State Regulators Coalition Calls for Enhancements to Proposed Rule Changes
A coalition of state regulators is advocating for significant modifications to a proposed rule change from the Financial Industry Regulatory Authority (FINRA). This rule concerns the outside business activities of associated persons at broker-dealer firms and aims to address potential risks to investors. The North American Securities Administrators Association (NASAA) submitted a letter this week regarding FINRA’s Regulatory Notice 25-05, expressing multiple concerns about the scope of proposed Rule 3290, which seeks to consolidate existing rules 3270 and 3280 to simplify compliance for registered broker-dealer firms. While NASAA recognizes some improvements over an earlier draft from 2018, it believes that critical aspects of the new proposal may still diminish investor protections unless amended.
Concerns Over Narrow Definitions and Investor Protections
Among its recommendations, NASAA has urged FINRA to broaden the definition of “investment-related activity.” The organization argues that the current proposal overly simplifies broker-dealer oversight by limiting the types of outside activities considered. NASAA highlighted that the existing language could weaken investor safeguards by failing to encompass a variety of pertinent activities. The letter warns, “By overlooking these additional activities, there is a greater risk that firms will miss identifying threats posed by unchecked conflicts of interest, dubious compensation structures, and potential fraudulent or unregistered actions.”
Recommendation to Include Crypto and Alternative Investments
Citing concerns about fraud, hidden expenses, and historical instances of investor exploitation, NASAA has suggested that FINRA explicitly include activities tied to cryptocurrency assets. This recommendation comes on the heels of a March alert to investors regarding such assets, as well as collectibles like art, wine, whiskey, and other alternative investments encompassing real estate, commodities, and private funds. Furthermore, the letter pointed out that investments presented as loans or lending have previously resulted in severe harm to investors.
Highlighting the Evolution of Investment Products
NASAA underscored the changing dynamics of the investment landscape, particularly the increasing interest in alternative assets and innovative technologies. The organization specifically noted the burgeoning popularity of tokenized products and investment vehicles that may not fit neatly into traditional security classifications. It stressed the necessity of including particular types of entities and arrangements within the rule’s provisions, such as investment partnerships, cooperatives, and platforms related to cryptocurrencies. The letter emphasized that as tokenization and crypto assets gain mainstream acceptance, it becomes crucial for FINRA member firms to recognize that their relationships with diverse actors in the industry fall under the remit of proposed Rule 3290.
Opposition to Reductions in Oversight for Investment Advisers
NASAA reiterated its opposition to any diminishment of oversight regarding activities performed at unaffiliated investment advisers. The earlier 2018 proposal had suggested eliminating such obligations entirely. Although the latest draft maintains these requirements, FINRA is still soliciting feedback on whether to reduce them. NASAA cautioned that external advisory relationships could pose risks to investors, especially when such entities are lightly regulated or operate as small businesses.
Importance of Broker-Dealer Oversight and Recordkeeping
The organization stressed that state securities regulators lack access to the daily operations of brokers, a privilege that firms possess. To bolster its position, NASAA referenced past enforcement actions where misconduct related to private securities transactions or undisclosed advisory roles was uncovered due to broker-dealer supervision. Without adequate oversight and reporting at the firm level, such incidents may have remained unnoticed, according to NASAA. The group also highlighted the critical role of robust recordkeeping requirements, particularly when broker-dealer personnel engage in outside advisory activities. The records maintained by firms can be crucial for examinations and enforcement actions, even if they overlap with other documentation.
Call for Regulatory Efficiency and Stronger Investor Protections
While acknowledging FINRA’s efforts to strike a balance between investor protection and regulatory efficiency, NASAA urged the self-regulatory organization to enhance Rule 3290 to better reflect the contemporary realities of financial services and investor behavior. The letter concluded with a warning, stating, “The risk of fraud tends to escalate during times of economic uncertainty and market volatility.” It cautioned that if the proposed rule is not strengthened, it may create gaps in investor protections at a time when investors are particularly vulnerable.
