[Federal Register Volume 79, Number 43 (Wednesday, March 5, 2014)]
[Notices]
[Pages 12541-12545]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-04797]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-71629; File No. SR-FINRA-2013-039]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc; Notice of Filing of Amendment No. 1 to Proposed Rule
Change To Clarify the Classification and Reporting of Certain
Securities to FINRA
February 27, 2014.
I. Introduction
On September 16, 2013, the Financial Industry Regulatory Authority,
Inc. (``FINRA'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to clarify the classification and reporting of
certain securities to FINRA. The proposed rule change was published for
comment in the Federal Register on September 30, 2013.\3\ The
Commission received two comments on the proposal.\4\ On November 12,
2013, FINRA granted the Commission an extension of time to act on the
proposal until December 29, 2013.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 70482 (September 23,
2013), 78 FR 59995 (September 30, 2013) (``Notice'').
\4\ See Letters to the Commission from Sean Davy, Managing
Director, Capital Markets, SIFMA, dated October 21, 2013 (``SIFMA
Letter''); and Manisha Kimmel, Executive Director, Financial
Information Forum, dated October 31, 2013 (``FIF Letter'').
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On December 24, 2013, the Commission instituted proceedings to
determine whether to disapprove the proposed rule change.\5\ On
February 12, 2014, FINRA submitted Amendment No. 1 to respond to the
comment letters and amend the proposed rule change, as described below
in Item II, which Item has been prepared by FINRA. The Commission is
publishing this notice to solicit comment from interested persons on
the proposed rule change, as modified by Amendment No. 1.
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\5\ See Securities Exchange Act Release No. 71180 (December 24,
2013), 78 FR 79716 (December 31, 2013).
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II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change, as Modified by Amendment
No. 1
In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any
[[Page 12542]]
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
FINRA trade reporting rules generally require that members report
over-the-counter (``OTC'') transactions in debt securities that are
``TRACE-Eligible Securities'' \6\ and equity securities to FINRA.\7\
FINRA Rule 6622 (Transaction Reporting) requires that members report
OTC transactions in ``OTC Equity Securities'' \8\ to the ORF and the
FINRA Rule 6700 Series requires members to report transactions in
TRACE-Eligible Securities to TRACE.
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\6\ FINRA Rule 6710(a) defines ``TRACE-Eligible Security'' to
include ``a debt security that is United States (`U.S.') dollar-
denominated and issued by a U.S. or foreign private issuer, and, if
a `restricted security' as defined in Securities Act Rule 144(a)(3),
sold pursuant to Securities Act Rule 144A.''
\7\ See FINRA Rules 6282 (relating to the Alternative Display
Facility (``ADF'')), 6380A (relating to the FINRA/Nasdaq Trade
Reporting Facility), 6380B (relating to the FINRA/NYSE Trade
Reporting Facility), 6622 (relating to the OTC Reporting Facility
(``ORF'')) and 6730 (relating to the Trade Reporting and Compliance
Engine (``TRACE'')).
\8\ FINRA Rule 6420(f) defines ``OTC Equity Security'' to
include ``any equity security that is not an `NMS stock' as that
term is defined in Rule 600(b)(47) of SEC Regulation NMS; provided,
however, that the term `OTC Equity Security' shall not include any
Restricted Equity Security.'' FINRA Rule 6420(k) defines
``Restricted Equity Security'' to mean ``any equity security that
meets the definition of `restricted security' as contained in
Securities Act Rule 144(a)(3).''
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FINRA recently has received inquiries regarding the appropriate
classification of certain ``hybrid'' securities for trade reporting
purposes. FINRA is aware that as new securities are created and issued,
in some cases, the newer hybrid iteration, although derived from a
traditional security, may be increasingly complex, and may have both
debt and equity-like features. These hybrid securities are frequently
designed to straddle both classifications for a variety of purposes,
including the tax treatment applicable to issuers and recipients when
distributions are made (or not made) to holders of the security, and
the treatment of the principal as capital for issuers subject to
capital requirements. As such, determining whether these hybrid
securities should be treated as an OTC Equity Security or a TRACE-
Eligible Security for purposes of trade reporting to the appropriate
FINRA facility has become less clear.
