Skjold

    New FINRA Rule 4530 is the latest example of the Financial Industry Regulatory Authority’s efforts to broaden their reach beyond the securities business into all areas of business in which a broker/dealer is engaged.

    The successor to the National Association of Securities Dealers, FINRA’s mission is to protect investors by making sure the securities industry operates fairly and honestly.  Historically, this has meant that FINRA’s reach extends to a broker/dealer’s securities business.  If that firm has other lines of business, such as insurance or an investment advisory business, regulatory responsibility would fall to another body, such as a state insurance regulator or the SEC.

    But FINRA is gradually trying to change this traditional division of responsibility.  CEO Richard Ketchum, testifying to the Senate in 2009, placed some of the blame for the recent financial crisis on various “regulatory gaps” that result from “similar products and services being regulated quite differently.”  Closing these gaps, he argued, requires “a consistent level of protection [for investors] no matter which financial professionals or products they choose.”  The implication, of course, is that FINRA’s reach should expand from securities to all financial products.

    There have been barriers erected to their attempts to broaden their reach, such as the Harkin Amendment to the Dodd-Frank Bill, which attempts to exclude fixed indexed annuities from the definition of securities, making them subject to oversight from state insurance regulators.

    Undeterred by such efforts, FINRA has taken several steps over the past year that appear to be designed to continue their expansion.  This past December, FINRA Rule 3270 governing outside business activities went into effect.  Rule 3270 requires broker/dealers to consider, before classifying an activity as an outside business activity, whether the activity might be viewed by the public as part of the member’s business.  The message is clear: FINRA doesn’t want broker/dealers to escape oversight by classifying insurance product sales as outside business activity.

    The most recent effort to broaden FINRA’s reach beyond securities regulations comes in the form of Rule 4530 relating to broker/dealer reporting requirements.  A summary of the rule can be found here.  FINRA Rule 4530 outlines when firms are required to report certain events to FINRA such as regulatory actions, customer settlements, securities-related lawsuits, and internal investigation results.

    Rule 4530(a)(1)(A) explicitly requires firms to report external findings of violations of insurance-related laws, rules, or regulations to FINRA for purposes of “assist[ing] FINRA in identifying members and associated persons that may pose a regulatory risk.”  While FINRA claims that this authority already existed, insurance-related violations outside the realm of securities were not explicitly mentioned in the old rule, and the rule was generally applied only to findings that were securities-related.

    Rule 4530(a)(1)(G) requires reporting of insurance civil litigation or arbitration that is “related to the provision of financial services,” even if the insurance products involved are not securities.

    Not only does the reporting requirement create an administrative burden, it greatly increases the potential for overlapping regulation, given that the primary purpose of the reporting requirements is to identify when FINRA should investigate a matter.  Requiring reporting of insurance-related events makes it far more likely that FINRA will get involved in insurance-related matters, even those that are already subject to regulatory action by a state insurance regulator.

    FINRA may be right that regulatory gaps can be a source of instability in the financial system.  But the solution is a consistent regulatory framework created at the legislative level, not a unilateral effort to oversee and regulate products that are already regulated by a different body.  Such overlap risks placing an excessive burden on broker/dealers, while wasting administrative resources that are best applied elsewhere.

    (Benjamin Skjold leads the securities practice at Minneapolis-based Skjold Parrington Business Attorneys).

    Originally Posted at Thomson Reuters on May 2, 2011 by Benjamin Skjold.

    Categories: Industry Articles
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