
[Federal Register Volume 78, Number 251 (Tuesday, December 31, 2013)]
[Notices]
[Pages 79716-79718]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-31226]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-71180; File No. SR-FINRA-2013-039]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc; Order Instituting Proceedings To Determine Whether To 
Disapprove Proposed Rule Change To Clarify the Classification and 
Reporting of Certain Securities to FINRA

December 24, 2013.

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. This order institutes proceedings 
under Section 19(b)(2)(B) of the Act \5\ to determine whether to 
disapprove the proposed rule change.
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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'').
    \5\ 15 U.S.C. 78s(b)(2)(B).
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II. Description of the Proposal

    FINRA employs trade reporting rules that generally require that 
members report over-the-counter (``OTC'') transactions in eligible debt 
and equity securities to FINRA.\6\ FINRA Rule 6622 requires that 
members report transactions in ``OTC Equity Securities'' to ORF \7\ and 
the Rule 6700 Series requires members to report transactions in 
``TRACE-Eligible Securities'' to TRACE.\8\
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    \6\ 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'')).
    \7\ 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).''
    \8\ 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.''
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    The current proposal would clarify how members would be required to 
report two classes of securities--``depositary shares'' and ``capital 
trust'' (or ``trust preferred'') securities--under these rules. Both 
classes are ``hybrid'' securities, in that each has debt- and equity-
like features. According to FINRA, such 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.\9\ FINRA states that it has received 
requests for guidance whether such hybrid securities should 
appropriately be classified as equities, and thus reported to ORF, or 
debt securities, and thus reported to TRACE.
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    \9\ See Notice, 78 FR at 59996.
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    FINRA has proposed to classify depositary shares, when not listed 
on an equity facility of a national securities exchange,\10\ as OTC 
Equity Securities under FINRA Rule 6420(f).\11\ As such, depositary 
shares would be equity securities reportable to ORF. According to 
FINRA, depositary shares generally are securities that represent a 
fractional interest in a share of preferred stock, and preferred stocks 
are considered equity securities. FINRA notes further that depositary 
shares generally entitle the holder, through the depositary, to a 
proportional fractional interest in the rights, powers, and preferences 
of the preferred stock represented by the depositary share.\12\
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    \10\ FINRA's proposed interpretation would apply 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 (applying 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 FINRA's proposed rule 
change, the term ``listed on an equity facility of a national 
securities exchange'' would mean a security that qualifies as an NMS 
stock (as defined in Rule 600(b)(47) of Regulation NMS) as 
distinguished from a security that is listed on a bond facility of a 
national securities exchange.
    \11\ See supra note 7.
    \12\ See Notice, 78 FR at 59996.
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    Under the proposal, FINRA members would be required to request a 
symbol for a depository share, if one had not already been assigned, 
and to report transactions in depositary shares in accordance with ORF 
requirements. Thus, the price of the transaction would be reported as 
the dollar price per share and volume should be reported as the number 
of depositary shares traded.\13\
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    \13\ See FINRA Rule 6622; see also Trade Reporting FAQ 101.6, 
available at www.finra.org/Industry/Regulation/Guidance/p038942#101.
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    With respect to capital trust (or trust preferred) securities, 
FINRA has proposed to include such securities within the definition of 
``TRACE-Eligible Security'' under FINRA Rule 6710(a).\14\ Thus, members 
would be required to report transactions in such securities to TRACE 
according to applicable TRACE reporting requirements. For example, 
members would be required to report price as a percentage of par value 
and volume as the total par value of the transaction (not the number of 
bonds traded).\15\
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    \14\ See supra note 8.
    \15\ See FINRA Rule 6730.
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    In explaining its proposed classification of capital trust 
securities, FINRA noted that, historically, many of these securities--
particularly those issued with $1,000 par value and not listed on an 
equity facility of a national securities exchange--were reported to 
Fixed Income Pricing System (``FIPS'') prior to the implementation of 
TRACE.\16\ When TRACE was proposed, reporting of FIPS securities was to 
be transferred to TRACE.\17\ FINRA also noted that, as part of the 
original TRACE proposal, FINRA (then NASD) specifically identified 
capital trust securities in a list of instruments that NASD considered 
TRACE-Eligible Securities, which would be reported to