Given the complexity of these hybrid securities, FINRA proposed an
interpretation regarding the classification and reporting of two
categories of hybrid securities (capital trust securities (also
referred to as trust preferred securities) and certain depositary
shares) to clarify the appropriate trade reporting facility to which
such securities should be reported.\9\ In addition, FINRA proposed a
policy to address the treatment of securities that are currently being
reported to a facility that is not the designated facility under this
interpretation.
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\9\ The proposed interpretation applies solely to a hybrid
security that is not listed on an equity facility of a national
securities exchange. See, e.g., FINRA Trade Reporting Notice,
February 22, 2008 (FINRA applied TRACE reporting requirements,
distinguishing between listed and unlisted securities, and required
members to report transactions in unlisted convertible debt and
unlisted equity-linked notes to TRACE, and OTC transactions in
convertible debt and equity-linked notes listed on an equity
facility of a national securities exchange to an appropriate FINRA
equity trade reporting facility for NMS Stocks (the ADF or a trade
reporting facility (``TRF'')). For purposes of this proposed rule
change, the term ``listed on an equity facility of a national
securities exchange'' means a security that qualifies as an NMS
stock (as defined in Rule 600(b)(47) of Regulation NMS under the
Act) as distinguished from a security that is listed on a bond
facility of a national securities exchange. See 17 CFR
242.600(b)(47).
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Comments Received
On September 30, 2013, the SEC published the proposed rule change
for comment in the Federal Register.\10\ The SEC received two comment
letters in response to the proposed rule change, both of which raised
concerns with certain aspects of the proposal.\11\ Both commenters
indicated that the vast majority of hybrid securities identified in the
interpretation are traded by their members as fixed income
securities.\12\ In particular, SIFMA noted that hybrid securities with
a par value of $1,000 or more have historically been traded and settled
with a debt convention \13\ as such securities traded on the basis of
yield and credit quality and, similarly, investors evaluated them based
on their debt-like characteristics, such as yield, time to first call,
credit rating and priority in the capital structure in that they are
paid after other debt but before common equity. Thus, commenters
indicated that reporting such securities to TRACE better accommodates
and is consistent with these debt trading conventions.
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\10\ See Securities Exchange Act Release No. 70482 (September
24, 2013), 78 FR 59995 (September 30, 2013) (Notice of Filing of
Proposed Rule Change To Clarify the Classification and Reporting of
Certain Securities to FINRA; File No. SR-FINRA-2013-039).
\11\ See Letter from Sean Davy, Managing Director, Capital
Markets, Securities Industry and Financial Markets Association, to
Elizabeth M. Murphy, Secretary, SEC, dated October 21, 2013
(``SIFMA'') and letter from Manisha Kimmel, Executive Director,
Financial Information Forum, to Elizabeth M. Murphy, Secretary, SEC,
dated October 31, 2013 (``FIF'').
\12\ See SIFMA and FIF.
\13\ In general, trading with a debt convention includes
counterparties discussing the notional amount of the security, its
price and the carried accrued interest that is expressed separately
from the price. However, SIFMA acknowledged that securities with par
value less than $1,000 generally trade as equity securities in an
equity format.
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Given that these securities have historically traded and been
reported as debt, the commenters raised many concerns about the
significant disruption to fixed income trading work flows that would
result if these securities were reported to the ORF, in light of the
interdependencies among trading systems, including the operational and
technology changes and costs associated therewith. Commenters
highlighted a variety of potential downstream impacts of reporting
depositary shares to ORF \14\ and questioned whether the benefits of
the proposal outweigh the costs.\15\
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\14\ For example, FIF noted potential impact relating to Section
31 fees, TAF fees, Electronic Blue Sheets, INSITE reporting, short
interest, beneficial ownership, order ticket, confirmations,
corporate actions and tax treatment.
\15\ See FIF. SIFMA also encouraged FINRA to consider more cost
effective alternatives, including making changes to its trade
reporting systems that would accomplish its goals without imposing
undue burdens on the market.
