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The Financial Industry Regulatory Authority, or FINRA, is a key player in regulating securities firms and brokers in the United States. As an independent, non-governmental organization, its role is critical in promoting transparency, fairness, and honesty in the financial markets.
FINRA sets and enforces rules that brokers and their firms must comply with, which helps protect investors and market integrity.
Broker-dealers must adapt to the rapidly changing financial regulation landscape, which requires understanding FINRA rules. These rules are central to developing compliance strategies and help firms align their practices with industry standards, fostering a fair environment that safeguards the interests of all involved.
This article explores 9 essential FINRA rules and provides insights to bolster your compliance efforts.
See also:
InnReg is a global regulatory compliance and operations consulting team serving financial services companies since 2013. If you need assistance with compliance or fintech regulations, click here.
Overview of FINRA and Its Role
First, let's explore FINRA's function and why it plays such a crucial role in the financial industry.
What Is FINRA?
The Financial Industry Regulatory Authority is a private, non-profit organization authorized by Congress to act as a self-regulatory organization (SRO).
FINRA oversees US broker-dealers to promote fair and honest operations within the securities industry. Unlike government regulatory agencies, FINRA is not part of the federal government. It operates independently, though it is overseen by the Securities and Exchange Commission (SEC).
This unique status allows FINRA to work closely with brokerage firms to enforce rules governing the behavior of more than 600,000 brokers across the country.
Why Is FINRA Important?
FINRA's role extends beyond regulatory enforcement. First, it is instrumental in administering the licensing exams required for professionals entering the industry.
Additionally, FINRA also provides a framework for arbitration and mediation services that help resolve disputes between investors and brokers more efficiently than traditional court systems. Moreover, it educates investors, helping them make informed decisions and understand the risks involved in investing.
For firms, particularly those in the fintech sector, understanding and complying with FINRA's regulations is critical for maintaining regulatory approval and preparing their operations to withstand scrutiny. These regulations cover a broad spectrum, from ethical practices like preventing conflict of interest to technical requirements such as maintaining accurate records and providing transparency in communications with the public.
By complying with FINRA's rules, firms support the interests of their clients as well as their own reputations and operational longevity in the competitive financial marketplace.
Why Was FINRA Created?
FINRA was established by consolidating the National Association of Securities Dealers (NASD) and the member regulation, enforcement, and arbitration operations of the New York Stock Exchange (NYSE) in 2007.
This merger aimed to eliminate overlapping regulations and reduce the cost and complexity of compliance for firms.
What Is the Difference Between FINRA and the SEC?
While FINRA focuses specifically on regulating brokerage firms and their agents, the SEC has a broader mandate to protect investors and maintain the integrity of the securities markets.
The SEC was formed following the stock market crash of 1929, leading to the Securities Act of 1933 and the Securities Exchange Act of 1934, which aimed to restore investor confidence through transparency and fair dealings. The SEC not only regulates the securities industry but also oversees corporate finance, risk analysis, and all market participants, aiming to uphold fairness for individual investors.
Unlike FINRA, which is a non-governmental organization, the SEC is a federal agency with the authority to bring civil or criminal actions against violators of securities laws.
Types of Firms Regulated by FINRA
FINRA's regulatory authority covers a broad spectrum of the financial industry, focusing primarily on the following types of firms:
Capital Acquisition Brokers
Funding Portals
Understanding the scope and focus of FINRA’s regulatory efforts can help firms navigate compliance and uphold their responsibilities under these regulations.
Broker-Dealers
Broker-dealers are among the firms most directly impacted by FINRA regulations.
These entities engage in buying and selling securities on behalf of themselves and their clients. FINRA oversees these firms to promote compliance with fair practice standards, maintain adequate capital, and follow strict reporting requirements to support investor interests and market integrity.
Broker-dealers range from large institutions offering a wide array of services to smaller firms specializing in specific types of securities or market segments.
See also:
Capital Acquisition Brokers
Capital Acquisition Brokers (CABs) are a specific category of broker-dealer firms that primarily advise companies and private equity funds on capital raising and corporate restructuring.
CABs may also advise companies regarding mergers and acquisitions and assist in buying and selling a firm's shares in private placement transactions. FINRA regulates these firms to promote adherence to ethical standards and maintain the required levels of transparency and fairness in their operations.
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Funding Portals
Funding portals are platforms that facilitate crowdfunding transactions, allowing startups and small businesses to raise capital from a broad array of investors.
Regulated under the JOBS Act, these portals must register with both the SEC and FINRA. The FINRA regulation supports investor protection by providing sufficient information to make informed decisions and guiding platforms to conduct operations in compliance with securities laws, including maintaining fair and transparent practices.
