[Federal Register Volume 86, Number 90 (Wednesday, May 12, 2021)]
[Notices]
[Pages 26084-26109]
[FR Doc No: 2021-10055]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-91789; File No. SR-FINRA-2021-008]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change Relating to
Security-Based Swaps

May 7, 2021.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on April 26, 2021, the Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission'') the proposed rule change as described in Items I,
II, and III below, which Items have been prepared by FINRA. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    FINRA is proposing to amend FINRA Rules 0180, 4120, 4210, 4220,
4240 and 9610 to clarify the application of its rules to security-based
swaps (``SBS'') following the SEC's completion of its rulemaking
regarding SBS dealers (``SBSDs'') and major SBS participants
(``MSBSPs'') (collectively, ``SBS Entities'').
    The text of the proposed rule change is available on FINRA's
website at http://www.finra.org, at the principal office of FINRA and
at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

1. Purpose
Background
    On July 21, 2010, President Obama signed into law the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank
Act'').\3\ Title VII of the Dodd-Frank Act, entitled the ``Wall Street
Transparency and Accountability Act of 2010,'' \4\ established a
comprehensive new regulatory framework for over-the-counter (``OTC'')
derivatives known in the industry as ``swaps,'' which were generally
unregulated in the United States prior to passage of the Dodd-Frank
Act. Among other things, Title VII of the Dodd-Frank Act was intended
to implement in the United States the mandate agreed by the G20 in
September 2009 for its members to improve the OTC derivatives markets
by improving transparency, mitigating systemic risk and protecting
against market abuse.\5\
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    \3\ Public Law 111-203, 124 Stat. 1376 (2010).
    \4\ See Dodd-Frank Act Section 701.
    \5\ See G20 Leaders' Statement from The Pittsburgh Summit (Sept.
24-25, 2009), https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
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    Generally, Title VII of the Dodd-Frank Act divided regulatory
jurisdiction over swap products between the Commodity Futures Trading
Commission (``CFTC'') and the SEC, with the CFTC regulating ``swaps''
and the SEC regulating SBS.\6\

The Dodd-Frank Act directed the SEC to promulgate rulemakings
implementing the new regulatory framework for SBS, including rules
requiring SBS Entities to register with the SEC; business conduct and
supervision requirements, risk mitigation techniques and other rules
specifically applicable to SBS Entities; recordkeeping and financial
reporting rules for SBS Entities; capital, margin and segregation
requirements for SBS Entities; rules requiring regulatory reporting and
public dissemination of SBS information; and processes to require SBS
to become subject to mandatory clearing and execution on a registered
or exempt execution facility or exchange.\7\ The Commission has now
finalized a majority of its rulemakings pursuant to Title VII of the
Dodd-Frank Act (the ``Title VII rulemakings'').\8\ The Commission has
also established the compliance date for registration of SBS Entities,
which will be October 6, 2021 (the ``Registration Compliance Date''),
and has broadly coordinated the compliance date for a number of other
Title VII rulemakings with the Registration Compliance Date.\9\
Accordingly, beginning on October 6, 2021, registered SBS Entities will
become subject to the Title VII rulemakings, and the deadline for the
initial wave of SBS Entity registrations is November 1, 2021.\10\
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    \6\ The terms ``swap'' and ``security-based swap'' are defined
in Sections 721 and 761 of the Dodd-Frank Act. The Commission and
the CFTC have jointly promulgated rules further defining these
terms. See Securities Exchange Act Release No. 67453 (July 18,
2012), 77 FR 48208 (August 13, 2012) (Further Definition of
``Swap,'' ``Security-Based Swap,'' and ``Security-Based Swap
Agreement''; Mixed Swaps; Security-Based Swap Agreement
Recordkeeping) (``Product Definitions''). Very generally, SBS are
swaps referencing a single security or loan, or a narrow-based
security index. Certain products sharing characteristics of both
swaps and SBS are regulated as ``mixed swaps'' subject to both CFTC
and SEC jurisdiction.
    \7\ See Dodd-Frank Act Section 763.
    \8\ See Securities Exchange Act Release No. 74244 (February 11,
2015), 80 FR 14564 (March 19, 2015) (Regulation SBSR--Reporting and
Dissemination of Security-Based Swap Information) (``Regulation SBSR
Release''); Securities Exchange Act Release No. 75611 (August 5,
2015), 80 FR 48964 (August 14, 2015) (Final Rule: Registration
Process for Security-Based Swap Dealers and Major Security-Based
Swap Participants) (``Registration Process Release''); Securities
Exchange Act Release No. 77617 (April 14, 2016), 81 FR 29960 (May
13, 2016) (Final Rule: Business Conduct Standards for Security-Based
Swap Dealers and Major Security-Based Swap Participants) (``Business
Conduct Standards Release''); Securities Exchange Act Release No.
78011 (June 8, 2016), 81 FR 39808 (June 17, 2016) (Final Rule: Trade
Acknowledgment and Verification of Security-Based Swap Transactions)
(``Trade Acknowledgment and Verification Release''); Securities
Exchange Act Release No. 86175 (June 21, 2019), 84 FR 43872 (August
22, 2019) (Final Rule: Capital, Margin, and Segregation Requirements
for Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital and Segregation Requirements for Broker-
Dealers) (``Capital, Margin, and Segregation Release''); Securities
Exchange Act Release No. 87005 (September 19, 2019), 84 FR 68550
(December 16, 2019) (Final Rule: Recordkeeping and Reporting
Requirements for Security-Based Swap Dealers, Major Security-Based
Swap Participants, and Broker-Dealers) (``Recordkeeping Release'');
Securities Exchange Act Release No. 87780 (December 18, 2019), 85 FR
6270 (February 4, 2020) (Final Rules; Guidance: Rule Amendments and
Guidance Addressing Cross-Border Application of Certain Security-
Based Swap Requirements) (``Cross-Border Release''); Securities
Exchange Act Release No. 87782 (December 18, 2019), 85 FR 6359
(February 4, 2020) (Final Rule: Risk Mitigation Techniques for
Uncleared Security-Based Swaps) (``Risk Mitigation Release''). The
SEC has also proposed, but not yet finalized, rules governing SBS
execution facilities (``SBSEFs'') and rules regarding fraud in the
SBS market. See Securities Exchange Act Release No. 63236 (November
3, 2010), 75 FR 68560 (November 8, 2010) (Prohibition Against Fraud,
Manipulation, and Deception in Connection with Security-Based Swaps;
Proposed Rule); Securities Exchange Act Release No. 63825 (February
2, 2011), 76 FR 10948 (February 28, 2011) (Registration and
Regulation of Security-Based Swap Execution Facilities; Proposed
Rule; Proposed Interpretation).
    \9\ See Cross-Border Release supra note 8, at 6345. The
Commission stated that the Registration Compliance Date for SBS
Entities will be 18 months after the effective date of the rules
adopted pursuant to the Cross-Border Release, which was April 6,
2020. See Cross-Border Release at 6270. Generally, the other Title
VII rulemakings will apply to SBS Entities upon registration with
the SEC. The first compliance date for SBS reporting under
Regulation SBSR will be the first Monday that is the later of (1)
six months after the date on which the first SBS data repository
(``SBSDR'') that can accept reports in a given asset class registers
with the SEC and (2) one month after the Registration Compliance
Date. See Cross-Border Release at 6346. No SBSDRs are currently
registered with the SEC.
    \10\ The Registration Compliance Date is October 6, 2021. The
SEC has also clarified that the transitional period before a person
that is deemed to be an SBSD must register with the SEC runs until
two months after the end of the month in which the person is no
longer able to satisfy the de minimis exception from the SBSD
definition. Therefore, entities exceeding the de minimis threshold
on the first counting date of August 6, 2021 or later in August 2021
must register no later than November 1, 2021. See SEC, Key Dates for
Registration of Security-Based Swap Dealers and Major Security-Based
Swap Participants, https://www.sec.gov/page/key-dates-registration-security-based-swap-dealers-and-major-security-based-swap-participants (``SEC Transitional Period Guidance'').
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    Title VII of the Dodd-Frank Act also amended the definition of
``security'' under the Act to expressly encompass SBS.\11\ Therefore,
in addition to the comprehensive new SBS-specific regulatory framework
discussed above, SBS are now also defined as securities under the Act
and the rules thereunder. This amendment to the Act was effective as of
July 16, 2011, the effective date of Title VII of the Dodd-Frank Act.
However, to allow sufficient time to consider the potentially complex
interpretive issues that may arise by defining SBS as securities, the
SEC issued a series of temporary exemptive orders beginning in July
2011.\12\ With limited exceptions, the SEC's temporary exemptive orders
relating to the regulation of SBS as securities have now expired or
will expire on the Registration Compliance Date.\13\
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    \11\ See Dodd-Frank Act Section 761(a)(2) (inserting ``security-
based swap'' in the definition of ``security'' in Section 3(a)(10)
of the Act); see also 15 U.S.C. 78c(a)(10).
    \12\ See, e.g., Securities Exchange Act Release No. 64795 (July
1, 2011), 76 FR 39927 (July 7, 2011) (Order Granting Temporary
Exemptions Under the Securities Exchange Act of 1934 in Connection
With the Pending Revision of the Definition of ``Security'' To
Encompass Security-Based Swaps, and Request for Comment) (``2011
Exemptive Order''); Securities Exchange Act Release No. 71485
(February 5, 2014), 79 FR 7731 (February 10, 2014) (Order Extending
Temporary Exemptions Under the Securities Exchange Act of 1934 in
Connection With the Revision of the Definition of ``Security'' to
Encompass Security-Based Swaps, and Request for Comment).
    \13\ See Securities Exchange Act Release No. 84991 (January 25,
2019), 84 FR 863 (January 31, 2019) (Order Granting a Limited
Exemption from the Exchange Act Definition of ``Penny Stock'' for
Security-Based Swap Transactions between Eligible Contract
Participants; Granting a Limited Exemption from the Exchange Act
Definition of ``Municipal Securities'' for Security-Based Swaps; and
Extending Certain Temporary Exemptions under the Exchange Act in
Connection with the Revision of the Definition of ``Security'' to
Encompass Security-Based Swaps) (``2019 Exemptive Order'');
Securities Exchange Act Release No. 90308 (November 2, 2020), 85 FR
70667 (November 5, 2020) (Order Granting Exemptions from Sections 8
and 15(a)(1) of the Securities Exchange Act of 1934 and Rules 3b-
13(b)(2), 8c-1, 10b-10, 15a-1(c), 15a-1(d) and 15c2-1 Thereunder in
Connection with the Revision of the Definition of ``Security'' to
Encompass Security-Based Swaps and Determining the Expiration Date
for a Temporary Exemption from Section 29(b) of the Securities
Exchange Act of 1934 in Connection with Registration of Security-
Based Swap Dealers and Major Security-Based Swap Participants).
Generally, the SEC has extended the expiration date for the
temporary exemptions directly related to pending SBS rulemakings
until the compliance date for the related SBS rulemakings. Temporary
exemptions not directly linked to SBS rulemakings have either
expired or, in certain limited circumstances, been extended or made
permanent.
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    The addition of SBS to the definition of ``security'' under the Act
had similar implications for FINRA rules. In particular, under the
amended definition, any FINRA rule that applies to FINRA members'
activities involving a security, securities business, a transaction
involving a security or a securities position applies by its terms to
those activities involving SBS. Therefore, consistent with the SEC's
actions in this area, on July 8, 2011, FINRA filed for immediate
effectiveness FINRA Rule 0180, which, with certain exceptions noted
below, temporarily limits the application of FINRA rules with respect
to SBS, thereby avoiding undue market disruptions resulting from the
change to the definition of ``security'' under the Act.\14\ Pending the
SEC's final implementation of the Title

