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  • 2002

    • 02-85 NASD Requires Immediate Member Firm Action Regarding Mutual Fund Purchases and Breakpoint Schedules

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      IMMEDIATE ACTION REQUIRED

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Operations
      Senior Management

      Mutual Funds Transactions
      Breakpoints

      Executive Summary

      Mutual funds that are sold with front-end sales loads often offer investors the opportunity to pay reduced sales loads under a variety of circumstances. The specified levels of dollar investment at which the front-end sales charge is reduced are set by the mutual fund company and are generally termed "breakpoints." As set by the mutual fund, the breakpoint levels can be reached through aggregating investments in specified related accounts.

      As a result of recent and ongoing examinations, NASD and Securities and Exchange Commission (SEC) staff are concerned that some member firms have not been charging investors the correct sales loads in many instances, particularly for mutual fund transactions involving letters of intent and rights of accumulation. NASD is directing each of its member firms that sells mutual fund shares to immediately review the adequacy of its policies and procedures to ensure that they are designed and implemented so that investors are charged the correct sales loads on mutual fund transactions. This review must include an assessment by each firm of whether it has been charging investors the correct sales loads. Firms must promptly adopt and implement any changes to their policies and procedures that are necessary to ensure that investors are charged the correct sales loads on mutual fund transactions in the future. Finally, each firm must retain a record of its review and the results for examination by NASD.

      In order for a customer purchasing a mutual fund through an NASD member firm to incur the most beneficial (the lowest) front-end sales charge percentage, complete information relating to the customer and certain related accounts is necessary. The required information relates to the customer's account and related and linked accounts and includes the dollar size of the pending transaction, the dollar size of anticipated transactions, and amounts previously invested in the specific fund and other related funds, valued as specified in the prospectus.

      With the advent of automated processing and settlement systems in the mutual fund industry, such as Fund/SERV, it is essential for members to enter correctly into these systems the breakpoint information pertaining to customer transactions. Members must have procedures reasonably designed to ascertain all information necessary to establish the correct breakpoint level; training and procedures to ensure that personnel understand the proper steps for inputting the information correctly into the automated processing and settlement system; and supervisory procedures that reasonably ensure compliance in this area. Due to the fact that automated processing and settlement systems may not disclose to the mutual fund company the identity of the member's customer, members cannot rely on the mutual fund company to allocate the correct breakpoint to a transaction or override the member's failure to do so.

      After consultation with SEC staff, NASD is issuing this Notice to Members to alert members to this important issue and to specify appropriate member action that must be taken immediately to ensure that their customers receive the advantage of breakpoints to which the customers are entitled, namely, a reduction in the sales charges commensurate with the size and nature of the customers' transactions.

      Questions/Further Information

      Questions regarding this Notice may be directed to Marc Menchel, Senior Vice President and General Counsel, Regulatory Policy and Oversight, NASD, at (202) 728-8071, or Daniel Sibears, Senior Vice President and Deputy, Department of Member Regulation, Regulatory Policy and Oversight, NASD, (202) 728-8221.

      Discussion

      Mutual funds sold with a front-end sales charge often have a breakpoint schedule that affords investors the opportunity to receive a discount on the front-end sales charge based on the specified dollar amounts of a transaction or series of transactions. For example, a mutual fund might charge a front-end sales load of 5.75% for all purchases less than $50,000; reduce that front-end sales charge to 4.50% for purchases aggregating at least that amount, but less than $100,000; and further reduce, or eliminate, the sales charge for various greater levels of aggregate purchases. Each mutual fund and family of funds can, in accordance with applicable law and disclosure requirements, set the terms concerning breakpoints. The terms for breakpoints thus vary from fund to fund.

      Investors may be entitled to a reduced front-end sales charge based on a single transaction because of its dollar amount. In addition, investors may become entitled to receive breakpoints by using letters of intent or based on rights of accumulation. A letter of intent ("LOI") is a statement signed by the investor indicating his intent to purchase a certain amount of fund shares over a stated period of time. A right of accumulation ("ROA") is the discount or breakpoint received in a current mutual fund transaction based on the cumulative value of previous transactions. In the case of either LOIs or ROAs, the other purchase transactions that are credited towards the discount may occur in accounts that are related or linked to the investor and in different mutual funds that are part of the same fund family.

      Dramatic growth in the number of fund families, share classes, and, to a lesser extent, customer account types, has underscored the need to assure that breakpoints are applied appropriately. Breakpoint schedules, and the conditions under which discounts are available, differ among fund families, as noted above. For example, different fund families establish different opportunities to link accounts, transactions, and share classes. Sales charge discounts related to reinstated transactions1 and exchanges also differ among fund families.

      Prior to the advent of automated processing and settlement systems for mutual fund transactions, many members dealt directly with the fund complexes in the settlement of transactions on a basis in which the customer's identity was disclosed. This allowed the mutual fund company the opportunity to apply breakpoints in cases where the discount may not have been properly applied by the member effecting the transaction. NASD understands that many firms now utilize automated processing and settlement systems, such as Fund/SERV,2 in which the underlying customer's identity may not be disclosed. The mutual fund company may be unable to monitor the application of the appropriate discount.

      The terms of the dealer agreement with a mutual fund company or complex generally require the member in its capacity as the dealer to assure that the member provides the appropriate breakpoint in a given transaction or series of transactions. Whether or not the terms of the dealer agreement imposes this obligation, a broker-dealer must (1) ensure that its registered representatives and other personnel engaged in processing these transactions understand the terms of offerings and reinstatements; (2) ascertain the information that should be recorded on the books and records of the member or its clearing firm, which is necessary in determining the availability and appropriate level of breakpoints; (3) apprise the customer of the breakpoint opportunity and inquire whether the customer has positions or transactions away from the member which should be considered in connection with a pending transaction; (4) make sure that the personnel processing these transactions are appropriately trained in order to ensure that the information pertaining to all aspects of a mutual fund order, including any applicable breakpoint, is accurately transmitted in a manner retrievable by the mutual fund company3; and (5) have in place appropriate and sufficient procedures, including supervisory procedures, with respect to breakpoint calculations.

      In addition to the rights and obligations created by virtue of applicable clearing agreements and dealer agreements, the introducing broker must ensure that its customer receives the appropriate breakpoint in a given mutual fund transaction absent a clearing arrangement in which the clearing broker expressly assumes this agency obligation in accordance with NASD Rule 3230(a). Introducing firms must, therefore, determine (based on the services offered by their clearing firms, other systems utilized to effect mutual fund transactions, or a combination of both) that they have the capacity and capability to ensure that customers receive the benefit of all applicable discounts.

      Conclusion

      NASD and SEC staff consider it essential that mutual fund executions are effected on the terms most advantageous to the customer. Determining the correct sales charge is an obligation held by members and requires a high degree of vigilance to ensure that customers receive the full benefit of available price discounts to which they are entitled. Such vigilance includes extensive product and customer knowledge on the part of registered representatives and related personnel and requires appropriate training, policies and supervisory procedures.


      1 A fund may offer its shareholders a "reinstatement privilege" to redeem or sell shares in the fund and allow the shareholder to reinvest some or all of the proceeds, by paying a reduced sales load or no sales load, within a specified period of time (for example, 180 days), in the same share class of that fund or another fund within the same fund family subject to other terms and conditions.

      2 FundSERV is a mutual fund transaction processing and settlement service offered by the National Securities Clearing Corporation.

      3 NASD has reason to believe that in certain cases members have incorrectly transmitted breakpoint information through Fund/SERV by populating the wrong fields in their transaction input system. Members must assure themselves that personnel understand and adhere to the appropriate protocols in submitting information.


      SEC Transmittal Letter

      UNITED STATES

      SECURITIES AND EXCHANGE COMMISSION

      WASHINGTON, D.C. 20549

      December 23, 2002

      Dear Executive Representative:

      Attached to this letter is an NASD Notice to Members directing all member firms to immediately review the adequacy of their existing policies and procedures to ensure that investors are charged the correct sales load on mutual fund transactions.

      As the NTM indicates, both the Commission and the NASD currently are engaged in examinations of NASD member firms' sales load practices with regard to mutual fund transantions as the first step in addressing the issues raised in the NTM. Because charging investors the correct sales loads is a fundamental and important process, we are taking the additional step of forwarding the NTM directly to you with this cover letter to ensure that you, as well as your chief legal and compliance officers, are aware of, and take immediate action on, these issues. Please share this cover letter and the NTM with your senior legal and compliance personnel immediately upon receipt.

      We will contact you again soon after the beginning of the new year to learn your assessment of the adequacy of your policies and procedures; whether your firm is in compliance with those policies and procedures and relevant NASD rules; and what assurances your firm can offer on a going forward basis that it will comply fully with those policies and procedures.

      If you seek additional information about the NTM or other NASD-related issued, please refer to the contact information in the NTM. For other questions, please call the Division of Market Regulation's Office of Interpretation and Guidance at 202-942-0069 or by e-mail at marketreg@sec.gov.

      In closing, we want to stress the importance of this NTM. Please be sure that you and your senior legal and compliance personnel give it the careful attention that it deserves.

      Sincerely,

      Annette L. Nazareth
      Director
      Division of Market Regulation

      Paul F. Roye
      Director
      Division of Investment Management

      Attachment

    • 02-84 2003 Trade Date — Settlement Date Schedule

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      Trade Date—Settlement Date

      SUGGESTED ROUTING

      KEY TOPICS

      Internal Audit
      Legal and Compliance
      Municipal/Government Securities
      Operations
      Trading and Market Making

      Holiday Trade Date-Settlement
      Date Schedule
      Trade Date—Settlement Date



      The NASDAQ Stock Market and the securities exchanges will be closed on Monday, January 20, 2003, in observance of Martin Luther King, Jr., Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Reg. T Date*
      Jan. 14 Jan. 17 Jan. 22
      15 21 23
      16 22 24
      17 23 27
      20 Markets Closed
      21 24 28


      Presidents' Day: Trade Date—Settlement Date Schedule

      The NASDAQ Stock Market and the securities exchanges will be closed on Monday, February 17, 2003, in observance of Presidents' Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Reg. T Date*
      Feb. 11 Feb. 14 Feb. 19
      12 18 20
      13 19 21
      14 20 24
      17 Markets Closed
      18 21 25


      Good Friday: Trade Date—Settlement Date Schedule

      The NASDAQ Stock Market and the securities exchanges will be closed on Good Friday, April 18, 2003. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Reg. T Date*
      April 14 April 17 April 22
      15 21 23
      16 22 24
      17 23 25
      18 Markets Closed
      21 24 28


      Memorial Day: Trade Date—Settlement Date Schedule

      The NASDAQ Stock Market and the securities exchanges will be closed on Monday, May 26, 2003, in observance of Memorial Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Reg. T Date*
      May 20 May 23 May 28
      21 27 29
      22 28 30
      23 29 June 2
      26 Markets Closed
      27 30 3


      Independence Day: Trade Date—Settlement Date Schedule

      The NASDAQ Stock Market and the securities exchanges will be closed on Friday, July 4, 2003, in observance of Independence Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Reg. T Date*
      June 30 July 3 July 8
      July 1 7 9
      2 8 10
      3 9 11
      4 Markets Closed
      7 10 14


      Labor Day: Trade Date—Settlement Date Schedule

      The NASDAQ Stock Market and the securities exchanges will be closed on Monday, September 1, 2003, in observance of Labor Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Reg. T Date*
      Aug. 26 Aug. 29 Sept. 3
      27 Sept. 2 4
      28 3 5
      29 4 8
      Sept. 1 Markets Closed
      2 5 9


      Columbus Day: Trade Date—Settlement Date Schedule

      The schedule of trade dates-settlement dates below reflects the observance by the financial community of Columbus Day, Monday, October 13, 2003. On this day, The NASDAQ Stock Market and the securities exchanges will be open for trading. However, it will not be a settlement date because many of the nation's banking institutions will be closed.

      Trade Date Settlement Date Reg. T Date*
      Oct. 7 Oct. 10 Oct. 14
      8 14 15
      9 15 16
      10 16 17
      13 16 20
      14 17 21

      Note: October 13, 2003, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board.

      Transactions made on Monday, October 13, will be combined with transactions made on the previous business day, October 10, for settlement on October 16. Securities will not be quoted ex-dividend, and settlements, marks to the market, reclamations, and buy-ins and sell-outs, as provided in the Uniform Practice Code, will not be made and/or exercised on October 13.


      Veterans' Day and Thanksgiving Day: Trade Date—Settlement Date Schedule

      The schedule of trade dates-settlement dates below reflects the observance of the financial community of Veterans' Day, Tuesday, November 11, 2003, and Thanksgiving Day, Thursday, November 27, 2003. On Tuesday, November 11, The NASDAQ Stock Market and the securities exchanges will be open for trading. However, it will not be a settlement date because many of the nation's banking institutions will be closed in observance of Veterans' Day. All securities markets will be closed on Thursday, November 27, 2003, in observance of Thanksgiving Day.

      Trade Date Settlement Date Reg. T Date*
      Nov. 5 Nov. 10 Nov. 12
      6 12 13
      7 13 14
      10 14 17
      11 14 18
      12 17 19
      21 26 Dec. 1
      24 28 2
      25 Dec. 1 3
      26 2 4
      27 Markets Closed
      28 3 5

      Note: November 11, 2003, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board.

      Transactions made on November 11 will be combined with transactions made on the previous business day, November 10, for settlement on November 14. Securities will not be quoted ex-dividend, and settlements, marks to the market, reclamations, and buy-ins and sell-outs, as provided in the Uniform Practice Code, will not be made and/or exercised on November 11.


      Christmas Day and New Year's Day: Trade Date—Settlement Date Schedule

      The NASDAQ Stock Market and the securities exchanges will be closed on Thursday, December 25, 2003, in observance of Christmas Day, and Thursday, January 1, 2004, in observance of New Year's Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Reg. T Date*
      Dec. 19 Dec. 24 Dec. 29
      22 26 30
      23 29 31
      24 30 Jan. 2, 2004
      25 Markets Closed
      26 31 5
      29 Jan. 2, 2004 6
      30 5 7
      31 6 8
      Jan. 1, 2004 Markets Closed
      2 7 9

      Brokers, dealers, and municipal securities dealers should use the foregoing settlement dates for purposes of clearing and settling transactions pursuant to the NASD Uniform Practice Code and the Municipal Securities Rulemaking Board Rule G-12 on Uniform Practice.

      Questions regarding the application of those settlement dates to a particular situation may be directed to the Market Integrity Department at (203) 375-9609.


      * Pursuant to Sections 220.8(b)(1) and (4) of Regulation T of the Federal Reserve Board, a broker/dealer must promptly cancel or otherwise liquidate a customer purchase transaction in a cash account if full payment is not received within five business days of the date of purchase or, pursuant to Section 220.8(d)(1), make application to extend the time period specified. The date by which members must take such action is shown in the column titled "Reg. T Date."

    • 02-83 NASD to Deduct Unpaid Mediation Filing Fees from CRD Accounts

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      INFORMATIONAL

      Mediation Filing Fees

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Registration
      Senior Management

      Central Registration Depository
      Mediation Fees



      Executive Summary

      Effective February 14, 2003, NASD will begin to deduct unpaid mediation filing fees owed by member firms from members' Central Registration Depository (CRD) accounts. NASD will use the same procedures as are now used to collect delinquent arbitration fees owed by members. These procedures include sending a written invoice informing the member that the fees are due, and deducting delinquent mediation filing fees from funds maintained in a member's CRD account if the mediation filing fees are not paid within 60 calendar days after the date of the notice. If a member was represented by outside counsel in the underlying mediation, the single invoice will be sent only to the outside counsel.

      This policy becomes effective on February 14, 2003.

      Questions/Further Information

      Questions regarding this Notice may be directed to Elizabeth McCoy, Assistant Director of Mediation, at (212) 858-4341 or elizabeth.mccoy@nasd.com.

      Discussion

      Under Rule 10407(a) of the NASD Code of Arbitration Procedure (Code), each party to a matter submitted directly to mediation administered by NASD must pay a mediation filing fee according to the schedule provided in the Code, unless the Director of Mediation waives the fee. In addition, Rule 10407(b) provides that when a matter is initially filed in arbitration and is subsequently submitted to mediation, each party in cases involving more than $25,000 in dispute must pay a mediation filing fee, unless the Director of Mediation waives the fee.

      Effective February 14, 2003, NASD will begin using the same procedures to collect unpaid mediation filing fees owed by member firms as are currently used to collect arbitration fees owed by member firms, including deducting delinquent fees from members' CRD accounts.

      At the conclusion of a mediation, parties will receive a final written invoice for outstanding mediation filing fees. If the member is represented by outside counsel that is the counsel of record, the member's invoice will be sent only to the member's counsel of record. If a member does not pay the fees it owes within 60 days after the date of the invoice, NASD will deduct the fees owed by the member from the member's CRD account. Written confirmation of each deduction will be provided to the member's compliance officer. If there are insufficient funds on deposit in the member's CRD account to cover the outstanding mediation filing fees owed by the member, and the member has not made other arrangements for payment, NASD will pursue cancellation or suspension of the member's membership pursuant to Article VI, Section 3 of NASD's By-Laws. Members are responsible for replenishing the funds on deposit to ensure that there are no delays in processing registration applications or any other CRD-related obligation.

      Beginning February 14, 2003, this policy will apply to all delinquent mediation filing fees for which an invoice has been sent, the 60-day period has passed, and full payment has not been received.

    • 02-82 Frequently Asked Questions Relating to Trading Halts

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      INFORMATIONAL

      Trading Halts

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Registered Representatives
      Senior Management
      Trading

      Quotations
      Trading Halts



      Executive Summary

      This NASD Notice to Members addresses frequently asked questions arising under NASD Rule 3340 (Rule 3340 or the Rule) regarding trading halts. Rule 3340 prohibits members or associated persons from effecting, directly or indirectly, any transaction in a security in which a trading halt is in effect. Rule 3340 was amended in 2001 also to prohibit NASD members from publishing quotations or indications of interest in a security during a trading halt. The trading and quoting conduct prohibited by Rule 3340 is only triggered when a trading halt is in effect. To facilitate compliance with the Rule, this Notice addresses questions that have been raised with respect to the application of the Rule to particular circumstances.

      Questions/Further Information

      Questions concerning this Notice may be directed to Kathleen O'Mara, Assistant General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8071; or Afshin Atabaki, Attorney, NASD Regulatory Policy and Oversight, at (202) 728-8902.

      Background

      On June 5, 2001, the Securities and Exchange Commission (SEC) approved amendments to Rule 3340 to prohibit publication of quotations or indications of interest in a security during a trading halt. Previously, Rule 3340 expressly prohibited members from directly or indirectly effecting a transaction in a security during a trading halt, but did not expressly prohibit members from publishing quotations or indications of interest during a halt. The rule change was originally scheduled to become effective on August 13, 2001.1 At the request of member firms, NASD delayed the effective date until October 9, 2001, to allow members additional time to make any necessary systems changes.

      Rule 3340, as amended, specifically prohibits members or associated persons from, directly or indirectly, effecting any transaction or publishing a quotation, a priced bid and/or offer, an unpriced indication of interest (including "bid wanted" and "offer wanted" and name only indications), or a bid or offer accompanied by a modifier to reflect unsolicited customer interest, in any security for which a trading halt is in effect. NASD believes that prohibiting the publication of quotations or indications of interest during a trading halt will prevent members from seeking to trade at a time when they cannot execute a trade. Further, the amended rule is designed to protect investors and to ensure the integrity of quotations by preventing fictitious or misleading quotations.

      Following the SEC's approval of the amendments to the Rule, some members requested guidance from NASD on the application of the Rule to particular scenarios. The following questions and answers are published to address some of these scenarios and to provide additional guidance. However, the guidance contained herein is not intended to provide an exhaustive analysis of all circumstances that could possibly arise under the Rule. Members should contact the NASD staff listed above in the event they have further questions.

      Frequently Asked Questions

      Trading Halts

      Question 1: May an electronic communications network (ECN) continue to disseminate quotations or indications of interest to subscribers in a security when trading in that security has been halted?

      No. Rule 3340 prohibits NASD members, including ECNs, from uot;publishing" quotations or indications of interest in a security during a trading halt. For purposes of the Rule, publication involves the dissemination of information to sources outside the member. Distribution of quotations to external subscribers would constitute publication. Some ECNs have asserted that this would require them to delete their book of orders in the subject security. Rule 3340 does not require ECNs to delete their book when there is a trading halt; they are, however, required to stop distributing quotations or indications of interest in a security during a trading halt. In this regard, an ECN can comply with the Rule by blanking out quotations and indications of interest in a security during a trading halt.

      Question 2: What are NASD member firms' responsibilities with respect to pulling back orders for a security sent immediately preceding a trading halt for that security?

      If an order is entered into a facility/system that publishes quotations and such quotations are not distributed during a trading halt, then the member firm is not required to pull back the order. However, if an order is sent to a facility/system that continues to publish quotations or indications of interest in a security during a trading halt, the firm that entered the order prior to the trading halt would be responsible for pulling back the order.

      Question 3: Are NASD members required to stop distributing quotations and indications of interest on internal proprietary systems for a particular security during a trading halt?

      In general, internal display of quotations or indications of interest within a broker/dealer's proprietary system does not constitute "publication" and, as such, is not prohibited by the Rule. However, dissemination of quotations or indications of interest outside of the member broker/dealer, including to an affiliate or a customer, is prohibited.

      Question 4: Are NASD members allowed to enter quotations into NASDAQ in anticipation of the end of a trading halt during what is commonly known as the "quoteonly" or "grace period"?

      Yes. After official notification by NASD or the primary market, quotations may be entered in conformity with the resumption process. When the primary market permits the entry of quotes, clearly identified as closed, a member, including an ECN, may resume disseminating quotes during that period provided that they are identified clearly as closed quotes.

      Question 5: If an NASD member sends quotation information or indications of interest to third parties, such as an Internet search engine or Web site, what are the member's responsibilities under the Rule?

      As stated above, an NASD member is prohibited from publishing quotations or indications of interest during a trading halt. If quotations or indications of interest are disseminated prior to the announcement of a trading halt, the NASD member is required to promptly notify the third party of the trading halt and request that the member's information be removed during the trading halt. Firms must be able to demonstrate compliance with Rule 3340, including maintaining records of requests made to third parties to stop displaying quotations in a particular security during a trading halt and compliance by third parties with such requests. Best practices suggest that NASD members that provide quotations or indications of interest to third parties do so pursuant to written agreements and that, as part of such agreements, the third parties agree immediately to cease the publication of quotations or indications of interest upon notice from the member firm of a trading halt. The written agreement should set forth an acceptable service level standard upon which the third party will act and failure of the third party to act, upon notice in accordance with such service level, should constitute a material breach of the written agreement. NASD member firms should proactively monitor third parties to ensure that publication of quotations and indications of interest during a trading halt does not occur. Furthermore, member firms should require documentation of third party compliance with the established service level that should be retained in conformity with standard recordkeeping practices. NASD member firms should notify third parties in the event that compliance with the service level is not achieved and receive assurances that can be reasonably relied upon that the matter will be remedied in the immediate future or, if appropriate, terminate the agreement. Absent extraordinary circumstances, the assurances of a third party should not be relied upon when such third party has either: (1) not immediately acted to rectify its failure to cease publication of quotations or indications of interest upon notification; or (2) repeatedly failed to achieve the service level standard for ceasing publication during a trading halt.

      Question 6: If an NASD member borrows stock to fulfill certain regulatory requirements and a trading halt is subsequently imposed, is the member prohibited under Rule 3340 from returning the stock while the trading halt is in effect?

      Rule 3340 prohibits NASD members from effecting any transaction, directly or indirectly, during a trading halt. The Rule does not extend to the return of stock pursuant to a stock lending arrangement, assuming no other activities occur that would constitute "effecting" a securities transaction. Accordingly, Rule 3340 generally should not be relied upon as a basis for failing to either return or accept delivery of securities pursuant to a stock lending arrangement.

      Question 7: If an NASD member receives a "not held" order for 100,000 shares, works the order throughout the day, and accumulates 60,000 shares, but then a trading halt is imposed, can the NASD member complete the transaction during the trading halt without violating Rule 3340?

      A firm cannot execute any part of the order once a trading halt is declared, including the 60,000 shares accumulated prior to the trading halt. Once the trading halt is lifted, the firm may resume its efforts to work the order or decline to fill the balance of the order, in the wake of the trading halt, in the best interests of the customer.

      Question 8: If an issue that is listed on a foreign market is subject to a trading halt on a U.S. market, but not halted on the foreign market, may an NASD member trade the security on the foreign market consistent with Rule 3340?

      No. NASD members may not directly effect trades on international markets for their own accounts and may not solicit customer orders in these securities. If a member firm receives an unsolicited customer order in a security subject to the NASDAQ trading halt, it may route the order to a non-member entity or non-member affiliate not covered by the halt for execution in a foreign market. Customer transactions effected outside the United States through the non-member may involve an NASD member firm to the extent required by SEC Rule 15a-6.


      1 See Notice to Members 01-47 (July 2001).

    • 02-81 NASD Reduces Certain TRACE Fees for the 4th Quarter of 2002

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      INFORMATIONAL

      TRACE Fees

      The fee changes are effective as of October 1, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Compliance
      Legal
      Operations
      Senior Management

      Rule 7010(k)
      TRACE Fees
      Rule 6200 Series



      Executive Summary

      On November 15, 2002, NASD submitted a rule filing (SR-NASD-2002-167) to the Securities and Exchange Commission (SEC) for immediate effectiveness to amend Rule 7010(k), reducing the Web Browser Access Fee, Cancel or Correct Fee, and "As of" Trade Late Fee for the TRACE system during the 4th quarter of 2002. The fee changes are effective as of October 1, 2002.1

      Questions/Further Information

      Questions concerning this Notice may be directed to Kosha K. Dalal, Assistant General Counsel, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-6903; or Justin Tubiolo, Vice President, Regulatory Services and Operations, at (212) 858-4419.

      Discussion

      On July 1, 2002, the Trade Reporting and Compliance Engine (TRACE) became effective. On June 28, 2002, the Commission approved proposed NASD fees relating to the operation of the TRACE system (Rule 7010(k)) on a pilot basis for a six-month period expiring on December 28, 2002.2 As part of that rule filing (Amendment No. 3 to SR-NASD-2002-63), NASD committed to review and reassess the proposed TRACE fees as soon as practicable and within six months after the effective date of TRACE, based on such factors as actual volume, usage, costs, and revenues.

      Based on an initial review of the TRACE fees, and input from member firms, on November 15, 2002, NASD submitted to the SEC for immediate effectiveness a rule change to reduce certain TRACE fees for the 4th quarter of 2002. The SEC published the rule filing in the Federal Register on December 3, 2002. The fee reductions are effective as of October 1, 2002.

      The adjustments to the TRACE fee structure are:

      Web Browser Access Fee. The current Web Browser Access Fee is $85 per month for the first user ID; $75 per month for the second through ninth user ID; and $70 per month for the second through ten or more user ID, if the member registers for ten or more user IDs. For the period commencing October 1, 2002 and ending December 31, 2002, for those firms that report less than 25 transactions per month, the Web Browser Access Fee has been reduced to $25 per month, per user ID.

      Cancel or Correct Fee. The current Cancel or Correct Fee is $3.00 for each canceled or corrected transaction reported. For the month of October 2002, the Cancel or Correct Fee has been reduced to $1.50 for each canceled or corrected transaction reported. For the month of November 2002, the Cancel or Correct Fee has been reduced to $2.25 for each canceled or corrected transaction reported. For the month of December 2002, the Cancel or Correct Fee will return to $3.00 for each cancelled or corrected transaction reported.

      "As of" Trade Late Fee. The current "As of" Trade Late Fee is $3.00 for each trade that is not timely reported. For the month of October 2002, the "As of" Trade Late Fee has been reduced to $1.50 for each such transaction reported. For the month of November 2002, the "As of" Trade Late Fee has been reduced to $2.25 for each such transaction reported.

      NASD believes that these fee adjustments will alleviate some of the immediate burden on small firms resulting from TRACE reporting requirements and grant all firms additional time to adjust to the Cancel or Correct Fee and the "As of" Trade Late Fee.

      NASD is in the process of reviewing the entire TRACE fee structure and expects to submit additional proposed amendments to TRACE fees to the SEC prior to the December 28, 2002 expiration of the pilot program. Future fee adjustments will be announced in Notices to Members.


      1 See SR-NASD-2002-167 (November 15, 2002), Exchange Act Release No. 46893, 67 FR 232 (December 3, 2002).

      2 The Commission approved Rule 7010(k) relating to TRACE fees on June 28, 2002 on a six-month pilot basis. See SEC Approval Order File No. SR-NASD-2002-63, Securities Exchange Act Release No. 46145.


      Attachment A

      New text is underlined. Deletions are in brackets.

      Proposed New Text of Rule 7010(k) - Trade Reporting and Compliance Engine (TRACE)

      Rule 7010(k) Trade Reporting and Compliance Engine (TRACE)

      (Rule 7010(k) shall expire on December 28, 2002, unless amended, extended, or permanently adopted by NASD pursuant to SEC approval at or before such date).
      The following charges shall be paid by participants for the use of the Trade Reporting and Compliance Engine ("TRACE"):
      System Fees Transaction Reporting Fees Market Data Fees
      Web Browser Access:
      $85/month for 1 user ID;
      $75/month for 2-9 user IDs;
      $70/month for 2-10+ user IDs

      If less than 25 trades per month, in October, November, or December 2002 - $25/month per user ID
      Trades up to and including $200,000 par value - $0.50/trade;

      Trades between $201,000 and $999,999 par value - $0.0025 times the number of bonds traded/trade;

      Trades of $1,000,000 par value or more - $2.50/trade
      BTDS Professional Display - $60/month per terminal
      CTCI - $25/month/line Cancel/Correct - $3/trade
      For October 2002 - $1.50/trade
      For November 2002 - $2.25/trade
      BTDS Internal Usage Authorization - $500/month per organization
      Third Party - $25/month "As of" Trade Late - $3/trade
      For October 2002 - $1.50/trade
      For November 2002 - $2.25/trade
      BTDS External Usage Authorization - $1,000/month per organization
      PDN Administrative - $100/month/line Browse & Query - $0.05 after first page BTDS Non-Professional Display - $1/month per terminal
          Daily List Fax - $15/month per fax number/addressee
      (1) System Related Fees
      There are three methods by which a member may report corporate bond transactions that are reportable to NASD [the Association] pursuant to the Rule 6200 Series. A member may choose among the following methods to report data to NASD [the Association]: (a) a TRACE web browser (either over the Internet or a secure private data network ("PDN")); (b) a Computer-to-Computer Interface ("CTCI") (either one dedicated solely to TRACE or a multi-purpose line); or (c) a third-party reporting intermediary. Fees will be charged based on the reporting methodology selected by the member.
      (A) Web Browser Access
      The charge to be paid by a member that elects to report TRACE data to NASD [the Association] via a TRACE web browser shall be as follows: for the first user ID registered, a charge of $85 per month; for the next two through nine user IDs registered, a charge of $75 per month, per such additional user ID; and for ten or more user IDs registered, a charge of $70 per month, per user ID from two to ten or more. If a member reports less than 25 trades per month to the TRACE system in October, November, or December 2002, the charge to be paid by a member for the TRACE web browser shall be $25, per such month, per user ID. In addition, a member that elects to report TRACE data to the Association via a web browser over a secure PDN rather than over the Internet shall pay an additional administrative charge of $100 per month, per line.1
      (B) Computer-to-Computer Interface Access
      No change.
      (C) Third Party Access - Indirect Reporting
      No change.
      (2) Transaction Reporting Fees
      For each transaction in corporate bonds that is reportable to NASD [the Association] pursuant to the Rule 6200 Series, the following charges shall be assessed against the member responsible for reporting the transaction:
      (A) Trade Reporting Fee
      No change.
      (B) Cancel or Correct Trade Fee
      A member shall be charged a Cancel or Correct Trade Fee of $3.00 per canceled or corrected transaction. To provide firms with time to adjust to the new reporting system, the Cancel or Correct Trade Fee will not be charged until the later of October 1, 2002 or 90 days after the effective date of TRACE. For the month of October 2002, the Cancel or Correct Trade Fee shall be $1.50 per canceled or corrected transaction. For the month of November 2002, the Cancel or Correct Trade Fee shall be $2.25 per canceled or corrected transaction.
      (C) "As of" Trade Late Fee
      A member shall be charged an "As of" Trade Late Fee of $3.00 per transaction for those transactions that are not timely reported "As of" as required by these rules. To provide firms with time to adjust to the new reporting system, the "As of" Trade Late Fee will not be charged until the later of October 1, 2002 or 90 days after the effective date of TRACE. For the month of October 2002, the "As of" Trade Late Fee shall be $1.50 per such transaction. For the month of November 2002, the "As of" Trade Late Fee shall be $2.25 per such transaction.
      (D) Browse and Query Fee
      No change.
      (3) Market Data Fees
      No change.
      (4) Daily List Fax Service
      No change.

      1 Charges that may be imposed by third parties, such as network providers, are not included in these fees.

    • 02-80 Development Regarding Treasury Information Requests Under Section 314 of the PATRIOT Act

      View PDF File

      INFORMATIONAL

      USA PATRIOT Act

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management

      Money Laundering
      Compliance Programs



      Executive Summary

      On November 19, 2002, the Department of the Treasury and its bureau the Financial Crimes Enforcement Network (FinCEN) advised associations representing major financial institutions of a brief moratorium on both new information requests and compliance with current information requests that have been recently issued under Section 314 of the USA PATRIOT Act of 2001. On November 26, 2002, the federal bank regulatory agencies issued a Joint Agency Notice (Notice) that addresses Section 314.1

      Questions/Further Information

      Questions regarding this Notice to Members may be directed to Emily Gordy, Department of Member Regulation, NASD Regulatory Policy and Oversight, at (202) 728-8070, or Nancy Libin, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8835.

      Discussion

      Background

      The USA PATRIOT Act of 2001, which was signed into law on October 26, 2001, recognizes that law enforcement must be able to communicate quickly with financial institutions when requesting information regarding those suspected of engaging in money laundering or terrorist financing activities.

      Section 314 of the PATRIOT Act authorizes law enforcement to establish a mechanism to communicate with financial institutions to request information about suspected money laundering and terrorist financing. Section 314 also allows financial institutions to share information among themselves regarding these activities. On September 26, 2002, the final rule implementing Section 314 became effective and is now part of the Treasury Department's Bank Secrecy Act regulations.2 Among other things, the final rule established a process through which law enforcement can communicate with financial institutions, including broker/dealers, in order to request information regarding those suspected of engaging in money laundering or terrorist activities so that any accounts and transactions involving these individuals or entities can be promptly located. On November 4, 2002, FinCEN began issuing information requests pursuant to this new authority.

      Temporary Moratorium on Information Requests3

      Since FinCEN began issuing these information requests (as described more fully in the bank regulators' Notice), some financial institutions have advised their regulators and FinCEN of a number of logistical issues and questions regarding compliance with the requests. In an effort to respond to and resolve these issues and concerns and to ensure that the most effective communication systems are in place between the government and the financial institutions, FinCEN has issued a brief moratorium on new information requests and on responding to prior requests. NASD understands that during the moratorium, FinCEN, in consultation with the federal financial regulators, will develop new guidance concerning future requests. Firms will be advised of both the lifting of the brief moratorium and the new guidance regarding the Section 314 information request process. Firms should monitor the Treasury and FinCEN Web Sites for this guidance.

      FinCEN has advised the federal financial regulators that, in the event of a threat to national security or other emergency, it reserves the right to take necessary steps, including immediate reinstatement of the Section 314 information request process.

      Anti-Money Laundering Compliance Officer Contact Information

      Up-to-date contact information is important to ensure that the information requests made on behalf of law enforcement agencies by FinCEN reach relevant financial institutions.

      In Notice to Members 02-78, NASD notified its members that, in order to facilitate Treasury's efforts to collect the anti-money laundering (AML) contact information that Section 314 requires, NASD had adopted an amendment to Rule 3011, requiring each member firm to provide to NASD contact information for the individual or individuals responsible for implementing the dayto- day operations and internal controls of the member's anti-money laundering program.4 The rule was effective immediately upon filing with the Securities and Exchange Commission on October 26, 2002, and will become operative on December 31, 2002. Accordingly, by December 31, 2002, firms are required to provide NASD with the following information: name, title, mailing address, e-mail address, telephone number, and facsimile number of the contact person.5 Members are also required to notify NASD promptly of any changes to the contact information.

      It is important that members firms meet their obligations under Rule 3011, as amended, and provide accurate and complete contact information for their AML compliance officer. It is also important that when that information changes and becomes inaccurate or incomplete, the firm provides updated information to NASD. Compliance with Rule 3011, as amended, will ensure that FinCEN has accurate and complete contact information to effectively communicate with broker/dealers in the future.


      1 Joint Agency Notice: Treasury Issues Moratorium on Section 314(a) Information Requests (November 26, 2002).

      2 31 C.F.R. Part 103.

      3 After the September 11, 2001 terrorist attacks, the Federal Bureau of Investigation (FBI) and other law enforcement agencies established a list of individuals and entities about whom information was sought from financial institutions regarding transactions or relationships with the named entities or individuals. The list was designated as the "Control List." SEC Release 2001-115. Information requests thus far have been disseminated to financial institutions that have been designated to receive the "Control List." FinCEN has also advised the federal financial regulators that the FBI will discontinue use of the "Control List" as a means of communicating information requests and will instead rely on the Section 314(a) process in the future.

      4 Notice to Members 02-78 (November 2002).

      5 While the AML compliance officer is not required to be a registered person as a result of serving that function, NASD anticipates that most AML compliance officers will be registered persons. Whether or not an AML compliance officer is registered with, or an employee of, the firm, an AML compliance officer is an associated person of the firm.


      Attachment A — FinCEN Announcement of Joint Agency Notice

      View PDF File

      Department of the Treasury Financial Crimes Enforcement Network
      On November 26, 2002, a Joint Agency Notice was released by FinCEN and the primary federal regulators addressing two matters associated with section 314 of the USA PATRIOT Act as described below. Generally, section 314 authorizes law enforcement authorities to communicate with banking organizations and others about suspected money launderers and terrorists, and banking organizations to communicate amongst themselves about such matters.

      Moratorium on Section 314(a) Information Requests

      On September 18, 2002, the U.S. Department of Treasury's Financial Crimes Enforcement Network (FinCEN) issued a Final Rule implementing section 314 of the USA PATRIOT Act. The Final Rule became effective on September 26, 2002 and is now part of Treasury's Bank Secrecy Act regulations, which are found at 31 CFR Part 103. The Final Rule, among other things, established a mechanism for law enforcement authorities to communicate names of suspected terrorists and money launderers to financial institutions in order to promptly locate accounts and transactions involving the suspects.
      On November 4, 2002, FinCEN, based on the authority in section 314(a) and the Final Rule, sent its first request for information to financial institutions throughout the United States. FinCEN has since sent several other requests. Significant and useful information has been provided to law enforcement in response to its requests. This has included information about various types of transactions and accounts involving persons suspected of involvement in terrorist financing and money laundering, including those who used multiple institutions in several different geographic locations.
      Financial institutions and their trade associations have notified the federal supervisory agencies and FinCEN about a number of logistical issues and questions with regard to the information request process instituted by FinCEN. In order to address these concerns and to ensure the most effective government-financial industry coordination possible, FinCEN, in coordination with relevant law enforcement agencies, has put into place a brief moratorium on new information requests and compliance with existing requests. During the moratorium, FinCEN, in consultation with the federal financial institution supervisory agencies, will develop additional guidance concerning section 314(a) information requests. You will be advised once this brief moratorium is lifted. At that time, you will also receive further guidance about the 314(a) information request process.
      Notwithstanding the moratorium, FinCEN has advised the federal financial institutions supervisory agencies that it reserves the right to take such steps as are necessary, including the reinstatement of the section 314(a) information request process, in the event of an immediate threat to national security or other emergency.

      The "Control List" and Section 314(a) Information Requests

      FinCEN has advised the federal financial supervisory agencies that the FBI will discontinue the use of the "Control List" and instead will use the section 314(a) process to communicate with banking organizations and others about individuals and entities who are suspected of engaging in terrorist financing activities.
      It is imperative that your bank, savings association or credit union be included in the contact list that FinCEN uses to communicate about suspected money launderers and terrorists. In developing its contact list, FinCEN decided to use the information that was provided in order to distribute the "Control List" and this information may have to be updated or enhanced. Accordingly, if your financial institution has not received any requests from FinCEN via e-mail or facsimile since November 4, 2002 (when FinCEN distributed its first section 314(a) information request), you should contact your primary federal supervisory agency to be added to FinCEN's contact list. The following information must be provided: financial institution name and charter number or other identifier; point of contact name and title, mailing (street number, P.O. box, city, state and zip code) and e-mail addresses; and telephone and facsimile numbers.
      You may contact the following representatives from the federal financial institutions supervisory agencies and FinCEN to provide section 314(a) contact information or if you have any questions:

      Board of Governors of the Federal Reserve System
      Contact information:
      e-mail: patriotact@frb.gov
      fax: (202) 736-5641
      Questions:
      telephone: Laurie A. Bender, Senior Special Anti-Money Laundering Examiner at (202) 452-3794, or Pamela J. Johnson, Senior Anti-Money Laundering Coordinator at (202) 728-5829

      Federal Deposit Insurance Corporation
      Contact information:
      e-mail: fdicadvisory@fdic.gov
      fax: (202) 898-3627
      Questions:
      telephone: Special Activities Section at (202) 898-6750

      Office of the Comptroller of the Currency
      Contact information:
      e-mail: nationalbankinfo@occ.treas.gov
      fax: (202) 874-5301
      Questions:
      telephone: Brian C. McCormally, Director, or Robert S. Pasley, Assistant Director, Enforcement and Compliance Division at (202) 874-4800

      Office of Thrift Supervision
      Contact information:
      e-mail: usap.contact@ots.treas.gov
      fax: (202) 906-6326
      Questions:
      telephone: John J. Davidson, Senior Project Manager at (202) 906-6012

      National Credit Union Administration
      Contact information:
      e-mail: www.ncua.gov/cuaddress
      fax: (703) 518-6569
      Questions:
      telephone: John K. Ianno, Senior Trial Attorney at (703) 518-6540

      Financial Crimes Enforcement Network (FinCEN)
      Contact information:
      e-mail: sys314a@FinCEN.treas.gov
      fax: (703) 905-3660
      Questions:
      telephone: FinCEN Regulatory Helpline at 1-800-949-2732


      Attachment B — Joint Agency Notice

      View PDF File


      Board of Governors of the Federal Reserve System
      Federal Deposit Insurance Corporation
      Office of the Comptroller of the Currency
      Office of Thrift Supervision
      National Credit Union Administration

      November 26, 2002

      Joint Agency Notice

      Treasury Issues Moratorium
      on
      Section 314(a) Information Requests


      To All Banks, Savings Associations, and Credit Unions:

      This Notice addresses two matters associated with section 314 of the USA PATRIOT Act as described below. Generally, section 314 authorizes law enforcement authorities to communicate with banking organizations and others about suspected money launderers and terrorists, and banking organizations to communicate amongst themselves about such matters.

      Moratorium on Section 314(a) Information Requests

      On September 18, 2002, the U.S. Department of Treasury's Financial Crimes Enforcement Network (FinCEN) issued a Final Rule implementing section 314 of the USA PATRIOT Act. The Final Rule became effective on September 26, 2002 and is now part of Treasury's Bank Secrecy Act regulations, which are found at 31 CFR Part 103. The Final Rule, among other things, established a mechanism for law enforcement authorities to communicate names of suspected terrorists and money launderers to financial institutions in order to promptly locate accounts and transactions involving the suspects.
      On November 4, 2002, FinCEN, based on the authority in section 314(a) and the Final Rule, sent its first request for information to financial institutions throughout the United States. FinCEN has since sent several other requests. Significant and useful information has been provided to law enforcement in response to its requests. This has included information about various types of transactions and accounts involving persons suspected of involvement in terrorist financing and money laundering, including those who used multiple institutions in several different geographic locations.
      Financial institutions and their trade associations have notified the federal supervisory agencies and FinCEN about a number of logistical issues and questions with regard to the information request process instituted by FinCEN. In order to address these concerns and to ensure the most effective government-financial industry coordination possible, FinCEN, in coordination with relevant law enforcement agencies, has put into place a brief moratorium on new information requests and compliance with existing requests. During the moratorium, FinCEN, in consultation with the federal financial institution supervisory agencies, will develop additional guidance concerning section 314(a) information requests. You will be advised once this brief moratorium is lifted. At that time, you will also receive further guidance about the 314(a) information request process.
      Notwithstanding the moratorium, FinCEN has advised the federal financial institutions supervisory agencies that it reserves the right to take such steps as are necessary, including the reinstatement of the section 314(a) information request process, in the event of an immediate threat to national security or other emergency.

      The "Control List" and Section 314(a) Information Requests

      FinCEN has advised the federal financial supervisory agencies that the FBI will discontinue the use of the "Control List" and instead will use the section 314(a) process to communicate with banking organizations and others about individuals and entities who are suspected of engaging in terrorist financing activities.
      It is imperative that your bank, savings association or credit union be included in the contact list that FinCEN uses to communicate about suspected money launderers and terrorists. In developing its contact list, FinCEN decided to use the information that was provided in order to distribute the "Control List" and this information may have to be updated or enhanced. Accordingly, if your financial institution has not received any requests from FinCEN via e-mail or facsimile since November 4, 2002 (when FinCEN distributed its first section 314(a) information request), you should contact your primary federal supervisory agency to be added to FinCEN's contact list. The following information must be provided: financial institution name and charter number or other identifier; point of contact name and title, mailing (street number, P.O. box, city, state and zip code) and e-mail addresses; and telephone and facsimile numbers.
      You may contact the following representatives from the federal financial institutions supervisory agencies and FinCEN to provide section 314(a) contact information or if you have any questions:

      Board of Governors of the Federal Reserve System
      Contact information:
      e-mail: patriotact@frb.gov
      fax: (202) 736-5641
      Questions:
      telephone: Laurie A. Bender, Senior Special Anti-Money Laundering Examiner at (202) 452-3794, or Pamela J. Johnson, Senior Anti-Money Laundering Coordinator at (202) 728-5829

      Federal Deposit Insurance Corporation
      Contact information:
      e-mail: fdicadvisory@fdic.gov
      fax: (202) 898-3627
      Questions:
      telephone: Special Activities Section at (202) 898-6750

      Office of the Comptroller of the Currency
      Contact information:
      e-mail: nationalbankinfo@occ.treas.gov
      fax: (202) 874-5301
      Questions:
      telephone: Brian C. McCormally, Director, or Robert S. Pasley, Assistant Director, Enforcement and Compliance Division at (202) 874-4800

      Office of Thrift Supervision
      Contact information:
      e-mail: usap.contact@ots.treas.gov
      fax: (202) 906-6326
      Questions:
      telephone: John J. Davidson, Senior Project Manager at (202) 906-6012

      National Credit Union Administration
      Contact information:
      e-mail: www.ncua.gov/cuaddress
      fax: (703) 518-6569
      Questions:
      telephone: John K. Ianno, Senior Trial Attorney at (703) 518-6540

      Financial Crimes Enforcement Network (FinCEN)
      Contact information:
      e-mail: sys314a@FinCEN.treas.gov
      fax: (703) 905-3660
      Questions:
      telephone: FinCEN Regulatory Helpline at 1-800-949-2732

    • For Your Information (December)

      View PDF File

      NASD Reminds Firms of E-Mail Address Established to Report System Outages to Market Regulation Department

      In the Winter 2000 Regulatory & Compliance Alert (2000 RCA), NASD provided the e-mail addresses specified below so that members could notify NASD's Market Regulation Department (the "staff") of system problems that impacted a member's ability to comply with certain SEC and NASD rules. Because firms experience system problems in the normal course of business and in connection with the implementation of new processes relating to market developments such as SuperMontage and TRACE, NASD staff is reminding members of these e-mail addresses, the purpose for which the e-mails are to be used, and the information that should be included in the e-mail messages.

      As noted in the 2000 RCA, NASD staff performs periodic surveillance reviews or "sweeps" of the industry for compliance with a variety of rules including, among others, the Securities and Exchange Commission (SEC) Order Handling Rules and NASD rules relating to trade reporting for equities and corporate bonds (TRACE), ACT compliance, trading during a halt, and trade-or-move obligations. Using sophisticated automated technology, the staff reviews the trading and market making activity of all member firms. Where warranted, the staff's review may result in the imposition of informal or formal disciplinary action.

      As part of its review, the staff considers whether a system outage or other technology-related problem caused, or contributed to, a member's failure to comply with a rule. To address such issues earlier in the "sweep" process, the Market Regulation Department established an e-mail address so that members can alert the staff when system outages or other technology-related problems have impeded the members' ability to comply with certain SEC or NASD rules. The staff uses the contemporaneous record created from the members' messages left at the e-mail address to evaluate the results of surveillance "sweeps." On a case-by-case basis, the staff will determine whether the incidents identified in that record should be viewed as a mitigating factor. NASD staff notes that any mitigation resulting from the notification of system problems is affected, among other things, by the cause, magnitude, duration, and continued frequency of the system problem. In addition, the promptness of the notification and the extent to which the member firm proactively addresses the problem will also be considered in assessing mitigation. It should be noted that the reporting of system problems in cases involving extended periods of non-compliance caused by such problems may not, by itself, have a mitigating effect unless the member firm can document sustained efforts to solve the problem.

      In the event a member experiences a system outage or other technology-related problem that impacts that member's ability to meet the obligations imposed by the applicable rules, the member should send a message to the appropriate e-mail address below that includes the following information:

      • The date(s) the system problem occurred;


      • The specific systems that were affected (e.g., the member's internal systems, third party vendor system);


      • The exact nature of the problem (e.g., complete outage, slow transmission times);


      • The time the problem began;


      • The time the member first detected the problem;


      • The time the problem was resolved and a brief description of the resolution;


      • The level of activity impacted (e.g., the approximate number of trades not reported) and a description of how the impact will be addressed (e.g., trade reports to be submitted on an "as of" basis the next business day);

      Contact name and telephone number; and

      Any additional information deemed relevant by the member firm reporting the problem.

      All system outages or technology-related problems involving equities should be reported to tradereporting@nasd.com. All system outages or other technology-related problems involving TRACE should be reported to bondreporting@nasd.com.

      Web-Based Appointment Scheduling and Confirmation System for Online Exam Scheduling Is Now Available

      Firms and employees of firms who have registered through Web CRD to take a computer-based exam can now schedule and confirm online exam appointments through Prometric's Appointment Scheduling and Confirmation Web Site.

      A sponsoring firm of the candidate must first request an examination on Web CRD before the candidate or firm can schedule an exam appointment using the online scheduling system.

      NOTE: Appointments CANNOT be re-scheduled or canceled via the Web Site. If an appointment needs to be re-scheduled or canceled, the candidate or firm must call Prometric's toll-free number at 1-800-578-6273.

      You may access the Web Site in two ways:

      www.nasdr.com/2630_confirm.asp provides instructions for using the Web Site and a link to the scheduling and confirmation Site

      OR

      www.2test.com provides direct access to Prometric's Web Site.

      Qualification Updates

      Effective December 2, 2002, questions on the Limited Representative-Equity Trader Examination, Series 55, will be updated to refer to the revised rules on NASDAQ execution systems. Questions on SOES and SuperSoes will be replaced with questions on SuperMontage. Questions on the new NASD rules on automated display facilities will also be added to the bank of questions for this examination. SOES and SuperSoes questions on the Series 10, 11, 24, and 62 examinations will be updated to reflect these changes on December 9. If you have any questions regarding this information, contact Karen Bescher, Qualifications Analyst, NASD Testing and Continuing Education Department, at (240) 386-4677.

      On September 30, 2002, the Municipal Securities Rulemaking Board (MSRB) filed a proposed rule change with the Securities and Exchange Commission for the MSRB's new Municipal Fund Securities Limited Principal Qualification Examination (Series 51), as well as an amendment to Rule G-3, on professional qualifications. Administration of the new Series 51 examination will begin on or about January 1, 2003. The amendment to Rule G-3 will extend to March 31, 2003, the transition period during which Series 24 and Series 26 principals may continue to supervise municipal fund securities activities without further qualification. This extension will provide a three-month period during which candidates can take and pass the Series 51 examination. Under the amendment, all municipal fund securities limited principals will be required to have taken and passed the Series 51 examination by April 1, 2003. This new exam requirement will not apply to individuals who are functioning as municipal securities principals or general securities sales supervisors, and who have passed either the Municipal Securities Principal Examination (Series 53) or the General Securities Sales Supervisors Examination (Series 8 or Series 9/10). For more information on this new examination requirement, contact Carole Hartzog, Assistant Director, NASD Testing and Continuing Education Department, at (240) 386-4678. This information is also available on the MSRB Web Site at www.msrb.org.

      2002 - 2003 Filing Due Dates

      NASD would like to remind members of their obligation to file the appropriate FOCUS reports, Annual Audits, and Customer Complaints by their due dates. The following schedule outlines due dates for 2003. Questions regarding the information to be filed can be directed to the appropriate District Office. Business questions as to how to file the FOCUS report, resetting passwords & technical questions concerning system requirements, file uploads, submission problems for Web-Based FOCUS and Customer Complaints can all be directed to (800) 321-NASD. Business questions regarding the Short Interest Reporting deadlines should be directed to Yvonne Huber at (240) 386-5034 or Jocelyn Rena at (240) 386-5091.

      2003 FOCUS Due Dates

      Annual Schedule I for 2002 Year End Due Date
      2002 FOCUS Schedule I January 27, 2003
      Annual Schedule I for 2003 Year End Due Date
      2003 FOCUS Schedule I January 27, 2004

      2003 Monthly and Fifth FOCUS II/IIA Filings

      A Fifth FOCUS report is an additional report that is due from a member whose fiscal year end is a date other than the calendar quarter.

      January 31, 2003 February 26, 2003
      February 28, 2003 March 25, 2003
      April 30, 2003 May 23, 2003
      May 31, 2003 June 24, 2003
      July 31, 2003 August 25, 2003
      August 31, 2003 September 24, 2003
      October 31, 2003 November 25, 2003
      November 30, 2003 December 23, 2003

      2003 Quarterly FOCUS Part II/IIA Filings

      Quarter Ending Due Date
      December 31, 2002 January 27, 2003
      March 31, 2003 April 24, 2003
      June 30, 2003 July 24, 2003
      September 30, 2003 October 23, 2003
      December 31, 2003 January 27, 2004

      2003 Annual Audit Filings Due Dates

      Period End Due Date
      January 31, 2003 April 1, 2003
      February 28, 2003 April 29, 2003
      March 31, 2003 May 30, 2003
      April 30, 2003 June 29, 2003
      May 31, 2003 July 30, 2003
      June 30, 2003 August 29, 2003
      July 31, 2003 September 29, 2003
      August 31, 2003 October 30, 2003
      September 30, 2003 November 29, 2003
      October 31, 2003 December 30, 2003
      November 30, 2003 January 29, 2004
      December 31, 2003 February 29, 2004

      2003 3070/Customer Complaints Due Dates

      4th Quarter 2002: January 15, 2003 (Wednesday)
      1st Quarter 2003: April 15, 2003 (Tuesday)
      2nd Quarter 2003: July 15, 2003 (Tuesday)
      3rd Quarter 2003: October 15, 2003 (Wednesday)
      4th Quarter 2003: January 15, 2004 (Thursday)

      Market Regulation Department 2003 Short Interest Reporting Deadlines

      Trade
      Date
      Settlement
      Date
      Exchange-Listed
      Short Interest
      Due*
      NASDAQ
      Short Interest
      Due*
      January 10
      Friday
      January 15
      Wednesday
      January 17
      1:00 p.m.
      Friday
      January 17
      6:00 p.m.
      Friday
      February 11
      Tuesday
      February 14
      Friday
      February 19
      1:00 p.m.
      Wednesday
      February 19
      6:00 p.m.
      Wednesday
      March 11
      Tuesday
      March 14
      Friday
      March 18
      1:00 p.m.
      Tuesday
      March 18
      6:00 p.m.
      Tuesday
      April 10
      Thursday
      April 15
      Tuesday
      April 17
      1:00 p.m.
      Thursday
      April 17
      6:00 p.m.
      Thursday
      May 12
      Monday
      May 15
      Thursday
      May 19
      1:00 p.m.
      Monday
      May 19
      6:00 p.m.
      Monday
      June 10
      Tuesday
      June 13
      Friday
      June 17
      1:00 p.m.
      Tuesday
      June 17
      6:00 p.m.
      Tuesday
      July 10
      Thursday
      July 15
      Tuesday
      July 17
      1:00 p.m.
      Thursday
      July 17
      6:00 p.m.
      Thursday
      August 12
      Tuesday
      August 15
      Friday
      August 19
      1:00 p.m.
      Tuesday
      August 19
      6:00 p.m.
      Tuesday
      September 10
      Wednesday
      September 15
      Monday
      September 17
      1:00 p.m.
      Wednesday
      September 16
      6:00 p.m.
      Wednesday
      October 9
      Thursday
      October 15
      Wednesday
      October 17
      1:00 p.m.
      Friday
      October 17
      6:00 p.m.
      Friday
      November 10
      Monday
      November 14
      Friday
      November 18
      1:00 p.m.
      Tuesday
      November 18
      6:00 p.m.
      Tuesday
      December 10
      Wednesday
      December 15
      Monday
      December 17
      1:00 p.m.
      Wednesday
      December 17
      6:00 p.m.
      Wednesday

      * Eastern Standard Time

      Updated Anti-Money Laundering Online Training Course

      NASD is pleased to announce that we will be offering an updated Anti-Money Laundering online course for 2003. The core AML course and case studies, first made available in April of 2002, are intended to educate members about AML laws, policies, and procedures. The course for 2003 will be updated to reflect revisions in the Suspicious Activity Reporting and other rules that have taken effect in the last year. The updated course is scheduled to be available in early January 2003.

      NASD also will launch supplemental online course modules with topics and case studies targeted to specific types of business. One specialty module will focus on the AML issues in the retail investments business. This module is scheduled to be available in the first quarter of 2003. A second specialty module is planned to focus on the AML issues in the institutional investments business. This module is scheduled to be available in the second quarter of 2003 and will reflect the Customer Identification rules that are currently being finalized.

      Firms have flexibility in determining how to meet their statutory responsibilities under the PATRIOT Act. This employee training program is one option for members to consider using as part of the AML programs they develop to comply with the PATRIOT Act.

      To access the training program and for further updates, visit this Web Page: www.nasd.com/aml/training.htm.

      Elimination of Free-Riding Questionnaires

      NASD administers a regulatory program that monitors and collects data on allocations of equity initial public offerings (IPOs) and the restrictions provided in the Free-Riding and Withholding Interpretation (NASD Conduct Rule IM-2110-1). For every equity IPO, the lead managing underwriter must submit information to the Corporate Financing Department (the Department) regarding each member participating in the offering and its retention amounts. The Department then notifies all participating members whether an offering is "hot" (i.e., trades at a premium in the secondary market) for purposes of the Free-Riding and Withholding Interpretation. The lead manager must report final retention amounts for each member after the offering. In addition, when IPO shares trade in the secondary market at premiums above a particular threshold level, the Department has required members to complete Free-Riding Questionnaires (FRQs) that provide more detail regarding allocations to accounts in order to demonstrate that the allocations are not made to accounts that are restricted under the Free-Riding and Withholding Interpretation. NASD has the technology and processes to effectively monitor compliance with the Free-Riding and Withholding Interpretation without requiring members to complete FRQs. Accordingly, NASD will no longer require members to complete FRQs and file them with the Department. Members, however, must continue to submit the initial and final retention information that NASD requires under the Free-Riding and Withholding Interpretation.

      Questions regarding this information may be directed to Therese Woods, NASD Corporate Financing Department, at (240) 386-4661.

    • 02-79 NASD Notice of Meeting and Proxy (A proxy package was sent to each NASD Executive Representative on November 4)

      View PDF File

      Board Elections

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives

      Board Elections



      The Annual Meeting of Members of NASD will be held on December 5, 2002, at 11:00 am, at the NASD Visitors Center, 1735 K Street, NW, in Washington, DC. The purpose of the meeting is to conduct the election of Governors to the NASD Board. Members can raise other topics for discussion by properly notifying NASD of these topics.1 The record date for the Annual Meeting is the close of business on November 1, 2002.

      It is important that all members be represented at the Annual Meeting. Members are urged to vote in the election of Board members using one of the methods described below.

      Board of Governors Election

      There are eight vacancies to be filled at this meeting—four Industry governorships, three Non-Industry governorships, and one Public governorship. The nominees for the vacancies are listed in Attachment A. The nominees elected will serve for terms specified in Attachment A.

      Attachment B includes the biographies of the nominees of the NASD National Nominating Committee (NNC). Attachment C contains the names of the current Board of Governors.

      Voting Methods

      Members will be able to vote using one of the following three methods:

      • U.S. Mail


      • Internet


      • Phone

      The enclosed proxy contains detailed instructions on the voting procedures.

      Questions regarding this Notice may be directed to:

      Barbara Z. Sweeney
      NASD
      Office of the Corporate Secretary
      1735 K Street, NW
      Washington, DC 20006-1500


      1 Pursuant to Sections 1 and 3(b) of Article XXI of the NASD By-Laws, an NASD member may properly bring any other business before the Annual Meeting by giving timely notice in writing to the Secretary of NASD. In addition, the member must be an NASD member at the time of the delivery of such notice, and the other business must be a proper matter for member action. To be timely, a member's notice must be delivered to the Secretary at NASD's principal executive offices (the address is listed above) within 25 days of the date of this notice. The member's notice must offer a brief description of the other business, any material interest of the member in such business, and the reasons for conducting such business at the Annual Meeting.


      ATTACHMENT A

      NASD Board of Governors Nominees

      The following three persons have been nominated by the NNC to serve on the Board of Governors of NASD for a term of one year, or until NASDAQ is able to operate other than as a facility of NASD, whichever occurs first. These individuals currently serve simultaneously on the NASDAQ Board. Terms of office for all nominees who simultaneously serve on the NASDAQ Board run from December 5, 2002 to December 2003.

      Terms of Office 2002-2003

      INDUSTRY  
      Richard C. Romano Chairman, Romano Brothers & Co.
      Hardwick Simmons Chairman and CEO, The NASDAQ Stock Market, Inc.
         
      NON-INDUSTRY  
      H. Furlong Baldwin Chairman, Mercantile Bankshares Corporation

      The following five persons have been nominated by the NNC to serve on the Board of Governors of NASD for a term of three years or until their successors are duly elected or qualified. Terms of office run from December 5, 2002 to December 2005.

      Terms of Office 2002-2005

      INDUSTRY  
      M. LaRae Bakerink Chief Executive Officer, Westfield Bakerink Brozak, LLC
      David A. DeMuro Managing Director, Director of Global Compliance and Regulation, Lehman Brothers, Inc. (Representative of a National Retail Firm)
         
      NON-INDUSTRY  
      John J. Brennan Chairman and CEO, The Vanguard Group, Inc. (Representative of an Issuer of Investment Company Shares)
      Eugene M. Isenberg Chairman and CEO, Nabors Industries, Inc.
         
      PUBLIC  
      Kenneth M. Duberstein Chairman and CEO, The Duberstein Group, Inc.


      ATTACHMENT B

      NASD Profiles of Board Nominees for Industry Governors

      Industry

      M. LaRae Bakerink is Chief Executive Officer of Westfield Bakerink Brozak, LLC. Ms. Bakerink currently serves on the Board of Directors and serves as President for the National Association of Independent Broker Dealers. Ms. Bakerink holds a B.S. and an M.B.A. from San Diego State University.

      David A. DeMuro currently serves as Chair of the National Adjudicatory Council (2001-2002). He is Managing Director, Director of Global Compliance and Regulation at Lehman Brothers. Mr. DeMuro joined Lehman Brothers in 1984. Prior to that, he held various positions with the Securities and Exchange Commission in Detroit, Chicago, Los Angeles, and Washington, DC. Mr. DeMuro is a current member of the NASD Membership Committee and the NASD Licensing and Registration Council. He has been a member of the Executive Committee of the Securities Industry Association's Compliance and Legal Division and Chairman of the Securities Industry/Regulatory Council on Continuing Education. He currently serves on the NYSE's content committee for the Continuing Education Regulatory Element supervisor's program and the advisory board of The Journal of Investment Compliance, a publication of Institutional Investor, Inc. Mr. DeMuro is also a member of the Board of Trustees of the Theta Xi Fraternity Foundation. He holds a B.A. from the University of Michigan and a J.D. from the University of Notre Dame.

      Richard C. Romano is Chairman of Romano Brothers & Company, having joined the firm in 1964. Mr. Romano has served on the Industry/Regulatory Council for Continuing Education, the NASD District Committee, and the NASD Board of Governors (1985-1988). Mr. Romano has also served on the NASD National Nominating Committee and the NASD Small Firm Advisory Board. He holds a B.S. from the University of Illinois and an M.S. and Ph.D. from the University of Delaware.

      Hardwick Simmons is Chairman and Chief Executive Officer of The NASDAQ Stock Market, Inc. Mr. Simmons joined NASDAQ in February 2001 as Chief Executive Officer, and was elected Chairman of the Board on September 26, 2001, succeeding Frank G. Zarb. Prior to joining the company, Mr. Simmons served from May 1991 to December 2000 as President and Chief Executive Officer of Prudential Securities, Incorporated, the investment and brokerage firm. Prior to joining Prudential Securities in 1991, Mr. Simmons was President of the Private Client Group at Shearson Lehman Brothers, Inc. Mr. Simmons is a member and former Chairman of the Securities Industry Association, a former Director of the Chicago Board Options Exchange, and former President and current member of The Bond Club of New York, Inc. He is a Director and executive committee member of the New York City Partnership and serves on the Board of the National Academy Foundation. Mr. Simmons is President of the Board of Trustees of the Groton School and a trustee of the Rippowam Cisqua School in Mt. Kisco, New York. He has an A.B. from Harvard University, a M.B.A. from Harvard Business School, and served in the U.S. Marine Corps Reserve.

      NASD Profiles of Board Nominees for Non-Industry Governors

      Non-Industry

      H. Furlong Baldwin is Chairman of the Mercantile Bankshares Corporation. Mr. Baldwin joined Mercantile-Safe Deposit & Trust Company in 1956 and was elected President in 1970 of Mercantile-Safe Deposit & Trust Company and Mercantile Bankshares Corporation, and served as CEO from 1976 - 2001. Mr. Baldwin serves on the Boards of W. R. Grace & Company, Wills Group, and NASDAQ. Mr. Baldwin graduated from Princeton University and served on active duty with the U.S. Marine Corps.

      John J. Brennan is Chairman and Chief Executive Officer and a member of the Board of Directors of each of the mutual funds in the Vanguard Group. Mr. Brennan joined Vanguard in July 1982. He was elected President in 1989, Chief Executive Officer in 1996, and Chairman of the Board in 1998. Prior to his career at Vanguard, Mr. Brennan had been employed at S.C. Johnson & Son in Racine, Wisconsin and the New York Bank of Savings. Mr. Brennan is the past Chairman of the Investment Company Institute and is a Trustee of the Financial Accounting Foundation. He graduated from Dartmouth College in 1976 with an A.B. degree, and received an M.B.A. from the Harvard Business School in 1980.

      Eugene M. Isenberg is Chairman and Chief Executive Officer of Nabors Industries, Inc., a position he has held since 1987. He serves as a Director of the American Stock Exchange and also Danielson Holding Corporation, an insurance holding company. Mr. Isenberg is also a member of the National Petroleum Council, which is an advisory panel to the United States Department of Energy. From 1969 to 1982, Mr. Isenberg was Chairman of the Board and principal shareholder of Genimar, Inc., a steel trading and building products manufacturing ompany, which was sold in 1982. From 1955 to 1968, Mr. Isenberg was employed in various management capacities with the Exxon Corporation. Mr. Isenberg is the founder and principal sponsor of the Parkside School for children with learning disabilities and has established the Eugene M. Isenberg Scholarships at the University of Massachusetts where the School of Management is named after him. He was an instructor at Princeton University from 1951 to 1952 and served as an officer in the U.S. Navy from 1952 to 1955. Mr. Isenberg holds a B.A. from the University of Massachusetts and an M.A. from Princeton University in 1952. Mr. Isenberg completed the program for Senior Executives at M.I.T.

      NASD Profile of Board Nominee for Public Governor

      Public

      Kenneth M. Duberstein is Chairman and Chief Executive Officer of The Duberstein Group. Prior to this, Mr. Duberstein served as Chief of Staff to President Ronald Reagan from 1988 to 1989. During President Reagan's two terms in office, Mr. Duberstein also served in the White House as Deputy Chief of Staff (1987), as well as both the Assistant and the Deputy Assistant to the President for Legislative Affairs (1981 to 1983). Mr. Duberstein currently serves on the Board of Governors of the American Stock Exchange and on the Board of Directors of Boeing Company, Conoco, Fannie Mae, Fleming, and The St. Paul Companies, Inc. He is Vice Chairman of the Kennedy Center for the Performing Arts. Mr. Duberstein holds an A.B. from Franklin and Marshall College and an M.A. from American University.


      ATTACHMENT C

      Current Board of Governors
      Governors with Terms Expiring in 2002

      Industry  
      M. LaRae Bakerink Chief Executive Officer, Westfield Bakerink Brozak, LLC
      David A. DeMuro Managing Director, Director of Global Compliance and Regulation, Lehman Brothers, Inc.
      Richard C. Romano Chairman, Romano Brothers & Co.
      Hardwick Simmons Chairman and CEO, The NASDAQ Stock Market, Inc.
         
      Non-Industry  
      H. Furlong Baldwin Chairman, Mercantile Bankshares Corporation
      Eugene M. Isenberg Chairman and CEO, Nabors Industries, Inc.
      James F. Rothenberg* President, Capital Research and Management Company
         
      Public  
      Kenneth M. Duberstein Chairman and CEO, The Duberstein Group, Inc.
      Donald J. Kirk*  
      John D. Markese* President, American Association of Individual Investors

      * Not eligible for re-election


      Governors with Terms Expiring in 2003

      Industry  
      William C. Alsover, Jr. Chairman, Centennial Securities Company, Inc.
         
      Non-Industry  
      Arvind Sodhani* Vice President and Treasurer, Intel Corporation
         
      Public  
      Brian T. Borders, Esq. Mayer, Brown, Rowe & Maw
      Sharon P. Smith Dean, College of Business Administration, Fordham University

      Governors with Terms Expiring in 2004

      Industry  
      John W. Bachmann Managing Partner, Edward D. Jones & Company
      Richard F. Brueckner Chief Operating Officer, Pershing Division of Credit Suisse First Boston
      Raymond A. Mason Chairman & CEO, Legg Mason Wood Walker, Inc.
      Non-Industry  
      Harry P. Kamen* Retired Chairman and Chief Executive Officer, Metropolitan Life Insurance Company
      Public  
      James E. Burton Chief Executive Officer, California Public Employees' Retirement System
      Sir Brian Corby Chairman (retired), Prudential Assurance Company
      James R. Rutherfurd, Jr. President and CEO, Moody's Corporation

      * Not eligible for re-election

    • 02-78 NASD Adopts Amendments to Rule 3011 to Require Members to Provide to NASD Contact Information for an Anti-Money Laundering Compliance Person(s)

      View PDF File

      INFORMATIONAL

      Anti-Money Laundering CompliancePrograms

      Effective date: December 31, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Registration
      Senior Management

      Compliance Programs
      Money Laundering



      Executive Summary

      NASD has adopted amendments to NASD Rule 3011 (Anti-Money Laundering Compliance Program) to require each member to provide to NASD contact information for the individual or individuals responsible for implementing and monitoring the dayto- day operations and internal controls of the member's anti-money laundering (AML) compliance program (AML Program) and to update the contact information as necessary. The rule change became effective immediately upon filing with the Securities and Exchange Commission on October 21, 2002 and will become operative on December 31, 2002. Attachment A contains the text of the amendments.

      Questions/Further Information

      Questions regarding this Notice to Members may be directed to Grace Yeh, Assistant General Counsel, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-6939.

      Discussion

      The USA PATRIOT Act of 2001 (PATRIOT Act),1 which was signed into law on October 26, 2001, recognizes that effective identification of money laundering and terrorist activities requires the expedited sharing and reporting of information among governmental and law enforcement authorities and financial institutions. In furtherance of this goal, Section 314(a) of the PATRIOT Act requires the Department of Treasury (Treasury) to adopt regulations to encourage cooperation and information sharing among financial institutions, their regulatory authorities, and law enforcement authorities. In particular, the regulations should be designed to facilitate law enforcement authorities' ability to share information with financial institutions and to request information from financial institutions about persons suspected of engaging in money laundering or terrorist activities. Section 314(a) further provides that the regulations adopted by Treasury may require that each financial institution designate one or more contact persons to receive information concerning, and to monitor accounts of, identified individuals or entities.

