Summary of selected FINRA regulatory notices and disciplinary actions, January-March 2009.(Financial Industry Regulatory Authority)

Abstract

Purpose--The purpose of this paper is to provide excerpts of selected Financial Industry Regulatory Authority (FINRA) Regulatory Notices and Disciplinary Actions issued from January to March 2009 and a sample of disciplinary actions during that period.

Design/methodology/approach--The paper provides excerpts from FINRA Regulatory 09-12, Auction Rate Securities; 09-13, Threshold for Single Arbitrator Cases; 09-14, Trading Ahead of Customer Limit Orders; 09-17, Investigations and Formal Disciplinary Actions.

Findings--The SEC has defined reporting requirements for settlements of customer disputes involving auction rate securities, raised the threshold for single arbitrator cases to $100,000, approved alternative means for calculating minimum price-improvement obligations that firms must provide to trade ahead of customer limit orders, and provided guidance on its enforcement process to improve transparency into its regulatory framework.

Originality/value--These are direct excerpts designed to provide a useful digest for the reader and an indication of regulatory trends. The FINRA staff is aware of this summary but has neither reviewed nor edited it. For further detail as well as other useful information, the reader should visit www.finra.org

Keywords Fraud, Investors

Paper type Technical paper

Regulatory Notice 09-12, February 2009 Auction rate securities

Reporting requirements for settlements of customer disputes involving auction rate securities notice type.

Executive summary

FINRA reminds firms that reach settlements of claims related to the sale of auction rate securities that, in determining the settlement amount for the purpose of potential reporting obligations pursuant to NASD Rule 3070 and Incorporated NYSE Rule 351 (Reporting Requirements) and Forms U4 and U5, firms must include the full dollar amount that was refunded to the customer as part of a repurchase agreement, plus any other damages identified in the settlement.

Questions/further information

Questions concerning this Notice may be directed to Philip Shaikun, Associate Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8451; or Erika L. Lazar, Senior Attorney, OGC, at (646) 315-8512.

Background and discussion

FINRA has reached final settlements with certain firms to resolve charges of misrepresentation in connection with the sale of auction rate securities (ARS). More specifically, the agreements settle allegations that these firms misled investors regarding the liquidity risks associated with ARS. FINRA's investigation found evidence that these firms misrepresented to their customers that ARS were liquid investments that were equivalent to cash and failed to disclose the increasing risks associated with ARS, including the firms' reduced ability to support the auctions in early 2008. These firms have agreed, among other things, to offer to repurchase at par ARS that were purchased by individual investors and some institutions between May 31, 2006, and February 28, 2008. The firms have also agreed to make whole individual investors who sold ARS below par after February 28, 2008. Additionally, firms involved in the settlements have agreed to a special arbitration procedure to resolve investor claims for any consequential damages (i.e. damages they may have suffered from their inability to access funds invested in ARS).

The Securities and Exchange Commission and certain states have reached similar settlements for ARS-related misconduct. FINRA expects more settlements as ARS investigations continue. In addition, certain firms are similarly settling other ARS-related arbitration claims and customer complaints, not in relation to a regulatory settlement, by repurchasing the securities at par.

ARS settlement reporting

Depending on the nature of the claim being settled--civil litigation, arbitration or other Claim for damages, such as a customer complaint--and the settlement amount, firms may have reporting or disclosure obligations pursuant to NASD Rule 3070 and NYSE Rule 351 and the requirements of Forms U4 and U5. When determining the dollar amount for reporting an ARS settlement, firms must include the full dollar amount that was refunded to the customer as part of a repurchase agreement, plus any other damages identified in the settlement. ARS settlement amounts may not be reduced by the actual (if it can be determined) or estimated market value of ARS.

The nature of the allegations in these circumstances is that customers were misled to believe that their purchases in ARS were cash equivalents. When those instruments could no longer be redeemed for full value on demand, those customers lost the entire value of the investment for which they had bargained (i.e. that the funds in question would be available on a cash-equivalent basis). As such, the entire dollar amount refunded to a customer must be considered for the purpose of determining settlement reporting thresholds. For example, a firm that agrees to repurchase $100,000 …