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94-93 NASD Requests Comment On Proposed Rule Governing Registered Persons Lending To Or Borrowing From Customers
Comment Period Expires January 31, 1995
At its November 1994 meeting, the NASD Board of Governors (Board) approved the issuance of a Notice to Members soliciting member comment on a proposed amendment to Article III of the Rules of Fair Practice. The proposed rule would require registered persons to provide prior notification to, and obtain prior approval from, their employing member firm before personally borrowing funds or securities from a customer, or before personally lending funds or securities to a customer. As proposed by the rule, the notification and the prior approval must be in writing.
Background And Description Of The Proposed Amendment
In May 1994, the Board's Advisory Council (composed of District Business Conduct and Market Surveillance Committee Chairpersons) issued its report of recommendations to the Board. Included in the report was a recommendation that the NASD consider adopting a rule that would require registered persons to notify their employing member when personally borrowing funds or securities from customers. The Council's proposal was discussed by the National Business Conduct Committee (NBCC) at its November 1994 meeting.
The NBCC supported the Advisory Council's proposal and recommended to the Board that the coverage of the proposed rule be expanded to include lending of funds or securities, in addition to the borrowing of funds or securities, by registered persons with their customers. The NBCC also recommended that the member, upon prior written notification by the registered person, must record in writing the approval or disapproval of the proposed transaction with the customer.
The NBCC's determinations were based, in part, on several recent NASD disciplinary actions that demonstrated examples of abuse where registered representatives had borrowed funds or securities from customers. Specifically, the SEC affirmed two NASD disciplinary actions where the principal violation focused on registered representatives borrowing funds from, but not repaying, customers.1
In approving this rule proposal for comment, the Board recognized that a number of member firms prohibit this type of conduct by their registered persons. Thus, the rule amendment is being proposed to establish a regulatory framework for member firms, which currently permit this practice by its registered persons, to follow.
A member's prior knowledge that a registered representative intends to borrow funds or securities from or loan funds or securities to its customers, and the member's subsequent approval, may serve as an effective deterrent to potential misconduct. It will also improve the member's ability to control and supervise the activities of its registered personnel. Additionally, the notice requirement will place an affirmative obligation on the representative that could be separately charged in a disciplinary action if not followed.
Along with the deterrent effect, the present proposal, if ultimately adopted, would clearly serve as an information gathering source for members about additional activities engaged in by their registered persons that may be considered to be beyond the scope of their normal activities. With the information in hand, members would be able to evaluate, before granting approval, whether these activities pose any unnecessary risk to the customer and/or the member.
Request For Comments
The NASD asks members to provide comments on the proposed amendment to the Rules of Fair Practice. Comments should be directed to:
Ms. Joan Conley
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.
1 In the Matter of Terry Wayne White. Exchange Act Release No. 34-27895, April 11, 1990: and In the Matter of William Louis Morgan. Exchange Act Release No. 34-32744, August 12, 1993, respectively.
Text Of The Proposed Amendment To Article III Of The Rules Of Fair Practice
(Note: New language is underlined.)
Borrowing Or Loaning Funds Or Securities With Customers
No person associated with a member in any registered capacity shall borrow funds or securities from or lend funds or securities to any customer of the member unless prior to such borrowing or loaning the registered person has provided written notice to the member and obtained written approval from the member. Notice shall be in the form required by the member. Activities subject to the requirements of Article in. Section 40 of the Rules of Fair Practice shall be exempted from the requirement of this Section.