Supervisory Systems - FINRA Conduct Rules

Look Out!
Throughout the FINRA Bylaws and Conduct Rules, the term "member" refers to broker-dealers, while registered representatives are referred to as "persons associated with a member".

Fidelity bonds
NASD (now known as FINRA) Rule 3020 requires members who are required to join the Securities Investor Protection Corp. (SIPC) and are not members in good standing with one of the major stock exchanges to carry a blanket fidelity bond that covers officers and employees in the event of losses including:

  • Fidelity
  • On premises
  • In transit
  • Misplacement
  • Loss
  • Forgery
  • Fraudulent trading

Outside Business Activities
NASD (FINRA) Rule 3030 requires registered persons who receive income from any business activity to provide written notification to their firm. Broker-dealers must approve and monitor such activity over time.

Private Securities Transactions
NASD (FINRA) Rule 3040 generally prohibits registered representatives from handling a securities transaction for a customer through another firm. Such a private security transaction is known as "selling away". There are two exceptions to this rule:

  • The first exception applies if the firm grants prior written approval after the representative gives prior written notice of the transaction before it occurs. If the firm does give approval, it is responsible for supervising the transaction.
  • The second exception is for transactions on behalf of immediate family members AND the registered person receives no compensation. In that case, no written notification to the firm is required.

Transactions for or by Associated Persons
NASD (FINRA) Rule 3050 requires that broker-dealers grant permission to other broker-dealers when the employees of broker-dealers or the spouses and minor children of broker-dealer employees establish investment accounts.

An important responsibility of the executing member is to determine adverse interest. They must use reasonable diligence to be sure that the execution of any securities transaction for the associated person would not adversely affect the interests of the employing member.

Prior to opening the account or placing an initial order for a securities transaction with a member firm (other than their own) the broker-dealer must notify both their employer and the executing member in writing. The FINRA requires notification from the account-holding broker-dealer to the employer and requires the receipt of duplicate confirmations upon the request of the employer.

This requirement also applies to investment advisor or bank accounts that involve the purchase of securities. However, it does not apply to the following types of accounts:

Exam Tips and Tricks
FINRA conduct rules state that when a firm member knows that a person associated with an employer member has a financial interest in or discretionary authority over any existing or proposed account carried by the executing firm, that firm member must notify the employer member in writing of the intention to open the account, send duplicate confirmations and statements to the employer member, if requested, and notify the person opening the account that these procedures will be followed.

Fiduciary Capacity
NASD (FINRA) Rule 3120 governs the use of information obtained by a registered person when in a fiduciary capacity (such as trustee, transfer agent or paying agent). If information regarding ownership of securities is received, the member may not make use of such information for the purpose of soliciting sales or purchases of the security except at the request of and on behalf of the issuer.

Influencing Employees of Others
NASD (FINRA) Rule 3060 states that members may not give any gift or item worth more than $100 per year to any person employed by another member firm. Such a gift is considered a gratuity and members must keep detailed records of all such amounts given to the employees of another member firm.

Reporting Requirements
NASD (FINRA) Rule 3070 requires members to report to the FINRA any of the following activities of either the member or any person associated with the member:

  • Violation of any securities law or regulation
  • Receipt of customer complaint involving allegations of theft, forgery or misappropriation of funds
  • Association in a business or financial activity with a person subject to statutory disqualification
  • Pleading guilty, no contest or being indicted or convicted of any criminal offense
  • Being expelled, suspended, disciplined or denied registration by any securities, commodities, insurance or self-regulatory body
  • Being subject to claims for damages greater than $15,000
  • Being named as a defendant or respondent in any proceeding brought by a regulatory or self-regulatory body

The member must report any such activity to the FINRA within 10 days of the occurrence.

Larceny and Embezzlement
Section 37 of the Investment Company Act of 1940 states that anyone who steals, unlawfully abstracts, unlawfully and willingly converts to his own use or to the use of another, or embezzles any of the moneys, funds, securities, credits, property or assets of any registered investment company shall be deemed guilty of a crime and, upon conviction thereof, shall be subject to the penalties provided in section 49 [15 USCS 80a-48]. A judgment of conviction or acquittal on the merits under the laws of any state shall be a bar to any prosecution under this section for the same act or acts.

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