VII rulemakings, FINRA has extended the expiration date of FINRA Rule
0180 a number of times, mostly recently in January 2020.\15\ FINRA Rule
0180 is currently set to expire on September 1, 2021.
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    \14\ See Securities Exchange Act Release No. 64884 (July 14,
2011), 76 FR 42755 (July 19, 2011) (Notice of Filing and Immediate
Effectiveness of File No. SR-FINRA-2011-033).
    \15\ See Securities Exchange Act Release No. 88023 (January 23,
2020), 85 FR 5261 (January 29, 2020) (Notice of Filing and Immediate
Effectiveness of File No. SR-FINRA-2020-001).
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    FINRA Rule 0180 broadly excepts SBS activities from most FINRA
requirements. Specifically, FINRA Rule 0180(a) provides that FINRA
rules shall not apply to members' activities and positions with respect
to SBS, except for FINRA Rule 2010 (Standards of Commercial Honor and
Principles of Trade), FINRA Rule 2020 (Use of Manipulative, Deceptive
or Other Fraudulent Devices), FINRA Rule 3310 (Anti-Money Laundering
Compliance Program) and FINRA Rule 4240 (Margin Requirements for Credit
Default Swaps).\16\ In addition, FINRA Rule 0180(b) provides that the
following rules apply to members' activities and positions with respect
to SBS only to the extent they would have applied as of July 15, 2011
(i.e., the day before the effective date of Title VII of the Dodd-Frank
Act): (i) NASD Rule 3110 and all successor FINRA Rules to such NASD
Rule, (ii) the FINRA Rule 4500 Series and (iii) the FINRA Rule 4100
Series.\17\ Finally, FINRA Rule 0180(c) provides that certain other
rules apply as necessary to effectuate members' compliance with the
rules applicable to SBS as noted above, including, for example,
supervision requirements and rules relating to FINRA investigations and
sanctions.
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    \16\ FINRA Rule 4240 establishes an interim pilot program with
respect to margin requirements for any transactions in credit
default swaps (``CDS'') held in an account at a FINRA member. Like
FINRA Rule 0180, the interim pilot program under FINRA Rule 4240
will automatically expire on September 1, 2021. See FINRA Rule
4240(a); see also Securities Exchange Act Release No. 89036 (June
10, 2020), 85 FR 36458 (June 16, 2020) (Notice of Filing and
Immediate Effectiveness of File No. SR-FINRA-2020-016).
    \17\ These FINRA rules relate to books and records requirements
and financial responsibility standards.
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    In light of the expiration of the SEC's temporary exemptive orders,
the finalization of the SEC's regulatory framework for SBS, and the
upcoming Registration Compliance Date, FINRA believes it is appropriate
and in the public interest for current FINRA Rule 0180 to expire and
for FINRA to clarify the treatment of SBS under FINRA rules going
forward.\18\ Accordingly, FINRA is proposing to amend FINRA Rules 0180,
4120, 4210, 4220, 4240 and 9610 to take into account members' SBS
activities once SBS Entities begin registering with the SEC on October
6, 2021. These proposed amendments generally fall into three
categories. First, the proposed rule change would adopt a new FINRA
Rule 0180, to replace expiring current FINRA Rule 0180, that would
generally apply FINRA rules to members' activities and positions with
respect to SBS, while providing limited exceptions for SBS in
circumstances where FINRA believes such exceptions are appropriate.
Second, the proposed rule change would amend FINRA's financial
responsibility and operational rules to conform to the SEC's amendments
to its capital, margin and segregation requirements for SBSDs and
broker-dealers, and to otherwise take into account members' SBS
activities. Finally, the proposed rule change would adopt a new margin
rule specifically applicable to SBS, which would replace the expiring
interim pilot program establishing margin requirements for CDS. Each
aspect of the proposed rule change is discussed in greater detail
below.
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    \18\ FINRA intends to extend the expiration dates of existing
FINRA Rules 0180 and 4240 to October 6, 2021 to align with the
Registration Compliance Date and implementation of the proposed rule
change.
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General Presumption of Applicability
    As described above, FINRA Rule 0180 currently provides a broad,
temporary exception from the application of FINRA requirements to SBS
by providing that FINRA rules shall not apply to members' activities
and positions with respect to SBS, with limited exceptions. Under the
proposed rule change, current FINRA Rule 0180 would be replaced by a
new FINRA Rule 0180 on October 6, 2021, which would effectively flip
the existing presumption that FINRA rules do not apply to SBS, with
certain exceptions, and instead provide that, going forward, FINRA
rules do apply to SBS, with certain exceptions.\19\ Specifically,
proposed FINRA Rule 0180(a) would provide that, except as otherwise
provided in FINRA Rule 0180, FINRA rules shall apply to members'
activities and positions with respect to SBS.\20\ As discussed in
greater detail below, proposed FINRA Rules 0180(b) through (g) would
specify the exceptions from this general presumption of applicability
that FINRA believes it should provide to members engaged in SBS
activity. Proposed FINRA Rule 0180(i) also would provide FINRA with
exemptive authority to consider exemptive relief from the application
of specific FINRA rules to SBS on a case-by-case basis.
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    \19\ Supplementary Material .01 to FINRA Rule 0180 provides that
for purposes of FINRA Rule 0180, ``security-based swap'' has the
same meaning as defined in Section 3(a)(68) of the Act and the rules
and guidance of the SEC or its staff. FINRA is not proposing to
modify the definition of ``security-based swap'' in Supplementary
Material .01.
    \20\ FINRA notes that since the definition of ``security'' now
includes SBS, once current FINRA Rule 0180 expires all FINRA rules
applicable to securities will apply by their terms to SBS,
regardless of whether a FINRA rule specifically states that FINRA
rules apply to SBS. However, FINRA believes that including an
affirmative statement regarding the application of FINRA rules to
SBS in proposed FINRA Rule 0180(a) will promote legal certainty and
provide greater clarity for its members.
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    As discussed above, Title VII of the Dodd-Frank Act amended the
definition of ``security'' under the Act to specifically encompass
SBS.\21\ As the Commission has noted, in ``making this change, Congress
intended for [SBS] to be treated as securities under the Exchange Act
and the underlying rules and regulations.'' \22\ FINRA is a registered
national securities association under Section 15A of the Act, which
requires, among other things, that FINRA rules be designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons engaged in regulating, clearing, settling, processing
information with respect to, and facilitating transactions in
securities, to remove impediments to and perfect the mechanism of a
free and open market and a national market system, and, in general, to
protect investors and the public interest.\23\ FINRA adopted existing
Rule 0180 to avoid undue market disruption while the SEC completed its
Title VII rulemaking, but this broad exception was always intended to
be temporary. Now that the SEC has largely finalized its regulatory
framework for SBS and set the Registration Compliance Date for SBS
Entities, FINRA believes it would be consistent with Congress's intent
and FINRA's regulatory responsibility to generally apply FINRA rules to
members' activities and positions with respect to SBS, subject to
specified exceptions.
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    \21\ See supra note 11.
    \22\ See 2011 Exemptive Order, supra note 12, at 39929.
    \23\ 15 U.S.C. 78o-3(b)(6).
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    Under proposed Rule 0180(a), FINRA rules would generally apply to
SBS in the same manner that such rules apply to securities
generally.\24\ FINRA notes that while the proposed rule change would
therefore regulate SBS activities similarly to any other securities

activities of its members, it expects that the practical impact of the
proposed rule change will be limited. As an initial matter, in
developing the proposed rule change, FINRA solicited input from its
members regarding their anticipated SBS activities, including through
direct conversations with a number of members that currently engage or
have affiliates that engage in SBS activity, an invitation for
submission of views and information on SBS activities on the FINRA
website,\25\ and issuance of Regulatory Notice 20-36 soliciting comment
on a concept proposal relating to SBS.\26\ Based on feedback received,
FINRA understands that only a small number of its members will register
as SBSDs or otherwise directly engage in SBS activities. In addition,
FINRA notes that many of its rules relate to specific activities or
lines of business that are unlikely to be relevant to SBS given the
unique and limited characteristics of SBS. For example, FINRA's rules
relating to securities offerings and underwriting are unlikely to
implicate SBS.\27\ Moreover, at present SBS generally may only be
entered into with persons who qualify as ``eligible contract
participants'' (``ECPs''),\28\ such that FINRA rules specific to
activities involving retail customers are unlikely to apply to SBS at
this time.
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    \24\ As for any other activity or product, members are
responsible for determining the regulatory characterization of SBS
and the applicability of specific rules to such products.
    \25\ See FINRA, Views and Information on Activity Related to
Security-Based Swaps, https://www.finra.org/rules-guidance/requests-for-comments/security-based-swaps.
    \26\ See FINRA Regulatory Notice 20-36 (October 2020).
    \27\ FINRA notes that certain rules in the FINRA Rule 5200
Series (Quotation and Trading Obligations and Practices) and 5300
Series (Handling of Customer Orders) apply by their terms to
``securities'' generally, and therefore would apply to SBS under the
proposed rule change. FINRA believes such rules are likely to have
limited impact on SBS at present because SBS are generally bilateral
OTC derivatives transactions negotiated and entered into between two
counterparties. However, these trading and quoting rules may become
more relevant to SBS in the future, particularly if trading or
execution of SBS on exchanges or SBSEFs becomes prevalent. FINRA
will monitor developments in the SBS market and evaluate the
appropriateness of applying these rules to SBS transactions if
quoting and trading activity develops.
    \28\ ``Eligible contract participant'' is defined under the Act
to have the same meaning as under the Commodity Exchange Act
(``CEA''). See 15 U.S.C. 78c(a)(65). Under the CEA, ECPs are defined
to include certain regulated entities, such as broker-dealers,
futures commission merchants (``FCMs''), financial institutions and
insurance companies, as well as government entities and certain
qualifying individuals and entities meeting net worth or total
assets thresholds. See 7 U.S.C. 1a(18). Generally, an individual
qualifying as an ECP must have amounts invested on a discretionary
basis in excess of $10,000,000, or $5,000,000 if hedging. See 7
U.S.C. 1a(18)(A)(xi). The Dodd-Frank Act amended the Securities Act
of 1933 (``Securities Act'') and the Act to require that SBS
transactions involving a person that is not an ECP must be
registered under the Securities Act and effected on a national
securities exchange. See Product Definitions, supra note 6, at 48246
n.429. FINRA understands that no SBS are currently registered or
available for execution on an exchange, and therefore all SBS at
present must be entered into with ECPs.
    FINRA's retail customer-focused rules generally apply to
accounts of customers that do not meet the definition of an
``institutional account'' under FINRA Rule 4512(c). In addition to
certain types of regulated entities, an ``institutional account''
under FINRA Rule 4512(c) includes any person with total assets of at
least $50 million. See FINRA Rule 4512(c)(3). Certain FINRA rules
also exclude other specified types of entities or persons from the
coverage of retail customer-focused provisions. See, e.g., FINRA
Rule 2210(a)(4) (defining ``institutional investor'' for purposes of
the communications with the public requirements as an institutional
account under FINRA Rule 4512(c) or certain other specified
entities, plans or persons). Given the differences between the ECP
definition and the definition of ``institutional account'' (or other
variations used to define non-retail customers in the FINRA
rulebook), it is possible that FINRA members may engage in SBS with
customers that qualify as ECPs but that do not qualify as
``institutional accounts,'' and therefore would be covered by FINRA
retail customer-focused rules. For example, an individual may have
more than $10 million invested on a discretionary basis, but not
total assets of at least $50 million. Given the nature of the SBS
market, FINRA believes that this scenario is likely to occur
infrequently, but believes it would be appropriate to apply FINRA
rules applicable to activities involving retail customers in such
situations. FINRA notes that its retail customer-focused rules would
also apply to SBS if non-ECP markets develop.
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    FINRA notes that current FINRA Rule 0180(a) provides: ``The Rules
shall not apply to members' activities and positions with respect to
security-based swaps, except for'' certain rules noted above. Article I
of the FINRA By-Laws defines the ``Rules'' as used in FINRA Rule
0180(a) to mean ``the numbered rules set forth in the [FINRA manual]
beginning with the Rule 0100 Series, as adopted by the Board pursuant
to these By-Laws, as hereafter amended or supplemented.'' Current FINRA
Rule 0180 does not provide an exception from other parts of the FINRA
manual, including the FINRA By-Laws and related governance documents,
the Capital Acquisition Broker (CAB) rulebook, the Funding Portal
rulebook or the Temporary Dual FINRA-NYSE Member Rules Series.
Therefore, to the extent any of FINRA's governance documents or other
rule sets apply to securities activities, they already apply to SBS by
their terms. However, FINRA believes that these other parts of the
FINRA manual likely have little direct relevance to SBS activities,
since they relate primarily to governance or, as is the case for the
CAB and Funding Portal rulebooks, are likely generally inapplicable due
to the restricted nature of activities covered. FINRA also notes that
Schedule A to the FINRA By-laws lists various fees that FINRA may
assess, including two types of transaction fees. First, Section 1 of
Schedule A provides for assessment of Member Regulatory Fees, including
the Trading Activity Fee or ``TAF.'' The TAF applies only to sales of
``covered securities'' as defined in paragraph (b) of Section 1 of
Schedule A. FINRA does not currently consider SBS to be ``covered
securities'' as currently defined in paragraph (b), and therefore has
not assessed the TAF with respect to SBS transactions entered into by
its members. Second, Section 3 of Schedule A provides that each member
shall be assessed a Regulatory Transaction Fee, which shall be
determined periodically in accordance with Section 31 of the Act.\29\
The SEC has addressed whether SBS are subject to Section 31 fees,
stating that SBS are not currently subject to Section 31 fees and will
not become subject to Section 31 fees until such time as the SEC
implements real-time public reporting of SBS transactions.\30\ FINRA
will monitor developments with respect to the applicability of Section
31 fees to SBS and apply its Regulatory Transaction Fee coextensively
with Section 31 fees. Therefore, FINRA expects that its Regulatory
Transaction Fee will apply to SBS if real-time reporting for SBS comes
into effect without the SEC providing an exemption for SBS from Section
31 fees. However, if the SEC grants an exemption from Section 31 for
SBS, the Regulatory Transaction Fee would likewise not apply to SBS.
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    \29\ See 15 U.S.C. 78ee.
    \30\ Specifically, the SEC has stated:
    A sale of a security is subject to Section 31 fees only if (1)
the sale occurs on a national securities exchange, or (2) the sale
is transacted by or through a member of a national securities
association otherwise than on a national securities exchange and the
security is registered on a national securities exchange or subject
to prompt last-sale reporting pursuant to the rules of the
Commission or a registered national securities association. Although
security-based swaps are securities, they do not meet any of the
conditions noted above. Thus, security-based swaps are currently not
subject to Section 31 fees and would not become subject to Section
31 fees due to the expiration of the Unlinked Temporary Exemptions
or the full implementation of Regulation SBSR as it currently
exists.
    The Dodd-Frank Act created a new Section 13(m) of the Exchange
Act that requires ``real-time public reporting'' of security-based
swap transactions. Once real-time public reporting is fully-
implemented, security-based swaps will be subject to prompt last-
sale reporting pursuant to the rules of the Commission, which will
subject them to Section 31 fees. Thus, when the Commission proposes
to implement prompt last-sale reporting for security-based swap
transactions, it may also revisit the appropriateness of exempting
security-based swaps from Section 31 fees at such time.
    See 2019 Exemptive Order, supra note 13, at 866 (citations
omitted).
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    FINRA believes that applying the general presumption of
applicability of FINRA rules to SBS under proposed

