In May of 2017, FINRA released a Retrospective Rule Review 17-20 requesting comments on the effectiveness and efficiency of its Rule 3270, Outside Business Activities (“OBAs”) of Registered Persons, and Rule 3280, Private Securities Transactions (“PSTs”) of an Associated Person. Then, in February of 2018, FINRA issued Regulatory Notice 18-08 seeking additional comments on a proposed new rule, FINRA 3290, to consolidate current FINRA Rule 3270 and current FINRA Rule 3280. The proposed rule change is a result of FINRA’s retrospective rule review the year before. FINRA again sought comments on streamlining and bringing the rule up to date.
What are the Rules on OBAs and PST?
Currently, FINRA Rule 3270 prohibits registered persons from engaging in, or being compensated for, business activities outside the scope of the relationship with their member firm unless they have provided prior written notice to their employing broker-dealer.
Likewise, FINRA Rule 3280 prohibits associated persons from “trading away” from their firm and engaging in securities transactions for any economic benefit absent notifying the firm and obtaining affirmative consent from the firm. Rule 3280 further requires the firm to record the securities transaction on its books and records and supervise the transaction as if it were the firm’s own.
What are the Proposed Changes?
The proposed changes include consolidating existing Rules 3270 and 3280, which govern registered persons’ OBAs and PSTs of associated persons, into a new rule, FINRA Rule 3290. In doing so, FINRA aims to clarify member firms’ obligations regarding these activities and allow firms to focus their resources on outside activities that pose more risk to customers. While FINRA goes into greater detail in the notice, some of the key concepts of the proposed rule are outlined below.
Selling Private Placements Away from Member
Subject to the proposed rule, potentially to the fullest extent – prior notice by the registered person and risk assessment by the member. If the member disapproves the activity, it has no further obligation. If the member approves the activity, the activity becomes part of the member’s business and must be supervised and recorded as such.
Activities at Third-Party IA
Subject to the proposed rule, but in an intermediate manner – prior notice by the registered person and risk assessment by the member because it is investment related and not excluded from the proposed rule, but the member is not required to supervise or keep records of the IA activities.
Non-Investment Related Work
Subject to the proposed rule, but in a limited manner – a registered person must provide prior notice to the member, but the member is not required to perform a risk assessment of or supervise the activity.
Activities at Affiliates
Generally excluded from the proposed rule – the proposed rule excludes activities at affiliates, whether or not investment related, unless those activities would require registration as a broker or dealer if not for the person’s association with a member.
Excluded from the proposed rule, but potentially subject to other rules (e.g., FINRA Rule 3210) or firm-imposed notice requirements.
How Firms Would be Impacted
If FINRA implements the proposed rule, it would be significant for broker-dealers whose representatives are also engaged in investment adviser activities. The proposed rule would require registered persons to provide their firms with prior written notice of all OBAs, whether investment related or not. If a broker-dealer decides to impose its own conditions or limitations on a registered person’s participation in an investment-related activity, the broker-dealer would then be required to reasonably supervise the registered person’s compliance with those specific conditions or limitations.
The Firm should be prepared to defend their conditions and limitations, as well as their supervision program for these activities. Actual supervision of the underlying activities would not be required. The required action the firm takes is dependent on the type of outside activity that the registered person partakes in and the risk involved in their activity. When the outside activity is investment related, the firm would be required to conduct a risk assessment regarding the activity. Under the proposed rule, any investment advisory activity conducted on behalf of a dually registered firm or for an investment adviser affiliate, would not trigger supervisory responsibilities for the member firm.
FINRA seeks comments on numerous issues related to the proposed rule, including: whether the rule should be expanded to apply to all associated persons, whether proposed exclusions to the rule are appropriate, and whether the rule’s elimination of firms’ general supervisory obligation over investment-advisory activities will undermine investor protection. FINRA continues to evaluate the appropriate method for regulating outside business activities, while providing the industry an opportunity to provide additional input.
For the full FINRA Notice, please see Regulatory Notice 18-08, “FINRA Requests Comment on Proposed New Rule Governing Outside Business Activities and Private Securities Transactions.”