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98-42 NASD Regulation Requests Comment On Proposed Rules Regarding Cease-And- Desist Proceedings
Comment Period Expires: July 31, 1998
Legal & Compliance
NASD Regulation, Inc. (NASD RegulationSM) requests comment on a series of National Association of Securities Dealers, Inc. (NASD®) rules that would authorize NASD Regulation Department of Enforcement staff, after obtaining approval of the President or Chief Operating Officer of NASD Regulation, to initiate temporary cease-and-desist proceedings with respect to the rule violations that pose the most serious and immediate investor protection concerns. The proceeding would allow the Department of Enforcement, after notice and opportunity for a hearing, to order a member or individual to stop engaging in activity that violates certain securities laws or rules. The order could remain in place until a regular disciplinary proceeding is completed. It is expected that temporary cease-and-desist proceedings would be used only in egregious cases. Further, the rules would permit an accelerated proceeding to impose sanctions for violations of temporary or permanent cease-and-desist orders.
Questions concerning this Request For Comment should be directed to Alden S. Adkins, Senior Vice President and General Counsel, NASD Regulation, at (202) 728-8332, or Peter R. Geraghty, Assistant General Counsel, Office of General Counsel, NASD Regulation, at (202) 728-8227.
Background And Discussion
The proposed microcap rules, which will be filed with the SEC shortly, would regulate broker/dealer and individual salesperson conduct in connection with the sale of smaller capitalization securities, which often have proved to be the source of significant fraudulent activity.1 To fully address serious broker/dealer and salesperson misconduct, NASD Regulation staff believes it needs to introduce a quicker process by which it can sanction such misconduct. The proposed Temporary Ceaseand Desist Order (TCDO) rule and the related proposed TCDO enforcement proceeding are designed to fulfill this need.
Specifically, the proposed rule would allow staff in an expedited proceeding to obtain an order prohibiting the continuing violation of specified rules where staff satisfies the required standard for issuance of the TCDO. Before a TCDO can be issued, the staff must show that the alleged rule violations are likely to result in significant dissipation or conversion of assets or other significant harm to investors prior to completion of the regular disciplinary proceeding. To ensure that the rule is limited to the most serious offenses, such orders could only be sought for alleged violations of the following specified investor protection provisions or rules: (1) Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, SEC Rule 10b-5, and NASD Rule 2120 (the SEC's and NASD's basic anti-fraud and manipulation rules); (2) SEC Rules 15g-1 to 15g-9 (the SEC's penny stock rules); and (3) NASD Rules 2110 and 2330, where the alleged violations include unauthorized trading, misuse or conversion of customer assets, or excessive markups.
If the firm or individual subject to a TCDO (or a permanent cease-anddesist order)2 violates the order by continuing to violate the rules specified in the order, the proposed rule would permit an accelerated proceeding to impose sanctions for violations of the order. The President or Chief Operating Officer of NASD Regulation could authorize the initiation of an expedited disciplinary proceeding under Rule 9513, which could result in sanctions up to and including bars and expulsions for violations of the order, after the Respondent was afforded a hearing. Because the proceeding would occur under Rule 9513, the Respondent would be afforded all the procedural protections of this rule. For example, the Respondent must be served with written notice initiating the proceeding; the Respondent would have 15 days to request a hearing; the hearing panel would be composed of a Director of NASD Regulation and a current or former Director of NASD Regulation, Governor of NASD, or member of the National Adjudicatory Council (NAC); the hearing panel's decision would have to address, among other things, the grounds for initiating the proceeding, findings of fact, a statement supporting the disposition of the main issue, and if a sanction is imposed, its effective date, time, and terms; and the hearing panel's decision would be subject to a call for review by the NASD Board of Governors.
In order to ensure that this authority is applied appropriately, a TCDO proceeding, as well as any proceeding to impose sanctions for violating the TCDO (or a permanent cease and desist order), could be initiated only with the written authorization of the President or Chief Operating Officer of NASD Regulation. This ensures that the prosecutorial judgment for such extraordinary proceedings is made at the highest staff levels. If the rule is approved, the staff will monitor its effectiveness and report to the Board of Directors of NASD Regulation, within two years after the effective date of the rule, on NASD Regulation's experience with the rule and obtain the Board's authorization to continue to exercise authority under the rule.
The initiation of the TCDO proceeding and any resulting order could be publicized under Interpretive Material 8310-2.
The proposed rule is modeled on a rule providing similar authority to the SEC, although unlike the SEC rule, the NASD rule does not include a provision for orders issued without the Respondent having any opportunity to be heard (so-called "ex parte" orders). Also, unlike the SEC rule, the proposed NASD rule is limited in the types of violations that the TCDO proceeding may be used to address.
The NASD Board of Directors and the National Adjudicatory Council approved the issuance of a Notice to Members. The Small Firm Advisory Board was supportive of the issuance of a Notice, but took no formal position. A subcommittee of the Legal Advisory Board reviewed and unanimously supported the issuance of a Notice to Members.
Request For Comment
The NASD encourages all interested parties to comment on the proposed rules. Comments should be mailed to:
Office of the Corporate Secretary
NASD Regulation, Inc.
1735 K Street, NW
Washington, D.C. 20006-1500
or e-mailed to:
Comments must be received by July 31, 1998. Before becoming effective, any rule change developed as a result of comments received must be adopted by the NASD Regulation Board of Directors, may be reviewed by the NASD Board of Governors, and must be approved by the SEC.
Text Of Proposed Rule
(Note: All language is new.)
9800. Temporary Cease-And-Desist Orders
9810. Initiation of Proceeding
9820. Appointment of Hearing Officer and Hearing Panel
As soon as practicable after the Department files a copy of the notice of the initiation of a temporary ceaseand-desist proceeding with the Office of Hearing Officers, the Chief Hearing Officer shall assign a Hearing Officer to preside over the temporary cease-and-desist proceeding. The Chief Hearing Officer shall appoint two Panelists to serve on a Hearing Panel with the Hearing Officer. The Panelists shall be current or former Governors, Directors, or National Adjudicatory Council members, and at least one Panelist shall be an associated person.
9840. Issuance of Temporary Cease-and-Desist Order by Hearing Panel
9850. Review by Hearing Panel
At any time after the Hearing Panel serves the Respondent with a temporary cease-and-desist order, a Party may apply to the Hearing Panel to have the order modified, set aside, limited, or suspended. The application shall set forth with specificity the facts that support the request. The Hearing Panel shall respond to the request in writing within ten days after receipt of the request. The Hearing Panel response shall be served on the Respondent via personal service, overnight commercial courier, or facsimile. The filing of an application under this Rule shall not stay the effectiveness of the temporary cease-and-desist order, unless the Hearing Panel otherwise orders.
9860. Violation of TCDO
A Respondent who violates a temporary cease-and-desist order imposed under this Rule Series may have its association or membership suspended or canceled under the Rule 9510 Series. The President or Chief Operating Officer of NASD Regulation, Inc., must authorize the initiation of any such proceeding.
9870. Application to Commission for Review
The right to have any action under this Rule Series reviewed by the Commission is governed by Section 19 of the Act. The filing of an application for review shall not stay the effectiveness of a temporary ceaseand-desist order, unless the Commission otherwise orders.
1 Among other things, the proposed microcap rules would require members to review current issuer financial statements prior to recommending a transaction in an over-thecounter (OTC) security to a customer and require members to provide certain disclosures on the trade confirmation for customer transactions in an OTC equity security. Also, the rules prohibit a member from quoting a security on the OTC Bulletin Board unless the issuer has made current filings with the Securities and Exchange Commission or other regulatory authority.