arbitration awards and settlements, ``let alone `Covered Pending
Arbitration Claims.''' \223\
---------------------------------------------------------------------------

    \222\ See PIABA Letter at 3.
    \223\ Id.
---------------------------------------------------------------------------

    In response, FINRA stated that a key reason why FINRA proposed a
factor-based approach to determining a Restricted Deposit Requirement
rather than a formulaic one is because it is less susceptible
manipulation by firms.\224\ Accordingly, nothing in proposed Rule 4111
would establish a floor for the amount of a Restricted Deposit
Requirement.\225\ Nevertheless, FINRA reiterated that proposed Rule
4111 would ``not absolve firms from paying unpaid arbitration awards,''
and that a member's ``thin capitalization at the time of the
Consultation would be only one factor'' that the Department considers
during that firm's Consultation process, and would ``not necessarily
result in a lower'' Restricted Deposit Requirement.\226\
---------------------------------------------------------------------------

    \224\ See FINRA March 4 Letter at 19.
    \225\ Id.
    \226\ Id.
---------------------------------------------------------------------------

    Finally, this commenter also suggested that proposed Rule 4111
should be amended to address how those investors owed unpaid
arbitration awards might access funds from a Restricted Firm's
restricted deposits to pay themselves.\227\ FINRA responded that
although it understands the purpose of the request, proposed Rule 4111
is intended to ``address the risks posed to investors by individual
brokers and member firms that have a history of misconduct,'' and while
the rule has features to incentivize payment of unpaid arbitration
awards, ``it is not intended to alter how aggrieved investors currently
may collect on an arbitration award.'' \228\
---------------------------------------------------------------------------

    \227\ See PIABA Letter at 4. In particular, PIABA indicated that
proposed Rule 4111 should address how an investor may access funds
from a firm's restricted deposit in the case of Former Members ``if
the former firm refuses to apply for a withdrawal, or if no one from
the former firm is available to make such a request on behalf of the
investor.'' Id.
    \228\ See FINRA March 4 Letter at 19-20.
---------------------------------------------------------------------------

    The Commission finds it is reasonable for FINRA to adopt the
Restricted Deposit Requirement as a separate obligation, distinct from
a Restricted Firm's existing obligations on member firms to satisfy
unpaid arbitration awards. As FINRA stated, its rules already include
comprehensive obligations on member firms that owe unpaid arbitration
awards, and impose significant penalties on those firms that fail to do
so.\229\ The Commission thus finds that structuring proposed Rule
4111's Restricted Deposit Requirement to instead primarily address
investor protection concerns more broadly, with the possibility of
reducing the number of unpaid customer arbitration awards as a
potential ancillary benefit, is reasonable. Moreover, the Commission
finds that FINRA's proposed use of the Consultation process--taking a
fulsome view of a firm's capitalization, including the potential effect
of any unpaid arbitration awards--when determining its Restricted
Deposit Requirement, provides a reasonable safeguard for evaluating the
application of the proposed rule to thinly capitalized firms. This
approach should enable FINRA to both further the intended goal of
proposed Rule 4111 to incentivize better behavior from firms without
undermining their financial stability, while also taking into account
their pre-existing obligations to satisfy unpaid arbitration awards.
Finally, as the Restricted Deposit Requirement is intended to provide
an obligation on Restricted Firms distinct from their pre-existing
obligations to satisfy unpaid arbitration awards, the Commission finds
the issue of collecting unpaid arbitration awards by investors is
beyond the subject matter of this proposed rule change and therefore,
is beyond the scope of this filing.
---------------------------------------------------------------------------

    \229\ See Notice at 78565 note 151 and accompanying text; see
also FINRA March 4 Letter at 7 note 15 and accompanying text.
---------------------------------------------------------------------------

    Another commenter stated that FINRA's data on unpaid arbitration
awards do not justify its establishment of ``an elaborate system of
additional

regulation to address the issue.'' \230\ In response, FINRA stated that
addressing the issue of unpaid arbitration awards was not the primary
purpose of the proposed rule change. Specifically, FINRA stated that
the proposed rule change's primary purpose is ``to create incentives
for members that pose outlier-level risks to change behavior.'' \231\
At the same time, FINRA believes that the proposed rule change ``may
have important ancillary effects in addressing unpaid customer
arbitration awards [including deterring] behavior that could otherwise
result in unpaid arbitration awards by incentivizing firms to reduce
their risk profile and violative conduct to avoid being deemed a
Restricted Firm and becoming subject to a Restricted Deposit
Requirement or other conditions or restrictions for a year or more.''
\232\ FINRA stated that it has ``long been concerned about non-payment
of arbitration awards'' \233\ and hopes to continue the dialogue about
``addressing the challenges of customer recovery across the financial
services industry.'' \234\
---------------------------------------------------------------------------

