FINRA is considered to be a self-regulatory organization (SRO). This independent regulation plays a critical role in America's financial system by enforcing high ethical standards, bringing the necessary resources and expertise to regulation, and enhancing investor safeguards and market integrity. All of this is done at no cost to taxpayers! In order to achieve a fair financial market, FINRA ensures the following:

•investors receive complete disclosure about a product before its purchase
•any securities product sold is suitable for that investor's needs
•all product advertisements are truthful and not misleading
•anyone who sells a securities product has been tested, qualified, and licensed

When terminating someone from the firm, the Form U5 must be electronically filed and sent to FINRA within 30 days. Within that timeframe, a written copy of the Form U5 should also be sent to the terminated individual. Failure to do so will result in a "late filing" penalty. If complaints against the associated person are open, the termination will not be processed until the issues have been resolved. Upon termination, FINRA retains jurisdiction over the associated person for two years. This time frame allows FINRA to file any complaints against them for behavior that occurred prior to termination.

Those interested in becoming a member of FINRA must fill out an application, pay required dues, and abide by all FINRA conduct rules. When registering with FINRA, a person must register as either a principal or representative. A principal is actively involved in the management of a broker-dealer's securities or investment banking business. A principal may also have the responsibility of supervising or training registered representatives. New representatives are required to go through a training program.

A registered representative must be associated with a member (broker-dealer) and supervised by a principal. A representative is anyone who is associated with a "member" (broker-dealer) and who is also engaged in investment banking or securities business for that member. Anyone who is associated with a member or performs the duties of that member is also considered to be a representative and must be registered as such. This includes all assistant officers (aside from principals).

A limited securities representative holds a series 6 license and is permitted to sell mutual funds and variable contracts. A general securities representative holds a series 7 license and is permitted to transact individual securities such as stocks, bonds, and mutual funds.

The following people are not required to register with FINRA:

•employees with only clerical or ministerial responsibilities
•employees not actively involved in the investment banking or securities business
•employees who only effect transactions on the floor of a national securities exchange (because those individuals will have already registered with that exchange)

ETHICAL STANDARDS IN SALES PRACTICE

Every FINRA member is held to high standards and honorable principles of trade. FINRA's General Standards of Business Conduct outlines prohibited practices for its members.

Trading ahead of customer orders (front-running) is the act of trading a security for one's own account prior to submitting a client's order for the same security. In other words, the member enters his own order knowing that his client has just entered a large order that will alter the stock price. The member is trying to profit from prior knowledge of the order at the expense of the client.

Trading ahead of research reports is when a member purposefully establishes, creates, or changes the firm's inventory position in a security. This is done in anticipation of a research report being issued by the member firm on that security.

Members are also forbidden from any misleading, fraudulent, manipulative and deceptive practices. The FINRA Rule 2120 and SEC Rule 10b-5 deems these behaviors as unethical and prohibited.

SUPERVISION

Per FINRA's member regulations, a supervisory system must be maintained for the firm's registered representatives. Written procedures on how to efficiently manage client accounts are necessary to fulfill compliance requirements with securities laws. Branch offices must have a registered principal to supervise representatives. Members must also conduct annual internal inspections. These inspections are designed to detect irregularities in customer accounts (records). Registered representatives should discuss compliance matters with the designated supervisor. All transactions and retail communication must be reviewed and given written approval by a registered principal.

Member firms must also maintain an Office of Supervisory Jurisdiction (OSJ) for any office location where the following activities occur:

•approval of new accounts
•approval of retail communication
•order execution
•custody of a client funds and securities
•review of client orders

Each OSJ must maintain a record of customer complaints, as well as the actions taken to resolve the issue. A complaint is a written statement from a client (or any person acting on his behalf) declaring a grievance against any of member(s) currently involved with the transactions and funds of a client (and his account).

When supervising registered representatives, the following matters are typically attended to:

Investigation of qualifications: Members must investigate the character, reputation, qualifications, and experience of an applicant prior to confirming his registration application.