FINRA Rule 0180(a) as described above is appropriate and in the public
interest. In formulating the proposed rule change, however, FINRA
reviewed its rulebook to evaluate whether it would be appropriate to
provide exceptions for SBS from particular FINRA rules or rule series
and, if so, under what circumstances such exceptions should apply.
Based on this review and feedback from its members and others, FINRA is
proposing to provide three categories of exceptions: (1) General
exceptions based on impracticability or operational burdens; (2)
limited exceptions for SBS Entities and associated persons of SBS
Entities; and (3) limited exceptions in connection with the conditions
to the SEC's cross-border SBS counting exception. In addition, FINRA is
proposing to provide exemptive authority to exempt a person from the
application of specific FINRA rules to the person's SBS activities in
circumstances not already covered by the proposed rule change. Each of
these aspects of the proposed rule change is discussed in greater
detail below.
General Exceptions From Presumption of Applicability
    Proposed FINRA Rule 0180(b) would provide that the following FINRA
rules shall not apply to members' activities and positions with respect
to SBS: (1) The FINRA Rule 6000 Series; (2) the FINRA Rule 7000 Series;
and (3) the FINRA Rule 11000 Series. While some of these rules could
potentially be interpreted as applying to SBS activities by their
terms, FINRA believes that these rules were intended for other types of
securities and could create operational difficulties if so applied.
Therefore, FINRA believes the proposed rule change would provide legal
certainty and clarity for its members by specifically excepting these
rules from applying to members' activities and positions with respect
to SBS.
    The FINRA Rule 6000 Series (Quotation, Order, and Transaction
Reporting Facilities) and 7000 Series (Clearing, Transaction and Order
Data Requirements, and Facility Charges) include various rules relating
to trading, quoting, clearing and reporting for different types of
securities. These rule series includes rules relating to quoting and
trading in NMS stocks, quoting and trading in OTC Equity Securities,
the Alternative Display Facility (the ADF, a facility for display of
quotations in, and reporting OTC transactions in, NMS stocks), the
Trade Reporting Facilities (the TRFs, facilities for reporting OTC
transactions in NMS stocks), the OTC Reporting Facility (the ORF, a
facility for reporting transactions in OTC Equity Securities), the OTC
Bulletin Board Service (the OTCBB, an interdealer quotation system for
OTC Equity Securities), the Trade Reporting and Compliance Engine
(TRACE, a facility for reporting transactions in eligible debt
securities), the Order Audit Trail system (OATS, a system to capture
order information in NMS stocks and OTC Equity Securities), compliance
with the Consolidated Audit Trail (CAT), and fees and charges
associated with various FINRA facilities. Many of these rules would
clearly not apply to SBS by their terms. For example, SBS are not NMS
stocks, nor are SBS subject to the CAT. However, FINRA understands that
the characterization of SBS may be unclear in some circumstances, which
could raise the possibility that certain of these rules could be
interpreted as applying to SBS. FINRA does not intend for the FINRA
Rule 6000 or 7000 Series to apply to SBS, as these rules were
specifically designed for other types of securities and would be
operationally burdensome if applied to SBS. In addition, reporting to
FINRA's various trade reporting facilities would be unnecessarily
duplicative with the SEC's Title VII rulemakings related to regulatory
reporting and public dissemination of SBS information.\31\ Therefore,
the proposed rule change would provide clarity in this area by
specifically providing exceptions for SBS from the FINRA Rule 6000 and
7000 Series.\32\
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    \31\ See Regulation SBSR Release, supra note 8.
    \32\ FINRA notes that the FINRA Rule 6400 Series (Quoting and
Trading in OTC Equity Securities) includes certain rules governing
quoting and trading practices for OTC Equity Securities. FINRA
believes these rules are not relevant to SBS at present because SBS
are generally OTC derivatives transactions negotiated and entered
into between two counterparties. However, these type of trading and
quoting rules may become more relevant to SBS in the future,
particularly if market centers begin quoting or trading SBS. FINRA
will monitor developments in the SBS market and evaluate the
appropriateness of applying these or similar rules to SBS
transactions at such time.
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    In addition, the FINRA Rule 11000 Series sets forth the Uniform
Practice Code (``UPC''). The UPC is a series of rules, interpretations
and explanations designed to make uniform, where practicable, custom,
practice, usage, and trading technique in the investment banking and
securities business, particularly with regards to operational and
settlement issues. These can include such matters as trade terms,
deliveries, payments, dividends, rights, interest, reclamations,
exchange of confirmations, stamp taxes, claims, assignments, powers of
substitution, computation of interest and basis prices, due-bills,
transfer fees, ``when, as and if issued'' trading, ``when, as and if
distributed'' trading, marking to the market, and close-out procedures.
The UPC was created so that the transaction of day-to-day business by
members may be simplified and facilitated, that business disputes and
misunderstandings, which arise from uncertainty and lack of uniformity
in such matters, may be eliminated, and that the mechanisms of a free
and open market may be improved and impediments thereto removed. For
example, FINRA Rules 11310 through 11365 address matters relating to
the delivery of securities, FINRA Rules 11510 through 11581 address
certificated security matters, FINRA Rules 11610 through 11650 address
the delivery of bonds and other evidence of indebtedness and FINRA
Rules 11810 through 11894 address close-out procedures.
    By its terms, the UPC applies to all OTC secondary market
transactions in securities between members, with enumerated
exceptions.\33\ Therefore, the UPC could be interpreted as applying to
SBS transactions in some circumstances. However, FINRA notes that the
UPC is limited to transactions between members. It would therefore
apply only in the very limited circumstances involving SBS transacted
between FINRA members. As discussed above, FINRA understands that only
a small number of its members will register as SBSDs or otherwise
directly engage in SBS activities. The UPC would therefore only
potentially be invoked for a small portion of the SBS market, which
FINRA believes has the potential to create confusion and uncertainty.
In addition, while FINRA recognizes the importance of operational and
settlement risks in SBS transactions, FINRA believes these risks are
more appropriately addressed through other means, including through the
contractual provisions utilized by SBS counterparties under industry-
standard SBS documentation and, where applicable, the SEC's risk
mitigation requirements.\34\ By contrast,

the UPC was designed to facilitate and make uniform the operational
aspects of cash securities transactions. These operational provisions
were not designed for, and are not well-suited to, the particular
characteristics of SBS transactions involving bilateral contractual
negotiations between counterparties. FINRA therefore believes it is
appropriate to except the FINRA Rule 11000 Series from applying to
members' activities and positions with respect to SBS.
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    \33\ See FINRA Rule 11100(a). Under FINRA Rule 11100(a)(1),
transactions in securities between members which are compared,
cleared or settled through the facilities of a registered clearing
agency are not subject to the UPC, except to the extent that the
rules of the clearing agency provide that rules of other
organizations shall apply. Paragraphs (a)(2) through (a)(5) of FINRA
Rule 11100 also provide exceptions for specific types of securities,
including exempted securities, municipal securities, redeemable
securities issued by investment companies and Direct Participation
Program Securities.
    \34\ For example, the SEC's SBS trading relationship
documentation rules require SBS Entities to have in place trading
relationship documentation including all terms governing the trading
relationship between the SBS Entity and its counterparty, including,
without limitation, terms addressing payment obligations, netting of
payments, events of default or other termination events, calculation
and netting of obligations upon termination, transfer of rights and
obligations, governing law, valuation, and dispute resolution. See
17 CFR 240.15Fi-5(b)(1).
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Exceptions for SBS Entities and Associated Persons
    As discussed above, the SEC has now completed the majority of its
Title VII rulemakings, including business conduct standards, trade
acknowledgement and verification requirements, risk mitigation
techniques and recordkeeping rules for SBS Entities.\35\ These rules
will apply to SBS Entities once they register with the SEC on or after
the Registration Compliance Date. As described below, certain of these
new SBS-specific rules are similar to existing FINRA rules that apply
to members' securities activities generally. FINRA believes that
applying both the SEC's rules for SBS Entities and FINRA's parallel
rules for its members to the same SBS activity would result in
unnecessary regulatory duplication. Therefore, to promote regulatory
clarity and avoid unnecessary regulatory duplication, the proposed rule
change would provide exceptions from specific FINRA rules in
circumstances where the SEC's SBS Entity rules will apply to the SBS
activity. As described in further detail below, proposed FINRA Rules
0180(c), (d), (f) and (g) would specify the FINRA rules subject to
these exceptions and the conditions to such exceptions.
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    \35\ See Business Conduct Standards Release; Trade
Acknowledgment and Verification Release; Risk Mitigation Release;
Recordkeeping Release, supra note 8.
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    Proposed FINRA Rules 0180(c) and (d) would provide that certain
specified FINRA rules shall not apply to members' activities and
positions with respect to SBS, to the extent that the member is acting
in its capacity as an SBS Entity or the associated person of the member
is acting in his or her capacity as an associated person of an SBS
Entity, as applicable, and that such activities or positions relate to
the business of the SBS Entity within the meaning of the Exchange Act
Rule 15Fh-3(h)(1).\36\ As described below, each rule listed in proposed
FINRA Rules 0180(c) and (d) is similar to a particular SEC rule or set
of rules applicable to SBS Entities (or specifically applicable to
SBSDs, but not MSBSPs, in the case of proposed FINRA Rule 0180(d)).
FINRA believes it is appropriate to provide exceptions from these
specific FINRA rules, but only to the extent that the SEC's parallel
SBS Entity rules will apply to the SBS activity.\37\ The exceptions are
therefore limited to circumstances where the member engaged in the SBS
activity is acting in its capacity as an SBS Entity, or where the
associated person engaged in the SBS activity is acting in his or her
capacity as an associated person of an SBS Entity.\38\ To ensure that
the exceptions apply only where the SBS activity is covered by the
SEC's rules and subject to the oversight and supervision of an SBS
Entity (which itself is subject to oversight by the Commission and, if
a FINRA member, FINRA), proposed FINRA Rules 0180(c) and (d) include a
further condition that the SBS activities or positions relate to the
business of the SBS Entity within the meaning of the SEC's SBS Entity
supervision rule.\39\
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    \36\ See 17 CFR 240.15Fh-3(h)(1). These exceptions are split
between paragraphs (c) and (d) of proposed FINRA Rule 0180 to
account for certain SEC rules that apply only to SBSDs, but not
MSBSPs. Specifically, the exceptions in proposed FINRA Rule 0180(c)
would apply for all Swap Entities, while the exceptions in proposed
FINRA Rule 0180(d) would apply only for SBSDs.
    \37\ Conversely, the proposed exceptions would not apply in
circumstances where the SEC's SBS Entity rules do not apply. For
example, the exceptions in proposed FINRA Rules 0180(c) and (d)
would not apply to a member engaged in SBS brokerage activity. FINRA
notes that the SEC has contemplated that a registered broker-dealer
engaged in SBS brokerage activity would be subject to applicable
self-regulatory organization rules. See, e.g., Cross-Border Release
at 6284, Business Conduct Standards Release at 29966-68, supra note
8. The exceptions would also not apply to a member entering into SBS
below the de minimis threshold for SBSD registration or engaging in
other SBS activity not requiring SBS Entity registration (e.g., SBS
hedging activity). In these circumstances, the FINRA rules would
apply to the SBS activity.
    \38\ FINRA's business conduct rules apply both to the FINRA
member and persons associated with the member. Similarly, the SEC's
SBS Entity rules apply to activity undertaken by an SBS Entity or
its associated persons. Therefore, proposed Rule 0180(c) applies to
the SBS activities engaged in by a member that is also registered as
an SBS Entity as well as SBS activities engaged in by an associated
person of a member where the associated person is acting in their
capacity as an associated person of an SBS Entity, since the SBS
Entity rules would apply in those circumstances. The exceptions
would therefore apply to an associated person of a member that is
also registered as an SBS Entity where the associated person is
acting in his or her capacity as an associated person of the SBS
Entity.
     FINRA understands that certain firms engaged in SBS activity
may employ a ``dual-hatted'' personnel structure. In this structure,
an affiliate of the member is registered as an SBS Entity, but the
member itself is not dually-registered as an SBS Entity. However,
certain personnel of the member may be ``dual-hatted'' such that
they act as associated persons of the member with respect to general
securities activities but as associated persons of the affiliated
SBS Entity with respect to the SBS Entity's SBS activities. FINRA
intends for the exceptions in proposed FINRA Rule 0180(c) to apply
to SBS activities undertaken by an associated person of a member
acting in his or her capacity as an associated person of an
affiliated SBS Entity under the dual-hatted structure described
above. FINRA is providing this guidance to promote legal certainty
and provide clarity to its members regarding the application of the
particular rules covered by the proposed exceptions in FINRA Rule
0180(c). The proposed rule change does not address whether or to
what extent other FINRA rules not covered by proposed FINRA Rule
0180(c) might apply to a dual-hatted associated person when he or
she is acting in his or her capacity as an associated person of an
affiliated SBS Entity.
     FINRA also notes that whether a particular individual is acting
as an associated person of the member or of an SBS Entity (whether
the same entity as the member or an affiliated entity) is a facts
and circumstances determination and is not dependent on the
particular method in which such arrangements are documented.
However, FINRA reminds members that they must be able to demonstrate
how a particular individual is designated and for what purposes, as
well as the specific capacity in which an individual is acting with
respect to any particular transaction or activity.
    \39\ The SEC's SBS supervision rule states: ``A security-based
swap dealer or major security-based swap participant shall establish
and maintain a system to supervise, and shall diligently supervise,
its business and the activities of its associated persons. Such a
system shall be reasonably designed to prevent violations of the
provisions of applicable federal securities laws and the rules and
regulations thereunder relating to its business as a security-based
swap dealer or major security-based swap participant,
respectively.'' 17 CFR 240.15Fh-3(h)(1). Therefore, to qualify for
the exceptions in proposed FINRA Rules 0180(c) and (d), the
particular SBS activity must be within the scope of the business of
the SBS Entity that is subject to the SBS Entity's supervisory
system. If an SBS Entity were to engage in other SBS activity that
it did not consider within the scope of its business as an SBS
Entity, and therefore not subject to the SEC's rules applicable to
SBS Entities, the exceptions would not be available and the
applicable FINRA rules would apply to that activity.
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    Under proposed FINRA Rules 0180(c) and (d), these proposed
exceptions would be available for eight FINRA rules, subject to the
conditions described above. Specifically, proposed FINRA Rule 0180(c)
would provide exceptions for the following FINRA rules:
     FINRA Rule 2210(d) (Communications with the Public--
Content Standards) requires members to adhere to content standards with
respect to all of their communications, whether correspondence, retail
communications or institutional communications. Among other things,
FINRA Rule 2210(d) requires that member communications be based on
principles