      On September 18, 2002, Treasury issued a final rule implementing Section 314 of the PATRIOT Act. Consistent with Section 314(a), the rule creates a system for the efficient communication of potential money laundering and terrorist information. Upon receiving a request for information by the Financial Crimes Enforcement Network (FinCEN), a bureau of Treasury, the rule requires financial institutions to identify a contact person to handle the request and to receive future information requests. When requested by FinCEN, the financial institution is required to provide the name, title, mailing address, e-mail address, telephone number, and facsimile number of the designated contact person. The financial institution must also promptly notify FinCEN of any changes to the contact information.

      NASD Rule 3011 requires each member to designate an individual or individuals responsible for implementing and monitoring the day-to-day operations of the firm's AML Program. To facilitate Treasury's efforts in collecting the AML contact information set forth in Treasury's final rule, NASD has amended Rule 3011 to require that members provide to NASD contact information concerning the members' designated AML compliance person(s). The information will be used by Treasury in connection with its regulatory obligations set forth in Section 314(a) of the PATRIOT Act and the implementing regulations promulgated thereunder. Consistent with Treasury's final rule, members will be required to provide to NASD the name, title, mailing address, e-mail address, telephone number, and facsimile number of the contact person. Members also will be required to promptly notify NASD of any changes to the information.2 In addition, NASD anticipates requiring members periodically to review and confirm the accuracy of the contact information. Additional information will be provided in future.

      NASD intends to initially collect the contact information through the Member Firm Contact Questionnaire on the NASD Web site. NASD anticipates that form and system changes necessary to collect the contact information will be completed by November 15, 2002. Members will have until December 31, 2002 to provide NASD with the necessary contact information.3


      1 Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, Pub. L. No. 107- 56, 115 Stat. 272 (2001).

      2 The amendments to Rule 3011 are consistent with New York Stock Exchange (NYSE) Rule 445 (AML Compliance Program) requirements that NYSE member organizations provide to the NYSE contact information identifying the member organization's designated AML compliance person and promptly notify the NYSE of any changes to the information.

      3 New member applicants will be required to provide the contact information during the application process.


      Attachment A

      New language is underlined.


      3011. Anti-Money Laundering Compliance Program

      On or before April 24, 2002, each member shall develop and implement a written antimoney laundering program reasonably designed to achieve and monitor the member's compliance with the requirements of the Bank Secrecy Act (31 U.S.C. 5311, et seq.), and the implementing regulations promulgated thereunder by the Department of the Treasury. Each member organization's anti-money laundering program must be approved, in writing, by a member of senior management. The anti-money laundering programs required by this Rule shall, at a minimum,
      (a) Establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of transactions required under 31 U.S.C. 5318(g) and the implementing regulations thereunder;
      (b) Establish and implement policies, procedures, and internal controls reasonably designed to achieve compliance with the Bank Secrecy Act and the implementing regulations thereunder;
      (c) Provide for independent testing for compliance to be conducted by member personnel or by a qualified outside party;
      (d) Designate, and identify to NASD (by name, title, mailing address, e-mail address, telephone number, and facsimile number) an individual or individuals responsible for implementing and monitoring the day-to-day operations and internal controls of the program and provide prompt notification to NASD regarding any change in such designation(s); and
      (e) Provide ongoing training for appropriate personnel.

    • 02-77 SEC Approves Rule Establishing New Registration Category for Proctors of In-Firm Delivery of the Regulatory Element

      View PDF File

      Regulatory Element

      Effective Date: December 2, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Continuing Education
      Legal and Compliance
      Registration
      Senior Management

      Regulatory Element



      Executive Summary

      On September 24, 2002, the Securities and Exchange Commission (SEC) approved NASD Rule 1043, a new registration category for proctors of in-firm delivery of the Regulatory Element of NASD's continuing education requirements. The Rule permits registration by an associated person as a proctor without taking a qualification exam. A person may obtain designation as a proctor upon approval of an Application for Registration pursuant to Article V, Section 2 of NASD's By-Laws.

      A person registered only as a proctor may not function in any other capacity that requires registration. However, the Rule does not prohibit a person who is registered with NASD in any other capacity from also serving as a proctor without being designated as such under the Rule.

      Included with this Notice is Attachment A, the text of the rule.

      Questions concerning this Notice should be directed to Philip Shaikun, Assistant General Counsel, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8451.

      Background and Discussion

      NASD Rule 1043 establishes a new registration category for proctors of in-firm delivery of the Regulatory Element of NASD's continuing education requirements. The Regulatory Element requires all registered persons to participate in a prescribed computer-based training session within 120 days of their second registration anniversary date and every three years thereafter. The Regulatory Element focuses on compliance, regulatory and ethical standards.

      NASD Rule 1120(a)(6) permits each member to administer the Regulatory Element to their registered persons through a program delivered on the member's premises, provided that the member adheres to certain technology, administrative and regulatory standards. Among the requirements for in-firm delivery of the Regulatory Element is that the program sessions be proctored by an individual registered with a selfregulatory organization and supervised by a designated principal.

      NASD believes the new registration category will make in-firm delivery a more attractive and efficient option for members while maintaining the integrity of the program. It will obviate the current need for members to either use a registered person who also has other day-to-day responsibilities or to commit resources needed to prepare a proctor for an exam-based registration.

      Importantly, while the rule permits proctors to be registered without an exam, it still requires proctors to submit an application for registration in accordance with NASD By-Laws. As such, proctors will be required to file a Form U-4, which provides detailed employment and disciplinary history so that NASD can monitor the fitness of individuals to serve in that capacity. Any person whose sole registration is as a proctor under new NASD Rule 1043 will not be permitted to engage in any other activities requiring registration with NASD. The proposal will not prohibit a person who is registered with NASD in any other capacity from also serving as a proctor, as is permitted under existing rules.

      Effective Date

      The Rule becomes effective on December 2, 2002. Members should note that Web CRD Release 4.2, which became available on October 21, 2002, contains an updated Form U-4 that includes a new category "IF" for the in-firm delivery proctor registration.


      Attachment A

      New language is underlined; deletions in brackets.


      1040. Registration of Assistant Representatives [-Order Processing] and Proctors

      1041. Registration Requirements for Assistant Representatives

      (a) through (c) No change.

      1042. Restrictions for Assistant Representatives

      (a) through (c) No change.

      1043. Proctors of In-Firm Delivery of Regulatory Element

      (a) Any person associated with a member seeking to be designated as a Proctor under Rule 1120(a)(6)(E) for the purposes of in-firm delivery of the Regulatory Element shall be required to be registered pursuant to Rule 1120(a)(6)(E)(iii), but shall not be required to pass a Qualification Examination.
      (b) Any person associated with a member may be designated as a Proctor upon approval of an Application for Registration pursuant to Article V, Section 2 of NASD's By-Laws. Any person whose sole registration is as a Proctor pursuant to this Rule 1043 shall not be qualified to function in any other area requiring registration with NASD.
      (c) Nothing in this Rule 1043 shall prohibit a person who is registered with NASD in any other capacity from also serving as a Proctor without being designated as such under these provisions.

    • 02-76 NASD Issues Interpretive Guidance to the Trade Reporting and Compliance Engine Rules (TRACE Rules)

      View PDF File

      INFORMATIONAL

      Corporate Debt Securities Transactions Subject to Reporting and Dissemination

      SUGGESTED ROUTING

      KEY TOPICS

      Continuing Education
      Legal & Compliance
      Registration
      Senior Management

      Foreign Deferrals
      In-Firm Delivery
      Regulatory Element



      Executive Summary

      NASD requires members to report corporate debt securities transactions to NASD and subjects transaction information of certain categories of securities to dissemination pursuant to the Trade Reporting and Compliance Engine (TRACE) rules (TRACE Rules). On June 28, 2002, the Securities and Exchange Commission (SEC) approved amendments to the TRACE Rules (the Rule 6200 Series).1 On July 1, reporting and dissemination under TRACE began and the TRACE Rules, as amended on June 28, 2002, became effective.2 In this Notice to Members (NtM), NASD addresses a number of interpretive issues that have arisen since TRACE began. In addition, the revised TRACE Rules are set forth in Attachment A.

      Questions/Further Information

      Questions concerning this Notice may be directed to tracefeedback@nasd.com.

      Interpretive Matters: Questions and Answers

      The following interpretive Questions and Answers address a variety of interpretive issues that have arisen since the TRACE Rules took effect. They also respond to specific questions NASD has received since TRACE began. The staff will continue to address open interpretive issues under the TRACE Rules in subsequent NtMs.

      1. How much time does a member have to resubmit a trade report that was rejected?
      NASD staff understands that in the initial phase of TRACE reporting, there may be incidences of trade reports being rejected by the TRACE System while members become familiar with TRACE reporting requirements and systems.3 The staff also understands that certain members are relying on technology that reports transactions to and receives verification of accepted reports back from TRACE via a "batch" process. This "batch" process may add time to the identification and correction of trade reports initially rejected by the TRACE System. Therefore, initially, the staff expects that members will correct and resubmit rejected trade reports that are "high priority reports," as defined below, as soon as practicable but not later than 21/2 hours after execution. For "low priority reports," as defined below, the staff expects that members will correct and resubmit rejected reports as soon as practicable, but not later than the end of the reporting day on the day of execution (or the first business day following the day of execution, if the transaction occurs on a non-business day).
      High and Low Priority Reports. If a report details a transaction in a debt security that is listed in TRACE Rule 6250(a) as eligible for dissemination, the report is a "high priority report." Currently, only certain very large issues of Investment Grade4 securities, and approximately 50 Non-Investment Grade securities5 are listed in Rule 6250(a).6 If a report concerns a transaction in a debt security that is not subject to dissemination under Rule 6250(a), the report is a "low priority report."
      Regardless of the reporting mechanism used by the member (e.g., batch submission, Computer-to-Computer Interface (CTCI), Web browser, or third party intermediary reporting systems), any rejected trade reports should be corrected and resubmitted to TRACE as soon as possible by the reporting member. NASD will be monitoring members' reporting to ensure that members have procedures in place that are reasonably designed to ensure that rejected trade reports are identified, corrected, and resubmitted in a timely manner. Patterns and practices of late submissions due to rejections may be considered a violation of the TRACE Rules and Rule 2110.

      2. Do the clock synchronization rules that apply in OATS apply to TRACE?
      Yes. Under NASD Rule 6953, "Synchronization of Member Business Clocks," all members with an obligation under any NASD rule to record the date and time of any event (such as the time of execution of a transaction under TRACE Rule 6210(d) and Rule 6230(c)) must synchronize their business clocks, including computer system clocks and mechanical clocks. The clock synchronization requirements apply to all members with a time-reporting obligation under any NASD Rule, and therefore apply to all members in reporting under the TRACE Rules. For more information about clock synchronization requirements and frequently asked questions, refer to "The NASD Provides Guidance On OATS Clock Synchronization," RCA (December 1998), www.nasdr. com/3050_9812.htm

      3. How does a member report the date and time of execution of a transaction executed on a weekend or a holiday?
      The TRACE Rules recognize that transactions in TRACE-eligible securities may occur at any time. In Rule 6230(a)(1)-(4), NASD established specific reporting periods. In Rule 6230(a)(4), NASD describes how to report when a transaction is executed during a weekend or on a holiday. Initially, the TRACE System is not able to recognize, and will reject, a transaction report that includes a calendar date that is a Saturday, Sunday, or a federal or religious holiday on which the TRACE System is closed. In addition, the TRACE System will reject a date in the "as/of" field for the same reason. Therefore, the actual date of transactions that are executed on a non-business day cannot be captured electronically at this time. Until the TRACE System is revised, Rule 6230(a)(4) requires members to report transactions that are executed on a nonbusiness day as follows. A member must report the transaction on the first business day following the actual date of the transaction within one hour and fifteen minutes of the opening of the TRACE System. The transaction date must be reported as the first business day after which the transaction occurred (the same day of the report). The time of execution must be reported as "00:01:00" (military time for 12:01:00 a.m., Eastern Time). This will distinguish the limited number of weekend and holiday transactions from transactions actually occurring on the business day. The modifier, "special price," must be selected. In addition, when the reporting method chosen provides a "special price memo" field, the member must enter the actual date and time that the transaction occurred.7

      4. If a member executes a transaction overseas, what time (and day) should the member use to report?
      Time of execution must be reported in military time based on Eastern Time (e.g., a transaction that occurs at 3:30:30 p.m., Eastern Time would be reported as "15:30:30"). Since the TRACE System is based upon Eastern Time, all trade reports must be submitted based on the time the transaction occurred, converted to Eastern Time, even if the local date and time of the reporting party and other parties to the transaction are not Eastern Time.8

      5. How should a member report a transaction when the market and the TRACE System close early and a transaction is executed after the market closes?
      When NASD announces an early market closing (or follows the early market closing announced by another self-regulatory organization), transactions that occur after the TRACE System closes on that business day should be reported according to Rule 6230(a)(2), which describes how to report "after system hours" for transactions that occur on a business day. Thus, the transaction report will include the day of execution (using the as/of feature) and the actual time of execution. The report must be filed within one hour and 15 minutes on the next business day that the TRACE System is open. For example, if NASD announces that the TRACE System will be open from 8:00 a.m. to 2:00 p.m., and that day a member executes a trade between 2:00 p.m. and 6:29:59 p.m., Eastern Time (e.g., 2:45 p.m., Eastern Time), the member will correctly and timely report the transaction if the member reports it the next TRACE business day, within one hour and 15 minutes after the TRACE System opens, reporting the transaction "as/of (month/day/year)," with time of execution (e.g., 14:45:00 p.m., Eastern Time).

      6. Has NASD staff identified specific instances, other than those identified in Rule 6230(c)(13), when yield is not required to be reported?
      Yield is a required element in reporting a debt securities transaction. However, paragraph (c)(13) of Rule 6230 sets forth specific exceptions from the requirement. In addition, the rule provides that yield is not required to be reported "where the principal or interest to be paid is an unknown variable or is an amount that is not currently ascertainable, or any other security that NASD designates if NASD determines that reporting yield would provide inaccurate or misleading information concerning the price of, or trading in, the security."
      NASD does not believe it is possible to identify, before each occurrence, all the instances in which it is not appropriate or useful to report yield. Instead, NASD has clarified that in those instances where the reported yield would provide inaccurate or misleading information concerning the price of, or trading in, the security, NASD will designate additional types or specific securities where yield is not required to be reported.
      Security In Default. Under one of the exceptions in Rule 6230(c)(13), a member is not required to report yield for a transaction in a security in default. Members have asked how default is interpreted under the Rule, or when it occurs. Under Rule 6230(c)(13), when market participants have begun to trade a bond "flat" in anticipation of a formal announcement (e.g., of a default, a bankruptcy, a filing seeking reorganization under Chapter XI, 11 U.S.C. §§1101 et seq. (2002), or any other official announcement that the company will not meet its financial obligations), but the official announcement has not occurred, a broker/dealer must indicate in its report that it is trading the bond "flat" using the "special price" indicator and, if available, the "special price memo" field. In such cases, yield is not required to be reported. When a formal announcement, made on behalf of and authorized by the issuer, has been disseminated in the market, yield is not required to be reported, and the special price indicator and the "special price memo" field would not be used.

      7. May a member report a yield on which the security is priced and sold, rather than the lower of yield to maturity or yield to call under Rule 6230(c)(13)?
      As modified, a member must report the lower of yield to call or yield to maturity under Rule 6230(c)(13). A member may not report yield that is calculated on a basis other than yield to call or yield to maturity. Thus, even if a member sells or buys a security at a yield other than the yield to call or yield to maturity, the member is required to report the transaction with the yield calculated using the applicable standard(s), so that yield in different transactions may be meaningfully compared.

      8. Which of the modifiers has priority over other modifiers described in Rule 6230(d)(4)?
      If the price of a transaction is determined using a weighted average price method, a member must indicate this with the modifier ".w." The member is required to select the modifier ".w" and may not select the "special price" modifier. In addition, the weighted average price modifier, ".w," has priority over modifiers used to indicate settlement other than "regular way." If the weighted average price modifier, ".w," and one of the settlement term modifiers are applicable to the transaction, ".w" must be selected when reporting the transaction. Rule 6230 (d)(4)(C). (Modifiers indicating special terms of settlement are set forth in Rule 6230(d)(4)(B).)

      9. Has NASD identified instances where the "special price" modifier must be used in a transaction report?
      Under Rule 6230(c)(4)(A), a member must indicate that certain transactions have been executed at a "special price." In addition, the reporting party must explain in the "special price memo" field, when available, why the transaction was executed at other than a current market price.
      The special price modifier should be used, for example, when a TRACE-eligible security is traded in the current market with a due bill or warrant attached, with the price reflecting the special conditions of the trade. In addition, when market participants perceive that an issuer is about to go into default on a security and begin trading a security "flat" before a formal announcement, the "special price" modifier should be used. (See Q. & A. No. 6. above.) Finally, there may be instances where a transaction done pursuant to an issuer's plan to repurchase some or all of its outstanding debt ("issuer open market repurchases") would require using the "special price" modifier. (See Q. & A. No. 13. below.)

      10. Are there instances when the special price modifier should not be used?
      Yes. The "special price" modifier should not be used when the transaction is priced by using a "weighted average price." "Weighted average price" is indicated using the "weighted average price" modifier, ".w," and should be used instead of the more general modifier, "special price."

      11. How does a member determine "time of execution" as required under Rule 6210(d) when a security is priced based on a yield of another security and that yield is not available at the time the parties decide to engage in a transaction?
      NASD amended Rule 6210(d) to clarify the term, "time of execution," when the yield in a transaction in a TRACE-eligible security will be established by determining the yield of a "benchmark" security. Under Rule 6210(d), "time of execution" means "the time when the parties to the transaction agree to all the terms of the transaction that are sufficient to calculate the dollar price of the trade." When a benchmark security is a reference for determining yield, the time of execution is deemed to occur when the parties to the transaction may identify and agree upon the yield for the security. For example, if the parties agree to determine the specific yield of Security A based upon a spread that is 150 points "off" (above) or"through" (below) the yield of a comparable U.S. Treasury security, and agree to measure the yield of the comparable U.S. Treasury security at 3:30 p.m. on the day of the transaction, the parties will be expected to agree upon the yield of Security A at 3:30 p.m. when the information becomes available. As of that time, the parties have knowledge of all of the elements of the transaction necessary to calculate the dollar price of the transaction, must identify them, and are obligated to report the transaction within one hour and 15 minutes.

      12. How does a member report a commission?
      If a member charges a commission in an agency transaction, the commission is reported separately under Rule 6230(c). Report the commission, stated in points per bond, with 1 point (1.00) equal to $10.00 per bond. (The bond is assumed to be a conventional bond having a $1000 par value.) If the commission is stated as a flat fee per transaction (e.g., $100 to execute a 10 bond odd lot transaction), the member must convert the commission to points per bond to report correctly.
      Ex. 1: If a "sixteenth" commission were charged (i.e., 1/16 point per bond), the commission reported would be 0.0625. If an "eighth" commission were charged (i.e., 1/8 point per bond), the commission reported would be 0.125.
      Ex. 2. If a $100 commission were charged to execute an odd lot transaction of 10 bonds, the commission reported would be 1.0 (point). If a $100 commission were charged to execute 20 bonds, the commission reported would be 0.5 (points).

      13. When may a member rely on the exception in Rule 6230(e)(3) that a transaction executed at a price "substantially unrelated to the current market for the TRACE-eligible security" is not required to be reported?
      Rule 6230(e)(3) provides that a member is not required to report a transaction if the buyer and seller have agreed to trade at a price substantially unrelated to the current market for the TRACE-eligible security. NASD interprets Rule 6230(e)(3) very narrowly. Generally, any one or more transactions executed in furtherance of an investment, commercial, or trading purpose will not fall within the exception of Rule 6230(e)(3). (NASD's example of a transaction (i.e., a gift) in the rule that is subject to the exception is a limited, one-time execution that occurs without reference to current market pricing and investment, commercial, or trading considerations.)
      When considering if a member is excepted from reporting under Rule 6230(e)(3), a member should consider the following: (1) NASD interprets the Rule 6230(e)(3) exception very narrowly; (2) the general requirement to report any transaction in a TRACE-eligible security under Rule 6230 is interpreted broadly in furtherance of the underlying policy goals of TRACE; and, (3) in furtherance of the policy goals, paragraph (d)(4)(A) of Rule 6230 provides that transactions in TRACE-eligible securities that do not reflect current market pricing must be reported using a "special price" modifier. Thus, with few exceptions, when a transaction in a TRACE-eligible security is executed, a member is required to report the transaction. If special conditions or circumstances affect the price, when in doubt, the member should report the transaction and append the "special price" modifier described in Rule 6230(d)(4)(A).9
      Issuer Open Market Repurchase Transactions. An issuer of debt may determine to repurchase a portion or all of an outstanding issue of debt. When an issuer engages, directly or indirectly, in repurchasing its debt in the open market, the transaction must be reported and is not subject to the exception in Rule 6230(e)(3). Generally, in such purchases and sales, market participants negotiate the price and other terms of the transaction (or multiple transactions) based on investment, commercial or trading considerations, and execute the transaction in furtherance of investment, commercial, or trading purposes. Even where an issuer, or a market participant on behalf of an issuer, determines to price and purchase a significant amount of a debt security, the price established for the transaction is determined substantially by the current market price of the security and current market conditions. Thus, regardless of the issuer's ultimate motivation, NASD interprets Rule 6230 as requiring the reporting of the transaction. If the exception in Rule 6230(e)(3) were interpreted to apply, NASD's surveillance of the debt markets may be hampered by incomplete information relating to significant trading activity. In addition, if such transactions were subject to dissemination, the market may be deprived of significant, relevant, current price information.10

      14. When a member uses a broker's broker or an inter-dealer broker to execute a TRACE-eligible transaction, what are the reporting requirements?
      Generally when one member ("B/D X") contacts a broker's broker or an inter-dealer broker ("IDB") and executes a transaction through IDB, B/D X will be required to report and IDB, which is also a member, will be required to report. (In addition, the member ("B/D Y") on the other side of IDB is required to report.) In total, in most transactions involving an IDB, a total of four transaction reports must be filed.
      Ex: B/D X contacts IDB to buy N Bond. IDB contacts B/D Y to sell N Bond to IDB.
      Report 1. IDB reports a BUY from B/D Y of N Bond
      Report 2. B/D Y reports a SELL to IDB of N Bond
      Report 3. IDB reports a SELL to B/D X of N Bond
      Report 4. B/D X reports a BUY from IDB of N Bond
      IDB is acting in either an agency or a principal capacity. IDB buys the N Bond at a price including its mark-down (or charges a commission) and sells the N Bond at a different price, which includes a mark-up (or a commission).

      15. What is a member's obligation under the TRACE Rules to identify new TRACE-eligible securities?
      NASD amended Rule 6260 to require an underwriter to make a good faith determination of TRACE eligibility. If in doubt, the underwriter should submit the information regarding a new debt security to NASD's TRACE Operations Center. NASD then will make the final determination if a debt security is a TRACE-eligible security.

      16. When a member that is required to notify NASD of a new TRACE-eligible security under Rule 6260 has not finalized all the information, such as coupon rate and maturity, required to be submitted prior to the deadline for notification, what should the member do?
      Rule 6260(b) provides that a member that is the lead underwriter of any newly issued TRACE-eligible security shall provide to the TRACE Operations Center the following information concerning a new TRACE-eligible security: (1) the CUSIP number; (2) the issuer name; (3) the coupon rate; (4) the maturity; (5) whether Rule 144A applies; and (6) a brief description of the issue. The information may be provided by e-mail, facsimile, or telephone. The specific contact information is set forth in two places on the TRACE Web page, "TRACE FAQs" and "TRACE Contacts," at www.nasd.com/mkt_sys/trace_info.asp.
      If all of the information has not been determined by the deadline for notification, the issuer may file "such other information as the NASD deems necessary" to properly identify the new issue for inclusion in the TRACE System. For example, an underwriter may notify the NASD of a new issue by providing the CUSIP number (Item 1) and Items, 2, 5, and 6 (which are, respectively, issuer name, whether Rule 144A applies, and a brief description of the issue), in those instances where the coupon rate and the maturity have not been established. A CUSIP number, however, must always be provided.11 In addition, the underwriter is required to provide the missing information, such as coupon rate and maturity, as soon as it becomes available.

      17. For a new issue, when does the primary distribution end? When does secondary market trading begin?
      Rule 6230(e)(1) provides that transactions that are part of a primary distribution are not required to be reported. Primary market distribution efforts cease when the underwriters of the offering (e.g., members of the underwriting syndicate) terminate the offering, and indicate that the issue is "free to trade."12 (Usually, the termination of an offering is announced over various wire services and other instantaneous means of communication that provide immediate notification to market participants.) For purposes of reporting under TRACE, all transactions that occur as of or after the termination of the offering are secondary market transactions and must be reported.

      1 See Exchange Act Release No. 46144 (June 28, 2002), 67 Fed. Reg. 44907 (July 5, 2002) (File No. SR-NASD-2002-46). The amendments, among other things:

      (1) extended the period to report a transaction from 1 hour to 75 minutes;
      (2) incorporated standards in Rule 6250 for designating additional Non-Investment Grade securities for dissemination, if fewer than 50 such securities are subject to dissemination;
      (3) required managing underwriters to provideto NASD the CUSIP number and additional identifying information about a new issue of a TRACE-eligible debt security prior to trading in the secondary market, with special provisions for issues offered on an intra-day basis;
      (4) clarified that securities of a governmentsponsored entity (GSE) are not TRACE-eligible securities;
      (5) clarified definitions, including "time of execution," "reportable TRACE transaction," "parties to the transaction," and "money market instrument";
      (6) clarified how to report transactions occurring before, during and after TRACE system ("TRACE System") operation hours on a business day, and on holidays and weekends;
      (7) described various trade reporting modifiers;
      (8) clarified how to report yield and when yield is not required; and
      (9) required that two transaction reports be filed for "crosses."

      2 Before the June 28, 2002 action, the SEC had approved three other rule filings in 2001 containing TRACE Rules. However, none of the TRACE Rules took effect until July 1, 2002. See Exchange Act Release No. 43873 (Jan. 23, 2001), 66 Fed. Reg. 8131 (Jan. 29, 2001) (File No. SR-NASD-99-65) (approval order); Exchange Act Release No. 44039 (Mar. 5, 2001), 66 Fed. Reg. 14234 (Mar. 9, 2001) (File No. SR-NASD-2001-04) (approval order); and Exchange Act Release No. 45229 (Jan. 3, 2002), 67 Fed. Reg. 1255 (Jan. 9, 2002) (File No. SR-NASD-2001-91) (notice of proposed rule and immediate effectiveness upon filing on December 13, 2001, and approval order). See NtM 01-18 (March 2001).

      Because the TRACE Rules became effective less than 72 hours after the SEC approved the amendments, NASD published a complete set of TRACE Rules on the NASD Web site on June 28, 2002, to provide members notice of the revised TRACE Rules prior to the start of TRACE on July 1, 2002.

      3 The term "reject" here refers to a TRACE report that is not accepted by the TRACE System. Therefore, no control number has been assigned to the report by the TRACE System. This differs from the situation in which a report is submitted to and accepted by the TRACE System and, therefore, a control number is assigned to the transaction report. If, for a transaction report accepted by the TRACE System, a member subsequently determines that one or more of the reported elements were submitted incorrectly, the trade report must be either corrected or "reversed." If "reversed," a new trade report is submitted to TRACE in its place.

      4 "Investment Grade" is defined in TRACE Rule 6210(h).

      5 "Non-Investment Grade" is defined in TRACE Rule 6210(i).

      6 Over time, NASD expects to increase the type and number of securities for which transaction information will be disseminated.

      7 NASD expects to modify the TRACE System so that it will accept, on a business day, transactions reported as executed on a weekend day or holiday that the TRACE System is not open (i.e., the member will submit the report on a business day during TRACE System hours, and TRACE will accept the report if the execution date states, for example, "as/of 12/25/02," as the holiday date on which the transaction was executed).

      8 The requirement in Rule 6230 to use Eastern Time applies to reporting and records regarding reporting. Members are not required to confirm transactions to customers in Eastern Time.

      9 Rule 6230(d)(4)(A) requires a member to select the special price modifier when a transaction "is not executed at a price that reflects the current market price."

      10 There may be circumstances in which a member reports a transaction done pursuant to an issuer open market repurchase, and appropriately appends the "special price modifier" described in Rule 6230(d)(4)(A). In most cases, however, it appears that such issuer repurchase transactions may establish pricing in the current market for that security, rather than deviate from current market pricing.

      11 The CUSIP number must be in the TRACE System in order for reporting to occur electronically using the System. If the appropriate CUSIP number has not been entered into the TRACE System, it will reject the transaction report, even if the security is a TRACE-eligible security.

      12 The SEC defines "distribution" in Regulation M. "'Distribution' means an offering of securities, whether or not subject to registration under the Securities Act, that is distinguished from ordinary trading transactions by the magnitude of the offering and the presence of special selling efforts and selling methods." Regulation M, Rule 100; 17 C.F.R. 242.100. A "primary distribution" or "primary offering" is the sale of a new issue of a debt or equity security.


      Attachment A


      6200. TRADE REPORTING AND COMPLIANCE ENGINE (TRACE)

      6210. Definitions

      The terms used in this Rule 6200 Series shall have the same meaning as those defined in the Association's By-Laws and Rules unless otherwise specified.
      (a) The term "TRACE-eligible security" shall mean all United States dollar denominated debt securities that are depository eligible securities under Rule 11310(d); Investment Grade or Non-Investment Grade; issued by United States and/or foreign private corporations; and: (1) registered with the Securities and Exchange Commission; or (2) issued pursuant to Section 4(2) of the Securities Act of 1933 and purchased or sold pursuant to Rule 144A of the Securities Act of 1933. The term "TRACE-eligible security" excludes debt issued by government-sponsored entities, mortgage- or asset-backed securities, collateralized mortgage obligations, and money market instruments. For purposes of the Rule 6200 Series, the term "money market instrument" means a debt security that at issuance has a maturity of one year or less.
      (b) The term "Trade Reporting and Compliance Engine" or "TRACE" shall mean the automated system developed by the NASD that, among other things, accommodates reporting and dissemination of transaction reports where applicable in TRACE-eligible securities.
      (c) The term "reportable TRACE transaction" shall mean any secondary market transaction in a TRACE-eligible security except transactions in TRACE-eligible securities that are listed on a national securities exchange registered under Section 6 of the Securities Exchange Act of 1934, when such transactions are executed on, and reported to the exchange and the transaction information is disseminated publicly, or transactions in convertible debt securities that are listed and quoted on the Nasdaq Stock Market, Inc. (Nasdaq), when such transactions are reported to Nasdaq and the transaction information is disseminated publicly.
      (d) The term "time of execution" for a transaction in a TRACE-eligible security shall be the time when the parties to the transaction agree to all of the terms of the transaction that are sufficient to calculate the dollar price of the trade. The time of execution for transactions involving TRACE-eligible securities that are trading "when issued" on a yield basis shall be when the yield for the transaction has been agreed to by the parties to the transaction.For a transaction in a TRACE-eligible security in which the actual yield for the transaction isestablished by determining the yield from one or more designated securities (e.g., a "benchmark security" such as a U.S. Treasury security maturing in 5 years, or a combination of such "benchmark securities") and adding the agreed upon "yield spread" (e.g., 150 basis points above the benchmark security), the "time of execution" occurs when the yield has been agreed to by the parties to the transaction.
      (e) The term "parties to the transaction" shall mean the introducing broker-dealer, if any, and the executing broker-dealer.
      (f) The term "TRACE Participant" shall mean any NASD member that reports transactions to the TRACE system, directly or indirectly.
      (g) The term "Introducing Broker" shall mean the NASD member that has been identified in the TRACE system as a party to the transaction, but does not execute or clear the transaction.
      (h) The term "Investment Grade" shall mean any TRACE-eligible security rated by anationally recognized statistical rating organization in one of its four highest generic rating categories.
      (i) The term "Non-Investment Grade" shall mean any TRACE-eligible security that is unrated, non-rated, split-rated (where one rating falls below Investment Grade), or otherwise does not meet the definition of Investment Grade in paragraph (h) above.

      Amended by SR-NASD-2002-46 eff. July 1, 2002
      Amended by SR-NASD-2001-91 eff. July 1, 2002
      Adopted by SR-NASD-99-65 eff. July 1, 2002.



      6220. Participation in TRACE

      (a) Mandatory Member Participation
      (1) Member participation in TRACE for trade reporting purposes is mandatory. Such mandatory participation obligates members to submit transaction reports in TRACE-eligible securities in conformity with the Rule 6200 Series.
      (2) Participation in TRACE shall be conditioned upon the TRACE Participant's initial and continuing compliance with the following requirements:
      (A) Execution of, and continuing compliance with, a TRACE Participant application agreement and all applicable rules and operating procedures of the Association and the Commission; and
      (B) Maintenance of the physical security of the equipment located on the premises of the TRACE Participant to prevent unauthorized entry of information into TRACE.
      (3) Each TRACE Participant shall be obligated to inform the Association of non-compliance with, or changes to, any of the participation requirements set forth above.
      (b) Participant Obligations in TRACE
      Upon execution and receipt by the Association of the TRACE Participant application agreement, a TRACE Participant may commence input of trade information in TRACE-eligible securities. TRACE Participants may access the service via an NASD-approved facility during the hours of operation.

      Amended by SR-NASD-2002-46 eff. July 1, 2002
      Adopted by SR-NASD-99-65 eff. July 1, 2002.



      6230. Transaction Reporting

      (a) When and How Transactions are Reported
      A member that is required to report transaction information pursuant to paragraph (b) below must report such transaction information within one hour and fifteen minutes of the time of execution, except as otherwise provided below, or the transaction report will be "late." The member must transmit the report to TRACE during the hours the TRACE system is open ("TRACE system hours"), which are 8:00 a.m. Eastern Time through 6:29:59 p.m. Eastern Time. Specific trade reporting obligations during a 24-hour cycle are set forth below.
      (1) Transactions Executed During TRACE System Hours
      Transactions in TRACE-eligible securities executed on a business day at or after 8:00 a.m. Eastern Time through 6:29:59 p.m. Eastern Time must be reported within one hour and fifteen minutes of the time of execution. If a transaction is executed on a business day less than one hour and fifteen minutes before 6:30 p.m. Eastern Time, a member may report the transaction the next business day within one hour and fifteen minutes after the TRACE system opens. If reporting the next business day, the member must indicate "as/of" and provide the actual transaction date.
      (2) Transactions Executed At or After 6:30 P.M. Through 11:59:59 P.M. Eastern Time
      Transactions in TRACE-eligible securities executed on a business day at or after 6:30 p.m. Eastern Time through 11:59:59 p.m. Eastern Time must be reported the next business day within one hour and fifteen minutes after the TRACE system opens. The member must indicate "as/of" and provide the actual transaction date.
      (3) Transactions Executed At or After 12:00 A.M. Through 7:59:59 A.M. Eastern Time
      Transactions in TRACE-eligible securities executed on a business day at or after 12:00 a.m. Eastern Time through 7:59:59 a.m. Eastern Time must be reported the same day within one hour and 15 minutes after the TRACE system opens.
      (4) Transactions Executed on a Non-Business Day
      Transactions in TRACE-eligible securities executed on a Saturday, Sunday, or a federal or religious holiday on which the TRACE system is closed, at any time during that day (determined using Eastern Time), must be reported the next business day within one hour and fifteen minutes after the TRACE system opens. The transaction must be reported as follows: the date of execution must be the first business day (the same day the report must be made); the execution time must be "12:01:00 a.m. Eastern Time" (stated in military time as "00:01:00"); and the modifier, "special price," must be selected. In addition, the transaction must not be designated "as/of". When the reporting method chosen provides a "special price memo" field, the member must enter the actual date and time of the transaction in the field.
      (5) Members have an ongoing obligation to report transaction information promptly, accurately, and completely. The member may employ an agent for the purpose of submitting transaction information; however, the primary responsibility for the timely, accurate, and complete reporting of transaction information remains the non-delegable duty of the member obligated to report the transaction.
      (6) A member may be required to report as soon as practicable to the Market Regulation Department on a paper form, the transaction information required under Rule 6230 if electronic submission into TRACE is not possible. Transactions that can be reported into TRACE, including transactions executed on a Saturday, Sunday or holiday as provided in (a)(4) above, and trades that can be submitted on the trade date or on a subsequent date on an "as/of" basis, shall not be reported on a paper form.
      (b) Which Party Reports Transaction
      Trade data input obligations are as follows:
      (1) In transactions between two members, both members shall submit a trade report to TRACE;
      (2) In transactions involving a member and a non-member, including a customer, the member shall be required to submit a trade report to TRACE.
      (c) Transaction Information To Be Reported
      Each TRACE trade report shall contain the following information:
      (1) CUSIP number or NASD symbol;
      (2) Number of bonds as required by paragraph (d) below;
      (3) Price of the transaction (or the elements necessary to calculate price, which are contract amount and accrued interest) as required by paragraph (d) below;
      (4) A symbol indicating whether the transaction is a buy or a sell;
      (5) Date of Trade Execution(as/of trades only);
      (6) Contra-party's identifier;
      (7) Capacity - Principal or Agent (with riskless principal reported as principal) as required by paragraph (d) below;
      (8) Time of trade execution;
      (9) Reporting side executing broker as "give-up" (if any);
      (10) Contra side Introducing Broker in case of "give-up" trade;
      (11) Stated commission;
      (12) Such trade modifiers as required by either the TRACE rules or the TRACE users guide; and
      (13) The lower of yield to call or yield to maturity. A member is not required to report yield when the TRACE-eligible security is a security that is in default; a security for which the interest rate is floating; a security for which the interest rate will be or may be increased (e.g., certain "step-up bonds") or decreased (e.g., certain "step-down bonds") and the amount of increase or decrease is an unknown variable; a pay-in-kind security ("PIK"); any other security where the principal or interest to be paid is an unknown variable or is an amount that is not currently ascertainable, or any other security that the Association designates if the Association determines that reporting yield would provide inaccurate or misleading information concerning the price of, or trading in, the security.
      (d) Procedures for Reporting Price, Capacity, Volume
      (1) For principal transactions, report the price, which must include the mark-up or mark-down. (However, if a price field is not available, report the contract amount and the accrued interest.) For agency transactions, report the price, which must exclude the commission. (However, if a price field is not available, report the contract amount and the accrued interest.) Then, report the commission, stated in points per bond, with 1 point equal to $10.00 per bond.
      (2) For agency and principal transactions, report the actual number of bonds traded, with $1,000 par value equal to 1 bond. If a bond has a par value of less than $1,000 ("baby bond") or the par value is not an even multiple of $1,000, report the fractional portion of $1,000 in decimals.
      (3) For in-house cross transactions, a member must report two transactions, which are the member's purchase transaction and the member's sale transaction.
      (4)
      (A) Special Price Modifier
      If a transaction is not executed at a price that reflects the current market price, select the modifier, "special price." When the reporting method chosen provides a "special price memo" field, state why the transaction was executed at other than the current market price in the "special price memo" field (e.g., when a debt security is traded conventionally and in the current market does not have a due bill and/or a warrant attached, but in the transaction to be reported is traded with a due bill and/or warrant attached, the price of the transaction is a "special price"). Do not select the modifier, "special price," where the transaction price is determined using a weighted average price.
      (B) Settlement Modifiers
      If a transaction is to be settled other than the regular way, report the settlement terms by selecting the appropriate modifier. If the parties agree to settlement on the same day the transaction is executed (i.e., cash settlement), select the modifier, ".c." If a trade will be settled the next day, select the modifier, ".nd." If a trade will be settled other than on the date of trade, the next day, or T+3, select the modifier, ".sNN," and enter the appropriate number of days (e.g., if a trade will be settled in 5 business days, the reporting party will enter ".s05" in the data field).
      (C) Weighted Average Price Modifier
      If the price of the transaction is determined using a weighted average price method, select the modifier, ".w." If one of the settlement modifiers and the weighted average price modifier apply to the transaction, select the modifier, ".w" for weighted average price and do not report the applicable settlement modifier.
      (e) Transactions Not Required To Be Reported
      The following types of transactions shall not be reported:
      (1) Transactions that are part of a primary distribution by an issuer;
      (2) Transactions in securities that are listed on a national securities exchange, when such transactions are executed on and reported to the exchange and the transaction information is disseminated publicly, and transactions in convertible debt securities that are listed and quoted on Nasdaq, when such transactions are reported to Nasdaq and the transaction information is disseminated publicly; and
      (3) Transactions where the buyer and the seller have agreed to trade at a price substantially unrelated to the current market for the TRACE-eligible security (e.g., to allow the seller to make a gift).
      (f) Compliance With Reporting Obligations
      A pattern or practice of late reporting without exceptional circumstances may be considered conduct inconsistent with high standards of commercial honor and just and equitable principles of trade, in violation of Rule 2110.

      Amended by SR-NASD-2002-46 eff. July 1, 2002
      Amended by SR-NASD-2001-04 eff. July 1, 2002
      Adopted by SR-NASD-99-65 eff. July 1, 2002.



      6240. Termination of TRACE Service

      The Association may, upon notice, terminate TRACE service to a member in the event that a member fails to abide by any of the rules or operating procedures of the TRACE service or the Association, or fails to honor contractual agreements entered into with the Association or its subsidiaries, or fails to pay promptly for services rendered by the TRACE service.

      Adopted by SR-NASD-99-65 eff. July 1, 2002.



      6250. Dissemination of Corporate Bond Trade Information

      (a) General Dissemination Standard
      Immediately upon receipt of transaction reports received at or after 8:00 a.m. through 6:29:59 p.m. Eastern Time, the Association will disseminate transaction information (except that market aggregate information and last sale information will not be updated after 5:15 p.m. Eastern Time) relating to transactions in:
      (1) a TRACE-eligible security having an initial issuance size of $1 billion or greater that is Investment Grade at the time of receipt of the transaction report; and
      (2) a TRACE-eligible security that is designated for dissemination according to the following criteria and is Non-Investment Grade at the time of receipt of the transaction report.
      (A) The staff of NASD will designate fifty of the most actively traded Non-Investment Grade securities that are TRACE-eligible securities for dissemination under this rule, based on (i) the security's volume; (ii) the security's price; (iii) the security's name recognition; (iv) the research following of the security; (v) the security having a minimum number of bonds outstanding; (vi) the security being traded routinely by at least two dealers; and (vii) the security contributing to arepresentation of diverse industry groups in the group of securities designated for dissemination.
      (B) A Non-Investment Grade security will not be designated, and may be immediately withdrawn from designation, for dissemination under this rule if the security: (i) has matured; (ii) has been called; (iii) has been upgraded to Investment Grade; or (iv) has been downgraded to an extent that the security's trading characteristics do not warrant designation for dissemination.
      (b) Transactions Excluded From Market Aggregate, Last Sale
      All trade reports in TRACE-eligible securities that are approved for dissemination and submitted to TRACE at or after 8:00 a.m. Eastern Time and prior to 5:15 p.m. Eastern Time will be included in the calculation of market aggregates and last sale except:
      (1) trades reported on an "as of" basis,
      (2) "when issued" trades executed on a yield basis,
      (3) trades in baby bonds with a par value of less than $1,000,
      (4) trades in which the price is determined by a weighted average price; and
      (5) trades in which the price is a "special price," as indicated by the use of the special price modifier.
      (c) Dissemination of Certain Trades Executed on A Business Day
      (1) Reports of transactions in TRACE-eligible securities that are subject to dissemination, are executed on a business day at or after 6:30 p.m. Eastern Time through 11:59:59 p.m. Eastern Time, and are reported pursuant to Rule 6230(a)(2) on the next business day and designated "as/of" will be disseminated beginning at 8:00 a.m. Eastern Time on the day of receipt. The reported information will not be included in the calculation of the day's market aggregates.
      (2) Reports of transactions in TRACE-eligible securities that are subject to dissemination, are executed on a business day at or after 12:00 a.m. Eastern Timethrough 7:59:59 a.m. Eastern Time, and are reported pursuant to Rule 6230(a)(3) on the same day beginning at 8:00 a.m. Eastern Time will be disseminated upon receipt. The reported information will be included in the calculation of the day's market aggregates, except as otherwise provided in Rule 6250(b)(1) through (5).
      (d) Dissemination of Trades Executed on Non-Business Days
      Reports of transactions in TRACE-eligible securities that are subject to dissemination, are executed on a non-business day at any time during the day, and are reported pursuant to Rule 6230(a)(4) on the next business day will be disseminated upon receipt. The reported information will not be included in the calculation of the day's market aggregates.

      Amended by SR-NASD-2002-46 eff. July 1, 2002
      Adopted by SR-NASD-99-65 eff. July 1, 2002.



      6260. Managing Underwriter Obligation To Obtain CUSIP

      (a) In order to facilitate trade reporting of secondary transactions in TRACE-eligible securities, the member that is the managing underwriter of any newly issued TRACE-eligible security must obtain and provide information to the TRACE Operations Center as required under paragraph (b). If a managing underwriter is not appointed, the group of underwriters must comply with paragraph (b).
      (b) For such TRACE-eligible securities, the managing underwriter must provide to the TRACE Operations Center: (1) the CUSIP number; (2) the issuer name; (3) the coupon rate; (4) the maturity; (5) whether Rule 144A applies; and (6) a brief description of the issue (e.g., senior subordinated note, senior note), or if such information has not been determined, such other information as the NASD deems necessary. The managing underwriter must obtain the CUSIP number and provide it and the information listed as (2) through (6) not later than 5:00 p.m. on the business day preceding the day that the registration statement becomes effective, or, if registration is not required, the day before the securities will be priced. If an issuer notifies an underwriter, or the issuer and the underwriter determine, that the TRACE-eligible securities of the issuer shall be priced, offered and sold the same business day in an intra-day offering under Rule 415 of the Securities Act of 1933 or Rule 144A of the Securities Act of 1933, the member shall provide the information not later than 5:00 p.m. on the day that the securities are priced and offered, provided that if such securities are priced and offered on or after 5:00 p.m., the member shall provide the information not later than 5:00 p.m. on the next business day. A member must make a good faith determination that the security is a TRACE-eligible security before submitting the information to the TRACE Operations Center.

      Amended by SR-NASD-2002-46 eff. July 1, 2002
      Adopted by SR-NASD-99-65 eff. July 1, 2002.

    • 02-75 NASD Provides Additional Information on the Trading Activity Fee

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      INFORMATIONAL

      Trading Activity Fee

      SUGGESTED ROUTING

      KEY TOPICS

      Compliance
      Legal
      Operations
      Senior Management

      NASD By-Laws
      Trading Activity Fee
      Section 8(a) Regulatory Fees



      Executive Summary

      As announced in Notice to Members 02-41 and Special Notice to Members 02-63, NASD has amended Section 8(a) of Schedule A to NASD's By-Laws, eliminating the Regulatory Fee and instituting a new transaction-based Trading Activity Fee which funds NASD's member regulatory activities.1

      Questions/Further Information

      Questions concerning this Notice should be directed to NASD Finance, at (240) 386-5397, or NASD Regulatory Policy and Oversight, Office of General Counsel, at (202) 728-8071.

      Discussion

      NASD has amended Section 8(a) of Schedule A to NASD's By-Laws to eliminate the Regulatory Fee and to institute a new transactionbased Trading Activity Fee. This fee is used by NASD solely to fund NASD's member regulatory activities, including the supervision and regulation of members through examinations, processing of membership applications, financial monitoring, policy, rulemaking,interpretive, and enforcement activities. The Trading Activity Fee does not fund Market Regulation activities which are funded solely through contracts with NASDAQ and other exchanges.

      These changes were originally submitted to the Securities and Exchange Commission (SEC) for immediate effectiveness. On Friday, October 18, 2002, NASD filed with the SEC two subsequent but related rule filings. The first is a proposed rule change2 filed with the SEC for immediate effectiveness that established a sunset provision that terminates on December 31, 2002 the proposed changes made to Schedule A to NASD's By-Laws. The second rule filing3 contains substantially the same rule language as originally proposed, but was submitted pursuant to Section 19(b)(1) of the Act4 to allow for an additional notice and comment period. NASD filed this in response to comments made by NASD's members that the Trading Activity Fee should not be filed as immediately effective, but instead should be given a full notice and comment period. In addition, this subsequent comment period allows NASD to further examine the impact of the Trading Activity Fee rates effective upon implementation and ensure they are consistent with NASD's overall intention that amendments to its pricing structure be revenue neutral.5

      Trading Activity Fee Initial Rate Structure

      NASD previously announced the initial rate structure for the Trading Activity Fee effective October 1, 2002. Based on further analysis of trading volumes and feedback from member firms, the rate structure has been further adjusted, retroactively effective to October 1, 2002. Adjustments to the rate structure are: 1) the initial rate of $0.0001 for covered equity securities has been reduced to $0.00005, 2) the maximum on covered equity securities has been reduced to $5.00, 3) the initial rate of $0.08 for security futures has been reduced to $0.04, and 4) the minimum exclusion has been extended to cover options and futures. The adjusted rate structure is as follows:

      • Each member shall pay to NASD $0.00005 per share for each sale of a covered equity security, with a maximum charge of $5 per trade.


      • Each member shall pay to NASD $0.002 per contract for each sale of an option.


      • Each member shall pay to NASD $0.04 for each round turn transaction of a security future.

      Additionally, if the execution price for a covered security is less than the Trading Activity Fee rate ($0.00005 for covered equity securities, $0.002 for covered option contracts, or $0.04 for a security future) on a per share, per contract, or round turn transaction basis then no fee will be assessed.

      NASD is filing the above initial rate structure with the SEC for immediate effectiveness. Additionally, NASD intends to file any further modifications to the Trading Activity Fee rate structure with the SEC.

      Submission/Payment Information

      Traditionally, the Section 8(a) Regulatory Fee had been assessed on clearing firms on behalf of members. Although reporting obligations are ultimately the responsibility of the member, the Trading Activity Fee will continue to be assessed directly to the clearing firms responsible for clearing the transaction on behalf of the member firm.

      In consideration of programming constraints and due to the further refinement of the initial rate structure, NASD has extended the submission and payment date for the October 1, 2002 through December 31, 2002 time period. Firms may self-report and remit payment to NASD for this time period no later than January 15, 2003.

      The prescribed form of the monthly report is available on the NASD Web Site at www.nasd.com Firms will be required to self-report to NASD the aggregate shares for stocks, aggregate number of contracts for options, and/or aggregate number of contracts traded on a round turn basis for security futures products at the clearing firm level only. For the October 1, 2002 through December 31, 2002 time period, a separate form for each month must be submitted.

      The monthly report and payment may be submitted to NASD by either US mail or overnight Express mail as follows:

      For US mail delivery:

      NASD
      P.O. Box 7777-W8555
      Philadelphia, PA 19175-8555

      Note: This P.O. Box will not accept courier r overnight deliveries.

      For courier & overnight deliveries:

      NASD
      W8555 c/o Mellon Bank, Rm 3490
      701 Market Street
      Philadelphia, PA 19106
      Phone number: 215-553-0697

      (if required for the recipient)

      If other payment methods are required, please call NASD Finance, at 240-386- 5394.

      Questions and Answers

      Question 1: The answer to Question 4 in the Question and Answer Section of Special Notice to Members 02-63, stated that although the general model is to assess the Trading Activity Fee on the sell side of member transactions, the Trading Activity Fee would be assessed on the buy side of member transactions where the counter party is not a broker/dealer. The answer further stated that NASD members will be charged a Trading Activity Fee when they are on the buy-side of a transaction with a non-broker/dealer (e.g., internalized trade). Since the rule states that each member shall pay a fee for each sale of a covered security, does this mean that for a transaction in which the sell-side is a customer and the buy-side is a member, two fees will be charged?

      No. More simply stated, a fee will be assessed on all sell side transactions. This includes both transactions where the sale is for the account of a customer and transactions where the sale is for the member itself.


      Question 2: If a member effects a sale for a customer on an agency basis, will the member be assessed a fee?

      Yes. If a member acts as agent for a non-broker/dealer customer in the sale of a covered security, the member will be assessed a fee for that transaction.


      Question 3: If a member effects a sale for another NASD member on an agency basis, will the member acting as agent be assessed a fee?

      No. If a member acts as agent on behalf of another NASD member in the sale of a covered security, the fee will be assessed to the member who is the ultimate seller of the security, not the member acting as agent.


      Question 4: How is the Trading Activity Fee calculated when a member uses an average price model to effect transactions on an agency basis for its customers?

      A member may choose to calculate the Trading Activity Fee on either the individual street side executions or on the account level average price confirmation if that member can link the street side executions to the account level average price confirmation(s). However, the methodology chosen by the member to calculate the fee assessment must be consistently applied to all average price transactions and must be documented by the member.

      Example 1. A customer places an order to sell one million shares of a covered security and the member executes ten 100,000 share trades that are then allocated to the customer on an average price basis. If the member can link the ten street side trades to the one million share average price confirmation to the customer, the member may calculate the fee based on either the ten street side trades (ten sales at $5) or on the account level average price confirmation to the customer (one sale at $5).
      Example 2. An investment advisor places an order to sell one million shares of a covered security. The member then executes ten 100,000 share trades to fill the investment advisor's order. The investment advisor subsequently allocates the one million shares to four separate customers. If the member can link the ten street side trades to the four account level average price confirmations, the member may calculate the fee based on either the ten street side trades (ten sales at $5) or on the account level average price confirmations (four sales at $5). The member may not calculate the fee based on the million share order from the investment advisor (one sale at $5) because it is comprised of multiple customer accounts.

      Question 5: Schedule A to NASD's By- Laws, Section 2(b)(3)(iii) states "each member shall pay to NASD a fee for each round turn transaction (treated as including one purchase and one sale of a contract of sale for future delivery) of a security future". Does this mean that the fee will be assessed on a per contract basis?

      Yes. Example: A member opens a position (long or short) of 100 contracts. No fee is assessed when the position is opened because the fee assessment is based on a round turn transaction. The member later closes half of its original 100 contract position. When the member closes out the 50 contracts, it will be assessed a fee of $0.04 x 50 contracts, totaling $2.


      Question 6: Will the Trading Activity Fee be assessed on transactions for nonmember broker-dealers who clear through an NASD member brokerdealer.

      No. The Trading Activity Fee only applies to NASD member firms. However, if the NASD member clearing firm also acts as the executing broker in a transaction, then the NASD clearing member will be assessed a fee for that transaction.


      Question 7: The rate structure includes a maximum charge per trade of $5 for covered securities. Does this apply to options and security futures?

      No. The maximum charge was established for equity securities, particularly for the very low priced over-the-counter securities that often trade in large share quantities.


      1 These changes were submitted to the SEC (for immediate effectiveness) on July 23, 2002 and amended on August 21, 2002. See Securities Exchange Act Release No. 46416 (August 23, 2002), 67 FR 55901 (August 30, 2002) (SR-NASD- 2002-98).

      2 See SR-NASD-2002-147.

      3 See SR-NASD-2002-148.

      4 15 U.S.C. 78s(b)(1).

      5 This proposed rule filing is to be read in conjunction with SR-NASD-2002-99. The two separate yet related rule filings are the result of a review of the overall NASD pricing structure and will be used to fund NASD's member regulatory activities.


      Attachment A

      Trading Activity Fee Self-Reporting Form

    • 02-74 NASD Requests Comment on its Public Information Review Initiative

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      ACTION REQUESTED

      Public Information Review

      Comment Period Expired: December 2, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Legal & Compliance
      Operations
      Senior Management

      Public Information Review



      Executive Summary

      NASD requests comment from members, associated persons, investors, investor groups, and other interested parties on a broad range of issues relating to information NASD makes public. NASD currently provides an unparalleled amount of information about firms, markets and regulation to the public. NASD's policy on public information, as established by various NASD rules, and guided by relevant federal law, has been the topic of frequent public attention. NASD has begun a corporate-wide initiative to review the information it collects or develops and the policies underlying its determination to make certain information public. The overall purpose of this initiative is to develop recommendations for a comprehensive Public Information Policy that will enhance investor protection without sacrificing the effectiveness of NASD regulatory programs or legitimate proprietary or privacy rights of member firms or their associated persons. The focus of this initiative is on information currently available to NASD, not increasing member firms' compliance or reporting obligations. Soliciting the views of NASD's constituents and the users of the information NASD makes public is a critical step in the conduct of this policy review.

      NASD is considering changes that would expand the information it currently makes public, including changes to its Public Disclosure Program (PD Program).1 Possible other changes include, for example, expanding the statistical information NASD makes available, increasing the broker-dealer information released and making arbitration award information more readily available to investors.

      One of the key challenges in conducting this policy review is the need to balance investor protection and an investor's ability to make informed decisions with the legitimate proprietary interests of member firms and the privacy interests of associated persons and other individuals. For example, NASD does not currently release personal information such as Social Security Number, home address or physical description of associated persons2 through its PD Program, and has no plans to do so.3 NASD is, however, considering expanding the information released via its PD Program to include historical form filing information and disclosure information reported by a former employer on Form U-54 as soon as the information is filed. Currently, disclosure information reported via Form U-5 is not released via the PD Program until the broker re-associates with another broker-dealer and is required to report the information via Form U-4.5

      Action Requested

      NASD seeks comment from members, associated persons, investors, investor groups, and other interested parties on issues relating to its Public Information Policy review and supporting or opposing the options discussed in this Notice.

      Comments must be received by December 2, 2002. Members and interested persons can submit their comments using the following methods:

      • mailing written comments to NASD
      • e-mailing written comments to pubcom@nasd.com
      • submitting written comments online on NASD's Web Site (www.nasd.com)

      Written comments submitted via hard copy should be mailed to:

      Barbara Z. Sweeney
      NASD
      Office of the Corporate Secretary
      1735 K Street, NW
      Washington, DC 20006-1500

      Important Note: The only comments that will be considered are those submitted in writing or by e-mail.

      Before becoming effective, any rule changes developed relating to this Notice to Members must be submitted to and approved by the Securities and Exchange Commission (SEC).

      Questions/Further Information

      Questions concerning this Notice may be directed to Jay Cummings, Vice President, NASD Registration and Disclosure Department, at (240) 386-4773 or Ann Bushey, Director, Regulatory Review and Disclosure, NASD Registration and Disclosure Department, at (240) 386-4724.

      Background

      NASD has begun a corporate-wide initiative to review the information it makes public. The initiative involves a comprehensive review of the information collected or developed by NASD and the applicable rules and policies governing whether such information is made available to the general public. As part of the Public Information Policy review, a number of options have been identified and are being presented for comment in this Notice. NASD is interested in comments on its Public Information Policy generally and whether commenters support or oppose the options discussed in this Notice. NASD will consider these comments when formulating rule or policy changes to its Public Information Policy.

      Some of the options relate to the expansion of NASD's PD Program. NASD established the PD Program in 1988 to provide investors with important information about the professional background, business practices, and conduct of NASD members and their associated persons. Recognizing the PD Program's value to investors, Congress passed legislation in 1990 requiring NASD to establish and maintain a toll-free telephone number to receive inquiries regarding its members and their associated persons. In 1998, NASD began providing certain administrative information (e.g., approved registrations and employment history) online via NASD's Web Site (www.nasd.com). In 1999, annual inquiries through the PD Program broke the 1,000,000 mark. In 2000, the SEC approved changes to NASD IM-8310-2 that allowed NASD to (1) release information about persons formerly associated with a member for a two-year period following the termination of their registration with NASD; (2) release information about terminated persons and firms that is provided on Form U-6 (the form regulators use to report regulatory actions)6, if such matters would be required to be reported on the Form U-4 or Form BD7; and (3) deliver automated disclosure reports, which include verbatim information submitted by filers on Uniform Registration Forms. The PD Program is structured to provide information on a per firm or per broker basis on firms or individuals identified by the requester of the information. NASD currently does not release certain information that other securities regulators may provide, particularly State securities regulators operating under applicable state public records laws. Nor has it historically released comparative information regarding NASD firms and their associated persons.

      NASD believes that the PD Program is a critical investor education and protection service, as demonstrated by the over 2 million inquiries now processed annually. The PD Program includes information on over 850,000 former and current registered individuals and over 6,000 current or former NASD registered firms. Information released through NASD's PD Program is derived from the Central Registration Depository (CRD®)8 system, a registration and licensing database used by regulators throughout the securities industry to register, license and regulate securities firms and their brokers.

      Through the PD Program, summary information about securities-related arbitration awards involving NASD member firms is made available to the public. In addition, NASD's Dispute Resolution division has an arrangement with the Securities Arbitration Commentator (SAC) to provide copies of awards for inclusion in its Web-based publication service. As part of this arrangement, individual investors may search the SAC Web Site (accessible via the NASD Dispute Resolution Web Site), using the arbitration award number, to view or copy an award. The award number is contained in a broker or firm report obtained from NASD's PD Program.

      NASD has a number of systems that collect data on matters that also must be reported through the CRD system. To ensure that the information is in fact reported on a timely basis, and therefore is available to the public through the PD Program, NASD plans to implement additional cross-checks to ensure that the matters reported to these systems are timely reported to the CRD system.

      Discussion

      The SEC, States and other self-regulatory organizations release a variety of information under their respective public information policies. These organizations often publish information NASD has available in its CRD system or other systems but does not release under its current information policy. NASD believes its Public Information Policy, including IM-8310-2 and any other relevant NASD Rules, should be amended as appropriate to enable investors to receive most of this information from NASD as well.

      NASD seeks comment from members, associated persons, investors, investor groups, and other interested parties on issues relating to its Public Information Policy and whether commenters support or oppose the suggestions and options set forth in this Notice and discussed in more detail below.

      1. Establish a Central Gateway for Access to Public Information

      NASD makes a broad range of information available to the public, mostly through its Web Sites. There is, however, no single place from which to obtain a listing of the information that is publicly available. Public information is currently spread across multiple pages on at least three different Web Sites. Information frequently is presented without explanations that put the information in context or that define how statistical information has been derived.

      To make information more useful and easily accessible, NASD is considering a single web location that would: (1) list and describe the public information NASD makes available; (2) provide a contact point for questions and/or comments regarding NASD public information; (3) consolidate access to all public statistical information; and (4) enhance the statistical information NASD makes available to include certain demographic and industry segmentation data. The end result would be a central gateway for access to NASD's public information from which an Internet user could see, at-a-glance, the types of information NASD makes available and link to the specific or more detailed information he or she is interested in.

      NASD seeks comment on other ways it can facilitate investor access to this information.

      2. Enhance NASD's Public Disclosure Program

      Over 2 million inquiries a year are processed through NASD's PD Program. It has become the primary source for investors and others seeking information about NASD member firms and their associated persons. To enhance investor protection, NASD believes that substantial changes should be made to its PD Program to:

      • make it easier to use;
      • provide disclosure information online;
      • alert investors to key changes in available information about a broker or firm;
      • put the information provided in context; and
      • expand the types of information released through the PD Program.

      Even with an expansion of the information available through the PD Program, there will be information available through other sources that is not available to NASD or that NASD is unable to make public.9 For example, NASD does not have information regarding certain complaints made by investors to State regulators. The only source for this information is the State regulator. NASD believes the PD Program should provide investors and other users with additional information about other sources of information on NASD member firms and associated persons, including the SEC, States, other self-regulators, and, where possible, provide additional contact information for these sources.

      Ease of Use - Redesign of Internet Application

      NASD's Public Disclosure Internet application was initially deployed in 1998, with subsequent enhancements made in 1999 and 2000. Although NASD's PD Program Internet application was designed to be simple and efficient in its delivery of information, the Internet technology and standards available today offer significant opportunities to make NASD's PD Program easier to use and the information presented easier to understand.

      To meet the needs of investors and other users, the PD Program must both provide a summary view of the wealth of detailed information that is available and the capability to view the detailed information. These two goals can best be achieved through an Internet-based approach using hyperlinks and other information architecture and presentation techniques.

      Online Access to Disclosure Information

      The information provided through the PD Program can be divided into two broad categories:

      • Administrative Information - information about the firm or broker (registrations, employment history, types of business, etc.). Administrative information is available online and in Public Disclosure reports available by mail or e-mail.
      • Disclosure Information - information provided in response to the disclosure questions on the Uniform Registration Forms (criminal, regulatory, disciplinary, customer sales practice complaints and related litigation or arbitration, etc.). Disclosure information is not available online and can only be obtained by requesting a Public Disclosure report by mail or e-mail.

      The existing federal law mandating the PD Program, enacted in 1990, does not address providing disclosure information online. At the time the legislation was enacted, the PD Program was telephonebased. Investors and other users called the NASD Hotline (800-289-9999) to request reports and the legislation specifically reflected that medium for communication; Internet and online disclosure was not contemplated. Today, although the NASD Hotline is still available, investors and other users prefer to use the Internet and have expressed the strong desire to be able to obtain disclosure information online. Over 95 percent of the inquiries to the PD Program are now received through the Internet.

      NASD believes it should continue to seek a change to the federal legislation governing the PD Program to provide for online presentation of disclosure information. Without the ability to display all data online, access to information and usability of the PD Program will continue to be hampered to the detriment of investor protection.

      Public Disclosure Report Updates

      NASD believes that current Internet technology provides a cost-effective means to provide investors and other users of the PD Program with e-mail notice if significant changes occur to the information available on a broker or member firm specified by an investor or other user of the PD Program.

      NASD is considering adding functionality to the PD Program that would allow an investor or other user of the PD Program to request an e-mail notice when certain changes occur in the information previously provided to the investor or other user through the PD Program.

      CRD Data and Form Filing Information

      NASD has expanded the amount of information available through the PD Program since its inception in 1988. The most recent changes occurred in February 2000.10 Although a broad range of information available to regulators through the CRD system also is available to investors and others through the PD Program, NASD believes that more CRD information should be made publiclyavailable through the PD Program.

      For example, NASD's PD Program does not release a broker's exam history or resultsM11 or other CRD system processing results; or the specific form filings and related information submitted during the course of a broker's career.12 NASD also does not release the date and reason for termination as reported on Form U-5. Further, as noted above, disclosure events reported via Form U-5 are disclosed only when (and if) a broker re-associates with another firm and is then required to report any new disclosure events via the Form U-4 filing submitted in connection with that application for registration. Similarly, the "firm information" currently disclosed through the PD Program does not include all information reported on Form BD, such as information regarding direct and indirect owners and control affiliates, answers and related details to all Form BD questions, disclosure information reported for control affiliates,13 or the actual initial Form BD and amendment filings submitted from time to time to keep a firm's CRD record current.

      Given that state regulators and the SEC consider these form filings to be public documents,14 and with respect to Form BD, given that firms, as commercial entities, do not have the privacy interests of individual brokers, NASD seeks comment on whether or not it should expand the information released through its PD Program pursuant to IM-8310-2 to include some or all of the additional information described above - or any other information not specifically mentioned in this Notice. For example, should NASD expand its PD Program to include additional information reported on current Uniform Forms and provide investors access to historical form filings that may include disclosure events that are no longer reportable?

      In considering any expansion of the information released through the PD Program, NASD will continue to balance the benefits of making this information available against the legitimate proprietary interests of member firms and the privacy interests of associated persons and other individuals whose information might be subject to disclosure. For example, NASD does not currently release personal information such as Social Security Number, home address or physical description of associated persons, and has no plans to do so. Further, NASD does not intend to disclose the date of termination and/or reason for termination as reported on Form U-5 until such time as the Form U-5 is amended to allow firms to correct any filing errors made in reporting the date or reason for termination.15

      NASD also seeks comment on whether it should provide a means for former brokers to file a response to information filed on Form U-5 by a firm with which they were associated or filed by a regulator on Form U-6. Further, NASD seeks comment on whether such a response should be through a Uniform Registration Form filing (either an existing form or a new form created for this purpose) and whether such response should be included in the CRD system and the PD Program or whether such response should be filed exclusively with NASD and made available only through the PD Program.

      Putting the Information in Context

      Although NASD cannot rate brokers or firms or specifically advise an investor whether or not to conduct business with a particular broker or firm, NASD believes that expanding the information available through the PD Program to include certain comparative information would help an investor better understand and evaluate the information on the specific broker or firm he or she may be interested in or how his or her broker or firm compares to the rest of the industry. NASD seeks comment on whether or not to expand the information released through the PD Program to include comparative information to help put the specific broker or firm information into context. For example, NASD proposes adding comparative information such as the total number of active brokers or firms, certain industry averages, the universe of active brokers or firms that have disclosure, the average number of disclosure events by category for brokers or firms that do have disclosure, and possibly breaking down the total number of disclosure events for a broker or firm by the number of disclosure events initiated in the past 1, 3, or 5 years or that occurred more than 10 years ago.

      Comment on the Public Disclosure Program

      In addition to the specific issues for comment identified in this section, NASD seeks comment on the PD Program in general, including comment on: making disclosure information available online; expanding the information made available through the PD Program; the overall design and delivery of information available via the Public Disclosure Internet application (accessing the application, navigation, online delivery of the information, display and usability of the data); and a Public Disclosure report update service (including the types of events that would trigger an update).

      3. Implement Additional Safeguards to Ensure Timely Reporting of Disclosure Information.

      The largest and most visible component of NASD's Public Information is the PD Program. The PD Program depends largely on the system of firm and broker self-reporting to the CRD system through the uniform registration forms. Although there are a broad range of safeguards16 in place today that serve as a "check and balance" to the overall self-reporting process, NASD believes more can be done across NASD regulatory systems to ensure data integrity, reduce or eliminate reporting gaps, and ensure that the information is reported quickly, thereby providing investors and the general public with the most current and complete information. NASD also believes that these additional safeguards will not increase an individual or firm's current reporting obligations or add significant burdens to firm compliance activities and requirements.

      In this regard, NASD is considering the following additional safeguards to help achieve its objectives:

      • Expand existing NASD staff review of sources of information other than the CRD system to ensure that information required to be reported by firms and brokers through the CRD system is filed in a timely manner.
      • Implement a new NASD agent registration status called "Inactive Disclosure Review" that would be applied whenever NASD staff discovers that an individual in an approved NASD registration status fails to meet a reporting requirement or fails to respond to a staff request for disclosure or related information within a prescribed period of time. This "Inactive Disclosure Review" status would parallel the existing "Inactive CE" and "Inactive Prints" agent registration statuses. A representative with this status would not be permitted to conduct sales or other regulated activity until the reporting obligation or response to the staff's request is satisfied.
      • . Impose a late disclosure filing fee whenever a new disclosure event, or a required update to an existing disclosure event, is reported to NASD more than 30 days17 from the date triggering the reporting obligation (e.g., the date the action was initiated or the date the firm or individual learned of the facts or circumstances giving rise to the reporting requirement).18
      • Require all registered individuals (approximately 7.5 percent of registered representatives) who have not yet filed a Form U-4 amendment electronically through the CRD system to do so. This will ensure that regulators and the investing public have access to information reported on the current registration forms and verified by the filing broker and firm.19
      • Establish a web page on NASD's Web Site where investors, attorneys or others can report instances where they believe a particular disclosure event that is required to be reported via Form U-4, Form U-5, or Form BD has not been reported. The underlying premise of this proposal is that an investor or other interested individual would alert NASD of the potential reporting requirement after viewing an individual or firm's Public Disclosure information and seeing that the specific event in question (e.g., complaint or arbitration they had filed) is not included as part of the broker or firm's public disclosure record.

      NASD seeks comment on the safeguards noted above and any additional safeguards that NASD should consider.

      4. Improve Ease of Access to Arbitration Awards.

      NASD developed the Securities Arbitration Commentator (SAC) portal to provide access to arbitration awards for parties in subsequent arbitration cases. As part of the arbitrator selection process, parties are entitled to review the background of all potential arbitrators for their case, including prior decisions of those arbitrators. For each potential arbitrator, NASD provides parties with a report containing extensive background information and a list of that arbitrator's prior awards. With that list, parties can easily view or print awards at any time with no charge. This mechanism was designed to replace a system in which the parties requested copies of awards from NASD. Many requests were extensive and the more voluminous requests resulted in fees charged to parties.

      SAC collects arbitration awards from NASD, from other self-regulatory organizations, and from the American Arbitration Association. SAC is in business to provide award summaries and searches of its award database for a fee. SAC's customers are typically attorneys for parties in arbitration matters. However, it may be possible for NASD to work with SAC to enhance the services available to individual investors in a public disclosure context. In addition, the PD Program could be enhanced to identify awards in a way that would allow more meaningful searches using the current SAC database.

      NASD seeks comment on these approaches and other issues regarding the availability of dispute resolution information.

      5. Other NASD Information

      NASD collects a broad range of information to fulfill its regulatory mission. Because of the proprietary and confidential nature of much of this information, and its potential use in investigations, examinations or disciplinary actions, NASD believes that this information should remain non-public. In assessing whether this information should be made public, NASD initially has concluded to implement the safeguards described above to ensure that the regulatory information most pertinent to investors (i.e., the information generally elicited by the uniform registration forms) is timely and fully reported to the CRD system (so it is available to regulators) and the PD Program so that it is available to investors and other users.

      NASD seeks comment on this proposed approach and on any other information that NASD should consider making publicly available.

      Summary

      As previously stated, NASD currently provides an unparalleled amount of information about firms, markets and regulation to the public. NASD's policy on public information, as established by various NASD rules, and guided by relevant federal law, has been the topic of frequent public attention. NASD has undertaken a corporate-wide initiative to review (1) the information it collects or develops and (2) the policies underlying its determination to make certain information public. The overall objective of this initiative is to develop recommendations for a comprehensive Public Information Policy that will enhance investor protection without sacrificing the effectiveness of NASD regulatory programs or legitimate proprietary or privacy rights of member firms or their associated persons, or increasing member firms' compliance obligations or burdens. Soliciting the views of NASD's constituents and the users of the information NASD makes public is a critical step in the conduct of this policy review.

