Daily Rules, Proposed Rules, and Notices of the Federal Government
FINRA is proposing to adopt NASD Rule 3020 (Fidelity Bonds) with certain changes into the consolidated FINRA rulebook as FINRA Rule 4360 (Fidelity Bonds), taking into account Incorporated NYSE Rule 319 (Fidelity Bonds) and its Interpretation.
The text of the proposed rule change is available on FINRA's Web site at
In its filing with the Commission, FINRA included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. FINRA has prepared summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements.
As part of the process of developing a new consolidated rulebook ("Consolidated FINRA Rulebook"),
NASD Rule 3020 and NYSE Rule 319 (and its Interpretation) generally require members to maintain minimum amounts of fidelity bond coverage for officers and employees, and that such coverage address losses incurred due to certain specified events. The purpose of a fidelity bond is to protect a member against certain types of losses, including, but not limited to, those caused by the malfeasance of its officers and employees, and the effect of such losses on the member's capital.
NASD Rule 3020(a) generally provides that each member required to join the Securities Investor Protection Corporation ("SIPC") that has employees and that is not a member in good standing of one of the enumerated national securities exchanges must maintain fidelity bond coverage; NYSE Rule 319(a) generally requires member organizations doing business with the public to carry fidelity bonds. Like NASD Rule 3020, proposed FINRA Rule 4360 would require each member that is required to join SIPC to maintain blanket fidelity bond coverage with specified amounts of coverage based on the member's net capital requirement, with certain exceptions.
NASD Rule 3020(a)(1) requires members to maintain a blanket fidelity bond in a form substantially similar to the standard form of Brokers Blanket Bond promulgated by the Surety Association of America. Under NYSE Rule 319(a), the Stockbrokers Partnership Bond and the Brokers Blanket Bond approved by the NYSE are the only bond forms that may be used by a member organization; NYSE approval is required for any variation from such forms. Proposed FINRA Rule 4360 would require members to maintain fidelity bond coverage that provides for per loss coverage without an aggregate limit of liability. Members may apply for this level of coverage with any product that meets these requirements, including the Securities Dealer Blanket Bond ("SDBB") or a properly endorsed Financial Institution Form 14 Bond ("Form 14").
Most fidelity bonds contain a definition of the term "loss" (or "single loss"), for purposes of the bond, which generally includes all covered losses resulting from any one act or a series of related acts. A payment by an insurer for covered losses attributed to a "single loss" does not reduce a member's coverage amount for losses attributed to other, separate acts. A fidelity bond with an aggregate limit of liability caps a member's coverage during the bond period at a certain amount if a loss (or losses) meets this aggregate threshold. FINRA believes that per loss coverage without an aggregate limit of liability provides firms with the most beneficial coverage since the bond amount cannot be exhausted by one or more covered losses, so it will be available for future losses during the bond period.
Under proposed FINRA Rule 4360, a member's fidelity bond must provide against loss and have Insuring Agreements covering at least the following: fidelity, on premises, in transit, forgery and alteration, securities and counterfeit currency. The proposed rule change modifies the descriptive headings for these Insuring Agreements, in part, from NASD Rule 3020(a)(1) and NYSE Rule 319(d) to align them with the headings in the current bond forms available to broker-dealers. FINRA has been advised by insurance industry representatives that the proposed rule change does not substantively change what is required to be covered by the bond.
In addition, proposed FINRA Rule 4360 would eliminate the specific coverage provisions in NASD Rule 3020(a)(4) and (a)(5), and NYSE Rule 319(d)(ii)(B) and (C), and (e)(ii)(B) and (C), that permit less than 100 percent of coverage for certain Insuring Agreements (
Like NASD Rule 3020(a)(1)(H) and NYSE Rule 319.12, proposed FINRA Rule 4360 would require that a member's fidelity bond include a cancellation rider providing that the insurer will use its best efforts to promptly notify FINRA in the event the bond is cancelled, terminated or "substantially modified." Also, the proposed rule change would adopt the definition of "substantially modified" in NYSE Rule 319 and would incorporate NYSE Rule 319.12's standard that a firm must immediately advise FINRA in writing if its fidelity bond is cancelled, terminated or substantially modified.
FINRA is proposing to add supplementary material to proposed FINRA Rule 4360 that would require members that do not qualify for a bond with per loss coverage without an aggregate limit of liability to secure
NASD Rule 3020 requires fidelity bond coverage for officers and employees of a member. Under NASD Rule 3020(e), the term "employee" or "employees" means any person or persons associated with a member firm (as defined in Article I, paragraph (rr) of the FINRA By-Laws) except: (1) Sole proprietors, (2) sole stockholders and (3) directors or trustees of a member who are not performing acts coming within the scope of the usual duties of an officer or employee. Under NYSE Rule 319(a), any member organization doing business with the public must maintain fidelity bond coverage for general partners or officers and its employees.