9 Essential FINRA Rules
In this section, we delve into 9 specific FINRA rules that are critical for compliance by firms in the financial sector. Each rule is thoroughly examined, providing insights into its applicability to various customer types, security types, and business units.
FINRA Rule 2111: Suitability
Link: finra.org/rules-guidance/rulebooks/finra-rules/2111
Business Units: Compliance or Supervision; Financial or Operations; Sales
Customer Types: Institutional
Security Types: Debt; Equity
What Is Rule 2111?
Rule 2111, known as the Suitability Rule, is fundamental for helping ensure that the investments recommended by brokers align with the client's financial needs and objectives. This rule applies to all broker-dealers and extends its influence across various customer types, both retail and institutional.
FINRA’s Suitability Rule requires that a broker-dealer or associated person have a reasonable basis to believe that a recommended transaction or investment strategy involving a security is suitable for the customer. This determination must be based on information obtained through due diligence to understand the customer's investment profile, which includes factors such as the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, and risk tolerance.
Why Does This FINRA Rule Matter?
The Suitability Rule helps prevent investors from receiving unsuitable investment advice and reduces the risk of financial harm.
It guides financial services firms to act in accordance with their clients' best interests, promoting trust and integrity within the financial markets. For firms, adherence to this rule is not just about compliance but also about fostering and maintaining trust-based relationships with their clients.
By understanding and effectively implementing Rule 2111, firms can significantly enhance their advisory services, striving to consistently align their investment recommendations with their clients' best interests and financial objectives.
FINRA Rule 2210: Communications with the Public
Link: finra.org/rules-guidance/rulebooks/finra-rules/2210
Business Units: Compliance or Supervision; Marketing or Advertising; Registration or Personnel; Research; Sales
Customer Types: Institutional; Retail
Security Types: Debt; Equity
What Is Rule 2210?
Rule 2210 is essential for firms as it guides them to keep all communications with the public clear, fair, and not misleading. It applies to all firm types regulated by FINRA, including broker-dealers, capital acquisition brokers, and funding portals.
This FINRA rule governs the standards for all communications with the public by member firms. Such communications include promotional materials or advertisements and other written or electronic communications made available to more than a select group of customers. The rule requires that firms base their communications on principles of fair dealing and good faith, avoiding false, exaggerated, or misleading statements or claims.
The rule also outlines requirements for the approval and record-keeping of communications, specifying that each piece of promotional material must be approved by a principal of the firm before its use. Additionally, firms must maintain records of all communications for the period FINRA specified.
Why Does This FINRA Rule Matter?
Rule 2210 plays a pivotal role in helping investors by encouraging firms to promote the delivery of information that is accurate, complete, and understandable. It helps maintain financial market integrity by preventing misleading or harmful information from influencing investment decisions.
For firms, strict adherence to this rule is essential not only for regulatory compliance but also for maintaining client trust and confidence. By clearly defining the standards for communications, Rule 2210 helps firms manage their interactions with the public in a responsible and compliant manner.
FINRA Rule 2231: Customer Account Statements
Link: finra.org/rules-guidance/rulebooks/finra-rules/2231
Business Units: Compliance or Supervision; Financial or Operations; Sales
Customer Types: Institutional; Retail
Security Types: Debt; Equity
What Is Rule 2231?
Rule 2231 sets standards for the issuance of account statements to customers by broker-dealers, requiring that firms send detailed account statements at regular intervals.
These statements must include a comprehensive summary of all account activity, including securities transactions, money balances, and other account-related activities. This FINRA rule mandates that firms send monthly statements to customers if any account activity has occurred and quarterly statements if the account has remained static.
The goal is to keep investors well-informed about the status and activity within their accounts, providing them with the necessary information to make educated decisions about their investments.
The regulation also stipulates that the information presented in the statements must be clear and accurate, presented in a way that is understandable to the average investor. This includes explaining any terms or figures that are not self-explanatory, helping to demystify the often complex information that financial statements can contain.
Why Does This FINRA Rule Matter?
Rule 2231 is vital for maintaining a transparent relationship between brokers and their clients.
Regular and accurate account statements help clients track investment performance, monitor account activity, and verify the accuracy of transactions. This transparency supports clients in maintaining control over their financial assets and helps detect unauthorized or erroneous transactions, which can then be promptly addressed.
Furthermore, this rule supports the credibility of the financial industry. By promoting consistent communication through regular account statements, FINRA Rule 2231 helps build and maintain trust between financial service providers and their clients. Compliance with this rule demonstrates a firm’s commitment to upholding high standards of customer service and operational integrity, which are crucial for fostering long-term client relationships in the financial sector.