      As discussed in this Notice, NASD is considering changes that would expand the information it currently makes public, including changes to its PD Program.

      One of the key challenges in conducting this policy review is the need to balance investor protection and an investor's ability to make informed decisions with the legitimate proprietary interests of member firms and the privacy interests of associated persons and other individuals.

      NASD believes that a more comprehensive Public Information Policy will enhance investor protection without sacrificing the effectiveness of NASD regulatory programs. NASD looks forward to receiving comments from members, associated persons, investors, investor groups, and other interested parties on the broad range of issues related to information NASD makes public and on whether commenters support or oppose the options discussed in this Notice.


      1 NASD Interpretive Material (IM) 8310-2(a) governs the information released via NASD's PD Program.

      2 This information is required to be reported by associated persons registered with NASD on their Uniform Registration Form U-4.

      3 Other regulators may make this information public, depending on applicable law. See Note 9, below.

      4 Form U-5: The Uniform Termination Notice for Securities Industry Registration.

      5 Form U-4: The Uniform Application for Securities Industry Registration or Transfer.

      6 Form U-6: Uniform Disciplinary Action Reporting Form.

      7 Form BD: Uniform Application for Broker-Dealer Registration. Form BD is an SEC form. As such, the SEC must adopt any proposed changes to Form BD.

      8 NASD operates the CRD system in accordance with an agreement with the North American Securities Administrators Association (NASAA). CRD policy is jointly established by NASD and NASAA.

      9 NASD's PD Program is governed by federal law, SEC regulations, and NASD rules approved by the SEC. Other sources may be governed by different substantive legal requirements. State disclosure programs are governed by state law, which may enable the State to provide additional information on firms or brokers licensed by the state.

      10 Broker information currently released via the PD Program includes the broker's name and CRD number, approved registrations (provided the individual is NASD registered), 10 years of employment history (includes current and previous employment), "other business" (if any) as reported on Form U-4, and all disclosure events currently required to be reported on Form U-4 (including disclosure events reported by regulators via Form U-6, and disclosure events reported by previously employing NASD firms via Form U-5 once a subsequent Form U-4 is submitted and the individual is then required to report any new disclosure events via Form U-4). Information released through the PD Program on current and former NASD registered firms includes: applicant's name, CRD number, SEC number, main office address, mailing address, business telephone number, NASD district office assignment, approved registrations (provided the firm is NASD registered), all disclosure events involving the firm required to be reported on Form BD (including disclosure events reported by regulators via Form U-6), and summary information about securities (or commodities) related NASD arbitration awards

      11 Exam information includes: exams requested, taken or not taken, and exam results (i.e., pass/fail or specific grades). NASD proposes providing pass/fail instead of actual scores in part because the number of questions and the required passing score varies from exam to exam and can change over time. Exam scores are not designed to predict performance or future regulatory compliance.

      12 Historical form filing information includes the specific form filings submitted to the CRD system and the information contained in the specific filing, including any disclosure events that were reported in error or that were required to be reported on a specific filing but are no longer reportable on the individual's current Form U-4 filing (based on a change to the question or a "sunset" provision within the question that requires reporting only for a specified period of time).

      13 Control affiliate disclosure can be obtained (if reported to the CRD system) by a separate request for infomation on the control affiliates.

      14 Forms U-4, U-5, U-6, BD, BDW and related amendment filings

      15 The Form U-5 and related instructions do not currently allow firms to amend any information reported on the form other than the associated person's residential address and disclosure information. As a result, firms that may make filing errors by entering an incorrect date or selecting an incorrect reason for termination from a drop down list have no mechanism to correct these errors via a Form U-5 amendment filing.

      16 Today's safeguards include, but are not limited to: Criminal History Record Information (CHRI) received from the Federal Bureau of Investigation as part of the fingerprint card processing results, which provides an independent source of criminal history information (fingerprint cards are submitted to NASD pursuant to Exchange Act Rule 17f-2); regulator reporting of disciplinary actions initiated against a broker or firm via Form U-6; and existing information sharing within NASD departments and among other regulators.

      17 Note that 30 calendar days is used here as an example. The requisite number of days is to be determined; however, it likely would be based on calendar days, and would be at least 30 days, except in cases involving a statutory disqualification. NASD's By-Laws, Article IV, Section 1(c ) and Article V, Section 2(c ), state that all applications with NASD must be kept current at all times by supplementary amendments and that such amendments should be filed with NASD not later than 30 days after learning of the facts or circumstances triggering the amendment filing requirement. Further, if the amendment involves a statutory disqualification as defined in Section 3(a)(39) and Section 15(b)(4) of the Exchange Act, the By-Laws state that the amendment should be filed not later than 10 days after the disqualification occurs.

      18 The intent of the late filing fee is not to generate revenue, but rather to deter late filing and ensure that the required amendment filings are submitted timely, thereby making the information available to the public as soon as possible. The fee would be imposed any time a reportable event was initially disclosed more the 30 days from the event date.

      19 In substantially all cases, the information provided through the PD Program represents the verbatim record as it was reported to NASD on the uniform registration form then in effect. The disclosure and other questions on these forms have changed substantially over time. In addition, in certain limited circumstances relating to the conversion to electronic form filing, NASD combined information about a single event that was reported by different sources. Filing electronically on the current form would address both issues. No fee would be charged member firms for this filing, unless the filing reported new or updated disclosure, in which case the standard disclosure review fee would apply.

    • 02-73 SEC Approves New Rules and Rule Amendments Concerning Security Futures

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      INFORMATIONAL

      Business Conduct and Responsibility Rules

      Effective Date: October 15, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations, Trading and Training
      Registered Representatives
      Senior Management

      Security Futures



      Executive Summary

      On October 15, 2002, the Securities and Exchange Commission (SEC) approved rule changes by NASD that both create and amend certain rules and interpretive materials to address the requirements for NASD members engaging in a security futures business. These rule changes:

      • amend registration rules to expand several registration categories to include engaging in and supervising security futures transactions;


      • amend Rule 1060 (Persons Exempt from Registration) to exempt from NASD registration persons associated with a member who are already registered with a registered futures association and whose functions are related exclusively to security futures transactions;


      • create Rule 2865 (Security Futures Rule) to regulate security futures sales practices and amend Interpretive Material 2310-2 (Fair Dealing with Customers) to refer to new Rule 2865 regarding security futures sales practices;


      • amend Interpretive Material 2110-3 (Front Running Policy) to add block trading in single stock futures to the prohibition against front running;


      • amend NASD's advertising rule - Rule 2210 (Communications with the Public) and create new Interpretive Material 2210-7 (Guidelines for Communications with the Public Regarding Security Futures) to regulate communications with the public regarding security futures;


      • amend Rule 3010(b)(2) (the Taping Rule) to recognize the ability of futures regulators to expel a member from the futures industry for futures-related sales practice violations;


      • amend Rule 3010(e) (Qualification of Job Applicants) to require firms to check the backgrounds of job applicants who have previously worked in the futures industry;


      • amend Rule 3050 (Transactions for or by Associated Persons) to require associated persons to notify their member firm when they open certain futures accounts or engage in certain security futures transactions; and


      • amend Rule 3370 (Prompt Receipt and Delivery of Securities) to exempt security futures from the affirmative determination requirement.

      These changes are included with this Notice (see Attachment A). They become effective October 15, 2002.

      This Notice also explains that adding a security futures business may constitute a material change of business and describes the factors a member should consider in determining whether engaging in a security futures business constitutes a material change that would require the member to file a continuing membership application with NASD and obtain prior approval before engaging in a security futures business. The Notice also clarifies that best execution obligations apply to transactions in security futures. In addition, the Notice explains that members engaged in a security futures business must comply with their obligations in the analyst rule, Rule 2711 ("Research Analysts and Research Reports").

      Questions/Further Information

      Questions concerning this Notice may be directed to the Office of General Counsel, NASD Regulatory Policy and Oversight: Gary L. Goldsholle, Associate General Counsel, (202) 728-8104; Alan Lawhead, Associate General Counsel, (202) 728-8853; or Patricia Albrecht, Assistant General Counsel, (202) 728-8026.

      Background

      The Commodity Futures Modernization Act of 2000 (CFMA) lifted the ban on the trading of security futures, i.e., single stock and narrow-based stock index futures ("security futures").1 The CFMA defines security futures both as securities under the federal securities laws,2 and as futures contracts for purposes of the Commodity Exchange Act (CEA).3 Accordingly, the SEC and the Commodity Futures Trading Commission (CFTC) have joint jurisdiction over the intermediaries and markets that trade security futures products.

      Because they are subject to regulation both as securities and as futures contracts, security futures must be traded on trading facilities4 and through intermediaries that are registered with both the SEC and the CFTC. Broker/dealers that wish to conduct a business in security futures are required to notice register with the CFTC as Futures Commission Merchants (FCMs) or Introducing Brokers (IBs).5 Similarly, FCMs and IBs are required to notice register as broker/dealers if they wish to conduct a business in security futures.6 Firms that are fully registered as both FCMs or IBs and broker/dealers may engage in security futures transactions without any notice registration.

      NASD has amended certain rules and interpretive materials and created new rules and interpretive materials to address security futures.7 This Notice explains and describes: (1) changes to the qualifications and testing requirements; (2) the provisions of new Rule 2865 and other rule changes; (3) that best execution obligations apply to transactions in security futures; (4) that adding a security futures business constitutes a material change of business under NASD rules and the implications of adding this new business; and (5) that members engaged in a security futures business must comply with their obligations in Rule 2711.

      I. Qualification and Training

      A. Changes to Registration; Continuing Education for Existing Registrants

      Under the CFMA, self-regulatory organizations (SROs) are responsible for ensuring that individuals engaging in a security futures business are properly qualified.8 To accommodate the introduction of security futures, several registration categories have been modified to include the activities of engaging in and supervising securities futures. In general, where a registration category permits an individual to engage in an options business, that category has been modified to permit activity in security futures. Specifically, the modified categories are the Series 4 (Registered Options and Security Futures Principal (replaces Registered Options Principal)), Series 9/10 (Limited Principal - General Securities Sales Supervisor),9 Series 7 (General Securities Representative), and Series 42 (Limited Representative - Options and Security Futures (replaces Limited Representative - Options)).10

      Until December 31, 2006, persons who are currently registered in the abovementioned categories or who become registered in one of these categories prior to the implementation of the revised examinations addressing security futures and who want to engage in a security futures business must complete a firm-element continuing education requirement addressing security futures before engaging in any security futures business. As discussed below, the continuing education requirement has been instituted as an alternative to retesting and is discussed below.

      The opportunity for eligible registrants to qualify to engage in a security futures business by completing a firm-element continuing education requirement ends on December 31, 2006. After that date, if an eligible registrant has not taken the firm element continuing education program and wants to begin participating in a security futures business, that registrant must take a revised qualification examination before engaging in a security futures business.

      We recognize that this is the first time NASD has mandated a particular firm-element continuing education program.11 Traditionally, member firms have determined the nature and content of their firm-element continuing education programs. The introduction of security futures in the United States, however, is an extraordinary situation. Following a nearly 20-year ban, securities professionals will be able to trade products that are both securities and futures. Accordingly, securities professionals may not be sufficiently familiar with the different risks, trading characteristics, and terms and nomenclature of these products, including the fact that the products are subject to the joint jurisdiction of the SEC and CFTC. Consequently, we have determined that firm element continuing education is the most effective method of ensuring that existing registrants are properly informed about security futures.12

      To facilitate firms' compliance with the continuing education requirement, we have developed with the National Futures Association (NFA) and the Institute for Financial Markets an internet-based training program that firms may use to satisfy the firm element requirement. Attached to this Notice is an outline of the content of the continuing education program. (See Attachment B). Registered personnel may access the training through NASD's Web Site at www.nasd.com. Use of the NASD/NFA program, however, is not mandatory. Firms may develop their own firm element training programs following the NASD syllabus. Firms also may engage other continuing education providers to deliver the training, provided that the training covers all of the subjects in the NASD syllabus. NASD and NFA are offering a web-based training program because we recognize that many firms may not have the resources or expertise to develop such programs "in-house" or in a timely manner. NASD is offering the training program free of charge. More information about the NASD/NFA continuing education program can be found at the NASD Web Site.

      B. Development of New Qualification Examinations

      We are currently working with industry representatives and other SROs to develop revised qualification examination questions on security futures. These new questions on security futures will be added to the Series 4, Series 9/10, and Series 42.13

      We also intend to offer a new Series 43 examination for general securities representatives seeking to engage in a security futures business. Once the Series 43 is developed, new applicants seeking to act as a general securities representative may choose to take only the Series 7, or, if they intend to engage in a security futures business, the Series 7 and Series 43 examinations. After the Series 43 examination is developed, persons taking only the Series 7 will not be permitted to engage in a security futures business, nor will they be able to qualify to engage in a security futures business by completing a firm-element continuing education program.14 Firmelement continuing education programs will be an option available only for persons who are registered as a general securities representative before the Series 43 examination becomes available.

      We are not amending the Series 24 - General Securities Principal examination. The Series 24 does not permit a principal to supervise options activity, and consequently, we do not intend to amend the examination to allow such persons to supervise security futures activity.

      NASD anticipates that the new and revised qualification examinations will be available six months after trading in security futures commences.

      In addition, NASD is allowing individuals who have passed the Series 30 (NFA's Branch Manager Examination) to supervise security futures activities. This is principally an accommodation to members that are registered as a broker/dealer and an FCM or IB, which are likely to have Series 30 personnel in their futures business. Rule 1022(f) requires each Registered Options and Security Futures Principal to pass "the appropriate Qualification Examination for Registered Options and Security Futures Principal, or an equivalent examination acceptable to NASD." NASD has deemed the Series 30 examination to be an "equivalent examination acceptable to NASD" for purposes of supervising security futures activities. Persons who have passed the Series 30 and, if appropriate, the necessary firm-element continuing education, may supervise a member's security futures activities. Such persons, however, may not supervise options activities.

      C. Limited Exemption from Registration for Certain Associated Persons Engaged Exclusively in Security Futures Transactions

      We are also amending Rule 1060 (Persons Exempt from Registration) to exempt from NASD registration requirements associated persons whose securities activities are related solely and exclusively to transactions in security futures, provided that such persons are registered with a registered futures association. The NFA currently is the only registered futures association. This rule change recognizes that certain persons in a firm that is a broker/dealer and either an FCM or IB, who currently engage solely in a commodities business, may seek to expand their activities into security futures. The rule change has been made to avoid having such persons be required to register as representatives. While those persons are not required to register as representatives, they must follow NFA rules concerning, among other things, continuing education.

      II. Security Futures Rule and Other Changes to Rules and Interpretive Materials

      NASD has developed rules regulating members' activities in security futures. One of the underpinnings of the CFMA is that the regulation of security futures should be comparable to the regulation of options.15 As noted below, that principle has guided the rule and interpretive material changes addressing the introduction of security futures.

      Rule 2865 — Security Futures Rule

      The principal CFMA-related rule change is Rule 2865 (Security Futures Rule), which is based on the options rule, Rule 2860 (Options Rule).16 Highlighted below are the new rule's major requirements.

      A. Opening of Accounts

      Rule 2865(b)(16) provides that a member may not open a security futures account unless the member follows specific procedures. These procedures generally include:

      • providing the customer with the security futures risk disclosure statement;


      • gathering specific, detailed information regarding the customer's financial situation and investment objectives;


      • obtaining written approval for security futures trading in the account by a principal qualified to supervise security futures activities based upon the information gathered; and


      • obtaining, within 15 days after the customer's account has been approved to trade security futures, the customer's verification of the background and financial information upon which the account was approved and a written agreement that the customer has received a copy of the security futures risk disclosure statement, agrees to be bound by NASD's security futures trading rules, and agrees not to violate applicable security futures position limits.

      B. Delivery of Security Futures Risk Disclosure Statement17

      In general, the requirements for delivery of the security futures risk disclosure statement are comparable to the requirements for the delivery of the options disclosure document. Under Rule 2865(b)(11), every member must deliver the security futures risk disclosure statement to each customer at or prior to the time such customer's account is approved for trading security futures. The SEC approved the security futures risk disclosure statement on October 10, 2002. Additionally, as noted above, under Rule 2865(b)(16)(D), a member must within 15 days after a customer's account has been approved for trading in security futures receive a written agreement from each customer that, among other things, states that the customer has received a copy of the security futures risk disclosure statement.

      Copies of the security futures risk disclosure statement may be obtained from NASD Media Source at (301) 590-6500, or from the NFA. Electronic copies may be downloaded from NASD's Security Futures Web Page at www.nasdr.com/futures.asp, or NFA's Web Site.

      C. Suitability

      When recommending security futures to a customer, a member must employ a heightened suitability standard similar to the suitability standard for options.18 This heightened standard recognizes that security futures carry a higher degree of risk to a customer than many other securities products. Specifically, if an associated person recommends a security futures transaction, Rule 2865(b)(19) imposes the additional requirement that the associated person have a reasonable basis for believing "that the customer has such knowledge and experience in financial matters that the customer may reasonably be expected to be capable of evaluating the risks of the recommended transaction and is financially able to bear the risks of the recommended position in the security future." To provide consistency with the suitability standard for security futures adopted by the NFA,19 our security futures standard also explicitly includes recommendations of "trading strategies."

      In addition, the suitability obligations applicable to recommendations to institutional customers, as specified in Interpretive Material 2310-3, apply to transactions in security futures and options.

      D. Discretionary Accounts

      Discretionary account procedures for security futures are comparable to those for discretionary accounts for options. Notably, as with options, Rule 2865(b)(18) provides that the customer must specifically authorize in writing security futures trading conducted on a discretionary basis in the account. Even those accounts that are permitted to trade options cannot trade security futures unless a new written discretionary account authorization specifically authorizing trading of security futures is on file.

      E. Statements of Account

      Under Rule 2865(b)(15), members must send customers an account statement at least each month where there has been an entry in the account during the prior month with respect to a security futures contract. Also, members must send quarterly account statements to all customers that have an open security futures position or money balance in the account.

      A customer account statement for a margin account must provide the market price, mark-to-market value and nominal value of each security futures position and the mark-to-market price and market value of other security positions in the margin account, the total market value of all positions in the account, the outstanding debit or credit balance in the account, and the account equity. In addition, an account statement must inform the customer that further information on commissions and other charges related to the security futures transactions covered in the statement have been included in the previously furnished transaction confirmations and that such information will be made available to the customer promptly upon request. Also, the statement must bear a legend requiring that the customer promptly report any material change in the customer's investment objectives or financial situation.

      F. Confirmations

      The SEC has adopted an amendment to Exchange Act Rule 10b-10 providing confirmation requirements for security futures transactions conducted in futures accounts.20 In view of the SEC's amendment, NASD currently is not amending its confirmation requirements to address transactions in security futures. However, irrespective of whether security futures are transacted in a futures account or a securities account, NASD members should ensure that the confirmations they provide to their customers for security futures transactions meet the appropriate requirements provided in Exchange Act Rule 10b-10.

      G. Maintenance of Records

      As part of their recordkeeping obligations, members are required under Rule 2865(b)(17) to maintain at their principal place of business or another designated principal office a separate record of all security futures-related complaints, through which these complaints can easily be identified and retrieved. In addition, Rule 2865(b)(17) requires members to maintain the background and financial information of any customer who has been approved for security futures trading at both the branch office servicing the customer's account and at the principal supervisory office having jurisdiction over that branch office. This recordkeeping provision is almost identical to the recordkeeping provision in the Options Rule.21

      H. Restrictions in Security Futures Transactions

      Rule 2865(b)(8) provides that NASD has the authority to impose on members any restrictions on security futures transactions if NASD deems the restrictions are necessary to maintain a fair and orderly market in security futures or in the underlying securities covered by those security futures or are otherwise necessary in the public interest or for the protection of investors. This provision is substantively similar to the provision on restrictions of option transactions in the Options Rule.22

      I. Security Futures Transactions and Reports by Market Makers in Listed Securities

      Under Rule 2865(b)(24), every member that is an off-board market maker in a security listed on a national securities exchange must report transactions involving 50 or more security futures contracts on such listed securities that are for the direct or indirect benefit of: (1) the member; or (2) any associated person or other employee of the member who is directly involved in the purchase or sale of the underlying security for the firm's proprietary account, is responsible for supervising such sales, or has information on the member's proprietary account in which the underlying security is traded. This provision applies to all security futures transactions, including transactions executed on an exchange in which the member belongs.

      J. Trading Ahead of Customer Orders

      Under Rule 2865(b)(25), every member must exercise due care to avoid trading ahead of customer security futures orders in a proprietary account or other account in which the member or an associated person has a direct or indirect interest. The prohibition is required only when a member has gained knowledge of or reasonably should have gained knowledge of the customer's order prior to the transmission of the member's order for a proprietary account or for any account in which it or any associated person has an interest.

      The provision against trading ahead of customer orders is based on the NFA's Interpretive Notice regarding obligations to customers and other market participants.23 The NFA's Interpretive Notice gives two examples of when a firm would reasonably not be aware of a customer's order: (1) when a customer's order originates in a different branch office than the firm's proprietary order; and (2) when the firm's trading department does not have access to information about customer orders. We believe that these two situations are also examples of when a member would not violate the provisions in Rule 2865(b)(25). Moreover, generally there may be additional situations in which a member reasonably would not be aware of a customer's order for purposes of applying the rule. In those situations, the member would not violate the rule if it transmits a proprietary order to a securities exchange before a customer's order.

      Interpretive Material 2110-3 (IM-2110-3) — Front Running Policy

      NASD's front running policy, IM-2110-3, prohibits members and associated persons from trading options or an underlying security when they have material non-public market information concerning an imminent block transaction in the underlying security or in the overlying option. The front running policy applies to members' proprietary accounts, accounts in which members or associated persons have an interest or discretionary authority, and customer accounts when a member or an associated person of a member has shared material, non-public market information with a customer.

      We have amended this policy to apply to security futures in the same manner that it applies to options. For example, when a member has material, non-public market information concerning an imminent block transaction in a stock, the member may not to trade the singlestock future overlying that stock in its proprietary account, other accounts in which it has an interest or discretionary authority, or in a customer's account if the member has shared the material, non-public information with the customer. The purpose of this amendment is to prohibit broker/dealers from trading security futures at a profit when they have material, non-public market information concerning a stock or from trading a stock at a profit when they have material, non-public market information concerning a security future. Once the material, non-public market information has been made publicly available, however, the front running policy restrictions no longer apply.

      Rule 2210 — Communications with the Public and Interpretive Material 2210-7 (IM-2210-7) — Guidelines for Communications with the Public Regarding Security Futures

      Rule 2210 (the Advertising Rule) has been amended to apply many of that rule's standards to security futures communications. In addition, new IM-2210-7 has been added to address additional advertising requirements for security futures. We have adopted this approach rather than create a standalone security futures advertising rule because we believe it will be easier for members to follow a modification of the general advertising rule.24

      A. Rule 2210 - Communications with the Public

      Under the Advertising Rule, only a principal qualified to supervise security futures activities can approve advertisements and sales literature concerning security futures.25 As with the pre-use filing requirements for options communications, a member must file its security futures advertisements with NASD's Advertising Regulation Department (Department) or another self-regulatory organization of which it is a member that has comparable standards applicable to security futures at least 10 days prior to use. NASD has determined that NFA's advertising rules are comparable. Thus, NASD members that are also NFA members may file their advertising materials with either the Department or NFA. The Department will review the advertisement and either approve it, disapprove it, or specify changes that the member must make to use the communication.

      As noted above, many of the Advertising Rule's standards apply to these communications. In particular, communications must be based on principles of fair dealing and good faith and should provide a sound basis for evaluating the facts regarding any security futures.26 Exaggerated, unwarranted, or misleading statements about security futures are not allowed.27 Moreover, no member may distribute any communication that the member knows or has reason to know contains misleading material.28 Nor may a member omit a material fact or qualification if the omission, in light of the context of the material presented, would cause the communication to be misleading.29 Communications with the public cannot contain promises of specific results, exaggerated or unwarranted claims or unwarranted superlatives, opinions for which there is no reasonable basis, or forecasts of future events that are unwarranted.30 In addition, members making recommendations about security futures must generally inform the public if they make a market in the underlying securities or if they own security futures of any recommended underlying securities.31 Finally, as explained further below, security futures communications must include specific disclosures about the risks of security futures and the ability to obtain, upon written request, documents that will support any claims made in the communications.

      B. IM-2210-7 - Guidelines for Communications with the Public Regarding Security Futures

      IM-2210-7 provides additional advertising guidelines for security futures communications, including generally requiring that all communications concerning security futures be accompanied or preceded by the security futures risk disclosure statement.32 IM-2210-7 also restricts the content of security futures communications, which include advertisements, sales literature, and correspondence, that are not accompanied or preceded by the security futures risk disclosure statement. Those communications must be limited to general descriptions of the security futures being offered. In addition, they may not contain statements of historical performance or projections and must contain contact information for obtaining a copy of the security futures risk disclosure statement.

      Only sales literature and correspondence that is accompanied or preceded by the security futures risk disclosure statement can contain projections or historical performance information. Additionally, IM-2210-7 provides stringent standards members must follow when making projections or using historical performance data in security futures sales literature and correspondence. For example, sales literature containing projections:

      • cannot suggest the certainty of future performance;


      • must clearly establish the performance parameters; and


      • must reflect all relevant costs, including commissions in the projections, and disclose the risks involved in the proposed transactions.

      Sales literature containing historical performance information must, among other things:

      • confine historical performances to a specific "universe" that can be fully isolated and that covers at least the most recent 12-month period;


      • include the date and price of each recommendation or transaction at the end of the period or when liquidation was suggested or effected;


      • disclose all relevant costs, including commissions; and


      • have a principal qualified to supervise security futures activities ratify that the records or statistics fairly represent the status of the recommendations or transactions reported upon.

      These requirements are similar to provisions in the options advertising rule and also are substantially similar to the NFA's requirement regarding communications with the public for security futures.33

      IM-2210-7 also requires three specific disclosures about security futures. First, if the communication refers to the potential advantages of security futures, the communication must balance the statement of advantages with a reference, in the same degree of specificity, about the corresponding risks. This requirement of a closely balanced presentation of advantages and risks is a more exacting standard than is contained in NASD's general standard for communications with the public, which prohibits exaggerated, unwarranted, or misleading statements.34 Second, the communication must include a warning that security futures are not suitable for all investors. Third, IM-2210-7 requires that the communications state that, upon request, the member will provide documents that support any claims, comparisons, recommendations, statistics, or other technical data used in the communication. All three of these disclosure requirements are similar to the requirements for options communications.35

      Rule 3010(b)(2) — The Taping Rule

      NASD Rule 3010(b)(2) (the Taping Rule) is applicable to NASD members if a certain percentage of their registered persons have been employed by a disciplined firm within the last three years. The Taping Rule requires subject NASD members to tape record "all telephone conversations between the member's registered persons and both existing and potential customers"36 and maintain other special written procedures for supervising the telemarketing activities of all of the member's registered persons. The Taping Rule seeks to prevent registered persons who have been employed by disciplined firms from clustering together at a different firm. For purposes of the Taping Rule, a disciplined firm is one that, in connection with sales practices involving the offer, purchase, or sale of any security, has been expelled from NASD membership, expelled from any other securities industry self-regulatory organization, or is subject to an SEC order revoking its registration as a broker/dealer.

      In the futures industry, the NFA's taping rule requires NFA members that have a certain percentage of associated persons who have been employed by disciplined firms to tape record telephone conversations between associated persons and customers. The NFA has a three-fold definition of a disciplined firm that includes the following: (1) the firm has been charged formally by either the CFTC or NFA with deceptive telemarketing practices or promotional material; (2) the charges have been resolved; and (3) the firm has been closed and permanently barred from the industry as a result of those charges.37

      NASD has incorporated this definition into the Taping Rule's existing definition of "disciplined firm" and has therefore broadened the scope of the Taping Rule to include FCMs and IBs that will be selling security futures within the group of intermediaries that can potentially meet the definition of a disciplined firm. We have adopted this amendment to promote consistency with the NFA in monitoring associated persons from disciplined firms that may engage in the security futures business.

      Rule 3010(e) — Qualifications of Job Applicants

      NASD Rule 3010(e) provides that members have a responsibility to investigate the good character, business repute, qualifications, and experience of a job applicant before the member applies to register that applicant with NASD. When the job applicant previously has been registered with NASD, the member must obtain a copy of the applicant's Uniform Termination Notice of Securities Industry Registration ("Form U-5") that was filed by the applicant's most recent member employer.

      In light of the passage of the CFMA, Rule 3010(e) has been modified to provide that an NASD member must also review a job applicant's employment experience to determine if the applicant has been recently employed by an FCM or an IB that is notice-registered with the SEC pursuant to Exchange Act Section 15(b)(11).38 In such a case, the hiring firm would be required to review a copy of CFTC Form 8-T, Notice of Termination of Associated Person, NFA Associate, Branch Office Manage, Designated Supervisor or Principal. The Form 8-T asks for the same types of information as does the Form U-5. We anticipate that NASD members will be able to review the CFTC Form 8-T by requesting it from the applicant or the applicant's previous employer. Rule 3010(e) has been amended because an individual's prior experience at an FCM or an IB that conducts a security futures business may have particular bearing on his or her fitness to be sponsored by an NASD member.

      In addition, Rule 3010(e) has been amended to provide members with greater flexibility in complying with its requirements. Currently, Rule 3010(e) requires members to obtain actual copies of the Form U-5 and amendments. When NASD replaced the Legacy Central Registration Depository ("CRD") system with Web CRDsm in August 1999, members received the ability to review Form U-5s and amendments via an internet connection. The Web CRD system allows members, with the applicant's consent, to review the Form U-5 by using a pre-hire search function. The amendment recognizes the ability of members to use the advanced functionality of Web CRD to review Form U-5s. Members, however, will be expected to be able to demonstrate compliance with the rule.

      Rule 3050 — Transactions for or by Associated Persons

      NASD Rule 3050(d) states that associated persons seeking to open accounts or place securities orders with a financial institution that is not their employer may not do so unless they notify their employer member and, upon written request by the employer member, obtain from the financial institution duplicate copies of certain documents concerning the orders or accounts. This rule allows NASD members to monitor the outside securities activities of their employees. The scope of this rule has been expanded to require the same notification standards for associated persons opening an account or placing an order with an FCM or IB that is notice-registered with the SEC to trade security futures.

      Rule 3370 — Prompt Receipt and Delivery of Securities

      Rule 3370 generally requires an NASD member, prior to accepting a short sale order from a customer in any security, to make an affirmative determination that the member can borrow or otherwise provide for delivery of the security by the settlement date.39 Because the CFMA exempts transactions in security futures from the short sale provisions of Exchange Act Section 10(a)(1),40 NASD has exempted security futures from the affirmative determination requirement of NASD Rule 3370.41 Members, however, would be prudent to ensure that their customers can provide delivery of the security by the settlement date.

      We also have amended the definition of "bona fide fully hedged" positions in Rule 3370 to include certain long single stock futures positions in connection with short positions. These particular single stock future positions are similar to inthe-money call options, which are already included in the definition.42

      III. Best Execution

      The duty of best execution applies to members' transactions in securities, which includes transactions in security futures. The duty of best execution, which is rooted in common law agency principles and fiduciary obligations, requires that a broker/dealer seek to obtain for its customers' orders the most favorable terms reasonably available under the circumstances.43 The obligation of best execution is codified in NASD Rule 2320, which provides that in any transaction for or with a customer, a member and persons associated with a member shall use reasonable diligence to ascertain the best market for a security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions. Best execution is, however, an obligation that necessarily involves a "facts and circumstances" analysis.

      In the context of security futures, when a customer's order may be executed on two or more markets that trade security future contracts that are not materially different, members have an obligation to use reasonable diligence to ascertain the market in which the customer's order will receive the most favorable terms. Members should consider the factors enumerated in Rule 2320 when making these decisions. If, however, a customer's order may be executed on only one exchange, or when a customer requests that a security futures order be directed to a particular market, members do not have to decide where to route the order.

      NASD recognizes the practical necessity of members automating the handling of retail orders and the impracticability of members making order-by-order routing decisions for typical retail orders. In the context of aggregate order handling decisions, members are required to have in place procedures to regularly and rigorously examine their execution quality as a whole.

      For a fuller discussion of best execution obligations, members should review the SEC's recent interpretation regarding a broker/dealer's best execution obligation for security futures.44

      IV. Membership Application Process

      In November 2000, NASD amended its rules governing the membership application process. The amended rules provide additional guidance about the requirement that a member firm must file a continuing membership application with NASD and obtain approval prior to effecting a material change in business operations.45 Specifically, the membership rules now define a "material change in business operations" as including: (1) market making, underwriting, or acting as a dealer for the first time; (2) adding business activities that require a higher minimum net capital; and (3) removing or modifying a membership agreement restriction.46 All other business expansions are to be evaluated on a facts and circumstances, case-by-case basis, and firms must make a decision as to whether any particular expansion is "material" for purposes of the rules and thus requires an application. In cases requiring an application, members may not proceed with the planned expansion until NASD approves the application.

      In making the required evaluation, members should consider the criteria identified in the guidance accompanying the amended rules.47 Specifically, as with any new line of business, an evaluation of all the relevant facts and circumstances should include, among other things, an assessment of the relationship between a security futures line of business and the firm's existing business; the effect that adding a security futures business will have on the firm's capital; the qualifications and experience of the firm's personnel; and the degree to which the firm's existing financial, operational, supervisory, and compliance systems can accommodate the addition of security futures.48

      For purposes of analyzing whether the addition of security futures constitutes a material change in business operations, member firms are considered to fall into two general categories: firms that currently conduct an options business a nd those that do not.

      Firms that currently conduct an options business should evaluate, based on the facts and circumstances, whether undertaking a security futures business constitutes a material change in business operations. These firms should apply the criteria identified previously for assessing the materiality of the proposed expansion.

      For firms that currently do not engage in an options business, it is likely that engaging in a security futures business will constitute a material change in business operations. As to these firms, if they have assessed the potential impact on their firm of adding a security futures business and would like District Office input on the issue of whether an application is required to approve this expansion, they can consult with the District Offices by submitting notice of their intent to engage in a security futures business to their District Office. The District Office will conduct an informal, expedited review of the firm's query that will include asking the firm questions about its existing operations and its potential security futures business. The District Office will then advise the firm regarding whether adding a security futures line of business constitutes a material change in business operations. If the District Office concludes that the firm should submit a continuing membership application, the District Office, in calculating the allotted review time, will give the firm credit for the amount of time elapsed since it provided the initial notice to the District Office.

      This approach provides certain firms the opportunity to have a quick, informal assessment of whether they need to submit a continuing membership application, reduces the regulatory burden on some firms, and increases the efficiency of the continuing membership application process.

      V. Analysts and Research Reports

      Rule 2711 ("Research Analysts and Research Reports") generally restricts the relationship between a member's research and investment banking departments; requires disclosure of financial interests in covered companies by the member's analyst and the member; requires members to disclose existing and potential investment banking relationships with subject companies; imposes quiet periods for the issuance of research reports; restricts personal trading by analysts; and requires disclosure of information that helps investors track the correlation between an analyst's rating and the stock's price movements.49 The provisions of Rule 2711 are generally applicable to security futures. For example, the restrictions on personal trading by analysts extend to trading in security futures on companies covered by the analyst. Similarly, provisions addressing disclosure of members' or research analysts' ownership interests in a security include security futures interests held by that person. And, the Rule 2711 definition of "Research Report" includes certain written or electronic communications on security futures because security futures are defined as "equity securities" under the Exchange Act.50


      1 Appendix E of Pub. L. No. 106-554, 114 Stat. 2763. Under Section 3(a)(55)(A) of the Securities Exchange Act of 1934 ("Exchange Act"), the term "security future" is defined as a contract of sale for future delivery of a single security or of a narrow-based security index. 15 U.S.C. 78c(a)(55)(A). Under Exchange Act Section 3(a)(56), the term "security futures product" is defined as a security future or an option on a security future. 15 U.S.C. 78c(a)(56).

      2 See, e.g., Exchange Act Section 3(a)(10) (15 U.S.C. 78c(a)(10)).

      3 The term "security future" is defined in CEA Section 1a(31) (7 U.S.C. 1a(31)) as a contract of sale for future delivery of a single security or a narrow-based security index. Under CEA Section 1a(33) (7 U.S.C. 1a(33)), the term "security futures product" is defined as a security future or an option on a security future.

      4 See Exchange Act Section 6(g) (15 U.S.C. 78f(g)); CEA Section 5f (7 U.S.C. 7b-1).

      5 CEA Section 4f(a)(2) (7 U.S.C. 6f(a)(2)); 66 FR 43080 (August 17, 2001).

      6 Exchange Act Section 15(b)(11)(a)(i) (15 U.S.C. 78o(b)(11)(a)(i)); 66 FR 45138 (August 27, 2001).

      7 NASD rules apply only to NASD members. Because FCMs and IBs that are notice-registered with the SEC are not required to become NASD members, any NASD rule changes, including the ones explained here, may not apply to them.

      8 See generally Exchange Act Section 19(b)(7)(A) (15 U.S.C. 78s(b)(7)(A)) (mandating that national securities exchanges or national securities associations registered with the SEC develop rules effectuating the obligation of these SROs to enforce the securities laws and to propose rule changes developing, among other things, sales practices for persons who effect transactions in security futures products); see also Exchange Act Section 15A(k)(2)(D) (15 U.S.C. 78o-3(k)(2)(D) (requiring registered futures associations that apply for registration as a limited purpose national securities association to have rules that ensure that members meet such standards of training, experience, and competence necessary to effect transactions in security futures products and are tested for their knowledge of securities and security futures products).

      9 Rule 1022(f)(5) and (g)(3), respectively; see also changes to Interpretive Materials 1022-1 and 1022-2. IM-1022-1 replaces references to the old category, Registered Options Principals, with the new category of Registered Options and Security Futures Principals and reflects that a Registered Options and Security Futures Principal may supervise security futures trading activities. Likewise, IM-1022-2 now reflects that a Limited Principal - General Securities Sales Supervisor may also supervise security futures sales activities.

      10 Rule 1032(a)(2)(E) and (d)(4), respectively.

      11 See NASD Rule 1120(b)(4) (provision permits NASD to require a member to provide specific training in areas NASD deems appropriate).

      12 Similarly, the National Futures Association (NFA) is requiring continuing education for its existing registrants.

      13 Some of these qualification exams are NYSE examinations. NASD, NYSE, and other SROs are working collectively to revise qualification examinations to address security futures.

      14 In contrast, persons registered in all of the other effected categories who intend to engage in a security futures business shall be able to elect to take firm-element continuing education programs until December 31, 2006, even if new qualifying examinations have been created prior to that date.

      15 For example, the CFMA establishes that margin requirements for security futures be consistent with comparable option contracts and that listing standards for security futures be no less restrictive than comparable listing standards for options traded on a national securities exchange or a national securities association. See Exchange Act Sections 7(c)(2) & 6(h)(3)(C); 15 U.S.C. 78g(c)(2) & 78f(h)(3)(C).

      16 On September 27, 2001, the SEC published a group of new NFA rules and amendments to NFA rules governing security futures. See 66 FR 49439 (September 27, 2001). The NFA's rules also were modeled after NASD's options rule. In developing NASD's security futures rule, we have sought to adopt requirements that are consistent with those of the NFA to avoid regulatory disparity between firms subject to the jurisdiction of the NFA and NASD.

      17 The security futures risk disclosure statement has been developed collectively by NASD, NFA, the New York Stock Exchange, the American Stock Exchange, One Chicago, the Chicago Board Options Exchange, NQLX, and the Options Clearing Corporation.

      18 See NASD Rule 2860(b)(19). We also are amending Interpretive Material 2310-2 (Fair Dealing with Customers) to require members to comply with the security futures sales practices and procedures contained in new Rule 2865.

      19 See NFA Rule 2-30(j)(4).

      20 See Exchange Act Release No. 46471 (Sept. 6, 2002), 67 FR 58302 (Sept. 13, 2002).

      21 See Rule 2860(b)(17).

      22 See Rule 2860(b)(8).

      23 National Futures Association Manual, 9041 (Vol. 7, No. 2 2001).

      24 Members also are advised that Rule 2240 ("Disclosure of Control Relationship with an Issuer") does not apply to security futures. Rule 2240 requires members that are controlled by, controlling, or under common control with, the issuer of any security to disclose to customers the existence of such control prior to entering into any contract with or for a customer for the purchase or sale of such security.

      25 See Rule 2210(b)(1) & (c)(2). Although many of the advertising requirements for security futures are similar to the options advertising requirements, the definitions of "options advertisement," "educational material," and "sales literature" differ from the definitions that will apply to security futures. Because the security futures advertising requirements follow the requirements of the NASD's general advertising rule, the definition of "advertisement" is essentially material that is disseminated via mass media channels. See Rule 2210(a)(1). "Sales literature" is defined to include circulars, research reports, market letters, performance reports or summaries, form letters, telemarketing scripts, seminar texts, and reprints or excerpts of any other advertisement, sales literature, or published article that is distributed or made generally available to customers or the public. See Rule 2210(a)(2).

      26 Rule 2210(d)(1)(A).

      27 Rule 2210(d)(1)(B).

      28 Rule 2210(d)(1)(B).

      29 Rule 2210(d)(1)(A).

      30 Rule 2210(d)(2)(C).

      31 Rule 2210(d)(2)(B)(i)a & b.

      32 These guidelines are similar in many respects to the requirements of Rule 2220, which governs the advertising of options.

      33 See NFA Rule 2-29(j)(12); see also 66 FR 49439 (September 27, 2001).

      34 See Rule 2210(d)(1)(B).

      35 See Rule 2220(d)(2)(A)(i) & (ii), 2220(d)(2)(D)(i).

      36 Rule 3010(b)(2)(iii).

      37 NFA Rule 2-9: Enhanced Supervisory Requirements - Interpretive Notice.

      38 66 FR 45137 (August 27, 2001).

      39 For NASDAQ National Market securities, NASD rules include an additional short sale restriction: the bid test. See Rule 3350(a). We believe that the bid test has no application to security futures, and we are not proposing any amendments to Rule 3350.

      40 See Exchange Act Section 10(a)(2) (15 U.S.C. 78j(a)(2)) (exempting transactions in security futures from short sale provisions in Exchange Act Section 10(a)(1)).

      41 Currently, the affirmative determination requirement of Rule 3370 does not apply to options transactions.

      42 See Rule 3370(b)(5)(iv).

      43 See Notice to Members 01-22 (April 2001).

      44 See SEC Interpretation: Commission Guidance on the Application of Certain Provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and Rules thereunder to Trading in Security Futures Products, Release Nos. 33-8107 & 34-46101 (June 27, 2002) (questions 21-23).

      45 A member is required to file an application pursuant to NASD Rule 1017 for, among other things, a material change in business operations. NASD Rule 1017(e).

      46 NASD Rule 1011(i).

      47 See Notice to Members 00-73 (Oct. 2000).

      48 Id.

      48 See Notice to Members 02-39 (July 2002).

      50 Exchange Act Section 3(a)(11) (15 U.S.C. 78c(a)(11)).


      Attachment A

      1000. Membership, Registration and Qualification Requirements

      * * * * *

      1020. Registration of Principals

      * * * * *

      1022. Categories of Principal Registration

      (a) through (e) No change
      (f) Registered Options and Security Futures Principals
      (1) Every member of the Association [which] that is engaged in, or [which] that intends to engage in transactions in security futures or put or call options with the public shall have at least one Registered Options and Security Futures Principal who shall have satisfied the requirements of this subparagraph. As to options transactions, each [such] member shall also designate a Senior Registered Options Principal and a Compliance Registered Options Principal in accordance with the provisions of Rule 2860(b)(20) and identify such persons to the Association. [A member which has a Registered Options Principal qualified in either put or call options shall not engage in both put and call option transactions until such time as it has a Registered Options Principal qualified in both such options.] Every person engaged in the management of the day-to-day options or security futures activities of a member shall also be registered as a Registered Options and Security Futures Principal. [In the event any Registered Options Principal ceases to act in such capacity, such fact shall be reported promptly to the Association together with a brief statement of the reasons therefor.]
      (2) Each person required by subparagraph (f)(1) [hereof] to be a Registered Options and Security Futures Principal shall pass the appropriate Qualification Examination for Registered Options and Security Futures Principal, or an equivalent examination acceptable to the Association [Corporation], for the purpose of demonstrating an adequate knowledge of options and Security Futures trading generally, the Rules of the Association applicable to trading of option and Security Futures contracts and the rules of registered clearing agencies for options and Security Futures [the Options Clearing Corporation], and be registered as such before engaging in the duties or accepting the responsibilities of a Registered Options and Security Futures Principal.
      [(3) A person shall not qualify as a Registered Options Principal for both put and call options unless he has passed an examination testing him with respect to both put and call options.]
      (3)[(4)] Each person required to register and qualify as a Registered Options and Security Futures Principal must, prior to or concurrent with such registration, be or become qualified pursuant to the Rule 1030 Series, as either a General Securities Representative or a Limited Representative—Corporate Securities and [also be or become qualified pursuant to Rule 1032(d) as] a Registered Options and Security Futures Representative.
      (4)[(5)] A person registered solely as a Registered Options and Security Futures Principal shall not be qualified to function in a principal capacity with responsibility over any area of business activity not prescribed in subparagraph (1) [hereof].
      (5)[(6)] Any person who is registered with NASD as a Registered Options and Security Futures Principal , or who becomes registered as a Registered Options and Security Futures Principal before a revised examination that includes security futures products is offered, must complete a firm-element continuing education program that addresses security futures and a principal's responsibilities for security futures before such person can supervise security futures activities. After a revised examination that includes security futures products is offered, a person associated with a member who passes such a revised Qualification Examination for Registered Options and Security Futures Principal (or any other examination covering security futures that is acceptable to NASD) is not required to complete a firm-element continuing education program that addresses security futures and a principal's responsibilities for security futures to supervise activities in such products, except as otherwise required by Rule 1120 generally or by the member firm. Any Registered Options and Securities Futures Principal who intends to qualify to supervise security futures activities by completing a firm-element continuing education program must complete such a program by December 31, 2006. Any Registered Options and Securities Futures Principal who has not completed a firm-element continuing education program by that date will be required to pass an appropriate qualification examination covering security futures to supervise security futures activities.
      (g) Limited Principal—General Securities Sales Supervisor
      (1) through (2) No change
      (3) Any person who is registered with NASD as a Limited Principal—General Securities Sales Supervisor , or who becomes registered as a Limited Principal - General Securities Sales Supervisor before a revised examination that includes security futures products is offered, must complete a firm-element continuing education program that addresses security futures and a principal's responsibilities for security futures before such person can supervise security futures activities. After a revised examination that includes security futures products is offered, a person associated with a member who passes such a revised Qualification Examination for Limited Principal—General Securities Sales Supervisor (or any other examination covering security futures that is acceptable to NASD) is not required to complete a firm-element continuing education program that addresses security futures and a principal's responsibilities for security futures to supervise such products, except as otherwise required by Rule 1120 generally or by the member firm. Any Limited Principal—General Securities Sales Supervisor who intends to qualify to supervise security futures activities by completing a firm-element continuing education program must complete such a program by December 31, 2006. Any Limited Principal—General Security Sales Supervisor who has not completed a firm-element continuing education program by that date will be required to pass an appropriate qualification examination covering security futures to supervise security futures activities.

      IM-1022-1. Registered Options and Security Futures Principals

      Members having a single Registered Options and Security Futures Principal are required promptly to notify the Association in the event such person is terminated, resigns, becomes incapacitated or is otherwise unable to perform the duties of an Options and Security Futures Principal.
      Following receipt of such notification, the Association will require members to agree, in writing, to refrain from engaging in any options- or security futures-related activities [which] that would necessitate the prior or subsequent approval of an Options and Security Futures Principal including, among other things, the opening of new options or security futures accounts or the execution of discretionary orders for option or security futures contracts until such time as a new Registered Options and Security Futures Principal has been qualified.
      Members failing to qualify a new Registered Options and Security Futures Principal within two weeks following the loss of their sole Registered Options and Security Futures Principal, or by the earliest available date for administration of the [Series 4] Registered Options and Security Futures Principal examination, whichever is longer, shall be required to cease doing an options and security futures business; provided, however, they may effect closing transactions in options and offsetting transactions in security futures [in order] to reduce or eliminate existing open options or security futures positions in their own account as well as the accounts of their customers.

      IM-1022-2. Limited Principal — General Securities Sales Supervisor

      Limited Principal — General Securities Sales Supervisor is an alternate category of registration designed to lessen the qualification burdens on principals of general securities firms who supervise sales. Without this category of limited registration, such principals could be required to separately qualify pursuant to the rules of the NASD, MSRB, NYSE and the options exchanges. While persons may continue to separately qualify with all relevant self-regulatory organizations, the Limited Principal — General Securities Sales Supervisor Examination permits qualification as a supervisor of sales of all securities by one examination. Persons registered as Limited Principals — General Securities Sales Supervisor may also qualify in any other category of principal registration. Persons who are already qualified in one or more categories of principal registration may supervise sales activities of all securities by also qualifying as Limited Principals—General Securities Sales Supervisor.
      Functions that may be performed by Limited Principals — General Securities Sales Supervisors. Any person required to be registered as a principal who supervises sales activities in corporate, municipal and option securities, investment company products, variable contracts, [and] direct participation programs, and security futures may be registered solely as a Limited Principal — General Securities [Sale] Sales Supervisor. In addition to branch office managers, other persons such as regional and national sales managers may also be registered solely as Limited Principals — General Securities Sales Supervisor as long as they supervise only sales activities. Qualification as a General Securities Representative is a prerequisite for registration as a Limited Principal — General Securities Sales Supervisor.
      * * * * *

      1032. Categories of Representative Registration

      (a) General Securities Representative
      (1) No change
      (2) Except as provided in Rule 1031(c):
      (A) through (D) No change
      (E) A person who is registered with the Association as a General Securities Representative, or who becomes registered as a General Securities Representative before a new examination that includes security futures is offered, must complete a firm-element continuing education program that addresses security futures products. After a new examination that includes security futures products is offered, a person associated with a member who passes such a new Qualification Examination for General Securities Representative (or any other examination covering security futures that is acceptable to NASD) is not required to complete a firm-element continuing education program that addresses security futures to act as a General Securities Representative with regard to such products, except as otherwise required by Rule 1120 generally or by the member firm. Once the new examination that includes security futures becomes available, persons seeking to become a General Securities Representative will be required to pass such new examination (or any other examination covering security futures that is acceptable to NASD) to act as a General Securities Representative with regard to security futures products. Only persons registered as a General Securities Representative prior to the time that the new examination is available ("eligible General Securities Representatives") will be eligible to use a firm-element continuing education program in lieu of passing the new examination or module to engage in a security futures business. Any eligible General Securities Representative who intends to qualify as a General Securities Representative with regard to security futures products by completing a firm-element continuing education program must complete such a program by December 31, 2006. Any eligible General Securities Representative who has not completed a firm-element continuing education program by that date will be required to pass an appropriate qualification examination to engage in security futures activities.
      (E) through (H) Renumbered as (F) through (I)
      (3) A person registered as a General Securities Representative shall not be qualified to function as a Registered Options and Security Futures Representative unless he or she is also qualified and registered as such pursuant to the provisions of paragraph (d) [hereof].
      (b) through (c) No change
      (d) Limited Representative — Options and Security Futures
      (1) Each person associated with a member who is included within the definition of a representative as defined in Rule 1031 may register with the Association as a Limited Representative — Options and Security Futures if:
      (A) such person's activities in the investment banking or securities business of the member involve the solicitation or sale of option or security futures contracts, including option contracts on government securities as that term is defined in Section 3(a)(42)(D) of the Act, for the account of a broker, dealer or public customer; and
      (B) such person passes an appropriate qualification examination for Limited Representative — Options and Security Futures.
      (2) Each person seeking to register and qualify as a Limited Representative — Options and Security Futures must, concurrent with or before such registration may become effective, become registered pursuant to the Rule 1032 Series, either as a Limited Representative — Corporate Securities or Limited Representative — Government Securities.
      (3) A person registered as a Limited Representative — Options and Security Futures shall not be qualified to function in any area not described in subparagraph (1)(A) [hereof].
      (4) Any person who is registered with the Association as a Limited Representative — Options and Security Futures, or who becomes registered as a Limited Representative — Options and Security Futures before a revised examination that includes security futures is offered, must complete a firm-element continuing education program that addresses security futures. After a revised examination that includes security futures products is offered, a person associated with a member who passes such a revised Qualification Examination for Limited Representative—Options and Security Futures (or any other examination covering security futures that is acceptable to NASD) is not required to complete a firm-element continuing education program that addresses security futures to act as a limited representative with regard to such products, except as otherwise required by Rule 1120 generally or by the member firm. Any Limited Representative — Options and Security Futures who intends to qualify as a Limited Representative with regard to security futures products by completing a firm-element continuing education program must complete such a program by December 31, 2006. Any Limited Representative — Options and Security Futures who has not completed a firm-element continuing education program by that date will be required to pass an appropriate qualification examination covering security futures to engage in security futures activities.
      (e) through (h) No change
      * * * * *

      1060. Persons Exempt from Registration

      (a) The following persons associated with a member are not required to be registered with the Association:
      (1) through (3) No Change
      (4) persons associated with a member whose functions are related solely and exclusively to:
      (A) No Change
      (B) transactions in municipal securities; [or]
      (C) transactions in commodities; or
      (D) transactions in security futures, provided that any such person is registered with a registered futures association.
      (b) No Change
      * * * * *

      IM-2110-3. Front Running Policy

      It shall be considered conduct inconsistent with just and equitable principles of trade for a member or person associated with a member, for an account in which such member or person associated with a member has an interest, for an account with respect to which such member or person associated with a member exercises investment discretion, or for certain customer accounts, to cause to be executed:
      (a) an order to buy or sell an option or a security future when such member or person associated with a member causing such order to be executed has material, non-public market information concerning an imminent block transaction in the underlying security, or when a customer has been provided such material, non-public market information by the member or any person associated with a member; or
      (b) an order to buy or sell an underlying security when such member or person associated with a member causing such order to be executed has material, non-public market information concerning an imminent block transaction in an option or a security future overlying that security, or when a customer has been provided such material, non-public market information by the member or any person associated with a member; prior to the time information concerning the block transaction has been made publicly available.
      The violative practice noted above may include transactions which are executed based upon knowledge of less than all of the terms of the block transaction, so long as there is knowledge that all of the material terms of the transaction have been or will be agreed upon imminently.
      The general prohibitions stated above shall not apply to transactions executed by member participants in automatic execution systems in those instances where participants must accept automatic executions.
      These prohibitions also do not include situations in which a member or person associated with a member receives a customer's order of block size relating to both an option and the underlying security or both a security future and the underlying security. In such cases, the member and person associated with a member may position the other side of one or both components of the order. However, in these instances, the member and person associated with a member would not be able to cover any resulting proprietary position(s) by entering an offsetting order until information concerning the block transaction involved has been made publicly available.
      The application of this front running policy is limited to transactions that are required to be reported on the last sale reporting systems administered by Nasdaq, Consolidated Tape Association (CTA), or Option Price Reporting Authority (OPRA). The front running policy also applies to security futures transactions regardless of whether such products are reported pursuant to such systems. Information as to a block transaction shall be considered to be publicly available when it has been disseminated via the tape or high speed communications line of one of those systems, a similar system of a national securities exchange under Section 6 of the Act, an alternative trading system under Regulation ATS, or by [of] a third-party news wire service.
      A transaction involving 10,000 shares or more of an underlying security, or options or security futures covering such number of shares is generally deemed to be a block transaction, although a transaction of less than 10,000 shares could be considered a block transaction in appropriate cases. A block transaction that has been agreed upon does not lose its identity as such by arranging for partial executions of the full transaction in portions which themselves are not of block size if the execution of the full transaction may have a material impact on the market. In this situation, the requirement that information concerning the block transaction be made publicly available will not be satisfied until the entire block transaction has been completed and publicly reported.
      * * * * *

      2210. Communications with the Public

      (a) No change
      (b) Approval and Recordkeeping
      (1) Each item of advertising and sales literature shall be approved by signature or initial, prior to use or filing with [the Association] NASD, by a registered principal of the member. This requirement may be met, only with respect to corporate debt and equity securities that are the subject of research reports as the term is defined in Rule 472 of the New York Stock Exchange, by the signature or initial of a supervisory analyst approved pursuant to Rule 344 of the New York Stock Exchange. This requirement may be met, only with respect to advertising and sales literature concerning security futures, by the signature or initial of a principal qualified to supervise security futures activities.
      (2) No Change
      (c) Filing Requirements and Review Procedures
      (1) No change
      (2) Advertisements concerning collateralized mortgage obligations, advertisements concerning security futures, and advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts and unit investment trusts) that include or incorporate rankings or comparisons of the investment company with other investment companies where the ranking or comparison category is not generally published or is the creation, either directly or indirectly, of the investment company, its underwriter or an affiliate, shall be filed with the Department for review at least 10 days prior to use (or such shorter period as the Department may allow in particular circumstances) for approval and, if changed by the Association, shall be withheld from publication or circulation until any changes specified by the Association have been made or, if expressly disapproved, until the advertisement has been refiled for, and has received, Association approval. The member must provide with each filing the actual or anticipated date of first use. Any member filing any investment company advertisement or sales literature pursuant to this paragraph shall include a copy of the data, ranking or comparison on which the ranking or comparison is based.
      (3) through (9) No Change
      (d) Standards Applicable to Communications with the Public
      (1) No Change
      (2) Specific Standards
      In addition to the foregoing general standards, the following specific standards apply:
      (A) No Change
      (B) Recommendations
      (i) In making a recommendation in advertisements and sales literature, whether or not labeled as such, a member must have a reasonable basis for the recommendation and must disclose any of the following situations which are applicable:
      a. that the member usually makes a market in the securities being recommended, or in the underlying security if the recommended security is an option or security future, or that the member or associated persons will sell to or buy from customers on a principal basis;
      b. that the member and/or its officers or partners own options, security futures, rights or warrants to purchase any of the securities of the issuer whose securities are recommended, unless the extent of such ownership is nominal;
      c. No Change
      (ii) through (iv) No Change
      (e) through (f) No Change
      * * * * *

      IM-2210-7. Guidelines for Communications with the Public Regarding Security Futures

      (a) Association Approval Requirements and Review Procedures
      (1) As set forth in paragraph (c)(2) of Rule 2210, all advertisements concerning security futures shall be submitted to the Advertising/Investment Companies Regulation Department of the Association at least ten days prior to use for approval and, if changed by the Association, shall be withheld from circulation until any changes specified by the Association have been made or, in the event of disapproval, until the advertisement has been refiled for, and has received, Association approval.
      (2) The requirements of this paragraph (a) shall not be applicable to:
      (A) advertisements submitted to another self-regulatory organization having comparable standards pertaining to such advertisements, and
      (B) advertisements in which the only reference to security futures is contained in a listing of the services of a member organization.
      (b) Disclosure Statement
      (1) All communications concerning security futures shall be accompanied or preceded by the security futures risk disclosure statement unless they meet the following requirements:
      (A) Such communications shall be limited to general descriptions of the security futures being offered.
      (B) Such communications shall contain contact information for obtaining a copy of the security futures risk disclosure statement.
      (C) Such communications shall not contain recommendations or past or projected performance figures, including annualized rates of return.
      (2) Communications concerning security futures that meet the requirements of subparagraph (1) may have the following characteristics:
      (A) the text of the communication may contain a brief description of security futures, including a statement that identifies registered clearing agencies for security futures. The text may also contain a brief description of the general attributes and method of operation of the security exchange or notice-registered securities exchange on which such security futures are traded, including a discussion of how a security future is priced;
      (B) the communication may include any statement required by any state law or administrative authority; and
      (C) advertising designs and devices, including borders, scrolls, arrows, pointers, multiple and combined logos and unusual type faces and lettering as well as attentiongetting headlines and photographs and other graphics may be used, provided such material is not misleading.
      (c) Recordkeeping
      Consistent with paragraph (b)(2) of Rule 2210, a member shall keep a separate file of all advertisements and sales literature concerning security futures, including the name(s) of the person(s) who prepared them and approved their use for a period of three years from the date of each use. In addition, members shall meet the same recordkeeping requirements for all correspondence concerning security futures. In the case of sales literature concerning security futures, a member shall record the source of any recommendation contained therein.
      (d) Specific Standards
      (1) The special risks attendant to security futures transactions and the complexities of certain security futures investment strategies shall be reflected in any communications that discuss the uses or advantages of security futures. Any statement referring to the potential opportunities or advantages presented by security futures shall be balanced by a statement of the corresponding risks. The risk statement shall reflect the same degree of specificity as the statement of opportunities, and broad generalities should be avoided.
      (2) Security futures communications shall include a warning to the effect that security futures are not suitable for all investors and such communications shall not contain suggestions to the contrary.
      (3) Security futures communications shall state that supporting documentation for any claims (including any claims made on behalf of security futures programs or the security futures expertise of sales persons), comparisons, recommendations, statistics or other technical data, will be supplied upon request.
      (4) No cautionary statements or caveats, often called hedge clauses, may be used in communications with the public if they are not legible, are misleading, or are inconsistent with the content of the material.
      (5) Statements suggesting the certain availability of a secondary market for security futures shall not be made.
      (e) Projections
      Notwithstanding the provisions of Rule 2210(d)(2)(N), security futures sales literature and correspondence may contain projected performance figures (including projected annualized rates of return), provided that:
      (1) all such sales literature and correspondence must be accompanied or preceded by the security futures risk disclosure statement;
      (2) no suggestion of certainty of future performance is made;
      (3) parameters relating to such performance figures are clearly established;
      (4) all relevant costs, including commissions, fees, and interest charges (as applicable) are disclosed and reflected in the projections;
      (5) such projections are plausible and are intended as a source of reference or a comparative device to be used in the development of a recommendation;
      (6) all material assumptions made in such calculations are clearly identified;
      (7) the risks involved in the proposed transactions are also disclosed; and
      (8) in communications relating to annualized rates of return, that such returns are not based upon any less than a sixty-day experience; any formulas used in making calculations are clearly displayed; and a statement is included to the effect that the annualized returns cited might be achieved only if the parameters described can be duplicated and that there is no certainty of doing so.
      (f) Historical Performance
      Security futures sales literature and correspondence may feature records and statistics that portray the performance of past recommendations or of actual transactions, provided that:
      (1) all such sales literature and correspondence must be accompanied or preceded by the security futures risk disclosure statement;
      (2) any such portrayal is done in a balanced manner, and consists of records or statistics that are confined to a specific "universe" that can be fully isolated and circumscribed and that covers at least the most recent 12-month period;
      (3) such communications include the date of each initial recommendation or transaction, the price of each such recommendation or transaction as of such date, and the date and price of each recommendation or transaction at the end of the period or when liquidation was suggested or effected, whichever was earlier; provided that if the communications are limited to summarized or averaged records or statistics, in lieu of the complete record there may be included the number of items recommended or transacted, the number that advanced and the number that declined, together with an offer to provide the complete record upon request;
      (4) such communications disclose all relevant costs, including commissions, fees, and daily margin obligations (as applicable);
      (5) whenever such communications contain annualized rates of return, such communications shall disclose all material assumptions used in the process of annualization;
      (6) an indication is provided of the general market conditions during the period(s) covered, and any comparison made between such records and statistics and the overall market (e.g., comparison to an index) is valid;
      (7) such communications state that the results presented should not and cannot be viewed as an indicator of future performance; and
      (8) a principal qualified to supervise security futures activities determines that the records or statistics fairly present the status of the recommendations or transactions reported upon and so initials the report.
      (g) Security Futures Programs
      In communications regarding a security futures program (i.e., an investment plan employing the systematic use of one or more security futures strategies), the cumulative history or unproven nature of the program and its underlying assumptions shall be disclosed.
      (h) Standard Forms of Worksheets
      Such worksheets must be uniform within a member firm. If a member has adopted a standard form of worksheet for a particular security futures strategy, nonstandard worksheets for that strategy may not be used.
      (i) Recordkeeping
      Communications that portray performance of past recommendations or actual transactions and completed worksheets shall be kept at a place easily accessible to the sales office for the accounts or customers involved.
      * * * * *

      IM-2310-2. Fair Dealing with Customers

      (a) through (d) No change
      (e) Fair Dealing with Customers with Regard to Derivative Products or New Financial Products
      The Board emphasizes members' obligations for fair dealing with customers when making recommendations or accepting orders for new financial products. As new products are introduced from time to time, it is important that members make every effort to familiarize themselves with each customer's financial situation, trading experience, and ability to meet the risks involved with such products and to make every effort to make customers aware of the pertinent information regarding the products. Members must follow specific guidelines, set forth below, for qualifying the accounts to trade the products and for supervising the accounts thereafter.
      (1) Security Futures
      Members must comply with the Rules, regulations and procedures applicable to security futures contained in Rule 2865.
      (2) Index Warrants
      Members are obliged to comply with the Rules, regulations and procedures applicable to index warrants and foreign currency warrants contained in the Rule 2840 Series.
      [(2)] (3) Hybrid Securities and Selected Equity-Linked Debt Securities ("SEEDS") Designated as Nasdaq National Market Securities Pursuant to the Rule 4400 Series
      Members are obligated to comply with any Rules, regulations, or procedures applicable to such securities pursuant to the Rule 4420 Series, as well as any other applicable Rule, regulation, or procedure of the Association.
      * * * * *

      2865. Security Futures

      (a) For purposes of this Rule, the term "security future" shall have the definition specified in Section 3(a)(55) of the Act.
      (b) Requirements
      (1) General
      (A) Applicability—This Rule shall be applicable to the trading of security futures.
      (B) Paragraphs (12) and (15) shall apply only to security futures carried in securities accounts.
      (C) Except to the extent that specific provisions in this Rule govern, or unless the context otherwise requires, the provisions of the By-Laws and Rules and all other interpretations and policies of the Board of Governors shall also be applicable to the trading of security futures.
      (2) Definitions
      (A) The terms "Beneficial Owner," "Control," and "Controls," "Is Controlled by" or "Is Under Common Control With" shall have the same meanings as in Rule 2860.
      (B) The term "principal qualified to supervise security futures activities" means a Registered Options and Security Futures Principal who, consistent with Rule 1022, has either completed a firm-element continuing education requirement that addresses security futures and a principal's responsibilities for security futures or has passed a revised qualification examination for Registered Options and Security Futures Principals that covers security futures, or a Limited Principal—General Securities Sales Supervisor who, consistent with Rule 1022, has either completed a firm-element continuing education requirement that addresses security futures and a principal's responsibilities for security futures or has passed a revised qualification examination for Limited Principal—General Securities Sales Supervisor.
      (3) through (7) Reserved
      (8) Restrictions on Security Futures Transactions
      The Association may impose from time to time such restrictions on security futures transactions that it determines are necessary in the interest of maintaining a fair and orderly market in security futures, or in the underlying securities covered by such security futures, or otherwise necessary in the public interest or for the protection of investors. During the period of any such restriction, no member shall effect any security futures transaction in contravention of such restriction.
      (9) through (10) Reserved
      (11) Delivery of Security Futures Risk Disclosure Statement
      (A) Every member shall deliver the current security futures risk disclosure statement to each customer at or prior to the time such customer's account is approved for trading security futures. Thereafter, each new or revised security futures risk disclosure statement shall be distributed to every customer having an account approved for such trading or, in the alternative, shall be distributed not later than the time a confirmation of a transaction is delivered to each customer who enters into a security futures transaction. The Association will advise members when a new or revised current security futures risk disclosure statement is available.
      (B) Where a broker or dealer enters its orders with another member in a single omnibus account, the member holding the account shall take reasonable steps to assure that such broker or dealer is furnished reasonable quantities of the current security futures risk disclosure statement.
      (C) Where an introducing broker or dealer enters orders for its customers with, or clears transactions through, a member on a fully disclosed basis and that member carries the accounts of such customers, the responsibility for delivering the current security futures risk disclosure statement as provided in this paragraph (b)(11) shall rest with the member carrying the accounts. However, such member may rely upon the good faith representation of the introducing broker or dealer that the current security futures risk disclosure statement has been delivered in compliance with paragraph (b)(11).
      (12) Reserved
      (13) Reserved
      (14) Reserved
      (15) Statements of Account
      Statements of account showing security and money positions, entries, interest charges, and any special charges that have been assessed against such account during the period covered by the statement shall be sent no less frequently than once every month to each customer in whose account there has been an entry during the preceding month with respect to a security futures contract and quarterly to all customers having an open security futures position or money balance. Interest charges and any special charges assessed during the period covered by the statement need not be specifically delineated if they are otherwise accounted for on the statement and have been itemized on transaction confirmations. With respect to security futures customers having a general (margin) account, such statements shall also provide the market price, and marek-to-market value and nominal value of each security futures position and other security positions in the general (margin) account (i.e., the mark-to-market value of all security futures positions and the market value of all other security positions), the total value of all positions in the account, the outstanding debit or credit balance in the account, and the general (margin) account equity. The statements shall bear a legend stating that further information with respect to commissions and other charges related to the execution of security futures transactions has been included in confirmations of such transactions previously furnished to the customer, and that such information will be made available to the customer promptly upon request. The statements shall also bear a legend requesting the customer promptly to advise the member of any material change in the customer's investment objectives or financial situation.
      (16) Opening of Accounts
      (A) Approval Required
      No member or person associated with a member shall accept an order from a customer to purchase or sell a security future, or approve the customer's account for the trading of security futures, unless the broker or dealer furnishes or has furnished to the customer the appropriate security futures risk disclosure statement and the customer's account has been approved for security futures trading in accordance with the provisions of subparagraphs (B) through (D) hereof.
      (B) Diligence in Opening Accounts
      In approving a customer's account for security futures trading, a member or any person associated with a member shall exercise due diligence to ascertain the essential facts relative to the customer, the customer's financial situation and investment objectives. Members shall establish specific minimum net equity requirements for initial approval and maintenance of customers' security futures accounts. Based upon such information, a principal qualified to supervise security futures activities shall specifically approve or disapprove in writing the customer's account for security futures trading. For account approvals, the written record shall include the reasons for approval.
      (i) With respect to security futures customers who are natural persons, members shall seek to obtain the following information at a minimum (information shall be obtained for all participants in a joint account):
      a. Investment objectives (e.g., safety of principal, income, growth, trading profits, or speculation);
      b. Employment status (name of employer, self-employed, or retired);
      c. Estimated annual income from all sources;
      d. Estimated net worth (exclusive of family residence);
      e. Estimated liquid net worth (cash, securities, or other);
      f. Marital status and number of dependents;
      g. Age; and,
      h. Investment experience and knowledge (e.g., number of years, size, frequency and type of transactions) for futures, commodities, options, stocks, bonds, and other financial instruments.
      (ii) In addition, a customer's account records shall contain the following information, if applicable:
      a. Source or sources of background and financial information (including estimates) concerning the customer;
      b. Discretionary authorization agreement on file, name, relationship to customer, and experience of person holding trading authority;
      c. Date disclosure document(s) furnished to customer;
      d. Name of registered representative;
      e. Name of principal approving account and date of approval; and
      f. Dates of verification of currency of account information.
      (iii) Members should consider using a standard account approval form to ensure the receipt of all the required information.
      (iv) Refusal of a customer to provide any of the information specified in subparagraph (i) shall be so noted on the customer's records at the time the account is opened. Information provided shall be considered together with the other information available in determining whether to approve the account for security futures trading.
      (v) A record of the information obtained pursuant to this subparagraph (B) and of the approval or disapproval of each account shall be maintained by the member as part of its records in accordance with paragraph (b)(17) herein.
      (C) Verification of Customer Background and Financial Information
      For every natural person whose account has been approved for security futures trading, the background and financial information upon which the account was approved shall be sent to the customer for verification within fifteen (15) days after the customer's account has been approved for security futures trading. This verification requirement shall not apply if the background and financial information is included in the customer's account agreement or if the member has previously verified the customer's information in connection with an options account. A copy of the background and financial information on file with a member also shall be sent to the customer for verification within fifteen (15) days after the member becomes aware of any material change in the customer's financial situation.
      Members shall satisfy the initial and subsequent verification of customer background and financial information by sending to the customer the information required in paragraph (B)(i)(a) through (i)(f) hereof, as contained in the member's records and providing the customer with an opportunity to correct or complete the information. In all cases, absent advice from the customer to the contrary, the information will be deemed to be verified.
      (D) Account Agreement
      Within fifteen (15) days after a customer's account has been approved for security futures trading, a member shall obtain from the customer a written agreement that the customer is aware of and agrees to be bound by the Rules of the Association applicable to the trading of security futures and, that the customer has received a copy of the current security futures risk disclosure statement. In addition, the customer should indicate on such written agreement that the customer is aware of and agrees not to violate applicable security futures position limits.
      (17) Maintenance of Records
      (A) In addition to the requirements of Rule 3110, every member shall maintain and keep current a separate central log, index, or other file for all security futuresrelated complaints, through which these complaints can easily be identified and retrieved. The central file shall be located at the principal place of business of the member or such other principal office as shall be designated by the member. At a minimum, the central file shall include: (i) identification of complainant; (ii) date complaint was received; (iii) identification of registered representative servicing the account; (iv) a general description of the matter complained of; and (v) a record of what action, if any, has been taken by the member with respect to the complaint. For purposes of this subparagraph, the term "security futures-related complaint" shall mean any written statement by a customer or person acting on behalf of a customer alleging a grievance arising out of or in connection with security futures. Each security futures-related complaint received by a branch office of a member shall be forwarded to the office in which the separate, central file is located not later than 30 days after receipt by the branch office that is the subject of the complaint. A copy of every security futures-related complaint shall also be maintained at the branch office that is the subject of the complaint.
      (B) Background and financial information of customers who have been approved for security futures trading shall be maintained at both the branch office servicing the customer's account and the principal supervisory office having jurisdiction over that branch office. Copies of account statements of security futures customers shall also be maintained at both the branch office supervising the accounts and the principal supervisory office having jurisdiction over that branch for the most recent six-month period. With respect solely to the above-noted record retention requirements applicable to principal supervisory offices, however, the customer information and account statements may be maintained at a location other than the principal supervisory office if such documents and information are readily accessible and promptly retrievable. Other records necessary to the proper supervision of accounts shall be maintained at a place easily accessible both to the branch office servicing the customer's account and to the principal supervisory office having jurisdiction over that branch office.
      (18) Discretionary Accounts
      (A) Authorization and Approval
      (i) No member or person associated with a member shall exercise any discretionary power with respect to trading in security futures in a customer's account, or accept orders for security futures for an account from a person other than the customer, except in compliance with the provisions of Rule 2510 and unless:
      a. The written authorization of the customer required by Rule 2510 shall specifically authorize security futures trading in the account; and
      b. the account shall have been accepted in writing by a principal qualified to supervise security futures activities.
      (ii) When analyzing an account to determine if it should be approved for security futures trading, a principal qualified to supervise security futures activities shall have a reasonable basis for believing that the customer was able to understand and bear the risk of the strategies or transactions proposed, and shall maintain a record of the basis for such determination. Each discretionary order shall be approved and initialed on the day entered by the branch office manager or other principal qualified to supervise security futures activities, provided that if the branch officer is not a principal qualified to supervise security futures activities, such approval shall be confirmed within a reasonable time by a principal qualified to supervise security futures activities. Each discretionary order shall be identified as discretionary on the order at the time of entry. Discretionary accounts shall receive frequent appropriate supervisory review. The provisions of this subparagraph (18) shall not apply to discretion as to the price at which or the time when an order given by a customer for the purchase or sale of a definite number of security futures contracts in a specified security shall be executed.
      (B) Record of Transactions
      A record shall be made of every transaction in security futures contracts in respect to which a member or person has exercised discretionary authority, clearly reflecting such fact and indicating the name of the customer, the designation and number of the security futures contracts, the price of the contract, and the date and time when such transaction was effected.
      (C) Security Futures Programs
      Where the discretionary account uses security futures programs involving the systematic use of one or more security futures strategies, the customer shall be furnished with a written explanation of the nature and risks of such programs.
      (19) Suitability
      (A) No member or person associated with a member shall recommend to any customer any transaction or trading strategy for the purchase or sale of a security future unless such member or person associated with the member has reasonable grounds to believe upon the basis of information furnished by the customer after reasonable inquiry by the member or person associated with the member concerning the customer's investment objectives, financial situation and needs, and any other information known by the member or associated person, that the recommended transaction or trading strategy is not unsuitable for the customer.
      (B) No member or person associated with a member shall recommend to a customer a transaction in any security future unless the person making the recommendation has a reasonable basis for believing, at the time of making the recommendation, that the customer has such knowledge and experience in financial matters that the customer may reasonably be expected to be capable of evaluating the risks of the recommended transaction, and is financially able to bear the risks of the recommended position in the security future.
      (20) Reserved
      (21) Violation of By-Laws and Rules of the Association or a Registered Clearing Agency
      (A) In Association disciplinary proceedings, a finding of violation of any provision of the rules, regulations, or by-laws of a registered clearing agency under Section 17A(b)(8) of the Act by any member or person associated with a member engaged in security futures transactions cleared by such registered clearing agency, may be deemed to be conduct inconsistent with just and equitable principles of trade and a violation of Rule 2110.
      (B) In Association disciplinary proceedings, a finding of violation of any provision of the Rules, regulations or By-Laws of the Association by any member or person associated with a member engaged in security futures transactions may be deemed to be conduct inconsistent with just and equitable principles of trade and a violation of Rule 2110.
      (22) Reserved
      (23) Reserved
      (24) Security Futures Transactions and Reports by Market Makers in Listed Securities
      Every member that is an off-board market maker in a security listed on a national securities exchange shall report to the Association in accordance with such procedures as may be prescribed by the Board of Governors, transactions involving 50 or more security futures contracts on such listed securities that are either directly for the benefit of (A) the member or (B) any employee, partner, officer, or director of the member who, by virtue of his or her position with the member, is directly involved in the purchase or sale of the underlying security for the firm's proprietary account(s) or is directly responsible for supervision of such persons; or who by virtue of his or her position in the firm, is authorized to, and regularly does, obtain information on the proprietary account(s) of the member in which the underlying security is traded. This subparagraph shall apply to all security futures transactions including those executed on an exchange to which the member may belong.
      (25) Trading Ahead of Customer Orders
      Every member shall exercise due care to avoid trading ahead of a customer's security futures order. A member must exercise the due care required by this subsection when the member has gained knowledge of or reasonably should have gained knowledge of the customer's order prior to the transmission to a securities exchange of the member's order for a proprietary account, or for any account in which it or any person associated with it is directly or indirectly interested.
      * * * * *

      3010. Supervision

      (a) No change
      (b) Written Procedures
      (1) No Change
      (2) Tape recording of conversations
      (i) through (viii) No change
      (x) For purposes of this Rule, the term "disciplined firm" means either a member that, in connection with sales practices involving the offer, purchase, or sale of any security, has been expelled from membership or participation in any securities industry self-regulatory organization or is subject to an order of the Securities and Exchange Commission revoking its registration as a broker/dealer; or a futures commission merchant or introducing broker that has been formally charged by either the Commodity Futures Trading Commission or a registered futures association with deceptive telemarketing practices or promotional material relating to security futures, those charges have been resolved, and the futures commission merchant or introducing broker has been closed down and permanently barred from the futures industry as a result of those charges; or a futures commission merchant or introducing broker that, in connection with sales practices involving the offer, purchase, or sale of security futures is subject to an order of the Securities and Exchange Commission revoking its registration as a broker or dealer.
      (xi) No change
      (c) through (d) No change
      (e) Qualifications Investigated
      Each member shall have the responsibility and duty to ascertain by investigation the good character, business repute, qualifications, and experience of any person prior to making such a certification in the application of such person for registration with this Association. Where an applicant for registration has previously been registered with the Association, the member shall review [obtain from the Central Registration Depository or from the applicant] a copy of the Uniform Termination Notice of Securities Industry Registration (Form U-5) filed with the Association by such person's most recent previous NASD member employer, together with any amendments thereto that may have been filed pursuant to Article V, Section 3 of the Association's By-Laws. The member shall review [obtain] the Form U-5 as required by this Rule no later than sixty (60) days following the filing of the application for registration or demonstrate to the Association that it has made reasonable efforts to comply with the requirement. [A member receiving a Form U-5 pursuant to this Rule shall review] In conducting its review of the Form U-5 and any amendments thereto, a member [and] shall take such action as may be deemed appropriate.
      Where an applicant for registration has been previously registered with a registered futures association ("RFA") member that is or has been registered as a broker/dealer pursuant to Section 15(b)(11) of the Act ("notice-registered broker/dealer") with the SEC to trade security futures, the member shall review a copy of the Notice of Termination of Associated Person (Form 8-T) filed with the RFA by such person's most recent previous RFA member employer, together with any amendments thereto. The member shall review the Form 8-T as required by this Rule no later than sixty (60) days following the filing of the application for registration or demonstrate to the Association that it has made reasonable efforts to comply with the requirement. In conducting its review of a Form 8-T and any amendments, a member shall take such action as may be deemed appropriate.
      (f) through (g) No change
      * * * * *

      3050. Transactions for or by Associated Persons

      (a) through (c) No change
      (d) Obligations of Associated Persons Concerning an Account with a Notice-Registered Broker/Dealer, Investment Adviser, Bank, or Other Financial Institution
      A person associated with a member who opens a securities account or places an order for the purchase or sale of securities with a broker/dealer that is registered pursuant to Section 15(b)(11) of the Act ("notice-registered broker/dealer"), a domestic or foreign investment adviser, bank, or other financial institution, except a member, shall:
      (1) notify his or her employer member in writing, prior to the execution of any initial transactions, of the intention to open the account or place the order; and
      (2) upon written request by the employer member, request in writing and assure that the notice-registered broker/dealer, investment adviser, bank, or other financial institution provides the employer member with duplicate copies of confirmations, statements, or other information concerning the account or order;
      provided, however, that if an account subject to this paragraph (d) was established prior to a person's association with a member, the person shall comply with this paragraph promptly after becoming so associated.
      * * * * *

      3370. Prompt Receipt and Delivery of Securities

      (a) No change
      (b) Sales
      (1) No change
      (2) "Short Sales"
      (A) Customer short sales
      No member or person associated with a member shall accept a "short" sale order for any customer in any security unless the member or person associated with a member makes an affirmative determination that the member will receive delivery of the security from the customer or that the member can borrow the security on behalf of the customer for delivery by settlement date. This requirement shall not apply, however, to transactions in corporate debt securities or transactions in security futures, as defined in Section 3(a)(55) of the Act.
      (B) Proprietary short sales
      No member shall effect a "short" sale for its own account in any security unless the member or person associated with a member makes an affirmative determination that the member can borrow the securities or otherwise provide for delivery of the securities by the settlement date. This requirement will not apply to transactions in corporate debt securities, to transactions in security futures, as defined in Section 3(a)(55) of the Act, to bona fide market making transactions by a member in securities in which it is registered as a Nasdaq market maker, to bona fide market maker transactions in non-Nasdaq securities in which the market maker publishes a two-sided quotation in an independent quotation medium, or to transactions [which] that result in fully hedged or arbitraged positions.
      (3) through (4) No change
      (5) "Bona Fide Fully Hedged" and "Bona Fide Fully Arbitraged"
      In determining the availability of the exemption provided in paragraph (b)(2)(B) above and in Rule 11830 from short sale requirements for "bona fide fully hedged" and "bona fide fully arbitraged" transactions, the following guidelines shall apply. These guidelines are for illustrative purposes and are not intended to limit the Association's ability to determine the proper scope of the terms "bona fide fully hedged" or "bona fide fully arbitraged" pursuant to this provision, on a case-by-case basis.
      (A) Bona Fide Fully Hedged
      The following transactions shall be considered bona fide fully hedged:
      (i) through (iii) No change
      (iv) Short a security and long a single stock future of the underlying security. Example: Long 1 single stock future of MNOP.
      • With the circumstances as above (and assuming a contract size of 100) 100 shares would be exempt.


