On July 9, 2016, FINRA Rule 2341 (Investment Company Securities) superseded NASD Rule 2830 (Investment Company Securities). Some of you may recall that FINRA published Regulatory Notice 15-23 in June 2015 to provide broker-dealers with limited relief from NASD Rule 2830(m). A broker-dealer meeting certain conditions listed in that Regulatory Notice would be relieved from the requirement to promptly transmit customer funds received in connection with sales of securities on a subscription-way basis for the purpose of completing suitability reviews. A broker-dealer qualifying for this limited relief may hold a customer check payable to an issuer or an appropriate third-party payee acting on behalf of the issuer (for example, a transfer agent or custodian) for up to seven business days from the date that an office of supervisory jurisdiction (“OSJ”) receives a complete and correct application package for the purchase of securities on a subscription-way basis. Presumably, this limited relief, which originally applied to NASD Rule 2830, now applies to FINRA Rule 2341.

Conditions for Relief

According to Regulatory Notice 15-23, a broker-dealer may hold a customer check payable to an issuer for up to seven business days from the date that an OSJ receives a complete and correct application package for the sale of securities on a subscription-way basis provided that all seven conditions delineated below are present:

  1. The reason that the broker-dealer is holding the application for the securities and a customer’s non-negotiated check payable to a third party is to allow completion of principal review of the transaction pursuant to FINRA Rule 2111 and FINRA Rule 3110.
  2. The associated person who recommended the purchase of the securities makes reasonable efforts to safeguard the check and, after receiving information necessary to prepare a complete and correct application package, promptly prepares and forwards the complete and correct copy of the application package to an OSJ.
  3. The broker-dealer has policies and procedures in place that are reasonably designed to ensure compliance with condition #2 above.
  4. A principal reviews and makes a determination of whether to approve or reject the purchase of the securities in accordance with the provisions of FINRA Rules 2111 and 3110.
  5. The broker-dealer holds the application and check no longer than seven business days from the date an OSJ receives a complete and correct copy of the application package.
  6. The broker-dealer maintains a copy of each such check and creates a record of the date the check was received from the customer and the date the check was transmitted to the issuer or returned to the customer.
  7. The broker-dealer creates a record of the date when the OSJ receives a complete and correct copy of the application package.

All seven conditions must be present. If any of these seven conditions are not present, FINRA’s limited relief will not apply. A broker-dealer’s failure to meet all conditions could subject it to a $250,000 minimum net capital requirement, which applies to broker-dealers that hold customer funds.

Concluding Thoughts

A broker-dealer is not required to collect and hold checks or funds prior to principal review and approval. It could, instead, wait until the principal approves the transaction before it collects the checks or funds. In our opinion, waiting to collect checks or funds is the best approach for the broker-dealer wishing to manage risk. Holding customer funds, as opposed to promptly forwarding them, generally increases the risk that they are lost, stolen, or mishandled while in the broker-dealer’s possession. In most cases, we would not recommend that a broker-dealer assume this additional risk.