FINRA Rule 2265: Extended Hours Trading Risk Disclosure
Link: finra.org/rules-guidance/rulebooks/finra-rules/2265
Business Units: Compliance or Supervision; Financial or Operations; Sales
Customer Types: Institutional; Retail
Security Types: Debt; Equity
What Is Rule 2265?
Rule 2265 mandates that brokerage firms provide their customers with a specific risk disclosure statement concerning the potential risks of participating in extended-hours trading.
This trading period refers to transactions that occur outside the standard trading hours of major US stock exchanges. The disclosure must inform investors about their unique risks when trading in these less conventional hours. Some of these risks include lower liquidity, higher volatility, changing prices that may not reflect daytime prices, and less opportunity to receive another price quote after one is received.
The rule emphasizes the importance of making customers aware of these conditions before they engage in extended-hours trading. Firms are required to deliver this disclosure to their clients either before they start trading or during the account opening process.
Why Does This FINRA Rule Matter?
Rule 2265 is crucial for investor protection. Extended hours trading can expose traders to volatility and market conditions that differ significantly from those seen during regular market hours. By requiring firms to disclose these risks upfront, FINRA Rule 2265 helps investors make more informed decisions about engaging in such trading activities. This rule is essential for less experienced investors who may not be fully aware of the implications of trading at these times.
Additionally, this rule promotes fairness and transparency in the financial markets. It holds financial institutions accountable for educating their clients, thereby supporting the integrity of financial practices.
See also:
FINRA Rule 3110: Supervision
Link: finra.org/rules-guidance/rulebooks/finra-rules/3110
Business Units: Compliance or Supervision; Financial or Operations; Investment Banking; Legal, Risk or Internal Audit; Marketing or Advertising; Registration or Personnel; Research; Sales; Trading or Quoting
Customer Types: Institutional; Retail
Security Types: Debt; Equity
What Is Rule 3110?
Rule 3110 requires FINRA-regulated firms to develop and enforce a supervision system that aligns with applicable securities laws, regulations, and FINRA rules.
This comprehensive system must include written procedures specifically tailored to monitor the activities and conduct of members. Key areas under supervision include reviewing employee communications, evaluating the suitability of advice given to clients, overseeing trading activities, establishing hiring practices, and managing other critical business operations.
The extent and scope of the supervision should be proportionate to the firm's size, structure, business nature, and the types of products and services it offers. Moreover, the rule stipulates that designated individuals within the firm must take responsibility for the supervision and maintain clear accountability.
Why Does This FINRA Rule Matter?
Effective supervisory practices are essential for detecting and mitigating potential misconduct, thereby preventing harm to investors and preserving the firm’s good standing.
Such practices foster a compliance-oriented culture throughout the organization, enhancing overall operational integrity and market stability. Adherence to this FINRA rule reassures investors about the reliability and ethical standards of their financial service providers, which is crucial for maintaining confidence in the financial system.
FINRA Rule 3310: Anti-Money Laundering Compliance Program
Link: finra.org/rules-guidance/rulebooks/finra-rules/3310
Business Units: Compliance or Supervision; Financial or Operations; Investment Banking; Legal, Risk or Internal Audit; Sales; Trading or Quoting
Customer Types: Institutional; Retail
Security Types: Debt; Equity
What Is Rule 3310?
Rule 3310 establishes the requirement for FINRA-regulated firms to develop and implement an anti-money laundering (AML) program.
The program must be reasonably designed to comply with the Bank Secrecy Act (BSA) and implementing regulations promulgated by the Department of the Treasury. Key components of an effective AML program include:
the establishment of internal policies, procedures, and controls;
the designation of a compliance officer;
ongoing employee training; and
an independent audit function to test the program.
The rule emphasizes the need for systems that can detect and report potentially suspicious transactions that might indicate money laundering or other illicit activities.
Why Does This FINRA Rule Matter?
FINRA Rule 3310 plays a critical role in the global fight against financial crimes, helping prevent financial markets from being exploited for money laundering and terrorism financing.
By mandating that firms maintain a comprehensive AML program, FINRA strives to ensure that these institutions are vigilant in monitoring, identifying, and reporting activities that might pose a risk. Furthermore, compliance with this rule reinforces investor confidence in the financial system, assuring clients and partners that the firm is committed to high ethical standards and rigorous compliance practices.
FINRA Rule 4512: Customer Account Information
Link: finra.org/rules-guidance/rulebooks/finra-rules/4512
Business Units: Compliance or Supervision; Financial or Operations; Investment Banking; Sales; Trading or Quoting
Customer Types: Institutional; Retail
Security Types: Debt; Equity
What Is Rule 4512?
