February 27, 2014.
On September 16, 2013, the Financial Industry Regulatory Authority, Inc. (“FINRA”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) 
and Rule 19b-4 thereunder,
a proposed rule change to clarify the classification and reporting of certain securities to FINRA. The proposed rule change was published for comment in the Federal Register on September 30, 2013.
The Commission received two comments on the proposal.
On November 12, 2013, FINRA granted the Commission an extension of time to act on the proposal until December 29, 2013.
On December 24, 2013, the Commission instituted proceedings to determine whether to disapprove the proposed rule change.
On February 12, 2014, FINRA submitted Amendment No. 1 to respond to the comment letters and amend the proposed rule change, as described below in Item II, which Item has been prepared by FINRA. The Commission is publishing this notice to solicit comment from interested persons on the proposed rule change, as modified by Amendment No. 1.
II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change, as Modified by Amendment No. 1
In its filing with the Commission, FINRA included statements concerning the purpose of and basis for the proposed rule change and discussed any Start Printed Page 12542comments 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.
A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change
FINRA trade reporting rules generally require that members report over-the-counter (“OTC”) transactions in debt securities that are “TRACE-Eligible Securities” 
and equity securities to FINRA.
FINRA Rule 6622 (Transaction Reporting) requires that members report OTC transactions in “OTC Equity Securities” 
to the ORF and the FINRA Rule 6700 Series requires members to report transactions in TRACE-Eligible Securities to TRACE.
FINRA recently has received inquiries regarding the appropriate classification of certain “hybrid” securities for trade reporting purposes. FINRA is aware that as new securities are created and issued, in some cases, the newer hybrid iteration, although derived from a traditional security, may be increasingly complex, and may have both debt and equity-like features. These hybrid securities are frequently designed to straddle both classifications for a variety of purposes, including the tax treatment applicable to issuers and recipients when distributions are made (or not made) to holders of the security, and the treatment of the principal as capital for issuers subject to capital requirements. As such, determining whether these hybrid securities should be treated as an OTC Equity Security or a TRACE-Eligible Security for purposes of trade reporting to the appropriate FINRA facility has become less clear.
Given the complexity of these hybrid securities, FINRA proposed an interpretation regarding the classification and reporting of two categories of hybrid securities (capital trust securities (also referred to as trust preferred securities) and certain depositary shares) to clarify the appropriate trade reporting facility to which such securities should be reported.
In addition, FINRA proposed a policy to address the treatment of securities that are currently being reported to a facility that is not the designated facility under this interpretation.
On September 30, 2013, the SEC published the proposed rule change for comment in the Federal Register.
The SEC received two comment letters in response to the proposed rule change, both of which raised concerns with certain aspects of the proposal.
Both commenters indicated that the vast majority of hybrid securities identified in the interpretation are traded by their members as fixed income securities.
In particular, SIFMA noted that hybrid securities with a par value of $1,000 or more have historically been traded and settled with a debt convention 
as such securities traded on the basis of yield and credit quality and, similarly, investors evaluated them based on their debt-like characteristics, such as yield, time to first call, credit rating and priority in the capital structure in that they are paid after other debt but before common equity. Thus, commenters indicated that reporting such securities to TRACE better accommodates and is consistent with these debt trading conventions.
Given that these securities have historically traded and been reported as debt, the commenters raised many concerns about the significant disruption to fixed income trading work flows that would result if these securities were reported to the ORF, in light of the interdependencies among trading systems, including the operational and technology changes and costs associated therewith. Commenters highlighted a variety of potential downstream impacts of reporting depositary shares to ORF 
and questioned whether the benefits of the proposal outweigh the costs.
SIFMA raised similar concerns emphasizing that the hybrid securities market is a critical part of the capital markets, noting that many of these securities are being issued by financial institutions to satisfy equity capital requirements as part of the International Regulatory Framework for Banks developed by the Bank for International Settlements, known as Basel III. SIFMA indicated that a shift in the market practice for these securities could create investor confusion in the market. SIFMA argues that investors, institutional investors in particular, use the debt trading analytics as a critical part of their investment decisions and any change to the practice could in turn negatively impact liquidity. Further, SIFMA emphasized that there is regulatory precedent to permit the subject securities to be reported to TRACE and would be consistent with conclusions reached by the Commission in other contexts with respect to non-convertible preferred securities that may be classified or treated as debt Start Printed Page 12543securities.