    \230\ See Harvin Letter at 5.
    \231\ See FINRA March 4 Letter at 12.
    \232\ Id.
    \233\ See FINRA March 4 Letter at 18 note 52 (citing FINRA,
Discussion Paper--FINRA Perspectives on Customer Recovery, at pp. 1,
19 (Feb. 8, 2018), available at https://www.finra.org/sites/default/files/finra_perspectives_on_customer_recovery.pdf).
    \234\ Id.
---------------------------------------------------------------------------

    FINRA has clarified that the primary purpose of the proposed rule
change is to incentivize better behavior from firms without undermining
their financial stability. While the Restricted Deposit Requirement may
also reduce the number of unpaid customer arbitration awards as a
potential ancillary benefit, the Commission finds that the issue of
collecting unpaid arbitration awards by investors is beyond the subject
matter of this proposed rule change and therefore, is beyond the scope
of this filing.
Expungement Concerns and Undercounting Arbitrations
    One commenter expressed concern about the ``pervasive nature of
expungement of customer disputes'' and how that might undermine FINRA's
ability to determine whether a firm should be deemed a Restricted Firm
under proposed Rule 4111.\235\ This commenter asserted that FINRA's
inability to review the ``full breadth of relevant disclosures'' due to
certain events being expunged from the record will likely lead to it
overlooking recidivist firms and registered representatives that should
be designated as Restricted Firms.\236\ As a result, the commenter
argued that proposed Rule 4111 incentivizes member firms and registered
representatives to ``sanitize their records'' by pursuing expungement
of customer complaints.\237\
---------------------------------------------------------------------------

    \235\ See PIABA Letter at 4-5.
    \236\ Id. at 4.
    \237\ Id.
---------------------------------------------------------------------------

    FINRA responded that its rules require accurate disclosures of
member firms and individuals, who are ``subject to disciplinary action
and possible disqualification if they fail to do so.'' \238\ Further,
FINRA stated that even if expungement requests rise due to proposed
Rule 4111, that does not mean that there will be a corresponding
increase in expungements that are granted, as such approvals may only
be provided ``after a court of competent jurisdiction has entered an
order directing expungement or confirming an arbitration award
containing expungement relief.'' \239\ FINRA also explained in its
Response that its Office of the Chief Economist has tested the proposed
thresholds under proposed Rule 4111 based on existing CRD data,\240\
and believes that the existing CRD data and proposed criteria using
these data are ``effective at identifying firms that pose greater risks
to customers.'' \241\ Finally, FINRA also pointed out that although
proposed Rule 4111 is not intended to address the expungement process,
it has undertaken a prior separate rulemaking to ``substantially
strengthen'' this process.\242\
---------------------------------------------------------------------------

    \238\ See FINRA March 4 Letter at 20. FINRA also stated that the
source of disclosures on Form U6 are regulators, and that FINRA's
Department of Credentialing, Registration, Education and Disclosure
``conducts a public records review to verify the completeness and
accuracy of criminal disclosure reporting.'' Id. (citing Notice at
79561).
    \239\ Id.
    \240\ Specifically, FINRA asserted it believes the use of
existing CRD data in conjunction with the criteria proposed under
the proposed rule effectively identifies higher risk firms. FINRA
bases this assertion on its comparison of firms captured by the
proposed thresholds to the firms that had recently been expelled,
that had unpaid arbitration awards, that Department staff had
identified as high risk for sales practice and fraud based on its
own risk-based analysis, and that subsequently had additional
disclosures after FINRA had made these preliminary identifications.
See FINRA March 4 Letter at 20-21.
    \241\ Id.
    \242\ Id.; see Exchange Act Release No. 90000 (Sep. 25, 2020),
85 FR 62142 (Oct. 1, 2020) (FINRA No. SR-FINRA-2020-030). FINRA
temporarily withdrew this rule filing from Commission consideration
so that they can further consider whether modifications to the
filing are appropriate. See FINRA Statement on Temporary Withdrawal
of Specialized Arbitrator Roster Rule Filing (May 28, 2021).
---------------------------------------------------------------------------

