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FINRA Office of General Counsel (Auction Rate Securities)

Staff Interpretive Memo
July 9, 2008

FINRA staff is issuing this memorandum to clarify certain questions that have arisen after the issuance of Regulatory Notice 08-21 (the Notice), in which FINRA provided guidance to its members on partial redemptions of auction rate securities.

As was referenced in the Notice, in response to current market conditions, some issuers are offering partial redemptions of auction rate securities. FINRA member firms have raised questions about the precise allocation methodologies that might be acceptable under NASD Rule 2110 and NYSE Rule 402.30 in such partial redemptions.

FINRA set out in the Notice the requirements of the respective governing rules. Where a member firm is considering the adoption of an allocation process that diverges from the express provisions of NYSE Rule 402.30, but such methodology is believed to comport with the principles set forth in the Notice—including that no customers are disadvantaged—given the exigencies of the partial redemptions in these particular securities, the member firm should contact its FINRA Coordinator for a determination that such methodology will be acceptable.

Member firms should note that such determination does not constitute a conclusion that the member firm's allocation methodology is consistent with an issuer's obligation pertaining to calls and redemptions under Investment Company Act Rule 23c-2. Member firms should understand that they must rely on their own counsel in determining compliance with any such federal rule, or seek guidance from the Securities and Exchange Commission staff. FINRA reminds member firms that allocation methodologies in redemptions or calls which are favorable to the called parties may include its proprietary positions and those of its associated persons only after all customer positions are satisfied.

FINRA notes further that, when dealing with investors who hold securities that have become illiquid (such as auction rate securities that are experiencing failed auctions), NASD Rule 2110 requires that firms must provide fair and balanced communications pertaining to material matters related to such securities, including allocation methodologies in the case of redemptions and calls. Among the possible methods of such communications could be:

  1. Specific notice by mail or email (in cases where that is an established means of communication with the customer) to affected customers, setting out in plain English the allocation procedures of the member firm;
  2. Maintenance of an accessible page on the member firm's Web site, provided that its availability is effectively communicated to customers; and/or
  3. Including prominent, plain English disclosures on customer statements.

Such communications should include examples of the allocation process to illustrate the explanation.

Please note that the opinions expressed in this memorandum are staff opinions only and have not been reviewed or endorsed by the FINRA Board of Governors. This staff memorandum responds only to the issues raised, and does not address any other rule or interpretation of FINRA, or all the possible regulatory and legal issues involved.

If you have any questions regarding this memorandum, please contact your Coordinator or Gregory Taylor, Principal Rule Counsel, Sales Practice Policies, Member Regulation, at (646) 315-8599.