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  • 2003

    • For Your Information

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      2003 - 2004 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 2004. 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, and technical questions concerning system requirements, file uploads, and 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 Mello at (240) 386-5091.

      2004 FOCUS Due Dates

      Annual Schedule I for 2003 Year End Due Date
      2003 FOCUS Schedule I January 27, 2004
      Annual Schedule I for 2004 Year End Due Date
      2004 FOCUS Schedule I January 26, 2005

      2004 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, 2004 February 25, 2004
      February 29, 2004 March 23, 2004
      April 30, 2004 May 25, 2004
      May 31, 2004 June 23, 2004
      July 31, 2004 August 24, 2004
      August 31, 2004 September 24, 2004
      October 31, 2004 November 23, 2004
      November 30, 2004 December 23, 2004

      2004 Quarterly FOCUS Part II/IIA Filings

      Quarter Ending Due Date
      December 31, 2003 January 27, 2004
      March 31, 2004 April 26, 2004
      June 30, 2004 July 26, 2004
      September 30, 2004 October 25, 2004
      December 31, 2004 January 26, 2005

      2004 Annual Audit Filings Due Dates

      Period End Due Date
      December 31, 2003 February 29, 2004
      January 31, 2004 March 31, 2004
      February 29, 2004 April 29, 2004
      March 31, 2004 June 1, 2004
      April 30, 2004 June 29, 2004
      May 31, 2004 July 30, 2004
      June 30, 2004 August 30, 2004
      July 31, 2004 September 29, 2004
      August 31, 2004 November 1, 2004
      September 30, 2004 November 29, 2004
      October 31, 2004 December 30, 2004
      November 30, 2004 January 31, 2005
      December 31, 2004 March 1, 2005

      2004 3070/Customer Complaints Due Dates

      4th quarter 2003: January 15, 2004
      1st quarter 2004: April 15, 2004
      2nd quarter 2004: July 15, 2004
      3rd quarter 2004: October 15, 2004
      4th quarter 2004: January 17, 2005

      Market Regulation Department 2004 Short Interest Reporting Deadlines

      Trade Date Settlement Date Exchange-Listed Short Interest Due* NASDAQ Short Interest Due*
      January 12
      Monday
      January 15
      Thursday
      January 20
      1:00 p.m., Tuesday
      January 20
      6:00 p.m., Tuesday
      February 10
      Tuesday
      February 13
      Friday
      February 18
      1:00 p.m., Wednesday
      February 18
      6:00 p.m., Wednesday
      March 10
      Wednesday
      March 15
      Monday
      March 17
      1:00 p.m., Wednesday
      March 17
      6:00 p.m., Wednesday
      April 12
      Monday
      April 15
      Thursday
      April 19
      1:00 p.m., Monday
      April 19
      6:00 p.m., Monday
      May 11
      Tuesday
      May 14
      Friday
      May 18
      1:00 p.m., Tuesday
      May 18
      6:00 p.m., Tuesday
      June 10
      Thursday
      June 15
      Tuesday
      June 17
      1:00 p.m., Thursday
      June 17
      6:00 p.m., Thursday
      July 12
      Monday
      July 15
      Thursday
      July 19
      1:00 p.m., Monday
      July 19
      6:00 p.m., Monday
      August 10
      Tuesday
      August 13
      Friday
      August 17
      1:00 p.m., Tuesday
      August 17
      6:00 p.m., Tuesday
      September 10
      Friday
      September 15
      Wednesday
      September 17
      1:00 p.m., Friday
      September 17
      6:00 p.m., Friday
      October 12
      Tuesday
      October 15
      Friday
      October 19
      1:00 p.m., Tuesday
      October 19
      6:00 p.m., Tuesday
      November 9
      Tuesday
      November 15
      Monday
      November 17
      1:00 p.m., Wednesday
      November 17
      6:00 p.m., Wednesday
      December 10
      Friday
      December 15
      Wednesday
      December 17
      1:00 p.m., Friday
      December 17
      6:00 p.m., Friday

      * Eastern Standard Time

    • 03-81 Regulatory Element of Continuing Education Fee to be Reduced from $65 to $60

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      INFORMATIONAL

      Continuing Education

      Effective Date: January 1, 2004

      SUGGESTED ROUTING

      KEY TOPICS

      Continuing Education
      Legal & Compliance
      Registration
      Senior Management

      Regulatory Element

      Executive Summary

      Effective January 1, 2004, the fee for the Regulatory Element of Continuing Education will be reduced from $65 to $60. The fee reduction applies to all three Regulatory Element programs: the S201 for Supervisors, the S106 for Series 6 Representatives, and the S101 General Program for all other registrations. Firms that participate in in-firm delivery of the Regulatory Element will continue to receive a $3 credit to their CRD account for the in-firm deliveries they make.

      Questions/Further Information

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

      Background

      The Regulatory Element, a computer-based education program that helps ensure that registered persons are kept up-to-date on regulatory, compliance, and sales practice matters in the industry, is a component of the Securities Industry Continuing Education Program (Program) under NASD Rule 1120. Member firms currently pay $65 each time one of their registered persons participates in the Regulatory Element. The Securities Industry/Regulatory Council on Continuing Education (Council)1 was organized in 1995 to facilitate cooperative industry/regulatory coordination of the administration and future development of the Program in keeping with applicable industry regulations and changing industry needs. It is the Council's responsibility to maintain the Program on a revenue-neutral basis while maintaining adequate reserves. In its annual financial review, the Council determined that Program reserves would remain adequate over the next two years if the fee for a Regulatory Element session were reduced by $5. As such, at its December 2003 meeting, the Council unanimously supported a recommendation to the SROs to reduce the Regulatory Element fee to $60, effective January 1, 2004. This is the second reduction in fees since the Program began in 1995. The first was a reduction of $10 in 1999.


      1 The Council consists of 20 individuals, six of whom represent self-regulatory organizations (the American Stock Exchange LLC; the Chicago Board Options Exchange, Inc.; the Municipal Securities Rulemaking Board; NASD; the New York Stock Exchange, Inc.; and the Philadelphia Stock Exchange, Inc.) and 14 who represent the industry. Its roles include recommending and helping develop specific content and questions for the Regulatory Element, defining minimum core curricula for the Firm Element component of the Program, and developing and updating information about the Program for industry-wide dissemination.

    • 03-80 NASDAQ Announces New Service Termination Policy

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      ACTION REQUIRED

      Effective Date: January 1, 2004

      SUGGESTED ROUTING

      KEY TOPICS

      Finance
      Legal and Compliance
      Operations
      Senior Management
      Systems

      Late Payments

      Background

      Effective January 1, 2004, The Nasdaq Stock Market, Inc. (NASDAQ) will implement a new service termination policy for members, issuers, and other market participants that are not current in their payments to NASDAQ for any services, including transaction, data, listing, or other services. Under the new policy, NASDAQ will terminate services for any firm that is more than 90 days delinquent in its payments to NASDAQ.

      Any firm that is 90 days delinquent on January 1, 2004, or becomes 90 days delinquent between January 1 and January 31, 2004, will have a transition period until February 16, 2004, to become current and resolve any billing disputes with NASDAQ. If a firm is not delinquent in all accounts—e.g., the firm is current in paying for transaction services but delinquent in paying for data services—then NASDAQ will, to the extent possible, terminate only those services for which the firm is more than 90 days delinquent. The 90-day period is measured from the date of the invoice.

      NASDAQ is implementing this policy to ensure that it applies its SEC-approved fee schedules in a fair and even-handed manner, consistent with NASDAQ's obligations under Section 15A of the Securities Exchange Act of 1934, as amended. NASDAQ continues to reserve its rights to terminate services as otherwise permitted under any applicable contracts or NASD rules.

      Questions/Further Information

      Questions regarding this policy may be directed to Mary Dunbar, Office of General Counsel, NASDAQ, at (202) 912-3033; Peter Geraghty, Office of General Counsel, NASDAQ, at (202) 912-3036; or John Yetter, Office of General Counsel, NASDAQ, at (202) 912-3039.

      Questions regarding an invoice or overdue payment to NASDAQ may be directed to NASDAQ Finance at (800) 955-3898.

    • 03-79 SEC Approves New Rule 2790 (Restrictions on the Purchase and Sale of IPOs of Equity Securities); Replaces Free-Riding and Withholding Interpretation

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      INFORMATIONAL

      Initial Public Offerings (IPOs)

      Voluntary Effective Date: December 23, 2003
      Mandatory Effective Date: March 23, 2004

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Financing
      Institutional
      Legal & Compliance
      Operations
      Senior Management
      Syndicate
      Trading & Market Making
      Training

      Free-Riding and Withholding
      IPOs
      Issuer Directed Securities
      Restricted Person
      Rule 2790

      Executive Summary

      On October 24, 2003, the Securities and Exchange Commission (SEC) approved new Rule 2790 (Restrictions on the Purchase and Sale of IPOs of Equity Securities), which replaces the Free-Riding and Withholding Interpretation (IM-2110-1).1 As described in detail below, Rule 2790 generally prohibits a member from selling a "new issue" to any account in which a "restricted person" has a beneficial interest. The term "restricted person" includes most associated persons of a member, most owners and affiliates of a broker/dealer, and certain other classes of persons. The Rule requires that a member, before selling a new issue to any account, meet certain "preconditions for sale," which generally require the member to obtain a representation from the beneficial owner of the account that the account is eligible to purchase new issues in accordance with the Rule. The Rule also contains a series of general exemptions.

      In view of the number of significant changes under the Rule, NASD has agreed to provide a three-month transition period in which members and associated persons may comply with either Rule 2790} or the Interpretation. Thus, through the period ending March 22, 2004, members and associated persons may comply with either the Rule or the Interpretation. Effective March 23, 2004, all members and associated persons must comply with Rule 2790.

      The SEC Approval Order, which includes the text of the Rule, is available at www.nasdr.com/pdf-text/rf99_60_app.pdf.

      Questions/Further Information

      Questions regarding this Notice may be directed to Gary L. Goldsholle, Associate General Counsel, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8104; or Afshin Atabaki, Attorney, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8902.

      Background and Discussion

      Rule 2790, like the Free-Riding and Withholding Interpretation (Interpretation) it replaces, is designed to protect the integrity of the public offering process by ensuring that: (1) NASD members make bona fide public offerings of securities at the offering price; (2) members do not withhold securities in a public offering for their own benefit or use such securities to reward persons who are in a position to direct future business to members; and (3) industry insiders, including NASD members and their associated persons, do not take advantage of their "insider" position to purchase "new issues" for their own benefit at the expense of public customers. The Rule plays an important part in maintaining investor confidence in the capital raising and public offering process.2

      Rule 2790 represents a significant restructuring and revision to the Interpretation. While the focus of this Notice is on the provisions of new Rule 2790, it is worth noting some of the more significant changes from the Interpretation. First, the Rule eliminates the requirement that an offering must be a "hot issue," which is defined in the Interpretation as securities of a public offering that trade at a premium in the secondary market whenever such secondary market beings. To avoid some of the problems arising from the fact that members could not always predict whether an offering would be a hot issue, the prohibitions in Rule 2790 apply to all new issues, regardless of whether they commence trading in the secondary market at a premium.

      Second, Rule 2790 eliminates the category of "conditionally restricted" persons. Under the Interpretation, persons generally referred to as "conditionally restricted" were eligible to purchase hot issues if certain conditions were met, including that the purchases were in accordance with the purchaser's "normal investment practice." NASD Rule 2790 instead more narrowly defines the category of restricted persons, but does not provide exemptions based on a person's individual circumstances.

      Third, Rule 2790 adopts a "de minimis" exemption, allowing an account that is beneficially owned in part by restricted persons to purchase new issues if the beneficial interests of such persons do not exceed 10 percent of such account. By contrast, the Interpretation contains no such exemption, and thus even the most minute interests by a restricted person would prohibit an account from purchasing a hot issue unless certain "carve-out" and certification procedures were followed.

      Fourth, the new Rule standardizes the records firms must maintain evidencing that sales to accounts are in accordance with the Rule. The Interpretation imposes varying certification requirements depending on whether an account is, for example, an investment partnership or corporation, a foreign investment company, an account for which a bank or trust company is acting as a conduit, or an account of a foreign broker/dealer (on behalf of non-restricted persons) that is participating in the distribution as an underwriter, etc.). Rule 2790 consolidates the recordkeeping requirements in a single section addressing "preconditions for sale."

      Finally, the Rule eliminates the cancellation provisions. Because the Interpretation applies only to hot issues, and it was not always known whether an offering would be a hot issue, the Interpretation contains a provision allowing a member within a specified time period to cancel an allocation to a restricted person and reallocate such shares to a non-restricted person. In view of the fact that Rule 2790 applies to all new issues, not just those that are "hot," this provision was deemed unnecessary.

      A. General Prohibitions

      Paragraph (a) sets forth the general prohibitions of the Rule. Subparagraph (a)(1) states that a member or a person associated with a member may not sell, or cause to be sold, a new issue to any account in which a restricted person has a beneficial interest, except as otherwise permitted by the Rule. Subparagraph (a)(2) provides that a member or a person associated with a member may not purchase a new issue in any account in which such member or person associated with a member has a beneficial interest, except as otherwise permitted by the Rule. Subparagraph (a)(3) provides that a member may not continue to hold new issues acquired by the member as an underwriter, selling group member,3 or otherwise, except as permitted by the Rule.

      Subparagraph (a)(4) sets for exceptions to the general prohibitions. Subparagraph (a)(4)(A) permits sales or purchases from one member of the selling group to another member that are incidental to the distribution of a new issue to a non-restricted person at the public offering price. Subparagraph (a)(4)(B) permits "accommodation sales"— sales to or purchases by a broker/dealer at the public offering price to enable that broker/dealer's customer to purchase a new issue at the public offering price. Lastly, subparagraph (a)(4)(C) is designed to exempt purchases by joint back office broker/dealers ("JBOs"4) that can fall within the de minimis exemption of paragraph (c)(4). NASD believes that the ability of hedge funds registered as JBOs (or with JBO subsidiaries) to purchase new issues should be determined by the status of the beneficial owners of the fund, not simply the fund's status as a broker/dealer (or owner of a broker/dealer). Accordingly subparagraph (a)(4)(C) exempts purchases of a new issue at the public offering price by a broker/dealer (or owner of a broker/dealer) organized as an investment partnership, provided that such purchases are credited to the capital accounts of its partners in accordance with the provisions of paragraph (c)(4). This provision allows an investment partnership that registers as a broker/dealer, or that has a broker/dealer subsidiary, to purchase new issues on the same terms as other investment partnerships.5
      B. Preconditions for Sale

      Paragraph (b) provides that a member may not sell new issues to any account unless within the previous 12 months it has in good faith obtained a representation from either (1) the beneficial owners of the account, or a person authorized to represent the beneficial owners of an account, that the account is eligible to purchase new issues in accordance with the Rule, or (2) certain conduits (such as a bank, foreign bank, broker/dealer, or investment adviser) that all purchases of new issues are in compliance with the Rule. Paragraph (b) further provides that a member may not rely upon any representation that it believes, or has reason to believe, is inaccurate. Paragraph (b) also sets forth the recordkeeping provisions applicable to the preconditions for sale.6

      NASD requires the initial verification of an account's status under the Rule to be a positive affirmation from the beneficial owners, person authorized to act on their behalf, or a conduit. However, as noted in the Approval Order, NASD will permit members to conduct the annual verification of an account's status through the use of negative consent letters. Thus, a member may furnish a customer with account information on record used to determine that the account is eligible to purchase new issues and ask the customer to indicate whether anything has changed to make the account restricted. In the absence of any response from the customer, the member may continue to deem the account as non-restricted. In addition, NASD intends to permit the use of electronic communications in accordance with the standards adopted by the SEC and NASD for the use of such communications (e.g., where appropriate notice has been provided and where necessary customer consent has been obtained). Lastly, however, NASD will not permit members to verify customer account information orally.

      During the rulemaking process, some commenters asked what type of representations would be required in a fund-of-funds context. NASD responded that under the Rule, a member only must obtain a representation from a person authorized to represent the beneficial owners of the fund/account that purchases new issues directly from the member ("master fund"). NASD expects, however, that any person making such a representation would need to ascertain the status of investors of any feeder funds that invest in the master fund. If a representative of a master fund is unable to ascertain the status of an investor in a feeder fund, the master fund must deem such feeder fund to be restricted and ensure that any profits from new issues are not allocated to that fund (or consider whether any exemption, such as the de minimis exemption, might apply to that feeder fund).

      While the Rule specifies that a member must verify the status of the master fund annually, the Rule does not specify a time period during which a master fund may rely on information from a feeder fund. NASD recognizes that logistical impracticalities may prevent all authorized representatives of feeder funds from verifying information at the same time as the representative of the master fund. Thus, NASD will allow the representative of a master fund to rely on information from any feeder fund that is no more than 12 months old. Similarly, the representative of a feeder fund that in turn receives investments from other feeder funds may rely on information that is no more than 12 months old.

      In addition, if a feeder fund is beneficially owned in part by restricted persons and seeks to avail itself of the de minimis exemption, the person authorized to represent that fund should specify the percentage ownership by restricted persons. An authorized representative of a master fund that invests directly in new issues will be responsible for aggregating interests of restricted persons from the feeder funds to ensure that the aggregate ownership by restricted persons does not exceed the 10 percent threshold.
      C. General Exemptions

      Rule 2790 contains a number of exemptions. Many of the exemptions in the Interpretation have been carried forward into Rule 2790. In some cases, new exemptions have been added, and in others, exemptions have been scaled back or eliminated entirely. The exemptions in Rule 2790 reflect the general proposition that sales to and purchases by entities that have numerous beneficial owners are generally not the type of transactions that the Rule should prohibit. Despite this general unifying theme, NASD emphasizes that it will not be sufficient for a member or purchaser to claim an exemption on the basis that a particular purchase or sale benefits numerous beneficial owners, few if any of whom are restricted persons. To purchase new issues under the Rule, an account otherwise restricted must be covered by a specific exemption under the Rule.
      1. Subparagraph (c)(1) exempts from the Rule sales to and purchases by investment companies registered under the Investment Company Act of 1940. This provision is similar to an existing exemption in the Interpretation.
      2. Subparagraph (c)(2) exempts sales to and purchases by common trust funds that have investments from 1000 or more accounts and that do not limit interests in the fund principally to trust accounts of restricted persons. This provision is a new exemption.
      3. Subparagraph (c)(3) exempts insurance company general, separate, or investment accounts provided that (a) the account is funded by premiums from 1000 or more policyholders, or, if a general account, the insurance company has 1000 or more policyholders; and (b) the insurance company does not limit the policyholders whose premiums are used to fund the account principally to restricted persons, or, if a general account, the insurance company does not limit its policyholders principally to restricted persons. This provision also is a new exemption.
      4. Subparagraph (c)(4) establishes the so-called "de minimis" exemption. The de minimis exemption exempts sales to and purchases by an account if the beneficial interests of restricted persons do not exceed in the aggregate 10 percent of such account. The de minimis exemption was created in part to reflect the burden of carving out interests of restricted persons that own only a small portion of a restricted account. NASD believes that allocations to accounts that are owned 90 percent or more by non-restricted persons generally do not present concerns underlying the Rule. While restricted persons may receive some benefit from new issues, nearly all of the benefit (90 percent or greater) flows to non-restricted persons. The introduction of a de minimis exemption represents a substantial change from the Interpretation, which required all interests of restricted persons to be "carved-out" no matter how small.

      In addition, the Rule provides more flexibility concerning the methods of effecting a "carve-out." In paragraph (g) of the Interpretation, NASD specified the process for "carving-out" interests of restricted persons. Generally, this called for the creation of "separate brokerage accounts." In administering these procedures, NASD staff observed that not all investment entities (and in particular funds of funds) were established in a manner to accommodate the specific procedures of paragraph (g), even though such accounts could just as effectively ensure that the benefits of IPOs did not reach restricted persons. In Rule 2790, NASD has eliminated specific "carve-out" procedures recognizing that there may be many effective means of segregating interests of restricted persons. Some investors may choose to establish "separate accounts" similar to the provisions of paragraph (g) of the Interpretation. Others instead may maintain one account but adjust the capital accounts of restricted persons to remove any gains (or losses) attributable to new issues.

      For purposes of determining the ownership level of restricted persons in a master fund, the interests of restricted persons in a feeder fund shall be attributed to a master fund in an amount equal to the restricted persons' interest in the feeder fund times the master fund's interest in the feeder fund. For example, if a master fund has an equal interest in 10 feeder funds, 5 of which are owned 20 percent by restricted persons, and 5 of which are owned 5 percent by restricted persons, the master fund is deemed to be owned 12.5 percent by restricted persons. The interest of the master fund in the each of the 5 funds that are owned 20 percent by restricted persons is determined as follows: 10 percent (the interest of the master fund in the first tier feeder fund) x 20 percent (the interest of the first tier feeder fund in the second tier feeder fund) = 2 percent. With respect to these 5 funds owned by the master fund, the interest of restricted persons in aggregate is 10 percent (5 funds x 2 percent each). The interest of the master fund in the each of the 5 funds that are owned 5 percent by restricted persons is determined as follows: 10 percent (the interest of the master fund in the first tier feeder fund) x 5 percent (the interest of the first tier feeder fund in the second tier feeder fund) = 0.5 percent. With respect to these 5 funds owned by the master fund, the interest of restricted persons is 2.5 percent (5 funds x 0.5 percent each). The total interest of restricted persons in the master fund is 12.5 percent (10 percent + 2.5 percent = 12.5 percent). In this case, the master fund would not be eligible to use the de minimis exemption unless it reduced the interest of restricted persons from 12.5 percent to 10 percent or below.
      5. Subparagraph (c)(5) establishes the "publicly traded entity exemption." Specifically, subparagraph (c)(5) exempts sales to and purchases by publicly traded entities (other than a broker/dealer or an affiliate7 of a broker/dealer where such broker/dealer is authorized to engage8 in the public offering of new issues either as a selling group member or underwriter) that are listed on a national securities exchange, are traded on the NASDAQ National Market, or are foreign issuers that meet the quantitative designation criteria for listing on a national securities exchange or the NASDAQ National Market. NASD notes that these entities have broad public ownership and may be purchased by any investor. Moreover, the publicly traded entity exemption recognizes the practical limitations in attempting to identify every beneficial owner, and that the benefits of investments in new issues are, indirectly, shared by the public shareholders.

      Thus, a parent company that is publicly traded and has a broker/dealer subsidiary that engages in public offerings would be restricted under paragraph (i)(10)(E) of the Rule and would not qualify for the publicly traded entity exemption. All accounts in which such parent company had a beneficial interest (including entities in which the parent held an interest of 10 percent or more) also would be restricted persons, even if the business of the subsidiaries was wholly unrelated to the broker/dealer activities. By contrast, a publicly traded parent company whose broker/dealer subsidiary does not engage in public offerings of new issues would qualify for the publicly traded entity exemption in paragraph (c)(5) of the Rule. The broker/dealer subsidiary would continue to be a restricted person, but the parent company and other non-restricted subsidiaries of the parent company would be eligible to purchase new issues.

      By looking at whether a broker/dealer is authorized to engage in public offerings of new issues, NASD is excluding affiliates of "full service" broker/dealers. On the other hand, Rule 2790 allows purchases of new issues by the many publicly traded entities that may have broker/dealer affiliates for limited corporate purposes. Subparagraph (c)(5) does not extend to a private company, which may avail itself of the de minimis exemption in paragraph (c)(4) discussed above.
      6. Subparagraph (c)(6) exempts sales to and purchases by foreign investment companies. Specifically, the exemption applies to an investment company organized under the laws of a foreign jurisdiction that is listed on a foreign exchange or authorized for sale to the public by a foreign regulatory authority, provided that no person owning 5 percent or more of the investment company is a restricted person. This exemption is similar to a existing provision in the Interpretation, but has been streamlined. NASD has eliminated requirements that a foreign investment company have 100 or more investors and limitations on the amount of the fund's assets that can be invested in a particular security being offered. A foreign investment company that does not meet the conditions of subparagraph (c) may, however, be eligible to purchase new issues under the de minimis exemption.

      NASD reminds firms that the foreign investment company exception is intended to extend benefits to foreign investment entities that are similar to U.S. mutual funds. In imposing a requirement that a foreign investment company be "authorized for sale to the public," NASD is attempting to equate to the way registered investment companies are offered in the United States. Foreign investment companies that are limited to high net worth individuals should not be considered "authorized for sale to the public," as a large segment of the foreign public would not be eligible to purchase them.
      7. Subparagraph (c)(7) exempts sales to and purchases by an ERISA benefits plan that is qualified under Section 401(a) of the Internal Revenue Code (IRC), provided that such plan is not sponsored solely by a broker/dealer. Thus, a plan sponsored by a broad-based financial services company that includes a broker/dealer subsidiary would be eligible to purchase new issues. The ERISA plan exemption is similar to a provision in the current Interpretation.
      8. Subparagraph (c)(8) exempts sales to and purchases by a state or municipal government plans that is subject to state and/or municipal regulation. This exemption reflects the fact that purchases of new issues by government and municipal plans, while not qualified under ERISA, do not raise concerns under the Rule.
      9. Subparagraph (c)(8) exempts sales to and purchases by a tax-exempt charity organized under Section 501(c)(3) of the IRC. NASD believes that sales of new issues to these charities are consistent with the purposes of the Rule and foster a bona fide public distribution.
      10. Subparagraph (c)(10) exempts sales to and purchases by church plans described in Section 414(e) of the IRC. Church plans, which are operated for the benefit of employees of a church or a convention or association of churches, are similar to other ERISA plans, but are not qualified under Section 401(a) of the IRC. NASD finds that the rationale for exempting ERISA plans qualified under Section 401(a) of the IRC applies equally to church plans as defined under Section 414(e) of the IRC.
      D. Issuer-Directed Securities

      Paragraph (d) addresses issuer-directed securities. Subparagraph (d)(1) exempts, for most purchasers, securities that are specifically directed by the issuer. The issuer-directed exemption for sales to and purchases by persons who are broker/dealer personnel, as defined in subparagraph (i)(10)(B), and finders and fiduciaries, as defined in subparagraph (i)(10)(C), applies only if such persons, or a member of their immediate family, is an employee or director of the issuer, the issuer's parent, or a subsidiary of the issuer or the issuer's parent.9 Unlike the Interpretation, the Rule 2790 issuer-directed exemption does not require that issuer-directed securities be subject to a three-month lock-up. NASD also believes that the issuer-directed exemption should apply only when shares are in fact directed by an issuer. Thus, members should not seek to circumvent prohibitions of the Rule by seeking to have issuers direct securities to restricted persons on their behalf. NASD also will continue its practice of holding a managing underwriter responsible for ensuring that all issuer-directed securities are distributed in accordance with the Rule.

      Subparagraph (d)(2) creates an exemption for securities distributed as part of a program sponsored by the issuer, or an affiliate of the issuer, that meets four conditions: (1) the opportunity to purchase a new issue under the program is offered to at least 10,000 participants; (2) every participant is offered an opportunity to purchase an equivalent number of shares or will receive a specified number of shares under a predetermined formula applied uniformly across all participants; (3) if not all participants receive shares under the program, the selection of the eligible participants is based on a random or other non-discretionary allocation method; and (4) the class of participants does not contain a disproportionate number of restricted persons.10 This exemption codifies the NASD staff position taken in several exemptive letters under the Interpretation.

      Subparagraph (d)(3) exempts new issues directed to eligible purchasers as part of a conversion offering11 conducted in accordance with the standards of the governmental agency or instrumentality having authority to regulate such conversion offering. This exemption is similar to an exemption in the Interpretation.
      E. Anti-Dilution Provisions

      Paragraph (e) of the Rule contains "anti-dilution" provisions. This provision permits a restricted person that is an existing equity owner of an issuer to purchase shares of the issuer in a public offering in order to maintain its equity ownership position. A restricted person seeking an exemption under this provision must meet the following criteria: (1) the account has held an equity ownership interest in the issuer for a period of one year prior to the effective date of the offering; (2) the sale of the new issue to the account does not increase the account's percentage equity ownership in the issuer above the ownership level as of three months prior to the filing of the registration statement in connection with the offering; (3) the sale of the new issue to the account does not include any special terms; and (4) the new issue purchased pursuant to this exemption is not sold or transferred for three months following the effective date of the offering. Paragraph (e) replaces the substantially similar "Venture Capital Investors" exemption of the Interpretation.
      F. Stand-By Purchasers

      Paragraph (f) of the Rule contains an exemption for stand-by purchasers. Specifically, paragraph (f) provides that the prohibitions on the purchase and sale of new issues do not apply to purchases and sales made pursuant to a stand-by agreement that meets the following four conditions: (1) the stand-by agreement is disclosed in the prospectus; (2) the stand-by agreement is the subject of a formal written agreement; (3) the managing underwriter represents in writing that it is unable to find any other purchasers for the securities; and (4) securities sold pursuant to the stand-by agreement are subject to a three-month lock-up period. Paragraph (f) is substantively similar to a provision in the Interpretation.
      G. Under-Subscribed Offerings

      Paragraph (g) permits an underwriter, pursuant to an underwriting agreement, to retain a portion of an offering of a new issue in its investment account if it is unable to sell that portion to the public. This is a new provision that became necessary as a result of the change in the Rule to apply to all new issues, not just those that were hot issues. Because the Rule applies to all new issues, even those for which they may not be sufficient demand, the Rule permits an underwriter to place unsold shares into its investment account. Members should be aware that this provision does not permit a member to place unsold shares into an account of another restricted person. Members are not permitted to place unsold shares into an account beneficially owned by restricted persons (other than an investment account of the member) because the net effect of such a provision would be akin to a hot issue standard (equating lack of demand with a flat or lower opening price in the secondary market), which the Rule seeks to abandon.
      H. Exemptive Relief

      Paragraph (h) provides the staff with the authority to grant an exemption for any or all of the provisions of the Rule if it determines that such exemption is consistent with the purposes of the Rule, the protection of investors, and the public interest. The exemptive authority under Rule 2790 is similar to the exemptive authority in the Interpretation. Consistent with guidance from SEC staff, NASD intends to use its exemptive authority only in circumstances that are "truly unique."12
      I. Definitions of Key Terms
      1. Beneficial Interest

      Subparagraph (i)(1) defines the term "beneficial interest" as any economic interest, such as the right to share in gains and losses. Consistent with a previously articulated position under the Interpretation, the definition of "beneficial interest" excludes the receipt of a management or performance-based fee for operating a collective investment account, or other fees for acting in a fiduciary capacity. The definition of "beneficial interest" differs from the definition in the Interpretation in that beneficial interest no longer includes solely a legal interest.

      NASD offers the following guidance with respect to a performance-based fee that is deferred for tax or other purposes. The initial receipt of a performance-based fee would not constitute a beneficial interest in a collective account. However, the accumulation of these payments, if subsequently invested in the collective investment account (as a deferred fee arrangement or otherwise) would constitute a beneficial interest in the account.
      2. Collective Investment Account

      Subparagraph (i)(2) defines the term "collective investment account" as any hedge fund, investment partnership, investment corporation, or any other collective investment vehicle that is engaged primarily in the purchase and/or sale of securities. As part of the reforms of Rule 2790, a collective investment account does not include a "family investment vehicle" or an "investment club." Each of these terms is separately defined in the Rule.
      3. Immediate Family Member

      Several of the definitions of the term "restricted person" are extended to certain immediate family members. Subparagraph (i)(5) defines "immediate family member" as a person's parents, mother-in-law or father-in-law, spouse, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-law, and children. Additionally, "immediate family member" includes any other individual to whom the person provides material support. This definition is substantively identical to the definition contained in the Interpretation.
      4. Material Support

      As noted above, several of the definitions of the term "restricted person" are extended to immediate family members that receive "material support" from a restricted person, or that provide "material support" to a restricted person. While the term "material support" was also used in the Interpretation, it was not a defined term. Rule 2790 defines the term as directly or indirectly providing more than 25 percent of a person's income in the prior calendar year. In addition, members of the immediate family living in the same household are deemed to be providing each other with "material support."
      5. New Issue

      Subparagraph (i)(9) defines the term "new issue" as any initial public offering of an equity security as defined in Section 3(a)(11) of the Securities Exchange Act of 1934, made pursuant to a registration statement or offering circular. Application of the Rule to all "new issues," rather than just those that are "hot issues," represents one of the most significant changes between Rule 2790 and the Interpretation. As the foregoing definition suggests, the Rule does not apply to secondary offerings. Similarly, the foregoing definition excludes offerings of debt securities.

      Furthermore, in view of the broader definition encompassed by the term "new issue," subparagraph (i)(9) expressly excludes other types of offerings. Subparagraph (i)(9)(A) excludes various private offerings. Subparagraph (i)(9)(B) excludes offerings of exempted securities. Subparagraph (i)(9)(C) excludes offerings of securities of a commodity pool operated by a commodity pool operator as defined under Section 1a(5) of the Commodity Exchange Act. Subparagraph (i)(9)(D) excludes rights offerings, exchange offerings, or offerings made pursuant to a merger or acquisition. Subparagraph (i)(9)(E) excludes offerings of investment grade asset-backed securities. NASD believes that the exclusion for investment grade asset-backed securities is necessary because certain asset-backed securities may be considered equity rather than debt securities. Subparagraphs (i)(9)(F) and (G) exclude offerings of convertible and preferred securities, respectively. Subparagraph (i)(9)(H) excludes offerings of securities of an investment company registered under the Investment Company Act of 1940. Lastly, subparagraph (i)(9)(I) excludes offerings of securities (in ordinary form or ADRs registered on Form F-6) that have a pre-existing market outside of the United States. This exemption in subparagraph (i)(9)(I) applies only to initial offerings of ADRs that are not part of a global initial public offering.13

      In administering the Interpretation, NASD staff occasionally was asked if it was permissible to allow journal entries between the accounts of non-restricted persons and restricted persons when an offering was no longer a hot issue. Historically, NASD did not view the Interpretation as permitting journaling of hot issues from one account to another. In administering Rule 2790, NASD does not intend to require an outright purchase and sale of a new issue to transfer ownership interests (and risks) to restricted persons. NASD believes that it would be appropriate for firms to allow restricted persons to share in the subsequent gains and losses from new issues provided that restricted persons' "purchase" of a new issue is not at the IPO price, but at the prevailing market price at the time their capital account reflects ownership of the security.
      6. Restricted Person

      The definition of "restricted person" covers five basic categories. Subparagraph (i)(10)(A) defines the term to include members or other broker/dealers. Subparagraph (i)(10)(B) defines the term to include broker/dealer personnel. Specifically, subparagraph (i)(10)(B)(i) extends the definition of restricted person to include any officer, director, general partner, associated person, or employee of a member or any other broker/dealer (other than a limited business broker/dealer).14 Subparagraph (i)(10)(B)(ii) provides that agents of a member or any other broker/dealer (other than a limited business broker/dealer) are restricted persons if they are engaged in the investment banking or securities business. Subparagraph (i)(10)(B)(iii) treats as a restricted person an immediate family member of a person specified in subparagraphs (B)(i) or (B)(ii) above, if that person: (a) materially supports or receives support from the immediate family member; (b) is employed by or associated with the member, or an affiliate of the member, selling the new issue to the immediate family member; or (c) has an ability to control the allocation of the issue.

      Subparagraph (i)(10)(C)(ii) treats finders and fiduciaries as restricted persons. Specifically, a restricted person includes, with respect to the security being offered, a finder or any person acting in a fiduciary capacity to the managing underwriter, including, but not limited to, attorneys, accountants, and financial consultants. The Rule also treats as a restricted person an immediate family member of a finder or fiduciary if the finder or fiduciary materially supports, or receives support from, the immediate family member. The provisions addressing finders and fiduciaries are similar to provisions in the Interpretation, but narrower in that they are limited to finders and fiduciaries in the particular offering.

      Subparagraph (i)(10)(D) treats portfolio managers as restricted persons. As noted above, one of the more significant changes under the new Rule is the elimination of the "conditionally restricted" status. Rule 2790 defines as a restricted person any person who has the authority to buy or sell securities for a bank, savings and loan institution, insurance company, investment company, investment advisor, or collective investment account. Although such persons are deemed to be restricted persons under the Rule, this category is substantially narrower than a similar category in the Interpretation in that it is based upon a person's activities rather than just his or her status as a "senior officer" or a person in a securities department. This definition applies to natural as well as non-natural persons. Similar to the other definitions of restricted person, an immediate family member of a portfolio manger as defined in subparagraph (i)(10)(D)(i) that materially supports, or receives material support from, the portfolio manager, also is a restricted person. One notable change between Rule 2790 and the Interpretation is that a person who has authority to buy or sell securities for an investment club or a family investment vehicle is no longer deemed to be a restricted person based solely upon that investment authority.

      Subparagraph (i)(10)(E) addresses owners of broker/dealers. NASD believes that the prohibition on purchases of new issues by a broker/dealer could be circumvented if the owners of a broker/dealer were permitted to purchase the new issue. Consequently, NASD has drafted the definition of restricted person to include owners of broker/dealers. Subparagraph (i)(10)(E)(i) captures direct owners by treating as a restricted person any person listed, or required to be listed, on Schedule A of Form BD15 (other than with respect to a limited business broker/dealer), except persons identified by an ownership code of less than 10 percent. Subparagraph (i)(10)(E)(ii) captures indirect owners by treating as a restricted person any person listed, or required to be listed, on Schedule B of Form BD,16 except persons whose listing on Schedule B relates to an ownership interest in a person listed on Schedule A identified by an ownership code of less than 10 . In addition, as Schedules A and B are used in connection with an initial application to become a broker/dealer, subparagraph (i)(10)(E)(iii) includes in the definition of restricted person any person listed, or required to be listed, on Schedule C of Form BD that meets the criteria of subparagraphs (i)(10)(E)(i) and (ii) above.

      In general, Schedules A and B do not require reporting of direct or indirect owners of "public reporting companies." However, persons owning significant concentrations of such persons may implicate the concerns the Rule is designed to address. Accordingly, subparagraphs (i)(10)(E)(iv) and (v) sweep in owners, above specified thresholds, of a public reporting company (other than a public reporting company that is listed on a national securities exchange or traded on the NASDAQ National Market). Owners of public reporting companies listed on a national securities exchange or traded on the NASDAQ National Market are excluded for reasons similar to those underlying the publicly traded entity exemption. Lastly, subparagraph (i)(10)(E)(vi) treats as a restricted person a member of the immediate family of a person specified in subparagraphs (i)(10)(E)(i)-(v) unless the person owning the broker/dealer: (a) does not materially support, or receive material support from, the immediate family member; (b) is not an owner of the member, or an affiliate of the member, selling the new issue to the immediate family member; and (c) has no ability to control the allocation of the new issue.

      Finally, as noted above, pursuant to paragraph (a)(1), a member or an associated person may not sell a new issue to any account in which a restricted person has a beneficial interest. This provision precludes, absent an exemption, sales of new issues to accounts in which an owner of a broker/dealer has a beneficial interest, including subsidiaries of the broker/dealer. NASD believes that applying the Rule to subsidiaries and other accounts is necessary to prevent a restricted person from evading the restriction by directing a subsidiary to purchase a new issue on its behalf. The application of this provision in combination with the publicly traded entity exemption would, nevertheless, permit a subsidiary to purchase new issues if the owner of the subsidiary is eligible to purchase new issues under the publicly traded entity exemption as discussed above. Further, the restriction would not apply to a subsidiary that independently qualifies for any other exemption under the Rule (e.g., if the subsidiary is a tax-exempt charity organized under Section 501(c)(3) of the IRC). In addition, a subsidiary that is beneficially owned in part by restricted persons is eligible to use the de minimis exemption.

      Effective Date

      In view of the number of significant changes in Rule 2790, and in response to comments raised during the rulemaking process, NASD has agreed to allow a three-month transition period in which members may comply with either Rule 2790 or the Interpretation. NASD believes that allowing members the option to continue to comply with the Interpretation for an additional three months will allow those firms sufficient time to develop the necessary procedures and obtain the necessary customer representations to comply with Rule 2790. Moreover, during this time, members and associated persons may choose to comply with either the Interpretation or Rule 2790 on an account-by-account basis. However, we note that once a member chooses to comply with Rule 2790 rather than the Interpretation, it must ensure that all representations relied upon are in conformity with the provisions of Rule 2790 (i.e., certifications made under the Interpretation, including those on behalf of investment partnerships under paragraph (f) will no longer be valid as the definitions of restricted persons has changed.) Effective March 23, 2004, all members and associated persons must comply with Rule 2790.


      1 SEC Order Approving Proposed Rule Change and Amendments Nos. 1 Through 4 Thereto and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 5 Thereto by the NASD Relating to Restrictions on the Purchase and Sale of Initial Public Offerings of Equity Securities, 61 Fed. Reg. 62126 (October 31, 2003) ("Approval Order") (File No. SR-NASD-99-60). See also Notice of Filing and Immediate Effectiveness of Proposed Rule Change by the National Association of Securities Dealers, Inc. to Interpret Two Provisions of New NASD Rule 2790 Relating to Initial Public Offerings, Release No. 34-48973 (December 22, 2003) (File No. SR-NASD-2003-190).

      2 Compliance with Rule 2790 does not obviate the need for firms that agreed to the Voluntary Initiative Regarding Allocations of Securities in "Hot" Initial Public Offerings to Corporate Executives and Directors to comply with its terms.

      3 The term selling group is defined in NASD Rule 0210(p).

      4 Certain hedge funds, or subsidiaries thereof, elect to become registered broker/dealers and share a back-office with another broker/dealer. These entities are called JBOs.

      5 Paragraph (a)(4)(C) refers specifically to "investment partnership" because we understand this is the most common organizational form of JBO hedge funds. We believe, however, that the decision to organize as a limited liability company, or some other corporate form, should not undermine the relief granted to hedge funds organized as JBOs or with JBO subsidiaries.

      6 None of the preconditions for sale require certification by an attorney or accountant. Certain provisions of the Interpretation (e.g., paragraphs (f) and (g)) require a written representation from an attorney or accountant, but NASD has not continued to make this a condition in Rule 2790.

      7 For purposes of this provision, "affiliate" has the same meaning as in NASD Rules 2710 and 2720.

      8 Under NASD rules, a member that seeks authority to engage in public offerings must make that part of its membership application. If an existing member that is not authorized to engage in public offerings seeks to do so in the future, such member must make application under NASD Rule 1017. Application of this provision in Rule 2790 will depend on whether a firm is authorized to engage in the public offering of new issues, not whether it actually conducts such offerings. Thus, information in Item 12 of Form BD will not be conclusive of whether a firm is authorized to engage in public offerings, because a member is not required to list on Item 12 activity if it is less than 1 percent of annual revenue. If a firm indicates on Item 12 of Form BD that it is engaged as an underwriter or selling group member, affiliates of such firms cannot purchase new issues.

      9 For purposes of this provision, a parent/subsidiary relationship is established if the parent has the right to vote 50 percent or more of a class of voting security of the subsidiary, or has the power to sell or direct 50 percent or more of a class of voting security of the subsidiary.

      10 This condition is designed to ensure that a program is not directed to a group composed to a significant extent of restricted persons.

      11 "Conversion offering" means any offering of securities made as part of a plan by which a savings and loan association, insurance company, or other organization converts from a mutual to a stock form of ownership.

      12 Approval Order, 68 Fed. Reg. at 62143.

      13 The definition of "new issue" is not limited to domestic securities offerings. Thus, the prohibitions in paragraph (a) of the Rule apply members and their associated persons with respect to foreign offerings.

      14 A limited business broker/dealer is defined as a broker/dealer whose authorization to engage in the securities business is limited solely to the purchase and sale of investment company/variable contracts securities and direct participation program securities. This definition is very similar to the definition in the Interpretation, but focuses on whether a firm is authorized to engage in a particular activity rather than on whether it engages in such activity.

      15 Schedule A is used by an applicant to list direct owners and executive officers in connection with an initial application to become a broker/dealer.

      16 Schedule B is used by an applicant to list indirect owners in connection with an initial application to become a broker/dealer.


      Attachment A

      Additions are underlined; deletions are in brackets.

      IM-2110-1. ["Free-Riding and Withholding"]

      Deleted in its entirety and replaced with: Reserved.

      IM-2750. Transactions with Related Persons

      A member who is acting, or plans to act, as sponsor of a unit investment trust will not violate Rule 2750 if it accumulates securities with respect to which the member has acted as a syndicate member, selling group member or reallowance dealer in an account of the member or related person of the member if, at the time of accumulation, the member in good faith intends to deposit the securities into the unit investment trust at the public offering price and intends to make a bona fide public offering of the participation units of that trust. Members engaged in such activity, however, will continue to be subject to Rule 2790. [IM-2110-1, "Free-Riding and Withholding."]

      2790. Restrictions on the Purchase and Sale of Initial Equity Public Offerings

      (a) General Prohibitions
      (1) A member or a person associated with a member may not sell, or cause to be sold, a new issue to any account in which a restricted person has a beneficial interest, except as otherwise permitted herein.
      (2) A member or a person associated with a member may not purchase a new issue in any account in which such member or person associated with a member has a beneficial interest, except as otherwise permitted herein.
      (3) A member may not continue to hold new issues acquired by the member as an underwriter, selling group member, or otherwise, except as otherwise permitted herein.
      (4) Nothing in this paragraph (a) shall prohibit:
      (A) sales or purchases from one member of the selling group to another member of the selling group that are incidental to the distribution of a new issue to a non-restricted person at the public offering price; [or]
      (B) sales or purchases by a broker/dealer of a new issue at the public offering price as part of an accommodation to a non-restricted person customer of the broker/dealer; or
      (C) purchases by a broker/dealer (or owner of a broker/dealer), organized as an investment partnership, of a new issue at the public offering price, provided such purchases are credited to the capital accounts of its partners in accordance with paragraph (c)(4).
      (b) Preconditions for Sale
      Before selling a new issue to any account, a member must in good faith have obtained within the twelve months prior to such sale, a representation from:
      (1) Beneficial Owners

      the account holder(s), or a person authorized to represent the beneficial owners of the account, that the account is eligible to purchase new issues in compliance with this rule; or
      (2) Conduits

      a bank, foreign bank, broker/dealer, or investment adviser, or other conduit that all purchases of new issues are in compliance with this rule.

      A member may not rely upon any representation that it believes, or has reason to believe, is inaccurate. A member shall maintain a copy of all records and information relating to whether an account is eligible to purchase new issues in its files for at least three years following the member's last sale of a new issue to that account.
      (c) General Exemptions

      The general prohibitions in paragraph (a) of this rule shall not apply to sales to and purchases by the following accounts or persons, whether directly or through accounts in which such persons have a beneficial interest:
      (1) An investment company registered under the Investment Company Act of 1940;
      (2) A common trust fund or similar fund as described in Section 3(a)(12)(A)(iii) of the Act, provided that:
      (A) the fund has investments from 1,000 or more accounts; and
      (B) the fund does not limit beneficial interests in the fund principally to trust accounts of restricted persons;
      (3) An insurance company general, separate or investment account, provided that:
      (A) the account is funded by premiums from 1,000 or more policyholders, or, if a general account, the insurance company has 1,000 or more policyholders; and
      (B) the insurance company does not limit the policyholders whose premiums are used to fund the account principally to restricted persons, or, if a general account, the insurance company does not limit its policyholders principally to restricted persons;
      (4) An account if the beneficial interests of restricted persons do not exceed in the aggregate 10% of such account;
      (5) A publicly traded entity (other than a broker/dealer or an affiliate of a broker/dealer where such broker/dealer is authorized to engage in the public offering of new issues either as a selling group member or underwriter) that:
      (A) is listed on a national securities exchange;
      (B) is traded on the Nasdaq National Market; or
      (C) is a foreign issuer whose securities meet the quantitative designation criteria for listing on a national securities exchange or trading on the Nasdaq National Market;
      (6) An investment company organized under the laws of a foreign jurisdiction, provided that:
      (A) the investment company is listed on a foreign exchange or authorized for sale to the public by a foreign regulatory authority; and
      (B) no person owning more than 5% of the shares of the investment company is a restricted person;
      (7) An Employee Retirement Income Security Act benefits plan that is qualified under Section 401(a) of the Internal Revenue Code, provided that such plan is not sponsored solely by a broker/dealer;
      (8) A state or municipal government benefits plan that is subject to state and/or municipal regulation;
      (9) A tax exempt charitable organization under Section 501(c)(3) of the Internal Revenue Code; or
      (10) A church plan under Section 414(e) of the Internal Revenue Code.
      (d) Issuer-Directed Securities

      The prohibitions on the purchase and sale of new issues in this rule shall not apply to securities that:
      (1) are specifically directed by the issuer to persons that are restricted under the rule; provided, however, that securities directed by an issuer may not be sold to or purchased by an account in which any restricted person specified in subparagraphs (i)(10)(B) or (i)(10)(C) of this rule has a beneficial interest, unless such person, or a member of his or her immediate family, is an employee or director of the issuer, the issuer's parent, or a subsidiary of the issuer or the issuer's parent. Also, for purposes of this paragraph (d)(1) only, a parent/subsidiary relationship is established if the parent has the right to vote 50% or more of a class of voting security of the subsidiary, or has the power to sell or direct 50% or more of a class of voting security of the subsidiary;
      (2) are part of a program sponsored by the issuer or an affiliate of the issuer that meets the following criteria:
      (A) the opportunity to purchase a new issue under the program is offered to at least 10,000 participants;
      (B) every participant is offered an opportunity to purchase an equivalent number of shares, or will receive a specified number of shares under a predetermined formula applied uniformly across all participants;
      (C) if not all participants receive shares under the program, the selection of the participants eligible to purchase shares is based upon a random or other non-discretionary allocation method; and
      (D) the class of participants does not contain a disproportionate number of restricted persons as compared to the investing public generally; or
      (3) are directed to eligible purchasers who are otherwise restricted under the rule as part of a conversion offering in accordance with the standards of the governmental agency or instrumentality having authority to regulate such conversion offering.
      (e) Anti-Dilution Provisions

      The prohibitions on the purchase and sale of new issues in this rule shall not apply to an account in which a restricted person has a beneficial interest that meets the following conditions:
      (1) the account has held an equity ownership interest in the issuer, or a company that has been acquired by the issuer in the past year, for a period of one year prior to the effective date of the offering;
      (2) the sale of the new issue to the account shall not increase the account's percentage equity ownership in the issuer above the ownership level as of three months prior to the filing of the registration statement in connection with the offering;
      (3) the sale of the new issue to the account shall not include any special terms; and
      (4) the new issue purchased pursuant to this paragraph (e) shall not be sold, transferred, assigned, pledged or hypothecated for a period of three months following the effective date of the offering.
      (f) Stand-by Purchasers

      The prohibitions on the purchase and sale of new issues in this rule shall not apply to the purchase and sale of securities pursuant to a stand-by agreement that meets the following conditions:
      (1) the stand-by agreement is disclosed in the prospectus;
      (2) the stand-by agreement is the subject of a formal written agreement;
      (3) the managing underwriter(s) represents in writing that it was unable to find any other purchasers for the securities; and
      (4) the securities sold pursuant to the stand-by agreement shall not be sold, transferred, assigned, pledged or hypothecated for a period of three months following the effective date of the offering.
      (g) Under-Subscribed Offerings

      Nothing in this rule shall prohibit an underwriter, pursuant to an underwriting agreement, from placing a portion of a public offering in its investment account when it is unable to sell that portion to the public.
      (h) Exemptive Relief

      Pursuant to the Rule 9600 series, the staff, for good cause shown after taking into consideration all relevant factors, may conditionally or unconditionally exempt any person, security or transaction (or any class or classes of persons, securities or transactions) from this rule to the extent that such exemption is consistent with the purposes of the rule, the protection of investors, and the public interest.
      (i) Definitions
      (1) "Beneficial interest" means any economic interest, such as the right to share in gains or losses. The receipt of a management or performance based fee for operating a collective investment account, or other fees for acting in a fiduciary capacity, shall not be considered a beneficial interest in the account.
      (2) "Collective investment account" means any hedge fund, investment partnership, investment corporation, or any other collective investment vehicle that is engaged primarily in the purchase and/or sale of securities. A "collective investment account" does not include a "family investment vehicle" or an "investment club."
      (3) "Conversion offering" means any offering of securities made as part of a plan by which a savings and loan association, insurance company, or other organization converts from a mutual to a stock form of ownership.
      (4) "Family investment vehicle" means a legal entity that is beneficially owned solely by immediate family members.
      (5) "Immediate family member" means a person's parents, mother-in-law or father-in-law, spouse, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-law, and children, and any other individual to whom the person provides material support.
      (6) "Investment club" means a group of friends, neighbors, business associates, or others that pool their money to invest in stock or other securities and are collectively responsible for making investment decisions.
      (7) "Limited business broker/dealer" means any broker/dealer whose authorization to engage in the securities business is limited solely to the purchase and sale of investment company/variable contracts securities and direct participation program securities.
      (8) "Material support" means directly or indirectly providing more than 25% of a person's income in the prior calendar year. Members of the immediate family living in the same household are deemed to be providing each other with material support.
      (9) "New issue" means any initial public offering of an equity security as defined in Section 3(a)(11) of the Act, made pursuant to a registration statement or offering circular. New issue shall not include:
      (A) offerings made pursuant to an exemption under Section 4(1), 4(2) or 4(6) of the Securities Act of 1933, or SEC Rule 504 if the securities are "restricted securities" under SEC Rule 144(a)(3), or Rule 144A or Rule 505 or Rule 506 adopted thereunder;
      (B) offerings of exempted securities as defined in Section 3(a)(12) of the Act, and rules promulgated thereunder;
      (C) offerings of securities of a commodity pool operated by a commodity pool operator as defined under Section 1a(5) of the Commodity Exchange Act;
      (D) rights offerings, exchange offers, or offerings made pursuant to a merger or acquisition;
      (E) offerings of investment grade asset-backed securities;
      (F) offerings of convertible securities;
      (G) offerings of preferred securities;
      (H) offerings of an investment company registered under the Investment Company Act of 1940; and
      (I) offerings of securities (in ordinary share form or ADRs registered on Form F-6) that have a pre-existing market outside of the United States. (10) "Restricted person" means:
      (A) Members or other broker/dealers;
      (B) Broker/Dealer Personnel
      (i) Any officer, director, general partner, associated person, or employee of a member or any other broker/dealer (other than a limited business broker/dealer);
      (ii) Any agent of a member or any other broker/dealer (other than a limited business broker/dealer) that is engaged in the investment banking or securities business; or
      (iii) An immediate family member of a person specified in subparagraph (B)(i) or (ii) if the person specified in subparagraph (B)(i) or (ii):
      a. materially supports, or receives material support from, the immediate family member;
      b. is employed by or associated with the member, or an affiliate of the member, selling the new issue to the immediate family member; or
      c. has an ability to control the allocation of the new issue.
      (C) Finders and Fiduciaries
      (i) With respect to the security being offered, a finder or any person acting in a fiduciary capacity to the managing underwriter, including, but not limited to, attorneys, accountants and financial consultants; and
      (ii) An immediate family member of a person specified in subparagraph (C)(i) if the person specified in subparagraph (C)(i) materially supports, or receives material support from, the immediate family member.
      (D) Portfolio Managers
      (i) Any person who has authority to buy or sell securities for a bank, savings and loan institution, insurance company, investment company, investment advisor, or collective investment account.
      (ii) An immediate family member of a person specified in subparagraph (D)(i) that materially supports, or receives material support from, such person.
      (E) Persons Owning a Broker/Dealer
      (i) Any person listed, or required to be listed, in Schedule A of a Form BD (other than with respect to a limited business broker/dealer), except persons identified by an ownership code of less than 10%;
      (ii) Any person listed, or required to be listed, in Schedule B of a Form BD (other than with respect to a limited business broker/dealer), except persons whose listing on Schedule B relates to an ownership interest in a person listed on Schedule A identified by an ownership code of less than 10%;
      (iii) Any person listed, or required to be listed, in Schedule C of a Form BD that meets the criteria of subparagraphs (E)(i) and (E)(ii) above;
      (iv) Any person that directly or indirectly owns 10% or more of a public reporting company listed, or required to be listed, in Schedule A of a Form BD (other than a reporting company that is listed on a national securities exchange or is traded on the Nasdaq National Market, or other than with respect to a limited business broker/dealer);
      (v) Any person that directly or indirectly owns 25% or more of a public reporting company listed, or required to be listed, in Schedule B of a Form BD (other than a reporting company that is listed on a national securities exchange or is traded on the Nasdaq National Market, or other than with respect to a limited business broker/dealer).
      (vi) An immediate family member of a person specified in subparagraphs (E)(i)-(v) unless the person owning the broker/dealer:
      a. does not materially support, or receive material support from, the immediate family member;
      b. is not an owner of the member, or an affiliate of the member, selling the new issue to the immediate family member; and
      c. has no ability to control the allocation of the new issue.

      3040. Private Securities Transactions of an Associated Person

      (a) through (d) No Change.
      (e) Definitions

      For purposes of this Rule, the following terms shall have the stated meanings:
      (1) "Private securities transaction" shall mean any securities transaction outside the regular course or scope of an associated person's employment with a member, including, though not limited to, new offerings of securities which are not registered with the Commission, provided however that transactions subject to the notification requirements of Rule 3050, transactions among immediate family members (as defined in Rule 2790 [IM-2110-1, Free-Riding and Withholding]), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities, shall be excluded.

      9600. PROCEDURES FOR EXEMPTIONS

      9610. Application

      (a) Where to File

      A member seeking an exemption from Rule 1021, 1022, 1070, 2210, 2320, 2340, 2520, 2710, 2720, 2790, 2810, 2850, 2851, 2860, Interpretive Material 2860-1, 3010(b)(2), 3210, 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.

    • 03-78 2004 Trade Date — Settlement Date Schedule (Note: The Regulation T date for "regular way" transactions made on December 27, 2004, has been corrected to January 3, 2005 (from January 4, 2005))

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      INFORMATIONAL

      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

      Martin Luther King, Jr., Day:

      Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market® and the securities exchanges will be closed on Monday, January 19, 2004, 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 Regulation T Date*
      January 13 January 16 January 21
      14 20 22
      15 21 23
      16 22 26
      19 Markets Closed
      20 23 27

      Presidents' Day

      Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market and the securities exchanges will be closed on Monday, February 16, 2004, 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 Regulation T Date*
      February 10 February 13 February 18
      11 17 19
      12 18 20
      13 19 23
      16 Markets Closed
      17 20 24

      Good Friday

      Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market and the securities exchanges will be closed on Good Friday, April 9, 2004. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Regulation T Date*
      April 5 April 8 April 13
      6 12 14
      7 13 15
      8 14 16
      9 Markets Closed
      12 15 19

      Memorial Day

      Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market and the securities exchanges will be closed on Monday, May 31, 2004, 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 Regulation T Date*
      May 25 May 28 June 2
      26 June 1 3
      27 2 4
      28 3 7
      31 Markets Closed
      June 1 4 8

      Independence Day

      Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market and the securities exchanges will be closed on Monday, July 5, 2004, 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 Regulation T Date*
      June 29 July 2 July 7
      30 6 8
      July 1 7 9
      2 8 12
      5 Markets Closed
      6 9 13

      Note: October 11, 2004, is considered a business day for receiving customers' payments under Regulation T of the Federal Reserve Board. Transactions made on Monday, October 11, will be combined with transactions made on the previous business day, October 8, for settlement on October 14. Securities will not be quoted exdividend, 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 11.

      Labor Day

      Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market and the securities exchanges will be closed on Monday, September 6, 2004, 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 Regulation T Date*
      August 31 September 3 September 8
      Sept 1 7 9
      2 8 10
      3 9 13
      6 Markets Closed
      7 10 14

      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 11, 2004. 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 Regulation T Date*
      October 5 October 8 October 12
      6 12 13
      7 13 14
      8 14 15
      11 14 18
      12 15 19

      Note: November 11, 2004, 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 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 November 11.

      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, Thursday, November 11, 2004, and Thanksgiving Day, Thursday, November 25, 2004. On Thursday, 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 25, 2004, in observance of Thanksgiving Day.

      Trade Date Settlement Date Regulation T Date*
      November 5 November 10 November 12
      8 12 15
      9 15 16
      10 16 17
      11 16 18
      12 17 19
      19 24 29
      22 26 30
      23 29 December 1
      24 30 2
      25 Markets Closed
      26 December 1 3

      Christmas Day

      Trade Date-Settlement Date Schedule

      The Nasdaq Stock Market and the securities exchanges will be closed on Friday, December 24, 2004, in observance of Christmas Day. "Regular way" transactions made on the business days noted below will be subject to the following schedule:

      Trade Date Settlement Date Regulation T Date*
      December 20 December 23 December 28
      21 27 29
      22 28 30
      23 29 31
      24 Markets Closed
      27 30 January 3, 2005

      Brokers, dealers, and municipal securities dealers should use the foregoing settlement dates for purposes of clearing and settling transactions pursuant to the National Association of Securities Dealers, Inc. (NASD®) Uniform Practice Code and the Municipal Securities Rulemaking Board Rule (MSRB) 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 "Regulation T Date."

    • 03-77 NASD Requests Comment on Proposed Amendments to Rules 2210 (Communications With the Public) and 2211 (Institutional Sales Material)

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      REQUEST FOR COMMENT

      Disclosure of Mutual Fund Expense Ratios in Performance Advertising

      Comment Period Expires: January 23, 2004

      SUGGESTED ROUTING

      KEY TOPICS

      Advertising/Investment Companies
      Executive Representatives
      Legal & Compliance
      Mutual Fund
      Senior Management

      Advertising
      Mutual Fund Expenses
      Investment Companies
      NASD Rules 2210 and 2211

      Executive Summary

      NASD proposes to amend Rules 2210 and 2211 to require all member communications with the public that contain investment company performance information ("performance advertising") to present specified information about the fund's expenses and performance in a prominent text box. These new requirements would improve investor awareness of the costs of buying and owning a mutual fund, facilitate comparisons among funds, and make presentation of standardized performance more prominent. NASD's proposal would require that:

      • All performance advertising contain a text box that sets forth the fund's (a) standardized performance information; (b) maximum sales charge; and (c) annual expense ratio; and


      • The text box information be presented in type size at least as large as non-standardized performance, if nonstandardized performance information is included.

      Questions/Further Information

      Questions concerning this Notice may be directed to Angela C. Goelzer, Counsel, Investment Company Regulation, Regulatory Policy and Oversight, at (202) 728-8120.

      Request for Comment

      NASD requests comment on the proposed amendments to Rules 2210 and 2211 described in this Notice. Members wishing to comment must make a submission that is received by January 23, 2004. Members and interested persons can submit their comments using the following methods:

      • Mailing in written comments;


      • E-mailing written comments to pubcom@nasd.com; or


      • Submitting comments online at 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, D.C. 20006-1500

      Important Notes:

      The only comments that will be considered are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the NASD Web Site. Generally, comments will be posted on the NASD Web Site one week after the end of the comment period. See Notice to Members 03-73.

      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.

      Background

      The content of performance advertising is governed primarily by SEC and NASD rules.1 NASD Rules 2210 and 2211 set forth NASD standards, and Rule 482 under the Securities Act of 1933 and Rule 34b-1 under the Investment Company Act of 1940 set forth SEC requirements. These rules help to ensure that these communications are fair, balanced, and not misleading.

      1. NASD Rules 2210 and 2211

      Rule 2210 governs communications with the public, including performance advertising. Rule 2210(d) provides that all member communications with the public must be based on principles of fair dealing and good faith, and should provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service. The rule further provides that "no member may omit any material fact or qualification" if the communication would cause the material to be misleading. In addition, Rule 2210(e) requires that members' public communications comply with all applicable rules of the SEC.

      NASD applies the standards of Rule 2210 and applicable SEC rules through the filing requirements and review procedures of Rule 2210(c). Generally, all advertisements and sales literature concerning registered investment companies must be filed with NASD within ten days of first use or publication.2 NASD staff reviews each piece to ensure that it is consistent with applicable SEC and NASD rules.

      NASD has not interpreted Rule 2210 to require performance advertising to include a fund's expense ratio. In addition, NASD does not have specific rules about how standardized performance information must be presented in all performance advertising.

      Rule 2211 governs institutional sales material and correspondence. Rule 2211 was adopted to create a separate rule for these communications and to present the requirements that apply to these communications in a more easily understandable format.3 Rule 2211(d)(1) provides that all institutional sales material and correspondence are subject to the content standards of Rule 2210(d)(1) and the applicable Interpretive Materials under Rule 2210.
      2. SEC Rules 482 and 34b-1

      Rule 482 and Rule 34b-1 permit an investment company to include performance information in sales material. If performance information is included, the SEC requires disclosure of the fund's maximum sales charges and its average annual total return for the most recent 1, 5, and 10-year periods, as of the most recent calendar quarter. The total return must be calculated according to standards set forth by the SEC, taking into account sales charges and expenses. These returns are generally referred to as standardized performance. These rules also require that the standardized performance figures be presented at least as prominently as any non-standardized performance information included in the sales material.

      On September 24, 2003, the SEC adopted amendments to Rule 482 and 34b-1 to require mutual fund sales material to convey balanced information to investors, particularly with regard to past performance. The amendments require a fund that advertises performance to make available, by toll-free telephone or Web site, standardized performance returns that are current to the most recent month-end. The amendments also require that performance advertisements include a legend alerting investors that past performance does not guarantee future results, and that current performance may be higher or lower than the performance quoted. These advertisements also must now highlight the availability of information in the prospectus about a fund's objectives, risks, and expenses. The amendments do not specifically address the manner in which standardized performance information must be presented or require the inclusion of a fund's expense ratio in performance advertising.

      The Proposal

      Congress, regulators, and investors increasingly have expressed concerns over the need for improved disclosure of fund expenses. These concerns are fueled in part by the increased prominence of mutual funds as an investment vehicle for millions of middleclass American investors. Approximately 95 million shareholders in 54.2 million U.S. households own mutual funds, figures that represent about half of all American households.4

      The focus on fund fees is important because fees can have a dramatic impact on an investor's return. With these considerations in mind, NASD proposes two improvements to performance advertising regulation. First, NASD proposes to require disclosure of a fund's annual expense ratio in performance advertising. Second, NASD proposes to provide more specific standards to ensure that standardized performance information is presented with sufficient prominence and clarity.

      By amending Rule 2210 to require the inclusion of a fund's expense ratio in performance advertising, NASD will help to ensure that each investor whose purchase of mutual fund shares may be influenced by performance advertising will be made aware of the fees charged to purchase and own the fund. By requiring that standardized performance information be presented prominently in a text box along with the fund's maximum sales charge and annual expense ratio, the amendments will ensure that these key items of information are presented in a manner that promotes investor awareness. They also will ensure that standardized performance information is presented at least as prominently as non-standardized performance.

      The proposal would amend Rule 2210 to require that any investment company communications with the public that include performance information permitted by Rule 482 or Rule 34b-1 also disclose:

      • The standardized information required by Rule 482 and Rule 34b-1;


      • The fund's maximum sales load; and


      • The fund's annual operating expenses.

      The rules would require that this information be presented in a prominent text box in a type size at least as large as that used to present non-standardized performance information. NASD recognizes that standardized mutual fund performance information already reflects the fund's sales load and expenses. Indeed, the disclosure required by this proposal would state this fact. NASD believes that, just as presentation of the maximum sales load informs customers about one-time charges that they may incur if they purchase the fund, disclosure of the expense ratio would provide investors with critical information about the annual expenses that they would incur. Consequently, the proposal would require disclosure of the expense ratio as well as the maximum sales load, separate and apart from the disclosure of standardized performance.

      Finally, the rules would provide that, in the case of materials delivered through an electronic medium, the new disclosure requirements may be satisfied by presenting the information required in a manner that is intended to draw investor attention to the disclosures. In the case of radio, television, or video performance advertising, the information required must be given prominence equal to that given to nonstandardized performance information, if applicable.

      NASD also is proposing an amendment to Rule 2211(d)(1) to reflect that institutional sales material and correspondence also would be subject to these proposed content standards in new Rule 2210(d)(3).

      NASD also seeks comment on possible alternatives to the disclosure proposed in this Notice to Members. Should the proposal be expanded to require disclosure of other types of information? Instead of disclosure of a fund's expense ratio, should NASD require disclosure of the actual dollar amount of expenses incurred by a hypothetical shareholder in the fund (e.g., dollar amount of expenses per a $10,000 investment)?

      NASD also seeks comment on whether the requirements in the proposal should be extended to certain types of investment company sales material that does not present performance information. For example, in December 1998, NASD notified members that advertisements and sales material that refer to a fund as "no-load" or part of a "noload" family of funds must disclose the fact that other fees and expenses apply to an investment in the fund and are described in the fund's current prospectus.5 Would investors be better served if all sales material that refers to a fund as "no-load" were required to disclose the fund's annual expense ratio?


      1 Performance advertising also is subject to the antifraud provisions of the federal securities laws.

      2 Rule 2210(c)(1). Rule 2210(c)(2) requires that such materials be filed at least ten days prior to first use if they include performance rankings or performance comparisons of the fund with other investment companies if the ranking or comparison category is not generally published or is the creation of the fund or a fund affiliate.

      3 Rule 2211, effective November 3, 2003, was adopted as part of NASD's modernization of its advertising rules earlier this year. See Notice to Members 03-38.

      4 See 2003 Mutual Fund Fact Book, Investment Company Institute. In contrast, only 6 percent of U.S. households owned funds in 1980.

      5 Notice to Members 98-107.


      Attachment A

      TEXT OF PROPOSED AMENDMENTS

      Rule 2210 is amended by adding the following new language at the end of paragraph (d):

      (d)(3) Standards Applicable to Investment Company Communications with the Public
      (A) Communications with the public that include investment company performance data as permitted by Rule 482 under the Securities Act of 1933 and Rule 34b-1 under the Investment Company Act of 1940 must disclose:
      (i) the standardized performance information mandated by Rule 482 and Rule 34b-1;
      (ii) the maximum sales charge imposed on purchases or the maximum contingent deferred sales charge, computed in accordance with Item 3 of Form N-1A under the Investment Company Act of 1940 ("Item 3"); and
      (iii) annual fund operating expenses, computed as a percentage of total net assets in accordance with Item 3, as of the most recent calendar quarter.
      (B) The information described in subparagraph (A) must be set forth in:
      (i) a prominent text box that contains only the information required by paragraph (A); and
      (ii) a type size at least as large as that used to present any non-standardized performance.
      (C) In a communication delivered through an electronic medium, the requirements of subparagraph (B) may be satisfied by presenting the information in a manner that is intended to draw investor attention to it. In a radio, television or video advertisement, the information must be given emphasis equal to that given to any non-standardized performance information.

      Rule 2211(d)(1) is amended as follows (new text is underlined):

      (1) All institutional sales material and correspondence are subject to the content standards of Rule 2210(d)(1) and (d)(3) and the applicable Interpretive Materials under Rule 2210.

      Attachment B

      Sample Disclosure

      "[performance numbers.] These performance numbers reflect the deduction of the fund's maximum [front-end/back-end] sales charge and annual expenses. The fund's current maximum [front-end/back-end] sales charge is __% and the fund's current annual expenses are __% of the fund's net assets.

    • 03-76 Access to Information Available Under Interpretive Material 8310-2

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      REQUEST FOR COMMENT

      NASD Seeks Comment on Enhanced Access to NASD BrokerCheck (Formerly Known as NASD's Public Disclosure Program)

      Comment Period Expires: January 9, 2004

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Registered Representatives
      Legal & Compliance
      Senior Management

      Central Registration Depository
      NASD BrokerCheck/Public Disclosure Program
      IM-8310-2

      Executive Summary

      Interpretive Material 8310-2 (IM-8310-2) governs the release of disciplinary and other information to the public through NASD BrokerCheck. In July 2002, NASD initiated a comprehensive review of the information that it makes public, including the information released under IM-8310-2. In November 2002, NASD requested comment on its public information review initiative in Notice to Members 02-74. Based on NASD's review and member, investor, and other comments, the NASD Board of Governors (NASD Board), at its July 31, 2003 meeting, authorized proposed changes to IM-8310-2 that would broaden the scope of administrative and disclosure information NASD releases to the public. These proposed changes adopt a principled and consistent approach to disclosure and reflect NASD's commitment to strike a fair balance between investor protection and the legitimate privacy interests of brokers. NASD has submitted a rule filing with the Securities and Exchange Commission (SEC) seeking approval of the proposed changes.

      In connection with the proposed changes to IM-8310-2, and the overall objectives of the public information review that led to these changes, NASD is seeking comment on proposed enhancements to the existing approach for the electronic delivery of written reports (e-mail) used by the NASD BrokerCheck Program. These enhancements, which include a link to a secure written report, are intended to address investor needs and enhance the security and integrity of the program.

