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83-74 Proposed Amendments to Article III, Section 19 of the Rules of Fair Practice, "Customers' Securities or Funds"
I M P O R T A N T
Officers * Partners * Proprietors
TO: All NASD Members
Last Voting Date Is January 30, 1984
Enclosed herewith are proposed amendments to Article III, Section 19 of the Rules of Fair Practice and the Explanation thereto. These amendments have been approved by the Association's Board of Governors for submission to the membership for a vote. If approved, they must then be filed with, and approved by, the Securities and Exchange Commission.
BACKGROUND OF THE PROPOSED AMENDMENTS
As an ongoing responsibility, the standing committees of the Board of Governors review and, if necessary, recommend revisions to the Association's rules and regulations. In this regard, the Capital and Margin Committee has proposed certain revisions to Article III, Section 19 of the Rules of Fair Practice, "Customers' Securities or Funds." The changes proposed by the Committee are more technical rather than substantive in nature and reflect similar actions by other self-regulatory organizations.
The revisions are intended to eliminate regulation which has been rendered obsolete by a member's obligation to comply with certain requirements of SEC Rule 15c3-3, the "Customer Protection Rule," which governs the protection of customers' funds and securities. The current provisions contained in Section 19 with respect to the lending of customers' securities under a "fair and reasonable" standard are now either addressed or superseded through the possession and control requirements of Rule 15c3-3.
The proposed revisions will also eliminate the necessity for receiving, processing and retaining certain duplicative paperwork. Specifically, the amendments will eliminate the requirement of obtaining written lending authorizations separate and apart from the standard margin agreements. This will permit members to use only one margin/loan consent agreement requiring only one signature from a customer rather than two as is currently required. As previously noted, these changes eliminating the "two signature" requirement have already been adopted by recent amendments to New York Stock Exchange Rule 402 and AMEX Rule 449.
In light of the foregoing considerations, the Board determined that this proposal should be circulated to the membership for approval.
DISCUSSION OF THE PROPOSED RULE AMENDMENTS
One of the proposed amendments to Section 19 includes the addition of a new section, entitled "General Provisions." This section places an affirmative obligation on a member to adhere to the provisions of SEC Rule 15c3-3 with respect to possession and control requirements and the maintenance of cash reserves.
A second proposed change concerns the section regarding a member's authorization to lend customers' securities. In this paragraph, the rule currently requires a member to obtain a lending authorization separate from, and in addition to, a margin account agreement before it may lend customers' securities. Federal securities laws relating to the lending of securities do not require such separate authorizations. In light of this, and in consideration of the other regulatory safeguards that have evolved over the years, the requirement for separate authorizations appears unnecessary. Therefore, the proposed revisions eliminate the two-agreement requirement entirely.
In a third proposed change, paragraph (c) of the current rule would be deleted. This paragraph requires that a member obtain from a customer a specific authorization designating the particular securities to be loaned should they be fully paid or excess margin securities. The proposal eliminates this requirement in favor of relying on the safeguards embodied in Rule 15c3-3(b)(3) with respect to the lending of fully paid and excess margin securities.
Finally, the Explanation of the Board of Governors, which follows the rule, has been revised in accordance with the provisions discussed above.
* * *
The text of the proposed rule is attached and merits your immediate attention. Please mark the 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 January 30, 1984.
The Board of Governors believes the proposed amendments are necessary and appropriate and recommends that members vote their approval.
Questions concerning this notice may be directed to James M. Cangiano, Associate Director, Department of Policy Research, at (202) 728-8273, or to your District Director.
Gordon S. Macklin
TEXT OF PROPOSED REVISIONS
Customers' Securities or Funds
Authorization to lend -
Pledging or lending related to indebtedness Separate lending authorization designating securities
Segregation and identification of securities
Prohibition against guarantees
Sharing in accounts; extent permissible
o o o Explanation of the Board of Governors
Certain Paragraphs Paragraph (d) Section 19 of Article III of the Rules of Fair Practice Paragraph (b) The first part of this paragraph requires a member to obtain a lending authorization in addition to a margin account agreement before lending a customer's securities. The particular securities to be lent need not be designated so long as the member does not lend more securities than are "fair and reasonable." The second part of this paragraph limits the amount of a customer's securities which may be lent or pledged under a general agreement with the customer. With respect to lending, the "fair and reasonable" standard means that a member may lend a customer's securities only in an amount which is reasonably related to the customer's debit balance, unless the additional written authorization required under paragraph (c) is obtained from the customer. With respect to pledging a customer's securities, the "fair and reasonable" standard refers to the amount of the customer's securities which a member would be required to deposit as collateral in order to borrow an amount approximating the customer's debit balance; the amount of collateral so required usually depends on the type and equality of securities in question, as well as the policies of the lending institution. Paragraph (c) This paragraph requires a member to obtain a specific authorization designating the particular securities in order to lend a customer's fully paid securities or those in excess of an amount which is reasonably related to the customer's debit balance.
This paragraph requires members to segregate and identify by customers both fully paid and
securities held in margin accounts which are in excess of the amount which may be pledged under the "fair and reasonable" standards in paragraph (b). These are commonly referred to as excess margin securities. although not mentioned as such in the section.
With regard to a customer's account which contains only stocks, it is general practice for firms to segregate that portion of the stocks having a market value in excess of 140% of the debit balance therein. When a customer's account contains bonds, the basis upon which the member is borrowing or can borrow on such bonds should be taken into consideration in determining the amount of securities to be segregated.
Following are three general types of segregation of customer's securities currently in use by many firms:
In all the above methods, the records should note the dates when the securities are segregated. When such securities are not in the actual custody of the member, for instance, when they are in the physical possession of a correspondent firm, their location and the means by which they may be identified as belonging to each customer should be indicated on the books of the member carrying the customers' accounts.
For purposes of Section 19, a customer's securities subordinated under a "satisfactory subordination," as defined in Rule 15c3-1 of the Securities and Exchange Commission, are not deemed to be securities carried for the account of a customer.