      • Even if the expiration date for the single stock future was more than 90 calendar days, 100 shares would be exempt.

      Attachment B

      NASD Security Futures Information

      Security Futures

      The content outline provided below has been established by NASD and NFA for use by firms in developing their firm-element training programs. The outline contains five modules or segments: (1) Stock and Stock Options; (2) Futures Contracts; (3) Security Futures Products; (4) Regulatory Requirements for Security Futures; and (5) Supervision of the Offer and Sale of Security Futures.

      Module 1 is intended primarily for futures professionals as an introduction to securities and securities law concepts. NASD will not require broker/dealers to administer the content of Module 1 to securities registrants. Firms should decide on their own whether their employees would benefit from the basic securities overview.

      Module 2 is intended primarily for securities professionals as an introduction to the basic concepts and terminology of futures. In general, NASD will require that members administer the content of Module 2 to securities registrants, although firms employing dually-licensed persons (i.e., persons registered with a broker/dealer and an futures commission merchant or introducing broker), may not need to administer Module 2 to such persons.

      Module 3 explains the characteristics and elements of security futures. Module 4 describes the regulatory framework, including sales practice and margin requirements, for these new products. All NASD member firms must administer the content of Modules 3 and 4 to their personnel before such persons may engage in a security futures business.

      Lastly, Module 5 addresses issues relevant for persons who will be supervising personnel engaged in a security futures business. Firms must administer Module 5 to their appropriately qualified individuals before such persons can supervise security futures activity.


      Module 1: Stocks and Stock Options

      Introduction to Stocks

      Capital formation

      Shares in Corporate Ownership

      Dividends

      Common Stock

      Preferred Stock

      Restricted Stock

      ADRs

      Corporate Actions

      • Stock splits


      • Reverse stock splits


      • Mergers and takeovers


      • Spin-offs

      Stock and Stock Options Markets and Clearing Organizations

      The Nasdaq Stock Market

      NYSE, AMEX and Regional Stock

      Exchanges

      Intermarket Trading System

      Electronic Communications

      Networks

      Options Exchanges

      Options Clearing Corporation

      Product fungibility

      Trading Stocks

      Price quotation conventions

      Short selling

      • Uptick rule


      • Stock loan


      • Affirmative determination


      • Dividends

      Types of orders (different than those in the futures markets)

      • All-or-none orders

      Immediate-or-cancel orders

      Fill-or-kill orders

      Trade settlement

      Insider trading

      Delayed openings

      Trading halts

      Circuit breakers

      Stock Options and Stock Index Options

      Basic description

      Synthetics

      Stock Market Analysis and Related Statistical Measures

      Stocks by sector Stocks by strategy and Industry outlook

      • Growth stocks


      • Value stocks


      • Income stocks

      Stocks by market capitalization

      • Large Cap


      • Mid Cap


      • Small Cap

      Statistical measures

      • Alpha


      • Beta

      Corporate Announcements and Other News and Information

      Quarterly earnings reports

      Corporate statements between reports

      Insider filings

      Short interest reports

      Income Statement and Balance Sheet

      General description

      Earnings per share

      Price/Earnings ratio

      Dividend yield

      Book value

      Liquidity measures

      • Current assets


      • Quick assets


      • Current liabilities


      • Working capital


      • Current ratio


      • Acid-test ratio


      • Cash flow

      Margin for Stocks and Stock Options

      Initial and maintenance margin for stock purchases

      Initial and maintenance margin for short stock positions

      Options margin

      • Premium payments


      • Margin for short positions

      Securities Investor Protection Corporation

      Purpose of SIPC

      Coverage limits

      Coverage amounts


      Module 2: Futures Contracts

      Introduction to Futures Contracts

      General characteristics

      Equal treatment of buys and sells

      Standardized contract terms

      Futures Markets and Clearing Organizations

      Open-outcry

      Electronic trading

      Floor brokers

      Floor traders

      Non-fungibility across exchanges

      Role of clearinghouse

      • Matching trades


      • Effecting settlement and payments


      • Guaranteeing performance


      • Facilitating deliveries

      Trading Futures

      Settlement

      • Physical delivery


      • Cash settlement

      Daily price limits

      Circuit breakers

      Types of orders (different than those in the securities markets)

      • Spread orders


      • Switch orders


      • Fill-or-kill orders

      Volume

      Open interest

      Commitments of traders

      Pricing of futures

      Hedging

      • Basis risk

      Speculation

      Position limits

      Arbitrage

      Spreading

      • Intramarket spreads


      • Intermarket spreads

      Margins

      Initial margin ("good faith deposit")

      Maintenance margin

      • Marking to market

      Clearing margins

      Segregated funds

      Segregation requirements

      Not covered by SIPC


      Module 3: Security Futures

      Security Futures

      Definitions

      • Futures on single stocks


      • Futures on narrow-based stock indexes


      • Index changes from narrow to broad-based

      Exchanges trading security futures

      Listing requirements

      Restrictions on trading security futures on foreign markets

      Contract Terms and Conditions for Security Futures Contracts

      Buying security futures

      Selling security futures

      • No short sale requirement

      Contract size

      Hours of trading

      Contract months/trading cycle

      Last trading date

      Expiration dates

      Minimum price variation

      Reporting requirements

      • Large trader reporting levels

      Position and position accountability limits

      Physical delivery

      Cash settlement

      Strategies

      • Arbitrage


      • Dividend-capture

      Other Characteristics of Security Futures

      Fungibilty (or lack thereof)

      Trading halts

      • Regulatory halts


      • Circuit breakers

      Treatment of corporate actions

      • Integral stock splits


      • Non-integral stock splits


      • Mergers


      • Takeovers


      • Spin-offs

      Tax treatment

      Block trading requirements


      Module 4: Regulatory Requirements for Security Futures

      Registration Requirements

      Registration of markets

      Registration of intermediaries with the SEC and CFTC

      Registration of certain collective investment vehicles or providers of investment advice

      Sales Practices

      Communications with the public Customer protection rules

      • SIPC


      • Segregated funds

      Risk disclosure statement

      Margin Requirements

      Initial margin

      Maintenance margin

      • Definition of current market value

      Risk-based margins

      • Strategy offsets


      • Portfolio-based margining systems (not allowed)

      Cross-margining

      Applicability of Regulation T Collateral

      • Type, form and use of collateral


      • Acceptable collateral deposits


      • Use of money market mutual funds

      Computation of equity

      Meeting margin calls

      Account liquidation

      Extension of credit

      Other Considerations

      Suitability

      Commissions

      Account approval and documentation

      Discretionary accounts

      Best execution requirement

      Reporting customer complaints

      Anti-fraud and anti-manipulation requirements

      • Section 4(b) of the CEA and 10(b) of the Securities Exchange Act


      • Prohibition against trading on inside information


      • Prohibition against trading ahead of research reports


      • Prohibition against trading ahead of customer orders

      Module 5: Supervision of the Offer and Sale of Security Futures

      Security Futures Principals

      General requirement

      Qualifications for principals and representatives

      • Licensing


      • Examination modules


      • New candidates


      • Existing candidates

      Hiring Employees

      Review of securities and futures employment background

      Annual Compliance Meetings

      Account Approval

      Specific approval required

      Written procedures

      • Criteria used

      Discretionary Accounts

      Approval

      Review of discretionary activity

      Promotional Material and Correspondence

      Review of correspondence

      Review and approval of promotional material

    • For Your Information (November)

      View PDF File

      Reminder to NASD Members - Transactions with NASD and American Stock Exchange Employees

      NASD members who carry brokerage accounts for NASD, NASDAQ, or American Stock Exchange employees are reminded of the need to promptly implement employees' instructions calling for duplicate statements to be provided to NASD. This requirement is set forth in NASD Rule 3090(a), which provides that "[w]hen a member has actual notice that an Association or American Stock Exchange employee has a financial interest in, or controls trading in, an account, the member shall promptly obtain and implement an instruction from the employee directing that duplicate account statements be provided by the member to the Association."1

      Rule 3090(a), which became effective on November 17, 2000, plays a vital role in helping NASD monitor whether employees are abiding by trading restrictions imposed by the NASD Code of Conduct. Among other things, employees may not own stock of broker/ dealers or companies that derive more than 25 percent of their gross revenues from broker/dealer activities, or stock purchased as part of an initial public offering. NASD reviews duplicate statements for employees' brokerage accounts to ensure that employees have abided by these restrictions.

      With respect to new accounts, the information necessary to give members actual notice of an employee's interest in an account is already included on the new account forms used by most broker/ dealers, and on a standardized duplicate instruction form that NASD and Amex employees can provide to their broker/ dealers. It is not necessary for an NASD official to issue a letter authorizing the opening of each employee account.

      With respect to existing accounts, Rule 3090(a) contemplates that NASD and Amex employees will use the above-referenced duplicate instruction form to give NASD members actual notice of their interest in an account. A member receiving such a form must promptly implement the duplicate statement instruction.

      Rule 3090(a) applies to accounts opened after the rule became effective on November 17, 2000, and to those pre-existing accounts as to which an NASD member has actual notice that an NASD or Amex employee has financial interest or controls trading. NASD members are not required to review accounts that existed before the rule became effective to identify those in which NASD or Amex employees may have an interest or control trading.

      NASD members with questions concerning Rule 3090(a) may contact Luley Chow, NASD Code of Conduct Administrator, NASD Office of General Counsel, at luley.chow@nasd.com or (202) 728-8315

      1 NASD Rule 0120(b) defines "Association" as meaning, collectively, NASD, NASD Regulation, NASDAQ, and NASD Dispute Resolution.

      Filing of Annual Attestation Required by Rule 2711 Research Analysts and Research Reports

      On May 10, 2002, the SEC approved new NASD Rule 2711, Research Analysts and Research Reports, which is intended to address conflicts of interest that can arise when securities analysts issue recommendations in research reports and public appearances and provide investors with more objective, reliable, and useful information. Most of the Rule is already in effect; the remaining provisions become effective on November 6, 2002.

      Rule 2711(i) requires each member subject to the rule to adopt and implement written supervisory procedures that are reasonably designed to achieve compliance with the rule's provisions. The rule further requires that a senior officer of the member attest annually to NASD that it has adopted and implemented such procedures.

      This notice is to advise members that the annual attestation must be received by NASD no later than the last business day of each calendar year. The attestation should be sent to the following address:

      Department of Member Regulation
      NASD Division of Regulatory Policy and Oversight
      Attn: Rule 2711 Attestation
      1735 K Street, NW
      Washington, DC 20006

      Questions concerning this information should be directed to the Department of Member Regulation, Regulatory Policy and Oversight, at (202) 728-8221.

      Trading Activity Fee Self-Reporting Form

      (Effective September 1, 2003)

      Firm Name:
      B/D #:
      Clearing #:
      For the Month of:
      Each member shall report sales of covered securities pursuant to the provisions of Section 2(b) [Trading Activity Fee] of Schedule A, Section 2 [Member Regulation Fees] to NASD's By-Laws. Covered securities include: 1) all exchange registered securities wherever executed (other than bonds, debentures, and other evidence of indebtedness), 2) all other equity securities traded otherwise than on an exchange, and 3) all security futures wherever executed.
      Transaction Type Aggregate Volume Rate Assessment Amount
      1. Covered Equity Securities (under maximum1) - # of Shares   $0.00010  
      2. Covered Equity Securities (at maximum1) - # of Trades   $ 10.00  
      3. Covered Option Contracts   $ 0.002  
      4. Covered Future Securities (# of Contracts Traded on a Round Turn Basis)   $ 0.04  
      Total Assessment      
         
      Signature of Authorized Representative Title
          /
      Print Name Date/Telephone Number
      Payment must be submitted with this form. The monthly form and payment are to be filed no later than the 10 business days following the end of the month. The monthly form and payment may be submitted to NASD by either US mail or overnight Express mail as follows:
      For US mail delivery:
      NASD
      P.O. Box 7777-W8555
      Philadelphia, PA 19175-8555
      Note: This P.O. Box will not accept courier or overnight
      For courier & overnight deliveries:
      NASD
      W8555 c/o Mellon Bank, Rm 3490
      Philadelphia, PA 19106
      Phone number: 215-553-0697 (if required for the deliveries. recipient)
      If other payment methods are required, please call NASD Finance, at 240-386-5394.
      Questions regarding the Trading Activity Fee or the report should be directed to NASD Finance, at (240) 386-5397.1

      1 There is a $10.00 maximum on covered equity securities. All volumes under the maximum of 100,000 shares must be reported as the aggregate number of shares on Line 1. Share volume for any transactions of 100,000 shares or more should be excluded from Line 1 and would be reported as the aggregate number of trades on Line 2.

    • 02-72 Veterans' Day and Thanksgiving Day

      View PDF File

      Trade Date—Settlement Date Schedule

      SUGGESTED ROUTING

      KEY TOPICS

      Internal Audit
      Legal & Compliance
      Municipal/Government Securities
      Operations
      Trading & Market Making

      Holiday Trade Date—Settlement Date Schedule

      The schedule of trade dates-settlement dates below reflects the observance of the financial community of Veterans' Day, Monday, November 11, 2002, and Thanksgiving Day, Thursday, November 28, 2002. On Monday, November 11, The NASDAQ Stock Market and the securities exchanges will be open for trading. However, it will not be a settlement date because many of the nation's banking institutions will be closed in observance of Veterans Day. All securities markets will be closed on Thursday, November 28, 2002, in observance of Thanksgiving Day.

      Trade Date Settlement Date Reg. T Date*
      Nov. 5 Nov. 8 Nov. 12
      6 12 13
      7 13 14
      8 14 15
      11 14 18
      12 15 19
      22 27 Dec. 2
      25 29 3
      26 Dec. 2 4
      27 3 5
      28 Markets Closed
      29 4 6

      Note: November 11, 2002, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board.

      Transactions made on November 11 will be combined with transactions made on the previous business day, November 8, for settlement on November 14. Securities will not be quoted ex-dividend, and settlements, marks to the market, reclamations, and buyins and sell-outs, as provided in the Uniform Practice Code, will not be made and/or exercised on November 11.

    • 02-71 NASDAQ Provides Guidance on Recent Amendments to "Trade-or-Move" Rule and SuperMontage Opening Process

      View PDF File

      SuperMontage

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Senior Management

      SuperMontage



      Executive Summary

      On May 28, 2002, the Securities and Exchange Commission (SEC) approved amendments made by The Nasdaq Stock Market, Inc. (NASDAQ®) to NASD Rule 4613(e), the Trade-or-Move Rule.1 The amendments change three aspects of the Trade-or-Move Rule as it operates today between 9:20 and 9:29:59 a.m., Eastern Time (ET).

      (1) Sequence of messaging: Electronic communications networks (ECNs) will now be required to send Trade-or-Move Directed Orders prior to entering locking/crossing quotes, and market makers will continue to be required to send Trade-or-Move Directed Orders after entering locking/crossing quotes;
      (2) Response Time: The time to respond to a Trade-or-Move Directed Order will be reduced from 30 seconds to 10 seconds; and
      (3) Minimum Share Requirement: The amendment creates a 10,000-share minimum requirement for Trade-or-Move Directed Orders for NASDAQ-100 Index® (NASDAQ-100) and S&P MidCap 400 Index (S&P-400) issues, while preserving the 5,000-share requirement for all other securities. The rule filing also preserves the existing exception for agency orders.

      As a result of these changes, ECNs will be required to send a Trade-or-Move Directed Order and then wait 10 seconds before entering a locking/crossing quotation. If the ECN receives no response, it may then cancel the Trade-or-Move Directed Order and enter a locking/crossing quote. If the recipient trades in full, the ECN will be required to send another Trade-or-Move Directed Order prior to entering a lock/cross.

      Market makers will adhere to the Rule as they do today, taking into account the modified minimum share and response time requirements. The Trade-or-Move requirements apply only to the markets that participate in NASDAQ market systems. Currently, those markets are NASDAQ and the Chicago Stock Exchange, Inc.

      On August 23, 2002, the SEC approved the new SuperMontageSM opening process.2 Beginning at 9:29:30 a.m., ET, the system will resolve any outstanding locked/crossed markets through a matching process that will continue until all locked/crossed orders are cleared.

      As members are aware, NASDAQ started to implement SuperMontage, including the new opening process, beginning on October 14, 2002, on a security-bysecurity basis. NASDAQ has decided to implement both the Trade-or-Move Rule changes as well as the SuperMontage opening process changes as NASDAQ rolls out SuperMontage in a particular security. In other words, the new Rule amendments will be implemented on a security-by-security basis, as soon as each NASDAQ security begins to trade on SuperMontage. The current Trade-or-Move Rule obligations will continue to apply to all securities continuing to trade through SuperSoesSM.

      Attachment A includes a question and answer section that explains the major points of the rule changes. Attachment B includes the text of the amended rule.

      Questions/Further Information

      Legal questions regarding this Notice may be directed to Jeffrey Davis, Associate General Counsel, or Thomas Moran, Associate Vice President, Office of General Counsel, NASDAQ, at (202) 728-8088. General trading questions may be directed to John Malitzis, Vice President; Karen Peterson, Associate Vice President; or Mary Revell, Associate Vice President; NASDAQ Transaction Services, at (212) 858-4322. Questions about market operations or the Clearly Erroneous Trade Rule may be directed to Dan Franks, Senior Vice President, NASDAQ Market Operations, NASDAQ, at (800) 219-4861.

      Background and Explanation

      To address ongoing concerns with locked/crossed markets prior to the open, NASDAQ proposed, and the SEC approved (on May 28, 2002), changes to NASD Rule 4613(e). The rule change alters three aspects of the Trade-or-Move Rule as it operates today between 9:20 and 9:29:59 a.m., ET. First, ECNs will be required to send Trade-or-Move Directed Orders prior to entering locking or crossing quotes, while market makers will continue to be required to send Trade-or-Move Directed Orders after entering locking or crossing quotes. Second, the time to respond to a Trade-or-Move Directed Order will be reduced from 30 seconds to 10 seconds. Third, the amendment creates a 10,000-share minimum requirement for Trade-or-Move Directed Orders for NASDAQ-100 and S&P 400 issues, while preserving the 5,000-share minimum requirement for all other securities. The rule filing preserves the existing exception to the minimum share requirement of 5,000 or 10,000 shares for agency orders.

      Sequence of Messages

      Under the new Trade-or-Move Rule, the sequence of Trade-or-Move Directed Orders will differ by market participant business model. The Rule has been changed to require ECNs to send a Tradeor-Move Directed Order before entering a locking/crossing quotation. The sequence procedures applicable to market makers will remain unchanged from the requirements under the current Rule: they are required to send a Trade-or-Move Directed Order immediately after entering a locking or crossing quote. The revised sequence applicable to ECNs, combined with the requirement to respond to a Trade-or-Move Directed Order within 10 seconds, should help ECNs avoid dual liability. The revised Rule will allow an ECN to send a Trade-or-Move Directed Order for the actual size of an agency order, wait 10 seconds for a response, and, assuming it receives no response, cancel the Trade-or-Move Directed Order and enter the agency order as a locking or crossing quote.

      Response Time

      The time for responding to a Trade-or-Move Directed Order has been reduced to 10 seconds from 30 seconds. This reduced response time should help facilitate the prompt resolution of locked and crossed markets when they occur.

      Minimum Share Requirement

      Under the current Trade-or-Move Rule, the aggregate size of the Trade-or-Move Directed Order must be for either at least 5,000 shares (i.e., the market participant must send a total of 5,000 shares to all parties it is locking or crossing) in the case of a proprietary quote or the actual size of the agency order if that is the basis for the locking or crossing quote (the "agency exception"). The amended Rule will require a market participant handling a proprietary order to send a Trade-or-Move Directed Order for a minimum of 10,000 shares in the case of NASDAQ-100 and S&P-400 issues and will retain the 5,000-share minimum requirement for all other issues. The "agency exception" will continue to operate as it does today. This means that if a market participant is representing agency interest that locks or crosses the market, it is required to send a Trade-or-Move Directed Order for the size of the agency interest (not the full 5,000 or 10,000 shares). This new size requirement may deter the entering of locking or crossing quotations in securities that are characterized by higher liquidity and faster trading.

      SuperMontage Opening Process; How Trade-or-Move Interacts with New Opening Process

      The SEC approved the new SuperMontage opening process on August 23, 2002. The new rules (1) permit the entry of market orders prior to 9:30 a.m., ET; (2) revise the time frame for the entry of Tradeor-Move Directed Orders to between 9:20 a.m. and 9:29:29 a.m., ET (from 9:29:59 a.m., ET); and (3) modify the SuperMontage opening process.

      Under the new opening process, starting at 9:29:30 a.m., ET, NASDAQ will resolve any outstanding locked and crossed markets. The system will pair off the most aggressively priced buy quote/order against the most aggressively priced sell quote/order. Once this "best-priced pair" is determined, the system will execute the two identified orders at the price of the newer order until the older order is fully satisfied. If the displayed size becomes exhausted at that price level, SuperMontage will continue to execute against available reserve size at that price level. This process will be repeated until an unlocked and uncrossed market results. After the initial locks/crosses are cleared, any additional locking or crossing quotes/orders entered between 9:29:30 and 9:29:59 a.m., ET, will be cleared consistent with the SuperMontage process for clearing locks and crosses applicable during regular market hours.


      1 Securities Exchange Act Release No. 45990 (May 28, 2002), 67 FR 38535 (June 4, 2002) (File No. SR-NASD-2000-76).

      2 Securities Exchange Act Release No. 46410 (August 23, 2002), 67 FR 55897 (August 30, 2002) (File No. SR-NASD-2002-56).

      3 File No. SR-NASD-2002-123 (filed September 18, 2002).


      Attachment A

      Questions and Answers

      Outlined below are a series of Questions and Answers. These Questions and Answers supplement the guidance provided in NASD Notice to Members 00-29.

      General Obligations

      1. Q. When will the Trade-or-Move ("Trade-or-Move") Rule amendments be implemented?

      A. The amendments will be implemented on a security-by-security basis at the same time that a security begins trading on SuperMontageSM. The current Trade-or-Move Rule obligations will continue to apply to all securities continuing to trade through SuperSoesSM.

      2. Q. After the launch of SuperMontage, must market participants still use SelectNet® to deliver Trade-or-Move Directed Orders during the 9:20 to 9:29:29 a.m., Eastern Time (ET), period?

      A. Market participants must use SuperMontage "Directed Orders" to deliver Trade-or-Move Directed Orders; they may not use any other system to comply with the Trade-or-Move Rule. (Note that the SuperMontage Directed Order Process is an enhanced version of SelectNet, and the Directed Order windows and messages on the NASDAQ Workstation II are still labeled as SelectNet.) Market participants will format Directed Orders in the same manner they format SelectNet Tradeor-Move Directed Orders. See Question 3 in NASD Notice to Members 00-29 for further guidance.

      3. Q. What is the relationship between the rule amendments and the rule that currently governs pre-opening locks or crosses?

      A. The rule amendments will modify the current rule only as described in this Notice. Unless otherwise noted, all current obligations imposed under the rule will remain the same as described in NASD Notice to Members 00-29 and related NASDAQ Head Trader Alerts.

      4. Q. What is the relationship between the approved rule amendments and the approved amendments to the SuperMontage opening?

      A. The amendments to the SuperMontage opening process revise the time frame for the entry of Tradeor-Move Directed Orders to conform to the changes in the opening process. The time frame for entering Trade-or-Move Directed Orders is now between 9:20 and 9:29:29 a.m., ET (as opposed to 9:29:59 a.m., ET). See discussion of the relationship between the Trade-or-Move Rule and the SuperMontage opening process, below.

      5. Q. How long does a market participant have to respond to a Trade-or-Move Directed Order?

      A. 10 seconds. The rule amendments reduce the response time from the current 30 seconds to 10 seconds.

      6. Q. Must a Trade-or-Move Directed Order always include a minimum of 5,000 shares?

      A. No. For stocks included in the NASDAQ-100 Index® and the S&P MidCap 400 Index, a market maker or electronic communication network (ECN) must send a Tradeor-Move Directed Order(s) for at least 10,000 shares, unless the quote/order represents an agency order. Trade-or-Move Directed Orders for all other stocks must include a minimum of 5,000 shares, unless the quote/order represents an agency order. The "agency exception" contained in the Tradeor-Move Rule, which states that a market participant that is representing an agency order (as defined in the Rule) is required to send a Trade-or-Move Directed Order in an amount equal to the agency order, even if that order is less than 5,000/10,000 shares, will continue to operate as it does today.

      7. Q. How will market makers and ECNs know which securities are in the NASDAQ 100 and the S&P MidCap 400 Index?

      A. NASDAQ will post on NASDAQtrader.com a list of securities included in these indices and for which the obligation to send 10,000 shares exists. That list will be the official source of information with respect to this obligation, and will be published on the first day of every month. The list is available on NASDAQtrader.com under SuperMontage Hot Topics (General Section).

      8. Q. Can a market participant satisfy the minimum share requirement by sending two or more Trade-or-Move Directed Orders to two or more different quotes/orders?

      A. Yes, as long as the aggregate size of all Trade-or-Move Directed Orders equals the minimum share requirement.

      9. Q. If a market participant receives a Trade-or-Move Directed Order from an ECN, what are its options?

      A. The recipient can trade in full (i.e., fill the incoming Directed Order for the full size of the order), in which case it is not required to move its quote. Alternatively, if the recipient of a Trade-or-Move Directed Order does not trade in full, it is required to move to a price that would both not lock or cross the market, and is at a minimum $0.01 away from the price of the inbound Trade-or-Move Directed Order from the ECN, because the ECN's quote has not yet been posted.

      10. Q. If a market participant receives a Trade-or-Move Directed Order from a market maker, what are its options?

      A. The recipient can trade in full, in which case it is not required to move its quote. Alternatively, if the recipient of a Trade-or-Move Directed Order does not trade in full, it is required to move to a price that would not lock or cross the market.

      ECN Obligations

      11. Q. What are an ECN's options for entering a quote/order between 9:20:00 a.m. and 9:29:29 a.m., ET, that would lock/cross the market if displayed in NASDAQ during that period?

      A. Before entering a quote/order that would lock or cross the market, the ECN must send a Trade-or-Move Directed Order and wait 10 seconds for a response to that message. This requirement applies regardless of the type of locking/crossing quote or order (agency or principal) entered.

      12. Q. What are an ECN's obligations if, after it has sent a Trade-or-Move Directed Order and has waited 10 seconds, the recipient of the Trade-or-Move Directed Order has not traded in full or moved its quotation?

      A. If the recipient of a Trade-or-Move Directed Order does not respond properly and in a timely manner to a Trade-or-Move Directed Order sent by an ECN, the ECN must immediately enter its locking/crossing quote or order. After posting its locking/crossing quote or order, the ECN may then cancel the Trade-or-Move Directed Order. It would be inconsistent with the rule for an ECN to send a Trade-or-Move Directed Order and then fail to enter a locking/crossing quote in an attempt to manipulate the market.

      13. Q. What are an ECN's options after it has sent a Trade-or-Move Directed Order?

      A. If all the recipients of a Trade-or-Move Directed Order sent by an ECN trade in full or move their quotes, an ECN may enter a new quote or order, but it would not be a a locking/crossing quote or order. If all the recipients of a Trade-or-Move Directed Order sent by an ECN trade in full and do not move their quotes, and the ENC still wants to lock/cross the market, the ECN must send another Trade-or-Move Directed Order. If after 10 seconds fewer than all recipients trade in full, the ECN must enter its locking or crossing quotation.

      Market Maker Obligations

      14. Q. What are a market maker's obligations for entering a quote or order between 9:20:00 a.m. and 9:29:29 a.m., ET, that would lock or cross the market if displayed in NASDAQ during that period?

      A. Except as specified above (with respect to the aggregate size of a Trade-or-Move Directed Order[s]), market makers' obligations with respect to Trade-or-Move will not change. If a market maker wishes to enter a quote/order that would lock or cross the market, it must enter the locking or crossing quote/order and then immediately send a Trade-or-Move Directed Order for the appropriate number of shares.

      15. Q. If a market maker sends a Tradeor-Move Directed Order and the recipient does not respond to the message within 10 seconds, can the market maker cancel the Trade-or-Move Directed Order?

      A. Yes. A market maker may cancel a Trade-or-Move Directed Order it sends if it has waited the full 10 seconds and the receiving market participant has not responded. (Refer to Question 20 below for further discussion.) A market maker also may cancel a Trade-or-Move Directed Order before 10 seconds elapse if the recipient moves its quote to a non-locking/non-crossing price or the market otherwise unlocks.

      Trade-or-Move Obligations to Orders Below a Market Maker's or an ECN's Top of File in a Multiple Order Environment

      The following two questions address a market participant's obligations where a market participant is displaying multiple levels of attributable orders below the market participant's top of file. These questions address how Trade-or-Move operates in an environment where a market maker may have several levels of orders in the system that could be locked or crossed.

      16. Q. If a market maker has orders in the SuperMontage book and receives a Trade-or-Move Directed Order at its quoted price and it executes all shares at that price, what obligations does the market maker have?

      A. The market maker must do one of two things:

      (1) If the market maker has orders or summary quotes at multiple price levels (i.e., orders below its top of file), and the actively crossing market maker sends a Trade-or-Move Directed Order priced at the passively crossed market maker's top of file, the passively crossed market maker does not have to cancel or move those summary quotes or orders against which the Trade-or-Move Directed Order is not marketable; it only has to execute at the price and quantity of the inbound Trade-or-Move Directed Order or it has to move. Thus, if a market maker receives a Trade-or-Move Directed Order priced at its top of file, it only has to trade in full with the Trade-or-Move Directed Order, even though the system will publish its next best quote or order that is then locked or crossed, once the order(s) at the top of file is(are) exhausted.
      For example, MMB wants to cross at $19.95, so it enters the $19.95 quote and sends MMA a Trade-or-Move Directed Order to sell at $20.00 for 10,000 shares. MMA has the following buy orders on its book: 1,000 shares at $20.00; 5,000 shares at $19.99; and 6,000 shares at $19.98. The shares at $19.99 and $19.98 are attributable but not displayed because they are below the top of its file. MMB is only obligated to send a sell order for 10,000 shares to the quoted price it sees: MMA at $20.00. MMA must execute the full 10,000 shares of the Trade-or-Move Directed Order to maintain its $20 bid. If MMA does not fully execute the Trade-or-Move Directed Order, it may partially execute the order at $20 and remove its trading interest at $20, or it may remove its trading interest at $20 altogether. MMA will re-appear at $19.99 for 5,000 shares, but it has no obligation to send a Trade-or-Move Directed Order. At this point, either party to the cross can (but is not obligated to) send a Trade-or-Move Directed Order.
      (2) If the market maker has orders or summary quotes at multiple price levels (i.e., orders below its top of file) and the actively crossing market maker sends a Trade-or-Move Directed Order priced better than the passively crossed market maker's top of file, then the passively crossed market maker is obligated to trade in full against the incoming Trade-or-Move Directed Order or move to a price that is not locking/crossing.
      For example, MMB wants to cross at $19.95, so it enters the $19.95 quote and sends MMA a Trade-or-Move Directed Order to sell at $19.95 for 10,000 shares. MMA has the following buy orders on its book: 1,000 shares at $20.00; 5,000 shares at $19.99; and 6,000 shares at $19.98. The shares at $19.99 and $19.98 are attributable but not displayed because they are below the top of its file. MMA is obligated to execute 1,000 shares at $20.00; 5,000 shares at $19.99; and 4,000 shares at $19.98, i.e., all prices against which the inbound Trade-or-Move Directed Order is marketable, up to the size of the inbound Trade-or-Move Directed Order (here, 10,000 shares). If MMA does not trade in full, MMA must cancel all orders and quotes that are crossed and move its quote to (or establish a new quote at) $19.94 (an uncrossed/unlocked price).

      17. Q. If a market maker is quoting only one price and does not have orders in the book and receives a Trade-or-Move Directed Order at its quoted price and it executes all shares at that price, what obligations does the market maker have?

      A. Nothing changes under this scenario. For example, MMA is quoting at $20.00 for 1,000 shares and MMC is quoting at $19.99 for 1,000 shares. MMB wants to cross at $19.95, and MMB sends MMA a Trade-or-Move Directed Order at $20.00 for 5,000 shares and MMC a Trade-or-Move Directed Order at $19.99 for 5,000 shares. Here both MMA and MMC would be required to trade 5,000 shares at $20.00 and $19.99 respectively or move their quotes to a price below $19.95.

      Interaction Between Trade-or-Move, SIZE, and the SuperMontage Open

      18. Q. If a market maker or ECN receives a Trade-or-Move Directed Order within the last 10 seconds before 9:29:30, ET (i.e., at or after 9:29:20 a.m., ET), does the market maker or ECN still have the obligation to trade or move within 10 seconds?

      A. A market participant continues to have an obligation to respond timely to a Trade-or-Move Directed Order sent after 9:29:20 a.m. and before 9:29:29 a.m., ET. As noted in Question 21 below, however, at and after 9:29:30 a.m., ET, the receiving market participant should not accept the Trade-or-Move Directed Order.

      19. Q. How long is a market participant obligated to leave a Trade-or-Move Directed Order live before it may be cancelled?

      A. A market participant generally is required to leave a Trade-or-Move Directed Order live for 10 seconds. As noted in Question 20 below, a market participant may cancel a Trade-or-Move Directed Order at any time after 9:29:30 a.m., ET.

      20. Q. May a market maker or ECN cancel a Trade-or-Move Directed Order at or after 9:29:30 a.m., ET, that is still "open"?

      A. Yes. Once the 9:29:30 a.m., ET, opening process begins, a market participant may cancel outstanding Trade-or-Move Directed Orders. Note, however, that a Trade-or-Move Directed Order—by system operation—cannot be canceled for 5 seconds (i.e., the NASDAQ system will reject the cancellation unless the order has been live for 5 seconds). Thus, a market participant will have to wait 5 seconds after sending a Trade-or-Move Directed Order before a cancellation will be successfully processed by NASDAQ systems.

      21. Q. If a market maker locks or crosses the market at or after 9:29:25, ET, is the market maker required to send a Trade-or-Move Directed Order?

      A. Yes. However, since the SuperMontage opening process will unlock or uncross the market beginning at 9:29:30 a.m., ET, the recipient of a Trade-or-Move Directed Order may NOT accept a Trade-or-Move Directed Order at or after 9:29:30 a.m., ET. This is to ensure that the sender of a Trade-or-Move Directed Order does not receive an execution of the outstanding Tradeor-Move Directed Order while simultaneously receiving an execution of its locking/crossing quote through the SuperMontage opening process. (Note that this amends the guidance set forth in Question 2 to NASD Notice to Members 00-29, where NASD and NASDAQ explicitly state that an obligation to a Trade-or-Move Message carries over after the open; this will no longer be the case given the changes to the SuperMontage Opening Process.) NASDAQ has submitted a proposed rule change to the SEC to establish that any trade executed after 9:29:30 a.m., ET, as a result of the receipt of a Trade-or-Move Directed Order may be broken (declared null and void) pursuant to the Clearly Erroneous Trade Rule (NASD Rule 11890) if a party submits an erroneous trade complaint.3

      22. Q. If an ECN wishes to lock or cross the market at or after 9:29:20 a.m., ET, what are its Trade-or-Move obligations?

      A. An ECN is required to send a Tradeor-Move Directed Order first, and wait 10 seconds before entering a locking or crossing quote. If the ECN does not receive a response by 9:29:29 a.m., ET, it may cancel the Trade-or-Move Directed Order and thereafter initiate a lock/cross. The system would resolve the resulting locked or crossed market at 9:29:30 a.m., ET (or thereafter) pursuant to the SuperMontage opening process.

      23. Q. If a market maker wishes to enter a quote or order into "SIZE" that would lock or cross another market participant between 9:20:00 a.m. and 9:29:29 a.m., ET, what are the market maker's Trade-or-Move obligations? (See Question 25 for an ECN's obligations.)

      A. A market maker that wishes to enter a locking or crossing quote or order into SIZE, must follow all rules that would be applicable to the entry of a locking or crossing quote or order under its own market participant identifier (MPID). Thus, a market maker wishing to lock or cross the market via SIZE during the Trade-or-Move period must, immediately after entering the locking or crossing quote/order into SIZE, send a Trade-or-Move Directed Order for the appropriate share amount to the market participant(s) it has locked or crossed or will lock or cross.

      24. Q. Does a market maker incur additional obligations by entering a locking or crossing quote or order into SIZE as opposed to its own MPID?

      A. Due to the anonymous nature of the SIZE MPID, and the resulting inability of other market participants to identify the entity with which to resolve a locked or crossed market, a market maker that elects to represent its trading interest in SIZE must comply with the following. If the market maker has locked/crossed the market using SIZE, it must send out the required Trade-or-Move Directed Order(s). If all recipients of a Trade-or-Move Directed Order trade in full and do not move their quotes to an unlocking/uncrossing position, a market maker that still wants to lock or cross the market via SIZE must send another Trade-or-Move Directed Order to the parties it has locked or crossed. A market maker that continues to actively lock or cross the market via SIZE must continue sending Trade-or-Move Directed Orders (every 10 seconds) until the locked or crossed market is resolved.

      25. Q. If an ECN wishes to enter a quote/order into SIZE that would lock or cross another market participant(s) between 9:20:00 a.m. and 9:29:29 a.m., ET, what are the ECN's Trade-or-Move obligations? (See Question 23 for a market maker's obligations.)

      A. An ECN wishing to actively lock or cross using the SIZE MIPD during the Trade-or-Move period must, before entering a locking or crossing quote or order into SIZE, send a Trade-or-Move Directed Order to the market participant(s) it will lock or cross. If the recipient trades in full with the message and does not move its quote to an unlocking or uncrossing position, the ECN that wishes to actively lock or cross the market via SIZE must continue to send Trade-or-Move Directed Orders every 10 seconds to the parties it wishes to lock or cross. The ECN must continue to send Trade-or-Move Directed Orders until the potential locked or crossed market is resolved.

      26. Q. What are the Trade-or-Move obligations of a market participant that wishes to lock or cross the SIZE MPID?

      A. Since SuperMontage does not currently have the capability to route Trade-or-Move Directed Orders to individual entities represented in SIZE, a market participant that wishes to lock or cross the SIZE MPID has no obligation under the Trade-or-Move Rule with respect to orders that reside in SIZE. The market participant retains all other Trade-or-Move obligations to interact with attributed quotes or orders that it has locked or crossed or that it will lock or cross.

      27. Q. What are the Trade-or-Move obligations of a market participant that has entered a quote or order into SIZE that is thereafter locked or crossed by another market participant?

      A. The Trade-or-Move Rule does not require the market participant whose quote or order is locked to send a Trade-or-Move Directed Order. Similarly, if a market participant enters an order into SIZE prior to 9:20 that locks/crosses, there is no obligation to send a Tradeor-Move Directed Order either before or after 9:20 a.m., E.T.

      NASDAQ does believe, however, that parties have an ongoing responsibility to monitor those orders and take reasonable steps to attempt to interact with displayed quotes/orders that lock/cross those orders. NASDAQ will closely monitor, and refer for regulatory review, market participants that routinely enter orders in SIZE and take no action to attempt to execute such orders despite clear indicia that other market participants are willing to execute at prices that would satisfy them.


      Attachment B

      Text of Amended Rule (reflecting amendments to the Trade-or-Move Rule and the SuperMontage Opening Process)

      4613. Character of Quotations

      (a) through (d) No Change.
      (e) Locked and Crossed Markets
      (1) A market maker shall not, except under extraordinary circumstances, enter or maintain quotations in NASDAQ during normal business hours if:
      (A) through (B) No Change.
      (C) Obligations Regarding Locked/Crossed Market Conditions Prior to Market Opening
      (i) Locked/Crossed Market Prior to 9:20 a.m. — For locks/crosses that occur prior to 9:20 a.m. Eastern Time, a market maker that is a party to a lock/cross because the market maker either has entered a bid (ask) quotation that locks/crosses another market maker's quotation(s) or has had its quotation(s) locked/crossed by another market maker ("party to a lock/cross") may, beginning at 9:20 a.m. Eastern Time, send a Directed Order of any size that is at the receiving market maker's quoted price ("Trade-or-Move Directed Order"). Exception: A market maker that is a party to a lock/cross may not send such an order to the SIZE MPID.
      (ii) Locked/Crossed Market Between 9:20 and 9:29:29 a.m. —
      (a) Before an ECN enters a quote that would lock or cross the market between 9:20 and 9:29:29 a.m. Eastern Time, the ECN must first send a Trade-or-Move Directed Order to the market maker or ECN whose quote it would lock or cross that is at or superior to the receiving market maker's or ECN's quoted price. An ECN that sends a Trade-or-Move Directed Order during these periods must then wait at least 10 seconds before entering a quote that would lock or cross the market. Exception: An ECN is not required to send such an order to the SIZE MPID.
      (b) If a market maker enters a quote that would lock or cross the market between 9:20 and 9:29:29 a.m. Eastern Time, the market maker must then immediately send a Trade-or-Move Directed Order to the market maker or ECN whose quote it would lock or cross that is at or superior to the receiving market maker's or ECN's quoted price. Exception: A market maker is not required to send such an order to the SIZE MPID.
      (c) If any market participant enters a quote that would lock or cross the market between 9:29:30 and 9:29:59, that quote will be processed as set forth in Rule 4710(b)(3)(B).
      (iii)
      (a) In the case of securities included in the Nasdaq 100 Index or the S&P 400 Index, a Trade-or-Move Directed Order must be for at least 10,000 shares (if multiple market makers would be locked/crossed, each one must receive a Trade-or-Move Directed Order and the aggregate size of all such messages must be for at least 10,000 shares); provided, however, that if a market participant is representing an agency order (as defined in subparagraph (vi) of this rule), the market participant shall be required to send a Trade-or-Move Directed Order(s) in an amount equal to the agency order, even if that order is for less than 10,000 shares.
      (b) In the case of all other securities, a Trade-or-Move Directed Order must be for at least 5,000 shares (if multiple market makers would be locked/crossed, each one must receive a Trade-or-Move Directed Order and the aggregate size of all such orders must be for at least 5,000 shares); provided, however, that if a market participant is representing an agency order (as defined in subparagraph (vi) of this rule), the market participant shall be required to send a Trade-or-Move Directed Order(s) in an amount equal to the agency order, even if that order is for less than 5,000 shares.
      (iv) A market maker that receives a Trade-or-Move Directed Order must, within 10 seconds of receiving such message, either fill the incoming Trade-or-Move Directed Order for the full size of the order, or move its bid down (offer up) by a quotation increment that restores or maintains an unlocked/uncrossed market.
      (v) A market maker that sends a Trade-or-Move Directed Order pursuant to subparagraphs (e)(1)(C)(i) or (e)(1)(C)(ii)(b) of this rule, or an ECN that sends a Trade-or-Move Directed Order pursuant to subparagraph (e)(1)(C)(ii)(a) of this rule, must append to the order a NASDAQ-provided symbol indicating that it is a Trade-or-Move Directed Order.
      (vi) No Change.
      (2) No Change.
      (3) Except as indicated in subsection (1)(C)(ii), for purposes of this rule, the term "market maker" shall include:
      (A) through (D) No Change.

    • 02-70 Securities Industry/Regulatory Council on Continuing Education Issues Firm Element Advisory

      View PDF File

      INFORMATIONAL

      Continuing Education

      SUGGESTED ROUTING

      KEY TOPICS

      Continuing Education
      Legal & Compliance
      Registration
      Senior Management

      Continuing Education
      Firm Element



      Executive Summary

      The Securities Industry/Regulatory Council on Continuing Education (Council) has issued the annual Firm Element Advisory, a guide for firms to use when developing their continuing education Firm Element training plans. The attached Firm Element Advisory lists topics that the Council considers to be particularly relevant to the industry at this time. The list is based on a review of recent regulatory events, as well as advisories issued by self-regulatory organizations (SROs) since the last Firm Element Advisory of November 2001. Firms should review the training topics listed in the Firm Element Advisory in conjunction with their annual Firm Element Needs Analysis in which firms identify training issues to be addressed by their written Firm Element training plan(s).

      Also, please note that the Council has two additional resources available on its Web Site to assist firms with Firm Element requirements. The first is the Firm Element Organizer, an easy-to-use software application in which the user identifies specific investment products or services and selects training topics from a defined list. The Firm Element Organizer then searches an extensive database of training resources like those listed in the Firm Element Advisory, and provides a report of relevant resources. The report can then be edited into a Firm Element training plan using a word processing program. A tutorial on the Web Site demonstrates this process. The second Firm Element resource comprises scenarios taken from the Regulatory Element computer-based training that may be suitable for Firm Element training. For more information, to use the Firm Element Organizer, or to order Regulatory Element scenarios, log on to www.securitiescep.com.

      Questions/Further Information

      Questions concerning this Notice may be directed to John Linnehan, Director, NASD Continuing Education, at (240) 386-4684.


      Securities Industry Continuing Education Program Firm Element Advisory

      Each year the Securities Industry/Regulatory Council on Continuing Education (Council) publishes the Firm Element Advisory to identify pertinent regulatory and sales practice issues for possible inclusion in Firm Element training plans. This year's topics have been taken from a review of industry regulatory and self-regulatory organization (SRO) publications issued since the last Firm Element Advisory of November 2001.

      The Council recommends that firms use the Firm Element Advisory when they undertake their annual Firm Element Needs Analysis. Begin by reviewing the training topics listed in the Firm Element Advisory that are most relevant to the firm's business as it exists today, including training for supervisors. Then, consider training topics prompted by new products or services the firm plans to offer, such as security futures, where training is mandated before a registered person can conduct business in this area. Other training topics may address issues raised by new rules, customer complaints, or regulatory examination findings.

      In addition to the training resources listed next to each topic in the Firm Element Advisory, there are two additional resources on the Council Web Site (www.securitiescep.com) to assist with Firm Element requirements. The first is the Firm Element Organizer, an easy-to-use software application. Just identify specific investment products or services and training topics from a defined list. The Firm Element Organizer then searches an extensive database of training resources similar to those listed in the Firm Element Advisory, and provides a report of relevant resources. The report can then be edited into a Firm Element training plan using a word processing program. A tutorial on the Web Site demonstrates how to use the Firm Element Organizer. The second Firm Element resource comprises scenarios taken from the Regulatory Element computer-based training that may be suitable for Firm Element training. For more information, log on to www.securitiescep.com, or phone Roni Meikle, Continuing Education Manager, the New York Stock Exchange (212-656-2156), or John Linnehan, Director, NASD Continuing Education, (240-386-4684).


      Training Topics and Relevant Training Points and References

      Anti-Money Laundering The SROs adopted rules, pursuant to amendments to Section 352 of USA PATRIOT Act, that every broker/dealer member must establish an anti-money laundering compliance program by April 24, 2002 that included certain specified minimum requirements:
      • the development of internal policies, procedures, and controls;

      • the designation of a compliance officer;


      • an ongoing employee training program; and


      • an independent audit function to test programs.
      Anti-money laundering is an evolving topic that places additional due diligence and reporting responsibilities on firms, supervisors, and registered representatives. Many SROs and government agencies maintain Web Sites on anti-money laundering, including the SEC (www.sec.gov), the U.S. Treasury (www.ustreas.gov => Bureaus=>Financial Crimes Enforcement Network (FinCEN)), NASD (www.nasdr.com/money.asp) and the SIA (www.sia.com => Reference Materials => Anti-Money Laundering Guidance). See also, NASD Notice To Members 02-21, NASD Provides Guidance To Member Firms Concerning Anti-Money Laundering Compliance Programs Required By Federal Law, April 2002; NYSE Information Memoranda Nos. 02-16, (April 12, 2002) Anti-Money Laundering Compliance Program Requirements, 02-21 (May 6, 2002), Approval of New Rule 445 - Anti-Money Laundering Compliance Program and 02-34 (August 1, 2002), Special Due Diligence for Correspondent Accounts and Private Banking Account; CBOE Rule 4.20, Anti-Money Laundering Compliance Program, and CBOE Regulatory Circular RG-02-69, Anti-Money Laundering Programs, August 19, 2002; Philadelphia Stock Exchange Rule 757 - Anti-Money Laundering Compliance Program.
      Business Conduct

      Outside Business Activities and Private Securities Transactions
      A registered person who sells a security away from his or her firm without first obtaining written approval from the firm violates NASD Rule 3040, and a registered person who engages in an outside business activity without prior notice to his or her firm, including the sale of non-securities products, violates NASD Rule 3030. Broker/dealers must have supervisory procedures to make sure that they are complying with NASD Rules 3030 and 3040 regarding outside business activities and private securities transactions. Broker/dealers must also appropriately educate their associated persons regarding the requirements of Rules 3030 and 3040. Registered persons are advised to provide written notice to their firms before they engage in the sale of any financial instrument that is not approved by their firm.

      NYSE Rule 407 amendment codifies the requirement that associated persons obtain their employers' written approval prior to establishing or monitoring securities or commodities accounts or entry into private securities transactions (rather than notification) and clarifies the terms "account," "private securities transactions," and "other financial institutions."

      See NYSE Information Memo No. 02-40, August 28, 2001, Amendments to Rule 407 Relating to Private Securities Transactions and NYSE Interpretation Memo 02-08, August 28, 2002, Interpretation to Rule 407 Transactions - Employees of Members, Member Organizations and the Exchange.
      Charitable Gift Annuities A Charitable Gift Annuity (CGA) enables an individual to transfer cash or marketable securities to charitable organizations that then issue gift annuities in exchange for a current income tax deduction and the organization's promise to make fixed annual payments for life. Registered persons may be told that CGAs do not require federal or state securities registration or licensing. This is false, however, if representatives will receive a commission.

      See NASD Regulatory & Compliance Alert, Regulatory Short Takes — Charitable Gift Annuities, Summer 2002.
      Short Term Promissory Notes Short-term promissory notes are often marketed to registered representatives by issuers, promoters, and marketing agents who misrepresent these products as non-securities products that do not have to be sold by a broker/dealer or by a registered person. See, NASD Notice To Members 01-79, Selling Away And Outside Business Activities, NASD Reminds Members Of Their Responsibilities Regarding Private Securities Transactions Involving Notes And Other Securities And Outside Business Activities, December 2001.
      Viatical Investments Viatical investments are structured to provide an insured with a percentage of a life insurance death benefit before his or her death, while the investors get a share of the death benefit when the insured dies. Originated as a way to help the gravely ill pay their bills, these interests in the death benefits of terminally ill patients are always risky and sometimes fraudulent. Because of uncertainties associated with predicting an insured's death, these investments are extremely speculative, and unscrupulous promoters misrepresent or fail to disclose the risks of viatical investments.

      Almost all state securities regulators consider viatical investments as securities under their respective laws, but a circuit court of appeals ruling in 1996 found that they were not securities under federal securities laws. The North American Securities Administrators Association (NASAA) has developed Guidelines regarding viatical investments (see www.nasaa.org/nasaa/Files/File_Uploads/viaticalfinal.37534-67899.pdf). Broker/dealers must appropriately educate themselves and their associated persons before venturing into offering viatical investments to clients.

      See also Risky 'death futures' draw warning from state securities regulators, congressional scrutiny; www.nasaa.org/nasaa/abtnasaa/display_top_story.asp?stid=245
      Communications with the Public

      Disclosure and Reporting Requirements — Research Analysts and Research Reports
      On May 10, 2002, the SEC, in order to improve the objectivity of research and provide investors with more useful and reliable information when making investment decisions, approved new NASD Rule 2711, Research Analysts and Research Reports, as well as amendments to NYSE Rule 472, Communications With The Public and Rule 351, Reporting Requirements. Rule 2711 and the NYSE rule amendments:
      • Place restrictions on relationships between a firm's investment banking department and its research department.


      • Restrict review of a research report by the subject company.


      • Prohibit certain forms of research analyst compensation.


      • Prohibit the promise of favorable research.


      • Impose Quiet or Blackout Periods.


      • Restrict trading by research analysts and firms.


      • Require new disclosures in research reports and public appearances.
      See NASD Notice to Members 02-39, SEC Approves Rule Governing Research Analysts' Conflicts of Interest, July 2002; and NYSE Information Memos re: Disclosure and Reporting Requirements Nos. 02-24, May 20, 2002; 02-26, June 26, 2002; and 02-30, July 9, 2002. Included therein is a Joint Memorandum that provides interpretive guidance for NASD and NYSE rules governing research reports and analysts.

      NASD also maintains a Web Site on this evolving topic that is continuously updated, see www.nasdr.com/analyst_guide.htm.
      Electronic Communications — Suitability and Online Communications In light of the dramatic increase in the use of the Internet for communication between broker/dealers and their customers, NASD has issued a Policy Statement to provide guidance concerning a firm's obligations under the NASD general suitability rule, Rule 2310, in this electronic environment.

      The Policy Statement briefly discusses some of the issues created by the intersection of online activity and the suitability rule, and it provides examples of electronic communications that NASD considers to be either within or outside the definition of "recommendation" for purposes of the suitability rule. In addition, the Policy Statement sets forth guidelines to assist members in evaluating whether a particular communication could be viewed as a "recommendation," thereby triggering application of the suitability rule.

      See Notice to Members 01-23, Suitability Rule And Online Communications, April 2001. See also Internet Guide for Registered Representatives, at www.nasdr.com/4040.asp.
      Customer Accounts, Trade and Settlement Practices

      Errors and Erroneous Transactions
      The NYSE gave notice to its members and member organizations of new NYSE Rule 407A, and amendments to NYSE Rules 134 and 411, addressing situations involving erroneous transactions and reports. In addition, there is a new requirement that all members maintain an error account, as well as a new requirement that members report to the Exchange any account in which the member has a direct or indirect financial interest or over which the member has discretionary authority.

      In addition these amendments to NYSE Rules 134 and 411 and new Rule 407A dealing with erroneous transactions, erroneous reports and member account disclosure announced in Information Memo 01-38 (November 6, 2001), gave rise to a number of questions concerning the application of these rules which the NYSE addressed in two separate Information Memos (Nos. 02-19 and 02-07).

      The NYSE also advised its members and member organizations regarding amendments to NYSE Rule 134.40 of the requirement to report profitable error transactions.

      See NYSE Information Memoranda 01-38, Mandatory Error Account Requirement, Error Transaction Procedures, Recordkeeping Requirements, Disclosure of All Member Accounts, and Procedures for Handling Erroneous Reports/Rules 134, 407A, and 411, November 6, 2001; 02-07, Mandatory Error Account Requirement and Error Transaction Procedures - Rules 134, 407A and 411, February 5, 2002; 02-10, Rule 134.10 - Reporting Profitable Error Transactions, March 5, 2002; and 02-19, Errors, Erroneous Reports and Error Accounts - Rules 134, 411 and 407A, April 29, 2002.
      Gifts and Gratuities NYSE restated and reminded its members and member organizations of the Exchange's policy on gifts and gratuities which prohibits most Exchange employees from accepting gifts and gratuities from members, allied members, and member organizations. Limited exceptions are provided for Exchange Operational/Clerical Trading Floor employees who may accept usual and customary gratuities, not in excess of $50 per year. The memo also references NYSE Rule 350 ("Compensation or Gratuities to Employees of Others").

      See NYSE Information Memo No. 01-49, December 19, 2001, Exchange Guidelines on Gifts and Gratuities.
      Margin Disclosure and Day-Trading Risk Disclosure Statements NASD has adopted amendments to (1) Rule 2341 (Margin Disclosure Statement) to require firms that permit customers to open accounts online or to engage in transactions in securities online to post the margin disclosure statement on their Web Sites and (2) NASD Rule 2362 (Day-Trading Risk Disclosure Statement) to require firms that promote a day-trading strategy to post the day-trading risk disclosure statement on their Web Sites.

      See NASD Notice to Members 02-35, Margin Disclosure and Day-Trading Risk Disclosure Statements, June 2002.
      Options

      AM-Settled Index Options
      Expiring AM-settled index options should be considered exercised, assigned or purged at the point the securities that comprise the index open for trading on the business day immediately preceding Saturday expiration. In the case of an AM-settled index option carried short and treated as "covered," the writing of a new index option on Friday, after the opening to replace the assigned or expiring option, will not be deemed to constitute an "uncovered" transaction.

      See CBOE Regulatory Circular RG02-46, Time at Which Expiring AM-Settled Index Options are Considered Exercised, Assigned or Purged.
      Alerting Customers to Adjustments to Option Contracts SROs reminded member organizations of the need to review their policies and procedures to ensure that customers are provided with relevant information concerning adjustments to option contracts as the result of corporate actions.

      See CBOE Regulatory Circular RG02-41, Alerting Customers to Adjustments to Options Contracts. NASD Notice to Members 02-17, Alerting Customers to Adjustments to Options Contracts, March 2002; NYSE Information Memo No. 02-42, September 19, 2002, Alerting Customers To Adjustments To Options Contracts Resulting From Corporate Actions.
      Municipal Securities

      Consultants
      MSRB Rule G-38 defines a consultant as any person used by a dealer to obtain or retain municipal securities business through direct or indirect communication by such person with an issuer on the dealer's behalf where the communication is undertaken by such person in exchange for, or with the understanding of, receiving payment from the dealer or any other person. Dealers must disclose to issuers certain information about their consultants and report certain information about their consultants to the MSRB on Form G-37/G-38, including certain of their consultants' political contributions to issuer officials and payments to state and local political parties.

      See MSRB Rule G-38: Consultants, MSRB Rule Book.
      Disclosure of Material Facts The SEC approved an interpretive notice regarding Rule G-17, on disclosure of material facts. The first prong of Rule G-17 is essentially an anti-fraud prohibition; the second prong of the rule imposes a duty on dealers to deal fairly. As part of a dealer's obligation to deal fairly, the dealer is required to disclose, at or before the sale of municipal securities to a customer, all material facts concerning the transaction, including a complete description of the security. These affirmative disclosure obligations apply even when a dealer is acting as an order taker and effecting nonrecommended secondary market transactions.

      See "Interpretive Notice Regarding Rule G-17, on Disclosure of Material Facts" (ww1.msrb.org/msrb1/archive/G-17NOTICE32002.htm).
      Municipal Fund Securities, Including 529 Plans A municipal fund security (e.g., 529 Plans and local government investment pools) is defined in MSRB Rule D-12 as a municipal security issued by an issuer that, but for the application of Section 2(b) of the Investment Company Act of 1940, would constitute an investment company thereunder.

      The MSRB recognizes that the market for municipal fund securities continues to evolve rapidly, particularly with respect to the 529 College Savings Plans. Many dealers active in this market have no other experience effecting municipal securities transactions and therefore may not be familiar with the rules of the MSRB. Other dealers that do have a sound understanding of MSRB rules as they relate to traditional debt securities have discovered that familiar rules are applied in unfamiliar ways due to the unique nature of municipal fund securities. All dealers are reminded that all activities in municipal fund securities are subject to MSRB rules. Dealers are required by MSRB Rule G-17 to deal fairly with all persons and that they not engage in any deceptive, dishonest, or unfair practice. In some cases, certain sales-related activities are governed by MSRB, e.g., Rule G-19, on suitability of recommendations and transactions, Rule G-21, on advertising, and Rule G-30, on prices and commissions. Other activities may not be explicitly addressed by a specific MSRB rule; however, the general principles of Rule G-17 always apply.

      The MSRB has amended Rule G-3, on professional qualifications, to provide a temporary alternative method for qualification of municipal securities principals in connection with municipal fund securities. Until March 31, 2003, a dealer may designate an investment company/variable contracts limited principal or a general securities principal to act as a municipal fund securities limited principal. A designated municipal fund securities limited principal will have all of the powers and responsibilities of a municipal securities principal under MSRB rules with respect to transactions in municipal fund securities and, under certain circumstances, may be counted toward the dealer's numerical requirement with regard to municipal securities principals.

      See "Municipal Fund Securities Limited Principal Qualification Examination: Filing of Test Specifications, Study Outline and Extension of Transition Period (ww1.msrb.org/msrb1/archive/Series51Notice.htm)

      "Application of Fair Practice and Advertising Rules to Municipal Fund Securities" (ww1.msrb.org/msrb1/archive/MFSFairPracticeNotice—5-02.htm).

      Also, see NASD's Smart Saving for College - Better By Degrees, 529 Plans and Other Savings Options, www.nasdr.com/529_saving.asp, and "Saving for Education: A Long-Term Investment Guide to Understanding 529 Plans," prepared by the College Savings Plans Network, the North American Securities Administrators Association, and the Investment Company Institute, www.nasaa.org/nasaa/Files/Top_Stories/529%20brochure1.37536-62599.pdf
      Political Contributions and Prohibitions on Municipal Securities Business Dealers are prohibited from engaging in municipal securities business with a municipal securities issuer within two years after any contribution to an official of such issuer made by the dealer, any municipal finance professional associated with such dealer, or any political action committee controlled by the dealer or any municipal finance professional. The only exception to this absolute prohibition on municipal securities business is for certain contributions made to issuer officials by municipal finance professionals, but only if the municipal finance professional is entitled to vote for such official and provided any contributions do not exceed, in total, $250 to each official, per election. Dealers must report certain information about political contributions, political party payments, municipal securities business, and consultants to the MSRB on Form G-37/G-38 or, if appropriate, dealers may file a Form G-37x with the MSRB.

      The definition of "municipal finance professional" includes any associated person of the dealer who solicits municipal securities business. "Associated person" is defined in Section 3(a)(18) of the Securities Exchange Act of 1934. See SEC order In the Matter of Fifth Third Securities, Inc., Exchange Act Release No. 46087, June 18, 2002; MSRB Rule G-37: Political Contributions and Prohibitions on Municipal Securities Business, MSRB Rule Book.
      Transactions in Securities with Minimum Denominations Dealers are prohibited from effecting transactions with customers in below-minimum denomination amounts for securities issued after June 1, 2002. There are two limited exceptions to this rule. First, dealers may purchase a below-minimum denomination position from a customer provided that the customer liquidates his or her entire position. Second, dealers may sell such a liquidated position to another customer but would be required to provide written disclosure, either on the confirmation or separately, to the effect that the security position is below the minimum denomination and that liquidity may be adversely affected by this fact. The MSRB issued an interpretation of Rule G-17, on fair practice, that states that any time a dealer is selling to a customer a quantity of municipal securities below the minimum denomination for the issue, the dealer should consider this to be a material fact about the transaction. The MSRB believes that a dealer's failure to disclose such a material fact to the customer, and to explain how this could affect the liquidity of the customer's position, generally would constitute a violation of the dealer's duty under Rule G-17 to disclose all material facts about the transaction to the customer.