      Action Requested

      NASD encourages all interested parties to comment on the proposal. Comments must be received by January 9, 2004. Members and interested persons can submit their comments using the following methods:

      • mailing in written comments


      • e-mailing written comments to pubcom@nasd.com


      • submitting comments online at 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 Notes:

      The only comments that will be considered are those submitted pursuant to the methods described above. All comments received in response to this Notice will be made available to the public on the NASD Web Site. Generally, comments will be posted on the NASD Web Site one week after the end of the comment period. See Notice to Members 03-73.

      Before becoming effective, any rule change developed as a result of comments received must be adopted by the Regulatory Services and Operations Committee of the NASD Board, may be reviewed by the NASD Board, and must be approved by the SEC following public comment.

      Questions/Further Information

      Questions concerning this Notice may be directed to Ann E. Bushey, Director, Registration and Disclosure, at (240) 386-4724; Richard E. Pullano, Associate Vice President/Chief Counsel, Registration and Disclosure, at (240) 386-4821; or Patricia M. Albrecht, Assistant General Counsel, at (202) 728-8026.

      Background

      IM-8310-2 governs the release of disciplinary and other information to the public through, among other means, NASD BrokerCheck. The BrokerCheck program processes over two million inquiries a year and provides investors with an unparalleled ability to obtain information essential to making an informed choice on whether to do business with a securities firm or an individual broker. Investors may request information either by accessing a toll-free telephone number (800-289-9999) or by visiting NASD's Web Site (www.nasd.com). As the program has grown, investors and other users have shown a marked preference for requesting and receiving information from the program electronically. Notwithstanding the toll-free number, NASD receives over 98 percent of program inquiries online, and the vast majority of investors and other requesters prefer to receive written NASD BrokerCheck reports electronically. In addition to this preference for electronic access and report distribution, investors want to receive more complete information from the program. They have consistently expressed a need for material that explains what the information they receive means and its importance to their decision whether to do business with a securities firm or an individual broker.

      In July 2002, NASD initiated a comprehensive review of, among other things, the information that it makes public through IM-8310-2(a). In November 2002, NASD requested comment on the public information review initiative in Notice to Members 02-74. Based on NASD's review and member, investor, and other comments, the NASD Board, at its July 31, 2003 meeting, authorized proposed changes to IM-8310-2 that would change the scope of administrative and disclosure information NASD releases through its public disclosure program. These proposed changes adopt a principled and consistent approach to disclosure and reflect NASD's commitment to strike a fair balance between investor protection and the legitimate privacy interests of brokers. NASD has submitted a rule filing with the SEC seeking approval of the proposed changes.1

      In connection with the proposed changes to IM-8310-2, and the overall objectives of the public information review that led to these changes, NASD is seeking comment from members and other interested parties regarding proposed enhancements to the existing approach for the electronic delivery of written reports (e-mail) generated by NASD BrokerCheck.

      Comment Requested on Enhanced Electronic Distribution of Written Reports

      In addition to expanding the scope of the information that may be disclosed through NASD BrokerCheck, NASD is considering enhancing the way in which investors or other requesters may obtain this information and is seeking comment on these proposed enhancements. Currently, NASD makes written reports available by U.S. Mail in printed (hard copy) form and by e-mail in an electronic format upon receipt of a request via email or the established toll-free number.2 These written reports provide administrative and disclosure information on NASD-registered firms and persons (as well as firms and persons whose NASD registrations were terminated within the last two years) and are principally intended to assist investors who may be interested in doing business with a firm or broker.

      NASD is proposing to enhance e-mail delivery of written reports by replacing the report attachment currently sent by e-mail with a unique access code and a link to a secure written report server, which NASD would send by e-mail. Individuals could access this server only with the requisite access code, and such access would be limited to the specific written report requested. Under the proposed approach, a person requesting a written report on a firm or broker in electronic format would provide his or her e-mail address. In response, NASD would send an e-mail to the individual providing a unique access code and a link to a secure written report server. The investor or other requester would use the access code and link to access the report on the requested firm or broker. The secure server would be accessible only to individuals who received the link (i.e., the URL address) and access code from NASD. NASD plans to implement security features and access controls to minimize the risk of unauthorized use of the secure written report server and of individual written reports. Once granted access to the requested written report, investors or other requesters would be able to view the written report electronically and print the report at their discretion. Investors also would be able to view investor education materials that would aid them in understanding the written report. NASD would continue to accept requests for reports via the toll-free number and provide hard-copy reports to those requesters.

      NASD believes that this proposed method of distribution is an improvement over the current distribution process. Users of the current program strongly prefer receiving written reports in an electronic format.3 However, a number of practical issues have arisen regarding e-mail delivery. For example, many Internet service providers limit the size of attachments that can be received by an individual via e-mail. Accordingly, NASD sends any written report that exceeds one megabyte (including, for example, reports on the largest NASD-registered broker/dealers) in hard copy via U.S. Mail. This is an inconvenience for investors who are expecting a written report via e-mail, rather than a hard-copy report.

      Also, investors often have requested additional information from NASD to explain the meaning of the information provided through the program. Adding this explanatory material would increase the overall size of the e-mail and would result in an even greater number of reports exceeding the one-megabyte threshold. In addition, e-mail distribution of explanatory material would require inclusion of all relevant explanatory material in every e-mail because there is no practical way to know in advance the specific needs or questions of each investor. The proposed delivery system would give NASD the flexibility to more easily provide contextual and other investor education material as part of the program.

      NASD believes that these enhancements will make NASD BrokerCheck easier to use and make the information provided through the program easier to understand by investors and other users by, among other things, providing investors with ready access to investor education materials that will provide context and address specific questions they may have about the information provided to them through the program. These changes also will provide investors and other requesters with electronic format written reports that are more readily accessible and more secure.

      Proposed Action

      NASD proposes enhancing the e-mail delivery of written reports by replacing the report attachment currently sent by e-mail with a unique access code and a link to a secure written report server. Only individuals with the requisite access code would be granted access to this server, and access would be limited to the specific written report requested. Once granted access to the requested written report, requesters would be able to view the written report electronically and print the report at their discretion. Requesters also would be able to view investor education materials that would aid them in understanding the written report.

      Request For Comment

      NASD requests comment on the following questions:

      (1) Should NASD implement an enhanced electronic delivery method for NASD BrokerCheck program reports that would replace the current e-mail system?
      (2) What alternative technical solutions, if any, can you suggest for NASD to consider that will achieve the objectives of the program?
      (3) How long should an authorization code remain valid? Should access to the report be unlimited during the time the authorization code is valid (or should access also be limited to a certain number of viewings of the report)?
      (4) What additional protections, if any, can you suggest for NASD to consider that might prevent misuse of the proposed system? For example, should NASD add a message to all outgoing reports requesting recipients to notify NASD if they did not request the report?

      1 File No. SR-NASD-2003-168. NASD will alert members when the SEC publishes the rule filing and remind them of their opportunity to comment.

      2 NASD voluntarily initiated the disclosure program as an investor protection service in 1988. In an endorsement of the program, Congress added Section 15A(i) to the Securities Exchange Act of 1934, which mandated that NASD implement a toll-free telephone number to receive inquiries regarding disciplinary actions involving its members and associated persons and promptly respond to such inquiries in writing.

      3 For example, in 2002, 93 percent of requesters elected to receive written reports in an electronic format, while only 7 percent elected to receive hard-copy reports via U.S. Mail.

    • 03-75 NASD Notice of Meeting and Proxy (A proxy package was sent to each NASD Executive Representative on December 2)

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      INFORMATIONAL

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives

      Board Elections

      The Annual Meeting of Members of NASD will be held on January 6, 2004, 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 December 1, 2003.

      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 four vacancies to be filled at this meeting—one Industry governorship and three Public governorships. 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 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


      Attachment A

      NASD Board of Governors Nominees

      The following four 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 January 6, 2004, to January 2007.

      Terms of Office 2004-2007

      INDUSTRY  
      William C. Alsover, Jr. Chairman, Centennial Securities Company, Inc.
      (Small Firm Representative)
      PUBLIC  
      Charles A. Bowsher2 Former Comptroller General of the U.S.
      Joel Seligman Dean, Washington University School of Law
      Sharon P. Smith Dean, College of Business Administration, Fordham University


      Attachment B

      NASD Profile of Board Nominee for Industry Governor

      William C. Alsover, Jr. is Chairman of Centennial Securities Company, Inc., a full service broker/dealer located in Grand Rapids, Michigan. Prior to joining Centennial, Mr. Alsover was with Fahnestock & Company. Mr. Alsover currently serves as Chairman of the Small Firm Advisory Board and on the Securities Advisory Committee, Office of Financial and Insurance Services, for the State of Michigan. He has served on several industry committees, including the Securities Industry Association (SIA) Investor Education and Local Firms Committees, and the New York Stock Exchange's Committee dealing with day trading and margin requirements. Mr. Alsover is the former Chairman of the SIA Local Firm Committee, and a former member of the NASD Chicago District 8 District Business Conduct Committee. He received his B.A. from Michigan State University.

      NASD Profiles of Board Nominees for Public Governors

      Charles A. Bowsher is the former Comptroller General of the United States and head of the General Accounting Office (GAO). Mr. Bowsher was appointed to his 15-year term in 1981 by President Reagan. Prior to this appointment, Mr. Bowsher was associated with Arthur Andersen & Co. for 25 years, and also served as Assistant Secretary of the Navy for Financial Management. He served as Chairman of the Public Oversight Board and currently serves on the corporate boards of American Express Bank, DeVry, Inc., the Washington Mutual Investors Fund, and S.I. International, Inc. He is a trustee of the Center for Naval Analysis, the Logistics Management Institute, the United States Navy Memorial Foundation, and the Concord Coalition, and serves on the advisory boards at several universities. He is the recipient of honorary doctorate degrees from five universities. Mr. Bowsher graduated from the University of Illinois and received an M.B.A. from the University of Chicago after serving two years in the U.S. Army.

      Joel Seligman is the Dean and Ethan A.H. Shepley University Professor at the Washington University School of Law. Before beginning his tenure as Dean in 1999, Mr. Seligman served as the Dean of the University of Arizona College of Law. He has also previously served on the law faculty of the universities of Michigan, George Washington and Northeastern. Since beginning as Dean at Washington University School of Law in 1999, Mr. Seligman served as Reporter for the National Conference of Commissioners on Uniform State Law, was Chair of the Securities and Exchange Commission Advisory Committee on Market Information; and has served as a member of the American Institute of Certified Public Accountants Professional Ethics Executive Committee. He is the author or co-author of 20 books and over 35 articles on legal issues related to securities and corporations. He is the co-author of Fundamentals of Securities Regulation and the casebook, Securities Regulation, which he co- wrote with John Coffee. His book, The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modern Corporate Finance, is widely regarded as the leading history of the Commission. He received his bachelor's degree magna cum laude from the University of California Los Angeles and his law degree cum laude from Harvard University School of Law.

      Sharon P. Smith is the Dean of the Schools of Business and of the Business Faculty at Fordham University, where she is also a Professor of Management Systems. Ms. Smith joined Fordham University in 1990 after serving as a Visiting Senior Research Economist at Princeton University from 1988 to 1990. Prior to this, she worked at American Telephone & Telegraph Co. for six years as a District Manager in various capacities, such as Corporate Strategy and Development, Labor Relations, and Economic Analysis Section. Before joining AT&T, she was a Senior Economist at the Federal Reserve Bank of New York. Ms. Smith currently serves as a public member of the Security Traders Association (STA) Board, the STA Foundation Advisory Council, as well as a variety of other professional organizations and associations. She holds a Ph.D. in Economics from Rutgers University.


      Attachment C

      Current Board of Governors

      Governors with Terms Expiring in January 2004

      INDUSTRY  
      William C. Alsover, Jr. Chairman, Centennial Securities Company, Inc. (Small Firm Representative)
      Douglas L. Kelly3 A.G. Edwards & Sons, Inc. (Chair of the National Adjudicatory Council)
      Richard C. Romano* Chairman, Romano Brothers & Co.
      Hardwick Simmons* Retired Chairman and CEO, The Nasdaq Stock Market, Inc.
      NON-INDUSTRY  
      H. Furlong Baldwin* Chairman (retired), Mercantile Bankshares Corporation
      Arvind Sodhani* Vice President and Treasurer, Intel Corporation
      PUBLIC  
      Brian T. Borders Borders Law Group
      Charles A. Bowsher Former Comptroller General of the U.S.
      Sharon P. Smith Dean, College of Business Administration, Fordham University

      * Not eligible for re-election

      Governors with Terms Expiring in January 2005

      INDUSTRY  
      John W. Bachmann Managing Partner, Edward D. Jones & Company
      Richard F. Brueckner Chief Executive Officer, Pershing LLC (Representative of a Clearing Firm)
      Raymond A. Mason Chairman and CEO, Legg Mason, Inc. (Representative of a Regional Retail Firm)
      NON-INDUSTRY  
      Harry P. Kamen* Retired Chairman and Chief Executive Officer, Metropolitan Life Insurance Company (Representative of an Insurance Company)
      PUBLIC  
      James E. Burton Chief Executive Officer, World Gold Council
      Sir Brian Corby Chairman (retired), Prudential Assurance Company
      John Rutherfurd, Jr. President and CEO, Moody's Corporation

      * Not eligible for re-election

      Governors with Terms Expiring in January 2006

      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 (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.

      * Not eligible for re-election


      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.

      2 Appointed in July 2003 to fill a vacancy on the Board.

      3 The Chair of the National Adjudicatory Council serves a one-year term on the NASD Board.

    • 03-74 Guidance Relating to the Application of NASD's Limit Order Protection Rule When Trading Proprietarily Through a Separate MPID

      View PDF File

      INFORMATIONAL

      Limit Order Protection

      SUGGESTED ROUTING

      KEY TOPICS

      Internal Audit
      Legal & Compliance
      Operations
      Senior Management
      Trading And Market Making

      Limit Order Protection
      Market Making
      Multiple MPIDs

      Executive Summary

      Recently The Nasdaq Stock Market, Inc. (NASDAQ) began permitting market makers and ECNs to request the use of a second Market Participant Identifier (MPID) in the NASDAQ quotation montage for the entry of quotes and orders and the display of quotations. Because members now may enter and display quotes and orders from other desks in a separate MPID, members have sought clarification concerning the applicability of previous guidance relating to Interpretive Material 2110-2, Trading Ahead of Customer Limit Order (commonly referred to as the "Manning Rule") provided in Special Notice to Members (NtM) 95-43 (June 5, 1995). Specifically, NtM 95-43 provided a "no knowledge" interpretation to the Manning Rule such that, if a firm implements and utilizes an effective system of internal controls, such as appropriate information barriers, that operate to prevent a non-market-making desk from obtaining knowledge of customer limit orders held at the firm's market-making desk, those other desks trading in a proprietary capacity may continue to trade at prices the same as or inferior to the customer limit orders held by the market-making desk. As described in more detail in this Notice, members using multiple MPIDs may continue to rely on the "no knowledge" interpretation to Manning contained in NtM 95-43 if they have established appropriate and effective information barriers between market-making desks and other trading desks exclusively engaged in proprietary trading.

      Questions/Further Information

      Questions regarding this Notice may be directed to the Legal Section, Market Regulation, NASD, at (240) 386-5126; or the Office of General Counsel, Regulatory Policy and Oversight, NASD, at (202) 728-8071.

      Background

      The Manning Rule generally prohibits market makers from trading for their own account at prices that would satisfy a customer's limit order in NASDAQ and listed securities, unless the market maker immediately thereafter executes the customer limit order.1 The legal underpinnings for the Manning Rule are the members' basic fiduciary obligations and the requirement that they must, in the conduct of their business, "observe high standards of commercial honor and just and equitable principles of trade."2 The Manning Rule codified an NASD disciplinary decision, which was affirmed by the SEC, that it was inconsistent with the member's fiduciary duty to compete with the customer with respect to the subject matter of their relationship: the execution of the customer's order. While the rule is written specifically to cover trading by market makers in their market-making capacity, NASD's long-held position is that a member's best-execution duty imposes the Manning obligation on all members, whether or not they are trading in a market-making capacity.3 Based on this interpretation, members sought guidance as to how Manning should be applied to a firm that has a marketmaking desk and several other non-market-making desks (e.g., an arbitrage desk) that trade NASDAQ securities exclusively on a proprietary basis.

      At issue was the question of whether proprietary transactions by these other desks would "trigger" the Manning obligation and require the firm to fill the customer limit orders held by the market-making desk. NtM 95-43 stated that it would be inconsistent with a member's best execution obligation for these other desks knowingly to trade ahead of a customer's limit order. However, NASD clarified its position on this issue in NtM 95-43 by establishing a "no knowledge" interpretation relating to whether trades by non-market-making desks trigger Manning. Specifically, the Notice stated that "[a]s long as a firm implements and utilizes an effective system of internal controls, such as appropriate 'Chinese walls,' that operate to prevent the non-market-making desk from obtaining knowledge of customers' limit orders, those other desks may continue to trade at prices the same as or inferior to the customers' limit orders."4

      Recently, members have sought clarification concerning the applicability of the Manning Rule and NtM 95-43's "no knowledge" interpretation in the context of using an additional unattributable MPID (hidden behind the SIZE MPID) or an additional displayed MPID (displayed in the quotation montage) to represent proprietary trading interest from a non-market-making desk. Specifically, members have inquired whether proprietary trades executed by a non-market-making desk through the use of such unattributable or attributable additional MPIDs would result in a Manning obligation to customer limit orders held by the market-making desk.

      In response, NASD staff is clarifying that, as stated in NtM 95-43, if the firm implements and utilizes an effective system of internal controls, such as appropriate information barriers, that operate to prevent non-market-making desks engaged exclusively in proprietary trading from obtaining knowledge of customer limit orders held at the market-making desk, those other proprietary non-market-making desks may continue to trade in a principal capacity at prices the same as or inferior to the customer limit orders held at the market-making desk. An effective system of internal controls must include specific policies and procedures that prevent each of the desks separated by information barriers from obtaining knowledge regarding orders or trading activity of the other desks. For example, if a trader or other person associated with a marketmaking desk, having observed the quotation activity of an affiliated non-marketmaking desk via a second MPID, attempted to contact that desk to obtain any information about the non-market-making desk's past, current, or future trading plans, such conduct would be inconsistent with the establishment of an effective system of internal controls and therefore would trigger Manning obligations for the marketmaking desk based on trading activity by the non-market-making desk. Conversely, knowledge of a quotation displayed by another proprietary desk using a separate MPID or a presumption based on publicly available information that the other proprietary desk may have executed a trade (e.g., a transaction accompanied by a quote decrementation), would not, in and of itself, trigger Manning obligations, if an effective system of internal controls between these desks had been established.

      Members are reminded that NASD will continue to examine and review members using information barriers for compliance with this and other applicable information barrier standards. In addition, NASD Rule 3010 requires that members establish and maintain a supervisory system that is designed to ensure compliance with the NASD rules. Accordingly, NASD will examine closely members' supervisory systems and written supervisory procedures and, where appropriate, initiate disciplinary action against firms and their supervisory personnel for failure to adopt, implement, and enforce appropriate supervisory procedures. NASD also will impose significant sanctions if it finds that members have intentionally compromised their information barriers to the detriment of customer orders.


      1 For example, if the market maker bought 100 shares at $10 when holding customer limit orders to buy at $10 equaling, in aggregate, 1000 shares, the market maker is required to fill 100 shares of the customer limit orders.

      2 See NASD Rule 2110.

      3 See NtM 95-43 at p. 309.

      4 Id.

    • 03-73 NASD Announces Online Availabilty of Comments

      View PDF File

      INFORMATIONAL

      Online Comments

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Registered Representative
      Senior Management

      Notices to Members
      Public Access to Comments
      Requests for Comment

      Executive Summary

      NASD today announced that it is now making available on its Web Site comments filed in response to Notices to Members that include a request for comments on rule proposals or regulatory initiatives. Posting comments online will make it easier for the public to access and review the submissions, and will improve the efficiency with which NASD maintains, reviews, and makes available the comments it receives.

      As in the past, comments may be submitted either in writing to Barbara Z. Sweeney, Senior Vice President and Corporate Secretary of NASD, or electronically to pubcom@nasd.com. On occasion, NASD may also provide commenters with an online form for this purpose.

      Questions/Further Information

      Questions regarding this Notice to Members may be directed to Barbara Z. Sweeney, Senior Vice President and Corporate Secretary, NASD, at (202) 728-8062 or Barbara.Sweeney@nasd.com.

      Discussion

      Comments received in response to a request for comments on rule proposals or regulatory initiatives via the Notice to Members process have always been available to the public to ensure that all interested parties have the opportunity to review them. In the past, comments were obtained by interested parties calling or writing NASD to request this material. Now, by posting all comments online, whether received by NASD in hard copy or electronically, the public will have easier access to review these submissions.

      Online availability of comments is consistent with the practice of the Securities and Exchange Commission (SEC) and other regulatory agencies. Like the SEC, NASD will post comments on its Web Site as submitted by the author(s). Therefore, parties should submit in their comments only information that they wish to make available publicly. Any individual or organization planning to submit comments to NASD should be aware that those comments, whether submitted electronically or via hard copy, will be made available online and in hard copy. The following notice will appear on NASD's Web Site concerning comments posted electronically: The views, expressions, findings, and opinions expressed in the comments on this Web page are solely those of the author(s) and NASD accepts no responsibility for the content of the comments.

      Background

      Before adopting a new rule that would govern the conduct of NASD member firms, NASD is required to file the proposed rule with the SEC, which then publishes the rule in the Federal Register so that the public may consider it. In general, interested persons have at least 21 days from the date of publication to register their comments. After those comments are received, the SEC may approve or disapprove the rule, or NASD may decide to change it.

      Prior to filing a rule change with the SEC, NASD generally solicits comments on the proposal from its members, investors, and the general public through a Notice to Members, which is posted on NASD's Web Site. At times, NASD also may solicit comment through a Notice to Members on alternative approaches to a particular issue, similar to the issuance of a "concept release" by the SEC. The Notice to Members describes the rule proposal or area of regulatory interest and indicates when and how comments may be submitted. Generally, members and interested parties may submit their comments via one of the following methods:

      • Mailing in written comments to Barbara Z. Sweeney, Senior Vice President and Corporate Secretary, 1735 K Street, NW, Washington, DC 20006-1500


      • E-mailing written comments to pubcom@nasd.com


      • Submitting comments online at the NASD Web Site (www.nasd.com)

      Comments received during the comment period from members, investors, and the general public are fully considered before any further action is taken by NASD.

      Procedure for Viewing Comments Online

      Interested parties will be able to access comments on NASD's Web Site by accessing the appropriate Notice to Members and through a special page that will list all Notices to Members that have requested comments. Generally, comments will be posted on the NASD Web Site one week after the end of a comment period.

      Members may continue to request a hard copy of the comments that NASD receives by sending a letter to:

      Barbara Z. Sweeney

      Senior Vice President and Corporate Secretary
      1735 K Street, NW
      Washington, DC 20006-1500

      Effective Date

      Comments will be posted online for all Notices to Members issued on or after December 1, 2003, that seek comment on a proposal.

    • 03-72 Request for Comment on Regulatory Approaches to Enhance IPO Pricing Transparency (Note: The comment period has been extended to January 23, 2004)

      View PDF File

      REQUEST FOR COMMENT

      Proposed Rule Governing Allocations and Distributions of Shares in Initial Public Offerings (IPOs)

      Comment Period Expires: January 9, 2004

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Financing
      Legal & Compliance
      Senior Management
      Trading & Market Making

      IPO Allocations
      IPO Pricing
      Rule 2710
      Rule 2712
      Underwriting Compensation

      Executive Summary

      NASD is proposing additional amendments to proposed Rule 2712— IPO Allocations and Distributions. On September 15, 2003, NASD filed with the Securities and Exchange Commission (SEC) proposed Rule 2712 to prohibit certain abuses in the allocation and distribution of shares in IPOs.1 The additional amendments would implement several recommendations of the NYSE/NASD IPO Advisory Committee (IPO Advisory Committee or Committee), which was established at the request of the SEC. On May 29, 2003, the IPO Advisory Committee issued a report with 20 recommendations for the self-regulatory organizations (SROs) and the SEC to enhance public confidence in the integrity of the IPO process.

      The proposed amendments to proposed Rule 2712 would address the following recommendations of the NYSE/NASD IPO Advisory Committee for SRO rulemaking:

      • Require the lead managing underwriter to disclose indications of interest and final allocations to the issuer's pricing committee;


      • Prohibit acceptance of market orders to purchase IPO shares in the aftermarket for one trading day following an IPO;


      • Impose procedures designed to ensure that reneged IPO allocations are not used to benefit favored clients of the underwriter;


      • Require that any lock-up that applies to shares owned by the issuer's officers and directors also applies to shares they purchase in "friends and family" programs; and


      • Impose new notification requirements when underwriters waive lock-ups.

      The Notice also requests comment on various additional regulatory steps that might be adopted to promote transparency in IPO pricing. These possible approaches, which could be adopted as alternatives, include requiring underwriters to:

      • Retain an independent broker/dealer to opine that the initial IPO price range at which the offering is marketed and the final offering price are reasonable and to require that the independent broker/dealer's opinion is disclosed in the prospectus; or


      • Use an auction or other system to collect indications of interest to help establish the final IPO price; or


      • Include a "valuation disclosure" section in the prospectus with information about how the managing underwriter and issuer arrived at the initial price range and final IPO price, such as the issuer's one-year projected earnings or P/E ratios and share price information of comparable companies.

      Action Requested

      NASD requests comment on the proposed amendments. Members wishing to comment must make a submission that is received by January 9, 2004. Members and interested persons can submit their comments using the following methods:

      • Mailing in written comments


      • E-mailing written comments to pubcom@nasd.com


      • Submitting comments online at 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 Notes: The only comments that will be considered are those submitted by e-mail or in writing.

      Before becoming effective, any rule change developed as a result of comments received must be adopted by 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 should be directed to Thomas M. Selman, Senior Vice President, Corporate Financing/Investment Companies, NASD, at (240) 386-4623; Joseph E. Price, Vice President, Corporate Financing Department, NASD, at (240) 386-4623; or Gary L. Goldsholle, Associate General Counsel, Office of General Counsel, NASD, at (202) 728-8104.

      Discussion

      On August 22, 2002, the SEC requested that NASD and the New York Stock Exchange (NYSE) convene a high-level group of business and academic leaders to review the IPO process, to recommend ways to address the problems evidenced during the hot market of the late-1990s and 2000, and to improve the underwriting process. The NYSE/NASD IPO Advisory Committee met frequently in 2002 and early 2003 and issued its final report, containing 20 recommendations, in May 2003.

      1. Rulemaking to Implement IPO Committee Proposals

      NASD published Notice to Members 02-55 in August 2002, requesting comment on proposed Rule 2712, which addressed allocation abuses. In September 2003, NASD filed with the Commission proposed Rule 2712 with modifications to the original proposal to reflect IPO Advisory Committee comments.2 The amendments proposed today would supplement proposed Rule 2712 by addressing the IPO Advisory Committee recommendations described below:
      a. Disclosure of Indications of Interest and Final Allocations

      The IPO Advisory Committee recommended that issuers establish a pricing committee to evaluate the proposed offering price, and that underwriters be required to disclose to the issuer's pricing committee all indications of interest received before the issuer finalizes the IPO price. The Committee also recommended that underwriters be required to disclose to the issuer the final allocations after the offering is priced.

      The Committee concluded that greater participation by issuers in pricing and allocation decisions would better ensure that those decisions are consistent with the fiduciary duty of directors and management, and would provide management with more information to evaluate the underwriter's performance. A requirement that issuers establish a pricing committee would necessitate a listing standard by The Nasdaq Stock Market and the NYSE.

      NASD's proposed rule would require that the book-running manager(s) disclose indications of interest to a pricing committee, or to the issuer's board of directors if the issuer has no pricing committee, and that the book-running manager(s) disclose to the issuer final allocations made by the manager(s).

      NASD requests comment on whether disclosure of other information to issuers also would be useful. For example, should issuers receive other specified information about the managing underwriters' pricing analysis or allocation decisions?
      b. Trading Restrictions

      The IPO Advisory Committee recommended a prohibition on market orders for one trading day following an IPO. The Committee concluded that, in light of the volatility of IPO issues, investors who place market orders immediately following an IPO may inadvertently purchase at prices that neither reflect their true investment decisions nor their reasonable expectations. By disallowing market orders for the first trading day following an IPO, the Committee reasoned that the market will have time to develop trading information, thereby making subsequent uncapped orders less likely to cause harm to retail investors. The proposed rule would prohibit any member from accepting a market order to purchase IPO shares during the first trading day that the IPO shares commence trading in the secondary market. Investors would remain free to place limit orders during this time period.

      The IPO Advisory Committee also offered a recommendation concerning IPO shares that are returned to the underwriter after completion of distribution. The Committee noted that currently, if an IPO's shares trade at an immediate aftermarket premium, underwriters can allocate returned shares to favored customers at the IPO price, providing what may be a risk-free investment to those customers. In order to eliminate the possibility that this practice will occur, the proposed rule would require underwriters to allot returned shares to the existing syndicate short position, then sell the remaining returned shares on the open market and return net profits to the issuer. When the market price does not rise above the offering price, the underwriter should be permitted to sell the shares for its account or retain the shares by placing them in its investment account.
      c. Limitations on "Friends and Family" Programs

      The IPO Advisory Committee offered several recommendations concerning issuerdirected allocations of IPO shares. Among those recommendations, the Committee recommended requiring that any lock-up that applies to shares owned by officers and directors include the shares purchased by those individuals in the "friends and family" program. The proposed rule would require that any lock-up or restriction on the transfer of the issuer's shares apply to issuer-directed shares held by officers and directors of the issuer.
      d. Requirements Concerning Lock-up Exemptions

      The IPO Advisory Committee concluded that investors reasonably expect that the issuer's directors, officers, and large pre-IPO shareholders who agree to "lock up" their shares will be bound by those agreements for the stated period. The Committee therefore recommended that:
      • Prior to granting any exemption to a lock-up, underwriters be required to notify the issuer and the issuer should be required to file a Form 8-K with the SEC concerning the exemption; and


      • Prior to the transaction, the lead underwriter announce the exemption through a major news service.
      The proposed rule would require an underwriter to notify the issuer prior to granting a lock-up exemption and to announce the exemption through a national news service. The requirement that issuers file a Form 8-K would require SEC rulemaking.
      e. Other IPO Committee Recommendations

      The IPO Advisory Committee offered other recommendations that will not necessitate rulemaking. In particular, the Committee recommended additional requirements for enhanced periodic internal review by underwriters of their IPO supervisory procedures and a heightened focus on the IPO process by the SROs. The Committee also recommended an educational program for new issuers and IPO investors. NASD intends to take action on these recommendations through our examinations and educational programs.
      2. Rulemaking Concerning the Pricing of Unseasoned Issuers

      Most of the IPO Advisory Committee's recommendations addressed the manner in which IPO shares are allocated, rather than the method by which they are priced. However, the IPO Advisory Committee did examine the pricing issue in two key respects:
      • First, the IPO Advisory Committee recommended that regulators review existing rules and practices in order to promote the development of alternatives to the bookbuilding process. In particular, the Committee was interested in whether regulators could take any steps to foster development of the "Dutch Auction" system of price discovery.


      • Second, the IPO Advisory Committee considered, but did not propose, a requirement that a prospectus provide an estimate of projected earnings in certain cases. Investment banks often provide projected earnings information to institutional investors, and this information is viewed as critical to the determination by institutional investors of whether IPO shares are fairly priced.
      NASD requests comment on potential regulatory initiatives that would address the issue of fair and reasonable pricing of IPOs. After analyzing the comments received, we will determine whether to propose any new rules in this area.

      Many IPO issuers in the late 1990s and 2000 had little or no revenues and subsequently experienced a dramatic run-up and decline in their stock price. Some critics have taken the position that the run-up demonstrates that these IPOs were underpriced; others have countered that the subsequent significant drop in the price of these securities, at times well below the IPO price, demonstrates that the offerings were actually overpriced. This debate suggests that some action may be appropriate to shed further light on IPO pricing.

      Three possible approaches might be to require the managing underwriter to:
      • Retain an independent broker/dealer to opine that the initial IPO price range at which the offering is marketed and the final offering price are reasonable and to require that the independent broker/dealer's opinion is disclosed in the prospectus; or


      • Use an auction or other system to collect indications of interest to help establish the final IPO price; or


      • Include a "valuation disclosure" section in the prospectus with information about how the managing underwriter and issuer arrived at the initial price range and final IPO price, such as the issuer's one-year projected earnings or P/E ratios and share price information of comparable companies.

      NASD requests comment on these potential approaches, including the relative merits of each. Commenters should be aware that these three approaches are listed as alternatives. NASD is requesting comment on these concepts both as stand-alone proposals and as alternatives. Which alternative or set of alternatives is most likely to benefit issuers and investors? What other alternatives, if any, might address the pricing issue?

      Should the reforms be adopted for the IPOs of all issuers or only for IPOs of "unseasoned" issuers? If the latter, how should seasoning be measured—for example, by three years of revenues, operating revenues, or net income? Would the reforms provide greater assurance that either unseasoned issuers are properly priced or that the methods by which their shares are valued are adequately disclosed?

      Finally, NASD asks commenters to address the additional risk placed on the issuer and underwriters by the independent pricing opinion and valuation disclosure proposals. Before requiring issuers and underwriters to assume additional liability risk by including this information in IPO prospectuses, would it be appropriate or necessary for the SEC to consider rulemaking to provide issuers and underwriters with a safe harbor from liability? Today, Rule 175 under the Securities Act of 1933 provides a safe harbor, but only for projections that have a "reasonable basis" and are "made in good faith." We have been informed that most issuers do not provide earnings projections under Rule 175 because of the litigation risk that is associated with these limitations. Section 27A of the Securities Act authorizes the SEC to provide a safe harbor that requires actual knowledge that a forward-looking statement is false before it becomes actionable. Currently, however, Section 27A does not apply to IPOs. Should the Section 27A safe harbor be expanded to IPOs if the independent pricing opinion or valuation disclosure reforms were required under NASD rules?

      Rule 2712.   Allocation and Pricing of Initial Public Offerings.

      (a) - (d) No changes from File No. SR-NASD-2003-140 (Sept. 15, 2003)
      (e) IPO Pricing

      No member may serve as the book-running lead manager of an initial public offering of equity securities ("IPO") unless the IPO meets all of the following conditions:
      (1) Underwriting Agreement. The agreement between the book-running lead manager and the issuer provides that:
      (A) the book-running lead manager will provide the issuer's pricing committee (or, if the issuer has no pricing committee, its board of directors):
      (i) a regular report of indications of interest, including the names of interested investors and the number of shares indicated by each;
      (ii) after the closing date of the IPO, a report of the final allocation of shares available to the manager, including the names of purchasers and the number of shares purchased by each;
      (B) any lock-up or other restriction on the transfer of the issuer's shares by officers and directors of the issuer will apply to their issuer-directed shares;
      (C) at least two business days before the release or waiver of any lock-up or other restriction on the transfer of the issuer's shares, the book- running lead manager will notify the issuer of the impending release or waiver and announce the impending release or waiver through a national news service;
      (2) Agreement Among Underwriters. The agreement between the book-running lead manager and other syndicate members provides that with respect to any shares returned by a purchaser to a syndicate member after secondary market trading commences:
      (A) the returned shares will be allotted to the existing short position of the syndicate;
      (B) if no short position exists, or if all existing syndicate short positions have been covered, the returned shares will be sold on a national securities exchange or Nasdaq;
      (C) in the event of any sales under paragraph (B), if the sales price exceeded the IPO price, the difference will be paid to the issuer;
      (D) if the market price is less than the IPO price, then the syndicate member may either sell the shares under paragraph (B) or retain them in its own investment account.
      (3) No member may accept a market order for the purchase of IPO shares during the first day that IPO shares commence trading on the secondary market.

      1 File No. SR-NASD-2003-140 (Sept. 15, 2003).

      2 As proposed in Notice to Members 02-55, Rule 2712 addressed "quid pro quo" allocations, "spinning," "laddering," and inequitable penalty bids. The amended proposal filed in September 2003 did not include the laddering provision, and the prohibition on spinning was modified to reflect the IPO Advisory Committee's recommendation that NASD bar IPO allocations to all executive officers and directors of a company with which a member has an investment banking relationship—not just allocations that constitute a quid pro quo for investment banking business.

    • 03-71 NASD Reminds Members of Obligations When Selling Non-Conventional Investments

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      INFORMATIONAL

      Non-Conventional Investments

      SUGGESTED ROUTING

      KEY TOPICS

      Legal/Compliance
      Retail
      Senior Management
      Internal Audit

      Advertising and Sales Literature
      Due Diligence
      Non-Conventional Investments
      Suitability

      Executive Summary

      In the aftermath of the recent downturn in the equity markets, NASD reviewed the services and products offered by members and observed that retail investors were being offered an array of different investments as alternatives to conventional equity and fixed-income investments. These alternative investments do not fall under a common category; the staff review indicates that brokers and retail investors have shown increased interest in products such as asset-backed securities, distressed debt, and derivative products (for ease of reference these products are collectively refered to as non-conventional investments or "NCIs"). NCIs often have complex terms and features that are not easily understood. NASD staff reminds members that the fact that an investment is an NCI does not in any way diminish a member's responsibility to ensure that such a product is offered and sold in a manner consistent with the member's general sales conduct obligations. This Notice to Members reminds members offering NCIs of their obligations to: (1) conduct adequate due diligence to understand the features of the product; (2) perform a reasonable-basis suitability analysis; (3) perform customer-specific suitability analysis in connection with any recommended transactions; (4) provide a balanced disclosure of both the risks and rewards associated with the particular product, especially when selling to retail investors; (5) implement appropriate internal controls; and (6) train registered persons regarding the features, risks, and suitability of these products.

      Questions/Further Information

      Questions regarding this Notice may be directed to Gary L. Goldsholle, Associate General Counsel, Regulatory Policy and Oversight, NASD, at (202) 728-8104; or Janene Marasciullo, Senior Attorney, Regulatory Policy and Oversight, NASD, at (202) 974-2978.

      Background and Discussion

      As a result of the recent downturn in the equity markets and historically low interest rates, brokers and retail investors have been turning to alternative investment vehicles in search of a better return or yield on investments. A review of members indicated that there is an increased interest in a variety of NCIs that have a wide array of terms, conditions, risks, and rewards.1 Some of these NCIs are marketed as offering greater security or a "guaranteed" return on investments. Other products seek to maximize the potential return on investments. Some of these products have unique features relating to risk and reward that may not be readily understood, especially by retail investors.

      For example, certain asset-backed securities and corporate bonds are secured by a range of collateral such as mobile homes, future royalty payments on popular music, payments from consumer credit cards or other consumer goods. The credit risks associated with these myriad forms of collateral are varied and for many noninstitutional parties may be difficult to understand and assess. Other NCIs, such as distressed corporate bonds and certain derivative contracts, may be offered to retail investors in an attempt to maximize the return on investment, but they correspondingly may involve greater degrees of risk. These products also tend to have less market liquidity, less transparency as to their pricing and value and may entail significant credit risks that are difficult to understand and assess.

      In sum, recent trends indicate that brokers and investors may be turning to NCIs in search of increased yield or return. Although these products may have attractive qualities, it is crucial that members understand the distinct features, and risks and rewards, of any product they sell. Thus, whenever members recommend NCIs to investors, they must take special care to ensure that all registered persons understand the features of the product in order to be in a position to perform the required suitability analysis before executing a transaction. Likewise, members have an obligation to ensure that all marketing materials used by the member provide an accurate and balanced description of the risks and rewards.

      NASD is issuing this Notice to Members to remind members of their sales conduct obligations.2 Given the complex nature of NCIs and the potential for customer harm or confusion, members are cautioned to ensure that their sales conduct procedures fully and accurately address any of the special circumstances presented by the sale of NCIs. Additionally, NASD is concerned that investors, particularly retail investors, may not fully understand the risks associated with these products. Accordingly, NASD reminds members that the sale of NCIs, like more traditional investments, requires them to: (1) conduct appropriate due diligence with respect to these products; (2) perform a reasonable-basis suitability analysis; (3) perform customer-specific suitability analysis for recommended transactions; (4) ensure that promotional materials used by the member are fair, accurate, and balanced; (5) implement appropriate internal controls; and (6) provide appropriate training to registered representatives that sell these products. Given the complex and, at times, difficult-to-understand nature of NCIs, members should take particular care to assure that they are fulfilling these obligations.

      Due Diligence/Reasonable-Basis Suitability

      As NASD noted most recently in Notice to Members 03-07 (pertaining to hedge fund sales to customers), performing appropriate due diligence is crucial to a member's obligation to undertake the required reasonable-basis suitability analysis.3 A reasonable-basis suitability determination is necessary to ensure that an investment is suitable for some investors (as opposed to a customer-specific suitability determination, discussed below, which is undertaken on a customer-by-customer basis). Thus, the reasonable-basis suitability analysis can only be undertaken when a member understands the investment products it sells. Accordingly, a member must perform appropriate due diligence to ensure that it understands the nature of the product, as well as the potential risks and rewards associated with the product. Moreover, the fact that a member intends to offer an NCI only to institutional investors does not relieve the member of its responsibility to conduct due diligence and a reasonable-basis suitability analysis.

      The type of due diligence investigation that is appropriate will vary from product to product. However, there are some common features that members must understand about products before registered representatives can perform the appropriate suitability analysis. These features include, but are not limited to:

      • The liquidity of the product


      • The existence of a secondary market and the prospective transparency of pricing in any secondary market transactions


      • The creditworthiness of the issuer


      • The creditworthiness and value of any underlying collateral


      • Where applicable, the creditworthiness of the counterparties


      • Principal, return, and/or interest rate risks and the factors that determine those risks


      • The tax consequences of the product


      • The costs and fees associated with purchasing and selling the product

      Members should examine these and other appropriate factors when conducting due diligence. A member may in good faith rely on representations concerning an NCI contained in a prospectus or disclosure document. However, reliance on such materials alone may not be sufficient for a member to satisfy its due diligence requirements where the content of the prospectus or disclosure document does not provide the member with sufficient information to fully evaluate the risk of the product or to educate and train its registered persons for sales purposes. In such case, the member must seek additional information about the NCI or conclude that the product is not appropriate for sale to the public. In addition, members should ensure that the persons responsible for conducting due diligence have appropriate training and skill to evaluate the terms of the investment as well as the potential risks and benefits.

      Customer-Specific Suitability

      Members and their associated persons must reasonably believe that the product is a suitable investment prior to making a recommendation to a particular customer. To ensure that a particular investment is suitable for a specific customer, members and their registered persons must examine: (1) the customer's financial status; (2) the customer's tax status; (3) the customer's investment objectives; and (4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.4

      NASD cautions members against relying too heavily upon a customer's financial status as the basis for recommending NCIs. A customer's net worth alone is not necessarily determinative of whether a particular product is suitable for that investor. Given the unique nature of NCIs, these products may present challenges when it comes to a member's duty to dispense its suitability obligation; however, the difficulty in meeting such challenges cannot be considered as a mitigating factor in determining whether members have met their suitability obligations. NCIs with particular risks may be suitable for recommendation to only a very narrow band of investors capable of evaluating and being financially able to bear those risks.

      Promotional Materials

      Sales materials and oral presentations regarding NCIs must present a fair and balanced picture regarding both the risks and benefits of investing in these products. For example, members may not claim that certain NCI products, such as asset-backed securities, distressed debt, derivative contracts, or other products, offer protection against declining markets or protection of invested capital unless these statements are fair and accurate. Moreover, when promoting the advantages of NCIs, it is critical that members balance their promotional materials with disclosures of the corresponding risks and limitations of the product discussed above in the "Due Diligence/Reasonable Basis Suitability" section of this Notice.

      Additionally, if applicable, members should provide investors with any prospectus and other disclosure material provided by the issuer or the sponsor. NASD reminds members, however, that simply providing a prospectus or offering memoranda does not cure unfair or unbalanced sales or promotional materials, whether prepared by the member, sponsor, or issuer.5

      Internal Controls

      Members must establish sufficient internal controls, including supervision and training requirements, that are reasonably designed to ensure that sales of NCIs comply with all applicable NASD and SEC rules. Members must ensure that their written procedures for supervisory and compliance personnel require that (1) the appropriate due diligence/reasonable-basis suitability is completed before products are offered for sale; (2) associated persons perform appropriate customer-specific suitability analysis; (3) all promotional materials are accurate and balanced; and (4) all NASD and SEC rules are followed. In addition to establishing written procedures, members also must document the steps they have taken to ensure adherence to these procedures.

      Training

      Members must train registered persons about the characteristics, risks, and rewards of each product before they allow registered persons to sell that product to investors. Likewise, members should train registered persons about the factors that would make such products either suitable or unsuitable for certain investors. Members' focus on training should not be limited to representatives selling such products; members also should provide appropriate training to supervisors of registered persons selling NCIs.

      For a variety of reasons, the need for adequate training is heightened when registered persons sell NCIs. First, due to the unique nature of these products, many investors, especially retail investors, may not understand the features of the product, and may not fully appreciate the associated risks of investing in them. Moreover, in light of the fact that investors may be turning to these products as an alternative to traditional equity and fixed income investments, it is crucial for registered persons to provide a full and balanced disclosure regarding both the risks and the rewards of these products.

      Educational brochures, videos, lectures, explanatory memoranda, and Web-based seminars are all appropriate ways of delivering training. The particular training methods will vary based upon the products themselves, as well as the size and customer base of the firm. NASD encourages firms that offer NCIs to offer training about these products as part of the Firm Element of their Continuing Education Program.

      Conclusion

      NCIs can be unusual and complex investment vehicles that may appear increasingly attractive to investors during periods in which traditional equity and fixed income investments come into disfavor. However, the unique and complex features of some NCIs may be difficult to understand and may obscure the risks. Accordingly, members must conduct appropriate due diligence/reasonable-basis suitability before offering any product to the public. Likewise, members must conduct a customer-specific suitability analysis prior to making any recommendations to a customer. Members also must ensure that all promotional materials are fair, accurate, and balanced. Finally, in connection with the recommendation and sale of NCIs, members must ensure that they implement appropriate supervisory internal control and appropriate training to all registered persons who sell such products to customers.


      1 Approximately 35% of the firms reviewed sold NCIs in denominations that raise the possibility of sales to retail investors. The list of NCIs being offered is broad and includes asset-backed securities, index-linked notes, non-traded REITS, equity-linked notes, multi-callable step up notes, redeemable secured notes, auction rate preferred securities, principal protected indexlinked CDs, distressed debt, derivative products, and emerging market debt securities.

      2 Members also are reminded of the application of IM-2310-2(e) (Fair Dealing with Customers with Regard to Derivative Products or New Financial Products), which emphasizes members' obligations for fair dealing with customers when making recommendations or accepting orders for new financial products.

      3 NASD's use of the term "due diligence" is not intended to equate the responsibilities of a member for its sales conduct obligations with the requirements of an underwriter under Section 11 of the Securities Act of 1933 and Securities Act Rule 176.

      4 NASD Conduct Rule 2310(b).

      5 See NASD Letter of Acceptance, Waiver and Consent, Altegris Invs., Inc., and Robert Amedeo, No. CAF030015 (April 15, 2003).

    • 03-70 NASD Reminds Members of Their Duty to Cooperate in Arbitration Discovery Process

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      INFORMATIONAL

      Discovery

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Senior Management

      Arbitration
      Discovery

      Executive Summary

      NASD rules require parties to NASD arbitrations to cooperate in the voluntary exchange of documents and information, and to respond to discovery requests from other parties within a certain time. In addition, the NASD Discovery Guide and Document Production Lists specify which documents are presumed to be discoverable in customer disputes. Absent a written objection, or an agreement by the parties to the contrary, parties must exchange documents listed on applicable Document Production Lists within the specified time frames.

      NASD has become increasingly aware of instances in which parties are not complying with their duty to cooperate in the exchange of documents requested by parties or listed on applicable Document Production Lists within the specified time. NASD will not tolerate abuses of the discovery process. NASD is issuing this Notice to Members to: (1) remind members and associated persons of that duty; and (2) notify them that NASD Dispute Resolution will continue to monitor compliance with its discovery rules, and will refer perceived abuses to NASD Regulatory Policy and Oversight for disciplinary review.1

      Questions/Further Information

      Questions regarding this Notice may be directed to Laura Gansler, Counsel, NASD Dispute Resolution, at (202) 728-8275, or via e-mail, laura.gansler@nasd.com.

      Discussion

      Rule 10321(a) of the NASD Code of Arbitration Procedure (Code) provides that "[t]he parties shall cooperate to the fullest extent practicable in the voluntary exchange of documents and information to expedite the arbitration." Rule 10321(b) provides that parties may request documents or information from one another, and that a party has 30 days to produce or object to the production of documents or information requested by a party. Rule 10321(b) also states that parties must try to resolve any dispute regarding the production of the documents or information before objecting under the rule.

      In addition to these rules, the NASD Discovery Guide provides guidance to parties in NASD arbitrations regarding documents that should be exchanged automatically, without arbitrator or staff intervention, and includes timetables and procedures for the exchange of such documents. The Discovery Guide includes Document Production Lists that specifically identify which documents are presumed to be discoverable in customer disputes. Document Production Lists 1 and 2 apply to all customer disputes, while Lists 3 through 14 apply to specific types of claims. The Discovery Guide makes clear that, absent a written objection, or an agreement by the parties to the contrary, parties must exchange documents listed on applicable Document Production Lists within the specified time frames.

      Despite the guidance provided in the Code and the Discovery Guide, NASD continues to receive complaints regarding possible abuses of the discovery process. One measure of the problem is the increasing frequency with which arbitration panels have imposed sanctions for discovery abuse. In October 2003, an arbitration panel sanctioned a member $10,000 a day for each day that the firm continued to withhold documents that the panel ordered the firm to produce. Other recent examples of discovery sanctions include:

      • A panel found that a member firm intentionally concealed documents, delaying the discovery process. The panel assessed the firm over $10,000 in sanctions and $2,500 in attorney's fees.


      • A panel awarded the claimant over $7,000 due to a member firm's failure to cooperate in the discovery process.


      • A panel awarded the claimant $2,750 in attorney's fees as a sanction for the member's failure to provide discoverable material.


      • A panel awarded the claimant $3,000 in sanctions for a respondent's failure to provide discoverable material as ordered by the panel.


      • A panel sanctioned a member $10,000 for failure to produce documents required by the chairperson of the panel.

      The increasing frequency with which arbitration panels are awarding monetary sanctions for discovery abuse, as well as increasing complaints from parties, leads NASD to conclude that discovery abuse is on the rise. This trend suggests that some parties believe that noncompliance with their duty to cooperate in the discovery process—to voluntarily turn over documents listed on applicable Document Production Lists, or requested by other parties under Rule 10321—is a routine and acceptable part of arbitration strategy. NASD is also concerned that these parties may not be deterred by monetary sanctions alone.

      This is a trend that NASD will not tolerate. Discovery abuse hinders the efficient and cost-effective resolution of disputes in this forum, and undermines the integrity and fairness of the NASD forum.

      Arbitrators have several tools available for addressing discovery abuse, including issuing monetary sanctions during or at the end of an arbitration, striking claims or defenses, and making disciplinary referrals at the end of a case (see Rule 10105). As part of an effort to reduce discovery abuse, NASD has taken several steps recently to enhance arbitrator training regarding these tools. The October 2003 issue of NASD Dispute Resolution's arbitrator newsletter, The Neutral Corner, features a front-page article entitled "Proactive Arbitrators Keep the Case Moving" by Robert D. Herschman, which describes several proactive approaches arbitrators may use for handling discovery problems. In addition, NASD Dispute Resolution's new online chairperson training course includes an extensive section on "Managing the Prehearing Discovery Conference." NASD Dispute Resolution is also currently working on the creation of a discovery "mini-course" that will be offered to all arbitrators online during the first quarter of 2004.

      Although NASD believes that enhanced arbitrator training will help reduce instances of discovery abuse, NASD also believes that it is important to remind parties of their duty to cooperate in the discovery process, and to comply with the discovery provisions of the Code and the Discovery Guide. In addition, NASD Dispute Resolution staff has recently initiated a practice of bringing all alleged discovery abuses to the attention of the Director of Arbitration and the President of NASD Dispute Resolution. These cases will be carefully reviewed and, when appropriate, NASD Dispute Resolution will refer such cases to NASD Regulatory Policy and Oversight for disciplinary review.

      NASD hopes that these measures will lead to a significant reduction in the instances of discovery abuse in the forum, and alleviate the need for future rule changes or other additional steps to deter such abuse.


      1 NASD recognizes that claimants as well as respondents may be responsible for discovery abuse. NASD also intends to remind claimants and their representatives of their duty to cooperate with NASD discovery rules and procedures.

    • 03-69 SEC Approves Changes to Rules on Reporting of Transactions through Electronic Communications Networks (ECNs)

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      ACTION REQUIRED

      Electronic Communications Networks

      Changes Effective: November 10, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representative
      Legal & Compliance
      Operations
      Senior Management

      Transaction Reporting
      Electronic Communication Networks

      Executive Summary

      NASD is issuing this Notice to replace and supersede Notice to Members (NtM) 03-55, which discussed the SEC's approval of rules on reporting of transactions executed through electronic communications networks (ECNs). The effective date of the rules was originally October 6, 2003, but was delayed until November 10, 2003. Minor amendments to the rules have since been filed with the Securities and Exchange Commission (SEC) on an immediately effective basis, and are reflected in this Notice. This Notice also repeats information that is in NtM 03-55.

      On September 4, 2003, the SEC approved changes to rules governing the reporting of transactions through Nasdaq's Automated Confirmation Transaction Service (ACT) in order to clarify the reporting requirements applicable to transactions conducted through electronic communications networks (ECNs).

      The new rules do not apply to trades reported through NASD's Trade Reporting and Comparison Service (TRACS). The changes, which take effect November 10, 2003, describe the three methods that may be used by ECNs and/or their customers to report trades executed through an ECN's facilities. ECNs that use ACT to report some or all of the transactions executed through their facilities are required to file a notice of their trade-reporting methods prior to November 10, 2003. Please use Attachment A to file this notice. Notices must be filed with NASDAQ's MarketWatch Department, 9509 Key West Avenue, Rockville, MD 20850, Attention: Sheila Dagucon (or you may fax the notification to (240) 386-6050); and NASD's Market Regulation Department, 9509 Key West Avenue, Rockville, MD 20850, Attention: Alternative Trading Systems Group (or you may fax the notification to (240) 386-5139).

      Questions/Further Information

      Questions regarding this Notice may be directed to Sheila Dagucon, NASDAQ MarketWatch, at (240) 386-6049; or John Yetter, NASDAQ Office of General Counsel, at (202) 912-3039.

      Background

      Current practices of ECN trade reporting have developed over time in conjunction with the growth of the number of ECNs. As each new ECN entered the market, it registered under NASD Rule 4623 and informed NASDAQ and NASD concerning its planned method for reporting transactions. Although the use of different reporting methodologies by different ECNs has generally allowed ECNs to fulfill reporting obligations while tailoring their methodology to their own business needs and those of their subscribers, the absence of clearly defined rules has, in some circumstances, created confusion as to the trade reporting responsibilities of ECNs and their subscribers. The rule change approved by the Commission will provide members greater certainty concerning their trade reporting responsibilities, while allowing ECNs to continue using the various methods of trade reporting that have developed over time.

      The rule change is based on NASDAQ's understanding of the different methods used by ECNs today to report trades, and, in general, the rule change is not intended to require ECNs to modify their current trade-reporting practices. Rather, the purpose of the rule change is to codify these practices in the form of clear, enforceable rules that will provide greater guidance to market participants. The rule change will apply to transactions in all securities that are executed through an ECN and reported to ACT.

      The rule change permits ECNs to use any of three methods for reporting transactions. However, each ECN must inform, in writing, NASD and NASDAQ simultaneously which method it will use for reporting trades to ACT for each of its subscribers, although it may change its method at any time by providing advance written notice simultaneously to NASD and NASDAQ.

      First, an ECN may assume sole responsibility for reporting transactions executed through its facilities and identify itself as the reporting party.

      Second, an ECN may assume sole responsibility for transaction reporting, but identify a subscriber as the reporting party. In that case, the identified reporting party would be determined in accordance with the existing rules for allocating trade-reporting responsibility in NASD Rule 6130(c). Thus, if the subscribers conducting a transaction through the ECN were both market makers or both Order Entry Firms, the selling party would be identified as the reporting party; if the transaction were between a market maker and an Order Entry Firm, the market maker would be identified as the reporting party; and if the transaction were between a member (i.e., a broker/dealer) and a non-member (such as an institutional investor), the member would be identified as the reporting party.

      Third, the ECN may impose some or all of the responsibility for reporting on its subscribers. In that case, the ECN would notify the appropriate reporting party, determined in accordance with the existing rules of priority for trade reporting in NASD Rule 6130(c), that it had an obligation to submit a report concerning the trade.

      At any given time, an ECN may utilize more than one of these methods, with the choice of the method varying depending on the needs of particular subscribers. Thus, an ECN may use one method for one of its subscribers and a different method for all of its other subscribers. The ECN must, however, provide simultaneously NASD and NASDAQ advance written notice concerning the method that it will use for each subscriber.

      In each case, the party submitting a trade report is responsible for ensuring its accuracy and completeness, by providing the information specified by Rule 6130(d). In addition, when an ECN submits a trade report identifying another party as the reporting party, both the ECN and the identified reporting party are responsible for ensuring the accuracy and completeness of the report.

      The rule change also addresses procedures for reporting transactions in several unique circumstances associated with ECNs. First, the rule change provides that when the parties to a transaction executed through an ECN are both non-members, the ECN must submit all required trade reports and identify itself as the reporting party. This is the case because, as non-members, the parties to the transaction would not be eligible to report trades through ACT. Second, in circumstances where one ECN routes an order to another ECN that executes the order, the ECN that executes the order would be responsible for reporting the transaction, or requiring a subscriber to report the transaction, in accordance with one of the three basic methods for trade reporting described above. For purposes of the rules for allocating trade-reporting responsibility between ECN subscribers, the routing ECN would be deemed to be an Order Entry Firm. Thus, if the executing ECN uses the second method of trade reporting (i.e., reporting on behalf of its subscribers), and it receives an order from a routing ECN that is matched against the order of an Order Entry Firm or another ECN, the sell side would be identified as the reporting party. If the executing ECN matched the routed order against the order of a market maker, however, the market maker would be identified as the reporting party.

      Finally, it should be noted that the rule change applies only to transactions that are reported to ACT, since NASDAQ does not have authority to establish rules governing the reporting of trades to non-NASDAQ systems, including NASD's TRACS system. Thus, in circumstances where an ECN has the option to report trades to ACT or to another trade-reporting system, such as NASD's TRACS system, the rule does not mandate that the ECN use ACT for trade reporting. However, to the extent that the ECN or its subscribers opt to use ACT to report a particular transaction, all provisions of the rule change would apply to that transaction.


      Attachment A

      Notice Required by NASD Rule 6130(c) for Electronic Communications Network (ECN) Transactions Reported through the Automated Confirmation Transaction Service (ACT)

      Name of ECN:

      Address:

      Contact person:

      Name of ECN subscriber Trade-Reporting Method

      (if the same method will be used for all subscribers, the subscribers are not required to be identified by name): (identified by number as indicated below):
         
         
         
         
         
         
         
         
         
         
         
         
         

      Trade-reporting methods:

      1. The ECN submits trade reports to ACT and identifies itself as the reporting party (NASD Rule 6130(c)(5)(A)).
      2. The ECN submits trade reports to ACT on behalf of the reporting party and identifies the reporting party in accordance with the rules for determining reporting parties reflected in NASD Rule 6130(c)(1), (2), (3), and (4) (NASD Rule 6130(c)(5)(B)).
      3. The ECN requires one of the parties to a transaction, determined in accordance with the rules for determining reporting parties reflected in NASD Rule 6130(c)(1), (2), (3), and (4), to submit the trade reports to ACT (NASD Rule 6130(c)(5)(C)).

      Notice should be sent to:

      • NASDAQ's MarketWatch Department
        9509 Key West Avenue
        Rockville, MD 20850


      • Or you may fax the notification to (240) 386-6050

        Attention: Sheila Dagucon

        AND

      • NASD's Market Regulation Department
        9509 Key West Avenue
        Rockville, MD 20850


      • Or you may fax the notification to (240) 386-5139

        Attention: Alternative Trading Systems Group


      Attachment B

      TEXT OF AMENDMENTS

      New text is underlined; deletions are in brackets.

      5400. NASDAQ STOCK MARKET AND ALTERNATIVE DISPLAY FACILITY TRADE REPORTING

      5430. Transaction Reporting

      (a) No change.
      (b) Which Party Reports Transaction and to Which Facility
      (1) In transactions between two Registered Reporting Nasdaq Market Makers, the member representing the sell side shall report the trade using ACT.
      (2) In transactions between a Registered Reporting Nasdaq Market Maker and a Non-Registered Reporting Member, the Registered Reporting Nasdaq Market Maker shall report the trade using ACT.
      (3) In transactions between two Non-Registered Reporting Members, the member representing the sell side shall report the trade using ACT or TRACS.
      (4) In transactions between a member and a customer, the member shall report as follows:
      (A) A Registered Reporting Nasdaq Market Maker shall report the trade using ACT;
      (B) A Registered Reporting ADF Market Maker shall report the trade using TRACS; and
      (C) A Non-Registered Reporting Member shall report the trade using ACT or TRACS.
      (5) In transactions between two Registered Reporting ADF Market Makers, the member representing the sell side shall report the trade using TRACS.
      (6) In transactions between a Registered Reporting ADF Market Maker and a Non-Registered Reporting Member, the Registered Reporting ADF Market Maker shall report the trade using TRACS.
      (7) In transactions between a Registered Reporting Nasdaq Market Maker and a Registered Reporting ADF Market Maker, the member representing the sell side shall report as follows:
      (A) A Registered Reporting Nasdaq Market Maker shall report the trade using ACT; and
      (B) A Registered Reporting ADF Market Maker shall report the trade using TRACS.
      (8) If a member simultaneously is a Registered Reporting Nasdaq Market Maker and a Registered Reporting ADF Market Maker, and has the trade reporting obligation pursuant to paragraphs (1), (2), (4), (5), (6), or (7), the member can report the trade using either ACT or TRACS, unless the trade is executed using ACES; the Nasdaq National Market Execution System ("NNMS"); [the SelectNet Service; the SmallCap Small Order Execution System ("SOES");] or the Primex Auction System ("Primex"). A trade executed using ACES must be reported using ACT, and trades executed using NNMS[, SelectNet, SOES,] or Primex will be reported to ACT automatically.
      (9) In transactions conducted through an ACT ECN (as defined in Rule 6110) that are reported to ACT, the ACT ECN shall ensure that transactions are reported in accordance with Rule 6130(c). If an ACT ECN is also a Registered Reporting ADF ECN (as defined in Rule 4200A), Rule 6130(c) shall apply only to transactions conducted through the ECN for which trade reports are submitted to ACT.

      6100. AUTOMATED CONFIRMATION TRANSACTION SERVICE (ACT)

      6110. Definitions

      (a) - (p) No change.
      (q) The term "ACT ECN" shall mean a member of the Association that is an electronic communications network that is a member of a registered clearing agency for clearing or comparison purposes or has a clearing arrangement with such a member, to the extent that transactions executed through it are reported to ACT.

      6130. Trade Report Input

      (a) - (b) No change.
      (c) Which Party Inputs Trade Reports to ACT

      ACT Participants shall, subject to the input requirements below, either input trade reports into the ACT system or utilize the Browse feature to accept or decline a trade within the applicable time-frames as specified in paragraph (b) of this Rule. Trade data input obligations are as follows:
      (1) in transactions between a Market Maker and an Order Entry Firm, the Market Maker shall be required to submit a trade report to ACT;
      (2) in transactions between two Market Makers, the member representing the sell side shall be required to submit a trade report to ACT;
      (3) in transactions between two Order Entry Firms, the member representing the sell side shall be required to submit a trade report to ACT[.];
      (4) in transactions between a member and a customer, the member shall be required to submit a trade report to ACT;
      (5) in transactions conducted through an ACT ECN that are reported to ACT, the ACT ECN shall ensure that transactions are reported in accordance with one of the following methods:
      (A) the ACT ECN shall submit the trade reports to ACT and identify itself as the reporting party;
      (B) the ACT ECN shall submit the trade reports to ACT on behalf of the reporting party and identify the reporting party in accordance with the rules for determining reporting parties reflected in paragraphs (1), (2), (3), and (4) above; or
      (C) the ACT ECN shall require one of the parties, determined in accordance with the rules for determining reporting parties reflected in paragraphs (1), (2), (3), and (4) above, to submit the trade reports to ACT.
      When an ACT ECN reports transactions in accordance with subparagraph (A), the ACT ECN shall be responsible for ensuring that the trade reports are accurate and contain all information required by subsection (d) of this rule for both the ACT ECN and the identified non-reporting party. When an ACT ECN reports transactions in accordance with subparagraph (B), both the ACT ECN and the party identified as the reporting party shall be responsible for ensuring that the trade reports are accurate and contain all information required by subsection (d) of this rule for both the ACT ECN and the identified reporting party. When an ACT ECN requires reporting of transactions in accordance with subparagraph (C), the reporting party shall be responsible for ensuring the accuracy and completeness of the trade report.

      An ACT ECN shall provide written notice to the Association of the method of trade reporting used by the ACT ECN for each of its subscribers, and may change the method of trade reporting used for a subscriber by providing advance written notice of the change to the Association;
      (6) in transactions conducted through two ACT ECNs or an ACT ECN and an ECN that is not an ACT ECN, an ACT ECN shall be responsible for complying with the requirements of paragraph (5) above for reporting a transaction executed through its facilities, and an ECN that routed an order to it for execution shall be deemed to be an Order Entry Firm and a member for purposes of the rules for determining reporting parties reflected in paragraphs (1), (3), and (4) above; and
      (7) in transactions conducted through an ACT ECN in which neither of the parties is a member, the ACT ECN shall report the transaction in accordance with the requirements of subparagraph (5)(A) above.
      (d) Trade Information To Be Input

      Each ACT report shall contain the following information:
      (1) Security identification symbol of the eligible security (SECID);
      (2) Number of shares;
      (3) Unit price, excluding commissions, mark-ups or mark-downs;
      (4) Execution time for any transaction in Nasdaq or CQS securities not reported within 90 seconds of execution;
      (5) A symbol indicating whether the party submitting the trade report represents the Market Maker side or the Order Entry side;
      (6) A symbol indicating whether the transaction is a buy, sell, sell short, sell short exempt or cross;
      (7) A symbol indicating whether the trade is as principal, riskless principal, or agent;
      (8) Reporting side clearing broker (if other than normal clearing broker);
      (9) Reporting side executing broker as "give-up" (if any);
      (10) Contra side executing broker;
      (11) Contra side introducing broker in case of "give-up" trade;
      (12) Contra side clearing broker (if other than normal clearing broker).
      (13) For any transaction in an order for which a member has recording and reporting obligations under Rules 6954 and 6955, the trade report must include:
      (A) An order identifier, meeting such parameters as may be prescribed by the Association, assigned to the order that uniquely identifies the order for the date it was received (see Rule 6954(b)(1)).
      (B) The time of the execution expressed in hours, minutes, and seconds. This information must be reported regardless of the period of time between execution of the trade and the ACT trade report. All times reported to the ACT system shall be in Eastern Time.
      (e) Aggregation of Transaction Reports

      Individual executions of orders in a security at the same price may be aggregated, for ACT reporting purposes, into a single report if the transactions are with the identical contra party; provided, however, that a reporting party may not withhold reporting a trade in anticipation of aggregating the transaction with other transactions.

      6400. REPORTING TRANSACTIONS IN LISTED SECURITIES

      6420. Transaction Reporting

      (a) No change.
      (b) Which Party Reports Transaction
      (1) Transactions executed on an exchange are reported by the exchange and shall not be reported by members.
      (2) In transactions between two Registered Reporting Members, only the member representing the sell side shall report.
      (3) In transactions between a Registered Reporting Member and a Non-Registered Reporting Member, only the Registered Reporting Member shall report.
      (4) In transactions between Non-Registered Reporting Members, only the member representing the sell side shall report.
      (5) In transactions conducted through an ACT ECN (as defined in Rule 6110), the ACT ECN shall ensure that the transactions are reported in accordance with Rule 6130(c).
      (c) - (e) No change.

      IM-6420. Transactions in Eligible Securities

      Summary Of Provisions Governing Members' Requirements To Report Transaction In Eligible Securities

      Chart 1 — General Reporting Requirements Under Rule 6420(b)

      Member Transaction Member Reports When Contra-Party Is
          [Designated]
      Registered
      Reporting
      Non-[Designated]
      Registered
      Reporting
          Member Member Exchange Customer
      [Designated]
      Registered Reporting
      buys from: No Yes No Yes
      Member sells to: Yes Yes No Yes
      Non-[Designated]
      Registered Reporting
      buys from: No No No Yes
      Member sells to: No Yes No Yes
      ACT ECN   See 6130(c) See 6130(c) No See 6130(c)

      Chart II — Reporting Requirements for "Riskless" Transactions as Defined in Rule 6420(d)(4)

      Member Transaction Member Reports When Contra-Party Is
          [Designated]
      Registered
      Reporting
      Non-[Designated]
      Registered
      Reporting
          Member Member Exchange Customer
      [Designated]
      Registered Reporting
      buys from customer and sells to: Yes Yes No Yes
      Member sells to customer and buys from: No Yes No Yes
      Non-[Designated]
      Registered Reporting
      buys from customer and sells to: No Yes No Yes
      Member sells to customer and buys from: No No No Yes

      6600. REPORTING TRANSACTIONS IN OVER-THE-COUNTER SECURITIES

      6620. Transaction Reporting

      (a) No change.
      (b) Which Party Reports Transaction
      (1) In transactions between two OTC Market Makers, only the member representing the sell side shall report.
      (2) In transactions between an OTC Market Maker and a Non-Market Maker, only the OTC Market Maker shall report.
      (3) In transactions between two Non-Market Makers, only the member representing the sell side shall report.
      (4) In transactions between a member and a customer, the member shall report.
      (5) In transactions conducted through an ACT ECN (as defined in Rule 6110), the ACT ECN shall ensure that the transactions are reported in accordance with Rule 6130(c), and the term "Market Maker" as used in such rule shall be construed to include an OTC Market Maker.
      (c) - (e) No change.

      6900. REPORTING TRANSACTIONS IN DIRECT PARTICIPATION PROGRAMS

      6920. Transaction Reporting.

      (a) No change.
      (b) Which Party Reports Transactions
      (1) In transactions between two members, only the member representing the sell side shall report.
      (2) In transactions between a member and a customer, the member shall report.
      (3) In transactions conducted through an ACT ECN (as defined in Rule 6110), the ACT ECN shall ensure that the transactions are reported in accordance with Rule 6130(c); provided that for purposes of Rule 6130(c)(5) (B) and (C), the party with the reporting obligation shall be as set forth in Rule 6130(c)(3) and the term "Order Entry Firm" as used in such rule shall be construed to refer to any member.
      (c) - (e) No change.

    • 03-68 NASD Reminds Members That Fee-Based Compensation Programs Must Be Appropriate

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      ACTION REQUIRED

      Fee-Based Compensation

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Registered Representatives
      Senior Management

      Charges for Services Performed
      Fee-Based Compensation
      NASD Rule 2110
      NASD Rule 2430

      Executive Summary

      Fee-based programs typically charge a customer a fixed fee or percentage of assets under management in lieu of transactionbased commissions. While NASD recognizes the benefits these programs offer for many customers, they are not appropriate in all circumstances. NASD therefore reminds members that they must have reasonable grounds for believing that a fee-based program is appropriate for a particular customer, taking into account the services provided, cost, and customer preferences.

      Questions/Further Information

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

      Background and Discussion

      NASD members increasingly are offering customers fee-based accounts that charge a fixed fee and/or percentage of assets under management ("fee-based programs") as an alternative to traditional commission-based charges for brokerage services. Many of these members have expanded their fee-based programs to cover traditional brokerage accounts that do not include investment advisory services.1 Previously, these programs typically involved "wrap" accounts, where broker/dealers provide investors with a suite of services—asset allocation, portfolio management, execution and administration—for a single fee. Most traditional wrap accounts are considered advisory accounts subject to the Investment Advisers Act.2

      The 1995 Report of the Committee on Compensation Practices (the "Tully Report")3 labeled fee-based programs a "best practice" because they more closely align the interests of the broker/dealer and customer and reduce the likelihood of abusive sales practices such as churning, high-pressure sales tactics, and recommending unsuitable transactions.4 The Tully Report noted that fee-based programs are particularly appropriate for investors who prefer consistent and explicit monthly or annual charges and those that engage in at least a moderate level of trading activity.

