Lesson 10.2: SROs and Record Retention

Regulators

Lesson 10.2: Self-Regulatory Organizations (SROs)

  • The securities industry is regulated by SROs, the foremost of which is FINRA.

  • The purpose of SROs is for the industry to regulate itself.

  • The idea is that the industry can best understand the rules needed to protect the public while allowing for effective capital markets.

LO 10.e Define the scope of authority of the Financial Industry Regulatory Authority (FINRA).

  • FINRA regulates:

    • Investment banking (securities underwriting)

    • Trading in the over-the-counter (OTC) market

    • Trading in exchange-listed securities

    • Conduct of FINRA member firms and associated persons

  • FINRA's purpose and objectives:

    • Promote the investment banking and securities business

    • Standardize principles and practices

    • Promote high standards of commercial honor

    • Encourage observance of federal and state securities laws

    • Provide a medium for communication among members, the government, and other agencies

    • Adopt, administer, and enforce rules to prevent fraudulent and manipulative practices and to promote just and equitable principles of trade

    • Promote self-discipline among members and investigate/resolve grievances between the public and members.

  • FINRA rules are broken down into four sections:

    • Conduct Rules: Establish the relationship between firms and customers; cover fair dealing, compensation, communications, and sales practice violations (serious violations).

      • Violations of the Conduct Rules are serious violations.

    • Code of Procedure (COP): Covers the enforcement of FINRA rules and punishment of members who violate the Conduct Rules.

      • FINRA's Department of Enforcement (DOE) investigates suspected violations arising from FINRA audits or customer complaints.

      • The DOE holds hearings to determine the outcome of any violation.

      • FINRA Actions Upon Violation:

        • Suspend, expel, or bar from membership

        • Impose fines

        • Censure

        • Any other action deemed appropriate

      • FINRA does not have arrest powers but can refer issues to law enforcement.

      • DOE decisions can be appealed to the National Adjudicatory Council (a FINRA division), then to the SEC, and then to the federal appellate courts.

    • Uniform Practice Code (UPC): Rules cover technical aspects of trading and payment for securities transactions (e.g., good delivery of securities, payment procedures for dividends on common stocks, and interest on bonds).

    • Code of Arbitration (COA): FINRA-run dispute resolution process to settle monetary disputes, aiming for faster and cheaper resolution than the court system.

      • COA decisions are final and binding; there is no appeal.

      • If a customer is involved in a monetary dispute with a BD, the customer must agree to arbitration.

      • A customer may agree to settle a dispute by arbitration prospectively, meaning they agree to settle a dispute by arbitration before any dispute arises.

      • Predispute arbitration agreements are often included in new account forms.

  • BD firms apply for membership to FINRA and agree to abide by the rules; they are often called member firms.

  • Those who work for FINRA firms also agree to FINRA rules; these people are called associated persons.

  • FINRA member firms may only do business with other FINRA member firms or with institutions that meet one of the listed exceptions.

    • Exceptions:

      • A bank in the underwriting of a municipal issue

      • A foreign firm that is a member of its nation's FINRA equivalent

  • FINRA has been delegated authority by the SEC to administer qualification tests for associates of member firms and investment advisers.

LO 10.f Recall the scope of authority of the MSRB and the exchanges.

  • Municipal Securities Rulemaking Board (MSRB):

    • The MSRB is the primary industry (SRO) regulator for underwriting and trading of state and municipal securities.

    • The MSRB writes the rules but does not have enforcement powers; it depends on other regulators for enforcement.

    • It has no regulatory power over the municipalities that issue municipal securities.

    • MSRB rules are enforced on the banking industry primarily through the Comptroller of the Currency, the Federal Reserve, and the FDIC.

    • MSRB rules on securities firms are enforced primarily by the SEC and FINRA.

    • The MSRB creates the rules for municipal securities, not just municipal debt. ABLE accounts and 529 plans are examples of non-debt municipal securities covered by the MSRB.