      See "Approval of Amendments Concerning Minimum Denominations" (ww1.msrb.org/msrb1/archive/approvalnotice.htm).
      Transactions with Sophisticated Municipal Market Professionals The SEC approved an interpretive notice concerning the application of MSRB rules to transactions with sophisticated municipal market professionals ("SMMP"). An institutional customer can be considered an SMMP if the dealer has reasonable grounds for concluding that the customer (i) has timely access to the to all publicly available material facts concerning a municipal securities transaction; (ii) is capable of independently evaluating the investment risk and market value of the municipal securities at issue; and, (iii) is making independent investment decisions about its investment in municipal securities. The notice addresses the manner in which a dealer has determined that it has met its fair practice obligations to certain institutional customers; it does not alter the basic duty of the dealer to deal fairly in all transactions and with all customers.

      See "Interpretive Notice Regarding the Application of MSRB Rules to Transactions with Sophisticated Municipal Market Professionals" (ww1.msrb.org/msrb1/archive/SMMPAPPROVAL0502.htm).
      Registration and Reporting

      Reportable Criminal Offenses
      The NYSE narrowed the scope of reportable criminal offenses to incidents which are more germane to the conduct of a securitiesrelated business minimizing the number of less material filings and maximizing the efficient use of resources committed to fulfilling self-regulatory responsibilities at both the Exchange and member organizations. The rule amendment captures the reporting of arrests for which any subsequent conviction or plea of no contest or guilty, would subject the individual to a statutory disqualification from securities industry employment or association.

      See NYSE Information Memo No. 02-31, Update Regarding Exchange Rule 351 - Reporting Requirements, July 15, 2002, and NYSE Information Memo No. 02-29, Exchange Rule 351 - Reporting Requirements, July 8, 2002.
      Registration and Reporting

      Trading Floor
      The NYSE has prepared an Information Memo that outlines requirements for conducting a public business from the Floor. Registration topics addressed include the distinction between dealing with the "public" as distinguished from "professional customers"; the registration requirements of sole proprietors; and the registration, disclosure, and supervisory requirements specifically applicable to dual employees.

      A general outline is included that references several prerequisites for conducting a public business including supervisory requirements, state registration, capital requirements, fidelity bond coverage, documentation requirements, and carrying agreements. The Memo also outlines policies and procedures related to permissible and restricted means of telephonic/electronic means of Floor communications.

      See NYSE Information Memo No. 01-41, November 21, 2001, Conducting a Public Business on the Floor.
      Security Futures (also know as Single Stock Futures) The Commodity Futures Modernization Act lifted the ban on the trading of security futures (i.e., futures on narrow-based indices, single stocks, and options on security futures). Because security futures have different characteristics and requirements than existing securities, the SROs have adopted rules that require any currently registered securities professional that intends to engage in a security futures business to complete a training program covering security futures, which may be included as Firm Element training for the pertinent registered persons. The SROs have also developed a content outline for use in the development of the training program, which focuses on the essential information individuals and supervisors should know before conducting a security futures business. The content outline has five modules:
      1. Stocks and Stock Options
      2. Futures Contracts
      3. Security Futures
      4. Regulatory Requirements for Security Futures
      5. Supervision of the Offer and Sale of Security Futures.
      An individual's current registration category will determine which of these modules must be completed before engaging in a security futures business. Series 7 registrants, for example, may not need to participate in the training on Stocks and Stock Options. Therefore, a member firm must consider the registration category and qualifications of persons in determining the nature and scope of his or her training.

      Firms may develop their own security futures training program or may engage a third-party provider to deliver the training program, so long as the training provided encompasses all appropriate subjects in the SRO-developed content outline. Firms remain responsible for compliance with SRO rules in all respects where training is developed and or administered by outside parties. NASD and the NFA have developed a Web-based security futures training program that, if completed in the prescribed manner, would satisfy the required training requirement. Information regarding this training program can be obtained at www.nasdr.com/futures.asp.

      Finally, members are reminded of the need to maintain records of the completion of any security futures training program designed to satisfy the requirement. Members may be required during an examination or investigation to demonstrate that individuals who are engaged in a security futures business have completed the required training.

      Please monitor the following SRO Web Sites as well as the NASD Web Site above for additional information:

      www.nqlx.com
      www.onechicago.com
      www.nfa.futures.org
      www.cboe.com
      www.nyse.com
      www.amextrader.com
      Supervision

      Books and Records
      Branch office managers and other supervisory personnel should be aware of SEC-approved amendments to the broker/dealer books and records rules, Rule 17a-3 and Rule 17a-4 under the Securities Exchange Act of 1934 that become effective on May 2, 2003. The amendments clarify and expand record-keeping requirements in connection with purchase and sale documents, customer records, associated person records, customer complaint records, and certain other matters. The amendments also require broker/dealers to maintain or promptly produce certain records at each office to which those records relate.

      Some of the more significant changes to the books and records rules are:
      • The definition of "office."


      • Updating Customer Account Records.


      • Additional Information Annotated on Order Tickets.


      • Additional Records Related to Associated Persons.


      • Retention of Communications With the Public.
      For more information, see Amendments To Broker/Dealer Books And Records Rules Under The Securities Exchange Act Of 1934, NASD Notice to Members 01-80, December 2001, www.nasdr.com/pdf-text/0180ntm.pdf.
      Supervision

      General Topics
      Industry SRO continuing education rules require a broker/dealer to include supervisory training for supervisors if its Firm Element Needs Analysis establishes the need for it. Supervisors should be trained on new rules with general application, e.g., anti-money laundering, as well as new rules relating to new products, such as security futures, if applicable. Firms should reiterate with supervisors the importance of internal controls as they relate to areas such as changing customer addresses, Letters of Authorization, mail directed to customer post office boxes, time and price discretionary orders, and supervision of producing managers.

      Broker/dealers may also find it helpful to periodically review with their supervisors various examples of conduct that violates SRO rules, such as
      • Exercising discretion without prior written authority


      • Failing to respond to SRO information requests


      • Failing to take advantage of mutual fund discounts


      • Falsifying documents


      • Forgery


      • Misrepresentations to customers


      • Selling away


      • Unsuitable recommendations


      • Unauthorized trading
      Supervisors in turn may wish to share this information with the registered persons they supervise. Many industry SROs publish information on their Web Sites that illustrate improper conduct and the disciplinary action taken by regulators. For example: NASD's quarterly Disciplinary Update at www.nasdr.com/disc_update_index.asp, and the NYSE's Disciplinary Actions at www.nyse.com/regulation/regulation.html.
      Variable Annuities

      Bonus Annuities
      Bonus annuities offer credits equal to a percentage of the amount invested in the variable annuity contract. The investment is usually from a 1031 exchange from another variable annuity contract. Bonus credits generally range from 3 percent to 5 percent of the money invested. In order to fund these bonus credits, the bonus contracts typically impose high mortality and expense charges and lengthy surrender charge periods. Registered persons recommending bonus annuities must be careful to comply with applicable SRO suitability rules. Communications promoting bonus annuities must disclose fees, expenses and surrender periods with the same prominence as the bonus feature of the new variable annuity contract.

      See NASD Regulation Cautions Firms For Deficient Variable Annuity Communications, Regulatory & Compliance Alert, Spring 2002 (www.nasdr.com/rca_spring02_adv.htm); Advertising Of Bonus Credit Variable Annuities, Regulatory & Compliance Alert, Summer 2000 (www.nasdr.com/rca_summer00.htm); and the NASD Regulation Investor Alert on exchanging variable annuities (www.nasdr.com/alert_02-01.htm)

      See also:
      • Notice to Members 99-35, The NASD Reminds Members Of Their Responsibilities Regarding The Sale Of Variable Annuities, May 1999, (www.nasdr.com/pdf-text/9935ntm.pdf).

      To Obtain More Information

      For more information about publications contact the SROs at these addresses:

      Self-Regulatory Organization Address and Phone Number On-line Address
      American Stock Exchange American Stock Exchange
      Marketing Department
      86 Trinity Place
      New York, NY 10006
      800-THE-AMEX
      www.amex.com
      www.amextrader.com
      Chicago Board Options Exchange Chicago Board Options Exchange
      400 S. LaSalle Street
      Chicago, IL 60605
      877-843-2263
      e-mail: help@cboe.com
      www.cboe.com
      Municipal Securities Rulemaking Board MSRB Publications Department
      1900 Duke Street
      Suite 600
      Alexandria, VA 22314
      703-797-6600
      www.msrb.org
      NASD NASD MediaSource
      P.O. Box 9403
      Gaithersburg, MD 20898-9403
      301-590-6142
      www.nasd.com
      New York Stock Exchange New York Stock Exchange
      Publications Department
      11 Wall Street
      18th Floor
      New York, NY 10005
      212-656-5273, or
      212-656-2089
      www.nyse.com
      Philadelphia Stock Exchange Philadelphia Stock Exchange
      Marketing Department
      1900 Market Street
      Philadelphia, PA 19103
      800-THE PHLX, or
      215-496-5158
      www.phlx.com or info@phlx.com

    • 02-69 Clarification of Member Obligations Regarding Brokered Certificates of Deposit

      View PDF File

      INFORMATIONAL

      Certificates of Deposit

      Effective Date: October 8, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Legal & Compliance
      Trading
      Operations
      Senior Management

      Certificates of Deposit



      Executive Summary

      NASD is issuing this Notice to supersede NASD Notice to Members 02-28 (Notice or Notice 02-28) and replace the guidance offered in Notice to Members 02-28, which addressed issues applicable to members offering "brokered" certificates of deposit (CDs). Accordingly, this Notice repeats pertinent information from Notice to Members 02-28. However, it also provides additional guidance not included in Notice to Members 02-28. First, the Notice gives a more detailed description of the characteristics of brokered CDs, the mechanics of the brokered CD market, and the circumstances in which brokered CDs may be considered securities. Second, the Notice harmonizes NASD's disclosure and sales practice requirements with the New York Stock Exchange's (NYSE's) disclosure and sales practice obligations applicable to its members offering brokered CDs. Finally, the Notice recommends the appropriate pricing that members should use in reporting the value of brokered CDs on customers' account statements and the appropriate disclosures that should appear in customers' account statements.

      Questions/Further Information

      Members may direct questions about this Notice to Patricia Albrecht, Assistant General Counsel, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8206.

      Characteristics of Brokered CD and Brokered CD Market

      CDs that typically are issued by a bank directly to a customer carry a fixed interest rate over a fixed duration of time and are insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000 against insolvency by the depository institution. As such, they are generally considered by the investing public to be simple, conservative products that carry few risks.

      However, some members have been soliciting customers with "brokered" CDs. As explained below, brokered CDs may have a longer holding period until maturity date, be more complex, and carry more risk than "traditional" CDs. Brokered CDs are CDs issued by banks via a "master CD" to deposit brokers, which in turn sell interests in the master certificate to individual retail investors. Any broker/dealer that sells brokered CDs is a deposit broker.

      The master CD is a negotiable instrument that represents a certain number of individual CDs, each with the same denomination. FDIC insurance attaches to the individual CDs represented in the master CD.1 The master CDs are held by a deposit broker as a custodian or by a sub-custodian appointed by the deposit broker. Either the deposit broker or the sub-custodian keeps the records of its customers' ownership interests in the CDs.2

      In general, brokered CDs have longer maturity dates (in some cases, 20 years from the date of issuance), than traditional CDs. The interest rate terms of brokered CDs can also differ significantly from the simple interest rate terms usually used by traditional CDs. For example, some brokered CDs have their interest rates tied to a market index, such as the S&P 500. Brokered CDs also may have special call features that allow the issuing bank to terminate the CD after a specified period of time if interest rates drop. In this respect, the CD is similar to a callable, fixed-rate bond. To compensate for these additional features, brokered CDs frequently pay a higher interest rate than traditional CDs.

      Because issuing banks may impose penalties on investors for withdrawing their funds before the maturity date of the CD or may not allow withdrawal prior to the maturity date, some deposit brokers (usually broker/dealers) may maintain a limited secondary market for customers who have purchased brokered CDs by buying back the CDs to resell to other customers. The deposit brokers maintain these markets to create some liquidity for the investment. However, the market conditions do not always favor the customer. For instance, if interest rates are high and a customer wants to trade in a low interest brokered CD for another CD with a higher interest rate, the customer might have to realize a loss on the principal of the CD in order to sell the CD. In addition, deposit brokers are not obligated to maintain a secondary market for brokered CDs sold to customers.

      Circumstances that May Make a Brokered CD a Security

      Although brokered CDs may have certain features that traditional CDs do not have, it is important to remember that, as long as a banking institution issues the brokered CDs, sets all of their features, and FDIC insurance applies to them, brokered CDs are generally considered bank products, not securities. However, there are several circumstances under which a brokered CD may be considered a security. For example, if a deposit broker materially alters the terms and features of a brokered CD (e.g., offering a different interest rate than the interest rate set by the issuing depository institution), the brokered CD is arguably a different investment vehicle that could be considered a security. Additionally, if a deposit broker buys for itself a largedenomination CD, fractionalizes it, and sells the fractions to investors, these actions could make the fractionalized CDs securities. Also, if a deposit broker affirmatively offers to customers certain expertise and skills that go beyond the sale of brokered CDs as incentives to purchase the brokered CDs, such as marketing and the ability to identify attractive CDs, these features may make the brokered CDs securities.3 As noted above, some deposit brokers maintain a limited secondary market for customers who have bought brokered CDs. If a deposit broker, as an incentive to purchase brokered CDs, offers and/or maintains a secondary market for customers to rely upon to provide additional liquidity to their brokered CDs, this feature may make brokered CDs securities.

      Training

      NASD expects registered persons to understand the characteristics and risk factors associated with all investment products, including each type of brokered CD offered by the member with which the registered persons are associated, before soliciting customers. NASD recommends that firms review their compliance programs, supervisory procedures, and continuing education offerings to ensure that registered persons are properly trained and educated about these products. Audits, compliance meetings, and continuing education programs should include a discussion of these products.

      Appropriate Disclosures and Sales Practices

      The NYSE has also provided guidance on the appropriate disclosures and sales practices for members selling brokered CDs to customers.4 As noted above, this Notice serves in part to harmonize NASD's disclosure and sales practice requirements applicable to members offering brokered CDs with those of the NYSE. Accordingly, the Notice recommends amended disclosure and sales practice requirements in the following areas: (1) loss of principal; (2) secondary market; (3) call features; and (4) "step-rate" CDs. The following disclosures should be provided sufficiently in advance of the transaction date in any brokered CD in order to provide customers with meaningful notice of the terms, conditions, and risks in connection with such a transaction.

      1. Loss of Principal
      If a member buys a brokered CD from a customer prior to the CD's maturity date, the member should disclose to the customer that, if the customer chooses to sell the CD prior to the maturity date, the pre-maturity sales price of the brokered CD may be less than its original purchase price. This will be particularly true if interest rates have risen since the time of the original sale. Buyers, including members, will not generally be interested in buying a lower interest rate CD in the secondary market if they can purchase a higher rate CD in the primary market. In addition, a member should not use the term "no penalty for early withdrawal" unless the issuer guarantees redemption of the full face value of the brokered CD in the event the owner decides to sell before the maturity date.
      2. Secondary Market
      Members should inform customers that the secondary market for brokered CDs may be limited. The following types of disclosures may be used to describe an organization's post-distribution intentions:
      "Upon completion of the distribution, the firm may not make a market in this CD."
      or
      "Upon completion of the distribution the firm may, as an accommodation to customers, make a market in this CD."
      or
      "The firm, though not obligated to do so, may maintain a secondary market in this CD upon completion of the distribution."
      3. Call Features
      Brokered CDs may include a provision that allows the issuing bank or other depository institution to "call" or redeem the CD prior to maturity at a given price. Call features typically are exercised when a brokered CD is trading at a premium to its call price in the secondary market. The call option is solely at the discretion of the issuer. Members should inform customers that the brokered CD they are purchasing is callable at the sole discretion of the issuing depository institution and that if the CD is "called," investors seeking to reinvest their redeemed funds will be subject to reinvestment risk because interest rates may have fallen since the time they first purchased the brokered CD. Also, in marketing callable brokered CDs, members should be careful not to predict the likelihood that the CDs will be called.
      4. "Step Rate" CDs
      Brokered CDs may also have "step-up" or "step-down" features. A "step-down" CD will pay an above-market interest rate for a defined period of time but will then "step-down" to a lower, predetermined rate that will be paid until maturity. Similarly, a "step-up" CD will generally pay a below market interest rate for a defined period of time and will "step-up" to a higher, predetermined rate that will be paid until maturity. Members should inform customers that the "step rate" on a brokered CD may be below or above then-prevailing market rates and that the CDs are also subject to secondary market risk and often will include a call provision by the issuing depository institution that would likewise subject them to reinvestment risk. Members should also remind customers that the initial rate cannot be used to calculate the yield to maturity.

      Written Communications

      Members should provide customers with written materials that describe the characteristics and risks of purchasing brokered CDs or prepare such material for distribution if not made available by the issuer. Any such written materials must also comply with Rule 2210 ("Communications With The Public").

      Account Statements

      NASD has observed that some members continue to price brokered CDs at par value on account statements. Carrying CDs at par value could be materially misleading if values have significantly eroded, and members are advised to diligently endeavor to price accurately the brokered CDs on customer account statements.

      There is no single method to determine the market value of brokered CDs. Members can obtain estimated values from several sources, including commercial pricing services. Some members rely on their fixed-income trading desks to determine a market value, while others have developed computerized valuation models or matrices to ascertain a theoretical market price. NASD recommends that when disclosing in account statements the more accurate values of brokered CDs held by customers, members should also disclose to customers that the value of brokered CDs on account statements are estimated and that their actual value may differ if customers elect to sell their brokered CDs in the secondary market. In addition, NASD recommends that members disclose the pricing method used to determine the market value of the brokered CDs. If market value is not provided as described above, NASD recommends that brokered CDs be reflected on customer statements as unpriced.

      The Notice also recommends including other disclosures on the account statement, covering the following points:

      (1) the secondary market for CDs is generally illiquid;
      (2) an accurate market value could not be determined by the member firm;
      (3) the actual value of the CDs may be different from their purchase price; and
      (4) a significant loss of principal could result if brokered CDs are sold prior to maturity. If the disclosure documents initially provided to customers purchasing brokered CDs provides information on these points, NASD does not believe that the disclosures, while preferable, need to appear in customers' account statements.

      Endnotes

      1 Federal deposit insurance generally covers deposits of up to $100,000 in the aggregate for each depositor in each bank, thrift, or credit union. A customer should ensure that purchasing any insured CD will not bring his or her aggregate deposit over the $100,000 FDIC insurance limit.

    • 2 For FDIC insurance protection to apply to the owner of the brokered CD, it is important that deposit brokers keep accurate records of the ownership interest in the brokered CD. However, the FDIC does not have to rely solely upon the records of the bank and/or the deposit broker to establish ownership. Under the FDIC's rules, if the brokered CDs are being held by a custodian, which is usually the case in sales by broker/dealers, the FDIC may also look to the records of a custodian to establish a relationship that permits deposit insurance to pass through the custodian to the purchaser. In addition, if the FDIC has reason to believe that the insured depository institution's deposit account records misrepresent the actual ownership of deposited funds and such misrepresentation would increase deposit insurance coverage, the FDIC may consider other available evidence of ownership and pay claims for insured deposits on the basis of the actual rather than the misrepresented ownership. See 12 C.F.R. § 330.5. Accordingly, firms should suggest to their customers that the customers keep records of their brokered CDs in the event the FDIC needs to look beyond the custodian's or deposit institution's records to establish ownership.

      3 See Gary Plastic v. Merrill Lynch, Pierce, Fenner & Smith, 756 F.2d 230 (2d Cir. 1985).

      4 See NYSE Information Memo No. 01-5 (March 7, 2001) and NYSE Information Memo No. 01-19 (July 20, 2001).

    • 02-68 Industry parties in California arbitration proceedings must waive contested California arbitrator disclosure standards if all parties who are investors, or associated persons with claims of statutory employment discrimination, have executed waiver agreements

      View PDF File

      INFORMATIONAL

      SEC Approves Rule Change to IM-10100

      Effective Date: On or After September 30, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Registered Representatives
      Registered Principals
      Senior Management

      Arbitration
      Associated Persons
      California Disclosure Standards Members



      Executive Summary

      The Securities and Exchange Commission (SEC or Commission) has approved amendments to IM-10100 of the NASD Code of Arbitration Procedure (Code) governing Failure to Act Under Provisions of Code of Arbitration Procedure.1 The amendments provide that members and associated persons involved in NASD arbitration proceedings in the State of California are required to waive application of California Ethics Standards for Neutral Arbitrators in Contractual Arbitration (the "California Standards") to their arbitration proceedings upon the request of investors or, in industry cases, of associated persons with claims of statutory employment discrimination, for a six-month pilot period (or until the conclusion of pending litigation contesting application of the standards to NASD).

      The new procedures will apply to the appointment of arbitrators on or after September 30, 2002, to serve in California arbitrations.

      The text of the rule change described in this Notice is included as Attachment A. A sample Memorandum to Parties and Counsel of Record and Waiver Agreement are included as Attachment B.

      Questions/Further Information

      Questions regarding this Notice may be directed to Jean I. Feeney, Chief Counsel and Associate Vice President, NASD Dispute Resolution, at (202) 728-6959, or e-mail, jean.feeney@nasd.com.

      Discussion

      For several months, NASD has taken many steps to address concerns raised by the California Standards, which NASD believes to be in conflict with the Code of Arbitration Procedure. Since July 1, 2002, NASD has postponed appointing arbitrators in arbitration proceedings scheduled to take place in California. Additional information on the history of this issue, and the measures NASD has taken to provide alternatives for parties, can be found in NASD's rule proposal, SR-NASD-2002-126,2 which was approved on an accelerated basis by the SEC on September 26, 2002.

      Effective September 30, 2002, NASD is implementing a six-month pilot amendment to IM-10100, "Failure to Act Under Provisions of Code of Arbitration Procedure," for cases that are affected by the new California Standards. The amendment requires industry parties to waive the California Standards in all cases in which all the parties in the case who are investors (referred to as "customers" in the Code) or associated persons with claims of statutory employment discrimination agree to waive application of the California Standards. Under such a waiver, the case would proceed in California under the existing NASD Code, which already contains extensive disclosure requirements and provisions for challenging arbitrators with potential conflicts of interest.

      NASD has resumed issuing lists of proposed arbitrators in California cases from which the parties select their panels under the current Neutral List Selection System (NLSS). NASD will send memoranda to investors and to associated persons with claims of statutory employment discrimination, giving them the option of waiving the California Standards and providing them with waiver forms. A sample of such a memorandum is attached to this Notice.

      NASD is also notifying industry parties in all pending California cases that they must waive the California Standards where the investors agree to a waiver (or associated persons, in the circumstances described above). Industry parties in such cases will be required to execute waiver agreements; however, their failure to do so will not stop the cases from moving forward and the failure to sign as required by the new rule will be referred for disciplinary action.

      Upon receipt of completed waiver forms signed by investors and their counsel, or by associated persons with claims ofstatutory employment discrimination and their counsel, NASD will immediatelycommence the arbitrator appointment process under existing NASD rules, and current NASD disclosure requirements.

      Effective Date

      The new procedures will apply to the appointment of arbitrators on or after September 30, 2002, to serve in California arbitrations.


      Endnotes

      1. Exchange Act Release No. 46562 (September 26, 2002) (File No. SR-NASD-2002-126).

      2. This rule filing may be found on the NASD Web site at: www.nasdadr.com/app_orders_index.asp#02-126.


      ATTACHMENT A

      Code of Arbitration Procedure

      IM-10100. Failure to Act Under Provisions of Code of Arbitration Procedure

      It may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2110 for a member or a person associated with a member to:

      (a) - (e) No change.
      (f) fail to waive the California Rules of Court, Division VI of the Appendix, entitled, "Ethics Standards for Neutral Arbitrators in Contractual Arbitration" (the "California Standards"), if all the parties in the case who are customers have waived application of the California Standards in that case; or
      (g) fail to waive the California Standards, if all the parties in the case who are associated persons with a claim alleging employment discrimination, including a sexual harassment claim, in violation of a statute have waived application of the California Standards in that case.

      (Remainder unchanged.)


      ATTACHMENT B

      NEW WAIVER OPTION EFFECTIVE SEPTEMBER 30, 2002

      MEMORANDUM

      TO: Parties and Counsel of Record
      FROM: NASD Dispute Resolution
      RE: New Waiver Option re: Appointment of Arbitrators In California
      DATE: September 30, 2002

      Effective September 30, 2002, customers in all cases and associated persons in cases involving employment discrimination claims may waive all rights and remedies they might otherwise be entitled to under the California Standards. Industry parties in such cases are required to execute waiver agreements. Upon receipt of the completed waiver form signed by all of the customers and their counsel, arbitrators will be appointed under existing NASD rules, and current NASD disclosure requirements.

      Since July 1, 2002, NASD has not appointed arbitrators in arbitration proceedings scheduled to take place in California. On that date, the state enacted Ethics Standards for Neutral Arbitrators ("California Standards"), which NASD and the Securities and Exchange Commission ("SEC") believe to be in conflict with the SEC-approved Code of Arbitration Procedure. These standards require significantly more disclosure by arbitrators of their financial and personal relationships; include provisions for arbitrators to be removed from a case on demand of a single party to the case; and also provide that an arbitrator's failure to provide the required disclosure is a basis for challenging the arbitration award in court. Trying to implement these standards would require NASD to violate its own SEC-approved rules, increase costs of arbitrations, reduce the number of arbitrators willing to serve on cases, and reduce the speed and certainty of arbitration proceedings. For these reasons, NASD and the New York Stock Exchange are challenging the California Standards in federal court in California.

      In July, NASD announced that it was taking steps to help investors deal with the delay in California cases. Specifically, we said we would provide venue changes for arbitration cases and absorb the extra administrative costs associated with the change of venue, using non-California arbitrators when appropriate. To accommodate cases being heard outside of California, we added Reno, Nevada as a new hearing location to the existing sites in Portland, Oregon; Seattle, Washington; Phoenix, Arizona; and Las Vegas, Nevada. On September 3, we further enhanced the venue selection for investors by announcing that cases would be moved outside of California at the request of an investor; industry party acquiescence is no longer required.

      We also encouraged parties to mediate their disputes by waiving our administrative fees for NASD-sponsored mediations, and assigning mediators who agreed to reduce their usual hourly rate. Finally, we assigned arbitrators from outside of California to all simplified arbitration cases, that is, claims involving under $25,000 that are decided by a single arbitrator without a hearing.

      In a further effort to provide arbitration hearings to parties who do not wish to travel outside of California or mediate, NASD has adopted a rule permitting arbitrators to be appointed in cases in California where customers waive the application of the California Standards to their arbitration proceedings. This rule was approved by the Securities and Exchange Commission on September 26, 2002, and is effective on Monday, September 30, 2002.

      The new rule provides that arbitrators will be appointed under existing NASD rules, and current NASD disclosure requirements, in cases where all of the customers and their counsel agree to waive all rights and remedies they might otherwise be entitled to under the California Standards. If all of the customers agree to waive the California Standards, then the rule requires industry parties (securities firms and their associated persons, a technical term for securities industry employees) to do the same. This rule applies to customers, whether they are the claimants or the respondents in an arbitration.

      In intra-industry cases involving claims of statutory employment discrimination, the rule provides that if associated persons and their counsel waive the California Standards, then the firms they are suing must also waive them. The rule does not apply to associated persons bringing non-statutory employment claims or other claims against firms or other associated persons; and it does not apply to associated persons who are respondents in a claim brought by a customer or another associated person.

      Customers and associated persons who want to have arbitrators appointed under current NASD rules must execute the attached Waiver Form and return it to NASD. Customers and associated persons who execute the waiver form acknowledge that the arbitrator disclosure requirements under NASD rules are different from and not as expansive as the disclosure requirements under the California Standards. They agree that they are arbitrating their cases under NASD rules and the Federal Arbitration Act, and not under the California Standards, and they agree that they will not seek to challenge the arbitration or arbitrators for failure to comply with the California Standards. Customers and associated persons should seek the advice of counsel before executing this waiver form, and counsel must also sign the form for the waiver to be effective.

      Industry parties in all pending California cases must waive the California Standards where the investor (or associated person, in the circumstances described above) agrees to a waiver. Industry parties in such cases will be required to execute waiver agreements; however, their failure to do so will not stop the cases from moving forward and the failure to sign as required by the proposed rule change will be referred for disciplinary action to the NASD Regulatory Policy and Oversight Division.

      NASD will start the arbitrator appointment process immediately for customers (in all cases) or associated persons (in employment discrimination cases) who execute and return the enclosed Waiver Forms.

      This procedure is available for customers (or associated persons with employment discrimination claims) who:

      • Have filed claims, but have not yet received arbitrator ranking forms;
      • Have received arbitrator ranking forms that are not yet due to be returned;
      • Have timely returned their arbitrator ranking forms, but have not been provided the names of the selected arbitrators;
      • Have received the names of their arbitrators, but a replacement arbitrator is needed; and
      • Have agreed to a non-California hearing location, but would prefer to have the case heard in California, with California arbitrators, now that this option is available (submission of the waiver form will render the agreement to use a non-California hearing location null and void).

      Completed forms should be mailed or faxed to:

      NASD Dispute Resolution
      300 South Grand Avenue
      Suite 900
      Los Angeles, CA 90071
      Facsimile: 213-613-2677

      WAIVER AGREEMENT

      The undersigned parties hereby agree that this arbitration shall be governed by the NASD Code of Arbitration Procedure and the Federal Arbitration Act, notwithstanding any contrary federal or state substantive or procedural law. In particular, the parties agree that the provisions of the NASD Code of Arbitration Procedure, specifically including its arbitrator disclosure requirements, arbitrator selection procedures, and arbitrator disqualification provisions, and not any provisions of the California Ethics Standards for Neutral Arbitrators in Contractual Arbitration in California ("California Standards"), will apply in this arbitration. The California Standards shall have no application whatsoever to any aspect of this arbitration, including without limitation any proceedings to obtain judicial review or judicial enforcement of any arbitration award that may be entered in this arbitration.

      The parties accept the disclosures required under the NASD Code of Arbitration Procedure as fully sufficient for purposes of this case, notwithstanding the fact that such disclosures may be less extensive than those required by the California Standards in cases to which those Standards apply. The parties further accept that the NASD Code of Arbitration Procedure's disqualification procedures vest the ultimate authority in the Director of Arbitration to determine whether to disqualify an arbitrator, whereas the California Standards purport to eliminate the Director of Arbitration's discretion in determining whether to disqualify arbitrators. In recognition of these, and other, variances between the NASD Code of Arbitration Procedure and the California Standards, the parties hereby expressly waive any and all rights, obligations, and/or benefits that might be conferred on them by the California Standards in this arbitration, expressly agree that they will not seek to enforce any rights or claim any remedies under or pursuant to the California Standards in any court, proceeding or forum in any matter relating to this arbitration, and expressly and irrevocably release any claim or claims that they may have based on the California Standards in connection with this arbitration or any proceedings relating thereto.

      In addition, and without limiting in any way the scope of the waiver and release set forth in the foregoing paragraph, the parties specifically agree not to assert, in any forum, that non-compliance with the California Standards is a basis for challenging the validity of any arbitrator or of any arbitration award, whether asserted during the arbitration proceeding or after an arbitration award has been issued. The parties also specifically agree not to seek any relief against NASD Dispute Resolution or NASD, or any arbitrator, for any failure to comply with the Standards.

      The parties understand and acknowledge that this waiver and release applies to and includes all unknown or unsuspected consequences or results arising from or relating to the parties' waiver of any and all rights under the California Standards in connection with this arbitration. The parties represent and warrant that they have read the contents of California Civil Code section 1542, which provides as follows:

      "A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected this settlement with the debtor."

      The Parties Expressly Waive Any and All Rights and Benefits Under California Civil Code Section 1542.


      ______________________________________ ______________________________________
      Date: Date:
      Claimant(s): Respondent(s): (Print here)
       
      ______________________________________ ______________________________________
      Claimant (print and sign above) Counsel for Respondent
       
      ______________________________________ ______________________________________
      Claimant (print and sign above) Counsel for Respondent
       
      ______________________________________ ______________________________________
      Claimant (print and sign above) Counsel for Respondent
       
      ______________________________________ ______________________________________
      Counsel for Claimant
      (add signature lines if additional space needed)
       

    • 02-67 Broker/Dealer, Investment Adviser Firm, Agent and Investment Adviser Representative Renewals for 2003

      View PDF File

      ACTION REQUIRED

      Broker/Dealer and Investment Adviser Renewal Program

      Payment Deadline: December 6, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Legal & Compliance
      Operations
      Registered Representatives
      Registration
      Senior Management

      IARDSM
      Maintenance Fees
      Renewals
      Registration
      Web CRDSM



      Executive Summary

      The 2003 NASD Broker/Dealer and Investment Adviser Registration Renewal Program begins on November 4, 2002, when online Preliminary Renewal Statements are made available to all firms on Web CRDSM/IARDSM. This annual program simplifies the registration renewal process for more than 21,000 Broker/Dealer (BD) and Investment Adviser (IA) firms and approximately 700,000 registered representatives and 100,000 investment adviser representatives by allowing the payment of one amount to NASD by the published deadline. There are two significant changes to the program this year. This is the first year that NASD will collect investment adviser representative (RA) Renewal Fees on behalf of participating state regulators. Also, NASD will assess a Late Payment Fee to all NASD members that do not pay by the 2003 Renewal payment deadline of December 6, 2002.

      Renewal Statements will include the following fees: NASD Web CRD/IARD System Processing Fees, NASD Branch Office Fees, as well as New York Stock Exchange (NYSE), American Stock Exchange (Amex), Chicago Board Options Exchange (CBOE), International Securities Exchange (ISE), Pacific Exchange (PCX) and Philadelphia Stock Exchange (PHLX) Maintenance Fees. The statement will also include state Agent, state Broker/Dealer, and if applicable, state Investment Adviser Firm and Representative Renewal Fees.

      Members should read this Notice to Members; any instructions posted to the NASD Web Site, www.nasd.com; the Investment Adviser Web Site (where applicable), www.iard.com; The Bulletin; and any other mailed information to ensure continued eligibility to do business in the states effective January 1, 2003. Any Renewal processing changes subsequent to the publishing of this Notice to Members will be provided to you in a Special Notice to Members.

      Questions concerning this Notice may be directed to the Gateway Call Center at (301) 869-6699.

      Preliminary Renewal Statements

      Beginning November 4, 2002, Preliminary Renewal Statements will be available for viewing and printing for all firms on Web CRD/IARD. The statements will include the following fees: Web CRD/IARD System Processing Fees, NASD Branch Office Fees, NYSE, Amex, CBOE, ISE, PCX and PHLX Maintenance Fees, state Agent Renewal Fees, state Broker/Dealer, and if applicable, Investment Adviser Firm and Representative Renewal Fees. NASD must receive full payment of the November Preliminary Renewal Statement amount no later than December 6, 2002.

      If payment is NOT received by the December 6, 2002, Payment Due Date, NASD member firms will be assessed a RENEWAL LATE PAYMENT FEE. This Renewal Late Payment Fee will be included as part of the member firm's Final Renewal Statement and will be calculated as follows: 10% of a member firm's cumulative Final Renewal Assessment or $100, whichever is greater, with a cap of $5,000. Please see Notice to Members 02-48 for details.

      Fees

      Beginning with this 2003 Renewal Program, NASD Personnel Assessment Fees will no longer be assessed through the annual Renewal Program. NASD will mail all NASD member firms a separate billing during the 1st quarter of 2003. Please see Notice to Members 02-41 for more details.

      A fee of $30.00 will be assessed for each person who renews his/her registration with any regulator through Web CRD.

      The RA Renewal System Processing Fee of $45.00 will be assessed for every Investment Adviser Representative who renews through the IARD Program.

      The IARD Firm System Fee of $100.00 will be assessed for every state-registered Investment Adviser firm that renews through the IARD.

      The NASD Branch Office Assessment Fee of $75 per branch, based on the number of active NASD branches as of December 31, 2002, will be assessed.

      Renewal Fees for NYSE, Amex, CBOE, PCX, ISE, PHLX, and state affiliations are also assessed in the Preliminary Renewal Statement on Web CRD. NYSE, Amex, CBOE, PCX, ISE and PHLX and state Maintenance Fees collected by NASD for firms that are registered with those exchanges, as well as NASD, are based on the number of NYSE, Amex, CBOE, PCX, ISE and PHLX and state-registered personnel employed by the member firm.

      Beginning this year with the 2003 Renewal Program, the State of California will collect its firm Broker/Dealer Renewal Fees through Web CRD. However, California will not collect its Agent (AG) Renewal Fees through the Renewal Program. Firms registered in California should contact the state directly to ensure compliance with Renewal requirements. In addition, some participating states may require steps beyond the payment of Renewal Fees to NASD to complete the Broker/Dealer or Investment Adviser Renewal process. Firms should contact each jurisdiction directly for further information on state renewal requirements. See the NASD Web Site for an SRO/State Directory.

      For detailed information regarding Investment Adviser renewals, you may also visit the Investment Adviser Web Site, www.iard.com. A matrix that includes a list of Investment Adviser Renewal Fees for states that participate in the 2003 IARD Investment Adviser Renewal Program is posted at www.iard.com/pdf/reg_directory.pdf.

      Renewal Payment

      Beginning with this Renewal Program, firms will be able to submit electronic payments through a Web-based application known as Web CRD/IARD E-Pay. The E-Payment application is accessible from either the NASD (www.nasdr.com/3400.asp) or IARD (www.iard.com) Web Sites and allows firms to make an ACH payment from a designated bank account to their Web CRD/IARD Renewal Account. In order for funds to be posted to your firm's Renewal account by December 6, 2002, payment must be submitted electronically, no later than 8:30 p.m., Eastern Time (ET), on December 4, 2002.

      Payment of the Preliminary Renewal Statement may also be made either in the form of a check made payable to NASD, or by bank wire transfer. The check should be drawn on the firm's account, with the firm's CRD Number included on the front of the check, along with the word "Renewals."

      Submit all Renewal Payments, along with a printout of the first page of your online Preliminary Renewal Statement directly to:

      U.S. Mail

      NASD, CRD-IARD
      P.O. Box 7777-W8705
      Philadelphia, PA 19175-8705

      (Note: This P.O. Box will not accept courier or overnight deliveries)

      or

      Express/Overnight Delivery

      NASD, CRD-IARD
      W8705
      c/o Mellon Bank, Rm 3490
      701 Market Street
      Philadelphia, PA 19106
      Telephone No: (301) 869-6699

      Use the full address, including the "W8705" number in either address to ensure prompt processing.

      Please note: The addresses for Renewal Payments are different from the addresses for funding your firm's CRD or IARD Daily Account.

      Check Instructions:

      To ensure prompt processing of your Renewal Payment check:

      • Include a printout of the first page of your Preliminary Renewal Statement with payment.


      • Do not include any other forms or fee submissions.


      • Write your firm's CRD Number and the word "Renewals" on the check memo line.


      • Be sure to send your payment either in the blue, pre-addressed Renewal envelope that will be mailed to you, or write the address on an envelope exactly as noted in this Notice.

      Wire Payment Instructions:

      Firms may wire full payment of the Preliminary Renewal Statement by requesting their bank to initiate the wire transfer to: "The Riggs National Bank in Washington, DC". You will need to provide your bank the following information:

      Transfer funds to: Riggs National Bank in Washington, DC
      ABA Number: 054-000030
      Beneficiary: NASD
      NASD Account Number: 086-761-52
      Reference Number: Firm CRD Number and the word "Renewals"

      To ensure prompt processing or your Renewal Payment by wire transfer:

      • Remember to inform your bank the funds are to be credited to the NASD Bank Account.


      • Provide your firm's CRD Number and the word "Renewals" as reference only.


      • Record the Confirmation Number of the wire transfer given by your bank.

      Members are advised that failure to return full payment of their Preliminary Renewal Statement to NASD by the December 6, 2002, deadline could cause a member to become ineligible to do business in the jurisdictions effective January 1, 2003.

      Renewal Reports

      Beginning November 4, 2002, the Renewal Reports are available to request, print, and/or download via Web CRD and IARD. There will be three reports available for reconciliation with the Preliminary Renewal Statement. All three reports will also be available as downloads:

      • Firm Renewal Report - applicable to Broker/Dealer and Investment Adviser Firms. This report lists individuals included in the 2003 Renewal processing and includes Billing Codes (if they have been supplied by the firm).


      • Branches Renewal Report - applicable to NASD members. This report lists each branch registered with NASD and lists branch offices for which the firm is being assessed a fee. Firms should use this report to reconcile their records for Renewal purposes.


      • Approved AG Reg Without NASD Approval Report - applicable to NASD members. This report contains all individuals who are not registered with NASD but are registered with one or more jurisdictions. This roster should be used to determine if any NASD registrations should be requested or jurisdictions terminated.

      Filing Form U-5

      If Forms U-5 (either Full or Partial) are filed electronically via Web CRD by 11:00 p.m., ET, November 1, for Agents (AGs)/Investment Adviser Representatives (RAs) terminating in one or more jurisdiction affiliations, for 2002, those individuals' Renewal Fees will not be included on the Preliminary Renewal Statement.

      The deadline for electronic filing of Forms U-5 for firms that want to terminate an Agent affiliation before year-end 2002 is 6:00 p.m., ET, on December 21, 2002. Firms may file both Partial and Full Forms U-5 with a post-dated termination date of December 31, 2002. (This is the only date that can be used for a post-dated Form U-5.) For more detailed information on post-dated Forms U-5, see the section titled "Post-Dated Form Filings" below.

      Filing Form BDW

      The CRD Phase II Program allows firms requesting Broker/Dealer termination (either full or partial) to electronically file their Forms BDW via Web CRD. Firms that file either a Full or Partial Form BDW by 11:00 p.m., ET, November 1, 2002, will avoid the assessment of the applicable Renewal Fees on the Preliminary Renewal Statement, provided that the regulator is a CRD Phase II participant. Currently, there are four regulators that participate in Web CRD Renewals for agent fees but do not participate in CRD Phase II:

      • American Stock Exchange


      • New York Stock Exchange


      • Pacific Exchange


      • Philadelphia Stock Exchange

      Firms requesting termination with any of the above-listed regulators must submit a paper Form BDW directly to the regulator, as well as submit one electronically to Web CRD.

      The deadline for electronic filing of Forms BDW for firms that want to terminate an affiliation before year-end 2002 is 6:00 p.m., ET, December 21, 2002. This same date applies to the filing of Forms BDW with regulators that are not Phase II participants. For information regarding the post-dating of Forms BDW with the termination date of December 31, 2002, see the section below titled "Post-Dated Form Filings."

      Filing Forms ADV to Cancel Notice Filings or Forms ADV-W to Terminate Registrations

      Firms that file either a Form ADV Amendment, unmarking a state, (generating the Status of "Removal Requested at End of Year") or a Full or Partial Form ADV-W by 11:00 p.m., ET, November 1, 2002, will avoid the assessment of the applicable Renewal Fees on their Preliminary Renewal Statement.

      The deadline for electronic filing of Form ADV Amendments or Forms ADV-W for firms that want to cancel a Notice Filing or terminate a state registration before year-end 2002 is 6:00 p.m., ET, December 21, 2002. For information regarding post-dating Form ADV-W with the termination date of December 31, 2002, for state registrations, see the following section.

      Post-Dated Form Filings

      Firms can begin electronically filing post-dated Forms U-5, BDW, Schedule E, and ADV-W via Web CRD/IARD on November 1, 2002. This program allows firms to file a termination form on, or after, November 1, with a termination date of December 31, 2002. Firms that submit post-dated termination filings will not be assessed Renewal Fees for the terminated jurisdictions on the Final Renewal Statement in January 2003.

      Between November 1 and December 21, 2002, firms may process Forms U-5, BDW, Schedule E, and ADV-W (both partial and full terminations) with a post-dated termination date of December 31, 2002. (This is the only date that can be used for a post-dated form filing.) If a Form U-5, BDW, Schedule E, or ADV-W indicates a termination date of December 31, 2002, an agent, Broker/Dealer and/or Investment Adviser (firm) and investment adviser representative (RA) may continue doing business in the jurisdiction until the end of the calendar year without being assessed 2003 Renewal Fees. Please ensure that electronic Forms U-5, BDW, Schedule E, and ADV-W are filed by the Renewal filing deadline date of 6:00 p.m., ET, on December 21, 2002.

      Members should exercise care when submitting post-dated Forms U-5, BDW, Schedule E, and ADV-W. NASD will systematically process these forms as they are submitted and cannot withdraw a post-dated termination once submitted and processed. A member that files a post-dated termination in error would have to file, electronically, a new Form U-4, BD Amendment or ADV when Web CRD/IARD resumes filing processing on January 2, 2003. New registration fees would be assessed as a result.

      Removing Open Registrations

      Beginning November 4, 2002, member firms will be able to request, via Web CRD, the "Approved AG Reg Without NASD Approval" Report. This report identifies agents whose NASD registration is either terminated or has been changed to a "purged" status due to the existence of a deficient condition (i.e., Exams or Fingerprints) but maintain an approved registration with a state. Member firms should use this roster to terminate obsolete state registrations through the submission of Forms U-5 or reinstate the NASD licenses through the filing of a Form U-4 Amendment. This roster should aid in the reconciliation of personnel registrations prior to year's end. The "Approved AG Reg Without NASD Approval" Report will also advise a firm if there are no agents within this category.

      Final Renewal Statements

      Beginning January 2, 2003, NASD will make available Final Renewal Statements via Web CRD and IARD. These statements will reflect the final status of Broker/Dealer, Registered Representative (AG), Investment Adviser Firm and Investment Adviser Representative (RA) registrations and/or Notice Filings as of December 31, 2002. Any adjustments in fees owed as a result of registration terminations, approvals, Notice Filings or Transitions, subsequent to the processing/posting of the Preliminary Renewal Statement will be made in the Final Renewal Statement on Web CRD.

      • If a firm has more agents, branch offices, or jurisdictions registered and/or Notice Filed on Web CRD and IARD at year's end than it did when the Preliminary Renewal Statement was generated, additional fees will be assessed.


      • If a firm has fewer agents, branch offices, or jurisdictions registered and/or Notice Filed at year end than it did when the Preliminary Renewal Statement was generated, a credit/refund will be issued. Beginning this 2003 Renewal Program, all 2003 Renewal overpayments will be systemically transferred to firms' Daily Accounts on January 6, 2003. Refund requests will be made from this account.

      After January 2, 2003, NASD member firms and "Joint" firms should access the Web CRD Reports function for the Firm Renewal Report, which will list all renewed personnel with the NASD, NYSE, Amex, CBOE, PCX, ISE, PHLX, and each jurisdiction. Agents and RAs whose registrations are "Approved" in any of these jurisdictions during November and December will be included in this roster. Registrations that are "Pending Approval" or are "Deficient" at year's end will not be included in the Renewal Program. Member firms will also be able to request the Branches Renewal Report that lists all NASD branches for which they have been assessed. Download versions of these reports will also available.

      Firms have until March 14, 2003, to report any discrepancies on the Renewal Reports. Firms should contact all jurisdictions directly in writing. Specific information and instructions concerning the Final Renewal Statements and Renewal Reports will appear in the January 2003 issue of Notices to Members. Firms may also refer to the Fall Bulletin, which is devoted entirely to Renewals and will be mailed to all firms. The blue Renewal payment envelope will be included with The Bulletin that will be sent to firms. The Bulletin will also be available for viewing on the CRD Page of the NASD Web Site.

    • 02-66 SEC Approves NASD Rule 2315; Recommendations to Customers in OTC Equity Securities

      View PDF File

      INFORMATIONAL

      OTC Equity Securities

      Effective Date: October 30, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management
      Trading

      NASD Rule 2315
      OTC Equity Securities



      Executive Summary

      On August 22, 2002, the Securities and Exchange Commission (SEC) approved new NASD Rule 2315, Recommendations to Customers in OTC Equity Securities (Recommendation Rule). The Rule generally requires a member to review current financial statements and material business information before recommending transactions in low-priced over-the-counter equity securities.1 The Rule supplements the federal securities laws and existing NASD rules, including suitability obligations and the requirement that any recommendation to a customer have a reasonable basis. The Rule also exempts certain transactions.

      The Notice provides a general overview of the Rule. Members should carefully read the text of the Rule (Attachment A). The SEC Approval Order also appears with this Notice (Attachment B).

      Question/Further Information

      Questions concerning this Notice should be directed to Philip Shaikun, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8451.

      Background and Discussion

      Rule 2315 is intended to address abuses in transactions involving thinly capitalized ("microcap") securities. The Rule mandates that a member conduct a due diligence review of an issuer's current financial and business information before recommending that issuer's microcap securities. Since the Rule does not supercede existing member obligations when recommending a security - e.g., suitability determination - compliance does not provide a safe harbor for recommendations of microcap securities.

      Requirements

      The Rule requires a member to review "current financial statements" and "current material business information" before it recommends the purchase or short sale of microcap securities. The Rule does not apply to recommendations to sell long positions.

      The Rule applies to those securities that are published in a "quotation medium" and are either (1) not listed on NASDAQ or a national securities exchange or (2) are listed on a regional securities exchange and do not qualify for dissemination of transaction reports via the Consolidated Tape. The Rule defines "quotation medium" as (1) any system of general circulation to brokers or dealers that regularly disseminates quotation or indications of interest of identified brokers or dealers or (2) any publication, alternative trading system or other device that is used by brokers or dealers to disseminate quotations or indication of interest to others.2

      The Rule defines "current financial statements" to include balance sheets, statements of profit and loss and publicly available financial statements and reports. The Rule makes distinctions in the definition as applied to foreign private issuers and all other issuers. For example, the Rule recognizes that the customary accounting periods and filing requirements of foreign issuers differ from domestic issuers. Accordingly, the Rule imposes different review periods for those foreign issuers. The Rule also limits review of financial filings to those that are publicly available and filed with the issuer's principal financial or securities regulatory authority in its home jurisdiction.

      The term "current material business information" has been interpreted to mean information that is available or relates to events that have occurred in the 12 months prior to the recommendation.

      The requisite review must be conducted by a Series 24 principal or someone supervised by a Series 24 principal. Members are required to keep a written record of the information reviewed, the date of the review, and the name of the person who conducted the review.

      Exemptions

      The Rule provides NASD with general exemptive authority. Furthermore, the Rule expressly exempts the following transactions:

      • Transactions that meet the requirements of Rule 504 of Regulation D under the Securities Act of 1933 (Securities Act) and transactions with an issuer not involving any public offering pursuant to Section 4(2) of the Securities Act.


      • Transactions with an "institutional account" under Rule 3110(c)(4), a "qualified institutional buyer" under Rule 144A of the Securities Act, or a "qualified purchaser" under Section 2(a)(51) of the Investment Company Act of 1940.


      • Transaction in the securities of issuers with at least $50 million in assets and $10 million in shareholder equity as reflected in the issuer's most recent audited "current financial statements."


      • Transactions in securities of a bank or insurance company that is subject to regulation by a state or federal bank or insurance authority.


      • Transactions in securities of an issuer that have had an average daily volume of $100,000 during each of the preceding 6 calendar months and any convertible security based on an underlying security that meets this requirement.


      • Transactions in securities that have a bid of at least $50 per share, as published in a quotation medium.

      Effective Date

      The Rule becomes effective on October 30, 2002.


      Endnotes

      1 NASD originally had intended to make the Recommendation Rule consistent with the SEC's reproposed Exchange Act Rule 15c2-11. The SEC has not yet acted on that reproposal, which published for comment on March 5, 1999. NASD will consider amending the Recommendation Rule after any Commission action on the reproposal.

      2 The Rule's definition of "quotation medium" is consistent with the definition of that term in the SEC's reproposed Exchange Act Rule 15c2-11. The SEC's reproposal does not expressly include indications of interest, but incorporates them through its definition of "quotation." The Recommendation Rule does not define "quotation."


      ATTACHMENT A

      New text is underlined


      2315. Recommendations to Customers in OTC Equity Securities

      Preliminary Note: The requirements of this Rule are in addition to other existing member obligations under NASD rules and the federal securities laws, including obligations to determine suitability of particular securities transactions with customers and to have a reasonable basis for any recommendation made to a customer. This Rule is not intended to act or operate as a presumption or as a safe harbor for purposes of determining suitability or for any other legal obligation or requirement imposed under NASD rules or the federal securities laws.
      (a) Review Requirement
      No member or person associated with a member shall recommend that a customer purchase or sell short any equity security that is published or quoted in a quotation medium and that either (1) is not listed on Nasdaq or on a national securities exchange or (2) is listed on a regional securities exchange and does not qualify for dissemination of transaction reports via the Consolidated Tape, unless the member has reviewed the current financial statements of the issuer, current material business information about the issuer, and made a determination that such information, and any other information available, provides a reasonable basis under the circumstances for making the recommendation.
      (b) Definitions
      (1) For purposes of this Rule, the term "current financial statements" shall include:
      (A) For issuers that are not foreign private issuers,
      (i) a balance sheet as of a date less than 15 months before the date of the recommendation;
      (ii) a statement of profit and loss for the 12 months preceding the date of the balance sheet;
      (iii) if the balance sheet is not as of a date less than 6 months before the date of the recommendation, additional statements of profit and loss for the period from the date of the balance sheet to a date less than 6 months before the date of the recommendation;
      (iv) publicly available financial statements and other financial reports filed during the 12 months preceding the date of the recommendation and up to the date of the recommendation with the issuer's principal financial or securities regulatory authority in its home jurisdiction, including the Commission, foreign regulatory authorities, bank and insurance regulators; and
      (v) all publicly available financial information filed with the Commission during the 12 months preceding the date of the recommendation contained in registration statements or Regulation A filings.
      (B) For foreign private issuers,
      (i) a balance sheet as of a date less than 18 months before the date of the recommendation;
      (ii) a statement of profit and loss for the 12 months preceding the date of the balance sheet;
      (iii) if the balance sheet is not as of a date less than 9 months before the date of the recommendation, additional statements of profit and loss for the period from the date of the balance sheet to a date less than 9 months before the date of the recommendation, if any such statements have been prepared by the issuer; and
      (iv) publicly available financial statements and other financial reports filed during the 12 months preceding the date of the recommendation and up to the date of the recommendation with the issuer's principal financial or securities regulatory authority in its home jurisdiction, including the Commission, foreign regulatory authorities, bank and insurance regulators.
      (2) For purposes of this Rule, the term "quotation medium" shall mean any:
      (A) System of general circulation to brokers or dealers that regularly disseminates quotations or indications of interest of identified brokers or dealers; or
      (B) Publication, alternative trading system or other device that is used by brokers or dealers to disseminate quotations or indications of interest to others.
      (c) Compliance Requirements
      (1) A member shall designate a registered person to conduct the review required by this Rule. In making such designation, the member must ensure that:
      (A) Either the person is registered as a Series 24 principal, or the person's conduct in complying with the provisions of this Rule is appropriately supervised by a Series 24 principal; and
      (B) Such designated person has the requisite skills, background and knowledge to conduct the review required under this Rule.
      (2) The member shall document the information reviewed, the date of the review, and the name of the person performing the review of the required information.
      (d) Additional Review Requirement for Delinquent Filers
      If an issuer has not made current filings required by the issuer's principal financial or securities regulatory authority in its home jurisdiction, including the Commission, foreign regulatory authorities, or bank and insurance regulators, such review must include an inquiry into the circumstances concerning the failure to make current filings, and a determination, based on all the facts and circumstances, that the recommendation is appropriate under the circumstances. Such a determination must be made in writing and maintained by the member.
      (e) Exemptions
      (1) The requirements of this Rule shall not apply to:
      (A) Transactions that meet the requirements of Rule 504 of Regulation D under the Securities Act of 1933 ("Securities Act") and transactions with an issuer not involving any public offering pursuant to Section 4(2) of the Securities Act;
      (B) Transactions with or for an account that qualifies as an "institutional account" under Rule 3110(c)(4) or with a customer that is a "qualified institutional buyer" under Rule 144A promulgated under the Securities Act or "qualified purchaser" under Section 2(a)(51) of the Investment Company Act of 1940;
      (C) Transactions in an issuer's securities if the issuer has at least $50 million in total assets and $10 million in shareholder's equity as stated in the issuer's most recent audited current financial statements, as defined in this Rule;
      (D) Transactions in securities of a bank as defined in Section 3(a)(6) of the Securities Exchange Act of 1934 and/or insurance company subject to regulation by a state or federal bank or insurance regulatory authority;
      (E) A security with a worldwide average daily trading volume value of at least $100,000 during each month of the six full calendar months immediately before the date of the recommendation;
      (F) A convertible security, if the underlying security meets the requirement of Section (e)(1)(E) of this Rule;
      (G) A security that has a bid price, as published in a quotation medium, of at least $50 per share. If the security is a unit composed of one or more securities, the bid price of the unit divided by the number of shares of the unit that are not warrants, options, rights, or similar securities must be at least $50; or
      (2) Pursuant to the Rule 9600 Series, NASD, for good cause shown after taking into consideration all relevant factors, may exempt any person, security or transaction, or any class or classes of persons, securities or transactions, either unconditionally or on specified terms, from any or all of the requirements of this Rule if it determines that such exemption is consistent with the purpose of this Rule, the protection of investors, and the public interest.

      PROCEDURES FOR EXEMPTIONS

      9610. Application

      (a) Where to File
      A member seeking exemptive relief as permitted under Rules 1021, 1070, 2210, 2315, 2320, 2340, 2520, 2710, 2720, 2810, 2850, 2851, 2860, Interpretive Material 2860-1, 3010(b)(2), 3020, 3210, 3230, 3350, 8211, 8212, 8213, 11870, or 11900, Interpretive Material 2110-1, or Municipal Securities Rulemaking Board Rule G-37 shall file a written application with the appropriate department or staff of the Association and provide a copy of the application to the Office of General Counsel of NASD Regulation.
      (b) through (c) No change.

      ATTACHMENT B

      Securities and Exchange Commission

      (Release No. 34-46376; File No. SR-NASD-99-04)

      August 19, 2002

      Self-Regulatory Organizations; Order Approving Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 2 to the Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Microcap Initiative - Recommendation Rule

      I. Introduction

      On February 19, 1999, the National Association of Securities Dealers, Inc. ("NASD" or "Association"), through its wholly owned subsidiary, NASD Regulation, Inc. ("NASD Regulation") filed with the Securities and Exchange Commission ("SEC" or "Commission") pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 ("Act")1 and Rule 19b-4 thereunder,2 a proposed rule change that would require members to review current financial statements of, and current material business information about, an issuer prior to recommending a transaction to a customer in an over-the-counter ("OTC") equity security.
      The proposed rule change was published for comment in the Federal Register on March 1, 1999.3 The Commission received six comment letters on the Original Proposal. On January 11, 2002, the NASD filed Amendment No. 1 to the proposed rule change, which among other things addressed the issues raised by commenters.4 Amendment No. 1 was published for comment in the Federal Register on January 22, 2002.5 On July 26, 2002, the NASD filed Amendment No. 2 to the proposed rule change.6
      The Commission received no comments regarding the proposal as amended. This order approves the proposed rule change, as amended.

      II. Description of Proposal

      To respond to concerns about abuses in the trading and sales of thinly traded, thinly capitalized securities (i.e., microcap securities) quoted in the OTC market, NASD Regulation has proposed to amend NASD rules to include new NASD Rule 2315, entitled "Recommendations to Customers in OTC Equity Securities" ("Recommendation Rule" or "Rule"). In the view of NASD Regulation, the lack of reliable and current financial information about issuers of microcap securities can create the potential for fraud and manipulation.
      The proposed rule would be limited to equity securities that are published or quoted in a quotation medium and that either: (1) are not listed on Nasdaq or a national securities exchange, or (2) are listed on a regional securities exchange and do not qualify for dissemination of transaction reports via the Consolidated Tape ("covered securities").7 The requirements in the Recommendation Rule is intended to supplement requirements under the federal securities laws and under NASD rules that a broker-dealer that recommends securities to its customers is required to have a reasonable basis for those recommendations.8 In addition, the proposed rule is not intended to act or operate as a presumption or as a safe harbor for purposes of determining suitability or for any other legal obligation or requirement imposed under NASD rules or the federal securities laws.
      A. Review Requirements
      Proposed NASD Rule 2315 would require a member and its associated persons to review the current financial statements of an issuer and current material business information about an issuer prior to recommending the purchase or short sale of any OTC equity security to a customer.9 Under the proposed rule, members must designate a person who is registered as a Series 24 principal, or who is supervised by a Series 24 principal, to conduct the required review. The person designated by the member must have the requisite skills, background and knowledge to conduct the review. Members are also required to document the information reviewed, the date of the review, and the name of the person performing the review of the required information.
      B. Information to be Reviewed
      As stated above, members must review the "current financial statements" of the issuer, as well as "current material business information" about the issuer, before recommending the purchase or short sale of an OTC security. NASD Regulation has stated that current material business information includes material information that is available or relates to events that have occurred within the last 12 months prior to the recommendation. Under the Recommendation Rule, because of differences in accounting practices, what constitutes "current financial statements" depends on whether the issuer is or is not a foreign private issuer.
      1. Issuers that are not foreign private issuers
      The current financial statements of issuers that are not foreign private issuers that must be reviewed prior to a recommendation to purchase or sell short a covered security are as follows:
      • publicly available financial statements and other financial reports filed during the 12 months preceding the date of the recommendation with the issuer's principal financial or securities regulatory authority in its home jurisdiction;


      • all publicly available financial information filed with the Commission during the 12 months preceding the date of the recommendation contained in registration statements or Regulation A filings;


      • a balance sheet as of a date less than 15 months before the date of recommendation; and


      • a statement of profit and loss for the 12 months preceding the date of the balance sheet.
      However, if the balance sheet is not as of a date less then 6 months before the date of the recommendation, the member must review additional statements of profit and loss for the period from the date of the balance sheet to a date less than 6 months before the date of the recommendation.
      2. Issuers that are foreign private issuers
      The current financial statements of issuers who are foreign private issuers that must be reviewed prior to a recommendation for purchase or short sale are as follows:
      • publicly available financial statements and other financial reports filed during the 12 months preceding the date of the recommendation and up to the date of the recommendation with the issuer's principal financial or securities regulatory authority in its home jurisdiction, including the Commission, foreign regulatory authorities, bank and insurance regulators;


      • a balance sheet as of a date less than 18 months before the date of the recommendation; and


      • a statement of profit and loss for the 12 months preceding the date of the balance sheet.
      However, if the balance sheet is not as of a date less than 9 months before the date of the recommendation, the member must review additional statements of profit and loss for the period from the date of the balance sheet to a date less than 9 months before the date of the recommendation, if any such statements have been prepared by the issuer.
      In addition, if any issuer has not made current filings required by the issuer's principal financial or securities regulatory authority in its home jurisdiction, including the Commission, foreign regulatory authorities, or bank and insurance regulators, the required review must include an inquiry into the circumstances concerning the failure to make current filings, and a determination, based on all the facts and circumstances, that a recommendation is appropriate under the circumstances. Such a determination must be made in writing and maintained by the member.
      C. Exemptions
      Under the Recommendation Rule, there are several transactions that are not subject to the Rule. Broker-dealers are not required to comply with the Recommendation Rule when effecting the following transactions:
      • transactions that meet the requirements of Rule 504 of Regulation D of the Securities Act of 1933 ("Securities Act")10 and transactions by11 an issuer not involving any public offering pursuant to Section 4(2) of the Securities Act;12


      • transactions with or for an account that qualifies as an "institutional account" under NASD Rule 3110(c)(4) or with a customer that is a "qualified institutional buyer" under Rule 144A of the Securities Act13 or "qualified purchaser" under Section 2(a)(51) of the Investment Company Act of 1940;14


      • transactions in an issuer's securities if the issuer has at least $50 million in total assets and $10 million in shareholder's equity are exempt;


      • transactions in securities of a bank as defined in Section 3(a)(6) of the Act15 and/or insurance company subject to regulation by a state or federal bank or insurance regulatory authority are exempt;


      • transactions involving securities with a worldwide daily trading volume value of at least $100,000 during each month of the six full calendar months immediately before the date of the recommendation, and transactions involving any convertible security based on a security meeting this requirement are exempt;16 and


      • transactions involving securities that have a bid price, as published in a quotation medium, of at least $50 per share.17
      In addition, under the proposed rule the NASD may, for good cause shown, exempt any person, security or transaction, or any class or classes of person, securities or transactions, either unconditionally or on specified terms, from any or all of the requirements of the Rule if it determines that such exemption is consistent with the purpose of the rule, the protection of investors and the public interest.18

      III. Discussion

      For the reasons discussed below, the Commission finds that the proposed rule is consistent with the provisions of Section 15A(b)(6) of the Act,19 which requires, among other things, that the Association's rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest.
      A. Review Requirements
      Manipulative and fraudulent schemes often have involved infrequently-traded securities of little-known issuers. Unscrupulous broker-dealers have recommended that customers purchase the securities of unseasoned issuers whose securities do not trade in a listed market, without giving due regard to the fundamentals regarding these issuers. Among the most critical pieces of information that a broker-dealer should have before making a recommendation regarding a security are the financial condition of, and business information about, the issuer, particularly with respect to those issuers whose securities are not listed on a national securities exchange or Nasdaq. Therefore, the Commission finds that the NASD's proposal to require broker-dealers to independently review current financial and business information about these issuers prior to making a recommendation to purchase or sell short covered securities is consistent with the Act, particularly its mandate that the Association's rules be designed to prevent fraudulent and manipulative acts.20
      While the Commission considers the review requirement to be appropriate, it also believes that the requirement is properly tailored to meet the Rule's objectives without over-burdening members. Under the Recommendation Rule, broker-dealers are required to review publicly available current financial statements and material business information. The Commission believes that the Recommendation Rule establishes appropriate parameters regarding what constitutes "current financial information" and "current material business information" that members and their sales personnel must review before making a recommendation as a means to lessen the opportunity for abusive practices when broker-dealers recommend covered securities to investors.
      1. Foreign private issuers vs. non-foreign private issuers
      Further, as detailed above, these definitions also distinguish between information that must be reviewed for issuers that are foreign private issuers and those that are not. The Commission believes that this is an important distinction because the customary accounting periods for foreign issuers are often different from those for domestic issuers. Foreign issuers maybe permitted to report financial information on a semi-annual basis, rather than on a quarterly basis, as is required for domestic issuers. Therefore, the Commission believes that it is appropriate to establish different time parameters regarding when financial information should be considered "current" for foreign private issuers in order to address this difference in accounting practices.
      2. Delinquent issuers
      The Commission notes that the Recommendation Rule contains a provision covering the situation when the issuer has not made current filings as required by the issuer's principal financial or securities regulatory authority in its home jurisdiction, including the Commission, foreign regulatory authorities, and bank and insurance regulators. In the event the issuer is delinquent with its filings, the Recommendation Rule requires that the member make an inquiry into the circumstances concerning the failure to make current filings and make a determination that a recommendation is appropriate under the circumstances.
      The Commission believes that the Rule is appropriately limited in that it does not prohibit recommendations in the event the issuer's filings are delinquent, nor does it require that a member confirm that the issuer is not delinquent in its filings with any regulatory authority prior to making a recommendation. Rather, the Rule requires that a member conduct an inquiry in the event that an issuer has been delinquent in its filings with its principal financial or securities regulatory authority in its home jurisdiction and then determine whether the recommendation is appropriate. The Commission believes that this requirement strikes a proper balance in those cases where the issuer has failed to make current filings.
      3. Persons responsible for review
      The Commission believes that it is appropriate to require that the person responsible for conducting the financial information review be registered as a Series 24 principal or be someone who is supervised by a Series 24 principal, as these individuals are under the jurisdiction of the NASD. Registered Series 24 principals are persons who are associated with a member and are permitted to manage or supervise the member's investment banking or securities business for corporate securities, direct participation programs, and investment company products/variable contracts. Therefore, the Commission believes that this requirement will ensure that financial information is reviewed by individuals who have the proper skills, background and knowledge to conduct a thorough analysis of the information prior to the firm or its associated persons making a recommendation.
      B. Exemptions from Recommendation Rule
      As indicated above, the Recommendation Rule lists several transactions that are exempt form the Rule and provides the Association with the authority, for good cause, to grant additional exemptions from its provisions. The Commission believes that these provisions are appropriately tailored to serve the purposes of the Rule so that only those transactions that are more likely to raise risks for retail investors are subject to the Rule, and that those transactions that are less likely to be the subject of fraudulent sales practices are not covered by the Rule.
      C. Interaction with other NASD Rules and Federal Securities Laws
      Finally, as noted in the Preliminary Note to the Recommendation Rule, the Commission emphasizes that the requirements of the Rule are in addition to other existing broker-dealer obligations under NASD rules and the federal securities laws, including obligations to determine the suitability of particular securities transactions with customers and to have a reasonable basis for any recommendation made to a customer. The Commission reiterates that the Recommendation Rule is not intended to act or operate as a presumption or as a safe harbor for purposes of determining suitability or for any other legal obligation or requirement imposed under NASD rule or the federal securities laws.
      D. Operational Date
      The Commission notes that the NASD will announce the operational date of the proposed rule change in a Notice to Members to be published no later than 60 days following the date of approval by the Commission. The operational date will be 30 days following the date of publication of the Notice to Members announcing Commission approval.

      IV. Amendment No. 2

      The Commission finds good cause for approving Amendment No. 2 prior to the thirtieth day after the date of publication of notice thereof in the Federal Register. In Amendment No. 2, the NASD amended NASD Rule 2315(a) to add a category of equity securities that, pursuant to NASD Rule 6530(b)(2), are eligible for quotation on the OTCBB. This change provides that members conducting transactions in securities that are listed on a regional securities exchange, but do not qualify for dissemination of transaction reports via the Consolidated Tape, must comply with the review requirements of the Recommendation Rule if such securities are published or quoted in a quotation medium.
      Because securities that are listed on a regional securities exchange but not eligible for the reporting of transactions to the Consolidated Tape are eligible for quotation on the OTCBB, and thus fall within the category of securities contemplated to be covered by the Recommendation Rule, the Commission believes that it is appropriate for these securities to be covered by the Recommendation Rule.
      In Amendment No. 2, the NASD also amended NASD Rule 2315(e)(1)(G)(2) to substitute "NASD" for the reference to "the Association" contained in the Rule. The Commission believes that this is a technical, non-substantive change to the proposal. In sum, the Commission finds that the NASD's proposed changes in Amendment No. 2 further strengthen and clarify the proposed rule change and raise no new regulatory issues. Further, the Commission believes that Amendment No. 2 does not significantly alter the original proposal, which was subject to a full notice and comment period. Therefore, the Commission finds that granting accelerated approval to Amendment No. 2 is appropriate and consistent with Section 19(b)(2) of the Act.21

      V. Solicitation of Comments

      Interested persons are invited to submit written data, views, and arguments concerning Amendment No. 2, including whether the proposed amendment is consistent with the Act. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed amendment that are filed with the Commission, and all written communications relating to the amendment between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying at the Commission's Public Reference Room. Copies of such filing also will be available for inspection and copying at the principal office of the NASD. All submissions should refer to File No. SR-NASD-99-04 and should be submitted by [insert date 21 days from date of publication].

      VI. Conclusion

      For all of the aforementioned reasons, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities association.
      IT IS THEREFORE ORDERED, pursuant to Section 19(b)(2) of the Act,22 that the proposed rule change (SR-NASD-99-04), as amended, is approved.
      For the Commission, by the Division of Market Regulation, pursuant to delegated authority.23

      Margaret H. McFarland
      Deputy Secretary


      Endnotes

      1 15 U.S.C. 78s(b)(1).

      2 17 CFR 240.19b-4.

      3 See Securities Exchange Act Release No. 41075 (February 19, 1999), 64 FR 10037 ("Original Proposal").

      4 In the Original Proposal, the NASD proposed subparagraph (e) to NASD Rule 6740. That provision would have permitted a member to submit a certification to the NASD stating that the firm complied with the requirements of SEC Rule 15c2-11, 17 CFR 240.15c2-11, including the member's review obligation, if the documents the firm was required to review were contained in the Commission's Electronic Data Gathering and Retrieval System, in lieu of submitting a copy of the documents reviewed. This proposed rule text was deleted as part of Amendment No. 1, although the change was not reflected in the narrative portion of the Amendment.

      5 See Securities Exchange Act Release No. 45277 (January 14, 2002), 67 FR 2937.

      6 See Letter from Marc Menchel, Senior Vice President and General Counsel, NASD, to Katherine A. England, Assistant Director, Division of Market Regulation ("Division"), Commission, dated July 26, 2002 ("Amendment No. 2). In Amendment No. 2, the NASD amended proposed NASD Rule 2315(a) to clarify that members conducting transactions in securities that are listed on a regional securities exchange, but do not qualify for dissemination of transaction reports via the Consolidated Tape, must comply with the review requirements of the Recommendation Rule if such securities are published or quoted in a quotation medium. The NASD also amended NASD Rule 2315(e)(1)(G)(2) to substitute "NASD" for the reference to "the Association" contained in the Rule.