of fair dealing and good faith, be fair and balanced, and not omit any
material facts or make false or exaggerated claims. The SEC's business
conduct rules for SBS Entities include Exchange Act Rule 15Fh-3(g),
which generally requires SBS Entities to communicate with
counterparties in a fair and balanced manner based on principles of
fair dealing and good faith.\40\ The SEC's business conduct rules also
include requirements for SBS Entities to make certain disclosures to
their SBS counterparties, including disclosures of material risks and
characteristics of the SBS and material incentives or conflicts of
interest (Exchange Act Rule 15Fh-3(b)), daily mark disclosures
(Exchange Act Rule 15Fh-3(c)) and disclosures regarding clearing rights
(Exchange Act Rule 15Fh-3(d)).\41\
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    \40\ See 17 CFR 240.15Fh-3(g); Business Conduct Standards
Release, supra note 8, at 30000-02.
    \41\ See 17 CFR 240.15Fh-3(b), (c) and (d); Business Conduct
Standards Release, supra note 8, at 29980-93.
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     FINRA Rule 2232 (Customer Confirmations) generally
requires members to provide customers with written confirmations in
conformity with Exchange Act Rule 10b-10,\42\ along with specified
additional disclosures for certain types of securities. Exchange Act
Rule 15Fi-2 requires SBS Entities to provide trade acknowledgements and
to establish, maintain and enforce written policies and procedures
reasonably designed to obtain prompt verification of the terms of such
trade acknowledgments.\43\ FINRA also notes that the SEC's trade
acknowledgement and verification rule provides that an SBS Entity that
is also a broker or dealer, is purchasing from or selling to any
counterparty, and that complies with the relevant requirements of the
trade acknowledgement and verification rule, is exempt from the
requirements of Exchange Act Rule 10b-10 with respect to the SBS
transaction.\44\
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    \42\ See 17 CFR 240.10b-10.
    \43\ See 17 CFR 240.15Fi-2; see generally Trade Acknowledgment
and Verification Release, supra note 8.
    \44\ See 17 CFR 240.15Fi-2(g); Trade Acknowledgement and
Verification Release, supra note 8, at 39824-25.
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     FINRA Rules 3110 (Supervision), 3120 (Supervisory Control
System) and 3130 (Annual Certification of Compliance and Supervisory
Processes) require, among other things, each member to establish and
maintain a supervisory system; establish, maintain and enforce written
supervisory procedures; designate principals to establish, maintain and
enforce a system of supervisory control policies and procedures;
designate a chief compliance officer; and submit annual certifications
to FINRA related to the member's compliance policies and written
supervisory procedures. The SEC's business conduct rules for SBS
Entities include Exchange Act Rules 15Fh-3(h) and 15Fk-1.\45\ Exchange
Act Rule 15h-3(h) requires, among other things, an SBS Entity to
establish and maintain a system to supervise, and to diligently
supervise, its business and the activities of its associated persons;
designation of at least one person with authority to carry out
supervisory responsibilities; and establishment, maintenance and
enforcement of written policies and procedures addressing supervision
of the SBS Entity's SBS business. Exchange Act Rule 15Fk-1 requires
each SBS Entity to designate a chief compliance officer and submit
annual compliance reports to the SEC.
---------------------------------------------------------------------------

    \45\ See 17 CFR 240.15Fh-3(h) and 15Fk-1; Business Conduct
Standards Release, supra note 8, at 30002-07 and 30050-61.
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    Proposed FINRA Rule 0180(d) would provide exceptions for the
following FINRA Rules:
     FINRA Rule 2030 (Engaging in Distribution and Solicitation
Activities with Government Entities) is FINRA's ``pay-to-play'' rule,
which imposes restrictions on member firms engaging in distribution or
solicitation activities with government entities. Exchange Act Rule
15Fh-6 imposes pay-to-play restrictions on SBSDs (but not MSBSPs),
including similar restrictions on an SBSD engaging in SBS transactions
with a municipal entity within two years after specified types of
political contributions have been made to officials of the municipal
entity.\46\
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    \46\ See 17 CFR 240.15Fh-6; Business Conduct Standards Release,
supra note 8, at 30045-50.
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     FINRA Rule 2090 (Know Your Customer) generally requires
that each member use reasonable diligence to know and retain essential
facts concerning every customer and the authority of each person acting
on behalf of such customer. The SEC's business conduct rules for SBS
Entities include Exchange Act Rules 15Fh-3(a) and (e).\47\ Exchange Act
Rule 15Fh-3(a) generally requires SBS Entities to verify the status of
their SBS counterparties, including verification that the counterparty
is an ECP and whether the counterparty is a ``special entity.'' \48\
Exchange Act Rule 15Fh-3(e) requires each SBSD (but not MSBSP) to
establish, maintain and enforce written policies and procedures
reasonably designed to obtain and retain a record of the essential
facts concerning each counterparty whose identify is known to the SBSD
that are necessary for conducting business with such counterparty.
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    \47\ See 17 CFR 240.15Fh-3(a) and (e); Business Conduct
Standards Release, supra note 8, at 29978-80 and 29993-94.
    \48\ ``Special entity'' is defined in Exchange Act Rule 15Fh-
2(d) and includes certain government entities, employee benefit
plans and endowments. See 17 CFR 240.15Fh-2(d).
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     FINRA Rule 2111 (Suitability) is FINRA's suitability rule,
which generally requires a member or associated person to have a
reasonable basis that a recommended transaction or investment strategy
is suitable for the customer.\49\ The SEC's business conduct rules for
SBS Entities include Exchange Act Rules 15Fh-3(f) and 15Fh-5.\50\
Exchange Act Rule 15Fh-3(f) imposes similar suitability obligations on
SBSDs (but not MSBSPs) with respect to recommendations of SBS or
trading strategies.\51\ In addition, Exchange Act

