May 14, 2018

Securities Alert: Two New Rules Take Effect Immediately

Two significant new rules affecting securities firms take effect immediately.  First, as of Friday May 11, 2018, FinCEN’s Customer Due Diligence Requirements for Financial Institutions (“CDD Rule”) requires FINRA members to identify and verify the beneficial owners of new “legal entity” customers.  Second, as of Monday May 14, 2018, FINRA members must make additional disclosures on trade confirmations for certain fixed income transactions executed on behalf of retail customers in conformity with revised FINRA Rule 2232.  Each new rule is summarized below:

FinCEN’S CDD Rule Requires Disclosure of Beneficial Owners of Legal Entity Customers

The CDD Rule (31 C.F.R. §§1010.230, 1023.220) amends the Bank Secrecy Act to improve financial transparency and prevent legal entities from funding illegal activities.  FINRA Rule 3310 requires members to comply with the Bank Secrecy Act.  Accordingly, when handling accounts titled in the manner of a legal entity (as opposed to individuals) FINRA members must:

  1. verify the underlying customers’ identity;
  2. identify and verify the beneficial owner of each account held in the name of a legal entity;
  3. develop a customer risk profile based on the nature and purpose of the legal entity as well as the underlying customer who is responsible for the legal entity; and
  4. monitor for suspicious transactions, and, where appropriate, update customer information and properly document any suspicious transactions.

FINRA member firms should pay particular attention to the second requirement because members are subject to new requirements regarding the beneficial owners of new legal entity customers. The CDD Rule requires member firms to obtain the beneficial ownership information from the natural person opening the account on behalf of the legal entity.  Firms will meet their beneficial ownership obligations by collecting ownership information on individuals who hold, directly or indirectly, 25% or more of the equity interests in, and one individual who has managerial control of, a legal entity account.  FINRA members are required to design and implement procedures to verify this beneficial ownership information, and to verify the accuracy of data they obtain from owners who are deemed higher risk.  Although there is no required universal form for this information, FinCEN has provided a standard form that outlines the CDD Rule’s requirements (available here).  Additionally, FinCEN’s Frequently Asked Questions about the CDD Rule are available here.

According to FinCEN, the first requirement, to verify the identity of the customer, is already a component of the anti-money laundering program of the Bank Secrecy Act.  The third and fourth requirements, to develop a customer risk profile and to monitor any suspicious activity, should already be implicitly covered in any member firm’s anti-money laundering programs.  Now is a good time to ensure that your firm’s anti-money laundering compliance programs address these procedures.

FINRA Rule 2232 Imposes New Disclosure Requirements on Retail Trade Confirmations For Corporate and Agency Debt Securities.

FINRA’s amended Rule 2232 requires that when a retail customer buys or sells a corporate or agency bond, the trade confirmation must disclose the mark-up or mark-down the member firm received in the transaction when “the member also executes an offsetting principal trade in the same security on the same trading day, which in the aggregate meet[s] or exceed[s] the size of the customer[’s] trade.”  FINRA Regulatory Notice17-08.

The firm is not, however, required to make the disclosure of its mark-up or mark-down if either one of the exceptions found in FINRA Rule 2232 (d)(1)-(2) is present:

  1. the member firm executed the retail customer transaction at a “principal trading desk that is functionally separate from the principal trading desk within the same member that executed” the member’s purchase or sale of the debt security and the member firm has policies in place that the principal trading desk handling the retail customer’s transaction had no knowledge of the other principal trading desk’s transaction; or
  2. “the member acquired the security in a fixed-price offering and sold the security to non-institutional customers at the fixed price offering price on the day the securities were acquired.”

FINRA’s Frequently Asked Questions provides guidance as to the “functionally separate” exception to the rule with an example: “the exception allows an institutional desk within a firm to service an institutional customer without necessarily triggering the disclosure requirement for an unrelated trade performed by a separate retail desk within the firm.”  At a minimum, member firms should design policies to shield institutional principal trading desks from non-institutional trading desks in order to claim this exception.

Amended Rule 2232(e) also requires members to disclose two additional items on all retail customer confirmations for corporate and agency debt security trades: (1) a reference, and a hyperlink if the confirmation is electronic, to a web page hosted by FINRA that contains publicly available trading data for the specific security that was traded, and (2) the execution time of the transaction, expressed to the second.

Keesal, Young & Logan Securities Group

This information has been prepared by Keesal, Young & Logan for informational purposes only and is not legal advice. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship between you and Keesal, Young & Logan. You should not act upon this information without seeking professional counsel.