      7 "Quotation medium" is defined as a system of general circulation to brokers or dealers that regularly disseminates quotations or indications of interest of identified brokers or dealers; or a publication, alternative trading system or other device that is used by brokers or dealers to disseminate quotations or indications of interest to others. The Recommendation Rule is intended to cover equity securities that are published or quoted in a quotation medium and that either: (1) are not listed on Nasdaq or a national securities exchange, or (2) are listed on a regional securities exchange and do not qualify for dissemination of transaction reports via the Consolidated Tape.

      8 See NASD Rule 2310 (Suitability Rule), which requires a member to have reasonable grounds for believing that a recommendation to a customer is suitable based on facts disclosed, other security holdings and financial situation and needs.

      9 The current financial and business information that a broker-dealer must review prior to recommending the purchase or short sale of a covered security is similar to that required by Rule 15c2-11 under the Act for those broker-dealers initiating or resuming quotations for securities covered by that rule. 17 CFR 240.15c2-11.

      10 17 CFR 230.504.

      11 Proposed NASD Rule 2315(e)(1)(A) contained a typographical error. In pertinent part, the Rule should read "transactions by an issuer not involving any public offering pursuant to Section 4(2) of the Securities Act" instead of "transactions with an issuer not involving any public offering pursuant to Section 4(2) of the Securities Act." (Emphasis added.) Telephone conversation between Phil Shaikun, Associate General Counsel, NASD Regulation, and Jennifer Colihan, Special Counsel, Division, Commission, on August 12, 2002.

      12 15 U.S.C. 77d(2).

      13 15 U.S.C. 77(a).

      14 15 U.S.C. 80a-2(a)(51).

      15 15 U.S.C. 78c(a)(6).

      16 See Securities Exchange Act Release No. 41110 (February 25, 1999), 64 11124 (March 8, 1999)("Rule 15c2-11 Reproposing Release"). This exemption is consistent with exemptions contained proposed Rules 15c2-11(h)(6) and (7).

      17 This exemption is consistent with an exemption contained in proposed Rule 15c2-11(h)(8). See Rule 15c2-11 Reproposing Release, supra note 16.

      18 As part of this proposed rule change, the NASD has added the Recommendation Rule to NASD Rule 9610, which provides the procedures for requesting exemptive relief from various Association rules.

      19 15 U.S.C. 78o-3(b)(6).

      20 The Recommendation Rule will apply to equity securities that are quoted on the OTCBB, in The Pink Sheets, or in any other system that regularly disseminates indications of interest and quotation information among broker-dealers and those securities either: (1) are not listed on Nasdaq or a national securities exchange, or (2) are listed on a regional securities exchange and do not qualify for dissemination of transaction reports via the Consolidated Tape. See Proposed NASD Rule 2315(a). As part of its application to become a national securities exchange, Nasdaq has filed rules to operate the OTCBB, which is expected to be renamed the Bulletin Board Service ("BBS"). NASD Regulation has advised the Commission that the Recommendation Rule will apply to BBS securities when Nasdaq operates the BBS. The Commission is also aware that Nasdaq intends to develop the OTCBB/BBS into a listed market, which will be called the Bulletin Board Exchange ("BBX"). See NASD-2001-82, pending before the Commission. Securities trading on the BBX would be listed securities, and therefore would not be covered under the current wording of the Recommendation Rule. NASD Regulation has advised the Commission that it will amend the Recommendation Rule at the appropriate time to ensure that securities listed on the BBX are covered by the Rule.

      21 15 U.S.C. 78s(b)(2).

      22 15 U.S.C. 78s(b)(2).

      23 17 CFR 200.30-3(a)(12).

    • For Your Information (October)

      View PDF File

      Important Information Regarding Annual Audited Report

      Under Securities and Exchange Commission (SEC) Rule 17a-5, NASD members must file with NASD an Annual Audited Report not more than 60-calendar days after the date selected for their fiscal year end.

      For the convenience of member firms, NASD has posted information to the Regulation section of the NASD Web Site listing essential information needed to complete the Annual Audited Reports. Please ensure that your auditors receive this information. We consistently find that audit filings are mailed to incorrect locations and departments, which often results in filings not reaching NASD in a timely fashion or not reaching NASD at all. In that regard, please note Notice to Members 01-54 regarding late fees which will be imposed for filing lateness.

      Please visit this Web page for more information:
      www.nasdr.com/aa_index.asp.

    • 02-65 Nominees for District Committee and District Nominating Committee

      View PDF File

      INFORMATIONAL

      District Elections

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Registration
      Senior Management

      District Elections



      Executive Summary

      The purpose of this Special Notice to Members is to announce the nominees for the District Committees and the District Nominating Committees. The individuals identified in this Special Notice to Members (see Attachment A) have been nominated for three-year terms1 on the District Committees and for one-year terms on the District Nominating Committees starting in January 2003. These nominees will be considered duly elected on October 11, 2002, unless an election is contested in accordance with the procedures summarized below.

      We appreciate the interest shown by many of you in participating in the District Committees and thank everyone for their continuing support of the self-regulatory process. We look forward to your participation in the matters of the Districts during the coming year, as well as hope that those who were not selected this year may wish to revisit this process next year.

      Contested Election Procedures

      If an officer, director, or employee of a NASD member is interested in being considered as an additional candidate, he/she must indicate his/her interest to the District Director by October 11, 2002. If an additional candidate(s) comes forward by that date, the candidate has until November 10, 2002 to submit a petition to the District Nominating Committee with signatures from at least 10 percent of Executive Representatives of members eligible to vote in the District.

      If no additional candidates submit petitions by November 10, 2002, then the candidates nominated by the District Nominating Committee shall be considered elected, and the District Committee shall certify the election to the Board of Directors of NASD Regulation.

      Additional information pertaining to the District Election Procedures can be found in Article VIII of the By-Laws of NASD Regulation.

      Questions/Further Information

      Questions concerning this Special Notice may be directed to the District Director noted in Attachment A or to Barbara Z. Sweeney, Senior Vice President and Corporate Secretary, NASD, at (202) 728-8062 or via e-mail at: barbara.sweeney@nasd.com.


      Endnote

      1 Some nominees are filling existing vacancies and therefore may serve less than a three-year term, as indicated on Attachment A.


      ATTACHMENT A

      District Committee and District Nominating Committee Nominees

      District 1

      Elisabeth P. Owens, District Director

      525 Market Street, Suite 300, San Francisco, CA 94105
      (415) 882-1200

      Northern California (the counties of Monterey, San Benito, Fresno, and Inyo, and the remainder of the state north or west of such counties), northern Nevada (the counties of Esmeralda and Nye, and the remainder of the state north or west of such counties), and Hawaii

      2002 District Nominating Committee Chair
      Stephen R. Adams Wells Fargo Investments LLC San Francisco, CA
       
      District 1 Nominees
      Steven R. Aaron J.P. Morgan Securities (one-year term) San Francisco, CA
      Gerard P. Gloisten GBS Financial Corporation (two-year term) Santa Rosa, CA
      Warren E. Gordon Charles Schwab & Co., Inc. San Francisco, CA
      William P. Hayes Wells Fargo Investments LLC San Francisco, CA
      Francis X. Roche, II RBC Dain Rauscher, Inc. San Francisco, CA
       
      District 1 Nominating Committee Nominees
      Sally G. Aelion Emmett A. Larkin Company, Inc. San Francisco, CA
      John H. Chung Alliant Partners Santa Clara, CA
      Glenn M. Colacurci Salomon Smith Barney San Francisco, CA
      James D. Klein UBS PaineWebber, Inc. San Francisco, CA
      Jerry D. Phillips RBC Dain Rauscher, Inc. San Francisco, CA


      District Committee And District Nominating Committee Nominees

      District 2

      Lani M. Sen Woltmann, District Director

      300 South Grand Avenue, Suite 1600, Los Angeles, CA 90071
      (213) 627-2122

      Southern California (that part of the state south or east of the counties of Monterey, San Benito, Fresno, and Inyo), southern Nevada (that part of the state south or east of the counties of Esmeralda and Nye), and the former U.S. Trust Territories

      2002 District Nominating Committee Chair
      George H. Casey Crowell Weedon & Co. Los Angeles, CA
       
      District 2 Nominees
      A. William Cohen Integrated Trading and Investments, Inc. Las Vegas, NV
      Don S. Dalis USB PaineWebber Inc. Newport Beach, CA
      Donna Bartlett Lawson First Allied Securities, Inc. San Diego, CA
       
      District 2 Nominating Committee Nominees
      Margaret M. Black Morgan Stanley Dean Witter Los Angeles, CA
      George H. Casey Crowell Weedon & Co. Los Angeles, CA
      Miles Z. Gordon Financial Network Investment Corporation Torrance, CA
      Dean A. Holmes Valic Financial Advisors, Inc. Glendale, CA
      Robert L. Winston American Funds Distributors, Inc. Los Angeles, CA


      District Committee And District Nominating Committee Nominees

      District 3

      Joseph M. McCarthy, District Director

      Republic Plaza Building, 370 17th Street, Suite 2900, Denver, CO 80202-5629
      (303) 446-3100

      Arizona, Colorado, New Mexico, Utah, and Wyoming

      James G. Dawson, District Director

      Two Union Square, 601 Union, Suite 1616, Seattle, WA 98101-2327
      (206) 624-0790

      Alaska, Idaho, Montana, Oregon, and Washington

      2002 District Nominating Committee Chair
      Thomas Petrie Petrie Parkman & Co., Inc. Denver, CO
       
      District 3 Nominees
      Gene G. Branson Partners Investment Network, Inc. Spokane, WA
      Bridget Gaughan SunAmerica Securities, Inc. Phoenix, AZ
      John W. Goodwin Goodwin Browning & Luna Securities Inc. Albuquerque, NM
       
      District 3 Nominating Committee Nominees
      L. Hoyt DeMers Wells Fargo Investments LLC Seattle, WA
      J. David Griswold Frank Russell Securities, Inc. Tacoma, WA
      Martin Nelson, Jr. Martin Nelson & Co., Inc. Seattle, WA
      William G. Papesh WM Funds Distributor, Inc. Seattle, WA
      Anthony Petrelli Neidiger, Tucker, Bruner, Inc. Denver, CO


      District Committee And District Nominating Committee Nominees

      District 4

      Thomas D. Clough, District Director

      120 W. 12th Street, Suite 900, Kansas City, MO 64105
      (816) 421-5700

      Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota

      2002 District Nominating Committee Chair
      Cheryl Cook-Schneider Edward Jones St. Louis, MO
       
      District 4 Nominees
      Deborah M. Castiglioni Cutter & Company, Inc. Chesterfield, MO
      Terry L. Lister Cambridge Investment Research, Inc. Fairfield, IA
      Richard J. Miller Walnut Street Securities, Inc. St. Louis, MO
       
      District 4 Nominating Committee Nominees
      Norman Frager Flagstone Securities, Inc. St. Louis, MO
      E. John Moloney Moloney Securities Co., Inc. St. Louis, MO
      Rodger O. Riney Scottrade, Inc. St. Louis, MO
      Jeffrey A. Schuh Marquette Financial Group, Inc. Minneapolis, MN
      Gail Werner-Robertson GWR Investments, Inc. Omaha, NE


      District Committee And District Nominating Committee Nominees

      District 5

      Warren A. Butler, Jr., District Director

      1100 Poydras Street, Energy Centre, Suite 850, New Orleans, LA 70163-0802
      (504) 522-6527

      Alabama, Arkansas, Kentucky, Louisiana, Mississippi, Oklahoma, and Tennessee

      2002 District Nominating Committee Chair
      Dene R. Shipp SunTrust Equitable Securities, Inc. Nashville, TN
       
      District 5 Nominees
      Victor E. Blaylock BancorpSouth Investment Services, Inc. Jackson, MS
      Carolyn R. May Benchmark Investments, Inc. Arkadelphia, AR
      F. Eugene Woodham Sterne, Agee & Leach, Inc. Birmingham, AL
       
      District 5 Nominating Committee Nominees
      Carl W. Busch Prudential Securities Incorporated Oklahoma City, OK
      E. Douglas Johnson, Jr. Johnson Rice & Company New Orleans, LA
      James M. Rogers J.J.B. Hilliard, L.L. Lyons, Inc. Louisville, KY
      William L. Tedford, Jr. Stephens Inc. Little Rock, AR
      Duncan F. Williams Duncan-Williams, Inc. Memphis, TN


      District Committee And District Nominating Committee Nominees

      District 6

      Bernerd E. Young, District Director

      12801 N. Central Expressway, Suite 1050, Dallas, TX 75243
      (972) 701-8554

      Texas

      2002 District Nominating Committee Chair
      Daniel C. Dooley Maplewood Investment Advisors, Inc. Dallas, TX
       
      District 6 Nominees
      Brent T. Johnson IFG Network Securities, Inc. Houston, TX
      John R. Muschalek First Southwest Company Dallas, TX
      Robert L. Nash SWS Securities, Inc. Dallas, TX
       
      District 6 Nominating Committee Nominees
      C. Ronald Baker Williams Financial Group Lubbock, TX
      Robert A. Estrada Estrada Hinojosa & Company, Inc. Dallas, TX
      Fredrick W. McGinnis UBS PaineWebber, Inc. Houston, TX
      Edward M. Milkie Milkie/Ferguson Investments, Inc. Dallas, TX
      Jim G. Rhodes Rhodes Securities, Inc. Fort Worth, TX


      District Committee And District Nominating Committee Nominees

      District 7

      Alan M. Wolper, District Director

      One Securities Centre, Suite 500, 3490 Piedmont Road, N.E., Atlanta, GA 30305
      (404) 239-6100

      Florida, Georgia, North Carolina, South Carolina, Virginia, Puerto Rico, the Canal Zone, and the Virgin Islands

      2002 District Nominating Committee Chair
      M. Anthony Greene Raymond James Financial Services, Inc. Atlanta, GA
       
      District 7 Nominees
      Joseph B. Gruber FSC Securities Corp. Atlanta, GA
      Dennis S. Kaminski Mutual Service Corporation West Palm Beach, FL
      James A. Klotz FMS, Inc. N. Miami Beach, FL
       
      District 7 Nominating Committee Nominees
      Michael D. Hearn Attorney Charlotte, NC
      Edward R. Hipp, III Legg Mason Wood Walker, Inc. Williamsburg, VA
      J. Lee Keiger, III Davenport & Company LLC Richmond, VA
      John W. Waechter William R. Hough & Co. St. Petersburg, FL
      Roark A. Young Young, Stovall & Company Miami, FL


      District Committee And District Nominating Committee Nominees

      District 8

      Carlotta A. Romano, District Director

      55 West Monroe Street, Suite 2700, Chicago, IL 60603
      (312) 899-4400

      Illinois, Indiana, Michigan, and Wisconsin

      William H. Jackson, Jr., District Director

      Renaissance on Playhouse Square, 1350 Euclid Avenue, Suite 650, Cleveland, OH 44115
      (216) 592-2950

      Ohio and part of upstate New York (the counties of Monroe, Livingston, and Steuben, and the remainder of the state west of such counties)

      2002 District Nominating Committee Chair
      David Slavik Pershing Division of Donaldson, Lufkin & Jenrette Securities Corporation Oak Brook, IL
       
      District 8 Nominees
      Wilbur H. Burch Merrill Lynch, Pierce, Fenner & Smith Incorporated Schaumburg, IL
      Thomas M. McDonald McDonald Investments, Inc. Cleveland, OH
      James J. Roth Pershing Division of Donaldson, Lufkin & Jenrette Securities Corporation Oak Brook, IL
       
      District 8 Nominating Committee Nominees
      Wallen L. Crane Salomon Smith Barney, Inc. Toledo, OH
      Mary D. Esser Cressman Esser Securities, Inc. Naperville, IL
      Wayne F. Holly Sage, Rutty & Co., Inc. Rochester, NY
      L. Gene Tanner NatCity Investments, Inc. Indianapolis, IN
      Rodney Trautvetter Harris Direct Chicago, IL


      District Committee And District Nominating Committee Nominees

      District 9

      John P. Nocella, District Director

      Eleven Penn Center, 1835 Market Street, Suite 1900, Philadelphia, PA 19103
      (215) 665-1180

      Delaware, Pennsylvania, West Virginia, District of Columbia, Maryland, and the southern part of New Jersey in the immediate Philadelphia vicinity

      Gary K. Liebowitz, District Director

      581 Main Street, 7th Floor, Woodbridge, NJ 07905
      (732) 596-2000

      New Jersey (except southern New Jersey in the immediate Philadelphia vicinity)

      2002 District Nominating Committee Chair
      Philip S. Cottone Rutherford, Brown & Catherwood LLC Philadelphia, PA
       
      District 9 Nominees
      Robert M. Berson Ryan, Beck & Co. LLC Livingston, NJ
      Richard Grobman Fahnestock & Co. Inc. Philadelphia, PA
      W. Dean Karrash Rutherford, Brown & Catherwood LLC Philadelphia, PA
      Michael S. Mortensen PNC Investments, a division of J.J.B. Hilliard, W.L. Lyons, Inc. (two-year term) Pittsburgh, PA
       
      District 9 Nominating Committee Nominees
      A. Louis Denton Philadelphia Corporation for Investment Services Philadelphia, PA
      James D. Lamke Goldman, Sachs & Co. Jersey City, NJ
      Lance A. Reihl 1717 Capital Management Company Berwyn, PA
      Lenda P. Washington GRW Capital Corporation Washington, DC
      Gregory R. Zappala RRZ Public Markets, Inc. Cranberry Township, PA


      District Committee And District Nominating Committee Nominees

      District 10

      Robert B. Kaplan, Acting District Director

      One Liberty Plaza, New York, NY 10006
      (212) 858-4000

      The five boroughs of New York City and Long Island

      2002 District Nominating Committee Chair
      Eugene A. Schlanger Nomura Holding America, Inc. New York, NY
       
      District 10 Nominees
      Raymond C. Holland, Sr. Triad Securities Corp. New York, NY
      Vicki Z. Holleman Loeb Partners Corporation New York, NY
      Andrew H. Madoff Bernard L. Madoff Investment Securities LLC New York, NY
      Richard J. Paley Fox-Pitt, Kelton Inc. New York, NY
       
      District 10 Nominating Committee Nominees
      Kevin J. Browne Banc of America Securities New York, NY
      Judith R. MacDonald Rothschild, Inc. New York, NY
      Eugene A. Schlanger Nomura Holding America, Inc. New York, NY
      Stephen C. Strombelline Barclays Capital Inc. New York, NY
      Tom M. Wirtshafter American Portfolios Financial Services, Inc. Holbrook, NY


      District Committee And District Nominating Committee Nominees

      District 11

      Frederick F. McDonald, District Director

      260 Franklin Street, 16th Floor, Boston, MA 02110
      (617) 261-0800

      Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont, and New York (except for the counties of Monroe, Livingston, and Steuben; the five boroughs of New York City; and Long Island)

      2002 District Nominating Committee Chair
      Arthur F. Grant Cadaret, Grant & Co., Inc. Syracuse, NY
       
      District 11 Nominees
      Mark R. Hansen State Street Global Markets LLC Boston, MA
      Gregg A. Kidd Pinnacle Investments, Inc. East Syracuse, NY
      Lee G. Kuckro Advest, Inc. Hartford, CT
       
      District 11 Nominating Committee Nominees
      Stephen O. Buff Fleet Securities, Inc. Boston, MA
      Richard DeAgazio Boston Capital Services, Inc. Boston, MA
      John D. Lane Lane Capital Markets LLC Fairfield, CT
      Dennis Surprenant Cantella & Co., Inc. Boston, MA
      Peter T. Wheeler Commonwealth Financial Network Waltham, MA

    • 02-64 NASD Advises Members that Participation in Tying Arrangements that Violate Federal Statutes Also Violate Just and Equitable Principles of Trade; Requests Information Concerning Such Practices

      View PDF File

      REQUEST FOR COMMENT

      Prohibition of Certain Bank Tying Arrangements

      Comment Period Expires: October 21, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Finance
      Legal & Compliance
      Senior Management

      Investment Banking
      Just and Equitable Principles of Trade
      NASD Rule 2110



      Discussion

      NASD is concerned that the practice of tying commercial credit to investment banking is becoming increasingly widespread. For example, a recent survey of 3,500 corporate financial officers by the Association of Financial Professionals found that 48% believed that "if they did not award other business to short-term lenders, the amount of short-term credit provided would be reduced" and 39% would expect no credit to be offered if they did not award other business to lenders.1

      Section 1972(1) of the Bank Holding Company Act Amendments of 1970 ("BHCA") provides that a bank shall not extend credit to a borrower on the condition that a borrower obtain some other service from the bank or an affiliate of the bank.2 Congress enacted the anti-tying provisions of the BHCA " to provide specific statutory assurance that the use of the economic power of the bank will not lead to a lessening of competition or unfair competitive practices." 3 In light of the unique economic role that banks play by virtue of their control over a company's credit, Congress perceived tying transactions involving credit as "inherently anti-competitive, operating to the detriment of banking and non-banking competitors alike; thus the anti-tying provisions were intended to regulate conditional transactions in the extension of credit by bank more stringently than had the Supreme Court under the general antitrust statutes." 4 Accordingly, Congress dispensed with the need to prove the economic power of banks or to prove the anticompetitive effects of tying arrangements under the BHCA.5 In addition, the statute permits customers or competitors who believe that they have suffered injury to their business or property due to illegal tying to pursue treble damages in a civil suit.

      NASD's investigations into bank tying arrangements indicate that tying commercial loans to investment banking services usually arises in the following three commercial banking contexts: (1) bridge loans in which the loan is intended to be repaid out of the proceeds of a bond offering; (2) backup credit facilities that support a company's issuance of commercial paper; and (3) syndicated loans.6 Access to these types of credit at commercial rates is critical to many companies and may provide a bank with the opportunity to require a company to purchase tied investment banking services, such as investment grade debt underwriting. In addition, illegal tying arrangements may involve structuring commercial credit transactions to support investment banking activities, such as providing federally insured bridge loans to support a merger or acquisition transaction managed by the investment bank.

      NASD cautions members that it would violate Rule 2110, which requires members to conduct business in accordance with just and equitable principles of trade, for any member to aid and abet a violation of the BHCA by an affiliated bank.7 A member would be deemed to have aided and abetted a violation of the BHCA if the member charged a company for investment banking services when it knew or had reason to know that the purchase of those services had been tied to the provision of commercial credit, in violation of the federal banking laws.

      NASD also is concerned that tying may occur with respect to other services, such as pension management services. For example, any arrangement that ties the pricing of a company's investment banking services to services the investment bank or its affiliates provide to the company's employee pension plan could violate the company's fiduciary duties under the Employee Retirement and Income Security Act (" ERISA" ).8 NASD cautions members that it would violate Rule 2110 for any member to aid and abet a violation of ERISA.

      Action Requested

      NASD encourages all interested parties to provide information concerning any arrangement in which commercial lending or pension plan services have been tied to investment banking services. NASD encourages commenters to provide specific examples of such arrangements. This information should be provided by October 21, 2002 to:

      Corporate Financing Department
      NASD
      9509 Key West Avenue
      Rockville, MD 20850

      Or

      e-mailed to nasdrcorpfin@nasdr.com

      Questions/Further Information

      Questions concerning this Notice to Members may be directed to Joseph E. Price, Director, Corporate Financing Department, at (240) 386-4623.


      Endnotes

      1 See also, Letter from Rep. John D. Dingell, Ranking Member, Committee on Energy and Commerce to Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System and John D. Hawke, Jr., Comptroller of the Currency, dated July 11, 2002 (tying "has become a central feature of the strategy of a number of large 'universal' banks").

      2 The prohibition is subject to certain exemptions for traditional commercial banking services. 12 U.S.C.A. @ 1971 et seq.

      3 S. Rep. No. 1084, 91st Cong., 2d Sess. 16, reprinted in 1970 U.S. Code Cong. & Admin. News 5519, 5535.

      4 Dibidale v. American Bank and Trust Co., 916 F. 2d 300, 306 (5th Cir. 1990) ("Dibidale"), quoting S. Rep. No. 1084, 1970 U.S. Code Cong. & Admin. News 5558 (Letter of Assistant Attorney General Richard McLaren).

      5 Id.

      6 Cf., The Association of the Bar of the City of New York to Ms. Jennifer Johnson, Secretary, Board of Governors of the Federal Reserve System (May 8, 2001).

      7 Section 23B of the Federal Reserve Act also prohibits an insured bank from extending credit to a company if the bank would not extend credit but for investment banking services provided to that company by an affiliate. A bank that under prices credit facilities as a loss leader in order to commit a company to purchase the bank's affiliated investment banking services would violate the Federal Reserve Act.

      8 H.R. Rep. No. 1280, 93rd Cong., 2d Session 302.

    • 02-63 NASD Provides Additional Information on Amendments to Section 8 of Schedule A to NASD's By-Laws to Eliminate the Regulatory Fee and to Implement a New Transaction-Based Trading Activity Fee as Announced in Notice to Members 02-41

      View PDF File

      INFORMATIONAL

      Regulatory Fees

      Implementation Date: October 1, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Compliance
      Legal
      Senior Management

      NASD By-Laws
      Regulatory Fee



      Executive Summary

      As announced in Notice to Members 02-41, NASD has amended Section 8 of Schedule A to the NASD By-Laws, eliminating the Regulatory Fee and instituting a new transaction-based Trading Activity Fee which funds NASD's member regulatory activities.1 NASD will implement these changes on October 1, 2002.

      Included with this Notice is Attachment A, the text of the amendments to Schedule A to the NASD By-Laws.

      Questions/Further Information

      Questions concerning this Notice should be directed to NASD Finance, at (240) 386-5397, or NASD Regulatory Policy and Oversight, Office of General Counsel, at (202) 728-8071.

      Discussion

      NASD has amended Section 8 of Schedule A to NASD's By-Laws to eliminate the Regulatory Fee and to institute a new transactionbased Trading Activity Fee. This fee is used by NASD solely to fund NASD's member regulatory activities, including the supervision and regulation of members through examinations, processing of membership applications, financial monitoring, policy, rulemaking, interpretive, and enforcement activities. As further detailed below, NASD will implement this rule change and assess the new Trading Activity Fee effective October 1, 2002.

      NASD currently assesses a Regulatory Fee upon its members through approximately 250 clearing and self-clearing firms on all transactions reported through Nasdaq's Automated Confirmation Transaction service (ACT). There is a 400 share minimum and 7,500 share maximum per transaction. The Regulatory Fee is assessed only against Nasdaq and other off-exchange transactions, although the revenues are used to support member regulatory activities across all markets. The amendment eliminates the existing Nasdaq market-based Regulatory Fee and institutes a transaction-based Trading Activity Fee applied across all markets. The Trading Activity Fee will be assessed on the sell-side of all member transactions in all covered securities regardless of where the trade is executed, with the exception that the fee will be assessed on the buy-side of member transactions in the case of transactions where the counterparty is not a broker/dealer (e.g., internalized customer trades).2 Specifically, covered securities are: 1) all exchange-registered securities wherever executed (other than bonds, debentures, and other evidence of indebtedness); 2) all other equity securities traded other than on an exchange; and 3) all security futures wherever executed.

      NASD anticipates that changes in the rate structure will ultimately reduce the revenue from the collection of the Trading Activity Fee by approximately 50%. This change in conjunction with the proposed amendments to the Gross Income Assessment and Personnel Assessment will be revenue neutral to NASD.3 To minimize the impact on member firms, the restructuring of fees will be phased in over a three-year period. Specifically, for the Trading Activity Fee, since the revenue generated from this fee will be reduced by approximately 50%, the fee reduction will be phased in at a rate of 33% in Year 1 (16.5% reduction), 67% in Year 2 (33.5% reduction) and 100% in Year 3 (50% reduction).

      The rate to be assessed for the Trading Activity Fee is currently being developed based on industry data for NASD members' transactions in covered securities. NASD will publish the applicable rate no later than the implementation date, October 1, 2002.

      Traditionally, the Regulatory Fee had been assessed on clearing firms on behalf of members. Although reporting obligations are ultimately the responsibility of the member, the Trading Activity Fee will continue to be assessed directly to the clearing firms responsible for clearing the transaction on behalf of the member firm. Clearing firms will be required to self-report to NASD on a monthly basis the aggregate shares for stocks, aggregate number of contracts for options, and/or aggregate number of round turn transactions for security future products at the clearing firm level. Submission segregated by exchange is optional and will not be required by NASD. Clearing firms will be required to self-report to NASD the required data and submit payment 10 business days following the end of the month. For example, for October 2002 transactions, clearing firms will be required to selfreport and remit payment by November 14, 2002. The prescribed form of the monthly report will be published prior to the filing deadline.

      Implementation Date

      NASD will implement this amendment beginning on October 1, 2002. The first self-reporting and payment will be due November 14, 2002.


      Questions and Answers

      Question 1: Are transactions effected on a national securities exchange by a dually registered specialist or floor based market maker, covered by the Trading Activity Fee?

      No. Proprietary transactions by a jointly registered NASD member, in its capacity as an exchange specialist or market maker, that are subject to SEC Section 11(a) and SEC Rule 11a1-1(T)(a) thereunder, are excluded from the scope of the Trading Activity Fee. However, any other transactions permitted by SEC Section 11(a), such as bona fide arbitrage or hedge transactions involving a long or short position in an equity security, will be subject to the Trading Activity Fee.4


      Question 2: Are transactions executed by floor based brokers who are dually registered with NASD and a national securities exchange exempt from the Trading Activity Fee?

      Yes. If the floor based broker qualifies for exemption from NASD registration under SEC Rule 15b9-1, then any transactions effected by that broker will be exempt from the Trading Activity Fee.


      Question 3: If a non-NASD member floor broker executes a trade on an NASD member's behalf on the floor of a national securities exchange, will a fee be assessed on the floorbroker?

      No. Non-NASD member floor brokers acting as agent on an NASD member's behalf will not be assessed the Trading Activity Fee. However, the NASD member, the seller of the security, will be assessed the Trading Activity Fee on the transaction.


      Question 4: If an NASD member purchases a covered security from a non-NASD member broker/dealer, will the NASD member's transaction be assessed a fee even though the rule provides for a fee assessment only on sales of covered securities?

      No. As noted above in the text of the Notice, although the general model is to assess the Trading Activity Fee on the sell side of the member transactions, the Trading Activity Fee will be assessed on the buy side of member transactions in transactions where the counterparty is not a broker/dealer. Because clearing firms have significant operational constraints that prevent them from efficiently identifying transactions with non-NASD member broker/dealers, no fee will be assessed on NASD member's transactions for purchases of covered securities from non-NASD member broker/dealers. In contrast, NASD members will be charged a Trading Activity Fee when they are on the buy- side of a transaction with a non broker/dealer (e.g., an internalized trade).


      Question 5: Schedule A to NASD's By-Laws, Section 2(b)(3), states that "each member shall pay to NASD a fee per share for each sale of a covered security." Will Electronic Communication Networks (ECN) that employ so called "facilitation" accounts to maintain the anonymity of their subscribers, be assessed a fee on transactions flowing through these facilitation accounts.

      No. In transactions where an ECN is acting as a contraparty for the purpose of maintaining the anonymity of its subscribers, the Trading Activity Fee will be assessed as if the two subscribers had engaged in the transaction directly.


      Question 6: Are debt securities excluded from the scope of the Trading Activity Fee?

      Yes. Consistent with SEC Section 31 Fees, debt securities including convertible debt are not included in the scope of the Trading Activity Fee.


      Question 7: Are conventional options traded over the counter excluded from the scope of the Trading Activity Fee?

      Yes. However, while the initial sale of a conventional option contract is excluded from the Trading Activity Fee, any resulting exercise will be subject to the Trading Activity Fee if the exercise results in the physical delivery of the underlying securities. See also Question 10.


      Question 8: How does NASD interpret the term "round turn" as it relates to assessing the Trading Activity Fee on security futures products?

      For purposes of applying the Trading Activity Fee to security futures products, a round turn transaction is defined as a purchase and subsequent liquidating sale, or a sale followed by a subsequent covering purchase, of a contract for future delivery by a single market participant.


      Question 9: The Trading Activity Fee includes in its definition of a covered security "all security futures wherever executed." An NASD member firm can be both a Futures Commission Merchant (FCM) and an NASD registered broker/dealer and therefore, can hold both futures accounts, which are regulated by the National Futures Association (NFA), and securities accounts, which are regulated by NASD. Does the Trading Activity Fee apply to transactions in the futures accounts held by an NASD member and regulated by the NFA?

      No. The Trading Activity Fee will only be assessed on transactions held in securities accounts regulated by NASD.


      Question 10: Will the Trading Activity Fee be assessed on the settlement or exercise of options or security futures products?

      Yes. If settlement results in the physical delivery of the underlying security or securities, the Trading Activity Fee will be assessed on the sale of the underlying security. However, options or security futures that are cash-settled and do not result in the sale of the underlying security or securities, do not result in a Trading Activity Fee assessment.


      Question 11: Are options and futures involving narrow and broad based indexes exempt from the Trading Activity Fee?

      Yes. As with the SEC Section 31 Fee, both options and futures on both narrow and broad based indexes are excluded from the Trading Activity Fee.


      Question 12: Are American Depository Receipts (ADRs) included in the scope of the Trading Activity Fee?

      Yes. Secondary market transactions in ADRs are subject to the Trading Activity Fee. However, conversions of ADRs to foreign ordinary shares are not subject to the Trading Activity Fee.


      Question 13: Are Exchange Traded Funds ("ETF") and other structured products included in the scope of the Trading Activity Fee?

      Yes. If an ETF or other structured product is subject to the SEC's Section 31 Fee, it will also be subject to the Trading Activity Fee. However, any transfer of underlying securities to create or redeem an ETF is not subject to the Trading Activity Fee.


      Question 14: If a firm executes a trade on a riskless principal basis, will a fee be assessed on both the initial leg of the transaction and the offsetting transaction with the customer?

      No. Riskless principal transactions reported correctly will be viewed as one transaction for purposes of assessing the Trading Activity Fee.


      Question 15: Will a Trading Activity Fee be assessed on clearing related transactions such as Prime Broker, Step Outs, CNS "flips", CMTA trades, "GUS give-ups", etc.?

      No. The scope of the Trading Activity Fee was designed to include only the initial execution of a transaction. Therefore, any back office or clearing related transactions that serve only to facilitate the clearance and settlement of a previously executed transaction will not be assessed a Trading Activity Fee.


      Question 16: Should the data be submitted to NASD by the clearing firm for the Trading Activity Fee?

      Yes. Data should be submitted as monthly aggregates at the clearing firm level.


      Question 17: Should the data be submitted on a trade by trade basis for the Trading Activity Fee?

      No. Monthly aggregate data should be submitted to NASD by the 10th business day following the end of the month. This should include aggregate number of shares for stocks, aggregate number of contracts for options and aggregate number of round turn transactions for security future products.


      Question 18: Should the data be calculated from the trade date?

      Yes. The data should be calculated from the trade date (as opposed to the settlement date).


      Question 19: Is the rate for the Trading Activity Fee based on principal value like the SEC Section 31 Fee?

      No. The rate for the Trading Activity Fee is based on aggregate volumes. There will be a separate rate for share volume for stocks, contract volume for options and round turn transaction volume for futures.


      Question 20: Will there be a minimum and maximum for the Trading Activity Fee similar to the Section 8 fee?

      No. There will not be a minimum and maximum. The transactions are to be reported in aggregate not per trade.


      Question 21: Will SEC Section 31 rounding rules apply for the Trading Activity Fee?

      No. Rounding rules will not apply because the Trading Activity Fee is calculated and reported in aggregate.


      Question 22: How will NASD verify the accuracy of members' self-reporting to ensure fair assessment of the Trading Activity Fee?

      As part of NASD's regular cycle examinations of members, the monthly Trading Activity Fee reports will be audited against the books and records to ensure the accuracy of the reports. Discrepancies may result in disciplinary action, depending on the facts and circumstances.


      Endnotes

      1. These changes were submitted to the SEC (for immediate effectiveness) on July 23, 2002 and amended on August 21, 2002. See Securities Exchange Act Release No. 46416 (August 23, 2002), 67 FR 55901 (August 30, 2002) (SR-NASD-2002-98).

      2. See Question 4 in the text of this Notice regarding transactions with non-NASD member broker/dealers.

      3. See Securities Exchange Act Release No. 46417 (August 23, 2002), 67 FR 55893 (August 30, 2002) (SR-NASD-2002-99).

      4. This is true as long as the underlying security is subject to the Trading Activity Fee.


      ATTACHMENT A

      New language is underlined; deletions are in brackets.

      Schedule A to [the] NASD By-Laws

      Assessments and fees pursuant to the provisions of Article VI of the By-Laws of [the] NASD shall be determined on the following basis.

      Section [8] 2 - Member Regulation [Transaction] Fees

      [(a) NASD fee on cleared transactions. Each member shall be assessed a transaction charge of $.0625 per 1,000 shares, with a minimum charge per side of $.025 and a maximum charge per side of $.46875 for each over-the-counter transaction with another member of the Association reportable through ACT in which the member acts either as an agent or a principal for the purchase and/or sale of equity securities.]
      [(b) SEC transaction fee. Each member shall be assessed a SEC transaction fee. The amount shall be determined by the SEC in accordance with Section 31 of the Act.]
      (a) Recovery of cost of services. NASD shall, in accordance with this section, collect Member Regulation fees that are designed to recover the costs to NASD of the supervision and regulation of members, including performing examinations, processing of membership applications, financial monitoring, policy, rulemaking, interpretive, and enforcement activities. NASD shall periodically review these revenues in conjunction with these costs to determine the applicable rate. NASD shall publish notices of the fees and adjustments to the assessment rates applicable under this section.
      (b) Each member shall be assessed a Trading Activity Fee for the sale of covered securities.
      (1) Covered Securities. For purposes of the rule, covered securities shall mean:
      (i) All exchange registered securities wherever executed (other than bonds, debentures, and other evidence of indebtedness);
      (ii) All other equity securities traded otherwise than on an exchange; and
      (iii) All security futures wherever executed.
      (2) Transactions exempt from the fee. The following shall be exempt from the Trading Activity Fee:
      (i) Transactions in securities offered pursuant to an effective registration statement under the Securities Act of 1933 (except transactions in put or call options issued by the Options Clearing Corporation) or offered in accordance with an exemption from registration afforded by Section 3(a) or 3(b) thereof, or a rule thereunder;
      (ii) Transactions by an issuer not involving any public offering within the meaning of Section 4(2) of the Securities Act of 1933;
      (iii) The purchase or sale of securities pursuant to and in consummation of a tender or exchange offer;
      (iv) The purchase or sale of securities upon the exercise of a warrant or right (except a put or call), or upon the conversion of a convertible security; and
      (v) Transactions which are executed outside the United States and are not reported, or required to be reported, to a transaction reporting association as defined in Rule 11Aa3-1 and any approved plan filed thereunder.

      NASD may exempt other securities and transactions as it deems appropriate.
      (3) Fee Rates
      (i) Each member shall pay to NASD a fee per share for each sale of a covered security.
      (ii) Each member shall pay to NASD a fee per contract for each sale of an option.
      (iii) Each member shall pay to NASD a fee for each round turn transaction (treated as including one purchase and one sale of a contract of sale for future delivery) of a security future.
      (4) Reporting of Transactions. Members shall report to NASD the aggregate share, contract, and/or round turn volume of sales of covered securities in a manner as prescribed by NASD from time to time.

      Section 3 - SEC Transaction Fee

      Each member shall be assessed an SEC transaction fee. The amount shall be determined by the SEC in accordance with Section 31 of the Act.

      Section [2] 4 - Fees

      (a) Each member shall be assessed a fee of $75.00 for the registration of each branch office, as defined in the By-Laws. Each member shall be assessed an annual fee for each branch office in an amount equal to the lesser of (1) $75.00 per registered branch, or (2) the product of $75.00 and the number of registered representatives and registered principals associated with the member at the end of [the Association] NASD's fiscal year.
      (b) [The] NASD shall assess each member a fee of:
      (1) $85.00 for each initial Form U-4 filed by the member with [the] NASD for the registration of a representative or principal, except that the following discounts shall apply to the filing of Forms U-4 to transfer the registration of representatives or principals in connection with acquisition of all or a part of a member's business by another member:

      Number of Registered
      Personnel Transferred
      Discount
      1,000-1,999 10%
      2,000-2,999 20%
      3,000-3,999 30%
      4,000-4,999 40%
      5,000 and over 50%
      (2) $40.00 for each initial Form U-5 filed by the member with [the] NASD for the termination of a registered representative or registered principal, plus a late filing fee of $80.00 if the member fails to file the initial Form U-5 within 30 days after the date of termination;
      (3) $20.00 for each amended Form U-4 or Form U-5 filed by the member with [the] NASD;
      (4) No change.
      (5) $10.00 for each fingerprint card submitted by the member to [the] NASD, plus any other charge that may be imposed by the United States Department of Justice for processing such fingerprint card; and
      (6) No Change.
      (c) through (k) No Change.
      (l)
      (1) Unless a specific temporary extension of time has been granted, there shall be imposed upon each member required to file reports, as designated by this paragraph, a fee of $100 for each day that such report is not timely filed. The fee will be assessed for a period not to exceed 10 business days. Requests for such extension of time must be submitted to [the Association] NASD at least three business days prior to the due date; and
      (2) through (3) No Change.

      Section [3] 5 - Elimination of Duplicate Assessments and Fees

      No Change to rule language.

      Section [4] 6 - Assessments and Fees for New Members, Resigning Members and Successor Organizations

      (a) The assessment of a firm, which is not a member throughout [the Association] NASD's full calendar year from January 1 to December 31, shall be based upon the number of quarter years of membership. The proration for a new member shall include the quarter year in which the member is admitted to membership. The proration for a member which resigns shall include the quarter year in which the member's letter of resignation is received in [the Association] NASD's Executive Office.
      (b) A member [which] that is a successor organization to a previous member or members shall assume the unpaid balance of the assessments of its predecessor or predecessors and its next assessment shall be determined, if applicable, upon the assessment data of its predecessors. Such successor member shall not be required to re-register branch offices and personnel of predecessor members or pay registration fees therefor. Whether a member is the successor organization to a previous member or members shall be determined by [the Association] NASD upon a consideration of the terms and conditions of the particular merger, consolidation, reorganization, or succession. A member [which] that has simply acquired the personnel and offices of another member under circumstances [which] that do not constitute the member a successor organization shall not be required to assume the unpaid assessments of the other member. Such non-successor member shall be required to re-register the branch offices and personnel acquired from the other member and pay applicable registration fees.

      Section [5] 7 - Gross Revenue for Assessment Purposes

      No Change to rule language.

      Section [6] 8 —Fees for Filing Documents Pursuant to the Corporate Financing Rule

      (a) There shall be a fee imposed for the filing of initial documents relating to any offering filed with [the] NASD pursuant to the Corporate Financing Rule equal to $500 plus .01% of the proposed maximum aggregate offering price or other applicable value of all securities registered on an SEC registration statement or included on any other type of offering document (where not filed with the SEC), but shall not exceed $30,500. The amount of filing fee may be rounded to the nearest dollar.
      (b) There shall be an additional fee imposed for the filing of any amendment or other change to the documents initially filed with [the] NASD pursuant to the Corporate Financing Rule equal to .01% of the net increase in the maximum aggregate offering price or other applicable value of all securities registered on an SEC registration statement, or any related Rule 462(b) registration statement, or reflected on any Rule 430A prospectus, or included on any other type of offering document. However, the aggregate of all filing fees paid in connection with an SEC registration statement or other type of offering document shall not exceed $30,500.

      Section [7] 9 —Service Charge for Processing Extension of Time Requests

      (a) No Change.
      (b) The service charge for processing each initial extension of time request and for all subsequent extension of time requests (1) involving the same transaction under Regulation T and/or (2) involving an extension of time previously granted pursuant to Rule 15c3-3(n) shall be $2.00; provided, however, that the service charge shall be $1.00 for extension of time requests filed electronically by members using [the Association] NASD's Automated Regulatory Reporting System.

      Section [9] 10 - Subscription Charges for Firm Access Query System (FAQS)

      No Change to rule language.

      Section [10] 11 - Request for Data and Publications

      No Change to rule language.

      Section [11] 12 - Reserved

      No Change to rule language.

      Section [12] 13 - Application and Annual Fees for Member Firms with Statutorily Disqualified Individuals

      (a) Any member firm seeking to employ or continuing to employ as an associated person any individual who is subject to a disqualification from association with a member as set forth in Article III, Section 4 of [the Association] NASD's By-Laws shall, upon the filing of an application pursuant to Article III, Section 3, paragraph (d) of [the Association] NASD's By-Laws, pay to [the Association] NASD a fee of $1,500.00. Any member firm whose application filed pursuant to Article III, Section 3, paragraph (d) of [the Association] NASD's By-Laws results in a full hearing for eligibility in [the Association] NASD pursuant to the Rule 9640 Series, shall pay to [the Association] NASD an additional fee of $2,500.00.
      (b) Any member firm continuing to employ as an associated person any individual subject to disqualification from association with a member as set forth in Article III, Section 4 of [the Association] NASD's By-Laws shall pay annually to [the Association] NASD a fee of $1,500.00 when such person or individual is classified as a Tier 1 statutorily disqualified individual, and a fee of $1,000.00 when such person or individual is classified as a Tier 2 statutorily disqualified individual.

      Section [13] 14 - Review Charge for Advertisement, Sales Literature, and Other Such Material Filed or Submitted

      There shall be a review charge for each and every item of advertisement, sales literature, and other such material, whether in printed, video or other form, filed with or submitted to [the Association] NASD, except for items that are filed or submitted in response to a written request from [the Association] NASD's Advertising Regulation Department issued pursuant to the spot check procedures set forth in [the Association] NASD's Rules as follows: (1) for printed material reviewed, $75.00, plus $10.00 for each page reviewed in excess of 10 pages; and (2) for video or audio media, $75.00, plus $10.00 per minute for each minute of tape reviewed in excess of 10 minutes.

      Where a member requests expedited review of material submitted to the Advertising Regulation Department there shall be a review charge of $500.00 per item plus $25 for each page reviewed in excess of 10 pages. Expedited review shall be completed within three business days, not including the date the item is received by the Advertising Regulation Department, unless a shorter or longer period is agreed to by the Advertising Regulation Department. The Advertising Regulation Department may, in its sole discretion, refuse requests for expedited review.

    • 02-62 NASD Announces Nominees for Regional Industry Member Vacancies on the National Adjudicatory council

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      INFORMATIONAL

      NAC Nominees

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Senior Management

      National Adjudicatory Council



      Executive Summary

      The purpose of this Special Notice to Members is to announce the cominee for the National Adjudicatory Council (NAC) for the North region. The nominee, nominated for a three-year term beginning in January 2003, is listed in Exhibit I. This nominee will be proposed to the NASD National Nominating Committee in 14 calendar days, unless the election is contested.

      We appreciate the interest shown by many members in expressing their desire to serve on the NAC and thank everyone for their continuing support of the self-regulatory process. The Regional Nominating Committee thoroughly reviewed the background of every candidate before selecting its nominee in an effort to secure appropriate and fair representation of the region.

      Contested Election Procedures

      If an officer, director, or employee of an NASD member in the North Region has not been proposed for nomination by the Regional Nominating Committee and wants to seek the nomination, he or she should send a written notice to Barbara Z. Sweeney, Corporate Secretary, at the address below within 14 calendar days after the publishing date (September 19) of this Special Notice.

      Barbara Z. Sweeney
      NASD
      Office of the Corporate Secretary
      1735 K Street, NW
      Washington, DC 20006-1500

      The Contested Nomination Procedures can be found in Article VI of the NASD Regulation By-Laws. If no additional candidate comes forward within 14 calendar days, the Regional Nominating Committee shall certify its candidate to the National Nominating Committee.

      Questions/Further Information

      Questions concerning this Special Notice to Members may be directed to Barbara Z. Sweeney, Senior Vice President and Corporate Secretary, NASD, at (202) 728-8062 or via e-mail at: barbara.sweeney@nasd.com.

      National Adjudicatory Council Membership and Function

      Membership

      The NAC consists of 14 members—seven Industry members and seven Non-Industry members. Two Industry members are nominated by the NASD National Nominating Committee and are appointed by the Board of Directors of NASD Regulation, Inc. as at-large members. Five Industry members each represent one of the following geographic regions:

      West Region:

      Hawaii, California, Nevada, Arizona, Colorado, New Mexico, Utah, Wyoming, Alaska, Idaho, Montana, Oregon, and Washington (Districts 1, 2, and 3)

      South Region:

      Alabama, Arkansas, Kentucky, Louisiana, Mississippi, Oklahoma, Tennessee, Texas, Florida, Georgia, North Carolina, South Carolina, Puerto Rico, Virginia, Canal Zone, and the Virgin Islands (Districts 5, 6, and 7)

      Central Region:

      Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, Illinois, Indiana, Michigan, part of Western New York state, and Wisconsin (Districts 4 and 8)

      North Region:

      Delaware, Maryland, Pennsylvania, West Virginia, District of Columbia, New Jersey, Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont, and New York (except for New York City, Long Island, and Western New York state) (Districts 9 and 11)

      New York:

      New York City and Long Island (District 10)

      Only one region (North) has a vacancy for this election. NAC members for the other four regions (West, South, Central, and New York) are indicated in Exhibit II, along with the year in which their terms expire.1

      Function

      According to the NASD Regulation By-Laws, the NAC is authorized to act for the NASD Board of Governors in matters concerning:

      • appeals or reviews of disciplinary proceedings, statutory disqualification proceedings, or membership proceedings;


      • the review of offers of settlement; letters of acceptance, waiver, and consent; and minor rule violation plan letters;


      • the exercise of exemptive authority; and


      • other proceedings or actions authorized by the Rules of the Association.

      The NAC also considers and makes recommendations to the Board on enforcement policy and rule changes relating to the business and sales practices of NASD members and associated persons.


      Endnote

      1 On September 20, 2001, the NASD Board of Governors approved an amendment to Article V, Section 5.4 of the NASD Regulation By-Laws changing the term of office of NAC members from two years, with the opportunity to serve consecutive terms, to a single three-year term. This By-Law amendment was approved by the SEC on October 17, 2001. To effect the change from two-year to three-year terms, NASD divided the NAC seats into three transitional classes, as nearly equal in number and as evenly divided between industry and non-industry seats as possible. The purpose of this division is to assure appropriate continuity and orderly turnover during the transitional period. The transitional period will end in January 2004, at which time all members of the NAC will be elected to a single three-year term.


      Exhibit I


      Nominee for NAC Industry Member Vacancy

      North Region (Districts 9 and 11)

      A. Louis Denton
      Philadelphia Corporation for Investment Services
      Philadelphia, PA


      Exhibit II


      NAC Members with Terms Expiring in January 2004

      Philip Oppenheimer (New York Region)
      Oppenheimer & Close, Inc.
      New York, NY

      William Svoboda (West Region)
      Morgan Stanley
      Palo Alto, CA


      NAC Members with Terms Expiring in January 2005

      Douglas Kelly (Central Region)
      A.G. Edwards & Sons, Inc.
      St. Louis, MO

      Barbara Weaver (South Region)
      Legg Mason Wood Walker, Inc.
      New Orleans, LA

    • 02-61 SEC Approves Proposed Changes to the Taping Rule and NASD Interpretive Material 8310-2

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      INFORMATIONAL

      Taping Rule

      Effective Date: October 14, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Legal & Compliance
      Operations
      Senior Management

      Rule 3010
      IM-8310-2
      Taping Rule



      Executive Summary

      On August 28, 2002, the Securities and Exchange Commission (SEC) approved amendments to NASD Rule 3010(b)(2), also known as the Taping Rule, and NASD IM-8310-2. The amendments to the Taping Rule (1) permit firms that become subject to the Taping Rule a one time opportunity to adjust their staffing levels to fall below the prescribed threshold levels and thus avoid application of the Rule; (2) revise the criteria by which firms become subject to the Taping Rule by not including certain short-term employees of disciplined firms into the calculations of the Taping Rule threshold levels; (3) expand the compliance deadline from 30 to 60 days for firms subject to the Taping Rule to install taping systems; (4) clarify NASD's authority to grant exemptions from the Rule pursuant to the Rule 9600 Series only in exceptional cases; and (5) extend the taping requirements from two years to three years to eliminate conflicting time periods in the Taping Rule. In addition, the amendments to NASD IM-8310-2 permit, upon request, public disclosure of whether a particular firm is subject to the Taping Rule.

      The amendments become effective on October 14, 2002. The text of the amendments to Rule 3010(b)(2) and IM-8310-2 is provided in Attachment A.

      Questions/Further Information

      Questions regarding this Notice to Members may be directed to Grace Yeh, Assistant General Counsel, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-6939, or to Kyra Armstrong, Senior Attorney, Department of Member Regulation, NASD Regulatory Policy and Oversight, at (202) 728-6962.

      Discussion

      The Taping Rule, which was adopted in 1998, is designed to ensure that members with a large number of registered persons from firms that have been expelled from membership or have had their registration revoked for sales practice violations (Disciplined Firms) have proper supervisory procedures over telemarketing activities to prevent fraudulent and improper sales practices or other customer harm. Under the Rule, firms that hire a significant number of employees from Disciplined Firms must establish, maintain, and enforce special written procedures for supervising the telemarketing activities of all their registered persons. In addition, such firms are required to install taping systems to record all telephone conversations between all of their registered persons and both existing and potential customers, review the tape recordings, and file quarterly reports with NASD.

      Generally, the amendments refine the application of the Taping Rule and provide additional flexibility to assist member firms in meeting their compliance obligations under the Rule.

      1. Establishment of a 30-Day Staff Adjustment Period

      The amendments provide all firms that, on or after October 14, 2002, trigger application of the Taping Rule (for the first time) a one-time opportunity to obtain relief from the Taping Rule requirements by adjusting their staffing levels.1 In particular, the amendments permit firms, within 30 days after receiving the notice that they are subject to the Taping Rule or obtaining actual knowledge that they are subject to the Rule (and have promptly notified the Department of Member Regulation that they are subject to the Rule), to reduce their staffing levels to fall below the threshold levels set forth in the Taping Rule and thus avoid application of the Taping Rule.2 Firms will not be permitted to hire additional registered representatives to fall below the stated thresholds but rather will be required to reduce their number of registered representatives from Disciplined Firms. Once a firm has made the reductions, the firm will not be permitted to rehire the terminated individuals for a period of at least 180 days. Firms may elect, but are not required, to make reductions to their staffing levels. If a firm chooses not to make the adjustment, then it will be required to comply with the Taping Rule requirements.

      A firm is permitted to adjust its staffing levels only when it becomes subject to the Taping Rule for the first time. If the firm re-triggers the Taping Rule at any point in the future, then the firm automatically will become subject to its provisions. While the amendments allow a new entity resulting from a restructuring (by a merger, acquisition, or otherwise) to make a staff adjustment to avoid application of the Taping Rule even if one of the participating members in the restructuring had previously adjusted its staff level pursuant to the amendments, this will not be the case for an entity that was restructured in an effort to avoid compliance with the Rule.

      2. Revision of the Criteria by Which Firms Become Subject to the Taping Rule

      The amendments revise the criteria for determining whether a firm is subject to the Taping Rule by excluding from the firm's calculations registered persons who were associated with a Disciplined Firm for only a short period of time.

      Specifically, in calculating whether firms exceed the Taping Rule thresholds set forth in the Rule, registered persons who were registered with one or more Disciplined Firms for 90 days or less within the last three years and who have no disciplinary history by a finding of a violation of the provisions set forth in IM-1011-1, while still included in the total number of registered persons at a firm, may be excluded from the number of registered persons at the firm from Disciplined Firms. The amendments recognize that persons registered with Disciplined Firms for a short period of time (i.e., an aggregate total of 90 days or less) are less likely to have acquired the "bad habits" from the Disciplined Firms that the Taping Rule seeks to redress.

      In addition, the amendments clarify that the calculation of registered representatives from Disciplined Firms includes independent contractors previously registered with a Disciplined Firm.

      3. Expansion of the Compliance Deadline from 30 to 60 Days

      The amendments extend the period for firms to implement the special supervisory procedures, including the installation of taping systems from 30 days to 60 days of receiving notice from NASD (or obtaining actual knowledge) that they are subject to the Taping Rule. Based on NASD's experience, 60 days should provide adequate time for firms to install the taping systems and would alleviate the need for firms to request extensions of time. NASD notes that generally, an acceptable taping system would not include one where a firm's associated persons whose communications with customers are required to be taped have control over the operation of, or the tape recordings produced from, the taping system.

      4. Clarification of the Exemptive Relief Authority

      The amendments clarify that NASD may grant exemptions from the Taping Rule in "exceptional circumstances" only. In reviewing exemptive requests, NASD generally has established high standards and required a firm to establish that it has alternative procedures to assure supervision at a level functionally equivalent to a taping system.

      5. Increase Duration of the Special Supervisory Requirements

      The amendments extend the time period for which firms must maintain taping systems from two years to three years. The period for which firms are required to maintain the taping system begins from the date that the member establishes its special supervisory procedures and implements the taping system. The amendments further clarify that a firm is required to both establish and implement the taping system within 60 days of receiving notice from NASD or obtaining actual knowledge that it is subject to the Taping Rule.

      Publication of the Identity of Firms Subject to the Taping Rule

      The amendments allow investors and the general public to ascertain, upon request, whether an identified firm is subject to the Taping Rule. Inquiries about whether a particular firm is subject to the Taping Rule may be made through the Public Disclosure Program's toll-free telephone listing.


      Endnotes

      1 Firms that, as of October 14, 2002, have a pending exemption request from the Taping Rule requirements, based on the firm's first-time triggering of the Rule, (or related appeal before the (National Adjudicatory Council) (NAC)), or for which the time period in which to seek an applicable exemption (or related appeal to the NAC) has not yet expired, may elect to comply with the Taping Rule as modified by the amendments in lieu of complying with the current requirements under the Rule.

      2 Firms that reduce their staffing levels pursuant to the amendments may consider reporting the termination as a voluntary termination on the Form U-5.


      ATTACHMENT A

      New language is underlined; deletions are in brackets.

      3010. Supervision

      (a) No Change.
      (b) Written Procedures
      (1) No Change.
      (2) Tape recording of conversations
      (A) [(i)] Each member that either is notified by NASD Regulation or otherwise has actual knowledge that it meets one of the criteria in paragraph (b)(2)(H)[(viii)] relating to the employment history of its registered persons at a Disciplined Firm as defined in paragraph (b)(2)(J)[(x)] shall establish, maintain, and enforce special written procedures for supervising the telemarketing activities of all of its registered persons.
      (B)[(ii)] The member must establish and implement the supervisory procedures required by this paragraph within [30] 60 days of receiving notice from NASD Regulation or obtaining actual knowledge that it is subject to the provisions of this paragraph.
      A member that meets one of the criteria in paragraph (b)(2)(H) for the first time may reduce its staffing levels to fall below the threshold levels within 30 days after receiving notice from NASD Regulation pursuant to the provisions of paragraph (b)(2)(A) or obtaining actual knowledge that it is subject to the provisions of the paragraph, provided the firm promptly notifies the Department of Member Regulation, NASD Regulation, in writing of its becoming subject to the Rule. Once the member has reduced its staffing levels to fall below the threshold levels, it shall not rehire a person terminated to accomplish the staff reduction for a period of 180 days. On or prior to reducing staffing levels pursuant to this paragraph, a member must provide the Department of Member Regulation, NASD Regulation with written notice, identifying the terminated person(s).
      (C) [(iii)] The procedures required by this paragraph shall include tape-recording all telephone conversations between the member's registered persons and both existing and potential customers.
      (D) [(iv)] The member shall establish reasonable procedures for reviewing the tape recordings made pursuant to the requirements of this paragraph to ensure compliance with applicable securities laws and regulations and applicable rules of [this] the Association. The procedures must be appropriate for the member's business, size, structure, and customers.
      (E) [(v)] All tape recordings made pursuant to the requirements of this paragraph shall be retained for a period of not less than three years from the date the tape was created, the first two years in an easily accessible place. Each member shall catalog the retained tapes by registered person and date.
      (F) [(vi)] Such procedures shall be maintained for a period of [two] three years from the date that the member establishes and implements the procedures required by the provisions of this paragraph.
      (G) [(vii)] By the 30th day of the month following the end of each calendar quarter, each member firm subject to the requirements of this paragraph shall submit to the Association a report on the member's supervision of the telemarketing activities of its registered persons.
      (H) [(viii)] The following members shall be required to adopt special supervisory procedures over the telemarketing activities of their registered persons:

      • A firm with at least five but fewer than ten registered persons, where 40% or more of its registered persons have been [employed by] associated with one or more Disciplined Firms in a registered capacity within the last three years;


      • A firm with at least ten but fewer than twenty registered persons, where four or more of its registered persons have been [employed by] associated with one or more Disciplined Firms in a registered capacity within the last three years;


      • A firm with at least twenty registered persons, where 20% or more of its registered persons have been [employed by] associated with one or more Disciplined Firms in a registered capacity within the last three years.

      For purposes of the calculations required in subparagraph (H), firms should not include registered persons who:
      (1) have been registered for an aggregate total of 90 days or less with one or more Disciplined Firms within the past three years; and
      (2) do not have a disciplinary history.
      (I)[(ix)] For purposes of this Rule, the term "registered person" means any person registered with the Association as a representative, principal, or assistant representative pursuant to the Rule 1020, 1030, 1040, and 1110 Series or pursuant to Municipal Securities Rulemaking Board ("MSRB") Rule G-3.
      (J)[(x)] For purposes of this Rule, the term "disciplined firm" means a member that, in connection with sales practices involving the offer, purchase, or sale of any security, has been expelled from membership or participation in any securities industry selfregulatory organization or is subject to an order of the Securities and Exchange Commission revoking its registration as a broker/dealer.
      (K)[(xi)] For purposes of this Rule, the term "disciplinary history" means a finding of a violation by a registered person in the past five years by the Securities and Exchange Commission, a self-regulatory organization, or a foreign financial regulatory authority of one or more of the provisions (or comparable foreign provision) listed in IM-1011-1 or rules or regulations thereunder.
      (L) Pursuant to the Rule 9600 Series, the Association may in exceptional circumstances, taking into consideration all relevant factors, exempt any member unconditionally or on specified terms and conditions from the requirements of this paragraph [upon a satisfactory showing that the member's supervisory procedures ensure compliance with applicable securities laws and regulations and applicable rules of the Association].
      * * *

      IM-8310-2. Release of Disciplinary [Information] and Other Information Through the Public Disclosure Program

      (a) In response to a written inquiry, electronic inquiry, or telephonic inquiry via a toll-free telephone listing, the Association shall release certain information contained in the Central Registration Depository regarding a current or former member, an associated person, or a person who was associated with a member within the preceding two years, through the Public Disclosure Program. Such information shall include:
      (1) the person's employment history and other business experience required to be reported on Form U-4;
      (2) currently approved registrations for the member or associated person;
      (3) the main office, legal status, and type of business engaged in by the member; and
      (4) an event or proceeding-
      (A) required to be reported under Item 23 on Form U-4;
      (B) required to be reported under Item 11 on Form BD; or
      (C) reported on Form U-6.
      The Association also shall make available through the Public Disclosure Program certain arbitration decisions against a member involving a securities or commodities dispute with a public customer. In addition, the Association shall make available in response to telephonic inquiries via the Public Disclosure Program's toll-free telephone listing whether a particular member is subject to the provisions of Rule 3010(b)(2). The Association shall not release through the Public Disclosure Program social security numbers, residential history information, or physical description information, or information that the Association is otherwise prohibited from releasing under Federal law.
      (b) through (l) No Change.

    • 02-60 Columbus Day

      View PDF File

      Trade Date — Settlement Date

      SUGGESTED ROUTING

      KEY TOPICS

      Internal Audit
      Legal & Compliance
      Municipal/Government Securities
      Operations
      Trading & Market Making

      Holiday Trade Date — Settlement Date Schedule



      The schedule of trade dates-settlement dates below reflects the observance by the financial community of Columbus Day, Monday, October 14, 2002. On this day, The NASDAQ Stock Market and the securities exchanges will be open for trading. However, it will not be a settlement date because many of the nation's banking institutions will be closed.

      Trade Date Settlement Date Reg. T Date*
      Oct. 8 Oct. 11 Oct. 15
      9 15 16
      10 16 17
      11 17 18
      14 17 21
      15 18 22

      Note: October 14, 2002, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board.

      Transactions made on Monday, October 14, will be combined with transactions made on the previous business day, October 11, for settlement on October 17. Securities will not be quoted ex-dividend, and settlements, marks to the market, reclamations, and buy-ins and sell-outs, as provided in the Uniform Practice Code, will not be made and/or exercised on October 14.


      * Pursuant to Sections 220.8(b)(1) and (4) of Regulation T of the Federal Reserve Board, a broker/dealer must promptly cancel or otherwise liquidate a customer purchase transaction in a cash account if full payment is not received within five business days of the date of purchase or, pursuant to Section 220.8(d)(1), make application to extend the time period specified. The date by which members must take such action is shown in the column titled "Reg. T Date."

    • 02-59 SEC Approves Amendment to Rule 10314 Regarding Specificity of Answers

      View PDF File

      Answers in Arbitration

      Effective Date: October 14, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance

      Answers
      Arbitration
      Dispute Resolution



      Executive Summary

      The Securities and Exchange Commission (SEC or Commission) has approved amendments to Rule 10314 of the NASD Code of Arbitration Procedure (Code) governing Initiation of Proceedings.1 The amendments will conform Rule 10314(b) to the current minimum standard applicable to claims, so that Answers need only specify relevant facts and available defenses to the Statement of Claim submitted.

      The text of the amendments as provided in Attachment A will apply to all claims filed on or after October 14, 2002.

      Questions/Further Information

      Questions regarding this Notice may be directed to Jean I. Feeney, Chief Counsel and Associate Vice President, NASD Dispute Resolution, at (202) 728-6959, or e-mail jean.feeney@nasd.com.

      Discussion

      NASD is amending the Code to conform Rule 10314(b) to the current minimum standard applicable to claims, so that Answers need only specify relevant facts and available defenses to the Statement of Claim that was submitted by the claimant, rather than specifying all such facts and defenses that may be relied upon at the hearing.

      As background, NASD recently streamlined its procedures for review of arbitration claims. NASD does not consider a Statement of Claim to be deficient if it meets the minimum requirements of a properly signed Uniform Submission Agreement that names the respondents as shown on the Statement of Claim, proper fees, and sufficient copies of the Statement of Claim. This has accelerated the claims review process, so that claims can be served promptly after filing. Accordingly, the Statement of Claim may not contain details on the evidence to be presented at the hearing.

      The rules relating to Answers continued to provide, however, that the Answer had to specify all available defenses and relevant facts that would be relied upon at the hearing, and that a respondent that failed to specify all available defenses and relevant facts in its Answer could be barred from presenting such facts or defenses at the hearing.2

      NASD determined that the above provisions could place the respondent at an unfair disadvantage because the initial claim may be quite brief, but may be expanded substantially by the time of the hearing. Based on Rule 10314(b), the arbitrators might prevent the respondent from introducing additional facts or defenses to the expanded claim. Therefore, Rule 10314(b)(1) has been amended to provide that the Answer should only be required to specify all relevant facts and available defenses to the Statement of Claim submitted, which makes the requirement consistent with the streamlined claims procedure; and Rule 10314(b)(2)(A) has been amended to apply only to general denials to pleadings that state specific facts and contentions.

      Effective Date

      The amendment described in this Notice will apply to all claims filed on or after October 14, 2002.


      Endnotes

      1 Exchange Act Release No. 46256 (July 25, 2002) (File No. SR-NASD-2002-62, 67 Federal Register 50499 (August 2, 2002).

      2 The term "defenses" in Rule 10314 is understood to include not only defenses to the specific allegations in the Statement of Claim, but also any affirmative defenses that the respondent may wish to set forth.


      ATTACHMENT A

      New language is underlined; deletions in brackets.

      Code of Arbitration Procedure

      10314. Initiation of Proceedings

      Except as otherwise provided herein, an arbitration proceeding under this Code shall be instituted as follows:
      (a) No change.
      (b) Answer - Defenses, Counterclaims, and/or Cross-Claims
      (1) Within 45 calendar days from receipt of the Statement of Claim, Respondent(s) shall serve each party with an executed Submission Agreement and a copy of the Respondent's Answer. Respondent's executed Submission Agreement and Answer shall also be filed with the Director of Arbitration with sufficient additional copies for the arbitrator(s) along with any deposit required under the schedule of fees. The Answer shall specify all [available defenses and] relevant facts and available defenses [thereto that will be relied upon at the hearing] to the Statement of Claim submitted and may set forth any related Counterclaim the Respondent(s) may have against the Claimant, any Cross-Claim the Respondent(s) may have against any other named Respondent(s), and any Third-Party Claim against any other party or person based on any existing dispute, claim, or controversy subject to arbitration under this Code.
      (2)
      (A) A Respondent, Responding Claimant, Cross-Claimant, Cross-Respondent, or Third-Party Respondent who pleads only a general denial [as an Answer] to a pleading that states specific facts and contentions may, upon objection by a party, in the discretion of the arbitrators, be barred from presenting any facts or defenses at the time of the hearing.
      [Remainder of rule unchanged.]

    • 02-58 SEC Approves Default Procedures Regarding Suspended or Terminated Respondents Who Fail to Answer Arbitration Claims

      View PDF File

      New Default Procedures Rule

      Effective Date: October 14, 2002

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Registered Representatives
      Registration
      Senior Management

      Arbitration
      Default Procedures
      Dispute Resolution
      Registration
      Suspension
      Termination



      Executive Summary

      The Securities and Exchange Commission (SEC or Commission) has approved amendments to Rule 10314 of the NASD Code of Arbitration Procedure (Code) governing Initiation of Proceedings.1 The amendments provide default procedures for situations in which a suspended, terminated or otherwise defunct member or associated person fails to answer in an arbitration proceeding, and the claimant nevertheless elects to pursue arbitration.

      The text of the amendments as provided in Attachment A will apply to all claims filed on or after October 14, 2002.

      Questions/Further Information

      Questions regarding this Notice may be directed to Jean I. Feeney, Chief Counsel and Associate Vice President, NASD Dispute Resolution, at (202) 728-6959, or jean.feeney@nasd.com.

      Discussion

      NASD Dispute Resolution is providing default procedures for situations in which a suspended, terminated or otherwise defunct member or associated person fails to answer in an arbitration proceeding, and the claimant nevertheless elects to pursue arbitration. The procedures are designed to make it easier for claimants to obtain an award against a defunct, non-answering party, which award then can be enforced in court.

      Background

      The United States General Accounting Office (GAO) issued a report in June 2000 expressing concern over the number of unpaid arbitration awards issued in connection with arbitration proceedings in the securities industry arbitration forums, and making several recommendations for improvements.2 The GAO Report observed that most of the unpaid awards resulted from broker/dealers that were no longer in business. In response to the GAO Report, NASD committed to undertake several initiatives to address the issue of unpaid awards. The proposed rule change will complete NASD Dispute Resolution's implementation of all initiatives.3

      In 2001, NASD amended Rule 10301(a) to prohibit a member firm whose membership has been terminated, suspended, canceled, or revoked, or that has been expelled from NASD, or that is otherwise defunct, from enforcing a predispute arbitration agreement against a customer in the NASD forum, unless the customer agrees to arbitration in writing after the claim has arisen. That rule change also provided that, before serving a customer claim against a member firm, NASD will notify the customer if the member firm falls into one of the enumerated categories, so customers can make an informed decision regarding whether to proceed in arbitration, to file their claim in court, or to take no action. Therefore, claims against defunct members now proceed in arbitration only at the customer's option.

      New Default Procedures

      In line with the GAO's recommendations, the new rule is designed to make it easier for claimants to obtain an award against a defunct, non-answering member or associated person. The rule applies to all categories of claimants, whether they are customers, associated persons, or member firm claimants that are bringing a claim against a defunct member or associated person. It does not apply to customer respondents, nor does it apply to respondent members or associated persons that are not defunct, as defined in Rule 10314(e).

      Under the new default procedures, if a respondent is an associated person whose registration is (1) terminated, revoked, or suspended; (2) a member whose membership has been terminated, suspended, canceled, or revoked; (3) a member that has been expelled from NASD; or (4) a member that is otherwise defunct, (collectively referred to in this Notice as "defunct") and that respondent fails to answer the claim in a timely manner,4 the claimant may elect to proceed under optional default procedures as to the defunct respondent. If there are several claimants, all must agree to use default procedures before they can be used. If the same attorney represents all claimants, a letter from the attorney agreeing on behalf of all claimants is sufficient.

      Default procedures may be used against one or more defunct, non-answering respondents while the rest of the initial arbitration proceeds against any remaining respondents under regular procedures. (See the discussion below on additional considerations in divided or "bifurcated" proceedings.)

      Defunct respondents who file an answer are not subject to the default procedures rule. Suspended or terminated associated persons and members should be aware that they remain subject to the filing of an arbitration claim against them for conduct that occurred while they were associated persons or members. Therefore, it is essential that they maintain a current address in the Central Registration Depository (CRD®) to ensure prompt notice of claims.5

      If the claimant opts to use default procedures, the case against the defunct, non-answering respondent will proceed with a single arbitrator without a hearing. NASD will continue to send notices to the respondent until the conclusion of the case.6

      The arbitrator in the default case will make a decision based upon the Statement of Claim and any other material submitted by the claimant. The arbitrator may request additional information from the claimant before rendering an award. No hearing will be held. In keeping with the streamlined nature of the procedures, neither the claimant nor the single arbitrator will have the option to ask that two additional arbitrators be appointed to decide the case.

