FINRA Issues an Interpretation to Clarify the Classification and Trade Reporting of Certain "Hybrid" Securities to FINRA
Capital Trust Security
Over-the-Counter Reporting Facility
Trust Preferred Security
Referenced Rules & Notices
FINRA Rule 6420
FINRA Rule 6622
FINRA Rule 6700 Series
FINRA Rule 6710
Regulation NMS Rule 600(b)(47)
Regulatory Notice 08-72
SEA Rule 144(a)(3)
SEA Rule 144A
SEA Section 31
Section 3 of Schedule A to the FINRA By-Laws
FINRA is publishing this Notice to provide additional information on how trades in certain securities that have both debt- and equity-like features (hybrid securities) must be reported to FINRA. Specifically, the SEC approved an interpretation regarding the appropriate trade reporting facility to which firms should report transactions in the following three types of hybrid securities: (1) unlisted depositary shares having a liquidation preference of $1,000 or more; (2) unlisted non-convertible, preferred securities having a liquidation preference of $1,000 or more; and (3) unlisted capital trust securities (also referred to as trust preferred securities) (together, "covered hybrid securities").1
In accordance with this interpretation, on June 16, 2014, firms will be required to report transactions in covered hybrid securities to the Trade Reporting and Compliance Engine (TRACE). However, firms may request the set-up of a new hybrid security for trade reporting purposes in accordance with this interpretation prior to that date. A list of covered hybrid securities that will be moved from the OTC Reporting Facility (ORF) to TRACE on June 16, 2014, is attached as Appendix A.
Questions regarding this Notice should be directed to:
Background and Discussion
FINRA trade reporting rules generally require that firms report over-the-counter (OTC) transactions in debt securities that are "TRACE-Eligible Securities"2 and equity securities to FINRA. FINRA Rule 6622 requires that firms report OTC transactions in "OTC Equity Securities"3 to ORF and the FINRA Rule 6700 series requires firms to report transactions in TRACE-Eligible Securities to TRACE.
In consultation with the industry, FINRA has determined that the term "TRACE-Eligible Security" includes the following covered hybrid securities (and thus these securities should be reported to TRACE):4
Any such security deemed a "TRACE-Eligible Security" would be excluded from the defined term "OTC Equity Security."7
All other preferred securities and depositary shares representing fractional interests in these securities, except the covered hybrid securities identified above, will continue to be included in the defined term "OTC Equity Security," and firms must report transactions in such securities to ORF.8 For example, a non-convertible preferred security having a par value or liquidation preference of $25 that is not listed on an equity facility of a national securities exchange would be an "OTC Equity Security" under the interpretation and would be required to be reported to ORF.
Thus, beginning on June 16, 2014, any firm reporting a trade in a hybrid security must report the transaction to the appropriate facility in compliance with this interpretation. However, prior to June 16, 2014, any firm requesting the set-up of a new hybrid security for trade reporting purposes may, but is not required to, do so in accordance with this interpretation.
A list of covered hybrid securities that will be moved from ORF to TRACE on June 16, 2014, is attached as Appendix A.
1See Securities Exchange Act Release No. 71927 (April 10, 2014), 79 FR 21494 (April 16, 2014) (Order Approving Proposed Rule Change, as Modified by Amendment No. 1 of File No. SR-FINRA-2013-039).
2 FINRA Rule 6710(a) defines "TRACE-Eligible Security" as a debt security that is United States ("U.S.") dollar-denominated and issued by a U.S. or foreign private issuer, and, if a "restricted security" as defined in Securities Act Rule 144(a) (3), sold pursuant to Securities Act Rule 144A; or is a debt security that is U.S. dollar-denominated and issued or guaranteed by an Agency as defined in paragraph (k) or a Government-Sponsored Enterprise as defined in paragraph (n). However, the term "TRACE-Eligible Security" does not include a debt security that is: issued by a foreign sovereign, a U.S. Treasury Security as defined in paragraph (p), or a money market instrument as defined in paragraph (o).
