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83-72 Request for Comments on Proposed Amendment to Schedule C to the By-Laws
I M P O R T A N T
Officers * Partners * Proprietors
TO: Members of the National Association of Securities Dealers, Inc. and Other Interested Persons
COMMENT PERIOD CLOSES ON: January 20, 1984
The National Association of Securities Dealers, Inc. ("Association") is publishing for comment a proposed amendment to Schedule C to the By-Laws. The amendment was approved by the Board of Governors at its November 1983 meeting. After the comment period has expired, the Board of Governors will review the proposal taking into consideration the comments received. If adopted by the Board of Governors the proposal will thereafter be filed with the Securities and Exchange Commission for approval.
A discussion of the background and purpose of the amendment, an explanation of the changes and the text of the amendment appear below.
BACKGROUND AND PURPOSE
The proposal would amend the definition of "representative" in Schedule C to the By-Laws to cover a class of persons including persons who are employed by certain non-broker/dealer organizations and who perform activities on behalf of members similar to those performed by registered representatives. The effect of the amendment will be to require members to register such persons as representatives and bring them under regulation comparable to the regulation to which registered representatives of members presently are subject.
In the mid-1940s the Association instituted its existing program for regulation of personnel of members by adopting amendments to its By-Laws and Rules of Fair Practice requiring members to register certain persons associated with members as registered representatives. The amendments also made registered representatives subject to the same obligations as members under the Association's rules and allowed disciplinary action to be brought against registered representatives for violations of Association rules. The regulation of registered representatives was extended in 1956 by the introduction of a requirement that persons becoming registered as representatives take and pass a written qualification examination before they could function as registered representatives of members.
At the present time the registration and qualification requirements are contained in Schedule C to the By-Laws adopted by the Board of Governors pursuant to the authority granted by Article I, Section 2(d) of the By-Laws. The provisions of Schedule C have been refined in the intervening years so that today there are separate registration categories for principals and representatives and separate examinations for principals and representatives. In addition, there are specialized qualification examinations within the two broad categories for principals and representatives who engage in specialized areas such as the sale of investment company securities and variable annuities, direct participation program securities, options and municipal securities.
Under existing Schedule C all persons who are compensated by members for solicitation, accepting orders, or recommending securities to customers or providing investment advice resulting in securities transactions must be registered before being permitted by a member to engage in such activities. The definition of "representative" in Schedule C covers persons who are engaged in the investment banking and securities business "for the member" including the functions of "solicitation or conduct of business in securities". The definition, however, has been traditionally applied only to employees, independent contractors and other natural persons who are directly compensated by the member for such activities.
The Board is proposing to extend the coverage of Schedule C to apply to certain persons who, if they were employees of a member, would clearly fall within the definition of representative. The securities activities of banks, savings and loan associations and certain other organizations such as real estate brokers have expanded over the past few years. In addition, the relationship between members and these institutions has assumed a different direction. There have traditionally been personnel within these institutions engaged in securities activities such as trust officers, traders, portfolio managers and investment consultants and financial consultants and investment officers. In the past, however, these institutions simply referred securities business to members which charged the institutions a commission or fee. The commissions or fees earned by members from this referred business was not shared by the members with the institutions. A number of banks and savings and loan associations and other business organizations have recently entered into contractual or other arrangements with members to refer the institution's customers to members for execution of transactions and in return for such business the members have agreed to compensate the institutions by sharing commissions or in other ways. 1/ This appears to be an increasing trend in the securities industry. In many cases the ability of institutions to provide brokerage services to its customers through these arrangements with members is actively promoted through advertising and publications. Although some personnel at the institutions appear to perform only clerical and ministerial functions, there do not appear to be any requirements to limit the ability of personnel to make recommendations or engage in other functions specified in the definition of representative in Schedule C to the By-Laws. If such persons do make recommendations to customers, however, it does not appear that the registration requirements of Schedule C would apply since they often receive no direct compensation from members even though the employer institution does.
The Board believes the public interest is not served by exempting from the registration requirements employees of organizations who are dealing with public customers in the same way in which registered representatives of members deal with the public. At the present time these persons are not required to take qualification examinations and function outside the supervisory responsibilities which members are required to exercise over their other representatives. It is also not entirely clear, absent registration, whether the Association could hold them individually accountable for misconduct by imposing disciplinary sanctions against them. The Association is concerned that the lack of any formal qualification standards, supervision and individual accountability for misconduct may create conditions which unnecessarily may expose public customers to the risk of harm. The Board believes that unless registration is a requirement it cannot fully carry out its statutory responsibility to prevent fraudulent acts and practices, to promote just and equitble principles of trade and to protect investors and the public interest.
The proposal is intended to cover non-broker/dealer personnel who perform securities activities on behalf of members. It is thus limited to employees of organizations which have entered into arrangements with members by which the activities of the employees actively further the securities business of the members. Further, the only non-broker/dealer employees who would come under the new definition of "representative" in proposed section (b)(ii) would be employees who receive compensation from members or whose employers receive compensation from members. The Board believes that its statutory duty to regulate its members is not fully implemented by allowing a situation where persons soliciting or receiving business for members are not required to take and pass qualification examinations and to be subject to disciplinary action for violations of applicable requirements. The Board believes that if a person is soliciting or receiving business for a member and the member compensates the employer the impact on the public interest is no less great than if the person is compensated directly by the member. The need for protection against unqualified persons achieved by examinations and accountability through disciplinary proceedings and member supervisory responsibility is no less important. Accordingly, the effect of the proposal is to require members to register such persons so that investors will receive equal protection under the Association's rules and the federal securities laws.
SCOPE OF PROPOSAL
The following is a brief discussion of the intended scope of the proposal.
The only persons who would be deemed representatives under the proposed amendment are those employees of non-broker/dealer organizations whose activities fall into two categories: (1) solicit or receive orders from public customers for the purchase or sale of securities, or (2) give investment advice or make recommendations to public customers with respect to securities transactions. The language used is intended to limit the definition to employees of non-broker/dealers who receive orders directly from members of the public, whether or not solicited, or who make recommendations or give advice directly to public customers with respect to securities even though any resulting order may be directly transmitted by the customer to the member for execution.
The proposal is not intended to interfere with conventional securities activities of banks or other organizations. Where no compensation is received from members, the personnel in bank trust departments, traders, money managers, portfolio managers could continue to engage in such securities activities as making recommendations covering securities and executing or transmitting orders to broker/dealers for execution without any requirement to register.
All comments pertaining to this proposal should be in writing and sent to S. William Broka, Secretary, National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006, and be received on or before January 13, 1984, in order to receive consideration. Questions concerning the proposal may be directed to John F. Mylod, Jr., Assistant General Counsel, at (202) 728-8288.
Frank J. Wilson
Executive Vice President
Legal and Compliance
TEXT OF PROPOSED AMENDMENTS
Schedule C to the By-Laws
REGISTRATION OF REPRESENTATIVES
[In addition, Subsections (2)(a)(i), (2)(b)(i), (2)(c)(i) and (2)(d) of Part II of Schedule C would be amended to eliminate the phrase "associated with a member".]
1/ Banks are exempt from the broker /dealers definitions in the 1934 Act and a number of savings and loans have received "no-action" letters to permit such arrangements without broker/dealer registration.