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88-84 SEC Approval of Amendments to NASD Rules of Fair Practice and Conforming Amendments to the By-Laws Re: Supervisory Practices and Definitions of Branch Office and Office of Supervisory Jurisdiction
*These are suggested departments only. Others may be appropriate for your firm.
On October 13, 1988, the Securities and Exchange Commission approved amendments to Article III, Section 27 of the Rules of Fair Practice and conforming amendments to Article I of the By-Laws and Schedule C to the By-Laws. The amendments to Article III, Section 27 (1) prescribe specific supervisory practices and procedures for all member firms and (2) revise the definitions of branch office and office of supervisory jurisdiction.
The conforming amendment amends the present text in the By-Laws to delete the substantive definition and instead references the definition set forth in Article III, Section 27. In addition, Schedule C to the By-Laws is amended to delete from an Explanation of the Board of Governors certain text pertaining to the definitions of office of supervisory jurisdiction and branch office. The texts of the amendments are attached.
In recent years, the NASD has become increasingly concerned that many persons associated with NASD members are engaging in the offer and sale of securities to the public without adequate ongoing supervision. In particular, the potential for significant regulatory problems exists when registered representatives conduct business at locations that are not subject to regular examination by the member and operate without direct oversight of qualified supervisory personnel.
The NASD also has considered whether certain aspects of a firm's business should be subject to on-site supervision by a registered principal so that the member can properly discharge its regulatory obligations. Further, the NASD has from time to time considered whether the definition of "branch office" in the By-Laws should be revised.
In connection with its review, the NASD, on February 9, 1988, issued Notice to Members 88-11, which requested comments on proposed amendments to Article III, Section 27 of the Rules of Fair Practice that set forth specific minimum requirements for supervisory practices and procedures for NASD members. After reviewing the comment letters, the NASD then published Notice to Members 88-44, requesting a member vote on proposed amendments substantially similar to those set forth in Notice to Members 88-11. The membership voted to approve the proposed amendments, and they were filed with the Securities and Exchange Commission. The Commission approved the amendments on October 13, 1988.
Amendments to Supervision Rules
The amendments substantially expand the specificity of Article III, Section 27 of the NASD Rules of Fair Practice with respect to a member's supervisory obligations. The NASD believes the new provisions will assist members in ensuring compliance with applicable laws, regulations, and rules by requiring that firms review their businesses and construct and document a supervisory system that is reasonably designed to achieve compliance with the securities laws and regulations and NASD rules applicable to the various areas of business in which NASD members are engaged.
The amendments also contain certain minimum required supervisory procedures and practices that the NASD believes to be necessary in any firm, regardless of size or type, in order to supervise adequately an investment banking and/or securities business.
The amendments require each firm to establish and maintain supervisory procedures and practices that provide for, at a minimum, the following:
The amendments require that each firm maintain written supervisory procedures that describe the supervisory system implemented according to the above requirements and that list the titles, registration status, and locations of the required supervisory personnel and the specific responsibilities assigned to each. A copy of the member's supervisory procedures, or the relevant parts thereof, will be required to be kept and maintained at each OSJ and at each other location where supervisory activities are conducted on behalf of the member. The member will be required to amend its written supervisory procedures, as appropriate, within a reasonable time after changes occur in applicable laws, regulations, and rules, and as changes occur in the firm's supervisory system, and to communicate these changes throughout its organization.
Members also will be required to conduct a review, at least annually, of the business in which it engages for purposes of detecting and preventing violations of, and to ensure compliance with, applicable laws, regulations, and rules. At a minimum, this will include the periodic examination of customer accounts to detect and prevent irregularities and abuses, an annual inspection of each OSJ, and the inspection of branch offices in accordance with a schedule to be set forth in the member's supervisory procedures. The member will be required to retain a written record of the dates upon which each inspection and review was conducted.
Amendments to Definitions of "Office of Supervisory Jurisdiction" and "Branch Office"
An "office of supervisory jurisdiction" (OSJ) is currently defined in Article III, Section 27 of the NASD Rules of Fair Practice as "... any office designated as directly responsible for the review of the activities of registered representatives or associated persons in such office and/or any other offices of the member." Under the amendments, an OSJ is any business location of a member firm at which one or more of the following functions take place:
The term "branch office" is currently defined in Article I, Section (c) of the NASD By-Laws as "... an office which is owned or controlled by a member, and which is engaged in the investment banking or securities business." An Explanation of the Board of Governors in Schedule C to the NASD By-Laws reiterates this definition and also provides that a place of business of a person associated with a member is considered a branch office if the member (1) directly or indirectly contributes a substantial portion of the operating expenses of such place of business; and/or (2) authorizes a listing in any publication or other media, including a professional dealers digest or telephone directory, that designates a place as an office or if the member designates any such place as an office to another organization.