Rule 15Fh-5 applies special, enhanced requirements when SBS Entities
act as counterparties to special entities.
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    \49\ Specifically, FINRA Rule 2111 is composed of three main
obligations: reasonable-basis suitability, customer-specific
suitability, and quantitative suitability. The reasonable-basis
obligation requires a member or associated person to have a
reasonable basis to believe, based on reasonable diligence, that the
recommendation is suitable for at least some investors. A member's
or associated person's reasonable diligence must provide the member
or associated person with an understanding of the potential risks
and rewards associated with the recommended security or strategy.
The customer-specific obligation requires that a member or
associated person have a reasonable basis to believe that the
recommendation is suitable for a particular customer based on that
customer's investment profile, with the ability to fulfill this
obligation for an institutional account if (i) the member or
associated person has a reasonable basis to believe that the
institutional customer is capable of evaluating investment risks
independently, both in general and with regard to particular
transactions and investment strategies involving a security or
securities, and (ii) the institutional customer affirmatively
indicates that it is exercising independent judgment in evaluating
the member's or associated person's recommendations. Quantitative
suitability requires a member or associated person to have a
reasonable basis for believing that a series of recommended
transactions, even if suitable when viewed in isolation, are not
excessive and unsuitable for the customer when taken together in
light of the customer's investment profile. See Supplementary
Material .05 to FINRA Rule 2111.
    \50\ See 17 CFR 240.Fh-3(f) and Fh-5; Business Conduct Standards
Release, supra note 8, at 29994-30000 and 30007-45.
    \51\ Specifically, Exchange Act Rule 15Fh-3(f)(1)(i) provides
that an SBSD that recommends an SBS or trading strategy involving an
SBS to a counterparty (other than an SBS Entity, swap dealer or
major swap participant) must undertake reasonable diligence to
understand the potential risks and rewards associated with the
recommended SBS or trading strategy involving an SBS. FINRA notes
that, as proposed, Exchange Act Rule 15Fh-3(f)(1)(i) would have
required an SBSD to have a reasonable basis to believe, based on
reasonable diligence, that the recommended SBS or trading strategy
is suitable for at least some counterparties (similar to FINRA Rule
2111's reasonable-basis obligation). See Business Conduct Standards
Release, supra note 8 at 29994. When adopting its final business
conduct rules, the SEC modified Exchange Act Rule 15Fh-3(f)(1)(i) to
``rephrase the suitability obligation . . . to make it consistent
with the CFTC's parallel suitability requirement in Commodity
Exchange Act Rule 23.434(a)(1), which explicitly requires [SBSDs] to
understand the risk-reward tradeoff of their recommendations.'' In
doing so, the SEC noted that the SEC's ``proposed formulation and
the CFTC's formulation would have achieved the same purpose.'' See
id. at 29996. The SEC also noted that the ``new formulation is also
consistent with FINRA's approach to this aspect of suitability
[i.e., the reasonable-basis obligation as described in Supplementary
Material .05(a) to FINRA Rule 2111].'' See id. at 29996 n.493. As
with the reasonable-basis obligation in FINRA Rule 2111, SBSDs ``are
always required to meet their suitability obligation in [Exchange
Act] Rule 15Fh-3(f)(1)(i), regardless of whether they avail
themselves of the institutional suitability alternative to meet
their customer-specific obligations.'' See id. at 29997.
    In addition, Exchange Act Rule 15Fh-3(f)(1)(ii) requires the
SBSD to have a reasonable basis to believe that a recommended SBS or
trading strategy involving an SBS is suitable for the counterparty
(similar to FINRA Rule 2111's customer-specific obligation). Also
similar to the institutional account alternative in FINRA Rule 2111,
an SBSD may fulfill its obligations under Exchange Act Rule 15Fh-
3(f)(1)(ii) with respect to an institutional counterparty if it
complies with specified conditions, including reasonably determining
that the counterparty or its agent is capable of independently
evaluating investment risks with regard to the relevant SBS or
trading strategy involving an SBS and that the counterparty or its
agent affirmatively represents in writing that it is exercising
independent judgment in evaluating the recommendations of the SBSD
with regard to the relevant SBS or trading strategy involving an
SBS. See Exchange Act Rules 15Fh-3(f)(2) and (3).
    FINRA acknowledges that the SEC's suitability rule differs in
some respects from FINRA's suitability requirements under FINRA Rule
2111. For example, Exchange Act Rule 15F-3(f) does not explicitly
include a quantitative suitability obligation. However, FINRA
believes that, while not identical, Exchange Act Rule 15Fh-3(f)
serves similar purposes to FINRA Rule 2111, such that requiring
members that are SBSDs to also comply with FINRA Rule 2111 in
circumstances where Exchange Act Rule 15Fh-3(f) applies would be
unnecessarily duplicative.
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    Proposed FINRA Rule 0180(f) would provide that FINRA Rules 2231
(Customer Account Statements) and 4512 (Customer Account Information)
shall not apply to members' activities and positions with respect to
SBS, to the extent that the member is acting in its capacity as an SBS
Entity and the customer's account solely holds SBS and collateral
posted as margin in connection with such SBS, provided that the member
complies with the portfolio reconciliation requirements of Exchange Act
Rule 15Fi-3 with respect to such account and that such portfolio
reconciliations include collateral posted as margin in connection with
SBS in the account. FINRA Rule 2231 generally requires each member to
provide, on at least a quarterly basis, an account statement to each
customer containing a description of any securities positions, money
balances or account activity during the period since the last customer
account statement. FINRA Rule 4512 generally requires each member to
maintain specified information for each customer account, including
specified identifying information about the customer.
    FINRA believes that the customer account statements required under
FINRA Rule 2231 generally should reflect a holistic view of a member's
relationship with its customer, including SBS transactions, positions
and related collateral, if applicable. Therefore, to the extent that a
customer's account includes SBS along with other securities positions
or activity, or related money balances, then FINRA believes that the
account statement under FINRA Rule 2231 should include SBS. However,
FINRA understands that members that are also registered SBS Entities
may have customer accounts that hold solely SBS and related collateral,
and do not hold any other securities positions or have any other
securities activity. While SBS Entities are not subject to a customer
account statement requirement with respect to SBS, the SEC's risk
mitigation requirements for SBS Entities include Exchange Act Rule
15Fi-3, which requires SBS Entities to engage in portfolio
reconciliation with their counterparties.\52\ Exchange Act Rule 15Fi-
3(a) generally requires SBS Entities to engage in portfolio
reconciliation for all SBS with their SBS Entity counterparties, with
the frequency of such portfolio reconciliations ranging from once each
business day (for SBS portfolios that include 500 or more SBS), to once
each week (for SBS portfolios that include more than 50 but fewer than
500 SBS on any business day during the week), to once each calendar
quarter (for SBS portfolios that include no more than 50 SBS at any
time during the calendar quarter).\53\ Exchange Act Rule 15Fi-3(b)
requires each SBS Entity to establish, maintain, and follow written
policies and procedures reasonably designed to ensure that it engages
in portfolio reconciliation for all SBS with non-SBS Entity
counterparties, with the frequency of such portfolio reconciliations
ranging from once each calendar quarter (for SBS portfolios that
include more than 100 SBS at any time during the calendar quarter) to
once annually (for SBS portfolios that include no more than 100 SBS at
any time during the calendar year).\54\
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    \52\ See 17 CFR 240.15Fi-3; Risk Mitigation Release, supra note
8, at 6362-70. For purposes of Exchange Act Rule 15Fi-3, ``portfolio
reconciliation'' is defined as any process by which counterparties
to one or more SBS (1) exchange the material terms of all SBS in the
SBS portfolio between the counterparties, (2) exchange each
counterparty's valuation of each SBS in the SBS portfolio between
the counterparties as of the close of business on the immediately
preceding day and (3) resolve any discrepancy in valuations or
material terms. See 17 CFR 240.15Fi-1(l).
    \53\ See 17 CFR 240.15Fi-3(a).
    \54\ See 17 CFR 240.15Fi-3(b).
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    FINRA acknowledges that the SEC's SBS portfolio reconciliation rule
differs in some respects from the customer account statement
requirements under FINRA Rule 2231. For example, the frequency of
portfolio reconciliations varies as described above, while customer
account statements must be delivered at least quarterly. In addition,
as described above, an SBS entity must have policies and procedures in
place to ensure that it engages in portfolio reconciliation with non-
SBS Entity counterparties, while a member must provide a customer
account statement to each customer unless a specific exception under
FINRA Rule 2231(b) applies. However, FINRA believes that, while not
identical, Exchange Act Rule 15Fi-3 serves similar purposes to FINRA
Rule 2231, such that requiring members that are SBS Entities to also
provide customer account statements for accounts holding solely SBS and
related collateral would be unnecessarily duplicative. Accordingly, to
promote regulatory clarity and avoid unnecessary duplication, proposed
FINRA Rule 0180(f) would provide an exception from FINRA Rule 2231 in
the limited circumstances where the member is acting in its capacity as
an SBS Entity and the account solely holds SBS and collateral posted as
margin in connection with such SBS. FINRA notes that collateral in a
customer's account would be included in account statements provided
under FINRA Rule 2231. The proposed rule change therefore includes as a
condition to the proposed exception that the member comply with
Exchange Act Rule 15Fi-3 with respect to an account qualifying for the
exception and include collateral in the portfolio reconciliation and
dispute resolutions requirements as applied to such an account.
    The SEC's risk mitigation requirements for SBS also include
Exchange Act Rule 15Fi-5, which requires SBS Entities to have in place
SBS trading relationship documentation with their SBS counterparties,
including all terms governing the trading relationship between the SBS
and its counterparty.\55\ In addition, SBS Entities that are also
registered broker-dealers are subject to the SEC's recordkeeping
requirements under Exchange Act Rule

17a-3, which require, among other things, certain records to be kept
for each SBS account.\56\ These SEC rules generally require SBS
Entities to obtain and keep records of certain information in
connection with their SBS accounts, including SBS-specific identifying
information. FINRA believes that, while not identical to FINRA Rule
4512, these SEC rules serve similar purposes, and that also applying
FINRA Rule 4512 to SBS-only accounts would be duplicative. Accordingly,
in order to promote regulatory clarity and avoid unnecessary
duplication, FINRA believes it is appropriate to provide an exception
from FINRA Rule 4512 in the limited circumstances where the member is
acting in its capacity as an SBS Entity and the account solely holds
SBS and collateral posted as margin in connection with such SBS. Both
exceptions under proposed FINRA Rule 0180(f) would not apply to
accounts holding SBS together with other securities or to members that
are not also registered SBS Entities.
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    \55\ See 17 CFR 240.15Fi-5; Risk Mitigation Release, supra note
8, at 6372-6377. SEC rules also require SBS Entities to maintain
records of SBS trading relationship documentation. See 17 CFR 17a-
4(e)(12)(ii).
    \56\ See 17 CFR 240.17a-3; see generally Recordkeeping Release,
supra note 8. FINRA notes in particular Exchange Act Rule 17a-
3(a)(9)(iv), which requires an SBS Entity to keep a record, for each
SBS account, of the unique identification code of the counterparty,
the name and address of the counterparty, and a record of the
authorization of each person the counterparty has granted authority
to transact business in the SBS account. See 17 CFR 240.17a-
3(a)(9)(iv).
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    Finally, proposed FINRA Rule 0180(g) would provide that persons
associated with a member whose functions are related solely and
exclusively to SBS undertaken in such person's capacity as an
associated person of an SBS Entity are not required to be registered
with FINRA.\57\ Generally, FINRA Rule 1210 requires that each person
engaged in the investment banking or securities business of a member
must be registered with FINRA as a representative or principal in each
category of registration appropriate to his or her functions and
responsibilities as specified in FINRA Rule 1220. Individuals seeking
to become registered with FINRA generally must pass an appropriate
qualification examination, and registered individuals are subject to
continuing education (``CE'') requirements under FINRA Rule 1240. These
registration, licensing and CE requirements would generally apply to
associated persons of a member engaged in SBS activities due to the
change to the definition of ``security'' to encompass SBS. Accordingly,
FINRA believes that associated persons of a member who are engaged in
SBS activities generally should be registered--and subject to
accompanying licensing and CE requirements--as appropriate based on the
scope of their activities (e.g., Series 7 for general SBS activities,
Series 24 for SBS principals, etc.). However, FINRA understands that
members that are also registered SBS Entities may in some limited
circumstances have an associated person whose securities-related
activities relate solely and exclusively to transactions conducted in
the individual's capacity as an associated person of the SBS Entity.
Such individuals engage solely in SBS activities on behalf of the SBS
Entity (and potentially non-securities activities, such as swaps), but
do not engage in any other securities activities that would require
registration under FINRA Rule 1210.
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    \57\ This exception is structured similarly to existing
exceptions from registration for persons associated with a member
whose functions are related solely and exclusively to certain other
product types (such as municipal securities, commodities or security
futures), as found in FINRA Rule 1230.
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    FINRA's current registration, licensing and CE requirements are not
specifically tailored to SBS. To reduce unnecessary regulatory burdens,
FINRA therefore believes it is appropriate for the proposed rule change
to provide an exception at the current time from these requirements in
the limited circumstances where an associated person of a member is
engaged solely and exclusively in SBS activities in his or her capacity
as an associated person of an SBS Entity. Under this proposed
exception, such persons would not be required to register with FINRA,
and therefore would not be required to pass any qualification
examinations or become subject to CE requirements under FINRA Rule
1240. This proposed exception is based on FINRA's analysis of its
existing registration and related requirements, and its understanding
that the number of such associated persons is limited. FINRA will
monitor developments with respect to the SBS activities of its members
and will continue to consider whether it would be appropriate to tailor
the registration and related requirements to SBS, for example through
targeted SBS-related registration categories or the addition of SBS-
specific content to qualification examinations or CE content. FINRA
will consider whether it would be appropriate to rescind the exception
under proposed FINRA Rule 0180(g) in such circumstances. The exception
under proposed FINRA Rule 0180(g) would not apply to associated persons
of a member engaged in any other securities activities or to associated
persons of members that are not also registered SBS Entities.\58\ FINRA
also notes that, although individuals qualifying for the proposed
exception would not be required to register with FINRA (and therefore a
member firm would not be required to file a Form U4 on behalf of such
individuals), they would remain associated persons of the member
subject to all FINRA and SEC rules applicable to such associated
persons, including fingerprinting requirements under Exchange Act Rule
17f-2.\59\
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    \58\ FINRA notes that associated persons of SBS Entities are not
independently subject to registration, licensing or CE requirements.
However, an SBS Entity is prohibited from permitting an associated
person that is subject to a statutory disqualification to effect or
be involved in effecting SBS on behalf of the SBS Entity. See 15
U.S.C. 78o-10(b)(6). The SEC's SBS Entity registration rules also
require an SBS Entity to certify that it neither knows, nor in the
exercise of reasonable care should have known, of any such statutory
disqualification. Such certifications must be supported by
questionnaires or employment applications serving as the basis for
background checks. See 17 CFR 240.15Fb6-2; Registration Process
Release, supra note 8, at 48973-79.
    \59\ See 17 CFR 240.17F-2.
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Exceptions in Connection With the SEC's Cross-Border Exception
    In connection with finalizing the Title VII rulemakings, the SEC
also adopted a number of rules and provided guidance to address the
cross-border application of various SBS requirements. One of these
rules, Exchange Act Rule 3a71-3(d), provides a conditional exception to
the provisions of Exchange Act Rule 3a71-3 that otherwise would require
non-U.S. persons to count--against the thresholds associated with the
de minimis exception to the SBSD definition--SBS dealing transactions
with non-U.S. counterparties when U.S. personnel arrange, negotiate or
execute those transactions.\60\ To qualify for this exception, all such
arranging, negotiating or executing activity must be conducted by U.S.
personnel in their capacity as persons associated with a registered
broker-dealer or a registered SBSD that is a majority-owned affiliate
of the non-U.S. person relying on the exception (the ``U.S. Registered
Affiliate'').\61\ Further, to qualify for the exception, the U.S.
Registered Affiliate must comply with specified SBS Entity rules with
respect to such SBS transactions as if the counterparties to the non-
U.S. person relying on the exception also were counterparties to the
U.S. Registered Affiliate and as if the U.S. Registered Affiliate were
registered as an SBSD, if not so registered.\62\ The

