After many years of negotiations with the SEC staff, FINRA recently proposed for comment Rule 3190 to clarify the scope of the obligations and supervisory responsibility of member firms for functions outsourced to third-party service providers. The rule would reiterate current restrictions on all member firm’s outsourcing arrangements while also applying new and heightened obligations to clearing and carrying firms. In addition, the proposed rule explicitly treats affiliates like any other third-party provider and requires notice to FINRA of outsourcing arrangements. The comment period expires on May 13, 2011.
Obligations and Supervisory Responsibilities Regarding Outsourcing Arrangements
The requirements in proposed FINRA Rule 3190 applicable to all member firm’s arrangements with third-party service providers largely codify and align with prior FINRA guidance in this area (most notably NASD Notice to Members 05-48). These include:
Heightened Restrictions on Clearing or Carrying Firms
Proposed FINRA Rule 3190 would impose heightened restrictions and obligations on clearing or carrying members, on the rationale that there is increased risk due to such firms’ roles in protecting customer funds and securities.
Activities that Must be Performed by Associated Person: The proposed rule would limit enumerated activities to an appropriately registered associated person subject to the direct control and supervision of the clearing or carrying firm. Such specified activities include the movement of customer proprietary cash or securities; preparation of net capital reserve formula computations; and the adoption or execution of compliance or risk management systems, subject to limited exceptions for ministerial activities.
- Additional Supervisory Procedures: A clearing or carrying firm would be required to adopt additional procedures to oversee third-party service providers to ensure the firm could take prompt corrective action if needed to ensure compliance with applicable requirements, and to require the firm to approve the use of sub-contracting by the third-party vendor.
- Notification Requirements: The proposed rule imposes new notification requirements of a clearing or carrying firm’s outsourcing arrangements. Within 30 days of entering into an outsourcing arrangement, a clearing or carrying firm would be required to provide to FINRA specified information (e.g. function to be performed, description of affiliation, identity and regulator of the vendor). Clearing or carrying firms would need to notify FINRA of all existing outsourcing arrangements within three months of the effective date of the rule. In the proposal, FINRA suggests that (while not required by the proposed rule) a clearing or carrying firm may seek FINRA’s review prior to entering into an arrangement with a third-party provider.
The proposal would need to be filed with and approved by the SEC prior to becoming effective.
Click here for the proposed rule.