    Given that the proposed rule change does not affect FINRA's
expungement process, the Commission finds recommendations to amend it
are outside the scope of the proposed rule change.
The Restricted Deposit Requirement and a Member Firm's Net Capital
Requirement
    One commenter argued that, although proposed Rule 4111 requires
deposits in the Restricted Deposit Account to be deducted when
determining a member firm's net capital under Exchange Act Rule 15c3-1
and FINRA Rule 4110 (Capital Compliance), the actual effect of the rule
is to require additional net capital of the firm.\243\ This commenter
argued that, under Rule 4110(a), FINRA may already prescribe greater
net capital or net worth requirements on carrying or clearing members,
which the commenter stated would appear to provide FINRA ``ample
authority'' to address the issue of unpaid customer arbitration
awards.\244\ FINRA responded by noting that proposed Rule 4111's
primary purpose is incentivizing member firms to engage in less risky
behaviors, and the extent to which the rule change addresses unpaid
arbitration awards, this is merely an ancillary benefit.\245\ Further,
FINRA stated that it had considered the alternative of applying
increased capital requirements on Restricted Firms, but determined this
approach would be accompanied by ``several drawbacks with respect to
economic incentives and anticipated impacts.'' \246\
---------------------------------------------------------------------------

    \243\ See Harvin Letter at 7.
    \244\ Id.
    \245\ See FINRA March 4 Letter at 12.
    \246\ Id.; see also Notice at 78556-57. FINRA stated that
maintaining the firm's assets under an increased net capital
requirement would not be isolated to a restricted account and thus
``may be fungible with other firm assets,'' potentially resulting in
such assets being withdrawn and used by the firm during the
restricted period. Thus, FINRA determined that such an approach
would likely provide a much lower deterrent effect on firms than the
Restricted Deposit Requirement under proposed Rule 4111. Similarly,
FINRA believes that using an increased net capital requirement,
rather than the Restricted Deposit Requirement, may not sufficiently
incentivize behavioral changes from those Restricted Firms that
already were carrying substantial excess net capital.). See Notice
at 78557.
---------------------------------------------------------------------------

    The Commission finds the use of a separate and distinct deposit
requirement is reasonable and designed to accomplish the separate
purpose of incentivizing Restricted Firms to engage in less risky
behaviors. The Commission anticipates that FINRA members will include
in their decision-making the possibility of having their funds held in
an account with significant withdrawal restrictions when making certain
business determinations, which should reduce their propensity to engage
in

risky behaviors that are not in their customers' interests. For these
reasons, the Commission finds FINRA's approach is designed to protect
investors and the public interest.
Potential Harm to Small Firms
    One commenter asserted that proposed Rule 4111 will have unintended
consequences for small firms including ``increased costs to defend and
reporting.'' \247\ FINRA responded that, although some reporting and
defense costs may increase for a limited number of firms, this will
impact firms of all sizes, and it does not believe proposed Rule 4111
imposes either disproportionate costs or impacts on small firms.\248\
These costs could include, for example, when a firm seeks to rebut the
presumption that it is a Restricted Firm, which would involve added
costs to collect and provide information to FINRA, and when a firm
seeks review through the expedited proceeding proposed in Rule
9561.\249\ FINRA further indicated that proposed Rule 4111 is designed
to impact a limited number of firms that pose significantly higher risk
compared to similarly sized peers--across all firm sizes.\250\ The
proposed ``funnel'' process proposed by FINRA includes subsequent
review and a Consultation process provides safeguards designed to
protect firms of all sizes against misidentification.\251\ Finally,
FINRA reiterated that the rule requires FINRA to consider a firm's
size, among other things, when it determines to impose a Restricted
Deposit Requirement or other conditions or restrictions, and thus
should not have a disproportionate impact on small firms.\252\
---------------------------------------------------------------------------

    \247\ See IBN Letter.
    \248\ See FINRA March 4 Letter at 5.
    \249\ Id.
    \250\ Id.
    \251\ Id.
    \252\ Id.
---------------------------------------------------------------------------