SIFMA also expressed its belief that the proposal does not address the full spectrum of hybrid securities and the classification should provide further clarity and guidance in anticipation of further market developments. Regardless of the ultimate reporting venue, SIFMA indicated at least one year is needed to implement any necessary changes.
Response to Commenters
After careful consideration of the comments, FINRA acknowledges that the appropriate classification of hybrid securities is a complex analysis that has important consequences. FINRA agrees with the commenters that hybrid securities, in particular securities with a liquidation preference of $1,000 or more, do indeed have significant debt-like characteristics, as noted by SIFMA, that were created to “mix and match both debt and equity characteristics to achieve the particular tax, regulatory capital and rating agency treatment needs of the issuer” and “is an important source of bank regulatory capital.” As such, given the multi-faceted nature of these products, FINRA believes all aspects of these products should be given consideration in evaluating the proper classification for trade reporting purposes. In this regard, FINRA further discussed the proposal with several institutional investor representatives who also agreed with the concerns raised by commenters of potential unintended downstream impact if these securities were not reported to TRACE.
Given the consistent view throughout the industry, FINRA believes it is appropriate to treat these securities as debt for purposes of trade reporting. Accordingly, FINRA proposes to modify its original interpretation to provide that, in addition to capital trust and trust preferred securities, the term TRACE-Eligible Security includes: (1) a depositary share having a liquidation preference of $1,000 or more (or a cash redemption price of $1,000 or more) that is a fractional interest in a non-convertible,
preferred security and is not listed on an equity facility of a national securities exchange (“hybrid $1,000 depositary share”); and (2) a non-convertible, preferred security having a liquidation preference of $1,000 or more (or a cash redemption price of $1,000 or more) that is not listed on an equity facility of a national securities exchange (“hybrid $1,000 preferred security”), such as a hybrid $1,000 preferred security that is offered directly to an investor or a preferred security underlying multiple hybrid $1,000 depositary shares.
Any such security deemed as a TRACE-Eligible Security would be excluded from the defined term OTC Equity Security.
FINRA believes that consistency in the market practice and maintaining the established securities transaction information flow to investors is important and furthers the highly developed reporting and transparency infrastructure already in place to which the marketplace and investors are accustom. FINRA believes that the TRACE system better accommodates the debt trading and reporting conventions of these securities and investors will be able to more reliably and efficiently find market information about these securities, consistent with how they access information for products that trade based on similar characteristics, e.g., yield and credit quality.
FINRA believes this amended interpretation will prevent investor confusion by allowing hybrid $1,000 depositary shares and hybrid $1,000 preferred securities to be reported to TRACE. Since the reporting determination is an important factor in driving certain downstream activities, such as clearing and settling such securities and the reporting data used by investors and other market participants, FINRA believes the proposed amended interpretation preserves the established market practice for these securities and achieves investor protection goals consistent with the debt-like nature of the security, without being unduly burdensome and requiring significant technological changes. As raised by SIFMA, FINRA also believes the revised interpretation is consistent with conclusions reached by the Commission in other contexts with respect to non-convertible preferred securities that may be classified or treated as debt securities.
While it is impossible to address all future types of securities, as it frequently is a security-specific fact-based analysis, FINRA believes that the expansion of the proposed interpretation to address additional forms of hybrid securities will address a significant portion of the market and adapt to future offerings. FINRA endeavors to continue to work directly with SIFMA, FIF and all market participants to ensure consistent reporting treatment across the hybrid securities market. Further, FINRA believes the modified interpretation set forth above provides sufficient detail and guidance for members to ensure accurate reporting to the appropriate trade reporting facility.