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TRACE and otherwise subject to the Rule 6700 Series requirements.\18\
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    \16\ FINRA (formerly, the National Association of Securities 
Dealers, Inc. (``NASD'')) operated FIPS through its then-subsidiary, 
NASDAQ. FIPS commenced operation in April 1994 and collected 
transaction and quotation information on domestic, registered, non-
convertible high-yield corporate bonds. OTC capital trust securities 
and trust preferred securities were treated as FIPS securities and 
often included in the regularly published lists of the most 
actively-traded FIPS securities, referred to as the ``FIPS 50.'' See 
Securities Exchange Act Release No. 43873 (January 23, 2001), 66 FR 
8131 (January 29, 2001) (Order Approving Proposed Rule Change and 
Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 4, Relating to the Creation of a Corporate Bond Trade 
Reporting and Transaction Dissemination Facility and the Elimination 
of Nasdaq's Fixed Income Pricing System) (File No. SR-NASD-99-65) 
(``TRACE Approval Order'').
    \17\ See, e.g., TRACE Approval Order, 66 FR at 8132-8133, nn. 13 
and 16.
    \18\ In SR-NASD-99-65, FINRA (then NASD) indicated that capital 
trust securities would be TRACE-Eligible Securities. See Securities 
Exchange Act Release No. 42201 (December 3, 1999), 64 FR 69305, 
69309 (December 10, 1999) (Notice of Filing of Proposed Rule Change 
Relating to the Creation of a Corporate Bond Trade Reporting and 
Transaction Dissemination Facility and the Elimination of Nasdaq's 
Fixed Income Pricing System (``FIPS'')).
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    FINRA stated that the proposed rule change would apply only on a 
prospective basis. It would not require FINRA members to review old 
trades and cancel and re-report those trades if they were reported 
contrary to the terms of the proposal. If the proposal became 
effective, however, it would require FINRA members to cancel and re-
report trades that occurred after the date of the proposal's 
effectiveness if those trades were reported incorrectly.\19\
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    \19\ See Notice, 78 FR at 59996-97.
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III. Comment Letters

    As noted above, the Commission received two comment letters 
concerning the proposal.\20\ Both comment letters express concern with 
FINRA's proposed guidance regarding trade reporting of hybrid preferred 
securities, such as depositary shares, and contend that hybrid 
securities currently being reported to TRACE should continue to be 
reported to TRACE. FINRA has not yet submitted a response to the 
comments.
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    \20\ See supra note 4.
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    The commenters make several arguments as to why depositary shares 
should continue to be reported to TRACE, rather than to ORF, as the 
proposal would require. According to the commenters, it is longstanding 
market practice to treat depositary shares more like debt than equity 
securities. The commenters also claim that it would be overly 
burdensome for market participants to make the technological changes 
required to report trades in depositary shares to ORF rather than 
TRACE.
    One of the commenters states that investors evaluate hybrid 
securities, including depositary shares, based upon their fixed income 
attributes. According to this commenter, depositary shares with a par 
value of $1,000 have historically been traded and settled with a debt 
convention, meaning on the basis of yield and credit quality rather 
than on the potential for capital appreciation.\21\ As a result, the 
commenter states, investors in hybrid securities, often institutional 
investors, make portfolio allocations based on yield, time to first 
call, and credit rating among other debt-like characteristics.\22\ The 
commenter acknowledges, however, that hybrid securities, including 
depositary shares, may also be issued with par values less than $1,000, 
and that such smaller par value securities most often trade as equity 
securities in an equity format.\23\
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    \21\ See SIFMA Letter at 6. See also FIF Letter at 1 (stating 
generally that the depositary shares ``are traded as fixed income 
securities'').
    \22\ See SIFMA Letter at 6.
    \23\ See id. at 7, n. 14.
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    This commenter takes the position that there is justification to 
support the current market practice of treating depositary shares with 
$1,000 par value or greater as debt securities. For instance, the 
commenter notes that hybrid securities, including depositary shares, 
generally hold a similar priority in the capital structure, meaning 
they are paid after all other debt and prior to common equity.\24\ 
Additionally, according to the commenter, hybrid securities tend to 
share core characteristics such as a fixed coupon or dividend and a 
lack of voting rights beyond statutory requirements, similar to the 
voting rights associated with debt indentures. Hybrid securities also 
may or may not be callable, and they may have a specific maturity 
date.\25\ Finally, the commenter cites a number of cases where it 
believes the Commission has suggested that preferred securities may 
properly be classified as debt securities.\26\
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    \24\ See id. at 6.
    \25\ See id.
    \26\ See id. at 8-9.
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    Furthermore, this commenter also identifies what it believes may be 
a significant harmful consequence of changing market practice with 
respect to the classification of depositary shares. The commenter notes 
that hybrid preferred securities, including depositary shares, are 
often issued by banks because of how the securities are treated for 
purposes of calculating a bank's regulatory capital. The commenter 
states that such securities are likely to become more important to 
banks as new, stricter standards concerning banks' capital ratios take 
effect. Absent a robust secondary market, the commenter contends, banks 
may be limited in their ability to issue hybrid preferred securities, 
which could impact their ability to comply with regulatory capital 
requirements. The commenter believes that, to the extent the proposal 
would change the way depositary shares are traded, it could dampen the 
secondary market by creating investor confusion or rendering the 
securities ineligible for inclusion in fixed income indices.\27\
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    \27\ See id. at 5.
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    Both commenters question the ability of market participants to 
adapt their systems to comply with the proposed reclassification of 
depositary shares. As one commenter notes, the data fields captured by 
FINRA's ORF are different than those captured by TRACE. For example, 
ORF collects for each transaction the price per share and number of 
shares traded. It does not have a data field for an accrued coupon or 
dividend, information captured as part of debt transactions reported to 
TRACE.\28\ Along the same lines, the second commenter notes that 
investors may prefer to receive confirmations of their depositary share 
trades with the additional data fields that TRACE collects but ORF does 
not.\29\ Furthermore, the second commenter points out, many firms have 
bifurcated trading, operations, and technology architecture for 
equities and debt that is tailored to the order lifecycle needs of each 
type of instrument, including order entry, market data, trade 
reporting, and settlement.\30\ In this commenter's view, the costs of 
altering such architecture are not warranted.\31\ The first commenter 
expressed similar sentiment, and it also urged FINRA to allow 
sufficient implementation time should it proceed with the proposal.\32\
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    \28\ See id. at 7.
    \29\ See FIF Letter at 4.
    \30\ See id. at 1.
    \31\ See id. at 3-4. This commenter also lists a number of other 
potential downstream impacts that it believes FINRA should consider 
at greater length before proceeding with the proposal. See id. at 2-
3.
    \32\ See SIFMA Letter at 12-14.
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    Aside from arguing for a particular treatment for depositary 
shares, the first commenter expressed its belief that the proposal does 
not contain sufficient guidance to clearly apply to the range of hybrid 
securities traded throughout the marketplace. This commenter offered 
several alternative formulations of the guidance that it believes would 
more thoroughly define the criteria by which a security would be 
classified as reportable to ORF or TRACE.\33\
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    \33\ See id. at 11-12.
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IV. Proceedings to Determine Whether to Disapprove SR-FINRA-2013-039 
and Grounds for Disapproval Under Consideration