The amendment redefines "branch office" as any business location of the member identified to the public or customers by any means as a location at which the investment banking or securities business is conducted on behalf of the member, excluding any location identified solely in a telephone directory line listing or on a business card or letterhead, which listing, card, or letterhead also sets forth the address and telephone number of the office of the member responsible for supervising the activities of the identified location.
Conforming Amendment to By-Laws
Article I of the NASD By-Laws sets forth certain definitions applicable to terms used in the By-Laws and the Rules of Fair Practice. Section (c) defines branch office. Because branch office is now defined in Article III, Section 27(f)(2), the substantive definition is deleted from the By-Laws provisions, and a reference to Article III, Section 27 of the Rules is substituted.
Amendment to Schedule C to the By-Laws
An Explanation of the Board of Governors set forth at Schedule C to the By-Laws contains material pertaining to the distinction between an office of supervisory jurisdiction and a branch office and to the definition of a branch office. This material has been deleted because the text is inconsistent with the amended Article III, Section 27.
As stated in Notice to Members 88-44, the Board of Governors has determined that it is appropriate to provide members with a six-month period following SEC approval to bring their supervisory practices and procedures into compliance with the new rules. The amendments will therefore take effect April 13, 1989.
The texts of the new rule and of the By-Law and Schedule C amendments are attached. The existing provisions of Section 27, with the exception of paragraph (e), are deleted.
Questions concerning this notice can be directed to Dennis C. Hensley, NASD, Deputy General Counsel, at (202) 728-8245, or Jacqueline D. Whelan, Senior Attorney, Office of the General Counsel, at (202) 728-8270.
ARTICLE III, SECTION 27 - RULES OF FAIR PRACTICE
AMENDMENTS TO ARTICLE I— NASD BY-LAWS
(Note: Deleted language is in brackets; new language is underlined.)
When used in these By-Laws, and any rules of the Corporation, unless the context otherwise requires, the term:
AMENDMENTS TO SCHEDULE C TO THE NASD BY-LAWS
Explanation of the Board of Governors.
[Distinction Between Branch Office and Office of Supervisory Jurisdiction;] Appointment of Executive Representative; [Standards for Determining Branch Offices].
[The term "office of supervisory jurisdiction" defined in Section 27 of Article HI of the Rules of Fair Practice means any office designated by the member in its memorandum of supervisory procedures, established pursuant to Article III, Section 27 of the Rules. Such office shall be directly responsible for the review of the activities of Registered Representatives and persons associated with the member in that office and/or in other offices of the member.]
The term "executive representative" as found in Section 3 of Article III of the By-Laws means that person designated by the member to represent, vote and act for the member in all the affairs of the Corporation. Pursuant to the provisions of Section 8 of Article III of the By-Laws, every member who maintains a registered branch office in a district of the Corporation other than the one in which its main office is located, is entitled to one vote on all matters pertaining solely to the district in which such registered branch office is located, including the election of members of the Board of Governors from such district. Should a member maintain more than one branch office in a district, it is entitled to only one vote in that district. Therefore, each member shall designate one executive representative and shall designate one "district executive representative" for each district other than the one in which the main office is located in which the member maintains a registered branch office.
[The term "branch office" defined in Article I of the By-Laws means any office, including a corporate subsidiary of a member, located in the United States and other than the main office which is owned or controlled by a member and engaged in the investment banking or securities business.]
Each member is under a duty to insure that its membership application with the Corporation is kept current at all times by supplementary amendments to its original application and that any offices other than the main office are properly designated and registered, if required, with the Corporation. [Each member must also determine in light of the requirements of Article III, Section 27 of the Rules of Fair Practice, the form of its written supervisory procedures, and, accordingly, which offices are to be designated as offices of supervisory jurisdiction responsible for carrying out the written procedures.]
Each member must designate to the Association those offices of supervisory jurisdiction, including the main office, and must register those offices which are deemed to be branch offices in accordance with the standards [found hereafter] set forth in Article HI, Section 27 of the Rules of Fair Practice. [A branch office would be considered an office of supervisory jurisdiction only if designated as such and only if specified supervisory activities are assigned to it under the member's written procedures. Members should note that the term "branch office" of itself does not carry any implication that the branch office personnel are required to perform any supervisory function. The term "branch office" is merely to designate and identify for registration purposes the various offices of a member other than the main office and as such are required to be registered and as to which a registration fee should be paid. If an office falls within the definition of both an office of supervisory jursidiction and a branch office, it must be designated to the Corporation in each category, and it must be registered as a branch office, and the applicable registration fee for a branch office must be paid.
In determining whether an office or the activities of a person associated with a member in an area constitutes a branch office of a member, the following standards shall be used: