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90-61 Proposed Amendments to Article III, Section 5(b) and Article IV, Sections 3 and 4 of the NASD By-Laws, and Article IV, Section 5 and Article V, Sections 1 and 3 of the NASD Rules of Fair Practice Re: Retention of Jurisdiction Over Member Firms and Associa

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MAIL VOTE

EXECUTIVE SUMMARY

Members are invited to vote on proposed amendments to Article III, Section 5(b) and Article IV, Sections 3 and 4 of the NASD By-Laws, and Article IV, Section 5 and Article V, Sections 1 and 3 of the NASD Rules of Fair Practice. The amendments to the By-Laws would codify procedures currently employed by the NASD in processing terminations of associated persons and cancellations and revocations of member firms. The amendments to the Rules of Fair Practice would clarify the obligation of members and persons who remain subject to the NASD's jurisdiction to respond to requests for information made by the NASD. The amendments to Article V, Sections 1 and 3 would conform those provisions to amendments to the Code of Procedure.

The text of the proposed amendments follows this notice.

BACKGROUND

A significant aspect of the NASD's self-regulatory activity is the investigation of members and associated persons to determine if their activities comply with the Association's rules and the federal securities laws. In addition to investigating the full range of potential violations, the Association also routinely investigates associated persons who have been terminated for cause to determine whether the circumstances leading to the termination involved violations of the NASD's or other securities rules.

Currently, Article IV, Section 3(a) of the Association's By-Laws only provides the NASD limited authority to place on hold a termination for cause where any complaint or action that involves the associated person is pending, or so long as any examination of the member or associated person is in process. Where no complaint, action, or examination is in process, the NASD's practice has been to place a hold on terminations for cause when the Uniform Termination Notice for Securities Industry Registration ("Form U-5") indicates the possibility of misconduct to ensure adequate time to investigate such matters fully and to bring disciplinary action where appropriate. The effect of the hold is to prevent the termination from becoming effective and thus postpone the start of the one-year period within which, under Article IV, Section 4 of the By-Laws, an individual no longer associated with a member firm remains subject to the NASD's jurisdiction to file a complaint.

A similar issue arises in connection with the membership status of firms whose membership has been canceled or revoked. When a member firm resigns its membership voluntarily, Article III, Section 5(b) of the By-Laws currently provides that the firm remains subject to the NASD's jurisdiction to file a complaint for one year. Furthermore, a resignation does not take effect if a complaint, action, or examination is pending.

The membership of numerous firms has been canceled or revoked by the NASD for failure to pay dues, fees, and fines and to file financial reports with the NASD. However, because Article III, Section 5(b) of the By-Laws does not apply to canceled or revoked firms, the NASD does not cancel or revoke the membership of a firm as a matter of practice. Instead, the NASD holds the cancellation or revocation of the firm membership in abeyance pending completion of any investigation in which it is determined that formal disciplinary action may be warranted. This procedure frustrates the NASD's obligation to cancel or revoke the membership of firms that do not comply with NASD requirements and can lead to firms remaining in the securities business for an extended period of time.

Investigations of terminations for cause, as with other investigations, necessarily involve obtaining information from terminated individuals, typically by means of a request for information pursuant to Article IV, Section 5 of the Rules of Fair Practice. The NASD has consistently taken the position that an individual who remains subject to the filing of a complaint pursuant to Article IV, Section 4 of the By-Laws, or whose termination is subject to a hold, remains a "person associated with a member" for purposes of the individual's obligation to provide information requested by the NASD pursuant to Article IV, Section 5 of the Rules of Fair Practice. In addition, the NASD regards any failure by a member or associated person to respond to Article IV, Section 5 requests for information to be a violation of Article III, Section 1 of the Rules of Fair Practice.

When required to provide information with regard to any matter involved in an NASD investigation, a member or associated person is required to testify on the record if so directed by any committee, or duly authorized agent of any such committee, in order to comply with Article IV, Section 5. The NASD's ability to require such persons to provide information regarding the circumstances of their termination and to impose sanctions for failure to do so is essential to the discharge of its regulatory obligations.

