February 24, 2015 Articles

FINRA and Regulatory Notice 14-40 Requirements

Firms are to explicitly advise parties to settlement and confidentiality agreements that they can initiate communications with regulators

By Dominick F. Evangelista, Regina Pepe Martorana, and Heather Murphy

On October 9, 2014, the Financial Industry Regulatory Authority (FINRA) issued Regulatory Notice 14-40, concerning non-disclosure provisions in FINRA arbitration confidentiality agreements and settlement agreements. While Notice 14-40 purports to be a “reminder” to firms as to the acceptable parameters of non-disclosure provisions used in FINRA arbitrations, it goes a step further than prior FINRA guidance. Firms are now required to explicitly notify signatories that confidentiality provisions do not limit their ability to initiate contact with regulators.  FINRA’s prior guidance on this topic was far more limited: It only required that confidentiality provisions state that they do not prevent a party from responding to a regulator upon inquiry.  Firms must now review their confidentiality provisions in light of this new guidance.

FINRA’s Prior Guidance on Confidentiality Provisions

FINRA, and its predecessor the National Association of Securities Dealers (NASD), has long been concerned that a member’s use of confidentiality clauses could have a negative effect on regulatory investigations and enforcement actions. Nearly 30 years ago, the NASD issued Notice 86-36 after finding that customers who had signed releases to settle arbitration complaints were reluctant to cooperate with NASD investigations out of fear that cooperation was a violation of the confidentiality clause. At that time, the NASD made clear that it was a violation of the NASD Rules of Fair Practice for a member to use a confidentiality provision to limit or impede a NASD investigation.  See also NASD Regulatory and Compliance Alert (June 1994), at 14.


A decade later, the NASD issued Notice 95-87, which advised members to review and correct FINRA arbitration agreements that contained confidentiality clauses that prohibited or discouraged parties from disclosing the settlement terms and/or underlying facts of the dispute to the NASD or any securities regulator upon inquiry. This notice was issued as a result of a series of NASD examinations and a special survey that was conducted to determine if confidentiality clauses were too broad and thus limiting investigations. For the first time, the NASD advised that a “violative confidentiality clause is one that prohibits or inhibits the customer or other person from disclosing the settlement terms (and the underlying facts of the dispute), upon inquiry, to a securities regulator, such as the NASD, or imposes conditions on such disclosure.” The notice concluded by stating that failure to include such a provision constituted “a serious violation of just and equitable principles of trade.” See also NASD Regulatory and Compliance Alert (July 1995)


In June 2004, the NASD issued their now penultimate notice on the issue. Notice 04-44 was issued to remind members of what constitutes permissible non-disclosure provisions in confidentiality clauses. The NASD advised that upon review it had found several examples of impermissible language in confidentiality provisions, including language requiring customers to withdraw complaints from regulators and/or providing affidavits to regulators that contradicted prior statements; prohibiting the customer from testifying before a regulator; or requiring that prior notice be given to the member firm before the customer provided testimony to a regulator. Notice 04-44 reiterated the requirement that confidentiality provisions “expressly authorize the customer or other person to respond, without restriction or condition, to any inquiry regarding the settlement or its underlying facts to a regulator, including NASD.”


FINRA’S Latest Guidance on Confidentiality Provisions

Notice 14-40 states that it is a “reminder” to members regarding acceptable confidentiality provisions. Yet this notice goes decisively further than FINRA’s prior guidance.  Notice 14-40 expands on the prior guidance in requiring that all parties be explicitly advised of their right to initiate contact with a regulator about the facts and circumstances of the case, regardless of a governing non-disclosure agreement.


Notice 14-40 begins by reminding firms that they cannot use confidentiality provisions with customers or individuals in FINRA arbitrations that impede or have the potential to limit regulatory investigations and enforcement actions. It then states that “confidentiality provisions also cannot be used to prohibit or restrict an individual from initiating communications directly with FINRA or other securities regulators regarding the settlement terms or underlying facts of a dispute, regardless of whether the individual has received an inquiry from such regulatory authority regarding the dispute.” (Emphasis added)


Notice 14-40 then takes this guidance one step further: “Confidentiality provisions in settlement agreements should be written to expressly authorize, without restriction or condition, a customer or other person to initiate direct communications with” FINRA or any other regulator. The notice concludes that any limit on a person’s ability to communicate with FINRA, the SEC, any self-regulatory organization or any state or federal regulatory authority regarding settlements or the underlying facts in any dispute is inconsistent with just and equitable principles of trade and constitutes a violation of FINRA Rule 2010.


This expansion of a member’s obligations with respect to confidentiality clauses is reflected by the suggested confidentiality clause language FINRA provided in its various notices. In 1995, the NASD suggested the following language for settlement agreements:


Any non-disclosure provision in this agreement does not prohibit or restrict you (or your attorney) from responding to any inquiry about this settlement or its underlying facts and circumstances by the Securities and Exchange Commission (SEC), the National Association of Securities Dealers, Inc. (NASD) or any other self-regulatory organization.


See FINRA Notice to Members 95-87 (October 1995). 


The suggested language for confidentiality clauses in the 2004 notice was verbatim except for the inclusion of the words “or providing testimony” to reiterate that any type of cooperation with a regulatory body was permissible.


In the latest notice, however, FINRA suggests the following language:


Any non-disclosure provision in this agreement does not prohibit or restrict you (or your attorney) from initiating communications directly with, or responding to any inquiry from, or providing testimony before, the SEC, FINRA, any other self-regulatory organization or any other state or federal regulatory authority, regarding this settlement or its underlying facts.


See FINRA Notice to Members 14-40 (October 2014).  


This slight change in language emphasizes the import of Notice 14-40: A clause allowing cooperation with regulators only when asked is no longer sufficient.


Members Must Review and Change the Language of Confidentiality Clauses

Regulators have long been concerned that confidentiality provisions were being used to hinder investigations into the conduct of registered firms and individuals. Through Notice 14-40, FINRA has now determined that members must explicitly advise customers or other persons that they are permitted to initiate contact with regulators at any time in regard to the conduct on which the arbitration is based. See also 17 C.F.R. § 240.21F-17 (“No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing or threatening to enforce, a confidentiality agreement…with respect to such communications”). In order to comply with Notice 14-40, member firms must review and revise non-disclosure provisions in confidentiality and settlement agreements to ensure that they explicitly advise signatories that signing the document does not prohibit them from initiating contact with a regulator regarding a settlement or the underlying facts of any dispute.