      On the other hand, the Tully Report acknowledged that fee-based programs may not fit the needs of certain investors. In this regard, commenters to the Tully Committee noted that accounts with low trading activity may be better off with a commissionbased program. These accounts might include those comprised mainly of bonds or mutual funds, but also could contain individual capital appreciation equities where the customer has a stated buy-and-hold strategy.

      Fee-Based Accounts Must Be Appropriate

      It generally is inconsistent with just and equitable principles of trade—and therefore a violation of Rule 2110—to place a customer in an account with a fee structure that reasonably can be expected to result in a greater cost than an alternative account offered by the member that provides the same services and benefits to the customer.5 Accordingly, before opening a fee-based account for a customer, members must have reasonable grounds to believe that such an account is appropriate for that particular customer. To that end, members should make reasonable efforts to obtain information about the customer's financial status, investment objectives, trading history, size of portfolio, nature of securities held, and account diversification. With that and any other relevant information in hand, members should then consider whether the type of account is appropriate in light of the services provided, the projected cost to the customer, alternative fee structures that are available, and the customer's fee structure preferences. In addition, members should disclose to the customer all material components of the fee-based program, including the fee schedule, services provided, and the fact that the program may cost more than paying for the services separately.

      NASD recognizes that factors other than cost may properly be considered to determine whether an account is appropriate for a customer. Thus, for example, a customer may place a premium on the positive characteristics of fee-based programs identified in the Tully Report: having his or her interests aligned with that of the member and registered representative and the certainty and consistency of cost that many fee-based programs provide. These non-price factors may constitute significant benefits to a particular customer; therefore, a member may give them corresponding weight in determining the appropriateness of a fee-based account for that customer. Even where a fee-based account is determined to be appropriate, members still must comply with their longstanding obligations under Rule 2430.6

      Absent inducement by the member, no liability under Rule 2110 (unless derivative of another rule violation) will attach to a member where it is disclosed to a customer that a potentially lower cost account is available, but the member can demonstrate that the customer nevertheless opted for a fee-based account for reasons other than pricing.7 In such circumstances, the member should document the fact that the customer chose a fee-based account for reasons other than cost.

      Supervisory Procedures

      Members should implement supervisory procedures to require a periodic review of fee-based accounts to determine whether they remain appropriate for their respective customers.8 As part of that review, members should consider whether reasonable assumptions about market conditions upon which the member based its initial determination of appropriateness have changed, as well as any changes in customer objectives or financial circumstances.

      Members also may wish—but are not required—to create reports that compare the asset-based fees to those that would have been generated in the same account on a commission basis. Since the appropriateness of a fee can be based upon factors other than cost to the customer, a retrospective finding that a customer would have been charged less in a commission-based account is not conclusive that the account is inappropriate for that customer. However, such a finding should cause the member to give careful scrutiny to those issues. Finally, members should review their sales literature, marketing material, and other correspondence related to fee-based programs to ensure the information is balanced and not misleading, and should include in training materials guidelines regarding the establishment of fee-based accounts.


      1 A 1999 SEC proposal to specifically exempt from the Investment Advisers Act these fee-based brokerage programs is awaiting final action. Under the proposal, only non-discretionary accounts where incidental advice is provided would be exempt. Exchange Act Release No. 42099 (November 4, 1999).

      2 This Notice to Members is focused on brokerage accounts that do not require registration under the Investment Advisers Act, but members nonetheless must ensure that advisory products and services are appropriate for a customer and that charges for such services are reasonable.

      In determining whether a broker/dealer meets the definition of "investment adviser," the SEC has excluded circumstances where advice given is solely incidental to typical brokerage services, such as execution and administration. The SEC has commented that the exception "amounts to a recognition that brokers and dealers commonly give a certain amount of advice to their customers in the course of their regular business and that it would be inappropriate to bring them within the scope of the [Advisers Act] merely because of this aspect of their business." Exchange Act Release No. 34-42099 (November 4, 1999).

      3 SEC Committee on Compensation Practices, Report on Broker-Dealer Compensation (April 10, 1995), available at www.sec.gov/news/studies.shtml (last modified July 25, 2003).

      4 Fee-based programs do not always align the interests of representative and customer: for example, income-producing securities may be more appropriate for certain investors, but because such securities may result in lower fees than would be produced by a portfolio of capital appreciation stocks, there could be an economic disincentive to recommend these securities. Some commenters also have expressed concern that fee-based programs might encourage account neglect. These concerns are most pronounced when the registered representative has discretionary authority over the account.

      5 Depending on the facts and circumstances surrounding the establishment of, and transactions in, a fee-based account, failure to obtain and assess for suitability the aforementioned information could result in a violation of Rule 2310. See Wendell Belden, Exchange Act Release No. 47859 (May 14, 2003). NASD construes Belden as supporting the principle that the manner of purchase of a recommended security by an associated person, where that security otherwise would be suitable based on the investor's investment objectives, risk tolerance, and financial means, can render that recommendation unsuitable, and therefore violative of 2310, if there is an alternative basis upon which the security can be purchased to the pecuniary advantage of the investor.

      6 Rule 2430 requires that charges for services "shall be reasonable and not unfairly discriminatory between customers." See Notices to Members 92-11 and 75-65. In referring to the predecessor rule to current Rule 2430, Notice to Members 75-65 states that charges must be "fair under the relevant circumstances and a member should be prepared to justify that its prices are fair as to each customer and transaction." This standard remains applicable today.

      7 Evidence of such disclosure does not, by itself, demonstrate that a customer opted for a fee-based account for non-pricing reasons. A member must also establish the specific reasons given by the customer for choosing a fee-based account after receiving the disclosure.

      Customer consent is not a defense to an otherwise unsuitable recommendation pursuant to Rule 2310 and therefore would be irrelevant if the facts established a suitability violation in accordance with the Belden decision.

      8 NASD believes that, absent unusual circumstances, it would be reasonable to conduct a review annually. Of course, reviews undertaken with greater frequency may prove to be of greater benefit to members and their customers. On those occasions where members review their customer accounts for business reasons, including determining profitability, they may not ignore relevant information related to whether the account is appropriate for the customer because the review was not conducted for that purpose.


      Fee-Based Account Questions & Answers

      Q. Is cost the only factor in deciding whether a fee-based account is appropriate for a customer in lieu of a commission-based account?

      A. Cost is an important factor, but not the only one. For this reason, NtM 03-68 points out that factors other than cost may properly be considered to determine whether a fee-based account is appropriate. Firms must consider the overall needs and objectives of the customer when determining the benefits of a fee-based account for that customer, including the anticipated level of trading activity in the account and non-price factors such as the importance that a customer places on aligning his or her interests with the broker. Additionally, firms must take into account the nature of the services provided, the benefits of other available fee structures, and the customer's fee structure preferences.

      Q. Is there a specific time frame of trading activity or inactivity that firms should consider when assessing the appropriateness of a fee-based account for a customer?

      A. Servicing a customer account is usually a long-term proposition, so there is no set period of time of trading activity or inactivity that should be used as the basis to determine the appropriateness of a fee-based versus a commission-based account. Generally, fee-based accounts are particularly appropriate for investors who engage in at least a moderate level of trading activity. But, the activity during different time periods in a particular account may vary greatly due to market conditions, interest rate moves, size and diversity of the portfolio, or a customer's personal needs. As a result, firms should periodically review fee-based accounts to determine whether they remain appropriate for each customer, revisiting the assumptions and objectives that previously led to that conclusion. NASD staff believes that, at a minimum, an annual review of such accounts provides a reasonable interval to allow members to assess the trading characteristics of a customer's account.

      Q. Does NtM 03-68 cover customer accounts that fall within the provisions of the Investment Advisers Act of 1940 (Advisers Act)?

      A. The requirements of NtM 03-68 do not apply to accounts that a member services in its capacity as a registered Investment Adviser. However, as noted in the NtM, NASD staff does expect members to ensure that advisory products and services are appropriate in nature for a customer and that charges for such services are reasonable.

      Q. Do fee-based "traditional" brokerage accounts differ from "wrap" accounts?

      A. Generally, yes. Wrap accounts typically include services such as asset allocation and portfolio management for a fixed fee. Most wrap accounts with these features are subject to the Advisers Act and are not the focus of NtM 03-68.

      Q. Has NASD detected any particular problems or issues with respect to fee-based accounts?

      A. Certain potential problems have been identified through our examination program. For example, it is not always clear that customers receive adequate disclosure about the distinctions and features of fee-based versus commission-based accounts, including the differences in fee structures and that fees will probably be higher in a fee-based account if the level of activity is modest. Training and education at some firms are minimal, particularly in giving brokers guidance on how to evaluate whether a customer is appropriate for a fee-based account. Moreover, firms do not always have systems in place to reasonably ensure that mutual funds and other similar products that may be purchased outside a fee-based account are not shortly thereafter switched into a fee-based account and a customer assessed both a load and a fee. Similarly, documentation that supports the appropriateness of a fee-based account for a customer may be non-existent or weak. Also, in some instances firms have not assigned a broker to customers with fee-based accounts. Finally, some firms may lack systems or procedures to ensure that a fee-based account is appropriate for a customer both at the point where the pricing feature is added and periodically thereafter.

      Q. Is NASD of the view that fee-based accounts outside of an advisory relationship are inappropriate?

      A. No. NASD cites the 1995 "Tully Report" in NtM 03-68 that described fee-based programs as a best practice because they tend to reduce the likelihood of abusive sales practices. But the Tully Report also acknowledged that customer accounts with low trading activity might be better suited for a commission-based arrangement. NASD staff's view is that firms must take those steps necessary to assess whether a fee-based account is appropriate for a particular customer and to periodically update this assessment.

      Q. What steps should a firm take to best ensure that a fee-based account structure is appropriate for a particular customer?

      A. Firms must have reasonable grounds to conclude that a fee-based account is appropriate. Firms should train brokers with respect to the features of fee based- accounts and the need to assess whether a fee-based account is appropriate for a customer. This will help the broker understand his or her role in gathering relevant information from customers, such as investment objectives, financial status, and trading history, among other things. Similarly, adequate training on fee-based accounts will better ensure that brokers make full and clear disclosures to customers.

    • 03-67 SEC Approves Proposed Changes to NASD Rules 3130 and 3131, Rule 9160, and the Rule 9410 Series

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      INFORMATIONAL

      Amendments to NASD Rules Regarding the Regulation of Activities of Members Experiencing Financial and/or Operational Difficulties

      Effective Date: December 1, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management

      Rule 3130
      Rule 3131
      Rule 9160
      Rule 9400 Series
      Net Capital
      SEC Rule 15c3-1

      Executive Summary

      On September 4, 2003, the Securities and Exchange Commission (SEC) approved amendments to NASD Rules 3130, 3131, 9160, and the Rule 9410 Series.1 The amended Rules 3130 and 3131 and Rule 9410 Series permit NASD to act on an expedited basis to place restrictions on the operations of any member when NASD's Department of Member Regulation (Member Regulation) has reason to believe that the member is experiencing financial or operational difficulties or suspend the operations of any member that is not in compliance with its applicable net capital requirements.

      The amendments become effective on December 1, 2003. The text of the amendments is provided in Attachment A.

      Questions/Further Information

      Questions concerning this Notice may be directed to Susan DeMando Director, Financial Operations, at (202) 728-8411.

      Background and Discussion

      Prior to these amendments, NASD's authority under Rules 3130 and 3131 was limited to the ability to direct members with a net capital requirement of $100,000 or more to either limit their business or not expand their business in order to maintain appropriate net capital levels; under these Rules, NASD did not have authority to require a member to suspend its business operations when it failed to maintain its minimum net capital.2 Rules 3130 and 3131, as amended, and the Rule 9410 Series permit NASD to act on an expedited basis to place restrictions on the operations of any member, regardless of its minimum net capital requirement, when Member Regulation has reason to believe that the member is in financial or operational difficulty. These Rules also permit NASD to suspend the business operations of a member during any period of time when the member is not in compliance with its applicable net capital requirements.

      Amendments to Rules 3130 and 3131

      The amendments to Rules 3130 and 3131 have significantly expanded NASD's authority. Prior to the rule change, NASD could only direct members with a net capital requirement of $100,000 or more either to limit their business or not expand their business in order to maintain appropriate net capital levels. Now, under amended Rules 3130 and 3131, NASD has the authority to regulate the activities of all member firms subject to the requirements of SEC Rule 15c3-1 (Net Capital Rule),3 regardless of their minimum capital requirement, and all member firms subject to the requirements of Section 402.2(c) (Liquid Capital Requirements for Government Securities Firms) of the rules of the Treasury Department.

      Further, in addition to having authority to direct members either not to expand their business operations or to restrict their business operations, NASD may now direct members to suspend all business operations during any period of time when the member is not in compliance with its applicable net capital requirements as set forth in the SEC's Net Capital Rule or Section 402.2(c) of the rules of the Treasury Department. NASD's ability to direct members to suspend their business operations should protect investors, market participants, and the general public from the risks posed by members operating securities businesses without appropriate levels of capital.4

      Rule 9410 Series

      NASD's Rule 9410 Series provides the procedural framework for actions taken under Rules 3130 and 3131. The first step in the process requires Member Regulation to issue a notice directing a member experiencing financial and operational difficulties as described in Rules 3130 and 3131 to restrict its business activities, either by limiting or ceasing to conduct those activities. The notice will specify the grounds on which such restrictions are being imposed, the nature of the restrictions to be imposed, the effective date of the restrictions, a fitting sanction that will be imposed if the member fails to comply with any of the restrictions set forth in the notice, and the conditions for terminating such restrictions.

      The member then has five days from the date of service of the notice to request a hearing. The request must state the specific grounds for withdrawing or modifying any of the restrictions specified in the notice. Generally, a request for hearing will stay the effective date of the notice. If a hearing is not requested, the restrictions prescribed in the notice become effective at least seven days after the date of service of the notice. If the member requests a hearing, the hearing must be held within 14 days of the notice. During that time, the parties will exchange exhibits and witness lists.

      Within seven days after the hearing,5 the hearing panel will issue a written decision. The decision will approve, modify, or withdraw the restrictions specified in the notice. If the decision imposes restrictions, it will state the grounds for the restrictions, the conditions for termination of the restrictions, and provide for a fitting sanction to be imposed if the member fails to comply with the restrictions. If a member does not comply with the limitations described in any effective notice or remedial action imposed by a hearing panel, Member Regulation may order the sanction set forth in the notice or specified in the hearing panel decision against the member. The member has the opportunity to request a second hearing if such sanctions are ordered.

      If a member continues to experience financial or operational difficulty, Member Regulation may issue a notice imposing additional restrictions, from which the member may seek relief by filing a written application for a hearing. If Member Regulation determines that any restrictions previously imposed should be reduced or removed, Member Regulation will so advise the member by written notice. Members have the right to have the SEC review any action taken by NASD pursuant to the Rule 9400 Series; however, the filing of an application for review will not stay the effectiveness of NASD action unless the SEC orders otherwise.


      1 See Release No. 34-48438 (File No. SR-NASD-2003-74) (Sept. 4, 2003), 68 Federal Register 53766 (Sept. 12, 2003).

      2 NASD Rule 9512 (Summary Proceedings) is available to address severe financial or operational difficulties. However, because this procedure allows NASD to suspend a member before a hearing is held and requires authorization from the Board of Governors, it is reserved for the most serious of circumstances and generally would be inappropriate to address certain instances of net capital deficiencies.

      3 Rule 15c3-1 under the Securities Exchange Act of 1934 requires that firms maintain certain specified levels of net capital. Section 402.2 of the Treasury Department rules contains liquid capital requirements for government securities broker/dealers. NASD does not set net capital requirements, but enforces these provisions as part of its regulatory function. However, Rules 3130 and 3131 effectively allow NASD to require net capital and liquid capital requirements in excess of those respective capital requirements stated above.

      4 Members are reminded that notwithstanding NASD's authority under Rules 3130 and 3131 and the Rule 9400 Series to direct members that are experiencing financial and/or operational difficulties not to expand, restrict, or suspend business operations, NASD may also determine to take disciplinary action against such members when appropriate for the same conduct.

      5 Rule 9160(g) was deleted because Member Regulation staff does not participate as an adjudicator in a Rule 9410 decision.


      Exhibit I

      Below is the text of the proposed rule change. Additions are underlined; deletions are in brackets.

      3130.   Regulation of Activities of Members Experiencing Financial and/or Operational Difficulties

      (a) Application—For the purposes of this Rule, the term "member" shall be limited to any NASD member [of the Association who] that is not designated to another self-regulatory organization by the Commission for financial responsibility pursuant to Section 17 of the Act and SEC Rule 17d-1 thereunder. Further, the term shall not be applicable to any member [who] that is [subject to paragraphs (a)(2)(iv), (a)(2)(v) or (a)(2)(vi) of SEC Rule 15c3-1, or is otherwise exempt from the provisions of said rule or is] subject to Rule 3131.
      (b) Each member subject to SEC Rule 15c3-1 shall comply with the net capital requirements prescribed therein and with the provisions of this Rule.
      [(b)] (c) A member, when so directed by [the Association] NASD, shall not expand its business during any period in which:
      (1) Any of the following conditions continue to exist, or have existed, for more than 15 consecutive business days:
      (A) A firm's net capital is less than 150 percent of its net capital minimum requirement or such greater percentage thereof as may from time to time be prescribed by [the Association] NASD;
      (B) If subject to the aggregate indebtedness requirement under SEC Rule 15c3-1, a firm's aggregate indebtedness is more than 1,000 per centum of its net capital;
      (C) If, in lieu of paragraph [(b)](c)(1)(B) above, the specified percentage of the aggregate debit items in the Formula for Determination of Reserve Requirements for Brokers and Dealers under SEC Rule 15c3-3 (the alternative net capital requirement) is applicable, a firm's net capital is less than 5 percent of the aggregate debit items thereunder; or
      (D) The deduction of capital withdrawals including maturities of subordinated debt scheduled during the next six months would result in any one of the conditions described in subparagraph (A), (B) or (C).
      (2) [The Association] NASD restricts the member for any other financial or operational reason.
      [(c)] (d) A member, when so directed by [the Association] NASD, shall forthwith reduce its business:
      (1) to a point [enabling its available capital to comply with the standards] at which the member would not be subject to a prohibition against expansion of its business as set forth in paragraph [(b)](c)(1)(A), (B) or (C) of this Rule if any of the following conditions continue to exist, or have existed, for more than [fifteen (15)] 15 consecutive business days:
      (A) A firm's net capital is less than 125 percent of its net capital minimum requirement or such greater percentage thereof as may from time to time be prescribed by [the Association] NASD;
      (B) No Change.
      (C) If, in lieu of paragraph [(c)](d)(1)(B) above, the specified percentage of the aggregate debit items in the Formula for Determination of Reserve Requirements for Brokers and Dealers, under SEC Rule 15c3-3 (the alternative net capital requirement) is applicable, a firm's net capital is less than 4 percent of the aggregate debit items thereunder; or
      (D) If the deduction of capital withdrawals including maturities of subordinated debt scheduled during the next six months would result in any one of the conditions described in paragraph [(c)](d)(1)(A), (B) or (C) of this Rule.
      (2) As required by [the Association] NASD when it restricts a member for any other financial or operational reason.
      (e) A member shall suspend all business operations during any period of time when the member is not in compliance with applicable net capital requirements as set forth in SEC Rule 15c3-1. The Department of Member Regulation may issue a notice to such member directing it to suspend all business operations; however, the member's obligation to suspend all business operations arises from its obligations under SEC Rule 15c3-1 and is not dependent on any notice that may be issued by the Department of Member Regulation.
      (f) Any notice directing a member to limit or suspend its business operations shall be issued by the Department of Member Regulation pursuant to Rule 9412.

      3131.   Regulation of Activities of Section 15C Members Experiencing Financial and/or Operational Difficulties

      (a) Application—For the purposes of this Rule, the term "member" shall be limited to any member of [the Association] NASD registered with the Commission pursuant to Section 15C of the Act that is not designated to another self-regulatory organization by the Commission for financial responsibility pursuant to Section 17 of the Act and Rule 17d-1 thereunder. [Further, the term shall not be applicable to any member that is subject to Section 402.2(c) of the rules of the Treasury Department, or is otherwise exempt from the provisions of said rule].
      (b) Each member subject to Section 402.2 of the rules of the Treasury Department shall comply with the capital requirements prescribed therein and with the provisions of this Rule.
      [(b)](c) A member, when so directed by [the Association] NASD, shall not expand its business during any period in which:
      (1) Any of the following conditions continue to exist, or have existed, for more than [fifteen (15)] 15 consecutive business days:
      (A) A firm's liquid capital is less than 150 percent of the total haircuts or such greater percentage thereof as may from time to time be prescribed by the Association] NASD.
      (B) through (C) No Change.
      (2) [The Association] NASD restricts the member for any other financial or operational reason.
      [(c)] (d) A member, when so directed by [the Association] NASD, shall forthwith reduce its business:
      (1) To a point [enabling its available capital to comply with the standards] at which the member would not be subject to a prohibition against expansion of its business as set forth in subparagraphs [(b)](c)(1)(A), (B), or (C) of this Rule if any of the following conditions continue to exist, or have existed, for more than [fifteen (15)] 15 consecutive business days:
      (A) A firm's liquid capital is less than 125 percent of total haircuts or such greater percentage thereof as may from time to time be prescribed by [the Association] NASD.
      (B) through (C) No Change.
      (2) As required by [the Association] NASD when it restricts a member for any other financial or operational reason.
      (e) A member shall suspend all business operations during any period of time when the member is not in compliance with applicable net capital requirements as set forth in Section 402.2 of the rules of the Treasury Department. The Department of Member Regulation may issue a notice to such member directing it to suspend all business operations; however, the member's obligation to suspend all business operations arises from its obligations under Section 402.2 of the rules of the Treasury Department and is not dependent on any notice that may be issued by the Department of Member Regulation.
      (f) Any notice directing a member to limit or suspend its business operations shall be issued by the Department of Member Regulation pursuant to Rule 9412.

      9160.   Recusal or Disqualification

      No person shall participate as an Adjudicator in a matter governed by the Code as to which he or she has a conflict of interest or bias, or circumstances otherwise exist where his or her fairness might reasonably be questioned. In any such case the person shall recuse himself or herself, or shall be disqualified as follows:
      (a) through (f) No change.
      [(g) NASD Regulation Staff As Adjudicator]
      [The President of NASD Regulation shall have authority to order the disqualification of a member of the staff of the Department of Member Regulation participating in a Rule 9410 Series decision.]

      9400.   [LIMITATION] PROCEDURES FOR ACTIONS TAKEN UNDER RULES 3130 AND 3131

      Rule 9412.   Notice [of Limitations]

      The Department of Member Regulation may issue a notice directing a member to [limit] restrict its business activities, either by limiting or ceasing to conduct those activities, if the Department of Member Regulation has reason to believe that [any] a condition specified in Rule 3130 or Rule 3131 exists. The notice shall specify the grounds on which such [action is being taken] restrictions are being imposed, the nature of the [limitations] restrictions to be imposed, the effective date of the restrictions [limitations], a fitting sanction that will be imposed if the member fails to comply with any [the] restrictions [limitations] set forth in the notice, and the conditions for terminating such [limitations] restrictions. The effective date of the [limitations] restrictions shall be at least seven days after the date of service of the notice. The notice also shall inform the member that it may request a hearing before the [Department 03-67 of Member Regulation] Office of Hearing Officers under Rule 9413. The Department of Member Regulation shall serve the notice by facsimile or overnight courier.

      9413.   Hearing Panel Review

      (a) Request for a Hearing

      A member subject to a notice issued under Rule 9412 may file a written request for hearing before a Hearing Panel with the Office of Hearing Officers. The request shall state the specific grounds for withdrawing or modifying any of the [limitations] restrictions specified in the notice. The request shall be filed pursuant to Rules 9135, 9136, and 9137 within five days after service of the notice under Rule 9412. The member may withdraw its request at any time by filing a written notice with the Office of Hearing Officers pursuant to Rules 9135, 9136, and 9137. The time limits set forth herein are to be strictly construed and cannot be modified except for good cause shown.
      (b) No Change.
      (c) Stay
      Unless otherwise ordered by the NASD Board Executive Committee, the [initiation of a review under this paragraph shall stay the decision of the Department of Member Regulation or an uncontested notice until a decision constituting final action of the Association is issued] request for a hearing shall stay the effective date of the notice.
      (d) through (h) No Change.
      (i) Evidence Not Admitted
      Evidence that is proffered but not admitted during the hearing shall not be part of the record, but shall be retained by the custodian of the record until the date when [the Association's] NASD's decision becomes final or, if applicable, upon the conclusion of any review by the Commission or the federal courts.
      (j) Failure to Request Hearing
      If a member does not request a hearing under paragraph (a), the [limitations] restrictions specified in the notice shall become effective on the date specified in the notice. Unless the Executive Committee calls the notice for review under Rule 9415, the [limitations] restrictions specified in the notice shall remain in effect until the Department of Member Regulation reduces or removes the [limitations] restrictions pursuant to Rule 9417(b).
      (k) Decision
      (1) Within seven days after the hearing, the Hearing Panel shall issue a written decision approving, modifying, or withdrawing the [limitations] restrictions specified in the notice. If the decision imposes [limitations] restrictions, the decision shall state the grounds for the [limitations] restrictions, the conditions for terminating such [limitations] restrictions, and provide for a fitting sanction to be imposed under Rule 9416 if the member fails to comply with the [limitations] restrictions. The Office of Hearing Officers shall promptly serve the decision by facsimile or overnight courier pursuant to Rules 9132 and 9134. The [limitations] restrictions imposed shall become effective upon service of the decision.
      (2) Contents of Decision

      The decision shall include:
      (A) a description of the Department of Member Regulation's [decision] notice, including its rationale;
      (B) a description of the principal issues regarding the imposition of [limitations] restrictions raised in the review and a statement supporting the disposition of such issues;
      (C) No Change.
      (D) a statement of whether the Department of Member Regulation's [decision] notice is affirmed, modified, or reversed, and a rationale therefor; and
      (E) if any restrictions [limitations] are imposed:
      (i) a description of the [limitations] restrictions and a statement describing a fitting sanction that will be imposed under Rule 9416 if the member fails to comply with any of the [limitations] restrictions; and
      (ii) the conditions for terminating the [limitations] restrictions.
      (l) Issuance of Decision After Expiration of Call for Review Period
      The Hearing Panel shall provide its proposed written decision to the NASD Board Executive Committee. The NASD Board Executive Committee may call the proceeding for review pursuant to Rule 9415. If the NASD Board Executive Committee does not call the proceeding for review, the proposed written decision of the Hearing Panel shall constitute the final action of [the Association] NASD.
      (m) Ex Parte Communications
      The prohibitions against ex parte communications in Rule 9143 shall become effective under the Rule 9410 Series when [Association] NASD staff has knowledge the NASD Board Executive Committee intends to review a decision on its own motion under this Rule.

      9414.   No change.

      9415.   Discretionary Review by the NASD Board Executive Committee

      (a) through (c) No change.
      (d) Decision of NASD Board Executive Committee, Including Remand
      After review, the NASD Board Executive Committee may affirm, modify, or reverse the proposed written decision of the Hearing Panel. Alternatively, the NASD Board Executive Committee may remand the proceeding with instructions. The NASD Board Executive Committee shall prepare a written decision that includes all of the elements described in Rule [9414(k)(2)] 9413(k)(2).
      (e) Issuance of Decision
      The NASD Board Executive Committee shall issue and serve its written decision on the member and the Department of Member Regulation pursuant to Rules 9132 and 9134. The decision shall be effective upon service. The decision shall constitute the final action of [the Association] NASD, unless the NASD Board Executive Committee remands the proceeding.

      9416.   Enforcement of Sanctions

      (a) Order
      If the Department of Member Regulation determines that a member has failed to comply with any [limitations] restrictions imposed by a decision or an effective notice under the Rule 9410 Series that has not been stayed, the Department of Member Regulation shall issue an order imposing the sanctions set forth in the decision or notice and specifying the effective date and time of such sanctions. The Department of Member Regulation shall serve the order on the member by facsimile or overnight courier.
      (b) through (c) No Change.
      (d) Decision
      Within four days after the hearing, the Hearing Panel shall affirm, modify, or reverse the order issued under paragraph (a). The Office of Hearing Officers shall serve the decision on the member pursuant to Rules 9132 and 9134. The decision shall become effective upon service and shall constitute final action of [the Association] NASD.

      9417.   Additional [Limitations] Restrictions; Reduction or Removal of [Limitations] Restrictions

      (a) Additional [Limitations] Restrictions
      If a member continues to experience financial or operational difficulty specified in Rule 3130 or 3131, notwithstanding an effective notice or decision under the Rule 9410 Series, the Department of Member Regulation may impose additional [limitations] restrictions by issuing a notice under Rule 9412. The notice shall state that the member may apply for relief from the additional [limitations] restrictions by filing a written application for a hearing under Rule 9413 and that the procedures in Rules 9413 through 9416 shall be applicable. An application for a hearing also shall include a detailed statement of the member's objections to the additional [limitations] restrictions.
      (b) Reduction or Removal of [Limitations] Restrictions
      If the Department of Member Regulation determines that any [limitations] restrictions previously imposed under the Rule 9410 Series should be reduced or removed, the Department of Member Regulation shall serve a written notice on the member pursuant to Rules 9132 and 9134.

      9418.   Application to Commission for Review

      The right to have any action taken by [the Association] NASD pursuant to this Rule Series reviewed by the Commission is governed by Section 19 of the Act. The filing of an application for review shall not stay the effectiveness of the action taken by [the Association] NASD, unless the Commission otherwise orders.

      9419.   Other Action Not Foreclosed

      Action by [the Association] NASD under the Rule 9410 Series shall not foreclose action by [the Association] NASD under any other Rule.

    • 03-66 SEC Approves Proposed Changes to NASD Rule 2520

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      Amendments to NASD Rules Regarding Margin Requirements

      Effective Date: December 1, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management

      Margin Requirements
      Regulation T
      Rule 2520

      Executive Summary

      On August 25, 2003, the Securities and Exchange Commission (SEC) approved amendments to NASD Rule 2520.1 As amended, Rule 2520 (1) reduces the customer maintenance margin requirements for certain non-equity securities; and (2) redefines "exempt account" and permits the extension of good faith margin treatment to certain non-equity securities held in "exempt accounts"; and (3) limits the amount of capital charges a broker/dealer may take in lieu of collecting marked to the market losses.2

      The amendments become effective on December 1, 2003. The text of the amendments is provided in Attachment A.

      Questions/Further Information

      Questions concerning this Notice may be directed to Susan M. DeMando, Director, Financial Operations, Department of Member Regulation, at (202) 728-8411.

      Background And Discussion

      Regulation T of the Federal Reserve Board establishes initial margin requirements for securities transactions effected in margin accounts. Regulation T also establishes margin requirements for transactions in non-equity securities held in "good faith" accounts. Such transactions are subject to the margin required by the creditor in "good faith" or the percentage set by the regulatory authority where the trade occurs, whichever is greater.3 Consequently, the margin requirements of NASD Rule 2520 apply to non-equity positions maintained in customers' accounts.

      The amendments to Rule 2520 provide for margin requirements for non-equity securities that are commensurate with the risk associated with positions in such securities held by customers. In particular, for positions not maintained in "exempt accounts," Rule 2520, as amended, reduces the customer maintenance margin requirement for certain non-equity securities and establishes a customer maintenance margin requirement of 20% of current market value for other marginable non-equity securities. The amended Rule 2520 also permits the extension of good faith margin to certain non-equity securities held in "exempt accounts" and limits the amount of capital charges a broker/dealer may take in lieu of collecting marked to the market losses.

      Definitional Changes

      Designated Account

      The term "designated account" means the account of: a bank (as defined in Section 3(a)(6) of the Securities Exchange Act of 1934 (Act)); a savings association (as defined in Section 3(b) of the Federal Deposit Insurance Act), the deposits of which are insured by the Federal Deposit Insurance Corporation; an insurance company (as defined in Section 2(a)(17) of the Investment Company Act of 1940); an investment company registered with the SEC under the Investment Company Act; a state or political subdivision thereof; or a pension or profit sharing plan subject to Employee Retirement Income Security Act (ERISA) or of an agency of the United States or of a state or a political subdivision thereof.

      Highly Rated Foreign Sovereign Debt Securities

      The term "highly rated foreign sovereign debt securities" means any debt securities (including major foreign sovereign debt securities) issued or guaranteed by the government of a foreign country, its provinces, state or cities, or a supranational entity, if at the time of the extension of credit the issue, the issuer or guarantor, or any other outstanding obligation of the issuer or guarantor ranked junior to or on a parity with the issue or the guarantee is assigned a rating (implicitly or explicitly) in one of the top two rating categories by at least one nationally recognized statistical rating organization.

      Investment Grade Debt Securities

      The term "investment grade debt securities" means any debt securities (including those issued by the government of a foreign country, its provinces, states, or cities, or a supranational entity), if at the time of the extension of credit the issue, the issuer, or guarantor, or any other outstanding obligation of the issuer or guarantor ranked junior to or on a parity with the issue or the guarantee is assigned a rating (implicitly or explicitly) in one of the top four rating categories by at least one nationally recognized statistical rating organization.

      Major Foreign Sovereign Debt

      The term "major foreign sovereign debt" means any debt securities issued or guaranteed by the government of a foreign country or a supranational entity, if, at the time of the extension of credit, the issue, the issuer or guarantor, or any other outstanding obligation of the issuer or guarantor ranked junior to or on a parity with the issue or the guarantee is assigned a rating (implicitly or explicitly) in the top rating category by at least one nationally recognized statistical rating organization.

      Mortgage-Related Securities

      The term "mortgage-related securities" means securities falling within the definition in Section 3(a)(41) of the Act.

      Exempt Account

      The term "exempt account" means a member, non-member broker/dealer registered as a broker or dealer under the Act, or "designated account." In addition, an "exempt account" may be any person who has a net worth of at least $45 million and financial assets of at least $40 million for purposes of subparagraphs (e)(2)(F) and (e)(2)(G) and either: (1) has securities registered pursuant to Section 12 of the Act and has been subject to the reporting requirements of Section 13 of the Act for a period of at least 90 days and has filed all the reports required to be filed thereunder during the preceding 12 months (or such shorter period as it was required to file such reports), or (2) has securities registered pursuant to the Securities Act of 1933, has been subject to the reporting requirements of Section 15(d) of the Act for a period of at least 90 days and has filed all the reports required to be filed thereunder during the preceding 12 months (or such shorter period as it was required to file such reports); or (3) if such person is not subject to Section 13 or 15(d) of the Act, it is a person with respect to which there is publicly available the information specified in paragraphs (a)(5)(i) to (xiv), inclusive, of Rule 15c2-11 under the Act; or (4) furnishes information to the SEC as required by Rule 12g3-2(b) of the Act; or (5) makes available to the member such current information regarding such person's ownership, business, operations, and financial condition (including such person's current audited statement of financial condition, statement of income, and statement of changes in stockholder's equity or comparable financial reports), as reasonably believed by the member to be accurate, sufficient for the purposes of performing a risk analysis in respect of such person.

      Non-Equity Securities

      The term "non-equity securities" means any securities other than equity securities as defined in Section 3(a)(11) of the Act.

      Listed Non-Equity Securities

      The term "listed non-equity securities" means any non-equity securities that are listed on a national securities exchange or have unlisted trading privileges on a national securities exchange.

      Other Marginable Non-Equity Securities

      The term "other marginable non-equity securities" means any debt securities not traded on a national securities exchange meeting all of the following requirements: (1) at the time of the original issue, a principal amount of not less than $25,000,000 of the issue was outstanding; (2) the issue was registered under Section 5 of the Securities Act of 1933 and the issuer either files periodic reports pursuant to Section 13(a) or 15(d) of the Act or is an insurance company that meets all of the conditions specified in Section 12(g)(2)(G) of the Act; and (3) at the time of the extensions of credit, the creditor has a reasonable basis for believing that the issuer is not in default on interest or principal payments; or, "other marginable non-equity securities" means any private pass-through securities (not guaranteed by any agency of the U.S. government) meeting all of the following requirements: (1) an aggregate principal amount of not less than $25,000,000 (which may be issued in series) was issued pursuant to a registration statement filed with the SEC under Section 5 of the Securities Act of 1933; (2) current reports relating to the issue have been filed with the SEC; and (3) at the time of the credit extension, the creditor has a reasonable basis for believing that mortgage interest, principal payments, and other distributions are being passed through as required and that the servicing agent is meeting its material obligations under the terms of the offering.

      Reduced Customer Maintenance Margin Requirements For Non-Equity Securities Held By Other Than Exempt Accounts

      Amended Rule 2520 establishes margin requirements for investment-grade debt securities and exempted securities other than U.S. debt securities that are comparable to the highest haircut percentages under the SEC's Net Capital Rule for proprietary positions in similar securities. The margin requirements for retail customers for nonequity securities that are not held in exempt accounts are as follows:

      • For investment-grade non-equity securities—reduced from 20% of current market value to 10% of current market value;


      • For exempted securities other than U.S. government debt—reduced from 15% of the current market value to 7% of current market value;


      • For highly rated foreign sovereign debt—the amounts specified for U.S. debt securities (1% to 6% of current market value, depending on the time to maturity);


      • For all other listed non-equity securities and other marginable non-equity securities—the percentage remains at 20% of current market value or 7% of the principal amount, whichever is greater.

      Good Faith Margin Treatment For Certain Non-Equity Securities Held By Exempt Accounts

      Rule 2520(2)(e)(F), as amended, will permit broker/dealers to effect transactions by persons or entities that qualify as "exempt accounts" without being required to collect either margin or marked to the market losses on exempted securities, mortgagerelated securities, or major foreign sovereign debt securities. However, a broker/dealer must take a capital charge for any uncollected marked to the market losses on exempt account positions in these securities.

      Rule 2520(e)(2)(G), as amended, establishes a margin requirement of:

      • 0.5% for transactions in exempt accounts involving highly rated foreign sovereign debt; and


      • 3% for transactions in investment-grade debt.

      Although a broker/dealer is not required to collect this margin, it must take a capital charge for any uncollected margin subject to the limitations provided in Rule 2520(e)(2)(H).

      Limitation on Capital Charges

      Rule 2520(e)(2)(H) limits the amount of capital charges a broker/dealer may take in lieu of collecting marked to the market losses. Specifically, when marked to market losses exceed either: (1) 5% of the broker/dealer's tentative net capital on any one account or group of commonly controlled accounts; or (2) 25% of the broker/dealer's tentative net capital on all accounts combined continue to exist on the fifth business day after they were incurred, the member must provide NASD with written notification and may not enter into any new transactions that would result in an increase in the amount of the excess.

      Written Risk Analysis

      Rule 2520(e)(2)(H) requires members to establish and maintain a "written risk analysis methodology" when extending margin on "good faith" securities transactions in "exempt accounts." This written risk methodology should include the following:

      • Procedures for obtaining and reviewing the appropriate customer account documentation and the customer financial information necessary to determine exempt account status for the extension of credit under the Rule.


      • Procedures and guidelines for the determination, review, and approval of credit limits to customers and across all customers who qualify as exempt accounts under the Rule.


      • Procedures and guidelines for monitoring credit risk exposure to the organization relating to exempt account customers.


      • Procedures and guidelines for the use of stress testing of exempt accounts in order to monitor market risk exposure from exempt accounts individually and in the aggregate.


      • Procedures providing for the regular review and testing of these risk management procedures by an independent unit such as internal audit, risk management, or other comparable group.


      1 See Release No. 34-48407 (File No. SR-NASD-2000-08 (August 25, 2003), 68 Federal Register 52259 (Sept. 2, 2003).

      2 The provisions of the proposed rule change are consistent with revisions to New York Stock Exchange (NYSE) Rule 431 that were approved on by the SEC on August 19, 2003 (Exchange Act Rel. No. 34-48365).

      3 Regulation T defines "good faith" margin as the amount of margin that a broker/dealer would require in exercising sound credit judgment.


      Attachment A

      Additions are underlined; deletions are in brackets.

      2520.   Margin Requirements

      (a) Definitions

      For purposes of this paragraph, the following terms shall have the meanings specified below:
      (1) through (3) No Change
      (4) The term "designated account" means the account of: [a bank, trust company, insurance company, investment trust, state or political subdivision thereof, charitable or nonprofit educational institution regulated under the laws of the United States or any state, or pension or profit sharing plan subject to ERISA or of any agency of the United States or of a state or a political subdivision thereof.]
      (A) a bank (as defined in Section 3(a)(6) of the Act),
      (B) a savings association (as defined in Section 3(b) of the Federal Deposit Insurance Act), the deposits of which are insured by the Federal Deposit Insurance Corporation,
      (C) an insurance company (as defined in Section 2(a)(17) of the Investment Company Act of 1940),
      (D) an investment company registered with the Securities and Exchange Commission (SEC) under the Investment Company Act,
      (E) a state or political subdivision thereof, or
      (F) a pension or profit sharing plan subject to Employee Retirement Income Security Act (ERISA) or of an agency of the United States or of a state or a political subdivision thereof.
      (5) through (8) No Change
      (9) The term "highly rated foreign sovereign debt securities" means any debt securities (including major foreign sovereign debt securities) issued or guaranteed by the government of a foreign country, its provinces, state or cities, or a supranational entity, if at the time of the extension of credit the issue, the issuer or guarantor, or any other outstanding obligation of the issuer or guarantor ranked junior to or on a parity with the issue or the guarantee is assigned a rating (implicitly or explicitly) in one of the top two rating categories by at least one nationally recognized statistical rating organization.
      (10) The term "investment grade debt securities" means any debt securities (including those issued by the government of a foreign country, its provinces, states or cities, or a supranational entity), if at the time of the extension of credit the issue, the issuer or guarantor, or any other outstanding obligation of the issuer or guarantor ranked junior to or on a parity with the issue or the guarantee is assigned a rating (implicitly or explicitly) in one of the top four rating categories by at least one nationally recognized statistical rating organization.
      (11) The term "major foreign sovereign debt" means any debt securities issued or guaranteed by the government of a foreign country or a supranational entity, if at the time of the extension of credit the issue, the issuer or guarantor, or any other outstanding obligation of the issuer or guarantor ranked junior to or on a parity with the issue or the guarantee is assigned a rating (implicitly or explicitly) in the top rating category by at least one nationally recognized statistical rating organization.
      (12) The term "mortgage related securities" means securities falling within the definition in Section 3(a)(41) of the Act.
      (13) The term "exempt account" means: [a member, non-member broker/dealer registered as a broker or dealer under the Act, "designated account," or any person having a net worth of at least forty-five million dollars and financial assets of at least forty-million dollars.]
      (A) a member, non-member broker/dealer registered as a broker or dealer under the Act, a "designated account," or
      (B) any person that:
      (i) has a net worth of at least forty-five million dollars and financial assets of at least forty-million dollars for purposes of subparagraphs (e)(2)(F) and (e)(2)(G), and
      (ii) either:
      a. has securities registered pursuant to Section 12 of the Act, has been subject to the reporting requirements of Section 13 of the Act for a period of at least 90 days and has filed all the reports required to be filed thereunder during the preceding 12 months (or such shorter period as it was required to file such reports), or
      b. has securities registered pursuant to the Securities Act of 1933, has been subject to the reporting requirements of Section 15(d) of the Act for a period of at least 90 days and has filed all the reports required to be filed thereunder during the preceding 12 months (or such shorter period as it was required to file such reports), or
      c. if such person is not subject to Section 13 or 15(d) of the Act, is a person with respect to which there is publicly available the information specified in paragraphs (a)(5)(i) to (xiv), inclusive, of Rule 15c2-11 under the Act, or
      d. furnishes information to the Securities and Exchange Commission as required by Rule 12g3-2(b) of the Act, or
      e. makes available to the member such current information regarding such person's ownership, business, operations and financial condition (including such person's current audited statement of financial condition, statement of income and statement of changes in stockholder's equity or comparable financial reports), as reasonably believed by the member to be accurate, sufficient for the purposes of performing a risk analysis in respect of such person.
      (14) The term "non-equity securities" means any securities other than equity securities as defined in Section 3(a)(11) of the Act.
      (15) The term "listed non-equity securities" means any non-equity securities that: (A) are listed on a national securities exchange; or (B) have unlisted trading privileges on a national securities exchange.
      (16) The term "other marginable non-equity securities" means:
      (A) Any debt securities not traded on a national securities exchange meeting all of the following requirements:
      (i) At the time of the original issue, a principal amount of not less than $25,000,000 of the issue was outstanding;
      (ii) The issue was registered under Section 5 of the Securities Act of 1933 and the issuer either files periodic reports pursuant to Section 13(a) or 15(d) of the Act or is an insurance company which meets all of the conditions specified in Section 12(g)(2)(G) of the Act; and
      (iii) At the time of the extensions of credit, the creditor has a reasonable basis for believing that the issuer is not in default on interest or principal payments; or
      (B) Any private pass-through securities (not guaranteed by any agency of the U.S. government) meeting all of the following requirements:
      (i) An aggregate principal amount of not less than $25,000,000 (which may be issued in series) was issued pursuant to a registration statement filed with the SEC under Section 5 of the Securities Act of 1933;
      (ii) Current reports relating to the issue have been filed with the SEC; and
      (iii) At the time of the credit extension, the creditor has a reasonable basis for believing that mortgage interest, principal payments and other distributions are being passed through as required and that the servicing agent is meeting its material obligations under the terms of the offering.
      (b)(1) through (e)(1) No change.
      (e)(2) Exempted Securities, [Marginable Corporate Debt Securities] Non-equity Securities and Baskets
      (A) Obligations of the United States and Highly Rated Foreign Sovereign Debt Securities

      On net "long" or net "short" positions in obligations (including zero coupon bonds, i.e., bonds with coupons detached or non-interest bearing bonds) issued or guaranteed as to principal or interest by the United States Government or [issued or guaranteed] by corporations in which the United States has a direct or indirect interest as shall be designated for exemption by the Secretary of the Treasury, or in obligations that are highly rated foreign sovereign debt securities, the margin to be maintained shall be the percentage of the current market value of such obligations as specified in the applicable category below:
      (i) Less than one year to maturity - 1 percent
      (ii) One year but less than three years to maturity - 2 percent
      (iii) Three years but less than five years to maturity - 3 percent
      (iv) Five years but less than ten years to maturity - 4 percent
      (v) Ten years but less than twenty years to maturity - 5 percent[, or]
      (vi) Twenty years or more to maturity - 6 percent
      Notwithstanding the above, on zero coupon bonds with five years or more to maturity the margin to be maintained shall not be less than 3 percent of the principal amount of the obligation.

      When such obligations other than United States Treasury bills are due to mature in thirty calendar days or less, a member, at its discretion, may permit the customer to substitute another such obligation for the maturing obligation and use the margin held on the maturing obligation to reduce the margin required on the new obligation, provided the customer has given the member irrevocable instructions to redeem the maturing obligation.
      (B) All Other Exempted Securities

      On any positions in exempted securities other than obligations of the United States, the margin to be maintained shall be [15] 7 percent of the current market value [or 7 percent of the principal amount of such obligation, whichever amount is greater].
      (C) [Non-Convertible Corporate Debt] Non-Equity Securities

      On any positions in [non-convertible corporate debt] non-equity securities, [which are listed or traded on a registered national securities exchange or qualify as an "OTC margin bond," as defined in Section 220.2(t) of Regulation T of the Board of Governors of the Federal Reserve System], the margin to be maintained (except where a lesser requirement is imposed by other provisions of this Rule) shall be:
      (i) 10 percent of the current market value in the case of investment grade debt securities; and
      (ii) 20 percent of the current market value or 7 percent of the principal amount, whichever amount is greater, in the case of all other listed non-equity securities, and all other marginable non-equity securities as defined in paragraph (a)(16) of this Rule [except on mortgage related securities as defined in Section 3(a)(41) of the Act the margin to be maintained for an exempt account shall be 5 percent of the current market value. For purposes of this subparagraph, an exempt account shall be defined as a member, non-member broker/dealer, "designated account" or any person having net tangible assets of at least sixteen million dollars].
      (D) and (E) No Change.
      (F) [Cash] Transactions With [Customers] Exempt Accounts Involving Certain "Good Faith" Securities

      [When a customer purchases an issued exempted security from or through a member in a cash account, full payment shall be made promptly. If, however, delivery or payment therefor is not made promptly after the trade date, a deposit shall be required as if it were a margin transaction, unless it is a transaction with a "designated account."]

      On any position resulting from a transaction [in issued] involving exempted securities, mortgage related securities, or major foreign sovereign debt securities [made for a member, or a non-member broker/dealer, or] made for or with [a "designated] an "exempt account," no margin need be required and any marked to the market loss on such position need not be [marked to the market] collected. However, [where such position is not marked to the market, an amount equal to the loss at the market in such position] the amount of any uncollected marked to the market loss shall be [charged against] deducted in computing the member's net capital as provided in SEC Rule 15c3-1, subject to the limits provided in paragraph (e)(2)(H) below.
      (G) Transactions With Exempt Accounts Involving Highly Rated Foreign Sovereign Debt Securities and Investment Grade Debt Securities

      On any position resulting from a transaction made for or with an "exempt account" (other than a position subject to paragraph (e)(2)(F)), the margin to be maintained on highly rated foreign sovereign debt and investment grade debt securities shall be, in lieu of any greater requirements imposed under this Rule, (i) 0.5 percent of current market value in the case of highly rated foreign sovereign debt securities, and (ii) 3 percent of current market value in the case of all other investment grade debt securities. The member need not collect any such margin, provided the amount equal to the margin required shall be deducted in computing the member's net capital as provided in SEC Rule 15c3-1, subject to the limits provided in paragraph (e)(2)(H) below.
      (H) Limits on Net Capital Deductions for Exempt Accounts
      (i) Members [organizations] shall maintain a written risk analysis methodology for assessing the amount of credit extended to exempt accounts pursuant to paragraphs (e)(2)(F) and (e)(2)(G) which shall be made available to the Association upon request.
      (ii) In the event that the deductions of securities positions from net capital deductions taken by a member as a result of marked to the market losses incurred under paragraphs (e)(2)(F) and (e)(2)(G) (exclusive of the percentage requirements established thereunder) exceed:
      a. on any one account or group of commonly controlled accounts, 5 percent of the member's tentative net capital, or
      b. on all accounts combined, 25 percent of the member's tentative net capital, and, such excess exists on the fifth business day after it was incurred, the member shall give prompt written notice to the Association and shall not enter into any new transaction(s) subject to the provisions of paragraphs (e)(2)(F) or (e)(2)(G) that would result in an increase in the amount of such excess under, as applicable, subparagraph a. or b. above.

    • 03-65 NASD Revises NASD Sanction Guidelines

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      INFORMATIONAL

      Sanction Guidelines

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Legal & Compliance
      Registered Representatives
      Senior Management

      NASD Sanction Guidelines
      Rule 3030
      Outside Business Activities
      Rule 3040
      Selling Away
      Recidivists

      Executive Summary

      The NASD Sanction Guidelines (Guidelines) are used by the various bodies that adjudicate disciplinary matters (Adjudicators) in determining appropriately remedial sanctions. NASD staff and respondents also may use these Guidelines in crafting settlements. The Guidelines were initially published in 1993 and have been periodically revised to promote consistency and uniformity in the imposition of sanctions in disciplinary matters. The Guidelines contain an introductory section that explains the purpose of NASD disciplinary sanctions and sets forth certain generally applicable principles and considerations for determining appropriately remedial sanctions. The Guidelines also specify the range of monetary and non-monetary sanctions generally used for particular violations.

      This Notice advises NASD members and Adjudicators of modifications to: (1) General Principles Applicable To All Sanction Determinations regarding the concept of progressive discipline (General Principle No. 2); (2) the Outside Business Activities - Failure to Comply With Rule Requirements Guideline; and (3) the Selling Away (Private Securities Transactions) Guideline. These Guidelines and General Principle No. 2, as modified, supersede the Outside Business Activities - Failure to Comply With Rule Requirements and Selling Away (Private Securities Transactions) Guidelines and General Principle No. 2 previously published by NASD and referenced in prior Notices to Members. The changes are effective as of December 1, 2003, and apply to all actions as of that date, including pending disciplinary cases.

      These Guidelines and General Principle No. 2, as modified, may be read in their entirety in Attachment A to this Notice. The revised Guidelines and General Principle No. 2 also will be available on the NASD Web Site (www.nasdr.com).

      Questions/Further Information

      Questions concerning this Notice may be directed to the Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8071.

      Discussion

      General Principle No. 2

      The Guidelines advise that General Principles Applicable to All Sanction Determinations should be considered in connection with the imposition of sanctions in all cases. General Principle No. 2 addresses the concept of deterring future misconduct by imposing progressively escalating sanctions on respondents who have engaged in past misconduct. Although registered persons with significant histories of disciplinary events constitute a small minority of industry participants, the potential negative impact of these few individuals on public investors may be significant.

      The changes to General Principle No. 2 reaffirm for Adjudicators that sanctions for recidivists should be more severe. General Principle No. 2 now clarifies, however, that more severe sanctions for recidivists need not remain within the range recommended in a particular guideline but can increase to a level beyond those recommended in a guideline. General Principle No. 2 also advises Adjudicators that progressively escalating sanctions for recidivists can include barring registered persons and expelling firms. Moreover, General Principle No. 2 advises Adjudicators always to consider a respondent's disciplinary history in determining sanctions.

      Outside Business Activities - Failure To Comply With Rule Requirements (NASD Conduct Rules 2110 and 3030)

      Rule 3030 requires registered persons to give their employer member firms prompt written notice of any business activity, other than a passive investment, that is outside the scope of their relationship with their firms. Private securities transactions are not covered by from this requirement and, instead, are subject to the requirements of Rule 3040.

      NASD has modified the principal considerations in the Outside Business Activities Guideline to emphasize to Adjudicators the importance of determining whether:

      • the outside activity involved customers of the firm;


      • the registered person's marketing and sale of the product or service could have created the impression that the employing member firm had approved the product or service;


      • the registered person misled his or her employer member firm about the existence of the outside activity or otherwise concealed the activity from the firm; and


      • the outside business activity caused injury to customers of the firm.

      The Guideline recommends that Adjudicators consider suspensions for up to 30 days in cases where the outside business activities do not involve aggravating conduct and suspensions of up to one year where there is aggravating conduct. In egregious cases, the Guideline recommends considering a longer suspension or a bar. Adjudicators should also consider other factors as described in the Principal Considerations for the Outside Business Activities Guideline and the General Principles Applicable to All Guidelines.

      Selling Away (Private Securities Transactions) (NASD Conduct Rules 2110 and 3040)

      Rule 3040 sets forth the reporting requirements for registered persons who wish to participate in any manner in a private securities transaction (i.e., sell securities away from their firm). NASD has modified the Selling Away Guideline to give firms and Adjudicators guidance on the methodology to be used in determining sanctions and the factors that will be considered in determining the seriousness of the violation when the associated person has been found to have failed to comply with the requirements of Rule 3040.

      The Guideline advises Adjudicators that the first step is to assess the extent of the selling away, including the dollar amount of sales, the number of customers, and the length of time over which the selling away occurred. Following this assessment, Adjudicators are advised to consider other factors as described in the Principal Considerations for the Selling Away Guideline and the General Principles Applicable to All Guidelines. The Guideline reminds Adjudicators that the presence of one or more mitigating or aggravating factors may either raise or lower sanctions.

      With slight modifications, the five Principal Considerations in the previous Guideline have been kept in the revised Selling Away Guideline. To help Adjudicators determine appropriate sanctions, the revised Guideline adds eight new Principal Considerations. These include:

      • a quantitative analysis of the dollar volume of sales, the number of customers, and the length of time over which the selling away activity occurred;


      • whether the product sold away has been found to involve a violation of federal or state securities laws or federal, state or SRO rules;


      • whether the selling away resulted in injury to the investing public;


      • the extent of the respondent's involvement in the selling away, i.e., whether the respondent referred customers or sold the product directly to customers and whether the respondent recruited other registered individuals to sell the product; and


      • whether the respondent misled his or her employer about the existence of the selling away activity or otherwise concealed the selling away activity from the firm.

      Effective Date

      These Guidelines and General Principle No. 2, as modified, supersede the Selling Away and Outside Business Activities Guidelines and General Principle No. 2 published by NASD in 2002 and referenced in prior NASD Notices to Members. The changes are effective as of December 1, 2003, and apply to all actions as of that date, including pending disciplinary cases.

      NASD Sanction Guildlines

      1. Activity Away From Associated Person's Member Firm

      Outside Business Activities—Failure To Comply With Rule Requirements

      NASD Conduct Rules 2110 And 3030

      Principal Considerations in Determining Sanctions Monetary Sanction Suspension, Bar or Other Sanction
      See Principal Considerations in Introductory Section    
      1. Whether the outside activity involved customers of the firm.
      2. Whether the outside activity resulted directly or indirectly in injury to customers of the firm and, if so, the nature and extent of the injury.
      3. The duration of the outside activity, the number of customers, and the dollar volume of sales.
      4. Whether the respondent's marketing and sale of the product or service could have created the impression that the employer (member firm) had approved the product or service.
      5. Whether the respondent misled his or her employer member firm about the existence of the outside activity or otherwise concealed the activity from the firm.
      Fine of $2,500 to $50,000.1 When the outside business activities do not involve aggravating conduct, consider suspending respondent for up to 30 business days.

      When the outside business activities involve aggravating conduct, consider a longer suspension of up to one year.

      In egregious cases, including those involving a substantial volume of activity or significant injury to customers of the firm, consider a longer suspension or a bar.

      1 As set forth in General Principle No. 6, Adjudicators may increase the recommended fine amount by adding the amount of a respondent's financial benefit.

      Selling Away (Private Securities Transactions)

      NASD Conduct Rules 2110 And 3040

      Principal Considerations in Determining Sanctions Monetary Sanction Suspension, Bar or Other Sanction
      See Principal Considerations in Introductory Section Associated Person Associated Person
      1. The dollar volume of sales.
      2. The number of customers.
      3. The length of time over which the selling away activity occurred.
      4. Whether the product sold away has been found to involve a violation of federal or state securities laws or federal, state or SRO rules.
      5. Whether the respondent had a proprietary or beneficial interest in, or was otherwise affiliated with, the selling enterprise or issuer and, if so, whether respondent disclosed this information to his or her customers.
      6. Whether respondent attempted to create the impression that his or her employer (member firm) sanctioned the activity, for example, by using the employer's premises, facilities, name, and/or goodwill for the selling away activity or by selling a product similar to the products that the employer (member firm) sells.
      7. Whether the respondent's selling away activity resulted, either directly or indirectly, in injury to the investing public and, if so, the nature and extent of the injury.
      Fine of $5,000 to $50,000.1 The first step in determining sanctions is to assess the extent of the selling away, including the dollar amount of sales, the number of customers, and the length of time over which the selling away occurred. Adjudicators should consider the following range of sanctions based on the dollar amount of sales:

      • Up to $100,000 in sales: 10 business days to 3 months


      • $100,000 to $500,000: 3 to 6 months


      • $500,000 to $1,000,000: 6 to 12 months


      • Over $1,000,000: 12 months to a bar

      Following this assessment, Adjudicators should consider other factors as described in the Principal Considerations for this Guideline and the General Principles applicable to all Guidelines. The presence of one or more mitigating or aggravating factors may either raise or lower the above-described sanctions.
      8. Whether respondent sold away to customers of his or her employer (member firm).
      9. Whether respondent provided his or her employer firm with verbal notice of the details of the proposed transaction and, if so, the firm's verbal or written response, if any.
      10. Whether respondent sold away after being instructed by his or her firm not to sell the type of the product involved or to discontinue selling the specific product involved in the case.
      11. Whether respondent participated in the sale by referring customers or selling the product directly to customers.
      12. Whether respondent recruited other registered individuals to sell the product.
      13. Whether respondent misled his or her employer (member firm) about the existence of the selling away activity or otherwise concealed the selling away activity from the firm.
      Where member firm receives written notice of a private securities transaction, but fails to provide written notice of approval, disapproval, or acknowledgment, fine of $2,500 to $10,000.2 Where member firm receives written notice of a private securities transaction, but fails to provide written notice of approval, disapproval, or acknowledgment, consider suspending responsible supervisory personnel in any or all capacities for up to two years.

      1 As provided for in General Principle No. 6, Adjudicators should increase the recommended fine amount by adding the amount of a respondent's financial benefit.

      2 If the allegations involve a member's failure to supervise the selling away activity, then Adjudicators should also consider the Supervision-Failure To Supervise guideline.

      General Principles Applicable To All Sanction Determinations

      2. Disciplinary Sanctions Should Be More Severe For Recidivists.

      An important objective of the disciplinary process is to deter and prevent future misconduct by imposing progressively escalating sanctions on recidivists beyond those outlined in these guidelines, up to and including barring registered persons and expelling firms. Adjudicators should always consider a respondent's disciplinary history in determining sanctions. Adjudicators should consider imposing more severe sanctions when a respondent's disciplinary history includes (a) past misconduct similar to that at issue; or (b) past misconduct that evidences disregard for regulatory requirements, investor protection, or commercial integrity. Even if a respondent has no history of relevant misconduct, however, the misconduct at issue may be so serious as to justify sanctions beyond the range contemplated in the guidelines, i.e., an isolated act of egregious misconduct could justify sanctions significantly above or different from those recommended in the guidelines.

      Certain regulatory incidents are not relevant to the determination of sanctions. Arbitration proceedings, whether pending, settled, or litigated to conclusion, are not "disciplinary" actions. Similarly, pending investigations or the existence of ongoing regulatory proceedings prior to a final decision are not relevant.

      In certain cases, particularly those involving quality-of-markets issues, these guidelines recommend increasingly severe monetary sanctions for second and subsequent disciplinary actions. This escalation is consistent with the concept that repeated acts of misconduct call for increasingly severe sanctions.

    • 03-64 New Arbitrator Applicants Must Undergo Background Verification and Pay Fee

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      INFORMATIONAL

      SEC Approves Arbitrator Background Verification Process

      Effective Date: October 1, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Senior Management

      Arbitration

      Executive Summary

      On September 25, 2003, the Securities and Exchange Commission (SEC) approved a proposal to conduct background verification and charge an application fee for NASD neutral roster applicants.1

      Questions/Further Information

      Questions regarding this Notice may be directed to Jean I. Feeney, Vice President and Chief Counsel, NASD Dispute Resolution, at (202) 728-6959 or jean.feeney@nasd.com; or Barbara L. Brady, Associate Vice President and Director of Neutral Management, at (212) 858-4352 or barbara.brady@nasd.com.

      Discussion

      Background

      NASD maintains a pool of approximately 7,000 available arbitrators. Arbitrator applicants submit biographical profile forms, together with two letters of reference. The biographical profile forms require applicants to provide detailed information on their business and employment histories, education, training, possible conflicts, experience, expertise, associations with industry members, and other matters. The application also requires a narrative background information statement in which applicants are asked to explain why they believe their experience and knowledge would benefit the process. Attorneys and accountants are further directed to provide specific details about their practices.

      Arbitrator information is entered into NASD's database and is provided to parties in the form of a disclosure report during the arbitrator selection process. Arbitrators must update this biographical information on a regular basis. NASD sends frequent reminders to arbitrators about the importance of this obligation, especially after they are notified regarding possible service as an arbitrator. NASD requires arbitrators in each case to affirm that they have reviewed their disclosure report and that it is accurate, and to complete a disclosure checklist attached to the oath. NASD provides each arbitrator on a panel with the co-panelists' biographical profiles in order to facilitate peer reviews for accuracy.

      In addition to gathering the above information, NASD currently checks records on the Central Registration Depository (CRD) for arbitrator applicants who have been registered with NASD, most of whom would be categorized as "non-public" arbitrators under NASD Rule 10308(a)(4). NASD has not verified the information provided by arbitrator applicants who do not have CRD records, most of whom would be classified as "public" arbitrators under NASD Rule 10308(a)(5).

      New Background Verification Procedure

      Effective October 1, 2003, NASD has expanded its verification of background information to cover all arbitrator applicants. This will provide additional protection to parties using the Dispute Resolution forum, raise the standards of the neutral roster, and enhance investor confidence in the integrity of the forum. NASD Dispute Resolution has engaged a vendor to provide the following verification services:

      • Criminal check in the county of the applicant's residence;


      • Federal criminal check;


      • Employment verification; and


      • Professional license verification.

      The verification fee will be $80 per application. For this amount, the vendor will perform county and federal criminal record checks; verify any professional licenses; and check the last employer or, if the applicant has been employed for fewer than ten years by the same employer, then the last two employers. To keep the fee reasonable, NASD will assume that verification of professional licenses provides an indirect check on the applicant's education, since licensing authorities generally verify an applicant's educational history. If the applicant does not have a professional license, however, then the vendor will substitute verification of the last degree awarded.

      The background verification fee will be charged for new arbitrator applications that are received by NASD after the effective date of the new procedure, which is October 1, 2003. It will not apply to arbitrators currently on NASD's arbitrator roster who wish to update information they supplied previously. Applications received after the effective date will not be processed until NASD receives the proper fee.

      Effective Date

      The new process is effective for arbitrator applications received after October 1, 2003.


      1 Securities Exchange Act Release No. 48541 (September 25, 2003), 68 Federal Register 56661 (October 1, 2003) (File No. SR-NASD-2003-122).

    • 03-63 SEC Issues Guidance on the Recording of Expenses and Liabilities by Broker/Dealers

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      ACTION REQUIRED

      Expense-Sharing Agreements

      SUGGESTED ROUTING

      KEY TOPICS

      Accounting
      Executive Representatives
      Internal Audit
      Legal & Compliance
      Operations
      Senior Management

      Expense-Sharing Agreements
      Net Capital
      Recordkeeping
      SEC Rule 15c3-1
      SEC Rules 17a-3, 17a-4, and 17a-5

      Executive Summary

      On July 11, 2003, the Securities and Exchange Commission (SEC) Division of Market Regulation (DMR) issued a letter (the "Letter") to clarify its position under SEC Rules 15c3-1, 17a-3, 17a-4, and 17a-5 (collectively, the "financial responsibility rules") regarding the treatment of broker/dealer expenses and liabilities. The Letter addresses situations in which another party has agreed to pay expenses related to the business of the broker/dealer. The Letter's requirements became effective when it was issued; however, the DMR and NASD recognize that some firms may need time to revise existing agreements and to obtain required documentation. NASD members must be able to demonstrate compliance with the requirements stated in the Letter (a copy of which is attached) by no later than December 1, 2003.

      Questions/Further Information

      Questions concerning this Notice to Members may be directed to NASD's Financial Operations Department at (202) 728-8221.

      Background

      Both NASD and the New York Stock Exchange (NYSE) (collectively, the self-regulatory organizations or the SROs) have become increasingly concerned that some broker/dealers are using expense-sharing agreements as a basis for not recording expenses and liabilities on the broker/dealer's books and records.1 In such circumstances, the books and records of the broker/dealer may not accurately reflect its operating performance and financial condition and may appear to artificially inflate its profitability and, ultimately, cause it to appear to be in capital compliance when it is not. Further, such firms may continue to conduct a securities business when not in capital compliance, which is a violation of the SEC's Net Capital Rule, as well as a violation of NASD Rule 2110. In addition, as the party paying the expenses of the broker/dealer is usually not a member of an SRO, obtaining books and records related to the broker/dealer's operations can be problematic. As a result, the SROs requested guidance from the DMR concerning the application of the financial responsibility rules when a third party, which may include a parent, holding company, or affiliate of a broker/dealer, agrees to assume responsibility for payment of the broker/dealer's expenses.

      Recording Certain Broker/Dealer Expenses and Liabilities

      The Letter addresses nine items/requirements based on how a broker/dealer incorporates an expense-sharing agreement into its operations. For clarification, the nine requirements are repeated below with additional information provided by NASD to explain the requirements of the letter.2

      1. Pursuant to Exchange Act Rule 17a-3(a)(1) and (a)(2), a broker-dealer must make a record reflecting each expense incurred relating to its business and any corresponding liability, regardless of whether the liability is joint or several with any person and regardless of whether a third party has agreed to assume the expense or liability. A broker-dealer must make a record of each expense incurred relating to its business, including the value of any goods or services used in its business, when a third party has furnished the goods or services or has paid or has agreed to pay the expense or liability, whether or not the recording of the expense is required by GAAP and whether or not any liability relating to the expense is considered a liability of the broker-dealer for net capital purposes. One proper method is to record the expense in an amount that is determined according to an allocation made by the third party on a reasonable basis.

      For purposes of this Letter, expenses include all costs for which a broker/dealer would derive direct or indirect benefit and/or for which a broker/dealer would be responsible if another entity had not agreed to pay for it. This would certainly include, but not be limited to, rent, telephone, copy services, etc. A broker/dealer's business is to be understood broadly. It includes the existence of the legal entity that is registered as a broker/dealer (even when not conducting a securities business) and all of that entity's activities (whether or not the activities are securities-related).

      The last sentence of this item indicates that a broker/dealer meets the requirements of the Letter if it records its expenses as incurred in amounts determined according to a reasonable allocation, applied on a consistent basis, of the costs assumed by the third party. A reasonable allocation is one that attempts to equate the proportional cost of a service or product to the proportional use of or benefit derived from the service or product. The broker/dealer must be prepared to provide the SROs with evidence of the reasonableness of the expenses.

      Members are advised that to the extent a third party pays certain expenses of a broker/dealer, particularly those costs related to compensation of its registered personnel, the third party may be required to register with the Securities and Exchange Commission as a broker/dealer in accordance with Section 15 of the Exchange Act.

      Further, members are cautioned that an arbitration award rendered against the broker/dealer is a liability of the broker/dealer until it is satisfied in an appropriate manner. See Notice to Members 00-63. NASD will consider any attempt to move the obligations associated with an unsatisfied arbitration award to a third party as a violation of NASD Rule 2110, and the firm may be subject to severe disciplinary action.

      Examples:

      Fact Patterns 1 and 2:
      1. An expense agreement provides that the broker/dealer will pay a certain monthly fee to an affiliated company "in consideration of the mutual covenants and agreements to be kept and performed on the part of the parties."
      2. An expense agreement states that the broker/dealer will pay its parent $25,000 per month for "management services and other administrative services" that the parent provides. The written agreement does not further define the services. The broker/dealer does not record any expenses such as rent, utilities, telephone, etc., and management says that all such expenses are included in the $25,000 per month fee.
      Analysis: In the computations of net capital, each broker/dealer in Fact Patterns 1 and 2 must reduce net worth by its actual expenses as if there were no expense agreement. An expense agreement must enumerate the services or products being provided to the broker/dealer, with a reasonable cost assigned to each.

      Fact Pattern 3:

      An expense agreement specifies that the broker/dealer will pay its holding company $1,000 per month for rent and $500 per month for utilities and telephone services. The broker/dealer occupies two floors of a three-story building, while the holding company and another affiliate occupy the third floor; the holding company pays $25,000 per month to rent the building, and pays $15,000 per month for telephones and utilities. Management states that the rent and utilities fees specified in the expense agreement are consistent with the business goals and objectives of both firms, and therefore have been allocated on a reasonable basis.

      Analysis: The expenses do not appear to be allocated on a reasonable basis. In its computation of net capital, the broker/dealer must reduce net worth by expenses allocated on a reasonable basis.
      2. If the broker-dealer does not record certain expenses on the reports it is required to file with the Commission or with its designated examining authority ("DEA") under the financial responsibility rules, the broker-dealer may satisfy the Exchange Act Rule 17a-3(a)(1) and (a)(2) requirement to make a record of those expenses by making a separate schedule of the expenses.

