I’m attorney Laura Anthony founding partner of Legal & Compliance, a full service corporate,
securities, and business transactions law firm.
Today is the final LawCast in a series about distributed ledger technology also known as
DLT or blockchain.
In addition to general information I have provided during this LawCast series I have
also been summarizing a report issued by FINRA in January, 2017 discussing the implications
of DLT for the securities industry, including FINRA member broker dealer firms.
In the report, FINRA specifically discussed some major areas of consideration.
In this and the previous LawCasts in this series, I have been going through each of
those topics and summarizing what was contained in the FINRA report.
Related to Anti-Money Laundering and Customer Identification Programs, DLT allows for global
and anonymous participation, and, accordingly, practices and regulations will need to address
anti-money laundering, called AML and customer identification obligations, known as CIP.
The Bank Secrecy Act of 1970 requires controls and procedures to detect and prevent money
laundering.
FINRA Rule 3310 addresses AML obligations.
In addition, FINRA Rule 2090, the Know Your Customer, or KYC Rule, requires firms to use
reasonable diligence, in regard to the opening and maintenance of every account, to know
and retain the essential facts concerning every customer and concerning the authority
of each person acting on behalf of such customer.
Technology is already being explored to centralize identity management functions such that once
a customer identity is verified, the information can be shared with all network participants.
Obviously this would greatly streamline processes for broker-dealers and customers alike.
It is likely that DLT technology will surpass regulatory changes in the AML, CIP and KYC
sectors.
The FINRA report notes that the current rules allows a firm to outsource functions to third
parties, but not overall responsibility.
Accordingly, a firm could utilize DLT technology for these functions now if they can fashion
internal controls and procedures that comply with the ultimate rule responsibilities.
This will be a big hurdle though it will be difficult.
Related to Customer Data Privacy, Broker-dealers have an obligation to protect personal customer
information as specified in Regulation S-P.
The rules also require that a firm provide an annual notice to customers related to the
protection, and sharing, of their personal information.
DLT by nature will include customer information and transaction histories that will be available
to all network participants.
Regulations, as well as internal controls and procedures, will need to adapt for this
DLT technology to protect personal identification identifying information.
Related to Trade and Order Reporting Requirements.
FINRA regulates the trading and order reporting requirements for the over-the-counter markets,
(OTC Markets, and requires certain reports to a centralized Securities Information Processor
for listed securities.
DLT may be soon be used for the facilitation of OTC Markets equity transactions.
This may involve tokenizing existing securities and trading on a different network.
FINRA Rule 6100 Series called Quoting and Trading in NMS Stock) Rule 6400 Series, Quoting
and Trading on OTC Equity Securities, Rule 4550 Series for Alternative Trading Systems
and Rule 5000 Series governing offering and trading standards and practices would all
be implicated.
Related to Supervision and Surveillance, DLT networks will present new and unique challenges
related to maintaining supervisory rules and procedures as well as surveillance systems
themselves.
This area includes the ability to review customer accounts and correct order errors.
Like other areas of DLT technology, centralized systems available to all network participants
are being developed that can perform some of these functions.
Related to Fees and Commissions: certain additional fees may be necessary for a DLT network, such
as wallet management, key management and on-boarding, whereby other areas may reduce fees as centralization
brings economies of scale.
In addition, consideration must be given to the payment of fees to third parties that
are not registered broker-dealers but that provide DLT outsource functions.
Related to Customer Confirmations and Account Statements: Exchange Act Rule 10b-10 requires
firms to provide customers with certain records including trade confirmations and account
statements.
DLT technology will change the flow and availability of this information.
Related to the Material Impact on Business Operations.
NASD Rule 1017(a)(5) requires broker-dealers that undergo a material change in business
operations to file a Continuing Membership Application.
or CMA, prior to implementing the material change.
Many of the aspects of DLT technology will result in material change and broker-dealers
will need to consider the need to file 1017 applications.
Finally, related to Business Continuity Plans.
FINRA Rule 4370 requires broker-dealers to maintain business continuity standards and
plans.
Firms may consider the impact, and must consider the impact of DLT technology on their plans
and update them accordingly.
I’m securities attorney Laura Anthony, founding partner of Legal & Compliance, and producer
of LawCast.
Should you have any questions about today’s topic, please visit SecuritiesLawBlog.com
and LawCast.com, or contact me directly.
Inquiries of a technical nature are always encouraged.