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92-32 Request for Comments on Proposed Amendment to the Rules of Fair Practice Relating to the Respective Obligations and Supervisory Responsibilities of Introducing and Clearing Firms; Last Date for Comments: July 22, 1992

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EXECUTIVE SUMMARY

The NASD requests comments on a proposed amendment to the Rules of Fair Practice to require members entering into clearing or carrying agreements to specify the obligations and supervisory responsibilities of both the introducing and clearing firm. The text of the proposed rule follows this Notice.

BACKGROUND

The NASD is proposing to amend the Rules of Fair Practice to require members entering into a clearing agreement, as either an introducing firm or a clearing firm, to specify the respective functions, obligations, and supervisory responsibilities of each party to the agreement. The proposed rule results from recommendations of the NASD's Advisory Council and the Securities Industry Association (SIA) that the NASD clarify the obligations and supervisory responsibilities of clearing and introducing firms.

In considering whether to adopt the proposed rule, the Board of Governors (Board) has considered that a similar New York Stock Exchange (NYSE) rule (NYSE Rule 382) was already in place. Accordingly, the Board believes that it is appropriate to propose a rule that would provide consistent treatment for broker/dealers that are not NYSE members.

At the time the Securities and Exchange Commission (SEC) considered the NYSE's proposed rule, the NASD commented to the SEC that permitting certain functions to be allocated to the introducing member may result in compliance failures and violations resulting from the inability of the introducing member to adequately perform those functions. The NASD urged that members should not be permitted to avoid obligations or responsibilities which would otherwise be theirs under the securities laws.

In its order approving the NYSE Rule 382, the SEC recognized the NASD's concerns and stated, "... no contractual arrangement for the allocation of functions between an introducing and carrying organization can operate to relieve either organization from their respective responsibilities under federal securities laws and applicable SRO rules."1 This rule incorporates this principle as previously asserted by the NASD and noted by the SEC.

Subsection (a) of the proposed rule requires a member's clearing agreement to specify the functions and responsibilities of the respective parties. Subsection (a) further requires that at a minimum the agreement address the seven functions enumerated in subsections (a)(1) through (a)(7), and that the agreement specify the party ordinarily responsible for any other function included in the agreement. Members which are subject to a comparable rule of a national securities exchange, such as NYSE Rule 382, are exempt from the provisions of the proposed rule.

Subsection (b) of the proposed rule requires a clearing member to submit its clearing agreement to the NASD for review and approval in the event there are any amendments relating to the functions specified in subsection (a)(1) through (a)(7), or if the clearing member enters into a new agreement with another introducing firm, unless the clearing member is subject to review and approval pursuant to a comparable rule of a national securities exchange.

Subsection (c) of the proposed rule requires an introducing member to submit its clearing agreement to the NASD in the event of any amendment relating to the functions specified in subsections (a)(1) through (a)(7), or if the introducing member enters into a new clearing agreement with another clearing firm. Subsection (a) does not require the introducing member to seek prior approval of any changes. Subsections (b) and (c) both embody the NASD's view that changes which are of little regulatory concern, such as changes to fees and charges, do not need approval.

Under Subsections (b) and (c), the NASD would review and approve clearing agreements required to be submitted by a clearing firm if the agreement is not subject to the review and approval of a national securities exchange.

Finally, Subsection (d) of the proposed rule requires introducing members to disclose the existence of the agreement to customers on the opening of an account and to disclose the terms of the agreement as it relates to the responsibilities specified in subsections (a)(1) through (a)(7).

The Board believes that this provision will reduce customer confusion regarding the identity of the responsible party when questions or complaints arise.

REQUEST FOR COMMENTS

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

Stephen Hickman
Office of the Secretary
National Association of Securities
Dealers, Inc.
1735 K Street, NW
Washington, DC 20006-1506.

Comments must be received no later than July 22, 1992. Comments received by this date will be considered by the Board. Prior to becoming effective, the rule must be adopted by the Board and the membership and then filed with the SEC for its approval.

Questions concerning this Notice should be directed to Elliott R. Curzon, Office of General Counsel, at (202) 728-8451.


1 Securities Exchange Act Release No. 18497.


TEXT OF PROPOSED RULE

Rules of Fair Practice

(Note: All language is new.)

Clearing Agreements

(a) Any clearing or carrying agreement entered into between a member firm and any other firm, except where the member is also subject to a comparable rule of a national securities exchange, shall specify the respective functions and responsibilities of each party to the agreement and shall, at a minimum, specify the responsibility of each party with respect to each of the following functions:
(1) opening, approving and monitoring customer accounts;
(2) extension of credit;
(3) maintenance of books and records;
(4) receipt and delivery of funds and securities;
(5) safeguarding of funds and securities;
(6) confirmations and statements; and
(7) acceptance of orders and execution of transactions.
(b) Whenever a clearing member amends its clearing or carrying agreement with an introducing firm with respect to any item enumerated in Subsections (a)(1) through (a)(7) of this Section, or enters into a new clearing or carrying agreement with an introducing firm, the clearing member shall submit the agreement to the NASD for review and approval unless the clearing member is subject to comparable review and approval requirements of a national securities exchange.
(c) Whenever an introducing member designated to the NASD under Securities and Exchange Commission Rule 17d-1 amends its clearing or carrying agreement with a clearing firm with respect to any item enumerated in Subsections (a)(1) through (a)(7) of this Section, or enters into a new clearing agreement with another clearing firm, the introducing member shall submit the agreement to the NASD.
(d) Each customer whose account is introduced on a fully disclosed basis shall be notified in writing upon the opening of his account of the existence of the clearing or carrying agreement and of the terms of the agreement as it relates to the responsibilities specified in subsections (a)(1) through (a)(7).

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