Notice of outside employment: A registered representative seeking employment outside his position with the member firm, he must provide written notice. The firm can accept or reject the outside employment if there is a possibility that a conflict of interest could arise.

Regulation of securities transactions: A member firm must be notified of any accounts opened for a representative at other securities firms. The member firm might request duplicate copies of the accounts. Also, the representative must not participate in any private securities transactions without giving advanced written notice to his employer. Mutual fund accounts and variable contracts registered under the Investment Company Act of 1940 are an exception to this rule.


FINRA CONDUCT RULE 2341: INVESTMENT COMPANY SECURITIES

This rule applies only to member activity with respect to investment company securities and defines the following important terms:

The term compensation refers to both cash and non-cash forms.

Cash compensation refers to any discount, concession, fee, service fee, commission, asset-based sales charge, loan, override, or cash benefit received in connection with the sale and distribution of investment company securities.

Non-cash compensation refers to any form of compensation received in connection with the sale and distribution of investment company securities that is not cash compensation. It includes but is not limited to merchandise, gifts/prizes, travel expenses, meals, and lodging.

Sales charges are fees paid to finance sales or sales promotion expenses. Examples are front-end, deferred, and asset-based sales charges. Fees for investment management, ministerial, recordkeeping, and administrative activities are not considered as sales charges.

An affiliated member refers to any member who directly or indirectly controls a non-member company. Someone who is controlled by another affiliated member or someone who is under the control of a non-member company is also considered an affiliated member.

An offeror is an investment company, an adviser to an investment company, a fund administrator, an underwriter, or any affiliated person of such entities.

A dealer concession is the investment firm's profit from the sale of securities in an underwriting. No underwriter of an investment company can sell a security to a dealer or broker at any price other than the public offering price (unless both parties reach a sales agreement, which must be in effect on the date of the transaction). This allows the concessions to be received by the rightful party. Concessions may only be offered to broker-dealers who are FINRA members.

"Sales charges where no asset-based sales charges exist": Members may not sell shares of an investment company if the sales charges described in the prospectus are excessive. Aggregate sales charges are deemed excessive for investment companies without asset-based sales charges if they do not allow breakpoints (discounts on large volume purchases). Aggregate sales charges may not exceed 8.5% of the fund's public offering price (POP). A mutual fund that charges 8.5% must offer the following three features to investors (if all three of these are not offered, the maximum allowable sales charge can only be 6.5% of the POP): :

•breakpoint schedule
•rights of accumulation and reinvestment of dividends
•capital gains at net asset value (NAV)

"Sales charges where asset-based sales charges do exist": Asset-based sales charges cannot exceed 0.75 of 1% per annum of the average annual net assets, or if the front or deferred sales charges are deducted (but not credited) to the investment company. The maximum aggregate sales charge is 6.25% (including service charges) for investment companies that do have an asset-based sales charge. If the mutual fund pays a service fee to broker-dealers for providing ongoing services to shareholders, the maximum sales charge it can charge is 7.25%. FINRA members are prohibited from selling mutual funds that charge a service fee more than 0.25%.

As with any refund, a refund of sales charges is granted under certain conditions. If a security issued by an open-end company is repurchased by the issuer or is tendered for redemption within seven business days of the transaction, two things must occur. First, the member must refund (to the underwriter) the full concession that was allowed on the original sale. Second, the underwriter must pay the issuer his (the underwriter's) share of the sales charge on the original sale.

In regard to selling dividends, members are not allowed to state or imply to a client that the purchase of a security is advantageous right before an ex-dividend date. The only exception is if there are meticulously-detailed advantages that exist (i.e. tax benefits). Additionally, members cannot suggest that a company's distributions of long-term capital gains should be viewed as part of the income yield of the company's investments.

Withholding is the act of waiting to place customers' orders for any investment company security with the intent to profit. FINRA members may not refrain from placing a client's securities order, especially when they want to do this to make a profit.