As a result of a significant number of recent disciplinary actions involving failure to provide information regarding terminations for cause and failure to provide information in response to NASD requests made pursuant to Article IV, Section 5, as well as cancellations and revocations of members and associated persons, the NASD Board of Governors decided to codify its practices to ensure the performance of its self-regulatory functions.

SUMMARY OF PROPOSED AMENDMENTS

Article III, Section 5 of the NASD By-Laws

The NASD is proposing to renumber current Section 5(b) to Article III of the By-Laws as new Section 6 and revise the provision to codify the NASD's current practice of retaining jurisdiction for one year over members whose membership has been canceled or revoked by the NASD for failure to pay a fee or fine or to file financial reports.

Article IV of the NASD By-Laws

Section 3 — The NASD is proposing to amend Article IV, Section 3(a) of the NASD By-Laws to codify the NASD's current practice of placing a hold on a termination for cause of a person associated with a member when the Form U-5 indicates that the circumstances surrounding the termination may have involved actionable misconduct. The proposed amendment would also codify the NASD's position that a hold may be imposed retroactively; that is, where a termination is permitted to become effective, the NASD may rescind the effective termination date based on the subsequent receipt of an amended Form U-5 or other information that discloses previously undiscovered misconduct. Any hold placed on the termination of registration of an associated person operates only to preserve the Association's jurisdiction and does not affect the termination of the person's relationship with his firm.

Section 4 — Article IV, Section 4 of the NASD By-Laws currently provides that the NASD retains, for a period of one year following the effective date of termination, jurisdiction to bring a disciplinary action against a person formerly associated with a member alleging misconduct that occurred during the period of association. The NASD is proposing to amend Section 4 to codify the NASD's practice of extending the one-year jurisdictional period by placing a hold on a termination for cause and preventing the termination from taking effect. The amendment would also provide that failure of a person to respond to a request for information pursuant to Article IV, Section 5 of the Rules of Fair Practice during the period that a person is subject to the NASD's jurisdiction to file a complaint may be charged as a violation of the NASD's rules, notwithstanding that such failure occurred after the person ceased to be associated with an NASD member.

Article IV, Section 5 of the NASD Rules of Fair Practice

The NASD is proposing to amend Article IV, Section 5 of the Rules of Fair Practice to codify the NASD's position that the obligation to respond to a request for information extends to persons who remain subject to the NASD's jurisdiction to file a complaint. The NASD believes it essential that persons whose terminations are being investigated for possible misconduct be under an obligation to provide information necessary to enable staff to determine whether a complaint is warranted.

In addition, the NASD is proposing to amend Section 5 to provide that "failure" to respond to an Article IV, Section 5 request for information constitutes a violation of the NASD's rules, rather than a "refusal" as is presently provided. When a member or associated person is required to report with regard to any matter, the Association is also proposing that such person must testify on the record if so directed by any NASD committee or duly authorized agent of any such committee. Finally, the NASD is proposing that Section 5 be amended to provide that a request for information is properly made if it is sent to a member's or person's last address of record with the NASD.

CONFORMING AMENDMENTS

Article V, Sections 1 and 3 of the NASD Rules of Fair Practice

The NASD is also proposing to amend Article V, Sections 1 and 3 of the Rules of Fair Practice to conform those rules to proposed amendments to the Code of Procedure pending at the Securities and Exchange Commission (SEC), implementing the recommendations of the Special Committee on NASD Structure and Governance that would provide that the decisions of the National Business Conduct Committee (NBCC) are the final decisions of the NASD in disciplinary cases and would not require action by the full Board to become effective. The proposed amendment to Section 1 would change the term "penalty" to "sanction" and empower the NBCC to impose sanctions for violations of NASD rules. The amendment to Section 3 would authorize the NBCC to impose costs of disciplinary proceedings on respondents.

