I had an experience with FINRA this week that cannot go without comment, as it highlights one of the biggest issues that my clients and I have with FINRA.
One of the more obscure departments within FINRA is the Market Operations Department. I am not entirely sure of all of its functions, but, at a minimum, it is the place where non-exchange-listed issuer company actions in the over-the-counter (OTC) securities market are reviewed and processed. Specifically, according to Reg Notice 10-38, the “Operations Department” “reviews and processes documents related to announcements for company-related actions pursuant to SEA Rule 10b-17,” which includes distributions in cash or kind, stock splits or reverse stock splits, or rights or other subscription offerings, as well as “other company actions, including the issuance of or change to a trading symbol or company name, mergers, acquisition, dissolutions or other company control transactions, bankruptcy or liquidations.”
This is all governed by FINRA Rule 6490. The way it works, when an OTC issuer wants to take a corporate action that is covered by the rule, it must file an application with FINRA’s Operations Department. If FINRA concludes “that it is necessary for the protection of investors, the public interest and to maintain fair and orderly markets,” it will deem the application “deficient” and simply not process it.
Last fall, a client of mine advised the Operations Department of its intent to effect a 1:50 reverse stock split, and filed the necessary application. In a four-page letter, the application was denied because the issuer’s CEO had a prior settlement with the SEC, which “raised concern for FINRA regarding the protection of investors and the transparency of the markets.” Notably, however, the SEC had elected not to bar the CEO from associating with issuers, as it could have, which clearly suggests that the SEC was ok with him serving as CEO. More importantly, the majority shareholder of the issuer, with over 60% of the shares, expressly wanted this guy to be the CEO notwithstanding his disciplinary history. Unfortunately, this was not good enough for FINRA.
So, a couple of weeks ago, we resubmitted the application, but this time we told FINRA that the issuer was prepared to find a new CEO. Moreover, we represented that while the old CEO would remain on the board of directors, he would be just one of four directors, with no unilateral ability to dictate any board decision. Finally, we also said that the old CEO would serve only in a consulting capacity, whose recommendations were subject to approval by the new CEO. We did not actually implement any of those changes, however, since to do so would be expensive, involve a lot of work, and possibly impact the value of the issuer’s shares in a negative way, as in, OMG, THE CEO WAS LET GO!! Instead, we simply told Operations that we would do these things, if they told us that if we made these changes, then the application would be approved this time.
We are still waiting for the decision on the resubmitted application, but, yesterday, we had a conference call with Operations, theoretically to discuss the proposed changes, to see what FINRA thought, i.e., to see if our proposal was enough to address the concerns that led to the application being denied the first time. Well, guess what? Operations absolutely, positively refused even to talk to us about our proposal. We were informed that all they could do was either approve or deny the specific application before them, but not give us any insight whatsoever into what they would do if the changes we proposed were actually implemented. We argued – respectfully – that it was their job to give advice, to help applicants get their applications approved by clearly articulating what their expectations were. I pointed out that FINRA employees from all Departments, whether Member Reg, Enforcement, Market Reg, etc., routinely give “conceptual” advice, to help members make sound business decisions. Indeed, at literally every securities conference I attend, Rick Ketchum and Susan Axelrod implore the audience to call them with questions or concerns, as FINRA is happy – HAPPY! – to answer them.
That all fell on deaf ears. When we pointed out that their very job was, really, to protect shareholders, and that their absolute refusal even to discuss our proposal could actually work to the detriment of the issuer’s shareholders, they merely shrugged it off, claiming what we asked was “impossible.” It turned into an utter waste of time and money.
There was a period of time, back in my NASD days, where senior NASD management implemented a “Customer Service” policy. The point of it was that we were to treat the NASD member firms as our “customers,” to help them with their compliance efforts, to answer their questions, to provide proactive advice and guidance, all to minimize the likelihood that any member would be found not to be in compliance. After all, the “customer is always right,” right? Well, that was short-lived. When the SEC found out about it, they went crazy, and admonished NASD for being so stupid as to treat its members as “customers.” And that was the end of that.
I am not saying, necessarily, that we need to return to those halcyon days of “Customer Service,” but I do firmly believe that FINRA has an obligation to its members to help them with compliance, to answer questions and to provide guidance. It is ridiculous for FINRA to refuse requests for assistance and, instead, simply to wait and watch to see if members who unsuccessfully seek help are somehow able to figure it out for themselves, and then deny applications (or bring Enforcement actions) if they cannot.
FINRA doesn’t seem to understand why its members are so frustrated and angry. It is events like yesterday’s that are part of the reason.
 Try searching on the FINRA website for its “Operations Department” or “Market Operations Department.” I am not sure it actually exists.
 The purpose of this post is not to discuss the intricacies of Rule 6490, but, for those who may be interested, the only grounds on which FINRA may base its conclusion are (1) FINRA staff’s reasonable belief that the forms and all documentation, in whole or in part, may not be complete, accurate or with proper authority; (2) the issuer is not current in its reporting requirements; (3) FINRA has actual knowledge that the issuer, associated persons, officers, directors, transfer agent, legal adviser, promoters or other persons connected to the issuer or the anticipated corporate action are the subject of a pending, adjudicated or settled regulatory action or investigation by a federal, state or foreign regulatory agency, or a self-regulatory organization; or a civil or criminal action related to fraud or securities laws violations; (4) a state, federal or foreign authority or self-regulatory organization has provided information to FINRA, or FINRA otherwise has actual knowledge indicating that the issuer, associated persons, officers, directors, transfer agent, legal adviser, promoters or other persons connected with the issuer or the anticipated corporate action may be potentially involved in fraudulent activities related to the securities markets and/or pose a threat to public investors; and/or (5) there is significant uncertainty in the settlement and clearance process for the security.