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SIFMA raised similar concerns emphasizing that the hybrid
securities market is a critical part of the capital markets, noting
that many of these securities are being issued by financial
institutions to satisfy equity capital requirements as part of the
International Regulatory Framework for Banks developed by the Bank for
International Settlements, known as Basel III. SIFMA indicated that a
shift in the market practice for these securities could create investor
confusion in the market. SIFMA argues that investors, institutional
investors in particular, use the debt trading analytics as a critical
part of their investment decisions and any change to the practice could
in turn negatively impact liquidity. Further, SIFMA emphasized that
there is regulatory precedent to permit the subject securities to be
reported to TRACE and would be consistent with conclusions reached by
the Commission in other contexts with respect to non-convertible
preferred securities that may be classified or treated as debt
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securities.\16\ SIFMA also expressed its belief that the proposal does
not address the full spectrum of hybrid securities and the
classification should provide further clarity and guidance in
anticipation of further market developments. Regardless of the ultimate
reporting venue, SIFMA indicated at least one year is needed to
implement any necessary changes.
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\16\ See Securities Exchange Act Release No 57621 (April 4,
2008), 73 FR 19270 (April 9, 2008) (Order Exempting Non-Convertible
Preferred Securities from Rule 611(a) of Regulation NMS under the
Securities Exchange Act of 1934). See also Rule 144(a)(4) and Rule
902 of Regulation S under the Securities Act of 1933 wherein ``non-
participatory preferred stock'' is included in the definition of
``debt securities''.
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Response to Commenters
After careful consideration of the comments, FINRA acknowledges
that the appropriate classification of hybrid securities is a complex
analysis that has important consequences. FINRA agrees with the
commenters that hybrid securities, in particular securities with a
liquidation preference of $1,000 or more, do indeed have significant
debt-like characteristics, as noted by SIFMA, that were created to
``mix and match both debt and equity characteristics to achieve the
particular tax, regulatory capital and rating agency treatment needs of
the issuer'' and ``is an important source of bank regulatory capital.''
As such, given the multi-faceted nature of these products, FINRA
believes all aspects of these products should be given consideration in
evaluating the proper classification for trade reporting purposes. In
this regard, FINRA further discussed the proposal with several
institutional investor representatives who also agreed with the
concerns raised by commenters of potential unintended downstream impact
if these securities were not reported to TRACE.
Given the consistent view throughout the industry, FINRA believes
it is appropriate to treat these securities as debt for purposes of
trade reporting. Accordingly, FINRA proposes to modify its original
interpretation to provide that, in addition to capital trust and trust
preferred securities, the term TRACE-Eligible Security includes: (1) a
depositary share having a liquidation preference of $1,000 or more (or
a cash redemption price of $1,000 or more) that is a fractional
interest in a non-convertible,\17\ preferred security and is not listed
on an equity facility of a national securities exchange (``hybrid
$1,000 depositary share''); and (2) a non-convertible, preferred
security having a liquidation preference of $1,000 or more (or a cash
redemption price of $1,000 or more) that is not listed on an equity
facility of a national securities exchange (``hybrid $1,000 preferred
security''), such as a hybrid $1,000 preferred security that is offered
directly to an investor or a preferred security underlying multiple
hybrid $1,000 depositary shares.\18\ Any such security deemed as a
TRACE-Eligible Security would be excluded from the defined term OTC
Equity Security.
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\17\ Non-convertible means not convertible into or exchangeable
for property or shares of any other series or class of the issuer's
capital stock.
\18\ FINRA is not modifying its previously filed interpretation
regarding the treatment of capital trust securities and trust
preferred securities. Specifically, the term TRACE-Eligible Security
includes capital trust securities and trust preferred securities
(other than a capital trust security or a trust preferred security
that is listed on an equity facility of a national securities
exchange) and transactions in such securities must be reported to
TRACE (and not to ORF) in compliance with the applicable reporting
requirements. This interpretation would apply even if the capital
trust security (or a trust preferred security) was previously listed
on an equity facility of a national securities exchange and reported
to a FINRA equity facility, but has since been delisted. Once
delisted, the security must be reported to TRACE.