    In raising concerns about the impact on small firms, this commenter
also provided a partial list of purported disclosure events applicable
to the commenter's firm, including that seven of the firm's 70
representatives were previously at now-expelled firms ``during their
career.'' \253\ FINRA stated that the list of disclosure events
included in this commenter's letter were broader than those covered by
the Preliminary Criteria for Identification, and could not determine
whether they would be captured by the proposed criteria without more
information.\254\ For example, in reference to the individuals who had
been at an expelled firm ``during their careers,'' FINRA stated that
the Registered Persons Associated with Previously Expelled Firms
category only covers a narrow scope of those registered representatives
who were registered with an expelled firm for at least one year and
whose registration with the previously expelled firm terminated during
the Evaluation Period.\255\
---------------------------------------------------------------------------

    \253\ See IBN Letter.
    \254\ See FINRA March 4 Letter at 6.
    \255\ Id. The Registered Persons Associated with Previously
Expelled Firms category only includes any Registered Person In-Scope
who was registered with the previously expelled firm (1) for at
least one year; and (2) ``whose registration with the previously
expelled firm terminated during the Evaluation Period'' (limiting
this to the prior five years from the current firm's Evaluation
Date). See FINRA Rule 4111(i)(4)(F). The same commenter also
referenced a registered representative with a ``financial
disclosure'' related to ``medical losses'' and expressed concerns
about pending arbitrations. See IBN Letter. FINRA reiterated that
neither a registered person's ``financial disclosures'' (e.g., the
compromises with creditors, bankruptcy petitions, bond-related
questions, unsatisfied judgments, and unsatisfied liens found in
Form U4, Questions 14K, 14L, and 14M), nor pending arbitrations and
written consumer-initiated complaints like those disclosed under
Form U4 Question 14I are counted in the Preliminary Criteria for
Identification. See FINRA March 4 Letter at 6-7. Only those ``awards
and settlements in specified investment-related, consumer initiated
arbitrations and complaints'' are counted within the Preliminary
Criteria for Identification. See FINRA March 4 Letter at 7.
---------------------------------------------------------------------------

    The Commission finds that the proposal, which is designed to
identify a limited number of firms with a significantly higher level of
risk related disclosures than similarly situated peers with thresholds
tailored to seven different firm sizes, takes a reasonable approach to
identifying firms that pose the greatest risk to investors, without
being unduly burdensome towards smaller firms. Further, FINRA's
commitment to tailoring any Restricted Deposit Requirement or other
conditions or restrictions it imposes on any firm it designates as a
Restricted Firm in a manner that accounts for the firm's size and
financial condition should help tailor the application of proposed Rule
4111 to the unique risks presented by particular firms. Finally,
pursuant to proposed Rule 4111(d), a firm would have an opportunity to
demonstrate that it should not be required to be subject to the maximum
Restricted Deposit Requirement by arguing that that certain disclosures
were improperly considered in determining its restricted status. For
these reasons, the Commission finds FINRA's approach is designed to
protect investors and the public interest.
Restricted Deposit Subject to Swings in Value
    One commenter asserted that proposed Rule 4111 fails to address
fluctuations in the valuation of ``qualified securities'' that a
Restricted Firm may deposit into its Restricted Deposit Account as
opposed to depositing cash.\256\ The commenter argued that as there is
no guarantee that securities used for this purpose will retain
sufficient value until they are redeemed to pay the firm's outstanding
debt, and proposed Rule 4111 lacks a ``mechanism . . . to ensure the
Restricted Deposit Account maintains sufficient value between FINRA
reviews,'' the proposal should be amended to require account
replenishment as necessary.\257\
---------------------------------------------------------------------------

    \256\ See PIABA Letter at 7.
    \257\ Id.
---------------------------------------------------------------------------

    FINRA has stated that proposed Rule 4111(a) only permits a
Restricted Firm to satisfy its Restricted Deposit Requirement with ``a
security issued by the United States or a security in respect of which
the principal and interest are guaranteed by the United States.'' \258\
FINRA believes such securities possess a sufficiently stable value such
that any post-deposit price fluctuation would not affect the financial
impact of their use to satisfy the Restricted Deposit Requirement, nor
the resulting incentive for the Restricted Firm to reform.\259\
Nevertheless, FINRA filed Amendment No. 2 to clarify that the proposed
rule change would not require a Restricted Firm to make additional
deposits in order to maintain continuously the original value of
qualified securities in its Restricted Deposit Account, if such
qualified securities have declined in value.\260\ Likewise, FINRA
clarified that, if the aggregate value of the assets deposited by a
member firm increases above the firm's Restricted Deposit Requirement,
that would not be a basis for the firm to request a withdrawal from its
Restricted Deposit Account. Rather, if a firm is re-designated as
Restricted Firm in the following year, it would need to deposit
additional cash or qualified securities if needed to meet the
Restricted Deposit Requirement at that time.\261\
---------------------------------------------------------------------------