FINRA Rule 4512 mandates that regulated firms maintain accurate and current customer account information. Key data requirements as outlined in the rule include:
General Requirements for All Accounts
Customer's name and residence
Customer's legal age status
Names and roles of associated persons responsible for the account
Signature of the partner, officer, or manager denoting that the account has been accepted according to the firm's policies
Requirements for Legal Entities
Names of individuals authorized to transact on behalf of the entity
Trusted contact person (name and contact information)
For non-institutional and discretionary accounts, additional requirements apply.
Why Does This FINRA Rule Matter?
The enforcement of Rule 4512 is crucial for several reasons. Firstly, it aims to ensure that financial advice and products offered by brokers align with their clients’ needs, relying on accurate and up-to-date information. This suitability is vital for protecting investors from unsuitable investment risks.
Secondly, maintaining accurate customer information helps firms comply with other regulatory requirements, such as those related to anti-money laundering. Accurate data collection and verification are essential tools in detecting and preventing financial crimes.
Moreover, FINRA Rule 4512 supports the overall trust and reliability of the financial system. By requiring that customer information be kept current and verified, firms demonstrate their commitment to responsible management and ethical handling of client data.
FINRA Rule 5130: Restrictions on the Purchase and Sale of Initial Equity Public Offerings
Link: finra.org/rules-guidance/rulebooks/finra-rules/5130
Business Units: Compliance or Supervision; Financial or Operations; Investment Banking; Legal, Risk or Internal Audit; Sales
Customer Types: Institutional; Retail
Security Types: Equity
What Is Rule 5130?
Rule 5130 imposes restrictions on the purchase and sale of initial equity public offerings (IPOs) to help make these offerings available to a broad, general public and to prevent unfair allocation of shares.
The rule prohibits certain individuals associated with the equity market, such as brokers, dealers, and their immediate family members, from purchasing IPO shares. This restriction is intended to prevent conflicts of interest and the practice of "spinning," where IPO shares are allocated to executives of potentially lucrative future corporate clients as a favor.
Why Does This FINRA Rule Matter?
Rule 5130 is vital for maintaining fairness and integrity in allocating IPO shares. It helps make new market opportunities accessible to the general public, not just a privileged few connected to the financial industry.
This broad distribution helps achieve a more equitable market and reduces the potential for manipulation or preferential treatment.
FINRA Rule 5310: Best Execution and Interpositioning
Link: finra.org/rules-guidance/rulebooks/finra-rules/5310
Business Units: Compliance or Supervision; Sales; Trading or Quoting
Customer Types: Institutional; Retail
Security Types: Debt; Equity
What Is Rule 5310?
Rule 5310 requires that firms take reasonable steps to secure the best possible execution of customer orders, considering factors such as price, speed of execution, reliability, and the overall cost of the transaction.
This commitment extends to all client transactions in securities, emphasizing that firms actively seek to optimize order execution in the best interest of their clients. The rule also addresses the practice of interpositioning—where an intermediary is inserted between the customer and the best market for security—which is prohibited unless it demonstrably improves the terms of the transaction for the client.
You can read more about FINRA’s Rule 5310 here.
Why Does This FINRA Rule Matter?
Rule 5310 is fundamental in guiding firms to conduct all client transactions with their best interest in mind, particularly regarding order execution. This rule is vital for protecting client interests by mandating that their orders are executed under the best possible terms, directly contributing to customers' trust and loyalty in their financial services providers.
Moreover, the requirement for firms to seek the best execution helps enhance the overall efficiency and competitiveness of the financial markets.
Understanding and adhering to FINRA rules is crucial for financial firms, especially those navigating the intricate landscape of securities regulations. These rules, ranging from suitability requirements to best execution obligations, not only promote compliance but also uphold the integrity of the financial markets and protect investor interests.
If you find navigating these regulations daunting, you're not alone. At InnReg, we specialize in helping firms like yours understand and comply with FINRA rules, adapting your operations to meet industry standards.
Whether you need assistance implementing compliance programs or guidance on specific FINRA rules, our team of experts is here to help. Contact us today for a free complimentary consultation.
How Can InnReg Help?
InnReg is a global regulatory compliance and operations consulting team serving financial services companies since 2013.
We are especially effective at launching and scaling fintechs with innovative compliance strategies and delivering cost-effective managed services, assisted by proprietary regtech solutions.
If you need help with compliance, reach out to our regulatory experts today:
Published on May 2, 2024
Last updated on May 2, 2024
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