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92-25 Proposed Amendment to Article III, Section 15 of the NASD Rules of Fair Practice Re: Exemption for Negative-Response Letters Used to Facilitate Certain Bulk Exchanges of Money Market Mutual Funds

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MAIL VOTE

EXECUTIVE SUMMARY

The NASD invites members to vote on a proposed amendment to Article III. Section 15 of the NASD Rules of Fair Practice that would permit members to use negative-response letters in bulk exchanges of money market funds in situations involving mergers or acquisitions, changes of clearing members: and exchanges of money market funds used in sweep accounts.

BACKGROUND

In Notice to Members 91-80 (December 1991), the NASD Board of Governors requested comments on a proposed amendment to Article III, Section 15 of the NASD Rules of Fair Practice. The amendment would permit members to use negative-response letters to facilitate bulk exchanges of money market funds in certain situations. These situations would include mergers and acquisitions, changes of clearing members, and exchanges of money market funds used in sweep accounts when investment performance is not the primary reason for the exchange.

Article III, Section 15 requires written authority from a customer before a member or a registered representative can exercise discretion in the customer's account. Negative-response letters permit the automatic execution of a recommendation in such letters if a customer does not respond to the letter by a specific date. Absent prior written authority from a customer, the use of a negative-response letter to facilitate an exchange of securities in a customer account would normally violate Article III, Section 15.

The NASD received 10 letters in response to Notice to Members 91 -80 requesting comment on the proposed amendment. All were in favor of the proposed amendment. Seven of the commenters suggested various changes to the proposed amendment.

One commenter believes that the requirement in the amendment for a tabular comparison of the fees charged by each fund would produce inexact figures that would be difficult to obtain. The commenter suggests that it should be replaced by a comparison of the yields of the two funds for the most recent practical data computed, and if desired by the member, the historical performance for each of the funds over comparable time periods. The commenter's rationale is that yields reflect all charges and expenses. The Board notes that it was the intention of the Investment Companies Committee, when drafting the proposal, that a tabular comparison would reflect the various fees that are disclosed in the front pages of every money market fund prospectus. These fees are exact and easily obtainable. Comparative yield figures do not, in the opinion of the Board, provide an adequate disclosure of fees.

Two commenters questioned applying the proposal to mergers and acquisitions because they are subject to a vote of shareholders. One suggested that, although it might be superfluous to include mergers and acquisitions, applying the proposal to these situations might obviate the need for a merger or acquisition. The other commenter suggested that the amendment might cause members to believe that a merger or an acquisition could be accomplished by using negative-response letters rather than a shareholder vote. The Board does not agree.

The Board also disagrees with the opinion of another commenter that a negative-response letter should be permitted when a "nonsweep account" is changed to a sweep account. The Board believes that such a change requires the authorization of the customer.

The Board had a similar reaction to two commenters who wish to expand the proposal to include, within the definition of bulk exchanges, changes in investment advisers and changes in accounts where a member or its affiliates provide sub-transfer agent or other support services. Another commenter suggested that any legitimate exchange of a money market fund should permit the use of a negative-response letter. The Board reiterates that any discretionary activity by a member or a registered representative in a customer's account would normally require a customer's written authorization. The narrow exemption provided by the proposed amendment in certain limited situations involving bulk transfers of money market funds is the only relief from the rule that the Board is currently prepared to grant on an across-the-board basis.

Another commenter recommended that exchanges required by administrative or judicial order not be subject to the 30-day delay in execution after a negative-response letter is mailed. The Board concluded that the nature of such an order will determine whether the 30-day requirement can be applied. Each such case, of which there will probably be few, will be considered on its merits and there is no necessity to amend the proposal.

Finally, a commenter suggested broadening the term "sweep account" to include those accounts where each "sweep" must be authorized by an employee of the member firm. The Board believes that, assuming that the customer has previously authorized credit balances to be swept periodically into a money market fund, the procedures adopted by a member to authorize each "sweep" would not cause such a sweep account to lose its "sweep" status.

REQUEST TO VOTE

The NASD Board of Governors concludes that the comments received do not warrant any changes to the original proposal. The Board considers that the proposed amendment to Article III, Section 15 of the NASD Rules of Fair Practice is necessary and appropriate. It recommends that members vote their approval. Please mark the enclosed 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 June 22, 1992.

Questions concerning this Notice may be directed to the Investment Companies/Insurance Affiliated Member Department at (202) 728-8329.

PROPOSED AMENDMENTS TO ARTICLE III, SECTION 15 OF THE OF THE NASD RULES OF FAIR PRACTICE

(Note: New text is underlined.)

Discretionary Accounts

Sec. 15.

Excessive transactions

(a) No member shall effect with or for any customer's account in respect to which such member or his agent or employee is vested with any discretionary power any transactions of purchase or sale which are excessive in size or frequency in view of the financial resources and character of such account.

Authorization and acceptance of account

(b) No member or registered representative shall exercise any discretionary power in a customer's account unless such customer has given prior written authorization to a stated individual or individuals and the account has been accepted by the member, as evidenced in writing by the member or the partner, officer or manager, duly designated by the member, in accordance with Section 27 of these rules.

Approval and review of transactions

(c) The member or the person duly designated shall approve promptly in writing each discretionary order entered and shall review all discretionary accounts at frequent intervals in order to detect and prevent transactions which are excessive in size or frequency in view of the financial resources and character of the account.

Exceptions

(d)(1) This section shall not apply to discretion as to the price at which or the time when an order given by a customer for the purchase or sale of a definite amount of a specified security shall be executed.
(d)(2) This section shall not apply to bulk exchanges of money market mutual funds ("funds") utilizing negative response letters provided:
(i) The bulk exchange is limited to situations involving mergers and acquisitions of funds, changes of clearing members and exchanges of funds used in sweep accounts.
(ii) The negative response letter contains a tabular comparison of the nature and amount of the fees charged by each fund.
(iii) The negative response letter contains a comparative description of the investment objectives of each fund and a prospectus of the fund to be purchased, (iv) The negative response feature will not be activated until at least 30 days after the date on which the letter was mailed.

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