    \258\ See FINRA March 4 Letter at 15.
    \259\ Id.
    \260\ See Amendment No. 2 at 4.
    \261\ Id. See also Rule 4111(f)(2), as modified by Amendment No.
2. The firm would be required to make any necessary additional
deposit promptly at the time of re-designation, or where a hearing
is requested pursuant to Proposed Rule 9561, promptly after the
Office of Hearing Officers or the NAC issues a written decision
under Rule 9559. Id.
---------------------------------------------------------------------------

    The Commission finds that FINRA's determination to not require a
Restricted Firm to replenish a Restricted Deposit Account to address
fluctuations in the value of qualified securities is reasonable.
Securities included within the ``qualified securities'' definition,

including U.S. Treasury Securities, serve as a benchmark for stability
and liquidity within U.S. securities markets. Thus, the Commission
expects that any change in value of these securities should be
relatively minimal during the year between any Restricted Firm
designation made by FINRA, and a firm's next annual Rule 4111
evaluation--wherein any re-designation of the firm as a Restricted Firm
would require the firm to again satisfy any Restricted Deposit
Requirement then imposed by FINRA. For these reasons, the Commission
finds FINRA's approach is designed to protect investors and the public
interest.
Additional Conditions and Restrictions Imposed on Restricted Firms
    One commenter stated that proposed Rule 4111.03 would unnecessarily
limit FINRA's options for conditioning or restricting the operation
high-risk firms.\262\ Specifically, the commenter stated that by
promulgating an illustrative list of conditions and restrictions that
could be imposed on Restricted Firms proposed Rule 4111 would not give
FINRA the necessary flexibility to impose obligations on such
firms.\263\ Instead, this commenter proposed that FINRA should
explicitly amend its proposal to make clear that it does not cede any
authority to take ``punitive'' action against firms that violate
FINRA's rules and the rights of their customers.\264\
---------------------------------------------------------------------------

    \262\ See Better Markets Letter at 20.
    \263\ Id. See Notice at 78548, providing in Supplementary
Material .03 to proposed Rule 4111, Examples of Conditions and
Restrictions that FINRA may impose on Restricted Firms other than a
Restricted Deposit Requirement.
    \264\ See Better Markets Letter at 20.
---------------------------------------------------------------------------

    FINRA does not take the view that proposed Rule 4111 provides
either an express or implied limit on the scope of conditions and
restrictions that FINRA could impose on Restricted Firms.\265\ Further,
FINRA disagrees with the suggestion that ``punitive'' conditions and
restrictions would be imposed, and in fact has pointed to proposed Rule
4111(e) as allowing the Department to impose those conditions and
restrictions on the ``operations and activities of the member and its
associated persons that are necessary or appropriate to address the
concerns indicated by the Preliminary Criteria for Identification and
protect investors and the public interest.'' \266\ However, FINRA
acknowledged the concerns raised by the commenter of the need to act,
when appropriate, to protect investors from predatory firms, and
indicated it ``fully intends to continue using its existing authority
to take action against predatory firms that violate FINRA's rules and
the rights of customers.'' \267\ Further, FINRA does not view anything
in proposed Rule 4111 to limit FINRA's authority to bring disciplinary
action against firms and registered representatives for violations and
``impose remedial sanctions for violations, including expulsions and
bars where appropriate.'' \268\
---------------------------------------------------------------------------

    \265\ See FINRA March 4 Letter at 15.
    \266\ Id. at 15-16.
    \267\ Id. at 16.
    \268\ Id. FINRA also stated that it is separately proposing the
adoption of Rule 9561(b) to permit it to bring expedited proceedings
against any firm that fails to comply with any of the Rule 4111
requirements--and also to seek the imposition of a suspension or
cancellation of that firm's membership. Id.
---------------------------------------------------------------------------