      To the extent a broker/dealer reflects its expenses and liabilities as part of its general ledger, and maintains proper backup documentation relative to the expense, no other documentation would be necessary relative to items 1 and 2 above. Otherwise, the broker/dealer must maintain the "record" as noted. This record must be updated as expenses are incurred similar to those records that support the broker/dealer's financial statements.
      3. If a third party agrees or has agreed to assume responsibility for an expense relating to the business of the broker-dealer, and the expense is not recorded on the reports the broker-dealer is required to file with the Commission or with its DEA under the financial responsibility rules, any corresponding liability will be considered a liability of the broker-dealer for net capital purposes unless:
      a. If the expense results in payment owed to a vendor or other party, the vendor or other party has agreed in writing that the broker-dealer is not directly or indirectly liable to the vendor or other party for the expense;
      b. The third party has agreed in writing that the broker-dealer is not directly or indirectly liable to the third party for the expense;
      c. There is no other indication that the broker-dealer is directly or indirectly liable to any person for the expense;
      d. The liability is not a liability of the broker-dealer under GAAP; and
      e. The broker-dealer can demonstrate that the third party has adequate resources independent of the broker-dealer to pay the liability or expense.

      The Net Capital Rule requires broker/dealers to have sufficient liquid capital to protect the assets of customers and to meet their obligations to other broker/dealers. In calculating net capital, broker/dealers begin with their net worth and then make various positive and negative adjustments. Item 3 refers to the requirement to charge a firm's net worth, in the computation of net capital, for any "liability" noted unless the broker/dealer can comply with all five conditions enumerated in 3(a) through 3(e).

      Item 3 indicates that a broker/dealer cannot avoid recording the expenses it incurs as a result of its activities by arranging to have a third party assume responsibility for such expenses, if the third party lacks adequate resources independent of the broker/dealer to pay the costs incurred by the broker/dealer. Further, if the broker/dealer remits funds to such third party, the broker/dealer is viewed as being indirectly liable for the expenses assumed by the third party, and would need to reflect those expenses on the reports it is required to file with the SEC under the financial responsibility rules, as a deduction from net worth in determining net capital.

      Upon entering into an expense-sharing agreement and annually thereafter, as of the broker/dealer's fiscal year-end, the broker/dealer has to obtain evidence that the third party has adequate resources independent of the broker/dealer to pay the costs incurred by the broker/dealer.

      i. If the third party is a reporting company under the Securities Act of 1933 and is current on all financial filings required under that Act, the firm may rely on those filings to determine whether the third party has adequate resources apart from the broker/dealer.
      ii. If the third party is not a reporting company under the Securities Act of 1933, the broker/dealer must obtain evidence pursuant to either a. or b. below, at a minimum, as well as further information as requested by NASD:
      a. A signed and dated copy of a complete set of the third party's most recent audited financial statements, but in no event with an as-of date older than 12 months; or a signed and dated copy of the third party's most current required Federal income tax return as it has been filed with the Internal Revenue Service within the last 12 months.
      b. If the shareholders, partners, or other owners of the third party want their abilities to infuse capital into the third party to be accepted as demonstrating adequate resources independent of the broker/dealer, they must, at a minimum, provide copies of their audited financial statements or Federal income tax returns, using the same twelve-month parameters as in a. Other additional evidence may also be required by NASD.
      With respect to the third party's financial statements, if, for example, the broker/dealer and the third party have a December 31st fiscal year-end, the broker/dealer could submit a copy of the third party's financial statements as of December 31st for the year prior. If the third party's fiscal year-end were June 30th, the broker/dealer would need to provide the third party's financial statements as of June 30th for the current year.
      Example:

      Fact Pattern 4:

      A broker/dealer has an expense agreement under which its parent pays the broker/dealer's rent of $10,000 per month, and GAAP (Generally Accepted Accounting Principles) does not require the broker/dealer to record a liability to either the vendor or the parent. The broker/dealer is unable to demonstrate to the SRO that the parent has adequate resources independent of the broker/dealer to pay the liability or expense. Analysis: In its computation of net capital, the firm must reduce net worth by the actual $10,000 rent expense. The firm must maintain a separate record of the rent expense.
      4. Any withdrawal of equity capital, as defined in paragraph (e)(4)(ii) of Exchange Act Rule 15c3-1, from a broker-dealer by a third party, other than a withdrawal described in paragraph (e)(4)(iii) of Exchange Act Rule 15c3-1, within three months before or within one year after the broker-dealer incurs an expense which the third party has paid or agreed to pay, will be presumed for net capital purposes to have been made to repay the third party for the expense of the broker-dealer, unless the broker-dealer's books and records reflect a liability to the third party relating to the expense.

      Paragraph (e)(4)(iii) indicates that the notice and limitation provisions on capital withdrawals do not preclude broker/dealers from making required tax payments or paying partners reasonable compensation and that such amounts are not included in the calculation of withdrawals, advances, or loans for the purposes of these provisions.

      Item 4 reaffirms the DMR's view that broker/dealers must maintain their financial records using an accrual basis of accounting. Capital withdrawals cannot be used as a means of timing the broker/dealer's recognition of the costs incurred in its operations.
      5. For purposes of determining net capital, if the broker-dealer records a capital contribution from a third party that has assumed responsibility for paying an expense of the broker-dealer, and the expense is not recorded on the reports the broker-dealer is required to file with the Commission or with its DEA under the financial responsibility rules, the broker-dealer must be able to demonstrate that the recording of a contribution to capital is appropriate. Among other things, the broker-dealer must be able to demonstrate that the third party has paid the expense or has adequate resources independent of the broker-dealer to pay the expense and that the brokerdealer has no obligation, direct or indirect, to a vendor or other party to pay the expense. For net capital purposes, any equity capital withdrawn by the third party, other than a withdrawal described in paragraph (e)(4)(iii) of Exchange Act Rule 15c3-1, within three months before or one year after the broker-dealer incurs the expense, will be deemed to have been a repayment of the expense to the third party. For net capital purposes, if a contribution to capital is made to a broker-dealer with an understanding that the contribution can be withdrawn at the option of the contributor, the contribution may not be included in the firm's net capital computation and must be re-characterized as a liability. Any withdrawal of capital as to that contributor within a period of one year, other than a withdrawal described in paragraph (e)(4)(iii) of Exchange Act Rule 15c3-1, shall be presumed to have been contemplated at the time of the contribution.

      Item 5 is similar to item 4, and reaffirms the DMR's view that broker/dealers must maintain their financial records using an accrual basis of accounting. The difference in the two items relates to the type of accounting treatment that the broker/dealer uses. Item 5 applies, for example, where the broker/dealer's actual expense to a vendor or service provider was recorded on the broker/dealer's general ledger as an expense and a related liability owed to the third party; the third party then forgave the liability, and the broker/dealer removed (debited) the (forgiven) liability and credited a capital contribution from the third party.

      The broker/dealer may not record the capital contribution until it demonstrates that the third party paid the expense, or has the financial wherewithal to pay the expense independent of the broker/dealer, and that the broker/dealer will not be obligated to repay the third party for any portion of the expense. To demonstrate the third party's ability to pay, the broker/dealer would need to provide the evidence discussed in the comments under item 3.

      Under items 4 and 5, a firm from which capital is withdrawn as described in those items will be required to recalculate its net capital beginning at the date of the incurrence of the expense which was paid by the third party, and to provide telegraphic notice as required per SEC Rule 17a-11, if necessary, based upon the revised computation.
      6. If a third party agrees or has agreed to assume responsibility for an expense of the broker-dealer, the broker-dealer must make, keep current, and preserve the following records pursuant to Exchange Act Rules 17a-3 and 17a-4:
      a. If a vendor or other party has agreed that the broker-dealer is not liable directly or indirectly to the vendor or other party for an expense, a written agreement between the broker-dealer and the vendor or other party that clearly states that the broker-dealer has no liability, direct or indirect, to the vendor or other party; and
      b. A record of each expense assumed by the third party.
      7. A broker-dealer must make, keep current, and preserve a written expense sharing agreement between the broker-dealer and a third party that has paid or agreed to pay an expense of the broker-dealer. The agreement must set out clearly which party is obligated to pay each expense, whether the broker-dealer has any obligation, direct or indirect, to reimburse or otherwise compensate any party for paying the expense, and, when the broker-dealer records the expense in an amount that is determined according to an allocation made by the third party, the method of allocation.
      8. Each broker-dealer and broker-dealer applicant must be able to demonstrate to the appropriate authorities that it is in compliance with the financial responsibility rules in connection with any expense-sharing agreement it has entered into, and therefore it may be required to provide these authorities with access to books and records, including those of unregistered entities, relating to the expenses covered by the agreement.

      If the broker/dealer does not provide appropriate access to all relevant books and records, including those of a third party with which it has an expense-sharing agreement, an SRO may operate under the rebuttable presumption that the broker/dealer was not in capital compliance for the period covered by the expense-sharing agreement.

      If the broker/dealer applicant does not provide appropriate access to all relevant books and records, including those of a party that has agreed to assume responsibility for paying all or a portion of the applicant's costs pursuant to paragraph (a)(7) of Membership and Registration Rule 1014, NASD will not permit the applicant to use an expense-sharing arrangement to demonstrate that it is capable of maintaining sufficient excess net capital to support its intended business operations on a continuing basis.
      9. A broker-dealer must notify its DEA if it enters into, or has entered into, an expense sharing agreement and the broker-dealer does not record each of the expenses it incurs relating to its business on the reports it is required to file with the Commission or with its DEA under the financial responsibility rules. The notification must include the date of the agreement and the names of the parties to the agreement. The brokerdealer must provide a copy of the agreement to its DEA upon request.

      The notification required in item 9 must be made, in writing, to a firm's assigned District Office for both existing and new expense-sharing agreements.

      1 Expense-sharing agreements include any arrangement in which another party bears or pays for all or a portion of the costs incurred by a broker/dealer.

      2 The redacted portions of the Letter, which are included in this Notice to Members, do not include the footnotes; a copy of the original Letter is attached to this Notice. The additional information provided by NASD is in italics.


      Attachment

      UNITED STATES
      SECURITIES AND EXCHANGE COMMISSION
      WASHINGTON, D.C. 20549

      July 11, 2003

      Ms. Elaine Michitsch
      Member Firm Regulation
      New York Stock Exchange, Inc.
      20 Broad Street
      New York, New York 10005

      Ms. Susan Demando
      Director, Financial Operations
      NASD Regulation, Inc.
      1735 K Street, NW, Washington, D.C. 20006-1500

      Re: Recording Certain Broker-Dealer Expenses and Liabilities

      Dear Ms. Michitsch and Ms. Demando:

      You have requested guidance from the Division of Market Regulation ("Division") of the U.S. Securities and Exchange Commission ("Commission") concerning the application of the financial responsibility rules1 when a third party, which may include a parent, holding company, or affiliate of a broker-dealer, agrees to assume responsibility for payment of the broker-dealer's expenses.2 You are concerned that some broker-dealers are using these expense-sharing agreements as a basis for not recording expenses and liabilities on the broker-dealer's books and records. In that instance, the books and records of the broker-dealer may not accurately reflects its performance and financial condition, artificially inflating its profitability, causing it to appear to be in capital compliance when it is not, and possibly disguising fraudulent activity. Further, you need access to sufficient records to verify that the broker-dealer is in compliance with the financial responsibility rules.

      Under the financial responsibility rules, broker-dealers are required to prepare certain financial statements in accordance with generally accepted accounting principles ("GAAP"). A broker-dealer is also required to make and keep current certain books and records relating to its business, including records "reflecting all assets and liabilities, income and expense and capital accounts."3 A broker-dealer must also retain copies of all written agreements entered into by the broker-dealer relating to its business.4

      It is the view of the Division that:

      1. Pursuant to Exchange Act Rule 17a-3(a)(1) and (a)(2), a broker-dealer must make a record reflecting each expense incurred relating to its business and any corresponding liability, regardless of whether the liability is joint or several with any person and regardless of whether a third party has agreed to assume the expense or liability. A broker-dealer must make a record of each expense incurred relating to its business, including the value of any goods or services used in its business, when a third party has furnished the goods or services or has paid or has agreed to pay the expense or liability, whether or not the recording of the expense is required by GAAP and whether or not any liability relating to the expense is considered a liability of the broker-dealer for net capital purposes. One proper method is to record the expense in an amount that is determined according to an allocation made by the third party on a reasonable basis.
      2. If the broker-dealer does not record certain expenses on the reports it is required to file with the Commission or with its designated examining authority ("DEA") under the financial responsibility rules, the broker-dealer may satisfy the Exchange Act Rule 17a-3(a)(1) and (a)(2) requirement to make a record of those expenses by making a separate schedule of the expenses.
      3. If a third party agrees or has agreed to assume responsibility for an expense relating to the business of the broker-dealer, and the expense is not recorded on the reports the broker-dealer is required to file with the Commission or with its DEA under the financial responsibility rules, any corresponding liability will be considered a liability of the broker-dealer for net capital purposes unless:
      a. If the expense results in payment owed to a vendor or other party, the vendor or other party has agreed in writing that the broker-dealer is not directly or indirectly liable to the vendor or other party for the expense;5
      b. The third party has agreed in writing that the broker-dealer is not directly or indirectly liable to the third party for the expense;
      c. There is no other indication that the broker-dealer is directly or indirectly liable to any person for the expense;
      d. The liability is not a liability of the broker-dealer under GAAP; and
      e. The broker-dealer can demonstrate that the third party has adequate resources independent of the broker-dealer to pay the liability or expense.
      4. Any withdrawal of equity capital, as defined in paragraph (e)(4)(ii) of Exchange Act Rule 15c3-1, from a broker-dealer by a third party, other than a withdrawal described in paragraph (e)(4)(iii) of Exchange Act Rule 15c3-1, within three months before or within one year after the broker-dealer incurs an expense which the third party has paid or agreed to pay, will be presumed for net capital purposes to have been made to repay the third party for the expense of the broker-dealer, unless the broker-dealer's books and records reflect a liability to the third party relating to the expense.
      5. For purposesof determining net capital, if the broker-dealer records a capital contribution from a third party that has assumed responsibility for paying an expense of the broker-dealer, and the expense is not recorded on the reports the broker-dealer is required to file with the Commission or with its DEA under the financial responsibility rules, the broker-dealer must be able to demonstrate that the recording of a contribution to capital is appropriate. Among other things, the broker-dealer must be able to demonstrate that the third party has paid the expense or has adequate resources independent of the broker-dealer to pay the expense and that the broker-dealer has no obligation, direct or indirect, to a vendor or other party to pay the expense. For net capital purposes, if a contribution to capital is made to a broker-dealer with an understanding that the contribution can be withdrawn at the option of the contributor, the contribution may not be included in the firm's net capital computation and must be re-characterized as a liability. Any withdrawal of capital as to that contributor within a period of one year, other than a withdrawal described in paragraph (e)(4)(iii) of Exchange Act Rule 15c3-1, shall be presumed to have been contemplated at the time of the contribution.6
      6. If a third party agrees or has agreed to assume responsibility for an expense of the broker-dealer, the broker-dealer must make, keep current, and preserve the following records pursuant to Exchange Act Rules 17a-3 and 17a-4:
      a. If a vendor or other party has agreed that the broker-dealer is not liable directly or indirectly to the vendor or other party for an expense, a written agreement between the broker-dealer and the vendor or other party that clearly states that the broker-dealer has no liability, direct or indirect, to the vendor or other party; and
      b. A record of each expense assumed by the third party.
      7. A broker-dealer must make, keep current, and preserve a written expense sharing agreement7 between the broker-dealer and a third party that has paid or agreed to pay an expense of the broker-dealer. The agreement must set out clearly which party is obligated to pay each expense, whether the broker-dealer has any obligation, direct or indirect, to reimburse or otherwise compensate any party for paying the expense, and, when the broker-dealer records the expense in an amount that is determined according to an allocation made by the third party, the method of allocation.
      8. Each broker-dealer and broker-dealer applicant must be able to demonstrate to the appropriate authorities that it is in compliance with the financial responsibility rules in connection with any expense-sharing agreement it has entered into, and therefore it may be required to provide these authorities with access to books and records, including those of unregistered entities, relating to the expenses covered by the agreement.
      9. A broker-dealer must notify its DEA if it enters into, or has entered into, an expense sharing agreement and the broker-dealer does not record each of the expenses it incurs relating to its business on the reports it is required to file with the Commission or with its DEA under the financial responsibility rules. The notification must include the date of the agreement and the names of the parties to the agreement. The broker-dealer must provide a copy of the agreement to its DEA upon request.

      Please contact me if you have any other questions or concerns relating to this matter.

      Sincerely yours,



      Michael A. Macchiaroli
      Associate Director


      1 For purposes of this letter, the financial responsibility rules include the net capital rule, Rule 15c3-1 under the Securities Exchange Act of 1934 ("Exchange Act"), and reporting and record keeping requirements under Exchange Act Rules 17a-3, 17a-4, and 17a-5.

      2 If a third party pays certain expenses of a broker-dealer, that party may be required to register with the Securities and Exchange Commission as a broker-dealer in accordance with Section 15 of the Exchange Act.

      3 Exchange Act Rule 17a-3.

      4 Exchange Act Rule 17a-4.

      5 This requirement does not apply to a fixed term arrangement with a lessor that was in place before the issuance of this letter.

      6 Letter from Michael A. Macchiaroli, Associate Director, Division of Market Regulation, to Raymond J. Hennessey, Vice President, New York Stock Exchange, and Susan Demando, Vice President, NASD Regulation (February 23, 2000). This letter presumes that a broker-dealer's designated examining authority could recognize an exception to this presumption under appropriate circumstances.

      7 Expense sharing agreements include franchising or other agreements relating to the costs of doing business of the broker-dealer.

    • 03-62 SEC Approves NASD Rule Proposal To Govern Lending Between Registered Persons and Customers

      View PDF File

      INFORMATIONAL

      Borrowing From and Lending to Customers

      Effective date: November 10, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Legal & Compliance
      Registered Representatives
      Senior Management

      Borrowing From and Lending to Customers
      Rule 2370

      Executive Summary

      On August 29, 2003, the Securities and Exchange Commission (SEC) approved the adoption of NASD Rule 2370, which prohibits registered persons from borrowing money from or lending money to a customer unless (1) the member has written procedures allowing such lending arrangements consistent with the rule; (2) the loan falls within one of five prescribed permissible types of lending arrangements; and (3) the member pre-approves the loan in writing.1 The text of Rule 2370 is provided in Attachment A and is effective on November 10, 2003.

      Questions/Further Information

      Questions concerning this Notice may be directed to Shirley H. Weiss, Associate General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8844.

      Background

      Loans between registered persons and their customers are of legitimate interest to NASD and member firms because of the potential for misconduct. NASD has brought disciplinary action against registered persons who have violated just and equitable principles of trade by taking unfair advantage of their customers by inducing them to lend money in disregard of the customers' best interests, or by borrowing funds from, but not repaying, customers.

      The potential for misconduct also exists when a registered person lends money to a customer. Rule 2370 provides the mechanism by which NASD and member firms can monitor lending arrangements between registered persons and their customers.

      Discussion

      First, under Rule 2370, lending arrangements between registered persons and customers are prohibited unless the member has written procedures allowing such lending arrangements. Second, if permitted by the member, the lending arrangement must fall within one of five permissible types of lending arrangements. The five types of permissible lending arrangements are:

      • The customer is a member of the registered person's immediate family (as defined in the rule);


      • The customer is in the business of lending money;


      • The customer and the registered person are both registered persons of the same firm;


      • The lending arrangement is based on a personal relationship outside of the broker-customer relationship; or


      • The lending arrangement is based on a business relationship outside of the broker-customer relationship.

      Third, the member must pre-approve the loan in writing.

      This regulatory framework will give members control over, and supervisory responsibility for, lending arrangements between their registered persons and customers. Members can choose to permit their registered persons to borrow from or lend to customers consistent with the requirements of the rule or prohibit the practice in whole or in part. Members that permit lending arrangements between their registered persons and customers are required to have written procedures in place to monitor such lending arrangements. Registered persons who wish to borrow from or lend to customers will be required to provide prior notice of the lending arrangement to the member, and the member will be required to approve the loan in writing. Members will be permitted to approve loans only if the loan falls within one of the five types of permissible lending arrangements. These requirements will enhance members' ability to supervise the activities of registered personnel.

      Rule 2370 gives members the ability to prohibit all lending arrangements between their registered persons and customers. However, if permitted, Rule 2370 establishes strict conditions under which such lending arrangements may take place. Under Rule 2370, firms are required to have written procedures in place evidencing their customer loan policy, and loans will be limited to five permissible types of arrangements that might not be problematic because of the relationship between the registered person and the customer. In addition, Rule 2370 provides additional safeguards by establishing a notice and approval requirement. These requirements will enable a member, to the extent it permits these loan arrangements, to assess the nature of each proposed arrangement and decide whether to approve it. These requirements also enhance NASD's ability to review these arrangements during the examination process. The safeguards provided under Rule 2370 are in addition to the general powers that NASD has to bring a disciplinary action against a registered person who has entered into an unethical lending arrangement with a customer under NASD Rule 2110.

      It is important to note that this proposal does not change the application of Regulation T to lending activities by associated persons. Specifically, the definition of "creditor" under Regulation T extends to associated persons of broker/dealers and therefore, certain loans to customers by associated persons may require compliance with the provisions of Regulation T.

      Effective Date

      These amendments become effective on November 10, 2003.


      1 See Release No. 34-48242 (Aug. 29, 2003), 68 FR 52806 (Sept. 5, 2003) (File No. SR-NASD-2003-92) ("SEC Approval Order").


      Attachment A

      RULE TEXT

      Below is the text of the proposed rule change. Proposed new language is underlined.

      2370.   Borrowing From or Lending to Customers

      (a) No person associated with a member in any registered capacity may borrow money from or lend money to any customer of the member unless: (1) the member has written procedures allowing the borrowing and lending of money between such registered persons and customers of the member; (2) the lending or borrowing arrangement meets one of the following conditions: (A) the customer is a member of such person's immediate family; (B) the customer is a financial institution regularly engaged in the business of providing credit, financing, or loans, or other entity or person that regularly arranges or extends credit in the ordinary course of business; (C) the customer and the registered person are both registered persons of the same member firm; (D) the lending arrangement is based on a personal relationship with the customer, such that the loan would not have been solicited, offered, or given had the customer and the associated person not maintained a relationship outside of the broker/customer relationship; or (E) the lending arrangement is based on a business relationship outside of the broker-customer relationship; and (3) the member has pre-approved in writing the lending or borrowing arrangement.
      (b) The term immediate family shall include parents, grandparents, mother-in-law or father-in-law, husband or wife, brother or sister, brother-in-law or sister-in-law, son-in law or daughter-in-law, children, grandchildren, cousin, aunt or uncle, or niece or nephew, and shall also include any other person whom the registered person supports, directly or indirectly, to a material extent.

    • 03-61 Broker/Dealer, Registered Representative, Investment Adviser Firm, and Investment Adviser Representative Renewals for 2004

      View PDF File

      ACTION REQUIRED

      Broker/Dealer and Investment Adviser Renewals

      Payment Deadline: December 5, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representatives
      Legal & Compliance
      Operations
      Registered Representative
      Registration
      Senior Management

      IARDSM
      Maintenance Fees
      Registration
      Renewals
      Web CRD®

      Executive Summary

      The 2004 NASD Broker/Dealer and Investment Adviser Renewal Program will begin November 3, 2003, when online Preliminary Renewal Statements are made available to all firms on Web CRD/IARD. This annual program simplifies the registration renewal process for more than 24,000 Broker/Dealer (BD) and Investment Adviser (IA) firms and approximately 700,000 registered representatives and investment adviser representatives with the payment of one amount to NASD by the published deadline. On October 27, 2003, firms may start submitting post-dated Forms U5, BDW, and Schedule E via Web CRD. Post-dated filings that are submitted by October 31, 2003, will not appear on the firm's Preliminary Renewal Statement. Joint (Broker/Dealer-Investment Adviser) firms may begin submitting post-dated ADV-Ws via IARD on November 3, 2003.

      Renewal Statements will include the following fees: NASD Web CRD/IARD System Processing Fees and 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 Broker/Dealer, registered representatives, and, if applicable, state Investment Adviser firm and representative Renewal Fees.

      Members should read this Notice to Members; any instructions posted to NASD's Web Site at www.nasdr.com/3400.asp, especially the Registration and Disclosure Fall Bulletin, which will be a special Renewal Program edition; the Investment Adviser Web Site, if applicable, at www.iard.com/renewals.asp; and any mailed information to ensure continued eligibility to do business as of January 1, 2004. Members should also visit the Renewal Program Web Pages at www.nasdr.com/3400_renewals_intro.asp to review Renewal information.

      Questions/Further Information

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

      Preliminary Renewal Statements

      Beginning November 3, 2003, Preliminary Renewal Statements will be available for viewing and printing in Web CRD/IARD for all entitled users. 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 5, 2003.

      If payment is not received by the December 5, 2003, Payment Due Date, the firm will be assessed a Renewal Payment Late Fee. This Renewal Payment Late Fee will be included as part of the 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 (NtM) 02-48 at www.nasdr.com/pdf-text/0248ntm.pdf for more details.

      Fees

      A fee of $30 will be assessed for each person who renews his/her registration with any regulator through Web CRD. Please see NTM 02-41 at www.nasdr.com/pdftext/0241ntm.pdf for more details. Firms can access a listing of agents for whom they were assessed a fee in their Preliminary Renewal Statement by requesting the Renewals-Firm Renewal Roster. The report will be available when the Renewal Statements are available.

      An NASD Branch Office Assessment Fee of $75 per branch will be assessed based on the number of active NASD branches at the time the Preliminary Renewal Statement is generated.

      The IARD Firm System Fee of $100 will be assessed for every state-registered Investment Adviser firm who renews through the IARD Program.

      The RA Renewal System Processing Fee of $45 will be assessed for every Investment Adviser Representative who renews through the IARD Program.

      This year, as last year, NASD Personnel Assessment Fees will not be assessed through the NASD Renewal Program. NASD will mail all NASD member firms a separate billing for this during the first quarter of 2004.

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

      Some participating jurisdictions 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 its renewal requirements (see the SRO/State Directory at www.nasdr.com/3450.htm

      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 jurisdictions that participate in the 2004 IARD Renewal Program is posted at www.iard.com/pdf/reg_directory.pdf.

      Renewal Payment

      Firms have four (4) payment methods available to pay 2004 Renewal Fees:

      • Web CRD/IARD E-Pay,


      • Wire transfer,


      • Check, or


      • Transfer of the entire amount from the firm's Daily to Renewal Account. (Note: The entire amount of the payment must be available.)

      Web E-Pay Instructions

      The E-Payment application is accessible from either the NASD (www.nasdr.com/3400.asp) or IARD (www.iard.com) Web Sites and from both the Preliminary and Final Renewal Statements 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 the firm's Renewal Account by December 5, 2003, payment must be submitted electronically, no later than 8:30 p.m., Eastern Time (ET), on December 3, 2003.

      Check Instructions

      The check should be drawn on the member firm's account, with the firm's CRD Number included on the front of the check, along with the word "Renewals" in the memo line.

      Firms should mail their Renewal Payment, along with the first page of their online 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

      Member firms should use the blue, pre-addressed Renewal Payment envelope that they should receive the first week of November; or, if using their own payment envelope, firms should use the full address, as noted above, including the "W8705" number.

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

      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 Payment envelope that will be mailed to you or write the address on the envelope exactly as noted above.

      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 Firms should provide their bank the following information:

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

      To ensure prompt processing of a Renewal Payment by wire transfer:

      • Remember to inform the bank that the funds are to be credited to the NASD Bank Account,


      • Provide the Firm's CRD Number and the word, "Renewals" as reference only, and


      • Record the Confirmation Number of the wire transfer provided by the bank.

      Transfer of Funds Instructions

      Firms may also call the Gateway Call Center at (301) 869-6699 and request that a transfer of the full Renewal balance be transferred from the firm's Daily to Renewal Account. The firm must have the available funds in its Daily Account in order for the transfer to be processed.

      Members are advised that failure to return full payment of their Preliminary Renewal Statement to NASD by the December 5, 2003, deadline could cause a member to become ineligible to do business in the jurisdictions effective January 1, 2004.

      Renewal Reports

      Beginning November 3, 2003, the Renewal Reports are available to request, print, and/or download via Web CRD. 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 2004 Renewal Program 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 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. The report should be used throughout the year, including during the annual Renewal Program, as an aid for firms to reconcile personnel registrations. Firms should request this report in October to determine if any NASD registrations need to be requested or jurisdictions terminated prior to Renewal processing for the Preliminary Renewal Statement on November 1. Note: any post-dated U5, BDW, and/or Schedule E terminations submitted by 11:00 p.m., ET, on October 31, 2003, will not appear on the firm's Preliminary Renewal Statement.

      Filing Forms U5

      Firms may begin submitting post-dated U5 filings on October 27, 2003. If Forms U5 (either Full or Partial) are filed electronically via Web CRD by 11:00 p.m., ET, October31, 2003, for Agents/Investment Adviser Representatives (RAs) terminating in one ormore jurisdiction, those Renewal Fees will not be included on the firm's Preliminary Renewal Statement.

      The deadline for electronic filing of Forms U5 for firms that want to terminate an agent affiliation before year-end 2003 is 6:00 p.m., ET, on December 20, 2003. Firms may file both Partial and Full Forms U5 with a post-dated termination date of December 31, 2003. (This is the only date that can be used for a post-dated Form U5.) The deadline for submission of all EFT (electronic file transfer) filings is also December 20, 2003 (2:00 p.m., ET). For more detailed information on post-dated Forms U5, see the section titled "Post-Dated Form Filings" below.

      It is important for firms to be aware that once a post-dated Form U5 is filed for an individual, the firm will not be able to submit either a U4 or U5 Amendment to update disclosure until on or after January 2, 2004.

      Post-Dated Form Filings

      Firms can begin electronically filing post-dated Forms U5, BDW, and Schedule E via Web CRD on October 27, 2003. This functionality allows firms to file a termination form on or after October 27, with a termination date of December 31, 2003. Firms that submit post-dated U5, BDW, and/or Schedule E termination filings by 11:00 p.m., ET, on October 31, 2003, will not be assessed Renewal Fees for the terminated jurisdictions on their Preliminary Renewal Statement in November. Joint (Broker/Dealer-Investment Adviser) firms may begin to submit post-dated ADV-Ws on November 3, 2003.

      Firms that submit post-dated termination filings on or after November 3, 2003, will not be assessed Renewal Fees for the terminated jurisdictions on the Final Renewal Statement in January. If a credit is due the firm, it will be transferred to the firm's Daily Account in conjunction with Renewal processing and will be posted there on January 2, 2004. In the case of an overpayment, the firm's Final Renewal Statement will read "Amount Paid in Full," and the deposit will be posted under the Transfer Detail of the firm's Daily Account.

      Firms may submit Forms U5, BDW, Schedule E, and ADV-W (both partial and full terminations) until December 20, 2003, with a post-dated termination date of December 31, 2003. (This is the only date that can be used for a post-dated form filing.) If a Form U5, BDW, Schedule E, or ADV-W indicates a termination date of December 31, 2003, a registered representative, Broker/Dealer, Investment Adviser (firm), or Investment Adviser representative (RA) may continue doing business in the jurisdiction until the end of the calendar year without being assessed 2004 Renewal Fees. Firms are encouraged to access the individual's or firm's form filing history after a termination filing is submitted to ensure that electronic Forms U5, BDW, Schedule E, and ADV-W have been successfully filed.

      Members should exercise care when submitting post-dated Forms U5, BDW, Schedule E, and ADV-W. CRD and IARD will systematically process these forms as they are submitted and NASD cannot withdraw a post-dated termination once submitted and processed. If a post-dated, full Form U5, BDW, or ADV-W has been submitted but the firm decides it does not want to terminate registration, then a new Form U4, Form BD, or Form ADV must be submitted on or after January 2, 2004, to re-register the representative or firm with jurisdictions. All applicable registration fees will be assessed. If a post-dated partial Form U5, BDW, or ADV-W has been submitted but the firm decides it does not want to terminate registration(s), then a Form U4 Amendment, Form BD Amendment, or ADV Amendment, as appropriate, must be submitted on or after January 2, 2004, to re-request registration with those jurisdictions. All applicable registration fees will be assessed.

      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, October 31, 2003, will avoid the assessment of the applicable Renewal Fees on their 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 they do not participate in CRD Phase II for BD terminations:

      • 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 2003 is 6:00 p.m., ET, December 20, 2003. 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, 2003, see the section titled "Post-Dated Form Filings."

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

      Joint (Broker/Dealer-Investment Adviser) firms that file a Form ADV Amendment,unmarking a state (generating the status of "Removal Requested at End of Year"), by 11:00 p.m., ET, October 31, 2003, will avoid the assessment of the applicable Renewal Fees on their Preliminary Renewal Statement. Post-dated Forms ADV-W cannot be submitted until November 3, 2003.

      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 2003 is 6:00 p.m., ET, December 20, 2003. For information regarding post-dating Form ADV-W with the termination date of December 31, 2003, for state registrations see the "Post-Dated Form Filings" section.

      Removing Open Registrations

      Throughout the year, firms have access to the "Approved AG Reg Without NASD Approval" Report via Web CRD. This report identifies agents whose NASD registrations are either terminated or have 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 report to terminate obsolete state registrations through the submission of Forms U5 or reapply for NASD licenses through the filing of a Form U4 Amendment. This report should aid firms in the reconciliation of personnel registrations prior to year's end and should be requested prior to October 27, 2003. Requesting this report will enable firms to identify individuals who can be terminated by October 31, 2003, to avoid being charged for those individuals on their Preliminary Renewal Statement. Firms may continue to terminate individuals until the December 20, 2003, 6:00 p.m., ET, deadline.

      Final Renewal Statements

      Beginning January 2, 2004, 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, 2003. 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-end than it did when the Preliminary Renewal Statement was generated, additional Renewal 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. As of January 2, 2004, overpayments will be transferred to firms' Daily Accounts. Firms that have a credit (sufficient) balance in their Daily Account may request a refund by contacting the Gateway Call Center at (301) 869-6699 or faxing a written request signed by the designated signatory to the User Support Unit at (240) 386-4849.

      After January 2, 2004, NASD member firms should access Web CRD Reports to request 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 report. 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 be available.

      Firms have until February 6, 2004, to report any discrepancies on the Renewal Reports. All discrepancies should be reported, in writing, to NASD. This is also the deadline for receipt of final payment. Specific information and instructions concerning the Final Renewal Statements and Renewal Reports will appear in the January 2004 Notices to Members. Firms may also refer to the Fall Registration and Disclosure Bulletin, which is devoted entirely to the 2004 NASD Renewal Program. Firms will be able to access the information at any time by viewing the CRD Information Pages of the NASD Web Site at www.nasdr.com/3400_publications.asp.

    • 03-60 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 January 6, 2004. The formal notice of the meeting, including the precise date, time, and location of the Annual Meeting, will be mailed on or about December 2, 2003.

      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 5331 voting members; therefore, the applicable 3 percent threshold is 160 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 533 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 number of Governors within this range is set by the Board. On July 1, 2003, the NASD Executive Committee approved a reduction in the size of the Board from 25 to 21 Governors, effective with the January 6, 2004 Annual Meeting, to eliminate the positions occupied by members who simultaneously serve on the Board of Directors of The Nasdaq Stock Market, Inc., and whose terms are expiring. In August of 2002, the Board took a similar action by reducing the size of the Board for 2003 by three Governors who also served on the NASDAQ Board and who were not eligible for re-election. Additionally, pursuant to its authority under Article VII, Section 5(d) of the NASD By-Laws, the Board determined in August of 2002 that the remaining NASD Board members who simultaneously served on the NASDAQ Board and who were eligible to serve an additional term on the NASD Board would, if re-elected, serve a term of one additional year on the NASD Board or until NASDAQ was able to operate other than as a facility of NASD, whichever were to occur first. Governors Baldwin, Romano, and Simmons were elected to the one-year term on the NASD Board at the December 5, 2002 Annual Meeting. Each of these Governors is now ineligible for re-election. A fourth NASD Board member who simultaneously serves on the NASDAQ Board and whose three-year term on the NASD Board is expiring, Governor Sodhani, is also ineligible for re-election. Accordingly, the size of the Board has been reduced to 21 Governors.

      On January 6, 2004, members will elect four Governors, one of whom will occupy an Industry position on the Board, and three of whom will occupy Public positions on the Board.

      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
      Executive Vice President and General Counsel
      NASD
      1735 K Street, NW
      Washington, DC 20006-1500
      (202) 728-8285

      NASD Board of Governors Nominees

      The following four 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 January 6, 2004, to January 2007.

      Terms of Office 2004-2007

      INDUSTRY  
      William C. Alsover, Jr. Chairman, Centennial Securities Company, Inc. (Small Firm Representative)
      PUBLIC  
      Charles A. Bowsher 1 Former Comptroller General of the U.S.
      Joel Seligman Dean, Washington University School of Law
      Sharon P. Smith Dean, College of Business Administration, Fordham University

      NASD Profile of Board Nominee for Industry Governor

      Industry

      William C. Alsover, Jr. is Chairman of Centennial Securities Company, Inc., a full service broker/dealer located in Grand Rapids, Michigan. Prior to joining Centennial, Mr. Alsover was with Fahnestock & Company. Mr. Alsover is currently Chairman of the Small Firm Advisory Board and serves on the Securities Advisory Committee, Office of Financial and Insurance Services for the State of Michigan. He has served on several industry committees, including the Securities Industry Association (SIA) Investor Education and Local Firms Committees, the New York Stock Exchange's Committee dealing with day trading and margin requirements. Mr. Alsover is the former Chairman of the SIA Local Firm Committee, and a former member of the NASD Chicago District 8 District Business Conduct Committee. He received his B.A. from Michigan State University.

      NASD Profiles of Board Nominees for Public Governors

      Public

      Charles A. Bowsher is the former Comptroller General of the United States and head of the General Accounting Office (GAO). Mr. Bowsher was appointed to his 15-year term in 1981 by President Reagan. Prior to this appointment, Mr. Bowsher was associated with Arthur Andersen & Co. for 25 years, and also served as Assistant Secretary of the Navy for Financial Management. He served as Chairman of the Public Oversight Board and currently serves on the corporate boards of American Express Bank, DeVry, Inc., the Washington Mutual Investors Fund, and S.I. International, Inc. He is a trustee of the Center for Naval Analysis, the Logistics Management Institute, the United States Navy Memorial Foundation, the Corcord Coalition, the Hitachi Foundation and serves on the advisory boards at several universities. He is the recipient of honorary doctorate degrees from five universities. Mr. Bowsher graduated from the University of Illinois and received an M.B.A. from the University of Chicago after serving two years in the U.S. Army.

      Joel Seligman is the Dean and Ethan A.H. Shepley University Professor at the Washington University School of Law. Before beginning his tenure as Dean in 1999, Mr. Seligman served as the Dean of the University of Arizona College of Law. He has also previously served on the law faculty of the universities of Michigan, George Washington and Northeastern. Since beginning as Dean at Washington University School of Law in 1999, Mr. Seligman served as Reporter for the National Conference of Commissioners on Uniform State Law, was Chair of the Securities and Exchange Commission Advisory Committee on Market Information; and has served as a member of the American Institute of Certified Public Accountants Professional Ethics Executive Committee. He is the author or co-author of 20 books and over 35 articles on legal issues related to securities and corporations. He is the co-author of Fundamentals of Securities Regulation and the casebook, Securities Regulation, which he co-wrote with John Coffee. His book, The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modern Corporate Finance, is widely regarded as the leading history of the Commission. He received his bachelor's degree magna cum laude from the University of California Los Angeles and his law degree cum laude from Harvard University School of Law.

      Sharon P. Smith is the Dean of the Schools of Business and of the Business Faculty at Fordham University, where she is also a Professor of Management Systems. Ms. Smith joined Fordham University in 1990 after serving as a Visiting Senior Research Economist at Princeton University from 1988 to 1990. Prior to this, she worked at American Telephone & Telegraph Co. for six years as a District Manager in various capacities, such as Corporate Strategy and Development, Labor Relations, and Economic Analysis Section. Before joining AT&T, she was a Senior Economist at the Federal Reserve Bank of New York. Ms. Smith currently serves as a public member of the Security Traders Association (STA) Board, the STA Foundation Advisory Council, as well as a variety of other professional organizations and associations. She holds a Ph.D. in Economics from Rutgers University.

      Governors with Terms Expiring in January 2004

      Industry  
      William C. Alsover, Jr. Chairman, Centennial Securities Company, Inc. (Small Firm Representative)
      Douglas L. Kelly 2 A.G. Edwards & Sons, Inc. (Chair of the National Adjudicatory Council)
      Richard C. Romano* Chairman, Romano Brothers & Co.
      Hardwick Simmons* Retired Chairman and CEO The Nasdaq Stock Market, Inc.
      Non-Industry  
      H. Furlong Baldwin* Chairman (retired), Mercantile Bankshares Corporation
      Arvind Sodhani* Vice President and Treasurer, Intel Corporation
      Public  
      Brian T. Borders Borders Law Group
      Charles A. Bowsher Former Comptroller General of the U.S.
      Sharon P. Smith Dean, College of Business Administration, Fordham University

      * Not eligible for re-election

      Governors with Terms Expiring in January 2005

      Industry  
      John W. Bachmann Managing Partner, Edward D. Jones & Company
      Richard F. Brueckner Chief Executive Officer, Pershing, LLC (Representative of a Clearing Firm)
      Raymond A. Mason Chairman and CEO, Legg Mason Wood Walker, Inc. (Representative of a Regional Retail Firm)
      Non-Industry  
      Harry P. Kamen* Retired Chairman and Chief Executive Officer Metropolitan Life Insurance Company (Representative of an Insurance Company)
      Public  
      James E. Burton Chief Executive Officer, World Gold Council
      Sir Brian Corby Chairman (retired), Prudential Assurance Company
      John Rutherfurd, Jr. President and CEO, Moody's Corporation

      * Not eligible for re-election

      Governors with Terms Expiring in January 2006

      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 (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.

      * Not eligible for re-election


      1 Elected July 2003 to fill a vacancy on the Board.

      2 The Chair of the National Adjudicatory Council serves a one-year term on the NASD Board.

    • 03-58 NASD Issues Interpretive Guidance to the Trade Reporting and Compliance Engine Rules (TRACE Rules)

      View PDF File

      INFORMATIONAL

      Corporate Debt Securities Transaction Reporting

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Finance
      Legal and Compliance
      Operations
      Senior Management
      Technology
      Trading and Market Making
      Training

      Debt Securities
      Dissemination
      Operations
      Rule 6200 Series
      Transaction Reporting

      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). In this Notice to Members, NASD provides guidance on frequently asked questions concerning the reporting of debt securities when par value is not a standard amount and the resubmission of rejected TRACE trade reports under the new 45-minute reporting requirement.

      Questions/Further Information

      Questions concerning this Notice may be directed to tracefeedback@nasd.com; Elliot Levine, Chief Counsel, Market Operations, Regulatory Services and Operations, at (202) 728-8405; or, Sharon K. Zackula, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8985.

      Interpretive Guidance

      Questions and Answers 1 through 5 address how a member reports bond quantities when the bond traded has a non-standard par value (a par value other than $1,000 per bond). Question and Answer 6 address the resubmission of rejected trade reports under the new 45-minute reporting requirement, and the rescission of prior guidance on this subject.

      Questions and Answers

      Q1.   How do I report a baby bond (less than $1,000 face value per bond)?

      A1.   Enter the amount in decimal form. Examples: 1/2 a bond = ".50"; a $512.37 piece of a bond = ".51237."

      Q2.   How do I report quantity for a bond with a pro-rata sinking fund that has a factor?

      A2.   The TRACE Rules and the TRACE System include the assumption that one bond is equal to $1,000 par value. Therefore, the quantity for bonds that involves a factor must be translated into a percentage of $1,000. Reporting quantity for bonds involving a factor is the same as reporting quantity for a baby bond.

      Example: A broker/dealer buys or sells 25 bonds with a pro-rata sinking fund for which the current factor is .300. To determine the quantity for reporting to TRACE, multiply 25 by .300 for a quantity of 7.5 bonds. This results in a remaining principal amount of $7,500 (at this point in the sinking fund schedule), instead of the original $25,000.

      Q3.   How do I report quantity on bonds with par values greater than $1,000? (Note that two exceptions, GMAC 0 12/1/12 and GMAC 0 6/15/15, are addressed in No. 4)

      A3.   As noted above, the TRACE Rules and TRACE System assume that one bond has a standard par value, which is $1,000. When this is not true, and the bond traded has a par value greater than $1,000, the total par value traded must be translated into $1,000 equivalents.

      Examples:

      A bond has a par value of $2,500. If 20 bonds are bought or sold, the total par value is $50,000. Divide $50,000 by $1,000. Quantity reported to TRACE = 50.

      A bond has a par value of $500,000. If 10 bonds are bought or sold, the total par value is $5,000,000. Divide by $1,000. Quantity reported to TRACE = 5,000.

      Q4.   How do I report quantity and price for GMAC 0 12/1/12 and GMAC 0 6/15/15? These issues trade on the NYSE in units and in prices expressed in hundreds rather than in bond dollars (representing a percentage of par). If I execute OTC, however, how do I report quantity, price, and yield into TRACE?

      A4.   Both the GMAC 0 12/1/12, CUSIP 370424CZ4 (Symbol GMAC.GC) and the GMAC 0 6/15/15 CUSIP 370424DA8 (Symbol GMAC.GD) are exceptions to the norm for reporting to TRACE, since firms may hold these securities differently on their stock records and price can also be expressed in multiple ways. Firms typically settle these trades ex-clearing, with settlement necessitating that both parties use the same standards.

      Both issues have par values greater than $1,000 and a final maturity value of $10,000. On the New York Stock Exchange (NYSE), both issues are traded in units: one unit = $10,000. For example, if one unit having a maturity value of $10,000 trades for a contracted value of $4,950, a price of $495 for a quantity of one unit (or one tenth of the contract amount) would be reported to the NYSE. To arrive at the same yield that is posted on the NYSE, market participants can perform a zero-coupon calculation using a workaround solution of entering a dollar price of 49.50 (moving the decimal place an additional place to the left, or one hundredth of the contract amount), which "resembles" bond dollars.

      In order to accommodate reporting of these two bonds, the TRACE System adopts the same workaround solution for the calculation of yield to maturity, based upon a "bondlike" price (a price under $100). The TRACE System assumes a $1,000 par value; hence, reporting a quantity of one (unit) would be disseminated as $1,000, which would be both incorrect and misleading. Therefore, since each security trades in increments of $10,000, the reporting party should report a quantity of 10 for each unit traded. When the transaction information is disseminated, the quantity will appear as 10,000. Report yield to maturity (YTM) only.

      Firms executing OTC transactions in either of these issues should submit their TRACE reports according to the example below. Firms reporting through third-party intermediaries should make sure that they can support this methodology; otherwise, reporting will have to be accomplished manually. When reporting through NSCC, the entry should be submitted using a zero-coupon price (e.g., less than 100) and a quantity 10 times the number of units traded (rather than the contract amount). The entry should be marked as a "reporting only" report, so that it will not flow through NSCC's comparison system. Any possible submissions to NSCC for comparison in these securities should be done separately from the TRACE transaction report.

      Example:

      One (1) unit is bought, having a maturity value of $10,000. Reported quantity = 10 and reported price = 49.50. YTM is determined from this price, using the zero-coupon calculation. When disseminated, the quantity reported of one unit will appear as 10,000 traded at 49.50 with the corresponding YTM. (To report the purchase of 4 units, report a quantity of 40.)

      Note: Report to TRACE YTM only.

      Q5.   How do I report commissions for the securities GMAC 0 12/1/12 and GMAC 0 06/15/15, referenced above?

      A5.   Commissions in fractions of a point: Because the maturity value of each unit is $10,000, one point = $100, rather than the norm of one point = $10 for a bond with a $1,000 principal value at maturity. If the commission charged to the customer in the purchase or sale of GMAC 0 12/1/12 or GMAC 0 06/15/15 is one-eighth of a point (.125), this represents $12.50 per each $10,000 maturity value. In this example, the member would report .125 in the commission field. If, for example, the price of one unit traded is $4,950 (on the NYSE, $495), on TRACE, the price reported is 49.50. Add or subtract the one-eighth of a point (.125) (depending upon whether you sold or bought) to/from the price that will be used to calculate the yield. If selling, the all-inclusive price would be 49.625 (49.50 + .125), with yield to maturity (YTM) calculated from this price. If buying, the all-in price would be 49.375 (49.50 - .125), with YTM calculated from this price.

      Flat-fee commissions: If the commission charged to the customer on two units of $10,000 is $50, and the price of one unit is $4,950 (on the NYSE, $495), then the price reported to TRACE is 49.50, and the commission is reported as .25. If selling, add .25 to 49.50 and calculate YTM from an all-in price of 49.75. If buying, subtract .25 from 49.50, which results in an all-in price of 49.25 with which to calculate YTM.

      Q6.   When the new TRACE 45-minute reporting period becomes effective, how much time does a member have to resubmit a trade report that was rejected?

      A6. As of October 1, 2003, the period to report a transaction to TRACE will be reduced from 75 minutes to 45 minutes.1 As a result, NASD is issuing new guidance, effective as of 8:00 a.m. Eastern Time on October 20, 2003, regarding the resubmission of rejected trade reports, and is withdrawing the guidance issued in NtM 02-76 (November 2002), Question and Answer No. 1 (Q & A 1).2 The guidance issued in NTM 02-76, Q & A 1, is withdrawn as of 8:00 a.m. Eastern Time on October 20, 2003, and, after that time, members should not rely on it.

      The period to report a transaction in a TRACE-eligible security will be reduced from 75 minutes to 45 minutes effective October 1, 2003. NASD recognizes, however, that some members may be using a reporting technology that does not immediately relay a message to the member that a transaction report has been rejected. Thus, members may be unaware for a substantial part of the 45-minute reporting period that they must resubmit the trade report.3 Accordingly, in these circumstances, as a general rule, NASD expects that members will correct and resubmit rejected trade reports as soon as practicable, but not later than 90 minutes from the time of execution. (This generally applicable interpretive guidance is referred to hereinafter as the "45-Minute Extension.")

      However, there are three scenarios when a member may not rely on the 45-Minute Extension. The three scenarios are set forth below.

      a. If a member executes a trade less than 45 minutes before the closing of the TRACE System (on or after 5:45:01 p.m. Eastern Time through 6:29:59 p.m. Eastern Time),4 under Rule 6230(a)(1), the member has the option to report the transaction to TRACE the same day, or the next day that the TRACE System is open, within 45 minutes of the opening. In both of these scenarios, a member is not entitled to rely on the 45-Minute Extension to comply with the obligation to timely report.
      i. No Extension of Time Applies: If the member reports the transaction to TRACE before the TRACE System closes and the transaction report is rejected, the member must report the transaction the next day the TRACE System is open, within the first 45 minutes that the System is open in order for the report to be timely. The 45-Minute Extension does not apply in these circumstances. For example, a member executes a transaction at 6:10 p.m. Eastern Time on Thursday, the member reports the transaction at 6:29 p.m. Eastern Time, and the transaction report is rejected. On Friday morning, the member must resubmit the corrected transaction report within the first 45 minutes that the TRACE System is open for the report to be timely.
      ii. Fifteen-Minute Extension: If the member opts to first file the transaction report on the next business day that the TRACE System is open, and the transaction report is rejected, the member must correct and resubmit the transaction report as soon as possible and not later than one hour after the TRACE System opens. Stated another way, the member has 45 minutes to report the transaction and is granted an additional 15 minutes to comply with its reporting obligation. The 45-Minute Extension does not apply in these circumstances. For example, a member executes a trade at 6:10 p.m. Eastern Time on Thursday, the member first reports the trade on Friday at 8:05 a.m. Eastern Time, and the report is rejected. The member must correct and resubmit the transaction report not later than 8:59:59 a.m. Eastern Time in order for the report to be considered timely filed. The 15-minute extension of time to report is appropriate because members have had time to prepare the transaction report, and should attempt to report outstanding transactions promptly after the TRACE System opens.
      b. Fifteen-Minute Extension: If a member executes a trade when the TRACE System is closed (e.g., on or after 6:30 p.m. Eastern Time on a business day that the TRACE System was open, during a weekend or a holiday, or before 8:00 a.m. Eastern Time on a business day that the TRACE System will open), the member is required under Rule 6230(a)(2) through (4) to report the transaction the first day that the TRACE System is open, within 45 minutes. If the transaction report is rejected, the member must correct and resubmit a transaction report as soon as possible, but not later than one hour after the TRACE System opens. In this case also, the member has 45 minutes to report the transaction and is granted only an additional 15 minutes to comply with its reporting obligation. In addition, the 45-Minute Extension does not apply. For example, a member executes a trade at 7:00 p.m. Eastern Time on Thursday. The TRACE System is closed until Friday at 8:00 a.m. Eastern Time. The member first reports the trade on Friday at 8:05 a.m. Eastern Time, and the report is rejected. The member must correct and resubmit the trade report not later than 8:59:59 a.m. Eastern Time to report on time. The member is permitted to use only an additional 15 minutes to report for the same reasons expressed above.

      Regardless of the reporting mechanism used by the member (e.g., batch submission, CTCI, Web browser, 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 continue to monitor 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.


      1 See NtM 03-36 (June 2003).

      2 Q & A 1 allowed a member, in certain extenuating circumstances, to resubmit rejected trade reports that were "high priority" reports as soon as practicable, but not later than 2 and 1/2 hours after the time of execution of the transaction, and allowed a member to correct and resubmit a "low priority" report 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 occurred on a nonbusiness day). High-priority reports were defined as reports of transactions in securities that are subject to dissemination under Rule 6250. Reports of transactions in securities not subject to dissemination under Rule 6250 were lowpriority reports. In this guidance, NASD has eliminated these two categories.

      3 Certain members are using technology that reports transactions to and receives verification of accepted reports back from TRACE via a "batch" process, and this batch process may add time to the identification and correction of trade reports initially rejected by the TRACE System.

      4 The normal schedule for TRACE System operations is 8:00 a.m. Eastern Time through 6:29:59 p.m. Eastern Time. The times are provided as an example. The actual times may vary if the TRACE System is not operating on a normal schedule.

    • 03-57 Securities Industry/Regulatory Council on Continuing Education Issues Firm Element Advisory

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      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 Council recommends that firms use the Firm Element Advisory as part of the Firm Element Needs Analysis to help identify relevant training topics for all covered persons, including supervisors. New rules or regulations, such as the Research Analyst Rules; major regulatory examination findings, such as those relating to mutual fund sales practices; ethics and professional conduct; and any new products or services the firm plans to offer should be considered as topics for Firm Element training.

      All of the training resources found in the Firm Element Advisory may be found on the CE Council Web Site at www.securitiescep.com, where there are also two additional Firm Element resources. The first is the Firm Element Organizer, an easy-to-use software application that enables a search of an extensive database of training resources related to specific investment products or services. The second resource comprises CDs with scenarios taken from the Regulatory Element Supervisor (S201) and General (S101) programs. Log on to the Council Web Site for descriptions of the available scenarios.

      Questions/Further Information

      Questions concerning this Notice may be directed to John Linnehan, Director, 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 current 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 October 2002.

      The Council recommends that firms use the Firm Element Advisory as part of a firm's Firm Element Needs Analysis to identify training topics that are relevant to the firm, including training for supervisors. New rules or regulations, such as the Research Analyst Rules; major regulatory examination findings, such as those relating to mutual fund sales practices; ethics and professional conduct; and any new products or services the firm plans to offer should be considered as topics for Firm Element training.

      The Council provides a convenient way for firms to access the training resources listed next to each topic in the Firm Element Advisory—the CE Council Web Site at www.securitiescep.com. In addition to the Firm Element Advisory material, there are also two additional resources to assist with Firm Element requirements. The first is the Firm Element Organizer. This is an easy-to-use software application that enables you to search an extensive database of training resources related to specific investment products or services you identify. The results of a search can then be edited into a document that will assist developing a Firm Element training plan. A tutorial on the CE Council Web Site demonstrates how to use the Firm Element Organizer. The second potential Firm Element resource comprises scenarios taken from the Regulatory Element Supervisor (S201) and General (S101) programs that may be suitable for Firm Element training.

      For more information, log on to www.securitiescep.com, or phone Roni Meikle, Continuing Education Manager, New York Stock Exchange (212-656-2156), or John Linnehan, Director, Continuing Education, NASD (240-386-4684).

      Training Topics and Relevant Training Points and References

      Anti-Money Laundering

      Anti-money laundering is an evolving topic. Many new rules and regulations have been adopted over the past two years to carry out the mandates of the USA PATRIOT Act. These requirements place additional due diligence, reporting, and training responsibilities on firms, supervisors, and registered representatives. Many SROs and government agencies maintain Web sites on anti-money laundering, including NASD (www.nasdr.com/money.asp), the U.S. Treasury (www.ustreas.gov => Bureaus => Financial Crimes Enforcement Network (FinCEN) (www.FinCEN.gov)), and the SIA (www.sia.com => Reference Materials => Anti-Money Laundering Guidance).

      See also, MSRB Notice 2003-28 (July 16, 2003), Approval by SEC of Rule G-41, on Anti-Money Laundering Compliance, NASD Notice To Members 02-47, Anti-Money Laundering: Treasury Issues Final Suspicious Activity Reporting Rule For Broker/Dealers, August 2002; NASD Notice to Members 03-34, Anti-Money Laundering Customer Identification Programs for Broker/Dealers, June 2003, and NYSE Information Memos 03-32, Customer Identification Programs For Broker-Dealers, July 14, 2003; 03-03, Lifting Of The Temporary Moratorium On Information Requests Under Section 314 Of The USA PATRIOT Act, February 20, 2003; 02-64, USA PATRIOT Act Updates: Section 356 Requirement To Report Suspicious Transactions; Deadline Extension For Sections 313 And 319, December 24, 2002; 02-46, Compliance With Section 326 ("Verification Of Identification") Of The USA PATRIOT Act, October 31, 2002 (www.nyse.com => Regulation => Information Memos).

      Brokered Certificates of Deposit

      NASD and the NYSE have provided guidance to their members that offer non-traditional certificate of deposit (CD) products. Typically, these products are long-term CDs offered by "deposit brokers" that carry a maturity date of more than one year, are callable at the discretion of the issuer, and trade in a secondary market. In certain circumstances, these products are securities. Irrespective of whether a particular CD product is a security, members must ensure that their registered representatives are properly trained and informed about the products, and that customers receive adequate disclosure of risk factors. Members are advised to carry CD products at fair market value on customer account statements. See Notice to Members 02-69, Certificates of Deposit: Clarification of Member Obligations Regarding Brokered Certificates of Deposit, October 2002; NYSE Information Memo 01-19, Long-Term Certificates Of Deposit - Sales Practices, July 20, 2001 (www.nyse.com => Regulation => Information Memos).

      Business Conduct

      Ethics

      Firms should be aware of the importance of ethics and professional responsibility as topics to include in their Firm Element training programs. Although the Securities Industry/Regulatory Council on Continuing Education (CE Council) will enhance the Regulatory Element programs via the introduction of scenarios and cases that will stress awareness of the ethical dimension to situations involving conflicts of interest, peer pressure, reputational risk, etc., Firm Element programs have certain advantages. Firm Element programs can utilize small, personal, and interactive training settings where different viewpoints and values can be expressed, evaluated, and shared. They can also deal with issues that are specific to the firm.

      Beginning in 2004, when amendments to SRO continuing education rules regarding research analysts become effective (see Research Analysts' Conflicts of Interest, below), research analysts will be required to be registered and will be subject to the Firm Element as well as the Regulatory Element. Firm Element training for research analysts, and their immediate supervisors, must include ethics, professional responsibility, and other more specific topics. While not mandated for all other registered persons, the CE Council urges firms to carefully consider ethics and professional responsibility as they relate to other Firm Element training topics.

      Guarantees and Sharing in Customer Accounts

      On February 12, 2003, the Securities and Exchange Commission (SEC) approved amendments to NASD Rules 2330(e) (Prohibition Against Guarantees) and 2330(f) (Sharing in Accounts; Extent Permissible). The amendments to Rule 2330(e) clarify that members and their associated persons are prohibited from guaranteeing any customer against loss in connection with any securities transaction or in any securities account of the customer. Rule 2330(f) has been amended to require that associated persons obtain prior written authorization from their employing member firm and that members and associated persons obtain prior written authorization from the customer before sharing in a customer's account. The amendments also delete from Rule 2330(f) the requirement that members and associated persons obtain the prior written authorization of the member carrying the account before sharing in a customer's account. See NASD Notice to Members 03-21, Prohibition Against Guarantees and Sharing in Customer Accounts, April 2003. See also NYSE Rule 352 (Guarantees and Sharing in Accounts) related to this topic.

      Hedge Funds

      Broker/dealers that offer hedge funds to their clients must fulfill their obligations to 1) provide balanced disclosure in promotional efforts; 2) perform a reasonable-basis suitability determination; 3) perform a customer-specific suitability determination; 4) supervise associated persons selling hedge funds and funds of hedge funds; 5) train associated persons regarding the features, risks, and suitability of hedge funds. See NASD Notice to Members 03-07, NASD Reminds Members of Obligations When Selling Hedge Funds, February 2003, and NASD Investor Alert, Funds Of Hedge Funds - Higher Costs And Risks For Higher Potential Returns, August 23, 2002, at www.nasdr.com/alert_hedgefunds.htm.

      Municipal Fund Securities

      529 Plan Sales Material

      The market for municipal fund securities, especially Section 529 College Savings Plans, is growing. Municipal fund securities represent investments in pools of securities, such as securities issued by registered investment companies. Municipal fund securities are municipal securities regulated by the MSRB. All sales materials related to them must comply with MSRB rules, including MSRB Rule G-21. In addition, certain sales materials for municipal fund securities must also comply with the advertising rules of the SEC and NASD, including NASD Rule 2210. See NASD Notice to Members 03-17, Municipal Fund Securities: Sales Material for Municipal Fund Securities, March 2003.

      Principals supervising the sale of municipal fund securities must be appropriately qualified and hold either a Series 53 or Series 51 license. For more information, see NASD's Web Site at www.nasd.com/Investor/Choices/College/ and the MSRB Web Site at ww1.msrb.org/msrb1/mfs/default.asp.

      Sales to Employees of Other Dealers

      MSRB Rule G-28 has been amended to exempt transactions in municipal fund securities from the requirement that a dealer opening an account for another dealer's employee (or a spouse or child of the employee) provide notice to the other dealer and follow the other dealer's instructions with respect to transactions for the employee (or spouse or child).

      See MSRB Notice 2003-9 (March 4, 2003), SEC Approves Amendment to Rule G-28 on Sales to Employees of Other Dealers (ww1.msrb.org/msrb1/archive/G-28approval.htm).

      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.

      Political Contributions and Prohibitions on Municipal Securities Business

      A recent rule change revised the definition of municipal finance professional (MFP) so that associated persons "primarily engaged" in municipal securities representative activities based on their retail sales of municipal securities are excluded from the definition. Any retail sales representatives who solicit municipal securities business from issuer officials remain covered under the rule as MFPs.

      The look back and look forward provisions have been revised. The revisions produce the following results:

      MFPs primarily engaged in municipal securities representative activities: The two-year look back is retained, and the look forward is reduced to one year.

      Solicitor MFPs: The two-year look back is retained, but limited only to contributions to officials of the issuer solicited, and the look forward is reduced to one year.

      Supervisor and management-level MFPs: The look back is reduced to six months and the look forward is reduced to one year.

      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 MFP, or any political action committee controlled by the dealer. A dealer that has triggered the ban may seek an exemption from the appropriate regulatory agency, or, in certain limited circumstances, use an automatic exemption. MSRB Rule G-37 describes relevant factors to be considered by the appropriate regulatory agency in determining whether to grant an exemption.

      See MSRB Notice 2003-25 (June 30, 2003), Electronic G-37 Submission System (eG-37 System) Becomes Operational (www.msrb.org/msrb1/archive/eG-37AnnouncementNotice.htm); and MSRB Notice 2003-17 (May 12, 2003), SEC Approves Amendments to Rule G-37 Revising the Exemption Process and the Definition of Municipal Finance Professional (ww1.msrb.org/msrb1/archive/G-37approval503.htm).

      Qualifications

      Dealers are required to ensure that their supervisors are appropriately qualified for their area of responsibility. The principal who serves as the primary contact for electronic communications from the MSRB must be qualified as a municipal securities principal or a municipal fund securities limited principal. The individual who is directly engaged in the functions of a municipal securities principal in a firm that limits its municipal securities activities to municipal fund securities must be qualified as a municipal securities principal or a municipal fund securities limited principal.

      See MSRB Notice 2003-6 (February 28, 2003), Reminder: To Supervise Municipal Fund Securities Activities, a Municipal Fund Securities Limited Principal (Series 51) or Municipal Securities Principal (Series 53) Qualification is Required by April 1, 2003 (ww1.msrb.org/msrb1/-archive/noticeG-3.htm); and MSRB Notice 2003-26 (July 1, 2003), Notice of Technical Amendments to Form G-40, on E-Mail Contacts (ww1.msrb.org/msrb1/archive/G-40Revisedform.htm).

      Transaction Reporting

      Broker/dealers have an obligation to report their municipal securities transactions to the MSRB accurately and on time. Transaction information is made available to the public, and to the NASD and other regulators for market surveillance and enforcement activities.

      See NASD Notice to Members 03-13, MSRB Rules G-12 and G-14: NASD Reminds Firms about Transaction Reporting Requirements and Announces Enforcement Actions Against Firms for Violations of MSRB Transaction Reporting Rules G-12 and G-14; MSRB Notice 2003-7 (March 3, 2003), Reminder Regarding MSRB Rule G-14, Transaction Reporting Requirements (ww1.msrb.org/msrb1/archive/-TRSnotice0203.htm); see also the section on Municipal Price Reporting/Transaction Reporting System on the MSRB Web Site, www.msrb.org.

      Mutual Funds

      Breakpoints and Share Classes

      Failure to provide customers with appropriate mutual fund discounts is conduct that violates SRO rules. NASD has issued Special Notice to Members 02-85 (NASD Requires Immediate Member Firm Action Regarding Mutual Fund Purchases and Breakpoint Schedules, December 2002) and two Investor Alerts regarding mutual funds to make investors aware of share classes and breakpoints. Broker/dealers should remind their associated persons of their obligation to ensure that their clients are charged the lowest possible front-end sales charge. See NASD Investor Alerts: Class B Mutual Fund Shares: Do They Make the Grade? (www.nasdr.com/alert_classb_funds.htm), dated June 25, 2003; Mutual Fund Breakpoints: A Break Worth Taking (www.nasdr.com/alert_breakpoint.htm), and Understanding Mutual Fund Share Classes (www.nasdr.com/alert_mfclasses.htm), both dated January 14, 2003.

      Note that the Report of the Joint NASD/Industry Task Force on Breakpoints (www.nasdr.com/breakpoints_report.asp, page 15) recommends greater focus on breakpoint rules, terms, and considerations in Firm Element training.

      To stay current on this important topic, firms should monitor NASD's Breakpoint Web Site: www.nasdr.com/breakpoints_members.asp.

      Late Trades and Market Timing

      Investment Company Act Rule 22c-1(a) generally requires that redeemable securities of investment companies be sold and redeemed at a price based on the net asset value (NAV) of the fund computed after the receipt of orders to purchase. It is a violation of NASD Rule 2110 (Standards of Commercial Honor and Principles of Trade), and may be a violation of the federal securities laws and NASD Rule 2120 (Use of Manipulative, Deceptive or Other Fraudulent Devices), for member firms and their associated persons to knowingly or recklessly effect mutual fund transactions that are priced based on NAV that is computed prior to the time the order to purchase or redeem was given by the customer. Furthermore, it may be a violation of NASD Rule 2110 and the federal securities laws to knowingly or recklessly facilitate certain mutual fund transactions, such as market timing transactions, in conjunction with, or with the acquiescence of, a mutual fund sponsor, fund administrator, investment adviser, underwriter, or any other affiliated person where those other parties acted contrary to a representation made in the prospectus or statement of additional information pursuant to which the mutual fund shares are offered.

      See NASD Special Notice to Members 03-50, Mutual Fund Transactions: NASD Reminds Member Firms of Their Obligations Regarding Mutual Fund Transactions and Directs Review of Policies and Procedures, September 2003.

      Options

      Supplement to the Options Disclosure Document

      The SEC approved the Options Clearing Corporation's supplement to the Options Disclosure Document (ODD) relating to:

      1) Options on Investment Companies and Similar Entities
      2) Special Exercise Settlement Procedures or Restrictions that may be imposed upon the occurrence of certain extraordinary events;
      3) Disclosure that a Registration Statement and Prospectus will no longer be available from the OCC or U.S. options exchanges.

      See CBOE Regulatory Circular RG03-12 dated March 5, 2003, Supplement to the Options Disclosure Document Regarding Exercise Settlement Values.

      OTC Equity Securities

      On August 22, 2002, the SEC approved new NASD Rule 2315, (Recommendations to Customers in OTC Equity Securities) [Recommendation Rule]. 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 with Rule 2315 does not provide a safe harbor from an RR's responsibility to determine the appropriateness of such securities for each prospective customer. See NASD Notice to Members 02-66, OTC Equity Securities: SEC Approves NASD Rule 2315; Recommendations to Customers in OTC Equity Securities, October 2002.

      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. 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 states that associated persons obtain their employers' written approval prior to establishing or monitoring securities or commodities accounts or entry into private securities transactions. See also NYSE Information Memo 02-40, Amendments To Rule 407 Relating To Private Securities Transactions, August 28, 2002 (www.nyse.com => Regulation => Information Memos).

      SEC-approved amendments to CBOE rules require non-supervisory associated persons who are registered and who engage in outside business activities to provide written notice to the member organization that employs them and receive the member's prior written consent for such outside activities. With respect to persons registered as ROPs, FinOps, or Sales Supervisors of member organizations of which the CBOE is the Designated Examining Authority, such individuals must have prior written authorization from the member firm prior to engaging in any outside business activity. The member firm is also required to provide prompt written notice to the CBOE of any outside business of registered supervisory personnel.

      See CBOE Regulatory Circular RG03-37 dated June 9, 2003, Other Affiliations of Registered Associated Persons.

      Principal-Protected Funds

      The recent bear market has left many investors worried more about securing the return of their investment dollars than about the return on their investments. Some have turned to new types of mutual funds that pledge to guarantee, for a set period of time, that the capital invested in the mutual fund or in a variable annuity's sub-accounts will be kept safe—for a price. These products are known as "principal-protected" funds (or, alternatively, principal protection, capital preservation, or guaranteed funds). Associated persons should be trained in the features, risks, and suitability of principal-protected funds and explain to their clients how they work and what they cost. See NASD Investor Alert, Principal-Protected Funds - Security Has a Price, (www.nasdr.com/alert_principal_protected_funds.htm), dated March 27, 2003.

      Registration and Reporting Requirements

      Criminal and Civil Complaints and Arbitration Claims

      On March 3, 2003, the SEC approved a 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. The amendment requires members promptly to file with NASD copies of the following documents: (1) any criminal complaints filed against the member or plea agreements entered into by the member that are covered by Rule 3070; (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 U4, irrespective of any dollar threshold requirements that question imposes for notification. See NASD Notice to Members 03-23, Rule 3070: SEC Approves Amendment to Rule 3070 to Require Filing with NASD of Criminal and Civil Complaints and Arbitration Claims, May 2003. See also NYSE Information Memos 03-11, Fingerprint Processing And FBI Identification Records, March 25, 2003, and 02-52, New Forms U-4 AND U-5 Filing Procedures Through Web CRD, November 18, 2002 (www.nyse.com) => Regulation => Information Memos).

      Research Analysts' Conflicts of Interest

      On May 10, 2002, the SEC approved new NASD Rule 2711 (Research Analysts and Research Reports), as well as amendments to New York Stock Exchange (NYSE) Rule 351, (Reporting Requirements), and Rule 472, (Communications With The Public). The intent of the new rule and rule amendments is to increase research analysts' independence from influences within their firms and provide disclosure of conflicts of interests that might potentially bias research analysts and the research reports they produce. Generally, the new rule and amendments: 1) restrict the relationship between research and investment banking departments; 2) require disclosure of financial interests in subject companies by analysts and firms; 3) require disclosure of existing and potential investment banking relationships with subject companies; 4) impose quiet periods for the issuance of research reports; 5) restrict personal trading by analysts; and 6) require disclosure of information that assists investors in tracking the correlation between analysts' recommendations and stock price movement.

      On July 29, 2003, the SEC approved further amendments to these rules. The amendments are the latest in a series of joint regulatory efforts intended to address broker/dealer and analyst conflicts of interest and to enhance public disclosure of such potential conflicts of interest. The amendments also amend NASD/NYSE rules to comply with the mandates of the Sarbanes-Oxley Act of 2002, and impose registration, qualification, and continuing education requirements on research analysts. When the amendments to SRO Continuing Education Rules become effective in 2004, research analysts will be required to be registered and will be subject to the Regulatory Element and the Firm Element. Firm Element training for research analysts and their immediate supervisors will be required to include ethics, professional responsibility, and the requirements of new Research Analyst rules, e.g., NASD Rule 2711.

