Supervising representatives

Tape recording (FINRA Rule 3170)

FINRA Rule 3170 (the Taping Rule) requires certain firms that have hired a threshold number of registered persons from disciplined firms to tape-record their telemarketing and sales activities. The rule exists because a hiring firm has no easy way to know which individuals were involved in a prior firm’s misconduct or may have picked up improper habits there, so FINRA requires the firm to record and review all telephone conversations between its registered persons and both existing and potential customers, under special supervisory procedures kept in place for three years.

It is extremely unlikely that this will ever apply to your firms, but you are welcome to search for the FINRA disciplined firms, and you will find the short list of them.

A firm is a taping firm if enough of its registered persons have been associated with one or more disciplined firms within the last three years:

• If they have 5-9 registered persons, if 40% or more have been associated
• A member with 10-19, where four or more have been associated
• A member with at least 20, where 20% or more have been associated

Any firm designated as a taping firm must establish, maintain, and enforce procedures for supervising telemarketing activities within 60 days of receiving notice from FINRA or otherwise learning that it is a taping firm. It must keep the tapes for at least three years, the first two in an easily accessible place, and report to FINRA on its supervision of telemarketing every quarter. A firm that becomes a taping firm for the first time may instead reduce its staff below the threshold within 30 days of that notice or knowledge, after promptly notifying FINRA in writing, and anyone terminated to get below it can’t be rehired for 180 days. The option isn’t available to a firm that becomes a taping firm again.

Communicating with the public

Advertisements generally mean any material published concerning services or products offered by the broker, dealer, or municipal securities dealer, excluding official statements and preliminary official statements.

There are primarily 3 types of communications: retail communications, correspondence, and institutional communications. We will go into detail on them, and a little more specifics on technicalities with them.

• Retail communication is any written (including electronic) communication distributed or made available to more than 25 retail investors within any 30 calendar-day period. A retail investor is anyone who isn’t an institutional investor, whether or not they have an account with the firm. It must be approved by a principal before being sent to clients, with limited exceptions, such as a retail communication that makes no financial or investment recommendation and doesn’t promote the firm’s products or services, or a post on an online interactive forum; those are supervised and reviewed like correspondence instead.
• Correspondence is any written (including electronic) communication distributed or made available to 25 or fewer retail investors within any 30 calendar-day period - for example, a birthday card or a “thank you for the introduction” letter. Unlike retail communication, correspondence is spot-checked by a principal rather than approved in advance.
• Institutional communication is communication sent only to institutional investors. If the representative has a reasonable belief that the communication will be shown to retail investors, then it must be treated as retail communication, not institutional. Institutional investors include banks, savings and loan associations, insurance companies, registered investment companies, an IA registered with the SEC or a state, government entities and subdivisions, employee benefit plans and qualified plans with at least 100 participants (but not the plans’ individual participants), FINRA member firms and their registered persons, anyone acting solely on behalf of an institutional investor, or any other person (natural, corporate, partnership, etc.) with total assets of at least $50 million.
• Internal communications is not a form of advertisement, but it could be distractors on the test. Materials distributed only to employees aren’t covered by the communications rules, but they aren’t unsupervised: Rule 3110 requires a registered principal to review internal communications relating to the firm’s securities business, to catch anything whose subject matter requires review. If clients are expected to see them, then they must be treated as retail communications.
• A form letter is not one of FINRA’s types but an MSRB term: under MSRB Rule G-21, it is a written letter or email distributed to more than 25 persons within any 90 consecutive days - a different counting window from the 30-day period used for retail communication and correspondence.

Principal approval

Retail communication is approved by a principal before clients see it. Some retail communications must also be filed with FINRA. Filing is not approval. FINRA’s Advertising Regulation Department reviews what is filed and can require changes, and a communication that must be filed before use is held back until they are made, but FINRA doesn’t approve communications. What must be filed, and when, depends on the type of communication and how long the firm has been a FINRA member.