specified SBS Entity rules under this exception are Exchange Act Rule
15Fh-3(b) (disclosures of material risks and characteristics and
material incentives or conflicts of interest), Exchange Act Rule 15Fh-
3(f)(1) (recommendations and suitability), Exchange Act Rule 15Fh-3(g)
(fair and balanced communications) and Exchange Act Rule 15Fi-2
(acknowledgement and verification of SBS transactions).\63\
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    \60\ See 17 CFR 240.3a71-3(d); Cross-Border Release, supra note
8, at 6276-92.
    \61\ See 17 CFR 240.3a71-3(d)(1)(i).
    \62\ See 17 CFR 240.3a71-3(d)(1)(ii)(A).
    \63\ See 17 CFR 240.3a71-3(d)(1)(ii)(B).
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    Where a member is acting as the U.S. Registered Affiliate for a
foreign affiliate pursuant to the exception in Exchange Act Rule 3a71-
3(d), the member would be required to comply with the SEC's SBS Entity
rules noted above. The consequence of the member not complying with
these rules is that the member's foreign affiliate would be required to
count such SBS toward its de minimis SBSD registration threshold. In
these circumstances, FINRA believes it is appropriate to provide
exceptions from the parallel FINRA rules to provide clarity and avoid
unnecessary regulatory duplication, but only where the member is in
fact complying with the specified SEC rules. Specifically, proposed
FINRA Rule 0180(e) would provide that the following rules shall not
apply to members' activities and positions with respect to SBS, to the
extent that the member or the associated person of the member, as
applicable, is arranging, negotiating or executing SBS on behalf of a
non-U.S. affiliate pursuant to, and in compliance with the conditions
of, the exception from counting certain SBS under Exchange Act Rule
3a71-3(d)(1): (1) FINRA Rule 2111 (Suitability); (2) FINRA Rule 2210(d)
(Communications with the Public--Content Standards); and (3) FINRA Rule
2232 (Customer Confirmations).\64\ As noted above, the availability of
the exceptions under proposed FINRA Rule 0180(e) would be conditioned
on the member's compliance with the rules specified in Exchange Act
Rule 3a71-3(d)(1)(ii)(B) as if the member were the counterparty to the
SBS transactions.\65\
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    \64\ FINRA believes these proposed exceptions are appropriate
for similar reasons as the proposed exceptions for SBS Entities in
proposed FINRA Rules 0180(c) and (d). See supra notes 40 through 44
and 49 through 51 and accompanying text.
    \65\ A member acting as the U.S. Registered Affiliate under
Exchange Act Rule 3a71-3(d) would remain subject to all other FINRA
rules applicable to such SBS brokerage activity. See supra note 37.
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Exemptive Authority
    As discussed above, in formulating the proposed rule change, FINRA
consulted with its members and reviewed its rulebook to determine
whether continuing exceptions from any of its rules are appropriate.
FINRA recognizes, however, that the SBS market continues to evolve and
that particular circumstances may arise in which applying specific
FINRA rules not otherwise covered by the proposed exceptions to SBS
activities may not be appropriate or feasible. Therefore, proposed
FINRA Rule 0180(i) would provide that, pursuant to the FINRA Rule 9600
Series, FINRA may, taking into consideration all relevant factors,
exempt a person unconditionally or on specified terms from the
application of FINRA rules (other than an exemption from the general
application of paragraph (a) of proposed FINRA Rule 0180) to the
person's SBS activities or positions as it deems appropriate consistent
with the protection of investors and the public interest. Under this
proposed provision, FINRA would consider written applications for
exemptive relief pursuant to FINRA Rule 9610 from the application of
specific rules to a member's SBS activities or positions. Such
applications would be required to address the need for exemptive relief
from specific FINRA rules on a rule-by-rule basis, and FINRA would not
provide exemptive relief from the application of FINRA rules generally
to a member's SBS activities or positions. Therefore, proposed FINRA
Rule 0180(i) would not provide for exemptive authority from the general
application of FINRA rules to SBS under proposed FINRA Rule 0180(a).
Pursuant to FINRA Rule 9620, FINRA would consider such an application
and issue a written decision to the requesting member, which may be
made publicly available.\66\ A member would have the ability to appeal
such a decision pursuant to FINRA Rule 9630. FINRA believes it is
appropriate and in the public interest to provide this exemptive
authority so that FINRA can account for specific situations that may
arise with respect to SBS in the future on a case-by-case basis.
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    \66\ FINRA would consider any such application based on the
specific circumstances described in the application and whether the
requested exemptive relief would be consistent with the protection
of investors and the public interest. FINRA expects that it would
apply heightened scrutiny to applications for exemptive relief from
members that are not also registered with the SEC as SBS Entities,
and therefore not subject to the SEC's regulatory framework for SBS.
---------------------------------------------------------------------------

    FINRA also is proposing a conforming change to FINRA Rule 9610 to
add FINRA Rule 0180 to the list of rules pursuant to which FINRA has
exemptive authority.
Financial Responsibility and Operational Requirements
    In June 2019, the Commission adopted final capital, margin and
segregation requirements for SBS Entities, along with amendments to the
existing capital and segregation requirements for broker-dealers, in
the Capital, Margin, and Segregation Release. As with many of its other
Title VII rulemakings, the SEC aligned the compliance date for the
amendments under the Capital, Margin, and Segregation Release with the
Registration Compliance Date.\67\ Among other things, the Capital,
Margin, and Segregation Release amended the existing net capital rule
for broker-dealers, Exchange Act Rule 15c3-1,\68\ in two key respects
relevant to FINRA's rules:
---------------------------------------------------------------------------

    \67\ See Capital, Margin, and Segregation Release, supra note 8,
at 43954.
    \68\ 17 CFR 240.15c3-1.
---------------------------------------------------------------------------

     First, the SEC adopted new minimum net capital
requirements for broker-dealers that are also registered as SBSDs, but
that do not operate pursuant to the alternative net capital (``ANC'')
requirements of Exchange Act Rule 15c3-1 (``Non-ANC Firms'').\69\ Non-
ANC Firms that are also registered as SBSDs will need to comply with a
new minimum dollar net capital requirement and a new component for
determining their minimum capital requirement that is based on a
percentage of initial margin computed for SBS (in addition to other
minimum requirements applicable to the broker-dealer).\70\ These
changes do not apply to broker-dealers that operate pursuant to the ANC
requirements of the rule (``ANC Firms''). These new minimum net capital
requirements also will not impact Non-ANC Firms that are not also
registered as SBSDs, regardless of whether such Non-ANC Firms engage in
SBS activities.\71\
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    \69\ Generally, a broker-dealer may apply to the SEC for
authorization to use the alternative method for computing net
capital contained in Appendix E to Exchange Act Rule 15c3-1. See 17
CFR 240.15c3-1(a)(7). Such broker-dealers are known as ``ANC broker-
dealers.'' There are currently five approved ANC broker-dealers. See
SEC, Broker-Dealers Using the Alternative Net Capital Computation
under Appendix E to Rule 15c3-1, https://www.sec.gov/tm/broker-dealers-alternative-net-capital-computation. Other broker-dealers
are known as non-ANC broker-dealers and must compute net capital
pursuant to the provisions of Exchange Act Rule 15c3-1.
    \70\ See 17 CFR. 240.15c3-1(a)(10).
    \71\ For example, the new minimum net capital requirements do
not apply to a Non-ANC Firm engaged in SBS dealing activity below
the de minimis threshold for SBSD registration, or to a Non-ANC Firm
engaged in SBS brokerage activity or entering into non-dealing SBS
transactions (e.g., hedging). FINRA notes that the SEC also adopted
new minimum capital requirements for MSBSPs, including that such
entities must at all times have and maintain a tangible net worth.
See Capital, Margin, and Segregation Release, supra note 8, at
43906-07. FINRA does not believe any changes to FINRA rules are
necessary with respect to the new MSBSP capital requirements.

---------------------------------------------------------------------------

     Second, the SEC changed the minimum net capital
requirements for ANC Firms, regardless of whether they transact in SBS.
For ANC Firms, the SEC increased the minimum dollar net capital
requirement, added a new component for determining the minimum capital
requirement that is based on a percentage of initial margin computed
for SBS (in addition to other minimum requirements applicable to the
broker-dealer), increased the minimum tentative net capital requirement
and amended the early warning notification requirement for tentative
net capital.\72\
---------------------------------------------------------------------------

    \72\ See 17 CFR 240.15c3-1(a)(7). The compliance date for the
amended minimum net capital requirements for all ANC Firms is the
Registration Compliance Date, i.e., October 6, 2021.
---------------------------------------------------------------------------

    FINRA Rule 4120 (Regulatory Notification and Business Curtailment)
sets forth certain early warning notification and business curtailment
requirements if a member's capital falls below certain thresholds.
Specifically, FINRA Rule 4120(a) requires each carrying or clearing
member to notify FINRA if its net capital falls below certain specified
levels.\73\ FINRA Rule 4120(b) allows FINRA to restrict a member from
expanding its business in certain circumstances and FINRA Rule 4120(c)
allows FINRA to require a member to reduce its business if its net
capital falls below certain specified levels (generally lower than
those required for notification under FINRA Rule 4120(a)). These
requirements are based on the minimum capital requirements applicable
to a member broker-dealer under Exchange Act Rule 15c3-1. FINRA
believes it is necessary to amend FINRA Rule 4120 to conform the rule
to the new and increased minimum capital requirements for Non-ANC Firms
that are also registered as SBSDs and for ANC Firms, as described
above.\74\
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    \73\ As discussed below, FINRA is also proposing to apply all
requirements in the FINRA Rule 4000 Series applicable to carrying or
clearing firms to members that act as principal counterparty to an
SBS, clear or carry an SBS, guarantee an SBS or otherwise have
financial exposure to an SBS.
    \74\ As noted above, the SEC did not amend Exchange Act Rule
15c3-1 to apply increased minimum capital requirements to Non-ANC
Firms that engage in SBS activities but that are not registered
SBSDs. FINRA is therefore not proposing to amend FINRA Rule 4120 to
impose any additional minimum thresholds on such members. However,
FINRA notes that, as a general matter, FINRA Rule 4120 would apply
to all members that engage in SBS transactions (and any related
transactions) because net capital is a holistic calculation based on
a firm's liquid net worth, which includes all of a firm's
activities.
---------------------------------------------------------------------------

    FINRA Rule 4120(a) requires each carrying or clearing firm to
promptly, but in any event within 24 hours, notify FINRA in writing if
its net capital falls below any of the percentages specified in
subparagraphs (A) through (F) of FINRA Rule 4120(a)(1). The proposed
rule change would modify subparagraph (D), which applies to ANC Firms,
and also add new subparagraph (E), applicable to Non-ANC Firm members
that are also registered SBSDs.\75\
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    \75\ The proposed rule change would also make non-substantive
and conforming changes to other subparagraphs of FINRA Rule 4120(a)
to reflect the insertion of new subparagraph (E), update cross-
references to SEC rules that have been amended and reflect FINRA
rulebook format conventions.
---------------------------------------------------------------------------

    Existing Exchange Act Rule 15c3-1(a)(7)(i) requires an ANC Firm to
maintain minimum tentative net capital of not less than $1 billion and
minimum net capital of not less than $500 million. In addition,
existing Exchange Act Rule 15c3-1(a)(7)(ii) requires an ANC Firm to
provide an ``early warning'' notice to the SEC when its tentative net
capital falls below $5 billion (or a lower threshold if the SEC has
granted an ANC Firm's application to use such lower threshold).
Subparagraph (D) of FINRA Rule 4120(a) is based on these net capital
requirements, requiring notification to FINRA if the member is an ANC
Firm and (i) its tentative net capital under Exchange Act Rule 15c3-
1(c)(15) is less than 50 percent of the early warning notification
amount required by Exchange Act Rule 15c3-1(a)(7)(ii) or (ii) its net
capital is less than $1.25 billion. In other words, notification to
FINRA is required if an ANC Firm's tentative net capital falls below
$2.5 billion (or a lower amount, if the ANC Firm has been permitted to
use a lower early warning notice threshold), which is half of the SEC's
early warning notification amount, or its net capital falls below $1.25
billion, which is 2.5 times the SEC's net capital requirement for ANC
Firms.
    In the Capital, Margin, and Segregation Release, the SEC amended
the net capital requirements for ANC Firms in three ways. First, the
SEC raised the tentative net capital requirement for ANC Firms from $1
billion to $5 billion. Second, the SEC raised the minimum net capital
requirement for ANC Firms from $500 million to the greater of $1
billion or the sum of the applicable ratio requirement under Exchange
Act Rule 15c3-1(a)(1) \76\ and two percent of the risk margin
amount.\77\ Third, the SEC raised the tentative net capital early
warning notification threshold from $5 billion to $6 billion. In light
of these increased capital requirements under the SEC's net capital
rule, FINRA believes it is appropriate to also modify the thresholds
for required notification to FINRA for ANC Firms under FINRA Rule
4120(a)(1)(D). Specifically, under the proposed rule change, an ANC
Firm would be required to notify FINRA if, in addition to the
conditions currently prescribed under FINRA Rule 4120(a)(1)(A), (E) and
(F):
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    \76\ See 17 CFR 240.15c3-1(a)(7)(i)(A). Under Exchange Act Rule
15c3-1(a)(1)(i), a broker-dealer generally may not permit its
aggregate indebtedness to exceed 1500 percent of its net capital. A
broker-dealer may elect not to be subject to the aggregate
indebtedness standard if it complies with an alternative method of
computing net capital. See 17 CFR 240.15c3-1(a)(1)(ii).
    \77\ The ``risk margin amount'' means the total initial margin
for SBS. See 17 CFR 15c3-1(c)(17). Exchange Act Rule 15c3-
1(a)(7)(i)(A) provides that initially the requirement will be two
percent of the risk margin amount. However, the SEC may issue an
order raising the requirement to four percent on or after the third
anniversary of the amended rule's compliance date and to eight
percent on or after the fifth anniversary of the amended rule's
compliance date. See 17 CFR 15c3-1(a)(7)(i)(A)(2) and (3) and 15c3-
1(a)(7)(i)(B).
---------------------------------------------------------------------------

     Its tentative net capital is less than 150 percent of the
minimum tentative net capital amount required by Exchange Act Rule
15c3-1(a)(7)(i)(A) (i.e., $5 billion, such that the notification amount
would be $7.5 billion),
     the member is subject to the aggregate indebtedness
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital
is less than the sum of 1/10th of its aggregate indebtedness and 150
percent of the required percentage of the risk margin amount,\78\ or
---------------------------------------------------------------------------

