Auction Rate Securities - FINRA Requires Firms to Allow Customers To Sell

FINRA is providing guidance to member firms on obligations that may arise in connection with customer requests to sell generally illiquid securities and informing customers of buy interest in such securities.

Recently, questions have been raised regarding a firm’s obligations when it receives a customer’s unsolicited instruction to liquidate a position in an illiquid security when the customer is aware of specific buying interest in that security. There is no FINRA rule that would require a firm to refuse to follow the customer’s instruction under these circumstances, even if the firm believes the market or price for the security is not favorable at that time. In those instances, the firm should fully disclose the pricing risks to the customer and receive a written acknowledgment that the customer understands those risks.

FINRA also recognizes that theremay be valid reasons for a firm to delay, or obtain more information, before following a customer’s instructions (e.g., if the firm has reason to doubt the identity of the person giving the instruction). However, a firm’s refusal to follow the customer’s unsolicited instruction to sell to a specific buyer may violate NASD Rule 2110. When the following conditions are present, firms should not delay or decline executing such a transaction in an illiquid security:

(1) the customers on both sides of the transaction have indicated their understanding that the firm is not recommending the transaction ormaking a suitability determination;

(2) the customers understand that the firm cannot reach a view as to the sufficiency or competitiveness of pricing; and

(3) there are no legitimate concerns as to the ability of both sides to settle the proposed transaction.

Customers may also learn of buy interest fromtheir firm. In informing customers of buy interest, firms should also consider appropriate disclosure, including, as applicable, information regarding the firm’s inability tomake a representation as to the nature, fairness or sufficiency of the pricing; and any pecuniary interest the firmmay have in the transaction. If the firm recommends the transaction to a customer, the firm has additional obligations andmust ensure that the transaction is suitable pursuant to NASD Rule 2310.3