• For an established firm, the communication is written, the principal approves it, and then they can send it to clients. Many retail communications never have to be filed. Certain types, such as those promoting a specific mutual fund or other registered investment company, or concerning public direct participation programs, must be filed with FINRA within 10 business days of first use. A few types, such as investment company performance rankings or comparisons that aren’t generally published, must be filed at least 10 business days before first use. Established firms are past their first year of FINRA membership.
• For a newly established firm, the communication is written and the principal approves it, but any retail communication published or used in public media, such as a website, newspaper, magazine, radio, television, or billboard, must be filed with FINRA at least 10 business days before first use. This pre-use filing requirement applies during the firm’s first year of FINRA membership.

Content standards for advertisements

All advertisements must be based on the principles of fair dealing and good faith, be fair and balanced, and provide a sound basis for evaluating the facts. We cannot omit material facts, primarily described as failing to state bad information that is important. The focus is on material fact, not simply any fact. In advertisements, there can also be no false or misleading claims. Footnotes and legends can be used, provided they are not placed in a way that inhibits the customer’s understanding. The broker-dealer must take into account the target audience and make it readable to them. Statements must be clear and not misleading. Advertisements may not predict performance; past performance is no guarantee of future results. Hypothetical illustrations of mathematical principles are allowed, provided they don’t predict or project performance. If a testimonial concerns a technical aspect of investing, the person making it must have the knowledge and experience to form a valid opinion. A retail communication or correspondence containing a testimonial must disclose that:

• Testimonials may not be representative,
• No guarantee of future performance, and
• If more than $100 was paid, it was a paid testimonial.

Beyond the three delivery-based categories above, communications are also classified by content. The following content-based types carry their own rules:

Professional advertisement means advertisement concerning facilities, services, or skills with respect to securities business of the advertising firm or a similar firm. No firm may publish one that contains any untrue statement of material fact or is otherwise false or misleading.

Product advertisement means any advertisement concerning one or more specific municipal securities products. Here the standard has a knowledge test the professional one lacks: no firm may publish one that it knows or has reason to know contains any untrue statement of material fact or is otherwise false or misleading.

Generic advertising is when a notice, circular, advertisement, or anything similar is published or sent to any person, but it doesn’t name the securities of a particular investment company, the investment company itself, or any other securities that aren’t exempt. It can explain investment companies in general, describe types of funds (growth funds, bond funds, no-load funds) or services that aren’t securities, and invite people to ask for more information - basically, letting people know that if they have questions about investing in funds, there are skilled and licensed people able to help. It has to carry the name and address of the broker-dealer sponsoring it. Generic, non-descript.

Research reports are written or electronic communications including an analysis of equity securities, individual companies, or industries, and provide information reasonably sufficient to base investment decisions. Their content must be approved by an appropriately registered principal: for equity research, a Research Principal or a Supervisory Analyst.

Public appearance is participating in a seminar, forum, radio or television interview, or other public speaking activity that is unscripted and isn’t a retail communication, institutional communication, or correspondence. A public appearance doesn’t need a principal’s approval beforehand. Instead, the person must follow the same fair and balanced content standards as any communication, must have a reasonable basis for any security they recommend and disclose any financial interest in it (unless nominal) or other material conflict, and the firm must have written procedures to supervise its associated persons’ public appearances.

Professional advertisements and product advertisements by municipal securities dealers fall under MSRB Rule G-21. The generic advertising described above comes from the SEC (Securities Act Rule 135a). Retail communication, correspondence, institutional communication, research reports, and public appearances fall under FINRA Rule 2210, and research reports are also governed by FINRA Rules 2241 (equity) and 2242 (debt).

Municipal fund securities must follow all of the standard municipal advertising rules, and some more specific rules. These are basically mutual funds, but they aren’t mutual funds, because they are municipal securities and therefore exempt. Municipal fund securities are those that would be investment companies if they weren’t municipals and exempt from being considered investment companies.

These will have an official statement, which contains the data and important disclosures. The dealer must deliver it to the customer by settlement of a sale, and unlike other new municipal issues, posting it on EMMA doesn’t satisfy that. For additional purchases under a plan or program, delivery is satisfied if the customer already received the official statement and the dealer promptly sends any new or amended one. An advertisement that includes performance data must carry a legend that the data represents past performance and that past performance does not guarantee future results.