      See NASD Notice to Members 03-44: Research Analysts and Research Reports, August 2003; NYSE Information Memos 03-36, Amendments to Disclosure and Reporting Requirements, August 25, 2003; 03-30, RULE 472 - Gatekeeper Requirements, July 10, 2003; 03-12, April 1st Reporting Requirement - Rules 351 & 472, March 25, 2003; Disclosure and Reporting Requirements Nos 02-55, November 29, 2002, and 02-30, July 9, 2002 (www.nyse.com => Regulation => Information Memos).

      See also NASD Notice to Members 02-39: SEC Approves Rule Governing Research Analysts' Conflicts of Interest, July 2002; and SEC Regulation Analyst Certifications (Reg AC) at www.sec.gov/rules/final/33-8193.htm.

      NASD maintains a Web Site on this evolving topic that is continuously updated at www.nasdr.com/analyst_guide.htm

      Security Futures (also know as Single Stock Futures)

      The Commodity Futures Modernization Act of 2000 lifted the ban on the trading of security futures (i.e., futures on narrow-based indices, single stocks, and options on securities 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 or to supervise such activity 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 securities 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 securities 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. Note: Securities and futures SROs are in the process of developing regulatory requirements for the registration and qualification of persons engaged in security futures contracts sales and supervision activities. Please monitor the NASD Web Site and these other SRO Web sites for additional information: www.nfa.futures.org, www.nyse.com, and www.amextrader.com.

      Broker/dealers 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.

      For more information on security futures in general, please see: www.nqlx.com and www.onechicago.com.

      Supervision

      Books and Records

      Branch office managers and other supervisory personnel, as well as RRs, 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 became effective on May 2, 2003. The amendments clarify and expand recordkeeping 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 aspects of 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 NASD's Books and Records Web Site at www.nasdr.com/books.asp, which has links to the following: SEC Interpretive Release: Books and Records Requirements for Brokers and Dealers Under the Securities Exchange Act of 1934, Rel. 34-47910 (5/29/03); NASD Notice to Members 01-80, Books and Records Rules: Amendments To Broker/Dealer Books And Records Rules Under The Securities Exchange Act Of 1934, December 2001; and Frequently Asked Questions.

      See also NYSE Information Memos 03-18, I. Amended Rule 36, (Communications Between Exchange And Members' Offices) - Cell Phones, And Requirements For Conducting A Public Business II. Clarification Of Recent SEC Books And Records Rules, May 6, 2003, and 03-16, Effective Date For "Books And Records" Rule Amendments, April 15, 2003 (www.nyse.com => Regulation => Information Memos).

      Also see CBOE Regulatory Circular RG03-032 dated May 2, 2003, Effective Date for "Books and Records" Rule Amendments, and PHLX Membership Memo 0551-03 dated May 5, 2003, Amendments to Broker-Dealer Books and Records Rules.

      General Topics

      Industry 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, 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


      • Failure to Respond to SRO Information Requests


      • Failure to Provide Customers With Mutual Fund Breakpoints


      • 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 NYSE's Disciplinary Actions at www.nyse.com/regulations.html.

      Instant Messaging

      Instant messaging is a developing technology that can pose supervisory and recordkeeping challenges for member firms. Instant Messaging's lack of formality does not exempt it from the general standards applicable to all forms of communication with the public. Broker/dealers must supervise the use of instant messaging consistent with the required supervision of e-mail messaging. Depending on the circumstances, instant messaging could be either sales literature or correspondence. Compliance in each of these situations depends on clear supervision and review procedures that are consistently followed. If a member is unable to establish an adequate supervisory program, the member must prohibit the use of instant messaging in customer communication. Broker/dealers must also ensure that their use of instant messaging complies with applicable SEC and SRO recordkeeping requirements. See NASD Notice to Members 03-33, Instant Messaging: Clarification for Members Regarding Supervisory Obligations and Recordkeeping Requirements for Instant Messaging, July 2003.

      Also, broker/dealers are required pursuant to NYSE Rule 440 and SEC Rules 17a-3 and 17a-4 to retain records that relate to the conduct of their business. Instant messaging, while a new format for communications, is subject to the same retention requirements as any other form of written or electronic communications. See Information Memo 03-7, Electronic Logs And Record Retention, March 5, 2003 (www.nyse.com => Regulation => Information Memos).

      Variable Annuities and Life Insurance

      Associated persons should be trained in the features, risks, and suitability of variable annuity and life insurance contract exchanges so as to assist their clients in making informed decisions. NASD has published a number of Investor Alerts on this subject:

      See also NASD Notice to Members 99-35, The NASD Reminds Members of Their Responsibilities Regarding the Sale of Variable Annuities, May 1999; and Variable Annuities: What You Should Know, at www.sec.gov/consumer/varannty.htm.

      To Obtain More Information

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

      Self-Regulatory Organization Address and Phone Number Online Address
      American Stock Exchange American Stock Exchange
      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
      240-386-4200
      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

    • 03-56 Rule Amendments to Require Member Applicants to File Forms U4 Electronically

      View PDF File

      INFORMATIONAL

      Forms U4

      Operative Date: October 27, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Registration
      Senior Management

      Central Registration Depository
      Form U4
      New Member Application
      Rule 1013
      Rule 1140

      Executive Summary

      NASD has amended Rule 1013 (New Member Application and Interview) to eliminate the requirement that new member applicants include in their membership applications signed, paper Forms U4 for their proposed associated persons. Rule 1013, as amended, requires new member applicants to file these Forms U4 electronically. NASD also has amended Rule 1140 (Electronic Filing Rules) to require new member applicants to follow the same procedures members must follow when making electronic Form U4 filings. The approved rule changes also make certain technical changes to Rules 1013 and 1140. Questions and answers explaining how members should comply with the amendments are included in Attachment A. The amendments are included with this Notice as Attachment B. The amendments to Rules 1013 and 1140 were filed with the Securities and Exchange Commission for immediate effectiveness on August 28, 2003;1 the amendments, however, do not become operative until October 27, 2003.

      Questions/Further Information

      Questions concerning this Notice may be directed to the Office of General Counsel, NASD Regulatory Policy and Oversight: Patricia Albrecht, Assistant General Counsel, (202) 728-8026.

      Background

      As part of its effort to make the membership application process more efficient and less burdensome for applicants, NASD has amended Rule 1013 and Rule 1140 to require that member applicants, upon approval of their Web CRD entitlement request forms, file their Forms U4 electronically via Web CRD.

      NASD Rule 1013 - New Member Application and Interview

      Rule 1013(a)(2) (Contents) identifies the items an applicant must submit with its new membership application. The amendment to Rule 1013 eliminates Rule 1013(a)(2)(B), which currently requires an applicant to include in its membership application an original, signed paper Form U4 for each of the applicant's proposed associated persons who are required to be registered with NASD. Instead, Rule 1013(a)(3) (Electronic Filings), as amended, requires that upon approval of the applicant's Web CRD entitlement request form, the applicant must file all required Forms U4 electronically via Web CRD. The electronic filing requirement allows an applicant to use one unified process for all Form U4 submissions in the membership application process, reduces the amount of paperwork the applicant must submit with its membership application, and eliminates the need for NASD staff to separate the Forms U4 from the membership application material and route them to the appropriate office for review and entry into the Web CRD system. Because Rule 1013(a)(3) will require an applicant to file Forms U4 directly with Web CRD, NASD Web CRD staff will not experience any delays that might occur as a result of the routing process.

      Process for Filing Electronic Forms U4

      Rule 1013(a)(2)(R) requires an applicant to submit with its membership application a Web CRD entitlement request form. NASD Registration and Disclosure (RAD) will send the Web CRD entitlement request form to the applicant if it was not included in the application. Upon receipt of the completed Web CRD entitlement request form, RAD will, as appropriate, approve the form and provide the applicant with access to Web CRD.

      Upon approval of the applicant's Web CRD entitlement request form, amended Rule 1013(a)(3) requires that the applicant submit electronically, among other things, Forms U4 for its proposed associated persons who are required to register under NASD rules. NASD expects an applicant to file Forms U4 for all proposed associated persons who are not yet registered with NASD within two weeks of receiving Web CRD access. Receiving such information within this two-week window will enable NASD staff to review the person's background information at an early stage in the application process.

      In contrast, in the case of proposed associated persons who are already registered with NASD at the time the applicant submits its membership application (and thus for whom NASD already possesses significant background information), the applicant may submit electronic Forms U4 for such persons at any time prior to the approval of the membership application; provided, however, that if a currently registered person needs to take a qualifying examination, the applicant must file the registered person's Form U4 early enough in the process to allow the registered person to take the necessary examination in a timely manner. In this regard, Rule 1014(a) (Standards for Admission) requires all associated persons to have the applicable licenses and registrations.2 NASD's current policy allows each individual a 90-day window to pass all required examinations following the filing of an electronic Form U4.3

      NASD Rule 1140 - Electronic Filing Rules

      In connection with the new electronic Form U4 filing requirement, NASD also has amended Rule 1140. Rule 1140, as amended, subjects applicants to the same electronic filing requirements that members must follow when filing electronic Forms U4. Rule 1140 requires every electronic Form U4 filing made by a member to be based on a signed Form U4 provided by the associated person. In addition, Rule 1140 requires members, as part of their recordkeeping requirements, to retain the signed Forms U4 and make them promptly available upon regulatory request. Rule 1140, as amended, requires applicants to follow these same procedures when making electronic Form U4 filings. Among other things, these requirements will help ensure that each associated person has reviewed and confirmed the information set forth in the electronic Form U4, and has undertaken all related representations in the Form U4.

      Technical Changes to NASD Rules 1013 and 1140

      Finally, the amendments to Rules 1013 and 1140 make several technical changes, including:

      • The references in these rules to "Form U-4" and "Form U-5" have been changed to "Form U4" and "Form U5," respectively.4


      • Rule 1140 has been amended to replace references to "applicant" in Rule 1140 with references, as appropriate, to persons on whose behalf Forms U4 filings are being made.


      1 SR-NASD-2003-136 (August 28, 2003); SEC Release No. 34-48448 (September 4, 2003); 68 FR 53626 (September 11, 2003).

      2 Rule 1014(a)(2).

      3 See NASD's "How to Become a Member" Web Page at www.nasdr.com/4700_toc.htm.

      4 This change is being made in accordance with SR-NASD-2003-57 (Rule Change to Revise Uniform Application for Securities Industry Registration or Transfer (Form U-4) and Uniform Termination Notice for Securities Industry Registration (Form U-5)), which changed the references for Forms "U-4" and "U-5" to "U4" and "U5." See SEC Release No. 34-48161 (July 10, 2003), 68 FR 42444 (July 17, 2003).


      Attachment A

      Questions and Answers Regarding Compliance With Amended NASD Rules 1013 and 1140

      Q:   Are the paper Forms U4 filed by applicants being replaced entirely by electronic Form U4 filings?

      A:   Yes. The requirement in Rule 1013(a)(2)(B) that a membership applicant must file signed, paper Forms U4 has been eliminated. Rule 1013(a)(3) has been amended to require that, upon approval of a membership applicant's Web CRD entitlement request form, the applicant must file Forms U4 electronically via Web CRD.

      Q:   Is the electronic Form U4 based on a signed, paper Form U4?

      A:   Yes, the electronic Form U4 is based on a signed, paper Form U4. Rule 1140(c) clarifies that all Forms U4 filed electronically must be based on a signed Form U4 that is provided to the member or an applicant for membership by the person.

      Q:   Who will retain the signed Form U4 and how will NASD obtain a copy if it needs it?

      A:   NASD Rule 1140 requires the member to retain the signed Form U4 and make it available promptly upon regulatory request.

      Q:   How does an applicant comply with amended Rule 1013(a)(3)?

      • If a person who is not yet registered with NASD wants to become a registered person of the applicant, the applicant must, within two weeks of receiving Web CRD access, electronically file the Form U4 for such person. Receiving such information within this two-week window will enable NASD staff to review the person's background information at an early stage in the application process.


      • If a person who is already registered with an NASD member (and thus for whom NASD already possesses significant background information) wants to become a registered person of the applicant, the applicant may submit electronic Forms U4 for such person at any time prior to the approval of the membership application; provided, however, that if a currently registered person needs to take a qualifying examination, the applicant must file the registered person's Form U4 early enough in the process to allow the registered person to take the necessary examination in a timely manner.

      ATTACHMENT B

      1000. Membership, Registration and Qualification Requirements

      1013. New Member Application and Interview

      (a) Filing of Application
      (1) Where to File

      An Applicant for [Association] NASD membership shall file its application with the Department of Member Regulation at the district office in the district in which the Applicant intends to have its principal place of business as defined in Rule 1011(l).
      (2) Contents

      The application shall include:
      (A) an original signed and notarized paper Form BD, with applicable schedules;
      [(B) an original signed paper Form U-4 for each Associated Person who is required to be registered under the Rules of the Association;]
      (C) through (H) Renumbered as (B) through (G).
      [(I)] (H) documentation of any of the following events, unless the event has been reported to the Central Registration Depository:
      (i) through (ii) No change.
      (iii) an investment-related customer complaint or arbitration that is required to be reported on Form U4 [U-4];
      (iv) through (v) No change.
      (J) through (S) Renumbered as (I) through (R).
      (3) Electronic Filings

      Upon approval of the Applicant's Web CRD entitlement request form, the Applicant shall submit its Forms U4 for each Associated Person who is required to be registered under NASD Rules, any amendments to its Forms BD or U4 [U-4, any additional Forms U-4], and any Form U5 [U-5] electronically via Web CRD.
      (4) through (7) No change.
      (b) No change.

      1140. Electronic Filing Rules

      (a) through (b) No change.
      (c) Form U4 [U-4] Filing Requirements
      (1) [Initial and transfer electronic application filings] Every initial and transfer electronic Form U4 filing shall be based on a signed Form U4 [U-4] provided to the member or applicant for membership by the person on whose behalf the Form U4 is being filed [applicant]. As part of the member's recordkeeping requirements, it shall retain the [applicant's] person's signed Form U4 [U-4] and make it available promptly upon regulatory request. An applicant for membership also must retain every signed Form U4 it receives during the application process and make them available promptly upon regulatory request.
      (2) Fingerprint Cards

      Upon filing an electronic Form U4 [U-4] on behalf of [an applicant] a person applying for registration, a member shall promptly submit a fingerprint card for [the applicant] that person. NASD [Regulation] may make a registration effective pending receipt of the fingerprint card. If a member fails to submit a fingerprint card within 30 days after NASD [Regulation] receives the electronic Form U4 [U-4], the person's registration shall be deemed inactive. In such case, NASD [Regulation] shall notify the member that the person must immediately cease all activities requiring registration and is prohibited from performing any duties and functioning in any capacity requiring registration. NASD [Regulation] shall administratively terminate a registration that is inactive for a period of two years. A person whose registration is administratively terminated may reactivate the registration only by reapplying for registration and meeting the qualification requirements of the applicable provisions of the Rule 1020 Series and the Rule 1030 Series. Upon application and a showing of good cause, [the Association] NASD may extend the 30-day period.
      (d) through (e) No change.

    • 03-55 SEC Approves Changes to Rules on Reporting of Transactions through Electronic Communications Networks (ECNs) (See Nasdaq Head Trader Alert 2003-140)

      View PDF File

      See Nasdaq Head Trader Alert 2003-140 at: www.nasdaqtrader.com/dynamic/newsindex/headtraderalerts_2003.stm

      ACTION REQUIRED

      Electronic Communications Networks

      Changes Effective: October 6, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representative
      Legal & Compliance
      Operations
      Senior Management

      Transaction Reporting
      Electronic Communication Networks

      Executive Summary

      On September 4, 2003, the Securities and Exchange Commission (SEC) approved changes to rules governing the reporting of transactions through NASDAQ's Automated Confirmation Transaction Service (ACT) in order to clarify the reporting requirements applicable to transactions conducted through electronic communications networks (ECNs). The new rules do not apply to trades reported through NASD's Trade Reporting and Comparison Service (TRACS).

      The changes, which take effect October 6, 2003, describe the three methods that may be used by ECNs and/or their customers to report trades executed through an ECN's facilities. ECNs that use ACT to report some or all of the transactions executed through their facilities are required to file a notice of their trade-reporting methods prior to October 6, 2003. Please use Attachment A to file this notice. Notices must be filed with NASDAQ's MarketWatch Department, 9509 Key West Avenue, Rockville, MD 20850, Attention: Sheila Dagucon (or you may fax the notification to (240) 386-6050); and NASD's Market Regulation Department, 9509 Key West Avenue, Rockville, MD 20850, Attention: Alternative Trading Systems Group (or you may fax the notification to (240) 386-5139).

      Questions regarding this Notice may be directed to Sheila Dagucon, NASDAQ MarketWatch, at (240) 386-6049; or John Yetter, NASDAQ Office of General Counsel, at (202) 912-3039.

      Background

      Current practices of ECN trade reporting have developed over time in conjunction with the growth of the number of ECNs. As each new ECN entered the market, it registered under NASD Rule 4623 and informed NASDAQ and NASD concerning its planned method for reporting transactions. Although the use of different reporting methodologies by different ECNs has generally allowed ECNs to fulfill reporting obligations while tailoring their methodology to their own business needs and those of their subscribers, the absence of clearly defined rules has, in some circumstances, created confusion as to the trade reporting responsibilities of ECNs and their subscribers. The rule change approved by the Commission will provide members greater certainty concerning their trade reporting responsibilities, while allowing ECNs to continue using the various methods of trade reporting that have developed over time.

      The rule change is based on NASDAQ's understanding of the different methods used by ECNs today to report trades, and, in general, the rule change is not intended to require ECNs to modify their current trade-reporting practices. Rather, the purpose of the rule change is to codify these practices in the form of clear, enforceable rules that will provide greater guidance to market participants. The rule change will apply to transactions in all securities that are executed through an ECN and reported to ACT.

      The rule change permits ECN's to use any of three methods for reporting transactions. However, each ECN must inform, in writing, NASD and NASDAQ simultaneously which method it will use for reporting trades to ACT for each of its subscribers, although it may change its method at any time by providing, simultaneously, advance written notice to NASD and NASDAQ.

      First, an ECN may assume sole responsibility for reporting transactions executed through its facilities and identify itself as the reporting party.

      Second, an ECN may assume sole responsibility for transaction reporting, but identify a subscriber as the reporting party. In that case, the identified reporting party would be determined in accordance with the existing rules for allocating trade-reporting responsibility in NASD Rule 6130(c). Thus, if the subscribers conducting a transaction through the ECN were both market makers or both order entry firms, the selling party would be identified as the reporting party; if the transaction were between a market maker and an order entry firm, the market maker would be identified as the reporting party; and if the transaction were between a member (i.e., a broker/dealer) and a non-member (such as an institutional investor), the member would be identified as the reporting party.

      Third, the ECN may impose some or all of the responsibility for reporting on its subscribers. In that case, the ECN would notify the appropriate reporting party, determined in accordance with the existing rules of priority for trade reporting in NASD Rule 6130(c), that it had an obligation to submit a report concerning the trade.

      At any given time, an ECN may utilize more than one of these methods, with the choice of the method varying depending on the needs of particular subscribers. Thus, an ECN may use one method for one of its subscribers and a different method for all of its other subscribers. The ECN must, however, provide simultaneously NASD and NASDAQ advance written notice concerning the method that it will use for each subscriber.

      In each case, the party submitting a trade report is responsible for ensuring its accuracy and completeness, by providing the information specified by Rule 6130(d). In addition, when an ECN submits a trade report identifying another party as the reporting party, both the ECN and the identified reporting party are responsible for ensuring the accuracy and completeness of the report.

      The rule change also addresses procedures for reporting transactions in several unique circumstances associated with ECNs. First, the rule change provides that when the parties to a transaction executed through an ECN are both non-members, the ECN must submit all required trade reports and identify itself as the reporting party. This is the case because, as non-members, the parties to the transaction would not be eligible to report trades through ACT. Second, in circumstances where one ECN routes an order to another ECN that executes the order, the ECN that executes the order would be responsible for reporting the transaction, or requiring a subscriber to report the transaction, in accordance with one of the three basic methods for trade reporting described above. For purposes of the rules for allocating trade-reporting responsibility between ECN subscribers, the routing ECN would be deemed to be a market maker. Thus, if the executing ECN uses the second method of trade reporting (i.e., reporting on behalf of its subscribers), and it receives an order from a routing ECN that is matched against the order of an order-entry firm or a non-member customer, the routing ECN would be identified as the reporting party. If the executing ECN matched the routed order against the order of a market maker or another ECN, however, the sell side would be identified as the reporting party.

      Finally, it should be noted that the rule change applies only to transactions that are reported to ACT, since NASDAQ does not have authority to establish rules governing the reporting of trades to non-NASDAQ systems, including NASD's TRACS system. Thus, in circumstances where an ECN has the option to report trades to ACT or to another trade-reporting system, such as NASD's TRACS system, the rule does not mandate that the ECN use ACT for trade reporting. However, to the extent that the ECN or its subscribers opt to use ACT to report a particular transaction, all provisions of the rule change would apply to that transaction.


      Attachment A

      Notice Required by NASD Rule 6130(c) for Electronic Communications Network (ECN) Transactions Reported through the Automated Confirmation Transaction Service (ACT)

      Name of ECN: _____________________________________________________________
      Address: __________________________________________________________________
      _________________________________________________________________________
      Contact person: ____________________________________________________________

      Name of ECN subscriber
      (if the same method will be used for all subscribers, the subscribers are not required to be identified by name):
      Trade-Reporting Method
      (identified by number as indicated below):
         
         
         
         
         
         
         
         
         
         
         
         
         
         

      Trade-reporting methods:

      1. The ECN submits trade reports to ACT and identifies itself as the reporting party (NASD Rule 6130(c)(5)(A)).
      2. The ECN submits trade reports to ACT on behalf of the reporting party and identifies the reporting party in accordance with the rules for determining reporting parties reflected in NASD Rule 6130(c)(1), (2), (3), and (4) (NASD Rule 6130(c)(5)(B)).
      3. The ECN requires one of the parties to a transaction, determined in accordance with the rules for determining reporting parties reflected in NASD Rule 6130(c)(1), (2), (3), and (4), to submit the trade reports to ACT (NASD Rule 6130(c)(5)(C)).

      Notice should be sent to:

      • Nasdaq's MarketWatch Department
        9509 Key West Avenue
        Rockville, MD 20850


      • Or you may fax the notification to (240) 386-6050

        Attention: Sheila Dagucon

        AND

      • NASD's Market Regulation Department
        9509 Key West Avenue
        Rockville, MD 20850


      • Or you may fax the notification to (240) 386-5139

        Attention: Alternative Trading Systems Group


      Attachment B

      Text of Amendments

      New text is underlined; deletions are in brackets.

      5400. NASDAQ STOCK MARKET AND ALTERNATIVE DISPLAY FACILITY TRADE REPORTING

      5430. Transaction Reporting

      (a) No change.
      (b) Which Party Reports Transaction and to Which Facility
      (1) In transactions between two Registered Reporting Nasdaq Market Makers, the member representing the sell side shall report the trade using ACT.
      (2) In transactions between a Registered Reporting Nasdaq Market Maker and a Non-Registered Reporting Member, the Registered Reporting Nasdaq Market Maker shall report the trade using ACT.
      (3) In transactions between two Non-Registered Reporting Members, the member representing the sell side shall report the trade using ACT or TRACS.
      (4) In transactions between a member and a customer, the member shall report as follows:
      (A) A Registered Reporting Nasdaq Market Maker shall report the trade using ACT;
      (B) A Registered Reporting ADF Market Maker shall report the trade using TRACS; and
      (C) A Non-Registered Reporting Member shall report the trade using ACT or TRACS.
      (5) In transactions between two Registered Reporting ADF Market Makers, the member representing the sell side shall report the trade using TRACS.
      (6) In transactions between a Registered Reporting ADF Market Maker and a Non-Registered Reporting Member, the Registered Reporting ADF Market Maker shall report the trade using TRACS.
      (7) In transactions between a Registered Reporting Nasdaq Market Maker and a Registered Reporting ADF Market Maker, the member representing the sell side shall report as follows:
      (A) A Registered Reporting Nasdaq Market Maker shall report the trade using ACT; and
      (B) A Registered Reporting ADF Market Maker shall report the trade using TRACS.
      (8) If a member simultaneously is a Registered Reporting Nasdaq Market Maker and a Registered Reporting ADF Market Maker, and has the trade reporting obligation pursuant to paragraphs (1), (2), (4), (5), (6), or (7), the member can report the trade using either ACT or TRACS, unless the trade is executed using ACES; the Nasdaq National Market Execution System ("NNMS"); [the SelectNet Service; the SmallCap Small Order Execution System ("SOES");] or the Primex Auction System ("Primex"). A trade executed using ACES must be reported using ACT, and trades executed using NNMS[, SelectNet, SOES,] or Primex will be reported to ACT automatically.
      (9) In transactions conducted through an ACT ECN (as defined in Rule 6110) that are reported to ACT, the ACT ECN shall ensure that transactions are reported in accordance with Rule 6130(c). If an ACT ECN is also a Registered Reporting ADF ECN (as defined in Rule 4200A), Rule 6130(c) shall apply only to transactions conducted through the ECN for which trade reports are submitted to ACT.

      6100. AUTOMATED CONFIRMATION TRANSACTION SERVICE (ACT)

      6110. Definitions

      (a) - (p) No change.
      (q) The term "ACT ECN" shall mean a member of the Association that is an electronic communications network that is a member of a registered clearing agency for clearing or comparison purposes or has a clearing arrangement with such a member, to the extent that transactions executed through it are reported to ACT.

      6130. Trade Report Input

      (a) - (b) No change.
      (c) Which Party Inputs Trade Reports to ACT

      ACT Participants shall, subject to the input requirements below, either input trade reports into the ACT system or utilize the Browse feature to accept or decline a trade within the applicable time-frames as specified in paragraph (b) of this Rule. Trade data input obligations are as follows:
      (1) in transactions between a Market Maker and an Order Entry Firm, the Market Maker shall be required to submit a trade report to ACT;
      (2) in transactions between two Market Makers, the member representing the sell side shall be required to submit a trade report to ACT;
      (3) in transactions between two Order Entry Firms, the member representing the sell side shall be required to submit a trade report to ACT[.];
      (4) in transactions between a member and a customer, the member shall be required to submit a trade report to ACT;
      (5) in transactions conducted through an ACT ECN that are reported to ACT, the ACT ECN shall ensure that transactions are reported in accordance with one of the following methods:
      (A) the ACT ECN shall submit the trade reports to ACT and identify itself as the reporting party;
      (B) the ACT ECN shall submit the trade reports to ACT on behalf of the reporting party and identify the reporting party in accordance with the rules for determining reporting parties reflected in paragraphs (1), (2), (3), and (4) above; or
      (C) the ACT ECN shall require one of the parties, determined in accordance with the rules for determining reporting parties reflected in paragraphs (1), (2), (3), and (4) above, to submit the trade reports to ACT.
      When an ACT ECN reports transactions in accordance with subparagraph (A), the ACT ECN shall be responsible for ensuring that the trade reports are accurate and contain all information required by subsection (d) of this rule for both the ACT ECN and the identified non-reporting party. When an ACT ECN reports transactions in accordance with subparagraph (B), both the ACT ECN and the party identified as the reporting party shall be responsible for ensuring that the trade reports are accurate and contain all information required by subsection (d) of this rule for both the ACT ECN and the identified reporting party. When an ACT ECN requires reporting of transactions in accordance with subparagraph (C), the reporting party shall be responsible for ensuring the accuracy and completeness of the trade report.

      An ACT ECN shall provide written notice to the Association of the method of trade reporting used by the ACT ECN for each of its subscribers, and may change the method of trade reporting used for a subscriber by providing advance written notice of the change to the Association;
      (6) in transactions conducted through two ACT ECNs or an ACT ECN and an ECN that is not an ACT ECN, an ACT ECN shall be responsible for complying with the requirements of paragraph (5) above for reporting a transaction executed through its facilities, and an ECN that routed an order to it for execution shall be deemed to be a Market Maker and a member for purposes of the rules for determining reporting parties reflected in paragraphs (1), (2), and (4) above; and
      (7) in transactions conducted through an ACT ECN in which neither of the parties is a member, the ACT ECN shall report the transaction in accordance with the requirements of subparagraph (5)(A) above.
      (d) Trade Information To Be Input

      Each ACT report shall contain the following information:
      (1) Security identification symbol of the eligible security (SECID);
      (2) Number of shares;
      (3) Unit price, excluding commissions, mark-ups or mark-downs;
      (4) Execution time for any transaction in Nasdaq or CQS securities not reported within 90 seconds of execution;
      (5) A symbol indicating whether the party submitting the trade report represents the Market Maker side or the Order Entry side;
      (6) A symbol indicating whether the transaction is a buy, sell, sell short, sell short exempt or cross;
      (7) A symbol indicating whether the trade is as principal, riskless principal, or agent;
      (8) Reporting side clearing broker (if other than normal clearing broker);
      (9) Reporting side executing broker as "give-up" (if any);
      (10) Contra side executing broker;
      (11) Contra side introducing broker in case of "give-up" trade;
      (12) Contra side clearing broker (if other than normal clearing broker).
      (13) For any transaction in an order for which a member has recording and reporting obligations under Rules 6954 and 6955, the trade report must include:
      (A) An order identifier, meeting such parameters as may be prescribed by the Association, assigned to the order that uniquely identifies the order for the date it was received (see Rule 6954(b)(1)).
      (B) The time of the execution expressed in hours, minutes, and seconds. This information must be reported regardless of the period of time between execution of the trade and the ACT trade report. All times reported to the ACT system shall be in Eastern Time.
      (e) Aggregation of Transaction Reports

      Individual executions of orders in a security at the same price may be aggregated, for ACT reporting purposes, into a single report if the transactions are with the identical contra party; provided, however, that a reporting party may not withhold reporting a trade in anticipation of aggregating the transaction with other transactions.

      6400. REPORTING TRANSACTIONS IN LISTED SECURITIES

      6420. Transaction Reporting

      (a) No change.
      (b) Which Party Reports Transaction
      (1) Transactions executed on an exchange are reported by the exchange and shall not be reported by members.
      (2) In transactions between two Registered Reporting Members, only the member representing the sell side shall report.
      (3) In transactions between a Registered Reporting Member and a Non-Registered Reporting Member, only the Registered Reporting Member shall report.
      (4) In transactions between Non-Registered Reporting Members, only the member representing the sell side shall report.
      (5) In transactions conducted through an ACT ECN (as defined in Rule 6110), the ACT ECN shall ensure that the transactions are reported in accordance with Rule 6130(c).
      (c) - (e) No change.

      IM-6420. Transactions in Eligible Securities

      Summary Of Provisions Governing Members' Requirements To Report Transaction In Eligible Securities

      Chart 1 — General Reporting Requirements Under Rule 6420(b)

      Member Transaction Member Reports When Contra-Party Is
        [Designated] Registered Reporting Non-[Designated]
      Registered
      Reporting
      Member Member Exchange Customer
      [Designated] Registered Reporting buys from: No Yes No Yes
      Member sells to: Yes Yes No Yes
      Non-[Designated] Registered Reporting buys from: No No No Yes
      Member sells to: No Yes No Yes
      ACT ECN   See 6130(c) See 6130(c) No See 6130(c)

      Chart II — Reporting Requirements for "Riskless" Transactions as Defined in Rule 6420(d)(4)

      Member Transaction Member Reports When Contra-Party Is
        [Designated] Registered Reporting Non-[Designated]
      Registered
      Reporting
      Member Member Exchange Customer
      [Designated] Registered Reporting buys from customer and sells to: Yes Yes No Yes
      Member sells to customer and buys from: No Yes No Yes
      Non-[Designated] Registered Reporting buys from customer and sells to: No Yes No Yes
      Member sells to customer and buys from: No No No Yes

      6600. REPORTING TRANSACTIONS IN OVER-THE-COUNTER SECURITIES

      6620. Transaction Reporting

      (a) No change.
      (b) Which Party Reports Transaction
      (1) In transactions between two OTC Market Makers, only the member representing the sell side shall report.
      (2) In transactions between an OTC Market Maker and a Non-Market Maker, only the OTC Market Maker shall report.
      (3) In transactions between two Non-Market Makers, only the member representing the sell side shall report.
      (4) In transactions between a member and a customer, the member shall report.
      (5) In transactions conducted through an ACT ECN (as defined in Rule 6110), the ACT ECN shall ensure that the transactions are reported in accordance with Rule 6130(c), and the term "Market Maker" as used in such rule shall be construed to include an OTC Market Maker.
      (c) - (e) No change.

      6900. REPORTING TRANSACTIONS IN DIRECT PARTICIPATION PROGRAMS

      6920. Transaction Reporting.

      (a) No change.
      (b) Which Party Reports Transactions
      (1) In transactions between two members, only the member representing the sell side shall report.
      (2) In transactions between a member and a customer, the member shall report.
      (3) In transactions conducted through an ACT ECN (as defined in Rule 6110), the ACT ECN shall ensure that the transactions are reported in accordance with Rule 6130(c); provided that for purposes of Rule 6130(c)(5) (B) and (C), the party with the reporting obligation shall be as set forth in Rule 6130(c)(3) and the term "Order Entry Firm" as used in such rule shall be construed to refer to any member.
      (c) - (e) No change.

    • 03-54 NASD Requests Comment on Proposed Amendments to Rule 2830 (Investment Company Securities)

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      REQUEST FOR COMMENT

      Compensation for the Sale of Investment Company Securities

      Comment Period Expires: October 17, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Advertising/Investment Companies
      Executive Representatives
      Legal & Compliance
      Mutual Fund
      Registered Representatives
      Senior Management

      NASD Rule 2830
      Revenue Sharing
      Investment Companies
      Advertising
      Variable Contracts

      Executive Summary

      NASD proposes to amend Rule 2830 to require disclosure of revenue sharing and differential cash compensation arrangements relating to the sale of investment company securities. The proposal would require that a member disclose these compensation arrangements in writing when a customer first opens an account or purchases fund shares. The proposal also would require a member to update this information twice a year and make updates available to each customer.

      NASD's proposal would:

      • Broaden the definition of "cash compensation" in Rule 2830(b)(1)(C) to include cash payments received for inclusion of an investment company on a preferred sales list, in any other sales program (e.g., for shelf space) or as expense reimbursements;


      • Add definitions of "differential cash compensation" and "gross dealer concessions" to Rule 2830(b); and


      • Revise Rule 2830(l)(4) to ensure that members disclose revenue sharing arrangements and differential cash compensation arrangements to customers.

      Questions/Further Information

      Questions concerning this Notice to Members may be directed to Joseph P. Savage, Counsel, Investment Companies Regulation, Regulatory Policy and Oversight, at (240) 386-4534; or Angela C. Goelzer, Counsel, Investment Companies Regulation, Regulatory Policy and Oversight, at (202) 728-8120.

      Request for Comment

      NASD requests comment on the proposed amendments to Rule 2830 described in this Notice. Members wishing to comment must make a submission that is received by October 17, 2003. Members and interested persons can submit their comments using the following methods:

      • mailing in written comments


      • e-mailing written comments to pubcom@nasd.com


      • submitting comments online at 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 by mail or e-mail.

      Before becoming effective, any rule change resulting from this proposal 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 Securities and Exchange Commission (SEC).

      Background

      NASD members and their registered representatives are compensated for the sale of mutual fund shares in various ways, and the disclosure that investors receive depends upon the particular compensation arrangement. For example, member compensation that is deducted from a shareholder account or from fund assets, such as sales charges and Rule 12b-1 fees, is disclosed in the fee table that appears in the mutual fund prospectus. Other forms of member compensation, such as payments from a mutual fund adviser for "shelf space," have been the subject of less prominent disclosure.

      NASD reminds members that compensation arrangements may never undermine a member's obligation to properly supervise its registered representatives, or a registered representative's obligation to make only suitable recommendations to customers.1 Members must adopt and implement procedures reasonably designed to ensure that all communications of their registered representatives concerning investment company products, whether written or oral, are accurate and complete.2 In recommending an investment company, registered representatives must disclose all material information, including the fund's expenses and sales charges, investment objective and risks.

      1. Rule 2830

      NASD rules regulate various compensation arrangements that present specific investor protection concerns. For example, NASD Conduct Rule 2830 effectively prohibits the payment of any form of compensation from third-party offerors to a member's associated persons. Rule 2830(l)(4) provides that a member may not accept cash compensation from an investment company offeror unless the compensation is described in the investment company's prospectus. The rule also prohibits a member from entering into "special cash compensation arrangements" with an investment company offeror unless the prospectus discloses the details of the arrangements. Earlier this year, NASD fined and censured two members for failing to disclose special cash compensation paid to dealer firms and to a group of registered representatives for the sale of mutual fund shares.3

      Rule 2830(l)(5) prohibits the payment of most forms of non-cash compensation, such as lavish gifts and trips to resort locations, to registered representatives.4 NASD has made clear to its members that this prohibition will be enforced in a manner that is appropriate in light of the purposes of the rule. Thus, for example, NASD has narrowly interpreted the "training and education exception" to the rule, forbidding reimbursement for tours, golf outings, and other forms of entertainment in connection with so-called "training and education meetings."5
      2. Proposed Amendments

      NASD is now proposing a disclosure approach concerning two types of compensation arrangements that present investor protection concerns. These two types of compensation arrangements are:

      • Revenue sharing arrangements, in which an investment adviser or other offeror agrees to pay an NASD member cash compensation not otherwise disclosed in the prospectus fee table (such as payments for "shelf space" to distribute the investment company's shares); and


      • Differential cash compensation arrangements, typically occurring when a member provides higher payouts to its registered representatives for the sale of certain investment company products, such as investment companies that are proprietary funds of the member.

      Revenue sharing and differential cash compensation arrangements may create incentives to inappropriately favor some funds over others, or to favor funds over nonfund investments. These compensation arrangements can create conflicts of interest by encouraging members and their registered representatives to recommend certain funds to maximize their compensation, rather than to best meet their customers' needs. They may provide point-of-sale incentives that could compromise proper customer suitability considerations and may present a situation in which the salesperson's interests are not, in some circumstances, fully aligned with the interests of customers.

      Disclosure of revenue sharing and differential cash compensation arrangements would enable investors to evaluate whether a registered representative's particular product recommendation was inappropriately influenced by these arrangements. Disclosure of these arrangements could be an important adjunct to existing suitability, sales practice, and disclosure requirements and may help ensure that there is an appropriate match between the needs of an investor and the most appropriate investment company.

      Congress and the SEC also are considering the adequacy of disclosure regarding mutual fund fees and broker/dealer compensation for fund sales, and Congress may enact legislation or the SEC may issue separate proposals addressing these matters. In July, SEC Chairman Donaldson asked his staff "to move ahead with the prospectus disclosure recommendations of the Task Force on Breakpoints and to develop additional investor protection initiatives concerning the costs and conflicts of interest in mutual fund investments." Chairman Donaldson also anticipated that "the Commission will consider additional regulation in this critical area of our markets in the near future."6 It is possible that Congressional or SEC action would require enhanced disclosure in the mutual fund prospectus, periodic reports, or confirmation statements. Such enhanced disclosure will be complementary to NASD's proposal. NASD will continue to work with Congress and the SEC on these investor protection initiatives.

      The Proposal

      1. Required Disclosure

      NASD proposes to amend Rule 2830 to better ensure that members disclose to their customers information about revenue sharing and differential cash compensation arrangements. The proposal recognizes that both revenue sharing and differential cash compensation arrangements may come in a variety of forms. For example, revenue sharing arrangements may include cash payments from a fund's investment adviser and expense reimbursements. A differential cash compensation arrangement may consist of a system under which a firm imposes ticket charges on their registered representatives for the sale of some, but not all, investment companies. Thus, a registered representative may not have to pay a ticket charge for the sale of a proprietary investment company, but may have to pay one for the sale of a nonproprietary investment company.

      Rule 2830(l)(4) would be revised to require that any member that within the previous twelve months has received from an investment company offeror cash compensation, or that uses differential cash compensation policies in compensating its associated persons, must disclose:

      • That information about a fund's fees and expenses may be found in the fee table located in the fund's prospectus and that the fund's statement of additional information contains information about how the fund selects brokers.


      • If applicable, that the member receives cash payments from fund offerors other than the sales charges (including Rule 12b-1 fees) and service fees disclosed in the prospectus fee table. The member also would have to list the offerors that made these payments to the member in descending order based upon the total amount of compensation received from each offeror. The member would not have to disclose the actual amounts of compensation received under these arrangements.7


      • If applicable, that an associated person (including a registered representative or branch manager) receives different rates of compensation depending upon which investment company shares are purchased by a customer, the nature of these arrangements, and the names of the investment companies favored by these arrangements. This disclosure requirement would not apply to arrangements under which different associated persons receive different payout ratios, so long as an individual associated person receives the same payout ratio for all funds that he or she sells. This disclosure requirement also would not apply to differences in total compensation received by the associated person, such as for the sale of an investment company that provides a higher gross dealer concession to the member, provided that the payout ratios are the same for all funds that the associated person sells.


      • A Web page or toll-free telephone number that a customer may use to obtain updated information about the member's revenue sharing and differential cash compensation arrangements. A member may choose not to maintain a Web page or toll-free number that provides updated information, but then must disclose that updated information will be sent to the customer on a semi-annual basis.

      Rule 2830 also would be amended to provide that the required disclosures must be updated on a semi-annual basis and must be made in writing to the customer:

      • At the time that the customer establishes an account with the member or the member's clearing broker;


      • If no account is established, at the time that the customer first purchases shares of an investment company;


      • For accounts that are in existence at the time that the proposed revisions to Rule 2830 become effective, at the later of ninety days after the effective date or the time at which the customer first purchases fund shares following the effective date.

      The proposal would retain, with modification, the current requirements in Rule 2830(l)(4) regarding prospectus disclosure of cash compensation arrangements.8 The modifications are designed to clarify a member's obligation not to accept any sales charges or service fees that are not described in a current fund prospectus. If a special sales charge or service fee arrangement is made available to some, but not all, members who distribute a fund's securities, the arrangement must be described in the fund's prospectus. Thus, consistent with current policy, if an offeror pays a higher percentage of a mutual fund's sales charges to one member than it pays to other members, the details of this special cash compensation arrangement would have to be disclosed in the fund's prospectus. NASD has interpreted Rule 2830(l)(4) to allow this required disclosure to be presented in a fund's Statement of Additional Information (SAI).9

      NASD seeks comment on whether SAI disclosure is an effective means to communicate with investors about special cash compensation arrangements. Should NASD require prospectus, rather than SAI, disclosure of these arrangements? Should the current requirements of Rule 2830(l)(4) be eliminated in light of the disclosure that would be required by the proposed amendments? If prospectus disclosure requirements are retained, should NASD provide additional guidance concerning the circumstances under which Rule 2830(l)(4) mandates disclosure and the level of detail that may be deemed appropriate?
      2. Cash Compensation

      The definition of "cash compensation" set forth in Rule 2830(b)(1)(C) would be amended to include cash payments received as a condition for inclusion of the investment company on a preferred or select sales list, in any other sales program (e.g., for shelf space), or as expense reimbursement.10 The definition also would be clarified to expressly include gross dealer concessions.
      3. Differential Cash Compensation

      Rule 2830(b)(1) would be amended to add a definition of "differential cash compensation." The definition is designed to encompass any compensation arrangement under which a member pays an associated person different rates of compensation depending upon which investment company securities (or classes thereof) are sold. For example, a differential cash compensation arrangement would be deemed to exist whenever a member pays an associated person a higher percentage of the member's "gross dealer concessions" for the sale of one fund's securities than the percentage paid for sale of the same dollar amount of another fund's securities. A differential compensation arrangement also would be found when a member sponsors a cash sales contest with sales targets that favor certain funds, or when a member imposes or waives ticket charges for the sale of certain funds. The proposed definition would not be limited to differential cash compensation arrangements favoring proprietary funds. Also, the definition would encompass payments to any associated person, including a registered representative or branch manager.

      NASD requests comment on whether money market funds should be excluded from the differential cash compensation provision. For example, a differential cash compensation arrangement could be deemed to exist whenever payout ratios are higher for the sale of one investment company than for another investment company that is not a money market fund. This provision would permit lower payouts for money market funds without mandating disclosure.
      4. Gross Dealer Concessions

      Integral to the proposed definition of "differential cash compensation" is NASD's proposed definition of "gross dealer concessions." Gross dealer concessions would be defined as the total amount of any compensation received by a member from an offeror for the sale of investment company securities, including all discounts, concessions, service fees, commissions, and asset-based sales charges.
      5. Alternative Approaches

      NASD seeks comments on alternatives to the proposed amendments. For example:

      • As proposed, a member would provide the required disclosure when a customer first establishes an account with a member or the member's clearing broker, or when the customer first purchases investment company shares. Are these the most appropriate times for a customer to receive the information? Would it be more appropriate for a customer to receive the information when he or she first receives a recommendation to purchase investment company shares, rather than at the opening of a brokerage account?


      • Would investors be well served by disclosure that provides a general "warning label" urging them to seek information from the member or its associated person concerning revenue sharing and differential cash compensation arrangements, rather than receiving a list of relevant funds?


      • In addition to the proposed disclosure, should NASD require disclosure of the actual dollar amounts paid under revenue sharing and differential cash compensation arrangements?


      • What are the costs and benefits of the proposed amendments and the alternative approaches?


      • Are there any other types of arrangements that should be covered by the rule due to the conflicts of interest that may be presented?

      With regard to disclosure of revenue sharing arrangements:

      • NASD specifically seeks comment on whether it would be appropriate for Rule 2830 to establish a de minimis threshold below which disclosure of revenue sharing would not be required and, if so, the appropriate level of a threshold for disclosure.


      • As proposed, a member that receives revenue sharing payments would be required to list the offerors that make the payments in descending order based upon the amount received by each. NASD requests comment on whether other listing requirements would be more appropriate. For example, offerors could be grouped according to the size of their revenue sharing payments (e.g., by highest to lowest quartile or quintile), without ranking the offerors in descending order within each group. Another alternative might be to list offerors according to revenue sharing payments per $10,000 in fund sales, rather than based on total payments per fund.

      NASD also seeks comment on whether the proposed definition of differential cash compensation should be broadened. As proposed, differential cash compensation would include arrangements in which a registered representative receives a higher percentage of the gross dealer concession for one fund than he or she would receive for the sale of another investment company. One alternative would be to expand this definition to include other circumstances in which the sale of the same dollar amount of different funds results in differing levels of compensation. For example, a registered representative may receive identical payout ratios for the sale of different funds, but the sale of one may result in higher compensation because the gross dealer concession is greater in absolute dollars.

      More generally, NASD seeks comment on whether the proposal should be expanded to require disclosure of revenue sharing and differential compensation arrangements with respect to products other than investment companies, such as variable annuities. Would imposition of the proposed disclosure requirements solely on investment companies create incentives for registered representatives to favor other investment products?

      1 NASD strictly monitors its members' sales practices in connection with the distribution of mutual funds and related investment products. For example, NASD's heightened scrutiny of sales practices in connection with the distribution of both mutual funds and variable annuities has resulted in over 75 disciplinary actions since the beginning of 2001.

      2 See, e.g., Notice to Members 98-107 (NASD Reminds Members Of Their Obligation To Disclose Mutual Fund Fees) and Notice to Members 94-16 (NASD Reminds Members Of Mutual Fund Sales Practice Obligations).

      3 See NASD Regulatory and Compliance Alert (Spring 2003). The respondents did not admit or deny the allegations but consented to the entry of findings.

      4 See Notice to Members 98-75 (amending Rules 2820 and 2830 to limit the extent to which members may pay or accept non-cash compensation).

      5 See NASD Regulatory and Compliance Alert (Summer 2000).

      6 SEC Press Release No. 2003-84 (July 22, 2003).

      7 The proposal would not require a member to disclose receipt of non-cash compensation permitted by Rule 2830(l)(5), such as gifts under $100, occasional meals, tickets to theater and sporting events, and reimbursement for associated persons' expenses in attending permissible training or education meetings.

      8 Rule 2830(l)(4) provides in part that "[n]o member shall accept any cash compensation from an offeror unless such compensation is described in a current prospectus of the investment company. When special cash compensation arrangements are made available by an offeror to a member, which arrangements are not made available on the same terms to all members who distribute the investment company securities of the offeror, a member shall not enter into such arrangements unless the name of the member and the details of the arrangements are disclosed in the prospectus."

      9 See Notice to Members 99-55 (Question #18).

      10 Thus, the definition of "cash compensation" would include payments, made from an offeror other than an investment company, received by members for the sale of fund shares or payments based on the amount of fund assets held in accounts at the member. The definition would not include directed brokerage to a member. Of course, the prohibitions of Rule 2830(k) would still apply even after adoption of the proposed amendments. Rule 2830(k) generally prohibits a member from directly or indirectly seeking brokerage commissions as a condition to the sale or distribution of investment company securities.


      Attachment A

      Text of Proposed Amendments

      Rule 2830(b)(1)(C) is revised to read as follows:

      (C) "Cash compensation" shall mean any cash payment received in connection with the sale or distribution of investment company securities, including but not limited to:
      (i) any discount, concession, gross dealer concession, fee, service fee, commission, asset-based sales charge, loan, override, cash employee benefit; or
      (ii) any cash payment received as a condition for inclusion of the investment company on a preferred or select sales list; in any other sales program; or as an expense reimbursement.

      New Rules 2830(b)(1)(F) and (G) are inserted as follows:

      (F) "Differential cash compensation" shall mean
      (i) the payment by a member to its associated persons of a higher percentage of the member's gross dealer concessions for the sale of a stated dollar amount of the securities of a particular investment company (or any class thereof) than the percentage of its gross dealer concessions that the member pays to its associated persons for the sale of the same dollar amount of securities of another investment company (or any class thereof); and
      (ii) other practices of a member that cause an associated person to earn different rates of compensation for investment company products (or classesthereof) depending on the product sold, including but not limited to a member's payment of additional cash compensation or the imposition or waiver of ticket charges for associated persons concerning the sale of particular investment company securities.
      (G) "Gross dealer concessions" shall mean the total amount of any discounts, concessions, fees, service fees, commissions or asset-based sales charges provided by the offeror to the member in connection with the sale and distribution of investment company securities.

      Rule 2830(l)(4) is revised to read as follows:

      (A) No member shall accept any sales charges or service fees from an offeror unless such compensation is described in a current prospectus of the investment company. When special sales charge or service fee arrangements are made available by an offeror to a member, which arrangements are not made available on the same terms to all members who distribute the investment company securities of the offeror, a member shall not enter into such arrangements unless the name of the member and the details of the arrangements are disclosed in the prospectus.
      (B) Any member that has within the previous 12 months received from an offeror any form of cash compensation, other than sales charges or service fees disclosed in the prospectus fee table, or that employs policies that involve differential cash compensation, must:
      (i) disclose that information about an investment company's fees and expenses may be found in the fund's prospectus and that the company's policies regarding selection of brokers (including soft dollar practices) may be found in the fund's statement of additional information;
      (ii) disclose, if applicable, that the member receives cash payments from an offeror, other than sales charges or service fees disclosed in the prospectus fee table, the nature of any such cash payments received in the past 12 months, and the name of each offeror that made such a cash payment, listed in descending order based upon the amount of compensation received from each offeror;
      (iii) disclose, if applicable, that the associated person receives different rates of compensation for different investment company products that may provide an incentive to offer specific products to the customer, a description of the differential cash compensation policy, and the names of the investment company or companies whose sales the policy favors; and
      (iv) provide a reference (or in the case of electronically delivered documents, a hyperlink) to the web page or toll-free telephone number described in paragraph (D). If the member elects not to maintain a web page or toll-free telephone number as described in paragraph (D), the member must disclose that updated information described in this paragraph (B) will be sent to the customer on a semi-annual basis.
      (C) The disclosure required by paragraph (B) must be updated on a semi-annual basis and must be made in written documentation:
      (i) at the time that the customer establishes an account with the member or the member's clearing broker;
      (ii) if no such account is established, by the time the customer first purchases shares of an investment company; or
      (iii) with respect to accounts existing when paragraph (B) becomes effective, the later of (a) 90 days after the effective date, or (b) the time the customer first purchases shares of an investment company after the effective date (other than purchases through reinvestment of dividends or capital distributions or through automatic investment plans).
      (D) Any member that receives cash payments from investment companies and their affiliates, other than sales charges or service fees disclosed in the prospectus fee table, or that employs policies that involve differential cash compensation, must either:
      (i) maintain a web page or toll-free telephone number that is available to the public and that provides updated information described in paragraph (B); or
      (ii) send updated information described in paragraph (B) in written form on a semi-annual basis to its customers who originally received this disclosure.
      (E) Other than disclosures regarding differential cash compensation, the requirements of Rule 2830(l)(4)(B) shall not apply to cash compensation in the form of a sales charge or service fee disclosed in the prospectus fee table of the offeror's investment company.

    • 03-53 SEC Announces Immediate Effectiveness of Amendments to Non-Cash Compensation Provisions of Rule 2710 and Rule 2810

      View PDF File

      INFORMATIONAL

      Non-Cash Compensation

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management

      Rule 2710
      Rule 2810
      Non-Cash Compensation Provisions
      Rule Modernization

      Executive Summary

      On April 7, 2003, NASD filed with the Securities and Exchange Commission (SEC) for immediate effectiveness a proposed rule change to codify existing staff interpretations regarding the noncash compensation provisions in Rule 2710 (Corporate Financing Rule) and Rule 2810 (Direct Participation Program or DPP Rule) and to make the rule text in such Rules consistent with the non-cash compensation provisions in Rule 2820 (Variable Contracts Rule) and Rule 2830 (Investment Company Rule).1 The rule change has become effective as of April 7, 2003.

      Rule 2710 and Rule 2810, as amended, are set forth in Attachment A.

      Questions concerning this Notice may be directed to Therese M. Woods, Deputy Director, Corporate Financing Department, NASD, at (240) 386-4661; or Kosha K. Dalal, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, NASD, at (202) 728-6903.

      Background and Discussion

      Since 1994, the SEC, NASD, and the securities industry have raised concerns about actual and potential conflicts of interest in the retail brokerage business created by a broad range of compensation practices whereby program sponsors or issuers provide incentives or rewards to individual broker/dealers and their registered representatives for selling the issuer's products. NASD staff believes that the use of non-cash compensation can create significant point-of-sale incentives that may compromise suitability determinations and heighten the potential for loss of supervisory control over sales practices. In addition, NASD staff believes that the use of non-cash compensation incentives may result in the loss of investor confidence by increasing the perception of inappropriate practices.

      Responding to these concerns, in January 1999 NASD amended the Variable Contracts and Investment Company Rules to establish comprehensive restrictions on the use of non-cash compensation in connection with the sale and distribution of investment company securities and variable contracts.2 These amendments generally limited the manner in which members can pay for or accept non-cash compensation and detail the types of non-cash compensation that are permissible. The amendments also provided limited exceptions to the non-cash compensation restrictions for payments or reimbursements that are in connection with training and education meetings. The 1999 amendments also defined certain key terms, such as "compensation" and "non-cash compensation."

      Since January 1999, through interpretive advice, responses to exemptive requests, and in the course of the filing review process under the Corporate Financing and DPP Rules, NASD staff has consistently applied the non-cash compensation prohibitions in the Variable Contracts and Investment Company Rules to sales of variable annuities, mutual funds, DPP securities, public offerings of debt and equity securities, and real estate investment trust (REIT) programs. Although training and education meetings were not permitted under the original non-cash compensation provisions of the Corporate Financing and DPP Rules, NASD has recognized that bona-fide training and education meetings that meet the strict requirements set out in the Variable Contracts and Investment Company Rules can be held consistent with the non-cash compensation prohibitions.

      The amendments to the Corporate Financing and DPP Rules codify a stated policy, practice, and interpretation that the more detailed non-cash compensation provisions in the Variable Contracts and Investment Company Rules apply to the sale and distribution of securities governed by the Corporate Financing and DPP Rules. NASD is conforming the language in the Corporate Financing and DPP Rules to be consistent with the more detailed language contained in the Variable Contracts and Investment Company Rules by: (1) adopting definitions of the terms "compensation," "non-cash compensation" and "offeror"; (2) providing express exceptions from the non-cash compensation limitations for bona-fide training and education meetings; and (3) prohibiting, with certain exceptions, members or persons associated with members from directly or indirectly accepting or paying any non-cash compensation in connection with public offerings of debt or equity securities, REIT programs, or DPP securities.

      Consistent with the Variable Contracts and Investment Company Rules, the rule amendments provide express exceptions from the non-cash compensation provisions that would permit: (1) gifts of up to $100 per associated person annually; (2) an occasional meal, ticket to a sporting event or theater, or comparable entertainment; (3) payment or reimbursement for training and education meetings held by broker/dealers or issuers/sponsors for the purpose of educating associated persons of broker/dealers, so long as certain conditions are met; (4) in-house sales incentive programs of broker/dealers for their own associated persons; and (5) contributions by any nonmember company or other member to a broker/dealer's permissible in-house sales incentive program, provided there is compliance with certain criteria.

      The amendments to the Corporate Financing and DPP Rules codify the application of the training and education meetings exception, and corresponding interpretive guidance, to the sale and distribution of public offerings of debt and equity securities, REIT programs, and DPPs. Currently, the Variable Contracts and Investment Company Rules contain an express exception to the non-cash compensation provisions for training and education meetings that the industry believes are necessary to educate representatives about their products. The two rules, however, contain conditions that must be satisfied before the exception can be used. Specifically, they require the following: receipt of prior approval of attendance by the associated person from his or her member firm; satisfaction of the recordkeeping requirements; that attendance at the meeting not be preconditioned on the achievement of a sales target; that the location of the meeting be appropriate and meet certain requirements;3 and that no reimbursement be provided for expenses of a guest. Since the adoption of these provisions, NASD has issued strict guidelines on the appropriate use of the training and education exception through Regulatory & Compliance Alerts, interpretive letters, and other correspondence with members. This guidance has stated that a sponsor is not permitted to pay for certain expenses in connection with a training and education meeting, including, but not limited to, golf outings, cruises, tours, and other entertainment.

      Effective Date

      The rule amendments were effective immediately upon filing with the Commission, which was April 7, 2003.


      1 See Securities Exchange Act Release No. 47697 (April 18, 2003), 68 FR 20191 (April 24, 2003) (Notice of Filing and Immediate Effectiveness of File No. SR-NASD-2003-68 (April 7, 2003)).

      2 See Securities Exchange Act Release No. 40214 (July 15, 1998), 63 FR 39614 (July 23, 1998), File No. SR-NASD-97-35 (May 7, 1997).

      3 The non-cash compensation provisions specify that the location of a training and education meeting must be appropriate to the purpose of the meeting, which shall mean an office of the offeror or the member, or a facility located in the vicinity of such office, or a regional location with respect to regional meetings.


      Attachment A

      New language is underlined; deletions are in brackets.

      2710. Corporate Financing Rule - Underwriting Terms and Arrangements

      (a) through (b) No Change.
      (c) Underwriting Compensation and Arrangements
      (1) through (5) No Change.
      (6) Unreasonable Terms and Arrangements
      (A) No Change.
      (B) Without limiting the foregoing, the following terms and arrangements, when proposed in connection with the distribution of a public offering of securities, shall be unfair and unreasonable:
      (i) through (xii) No Change.
      (xiii) [for a member or person associated with a member to accept, directly or indirectly, any non-cash sales incentive item including, but not limited to, travel bonuses, prizes and awards, from an issuer or an affiliate thereof in excess of $100 per person per issuer annually. Notwithstanding the foregoing, a member may provide non-cash sales incentive items to its associated persons provided that no issuer, or an affiliate thereof, including specifically an affiliate of the member, directly or indirectly participates in or contributes to providing such non-cash sales incentive; or]
      (xiv) - (xv) Renumbered (xiii) - (xiv).
      (7) through (8) No Change.
      (d) Non-Cash Compensation
      (1) Definitions

      The terms "compensation," "non-cash compensation" and "offeror" as used in this Section (d) of this Rule shall have the following meanings:
      (A) "Compensation" shall mean cash compensation and non-cash compensation.
      (B) "Non-cash compensation" shall mean any form of compensation received in connection with the sale and distribution of securities that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging.
      (C) "Offeror" shall mean an issuer, an adviser to an issuer, an underwriter and any affiliated person of such entities.
      (2) Restrictions on Non-Cash Compensation

      In connection with the sale and distribution of a public offering of securities, no member or person associated with a member shall directly or indirectly accept or make payments or offers of payments of any non-cash compensation, except as provided in this provision. Non-cash compensation arrangements are limited to the following:
      (A) Gifts that do not exceed an annual amount per person fixed periodically by the Board of Governors1 and are not preconditioned on achievement of a sales target.
      (B) An occasional meal, a ticket to a sporting event or the theater, or comparable entertainment which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a sales target.
      (C) Payment or reimbursement by offerors in connection with meetings held by an offeror or by a member for the purpose of training or education of associated persons of a member, provided that:
      (i) associated persons obtain the member's prior approval to attend the meeting and attendance by a member's associated persons is not conditioned by the member on the achievement of a sales target or any other incentives pursuant to a non-cash compensation arrangement permitted by subparagraph (d)(2)(D);
      (ii) the location is appropriate to the purpose of the meeting, which shall mean an office of the issuer or affiliate thereof, the office of the member, or a facility located in the vicinity of such office, or a regional location with respect to regional meetings;
      (iii) the payment or reimbursement is not applied to the expenses of guests of the associated person; and
      (iv) the payment or reimbursement by the issuer or affiliate of the issuer is not conditioned by the issuer or an affiliate of the issuer on the achievement of a sales target or any other non-cash compensation arrangement permitted by subparagraph (d)(2)(D).
      (D) Non-cash compensation arrangements between a member and its associated persons or a company that controls a member company and the member's associated persons, provided that no unaffiliated non-member company or other unaffiliated member directly or indirectly participates in the member's or non-member's organization of a permissible non-cash compensation arrangement; and
      (E) Contributions by a non-member company or other member to a non-cash compensation arrangement between a member and its associated persons, provided that the arrangement meets the criteria in subparagraph (d)(2)(D).
      A member shall maintain records of all non-cash compensation received by the member or its associated persons in arrangements permitted by subparagraphs (d)(2)(C)-(E). The records shall include: the names of the offerors, non-members or other members making the non-cash compensation contributions; the names of the associated persons participating in the arrangements; the nature and value of non-cash compensation received; the location of training and education meetings; and any other information that proves compliance by the member and its associated persons with subparagraph (d)(2)(C)-(E).
      (d) Renumbered as (e).

      2810. Direct Participation Programs

      (a) No Change.
      (b) Requirements
      (1) through (3) No Change.
      (4) Organization and Offering Expenses
      (A) through (D) No Change.
      (E) [No member or person associated with a member shall directly or indirectly accept any non-cash compensation or sales incentive item including, but not limited to, travel bonuses, prizes, and awards offered or provided to such member or its associated persons by any sponsor, affiliate of a sponsor or program. Notwithstanding the foregoing, a member may provide non-cash compensation or sales incentive items to its associated persons provided that no sponsor, affiliate of a sponsor or program, including specifically an affiliate of the member, directly or indirectly participates in or contributes to providing such non-cash compensation. Further, this subparagraph shall not prohibit a person associated with a member from accepting any non-cash sales incentive item offered directly to that person by a sponsor, affiliate of a sponsor or program where:
      (i) the aggregate value of all such items paid by any sponsor or affiliate of a sponsor to each associated person during any year does not exceed $100.00;
      (ii) the value of all such items to be made available in connection with an offering is included as compensation to be received in connection with the offering for purposes of subparagraph (B); and
      (iii) the proposed payment or transfer of all such items is disclosed in the prospectus or similar offering document,]
      (F) Renumbered to (E).
      (5) through (6) No Change.
      (c) Non-Cash Compensation
      (1) Definitions

      The terms "compensation," "non-cash compensation" and "offeror" as used in this Section (c) of this Rule shall have the following meanings:
      (A) "Compensation" shall mean cash compensation and non-cash compensation.
      (B) "Non-cash compensation" shall mean any form of compensation received in connection with the sale and distribution of direct participation securities that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging.
      (C) "Offeror" shall mean an issuer, sponsor, an adviser to an issuer or sponsor, an underwriter and any affiliated person of such entities.
      (2) Restriction on Non-Cash Compensation

      In connection with the sale and distribution of direct participation securities, no member or person associated with a member shall directly or indirectly accept or make payments or offers of payments of any non-cash compensation, except as provided in this provision. Non-cash compensation arrangements are limited to the following:
      (A) Gifts that do not exceed an annual amount per person fixed periodically by the Board of Governors1 and are not conditioned on achievement of a sales target.
      (B) An occasional meal, a ticket to a sporting event or the theater, or comparable entertainment which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a sales target.
      (C) Payment or reimbursement by offerors in connection with meetings held by an offeror or by a member for the purpose of training or education of associated persons of a member, provided that:
      (i) associated persons obtain the member's prior approval to attend the meeting and attendance by a member's associated persons is not conditioned by the member on the achievement of a sales target or any other incentives pursuant to a non-cash compensation arrangement permitted by subparagraph (c)(2)(D);
      (ii) the location is appropriate to the purpose of the meeting, which shall mean an office of the offeror or the member, or a facility located in the vicinity of such office, or a regional location with respect to regional meetings;
      (iii) the payment or reimbursement is not applied to the expenses of guests of the associated person; and
      (iv) the payment or reimbursement by the offeror is not conditioned by the offeror on the achievement of a sales target or any other non-cash compensation arrangement permitted by subparagraph (c)(2)(D).
      (D) Non-cash compensation arrangements between a member and its associated persons or a company that controls a member company and the member's associated persons, provided that no unaffiliated non-member company or other unaffiliated member directly or indirectly participates in the member's or non-member's organization of a permissible non-cash compensation arrangement; and
      (E) Contributions by a non-member company or other member to a non-cash compensation arrangement between a member and its associated persons, provided that the arrangement meets the criteria in subparagraph (c)(2)(D).
      A member shall maintain records of all non-cash compensation received by the member or its associated persons in arrangements permitted by subparagraphs (c)(2)(C)-(E). The records shall include: the names of the offerors, non-members or other members making the non-cash compensation contributions; the names of the associated persons participating in the arrangements; the nature and value of non-cash compensation received; the location of training and education meetings; and any other information that proves compliance by the member and its associated persons with subparagraph (c)(2)(C)-(E).
      (c) Renumbered as (d).