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FINRA believes that consistency in the market practice and
maintaining the established securities transaction information flow to
investors is important and furthers the highly developed reporting and
transparency infrastructure already in place to which the marketplace
and investors are accustom. FINRA believes that the TRACE system better
accommodates the debt trading and reporting conventions of these
securities and investors will be able to more reliably and efficiently
find market information about these securities, consistent with how
they access information for products that trade based on similar
characteristics, e.g., yield and credit quality.
FINRA believes this amended interpretation will prevent investor
confusion by allowing hybrid $1,000 depositary shares and hybrid $1,000
preferred securities to be reported to TRACE. Since the reporting
determination is an important factor in driving certain downstream
activities, such as clearing and settling such securities and the
reporting data used by investors and other market participants, FINRA
believes the proposed amended interpretation preserves the established
market practice for these securities and achieves investor protection
goals consistent with the debt-like nature of the security, without
being unduly burdensome and requiring significant technological
changes. As raised by SIFMA, FINRA also believes the revised
interpretation is consistent with conclusions reached by the Commission
in other contexts with respect to non-convertible preferred securities
that may be classified or treated as debt securities.\19\
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\19\ See note 14.
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While it is impossible to address all future types of securities,
as it frequently is a security-specific fact-based analysis, FINRA
believes that the expansion of the proposed interpretation to address
additional forms of hybrid securities will address a significant
portion of the market and adapt to future offerings. FINRA endeavors to
continue to work directly with SIFMA, FIF and all market participants
to ensure consistent reporting treatment across the hybrid securities
market. Further, FINRA believes the modified interpretation set forth
above provides sufficient detail and guidance for members to ensure
accurate reporting to the appropriate trade reporting facility.
In light of the expanded and modified interpretation discussed
above, FINRA declines to extend the implementation date beyond the
originally proposed maximum of 150 days following Commission approval.
FINRA believes that the modified interpretation largely follows current
market practice and accordingly anticipates that members will be able
to comply within such timeframe.
Other Preferred Securities and Depositary Shares
All other preferred securities and depositary shares representing
fractional interests in such securities except the hybrid securities
identified above--hybrid $1,000 preferred securities and hybrid $1,000
depositary shares--will continue to be included in the defined term OTC
Equity Security, and members must report transactions in such
securities to ORF. For example, a non-convertible preferred security
having a par value or liquidation preference of $25 that is not listed
on an equity facility of a national securities exchange would be an OTC
Equity Security under the interpretation and would be required to be
reported to ORF.\20\ When reporting to ORF is required, members must
report in accordance with ORF requirements. For example, price should
be reported as the dollar price per share and volume should be reported
as the number of preferred shares traded.
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\20\ Under this interpretation, members must request a symbol,
if one has not already been assigned, for such preferred shares for
ORF reporting in compliance with the applicable reporting
requirements.
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[[Page 12544]]
Hybrid Securities Currently Being Reported to ORF and TRACE
As noted in the original proposal, FINRA believes that, given the
complexity of many of the securities that are the subject of this
proposed rule change, it is reasonable that firms, despite their best
efforts, may have reached different conclusions on where transactions
in these hybrid securities should be reported. FINRA proposes that, as
of the implementation date of this proposed rule change, securities
that are affected by this amended proposed interpretation will be
transferred, if necessary, for reporting to the appropriate trade
reporting facility, and after this transfer members must report all
transactions in such securities to the appropriate trade reporting
facility. Members will not be required to retroactively cancel and
correct any transactions in such securities previously reported to a
facility that is not the designated facility under this interpretation.
Thus, members will not be required to cancel and correct transactions
in capital trust securities reported to the ORF or transactions in
preferred securities and depositary shares reported to TRACE (excluding
hybrid $1,000 preferred securities and hybrid $1,000 depositary shares)
prior to the implementation date of this proposed rule change.\21\
However, if a firm reported a transaction to the facility designated in
this proposed interpretation, but did not report in accordance with the
applicable trade reporting requirements of that facility (e.g., a firm
reported a transaction to ORF, but inaccurately reported the price or
size as if reporting to TRACE), the firm will be required to cancel and
re-report such transactions accurately.