Proposed FINRA Rule 4360, similar to NASD Rule 3020 and NYSE Rule 319, would require each member to maintain, at a minimum, fidelity bond coverage for any person associated with the member, except directors or trustees of a member who are not performing acts within the scope of the usual duties of an officer or employee. As further detailed below, the proposed rule change would eliminate the exemption in NASD Rule 3020 for sole stockholders and sole proprietors.
The proposed rule change would increase the minimum required fidelity bond coverage for members, while continuing to base the coverage on a member's net capital requirement. To that end, proposed FINRA Rule 4360 would require a member with a net capital requirement that is less than $250,000 to maintain minimum coverage of the greater of 120 percent of the firm's required net capital under Exchange Act Rule 15c3-1 or $100,000. The increase to $100,000 would modify the present minimum requirement of $25,000. FINRA believes this increase is warranted since the NASD and NYSE fidelity bond rules have not been materially modified since their adoption--over 30 years ago--and $25,000 in 1974 (the year the NASD rule was adopted) is equal to approximately $110,000 today (adjusted for inflation). Although members may experience a slight increase in costs for their premiums under the proposed rule change, FINRA believes that the proposed amendments to the fidelity bond minimum requirements are necessary to provide meaningful and practical coverage for losses covered by the bond.
Under proposed FINRA Rule 4360, members with a net capital requirement of at least $250,000 would use a table in the rule to determine their minimum fidelity bond coverage requirement. The table is a modified version of the tables in NASD Rule 3020(a)(3) and NYSE Rule 319(e)(i). The identical NASD and NYSE requirements for members that have a minimum net capital requirement that exceeds $1 million would be retained in proposed FINRA Rule 4360; however, the proposed rule would adopt the higher requirements in NYSE Rule 319(e)(i) for a member with a net capital requirement of at least $250,000, but less than $1 million.
Under the proposed rule, the entire amount of a member's minimum required coverage must be available for covered losses and may not be eroded by the costs an insurer may incur if it chooses to defend a claim. Specifically, any defense costs for covered losses must be in addition to a member's minimum coverage requirements. A member may include defense costs as part of its fidelity bond coverage, but only to the extent that it does not reduce a member's minimum required coverage under the proposed rule.
Under NASD Rule 3020(b), a deductible provision may be included in a member's bond of up to $5,000 or 10 percent of the member's minimum insurance requirement, whichever is greater. If a member desires to maintain coverage in excess of the minimum insurance requirement, then a deductible provision may be included in the bond of up to $5,000 or 10 percent of the amount of blanket coverage provided in the bond purchased, whichever is greater. The excess of any such deductible amount over the maximum permissible deductible amount based on the member's minimum required coverage must be deducted from the member's net worth in the calculation of the member's net capital for purposes of Exchange Act Rule 15c3-1. Where the member is a subsidiary of another member, the excess may be deducted from the parent's rather than the subsidiary's net worth, but only if the parent guarantees the subsidiary's net capital in writing.
Under NYSE Rule 319(b), each member organization may self-insure to the extent of $10,000 or 10 percent of its minimum insurance requirement as fixed by the NYSE, whichever is greater, for each type of coverage required by the rule. Self-insurance in amounts exceeding the above maximum may be permitted by the NYSE provided the member or member organization certifies to the satisfaction of the NYSE that it is unable to obtain greater bonding coverage, and agrees to reduce its self-insurance so as to comply with the above stated limits as soon as possible, and appropriate charges to capital are made pursuant to Exchange Act Rule 15c3-1. This provision also contains identical language to the NASD rule regarding net worth deductions for subsidiaries.
Proposed FINRA Rule 4360 would provide for an allowable deductible amount of up to 25 percent of the fidelity bond coverage purchased by a member. Any deductible amount elected by the firm that is greater than 10 percent of the coverage purchased by the member
Consistent with NASD Rule 3020(c) and NYSE Rule 319.10, proposed FINRA Rule 4360 would require a member (including a firm that signs a multi-year insurance policy), annually as of the yearly anniversary date of the issuance of the fidelity bond, to review the adequacy of its fidelity bond coverage and make any required adjustments to its coverage, as set forth in the proposed rule. Under proposed FINRA Rule 4360(d), a member's highest net capital requirement during the preceding 12-month period, based on the applicable method of computing net capital (dollar minimum, aggregate indebtedness or alternative standard), would be used as the basis for determining the member's minimum required fidelity bond coverage for the succeeding 12-month period. The "preceding 12-month period" includes the 12-month period that ends 60 days before the yearly anniversary date of a member's fidelity bond. This would give a firm time to determine its required fidelity bond coverage by the anniversary date of the bond.
