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94-95 NASD Requests Comment On Proposed Customer Complaint Rules

Comment Period Expires January 31, 1995

SUGGESTED ROUTING

Senior Management
Legal & Compliance
Registration

Executive Summary

The National Association of Securities Dealers, Inc. (NASD) requests comments on a proposed amendment to Article III of the Rules of Fair Practice (Rules) to require members to report to the NASD the occurrence of specified events and quarterly summary statistics concerning customer complaints. The proposed rule would provide important new regulatory information that will assist the NASD in the timely identification of problem members, branch offices, and registered representatives in order to more aggressively detect and investigate sale practice violations. If adopted, the proposed rule would significantly parallel comparable provisions of existing Rule 351 of the New York Stock Exchange (NYSE). The text of the proposed rule follows this Notice.

Background

In view of increasing concerns about sales practice abuses of some registered representatives associated with broker/dealers, the NASD's regulation program for 1994 required each District Office to identify and conduct intense sales practice examinations of main offices, branch offices, and individuals associated with such offices who may pose certain regulatory concerns due to, among other things, past misconduct related to abusive sales and trading practices.

In this regard, the NASD has developed an interim automated system that draws on the Central Registration Depository (CRD) and NASD internal regulatory systems to profile and analyze the current registered representative population. When incorporated with NASD regulatory systems that contain, for example, information about all examinations, District Business Conduct Committee (DBCC) disciplinary actions, customer complaints, and terminations for cause, the NASD has the capacity to more precisely and expeditiously profile registered representatives that pose regulatory risks to public investors.

Over the past several years, the NASD has taken a number of actions to increase sanctions for sales practice violations, to emphasize improving the hiring and termination practices of member firms, and to commit additional resources to sales practice cases. Member supervisory systems, practices, and procedures also remain the subject of increased scrutiny. Members employing individuals with a history of compliance or disciplinary problems have also been made aware of their heightened standard of supervisory responsibility that demands that special supervisory practices be designed to address the particular problems of those individuals.

In furtherance of its varied initiatives to address sales practice abuses and supervisory concerns, the NASD is proposing an amendment to Article III of the Rules that will significantly strengthen the NASD's regulatory and surveillance efforts by requiring member firms to report to the NASD the occurrence of certain specified events and summary statistics concerning customer complaints. If adopted, the proposed NASD rule would significantly parallel comparable provisions of NYSE Rule 351.

Critical material information identified in the proposed rule, such as reports on statutory disqualifications, internal disciplinary actions, and quarterly statistical data regarding customer complaints received by a member is not required by Form U-4 or other required filings made with the NASD. As such, this information is not available to the NASD staff on a routine, systematic, or timely basis. In this regard, the NASD believes that the affirmative obligation of members to provide the NASD with notice of certain events concerning member firms or their associated persons will significantly enhance the NASD's ability to quickly identify problem representatives and appropriately respond in a timely manner.

The Securities and Exchange Commission (SEC) supported the NASD adoption of a customer complaint reporting rule similar to NYSE Rule 351 in its Large Firm Project Report issued in conjunction with a cooperative effort involving the NASD, SEC, and NYSE that examined the hiring and retention practices of nine of the largest broker/dealers in the United States. Similarly, the General Accounting Office (GAO) in its report titled Securities Markets: Actions Needed to Better Protect Investors Against Unscrupulous Brokers, recommended that member firms' customer complaint information be computer captured and utilized as an additional tool by regulators for identifying potentially problem firms.

Summary Of The Proposed Amendments

As proposed, Subsection (a) of the rule requires member firms to file a report with the NASD when any of 10 different specified events occurs. These 10 events vary significantly, ranging from situations where a court, government agency, or self-regulatory organization (SRO) has determined there has been a violation of the securities laws, to circumstances where a firm has received a written customer complaint alleging theft or misappropriation of funds or securities, or forgery. Subsection (b) of the proposed rule requires each person associated with an NASD member to properly report to the member the existence of any of the 10 conditions set forth in Subsection (a) of the proposed rule.

Subsection (c) of the rule further requires members to report to the NASD statistical and summary information regarding written customer complaints received by the member firm or relating to the firm or any of its associated persons. Importantly, Subsection (e) of the proposed rule eliminates the possibility of unnecessary regulatory duplication by providing an exemption from filing with the NASD for members already subject to similar reporting requirements of another SRO. NYSE Rule 351 is the only such rule in place at this time.