  • Example: The City of New Orleans issuing municipal bonds.

    • The MSRB has no power to enforce its municipal securities rules; FINRA will ensure that the BDs underwriting these new bonds abide by all securities rules and regulations (including those of the MSRB) regarding the sale of new securities to the public.

  • The Exchanges:

    • The exchanges are also regulators, in addition to their role as a market center.

    • Each exchange regulates trading activity that occurs on the exchange.

    • Each exchange has some authority over the securities that are listed on the exchange, as well as the issuers of those securities.

    • The exchanges have the power to remove a listed security (delisting) and to suspend trading on a listed security. The NYSE is the model used for this exam.

LO 10.g Determine record retention requirements.

  • SEC rules mandate which records must be prepared by members, when those records must be prepared, and for how long the records must be retained.

  • Firms may use digital storage media, which must maintain records in a nonrewriteable and nonerasable format.

  • Different records must be kept for different lengths of time: for the life of the firm, or for six, four, or three years.

  • Records Kept for the Life of the Firm:

    • Retained indefinitely for as long as the firm exists.

    • Partnership agreement: Used when the BD is organized as a partnership; the foundational document of a partnership.

    • Corporate charter or articles of incorporation: Used if the BD is organized as a corporation; the foundational document of a corporation.

    • Stock certificate books: Actual books where certificates are held until issued; record of who certificates are issued to.

    • Minutes: A record of the meetings of the board of directors (corporation) or the partners (partnership).

    • Amendments: Any amendments to any of these records are kept with the original record.

    • Organizational records: Other records related to the foundations of the firm; an example would be Form BD, the registration application for a BD.

  • Records Maintained for Six Years:

    • Generally, those having to do with the BD's holdings and assets it holds for customers.

    • A BD's financial records are also six-year retention records.

    • Blotters: A record of original entry; member generally maintains blotters relating to the purchase and sale of securities, the receipt and delivery of securities, and the receipt and disbursement of cash. Must reflect transactions as of the trade date (or event date) and must be prepared no later than the following business day.

    • General ledger: Contains accounting records of the firm's assets, liabilities, and net worth accounts. From this, a firm prepares its financial statements. Must be prepared as frequently as necessary to determine compliance with the net capital rule, but in no event less frequently than monthly.

    • Stock record: Shows all securities held by the firm, the ownership of these securities, and where the securities are held. Must be posted no later than the business day after the settlement date.

    • Customer ledgers: Customer statements. Cash accounts and margin accounts are shown on separate ledgers. These ledgers must be posted no later than the settlement date.

    • Customer account records: Customer account records might include the new account form and margin agreement, if appropriate.

    • Designation of principals: Designation of principals records show when an associate is appointed to a principal position and what areas they will oversee.

  • Records Maintained for Four Years:

    • Written complaints must be retained for four years after resolution. These records are normally maintained at the office of supervisory jurisdiction for the office where the complaint originated. If a complaint was delivered directly to the firm's headquarters, the record may be retained there. This also applies to reports regarding written complaints.

    • Includes paper, email, text, instant message, tweet, social media post, etc.

    • FINRA Rule 4513 (four years) and SEC Rule 17a-3 (three years, with at least two readily available) on record retention differ regarding complaints.

    • Assume the FINRA rule is what is tested for the SIE unless the question refers specifically to the SEC rule. Most firms simply hold complaints for four years-meeting the FINRA requirement while exceeding the SEC rule.

  • Records Maintained for Three Years:

    • Almost all other records must be retained for three years after last use.

    • Advertising

    • Trial balances (monthly financial report)

    • Forms U4 and U5, and fingerprint cards for terminated personnel

    • Customer confirmations

    • Order tickets

    • Other ledgers, such as securities borrowed and securities loaned, monies borrowed and monies loaned, and dividends and interest received

    • A list of every office where each associated person regularly conducts business

    • Associated persons' compensation records

    • The firm's compliance and procedures manual