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90-52 SEC Approval of Amendments to Article III, Sections 2 and 21 (c) of the Rules of Fair Practice Re: Customer Account Information

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EXECUTIVE SUMMARY

The SEC has approved amendments to Article III, Sections 2 and 21 (c) of the Rules of Fair Practice ("Rules") to require NASD members to make reasonable efforts to obtain additional information pertaining to customer accounts. In the case of noninstitutional accounts, the amendment to Section 21 (c) requires NASD members to make reasonable efforts to obtain the necessary additional information prior to the settlement of the initial transaction in the account, including discretionary and corporate accounts. Existing requirements regarding institutional accounts are retained, and the new rule also requires that the names of any persons authorized to transact business on behalf of the entities should be obtained, if the customer is a corporation, partnership, or other legal entity.

The amendment to Section 2 requires NASD members to make reasonable efforts to obtain the additional information prior to the execution of a transaction recommended to a noninstitutional customer.

Both amendments exclude transactions and accounts when the investments are limited to money market mutual funds. These new requirements will apply to accounts opened, and recommendations made, after the effective date of January 1, 1991. The text of each amendment follows this notice.

BACKGROUND AND SUMMARY OF AMENDMENTS

On May 2, 1990, the SEC approved an NASD rule change that requires NASD members to make reasonable efforts to obtain additional information pertaining to customer accounts.1

Pursuant to existing Article III, Section 21(c) of the Rules, the accounts of all customers are required to be maintained in such form and manner as to show name; address; age; signatures of the introducing representative and member, partner, officer, or manager accepting the account for the member; and a customer's association with or employment by another member. In discretionary accounts, the customer's occupation must be noted, along with the signature of each person authorized to exercise discretion in such account. When recommending to a customer the purchase, sale, or exchange of any security, Article III, Section 2 currently requires that a member have reasonable grounds for believing that the recommendation is suitable for the customer on the basis of any facts disclosed by the customer about his other security holdings, financial situation, and needs.

As amended, Section 21(c) requires a member to make reasonable efforts to obtain, prior to the settlement of the initial transaction in a noninstitutional customer account, the tax identification or Social Security number of the customer and the occupation and name and address of the employer of each customer for each account, in addition to the above-listed information currently required to be obtained. Furthermore, if the customer is a corporation, partnership, or other entity, the member also must obtain the names of any persons authorized to transact business on behalf of such entity. For discretionary accounts, the member is required to obtain the signature of each person authorized to exercise discretion in the account and the date such discretion is granted.

Amended Section 2 provides that, prior to the execution of a transaction recommended to a noninstitutional customer, a member must make reasonable efforts to obtain information concerning that customer's financial status, tax status, investment objectives, and such other information used or considered to be reasonable and necessary by the member or registered representative in making recommendations to the customer.

Both amendments exclude transactions and accounts in which investments are limited to money market mutual funds.

The NASD believes the amendments to Article III, Sections 2 and 21(c) of the Rules will provide extra protection for both customers and firms since the additional information obtained will permit more informed determinations as to customer accounts and investment recommendations. The requirement of "reasonable effort" can be met by prepared questionnaires for customers to complete and return or by telephone inquiry. It is not necessary to obtain a written statement from a customer in each instance in order to be in compliance with the rule.

The NASD also believes that the requirement of Section 21(c) that information be obtained prior to the settlement of the initial transaction, and of Section 2 that information be obtained prior to the execution of a transaction recommended to a noninstitutional customer, will allow some freedom in opening new accounts. Moreover, it may be advisable for members to keep a record of efforts they have made to obtain a customer's tax identification or Social Security number, as required by Section 103.35, Part 103 of Title 31 of the Code of Federal Regulations adopted by the Treasury Department, effective June 1972.

The new requirements will apply to accounts opened, and recommendations made, after the effective date of January 1, 1991.

TEXT OF AMENDMENT TO ARTICLE III, SECTION 2 OF THE NASD RULES OF FAIR PRACTICE

(Note: New language is underlined.)

Recommendation to Customers

Sec. 2.(a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.

(b) Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:
(i) the customer's financial status;
(ii) the customer's tax status;
(iii) the customer's investment objectives; and
(iv) such other information used or considered to be reasonable and necessary by such member or registered representative in making recommendations to the customer.

TEXT OF AMENDMENT TO ARTICLE III, SECTION 21(c) OF THE NASD RULES OF FAIR PRACTICE

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

Books and Records

Sec. 21.

* * * * *

[Information on accounts

(c) Each member shall maintain accounts of customers in such form and manner as to show the following information: name, address, and whether the customer is legally of age; the signature of the registered representative introducing the account and the signature of the member or the partner, officer, or manager accepting the account for the member. If the customer is associated with or employed by another member, this fact must be noted. In discretionary accounts, the member shall also record the age or approximate age and occupation of the customer as well as the signature of each person authorized to exercise discretion in such account.]

Customer Account Information

(c) Each member shall maintain accounts opened after January 1, 1991 as follows:
(1) for each account, each member shall maintain the following information:
(i) customer's name and residence;
(ii) whether customer is of legal age,
(iii) signature of the registered representative introducing the account and signature of the member or partner, officer, or manager who accepts the account; and
(iv) if the customer is a corporation, partnership, or other legal entity, the names of any persons authorized to transact business on behalf of the entity:
(2) for each account other than an institutional account, and accounts in which investments are limited to transactions in money market funds, each member shall also make reasonable efforts to obtain, prior to the settlement of the initial transaction in the account, the following information to the extent it is applicable to the account:
(i) customer's tax identification or Social Security number;
(ii) occupation of customer and name and address of employer; and
(iii) whether customer is an associated person of another member; and
(3) for discretionary accounts, in addition to compliance with subsections (1) and (2) above, and Article III, Section 15(b) of these rules, the member shall:
(i) obtain the signature of each person authorized to exercise discretion in the account; and
(ii) record the date such discretion is granted.
(4) For purposes of this section and Article III, Section 2, the term "institutional account" shall mean the account of:
(i) a bank, savings and loan association, insurance company, or registered investment company;
(ii) an investment adviser registered under Section 203 of the Investment Advisers Act of 1940; or
(iii) any other entity (whether a natural person, corporation, partnership, trust, or otherwise) with total assets of at least $50 million.

1See Release No. 34-27982 (May 2, 1990), 55 FR 19402 (May 9, 1990).



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