FINRA’s Proposed Rule 3110 May Extend the Scope of Broker-Dealer Supervision of Investment Advisors

July 16, 2008

FINRA’s (The Financial Industry Regulatory Authority) proposed rule 3110 would expand the supervision responsibilities of broker-dealers by requiring broker-dealer principals to supervise business that the firm’s registered representatives engage in, regardless of whether such activity requires registration as a broker-dealer. The current FINRA rules require broker-dealer firms to designate a registered principal to supervise each type of business that requires registration as a broker-dealer, and additionally require registered representatives to notify their broker-dealer and get written approval for outside business activities.

If the proposed rule is passed, the scope of broker-dealer supervisory responsibilities will go beyond written approval for the outside business activity and arguably will require supervision of all approved outside business activities. As a result, the offer of investment advisory services by representatives affiliated with a broker-dealer would be subject to supervision by broker-dealer principals. If this truly is the intent of proposed rule 3110, it is a significant departure from previous FINRA guidance on this issue. Notice to Members 94-44 had indicated that investment advisory activities that did not include the RR/IA’s participation in the execution of a securities transaction would require notification of the investment advisory activity to the broker-dealer firm but would not require record keeping and supervision of the transactions. Notice to Members 96-33 again clarified that supervision of specific transactions by a FINRA member firm would be required only if the registered representative who is also an investment adviser (“RR/IA”) “participates in the execution of a securities transaction such that his or her actions go beyond a mere recommendation, thereby triggering the record keeping and supervision requirements” for the broker-dealer firm. See NTM 96-33. It appears that the current version of the proposed rule may be an attempt to broaden the scope of the supervisory responsibility of broker-dealer firms in that it could require broker-dealer firms to supervise investment advisory activities at a level beyond notification and with such supervision to potentially include record keeping, and approval or disapproval at the transaction level. Consequently, investment advisors affiliated with a broker-dealer would be required to obtain prior written approval from their broker-dealer for investment advisory activities.

FINRA has accepted comments regarding the proposed rule and many in the financial industry have voiced concerns including that the language of the proposed rule is vague and that the proposed rule is too broad, overlaps with the jurisdiction of other regulators, and that the rule may conflict with rules which restrict the release of client information without client approval. Marc Menchel, executive vice president and general counsel of FINRA has commented that FINRA is not trying to expand its jurisdiction with this rule proposal and that FINRA believes that broker-dealer firms should be supervising the investment advisory business in which the representatives of their firm engage. See “Brokers, Advisers Blast FINRA Proposal”, Investment News, June 30, 2008. In response to comments submitted, FINRA may amend the proposed rule or provide clarification related to the language of the proposed rule. Additionally, the Securities and Exchange Commission would need to approve FINRA’s proposed rule before it could take effect. FINRA encouraged all interested parties to comment on the rule proposal by June 13, 2008. FINRA has not yet submitted the rule proposal to the SEC.

Posted by Bryan Hill
Labels: Outside Business Activities