Recision Of Schedule C, Part V

Currently, Part V of Schedule C to the NASD By-Laws requires members to promptly notify the NASD in writing of any disciplinary action that the member takes against any of its associated persons involving suspension, termination, the withholding of commissions or imposition of fines in excess of $2,500, or any other significant limitation on activities. As this existing disclosure requirement is incorporated into the proposed rule in Subsection (a)(10), the NASD proposes to rescind this part of Schedule C with the adoption of the new rule.

Request For Comment

The NASD asks members and other interested persons to comment on the proposed amendment to the Rules of Fair Practice. Comments should be directed to:

Ms. Joan Conley
Corporate Secretary
National Association of Securities Dealers, Inc.
1735 K Street, NW
Washington, DC 20006-1500.

Comments must be received no later than January 31, 1995. Comments received by this date will be considered by the Board. Before becoming effective, the rule must be adopted by the Board and the membership and then filed with the SEC for its approval.

Text Of Proposed Rule

(Note: New language is underlined.)

Reporting Requirements

Section

(a) Each member should promptly report to the Association whenever such member or person associated with the member:
(1) has violated any provision of any securities law or regulation, or rule or standards of conduct of any governmental agency, self-regulatory organization, or business or professional organization, or engaged in conduct which is inconsistent with just and equitable principles of trade;
(2) is the subject of any written customer complaint involving allegations of theft or misappropriation of funds or securities or of forgery:
(3) is named as a defendant or respondent in any proceeding brought by a regulatory or serf-regulatory body alleging the violation of any provision of the Securities Exchange Act of 1934, or any other federal or state securities, insurance, or commodities statute, or of any rule or regulation thereunder, or of any provision of the By-Laws, rules or similar governing instruments of any securities, insurance or commodities regulatory or self-regulatory organization:
(4) is denied registration or is expelled, enjoined, directed to cease and desist, suspended or otherwise disciplined by any securities, insurance or commodities industry regulatory or serf-regulatory organization or is denied membership or continued membership in any such self-regulatory organization: or is barred from becoming associated with any member of any such serf-regulatory organization:
(5) is arrested, arraigned, indicted, or convicted of. or pleads guilty to. or pleads no contest to. any criminal offense (other than minor traffic violations):
(6) is a director, controlling stockholder, partner, officer or sole proprietor of, or an associated person with, a broker-dealer, investment company, investment advisor, underwriter or insurance company which was suspended, expelled or had its registration denied or revoked by any agency, jurisdiction or organization or is associated in such a capacity with a bank, trust company or other financial institution which was convicted of or pleaded no contest to. any felony or misdemeanor:
(7) is defendant or respondent in any securities or commodities-related civil litigation or arbitration which has been disposed of by judgement, award or settlement for an amount exceeding $15.000. However, when the member is defendant or respondent, then the reporting to the Association shall be required only when such judgement, award or settlement is for an amount exceeding $25.000:
(8) is the subject of any claim for damages by a customer, broker, or dealer which is settled for an amount exceeding $15.000. However, when the claim for damages is against a member, then the reporting to the Association shall be required only when such claim is settled for and amount exceeding $25.000:
(9) is. or learns that he is associated in any business or financial activity with any person who is. subject to a "statutory disqualification" as that term is defined in the Securities Exchange Act of 1934. and shall include with required reports the name of the person subject to the statutory disqualification and detail concerning the disqualification:
(10) is the subject of any disciplinary action taken by the member against any person associated with the member involving suspension, termination, the withholding of commissions or imposition of fines in excess of $2.500. or otherwise disciplined in any manner which would have significant limitation on the individual's activities on a temporary or permanent basis.
(b) Each person associated with a member shall promptly report to the member the existence of any of the conditions set forth in paragraph (a) of misrule.
(c) Each member shall report to the Association statistical and summary information regarding customer complaints in such detail as the Association shall specify by the 15th day of the month following the calendar quarter in which customer complaints are received by the member. For the purposes of this paragraph, "customer" includes any person other than a broker or dealer with whom the member has engaged, or has sought to engage, in securities activities, and "complaint" includes any written grievance by a customer involving the member or person associated with a member.
(d) Nothing contained in paragraph (a), (b), and (c) of this Section shall eliminate, reduce, or otherwise abrogate the responsibilities of a member or person associated with a member to promptly file with full disclosure, required amendments to Form BD, Forms U-4 and U-5, or other required filings, and to respond to the Association with respect to any customer complaint, examination, or
(c) Any member subject to substantially similar reporting requirements of another self-regulatory organization of which it is a member is exempt from the provisions of this Section.

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