Should the proposed exclusions also cover unaffiliated outside investment advisors?
Key Takeaways
- FINRA proposes a new rule to simplify requirements in Rules 3270 and Rule 3280, aiming to reduce unnecessary burdens.
- The structure of Proposed FINRA Rule 3290 requires prior written notice for investment-related activity outside the scope of the individual’s relationship with the member.
- Among the proposed exceptions: personal investments, securities transactions among immediate family members not involving selling compensation, and non-broker-dealer activity on behalf of a member or its affiliate.
FINRA is requesting comments by May 13, 2025, to its proposal in Regulatory-Notice 25-05 ("Notice 25-05") to reduce unnecessary burdens and simplify requirements in current FINRA Rule 3270 (Outside Business Activities of Registered Persons) and FINRA Rule 3280 (Private Securities Transactions of an Associated Person). FINRA proposes to create a new rule covering the requirements in both Rules 3270 and 3280, with some proposed modifications. Many of the proposals are non-controversial and likely would ease supervision and administrative burdens on members.
Arguably, however, FINRA's proposal could go even further in this regard and expand the exclusion in Proposed FINRA Rule 3290 ("Rule 3290") to cover unaffiliated outside investment advisors ("IAs"), as discussed more fully herein. This approach would be consistent with Regulatory Notice 25-04 ("Notice 25-04"), wherein FINRA has requested comments specifically on regulatory requirements that create duplicative burdens and invite investor confusion related to the interaction between members and IAs.[1] Further, SEC Acting Chair Mark Uyeda discussed in a recent speech the desire to get "back to basics" on rulemaking, including the notion that regulations should be "both effective and not costly." Excluding unaffiliated outside IAs from the private securities transaction ("PST") requirements would further these objectives for the reasons discussed herein.
Structure of the Proposed Rule
The structure of Rule 3290 would require prior written notice to members for: (1) a registered person's investment-related activity[2] outside the scope of such person's relationship with the member that is not in connection with a securities transaction ("outside activity"); and (2) an associated person's investment-related activity outside the scope of such person's relationship with the member that is in connection with a securities transaction ("outside securities transaction").[3] Individuals would be required to report material changes to the information provided concerning both outside activities and outside securities transactions, respectively.[4]
Further, members would be required to assess whether the proposed activity: (1) is an outside activity or in the case of a securities transaction, whether the securities transaction is for selling compensation (different requirements would apply depending on the conclusion);[5] (2) involves a customer of the member; (3) would interfere with or otherwise compromise the individual's responsibilities to the member or the member's customers; and (4) would be viewed by the member's customers or the public as part of the member's business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered.
Based on the above criteria for outside activities, members would determine whether there should be any limitations or conditions imposed or whether the activity should be prohibited. For outside securities transactions with no selling compensation, members would make an assessment whether to approve the outside securities transactions or impose conditions or limitations. For securities transactions with selling compensation, the member would be required to: (a) record each transaction on the books and records of the firm; and (b) supervise the person's participation "as if executed on behalf of the member."[6]
Exclusions From the Proposed Rule
The proposed rule also contains exclusions for: (1) personal investments (i.e., securities transactions subject to FINRA Rule 3210; personal investments in non-securities; and purchase, sale, rental or lease of main home or dwelling unit or personal use rental property); (2) securities transactions among immediate family members where the individual does not receive selling compensation; and (3) "non-broker-dealer activity on behalf of a member or its affiliate (e.g., investment advisory activity conducted for a dually registered broker-dealer/investment adviser or investment advisory, insurance or banking activity conducted at an affiliate of the member)."[7] According to Notice 25-05: "Activity performed on behalf of a dually registered firm is not considered activity performed away from the member. The exclusion for activity conducted at an affiliate recognizes members' ability to implement meaningful controls across business lines."
FINRA considered but determined not to include an exception from the PST requirements for unaffiliated outside IA activity, which has been the subject of debate for many years. Pursuant to guidance dating back to the late 1990s, as noted in Notice 25-05, "an associated person's IA activities constitute 'participation in' PSTs if the person did more than simply recommend the securities transaction (i.e., an IA's effecting or placing an order would constitute 'participation in' a PST under the Notices)." Further, if an individual received asset-based or performance-based fees, the member would have supervisory and recordkeeping obligations related to this unaffiliated outside IA activity.
