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88-86 Approval and Immediate Effectiveness of Article III, Section 43 of the NASD Rules of Fair Practice Regarding Outside Business Activities

SUGGESTED ROUTING*

Senior Management
Legal & Compliance
Operations
Trading
Training

*These are suggested departments only. Others may be appropriate for your firm.

EXECUTIVE SUMMARY

The SEC has approved new Section 43 to Article III of the NASD Rules of Fair Practice. The new section prohibits all persons associated with a member in any registered capacity from accepting employment or compensation from any other person as a result of business activity outside the scope of the employment relationship with a member unless prompt written notice to the member firm is provided. This provision does not apply to compensation from passive investments and activities subject to the requirements of Article III, Section 40 of the Rules of Fair Practice. The text of the rule follows this notice.

BACKGROUND

On October 13, 1988, the Securities and Exchange Commission (SEC) approved new Section 43 to Article III of the NASD Rules of Fair Practice (see SEC Release No. 34-26178 (dated October 13, 1988). The section is intended to improve the supervision of registered personnel by providing information to member firms concerning outside business activities of their representatives.

On January 14, 1988, the NASD issued Notice to Members 88-5, which solicited comments on a proposed NASD Rule of Fair Practice prohibiting any person associated with a member firm from being employed by, or accepting compensation from, any other person based on any business activity outside the scope of the employment relationship with a member firm, unless such person had provided prior written notice to that firm.

When requesting comments concerning the proposed rule, the NASD Board of Governors observed that the expansion of the financial services industry had provided increased business opportunities for persons associated with a member firm, both within the scope of their employment with a member and otherwise. The Board noted that, in recent disciplinary cases, prior notice to a member firm of an associated person's outside business activities might have prevented harm to the investing public or the firm's entanglement in legal difficulties.

The Board further observed that the internal rules of many member firms already included limitations on outside business activities and notification requirements, and that both the New York Stock Exchange and the American Stock Exchange require associated persons of member firms to notify their firms of outside business activities.1 The Board concluded that it was appropriate for member firms to receive prompt notification of all outside business activities of their associated persons so that the member's objections, if any, to such activities could be raised at a meaningful time and so that appropriate supervision could be exercised as necessary under applicable law.

After reviewing comments submitted by the membership, the NASD Board concluded that the proposed rule should be adopted with certain modifications limiting the rule's application to persons associated with a member in a registered capacity and exempting passive investments and activities subject to the requirements of Article III, Section 40 of the NASD Rules of Fair Practice from the proposed rule's notice requirements. The Board determined that prompt, rather than prior, notice should be required under the proposed rule, and that the form of the written notice should be determined by the employer-member and could therefore include using Form U-4. The proposed rule, as modified, was approved after a member vote (see Notice to Members 88-45 dated July 1, 1988) and was filed with the SEC on July 27, 1988.

Questions concerning this notice can be directed to Norman Sue, Jr., Senior Attorney, Office of the General Counsel, at (202) 728-8117

OUTSIDE BUSINESS ACTIVITIES

Sec. 43. No person associated with a member in any registered capacity shall be employed by, or accept compensation from, any other person as a result of any business activity, other than a passive investment, outside the scope of his relationship with his employer firm, unless he has provided prompt written notice to the member. Such notice shall be in the form required by the member. Activities subject to the requirements of Article III, Section 40 of the Rules of Fair Practice shall be exempted from this requirement.


1 New York Stock Exchange Rule 346(b), (e), and Supplementary Material .10; American Stock Exchange Rule 342(a), (b), and Commentary .20. Both organizations also require persons in supervisory positions to devote their entire time during business hours to the business of their firms and allow such persons to obtain permission from the exchange to devote less than full time to the business of their firm when it will not impair the protection of investors or the public interest.



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