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Edward Canter

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Last week, Richard Ketchum, Chairman and CEO of the Financial Industry Regulatory Authority (“FINRA”), doubled-down on his recent criticism of the U.S. Department of Labor’s (“DOL”) proposed regulation addressing the standard of care for broker-dealers providing retirement investment advice. Speaking at FINRA’s annual conference, Chairman Ketchum said that, while he supports a “best interests of the customer” standard, the DOL’s proposal – which we wrote about here – is “not the appropriate way to meet that goal.”

Chairman Ketchum expressed particular concern over language in the DOL proposal that would require an advisor to make recommendations in the best interest of the customer “without regard to the financial or other interests” of the advisor. He worried that this language could lead to class action lawsuits and arbitration where the standard would be misapplied, stating, “I’m not sure, but I suspect, a judicial arbiter might draw a sharp line prohibiting most products with higher financial incentives no matter how sound the recommendation might be.”

finra_logoOn May 1, 2015, Richard Ketchum, Chairman and CEO of the Financial Industry Regulatory Authority (“FINRA”), reaffirmed his support for a uniform fiduciary standard for broker-dealers. Testifying before the House Financial Services Committee, Chairman Ketchum emphasized that the U.S. Securities and Exchange Commission (the “SEC”) – and not the U.S. Department of Labor (the “DOL”) – is best suited to establish and implement a new industry-wide standard of care.

Chairman Ketchum’s comments come less than three weeks after the DOL issued its highly anticipated, re-proposed regulation addressing when a person providing certain types of retirement investment advice is considered a fiduciary under the Employee Retirement Income Security Act (“ERISA”) and the Internal Revenue Code (“Code”). At present, broker-dealer recommendations typically must be based on a reasonable determination that the investment is suitable in light of the investor’s financial situation and investment objectives. Under the proposed rule, broker-dealers providing retirement investment advice would be held to a higher (fiduciary) standard – they would be required to act in the best interest of their client.

insider tradingOn March 25, 2015, U.S. Representative Jim Himes introduced the Insider Trading Prohibition Act.  The bill is the latest in a series of efforts to define insider trading following the Second Circuit’s decision last year in United States v. Newman.  We have blogged previously about similar legislation introduced by U.S. Senators Jack Reed and Bob Menendez and U.S. Representative Stephen F. Lynch.

The Himes bill would create a new Section 16A of the Securities Exchange Act.  The new section would make it illegal for a person to trade securities on the basis of material, non-public information that the person knows (or recklessly disregards) was wrongfully obtained.  The bill would also make it illegal for a person whose own trading would be illegal to wrongfully communicate material, non-public information to another person when it is reasonably foreseeable that the other person is likely to trade on it or pass it on to others.

On March 25, 2015, the SEC proposed an amendment to Rule 15b9-1 that would require high-frequency trading firms to register with FINRA.  According to the SEC, the proposed amendment will better align the scope of Rule 15b9-1 with today’s market structure.

Rule 15b9-1, as presently written, exempts certain market participants from the requirement under the Securities Exchange Act that broker-dealers become a member of a registered national securities association.  Specifically, Rule 15b9-1 exempts broker-dealers from the membership requirement if they (1) are a member of a national securities exchange, (2) carry no customer accounts, and (3) derive $1,000 or less in gross annual income from securities transactions conducted outside of a national securities exchange of which they are a member (the “de minimis allowance”).  Under the current Rule, income derived from trading for the broker-dealer’s own account with other broker-dealers does not count against the $1,000 limit.

In the latest regulatory action addressing high frequency and other algorithmic trading, a recent FINRA Regulatory Notice seeks comment on a proposed rule change under which persons associated with a member firm would be required to register as Equity Traders under Rule 1032(f) if they are primarily responsible for the design, development or significant modification of an algorithmic trading strategy that generates orders routed to an exchange or traded over the counter. Persons responsible for supervising this type of activity must also register.

The proposed rule change addresses FINRA’s stated concern that persons responsible for developing or modifying trading algorithms may lack adequate knowledge of the securities rules and regulations and that this lack of knowledge could result in trading algorithms that do not comply with applicable rules. The Regulatory Notice states, for example, that FINRA has observed algorithmic trading strategies that generated trading activity apparently violating Regulation NMS, Regulation SHO, Rule 15c3-5 and other market and investor protections.

Ever since the U.S. Court of Appeals for the Second Circuit issued its landmark decision in United States v. Newman, debate has raged about whether the court has sanctioned insider trading or has appropriately restrained the Government’s efforts to prosecute innocent market conduct – and whether the judiciary, rather than Congress, should be defining and outlawing insider trading in the first place. Some members of Congress have now stepped into the act.

Last week, U.S. Senators Jack Reed and Bob Menendez introduced the Stop Illegal Insider Trading Act (S.702). The Reed-Menendez bill would make it illegal to (1) trade securities on the basis of material information that a person knows or has reason to know is not publicly available or (2) knowingly or recklessly communicate material information that a person knows or has reason to know is not publicly available when it is reasonably foreseeable that such communication is likely to result in the unlawful purchase or sale of securities.

Seal_of_the_Supreme_Court_of_Delaware_svgThe Delaware Supreme Court will address the standard for pleading that an independent director has breached fiduciary duties in connection with a controlling shareholder buyout. The issue was certified for interlocutory appeal in a pair of recent Delaware Chancery Court cases. In re Cornerstone Therapeutics Stockholder Litigation, No. CIV.A. 8922-VCG (Del. Ch. Sept. 10, 2014) (Glasscock, V.C.); In re Zhongpin Stockholders Litigation, No. CV 7393-VCN (Del. Ch. Nov. 26, 2014) (Noble, V.C.).

In Cornerstone and Zhongpin, minority shareholders sued after the controlling shareholder of a publicly-traded company attempted a going-private transaction. In both cases, the board of directors formed a special committee of independent directors to negotiate with the controller; however, neither deal was conditioned, at the outset, on approval of a majority of the minority shareholders. In both cases, the corporate charter contained a provision enacted pursuant to Delaware General Corporation Law 102(b)(7), which exculpated directors from liability for breach of the duty of care.

On February 3, 2015, the Financial Industry Regulatory Authority (“FINRA”) issued its Report on Cybersecurity Practices. Reinforcing FINRA’s emphasis on protecting investor information, the report discusses the results of a recent industry-wide cybersecurity examination and presents a list of principles and best practices to guide the industry’s cybersecurity efforts going forward.

2014 Cybersecurity Examination

Last year, FINRA conducted a targeted examination of certain firms in the financial services industry. The examination sought information about various cybersecurity threats and firms’ particular vulnerabilities. The examination gathered information about firms’ approaches to managing these threats.