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85-58 Request for Comments on a Proposed New Rule Governing the Prompt Payment for Investment Company Shares Sold to Customers by NASD Members
TO: All NASD Members and Other Interested Persons
LAST DATE FOR COMMENT: SEPTEMBER 30, 1985
The National Association of Securities Dealers, Inc. (NASD), is soliciting comments from members and other interested persons on a proposed new rule (new paragraph (m), Article III, Section 26, NASD Rules of Fair Practice) that would govern the prompt payment by NASD members for investment company shares.
The new rule would require NASD members to transmit payments for investment company shares, which such members have sold to customers, to underwriters by the end of the fifth business day after receiving a purchase order from a customer (trade date + 5). The rule would also require members who are underwriters to transmit payment for investment company shares, which they have received from customers or other members, to investment company issuers within one business day after receiving such payments (day of receipt + l).
The new rule would replace the NASD Board of Governors' interpretation governing the prompt payment by members for shares of investment companies, which appears at ¶5265 of the NASD Manual and is attached as Exhibit 2.
The text of the proposed rule is attached to this notice as Exhibit 1.
PROPOSED PROMPT PAYMENT RULE: BACKGROUND AND EXPLANATION
During the past several years, the investment company industry has experienced unprecedented growth. For the first five months of 1985, sales of mutual funds (excluding short-term funds) totaled $37.1 billion. Total annual sales were $45.9 billion in 1984 and $40.4 billion in 1983. Both totals set new records at the time.
As of December 31, 1983, total net assets of all mutual funds were $293 billion, compared with the end of May 1985 when they were $424 billion.
In 1984, 57 percent ($38 billion) of investors' purchases and redemptions of mutual funds (excluding short-term funds) were processed by NASD member firms using multifarious procedures that included the telephone, mail deliveries, express mail, messengers and some automation facilities. These procedures are often inefficient, costly and non-uniform. The ever-increasing number of transactions magnified the adverse effect of these inefficiencies and led to the formation of a joint NASD/Investment Company Institute Task Force, which was charged with the responsibility of finding a solution to the problem.
After lengthy discussions of a variety of options, the Task Force reached an agreement with the National Securities Clearing Corporation (NSCC) in January 1985. The NSCC began developing a system that will automate, standardize and centralize the processing of transactions in mutual funds. It is anticipated that a substantial volume of members' transactions in mutual fund shares will be processed through the system when it begins operating in 1986.
The new system will provide for automatic net settlement in a participating member's account with the NSCC on the fifth business day following the trade date. It will also provide for net settlement with mutual fund issuers on the same day.
For the past 28 years, prompt payment by members for mutual fund shares, which they have sold to customers, has been governed by the NASD Board of Governors' Prompt Payment Interpretation. This interpretation was adopted when the mutual fund industry was in its infancy in terms of the volume of transactions, (in 1957, there were 143 mutual funds with $8.7 billion in net assets and annual sales of $1.4 billion.)
The interpretation does not include a definition of the term "prompt payment." Under its provisions, if an underwriter does not receive payment from a member within 10 business days of the trade date, it is required to notify the local NASD District Office where the originating dealer's office is located. Currently, this results in a blizzard of paper flowing into NASD District Offices. Upon investigation of the reason for such late payments, the NASD staff invariably finds that the cause is the inefficiencies of the various settlement systems currently used which have often been overwhelmed by the sheer volume of transactions.
The NASD believes that the adoption of a centralized settlement system will solve most of the settlement problems that participants in the proposed system are experiencing, and it will do so at a lower unit cost.
The NASD also believes that the trade date + 5 settlement requirement that is to be incorporated into the new system should become the universal standard for all mutual fund sales processed by NASD members. It considers that all members who are underwriters should be governed by a similar standard for settlement with mutual fund issuers. That is, payments for mutual fund shares received directly from customers or from other members should be transmitted within one business day of the receipt of such payments.
RESCISSION OF THE PROMPT PAYMENT INTERPRETATION
Several of the provisions that are included in the current Prompt Payment Interpretation, the rescission of which is being proposed, are not included in the proposed new rule for the following reasons:
Since the provisions of Rule 17(a)(3) under the Securities Exchange Act of 1934 and Article III, Section 21 of the NASD Rules of Fair Practice, govern the recordkeeping requirements to which all members are subject, there is no reason to repeat such requirements in the proposed rule.
Ten-Day Notification Requirement
For the reasons discussed above, the NASD does not believe it is necessary to retain this requirement. Although there may have been rationale for such a requirement in the absence of a definition of the term "prompt payment," such will no longer be valid when a rule is in place that defines prompt payment in specific terms and which will subject members to disciplinary action for violation of its provisions.
Reference to Regulation T
The NASD considers that the negative reference to Regulation T in the interpretation serves no useful purpose, and is therefore superfluous.
* * * * *
All members and other interested persons are invited to submit written comments on the proposed new rule and the proposed rescission of the Prompt Payment Interpretation. Comments must be received no later than September 30, 1985, and should be directed to:
Mr. James M. Cangiano
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006
Comments received by the indicated date will be considered by the Investment Companies Committee and the NASD Board of Governors. If the proposals are approved by the Board, they must then be submitted to the membership for a vote. Any rule approved by the Board and the membership must be filed with and approved by the Securities and Exchange Commission before becoming effective.
Questions regarding this notice should be directed to A. John Taylor, Vice President, Investment Companies/Variable Contracts, at (202) 728-8328.
Frank J. Wilson
Executive Vice President and General Counsel
Legal and Compliance
Proposed Amendment to Article III, Section 26 of the NASD Rules of Fair Practice*
Prompt Payment for Investment Company Shares
Prompt Payment by Members for Shares of Investment Companies*
Failure by members to pay underwriters (who are also members) promptly, and failure by underwriters to insist upon such prompt payment by members, for investment company shares which members have sold to customers is contrary to the accepted standards of the business.
Members are required to transmit payment to underwriters (or custodians) promptly after the date of the transaction. Underwriters must pay issuers for shares acquired to fill dealers' orders promptly after the date of the transaction.
Members must maintain records, showing date of transaction, date upon which payment is received from customer, and date of payment to underwriter, as to all transactions in investment company shares.
In the event an underwriter does not receive payment from a member within ten (10) business days following the date of any transaction involving more than $100, or if any check received from a dealer for payment of an open transaction is returned by a bank as uncollectable, regardless of when the check was originally received, the underwriter must immediately notify the district office of the Association in the district where the dealer's office is located. The notice to the Association shall state that the underwriter has communicated with the member and shall contain any explanation furnished by the member for the failure to make prompt payment. A copy of this notice must be furnished to the member involved.
Failure to comply with the procedures set forth herein may be considered a violation of Section 1 of Article III of the Rules of Fair Practice.
Transactions in investment company shares between customers and members are subject to Regulation T of the Federal Reserve Board. However, the Interpretation above is in no way related to Regulation T.
[As amended effective August 3, 1978.]
* New language is underlined.
* This interpretation is proposed to be deleted in its entirety.