    The Commission agrees with FINRA's assessment that proposed Rule
4111 provides no express or implied limitation on the scope of
conditions or restrictions that it may impose as necessary or
appropriate to protect investors and the public interest, or both,
without seeking to undermine the viability of such firms' ongoing
operations. Additionally, the Commission agrees with FINRA's assessment
that nothing in proposed Rule 4111 limits its authority to impose
remedial sanctions--including expulsions and bars where appropriate--
through separate disciplinary actions against firms and registered
representatives for violations of FINRA rules. For these reasons, the
Commission finds FINRA's approach is designed to protect investors and
the public interest.
FINRA Should Impose Specific ``Terms and Conditions'' on Restricted
Firms That Circumvent Conditions and Restrictions Imposed by FINRA
Under Proposed Rule 4111, or Fail to Significantly Improve Compliance
    One commenter argued that FINRA should add to proposed Rule 4111
the general authority to impose ``terms and conditions'' on firms that
demonstrate ``significant compliance failures'' to prevent any
``gaming'' of the Preliminary Identification Metric Thresholds.\269\ In
particular, this commenter expressed support for FINRA using this
authority regarding those firms that ``either circumvent the
obligations and restrictions placed upon them by proposed Rule 4111 . .
. or otherwise refuse to significantly improve their compliance
culture.'' \270\ FINRA responded that although it is not adopting a
``terms and conditions'' approach currently, it will explore doing so
in the future to address any compliance issues.\271\ While FINRA
recognized that a terms and conditions rule would make it more
difficult for firms to evade the identification criteria, FINRA
believed that proposed Rule 4111 may offer a better deterrent effect
for firms to change their behavior, particularly those firms that may
be close to meeting such criteria.\272\ For Restricted Firms that evade
compliance with the conditions and restrictions imposed on them, FINRA
stated that proposed Rule 9561(b) would permit it to ``bring an
expedited proceeding against a member that fails to comply with any
Rule 4111 Requirements'' that could result in the suspension or
cancellation of the firm's membership.\273\ Further, FINRA asserted
that proposed Rule 4111 already has been designed with features that
will make it more difficult to manipulate their Preliminary
Identification Metrics, but that it appreciates the support for any
further efforts it adopts to curtail such behavior.\274\
---------------------------------------------------------------------------

    \269\ See Better Markets Letter at 19-20. Better Markets further
indicated that, to prevent the gaming of Preliminary Identification
Metric Thresholds, it will support ``any reasonable and appropriate
amendments or future proposals that will allow FINRA to address
firms with substantial compliance issues that cannot be captured by
the proposed numerical framework.'' See Better Markets Letter at 19-
20. As part of the proposal, FINRA considered an approach similar to
the Investment Industry Regulatory Organization of Canada's
(``IIROC'') ``terms and conditions'' rule to identify a limited
number of firms with significant compliance failures using non-
public information from FINRA's examination and monitoring process
and impose appropriate terms and conditions to encourage these
firms' increased compliance. However, it elected not to propose a
terms and conditions rule at this time. See Notice at 78554-55
(referencing IIROC Consolidated Rule 9208).
    \270\ See Better Markets Letter at 5.
    \271\ See FINRA March 4 Letter at 27. FINRA stated that it had
already explained one possible alternative approach it has
considered is to adopt an approach similar to the ``terms and
conditions'' rule used by IIROC, under IIROC Consolidated Rule 9208.
See Notice at 78554.
    \272\ See Notice at 78554-55.
    \273\ Id.
    \274\ See FINRA March 4 Letter at 27-28. FINRA stated that
particular aspects of proposed Rule 4111 that are designed to
curtail efforts by firms to game their Preliminary Identification
Metrics include: (1) Defining ``Registered Persons In-Scope'' under
proposed Rule 4111(i)(13) to cover all persons registered with the
firm for one or more days within the year prior to the Evaluation
Date, undercutting any effort to manipulate the outcome by reducing
staff immediately before FINRA's annual calculation of that firm's
Preliminary Criteria for Identification; and (2) performing the
annual calculation of a firm's Preliminary Criteria for
Identification at least 30-45 days after the Evaluation Date, ``to
account for the lag time between when relevant disclosure events
occurred and when they are required to be reported on the Uniform
Registration Forms'' to prevent any attempt by a firm to delay
Uniform Registration Form submissions to manipulate annual metrics.
Id.
---------------------------------------------------------------------------