3 FINRA Rule 6420(f) defines "OTC Equity Security" to include "any equity security that is not an 'NMS stock' as that term is defined in Rule 600(b) (47) of SEC Regulation NMS; provided, however, that the term 'OTC Equity Security' shall not include any Restricted Equity Security." FINRA Rule 6420(k) defines "Restricted Equity Security" to mean "any equity security that meets the definition of 'restricted security' as contained in Securities Act Rule 144(a)(3)."
4 This interpretation applies solely to a hybrid security that is not listed on an equity facility of a national securities exchange. See e.g., FINRA Trade Reporting Notice–2/22/08, (FINRA applied TRACE reporting requirements, distinguishing between listed and unlisted securities, and required firms to report transactions in unlisted convertible debt and unlisted equity-linked notes to TRACE, and OTC transactions in convertible debt and equity-linked notes listed on an equity facility of a national securities exchange to an appropriate FINRA equity trade reporting facility for NMS Stocks (the Alternative Display Facility (ADF) or a trade reporting facility (TRF)). For purposes of this interpretation, the term "listed on an equityfacility of a national securities exchange" means a security that qualifies as an NMS stock (as defined in Rule 600(b)(47) of Regulation NMS under the Act) as distinguished from a security that is listed on a bond facility of a national securities exchange. See 17 CFR 242.600(b)(47).
5 The term "TRACE-Eligible Security" includes capital trust securities and trust preferred securities (other than a capital trust security or a trust preferred security that is listed on an equity facility of a national securities exchange) and transactions in such securities must be reported to TRACE (and not to ORF) in compliance with the applicable reporting requirements. This interpretation would apply even if the capital trust security (or a trust preferred security) was previously listed on an equity facility of a national securities exchange and reported to a FINRA equity facility, but has since been delisted. Once delisted, the security must be reported to TRACE. Similarly, any other hybrid security that does not meet the definition of "covered hybrid security" solely because it is listed on a national securities exchange would be required to be reported to TRACE once delisted.
6 Non-convertible means not convertible into or exchangeable for property or shares of any other series or class of the issuer's capital stock.
7 This interpretation also applies to unlisted American Depository Receipts (ADRs) on hybrid securities in the same manner in which it applies to the underlying hybrid security. Thus, an unlisted ADR on a covered hybrid security would be excluded from the definition of "OTC Equity Security" under the interpretation and would be required to be reported to TRACE. Whereas, an unlisted ADR on a depositary share having a par value or liquidation preference of $25 would be an "OTC Equity Security" under the interpretation and would be required to be reported to ORF.
8 Pursuant to Section 31 of the Act, FINRA and the national securities exchanges are required to pay transaction fees and assessments to the SEC that are designed to recover the costs related to the government's supervision and regulation of the securities markets and securities professionals. See 15 U.S.C. 78ee. FINRA obtains its Section 31 fees and assessments from its membership, in accordance with Section 3 of Schedule A to the FINRA By-Laws. The transactions that are assessable under Section 3 of Schedule A to the FINRA By-Laws are reported to FINRA through one of FINRA's equity trade reporting facilities: the ORF, the ADF, or a TRF. As expressly stated in the Act, sales of bonds, debentures, or other evidence of indebtedness (debt securities) are excluded from Section 31 of the Act. See 15 U.S.C. 78ee(b). Because of this exclusion under Section 31 of the Act, transactions reported to TRACE are not subject to the regulatory transaction fee under Section 3 of Schedule A to the FINRA By-Laws. To determine whether a non-exchange listed security is an equity security or a debt security for purposes of assessing the regulatory transaction fee, FINRA relies on the facility to which the transaction is reported. If the transaction is reported to the ORF, the transaction is treated as one involving an equity security and is subject to the regulatory transaction fee. If the transaction is reported to TRACE, the transaction is treated as one involving a debt security and thus is not subject to the regulatory transaction fee. See Regulatory Notice 08-72.
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