Effective 11/1/11, firms relying on the reporting exception for transactions that are part of an “unregistered secondary distribution” have a new set of obligations - i.e., they must provide FINRA notice and information relating to the transactions. 

FINRA's rule changes, approved by the SEC earlier this month, serve two purposes.  First, they clarify that, for purposes of the exception from the trade reporting requirements for transactions that are part of a distribution of securities, “distribution” has the meaning set forth under SEC Regulation M.  That means, beginning 11/1, firms that rely on the exception for transactions that are part of an “unregistered secondary distribution” must provide FINRA notice and information relating to the transactions, as described herein. 

Second, the amendments clarify that transfers of securities for the purpose of creating or redeeming instruments - such as ADRs and ETFs - are expressly excluded from the trade reporting requirements.

Current FINRA Trade Reporting Rules.   Firms are required to report OTC equity transactions to FINRA unless they fall within an express exception. As a general matter, when firms report OTC trades, FINRA facilitates the public dissemination of the trade information and/or assesses regulatory transaction fees under Section 3 of Schedule A to the FINRA By-Laws (Section 3)2 and the Trading  Activity Fee (TAF). 

Certain transactions and transfers are not reported to FINRA at all - e.g., those trades executed and reported through an exchange and transfers made pursuant to an asset purchase agreement that has been approved by a bankruptcy court,  Other transactions must be reported to FINRA for regulatory transaction fee assessment purposes only - e.g., away-from-the-market sales and transfers in connection with certain corporate control transactions. 

For each of these exceptions, firms must have policies and procedures and internal controls in place, including, as necessary, consultation with their counsel, to determine whether a transaction qualifies for an exception under the rules. 

Transactions Part of a Securities Distribution.   FINRA revised rules contain an exception from the trade reporting requirements for transactions that are effected in connection with a distribution of securities, specifically:

• transactions that are part of a primary distribution by an issuer or of a registered secondary distribution - other than “shelf distributions” - or of an unregistered secondary distribution.

Thus, transactions that are part of a distribution (other than a secondary shelf distribution) are not reported to FINRA or publicly disseminated, and they are not assessed regulatory transaction fees under Section 3 or the TAF.  The amendments clarify that for purposes of this trade reporting exception, “distribution” has the meaning set forth under SEC Regulation M.  A “distribution” is defined under Rule 100 of Regulation M as “an offering of securities, whether or not subject to registration under the Securities Act, that is distinguished from ordinary trading transactions by the magnitude of the offering and the presence of special selling efforts and selling methods.”

Firms are reminded that under FINRA rules, large block trades - even those at a significant discount from the current market price - must be reported to FINRA for tape dissemination purposes and are assessed regulatory transaction fees under Section 3 and the TAF. The amendments clarify that the trade reporting exception does not apply to block trades, unless they otherwise meet the definition of “distribution” under Regulation M. 

Notice requirement for transactions that are part of an “unregistered secondary distribution” Pursuant to new Supplementary Material in Rules 6282, 6380A, 6380B and 6622, firms that would otherwise have the trade reporting obligation under FINRA rules must provide notice to FINRA that they are relying on the exception for transactions that are part of an “unregistered secondary distribution.” The firm also must provide the following information to FINRA for each transaction that is part of the unregistered secondary distribution and not reported:

• security name and symbol;
• execution date;
• execution time;
• number of shares;
• trade price; and
• FINRA member firms that are parties to the trade.

Firms are required to provide such notice and information no later than 3 business days following trade date. If the trade executions will occur over multiple days, then initial notice and available information must be provided no later than 3 business days following the first trade date and final notice and information must be provided no later than 3 business days following the last trade date.

Such notice and information should be provided on the Regulation M Trading Notification Form (which may be found on pages 7-8 of FINRA RegNote 11-40 - see link below).  That same updated form will be available as of 11/1/11, at www.finra.org/RegM, and should be submitted to FINRA’s Market Regulation Department via:

• email to secondaryofferings@finra.org;
• fax to (301) 339-7403; or
• a third-party vendor (e.g., Dealogic, Ipreo).

Firms also may obtain a version of the Regulation M Trading Notification Form that can be
completed and submitted electronically by emailing a request to FINRA.

FINRA is combining the form of notice required under the trade reporting rules with the form of notice required under Rule 519012 to streamline firms’ reporting obligations since, if a firm is relying on this trade reporting exception, applicable notice requirements under Rule 5190 also must be satisfied. However, firms are reminded that the notice requirement under the trade reporting rules is separate and distinct from the notice requirements under Rule 5190. Accordingly, providing notice under the trade reporting rules does not relieve a firm of any additional notification obligations it may have under Rule 5190 (and vice versa), nor does it impact the timing of any notice required under Rule 5190. Firms must comply with the requirement under Rule 5190 to submit the Regulation M Trading Notification Form no later than the close of business the next business day following pricing of the distribution, irrespective of the fact that firms have until three days after trade date to provide notice and information under the trade reporting rules.  The new Supplementary Material also requires that the firm retain records sufficient to document the basis for relying on this trade reporting exception, including, but not limited to, the basis for determining that the transactions are part of a distribution, as defined under Regulation M. Firms must be able to demonstrate that the “magnitude of the offering” and “special selling efforts” criteria under Regulation M have been satisfied. The mere assertion that the order was large sized or a block or that execution of the order was “worked” by a firm will not by itself be sufficient.

Transfers of equity securities to create or redeem instruments such as ADRs and ETFs The amendments expressly exclude from the trade reporting requirements any transfer of equity securities for the sole purpose of creating or redeeming an instrument, such as an ADR or ETF, that evidences ownership of or otherwise tracks the underlying securities transferred. Such transfers are not considered OTC transactions for purposes of the trade reporting rules and thus are not reportable events.  The amendments codify current guidance and practice in this area. For example, FINRA has previously stated that the conversion of foreign ordinary shares into ADRs (or vice versa) at a bank depository is not a trade reportable event.  Similarly, when a financial institution or “authorized participant” deposits with an ETF a basket of securities (or other assets) and receives the ETF creation unit in return, these are not trade reportable events.  FINRA notes that the exception applies irrespective of whether a firm is acting as agent, principal or riskless principal in the creation process. For example, an authorized participant, as riskless principal on behalf of a customer, transfers securities to an ETF and in return receives ETF creation units. The transfer of the shares and receipt of ETF creation units by the authorized participant are not reportable events. Similarly, the subsequent “flip” of the ETF creation units from the authorized participant to its customer also is not reportable.

Firms are reminded, however, that purchases and sales of the securities that are to be transferred for the purpose of creating or redeeming instruments such as ADRs and ETFs, and subsequent purchases and sales of the instruments themselves in the secondary market, are OTC transactions and must be reported to FINRA in accordance with the trade reporting rules.15 Additionally, purchases and sales of the underlying securities in order to track the performance of an instrument such as an ADR or ETF, without actually creating  the instrument, must be reported.

For further details, go to:   [FINRA RegNote 11-40, Trade Reporting, August 2011]