Chapter 9 - § 9.3 • BROKER-DEALER REGULATION
| Jurisdiction | Colorado |
§ 9.3.1—Overview
Once registered, the broker-dealer becomes subject to stringent regulations by the SEC and the FINRA. Included among numerous and complex rules to which brokers and dealers become subject upon registration is the "net capital rule," Rule 15c3-l. Under this rule, each registered broker-dealer must maintain at least a minimum required net capital. This is computed according to strict and complicated rules, and must be adequate on a daily basis. Even brokers who never receive customers' securities or funds are required to maintain specified minimum net capital.69
Each registered broker-dealer must do business in accordance with the FINRA's "Conduct Rules." As a result, under Rule 12201, members of the FINRA agree in advance to arbitration of a number of issues that they might rather argue in court, including those in connection with an underwriting.70 The "issuer" in a public offering has been held to be a "customer" of a member of the FINRA71 as is a person purchasing auction-facilitating services from a broker-dealer.72 The Fourth Circuit has held that a brokerage firm was subject to arbitration for advice given by a financial advisor in another firm where there was "extensive overlap" between the two entities.73
In actions to enjoin FINRA arbitration proceedings brought by purported "customers," courts have held that the term "customer" should be construed in a manner consistent with the "reasonable expectations" of FINRA members.74 Opening an account with a FINRA member and placing funds with the FINRA member for investment clearly constitutes a customer relationship subject to the arbitration rules if elected by the customer.75 There are many less-clear cases where purported customers have demanded FINRA arbitration over the objections of the FINRA member and the member has sued to enjoin the arbitration. For example, in Citigroup Global Mkts. v. Abbar, the court affirmed a permanent injunction holding that "a 'customer' under FINRA Rule 12200 is one who, while not a broker or a dealer, either (1) purchases a good or service from a FINRA member; or (2) has an account with a FINRA member."76 "When it is clear that no goods or services were provided by the FINRA member, 'there is no need to grapple with the precise boundaries of the FINRA meaning of 'customer' because 'no rational factfinder could infer' a customer relationship on such facts.'"77
In Scobee Combs Funeral Home, Inc. v. E.F. Hutton & Co.,78 the courts held that customers are intended to be third-party beneficiaries entitled to invoke the FINRA compulsory arbitration clause even in the absence of a specific written agreement between the company and the broker-dealer to do so. Then, in 2011, the Second Circuit decided that FINRA arbitrators should decide the enforceability of a forum selection clause in the parties' arbitration agreement.79
On the other hand, the Eighth Circuit has held that there must be a business relationship between the customer and the FINRA member related to the investment or brokerage services being challenged. In Berthel Fisher & Co. Financial Services, Inc. v. Larmon,80 disappointed investors sought arbitration against the broker-dealer that managed a placement of tenant-in-kind securities even though the investors had no contact with the broker-dealer but invested through selling-group members. The Eighth Circuit disagreed, finding that these investors were not "customers" of Berthel Fisher as defined in FINRA Rule 12200.81
The FINRA has a six-year statute of limitations on arbitration actions.82 This is a "procedural provision to be interpreted by the arbitrators rather than a substantive limitation on arbitrability to be interpreted by the court."83
Members of the FINRA must also undergo inspections by the SEC, the FINRA, and state regulatory bodies.
1934 Act § 15(c) provides severe restrictions on the ability of registered broker-dealers to extend credit to customers, and applies directly to the broker-dealers applicable regulations of the Board of Governors of the Federal Reserve. Not all securities are "marginable." 1934 Act § 15(d) provides that it is unlawful for any person other than a broker-dealer to lend money for the purchase of a security unless in compliance with the requirements of the Federal Reserve. This latter prohibition does not apply to credit extended, maintained, or arranged by a person not in the ordinary course of business, and in limited other cases.84
Registered representatives associated with the broker-dealers must also be licensed by the SEC, the FINRA, and the states. There are numerous exams that the registered representatives must pass to achieve various levels of responsibility in the brokerage organization. Broker-dealers and registered representatives are also subject to rules adopted by FINRA applicable to their conduct. For example, FINRA Rule 2010 (included in the transitional FINRA rulebook) requires "a member, in the conduct of its business [to] observe high standards of commercial honor and just and equitable principles of trade." Once associated with a broker-dealer, FINRA Rule 3040 prohibits a registered representative from engaging in securities transactions outside the broker-dealer without the specific consent of the broker-dealer.
§ 9.3.2—Operational Regulation Of Broker-Dealers
Broker-dealers have a great deal of regulation on their everyday methods of doing business and must comply with specific rules regarding trading in securities for their customers' accounts.
Before broker-dealers can make transactions in securities for their customers (except for certain "unsolicited transactions"), there must be adequate information about the security that is available to the public. For securities that are registered under the 1934 Act or are otherwise reporting under the 1934 Act, the reporting requirements satisfy the information requirements regardless of whether the broker-dealer actually has copies of the reports.
For securities that are not subject to the 1934 Act reporting requirements, the issuer can still make information available pursuant to Rule 15c2-11. 1934 Act Rule 15c2-11(a) provides:
As a means reasonably designed to prevent fraudulent, deceptive, or manipulative acts or practices, it shall be unlawful for a broker or dealer to publish any quotation for a security...
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