    \78\ See supra note 77.
---------------------------------------------------------------------------

     the member elects to use the alternative method of
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii),
and its net capital is less than the sum of the level specified in
Exchange Act Rule 17a-11(b)(2) \79\ and 150 percent of the required
percentage of the risk margin amount.\80\
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    \79\ See 17 CFR 240.17a-11(b)(2). Exchange Act Rule 17a-11
requires broker-dealers to promptly notify the SEC after the
occurrence of certain events. Exchange Act Rule 17a-11(b)(2)
requires such notification for broker-dealers using the alternative
method of computing net capital pursuant to Exchange Act Rule 15c3-
1(a)(1)(ii) when net capital is less than five percent of aggregate
debit items under the Exchange Act Rule 15c3-3 reserve formula.
    \80\ See supra note 77.
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    FINRA believes these modified thresholds are appropriately
calibrated to provide FINRA with sufficient early warning that an ANC
Firm's capital levels may be deteriorating. By revising the early
warning levels as proposed, the proposed rule change aligns the
historical thresholds in FINRA Rule

4120(a) for early warning notification for ANC Firms with the revised
capital requirements applicable to such firms under the SEC's amended
rules. Additionally, ANC Firms historically maintain capital far in
excess of the proposed amounts, so FINRA does not expect these levels
to be problematic for firms to maintain.
    In the Capital, Margin, and Segregation Release, the SEC also added
a new minimum net capital requirement for Non-ANC Firms that are also
registered as SBSDs.\81\ Specifically, a Non-ANC Firm that is
registered as an SBSD must maintain minimum net capital of not less
than the greater of $20 million or the sum of the ratio requirements
under Exchange Act Rule 15c3-1(a)(1) \82\ and two percent of the risk
margin amount.\83\ Accordingly, FINRA believes it is necessary to add
corresponding new thresholds for required notification to FINRA for
Non-ANC Firms that are also registered SBSDs under new FINRA Rule
4120(a)(1)(E). Specifically, under the proposed rule change, a Non-ANC
Firm that is also a registered SBSD would be required to notify FINRA
if, in addition to the conditions currently prescribed under FINRA Rule
4120(a)(1)(A), (E) and (F):
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    \81\ See 17 CFR 15c3-1(a)(10).
    \82\ See supra note 76.
    \83\ See supra note 77.
---------------------------------------------------------------------------

     The member is subject to the aggregate indebtedness
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital
is less than the sum of 1/10th of its aggregate indebtedness and 150
percent of the required percentage of the risk margin amount,\84\ or
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    \84\ See supra note 77.
---------------------------------------------------------------------------

     the member elects to use the alternative method of
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii),
and its net capital is less than the sum of the level specified in
Exchange Act Rule 17a-11(b)(2) \85\ and 150 percent of the required
percentage of the risk margin amount.\86\
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    \85\ See supra note 79.
    \86\ See supra note 77.
---------------------------------------------------------------------------

    FINRA believes it is appropriate to include specific thresholds for
early notification to FINRA based on the new minimum net capital
requirements for Non-ANC Firms that are registered SBSDs. FINRA also
believes that the thresholds described above are appropriately
calibrated to provide FINRA with sufficient early warning that such a
firm's capital levels may be deteriorating. By defining the early
warning levels as proposed, the proposed rule change aligns the
historical thresholds in FINRA Rule 4120(a) for early warning
notification with the new capital requirements applicable to Non-ANC
Firms that are registered SBSDs under the SEC's amended rules.
    FINRA Rule 4120(b) allows FINRA to require a member that carries
customer accounts or clears transactions to not expand its business
during any period in which any of the conditions described in paragraph
(a)(1) of FINRA Rule 4120 continue to exist for more than 15
consecutive business days, provided that such condition(s) has been
known to FINRA or the member for at least five consecutive business
days. Since the proposed rule change would modify the conditions
specified in FINRA Rule 4120(a)(1) as described above, the triggers for
the application of restrictions under FINRA Rule 4120(b) would be
similarly affected. However, FINRA does not believe that any conforming
changes are needed at this time to the restrictions on business
expansion requirements under FINRA Rule 4120(b). FINRA notes that FINRA
Rule 4120(b)(3)(A)-(G) includes a non-exclusive list of activities that
may constitute an ``expansion of business'' for these purposes, and
FINRA Rule 4120(b)(3)(H) provides that the term ``expansion of
business'' may include such other activities as FINRA deems appropriate
under the circumstances, in the public interest or for the protection
of investors. FINRA believes that a member firm's SBS activities would
be within the scope of ``other activities'' contemplated by FINRA Rule
4120(b)(3)(H).
    FINRA Rule 4120(c) allows FINRA to require a member to reduce its
business if its net capital falls below any of the percentages
specified in subparagraphs (A) through (F) of FINRA Rule 4120(c)(1).
Similar to the proposed modifications to FINRA Rule 4120(a) described
above, the proposed rule change would modify subparagraph (D) of FINRA
Rule 4120(c)(1), which applies to ANC Firms, and also add new
subparagraph (E), applicable to Non-ANC Firm members that are also
registered SBSDs.\87\
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    \87\ The proposed rule change would also make non-substantive
and conforming changes to other subparagraphs of FINRA Rule
4120(c)(1) to reflect the insertion of new subparagraph (E), update
cross-references to SEC rules that have been amended and reflect
FINRA rulebook format conventions. Similar non-substantive changes
would be made to paragraph (b)(1) and Supplementary Material .01 to
FINRA Rule 4120 to reflect FINRA rulebook format conventions.
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    Current subparagraph (D) of FINRA Rule 4120(c)(1) permits business
curtailment if the member is an ANC Firm and (i) its tentative net
capital under Exchange Act Rule 15c3-1(c)(15) is less than 40 percent
of the early warning notification amount required by Exchange Act Rule
15c3-1(a)(7)(ii) or (ii) its net capital is less than $1 billion. These
thresholds are based on the current broker-dealer net capital rule. As
described above, the SEC amended the net capital requirements for
broker-dealers in the Capital, Margin, and Segregation Release.
Accordingly, under the proposed rule change, a member that is an ANC
Firm would be subject to the business curtailment provisions of FINRA
Rule 4120(c)(1) if, in addition to the conditions currently prescribed
under FINRA Rule 4120(c)(1)(A), (E) and (F):
     Its tentative net capital is less than the amount
specified under Exchange Act Rule 15c3-1(a)(7)(ii) (i.e., the early
warning amount, $6 billion),
     the member is subject to the aggregate indebtedness
requirement of Exchange Act Rule 15c3-1(a)(1)(i), and its net capital
is less than the sum of 1/12th of its aggregate indebtedness and 125
percent of the required percentage of the risk margin amount,\88\ or
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    \88\ See supra note 77.
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     the member elects to use the alternative method of
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii),
and its net capital is less than the sum of one percentage point below
the level specified in Exchange Act Rule 17a-11(b)(2) \89\ and 125
percent of the required percentage of the risk margin amount.\90\
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    \89\ See supra note 79.
    \90\ See supra note 77.
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    FINRA believes these modified thresholds are appropriately
calibrated to provide FINRA with the ability to require ANC Firms to
reduce their business when their capital levels have deteriorated to a
level that may jeopardize their ability to continue to comply with
their capital requirements.
    As described above, in the Capital, Margin, and Segregation
Release, the SEC also added a new minimum net capital requirement for
Non-ANC Firms that are also registered as SBSDs. Accordingly, the
proposed rule change would add corresponding new thresholds for
business curtailment for Non-ANC Firms that are also registered SBSDs
under new FINRA Rule 4120(c)(1)(E). Specifically, under the proposed
rule change, a Non-ANC Firm that is also a registered SBSD would be
subject to the business curtailment provisions of FINRA Rule 4120(c)(1)
if, in addition to the conditions currently prescribed under FINRA Rule
4120(c)(1)(A), (E) and (F):
     The member is subject to the aggregate indebtedness
requirement of

Exchange Act Rule 15c3-1(a)(1)(i), and its net capital is less than the
sum of 1/12th of its aggregate indebtedness and 125 percent of the
required percentage of the risk margin amount,\91\ or
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    \91\ See supra note 77.
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     the member elects to use the alternative method of
computing net capital pursuant to Exchange Act Rule 15c3-1(a)(1)(ii),
and its net capital is less than the sum of one percentage point below
the level specified in Exchange Act Rule 17a-11(b)(2) \92\ and 125
percent of the required percentage of the risk margin amount.\93\
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    \92\ See supra note 79.
    \93\ See supra note 77.
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    FINRA believes it is appropriate to include specific thresholds for
business curtailment based on the new minimum net capital requirements
for Non-ANC Firms that are registered SBSDs. FINRA also believes that
the thresholds described above are appropriately calibrated to provide
FINRA with the ability to require such firms to reduce their business
when their capital levels have deteriorated to a level that may
jeopardize their ability to continue to comply with their capital
requirements.
    Lastly, FINRA notes that FINRA Rule 4120(c)(3)(A)-(J) includes a
non-exclusive list of activities that may constitute a ``business
reduction'' for these purposes, and FINRA Rule 4120(c)(3)(K) provides
that the term ``business reduction'' may include such other activities
as FINRA deems appropriate under the circumstances, in the public
interest or for the protection of investors. FINRA believes that a
member firm's SBS activities would be within the scope of ``other
activities'' contemplated by FINRA Rule 4120(c)(3)(K).
    In addition to these conforming changes to FINRA Rule 4120, the
proposed rule change would apply FINRA's financial and operational
rules more broadly to firms that enter into, or otherwise have exposure
to, SBS. Specifically, certain rules in the FINRA Rule 4000 Series
(Financial and Operational Rules) include provisions that impose higher
standards, or provide FINRA the authority to impose additional
requirements, on firms that carry or clear transactions or accounts
(generally referred to as ``carrying or clearing firms''). This
``tiering'' structure was built into certain rules so that firms that
only introduce their customer accounts and do not have exposure to the
settlement system are provided relief from the higher standards
required of firms that carry or clear transactions and accounts. Below
is a list of rules in the FINRA Rule 4000 Series where tiering has been
employed for carrying or clearing firms and a brief description of the
tiered requirements for such firms:
     FINRA Rule 4110 (Capital Compliance) includes requirements
for carrying or clearing firms to keep greater net capital, seek
permission for withdrawals of capital and seek approval for certain
add-backs to net capital.
     FINRA Rule 4120 (Regulatory Notification and Business
Curtailment) includes restrictions on expanding, or requirements to
reduce business, if sufficient capital levels are not maintained.
     FINRA Rule 4521 (Notifications, Questionnaires and
Reports) allows FINRA to collect additional data and require reporting
of a material decline in tentative net capital.
     FINRA Rule 4522 (Periodic Security Counts, Verification
and Comparison) requires more frequent security counts, verifications
and comparisons than would be required under Exchange Act Rule 17a-
13.\94\
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    \94\ See 17 CFR 240.17a-13. Exchange Act Rule 17a-13 generally
requires broker-dealers to perform quarterly security counts.
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     FINRA Rule 4523 (Assignment of Responsibility for General
Ledger Accounts and Identification of Suspense Accounts) requires a
record of primary and supervisory named individuals over general ledger
bookkeeping accounts.
    The intent of the tiering employed in these rules in the FINRA Rule
4000 Series is to impose higher capital, recordkeeping and operational
standards on firms that carry or clear transactions and accounts, and
therefore may have financial exposure to customers, other broker-
dealers, central counterparties or others. FINRA believes that similar
considerations apply for members with exposure to SBS. SBS are complex
transactions that will, by their nature, require detailed
recordkeeping, margining, legal agreements, collateral management,
reconciliation and risk management. FINRA therefore believes it is
appropriate to also employ tiering in the FINRA Rule 4000 Series for
members that enter into SBS on a principal basis or otherwise have
financial exposure to SBS. Specifically, under the proposed rule
change, proposed FINRA Rule 0180(h) would provide that, for purposes of
the FINRA Rule 4000 Series, all requirements that apply to a member
that clears or carries customer accounts shall also apply to any member
that acts as a principal counterparty to an SBS, clears or carries an
SBS, guarantees an SBS or otherwise has financial exposure to an
SBS.\95\ FINRA believes that applying these higher standards when a
member enters into SBS or otherwise has exposure to SBS is appropriate
and consistent with the protection of investors and the public
interest.
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    \95\ Although this proposed tiering provision relates to the
financial responsibility and operational rules, FINRA believes it
should be included as a paragraph in proposed FINRA Rule 0180 so
that all provisions relating to the treatment of SBS under FINRA
rules are found in a single, consolidated rule.
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Margin Requirements
    As discussed above, in June 2019 the Commission adopted its final
Capital, Margin, and Segregation Release, with a compliance date
aligned with the Registration Compliance Date.\96\ Among other things,
the Capital, Margin, and Segregation Release adopted new Exchange Act
Rule 18a-3, which prescribes margin requirements for nonbank SBSDs with
respect to uncleared SBS.\97\ Generally, Exchange Act Rule 18a-3
requires a nonbank SBSD to calculate, for each account of an SBS
counterparty as of the close of business of each day: (i) The amount of
current exposure in the account (i.e., variation margin) and (ii) the
initial margin amount for the account.\98\ Under Exchange Act Rule 18a-
3, variation margin must be calculated by marking the position to
market, while initial margin must generally be calculated using
standardized haircuts, which are prescribed in Exchange Act Rule 15c3-1
for nonbank SBSDs that are registered broker-dealers.\99\ Nonbank SBSDs
may apply to the SEC for authorization to use models to calculate
initial margin instead of the standardized haircuts (including the
option to use the more risk sensitive methodology in Exchange Act Rule
15c3-1a), but nonbank SBSDs that are