    The Commission finds the proposal provides for reasonable measures
to

prevent firms from manipulating their Preliminary Identification
Metrics, particularly by adopting checks within proposed Rule 4111 to
impede any efforts to distort FINRA's initial calculations of a firm's
metrics as of the Evaluation Date. For these reasons, the Commission
finds FINRA's approach is designed to protect investors and the public
interest.
Economic Impact Analysis
    One commenter suggested that although proposed Rule 4111 may
increase investor protection above the status quo, FINRA should conduct
a ``full economic assessment'' that not only compares proposed Rule
4111 against the ``baseline scenario where FINRA takes no action to
monitor or control predatory wolf-pack firms,'' but also compares
proposed Rule 4111 against an alternative scenario that ``assumes the
improvements offered'' by the commenter.\275\ FINRA rejected the
suggestion, as it believes that its current economic impact analysis
``thoroughly addresses'' how proposed Rule 4111 addresses the current
regulatory need better than reasonable alternatives,\276\ and is also
``consistent with the framework for FINRA's approach to economic impact
assessments in proposed rulemakings.'' \277\ FINRA asserted that the
appropriate economic baseline, and the one that it used to evaluate the
economic impacts of proposed Rule 4111, is the ``current regulatory
framework,'' which includes numerous provisions related to FINRA's
current supervision and oversight of member firms.\278\ FINRA argued
that it has already conducted a thorough economic impact analysis of
proposed Rule 4111, and assessed the potential impacts by examining the
number of firms that would have met the Preliminary Criteria for
Identification between 2013-2017, and the number of ``new'' Registered
Person and Member Firm Events in the 2014-2019 period.\279\ FINRA
believes this assessment provided the ``appropriate information about
the economic baseline and effectiveness of the proposed rule in
identifying firms that may be associated with additional events after
identification.'' \280\
---------------------------------------------------------------------------

    \275\ See Better Markets Letter at 13. As discussed more fully
above, the Commission considered this commenter's recommended
alternatives and has concluded that the proposed rule change
represents a reasonable approach to identifying firms that pose the
greatest risk to investors and imposing obligations on those firms
to encourage them to change their behavior.
    \276\ See FINRA March 4 Letter at 26. For example, FINRA
indicated that it ``considered several alternative specifications to
the numeric threshold based-approach, including alternative
categories of reported disclosure events and metrics, alternative
counting criteria for the number of reported events or conditions,
and alternative time periods over which the events or conditions are
counted.'' See FINRA March 4 Letter at 26 note 70.
    \277\ Id. See Framework Regarding FINRA's Approach to Economic
Impact Assessment for Proposed Rulemaking (Sept. 2013), available at
https://www.finra.org/sites/default/files/Economic%20Impact%20Assessment_0_0.pdf.
    \278\ See FINRA March 4 Letter at 25. Specifically, FINRA
highlighted its rules pertaining to FINRA supervision, the
membership application process, proceedings for statutory
disqualification and other disciplinary proceedings as to firms and
registered representatives, along with FINRA's current ``risk
monitoring and focused examination programs . . . designed to
monitor and address the risks posed by high-risk firms and high-risk
brokers.'' Id.
    \279\ Id. FINRA indicated that economic analysis ``demonstrated
that for firms that would have met the Preliminary Criteria for
Identification in the years 2013-2017, those firms were associated
with 2,995 `new' Registered Person and Member Firm Events in the
Post-Identification Period . . . [and] also demonstrated that such
firms had between 6.1 and 19.9 times more ``new'' disclosure events
(per registered person) in the years after identification than other
firms registered during the 2013-2017 period.'' See FINRA March 4
Letter at 25-26.
    \280\ See FINRA March 4 Letter at 26.
---------------------------------------------------------------------------

    The Commission finds it is both reasonable and appropriate for
FINRA to assess the hypothetical results of proposed Rule 4111 using
the current regulatory framework as its economic baseline. Doing so
enables FINRA to determine the potential impact of the proposal based
on existing, recent market data. As any modification of the existing
regulatory framework will lead to a response in the market and changes
in firm behavior, it is appropriate for FINRA to compare the
hypothetical impacts of proposed Rule 4111 against this pre-existing,
recent market data.
    In sum, the Commission finds that proposed Rule 4111 would provide
an important new tool to FINRA in identifying and imposing conditions
or restrictions on those member firms with outlier-level disclosure
events relative to their similarly sized peers. In addition, the
Commission finds that proposed Rule 4111 takes a reasonable and
appropriate approach to incentivizing better behavior from such firms
for the protection of investors and the public interest. Further, the
Commission finds that the proposed Rule 4111 process provides firms
with ample opportunity to affect the ultimate outcome of FINRA's
decisions, including an extensive Consultation process--that will
provide member firms who would be initially identified by FINRA with
opportunities to demonstrate why they should not actually be designated
as a Restricted Firm, or thereafter why they should not be subject to
the maximum Restricted Deposit Requirement or other operational
conditions or restrictions--along with avenues to seek further review
if necessary. Moreover, by establishing different thresholds for
identification across seven different firm sizes, proposed Rule 4111
should help reduce the possibility that the rule becomes overly
burdensome on any group of firms based solely on their size or
resources.
    Accordingly, the Commission finds proposed Rule 4111 is reasonably
designed to protect investors by helping incentivize compliant behavior
from those firms exhibiting higher levels of disclosure events, while
effectively tailoring the review process to mitigate the burdens on
member firms throughout that process. The Commission further supports
FINRA's commitment to working with individual state securities
regulators to share relevant information and observes its commitment to
further consider public disclosure of a firm's designation as a
Restricted Firm by filing proposed amendments to Rule 8312 that would
require FINRA to identify on BrokerCheck those member firms or former
member firms that are designated as Restricted Firms pursuant to
proposed Rules 4111 and 9561.