FINRA CONDUCT RULE 2320: MEMBER COMPENSATION

A person who is associated with a member may not accept compensation from anyone but that member. Sometimes, however, a company will directly pay that associated person. This is only acceptable if the following is true:

•the member has agreed to the arrangement
•the member relies on a "no-action," SEC-issued letter or rule that applies to a particular part of the arrangement
•the associated person gets the same type of receipt as the member would get after being compensated
•all record keeping requirements are satisfied
       *Members are required to keep a record of all compensation sent by offerors to members and their associates.
       The record must include the names of each party involved, the cash amount, the value of the non-cash
       compensation, and the nature of the compensation

A person may not accept compensation from an offeror in the form of a security. He may not directly or indirectly accept compensation (or offer any compensation) other than what is described in the prospectus. However, there are a few exceptions.

An occasional meal, event ticket, or other form of entertainment are all acceptable (as long as they were not promised or given as a result of reaching a sales goal and as long as these meals or other perks do not occur so frequently that they begin to appear improper).

Reimbursement of expenses from attending trainings or educational meetings is also okay.

Gifts are also fine, as long as they do not exceed the specific amount that FINRA states ($100), and as long as these gifts were not promised or given as a result of reaching a sales goal.

EXECUTION OF PORTFOLIO TRANSACTIONS

FINRA prohibits its members and investment companies from any favoritism in regards to portfolio transactions. There are several specific actions which are prohibited.

A member may not favor or disfavor the sale or distribution of an investment company's shares based on any previous commissions that were earned.

A member may not act as an underwriter for (or sell the shares of) an investment company if he knows that the company is planning to direct portfolio securities transactions to a broker or dealer, which would increase the sale of shares.

A member may not demand any commissions from anyone as a condition of a sale.

A member who is an underwriter may not sponsor another member's incentive campaigns or special sales efforts if the commissions will ultimately be directed back to him (the underwriter).

FINRA CONDUCT RULE 2320: VARIABLE CONTRACTS

This rule applies only to member activity with respect to variable contracts, to the extent such activities are subject to regulation under the federal securities laws. The term purchase payment refers to the amount of money (consideration) paid during each payment of a variable contract.

A variable contract are contracts providing for benefits or values which may vary according to the investment experience of any separate or segregated account or accounts maintained by an insurance company.

An Affiliated Member is a member which, directly or indirectly, controls, is controlled by, or is under common control with a non-member company.

Compensation includes cash compensation and non-cash compensation.

Cash compensation includes any discount, concession, fee, service fee, commission, asset based sales charge, loan, override, or cash employee benefit received in connection with the sale and distribution of variable contracts.

Non-cash compensation includes any form of compensation received in connection with the sale and distribution of variable contracts that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging.

An Offeror is an insurance company, a separate account of an insurance company, an investment company that funds a separate account, any adviser to a separate account of an insurance company or an investment company that funds a separate account, a fund administrator, an underwriter and any affiliated person of the Investment Company Act) of such entities.

Receipt of payment: A FINRA member cannot receive any payment that is outside the provisions of a variable contract (including the prospectus). Additionally, payments are not considered to be "received" until the application is accepted by the insurance company. A payment might be considered as "received" if a mutual agreement was reached between the contract purchaser and seller.

Transmittal: A member who receives applications or purchase payments for variable contracts must promptly transmit these items to the issuer. This is especially crucial because a portion of the purchase payment is required to be credited to the variable contract.

Selling agreements: A member who is a principal underwriter may not sell variable contracts through another broker-dealer unless the broker-dealer is a FINRA member, or unless there is a sales agreement in effect between both parties. The sales agreement must require the commission to be returned to the issuing company if the variable contract is tendered for redemption within seven business days from when the application was accepted.

Redemption: When a contract owner wants to partially or fully redeem his variable contract, he must submit a formal request. Then, the insurance company will promptly make payments on the amount requested (in accordance with the terms of the contract).