      1 The current annual amount fixed by the Board of Governors is $100.

    • 03-52 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 thenominees 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 2004. These nominees will be considered duly elected on October 1, 2003, 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 or the Corporate Secretary, Barbara Z. Sweeney, by October 1, 2003. If an additional candidate(s) comes forward by that date, the candidate has until October 31, 2003, 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 October 31, 2003, then the candidates nominated by the District Nominating Committee shall be considered elected as of October 1, 2003, 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 94105-2711

      (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

      2003 District Nominating Committee Chair

      Glenn M. Colacurci Salomon Smith Barney San Francisco, CA

      District 1 Nominees

      William A. Evans Stone & Youngberg LLC San Francisco, CA
      Mansoor Kisat Citigroup Global Markets, Inc. Santa Rosa, CA
      Arthur E. Raitano Hoefer & Arnett, Incorporated San Francisco, CA

      District 1 Nominating Committee Nominees

      Stephen R. Adams Wells Fargo Investments, LLC San Francisco, CA
      Sally G. Aelion Emmett A. Larkin Company, Inc. San Francisco, CA
      Robert S. Basso Correspondent Services Corporation San Francisco, CA
      James D. Klein UBS PaineWebber, Inc. San Francisco, CA
      L. Robert McKulla Prudential Division of Wachovia Securities, LLC Walnut Creek, 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

      2003 District Nominating Committee Chair

      Robert L. Winston American Funds Distributors, Inc. Los Angeles, CA

      District 2 Nominees

      Stephen B. Benton Financial Network Investment Corp. Torrance, CA
      James M. S. Dillahunty Fixed Income Securities, LLC San Diego, CA
      John D. Lewis JDL Securities Corp. Newport Beach, CA

      District 2 Nominating Committee Nominees

      James E. Biddle The Securities Center Incorporated Chula Vista, CA
      Margaret M. Black Morgan Stanley Dean Witter Los Angeles, CA
      Diane P. Blakeslee Blakeslee & Blakeslee, Inc. San Luis Obispo, CA
      Miles Z. Gordon   Indian Wells, CA
      Steven K. McGinnis Keystone Capital Corporation San Diego, CA

      District Committee And District Nominating Committee Nominees

      District 3

      Joseph M. McCarthy, District Director

      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 Street, Suite 1616, Seattle, WA 98101-2327

      (206) 624-0790

      Alaska, Idaho, Montana, Oregon, and Washington

      2003 District Nominating Committee Chair

      Martin O. Nelson Martin Nelson & Co., Inc. Seattle, WA

      District 3 Nominees

      Curtis J. Hammond Morgan Stanley Dean Witter, Inc. Bellevue, WA
      J. Keith Kessel AFS Brokerage, Inc. Greenwood Village, CO
      Arlene M. Wilson D.A. Davidson & Co. Great Falls, MT

      District 3 Nominating Committee Nominees

      Elyssa S. Baltazar Morgan Stanley Dean Witter, Inc. Denver, CO
      L. Hoyt DeMers Wells Fargo Investments, LLC Seattle, WA
      Steven Larson Richards Merrill & Peterson Inc. Spokane, WA
      Anthony B. Petrelli Neidiger, Tucker, Bruner, Inc. Denver, CO
      Kathryn A. Supko Northwestern Mutual Investment Services, LLC Boise, ID

      District Committee And District Nominating Committee Nominees

      District 4

      Thomas D. Clough, District Director

      120 West 12th Street, Suite 900, Kansas City, MO 64105

      (816) 421-5700

      Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota

      2003 District Nominating Committee Chair

      Norman Frager Flagstone Securities, LLC St. Louis, MO

      District 4 Nominees

      Michael D. Burns
      (2-Year Term)
      USAllianz Securities, Inc. Minneapolis, MN
      Joseph D. Fleming U.S. Bancorp Piper Jaffray, Inc. Minneapolis, MN
      Richard M. Hurwitz Benefit Finance Securities, LLC St. Louis, MO
      Mark T. Lasswell Wells Fargo Brokerage Services, LLC Minneapolis, MN
      Kevin P. Maas
      (2-Year Term)
      PrimeVest Financial Services, Inc. St. Cloud, MN

      District 4 Nominating Committee Nominees

      Gene M. Diederich A.G. Edwards & Sons, Inc. Overland Park, KS
      Timothy J. Lyle Trusted Securities Advisors Corp. Minneapolis, MN
      E. John Moloney Moloney Securities Co., Inc. St. Louis, MO
      L.C. (Jack) Petersen Kirkpatrick, Pettis, Smith, Polian, Inc. Omaha, NE
      Pamela R. Ziermann Dougherty & Company, LLC Minneapolis, MN

      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, Louisiana, Mississippi, Oklahoma, and Tennessee

      2003 District Nominating Committee Chair

      Duncan F. Williams Duncan-Williams, Inc. Memphis, TN

      District 5 Nominees

      Jennifer Carty Scola Carty & Company, Inc. Memphis, TN
      R. Patrick Shepherd Avondale Partners, L.L.C. Nashville, TN
      Donald R. Winton Crews & Associates, Inc. Little Rock, AR

      District 5 Nominating Committee Nominees

      David A. Daugherty James Baker & Associates Oklahoma City, OK
      James S. Holbrook, Jr. Sterne, Agee & Leach, Inc. Birmingham, AL
      E. Douglas Johnson, Jr. Johnson Rice & Company L.L.C. New Orleans, LA
      Tom R. Steele Equitable Advisors, Inc. Nashville, TN
      Duncan F. Williams Duncan-Williams, Inc. Memphis, TN

      District Committee And District Nominating Committee Nominees

      District 6

      Virginia F. M. Jans, District Director

      12801 N. Central Expressway, Suite 1050, Dallas, TX 75243

      (972) 701-8554

      Texas

      2003 District Nominating Committee Chair

      Fredrick W. McGinnis UBS PaineWebber, Inc. Houston, TX

      District 6 Nominees

      Karen Banks Frost Brokerage Services, Inc. San Antonio, TX
      Cynthia E. Besek Maplewood Investment Advisors, Inc. Dallas, TX
      Darryl W. Traweek RBC Dain Rauscher Inc. Houston, TX

      District 6 Nominating Committee Nominees

      Christopher R. Allison M.E. Allison & Co., Inc. San Antonio, TX
      C. Ronald Baker The (Wilson) Williams Financial Group Lubbock, TX
      William B. Madden Madden Securities Corporation Dallas, TX
      Edward M. Milkie Milkie/Ferguson Investments, Inc. Dallas, TX
      David W. Turner Wachovia 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, NE, Atlanta, GA 30305

      (404) 239-6100

      Florida, Georgia, North Carolina, South Carolina, Puerto Rico, the Canal Zone, and the Virgin Islands

      2003 District Nominating Committee Chair

      Edward R. Hipp, III Legg Mason Wood Walker, Inc. Norfolk, VA

      District 7 Nominees

      Susan J. Hechtlinger Banc of America Investment Services, Inc. Charlotte, NC
      Landrum H. Henderson, Jr. Legg Mason Wood Walker, Inc. Charlotte, NC
      Alan L. Maxwell, Jr. Wachovia Capital Markets, LLC Charlotte, NC
      Mr. Roark A. Young
      (One-Year Term)
      Young, Stovall and Company Miami, FL

      District 7 Nominating Committee Nominees

      Michael D. Hearn, Esq. Banc of America Investment Services, Inc. Charlotte, NC
      Kenneth W. McGrath Popular Securities, Inc. Hato Rey, PR
      C. John O'Bryant, III PowellJohnson, Private Asset Management Raleigh, NC
      Glenn R. Oxner Scott & Stringfellow, Inc. Greenville, SC
      John W. Waechter William R. Hough & Co. St. Petersburg, FL

      District Committee And District Nominating Committee Nominees

      District 8

      Carlotta A. Romano, District Director

      55 West Monroe Street, Suite 2700, Chicago, IL 60603-5051

      (312) 899-4400

      Illinois, Indiana, Kentucky, 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

      2003 District Nominating Committee Chair

      Wallen L. Crane Salomon Smith Barney Toledo, OH

      District 8 Nominees

      Michael E. Bosway City Securities Corporation Indianapolis, IN
      Robert J. Michelotti Ferris, Baker Watts Incorporated Auburn Hills, MI
      Lora Rosenbaum Northwestern Mutual Investment Services Milwaukee, WI

      District 8 Nominating Committee Nominees

      William C. Alsover, Jr. Centennial Securities Company, Inc. Grand Rapids, MI
      Mary D. Esser Cressman Esser Securities, Inc. Naperville, IL
      Gregory Goelzer Goelzer Investment Management Indianapolis, IN
      Rodney Trautvetter Harris Investor Services, LLC Chicago, IL
      Bruce J. Young Mesirow Financial, Inc. Chicago, IL

      District Committee And District Nominating Committee Nominees

      District 9

      Gary K. Liebowitz, District Director

      581 Main Street, 7th Floor, Woodbridge, NJ 07905

      (732) 596-2000

      New Jersey and New York (except for the counties of Nassau, Orange, Putnam, Rockland, Suffolk, Westchester, and the five boroughs of New York City)

      John P. Nocella, District Director

      Eleven Penn Center, 1835 Market Street, Suite 1900, Philadelphia, PA 19103

      (215) 665-1180

      Delaware, the District of Columbia, Maryland, Pennsylvania, Virginia and West Virginia

      2003 District Nominating Committee Chair

      A. Louis Denton Philadelphia Corporation for Investment Services Philadelphia, PA

      District 9 Nominees

      John Bluher Knight Securities, L.P. Jersey City, NJ
      Barry M. Cash UBS Financial Services, Inc. Fishkill, NY
      Peter P. Jenkins Credit Suisse First Boston LLC Baltimore, MD

      District 9 Nominating Committee Nominees

      J. Lee Keiger, III Davenport & Company, LLC Richmond, VA
      John P. Meegan Parker/Hunter Incorporated Pittsburgh, PA
      Lance A. Reihl 1717 Capital Management Company Berwyn, PA
      Howard B. Scherer Janney Montgomery Scott LLC Philadelphia, PA
      Lenda P. Washington GRW Capital Corporation Washington, DC

      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

      New York (the counties of Wassau, Orange, Putnam, Rockland, Suffolk and Westchester, and the five boroughs of New York City)

      2003 District Nominating Committee Chair

      Tom M. Wirtshafter AXA Advisors, LLC New York, NY

      District 10 Nominees

      Richard Berenger MetLife Securities, Inc. New York, NY
      Lon T. Dolber American Portfolios Financial Services Holbrook, NY
      George T. Mimura Nomura Securities International, Inc. New York, NY
      Howard R. Plotkin Lehman Brothers Inc. New York, NY

      District 10 Nominating Committee Nominees

      William Behrens Northeast Securities, Inc. New York, NY
      Ruth S. Goodstein UBS Financial Services, Inc. New York, NY
      Judith R. MacDonald Rothschild, Inc. New York, NY
      Charles V. Senatore Fidelity Brokerage Services, LLC New York, NY
      Stephen C. Strombelline BNP Paribas Securities Corp. New York, 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 and Vermont

      2003 District Nominating Committee Chair

      Stephen O. Buff Fleet Securities, Inc. Boston, MA

      District 11 Nominees

      David K. Booth Jefferson Pilot Securities Corp. Concord, NH
      Thomas F. Hollenbeck J.P. Morgan Invest, LLC Boston, MA
      Curtis L. Snyder, Jr. American Technology Research, Inc. Old Greenwich, CT

      District 11 Nominating Committee Nominees

      Richard J. DeAgazio Boston Capital Services, Inc. Boston, MA
      John I. Fitzgerald Leerink Swann & Company Boston, MA
      John D. Lane Lane Capital Markets LLC Fairfield, CT
      Robert V. Rodia People's Securities, Inc. Bridgeport, CT
      Gregory D. Teese Equity Services, Inc. Montpelier, VT

    • 03-51 Amendments to Article VIII of the By-Laws of NASD Regulation, Inc., Regarding District Committees and District Nominating Committees

      View PDF File

      INFORMATIONAL

      District Committees and District Nominating Committees

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management

      Article VIII NASD Regulation By-Laws
      District Committees
      District Nominating Committees

      Executive Summary

      On March 21, 2003, NASD filed with the Securities and Exchange Commission (SEC) a proposed rule change to amend Article VIII of the By-Laws of NASD Regulation, Inc. (By-Laws), to streamline the nomination and election processes governing District Committees and District Nominating Committees (collectively, the Committees), modernize communication procedures, and improve consistency among the Committees across all Districts.1 The filing was designated as a "non-controversial" rule change and by its terms would have become operative on June 6, 2003. However, to avoid any confusion during this year's Committee election cycle that was already underway, NASD submitted a subsequent rule filing with the SEC to delay the implementation date of the amendments to January 1, 2004.2 NASD is conducting this year's District Committee and District Nominating Committee elections in accordance with the provisions of Article VIII of the By-Laws as in effect prior to the filing of these rule changes.

      Article VIII of the By-Laws of NASD Regulation, Inc., as amended, is set forth in Attachment A.

      Questions concerning this Notice may be directed to Kosha K. Dalal, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, NASD, at (202) 728-6903.

      Background and Discussion

      Article VIII of the By-Laws sets forth provisions relating to the operation of District Committees and District Nominating Committees, including specifically, provisions regarding Committee meetings, vacancies, and elections. Under Article VIII, the role of the District Committee members includes serving as panelists in disciplinary proceedings in accordance with NASD rules, recommending policy and rule changes to the Board, educating members in their District, and selecting members of the regional District Committee and District Nominating Committees in a manner consistent with Article VIII of the By-Laws. The role of the District Nominating Committee includes nominating candidates to serve on the District Committee and District Nominating Committee for that region.

      Currently, there are 11 District Committees, divided by geographic region. Based on the experience of NASD staff in working with the Committees since that time, and the current practices of the Committees, NASD has adopted a series of amendments to modernize and clarify the Article VIII provisions. The amendments are designed to streamline the nomination and election processes by, among other things, centralizing the communication procedures in the Corporate Secretary's Office, revising the nomination and election timeline, and modernizing the methods of communication by permitting electronic delivery of documents. In addition, the amendments will improve coordination and consistency among the Committees across the Districts, modify the procedures to fill vacancies, and provide for more administrative flexibility.

      The key amendments are discussed below.

      Section 8.2 (Composition of District Committees) and Section 8.9 (Composition of District Nominating Committees)

      Create Consistency in Size of Committee. To create more consistency in District Committee sizes across Districts, the amendments allow the Board of Directors (Board) to determine the size of each Committee.

      Clarify Qualifications to Serve on Committee. The amendments clarify the qualifications necessary to serve as a member of a Committee. The amendments provide that a member must: (1) be employed by an NASD member eligible to vote in the District for District Committee elections; and (2) work primarily from such NASD member's principal office or a branch office that is located within the District where the member serves on a Committee. NASD believes this will ensure that local interests are represented on Committees.

      Eliminate Requirement in Section 8.9 that One District Nominating Committee Member be a Current or Former Director or Governor. The amendments eliminate the requirement that at least one member of the District Nominating Committee be a current or former Director or Governor. Based on the experience of NASD staff, it has become increasing difficult to satisfy this composition requirement.

      Section 8.3 (Term of Office of District Committee Member) and Section 8.10 (Term of Office of District Nominating Committee Member)

      Clarify Term of Office. The amendments clarify that there is no limit on the number of terms that a Committee member may serve, provided a member may not serve more than two consecutive terms. The word "term" is defined to include either a full term (three years for District Committees or one year for District Nominating Committees) or any partial term where a member is appointed to fill a vacancy. NASD believes that this will allow for greater member participation in the Committees over time.

      Section 8.4 (Filling of Vacancies on District Committee) and Section 8.9 (Filling of Vacancies for District Nominating Committees)

      Streamline Process for Filling Vacancies. The amendments clarify that Committee members may formally resign from their positions by serving a notice to the Chair. In addition, the amendments provide a process for filling vacancies. Under the amendments, the Executive Vice President, Regulatory Policy and Programs, the Executive Vice President, Member Regulation, or their respective designee(s) are authorized to determine whether a vacancy created on the Committee needs to be filled. In some instances there may not be a need to fill a vacancy immediately - for example, when there is no scheduled meeting between the time of the vacancy and the next regularly scheduled election. If a determination is made to fill a vacancy or where a new position is created by an increase in Committee size, the Committee would fill such vacancy by a majority vote of a quorum present at a meeting in accordance with the provisions of Sections 8.4 (District Committee) and 8.11 (District Nominating Committee).

      Section 8.5 (Meetings of District Committee) and Section 8.12 (Meetings of District Nominating Committees)

      Coordinate Procedures for Meetings. To simplify and better coordinate Committee meetings across Districts, the amendments authorize the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) to determine the times, places, and procedures for Committee meetings in consultation with the Chair of each Committee. In addition, the amendments clarify that an individual may attend a meeting either in person or by telephone and that action taken by telephonic vote will not require written confirmation.

      Section 8.6 (Election of District Officers) and Section 8.13 (Election of District Nominating Committees)

      Eliminate Requirement to Designate Function of Committee Officers. The amendments eliminate the requirement for Committees to prescribe the powers and duties of its elected officers because Committees have not found it necessary to perform this function.

      Section 8.7 (Advisory Council)

      Members to Advisory Council. The amendments clarify that the Chair of the Market Regulation Committee of NASD is a member of the Advisory Council to the Board.

      General Amendments to Allow Electronic Communications

      The amendments provide that where provisions in Article VIII call for notice and other communications to be given either among Committee members, or between Committees and NASD staff, the requirement may be satisfied by electronic means provided the person entitled to notice consents to receive notice in this manner. Specifically, the amendments define the term "Notice" as used in Article VIII to mean a notice in writing or by electronic transmission.

      General Amendments to Centralize Procedures for Nominations and Elections

      In general, the amendments establish a more streamlined and flexible election process, conform the By-Laws text with current practice, and allow the Secretary of NASD to play a more centralized role in the election process. For example, the amendments provide that the Secretary of NASD Regulation perform many of the notification and other communication functions currently performed by other parties, such as notifying NASD members of upcoming elections, requesting submission of candidates, notifying NASD members of the candidates nominated by the District Nominating Committee, notifying NASD members in the event of a contested election, and notifying the Board of election results.

      Effective Date

      The rule amendments become effective on January 1, 2004.


      1 See Securities Exchange Act Release No. 48015 (June 11, 2003), 68 FR 35926 (June 17, 2003) (Notice of Filing and Immediate Effectiveness of File No. SR-NASD-2003-55 (Amendment No. 3 filed on June 6, 2003)).

      2 See Securities Exchange Act Release No. 48259 (July 30, 2003), 68 FR 46673 (August 6, 2003) (Notice of Filing and Immediate Effectiveness of File No. SR-NASD-2003-107 (Amendment No. 3 filed on June 6, 2003)).


      Attachment A

      New language is underlined; deletions are in brackets.

      ARTICLE VIII

      DISTRICT COMMITTEES AND DISTRICT NOMINATING COMMITTEES

      Establishment of Districts

      Sec. 8.1 The Board shall establish boundaries for districts within the United States to assist NASD Regulation in administering its affairs in a manner that is consistent with applicable law, the Restated Certificate of Incorporation, these By-Laws, the Delegation Plan, and the Rules of the Association. The Board may make changes from time to time in the number or boundaries of the districts as it deems necessary or appropriate. The Board shall prescribe such policies and procedures as are necessary or appropriate to address the implementation of a new district configuration in the event of a change in the number or boundaries of the districts.

      Composition of District Committees

      Sec. 8.2

      (a) A district created under Section 8.1 shall elect a District Committee pursuant to this Article. A District Committee shall consist of no fewer than five and no more than 20 members, unless otherwise provided by resolution of the Board. Subject to the limitation set forth in the immediately preceding sentence, the authorized number of members of a District Committee shall be determined from time to time by the Board; provided, however, that no decrease in the authorized number of members of a District Committee shall shorten the term of office of any member thereof. Each District Committee member shall: (1) be employed [in the office of]by an NASD member eligible to vote in the district for District Committee elections, and (2) work primarily from such NASD member's principal office or a branch office that is located within the district where the member serves on a District Committee. [A District Committee shall determine the number of its members to be elected each year.] Members of the District Committees shall serve as panelists in disciplinary proceedings in accordance with the Rules of the Association. The District Committees shall consider and recommend policies and rule changes to the Board. The District Committees shall endeavor[, in such manner as they deem appropriate,] to educate NASD members and other brokers and dealers in their respective districts as to the objects, purposes, and work of the NASD[,] and NASD Regulation[, and Nasdaq] in order to foster NASD members' interest and cooperation.
      (b) A member of a District Committee may resign at any time upon giving Notice to the District Director. Any such resignation shall take effect upon receipt of such Notice or at any later time specified therein, provided that notice of resignation at a later date may be made immediately effective at the discretion of the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s). The acceptance of such resignation shall not be necessary to make such resignation effective.
      (c) [(b)] In the event of the refusal, failure, neglect, or inability of a member of a District Committee to discharge his or her duties, or for any cause affecting the best interests of NASD Regulation, the sufficiency of which shall be decided by the District Committee, the District Committee may remove the member by the affirmative vote of two-thirds of the members of the District Committee then in office and declare the member's position vacant. The District Committee shall notify the District Committee member of his or her removal within seven days after the vote. [The member's position shall be filled pursuant to Section 8.4.]A member who is removed may submit a written appeal of the removal to the Board within 30 days after the date he or she is notified of the removal. The Board may affirm, reverse, or modify the determination of the District Committee. A vote of a majority of the Directors then in office shall be required to reverse or modify the action of the District Committee.
      (d) In the event of a vacancy in a District Committee resulting from death, resignation, removal, or other cause, the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) shall determine whether such vacancy shall be filled prior to the next regularly scheduled election of District Committee members. In the event the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) determines that a vacancy on a District Committee should be filled, the vacancy shall be filled pursuant to Section 8.4.

      Term of Office of District Committee Members

      Sec. 8.3 Each regularly elected member of a District Committee shall hold office for a "full term" [of three years] which is the later of three years or until a successor is elected and qualified. Notwithstanding the term of office for a regularly elected member, such member's term shall terminate sooner upon the member's [, or until]death, resignation, or removal. [A member of a District Committee may not serve more than two consecutive terms.]There is no limit on the number of terms that may be served by a member of a District Committee, provided, that no more than two terms may be served consecutively. The word "term" as used for the purpose of this Section shall mean either a full term for a regularly elected member or a "partial term" which is a term served by a member appointed to fill a vacancy on the District Committee created by the termination of a regularly elected member's office prior to the expiration of the full term.

      Filling of Vacancies on District Committees

      Sec. 8.4 In the event of a vacancy on a District Committee [caused by the departure of a Committee member] prior to the expiration of the member's term of office, and where the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) determines, pursuant to Section 8.2(d), that such vacancy should be filled, or in the event of a newly created membership on a District Committee by virtue of an increase in the authorized number of members thereof, the District Committee shall appoint by majority vote a representative of an NASD member eligible pursuant to Section 8.2(a) [to vote in the district ]to fill the vacancy or newly created membership. The appointment by the District Committee shall be effective until the next regularly scheduled election [occurs], and until such member's successor is elected and qualified. Following the next regularly scheduled election, in the event of a vacancy, the newly elected Committee member shall serve only the duration of the departed Committee member's term, and in the event of a newly created membership, the newly elected Committee member shall serve only the duration of the term for such class of membership.

      Meetings of District Committees

      Sec. 8.5 Meetings of a District Committee shall be held at such times and places, upon such notice, and in accordance with such procedures as [each District Committee] the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) in [its] his or her discretion may determine in consultation with the Chair of the District Committee. A quorum of a District Committee shall consist of a majority of its members, and any action taken by a majority present at any meeting at which a quorum is present, except as otherwise provided in these By-Laws, shall constitute the action of the Committee. Any or all members of a District Committee may participate in any such meeting by means of conference telephone or other communications equipment by means of which all participants can communicate with each other, and such participation shall constitute presence in person at the meeting. Action by a District Committee may be taken by consent in writing or by electronic transmission in lieu of a meeting [mail, telephonic, or telegraphic vote], in which case any action taken by a majority of the Committee shall constitute the action of the Committee. [Any action taken by telephonic vote shall be confirmed in writing at a regular meeting of the District Committee.]

      Election of District Officers

      Sec. 8.6 At or following its last regularly scheduled meeting of the calendar year, [Following the annual election of members of the District Committees pursuant to this Article] each District Committee shall elect from its members a Chair and such other officers as it deems necessary for the proper performance of its duties under these By-Laws[, and shall prescribe their powers and duties].

      Advisory Council

      Sec. 8.7

      (a) The Chairs of the District Committees, elected pursuant to Section 8.6, together with the Chair of the Market Regulation Committee shall constitute an Advisory Council to the Board.
      (b) The Advisory Council shall be advised of and entitled to attend such meetings of the Board as the Board may designate for such Advisory Council's attendance, and the Board shall designate at least one such meeting annually. The Advisory Council shall not be entitled to vote at meetings of the Board.

      Expenses of District Committees

      Sec. 8.8 Funds to meet the regular expenses of each District Committee shall be provided by the Board, and all such expenses shall be subject to the approval of the Board.

      Composition of District Nominating Committees

      Sec. 8.9

      (a) Each district created under Section 8.1 shall elect a District Nominating Committee pursuant to this Article. A District Nominating Committee shall consist of five members, unless the Board by resolution increases a District Nominating Committee to a larger number. Each District Nominating Committee member [of a District Nominating Committee]shall: (1) be employed [in the office of]by an NASD member eligible to vote in the district for District Committee elections, and (2) work primarily from such NASD member's principal office or a branch office that is located within the district where the member serves on a District Nominating Committee, but shall not be a member of the District Committee. A majority of the members of the District Nominating Committee shall include [a majority of] persons who previously have served on a District Committee or who are current or former Directors or current or former Governors of the NASD Board[, and shall include at least one current or former Director or Governor].
      (b) A member of a District Nominating Committee may resign at any time upon giving Notice to the District Director. Any such resignation shall take effect upon receipt of such Notice or at any later time specified therein, provided that notice of resignation at a later date may be made immediately effective at the discretion of the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s). The acceptance of such resignation shall not be necessary to make such resignation effective.
      (c) [(b)] In the event of the refusal, failure, neglect, or inability of a member of a District Nominating Committee to discharge his or her duties, or for any cause affecting the best interests of NASD Regulation, the sufficiency of which shall be decided by the District Nominating Committee, the District Nominating Committee may remove the member by the affirmative vote of two-thirds of the members of the District Nominating Committee then in office and declare the member's position vacant. [The member's position shall be filled pursuant to Section 8.11.] The District Nominating Committee shall notify the District Nominating Committee member of his or her removal within seven days after the vote. A member who is removed may submit a written appeal of the removal to the Board within 30 days after the date he or she is notified in writing of the removal. The Board may affirm, reverse, or modify the determination of the District Nominating Committee. A vote of a majority of the Directors then in office shall be required to reverse or modify the action of the District Nominating Committee.
      (d) In the event of a vacancy in a District Nominating Committee resulting from death, resignation, removal, or other cause, the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) shall determine whether such vacancy shall be filled prior to the next regularly scheduled election of District Nominating Committee members. In the event the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) determines that a vacancy on a District Nominating Committee should be filled, the vacancy shall be filled pursuant to Section 8.11.

      Term of Office of District Nominating Committee Members

      Sec. 8.10 Each regularly elected member of a District Nominating Committee shall hold office for a "full term" [of one year] which is the later of one year [and] or until a successor is elected and qualified. Notwithstanding the term of office for a regularly elected member, such member's term shall terminate sooner upon the member's [, or until]death, resignation, or removal. [A member of a District Nominating Committee may not serve more than two consecutive terms.]There is no limit on the number of terms that may be served by a member of a District Nominating Committee, provided, that no more than two terms may be served consecutively. The word "term" as used for the purpose of this Section shall mean either a full term for a regularly elected member or a "partial term" which is a term served by a member appointed to fill a vacancy on the District Nominating Committee created by the termination of a regularly elected member's office prior to the expiration of the full term.

      Filling of Vacancies for District Nominating Committees

      Sec. 8.11 In the event of a vacancy on a District Nominating Committee [caused by the departure of a Committee member] prior to the expiration of the member's term of office, and where the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) determines, pursuant to Section 8.9(d), that such vacancy should be filled, or in the event of a newly created membership on a District Nominating Committee by virtue of an increase in the authorized number of members thereof, the District Nominating Committee shall appoint by majority vote a representative of an NASD member eligible pursuant to Section 8.9(a) [to vote in the district ]to fill the vacancy or newly created membership. The appointment shall be effective until the next regularly scheduled election [occurs] pursuant to this Article, and until such member's successor is elected and qualified.

      Meetings of District Nominating Committees

      Sec. 8.12 Meetings of a District Nominating Committee shall be held at such times and places, upon such notice, and in accordance with such procedures as [each District Nominating Committee] the Executive Vice President, Regulatory Policy and Programs or the Executive Vice President, Member Regulation or their respective designee(s) in [its] his or her discretion may determine in consultation with the Chair of the District Nominating Committee. A quorum of a District Nominating Committee shall consist of a majority of its members, and any action taken by a majority [of the entire Committee]present at any meeting at which a quorum is present, except as otherwise provided in these By-Laws, shall constitute the action of the District Nominating Committee. Any or all members of a District Nominating Committee may participate in any such meeting by means of conference telephone or other communications equipment by means of which all participants can communicate with each other, and such participation shall constitute presence in person at the meeting. Action by a District Nominating Committee may be taken by consent in writing or by electronic transmission in lieu of a meeting [mail, telephonic, or telegraphic vote], in which case any action taken by a majority of the District Nominating Committee shall constitute the action of the District Nominating Committee. [Action taken by telephonic vote shall be confirmed in writing at a regular meeting of the District Committee].[.]

      Election of District Nominating Committee Officers

      Sec. 8.13 Following the annual election of members of the District Nominating Committees pursuant to this Article, each District Nominating Committee shall elect from its members a Chair and such other officers as it deems necessary for the proper performance of its duties under these By-Laws[, and shall prescribe their powers and duties].

      Expenses of District Nominating Committees

      Sec. 8.14 Funds to meet the regular expenses of each District Nominating Committee shall be provided by the Board, and all such expenses shall be subject to the approval of the Board.

      Notice to [Chair] District Nominating Committee

      Sec. 8.15 On or before [May 1]June 1 of each year, the Secretary of NASD Regulation shall give a Notice [send a written notice] to [the Chair of] each District Nominating Committee member and each District Director [and each District Committee] identifying the members of the District Nominating Committee and the District Committee whose terms of office shall expire in the next calendar year. The Notice [notice] shall describe election procedures for filling the offices.

      Solicitation of Candidates and Secretary's Notice to NASD Members

      Sec. 8.16 The Secretary of NASD Regulation shall give a Notice of the upcoming election to NASD members and the Executive Representatives of NASD members describing the election procedures and stating that NASD members may submit names of candidates for consideration to the District Director. NASD Regulation staff shall provide the District Nominating Committee with a description of the NASD membership in the district. The District Nominating Committee shall identify and solicit candidates to nominate for election to [the vacancies on] the District Committee and the District Nominating Committee. [The District Nominating Committee Chair shall send a written notice of the upcoming election to the Executive Representative and each branch office of the NASD members in the district and request that such NASD members submit names of candidates to the District Nominating Committee or the District Director for consideration.]

      [Secretary's Notice to NASD Members]

      [Sec. 8.17 The Secretary of NASD Regulation shall send a written notice to NASD members in the district describing the election procedures.]

      District Nominating Committee Slate

      Sec. 8.17 [Sec. 8.18]

      (a) The District Nominating Committee shall review the background of proposed candidates and the description of the NASD membership provided by NASD Regulation staff and shall nominate a slate of candidates for the election. The slate shall include one [or more] candidate[s] for each position on the District Committee and the District Nominating Committee subject to election at the next annual election [vacancy]. In nominating candidates for the office of member of the District Committee and the office of member of the District Nominating Committee, the District Nominating Committee shall endeavor to secure appropriate and fair representation on the District Committee and on the District Nominating Committee of the various sections of the district and [all] various classes and types of NASD members engaged in the investment banking or securities business within the district. In nominating candidates for the office of member of the District Nominating Committee, a District Nominating Committee shall assure that the composition of the District Nominating Committee meets the standards in Section 8.9(a).
      (b) A District Nominating Committee shall not nominate an incumbent member of the District Committee to succeed himself or herself on the District Committee [unless the District Nominating Committee first takes appropriate action by a written ballot of the entire NASD membership within the district to ascertain that such nomination is acceptable to a majority of the NASD members in the district,] unless the incumbent member of the District Committee is serving pursuant to the provisions of Section 8.4 or is serving a term pursuant to the provisions of Section 8.2 and reelection would not cause the incumbent member to violate the provisions of Section 8.3. A District Nominating Committee may not nominate more than two incumbent members of the District Nominating Committee to succeed themselves.

      [Certification] Notification of Nomination

      Sec. 8.18 [Sec. 8.19] The District Director, acting on behalf of the District Nominating Committee, shall give a Notice to the Secretary of NASD Regulation of [certify to the District Committee] each candidate nominated by the District Nominating Committee and the office to which the candidate is nominated. [Within five calendar days after the certification, the District Committee shall send to the Executive Representatives of NASD members in the district a copy of the certification.] On or before October 1 of each year, the Secretary of NASD Regulation shall give a Notice of the nominated candidates to the Executive Representatives of NASD members and the District Committee.

      Uncontested Election

      Sec. 8.19 If the District Nominating Committee nominates one candidate for each position on the District Committee and the District Nominating Committee subject to election at the next annual election and no additional candidate is nominated pursuant to Section 8.22, the candidates nominated by the District Nominating Committee shall be considered duly elected.

      Designation of Additional Candidates

      Sec. 8.20 If an officer, director, or employee of an NASD member who meets the qualifications of Section 8.2 or 8.9, as applicable, is not nominated by the District Nominating Committee and wants to be considered for election to [a vacancy on] the District Committee or the District Nominating Committee, he or she shall deliver [send] a written notice to the District Director within 14 calendar days after the Secretary of NASD Regulation gives the Notice of nominated candidates [the mailing date of the certification to the Executive Representatives] pursuant to Section 8.18[9]. The District Director shall make a written record of the time and date of the receipt of the officer's, director's, or employee's notice. The officer, director, or employee shall be designated as an "additional candidate."

      List of NASD Members Eligible to Vote

      Sec. 8.21

      (a) The Secretary of NASD Regulation shall provide a list of all NASD members eligible to vote in the district, their mailing addresses, and their Executive Representatives to the additional candidate promptly [immediately] following receipt of the additional candidate's timely notice by the District Director.
      (b) An NASD member that has its principal office[,] and/or one or more registered branch offices[, or its principal office and one or more registered branch offices] in the district shall be eligible to cast one vote through the NASD member's Executive Representative for each position on the District Committee and the District Nominating Committee [vacancy] to be filled in the election.

      Requirement for Petition Supporting Additional Candidate

      Sec. 8.22 An additional candidate shall be nominated if a petition signed by at least ten percent of the NASD members eligible to vote in the district is filed with the District Nominating Committee within 30 calendar days after the date of the mailing of the list to the additional candidate pursuant to Section 8.21. Only an Executive Representative may sign a petition on behalf of an NASD member.

      [Uncontested Election]

      [Sec. 8.23 If the District Nominating Committee nominates one candidate for each vacancy and no additional candidate is nominated pursuant to Section 8.22, the candidates nominated by the District Nominating Committee shall be considered duly elected and the District Committee shall certify the election to the Board.]

      Notice of Contested Election

      Sec. 8.23 [Sec. 8.24] If [the District Nominating Committee nominates more than one candidate for vacancy, or if] an additional candidate is nominated pursuant to Section 8.22, the election shall be considered a contested election. The Secretary of NASD Regulation shall give a Notice [District Committee shall send a notice] to the Executive Representatives of the NASD members eligible to vote in the district announcing the names of the candidates and the office to which each candidate is nominated and describing contested election procedures.

      Administrative Support

      Sec. 8.24 [Sec. 8.25] The District Office shall provide administrative support to all candidates by sending, by electronic transmission, to NASD members eligible to vote in the district up to two distributions [mailings] of materials prepared by the candidates. [NASD Regulation shall pay the postage for the mailings.] If a candidate wants such distributions [mailings] sent, the candidate shall prepare such material on the candidate's personal stationery and make the material available to NASD Regulation in electronic format. The material shall state that it represents the opinion of the candidate. [The candidate shall provide a copy of the material for each member of the NASD in the district.] Candidates nominated by the District Nominating Committee may identify themselves as such in their materials. Any candidate also may send [additional] mailings at the candidate's own expense. Except as provided in this Article, NASD Regulation, the Board, the Regional Nominating Committee, any other committee, and NASD Regulation staff shall not provide any other administrative support to a candidate in the election.

      Ballots

      Sec. 8.25 [Sec. 8.26] With the assistance of the Secretary of NASD Regulation and an Independent Agent, the District Nominating Committee shall prepare a ballot with the names of the District Nominating Committee's candidates and any additional candidate nominated pursuant to Section 8.22 and the office to which each candidate is nominated. The ballot shall list separately, in alphabetical order, the candidates [in alphabetical order and shall identify the candidates] nominated by the District Nominating Committee and the additional candidates nominated pursuant to Section 8.22. The Secretary of NASD Regulation [District Nominating Committee] shall send a ballot to the Executive Representative of each NASD member eligible to vote in the district. Instructions on the ballot shall direct the Executive Representative to return the ballot to the Independent Agent and state that the ballot envelope must be postmarked on or before the return date specified on the ballot. The return date specified on the ballot shall be no fewer than [30]20 and no more than [45]30 days after the date of mailing of the ballot.

      Vote Qualification List

      Sec. 8.26 [Sec. 8.27] Eligibility to vote in a district election shall be based on the NASD's membership records as of a date selected by the Secretary of NASD Regulation that is not more than 30 days before the date of mailing of the ballot. The Secretary of NASD Regulation shall prepare a list of NASD members eligible to vote in the district, their mailing addresses, and their Executive Representatives, which shall be used for vote qualification purposes, and shall provide the list to the candidates.

      Ballots Returned as Undelivered

      Sec. 8.27 [Sec. 8.28] The Independent Agent shall open any ballot envelope returned undelivered and shall determine whether it was sent to the NASD member's address of record. If incorrectly addressed, the Independent Agent shall send a new ballot to the address of record.

      General Procedures for Qualification and Accounting of Ballots

      Sec. 8.28 [Sec. 8.29] After the voting period, on a date or dates designated by the Secretary of NASD Regulation, the qualification and accounting of ballots shall take place. The date or dates designated shall be not later than 14 calendar days after the return date specified on the ballot pursuant to Section 8.25[6]. Candidates and their representatives shall be allowed to observe the qualification and accounting of ballots. Representation for each candidate shall be limited to two individuals. The Independent Agent shall bring to [the district office] a location within the district agreed to between the Independent Agent and the Secretary of NASD Regulation all ballots timely received. Under the direction of the Secretary of NASD Regulation or the Secretary's designee, the Independent Agent shall open and count the ballots. For ballot qualification purposes, the Independent Agent shall identify to the candidates the NASD members that timely returned ballots and inform the candidates of the Independent Agent's determination of whether or not a ballot is qualified for voting purposes. The determination shall be based on a comparison of ballots received against the list of NASD members eligible to vote in the district and their Executive Representatives as prepared by the Secretary of NASD Regulation pursuant to Section 8.26[7]. The Secretary of NASD Regulation or the Secretary's designee shall make the final determination of the qualification of a ballot. Upon the qualification of a ballot, the Independent Agent shall record the vote indicated on the ballot. The candidates and their representatives shall not be allowed to see the vote of an NASD member.

      Ballots Set Aside

      Sec. 8.29 [Sec. 8.30] The Independent Agent shall set aside a ballot if: (a) the ballot is received from an NASD member eligible to vote in the district and the ballot is signed by a person who is not the Executive Representative listed on the vote qualification list prepared under Section 8.26[7], and the Secretary of the NASD has not received proper notice of a change in Executive Representative pursuant to the NASD By-Laws; or (b) if two or more properly executed ballots are received from an NASD member eligible to vote in the district. If the Independent Agent determines that the ballots set aside are material to the outcome of the election, the Secretary of NASD Regulation and the Independent Agent shall make reasonable efforts to resolve each ballot set aside. With respect to a ballot not signed by an Executive Representative of record, the Secretary of NASD Regulation shall contact the NASD member to request that the NASD member send written notice of any change in Executive Representative by facsimile so that the ballot may be counted. With respect to multiple ballots from an NASD member, the Independent Agent shall contact the Executive Representative of the NASD member to obtain the NASD member's vote. The Secretary of NASD Regulation shall keep a list of NASD members that reported their ballot was lost or not received and that were provided with a duplicate ballot. The Secretary of NASD Regulation shall provide the list to the Independent Agent and, upon request, to the candidates.

      Invalid Ballots

      Sec. 8.30 [Sec. 8.31] The Independent Agent shall declare a ballot invalid if one or more of the following conditions exist:

      (a) the ballot is not signed by the Executive Representative (unless Section 8.29[30] applies);
      (b) a vote is not indicated on the ballot; or
      (c) the ballot indicates votes for more candidates than there are positions on the District Committee or District Nominating Committee subject to election in the election [vacancies for an office].

      [Certification of] Election Results

      Sec. 8.31 [Sec. 8.32] Under the direction of the Secretary of NASD Regulation or the Secretary's designee, the Independent Agent shall count the votes received for each candidate in a district. The candidates for the office of member of the District Committee or District Nominating Committee receiving the largest number of votes cast in the district for the office shall be declared elected such that the number of candidates declared elected equals the number of positions [vacancies] on the District Committee or District Nominating Committee subject to election in the election. [The candidates for the office of member of the District Nominating Committee receiving the largest number of votes cast in the district for the office shall be declared elected such that the number of candidates declared elected equals the number of vacancies on the District Nominating Committee.] In the event of a tie, there shall be a run-off election. The Secretary of NASD Regulation shall notify the Board of the election results. [Each District Committee shall send a written certification of the election results to the Board.] The notification [certification] shall state the number of votes received by each candidate and the number of ballots set aside.

      Extensions of Time and Additional Procedures

      Sec. 8.32 [Sec. 8.33] The Secretary of NASD Regulation may extend a time period under this Article for good cause shown. In extraordinary circumstances, the Secretary of NASD Regulation, with the approval of the Executive Committee or the Board, may adopt additional procedures for elections under this Article.

      Definitions

      Sec. 8.33

      (a) When used in Article VIII of these By-Laws, the term "Notice" means a notice in writing or by electronic transmission and the term "electronic transmission" means any form of communication, not directly involving the physical transmission of paper, that creates a record that may be retained, retrieved and reviewed by a recipient thereof, and that may be directly reproduced in paper form by such a recipient through an automated process.
      (b) For purposes of this Article VIII, any notice by NASD Regulation, the Secretary of NASD Regulation, or the District Director given by electronic transmission shall be deemed given: (1) if by facsimile telecommunication, when directed to a number at which the person entitled to notice has consented to receive notice; (2) if by electronic mail, when directed to an electronic mail address at which the person entitled to notice has consented to receive notice; (3) if by a posting on an electronic network when the person entitled to notice has consented to receive notice in this manner, together with separate notice to the person entitled to notice of such specific posting, upon the later of (A) such posting and (B) the giving of such separate notice; and (4) if by any other form of electronic transmission when the person entitled to notice has consented to receive notice in this manner, when directed to the person entitled to notice. For purposes of this Article VIII, if mailed, any such notice by NASD Regulation, the Secretary of NASD Regulation, or the District Director shall be deemed given when deposited in the United States mail, postage prepaid, directed to the person entitled to notice at such person's address as it appears on the records of NASD Regulation.

    • 03-50 NASD Reminds Member Firms of their Obligations Regarding Mutual Fund Transactions and Directs Review of Policies and Procedures

      View PDF File

      ACTION REQUIRED

      Mutual Fund Transactions

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Mutual Fund Sales
      Operations
      Senior Management

      Mutual Fund Transactions

      Executive Summary

      Investment Company Act Rule 22c-1(a) generally requires that redeemable securities of investment companies be sold and redeemed at a price based on the net asset value (NAV) of the fund computed after the receipt of orders to purchase. It is a violation of NASD Rule 2110, and may be a violation of the federal securities laws and NASD Rule 2120, for member firms and their associated persons to knowingly or recklessly effect mutual fund transactions that are priced based on NAV that is computed prior to the time the order to purchase or redeem was given by the customer. Furthermore, it may be a violation of NASD Rule 2110 and the federal securities laws to knowingly or recklessly facilitate certain mutual fund transactions, such as market timing transactions, in conjunction with, or with the acquiescence of, a mutual fund sponsor, fund administrator, investment adviser, underwriter, or any other affiliated person1 where those other parties acted contrary to a representation made in the prospectus or statement of additional information pursuant to which the mutual fund shares are offered.

      NASD is issuing this Notice to Members to (1) remind members of their responsibility to ensure that they have policies and procedures reasonably designed to detect and prevent the occurrence of mutual fund transactions that would violate NASD Rule 2110 and the federal securities laws; and (2) direct each member firm executing mutual fund sales and redemptions to review its policies and procedures to assure that they are adequate with respect to the matters that are discussed in this Notice to Members.

      Questions/Further Information

      Questions concerning this Notice may be directed to Marc Menchel, Executive Vice President and General Counsel, Regulatory Policy and Oversight, NASD (202) 728-8071; Daniel M. Sibears, Senior Vice President & Deputy, Department of Member Regulation, Regulatory Policy and Oversight, NASD (202) 728-8221; or Tom Selman, Senior Vice President, Investment Companies/Corporate Finance, NASD (240) 386-4500.

      Discussion

      Investment Company Act Rule 22c-1(a) essentially requires the forward pricing of mutual fund shares. In practice, mutual fund companies usually calculate their NAVs at the close of trading (4:00 p.m. EST). The purpose of the rule is to place all purchasers of mutual fund shares on equal footing as to price and information on any one day. Investors who seek to purchase or redeem mutual fund transactions after the close of trading at the NAV calculated for the same trading day gain the possibility of an information advantage based on after-close news that could affect the mutual fund's holdings but is not reflected in the NAV pricing for that day.

      Member firms and their associated persons that knowingly or recklessly effect or facilitate an after-close mutual fund purchase or redemption at the same day's NAV (late trading) violate NASD Rule 2110, which requires the observance of just and equitable principles of trade. Such conduct may also be violative of the federal securities laws and NASD Rule 2120. Late trading is not excused or mitigated as a result of the consent or acquiescence of a mutual fund company, mutual fund sponsor, fund administrator, investment adviser, underwriter, or any other affiliated person.

      Member firms executing mutual fund purchases and redemptions must have and implement policies and procedures reasonably designed to detect and prevent the occurrence of late trading. Member firms should pay particular attention to policies and practices regarding the entry of trades time stamped before or at the close but entered or executed after the close.2 Similarly, members should take steps reasonably designed to ensure that their systems to correct errors after the close cannot be subverted for the purposes of effecting late trading.

      In addition, member firms and their associated persons who knowingly or recklessly undertake, effect, or otherwise facilitate transactions in conjunction with, or with the acquiescence of, a mutual fund sponsor, fund administrator, investment adviser, underwriter, or any other affiliated person where these other parties would have acted contrary to a representation made in the prospectus or statement of additional information (SAI) pursuant to which the mutual fund shares are offered violate NASD Rule 2110 and may be found to have violated the federal securities laws and NASD Rule 2120.

      For example, certain mutual fund companies represent in their prospectuses or SAIs that they engage in practices that are intended to prevent or control market timing transactions. Market timing transactions include mutual fund trades that occur when the purchaser or seller believes that the mutual fund's NAV does not fully reflect the value of the fund's holdings - for example, when the fund has in its portfolio particular holdings, such as foreign or thinly traded securities, which are priced on a basis that does not include the most updated information possible. In order to retard the efforts of investors who seek to profit on these pricing inefficiencies by executing mutual fund trades on a day when the NAV likely will not fully reflect the value of a fund's holdings and realizing the profit by trading the next day, some mutual fund companies have implemented measures to counteract the efforts of timers and have represented in their prospectuses or SAIs that they are conducting these measures. Consequently, where the mutual fund company and/or its affiliated persons have represented that they have taken steps to protect investors from market timers, a member firm and its associated persons may not knowingly or recklessly act in conjunction with, or with the acquiescence of, the fund and/or its affiliated persons to undertake, effect, or facilitate a market timing transaction. Again, members must have in place policies and procedures reasonably designed to detect and prevent this collusion with mutual funds and their affiliated persons to circumvent the mutual funds stated procedures.

      Members must review the adequacy of their policies and practices with regard to the matters discussed in this Notice to Members. NASD intends to examine for reasonable policies and practices with regard to these matters.


      1 As used in the this Notice to Members, the term "affiliated person" is as defined under Section 2(a)(3) of the Investment Company Act of 1940.

      2 There may be situations where member firms legitimately receive orders prior to or at the close of trading but enter such orders after market's close. However, members bear the burden of demonstrating that they have implemented policies and procedures that are reasonably designed to prevent the occurrence of late trading.

    • 03-49 NASD Requests Comment on Proposed Amendments to Rule 3010 to Require Heightened Supervision Plans for Associated Persons with a Specified Threshold of Industry/Regulatory-Related Events (Note: The comment period has been extended to October 31, 2003)

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      REQUEST FOR COMMENT

      Supervision Rules

      Comment Period Expires: October 10, 2003

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Senior Management

      Rule 3010
      Supervisory Systems

      Executive Summary

      NASD requests comment on proposed amendments to Rule 3010 (Supervision) to require members to adopt heightened supervision plans for those associated persons who have met or exceeded specified threshold numbers of industry/regulatory-related events, or to document their rationale (which must be reasonable) for not doing so. Rule 3010 generally requires members to establish and maintain supervisory systems for each of their associated persons that are reasonably designed to achieve compliance with applicable securities laws and NASD rules. However, the rule does not specifically address supervision of associated persons with a history of industry/regulatory-related events. The proposed rule change is intended to bolster investor protection by promoting earlier and more effective detection, and thus prevention, of future sales practice and other regulatory abuses by the associated person(s) requiring heightened supervision. In connection with the heightened supervision requirement, NASD seeks comment on the types and frequency of incidents that should be considered in requiring that persons be subject to heightened supervision plans.

      NASD further requests comment on amendments that would require that the registered person responsible for supervising the activities of the associated person(s) subject to the plan approve in writing the heightened supervision plans. As part of the approval of the plan, the supervisor would acknowledge responsibility for execution of the plan. This rule change is intended to ensure effective implementation of the heightened supervision plans and coordination between the personnel responsible for hiring and compliance personnel by encouraging more awareness and careful consideration of a person's background during the hiring process.

      Questions/Further Information

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

      Request for Comment

      NASD requests comment on the proposed amendments to Rule 3010 described in this Notice. Members wishing to comment must make a submission that is received by October 10, 2003. Members and interested persons can submit their comments using the following methods:

      • mailing in written comments


      • e-mailing written comments to pubcom@nasd.com


      • submitting comments online at 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 by mail, e-mail, or via 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 (SEC).

      Background and Discussion

      Supervisory systems are a basic component of self-regulation within the securities industry. An effective supervisory system plays an essential role in the prevention of sales practice and other abuses and, thus, enhances investor protection and market integrity. As such, it is essential that firms monitor the regulatory histories of their associated persons and establish additional measures to supervise the activities of those associated persons with greater potential of creating customer harm.

      Persons who have engaged in certain types of serious misconduct become subject to statutory disqualification under the federal securities laws and NASD rules and are required to undergo an eligibility proceeding.1 In such a proceeding, NASD may seek to prevent the entry or continuance in the securities industry of persons subject to a statutory disqualification, or may permit them to work if the employment is consistent with the public interest and protection of investors. NASD, in virtually every instance where continued employment is permitted, will condition employment of the individual on the establishment of safeguards, including enhanced supervision by the employer member of the individual's business activities.

      Neither the federal securities laws nor NASD rules, however, explicitly address members' supervisory obligations with respect to associated persons who have a history of industry/regulatory-related incidents, but who fall short of triggering the statutory disqualification provisions. Rule 3010 generally requires members to establish and maintain supervisory systems for each of their associated persons that are reasonably designed to achieve compliance with applicable securities laws and NASD rules, but the rule does not specifically address supervision of associated persons with a history of industry-related events.2 Notices to Members issued in this area have provided guidance for members concerning heightened supervision plans for associated persons with these types of histories, but the guidance has not been incorporated into NASD rules.3

      Accordingly, to address regulatory concerns raised by associated persons with these histories, NASD is seeking comment on the adoption of rule amendments to require explicitly that members adopt heightened supervision plans for those associated persons who meet or exceed threshold numbers of industry/regulatory-related incidents (such as customer complaints, arbitration proceedings, terminations for cause, and disciplinary actions). Along with numerical threshold tests, NASD recognizes that a qualitative analysis of the associated persons' activities also is an important tool for identifying whether they require heightened supervision. As such, the proposed amendments would provide firms with the flexibility not to impose a heightened supervision plan on a particular individual based upon a qualitative review of the activities of that individual. If a member decides not to impose heightened supervisory procedures on a person who has met one or more of the triggers, the member must document a clear, well-reasoned rationale supporting its determination. NASD requests comment on whether firms that have a certain number of associated persons who meet the heightened supervision requirements should not be allowed to opt-out of the heightened supervision requirement, and, if so, what this threshold number should be.

      As required by Rule 3010, any supervision plan should be reasonably designed to ensure compliance with applicable securities laws and regulations and NASD rules. However, members would have the flexibility to tailor the plans to fit the firm's business and to address the nature of the concerns raised by the associated person's industry/regulatory-related incidents. Members also would have discretion in determining the duration of a heightened supervision plan, based on the member's reasonable assessment of the facts and circumstances surrounding the particular associated person's activities. While a member would be expected to maintain any heightened supervision plan imposed until such time that the associated person no longer meets any of the triggers for heightened supervision, the member may determine to eliminate such plan earlier provided the member provides a reasonable rationale for the earlier termination.

      The proposed amendments would require that the plans be approved in writing by the person responsible for supervising the associated person subject to the plan. As part of the approval of the plan, such supervisor would acknowledge responsibility for execution of the plan. NASD believes that requiring approval and acknowledgement by a supervisor would help to ensure effective implementation of the plans as well as an even more careful consideration of an associated person's background in the hiring process. In addition, as required by Rule 3010(b)(4), members would need to maintain such plans in their firm records. NASD staff would review the plans as part of the examination program.

      As part of this initiative, NASD staff has reviewed CRD data regarding industry/regulatory events for persons currently registered with NASD to determine what numerical tests would be appropriate as triggers to require firms to assess whether to impose a heightened supervision plan. A preliminary review of existing data as reported to the CRD system indicates that 29,500 out of the 663,000 persons currently registered with NASD (approximately four percent of currently active registered persons) have been subject to one or more customer complaints and arbitrations within the last five years. Of this number, 2,751 persons (.41 percent of all registered persons) have had three or more complaints and arbitrations.4

      Based on this preliminary data, NASD proposes that members be required to impose (or document their rationale, which must be reasonable, for not imposing) heightened supervision plans on any associated person subject to three or more customer complaints and arbitrations within the past five years, given that three or more complaints and arbitrations is an unusually high number of complaints and arbitrations in the industry. Similarly, NASD proposes that members be required to impose heightened supervision plans on their associated persons who, within the previous five years, were subject to three or more pending, adjudicated, or settled regulatory actions or investigations,5 or two or more terminations relating to regulatory or compliance issues or internal reviews initiated by an employing member firm to examine whether an individual engaged in misconduct.6 The preliminary universe of persons reported in this Notice who would trigger the heightened supervision requirement include some overlap between categories as well as overlap due to a positive reporting in more than one category based on the same incident. NASD intends to periodically review the methodology to ensure that the appropriate associated persons are identified for heightened supervision.

      Finally, while the proposed amendments would require members to adopt heightened supervision plans (unless members document their rationale for not imposing heightened supervision) if certain triggers are reached, members would continue to be obligated to review those associated persons with lower numbers of the events discussed in this Notice, other regulatory and litigation events, or other instances where they are the subject of internal actions by members to caution, discipline, or limit their activities, to determine whether heightened supervision plans or other measures are needed.


      1 Events triggering statutory disqualification include, for example, certain enumerated misdemeanor and all felony criminal convictions for a period of ten years from the date of conviction; temporary and permanent injunctions (regardless of their age) involving a broad range of unlawful investment activities; bars (and current suspensions) ordered by the SEC or a self-regulatory organization (SRO); and findings that a person willfully has made or caused to be made false statements of a material fact to an SRO. See Sections 3(a)(39) and 15(b)(4)(A) of the Securities Exchange Act of 1934; NASD By-Laws Article III, Section 4. Persons who are or become subject to a statutory disqualification may seek to enter, reenter, or in the case of incumbents, continue in the securities industry.

      2 Rule 3010(a)(7) requires that members conduct annual meetings with their registered representatives at which compliance matters relevant to the activities of the representatives are discussed, but does not require that members take supervisory steps tailored to specific incidents concerning the registered representatives.

      3 See Notice to Members 97-19 (April 1997) stating that a member with a registered representative who develops a history of customer complaints, final disciplinary actions involving sales practice abuse or other customer harm, or adverse arbitration decisions should consider developing special supervisory procedures for that registered representative. See also Notice to Members 98-38 (May 1998) indicating that unexpected supervisory visits to offices with personnel who have disciplinary records may be appropriate.

      4 The preliminary data show that of the 29,500 persons subject to customer complaints within the last five years, 3.3 percent of all registered persons (22,003 persons) were subject to 1 complaint, .71 percent of all registered persons (4,726 persons) were subject to 2 complaints, .22 percent of all registered persons (1,487 persons) were subject to three complaints, .09 percent of all registered persons (568 persons) were subject to four complaints, and .04 percent of all registered persons (290 persons) were subject to 5 complaints.

      5 Preliminary data indicate that .52 percent of all persons currently registered with NASD (3,446 persons) have been subject to regulatory actions or investigations within the last five years. Of those subject to such actions/investigations, only .03 percent of all registered persons (216 persons) were subject to three or more.

      6 Preliminary data indicate that .37 percent of all registered persons (2,475 persons) have been terminated or been the subject of an internal review initiated by the firm based on alleged investment-related misconduct. Of those persons, .18 percent of all registered persons (1,198 persons) had two or more such incidents.


      Attachment A

      New language is underlined; deletions are in brackets.

      3010. Supervision

      (a) No change.
      (b) Written Procedures
      (1) and (2) No change.
      (3) Heightened supervisory procedures
      (A) Each member that either is notified by NASD or otherwise has knowledge that any of its associated persons meets one of the criteria in paragraph (b)(3)(D) shall establish, maintain, and enforce special written procedures for supervising the activities of such associated persons.
      (B) The member must establish and implement the supervisory procedures required by this paragraph within 30 days of receiving notice from NASD or obtaining actual knowledge that it is subject to the provisions of this paragraph.
      (C) The procedures required by this paragraph must be appropriate for the member's business, size, structure, and customers and must be reasonably designed to supervise the types of activities that gave rise to the special supervision required by this paragraph.
      (D) Members shall be required to adopt special supervisory procedures over the activities of the following associated person(s):

      • The associated person has been subject to three or more customer complaints and arbitrations (as reported on Item 14I on Form U-4) in the previous five years;


      • The associated person has been subject to three or more pending, adjudicated, or settled regulatory actions or investigations by the Commission, the Commodity Futures Trading Commission, a federal, state, or foreign regulatory agency, or a self-regulatory organization in the previous five years; or


      • The associated person has been subject to two or more terminations for cause or internal reviews for alleged investmentrelated misconduct in the previous five years.

      (E) A member must maintain the special supervisory procedures until such date that the associated person no longer meets any one of the criteria in paragraph (b)(3)(D), unless the member documents reasonable rationale for earlier termination of such procedures.
      (F) If a member determines not to adopt special supervisory procedures for an associated person who meets one or more of the criteria in paragraph (b)(3)(D), the member must have a reasonable basis for its determination, which must be documented.
      (G) The special supervisory procedures established under this paragraph must be approved, in writing, by a person supervising the associated person subject to the special supervisory procedures. The approving supervisor must also acknowledge responsibility for implementation and execution of the special supervisory procedures.
      (4) [(3)] The member's written supervisory procedures shall set forth the supervisory system established by the member pursuant to paragraph (a) above, and shall include the titles, registration status and locations of the required supervisory personnel and the responsibilities of each supervisory person as these relate to the types of business engaged in, applicable securities laws and regulations, and the Rules of this Association. The member shall maintain on an internal record the names of all persons who are designated as supervisory personnel and the dates for which such designation is or was effective. Such record shall be preserved by the member for a period of not less than three years, the first two years in an easily accessible place.
      (5) [(4)] A copy of a member's written supervisory procedures, or the relevant portions thereof, shall be kept and maintained in each OSJ and at each location where supervisory activities are conducted on behalf of the member. Each member shall amend its written supervisory procedures as appropriate within a reasonable time after changes occur in applicable securities laws and regulations, including the Rules of this Association, and as changes occur in its supervisory system, and each member shall be responsible for communicating amendments through its organization.
      (c) - (g) No change.

    • 03-48 SEC Approves Extension of Pilot Relating to Bond Mutual Fund Volatility Ratings

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      INFORMATIONAL

      Bond Mutual Fund Volatility Ratings

      SUGGESTED ROUTING

      KEY TOPICS

      Advertising/Investment Companies
      Executive Representatives
      Legal & Compliance
      Mutual Fund
      Registered Representatives
      Senior Management

      Bond Mutual Fund Volatility Ratings
      NASD IM-2210-5
      NASD Rule 2210

      Executive Summary

      On August 7, 2003, NASD filed with the Securities and Exchange Commission (SEC) a proposed rule change to extend for two years the effectiveness of NASD rules that govern the use of bond mutual fund volatility ratings in member sales material. The rule change was effective upon filing. NASD Interpretive Material 2210-5 permits members and associated persons to include bond mutual fund volatility ratings in supplemental sales literature, subject to certain conditions. NASD Rule 2210(c)(3) requires supplemental sales literature containing bond mutual fund volatility ratings to be filed with the Advertising Regulation Department (the Department) for review and approval at least 10 days prior to use.

      On February 29, 2000, the SEC approved IM-2210-5 and Rule 2210(c)(3) on an interim 18-month pilot basis. In August 2001, NASD extended the pilot for two-years, until August 31, 2003. The most recent rule filing extends these rules' effectiveness for an additional two years, until August 31, 2005.

      Included with this Notice is Attachment A (text of rule amendments).

      Questions/Further Information

      Questions or comments concerning this Notice may be directed to Joseph P. Savage, Counsel, Investment Companies Regulation, Regulatory Policy and Oversight, at (240) 386-4534, or Philip A. Shaikun, Associate General Counsel, Regulatory Policy and Oversight, at (202) 728-8451.

      Background

      On February 29, 2000, the SEC approved the adoption of NASD Interpretive Material 2210-5, which permits members and their associated persons to include bond fund volatility ratings in supplemental sales literature (mutual fund sales material that is accompanied or preceded by a fund prospectus). The SEC also approved at that time new NASD Rule 2210(c)(3), which sets forth the filing requirements and review procedures applicable to sales literature containing bond mutual fund volatility ratings. Previously, NASD staff interpreted NASD rules to prohibit the use of bond fund volatility ratings in sales material.

      IM-2210-5 permits the use of bond fund volatility ratings only in supplemental sales literature and only if certain conditions are met:

      • The word "risk" may not be used to describe the rating.


      • The rating must be the most recent available and be current to the most recent calendar quarter ended prior to use.


      • The rating must be based exclusively on objective, quantifiable factors.


      • The entity issuing the rating must provide detailed disclosure on its rating methodology to investors through a toll-free telephone number, a Web site, or both.


      • A disclosure statement containing all of the information required by the rule must accompany the rating. The statement must include such information as the name of the entity issuing the rating, the most current rating and the date it was issued, and a description of the rating in narrative form containing certain specified disclosures.

      Rule 2210(c)(3) requires members to file bond mutual fund sales literature that includes or incorporates volatility ratings with the Department at least 10 days prior to use for Department approval. If the Department requests changes to the material, the material must be withheld from publication or circulation until the requested changes have been made or the material has been re-filed and approved. For a more complete description of IM-2210-5 and Rule 2210(c)(3), please see Notice to Members 00-23 (April 2000).

      Extension of Pilot Period

      The SEC originally approved IM-2210-5 and new Rule 2210(c)(3) on an 18-month trial basis, until August 31, 2001, to provide NASD an opportunity to assess whether the rule had facilitated the dissemination of useful, understandable information to investors, and whether it had prevented the dissemination of inappropriate and misleading information.

      During the initial pilot period, the Department received very few filings pursuant to these provisions. In general, these filings have met the requirements of IM-2210-5. Although these filings generally met the rule's requirements, the staff did not believe that it had received a sufficient number of filings to evaluate adequately the rule's effectiveness. Accordingly, in July 2001, NASD, pursuant to a rule filing with the SEC, extended the pilot for two years.1 The extended period expires on August 31, 2003.

      The Department has continued to receive very few filings under these rules during the extended pilot period. During the entire period from February 2000, when the rule was first approved, until the present, NASD has received a total of 41 submissions from three NASD members. In general, these filings met the requirements of IM-2210-5. However, the staff still does not believe that it has received a sufficient number of filings to adequately evaluate the rule's effectiveness.

      In this regard, NASD notes that, because of the low interest rates over the last two years, bond mutual funds may have had little reason to distribute sales material that contains volatility ratings.

      Accordingly, NASD is proposing to extend the expiration date of IM-2210-5 and Rule 2110(c)(3) for an additional two years, until August 31, 2005, to allow more filings to be made. The SEC recently published notice of this extension in the Federal Register.2 Before this period expires, the staff will evaluate the rule and determine whether to recommend that the rule be eliminated, modified, or permanently approved in its current form.


      1 See SEC Release No. 34-44737 (Aug. 22, 2001), 66 Fed. Reg. 45350 (Aug. 28, 2001) (SR-NASD-2001-49).

      2 See SEC Release No. 34-48353 (Aug. 15, 2003), 68 Fed. Reg. 50568 (Aug. 21, 2003) (SR-NASD-2003-126).


      Attachment A — Rule Text

      New text is underlined and deleted text is bracketed.

      2210. Communications with the Public

      (c) Filing Requirements and Review Procedures
      (3) Sales Literature Containing Bond Fund Volatility Ratings

      Sales literature concerning bond mutual funds that include or incorporate bond mutual fund volatility ratings, as defined in Rule IM-2210-5, shall be filed with the Department for review at least 10 business days prior to use (or such shorter period as the Department may allow in particular circumstances) for approval and, if changed by NASD, shall be withheld from publication or circulation until any changes specified by NASD have been made or, if expressly disapproved, until the sales literature has been refiled for, and has received, NASD approval. Members are not required to file advertising and sales literature which have previously been filed and which are used without change. The member must provide with each filing the actual or anticipated date of first use. Any member filing sales literature pursuant to this paragraph shall provide any supplemental information requested by the Department pertaining to the rating that is possessed by the member.

      IM-2210-5. Requirements for the Use of Bond Mutual Fund Volatility Ratings

      (This rule and Rule 2210(c)(3) will expire on August 31, [2003] 2005, unless extended or permanently approved by [the Association] NASD at or before such date.)

      (a) Definition of Bond Mutual Fund Volatility Ratings

      For purposes of this Rule and any interpretation thereof, the term "bond mutual fund volatility rating" is a description issued by an independent third party relating to the sensitivity of the net asset value of a portfolio of an open-end management investment company that invests in debt securities to changes in market conditions and the general economy, and is based on an evaluation of objective factors, including the credit quality of the fund's individual portfolio holdings, the market price volatility of the portfolio, the fund's performance, and specific risks, such as interest rate risk, prepayment risk, and currency risk.
      (b) Prohibitions on Use

      Members and persons associated with a member may use a bond mutual fund volatility rating only in supplemental sales literature and only when the following requirements are satisfied:
      (1) The rating does not identify or describe volatility as a "risk" rating.
      (2) The supplemental sales literature incorporates the most recently available rating and reflects information that, at a minimum, is current to the most recently completed calendar quarter ended prior to use.
      (3) The criteria and methodology used to determine the rating must be based exclusively on objective, quantifiable factors. The rating and the Disclosure Statement that accompanies the rating must be clear, concise, and understandable.
      (4) The supplemental sales literature conforms to the disclosure requirements described in paragraph (c).
      (5) The entity that issued the rating provides detailed disclosure on its rating methodology to investors through a toll-free telephone number, a web site, or both.
      (c) Disclosure Requirements
      (1) Supplemental sales literature containing a bond mutual fund volatility rating shall include a Disclosure Statement containing all the information required by this Rule. The Disclosure Statement may also contain any additional information that is relevant to an investor's understanding of the rating.
      (2) Supplemental sales literature containing a bond mutual fund volatility rating shall contain all current bond mutual fund volatility ratings that have been issued with respect to the fund. Information concerning multiple ratings may be combined in the Disclosure Statement, provided that the applicability of the information to each rating is clear.
      (3) All bond mutual fund volatility ratings shall be contained within the text of the Disclosure Statement. The following disclosures shall be provided with respect to each such rating:
      (A) the name of the entity that issued the rating;
      (B) the most current rating and date of the current rating, with an explanation of the reason for any change in the current rating from the most recent prior rating;
      (C) a description of the rating in narrative form, containing the following disclosures:
      (i) a statement that there is no standard method for assigning ratings;
      (ii) a description of the criteria and methodologies used to determine the rating;
      (iii) a statement that not all bond funds have volatility ratings;
      (iv) whether consideration was paid in connection with obtaining the issuance of the rating;
      (v) a description of the types of risks the rating measures (e.g., short-term volatility);
      (vi) a statement that the portfolio may have changed since the date of the rating; and
      (vii) a statement that there is no guarantee that the fund will continue to have the same rating or perform in the future as rated.

    • 03-47 Refunds to Customers Who Did Not Receive Appropriate Breakpoint Discounts in Connection with the Purchase of Class A Shares of Front-End Load Mutual Funds and the Capital Treatment of Refund Liability

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      IMMEDIATE ACTION REQUIRED

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Senior Management
      Accounting
      Operations
      Retail

      Mutual Funds
      Mutual Fund Breakpoints
      Customer Refunds
      Net Capital Compliance

      Background

      In late 2002, as a result of several routine examinations, NASD discovered that some members had failed to deliver breakpoint discounts to investors purchasing Class A shares of front-end load mutual funds. This led to a joint examination of 43 broker/dealers by NASD, the Securities and Exchange Commission ("SEC"), and the New York Stock Exchange ("NYSE"), which confirmed that broker/dealers were not uniformly delivering appropriate breakpoint discounts. In December 2002, NASD issued Special Notice to Members 02-85, which reminded members of their obligation to deliver all available breakpoint discounts to customers purchasing Class A shares of front-end load mutual funds.

      In March 2003, NASD directed member firms that processed 100 or more automated purchases of front-end load mutual funds in either 2001 or 2002 to conduct a "self-assessment" of their record of delivering breakpoint discounts to customers. The self-assessment was designed to produce a statistically significant sample that would allow NASD to determine the scope of overcharges at individual member firms and to gauge the scope of the problem across the industry as a whole.

      A preliminary analysis of the data obtained as a result of the self-assessment indicates that most members did not uniformly deliver appropriate breakpoint discounts; the degree to which firms applied the appropriate discount varied. It is imperative that member firms make appropriate refunds to customers who did not receive discounts for which they were eligible and that members properly account for overcharge liabilities. This Notice to Members provides guidelines for firms to follow when calculating refunds to customers and discusses how firms must account for their anticipated refund liabilities.1

      Questions/Further Information

      Questions regarding refunds may be directed to Janene Marasciullo, Senior Attorney, NASD Office of General Counsel, at (202) 974-2978. Questions regarding net capital issues may be directed to Susan DeMando, Director, Financial Operations, NASD, Member Regulation at (202) 728-8411.

      Discussion

      Refunds to Customers

      NASD expects that members will make refunds to customers expeditiously where they are aware that customers did not receive the sales load discount to which they were entitled. A number of NASD member firms have already begun that process.2 Members who have completed the self-assessment have already identified certain customers who did not receive available breakpoint discounts. Members should take immediate steps to make refunds to these customers in accordance with the calculation guidelines set forth below.

      Additionally, NASD expects members to make refunds to any customers who come forward and assert that they did not receive all applicable breakpoint discounts. Once a member is in contact with a customer seeking a refund, the member firm must review its records to determine whether the customer is entitled to a refund and to determine the amount of the appropriate refund.3 A member may not place the burden of demonstrating entitlement to a refund upon the customer and, therefore, may not refuse to make a refund to a customer without first checking its own records to determine whether the customer is entitled to a refund. However, members may require documentation from customers where the availability of the breakpoint discount can only be determined by reference to records not held by the member.

      NASD has taken steps to inform investors regarding the availability of breakpoint discounts and the problems that the financial industry experienced delivering breakpoint discounts in the past.4 NASD has also advised investors that they may be entitled to refunds if they did not receive appropriate breakpoint discounts on past mutual fund purchases.5 Therefore, NASD members should be prepared to make prompt refunds to those customers who were identified during the self-assessment as having been overcharged, as well as other customers who come forward seeking refunds on their own and are owed a refund based on the firm's assessment and in accordance with the guidelines set forth below.

      Refund Calculation Guidelines

      Members should make full refunds to customers who have valid claims that they were overcharged. To ensure that the refunds make customers whole and are distributed in a timely and equitable fashion, NASD has developed the following guidelines that firms must follow when providing refunds:

      • Refunds should be made in cash sent to the customer, or through cash deposits made to an existing customer's account with notice to that customer.


      • Refunds should be equal to the amount of the sales load overcharge plus interest at a simple rate of at least 2.5%, for overcharges that occurred between January 1, 2001, and the present. For transactions that took place prior to that time, members should use a comparable interest rate.6


      • Refunds should be made regardless of the performance of the mutual fund purchased by the customer.

      Making and Maintenance of Records

      Members are reminded that, pursuant to NASD Rule 3110 and Exchange Act Rules 17a-3 and 17a-4, they must make and preserve records that reflect their determinations regarding customers' refund eligibility and the calculation and payment of any such refunds. Members should ensure that they maintain these records for the first two years in an easily accessible place.

      Capital Treatment of Refund Liability

      A member's obligation to provide refunds to customers who were overcharged may impact net capital. NASD provides the following guidance to member firms regarding the accounting treatment applicable to a member's obligation to provide refunds to customers who did not receive breakpoint discounts to which they were entitled. NASD has concluded that a member's refund obligation comes within the definition of "liability" set forth in the Financial Accounting Standards Board's Statement of Financial Accounting Concept No. 6 ("SFAC No. 6") because it meets each of the following characteristics:

      (a) It is a present duty or responsibility to one or more other entities that entails settlement by probable future transfer or use of assets at a specified or determinable date, on occurrence of a specified event, or on demand;
      (b) The duty or responsibility obligates a particular entity, leaving it no discretion to avoid the future sacrifice;7 and
      (c) The transaction or other event obligating the entity has already happened.

      The recognition of this liability may impact a member's net capital computation, and compliance with net capital requirements set by SEC Rule 15c3-1, and other financial reporting.

      In determining the amount of this liability, members should consider that SFAC No. 6 specifically recognizes that the amount of a liability does not need to be certain before it is recorded. SFAC No. 6 ¶ 46.8 Accordingly, approximations and estimates may be used to record a liability. Id. Thus, firms must determine their probable liability based upon currently available information in accordance with SFAC No. 6 and generally accepted accounting principles ("GAAP").9

      Segregation and Protection of Funds Necessary to Satisfy Refund Liability to Investors

      Regardless of the methodology that a firm uses to determine the amount of its liability, each member must, to the extent necessary, segregate the funds needed to satisfy its liability through either a Special Reserve Bank Account for the Exclusive Benefit of Customers ("Special Reserve Bank Account") or through an account established for the benefit of customers in accordance with section (k)(2)(i) of Exchange Act Rule 15c-3-3 ("A Special Account"). To ensure that firms properly segregate the funds set aside to satisfy their refund liability, NASD provides the following guidelines for setting aside and protecting the funds necessary to satisfy a member's refund obligation:

      • Member firms that are fully subject to the Customer Protection Rule (SEC Rule 15c3-3), must, beginning with their next and on all subsequent Reserve Requirement computation dates (whether weekly or monthly):


        • Include the refund liability amount as a credit in the Reserve Formula; and


        • Pay investor refunds as soon as feasible, while continuing to include the refund liability amount as a credit in the Reserve Formula.

      • Member firms that are exempt from the Reserve Requirement computation of the Customer Protection Rule must pay the amounts owed to any investor making a claim within two business days of determining the proper amount of the claim. To the extent that such member firms do not pay all claims within two business days of determining the proper amount of the claim, these member firms must:


        • Immediately establish a separate Special Account for the benefit of customers in accordance with the requirements of paragraph (k)(2)(i) of SEC Rule 15c3-3;


        • Deposit the remaining amount of the liability into that Special Account; and,


        • Pay the investor refunds as soon as feasible from and through the separate Special Account, while continuing to hold any unpaid refund liability in that account.

      Conclusion

      Firms must take prompt and immediate action to provide refunds to customers in accordance with the guidelines set forth above. Failure to provide such refunds will subject firms to disciplinary action, separate and apart from any disciplinary actions that may result from the initial failure to deliver breakpoint discounts. Furthermore, firms must treat their refund obligations as liabilities on their financial statements and must ensure that they are operating in net capital compliance after accounting for these liabilities. Finally, firms must take appropriate actions to segregate and protect the funds necessary to satisfy their refund liability.


      1 NASD, in coordination with SEC staff, is determining the nature and scope of further regulatory action against certain firms based upon their record of delivering breakpoint discounts.

      2 Any firm that has already provided its customers with refunds should contact NASD if it used an alternative methodology to determine whether it calculated its refunds in a satisfactory manner.

      3 Firms that do not respond appropriately to customer requests for refunds may be subject to disciplinary action by NASD.

      4 NASD Investor Alert, "Mutual Fund Breakpoints: A Break Worth Taking," available at www.nasd.com/investor/Alerts/alert_breakpoint.htm; Report of Joint NASD/Industry Task Force on Breakpoints, available at www.nasdr.com/breakpoints_report.asp.