registered broker-dealers must use standardized haircuts to calculate
initial margin for uncleared equity SBS.\100\ Based on these
calculations, Exchange Act Rule 18a-3 generally requires a nonbank SBSD
to collect and deliver variation margin, and to collect (but not
deliver) initial margin.\101\ Exchange Act Rule 18a-3 also provides
certain exceptions from the margin requirements, establishes thresholds
and minimum transfer amounts, specifies collateral requirements
(including collateral haircuts), establishes risk monitoring
requirements and includes other miscellaneous provisions, such as
definitions. All nonbank SBSDs, including nonbank SBSDs that are FINRA
members, will become subject to the margin requirements set forth in
Exchange Act Rule 18a-3 beginning on the Registration Compliance Date.
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    \96\ See Capital, Margin, and Segregation Release, supra note 8,
at 43954.
    \97\ See 17 CFR 240.18a-3. Exchange Act Rule 18a-3 also
prescribes margin requirements for nonbank MSBSPs with respect to
uncleared SBS. As discussed above, Exchange Act Rule 18a-3 generally
requires SBSDs to collect or deliver variation margin, and also to
collect initial margin, with respect to its SBS counterparties.
However, Exchange Act Rule 18a-3 requires that a nonbank MSBSP only
collect and deliver variation margin, without prescribing any
initial margin requirement. See Capital, Margin, and Segregation
Release, supra note 8, at 43877. As discussed below, FINRA believes
it is appropriate to apply variation margin and initial margin
requirements to all of its members that transact in uncleared SBS.
Therefore, proposed FINRA Rule 4240 would provide an exception for
members that are registered as SBSDs (and therefore subject to the
variation and initial margin requirements of Exchange Act Rule 18a-
3), but not for members that are registered as MSBSPs.
    \98\ See 17 CFR 240.18a-3(c)(1)(i); Capital, Margin, and
Segregation Release, supra note 8, at 43876.
    \99\ See 17 CFR 240.18a-3(d).
    \100\ See supra note 99; Capital, Margin, and Segregation
Release, supra note 8, at 43876.
    \101\ See 17 CFR 240.18a-3(c)(1)(ii).
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    The FINRA Rule 4200 Series sets forth margin requirements
applicable to FINRA members. In particular, FINRA Rule 4210 describes
the margin requirements that determine the amount of equity or
``margin'' customers are expected to maintain in their securities
accounts, including margin requirements for equity and fixed income
securities as well as options, warrants and security futures. Current
FINRA Rule 4240 separately establishes an interim pilot program with
respect to margin requirements for any transactions in CDS held in an
account at a member (the ``Interim Pilot Program''). Under current
FINRA Rule 0180, FINRA Rule 4210 does not apply to members' activities
and positions with respect to SBS, but current FINRA Rule 4240 does
apply to activities and positions within its scope. Therefore, to the
extent that a FINRA member enters into SBS that are CDS, the margin
requirements under the Interim Pilot Program apply to such SBS.\102\
However, the Interim Pilot Program is a temporary rule, and SBS that
are not CDS are not currently subject to any margin requirements under
FINRA rules.
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    \102\ For purposes of current FINRA Rule 4240, the term ``credit
default swap'' includes any product that is commonly known to the
trade as a ``credit default swap'' and is an SBS as defined pursuant
to Section 3(a)(68) of the Act or the rules and guidance of the SEC
and its staff. See FINRA Rule 4240(a).
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    The Interim Pilot Program was originally proposed by FINRA and
approved by the Commission in 2009 specifically to address concerns
arising from systemic risk posed by CDS.\103\ Pending the SEC's final
implementation of the Title VII rulemakings, FINRA has extended the
expiration date of the Interim Pilot Program a number of times, mostly
recently in June 2020.\104\ The Interim Pilot Program under current
FINRA Rule 4240 is currently set to expire on September 1, 2021, the
same date that current FINRA Rule 0180 is set to expire.\105\
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    \103\ See Securities Exchange Act Release No. 59955 (May 22,
2009), 74 FR 25586 (May 28, 2009) (Order Approving File No. SR-
FINRA-2009-012).
    \104\ See supra note 16.
    \105\ See supra note 18.
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    In light of the finalization of the SEC's margin requirements for
nonbank SBSDs under Exchange Act Rule 18a-3 and the upcoming
Registration Compliance Date, FINRA believes it is appropriate and in
the public interest for the Interim Pilot Program to expire and for
FINRA to adopt a new margin rule specifically applicable to SBS.\106\
Accordingly, under the proposed rule change, current FINRA Rule 4240
would be replaced by a new FINRA Rule 4240 on October 6, 2021 that
would prescribe margin requirements for SBS. Consistent with Exchange
Act Rule 18a-3--and unlike the Interim Pilot Program--proposed new Rule
4240 would apply margin requirements to all SBS, not just CDS. However,
proposed new FINRA Rule 4240 would not apply to any member that is
registered as an SBSD, as such members will be subject to the margin
requirements of Exchange Act Rule 18a-3 as summarized above.
Additionally, and consistent with the SEC's approach under the Act and
Exchange Act Rule 18a-3, proposed FINRA Rule 4240 would defer to
registered clearing agencies to set the margin requirements for cleared
SBS, and as such would only specify new variation margin and initial
margin requirements for uncleared SBS. Therefore, the specific new
margin requirements prescribed under proposed FINRA Rule 4240 would
only apply to uncleared SBS transacted by FINRA members that are not
registered SBSDs. FINRA believes that, by applying margin requirements
in these circumstances, the proposed rule change would fill an
important regulatory gap, protect FINRA members against counterparty
credit risk, maintain a level playing field for members and prevent
regulatory arbitrage. As described in further detail below, the margin
requirements under proposed FINRA Rule 4240 would be structurally
aligned with the margin requirements that will apply to nonbank SBSDs
under Exchange Act Rule 18a-3, with certain modifications that FINRA
believes are necessary given that such members will not be subject to
the SEC's comprehensive regulatory framework for SBSDs. Thus, subject
to certain exceptions described in the proposed rule, proposed FINRA
Rule 4240 would require members that are not SBSDs to collect and
deliver variation margin on a daily basis to cover the member's current
exposure to or from each uncleared SBS counterparty, and also to
collect (but not deliver) initial margin from each SBS counterparty.
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    \106\ FINRA notes that, under the proposed rule change, proposed
FINRA Rule 0180 would no longer provide an exception from current
FINRA Rule 4210 applying to members' activities and positions with
respect to SBS. Absent additional changes, therefore, the general
margin requirements under FINRA Rule 4210 would apply to SBS.
However, as described above, FINRA believes specifically listing SBS
within the exceptions listed in FINRA Rule 4210, and adopting a
separate, new FINRA Rule 4240 applicable to SBS, would promote legal
certainty and provide clarity to its members.
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    Proposed FINRA Rule 4240 is divided into a header followed by
paragraphs (a) through (d). The header would specify the scope of the
margin requirements under proposed FINRA Rule 4240. Paragraph (a) would
describe the margin requirements for cleared SBS. Paragraph (b) would
describe the margin requirements for uncleared SBS. Specifically,
paragraph (b)(1) would set forth how variation margin must be
calculated, paragraph (b)(2) would set forth how initial margin must be
calculated, paragraph (b)(3) would prescribe the collection and
delivery requirements for variation and initial margin, paragraph
(b)(4) would specify the manner and time of collection or delivery of
variation and initial margin, and paragraph (b)(5) would list certain
exceptions from the margin requirements. Paragraph (c) would require
members to employ specified risk monitoring procedures and guidelines
for uncleared SBS. Finally, paragraph (d) would define certain terms
used in proposed FINRA Rule 4240. Each of these aspects of the proposed
rule change is described in further detail below.
    Proposed FINRA Rule 4240 would be entitled ``Security-Based Swap
Margin Requirements.'' \107\ The header text to

the rule would state that each member that is a party to an SBS with a
customer, broker or dealer, or other Counterparty,\108\ or who has
guaranteed or otherwise become responsible for any other person's SBS
obligations, shall comply with the requirements of proposed FINRA Rule
4240, except that a member that is registered as an SBSD shall instead
comply with Exchange Act Rule 18a-3. This provision of the proposed
rule is intended to clarify that the margin requirements under proposed
FINRA Rule 4240 apply in all circumstances where a member is a party to
a SBS, regardless of the type of counterparty, and also where a member
has financial exposure to an SBS, whether through a guarantee or other
arrangements under which the member is responsible for another person's
SBS obligations. FINRA believes that this provision is necessary to
ensure that the proposed margin requirements adequately protect member
firms against counterparty credit risk, regardless of the specific
manner through which the member has become exposed to such risk.
Additionally, as discussed above, this provision clarifies that members
that are registered SBSDs are not subject to the proposed margin
requirements because they are instead required to comply with Exchange
Act Rule 18a-3. FINRA believes it should defer to the SEC's margin
framework for registered SBSDs rather than impose additional or
different requirements on such entities.
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    \107\ In addition to the new provisions under proposed FINRA
Rule 4240 discussed above, the implementation of new margin
requirements for SBS under proposed FINRA Rule 4240 will also
require a conforming change to FINRA Rule 4220 (Daily Record of
Required Margin). FINRA Rule 4220 requires each member carrying
securities margin accounts for customers to make a record each day
of every case in which initial or additional margin must be obtained
in a customer's account. To ensure that similar records are
maintained for SBS margin required under proposed new FINRA Rule
4240, the proposed rule change would update FINRA Rule 4220 to also
require such records for each member subject to proposed FINRA Rule
4240.
     In addition, the proposed rule change would add new
Supplementary Material .06 to FINRA Rule 4210 to clarify that a
Regulation T good faith account, other than a non-securities
account, is a margin account for purposes of FINRA Rule 4210. This
provision is intended merely to codify FINRA's existing
interpretation regarding the scope of FINRA Rule 4210. The proposed
rule change would also include a parallel provision in new
Supplementary Material .01 to proposed new Rule 4240.
     Finally, the proposed rule change would make two other
conforming changes to FINRA Rule 4210, including to add proposed new
FINRA Rule 4240(e)(9) and to make a technical adjustment to FINRA
Rule 4240(g)(2)(H). These proposed changes are discussed below.
    \108\ ``Counterparty'' would be defined under proposed FINRA
Rule 4240(d)(5) to mean a person with whom a member has entered into
an Uncleared SBS. An ``SBS'' would be defined in proposed FINRA Rule
4240(d)(16) by reference to the definition of ``security-based
swap'' under Section 3(a)(68) of the Act and ``Uncleared'' would be
defined in proposed FINRA Rule 4240(d)(18) as an SBS that is not
Cleared. Under proposed FINRA Rule 4240(d)(3), an SBS would be
considered Cleared if it is cleared through a Clearing Agency by or
on behalf of the member, and Clearing Agency would be defined under
proposed FINRA Rule 4240(4) as a clearing agency registered pursuant
to Section 17A of the Act or exempted by the SEC from such
registration by a rule or order pursuant to Section 17A of the Act.
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    Proposed FINRA Rule 4240(a), entitled ``Cleared SBS Margin
Requirements,'' would state that, except as provided in paragraph
(b)(5) (i.e., specified exceptions from proposed FINRA Rule 4240,
discussed below), the margin to be maintained on any Cleared SBS is the
margin on such Cleared SBS required by the Clearing Agency through
which such SBS is Cleared. As discussed above, this provision clarifies
that proposed FINRA Rule 4240 defers to registered clearing agencies to
set the margin requirements for cleared SBS. FINRA believes that it is
appropriate to defer to clearing agencies to establish margin
requirements for cleared SBS in light of the SEC's comprehensive
regulation of clearing agencies, including their required margin
levels, under the Act.
    Proposed FINRA Rule 4240(b), entitled ``Uncleared SBS Margin
Requirements,'' would set forth the substantive margin requirements
applicable to members that are not SBSDs when such members transact in
Uncleared SBS. Paragraph (b)(1), entitled ``Current Exposure
Calculation,'' would require that, as of the close of business of each
business day, the member calculate with respect to each Uncleared SBS
Account \109\ the Counterparty's Current Exposure to the member (if
positive) or the member's Current Exposure to the Counterparty (if
negative). Current Exposure would be calculated as an amount equal to
the net Value \110\ of all Uncleared SBS in the Uncleared SBS Account