The arguments against the requirement to have members supervise (and maintain records related to) unaffiliated outside IA activity include the following:
- Eliminating the PST obligation for unaffiliated outside IA activity would reduce costs for members, which are usually passed on to the customers (and is an issue generally raised in Acting Chair Uyeda's recent speech).
- FINRA regulates broker-dealers; the SEC and the states regulate IAs. As discussed in Notice 25-05, there have been arguments that "FINRA member oversight of outside IA activities is therefore redundant. . .".
- There are concerns about whether customers can become confused as to which entity is responsible for supervising the IA activities, an issue raised in Notice 25-04.
- Privacy challenges exist when members seek account information for customers of an unaffiliated IA through which the member's registered person may be acting as an IA.
- IAs are held to a fiduciary standard, which is a different standard than members have, and which therefore may create challenges to a member's supervision over unaffiliated outside IA activity.
- Members, especially smaller ones, may not have the expertise to supervise certain products or strategies at unaffiliated IAs.
There are arguments in favor of requiring a member to supervise unaffiliated outside IA activity as a PST, the weightiest of which is that such inclusion best protects investors. Notably:
- There is concern about eliminating member oversight of unaffiliated outside IA activity. Doing so arguably would place investors at risk because the SEC and state oversight of IAs typically does not occur with the same frequency as FINRA's oversight of its members.
- Some IA firms lack the resources and ability to properly supervise their own IA activities, a void that could be filled by FINRA members.[8]
From a policy perspective, these are valid concerns. However, the PST requirement to supervise (and maintain records related to) unaffiliated outside IA activity arguably goes beyond FINRA's purview as a regulator of brokerage activity and creates additional costs (that customers may bear) plus duplicative regulation. The question is whether this remains a tenable approach going forward, given the SEC's current posture on rulemaking[9] and FINRA's own initiative in Notice 25-04 to eliminate unnecessary burdens and avoid investor confusion.
Conclusion
Members should carefully review Rule 3290 and submit comments no later than May 13, 2025, so that their concerns can be adequately addressed in any final rulemaking proposal that the SEC considers.
[1] Notice 25-04 (Request for Comment No. 5) ("Where does FINRA's oversight of its member firms interact with other non-FINRA regulatory requirements in a manner that should be a focus for modernization, based on unnecessary or duplicative burdens, insufficiently tailored requirements, member firm or investor confusion, or otherwise? For example, what differences between FINRA's requirements for broker-dealers and the requirements that apply for investment advisers engaging in similar activities should be a focus for modernization?").
[2] "Investment-related activity" would be defined broadly in Rule 3290 as "pertaining to financial assets, including securities, crypto assets, commodities, derivatives (such as futures and swaps), currency, banking, real estate or insurance." Given the ongoing work of the SEC Crypto Task Force, there is a valid question as to whether "crypto assets" should be included in this definition.
[3] According to FINRA, the focus on outside investment-related activities is intended to decrease the burden on members by eliminating reporting and assessment of "low risk activities that create white noise (e.g., refereeing sports games, driving for a car service, bartending on weekends)."
[4] Rule 3290 would also specify content for the individual's notice as well as the circumstances when a single prior written notice would be sufficient versus when a prior written notice would be required on a transaction-by-transaction basis. See also Notice 25-05 at 5 for a further discussion of registered and associated persons' prior written notice obligations, respectively.
[5] "Selling compensation" also would be defined broadly in Rule 3290 as "any compensation paid directly or indirectly from whatever source in connection with or as a result of the purchase, sale or exchange of a security, including, though not limited to, commissions; finder's fees; securities or rights to acquire securities; rights of participation in profits; tax benefits; dissolution proceeds, as a general partner or otherwise; or expense reimbursements."
[6] Notice 25-05 at 3. See also, id. at 6 for a discussion of clarifications concerning members' obligations related to portfolio managers and investment committees, among other issues.
[7] Rule 3290 (Exclusions).
[8] Even without a mandate, members could voluntarily elect to supervise the activities of unaffiliated outside IA activity as a PST.
[9] See, e.g., speech.
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