      5 NASD has already stated that investors have a right to receive a refund to compensate them for sales load overcharges. See July 22, 2003, NASD Press Release, "Joint NASD/Industry Breakpoint Task Force Issues Report," in which NASD Chairman Robert Glauber stated, "NASD is committed to helping investors receive refunds for missed breakpoints." See also February 18, 2003, NASD Press Release, "NASD Announces Joint NASD/Industry Breakpoint Task Force." NASD recognizes that some refund claims may prove to be without merit or be time-barred. However, NASD expects members who receive claims for refunds to carefully review the merits of each claim and provide refunds in all cases where there is a timely and meritorious claim for a refund.

      6 The 2.5% rate is based on data posted on the Federal Reserve Web Site for simple average dealer rates on negotiated six month CDs nationally traded in the secondary market from January 2001 until June 2003. See www.federalreserve.gov/releases/h15/data/m/cd6m.txt. Data posted on the Federal Reserve Site for six month CDs for periods prior to January 2, 2001, may be considered for determining refunds relating to overcharges outside of the period covered by the selfassessment.

      7 Members are obligated to provide all breakpoint discounts disclosed in a mutual fund's prospectus. However, the Financial Accounting Standards Board has recognized that "although most liabilities rest generally on a foundation of legal rights and duties, existence of legally enforceable claim is not a prerequisite for an obligation to qualify as a liability if for other reasons the entity has the duty or responsibility to pay cash, to transfer assets, or to provide services to another entity." SFAC No. 6, ¶ 36.

      8 The fact that members may not currently know the identity of all investors who are entitled to refunds is not relevant to the determination of whether the refund obligation is a liability. See SFAC No. 6 (explaining that "the identity of the recipient need not be known to the obligated entity before the time of settlement.").

      9 Members should be aware that NASD, in reviewing members' determinations of their probable liability for the years 2001 and 2002, will use, as a reference for comparison, statistically significant extrapolations of each member's total liability for that period derived from each member's data provided in response to the self-assessment. NASD recognizes that a member's determination of its liability under GAAP may vary from these extrapolations. NASD will communicate to each member that was subject to the self-assessment its extrapolated total liability for years 2001 and 2002. NASD recognizes that some firms may have refund obligations as a result of transactions that were executed prior to the self-assessment period. In this regard, a significant number of valid customer claims may result in the need for firms to calculate the liability for transactions executed prior to 2001, in accordance with GAAP and SFAC No. 6. The existence of pre-2001 claims and refunds, and the recording of attendant liabilities, may be covered in NASD examinations. In all cases, members should be prepared to demonstrate that the calculation of probable liability is in accordance with GAAP.

    • 03-46 Amendments Relating to Requests for Underwriting Activity Reports

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      INFORMATIONAL

      Underwriting Activity Reports

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Operations
      Technology
      Trading and Market Making

      Underwriting Activity Reports
      Public Offerings

      Executive Summary

      NASD has amended its rules to require members to request Underwriting Activity Reports (UARs) from NASD's Market Regulation Department rather than NASD's Corporate Finance Department. The rule change, as amended, was filed with the Securities and Exchange Commission (SEC) on July 9, 2003. Pursuant to Section 19(b)(3)(A)(iii) of the Securities Exchange Act of 1934 and SEC Rule 19b-4(f)(3) thereunder, the rule change became effective upon filing.1

      Questions/Further Information

      Questions regarding this Notice may be directed to Patrick Geraghty, Associate Director, Quality of Markets, NASD Market Regulation Department, (240) 386-4973.

      Background

      NASD Rules 2710(b)(10) and 6540(d) require, among other things, that a member acting as the lead manager of a distribution of a publicly traded security that is subject to SEC Rule 101 of Regulation M submit a request to NASD for a UAR. A member must request a UAR at the time a registration statement or similar offering document is filed with NASD's Corporate Finance Department, the SEC, or other regulatory agency, or, if not filed with any regulatory agency, at least two business days prior to the commencement of the restricted period under SEC Rule 101.

      Since June 2002, NASD staff has asked that members submit their requests for UARs to NASD's Market Regulation Department rather than NASD's Corporate Finance Department, as was previously required under NASD rules. NASD staff believes that the Market Regulation Department is better-suited to handle such requests because the analysts within the Market Regulation Department are trained specifically to review UARs for accuracy and are better-equipped to answer questions relating to the information provided in UARs. Accordingly, NASD has amended its rules to require that members submit a request for a UAR to the Market Regulation Department instead of the Corporate Finance Department. The rule change does not affect the substantive content of UAR requests, the manner in which a request can be submitted, or the time period associated with a request.


      1 File No. SR-NASD-2003-75. See Exchange Act Release No. 48215 (July 23, 2003), 68 Fed. Reg. 44826 (July 30, 2003) (Notice of Filing and Immediate Effectiveness of Rule Change).

    • 03-45 SEC Approves Amendments to TRACE Rule 6260 to Require New Issue Notifications to Include Dissemination Eligibility Information and Be Submitted in Writing

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      INFORMATIONAL

      Corporate Debt Securities

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Finance
      Legal and Compliance
      Operations
      Senior Management
      Technology
      Trading and Market Making
      Training

      Underwriting
      Debt Securities
      Operations
      Rule 6200 Series
      Transaction Reporting

      Executive Summary

      On August 8, 2003, the Securities and Exchange Commission (SEC or Commission) approved amendments to Rule 6260 of the Trade Reporting and Compliance Engine (TRACE) Rules, the Rule 6200 Series.1 The amendments to Rule 6260 require that a managing underwriter, or, if there is no managing underwriter, the group of underwriters, of an initial offering of a TRACE-eligible security provide information that will aid NASD in determining if the new issue will be subject to dissemination when the managing underwriter or other underwriter submits the notification of the new issue to NASD (new issue notification). The specific additional information required will vary according to the dissemination requirements in Rule 6250. The amendments also require that the new issue notification be submitted in writing. Rule 6260, as amended, is set forth in Attachment A.

      The amendments to Rule 6260 will become effective on August 25, 2003.

      Questions/Further Information

      Questions concerning this Notice should be directed to tracefeedback@nasd.com; Elliot Levine, Chief Counsel, Market Operations, Regulatory Services and Operations, at 202-728-8405; or, Sharon K. Zackula, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at 202-728-8985.

      Background and Discussion

      Currently, Rule 6260(b) requires a member that is the managing underwriter, or if there is no managing underwriter, the group of underwriters (hereinafter, "managing underwriter" refers to any underwriter responsible for complying with Rule 6260), of any newly issued TRACE-eligible security to submit a new issue notification to NASD. The new issue notification must contain basic descriptive information about the new TRACE-eligible security. Specifically, the Rule requires that the new issue notification contain: (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.

      Rule 6260(b), as amended, requires a managing underwriter to provide to the TRACE Operations Center additional information, as determined by NASD staff, that is required to determine if the new TRACE-eligible security is subject to dissemination under Rule 6250, in addition to the six items of information specified above. The purpose of the new requirement is to provide NASD staff relevant information that will allow NASD staff to quickly and accurately determine if a newly issued TRACE-eligible security is subject to dissemination. The amendments are necessary because NASD, with the support of industry members, has developed a variety of criteria, which must be reviewed, in order to determine if a new TRACE-eligible security is subject to dissemination.

      The dissemination criteria for TRACE-eligible securities are set forth in Rule 6250(a)(1) through (a)(4). For example, in paragraph (a)(1), securities that are Investment Grade2 at the time of receipt of the transaction report and have an initial issuance size of $1 billion or greater are subject to dissemination. Also, in paragraph (a)(3), securities that are Investment Grade and rated by Moody's Investors Service, Inc.3 as "A3" or higher and by Standard & Poor's, a division of McGraw Hill Co., Inc.,4 as "A-" or higher and have an original issuance size of $100 million or greater are subject to dissemination. Accordingly, in many but not all cases, the additional information that NASD staff will require to determine if the newly issued security is subject to dissemination will be the rating(s) of the security and the original issue size of the offering. If, in a particular instance, NASD staff determines that other additional information is needed to quickly and accurately determine if the new TRACE-eligible security is subject to dissemination, NASD staff will require the managing underwriter to provide such information.

      In the future, Rule 6250 may be amended to add additional factors that must be considered by staff in order to determine if a newly issued TRACE-eligible security is required to be disseminated. If Rule 6250 were so amended, under Rule 6260(b), NASD staff would require managing underwriters to provide any additional type of information relating to those factors that would be needed by NASD staff in order to quickly and accurately determine if newly issued TRACE-eligible securities are subject to dissemination. NASD would inform all members of the changes in the new issue notification information requirements in a Notice to Members and through other media.

      Members are reminded that any additional information required must be provided within the time frames set forth in Rule 6260(b).

      Provide Written New Issue Notification

      Rule 6260, as amended, requires the member that is submitting the new issue notification to provide the information in writing. The written notification may be in the form of an e-mail or facsimile transmission.

      Effective Date

      The amendments to Rule 6260 will become effective on August 25, 2003.


      1 See Securities Exchange Act Release No. 48305 (August 8, 2003), 68 F.R. 48656 (August 14, 2003) (File No. SR-NASD-2003-99).

      2 The term "Investment Grade" is defined in Rule 6210(h).

      3 Moody's Investors Service, Inc. (Moody's), is a nationally recognized statistical rating organization. Moody's is a registered trademark of Moody's Investors Service. Moody's ratings are proprietary to Moody's and are protected by copyright and other intellectual property laws. Moody's licenses ratings to NASD. Ratings may not be copied or otherwise reproduced, repackaged, further transmitted, transferred, disseminated, redistributed or resold, or stored for subsequent use for any purpose, in whole or in part, in any form or manner or by any means whatsoever, by any person without Moody's prior written consent.

      4 Standard & Poor's, a division of the McGraw-Hill Companies, Inc. (S&P), is a nationally recognized statistical rating organization. S&P's ratings are proprietary to S&P and are protected by copyright and other intellectual property laws. S&P's licenses ratings to NASD. Ratings may not be copied or otherwise reproduced, repackaged, further transmitted, transferred, disseminated, redistributed or resold, or stored for subsequent use for any such purpose, in whole or in part, in any form or manner or by any means whatsoever, by any person without S&P's prior written consent.


      Attachment A

      New text is underlined, and deleted text is bracketed.

      6200. TRADE REPORTING AND COMPLIANCE ENGINE (TRACE)

      6260. Managing Underwriter Obligation To Obtain CUSIP

      (a) In order to facilitate trade reporting and dissemination 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 by email or facsimile 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, by email or facsimile: (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)[,]; and, (7) information, as determined by NASD, that is required to determine if a TRACE-eligible security must be disseminated under Rule 6250 (e.g., size of issue and rating), or if any of items (2) through (7)[(6)] has not been determined, such other information as NASD deems necessary. The managing underwriter must obtain the CUSIP number and provide it and the information listed as (2) through (7)[(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 a managing underwriter, or the issuer and the managing 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 managing underwriter 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 managing underwriter shall provide the information not later than 5:00 p.m. on the next business day. The managing underwriter must make a good faith determination that the security is a TRACE-eligible security before submitting the information to the TRACE Operations Center.

  • 03-44 SEC Approves Amendments to Rules Governing Research Analysts' Conflicts of Interest

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    ACTION REQUIRED

    Research Analysts and Research Reports

    SUGGESTED ROUTING

    KEY TOPICS

    Executive Representative
    Legal & Compliance
    Senior Management
    Operations

    Research Reports
    Qualification and Registration
    Continuing Education Requirements
    Advertising
    Investment Banking

    Executive Summary

    On July 29, 2003, the Securities and Exchange Commission (SEC) approved new NASD Rule 1050 (Registration of Research Analysts) and amendments to Rule 1120 (Continuing Education Requirements) and Rule 2711 (Research Analysts and Research Reports).1 Generally, the new rule and amendments impose registration, qualification, and continuing education requirements on research analysts; further separate analyst compensation from investment banking influence; prohibit analysts from issuing "booster shot" research reports; prohibit analysts from soliciting investment banking business; and require members to publish a final research report when they terminate coverage of a subject company. The amendments also revise Rule 2711 to augment disclosure requirements and make other changes necessary to comply with the research analyst provisions of the Sarbanes-Oxley Act of 2002.

    The SEC also approved on the same day similar amendments to New York Stock Exchange Rules 344, 345A, 351 and 472. NASD generally will implement the new rule and amendments in phases during the period from July 29, 2003, to January 26, 2004. The implementation schedule is set forth below.

    This Notice includes as Attachment A the text of the new rule and amendments.

    Questions/Further Information

    Questions concerning this Notice may be directed to Nileema Pargaonker in NASD's Corporate Financing Department, Regulatory Policy and Oversight, at (240) 386-4623, or Philip Shaikun, Associate General Counsel, Regulatory Policy and Oversight, at (202) 728-8451.

    Implementation Schedule

    New Rule 1050 and the amendments to Rules 1120 and 2711 will take effect as follows:

    • Qualification, examination, registration, and continuing education requirements for research analysts (new Rule 1050 and amendments to Rule 1120): January 26, 2004, or such later date as determined by NASD.


    • New compensation and client disclosure provisions (Rule 2711(h)(2)): January 26, 2004, plus up to an additional 90 days as deemed appropriate by NASD on a case-by-case basis.


    • Rule 2711(h)(2)(C) - Exemption from Disclosure Requirements:


      • As applied to disclosures under Rules 2711(h)(2)(A)(ii)(b) and (c): July 29, 2003.


      • As applied to disclosures under Rule 2711(h)(2)(A)(iii)(b), (h)(2)(B)(i) and (iii): January 26, 2004.

    • Research analyst compensation review procedures (Rule 2711(d)(2)): October 27, 2003.


    • Prohibition of retaliation against research analysts (Rule 2711(j)): July 29, 2003.


    • Exceptions for small firms (Rule 2711(k)): July 29, 2003.


    • All other rule changes: September 29, 2003.


    1 SEC Release No. 34-48252 (July 29, 2003), 68 Fed. Reg. 45875 (Aug. 4, 2003).


    Attachment A

    This attachment provides the text of new Rule 1050 and the amendments to Rules 1120 and 2711. New text is underlined, and deleted text is bracketed. Paragraphs that have not been revised are designated as "No change."

    Rule 1050.   Registration of Research Analysts

    All persons associated with a member who are to function as research analysts shall be registered with NASD. Before their registrations can become effective, they shall pass a Qualification Examination for Research Analysts as specified by the Board of Governors. For the purposes of this Rule 1050, "research analyst" shall mean an associated person who is primarily responsible for the preparation of the substance of a research report or whose name appears on a research report.

    Rule 1120.   Continuing Education Requirements

    This Rule prescribes requirements regarding the continuing education of certain registered persons subsequent to their initial qualification and registration with the Association. The requirements shall consist of a Regulatory Element and a Firm Element as set forth below.

    (a) Regulatory Element
    (1) through (4) No change.
    (5) Definition of Registered Person

    For purposes of this Rule, the term "registered person" means any person registered with [the Association]NASD as a representative, principal, [or] assistant representative or research analyst pursuant to Rule 1020, 1030, 1040, 1050 and 1110 Series.
    (6) No change.
    (b) Firm Element
    (1) Persons Subject to the Firm Element

    The requirements of this subparagraph shall apply to any person registered with the member who has direct contact with customers in the conduct of the member's securities sales, trading and investment banking activities, any person registered as a research analyst pursuant to Rule 1050, and to the immediate supervisors of such persons, (collectively, "covered registered persons"). "Customer" shall mean any natural person and any organization, other than another broker or dealer, executing securities transactions with or through or receiving investment banking services from a member.
    (2) Standards for the Firm Element
    (A) No change.
    (B) Minimum Standards for Training Programs - Programs used to implement a member's training plan must be appropriate for the business of the member and, at a minimum must cover the following matters concerning securities products, services, and strategies offered by the member:
    (i) General investment features and associated risk factors;
    (ii) Suitability and sales practice considerations; [and]
    (iii) Applicable regulatory requirements[.]; and
    (iv) With respect to registered research analysts and their immediate supervisors, training in ethics, professional responsibility and the requirements of Rule 2711.
    (C) No change.
    (3) through (4) No change.

    Rule 2711.   Research Analysts and Research Reports

    (a) Definitions

    For purposes of this rule, the following terms shall be defined as provided.
    (1) through (3) No change.
    (4) "Public appearance" means any participation in a seminar, forum (including an interactive electronic forum), radio, [or] television or print media interview, or other public speaking activity, or the writing of a print media article, in which a research analyst makes a recommendation or offers an opinion concerning an equity security.
    (5) "Research analyst" means the associated person who is [principally] primarily responsible for, and any associated person who reports directly or indirectly to such a research analyst in connection with, preparation of the substance of a research report, whether or not any such person has the job title of "research analyst."
    (6) "Research analyst account" means any account in which a research analyst or member of the research analyst's household has a financial interest, or over which such analyst has discretion or control, other than an investment company registered under the Investment Company Act of 1940. This term does not include a "blind trust" account that is controlled by a person other than the research analyst or member of the research analyst's household where neither the research analyst nor a member of the research analyst's household knows of the account's investments or investment transactions.
    (7) No change.
    (8) "Research report" means a written or electronic communication [which]that includes an analysis of equity securities or individual companies or industries, and [which]that provides information reasonably sufficient upon which to base an investment decision [and includes a recommendation].
    (9) "Subject company" means the company whose equity securities are the subject of a research report or [recommendation in] a public appearance.
    (b) Restrictions on [Investment Banking Department]Relationships with Research Department
    (1) No research analyst may be subject to the supervision or control of any employee of the member's investment banking department, and no personnel engaged in investment banking activities may have any influence or control over the compensatory evaluation of a research analyst.
    (2) Except as provided in paragraph (b)(3), no employee of the investment banking department or any other employee of the member who is not directly responsible for investment research ("non-research personnel"), other than legal or compliance personnel, may review or approve a research report of the member before its publication.
    (3) [Investment banking]Non-research personnel may review a research report before its publication as necessary only to verify the factual accuracy of information in the research report or [to review the research report for]identify any potential conflict of interest, provided that:
    (A) any written communication between [investment banking]non-research personnel and research department personnel concerning [such]the content of a research report must be made either through [an] authorized legal or compliance [official]personnel of the member or in a transmission copied to such [an official]personnel; and
    (B) any oral communication between [investment banking]non-research personnel and research department personnel concerning [such]the content of a research report must be documented and made either through [an] authorized legal or compliance [official]personnel acting as intermediary or in a conversation conducted in the presence of such [an official]personnel.
    (c) Restrictions on [Review of a Research Report by]Communications with the Subject Company
    (1) No change.
    (2) A member may submit sections of such a research report to the subject company before its publication for review as necessary only to verify the factual accuracy of information in those sections, provided that:
    (A) No change.
    (B) a complete draft of the research report is provided to [the] legal or compliance [department]personnel before sections of the report are submitted to the subject company; and
    (C) if after submitting the sections of the research report to the subject company the research department intends to change the proposed rating or price target, it must first provide written justification to, and receive written authorization from, [the] legal or compliance [department]personnel for the change. The member must retain copies of any draft and the final version of such a research report for three years following its publication.
    (3) No change.
    (4) No research analyst may participate in efforts to solicit investment banking business. Accordingly, no research analyst may, among other things, participate in any "pitches" for investment banking business to prospective investment banking clients, or have other communications with companies for the purpose of soliciting investment banking business.
    (d) [Prohibition of Certain Forms of]Restrictions on Research Analyst Compensation
    (1) No member may pay any bonus, salary or other form of compensation to a research analyst that is based upon a specific investment banking services transaction.
    (2) The compensation of a research analyst who is primarily responsible for the preparation of the substance of a research report must be reviewed and approved at least annually by a committee that reports to the member's board of directors, or when the member has no board of directors, to a senior executive officer of the member. This committee may not have representation from the member's investment banking department. The committee must consider the following factors when reviewing such a research analyst's compensation, if applicable:
    (A) the research analyst's individual performance, including the analyst's productivity and the quality of the analyst's research;
    (B) the correlation between the research analyst's recommendations and the stock price performance; and
    (C) the overall ratings received from clients, sales force, and peers independent of the member's investment banking department, and other independent ratings services.

    The committee may not consider as a factor in reviewing and approving such a research analyst's compensation his or her contributions to the member's investment banking business. The committee must document the basis upon which each such research analyst's compensation was established. The annual attestation required by Rule 2711(i) must certify that the committee reviewed and approved each such research analyst's compensation and documented the basis upon which this compensation was established.
    (e) No change.
    (f) [Imposition of Quiet Periods]Restrictions on Publishing Research Reports and Public Appearances; Termination of Coverage
    (1) No member may publish or otherwise distribute a research report and no research analyst may make a public appearance regarding a subject company for which the member acted as manager or co-manager of:
    [(1)](A) an initial public offering, for 40 calendar days following the date of the offering; or
    [(2)](B) a secondary offering, for 10 calendar days following the date of the offering; provided that:
    [(A)](i) paragraphs (f)(1)(A) and (f)[(2)](1)(B) will not prevent a member from publishing or otherwise distributing a research report, or prevent a research analyst from making a public appearance, concerning the effects of significant news or a significant event on the subject company within such 40- and 10-day periods, and provided further that [the] legal [and]or compliance [department]personnel authorize[s] publication of that research report before it is issued or authorize the public appearance before it is made; and
    [(B)](ii) paragraph (f)[(2)](1)(B) will not prevent a member from publishing or otherwise distributing a research report pursuant to SEC Rule 139 regarding a subject company with "actively-traded securities," as defined in Regulation M, 17 CFR 242.101(c)(1), and will not prevent a research analyst from making a public appearance concerning such a company.
    (2) No member that has agreed to participate or is participating as an underwriter or dealer (other than as manager or co-manager) of an issuer's initial public offering may publish or otherwise distribute a research report or make a public appearance regarding that issuer for 25 calendar days after the date of the offering.
    (3) For purposes of paragraphs (f)(1) and (f)(2), the term "date of the offering" refers to the later of the effective date of the registration statement or the first date on which the security was bona fide offered to the public.
    (4) No member that has acted as a manager or co-manager of a securities offering may publish or otherwise distribute a research report or make a public appearance concerning a subject company 15 days prior to and after the expiration, waiver or termination of a lock-up agreement or any other agreement that the member has entered into with a subject company or its shareholders that restricts or prohibits the sale of securities held by the subject company or its shareholders after the completion of a securities offering. This paragraph will not prevent a member from publishing or otherwise distributing a research report concerning the effects of significant news or a significant event on the subject company within such period, provided legal or compliance personnel authorize publication of that research report before it is issued. In addition, this paragraph shall not apply to the publication or distribution of a research report pursuant to SEC Rule 139 regarding a subject company with "actively traded securities," as defined in Regulation M, 17 CFR 242.101(c)(1), or to a public appearance concerning such a subject company.
    (5) If a member intends to terminate its research coverage of a subject company, notice of this termination must be made. The member must make available a final research report on the subject company using the means of dissemination equivalent to those it ordinarily uses to provide the customer with its research reports on the subject company. The report must be comparable in scope and detail to prior research reports and must include a final recommendation or rating, unless it is impracticable for the member to produce a comparable report (e.g., if the research analyst covering the subject company or sector has left the member or if the member terminates coverage of the industry or sector). If it is impracticable to produce a final recommendation or rating, the final research report must disclose the member's rationale for the decision to terminate coverage.
    (g) Restrictions on Personal Trading by Research Analysts
    (1) No change.
    (2) No research analyst account may purchase or sell any security issued by a company that the research analyst follows, or any option on or derivative of such security, for a period beginning 30 calendar days before and ending five calendar days after the publication of a research report concerning the company or a change in a rating or price target of the company's securities; provided that:
    (A) No change.
    (B) a member may permit a research analyst account to purchase or sell any security issued by a subject company within 30 calendar days before the publication of a research report or change in the rating or price target of the subject company's securities due to significant news or a significant event concerning the subject company, provided that [the member's] legal or compliance [department]personnel pre-approve[s] the research report and any change in the rating or price target.
    (3) No change.
    (4) [A member's l]Legal or compliance [department]personnel may authorize a transaction otherwise prohibited by paragraphs (g)(2) and (g)(3) based upon an unanticipated significant change in the personal financial circumstances of the beneficial owner of the research analyst account, provided that:
    (A) [the] legal or compliance [department]personnel authorize[s] the transaction before it is entered;
    (B) each exception is granted in compliance with policies and procedures adopted by the member that are reasonably designed to ensure that these transactions do not create a conflict of interest between the professional responsibilities of the research analyst and the personal trading activities of a research analyst account; and
    (C) No change.
    (5) No change.
    (6) Legal or compliance personnel of the member shall pre-approve all transactions of persons who oversee research analysts to the extent such transactions involve equity securities of subject companies covered by the research analysts that they oversee. This pre-approval requirement shall apply to all persons, such as the director of research, supervisory analyst, or member of a committee, who have direct influence or control with respect to the preparation of the substance of research reports or establishing or changing a rating or price target of a subject company's equity securities.
    (h) Disclosure Requirements
    (1) No change.
    (2) Receipt of Compensation
    (A) A member must disclose in research reports [if]:
    (i) if the research analyst [principally responsible for the preparation of the report] received any compensation:
    a. [that is ]based upon (among other factors) the member's investment banking services revenues; [and ]or
    b. from the subject company in the past 12 months.
    (ii) if the member or any [its ]affiliate[s]:
    a. managed or co-managed a public offering of securities for the subject company in the past 12 months;
    b. received compensation for investment banking services from the subject company in the past 12 months; or
    c. expects to receive or intends to seek compensation for investment banking services from the subject company in the next 3 months.
    (iii) if (1) as of the end of the month immediately preceding the date of publication of the research report (or the end of the second most recent month if the publication date is less than 30 calendar days after the end of the most recent month) or (2) to the extent the research analyst or an employee of the member with the ability to influence the substance of the research knows:
    a. the member received any compensation for products or services other than investment banking services from the subject company in the past 12 months; or
    b. the subject company currently is, or during the 12-month period preceding the date of distribution of the research report was, a client of the member. In such cases, the member also must disclose the types of services provided to the subject company. For purposes of this Rule 2711(h)(2), the types of services provided to the subject company shall be described as investment banking services, non-investment banking securities-related services, and non-securities services.
    (iv) if, to the extent the research analyst or an employee of the member with the ability to influence the substance of the research report knows an affiliate of the member received any compensation for products or services other than investment banking services from the subject company in the past 12 months.
    (v) if, to the extent the research analyst or member has reason to know, an affiliate of the member received any compensation for products or services other than investment banking services from the subject company in the past 12 months.
    a. This requirement will be deemed satisfied if such compensation is disclosed in research reports within 30 days after completion of the last calendar quarter, provided that the member has taken steps reasonably designed to identify any such compensation during that calendar quarter. This requirement shall not apply to any subject company as to which the member initiated coverage since the beginning of the current calendar quarter.
    b. The research analyst and the member will be presumed not to have reason to know whether an affiliate received any compensation for products or services other than investment banking services from the subject company in the past 12 months if the member maintains and enforces policies and procedures reasonably designed to prevent the research analysts and employees of the member with the ability to influence the substance of research reports from, directly or indirectly, receiving information from the affiliate concerning whether the affiliate received such compensation.
    (vi) For the purposes of this Rule 2711(h)(2), an employee of the member with the ability to influence the substance of the research report is an employee who, in the ordinary course of that person's duties, has the authority to review the particular research report and to change that research report prior to publication.
    (B) A research analyst must disclose in public appearances:
    (i) if, to the extent the research analyst knows or has reason to know, the member or any affiliate received any compensation from the subject company in the past 12 months;
    (ii) if the research analyst received any compensation from the subject company in the past 12 months; or
    (iii) if, to the extent the research analyst knows or has reason to know, [that ]the subject company currently is, or during the 12-month period preceding the date of distribution of the research report, was, a client of the member [or its affiliates]. In such cases, the research analyst also must disclose the types of services provided to the subject company, if known by the research analyst.
    (C) A member or research analyst will not be required to make a disclosure required by paragraphs (h)(2)(A)(ii)(b) and (c), (h)(2)(A)(iii)(b), or (h)(2)(B)(i) and (iii) to the extent such disclosure would reveal material non-public information regarding specific potential future investment banking transactions of the subject company.
    (3) through (11) No change.
    (12) Records of Public Appearances

    Members must maintain records of public appearances by research analysts sufficient to demonstrate compliance by those research analysts with the applicable disclosure requirements under paragraph (h) of this Rule. Such records must be maintained for three years from the date of the public appearance.
    (i) Supervisory Procedures

    Each member subject to this rule must adopt and implement written supervisory procedures reasonably designed to ensure that the member and its employees comply with the provisions of this rule (including the attestation requirements of Rule 2711(d)(2)), and a senior officer of such a member must attest annually to [the Association]NASD by April 1 of each year that it has adopted and implemented those procedures.
    (j) Prohibition of Retaliation Against Research Analysts

    No member and no employee of a member who is involved with the member's investment banking activities may, directly or indirectly, retaliate against or threaten to retaliate against any research analyst employed by the member or its affiliates as a result of an adverse, negative, or otherwise unfavorable research report or public appearance written or made by the research analyst that may adversely affect the member's present or prospective investment banking relationship with the subject company of a research report. This prohibition shall not limit a member's authority to discipline or terminate a research analyst, in accordance with the member's policies and procedures, for any cause other than the writing of such an unfavorable research report or the making of such an unfavorable public appearance.
    (k) Exceptions for Small Firms

    The provisions of paragraph (b) shall not apply to members that over the previous three years, on average per year, have participated in 10 or fewer investment banking services transactions as manager or co-manager and generated $5 million or less in gross investment banking services revenues from those transactions. For purposes of this paragraph (k), the term "investment banking services transactions" includes the underwriting of both corporate debt and equity securities but not municipal securities. Members that qualify for this exemption must maintain records for three years of any communication that, but for this exemption, would be subject to paragraph (b) of this Rule.

  • 03-43 SEC Approves Increase to the Trading Activity Fee

    View PDF File
    View Trading Activity Fee Self-Reporting Form

    INFORMATIONAL

    SUGGESTED ROUTING

    KEY TOPICS

    Senior Management
    Legal and Compliance
    Operations Managers

    NASD By-Laws
    Trading Activity Fee

    Executive Summary

    On July 28, 2003, the Securities and Exchange Commission (SEC or Commission) approved an NASD rule filing amending the Trading Activity Fee (TAF) to establish a new rate for covered equity securities.1 NASD had been collecting the TAF and determined that the equity rate needed to be increased to ensure adequate funding levels for its member regulatory program. The new TAF rates for covered equity securities will go into effect on September 1, 2003. A revised Trading Activity Fee Self-Reporting Form is available on the NASD Web Site at www.nasdr.com/pdf-text/0275ntm_a.pdf.

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

    Discussion

    On May 30, 2003, the Commission approved the last component of a series of changes to NASD's member regulatory fee structure. Under the new fee structure, there are now three types of fees and assessments used to fund NASD's member regulatory activities: (1) the TAF;2 (2) Personnel Assessment; and (3) Gross Income Assessment.3 These fees, assessed upon and paid by member firms, are used by NASD to fund NASD's member regulatory activities, including the regulation of members through examinations, processing of membership applications, financial monitoring, policy, rulemaking, interpretive, and enforcement activities. The new ember regulatory fee structure was designed to be revenue neutral to NASD and to better align NASD's regulatory fees with its functions, efforts, and costs.

    On June 11, 2003, NASD filed with the Commission a proposed rule change to adjust the TAF rate, and related maximum charge and minimum price exceptions, for equity securities. The proposed rule change was published for notice and comment in the Federal Register on June 25, 20034 and was subsequently approved by the Commission on July 28, 2003.5

    NASD had been collecting the TAF for transactions effected after October 1, 2002 on a pilot basis, and determined that the equity rate needed to be increased to ensure adequate funding levels for its member regulatory program. The TAF will be increased from $0.00005 per share to $0.0001 per share for covered equity securities. The maximum charge for equity securities also was changed from $5.00 per trade to $10.00 per trade. Last, the exclusion for transactions in covered equity securities if the execution price is less than the TAF rate was modified from $0.00005 to $0.0001. The new TAF rates for covered equity securities will go into effect on September 1, 2003. Members should make the necessary changes to their internal systems to ensure compliance with the new TAF rates for covered equity securities by September 1, 2003. Additionally, a revised Trading Activity Fee Self-Reporting Form is available on the NASD Web Site at www.nasdr.com/pdf-text/0275ntm_a.pdf.

    The proposed rate change is driven by lower than expected TAF revenues, not increased or unexpected member regulatory costs. NASD originally had proposed a rate of $0.0001 per share for equity securities (announced on September 27, 2002 and published on NASD's Web Site), but after informal feedback from the membership about the level of volume meeting the definition of "covered equity security," NASD decided to reduce the rate to $0.00005. Six months experience with the TAF has demonstrated that the initially proposed rate is more accurate to ensure revenue neutrality and adequate funding.

    NASD periodically will analyze rates, volumes, and regulatory responsibilities to ensure adequate funding levels for its member regulatory programs.6 NASD also will perform an analysis for the annual Personnel Assessment and Gross Income Assessment, to ensure adequate contributions from each component fee, as well as adequate levels of funding overall. In addition, NASD previously stated its intent to reduce the percentage that the TAF contributes to the overall funding structure in 2004 and again in 2005 (increasing the percentage funded by the PA and holding the GIA percentage static). NASD remains committed to that program, and should regulatory costs and market volumes remain constant, fee levels for the TAF for 2004 could be expected to drop by approximately 20%. Of course, NASD will analyze all relevant factors prior to making any determination to modify the TAF.


    1 Securities Exchange Act Rel. No. 48234 (July 28, 2003) (File No. SR-NASD-2003-93).

    2 Securities Exchange Act Rel. No. 47946 (May 30, 2003), 68 FR 34021 (June 6, 2003) (File No. SR-NASD-2002-148).

    3 Securities Exchange Act Rel. No. 47106 (Dec. 30, 2002), 68 FR 819 (January 7, 2003) (File No. SR-NASD-2002-99).

    4 Securities Exchange Act Rel. No. 48061 (June 19, 2003), 68 FR 37877 (June 25, 2003) (File No. SR-NASD-2003-93).

    5 Securities Exchange Act Rel. No. 48234 (July 28, 2003) (File No. SR-NASD-2003-93).

    6 Specifically, NASD stated in the text of the TAF rule language that it will "periodically review these revenues in conjunction with these costs to determine the applicable rate." NASD By-Laws, Schedule A, Section 1(a).

  • 03-42 SEC Approves Proposed Changes to Forms U4 and U5; Implementation Date: July 14, 2003

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    INFORMATIONAL

    Revised Forms U4 and U5

    SUGGESTED ROUTING

    KEY TOPICS

    Legal & Compliance
    Operations
    Registered Representatives
    Registration
    Senior Management
    Training

    Central Registration Depository
    Form U4
    Form U5
    Statutory Disqualification

    Executive Summary

    The Securities and Exchange Commission (SEC) has approved changes to the Form U4 (Uniform Application for Securities Industry Registration or Transfer) and Form U5 (Uniform Termination Notice for Securities Industry Registration). The changes: (1) add new disclosure questions to the "Regulatory Disciplinary Actions" subsection of Section 14 (Disclosure Questions) of the Form U4 and a new corresponding Disclosure Reporting Page (DRP), to elicit information regarding events that might cause a person to be subject to a statutory disqualification as a result of new disqualifying events created by the Sarbanes-Oxley Act of 2002; (2) add new disclosure question Question 7F and corresponding DRP on the Form U5 to mirror Question 14J on the Form U4 relating to terminations for cause; (3) streamline the language associated with Form U4 questions relating to fingerprinting requirements; and (4) make other non-substantive technical, clarifying, and conforming revisions.

    The revised forms will be implemented on July 14, 2003. Copies of the new forms are available on the NASD Web Site at www.nasd.com.

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

    Background And Discussion

    The SEC has approved changes to the Forms that: (1) add new disclosure Question14D(2) to the "Regulatory Disciplinary Actions" subsection of Section 14 (Disclosure Questions) of the Form U4 and a new Disclosure Reporting Page (DRP), to elicit information regarding events that might cause a person to be subject to a statutory disqualification as a result of new disqualifying events created by the passage of the Sarbanes-Oxley Act of 2002;1 (2) add new disclosure question Question 7F and corresponding DRP on the Form U5 to mirror Question 14J on the Form U4 relating to terminations for cause; (3) streamline the language associated with Form U4 questions relating to fingerprinting requirements; and (4) make other non-substantive technical, clarifying, and conforming revisions generally designed to make the Forms clearer and easier to use.

    This Notice highlights the changes made in the Forms. Additional background and explanatory information may be found in SEC Release No. 34-48161 (July 10, 2003), the SEC release approving Forms U4 and U5 revisions.2

    New Questions 14D(2) (a) and (b) on Form U4

    The Form U4 historically has been the vehicle for reporting events that may cause a person to become subject to statutory disqualification. Accordingly, with the concurrence of a working group of regulators, including state regulators, representatives of other self-regulatory organizations (SROs), and SEC observers, NASD proposed and the SEC approved an amendment to Section 14 of the Form U4 to add Question 14D(2). New Question 14D(2) will elicit reporting of regulatory actions that may cause an individual to be subject to a statutory disqualification under the expanded definition of disqualification in Section 15(b)(4)(H) of the Exchange Act, created by the passage of the Sarbanes-Oxley Act. Question 14D(2) requires firms to report certain orders issued by a State securities commission (or any agency or officer performing like functions), State authority that supervises or examines banks, savings associations, or credit unions, State insurance commission (or any agency or office performing like functions), an appropriate Federal banking agency (as defined in section 3 of the Federal Deposit Insurance Act), or the National Credit Union Administration (NCUA) that: bars persons from association with an entity regulated by such commission, authority, agency, or officer, or from engaging in the business of securities, insurance banking, savings association activities, or credit union activities; or constitutes a final order based on violations of any laws or regulations that prohibit fraudulent, manipulative or deceptive conduct. Former Regulatory Action Disclosure Question 14D has been renumbered as Question 14D(1). To aid members and associated persons in reporting events required to be reported under Question 14D(2), NASD has also amended the Regulatory Action DRP and added two defined terms, "final order" and "federal banking agency," to the "Explanation of Terms" section.

    Generally, a change to a disclosure question or the addition of a new disclosure question on Form U4 requires the prompt filing of an amended Form U4 only if a registered person is subject to an action or event that requires an affirmative response to the changed or new question or additional disclosure on detailed DRPs relating to the new or changed question. Firms making such amendments to Section 14 (Disclosure Questions) or any DRP also generally are required to complete Section 15D of the Form U4 (the Individual/Applicant's Amendment Acknowledgment and Consent). If a registered person has not been the subject of an action or event that is elicited by a changed or new disclosure question, he or she need not answer the changed or new disclosure question until an amended Form U4 filing is otherwise required (e.g., with the filing of a change of address, a request for a new registration category or license, or any new or amended responses to the questions in Section 14 or related DRPs).

    Therefore, with respect to the new Question 14D(2), firms must immediately determine whether their registered persons have been subject to an action that requires reporting under the new question. If a member firm determines that any one of its registered persons has been the subject of a regulatory action that would require a "yes" answer to Question 14D(2), it must amend that person's Form U4 to provide a "yes" answer to the appropriate subsection of Question 14D(2) not later than 30 days from implementation of the new question or August 13, 2003. Firms must also obtain a completed Form U4 Section 15D (the Individual/Applicant's Amendment Acknowledgement and Consent) in such cases. These amendment filings must include completed DRP(s) covering the proceedings or action reported. Firms are required to maintain a copy, with original signatures, of these amendment filings.3 Firms will not be required to amend a registered person's Form U4 within 30 days, i.e., by August 13, 2003, if the firm has determined that the registered person is not required to answer "yes" to any part of Question 14D(2).

    In sum, even though current Question 14D elicits much of the information elicited by new Question 14D(2), firms must submit any "yes" answers to Question 14D(2) by August 13, 2003, notwithstanding that previous answers to Question 14D may appear to provide the same information. In such cases, firms must also review and, as necessary, amend the previously submitted "Regulatory Action" DRP to mark the appropriate checkboxes for Question 14D(2) and make sure the details for the affirmative response to new Question 14D(2) are reported.

    Firms must submit amended Forms U4 by August 13, 2003, if "yes" answers are required for any part of new Question 14D(2), and must also obtain a completed Form U4 Section 15D (the Individual/Applicant's Amendment Acknowledgment and Consent) in such cases. These amendment filings must include completed DRP(s) covering the proceedings or action reported, and firms are required to maintain a copy, with original signatures, of these amendment filings. Any registered person for whom a firm has not filed an amended Form U4 reporting "yes" answers to Question 14D(2) by August 13, 2003, will be deemed to have represented that he or she has not been the subject of any such proceedings as of that date.4

    The CRD system will process amendments to Form U4 filings on or after July 14, 2003, as follows. As of July 14, 2003, for all registered persons who have no "yes" answers to Questions 14A through M in the Disclosure Section of the Form U4, the CRD system will default new disclosure Question 14D(2) with a "no" response for any filings prepared for submission after implementation of the new questions, and the firm will not be required to obtain an executed Section 15D for purposes of answering Question 14D(2). Form U4 amendments filed by the firm for such individuals will not fail the completeness check because of these new questions; however, by submitting the filing, a firm will be representing that it is filing "no" answers to the new questions, unless it affirmatively changes the system-defaulted "no" answer to "yes" before submitting the filing. Similarly, as discussed above, a registered person who has not filed an amended Form U4 reporting "yes" answers to Question 14D(2) within the specified 30-day period will be deemed to have represented that he or she has not been the subject of any such proceedings.

    If a registered person has answered "yes" to any question in Questions 14A through M in the Disclosure Section of the Form U4 as of July 14, 2003, the CRD system will require that a firm filing an amended Form U4 enter a response (by selecting the appropriate "yes" or "no" radio button) to new Disclosure Question 14D(2) and also obtain an executed Section 15D. If those questions are not answered at that time, the filing will fail the CRD system completeness check. In any event, firms should promptly amend Forms U4 at such time as any of their registered persons become subject to a disqualification under Section 3(a)(39) of the Exchange Act (which incorporates Section 15(b)(4)(H) by reference).5

    New Question 7F on Form U5

    The revised Form U5 includes a new Question 7F and corresponding DRP that mirrors Question 14J on the Form U4. Both questions concern terminations for cause. New Question 7F will enable firms to report that an individual was terminated after allegations of certain violations, fraud, wrongful taking of property, or failure to supervise.

    Affirmative answers to that question will further clarify an individual's obligation to report the termination in response to Question 14J on a subsequent Form U4. In addition, the term "resign or resigned" has been added on the Form U5 "Explanation of Terms" section to parallel the term on the Form U4.

    Modifications to the Form U4 Relating to Fingerprinting Requirements

    The revised Form U4 streamlines the language in Section 2 (Fingerprint Information) and Section 6 (Registration Requests with Affiliated Firms) to clarify fingerprint requirements applicable to associated persons of broker/dealers and investment adviser representatives.

    Section 2 has been modified to address two situations that were not specifically covered in the March 2002 version of the Form U4. The first involves a firm submitting fingerprint results on behalf of an individual whose fingerprints were processed through another SRO, in lieu of submitting fingerprint cards. The second occurs when the firm is seeking registration for an individual who is currently employed by the firm (usually in an unregistered capacity) and previously has been fingerprinted (either through NASD or another SRO). The new language allows firms and individuals to represent that the filing firm (1) has continuously employed the individual since the last submission of a fingerprint card to NASD (and therefore is not required to resubmit a card with this filing) or (2) has continuously employed the individual since the individual had his or her fingerprints processed through another SRO, and the individual will submit (or has submitted) the processed results to the CRD system.

    The "Exceptions to the Fingerprint Requirement" subsection under Section 2 has also been modified to allow firms to select the specific permissive fingerprint exemption under Exchange Act Rule 17f-2(a)(1)(i) and/or (a)(1)(iii). The previous Form U4 language contained a general exception to the fingerprint requirement in which firms represented that an individual had been continuously employed by the filing firm in an unregistered capacity (and had previously submitted a fingerprint card in connection with that employment) or met one or more exemptions under Rule 17f-2.6

    Additionally, Section 2 has been modified to clarify fingerprint filing requirements for investment adviser representativeonly applicants who use the Form U4 to register with states in an investment adviser representative capacity (shown as "RA" on the Form U4). In particular, language has been added to clarify the circumstances under which an individual may need to file a fingerprint card when submitting an application for state licensure as an investment adviser representative, notwithstanding having previously submitted a fingerprint card with an unaffiliated broker/dealer. The amended language also allows an investment adviser representative to represent on the Form U4 that he or she previously satisfied a state fingerprint requirement.7

    A fingerprint question also has been added to Section 6 (Registration Requests with Affiliated Firms) to create appropriate options (relating to fingerprint obligations) for individuals requesting new registrations with a firm affiliated with the filing firm.8

    Technical/Conforming Changes

    The 2003 revisions include technical and other changes to increase the consistency between the Forms U4 and U5 and better clarify the disclosure information that is required to be reported on the Forms, including the following:

    • Hyphens have been removed from "U-4" and "U-5" (Forms will now be referenced as "U4" and "U5.")


    • Summary fields on the DRPs (where individuals may elect to add comments on a reported event) have been reworded to emphasize that those fields are optional.


    • The Customer Complaint DRPs on both Forms have been modified to clearly distinguish the fields that are required for reporting a customer complaint, arbitration claim, and/or litigation. The additional instructions and rearrangement of the questions into a more logical order clarify the information that is required to be reported on the Customer Complaint DRP; however, the content of the DRP has not changed.


    • Question 14F has been revised to clarify the intent of the reporting obligation. Question 14F now asks whether an applicant has ever had an authorization to act as an attorney, accountant or federal contractor that was revoked or suspended.


    • The hair and eye color codes have been modified to match the codes used by the Federal Bureau of Investigation's fingerprint system.


    • Additional bolding and underlining has been introduced to emphasize certain instructions and facilitate reporting of certain information on the DRPs.

    Uniform Forms Reference Guide

    NASD created the Uniform Form Reference Guide in March 2002 to provide member firms and other users of the Forms with resource and contact information. In conjunction with the 2003 revised Forms, NASD has updated and amended the Uniform Form Reference Guide, which is available on www.nasd.com.


    1 Section 604 of the Sarbanes-Oxley Act expanded the definition of "statutory disqualification" by amending Sections 3(a)(39) and 15(b)(4) of the Securities Exchange Act of 1934 (Exchange Act).

    2 For additional background, see SEC Release No. 34-47936, File No. SR-NASD-2003-57, 68 FR 33545 (June 4, 2003) (proposing release).

    3 NASD appreciates that this requirement places an administrative burden on member firms. However, the burden should be mitigated by the following facts. First, as a practical matter, current Question 14D elicits virtually all information required by the Sarbanes-Oxley Act changes, with the exception of NCUA and state credit union regulatory proceedings or actions. Consequently, registered persons already should have reported most information responsive to the Sarbanes-Oxley Act changes, with the exception of those proceedings or actions. Based on preliminary discussions with the NCUA and state regulators, NASD believes that the number of Form U4 amendments firms will be obligated to file to report affirmative answers to new Question 14D(2) by August 13, 2003, should be quite small.

    4 A registered person who fails timely to notify his or her member firm of a reportable credit union regulatory proceeding will be deemed to have made a false or incomplete filing in these circumstances, irrespective of whether his or her firm has made a specific inquiry of its registered persons about such proceedings. NASD wishes to emphasize that reporting such proceedings is an affirmative obligation of the registered person, which is not excused by a firm's failure specifically to inquire as to the existence of such proceedings.

    5 In SEC Release No. 34-48161A, the reference to "Questions 14A through J" was corrected to read "Questions 14A through M" in these two paragraphs.

    6 Rule 17f-2 governs the fingerprinting requirements of securities personnel. Rule 17f-2(a)(1)(i) permits an exemption for persons who are not engaged in the sale of securities; do not regularly have access to the keeping, handling, or processing of securities, monies, or books and records; and do not have supervisory responsibility over persons engaged in such activities. Rule 17f-2(a)(1)(iii) generally exempts the partners, directors, officers, and employees of a broker/dealer that is engaged exclusively in the sales of certain securities, such as variable contracts, limited partnership interests, and unit investment trusts.

    7 This addition should be particularly helpful to investment adviser representatives who became licensed in a jurisdiction through the submission of a hard copy Form U4 before that jurisdiction accepted electronic filings via the Investment Adviser Registration Depository and who are now being "transitioned" onto an electronic system via an electronically filed Form U4 amendment.

    8 "Affiliated firm" has been added to the "Explanation of Terms" to clarify the use and meaning of that term on the Form U4.

  • 03-41 NASD Has Amended Section 4(b) of Schedule A to the NASD By-Laws to Increase and Establish New Fingerprint Processing Fees

    View PDF File

    INFORMATIONAL

    Fingerprint Processing Fees

    Implementation Date: July 15, 2003

    SUGGESTED ROUTING

    KEY TOPICS

    Legal & Compliance
    Registered Representatives
    Senior Management

    Fingerprint Processing Fees
    NASD By-Laws

    Executive Summary

    This Notice supersedes NASD Notice to Members 03-39. NASD is issuing this Notice to notify members that NASD has increased the fee charged for processing each set of fingerprints submitted by a member to NASD from $10.00 to $13.00; and (2) established a $13.00 fee to be charged by NASD to members that submit to NASD for posting to Web CRD fingerprint results and identifying information that have been processed through another selfregulatory organization (SRO).

    NASD has also made a technical change to Section (4)(b)(4) of Section A to the NASD By-Laws to substitute the term "set of fingerprints" for "fingerprint cards."

    The rule change was filed with the Securities and Exchange Commission (SEC) on July 9, 2003.1 Pursuant to Section 19(b)(3)(A) of the Securities Exchange Act of 1934 (Exchange Act) and SEC Rule 19b-4(f)(2) thereunder, the rule change became immediately effective upon filing. NASD will implement the rule change on July 15, 2003.

    Included with this Notice is Attachment A, the text of amended Section 4(b)(4) of Schedule A to the NASD By-Laws.

    Questions/Further Information

    Questions concerning this Notice may be directed to NASD's Gateway Call Center at (301) 590-6500.

    Fingerprint Processing Fees

    First, to help cover NASD costs associated with its fingerprinting program, NASD has increased the portion of the fee it charges to process each set of fingerprints submitted by a member to NASD from $10.00 to $13.00. Together with the $22.00 fee currently charged by the FBI for fingerprint processing, the $3.00 increase will raise the total fingerprint-processing fee from $32.00 to $35.00.

    Second, NASD will begin assessing members a $13.00 fee to cover NASD's cost of accepting and posting to Web CRD fingerprint results that were processed through another SRO consistent with the requirements of Section 17(f)(2) of the Exchange Act and Rule 17f-2 thereunder. According to those provisions of the Exchange Act, other SROs may process fingerprint cards for persons required to have their fingerprints processed through the FBI, consistent with fingerprint plans submitted by those SROs to the Commission, and NASD currently accepts those FBI results and posts them to Web CRD.

    NASD will implement the two fee-related changes on July 15, 2003.


    1 SR-NASD-2003-109


    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 NASD shall be determined on the following basis.

    Sections 1 through 3 No change.

    Section 4 - Fees

    (a) No change.
    (b) NASD shall assess each member a fee of:
    (1) through (3) No change.
    (4) [$10.00] $13.00 for processing and posting to the CRD system each set of fingerprints [fingerprint card] submitted by the member to NASD, plus any other charge that may be imposed by the United States Department of Justice for processing [such] each set of fingerprints [card].
    (5) $13.00 for processing and posting to the CRD system each set of fingerprint results and identifying information that have been processed through another self-regulatory organization and submitted by a member to NASD.
    [(5)] (6) $30.00 annually for each of the member's registered representatives and principals for system processing.
    [(6)] (7) 10% of a member's final annual renewal assessment or $100, whichever is greater, with a maximum charge of $5,000, if the member fails timely to pay the amount indicated on its preliminary renewal statement.
    (c) through (l) No change.

  • 03-40 The Regulatory Element Continuing Education Supervisors Program (S201) to be available July 14, 2003, at Pearson VUE centers in London and Paris; the S201 is available now for members that provide In-Firm Delivery of the Regulatory Element.

    View PDF File

    INFORMATIONAL

    Continuing Education

    SUGGESTED ROUTING

    KEY TOPICS

    Continuing Education
    Legal & Compliance
    Registration
    Senior Management

    Foreign Deferrals
    In-Firm Delivery
    Regulatory Element

    Executive Summary

    Effective July 14, 2003, the Regulatory Element Continuing Education Supervisors Program (S201) will be available at Pearson VUE centers in London and Paris. As a result, all registered principals and supervisors living in Belgium, France, Luxembourg, The Netherlands, and the UK who become required to take the S201, will no longer be eligible for a foreign deferral of the Regulatory Element. Individuals in these countries who currently have a foreign deferral will be required to meet their Regulatory Element requirement when their next anniversary window opens. Principals and supervisors living in Europe outside the above countries or in other countries outside North America remain eligible for a foreign deferral1 until the S201 is available.

    Effective immediately, all the Regulatory Element programs (the S101 General Program, the S106 Investment Representative Program, and the S201 Supervisors Program) are available to member firms that provide In-Firm Delivery of the Regulatory Element on firm premises.2 Previously, only the S101 and S106 were available.

    Questions/Further Information

    Questions about this Notice may be directed to Heather Bevans, Continuing Education, NASD, at (240) 386-4685.


    1 Foreign deferral requests must be in writing, signed by a principal of the firm, and mailed or faxed to: NASD, Continuing Education Department, 9509 Key West Avenue, Rockville, MD 20850; fax: 240-386-4675. Requests must contain the individual's name, CRD number, and the city and country of residence. Firms must proactively request a foreign deferral for each anniversary date that subjects a registered person to a Regulatory Element requirement. NASD does not automatically renew foreign deferrals.

    2 See NASD Notice To Members 01-14, February 2001, and NASD Notice To Members 02-77, November 2002.

  • 03-39 NASD Announces Implementation of the First Phase of Electronic Fingerprint Processing in July 2003 and Amends Section 4 of Schedule A to the NASD By-Law to Increase and Establish New Fingerprint Processing Fees (This Notice was withdrawn on 07/09/03)

  • 03-38 SEC Approves Amendments to NASD Rules Governing Member Communications with the Public

    View PDF File

    INFORMATIONAL

    Advertising Modernization

    SUGGESTED ROUTING

    KEY TOPICS

    Advertising
    Internal Audit
    Investment Companies
    Legal & Compliance
    Registered Representatives
    Senior Management
    Variable Contracts

    Advertising
    Communications with the Public
    NASD Rule 2210

    Executive Summary

    On May 9, 2003, the Securities and Exchange Commission ("SEC" or "Commission") approved amendments to NASD Rule 2210 (Communications with the Public) and the Interpretive Materials that follow Rule 2210, the creation of new Rule 2211 (Institutional Sales Material and Correspondence), and the renumbering of current Rule 2211 (Telemarketing) as Rule 2212 (collectively, the "Amendments").1 The Amendments modernize, simplify, and clarify the rules governing member communications with the public. The Amendments become effective on November 3, 2003. The amended Rule 2210 and accompanying Interpretive Materials are set forth in Attachment A.

    Questions/Further Information

    Questions concerning this Notice should be directed to the Advertising Regulation Department, Regulatory Policy and Oversight, at (240) 386-4500.

    Background

    The Amendments modernize and clarify the rules governing member communications with the public. Among the most notable changes, the Amendments exclude all communications to institutional investors from member pre-use approval and NASD filing requirements and from many of the content standards. Form letters and group e-mail to existing retail customers and fewer than 25 prospective retail customers also are eligible for these exclusions, provided that a member has appropriate policies and procedures to supervise and review such communications. Additionally, the Amendments exclude "independently prepared reprints" from the filing requirements and many of the content standards, and exclude certain press releases from the filing requirements. The Amendments also simplify the content standards applicable to those covered member communications.

    Reorganization of Rule 2210

    The Amendments rewrite many of the current regulatory standards contained in Rule 2210, and relocate certain of its provisions to other areas of the rule. In this regard, the Amendments substantially shorten and simplify the standards applicable to communications with the public, which are currently contained in Rule 2210(d). The Amendments relocate certain of these standards to new Interpretive Material 2210-1, Guidelines to Ensure that Communications Are Not Misleading.2 IM-2210-1 makes clear that members have the primary responsibility to ensure that their communications with the public are not misleading, and rewrites many standards in plain English.

    New IM-2210-1 eliminates certain of the specific standards currently in Rule 2210, including those regarding non-existent or self-conferred degrees or designations, offers of free service, claims for research facilities, hedge clauses, recruiting advertising, and periodic investment plans. To the extent that these provisions prohibited statements that are misleading, unbalanced, or inaccurate regarding particular types of communications, they duplicate Rule 2210's more general prohibition on use of such statements.

    The Amendments also create new Rule 2211—a separate rule for institutional sales material and correspondence that should facilitate a reader's ability to determine how the advertising rules apply to those communications. In order to further simplify this process, the Amendments provide cross-references between Rule 2210 and Rule 2211 in appropriate places. Existing Rule 2211, concerning telemarketing, is renumbered as Rule 2212.

    Definition of "Communications with the Public"

    The Amendments broaden the definition of "communications with the public" to include not only advertisements, sales literature, and correspondence, but also public appearances, institutional sales material, and independently prepared reprints.

    Public Appearances

    The inclusion of public appearances within the definition of communications with the public does not change current NASD policy. In this regard, existing Rule 2210(d)(1)(C) provides that members who engage in public appearances or speaking activities must follow the content standards of Rule 2210(d) and (f). Consequently, public appearances already are subject to strict content requirements. New Rule 2210(a)(5) clarifies the application of Rule 2210 to such appearances by defining "public appearance" as a type of communication with the public.

    Public appearances include participation in a seminar, forum (including an interactive electronic forum), radio or television interview, or other public appearance or public speaking activity. By defining "public appearance" to include an interactive electronic forum, the Amendments also codify the NASD staff's position that Internet chat rooms constitute public appearances rather than advertisements or sales literature for purposes of Rule 2210. The Amendments also provide members with more flexibility by subjecting public appearances only to some, but not all, of the content standards of Rule 2210.

    Institutional Sales Material

    Rule 2210 currently does not distinguish between retail and institutional sales material. Moreover, the rule currently defines "sales literature" to include any "form letter," which NASD has interpreted to mean written communications, including e-mail messages sent to at least two persons. Consequently, any communication sent to two or more institutional investors currently is deemed "sales literature," must comply with the content standards of Rule 2210, be pre-approved by a registered principal, and may have to be filed with the Advertising Regulation Department of NASD (the "Department") if it concerns certain types of products, such as registered investment companies.

    The Amendments eliminate the pre-use approval and filing requirements applicable to communications that are distributed or made available only to institutional investors. Instead, institutional sales material will be subject to new supervision and review requirements that are modeled on those in Rule 3010, which currently apply to correspondence. Moreover, institutional sales material will continue to be subject to the record-keeping requirements and some, but not all, of the content standards in Rule 2210.3

    The institutional sales material definition contains an important caveat: no member may treat a communication as having been distributed to an institutional investor if the member has reason to believe that the communication or any excerpt thereof will be forwarded or made available to any person other than an institutional investor. For example, if a member has reason to believe that such a communication would be forwarded or made available to 401(k) plan participants or other beneficiaries of institutional accounts, it will be treated as retail sales material. Plan participants and other beneficiaries of institutional accounts are entitled to the same protections under the advertising rules as other retail investors. Similarly, an advertisement in a publication designed for broker/dealers or other institutional investors may not be treated as institutional sales material if the member has reason to believe that the publication will be made available to any person other than an institutional investor.

    New Rule 2211(a)(3) defines "institutional investor" as any:

    • person described in Rule 3110(c)(4), regardless of whether that person has an account with an NASD member;4


    • governmental entity or subdivision thereof;


    • employee benefit plan that meets the requirements of Section 403(b) or Section 457 of the Internal Revenue Code and has at least 100 participants, but does not include any participants of such a plan;


    • qualified plan, as defined in Section 3(a)(12)(C) of the Securities Exchange Act of 1934, that has at least 100 participants, but does not include any participant of such a plan;


    • NASD member or registered associated person of such a member;5 and


    • person acting solely on behalf of any such institutional investor.

    Form Letters and Group Electronic Mail

    The definition of "correspondence" has been amended to include form letters and group e-mails sent to existing retail customers and to fewer than 25 prospective retail customers within any 30 calendar-day period ("Group Correspondence"), as well as written and electronic communications prepared for delivery to a single retail customer. Rule 2211(a)(4) defines "existing retail customer" as any person, other than an institutional investor, for whom the member or a clearing broker or dealer on behalf of the member carries an account, or who has an account with any registered investment company for which a member serves as principal underwriter. Thus, a person who has opened an account with an investment company or with a transfer agent for such an investment company could qualify as an existing retail customer of the investment company's principal underwriter.

    Pursuant to new Rule 2211(b)(1)(A), principal approval is not required of Group Correspondence; however, such correspondence will be subject to the strict supervisory procedures in Rule 3010(d), which governs the approval and review of correspondence, and to those content standards that apply to correspondence. Form letters and group e-mails sent to 25 or more prospective retail customers within any 30 calendarday period will continue to be subject to the pre-use approval, filing, and recordkeeping requirements of Rule 2210, and to all of the content standards applicable to sales literature.6

    NASD believes that Rule 3010(d) provides the most effective means of supervising form letters and group e-mails sent to existing and a limited number of prospective retail customers. Rule 3010(d) requires members to adopt written procedures for the review of correspondence by registered principals. Any member that does not pre-approve all correspondence must educate and train associated persons as to NASD rules governing communications with the public and the firm's procedures, document this training, and monitor adherence to these procedures. Members must retain all correspondence of registered representatives related to the member's investment banking or securities business.

    Notice to Members 98-11 provides guidance to members concerning Rule 3010(d). The Notice makes clear that, at a minimum, a member must develop procedures for the review of some of each registered representative's correspondence with the public relating to the member's investment banking or securities business, tailored to its structure and the nature and size of its business and customers.

    The Notice provides that members must:

    • specify in writing the firm's policies and procedures for reviewing different types of correspondence;


    • identify what types of correspondence will be pre- or post-reviewed by a registered principal; and


    • periodically re-evaluate the effectiveness of the firm's procedures for reviewing public correspondence and consider any necessary revisions.

    These procedures must be reasonably designed to ensure that a member's correspondence complies with the content standards of the applicable advertising rules.

    Members will be expected to review their procedures to ensure that they adequately address potential concerns with the distribution of Group Correspondence. More specifically, members should consider whether to adopt stricter procedures that require registered principal pre-use approval and filing with NASD of Group Correspondence that presents a higher risk to investors. This determination should be based upon such factors as the content, purpose, and targeted audience of the Group Correspondence.

    Thus, for example, members may wish to consider adopting procedures requiring pre-use principal review and filing as appropriate with NASD of Group Correspondence that promotes a new investment product or strategy that is sent to existing retail customers. In addition, members should strongly consider requiring pre-use principal review of Group Correspondence sent by a registered representative that has been disciplined in the past for advertising or sales practice violations.

    Independently Prepared Reprints

    The Amendments define a new type of communication with the public, an "independently prepared reprint," and exclude them from the filing requirements and most of the content standards. Under Rule 2210(a)(6)(A), an independently prepared reprint consists of any article reprint that meets certain standards that are designed to ensure that the reprint was issued by an independent publisher and was not materially altered by the member. A member may alter the contents of an independently prepared reprint in a manner necessary to make it consistent with applicable regulatory standards or to correct factual errors.

    An article reprint qualifies as an "independently prepared reprint" under Rule 2210(a)(6)(A) only if, among other things, its publisher is not an affiliate of the member using the reprint or any underwriter or issuer of the security mentioned in the reprint. For purposes of this provision, "affiliate" has the same meaning as that term is defined in NASD Rule 2720(b)(1)(A) and (B). The term "affiliate" as used in Rule 2210(a)(6)(B) also has this meaning.

    Pursuant to Rule 2210(a)(6)(B), independently prepared reprints also include independent reports concerning investment companies that meet certain standards. Under current Rule 2210(c)(7)(G), these types of reports are already exempt from the Rule 2210 filing requirements for investment company sales material. This filing exemption is maintained by including these reports within the definition of independently prepared reprint.

    Some, but not all, content standards apply to independently prepared reprints. For example, Rule 2210(d)(1) will impose various content standards on all communications with the public, including independently prepared reprints. Independently prepared reprints are subject to the pre-use approval and record-keeping requirements of Rule 2210.

    Article reprints and research reports that do not meet the definition of "independently prepared reprint" constitute sales literature that must meet all of the requirements applicable to sales literature.

    Filing Requirements

    General Filing Requirements

    The Amendments maintain many of current Rule 2210's filing requirements for advertisements and sales literature. In this regard, advertisements and sales literature concerning registered investment companies that are not governed by Rule 2210(c)(3) or Rule 2210(c)(4) still must be filed with the Department within 10 business days of first use or publication. This 10-business-day filing requirement also continues to apply to advertisements and sales literature concerning public direct participation programs and advertisements concerning government securities.

    Rule 2210(c)(3) continues to apply a 10-business day pre-filing requirement to sales literature containing bond fund volatility ratings. New Rule 2210(c)(4) maintains the 10-business day pre-filing requirement for registered investment company advertisements and sales literature that include or incorporate selfcreated rankings or comparisons, advertisements concerning collateralized mortgage obligations, and advertisements concerning security futures.

    Television and Video Advertisements

    New Rule 2210(c)(6) requires members that have filed a draft version or "storyboard" of a television or video advertisement pursuant to a filing requirement also to file the final filmed version within 10 business days of first use or broadcast. This provision codifies an existing Department policy regarding television and video sales material. The Department imposes a filing fee only when the draft version or storyboard is filed. No additional fee is assessed when the final filmed version is filed.

    Press Releases

    Rule 2210(a)(2) defines "sales literature" to include press releases concerning a member's product or service. New Rule 2210(c)(8)(G) excludes from the filing requirements press releases that are made available only to members of the media.

    Legends and Footnotes

    New Rule 2210(d)(1)(C) provides that information may be placed in a legend or footnote only when such placement would not inhibit an investor's understanding of the communication. Thus, for example, footnotes in especially small type in an advertisement might be deemed to inhibit an investor's understanding of the advertisement. Similarly, an advertisement that presents bold claims that are supposedly "balanced" only with footnote disclosure might not comply with this content standard.

    Use and Disclosure of a Member's Name

    New Rule 2210(d)(2)(C) simplifies the current provisions concerning disclosure of member names by deleting many of the current specific provisions governing the use of member names. In addition, Rules 2210(d)(2)(C) and 2211(d)(2) make clear that the requirement to disclose the member's name applies to advertisements, sales literature, correspondence, business cards, and letterhead. NASD does not intend to modify the substance of the current standards in Rule 2210(f) with regard to use and disclosure of member names, however. Accordingly, members' use of names that meet the current standards of Rule 2210(f) will also be deemed to be in compliance with new Rules 2210(d)(2)(C) and 2211(d)(2).

    Recommendations

    The provisions governing member recommendations have been relocated from current Rule 2210(d)(2)(B) to new IM-2210-1(6). These provisions have been modified in several respects to make them consistent with NASD Rule 2711, which requires certain disclosures when securities are recommended in member research reports.

    First, current Rule 2210(d)(2)(B)(i)(a) requires a member to disclose if the member "usually" makes a market in the securities being recommended. New IM-2210-1(6)(A)(i) will require a member to disclose if the member was making a market in the securities being recommended at the time the advertisement or sales literature was published.

    Second, current Rule 2210(d)(2)(B)(i)(b) requires a member to disclose if the member or its officers and partners own options, security futures, rights, or warrants to purchase the recommended issuer's securities, unless the extent of such ownership is nominal. New IM-2210-1(6)(A)(ii) will require the member to disclose if the member or its officers or partners have a financial interest in any of the recommended issuer's securities, and the nature of the financial interest, unless the extent of the financial interest is nominal. A member that discloses in its research reports that it owns one percent or more of any class of common equity securities of a recommended issuer pursuant to Rule 2711(h)(1)(B) will be deemed to be in compliance with the requirement to disclose its financial interest in the recommended issuer pursuant to IM-2210-1(6)(A)(ii).

    Finally, current Rule 2210(d)(2)(B)(i)(b) requires a member to disclose if the member had acted as manager or co-manager of a public offering of the recommended issuer's securities within the last three years. Under new IM-2210-1(6)(A)(iii), this look-back period will be shortened to the past 12 months.

    Ranking Guidelines

    New IM-2210-3 (Use of Rankings in Investment Companies Advertisements and Sales Literature) modifies the current ranking guidelines in several respects. First, IM-2110-3(b) makes clear that no advertisement or sales literature may present a ranking, except those (1) created and published by a Ranking Entity, which the ranking guidelines define to include certain independent entities, or (2) created by an investment company or an investment company affiliate but based on the performance measurements of a Ranking Entity.7 Second, the ranking guidelines in IM-2210-3 apply only to advertisements and sales literature.

    Third, IM-2210-3(g) permits the use of investment company family rankings, provided that when a particular investment company is being advertised, the individual rankings for that investment company also must be presented. Of course, as with all performance rankings, use of an investment company family ranking must comply with the other applicable requirements of Rule 2210.

    Limitations on Use of NASD's Name

    New IM-2210-4 simplifies and shortens the requirements concerning the use of NASD's name. The Amendments also delete current Rule 2210(d)(2)(J) concerning references to regulatory organizations.

    Communications About Collateralized Mortgage Obligations

    The Amendments rewrite existing IM-2210-1 (the CMO Guidelines), which governs communications about collateralized mortgage obligations and renumber it as IM-2210-8. The Amendments simplify, shorten, and reorganize the CMO Guidelines to provide a more straightforward and uniform list of disclosure requirements.


    1 SEC Release No. 34-47820 (May 9, 2003), 68 Fed. Reg. 27116 (May 19, 2003) (SR-NASD-00-12) (www.nasdr.com/pdf-text/rf03_94_app.pdf). On June 11, 2003, NASD filed a technical amendment to Rule 2210 that reinserted certain current Rule 2210 language that was inadvertently omitted from the Amendments. See SEC Release No. 34-48079 (June 24, 2003), 68 Fed. Reg. 39171 (July 1, 2003) (SR-NASD-2003-94).

    2 The current IM-2210-1 concerning collateralized mortgage obligations is re-designated as IM-2210-8.M

    3 The Amendments revise the content standards to specifically indicate which type of communication is subject to each standard. Therefore, standards that apply only to "advertisements" or "sales literature" will not apply to institutional sales material. For example, the ranking guidelines in IM-2210-3 will apply only to advertisements and sales literature and therefore will not apply to institutional sales material.

    4 Rule 3110(c)(4) defines "institutional account" to mean the account of a bank, savings and loan, insurance company, registered investment company, or registered investment adviser. It also includes the account of any other entity or natural person with total assets of at least $50 million. For purposes of Rule 2210 and Rule 2211, the term "institutional investor" includes trust companies organized under state law that come within the definition of "bank" in Article I(b) of the NASD By-Laws.

    5 Currently all content standards of Rule 2210 apply to advertisements and sales literature sent only to members or their registered persons. By including this material within the definition of institutional sales material, and subjecting it only to those standards applicable to institutional sales material, the Amendments provide members with more flexibility to include various information in broker/dealer-only material.

    6 The Amendments will permit members to treat form letters or group e-mail sent to a combination of existing customers and fewer than 25 prospective retail customers within any 30 calendar-day period as correspondence. Of course, members may not "sanitize" an advertisement or item of sales literature by enclosing it with Group Correspondence. For example, an item that a member has distributed as sales literature will remain sales literature for purposes of Rule 2210 when the member encloses it in Group Correspondence.

    7 The application of this limitation to correspondence would appear in new Rule 2211(d)(3) rather than in IM-2210-3.


    Attachment A

    As of November 3, 2003, current Rule 2210 and Interpretive Materials 2210-1, 2210-3, and 2210-4 are replaced with the following rule language. In addition, as of November 3, 2003, Interpretive Materials 2210-2 and 2210-7 are revised as shown below, and new Rule 2211 and Interpretive Material 2210-8 become effective.