The Board of Governors believes that the proposed amendments to Article III, Section 5(b) and Article IV, Sections 3 and 4 of the NASD By-Laws and Article IV, Section 5 and Article V, Sections 1 and 3 of the NASD Rules of Fair Practice are necessary and appropriate and recommends that members vote their approval. Prior to becoming effective, the proposed amendments also must be approved by the SEC.

Please mark the attached ballot according to your convictions and return it in the enclosed, stamped envelope to the Corporation Trust Company. Ballots must be postmarked no later than November 5, 1990.

Questions concerning this notice may be directed to the Office of General Counsel at (202) 728-8294.

PROPOSED AMENDMENTS TO NASD BY-LAWS

(Note: New text is underlined; deleted text is in brackets.)

ARTICLE III

Membership

Comments were requested on the amendments to the Code of Procedure in Notice to Members 90-19 (April 1990) and Securities Exchange Act Rel. No. 34-28289 (July 31, 1990).

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Resignation of Members

Current Section 5(a) is renumbered as Section 5.

Retention of Jurisdiction

[Sec. 5(b)] Sec. 6. A resigned member or a member that has had its membership canceled or revoked shall continue to be subject to the filing of a complaint under the Code of Procedure based upon conduct which commenced prior to the effective date of the member's resignation from the Corporation or the cancellation or revocation of its membership. Any such complaint, however, shall be filed within one year after the effective date of the resignation, cancellation or revocation.

Current Sections 6-9 are renumbered as Sections 7-10, respectively.

ARTICLE IV

Registered Representatives and Associated Person

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Notification by Member to Corporation and Associated Person of Termination; Amendments to Notification

Sec. 3(a). Following the termination of the association with a member of a person who is registered with it, such member shall promptly, but in no event later than thirty (30) calendar days after such termination, give written notice to the Association on a form designated by the Board of Governors of the termination of such association, and concurrently shall provide to the person whose association has been terminated a copy of said notice as filed with the Association. A member who does not submit such notification in writing, and provide a copy thereof to the person whose association has been terminated, within the time period prescribed shall be assessed a late filing fee as specified by the Board of Governors. Termination of registration of such person associated with a member shall not take effect so long as any complaint or action is pending against a member and to which complaint or action such person associated with a member is also a respondent, or so long as any complaint or action is pending against such person individually or so long as any examination of the member or person associated with such member is in process. The Corporation may in its discretion determine that termination of registration of such person associated with a member shall not take effect where the written notice thereof discloses that such person engaged or may have engaged in conduct that may constitute a violation of any statute, rule or regulation governing such person's activities while associated with a member. The Corporation, however, may in its discretion declare the termination effective at any time. The Corporation may also in its discretion declare the termination ineffective as of the date the Corporation first received notice of the termination if, during the period that such person remains subject to the Corporation's jurisdiction to file a complaint under the Code of Procedure as provided in Section 4 of this Article IV, the Corporation shall receive notice from any source that such person engaged or may have engaged in conduct that may constitute a violation of any statute, rule or regulation governing such person's activities while associated with a member.

(b) The member shall notify the Association in writing by means of an amendment to the notice filed pursuant to paragraph (a) above in the event that the member learns of facts or circumstances causing any information set forth in said notice to become inaccurate or incomplete. Such amendment shall be filed with the Association and provided to the person whose association with the member has been terminated not later than thirty (30) calendar days after the member learns of the fact or circumstances giving rise to the amendment.

Retention of Jurisdiction

Sec. 4. A person whose association with a member has been terminated and is no longer associated with any member of the Corporation or a person whose registration has been revoked shall continue to be subject to the filing of a complaint under the Code of Procedure based upon conduct which commenced prior to the termination or revocation or upon such person's failure, while subject to the Corporation's jurisdiction as provided herein, to provide information requested by the Corporation pursuant to Article IV, Section 5 of the NASD Rules of Fair Practice, but any such complaint shall be filed within one (1) year after the effective date of termination of registration pursuant to Section 3 above, within one (1) year after the effective date of revocation of registration pursuant to Article V, Section 2 of the Association's Rules of Fair Practice or, in the case of an unregistered person, within one (1) year after the date upon which such person ceased to be associated with the member. In the event that the Corporation shall determine pursuant to Section 3 above that the termination of a person's association with a member shall not take effect, such person shall continue to be subject to the filing of a complaint as provided herein until, and for one (1) year following, the Corporation's determination to permit the termination to take effect.

