What is the Rule 407 letter? – Definition, Explanation, Example, and More

Definition

Rule 407 was a law that required a letter which requires an employee working in Financial Industry regulatory authority or FINRA, which allowed the employee to hold investments in equities or bonds in personal accounts. The employees must disclose personal bank account information about the account in which they are holding the security. It was a rule designed to avoid conflict of interest and protect retail investors.

Explanation

Financial Industry regulatory authority or FINRA is a regulatory authority of the United States of America, which regulates the brokerage firms and exchange industry in the United States of America. It has a very peculiar design as it is a self-regulatory authority which means it is not a government agency, but an organization run by private members.

It is a very important self-regulatory authority that regulates the important brokerage and exchange industry in the United States. It also regulates the working of the New York Stock Exchange and is superseded by the U.S Securities and Exchange Commission. FINRA oversees more than six hundred twenty thousand members. It is a huge organization, covering the biggest financial market in the world.

Importance of the Rule 407

The Rule 407 letter was a very important piece of regulation. Take, for example, Adam, who works for FINRA, it means he has the inner knowledge and working of FINRA. It also means that they get the information about various new regulations or rule knowledge before it is revealed to the public.

Now, Adam can profit from this knowledge, personally. He can invest in or sell the stocks or securities which will be impacted positively or negatively from new law changes by FINRA. So, FINRA regulated Adam under rule 407.

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This creates a huge conflict of interest. To avoid this conflict of interest, employees of FINRA must provide a rule 407 letter. It means they require permission before they invest in any security, or if they hold this security in their personal account.

Rule 407 letter important points

The most important point regarding the regulations around rule 407 letter are as follows:

  1. No member of FINRA is allowed to open an account in the name of an employer or another member, without prior permission from the employer or the member.
  2. No transaction is allowed in which there may arise a direct or indirect conflict of interest due to an interest of an employee or member in the underlying account.
  3. It is not allowed that a member of FINRA or an employee can invest in security in which another member has financial interest. This is true for both domestic and foreign security.
  4. All the members must provide and keep the entire necessary document regarding any transaction from all accounts under the Rule 407. Member brokerages are also required to keep information about their employees.

Rule 407 is superseded by rule 3210

A new rule 3210 was introduced in 2016 and approved by the U.S. Securities and Exchange Commission in 2016. Rule 407 is old and does not apply anymore. It is now superseded by Rule 3210 in the United States Securities market. Rule 3210, not only superseded rule 407, but some other rules too.

What is the new rule 3210?

While it is almost the same as the previous Rule 407, it does have some new regulations introduced by FINRA to protect investors. While before any employee or member of the FINRA was required to disclose all the information about personal accounts holdings where they hold any securities, the new rule 3210, increases the scope, and now covers the account where members brokerages and employees are acting as advisors to investors.

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Furthermore, it also covers all the employees and members and their family members’ parents, children, siblings, and partners to disclose any information regarding them. Rule 407 did not allow that which may sometimes lead to employees opening the account in the name of their children and acting as advisors.

Rule 3210 also covers this broad area. This allows the conflict of interest to reduce to a minimum. It also allows covering the holes left by rule 407. It has also managed to reduce insider trading.

Rule 3210 has not only replace rule 407 but also rule 3050, which required any personal relationship to be disclosed before execution of any trade from the member or an employee’s account.

So, rule 3210 is a wide-ranging covering regulation designed to protect investors from insiders looking to profit from insider trading. The disclosed information prevents any conflict of interest.

Importance of the new Rule 3210

The most important regulations covered under the new rule 3210 are as follows:

  1. It requires all the members to disclose if they are opening a brokerage account in another FINRA member’s brokerage.
  2. It requires brokerage firms to provide all the information from the licensed brokers working in their brokerage to disclose any personal investment which they have in another member’s brokerage.
  3. Members are required to keep track of all the transactions from their employees.
  4. The personal advisors which are members of FINRA are required to disclose any and all personal information and transaction not only about themselves, but also their family members.
  5. The new Rule 3210 provides a better protection against the conflict of interests than the old rule 407, it also provides a better protection to the investors.
  6. The new rule requires that employee of new brokerages must disclose all the information required under the rule 3210, under just a month.
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Conclusion

Rule 407 was a very important piece of regulation that has now been replaced by the new rule 3210, introduced by FINRA and approved by the U.S. S.E.C. It is a better and wide-ranged regulation, which deflates the conflict of interests and provides better protection to investors than the old rule 407.

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