Proposed Rule 9561 (Procedures for Regulating Activities Under Rule
4111) and Amendments to Rule 9559 To Implement the Requirements of
Proposed Rule 4111

    The proposal to adopt new Rule 9561 and to amend Rule 9559 to
establish new, expedited proceedings to enable firms to challenge any
requirements imposed by the Department under the Rule 4111 process will
help provide for both the fair administration of Rule 4111, and faster
remediation of instances of non-compliance. Proposed new Rule 9561 is
designed to afford firms with an opportunity to address such matters
through timely notice of FINRA's decision to impose obligations, or
determination that a firm is failing to comply with such obligations,
and the ability to thereafter request a hearing regarding such a
decision or determination. Correspondingly, the proposed amendments to
Rule 9559 would assist in the administration of such requested
hearings.
    One commenter suggested that the expedited proceeding rule be
amended to include a requirement ``that each member firm be given
notice of the Preliminary Identification Metrics.'' \281\ FINRA
declined this suggestion, asserting that the purpose of the proposed
rule, ``is to establish procedures for when the Department determines,
after the Rule 4111 process,

that a firm is a Restricted Firm and seeks to impose requirements,
conditions, or restrictions on the Restricted Firm.'' \282\ Further,
FINRA asserted that the proposed expedited proceeding rule is not
intended to provide any notice of the Preliminary Identification
Metrics to firms other than those few that are deemed to be Restricted
Firms.\283\ FINRA believes that the commenter may have instead been
suggesting that it provide each firm with notice of its own Preliminary
Identification Metrics under proposed Rule 4111, and indicated that if
this is the case, FINRA reiterates its commitment to providing firms
with compliance tools for the Rule 4111 process.\284\
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    \281\ See Harvin Letter at 1.
    \282\ See FINRA March 4 Letter at 25.
    \283\ Id.
    \284\ Id. See supra note 152 (addressing FINRA's commitment to
providing additional guidance and resources to member firms to
assist in satisfying their compliance burdens under the proposed
rule).
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    The expedited proceedings process proposed by FINRA will help
afford firms with fair procedures to contest such decisions and
determinations. The Commission also agrees with FINRA that disclosure
of the Preliminary Identification Metrics to member firms does not fall
within the purpose of the expedited proceedings rule.\285\ Accordingly,
the Commission finds that the proposed new Rule 9561 and proposed
amendments to existing Rule 9559 will help facilitate the effective
administration of proposed new Rule 4111, while providing a fair appeal
and review process for firms seeking to challenge FINRA's decisions and
determinations thereunder. For these reasons, the Commission finds
FINRA's approach is designed to protect investors and the public
interest.
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    \285\ Separate comments addressing whether FINRA should
otherwise disclose to firms their Preliminary Identification Metrics
across all six categories is discussed above in ``Resources to
assist Member Firms with Compliance.''
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    However, the Commission also supports and encourages FINRA's
willingness to regularly reassess the performance of the Rule 4111
process in practice to continue to identify what further measures, if
any, are necessary and appropriate to guard against such manipulation
by firms.

IV. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the
Exchange Act \286\ that the proposed rule change (SR-FINRA-2020-041),
as modified by Amendment No. 1 and Amendment No. 2, be, and hereby is,
approved.
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    \286\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\287\
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    \287\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2021-16671 Filed 8-4-21; 8:45 am]
BILLING CODE 8011-01-P