      The default procedures have several provisions to safeguard the integrity of the process and discourage abuses:

      • The claimant may not amend a claim to increase the relief requested after the staff has notified the parties that the claim will proceed under default procedures.


      • An arbitrator may not make an award based solely on the nonappearance of a respondent. The claimant's materials must present a sufficient basis to support the making of an award in its favor.


      • The arbitrator may not award damages in an amount greater than the damages requested in the Statement of Claim, and may not award any other relief that was not requested in the Statement of Claim.

      The above safeguards apply only to the claim that is subject to default procedures. If another part of the original claim is proceeding under regular procedures, then the normal Code provisions apply.

      Finally, if a respondent thought to be defunct belatedly files an answer after the staff has notified the parties that the claim will proceed under default procedures but before an award has been rendered in the default case, the default procedures will be terminated, and the case will proceed under the regular procedures.7 As noted below, however, the late-answering respondent may have missed the opportunity to select the panel, and may be barred from presenting certain matters at the hearing.

      Bifurcated Proceedings

      Default procedures may be used against one or more defunct respondents while the rest of the initial arbitration proceeds against any remaining respondents. This splitting of the original case is known as "bifurcation." If a case is to be bifurcated and handled under two different procedures, regular and default, each proceeding will be assigned a separate arbitration case number to avoid confusion. Rule 10314(e) provides that the default award will have no effect on any non-defaulting party.

      If the regular case is to be decided by a single arbitrator, that same arbitrator will decide the default case. If the regular case is to be decided by a panel of three arbitrators, then the chair of the panel will serve as the single arbitrator for the default proceeding.

      If a respondent in a default case belatedly files an answer, the respondent will join the regular case where the respondent finds it. That is, if a panel already has been selected, the respondent must accept that panel without input into its selection, subject only to a challenge for cause. If a prehearing conference or hearing session has been held, the late-answering respondent must deal with what has gone on before unless the respondent successfully moves the panel for relief. Finally, Rule 10314(b)(2)(C) provides that a respondent who fails to file an answer within 45 calendar days from receipt of service of a claim, unless the time to answer has been extended, "may, in the discretion of the arbitrators, be barred from presenting any matter, arguments, or defenses at the hearing."

      Fees

      Claimant already will have paid a nonrefundable filing fee and hearing session deposit when the original case was filed, and a nonrefundable member surcharge and process fees will have been assessed against the appropriate member at the same time, so no new fees will be due at the commencement of the default case. Since the default case will not involve a hearing, NASD will charge only the Deposit for Cases to Be Decided on the Paper Record as shown in Rule 10332(k), which ranges from $25 to a maximum of $300 for cases involving more than $10,000 (NASD will cap this fee at $300 for default cases, even if the dispute is for over $25,000). At the conclusion of the default case, the arbitrator may allocate the forum fees between or among the parties as usual, and the claimant may be issued a hearing deposit refund. When a case is bifurcated, there will be no additional fees for the default case.

      Effective Date

      The amendments described in this Notice will apply to all claims filed on or after October 14, 2002.


      Endnotes

      1 Exchange Act Release No. 46221 (July 17, 2002) (File No. SR-NASD-2002-15), 67 Federal Register 48237 (July 23, 2002).

      2 The report is entitled, "Securities Arbitration: Actions Needed to Address Problem of Unpaid Awards" ("GAO Report"), Report No. GAO/GGD-00-115 (June 2000), available online at www.gao.gov.

      3 See Notices to Members 00-55 and 01-29 for information on prior initiatives.

      4 Default procedures may be used when a defunct respondent fails to answer within the standard 45-day period provided in Rule 10314(b). In Simplified Arbitration (for claims not exceeding $25,000), respondents have only 20 days to answer. Simplified cases already proceed on the papers with a single arbitrator; however, in the event that a claimant in a simplified case wishes to use the default procedures instead of the simplified procedures, the claimant may do so after waiting for the 45-day period to pass.

      5 As explained in Notice to Members 99-77, both current and former associated persons must keep their addresses in CRD current in order to receive mailings from NASD. Such mailings will be sent to the associated person's last address in NASD's records, and are considered to have been received at that address, whether or not the individual has actually received them. Therefore, associated persons who have failed to update their addresses after termination may have a default decision issued against them in disciplinary proceedings. The same presumption of the accuracy of CRD addresses will apply in the context of default arbitration procedures.

      6 Since Rule 10314(e)(7) provides for the possibility that a defunct respondent may file a late answer, which terminates the default procedures as to that respondent, three arbitrators will be chosen for cases that would otherwise require a three-person panel under Rule 10308, to eliminate delay in the event that a full three-person panel is needed later. However, only the chair will participate in the default case.

      7 For this purpose, NASD will define the date "rendered" as the date when the award is served on the parties pursuant to Rule 10314(c)(1).


      ATTACHMENT A

      New language is underlined.

      Code of Arbitration Procedure

      10314. Initiation of Proceedings

      Except as otherwise provided herein, an arbitration proceeding under this Code shall be instituted as follows:
      (a) No change.
      (b) Answer - Defenses, Counterclaims, and/or Cross-Claims
      (1) No change.
      (2)
      (A) - (B) No change.
      (C) A Respondent, Responding Claimant, Cross-Claimant, Cross-Respondent, or Third-Party Respondent who fails to file an Answer within 45 calendar days from receipt of service of a Claim, unless the time to answer has been extended pursuant to subparagraph (5), below, may, in the discretion of the arbitrators, be barred from presenting any matter, arguments, or defenses at the hearing. Such a party may also be subject to default procedures as provided in paragraph (e) below.
      (3) - (4) No change.
      (5) No change.
      (c) - (d) No change.
      (e) Default Procedures
      (1) A Respondent, Cross-Respondent, or Third-Party Respondent that fails to file an Answer within 45 calendar days from receipt of service of a Claim, unless the time to answer has been extended pursuant to paragraph (b)(5), may be subject to default procedures, as provided in this paragraph, if it is:
      (A) a member whose membership has been terminated, suspended, canceled, or revoked;
      (B) a member that has been expelled from the NASD;
      (C) a member that is otherwise defunct; or
      (D) an associated person whose registration is terminated, revoked, or suspended.
      (2) If all Claimants elect to use these default procedures, the Claimant(s) shall notify the Director in writing and shall send a copy of such notification to all other parties at the same time and in the same manner as the notification was sent to the Director.
      (3) If the case meets the requirements for proceeding under default procedures, the Director shall notify all parties.
      (4) The Director shall appoint a single arbitrator pursuant to Rule 10308 to consider the Statement of Claim and other documents presented by the Claimant(s). The arbitrator may request additional information from the Claimant(s) before rendering an award. No hearing shall be held, and the default award shall have no effect on any non-defaulting party.
      (5) The Claimant(s) may not amend the claim to increase the relief requested after the Director has notified the parties that the claim will proceed under default procedures.
      (6) An arbitrator may not make an award based solely on the non-appearance of a party. The party who appears must present a sufficient basis to support the making of an award in that party's favor. The arbitrator may not award damages in an amount greater than the damages requested in the Statement of Claim, and may not award any other relief that was not requested in the Statement of Claim.
      (7) If the Respondent files an Answer after the Director has notified the parties that the claim will proceed under default procedures but before an award has been rendered, the proceedings under this paragraph shall be terminated and the case will proceed under the regular procedures.

    • 02-57 Use of Negative Response Letters for the Bulk Transfer of Customer Accounts

      View PDF File

      INFORMATIONAL

      Bulk Transfer of Customer Accounts

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management

      Customer Accounts
      Rule 2110



      Executive Summary

      In October 2000, the staff of NASD issued an interpretive letter concerning the use of "negative response letters" to transfer certain customer accounts to a new broker/dealer. Since the publication of the interpretive letter, the staff has received many inquiries from the membership for guidance on the use of negative response letters to transfer customer accounts. The purpose of this Notice to Members is to provide interpretive guidance to the membership on this topic.1

      Questions/Further Information

      Questions concerning this Notice to Members may be directed to Sarah J. Williams, Assistant General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8083.

      Background

      NASD Rule 11870, Customer Account Transfer Contracts, describes the process by which a customer can transfer his or her account from one member firm to another. The process requires the customer to submit a completed transfer instruction to the member that is to receive the customer's account, and sets forth specific procedures pursuant to which the firm receiving the account and the firm transferring the account coordinate their efforts to accomplish the transfer.

      Situations may arise where a firm seeks to initiate a bulk transfer of customer accounts. For example, a firm experiencing financial or operational difficulties may seek to transfer all of its accounts to another member. In this situation, soliciting customers individually to submit instructions directing the transfer of their accounts to a particular firm can be a lengthy process. Moreover, while the process is underway, the assets in the customer accounts may be at risk because of the member's precarious financial condition.

      NASD rules do permit member firms to use "negative response letters" to obtain authorization to take certain actions on behalf of their customers without obtaining affirmative consent, but only in limited circumstances.2 NASD Rule 2510(d) allows a member to use negative response letters in certain situations to effect the bulk exchange of a customer's money market mutual fund for a different fund without the affirmative consent of a customer, provided certain conditions are met.3 The staff also has interpreted the NASD trade-reporting rules regarding riskless principal trading to permit the use of negative response letters to document an institutional customer's agreement to trade with a firm on a net basis.4

      The staff generally believes that a customer should affirmatively consent to the transfer of his or her account to another firm. Various factors may affect an investor's decision to move an account to a new firm, including, for example, the level and quality of service of the new firm, the fees and charges imposed by the new firm, and the cost of the transfer itself. However, when a firm initiates the transfer of a customer's account, there is no assurance that the customer has had sufficient time or information with which to decide whether to object to the transfer. Further, members may be inclined to use negative response letters because of the convenience these letters provide without giving due consideration to whether soliciting affirmative customer consent is a viable alternative. For these reasons, transfers of customer accounts by a member using negative response letters may, under certain circumstances, conflict with a member's obligation to observe high standards of commercial honor and just and equitable principles of trade under NASD Rule 2110.

      In October 2000, the staff of NASD Regulatory Policy and Oversight, Office of General Counsel, issued an interpretive letter to a member firm addressing the question of whether a departing registered representative could send a negative response letter to customers serviced by the registered representative to effect the transfer of those customers to the registered representative's new firm.5 The staff advised that the use of a negative response letter in those circumstances raised concerns under Rule 2110.

      Bulk Transfers of Customer Accounts Using Negative Response Letters

      With respect to the transfer by a member firm of a group of customer accounts, the staff believes that there are situations where a negative response letter may be appropriate to provide for the efficient transfer of those accounts. In identifying these situations, the staff has considered the need to effect a timely transfer of the account and the interests of customers affected by the transfer.

      The staff generally believes the use of negative response letters may be appropriate in the following circumstances:

      • A Member Experiencing Financial or Operational Difficulties - An introducing firm that is experiencing financial or operational difficulties may seek the transfer of all of its customer accounts to another introducing firm using negative response letters;


      • An Introducing Firm No Longer in Business - When an introducing firm has gone out of business, the clearing firm may effect the transfer of all of the introducing firm's customer accounts to another introducing firm using negative response letters;


      • Changes in a Networking Arrangement with a Financial Institution - Upon the conclusion or termination of a networking arrangement with a financial institution pursuant to NASD Rule 2350, a member may seek the transfer of all customer accounts established pursuant to the networking arrangement to a new firm with which the financial institution has formed a networking arrangement using negative response letters;


      • Acquisition or Merger of a Member Firm - When a firm is acquired by or merges with another firm, the firm originating the accounts may seek the transfer of all of its accounts to the new firm using negative response letters; and


      • Change in Clearing Firm by an Introducing Firm - When an introducing firm decides to enter into a clearing arrangement with a different firm, the introducing firm may use negative response letters to transfer customer accounts to the new clearing firm.

      The staff believes that the use of a negative response letter to facilitate the bulk transfer of customer accounts in these situations is appropriate, given the potential risk to investors and costs to firms that could result if firms were required to solicit individual transfer instructions from each customer. The bulk transfer of accounts in these situations also helps minimize interruptions to customers' access to their accounts and the trading markets. The staff recognizes that circumstances may exist outside of the scenarios described above where the use of negative response letters may be appropriate. The staff is prepared to provide guidance on specific situations through NASD's interpretive letter process, as needed. While the use of negative response letters by firms to transfer customer accounts may be appropriate in the situations described above, the staff continues to believe that negative response letters may not be used by registered representatives to transfer customer accounts.

      Recommended Disclosures in Negative Response Letters

      The staff expects a member seeking to transfer customer accounts using negative response letters to provide account holders, consistent with just and equitable principles of trade under Rule 2110, with adequate time and information to decide whether to object to the transfer. The staff advises members seeking to transfer customer accounts using negative response letters as permitted under this Notice to Members to provide each customer with the following information in the negative response letter:

      (1) A brief description of the circumstances necessitating the transfer;
      (2) A statement that the customer has the right to object to the transfer;
      (3) Information on how a customer can effectuate a transfer to another firm;
      (4) A sufficient time period for the customer to respond to the letter (at least 30 days from the receipt of the letter unless exigent circumstances exist that warrant a shorter timer period);
      (5) Disclosure of any cost that will be imposed on the customer as a result of the transfer, including costs to the customer if the customer initiates a transfer of the account after the account is moved pursuant to the negative response letter; and
      (6) A statement regarding the firm's compliance with Securities and Exchange Commission (SEC) Regulation S-P (Privacy of Consumer Financial Information) in connection with the transfer.6

      Member firms that receive customer accounts pursuant to a transfer by a negative response letter should furnish customers with any applicable customer account information and agreements upon the receipt of the accounts.

      Both the transferring and receiving firms in a customer account transfer situation are reminded that the firms must be in full compliance with SEC Regulation S-P. Regulation S-P governs the collection, use, and maintenance by a financial institution of nonpublic personal information of consumers and customers. Unless the transfer is being conducted pursuant to a permitted exception to Regulation S-P, the transferring firm should have reserved the right to transfer customer accounts in its privacy notice that was previously sent to its customers.7 Generally, firms receiving the customer accounts must provide privacy notices upon the establishment of a customer account. Member firms that have questions or require additional information regarding the application of Regulation S-P should consult the Office of the Chief Counsel, Division of Market Regulation, SEC.


      Endnotes

      1 This Notice to Members does not apply to transfers of special product accounts such as mutual fund or variable annuity accounts, nor does it apply to the transfer of specific securities. Further, certain account transfers may require NASD approval under Rule 1017.

      2 A negative response letter generally informs the recipient of the letter of an impending action, and requires the recipient to respond or act within a specified time frame if the recipient objects to the action. If the recipient does not respond, he or she is deemed to have consented to the action.

      3 NASD Rule 2510(d)(2) limits the use of negative response letters to situations involving mergers and acquisitions of funds, changes of clearing members, and exchanges of funds used in sweep accounts. Moreover, the rule requires that the negative response letter contain certain disclosures about the funds being exchanged and that the negative response feature will not be activated until at least 30 days after the date on which the letter was mailed.

      4 See Notice to Members 00-79,"Riskless Principal Trade Reporting," (November 2000).

      5 See Letter to Merit Capital Associates, Inc., from Office of General Counsel, NASD Regulation, Inc. (predecessor to NASD Regulatory Policy and Oversight) dated October 16, 2000.

      6 See Exchange Act Rel. No. 42974 (June 22, 2000), 65 Fed. Reg. 40334 (June 29, 2000) ("Privacy of Consumer Financial Information").

      7 If applicable, firms must also abide by any opt out notices received from customers.

    • 02-56 Nominees for NASD Board of Governors

      View PDF File

      INFORMATIONAL

      Board of Governors Nominees

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Senior Management

      NASD Board of Governors



      The Annual Meeting of members of NASD will be held on December 5, 2002. The formal notice of the meeting, including the precise date, time, and location of the Annual Meeting, will be mailed on or about November 4, 2002.

      The individuals nominated by the NASD National Nominating Committee (NNC) for election to the NASD Board of Governors are identified in this Special Notice. Pursuant to Section 10 of Article VII of the NASD By-Laws, a person who has not been so nominated for election to the Board of Governors may be included on the ballot for the election of Governors if:

      (a) within 45 days of the date of this Special Notice such person presents to the Secretary of NASD petitions in support of such nomination duly executed by at least 3 percent of the members of NASD. As of the date of this Special Notice, NASD has 5469 voting members; therefore, the applicable 3 percent threshold is 164 members. If, however, a candidate's name appears on a slate of nominees, the slate must be endorsed by 10 percent of NASD's voting members. The applicable 10 percent threshold is 546 members; and
      (b) the Secretary certifies that such petitions have been duly executed by the Executive Representatives of the requisite number of members of NASD, and the person being nominated satisfies the classification of the governorship to be filled based on the information provided by the person as is reasonably necessary for the Secretary to make the certification.

      Pursuant to Article VII, Section 4, of the NASD By-Laws, the NASD Board must consist of no fewer than 17 and no more than 27 Governors. The By-Laws also provide that the number of Governors within the range is set by the Board. In recent years, the Board has operated at its maximum size of 27. However, on August 13, the Board determined to set the size of the Board at 24, effective with the December 5, 2002 Annual Meeting. As a result, on December 5, the members will elect eight Governors.

      Article VII, Section 5(d), of the NASD By-Laws requires the Board to fix the term of persons being nominated. Recently, the NASD Board determined that the current NASD Board members who simultaneously serve on the NASDAQ Board of Directors and who are eligible to serve an additional term on the NASD Board would, if re-elected, serve one additional year on the NASD Board or until NASDAQ is able to operate other than as a facility of NASD, whichever occurs first. Of the eight Governors whose terms are expiring, three are presently members of the NASDAQ Board and are eligible to serve an additional term on the NASD Board.

      The three are H. Furlong Baldwin, Richard C. Romano, and Hardwick Simmons,1 and they have been nominated by the NNC to serve an additional term on the Board. The Board also determined that the other five positions will serve for the traditional three-year term.

      Questions regarding this Special Notice may be directed to:

      Barbara Z. Sweeney
      Senior Vice President and Corporate Secretary
      NASD
      1735 K Street, NW
      Washington, DC 20006-1500
      (202) 728-8062

      or

      T. Grant Callery
      Senior Vice President and General Counsel
      NASD
      1735 K Street, NW
      Washington, DC 20006-1500
      (202) 728-8285


      NASD Board of Governors Nominees

      The following three persons (see attached profiles) have been nominated by the NNC to serve on the Board of Governors of NASD for a term of one year, or until NASDAQ is able to operate other than as a facility of NASD, whichever occurs first. These individuals currently serve simultaneously on the NASDAQ Board. Terms of office for all nominees who simultaneously serve on the NASDAQ Board run from December 5, 2002 to December 2003.

      Terms of Office 2002-2003

      INDUSTRY  
      Richard C. Romano President, Romano Brothers & Co.
      Hardwick Simmons Chairman and CEO, The NASDAQ Stock Market, Inc.
         
      NON-INDUSTRY  
      H. Furlong Baldwin Chairman, Mercantile Bankshares Corporation


      The following five persons (see attached profiles) have been nominated by the NNC to serve on the Board of Governors of NASD for a term of three years or until their successors are duly elected or qualified. Terms of office run from December 5, 2002 to December 2005.

      Terms of Office 2002-2005

      INDUSTRY  
      M. LaRae Bakerink Chief Executive Officer, Westfield Bakerink Brozak, LLC
      David A. DeMuro2 Managing Director, Director of Global Compliance and Regulation, Lehman Brothers, Inc. (Representative of a National Retail Firm)
         
      NON-INDUSTRY  
      John J. Brennan Chairman and CEO, The Vanguard Group, Inc.
      (Representative of an Issuer of Investment Company Shares)
      Eugene M. Isenberg Chairman and CEO, Nabors Industries, Inc.
         
      PUBLIC  
      Kenneth M. Duberstein Chairman and CEO, The Duberstein Group, Inc.


      NASD Profiles of Board Nominees for Industry Governors

      Industry

      M. LaRae Bakerink is Chief Executive Officer of Westfield Bakerink Brozak, LLC. Ms. Bakerink currently serves on the Board of Directors and serves as President for the National Association of Independent Broker Dealers. Ms. Bakerink holds a B.S. and an M.B.A. from San Diego State University.

      David A. DeMuro currently serves as Chair of the National Adjudicatory Council (2001-2002). He is Managing Director, Director of Global Compliance and Regulation at Lehman Brothers. Mr. DeMuro joined Lehman Brothers in 1984. Prior to that, he held various positions with the Securities and Exchange Commission in Detroit, Chicago, Los Angeles, and Washington, DC. Mr. DeMuro is a current member of the NASD Membership Committee and the NASD Licensing and Registration Council. He has been a member of the Executive Committee of the Securities Industry Association's Compliance and Legal Division and Chairman of the Securities Industry/Regulatory Council on Continuing Education. He currently serves on the NYSE's content committee for the Continuing Education Regulatory Element supervisor's program and the advisory board of The Journal of Investment Compliance, a publication of Institutional Investor, Inc. Mr. DeMuro is also a member of the Board of Trustees of the Theta Xi Fraternity Foundation. He holds a B.A. from the University of Michigan and a J.D. from the University of Notre Dame.

      Richard C. Romano is President of Romano Brothers & Company, having joined the firm in 1964. Mr. Romano has served on the Industry/Regulatory Council for Continuing Education, the NASD District Committee, and the NASD Board of Governors (1985-1988). Mr. Romano has also served on the NASD National Nominating Committee and the NASD Small Firm Advisory Board. He holds a B.S. from the University of Illinois and an M.S. and Ph.D. from the University of Delaware.

      Hardwick Simmons is Chairman and Chief Executive Officer of The NASDAQ Stock Market, Inc. Mr. Simmons joined NASDAQ in February 2001 as Chief Executive Officer, and was elected Chairman of the Board on September 26, 2001, succeeding Frank G. Zarb. Prior to joining the company, Mr. Simmons served from May 1991 to December 2000 as President and Chief Executive Officer of Prudential Securities, Incorporated, the investment and brokerage firm. Prior to joining Prudential Securities in 1991, Mr. Simmons was President of the Private Client Group at Shearson Lehman Brothers, Inc. Mr. Simmons is a member and former Chairman of the Securities Industry Association, a former Director of the Chicago Board Options Exchange, and former President and current member of The Bond Club of New York, Inc. He is a Director and executive committee member of the New York City Partnership and serves on the Board of the National Academy Foundation. Mr. Simmons is President of the Board of Trustees of the Groton School and a trustee of the Rippowam Cisqua School in Mt. Kisco, New York. He has an A.B. from Harvard University, a M.B.A. from Harvard Business School, and served in the U.S. Marine Corps Reserve.


      NASD Profiles of Board Nominees for Non-Industry Governors

      Non-Industry

      H. Furlong Baldwin is Chairman of the Mercantile Bankshares Corporation. Mr. Baldwin joined Mercantile-Safe Deposit & Trust Company in 1956 and was elected President in 1970 of Mercantile-Safe Deposit & Trust Company and Mercantile Bankshares Corporation, and served as CEO from 1976 - 2001. Mr. Baldwin serves on the Boards of W. R. Grace & Company, Wills Group, and NASDAQ. Mr. Baldwin graduated from Princeton University and served on active duty with the U.S. Marine Corps.

      John J. Brennan is Chairman and Chief Executive Officer and a member of the Board of Directors of each of the mutual funds in the Vanguard Group. Mr. Brennan joined Vanguard in July 1982. He was elected President in 1989, Chief Executive Officer in 1996, and Chairman of the Board in 1998. Prior to his career at Vanguard, Mr. Brennan had been employed at S.C. Johnson & Son in Racine, Wisconsin and the New York Bank of Savings. Mr. Brennan is the past Chairman of the Investment Company Institute and is a Trustee of the Financial Accounting Foundation. He graduated from Dartmouth College in 1976 with an A.B. degree, and received an M.B.A. from the Harvard Business School in 1980.

      Eugene M. Isenberg is Chairman and Chief Executive Officer of Nabors Industries, Inc., a position he has held since 1987. He serves as a Director of the American Stock Exchange and also Danielson Holding Corporation, an insurance holding company. Mr. Isenberg is also a member of the National Petroleum Council, which is an advisory panel to the United States Department of Energy. From 1969 to 1982, Mr. Isenberg was Chairman of the Board and principal shareholder of Genimar, Inc., a steel trading and building products manufacturing company, which was sold in 1982. From 1955 to 1968, Mr. Isenberg was employed in various management capacities with the Exxon Corporation. Mr. Isenberg is the founder and principal sponsor of the Parkside School for children with learning disabilities and has established the Eugene M. Isenberg Scholarships at the University of Massachusetts where the School of Management is named after him. He was an instructor at Princeton University from 1951 to 1952 and served as an officer in the U.S. Navy from 1952 to 1955. Mr. Isenberg holds a B.A. from the University of Massachusetts and an M.A. from Princeton University in 1952. Mr. Isenberg completed the program for Senior Executives at M.I.T.


      NASD Profile of Board Nominee for Public Governor

      Public

      Kenneth M. Duberstein is Chairman and Chief Executive Officer of The Duberstein Group. Prior to this, Mr. Duberstein served as Chief of Staff to President Ronald Reagan from 1988 to 1989. During President Reagan's two terms in office, Mr. Duberstein also served in the White House as Deputy Chief of Staff (1987), as well as both the Assistant and the Deputy Assistant to the President for Legislative Affairs (1981 to 1983). Mr. Duberstein currently serves on the Board of Governors of the American Stock Exchange and on the Board of Directors of Boeing Company, Conoco, Fannie Mae, Fleming, and The St. Paul Companies, Inc. He is Vice Chairman of the Kennedy Center for the Performing Arts. Mr. Duberstein holds an A.B. from Franklin and Marshall College and an M.A. from American University.


      Governors with Terms Expiring in 2002

      Industry  
      M. LaRae Bakerink Chief Executive Officer, Westfield Bakerink Brozak, LLC
      David A. DeMuro Managing Director and Director of Global Compliance Regulation, Lehman Brothers, Inc.
      Richard C. Romano President, Romano Brothers & Co.
      Hardwick Simmons Chairman and CEO, The NASDAQ Stock Market, Inc.
         
      Non-Industry  
      H. Furlong Baldwin Chairman, Mercantile Bankshares Corporation
      Eugene M. Isenberg Chairman and CEO, Nabors Industries, Inc.
      James F. Rothenberg* President, Capital Research and Management Company
         
      Public  
      Kenneth M. Duberstein Chairman and CEO, The Duberstein Group, Inc.
      Donald J. Kirk*  
      John D. Markese* President, American Association of Individual Investors

      * Not eligible for re-election


      Governors with Terms Expiring in 2003

      Industry  
      William C. Alsover, Jr. Chairman, Centennial Securities Company, Inc.
         
      Non-Industry  
      Arvind Sodhani* Vice President and Treasurer, Intel Corporation
         
      Public  
      Brian T. Borders, Esq. Mayer, Brown, Rowe & Maw
      Sharon P. Smith Dean, College of Business Administration, Fordham University


      Governors with Terms Expiring in 2004

      Industry  
      John W. Bachmann Managing Partner, Edward D. Jones & Company
      Richard F. Brueckner Chief Operating Officer, Pershing Division of Credit Suisse First Boston
      Raymond A. Mason Chairman & CEO, Legg Mason Wood Walker, Inc.
         
      Non-Industry  
      Harry P. Kamen* Retired Chairman and Chief Executive Officer, Metropolitan Life Insurance Company
         
      Public  
      James E. Burton Chief Executive Officer, California Public Employees' Retirement System
      Sir Brian Corby Chairman (retired), Prudential Assurance Company
      James R. Rutherfurd, Jr. President and CEO, Moody's Corporation

      * Not eligible for re-election


      Endnotes

      1 Hardwick Simmons was appointed to the NASD Board in 2001 to replace Arthur Rock who resigned.

      2 Governor DeMuro currently serves on the NASD Board as Chair of the National Adjudicatory Council (NAC). His term as Chair of the NAC expires in 2002. In accordance with Article VII, Section 5(b) of the NASD By-Laws, after serving as Chair of the NAC, an individual is eligible to serve as a Governor elected by the members of NASD.

    • 02-55 NASD Requests Comment on Proposed New Rule 2712 (IPO Allocations and Distributions) and on an Amendment to Rule 2710 (Corporate Financing Rule)

      View PDF File

      REQUEST FOR COMMENT

      Regulation of IPO Allocations and Distributions

      Comment Period Expires: September 9, 2002.

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Financing
      Legal & Compliance
      Registered Representatives
      Senior Management
      Trading & Market Making

      Flipping
      IPO Allocations
      NASD Rule 2710
      NASD Rule 2712
      Penalty Bids
      Spinning
      Underwriting Compensation



      Executive Summary

      NASD is proposing to create new Rule 2712 and amend existing Rule 2710 to prohibit certain IPO allocation abuses. The federal securities laws1 and existing NASD rules2 already prohibit certain IPO allocation abuses. These laws and rules would continue to apply if NASD adopts proposed new Rule 2712. Nevertheless, new, specifically targeted provisions in Rule 2712 would aid member compliance efforts and help to maintain investor confidence in the capital markets. In particular, the proposal would expressly prohibit the following types of conduct:

      • the allocation of IPO shares as consideration or inducement for the payment of excessive compensation for other services provided by the member;


      • the solicitation of aftermarket orders for the allocation of IPO shares;


      • the allocation of IPO shares to an executive officer or director of a company on the condition that the officer or director send the company's investment banking business to the member, or as consideration for investment banking services previously rendered; and


      • the imposition of a penalty on registered representatives whose retail customers have "flipped" IPO shares when similar penalties have not been imposed with respect to syndicate members.

      The proposal would require members to adopt procedures reasonably designed to ensure that the requirements and prohibitions in Rule 2712 are followed. The proposal also would amend Rule 2710 to allow NASD to collect certain data on potential "spinning" abuses from members. See Exhibits A and B for rule language.

      Action Requested

      NASD encourages all interested parties to comment on the proposal. Comments must be received by September 9, 2002. Comments should be mailed to:

      Barbara Z. Sweeney
      NASD
      Office of the Corporate Secretary
      1735 K Street, NW
      Washington, DC 20006-1500

      Important Note: The only comments that will be considered are those submitted via e-mail or in writing.

      Before becoming effective, any rule change developed as a result of comments received must be adopted by the NASD Regulation Board of Directors, may be reviewed by the NASD Board of Governors, and must be approved by the SEC.

      Questions/Further Information

      As noted, written comment should be submitted to Barbara Z. Sweeney. Questions concerning this Notice to Members — Request for Comment may be directed to Joseph E. Price, Director, Corporate Financing Department, NASD Regulatory Policy and Oversight, at (240) 386-4623, or Gary Goldsholle, Associate General Counsel, NASD, Regulatory Policy and Oversight, at (202) 728-8104.

      Background

      NASD is proposing new Rule 2712 and an amendment to Rule 2710. These rule changes will better ensure that members avoid unacceptable conduct when they engage in the allocation and distribution of IPOs. In addition, these rule changes are intended to sustain public confidence in the IPO process, which is critical to the continued success of the capital markets.

      Members are reminded that each provision in proposed Rule 2712 would apply independently. Compliance with one provision would not provide a safe harbor with respect to the other provisions of the rule. Moreover, members would have to ensure that their participation in the allocation and distribution of IPOs complies not only with Rule 2712, but with applicable federal securities laws and other NASD rules, including those referred to above.

      1. Prohibition of Abusive Allocation Arrangements

      Rule 2712(a) would expressly prohibit a member and its associated persons from offering or threatening to withhold an IPO allocation as consideration or inducement for the receipt of compensation that is excessive in relation to the services provided by the member. This provision would prohibit this activity not only with respect to services, but any service offered by the member.

      NASD does not intend that this prohibition interfere with legitimate customer relationships. For example, the prohibition is not intended to prohibit a member from allocating IPO shares to a customer because the customer has separately retained the member for other services, when the customer has not paid excessive compensation in relation to those services. NASD requests comment on whether this provision appropriately balances the need to protect the integrity of the IPO allocation process with the desire to avoid undue interference with legitimate customer relationships.

      2. Prohibition of Aftermarket Tie-in Agreements

      Rule 2712(b) would expressly prohibit a member or an associated person that is participating in an IPO from requesting that a customer purchase shares in the aftermarket as a condition to being allocated shares in the IPO. In August 2000, the SEC's Division of Market Regulation issued Staff Legal Bulletin No. 10, in which it stated that requiring a customer to agree to buy additional shares in the aftermarket as a condition to being allocated shares in the distribution violates Rules 101 and 102 of Regulation M and may violate other anti-fraud and anti-manipulation provisions of the federal securities laws. The Staff Legal Bulletin explained that aftermarket tie-in agreements are a particularly egregious form of solicited transaction prohibited by Regulation M. The SEC staff wrote that "solicitations and tie-in agreements for aftermarket purchases are manipulative because they undermine the integrity of the market as an independent pricing mechanism." Rule 2712(b) would expressly prohibit these types of aftermarket tie-in agreements, thereby supplementing existing prohibitions in Regulation M and Rule 2110.

      The proposed rule would prohibit discussions in which after-market purchases are requested as a condition for the receipt of an IPO allocation. We request comment on this provision.

      3. Prohibition of Spinning

      Rule 2712(c) would expressly prohibit a member and its associated persons from allocating IPO shares to an executive officer or director of a company on the condition that the executive officer or director, on behalf of the company, direct future investment banking business to the member. The rule also would prohibit IPO allocations to an executive officer or director as consideration for directing investment banking services previously rendered by the member to the company.

      "Spinning" or awarding IPO shares to the executive officers and directors of the company divides the loyalty of the agents of the company (i.e., the executive officers and directors) from the principal (i.e., the company) on whose behalf they must act. This practice is inconsistent with just and equitable principles of trade.

      Rule 2712(c) would prohibit the allocation of IPO shares on the condition that the executive officer or director send investment banking business to the member, or as consideration for previously directed investment banking business. The provision is not intended to prohibit a member from allocating IPO shares to a customer merely because the customer is an executive officer or director of a company.

      NASD also is proposing to amend Rule 2710, the Corporate Financing Rule, to require that members file information regarding the allocation of IPO shares to executive officers and directors of a company that hires a member to be the book-running managing underwriter of the company's IPO. This information would assist the staff in monitoring the possibility that improper allocations to executive officers or directors may have occurred. This information also may alert the staff to allocations that could violate Rule 2712(a).

      4. Restrictions on Penalty Bids

      Rule 2712(d) would prohibit members from penalizing registered representatives whose customers have "flipped" IPO shares that they have purchased through the member, unless a penalty bid, as defined in Regulation M Rule 101 has been imposed. Rule 101 defines a penalty bid as "an arrangement that permits the managing underwriter to reclaim a selling concession from a syndicate member in connection with an offering when the securities originally sold by the syndicate member are purchased in syndicate covering transactions."

      Regulation M and Nasdaq Stock Market Rule 4624 provide notice and recordkeeping requirements for penalty bids. Penalty bids typically are used in the aftermarket of an offering that is under downward price pressure from an imbalance of sell orders relative to purchase orders. NASD does not oppose this use of penalty bids. However, some members have penalized their registered representatives in connection with flipping by retail customers, even when the managing underwriter has not imposed a penalty bid on the syndicate members. For example, members have penalized their registered representatives by recouping the commission or credits previously granted for the sale of IPO shares.

      The practical consequence of this practice is that registered representatives are penalized, and their retail customers may be pressured to retain their long position in the IPO shares, while representatives for institutional customers generally are not penalized at all for their flipping activity. The inequity of this selective penalization is most difficult to justify in light of the fact that most IPO shares are typically allocated to institutional customers, and the need to encourage institutional customers to remain committed to the issuer may therefore be greater. The proposed rule would effectively prohibit this selective practice by permitting members to impose internal penalties on their registered representatives only when the managing underwriter has imposed a penalty bid on the syndicate members. The provision would not place any limit on syndicate penalty bids, however.

      5. Requirement for Procedures

      Rule 2712(d) would require members to adopt procedures reasonably designed to ensure that the requirements and prohibitions in Rule 2712 are followed. The proposal would not mandate specific procedures that would apply to all members. Instead, it would permit members to tailor the required procedures to their particular corporate structure and the nature of their underwriting and distribution activities. Accordingly, members that do not engage in the allocation or distribution of IPOs would not be required to adopt procedures under Rule 2712.


      Endnote

      1 E.g., Rules 10b-5 (Employment of Manipulative and Deceptive Devices) and Rule 100 (Regulation M).

      2 E.g., Rules 2110 (Standards of Commercial Honor and Principles of Trade), 2710 (Corporate Financing Rule), 2330 (Customers' Securities or Funds), 3010 (Supervision), and 3060 (Influencing or Rewarding Employees of Others).


      EXHIBIT A

      Rule 2712. IPO Allocations and Distribution

      (a) Abusive Allocations. No member or person associated with a member may offer or threaten to withhold shares it allocates in an initial public offering ("IPO") as consideration or inducement for the receipt of compensation that is excessive in relation to the services provided by the member.
      (b) Aftermarket Tie-in Agreements. No member or person associated with a member that is participating in an IPO may request that a customer purchase shares in the aftermarket as a condition to being allocated shares in the IPO distribution.
      (c) Spinning. No member or person associated with a member may allocate IPO shares to an executive officer or director of a company:
      (1) on the condition that the executive officer or director, on behalf of the company, direct future investment banking business to the member, or
      (2) as consideration for directing investment banking services previously rendered by the member to the company.
      (d) Policies Concerning Flipping. No member or person associated with a member may directly or indirectly recoup, or attempt to recoup, any portion of a commission or credit paid or awarded to an associated person for selling shares in an IPO as a penalty or disincentive for selling the shares to a customer that engaged in flipping, unless the managing underwriter has assessed a penalty bid on the member.
      (1) In connection with its obligation to maintain records relating to penalty bids under SEC Rule 17a-2(c)(1), a member must promptly record and maintain information regarding any penalty or disincentive assessed on its associated persons in connection with a penalty bid.
      (2) Definitions
      For purposes of this Rule, the following terms shall have the meanings stated below.
      (A) "Flipping," means the initial sale of IPO shares purchased in an offering within 30 days following the effective date of such offering.
      (B) "Penalty bid" means an arrangement that permits the managing underwriter to reclaim a selling concession from a syndicate member in connection with an offering when the securities originally sold by the syndicate member are purchased in syndicate covering transactions.
      (e) Supervisory Procedures. Each member subject to this rule must adopt and implement written procedures reasonably designed to ensure that the member and its employees comply with the provisions of this rule.

      EXHIBIT B

      New language is underlined.

      Rule 2710. Corporate Financing Rule — Underwriting Terms and Arrangements

      *  *  *
      (b) Filing Requirements
      (1) - (3) No change
      (4) Requirement for Filing
      (A) Unless filed by the issuer, the managing underwriter, or another member, a member that anticipates participating in a public offering of securities subject to this Rule shall file with the Association the documents and information with respect to the offering specified in subparagraphs (5) and (6) below no later than one business day after the filing of any such documents:
      *  *  *
      ; provided, however, that the information required under Rule 2710(b)(6)(A)(viii) must be filed no later than 15 calendar days after the conclusion of the 180 calendar-day period immediately following the effective date of the offering.
      (5) No change
      (6) Information Required to be Filed
      (A) Any person filing documents with the Association pursuant to subparagraph (4) above shall provide the following information with respect to the offering:
      (i) - (vi) No change.
      (vii) a statement regarding whether any executive officer or director of the issuer acquired from the book-running managing underwriter of the public offering any shares in an initial public offering of securities ("IPO") during the 180 calendar-day period immediately preceding the required filing date of the offering. For each executive officer or director of the issuer who acquired those IPO shares, the statement must disclose:
      a. the name of the executive officer or director;
      b. the date of the IPO, the name of the issuer in the IPO, the number of securities purchased or received by the executive officer or director and the price paid for those securities; and
      c. whether the executive officer or director participated in any capacity in the selection of the book-running managing underwriter for the issuer's public offering.
      (viii) a statement containing the information required in Rule 2710(b)(6)(vii)(a)-(c) if any executive officer or director of the issuer purchases or acquires from the book-running managing underwriter any shares in an IPO within 180 calendar days after the effective date of the offering.

  • 02-54 NASD Requests Comment on Proposed Amendments to Rules 1014 and 1017

    View PDF File

    REQUEST FOR COMMENT

    Membership Application Rules

    Comment Period Expires: September 20, 2002

    SUGGESTED ROUTING

    KEY TOPICS

    Legal & Compliance
    Senior Management

    Membership Application Process
    Membership Continuation Process
    Rule 1014
    Rule 1017



    Executive Summary

    NASD requests comment on proposed amendments to Rules 1014 and 1017. Rule 1017(a) sets forth certain events relating to changes in a member's ownership, control, or business operations, which require a member to apply and obtain approval from NASD staff.1 Rule 1014 establishes the standards for approval of both new member applications under Rule 1013 and "continuing member applications" under Rule 1017. NASD is proposing amendments to Rules 1014 and 1017 to clarify and further strengthen NASD's authority under these rules in an effort to stay abreast of market developments.

    Specifically, NASD has experienced an increase in member consolidations, business restructurings, and asset sales. NASD has reviewed proposed transactions that could have an adverse effect on the payment of arbitration awards and satisfaction of other customer claims. To address concerns raised in such transactions, NASD seeks comment on amendments to Rules 1014 and 1017 that would: (1) expand NASD's authority to review asset transfers to include any transfer involving a material amount of assets and/or revenues that contribute materially to earnings; (2) require that any seller that is not a member of the New York Stock Exchange (NYSE) file an application for asset transfers covered by the rule even in the case where the buyer to the transaction is an NYSE member (which currently is a situation excluded from review under Rule 1017); and (3) create a new standard of admission explicitly identifying as decisional criteria unpaid arbitration awards or other adjudicated customer awards, as well as pending arbitration claims by an applicant, its controlling persons, principals, registered representatives, any lender of 5% or more of the applicant's net capital, and any other member with respect to which these persons were a controlling person or a 5% lender of its net capital.

    In addition, former members or their associated persons with a significant disciplinary history, including a history of unpaid arbitrations, may later seek to re-enter the securities industry. NASD is concerned about the investor protection issues and the potential adverse impact on the integrity of the marketplace posed by these persons. In this regard, as further outlined below, NASD is requesting comments on an amendment that would place the burden on applicants to demonstrate that their applications should be approved notwithstanding that the applicant has a history of certain regulatory events.

    NASD further seeks comment on whether Rule 1014 should be amended to include reference to entities as controlling persons in light of the fact that NASD's current definition of "associated persons" does not include non-natural persons.

    Questions/Further Information

    Questions regarding this Notice to Members may be directed to the NASD Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8071; or the NASD Member Regulation Department, Regulatory Policy and Oversight, at (202) 728-8221.

    Request for Comment

    NASD requests comment on the proposed amendments to Rules 1014 and 1017 described in this Notice. For your convenience, we have provided a checklist (see Attachment B) that offers a convenient method to participate in the comment process concerning the proposed amendments.

    Comments must be received by September 20, 2002. Members and interested persons can submit their comments using the following methods:

    • mail Attachment B—Request for Comment Form—along with written comments


    • mail written comments


    • e-mail written comments to pubcom@nasd.com


    • submit written comments online on our Web Site (www.nasd.com)

    Written comments submitted via hard copy should be mailed to:

    Barbara Z. Sweeney
    NASD
    Office of the Corporate Secretary
    1735 K Street, NW
    Washington, DC 20006-1500

    Important Note: The only comments that will be considered are those submitted by mail, e-mail, or those submitted to the NASD Web Site.

    Before becoming effective, any rule change developed as a result of responses received to this Notice must be approved by the Securities and Exchange Commission.

    Background

    The membership application and membership continuation processes have played an important role in investor protection by helping to ensure that new members and members that make a material change to their business comply and continue to comply with rigorous standards. Rule 1014, which sets forth the standards used when reviewing new member and continuing member applications, specifically requires NASD to consider the public interest and protection of investors when reviewing applications.

    Recently, there has been an increase in company restructurings, including the selling of company assets. Asset transfer applications filed pursuant to Rule 1017 are often time-sensitive and may be the first step in a member's withdrawal from the securities business. While asset transfers often serve legitimate business purposes, they also can raise customer protection issues. NASD has encountered several instances where the effect of a member attempting to restructure by transferring assets is to insulate the member and its owners from responsibility for payment of pending or unpaid arbitrations. In some cases, the member will transfer its assets without a corresponding transfer of its liabilities.Because the corporate format used by many members seeks to insulate the owners from liabilities of the member, a customer with an award or judgment against the member may only be able to be paid from the member's assets. Thus, an asset transfer may transform the member from an operating business that can generate value over time to a shell holding the firm's liquidated value, leaving behind customers with arbitration claims pending against, or arbitration awards unsatisfied by, a member.

    Discussion

    Based on NASD's experience in applying the membership application procedures, especially in light of increasing concerns regarding the potentially negative effects of asset transfers on former and current customers, NASD believes that Rules 1014 and 1017 should be amended to allow NASD to better identify and respond to applications that may leave pending arbitrations and customer claims unaccounted for.

    1. Review of Material Transfer of Member's Assets

    NASD believes it is important that it has the opportunity to review all member transactions that can materially adversely affect current and former customers. Rule 1017(a)(3) requires a member to submit an application only upon the transfer of substantially all of the member's assets. However, this may potentially eliminate from NASD's review a member's piecemeal transfer of its assets that, while not "substantially all" in amount, may nevertheless have a material impact on the operations or profitability of the selling member. In this regard, NASD proposes broadening the scope of Rule 1017(a)(3) to require members to submit applications prior to the transfer of a material amount of the member's assets or prior to the transfer of any asset, business or line of operation that generates revenues comprising a material portion of the selling member's earnings.2 NASD further seeks comment on whether "material" should be more specifically defined in the Rule and, if so, the appropriate standard of materiality. For example, should NASD define "material" for these purposes to be 25% or more of the member's assets or any asset, business or line of operation that generates revenues of 25% or greater of the selling member's earnings. NASD seeks comment on whether some other standard is more appropriate.

    2. Clarification of Members Required to Submit Applications

    Because of concerns that a selling member's customers may be left unprotected following an asset transfer, NASD believes that the seller's situation should be reviewed in connection with all such transactions. Rule 1017(a) currently exempts selling members from the requirement to submit applications if the acquiring firm is a member of the NYSE. The proposed amendments would require all non-NYSE selling members to submit an application regardless of whether the buyer is an NYSE member. NASD does not intend to put applicants through duplicative approval processes where the transaction is otherwise subject to adequate customer protection safeguards. Rather, in requiring an application regardless of whether the acquirer is a member of the NYSE, NASD will be assured of receiving notice and will be in a position to target particular aspects of the transaction for additional review, if necessary.

    3. Consideration of Arbitrations in Application Process

    Comporting with NASD's attempts to foster compliance with the terms of arbitration and other adjudicated customer awards, NASD proposes to amend Rule 1014(a)(3) explicitly to include as factors in the consideration of both new and continuing member applications the unpaid arbitration awards or other adjudicated customer awards, as well as pending arbitration claims against an applicant and other persons that may have significant control or influence over the applicant, including its controlling persons, principals, registered representatives, any lender of 5% or more of the applicant's net capital, and any other member with respect to which these persons were a controlling person or a 5% lender of its net capital.3

    4. Burden of Proof

    NASD has seen instances where an applicant (both new member and change of ownership/control) has a disciplinary history of some concern that falls short of a statutory disqualification. Many of these cases involve applications from closely held firms where, even if the broker/dealer establishes heightened supervisory procedures, the influence of the control person on the small broker/dealer may overcome the supervisory structures. Rule 1014(a)(3) requires NASD to determine whether an applicant and its associated persons "are capable of complying with" federal securities laws and the rules of NASD. A variety of specific events, including past and current disciplinary actions and customer claims, are among the considerations referenced in the rule. However, there is little case precedent to guide NASD in applying this standard, particularly in the context of the key principals and control persons of smaller firms.

    NASD is proposing to further enhance its authority under Rule 1014(a), for all categories of applications, to consider the impact of an applicant's past behavior by creating a rebuttable presumption that the presence of any of the events enumerated in Rule 1014(a)(3)(A) and (C) though (E), places the burden on the applicant to demonstrate that the application should be approved notwithstanding the presence of that regulatory history. The rebuttable presumption does not create new standards for admission, but merely shifts the burden of proof to applicants to show that they should be allowed admission. NASD believes that investor protection and service of the public interest demands that applicants with a regulatory history bear the burden of overcoming the rebuttable presumption that their application should be denied.

    Additional Issue for Comment

    Finally, NASD proposes to amend Rule 1014 to include reference to non-natural controlling persons in light of the fact that NASD's current definition of "associated persons" does not encompass non-natural persons.


    Endnotes

    1 The changes requiring application and approval are: mergers, the acquisition of a member, the acquisition of substantially all of a member's assets, a change in ownership or control of a member, and a material change in a member's business operations.

    2 As with other Rule 1017 applications, Rule 1017(c)(1) allows NASD to place interim restrictions on any asset transfer if NASD believes that the application does not meet Rule 1014 standards. These interim restrictions are meant for the protection of investors and ordinarily would not prevent a transaction from moving forward. However, there may be some instances where the protection of investors will require that interim restrictions will prohibit or delay a transaction from closing.

    3 NASD further notes that Rule 2110 applies to efforts by a firm and its owners to unfairly prejudice customers seeking relief in arbitration proceedings.


    ATTACHMENT A

    New language is underlined; deletions are in brackets.

    1014. Department Decision

    (a) Standards for Admission
    After considering the application, the membership interview, other information and documents provided by the Applicant, other information and documents obtained by the Department, and the public interest and the protection of investors, the Department shall determine whether the Applicant meets each of the following standards:
    (1) - (2) No Change.
    (3) The Applicant and its Associated Persons are capable of complying with the federal securities laws, the rules and regulations thereunder, and the Rules of the Association, including observing high standards of commercial honor and just and equitable principles of trade. In determining whether this standard is met, the Department may take into consideration whether:
    (A) - (B) No Change.
    (C) an Applicant or Associated Person is the subject of a pending, adjudicated, or settled regulatory action or investigation by the Commission, the Commodity Futures Trading Commission, a federal, state, or foreign regulatory agency, or a self-regulatory organization; a pending, adjudicated, or settled investment-related civil action for damages or an injunction; or a criminal action (other than a minor traffic violation) that is pending, adjudicated, or that has resulted in a guilty or no contest plea; or an Applicant, its control persons, principals, registered representatives, any lender of 5% or more of the Applicant's net capital, and any other member with respect to which these persons were a control person or a 5% lender of its net capital is subject to unpaid arbitration awards, other adjudicated customer awards, unpaid arbitration settlements, or pending arbitrations;
    (D) - (F) No Change.
    (4) - (14) No Change.
    (b) Granting or Denying Application
    (1) In reviewing an application for membership, the Department shall consider whether the applicant meets each of the standards in paragraph (a), provided the Applicant overcomes the presumption that the application should be denied where one or more of the circumstances identified in Rule 1014(a)(3)(A) and (C) through (E) exist.
    (2) [(1)] If the Department determines that the Applicant meets each of the standards in paragraph (a), the Department shall grant the application for membership.
    (3) [(2)] If the Department determines that the Applicant does not meet one or more of the standards in paragraph (a) in whole or in part, the Department shall:
    (A) grant the application subject to one or more restrictions reasonably designed to address a specific financial, operational, supervisory, disciplinary, investor protection, or other regulatory concern based on the standards for admission in Rule 1014(a); or
    (B) deny the application.
    (c) - (g) No Change.
    (h) Definition of Associated Person
    For purposes of this Rule 1014, the term "Associated Person" shall mean (1) a natural person registered under the Rules of NASD; or (2) a sole proprietor, partner, officer, director, branch manager, or other natural person, company, government, or political subdivision, agency, or instrumentality of a government occupying a similar status or performing similar functions who will be or is anticipated to be associated with the Applicant, or a natural person or company, government, or political subdivision, agency, or instrumentality of a government engaged in the investment banking or securities business who will be or is anticipated to be directly or indirectly controlling or controlled by the Applicant, whether or not any such person or company, government, or political subdivision, agency, or instrumentality of a government is registered or exempt from registration under the NASD By-Laws or the Rules of NASD.

    1017. Application for Approval of Change in Ownership, Control, or Business Operations

    (a) Events Requiring Application
    A member shall file an application for approval of any of the following changes to its ownership, control, or business operations:
    (1) a merger of the member with another member, unless both are members of the New York Stock Exchange, Inc. or the surviving entity will continue to be a member of the New York Stock Exchange, Inc.;
    (2) a direct or indirect acquisition by the member of another member, unless the acquiring member is a member of the New York Stock Exchange, Inc.;
    (3) a direct or indirect acquisition of [substantially all] a material amount of the member's assets or any asset, business or line of operation that generates revenues comprising a material portion of the member's earnings, unless [the acquirer is a member] both the seller and acquirer are members of the New York Stock Exchange, Inc.;
    (4) a change in the equity ownership or partnership capital of the member that results in one person or entity directly or indirectly owning or controlling 25 percent or more of the equity or partnership capital; or
    (5) a material change in business operations as defined in Rule 1011(i).
    (b) - (f) No Change.
    (g) Department Decision
    (1) The Department shall consider the application, the membership interview, other information and documents provided by the Applicant or obtained by the Department, the public interest, and the protection of investors. In rendering a decision on an application submitted under Rule 1017(a), the Department shall consider whether the applicant meets each of the standards in Rule 1014(a), provided the Applicant overcomes the presumption that the application should be denied where one or more of the circumstances identified in Rule 1014(a)(3)(A) and (C) through (E) exist.
    (A) In rendering a decision on an application for approval of a change in ownership or control, or an application for approval of a material change in business operations that does not involve modification or removal of a membership agreement restriction, the Department shall determine if the Applicant would continue to meet the standards in Rule 1014(a) upon approval of the application.
    (B) In rendering a decision on an application requesting the modification or removal of a membership agreement restriction, the Department shall consider whether the maintenance of the restriction is appropriate in light of:
    (i) the standards set forth in Rule 1014;
    (ii) the circumstances that gave rise to the imposition of the restriction;
    (iii) the Applicant's operations since the restriction was imposed;
    (iv) any change in ownership or control or supervisors and principals; and
    (v) any new evidence submitted in connection with the application.
    (2) - (4) No Change.
    (h) - (k) No Change.

    ATTACHMENT B

    Request For Comment Form

    We have provided below a form that members and other interested parties may use in addition to written comments. This form is intended to offer a convenient way to participate in the comment process, but does not cover all aspects of the proposal described in the Notice. We therefore encourage members and other interested parties to review the entire Notice and provide written comments, as necessary.

    Instructions

    Comments must be received by September 20, 2002. Members and interested parties can submit their comments using the following methods:

    • mail Attachment B—Request for Comment Form—along with written comments


    • mail written comments


    • e-mail written comments to pubcom@nasd.com


    • submit written comments online on our Web Site (www.nasd.com)

    Written comments submitted via hard copy should be mailed to:

    Barbara Z. Sweeney
    NASD
    Office of the Corporate Secretary
    1735 K Street, NW
    Washington, DC 20006-1500


    Proposed Amendments to Rules 1014 and 1017

    1. Is it appropriate for NASD to review transfers of a material amount of a member's assets or transfers of any asset, business or line of operation that generates revenues comprising a material portion of the selling member's earnings?

    Yes No See my attached written comments

    2. In connection with the proposed expanded review of asset transfers, should NASD include a more specific standard of materiality in the Rules?

    Yes No See my attached written comments

    3. Should NASD review other types of transactions that are not currently included in the Rules?

    Yes No See my attached written comments

    4. Should NASD require all non-NYSE selling members to submit applications to NASD for approval prior to the transfer of assets?

    Yes No See my attached written comments

    5. (a) Is it appropriate for applicants to bear the burden of proof to demonstrate that they should be approved for membership despite the presence of a regulatory history and,

    Yes No See my attached written comments

    5. (b) if so, is it appropriate to impose this burden for pending matters such as pending investigations and arbitrations?

    Yes No See my attached written comments

    6. Should the scope of Rule 1014 be expanded to include non-natural persons?

    Yes No See my attached written comments


    Contact Information

    Name:
    Firm:
    Address:
    City/State/Zip:
    Phone:
    E-Mail:

    Are you:

      An NASD Member
      An Investor
      A Registered Representative
      Other:

  • 02-53 NASD Files Proposal to Amend Rule 3070 to Require Filing of Criminal and Civil Complaints and Arbitration Claims with NASD; Revises Letters Sent When Determination Made to Close an Investigation Without Further Action

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    NASD Rule 3070

    SUGGESTED ROUTING

    KEY TOPICS

    Legal & Compliance
    Operations
    Senior Management

    NASD Rule 3070
    NASD Rule 2110



    Executive Summary

    NASD has undertaken two initiatives to improve the quality and flow of information to it about allegations of broker misconduct. First, on August 14, 2002, NASD filed with the Securities and Exchange Commission (SEC) a rule proposal to amend NASD Rule 3070 to require members promptly to file with NASD copies of certain criminal and civil complaints and arbitration claims that name a member or an associated person as defendant or respondent. Specifically, the proposed rule change would require members to file with NASD copies of (1) any criminal complaints filed against the member or plea agreements entered into by the member that are covered by the rule; (2) any securities or commodities-related private civil complaints filed against the member; (3) any arbitration claim against the member; and (4) any criminal complaint or plea agreement, private civil complaint or arbitration claim against an associated person that is reportable under Question 14 on Form U-4, irrespective of any dollar threshold requirements that question imposes for notification. Members would not be required to file copies of any arbitration claims filed in the NASD Dispute Resolution forum. NASD recently began to review copies of claims filed in that forum for possible regulatory response.

    Second, NASD has revised the letters it sends to customers and members when a determination is made to close an investigation without disciplinary action. The revised letters state that a determination by NASD not to take action against a member or a member's associated person has no evidentiary weight in any mediation, arbitration, or judicial proceeding. Further, NASD considers it inconsistent with just and equitable principles of trade (Rule 2110) for a member or a member's associated person to attempt to introduce such a determination into evidence in any of those proceedings.

    The text of the proposed amendments to Rule 3070 is attached. Comments on the proposal should be directed in writing to the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549.

    Questions concerning this Notice should be directed to Philip Shaikun, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8451.

    Background and Discussion

    Rule 3070

    Rule 3070 currently requires, among other things, that a member report to NASD when it is a defendant or respondent in felony criminal proceedings, certain misdemeanor criminal proceedings, or in certain civil or arbitration actions. As to the latter, Rule 3070(a)(7) requires that a member report to NASD when the member or a person associated with the member is a defendant or respondent in securities or commodities-related civil litigation or arbitration only when the proceeding has been disposed of by a judgment, award or settlement in an amount exceeding either $15,000 (if the defendant or respondent is an associated person) or $25,000 (if the defendant or respondent is the member). No existing rules require a member routinely to file copies with NASD of complaints filed against it in any legal proceedings.

    Similar to Rule 3070, Question 14 on Form U-4 requires notice that an associated person has been charged or convicted of a felony or certain misdemeanors. It further requires notice that an associated person has been named as a respondent or defendant in a consumer-initiated arbitration or civil litigation involving a sales practice violation that is pending, resulted in a judgment, settled for $10,000 or more, or contains a claim for compensatory damages of at least $5,000. However, Form U-4 does not require that the member or associated person file with NASD a copy of the complaint that initiates such proceedings or any plea agreements to resolve reportable criminal charges.

    By requiring members to file with NASD copies of certain criminal and civil complaints and arbitration claims, the proposed amendments to Rule 3070 will provide NASD with additional sources of pertinent information regarding broker misconduct. As a result, NASD can enhance investor protection efforts by promptly taking appropriate regulatory action to address specific allegations and to prevent similar or related misconduct in the future. Moreover, the information can be combined with other sources of regulatory intelligence to identify patterns and trends at the earliest possible stage, thereby deploying resources to higher risk areas that better protect investors. With respect to associated persons, it is important to receive copies of complaints and claims reportable under Question 14 on Form U-4, even when they fall below specified dollar thresholds, as such matters may also point to trends or otherwise flag conduct where regulatory action might be warranted.

    NASD now makes copies, at its own expense, of all arbitration claims filed in the NASD Dispute Resolution forum. Those claims are forwarded after copying to a unit within NASD that reviews the allegations in the claims for possible regulatory action.

    NASD would treat similarly copies of other complaints, claims and plea agreements required to be filed with NASD under the rule proposal.

    The rule proposal minimizes the burden on members in that the rule requires only the filing of those complaints and claims most likely to reveal information to assist NASD's regulatory mission. For example, members would not be required to file private civil litigation complaints or arbitration claims that do not relate to securities or commodities-related conduct. Furthermore, as discussed above, the proposal would not require members to file with NASD any arbitration claims that are originally filed in the NASD Dispute Resolution forum. NASD is already incurring the cost to make copies of those claims and will continue to do so under the proposal.

    Content and Use of Close-Out Letters

    In a related initiative, NASD recently revised the letters that are sent to customers and members when a determination is made to close an investigation without further disciplinary action. This step was taken after NASD learned that some customers chose not to bring allegations to the attention of NASD out of concern that a letter declining further action would be offered as exculpatory evidence in an arbitration, mediation, or judicial proceeding.

    NASD is not litigating a private arbitration claim when it conducts a regulatory review. As a result, the revised letters now state NASD's contention that a determination not to take action against a member has no evidentiary weight in a subsequent proceeding, such as mediation, arbitration, or a judicial action. In addition, NASD now gives the customer the option not to receive a close-out letter. To opt out, a customer must notify NASD of this decision in writing or by e-mail. In the event a customer does opt out, NASD will not issue a final close-out letter.

    Furthermore, the revised letters warn that NASD considers it inconsistent with just and equitable principles of trade (Rule 2110) for a member or associated person to attempt to introduce the letter, or the fact that NASD declined further action, as evidence in a subsequent legal proceeding. NASD's decision to close an investigation without further action can result from many factors unrelated to the merits of a complaint, such as jurisdictional limitations or the existence of an ongoing or completed enforcement action by another law enforcement or regulatory agency. As such, NASD considers it unethical and potentially misleading to suggest to an adjudicator or mediator that NASD's determination is probative evidence in a dispute on the merits of a related claim.


    ATTACHMENT A

    Proposed Amendment to NASD Rule 3070

    Additions are underlined. Deletions are in brackets.

    3070. Reporting Requirements

    (a) through (c) No change.
    (d) Nothing contained in [paragraphs (a), (b) and (c) of] this Rule shall eliminate, reduce, or otherwise abrogate the responsibilities of a member or person associated with a member to promptly file with full disclosure, required amendments to Form BD, Forms U-4 and U-5, or other required filings, and to respond to [the Association] NASD with respect to any customer complaint, examination, or inquiry.
    (e) Any member subject to substantially similar reporting requirements of another selfregulatory organization of which it is a member is exempt from [the provisions] paragraphs (a), (b) and (c) of this Rule.
    (f) Each member shall promptly file with NASD copies of:
    (1) any indictment, information or other criminal complaint or plea agreement for conduct reportable under paragraph (a)(5) of this Rule;
    (2) any complaint in which a member is named as a defendant or respondent in any securities or commodities-related private civil litigation;
    (3) any securities or commodities-related arbitration claim filed against a member in any forum other than the NASD Dispute Resolution forum;
    (4) any indictment, information or other criminal complaint, any plea agreement, or any private civil complaint or arbitration claim against a person associated with a member that is reportable under question 14 on Form U-4, irrespective of any dollar thresholds Form U-4 imposes for notification, unless, in the case of an arbitration claim, the claim has been filed in the NASD Dispute Resolution forum.

  • 02-52 NASD Requests Comment on Proposed Amendments to NASD Rule 3010(g)(2) ("Branch Office Definition")

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    REQUEST FOR COMMENT

    Branch Office Definition

    Comment Period Expires: September 20, 2002

    SUGGESTED ROUTING

    KEY TOPICS

    CRD
    Legal & Compliance
    Member Regulation
    Operations
    Senior Management

    Branch Office Definition
    Rule Modernization
    Rule 3010(g)(2)



    Executive Summary

    NASD requests comment from members, investors, and other interested parties on proposed amendments to NASD Rule 3010(g)(2) ("Branch Office Definition"), which were developed collectively by NASD, the New York Stock Exchange, Inc. (the NYSE) and the North American Securities Administrators Association, Inc. (NASAA), with the intention of creating a uniform definition of the term among regulators. Currently, there is no uniform approach among regulators for classifying locations at which securities operations are conducted. The creation of a uniform branch office definition would allow NASD to pursue registration of branch offices through NASD's Central Registration Depository (CRD) system.

    NASD seeks comment on the proposed definition of branch office, including on whether the proposed uniform definition: (1) provides greater clarity on when a location is required to be registered as a branch office; (2) provides a cost savings to firms as a result of centralized registration of locations through NASD's CRD system; (3) minimizes regulatory compliance burdens; (4) significantly affects the number of locations that a firm is required to register; and (5) adequately addresses evolving business practices based on technological innovations. Additionally, NASD seeks comment on whether the proposed exceptions to the branch office are appropriate. Commenters are encouraged to provide empirical data where possible to support their views.

    Questions/Further Information

    Questions concerning this Notice may be directed to Kosha Dalal, Assistant General Counsel, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-6903; or questions concerning NASD coordination with the NYSE and NASAA may be directed to Chip Jones, Associate Vice President, NASD Registration and Disclosure, at (240) 386-4797.

    Request for Comment

    NASD requests comment on the proposed amendments to Rule 3010(g)(2). Comments must be received by September 20, 2002. Members and interested persons can submit their comments using the following methods:

    • mail Attachment B—Request for Comment Form—along with written comments


    • mail written comments


    • e-mail written comments to pubcom@nasd.com


    • submit written comments online on our Web Site (www.nasd.com)

    Written comments submitted via hard copy should be mailed to:

    Barbara Z. Sweeney
    NASD
    Office of the Corporate Secretary
    1735 K Street, NW
    Washington, DC 20006-1500

    Important Note: The only comments that will be considered are those submitted by mail, e-mail, or those submitted to the NASD Web Site.

    Before becoming effective, any rule change developed as a result of responses received to this Notice must by approved by the Securities and Exchange Commission.

    Background

    In July 2001, NASD announced in Notice to Members 01-35 its intention to move forward with an initiative designed to ensure that NASD rules are as streamlined as possible, and impose the least burden to accomplish their objectives while achieving investor protection. In response to NASD Notice to Members 01-35, NASD received 37 comment letters identifying rules that should be the focus of our rule modernization effort. After reviewing these comment letters, in NASD Notice to Members 02-10 (January 2002), NASD requested comment on certain proposals that were under consideration, including establishing a uniform branch office definition. Of the approximately 65 commenters who responded regarding Rule 3010(g)(2), the responses were overwhelmingly in favor of developing a uniform definition that would allow centralized registration through the CRD system.

    Current Definition

    NASD Rule 3010(g)(2) defines a branch office generally as any location identified by any means to the public or customers as a location at which the member conducts an investment banking or securities business ("holding out"). The current definition excludes certain locations that only are identified in telephone listings, business cards, or letterhead, or referred to in advertising, or identified in a member's sales literature, provided that the address and telephone number of the branch office or office of supervisory jurisdiction (OSJ) from which the associated person is supervised is given.

    NASD designates locations from which associated persons work, other than the main office, as either branch offices or unregistered locations. This designation primarily affects the supervisory responsibilities of, and the fees paid by, members. An office that is designated a "branch office" under NASD rules must pay an annual registration fee and have onsite supervision by a branch manager. A branch office is further classified as an OSJ if any one of the following enumerated activities occurs at the location: order execution, maintenance of customer funds and securities, final approval of new accounts and advertisements, review of customer orders, and supervision of associated persons at other branch offices. An office that is designated an OSJ must have a registered principal onsite. The proposed uniform definition would not affect or change the definition, or responsibilities, of an OSJ.

    Need for Uniformity

    Currently, there is no uniform approach among regulators for classifying locations at which securities operations are conducted. NASD, the Securities and Exchange Commission (the SEC), the NYSE, and state regulators define the term (or a similar term) differently. The term also has different significance based on who classifies it. Under NASD rules, for example, the term triggers supervisory obligations and fees and, under the SEC rules, the term triggers record keeping requirements. NASD believes that a uniform definition of the term branch office would reduce regulatory burdens on firms because (1) there would be no need to keep track of varying definitions in numerous jurisdictions; (2) the risk of noncompliance would be reduced; and (3) a centralized registration process would provide efficiencies.

    The SEC's books and records rules, Rule 17a-3 and Rule 17a-4 under the Securities Exchange Act of 1934 ("Exchange Act")(hereinafter the "Books and Records Rules"), specify minimum requirements with respect to the records that broker/dealers must make, and how long those records and other documents relating to a broker/dealer's business must be kept. The proposed branch office definition would not alter or affect the obligations of a firm to comply with the requirements of the Books and Records Rules. The definition proposed here, and agreed upon by representatives of NASAA and the NYSE, largely tracks the definition in the SEC's Books and Records Rules for the term "office."1

    In July 2002, the NASD Board approved publication of this Notice seeking comment on the proposed uniform definition. In August 2002, the Board of Directors of the NYSE approved the proposed uniform definition and authorized its staff to file a proposed rule change with the SEC. In addition, NASAA's Broker-Dealer Section Committee has approved the proposed definition. NASAA also has committed to support the adoption of the uniform definition with the various states.

    Proposed Definition of "Branch Office"

    As proposed, a "branch office" would be any location, other than the main office, where one or more associated persons of a member regularly conduct the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of, any security, or that is held out as such.

    The interpretation of what it means to "regularly conduct the business of effecting transactions in, or inducing or attempting to induce the purchase or sale of any security" under the proposed uniform definition would include activities such as: (1) soliciting new accounts or orders; (2) opening new accounts; (3) accepting or entering orders; and (4) conducting seminars for existing or prospective customers. In addition, "holding out" a location would include references to a location on or in business cards, stationery, advertisements, sales literature, and signage that would lead investors to believe that they are dealing with a branch office of a member firm, regardless of whether the location from which the office is supervised is listed on the communication.

    The definition of "branch office" would expressly exclude, subject to the satisfaction of certain conditions:

    (1) a location that operates as a back office;
    (2) a representative's primary residence, provided the residence is used for securities business for less than 50 days annually and not held out to the public;
    (3) a location, other than a primary residence, provided that it is used for securities business for less than 30 days annually and not held out to the public (e.g., a vacation home);
    (4) a location used by a circuit-rider to meet with customers occasionally and exclusively by appointment;
    (5) a location that is primarily used for non-securities business (e.g., by insurance agents to sell nonsecurities insurance products) and from which the associated person(s) effects no more than 25 securities transactions in any one calendar year;
    (6) the floor of a registered exchange; and
    (7) a temporary location established in response to implementation of a business continuity plan.

    See Attachment A for a full description of the conditions that need to be satisfied for each exception to apply.

    Comparison of Current Definition vs. Proposed New Definition

    The current NASD branch office definition is based on a "holding out" standard (any location identified to the public or customers as a location at which the member conducts an investment banking or securities business). The definition is broad and is not dependent on the number of associated persons working at any particular location. The current definition excludes certain locations held out to the public so long as the identification of such locations is limited and sets forth the address and telephone number of the branch office or OSJ of the firm from which the associated person is directly supervised (for example, a business card or letterhead can list a non-branch location so long as the address and telephone number of the branch office or OSJ is also listed). Under the proposed uniform definition, this type of exception would no longer exist.

    The proposed uniform definition is intended to provide clarity in application and consistency between self-regulatory organizations (SROs) and state securities administrators. Under the proposed definition, any location where one or more associated persons regularly conduct the business of effecting transactions in, or inducing or attempting to induce the purchase or sale of, any security or that is held out as such is subject to registration as a branch office unless the location meets one of the seven specific exclusions. The exclusions are intended to provide firms with the flexibility that today's business environment demands (for example, many associated persons work from home for some part of the year, or conduct business while on vacation).

    The chart on the next page briefly compares the two definitions.

    Location Current Definition Proposed New Definition
    Back Office Subject to registration if the location is identified to the public in any way, including in a business card, letterhead, or identified in sales literature, etc., unless the address and telephone number of the branch office or OSJ is also identified Specifically excluded from registration so long as no sales activities occur at the location and it is not held out to the public as a branch office
    Primary Residence Subject to registration if the location is identified to the public in any way, including in a business card, letterhead, or identified in sales literature, etc., unless the address and telephone number of the branch office or OSJ is also identified Specifically excluded from registration so long as the primary residence is used for securities business for less than 50 business days per year and other conditions are satisfied
    Vacation Locations Subject to registration if the location is identified to the public in any way, including in a business card, letterhead, or identified in sales literature, etc., unless the address and telephone number of the branch office or OSJ is also identified Specifically excluded from registration so long as the location is used for securities business for less than 30 business days per year and other conditions are satisfied
    Bank Circuit Rider Not subject to registration so long as the address and phone number of the branch office or OSJ are also identified Not subject to registration so long as not held out (signage required by banking regulations is permitted)
    Non-securities Business Subject to registration if the location is identified to the public in any way, including in a business card, letterhead, or identified in sales literature, etc., unless the address and telephone number of the branch office or OSJ is also identified Not subject to registration so long as location is used primarily to conduct non-securities business (e.g., sell nonsecurity insurance products) and no more than 25 securities transactions are effected in one year and address and phone number of branch or OSJ is identified
    Floor of Registered National Securities Exchange Potentially subject to registration Not subject to registration
    Temporary Location for Business Continuity Potentially subject to registration Not subject to registration

    Benefits of Proposed New Definition

    NASD believes that a uniform definition would benefit member firms by reducing regulatory burdens and costs, without jeopardizing investor protection. In addition, the potential to use the CRD system for centralized registration of branch offices should provide greater clarity, efficiency, and time and potential liability savings resulting from uniformity. Currently, members with numerous offices must register with each individual state that requires registration; in some jurisdictions, failure to timely register can result in significant sanctions.