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\21\ Pursuant to Section 31 of the Act, FINRA and the national
securities exchanges are required to pay transaction fees and
assessments to the SEC that are designed to recover the costs
related to the government's supervision and regulation of the
securities markets and securities professionals. See 15 U.S.C. 78ee.
FINRA obtains its Section 31 fees and assessments from its
membership, in accordance with Section 3 of Schedule A to the FINRA
By-Laws. The transactions that are assessable under Section 3 of
Schedule A to the FINRA By-Laws are reported to FINRA through one of
FINRA's equity trade reporting facilities: the ORF, the ADF, or a
TRF. As expressly stated in the Act, sales of bonds, debentures, or
other evidence of indebtedness (debt securities) are excluded from
Section 31 of the Act. See 15 U.S.C. 78ee(b). Because of this
exclusion under Section 31 of the Act, transactions reported to
TRACE are not subject to the regulatory transaction fee under
Section 3 of Schedule A to the FINRA By-Laws. To determine whether a
non-exchange listed security is an equity security or a debt
security for purposes of assessing the regulatory transaction fee,
FINRA relies on the facility to which the transaction is reported.
If the transaction is reported to the ORF, the transaction is
treated as one involving an equity security and is subject to the
regulatory transaction fee. If the transaction is reported to TRACE,
the transaction is treated as one involving a debt security and thus
is not subject to the regulatory transaction fee. See Regulatory
Notice 08-72 (December 2008).
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FINRA will publish the interpretation and its implementation date
in a Regulatory Notice no later than 60 days following Commission
approval. The implementation date will be no later than 90 days
following publication of the Regulatory Notice announcing Commission
approval.
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\22\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. FINRA believes that by clarifying the classification
of certain hybrid securities that are not listed on an equity facility
of a national securities exchange for reporting purposes, the proposed
rule change will reduce market and investor confusion. In addition,
FINRA believes that the proposed rule change will improve transparency
significantly because members will report transactions in the same
security using a uniform set of conventions and to the same facility
(i.e., the ORF or TRACE). This will allow investors and other market
participants to better compare transaction pricing and the quality of
their executions, which promotes just and equitable principles of
trade, deters fraudulent and manipulative acts and practices in the
market for such securities, and furthers the protection of investors
and the public interest.
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\22\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA does not believe that the proposed rule change, as amended,
will result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act. Members that are
required currently to report transactions in hybrid securities will
continue to be subject to transaction reporting requirements and will
be provided clarity as to which facility such hybrid securities should
be reported, which will promote uniformity and consistency in trade
reporting within these categories of products.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
On September 30, 2013, the Commission published the proposed rule
change for comment in the Federal Register.\23\ The comment period
closed on October 21, 2013. The Commission received two comment letters
in response to the proposed rule change.\24\ On December 24, 2013, the
Commission published an order to institute proceedings pursuant to
Section 19(b)(2)(B) of the Act \25\ to determine whether to disapprove
the proposed rule change.\26\ No other comments were received by the
Commission. A summary of the comments received and FINRA's response are
provided above in Item 2 of this filing.
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\23\ See note 8.
\24\ See note 9.
\25\ 15 U.S.C. 78s(b)(2)(B).
\26\ See Securities Exchange Act Release No. 71180 (December 24,
2013), 78 FR 79716 (December 31, 2013) (Order Instituting
Proceedings to Determine Whether to Disapprove Proposed Rule Change
to Clarify the Classification and Reporting of Certain Securities to
FINRA.
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III. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change, as modified by Amendment No. 1, is consistent with the Act.
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-FINRA-2013-039 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2013-039. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule changes that are
filed with the
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Commission, and all written communications relating to the proposed
rule changes between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for Web site viewing and printing in
the Commission's Public Reference Room, 100 F Street, NE., Washington,
DC 20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at principal office of the Exchange. All comments received
will be posted without change; the Commission does not edit personal
identifying information from submissions. You should submit only
information that you wish to make publicly available. All submissions
should refer to File Number SR-FINRA-2013-039 and should be submitted
on or before March 26, 2014.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\27\
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\27\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-04797 Filed 3-4-14; 8:45 am]
BILLING CODE 8011-01-P