    2210. Communications with the Public

    (a) Definitions - For purposes of this Rule and any interpretation thereof, "communications with the public" consist of:
    (1) "Advertisement." Any material, other than an independently prepared reprint and institutional sales material, that is published or used in any electronic or other public media, including any Web site, newspaper, magazine or other periodical, radio, television, telephone or tape recording, videotape display, signs or billboards, motion pictures, or telephone directories (other than routine listings).
    (2) "Sales Literature." Any written or electronic communication, other than an advertisement, independently prepared reprint, institutional sales material and correspondence, that is generally distributed or made generally available to customers or the public, including circulars, research reports, market letters, performance reports or summaries, form letters, telemarketing scripts, seminar texts, reprints (that are not independently prepared reprints) or excerpts of any other advertisement, sales literature or published article, and press releases concerning a member's products or services.
    (3) "Correspondence" as defined in Rule 2211(a)(1).
    (4) "Institutional Sales Material" as defined in Rule 2211(a)(2).
    (5) "Public Appearance." Participation in a seminar, forum (including an interactive electronic forum), radio or television interview, or other public appearance or public speaking activity.
    (6) "Independently Prepared Reprint."
    (A) Any reprint or excerpt of any article issued by a publisher, provided that:
    (i) the publisher is not an affiliate of the member using the reprint or any underwriter or issuer of a security mentioned in the reprint or excerpt and that the member is promoting;
    (ii) neither the member using the reprint or excerpt nor any underwriter or issuer of a security mentioned in the reprint or excerpt has commissioned the reprinted or excerpted article; and
    (iii) the member using the reprint or excerpt has not materially altered its contents except as necessary to make the reprint or excerpt consistent with applicable regulatory standards or to correct factual errors;
    (B) Any report concerning an investment company registered under the Investment Company Act of 1940, provided that:
    (i) the report is prepared by an entity that is independent of the investment company, its affiliates, and the member using the report (the "research firm");
    (ii) the report's contents have not been materially altered by the member using the report except as necessary to make the report consistent with applicable regulatory standards or to correct factual errors;
    (iii) the research firm prepares and distributes reports based on similar research with respect to a substantial number of investment companies;
    (iv) the research firm updates and distributes reports based on its research of the investment company with reasonable regularity in the normal course of the research firm's business;
    (v) neither the investment company, its affiliates nor the member using the research report has commissioned the research used by the research firm in preparing the report; and
    (vi) if a customized report was prepared at the request of the investment company, its affiliate or a member, then the report includes only information that the research firm has already compiled and published in another report, and does not omit information in that report necessary to make the customized report fair and balanced.
    (b) Approval and Recordkeeping
    (1) Registered Principal Approval for Advertisements, Sales Literature and Independently Prepared Reprints

    A registered principal of the member must approve by signature or initial and date each advertisement, item of sales literature and independently prepared reprint before the earlier of its use or filing with NASD's Advertising Regulation Department ("Department"). With respect to debt and equity securities that are the subject of research reports as that term is defined in Rule 472 of the New York Stock Exchange, this requirement may be met by the signature or initial of a supervisory analyst approved pursuant to Rule 344 of the New York Stock Exchange. A registered principal qualified to supervise security futures activities must approve by signature or initial and date each advertisement or item of sales literature concerning security futures.
    (2) Record-keeping
    (A) Members must maintain all advertisements, sales literature, and independently prepared reprints in a separate file for a period of three years from the date of last use. The file must include the name of the registered principal who approved each advertisement, item of sales literature, and independently prepared reprint and the date that approval was given.
    (B) Members must maintain in a file information concerning the source of any statistical table, chart, graph or other illustration used by the member in communications with the public.
    (c) Filing Requirements and Review Procedures
    (1) Date of First Use and Approval Information

    The member must provide with each filing under this paragraph the actual or anticipated date of first use, the name and title of the registered principal who approved the advertisement or sales literature, and the date that the approval was given.
    (2) Requirement to File Certain Material

    Within 10 business days of first use or publication, a member must file the following advertisements and sales literature with the Department:
    (A) Advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts, continuously offered closed-end funds, and unit investment trusts) not included within the requirements of paragraph (c)(3). The filing of any advertisement or sales literature that includes or incorporates a performance ranking or performance comparison of the investment company with other investment companies must include a copy of the ranking or comparison used in the advertisement or sales literature.
    (B) Advertisements and sales literature concerning public direct participation programs (as defined in Rule 2810).
    (C) Advertisements concerning government securities (as defined in Section 3(a)(42) of the Act).
    (3) Sales Literature Containing Bond Fund Volatility Ratings

    Sales literature concerning bond mutual funds that include or incorporate bond mutual fund volatility ratings, as defined in Rule IM-2210-5, shall be filed with the Department for review at least 10 business days prior to use (or such shorter period as the Department may allow in particular circumstances) for approval and, if changed by NASD, shall be withheld from publication or circulation until any changes specified by NASD have been made or, if expressly disapproved, until the sales literature has been refiled for, and has received, NASD approval. Members are not required to file advertising and sales literature which have previously been filed and which are used without change. The member must provide with each filing the actual or anticipated date of first use. Any member filing sales literature pursuant to this paragraph shall provide any supplemental information requested by the Department pertaining to the rating that is possessed by the member.
    (4) Requirement to File Certain Material Prior to Use

    At least 10 business days prior to first use or publication (or such shorter period as the Department may allow), a member must file the following communications with the Department and withhold them from publication or circulation until any changes specified by the Department have been made:
    (A) Advertisements and sales literature concerning registered investment companies (including mutual funds, variable contracts, continuously offered closed-end funds and unit investment trusts) that include or incorporate performance rankings or performance comparisons of the investment company with other investment companies when 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. Such filings must include a copy of the data on which the ranking or comparison is based.
    (B) Advertisements concerning collateralized mortgage obligations.
    (C) Advertisements concerning security futures.
    (5) Requirement for Certain Members to File Material Prior to Use
    (A) Each member that has not previously filed advertisements with the Department (or with a registered securities exchange having standards comparable to those contained in this Rule) must file its initial advertisement with the Department at least 10 business days prior to use and shall continue to file its advertisements at least 10 business days prior to use for a period of one year.
    (B) Notwithstanding the foregoing provisions, the Department, upon review of a member's advertising and/or sales literature, and after determining that the member has departed from the standards of this Rule, may require that such member file all advertising and/or sales literature, or the portion of such member's material that is related to any specific types or classes of securities or services, with the Department, at least 10 business days prior to use. The Department will notify the member in writing of the types of material to be filed and the length of time such requirement is to be in effect. Any filing requirement imposed under this paragraph will take effect 30 calendar days after the member receives the written notice, during which time the member may appeal pursuant to the hearing and appeal procedures of the Code of Procedure contained in the Rule 9510 Series.
    (6) Filing of Television or Video Advertisements

    If a member has filed a draft version or "story board" of a television or video advertisement pursuant to a filing requirement, then the member also must file the final filmed version within 10 business days of first use or broadcast.
    (7) Spot-Check Procedures

    In addition to the foregoing requirements, each member's written and electronic communications with the public may be subject to a spot-check procedure. Upon written request from the Department, each member must submit the material requested in a spot-check procedure within the time frame specified by the Department.
    (8) Exclusions from Filing Requirements

    The following types of material are excluded from the filing requirements and (except for the material in paragraphs (G) through (J)) the foregoing spot-check procedures:
    (A) Advertisements and sales literature that previously have been filed and that are to be used without material change.
    (B) Advertisements and sales literature solely related to recruitment or changes in a member's name, personnel, electronic or postal address, ownership, offices, business structure, officers or partners, telephone or teletype numbers, or concerning a merger with, or acquisition by, another member.
    (C) Advertisements and sales literature that do no more than identify the Nasdaq or a national securities exchange symbol of the member or identify a security for which the member is a Nasdaq registered market maker.
    (D) Advertisements and sales literature that do no more than identify the member or offer a specific security at a stated price.
    (E) Prospectuses, preliminary prospectuses, fund profiles, offering circulars and similar documents that have been filed with the Securities and Exchange Commission (the "SEC") or any state, or that is exempt from such registration, except that an investment company prospectus published pursuant to SEC Rule 482 under the Securities Act of 1933 will not be considered a prospectus for purposes of this exclusion.
    (F) Advertisements prepared in accordance with Section 2(10)(b) of the Securities Act of 1933, as amended, or any rule thereunder, such as SEC Rule 134, and announcements as a matter of record that a member has participated in a private placement, unless the advertisements are related to direct participation programs or securities issued by registered investment companies.
    (G) Press releases that are made available only to members of the media.
    (H) Independently prepared reprints.
    (I) Correspondence.
    (J) Institutional sales material.

    Although the material described in paragraphs (c)(8)(G) through (J) is excluded from the foregoing filing requirements, investment company communications described in those paragraphs shall be deemed filed with NASD for purposes of Section 24(b) of the Investment Company Act of 1940 and Rule 24b-3 thereunder.
    (9) Material that refers to investment company securities, direct participation programs, or exempted securities (as defined in Section 3(a)(12) of the Act) solely as part of a listing of products or services offered by the member, is excluded from the requirements of paragraphs (c)(2) and (c)(4).
    (10) Pursuant to the Rule 9600 Series, NASD may exempt a member or person associated with a member from the pre-filing requirements of this paragraph (c) for good cause shown.
    (d) Content Standards
    (1) Standards Applicable to All Communications with the Public
    (A) All member communications with the public shall be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service. No member may omit any material fact or qualification if the omission, in the light of the context of the material presented, would cause the communications to be misleading.
    (B) No member may make any false, exaggerated, unwarranted or misleading statement or claim in any communication with the public. No member may publish, circulate or distribute any public communication that the member knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading.
    (C) Information may be placed in a legend or footnote only in the event that such placement would not inhibit an investor's understanding of the communication.
    (D) Communications with the public may not predict or project performance, imply that past performance will recur or make any exaggerated or unwarranted claim, opinion or forecast. A hypothetical illustration of mathematical principles is permitted, provided that it does not predict or project the performance of an investment or investment strategy.
    (E) If any testimonial in a communication with the public concerns a technical aspect of investing, the person making the testimonial must have the knowledge and experience to form a valid opinion.
    (2) Standards Applicable to Advertisements and Sales Literature
    (A) Advertisements or sales literature providing any testimonial concerning the investment advice or investment performance of a member or its products must prominently disclose the following:
    (i) The fact that the testimonial may not be representative of the experience of other clients.
    (ii) The fact that the testimonial is no guarantee of future performance or success.
    (iii) If more than a nominal sum is paid, the fact that it is a paid testimonial.
    (B) Any comparison in advertisements or sales literature between investments or services must disclose all material differences between them, including (as applicable) investment objectives, costs and expenses, liquidity, safety, guarantees or insurance, fluctuation of principal or return, and tax features.
    (C) All advertisements and sales literature must:
    (i) prominently disclose the name of the member and may also include a fictional name by which the member is commonly recognized or which is required by any state or jurisdiction;
    (ii) reflect any relationship between the member and any non-member or individual who is also named; and
    (iii) if it includes other names, reflect which products or services are being offered by the member.

    This paragraph (C) does not apply to so-called "blind" advertisements used to recruit personnel.
    (e) Violation of Other Rules

    Any violation by a member of any rule of the SEC, the Securities Investor Protection Corporation or the Municipal Securities Rulemaking Board applicable to member communications with the public will be deemed a violation of this Rule 2210.

    IM-2210-1. Guidelines to Ensure That Communications With the Public Are Not Misleading

    Every member is responsible for determining whether any communication with the public, including material that has been filed with the Department, complies with all applicable standards, including the requirement that the communication not be misleading. In order to meet this responsibility, member communications with the public must conform with the following guidelines. These guidelines do not represent an exclusive list of considerations that a member must make in determining whether a communication with the public complies with all applicable standards.

    (1) Members must ensure that statements are not misleading within the context in which they are made. A statement made in one context may be misleading even though such a statement could be appropriate in another context. An essential test in this regard is the balanced treatment of risks and potential benefits. Member communications should be consistent with the risks of fluctuating prices and the uncertainty of dividends, rates of return and yield inherent to investments.
    (2) Members must consider the nature of the audience to which the communication will be directed. Different levels of explanation or detail may be necessary depending on the audience to which a communication is directed. Members must keep in mind that it is not always possible to restrict the audience that may have access to a particular communication with the public. Additional information or a different presentation of information may be required depending upon the medium used for a particular communication and the possibility that the communication will reach a larger or different audience than the one initially targeted.
    (3) Member communications must be clear. A statement made in an unclear manner can cause a misunderstanding. A complex or overly technical explanation may be more confusing than too little information.
    (4) In communications with the public, income or investment returns may not be characterized as tax-free or exempt from income tax when tax liability is merely postponed or deferred, such as when taxes are payable upon redemption.
    (5) In advertisements and sales literature, references to tax-free or tax-exempt income must indicate which income taxes apply, or which do not, unless income is free from all applicable taxes. For example, if income from an investment company investing in municipal bonds is subject to state or local income taxes, this fact must be stated, or the illustration must otherwise make it clear that income is free only from federal income tax.
    (6) Recommendations
    (A) 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:
    (i) that at the time the advertisement or sales literature was published, the member was making 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;
    (ii) that the member and/or its officers or partners have a financial interest in any of the securities of the issuer whose securities are recommended, and the nature of the financial interest (including, without limitation, whether it consists of any option, right, warrant, future, long or short position), unless the extent of the financial interest is nominal;
    (iii) that the member was manager or co-manager of a public offering of any securities of the recommended issuer within the past 12 months.
    (B) The member shall also provide, or offer to furnish upon request, available investment information supporting the recommendation. Recommendations on behalf of corporate equities must provide the price at the time the recommendation is made.
    (C) A member may use material referring to past recommendations if it sets forth all recommendations as to the same type, kind, grade or classification of securities made by a member within the last year. Longer periods of years may be covered if they are consecutive and include the most recent year. Such material must also name each security recommended and give the date and nature of each recommendation (e.g., whether to buy or sell), the price at the time of the recommendation, the price at which or the price range within which the recommendation was to be acted upon, and indicate the general market conditions during the period covered.
    (D) Also permitted is material that does not make any specific recommendation but which offers to furnish a list of all recommendations made by a member within the past year or over longer periods of consecutive years, including the most recent year, if this list contains all the information specified in subparagraph (C). Neither the list of recommendations, nor material offering such list, shall imply comparable future performance. Reference to the results of a previous specific recommendation, including such a reference in a follow-up research report or market letter, is prohibited if the intent or the effect is to show the success of a past recommendation, unless all of the foregoing requirements with respect to past recommendations are met.

    IM-2210-2. Communications with the Public About Variable Life Insurance and Variable Annuities

    The standards governing communications with the public are set forth in Rule 2210. In addition to those standards, the following guidelines must be considered in preparing advertisements and sales literature about variable life insurance and variable annuities. The guidelines are applicable to advertisements and sales literature as defined in Rule 2210, as well as individualized communications such as personalized letters and computer generated illustrations, whether printed or made available on-screen.

    (a) General Considerations

    No change to rule text.
    (b) Specific Considerations
    (1) Fund Performance Predating Inclusion in the Variable Product

    In order to show how an existing fund would have performed had it been an investment option within a variable life insurance policy or variable annuity, communications may contain the fund's historical performance that predates its inclusion in the policy or annuity. Such performance may only be used provided that no significant changes occurred to the fund at the time or after it became part of the variable product. However, communications may not include the performance of an existing fund for the purposes of promoting investment in a similar, but new, investment option (i.e., clone fund or model fund) available in a variable contract. The presentation of historical performance must conform to applicable NASD and SEC standards. Particular attention must be given to including all elements of return and deducting applicable charges and expenses.
    (2) Product Comparisons

    A comparison of investment products may be used provided the comparison complies with applicable requirements set forth under Rule 2210. Particular attention must be paid to the specific standards regarding "comparisons" set forth in Rule 2210(d)(2)(B).
    (3)–(5) No change to rule text.

    IM-2210-3. Use of Rankings in Investment Companies Advertisements and Sales Literature

    (a) Definition of "Ranking Entity"

    For purposes of the following guidelines, the term "Ranking Entity" refers to any entity that provides general information about investment companies to the public, that is independent of the investment company and its affiliates, and whose services are not procured by the investment company or any of its affiliates to assign the investment company a ranking.
    (b) General Prohibition

    Members may not use investment company rankings in any advertisement or item of sales literature other than (1) rankings created and published by Ranking Entities or (2) rankings created by an investment company or an investment company affiliate but based on the performance measurements of a Ranking Entity. Rankings in advertisements and sales literature also must conform to the following requirements.
    (c) Required Disclosures
    (1) Headlines/Prominent Statements

    A headline or other prominent statement must not state or imply that an investment company or investment company family is the best performer in a category unless it is actually ranked first in the category.
    (2) Required Prominent Disclosure

    All advertisements and sales literature containing an investment company ranking must disclose prominently:
    (A) the name of the category (e.g., growth);
    (B) the number of investment companies or, if applicable, investment company families, in the category;
    (C) the name of the Ranking Entity and, if applicable, the fact that the investment company or an affiliate created the category or subcategory;
    (D) the length of the period (or the first day of the period) and its ending date; and
    (E) criteria on which the ranking is based (e.g., total return, riskadjusted performance).
    (3) Other Required Disclosure

    All advertisements and sales literature containing an investment company ranking also must disclose:
    (A) the fact that past performance is no guarantee of future results;
    (B) for investment companies that assess front-end sales loads, whether the ranking takes those loads into account;
    (C) if the ranking is based on total return or the current SEC standardized yield, and fees have been waived or expenses advanced during the period on which the ranking is based and the waiver or advancement had a material effect on the total return or yield for that period, a statement to that effect;
    (D) the publisher of the ranking data (e.g., "ABC Magazine, June 2003"); and
    (E) if the ranking consists of a symbol (e.g., a star system) rather than a number, the meaning of the symbol (e.g., a four-star ranking indicates that the fund is in the top 30% of all investment companies).
    (d) Time Periods
    (1) Current Rankings

    Any investment company ranking included in an item of sales literature must be, at a minimum, current to the most recent calendar quarter ended prior to use. Any investment company ranking included in an advertisement must be, at minimum, current to the most recent calendar quarter ended prior to the submission for publication. If no ranking that meets this requirement is available from the Ranking Entity, then a member may only use the most current ranking available from the Ranking Entity unless use of the most current ranking would be misleading, in which case no ranking from the Ranking Entity may be used.
    (2) Rankings Time Periods; Use of Yield Rankings

    Except for money market mutual funds:
    (A) advertisements and sales literature may not present any ranking that covers a period of less than one year, unless the ranking is based on yield;
    (B) an investment company ranking based on total return must be accompanied by rankings based on total return for a one year period for investment companies in existence for at least one year; one and five year periods for investment companies in existence for at least five years, and one, five and ten year periods for investment companies in existence for at least ten years supplied by the same Ranking Entity, relating to the same investment category, and based on the same time period; provided that, if rankings for such one, five and ten year time periods are not published by the Ranking Entity, then rankings representing short, medium and long term performance must be provided in place of rankings for the required time periods; and
    (C) an investment company ranking based on yield may be based only on the current SEC standardized yield and must be accompanied by total return rankings for the time periods specified in paragraph (d)(2)(B).
    (e) Categories
    (1) The choice of category (including a subcategory of a broader category) on which the investment company ranking is based must be one that provides a sound basis for evaluating the performance of the investment company.
    (2) An investment company ranking must be based only on (A) a category or subcategory created and published by a Ranking Entity or (B) a category or subcategory created by an investment company or an investment company affiliate but based on the performance measurements of a Ranking Entity.
    (3) An advertisement or sales literature may not use any category or subcategory that is based upon the asset size of an investment company or investment company family, whether or not it has been created by a Ranking Entity.
    (f) Multiple Class/Two-Tier Funds

    Investment company rankings for more than one class of investment company with the same portfolio must be accompanied by prominent disclosure of the fact that the investment companies or classes have a common portfolio.
    (g) Investment Company Families

    Advertisements and sales literature may contain rankings of investment company families, provided that these rankings comply with the guidelines above, and further provided that no advertisement or sales literature for an individual investment company may provide a ranking of an investment company family unless it also prominently discloses the various rankings for the individual investment company supplied by the same Ranking Entity, as described in paragraph (d)(2)(B). For purposes of this IM-2210-3, the term "investment company family" means any two or more registered investment companies or series thereof that hold themselves out to investors as related companies for purposes of investment and investor services.

    IM-2210-4. Limitations on Use of NASD's Name

    (a) Statements of Membership

    Members may indicate NASD membership in conformity with Article XV, Section 2 of the NASD By-Laws in the following ways:
    (1) in any communication with the public, provided that the communication complies with the applicable standards of Rule 2210 and neither states nor implies that NASD or any other regulatory organization endorses, indemnifies, or guarantees the member's business practices, selling methods, the class or type of securities offered, or any specific security;
    (2) in a confirmation statement for an over-the-counter transaction that states: "This transaction has been executed in conformity with the NASD Uniform Practice Code."
    (b) Certification of Membership

    Upon request to NASD, a member will be entitled to receive an appropriate certification of membership, which may be displayed in the principal office or a registered branch office of the member. The certification shall remain the property of NASD and must be returned by the member upon request of the NASD Board or its Chief Executive Officer.

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

    (a) NASD Approval Requirements and Review Procedures
    (1) As set forth in paragraph (c)(4) of Rule 2210, all advertisements concerning security futures shall be submitted to the Advertising Regulation Department of NASD at least ten days prior to use for approval and, if changed by NASD, shall be withheld from circulation until any changes specified by NASD have been made or, in the event of disapproval, until the advertisement has been refiled for, or has received, NASD approval.
    (2) No change to rule text.
    (b)–(d) No change to rule text.
    (e) Projections

    Notwithstanding the provisions of Rule 2210(d)(1)(D), security futures sales literature and correspondence may contain projected performance figures (including projected annualized rates of return), provided that:
    (1)–(8) No change to rule text.
    (f)–(i) No change to rule text.

    IM-2210-8 Communications with the Public About Collateralized Mortgage Obligations (CMOs)

    (a) Definition

    For purposes of the following guidelines, the term "collateralized mortgage obligation" (CMO) refers to a multiclass debt instrument backed by a pool of mortgage pass-through securities or mortgage loans, including real estate mortgage investment conduits (REMICs) as defined in the Tax Reform Act of 1986.
    (b) Disclosure Standards and Required Educational Material
    (1) Disclosure Standards

    All advertisements, sales literature and correspondence concerning CMOs:
    (A) must include within the name of the product the term "Collateralized Mortgage Obligation";
    (B) may not compare CMOs to any other investment vehicle, including a bank certificate of deposit;
    (C) must disclose, as applicable, that a government agency backing applies only to the face value of the CMO and not to any premium paid; and
    (D) must disclose that a CMO's yield and average life will fluctuate depending on the actual rate at which mortgage holders prepay the mortgages underlying the CMO and changes in current interest rates.
    (2) Required Educational Material

    Before the sale of a CMO to any person other than an institutional investor, a member must offer to the customer educational material that includes the following:
    (A) a discussion of:
    (i) characteristics and risks of CMOs including credit quality, prepayment rates and average lives, interest rates (including their effect on value and prepayment rates), tax considerations, minimum investments, transaction costs and liquidity;
    (ii) the structure of a CMO, including the various types of tranches that may be issued and the rights and risks pertaining to each (including the fact that two CMOs with the same underlying collateral may be prepaid at different rates and may have different price volatility); and
    (iii) the relationship between mortgage loans and mortgage securities;
    (B) questions an investor should ask before investing; and
    (C) a glossary of terms.
    (c) Promotion of Specific CMOs

    In addition to the standards set forth above, advertisements, sales literature and correspondence that promote a specific security or contain yield information must conform to the standards set forth below. An example of a compliant communication appears at the end of this section.
    (1) The advertisement, sales literature or correspondence must present the following disclosure sections with equal prominence. The information in Sections 1 and 2 must be included. The information in Section 3 is optional; therefore, the member may elect to include any, all or none of this information. The information in Section 4 may be tailored to the member's preferred signature.

    Section 1 Title - Collateralized Mortgage Obligations
    Coupon Rate
    Anticipated Yield/Average Life
    Specific Tranche - Number & Class
    Final Maturity Date
    Underlying Collateral
    Section 2 Disclosure Statement:

    "The yield and average life shown above consider prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life. Please contact your representative for information on CMOs and how they react to different market conditions."
    Section 3 Product Features (Optional):
    Minimum Denominations
    Rating Disclosure
    Agency/Government Backing
    Income Payment Structure
    Generic Description of Tranche (e.g., PAC, Companion)
    Yield to Maturity of CMOs Offered at Par
    Section 4 Company Information:
    Name, Memberships
    Address
    Telephone Number
    Representative's Name
    (2) Additional Conditions

    The following conditions must also be met:
    (A) All figures in Section 1 must be in equal type size.
    (B) The disclosure language in Section 2 may not be altered and must be given equal prominence with the information in Section 1.
    (C) The prepayment assumption used to determine the yield and average life must either be obtained from a nationally recognized service or the member firm must be able to justify the assumption used. A copy of either the service's listing for the CMO or the firm's justification must be attached to the copy of the communication that is maintained in the firm's advertising files in order to verify that the prepayment scenario is reasonable.
    (D) Any sales charge that the member intends to impose must be reflected in the anticipated yield.
    (E) The communication must include language stating that the security is "offered subject to prior sale and price change." This language may be included in any one of the four sections.
    (F) If the security is an accrual bond that does not currently distribute principal and interest payments, then Section 1 must include this information.
    (3) Radio/Television Advertisements
    (A) The following oral disclaimer must precede any radio or television advertisement in lieu of the Title information set forth in Section 1:

    "The following is an advertisement for Collateralized Mortgage Obligations. Contact your representative for information on CMOs and how they react to different market conditions."
    (B) Radio or television advertisements must contain the following oral disclosure statement in lieu of the legend set forth in Section 2:

    "The yield and average life reflect prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life."
    (4) Standardized CMO Communication Example

    Collateralized Mortgage Obligations

    7.50% Coupon
    7.75% Anticipated Yield to 22-Year Average Life
    FNMA 9532X, Final Maturity March 2023
    Collateral 100% FNMA 7.50%

    The yield and average life shown above reflect prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life. Please contact your representative for information on CMOs and how they react to different market conditions.

    $5,000 Minimum
    Income Paid Monthly
    Implied Rating/Volatility Rating
    Principal and Interest Payments Backed by FNMA
    PAC Bond
    Offered subject to prior sale and price change.

    Call Mary Representative at (800)555-1234
    Your Company Securities, Inc., Member SIPC
    123 Main Street
    Anytown, State 12121

    2211. Institutional Sales Material and Correspondence

    (a) Definitions

    For purposes of Rule 2210, this Rule, and any interpretation thereof:
    (1) "Correspondence" consists of any written letter or electronic mail message distributed by a member to:
    (A) one or more of its existing retail customers; and
    (B) fewer than 25 prospective retail customers within any 30 calendar-day period.
    (2) "Institutional Sales Material" consists of any communication that is distributed or made available only to institutional investors.
    (3) "Institutional Investor" means any:
    (A) person described in Rule 3110(c)(4), regardless of whether that person has an account with an NASD member;
    (B) governmental entity or subdivision thereof;
    (C) employee benefit plan that meets the requirements of Section 403(b) or Section 457 of the Internal Revenue Code and has at least 100 participants, but does not include any participant of such a plan;
    (D) qualified plan, as defined in Section 3(a)(12)(C) of the Act, that has at least 100 participants, but does not include any participant of such a plan;
    (E) NASD member or registered associated person of such a member; and
    (F) person acting solely on behalf of any such institutional investor.

    No member may treat a communication as having been distributed to an institutional investor if the member has reason to believe that the communication or any excerpt thereof will be forwarded or made available to any person other than an institutional investor.
    (4) "Existing Retail Customer" means any person for whom the member or a clearing broker or dealer on behalf of the member carries an account, or who has an account with any registered investment company for which the member serves as principal underwriter, and who is not an institutional investor. "Prospective Retail Customer" means any person who has not opened such an account and is not an institutional investor.
    (b) Approval and Recordkeeping
    (1) Registered Principal Approval
    (A) Correspondence. Correspondence need not be approved by a registered principal prior to use, but is subject to the supervision and review requirements of Rule 3010(d).
    (B) Institutional Sales Material. Each member shall establish written procedures that are appropriate to its business, size, structure, and customers for the review by a registered principal of institutional sales material used by the member and its registered representatives. Such procedures should be in writing and be designed to reasonably supervise each registered representative. Where such procedures do not require review of all institutional sales material prior to use or distribution, they must include provision for the education and training of associated persons as to the firm's procedures governing institutional sales material, documentation of such education and training, and surveillance and follow-up to ensure that such procedures are implemented and adhered to. Evidence that these supervisory procedures have been implemented and carried out must be maintained and made available to NASD upon request.
    (2) Record-keeping
    (A) Members must maintain all institutional sales material in a file for a period of three years from the date of last use. The file must include the name of the person who prepared each item of institutional sales material.
    (B) Members must maintain in a file information concerning the source of any statistical table, chart, graph or other illustration used by the member in communications with the public.
    (c) Spot-Check Procedures

    Each member's correspondence and institutional sales literature may be subject to a spot-check procedure under Rule 2210. Upon written request from the Advertising Regulation Department (the "Department"), each member must submit the material requested in a spotcheck procedure within the time frame specified by the Department.
    (d) Content Standards Applicable to Institutional Sales Material and Correspondence
    (1) All institutional sales material and correspondence are subject to the content standards of Rule 2210(d)(1) and the applicable Interpretive Materials under Rule 2210.
    (2) All correspondence (which for purposes of this provision includes business cards and letterhead) must:
    (A) prominently disclose the name of the member and may also include a fictional name by which the member is commonly recognized or which is required by any state or jurisdiction;
    (B) reflect any relationship between the member and any nonmember or individual who is also named; and
    (C) if it includes other names, reflect which products or services are being offered by the member.
    (3) Members may not use investment company rankings in any correspondence other than rankings based on (A) a category or subcategory created and published by a Ranking Entity as defined in IM-2210-3(a) or (B) a category or subcategory created by an investment company or an investment company affiliate but based on the performance measurements of a Ranking Entity.
    (e) Violation of Other Rules

    Any violation by a member of any rule of the SEC, the Securities Investor Protection Corporation or the Municipal Securities Rulemaking Board applicable to institutional sales material or correspondence will be deemed a violation of this Rule and Rule 2210.

    2212. Telemarketing

    No change to rule text.

  • 03-37 New Series 23 Examination

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    INFORMATIONAL

    Registration Rules

    Effective Date: July 7, 2003

    SUGGESTED ROUTING

    KEY TOPICS

    Legal & Compliance
    Operations
    Principals
    Registration
    Registered Representatives
    Senior Management
    Training

    Qualification Examinations
    General Securities Principal Sales Supervisor Module (Series 23)
    General Securities Principal (Series 24)
    General Securities Sales Supervisor (Series 9/10)

    Executive Summary

    On June 4, 2003, NASD filed with the Securities and Exchange Commission (SEC) for immediate effectiveness a proposed rule change to establish the General Securities Principal Sales Supervisor Module (Series 23) examination program.1 The new Series 23 examination, in combination with the General Securities Sales Supervisor (Series 9/10) examination, will be an acceptable qualification alternative to the General Securities Principal (Series 24) examination for associated persons who are required to register and qualify as a General Securities Principal with NASD. The Series 23 examination covers material from the Series 24 examination not otherwise covered under the Series 9/10 examination. The implementation date of the new Series 23 examination is July 7, 2003.

    Questions/Further Information

    Questions concerning this Notice may be directed to Afshin Atabaki, Attorney, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8902, or one of the following persons in NASD's Testing and Continuing Education Department: Carole Hartzog at (240) 386-4678; Eva Cichy at (240) 386-4680; Elaine Warren at (240) 386-4679; or Karen Bescher at (240) 386-4677.

    Background/Discussion

    The SEC recently approved a proposed rule change to NYSE Rule 342 that recognized NASD's Series 24 examination as an acceptable qualification alternative to the Series 9/10 examination for a General Securities Sales Supervisor whose duties do not include the supervision of options or municipal securities sales activity.2 In an effort to establish reciprocal qualification standards, NASD will permit General Securities Sales Supervisors to register and qualify as a General Securities Principal by passing the newly developed Series 23 qualification examination.

    NASD developed the Series 23 examination program to allow persons associated with NASD members who are registered as a General Securities Sales Supervisor and who are seeking to register and qualify as a General Securities Principal an alternative to completing the Series 24.

    The Series 23 examination is a limited qualification examination that covers those subject matters that are covered on the Series 24 examination, but not included on the Series 9/10 examination. A committee of industry representatives that oversees the Series 24 examination program, together with NASD staff, compared the subject matters covered on the Series 9/10 and Series 24 examinations to determine the topics that would be extracted from the Series 24 examination to create the Series 23 examination program. The Series 23 examination program tests a candidate's knowledge of securities industry rules and regulations pertaining to the supervision of investment banking, securities markets, and trading as well as financial responsibility requirements. The committee, including NASD staff, developed the selection specifications, study outline, and question bank for the Series 23 examination.

    Prerequisite Examination

    In order to take the Series 23, an individual must be registered as a General Securities Sales Supervisor, or have been registered in this capacity within the past two years.3

    The New Series 23 Examination

    A study outline has been created to assist member firms in preparing candidates for the new Series 23 examination. The study outline may be used to structure or prepare training material, develop lecture notes and seminar programs, and serve as a training aide for the candidates themselves.

    The Series 23 examination contains 100 questions, and candidates are allowed 2½ hours to complete the examination. A candidate must correctly answer 70 percent of the questions to receive a passing grade. The test is administered as a closed-book exam. The proctor will provide scratch paper and a basic electronic calculator. At the completion of the test, candidates will be provided with an informational breakdown of their performance on each of the sections, along with their overall score.

    The Series 23 outline and test are divided into five topical sections, which are listed below along with the number of questions designated to each section.

    Section 1: Supervision of Investment Banking Activities (25)

    Section 2: Supervision of Trading and Market Making Activities (29)

    Section 3: Supervision of Brokerage Office Operations (16)

    Section 4: Sales Supervision, General Supervision of Employees, Regulatory Framework of NASD (19)

    Section 5: Compliance with Financial Responsibility Rules (11)

    The questions used in the examination will be updated to reflect changes in the federal securities laws and NASD rules. Questions on new rules will be added to the examination within a reasonable period of their effective dates. Questions on rescinded rules will be promptly deleted from the examination. Candidates will only be asked questions pertaining to rules that are effective at the time they take their exams.

    Availability Of Study Outline

    The study outline for the new Series 23 examination program will be available shortly from NASD's Qualifications Web Page at: www.nasdr.com/5200_explan.htm.


    1 See Securities Exchange Act Release No. 48042 (June 17, 2003), 68 FR 37186 (June 23, 2003) (notice of filing and immediate effectiveness of File No. SR-NASD-2003-91).

    2 See Securities Exchange Act Release No. 46631 (October 9, 2002), 67 FR 64187 (October 17, 2002) (order approving File No. SR-NYSE-2002-24).

    3 As a prerequisite to the Series 23 examination, NASD also will recognize the Series 8, the historical equivalent to the Series 9/10, and the Series 12, a subset of the Series 9/10 omitting questions on options and municipal securities.

  • 03-36 SEC Approves Amendments to TRACE Rule 6230 to Reduce the Reporting Period to 45 Minutes

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    INFORMATIONAL

    Corporate Debt Securities

    SUGGESTED ROUTING

    KEY TOPICS

    Corporate Finance
    Legal and Compliance
    Operations
    Senior Management
    Technology
    Trading and Market Making
    Training

    Debt Securities
    Operations
    Rule 6200 Series
    Transaction Reporting

    Executive Summary

    On June 18, 2003, the Securities and Exchange Commission (SEC or Commission) approved amendments to Rule 6230 of the Trade Reporting and Compliance Engine (TRACE) Rules (Rule 6200 Series).1 The amendments to TRACE Rule 6230 reduce the time to report a transaction in a TRACE-eligible security from 75 minutes to 45 minutes. Rule 6230, as amended, is set forth in Attachment A.

    The amendments to Rule 6230 will become effective on October 1, 2003.

    Questions/Further Information

    Questions concerning this Notice should be directed to tracefeedback.com; Elliot Levine, Chief Counsel, Market Operations, Regulatory Services and Operations, at (212) 858-4174; or Sharon K. Zackula, Assistant General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8985.

    Background and Discussion

    On July 1, 2002, when TRACE became effective, members were required to report required transaction information in TRACE eligible corporate debt securities within 75 minutes of the time of execution. At that time, NASD indicated that it planned to reduce the reporting period after members had obtained experience reporting. Reducing the reporting period was, and continues to be, an important regulatory goal that results in the market receiving marketbased pricing information more quickly, which enhances the transparency of the debt market.

    On May 2, 2003, NASD proposed to reduce the reporting period from 75 minutes to 45 minutes. Since 1999, NASD, the SEC, and industry participants have discussed reducing the reporting period after members obtained experience reporting corporate bond transactions to TRACE. Since July 1, 2002, when TRACE began, members have obtained that reporting experience. In addition, during the first year of TRACE, members have developed the technical and operational capabilities to report transactions within a much shorter period than the current 75-minute period. TRACE data shows that approximately 80% of all reported transactions (measured either by transaction count or par value) currently are being reported to TRACE within 45 minutes.

    45 Minute Reporting Requirement

    The SEC approved the 45 minute reporting requirement on June 18, 2003. Thus, generally, in Rule 6230(a) and (a)(1), as amended, a member must report a transaction in a TRACE-eligible security within 45 minutes of the time of execution. In addition, NASD reduced other 75 minute reporting periods to 45 minutes in paragraphs (1) through (4) of Rule 6230(a). Specifically, under Rule 6230(a)(1) as amended, if a member executes a transaction within 45 minutes of the time the TRACE system closes, a member is permitted to report the transaction the next business day that the TRACE system opens, but must do so within 45 minutes after the TRACE system opens for the report to be timely.2 Under Rule 6230(a)(2) as amended, a member is required to report a transaction that occurs after the TRACE system closes the next business day that the TRACE system opens, and must do so within 45 minutes after the TRACE system opens. Similarly, under paragraphs (a)(3) and (a)(4) as amended, a member is required to report on the next business day that the TRACE system opens, and within 45 minutes of the TRACE system open, any transaction in a TRACE-eligible security that occurs at or after 12:00 a.m. (midnight) through 7:59:59 a.m., Eastern Time, or during a weekend or a holiday

    Effective Date

    The amendments to Rule 6230 will become effective on October 1, 2003. Based on current reporting practices, it appears that many members are already technically and operationally capable of reporting within 45 minutes. By October 1, 2003, NASD expects that the membership as a whole will be able to report within 45 minutes, and intends to guide members in making the transition.


    1 See Securities Exchange Act Release No. 48056 (June 18, 2003), 68 Fed. Reg. 37886 (June 25, 2003) (File No. SR-NASD-2003-78).

    2 Generally, the TRACE System is open to receive reports Monday through Friday, from 8:00 a.m. through 6:29:59 p.m., Eastern Time.


    Exhibit A

    6200. TRADE REPORTING AND COMPLIANCE ENGINE (TRACE)

    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]45 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 45[one hour and fifteen] minutes of the time of execution. If a transaction is executed on a business day less than 45[one hour and fifteen] minutes before 6:30 p.m. Eastern Time, a member may report the transaction the next business day within 45[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 45[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 45[one hour and fifteen] 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 45[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) through (6) No Change
    (b) through (f) No Change

  • 03-35 SEC Approves NASD Rule Change Giving NASD Authority to Issue and Enforce Temporary Cease and Desist Orders

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    INFORMATIONAL

    Temporary Cease and Desist Orders

    SUGGESTED ROUTING

    KEY TOPICS

    Legal & Compliance
    Senior Management

    Cease and Desist Proceedings and Orders

    Executive Summary

    On May 23, 2003, the Securities and Exchange Commission (SEC) approved an NASD proposed rule change that gives NASD the authority to impose and enforce temporary cease and desist orders for alleged violations of specified securities laws and NASD rules.1 The rule change also makes explicit NASD's authority to impose and enforce permanent cease and desist orders as a remedy in disciplinary cases. The SEC approved the rule change on a trial basis for a two-year period.2 The new rule text is contained in Attachment A and is effective as of the date of this Notice to Members (Notice).

    Questions/Further Information

    Questions regarding this Notice may be directed to James S. Wrona, Associate General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8270.

    Background

    In the past, NASD rules did not provide NASD staff with the means to respond rapidly to curtail certain types of serious misconduct by NASD members and associated persons. NASD's only means of addressing such situations was to prosecute a normal disciplinary action, a process that could take months to complete. In some instances, members or associated persons continued to engage in misconduct during the interim. In others, the members' or associated persons' financial condition significantly deteriorated.

    In either case, there was a significant risk that the investing public could be further harmed while the disciplinary action was adjudicated.

    The rule change described in this Notice will allow NASD to address such situations quickly and effectively. It establishes procedures that enable NASD to issue temporary cease and desist orders and makes explicit NASD's ability to impose permanent cease and desist orders as a remedy in disciplinary cases. The rule change also gives NASD authority to initiate non-summary proceedings when respondents violate temporary or permanent cease and desist orders. The rule change will expire in two years from the date of this Notice unless it is renewed by NASD with SEC approval.

    The rule change includes a number of procedural checks and safeguards to ensure that cease and desist proceedings are used prudently, sparingly, and fairly. NASD, for instance, may institute such proceedings only with the written authorization of the President of NASD Regulatory Policy and Oversight or the Executive Vice President for NASD Regulatory Policy and Programs. This provision ensures that such decisions are made at the highest NASD staff levels. In addition, NASD may initiate temporary cease and desist proceedings only for alleged violations of specified securities laws and NASD rules.3

    After the President or Executive Vice President authorizes the initiation of a temporary cease and desist proceeding, NASD's prosecuting staff must file a notice with NASD's Office of Hearing Officers (OHO) and serve it on the respondent. The notice must set forth the rule or law that NASD staff alleges the respondent has violated (or is violating), contain a declaration of facts that specifies the acts or omissions that constitute the alleged violation, and include a proposed order that contains the required elements of a temporary cease and desist order. In addition, if NASD staff has not already issued a complaint under NASD Rule 9211 against the respondent relating to the subject matter of the temporary cease and desist proceeding, NASD staff must serve the complaint with the notice initiating the temporary cease and desist proceeding.

    Respondents also are entitled to a hearing before an OHO hearing panel prior to the issuance of a cease and desist order. Moreover, before a hearing panel can issue such an order, it must find, by a preponderance of the evidence, that the respondent committed the alleged violation and that the violative conduct, or its continuation, is likely to result in significant dissipation or conversion of assets or other significant harm to investors prior to the completion of the disciplinary proceeding under the Rule 9200 and 9300 Series.

    If the hearing panel issues a temporary cease and desist order, the order will generally remain in effect until the conclusion of the underlying disciplinary proceeding. Furthermore, in any disciplinary proceeding for which a temporary cease and desist order has been issued, the hearing in the companion disciplinary matter will be held and the decision issued at the earliest possible time. If a respondent believes the companion disciplinary proceeding is not being conducted on an expedited basis, the respondent may petition the hearing panel to have the order modified, set aside, limited, or suspended. In addition, the respondent may seek to challenge a temporary cease and desist order by filing an application for review with the SEC pursuant to Section 19 of the Securities Exchange Act of 1934.4

    The rule change also provides hearing panels the explicit authority to issue permanent cease and desist orders as a remedy in disciplinary proceedings. In addition, the rule change provides NASD with a mechanism to enforce both temporary and permanent cease and desist orders. NASD may suspend or cancel a respondent's membership or association if, after a non-summary proceeding under the Rule 9510 Series, an OHO hearing panel determines that the respondent violated the cease and desist order.5

    In sum, this rule change provides NASD with a mechanism to take appropriate remedial action against a member or an associated person that has engaged (or is engaging) in violative conduct that could cause continuing harm to the investing public if not addressed expeditiously. At the same time, the rule change contains numerous procedural protections for respondents to ensure that the proceedings are fair.


    1 Exchange Act Release No. 47925 (May 23, 2003) (File No. SR-NASD-98-80), 68 Federal Register 33548 (June 4, 2003). The rule change authorizes NASD to initiate cease and desist proceedings for alleged violations of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder; Rules 15g-1 through 15g-9 under the Exchange Act; or NASD Rules 2110, 2120 or 2330. With regard to alleged violations of NASD rules, the rule change is further limited. For NASD Rule 2110, governing standards of commercial honor and just and equitable principles of trade, the alleged violations are limited to violations of Section 17(a) of the Securities Act of 1933 or circumstances involving unauthorized trading or misuse or conversion of customer assets. For NASD Rule 2330, governing members' use of customers' securities or funds, the alleged violations are limited to circumstances involving misuse or conversion of customer assets.

    2 The temporary cease and desist order pilot will expire two years after the effective date indicated in this Notice to Members unless NASD seeks and obtains SEC approval to extend or permanently adopt the proposal.

    3 See supra note 1.

    4 A respondent's application to challenge an order, however, will not stay the effectiveness of the order, unless the SEC orders otherwise.

    5 The President of NASD Regulatory Policy and Oversight or the Executive Vice President for NASD Regulatory Policy and Programs must provide written authorization before NASD prosecuting staff can institute a proceeding to suspend or cancel a respondent's association or membership for violating an order.


    Attachment A

    New language is underlined and deletions are in brackets.

    Text of Rule Change

    Sanctions

    8310. Sanctions for Violation of the Rules

    (a) Imposition of Sanction

    After compliance with the Rule 9000 Series, the Association may impose one or more of the following sanctions on a member or person associated with a member for each violation of the federal securities laws, rules or regulations thereunder, the rules of the Municipal Securities Rulemaking Board, or Rules of the Association, or may impose one or more of the following sanctions on a member or person associated with a member for any neglect or refusal to comply with an order, direction, or decision issued under the Rules of the Association:
    (1) through (4) No Change.
    (5) suspend or bar a member or person associated with a member from association with all members; [or]
    (6) [impose any other fitting sanction.] impose a temporary or permanent cease and desist order against a member or a person associated with a member; or
    (7) impose any other fitting sanction.
    (b) No Change.

    IM-8310-2. Release of Disciplinary Information

    (a) through (c) No Change.
    (d)
    (1) The Association shall release to the public information with respect to any disciplinary decision issued pursuant to the Rule 9000 Series imposing a suspension, cancellation or expulsion of a member; or suspension or revocation of the registration of a person associated with a member; or suspension or barring of a member or person associated with a member from association with all members; or imposition of monetary sanctions of $10,000 or more upon a member or person associated with a member; or containing an allegation of a violation of a Designated Rule; and may also release such information with respect to any disciplinary decision or group of decisions that involve a significant policy or enforcement determination where the release of information is deemed by the President of NASD Regulation, Inc. to be in the public interest. The Association also may release to the public information with respect to any disciplinary decision issued pursuant to the Rule 8220 Series imposing a suspension or cancellation of the member or a suspension of the association of a person with a member, unless the National Adjudicatory Council determines otherwise. The National Adjudicatory Council may, in its discretion, determine to waive the requirement to release information with respect to a disciplinary decision under those extraordinary circumstances where the release of such information would violate fundamental notions of fairness or work an injustice. The Association also shall release to the public information with respect to any temporary cease and desist order issued pursuant to the Rule 9800 Series. The Association may release to the public information on any other final, litigated, disciplinary decision issued pursuant to the Rule 8220 Series or Rule 9000 Series, not specifically enumerated in this paragraph, regardless of sanctions imposed, so long as the names of the parties and other identifying information is redacted.
    (A) through (B) No Change.
    (2) No Change.
    (e) through (l) No Change.

    9120. Definitions

    (a) through (w) No Change.
    (x) "Party"

    With respect to a particular proceeding, the term "Party" means:

    in the Rule 9200 Series, [and] the Rule 9300 Series, and the Rule 9800 Series, the Department of Enforcement or the Department of Market Regulation or a Respondent;
    (2) No Change.
    (y) through (cc) No Change.

    9240. Pre-Hearing Conference and Submission

    9241. Pre-Hearing Conference

    (a) through (b) No Change.
    (c) Subjects to be Discussed

    At a pre-hearing conference, the Hearing Officer shall schedule an expedited proceeding as required by Rule 9290, and may consider and take action with respect to any or all of the following:
    (1) through (10) No Change.
    (d) through (f) No Change.

    9290. Expedited Disciplinary Proceedings

    For any disciplinary proceeding, the subject matter of which also is subject to a temporary cease and desist proceeding initiated pursuant to Rule 9810 or a temporary cease and desist order, hearings shall be held and decisions shall be rendered at the earliest possible time. An expedited hearing schedule shall be determined at a pre-hearing conference held in accordance with Rule 9241.

    9310. Appeal to or Review by National Adjudicatory Council

    9311. Appeal by Any Party; Cross-Appeal

    (a) No Change.
    (b) Effect

    An appeal to the National Adjudicatory Council from a decision issued pursuant to Rule 9268 or Rule 9269 shall operate as a stay of that decision until the National Adjudicatory Council issues a decision pursuant to Rule 9349 or, in cases called for discretionary review by the NASD Board, until a decision is issued pursuant to Rule 9351. Any such appeal, however, will not stay a decision, or that part of a decision, that imposes a permanent cease and desist order.
    (c) through (f) No Change.

    9312. Review Proceeding Initiated By National Adjudicatory Council

    (a) No Change.
    (b) Effect

    Institution of review by a member of the National Adjudicatory Council on his or her own motion, a member of the Review Subcommittee on his or her own motion, or the General Counsel, on his or her own motion, shall operate as a stay of a final decision issued pursuant to Rule 9268 or Rule 9269 as to all Parties subject to the notice of review, until the National Adjudicatory Council issues a decision pursuant to Rule 9349, or, in cases called for discretionary review by the NASD Board, until a decision is issued pursuant to Rule 9351. Institution of any such review, however, will not stay a decision, or that part of a decision, that imposes a permanent cease and desist order.
    (c) through (d) No Change.

    9360. Effectiveness of Sanctions

    Unless otherwise provided in the decision issued under Rule 9349 or Rule 9351, a sanction (other than a bar, [or] an expulsion, or a permanent cease and desist order) specified in a decision constituting final disciplinary action of the Association for purposes of SEC Rule 19d-1(c)(1) shall become effective on a date to be determined by Association staff. A bar, [or] an expulsion, or a permanent cease and desist order shall become effective upon service of the decision constituting final disciplinary action of the Association, unless otherwise specified therein. The Association shall serve the decision on a Respondent by courier, facsimile or other means reasonably likely to obtain prompt service when the sanction is a bar, [or] an expulsion, or a permanent cease and desist order.

    9511. Purpose and Computation of Time

    (a) Purpose

    The Rule 9510 Series sets forth procedures for: (1) summary proceedings authorized by Section 15A(h)(3) of the Act; and (2) non-summary proceedings to impose (A) a suspension or cancellation for failure to comply with an arbitration award or a settlement agreement related to an arbitration or mediation pursuant to Article VI, Section 3 of the NASD By-Laws; (B) a suspension or cancellation of a member, or a limitation or prohibition on any member, associated person, or other person with respect to access to services offered by the Association or a member thereof, if the Association determines that such member or person does not meet the qualification requirements or other prerequisites for such access or such member or person cannot be permitted to continue to have such access with safety to investors, creditors, members, or the Association; [or] (C) an advertising pre-use filing requirement; or (D) a suspension or cancellation of the membership of a member or the registration of a person for failure to comply with a permanent cease and desist order entered pursuant to a decision issued under the Rule 9200 Series or Rule 9300 Series or a temporary cease and desist order entered pursuant to a decision issued under the Rule 9800 Series.
    (b) No Change.

    9513. Initiation of Non-Summary Proceeding

    (a) Notice

    Association staff may initiate a proceeding authorized under Rule 9511(a)(2)(A) or (B), by issuing a written notice to the member, associated person, or other person. Association staff may initiate a proceeding authorized under Rule 9511(a)(2)(D), after receiving written authorization from the President of NASD Regulatory Policy and Oversight or the Executive Vice President for NASD Regulatory Policy and Programs, by issuing a written notice to the member or associated person. The notice shall specify the grounds for and effective date of the cancellation, suspension, bar, limitation, or prohibition and shall state that the member, associated person, or other person may file a written request for a hearing under Rule 9514. In addition, if the proceeding is authorized under Rule 9511(a)(2)(D), the notice shall specifically identify the provision of the permanent or temporary cease and desist order that is alleged to have been violated, and shall contain a statement of facts specifying the alleged violation. The notice shall be served by facsimile or overnight commercial courier.
    (b) Effective Date

    For any cancellation or suspension pursuant to Rule 9511(a)(2)(A), the effective date shall be at least 15 days after service of the notice on the member or associated person. For any action pursuant to Rule 9511(a)(2)(B) or (D), the effective date shall be at least seven days after service of the notice on the member or person, except that the effective date for a notice of a limitation or prohibition on access to services offered by the Association or a member thereof with respect to services to which the member, associated person, or other person does not have access shall be upon receipt of the notice.
    (c) No Change.

    9800. TEMPORARY CEASE AND DESIST ORDERS

    (The entire Rule 9800 Series, and related amendments adopted by SR-NASD-98-80 to Rule 8310, IM-8310-2(d)(1), 9120(x), 9241(c), 9290, 9311(b), 9312(b), 9360, 9511(a), 9513(a) and 9513(b) shall expire on June 23, 2005, unless extended or permanently adopted by the Association pursuant to SEC approval at or before such date.)

    9810. Initiation of Proceeding

    (a) Department of Enforcement or Department of Market Regulation

    With the prior written authorization of the President of NASD Regulatory Policy and Oversight or the Executive Vice President for NASD Regulatory Policy and Programs, the Department of Enforcement or the Department of Market Regulation may initiate a temporary cease and desist proceeding with respect to alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 thereunder; SEC Rules 15g-1 through 15g-9; NASD Rule 2110 (if the alleged violation is unauthorized trading, or misuse or conversion of customer assets, or based on violations of Section 17(a) of the Securities Act of 1933); NASD Rule 2120; or NASD Rule 2330 (if the alleged violation is misuse or conversion of customer assets). The Department of Enforcement or the Department of Market Regulation shall initiate the proceeding by serving a notice on a member or associated person (hereinafter "Respondent") and filing a copy thereof with the Office of Hearing Officers. The Department of Enforcement or the Department of Market Regulation shall serve the notice by personal service, overnight commercial courier, or facsimile. If service is made by facsimile, the Department of Enforcement or the Department of Market Regulation shall send an additional copy of the notice by overnight commercial courier. The notice shall be effective upon service.
    (b) Contents of Notice

    The notice shall set forth the rule or statutory provision that the Respondent is alleged to have violated and that the Department of Enforcement or the Department of Market Regulation is seeking to have the Respondent ordered to cease violating. The notice also shall state whether the Department of Enforcement or the Department of Market Regulation is requesting the Respondent to be required to take action or to refrain from taking action. The notice shall be accompanied by:
    (1) a declaration of facts, signed by a person with knowledge of the facts contained therein, that specifies the acts or omissions that constitute the alleged violation; and
    (2) a proposed order that contains the required elements of a temporary cease and desist order (except the date and hour of the order's issuance), which are set forth in Rule 9840(b).
    (c) Filing of Underlying Complaint

    If the Department of Enforcement or the Department of Market Regulation has not issued a complaint under Rule 9211 against the Respondent relating to the subject matter of the temporary cease and desist proceeding and alleging violations of the rule or statutory provision specified in the notice described in paragraph (b), the Department of Enforcement or the Department of Market Regulation shall serve and file such a complaint with the notice initiating the temporary cease and desist proceeding.

    9820. Appointment of Hearing Officer and Hearing Panel

    (a) As soon as practicable after the Department of Enforcement or the Department of Market Regulation files a copy of the notice initiating a temporary cease and desist proceeding with the Office of Hearing Officers, the Chief Hearing Officer shall assign a Hearing Officer to preside over the temporary cease and desist proceeding. The Chief Hearing Officer shall appoint two Panelists to serve on a Hearing Panel with the Hearing Officer. The Panelists shall be current or former Governors, Directors, or National Adjudicatory Council members, and at least one Panelist shall be an associated person.
    (b) If at any time a Hearing Officer or Hearing Panelist determines that he or she has a conflict of interest or bias or circumstances otherwise exist where his or her fairness might reasonably be questioned, or if a Party files a motion to disqualify a Hearing Officer or Hearing Panelist, the recusal and disqualification proceeding shall be conducted in accordance with Rules 9233 and 9234, except that:
    (1) a motion seeking disqualification of a Hearing Officer or Hearing Panelist must be filed no later than 5 days after the later of the events described in paragraph (b) of Rules 9233 and 9234; and
    (2) the Chief Hearing Officer shall appoint a replacement Panelist using the criteria set forth in paragraph (a) of this Rule.

    9830. Hearing

    (a) When Held

    The hearing shall be held not later than 15 days after service of the notice and filing initiating the temporary cease and desist proceeding, unless otherwise extended by the Hearing Officer with the consent of the Parties for good cause shown. If a Hearing Officer or Hearing Panelist is recused or disqualified, the hearing shall be held not later than five days after a replacement Hearing Officer or Hearing Panelist is appointed.
    (b) Service of Notice of Hearing

    The Office of Hearing Officers shall serve a notice of date, time, and place of the hearing on the Department of Enforcement or the Department of Market Regulation and the Respondent not later than seven days before the hearing, unless otherwise ordered by the Hearing Officer. Service shall be made by personal service, overnight commercial courier, or facsimile. If service is made by facsimile, the Office of Hearing Officers shall send an additional copy of the notice by overnight commercial courier. The notice shall be effective upon service.
    (c) Authority of Hearing Officer

    The Hearing Officer shall have authority to do all things necessary and appropriate to discharge his or her duties as set forth under Rule 9235.
    (d) Witnesses

    A person who is subject to the jurisdiction of the Association shall testify under oath or affirmation. The oath or affirmation shall be administered by a court reporter or a notary public.
    (e) Additional Information

    At any time during its consideration, the Hearing Panel may direct a Party to submit additional information. Any additional information submitted shall be provided to all Parties at least one day before the Hearing Panel renders its decision.
    (f) Transcript

    The hearing shall be recorded by a court reporter and a written transcript thereof shall be prepared. A transcript of the hearing shall be available to the Parties for purchase from the court reporter at prescribed rates. A witness may purchase a copy of the transcript of his or her own testimony from the court reporter at prescribed rates. Proposed corrections to the transcript may be submitted by affidavit to the Hearing Panel within a reasonable time determined by the Hearing Panel. Upon notice to all the Parties to the proceeding, the Hearing Panel may order corrections to the transcript as requested or sua sponte.
    (g) Record and Evidence Not Admitted

    The record shall consist of the notice initiating the proceeding, the declaration, and the proposed order described in Rule 9810(b); the transcript of the hearing; all evidence considered by the Hearing Panel; and any other document or item accepted into the record by the Hearing Officer or the Hearing Panel. The Office of Hearing Officers shall be the custodian of the record. Proffered evidence that is not accepted into the record by the Hearing Panel shall be retained by the custodian of the record until the date when the NASD's decision becomes final or, if applicable, upon the conclusion of any review by the Commission or the federal courts.
    (h) Failure to Appear at Hearing

    If a Respondent fails to appear at a hearing for which it has notice, the allegations in the notice and accompanying declaration may be deemed admitted, and the Hearing Panel may issue a temporary cease and desist order without further proceedings. If the Department of Enforcement or Department of Market Regulation fails to appear at a hearing for which it has notice, the Hearing Panel may order that the temporary cease and desist proceeding be dismissed.

    9840. Issuance of Temporary Cease and Desist Order by Hearing Panel

    (a) Basis for Issuance

    The Hearing Panel shall issue a written decision stating whether a temporary cease and desist order shall be imposed. The Hearing Panel shall issue the decision not later than ten days after receipt of the hearing transcript, unless otherwise extended by the Hearing Officer with the consent of the Parties for good cause shown. A temporary cease and desist order shall be imposed if the Hearing Panel finds:
    (1) by a preponderance of the evidence that the alleged violation specified in the notice has occurred; and
    (2) that the violative conduct or continuation thereof is likely to result in significant dissipation or conversion of assets or other significant harm to investors prior to the completion of the underlying disciplinary proceeding under the Rule 9200 and 9300 Series.
    (b) Content, Scope, and Form of Order

    A temporary cease and desist order shall:
    (1) be limited to ordering a Respondent to cease and desist from violating a specific rule or statutory provision, and, where applicable, to ordering a Respondent to cease and desist from dissipating or converting assets or causing other harm to investors;
    (2) set forth the alleged violation and the significant dissipation or conversion of assets or other significant harm to investors that is likely to result without the issuance of an order;
    (3) describe in reasonable detail the act or acts the Respondent is to take or refrain from taking; and
    (4) include the date and hour of its issuance.
    (c) Duration of Order

    A temporary cease and desist order shall remain effective and enforceable until the issuance of a decision under Rule 9268 or Rule 9269.
    (d) Service

    The Office of Hearing Officers shall serve the Hearing Panel's decision and any temporary cease and desist order by personal service, overnight commercial courier, or facsimile. If service is made by facsimile, the Office of Hearing Officers shall send an additional copy of the Hearing Panel's decision and any temporary cease and desist order by overnight commercial courier. The temporary cease and desist order shall be effective upon service.

    9850. Review by Hearing Panel

    At any time after the Office of Hearing Officers serves the Respondent with a temporary cease and desist order, a Party may apply to the Hearing Panel to have the order modified, set aside, limited, or suspended. The application shall set forth with specificity the facts that support the request. The Hearing Panel shall respond to the request in writing within ten days after receipt of the request, unless otherwise extended by the Hearing Officer with the consent of the Parties for good cause shown. The Hearing Panel's response shall be served on the Respondent via personal service, overnight commercial courier, or facsimile. If service is made by facsimile, the Office of Hearing Officers shall send an additional copy of the temporary cease and desist order by overnight commercial courier. The filing of an application under this Rule shall not stay the effectiveness of the temporary cease and desist order.

    9860. Violation of Temporary Cease and Desist Orders

    A Respondent who violates a temporary cease and desist order imposed under this Rule Series may have its association or membership suspended or canceled under the Rule 9510 Series. The President of NASD Regulatory Policy and Oversight or the Executive Vice President for NASD Regulatory Policy and Programs must authorize the initiation of any such proceeding in writing.

    9870. Application to Commission for Review

    Temporary cease and desist orders issued pursuant to this Rule Series constitute final and immediately effective disciplinary sanctions imposed by the Association. The right to have any action under this Rule Series reviewed by the Commission is governed by Section 19 of the Exchange Act. The filing of an application for review shall not stay the effectiveness of the temporary cease and desist order, unless the Commission otherwise orders.

  • 03-34 Treasury and SEC Issue Final Rule Regarding Customer Identification Programs for Broker/Dealers

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    INFORMATIONAL

    Anti-Money Laundering Customer Identification Programs for Broker/Dealers

    Effective Date: October 1, 2003

    SUGGESTED ROUTING

    KEY TOPICS

    Legal & Compliance
    Operations
    Registration
    Senior Management

    Anti-Money Laundering
    Compliance Programs

    Executive Summary

    On April 30, 2003, the Department of Treasury (Treasury) and the Securities and Exchange Commission (SEC or Commission) jointly issued a final rule to implement Section 326 of the USA PATRIOT Act (PATRIOT Act).1 Section 326 provides that Treasury and SEC issue a rule that, at a minimum, requires broker/dealers to implement reasonable procedures to: (1) verify the identity of any person seeking to open an account, to the extent reasonable and practicable; (2) maintain records of the information used to verify the person's identity; and (3) determine whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided to brokers or dealers by any government agency. The final rule requires each broker/dealer to establish a written Customer Identification Program (CIP) to verify the identity of each customer who opens an account. The written CIP must also include recordkeeping procedures and procedures for providing customers with notice that the broker/dealer is requesting information to verify their identity. Broker/dealers must fully implement their CIPs by October 1, 2003.

    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

    On October 26, 2001, President Bush signed into law the PATRIOT Act. Title III of the PATRIOT 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 these obligations, broker/dealers were required to have an AML compliance program in place as of April 24, 2002. Consistent with this requirement under the PATRIOT Act, NASD Rule 3011 requires each member, to develop and implement a written AML program reasonably designed to achieve and monitor the member's compliance with the requirements of the BSA and the implementing regulations.

    On July 23, 2002, Treasury and the SEC jointly proposed a rule to implement Section 326 of the PATRIOT Act with respect to broker/dealers. The SEC received 20 comment letters in response to the proposal. Members of the industry questioned, among other things, the proposed rule's definition of "customer," which included persons with trading authority over an account. Others expressed concern about the verification and recordkeeping requirements. The final rule addresses many of the comments.

    Description of Final Rule

    Relevant Definitions

    The final rule provides several definitions, which, among other things, assist members in determining who are the relevant persons whose identities need to be verified.

    1. Account. The final rule defines an "account" as a formal relationship with a broker/dealer established to effect transactions in securities, including, but not limited to, the purchase or sale of securities, securities loaned and borrowed activity, and the holding of securities or other assets for safekeeping or as collateral.2

    Importantly, the final rule contains two exclusions from the definition of "account." The definition excludes: (a) an account that the broker/dealer acquires through any acquisition, merger, purchase of assets, or assumption of liabilities;3 and (b) an account opened for the purpose of participating in an employee benefit plan established under the Employee Retirement Income Security Act of 1974 ("ERISA").4

    The Adopting Release explains that in acquisitions, mergers, purchases of assets, or assumptions of liabilities, customers do not initiate these transfers and, therefore, the accounts do not fall within the scope of Section 326 of the PATRIOT Act.5

    In addition, transfers of accounts that result from an introducing broker/dealer changing its clearing firm would fall within this exclusion.6

    As initially proposed, the definition of "account" contained several examples of types of accounts that would be covered including cash accounts, margin accounts, prime brokerage accounts, and accounts established to engage in securities repurchase transactions. The Adopting Release notes that these types of accounts remain "accounts" for purposes of the final rule, but the final rule does not specifically include them as examples to clarify that the list is not exhaustive.
    2. Broker/dealer. "Broker/dealer" is defined as a person registered or required to be registered as a broker or dealer with the Commission under the Securities Exchange Act of 1934 (Exchange Act) except persons who are required to be registered solely because they effect transactions in security futures products.7
    3. Customer. The final rule defines "customer" as: (a) a person that opens a new account; and (b) an individual who opens a new account for an individual who lacks legal capacity or for an entity that is not a legal person.8

    Under this definition, "customer" does not refer to persons who fill out account opening paperwork or who provide information necessary to set up an account, if such persons are not the accountholder as well.

    In addition, the Adopting Release addresses concerns about identity verification in situations involving trust and omnibus accounts. The release explains that a broker/dealer is not required to look through a trust or similar account to its beneficiaries, and is required only to verify the identity of the named accountholder.9 Similarly, with respect to an omnibus account established by an intermediary, a broker/dealer is not required to look through the intermediary to the underlying beneficial owners, if the intermediary is identified as the accountholder.10

    As noted above, the proposed rule required that the broker/dealer verify the identity of those with trading authority over an account. The final rule, however, does not include persons with trading authority over accounts in the definition of "customer." Accordingly, the broker/dealer does not have to verify those individuals' identities. However, the final rule recognizes that situations may arise where a broker/dealer will have to take extra steps to verify the identity of those with trading authority. In these instances, a CIP is required to address situations where the broker/dealer will take additional steps to verify the identity of a customer that is not an individual by seeking information about individuals with authority or control over the account in order to verify the customer's identity.11

    The final rule's definition also contains additional exclusions. The following entities are excluded from the definition of "customer":

    • A person that has an existing account with the broker/dealer, provided the broker/dealer has a reasonable belief that it knows the true identity of the person;


    • A financial institution regulated by a Federal functional regulator (the definitions of which are discussed below in numbers 4 and 5 of this section);


    • Banks regulated by a state bank regulator;


    • A department or agency of the United States, of any State, or of any political subdivision of any State;


    • Any entity established under the laws of the United States, of any state, or of any political subdivision of any state, or under an interstate compact between two or more states, that exercises governmental authority on behalf of the United States or any such state or political subdivision; or


    • Any entity, other than a bank, whose common stock or analogous equity interests are listed on the New York Stock Exchange or the American Stock Exchange or whose common stock or analogous equity interests have been designated as a NASDAQ National Market Security listed on The NASDAQ Stock Market (except stock or interests listed under the separate "NASDAQ Small-Cap Issues" heading), provided that, for purposes of this provision, a person that is a financial institution, other than a bank, is an exempt person only to the extent of its domestic operations.

    4. Federal functional regulator. "Federal functional regulator" is defined as: the SEC; the Commodity Futures Trading Commission; the Board of Governors of the Federal Reserve System; the Office of the Comptroller of the Currency; the Board of Directors of the Federal Deposit Insurance Corporation; the Office of Thrift Supervision; or the National Credit Union Administration.12
    5. Financial Institution. "Financial Institution" is defined to include: an insured bank (as defined in section 3(h) of the Federal Deposit Insurance Act (12 U.S.C. 1813(h))); a commercial bank or trust company; a private banker; an agency or branch of a foreign bank in the United States; an insured institution (as defined in section 401(a) of the National Housing Act, 12 U.S.C. 1724(a)); a thrift institution; a broker or dealer registered with the SEC under the Exchange Act; a broker or dealer in securities or commodities; an investment banker or investment company; a currency exchange; an issuer, redeemer, or cashier of travelers' checks, checks, money orders, or similar instruments; an operator of a credit card system; an insurance company; a dealer in precious metals, stones, or jewels; a pawnbroker; a loan or finance company; a travel agency; a licensed sender of money; a telegraph company; a business engaged in vehicle sales, including automobile, airplane, and boat sales; persons involved in real estate closings and settlements; the United States Postal Service; an agency of the United States Government or of a state or local government carrying out a duty or power of a business described in this paragraph; a casino, gambling casino, or gaming establishment with an annual gaming revenue of more than $1,000,000 which is licensed as a casino, gambling casino, or gaming establishment under the laws of any State or any political subdivision of any State; or is an Indian gaming operation conducted under or pursuant to the Indian Gaming Regulatory Act other than an operation which is limited to class I gaming (as defined in section 4(6) of such Act); any business or agency which engages in any activity which the Secretary of the Treasury determines, by regulation, to be an activity which is similar to, related to, or a substitute for any activity in which any business described in this paragraph is authorized to engage; or any other business designated by the Secretary whose cash transactions have a high degree of usefulness in criminal, tax, or regulatory matters.13
    6. Taxpayer identification number. "Taxpayer identification number" has 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 (e.g., social security number or employer identification number).14
    7. U.S. person. "U.S. person" means a United States citizen or a person other than an individual (such as a corporation, partnership or trust) that is established or organized under the laws of a State or the United States.15
    8. Non-U.S. person. "Non-U.S. person" means a person that is not a U.S. person.16

    Customer Identification Program

    Minimum Requirements

    The final rule requires that broker/dealers establish, document, and maintain a written CIP. This program must be appropriate for the firm's size and business, be part of the firm's anti-money laundering compliance program, and, at a minimum, must contain procedures for the following: identity verification, recordkeeping, comparison with government lists, and providing customer notice.17

    Required Customer Information

    A broker/dealer's CIP must contain procedures for opening an account that specifies the identifying information that will be obtained from each customer. The minimum identifying information that must be obtained from each customer prior to opening an account is:

    • A name;


    • A date of birth, for an individual;


    • An address, which will be:


      • For an individual, a residential or business street address;


      • For an individual who does not have a residential or business street address, an Army Post Office (APO) or Fleet Post Office (FPO) box number, or the residential or business street address of a next of kin or another contact individual; or


      • For a person other than an individual (such as a corporation, partnership, or trust), a principal place of business, local office, or other physical location; and


      • An identification number, which will be:

      • For a U.S. person, a taxpayer identification number; or


      • For a non-U.S. person, one or more of the following:


        • a 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.18

    Treasury and the SEC adopted the required customer information provisions substantially as proposed with changes to accommodate individuals who may not have physical addresses. The Adopting Release notes that the minimum required information is collected by most broker/dealers already, is necessary for the verification process, and serves an important law enforcement function. With respect to non-U.S. persons, the final rule contains some flexibility in the identification number requirement because a firm can choose from a variety of information numbers to accept from a non-U.S. person. In this regard, the Adopting Release states that there is no uniform identification number that non-U.S. persons would be able to provide to a broker/dealer. Nevertheless, whatever identifying information the firm does accept must enable the firm to form a reasonable belief that it knows the true identity of a customer.19

    Exception for Persons Applying for a Taxpayer Identification Number

    The proposed rule allowed broker/dealers to open an account for a new business that applied for, but had not received, a taxpayer identification number. The final rule expanded the exception in the proposed rule to include natural persons who have applied for, but not received, a taxpayer identification number. Therefore, instead of obtaining a taxpayer identification number from a cu