    NASD, therefore, solicits comment on whether to amend the Branch Office Definition as proposed in Attachment A. NASD also solicits comment specifically on whether the proposed uniform definition: (1) provides greater clarity on when a location is required to be registered as a branch office; (2) provides a cost savings to firms as a result of centralized registration of locations through CRD; (3) minimizes regulatory compliance burdens; (4) significantly affects the number of locations that a firm is required to register; and (5) adequately addresses evolving business practices based on technological innovations. Additionally, NASD seeks comment on whether the proposed exceptions to the branch office definition are appropriate. Commenters are encouraged to provide empirical data where possible to support their views.


    Endnote

    1 Rule 17a-3(g)(1) under the Exchange Act defines the term "office" to mean any location where one or more associated persons regularly conduct the business of handling funds or securities or effecting any transactions in, or inducing or attempting to induce the purchase or sale, of any security.


    ATTACHMENT A

    Proposed New Text of Rule 3010(g)(2) — "Branch Office" Definition

    A "branch office" is any location, other than the main office, where one or more associated persons of a member regularly conduct the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of, any security, or that is held out as such, excluding:

    (A) any location that is established solely for customer service and/or back office type functions where no sales activities are conducted and that is not held out to the public as a branch office;
    (B) any location that is the associated person's primary residence; provided that (i) the location is used for securities business for less than 50 business days in any one calendar year; (ii) only one person, or multiple associated persons who reside at that location and are members of the same immediate family, conduct business at the location; (iii) the location is not held out to the public as an office and the associated person does not meet with customers at the location; (iv) neither customer funds nor securities are handled at that location; (v) the associated person is assigned to a designated branch office, and such designated branch office is reflected on all business cards, stationery, advertisements and other communications to the public by such associated person; (vi) the associated person's correspondence and communications with the public are subject to the firm's supervision; (vii) electronic communications (i.e., e-mail) are made through the member's electronic system; (viii) all orders are entered through the designated branch office; (ix) written supervisory procedures pertaining to supervision of sales activities conducted at the residence are maintained by the member; and (x) a list of the residence locations are maintained by the member;
    (C) any location, other than a primary residence, that is used for securities business for less than 30 business days in any one calendar year, provided the member complies with the provisions of paragraph (B) above;
    (D) any office of convenience, where associated persons occasionally and exclusively by appointment meet with customers, which is not held out to the public as a branch office (Where such location is on bank premises, only signage required by the Interagency Statement (Statement on Retail Sales of Nondeposit Investment Products required under Banking Regulations) may be displayed);
    (E) any location that is used primarily to engage in non-securities activities and from which the associated person(s) effects no more than 25 securities transactions in any one calendar year; provided that any advertisements or sales literature identifying such location also sets forth the address and telephone number of the location from which the associated person(s) conducting business at the nonbranch locations are directly supervised; or
    (F) the Floor of a registered national securities exchange where a member conducts a direct access business with public customers; and
    (G) a temporary location established in response to the implementation of a business continuity plan.

    The term "business day" as used herein shall not include any partial business day provided that the associated person spends at least four hours on such business day at his or her designated branch office during the hours that such office is normally open for business.


    ATTACHMENT B

    Request for Comment Form

    We have provided below a form that members and other interested parties may use in addition to written comments. This form is intended to offer a convenient way to participate in the comment process, but does not cover all aspects of the proposal described in the Notice. We therefore encourage members and other interested parties to review the entire Notice and provide written comments, as necessary.

    Instructions

    Comments must be received by September 20, 2002. Members and interested parties can submit their comments using the following methods:

    • mail Attachment B—Request for Comment Form—along with written comments


    • mail written comments


    • e-mail written comments to pubcom@nasd.com


    • submit written comments online on our Web Site (www.nasd.com)

    This form and/or written comments should be mailed to:

    Barbara Z. Sweeney
    NASD, Office of the Corporate Secretary
    1735 K Street, NW
    Washington, DC 20006-1500


    Proposed Amendments to Rule 3010(g)(2) - "Branch Office" Definition

    1. Should NASD adopt the proposed uniform branch office definition?

    Yes No See my attached written comments

    2. Should NASD provide for the centralized registration of branch offices for NASD and other regulators through the CRD system?

    Yes No See my attached written comments

    3. Are the exceptions to branch office definition appropriate?

    Yes No See my attached written comments

    4. How many registered branch offices do you currently have?

    _________________

    5. How many registered branch offices would you have under the proposed uniform definition?

    _________________

    6. In how many states do you register branch offices?

    _________________

    7 a. How much of a cost savings or increase will you have as a result of the proposed uniform definition?

    $________________

    7 b. If you expect the proposed definition would increase your costs, then would the efficiencies created by the ability to register branch offices through CRD offset such increased costs?

    Yes No See my attached written comments


    Contact Information

    Name:
    Firm:
    Address:
    City/State/Zip:
    Phone:
    E-Mail:

    Are you:

      An NASD Member
      An Investor
      A Registered Representative
      Other:

  • 02-51 NASD Requests Comment on Proposed Interpretative Material Regarding Investment Analysis Tools.

    View PDF File

    REQUEST FOR COMMENT

    Investment Analysis Tools

    Comment Period Expires: September 13, 2002

    SUGGESTED ROUTING

    KEY TOPICS

    Executive Representative
    Legal & Compliance
    Senior Management

    Investment Analysis Tools
    Rule 2210



    Executive Summary

    NASD Rule 2210(d)(2)(N) prohibits NASD member firms from making predictions or projections of investment results to the public.1 NASD staff has interpreted the rule to prohibit members from providing customers with access to interactive technological tools that produce simulations and statistical analyses showing a range of probabilities that various investment outcomes might occur. The proposed Interpretive Material to Rule 2210 (Attachment A) would provide a limited exception to Rule 2210(d)(2)(N), allowing members to provide customers direct access to such tools under certain circumstances. NASD seeks comment on whether it should amend Rule 2210(d)(2)(N) to create such an exception and, if so, on the specific provisions of the proposed Interpretive Material.

    Action Requested

    NASD requests comment from all interested parties on whether and to what extent NASD should amend Rule 2210(d)(2)(N) to allow members to provide investment analysis tools directly to their customers. Comments must be received by September 13, 2002. Members and interested persons can submit their comments using the following methods:

    • mailing Attachment B—Request for Comment Form— along with written comments to NASD


    • mailing written comments to NASD


    • e-mailing written comments to pubcom@nasd.com


    • submitting written comments online on the NASD Web Site (www.nasd.com)

    Written comments submitted via hard copy should be mailed to:

    Barbara Z. Sweeney
    NASD
    Office of the Corporate Secretary
    1735 K Street, NW
    Washington, DC 20006-1500

    Important Note: The only comments that will be considered are those submitted in writing or by e-mail.

    Before becoming effective, any rule change developed as a result of comments received must be submitted to and approved by the Securities and Exchange Commission (SEC).

    Questions/Further Information

    Questions or comments concerning the information contained in this Notice to Members (NtM) may be directed to Nancy C. Libin, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8835 or nancy.libin@nasd.com, or James S. Wrona, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8270 or jim.wrona@nasd.com, or Joseph P. Savage, Counsel, Investment Companies Regulation, Regulatory Policy and Oversight, at (240) 386-4534 or joe.savage@nasd.com.

    Background

    In recent years, the public increasingly has sought access to additional investment information and tools to make investment decisions. Technology has been a key component of members' attempts to meet this investor demand.2 NASD's proposed Interpretive Material to Rule 2210 seeks to modernize certain aspects of the rule to keep pace with investor needs and technological developments. In doing so, however, NASD does not want to compromise Rule 2210's general purpose—to ensure that "communications [with the public] are fair, balanced, and not misleading."3

    NASD Rule 2210(d)(2)(N) prohibits members from predicting or projecting investment results in communications to the public. NASD staff has interpreted this provision to prohibit members from providing their customers with access to automated tools that indicate the probability that an investment strategy will produce a desired result. NASD seeks comment on its proposal to modify that interpretation to allow members to provide customers direct access to such tools under certain, limited circumstances.

    The proposed Interpretive Material would allow members to make available to their customers "investment analysis tools," defined as interactive technological tools that produce simulations and statistical analyses showing a range of probabilities that various investment outcomes might occur. In general, these tools express in quantitative terms the likelihood that a specific event—such as meeting a financial goal—might occur. A customer using such a tool usually enters information regarding, for example, his or her age, financial situation, and investment objectives to receive personalized investment advice.

    Although NASD staff has not permitted members to provide customers direct access to such tools under NASD's current rules,4 other financial advisors and institutions have offered public access to similar automated tools for some time. With appropriate disclosures and other safeguards, NASD believes that investors could properly use these tools in making judgments about how an investment strategy might perform. Importantly, under the proposed Interpretive Material, the tools could not predict that a particular outcome will in fact occur.

    NASD is proposing certain requirements for members' use of the tools with their customers. For instance, among other requirements, members would have to:

    • Disclose the entire range of possible outcomes, giving both downside risk and upside gain.


    • Disclose the universe of investments considered and state that other investments not considered might have characteristics similar to those that the tools analyze.


    • Explain all material assumptions in a clear and understandable manner.


    • Disclose whether the tools search, analyze or in any way favor certain securities within the universe of securities considered and explain the reasons for such selectivity.

    Members also would need to provide NASD with access to the tools prior to their use and file with NASD any related sales material for its review. The proposed Interpretive Material, moreover, makes clear that, to the extent that these tools make investment recommendations, NASD's suitability rule, Rule 2310, would apply.5

    Request For Comment on Proposed Interpretive Material to Rule 2210 Regarding Investment Analysis Tools

    NASD is soliciting comments on its proposed Interpretive Material to Rule 2210. NASD requests that members and other interested parties comment on whether Rule 2210(d)(2)(N) should be amended to create an exception that allows members to provide customers direct access to investment analysis tools that indicate probabilities of certain investment outcomes. In addition, NASD seeks comments on the proposed Interpretive Material's specific provisions. NASD also is interested in receiving comments on the benefits and risks associated with customers' use of these tools on members' Web sites.6

    NASD has found comments from member firms and the public, as well as state and federal regulators, to be a valuable resource in the decision-making process. NASD encourages all interested parties to comment on the concepts discussed above regarding the proposed "investment analysis tools" exception to Rule 2210(d)(2)(N)'s prohibitions. NASD will consider the comments it receives in determining whether to submit the Interpretive Material as a formal rule change to the SEC and, if so, the form that rule change will take. Comments must be submitted by September 13, 2002.


    Endnotes

    1 NASD Rule 2210(d)(2)(N) states that: In communications with the public, investment results cannot be predicted or projected. Investment performance illustrations may not imply that gain or income realized in the past will be repeated in the future. However, for purposes of this Rule, hypothetical illustrations of mathematical principles are not considered projections of performance; e.g., illustrations designed to show the effects of dollar cost averaging, tax-free compounding, or the mechanics of variable annuity contracts or variable life policies.

    2 See Commissioner Laura Unger, SEC, On-Line Brokerage: Keeping Apace of Cyberspace, 1 (Nov. 1999), available at www.sec.gov/pdf/cybrtnd.pdf ("[I]investors can—from the comfort of their own homes—access a wealth of financial information on the same terms as market professionals, including breaking news developments and market data. In addition, online brokerage provides investors with tools to analyze this information, such as research reports, calculators, and portfolio analyzers."); Use of Electronic Media, Release Nos. 33-7856, 34-42728, IC-24426, 65 Fed. Reg. 25843, 25844 (May 4, 2000), 2000 SEC LEXIS 847, at *4 (Apr. 28, 2000) (discussing technology's impact on the securities industry).

    3 SEC Order Approving Proposed Rule Change Relating to Standards for Individual Correspondence, Release No. 34-40365, 63 Fed. Reg. 47062, 47062 (Sept. 3, 1998), 1998 SEC LEXIS 1841, at *3 (Aug. 26, 1998). As the SEC has commented, regulators need to be "sensitive to the regulatory challenges of a changing technological environment" and must "balance the benefits of encouraging innovation and the use of new technologies against the need to protect investors and maintain orderly markets." SEC Report to the Congress: The Impact of Recent Technological Advances on the Securities Markets (Sept. 1997), available at www.sec.gov/news/studies/techrp97.htm.

    4 As a general matter, members are responsible for hyperlinked information, including any information contained in a hyperlinked Web site that provides an investment analysis tool. However, under certain limited circumstances, members are not responsible for the content and filing of material that appears on independent, third-party Web sites. See Interpretive Letter from Thomas Selman, Director of NASD Advertising/Investment Companies Regulation, to Craig S. Tyle, General Counsel of Investment Company Institute (Nov. 11, 1997), available at www.nasdr.com/2910/2210_01.htm (providing guidance regarding members' regulatory responsibilities for hyperlinks to third-party Web sites). Because the circumstances surrounding hyperlinks will vary, members should file with NASD's Advertising Regulation Department any Web pages that include hyperlinks to Web sites that contain investment analysis tools to determine the extent to which the member is responsible for the content and filing of such sites.

    5 In April 2001, NASD issued its Online Suitability Policy Statement, Notice to Members 01-23, 66 Fed. Reg. 20697 (Apr. 24, 2001), 2001 NASD LEXIS 28 (Apr. 2001), available at www.nasdr.com/pdf-text/0123ntm.pdf. The Policy Statement discusses the circumstances under which "recommendations" are made in the online environment for purposes of the suitability rule. The Policy Statement also states that the suitability rule applies to recommendations made by computer programs.

    6 Will access to these products improve investors' ability to make investment decisions and properly allocate their assets? Are there any risks that investors will rely too heavily on projected returns without recognizing that their actual returns may be different?


    ATTACHMENT A

    Text of Proposed Interpretive Material to Rule 2210

    IM-2210 Requirements for the Use of Investment Analysis Tools

    (a) General Considerations
    This Interpretive Material provides a limited exception to NASD Rule 2210(d)(2)(N).1 No member may imply that NASD endorses or approves the use of any investment analysis tool or any recommendation based on such a tool. Members that intend to offer an investment analysis tool under this Interpretive Material must provide NASD's Advertising Regulation Department (Department) with access to the investment analysis tool at least 30 days prior to first use and must file any sales material concerning the tool with the Department at least 30 days prior to use. Members also must provide any supplemental information requested by the Department. If the Department requests changes to the investment analysis tool or sales material, the tool or sales material may not be offered or used until all changes specified by the Department have been made and approved by the Department. In addition, as in all cases, a member's compliance with this Interpretive Material does not mean that the member is acting in conformity with other applicable laws and rules. Members that offer an investment analysis tool under this Interpretive Material are responsible for ensuring that use of the investment analysis tool and all recommendations based on the investment analysis tool comply with NASD's suitability rule, Rule 2310, the other provisions of Rule 2210, and the other applicable federal securities laws and Securities and Exchange Commission and NASD rules.
    (b) Definition
    For purposes of this Interpretive Material and any interpretation thereof, an "investment analysis tool" is an interactive technological tool that produces simulations and statistical analyses that present a range of probabilities that various investment outcomes might occur thereby enabling investors to evaluate the potential risks of and returns on particular investments.
    (c) Use of Investment Analysis Tools and Related Sales Material
    Members may provide investment analysis tools and use related sales material only if they:
    (1) present a range of probabilities that various investment outcomes might occur and do not state that a particular investment outcome will, in fact, occur;
    (2) prominently disclose the range of all possible investment outcomes generated by the investment analysis tool;
    (3) use a reproducible mathematical process;
    (4) describe the criteria and methodology used;2
    (5) give investors a fair and balanced presentation of the risks as well as the potential rewards of using the investment analysis tool, including, but not limited to:
    (A) identification and explanation of the limitations of the methodology employed; and
    (B) an explanation that it is likely that the analysis will change over time with respect to the same investments.
    (6) disclose the universe of investments considered in the analysis and state that other investments not considered may have characteristics similar to those being analyzed;
    (7) disclose whether the investment analysis tool searches, analyzes or in any way favors certain securities within the universe of securities considered, beyond the criteria and methodology disclosed under paragraph (c)(4), and the reasons for this selectivity;3 and
    (8) explain all material assumptions in a clear and understandable manner.4
    (d) Disclosures
    (1) The disclosures and other required information discussed in paragraphs (c) and (d)(2) must be in narrative form, may not be contained in footnotes or in a font size that is inconsistent with the tool's overall written presentation, and, where feasible, should be located in areas related to the subject of the disclosure or other required information; and
    (2) members must prominently display the following additional disclosure: "IMPORTANT: The forecasts or other information generated by [brand name of investment analysis tool] regarding the probabilities that various investment outcomes might occur are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. [Brand name of investment analysis tool] only presents a range of possible outcomes."

    1 NASD Rule 2210(d)(2)(N) prohibits NASD member firms from making predictions or projections of investment results to the public. In the past, the rule also had been interpreted as prohibiting members from providing customers with direct access to investment analysis tools. This Interpretive Material allows member firms to offer such tools in certain circumstances.

    2 This disclosure should provide detailed information about how the tool conducts its analyses and the principles on which those analyses are based, including, but not limited to, the security- or fund-specific attributes of the recommended securities or mutual funds, transaction costs, tax implications, interest rate and inflationary analysis, historical performance, and the consistency of that performance over time.

    3 This disclosure should indicate, among other things, whether the investment analysis tool searches, analyzes or in any way favors certain securities within the universe of securities considered based on revenue received by the member in connection with the sale of those securities or based on relationships or understandings between the member and the entity that created the investment analysis tool. The disclosure also should indicate whether the investment analysis tool is limited to searching, analyzing or in any way favoring securities in which the member makes a market or has any other direct or indirect interest.

    4 The investment analysis tool should provide the investor with information sufficient to evaluate the tool's analysis and forecast. The tool also should explain fully the differences between the securities or mutual funds previously owned and the securities or mutual funds recommended so that the customer can assess the tool's analysis. If the tool recommends a mutual fund, the tool should provide information about the fund's investment objectives, fees and expenses and other pertinent information, and the fact that these attributes can change.


    ATTACHMENT B

    Request for Comments Form

    Proposed Interpretive Material to Rule 2210 Regarding Members' Ability to Provide Customers Direct Access to Investment Analysis Tools

    We have provided below a form that members and other interested parties may use in addition to written comments. This form is intended to offer a convenient way to participate in the comment process, but it does not cover all aspects of the proposal described in the Notice to Members (NtM). We therefore encourage members and other interested parties to review the entire NtM and provide written comments, as necessary.

    Instructions

    Comments must be received by September 13, 2002. Members and interested parties can submit their comments using the following methods:

    • mailing Attachment B—Request for Comment Form—along with written comments to NASD


    • mailing written comments to NASD


    • e-mailing written comments to pubcom@nasd.com


    • submitting written comments online on the NASD Web Site (www.nasd.com)

    Written comments submitted via hard copy should be mailed to:

    Barbara Z. Sweeney
    NASD
    Office of the Corporate Secretary
    1735 K Street, NW
    Washington, DC 20006-1500


    Proposed Interpretive Material to Rule 2210 Regarding Members' Ability to Provide Customers Direct Access to Investment Analysis Tools

    NASD requests comment from all interested parties on whether and to what extent Rule 2210 should be amended to allow members to provide investment analysis tools directly to their customers. In particular, NASD seeks input on the following topics:

    1. Should NASD amend Rule 2210(d)(2)(N) to permit members to provide investment analysis tools directly to their customers?

    Yes No See my attached written comments

    2. If yes, should members be permitted to provide investment analysis tools directly to their customers and use related sales material only if they present a range of probabilities that various investment outcomes might occur and do not state that a particular investment outcome will, in fact, occur?

    Yes No See my attached written comments

    3. Should members be permitted to provide investment analysis tools directly to their customers and use related sales material only if they use a reproducible mathematical process?

    Yes No See my attached written comments

    4. Should firms be required to provide the information listed below?

    a. The range of all possible investment outcomes generated by the investment analysis tool.

    Yes No See my attached written comments

    b. The criteria and methodology used.

    Yes No See my attached written comments

    c. The risks as well as the potential rewards of using the investment analysis tool, including, but not limited to: identification and explanation of the limitations of the methodology employed; and an explanation that it is likely that the analysis will change over time with respect to the same investments.

    Yes No See my attached written comments

    d. The universe of investments considered in the analysis and whether other investments not considered may have characteristics similar to those being analyzed.

    Yes No See my attached written comments

    e. Whether the investment analysis tool searches, analyzes or in any way favors certain securities within the universe of securities considered and the reasons for this selectivity.

    Yes No See my attached written comments

    5. Should members also be required to display the following additional disclosure?

    "IMPORTANT: The forecasts or other information generated by [brand name of investment analysis tool] regarding the probabilities that various investment outcomes might occur are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. [Brand name of investment analysis tool] only presents a range of possible outcomes."

    Yes No See my attached written comments

    6. Will access to these products improve investors' ability to make investment decisions and properly allocate their assets?

    Yes No See my attached written comments

    7. Are there any risks that investors will rely too heavily on projected returns without recognizing that their actual returns may be different?

    Yes No See my attached written comments


    Contact Information

    Name:
    Firm:
    Address:
    City/State/Zip:
    Phone:
    E-Mail:

    Are you:

      An NASD Member
      An Investor
      A Registered Representative
      Other:

  • 02-50 Treasury and SEC Request Comment on Proposed Regulation Regarding Broker/Dealer Anti-Money Laundering Customer Identification Requirements

    View PDF File

    INFORMATIONAL

    Comment Period Expires: September 6, 2002

    SUGGESTED ROUTING

    KEY TOPICS

    Legal & Compliance
    Operations
    Registration
    Senior Management

    Money Laundering Compliance Programs



    Executive Summary

    On October 26, 2001, President Bush signed into law the USA PATRIOT Act (PATRIOT Act). Title III of the PATRIOT Act, referred to as the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (Money Laundering Abatement Act), imposed obligations on broker/dealers under new anti-money laundering (AML) provisions and amendments to the Bank Secrecy Act (BSA) in an effort to make it easier to prevent, detect, and prosecute money laundering and the financing of terrorism.

    Among other things, Section 326 of the Act required the Secretary of the Department of Treasury (Treasury) and the Securities and Exchange Commission (SEC or Commission) jointly to issue a regulation setting forth minimum standards for broker/dealers and their customers regarding customer identification in the account opening process.

    On July 23, 2002, the Treasury and SEC published for comment the proposed regulation to implement Section 326.1 The proposed regulation would require broker/dealers to, at a minimum: (1) adopt and implement reasonable procedures to verify the identity of any person seeking to open an account, to the extent reasonable and practicable; (2) maintain records related to the verification of the person's identity; and (3) determine whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided by any government agency. The release was published in the Federal Register;2 use this URL to view the text: www.treas.gov/FinCEN/section326brokerdealers.pdf.

    Questions/Further Information

    Questions regarding this Notice to Members may be directed to Kyra Armstrong, at (202) 728-6962, or Vicky Berberi-Doumar, at (202) 728-8905, both of the Department of Member Regulation; or Nancy Libin, at (202)-728-8835, or Grace Yeh, at (202) 728-6939, both of the Office of General Counsel, NASD Regulatory Policy and Oversight.

    Background

    Introduction

    The PATRIOT Act is designed to deter and punish terrorists in the United States and abroad and to enhance law enforcement investigation tools by prescribing, among other things, new surveillance procedures, new immigration laws, and new and more stringent AML laws. The Money Laundering Abatement Act strengthens the AML provisions put into place by earlier legislation.

    Among these obligations, broker/dealers are required to have in place as of April 24, 2002, an AML compliance program. NASD Rule 3011, which was approved by the SEC on April 22, 2002, requires that each member develop and implement, by April 24, 2002, a written AML program reasonably designed to achieve and monitor the member's compliance with the requirements of the BSA and the implementing regulations promulgated thereunder by the Treasury, including the obligation to establish reasonable customer identification and verification procedures. In addition to this Notice, members may also refer to Notice to Members 02-21 (April 2002), which provides guidance to members regarding the development of AML programs and procedures for account holder identification and verification.

    Description of Proposed Regulation

    The proposed regulation provides several definitions, which are briefly reviewed below.

    1. Account. The proposed regulation defines "account" to include all types of securities accounts maintained by brokers or dealers.3 These include accounts to purchase, sell, lend, or otherwise hold securities or other assets, cash accounts, margin accounts, prime brokerage accounts that consolidate trading done at a number of firms, and accounts for repurchase and stock loan transactions.

    2. Broker/dealer. "Broker/dealer" is defined to include any person registered, or required to be registered, with the Commission as a broker or dealer under the Securities Exchange Act of 1934 (Exchange Act), except persons who register, or are required to be registered, solely because they effect transactions in security futures products.4

    3. Customer. "Customer" is defined as any person who opens a new account at a broker/dealer or is granted trading authority with respect to an account at a broker/dealer.5 Under this definition, a person who has an account at a broker/dealer prior to the effective date of the regulation would not be a customer. However, such a person becomes a customer if the person opens a new or different type of account. The proposed regulation also states that a person with trading authority prior to the effective date of the regulation is not a customer; however, any person who was granted trading authority after the effective date is a customer.

    The proposed regulation does not apply to persons seeking information about an account (such as a schedule of transaction fees) if an account is not opened. Transfers of accounts from one broker/dealer to another that are not initiated by the customer are not covered by the proposed regulation.6 Examples of an account transfer not initiated by a customer include a merger, acquisition, or purchase of assets or assumption of liabilities.

    4. Person. "Person" is defined to include natural persons, corporations, partnerships, trusts or estates, joint stock companies, associations, syndicates, joint ventures, any unincorporated organizations or groups, Indian tribes, and all entities cognizable as legal entities.7

    5. U.S. person. "U.S. person" is defined as a U.S. citizen, or for persons other than natural persons, an entity established or organized under the laws of a State or the United States.8

    6. Non-U.S. person. A "Non-U.S. person" is defined as a person that is not a U.S. person as that term is defined in the regulation.9

    7. Taxpayer Identification number. "Taxpayer identification number" is defined to have the same meaning as determined under the provisions of Section 6109 of the Internal Revenue Code and the regulations of the Internal Revenue Service thereunder.10

    Customer Identification Program

    A key aspect of the proposed regulation is the requirement that broker/dealers establish and operate a customer identification program (CIP).11 A CIP must be part of a firm's overall AML compliance program as required under Section 352 of the PATRIOT Act.12 It must be approved by the most senior level of the firm, which can be the board of directors, managing partners, board of managers, or other governing body performing similar functions, or by persons authorized to approve such a program.13 A CIP's procedures also must enable the firm to form a reasonable belief that it knows the true identity of the customer.

    Several factors must be considered in creating and developing CIPs. Firms should consider the types of identifying information available for customers and the methods available to verify that information. The release notes that while the proposed regulation sets forth certain minimum required information and suitable verification methods, firms should consider on an ongoing basis whether additional information and methods are appropriate. In addition, firms should consider the risks associated with their business operations. In considering the risks, firms should consider the following factors:

    (1) the broker/dealer's size;
    (2) the broker/dealer's location;14
    (3) the method by which customers open accounts at the broker/dealer;15
    (4) the types of accounts the broker/dealer maintains for customers;16
    (5) the types of transactions the broker/dealer executes for customers;17
    (6) the customer base; and
    (7) the broker/dealer's reliance on another broker/dealer with which it shares an account relationship.18

    This last risk factor refers to shared accounts subject to a carrying or clearing agreement governed by NASD Rule 3230 or NYSE Rule 382.19 The proposed regulation notes that firms sharing accounts may share responsibilities pursuant to their clearing agreements. For example, the correspondent firm may undertake to obtain the identifying information while the clearing firm may undertake the verification. Nonetheless, the proposed regulation makes it clear that both firms are responsible for ensuring that each requirement in the regulation is met with respect to each customer. Therefore, broker/dealers must continually assess whether the other firm can be relied on to perform its responsibilities. A broker/dealer is expected to cease such reliance if it is no longer reasonable.

    Required Information

    A broker/dealer's CIP must have customers provide, at a minimum, certain identifying information before an account is opened for the customer or the customer is granted trading authority over an account. The firm must obtain from each customer, his or her:

    • Name;


    • Date of birth, for a natural person;


    • Address(es):


      • Residence and mailing (if different) for a natural person; or


      • Principal place of business and mailing (if different) for a person other than a natural person; and
    • Documentary Number:


      • For each customer that is a U.S. person, a taxpayer identification number (such as a Social Security number or employer identification number); or


      • For each customer that is a non-U.S. person,


        • a U.S. taxpayer identification number;


        • a passport number and country of issuance;


        • an alien identification card number; or


        • the number and country of issuance of any other government-issued document evidencing nationality or residence and bearing a photograph or similar safeguard.20

    Firms should determine whether other identifying information is necessary to form a reasonable belief concerning the true identity of each customer during this process. The proposed regulation notes that there may be certain situations or customers that may cause the firm to obtain additional information. CIPs should have guidelines for such situations to assist in making such determinations.

    The Treasury and the SEC have proposed a limited exception to the requirement that a taxpayer identification number be provided prior to opening an account or the granting of trading authority. For new businesses that have applied for, but not received, employer identification numbers (EINs) from the Internal Revenue Service, the CIP may allow the EIN to be provided within a reasonable time after the account is opened. However, CIPs must require the broker/dealer to obtain a copy of the EIN application prior to the account opening or to the grant of trading authority.

    Verification Procedures

    The procedures for verifying the accuracy of the information must be undertaken within a reasonable time before or after an account is opened or a customer is granted trading authority. There is some flexibility in determining what is a reasonable time. The amount of time may depend on the type of account opened, whether the account was opened in person, and on the type of identifying information available. Although an account is opened, a firm may choose to place limits on the account until the customer's identity is verified. Therefore, firms may use a risk-based approach to determine when the identity of a customer must be verified relative to the opening of an account or the granting of trading authority.

    The proposed regulation explains that the verification requirements would apply every time a person opens a new account at a firm or is granted trading authority with respect to an account. However, if a customer whose identification has been verified previously opens a new account or is granted new authority, the firm would not need to verify the customer's identity a second time, provided the broker/dealer (1) previously verified the customer's identity in accordance with procedures consistent with the proposed regulation; and (2) continues to have a reasonable belief that it knows the true identity of the customer.

    Verification may occur through two methods: through documents and through non-documentary means. The means of verification may vary based on the type of customer and the method of opening an account. A CIP must discuss both methods and provide guidance on when it is appropriate to use either one or a combination of both.

    Documents

    CIPs must provide guidance concerning when it is appropriate to use documents to verify a customer's identity. The proposed regulation lists some suitable documents.

    They include:

    • For natural persons, an unexpired government-issued identification evidencing nationality or residence and bearing a photograph or similar safeguard.


    • For entities, documents showing existence such as registered articles of incorporation, a governmentissued business license, a partnership agreement, or a trust instrument.

    Non-Documentary Means

    A CIP must describe non-documentary verification methods and when these methods will be used in addition to, or instead of relying on, documents. The regulation provides for the exclusive use of non-documentary means (if necessary) due to the number of accounts opened over the Internet, the telephone, and the mail. Suitable non-documentary methods of verification include:

    • contacting a customer after the account is opened (particularly, if the account is opened online or by mail);


    • obtaining a financial statement;


    • comparing the identifying information provided by the customer against fraud and bad check databases to determine whether any of the information is associated with known incidents of fraudulent behavior (negative verification);


    • comparing the identifying information with information available from a trusted third-party source, such as a credit report from a consumer reporting agency (positive verification);21 and


    • checking references with other financial institutions.

    Other factors to consider include checking whether there is a logical consistency between the identifying information provided such as the customer's name; street address; zip code; telephone number, if provided; the customer's date of birth; and Social Security number.

    Non-documentary methods should be used in certain situations, particularly when a firm cannot examine original documents. The following are examples of situations when non-documentary methods should be used:

    • a person is unable to provide an unexpired government-issued identification document with a photograph or similar safeguard;


    • the firm is presented with unfamiliar documents to verify an identity;


    • the firm does not meet the customer face-to-face; or


    • there is a risk that the documents will not enable the firm to verify the customer's identity.

    Also, in light of the increase in identity fraud, firms are encouraged to use nondocumentary methods, even when a customer has provided documents.

    Use of Government Lists

    The proposed regulation also requires reasonable procedures for determining whether a customer appears on any list of known or suspected terrorists or terrorist organizations provided by any government agency. This requirement applies only with respect to lists circulated by the federal government such as the list found on Treasury's Office of Foreign Assets Control (OFAC) Web Site (www.treas.gov/fac) and available on www.nasdr.com/money.asp under "OFAC List." Broker/dealers must have procedures for responding to circumstances when a customer is named on a list.22

    Customer Notice

    The proposed regulation states that firms must give their customers notice of their identity verification procedures.23 The CIP must include procedures for providing customers with adequate notice that the broker/dealer is requesting information to verify their identity. This requirement may be satisfied generally by notifying customers about the procedures a firm must comply with to verify their identities. The release also cites, as an example, posting a sign in a firm's lobby or providing customers with any form of written, electronic, or oral notice. Notice must be given before an account is opened or trading authority is granted.

    Lack of Verification

    As stated above, a broker/dealer should maintain an account for a customer only when it can form a reasonable belief that it knows the customer's true identity. However, a CIP must have procedures for responding to circumstances when a firm cannot form a reasonable belief.24 There should also be guidelines for when an account will not be opened. Furthermore, a CIP should specify when an account should be closed after attempts have been made to verify a customer's identity. There should also be procedures for determining when a suspicious activity report (SAR) should be filed.25

    Recordkeeping

    The proposed regulation requires procedures for maintaining records of information used to verify a person's identity, including name, address, and other identifying information.26 Information that must be maintained includes all identifying information provided by a customer. A firm must make a record of each customer's name, date of birth (if applicable), addresses, and tax identification number or other number. Firms also must maintain copies of any documents that were relied on, evidencing the type of document and any identification number it may contain. Firms must make and maintain records of the methods and results of measures undertaken to verify the identity of a customer. These records must be maintained for five years after the date the account is closed or the grant of authority to effect transactions with respect to the account is revoked.

    Exemptions

    The proposed regulation provides that the Commission, with the concurrence of the Secretary of the Treasury, may exempt any broker/dealer that registers with the Commission from this requirement. Excluded from this exemptive authority are firms that register as broker/dealers solely because they deal in security futures products. In issuing such exemptions, the Commission and the Secretary will consider whether the exemption is consistent with the purposes of the BSA and in the public interest and may consider other necessary and appropriate factors.27

    Comments

    Treasury and the SEC seek comment on all aspects of the proposed regulation, and specifically seek comment on the following issues:

    1. Whether the proposed definition of "account" (which includes all types of securities accounts maintained by brokers or dealers) is appropriate and whether other examples of accounts should be added to the text of the regulation.
    2. How broker/dealers can comply with the requirement to obtain both the address of a person's residence, and, if different, the person's mailing address in situations involving natural persons who lack a permanent address.
    3. Whether non-U.S. persons that are not natural persons will be able to provide a broker/dealer with the identifying information required in 31 CFR 103.122(c)(4),28 or whether other categories of identifying information should be added to this section.
    4. The extent to which the verification procedures required by the proposed regulation makes use of the information that broker/dealers currently obtain in the account opening process.
    5. Whether any of the exemptions from the customer identification requirements contained currently in 31 CFR 103.35(a)(3) should be continued in the proposed regulation. Commenters should address the standards set forth in paragraph (j) of the proposed regulation as well as any other appropriate factors.29

    Written comments may be mailed to FinCEN, Section 326 Broker-Dealer Rule Comments, P.O. Box 39, Vienna, Virginia 22183, or sent to e-mail address regcomments@FinCEN.treas.gov with the caption "Attention: Section 326 Broker/Dealer Rule Comments" in the body of the text.

    Written comments should be submitted in triplicate to the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. All submissions should refer to the File No. S7-25-02. Comments may also be submitted electronically at the following e-mail address: rulecomments@sec.gov. The file number should be included on the subject line if e-mail is used.

    Written comments must be submitted to Treasury and the SEC on or before September 6, 2002.

    Conclusion

    NASD will update members when the proposed regulation becomes final. In the interim, NASD reminds members to comply with the provisions of the PATRIOT Act that currently apply to broker/dealers.


    Endnotes

    1 67 Fed. Reg. 48,306 (July 23, 2002).

    2 Treasury, jointly with other federal financial regulators, also separately issued customer identification requirements for banks and trust companies, savings associations, credit unions, mutual funds, futures commission merchants, and futures introducing brokers.

    3 67 Fed. Reg. 48,306 at 48,307.

    4 Id.

    5 Id.

    6 The release notes that there may be times when a broker/dealer may need to verify the identity of customers associated with accounts it is acquiring. Procedures for the transfer of accounts are expected to be part of a firm's AML compliance program required under Section 352 of the PATRIOT Act.

    7 67 Fed. Red. 48,306 at 48,307. Broker/dealers that register solely because they effect transactions in security futures products will be subject to separate customer identification regulations issued jointly by Treasury and the Commodity Futures Trading Commission.

    8 Id.

    9 Id.

    10 Id. See also 26 U.S.C. 6109 (2002), which states that, generally speaking, the identifying number of an individual is his or her Social Security account number or employer identification number.

    11 67 Fed. Reg. 48,306 at 48,307- 48,308.

    12 31 U.S.C. 5318(h).

    13 67 Fed. Reg. 48,306 at 48,311.

    14 Firms located in certain known money laundering areas, for example, may pose a greater risk than firms located in other areas. See 67 Fed. Reg. 48,306 at 48,308.

    15 This refers to whether the account was opened in person or whether it was opened online, for example. See 67 Fed. Reg. 48,306 at 48,308.

    16 A firm must determine if the account is a cash, margin, or prime brokerage account, for example. See 67 Fed. Reg. 48,306 at 48,308.

    17 This could be short sales, block trades, repurchases, and reverse repurchase agreements, for example. See 67 Fed. Reg. 48 306 at 48,308.

    18 67 Fed. Reg. 48,306 at 48,308.

    19 NASD Rule 3230 governs clearing agreements. It states, among other things, that all clearing or carrying agreements entered into by a member, except where any party to the agreement is also subject to a comparable rule of a national securities exchange, shall specify the respective functions and responsibilities of each party to the agreement. NYSE 382 also addresses carrying agreements and states, in part, that each carrying agreement shall identify and allocate the respective functions and responsibilities of the introducing and carrying organizations.

    20 A "similar safeguard" is included in the definition to permit for the use of any biometric identifier that may be used in addition to, or instead of, photographs.

    21 See NASD Notice to Members 02-21 at 6, which discusses the use of databases such as Equifax, Exertion and Lexis/Nexis. Please note that NASD is not endorsing any particular product, but offering the names as references.

    22 67 Fed. Reg. 48,306 at 48,310. See also NASD Notice to Members 02-21 at 6.

    23 67 Fed. Reg. 48,306 at 48,310.

    24 Id.

    25 67 Fed. Reg. 40448 (July, 1, 2002).

    26 Id.

    27 67 Fed. Reg. 48,306 at 48,311.

    28 See 67 Fed. Reg. 48,306 at 48,308. Section 103.122(c)(4) requires that a broker/dealer obtain from a customer before an account is opened or trading authority is granted a "documentary number."

    29 31 CFR 103.35(a)(3) currently provides that a broker/dealer need not obtain a taxpayer identification number with respect to specified categories of persons opening accounts, such as (i) agencies and instrumentalities of Federal, State, local, or foreign governments; (ii) aliens who are ambassadors; ministers, career diplomatic or consular officers; naval, military or other attaches of foreign embassies and legations; and members of their immediate families; (iii) aliens who are accredited representatives of certain international organizations, and their immediate families; (iv) aliens temporarily residing in the United States for a period not to exceed 180 days; (v) aliens not engaged in a trade or business in the United States who are attending a recognized college or university, or any training program supervised or conducted by an agency of the Federal Government; and (vi) unincorporated subordinate units of a tax exempt central organization that are covered by a group exemption letter. The proposed regulation does not contain any exemptions from the Customer Identification Program requirements.


    Attachment A — Federal Register Notice

    View PDF File


    SECURITIES AND EXCHANGE COMMISSION

    17 CFR Part 240

    [Release No. 34-46192, File No. S7-25-02]

    DEPARTMENT OF THE TREASURY

    31 CFR Part 103

    RIN 1506-AA32

    Customer Identification Programs For Broker-Dealers

    AGENCIES: Financial Crimes Enforcement Network, Treasury; Securities and Exchange Commission.

    ACTION: Joint notice of proposed rulemaking.

    SUMMARY: The Department of the Treasury, through the Financial Crimes Enforcement Network (FinCEN), and the Securities and Exchange Commission are jointly issuing a proposed regulation to implement section 326 of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001 (the Act). Section 326 requires the Secretary of the Treasury to jointly prescribe with the Securities and Exchange Commission a regulation that, at a minimum, requires broker-dealers to implement reasonable procedures to verify the identity of any person seeking to open an account, to the extent reasonable and practicable; maintain records of the information used to verify the person's identity; and determine whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided to the broker-dealer by any government agency.

    DATES: Written comments on the proposed rule may be submitted to the Treasury Department and the Securities and Exchange Commission on or before September 6, 2002.

    ADDRESSES: Because paper mail in the Washington area may be subject to delay, commenters are encouraged to email comments. Comments should be sent by one method only.

    Treasury: Comments may be mailed to FinCEN, Section 326 Broker-Dealer Rule Comments, P.O. Box 39, Vienna, VA 22183, or sent to Internet address regcomments@FinCEN.treas.gov with the caption "Attention: Section 326 Broker-Dealer Rule Comments" in the body of the text. Comments may be inspected at FinCEN between 10 a.m. and 4 p.m. in the FinCEN Reading Room in Washington, DC. Persons wishing to inspect the comments submitted must request an appointment by telephoning (202) 354-6400 (not a toll-free number).

    Securities and Exchange Commission: Comments also should be submitted in triplicate to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Comments also may be submitted electronically at the following e-mail address: rulecomments@sec.gov. Comment letters should refer to File No. S7-25-02; this file number should be included on the subject line if e-mail is used. All comments received will be available for public inspection and copying at the Commission's Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549-0102. Electronically submitted comment letters will be posted on the Commission's Internet web site (www.sec.gov). Personal identifying information, such as names or e-mail addresses, will not be edited from electronic submissions. Submit only information you wish to make publicly available.

    FOR FURTHER INFORMATION CONTACT:

    Treasury: Office of the Chief Counsel (FinCEN), 703/905-3590; Office of the Assistant General Counsel for Enforcement (Treasury), 202/622-1927; or the Office of the Assistant General Counsel for Banking & Finance (Treasury), 202/622-0480.

    Securities and Exchange Commission: Division of Market Regulation, 202/942-0177 or marketreg@sec.gov.

    SUPPLEMENTARY INFORMATION:

    I. Background

    A. Section 326 of the USA PATRIOT Act

    On October 26, 2001, President Bush signed into law the USA PATRIOT Act.1 Title III of the Act, captioned "International Money Laundering Abatement and Anti-terrorist Financing Act of 2001," adds several new provisions to the Bank Secrecy Act (BSA). See 31 U.S.C. 5311 et seq. These provisions are intended to facilitate the prevention, detection, and prosecution of international money laundering and the financing of terrorism.

    Section 326 of the Act adds a new subsection (l) to 31 U.S.C. 5318 that requires the Secretary of the Treasury (Secretary) to prescribe regulations setting forth minimum standards for financial institutions and their customers regarding the identity of the customer that shall apply in connection with the opening of an account at the financial institution.

    Section 326 applies to all "financial institutions." This term is defined very broadly in the BSA to encompass a variety of entities including banks, agencies and branches of foreign banks in the United States, investment companies, thrifts, credit unions, brokers and dealers in securities or commodities, insurance companies, travel agents, pawnbrokers, dealers in precious metals, check-cashers, casinos, and telegraph companies, among many others. See 31 U.S.C. 5312(a)(2).

    For any financial institution engaged in financial activities described in section 4(k) of the Bank Holding Company Act of 1956 (section 4(k) institutions), the Secretary is required to prescribe the regulations issued under section 326 jointly with each Federal functional regulator appropriate for such financial institution. The Federal functional regulators include the Securities and Exchange Commission (Commission), the Commodity Futures Trading Commission (CFTC), and the banking agencies (banking agencies), namely, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the National Credit Union Administration. Final regulations implementing section 326 must be effective before October 25, 2002.

    Section 326 provides that the regulations, at a minimum, must require financial institutions to implement reasonable procedures for (1) verifying the identity of any person seeking to open an account, to the extent reasonable and practicable; (2) maintaining records of the information used to verify the person's identity, including name, address, and other identifying information; and (3) determining whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided to the financial institution by any government agency.

    In prescribing these regulations, the Secretary is directed to take into consideration the various types of accounts maintained by various types of financial institutions, the various methods of opening accounts, and the various types of identifying information available.

    The following proposal is being issued jointly by Treasury and the Commission. It applies only to persons registered, or required to be registered, with the Commission as brokers or dealers under the Securities Exchange Act of 1934 (Exchange Act), except persons who register pursuant to paragraph (b)(11) of section 15 of the Exchange Act (15 U.S.C. 78o(b)(11)) solely because they effect transactions in security futures products. This class of brokers and dealers will be subject to regulations issued by Treasury and the CFTC separately. Regulations governing the applicability of section 326 to other financial institutions, such as those regulated by the banking agencies, will be issued separately as well. Treasury, the Commission, the CFTC and the banking agencies consulted extensively in the development of all rules implementing section 326 of the Act. All of the participating agencies intend the effect of the rules to be uniform throughout the financial services industry.

    The Secretary has determined that the records required to be kept by section 326 of the Act have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities, to protect against international terrorism. In addition, Treasury under its own authority is proposing conforming amendments to 31 CFR 103.35, which currently imposes requirements concerning the identification of bank customers.

    B. Codification of the Joint Proposed Rule

    The substantive requirements of the joint proposed rule will be codified with other BSA regulations as part of Treasury's regulations in 31 CFR part 103. To minimize potential confusion by affected entities regarding the scope of the joint proposed rule, the Commission is also proposing to add a provision in its own regulations in 17 CFR part 240 that will cross-reference the regulations in 31 CFR part 103. Although no specific text is being proposed at this time, the crossreference will be included in a final rule published by the Commission concurrently with the joint final rule issued by Treasury and the Commission implementing section 326 of the Act.

    1 Pub. L. 107-56.

    II. Section-by-Section Analysis

    A. Section 103.122(a) Definitions

    Section 103.122(a)(1) Account. The proposed rule's definition of "account" is intended to include all types of securities accounts maintained by brokers or dealers. These include accounts to purchase, sell, lend or otherwise hold securities or other assets, cash accounts, margin accounts, prime brokerage accounts that consolidate trading done at a number of firms, and accounts for repurchase and stock loan transactions.

    Section 103.122(a)(2) Broker-dealer. The proposed rule defines "brokerdealer" to include any person registered, or required to be registered, with the Commission as a broker or dealer under the Exchange Act, except persons who register, or are required to be registered, solely because they effect transactions in security futures products. These latter brokers or dealers, which register with the Commission pursuant to section 15(b)(11) of the Exchange Act, will be subject to a separate regulation issued jointly by Treasury and the CFTC implementing section 326.

    Section 103.122(a)(3) Commission. The proposed rule defines "Commission" to mean the United States Securities and Exchange Commission.

    Section 103.122(a)(4) Customer. The proposed rule defines "customer" as any person who opens a new account at a broker-dealer or is granted trading authority with respect to an account at a broker-dealer. Under this definition, a person who has an account at a brokerdealer prior to the effective date of the regulation would not be a "customer." However, such a person becomes a "customer" if the person opens a different account. Moreover, a person becomes a "customer" each time the person opens a different type of account at a broker-dealer. Thus, if a person opens a cash account and subsequently opens a margin account, the person would be a "customer" for verification purposes on both occasions.

    Similarly, a person with trading authority prior to the effective date of the regulation is not a "customer." However, any person being granted trading authority after the effective date is a customer. This is true even if the person is granted trading authority with respect to an account that existed prior to the effective date or the person had been granted trading authority for another account prior to the effective date.

    The requirements of section 326 apply to "customers" (i.e., persons opening new accounts or being granted trading authority), but do not apply to persons seeking information about an account such as a schedule of transaction fees, if an account is not opened. In addition, transfers of accounts from one brokerdealer to another that are not initiated by the customer, for example as a result of a merger, acquisition, or purchase of assets or assumption of liabilities, fall outside of the scope of section 326, and are not covered by the proposed regulation.2

    Section 103.122(a)(5) Person. The proposed rule defines "person" as having the same meaning as that term is defined in section 103.11(z). Thus, the term includes natural persons, corporations, partnerships, trusts or estates, joint stock companies, associations, syndicates, joint ventures, any unincorporated organizations or groups, Indian Tribes, and all entities cognizable as legal entities.

    Section 103.122(a)(6) U.S. person. The proposed rule defines "U.S. person" because U.S. citizens and persons incorporated under U.S. laws will be required to provide U.S. tax identification numbers whereas other persons, who may not have a U.S. tax identification number, will be required to provide other similar numbers. Thus, the rule defines "U.S. person" to mean a U.S. citizen or, for persons other than natural persons, an entity established or organized under the laws of a State or the United States.3

    Section 103.122(a)(7) Non-U.S. person. The proposed rule defines a "Non-U.S. person" as a person that is not a "U.S. person" as that term is defined in the rule.

    Section 103.122(a)(8) Taxpayer identification number. The proposed rule defines "taxpayer identification number" to have the same meaning as determined under the provisions of section 6109 of the Internal Revenue Code and the regulations of the Internal Revenue Service thereunder.

    B. Section 103.122(b) Customer Identification Program

    Section 326 of the Act requires the Secretary and the Commission to prescribe regulations requiring brokerdealers to implement and comply with "reasonable procedures" for: verifying the identity of customers "to the extent reasonable and practicable;" maintaining records associated with such verification; and consulting lists of known terrorists.

    Paragraph (b) of the proposed rule sets forth the requirement that a brokerdealer must develop and operate a customer identification program ("CIP") and sets forth relevant factors for the design of CIP procedures. The degree to which a CIP is effective will be a function of a broker-dealer's assessment of these factors and the nature of its response to them (as manifested in the CIP's procedures and guidelines). In addition, as section 326 and the proposed rule provide, the reasonableness of the CIP also will be a function of what is practicable for the broker-dealer.

    In developing and updating CIPs, broker-dealers should consider the type of identifying information available for customers and the methods available to verify that information. While certain minimum identifying information is required in paragraph (c) of this proposed rule and certain suitable verification methods are described in paragraph (d), broker-dealers should consider on an ongoing basis whether other information or methods are appropriate, particularly as they become available in the future.

    Broker-dealers must also base their CIPs on the risks associated with their business operations. Some relevant risk factors to be considered are set forth in paragraph (b) and discussed below in general terms.4

    The first risk factor to consider is the broker-dealer's size. For example, a large firm that opens a substantial number of accounts on any given day will have different risks than one that opens a new account no more than once or twice a month. The same is true with respect to a firm that has many branches as compared to a firm with one office.

    The second risk factor is the location of the broker-dealer. Firms should assess whether they are located in areas where money laundering activities have been known to exist or that otherwise raise the risk that attempts will be made to open accounts for money laundering purposes.

    The third risk factor is the method by which customers open accounts at the broker-dealer. Accounts opened exclusively on-line present different, and perhaps greater, risks than those opened in person on the firm's premises.

    The fourth and fifth risk factors are the types of accounts and transactions offered by the broker-dealer. Brokerdealers should assess whether there are different risks (and degrees of risk) associated with the various types of accounts they provide to customers (e.g., cash, margin, prime-brokerage) and transactions they execute in those accounts (e.g., short sales, over-thecounter derivatives, repurchase and reverse repurchase agreements, block trades).

    The sixth risk factor is the customer base. Broker-dealers should assess the risks associated with different types of customers. For example, a firm should examine whether it is opening accounts for customers located in countries the Secretary determines to be of "primary money laundering concern" pursuant to section 311 of the Act. Verification procedures should account for the concerns raised by such customers. In addition, certain legal entities may pose greater risks (e.g., a closely held corporation as opposed to one that is publicly traded).

    The seventh risk factor requires an assessment of whether the broker-dealer can rely on another broker-dealer, with which it shares an account relationship, to undertake any of the steps required by this proposed rule with respect to the shared account. A shared account means an account subject to a carrying or clearing agreement governed by New York Stock Exchange (NYSE) Rule 382 or National Association of Securities Dealers, Inc. (NASD) Rule 3230 (i.e., a customer account introduced by a correspondent broker-dealer to a clearing and carrying broker-dealer). Rules 382 and 3230 allow correspondents and clearing firms to set forth in written agreements a division of responsibilities with respect to the accounts they share.

    We anticipate broker-dealers sharing accounts may realize efficiencies by dividing up the requirements in this proposed rule pursuant to their clearing agreements. For example, the correspondent may undertake to obtain the identifying information from customers as required in paragraph (c), and the clearing firm may undertake the verification procedures as required in paragraph (d). Nonetheless, both firms would still be responsible for ensuring that each requirement in the rule is met with respect to each customer. Accordingly, a broker-dealer must continually assess whether the other firm can be relied on to perform its responsibilities. This would include communicating and coordinating with the other firm on an on-going basis. Moreover, a broker-dealer is expected to cease such reliance if it is no longer reasonable.

    Paragraph (b) also requires that the identity verification procedures must enable the broker-dealer to form a reasonable belief that it knows the true identity of the customer. This provision makes clear that, while there is flexibility in establishing these procedures, the broker-dealer is responsible for exercising reasonable efforts to ascertain the identity of each customer.

    Finally, paragraph (b) requires that broker-dealers make their CIPs part of their overall anti-money laundering programs required under section 352 of the Act (31 U.S.C. 5318(h)).5 This requirement is intended to make it clear that the CIP is not a separate program, but rather should be integrated into a broker-dealer's overall anti-money laundering procedures and policies. However, this should not be read to create any negative inference about a broker-dealer's need to establish and maintain an overall money laundering program that is designed to ensure compliance with all other applicable regulations promulgated under the Act.

    C. Section 103.122(c) Required Information

    The first step in verifying identity is obtaining identifying information from customers. Paragraph (c) of the proposed rule provides that a brokerdealer's CIP must require customers to provide, at a minimum, certain identifying information before an account is opened for the customer or the customer is granted trading authority over an account. Specifically, the broker-dealer must obtain each customer's: (1) Name; (2) date of birth, if applicable; (3) addresses; 6 and (4) documentary number.7

    The rule requires only that the minimum identifying information be obtained from each customer. Brokerdealers, in assessing the risk factors in paragraph (b), should determine whether other identifying information is necessary to form a reasonable belief as to the true identity of each customer. There may be certain types of customers from whom it is reasonable to obtain other identifying information in addition to the minimum required information. There also may be circumstances that make it appropriate to obtain additional information. If a broker-dealer, in examining the nature of its business and operations, determines that additional information should be obtained in certain cases, it should set forth guidelines in its CIP indicating the types of additional information and the circumstances when it shall be obtained.

    Treasury and the Commission recognize that a new business may need to open a brokerage account before it has received an employer identification number (EIN) from the Internal Revenue Service. For this reason, the proposed rule contains a limited exception to the requirement that a taxpayer identification number must be provided prior to the opening of an account or the granting of trading authority. Accordingly, a CIP may permit an account to be opened or trading authority to be granted for a person, other than an individual (such as a corporation, partnership or trust), that has applied for, but has not received, an EIN. However, in such a case, the CIP must require that the broker-dealer obtain a copy of the application for the EIN prior to the time the account is opened or trading authority granted. Currently, the IRS indicates that the issuance of an EIN can take up to five weeks. This length of time, coupled with when the person applied for the EIN, should be considered by the broker-dealer in determining the reasonable period of time within which the person should provide its EIN to the broker-dealer.

    D. Section 103.122(d) Required Verification Procedures

    After obtaining identifying information from a customer, the broker-dealer must take steps to verify the accuracy of that information in order to reach a point where it can form a reasonable belief that it knows the true identity of the customer. Accordingly, paragraph (d) of the proposed rule requires a broker-dealer's CIP to have procedures for verifying the accuracy of the identifying information provided by the customer. The extent of the verification for each customer will depend on the steps necessary for a broker-dealer to reach a reasonable belief that it knows the true identity of the customer.

    Paragraph (d) requires that the verification procedures must be undertaken within a reasonable time before or after a customer's account is opened or a customer is granted authority to effect transactions with respect to an account. This flexibility must be exercised in a reasonable manner, given that verifications too far in advance may become stale and verifications too long after the fact may provide opportunities to launder money while verification is pending. The amount of time it will take a brokerdealer to verify the identity of a customer may depend on the type of account opened, whether the customer opens the account in person, and on the type of identifying information available. In addition, although an account is opened, a broker-dealer may choose to place limits on the account, such as restricting the number of transactions or the dollar value of transactions, until a customer's identity is verified. Therefore, the proposed rule provides broker-dealers with the flexibility to use a risk-based approach to determine when the identity of a customer must be verified relative to the opening of an account or the granting of trading authority.8

    A person becomes a customer each time the person opens a new account at a broker-dealer or is granted trading authority with respect to an account. Therefore, upon the opening of each account or the granting of new authority, the verification requirements of this rule would apply. However, if a customer whose identification has been verified previously opens a new account or is granted new authority, the brokerdealer would not need to verify the customer's identity a second time, provided the broker-dealer (1) previously verified the customer's identity in accordance with procedures consistent with the proposed rule, and (2) continues to have a reasonable belief that it knows the true identity of the customer.

    The rule provides for two methods of verifying identifying information: verification through documents and verification through non-documentary means. For example, using documents would include obtaining a driver's license or passport from a natural person or articles of incorporation from a company. Non-documentary methods would include cross-checking the information provided by a customer against that supplied by a credit bureau.

    The proposed rule requires that a broker-dealer's CIP address both methods of verification. Depending on the type of customer and the method of opening an account, it may be more appropriate to use either documentary or non-documentary methods. In some cases, it may be appropriate to use both methods. The CIP should set forth guidelines describing when documents, non-documentary methods, or a combination of both will be used. These guidelines should be based on the broker-dealer's assessment of the factors described in paragraph (b) of the proposed rule.

    The risk a broker-dealer will not know a customer's true identity will be heightened for certain types of accounts, such as accounts opened in the name of a corporation, partnership, or trust that is created or conducts substantial business in a jurisdiction the Secretary determines is a primary money laundering concern or an international body, such as the Financial Action Task Force on Money Laundering, designates as non-cooperative. Obtaining sufficient information to verify a given customer's true identity can reduce the risk a broker-dealer will be used as a conduit for money laundering and terrorist financing. A broker-dealer's identity verification procedures must be based on its assessments of the factors in paragraph (b). Accordingly, when those assessments suggest a heightened risk, the broker-dealer should prescribe additional verification measures.

    1. Verification Through Documents

    Paragraph (d)(1) provides that the CIP must describe when a broker-dealer will verify identity through documents and set forth the documents that will be used for this purpose. The rule also lists certain documents that are suitable for verification. For natural persons, these documents may include: unexpired government-issued identification evidencing nationality or residence and bearing a photograph or similar safeguard. For other persons, suitable documents would be ones showing the existence of the entity, such as registered articles of incorporation, a government-issued business license, a partnership agreement, or a trust instrument.
    2. Verification Through Non-Documentary Methods

    Paragraph (d)(2) provides that the CIP must describe non-documentary verification methods and when such methods will be employed in addition to, or instead of, using documents. The rule allows for the exclusive use of nondocumentary methods because frequently accounts are opened by telephone, mail, or over the Internet. However, even if the customer presents documents, it may be appropriate to use non-documentary methods as well. Ultimately, the broker-dealer is responsible for employing sufficient verification methods to be able to form a reasonable belief that it knows the true identity of the customer.

    The proposed rule sets forth certain non-documentary methods that would be suitable for verifying identity. These methods include contacting a customer after the account is opened; 9 obtaining a financial statement; comparing the identifying information provided by the customer against fraud and bad check databases to determine whether any of the information is associated with known incidents of fraudulent behavior (negative verification); comparing the identifying information with information available from a trusted third party source, such as a credit report from a consumer reporting agency (positive verification); and checking references with other financial institutions. The broker-dealer also may wish to analyze whether there is logical consistency between the identifying information provided, such as the customer's name, street address, ZIP code, telephone number (if provided), date of birth, and social security number (logical verification).

    Paragraph (d)(2) also provides that the CIP must require the use of nondocumentary methods in certain cases; specifically, when a natural person is unable to present an unexpired government issued identification document that bears a photograph or similar safeguard and when the brokerdealer is presented with unfamiliar documents to verify the identity of a customer, does not obtain documents to verify the identity of a customer, does not meet face-to-face a customer who is a natural person, or is otherwise presented with circumstances that increase the risk the broker-dealer will be unable to verify the true identity of a customer through documents.

    Thus, non-documentary methods should be used when a broker-dealer cannot examine original documents. In addition, Treasury and the Commission recognize that identification documents, including those issued by a government entity, may be obtained illegally and may be fraudulent. In light of the recent increase in identity fraud, brokerdealers are encouraged to use nondocumentary methods, even when a customer has provided identification documents.

    E. Section 103.122(e) Government Lists

    Section 326 of the Act also requires reasonable procedures for determining whether a customer appears on any list of known or suspected terrorists or terrorist organizations provided by any government agency. The proposed rule implements this requirement and clarifies that the requirement applies only with respect to lists circulated by the Federal government. In addition, the proposed rule states that broker-dealers must follow all Federal directives issued in connection with such lists. This provision makes clear that a brokerdealer must have procedures for responding to circumstances when a customer is named on a list.

    F. Section 103.122(f) Customer Notice

    Section 326 provides that financial institutions must give their customers notice of their identity verification procedures. Therefore, a broker-dealer's CIP must include procedures for providing customers with adequate notice that the broker-dealer is requesting information to verify their identity. A broker-dealer may satisfy the notice requirement by generally notifying its customers about the procedures the broker-dealer must comply with to verify their identities. For example, the broker-dealer may post a sign in its lobby or provide customers with any other form of written or oral notice. If an account is to be opened electronically, such as through an Internet website, the broker-dealer may provide notice electronically. Notice must be given before an account is opened or trading authority is granted.

    G. Section 103.122(g) Lack of Verification

    Paragraph (g) of the proposed rule states that a broker-dealer's CIP must include procedures for responding to circumstances in which it cannot form a reasonable belief that it knows the true identity of a customer. Generally, a broker-dealer should maintain an account for a customer only when it can form a reasonable belief that it knows the customer's true identity. 10 Thus, a broker-dealer's CIP should specify the actions to be taken when it cannot form a reasonable belief. There also should be guidelines for when an account will not be opened. In addition, the CIP should address the terms under which a customer may conduct transactions while a customer's identity is being verified. The CIP should specify at what point, after attempts to verify a customer's identity have failed, an account that has been opened will be closed. Finally, the procedures should include a process for determining whether a Suspicious Activity Report should be filed in accordance with applicable laws and regulations.

    H. Section 103.122(h) Recordkeeping

    Section 326 of the Act requires procedures for maintaining records of the information used to verify a person's identity, including name, address, and other identifying information. Paragraph (h) of the proposed rule sets forth recordkeeping procedures that must be included in a broker-dealer's CIP. These procedures must provide for the maintenance of all information obtained pursuant to the CIP. Information that must be maintained includes all identifying information provided by a customer pursuant to paragraph (c). Thus, the broker-dealer must make a record of each customer's name, date of birth (if applicable), addresses, and tax identification number or other number. Broker-dealers also must maintain copies of any documents that were relied on pursuant to paragraph (d)(1) evidencing the type of document and any identification number it may contain. For example, if a customer produces a driver's license, the brokerdealer must make a copy of the driver's license that clearly indicates it is a driver's license and legibly depicts any identification number on the license.

    Broker-dealers also must make and maintain records of the methods and results of measures undertaken to verify the identity of a customer pursuant to paragraph (d)(2). For example, if a broker-dealer obtains a report from a credit bureau concerning a customer, the report must be maintained. Brokerdealers also must make and maintain records of the resolution of any discrepancy in the identifying information obtained. To continue with the previous example, if the customer provides a residence address that is different than the address shown on the credit report, the broker-dealer must document how it resolves this discrepancy or, if the discrepancy is not resolved, how it forms a reasonable belief notwithstanding the discrepancy. The broker-dealer must retain all of these records for five years after the date the account is closed or the grant of authority to effect transactions with respect to an account is revoked. In all other respects, the records should be maintained in accordance with the requirements of Rule 17a-4. 11

    Nothing in this proposed regulation modifies, limits or supersedes section 101 of the Electronic Records in Global and National Commerce Act, Public Law 106-229, 114 Stat. 464 (15 U.S.C. 7001) (E-Sign Act). Thus, a brokerdealer may use electronic records to satisfy the requirements of this regulation, as long as the records are maintained in accordance with Rule 17a-4(f), which the Commission has interpreted as being consistent with the requirements in the E-Sign Act. 12 Treasury and the Commissionemphasize that the collection and retention of information about a customer, as an ancillary part of collecting identifying information, do not relieve a broker-dealer from its obligations to comply with antidiscrimination laws and regulations.

    I. Section 103.122(i) Approval of Program

    Paragraph (i) of the proposed rule requires that the broker-dealer's CIP be approved by the most senior level of the firm (e.g., the board of directors, managing partners, board of managers, or other governing body performing similar functions) or by persons specifically authorized by that body to approve such a program.

    J. Section 103.122(j) Exemptions

    Section 326 states that the Secretary and the Federal functional regulator jointly issuing a rule under that section may by order or regulation exempt any financial institution or type of account from the regulation in accordance with such standards and procedures as the Secretary may prescribe. The proposed rule provides that the Commission, with the concurrence of the Secretary, may exempt any broker-dealer that registers with the Commission pursuant to 15 U.S.C. 78o and 78o-4. However, it excludes from this exemptive authority broker-dealers that register pursuant to 15 U.S.C. 78o(b)(11). These are firms that register as broker-dealers solely because they deal in securities futures products. The exemptive authority with respect to these firms will be in the rule issued jointly by Treasury and the CFTC. The proposed rule provides that the Secretary, with the concurrence of the Commission, may exempt any broker-dealer that registers pursuant to 15 U.S.C 78o-5 (i.e., government securities dealers).

    In issuing exemptions under the proposed rule, the Secretary and the Commission shall consider whether the exemption is consistent with the purposes of the BSA, and in the public interest, and may consider other necessary and appropriate factors.

    2 However, there may be situations involving the transfer of accounts where it would be appropriate for a broker-dealer to verify the identity of customers associated with the accounts it is acquiring. Therefore, Treasury and the Commission expect procedures for transfers of accounts to be part of a broker-dealer's overall anti-money laundering program required under section 352 of the Patriot Act. See Footnote 5 infra for a discussion of the requirements of section 352.

    3 The terms "State" and "United States" are defined in section 103.11.

    4 This discussion of the risk factors is included in the release because it may be helpful in providing some meaning and context with respect to the factors. However, it is not meant to provide comprehensive definitions of these risk factors or an exhaustive description of the considerations involved in assessing them. Instead, it should serve as a starting point for defining and assessing them.

    5 Section 352 requires brokers and dealers to establish anti-money laundering programs that, at a minimum, include (1) the development of internal policies, procedures, and controls; (2) the designation of a compliance officer; (3) an ongoing employee training program; and (4) an independent audit function to test programs. On April 22, 2002, the Commission approved rule changes submitted by the NASD and the NYSE. Exchange Act Release No. 45798 (April 22, 2002), 67 FR 20854 (April 26, 2002). These rules (NASD Rule 3011 and NYSE Rule 445) set forth minimum requirements for these programs.

    6 With respect to the address requirement, each customer must provide a mailing address, and, if different, the address of the customer's residence (if a natural person) or principal place of business (if not a natural person).

    7 Each customer that is a U.S. person must provide a U.S. taxpayer identification number (e.g., social security number or employer identification number). Customers that are Non-U.S. persons must provide either a U.S. taxpayer identification number, an alien identification card number, or the number and country of issuance of any other government-issued document evidencing nationality or residence and bearing a photograph or similar safeguard. The term "similar safeguard" is included to permit the use of any biometric identifiers that may be used in addition to, or instead of, photographs.

    8 We note that it is possible a broker-dealer could violate other laws by permitting a customer to transact business prior to verifying the customer's identity. See, e.g., 31 CFR part 500, prohibiting transactions involving designated foreign countries or their nationals.

    9 The purpose of engaging in verification is to check identifying information about a customer against an independent source. Contacting a customer may be a useful part of the verification process when an account is opened on-line or by mail. However, a broker-dealer should not rely solely on this method as a means of verification.

    10 There are some exceptions to this basic rule. For example, a broker-dealer may maintain an account, at the direction of law enforcement, notwithstanding that the broker-dealer does not know the true identity of a customer.

    11 17 CFR 240.17a-4.

    12 See Exchange Act Release No. 44238 (May 1, 2001), 66 FR 22916 (May 7, 2001).

    III. Conforming Amendments to 31 CFR 103.35

    Current section 103.35(a) sets forth customer identification requirements when certain brokerage accounts are opened. Generally, sections 103.35(a)(1) and (2) require a broker-dealer, within 30 days after an account is opened, to secure and maintain a record of the taxpayer identification number of the customer involved. If the broker-dealer is unable to obtain the taxpayer identification number within 30 days (or a longer time if the person has applied for a taxpayer identification number), it need take no further action under section 103.35 concerning the account if it maintains a list of the names, addresses, and account numbers of the persons for which it was unable to secure taxpayer identification numbers, and provides that information to the Secretary upon request. In the case of a non-resident alien, the brokerdealer is required to record the person's passport number or a description of some other government document used to determine identification.

    Section 103.35(a)(3) currently provides that a broker-dealer need not obtain a taxpayer identification number with respect to specified categories of persons 13 opening accounts. The proposed rule does not contain any exemptions from the CIP requirements. Treasury believes that the requirements of section 103.35(a)(1) and (2) are inconsistent with the intent and purpose of section 326 of the Act and incompatible with the proposed rule. For these reasons, Treasury, under its own authority, is proposing to repeal section 103.35(a).

    In addition, Treasury and the Commission are requesting comments on whether any of the exemptions in Section 103.35(a)(3) should apply in the context of the proposed CIP requirements in light of the intent and purpose of section 326 of the Act.

    13 The exemption applies to (i) agencies and instrumentalities of Federal, State, local, or foreign governments; (ii) aliens who are ambassadors; ministers; career diplomatic or consular officers; naval, military, or other attaches of foreign embassies and legations; and members of their immediate families; (iii) aliens who are accredited representatives of certain international organizations, and their immediate families; (iv) aliens temporarily residing in the United States for a period not to exceed 180 days; (v) aliens not engaged in a trade or business in the United States who are attending a recognized college or university, or any training program supervised or conducted by an agency of the Federal Government; and (vi) unincorporated subordinate units of a tax exempt central organization that are covered by a group exemption letter.

    IV. Request for Comments

    Treasury and the Commission invite comment on all aspects of the proposed regulation, and specifically seek comment on the following issues:

    1. Whether the proposed definition of "account" is appropriate and whether other examples of accounts should be added to the rule text.
    2. How broker-dealers can comply with the requirement to obtain both the address of a person's residence, and, if different, the person's mailing address in situations involving natural persons who lack a permanent address.
    3. Whether non-U.S. persons that are not natural persons will be able to provide a broker-dealer with the identifying information required in § 103.122(c)(4), or whether other categories of identifying information should be added to this section. Commenters on this issue should suggest other means of identification that broker-dealers currently use or should use in this circumstance that would allow a broker-dealer to form a reasonable belief that it knows the true identity of the entity.
    4. The extent to which the verification procedures required by the proposed rule make use of information that broker-dealers currently obtain in the account opening process. We note that the legislative history of section 326 indicates that Congress intended "the verification procedures prescribed by Treasury [to] make use of information currently obtained by most financial institutions in the account opening process." See H.R. Rep. No. 107-250, pt. 1, at 63 (2001).
    5. Whether any of the exemptions from the customer identification requirements contained in current section 103.35(a)(3) should be continued in the proposed rule. In this regard, Treasury and the Commission request that commenters address the standards set forth in paragraph (j) of the proposed rule (as well as any other appropriate factors).

    V. Paperwork Reduction Act

    Certain provisions of the proposed rule contain "collection of information" requirements within the meaning of the Paperwork Reduction Act of 1995.14 Treasury has submitted the proposed rule to the Office of Management and Budget (OMB) for review in accordance with 44 U.S