Similar to NASD Rule 3020(c)(2), proposed FINRA Rule 4360 would allow a member that has only been in business for one year and elected the aggregate indebtedness ratio for calculating its net capital requirement to use, solely for the purpose of determining the adequacy of its fidelity bond coverage for its second year, the 15 to 1 ratio of aggregate indebtedness to net capital in lieu of the 8 to 1 ratio (required for broker-dealers in their first year of business) to calculate its net capital requirement. Notwithstanding the above, such member would not be permitted to carry less minimum fidelity bond coverage in its second year than it carried in its first year.
Based in part on NASD Rule 3020(a), proposed FINRA Rule 4360 would exempt from the fidelity bond requirements members in good standing with a national securities exchange that maintain a fidelity bond subject to the requirements of such exchange that are equal to or greater than the requirements set forth in the proposed rule.
Proposed FINRA Rule 4360 would not maintain the exemption in NASD Rule 3020(e) for a one-person firm.
FINRA understands that changes to a firm's fidelity bond policy, in coordination with insurance providers, may be impacted by bond renewal cycles and changes required by the insurance industry. FINRA will consider such factors in establishing an implementation date for the proposed rule change upon approval by the SEC.
FINRA will announce the implementation date of the proposed rule change in a
FINRA believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act,
FINRA does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.
In July 2009, FINRA published
As originally proposed in
Many commenters noted that an aggregate limit of liability is standard in the industry and important to most underwriters because it quantifies and controls the underwriter's maximum exposure to loss during the bond period.
In response to the comments, FINRA made certain changes to the original proposal. Specifically, FINRA has amended the proposed rule to remove the requirement that a member maintain fidelity bond coverage with the SDBB, and alternatively with the Form 14. As detailed in the Purpose section of this rule filing, the proposed rule would require a member to maintain blanket fidelity bond coverage with a bond that would provide for per loss coverage without an aggregate limit of liability (
Additionally, FINRA has amended its original proposal for alternative coverage in the supplementary material to the proposed rule to provide that a member that does not qualify for blanket fidelity bond coverage as required by proposed FINRA Rule 4360(a)(3) must maintain substantially similar fidelity bond coverage in compliance with all other provisions of the proposed rule, provided that the member maintains written correspondence from two insurance providers stating that the member does not qualify for the coverage required by proposed FINRA Rule 4360(a)(3). The member would be required to retain such correspondence for the period specified by Exchange Act Rule 17a-4(b)(4).
One commenter agreed with FINRA's proposal to increase the minimum bond limit requirement because losses often exceed the current minimum bond requirements, which exposes firms' net capital and, in some cases, results in a SIPC liquidation proceeding.
Certain other commenters opposed the increase in the minimum bond requirement arguing that it will have a disproportionately negative effect on small firms, including small firms that engage in certain business areas that require a higher net capital amount.
FINRA does not propose to make any changes to the proposed minimum requirements set forth in
One commenter suggested that the proposed rule require notification to FINRA in the event that the member has experienced a loss or losses that have exhausted its fidelity bond coverage.
Two commenters suggested that FINRA incorporate an exemption into the proposed rule for firms that are a subsidiary of a larger parent organization.
FINRA notes that neither the current fidelity bond rule nor the proposed fidelity bond rule precludes a member from being part of its parent organization's fidelity bond coverage as long as the coverage under the parent's bond provides equal to or greater
Two commenters urged FINRA to maintain an exemption from the fidelity bond requirements for one-person firms.
As noted above in the Purpose section of this rule filing, many one-person firms currently maintain fidelity bond coverage notwithstanding the exemption in NASD Rule 3020, and claims are likely to be paid based on a facts-and-circumstances analysis, not on a firm's size or structure. As such, FINRA is not proposing any changes to the original proposal in this respect.
One commenter noted that the proposed rule serves no purpose to investors of the financial markets in its application to small firms that do not hold customer funds, execute transactions in securities on public markets, or engage in trading or underwriting (
FINRA believes that all members of SIPC should maintain fidelity bond coverage. FINRA does not agree with the commenter's assessment, since any firm could be the target of malfeasance of one of its employees. Thus, FINRA is not proposing to incorporate an exemption for these small firms.
One commenter encouraged FINRA to incorporate a requirement for an insuring agreement for Computer Theft.
One commenter supported increased deductible thresholds; however, the commenter suggested deleting the haircut provision because the proposed rule may discourage a firm from pursuing or accepting higher deductibles if it has to take a haircut in its net capital computation for deductibles over 10 percent.
Within 45 days of the date of publication of this notice in the
(A) By order approve or disapprove the proposed rule change, or (B) institute proceedings to determine whether the proposed rule change should be disapproved.
Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods:
* Use the Commission's Internet comment form (
* Send an e-mail to
* Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.