PROPOSED AMENDMENTS TO NASD RULES OF FAIR PRACTICE

ARTICLE IV

Complaints

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Reports and Inspection of Books for Purposes of Investigating Complaints

Sec. 5. For the purpose of any investigation, or determination as to filing of a complaint or any hearing of any complaint against any member of the Corporation or any person associated with a member made or held in accordance with the Code of Procedure, any Local Business Conduct Committee, any District Business Conduct Committee, or the Board of Governors, or any duly authorized member or members of any such Committees or Board or any duly authorized agent or agents of any such Committee or Board shall have the right (1) to require any member of the Corporation, [or] person associated with a member, or person no longer associated with a member when such person is subject to the Corporation's jurisdiction to report, either informally or on the record, orally or in writing with regard to any matter involved in any such investigation or hearing, and (2) to investigate the books, records and accounts of any such member or person with relation to any matter involved in any such investigation or hearing. No such member or person [associated with a member,] shall [refuse] fail to make any report as required in this Section, or [refuse] fail to permit any inspection of books, records and accounts as may be validly called for under this Section. Any notice requiring an oral or written report or calling for an inspection of books, records and accounts pursuant to this Section shall be deemed to have been received by the member or person to whom it is directed by the mailing thereof to the last known address of such member or person as reflected on the Corporation's records.

ARTICLE V

Sanctions [Penalties]

Sanctions [Penalties] for Violation of the Rules

Sec. 1. Any District Business Conduct Committee, Market Surveillance Committee, the National Business Conduct Committee, any other committee exercising powers assigned by the Board, or the Board, [of Governors,] in the administration and enforcement of these Rules, and after compliance with the Code of Procedure, may (1) censure any member or person associated with a member, and/or (2) impose a fine upon any member or person associated with a member, and/or (3) suspend the membership of any member or suspend the registration of a person associated with a member, if any, for a definite period, and/or (4) expel any member or revoke the registration of any person associated with a member, if any, and/or (5) suspend or bar a member or person associated with a member from association with all members, and/or (6) impose any other fitting sanction [penalty] deemed appropriate under the circumstances, for each or any violation of any of these Rules by a member or person associated with a member or for any neglect or refusal to comply with any orders, directions or decisions issued by any such committee [District Business Conduct Committee, Market Surveillance Committee] or by the Board [of Governors] in the enforcement of these Rules, including any interpretative ruling made by the Board [of Governors], as any such c[C]ommittee or the Board, in its discretion, may deem to be just; provided, however, that no such sanction imposed by any such [District Business Conduct or Market Surveillance] c[C]ommittee shall take effect until the period for appeal therefrom or review thereof by the National Business Conduct Committee or the Board, as applicable, has expired[,] and any such appeal or review has been completed in accordance with [as provided in Article III, Section 1 of] the Code of Procedure; and provided, further, that all parties to any proceeding resulting in a sanction shall be deemed to have assented to or to have acquiesced in the imposition of such sanction unless a party aggrieved thereby shall have made application [to the Board of Governors] for review thereof pursuant to the Code of Procedure, within fifteen (15) days after the date of the decision rendered in such proceeding [such notice].

* * * * *

Costs of Proceedings

Sec. 3. Any member or any person associated with a [such] member disciplined pursuant to Section 1 of this Article shall bear the costs of the proceedings as [the District Business Conduct Committee] any committee referred to in such Section 1 or the Board [of Governors] deems fair and appropriate under the circumstances.


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