In light of the expanded and modified interpretation discussed above, FINRA declines to extend the implementation date beyond the originally proposed maximum of 150 days following Commission approval. FINRA believes that the modified interpretation largely follows current market practice and accordingly anticipates that members will be able to comply within such timeframe.
Other Preferred Securities and Depositary Shares
All other preferred securities and depositary shares representing fractional interests in such securities except the hybrid securities identified above—hybrid $1,000 preferred securities and hybrid $1,000 depositary shares—will continue to be included in the defined term OTC Equity Security, and members must report transactions in such securities to ORF. 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.
When reporting to ORF is required, members must report in accordance with ORF requirements. For example, price should be reported as the dollar price per share and volume should be reported as the number of preferred shares traded.
Start Printed Page 12544
Hybrid Securities Currently Being Reported to ORF and TRACE
As noted in the original proposal, FINRA believes that, given the complexity of many of the securities that are the subject of this proposed rule change, it is reasonable that firms, despite their best efforts, may have reached different conclusions on where transactions in these hybrid securities should be reported. FINRA proposes that, as of the implementation date of this proposed rule change, securities that are affected by this amended proposed interpretation will be transferred, if necessary, for reporting to the appropriate trade reporting facility, and after this transfer members must report all transactions in such securities to the appropriate trade reporting facility. Members will not be required to retroactively cancel and correct any transactions in such securities previously reported to a facility that is not the designated facility under this interpretation. Thus, members will not be required to cancel and correct transactions in capital trust securities reported to the ORF or transactions in preferred securities and depositary shares reported to TRACE (excluding hybrid $1,000 preferred securities and hybrid $1,000 depositary shares) prior to the implementation date of this proposed rule change.
However, if a firm reported a transaction to the facility designated in this proposed interpretation, but did not report in accordance with the applicable trade reporting requirements of that facility (e.g., a firm reported a transaction to ORF, but inaccurately reported the price or size as if reporting to TRACE), the firm will be required to cancel and re-report such transactions accurately.
FINRA will publish the interpretation and its implementation date in a Regulatory Notice no later than 60 days following Commission approval. The implementation date will be no later than 90 days following publication of the Regulatory Notice announcing Commission approval.
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act,
which requires, among other things, that FINRA rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. FINRA believes that by clarifying the classification of certain hybrid securities that are not listed on an equity facility of a national securities exchange for reporting purposes, the proposed rule change will reduce market and investor confusion. In addition, FINRA believes that the proposed rule change will improve transparency significantly because members will report transactions in the same security using a uniform set of conventions and to the same facility (i.e., the ORF or TRACE). This will allow investors and other market participants to better compare transaction pricing and the quality of their executions, which promotes just and equitable principles of trade, deters fraudulent and manipulative acts and practices in the market for such securities, and furthers the protection of investors and the public interest.
B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA does not believe that the proposed rule change, as amended, will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. Members that are required currently to report transactions in hybrid securities will continue to be subject to transaction reporting requirements and will be provided clarity as to which facility such hybrid securities should be reported, which will promote uniformity and consistency in trade reporting within these categories of products.
C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others
On September 30, 2013, the Commission published the proposed rule change for comment in the Federal Register.
The comment period closed on October 21, 2013. The Commission received two comment letters in response to the proposed rule change.
On December 24, 2013, the Commission published an order to institute proceedings pursuant to Section 19(b)(2)(B) of the Act 
to determine whether to disapprove the proposed rule change.
No other comments were received by the Commission. A summary of the comments received and FINRA's response are provided above in Item 2 of this filing.
III. Solicitation of Comments
Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as modified by Amendment No. 1, is consistent with the Act. Comments may be submitted by any of the following methods:
- Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2013-039. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule changes that are filed with the Start Printed Page 12545Commission, and all written communications relating to the proposed rule changes between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make publicly available. All submissions should refer to File Number SR-FINRA-2013-039 and should be submitted on or before March 26, 2014.
For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.27
Kevin M. O'Neill,
[FR Doc. 2014-04797 Filed 3-4-14; 8:45 am]
BILLING CODE 8011-01-P