FINRA Adopts New Rule 2272 Regarding Securities Offers and Sales on Military InstallationsJune 2016 – Securities & Derivatives Alert
Congress amended § 15A(b) of the Securities Exchange Act of 1934 with the enactment of the Military Personnel Financial Services Protection Act (the “Military Act”) to require FINRA to adopt rules governing the sales or offers of sales of securities on the premises of any military installation to members of the U.S. Armed Forces or their dependents. The stated purpose of the Military Act is to protect members of the U.S. Armed Forces from unscrupulous practices regarding sales of securities. Pursuant to the Military Act, FINRA was directed to promulgate a rule that meets the minimum requirements set forth by Congress.
In response, in August 2015, FINRA approved FINRA Rule 2272, which became effective on March 30, 2016.
Scope of FINRA Rule 2272
In drafting FINRA Rule 2272, FINRA strictly adhered to the minimum requirements set forth by Congress in the Military Act. Specifically, FINRA Rule 2272 applies to offers and sales of securities on the premises of a military installation to members of the U.S. Armed Forces or their dependents. Importantly, FINRA interprets Rule 2272 broadly so as to include within the protected class of “members of the U.S. Armed Forces” all active duty, retired, discharged or separated members of the U.S. Armed Forces.
FINRA Rule 2272(a) defines “military installation” to mean “any federally owned, leased or operated base, reservation, post, camp, building or other facility to which members of the U.S. Armed Forces are assigned for duty, including barracks, transient housing and family quarters.” The U.S. Department of Defense maintains a non-exhaustive directory of military installations on its website. However, this list is intended merely as guidance and member firms are ultimately responsible for conducting their own due diligence to determine whether a particular location would constitute a “military installation” under FINRA Rule 2272.
Despite the broad interpretation of the rule, the restrictions imposed by FINRA Rule 2272 do not apply to written communications related to the solicitation of securities to members of the U.S. Armed Forces, even if such written communication is received on the premises of a military installation. However, it is important to note that any communication with the general public would be governed by FINRA Rule 2010. Specifically, FINRA Rule 2210 governs communications by member firms with the public by providing standards for the content and arranging for the approval, recordkeeping and filing of communications with FINRA. FINRA’s Advertising Regulation Department reviews member firms’ advertisements and other communications with the public to ensure they are fair, balanced, not misleading and comply with the standards and advertising rules of the Securities Exchange Commission, Municipal Securities Rulemaking Board and Securities Investor Protection Corporation. After conducting a review of the communications, the department provides member firms with written commentary. If egregious violations are identified, the staff will instruct the member firm to cease using the communication and may refer the matter for disciplinary action. FINRA Rule 2210 establishes different rules for different categories of communication with the public, including retail communication, correspondence and institutional communication.
In addition to written communications, FINRA Rule 2272 similarly does not apply to sales or offers made off the premises of a military installation. However, any such sale of securities off the premises of a military installation must comply with all other applicable FINRA rules in connection with such solicitation, including suitability requirements under FINRA Rule 2111 (discussed below). Additionally, any misleading representation made off the premises of a military installation to any member of the U.S. Armed Forces or a dependent thereof that the securities are being offered or provided on behalf of, or sanctioned, recommended, or encouraged by the federal government is also otherwise prohibited by FINRA rules.
Required Disclosures by Member Firms
FINRA Rule 2272(b) requires that any member firm engaging in sales or offers of sales of securities on the premises of a military installation to any member of the U.S. Armed Forces or a dependent thereof clearly and conspicuously disclose in writing to a potential investor prior to engaging in sales or offers of sales of securities to the investor: (i) the identity of the member offering the securities; and (ii) that the securities offered are not being offered or provided by the member on behalf of the federal government, and that the offer of such securities is not sanctioned, recommended or encouraged by the federal government.
FINRA Rule 2272(c) requires a member firm making a recommendation on the premises of a military installation to any member of the U.S. Armed Forces or a dependent thereof to satisfy the suitability obligations imposed by FINRA Rule 2111. FINRA Rule 2111 requires an appropriate suitability determination, including consideration of costs and knowledge about securities, prior to making any recommendation.
Specifically, FINRA Rule 2111 requires that a member firm or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member firm or associated person to ascertain the customer’s investment profile. A customer’s investment profile includes, but is not limited to: the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.
Restriction on Referral Fees and Incentive Compensation
FINRA Rule 2272 also prohibits a member firm from causing a person to receive a referral fee or incentive compensation in connection with sales or offers of sales of securities on the premises of a military installation with any member of the U.S. Armed Forces or a dependent thereof, unless such person is an associated person of a registered broker-dealer who is appropriately qualified consistent with FINRA rules and the payment complies with applicable federal securities laws and FINRA rules. This rule also applies to referral fees or incentive compensation paid to bank employees in connection with sales of securities on premises of a military installation to members of U.S. Armed Forces.
It is important to note that in addition to the FINRA rules addressed above, the U.S. Department of Defense has also issued regulations that restrict the ability of member firms to solicit members of the U.S. Armed Forces on the premises of military installations. However, unlike the FINRA rules, which are intended to govern the conduct of member firms, the U.S. Department of Defense regulations -- specifically, Instruction No. 1344.07 -- also impose restrictions on both the conduct of the members of the U.S. Armed Forces, in addition to any person seeking to solicit on the premises of a military installation.
In sum, although it is permissible to sell or offer to sell securities on the premises of a military installation to members of the U.S. Armed Forces or their dependents, it is critical that any member firm or associated person intending to do so be fully aware of the rules and regulations described above that govern such conduct, both from the standpoint of the FINRA rules and the Department of Defense regulations. FINRA’s new Rule 2272 is intended to protect innocent investors against predatory practices by broker-dealers, similar to prior rules designed to protect senior citizens from abusive sales practices. We ask that our financial services clients familiarize themselves with FINRA Rule 2272 and, of course, we are willing and able to counsel our clients on the specific nuances of this new rule.
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© 2016 Herrick, Feinstein LLP. This alert is provided by Herrick, Feinstein LLP to keep its clients and other interested parties informed of current legal developments that may affect or otherwise be of interest to them. The information is not intended as legal advice or legal opinion and should not be construed as such.