    The Commission is instituting proceedings pursuant to Section 
19(b)(2)(B) of the Act \34\ to determine whether the proposals should 
be disapproved. Institution of such

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proceedings is appropriate at this time in view of the legal and policy 
issues raised by the proposals. Institution of disapproval proceedings 
does not indicate that the Commission has reached any conclusions with 
respect to any of the issues involved. Rather, as described in greater 
detail below, the Commission seeks and encourages interested persons to 
provide additional comment on the proposals.
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    \34\ 15 U.S.C. 78s(b)(2)(B).
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    Pursuant to Section 19(b)(2)(B),\35\ the Commission is providing 
notice of the grounds for disapproval under consideration. The 
Commission notes that Section 15A(b)(9) of the Act \36\ requires that 
FINRA's rules be designed to, among other things, promote just and 
equitable principles of trade, remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest. Commenters 
have raised concerns about whether the proposed reclassification of 
depositary shares for trade reporting purposes could cause harm to the 
market for hybrid preferred securities. They have also questioned 
whether the proposal could cause investor confusion, and whether it is 
sufficiently detailed to provide adequate guidance to market 
participants.
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    \35\ See id.
    \36\ 15 U.S.C. 78o-3(b)(6).
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    The Commission believes that these concerns raise questions as to 
whether the proposed rule change is consistent with the requirements of 
the Section 15A(b)(9) of the Act, including whether they would promote 
just and equitable principles of trade, perfect the mechanism of a free 
and open market and a national market system, and protect investors and 
the public interest. As of the date of this order, FINRA had not yet 
addressed the comments by, for example, amending the proposal to 
respond to comments or arguing that the proposal should be approved by 
the Commission in its present form notwithstanding the comments. The 
self-regulatory organization submitting the proposal bears the burden 
of demonstrating that it is consistent with the Act, and given the 
outstanding comments, FINRA has not at this time satisfied that 
burden.\37\ Accordingly, the Commission believes that it is appropriate 
at this time to issue this order to institute proceedings under Section 
19(b)(2)(B) of the Act to determine whether to disapprove the proposed 
rule change.
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    \37\ See 17 CFR 201.700(b)(3).
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V. Procedure: Request for Written Comments

    The Commission requests that interested persons provide written 
submissions of their views, data, and arguments with respect to the 
concerns identified above, as well as any others they may have with the 
proposed rule change. In particular, the Commission invites the written 
views of interested persons concerning whether the proposed rule change 
is inconsistent with Section 15A(b)(9) or any other provision of the 
Act, or the rules and regulation thereunder. Although there do not 
appear to be any issues relevant to approval or disapproval which would 
be facilitated by an oral presentation of views, data, and arguments, 
the Commission will consider, pursuant to Rule 19b-4, any request for 
an opportunity to make an oral presentation.\38\
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    \38\ Section 19(b)(2) of the Act, as amended by the Securities 
Act Amendments of 1975, Public Law 94-29 (June 4, 1975), grants the 
Commission flexibility to determine what type of proceeding--either 
oral or notice and opportunity for written comments--is appropriate 
for consideration of a particular proposal by a self-regulatory 
organization. See Securities Act Amendments of 1975, Senate Comm. on 
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st 
Sess. 30 (1975).
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    Interested persons are invited to submit written data, views, and 
arguments regarding whether the proposed rule changes should be 
[approved or] disapproved by January 21, 2014. Any person who wishes to 
file a rebuttal to any other person's submission must file that 
rebuttal by February 4, 2014.
    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 rule-comments@sec.gov. 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 change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change 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. 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 January 21, 2014. 
Rebuttal comments should be submitted by February 4, 2014.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\39\
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    \39\ 17 CFR 200.30-3(a)(57).
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Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013-31226 Filed 12-30-13; 8:45 am]
BILLING CODE 8011-01-P


